{"filename":"14920_1994.txt","cik":"14920","year":"1994","section_1":"Item 1. Business.\nGeneral\nBruno's, Inc. (\"Bruno's\" or the \"Company\"), a corporation organized in 1959 under the laws of the State of Alabama, is a leading regional supermarket retailer operating in the southeastern United States. The Company operates a total of 257 supermarkets and combination food and drug stores, of which 125 are located in Alabama, 90 in Georgia, 20 in Florida, 11 in Tennessee, 6 in Mississippi and 5 in South Carolina. The Company attempts to achieve high sales volume by offering a wide variety of nationally-advertised brands at prices equal to or below those of competing stores. The Company, through pricing, merchandising and promotion, attempts to achieve a first or second market share position in each market area in which it operates. The Company also operates eight liquor stores in Florida which are adjacent to supermarkets operated by the Company.\nThe Company operates conventional, discount and warehouse supermarkets and combination food and drug stores of various sizes, primarily under five separate store formats. The Company utilizes these different formats to enable it to vary its pricing strategy, store size, product mix, and decor and design to best suit the demographic conditions and competitive environment of each store location.\nThe Company's major formats include:\nFood World. The Company's 80 Food World supermarkets range in size from 30,000 to 60,000 square feet, and offer a wide selection of brand-name merchandise in a modern format that includes expanded specialty departments. These supermarkets advertise everyday low prices on television, radio and in newspapers in an effort to draw customers from a wide area around each location.\nFood Max. The Company's 50 Food Max stores are large \"superwarehouse\" stores emphasizing an open warehouse appearance with modern decor and ranging in size from 34,000 to 75,000 square feet. In addition to a wide selection of brand-name merchandise, these superwarehouse stores emphasize private label and generic merchandise, bulk foods, large delicatessens and expanded meat and produce departments. These stores, which achieve low overhead through reduced staffing, are promoted primarily through newspaper advertising and regularly offer unadvertised specials.\nFood Fair. The Company's 32 Food Fair supermarkets range in size from 21,000 to 42,000 square feet. These smaller supermarkets are designed to operate with a lower overhead and competitive pricing in areas that will not support the volume necessary for a larger supermarket. These stores are promoted primarily through newspaper and radio advertising. Bruno's Food and Pharmacy. The Company's 17 Bruno's Food and Pharmacy stores generally are located in markets with suburban shoppers who appreciate \"one-stop shopping\" and a wide range of merchandise. These combination stores range in size from 48,000 to 60,000 square feet and typically contain expanded produce, bakery and delicatessen departments, full service seafood and meat departments, a floral department, pharmacy, and a large selection of general merchandise. These stores carry specialty and gourmet foods generally not found in conventional supermarkets, as well as a variety of products normally found in large drug stores. Many also have in-store banking services. The Bruno's Food and Pharmacy stores are promoted primarily through newspaper advertising.\nPiggly Wiggly. The Company's 56 Piggly Wiggly stores are conventional supermarkets, ranging in size from 18,000 to 48,000 square feet and are typically located in medium to small towns all in central and southern Georgia. These Piggly Wiggly stores offer weekly specials on selected merchandise, store specials and double manufacturers' coupons. They are promoted primarily through newspaper advertising and printed circulars available in the stores.\nThe majority of the Company's other supermarkets operate under the names Bruno's Finer Foods (12 stores), Bruno's Super Center (5 stores), and Consumer Warehouse Foods (2 stores).\nAll of the Company's stores offer fresh produce, meat and poultry and a wide selection of groceries, including dairy and bakery products, frozen foods, soft drinks, health and beauty aids and a variety of other general merchandise customarily carried by supermarkets. Many of the Company's stores, including all of the Food World, Bruno's Food & Pharmacy, Bruno's Finer Foods, Bruno's Super Center and Food Max stores, have delicatessens and bakery departments. All of the Company's stores are air-conditioned, well-lighted, and equipped with modern fixtures and adjacent to off street parking facilities. All of the Company's stores are equipped with electronic scanning equipment except the Piggly Wiggly stores, of which the majority are so equipped. The Company varies the inventory in its stores to take into account seasonal changes in consumer demand.\nDistribution\nThe Company minimizes the square footage utilized for warehousing in each store in order to maximize the square footage available in each store to display merchandise for sale. Restocking of inventory is achieved primarily through the Company's warehouses. Each of the Company's stores receives frequent deliveries from the Company's distribution fleet of 153 tractors, 152 refrigerated trailers and 184 dry trailers. The approximately 1,375,000 square foot Birmingham warehouse, distribution center and executive headquarters are located on a 200-acre site. The Company-owned\nVidalia warehouse and distribution center is located in southeastern Georgia on a 90-acre site. The Birmingham warehouse utilizes a computerized inventory control and ordering system that is linked directly to the stores it serves. Approximately 26% of the Company's purchases, including beverages, tobacco products, milk, bread and snack foods, are supplied directly to the stores by local distributors. The Company believes that the existing warehouse capacity will be sufficient to serve all stores proposed to be opened during the next two years. The Company owns ample adjacent acreage for expansion thereafter. Generally, it is efficient to supply stores within a 300-mile radius of a distribution facility.\nExpansion\nThe Company has expanded through the development of individual stores and the acquisition of existing stores. The Company's expansion policy is to seek locations for new stores in areas believed to be capable of supporting a high level of sales volume. The Company plans to continue to expand through the development of new stores in Alabama and Georgia and in the surrounding southeastern states and may acquire existing stores or supermarket chains, if attractive opportunities become available. There are no current agreements or negotiations with respect to any acquisitions, and there can be no assurances that opportunities to make acquisitions will become available on terms deemed favorable by the Company or that the Company will be able to effect any acquisitions. During the past several years, the Company has emphasized the development of larger stores. The Company plans to open approximately 8 new stores during the current fiscal year and 10 new stores during the following year.\nThe following table sets forth certain statistical information with respect to the Company's supermarket operations for the fiscal years indicated.\nCompetition\nThe Company's business is highly competitive. In each of the markets in which the Company operates, it competes directly with a\nnumber of national and regional chains, as well as with various local chains and numerous single unit stores. Many items sold by the Company's combination stores also can be found in variety stores, discount stores, drug stores and department stores. The supermarket business is characterized by narrow profit margins and, accordingly, the Company's earnings depend primarily on the efficiency of its operations and on its ability to maintain a large sales volume. Competition among supermarkets and drug stores generally takes the form of price competition, store location, product selection and service performance. The Company believes that its policy of pricing its merchandise competitively with, and generally lower than, competing stores is an important competitive factor.\nThe number of competitors and the amount of competition experienced by the Company's stores varies from city to city and in various locations within cities. The main competitors of the Company are the supermarket chains operated by Winn-Dixie Stores, Inc., the Kroger Company, BiLo, Food Lion and Delchamps, Inc. Winn-Dixie Stores, Inc. competes with the Company throughout Alabama and Georgia, and the Kroger Company competes with the Company throughout Alabama, with the exception of the Birmingham, Montgomery and Mobile markets and certain parts of Georgia. BiLo and Food Lion compete with the Company throughout Georgia with the exception of Atlanta.\nEmployees\nAt July 2, 1994, the Company employed approximately 11,084 full time and 16,136 part-time employees. Of this number, approximately 25,553 are employed in the supermarkets and combination stores, 1,363 are employed in the warehousing operations and 304 are employed in the Company's business offices. Approximately 69% of such employees are covered under collective bargaining agreements. The Company believes that its relationship with its employees is good.\nThe Company has an incentive compensation plan covering its key purchasing, warehouse and management staff and with each district manager, store manager, co-manager and assistant manager in which their compensation is based upon the profitability of the operations within the scope of their management responsibility.\nOther Matters\nBruno's does not include industry segments. The Company's business is not seasonal to any material extent. No part of the business of Bruno's is dependent upon a single customer, or a few customers, the loss of any one of which would have a materially adverse effect upon the Company. Bruno's does not engage in any operations in foreign countries, nor is any portion of its sales or revenue derived from customers in any foreign countries.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nStore Properties\nAs of the end of the latest fiscal year, Bruno's leased 185 of its 257 food stores and seven of its eight liquor stores under standard commercial leases, no one of which is deemed to be materially important to the Company. All of these leases are long-term leases, generally with one or more renewal options. The Company generally owns the furniture and fixtures in each leased location, and has made various leasehold improvements in the store locations. Thirteen of the leases are with PM Associates, a joint venture owned 50% by a wholly-owned subsidiary of Bruno's and 50% by Metropolitan Life Insurance Company.\nAs of the end of the latest fiscal year, Bruno's owned 72 of its 257 food stores. Of these 72 stores, 48 are free-standing stores situated on tracts of land owned by Bruno's in various locations in Alabama and one store in Florida situated on leased land. In addition, 24 stores owned by the Company are located in shopping centers owned by Bruno's in various locations in Alabama, Tennessee and Georgia, with the remaining space in these shopping centers leased to commercial tenants. Bruno's also owns one shopping center in the Roebuck area of Birmingham, Alabama, in which the Company does not operate a store, with all space being leased to other commercial tenants.\nWarehouse Properties\nThe approximately 1,375,000 square foot Birmingham warehouse, distribution center and office complex is located on a 200-acre site in the Oxmoor West Industrial Park in Birmingham, Alabama. The Company leases the Birmingham warehouse from The Industrial Development Board of the City of Birmingham, pursuant to a lease entered into in connection with the issuance of industrial revenue bonds. The lease has a primary term of 20 years. Upon the expiration of the lease term, the Company has the right to purchase the entire property for nominal consideration.\nThe approximately 686,000 square foot Vidalia warehouse and distribution center, owned by the Company, is located on a 90-acre site owned by the Company in Vidalia, Georgia.\nThe Company owns four additional warehouses in the Birmingham area, located on two separate parcels of land owned by the Company, which warehouses were formerly used for its central warehouse facility prior to the completion of its new distribution center in May of 1986. The Company is using one of these additional warehouses and three are vacant. The Company intends to sell these warehouses whenever it locates a suitable purchaser and has written the carrying value of these assets down to the estimated net realizable values.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIn 1991, the Company received a favorable termination letter with respect to the termination of the employee pension plan of a supermarket chain acquired by the Company in 1989. Pursuant to that termination, distributions were made to all participants of that employee pension plan. After all of the benefit liabilities were paid, there remained a balance of $2,716,795 which was transferred to the Company as a reversion of excess pension assets. On June 15, 1992, the Company received a letter from the Pension Benefit Guaranty Corporation contending that inappropriate actuarial assumptions were used to determine the value of the employee's benefits distributed and that additional distributions must be made to numerous former participants of the said plan. It is impossible to quantify the extent of any liability at this time, if any, but any liability is not expected to exceed $2,716,795.\nExcept for this matter, there are no material, pending legal proceedings, other than ordinary, routine litigation incidental to the business, to which Bruno's 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.\nBruno's did not submit any matters to a vote of its security holders during the fourth quarter of its fiscal year ended July 2, 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 NASDAQ National Market System under the symbol BRNO. The following table sets forth, by fiscal quarter, the high and low sales prices, rounded to the nearest eighth, reported by the NASDAQ National Market System for the periods indicated.\nAs of September 7, 1994, there were approximately 8,077 holders of record of the Company's Common Stock.\nThe following table sets forth the dividends paid by Bruno's to its shareholders during the last two fiscal years. Bruno's intends to continue its policy of paying quarterly cash dividends. Future dividends will be dependent, however, upon the Company's earnings, financial requirements and other relevant factors.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information set forth under the caption \"Selected Financial Data\", appearing on page 23 of the Bruno's, Inc. Annual Report to Shareholders for the Fiscal Year Ended July 2, 1994, 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 the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", appearing on pages 24 through 26 of the Bruno's, Inc. Annual Report to Shareholders for the Fiscal Year Ended July 2, 1994, is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe Financial Statements appearing on pages 9 through 22, and the Unaudited Quarterly Financial Data appearing on page 27, of the Bruno's, Inc. Annual Report to Shareholders for the Fiscal Year Ended July 2, 1994, 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.\nThe information set forth under the captions \"NOMINEES\" and \"OFFICERS\", appearing in the Bruno's, Inc. Proxy Statement for the 1994 Annual Meeting of Shareholders dated September 16, 1994, is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information set forth under the captions \"BOARD OF DIRECTORS\" and \"COMPENSATION TO EXECUTIVE OFFICERS\", appearing in the Bruno's, Inc. Proxy Statement for the 1994 Annual Meeting of Shareholders dated September 16, 1994, 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 captions \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\" and \"NOMINEES\", appearing in the Bruno's, Inc. Proxy Statement for the 1994 Annual Meeting of Shareholders dated September 16, 1994, is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information set forth under the caption \"INTERESTS OF OFFICERS, DIRECTORS AND OTHERS IN CERTAIN TRANSACTIONS\", appearing in the Bruno's, Inc. Proxy Statement for the 1994 Annual Meeting of Shareholders dated September 16, 1994, 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\nThe following financial statements of the Company and report of independent public accountants are incorporated herein by reference to the Bruno's, Inc. Annual Report to Shareholders for the Fiscal Year Ended July 2, 1994:\nConsolidated Balance Sheets as of July 2, 1994, and July 3, 1993.\nConsolidated Statements of Income for Fiscal Years Ended July 2, 1994, July 3, 1993, and June 27, 1992.\nConsolidated Statements of Shareholders' Investment for Fiscal Years Ended July 2, 1994, July 3, 1993, and June 27, 1992.\nConsolidated Statements of Cash Flows for Fiscal Years Ended July 2, 1994, July 3, 1993, and June 27, 1992.\nNotes to Consolidated Financial Statements\nReport of Independent Public Accountants\nUnaudited Quarterly Financial Data\n2. Schedules to Financial Statements\nIndex to Schedules\nReport of Independent Public Accountants\nSchedule V - Property and Equipment\nSchedule VI - Reserves for Depreciation and Amortization of Property and Equipment\n3. Exhibits\nExhibit No. Description\n3(i) Certificate of Incorporation of the Company, and amendments thereto, incorporated by reference to Exhibit 3(a) to the Company's Annual Report on Form 10-K, dated September 24, 1990.\n1994, into this Form 10-K Annual Report and the Company's Form S-8 Registration Statement No. 2-81642.\n27 Financial Data Schedule\nBRUNO'S, INC. WILL FURNISH TO EACH SHAREHOLDER, UPON WRITTEN REQUEST, COPIES OF THE EXHIBITS REFERRED TO ABOVE AT A COST OF TEN CENTS PER PAGE. REQUESTS SHOULD BE ADDRESSED TO: GLENN J. GRIFFIN, ASSISTANT SECRETARY, BRUNO'S, INC., POST OFFICE BOX 2486, BIRMINGHAM, ALABAMA 35201.\n(b) No report on Form 8-K has been filed by Bruno's during the last quarter of the fiscal year ended July 2, 1994.\nBRUNO'S, INC. AND SUBSIDIARIES\nINDEX TO SCHEDULES\nJULY 2, 1994\nSchedules other than those listed above have been omitted since the information is not applicable, not required, or is included in the financial statements or notes thereto.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders of Bruno's, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in the BRUNO'S, INC. fiscal 1994 annual report to shareholders incorporated by reference in this Form l0-K, and have issued our report thereon dated July 29, 1994. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the accompanying index are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nBirmingham, Alabama July 29, 1994\nBRUNO'S, INC. AND SUBSIDIARIES\nSCHEDULE V -- PROPERTY AND EQUIPMENT\n(DOLLAR AMOUNTS IN THOUSANDS)\n(1) Leasehold improvements, investment in property under capital leases, and leasehold interests in the consolidated financial statements are net of the related reserves for amortization, as follows:\nBRUNO'S, INC. AND SUBSIDIARIES\nSCHEDULE VI--RESERVES FOR DEPRECIATION AND AMORTIZATION\nOF PROPERTY AND EQUIPMENT\n(DOLLAR AMOUNTS IN THOUSANDS)\n(1) The reserves for amortization of leasehold improvements, investment in property under capital leases and leasehold interests have been netted against the respective cost of leasehold improvements, investment in property under capital leases and leasehold interests in the consolidated financial statements (see reconciliation on Schedule V). A reconciliation of the reserves for depreciation, as reflected in the consolidated financial statements, are as follows:\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Bruno's, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBRUNO'S, INC.\nBy \/s\/ Ronald G. Bruno -------------------------------- Ronald G. Bruno, Chief Executive Officer and Chairman of the Board\nDATED: September 29, 1994\nBy \/s\/ Glenn J. Griffin -------------------------------- Glenn J. Griffin, Treasurer, Chief Financial Officer, Executive Vice President and Assistant Secretary\nDATED: September 29, 1994\nPursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"73945_1994.txt","cik":"73945","year":"1994","section_1":"Item 1. Business.\nThe Company\nThe Ohio Bell Telephone Company (Company), incorporated under the laws of the State of Ohio, has its principal office at 45 Erieview Plaza, Cleveland, Ohio 44114 (telephone number 216-822-9700). The Company is a wholly owned subsidiary of Ameritech Corporation (Ameritech), a Delaware Corporation. Ameritech is the parent of the Company; Illinois Bell Telephone Company; Indiana Bell Telephone Company, Incorporated; Michigan Bell Telephone Company and Wisconsin Bell, Inc. (referred to collectively as the \"Ameritech landline telephone subsidiaries\"), as well as several other communications businesses, and has its principal executive offices at 30 South Wacker Drive, Chicago, Illinois 60606 (telephone number 312-750-5000). The Company is a statutory close corporation managed by its sole shareowner rather than a Board of Directors as permitted by Ohio law.\n1994 was the first full year in which Ameritech operated its redesigned business within the framework of a customer-specific business unit strategy, delivering specialized services to various categories of customers, each with unique requirements. The functions of the business units, which include consumer, business, cellular, advertising and leasing services, as well as services provided to other companies in the telecommunications industry, overlap the legal entities, including the Company, which form the infrastructure of Ameritech. The products and services of all the business units are marketed under the \"Ameritech\" brand identity, but Ameritech's five landline telephone subsidiaries remain responsible within their respective service areas for providing phone and other telecommunications services, subject to regulation by the Federal Communications Commission (FCC) and the five respective state public utility commissions. The Company is regionally identified as Ameritech Ohio.\nOperations Under Line-of-Business Restrictions\nThe operations of the Company are subject to the requirements of a consent decree entitled \"Modification of Final Judgment\" (Consent Decree) approved by the United States District Court for the District of Columbia (Court) in August 1982. The Consent Decree arose out of antitrust litigation brought by the Department of Justice (DOJ) and required AT&T Corp. (AT&T), formerly named American Telephone and Telegraph Company, to divest itself of those assets relating to exchange telecommunications, exchange access functions, printed directories and cellular mobile communications. The Consent Decree, together with the Court approved Plan of Reorganization (Plan), outlined the method of divestiture and established restrictions on the post-divestiture activities of the seven regional holding companies (RHCs), including Ameritech, formed to receive AT&T's divested assets. Effective January 1, 1984, AT&T transferred to Ameritech its 100% ownership of the exchange telecommunications, exchange access and printed directory advertising portions of the Ameritech landline telephone subsidiaries, as well as a cellular mobile communications company.\nThe Consent Decree, as originally approved, prohibited the RHCs from providing long-distance telecommunications services or information services, manufacturing telecommunications equipment, or providing any product or service, except exchange telecommunications and exchange access service, that is not a natural monopoly service actually regulated by tariff. The Consent Decree allowed the RHCs to provide printed directory advertising and to provide, but not manufacture, customer premises equipment.\nOver time, the Court granted waivers to the RHCs to engage in otherwise prohibited lines of business upon a showing to the Court that there was no substantial possibility that the company could use its monopoly power to impede competition in the market it sought to enter. In decisions handed down in September 1987 and March 1988, the Court continued prohibitions relating to equipment manufacture and long-distance services. The rulings allowed limited provision of information services by transmission of information and provision of information gateways, but excluded generation or manipulation of information content. In addition, the rulings eliminated the need for a waiver for entry into non-telephone related businesses. In July 1991, the Court lifted the information services ban, but stayed the effect of the decision pending outcome of the appeals process. Soon after, the stay was lifted on appeal and in July 1993, the U.S. Court of Appeals unanimously upheld the Court's order allowing the RHCs to\nproduce and package information for sale across business and home phone lines. In November 1993, the U.S. Supreme Court declined to review the lower court ruling.\nIn July 1994, four of the RHCs (Ameritech was not a participant) filed a motion in the Court to vacate the entire Consent Decree. The filing was supported by numerous affidavits from consultants to the companies which largely suggested that RHC entry into restricted markets would not impede competition in those markets, but actually spur competition and result in lower prices for consumers. After a brief review by the Court, the matter was referred to the DOJ which has taken comments from interested parties as part of an extensive fact finding effort. The DOJ's recommendation is expected in late 1995 or early 1996. Ameritech is pursuing its own unique strategy to enter new businesses. Ameritech's Customers First plan is discussed in the section on Competition.\nSeveral bills have been introduced in Congress which have called for the modification or elimination of restrictions set by the Consent Decree. It is impossible for the Company to predict either the probability of passage or the impact of any new legislation on the business.\nThe Company furnishes a wide variety of advanced telecommunications services, including local exchange and toll service, network access and telecommunications products, in an operating area comprised of 5 Local Access and Transport Areas (LATAs) in Ohio. These LATAs are generally centered on a city or other identifiable community of interest, and each LATA marks the boundary within which the Company may provide telephone service. The Company provides two basic types of telecommunications services. First, it transports telecommunications traffic between a subscriber's equipment and the telephone exchange offices located within the same LATA (intraLATA service). These services include local exchange, private line and intraLATA toll services (including 800 and special services for data, radio and video transport). Second, it provides exchange access service, which links a subscriber's telephone or other equipment to the network of transmission facilities of long-distance carriers, which in turn provide telecommunications service between LATAs (interLATA, or long-distance, service).\nAbout 60% of the population and 25% of the area of Ohio is served by the Company. The remainder of the state is served by nonaffiliated telephone companies. About 80% of the Company's access lines in service are in, or adjacent to, six cities with populations in excess of 95,000, including the metropolitan area of Cleveland, where 30% of the access lines are located.\nThe Company provides billing and collection services for several companies, including billing for long-distance services offered by certain long-distance carriers. The Company also provides directory assistance, local and toll operator services, including collect calls, third number billing, person-to-person and calling card calls, and offers such digital network services as voice-mail, on-line database access and fax messaging, document sharing functions, and video-conferencing for desktop computers.\nThe following table sets forth the number of access lines served by the Company at the end of each of the last five years:\nThe Company has certain agreements with Ameritech Publishing, Inc. (API), an Ameritech subsidiary, under which API publishes and distributes classified directories under a license from the Company and provides services to the Company relating to both classified and alphabetical directories. API pays license fees to the Company under the agreements. API has provided notice to terminate these agreements effective December 31, 1995. The Company anticipates negotiating a subsequent agreement with API.\nAmeritech Services Inc. (ASI) is a company jointly owned by the Company and the other Ameritech landline telephone subsidiaries. ASI provides to those companies human resources, technical, marketing, regulatory planning, and real estate asset management services, purchasing and material management support, as well as labor contract bargaining oversight and coordination. ASI acts as a shared resource for the Ameritech subsidiaries providing operational support for the Ameritech landline telephone subsidiaries and integrated communications and information systems for all the business units.\nIn 1994, about 90% of the total operating revenues of the Company were from telecommunications services and the remainder principally from billing and collection services, rents, directory advertising and other miscellaneous nonregulated operations. About 79% of the revenues from telecommunications services were attributable to intrastate operations.\nRegulatory Environment - Federal\nThe Company is subject to the jurisdiction of the FCC with respect to interstate services. The FCC prescribes for communications companies a uniform system of accounts, rules for apportioning costs between regulated and nonregulated services and the principles and standard procedures (separations procedures) used to separate regulated property costs, revenues, 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.\nAccess Services\nThe Company provides access services that allow long-distance carriers and other customers to originate and terminate interstate and intrastate telecommunications services using the facilities of the Company. These charges recover the Company's access-related costs allocated to the two jurisdictions under the FCC's jurisdictional cost allocation rules. Access charges are of four types: common line, switched access, trunking and special access. There are no common line charges applicable to intrastate operations.\nThe common line portion of interstate costs is recovered through separate charges applied to end users (monthly end user common line charges) and the long-distance carriers. The FCC has authorized end user common line charges of up to $3.50 per access line per month for residential and single line business customers and up to $6.00 per access line per month for multiple line business customers.\nEffective January 1, 1994, rates for local transport services were restructured and a new trunking service category was created. Trunking services consist of two types: those associated with the local transport element of switched access and those associated with special access. Trunking services associated with switched access handle the transmission of traffic between a customer's premises and an Ameritech end office where local switching occurs. Trunking services associated with special access handle the transmission of telecommunications services between any two customer-designated premises or between a customer-designated premise and a Company end office where multiplexing, the transmission of two or more signals over a single channel, occurs. Special access charges are monthly charges assessed to customers for access to private line services.\nEffective January 1, 1991, the FCC adopted a new system for regulating the interstate rates of local exchange carriers, including the Company, establishing a price cap mechanism that sets maximum limits on the prices they can charge. The limits are adjusted each year to reflect inflation, a productivity factor and certain other cost changes. Local exchange carriers subject to price caps have increased flexibility to change the prices of existing services within certain groupings of interstate services. Local exchange carriers which operate under price caps are allowed to elect annually by April 1 a productivity offset factor of 3.3% or 4.3%. If the lower offset is chosen, such carriers will be allowed to earn up to a 12.25% overall rate of return without sharing. If such carriers earn between 12.25% and 16.25%, half of the earnings in this range will be flowed through to customers in the form of a lower price cap index in the following year. All earnings over 16.25% would be flowed through to customers. If such carriers elect a 4.3% productivity offset, all earnings below 13.25% may be retained, earnings up to 17.25% would be shared, and earnings over 17.25% would flow through to customers. Since price caps were implemented, Ameritech has chosen the 3.3% offset.\nIn February 1994, the FCC initiated its review of price cap regulation. The FCC identified three broad sets of issues for examination including those related to the basic goals of price cap regulation, the operation of price caps and the transition of local exchange services to a fully competitive market. In the course of this proceeding, the Ameritech landline telephone subsidiaries have advocated the elimination of earnings sharing, increased pricing flexibility, and no change to the productivity factor.\nOther Matters\nIn June 1994, the U.S. Court of Appeals for the District of Columbia overturned a 1992 FCC decision requiring local exchange carriers to provide space within their central office switching centers for physical collocation by competitive access providers, long-distance carriers and end users. The court also told the FCC to reconsider its requirement that local exchange carriers allow competitors to arrange virtual collocation, interconnection adjacent to but not in a central office. In light of this decision, Ameritech has re-examined its collocation policy and the Ameritech landline telephone subsidiaries are now offering virtual collocation.\nRegulatory Environment - State\nThe Company is also subject to regulation by the Public Utilities Commission of Ohio (PUCO) with respect to certain intrastate rates and services, issuance of securities and other matters. Ameritech's regulatory environment is recognized as one of the nation's most progressive and in 1994, it became the first regional company to replace rate of return regulation with pure price regulation throughout its region.\nIn November 1994, the PUCO announced approval of the Advantage Ohio price regulation plan, implemented in January 1995. Under the plan, future overall rate changes are subject to price ceilings based on inflation, a productivity factor of 3%, service quality and significant tax law or accounting rule changes. Rates for all services are capped in 1995 and rates for basic access lines and usage are capped for an additional five years. The plan provides for the ability to flexibly price competitive services and discretionary services. A series of rate reductions totaling $84.4 million will be phased in over six years including the elimination of Touch Tone[R] charges, reductions in the rates for residential local usage and access lines, reductions in carrier access, and the deaveraging of business access line rates. Under the plan, the PUCO no longer oversees depreciation. The plan includes an $18 million grant program for distance learning equipment for schools in Ohio and $2.2 million to set up 14 public computer centers around the state. The Company has also committed to meeting certain benchmarks for the deployment of advanced technology, including inter-office fiber optics, digital switching, Signal System 7 (SS7), an interactive video network and ISDN.\nCompetition\nGeneral\nThe telecommunications industry is undergoing significant changes. Local exchange and long-distance service companies, cable TV companies, cellular service companies, computer concerns and the entertainment and information services industries are converging, forming alliances and positioning to provide a variety of services. Regulatory, legislative and judicial decisions and technological advances, as well as heightened customer interest in advanced telecommunications services, have expanded the types of available communications services and products, as well as the number of companies offering such services. Market convergence, already a reality, is intensifying.\nAmeritech has positioned itself for success in the competitive market through a number of initiatives. Ameritech has aggressively promoted its Customers First plan, agreeing to open its network to all competitors in exchange for being allowed to enter the long-distance market. Such a trade-off is a core principle of legislation that was considered by Congress in 1994 and will be debated again in 1995. Ameritech has been successful in achieving more flexibility on profits and pricing in Ohio and throughout the region. New regulatory policies allow the Company to keep profits resulting from improved efficiency. Achieving price regulation in the region and recognizing increased competition, the Company and the other Ameritech landline telephone subsidiaries adopted accounting used by competitive companies, discontinuing the use of Statement of Financial Accounting Standards No. 71 (FAS 71), \"Accounting for the Effects of Certain Types of Regulation,\" and increasing the Company's depreciation reserve to reflect lower values for assets in a competitive market. Internally, the Company has streamlined its processes, reduced staffing and cut other costs to make Ameritech the most efficient of the RHCs.\nLocal Market\nNew technologies have opened up competition in the local market. These technologies include coaxial cable used to deliver cable TV, fiber-optic cable used to upgrade the capacity of the current telephone network, and cellular telephone systems.\nCertification requests to offer local and other services in competition with the Company are pending. MCI Communications Corp., backed by investor British Telecom, plans to begin offering local phone service in Chicago, Detroit, Indianapolis, Cleveland, Dayton and Columbus, starting in 1996. MFS Communications Company, Inc. has applied to provide local and long-distance service to medium and small businesses in Cleveland's business district and other parts of Ohio by mid-1995. Time Warner Cable, Inc. plans to compete with Ameritech in 37 Ohio counties.\nAT&T and other long-distance companies are competing with the Company's toll calling business, promoting discounts to encourage customers to use their service instead of the Company's. Ameritech has responded with advertising to counter those initiatives.\nProviders of cellular services and personal communications services (PCS) also constitute potential competition to the Company as well as to Ameritech's cellular services business unit. The FCC licenses two carriers in each cellular market area. In Ohio, AirTouch Communications, Inc. (AirTouch) provides cellular service in competition with Ameritech. In 1994, a number of companies allied to form expanded cellular networks. AT&T acquired McCaw Cellular Communications, Inc., the largest domestic cellular communications company, creating the possibility of a wireless network with nationwide presence and brand-name recognition. US West, Inc. (US West) and AirTouch plan to merge their cellular operations, as do Bell Atlantic Corporation (Bell Atlantic) and NYNEX Corporation (NYNEX). The combined US West\/AirTouch and Bell Atlantic\/NYNEX entities subsequently allied their cellular networks and agreed to jointly bid for PCS licenses. In addition, Sprint Communications Co. formed a joint venture with cable companies Tele-Communications, Inc., Comcast Corp. and Cox Cable Communications, Inc. to offer alternative wireless and landline local telephone service.\nIn March 1995, the FCC concluded its auction, which began in late 1994, of over 2,000 licenses for PCS. Various telecommunications groups, including almost all the nation's largest telephone and cable companies, competed for licenses to offer PCS in Ameritech's service region. At the conclusion of the PCS major trading area license auctions, Ameritech had bid $87 million and won the PCS license for the greater Cleveland area. Ameritech will offer wireless service to customers in Cleveland in 1995. AT&T and GTE were the winners of other PCS licenses in the Company's coverage area. The Company may also face additional competition from wireless technology that may be developed and introduced in the future.\nThough most wireless calls still need to interconnect with the existing wire-based telecommunications infrastructure, legislation permitting cable TV companies to enter the local voice communications market would provide a competing wireline infrastructure for cellular service providers. Alliances have been formed between certain RHCs and large cable concerns which are operating cable TV systems throughout the United States.\nIn addition, the FCC has awarded licenses to several companies which hope to launch low earth orbit satellites that could be reached directly by a new generation of telephones, paging devices and fax machines.\nIn this highly competitive era, the cable industry is consolidating in the hands of a few companies anxious to compete with the telephone companies as the two industries converge. In October 1994, a U.S. District Court in Illinois ruled in favor of Ameritech in the Company's challenge, filed in November 1993, to the video programming ban of the Cable Communications Policy Act of 1984. Ameritech initially filed motions in two federal courts questioning the constitutionality of provisions that bar companies from providing cable TV services and traditional video programming where they also provide local telephone service. The court's ruling applies throughout Ameritech's five state region. Ameritech was the fourth RHC to win the right to provide cable services.\nRegulatory Relief Strategy\nCustomers First: Ameritech's Advanced Universal Access Plan\nRegulatory reform continues to be one of the most significant issues facing the telecommunications industry today. Ameritech believes that relief from regulation will benefit customers and ultimately shareowners by enabling the industry to compete effectively and meet customers' expanding needs. To that end, Ameritech has offered its Customers First plan.\nBarred from offering long-distance service by the Consent Decree, in October 1994 Ameritech took another step in its efforts to provide a full range of communications services by requesting Illinois Commerce Commission (ICC) certification to offer long-distance services throughout Illinois. In its filing with the ICC, Ameritech requested permission to offer long-distance service using its own network facilities or network capacity obtained from other sources. Ameritech intends to offer a broad range of long-distance services, from consumer short- and long-haul long-distance, to 800 service and special high-capacity services used by large businesses.\nIn March 1993, Ameritech unveiled its Customers First plan, becoming the first company in the U.S. communications industry to voluntarily offer to open its local network to competitors. In the plan, filed with the FCC and the ICC, Ameritech proposed to change the way local telecommunications services are provided and regulated and to furnish a policy framework for advanced universal access to modern telecommunications services -- voice, data and video information. Ameritech wants to facilitate competition in the local exchange business by allowing other service providers to purchase components of its network and to repackage them with their own services for resale. Ameritech believes this action is a predicate to entry into a currently prohibited business - long-distance service. In addition, Ameritech has asked for modifications to the current price cap rules and FCC approval to collect, in a competitively neutral manner, the social subsidies currently embedded in the rates the landline telephone companies charge long-distance carriers for network access. Under the plan, customers would be able to choose from competitive providers for local service as they now can choose a provider for long-distance service.\nAmeritech currently is awaiting authorization from the DOJ and the U.S. District Court in Washington D.C. to proceed with a trial in certain areas of the Ameritech region under which it would provide both local and long-distance services, demonstrating conclusively the substantial customer and economic benefits of full competition. In January 1995, ICC hearing examiners issued a proposed order concerning implementation of the plan in the Chicago area, which Ameritech largely endorsed. To speed the DOJ's recommendation and the court's decision concerning Ameritech's entry into the long-distance market, Ameritech agreed to open its local phone network to competition without tying this agreement to its request to provide long-distance service. Ameritech is awaiting the ICC's final order.\nAmeritech's Video Dial Tone Network\nIn December 1994, the FCC approved Ameritech's request to begin building a state-of-the-art digital video network capable of delivering multicast and interactive services to 6 million customers by the year 2001. Ameritech plans to spend $4.4 billion over the next 15 years to build the new network, which will be separate from the Ameritech landline telephone subsidiaries' local communications network. A computer network, fiber-optic and coaxial cable will be used to connect the homes, businesses, libraries and schools in the service territory.\nIn phase I of the video network project, Ameritech plans to offer service to about 1.2 million potential customers by the end of 1996 in 134 communities in its Midwest region. The network could be expanded to approximately 1 million additional potential customers in each of the next five years. Construction is expected to begin as soon as Ameritech secures permits from the local communities.\nAmeritech will be only one of many users of the broadband network. A multitude of competing video information providers, businesses, institutions, long-distance carriers and video telephony customers will also have access to the technology. Under the FCC's action, Ameritech will act as a common carrier, transmitting programs from all sources willing to pay a transmission fee. Some of these programs could be supplied by ventures in which Ameritech has a financial interest. Although Federal regulations prevent Ameritech from providing its own programming, Ameritech is pursuing alliances and partnerships that will position it as a key participant in the emerging era of interactive video experiences, exploring a variety of services with many different suppliers of traditional cable TV offerings, video-on-\ndemand, home health care, interactive educational courses, distance learning, interactive games and shopping and other entertainment and information services.\nPatents, Trademarks and Licenses\nThe Company, through its parent company, has rights to use various patents, copyrights and trademarks and other intellectual property which are necessary for it to conduct its present business operations. It is not anticipated that any of such property will be subject to expiration or renewal of rights which would materially and adversely affect the Company.\nEmployee Relations\nAs of December 31, 1994, the Company employed 9,084 persons, a decrease from 10,023 at December 31, 1993. Work force restructuring at the Company reduced staffing by 2,207 employees.\nIn late 1994, Ameritech updated its estimate of the results of the early retirement offer it made to its nonmanagement employees earlier in the year, bringing the total number of expected employee retirements and resignations to 11,500 by August 1995, including 2,686 employees at the Company. Under terms of agreements between Ameritech, the Communications Workers of America (CWA) and the International Brotherhood of Electrical Workers (IBEW), Ameritech implemented an enhancement to the Ameritech pension plan by adding three years to the age and the net credited service of eligible nonmanagement employees who will leave the business during a designated period ending in 1995. As of December 31, 1994, 2,085 employees had left the Company under this program. In addition, 122 management employees left the payroll as a result of an involuntary work force reduction program. Reduction of the work force reflects recognition of technological improvements, consolidations, and initiatives to balance cost structure with emerging competition.\nApproximately 78% of the Company's employees are represented by the CWA which is affiliated with the AFL-CIO. When current contracts with the IBEW and CWA expire in June and August 1995, respectively, new contracts will be negotiated regionally.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe properties of the Company do not lend themselves to description by character and location of principal units. At December 31, 1994, the Company's investment in property, plant and equipment consisted of the following:\nCentral office equipment includes analog and digital switching equipment, transmission equipment and related facilities. Buildings includes principally central offices. Cable, wiring and conduit constitute outside plant, and includes poles as well as cable, conduit and wiring primarily on or under public roads, highways or streets or on or under private property. Substantially all of the installations of central office equipment and administrative offices are located in buildings owned by the Company and situated on property it owns. Many garages and business offices and some installations of central office equipment and administrative offices are in leased quarters.\nAs a result of an extensive review of Company assets and an assessment of future needs, the Company is selling, or will no longer use in the business, certain real estate, thereby reducing costs and improving asset utilization.\nCapital Investment Plans\nCapital expenditures, the single largest use of Company funds, were as follows for the last five years (in millions):\nThe Company has been making and expects to continue to make large capital expenditures to respond to the market's demand for a modern, efficient and productive network. The total investment in property, plant and equipment increased from about $4.9 billion at December 31, 1989, to about $5.6 billion at December 31, 1994, after giving effect to retirements but before deducting accumulated depreciation at either date.\nCapital expenditures are expected to be about $255 million in 1995, including capital expenditures related to the Company's portion of Ameritech's video network upgrade program.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nPre-Divestiture Contingent Liabilities Agreement\nThe Plan provides for the recognition and payment of liabilities that are attributable to pre-divestiture events (including transactions to implement the divestiture) but that 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, equal employment matters, environmental matters and torts (including business torts, such as alleged violations of the antitrust laws).\nWith respect to such liabilities, under agreements entered into at divestiture, AT&T and the former Bell operating companies of AT&T (Bell Companies) will share the costs of any judgment or other determination of liability entered by a court or administrative agency, the costs of defending the claim (including attorneys' fees and court costs) and the cost of interest or penalties with respect to any such judgment or determination. Except to the extent that affected parties may otherwise agree, the general rule is that responsibility for such contingent liabilities will be divided among AT&T and the Bell Companies on the basis of their relative net investment (defined as total assets less reserves for depreciation) as of the effective date of divestiture. Different allocation rules apply to liabilities which relate exclusively to pre-divestiture interstate or intrastate operations. Effective in 1994, Ameritech and the other six RHCs agreed to discontinue sharing of new pre-divestiture claims and certain existing claims other than claims relating to environmental matters. AT&T is not a party to this agreement.\nAlthough 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 all of the foregoing actions would not be material in amount to the Company.\nPART II\nItem 6.","section_4":"","section_5":"","section_6":"Item 6. Selected Financial and Operating Data.\nTHE OHIO BELL TELEPHONE COMPANY Selected Financial and Operating Data (Dollars in Millions)\n* As discussed in Note E to the financial statements, 1994 operating expenses include a nonmanagement work force restructuring charge of $173.2. ** As discussed in Note B to the financial statements, the Company had an extraordinary charge in 1994 of $445.2 for the discontinuance of FAS 71. As discussed in Note E to the financial statements, the Company had accounting changes in 1992 for FAS 106 and FAS 112 aggregating $347.3.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations. (Dollars in Millions)\nFollowing is a discussion and analysis of the results of operations of the Company for the year ended December 31, 1994 and for the year ended December 31, 1993, which is based on the Statements of Income and Reinvested Earnings (Deficit). Other pertinent data are also given in the Selected Financial and Operating Data. The discontinuation of certain regulated accounting practices in 1994, resulted in a net loss in 1994.\nResults of Operations\nRevenues\nTotal revenues increased by 3.2% to $2,178.6 in 1994. This increase was primarily attributable to higher landline telephone network usage resulting from access line growth, growth in custom calling features and increases in switched access minutes of use and toll messages. Rate reductions, primarily in the network access revenue categories, partially offset these increases.\nLocal service revenues include basic monthly service fees and usage charges, fees for custom-calling features, public phone revenues and installation and connection charges. Local service rates are regulated by the Public Utilities Commission of Ohio (PUCO). Through the Advantage Ohio proceeding, price regulation of intrastate services was achieved in 1994. In exchange for certain regulatory freedoms, the Company agreed to certain rate reductions and moratoriums on price increases for six years. Rate reductions will affect 1995 revenues by about $40.3. All intrastate limits on earnings have been removed.\nHigher network usage increased local service revenues by $59.5 during 1994. The increase in calling volumes principally resulted from 3.7% growth in the number of access lines, fueled by second line additions. Greater sales of custom calling features also contributed to the higher local service revenues.\nNetwork access revenues are fees charged to interexchange carriers, such as AT&T and MCI, that use the local telecommunications network to provide long-distance services to their customers. In addition, end users pay flat rate interstate access fees to connect to the local network to obtain long-distance service.\nInterstate network access revenues increased $11.6 in 1994 due primarily to higher network usage revenues of $16.2 and local transport rate restructure changes of $12.8, as well as reductions in National Exchange Carrier Association (NECA) support payments of $8.9. Revenue sharing accrual differences contributed $1.5 to the 1994 revenue increases. These increases were partially offset by rate reductions of $29.7. Minutes of use related to interstate calls increased by 6.3%.\nIntrastate network access revenues decreased $7.5 in 1994. This decrease was primarily attributable to net rate reductions of $18.3, partially offset by increased revenues of $10.9 primarily attributable to higher network usage. Minutes of use related to intrastate calls increased by 11.2%. Rate reductions will affect 1995 revenues by about $3.6.\nLong-distance revenues result when a customer makes a call to a location outside of the local calling area but within the same service area. The decrease in long-distance revenues for 1994 was attributable to a rate reduction of $9.7, partially offset by volume related increases of $5.6.\nOther revenues are derived from publishing telephone directories, billing and collection services, inside wire installation and maintenance services and other miscellaneous services.\nContributing to the increase was demand growth and price increases in nonregulated services, such as inside wire maintenance at the Company and to nonrecurring revenues from a facilities lease.\nOperating Expenses\nTotal operating expenses in 1994 increased $252.4 or 15.1% from 1993. This increase was primarily attributable to restructuring charges of $173.2 in 1994, as well as increases in advertising expenses, access charges and contract and professional services. Also contributing to the increase was a charge of $7.2 for certain real estate which the Company is selling or no longer plans to use in the business.\nThe increase in employee-related expenses in 1994 was primarily attributable to the effects of higher wage rates, increased overtime payments, higher incentive accruals and postretirement benefits. Partially offsetting the increases were the effects of work force reductions over the past year and increased pension credits of $13.0.\nThere were 9,084 employees at December 31, 1994, compared with 10,023 at December 31, 1993. Work force restructuring at the Company resulted in a decline of 2,207 employees.\nThe decrease in depreciation and amortization expense in 1994 was due to a lower average composite depreciation rate partially offset by the continued expansion of the plant investment base. Effective in the fourth quarter of 1994, the Company discontinued the application of FAS 71, which slowed the increase in depreciation expense (See Note B to the financial statements).\nThe increase in other operating expenses in 1994 was primarily attributable to increased contract and professional services. Increased uncollectibles contributed $8.3 to the increase, which results in part from higher revenues. In addition, this cost category includes the $7.2 charge for the reduction in certain asset values, primarily real estate, previously discussed. The increase was moderated by a net credit of $13.9 from a management separation program. The credit results from pension settlement and curtailment gains exceeding severance costs.\nAs discussed more fully in Note E to the financial statements, Ameritech announced on March 25, 1994 that it intended to reduce its existing nonmanagement work force by 6,000 employees by the end of 1995. Reduction of the work force results from the Company's implementation of technological improvements, consolidations and initiatives to balance its cost structure with emerging competition. Ameritech now expects its nonmanagement work force to be reduced by about 11,500 employees through 1995 instead of the 6,000 originally estimated in March, including 2,686 at the Company. Charges related to the original 6,000 employees (1,500 at the Company) were recorded in the first quarter, and additional charges, net of settlement gains, were recorded in the third and fourth quarters to reflect acceptance of the plan by the additional employees. After recording offsetting noncash settlement gains of $80.2 associated with lump-sum pension payments through December 31, 1994, total restructuring charges recorded at the Company in 1994 were $173.2. Additional settlement gains (estimated at $70.0) are anticipated in the future.\nActual employee reductions by quarter in 1994 were: 365 in the second quarter, 358 in the third quarter and 1,362 in the fourth quarter. Estimates for 1995 are 61 in the first quarter, 131 in the second quarter and 409 in the third quarter. Cash requirements of the Company to fund the financial incentives (principally contractual termination payments totaling approximately $61.7) are being met as prescribed by applicable collective bargaining agreements. Certain of these collective bargaining agreements require contractual termination payments to be paid to employees in a manner other than lump-sum, thus requiring cash payments beyond an employee's termination date.\nThe Company believes this program will reduce its annual employee-related costs by approximately $50 thousand per departing employee. The projected savings will be partially offset by the hiring of new employees with better matched skills to accommodate growth, ensure high quality customer service and meet staffing requirements for new business opportunities.\nTaxes other than income taxes increased due to an increase in property tax rates. Gross receipts taxes also increased by $1.3.\nOther Income and Expenses\nThe increase in interest expense during 1994 was due to higher average long-term debt outstanding partially offset by lower average interest rates. The calling of certain long-term debt in 1993 was refinanced in part at lower long-term interest rates and by instruments with lower short-term interest rates as compared with the original called debt. Also partially offsetting the increase were decreased short-term borrowings from Ameritech.\nOther (income) expense, net includes earnings related to the Company's investments (when the equity method of accounting is followed), interest income and other nonoperating items.\nOther (income) expense, net increased in 1994 as a result of certain nonrecurring transactions reflected in 1993 results. 1993 results included $9.5 in costs (call premiums and unamortized deferred costs) incurred in connection with the early extinguishment of debt.\nThe decrease in income taxes in 1994 was due primarily to lower pretax income as a result of work force restructuring charges of $173.2 ($112.6 after-tax).\nExtraordinary Item - FAS 71\nAs described in Note B to the financial statements, the Company has discontinued applying Statement of Financial Accounting Standards No. 71 (FAS 71), \"Accounting for the Effects of Certain Types of Regulation.\" The Company determined in the fourth quarter of 1994 that it no longer met the criteria for following FAS 71. The factors that gave rise to this decision were changes in the manner in which the Company is regulated and the heightened competitive environment. The accounting impact to the Company was an extraordinary noncash after-tax charge of $445.2.\nAs a result of the discontinuation of applying FAS 71, the Company expects 1995 depreciation expense to decrease due to a lower net plant base. Depreciation expense in 1996 and beyond will likely be higher as the effects of shorter lives intensifies at the Company.\nCertain additional financial statement impacts occur as a result of no longer following FAS 71. Specifically, future effective income tax rates are expected to increase as a result of the elimination of excess deferred tax balances previously amortized as a reduction to tax expense over the lives of the related assets. In addition, business transactions will be recorded following their economic substance, and regulatory assets and liabilities pursuant to FAS 71 will no longer be recognized. The Company also made certain retroactive reclassifications to its statements of income to conform to the presentation of unregulated enterprises. Specifically, the provision for uncollectibles, previously shown as a reduction in other revenues, has been reclassified to other operating expenses. Further, interest during construction, previously a component of other income, has been reclassified to reduce interest expense. These changes had no impact on net income. Determination of future uncollectibles and capitalized interest expense is not expected to change materially.\nAlthough Company recorded assets and net equity were substantially reduced as a result of the discontinuance of application of FAS 71, no material impact on future cash flows is anticipated. Further, income taxes, a major expense of the Company, will be payable by the Company following the same schedule and amounts as before. The rating agencies that report on the Company reviewed the Company's assessment that no material future cash flow impact results from discontinuance of FAS 71 and reaffirmed their credit ratings.\nChanges in Accounting Principles\nThe Company changed its accounting for income taxes effective January 1, 1993, as required by FAS 109, \"Accounting for Income Taxes.\" The impact of adoption on the Company's financial statements was not significant.\nAs more fully discussed in Note E to the financial statements, effective January 1, 1992, the Company adopted FAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and FAS 112, \"Employers' Accounting for Postemployment Benefits.\" As a result of implementing these standards\nthe Company recorded an after-tax noncash charge of approximately $347.3 1992. This charge caused the Company to have a loss in 1992.\nSignificant Balance Sheet Changes Certain amounts shown on the Company's 1994 balance sheet are substantially different from a year ago due to the following. First, the effects from the discontinuance of FAS 71 (all noncash) resulted in lower equity, net plant, deferred income taxes, and regulated assets and liabilities, all of which are detailed in Note B to the financial statements. Secondly, the net effects of the nonmanagement work force reduction increased its FAS 106 obligation by $84.6.\nOther Matters\nIn 1994, the Company replaced rate of return regulation with price regulation. See Regulatory Environment - State in Part I.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareowner of The Ohio Bell Telephone Company\nWe have audited the accompanying balance sheets of The Ohio Bell Telephone Company (an Ohio Corporation) as of December 31, 1994 and 1993, and the related statements of income and reinvested earnings (deficit) 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 this 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 The Ohio Bell Telephone 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.\nAs discussed in Note B to the financial statements, the Company discontinued applying the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" in 1994. As discussed in Note E, the Company changed its method of accounting for certain postretirement and postemployment benefits in 1992.\nOur audits are made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedule included in Item 14(a)(2) 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 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\nCleveland, Ohio February 3, 1995\nTHE OHIO BELL TELEPHONE COMPANY STATEMENTS OF INCOME AND REINVESTED EARNINGS (DEFICIT) (Dollars in Millions)\nThe accompanying notes are an integral part of the financial statements.\nTHE OHIO BELL TELEPHONE COMPANY BALANCE SHEETS (Dollars in Millions)\nThe accompanying notes are an integral part of the financial statements.\nTHE OHIO BELL TELEPHONE COMPANY STATEMENTS OF CASH FLOWS (Dollars in Millions)\nThe accompanying notes are an integral part of the financial statements.\nTHE OHIO BELL TELEPHONE COMPANY NOTES TO FINANCIAL STATEMENTS (Dollars in Millions)\nThe Ohio Bell Telephone Company (the Company) is a wholly owned subsidiary of Ameritech Corporation (Ameritech).\nA. SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF ACCOUNTING - The financial statements have been prepared in accordance with generally accepted accounting principles (GAAP). In the fourth quarter of 1994, the Company discontinued following accounting prescribed by Statement of Financial Accounting Standards No. 71 (FAS 71), \"Accounting for the Effects of Certain Types of Regulation\" (see Note B).\nTRANSACTIONS WITH AFFILIATES - The Company has various agreements with affiliated companies. Below is a description of the significant arrangements followed by a table of the amounts involved.\n1. Ameritech Services, Inc. (ASI) - The Company has a 21% ownership interest in ASI, an Ameritech-controlled affiliate, that provides consolidated planning, development, management and support services to all of the Ameritech landline telephone subsidiaries. The Company also provides certain services, such as loaned employees and facilities, to ASI.\n2. Ameritech (the Company's parent) - Ameritech provides various administrative, planning, financial and other services to the Company. These services are billed to the Company at cost.\n3. Ameritech Publishing, Inc. (API), a wholly owned subsidiary of Ameritech - The Company has an agreement under which payments are made to the Company by API for license fees and billing and collection services provided by the Company. The Company also purchases directory services from API under the same agreement. API has advised the Company that it will terminate their agreement effective December 31, 1995 and negotiate a new agreement.\n4. Ameritech Information Systems, Inc. (AIS), a wholly owned subsidiary of Ameritech - The Company has an agreement under which the Company reimburses AIS for costs incurred by AIS in connection with the sale of network services by AIS employees.\n5. Bell Communications Research, Inc. (Bellcore) - Bellcore provides research and technical support to the Company. ASI has a one-seventh ownership interest in Bellcore and bills the Company for the costs.\nPROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated principally at original cost. The provision for depreciation is based principally on straight-line remaining life and straight-line equal life group methods of depreciation applied to individual categories of plant with similar characteristics. As a result of the discontinuation of applying FAS 71 in 1994, the Company recognized shorter, more economically realistic lives and increased its accumulated depreciation balance by $736.3. (See Note B to the financial statements).\nGenerally, when depreciable plant is retired, the amount at which such plant has been carried in property, plant and equipment is charged to accumulated depreciation. The cost of maintenance and repair of plant is charged to expense.\nINVESTMENTS - The Company's investments in ASI (21% ownership and $57.1) and The Champaign Telephone Company (50% ownership and $8.7) are reflected in the financial statements using the equity method of accounting. All other investments are carried at cost. Derivative transactions are generally handled by Ameritech. The Company had no derivatives in 1994.\nMATERIAL AND SUPPLIES - Inventories of new and reusable material and supplies are stated at the lower of cost or market with cost generally determined on an average-cost basis.\nINCOME TAXES - The Company is included in the consolidated federal income tax return filed by Ameritech and its subsidiaries. Effective January 1, 1993 the Company adopted FAS 109, \"Accounting for Income Taxes.\" The new accounting method is essentially a refinement of the liability method previously followed by the Company and, accordingly, did not have a significant impact on the Company's financial statements upon adoption. The Company's provision for income taxes is determined effectively on a separate company basis.\nDeferred tax assets and liabilities are based on differences between the financial statement bases of assets and liabilities and the tax bases of those same assets and liabilities. Under the liability method, deferred tax assets and liabilities at the end of each period are determined using the statutory tax rates in effect when these temporary differences are expected to reverse. Deferred income tax expense is measured by the change in the net deferred income tax asset or liability during the year.\nThe Company uses the deferral method of accounting for investment tax credits. Therefore, credits earned prior to the repeal of the investment tax credit by the Tax Reform Act of 1986, and also certain transitional credits earned after the repeal, are being amortized as reductions in tax expense over the life of the plant that gave rise to the credits.\nTEMPORARY CASH INVESTMENTS - Temporary cash investments are stated at cost which approximates market value. The Company considers all highly liquid, short-term investments with an original maturity of three months or less to be cash equivalents.\nSHORT-TERM FINANCING ARRANGEMENT - During 1991, Ameritech entered into an arrangement with its subsidiaries, including the Company, for the provision of short-term financing and cash management services. Ameritech issues commercial paper and notes and secures bank loans to fund the working capital requirements of its subsidiaries and invests short-term, excess funds on their behalf. (See Note F to the financial statements.)\nThe results of these efforts are as follows:\nRECLASSIFICATIONS - The Company has made certain reclassifications to its financial statements. The more significant ones are as follows. The Company's provision for uncollectibles, previously shown as a reduction in other revenues, has been reclassified to other operating expenses. Further, interest capitalized during construction, previously a component of other income, has been reclassified to reduce interest expense. These changes have been applied retroactively and were made to correspond to financial reporting for unregulated enterprises.\nB. DISCONTINUATION OF REGULATORY ACCOUNTING - FAS 71\nOn a regular basis management has evaluated the continued applicability of FAS 71. In the fourth quarter of 1994, having achieved price regulation and recognizing increased competition, the Company concluded that GAAP prescribed by FAS 71 was no longer appropriate. As a result of the discontinuation of applying FAS 71, the Company recorded a fourth-quarter extraordinary noncash after-tax charge of $445.2. The following table is a summary of the extraordinary charge.\nThe adjustment of $736.3 to net property, plant and equipment was necessary since estimated useful lives and depreciation methods historically prescribed by regulators did not keep up with the rapid pace of technological changes in the Company and differed significantly from those used by unregulated enterprises. Plant balances were adjusted by increasing the accumulated depreciation balance. The increase to the accumulated depreciation balance was determined by a discounted cash flow analysis which considered technological changes, capital requirements and estimated impacts of future competition. To corroborate this study, a depreciation reserve study was also performed that identified inadequate accumulated depreciation levels by individual asset categories. The Company believes these levels developed over the years as a result of the systematic underdepreciation of assets resulting from the regulatory process. When adjusting its net property, plant and equipment, the Company gave effect to shorter, more economically realistic lives.\nThe discontinuance of FAS 71 also required the Company to eliminate from its balance sheet, prepared for financial reporting purposes, the effects of any actions of regulators that had been recognized as assets and liabilities pursuant to FAS 71, but would not have been recognized as assets and liabilities by enterprises in general. The elimination of other net regulatory assets primarily related to compensated absences and unamortized discounts being reduced under regulatory principles, as well as certain other costs deferred and recognized as expense in accounting periods other than those required under GAAP, absent FAS 71.\nThe tax-related adjustments were required to adjust excess deferred tax levels to the currently enacted statutory rates and to eliminate tax-related regulatory assets and liabilities. Prior to the discontinuance of FAS 71, the Company had recorded deferred income taxes on the cumulative amount of tax benefits previously flowed through to ratepayers and recorded a regulatory asset for the same amount ($40.6 at December 31, 1993). Also the Company had recorded a regulatory liability for the difference between deferred taxes recorded at higher historical tax rates compared with currently enacted and deferred taxes provided on unamortized investment tax credits ($75.8 at December 31, 1993). These regulatory assets and liabilities were grossed up for the tax effect anticipated when collected in future rates.\nAt the time the Company discontinued the application of FAS 71, the above tax-related regulatory assets and liabilities were eliminated and deferred tax balances adjusted to reflect application of FAS 109 consistent with other unregulated enterprises.\nThe Company uses the deferral method of accounting for investment tax credits and amortize the credits as a reduction to tax expense over the life of the asset that gave rise to the tax credit. As asset lives were shortened, the investment tax credits deemed already earned were credited to income ($10.3).\nThe effects on the Company's financial statements going forward without FAS 71 are discussed in Management's Discussion and Analysis of Results of Operations.\nC. INCOME TAXES\nThe components of income tax expense follow:\nTotal income taxes paid were $166.0, $158.6 and $135.7 in 1994, 1993 and 1992, respectively.\nThe following is a reconciliation between the statutory federal income tax rate for each of the past three years and the Company's effective tax rate:\nThe Revenue Reconciliation Act of 1993, enacted in August 1993, increased the statutory federal income tax rate to 35%. In accordance with the liability method of accounting, the Company adjusted, on the enactment date, its deferred income tax balances. The result was a reduction in deferred income tax expense of $8.3, primarily from increasing the deferred tax assets associated with FAS 106 and 112 (See Note E to the financial statements).\nAs of December 31, 1994 and 1993 the components of long-term accumulated deferred income taxes were as follows:\nDeferred income taxes in current assets and liabilities relate primarily to temporary differences caused by work force restructuring charges (see Note E). The Company has valuation allowances in 1994 against certain deferred tax assets aggregating $2.5 as of December 31, 1994.\nD. PROPERTY, PLANT AND EQUIPMENT\nThe components of property, plant and equipment are as follows:\nDepreciation expense on fixed assets was $372.6, $387.8 and $341.7 in 1994, 1993 and 1992, respectively. The large increase in the accumulated depreciation balance in 1994 was due primarily to the discontinuation of applying FAS 71.\nDuring 1994, the Company recorded a charge of $7.2 associated with real estate the Company is selling or no longer plans to use in the business. The charge, reflected in other operating expenses, was made to reduce such real estate to estimated net realizable value.\nE. EMPLOYEE BENEFIT PLANS\nPENSION PLANS - Ameritech maintains noncontributory defined pension and death benefit plans covering substantially all management and nonmanagement employees. The pension benefit formula used in the determination of pension cost is based on the average compensation earned during the five highest consecutive years of the last ten years of employment for the management plan and a flat dollar amount per year of service for the nonmanagement plan. Pension credits are allocated to subsidiaries based upon the percentage of compensation for the management plan and per employee for the nonmanagement plan. The Company's funding policy is to contribute annually an amount up to the maximum amount that can be deducted for federal income tax purposes. However, due to the funded status of the plans, no contributions have been made for the years reported below. The following data provides information on the Company's credit for the Ameritech plans:\nPension credits were determined using the projected unit credit actuarial method in accordance with FAS 87, \"Employers' Accounting for Pensions.\" The resulting pension credits are primarily attributable to favorable investment performance and the funded status of the plans.\nCertain disclosures are required to be made of the components of pension credits and the funded status of the plans, including the actuarial present value of accumulated plan benefits, accumulated projected benefit obligation and the fair value of plan assets. Such disclosures are not presented for the Company because the structure of the Ameritech plans does not permit the plans' data to be readily disaggregated.\nThe assets of the Ameritech plans consist principally of debt and equity securities, fixed income securities and real estate. As of December 31, 1994, the fair value of plan assets available for plan benefits exceeded the projected benefit obligation (calculated using a discount rate of 7.2% and 5.8% as of December 31, 1994 and 1993, respectively). The assumed long-term rate of return on plan assets used in determining pension credits (or income) was 7.25% for 1994, 1993 and 1992. The assumed increase in future compensation levels, also used in the determination of the projected benefit obligation, was 4.5% in 1994 and 1993.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS - Effective January 1, 1992, the Company adopted FAS 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions.\" FAS 106 requires the cost of postretirement benefits granted to employees to be accrued as expense over the period in which the employee renders service and becomes eligible to receive benefits. The cost of postretirement health care and postretirement life insurance benefits for current and future retirees was recognized as determined under the projected unit credit actuarial method.\nIn adopting FAS 106, the Company elected to immediately recognize, effective January 1, 1992, the transition obligation for current and future retirees. The unrecognized obligation was $481.2 less deferred income taxes of $163.6 or $317.6, net. To this amount is added the Company's 21% share of ASI's transition obligation of $12.9 for a total charge of $330.5.\nSubstantially all current and future retirees are covered under postretirement benefit plans sponsored by Ameritech. Such benefits include medical, dental, and group life insurance. Ameritech has been prefunding (including cash received from the Company) certain of these benefits through Voluntary Employee Benefits Association trust funds (VEBAs) and Retirement Funding Accounts (RFAs). The associated plan assets (primarily corporate securities and bonds) were considered in determining the transition obligation under FAS 106. Ameritech intends to continue to fund its obligations appropriately and is exploring other available funding and cost containment alternatives. Ameritech allocates its retiree health care cost on a per participant basis, whereas group life insurance is allocated based on compensation levels.\nFAS 106 requires certain disclosures as to the components of postretirement benefit costs and the funded status of the plans. Such disclosures are not presented for the Company as the structure of the Ameritech\nplans does not permit the data to be readily disaggregated. However, the Company has been advised by Ameritech as to the following assumptions used in determining FAS 106 costs.\nAs of December 31, 1994 the accumulated postretirement benefit obligation exceeded the fair value of plan assets available for plan benefits. The assumed discount rate used to measure the accumulated postretirement benefit obligation was 8.5% as of December 31, 1994 and 7.0% as of December 31, 1993. The assumed rate of increase in future compensation levels was 4.5% as of December 31, 1994 and December 31, 1993. The expected long-term rate of return on plan assets was 7.25% in 1994 and 1993 on the VEBAs and 8.0% in 1994 and 1993 on RFAs. The assumed health care cost trend rate in 1994 was 9.2% and 9.6% in 1993, and is assumed to decrease gradually to 4.0% in 2007 and remain at that level. The assumed health care cost trend rate is 8.8% for 1995. The health care cost trend rate has a significant effect on the amounts reported for costs each year as well as in the accumulated postretirement benefit obligation. Specifically, increasing the assumed health care cost trend rate by one percentage point in each year would increase the 1994 annual expense by approximately 16%.\nPostretirement benefit cost under FAS 106 was $51.2 in 1994, $45.9 in 1993 and $45.2 in 1992.\nAs of December 31, 1994, the Company had approximately 11,172 retirees eligible to receive health care and group life insurance benefits.\nPOSTEMPLOYMENT BENEFITS - Effective January 1, 1992, the Company adopted FAS 112, \"Employers' Accounting for Postemployment Benefits.\" FAS 112 requires employers to accrue the future cost of certain benefits such as workers' compensation, disability benefits and health care continuation coverage. A one-time charge related to adoption of FAS 112 was recognized as a change in accounting principle, effective as of January 1, 1992. The charge, net of a deferred tax benefit of $16.4, was $24.9. Current expense levels are dependent upon actual claim experience but are not materially different than prior charges to income.\nNONMANAGEMENT WORK FORCE RESTRUCTURING - During 1994, Ameritech announced its plan to reduce its existing nonmanagement work force. Approximately 2,686 employees will leave the Company under this program. Under terms of agreements between Ameritech, the Communications Workers of America (CWA) and the International Brotherhood of Electrical Workers (IBEW), Ameritech implemented an enhancement to the Ameritech Pension Plan by adding three years to both the age and the net credited service of eligible nonmanagement employees who leave the business during a designated period that ends in mid-1995. In addition, certain of Ameritech's business units are offering financial incentives under terms of the current contracts with the CWA and the IBEW to selected nonmanagement employees who leave the business before the end of 1995.\nThe Company recorded charges in 1994 of $173.2, or $112.6 after-tax, to reflect the cost of restructuring. These charges reduced the Company's prepaid pension asset by $39.5 for pension enhancements and curtailment losses, net of settlement gains. The charges also included curtailment losses of $84.6 related to FAS 106, and additional severance accruals of $49.1. The charges reflect settlement gains of $80.2 associated with lump sum pension payments through year-end. At December 31, 1994, the Company's remaining severance accrual was $42.9.\nAs of December 31, 1994, 2,085 employees had left the Company under this program, with 601 to leave in 1995.\nMANAGEMENT WORK FORCE REDUCTIONS - During 1994, 122 management employees left the Company involuntarily. The net cost of these reductions, including termination benefits, settlement and curtailment gains from the pension plan, was a net credit to expense of $6.6. The involuntary termination plan was in effect until December 31, 1994.\nDuring 1993, 128 management employees left the Company under an involuntary termination plan. The net cost of these reductions, including termination benefits, settlement and curtailment gains from the pension plan, was a credit to expense of $3.0.\nDuring 1992, 430 management employees left the Company through a voluntary early retirement program and involuntary terminations. The net cost of this program, along with other transfers from the pension plan, including termination benefits, settlement and curtailment gains from the pension plan, was a credit to expense of $3.8.\nFunding of the 1992 termination benefits was primarily from the management pension plan. The involuntary plans are funded from Company operations and required cash payments of $4.7 and $5.0 in 1994 and 1993, respectively.\nF. DEBT MATURING WITHIN ONE YEAR\nDebt maturing within one year is included as debt in the computation of debt ratios and consists of $35.5 due Ameritech as of December 31, 1993, having a weighted average interest rate of 3.2%, as well as current maturities of capital lease obligations of $0.4 and $0.5 as of December 31, 1994 and 1993 respectively.\nDuring 1991 Ameritech consolidated the short-term financing of its subsidiaries at Ameritech Corporate. See Note A - short-term financing arrangements.\nG. LONG-TERM DEBT\nLong-term debt consists principally of notes and debentures issued by the Company.\nThe following table sets forth interest rates and other information on long-term debt outstanding at December 31.\nH. LEASE COMMITMENTS\nThe Company leases certain facilities and equipment used in its operations under both operating and capital leases. Rental expense under operating leases was $5.2, $6.7 and $7.8 for 1994, 1993 and 1992, respectively. At December 31, 1994 the aggregate minimum rental commitments under noncancelable leases were approximately as follows:\nI. FINANCIAL INSTRUMENTS\nThe following table presents the estimated fair value of the Company's financial instruments as of December 31, 1994 and 1993:\nThe following methods and assumptions were used to estimate the fair value of financial instruments:\nCASH AND TEMPORARY CASH INVESTMENTS - Carrying value approximates fair value because of short-term maturity of these instruments.\nDEBT - The carrying amount (including accrued interest) of debt maturing within one year approximates fair value because of the short-term maturities involved. The fair value of long-term debt was estimated based on the year-end quoted market price for the same or similar issues.\nOTHER ASSETS AND LIABILITIES - These financial instruments consist primarily of other investments and customer deposits. The fair values of these items are based on expected cash flows or, if available, quoted market prices.\nLONG-TERM PAYABLE TO ASI (FOR POSTRETIREMENT BENEFITS) - Carrying value approximates equal fair value.\nJ. ADDITIONAL FINANCIAL INFORMATION\nInterest paid, net of amounts capitalized, was $54.1, $61.1 and $71.7 in 1994, 1993 and 1992, respectively.\nRevenues from AT&T Corp., principally for interstate network access and billing and collection services, comprised approximately 10%, 12% and 13% of consolidated revenues in 1994, 1993 and 1992, respectively. No other customer accounted for more than 10% of revenues.\nK. OTHER (INCOME) EXPENSE, NET\nThe components of other (income) expense, net are as follows:\n* Includes, in 1992, the Company's portion of ASI's equity (earnings) loss related to the change in accounting principles.\nL. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nTotal nonmanagement work force restructuring charges in 1994 were $173.2 or $112.6 after-tax as follows: $132.5 or $86.1 after-tax in the first quarter, $54.6 or $35.5 after-tax in the third quarter, and a net credit of $13.9 (net credit of $9.0 after-tax) in the fourth quarter. The credit in the fourth quarter results from pension settlement gains. See Note E above. The fourth quarter of 1994 also includes a $445.2 after-tax extraordinary charge related to the discontinuance of applying FAS 71, as discussed in Note B to the financial statements.\nSeveral other significant income and expense items were reported in the fourth quarter of both years, the net result of which in both years was not material to the respective quarter or years except as follows. The fourth quarter of 1994 includes a $7.2 ($4.7 after-tax) charge related to the reduction of certain asset values, primarily real estate. In the first quarter of 1993, the Company recognized a charge of $9.5 for the early retirement of debt.\nAll adjustments necessary for a fair statement of results for each period have been included.\nM. CALCULATION OF RATIO OF EARNINGS TO FIXED CHARGES\nThe ratio of earnings to fixed charges of the Company for the years ended December 31, 1994, 1993, 1992, 1991 and 1990 were 4.22, 6.97, 6.33, 4.84 and 5.05, respectively.\nFor the purpose of calculating this ratio, (i) earnings have been calculated by adding to income before interest expense, extraordinary item and accounting changes, the amount of related taxes on income and the portion of rentals representative of the interest factor, (ii) the Company considers one-third of rental expense to be the amount representing return on capital, and (iii) fixed charges comprise total interest expense and such portion of rentals.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNo disagreements with accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure occurred during the period covered by this annual report.\nPART IV\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) Documents filed as part of the report: (1) Financial Statements: Page ---- Selected Financial and Operating Data . . . . . . . . . . 10 Report of Independent Public Accountants . . . . . . . . 16 Statements: Statements of Income and Reinvested Earnings (Deficit) . 17 Balance Sheets . . . . . . . . . . . . . . . . . . . . 18 Statements of Cash Flows . . . . . . . . . . . . . . . 19 Notes to Financial Statements . . . . . . . . . . . . . 20 (2) Financial Statement Schedule: II -- Valuation and Qualifying Accounts . . . . . . . . . 35\nFinancial statement schedules other than the one listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not required or applicable.\n(3) Exhibits\nExhibits identified in parenthesis below, on file with the SEC, are incorporated herein by reference as exhibits hereto.\nExhibit Number - ------\n3a -- Articles of Association of the Company as amended April 25, 1974 (Exhibit 3a to Form 10-K for 1980, File No. 1-6781).\n3b -- Regulations of the Company as restated February 28, 1990 (Exhibit 3b to Form 10-K for 1989, File No. 1-6781).\n4a -- Close Corporation Agreement with Ameritech Corporation dated February 28, 1990 (Exhibit (4)(i) to Form 10-K for 1989, File No. 1-6781).\n4b -- No instrument which defines the rights of holders of long and intermediate term debt of the Company is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the Company hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n10 -- Reorganization and Divestiture Agreement between American Telephone and Telegraph Company, Ameritech Corporation and Affiliates, dated as of November 1, 1983 (Exhibit 10a to Form 10-K for 1983 for Ameritech Corporation, File No. 1-8612).\n12 -- Computation of ratio of earnings to fixed charges for the five years ended December 31, 1994.\n27 -- Financial Data Schedule for the year ended December 31, 1994.\n(b) Reports on Form 8-K:\nOn December 1, 1994, the Company filed a Current Report on Form 8-K dated November 28, 1994, to report on Item 5, Other Events, the Company's discontinuation of the use of Statement of Financial Accounting Standards No. 71 (FAS 71), \"Accounting for the Effects of Certain Types of Regulation,\" and on the resulting extraordinary, noncash charge recorded 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.\nTHE OHIO BELL TELEPHONE COMPANY\nBy \/s\/ Richard A. Kuzmar ------------------------------- (Richard A. Kuzmar, Vice President and Comptroller)\nMarch 21, 1995\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 date indicated.\nPrincipal Executive Officer:\n\/s\/ Jacqueline F. Woods - --------------------------------------------------- (Jacqueline F. Woods, President)\nPrincipal Financial and Accounting Officer:\n\/s\/ Richard A. Kuzmar - --------------------------------------------------- (Richard A. Kuzmar, Vice President and Comptroller)\nAmeritech Corporation:\n\/s\/ Richard H. Brown - --------------------------------------------------- (Richard H. Brown, Vice Chairman)\nThe sole shareowner of the registrant, which is a statutory close corporation managed by the shareowner rather than by a board of directors.\nMarch 21, 1995\nSCHEDULE II\nTHE OHIO BELL TELEPHONE COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS ALLOWANCE FOR UNCOLLECTIBLES (Dollars in Millions)\n(a) Excludes direct charges and credits to expense on the statements of income and reinvested earnings (deficit) related to interexchange carrier receivables.\n(b) Includes principally amounts previously written off which were credited directly to this account when recovered and amounts related to long-distance carrier receivables which are being billed by the Company.\n(c) Amounts written off as uncollectible.","section_15":""}
{"filename":"77231_1994.txt","cik":"77231","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nGas. PG&W's gas system consists of approximately 2,191 miles of distribution lines, nine city gate and 67 major regulating stations and miscellaneous related and additional property. PG&W believes that its gas utility properties are adequately maintained and in good operating condition in all material respects. Continued expenditures will, however, be required with regard to PG&W's on-going valve maintenance program. See \"Business-Gas Business-Valve Maintenance.\"\nMost of PG&W's gas utility properties are subject to a first mortgage lien pursuant to the Indenture of Mortgage and Deed of Trust dated as of March 15, 1946, as supplemented by twenty-nine supplemental indentures (collectively, the \"Indenture\") from PG&W to First Trust of New York, National Association, as Trustee.\nWater. PG&W's water system consists principally of 36 active and standby reservoirs and stream intakes, ten water treatment plants, five wells, various distribution system storage tanks, approximately 1,689 miles of aqueducts and pipelines, and miscellaneous related and additional property. In addition, PG&W owns approximately 53,000 acres of land situated in northeastern Pennsylvania.\nIn PG&W's opinion, its water utility properties are adequately maintained and in good operating condition in all material respects. Continued capital expenditures will, nonetheless, be required for PG&W's on-going program of water main replacement and rehabilitation and other improvements to ensure the integrity of PG&W's distribution system. See \"Business-Water Business-Main Replacement and Rehabilitation Program and Other Distribution System Improvements.\"\nMost of PG&W's water utility properties are subject to a first mortgage lien pursuant to the Indenture. Additionally, certain of these properties are subject to a second mortgage lien (the \"PENNVEST Mortgage\") pursuant to a loan agreement, dated October 16, 1987, between PG&W and the Pennsylvania Water Facilities Loan Board and pursuant to loan agreements, dated March 3, 1989, and December 3, 1992, between PG&W and the Pennsylvania Infrastructure Investment Authority (\"PENNVEST\"), under the terms of which funds were provided to finance the construction of certain water facilities. The PENNVEST Mortgage also secures PG&W's obligations under assumption agreements dated April 5, 1993, with PENNVEST which relate to loans which were assumed by PG&W in connection with its acquisition of two small water companies.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no legal proceedings other than ordinary routine litigation incidental to the business of the Company or its subsidiaries.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of 1994, there were no matters submitted to a vote of security holders of the registrant through the solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information captioned \"Common Stock and Dividend Information\" and presented on page 56 of the Company's 1994 Annual Report to Shareholders is incorporated herein by reference.\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\nPages 22 through 32 of the Company's 1994 Annual Report to Shareholders are incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPages 33 through 51 of the Company's 1994 Annual Report to Shareholders are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGE 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(a) Identification of Directors\nThe information required by this item concerning directors of the Company has been omitted from this Form 10-K since the Company expects to file its definitive proxy statement not later than 120 days after the close of its fiscal year covered by this Form 10-K.\n(b) Identification of Executive Officers\nInformation concerning the Company's executive officers is set forth in Part I of this Form 10-K under the heading \"Executive Officers of the Company.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThis information has been omitted from this Form 10-K since the Company expects to file its definitive proxy statement not later than 120 days after the close of its fiscal year covered by this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information has been omitted from this Form 10-K since the Company expects to file its definitive proxy statement not later than 120 days after the close of its fiscal year covered by this Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis information has been omitted from this Form 10-K since the Company expects to file its definitive proxy statement not later than 120 days after the close of its fiscal year covered by this Form 10-K.\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, notes to consolidated financial statements and report of independent public accountants for the Company and its subsidiaries contained in the Company's 1994 Annual Report to Shareholders filed as Exhibit 13 hereto are incorporated herein by reference. [CAPTION] Annual Report Pages [S] [C] Consolidated Statements of Income for each of the three years in the period ended December 31, 1994. . . . . . . . . . . . 33\nConsolidated Balance Sheets as of December 31, 1994 and 1993 . 34\nConsolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1994. . . . . . . . . 36\nConsolidated Statements of Capitalization as of December 31, 1994 and 1993. . . . . . . . . . . . . . . . . . . . . . . . 37\nConsolidated Statements of Common Shareholders' Investment for each of the three years in the period ended December 31, 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . 38\nNotes to Consolidated Financial Statements . . . . . . . . . . 39\nReport of Independent Public Accountants . . . . . . . . . . . 51\n2. Financial Statement Schedules The following consolidated financial statement schedule for the Company and its subsidiaries is filed as a part of this Form 10-K. Schedules not included have been omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\nSchedule Number Page II Valuation and Qualifying Accounts for the three-year period ended December 31, 1994 . . . . . . . . . . . . 22\n3. Exhibits See \"Index to Exhibits\" located on page 24 for a listing of all exhibits filed as part of this report on Form 10-K.\n(b) Reports on Form 8-K No reports on Form 8-K were filed during the last quarter of 1994.\n(c) Executive Compensation Plans and Arrangements\nThe following listing includes the Company's executive compensation plans and arrangements in effect as of December 31, 1994.\nExhibit\n10-33 Form of Change in Control Agreement between the Company and certain of its Officers -- filed as Exhibit 10-38 to the Company's Annual Report on Form 10-K for 1989, File No. 0-7812.\n10-34 Agreement by and between the Company, PG&W and Robert L. Jones dated as of March 15, 1991 -- filed as Exhibit No. 10-44 to the Company's Annual Report on Form 10-K for 1990, File No. 0-7812.\n10-35 Employment Agreement effective September 1, 1994, between the Company and Dean T. Casaday -- filed as Exhibit 10-1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, File No. 0-7812.\n10-36 Supplemental Retirement Agreement, dated as of December 23, 1991, between the Company and Dean T. Casaday -- filed as Exhibit 10-17 to the Company's Common Stock Form S-2, Registration No. 33-43382.\n10-37 First Amendment to the Supplemental Retirement Agreement, dated as of September 1, 1994, between the Company and Dean T. Casaday -- filed herewith.\n10-38 Pennsylvania Enterprises, Inc. 1992 Stock Option Plan, effective June 3, 1992 -- filed as Exhibit A to the Company's 1993 definitive Proxy Statement, File No. 0-7812.\n(d) Statements Excluded from Annual Report to Shareholders Not applicable.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE\nTo Pennsylvania Enterprises, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Pennsylvania Enterprises, Inc.'s 1994 Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 17, 1995. Our audit was made for the purpose of forming an opinion on those consolidated financial statements taken as a whole. Supplemental Schedule II, Valuation and Qualifying Accounts for the three-year period ended December 31, 1994 (see index of financial statements) is presented for purposes of complying with the Securities and Exchange Commissions rules and is not part of the basic consolidated financial statements. This schedule has been subject 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\nNew York, N.Y. February 17, 1995\nSCHEDULE II\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. [CAPTION] PENNSYLVANIA ENTERPRISES, INC. (Registrant) [S] [C] Date: March 27, 1995 By: \/s\/ Dean T. Casaday Dean T. Casaday President and Chief Executive Officer (Principal Executive Officer)\nDate: March 27, 1995 By: \/s\/ John F. Kell, Jr. John F. Kell, Jr. Vice President, Finance (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. [CAPTION] Signature Capacity Date [S] [C] [C] \/s\/ Kenneth L. Pollock Chairman of the Board of March 27, 1995 Kenneth L. Pollock Directors\n\/s\/ William D. Davis Vice Chairman of the Board March 27, 1995 William D. Davis of Directors\n\/s\/ Dean T. Casaday Director, President and March 27, 1995 Dean T. Casaday Chief Executive Officer\n\/s\/ Robert J. Keating Director March 27, 1995 Robert J. Keating\n\/s\/ John D. McCarthy Director March 27, 1995 John D. McCarthy\n\/s\/ Kenneth M. Pollock Director March 27, 1995 Kenneth M. Pollock\n\/s\/ James A. Ross Director March 27, 1995 James A. Ross\n\/s\/ Ronald W. Simms Director March 27, 1995 Ronald W. Simms\nINDEX TO EXHIBITS Exhibit Number [CAPTION] (3) Articles of Incorporation and By Laws: [S] [C] 3-1 Restated Articles of Incorporation of the Company, as amended -- filed as Exhibit 3-1 to the Company's Senior Note Form S-2, Registration No. 33-47581.\n3-2 By-Laws of the Company, as amended and restated on January 18, 1995 -- filed herewith.\n(4) Instruments Defining the Rights of Security Holders, Including Debentures:\n4-1 Indenture of Mortgage and Deed of Trust, dated as of March 15, 1946, between Scranton-Spring Brook Water Service Company (now PG&W) and Guaranty Trust Company, as Trustee (now Morgan Guaranty Trust Company of New York) -- filed as Exhibit 2(c) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-2 Fourth Supplemental Indenture, dated as of March 15, 1952 -- filed as Exhibit 2(d) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-3 Ninth Supplemental Indenture, dated as of March 15, 1957 -- filed as Exhibit 2(e) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-4 Tenth Supplemental Indenture, dated as of September 1, 1958 -- filed as Exhibit 2(f) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-5 Twelfth Supplemental Indenture, dated as of July 15, 1960 -- filed as Exhibit 2(g) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-6 Fourteenth Supplemental Indenture, dated as of December 15, 1961 -- filed as Exhibit 2(h) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-7 Fifteenth Supplemental Indenture, dated as of December 15, 1963 -- filed as Exhibit 2(i) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-8 Sixteenth Supplemental Indenture, dated as of June 15, 1966 -- filed as Exhibit 2(j) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-9 Seventeenth Supplemental Indenture, dated as of October 15, 1967 -- filed as Exhibit 2(k) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-10 Eighteenth Supplemental Indenture, dated as of May 1, 1970 -- filed as Exhibit 2(1) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-11 Nineteenth Supplemental Indenture, dated as of June 1, 1972 -- filed as Exhibit 2(m) to PG&W's Bond Form S-7, Registration No. 2-55419.\nExhibit Number\n4-12 Twentieth Supplemental Indenture, dated as of March 1, 1976 -- filed as Exhibit 2(n) to PG&W's Bond Form S-7, Registration No. 2-55419.\n4-13 Twenty-first Supplemental Indenture, dated as of December 1, 1976 -- filed as Exhibit 4-16 to PG&W's Annual Report on Form 10-K for 1982, File No. 1-3490.\n4-14 Twenty-second Supplemental Indenture, dated as of August 15, 1989 -- filed as Exhibit 4-22 to the Company's Annual Report on Form 10-K for 1989, File No. 0-7812.\n4-15 Twenty-third Supplemental Indenture, dated as of August 15, 1989 -- filed as Exhibit 4-23 to the Company's Annual Report on Form 10-K for 1989, File No. 0-7812.\n4-16 Twenty-fourth Supplemental Indenture, dated as of September 1, 1991, from PG&W to Morgan Guaranty Trust Company of New York, as Trustee -- filed as Exhibit 4-3 to the Company's Common Stock Form S-2, Registration No. 33-43382.\n4-17 Twenty-fifth Supplemental Indenture, dated as of September 1, 1992, from PG&W to Morgan Guaranty Trust Company of New York, as Trustee -- filed as Exhibit 4-17 to the Company's Annual Report on Form 10-K for 1992, File No. 0-7812.\n4-18 Twenty-sixth Supplemental Indenture, dated as of December 1, 1992, from PG&W to Morgan Guaranty Trust Company of New York, as Trustee -- filed as Exhibit 4-18 to the Company's Annual Report on Form 10-K for 1992, File No. 0-7812.\n4-19 Twenty-seventh Supplemental Indenture, dated as of December 1, 1992, from PG&W to Morgan Guaranty Trust Company of New York, as Trustee -- filed as Exhibit 4-19 to the Company's Annual Report on Form 10-K for 1992, File No. 0-7812.\n4-20 Twenty-eighth Supplemental Indenture, dated as of December 1, 1993, from PG&W to Morgan Guaranty Trust Company of New York, as Trustee -- filed as Exhibit 4-20 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n4-21 Twenty-ninth Supplemental Indenture, dated as of November 1, 1994, from PG&W to First Trust of New York, National Association, as Successor Trustee to Morgan Guaranty Trust Company of New York -- filed as Exhibit 4-21 to PG&W's Annual Report on Form 10-K for 1994, File No. 1-3490.\nNOTE: The First, Second, Third, Fifth, Sixth, Seventh, Eighth, Eleventh and Thirteenth Supplemental Indentures merely convey additional properties to the Trustee.\n4-22 Indenture dated as of June 15, 1992, between the Company and Chemical Bank, as Trustee, with respect to the Company's 10.125% Senior Notes due June 15, 1999 -- filed as Exhibit 4-20 to the Company's Annual Report on Form 10-K for 1992, File No. 0-7812.\nExhibit Number\n(10) Material Contracts:\n10-1 Service Agreement for storage service under Rate Schedule LGA, dated August 6, 1974, between PG&W and Transcontinental Gas Pipe Line Corporation -- filed as Exhibit 10-3 to PG&W's Annual Report on Form 10-K for 1984, File No. 1-3490.\n10-2 Service Agreement for transportation service under Rate Schedule FT, dated February 1, 1992, by and between PG&W and Transcontinental Gas Pipe Line Corporation -- filed as Exhibit 10-4 to PG&W's Annual Report on Form 10-K for 1991, File No. 1-3490.\n10-3 Service Agreement for storage service under Rate Schedule SS-2, dated April 1, 1990, between PG&W and Transcontinental Gas Pipe Line Corporation -- filed as Exhibit 10-8 to the Company's Common Stock Form S-2, Registration No. 33-43382.\n10-4 Service Agreement for sales service under Rate Schedule FS, dated August 1, 1991, between PG&W and Transcontinental Gas Pipe Line Corporation -- filed as Exhibit 10-6 to the Company's Annual Report on Form 10-K for 1991, File No. 0-7812.\n10-5 Service Agreement for transportation service under Rate Schedule FT, dated August 1, 1991, between PG&W and Transcontinental Gas Pipe Line Corporation -- filed as Exhibit 10-10 to the Company's Common Stock Form S-2, Registration No. 33-43382.\n10-6 Service Agreement for transportation service under Rate Schedule IT, dated January 31, 1992, between PG&W and Transcontinental Gas Pipeline Corporation -- filed as Exhibit 10-8 to the Company's Annual Report on Form 10-K for 1991, File No. 0-7812.\n10-7 Service Agreement for storage service under Rate Schedule LSS, dated October 1, 1993, by and between PG&W and Transcontinental Gas Pipe Line Corporation -- filed as Exhibit 10-7 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n10-8 Service Agreement for storage service under Rate Schedule GSS, dated October 1, 1993, by and between PG&W and Transcontinental Gas Pipeline Corporation Company -- filed as Exhibit 10-8 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n10-9 Service Agreement for transportation service under Rate Schedule FTS, dated November 1, 1993, by and between PG&W and Columbia Gas Transmission Corporation -- filed as Exhibit 10-9 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n10-10 Service Agreement for transportation service under Rate Schedule SST, dated November 1, 1993, by and between PG&W and Columbia Gas Transmission Corporation -- filed as Exhibit 10-10 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\nExhibit Number\n10-11 Service Agreement for storage service under Rate Schedule FSS, dated November 1, 1993, by and between PG&W and Columbia Gas Transmission Corporation -- filed as Exhibit 10-11 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n10-12 Service Agreement for transportation service under Rate Schedule FTS-1, dated November 1, 1993, by and between PG&W and Columbia Gulf Transmission Company -- filed as Exhibit 10-12 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n10-13 Service Agreement for transportation service under Rate Schedule ITS-1, dated November 1, 1993, by and between PG&W and Columbia Gulf Transmission Company -- filed as Exhibit 10-13 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n10-14 Service Agreement for transportation service under Rate Schedule ITS, dated November 1, 1993, by and between PG&W and Columbia Gas Transmission Corporation -- filed as Exhibit 10-14 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n10-15 Service Agreement (Contract No. 946) for transportation service under Rate Schedule FT-A, dated September 1, 1993, by and between PG&W and Tennessee Gas Pipeline Company -- filed as Exhibit 10-1 to PG&W's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, File No. 1-3490.\n10-16 Service Agreement (Service Package No. 171) for transportation service under Rate Schedule FT-A, dated September 1, 1993, by and between PG&W and Tennessee Gas Pipeline Company -- filed as Exhibit 10-2 to PG&W's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, File No. 1-3490.\n10-17 Service Agreement (Service Package No. 187) for transportation service under Rate Schedule FT-A, dated September 1, 1993, by and between PG&W and Tennessee Gas Pipeline Company -- filed as Exhibit 10-3 to PG&W's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, File No. 1-3490.\n10-18 Service Agreement (Service Package No. 190) for transportation service under Rate Schedule FT-A, dated September 1, 1993, by and between PG&W and Tennessee Gas Pipeline -- filed as Exhibit 10-4 to PG&W's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, File No. 1-3490.\n10-19 Service Agreement (Contract No. 2289) for storage service under Rate Schedule FS, dated September 1, 1993, by and between PG&W and Tennessee Gas Pipeline -- filed as Exhibit 10-5 to PG&W's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, File No. 1-3490.\n10-20 Bond Purchase Agreement, dated September 1, 1989, relating to PG&W's First Mortgage Bonds 9.23% Series due 1999 and First Mortgage Bonds 9.34% Series due 2019 among Allstate Life Insurance Company, Allstate Life Insurance Company of New York and PG&W -- filed as Exhibit 10-34 to the Company's Annual Report on Form 10-K for 1989, File No. 0-7812.\nExhibit Number\n10-21 Form of Bond Purchase Agreement, dated as of September 1, 1991, re: $50.0 million of 9.57% First Mortgage Bonds, due September 1, 1996, entered into between PG&W and each of the following parties: Pacific Mutual Life Insurance Company, Principal Mutual Life Insurance Company, Great West Life & Annuity Insurance Company, The Life Insurance Company of Virginia, Lutheran Brotherhood, Transamerica Life Insurance and Annuity Company and The Franklin Life Insurance Company -- filed as Exhibit 10-7 to the Company's Common Stock Form S-2, Registration No. 33-43382.\n10-22 Amended and Restated Project Facilities Agreement dated as of September 1, 1992, between PG&W and the Luzerne County Industrial Development Authority -- filed as Exhibit 10-27 to the Company's Annual Report on Form 10-K for 1992, File No. 0-7812.\n10-23 7.20% Bond Purchase Agreement, dated September 2, 1992, among the Luzerne County Industrial Development Authority, PG&W and Butcher & Singer, a division of Wheat First Securities Inc., as representative on behalf of itself and Legg Mason Wood Walker Incorporated -- filed as Exhibit 10-28 to the Company's Annual Report on Form 10-K for 1992, File No. 0-7812.\n10-24 Project Facilities Agreement, dated December 1, 1992, between Luzerne County Industrial Development Authority and PG&W -- filed as Exhibit 10-29 to the Company's Annual Report on Form 10-K for 1992, File No. 0-7812.\n10-25 7.125% Bond Purchase Agreement, dated December 10, 1992, among the Luzerne County Industrial Development Authority, PG&W and Butcher & Singer, a division of Wheat First Securities Inc., as representative on behalf of itself and Legg Mason Wood Walker Incorporated -- filed as Exhibit 10-30 to the Company's Annual Report on Form 10-K for 1992, File No. 0-7812.\n10-26 Second Amended and Restated Project Facilities Agreement dated as of December 1, 1993, between PG&W and the Luzerne County Industrial Development Authority -- filed as Exhibit 10-30 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n10-27 6.05% Bond Purchase Agreement, dated December 2, 1993, among the Luzerne County Industrial Development Authority, PG&W and Butcher & Singer, a division of Wheat First Securities, Inc., as representative on behalf of itself and Legg Mason Wood Walker Incorporated -- filed as Exhibit 10-31 to PG&W's Annual Report on Form 10-K for 1993, File No. 1-3490.\n10-28 7% Bond Purchase Agreement, dated November 1, 1994, among the Luzerne County Industrial Development Authority, PG&W and Wheat First Butcher Singer, as representative on behalf of itself and Legg Mason Wood Walker Incorporated -- filed as Exhibit 10-28 to PG&W's Annual Report on Form 10-K for 1994, File No. 1-3490.\nExhibit Number\n10-29 Amended and Restated Project Facilities Agreement dated as of November 1, 1994, between PG&W and the Luzerne County Industrial Development Authority -- filed as Exhibit 10-29 to PG&W's Annual Report on Form 10-K for 1994, File No. 1-3490.\n10-30 Term Loan Agreement, dated as of May 31, 1994, by and among Pennsylvania Enterprises, Inc. and the Banks parties thereto and PNC Bank, National Association, as Agent -- filed as Exhibit 10-1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994, File No. 0-7812.\n10-31 Credit Agreement, dated as of April 19, 1993, by and among PG&W, the Banks parties thereto and PNC Bank, Northeast PA, as Agent, and CoreStates Bank, N.A. and NBD Bank, N.A. as Co-Agents -- filed as Exhibit 10-1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993, File No. 0-7812.\n10-32 First Amendment to Credit Agreement and Notes, dated as of December 16, 1994, by and among PG&W, the Banks parties thereto and PNC Bank, Northeast PA, as Agent, and CoreStates Bank, N.A. and NBD Bank, N.A. as Co-Agents -- filed as Exhibit 10-31 to PG&W's Annual Report on Form 10-K for 1994, File No. 1-3490.\n10-33 Form of Change in Control Agreement between the Company and certain of its Officers -- filed as Exhibit 10-38 to the Company's Annual Report on Form 10-K for 1989, File No. 0-7812.\n10-34 Agreement, dated as of March 15, 1991, by and between the Company, PG&W and Robert L. Jones -- filed as Exhibit 10-38 to the Company's Annual Report on Form 10-K for 1990, File No. 0-7812.\n10-35 Employment Agreement effective September 1, 1994, between the Company and Dean T. Casaday -- filed as Exhibit 10-1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, File No. 0-7812.\n10-36 Supplemental Retirement Agreement, dated as of December 23, 1991, between the Company and Dean T. Casaday -- filed as Exhibit 10-17 to the Company's Common Stock Form S-2, Registration No. 33-43382.\n10-37 First Amendment to the Supplemental Retirement Agreement, dated as of September 1, 1994, between the Company and Dean T. Casaday -- filed herewith.\n10-38 Pennsylvania Enterprises, Inc. 1992 Stock Option Plan, effective June 3, 1992 - filed as Exhibit A to the Company's 1993 definitive Proxy Statement, File No. 0-7812.\nExhibit Number\n(11) Statement Re Computation of Per Share Earnings:\n11-1 Statement Re Computation of Per Share Earnings -- filed herewith.\n(13) Annual Report to Security Holders:\n13-1 1994 Annual Report to Shareholders (except for the information presented on the front and rear covers and pages 1 through 21, which are not deemed to be filed with the Securities and Exchange Commission for the purposes of the Securities Exchange Act of 1934) -- filed herewith.\n(21) Subsidiaries of the Registrant:\n21-1 Subsidiaries of the Registrant -- filed herewith.\n(23) Consents of Experts and Counsel:\n23-1 Consent of Independent Public Accountants -- filed herewith.\n(THIS PAGE INTENTIONALLY LEFT BLANK)","section_15":""}
{"filename":"717829_1994.txt","cik":"717829","year":"1994","section_1":"Item 1. Business Gibson Greetings, Inc. and its wholly-owned and majority-owned subsidiaries (the \"Company\") operate in a single industry segment -- the design, manufacture and sale of everyday and seasonal greeting cards, gift wrap and accessories, paper partywares and related specialty products.\nProducts The Company's major products are extensive lines of greeting cards (both everyday and seasonal) and gift wrap. Everyday cards are categorized as conventional greeting cards and alternative market cards. Seasonal cards are devoted to holiday seasons, which include, in declining order of net sales, Christmas, Valentine's Day, Mother's Day, Easter, Father's Day, Graduation and Thanksgiving. In 1994, approximately 61% of net sales of cards were derived from everyday cards and approximately 39% from seasonal cards. The Company produces gift wrap and gift wrap accessories (including tissue and kraft paper, gift bags, tags, ribbons, bows and gift trims) predominately for the Christmas season. The Company's products also include paper partywares, candles, calendars, gift items and holiday decorations. The following table sets forth, in thousands of dollars for the years indicated, the Company's net sales attributable to each of the principal classes of the Company's products:\nYears Ended December 31, ---------------------------------- 1994 1993 1992 -------- -------- -------- Greeting cards $243,313 $268,952 $243,647 Gift wrap 202,439 192,862 187,965 Other products 102,290 84,351 52,506 -------- -------- -------- Total net sales $548,042 $546,165 $484,118 ======== ======== ========\nMany of the Company's products incorporate well-known proprietary characters. Net sales associated with licensed properties accounted for approximately 17% of overall 1994 net sales. The Company believes it benefits from the publication of cartoon strips, television programming, advertising and other promotional activities by the creators of such licensed characters. The Company has also developed proprietary properties of its own. See \"Trademarks, Copyrights and Licenses.\"\nApproximately 3% of the Company's revenues in 1994 were attributable to export sales and royalty income from foreign sources. During 1993, the Company acquired The Paper Factory of Wisconsin, Inc. (\"The Paper Factory\"), a Wisconsin corporation, to strengthen the Company's position in the rapidly-growing party area of the industry. During 1992, the Company formed Gibson de Mexico, S.A. de C.V., a Mexican corporation, which purchased the net assets of a Mexican manufacturer and marketer of greeting cards, to market the Company's products primarily in Mexico. During 1991, the Company formed Gibson Greetings International Limited, a Delaware corporation, to market the Company's products in the United Kingdom and other European countries. PAGE\nSales and Marketing The Company's products are sold in more than 50,000 retail outlets worldwide. Because of the value consumers place on convenience, the Company continues to concentrate its distribution through one-stop-shopping outlets. To market effectively through these outlets, the Company has developed specific product programs and new product lines and introduced new in-store displays. The Company's products are primarily sold under the Gibson and Cleo brand names and are primarily distributed to deep discounters, supermarkets, mass merchandisers, drug stores and variety stores. During 1994, the Company's five largest customers accounted for approximately 35% of the Company's net sales and only one customer, Wal-Mart Stores Inc., accounted for more than 10% of the Company's net sales.\nThe Company's products under the Gibson brand name are usually stocked in a department where only these products are displayed. Product displays are expressly designed for the presentation of greeting cards, gift wrap, paper partywares, candles and other products. The Company also supplies corrugated displays for seasonal specialties. The Company's method of selling greeting cards requires frequent and attentive merchandising service and fast delivery of reorders. The Company employs a direct field sales force that regularly visits most of the Company's customers, supported by a larger, nationwide merchandising service force.\nIn order to properly display and service these products, a sizable initial investment is made in store display fixtures, sometimes totaling 300 linear feet, and in the hiring and training of service associates. To minimize costs and disruption, in the short-term, caused by the loss of a customer, the Company has entered into longer term contracts with certain retailers, consistent with general industry practice. These contracts generally have terms of from three to six years, and sometimes specify a minimum sales volume commitment. Some of the advantages to the Company include: less disruption to its distribution channels; the ability to plan product offerings into the future; and establishment of a reliable service network to ensure the best product display and salability. In certain of these contracts, cash payments or credits are negotiated constituting advance discounts against future sales. These payments are capitalized and amortized over the initial term of the contract. In the event of contract default by a retailer, such as bankruptcy or liquidation, a contract may be deemed impaired and unamortized amounts may be charged against operations immediately following the default. Use of these contracts has expanded in recent years within the industry and the Company currently has contracts with a number of customers including two of its top five customers.\nMost of the Company's gift wrap is Christmas-related and is sold under the Cleo brand name. These products are usually shipped in corrugated cartons which may be used as temporary free-standing displays. Separate free-standing product displayers and display planning services are also made available for the purpose of enhancing the presentation of Cleo products. The Company's Cleo brand gift wrap is typically sold at lower unit retail price levels than the Company's other brands of gift wrap. In general, the Company does not provide in-store merchandising services with respect to Cleo products but rather ships these products directly to the retailers' stores or their warehouses for subsequent distribution to individual stores. PAGE\nIt is characteristic of the Company's business and of the industry that accounts receivable for seasonal merchandise are carried for relatively long periods, typically as long as six months. Consistent with general industry practice, the Company allows customers to return for credit certain seasonal greeting cards.\nDesign and Production Most of the Company's greeting cards are designed, printed and finished at its Cincinnati, Ohio facility and then sent to its facilities in Berea or Covington, Kentucky for shipment directly to retail stores. Most of the Company's gift wrap is designed, printed, finished and distributed at the Company's facilities in Memphis, Tennessee. The Company also purchases for resale certain finished and semi-finished products, such as gift items, from both domestic and foreign sources.\nThe Company maintains a full-time staff of artists, writers, art directors and creative planners who design a majority of the Company's products. Design of everyday products begins approximately 12 months in advance of shipment. The Company's seasonal greeting cards and other items are designed and printed over longer periods than the everyday cards. Designing seasonal products begins approximately 18 months before the holiday date. Seasonal designs go into production about 12 months before the holiday date.\nProduction of the Company's products increases throughout the year until late September. Because a substantial portion of the Company's shipments are typically concentrated in the latter half of the year, the Company normally is required to carry large inventories.\nThe Company believes that adequate quantities of raw materials used in its business are and will continue to be available from many suppliers. Paper costs are the most significant component of the Company's product cost structure.\nCompetition The greeting card and gift wrap industry is highly competitive. Based upon its general knowledge of the industry and the limited public information available about its competitors, the Company believes it is the third largest producer of greeting cards and gift wrap in the United States. The Company's principal competitors are Hallmark Cards, Inc. and American Greetings Corporation, which are predominant in the industry, and CPS\/Artfaire, Inc. Certain of the Company's competitors have greater financial and other resources than the Company.\nThe Company believes that the principal areas of competition with respect to its products are quality, design, service to the retail outlet, price and terms, which may include payments and other concessions to retail customers under long-term agreements, and that it is competitive in all of these areas. See \"Sales and Marketing.\" PAGE\nTrademarks, Copyrights and Licenses The Company has approximately 40 registrations of trademarks in the United States and foreign countries. Although the Company does not generally register its creative artwork and editorial text with the U.S. Copyright Office, it does obtain certain copyright protection by printing notice of a claim of copyright on its products. The Company has rights under various license agreements to incorporate well-known proprietary characters into its products. These licenses, most of which are exclusive, are generally for terms of one to four years and are subject to certain renewal options. There can be no assurance that the Company will be able to renew license agreements as to any particular proprietary character. The Company believes that its business is not dependent upon any individual trademark, copyright or license.\nEmployees As of December 31, 1994, the Company employed approximately 4,500 persons on a full-time basis. In addition, as of December 31, 1994, the Company employed approximately 6,100 persons on a part-time basis. Because of the seasonality of the Company's sales, the number of the Company's production and warehousing employees varies during the year, normally reaching a peak level in September. Approximately 800 hourly employees in the Company's Memphis, Tennessee facilities are represented by a local union affiliated with the United Paper Workers International Union and are employed under a contract which expires in 1996. Approximately 200 hourly employees currently on the payroll at the Company's Berea, Kentucky facility are represented by a local union affiliated with the International Brotherhood of Firemen and Oilers Union. Unfair labor practice charges have been filed against the Company as an outgrowth of a strike at the Berea facility in 1989. See \"Legal Proceedings.\"\nEnvironmental Issues The Company, over the past decade, has taken a proactive approach to environmental concerns. In 1986, the Company's subsidiary Cleo, Inc. (\"Cleo\") converted its printing operations to water-based inks. Likewise, in early 1990, the Gibson Card Division (the\"Card Division\") converted its card and related products production to water-based inks. Previously, the Card Division had its Cincinnati-produced waste solvents incinerated. All but one underground storage tank on Company owned and leased premises were removed in or before 1988. In 1990, the last underground storage tank, which had contained isopropyl alcohol, was also removed in accordance with governmental closure regulations. For the past seven years, the Company has consulted with professional firms for environmental audits before entering into potential long-term real estate transactions. Historically, expenditures associated with managing and limiting pollution or hazardous substances, as well as expenditures to remediate previously contaminated sites, have not been material to the Company's financial statements. The Company is aware of two contingent environmental liabilities as discussed below: PAGE\nDiaz Refinery - Jackson County, Arkansas In 1989, the Company was identified by the Arkansas Department of Pollution Control and Ecology (\"ADPC&E\") as a potentially responsible party (\"PRP\") in connection with the Diaz Refinery site in Jackson County, Arkansas. The Company is participating with approximately 700 other PRPs in a settlement with ADPC&E for remediation of the site. To date, the Company's share of total site costs has been approximately $46,000, which has been paid. A site investigation and remedial action alternatives study has been conducted. The study found that there are no immediate risks posed by the site soils and groundwater, but recommended that the groundwater be monitored for an additional five years at which time the risk will be reevaluated. If current trends which show improvements in groundwater constituents continue, remediation efforts at the site may be terminated at the end of five years. The Company has been informed by the PRP Common Counsel that there are sufficient PRP funds available to cover the costs of ongoing and planned remediation activities.\nKirk Heathcott Site - Dyer County, Tennessee In December 1993, the Company was advised by the Tennessee Department of Environment and Conservation (\"TDEC\") that Cleo had been identified by the State as a potentially liable party for reimbursement of Superfund expenditures made by the State of Tennessee for site identification, investigation, containment and clean-up, including monitoring and maintenance activities. The Company has ascertained that Cleo's alleged responsibility involves the alleged disposal of certain waste solvents by a third party at the site during the period 1972-1977. At this time, insufficient information is available to determine the Company's potential liability, although such liability could exceed $200,000. Originally, the TDEC requested payment of approximately $13,000 in costs. The state has since identified twelve other PRPs, and has recently undertaken an investigation as to each PRP's involvement in the site. The Company has identified two insurance companies that issued policies to a predecessor company during the applicable time period. These companies have been notified of the occurrence. The Company believes that this insurance may provide coverage for Cleo's potential liability at this site. PAGE\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties The following is a summary of the Company's principal manufacturing, distribution and administrative facilities:\nApproximate Floor Space Location Principal Use (Sq Ft) - -------------------- ------------------------------------- ----------- Cincinnati, Ohio Corporate headquarters, manufacturing and administration 593,700\nMemphis, Tennessee Manufacturing, distribution and administration 1,002,800\nBerea, Kentucky Manufacturing and distribution 597,100\nMexico City, Mexico Manufacturing and distribution 25,900\nTelford, England Manufacturing, distribution and administration 58,800\nMemphis, Tennessee Manufacturing and distribution 1,153,200\nCovington, Kentucky Manufacturing and distribution 293,000\nFlorence, Kentucky Manufacturing and distribution 80,000\nReynosa, Tamaulipas, Mexico Manufacturing 86,800\nBloomington, Indiana Distribution 167,700\nMemphis, Tennessee Distribution (3 facilities) 796,600\nNeenah, Wisconsin Distribution 36,600 --------- Total 4,892,200 =========\nThe first three facilities listed above are all currently leased for an initial term expiring in 2002. The Company has the right to renew the lease for two additional terms of five years each. The Company also has an option to purchase these facilities in 2002 at the higher of $35,400,000 or the fair market value of the properties at that time. For accounting purposes, this lease has been treated as an operating lease. See Note 11 of Notes to Consolidated Financial Statements set forth in Item 8 below.\nThe Company's 1.1 million square foot manufacturing and distribution facility in Memphis, Tennessee has been financed primarily through the issuance, by the Industrial Development Board of the City of Memphis and County of Shelby, Tennessee (the \"Development Board\"), of both taxable and tax-exempt economic development revenue bonds for the benefit of Cleo. Title to the facility will be held until 2004 by the Development Board. See Note 6 of Notes to Consolidated Financial Statements set forth in Item 8 below. PAGE\nThe Telford, England, Covington, Kentucky and Bloomington, Indiana manufacturing and distribution facilities are owned by the Company. The Covington, Kentucky facility has been financed principally through tax-exempt debt and is pledged to secure the repayment of such debt. See Note 6 of Notes to Consolidated Financial Statements set forth in Item 8 below.\nThe Florence, Kentucky facility, the Mexico City, Mexico facility, the Reynosa, Tamaulipas, Mexico facility and the distribution facilities at Memphis, Tennessee, and Neenah, Wisconsin are leased. The Company also leases sales offices, other manufacturing, distribution and administrative facilities and, on a temporary basis, uses public warehouse space in various locations throughout the United States. The Paper Factory leases approximately 160 stores averaging approximately 3,000 to 4,000 square feet per store. Certain of these leases contain contingent payments based upon individual store sales. Leases for all such facilities expire at various dates through 2003.\nThe Company believes that its facilities are adequate for its present needs and that its properties, including machinery and equipment, are generally in good condition, well maintained and suitable for their intended uses.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn July 1, 1994, the Company announced that it had determined that the inventory of Cleo at December 31, 1993 had been overstated, resulting in an overstatement of the Company's previously reported 1993 consolidated net income. See Item 7 hereof.\nImmediately following the announcement of the inventory misstatement at Cleo, five purported class actions were commenced by certain stockholders against the Company and its Chairman, President and Chief Executive Officer in the United States District Court for the Southern District of Ohio. These suits were consolidated and a Consolidated Amended Class Action Complaint against the Company, its Chairman, President and Chief Executive Officer, its Chief Financial Officer and the former President and Chief Executive Officer of Cleo was filed on October 7, 1994 (In Re Gibson Securities Litigation). This Complaint alleged violations of the federal securities laws and sought unspecified damages for an asserted public disclosure of false information regarding the Company's earnings. The Company intends to defend the suit vigorously and has filed an Answer denying any wrongdoing, a Third Party Complaint against its former auditor for contribution against any judgment adverse to the Company and a motion to dismiss one count of the Complaint. On December 6, 1994 the Court ruled that neither of the two named plaintiffs qualified as a class representative. On March 3, 1995 the Court granted plaintiffs' Motion for Leave to File An Amended Complaint to name a substitute class representative.\nThe Securities and Exchange Commission is conducting a private investigation to determine whether the Company or any of its officers, directors and employees have engaged in conduct in violation of certain provisions of the Securities Exchange Act of 1934 and the rules and regulations thereunder. The Company believes that such investigation is focused principally on the Company's derivative transactions and the Company's public statements and accounting with respect thereto. The Company is cooperating in such investigation. PAGE\nIn March 1995 the previously reported litigation captioned Rocks v. Gibson Greetings, et al. was voluntarily dismissed by the plaintiff with the Court's approval.\nOn April 10, 1995, two purported class action lawsuits were commenced against the Company, its Chairman, President and Chief Executive Officer and its Chief Financial Officer in the United States District Court for the Southern District of Ohio (Kurtz v. Gibson Greetings, Inc., et al. and Komine v. Gibson Greetings, Inc., et al.). The Complaints allege violations of the federal securities law for an asserted failure to disclose allegedly material information regarding the Company's financial performance. The Company intends to defend the suits vigorously.\nThe litigation described above is in early stages of proceedings. Accordingly, management is unable to predict their likely effect upon the Company's results of operations and financial condition.\nIn 1989, unfair labor practice charges were filed against the Company as an outgrowth of a strike at its Berea, Kentucky facility. Remedies sought include back pay from August 8, 1989 and reinstatement of employment for approximately 200 employees. In February 1990, the General Counsel of the National Labor Relations Board (\"NLRB\") issued a complaint based on certain of the allegations of these charges (In the Matter of Gibson Greetings, Inc. and International Brotherhood of Firemen and Oilers, AFL-CIO, Cases 9-CA-26706, 27660, 26875.) On December 18, 1991, an Administrative Law Judge of the NLRB issued a recommended order, which included reinstatements and back pay affecting approximately 160 strikers, based on findings that the Company had violated certain provisions of the National Labor Relations Act. On May 7, 1993, the NLRB upheld the Administrative Law Judge's decision in some respects, and enlarged the number of strikers entitled to back pay to approximately 240. An appeal was filed in the United States Court of Appeals for the District of Columbia Circuit. The Company believes it has substantial defenses to the charges, and these defenses were presented in briefs and in appellate oral argument which was heard on September 14, 1994. A decision is expected in 1995. Management does not believe that an adverse outcome as to this matter would have a material adverse effect on the Company's net worth or total cash flows; however, the impact on the statement of operations in a given year could be material.\nIn addition, the Company is a defendant in certain other litigation.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders Not applicable.\nExecutive Officers of the Registrant See Item 10. Directors and Executive Officers of the Registrant.\nPAGE\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters The Company's debt agreements contain certain covenants including limitations on dividends based on a formula related to net income (loss), stock sales and certain restricted investments. At December 31, 1994, the amount of unrestricted retained earnings available for dividends (in thousands of dollars) was $20,250. There were approximately 9,400 stockholders of record on February 28, 1995.\n[FN] (1) Per share prices are based on the closing price as quoted in the Nasdaq National Market. PAGE\nItem 6.","section_6":"Item 6. Selected Financial Data The following summaries set forth selected financial data for the Company for each of the five years in the period ended December 31, 1994. Selected financial data should be read in conjunction with the Consolidated Financial Statements set forth in Item 8 below.\n[FN]\n(1) The full year results for 1993 have been restated to correct the Cleo inventory overstatement and to record unrealized net losses\non derivative transactions (Refer to Note 1 of Notes to Consolidated Financial Statements). The Cleo inventory restatement reduced income before income taxes for 1993 by $8,806. The derivatives' net impact on income before income taxes was a reduction of $5,689 for 1993. The aggregate effect of these changes was to reduce net income by $10,584, and to reduce net income per share by $.66. (2) Includes the current portion of long-term debt which consisted of $11,164 in 1994, $3,917 in 1993, $1,811 in 1992, $708 in 1991, and $6,702 in 1990. PAGE\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\nAs announced on July 1, 1994, the Company determined that the inventory of its Cleo, Inc. gift wrap subsidiary (Cleo) had been overstated, resulting in an overstatement of the Company's previously reported 1993 consolidated net income. As a result of this overstatement, as well as the accrual of an unrealized market value net loss on certain derivative transactions which did not qualify as hedges, it was necessary for the Company to amend and restate its consolidated financial statements for the third quarter ended September 30, 1993, the fourth quarter ended December 31, 1993, the twelve months ended December 31, 1993 and for the first quarter ended March 31, 1994. The adjustments made are described in Note 1 to the Consolidated Financial Statements included in this report and should be reviewed in conjunction with the discussions of \"Results of Operations\" and \"Liquidity and Capital Resources\" presented below. Also see Note 13 of Notes to Consolidated Financial Statements set forth in Item 8","section_7A":"","section_8":"Item 8 below. PAGE\nItem 8. Financial Statements and Supplementary Data\n[FN]\nSee accompanying notes to consolidated financial statements.\nPAGE\n[FN]\nSee accompanying notes to consolidated financial statements.\nPAGE\n[FN]\nSee accompanying notes to consolidated financial statements.\nPAGE\n[FN]\nSee accompanying notes to consolidated financial statements.\nPAGE\nGibson Greetings, Inc. Notes to Consolidated Financial Statements Years Ended December 31, 1994, 1993, and 1992 (Dollars in thousands except per share amounts)\nNote 1--Nature of Business and Statement of Accounting Policies\nPrinciples of consolidation The consolidated financial statements include the accounts of Gibson Greetings, Inc. and its wholly-owned and majority-owned subsidiaries (the Company). All material intercompany transactions have been eliminated.\nNature of business The Company operates in a single industry segment: the design, manufacture and sale of greeting cards, gift wrap and related products. The Company sells to customers in several channels of the retail trade principally located in the United States. The Company recognizes sales at the time of shipment from its facilities. Provisions for sales returns are recorded at the time of the sale, based upon current conditions and the Company's historic experience. The Company conducts business based upon periodic credit evaluations of its customers' financial condition and generally does not require collateral. The Company does not believe a concentration of business risk exists due to the diversity of channels of distribution and geographic location of its retail customers; however, the Company does believe it has certain risks related to up-front contract payments. During the year ended December 31, 1994, the Company's largest customer accounted for approximately 12% of total revenues and during the years ended December 31, 1993 and 1992, the same customer accounted for approximately 12% and 11% of total revenues, respectively.\nRetail Operations On June 1, 1993, the Company acquired The Paper Factory of Wisconsin, Inc. (The Paper Factory) for $25,100 in a business combination accounted for as a purchase. The Paper Factory operates retail stores located primarily in manufacturers' outlet shopping centers. The results of The Paper Factory are not material and are included in the consolidated financial statements since the date of acquisition. The total cost of the acquisition exceeded the fair value of the net assets of The Paper Factory by $26,200. In connection with the acquisition, the Company assumed liabilities of approximately $11,600.\nInternational Operations During 1992, the Company formed Gibson de Mexico, S.A. de C.V. (Gibson de Mexico) to purchase certain assets and assume certain liabilities of Pagina Once, S.A. de C.V. (Pagina Once). Pagina Once was primarily engaged in the manufacturing and marketing of greeting cards. Minority stockholders of Gibson de Mexico are principal officers of Gibson de Mexico. The total cost of the acquisition exceeded the fair value of the net assets by $583.\nDuring 1991, the Company formed Gibson Greetings International Limited (Gibson International) to market the Company's products primarily in the United Kingdom and other European countries. The minority stockholders of Gibson International are principal officers of Gibson International. PAGE\nThe activities of these subsidiaries were not material to consolidated operations in either 1994 or 1993.\nCash and equivalents Cash and equivalents are stated at cost. Cash equivalents include time deposits, money market instruments and short-term debt obligations with original maturities of three months or less. The carrying amount approximates fair value because of the short maturity of these instruments.\nInventories Inventories are stated at the lower of cost (first-in, first-out) or market.\nPlant and equipment Plant and equipment are stated at cost. Plant and equipment, except for leasehold improvements, are depreciated over their related estimated useful lives, using the straight-line method. Leasehold improvements are amortized over the terms of the respective leases, using the straight-line method. Expenditures for maintenance and repairs are charged to operations currently; renewals and betterments are capitalized.\nOther assets Other assets include deferred and prepaid costs, goodwill and other intangibles. Deferred and prepaid costs principally represent costs incurred relating to long-term customer sales agreements. Deferred and prepaid costs are amortized ratably over the terms of the agreements, generally three to six years. Goodwill and other intangibles are amortized over periods ranging from three to twenty years, using the straight-line method. Accumulated goodwill amortization at December 31, 1994 was $3,926.\nIncome taxes 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 currently enacted tax laws. Investment tax credits are amortized to income over the lives of the related assets.\nInterest rate swap agreements The difference between the amount of interest to be paid and the amount of interest to be received under interest rate swap agreements (used for hedging purposes) due to changing interest rates is charged or credited to interest expense over the life of the agreements. Interest rate swap and derivative transactions that do not qualify as hedges are recorded at their fair value. The fair value of interest rate swaps and derivative transactions is the estimated amount that the Company would receive or pay to terminate the swap agreements at the reporting date as determined by a financial institution's valuation model based on the projected value of the transactions at maturity.\nPostemployment Benefits Effective January 1, 1994, the Company adopted SFAS No. 112 - \"Employers' Accounting for Postemployment Benefits.\" This statement requires accrual accounting for benefits provided to former or inactive employees after employment but before retirement. The Company previously accounted for a certain portion of these postemployment benefits on a pay-as-you-go-basis. PAGE\nOther Postretirement Benefits Effective January 1, 1992, the Company adopted SFAS No. 106 - \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This Statement requires that the cost of these benefits be recognized in the financial statements during the employee's active working career.\nComputation of net income (loss) per share The computation of net income (loss) per share is based upon the weighted average number of shares of common stock and equivalents outstanding during the year: 16,130,140 shares for 1994, 16,102,709 shares for 1993, and 16,103,897 shares for 1992.\nRestatements and Reclassifications On July 1, 1994, the Company announced that it had determined that the inventory of Cleo, Inc. (Cleo), a wholly-owned subsidiary, at December 31, 1993 had been overstated, resulting in an overstatement of the Company's 1993 consolidated net income. The overstatement of inventory and income before income taxes was $8,806 and the effect on net income was $5,346 at December 31, 1993 and for the year then ended. The accompanying 1993 Consolidated Financial Statements have been amended and restated to reflect the correction of such overstatement. See Note 12.\nIn addition, the accompanying 1993 Consolidated Financial Statements have been restated for the reasons set forth in Note 13.\nCertain prior year amounts in the consolidated financial statements have been reclassified to conform to the 1994 presentation.\nNote 2--Trade Receivables\nTrade receivables at December 31, 1994 and 1993, consist of the following:\nPAGE\nNote 3--Inventories\nInventories at December 31, 1994 and 1993, consist of the following:\nNote 4--Plant and Equipment\nPlant and equipment at December 31, 1994 and 1993, consist of the following:\nNote 5--Other Assets\nOther assets at December 31, 1994 and 1993, consist of the following:\nPAGE\nNote 6--Debt\nDebt at December 31, 1994 and 1993, consists of the following:\nPAGE\nIn 1993, the Company entered into a three-year revolving credit agreement, replacing a similar existing facility, which expires April 26, 1996. The amount which can be borrowed under this agreement is $210,000.\nThe 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 gross long-term debt at December 31, 1994 was $76,716.\nThe Company periodically has entered into interest rate swap or derivative transactions with the intent to manage the interest rate sensitivity of portions of its debt. On March 4, 1994, the Company felt compelled to enter into two interest rate derivative transactions to cap its exposure on two prior uncapped interest rate derivative transactions that had a negative market value in excess of $17,000. These two new transactions imposed caps on the Company's total exposure and replaced the previous uncapped positions that were entered into subsequent to December 31, 1993 in an attempt to limit the Company's exposure against rising short-term interest rates.\nIn September 1994, the Company filed suit against Bankers Trust Company and its affiliate BT Securities (Bankers Trust) alleging that in connection with the sale of these and earlier derivatives to the Company, Bankers Trust had breached fiduciary duties, made fraudulent representations, and failed to make adequate disclosures, in violation of common law and statutory obligations to the Company. The suit was settled on November 23, 1994. The Company agreed to pay Bankers Trust $6,180 which included $3,344 of cash payments made to the Company which had been recorded as gains with respect to a number of earlier transactions. In return, the remaining transactions were terminated with no further liability to the Company. See Note 13.\nAt December 31, 1994, the Company had two outstanding interest rate swap positions with a total notional amount of $4,800. These two agreements, with terms similar to the related bonds, are constituted as hedges and effectively reduce the Company's interest on $2,400 of industrial revenue bonds from 9.25% to 6.67% through February 1998.\nThe annual principal payments due on long-term debt for each of the years in the five-year period ended December 31, 1999, are $11,164, $11,269, $11,116, $9,205 and $8,713, respectively.\nCapitalized interest for the year ended December 31, 1992 was $74. No interest was capitalized for the years ended December 31, 1994 and 1993.\nThe Company's debt agreements contain certain covenants including limitations on dividends based on a formula related to net income (loss), stock sales and certain restricted investments. At December 31, 1994, the amount of unrestricted retained earnings available for dividends was $20,250. PAGE\nNote 7--Income Taxes The Company adopted the provisions of SFAS No. 109 effective January 1, 1992, and recorded a credit of $1,038 and increased net income per share by $.06 for the cumulative effect of this change in accounting principle. There was no effect on income before income taxes for the year ended December 31, 1992, resulting from the adoption of SFAS No. 109.\nThe provision for income taxes for the years ended December 31, 1994, 1993 and 1992 consists of the following:\nPAGE\nFor the year ended December 31, 1992, provision for income taxes was included in the financial statements as follows:\nTax laws raised the statutory tax rate for corporations from 34% to 35%, retroactive to January 1, 1993. Partially offsetting the adverse impact of the 1% increase in effective tax rates in 1993 and future periods is the favorable adjustment of $700 recorded in 1993 due to the revaluation of certain deferred tax assets.\nThe effective income tax rate for the years ended December 31, 1994, 1993 and 1992, varied from the statutory federal income tax rate as follows:\nThe above schedule includes the effect of a foreign net operating loss for which no benefit has been provided.\nDeferred 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 currently enacted tax laws. PAGE\nThe net deferred taxes are comprised of the following:\nThe Company did not record any valuation allowances against U.S. deferred tax assets at January 1, 1992 or December 31, 1992, due to the substantial amounts of taxable income generated over the last three to five years. The Company has recorded a valuation allowance with respect to the deferred tax assets reflected in the table below as a result of recent capital losses and uncertainties with respect to the amount of taxable capital gain income which will be generated in future years. PAGE\nThe tax balances of significant temporary differences representing deferred tax assets and liabilities for the years ended December 31, 1994 and 1993 were as follows:\nNote 8--Other Current Liabilities Other current liabilities at December 31, 1994 and 1993, consist of the following:\nPAGE\nNote 9--Postretirement Benefits The Company sponsors a defined benefit pension plan (the Retirement Plan) covering substantially all employees who meet certain eligibility requirements. Benefits are based upon years of service and average compensation levels. The Company's general funding policy is to contribute amounts deductible for federal income tax purposes. Contributions are intended to provide not only for benefits earned to date, but also for benefits expected to be earned in the future.\nThe following table sets forth the Retirement Plan's funded status on the measurement dates, December 31, 1994 and September 30, 1993, and a reconciliation of the funded status to the amounts recognized in the Company's consolidated balance sheets at December 31, 1994 and 1993:\nThe fair market value of the Retirement Plan's assets at December 31, 1994 and 1993, was $58,235 and $61,559, respectively. The changes in asset values relative to the measurement dates are primarily due to fluctuations in the market value of the plan's equity investments. PAGE\nIn 1990, the Company established a nonqualified defined benefit plan for employees whose benefits under the Retirement Plan are limited by provisions of the Internal Revenue Code. Additionally in 1990, the Company established a nonqualified defined benefit plan to provide supplemental retirement benefits for selected executives in addition to benefits provided under other Company plans. A nonqualified plan was also established to provide retirement benefits for members of the Company's Board of Directors who are not covered under any of the Company's other plans. All plans established in 1990 were unfunded at December 31, 1994 and 1993, although assets for those plans are held in certain grantor tax trusts known as \"Rabbi\" trusts. These assets are subject to claims of the Company's creditors but otherwise must be used only for purposes of providing benefits under the plans.\nThe following table sets forth the nonqualified defined benefit plans' benefit obligations on the measurement dates, December 31, 1994 and September 30, 1993, and a reconciliation of those obligations to the amounts recognized in the Company's consolidated balance sheets at December 31, 1994 and 1993:\nThe assumed weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation for the plans was 8.5% and 5.0% in 1994 and 7.0% and 5.0% in 1993, respectively. The assumed long-term rate of return on plan assets used for valuation purposes was 9.0% for 1994 and 1993. PAGE\nA summary of the components of net pension expense for all of the Company's defined benefit plans for the years ended December 31, 1994, 1993 and 1992, is as follows:\nThe Company has a defined contribution pension plan for employees who are members of a collective bargaining unit. Benefits under this plan are determined based upon years of service and an hourly contribution rate. Pension expense for this plan for the years ended December 31, 1994, 1993 and 1992, was $409, $451 and $479, respectively.\nDuring 1994, Cleo offered a voluntary early retirement program to eligible employees resulting in curtailments of certain employee benefit plans. Consequently, the Company recognized curtailment losses of $284 and $68 in a defined benefit plan and medical and life insurance plan, respectively, for the year ended December 31, 1994.\nThe Company has two defined contribution plans pursuant to Section 401(k) of the Internal Revenue Code. The plans provide that employees meeting certain eligibility requirements may defer a portion of their salary subject to certain limitations. The Company pays certain administrative costs of the plans and contributes to the plans based upon a percentage of the employee's salary deferral and an annual additional contribution at the discretion of the Board of Directors. The total expense for these plans for the years ended December 31, 1994, 1993 and 1992, was $550, $501 and $481, respectively. PAGE\nIn addition to providing pension benefits, the Company provides medical and life insurance benefits for certain eligible employees upon retirement from the Company. Substantially all employees may become eligible for such benefits upon retiring from active employment of the Company. Medical and life insurance benefits for employees and retirees are paid by a combination of company and employee or retiree contributions. Retiree insurance benefits are provided by insurance companies whose premiums are based on claims paid during the year. The Company adopted the provisions of SFAS No. 106 effective January 1, 1992. This standard requires companies to accrue an actuarially determined charge for postretirement benefits during the period in which active employees become eligible, under existing plan agreements, for such future benefits. The cumulative effect of this change resulted in a charge to net income of $2,487 or $.15 per share after taxes of $1,609. Prior to January 1, 1992, the Company recognized these costs, which were not significant to operations, on a cash basis.\nNet periodic cost of these benefits for the years ended December 31, 1994, 1993 and 1992 is as follows:\nA reconciliation of the accumulated postretirement benefit obligation (APBO) measured as of December 31, 1994 and September 30, 1993 to the Company's consolidated balance sheets at December 31, 1994 and 1993 is as follows:\nPAGE\nThe accumulated benefit obligation for 1994 and 1993 was determined using the following assumptions:\n1994 1993 ---------------- ------------------ Discount rate 8.5% 7% Health care cost 10% for 1995 11% for 1994 trend rate graded down per graded down 1% per year to 6% in the year to 5% in the year 2002, 5.5% year 2000, 5% thereafter thereafter\nThe health care cost trend rate assumption does not have a significant effect on the amounts reported. For example, a 1% increase in the health care cost trend rate would increase the accumulated postretirement benefit obligation as of December 31, 1994, and the net periodic cost for the year then ended by approximately 5% and 4%, respectively.\nEffective January 1, 1994, the Company adopted SFAS No. 112 - \"Employers' Accounting for Postemployment Benefits.\" The statement requires accrual accounting for benefits provided to former or inactive employees after employment but before retirement. The Company previously accounted for a certain portion of these postemployment benefits on a pay-as-you-go-basis. Adoption of SFAS No. 112 did not have a material effect on the consolidated financial statements of the Company.\nNote 10--Stockholders' Equity\nEmployee stock plans Under various stock option and incentive plans, the Company may grant incentive and nonqualified stock options to purchase its common stock. All incentive options are granted at the fair market value on the date of grant. Incentive stock options generally become exercisable one year after the date granted and expire ten years after the date granted, if not earlier expired due to termination of employment. Nonqualified stock options become exercisable according to a vesting schedule determined at the date granted and expire on the date set forth in the option agreement, if not earlier expired due to termination of employment. PAGE\nA summary of stock option activity during the years ended December 31, 1994, 1993 and 1992, is as follows:\nThe exercise prices of options granted in 1994 ranged from $13.88 to $21.13. The exercise prices of options granted in 1993 ranged from $18.88 to $21.25 and the exercise price of options granted in 1992 ranged from $18.38 to $28.63. Options exercised were at prices of $2.38 to $22.50, in 1994, 1993 and 1992. Options outstanding at December 31, 1994, are at prices ranging from $11.38 to $28.63.\nUnder certain stock incentive plans, the Company may grant the right to purchase restricted shares of its common stock. Such shares are subject to restriction on transfer and to repurchase by the Company. The purchase price of restricted shares is determined by the Company and may be nominal. In 1992, 5,000 restricted shares were purchased at a price of $1.00 per share. No restricted shares were purchased in 1994 or 1993.\nAt December 31, 1994, 308,662 shares were available under the stock option and incentive plans, of which 216,369 shares could be issued as restricted shares.\nStock rights On December 4, 1987, the Company's Board of Directors declared a dividend distribution of one right for each outstanding share of the Company's common stock to stockholders of record on December 21, 1987. Each right entitles the holder to purchase, for the exercise price of $40 per share, 1\/100th of a share of Series A Preferred Stock. Until exercisable, the rights are attached to all shares of the Company's common stock outstanding. PAGE\nThe rights are exercisable only in the event that a person or group of persons (i) acquires 20% or more of the Company's common stock and there is a public announcement to that effect, (ii) announces an intention to commence or commences a tender or exchange offer which would result in that person or group owning 30% or more of the Company's common stock, or (iii) beneficially owns a substantial amount (at least 15%) of the Company's common stock and is declared to be an Adverse Person (as defined in the Rights Agreement) by the Company's Board of Directors. Upon a merger or other business combination transaction, each right may entitle the holder to purchase common stock of the acquiring company worth two times the exercise price of the right. Under certain other circumstances (defined in the Rights Agreement) each right may entitle the holder (with certain exceptions) to purchase common stock, or in certain circumstances, cash, property or other securities of the Company, having a value worth two times the exercise price of the right.\nThe rights are redeemable at one cent per right at anytime prior to 20 days after the public announcement that a person or group has acquired 20% of the Company's common stock. Unless exercised or redeemed earlier by the Company, the rights expire on December 28, 1997.\nNote 11--Commitments\nLease commitments The Company has a long-term lease agreement for certain of its principal facilities. The initial lease term runs through January 31, 2002, with two five-year renewal options available. The basic rent under the lease is subject to adjustment based on changes in the Consumer Price Index for the preceding five years, effective March 1, 1987, and every five years thereafter including renewal periods. The lease provides a purchase option exercisable in 2002. The option price is the higher of $35,400 or the fair market value on the date of exercise. As a condition of the lease, all property taxes, insurance costs and operating expenses are to be paid by the Company.\nThe Company also leases additional manufacturing, distribution and administrative facilities, sales offices and personal property under noncancellable leases which expire on various dates through 2003. Certain of these leases contain renewal and escalating rental payment provisions.\nRental expense for the years ended December 31, 1994, 1993 and 1992, on all real and personal property, was $24,493, $20,297 and $15,846, respectively. Minimum future annual rentals under noncancellable leases for each of the years in the five-year period ended December 31, 1999 are $20,757, $18,290, $14,712, $11,744 and $9,835, respectively. After 1999, these commitments aggregate $17,752.\nContract commitments The Company has several long-term customer sales agreements which require payments and credits for each of the years in the five-year period ended December 31, 1999, of $17,048, $6,439, $4,929, $4,724 and $2,922, respectively. After December 31, 1999, these commitments aggregate $2,093. All of these amounts have been recorded as other current liabilities or other liabilities in the accompanying consolidated balance sheet as of December 31, 1994. PAGE\nEmployment agreements The Company has employment agreements with certain executives which provide for, among other things, minimum annual salaries adjusted for cost-of-living changes, continued payment of salaries in certain circumstances and incentive bonuses. Certain agreements further provide for signing bonuses, deferred compensation payable upon expiration of the agreements and employment termination payments, including payments contingent upon any person becoming the beneficial owner of 50% or greater of the Company's outstanding stock.\nNote 12--Legal Proceedings\nOn July 1, 1994, the Company announced that it had determined that the inventory of Cleo at December 31, 1993 had been overstated, resulting in an overstatement of the Company's previously reported 1993 consolidated net income. See Note 1.\nImmediately following the announcement of the inventory misstatement at Cleo, five purported class actions were commenced by certain stockholders against the Company and its Chairman, President and Chief Executive Officer in the United States District Court for the Southern District of Ohio. These suits were consolidated and a Consolidated Amended Class Action Complaint against the Company, its Chairman, President and Chief Executive Officer, its Chief Financial Officer and the former President and Chief Executive Officer of Cleo was filed on October 7, 1994 (In Re Gibson Securities Litigation). This Complaint alleged violations of the federal securities laws and sought unspecified damages for an asserted public disclosure of false information regarding the Company's earnings. The Company intends to defend the suit vigorously and has filed an Answer denying any wrongdoing, a Third Party Complaint against its former auditor for contribution against any judgment adverse to the Company and a motion to dismiss one count of the Complaint. On December 6, 1994 the Court ruled that neither of the two named plaintiffs qualified as a class representative. On March 3, 1995 the Court granted plaintiffs' Motion for Leave to File An Amended Complaint to name a substitute class representative.\nThe SEC is conducting a private investigation to determine whether the Company or any of its officers, directors and employees have engaged in conduct in violation of certain provisions of the Securities Exchange Act of 1934 and the rules and regulations thereunder. The Company believes that such investigation is focused principally on the derivative transactions discussed in Note 6 and the Company's public statements and accounting with respect thereto. The Company is cooperating in such investigation. PAGE\nOn September 12, 1994 the Company filed suit against Bankers Trust Company and its affiliate BT Securities in the United States District Court for the Southern District of Ohio (Gibson Greetings, Inc. v. Bankers Trust Company and BT Securities Corporation) alleging that in connection with the sale of derivatives to the Company they had breached fiduciary duties, made fraudulent misrepresentations, and failed to make adequate disclosures, in violation of common law and statutory obligations to the Company. The suit sought damages and asked that the court declare the Company's existing derivative transactions with Bankers Trust to be unenforceable. Bankers Trust filed an Answer denying the allegations and a counterclaim seeking enforcement of the existing derivative transactions. On November 23, 1994 the Company settled its claims against Bankers Trust. As part of the settlement, the Company paid Bankers Trust $6,180, which included the reimbursement of approximately $3,344 of cash payments previously made to the Company by Bankers Trust and recorded as income in 1993. In return, the remaining transactions were terminated with no further liability to the Company.\nIn March 1995 the previously reported litigation captioned Rocks v. Gibson Greetings, et al. was voluntarily dismissed by the plaintiff with the Court's approval.\nOn April 10, 1995, two purported class action lawsuits were commenced against the Company, its Chairman, President and Chief Executive Officer and its Chief Financial Officer in the United States District Court for the Southern District of Ohio (Kurtz v. Gibson Greetings, Inc., et al. and Komine v. Gibson Greetings, Inc., et al.) The Complaints allege violations of the federal securities law for an asserted failure to disclose allegedly material information regarding the Company's financial performance. The Company intends to defend the suits vigorously.\nThe litigation described above is in early stages of proceedings. Accordingly, management is unable to predict their likely effect upon the Company's results of operations and financial condition.\nIn 1989, unfair labor practice charges were filed against the Company as an outgrowth of a strike at its Berea, Kentucky facility. Remedies sought include back pay from August 8, 1989 and reinstatement of employment for approximately 200 employees. In February 1990, the General Counsel of the National Labor Relations Board (NLRB) issued a complaint based on certain of the allegations of these charges (In the Matter of Gibson Greetings, Inc. and International Brotherhood of Firemen and Oilers, AFL-CIO, Cases 9-CA-26706, 27660, 26875). On December 18, 1991, an Administrative Law Judge of the NLRB issued a recommended order, which included reinstatements and back pay affecting approximately 160 strikers, based on findings that the Company had violated certain provisions of the National Labor Relations Act. On May 7, 1993, the NLRB upheld the Administrative Law Judge's decision in some respects, and enlarged the number of strikers entitled to back pay to approximately 240. An appeal was filed in the United States Court of Appeals for the District of Columbia Circuit. The Company believes it has substantial defenses to the charges, and these defenses were presented in briefs and in appellate oral argument which was heard on September 14, 1994. A decision is expected in 1995. Management does not believe that an adverse outcome as to this matter would have a material adverse effect on the Company's net worth or total cash flows; however, the impact on the statement of operations in a given year could be material. PAGE\nIn addition, the Company is a defendant in certain other litigation.\nNote 13--Subsequent Event\nAs discussed in Note 12, the SEC is investigating the Company's accounting and reporting of derivative transactions during the year ended December 31, 1993.\nIn an institution and settlement of administrative proceedings dated December 22, 1994 against Bankers Trust (the Bankers Trust Order), the SEC alleged that Bankers Trust misled the Company about the value of the Company's derivative positions by providing the Company with fair values that were significantly different from the values determined by Bankers Trust's computer model and recorded on Bankers Trust's financial records, which difference of $4,571 as of December 31, 1993 resulted in a significant understatement of the magnitude of the Company's losses. In late March 1995, the SEC advised the Company that it believed that the Company should restate its 1993 consolidated financial statements due to the SEC's allegation that Bankers Trust caused the Company to materially understate its unrealized losses related to certain derivative transactions during 1993.\nThe Company has restated the accompanying 1993 year-end consolidated financial statements to reflect derivative values based on Bankers Trust's computer model as set forth in the Bankers Trust Order. Such restatement resulted in a $4,571 reduction in previously reported 1993 consolidated net income and a corresponding decrease in 1994 consolidated net loss. This restatement, coupled with the November 23, 1994 settlement between the Company and Bankers Trust, as discussed in Note 12, resulted in a net gain (loss) on derivative transactions and settlement in 1994 and 1993 of $1,641 and ($5,689), respectively, as shown in the accompanying consolidated statements of operations.\nBankers Trust has yet to provide the Company and its independent auditors with either support for the $4,571 differential or with the effects of such net differential on the Company's 1994 and 1993 consolidated quarterly results. Accordingly, the Company has prepared its 1994 and 1993 annual consolidated financial statements based solely on the net differential amount contained in the Bankers Trust Order. The Company has had continuing discussions with the SEC regarding the Company's ongoing attempts to obtain supporting year-end and quarterly amounts from Bankers Trust in order to complete the 1994 and 1993 consolidated financial statements so that the Company's independent auditors can complete their audits of such consolidated financial statements.\nPAGE\nNote 14--Quarterly Financial Data (Unaudited)\n[FN]\n(1) As discussed in Note 13 of the Notes to the Consolidated Financial Statements, Bankers Trust has not provided the Company with quarterly fair values of certain derivative transactions. Such fair values are required for the Company to determine the quarterly impact of the restatement described in Note 13.\nPAGE\nIndependent Auditors' Report\nThe audits of the consolidated financial statements, as restated, for the years ended December 31, 1994 and 1993 have not been completed due to matters discussed in Note 13 of the Notes to Consolidated Financial Statements. Auditors' reports will be filed in an amended Form 10-K as soon as possible after the Company's independent auditors have completed their audits of such financial statements.\nPAGE\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The disclosure called for by this item has been previously reported in the Company's Current Report on Form 8-K, as amended, dated September 29, 1994.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe Board of Directors of the Company (at April 1,1995) are as follows:\nTHOMAS M. COONEY, age 69. Mr. Cooney was the Company's Chairman of the Board from 1986 until 1989 and currently serves as Chairman Emeritus of the Company and as President of Gibson Foundation, Inc., a charitable foundation established by the Company. He joined the Company as its President and Chief Executive Officer in 1978 and served as President until 1986 and as Chief Executive Officer until 1987. He is also a director of Genovese Drug Stores, Inc. Mr. Cooney has been a director of the Company since 1982 and a member of the Nominating Committee since 1990.\nCHARLES D. LINDBERG, age 66. Mr. Lindberg has been a partner in the law firm of Taft, Stettinius & Hollister, counsel to the Company, for more than the past five years and currently serves as Managing Partner. He has been a director of the Company since May 1991 and has been a member of the Audit Committee since 1994.\nALBERT R. PEZZILLO, age 66. Mr. Pezzillo is currently a business consultant. He retired in 1990 from his position as Senior Vice President of American Home Products Corporation, a manufacturer and marketer of ethical pharmaceuticals, medical supplies and hospital, consumer health care, food and household products. Prior to joining American Home Products in 1981, he held a variety of executive positions with Warner Lambert Company and Colgate Palmolive Company. Mr. Pezzillo became a director of the Company in April 1990. He has been a member of the Audit Committee since 1990 and a member of the Compensation Committee since 1994.\nCHARLOTTE A. ST. MARTIN, age 49. Ms. St. Martin has been Executive Vice President of Loews Hotels and President and Chief Executive Officer of Loews Anatole Hotel, Dallas, Texas, since 1989. Previously she served Loews Hotels in a variety of other executive capacities. Loews Hotels owns and operates fourteen hotels nationally and internationally. Ms. St. Martin is also a former President of the Dallas Convention and Visitors' Bureau. She has been a director of the Company since August 1993 and a member of the Compensation Committee since 1994. PAGE\nBENJAMIN J. SOTTILE, age 57. Mr. Sottile has been the Company's Chairman of the Board since 1989, its Chief Executive Officer since 1987 and its President since 1986. From 1986 to 1987 he was the Company's Chief Operating Officer. Mr. Sottile was President of Group I, Revlon Beauty Group, Revlon Corp., a manufacturer of cosmetic and beauty supplies, from 1984 to 1986. From 1981 to 1984 he was a Senior Vice President of Warner Communications, Inc., where he was chiefly responsible for the operating activities of consumer product companies including The Franklin Mint, Warner Cosmetics and Fragrances and Knickerbocker Toy Company. He became a director of the Company in January 1987 and has been a member of the Nominating Committee since 1989.\nFRANK STANTON, age 65. Until his retirement in 1990, Mr. Stanton had served as Chairman and Chief Executive Officer of MRB Group, Inc., a world-wide media and marketing research organization, which he founded in 1987. From 1974 until 1989 he was President and Chief Executive Officer of Simmons Market Research Bureau, a leading rating service for the magazine industry and now a subsidiary of MRB Group, Inc. He has been a director of the Company since June 1985. He has been a member of the Audit and Compensation Committees since 1986.\nROGER T. STAUBACH, age 53. Mr. Staubach has been Chairman of the Board and Chief Executive Officer of The Staubach Company, a Dallas, Texas-based integrated real estate service company, since 1990. He was President of that company from 1981 until 1990 and was active in other real estate brokerage businesses prior to 1981. From 1969 through 1979 he was a member of The Dallas Cowboys professional football team. He is also a director of Brinker International, Inc., Columbus Realty Trust, First USA, Inc., Halliburton Company and Life Partner's Group, Inc. Mr. Staubach became a director of the Company in January 1992. He has been a member of the Nominating Committee since 1994.\nC. ANTHONY WAINWRIGHT, age 61. Mr. Wainwright has been Chairman of Compton Partners, Saatchi & Saatchi (formerly Campbell-Mithun-Esty), a national advertising agency, since May 1994. He had served as Vice Chairman of that company since 1989. From 1980 until 1989 he was President, Chief Operating Officer and a director of The Bloom Companies, Inc., a holding company for a national advertising agency group. Prior to 1980, Mr. Wainwright held various executive positions with companies in the advertising and marketing industries. He is also a director of American Woodmark Corporation, Del Webb Corp. and Specialty Retail Group, Inc. He has been a director of the Company since March 1988 and has been a member of the Compensation Committee since 1993 and a member of the Nominating Committee since 1991. PAGE\nThe Executive Officers of the Company (at April 1,1995) are as follows:\nName Age Title ------------------- --- ---------------------------- Benjamin J. Sottile 57 Chairman of the Board, President and Chief Executive Officer\nWilliam L. Flaherty 47 Vice President, Finance and Chief Financial Officer\nNelson J. Rohrbach 54 Vice President\nStephen M. Sweeney 58 Vice President, Human Resources\nInformation about Mr. Sottile is given above.\nWILLIAM L. FLAHERTY. Mr. Flaherty has been Vice President, Finance and Chief Financial Officer of the Company since November 1993. Prior to that time, he served as Vice President and Corporate Treasurer of FMR Corp., the parent company of Fidelity Investments Group, a mutual fund management and discount stock brokerage firm (1989 - 1992) and as Vice President and Treasurer of James River Corporation, an integrated manufacturer of pulp, paper and converted paper and plastic products (1987 - 1989).\nNELSON J. ROHRBACH. Mr. Rohrbach has been a Vice President of the Company since April 21, 1994 and President and Chief Executive Officer of Cleo, Inc. since April 12, 1994. Prior to that time, he served as the President and Chief Executive Officer of The Paper Factory of Wisconsin, Inc. (1989 - 1994) , a factory outlet chain acquired by the Company in 1993. Mr. Rohrbach continues to serve as The Paper Factory's Chief Executive Officer. From 1980 to 1989 he served as President of CPS\/Artfaire, a manufacturer of personal expression products.\nSTEPHEN M. SWEENEY. Mr. Sweeney joined the Company as Vice President, Human Resources in 1987. He held similar positions with Coca Cola Enterprises, Inc. from 1985 until 1987, the Tribune Company from 1983 until 1985 and Contel, Inc. from 1976 to 1983.\nOfficers serve with the approval of the Board of Directors.\nCompliance with Section 16(a) of the Securities and Exchange Act of\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's executive officers and directors, and persons who beneficially own more than ten percent of the Company's equity securities, to file reports of security ownership and changes in such ownership with the SEC. These persons also are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. PAGE\nBased upon a review of such forms and written representations from its executive officers and directors, the Company believes that all Section 16(a) filing requirements were complied with on a timely basis during and for 1994 except that a 1993 stock option grant was not timely reported by Mr. William L. Flaherty and Form 3 was filed after its due date by Mr. Anthony L. Forcellini.\nItem 11.","section_11":"Item 11. Executive Compensation\nSummary Information. The following table sets forth, for each of the three years in the period ending December 31, 1994, amounts of cash and certain other compensation paid by the Company in respect of the year to (i) Mr. Sottile, (ii) each of the three other executive officers of the Company who were serving as executive officers at the end of 1994 and whose 1994 salary and bonus exceeded $100,000, and (iii) Ralph J. Olson, an executive officer of the Company until November 1994. Mr. Sottile and these other persons are sometimes referred to hereafter as the \"named executive officers.\"\n[FN] - --------------------------\n(1) For 1994, perquisites did not exceed the lesser of $50,000 or 10% of salary and bonus for any named executive officer.\n(2) At December 31, 1994, Mr. Sottile held 5,000 shares of restricted stock having an aggregate award value (based upon the closing price of $14.75 per share on that date for the Company's common stock less the consideration paid) of $68,750.\n(3) For 1994, includes the following: (i) matching contributions to the Company's Matched PaySaver (401(k)) Plan on behalf of each of Messrs. Sottile ($1,125), Flaherty ($0), Rohrbach ($900), Sweeney ($1,125) and Olson ($0) in respect of their 1994 contributions to the Plan; (ii) group term life insurance payments for Mr. Sottile ($5,400), Mr. Flaherty ($1,827), Mr. Rohrbach ($3,245), Mr. Sweeney ($4,158) and Mr. Olson ($3,456); (iii) whole-life insurance premiums of $46,500 for the benefit of Mr. Sottile; (iv) reimbursement of temporary living and travel expenses of $49,556 for Mr. Flaherty and $24,174 for Mr. Rohrbach; (v) miscellaneous insurance-related compensation of $1,398 for Mr. Flaherty; and (vi) termination costs of $745,981 for Mr. Olson.\n(4) Mr. Flaherty and Mr. Rohrbach were first employed by the Company in 1993.\nPAGE\nStock Options. The Company has six existing plans pursuant to which options for shares of common stock may be granted to key employees. These are the 1982, 1983, 1985 and 1987 Stock Option Plans and the 1989 and 1991 Stock Incentive Plans (together, the \"Plans\"). None of the Plans provides for the grant of stock appreciation rights (\"SARs\"). The following table contains information concerning stock option grants under the Plans to the named executive officers during the year ended December 31, 1994.\n[FN] (1) All options vest at an annual rate of one-third per year commencing (i) April 11, 1995 for Mr. Rohrbach's options that expire April 10, 2004 and (ii) June 15, 1995 for all other options. The exercise price of all options may be paid in cash or, if permitted by the Stock Option Committee, by the transfer of shares of the Company's common stock valued at their fair market value on the date of exercise. Each option becomes exercisable in full (i) if any person becomes, or commences a tender offer which could result in the person becoming, the beneficial owner of more than 50% of the outstanding shares of the Company's common stock or (ii) unless the survivor or transferee corporation agrees to continue the option, in the event of the execution of an agreement of merger, consolidation or reorganization pursuant to which the Company is not to be the surviving corporation or the execution of an agreement of sale or transfer of all or substantially all of the assets of the Company.\n(2) In accordance with Securities and Exchange Commission rules, the Black-Scholes option pricing model was used to estimate the grant date present value of the options shown. The Company's use of this model should not be construed as an endorsement of its accuracy at valuing options. All stock option valuation models, including the Black-Scholes model, require a prediction about the future movement of the stock price. The real value of an option, if any, depends upon the actual performance of the Company's stock during the applicable period.\n(3) The options granted to Mr. Olson terminated unexercised as a result of his termination of employment with the Company.\nPAGE\nWith respect to each named executive officer, the following table sets forth information concerning unexercised options held at December 31, 1994. No named executive officer exercised options during 1994.\n[FN] (1) All options terminated unexercised prior to fiscal year-end as a result of Mr. Olson's termination of employment with the Company.\nPension Plans. The Pension Plan Table set forth below shows estimated annual pension benefits payable to a covered participant under the Company's Retirement Income Plan (the \"Retirement Plan\"), a qualified defined benefit pension plan, and under the Gibson Greetings, Inc. ERISA Makeup Plan (the \"Makeup Plan\"), a nonqualified supplemental pension plan providing benefits that would otherwise be denied participants because of certain Internal Revenue Code limitations on qualified plan benefits. Benefits shown are computed as a straight life annuity for an employee retiring at age 65 in 1994 with no offsets. PAGE\n[FN] (1) Except as indicated, the percentage of shares held by each person is less than 1%. Includes shares which may be purchased upon exercise of presently exercisable options and options exercisable within 60 days after February 28, 1995, in the following amounts: Mr. Cooney, 2,000 shares; Mr. Sottile, 205,000 shares; Messrs. Stanton and Wainwright, 6,000 shares each; Mr. Pezzillo, 5,000 shares; Messrs. Lindberg and Staubach, 3,000 shares each; Ms. St. Martin, 1,000 shares; Mr. Flaherty, 5,000 shares; Mr. Rohrbach, 10,000 shares; Mr. Sweeney, 19,500 shares; and all directors and executive officers as a group, 265,500 shares. No information is presented for Mr. Olson whose employment with the Company terminated prior to February 28, 1995.\n(2) Includes the following numbers of shares as to which beneficial ownership is disclaimed: 300 shares held by the wife of Mr. Stanton and 100 shares held by the wife of Mr. Wainwright.\n(3) The Company has also been advised by two institutional investors, Heartland Advisors, Incorporated and Hughes Investment Management Company, that each is the beneficial owner of in excess of 5% of the Company's outstanding shares of Common Stock. However, neither of these institutional investors has at this time filed a formal report of ownership, and the Company is not aware of the exact number of shares of which each claims beneficial ownership.\nPAGE\nItem 13.","section_12":"","section_13":"Item 13. Certain Relationships and Related Transactions\nCertain Transactions. The Staubach Company, of which Mr. Staubach is Chairman and Chief Executive Officer, has been retained to sell certain property owned by the Company. If the property is sold in 1995, The Staubach Company anticipates receiving a net commission in excess of $60,000. During 1994, The Staubach Company received a $20,000 advance from the Company for expenses in connection with this project and also received fees of $26,487 from the Company for its representation of the Company in a lease transaction.\nPAGE\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 part of this report:\nFinancial Statements: 1. Page Herein Financial Statement ------ --------------------------------------------- 12 Consolidated Statements of Operations for the years ended December 31, 1994, 1993 and 1992 13 Consolidated Balance Sheets as of December 31, 1994 and 1993 14 Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 15 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992 16 Notes to Consolidated Financial Statements 29 Independent Auditors' Report\n2. Exhibits: See Index of Exhibits (page 41) for a listing of all exhibits filed with this annual report on Form 10-K\nb) Reports on Form 8-K: The Company filed a Form 8-K with the Securities and Exchange Commission on October 4, 1994 (date of report: September 29, 1994) reporting a change in the Company's independent auditors.\nThe Company filed a Form 8-K\/A (Amendment No. 1) with the Securities and Exchange Commission on October 10, 1994 (date of report: September 29, 1994) further relating to the change in the Company's independent auditors.\nThe Company filed a Form 8-K with the Securities and Exchange Commission on November 23, 1994 (date of report: November 23, 1994) attaching the Company's press release dated November 23, 1994.\nThe Company filed a Form 8-K with the Securities and Exchange Commission on December 7, 1994 (date of report: December 7, 1994) attaching the Company's press release dated December 7, 1994.\nNo financial statements were required to be filed in connection with any of the foregoing reports.\nPAGE\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 17th day of April 1995.\nGibson Greetings, Inc.\nBy \/s\/ Benjamin J. Sottile ----------------------- Benjamin J. Sottile 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 and in the capacities indicated as of the 17th day of April 1995. Signature Title ---------- ----- Chairman of the Board, \/s\/ Benjamin J. Sottile President and Chief Executive Officer ------------------------- Benjamin J. Sottile (principal executive officer)\nVice President, Finance \/s\/ William L. Flaherty Chief Financial Officer ------------------------- William L. Flaherty (principal financial and accounting officer)\n\/s\/ Thomas M. Cooney ------------------------- Thomas M. Cooney Director\n\/s\/ Charles D. Lindberg ------------------------- Charles D. Lindberg Director\n\/s\/ Albert R. Pezzillo ------------------------- Albert R. Pezzillo Director\n------------------------- Frank Stanton Director\n\/s\/ Charlotte St. Martin ------------------------- Charlotte St. Martin Director\n\/s\/ Roger T. Staubach ------------------------- Roger T. Staubach Director\n\/s\/ C. Anthony Wainwright ------------------------- C. Anthony Wainwright Director PAGE\nIndex of Exhibits\nExhibit Number Description ------- ----------------------------------------------------------------- 3(a) Restated Certificate of Incorporation as amended (*1)\n3(b) Bylaws (*2)\n4(a) Article 4.01 of Restated Certificate of Incorporation (included in Exhibit 3(a))\n4(b) Rights Agreement dated as of December 4, 1987, between Gibson Greetings, Inc. and The First National Bank of Boston, Rights Agent, including Certificate of Designation, Preferences and Rights of Series A Preferred Stock (*3)\n10(a) Lease Agreement dated January 25, 1982 between Corporate Property Associates 2 and Corporate Property Associates 3 and Gibson Greeting Cards, Inc. (*4)\n10(b) Sublease Agreement dated January 1, 1977 between B.F. Goodrich and Cleo Wrap Division of Gibson Greetings Card, Inc. (*4)\n10(c) Amendment and Extension of Term of Sublease dated June 26, 1983, between B.F. Goodrich Company and Gibson Greeting Cards, Inc. (*5)\n10(d) Amendment dated June 25, 1985, to Lease Agreement, dated January 25, 1982, by and between Corporate Property Associates 2 and Corporate Property Associates 3 and Gibson Greeting Cards, Inc. (*6)\n10(e) Lease and Agreement dated March 7, 1986 between Associated Warehouses, Inc. and Cleo Wrap Division of Gibson Greetings, Inc. (*6)\n10(f) Commercial Paper Issuing Agent Agreement dated as of July 11, 1986, between Gibson Greetings, Inc. and Irving Trust Corporation (*7)\n10(g) Commercial Paper Dealer Agreement dated July 16, 1986, between Gibson Greetings, Inc. and The First Boston Corporation (*7)\n10(h) Credit Agreement, dated as of April 26, 1993, by and among Gibson Greetings, Inc.; Bankers Trust Company; The Bank of New York; Mellon Bank, N.A.; The Fifth Third Bank; Harris Trust and Savings Bank; NBD Bank, N.A.; Royal Bank of Canada; The Sanwa Bank, Ltd.; Society National Bank; Union Bank of Switzerland; Wachovia Bank of Georgia, N.A.; and Bankers Trust Company, as agent (*8)\n10(i) Form of Note Agreement between Gibson Greetings, Inc. and Connecticut Mutual Life, The Minnesota Mutual Life Insurance Company, The Reliable Life Insurance Company, Federated Life Insurance Company, The Variable Annuity Life Insurance Company and Nationwide Life Insurance Company, dated May 15, 1991 (*9)\n10(j) Executive Compensation Plans and Arrangements\n(i) 1982 Stock Option Plan (*2)\n(ii) 1983 Stock Option Plan (*2)\n(iii) 1985 Stock Option Plan (*2)\n(iv) 1987 Stock Option Plan (*2)\n(v) 1989 Stock Option Plan (*2)\n(vi) 1989 Stock Option Plan for Nonemployee Directors (*2)\n(vii) 1991 Stock Option Plan (*2)\n(viii) Employment Agreement with Mr. Cooney (*10)\n(ix) Form of Second Amendment to Employment Agreement with Mr. Cooney (*1)\nPAGE\nExhibit Number Description ------- ----------------------------------------------------------------- (x) Employment Agreement between Gibson Greetings, Inc. and Benjamin J. Sottile, dated April 1, 1993 (*8)\n(xi) ERISA Makeup Plan (*12)\n(xii) Supplemental Executive Retirement Plan (*12)\n(xiii) Agreements dated January 2, 1991 and December 10, 1993 between Gibson Greetings, Inc. and Stephen M. Sweeney (*2)\n(xiv) Agreement dated November 18, 1993 between Gibson Greetings, Inc. and William L. Flaherty (*2)\n(xv) Agreement dated February 22, 1994 between Gibson Greetings, Inc. and Michael A. Pietrangelo\n(xvi) Agreement dated May 28, 1993 between Gibson Greetings, Inc. and Nelson J. Rohrbach (*12)\n(xvii) Agreement dated June 24, 1994 between Gibson Greetings, Inc. and Ralph J. Olson (*13)\n(xviii) Agreement dated December 21, 1994 between Gibson Greetings, Inc. and Ralph J. Olson\n(xix) Agreement dated November 21, 1994 between Gibson Greetings, Inc. and Nelson J. Rohrbach\n11 Computation of Income per Share\n21 Subsidiaries of the Registrant\n- ----------------------\n* Filed as an Exhibit to the document indicated and incorporated herein by reference:\n(1) The Company's Report on Form 10-K for the year ended December 31, 1988.\n(2) The Company's Report on Form 10-K\/A (Amendment No. 1) for the year ended December 31, 1993.\n(3) The Company's Report on Form 8-K dated December 28, 1987, filed January 4, 1988.\n(4) The Company's Registration Statement on Form S-8 (No. 2-82990).\n(5) The Company's Registration Statement on Form S-8 (No. 2-96396).\n(6) The Company's Report on Form 10-K for the year ended December 31, 1985.\n(7) The Company's Report on Form 10-Q for the quarter ended September 30, 1986.\n(8) The Company's Report on Form 10-Q for the quarter ended June 30, 1993.\n(9) The Company's Report on Form 10-Q for the quarter ended June 30, 1991.\n(10) The Company's Report on Form 10-K for the year ended December 31, 1986.\n(11) The Company's Report on Form 10-K for the year ended December 31, 1992.\n(12) The Company's Report of Form 10-Q\/A (Amendment No.1) for the quarter ended March 31, 1994.\n(13) The Company's Report on Form 10-Q for the quarter ended September 30, 1994.\n- ----------------------\nThe Company will furnish to the Commission upon request its long-term debt instruments not listed above.\nPAGE","section_15":""}
{"filename":"914174_1994.txt","cik":"914174","year":"1994","section_1":"Item 1. Business\nUnless the context otherwise requires, the term \"Company\" refers to Canandaigua Wine Company, Inc. and its subsidiaries, all references to \"net sales\" refer to gross revenues less excise taxes and returns and allowances to conform with the Company's method of classification, and all references to the Company's fiscal year shall refer to the year ended August 31 of the indicated year. Market share and industry data disclosed in this Report have been obtained from the following industry publications: Wines & Vines; The Gomberg-Fredrikson Report; Jobson's Liquor Handbook; Jobson's Wine Handbook; The U.S. Wine Market: Impact Databank Review and Forecast, 1994 Edition; The U.S. Beer Market: Impact Databank Review and Forecast, 1994 Edition; Beer Marketer's Insights: 1994 Import Insights; and 1994 Beer Industry Update. The Company has not independently verified this data. References to market share data are based on unit volume.\nThe Company is a Delaware corporation organized in 1972 as the successor to a business founded in 1945 by Marvin Sands, Chairman of the Board of the Company.\nThe Company is a leading producer and marketer of branded beverage alcohol products, with over 125 national and regional brands which are distributed by over 1,000 wholesalers throughout the United States and in selected international markets. The Company is the second largest supplier of wines, the fourth largest importer of beers and the eighth largest supplier of distilled spirits in the United States. The Company's beverage alcohol brands are marketed in five general categories: table wines, sparkling wines, dessert wines, imported beer and distilled spirits, and include the following principal brands:\n. Table Wines: Almaden, Inglenook, Paul Masson, Taylor California Cellars, Cribari, Manischewitz, Taylor New York, Marcus James, Deer Valley and Dunnewood\n. Sparkling Wines: Cook's, J. Roget, Great Western and Taylor New York\n. Dessert Wines: Richards Wild Irish Rose, Cisco, Taylor New York and Italian Swiss Colony\n. Imported Beer: Corona, St. Pauli Girl, Modelo Especial, Tsingtao and Pacifico\n. Distilled Spirits: Barton's Gin and Vodka, Ten High Bourbon Whiskey, Crystal Palace Gin and Vodka, Montezuma Tequila, Northern Light Canadian Whisky, Lauder's Scotch Whisky and Monte Alban Mezcal\nBased on available industry data, the Company believes it has a 21% share of the wine market, a 10% share of the imported beer market and a 4% share of the distilled spirits market in the United States. Within the wine market, the Company believes it has a 31% share of the non-varietal table wine market, a 10% share of the varietal table wine market, a 50% share of the dessert wine market and a 32% share of the sparkling wine\nmarket. Many of the Company's brands are leaders in their respective categories in the United States, including Corona, the second largest selling imported beer brand, Almaden and Inglenook, the fifth and sixth largest selling wine brands, Richards Wild Irish Rose, the largest selling dessert wine brand, Cook's champagne, the second largest selling sparkling wine brand, Montezuma, the second largest selling tequila brand, and Monte Alban, the largest selling mezcal brand.\nDuring the past four years, the Company has diversified its product portfolio through a series of strategic acquisitions that have resulted in an increase in the Company's net sales from $176.6 million in fiscal 1991 to $876.4 million on a pro forma basis in fiscal 1994. Through these acquisitions, the Company acquired strong market positions in growing product categories in the beverage alcohol industry, such as varietal table wine and imported beer. The Company ranks second and fourth in the varietal table wine and imported beer categories, respectively. Over the past four years, industry shipments of varietal table wine and imported beer have grown 64% and 7%, respectively. The Company has successfully integrated the acquired businesses into its existing business and achieved significant cost reductions through reduced product and organizational costs. The Company has also strengthened its relationship with wholesalers, expanded its distribution and enhanced its production capabilities as well as acquired additional management, operational, marketing and research and development expertise.\nIn October 1991, the Company acquired the Cook's, Cribari, Dunnewood and other brands and related facilities and assets (the \"Guild Acquisition\") from Guild Wineries and Distillers (\"Guild\"), which enabled the Company to establish a significant market position in the California sparkling wine category and to enter the California table wine market. The Company acquired Barton Incorporated (\"Barton\") in June 1993, further diversifying into the imported beer and distilled spirits categories (the \"Barton Acquisition\"). On October 15, 1993, the Company acquired the Paul Masson, Taylor California Cellars and other brands and related facilities and assets of Vintners International Company, Inc. (\"Vintners\") (the \"Vintners Acquisition\"). On August 5, 1994, the Company acquired the Almaden, Inglenook and other brands, a grape juice concentrate business and related facilities and assets (the \"Almaden\/Inglenook Product Lines\") from Heublein Inc. (the \"Almaden\/Inglenook Acquisition,\" and together with the Barton Acquisition and the Vintners Acquisition, the \"Acquisitions\"). See \"Recent Acquisitions.\"\nThe Company's business strategy is to continue to strengthen its market position in each of its principal product lines. Key elements of its strategy include: (i) making selective acquisitions in the beverage alcohol industry to improve market position and capitalize on growth trends within the industry; (ii) improving operating efficiencies through reduced product and organizational costs of existing and acquired businesses; (iii) capitalizing on strong wholesaler relationships resulting from its expanded portfolio of brands; and (iv) expanding distribution into new markets and increasing penetration of existing markets primarily through line extensions and promotional activities.\nIn furtherance of its business strategy of improving operating efficiencies of acquired businesses, the Company announced a plan to restructure the operations of its California wineries, including a consolidation of facilities, centralization of bottling operations and\nreduction of overhead, including the elimination of approximately 260 jobs (the \"Restructuring Plan\"). As a result of the Restructuring Plan, the Company has taken a charge in the fourth quarter of fiscal 1994 which reduced after-tax income for fiscal 1994 by $14.9 million, or $0.91 per share on a fully diluted basis. The Company anticipates that the Restructuring Plan will result in net cost savings of approximately $1.7 million in fiscal 1995 and approximately $13.3 million of annual net cost savings beginning in fiscal 1996. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nRECENT ACQUISITIONS\nThe Barton Acquisition. On June 29, 1993, the Company acquired all of the outstanding shares of capital stock of Barton. Barton is the United States' fourth largest importer of beers and eighth largest supplier of distilled spirits. The Barton Acquisition has enabled the Company to diversify within the beverage alcohol industry by participating in the imported beer and distilled spirits markets, which have similar marketing approaches and distribution channels to the Company's wine business, and to take advantage of the experienced management team that developed Barton as a successful company. With this acquisition, the Company acquired the right to distribute Corona and Modelo Especial beer in 25 primarily western states, national distribution rights for St. Pauli Girl and Tsingtao and a diversified line of distilled spirits including Barton Gin and Vodka, Ten High Bourbon Whiskey and Montezuma Tequila.\nBarton is being operated independently by its current management as a subsidiary of the Company. Until August 31, 1996, consistent with past practices and subject to annual approval by the Company's Board of Directors of an annual operating plan for the coming year, Ellis M. Goodman, the Chief Executive Officer of Barton, has full and exclusive strategic and operational responsibility for Barton and all of its subsidiaries.\nThe Vintners Acquisition. On October 15, 1993, the Company acquired substantially all of the assets of Vintners, and assumed certain liabilities. Vintners was the United States' fifth largest supplier of wine with two of the country's most highly recognized brands, Paul Masson and Taylor California Cellars. The Vintners Acquisition enabled the Company to expand its wine portfolio to include several large and highly recognized table wine brands that are distributed by a substantially common wholesaler network. Vintners' operations were immediately integrated with those of the Company at the closing of the acquisition. With this acquisition, the Company acquired the Paul Masson, Taylor California Cellars, Taylor New York, Deer Valley, St. Regis (non- alcoholic) and Great Western brands and related facilities.\nThe Almaden\/Inglenook Acquisition. On August 5, 1994, the Company acquired the Almaden and Inglenook brands, the fifth and sixth largest selling table wines in the United States, a grape juice concentrate business, and wineries in Madera and Escalon, California, from Heublein. The Company also acquired Belaire Creek Cellars, Chateau La Salle and Charles Le Franc table wines, Le Domaine champagne and Almaden, Hartley and Jacques Bonet brandy. The accounts receivable and the accounts payable related to the acquired assets were not acquired by the Company.\nAs a result of the Almaden\/Inglenook Acquisition, the Company has strengthened its position as the second largest supplier of wines in the United States. The acquisition of the Inglenook brand significantly expands the Company's restaurant and bar on-premises presence. The Company intends to maintain the existing sales force and distribution network of the Almaden and Inglenook brands. Further, the Almaden\/Inglenook Acquisition has resulted in the Company becoming the leading grape juice concentrate producer in the United States. The Company believes that the Almaden\/Inglenook Acquisition will enable the Company to achieve significant cost savings through the consolidation of its California winery operations.\nHeublein also agreed not to compete with the Company in the United States and Canada for a period of five years following the closing of the Almaden\/Inglenook Acquisition in the production and sale of grape juice concentrate or sale of packaged wines bearing the designation \"Chablis\" or \"Burgundy\" except where, among other exceptions, such designations are currently used with certain brands retained by Heublein. Certain companies acquired by Heublein, however, may compete directly with the Company.\nINDUSTRY\nThe beverage alcohol industry in the United States consists of the production, importation, marketing and distribution of beer, wine and distilled spirits products. Over the past five years there has been increasing consolidation at the supplier, wholesaler and, in some markets, retailer tiers of the beverage alcohol industry. As a result, it has become advantageous for certain suppliers to expand their portfolio of brands through acquisitions and internal development in order to take advantage of economies of scale and to increase their importance to a more limited number of wholesalers and, in some markets, retailers. From 1978 through 1993, the overall per capita consumption of beverage alcohol products in the United States has generally declined. However, table wines, and in particular varietal table wines, and imported beer consumption have increased during the period.\nThe following table sets forth the industry unit volumes for shipments of beverage alcohol products in the Company's five principal beverage alcohol product categories in the United States for the five calendar years ended December 31, 1993:\n(a) Units are in thousands of gallons. Data exclude sales of wine coolers. (b) Includes other special natural (flavored) wines under 14% alcohol. (c) Includes dessert wines, other special natural (flavored) wines over 14% alcohol and vermouth. (d) Units are in thousands of cases (2.25 gallons per case). (e) Units are in thousands of 9-liter cases (2.378 gallons per case).\nTable Wines. Wines containing 14% or less alcohol by volume are generally referred to as table wines. Within this category, table wines are further characterized as either \"non-varietal\" or \"varietal.\" Non- varietal wines include wines named after the European regions where similar types of wines were originally produced (e.g., burgundy), niche products and proprietary brands. Varietal wines are those named for the grape that comprises the principal component of the wine. Table wines that retail at less than $5.75 per 750 ml. bottle are generally considered to be popularly priced while those that retail at $5.75 or more per 750 ml. bottle are considered premium wines.\nFrom 1989 to 1993, shipments of domestic table wines increased at an average compound annual rate of approximately 1.5%. In 1992, domestic table wine shipments increased 8% from the previous year; this rate of increase was markedly larger than in previous years and was attributed in large part to the November 1991 CBS television 60 Minutes, French Paradox broadcast about the healthful benefits of moderate red wine consumption. In 1993, domestic table wine shipments declined by 2.3% when compared to 1992. This decline has been attributed to an overall wholesale and retail wine inventory surplus at the end of 1992. Based on shipments of California table wines, which constituted approximately 94% of the total domestically produced table wine market in 1993, shipments of varietal wines have grown at an average compound annual rate of 13.3% since 1989, with shipments in the first half of 1994 increasing 16% over the prior year. In contrast, shipments of non-varietal table wines have generally declined over the same period although they showed a slight increase in\n1992 as compared to 1991. For the first half of calendar 1994, shipments of California table wines increased approximately 7% over the same period in 1993. Shipments of imported table wines have generally decreased over the last six years, decreasing from 58.9 million gallons in 1989 to 52.4 million gallons in 1993. Imported table wines constituted 15% of the United States table wine market in calendar 1993.\nDessert Wines. Wines containing more than 14% alcohol by volume are generally referred to as dessert wines. Dessert wines generally fall into the same price categories as table wines. Dessert wine consumption in the United States has been declining for many years reflecting a general shift in consumer preferences to table and sparkling wines. For calendar year 1993, shipments of domestic dessert wines decreased 9.9% over calendar year 1992, a lesser rate than from 1989 to 1993, during which period shipments of domestic dessert wines declined at an average compound annual rate of 14.2%. Dessert wines, which are generally popularly priced, have been adversely affected by the January 1, 1991 increase in federal excise taxes which had the effect of increasing the cost of these products to the consumer disproportionately with certain other beverage alcohol products. Shipments of dessert wines continued to decline during the first half of calendar 1994 as compared to the first half of calendar 1993 as is evidenced by a 7% decline during this period in shipments of California dessert wines, which constituted approximately 73% of the domestically produced dessert wine market in 1993.\nSparkling Wines. Sparkling wines include effervescent wines like champagne and spumante. Sparkling wines generally fall into the same price categories as table wines. Shipments of sparkling wines declined at an average compound annual rate of 2.9% from 1989 to 1993; with shipments of domestic sparkling wines declining 0.8% in calendar 1993 as compared to calendar 1992. The decline in sparkling wine consumption is believed to reflect mounting concerns about drinking and driving, as a large part of sparkling wine consumption occurs outside the home at social gatherings and restaurants. Shipments of sparkling wines continued to decline during the first half of 1994 as compared to the first half of 1993 as is evidenced by a decline of 12% during this period in shipments of California sparkling wines which constituted approximately 92% of the domestically produced sparkling wine market in 1993. The Company believes that shipments in the first half of 1994 were also adversely affected by high levels of retail inventory at the beginning of the period.\nImported Beer. Shipments of imported beers have increased at an average compound annual rate of 1.7% from 1989 to 1993. Shipments of Mexican beers in calendar 1993 increased 10.4% over 1992. During the first half of calendar 1994 as compared to the corresponding period in 1993, shipments of Mexican beers increased 14.5% as compared to an increase of 19.3% for the entire imported beer category. In 1993, imported beers constituted 4.9% of the United States beer market. This reflects an increase from 1992 when imported beers constituted 4.4% of the United States beer market. Imported beers are generally priced above the leading domestic premium brands. This price category also includes beers produced by microbreweries and super-premium priced domestic beers.\nDistilled Spirits. Shipments of distilled spirits in the United States declined at an average compound annual rate of 1.9% from 1989 to 1993. Although shipments increased slightly in calendar 1992 as compared to calendar 1991, shipments again declined in calendar 1993 by 2.6% when\ncompared to calendar 1992. Shipments of distilled spirits have been affected by many of the same trends evident in the rest of the beverage alcohol industry. Over the past five years, whiskey sales have declined significantly while sales of rum, tequila, cordials and liqueurs have increased. The Company believes that distilled spirits can be divided into two general price segments, with distilled spirits selling for less than $7.00 a 750 ml. bottle being referred to as price value products and those selling for over $7.00 a 750 ml. bottle being referred to as premium products.\nPRODUCT CATEGORIES\nThe Company produces, imports and markets beverage alcohol products in five principal product categories: table wines, dessert wines, sparkling wines, imported beer and distilled spirits. The table below sets forth the unit volumes (in thousands of gallons) and net sales (in thousands) for all of the table, dessert and sparkling wines, grape juice concentrate and other wine related products and services sold by the Company and under brands and products acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition for the 1992, 1993 and 1994 fiscal years.\n(a) Data for fiscal years ended August 31, 1992, 1993 and 1994. The data for the Company's fiscal year ended August 31, 1994 excludes the net sales for the brands and other products acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition.\n(b) Data for fiscal years ended July 31, 1992 and 1993 and for the twelve months ended August 31, 1994.\n(c) Data for fiscal years ended September 30, 1992 and 1993 and for the twelve months ended August 31, 1994.\nTable Wines. The Company sells over 45 different brands of non- varietal table wines, substantially all of which are marketed in the popularly priced segment which constituted approximately 43% of the domestic table wine market in the United States for the 1993 calendar year. The Company also sells over 15 different brands of varietal table wines in both the popularly priced and premium categories. The table\nbelow sets forth the unit volumes (in thousands of gallons) for the domestic table wines sold by the Company and under domestic table wine brands acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition for the 1992, 1993 and 1994 fiscal years:\n(a) Excludes sales of wine coolers but includes sales of wine in bulk.\nThe Company's table wine brands include:\nAlmaden: The fifth largest selling table wine brand and the ninth largest varietal wine brand in the United States. Almaden is one of the oldest and best known table wines in the United States.\nInglenook: The sixth largest selling table wine brand and the seventh largest varietal wine in the United States with a significant restaurant and bar presence.\nPaul Masson: The 11th largest selling table wine brand in the United States which is offered in all major varietal and non-varietal product categories in a full range of sizes.\nTaylor California Cellars: The 14th largest domestic selling table wine brand in the United States which is also offered in all major varietal and non-varietal product categories in a full range of sizes.\nCribari: A well known brand of both varietal and non-varietal table wines marketed in the popularly priced segment.\nManischewitz: The largest selling brand of kosher wine in the United States.\nTaylor New York: One of the United States' oldest brands of non- varietal wine marketed primarily in the eastern half of the United States.\nRichards Wild Irish Rose: A brand of table wine possessing unique taste characteristics which is a line extension of the nation's leading dessert wine brand.\nDeer Valley: This line of California varietal and non-varietal table wines introduced in 1989 has had significant success in California. The Company is in the process of introducing this brand in other regions of the country.\nCook's: This varietal wine was created to take advantage of the brand recognition associated with Cook's sparkling wines.\nDunnewood: From California's north coast, unit volumes of this varietal wine have also increased significantly. This brand is marketed at the lower end of the premium price category.\nThe Company has pursued a strategy of increasing its unit volume sales in the table wine segment by acquiring new brands and by growing existing brands. The Company's unit volume sales of non-varietal table wines increased from approximately 9.3 million gallons in fiscal 1992 to approximately 52.6 million gallons on a pro forma basis for fiscal 1994 as a result of the Vintners Acquisition and the Almaden\/Inglenook Acquisition. Likewise, the Company's unit volume sales of varietal table wines increased from approximately 1.1 million gallons in fiscal 1992 to over 12.8 million gallons on a pro forma basis for fiscal 1994 as a result of the Vintners Acquisition and the Almaden\/Inglenook Acquisition. The Company believes that its recent acquisition of the Almaden\/Inglenook Product Lines, including the Almaden and Inglenook brands, creates additional opportunities for growth in this product category.\nThe 1993 decrease in unit volume of Vintners' table wines resulted from a number of factors including a significant decrease in Vintners' expenditures for advertising, promotion and selling activities during the three year period ended July 31, 1993. The Company believes that this decrease resulted in a reduction in the level of wholesaler attention paid to Vintners' brands, and the Company believes that certain of Vintners' products were not competitively priced. During the Company's fiscal 1994, unit volume sales of Vintners table wines continued to decline. During fiscal 1994, the Company implemented steps to address this decline, including a reduction in prices for its Taylor California brands, the implementation of new promotional programs and repackaging of selected products. As a result of these efforts, the Company believes that sales of Vintners' brands have begun to stabilize.\nThe Company also markets a selection of popularly priced imported table wines. These brands include:\nMarcus James: One of the largest selling imported varietal wines in the United States. Marcus James is a line of varietal table wines which includes white zinfandel, chardonnay, cabernet sauvignon and merlot. The Company owns the Marcus James brand and contracts for its production in Brazil.\nPartager: A popularly priced French table wine with both varietal and non-varietal products. The Company owns the Partager brand and contracts for its production in France.\nMateus: The second largest selling Portuguese table wine and a highly recognized brand name. This brand is imported by the Company under a distribution agreement.\nThe Company's unit volume sales of imported wine increased steadily from 1.3 million gallons in fiscal 1992 to 1.9 million gallons in fiscal 1994. This increase is attributable primarily to increased sales of the Marcus James brand and the inclusion of a full year of Mateus sales. Including sales of Partager by Vintners prior to its acquisition by the Company, on a pro forma basis for fiscal 1994, the Company sold approximately 2.0 million gallons of imported table wines.\nDessert Wines. The Company markets substantially all of its dessert wines in the lower end of the popularly priced segment. The popularly priced segment represented approximately 88% of the dessert wine market in calendar 1993. Sales of dessert wines comprised 10.2% of the Company's total revenues during the fiscal year ended August 31, 1994, on a pro forma basis. The table below sets forth the unit volumes (in thousands of gallons) for the domestic dessert wines sold by the Company and under domestic dessert wine brands acquired in the Vintners Acquisition for the 1992, 1993 and 1994 fiscal years:\nThe Company's dessert wines include:\nRichards Wild Irish Rose: The largest selling dessert wine brand in the United States and the Company's leading dessert wine brand in unit volume sales.\nCisco: The fourth largest selling dessert wine brand in the United States. Cisco is a flavored dessert wine positioned higher in price than Richards Wild Irish Rose.\nTaylor New York: Premium dessert wines, including port and sherry.\nThe Company's unit volume sales of dessert wines have declined over the last three years. The decline can be attributed to a general decline in dessert wine consumption in the United States. The Company's unit volume sales of its dessert wine brands (including the brands acquired from Vintners) have decreased 26.9% from fiscal 1992 to fiscal 1994.\nSparkling Wines. The Company markets substantially all of its sparkling wines in the popularly priced segment, which constituted\napproximately 48% of the domestic sparkling wine market in calendar 1993. The table below sets forth the unit volumes (in thousands of gallons) for the domestic sparkling wines sold by the Company and under domestic sparking wine brands acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition for the 1992, 1993 and 1994 fiscal years:\nThe Company's sparkling wine brands include:\nCook's: The second largest selling domestic sparkling wine in the United States. This brand of champagne is marketed in a bell shaped bottle and is cork-finished, packaging generally associated with higher priced products.\nJ. Roget: The sixth largest selling domestic sparkling wine in the United States, priced slightly below Cook's.\nGreat Western: A premium priced champagne, fermented in the bottle.\nTaylor New York: A well known premium priced champagne also fermented in the bottle.\nCodorniu: The second largest Spanish sparkling wine imported in the United States; sold in the premium price category.\nJacques Bonet: Priced in the economy segment, this product appeals to restaurants and caterers.\nThe Company has maintained sales levels of sparkling wine over the last three years in contrast to a general industry decline in sales for this product category.\nGrape Juice Concentrate. As part of its wine business, the Company produces grape juice concentrate. Grape juice concentrate is sold to the food and wine industries as a raw material for the production of juice- based products, no-sugar-added foods and beverages. Grape juice concentrate competes with other domestically produced and imported fruit- based concentrates. As a result of the Almaden\/Inglenook Acquisition, the Company believes that it is the leading grape juice concentrate producer in the United States. Sales of grape juice concentrate accounted for approximately 11% and 12% of the Company's net sales for its fiscal years ended 1992 and 1993, respectively. The table below sets forth the unit volumes (in thousands of gallons) for the grape juice concentrate sold by the Company and the grape juice concentrate business acquired in the Almaden\/Inglenook Product Lines for the 1992, 1993 and 1994 fiscal years:\nOther Wine Product and Related Services. The Company's other wine related products and services include: grape juice; St. Regis, the leading non-alcoholic line of wines in the United States; Paul Masson and other brandies; wine coolers sold primarily under the Sun Country brand name; cooking wine; and wine for the production of vinegar. The Company also provides various bottling and distillation production services for third parties.\nBeer. The Company is the fourth largest marketer of imported beers in the United States. The Company distributes Corona, St. Pauli Girl, Modelo Especial and Tsingtao, four of the top imported beer brands in the United States. The table below sets forth the unit volume (in thousands of cases) and net sales (in thousands) for the beer sold by Barton for the years ended August 31:\n1992 1993 1994\nNET VOLUME NET VOLUME NET VOLUME SALES SALES SALES\n$131,868 10,152 $158,359 12,422 $173,883 14,100\nThe Company's principal imported beer brands include:\nCorona: The number one selling beer in Mexico and the second largest selling imported beer in the United States. In addition, the Company believes that Corona is the largest selling import in the territory in which it is distributed by the Company. The Company has represented the supplier of Corona since 1978 and currently sells Corona and its related Mexican beer brands in 25 primarily western states.\nSt. Pauli Girl: The 15th largest selling imported beer in the United States, and the second largest selling German import.\nModelo Especial: One of the family of products imported from the supplier of Corona, Modelo Especial is the number one selling canned beer in Mexico and is growing in the United States with 1994 shipments into the United States increasing by 57% over 1993 shipments in the same period.\nTsingtao: The largest selling Chinese beer in the United States.\nThe Company's other imported beer brands include Pacifico and Negra Modelo from Mexico, Peroni from Italy and Double Diamond from the United\nKingdom. In September 1992 the Company acquired the Stevens Point Brewery, a regional brewer located in Wisconsin, together with its brands including Point Special.\nNet sales and unit volumes of the Company's beer brands have grown during the previous two fiscal years as a result of the acquisition of the St. Pauli Girl and Double Diamond brands on July 1, 1992, the acquisition of the Point brands in September 1992 and increased sales of Corona and the Company's other Mexican beer brands. The Company's selling prices were not increased significantly over this time period.\nDistilled Spirits. The Company is the eighth largest producer, importer and marketer of distilled spirits in the United States. The Company produces, bottles, imports and markets a diversified line of quality distilled spirits, and also exports distilled spirits to more than 15 foreign countries. The table below sets forth the unit volumes (in thousands of 9-liter cases) and net sales (in thousands) for the distilled products case goods sold by Barton for the years ended August 31:\n1992 1993 1994\nNET VOLUME NET VOLUME NET VOLUME SALES SALES SALES\n$82,677 5,609 $82,270 5,529 $81,367 5,370\nThe Company's leading distilled spirits brands include:\nMonte Alban: A premium priced product which the Company believes is the number one selling mezcal in the United States.\nMontezuma: This brand is the number two selling tequila in the United States.\nTen High Bourbon: One of the leading bourbon brands in the United States.\nBarton Gin and Vodka: Well-known leading national brands.\nOther products include Crystal Palace Gin and Vodka, Lauder's, House of Stuart and Highland Mist Scotch whiskeys, Kentucky Gentleman, Very Old Barton and Tom Moore bourbon whiskeys, Sabroso coffee liqueur, Northern Light, Canadian Host and Canadian Supreme Canadian whiskeys and Imperial, Barton Reserve and Barton Premium blended whiskeys. Substantially all of the Company's unit volume consists of products marketed in the price value segment, which the Company believes constituted approximately 50% of the distilled spirits market in calendar 1993.\nNet sales and unit volumes of the Company's distilled spirits brands have decreased 1.6% and 4.3%, respectively, over the periods shown, there have been changes in sales of particular brands. Unit volumes of vodka and tequila have increased while Scotch and bourbon have experienced\ndecreases in unit volume. Net sales have generally not been affected by price increases.\nIn addition to the branded products described above, the Company also sells distilled spirits in bulk and provides contract production and bottling services. These activities accounted for net sales during the 12 month periods ended August 31, 1992, 1993 and 1994 of $11.8 million, $10.6 million and $7.0 million, respectively.\nMarketing and Distribution\nThe Company's products are distributed and sold throughout the United States through over 1,000 wholesalers, as well as through state alcoholic beverage control agencies. The Company employs a full-time in-house sales organization of approximately 350 people to develop and service its sales to wholesalers and state agencies. The Company's sales force is organized in four sales units: a beer unit, a spirits unit and two wine units, one of which focuses on the newly acquired brands purchased in the Almaden\/Inglenook Acquisition. The Company believes that the organization of its sales force into four divisions positions it to maintain a high degree of focus on each of its principal product categories.\nThe Company's marketing strategy places primary emphasis upon promotional programs directed at its broad national distribution network (and to the retailers served by that network). The Company closely manages its advertising expenditures in relation to the performance of its brands. The Company has extensive marketing programs for its brands including television, radio, outdoor and print advertising, promotional programs on both a national basis and regional basis in accordance with the strength of the brands, event sponsorship, market research, point-of- sale materials, trade advertising and public relations.\nTrademarks and Distribution Agreements\nThe Company's wine products are sold under a number of trademarks. All of these trademarks are either owned by the Company or used by the Company under exclusive license or distribution agreements.\nThe Company also owns the following trademarks used in its distilled spirits business: Montezuma, House of Stuart, Highland Mist, Kentucky Gentleman, Barton, Canadian Supreme and Sabroso. The Monte Alban trademark for use outside of Mexico is jointly owned by the Company and the supplier of Monte Alban Mezcal. The Company owns the world-wide sales and marketing rights outside of Mexico.\nIn September 1989, Barton purchased certain assets from Hiram Walker & Sons, Inc. (\"Hiram Walker\") and obtained licenses to use the trade names Ten High, Crystal Palace, Northern Light, Lauder's, and Imperial for an initial seven year period. Under an agreement dated January 28, 1994, the Company paid $5.1 million to Hiram Walker for the extension of licenses to use these brand names and certain other spirits brands, for varying periods, the longest of which terminates in 2116.\nAll of the Company's imported beer products are marketed and sold pursuant to exclusive distribution agreements from the suppliers of these products. These agreements have terms that vary and prohibit the Company from importing other beers from the same country. The Company's agreement\nto distribute Corona and its other Mexican beer brands exclusively throughout 25 states was renewed effective January 1994 and expires in December 1998 with automatic renewal thereafter for one year periods from year to year unless terminated. Under this agreement, the Mexican supplier has the right to consent to Mr. Goodman's successor as Chairman and Chief Executive Officer of Barton's beer subsidiary, which consent may not be unreasonably withheld, and, if such consent is properly withheld, to terminate the agreement. The Company's agreement for the importation of St. Pauli Girl expires in 1998 with automatic renewal until 2003 unless the Company terminates the Agreement. The Company's agreement for the exclusive importation of Tsingtao throughout the entire United States was renewed effective January 1994 and expires in December 1996 with an automatic renewal to December 1999. Prior to their expiration, these agreements may be terminated if the Company fails to meet certain performance criteria. The Company believes it is currently in compliance with all of its material distribution agreements. Given the Company's long-term relationships with its suppliers, the Company does not believe that these agreements will be terminated and expects that such agreements will be renewed prior to their expiration.\nCOMPETITION\nThe beverage alcohol industry is highly competitive. The Company competes on the basis of quality, price, brand recognition and distribution. The Company's beverage alcohol products compete with other alcoholic and non-alcoholic beverages for consumer purchases, as well as shelf space in retail stores and for marketing focus by the Company's wholesalers. The Company competes with numerous multinational producers and distributors of beverage alcohol products, many of which have significantly greater resources than the Company. The Company's principal competitors include E&J Gallo Winery in the wine category, Van Munching & Co., Molson Breweries USA and Guinness in the imported beer category and United Distillers Glenmore and Jim Beam Brands in the distilled spirits category.\nPRODUCTION\nThe Company's wines are produced from several varieties of wine grapes grown principally in California and New York. The grapes are crushed at the Company's wineries and stored as wine, grape juice or concentrate. Such grape products may be made into wine for sale under the Company's brand names, sold to other companies for resale under their own labels, or shipped to customers in the form of juice, juice concentrate, unfinished wines, high-proof grape spirits or brandy. Most of the Company's wines are bottled and sold within 18 months after the grape crush. The Company's inventories of wines, grape juice and concentrate are usually at their highest levels in November and December, immediately after the crush of each year's grape harvest, and are substantially reduced prior to the subsequent year's crush.\nThe bourbon whiskeys, domestic blended whiskeys and light whiskeys marketed by the Company are primarily produced and aged by the Company at its distillery in Bardstown, Kentucky, though it may from time to time supplement its inventories through purchases from other distillers. At its Atlanta, Georgia facility, the Company produces all of the grain neutral spirits used by it in the production of vodka, gin and blended whiskey sold by it to customers in the state of Georgia. The Company's\nrequirements of Canadian and Scotch whiskeys, and tequila, mezcal, and the grain neutral spirits used by it in the production of gin and vodka for sale outside of Georgia, and other spirits products, are purchased from various suppliers.\nSources and Availability of Raw Materials\nThe principal components in the production of the Company's branded beverage alcohol products are: packaging materials, primarily glass; grapes; and other agricultural products, such as grain.\nThe Company utilizes glass bottles and other materials, such as caps, corks, capsules, labels and cardboard cartons in the bottling and packaging of its products. Glass bottle costs is one of the largest components of the Company's cost of product sold. The glass bottle industry is highly concentrated with only a small number of producers. The Company has traditionally obtained, and continues to obtain, its glass requirements from a limited number of producers. The Company has not experienced difficulty in satisfying its requirements with respect to any of the foregoing and considers its sources of supply to be adequate. However, the inability of any of the Company's glass bottle suppliers to satisfy the Company's requirements could adversely affect the Company's operations.\nMost of the Company's annual grape requirements are satisfied by purchases from each year's harvest, which occurs from July through October. The Company owns no vineyards in California and purchases grapes from over 1,000 independent growers principally in California and New York. In connection with the Vintners Acquisition and the Almaden\/Inglenook Acquisition, the Company acquired certain long term grape purchase contracts. The Company enters into written purchase agreements with a majority of these growers on a year-to-year basis. As a result of this ample grape supply the Company believes that its exposure to phylloxera and other agricultural risks is minimal.\nThe distilled spirits manufactured by the Company require various agricultural products, neutral grain spirits and bulk spirits. The Company fulfills its requirements through purchases from various sources, through contractual arrangements and through purchases on the open market. The Company believes that adequate supplies of the aforementioned products are available at the present time.\nGOVERNMENT REGULATION\nThe Company's operations are subject to extensive federal and state regulation. These regulations cover, among other matters, sales promotion, advertising and public relations, labeling and packaging, changes in officers or directors, ownership or control, distribution methods and relationships, and requirements regarding brand registration and the posting of prices and price changes. All of the Company's facilities are also subject to federal, state and local environmental laws and regulations and the Company is required to obtain permits and licenses to operate its facilities. The Company believes that it is in compliance in all material respects with all presently applicable governmental laws and regulations and that the cost of administration of compliance with such laws and regulations does not have, and is not\nexpected to have, a material adverse impact on the Company's financial condition or results of operations.\nEMPLOYEES\nThe Company has approximately 2,650 full-time employees, approximately 900 of whom are covered by collective bargaining agreements. The Company's collective bargaining agreement covering 368 employees at the Mission Bell winery has expired and negotiations have commenced. Additional workers may be employed by the Company during the grape crushing season. The Company considers its employee relations to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company currently operates 15 wineries, two bottling and distilling plants, one bottling and rectifying plant and a brewery, all of which include warehousing and distribution facilities on the premises. The Company considers its principal facilities to be the Mission Bell winery in Madera, California, the Canandaigua, New York winery, and the Gonzales, California winery and the distilling and bottling facility located in Bardstown, Kentucky. Under the Restructuring Plan, the Central Cellars winery located in Lodi, California and the Soledad, California winery will be closed and offered for sale to reduce excess capacity.\nIn New York, the Company operates four wineries located in Canandaigua, Naples, Batavia and Hammondsport. The Hammondsport winery lease, acquired in the Vintners Acquisition, expires in April 1995. Production at this winery will be consolidated at the Company's other New York wineries.\nThe Company currently operates 11 winery facilities in California, including Central Cellars and Soledad Cellars which are to be closed. In the Almaden\/Inglenook Acquisition, the Company acquired two new facilities located in Escalon and Madera, California. The Madera winery (known as the Mission Bell winery) is a crushing, wine production, bottling and distribution facility and a grape juice concentrate production facility. The Mission Bell winery will absorb the production of Central Cellars. The Escalon facility is operated under a long-term lease with an option to buy. As part of the Restructuring Plan, the branded wine bottling operations at the Gonzales, California facility where Paul Masson and Taylor Cellars are currently bottled will be moved to the Mission Bell winery during fiscal 1995. The other wineries operated in California are located in Lodi, McFarland, Madera, Fresno and Ukiah.\nThe Company operates three facilities that produce and\/or bottle and store distilled spirits. It owns production, bottling and storage facilities in Bardstown, Kentucky and Atlanta, Georgia, and operates a bottling plant in Carson, California, near Los Angeles, under a management contract. The Bardstown facility distills, bottles and warehouses whiskey for the Company's account and on a contractual basis for other participants in the industry. The Company also owns a production plant in Atlanta, Georgia which produces vodka, gin and blended whiskeys. The Carson plant receives distilled spirits in bulk from Bardstown and outside vendors, which it bottles and distributes. The Company also performs contract bottling at the Carson plant.\nThe Company owns a brewery in Stevens Point, Wisconsin where it produces and bottles Point beer. In addition, the Company owns and maintains its corporate headquarters in Canandaigua, New York, and leases office space in Chicago, Illinois, for its Barton headquarters.\nThe Company believes that all of its facilities are in good condition and working order and have adequate capacity to meet its needs for the foreseeable future.\nMost of the Company's real property has been pledged under the terms of collateral security mortgages as security for the payment of outstanding loans under the Credit Facility.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are subject to litigation from time to time in the ordinary course of business. Although the amount of any liability with respect to such litigation cannot be determined, in the opinion of management, such liability will not have a material adverse effect on the Company's financial condition or results of operations.\nIn connection with an investigation in the State of New Jersey into regulatory trade practices in the beverage alcohol industry, one employee of the Company was arrested in March 1994 and another employee has subsequently come under investigation in connection with providing \"free goods\" to retailers in violation of New Jersey beverage alcohol laws. Employees of several wholesalers and other alcoholic beverage manufacturers were also arrested or are under active investigation. Although the New Jersey Attorney General's office may expand its criminal investigation to include the Company and other manufacturers, to date, no grand jury subpoenas have been issued and no charges have been brought. The Company has cooperated with the Attorney General's office and, as a result of extensive discussions, the Attorney General's office has requested and the Company has submitted a detailed proposal to achieve a resolution of all civil, criminal and regulatory issues. The Company does not believe that the dollar amount of such a settlement or its effect on the Company's operations, if any, will be material.\nThe United States Environmental Protection Agency (the \"EPA\") and the Georgia Environmental Protection Division (the \"GEPD\") conducted a Compliance Evaluation Inspection (\"CEI\") of Barton Brands of Georgia, Inc. (\"Barton Georgia\"), a subsidiary of Canandaigua Wine Company, Inc., on February 15, 1994. The CEI was conducted to determine compliance with the Resource Conservation and Recovery Act (\"RCRA\"). Following the inspection, the EPA sent a report of its findings together with a transmittal letter, dated March 7, 1994, to Barton Georgia.\nBy letter dated March 21, 1994, the GEPD implemented enforcement action by serving Barton Georgia with a formal Notice of Violation alleging that between August 1991 and August 1993, Barton Georgia has violated certain regulations pertaining to (i) generation and accumulation of hazardous waste and (ii) hazardous waste burning in boilers. These alleged violations relate to the burning of fusel oil which is a mixture of alcohols created by the distillation process used\nin manufacturing various types of liquor products. Accompanying the Notice of Violation was a proposed settlement agreement in the form of a Consent Order between the GEPD and Barton Georgia. Following counterproposals, on October 21, 1994, Barton Georgia entered into a settlement agreement under the terms of a final Consent Order (the \"Order\") with the GEPD with respect to this matter. Under the Order, Barton Georgia has paid a stipulated civil penalty of $99,000, and will incur approximately $16,000 of other costs. Barton Georgia is not burning fusel oil in its current operations. The signing of the settlement agreement by Barton Georgia does not constitute any finding, determination or adjudication of liabiity on the part of Barton Georgia, nor any finding, determination or adjudication of a violation of any State or Federal laws, rules, standards or requirements; nor did Barton Georgia make any admission with respect thereto by signing the settlement agreement.\nExecutive Officers of the Company\nThe following table sets forth information with respect to the executive officers of the Company:\nNAME AGE OFFICE HELD\nMarvin Sands 70 Chairman of the Board Richard Sands 43 President and Chief Executive Officer Robert Sands 36 Executive Vice President and General Counsel Ellis M. Goodman 57 Executive Vice President of the Company and Chief Executive Officer of Barton Incorporated Lynn K. Fetterman 47 Senior Vice President, Chief Financial Officer and Secretary Chris Kalabokes 47 Senior Vice President, President of Wine Division Bertram E. Silk 62 Senior Vice President\nMarvin Sands is the founder of the Company, which is the successor to a business he started in 1945. He has been a director of the Company and its predecessor since 1946 and was Chief Executive Officer until October 1993. Marvin Sands is the father of Richard Sands and Robert Sands.\nRichard Sands, Ph.D. has been employed by the Company in various capacities since 1979. He was elected Executive Vice President and a director in 1982, became President and Chief Operating Officer in May 1986 and was elected Chief Executive Officer in October 1993. He is a son of Marvin Sands and the brother of Robert Sands.\nRobert Sands was appointed Executive Vice President, General Counsel in October 1993. He was elected a director of the Company in January 1990 and served as Vice President, General Counsel since June 1990. From June 1986, until his appointment as Vice President, General Counsel, Mr. Sands was employed by the Company as General Counsel. He is a son of Marvin Sands and the brother of Richard Sands.\nEllis M. Goodman has been a director and Vice President since July 1993 and was elected Executive Vice President in October 1993. Mr. Goodman has been Chief Executive Officer of Barton Incorporated since\n1987 and Chief Executive Officer of Barton Brands, Ltd. (predecessor to Barton Incorporated) since 1982.\nLynn K. Fetterman joined the Company during April 1990 as its Vice President, Finance and Administration, Secretary and Treasurer and was elected Senior Vice President, Chief Financial Officer and Secretary in October 1993. For more than 10 years prior to that, he was employed by Reckitt and Colman in various executive capacities, including Vice President, Finance of its Airwick Industries Division and Vice President, Finance of its Durkee-French Foods Division. Mr. Fetterman's most recent position with Reckitt and Colman was as its Vice President-Controller. Reckitt and Colman's principal business relates to consumer food and household products.\nChris Kalabokes joined the Company during October 1991 as President and Chief Executive Officer of the Company's Guild Wineries & Distilleries, Inc. subsidiary. During September 1992, he was appointed to the position of Vice President, President of the Wine Division of the Company and in October 1993 was appointed a Senior Vice President. For more than five years prior to joining the Company, he was employed by Guild. Mr. Kalabokes joined Guild in April 1985 as its Chief Financial Officer and continued in that position until June 1987 when he was promoted to President and Chief Executive Officer.\nBertram E. Silk has been a director and Vice President of the Company since 1973 and was elected Senior Vice President in October 1993. He has been employed by the Company since 1965. Currently, Mr. Silk is in charge of the Company's grape grower relations in California. Before moving from Canandaigua, New York to California in 1989, Mr. Silk was in charge of production for the Company. From 1989 to August 1994, Mr. Silk was in charge of the Company's grape juice concentrate business in California.\nPART II\nItem 5.","section_4":"","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nThe Company's Class A Common Stock and Class B Common Stock are quoted on the Nasdaq National Market under the symbols \"WINEA\" and \"WINEB\", respectively. The following table sets forth for the periods indicated the high and low sales prices of the Class A Common Stock and the Class B Common Stock as reported on the Nasdaq National Market.\nProperty, plant and equipment - Property, plant and equipment is stated at cost. Major additions and betterments are charged to property accounts, while maintenance and repairs are charged to operations as incurred. The cost of properties sold or otherwise disposed of and the related allowance for depreciation are eliminated from the accounts at the time of disposal and resulting gains or losses are included as a component of operating income.\nOther assets - Other assets which consist of goodwill, distribution rights, agency license agreements, trademarks, deferred financing costs, cash surrender value of officers' life insurance and other amounts, are stated at cost, net of accumulated amortization. Amortization is calculated on a straight-line or effective interest basis over periods ranging from five to forty years. At August 31, 1994, the weighted average of the remaining useful lives of these assets was approximately thirty-five years. The face value of the officers' life insurance policies totaled $2,852,000 in both 1994 and 1993.\nDepreciation - Depreciation is computed primarily using the straight-line method over the following estimated useful lives:\nDescription Depreciable Life Buildings and improvements 10 to 33 1\/3 years Machinery and equipment 7 to 15 years Motor vehicles 3 to 7 years\nAmortization of assets capitalized under capital leases is included with depreciation expense. Amortization is calculated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.\nIncome taxes -\nThe Company uses the liability method of accounting for income taxes. The liability method accounts for deferred income taxes by applying statutory rates in effect at the balance sheet date to the difference between the financial reporting and tax basis of assets and liabilities. In fiscal 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" which replaced Statement of Financial Accounting Standards No. 96, which was the standard the Company previously used. The cumulative effect of this change in accounting principle was not material to the Company's financial statements and was included in the fiscal 1992 tax provision.\nEnvironmental - Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and\/or remedial efforts are probable, and the cost can be reasonably estimated. Generally, the timing of these accruals coincides with completion of a feasibility study or the Company's commitment to a formal plan of action. At August 31,1994 and 1993, liabilities for environmental costs of $100,000 and $1,300,000, respectively, are recorded in other accrued liabilities.\nCommon stock - The Company has two classes of common stock: Class A Common Stock and Class B Common Stock. Class B Common Stock shares are convertible into shares of Class A Common Stock on a one-to-one basis at any time at the option of the holder. Holders of Class B Common Stock are entitled to ten votes per share. Holders of Class A Common Stock are entitled to only one vote per share but are entitled to a cash dividend premium. If the Company pays a cash dividend on Class B Common Stock, each share of Class A Common Stock will receive an amount at least ten percent greater than the amount of the cash dividend per share paid on Class B Common Stock. In addition, the Board of Directors may declare and pay a dividend on Class A Common Stock without paying any dividend on Class B Common Stock.\nOn September 26, 1991 and June 1, 1992, the Company approved three-for-two stock splits of both Class A and Class B Common Stock to stockholders of record on October 11, 1991 and June 22, 1992, respectively. All references in the consolidated financial statements to weighted average number of shares and issued shares have been retroactively restated to reflect the splits (see Note 10).\nNet income per common and common equivalent share - Primary net income per common and common equivalent share is based on the weighted average number of common and common equivalent shares (stock options and stock appreciation rights determined under the treasury stock method) outstanding during the year for Class A Common Stock and Class B Common Stock. Fully diluted earnings per common and common equivalent share assumes the conversion of the 7% convertible subordinated debentures under the \"if converted method\" and assumes exercise of stock options and stock appreciation rights using the treasury stock method.\nAll share and per share amounts have been adjusted for the three-for-two stock splits (see Note 10).\n2. ACQUISITIONS:\nGuild - On October 1, 1991, the Company acquired Cook's, Cribari, Dunnewood and other brands and substantially all of the assets and assumed certain liabilities (the Guild Acquisition) from Guild Wineries and Distilleries (Guild). The assets acquired included accounts receivable, inventories, property, plant and equipment and other assets. The Company also assumed certain liabilities consisting primarily of accounts payable. The aggregate purchase price, after adjustments based on a post-closing audit, was approximately $69,300,000. With respect to the purchase price, the Company paid approximately $59,400,000 in cash at closing, assumed liabilities of approximately $11,400,000 of which approximately $1,600,000 was discharged immediately and, based upon the results of a post-closing audit, received from Guild during October 1992 approximately $1,500,000, exclusive of accrued interest. The Company also paid approximately $2,700,000 of direct acquisition costs and $2,600,000 in escrow to finance the purchase of grapes related to Guild's 1991 grape harvest.\nThe Guild Acquisition was accounted for using the purchase method; accordingly, the assets and liabilities of Guild have been recorded at their estimated fair market value at the date of acquisition. The excess of purchase price over the estimated fair market value of the net assets acquired (goodwill), $1,344,000, is being amortized on a straight-line basis over forty years. The results of operations of Guild have been included in the Consolidated Statements of Income since the date of acquisition.\nBarton - On June 29, 1993, pursuant to the terms of a Stock Purchase Agreement (the Stock Purchase Agreement) among the Company, Barton Incorporated (Barton) and the Selling Stockholders, the Company acquired from the Selling Stockholders all of the outstanding shares of the capital stock of Barton (the Barton Acquisition), a marketer of imported beers and imported distilled spirits and a producer and marketer of distilled spirits and domestic beers.\nThe aggregate consideration for Barton consisted of approximately $65,510,000 in cash, one million shares of the Company's Class A Common Stock and payments of up to an aggregate amount of $57,300,000 (the Earn-Out Amounts) which are payable to the Selling Stockholders in cash over a three year period upon the satisfaction of certain performance goals. In addition, the Company paid approximately $1,981,000 of direct acquisition costs, $2,269,000 of direct financing costs, and assumed liabilities of approximately $47,926,000.\nThe purchase price was funded through a $50,000,000 term loan (see Note 7), through $18,835,000 of revolving loans under the Company's Credit Agreement (see Note 7), and through approximately $925,000 of accrued expenses. In addition, one million shares of the Company's Class A Common Stock were issued at $13.59 per share, which reflects the closing market price of the stock at the closing date, discounted for certain restrictions on the issued shares. Of these shares, 428,571 were delivered to the Selling Stockholders and 571,429 were delivered into escrow to secure the Selling Stockholders' indemnification obligations to the Company. Subsequent to year end, the 571,429 shares were released from escrow and delivered to the Selling Stockholders.\nThe Earn-Out Amounts consist of four payments scheduled to be made over a three year period ending November 29, 1996. The first payment of $4,000,000 is required to be made to the Selling Stockholders upon satisfaction of certain performance goals. These goals have been satisfied and this payment was accrued at August 31, 1993 and was made on December 31, 1993. The second payment of $28,300,000 has been accrued at August 31, 1994 and will be made to the Selling Stockholders on December 30, 1994, as a result of satisfaction of certain performance goals and the achievement of targets for earnings before interest and taxes at August 31, 1994. These additional payments have been properly accounted for as additional purchase price for the Barton acquisition. The remaining payments are contingent upon Barton achieving and exceeding certain targets for earnings before interest and taxes and certain other performance goals and are to be made as follows: up to $10,000,000 is to be made on November 30, 1995; and up to $15,000,000 is to be made on November 29, 1996. Such payment obligations are secured in part by the Company's standby irrevocable letter of credit (see Note 7) under the Credit Agreement in an original maximum face amount of $28,200,000 and are subject to acceleration in certain events as defined in the Stock Purchase Agreement. All Earn-Out amounts will be accounted for as additional purchase price for the Barton acquisition when the contingency has been satisfied in accordance with the Stock Purchase Agreement and allocated based upon the fair market value of the underlying assets.\nPursuant to Barton's Phantom Stock Plan (the Phantom Stock Plan) effective April 1, 1990 and amended and restated for Units (as defined in the Phantom Stock Plan) granted after March 31, 1992, certain participants received payments at closing amounting in the aggregate to $1,959,000 in connection with the Barton acquisition. Certain other participants will receive payments only upon vesting in the Phantom Stock Plan during years subsequent to the acquisition. All participants under the Phantom Stock Plan may receive additional payments in the event of satisfaction of the performance goals set forth in the Stock Purchase Agreement and upon release of the shares held in escrow. In the event the maximum payments are received under the Stock Purchase Agreement, the participants will receive an additional $2,137,000 in connection therewith. At August 31, 1994, $554,000 has been accrued under the Phantom Stock Plan and will be paid on January 3, 1995.\nThe Acquisition was accounted for using the purchase method; accordingly, Barton's assets were recorded at fair market value at the date of acquisition. The fair market value of Barton totaled $236,178,000 which was adjusted for negative goodwill of $72,390,000 and an additional deferred tax liability of $24,326,000 based on the difference between the fair market value of Barton's assets and liabilities as adjusted for allocation of negative goodwill and the tax basis of those assets and liabilities which was allocated on a pro-rata basis to noncurrent assets. The results of operations of Barton have been included in the Consolidated Statements of Income since the date of Acquisition.\nVintners - On October 15, 1993, the Company acquired substantially all of the tangible and intangible assets of Vintners International Company, Inc. (Vintners) other than cash and the Hammondsport Winery (the Vintners Assets), and assumed certain current liabilities associated with the ongoing business (the Vintners Acquisition). Vintners was the United States fifth largest supplier of wine with two of the country's most\nhighly recognized brands, Paul Masson and Taylor California Cellars. The wineries acquired from Vintners are the Gonzales winery in Gonzales, California and the Paul Masson wineries in Madera and Soledad, California. In addition, the Company is leasing from Vintners the Hammondsport winery in Hammondsport, New York. The lease is for a period of 18 months from the date of the Vintners Acquisition.\nThe aggregate purchase price of $148,900,000 (the Cash Consideration), is subject to adjustment based upon the determination of the Final Net Current Asset Amount (as defined below). In addition, the Company incurred $8,961,000 of direct acquisition and financing costs. The Company also delivered options to Vintners and Household Commercial of California, Inc., one of Vintners' lenders, to purchase an aggregate of 500,000 shares (the Vintners Option Shares) of the Company's Class A Common Stock, at an exercise price per share of $18.25, which are exercisable at any time until October 15, 1996. These options have been recorded at $8.42 per share, based upon an independent appraisal and $4,210,000 has been reflected as a component of additional paid-in capital. Subsequent to year-end, 432,067 of the Vintners Option Shares have been exercised (see Note 10).\nThe Cash Consideration was funded by the Company pursuant to (i) approximately $12,600,000 of Revolving Loans under the Credit Facility of which $11,200,000 funded the Cash Consideration and $1,400,000 funded the payment of direct acquisition costs; (ii) an accrued liability of approximately $7,700,000 for the holdback described below and (iii) the $130,000,000 Subordinated Bank Loan (see Note 7).\nAt closing the Company held back from the Cash Consideration approximately 10% of the then estimated net current assets of Vintners purchased by the Company, and deposited an additional $2,800,000 of the Cash Consideration into an escrow to be held until October 15, 1995. If the amount of the net current assets as determined after the closing (the Final Net Current Asset Amount) is greater than 90% and less than 100% of the amount of net current assets estimated at closing (the Estimated Net Current Asset Amount), then the Company shall pay into the established escrow an amount equal to the Final Net Current Asset Amount less 90% of the Estimated Net Current Asset Amount. If the Final Net Current Asset Amount is greater than the Estimated Net Current Asset Amount, then, in addition to the payment described above, the Company shall pay an amount equal to such excess, plus interest from the closing, to Vintners. If the Final Net Current Asset Amount is less than 90% of the Estimated Net Current Asset Amount, then the Company shall be paid such deficiency out of the escrow account. As of August 31, 1994, no adjustment to the established escrow was required and the Final Net Current Asset Amount has not been determined.\nThe Vintners Acquisition was accounted for using the purchase method; accordingly, the Vintners Assets were recorded at fair market value at the date of acquisition. The excess of the purchase price over the estimated fair market value of the net assets acquired (goodwill), $42,049,000, is being amortized on a straight-line basis over forty years. The results of operations of Vintners have been included in the Consolidated Statements of Income since the date of acquisition.\nAlmaden\/Inglenook -\nOn August 5, 1994 the Company acquired the Almaden and Inglenook brands, the fifth and sixth largest selling table wines in the United States, a grape juice concentrate business, and wineries in Madera and Escalon, California, from Heublein, Inc. (Heublein) (the Almaden\/Inglenook Acquisition). The Company also acquired Belaire Creek Cellars, Chateau La Salle and Charles Le Franc table wines, Le Domaine champagne and Almaden, Hartley and Jacques Bonet brandy. The accounts receivable and the accounts payable related to the acquired assets were not acquired by the Company.\nThe aggregate consideration for the acquired brands and other assets consisted of $130,600,000 in cash, assumption of certain current liabilities and options to purchase an aggregate of 600,000 shares of Class A Common Stock (the Almaden Option Shares). Of the Almaden Option Shares, 200,000 are exercisable at a price of $30 per share and the remaining 400,000 are exercisable at a price of $35 per share. All of the options are exercisable at any time until August 5, 1996. The 200,000 and 400,000 options have been recorded at $5.83 and $4.19 per share, respectively based upon an independent appraisal, and $2,842,000 has been reflected as a component of additional paid-in capital. The source of the cash payment made at closing, together with payment of other costs and expenses required by the Almaden\/Inglenook Acquisition, was financing provided by the Company pursuant to a term loan under the Credit Facility (see Note 7).\nThe cash purchase price is subject to adjustment based upon the determination of the Final Net Asset Amount as defined in the Asset Purchase Agreement; and, based upon a closing statement delivered to the company by Heublein, was reduced by $9,297,000. In accordance with the terms of the Asset Purchase Agreement, Heublein is obligated to the pay Company this amount plus interest from the closing date. The purchase price for the Almaden\/Inglenook Acquisition at August 31, 1994, reflects the purchase price as adjusted for the payment expected to be received from Heublein. However, as of August 31, 1994, the Final Net Asset Amount has not been determined.\nHeublein also agreed not to compete with the Company in the United States and Canada for a period of five years following the closing of the Almaden\/Inglenook Acquisition in the production and sale of grape juice concentrate or sale of packaged wines bearing the designation \"Chablis\" or \"Burgundy\" except where, among other exceptions, such designations are currently used with certain brands retained by Heublein. Certain companies acquired by Heublein, however, may compete directly with the Company.\nThe Almaden\/Inglenook Acquisition was accounted for using the purchase method; accordingly, the Almaden\/Inglenook assets were recorded at fair market value at the date of acquisition. The excess of purchase price over the estimated fair market value of the net assets acquired (goodwill), $43,939,000, is being amortized on a straight-line basis over forty years. The results of operations of Almaden\/Inglenook have been included in the Consolidated Statement of Income since the date of the acquisition.\nThe following table sets forth unaudited pro forma consolidated statements of income of the Company for the years ended August 31, 1994 and 1993. The fiscal 1994 pro forma consolidated statement of income\ngives effect to the Almaden\/Inglenook Acquisition and the Vintners Acquisition as if they occurred on September 1, 1993. The fiscal 1993 pro forma consolidated statement of income gives effect to the Almaden\/Inglenook Acquisition, the Vintners Acquisition and the Barton Acquisition as if they occurred on September 1, 1992. The August 31, 1994 and 1993 unaudited pro forma consolidated income statements are presented after giving effect to certain adjustments for depreciation, amortization of goodwill, interest expense on the acquisition financing and related income tax effects. The pro forma consolidated statements of income are based upon currently available information and upon certain assumptions that the Company believes are reasonable under the circumstances. The pro forma consolidated statements of income do not purport to represent what the Company's results of operations would actually have been if the aforementioned transactions in fact had occurred on such date or at the beginning of the period indicated or to project the Company's financial position or results of operations at any future date or for any future period.\nSenior Credit Facility - During fiscal 1993, the Company amended its Credit Agreement which provided for $50,000,000 of term loans, up to $55,000,000 in revolving credit loans and a standby, irrevocable letter of credit with a maximum\nface amount of $28,200,000. At August 31, 1993, the Company had outstanding borrowings of $50,000,000 under the term loan and $9,000,000 under the Revolving Credit Loans. At August 31, 1993, the Company had available Revolving Credit Loans totaling $46,000,000 under the amended Credit Agreement. Interest, as described in the agreement, was payable quarterly or on the last day of each interest period based upon either the base rate (higher of the Federal Funds Rate plus 1\/2 of 1% or the bank's prime rate) or the Eurodollar rate, as defined in the Credit Agreement, at the discretion of the Company.\nDuring fiscal 1994, the Company further amended its Credit Agreement in connection with the Vintners and the Almaden\/Inglenook Acquisitions. The amended Credit facility provides for (i) a $224,000,000 Term Loan (the Term Loan) facility due in June 2000, (ii) a $185,000,000 Revolving Credit (the Revolving Credit Loans) facility, which expires in June 2000 and (iii) the continuation of the existing $28,200,000 Letter of Credit related to the contingent payments incurred with the Barton Acquisition. At August 31, 1994, the Company has outstanding Term Loan borrowings of $177,000,000 and Revolving Credit Loans of $19,000,000. On October 24, 1994 the Company borrowed an additional $47,000,000 on the Term Loan and used the proceeds to repay a portion of the outstanding balance on the Revolving Credit Loans incurred since August 31, 1994. The Term Loan Commitment was fully utilized after this borrowing. The Term Loans borrowed under the Credit Facility may be either base rate loans or Eurodollar base rate loans. Base rate loans have an interest rate equal to the higher of either the Federal Funds rate plus 0.5% or the prime rate. Eurodollar rate loans have an interest rate equal to LIBOR plus a margin of 1.25%. The current interest rate margin for both base rate and Eurodollar rate loans may be increased by up to 0.25% and Eurodollar rate loans may be decreased by up to .375%, depending on the Company's debt coverage ratio and long-term senior secured securities' ratings. The principal of the Term Loans is to be repaid in twenty-two quarterly installments of $7,000,000 each beginning December 15, 1994, with a final quarterly payment of $70,000,000 due June 15, 2000. The Company may prepay the principal of the Term Loans and the Revolving Credit Loans at its discretion and must prepay the principal with 65% of its annual excess cash flow, as defined, with proceeds from the sale of certain assets in excess of $10,000,000 and the first $60,000,000 of the net proceeds from any issuance of equity plus 50% of any net proceeds in excess of $60,000,000 (see Note 10). These prepayments must be first applied against regular payments due with respect to the Term Loans in their inverse order of maturity until the Term Loans are fully retired and any further prepayments will be applied to reduce the outstanding Revolving Credit Loans.\nThe $185,000,000 revolving credit available under the Credit Facility may be utilized by the Company either in the form of Revolving Credit Loans or as revolving letters of credit up to a maximum of $12,000,000. At August 31, 1994 the Company had available Revolving Credit Loans under the Senior Credit Facility of $163,753,000. As with Term Loans, Revolving Credit Loans may be either base rate loans or Eurodollar rate loans. Revolving Credit Loans will mature and must be repaid June 15, 2000. For thirty consecutive days at any time during the last two quarters of each fiscal year, the aggregate outstanding principal amount of Revolving Credit Loans combined with the revolving letters of credit cannot exceed $50,000,000.\nThe banks under the Credit Facility have been given security interests in substantially all of the assets of the Company including mortgage liens on certain real property. The Credit Facility requires the Company to meet certain covenants and provides for restrictions on mergers, consolidations and sales of assets, payment of dividends, incurring of other debt, liens or guarantees and the making of investments. The primary financial covenants as defined in the Credit Facility require the maintenance of minimum defined tangible net worth, a debt to cash flow coverage ratio, a fixed charges ratio, maximum capital expenditures, an interest coverage ratio and a current ratio. Among the most restrictive covenants contained in the Credit Facility, the Company is required to maintain a fixed charges ratio not less than 1.0 to 1.0 at the last day of each fiscal quarter of each fiscal year.\nThe Revolving Credit Loans require commitment fees totaling .375% per annum on the daily average unused balance. Commitment fees totaled approximately $223,000, $228,000 and $154,000 in fiscal 1994, 1993 and 1992, respectively.\nThe Company maintains in accordance with the Senior Credit Facility a collar agreement, which protects the Company against three-month London Interbank Offered Rates exceeding 7.5% per annum with a floor rate of 3.3% per annum in an amount equal to $25,000,000 expiring in July 1995. At August 31, 1993, there were no interest rate swap agreements outstanding. At August 31, 1992, the Company had a contract applicable to $22,000,000 of short-term seasonal borrowings which effectively guaranteed a fixed interest rate of 6.82% for seasonal borrowing during the four month period ended September 15, 1992. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements. The Company has not incurred any credit losses in connection with these agreements.\nSenior Subordinated Notes - During fiscal 1994, the Company borrowed $130,000,000 under the Senior Subordinated Loan Agreement. The Company repaid the Subordinated Loan in December 1993 from the proceeds from the Senior Subordinated Notes offering together with revolving loan borrowings. The $130,000,000 Notes are due in 2003 with a stated interest rate of 8.75% per annum. Interest is payable semi-annually on June 15 and December 15 of each year. The Notes are unsecured and subordinated to the prior payment in full of all senior indebtedness of the Company, which includes the Credit Agreement. The Notes are guaranteed, on a senior subordinated basis, by all of the Company's significant operating subsidiaries.\nThe indenture relating to the Notes contains certain covenants, including, but not limited to, (i) limitation on indebtedness; (ii) limitation on restricted payments; (iii) limitation on transactions with affiliates; (iv) limitation on senior subordinated indebtedness; (v) limitation on liens; (vi) limitation on sale of assets; (vii) limitation on issuance of guarantees of and pledges for indebtedness; (viii) restriction on transfer of assets; (ix) limitation on subsidiary capital stock; (x) limitation on the creation of any restriction on the ability of the Company's subsidiaries to make distributions and other payments; and (xi) restrictions on mergers, consolidations and the transfer of all or substantially all of the assets of the Company to another person. The limitation on indebtedness covenant is governed by a rolling four quarter fixed charge coverage ratio covenant requiring a specified minimum.\nConvertible subordinated debentures -\nOn July 23, 1986, the Company issued $60,000,000 7% convertible subordinated debentures used to expand the Company's operations through capital expenditures and acquisitions. The debentures were convertible at any time prior to maturity, unless previously redeemed, into Class A Common Stock of the Company at a conversion price of $18.22 per share, subject to adjustment in the event of future issuances of Common Stock.\nDuring fiscal 1993, an aggregate principal amount of $977,000 of these debentures was converted to 53,620 shares of Class A Common Stock.\nOn October 18, 1993, the Company called its Convertible Debentures for redemption on November 19, 1993 at a redemption price of 102.1% plus accrued interest. Bondholders had until November 19, 1993 to convert their debentures to common stock; any debentures remaining unconverted after that date would be redeemed for cash in accordance with the terms of the original indenture.\nDuring the period September 1, 1993, through November 19, 1993, debentures in an aggregate principal amount of $58,960,000 were converted to 3,235,882 shares of the Company's Class A Common Stock at a price of $18.22 per share. Debentures in an aggregate principal amount of approximately $63,000 were redeemed. Interest was accrued on the debentures until the date of conversion but was forfeited by the debenture holders upon conversion. Accrued interest of approximately $1,370,000, net of the related tax effect of $520,000 was recorded as an addition to additional paid-in capital.\nAt the redemption date, the capitalized debenture issuance costs of approximately $2,246,000 net of accumulated amortization of approximately $677,000 were recorded as a reduction of additional paid-in-capital.\nLoans payable - Loans payable, secured by officers' life insurance policies, carry an interest rate of 5%. The notes carry no due dates and it is management's intention not to repay the notes during the next fiscal year.\nCapitalized lease agreements-Industrial Development Agencies - Certain capitalized lease agreements require the Company to make lease payments equal to the principal and interest on certain bonds issued by Industrial Development Agencies (IDA's). The bonds are secured by the leases and the related facilities. Upon payment of the outstanding bonds, title to the facilities will be conveyed to the Company. These transactions have been treated as capital leases with the related assets acquired to date ($10,731,000) included in property, plant and equipment and the lease commitments included in long-term debt. Accumulated amortization of the foregoing assets under capital leases at August 31, 1994 and 1993 is approximately $8,456,000 and $7,803,000 respectively.\nAmong the provisions under the debenture and lease agreements are covenants that define minimum levels of working capital and tangible net worth and the maintenance of certain financial ratios as defined in the debt agreements.\nPrincipal payments required under long-term debt obligations during the next five fiscal years are as follows:\nYear Ending August 31: (in thousands)\n1995 $ 31,001 1996 29,220 1997 28,698 1998 28,118 1999 28,118 Thereafter 174,968 $320,123\n8. INCOME TAXES:\nDeferred income taxes are provided to reflect the effect of temporary differences primarily related to: (1) using the FIFO basis to value certain inventories for income tax purposes and the LIFO basis for financial reporting purposes; (2) the use of accelerated depreciation methods for income tax purposes and the straight-line method for financial reporting purposes; (3) differences in the treatment of advertising expense and other accruals for financial reporting and income tax purposes and (4) differences between the financial reporting and tax basis of assets and liabilities.\nThe provision for federal and state income taxes consists of the following for the years ended August 31:\nThe deferred tax provision has been increased by approximately $45,000 and $235,000 in fiscal 1994 and 1993, respectively for the impact of the change in the federal statutory rate.\nA reconciliation of total tax provision to the amount computed by applying the expected U.S. Federal income tax rate to income before provision for income taxes is as follows for the years ended August 31:\n9. PROFIT SHARING RETIREMENT PLAN AND RETIREMENT SAVINGS PLAN:\nThe Company's profit-sharing retirement plan, which covers substantially all employees, provides for contributions by the Company in such amounts as the Board of Directors may annually determine and for voluntary contributions by employees. The plan has qualified as tax-exempt under the Internal Revenue Code and conforms with the Employee Retirement Income Security Act of 1974. Company contributions to the plan were $3,414,000, $1,290,000, and $1,249,000 in fiscal 1994, 1993 and 1992, respectively.\nThe Company's retirement savings plan, established pursuant to Section 401(k) of the Internal Revenue Code, permits substantially all full-time employees of the Company to defer a portion of their compensation on a pre-tax basis. Participants may defer up to 10% of their compensation for the year. The Company makes a matching contribution of 25% of the first 4% of compensation an employee defers. Company contributions to this plan were $207,000, $131,000, and $109,000 in fiscal 1994, 1993 , 1992, respectively.\nIn connection with the Barton acquisition, the Company assumed Barton's profit-sharing plan which covers all salaried employees. The amount of Barton's contribution is at the discretion of its Board of Directors, subject to limitations of the plan. Contribution expense was $1,395,000 in fiscal 1994 and $230,000 from the date of acquisition to August 31, 1993.\n10. STOCKHOLDERS' EQUITY:\nStock option and stock appreciation right plan - Canandaigua Wine Company, Inc. has in place a Stock Option and Stock Appreciation Right Plan (the Plan). Under the Plan, non-qualified stock options and incentive stock options may be granted to purchase and stock appreciation rights may be granted with respect to, in the aggregate, not more than 3,000,000 shares of the Company's Class A Common Stock. Options and stock appreciation rights may be issued to employees, officers, or directors of the Company. Non-employee directors are eligible to receive only non-qualified stock options and stock appreciation rights. The option price of any incentive stock option may not be less than the fair market value of the shares on the date of grant. The exercise price of any non-qualified stock option must equal or exceed 50% of the fair market value of the shares on the date of grant. Options are exercisable as determined by the Compensation Committee of the Board of Directors. Changes in the status of the stock option plan during fiscal 1994, 1993 and 1992 are summarized as follows:\nPursuant to the original Plan, on December 21, 1987, the Company granted to key employees stock appreciation rights with respect to 38,250 shares of the Company's Class A Common Stock at a base price of $4.40 per share (the average closing price per share for November 1987 adjusted for the effect of the stock splits). Such rights entitled the employees to payment in stock and cash of market price increases in the Company's stock in the excess of the base price in equal twenty-five percent increments on September 30, 1989 through 1992. In September 1992 and 1991, employees exercised their stock appreciation rights with respect to 4,104 and 2,556 shares of Class A Common Stock, respectively. In addition, an aggregate of 4,950 of the rights were canceled through August 31, 1992. During fiscal 1993, stock appreciation rights previously granted under the Plan expired in accordance with the terms of the Plan.\nEmployee stock purchase plan - In fiscal 1989, the Company approved a stock purchase plan under which 1,125,000 shares of Class A Common Stock can be issued. Under the terms of the plan, eligible employees may purchase shares of the Company's Class A Common Stock through payroll deductions. The purchase price is the lower of 85% of the fair market value of the stock on the first or last day of the purchase period. During fiscal 1993, the plan was amended to allow the participation of Barton employees. During fiscal 1994, 1993 and 1992, employees purchased 58,955, 21,071 and 18,526 shares, respectively.\nCommon stock - On September 26, 1991 and June 1, 1992, the Company's Board of Directors declared three-for-two splits of the Company's common shares. The new shares were distributed on November 8, 1991 and July 20, 1992 to holders of record on October 11, 1991 and June 22, 1992, respectively. At August 31,1994, there were 12,617,301 shares of Class A Common Stock and 3,390,051 shares of Class B Common Stock outstanding, net of treasury stock. All per share amounts have been retroactively restated to give effect to the splits.\nOn June 28, 1993, the Company approved an increase in the number of authorized shares of the Company's Class A Common Stock from 15,000,000 shares to 60,000,000 shares and an increase in the number of authorized shares of the Company's Class B Common Stock from 5,000,000 shares to 20,000,000 shares.\nStock offering - During February 1992, the Company completed a public offering of 2,589,750 shares of its Class A Common Stock resulting in net proceeds after underwriters' discounts and commissions and expenses to the Company, of approximately $31,981,000. Under the terms of the Credit Agreement, approximately $16,000,000, constituting approximately 50% of the net proceeds, was applied to reduction of the Term Loans, and $5,000,000 was applied by the Company to reduce the balances outstanding under the Revolving Credit Loans.\nOn November 10, 1994, the Company completed a public offering of 3,000,000 shares of its Class A Common Stock resulting in net proceeds after underwriters' discounts and commissions and estimated expenses to the Company, of approximately $95,428,000 . In connection with the offering, 432,067 of the Vintners Option Shares were exercised and the Company received proceeds of $7,885,000. Under the terms of the amended Credit Agreement, approximately $82,000,000, will be used to repay a portion of the Term Loan under the Company's Credit Agreement. The balance of net proceeds will be used for working capital purposes and will initially be used to repay Revolving Credit Loans under the Credit Facility.\n11. COMMITMENTS AND CONTINGENCIES:\nOperating leases - Future payments under noncancelable operating leases having initial or remaining terms of one year or more are as follows:\nYear ending August 31: (in thousands) 1995 $1,487 1996 1,352 1997 1,358 1998 1,114 1999 831 Thereafter 3,543 $9,685\nRental expense was approximately $3,318,000 in fiscal 1994, $1,841,000 in fiscal 1993 and $1,460,000 in fiscal 1992.\nPurchase commitments - The Company has two agreements with certain suppliers to purchase blended Scotch whisky through December 31, 1999. The purchase prices under the agreements are denominated in British pounds sterling and based upon exchange rates at August 31, 1994, the Company's aggregate future obligation will be approximately $13,124,000 to $16,306,000 for the contracts expiring on December 31, 1995 and approximately $11,160,000 to $13,640,000 for the contracts expiring on December 31, 1999.\nIn connection with the Vintners Acquisition, and the Almaden\/Inglenook Acquisition, the Company has assumed purchase contracts with certain growers and suppliers. Under the grape purchase contracts, the Company is committed to purchase all grape production yielded from a specified number of acres for a period of time ranging up to ten years. The actual tonnage and price of grapes that must be purchased by the Company will vary each year depending on certain factors, including weather, time of harvest, overall market conditions and the agricultural practices and location of the growers and suppliers under contract.\nThe Company purchased $ 25,167,000 of grapes under these contracts during the period October 15, 1993 through August 31, 1994. Based on current production yields and published grape prices, the Company estimates that the aggregate purchases under these contracts over the remaining term of the contracts will be approximately $394,467,000. During fiscal 1994, in connection with the Vintners Acquisition and the Almaden\/Inglenook Acquisition, the Company established a reserve for the estimated loss on these firm purchase commitments of approximately $62,664,000.\nThe Company's aggregate obligations under the grape crush and processing contracts will be approximately $5,503,000 over the remaining term of the contracts which expire through fiscal 1997.\nCurrency forward contracts - At August 31, 1994 and 1993, the Company had open currency forward contracts to purchase German deutsche marks of $6,674,000 and $6,031,000 respectively, and British pounds of $579,000 and $928,000, respectively,\nall of which mature within 12 months; their fair market values, based upon August 31, 1994 and 1993 market exchange rates, were $7,382,000 and $6,262,000, respectively, for German deutsche marks and $614,000 and $929,000 respectively for British pounds.\nEmployment contracts - The Company has employment contracts with certain of its executive officers and certain other management personnel with remaining terms ranging up to five years. These agreements provide for minimum salaries, as adjusted for annual increases, and may include incentive bonuses based upon attainment of specified management goals. In addition, these agreements also provide for severance payments in the event of specified terminations of employment. The aggregate commitment for future compensation and severance, excluding incentive bonuses, was approximately $7,300,000 as of August 31, 1994.\nLegal matters - The Company is subject to litigation from time to time in the ordinary course of business. Although the amount of any liability with respect to such litigation cannot be determined, in the opinion of management, such liability will not have a material adverse effect on the Company's financial condition or results of operations.\n12. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK:\nThe Company sells its products principally to wholesalers for resale to retail outlets including grocery stores, package liquor stores, club and discount stores and restaurants. Gross sales to the five largest wholesalers of the Company represented 23.7%, 25.1% and 28.5% of the Company's gross sales for the fiscal years ended August 31, 1994, 1993 and 1992, respectively. Gross sales to the Company's largest wholesaler represented 12.3% of the Company's gross sales for the fiscal year ended August 31, 1994; no single wholesaler was responsible for greater than 10% of gross sales during the fiscal years ended August 31, 1993 and 1992. Gross sales to the Company's five largest wholesalers are expected to continue to represent a significant portion of the Company's revenues. The Company's arrangements with certain of its wholesalers may, generally, be terminated by either party with prior notice. The Company performs ongoing credit evaluations of its customers' financial position, and management of the Company is of the opinion that any risk of significant loss is reduced due to the diversity of customers and geographic sales area.\n13. THE RESTRUCTURING PLAN\nIn the fourth quarter, the Company provided for costs to restructure the operations of its California wineries (the Restructuring Plan). Under the Restructuring Plan, all bottling operations at the Central Cellars winery in Lodi, California and the branded wine bottling operations at the Monterey Cellars Winery in Gonzales, California will be moved to the Mission Bell Winery located in Madera, California which was acquired by the Company in the Almaden\/Inglenoook Acquisition. The Monterey Cellars Winery will continue to be used as a crushing, winemaking and contract bottling facility. The Central Cellars Winery and the winery in Soledad, California will be closed and offered for sale to reduce surplus capacity. The\nRestructuring Plan reduced income before income taxes and net income by approximately $24,005,000 and $14,883,000, respectively or $.91 per share, on a fully diluted basis. Of the total pretax charge, approximately $16,481,000 is to recognize estimated losses associated with the revaluation of land, buildings and equipment related to the facilities described above to their estimated net realizable value; and approximately $7,524,000 relates to severance and other benefits associated with the elimination of 260 jobs. The Restructuring Plan will require the Company to make capital expenditures of approximately $20,000,000 during fiscal 1995 to expand storage capacity and install certain relocated equipment. As of August 31,1994, the Company has a remaining accrual of approximately $9,106,000 with respect to the Restructuring Plan. The Company expects to have the Restructuring Plan fully implemented by the end of fiscal 1995.\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nSELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (In thousands, except per share data)\nQUARTER ENDED 11\/30\/93 2\/28\/94 5\/31\/94 8\/31\/94 YEAR\nNet sales $154,485 $140,031 $154,223 $180,845 $629,584 Gross profit 44,655 41,668 42,775 53,275 182,373 Net income 5,653 5,741 6,655 (6,316) 11,733 Earnings per share: Primary .40 .35 .41 (.39) .74 Fully diluted .37 .35 .41 (.38) .74\nQUARTER ENDED 11\/30\/92 2\/28\/93 5\/31\/93 8\/31\/93 YEAR\nNet sales $71,109 $58,782 $60,495 $115,922 $306,308 Gross profit 21,537 17,693 18,411 33,737 91,378 Net income 3,604 2,952 3,391 5,657 15,604 Earnings per share: Primary .31 .25 .29 .45 1.30 Fully diluted .28 .24 .27 .41 1.20\nQUARTER ENDED 11\/30\/91 2\/28\/92 5\/31\/92 8\/31\/92 YEAR\nNet sales $63,580 $56,942 $65,068 $59,652 $245,242 Gross profit 17,834 17,211 18,829 16,683 70,557 Net income 2,410 2,128 3,357 3,461 11,356 Earnings per share: Primary .26 .23 .29 .30 1.08 Fully diluted .25 .22 .27 .27 1.01\nPer share amounts have been appropriately adjusted to reflect the Company's stock splits (see Note 10 in the Company's consolidated financial statements).\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE V CANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nPROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\nBalance at Transfers, Balance Beginning Addition Retirements at End Classification of Year at Cost or Sales of Year\nYEAR ENDED AUGUST 31, 1992: Land $ 1,206 $ 2,925 $ - $ 4,131 Buildings and improvements 19,926 6,370 - 26,296 Machinery and equipment 57,606 25,126 60 82,672 Motor vehicles 1,792 19 - 1,811 Construction in progress 937 3,702 2,425 2,214 $81,467 $38,142 $ 2,485 $117,124\nYEAR ENDED AUGUST 31, 1993: Land $ 4,131 $ 472 $ 298 $ 4,305 Buildings and improvements 26,296 3,839 - 30,135 Machinery and equipment 82,672 9,095 606 91,161 Motor vehicles 1,811 1,495 752 2,554 Construction in progress 2,214 5,404 5,543 2,075 $117,124 $20,305 $ 7,199 $130,230\nYEAR ENDED AUGUST 31, 1994: Land $ 4,305 $ 9,889 $ 380 $ 13,814 Buildings and improvements 30,135 34,160 1,855 62,440 Machinery and equipment 91,161 90,006 12,936 168,222 Motor vehicles 2,554 171 173 2,552 Construction in progress 2,075 6,964 59 8,989 $130,230 $141,190 $15,403 $256,017\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE VI\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nACCUMULATED DEPRECIATION AND AMORTIZATION OF\nPROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\nBalance at Retirements Balance at Beginning and Other End of Classification of Year Provision Disposals Year\nYEAR ENDED AUGUST 31, 1992: Buildings and improvements $ 5,990 $ 760 $ - $ 6,750 Machinery and equipment 31,523 5,150 3 36,670 Motor vehicles 962 172 - 1,134 $38,475 $6,082 $ 3 $44,554\nYEAR ENDED AUGUST 31, 1993: Buildings and improvements $ 6,750 $ 918 $ - $ 7,668 Machinery and equipment 36,670 6,315 9 42,976 Motor vehicles 1,134 156 304 986 $44,554 $7,389 $313 $51,630\nYEAR ENDED AUGUST 31, 1994: Buildings and improvements $ 7,668 $ 1,361 $ 2 $ 9,027 Machinery and equipment 42,976 8,989 296 51,669 Motor vehicles 986 184 132 1,038 $51,630 $10,534 $430 $61,734\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE IX\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nSHORT-TERM BORROWINGS\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\n1994 1993 1992\nNotes Payable to Banks for Short-Term Borrowings\nBalance at August 31, $19,000 $ 9,000 $ -\nWeighted average interest rate on notes payable to banks at end of year 6.45% 5.7% -\nMaximum amount of notes payable outstanding at any month-end 185,000 35,000 14,000\nWeighted average amount of notes payable outstanding during the year (a) 55,375 18,500 4,000 Weighted average interest rate on notes payable outstanding during the year (b) 6.07% 5.7% 7.3%\n(a) The weighted average amount of notes payable outstanding for fiscal 1994, 1993 and 1992 was calculated by dividing the sum of total short-term borrowings outstanding at each month end by the number of months in the fiscal year.\n(b) The weighted average interest rate on notes payable outstanding during fiscal 1994, 1993 and 1992 was calculated by dividing the total interest expense on all short-term borrowings by the average daily amount outstanding.\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE X\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nSUPPLEMENTARY OPERATING STATEMENT INFORMATION\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\nCharged to Cost and Expenses Item 1994 1993 1992\nExcise taxes $231,475 $83,109 $59,875\nAdvertising 64,540 33,002 24,285\nMaintenance and repairs 5,221 2,563 2,171\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\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 (except for the information regarding executive officers required by Item 401 of Regulation S-K which is included in Part I hereof in accordance with General Instruction G(3)) is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995 under the heading \"Nomination and Election of Directors\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\nItem 11. Executive Compensation.\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995, under the heading \"Executive Compensation\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995, under the headings \"Beneficial Ownership\" and \"Nomination and Election of Directors\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\nItem 13. Certain Relationships and Related Transactions\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995, under the heading \"Executive Compensation\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\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 Company are submitted herewith:\nReport of Independent Public Accountants\nConsolidated Balance Sheets - August 31, 1994 and 1993\nConsolidated Statements of Income for the years ended August 31, 1994, 1993 and 1992\nConsolidated Statements of Changes in Stockholders' Equity for the years ended August 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the years ended August 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe following consolidated financial information is submitted herewith:\nSchedule V Property, Plant and Equipment for the years ended August 31, 1994, 1993 and 1992\nSchedule VI Accumulated Depreciation and Amortization of Property, Plant and Equipment for the years ended August 31, 1994, 1993 and 1992\nSchedule IX Short-term Borrowings for the years ended August 31, 1994, 1993 and 1992\nSchedule X Supplementary Operating Statement Information for the years ended August 31, 1994, 1993 and 1992\nSelected Financial Data -- Five-Year Summary\nSelected Quarterly Financial Information (Unaudited)\nAll other schedules are not submitted because they are not applicable or not required under Regulation S-X or because the required information is included in the financial statements or notes thereto.\nIndividual financial statements of the Registrant have been omitted because the Registrant is primarily an operating company and no subsidiary included in the consolidated financial statements has minority equity interests and\/or non-current indebtedness, not guaranteed by the Registrant, in excess of 5% of total consolidated assets.\n3. Exhibits required to be filed by Item 601 of Regulation S-K\nThe following exhibits are filed herewith or incorporated herein by reference, as indicated:\n2.1 Asset Purchase Agreement dated August 2, 1991 between the Registrant and Guild Wineries and Distilleries, as assigned to an acquiring subsidiary (filed as Exhibit 2(a) to the Registrant's Report on Form 8-K dated October 1, 1991 and incorporated herein by reference). 2.2 Stock Purchase Agreement dated April 27, 1993 among the Registrant, Barton Incorporated and the stockholders of Barton Incorporated, Amendment No. 1 to Stock Purchase Agreement dated May 3, 1993, and Amendment No. 2 to Stock Purchase Agreement dated June 29, 1993 (filed as Exhibit 2(a) to the Registrant's Current Report on Form 8-K dated June 29, 1993 and incorporated herein by reference). 2.3 Asset Sale Agreement dated September 14, 1993 between the Registrant and Vintners International Company, Inc. (filed as Exhibit 2(a) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 2.4 Amendment dated as of October 14, 1993 to Asset Sale Agreement dated as of September 14, 1993 by and between Vintners International Company, Inc. and the Registrant (filed as Exhibit 2(b) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 2.5 Amendment No. 2 dated as of January 18, 1994 to Asset Sale Agreement dated as of September 14, 1993 by and between Vintners International Company, Inc. and the Registrant (filed as Exhibit 2.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended February 28, 1994 and incorporated herein by reference). 2.6 Asset Purchase Agreement dated August 3, 1994 between the Registrant and Heublein, Inc. (filed as Exhibit 2(a) to the Registrant's Current Report on Form 8-K dated August 5, 1994 and incorporated herein by reference). 2.7 Amendment dated November 8, 1994 to Asset Purchase Agreement between Heublein, Inc. and Registrant (filed as Exhibit 2.2 to the Registrant's Registration Statement on Form S-3 (Amendment No. 2) (Registration No. 33-55997) filed with the Securities and Exchange Commission on November 8, 1994 and incorporated herein by reference).\n2.8 Amendment dated November 18, 1994 to Asset Purchase Agreement between Heublein, Inc. and the Registrant (filed herewith). 3.1 Restated Certificate of Incorporation of the Company (filed as Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 3.2 Amended and Restated By-laws of the Company (filed as Exhibit 4.2 to the Registrant's Registration Statement on Form S-8 (Registration No. 33-56557) and incorporated herein by reference).\n4.1 Specimen of Certificate of Class A Common Stock of the Company (filed as Exhibit 1.1 to the Registrant's Registration Statement on Form 8-A, dated April 28, 1992 and incorporated herein by reference). 4.2 Specimen of Certificate of Class B Common Stock of the Company (filed as Exhibit 1.2 to the Registrant's Registration Statement on Form 8-A, dated April 28, 1992 and incorporated herein by reference). 4.3 Indenture dated as of December 27, 1993 among the Registrant, its Subsidiaries and Chemical Bank (filed as Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1993 and incorporated herein by reference). 4.4 First Supplemental Indenture dated as of August 3, 1994 among the Registrant, Canandaigua West, Inc. and Chemical Bank (filed as Exhibit 4.5 to the Registrant's Registration Statement on Form S-8 (Registration No. 33- 56557) and incorporated herein by reference). 10.1 The Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Appendix B of the Company's Definitive Proxy Statement dated December 23, 1987 and incorporated herein by reference). 10.2 Amendment No. 1 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1992 and incorporated herein by reference). 10.3 Amendment No. 2 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 28 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1992 and incorporated herein by reference). 10.4 Amendment No. 3 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Rights Plan (filed as Exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.5 Amendment No. 4 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1993 and incorporated herein by reference). 10.6 Amendment No. 5 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended February 28, 1994 and incorporated herein by reference). 10.7 Employment Agreement between Barton Incorporated and Ellis M. Goodman dated as of October 1, 1991 as amended by Amendment to Employment Agreement between Barton Incorporated and Ellis M. Goodman dated as of June 29, 1993 (filed as Exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.8 Barton Incorporated Management Incentive Plan (filed as Exhibit 10.6 to the Registrant's Annual Report on Form\n10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.9 Ellis M. Goodman Split Dollar Insurance Agreement (filed as Exhibit 10.7 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.10 Barton Brands, Ltd. Deferred Compensation Plan (filed as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.11 Marvin Sands Split Dollar Insurance Agreement (filed as Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.12 Amendment and Restatement dated as of June 29, 1993 of Credit Agreement among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(b) to the Registrant's Current Report on Form 8-K dated June 29, 1993 and incorporated herein by reference). 10.13 Amendment No. 1 dated as of October 15, 1993 to Amendment and Restatement dated as of June 29, 1993 of Credit Agreement among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(c) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 10.14 Senior Subordinated Loan Agreement dated as of October 15, 1993 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as Agent (filed as Exhibit 2(d) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 10.15 Second Amendment and Restatement dated as of August 5, 1994 of Amendment and Restatement of Credit Agreement dated as of June 29, 1993 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(b) to the Registrant's Current Report on Form 8-K dated August 5, 1994 and incorporated herein by reference). 10.16 Amendment No. 1 (dated as of August 5, 1994) to Second Amendment and Restatement dated as of August 5, 1994 of Amendment and Restatement of Credit Agreement dated as of June 29, 1993 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed herewith). 10.17 Security Agreement dated as of August 5, 1994 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(c) to the Registrant's Current Report on Form 8-K dated August 5, 1994 and incorporated herein by reference. 11.1 Statement of computation of per share earnings (filed herewith). 21.1 Subsidiaries of Registrant (filed herewith). 23.1 Consent of Arthur Andersen & Co. (filed herewith).\n(b) Reports on Form 8-K\nThe following Current Reports on Form 8-K were filed with the Securities and Exchange Commission during the fourth quarter of the Company's 1994 fiscal year:\n1. Form 8-K dated June 23, 1994. This Form 8-K reported information under Item 5 (Other Events).\n2. Form 8-K dated August 5, 1994. This Form 8-K reported information under Item 2 (Acquisition or Disposition of Assets), Item 5 (Other Events) and 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":"704386_1994.txt","cik":"704386","year":"1994","section_1":"ITEM 1. BUSINESS\nVLSI Technology, Inc., a Delaware corporation (\"VLSI\" or the \"Company\"), was incorporated in May 1987 as a successor to the business of VLSI Technology, Inc., a California corporation, (\"VLSI-California\"). The merger of VLSI-California with and into the Company was consummated on December 31, 1987. All references herein to \"VLSI\" or the \"Company\" include its predecessor VLSI-California unless specified or unless the context otherwise requires.\nOVERVIEW\nVLSI designs, manufactures and sells complex application-specific integrated circuits (\"ASICs\"), which are custom designed chips for an individual customer, and application-specific standard products (\"ASSPs\"), which are semi-custom chips designed for a particular market application that may be used by several different customers. Through its majority-owned subsidiary, COMPASS Design Automation, Inc. (\"COMPASS\"), VLSI offers an integrated suite of electronic design automation (\"EDA\") software tools, foundry-flexible libraries and support services for use by systems and circuit designers at other semiconductor and systems design companies in addition to VLSI (see \"COMPASS DESIGN AUTOMATION\" below).\nVLSI applies its value-added technology to deliver products targeted at specific segments of the electronics marketplace. These products address a range of applications in the personal computer (\"PC\"), communications, workstation, government, high-performance computer and entertainment markets. VLSI targets a limited number of key Original Equipment Manufacturer (\"OEM\") customers who are leaders in their respective industries. The Company's top customers in 1994 include Compaq Computer Corporation (\"Compaq\"), Apple Computer, Inc. (\"Apple\"), Telefonaktiebolaget LM Ericsson (\"Ericsson\"), Hewlett-Packard Company (\"Hewlett-Packard\"), and Digital Equipment Corporation (\"DEC\"). See \"MARKETING AND CUSTOMERS\" below.\nThe Company has applied a market segment approach to its method of planning and organizing its business. The Company has targeted a limited number of growth markets in which it has developed significant expertise utilizing its library of proprietary cells and highly integrated building blocks to assist customers in rapidly designing products and bringing them to market.\nThe Company's objective is to design and manufacture highly-integrated, complex semiconductor devices that allow its customers to develop and bring to market higher value-added systems and products. Key elements in its strategy to achieve this objective include:\nTarget selected growth markets. VLSI has targeted a limited number of growth markets in which it has built significant expertise. In these markets, the Company can utilize its library of proprietary cells and high-level building blocks to assist customers in designing and bringing the customers' products to market rapidly. VLSI believes that this allows the Company to offer more value to the customer at potentially higher gross margins for the Company. VLSI's target markets include high-end computing applications, wireless and networking communications applications, entertainment systems and desktop and portable personal computers.\nDevelop differentiated products. VLSI seeks to develop differentiated products that allow a customer both to distinguish the customer's products from those offered by its competitors and to reduce the customer's product cost. The Company creates highly complex products that reduce the number of integrated circuit devices required for a given application and contain advantageous combinations of features and functionality. VLSI emphasizes high performance applications where its products are critical elements of complex electronic systems.\nFocus on large, industry-leading OEM customers. VLSI focuses its manufacturing and research and development resources on products for a limited number of OEM customers who are leaders in their respective industries. The Company believes that such large OEM customers provide the Company with\nsignificant potential. During the year ended December 30, 1994, approximately two-thirds of the Company's net revenues were derived from sales to its top 20 customers.\nBalance manufacturing. The Company balances its wafer production between its own facilities and the use of foundry capacity of third party wafer subcontractors. The Company believes that this strategy improves cost-effectiveness, responsiveness to customers, access to capacity, ability to implement leading-edge process technology and time to market, as compared to semiconductor companies that lack fabrication facilities, while providing a partial buffer against over-capacity in times of diminished demand. During 1994, VLSI produced approximately three-quarters of its wafer requirements at its own facilities. The Company believes that when demand exceeds industry-wide fabrication capacity, its manufacturing strategy also results in enhanced responsiveness to customers, as compared to semiconductor companies lacking fabrication facilities. In addition, the Company's fabrication facility in San Antonio, Texas is designed to permit the Company to significantly increase its current manufacturing capacity at that facility.\nUse FSB(TM) libraries to reduce customers' time to market. VLSI's Functional System Block(TM) (\"FSB\") libraries, an expanding collection of pre-designed cells and high-level building blocks, provides easy design-in of frequently used integrated circuit functions. The FSB library elements allow VLSI and its customers to more rapidly design and integrate products, thereby reducing VLSI's customers' time to market. VLSI's library of FSBs includes Graphics Controllers (LCD and CRT), a DES Encryption FSB, a PCI FSB, Floppy Disk Controllers, SCSI Controllers, T1 Controllers and a suite of analog functions for communications FSBs. VLSI continues to expand its FSB libraries through internal development and through the acquisition or licensing of technology from other companies. Technology acquired and\/or licensed from other companies include an ARM RISC-based microprocessor (low power, high performance embedded control applications), power management, communications (including standards such as DECT, CT2, GSM and PHS), signal converters, forward error correction and digital signal processing.\nFocus on customer support. The Company seeks to differentiate itself from its competitors not only through the quality of its products, but also through the level of its technological support and service. VLSI operates a network of geographically dispersed Technology Centers where experienced engineers with a specific technical focus work directly with customers to develop designs for new products and to provide continuing after-sale customer support.\nSILICON OPERATIONS\nPRODUCTS AND SERVICES\nVLSI has organized its business around targeted market segments, establishing divisions to address specific silicon markets. Each of the Company's silicon divisions maintains independent marketing and applications research and development capabilities.\nThe Company's market-focused structure permits VLSI to dedicate certain of its engineers to develop systems expertise in, and experience with issues peculiar to, applications in a particular market. VLSI believes that this increased systems expertise allows it to offer more value to the customer through the development of FSBs to address those specific issues. VLSI's customers in silicon market segments have a choice of using proprietary solutions, standard solutions that are shared among multiple customers, or a combination of both.\nThe VLSI Product Divisions design, manufacture and market devices for the computer, communications and entertainment markets, including personal computer applications (Apple operating system), high-end computing applications (such as graphics workstations and high-end storage), secure communications, home entertainment applications (such as interactive television and video game systems), networking and wireless communications. The Personal Computer Division designs, manufactures and markets ASSPs for desktop and portable computers designed on the X86 architectures for 486 and Pentium(TM)-based computers.\nVLSI Product Divisions\nThe VLSI Product Divisions (\"VPD\") consist of market segment divisions: the Apple Products Division, the Computer and Government Product Divisions, the Consumer and Industrial Product Divisions, the Network Products Division and the Wireless Products Division.\nThe key to the success of VPD is providing customers with timely silicon solutions optimized for their applications. This approach enables rapid market introduction of customer products coupled with the ability to customize for specific customer requirements.\nFSB library elements consist of system-level blocks that provide a higher level of integration than in a traditional design library. These blocks are designed to be combined with other FSB blocks, random logic and compiled elements to provide the optimum silicon circuit with minimum customer design time. FSB cells are intended to speed the development of integrated circuits (\"ICs\"), resulting in faster time to market for customers.\nVPD's competition comes from a wide variety of large, established IC providers, including, but not limited to, American Telephone & Telegraph Company (\"AT&T\"), International Business Machines Corporation (\"IBM\"), LSI Logic Corporation (\"LSI\"), Motorola, Inc. (\"Motorola\"), Texas Instruments Incorporated (\"TI\") and Toshiba Corporation (\"Toshiba\").\nApple Products Division\nThis division produces devices for Apple, its subcontractors and licensees as well as Apple-compatible peripheral suppliers worldwide. Apple has been provided with high-performance gate array and cell-based products, which are used in Apple's older Quadra(TM) and Powerbook(TM) computer lines based on the Macintosh(R) platform and in a host of printer products. The Company does not have significant silicon content in Apple's first generation Power Macintosh(TM) machines. As a result, the 1994 production volumes for Apple were significantly lower than 1993 levels. Also see \"MARKETING AND CUSTOMERS\" below.\nComputer and Government Product Divisions\nThe computer product division markets include workstations (from entry-level through high-end graphic), servers, parallel processors, mass storage devices and peripherals. Significant customers include Silicon Graphics, Inc., AT&T, Storage Technology Corporation and DEC.\nTarget market segments for VPD's government product business involve commercial applications of technologies developed for military applications, including Geo-Positioning Satellite (\"GPS\") systems and entertainment applications of graphics technology. Secure information technologies in the form of data encryption strategies are another key area of focus for this division. This group provides devices to large electronics-related defense contractors but does not act as a prime contractor on government contracts.\nConsumer and Industrial Product Divisions\nThe consumer and industrial product divisions primarily target high-volume entertainment-related markets including television and satellite cable applications, HDTV, and electronic games as well as other miscellaneous applications including manufacturing and robotics. The customer base for these divisions includes Sony Corporation, Pioneer Electric Corporation, The 3DO Company, Scientific Atlanta, Inc., Thompson Consumer Electronics Inc. and the Allen-Bradley Division of Rockwell International Corporation.\nNetwork Products Division\nThe network products division supports customers such as DSC Communications Corporation, Alcatel Alsthom Compagnie Generale d'Electricite and Tellabs Incorporated in several applications, including digital cross-connect, transmission, networking\/internetworking, switching and multiplexing. Certain communications-specific FSB cells have been employed as high-level building blocks and designed to consolidate voice, data, image and video onto single networks and comply with the relevant industry standards that include high\ncomplexity analog, digital and memory functions. Specific solutions for major customers include FSB cells for various networking standards, including ATM, T1, E1 and Sonet\/SDH.\nWireless Products Division\nThe wireless products division provides wireless communications voice and data system solutions. This division uses baseband signal processing technology developed to support various voice and data standards, including GSM, PHS, DECT and CDPD solutions. The division supports major wireless telephone manufacturers, including Ericsson, Orbitel Mobile Communications Ltd., Nokia Corporation Information Systems, Motorola, DDI Corporation and Nippon Electric Corporation (\"NEC\"). Additionally, solutions have been developed for other markets and standards. Wireless revenues are primarily generated in the European market; additionally, sales to a single OEM, Ericsson, account for over 60% of 1994 worldwide wireless revenues.\nPersonal Computer Division\nThe Personal Computer Division (\"PCD\"), located in Tempe, Arizona, supplies system-logic chip sets and peripheral components for desktop and portable personal computers based on X86 architectures. The product line consists of highly-integrated core logic and peripheral input\/output devices for X86 systems. The division primarily serves a selected set of high-volume market leaders worldwide, such as Compaq, Hewlett-Packard, AST Research, and Dell Computer. VLSI's chip sets currently support Intel Corporation (\"Intel\"), Advanced Micro Devices, Inc., and other X86 microprocessors.\nThe PC chip set market has been characterized by intense competition, resulting in constant pressure to improve pricing and features to maintain market share. With new PC design cycles occurring every six to twelve months, this competitive environment requires continuous efforts to develop and introduce new products into the marketplace. Any delays in the development of a new chip set can result in substantial loss of both market share and profitability. While PCD has generally been successful in its development and introduction of new products in the past, there can be no guarantee that this success will continue in the future.\nPCD's development efforts involve the timely introduction of highly integrated chip sets, enabling PC manufacturers to supply cost-effective computing systems to end users within narrow market windows. While PCD works closely with key customers to identify the correct set of features and functions to include in its future products, the division must make critical decisions concerning chip set configurations using imperfect information. If the actual direction of the PC chip set market takes a turn that is substantially different from the one anticipated by the division's development team, substantial losses in market share, gross margin, and profitability may result.\nIn 1994, the microprocessor architecture used by most PC manufacturers continued to be the 486 system for which PCD produced its SC483(TM), a low-power controller. Also during the year, PCD initiated commercial volume production of a controller chip for Intel's Pentium system, the production of which is expected to increase throughout 1995. PCD also shipped significant amounts of its SCAMP IV(TM) chip set for portable PCs, although revenues from the device are expected to decline in 1995 as the portable market transitions to the Pentium architecture.\nThe Technology and Manufacturing Agreement (\"Technology Agreement\"), signed by VLSI and Intel in July 1992, provided VLSI with access to Intel's 386SL(TM) microprocessor technology intended for integration into products for the handheld computer market. While the development efforts were completed in 1994, this market failed to materialize at a rate supporting commercial production. As a result, the Technology Agreement was mutually terminated in November 1994 and, in January and February 1995, Intel disposed of its ownership of VLSI Common Stock. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results\" in Item 7 of Part II herein.\nMARKETING AND CUSTOMERS\nThe Company uses a direct sales force, commissioned representatives and distributors to sell its silicon products and services. VLSI's silicon operations have 28 sales offices (20 in the United States, four in Europe, two in Japan and two in the Asia-Pacific region) as well as 18 Technology Centers (11 in the United States, four in Europe, two in Japan and one in the Asia-Pacific region). Direct sales represent the Company's primary distribution channel. The direct sales force is assisted by VLSI engineers located in its Technology Centers.\nThe Company's Technology Centers support VLSI's customers by offering a range of design services. These services include system definition, complete logic and circuit design and test program generation. Staffed by system and integrated circuit designers, the Technology Centers are located near potential customers.\nApproximately two-thirds of the Company's net revenues for 1994 were derived from sales to the Company's top 20 customers, eight of whom operate in the personal computer industry. As a result of this concentration of its customer base, the loss of business from any of these customers, significant changes in scheduled deliveries to any of these customers or decreases in the prices of products sold to any of these customers could materially adversely affect the Company's results of operations. For example, during 1992 and 1993, Apple was the Company's largest customer, accounting for approximately 15% and 19%, respectively, of the Company's net revenues in those years. In December 1993, Apple postponed and, in some cases, canceled shipments planned for delivery in 1994, adversely affecting VLSI's results of operations for 1994. The net effect was that Apple was not a 10% customer in 1994. Significant customers in 1994 include Compaq, comprising 22% of 1994 net revenues. See also Item 7 of Part II herein, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results.\"\nRESEARCH AND DEVELOPMENT\nThe Company's research and development (\"R&D\") is focused on continued development and improvement of its systems applications expertise, process and packaging technologies, design libraries and its expertise with cell-based and gate array ICs. The Company's R&D expenditures for the years 1992, 1993 and 1994 have shown sequential increases with total expenses of $50.4 million, $65.4 million and $78.9 million, respectively.\nThe Company's future success depends on its ability to develop and introduce new products that compete effectively on the basis of price and performance and that satisfy customer requirements. New product development often requires long-term forecasting of market trends, development and implementation of new processes and technologies and substantial capital commitments. For example, the Company invested significant resources toward developing products for the handheld computer market, which failed to develop as estimated, thereby postponing, if not permanently deferring, the Company's recovery of the cost of these development expenditures. If the Company is unable to design, develop, manufacture and market new products successfully and in a timely manner, its operating results could be adversely affected. No assurance can be given that the Company's product and process development efforts will be successful.\nThe Company's process technology development activities in 1994 concentrated on the successful development of a 0.5-micron CMOS process, the initiation of a 0.35-micron CMOS process and for the development of software for the EDA market. R&D activities in the packaging area focus on high performance, high pincount advanced packaging solutions and assembly techniques.\nResearch and development activities are sometimes augmented through alliances with other companies. Wafer process technology development efforts in 1994 in conjunction with the Company's strategic agreement with Hitachi, Ltd. include integration of 0.5- and 0.35-micron CMOS process and manufacturing methodologies in the San Antonio, Texas wafer fabrication facility.\nSee also \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results\" in Item 7 of Part II herein.\nMANUFACTURING\nThe fabrication of ICs is an extremely complex and precise process consisting of hundreds of separate steps and requiring production in a highly controlled, clean environment. Minute impurities, errors in any step of the fabrication process, defects in the masks used to print circuits on a wafer or a number of other factors can cause a substantial percentage of wafers to be rejected or numerous die on each wafer to be nonfunctional.\nSemiconductor manufacturing is also highly capital intensive, and capital costs have tended to significantly increase as geometries have decreased in size. The marketplace has placed an ongoing emphasis on ever-smaller geometries, evidenced by increasing demand for deep sub-micron devices (those geometries under 0.6-micron), requiring the Company to increase its capital investment requirements to keep abreast of market demand.\nThe Company's success is partially dependent upon its ability to develop and implement new manufacturing process technologies. Semiconductor design and process methodologies are subject to rapid technological change, requiring large expenditures for research and development. The Company believes that the transition to smaller geometry process technologies will be important to remaining competitive. There can be no assurance that the Company will be able to profitably manufacture devices in geometries smaller than 0.6-micron.\nIn addition to large R&D expenditures required to develop processes for deep sub-micron devices, capital expenditure requirements to manufacture at such small geometries increase rapidly. Decreases in geometries call for sophisticated design efforts, advanced manufacturing equipment and cleaner fabrication environments. The Company made significant investments during 1994 into sub-micron manufacturing and expects to continue a high level of investment in this area in the future.\nThe majority of the Company's 1994 wafer production utilized a 0.8-micron CMOS process. The Company balances its wafer manufacturing between its own wafer fabrication facilities and those of third-party wafer subcontractors. This strategy provides manufacturing flexibility and the ability to realize economies of scale by operating the Company-owned fabrication facilities at capacity with a buffer in case of changes in demand. Approximately 80% of the Company's wafers in 1992 were manufactured internally. This percentage decreased to approximately 75% during 1993 and 1994, as the demand for the Company's products exceeded the rate of expansion of internal manufacturing capacity.\nThe Company has three manufacturing facilities. Its San Jose, California plant performs wafer fabrication, probe and final test activities. The San Antonio, Texas facility is dedicated to wafer fabrication and includes four modules. All of Module A and Module B have been facilitized. Equipping the remaining component of Module B will allow the Company to potentially double the Company's production capability at the San Antonio facility. The Tempe, Arizona site contains design, probe and final test facilities.\nThe building housing the Company's San Jose wafer fabrication facility, which currently accounts for approximately 40% of its total internal wafer production, was purchased by the Company during the first quarter of 1994. The Class 10 San Jose facility is currently being converted from a 5-inch wafer process to a 6-inch process in order to significantly increase device production capacity at this facility. The San Jose wafer fabrication facility is located near major earthquake faults and in an area that has in the recent past experienced an extended drought. Additionally, as a 11-year-old fabrication facility, it faces certain technological limitations. Due to the age of the Class 10 San Jose facility and other factors, including ground motion, it is uncertain whether geometries smaller than the 0.8-micron level can ever be profitably manufactured there.\nDuring 1995, the Company expects to convert its San Antonio wafer fabrication facility from a predominantly 0.8-micron process to a predominantly 0.6-micron process. The conversion, if successfully completed, will increase device volume production and lead to lower overall device costs.\nIn addition to manufacturing in its own facilities, VLSI has wafer manufacturing arrangements with foreign companies specializing in subcontract wafer foundry services. These wafer subcontractors are themselves subject to all of the manufacturing risks that are applicable to VLSI's own wafer manufacturing operations. In addition, the Company's foreign subcontract manufacturing arrangements are subject to risks\nsuch as changes in government policies, transportation delays, increased tariffs, fluctuations in foreign exchange rates, and export and tax controls.\nEven though the Company utilizes both of its fabrication plants and multiple subcontractors to manufacture its wafers and has the ability to shift manufacturing from one plant to another for many of its products, disruption of operations at either the Company's production facilities or those of its subcontractors for any reason, such as fire or earthquake, could cause significant delays in shipments until the Company could shift the products from an affected facility or subcontractor to another facility.\nThe Company subcontracts substantially all of its integrated circuit packaging and approximately 30% of its final testing to third parties. The final tested circuits are normally returned to the Company for shipment to customers. Subcontractors include Anam Semiconductor Technology Co. Ltd. in Korea and the Philippines (see Item 13 in Part III hereof). Although the Company has no long-term contractual commitments from these suppliers, the Company believes that these sources of packaging and testing services are relatively reliable given their level of interdependence with the Company and the overall level of availability of worldwide subcontract packaging and testing capacity. Any problems experienced in obtaining acceptable subcontract manufacturing services could delay shipments of the Company's products and affect the Company's results of operations.\nThe principal raw materials used by the Company in the manufacture of its products are silicon wafers, processing chemicals and gases and certain precious metals. Subcontractors use ceramic and plastic packages to enclose the devices produced for the Company. Certain raw materials used for the manufacture of ICs are available from a limited number of worldwide suppliers. The Company does not generally depend on long-term fixed-price supply contracts. Shortages could occur in various essential materials due to interruption of supply or increased demand in the industry. If VLSI was 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 also depend upon a continuing adequate supply of electricity, natural gas and water.\nSee also \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results\" in Item 7 of Part II herein.\nCOMPETITION\nThe semiconductor industry in general and the markets in which the Company competes in particular are intensely competitive, exhibiting both rapid technological change and ongoing price erosion as technologies mature. From time to time, the industry has also experienced significant downturns, often in connection with, or in anticipation of, declines in general economic conditions. These downturns, which in some cases have lasted for more than a year, have been characterized by diminished product demand, production over-capacity and subsequent accelerated erosion of average sales prices. Competition in the personal computer market, the Company's largest individual market segment, is especially intense and is subject to significant shifts in demand and severe pricing pressures. For example, during the third quarter of 1992, the migration of the PC market from the 386 to the 486 architecture caused a decline in demand for 386 chip sets and related devices, resulting in an excess of worldwide supply of such chip sets and significant price declines as competitors struggled to maintain market share. A similar occurrence is possible with respect to the transition from 486 architecture to the Pentium-compatible architecture. Although this transition has already begun, it is very difficult to predict the speed and exact timing of this change.\nThe Company competes with large domestic and foreign companies that have substantially greater financial, technical, marketing and management resources than the Company, such as AT&T, LSI, Motorola, TI and Toshiba. Additionally, VLSI's competitors in the personal computer chip set market are continuously changing and include Intel, ACC Microelectronics Corporation, OPTi, Inc., Silicon Integrated Systems and Cirrus Logic Inc. There is no assurance that the Company will be able to compete successfully in the future.\nCompetition is based on such factors as design capabilities (including both the design tool features and the skills of the design team), quality, delivery time and price. The Company believes that its competitive\nstrengths include: a growing expertise in systems applications in specific market segments, its high quality wafer processing technology and fabrication facilities, its experienced engineering staff, test capabilities, cost effectiveness, technical design services offered through its network of Technology Centers and design tools and services, including its proprietary FSB libraries.\nSee also \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results\" in Item 7 of Part II herein.\nCOMPASS DESIGN AUTOMATION, INC.\nThe Company's COMPASS subsidiary designs, develops, markets and services software-based products used by systems or circuit designers to design complex integrated circuits using either schematic capture, high level design languages, data path descriptions or state diagrams. These design tools integrate many steps of the design process, from design specification (beginning with synthesis and test) through physical layout and verification.\nCOMPASS product offerings are organized into four main product lines: logic design and analysis tools, physical design and verification tools, library development tools and physical libraries. These products are intended to reduce overall time to market and decrease engineering and production costs for advanced integrated circuit design.\nCOMPASS produces a complete set of tools for all levels of design from VHDL and Verilog down to basic silicon structures. In the top-down design market segment, COMPASS is focused on VHDL and Verilog-based synthesis and test-generation tools, along with services to import custom libraries from various semiconductor vendors to work on the COMPASS toolset. In the physical design software area, COMPASS develops tools for floorplanning, automatic place-and-route, a range of symbolic and polygon-based custom layout tools, and a complete set of physical layout verification tools. In library technology, COMPASS develops a wide range of Foundry Flexible(TM) libraries, memory and datapath compilers. It also develops high-productivity tools to automate the process of library generation.\nCOMPASS' R&D efforts are focused on making its array of software technology capable of supporting a wider variety of semiconductor vendor design tools and semiconductor foundry formats. Product development efforts are focused on the design environment requirements imposed by deep sub-micron designs. During 1994 and continuing in 1995, the COMPASS product development focus is on deep sub-micron physical libraries, the associated physical design software tools, and related EDA tools required by large, complex design projects.\nCOMPASS competes with other software vendors in the EDA market for integrated circuit design automation. Competition in the EDA market has come primarily from a few large established vendors, such as Cadence Design Systems, Inc., Mentor Graphics Corporation, Viewlogic Systems, Inc., and Synopsys, Inc. COMPASS is pursuing cooperative relationships with certain of these large EDA companies to provide complementary solutions to the vendors' offerings. Competition is based on such factors as design capabilities (including both the design tool features and the skills of the design team), quality, delivery time and price. The Company believes that a principal competitive strength of COMPASS is its expertise and products for deep sub-micron libraries and physical design. The Company's ability to compete in the EDA market will depend upon the expansion of vendor libraries available for the logic design system and the foundries that can fabricate designs using COMPASS libraries. Such vendor libraries are available from COMPASS as well as other semiconductor vendors, which include Fujitsu Ltd., General Electric Corporation Ltd.'s Plessey Division, Gold Star Co., Ltd., Hitachi, Mitsubishi Ltd., NEC and Toshiba. Additionally, COMPASS Foundry Flexible libraries are supported by VLSI, Taiwan Semiconductor Manufacturing Company Ltd., Chartered Semiconductor Manufacturing Pte Ltd., European Silicon Structures BV, and other foundries.\nCOMPASS uses direct sales, commissioned representatives and distributors to sell its software products. COMPASS' 19 sales offices (13 in the United States, four in Europe, one in Japan and one in the Asia-Pacific region) include its three worldwide development centers. Direct sales represent COMPASS' primary domestic and\nEuropean distribution channels, allowing COMPASS to bring to focus the technical and systems expertise necessary to sell EDA software.\nCOMPASS generally licenses its design tools under nontransferable, non-exclusive license agreements and provides postcontract customer and software revision support. In addition, COMPASS offers training and consulting services to its customers. COMPASS retains ownership rights to all software that it develops. COMPASS uses various security schemes to protect its software products from unauthorized use or copying.\nCOMPASS does sell its products to U.S. government agencies and defense related customers. However, such revenues are not currently material, nor are they expected to be a material part of the COMPASS business in the future.\nBACKLOG\nThe Company's sales are made primarily pursuant to standard purchase orders for delivery of products, with such purchase orders officially acknowledged by VLSI according to its own terms and conditions. Due to industry practice with respect to cancellation of orders, VLSI believes that backlog is a potentially misleading indicator of future revenue levels.\nEMPLOYEES\nAs of December 30, 1994, the Company and its subsidiaries had approximately 2,700 employees worldwide. Management believes that the future success of VLSI will depend in part on its ability to attract and retain qualified employees, including technical and design personnel and high-level executives. The Company has granted stock options to many of its employees and has implemented stock purchase and profit sharing programs. In addition, the Company currently has Management Continuity Agreements with seven of its officers (see Exhibit 10.50 and the information contained in the Proxy Statement under the caption \"Executive Officer Compensation -- Management Continuity Agreements\", which information is incorporated herein by reference).\nPATENTS AND LICENSES\nThe Company has filed a number of patent applications and currently holds various U.S. patents expiring from 2003 to 2012 covering inventions in the areas of computer-aided engineering and electronic circuitry. VLSI has also filed corresponding patent applications in foreign jurisdictions. The Company expects to file future patent applications from time to time, as appropriate, both in the United States and abroad. VLSI does not consider the success of its business to be materially dependent on any single patent or group of patents.\nThe semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights and positions, which have on occasion resulted in protracted and expensive litigation. The Company is currently one of four remaining defendants in a major patent infringement suit brought by TI (see \"Legal Proceedings\" in Item 3 of Part I herein). A court date for this proceeding has been set for April 1995. While the outcome of this matter is currently not determinable, management believes that its ultimate resolution will not have a material adverse effect on the Company's consolidated financial position or results of operations. However, should the ultimate outcome of this matter be unfavorable, VLSI may be required to pay damages and other expenses.\nIBM and Motorola have separately contacted the Company concerning its alleged use of intellectual property belonging to them. The Company does not believe it is using either of these companies' intellectual property.\nThere can be no assurance that additional intellectual property claims will not be made against the Company in the future or that the Company will not be prohibited from using the technologies subject to such claims or be required to obtain licenses and make corresponding royalty payments for past or future use. There can be no assurance that any such licenses could be obtained on commercially reasonable terms.\nVLSI has also entered into a number of licensing agreements and technology exchange agreements with various strategic partners and other third parties in order to allow VLSI limited access to third party technology, or to allow third parties limited access to VLSI's technology.\nWORKING CAPITAL\nInformation regarding the Company's working capital practices is incorporated herein by reference from Item 7 of Part II hereof under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\" and from Item 8 of Part II hereof under the heading \"Revenues\" in Note 1 of Notes to Consolidated Financial Statements.\nFINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC DATA\nThis information is included in Note 10 of Notes to Consolidated Financial Statements, which information is incorporated herein by reference to Item 8 of Part II hereof.\nENVIRONMENTAL ISSUES\nThe Company is subject to a variety of federal, state and local governmental regulations related to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in its manufacturing process. Increasing public attention has been focused on the environmental impact of semiconductor manufacturing operations. The Company's San Jose, California facilities are located near recently developed residential areas and a potential elementary school site, which could increase the incidence of environmental complaints or investigations. There can be no assurance that changes in environmental regulations will not impose the need for additional capital equipment or other requirements. Any failure by the Company to control the use of, or adequately to restrict the discharge of, hazardous substances under present or future regulations could subject VLSI to substantial liability or could cause its manufacturing operations to be suspended, which could have a potentially adverse effect on the Company's operating results.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company has three manufacturing facilities located in San Jose, California, Tempe, Arizona and San Antonio, Texas. In addition, VLSI (including its subsidiary, COMPASS) has 47 sales offices (33 in the U. S., eight in Europe, three in Japan and three in the Asia-Pacific region) and 18 Technology Centers (11 in the U. S., four in Europe, two in Japan and one in the Asia-Pacific region). The Company purchased two buildings used for wafer fabrication and test areas at its San Jose site in 1994 and additionally owns its Tempe, Arizona and San Antonio, Texas facilities. The Company's other properties are occupied under operating leases that expire from April 1995 through February 2020 with options to renew in most instances. The Tempe facility is located on land held under a long-term ground lease, which expires in December 2037, while the Company owns the land beneath its San Antonio facilities.\nThe Company's San Jose facility, which includes manufacturing, COMPASS, VPD marketing and corporate support services such as its computer center, technology development, primary shipping location and major design center, is located near major earthquake faults. Should an earthquake cause an interruption in operations, operating results would be materially adversely affected.\nThe San Antonio facility began qualified production in 1989 and is dedicated to wafer fabrication. Module A of four planned modules of class 1 clean room was completed in 1990. Module B was partially facilitized, equipped and used to augment capacity beginning in 1991 with the balance of facilitization completed in 1993. As of the end of 1994, approximately two-thirds of module B has been equipped. The remaining one-third of module B can be incrementally equipped in order to expand internal fabrication capacity. Future expansion strategy has not been established for unfacilitized, unequipped modules C and D at the San Antonio plant.\nThe Tempe site contains the primary research and development resources for PCD, test facilities, marketing, sales and Technology Center functions. The facility, occupied in 1987, was expanded on 6.2 acres of immediately adjacent property in 1992.\nVLSI expanded into new leased facilities adjacent to its San Jose headquarters in 1993 and has leased additional space adjacent to its San Jose campus in 1994 to augment its near-term space requirements. The Company anticipates that the lease of the additional space, along with an option obtained for additional space adjacent to its newly leased facilities in San Jose, will satisfy the Company's growth needs in the medium term.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a named defendant in a lawsuit that claims alleged patent infringement. In addition, four lawsuits filed in 1993 alleging violations of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), were dismissed with prejudice in 1994.\nTexas Instruments Patent Litigation\nIn July 1990, TI filed two actions against the Company and four other defendants, Analog Devices, Inc., Integrated Device Technology, Inc. (\"IDT\"), LSI and Cypress Semiconductor Corporation (the Company and such other defendants are collectively referred to as the \"TI Defendants\"). IDT settled its cases with TI in late December 1992.\nIn the action filed before the United States International Trade Commission (\"ITC\"), TI sought to exclude from importation into the U.S. all TI Defendants' products manufactured outside the U.S. that allegedly utilize a plastic encapsulation process described in U.S. Patent No. 4,043,027 (the \"027 patent\"). On October 15, 1991, the Administrative Law Judge (\"ALJ\") found the 027 patent to be valid and infringed by the Company's old plastic encapsulation gating process. However, a new plastic encapsulation gating process developed and used by the TI Defendants was found not to infringe the 027 patent. In December 1991, the full ITC determined that it would not consider TI's appeal to overturn the ALJ's decision on noninfringement of the new process. As a result, the Company believes that the importation of its products containing the new noninfringing plastic encapsulation gating process will continue unabated. The United States Court of Appeals for the Federal Circuit affirmed the ITC decision in March 1993.\nTI also filed a patent infringement action against the TI Defendants in the United States District Court for the Northern District of Texas seeking an injunction against the sale and\/or manufacture by the TI Defendants of products that allegedly infringe the 027 patent. The action also seeks damages for alleged past infringement of the 027 patent and expired U.S. Patent No. 43,716,764. The motions of both TI and the TI Defendants for Summary Judgment in this case were both denied in August 1994. A trial date for this matter has been scheduled for April 1995. If the patent infringement claim is upheld, the Company believes that licenses will be available for a negotiated fee. If VLSI is unable to pass any increased costs of manufacturing due to patent license fees on to its customers, VLSI's gross margins would be adversely affected. No assurance can be given that TI would offer a license to VLSI, that the terms of any such license would be favorable, or that any patent dispute will be resolved without a material adverse impact on the Company. Should licenses be unavailable, the Company may be required to discontinue its use of certain processes or the manufacture and sale of certain of its products.\nOther Patent Matters\nIn addition, in the normal course of business, the Company receives and makes inquiries with regard to other possible patent infringement. Where deemed advisable, the Company may seek or extend licenses or negotiate settlements. See \"Patents and Licenses\" in Item I of Part I herein.\nClass Action Securities Litigation\nThe Exchange Act claims were four class action litigation claims filed during the fourth quarter of 1993 and subsequently consolidated during the first quarter of 1994 to a single action, Waldron et al. vs. Fiebiger, et al. The claim related to a decrease in the market price of the Company's Common Stock in December 1993. On April 25, 1994, the case was dismissed with prejudice as a result of a stipulation entered into by all parties. No consideration was paid.\nThe Company will vigorously defend itself in any legal matters and while the ultimate outcome of such matters is not determinable, management believes that such actions, either individually or in the aggregate, should not have a materially adverse impact on its results of operations or consolidated financial position. However, the ongoing costs of defending lawsuits utilizes cash and management resources and, should the ultimate outcome of any of the actions be unfavorable, VLSI may be required to pay damages and other expenses.\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 fiscal 1994, which ended December 30, 1994.\nEXECUTIVE OFFICERS OF THE COMPANY\nInformation concerning executive officers of the Company who are not also directors is set forth below:\nMr. John C. Batty, age 40, was elected Vice President and Treasurer in December 1992. Mr. Batty joined the Company in June 1986 as Financial Manager. From April 1989 to April 1991, Mr. Batty was the Tempe, Arizona Site Controller. From April 1991 to December 1992, Mr. Batty was Director, Corporate Financial Planning.\nMr. Donald L. Ciffone, Jr., age 39, was elected Vice President and General Manager of the VLSI Product Divisions in August 1992. Mr. Ciffone joined the Company in November 1991 as Vice President, Primary and Emerging Markets Division. From March 1991 until joining the Company, Mr. Ciffone was Director of Marketing for Oasic Technology, an ASIC company. Mr. Ciffone was employed by National Semiconductor Corporation in various capacities from 1978 until 1991, most recently as Director of Marketing, ASIC Division.\nMr. Gregory K. Hinckley, age 48, was elected Vice President, Finance and Chief Financial Officer of the Company in August 1992 upon joining the Company. From December 1991 until August 1992, he was an independent consultant. From January 1989 until December 1991, Mr. Hinckley was Senior Vice President and Chief Financial Officer of Crowley Maritime Corporation, a U.S. shipping company. Mr. Hinckley is a director of Advanced Molecular Systems.\nMr. Balakrishnan S. Iyer, age 38, joined the Company in April 1993 as Vice President and Controller. From July 1992 until joining VLSI, Mr. Iyer was Corporate Controller for Cypress Semiconductor Corporation, a semiconductor manufacturer. From August 1988 until July 1992, Mr. Iyer was Group Controller at Advanced Micro Devices, Inc., a semiconductor manufacturer.\nMr. L. Don Maulsby, age 43, was named Vice President and General Manager of the Personal Computer Division in June 1994. Prior to that time, he was Vice President, Worldwide Sales and Technology Center Operations, from November 1992. Mr. Maulsby joined the Company in 1988 as a Regional Sales Manager. Mr. Maulsby was Area Sales Manager from January 1989 to September 1990. From September 1990 to August 1991, Mr. Maulsby was Vice President, Central U.S. Business Unit; and from August 1991 to November 1992, Vice President, North American Sales and Technology Center Operations.\nMr. Dieter J. Mezger, age 51, has been President of the Company's subsidiary, COMPASS Design Automation, Inc., since its formation in February 1991. Since July 1990, Mr. Mezger has also been Senior Vice President of the Company. He joined the Company in 1984 as Director and General Manager of the\nCompany's European operations. From December 1988 until March 1991, he was President of VLSI Technology Europe.\nMr. Thomas F. Mulvaney, Esq., age 46, was elected Vice President and Secretary of the Company in July 1990. Mr. Mulvaney joined the Company in May 1990 as the Company's General Counsel, in which capacity he continues to serve. Prior to joining the Company, he was employed at CP National Corporation (\"CPN\"), a telecommunications concern, from 1981 to May 1990, as Vice President and General Counsel. He also served as President and Chief Executive Officer of Control Communications Industries, Inc., CPN's manufacturing entity, from December 1988 to May 1990.\nThere are no family relationships among the named officers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nFINANCIAL INFORMATION BY QUARTER (UNAUDITED) (THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n- ---------------\n(1) Costs associated with the Company's Technology Centers have been reclassified from Research and development to Cost of sales and Marketing, general and administrative. See Note 1 of Notes to Consolidated Financial Statements in Item 8 of Part II herein.\n(2) The Company's Common Stock is traded on the Nasdaq National Market under the symbol VLSI. The market prices per share represent the highest and lowest closing prices for VLSI's Common Stock on the Nasdaq National Market during each quarter. On February 24, 1995, there were approximately 1,878 stockholders of record. The Company has not paid cash dividends and is currently prohibited from doing so. See Note 2 of Notes to Consolidated Financial Statements in Item 8 of Part II herein.\n(3) Included in operations for the second quarter of 1993 is a special charge of $1.0 million, representing a charge for purchased in-process research and development relating to the acquisition of certain assets and development efforts. See Note 6 of Notes to Consolidated Financial Statements in Item 8 of Part II herein.\nDuring the first quarter of 1994, all outstanding shares of the Company's Series B Common Stock, $.01 par value per share (\"Junior Common Stock\"), a series of Common Shares, automatically converted into shares of Common Stock on a one-for-one basis. Such automatic conversion was triggered by the Company's attainment of certain revenue and pre-tax income milestones specified in the Company's Certificate of Incorporation, as amended. Accordingly, there are no shares of Junior Common Stock outstanding.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n- --------------- (1) Included in operations for the second quarter of 1993 is a special charge of $1.0 million, representing a charge for purchased in-process research and development relating to the acquisition of certain assets and development efforts. See Note 6 of Notes to Consolidated Financial Statements in Item 8 of Part II herein.\n(2) Included in operations for the fourth quarter of 1992 is a special charge of $22.5 million related to the deemphasis of older technologies, costs of streamlining sales distribution channels, costs of relocating certain offices, writedowns of non-performing assets and costs associated with intellectual property matters. See Note 6 of Notes to Consolidated Financial Statements in Item 8 of Part II herein.\n(3) Included in operations for the third quarter of 1990 is a charge of $12.8 million, reflecting the estimated cost of corporate reorganization related to exiting the memory business.\n(4) Costs associated with the Company's Technology Centers have been reclassified from Research and development to Cost of sales and Marketing, general and administrative. See Note 1 of Notes to Consolidated Financial Statements in Item 8 of Part II herein.\nThe Company has never paid any cash dividends and is currently prohibited from doing so.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the 1994 Consolidated Financial Statements and Notes thereto in Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND FINANCIAL DATA\nThe chart entitled \"Financial Information by Quarter (Unaudited)\" contained in Item 5 of Part II hereof is hereby incorporated by reference into this Item 8 of Part II of this Form 10-K.\nVLSI TECHNOLOGY, INC.\nANNUAL REPORT ON FORM 10-K\nYEAR ENDED DECEMBER 30, 1994\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nConsolidated Financial Statements Included in Item 8:\nSchedules other than those listed above have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders of VLSI Technology, Inc.\nWe have audited the accompanying consolidated balance sheets of VLSI Technology, Inc. as of December 30, 1994 and December 25, 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three fiscal years in the period ended December 30, 1994. Our audits also included the financial statement schedule listed in the index at Item 14(a)(2). 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 VLSI Technology, Inc. at December 30, 1994 and December 25, 1993, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended December 30, 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 -------------------------------------- ERNST & YOUNG LLP\nSan Jose, California January 17, 1995\nVLSI TECHNOLOGY, INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS\n(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n- --------------- (1) See Note 9 for related party disclosures.\n(2) See Note 1 for reclassifications of Technology Center costs.\nSee accompanying Notes to Consolidated Financial Statements.\nVLSI TECHNOLOGY, INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\n(DOLLARS AND SHARES IN THOUSANDS)\nSee accompanying Notes to Consolidated Financial Statements.\nVLSI TECHNOLOGY, INC.\nCONSOLIDATED BALANCE SHEETS\n(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n- --------------- (1) See Note 9 for related party disclosures.\nSee accompanying Notes to Consolidated Financial Statements.\nVLSI TECHNOLOGY, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(DOLLARS IN THOUSANDS)\nSee accompanying Notes to Consolidated Financial Statements.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 30, 1994\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION. The consolidated financial statements include the accounts of VLSI Technology, Inc. (VLSI or the Company) and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nFISCAL YEAR. In 1994, the Company changed its fiscal year to end on the last Friday in December; in prior years, the Company's fiscal year ended on the last Saturday in December. Fiscal years 1994, 1993 and 1992 ended December 30, 25 and 26, respectively. Fiscal year 1994 consisted of 53 weeks, while all other years presented herein consisted of 52 weeks.\nCASH EQUIVALENTS AND LIQUID INVESTMENTS. Cash equivalents reflect highly liquid short-term investments with maturities at date of purchase of three months or less. These investments are readily convertible to known amounts of cash, while investments with maturities of between three and twelve months are considered liquid investments.\nLiquid investments consist of commercial paper and are valued at fair value.\nCONCENTRATIONS OF CREDIT RISK. Financial instruments that potentially subject VLSI to concentration of credit risk consist principally of cash equivalents, liquid investments and trade receivables. VLSI places its investments with high-credit-quality financial institutions and, by policy, limits the amount of credit exposure to any one financial institution. A majority of VLSI's trade receivables are derived from sales to manufacturers of computer systems, with the remainder spread across various other industries. Management believes that any risk of accounting loss is significantly reduced due to the diversity of its products, end customers and geographic sales areas. VLSI performs ongoing credit evaluations of its customers' financial condition and requires collateral, such as letters of credit and bank guarantees, whenever deemed necessary.\nINVENTORIES. Inventories are stated at the lower of cost or market. Cost is computed on a currently adjusted standard basis (which approximates average cost on a FIFO basis); market is based upon estimated net realizable value.\nPROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are stated at cost. Depreciation and amortization are provided on the straight-line method for financial reporting purposes and on accelerated methods for tax purposes. Assets leased under capitalized leases are recorded at the present value of the lease obligations and amortized on a straight-line basis over the lease term.\nCAPITALIZATION OF SOFTWARE DEVELOPMENT COSTS. Capitalization of software costs begins when technological feasibility is established. Such costs are stated at the lower of unamortized cost or net realizable value. Amortization is computed using (a) the straight-line method based on the estimated economic life of each product, or (b) the ratio of each product's current gross revenue for that product to the total of current and anticipated gross revenue for that product, whichever is greater. Software development costs of $0.6 million, $0.8 million and $0.2 million were capitalized in 1994, 1993 and 1992, respectively, and $0.7 million, $0.8 million and $0.5 million were amortized to cost of sales in 1994, 1993 and 1992, respectively.\nREVENUES. Revenues from silicon product sales to customers other than distributors are recognized upon shipment. Certain sales made to distributors are under agreements allowing the right of return and price protection on merchandise not sold by the distributors. Accordingly, the Company defers recognition of revenue and profit until the merchandise is sold by the distributors.\nRevenues associated with software system sales and software licenses are generally recognized at the time of shipment. Postcontract customer support revenues are recognized ratably over the term of the related agreements. Training and consulting revenues are recognized as the related services are performed.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\nRevenues relating to the licensing of technology are generally recognized when the significant contractual obligations have been fulfilled and the fees are billable.\nTRANSLATION OF FOREIGN CURRENCIES. VLSI translates accounts denominated in foreign currencies using the respective local subsidiary currency as the functional currency. Thus, results from foreign operations are subject to exchange rate fluctuations and foreign currency transaction costs. Net foreign currency transaction losses included in interest income and other expenses, net, were not material in 1994, 1993 and 1992. Foreign translation gains and losses and the effect of foreign currency exchange rate fluctuations on cash flows in all years have not been material.\nFOREIGN EXCHANGE CONTRACTS. The Company's policy is to hedge all material monetary assets, liabilities and commitments denominated in currencies other than the functional currency of the Company's subsidiaries. This activity is primarily performed using forward contracts. This policy of hedging is intended to minimize the effect of fluctuating foreign currencies on reported income on a going-forward basis. No high correlation hedging activities are performed, as all currency risks are hedged with instruments using the same currency. The forward contracts qualify as hedges for financial reporting purposes and accordingly, are reported at market value with gains and losses on such hedges included in other current assets or accrued liabilities and offset against foreign exchange gains or losses on the exposures hedged. The forward contracts position at December 30, 1994, all of which relate solely to hedging foreign currency net asset positions, consist of 1) foreign exchange forward contracts to sell $18.9 million in foreign currency and buy $21.8 million in foreign currency and 2) cross currency contracts to exchange 23.2 million French francs for Deutsche marks. These contracts were with major international financial institutions, matured through January 1995 resulting in a net gain of $0.4 million and included no deferred gains or losses. The realized gain on the contracts substantially equaled the offsetting loss of the underlying exposure.\nFAIR VALUE DISCLOSURES. The following estimated fair values have been determined by the Company using available market information and appropriate valuation methodologies:\nCash, cash equivalents and liquid investments -- The carrying amounts of these items are their fair value.\nDebt (See Note 2) -- Quoted market prices of the Company's Convertible Subordinated Debentures are currently available. Interest rates that are currently available to the Company for issuance of debt similar to existing secured equipment loans are used to estimate the fair value of remaining maturities of existing secured equipment loans.\nForeign currency contracts -- The estimated fair value of foreign currency contracts is based on quoted market prices obtained from dealers.\nThe carrying amount and fair value of the Company's financial instruments at December 30, 1994 and December 25, 1993 are as follows:\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\nThe fair value estimates presented are based on pertinent information available to management as of December 30, 1994 and December 25, 1993, respectively. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since such dates, and current estimates of fair value may differ significantly from the amounts presented.\nEffective December 26, 1993, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (FAS 115), which creates certain classification categories for such investments, based on the nature of the securities and the intent and investment goals of the Company. FAS 115 has been adopted on a prospective basis, and the financial statements of prior years have not been restated. The cumulative effect of the change was not material.\nUnder FAS 115, management classifies investments as available-for-sale or held-to-maturity at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost with corresponding premiums or discounts amortized over the life of the investment to interest income. Marketable equity securities, and debt securities not classified as held-to-maturity, are classified as available-for-sale and reported at fair value. Unrecognized gains or losses on available-for-sale securities are included, net of tax, in equity until their disposition. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in interest income. The cost of securities sold is based on the specific identification method.\nAll investments at December 30, 1994 are classified as available-for-sale securities. Such investments, which mature through April 1995, are categorized in the following table.\nThere were no gains or losses on sales of available-for-sale securities during 1994. Unrealized holding losses on available-for-sale securities included in stockholders' equity in 1994 were immaterial.\nINTEREST EXPENSE AND OTHER, NET. Interest expense net of interest income and other expenses, net include costs associated with material litigation, such as that brought by Texas Instruments Incorporated (TI)\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\n(See Note 4). Such litigation costs were immaterial in 1994 and 1993 and $3.2 million in 1992. Also included in interest income and other expenses, net, in 1992 is $0.9 million associated with a stockholder class action lawsuit settlement regarding alleged violations of federal securities and certain state laws. Of total interest expenditures in 1994 of $8.7 million, the Company capitalized $0.4 million. Amounts subject to capitalization in prior years were not material.\nINCOME TAXES. Effective December 27, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (FAS 109), for the 1993 and subsequent fiscal years. The cumulative effect of the adoption of FAS 109 was not material. Prior to the adoption of FAS 109, income taxes were accounted for under FAS 96.\nNET INCOME (LOSS) PER SHARE. Net income (loss) per share is computed using the weighted average number of shares of outstanding Common Stock and dilutive common equivalent shares -- shares issuable under the stock option plans and a warrant held by Intel Corporation (Intel). The Convertible Subordinated Debentures are not included, because the effect would be antidilutive. Fully diluted earnings per share have not been presented, because the amounts would be antidilutive.\nRECLASSIFICATIONS. During 1994, the Company reclassified costs associated with its Technology Centers from research and development to cost of sales and marketing, general and administrative in order to make the presentation of the Company's financial statements more comparable with the financial statements of its closest competitors and to better reflect the nature of these costs. Amounts reclassified in 1994, 1993 and 1992 total $22.7 million, $18.4 million and $19.1 million, respectively. Cost of sales were increased $17.9 million, $14.2 million and $14.9 million for 1994, 1993 and 1992, respectively. Marketing, general and administrative expenses were increased $4.8 million, $4.2 million and $4.2 million for 1994, 1993 and 1992, respectively.\nCertain other prior year amounts previously reported have been reclassified to conform to the 1994 presentation.\nThe Company must adopt Statement of Position 93-7, \"Reporting on Advertising Costs\" (SOP 93-7) in fiscal 1995. Adoption of SOP 93-7 will not have a material effect on the Company's consolidated financial statements.\n2. LONG-TERM DEBT\nTotal debt at December 30, 1994 and December 25, 1993 consists of the following:\nAs of December 30, 1994, VLSI had unsecured domestic and foreign uncommitted credit facilities plus committed credit, lease and secured equipment financing aggregating $81.4 million ($67.0 million available). Interest on short-term borrowing facilities was based on market rates. Interest on long-term borrowing facilities is generally payable quarterly at contractual rates based on U.S. Treasury securities. Certain secured\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\nequipment loans require adherence to certain financial covenants, one of which prohibits payment of cash dividends.\nIn 1994, the Company entered a two-year committed Credit Agreement (the Credit Agreement) with a syndicate of banks providing for borrowings of up to $52,500,000 at various rates of interest. All borrowings under the Credit Agreement are due no later than June 7, 1996. The Credit Agreement has various covenants that preclude the Company from, among other things, paying dividends and also limit the Company's ability to purchase its own stock, dispose of its properties and make certain investments. The Company is required to maintain certain financial ratios as defined in the Credit Agreement. The Credit Agreement also calls for a variable limit on the Company's dollar amount of capital spending. Annual commitment fees, which the Company believes are immaterial, are charged on the unused portion of the committed credit amount. There are no compensating balance requirements. Borrowings outstanding under the Credit Agreement are unsecured. At December 30, 1994, the Company had no outstanding borrowings on the Credit Agreement.\nInterest on the Convertible Subordinated Debentures (Debentures) is payable semi-annually on November 1 and May 1 of each year. The Debentures are convertible into Common Stock of the Company at any time prior to maturity, unless previously redeemed, at a conversion price of $22.00 per share, subject to adjustment under certain conditions. Required annual sinking fund payments commencing May 1, 1998 will retire 70% of the Debentures prior to maturity. At December 30, 1994, the Debentures were redeemable at the Company's option at 102.1% of the principal amount and at diminishing prices thereafter. The Debentures are subordinated in right of payment to senior indebtedness as defined.\nMaturities of debt are as follows: 1995 -- $7.6 million, 1996 -- $7.4 million, 1997 -- $6.0 million, 1998 -- $8.2 million, 1999 -- $5.6 million and thereafter (starting in 2000) -- $64.6 million.\n3. LEASES AND OTHER COMMITMENTS\nObligations under capital leases represent the present value of future rental payments under various agreements to lease manufacturing equipment. The Company has options to purchase leased assets at the end of the lease terms for their fair market values or at stipulated values up to 30% of original cost. Accumulated amortization of these leased assets was $54.6 million and $47.8 million at December 30, 1994 and December 25, 1993, respectively.\nThe Company rents certain equipment and manufacturing and office facilities under operating lease agreements which expire through 2037 and contain renewal options and provisions adjusting the lease payments, based upon changes in the Consumer Price Index or in fixed increments. VLSI is generally responsible for taxes, insurance and utilities under these leases.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\nFuture minimum lease payments under capital leases, together with the present value of those payments and the aggregate annual rental commitments under noncancelable operating leases as of December 30, 1994, are shown as follows:\nRental expense was approximately $9.0 million in 1994 ($11.3 million in 1993 and $10.7 million in 1992).\nOTHER COMMITMENTS. Commitments for purchase of equipment totaled approximately $48.3 million at December 30, 1994.\n4. LITIGATION AND CONTINGENCIES\nThe Company is a named defendant in a lawsuit alleging patent infringement.\nIn 1990, patent infringement claims were filed by TI against the Company and four other defendants with the International Trade Commission (ITC) and the U.S. District Court for the Northern District of Texas, Dallas Division (District Court), seeking to preclude importation into the U.S. of, and an injunction against the sale and\/or manufacture of, parts using the allegedly protected process and seeking unspecified damages, respectively. During 1991, the Company developed an alternate process and discontinued use of the allegedly protected process. In February 1992, the ITC determined that the Company infringed the original patented process, but found the alternate process to be non-infringing. The Court of Appeal, for the Federal Circuit, affirmed the ITC decision in 1993.\nAt the request of the District Court, the parties filed Motions for Summary Judgment and responses thereto in the first quarter of 1994, all of which were denied in August 1994. A trial date for TI's patent infringement action in the District Court case has been set for April 1995. If the patent infringement is upheld relative to the Company's products that used the old process, damages for past infringement may be assessed. If the alternate process is found to be infringing and the patent infringement claim is upheld, the Company believes that licenses will be available for a negotiated fee. No assurance can be given that the terms of any offered license will be favorable, or that any patent dispute will be resolved without an adverse effect on the Company. If VLSI is unable to pass any increased costs of manufacturing due to patent license fees on to its customers, VLSI's gross margins would be adversely affected. Should licenses be unavailable, the Company may be required to discontinue its use of certain processes and\/or the manufacture and sale of certain of its products. The Company is vigorously defending itself against the TI claims. However, should the ultimate outcome of this matter be unfavorable, VLSI may be required to pay damages and other expenses.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\nIn addition, in the normal course of business, the Company receives and makes inquiries with regard to other possible patent infringement. Where deemed advisable, the Company may seek or extend licenses or negotiate settlements.\nWhile the outcome of this matter is currently not determinable, management believes that the ultimate resolution of this matter will not have a material adverse effect on the Company's consolidated financial position or results of operations. However, should the ultimate outcome of this matter be unfavorable, VLSI may be required to pay damages and other expenses.\nFour shareholder claims filed in December 1993 for alleged violations of federal securities laws were consolidated into one action and dismissed with prejudice during 1994.\n5. STOCKHOLDERS' EQUITY\nThe Company's amended certificate of incorporation authorizes 57,000,000 shares of Capital Stock for issuance, 55,000,000 shares of which are designated Common Shares and 2,000,000 shares of which are designated Preferred Shares. The Common Shares are authorized to be issued in series, with the first series designated Common Stock and consisting of 54,000,000 shares. All other series of Common Shares (other than Common Stock) are designated, as a group, Junior Common Stock and consist of 1,000,000 shares. The Board of Directors (Board) has authorized an increase of 45,000,000 Common Shares, subject to stockholder approval. The Board has the authority to issue the Preferred Shares and the Common Shares (other than Common Stock) in series, the rights, preferences and privileges of which can be determined by the Board without stockholder approval.\nINTEL AGREEMENTS. On August 25, 1992, Intel invested $50 million in VLSI to acquire 5,355,207 shares of the Company's Common Stock (Intel Shares) plus a warrant (Warrant) to purchase an additional 2,677,604 shares of the Company's Common Stock (Warrant Shares) at $11.69 per share pursuant to the Intel\/VLSI Stock and Warrant Purchase Agreement (Equity Agreement). In addition, on July 8, 1992, VLSI and Intel entered into a Technology and Manufacturing Agreement (Technology Agreement). Pursuant to the Technology Agreement, the two companies were working together to manufacture -- with VLSI responsible for designing, marketing and selling -- chips that would enable manufacturers to build handheld computers on the standardized system platform to be developed by the companies. The development efforts were completed in 1994, however the market for handheld computers developed more slowly than originally anticipated. As a result, in November 1994, the Company and Intel terminated the Technology Agreement, and in January and February 1995, Intel sold all of the Intel Shares.\nThe Equity Agreement currently provides Intel with demand registration rights with respect to the Warrant Shares. The Equity Agreement also imposes certain restrictions on Intel, including a limitation on Intel's ability to acquire additional shares of VLSI voting stock (referred to as a standstill) and a requirement that Intel vote its VLSI stock in the same proportion as other stockholders on matters submitted to the VLSI stockholders for approval (unless it would be materially adverse to Intel's interest). All other significant rights of, and restrictions on, Intel under the Equity Agreement have terminated.\nThe Warrant, which expires in August 1995, contains certain antidilution provisions and provisions for minimum payment to the Warrant holder in the event VLSI is acquired. As of December 30, 1994, such minimum amount was equal to $0.72 per Warrant Share and decreases on a straight-line daily basis over the three-year term of the Warrant to zero. The Warrant does not give the holder any voting rights prior to exercise of the Warrant and issuance of the Warrant Shares.\nSTOCKHOLDERS' RIGHTS PLAN. In August 1992, the Board of Directors approved the adoption of the First Amended and Restated Rights Agreement (Restated Rights Agreement), which replaces the Common Shares Rights Agreement dated as of November 7, 1989 (Prior Rights Agreement) and amends the\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\noutstanding rights issued pursuant to the Prior Rights Agreement (Rights). Among other things, the Restated Rights Agreement provides that each Right will now relate to a fraction of a share of Series A Participating Preferred Stock of the Company (a Unit), which is economically equivalent to one share of Common Stock. On August 24, 1992, the Board of Directors further amended the Restated Rights Agreement for the purpose of excepting certain transactions contemplated by the Equity Agreement between the Company and Intel from operation of the Restated Rights Agreement. The Rights can be transferred or exercised (initially at a price of $45 per Unit) only upon the occurrence of certain events involving substantial transfers of ownership of Common Shares. The Rights are redeemable, in whole but not in part, at VLSI's option at $.01 per Right, at any time prior to becoming exercisable and in certain other circumstances. The Rights expire no later than November 7, 1999.\nDIRECTORS' STOCK OPTION PLAN. Under the Directors' Stock Option Plan, which expires in 2001, options having ten-year terms are automatically granted annually to non-employee directors. At December 30, 1994, non-employee directors held options to purchase 110,000 shares of Common Stock at exercise prices ranging from $6.75 to $14.25 per share, of which 70,000 were exercisable. In addition, 175,000 shares were available for future grant under this Plan.\nEMPLOYEE STOCK PURCHASE PLAN. Under VLSI's Employee Stock Purchase Plan, qualified employees are entitled to purchase shares of Common Stock at 85% of the fair market value at certain specified dates. Of the 6,600,000 shares authorized to be issued under this Plan, 6,076,162 shares have been issued through December 30, 1994. The Board has authorized an increase of 2,400,000 shares under this Plan, subject to stockholder approval.\nSTOCK OPTION PLANS. Employees and consultants may be granted options to purchase shares of VLSI's authorized but unissued Common Stock, as well as certain other awards under the Company's 1992 Stock Plan. Additionally, employees and consultants may exercise options to purchase shares of VLSI Common Stock previously granted under the 1982 Incentive Stock Option Plan. No new options may be granted under the 1982 Incentive Stock Option Plan. Options granted under these Plans may either be \"incentive stock options\" or \"nonstatutory\" options. All outstanding options have exercise prices equal to the fair market value on the date of grant. Generally, outstanding options expire ten years from date of grant and become exercisable at a rate of 25% per year from date of grant. At December 30, 1994, 48,703 shares were available for grant under the 1992 Stock Plan. This Plan expires in 2002. The Board has authorized an increase of 2,500,000 shares under this Plan, subject to stockholder approval. The Board has also amended this Plan to limit the total number of shares that may be granted under the Plan to any one individual to 500,000 shares per annum for both new and existing employees, subject to stockholder approval.\nAdditional information relative to the Plans is as follows:\nDuring 1994, VLSI recorded a tax benefit related to options exercised under the Plans, resulting in a $1,200,000 increase in stockholders' equity ($1,680,000 in 1993 and $600,000 in 1992).\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\n6. SPECIAL CHARGES\nThe special charge in 1993 of $1.0 million represents a charge for purchased in-process research and development relating to the acquisition of certain assets and development efforts of Open Solutions, Inc. and its subsidiary, CAD Language Systems, Inc., by COMPASS Design Automation, Inc., a Company subsidiary, in June 1993. The acquisition was accounted for as a purchase. Results of operations from the effective date to year-end are included in the statement of operations. The aggregate purchase price totaled $2.4 million, including assumption of liabilities.\nDuring the fourth quarter of 1992, the Company recorded a special charge of $22.5 million related to the deemphasis of older technologies, costs of streamlining sales distribution channels, costs of relocating certain offices, write-downs of non-performing assets and costs associated with intellectual property matters. There have been no changes to the amounts estimated in the special charge. Except for reserves for intellectual property matters, substantially all cash disbursements associated with this charge have been made. The remaining unpaid reserves are included in reserve for special charges and will be paid based on the resolution of the litigation discussed in Note 4.\n7. EMPLOYEE BENEFIT PLANS\nThe Company accrued approximately $5,043,000, $3,751,000 and $206,000 in 1994, 1993 and 1992, respectively, for its Employee Profit Sharing Plan, Executive Performance Incentive Plan and Performance Recognition Plan. The Company's contribution expenses associated with its 401(k) plan were approximately $647,000, $548,000 and $480,000 in 1994, 1993 and 1992, respectively.\n8. INCOME TAXES\nThe provision for taxes on income is as follows:\nPre-tax income (loss) from foreign operations was $4.5 million in 1994, $1.2 million in 1993 and $(3.0) million in 1992.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\nThe provision for taxes reconciles with the amount computed by applying the U.S. statutory rate to income (loss) before provision for taxes as follows:\nDeferred income taxes reflect tax credits and loss carryforwards and the 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.\nSignificant components of the Company's deferred tax liabilities and assets are as follows:\nThe valuation allowance decreased $462,000 during 1993. Approximately $4.4 million of the December 30, 1994 valuation reserve is related to benefits of stock option deductions, which will be allocated directly to additional paid-in capital when realized.\nThe 1992 deferred tax provision of $358,000 consisted of individually immaterial items.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\nFor U.S. tax purposes, at December 30, 1994, VLSI had general business and alternative minimum tax credit carryforwards of approximately $6.0 million. Foreign subsidiaries have tax loss carryforwards of approximately $10.5 million. Such credit and loss carryforwards expire in various years beginning in 1997. The Company's federal income tax returns have been examined by the Internal Revenue Service (IRS) for all years through 1990. All issues have been resolved with no material effect, and the IRS has closed those years.\nCertain foreign subsidiaries have accumulated earnings of $8.1 million, on which no U.S. deferred taxes have been provided. There is no intention to distribute these earnings. If distributed, there would be minimal incremental income taxes.\n9. RELATED PARTIES\nAs of December 30, 1994, VLSI had received advances of $5.5 million from Intel in accordance with the Technology Agreement, of which $3.3 million and $2.2 million was amortized to income in 1994 and 1993, respectively, in accordance with the terms of the Technology Agreement.\nVLSI purchased $27.6 million, $38.1 million and $23.3 million in 1994, 1993 and 1992, respectively, of production, assembly and test services from a company with whom a director of the Company is affiliated. Outstanding amounts payable to that company were $1.9 million and $2.3 million in 1994 and 1993, respectively.\n10. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION\nVLSI operates in a single industry segment and designs, manufactures and markets primarily custom and semicustom integrated circuits of high complexity, along with associated integrated circuit computer-aided engineering and design software and systems. The Company distributes its products through worldwide direct sales, commissioned representatives and distributors.\nIn 1994, Compaq Computer Corporation accounted for 22% of net revenues. In 1993 and 1992, Apple Computer, Inc. accounted for 19% and 15%, respectively, of net revenues.\nMajor operations outside the United States include sales offices and technology centers in Western Europe, Japan and Asia-Pacific. Foreign operations are subject to risks of political instability and foreign currency exchange rate fluctuations.\nTransfers between geographic areas are accounted for at amounts that are generally above cost and consistent with the rules and regulations of governing tax authorities. Such transfers are eliminated in the consolidated financial statements. Identifiable assets are those assets that can be directly associated with a particular geographic area and thus do not include assets used for general corporate purposes, such as cash, cash equivalents and liquid investments.\nVLSI TECHNOLOGY, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 30, 1994\nThe following is a summary of operations located within the indicated geographic areas for the three years ended December 30, 1994:\nU.S. export revenues, primarily to the Asia-Pacific region, were approximately $162.1 million, $126.7 million and $82.2 million in 1994, 1993 and 1992, respectively.\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 directors appearing under the caption \"Election of Directors -- Nominees for Director\" in the Proxy Statement is hereby incorporated herein by reference.\nInformation regarding executive officers who are not also directors is incorporated herein by reference from Part I hereof under the heading \"Executive Officers of the Company\" immediately following Item 4 in Part I hereof.\nInformation regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is hereby incorporated herein by reference from the section entitled \"Information Concerning Solicitation and Voting -- Compliance with Section 16(a) Filing Requirements\" in the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated herein by reference from the Proxy Statement under the captions \"Election of Directors -- Nominees for Director\", \"Election of Directors -- Director Compensation\", \"Election of Directors -- Compensation Committee Interlocks and Insider Participation\" and \"Executive Officer Compensation\" .\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated herein by reference from the Proxy Statement under the caption \"Information Concerning Solicitation and Voting -- Security Ownership\".\nITEM 13.","section_13":"ITEM 13. CERTAIN TRANSACTIONS AND RELATED TRANSACTIONS\nIncorporated herein by reference from the Proxy Statement under the captions \"Election of Directors -- Compensation Committee Interlocks and Insider Participation\", \"Election of Directors -- Certain Transactions\" and \"Executive Officer Compensation\".\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 (including the notes thereto) listed in the accompanying index to financial statements and financial statement schedules are filed within this Annual Report on Form 10-K.\n2. Financial Statement Schedules\nThe financial statement schedule listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedule are filed as part of this Annual Report on Form 10-K.\n3. Exhibits\nThe exhibits listed under Item 14(c) hereof are filed as part of this Annual Report on Form 10-K.\n(b) Reports on Form 8-K.\nThere were no filings on Form 8-K during the fourth quarter ended December 30, 1994.\n(c) Exhibits\n- --------------- * Denotes a compensation plan in which an executive officer participates.\n** Denotes a document for which confidential treatment has been granted for selected portions.\n(d) Financial Statement Schedules\nSee Item 14(a)(2) above.\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements (Forms S-8 Nos. 2-86600, 2-90890, 33-4797, 33-12909, 33-21116, 33-27872, 33-39653, 33-52908, 33-62068, 33-57433 and 33-57991) pertaining to the Employee Stock Purchase Plan, 1992 Stock Plan, 1982 Incentive Stock Option Plan, 1983 Incentive Junior Stock Plan and 1986 Directors' Stock Option Plan of VLSI Technology, Inc. and in the related Prospectuses, of our report dated January 17, 1995, with respect to the consolidated financial statements and schedules of VLSI Technology, Inc. included in this Annual Report (Form 10-K) for the year ended December 30, 1994.\n\/s\/ ERNST & YOUNG LLP -------------------------------------- ERNST & YOUNG LLP\nSan Jose, California March 20, 1995\nVLSI TECHNOLOGY, INC.\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\n- --------------- (1) Deductions represent amounts written off against the allowance for doubtful accounts and customer returns.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nVLSI TECHNOLOGY, INC. (Registrant)\nBy \/s\/ ALFRED J. STEIN\n------------------------------------ Alfred J. Stein, Chairman of the Board, Chief Executive Officer and President\nDate: March 1, 1995\nPOWER OF ATTORNEY\nKNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Alfred J. Stein and Gregory K. Hinckley, 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 Annual 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.\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* Denotes a compensation plan in which an executive officer participates.\n** Denotes a document for which confidential treatment has been granted selected portions.","section_15":""}
{"filename":"813621_1994.txt","cik":"813621","year":"1994","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nAmerican Colloid Company was originally incorporated in South Dakota in 1924 as the Bentonite Mining & Manufacturing Co. Its name was changed to American Colloid Company in 1927, and it was reincorporated in Delaware in 1959. Except as otherwise noted, and unless the context indicates otherwise, the term \"Company\" or \"Colloid\" refers to American Colloid Company and its subsidiaries.\nThe Company may be generally divided into three principal categories of operations; minerals, absorbent polymers and environmental. The Company also operates a transportation business primarily for delivery of its own products. In general, the Company's products are used for their liquid-absorption properties. The Company is a leading producer of bentonite products, which have a variety of applications, including use as a bonding agent to form sand molds for metal castings, in cat litter, as a moisture barrier in commercial construction and landfill liners and in a variety of other industrial, commercial and agricultural applications. The Company also manufactures absorbent polymers, predominantly superabsorbent polymers, used in disposable baby diapers and other personal care products, such as adult incontinence and feminine hygiene products.\nThe following table sets forth the percentage contributions to net sales of the Company attributable to its minerals, absorbent polymers, environmental and transportation segments for the last five calendar years.\nNet revenues, operating income and identifiable assets attributable to each of the Company's business segments are set forth in Note 2 of the Company's Notes to Consolidated Financial Statements included elsewhere herein, which Note is incorporated herein by reference.\nMINERALS\nCommercially produced bentonite is a type of montmorillonite clay found in beds ranging in thickness from two to ten feet under overburden of up to 120 feet. There are two basic types of bentonite, each having different chemical and physical properties. These are commonly known as sodium (western) bentonite and calcium (southern) bentonite. A third type of clay, a less pure type of calcium montmorillonite called fuller's earth, is used as a form of cat litter and for other applications, including use as a carrier for agri-chemicals.\nThe Company's bentonite used in industrial applications is marketed under various internationally registered trade names, including VOLCLAY-Registered Trademark- and PANTHER CREEK-Registered Trademark-. The Company's cat litter is sold under the trade names NATURAL SELECT-Registered Trademark-, PREMIUM CHOICE-TM-, CARE FREE KITTY-TM- and various private labels.\nPRINCIPAL MARKETS AND PRODUCTS\nDURABLE GOODS\nMETALCASTING. In the formation of sand molds for metal castings, sand is bonded with bentonite and various other additives to secure the desired surface finish. The Company produces both standard and customized blended mineral products, sold under the trade name ADDITROL-Registered Trademark-, as well as sodium and calcium bentonite, used as additives to metalcasting molds. In addition, several high-performance specialty products are sold to foundries and companies that service foundries.\nIRON ORE PELLETIZING. The Company is a major supplier of sodium bentonite for use as a pelletizing aid in the production of taconite pellets in North America.\nWELL DRILLING. Sodium bentonite and leonardite are ingredients of drilling mud, which allows rock cuttings to be suspended and brought to the surface in oil and gas well drilling. Drilling mud lubricates the drilling bit and coats the underground formations to prevent hole collapse and drill bit siezing. In the late 1970's and early 1980's oil well drilling was the Company's largest market for bentonite.\nOTHER INDUSTRIAL PRODUCTS. The Company is a supplier of fuller's earth products for use as an oil and grease absorbent in industrial applications. The Company also produces bentonite and bentonite blends for the construction industry, which are used as a plasticizing agent in cement, plaster and bricks and as an emulsifier in asphalt.\nCONSUMABLE GOODS\nCAT LITTER. The Company produces two types of cat litter products, a fuller's earth-based or traditional product and a sodium bentonite-based scoopable (or clumping) product. The Company's scoopable products' clump-forming capability traps urine, allowing for easy removal of the odor producing elements. Scoopable cat litter has grown to 42% of the U.S. grocery market for cat litter in 1994 from 0.4% in 1989. Both types of products are sold primarily to private label grocery and mass merchants, though the Company also sells its own brands to the grocery, pet store and mass markets. The Company's scoopable product is marketed under the trade names NATURAL SELECT-Registered Trademark-, PREMIUM CHOICE-TM- and CARE FREE KITTY-TM-.\nFINE CHEMICALS. Purified grades of sodium bentonite are marketed to the pharmaceutical and cosmetics industries. Small amounts of purified bentonite act as a binding agent for pharmaceutical tablets, and bentonite's expansion quality also aids in tablet disintegration. Bentonite also acts as a suspension agent and thickener in lotions and has a variety of other specialized uses as a flow control additive. Calcium bentonite is used as a catalyst or as a clarifying agent for edible oils, fats, dimer acids and petroleum products.\nAGRICULTURAL. Sodium bentonite, calcium bentonite and fuller's earth are sold as pelletizing aids in livestock feed and as dusting agents to prevent caking of feeds in storage or in transit. Fuller's earth and sodium bentonite are used as carriers for agri-chemicals. Fuller's earth is also used as a drying agent in blending liquid and dry fertilizers prior to application.\nSALES AND DISTRIBUTION\nIn 1994, the top two customers accounted for approximately 11% of the Company's mineral sales, and the top five customers accounted for approximately 20% of such sales. The Company's mineral products are sold domestically and internationally to approximately 3,700 customers.\nThe Company has established industry-specialized sales groups staffed with technically-oriented salespersons to serve each major market in which the Company's products are utilized. Each group has a network of distributors and representatives, including companies that warehouse at strategic locations.\nMost of its customers in the metalcasting industry are served on a direct basis by teams of Company sales, technical and manufacturing personnel. The Company also provides training courses and laboratory testing for customers who use the Company's products in the metalcasting process.\nSales to the oil well drilling industry are primarily made directly to oil well drilling mud service companies, both under the Company's name and under private label. Bentonite used in oil well drilling is sold by oil well service organizations, two of which are vertically integrated. The Company's potential market is, therefore, generally limited to those oil well service organizations which either do not have captive production or long-term supply arrangements.\nSales to the cat litter market are made on a direct basis and through industry brokers. All sales to the iron ore pelletizing industry are made directly to the end user. Sales to the Company's remaining markets are made primarily through independent distributors and representatives.\nCOMPETITION\nBENTONITE. The Company is one of the largest producers of bentonite products in the U.S. There are at least four other major domestic producers of sodium bentonite and at least one other major domestic producer of calcium bentonite. Two of the domestic producers are companies primarily in other lines of business and have substantially greater financial resources than the Company. There also is substantial competition overseas. The Company's bentonite processing plants in the U.K. and Australia compete with a total of six U.K. and Australian processors. Competition in both the Company's domestic and international markets is essentially a matter of product quality, price, delivery, service and technical support, and it historically has been very vigorous.\nFULLER'S EARTH. There are approximately ten major competitors in the U.S., some of which are larger and have substantially greater financial resources than the Company. Price, service, product quality and geographical proximity to the market are the principal methods of competition in the Company's markets for fuller's earth.\nSEASONALITY\nAlthough business activities in certain of the industries in which the Company's mineral products are sold (such as well drilling) are subject to factors such as weather conditions, the Company does not consider its mineral business as a whole to be seasonal.\nENVIRONMENTAL\nPRINCIPAL PRODUCTS AND MARKETS\nThrough its wholly owned subsidiary, Colloid Environmental Technologies Company (CETCO), the Company sells sodium bentonite, products containing sodium bentonite and various other products and equipment for use in environmental and construction applications.\nCETCO sells bentonite and its geosynthetic clay liner product, BENTOMAT-Registered Trademark-, for lining and capping landfills, and for containment in tank farms, leach pads, waste stabilization lagoons and decorative ponds.\nThe Company's VOLCLAY-Registered Trademark- Waterproofing System is sold to the non-residential construction industry. This line includes a product sold under the registered trade name VOLCLAY PANELS-Registered Trademark- consisting of biodegradable cardboard panels filled with sodium bentonite installed to prevent leakage through underground foundation walls. A waterproofing liner product with the trade name VOLTEX-Registered Trademark-, a joint sealant product with the trade name WATERSTOP-RX-Registered Trademark- and a waterproofing membrane for concrete slit slabs and plaza areas sold under the trade name VOLCLAY SWELLTITE-Registered Trademark- round out the principal components of the product line.\nCETCO sells elastomeric urethane coatings designed for vehicular traffic decks, roofs, balconies and pedestrian walkways. The products, sold under the trade name ACCOGUARD-Registered Trademark-, are among the more environmentally friendly primers and coatings available to the construction industry.\nCETCO's ground water products are used to drill environmental wells and water wells, rehabilitate existing water wells and seal abandoned exploration drill holes. VOLCLAY GROUT-Registered Trademark-, BENTOGROUT-Registered Trademark- and VOLCLAY-Registered Trademark- Tablets are among the trade names for products used in these applications.\nBentonite-based flocculents and customized equipment are used to remove emulsified oils and heavy metals from waste water. Another bentonite based product is formulated to solidify liquid waste for proper disposal in landfills. These products are sold primarily under the System-AC RM10-Registered Trademark- and SORBOND-Registered Trademark- trade names.\nCETCO acquired the assets of Aquatec Engineering and Supply Company in July, 1994 and continues to operate the business as a division of the Company. This division specializes in providing water equipment and services to the environmental remediation industry and activated carbon purification systems for the beverage and municipal water treatment industries. Its operations include a fully equipped engineering and fabrication facility for producing pressure vessels used in filtration applications. In addition, a network of regional service centers provides services and distribution to support markets such as remediation of petroleum-contaminated ground water. This fast growing sector is expanding in the number of service centers and its geographic coverage.\nHydron, Inc., a division of CETCO acquired in June, 1994, designs water treatment systems using dissolved air flotation technologies. As a part of the transaction, CETCO acquired certain patent rights for using bentonite flocculants in conjunction with dissolved air flotation systems.\nCOMPETITION\nCETCO has three principal competitors in the geosynthetic clay liner market. The construction and wastewater treatment product lines are niche businesses which compete primarily with alternative technologies. The service center remediation business has two major competitors, one of which is substantially larger and with greater resources. The ground water monitoring and soil sealants products compete with the Company's traditional rivals in the sodium bentonite business. Competition is based on product quality, service, price, technical support and availability of product. Historically, the competition has been very vigorous.\nSALES AND DISTRIBUTION\nIn 1994, no customer accounted for more than 5% of environmental sales. CETCO products are sold domestically and internationally. CETCO sells most of its products through independent distributors and commissioned representatives. Contract remediation work is done on a direct basis working with consulting engineers engaged by the customers. CETCO employs technically oriented marketing personnel to support its network of distributors and representatives. In the service center business, salespersons develop business in the regional markets to supplement contract remediation work performed for national accounts.\nSEASONALITY\nMuch of the business in the environmental sector is impacted by weather and soil conditions. Many of the products cannot be applied in harsh weather conditions and, as such, sales and profits tend to be stronger April through October. As a result, the Company considers this segment to be seasonal.\nMINERAL RESERVES\nBoth the mineral and environmental segments have sodium bentonite reserves and processing plants. The discussion of mineral reserves which follows applies to both units.\nRESEARCH AND DEVELOPMENT\nThe minerals and environmental segments share research and laboratory facilities. Both CETCO and the U.K. minerals operation have intentions of developing independent research capabilities. Plans are underway to accomplish their objectives. Technological developments are shared between the companies, subject to license agreements where appropriate.\nMINERALS\/ENVIRONMENTAL COMMON OPERATIONAL FUNCTIONS\nMINERAL RESERVES\nThe Company has reserves of sodium and calcium bentonite at various locations in Wyoming, South Dakota, Montana, Nevada, Mississippi and Alabama, and reserves of fuller's earth in Tennessee and Illinois. At 1994 consumption rates, based on internal estimates, the Company believes that its proven reserves of commercially usable sodium and calcium bentonite will be adequate for approximately 30 years (although reserves for certain specialty uses differ significantly from this 30-year period) and that its proven reserves of fuller's earth will be adequate for approximately 20 years. While the Company, based upon its experience, believes that its reserve estimates are reasonable and its title and mining rights to its reserves are valid, the Company has not obtained any independent verification of such reserve estimates or such title or mining rights. The Company owns or controls the properties on which its reserves are located through long-term leases, royalty agreements and patented and unpatented mining claims. A majority of the Company's bentonite reserves are owned. All of the properties on which the Company's reserves are located are either physically accessible for the purposes of mining and hauling, or the cost of obtaining physical access would not be material.\nOf the total reserves, approximately 20% are located on unpatented mining claims owned or leased by the Company, on which the Company has the right to undertake regular mining activity. To retain possessory rights, a fee of $100 per year for each unpatented mining claim is required. The validity of title to unpatented mining claims is dependent upon numerous factual matters. The Company believes that the unpatented mining claims which it owns have been located in compliance with all applicable federal, state and local mining laws, rules and regulations. The Company is not aware of any material conflicts with other parties concerning its claims. From time to time, members of Congress as well as members of the executive branch of the federal government have proposed amendments to existing federal mining laws. As currently proposed, the various amendments would have a prospective effect on mining operations on federal lands and include, among other things, the imposition of royalty fees on the mining of unpatented claims, the elimination or restructuring of the patent system and an increase in fees for the maintenance of unpatented claims. To the extent that these proposals may result in the imposition of royalty fees on unpatented lands, the mining of the Company's unpatented claims may become uneconomic, and royalty rates for privately leased lands may be affected. The Company cannot predict the form that any amendments might ultimately take or whether or when any such amendments might be adopted.\nThe Company's fuller's earth reserves are both owned and leased. The loss of any of the leased reserves could materially decrease the Company's reserves of fuller's earth, but it is believed that alternative economical reserves could be developed.\nThe Company maintains a continuous program of exploration for additional reserves and attempts to acquire reserves sufficient to replenish its consumption each year, but it cannot assure that additional reserves will continue to become available.\nThe Company oversees all of its mining operations, including its exploration activity and the obtaining of necessary state and federal mining permits.\nThe following table shows a summary of minerals sold by the Company for the last five years in short tons:\nThe Company estimates that available supplies of other materials utilized in its mineral business are sufficient to meet its production requirements for the foreseeable future.\nMINING AND PROCESSING\nBENTONITE. Bentonite is surface mined, generally with large earthmoving scrapers, and then loaded into trucks and off-highway haul wagons for movement to the processing plants. The mining and hauling of the Company's clay is done both by the Company and by independent contractors. Each of the Company's processing plants generally maintain stock piles of unprocessed clay of approximately 4 to 8 months' production requirements.\nAt the processing plants, bentonite is dried, crushed and sent through grinding mills, where it is sized into shipping form, then chemically modified where needed and transferred to silos for automatic bagging or shipment in bulk. Virtually all production is shipped as processed, rather than stored for inventory.\nFULLER'S EARTH. Fuller's earth is also surface mined using a combination of scrapers, dozers and loaders. Crude clay is then loaded into dump trucks and hauled to the processing plant where it is dried or calcined, crushed and screened. Inventories of unprocessed clay generally are no more than two week's supply. Mining is thus performed on a year round basis.\nPRODUCT DEVELOPMENT AND PATENTS\nThe Company works actively with customers in each of its major markets in order to develop commercial applications of specialized grades of bentonite, and it maintains a bentonite research center and laboratory testing facility adjacent to its corporate headquarters as well as one in the U.K. When a need for a product which will accomplish a particular goal is perceived, the Company will work to develop the product, research its marketability and study the feasibility of its production. The Company will also continue its practice of co-developing products with customers or others as new needs arise. The Company's development efforts emphasize markets with which it is familiar and products for which it believes there is a viable market.\nThe Company holds a number of U.S. and international patents covering the use of bentonite and products containing bentonite. The Company follows the practice of obtaining patents on new developments whenever feasible. The Company, however, does not consider that any one or more of such patents is material to its Minerals and Environmental business as a whole.\nREGULATION AND ENVIRONMENTAL\nThe Company believes it is in material compliance with applicable regulations now in effect with respect to surface mining. Since reclamation of exhausted mining sites has been a regular part of the Company's surface mining operations for the past 26 years, maintaining compliance with current regulations has not had a material effect on its mining costs. The costs of reclamation are reflected in the prices of the bentonite sold.\nThe grinding and handling of dried clay is part of the production process, and, because it generates dust, the Company's mineral processing plants are subject to applicable clean air standards, and all of the Company's plants are equipped with dust collection systems. The Company has not had and does not presently anticipate any significant problems in connection with its dust emission, nor does it presently expect ongoing expenditures for the maintenance of its dust collection systems to be material.\nThe Company's mineral operations are also subject to other federal, state, local and foreign laws and regulations relating to the environment and to health and safety matters. Certain of these laws and regulations provide for the imposition of substantial penalties for non-compliance. While the costs of compliance with, and penalties imposed under, these laws and regulations have not had a material adverse effect on the Company, future events, such as changes in, or modified interpretations of, existing laws and regulations or enforcement policies or further investigation or evaluation of potential health hazards of certain products, may give rise to additional compliance and other costs that could have a material adverse effect on the Company. See \"Legal Proceedings.\"\nABSORBENT POLYMERS\nSince the early 1970s, the Company has utilized a technique called modified bulk polymerization (\"MBP\") to manufacture water soluble polymers for the oil well drilling fluid industry. This technique has been modified to produce superabsorbent polymers (\"SAP\"), a category of polymers known for their extremely high water absorbency. Chemdal Corporation was formed in March 1986 to manufacture and market absorbent polymers, with primary emphasis on SAP. To date, the Company's sales of SAP have been almost exclusively for use as an absorbent in personal care products, primarily disposable baby diapers. The Company produces SAP at its U.S. facility with an annual capacity of 40,000 tons and at its U.K facility, through Chemdal Limited, with an annual capacity of 40,000 tons.\nDemand for the Company's SAP in the U.S. has grown significantly in recent years as the amount of SAP used in new diaper designs has increased. SAP is more absorbent than the fluff pulp used in traditional disposable diapers. The increased use of SAP in diapers allows for a thinner diaper that occupies less shelf space in stores and less landfill space. The use of SAP also helps to keep the moisture inside the diaper, thereby causing less irritation to the wearer's skin and reducing leakage. The Company expects that the trend in Europe will follow that in the U.S. and anticipates an increase in demand for its SAP in Europe. However, there can be no assurance that consumer preferences and other factors in the European market will result in increased demand for the Company's products. Based upon the Company's expectations regarding consumer and retail preferences, the Company also believes that the trend in the diaper industry will continue to be toward increasing amounts of SAP being used in new diaper designs. While no assurance can be given that markets in developing countries will follow the trends of developed countries, the Company also believes that disposable diapers containing SAP will gain more acceptance in developing countries as per capita incomes in those countries rise.\nThe Company expanded its U.S. capacity from 20,000 to 40,000 tons annually in March 1994, and it expects to complete an additional expansion of 30,000 tons by mid 1995, which will bring the total production capacity of its U.S. facility to 70,000 tons annually. In addition, the Company increased its U.K. capacity from 10,000 to 40,000 tons annually in October 1994.\nPRINCIPAL MARKETS AND PRODUCT\nThe Company's SAP is primarily marketed under the trade names ARIDALL-Registered Trademark- and ASAP-Registered Trademark-. To date, the Company's customers have been primarily private label and national brand diaper manufacturers. The Company believes that this segment of the diaper market has grown faster than the brand name segment, which currently accounts for the majority of that market. The Company has recently begun sales to manufacturers of brand name personal care products and is seeking to increase its sales to that segment of the market.\nSALES AND DISTRIBUTION\nThe Company sells SAP to the personal care market in the U.S. on a direct basis and, in other countries, both on a direct basis and through distributors. The Company expects to rely increasingly on a direct sales approach in the personal care market. The Company's direct sales efforts employ a team approach that includes both technical and marketing representatives. In 1994, the top two customers accounted for approximately 32% of the Company's polymer sales, and the top five customers accounted for approximately 48% of such sales.\nThe Company sells SAP for use in agricultural market applications through an exclusive worldwide distributor. Sales to date in this market have been insignificant.\nPRODUCT DEVELOPMENT AND PATENTS\nThe Company continually seeks to improve the performance of its absorbent polymers. It also intends to pursue additional applications for its absorbent polymers in other markets either directly, or indirectly through marketing or distribution arrangements. For example, the Company has entered into a contract for the marketing and distribution of polymers in agricultural markets. Agricultural applications of polymers include use as a soil treatment to hold moisture to aid in hydration of plants and as a seed coating to hold moisture around seeds that tend to be delicate and difficult to germinate. Polymers also have applications in water treatment and in cosmetics, and acrylic-based polymers can be used in the newer, more concentrated detergents which use smaller packaging.\nThe Company owns several patents relating to its MBP process developed in the 1970s, and to modifications of its MBP process developed in the 1980s which relate to its SAP manufacturing process. The patents on the MBP process have begun to expire. The patents relating to the SAP modifications thereto expire at various times commencing in 2002.\nThe Company follows the practice of obtaining patents on new developments whenever reasonably practicable. The Company also relies on unpatented know-how, trade secrets and improvements in connection with its SAP manufacturing process. There can be no assurance that others will not independently develop substantially equivalent proprietary information and techniques, or otherwise gain access to or disclose the Company's trade secrets, or that the Company can meaningfully protect its rights to its unpatented trade secrets.\nRAW MATERIALS\nThe process used by the Company to produce SAP primarily uses acrylic acid and, to a lesser extent, potassium and sodium alkalies and catalysts. The Company's polymer operations are supplied by three major producers of acrylic acid. The Company has been able to obtain adequate supplies of acrylic acid to meet its production requirements to date.\nThe Company knows of four acrylic acid suppliers in the U.S., three in Europe and four in the Far East. The Company is aware that at least five of these suppliers manufacture SAP and, therefore, compete with the Company in this market.\nPotassium and sodium alkalies are available on a commercial basis worldwide with no meaningful limitations on availability. Catalysts are available from a small number of high-technology chemical manufacturers; however, the Company does not anticipate any difficulties in obtaining catalysts.\nCOMPETITION\nThe Company believes that there are approximately five polymer manufacturers and several importers that compete with its U.S. operation, three of which have more production capacity and several of which have substantially greater resources than the Company. The Company's U.K. operation competes with a total of approximately seven producers and several importers. Only one producer has substantially more production capacity and several producers have greater resources than the Company. Further, several of these competitors are vertically integrated and produce acrylic acid, the primary cost component of SAP. The competition in both the Company's domestic and international markets is primarily a matter of product quality and price, and it historically has been very vigorous.\nThe Company believes that its polymer manufacturing process has enabled it to add polymer production capacity at a significantly lower capital investment cost than that required by other processes currently in widespread commercial use.\nREGULATION AND ENVIRONMENTAL\nThe Company's production process for SAP consumes virtually all chemicals and other raw materials used in the process. Virtually all materials which are not consumed by the end product are recycled through the process. The Company's polymer plants, therefore, generate a minimal amount of chemical waste.\nThe handling of dried polymer is part of the production process, and, because this generates dust, the Company's polymer plants must meet clean air standards. The Company's polymer plants are equipped with dust collection systems, and the Company believes that it is in material compliance with applicable state and federal clean air regulations.\nThe Company's absorbent polymer business is subject to other federal, state, local and foreign laws and regulations relating to the environment and to health and safety matters. Certain of these laws and regulations provide for the imposition of substantial penalties for non-compliance. While the costs of compliance with, and penalties imposed under, these laws and regulations have not had a material adverse effect on the Company, future events, such as changes in, or modified interpretations of, existing laws and regulations or enforcement policies or further investigation or evaluation of potential health hazards of certain products, may give rise to additional compliance and other costs that could have a material adverse effect on the Company.\nTRANSPORTATION\nThe Company operates a long-haul trucking business and a freight brokerage business primarily for delivery of its own products in package and bulk form throughout the continental U.S. Through its transportation subsidiary, the Company is better able to control costs, maintain delivery schedules and assure equipment availability. This subsidiary performs transportation services on outbound movements from the Company's production plants and attempts to haul third parties' products on return trips whenever possible. In 1994, approximately 74% of the carrier business involved the Company's products.\nFOREIGN OPERATIONS AND EXPORT SALES\nApproximately 22% of the Company's 1994 net sales were to customers in approximately 60 countries other than the U.S. To enhance its overseas market penetration, the Company maintains a mineral processing plant in the U.K. A processing plant, 60% owned by the Company, operates in Australia, and a blending plant in Canada. Through a joint venture, the Company also has the capability to process minerals in Mexico. Chartered vessels deliver large quantities of the Company's bulk, dried sodium bentonite to the plants in the U.K. and Australia, where it is processed and mixed with other clays and distributed throughout Europe and Australia. The Company's U.S. bentonite is also shipped in bulk to Japan. The Company also maintains a worldwide network of independent dealers, distributors and representatives.\nThe Company produces absorbent polymers at its U.S. and U.K plants and serves markets in Western Europe, South America, Asia and the Middle East.\nThe Company's international operations are subject to the usual risks of doing business abroad, such as currency devaluations, restrictions on the transfer of funds and import and export duties. The Company to date has not been materially affected by any of these risks.\nSee Note 2 of the Company's Notes to Consolidated Financial Statements included elsewhere herein, which Note is incorporated by reference for sales attributed to foreign operations and export sales from the United States.\nEMPLOYEES\nAs of December 31, 1994, the Company employed 1,328 persons, 217 of whom were employed overseas. At December 31, 1994, there were approximately 764, 281, 204 and 23 persons employed in the Company's minerals, absorbent polymers, environmental and transportation segments respectively, along with 56 corporate employees. Operating plants are adequately staffed, and no significant labor shortages are presently foreseen. Approximately 220 of the Company's employees in the U.S. and approximately 30 of the Company's employees in the U.K are represented by six labor unions, which have entered into separate collective bargaining agreements with the Company. Employee relations are considered good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and its subsidiaries operate the following principal plants, mines and other facilities, all of which are owned, except as noted:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn November 1992, Sorb-All Co. (\"Sorb-All\") filed suit in the U.S. District Court for the Southern District of Texas against the Company. Sorb-All seeks a declaratory judgment that the Company's patent covering clumping cat litter products is invalid and that Sorb-All's product does not infringe on the Company's patent. Sorb-All also asserts that the Company's patent is invalid or unenforceable due to misuse and inequitable conduct before the U.S. Patent and Trademark Office, that the Company has engaged in false advertising in connection with its patent in violation of federal and state law, that the Company has engaged in violations of the federal antitrust laws and that the Company wrongfully interfered with Sorb-All's contractual relationships. The parties have reached a tentative settlement of this matter.\nThe Company is party to a number of other lawsuits arising in the normal course of its business. The Company does not believe that any pending litigation will have a material adverse effect on its consolidated financial position.\nThe Company's processing operations require permits from various governmental authorities. From time to time, the Company has been contacted by government agencies with respect to required permits or compliance with existing permits, while the Company has been notified of certain situations of non-compliance, management does not expect the fines, if any, to be significant.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF REGISTRANT\nAll officers of the Company are elected annually by the Board of Directors for a term expiring at the annual meeting of directors following their election or when their respective successors are elected and shall have qualified. All directors are elected by the stockholders for a term expiring when their respective successors are elected and shall have qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Common Stock is traded on the Nasdaq Stock Market under the symbol ACOL. The following table sets forth, for the periods indicated, the high and low sale prices of the Common Stock, as reported by the Nasdaq Stock Market, and cash dividends declared per share. Prices and cash dividends have been adjusted to reflect three-for-two and two-for-one stock dividends in January 1993 and June 1993, respectively.\nThe Company has paid cash dividends every year for over 57 years. The Company intends to continue to pay cash dividends on its Common Stock, but the payment of dividends and the amount and timing of such dividends will depend on the Company's earnings, capital requirements, financial condition and other factors deemed relevant by the Company's Board of Directors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following is selected financial data for the Company and its subsidiaries for the five years ended December 31, 1994. Per share amounts have been adjusted to reflect a two-for-one stock split and a three-for-two stock split effected in the nature of stock dividends in June 1993 and January 1993 respectively. All per share calculations are fully diluted, based on weighted average number of common and common equivalent shares outstanding during the year.\nSUMMARY OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND FINANCIAL CONDITION\nAt December 31, 1994, the Company had outstanding debt of $75.0 million (including both long and short term debt) and cash and cash equivalents of $10.4 million compared with $20.0 million in debt and $20.5 million in cash and cash equivalents at December 31, 1993. The long-term debt to total capitalization at December 31, 1994 was 33.6% compared with 11.7% at December 31, 1993.\nThe Company had a current ratio of 2.89 to 1 on December 31, 1994, with approximately $69.2 million in working capital compared with 3.39 to 1 and $65.6 million, respectively at December 31, 1993. The $3.6 million net increase in working capital included increases in accounts receivable of $11.8 million (30.1%) and inventories of $11.0 million (38.1%), a $10.1 million reduction in cash and cash equivalents, and a $9.0 million increase in accounts payable and accrued liabilities. Accounts receivable increased in the polymer segment as a greater percentage of the balance related to sales to export customers with longer payment terms. Environmental segment receivables also reflected longer average terms for liner products, and additional receivables associated with the Aquatec acquisition. Inventories (including advanced mining) increased in both the minerals and polymer segments ($6.8 million and $3.5 million, respectively). The minerals' segment increase occurred as a result of larger domestic clay inventories, higher cat litter inventories due to expanded packaging operations and a build up of Bentomat inventory in the U.K. Polymer inventories were built in anticipation of the start of shipments to a major customer in the U.K. The decrease in cash was expected as the temporary surplus from the October, 1993 stock offering was spent on capital expenditures.\nThe Company made capital expenditures of approximately $81 million, of which, 55% was spent in the polymer area, 30% in minerals and 13% in the environmental segment. The capital investment in the polymer segment was directed toward the completion of the 20,000 ton capacity expansion in the U.S. and the 30,000 ton expansion in the U.K. Worldwide production capacity at December 31, 1994 stood at 80,000 tons, with a further 30,000 ton expansion underway in the U.S. Capital expenditures in the domestic minerals sector were directed primarily to expanded capabilities and improved economics in the cat litter manufacturing arena. Overseas mineral investment activities were primarily devoted to infrastructure improvements to allow for future growth. The expenditures in the environmental segment were largely comprised of the property, equipment and intangibles related to the acquisitions of the Bentomat manufacturing facility, the operations of Aquatec Engineering and Supply Company and Hydron, Inc.\nOn October 4, 1994, the Company entered into two new loan agreements. A $50 million long-term loan, with a seven-year average life and essentially the same terms as the previous long-term note, was negotiated with the incumbent lender. The $40 million revolving credit agreement with Harris Bank was replaced by a $50 million facility with a four bank group at terms generally more favorable than the previous agreement.\nThe Company had $42.0 million in unused, committed credit lines at December 31, 1994. In addition to the committed credit lines, the Company has demand facilities in the United States and the United Kingdom which allow for short-term borrowings of approximately $8.1 million and letters of credit of $8.3 million at favorable rates.\nThe Company anticipates 1995 capital expenditures of approximately $40 million. Capital expenditures in the polymer segment are estimated at $16 million, minerals at $17 million, and environmental at $4 million. The major project in the polymer segment is the completion of the 30,000 ton capacity expansion in the U.S. Capital expenditures in the mineral segment will be directed toward replacing mining equipment and enhancing cat litter manufacturing capabilities domestically, and expanding manufacturing capability in the U.K. The environmental capital expenditures will be dedicated to expanding Bentomat manufacturing capacity and expanding the network of service centers for its Aquatec division. The remaining capital will be devoted to enhancing corporate research and development capabilities.\nThe current indicated annual dividend rate is $.24 per share. If the rate remains constant, dividend payments will be approximately $4.6 million for 1995, compared with $4.5 million in 1994.\nManagement believes that the Company has adequate resources to fund the capital expenditures discussed above, the dividend payments, and anticipated increases in working capital requirements through its existing credit lines, cash balances and operating cash flow. In addition to the capital expenditures which have been authorized by the Board of Directors, management continues to explore other growth prospects in the environmental and minerals segments, as well as further capacity expansion in the polymer segment.\nRESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1994\nNet sales increased by $46.3 million, or 21.1%, from 1993 to 1994 and by $36.5 million, or 20.0%, from 1992 to 1993. Operating profits increased by $2.7 million, or 12.6%, from 1993 to 1994 and by $4.8 million, or 29.1% form 1992 to 1993. A review of sales, gross profit, general, selling and administrative expenses and operating profit by segment follows:\nMINERALS\nSales in the minerals segment increased in both the durable goods sector and the consumables sector from 1992 to 1994, and in the U.K. from 1993 to 1994 largely due to increased volume. Sales to the domestic durable goods markets increased with the aid of an improved economy and a rebound in the automotive industry. The Company also expanded its production capability and market presence through plant acquisitions at Chattanooga, Tennessee in July, 1992 and Toronto, Canada in June, 1993. Continued market penetration of scoopable cat litters led to the increase in the Company's consumable goods sector. Scoopable litter volume increased in each of the years, though patent royalty income was inconsistent. Royalties declined by approximately $1 million from 1992 to 1993, and increased approximately $2.3 million from 1993 to 1994. Royalties are expected to decline in the future as most agreements have been converted to fully paid licenses. Growth in the agricultural market has come from sales of clay granules to the agricultural chemical industry. The acquisition of the Paris, Tennessee plant, which began operation in July, 1993, provided the capacity for the Company's increase in market share. Use of granular clay is dependent on its performance with specific chemical additives in fertilizer and herbicide applications. Reformulations and new product instructions can radically impact the demand for this type of product. The U.K. minerals operation produced a 32.3% sales increase from 1993 to 1994 after a flat performance in the previous year. The increase came from the construction and environmental markets, as well as the cat litter sector. Sales of environmental products continue to be sold through this unit since most of the current product line is mineral based.\nGross profit margins declined by approximately 430 basis points, or 18.3%, from 1992 to 1993 as royalties declined and wet weather conditions adversely affected the Company's western mining operations. The combination accounted for the entire shortfall in gross profit from 1992 to 1993. Gross profit margins improved by approximately 230 basis points, or 12.0%, from 1993 to 1994 as a result of higher royalties and price increases initiated over the course of the past year.\nGeneral, selling and administrative expenses dropped by $.5 million, or 3.9%, from 1992 to 1993, primarily due to lower promotion costs for the Company's branded litter products. The $1.0 million increase in expenses from 1993 to 1994 was driven primarily by increased selling expenses in both the U.S. and U.K.\nLower royalties will have an adverse impact on operating profit margins in the future, but volume is expected to grow as a result of more favorable unit costs for the licensees.\nABSORBENT POLYMERS\nGrowth in private label and national branded diaper sales, as well as increasing amounts of polymer being used in new diaper designs, fueled the sales growth experienced by the U.S. polymer operations from 1992 to 1994. Higher unit demand during 1992 prompted management to add 10,000 tons of capacity, which was operational in April, 1993. In 1993, continuing strong demand and impending capacity constraints caused management to add 20,000 tons of capacity at Aberdeen, Mississippi, bringing total capacity to 40,000 tons annually. Late in the year, however, competitors also brought on more capacity and began aggressively marketing their polymer products. A significant customer shifted its business to a competitor effective December, 1993. In addition, the return to a more normal balance of supply and demand resulted in decreased business with certain customers who used the Company as a secondary source. This combined loss of business represented 21% of the 1993 unit sales volume. During 1994, the lost volume was replaced and, in fact, unit sales volume grew approximately 15%. This was achieved in spite of the fact that the movement toward thinner diapers did not penetrate the sectors of the diaper market served by the Company as quickly as had been originally anticipated. Further penetration of export markets, primarily Latin America, accounted for much of the growth. Unit pricing showed signs of softness during 1994, and continuing pressure on prices is expected for 1995.\nUnit sales volume of the U.K. polymer operation increased by approximately 50% from 1992 to 1993 and by approximately 19% from 1993 to 1994. Sales for 1993 were adversely impacted by less favorable translation rates and by foreign exchange fluctuations, while 1994 sales suffered from increased competition and expanded available capacity. During 1993, the U.K. operation significantly expanded its direct selling effort in the European market by phasing out the distributor who previously handled the continental European customers. This shift, while expected to be a positive for the long-term, exposed the Company to the risks of selling in local currency which the distributor had previously handled. In late 1993, the Company formulated a new product to expand its market presence. This product, produced from a 30,000 ton plant expansion, became available in October, 1994. A commitment was secured from a major diaper manufacturer for 10,000 tons of product annually. Sales under this agreement began in January, 1995.\nGross margins at the U.S. plant and the U.K. plant were positively impacted by increased production from 1992 to 1993 as combined unit volume increased 70%. Lower margins were experienced during 1994 as capacity increased from 30,000 tons to 80,000 tons over the course of the year while unit sales volume increased 16%. Additional staff were hired and trained to operate the new capacity, resulting in additional costs without the incremental sales volume to support such costs. Management expects raw material costs to increase in 1995 with the rise in acrylic acid prices.\nGeneral, selling and administrative expenses increased from 1992 to 1993 as a result of increased staffing levels in marketing and research, higher benefit costs associated with the larger staff and higher incentive compensation expenses. The 1993 to 1994 increase was mainly in the marketing and administrative areas to provide the infrastructure for further growth.\nThe U.K. plant incurred an operating loss in 1992. The unit produced an operating profit for the full year of 1993, but experienced a setback in the fourth quarter when it produced an operating loss. In 1994, the U.K operation produced an operating loss. The new product formulation and expanded plant capability are expected to significantly improve the Company's profit outlook for 1995.\nThe Company has expanded aggressively in the absorbent polymer market over the three year period ending in 1994. Its worldwide production capacity has grown from 20,000 tons annually at the beginning of 1992 to an annual capacity of 80,000 tons at the end of 1994. A further 30,000 ton expansion is underway in the U.S. With the completion of this plant scheduled in mid-1995, the Company's capability will challenge the market leaders. The Company has expanded at this pace to jump ahead of the demand curve and be able to position itself for the increase in market demand as it occurs. The most recent U.S. expansion, and the U.K. addition, manufacture a product specifically designed for the requirements of thinner diapers. Depreciation for these facilities will be calculated on a units-of-production basis for the first year, and on a straight-line basis thereafter.\nENVIRONMENTAL\nApproximately 85% of the sales growth from 1993 to 1994 came from the combination of acquisitions and the increased sales of Bentomat environmental liner products. Sales in 1993 grew only 6% from the 1992 level as wet weather conditions prevailed in many areas of the U.S., preventing installation of liner products.\nGross profit margins were higher in 1993 than 1992 because of a more profitable sales mix. Margins in 1994 declined as a result of a greater sales of lower margin products. The Bentomat liner product has experienced price erosion over the past three years, however the Company has seen its share of the market increase over that same time frame. In addition to the less favorable sales mix in 1994, the Company recorded approximately $1 million in provisions for inventory obsolescence, rework and disposal related to one of its product lines. The Company has engaged a third party to manufacture this product line. The Company also realigned a significant distribution arrangement, resulting in a return of materials and a sales allowance of approximately $.2 million.\nGeneral, selling and administrative expenses increased 49% from 1993 to 1994. Over half of the increase was related to the newly acquired operations of Aquatec and Hydron. The balance of the increase was primarily related to increased staffing and costs in the marketing area, including the establishment of an international marketing department. The 21% increase in expenses from 1992 to 1993 was primarily directed to increased administrative costs.\nTRANSPORTATION\nThe continuing momentum from increased brokerage of cat litter and environmental shipments, which began in 1992, has fueled the growth in transportation revenues over the three year period. Gross profits and gross margins have both benefited from the increased volume. The increase in general, selling and administrative expenses included higher compensation costs in both 1993 and 1994. Telephone and computer software costs also increased in 1994.\nCORPORATE\nGeneral, selling and administrative expenses increased 33% in 1994 as a result of increased expenditures for management information systems and research and development. A new software system was installed in 1994 to accommodate the growth of the Company. The higher level of expenditures in this area are anticipated to continue. Research and development expenditures are expected to rise as the Company continues to explore growth opportunities outside of its traditional markets.\nNET INTEREST EXPENSE\nNet interest expense decreased by $448,000 from 1992 to 1993 and by $704,000 from 1993 to 1994. Lower average borrowing levels and interest rates accounted for the decline from 1992 to 1993, while capitalized interest accounted for the reduction from 1993 to 1994.\nOTHER INCOME (EXPENSE)\nOther expense for 1992 includes the settlement of certain litigation, while other income in 1993 included $455,000 related to the recovery of defense costs incurred in prior years. Other income in 1994 included $463,000 of investment grants related to the U.K. polymer plant expansion.\nINCOME TAXES\nThe income tax rate for 1992 was 32.3%, compared with 29.7% in 1993 and 30.8% in 1994. The estimated tax rate for 1995 is 35%.\nEARNINGS PER SHARE\nEarnings per share were calculated using the weighted average number of shares, including common stock equivalents, outstanding during the period. Stock options issued to key employees and directors are considered common stock equivalents. Higher stock prices, which the Company experienced over much of the three-year period, increased the number of shares outstanding. In addition, the equity offering completed in the fourth quarter of 1993 also had a dilutive impact on earnings per\nshare when comparing 1992 to 1993. The weighted average number of common and common equivalent shares was approximately 19.5 million for 1994, compared with approximately 17.2 million for 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee the Index to Financial Statements and Financial Statement Schedules on page. Such Financial Statements and Schedules 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\nThe table below lists the names and ages of all directors and nominees of the Company, and all positions each person holds with the Company.\nBOARD OF DIRECTORS OF THE REGISTRANT\nARTHUR BROWN, 54, (2)\nChairman, President and Chief Executive Officer of Hecla Mining Company. Director since 1990.\nROBERT E. DRISCOLL, III, 56, (2,3)\nFormer Dean and Professor of Law, University of South Dakota. Director since 1985.\nRAYMOND A. FOOS, 66, (2,3)\nFormer Chairman of the Board, President and Chief Executive Officer of Brush Wellman, Inc. (manufacturer of beryllium and specialty materials). Director since 1981.\nROY H. HARRIS, 69, (1)\nFormer Chief Executive Officer, President and Executive Vice President of American Colloid Company. Officer of the Board and consultant to the Company since 1985. Director since 1971.\nJOHN HUGHES, 52, (1)\nPresident and Chief Executive Officer, American Colloid Company. Director since 1984.\nROBERT C. HUMPHREY, 76, (1,3,4)\nDirector and retired Chairman of the Board, NBD Bank Evanston, N.A. Director since 1977, except for a three-month period in 1989.\nC. EUGENE RAY, 62, (1,2,3,4)\nChairman of the Board since 1988. Former Executive Vice President-Finance of Signode Industries, Inc. (manufacturer of industrial strapping products). Director since 1981.\nCLARENCE O. REDMAN, 52, (1,5)\nPartner and Chief Executive Officer of the law firm of Keck, Mahin & Cate. Secretary of the Company since 1982. Director since 1989.\nPAUL G. SHELTON, 45, (1)\nSenior Vice President - Chief Financial Officer, American Colloid Company. Director since 1988.\nEVERETT P. WEAVER, 77, (1,3,4,5)\nFormer Chairman of the Board and Chief Executive Officer of American Colloid Company, from 1966 until 1978. Director since 1949, except for the period between May 1988 and February 1991.\nWILLIAM D. WEAVER, 74, (1,4,5)\nFormer Chairman of the Board, American Colloid Company, from 1978 until November 1988. Prior thereto, Chief Executive Officer, Vice Chairman and Vice President. Director since 1949.\nPAUL C. WEAVER, 32\nCorporate Account Manager for Nielsen North America. Nominee for Director. ------------------------\n(1) Member of Executive Committee of the Board of Directors\n(2) Member of Audit Committee\n(3) Member of Compensation Committee\n(4) Member of Nominating Committee\n(5) Member of Option Committee\nAdditional information regarding the directors of the Company is included under the caption \"Election of Directors\" in the Company's proxy statement to be dated on or about April 7, 1995, and is incorporated herein by reference. Information regarding executive officers of the Company is included under a separate caption in Part I hereof, and is incorporated herein 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 \"Compensation and Other Transactions with Management\" in the Company's proxy statement to be dated on or about April 7, 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 caption \"Security Ownership\" in the Company's proxy statement to be dated on or about April 7, 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 \"Compensation and Other Transactions with Management\" in the Company's proxy statement to be dated on or about April 7, 1995, and is incorporated herein by reference.\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\n2. Financial Statement Schedules on page. Such Financial Statements and Schedules are incorporated herein by reference.\n3. See Index to Exhibits immediately following the signature page.\n(b) None.\n(c) See Index to Exhibits immediately following the signature page.\n(d) See Index to Financial Statements and Financial Statement Schedules on page .\nITEM 14(A) INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nAll other schedules called for under Regulation S-X are not submitted because they are not applicable or not required or because the required information is not material or is included in the financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders American Colloid Company:\nWe have audited the consolidated financial statements of American Colloid Company 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 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 American Colloid Company 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\nChicago, Illinois March 10, 1995\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ASSETS\nSee accompanying notes to consolidated financial statements.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of American Colloid Company (the Company) and its foreign and domestic subsidiaries. All subsidiaries are wholly-owned except for one of the Australian subsidiaries, which is 60% owned by the Company, and a 49% interest in a Mexican subsidiary, which is accounted for at cost. All material intercompany balances and transactions, including profits on inventories, have been eliminated in consolidation.\nTRANSLATION OF FOREIGN CURRENCIES\nThe accounts and transactions of subsidiaries located outside of the United States are translated into U.S. dollars at rates of exchange in accordance with Statement of Financial Accounting Standards No. 52, \"Foreign Currency Translation.\" The assets and liabilities of these subsidiaries are translated at the rate of exchange at the balance sheet date. The statements of operations are translated at the weighted average monthly rate. Foreign exchange translation adjustments are accumulated as a separate component of stockholders' equity while realized exchange gains or losses are included in income.\nINVENTORIES\nInventories are valued at the lower of cost or market. For domestic crude bentonite, chromite sand, and leonardite stockpiles, which represent approximately 16% and 15% of total inventories in 1994 and 1993, respectively, cost is determined by the last-in, first-out method (LIFO). The excess of current cost over LIFO cost approximated $2,852 in 1994 and $2,785 in 1993. For all other inventories, cost is determined by the first-in, first-out (FIFO) or moving average methods.\nPROPERTY, PLANT, EQUIPMENT, AND MINERAL RIGHTS AND RESERVES\nProperty, plant, equipment, and mineral rights and reserves are carried at cost. Depreciation is computed using the straight-line method for substantially all of the assets. Certain other assets, primarily field equipment are depreciated on the units-of-production method. Mineral rights and reserves are depleted using the units-of-production method.\nGOODWILL AND OTHER INTANGIBLE ASSETS\nGoodwill represents the excess of the purchase price over the fair value of the net assets acquired. Goodwill is being amortized on the straight-line method over periods of 25 to 40 years. Other intangibles, including trademarks and noncompete agreements, are amortized on the straight-line method over periods of two to ten years.\nINCOME TAXES\nThe Company and its U.S. subsidiaries file a consolidated tax return. 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 basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect for the year in which those temporary differences are expected to be recovered or settled.\nEXPLORATION COSTS AND ADVANCE MINING\nExploration costs are expensed as incurred. Costs incurred in removing overburden and mining bentonite are capitalized as advance mining costs until the bentonite from such mining area is transported to the plant site, at which point the costs are included in crude bentonite stockpile inventory.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RESEARCH AND DEPVELOPMENT\nResearch and development costs, included in general, selling and administrative expenses, were approximately $2,353, $1,764, and $874 for the years ended December 31, 1994, 1993, and 1992.\nINTEREST INCOME\nInterest income, included in interest expense, net, was $718, $566 and $339 for the years ended December 31, 1994, 1993, and 1992.\nEARNINGS PER SHARE\nEarnings per share are computed by dividing net income by the weighted average of common shares outstanding after consideration of the dilutive effect of stock options outstanding at the end of each period. The weighted average number of common and common equivalent shares outstanding was 19,486,520 for 1994, 17,223,854 for 1993, and 16,480,644 for 1992.\nCASH EQUIVALENTS\nFor purposes of the statement of cash flows, the Company considers all highly-liquid investments with original maturities of three months or less as cash equivalents.\nRECLASSIFICATION\nCertain items in the 1993 and 1992 consolidated financial statements have been reclassified to comply with the consolidated financial statements presentation for 1994.\n(2) BUSINESS SEGMENT AND GEOGRAPHIC AREA INFORMATION The Company operates in four major industry segments minerals, absorbent polymers, environmental and transportation. The minerals segment mines, processes, and distributes clays and products with similar applications to various industrial and consumer markets. The absorbent polymer segment produces and distributes superabsorbent polymers primarily for use in consumer markets. The environmental segment processes and distributes clays and products with similar applications for use as a moisture barrier in commercial construction, landfill liners and in a variety of other industrial and commercial applications. The transportation segment includes a long haul trucking business and a freight brokerage business which provide services to both the Company's plants and outside customers.\nIntersegment sales are insignificant. Operating profit is defined as sales and other income directly related to a segment's operations, less operating expenses, which do not include interest costs.\nIdentifiable assets by segments are those assets used in the Company's operations in that segment. Corporate assets are primarily cash and cash equivalents, corporate leasehold improvements, and miscellaneous equipment.\nExport sales included in the United States were approximately $17,430, $12,206, and $10,538 for the years ended December 31, 1994, 1993, and 1992.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(2) BUSINESS SEGMENT AND GEOGRAPHIC AREA INFORMATION (CONTINUED) The following summaries set forth certain financial information by business segment and geographic area for the years ended December 31, 1994, 1993, and 1992.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(2) BUSINESS SEGMENT AND GEOGRAPHIC AREA INFORMATION (CONTINUED)\n(3) INVENTORIES Inventories consisted of:\nDuring 1994, 1993, and 1992 quantities in certain LIFO pools were reduced, resulting in a liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years. The effect on net income and earnings per share was insignificant in 1994 and 1993. The liquidation of certain LIFO inventory quantities in 1992 increased net income by approximately $123. The effect on earnings per share was an increase of $.01 in 1992.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(4) PROPERTY, PLANT, EQUIPMENT, AND MINERAL RIGHTS AND RESERVES Property, plant, equipment, and mineral rights and reserves consisted of the following:\nDepreciation and depletion were charged to income as follows:\n(5) INCOME TAXES The components of the provision for domestic and foreign income tax expense for the years ended December 31, 1994, 1993 and 1992 consist of:\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(5) INCOME TAXES (CONTINUED) The components of the deferred tax assets and liabilities as of December 31, 1994 and 1993 are as follows:\nThe following analysis reconciles the statutory Federal income tax rate to the effective tax rates:\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(6) LONG-TERM DEBT Long-term debt consisted of the following:\nThe Company has a committed $50,000 revolving credit agreement which matures October 4, 1997, with an option to extend for three one-year periods. As of December 31, 1994, there was $42,018 available in unused lines of credit. The revolving credit note is a multi-currency agreement which allows the Company to borrow at various interest rates including, but not limited to, prime and an adjusted LIBOR rate plus .375% to .75% depending upon debt to capitalization ratios and the amount of the credit line used.\nThe Industrial Revenue Bond outstanding at December 31, 1994 is payable in equal semi-annual installments of $117 until the year 2000. The Aberdeen, Mississippi bentonite operations of the Company are pledged as collateral. The carrying value of the pledged assets at December 31, 1994 was $2,376.\nMaturities of long-term debt at December 31, 1994 are as follows:\nThe estimated fair value of the term notes at December 31, 1994 was $62,000 based on discounting future cash payments at current market interest rates for loans with similar terms and maturities while the carrying value for these term notes was $64,280.\nAll loan agreements include covenants which require the maintenance of specific minimum amounts of working capital, tangible net worth and financial ratios and limit additional borrowings and guarantees. The Company is not required to maintain a compensating balance.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(7) FINANCIAL INSTRUMENTS The Company has approved the use of derivative instruments, principally interest rate swaps, forward contracts and options, in its management of foreign currency and interest rate exposures. These contracts hedge transactions and balances for periods consistent with its committed exposures.\nRealized and unrealized foreign exchange gains and losses are recognized and offset against foreign exchange gains or losses on the underlying exposures. The interest differential paid or received on swap agreements is recognized as an adjustment to interest expense.\nAt December 31, 1994, the Company had a swap agreement that effectively converted the interest on $25,000 of its Term Note borrowings from fixed to floating interest rates. This swap agreement, entered in October 1994, resulted in a $35 interest expense reduction in 1994. The Company also has $2,000 of forward exchange contacts outstanding as of December 31, 1994.\n(8) LEASES The Company leases certain railroad cars, trailers, computer software, office equipment, and office and plant facilities. Total rent expense under operating lease agreements was approximately $1,920, $1,721, and $1,324 in 1994, 1993, and 1992, respectively. Rent expense on railroad cars is offset by mileage earnings paid by the railroads of approximately $124, $137, and $142 in 1994, 1993, and 1992, respectively.\nRailroad cars and computer software under capital leases are included in property, plant and equipment as follows:\nThe following is a schedule of future minimum lease payments for the capital leases and for operating leases (with initial terms in excess of one year) as of December 31, 1994:\n(9) EMPLOYEE BENEFIT PLANS The Company has noncontributory pension plans covering substantially all of its domestic employees. The Company's funding policy is to contribute annually the maximum amount calculated\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(9) EMPLOYEE BENEFIT PLANS (CONTINUED) using the actuarially determined entry age normal method that can be deducted for Federal income tax purposes. Contributions are intended to provide not only for benefits attributed to services to date, but also for those expected to be earned in the future. The Plan is fully funded for tax purposes.\nPension cost in 1994, 1993, and 1992 was comprised of:\nThe following table summarizes the funded status and amounts recognized in the Company's balance sheet at December 31, 1994 and 1993:\nThe Company's pension benefit plan was valued as of October 1, 1994 and 1993, respectively. Approximately 89% of the plan assets are invested in common stocks, corporate bonds and notes, and guaranteed income contracts purchased from insurance companies. The remainder of the plan assets are invested in cash and a real estate trust.\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 8.0% in 1994 and 7.0% in 1993, while the rate of increase in future compensation levels was 6.0% in 1994 and 1993. The expected long-term rate of return on plan assets was 9.0% in 1994 and 8.0% in 1993.\nThe Company also has a savings plan for its domestic personnel. The Company has contributed an amount equal to an employee's contribution up to a maximum of 4% of the employee's annual earnings. Company contributions are made using Company stock purchased on the open market. Company contributions under the savings plan were $963 in 1994, $854 in 1993, and $676 in 1992.\nThe foreign pension plans, not subject to ERISA, are funded using individual annuity contracts and therefore, are not included in the information noted above.\n(10) STOCKHOLDERS' EQUITY On August 23, 1993, the Board of Directors authorized up to 2,500,000 shares of common stock, $.01 par value per share, to be offered and sold pursuant to a public offering. The public offering was\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(10) STOCKHOLDERS' EQUITY (CONTINUED) completed on October 27, 1993. The par value for these additional shares was increased by $25 and additional paid-in capital was increased by $58,808, the total of which represents the net proceeds from the sale of 2,500,000 shares of common stock.\nOn May 10, 1993, the stockholders of American Colloid Company approved an amendment to the Company's Restated Certificate of Incorporation to increase the number of authorized shares of common stock of the Company from 12 million to 50 million. The stockholders also approved an amendment to change the par value of the common stock from $1.00 per share to $0.01 per share. Additional paid-in capital was increased and common stock reduced by $9,328 for the change in the par value of the common stock.\nOn May 10, 1993, the Board of Directors declared a two-for-one stock split effected in the nature of a stock dividend to stockholders of record on June 8, 1993, which was paid June 23, 1993. The par value of these additional shares was capitalized by a transfer of $94 from retained earnings to common stock.\nOn November 12, 1992, the Board of Directors declared a three-for-two stock split effected in the nature of a stock dividend to stockholders of record on December 5, 1992, which was paid January 4, 1993. The par value of these additional shares was capitalized by a transfer of $3,141 from retained earnings to common stock.\nAll current and prior year common share and per share disclosures have been restated to reflect the stock dividends.\n(11) STOCK OPTION PLANS\n1983 INCENTIVE STOCK OPTION PLAN\nThe Company reserved 1,800,000 shares of its common stock for issuance of incentive stock options to its officers and key employees. Options awarded under this plan, which entitle the optionee to one share of common stock, may be exercised at a price equal to the fair market value at the time of grant. Options awarded under the plan vest 40% after two years and continue to vest at the rate of 20% per year for each year thereafter, until they are fully vested. Options are exercisable as they vest and expire ten years after the date of grant, except in the event of termination, retirement or death of the optionee or a change in control of the Company.\nThis plan expired during 1993, though options which were granted prior to its expiration continue to be valid until the individual option grants expire.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(11) STOCK OPTION PLANS (CONTINUED) 1993 STOCK PLAN\nThe Company reserved 840,000 shares of its common stock for issuance to its officers and key employees in the form of incentive stock options, nonqualified stock options, restricted stock, stock appreciation rights and phantom stock. Different terms and conditions apply to each form of award made under the plan. To date, only incentive stock options have been awarded. Options awarded under this plan, which entitle the optionee to one share of common stock, may be exercised at a price equal to the fair market value at the time of grant. Options awarded under the plan generally vest 40% after two years and continue to vest at the rate of 20% per year for each year thereafter, until they are fully vested, unless a different vesting schedule is established by the Option Committee of the Board of Directors on the date of grant. Options are exercisable as they vest and expire ten years after the date of grant, except in the event of termination, retirement or death of the optionee or a change in control of the Company.\n1987 NONQUALIFIED STOCK OPTION PLAN\nThe Company reserved 340,000 shares of its common stock for issuance of nonqualified stock options to outside officers and directors, as well as key employees. The stock options are exercisable at a price per share which may be no less than the fair market value at the time of grant according to the vesting provisions of the plan. Options awarded under the plan generally vest 40% after two years and continue to vest at the rate of 20% per year for each year thereafter, until fully vested. Options are exercisable as they vest and expire ten years after the date of grant, except in the event of termination, retirement or death of the optionee or a change in control of the Company.\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(12) ACCRUED LIABILITIES\n(13) QUARTERLY RESULTS (UNAUDITED) Unaudited summarized results for each quarter in 1994 and 1993 are as follows:\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n(13) QUARTERLY RESULTS (UNAUDITED) (CONTINUED)\nAMERICAN COLLOID COMPANY AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)\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.\nDate: March 24, 1995\nAMERICAN COLLOID COMPANY\nBy: _________\/s\/__JOHN HUGHES_________ John Hughes 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.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"790706_1994.txt","cik":"790706","year":"1994","section_1":"ITEM 1. BUSINESS\nBACKGROUND\nWestern Publishing Group, Inc., through its two operating subsidiaries, Western Publishing Company, Inc., a Delaware corporation, and Penn Corporation, a Delaware corporation, is engaged in two business segments. The Consumer Products segment produces and markets a variety of consumer products including children's story and picture books, coloring and activity books, educational workbooks sold at retail, interactive story books, craft products, children's pre-recorded music cassettes, book and audio cassette sets, pre-recorded video cassettes, puzzles, games, activity products incorporating electronic sounds, special interest books for adults, decorated paper tableware, paper party accessories, gift wrap products, invitations, stationery and gift items. The Commercial Products segment provides the following printing and manufacturing services: (1) graphic services and commercial printing, such as the printing of books, catalogs, labels, tax forms, magazines and trading cards; (2) specialty printing and game manufacturing, such as manufacturing, packaging and distribution of games, instructional manuals for computer software manufacturers and educational kits; (3) \"Custom Publishing\" services, such as the creation, production, assembly and distribution for consumer product and fast food companies of customized products for their marketing and promotional programs; and (4) manufacturing and\/or the imprinting of customized writing instruments, vinyl products and wearables for the advertising specialty market and for executive gifts.\nWestern Publishing Group, Inc.'s principal offices are located at 444 Madison Avenue, New York, New York 10022, and its telephone number is (212) 688-4500.\nSale and Phase Out of Operations\nOn November 29, 1993, the Company announced that it had recently been approached by several companies expressing a desire to discuss a business combination. The Board of Directors of the Company authorized the retention of two investment banking firms as its advisors to explore alternatives to maximize shareholder value. Based on an analysis of various alternatives, the Company adopted a plan designed to improve its competitive position and reduce its cost structure through the sale or phase out of certain operations, property divestitures and consolidations, and a workforce reduction.\nThe plan includes the following major components:\no An agreement in principle to sell the game and puzzle operation (including certain inventories) to Hasbro, Inc. (Hasbro) for approximately $103,000,000. This transaction is subject to customary conditions and is expected to be completed in the second quarter of Fiscal 1995.\no The decision to exit the direct marketing continuity clubs and\nschool book club businesses. It is anticipated that this will be completed by the end of Fiscal 1995.\no The closedown and sale of the Company's Fayetteville, North Carolina manufacturing and distribution facility, which is primarily dedicated to the game and puzzle operation but will not be included in the sale to Hasbro.\no The decision to streamline the Company's publishing business so as to focus on its core competencies. This will include a reduction in the management, administrative and direct labor workforces.\nThe Company intends to use the net cash proceeds arising from the plan to repay outstanding debt under its Revolving Credit Agreement. It is anticipated that the plan, which will begin to be implemented in the first quarter of Fiscal 1995, will result in a net gain, inclusive of operating losses of the game, puzzle, direct marketing and school book club operations from January 30, 1994 through the expected disposition dates. Accordingly, the anticipated gain will not be reflected in the consolidated statement of operations until realized.\nProvision for Write-Down of Division\nOn May 12, 1993, the Board of Directors of the Company directed management to review the operations of the Advertising Specialty Division of the Company's Penn Corporation subsidiary and evaluate various strategic alternatives, including its disposition. Accordingly, the Company established a provision, including operating losses through the expected disposition date, to write-down the assets of the Division to net realizable value.\nOn April 29, 1994, the Company entered into a letter of intent to sell this Division for approximately $14,000,000. It is anticipated that this transaction, which is expected to be completed in the second quarter of Fiscal 1995, will result in a net gain. The net cash proceeds from the sale of this division will be utilized to repay outstanding debt under the Revolving Credit Agreement.\nBUSINESS SEGMENT INFORMATION\nFor certain information with respect to revenues, operating profits and identifiable assets attributable to Western Publishing Group, Inc.'s Consumer Products and Commercial Products business segments, see Note 14 of the Notes to Western Publishing Group, Inc.'s consolidated financial statements, said Note being set forth on pages to herein.\nCONSUMER PRODUCTS SEGMENT Products\nWestern Publishing Company, Inc. is the largest creator, publisher, manufacturer, printer and marketer of children's books in the United States. Children's books include story and picture books for children aged two through eight marketed as GOLDEN BOOKS(Registered) and LITTLE GOLDEN BOOKS(Registered), Sound Story Books and musical story books for children aged three and up marketed under the GOLDEN BOOKS(Registered) with sound, GOLDEN SIGHT & SOUND(Registered), GOLDEN(Registered) SING ALONG, MY FIRST GOLDEN SOUND STORY(Trademark), GOLDEN TALKING TALES(Trademark), GOLDEN SEEK N' SOUND(Trademark), GOLDEN(Registered) SOUND STORY(Registered) and SOUND STORY(Trademark) trademarks and activity books and products and educational workbooks for children aged two through eight marketed under the GOLDEN(Registered), MERRIGOLD(Registered), GOLDEN\/STEP AHEAD(Registered) and GOLDEN\/BOOK 'N' TAPE(Registered) trademarks. Activity books and products include coloring books, PAINT WITH WATER(Registered) books, STICKER FUN(Registered) books, paper doll books, pop-up books, board books, shape books, MAGIC SLATE(Registered), crayons and boxed activity products. Western Publishing Company, Inc. also produces and markets pre-recorded video and audio cassettes for children under its GOLDEN BOOK VIDEOS(Registered) and GOLDEN MUSIC(Registered) trademarks and coin collecting products under its WHITMAN(Registered) trademark. Western Publishing Company, Inc. also sells arts and crafts products under its MERRIGOLD(Registered), GOLDEN(Registered), and COLOR EXPRESS(Registered) trademarks, pre- recorded audio cassette tapes packaged with books under its BOOK 'N' TAPE trademark and other products that complement its lines of books, puzzles and games.\nWestern Publishing Company, Inc. believes that its GOLDEN(Registered) and GOLDEN BOOK(Registered) brand names have strong consumer awareness and recognition and a reputation among consumers for creativity, quality, entertainment and educational value and customer satisfaction. Among the best known GOLDEN BOOK(Registered) titles are \"Richard Scarry's Best Word Book Ever\", \"Pat the Bunny\", \"The Poky Little Puppy\" and the \"Golden Treasury of Children's Literature.\" GOLDEN(Registered) and GOLDEN BOOK(Registered) products are believed by Western Publishing Company, Inc., as a result of market research, to be recognized by virtually all American mothers with children under the age of ten.\nWestern Publishing Company, Inc. believes that it is the nation's largest manufacturer and marketer of children's and adult jigsaw puzzles and is one of the largest producers and marketers of children's games, electronic sound games, card games, classic family board games and adult board games. Western Publishing Company, Inc.'s GUILD(Registered), FRAME TRAY(Registered) and other jigsaw puzzles range in piece count from as few as 12 piece puzzles for pre-schoolers to 1,500 piece puzzles for adults. Western Publishing Company, Inc. markets classic games such as bingo, checkers, chess, backgammon, dominoes and various boxed card games under the GOLDEN(Registered) and WHITMAN(Registered) trademarks and children's games which incorporate licensed characters. Board games include PICTIONARY(Registered), PRETTY PRETTY PRINCESS(Trademark), BALDERDASH(Trademark), OUTBURST(Registered), SONGBURST(Registered), GIRL TALK(Registered), and HI-HO! CHERRY-O(Registered). As set forth in the section entitled \"Sale and Phase Out of Operations,\" the Company has agreed in principle to sell its games and puzzles business to Hasbro, Inc.\nMany of Western Publishing Company, Inc.'s products are published or produced under license from authors, inventors and other owners of intellectual properties. Other products often feature popular characters licensed from other companies, including The Walt Disney Company, Children's Television Workshop (Sesame Street(Registered)), Mattel, Inc., The Lyons Group, Time Warner, Inc. (through Warner Brothers, Inc. and D.C. Comics), MCA\/Universal Merchandising, Inc., Saban Entertainment, Inc., Paramount Pictures Corporation, and Twentieth Century Fox Corporation.\nWestern Publishing Company, Inc.'s adult non-fiction book line is designed to inform the family on subjects of special interest and includes the GOLDEN GUIDES(Registered) line of books on subjects such as science, birds and astronomy and WHITMAN(Registered) coin collector products and other special interest adult books. Western Publishing Company, Inc. however is not a major factor in the market for adult books.\nPenn Corporation believes that it is a recognized leader in the design and production of quality decorated paper tableware, party accessories, invitations, gift wrap products, stationery and giftware. Under its BEACH(Registered) and CONTEMPO(Registered) trademarks, Penn Corporation produces and markets to retailers an extensive line of decorated paper tableware consisting of plates, cups, napkins, table covers, guest towels, coasters and doilies in a variety of coordinated designs, themes and colors. Penn Corporation works directly with leading design studios such as Gloria Vanderbilt, Gear, Saloomey Design, Laurette, Bob Van Allen, Joan Luntz, Mary Quant and J.G. Hook to offer tableware patterns that it believes are representative of the most current international design trends. Penn Corporation also produces and\/or markets an extensive line of children's party tableware, party favors and accessories (such as horns, hats and blowouts), many of which feature characters licensed from The Walt Disney Company, Western Publishing Company, Inc., Children's Television Workshop (Sesame Street(Registered)), Time Warner, Inc. and Marvel Entertainment Group, Inc.\nPenn Corporation also produces under its CONTEMPO(Registered) trademark a complete line of gift wrap products, including gift wrap paper, ribbons, bows, gift enclosure cards, tissue paper and tote bags. Penn Corporation's gift wrap products are produced in a wide variety of colors and designs, including the designs of many of the same leading fashion designers who design Penn Corporation's tableware products. Penn Corporation's gift wrap paper also comes in a variety of materials, including metallic and high gloss paper.\nUnder the RENNER DAVIS(Registered) by CONTEMPO(Trademark) trademark, Penn Corporation produces and markets hand-crafted stationery and giftware. RENNER DAVIS(Registered) stationery items include correspondence cards, invitations, writing papers and envelopes. Penn Corporation's writing papers are crafted by hand from fine quality watermarked papers with a high cotton fiber content. All sheets and notes are individually hand-edged and all envelopes are either lined or hand-bordered. The RENNER DAVIS(Registered) by CONTEMPO(Trademark) giftware line includes hand-crafted keepsake boxes, imaginative gift books featuring Walt Disney Company characters, desk accessories and decorative kitchen accessories, such as address books, memo holders, picture frames and pencil holders, which are constructed from quality materials coordinated for color, finish, texture, pattern and style. Licensing\nLicensing agreements are important factors in the differentiation of Western Publishing Group, Inc.'s products from those of its competitors. In the year ended January 29, 1994 (\"Fiscal 1994\"), approximately 66% of Western Publishing Group, Inc.'s Consumer Products segment's sales were generated by books, games, activity products, paper party goods and party favors featuring popular juvenile characters and properties licensed by Western Publishing Company, Inc. and Penn Corporation from authors, illustrators, inventors and other companies. Most of Western Publishing Group, Inc.'s character licenses have terms of one to three years. Despite the relatively short period of each license, Western Publishing Group, Inc. has longstanding relationships with many of its licensors. Licenses from authors and inventors are generally longer in duration, often for the term of the copyright.\nApproximately 44% of the Consumer Products segment's sales in Fiscal 1994 were attributable to juvenile products incorporating characters and properties licensed from its five largest licensors: The Walt Disney Company, Children's Television Workshop (Sesame Street(Registered)), The Lyons Group, Mattel, Inc., and Time Warner, Inc. (through Warner Brothers, Inc. and D.C. Comics, Inc.).\nRoyalty rates paid by Western Publishing Company, Inc. generally range from 6% to 10% of the invoiced price of the merchandise featuring the licensed characters and properties. Many license agreements require advance royalty payments and minimum royalty guarantees, contain editorial standards that govern Western Publishing Company, Inc.'s use of the characters and properties and can be cancelled for failure to meet these standards or certain other contractual obligations. In recent years, none of Western Publishing Company, Inc.'s licenses has been cancelled by the licensor for failure to meet these standards or obligations.\nWestern Publishing Company, Inc. selects the characters and properties to be licensed primarily on such factors as adaptability to its markets, compatibility with its product lines, the identity of the licensor and other licensees of the character, the amount of licensor advertising and marketing support for the character, the timing of any scheduled promotion of the character and the terms offered by the licensor. Western Publishing Company, Inc. believes that the large breadth of its product categories and its vast distribution network, as well as the breadth and effectiveness of its sales and in-store retail merchandising forces, gives it an advantage over its competitors in obtaining licensing rights. However, competition to obtain licenses is intense, and Western Publishing Company, Inc. sometimes does not obtain a license that it seeks, or only obtains a non-exclusive license, and other times does not obtain a license for all of its desired product categories. In Fiscal 1994, Western Publishing Company, Inc. entered into many new licensing agreements, including Thomas The Tank Engine with Quality Family Entertainment, Sonic The Hedgehog with Sega, Muppet Workshop with Henson Associates, Ghost Writer with Children's Television Workshop and Mighty Morphin Power Rangers(Trademark) with Saban Entertainment, Inc. In addition, licenses were obtained and product lines\nwere produced in conjunction with Disney's release of the movie, Aladdin(Registered), The Nightmare Before Christmas(Registered), Snow White(Registered) and the re-release of Pinocchio(Registered). Further, a licensing agreement was entered into with The Walt Disney Company for The Lion King, Disney's spring theatrical release. A licensing agreement was also entered into with MCA\/Universal Merchandising, Inc. and Amblin Entertainment, Inc. for products related to their upcoming theatrical release of The Flintstone Movie and with 20th Century Fox Film Corporation for their upcoming \"Page Master \" theatrical release.\nUpon obtaining a license, Western Publishing Company, Inc. develops story books and other products featuring the licensed character or property to incorporate into its GOLDEN(Registered) and GOLDEN BOOK (Registered) lines and associated products. To develop those products, Western Publishing Company, Inc. utilizes its internal creative staff of over 100 editors, artists and game and puzzle designers and an extensive network of authors, artists and inventors who work on a regular, but free-lance basis, with Western Publishing Company, Inc.\nPenn Corporation's Beach\/Contempo Division produces a line of children's party tableware and accessories featuring characters licensed from, among others, The Walt Disney Company, Western Publishing Company, Inc., Children's Television Workshop (Sesame Street(Registered)), Time Warner, Inc. and Marvel Entertainment Group, Inc. Royalty rates paid by Penn Corporation range from 5% to 10% of the invoiced price of the product on which the licensed characters appear.\nNew Product Lines\nWestern Publishing Group, Inc., through market research activities, has intensified its efforts to identify opportunities for either the development or acquisition of new product lines that consumers will recognize as offering value at a popular price and has allocated substantial resources to its new product acquisition and development efforts. In calendar 1991, it introduced SECRET DIARY(Trademark), a game of sharing secrets for girls, SESAME STREET ALL-STAR BAND(Trademark), a fun-filled electronic music activity product, movie poster puzzles and unreleased pre-recorded videos acquired from Media Home Entertainment, Inc. Also in 1991, Western Publishing Company, Inc. entered into a joint venture with Hersch and Company to manufacture, market, promote, sell and distribute SONGBURST(Registered), a board game based upon musical lyrics. In calendar 1992, it introduced SQUIGGLY WORMS(Trademark), a juvenile skill and action game, a relaunched HI-HO! CHERRY-O(Registered), a child's first counting game, SOUND SAFARI(Trademark), an electronic sound adventure game for children. New SOUND STORY(Registered) products in 1992 included LITTLE GOLDEN BOOKS(Registered) SOUND STORY Books, GOLDEN SING-A-LONG(Trademark) Books and BIG BIRDS TALKING BINGO(Trademark). In calendar 1993, it introduced SONGBURST COUNTRY AND WESTERN EDITION(Trademark), POPPIN POPCORN(Registered),\na juvenile action game, BARBIE(Trademark) DRESS UP GAME, a dress your doll with fashion accessories game for children. It also reintroduced HUSKER DU(Registered), the match the pictures memory game and BOOBY TRAP, the suspenseful spring action game. New SOUND STORY(Registered) products in 1993 included GOLDEN SING ALONG(Trademark), MY FIRST GOLDEN SOUND STORY(Trademark) and GOLDEN TALKING TALES(Trademark) books as well as GOLDEN SEEK N' SOUND(Trademark) games.\nIn calendar 1991, Penn Corporation's Beach\/Contempo Division expanded on the success of The Victoria collection, which once again was its number one selling ensemble, as well as introducing Sesame Street(Registered) licensed products under its Contempo brand and sold to the gift and party store markets. In addition, new size gift bags, metallic tableware and die cut invitations, announcements and note pads were successfully introduced. In calendar 1992, it introduced The Pretty Florals collection of decorated paper tableware which represented the top selling designs for the year. In addition, the Garden Variety and Hot 'n Spicy collections were introduced. In calendar 1993, it introduced the first shape and die cut paper plates and the first all over spring designs for napkins and table covers. It also introduced The Disney Gift Book program of social expression books in 8 innovative formats.\nThe Company, since acquiring Sight & Sound, Inc. in July 1990, has expanded its SOUND STORY(Registered) product line to over 85 titles, including the DELUXE SOUND STORY(Registered) with 10 sounds, the CLASSIC SOUND STORY(Registered) with 7 sounds, LITTLE GOLDEN BOOK(Registered) SOUND STORY(Registered) with 4 sounds, GOLDEN SEEK N' SOUND(Trademark) with 10 sounds and GOLDEN SING ALONG(Trademark) with 8 songs and 5 sounds. It should be pointed out that the Company sources sound pad components abroad and as a result, scheduling is an important pre-requisite to producing and distributing particular licensed product in a timely fashion. The Company experienced scheduling problems in Fiscal 1994 and, as a result, virtually none of its new sound emitting product introductions were shipped in time for the Fiscal 1994 selling season.\nIn July 1991, Western Publishing Company, Inc. acquired the rights to a library of never before released children's pre-recorded video programs from Media Home Entertainment, Inc. This series includes such well known children's favorites as titles featuring the character Madeline, Baby Songs(Trademark) and others. Western believes that this acquired group of products has provided new product introductions since acquisition as well as a number of backlist titles. To effectively handle these new products, as well as existing video and audio products, Western Publishing Company, Inc. established separate and distinct groups of sales, creative and marketing personnel called the Golden Entertainment Group.\nIn February 1992, Western Publishing Company, Inc. announced that, as a result of a series of agreements with Games Gang, Ltd., it had obtained the exclusive right to sell Pictionary(Registered) and Balderdash(Registered) and a group of other popular board games in the United States and other specified territories.\nMarketing and Distribution\nWestern Publishing Company, Inc.'s marketing strategy for its consumer products is to create consumer demand through advertising, promotion and attractive point-of-purchase presentations in order to sell a high volume of popularly priced products, through mass merchandising chains such as Wal-Mart Stores, Inc., K-Mart Corp., Caldor, Inc. and Target Stores Incorporated, a division of Dayton Hudson Corporation; national book chains such as B. Dalton Book Seller and Walden Book Co., Inc.; toy stores such as Toys \"R\" Us, Inc. and Kay-Bee Toy & Hobby Shops, Inc.; supermarkets such as Winn Dixie Stores, Inc., HE Butt Grocery Co. Inc. and Smith's Food and Drug Centers, Inc.; drug chains such as Walgreens Co., Revco D.S., Inc., Long's Drug Stores Corporation and Eckerd Corporation; warehouse clubs such as The Price\/Costco and Sam's Clubs (Wal-Mart Stores, Inc.); deep discount drug stores such as Drug Emporium, Inc., Marc Glassman, Inc. (Marc's) and Phar-Mor, Inc.; trade bookstores; independent toy stores and other retail outlets.\nA majority of Western Publishing Company, Inc.'s consumer products sales are made directly to retailers through its 164 employee direct sales force, which it believes is larger than any of its competitors. This sales force is divided into four groups. The GOLDEN Press Group, with approximately 111 salespersons, handles all book products. The GOLDEN Games Group, consisting of approximately 35 salespersons, is responsible for all games and puzzle sales. The GOLDEN Entertainment Group, consisting of 6 salespersons (established in 1991), is responsible for the sale of video and audio products. In Fiscal 1993, Western established a fourth sales force of approximately 12 salespersons dedicated to calling upon independent and emerging chain trade bookstores and designed to support the sales of Western's rapidly increasing list of higher priced, trade books sold under The Artists and Writer's Guild (Registered) and GOLD KEY(Registered) imprints.\nWestern Publishing Company, Inc. also sells through wholesalers, distributors, sales representatives and food brokers. Western Publishing Company, Inc. generally provides retailers with permanent wood racks, spinners, plan-o-gramming and its computerized space management planning service, all of which it believes provides it with a competitive advantage in obtaining favorable shelf space for its products. To promote sales, Western Publishing Company, Inc. uses print media, television, cooperative advertising programs, point-of-sale displays and a variety of consumer promotions.\nWestern Publishing Company, Inc. also markets selected products directly to the consumer through its Direct Marketing group. The Company intends to dispose of its Direct Marketing business as set forth in the section on \"Sale and Phase Out of Operations\" on page 3. Presently, its most common method of sale is through continuity club plans. This sales method features an introductory offer delivered directly to the consumer, followed by regular shipments until the program is completed or the consumer chooses to terminate the program. These programs are offered through traditional direct response media, which include direct mail, magazine and television advertising. The product offerings are divided into children's and adult programs. Current children's programs include the popular Sesame Street(Registered) Book Club and The Berenstain Bears(Registered) Cub\nClub, a juvenile program based on the popular Berenstain Bears and Girl Talk Fun Club, a continuity book club for preteen girls. The adult programs feature craft programs such as programs involving knitting, crocheting and sewing. Western's school book club, the Golden(Registered) Book Club, first introduced in 1990, made progress in expanding its name recognition, sales and market penetration.\nBeach Products markets its products to retailers through a combination of independent sales representatives and its own sales force. Beach Products provides retailers with display units and racks for its party goods and gift wrap products and conducts various sales incentive programs for its representatives and retailers. Beach Products also markets its decorated paper tableware directly to food service organizations and other institutional customers under the CUSTOMPRINTS(Registered) trademark. These items are imprinted with names, logos or messages for business and promotional use. In the mass market and chain store channels, Beach Products utilizes Western Publishing Group, Inc.'s in-store retail merchandising force.\nInternational Sales\nWestern Publishing Group, Inc.'s international sales in Fiscal 1994 were approximately 6% of net sales, the majority of which were derived through a Canadian subsidiary of Western Publishing Company, Inc., Western Publishing (Canada) Inc., and a sales, distribution and licensing division of Western Publishing Company, Inc. in the United Kingdom. The Canadian subsidiary serves the Canadian market and distributes Western Publishing Company, Inc.'s books, puzzles and game products, as well as distributing toy and hobby products for other manufacturers. The operation located in London, England serves the United Kingdom and other European markets. The Company has been expanding its international sales to its distributor in Australia as well as to customers in Spanish speaking countries including Mexico and South America. In addition, the Company has been exporting sound pads for its SOUND STORY(Registered) books to many countries throughout Europe and the Far East.\nIn-Store Merchandising\nIn Fiscal 1994, Western Publishing Group, Inc. made significant investments in the further development and expansion of its in-store retail merchandising service unit. This merchandising unit operates independently of any of Western's business units or sales groups and is responsible for providing in-store merchandising services in support of all Western Publishing Group, Inc.'s product lines, i.e. Golden Press, Golden Games, Golden Entertainment and Beach Products. This unit is focused on mass market, discount, toy and chain drug classes of trade and supports Western's expansion into other retail channels. By setting plan-o-grams, moving merchandise out of stock rooms, building displays, managing racks and product presentation and performing store level ordering services, product take away has increased and additional retail space has been captured. Sales increases have been experienced in major retail chains where Western's merchandising services have been initiated. The Company believes it is providing vital services to the retailer which will enhance the long-term relationship between Western and the retailer. The merchandising group currently consists of the equivalent of over 800 permanent part-time employees.\nRetail Businesses\no Category Management\nUnder Western Publishing Company, Inc.'s Total Category Management program, the retailer never touches the product, but rather provides strategic direction and parameters to Western who, in turn, manages all the operational and supply chain management tasks.\nIn Fiscal 1994, Western further enhanced its innovative \"shop- within-a-store\" Books 'R' Us(Trademark) concept at Toys 'R' Us. It designed, serviced, supplied, warehoused and distributed the best juvenile books from Western and more than 40 other publishers. The program was expanded to approximately 190 stores. Western returned the day to day actual operation of these \"shop-within-a-store\" locations over to Toys 'R' Us as of February 1, 1994. Toys 'R' Us intends to open approximately 125 additional Books 'R' Us locations in calendar 1994. All will feature a full array of Golden Books.\nWestern has created similar merchandising innovations designed to enhance the retail environment for its product category. Just For Kids(Trademark) is a new children's book, audio and video \"store-within- a-store\" at Wal-Mart, Inc. Approximately 100 Just For Kids(Trademark), Wal-Mart stores are scheduled to be opened in 1994.\nWestern's Storyland(Trademark) \"store-within-an-aisle\" program is a scaled down version of the same concept. It features a greatly expanded books department at mass market retailers, with a bookstore atmosphere including special racks, signage and full face presentation of children's books. The Storyland program is managed and serviced by Western. Wal-Mart, Caldor's, Fred Meyers and several other national chains are installing the program with approximately 130 stores currently in place. The number of chains and stores adapting the Storyland program is growing and Western has plans to open 550 additional locations in calendar 1994. In each case where a Storyland program has been installed, sales of children's books and of Western's books in particular, have increased markedly.\no Company Stores\nAfter opening its first Golden Book(Registered) Showcase store in Schaumburg, IL. in November 1992, Western Publishing Company opened its second Golden Book(Registered) Showcase store in the CityWalk Center in Burbank, CA in June 1993. The Company opened its third store in Rockefeller Center in New York City in April 1994. Each of the stores features only Western Publishing Group, Inc. consumer products. Each store is located in a different environment. For example, the Schaumburg, IL store is located in the Woodfield Mall, an upscale suburban mall. The CityWalk store is located just outside of the Universal City tour in Burbank, CA. The New York City store is located in a midtown, high-trafficked urban area. All three Golden Book(Registered) Showcase stores permit the Company to support and expand its Golden brand recognition as well as test product and survey customers in different environments.\nCompetition\nAlthough Western Publishing Company, Inc. has one of the largest shares of the market for children's story books and activity books, there are other major competitors in the industry, such as Random House, Inc., Simon and Schuster, Inc. and G.P. Putnam & Sons, a division of The Putnam Berkley Publishing Group, as well as many other publishers. There also are numerous competitors in the markets for puzzles, games and adult books marketed by Western Publishing Company, Inc. Competition is intense and is based primarily on price, quality, distribution, advertising and licenses. In addition, Western Publishing Company, Inc. competes for a share of consumer spending on juvenile entertainment and educational products against companies that market a broad range of other products for children.\nWestern Publishing Company, Inc. believes that its specialized manufacturing equipment for many of its products results in lower production costs and its integrated production facilities provide it with greater flexibility in the timing and volume of its production of inventory. Its large market share in most of the product lines in which it competes gives it greater economies of scale in producing, marketing, selling and distributing those products.\nPenn Corporation has many major competitors in the paper tableware, gift wrap and stationery industries, such as Hallmark Cards, Inc., American Greetings, Inc., James River Company, Unique Industries, Inc., Amscan, Inc. and many other companies.\nTrademarks\nWestern Publishing Company, Inc. has numerous registered trademarks in the United States and other countries, including for various uses the names LITTLE GOLDEN BOOKS(Registered), GOLDEN BOOKS(Registered), GOLDEN PRESS(Registered), GOLDEN SIGHT & SOUND(Registered), GOLDEN(Registered) SOUND STORY(Trademark), MERRIGOLD(Registered) and WHITMAN(Registered). Western Publishing Company, Inc. believes that the GOLDEN(Registered) and GOLDEN Book (Registered)trademarks are material to the conduct of its business. Western Publishing Company, Inc. also has registered the trademark MAGIC SLATE (Registered) for its well-known children's activity product and WHITMAN (Registered) for its line of products for coin collecting enthusiasts. Western Publishing Company, Inc. has certain patents, some of which are material to the conduct of its business. Penn Corporation has several registered trademarks in the United States, including BEACH(Registered), CONTEMPO(Registered) and RENNER DAVIS(Registered).\nInventory; Returns; Backlog\nBoth Western Publishing Company, Inc. and Penn Corporation have their own production capabilities and do not rely to any material extent on suppliers for their finished product inventory needs, except for a limited number of products that they do not self-manufacture. Western Publishing Company, Inc. continues to maintain a high level of finished goods inventory to improve customer service (see Management's Discussion & Analysis on page 20 for a discussion of inventory). When Company approval is secured in advance, a customer may return saleable merchandise. Both companies provide payment terms standard in their respective industries, which, in the case of Western Publishing Company, Inc., includes extended dating programs. Backlog is not meaningful to either company's business.\nRegulation\nSome of Western Publishing Company, Inc.'s products must comply with the child safety laws which, in general, prohibit the use of materials that might be hazardous to children. Western Publishing Company, Inc. maintains its own materials testing laboratory to assure the quality and safety of its products. Western Publishing Company, Inc. has experienced no difficulty and incurred no material costs in complying with these laws. Certain of Penn Corporation's tableware products are subject to regulations of the Food and Drug Administration and the Company has experienced no difficulty and incurred no material costs in complying with these regulations.\nCOMMERCIAL PRODUCTS SEGMENT\nWestern Publishing Company, Inc., through its Diversified Products Division, provides printing and publishing services to others. Western Publishing Company, Inc. groups these activities into five principal categories: graphic services and commercial printing; specialty printing and game manufacturing; custom publishing services; literature and software distribution services; and educational kit manufacturing. Western Publishing Company, Inc. has been shifting its business emphasis from commercial printing to the other activities of its Diversified Products Division, which are less price sensitive and which can utilize its creative resources and specialized production equipment.\nGraphic Services and Commercial Printing\nA substantial portion of Western Publishing Company's graphic services and commercial printing business is concentrated in the printing of books, industrial manuals, catalogs, labels and promotional materials. Western Publishing Company, Inc. also engages in commodity printing (such as tax instruction booklets and tax forms), which business usually is obtained on a competitive bid basis and is generally produced when Western has open production capacity available. Customers include Random House, Inc., Bantam Doubleday Dell Inc., the American Bible Society, the International Bible Society, the U.S. government, Houghton Miflin Company, Musical Heritage Society, Inc., etc.\nSpecialty Printing and Game Manufacturing\nSpecialty printing services include printing, packaging and distributing for others printed products such as games, puzzles, playing cards, trading picture cards and posters. Customers include Classic Games,\nInc. (a subsidiary of The Score Board, Inc.), Regina Press (a division of Malhave & Co.), Publishers and Importers, Inc. and TH-Q, Inc.\nCustom Publishing\nCustom publishing includes the creation, design, production, assembly and distribution for major consumer products and fast food companies of customized products for their marketing and promotional programs. Recent Custom Publishing customers include Wendy's International, Inc., Pizza Hut Inc., Continental Baking Company, Motts Division (Cadbury Beverages Inc.) and Continental Airlines, Inc. Custom publishing utilizes the complete creative capabilities of Western Publishing Company, Inc., as well as its marketing, art, editorial, rights and royalty and product engineering groups.\nEducational Kit Manufacturing\nEducational kit manufacturing includes the printing, sorting and collating of as many as 200 different components for one kit. Western Publishing Company, Inc. has produced educational kits for the nation's foremost educational publishers, including World Book, Inc., Scott Foresman & Company, Inc. and Macmillan\/McGraw-Hill.\nLiterature Distribution and Software Publishing\nThe literature distribution and software manual printing segment includes the printing of manuals, providing telemarketing services and physical distribution for software publishing companies. Recent customers for whom Western Publishing Company, Inc. has provided these services have included IBM, Sun Microsystems, Inc., Xerox Corporation and Aldus Corporation.\nMarketing and Competition\nWestern Publishing Company, Inc.'s Diversified Products services are sold by approximately 38 employee sales representatives located in ten field sales offices throughout the United States. Western Publishing Company, Inc. utilizes its consumer products resources and relationships to assist in the marketing of its Diversified Products services. Competition, which is based upon price, quality and delivery, is intense, particularly in the graphics and commercial printing businesses. Western Publishing Company, Inc. competes in this area with hundreds of companies, the largest of which is R.R. Donnelly & Sons Company.\nGENERAL INFORMATION\nSeasonality\nWestern Publishing Group, Inc. experiences seasonality, particularly in the Consumer Products segment, with highest revenues in the third fiscal quarter. Western Publishing Company, Inc. generally uses certain of its production facilities that are not being fully utilized for its consumer products for its graphics and commercial printing activities, thereby somewhat reducing the seasonality of Western Publishing Company, Inc.'s overall business. However, overall sales have migrated to the\nsecond half of the fiscal year and, in Fiscal 1994, approximately 61% of revenues were generated in this time period.\nRaw Materials\nBoth Western Publishing Company, Inc. and Penn Corporation use a wide variety of paper, plastic, inks and other raw materials in the manufacture of their products. Neither Western Publishing Company, Inc. nor Penn Corporation is dependent on any one supplier for any raw material, and neither has experienced any material difficulty in obtaining raw materials or subcontracted products.\nEmployees\nWestern Publishing Group, Inc. employs in the aggregate approximately 4,200 full-time employees and 799 part time employees. Approximately 1,100 employees are represented by labor unions. In Fiscal 1994, Western Publishing Company, Inc. negotiated new three-year contracts with the International Automobile workers on terms it considers satisfactory. Western Publishing Company, Inc. and Penn Corporation, believe that their relations with their employees are generally good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nWestern Publishing Company, Inc.'s facilities are designed principally for the manufacture of products of its Consumer Products and Diversified Products Divisions. Western Publishing Company, Inc. devotes substantial resources to maintain its facilities in good operating condition and, where appropriate, to improve facilities so that they are cost-efficient and competitive in the principal markets in which it competes. Western Publishing Company, Inc. has substantial sheetfed and web press manufacturing capacity in its Cambridge, Maryland and Racine, Wisconsin plants, and substantial game and puzzle manufacturing and printing capacity in its Fayetteville, North Carolina plant. Capacity utilization in these facilities, based on operating three shifts a day, five days a week, averaged approximately 81% in Fiscal 1994.\nPenn Corporation's manufacturing facilities are designed solely for the manufacture of its products. These facilities are maintained in good operating condition and, where necessary, upgraded in line with business needs. Penn Corporation employs certain sophisticated machinery in its manufacturing facilities including sophisticated napkin, table cover, paper plate and cup making machinery, including color presses, a narrow web press, plate formers, table cover embosser\/folders and Senning wrap-over machines at its BEACH\/CONTEMPO Division; and paper cutting, scoring, box erecting and envelope making machinery at its RENNER DAVIS(Registered) Division.\nCertain information as to the significant properties used by Western Publishing Company, Inc. and Penn Corporation in the conduct of their businesses is set forth in the following table:\nLocation Square Feet Type of Use - - -------- ----------- -----------\nRacine, 1,556,000 Corporate, creative and marketing Wisconsin offices; printing and facilities; warehousing\nFayetteville, 1,036,000 Game and puzzle production and North Carolina assembly; warehousing and distribution\nCoffeyville, 672,000 Warehousing and distribution Kansas\nKalamazoo, 458,000 Corporate offices; manufacturing; Michigan warehousing and distribution\nCambridge, 200,000 Printing; warehousing Maryland\nCambridge, 148,000 Canadian corporate offices; sales Ontario, Canada offices; warehousing and distribution\nCrawfordsville, 403,000 Distribution and Warehousing Indiana\nLittle Rock, 135,000 Warehousing Arkansas\nFenton, 74,000 Manufacturing; warehousing and Missouri distribution\nW. Springfield, 41,000 Manufacturing; warehousing Massachusetts\nNew York, 35,000 Publishing offices; sales offices New York\nNew York, 17,000 Showroom New York\nNew York, 2,213 Retail Store New York\nAll of these properties are owned by either Western Publishing Company, Inc. or Penn Corporation, except for three leases covering 438,000 square feet of the Wisconsin properties (leases expire July 31, 1994, January 31, 1995, and August 31, 1995 with Western Publishing Company, Inc. having options to renew with respect to these leases); one lease in Little Rock, Arkansas expiring May 31, 1994, which will not be renewed; two leases covering 90,000 square feet in Cambridge, Maryland, the first of which expires on September 30, 1995 and the second of which is on a month to month basis; two leases covering 283,000 square feet in Fayetteville, North Carolina, the first of which expired on March 31, 1994 but was renewed on a month to month basis and the second of which expires on June 30, 1994; one lease covering 60,000 square feet in Coffeyville, Kansas which expired April 30, 1994, and will not be renewed; one lease covering\nthe Massachusetts property (lease expires May 31, 1995 with Penn Corporation having an option to renew); one lease covering the Creve Coeur, Missouri property (lease expires May 31, 1995 with Penn Corporation having an option to renew); and three leases covering the New York properties (leases expire March 31, 2003, April 30, 2003 and March 31, 2003; two of which are with a subsidiaries of Western Publishing Company, Inc.). All of these properties, except for West Springfield, Massachusetts and Canada are employed in both the Consumer Products and Commercial Business Segments; the West Springfield, Massachusetts, the Little Rock, Arkansas and the Canada properties are used solely in the Consumer Products business segment. In addition to the properties described above, Western Publishing Company, Inc. and Penn Corporation own or rent various other properties that are used for administration, sales offices and warehousing.\nWestern Publishing Group, Inc. believes that, in general, its plants and equipment are well maintained and in good operating condition and adequate for its present needs. Western Publishing Group, Inc. regularly upgrades and modernizes its facilities and equipment. Capital additions were $37,359,000 in Fiscal 1994.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nWestern Publishing Group, Inc. and its subsidiaries are parties to certain legal proceedings which are incidental to their ordinary business and none of which involve amounts in controversy which are material to Western Publishing Group, Inc. or its subsidiaries.\nTwo subsidiaries of Western Publishing Group, Inc., Western Publishing Company, Inc. (\"Western\") and Penn Corporation (\"Penn\"), face potential environmental liabilities under the Comprehensive Environmental Response, Compensation and Liability Act (commonly know as \"CERCLA\" or \"SuperFund\") and other federal and state laws as a result of past off-site waste disposal practices. The United States Environmental Protection Agency (\"EPA\"), and in some cases state regulatory agencies, have informed Western that it is a potentially responsible party (\"PRP\") at six disposal sites and that Penn is a PRP at one such site. In each instance, the affected subsidiary of Western Publishing Group, Inc. is one of a number of PRPs that have been identified by EPA or the relevant state agency. In addition, Western maintains insurance coverage for certain of its liabilities and has asserted claims against its insurers.\nAt three of these sites, the volume of waste disposed of by Western is relatively small compared to other PRPs. As such, Western either has been, or is likely to be, determined to be a \"de minimis\" party. In addition, during the first quarter of 1994, Western was identified as a PRP at a fourth site. To date in its investigation, Western has not discovered any information demonstrating that it shipped any material to this site.\nAt a fifth site, Western's liability is limited to approximately 4% of the total costs at the site, which are estimated to be in the range of $22,000,000. Western has reached a settlement with certain of its insurance carriers with respect to this site pursuant to which these insurers have reimbursed Western for a portion of Western's liability and\ndefense costs.\nAt a sixth site, the Hertel Landfill in Plattekill, New York, Western is one of six PRPs that have been identified by EPA. In September 1991, EPA approved a remedial action for the site that had a present value cost of approximately $8 million. In September 1992, EPA issued a unilateral administrative order to the six PRPs. This order requires the implementation of the remedial design and remedial action for the site. Believing that it had sufficient cause not to comply, Western did not comply with the order. One of the other PRPs is complying with the order. Western anticipates that this PRP will seek a monetary contribution from Western in the future. In addition, although Western has certain defenses available to it, EPA could seek penalties of up to $25,000 per day and\/or its costs plus treble damages from Western resulting from Western's decision not to comply with the administrative order.\nWestern and the performing PRP are actively engaged in an effort to identify other PRPs at the Hertel Landfill site, with the goal of seeking contribution from them for the remedial design and remedial action activities. The parties have not allocated responsibility at this site on a percentage basis, and liability for response costs under CERCLA can be joint and several. Western and certain of Western's insurers have entered into a Confidential Partial Interim Settlement Agreement pursuant to which they have agreed, inter alia, subject to certain conditions, to stay litigation brought by Western for a period of two years. Upon expiration of the stay, it is anticipated that the parties would resume litigation concerning the insurers' duty to defend and indemnify Western.\nA division of Penn has been identified as a PRP at the West KL Avenue Landfill site in Kalamazoo, Michigan. In September 1990, EPA approved a remedial action for this site that EPA estimated would cost $16.2 million. The PRP identified as the largest contributor to the site is conducting the cleanup, and has entered into settlements with approximately 225 other PRPs. This PRP filed a private cost recovery action against Penn and approximately 40 other PRPs in 1992 in the U.S. District Court for the Western District of Michigan. The percentage of waste at the site attributed to Penn is approximately 1% or less of the total volume of waste shipped to the site, but Penn has not been able to reach a settlement with the plaintiff PRP. The litigation is currently in discovery.\nWestern and Penn are actively pursuing resolution of the aforementioned matters. Western Publishing Group, Inc. does not believe that any of these liabilities will be material to its business, financial condition or results of operations. Where known, provision has been made for any uninsured portion of any liabilities Western or Penn may have.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nNAME AGE POSITION(S)\n- - ---- --- ----------- Glenn R. Albrecht 57 Senior Vice President-Logistics and Distribution of Western Publishing Company, Inc.\nBruce A. Bernberg 50 Senior Vice President, Finance and Administration of Western Publishing Company, Inc.\nRichard A. Bernstein 47 Director, Chairman and Chief Executive Officer of Western Publishing Group, Inc.; Chairman of Western Publishing Company, Inc.; Chairman, President and Chief Executive Officer of Penn Corporation\nJames A. Cohen 48 Senior Vice President-Legal Affairs and Secretary of Western Publishing Group, Inc.; Vice President-Legal Affairs and Secretary of Western Publishing Company, Inc. and Penn Corporation.\nFrank P. DiPrima 56 Director, President and Chief Operating Officer of Western Publishing Group, Inc.\nIra A. Gomberg 50 Vice President-Business Development and Corporate Communications of Western Publishing Group, Inc.; Vice President of Penn Corporation\nDale Gordon 45 Vice President and General Counsel of Western Publishing Group, Inc., Western Publishing Company, Inc. and Penn Corporation\nSteven M. Grossman 33 Vice President-Financial Planning of Western Publishing Group, Inc.\nGeorge P. Oess 58 President of Western Publishing Company, Inc.\nLily Lai Ray 34 Vice President -- Worldwide Sourcing of Western Publishing Group, Inc.\nIlan Reich 39 Vice President-Special Projects of Western Publishing Group, Inc.\nStuart Turner 49 Executive Vice President, Treasurer and Chief Financial Officer of Western Publishing Group, Inc.; Executive Vice President and Treasurer of Western Publishing Company, Inc.; Executive Vice President, Treasurer and Chief Financial Officer of Penn Corporation\nLaurence Usdin 51 Vice President and Corporate Controller of Western Publishing Group, Inc.\nHal B. Weiss 37 Vice President and Assistant Treasurer of Western Publishing Group, Inc. Mr. Albrecht has been Senior Vice President-Logistics and Distribution of Western Publishing Company, Inc. since March 24, 1994. Prior to that Mr. Albrecht had been Senior Vice President-Manufacturing and Distribution from May 24, 1991 to March 23, 1994. From August 1986 to May 1991, Mr. Albrecht had been Vice President of Manufacturing. Mr. Albrecht joined Western Publishing Company, Inc. in a manufacturing management capacity in 1973. Prior to being appointed Vice President, Mr. Albrecht held a succession of manufacturing management positions. Mr. Albrecht is a board member of the Racine United Way, a director of Printing Industries of Wisconsin and a director of the Racine Area Manufacturers Association.\nMr. Bernberg has been Senior Vice President-Finance and Administration of Western Publishing Company, Inc. since May 1987. Mr. Bernberg joined Western Publishing Company, Inc. as Vice President, Finance in 1982 and was elected Treasurer and Chief Financial Officer in 1984. Mr. Bernberg is a director of St. Mary's Medical Center and St. Lukes Hospital in Racine, Wisconsin. He is also a director of MEI, Inc.\nMr. Bernstein has been Chairman and Chief Executive Officer of Western Publishing Group, Inc. and Chairman of Western Publishing Company, Inc. since February 1984. From 1984 to August 1989, Mr. Bernstein was also President of Western Publishing Group, Inc. In November 1986, Mr. Bernstein became Chairman, President and Chief Executive Officer of Penn Corporation. He is President of P&E Properties, Inc., a private commercial real estate ownership\/management company, and has been for more than five years. Mr. Bernstein is the sole shareholder of P&E Properties, Inc. He is a member of the Regional Advisory Board of Chemical Bank, a member of the Board of Trustees of New York University, a member of the Board of Overseers of the New York University Stern School of Business, a Director and Vice President of the Police Athletic League, Inc., a member of the Board of Trustees of the Hospital for Joint Diseases\/Orthopaedic Institute, a member of the Board of Directors of The Big Apple Circus, Inc., a member of the Investment Advisory Board of the New York State Employees Retirement System, a member of The New York State Legislative Commission on Expenditure Review and a member of The Economic Club of New York.\nMr. Cohen has been Senior Vice President-Legal Affairs and Secretary of Western Publishing Group, Inc. since December 1991 and a senior executive of P&E Properties, Inc. since February 1984. From February 1984 until December 1991 he was Vice President, General Counsel and Secretary of Western Publishing Group, Inc. He became Vice President- Legal Affairs and Secretary of Western Publishing Company, Inc. in March 1987. In November 1986, Mr. Cohen became Secretary of Penn Corporation and in April 1987, Vice President and General Counsel of that corporation. From March 1982 to February 1984 Mr. Cohen held various senior positions with the United States Department of Housing and Urban Development, including Regional Counsel. From 1976 to 1982 Mr. Cohen was the Deputy Regional Counsel of the United States Department of Energy.\nMr. DiPrima is President and Chief Operating Officer of Western Publishing Group, Inc., serving in that capacity since May 1990. From June 1987 to May 1990, Mr. DiPrima served as Executive Vice President and Chief Operating Officer of Thompson Medical Company, Inc., a corporation that owns and markets a variety of advertised non-prescription drugs and at the\ntime of Mr. DiPrima's employment also owned and marketed SLIM-FAST(Registered) products. Between June 1984 and June 1987, Mr. DiPrima was Executive Vice President and Chief Operating Officer of Jeffrey Martin, Inc., a national marketer of health and beauty aids. Previously, Mr. DiPrima served for four years at Merck & Co., Inc., nine years at Schering-Plough Corporation, and five years at Playboy Enterprises, Inc., in various capacities in legal and financial affairs and in general management. Mr. DiPrima is a former member of the Board of Directors of the Nonprescription Drug Manufacturers Association. He is admitted to practice law in the states of New York, New Jersey, Illinois and Tennessee and in the District of Columbia.\nMr. Gomberg has been Vice President-Business Development and Corporate Communications of Western Publishing Group, Inc. since February 1986. In April 1987, Mr. Gomberg became a Vice President of Penn Corporation. In addition, he is a Vice President and Assistant Secretary of Western Publishing Company, Inc. Since February 1986, he has also been a senior executive of P&E Properties, Inc. From 1976 through January 1986, Mr. Gomberg was employed by Sony Corporation of America, a manufacturer and distributor of consumer electronic products, first as General Counsel and after November 1983 as Vice President-Government Affairs.\nMr. Gordon joined Western Publishing Company, Inc. in August 1993 as Vice President and General Counsel. He became Vice President and General Counsel of Western Publishing Group, Inc. and Penn Corporation in January, 1994. From 1980 through July 1993 he was with Playboy Enterprises, Inc. in various legal\/management positions, most recently as Vice President, Secretary and Associate General Counsel.\nMr. Grossman joined Western Publishing Group, Inc. in July 1992 as Vice President-Financial Planning. From August 1983 to July 1992 Mr. Grossman was with the public accounting firm of Deloitte & Touche. He is a Certified Public Accountant licensed in the State of New York.\nMr. Oess was elected President of Western Publishing Company, Inc. on April 7, 1992. He had been Executive Vice President-Consumer Products from May 1991 through April 7, 1992. Mr. Oess joined Western Publishing Company, Inc. in a sales management capacity in 1968 and since then has held a succession of management responsibilities. He was appointed Vice President-Commercial Products of Western Publishing Company, Inc. in 1976 and Senior Vice President-Business Development in 1989.\nMs. Ray joined Western Publishing, Group, Inc. in February 1993 as Vice President -- Worldwide Sourcing. From 1991 to January 1993 she served as an independent consultant for Mattel KK (Japan) working on projects related to shipping and planning. From 1989 to 1991 she served as Senior Group Manager of Planning and Development at Mattel as well as General Manager of their Arco Toys Division in Thailand.\nMr. Reich has been Vice President-Special Projects of Western Publishing Group, Inc. since October 1992. Since December, 1987 he has also been an employee of P&E Properties, Inc.\nMr. Turner has been the Executive Vice President, Treasurer and\nChief Financial Officer of Western Publishing Group, Inc. and Executive Vice President of Western Publishing Company, Inc. since February 1984. In November 1986, Mr. Turner became the Executive Vice President, Treasurer and Chief Financial Officer of Penn Corporation. Since May 1981, Mr. Turner has been a senior executive of P&E Properties, Inc. From 1969 to May 1981 he was a partner of Turner, Imowitz and Company, a firm of certified public accountants.\nMr. Usdin has been Vice President, Corporate Controller of Western Publishing Group, Inc. since August 1990. Mr. Usdin joined Western Publishing Group, Inc. in 1989 as Corporate Controller. From 1988 to 1989, Mr. Usdin was Vice President-Finance of New American Shoe Company, Inc. and from 1982 to 1988 he was Vice President-Finance and Corporate Controller of Ziff Communications Company. From 1973 to 1982 he was associated with Mego International, Inc. in several financial positions, including Senior Vice President-Finance. Mr. Usdin is a Certified Public Accountant. He serves on the Advisory Board to Pace University's Masters of Science in Publishing program.\nMr. Weiss has been Vice President and Assistant Treasurer of Western Publishing Group, Inc. since August 1990. From April 1986 until July 1990, Mr. Weiss was Controller and Assistant Treasurer of Western Publishing Group, Inc. and from November 1986 until July 1989 he was Controller of Penn Corporation. In addition, Mr. Weiss has been Controller of P&E Properties, Inc. since 1985. Mr. Weiss is a Certified Public Accountant. Prior to joining Western Publishing Group, Inc. in 1985, Mr. Weiss practiced public accounting. PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nSTOCKHOLDERS' INFORMATION\nCOMMON STOCK PRICES\nWestern Publishing Group, Inc. completed an initial public offering of its Common Stock on April 22, 1986. The Common Stock is traded over-the-counter and is quoted on the NASDAQ National Market System (symbol WPGI). The following table sets forth the range of prices (which represent actual transaction) by quarter as provided by the National Association of Securities Dealers, Inc.\nFiscal Year Ended January 29, 1994\nHigh Low First Quarter 18 1\/2 13 1\/4 Second Quarter 17 3\/8 13 3\/8 Third Quarter 16 3\/4 13 3\/8 Fourth Quarter 20 1\/4 12 1\/4\nFiscal Year Ended January 30, 1993\nHigh Low First Quarter 19 1\/8 16 1\/4 Second Quarter 18 5\/8 15 Third Quarter 22 3\/4 15 5\/8 Fourth Quarter 22 1\/2 16\nDIVIDEND POLICY\nSince its organization in 1984, Western Publishing Group, Inc. has not paid any cash dividends on its Common Stock. Management does not anticipate the payment of cash dividends on Common Stock in the foreseeable future (see Note 6 to the Company's Consolidated Financial Statements).\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data should be read in conjunction with the audited consolidated financial statements and notes thereto included elsewhere herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFISCAL YEAR ENDED JANUARY 29, 1994 (FISCAL 1994) COMPARED TO FISCAL YEAR ENDED JANUARY 30, 1993 (FISCAL 1993)\nRevenues for the year ended January 29, 1994 decreased $35.5 million (5.4%) to $616.7 million as compared to $652.2 million for the year ended January 30, 1993. On May 12, 1993, the Board of Directors of the Company directed management to review the operations of the Advertising Specialty Division of the Company's Penn Corporation subsidiary and evaluate various strategic alternatives, including its disposition. Therefore, subsequent to the Company's first quarter ended May 1, 1993, the results of operations do not include the results of this Division. Excluding revenues of the Advertising Specialty Division for both periods, revenues decreased 1.2% or $7.6 million as compared to the prior year. Consumer Products Segment revenues decreased $7.4 million (1.4%) for the year ended January 29, 1994. The decrease was primarily due to decreases in domestic consumer product sales and the negative effect of foreign currency rates with respect to the Company's international sales during the year. The decline in domestic consumer product sales was primarily the result of out-of- stock conditions of fast moving titles and late availability of new product introductions, partially offset by increased sales from category management programs. Commercial product segment revenues, other than revenues of the Advertising Specialty Division, is comprised of printing services which decreased $.3 million (.4%) for the year ended January 29, 1994. The decline for the year was due to a decrease in sales of graphic products, offset by increases in the sale of kits and custom publishing.\nPrice increases in the Consumer Products Segment were approximately 5%. Sales of printing services are the result of individual agreements entered into with customers as to price and services performed. Accordingly, the effects on inflation cannot be determined on the sales of printing services.\nThe loss before the provision for write-down of Division, interest expense, income taxes and the cumulative effect of a change in accounting principle for the year ended January 29, 1994 was $18.9 million as compared to income of $38.7 million for the year ended January 30, 1993. This decrease of $57.6 million was the result of a $42.4 million decrease in gross profit and a $15.2 million increase in selling, general and administrative expenses. In addition, the Company recorded a $28.2 million provision to write- down the carrying value of the assets of the Advertising Specialty Division to their estimated net realizable value.\nGross profit for the year ended January 29, 1994 was $184.5 million, compared to $226.9 million for the year ended January 30, 1993, a decrease of 18.7%. As a percentage of revenues, the gross profit margin decreased to 29.9% for fiscal 1994 as compared to\n34.8% for fiscal 1993. In the Consumer Products Segment, gross profit decreased $33.8 million (16.1%) to $176.1 million for the year ended January 29, 1994 as compared to the year ended January 30, 1993. As a percentage of revenues, the consumer gross profit margin decreased to 32.7% for fiscal 1994 as compared to 38.5% for fiscal 1993. A substantial portion of the decrease in gross profit margin was due to lower production in response to higher average inventories, resulting in negative manufacturing variances. Additionally, the decrease in gross profit was attributable to an unfavorable change in product mix, increased inventory obsolescence, increased freight costs associated with category management programs and increased storage costs incurred in conjunction with higher average inventories. In the Commercial Products Segment, the gross profit margin of printing services decreased to 11.3% from 11.9% of revenues for the year, as compared to the prior year. The decrease was primarily due to the change in sales mix to lower margin services, partially offset by a reduction in unfavorable manufacturing variances.\nSelling, general and administrative expenses for the year ended January 29, 1994 increased $15.2 million (8.1%) to $203.4 million as compared to $188.2 million for the year ended January 30, 1993. Consumer Products Segment increases were primarily attributable to increased costs for the expansion of the in-store retail merchandising force and category management programs of $11.4 million, increased creative costs and increased general and administrative expenses, including the annual costs of postretirement benefits, other than pension costs, offset by a decrease in consumer advertising.\nInterest expense for the year increased $5.9 million to $16.3 million as compared to $10.4 million in fiscal 1993. The increase was due to higher average debt outstanding and higher interest rates. Total average outstanding debt increased to $248.7 million in fiscal 1994 from $168.4 million in fiscal 1993 (see Financial Condition, Liquidity and Capital Resources), while average interest rates increased to 6.6% for fiscal 1994 as compared to 6.1% for fiscal 1993. The increase in average interest rates resulted primarily from the issuance of $150 million, 10 year maturity, 7.65% Senior Notes in September, 1992.\nThe effective income tax benefit rate was 35.2% in fiscal 1994, as compared to an income tax rate of 38.3% in fiscal 1993. The change in effective tax rate is primarily the result of the inability to utilize loss carrybacks against state taxes, resulting in a lower state income tax benefit in fiscal 1994. This was offset by the 1% increase in the federal statutory rate.\nThe loss for the year ended January 29, 1994, before the provision to write-down of Division and the cumulative effect of a change in accounting principle (postretirement benefits other than pensions) was $21.7 million or $1.07 per share, compared to income of $17.5 million or $.80 per share for the year ended January 30, 1993. During the first quarter of fiscal 1994, the Company adopted\nStatement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\", using the immediate recognition method. As a result, the Company recorded a pre-tax non-cash charge of $24.3 million ($14.8 million, net of income taxes) or $.71 per share as a cumulative effect of a change in accounting principle in the statement of operations. The Company's provision for write-down of Division was $28.2 million ($19.3 million, net of income taxes) or $.92 per share. Therefore, the net loss for the year was $55.8 million or $2.70 per share.\nThe seasonality of the Company's business, which leads to a greater percentage of sales and profits in the third quarter of the fiscal year, continued in fiscal 1994.\nWith respect to fiscal 1995, the Company's operating results for the first quarter will experience a downturn as compared with the prior year due to the continuing difficult retail environment caused by unusually severe weather conditions in much of the country, distractions resulting from the contemplated sale of the Company, overhead reduction measures announced during the first quarter and the pending sales of certain of the Company's operating divisions and product lines.\nFISCAL YEAR ENDED JANUARY 30, 1993 (FISCAL 1993) COMPARED TO FISCAL YEAR ENDED FEBRUARY 1, 1992 (FISCAL 1992)\nWestern Publishing Group, Inc.'s revenues increased $97.7 million (17.6%) to $652.2 million in fiscal 1993, as compared to $554.5 million in fiscal 1992. Consumer Products Segment revenues increased $105.7 million (24.0%). This increase was due, in large part, to growth in sales of storybooks (includes Sound Storybooks(Registered)), puzzles, activity books, games, paper tableware and party goods. Commercial Products Segment revenues decreased $7.6 million (6.7%) due to a sales decrease of $9.3 million (11.6%) in printing services partially offset by a sales increase of $1.7 million (5.0%) in sales of Advertising Specialty products over the comparable period in the prior year.\nPrice increases in the Consumer Products Segment were approximately 4%. Sales of printing services are the result of individual agreements entered into with customers as to price and services performed. Accordingly, the effects of inflation cannot be determined on the sales of printing services.\nIncome before interest expense and income taxes increased $10.2 million (35.7%) to $38.7 million in fiscal 1993, as compared to $28.5 million in fiscal 1992. As a percentage of total revenues, this was an increase to 5.9% of revenues in fiscal 1993 as compared to 5.1% in fiscal 1992. This increase was the result of a $38.3 million increase in gross profit, offset by a $28.1 increase in selling, general and administrative expenses.\nGross profit increased $38.3 million (20.3%) to $226.9 million for the year ended January 30, 1993, as compared to $188.6 million for\nthe year ended February 1, 1992. As a percentage of revenues, the gross profit margin increased to 34.8% for the year ended January 30, 1993, from 34.0% for the year ended February 1, 1992. The increase in gross profit margin for the year is due to a change in product mix to higher gross profit margin consumer products and a decrease in sales of lower margin commercial products. In the Consumer Products Segment, gross profit increased $39.5 million (23.2%) to $209.9 million in fiscal 1993 as compared to $170.3 million in fiscal 1992. The increase in gross profit was attributable to increased sales. As a percentage of revenues, the gross profit margin was approximately the same at 38.5% in fiscal 1993 as compared to 38.7% in fiscal 1992. Notwithstanding a decrease in sales in the Commercial Products Segment, the gross profit margin increased to 14.9% in fiscal 1993 from 14.1% in fiscal 1992. The increase was primarily in printing services which experienced a change in sales mix to higher margin products.\nSelling, general and administrative expenses for the year ended January 30, 1993, increased $28.1 million (17.6%) to $188.2 million as compared to $160.1 million for the year ended February 1, 1992. This increase was primarily in the Consumer Products Segment and was attributable to increases in sales promotion, selling expense (primarily costs for the in-store retail merchandising force) and advertising.\nInterest expense increased $4.1 million (65.6%) to $10.4 million in fiscal 1993 as compared with $6.3 million in fiscal 1992. The increase was due to higher average debt outstanding, partially offset by lower interest rates. Total outstanding debt, due to the planned increase in consumer products finished goods inventory, increased to an average of $168.4 million in fiscal 1993 from $92.5 million in fiscal 1992, (see Financial Condition, Liquidity and Capital Resources), while average interest rates were 6.1% and 6.6%, respectively.\nThe effective tax rate decreased to 38.3% in fiscal 1993, from 38.5% in fiscal 1992. The slight decrease was primarily due to the favorable effect of foreign tax credits.\nNet income increased $3.8 million (27.8%) to $17.5 million as compared to $13.7 million in 1992. Income per common share increased 29.0% to $.80 per share in fiscal 1993, from $.62 per share in fiscal 1992. The trend toward seasonality, leading to greater sales and profits in the third fiscal quarter continued in fiscal 1993.\nEFFECTS OF INFLATION\nDuring fiscal 1990, the Company experienced significant increases in its costs for certain raw materials, particularly paper, which is the Company's primary raw material. A portion of the inflationary effects were recouped through price increases. In fiscal 1991, additional productive capacity in the paper industry caused a decline in paper costs. In fiscal 1993 and fiscal 1994,\npaper prices remained stable. Management does not anticipate that there will be any significant increase in the cost of raw materials in fiscal 1995.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nOperations for the year ended January 29, 1994, excluding non-cash charges for depreciation, amortization, provision for losses on accounts receivable, the adoption of FASB No. 106, the provision for the write-down of a division and changes in working capital, provided cash of approximately $17.5 million. The profit for the year ended January 30, 1993, excluding depreciation, amortization, provision for losses on accounts receivable and changes in working capital, provided cash of approximately $36.7 million. During the years ended January 29, 1994 and January 30, 1993, other changes in assets and liabilities, resulting from operating activities, amounted to $32.0 million and $107.5 million, respectively, resulting in net cash used in operating activities of $14.5 million and $70.8 million, respectively.\nAcquisitions of property, plant and equipment, were $37.4 million during the year ended January 29, 1994 as compared to $23.7 million during the year ended January 30, 1993. In fiscal 1994, the Company acquired and retrofitted a 403,000 square foot distribution center in Crawfordsville, Indiana. The distribution center is expected to cost approximately $10 million, of which $9.0 million was expended through January 29, 1994. The Company is currently reconsidering its previously announced plans to undertake a facility expansion of its paper tableware and party goods operations in Kalamazoo, Michigan in conjunction with the Company's plan to improve its competitive position and reduce its overall operating cost structure. As yet, no material commitments for this facility expansion have been made.\nCash provided by financing activities during the year ended January 29, 1994, was primarily from borrowings under the Company's Revolving Credit Agreement, while the issuance of the 7.65% Senior Notes provided the cash from financing activities during the year ended January 30, 1993.\nWorking capital increased to $333.0 million from $283.1 million at January 30, 1993. This increase includes $17.0 million of games, puzzles, direct marketing continuity and school book club non- current assets which were reclassified to net assets held for sale. Accounts receivable at January 29, 1994, decreased $7.1 million (a 4.9% decrease), as compared to the prior year, which is consistent with the decrease in revenues. Inventories, including $30.6 million which was reclassified to net assets held for sale, decreased $56.5 million, as compared to January 30, 1993. This is the result of the Company's inventory management program which was designed and implemented in fiscal 1994 to reduce overall inventory levels. Additionally, the income tax effect of the fiscal 1994 operating results increased refundable and current deferred income taxes $22.3 million. The balance of loans outstanding under the\nRevolving Credit Agreement at January 29, 1994 as compared to January 30, 1993, increased by $50.0 million to a total of $80.0 million. The increase in the loan balance was primarily utilized to fund operating losses and capital expenditures, offset by reductions in accounts receivable and inventories.\nThe Company's Revolving Credit Agreement, dated November 12, 1992, initially provided for a line of credit totaling $200 million. The facility provides for the seasonal working capital requirements of the Company. In October, 1993, the Revolving Credit Agreement was amended to provide credit availability of $140 million from December 28, 1993 until the third quarter of fiscal 1995. Subsequently, an agreement was entered into to further amend the Revolving Credit Agreement to provide for borrowings up to $125 million through July 31, 1994 and $140 million thereafter; in each case, including letters of credit of $10 million. Concurrent with the completion of the sale of the game and puzzle operation (the \"Sale\"), the Revolving Credit Agreement facility will be $90 million, including letters of credit of $10 million. Additionally, the provision that borrowings not exceed $115 million during any thirty day period in the first quarter of each fiscal year will be $15 million after the Sale. The Revolving Credit Agreement expires May 31, 1995.\nThe Company's management believes that the credit facilities available under the Revolving Credit Agreement are sufficient to meet the Company's seasonal borrowing needs.\nRECENT EVENTS\nAs discussed in Note 2 to the Consolidated Financial Statements, the Company adopted a plan which is aimed at focusing management's attention on its core competencies, and therefore grow the Company's publishing, paper party goods, stationery and printing businesses. The plan is designed to improve the Company's competitive position and reduce its operating cost structure through the sale or closedown of certain operations, property divestitures and consolidations, and a reduction in the management, administrative and direct labor workforces. It is anticipated that the plan will be substantially completed by the fourth quarter of fiscal 1995. This plan was adopted after extensive consultation with the Company's investment bankers upon completion of discussions with parties which had expressed an interest in a business combination with the Company, as the best means available to maximize value to shareholders. The Company is no longer engaged in discussions regarding a business combination.\nAs part of the plan, the Company has entered into an agreement in principle to sell its game and puzzle operation to Hasbro, Inc. for approximately $103 million (including the sale of certain inventories). This transaction is subject to customary conditions and is expected to be completed in the second quarter of fiscal 1995. In conjunction therewith, the Company intends to close its Fayetteville manufacturing and distribution facility, where\nmanufacturing is primarily dedicated to games and puzzles. Additionally, the Company will exit the direct marketing continuity and school book club businesses.\nThe sale of the game and puzzle operation, along with the implementation of the balance of the plan is expected to have a favorable effect on the Company's financial position, results of operations, and future capital requirements. As a result of the plan, the Company will dispose of operations with fiscal 1994 aggregate sales of approximately $125,000,000 and pre-tax operating losses of approximately $20,000,000. Furthermore, the Company estimates that the disposition of those operations will reduce the Company's average working capital needs by approximately $60,000,000. The Company will use the net cash proceeds from the sale of the game and puzzle operation to repay outstanding indebtedness under its Revolving Credit Agreement facility, which was $100 million on April 30, 1994.\nAnnual operating cost savings associated with the plan, exclusive of the impact of the sale of the game, puzzle, direct marketing and school book club operations will begin to be realized in the second quarter of fiscal 1995. The Company will continue to evaluate opportunities for additional cost savings through fiscal 1995, including possible additional facility consolidations and further headcount reductions.\nIn addition to the plan's adoption, the Company entered into a letter of intent to sell the Advertising Specialty Division of the Company's Penn Corporation subsidiary for approximately $14 million. The transaction, which is subject customary conditions, is expected to be completed in the second quarter of fiscal 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Index to Consolidated Financial Statements and Schedules on Page.\nCONSOLIDATED QUARTERLY FINANCIAL INFORMATION\n(1) Includes provision for write-down of Division of $28,180, before income taxes of $8,900 ($6,400 of which was recognized in the first quarter and $2,500 in the fourth quarter). The impact on net loss per share for the year was $.92.\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 called for with respect to directors is incorporated by reference to the information under \"Business Experience of Nominees for Election as Directors\" at pages 3 through 5 of the Proxy Statement.\nThe information called for with respect to executive officers appears in Part I of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information called for is incorporated by reference to the information under \"Executive Compensation\" at page 10 and 11 of the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information called for is incorporated by reference to the information under \"Stock Ownership of Principal Stockholders\" and \"Stock Ownership of Directors ard Officers at pages 2 and 5 of the Proxy Statement, respectively.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for is incorporated by reference to the information under \"Certain Transactions\" at page 12 of the Proxy Statement. PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) See Index to Consolidated Financial Statements and Schedules on Page.\nEXHIBITS\n3.1 Restated Certificate of Incorporation of the Registrant dated March 11, 1986 (incorporated by reference to Exhibit 3.1 to the Registrant's Registration Statement No 33-4127 on Form S-1 (the \"Registration Statement\")).\n3.2 Certificate of Correction of the Certificate of Incorporation of the Registrant dated January 13, 1987 (incorporated by reference to Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for fiscal year 1988 (the \"1988 Form 10-K\")).\n3.3 Amendment to Certificate of Incorporation of Registrant as approved by a majority of the stockholders at the Annual Meeting of Stockholders held May 14, 1987 (incorporated by reference to Exhibit 3.3 to the 1988 Form 10-K).\n3.4 Amendment to Certificate of Incorporation of Registrant as approved by a majority of the stockholders at the Annual Meeting of Stockholders held May 17, 1990 (incorporated by reference to Exhibit 3.4 to the 1991 Form 10-K).\n3.5 By-laws of the Registrant (incorporated by reference to Exhibit 3.4 to the 1988 Form 10-K).\n4.1 Form of certificate for shares of the Registrant's Common Stock (incorporated by reference to Exhibit 4.4 to the Registration Statement).\n10.27 Lease dated January 15, 1985, between PG Investments and Western Publishing Company, Inc. with amendment dated January 22, 1986 (incorporated by reference to Exhibit 10.9 to the Registration Statement).\n10.28 Amendment dated December 29, 1986, between PG Investments and Western Publishing Company, Inc. to the lease dated January 15, 1985, as amended (incorporated by reference to Exhibit 10.9 to the 1988 Form 10-K).\n10.29 Amendment dated January 18, 1988, between PG Investments and Western Publishing Company, Inc. to the Lease dated January 15, 1985, as amended (incorporated by reference to Exhibit 10.10 to the 1988 Form 10-K).\n10.30 Amendment dated August 25, 1988, between PG Investments and Western Publishing Company, Inc. to the Lease dated January 15, 1985, as amended (incorporated by reference to Exhibit 10.16 to the 1989\nForm 10-K).\n10.31 Amendment dated December 21, 1989, between PG Investments and Western Publishing Company, Inc. to the Lease dated January 15, 1985, as amended (incorporated by reference to Exhibit 10.31 to the Registrant's Annual Report on Form 10-K for the fiscal year 1990 (the \"1990 Form 10-K\")).\n10.32 Lease commencing July 24, 1988, between Jeno Partnership and Western Publishing Company, Inc. (incorporated by reference to Exhibit 10.17 to the 1989 Form 10-K).\n10.33 Lease dated February 1, 1989, between Golden Press, Inc. and 850 Third Ave. LP (incorporated by reference to Exhibit 10.33 to the Registrant's Annual Report on Form 10-K for the fiscal year 1990 (the \"1990 Form 10-K\")).\n10.33a First Amendment Agreement dated as of February 3, 1993 (to lease dated February 1, 1989) between 850 Third Avenue Limited Partnership and Golden Press, Inc., as modified by Letter Agreement dated February 3, 1993 (incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year 1990).\n10.34 Lease dated November 9, 1992, between 200 Fifth Avenue Associates and Western Publishing Company, Inc.\n10.35 Warehouse Lease Agreement -- Indenture dated as of April 15, 1987, between Cambridge Terminal Warehouse and Western Publishing Company, Inc. (incorporated by reference to Exhibit 10.21 to the 1988 Form 10-K).\n10.36 Lease Amendment dated March 17, 1989, between Cambridge Terminal Warehouse and Western Publishing Company, Inc. to the Warehouse Lease Agreement -- Indenture dated as of April 15, 1987 (incorporated by reference to Exhibit 10.36 to the Registrant's Annual Report on Form 10-K for the fiscal year 1990 (the \"1990 Form 10-K\")).\n10.37 Lease dated May 1, 1987, between West Springfield Industrial Center, Inc. and Penn Corporation (incorporated by reference to Exhibit 10.23 to the 1988 Form 10-K).\n10.39 Indenture to Lease dated March 24, 1988, between The Equitable Life Assurance Society of the United States and Penn Corporation (incorporated by reference to Exhibit 10.29 to the 1989 Form 10-K).\n10.40 Golden Comprehensive Security Program, as amended and restated, effective January 1, 1993\n10.53 Golden Retirement Savings Program, as amended and restated, effective as of January 1, 1993.\n10.63 Penn Corporation Comprehensive Security Program, effective January 1, 1987 (incorporated by reference to Appendix A to the\nRegistrant's Registration Statement 33-18430 on Form S-8 (the \"Penn Comprehensive Registration Statement\")).\n10.64 First Amendment of Penn Corporation Comprehensive Security Program, effective November 2, 1987 (incorporated by reference to Appendix A to the Penn Comprehensive Registration Statement).\n10.65 Second Amendment of Penn Corporation Comprehensive Security Program, effective January 1, 1987 (incorporated by reference to Exhibit 10.36 to the 1988 Form 10-K).\n10.66 Third Amendment of Penn Corporation Comprehensive Security Program, effective November 2, 1987 (incorporated by reference to Exhibit 10.37 to the 1988 Form 10-K).\n10.67 Fourth Amendment of Penn Corporation Comprehensive Security Program, effective January 1, 1988 (incorporated by reference to Exhibit 10.48 to the 1989 Form 10-K).\n10.68 Fifth Amendment of Penn Corporation Comprehensive Security Program, effective January 1, 1988 (incorporated by reference to Exhibit 10.49 to the 1989 Form 10-K).\n10.69 Sixth Amendment of Penn Corporation Comprehensive Security Program, effective January 1, 1988 (incorporated by reference to Exhibit 10.50 to the 1989 Form 10-K).\n10.70 Seventh Amendment of Penn Corporation Comprehensive Security Program, effective January 1, 1987, 1988 or 1989 as applicable (incorporated by reference to Exhibit 10.52 to the 1990 Form 10-K).\n10.71 Eighth Amendment of Penn Corporation Comprehensive Security Program, effective October 18, 1989 (incorporated by reference to Exhibit 10.67 to the Registrant's Annual Report on Form 10-K for the fiscal year 1990 (the \"1990 Form 10-K\")).\n10.71a Ninth Amendment of Penn Corporation Comprehensive Security Program, effective July 1, 1991 (incorporated by reference to Exhibit 10.67 to the Registrant's Annual Report on Form 10-K for the fiscal year 1990 (the \"1990 Form 10-K\")).\n10.71b Tenth Amendment of Penn Corporation Comprehensive Security Program effective April 1, 1993 (incorporated by reference to Exhibit 10.67 to the Registrant's Annual Report on Form 10-K for the fiscal year 1990 (the \"1990 Form 10-K\")).\n10.72 Beach Products (Division of Penn Corporation) Retirement Savings Program, effective May 2, 1989 (incorporated by reference to Exhibit 10.72 to the Registrant's Annual Report on Form 10-K for the fiscal year 1992 (the \"1992 Form 10-K\")).\n10.73 First Amendment of Beach Products (Division of Penn Corporation) Retirement Savings Program, effective October 1, 1990 (incorporated by reference to Exhibit 10.73 to the Registrant's Annual Report on\nForm 10-K for the fiscal year 1992 (the \"1992 Form 10-K\")).\n10.74 Second Amendment of Beach Products (division of Penn Corporation) Retirement Savings Program, effective October 17, 1991 (incorporated by reference to Exhibit 10.74 to the Registrant's Annual Report on Form 10-K for the fiscal year 1993 (the \"1993 Form 10-K\")).\n10.74a Third Amendment of Beach Products (division of Penn Corporation) Retirement Savings Program, effective July 1, 1991 (incorporated by reference to Exhibit 10.73 to the Registrant's Annual Report on Form 10-K for the fiscal year 1993 (the \"1993 Form 10-K\")).\n10.74b Fourth Amendment of Beach Products (division of Penn Corporation) Retirement Savings Program, effective April 1, 1993 (incorporated by reference to Exhibit 10.73 to the Registrant's Annual Report on Form 10-K for the fiscal year 1993 (the \"1993 Form 10-K\")).\n10.75 Master Trust Agreement between the Registrant, Western Publishing Company, Inc., Penn Corporation and Bankers Trust Company, effective November 19, 1987 (incorporated by reference to Exhibit 10.38 to the 1988 Form 10-K).\n10.76 Form of Agreement between the Registrant, Penn Corporation and certain employees of Penn Corporation relating to the award of shares of common stock of the Registrant, as adopted by the Board of Directors of the Registrant on May 1, 1987 (incorporated by reference to Exhibit 10.39 to the 1988 Form 10-K).\n10.77 Amended and Restated 1986 Employee Stock Option Plan of the Registrant (incorporated by reference to Exhibit 10.40 to the 1988 Form 10-K).\n10.78 Amendment dated April 11, 1989 to the Amended and Restated 1986 Employee Stock Option Plan of the Registrant (incorporated by reference to Exhibit 10.56 to the 1990 Form 10-K).\n10.79 Employment Agreement dated the 24th day of April, 1990 between Western Publishing Group, Inc. and Frank P. DiPrima (incorporated by reference to Exhibit 10.72 to the Registrant's Annual Report on Form 10-K for the fiscal year 1991 (the \"1991 Form 10-K\")).\n10.80 Western Publishing Company, Inc.'s Executive Medical Reimbursement Plan dated January 1, 1991 (incorporated by reference to Exhibit 10.73 to the Registrant's Annual Report on Form 10-K for the fiscal year 1991 (the \"1991 Form 10-K\")).\n10.88 Credit Agreement dated as of November 12, 1992, providing up to $200 million, among the Registrant, Western Publishing Group, Inc. and a group of commercial banks (incorporated by reference to Exhibit 10.88 to the Form 10-Q for the quarter ended October 31, 1992).\n10.89 Amendment No. 1 dated as of July 31, 1993, to the Credit Agreement dated as of November 12, 1992 10.90 Amendment No. 2 dated as of October 30, 1993, to the Credit Agreement dated as of November 12, 1992.\n10.91 Guarantee Agreement dated as of December 13, 1993, to the Credit Agreement dated as of November 12, 1992.\n10.92 Amendment No. 3 dated as of May 13, 1994 to the Credit Agreement dated as of November 12, 1992.\n21.1 List of Subsidiaries.\n23.1 Consent dated May 13, 1994 of Deloitte & Touche, Independent Auditors.\n99.1 Financial Statements for the Golden Comprehensive Security Program.\n99.2 Financial Statements for the Golden Retirement Savings Program.\n99.3 Financial Statements for the Penn Corporation Comprehensive Security Program.\n99.4 Undertaking incorporated by reference into Part II of certain registration statements on Form S-8 of the Registrant.\nb) Reports on Form 8-K. None.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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: May 16, 1994\nWestern Publishing Group, Inc.\nBy: \/s\/ Richard A. Bernstein -------------------------- Richard A. Bernstein, Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been executed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.\nSignature Title Date - - --------- ----- ----\n\/s\/ Richard A. Bernstein Chairman, Chief Executive May 16, 1994 - - ------------------------------ Officer and Director Richard A. Bernstein (Principal Executive Officer)\n\/s\/ Stuart Turner Executive Vice President, May 16, 1994 - - ------------------------------ Treasurer and Chief Financial Stuart Turner Officer (Principal Financial and Accounting Officer) \/s\/ Frank P. DiPrima President, Chief Operating May 16, 1994 - - ------------------------------ Officer and Director Frank P. DiPrima\n\/s\/ Allan S. Gordon Director May 16, 1994 - - ------------------------------ Allan S. Gordon\n\/s\/ Robert A. Bernhard Director May 16, 1994 - - ------------------------------ Robert A. Bernhard\n\/s\/ Samuel B. Fortenbaugh, III Director May 16, 1994 - - ------------------------------ Samuel B. Fortenbaugh, III\n\/s\/ Michael A. Pietrangelo Director May 16, 1994 - - ------------------------------ Michael A. Pietrangelo\n\/s\/ Jenny Morgenthau Director May 16, 1994 - - ------------------------------ Jenny Morgenthau\nWESTERN PUBLISHING GROUP, INC AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nFinancial Statements PAGE - - -------------------- ----\nIndependent Auditors' Report Consolidated Balance Sheets as of January 29, 1994 and January 30, 1993. Consolidated Statements of Operations for the Years ended January 29, 1994, January 30, 1993 and February 1, 1992. Consolidated Statements of Common Stockholders' Equity for the Years Ended January 29, 1994, January 30, 1993 and February 1, 1992. Consolidated Statements of Cash Flows for the Years Ended January 29, 1994, January 30, 1993 and February 1, 1992.\nNotes to Consolidated Financial Statements.\nSchedules\nVIII -- Valuation and Qualifying Accounts S-1 IX -- Short-Term Borrowings S-2 X -- Supplementary Income Statement Information S-3\nSchedules which are not included have been omitted because either they are not required or are not applicable or because the required information has been included elsewhere in the consolidated financial statements or notes thereto. INDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Western Publishing Group, Inc.:\nWe have audited the accompanying consolidated balance sheets of Western Publishing Group, Inc. and subsidiaries as of January 29, 1994 and January 30, 1993, and the related consolidated statements of operations, common stockholders' equity and cash flows for each of the three years in the period ended January 29, 1994. Our audits also included the financial statement schedules listed in the Index at Item 14. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on 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 companies at January 29, 1994 and January 30, 1993, and the results of their operations and their cash flows for each of the three years in the period ended January 29, 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 13 to the consolidated financial statements, in fiscal 1994 the companies changed their method of accounting for postretirement benefits other than pensions to conform with Statement of Financial Accounting Standards No. 106.\nDELOITTE & TOUCHE Milwaukee, Wisconsin May 13, 1994\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS JANUARY 29, 1994 AND JANUARY 30, 1993 (In Thousands Except for Share and Per Share Data)\nSee notes to consolidated financial statements.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS THREE YEARS ENDED JANUARY 29, 1994 (In Thousands Except for Per Share Data)\nSee notes to consolidated financial statements.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY THREE YEARS ENDED JANUARY 29, 1994 (In Thousands Except for Share and Per Share Data)\nSee notes to consolidated financial statements.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS THREE YEARS ENDED JANUARY 29, 1994 (In Thousands)\nSee notes to consolidated financial statements.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS THREE YEARS ENDED JANUARY 29, 1994 (In Thousands)\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED JANUARY 29, 1994\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation - The consolidated financial statements include the accounts of Western Publishing Group, Inc., and its wholly-owned subsidiaries (the \"Company\"). Certain reclassifications have been made in the prior year financial statements to conform with the current year presentation.\nAll significant intercompany transactions and balances are eliminated in consolidation.\nFiscal Year - The fiscal year of the Company ends on the Saturday nearest January 31. Accordingly, fiscal 1994, 1993, and 1992 each contained 52 weeks.\nCash and Cash Equivalents - The Company considers all highly liquid debt instruments purchased with maturities of three months or less to be cash equivalents. The carrying amounts of short-term financial instruments approximate fair value.\nInventories - Inventories are valued at the lower of cost or market. Cost is determined by the last-in, first-out (LIFO) method for substantially all domestic inventories. Inventories of Western Publishing Company, Inc.'s international operations are valued using the first-in, first-out (FIFO) method. At January 29, 1994 and January 30, 1993, approximately 93% and 95% of total inventories were valued under the LIFO method.\nPrepublication and Prepaid Advertising Costs - Prepublication costs (comprised principally of externally developed art, manuscript and\neditorial costs and internally or externally developed plate costs) and advertising and premium costs associated with the Company's direct marketing operation are deferred. Such costs are amortized from the date of initial product sale, generally over a period of one year. At January 29, 1994, the direct marketing advertising and premium costs were included as a component of Net Assets Held for Sale.\nProperties and Depreciation - Property, plant and equipment are stated at cost and depreciated on the straight-line method over the following estimated useful lives for financial statement purposes:\nBuildings and improvements 10-40 years Machinery and equipment 3-10 years\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nExpenditures which significantly increase value or extend useful lives are capitalized, while maintenance and repairs are expensed as incurred. The cost and related accumulated depreciation of assets replaced, retired or disposed of are eliminated from the property accounts, and any gain or loss is reflected in operations.\nCosts related to the development of information systems that are expected to benefit future periods are capitalized and amortized over the estimated useful lives of the systems.\nIdentified Intangibles - Identified intangibles arising from the acquisition of Penn Corporation in fiscal 1987 are being amortized generally by accelerated methods over periods of from 10 to 26 years.\nCost in Excess of Net Assets Acquired - The cost in excess of net assets acquired (goodwill) arising from the acquisition of Penn Corporation is being amortized on the straight-line method over a 40-year period.\nForeign Currency Translation - Foreign currency assets and liabilities are translated into United States dollars at end of period rates of exchange, and income and expense accounts are translated at the weighted average rates of exchange for the period. Resulting translation adjustments are included as a separate component of common stockholders' equity.\n2. SALE AND PHASE OUT OF OPERATIONS; PROVISION FOR WRITE-DOWN OF DIVISION; NET ASSETS HELD FOR SALE\nSale and Phase Out of Operations\nOn November 29, 1993, the Company announced that it had recently been approached by several companies expressing a desire to discuss a business combination. The Board of Directors of the Company authorized the retention of two investment banking firms as its advisors to explore alternatives to maximize shareholder value. Based on an analysis of various alternatives, the Company adopted a plan designed to improve its competitive position and reduce its cost structure through the sale or\nphase out of certain operations, property divestitures and consolidations, and a workforce reduction.\nThe plan includes the following major components:\no An agreement in principle to sell the game and puzzle operation (including certain inventories) to Hasbro, Inc. (Hasbro) for approximately $103,000,000. This transaction is subject to customary conditions and is expected to be completed in the second quarter of fiscal 1995.\no The decision to exit the direct marketing continuity clubs and school book club businesses. It is anticipated that this will be completed by the end of fiscal 1995.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\no The closedown and sale of the Company's Fayetteville, North Carolina manufacturing and distribution facility, which is primarily dedicated to the game and puzzle operation but will not be included in the sale to Hasbro.\no The decision to streamline the Company's publishing business so as to focus on its core competencies. This will include a reduction in the management, administrative and direct labor workforces.\nThe Company will use the net cash proceeds arising from the plan to repay outstanding debt under its Revolving Credit Agreement (see Note 6). It is anticipated that the plan, which will begin to be implemented in the first quarter of fiscal 1995, will result in a net gain, inclusive of operating losses of the game, puzzle, direct marketing and school book club operations from January 30, 1994 through the expected disposition dates. Accordingly, the anticipated gain will not be reflected in the consolidated statement of operations until realized.\nThe net assets of the game, puzzle, direct marketing and school book club operations and the Fayetteville facility are included as a component of Net Assets Held for Sale at January 29, 1994. For fiscal 1994, 1993 and 1992 the game, puzzle, direct marketing and school book club operations had revenues of approximately $125,000,000, $142,000,000, and $123,000,000, respectively.\nProvision for Write-Down of Division\nOn May 12, 1993, the Board of Directors of the Company directed management to review the operations of the Advertising Specialty Division of the Company's Penn Corporation subsidiary and evaluate various strategic alternatives, including its disposition. Accordingly, the Company established a provision, including operating losses through the expected disposition date, to write-down the assets of the Division to net realizable value.\nOn April 29, 1994, the Company entered into a letter of intent to sell this Division for approximately $14,000,000, subject to customary conditions. It is anticipated that this transaction, which is expected to be completed in the second quarter of fiscal 1995, will result in a net gain. The net cash proceeds from the sale of this Division will be utilized to repay outstanding debt under the Revolving Credit Agreement (see Note 6).\nRevenues and losses before interest expense and income taxes of the Division, included in the accompanying statements of operations, exclusive of the provision for write-down, are as follows (subsequent to May 1, 1993, the statements of operations do not include the results of the Division):\n1994 1993 1992 (In Thousands) Revenues $7,202 $35,037 $33,367 ------ ------- ------- ------ ------- ------- Loss before interest expense and income taxes, exclusive of the provision for write-down $2,083 $ 4,635 $ 6,638 ------ ------- ------- ------ ------- -------\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNet Assets Held for Sale\nAs of January 29, 1994, net assets held for sale consisted of the following:\n(In thousands) Current assets $ 60,020 Property, plant and equipment, net 32,655 Other assets (primarily identified intangibles and goodwill), net 27,933 -------- 120,608 Less: Current liabilities (5,680) Provision for write-down, net of Division operations subsequent to May 1, 1993 (26,405) -------- Net assets held for sale $ 88,523 -------- --------\n3. ACCOUNTS RECEIVABLE\nAccounts receivable consisted of the following:\n1994 1993 (In thousands) Accounts receivable $154,090 $160,178 Allowance for doubtful accounts (4,491) (6,929)\nAllowance for returns (11,678) (8,243) -------- -------- $137,921 $145,006 -------- -------- -------- --------\n4. INVENTORIES\nInventories consisted of the following: 1994 1993 (In thousands) Raw materials $ 14,913 $ 25,205 Work-in-process 28,783 36,050 Finished goods 77,482 116,375 -------- -------- $121,178 $177,630 -------- -------- -------- --------\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAt January 29, 1994 and January 30, 1993, the replacement cost of inventories valued using the LIFO method exceeded the net carrying amount of such inventories by $8,840,000 and $6,930,000, respectively.\n5. IDENTIFIED INTANGIBLES AND GOODWILL\nIdentified intangibles and goodwill, all of which result from the acquisition of Penn Corporation in fiscal 1987, net of amortization, included in the accompanying consolidated balance sheets, were as follows (see Note 2):\n1994 1993 (In thousands) Goodwill $ 6,114 $16,229 Identified intangibles: Customer lists 6,730 8,707 Other 736 2,854 Distributor network 15,019 ------- ------- $13,580 $42,809 ------- ------- ------- -------\nIn connection with the provision for write-down of the Advertising Specialty Division, the portion of identified intangibles and goodwill related to this Division ($24,341,000, net of amortization at January 29, 1994) has been included as a component of Net Assets Held for Sale (see Note 2).\n6. LONG-TERM DEBT\nLong-term debt consisted of the following:\n1994 1993 (In thousands) Notes payable to banks $ 80,000 $ 30,000 7.65% Senior Notes ($150,000,000 face amount) due in 2002 149,812 149,797 -------- -------- $229,812 $179,797 -------- -------- -------- --------\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company maintains a Revolving Credit Agreement dated November 12, 1992, with a group of commercial banks, which expires on May 31, 1995. Under the terms of an agreement to amend the Revolving Credit Agreement, the Company may borrow up to $125,000,000 through July 31, 1994 and $140,000,000 thereafter; in each case, including letters of credit of $10,000,000. Concurrent with the completion of the sale of the game and puzzle operation (the \"Sale\") (see Note 2), the Revolving Credit Agreement facility will be $90,000,000, including letters of credit of $10,000,000. Additionally, the provision that borrowings not exceed $115,000,000 during any thirty day period in the first quarter of each fiscal year will be $15,000,000 after the Sale. Further reductions in the facility will occur based upon the net cash proceeds from other asset sales, including the sale of the Advertising Specialty Division of the Company's Penn Corporation subsidiary (see Note 2). Borrowings will bear interest at one percent above the Base Rate. A commitment fee of 1\/2% is payable quarterly on the unused portion of the facility. On January 29, 1994, notes totalling $80,000,000 at a weighted average interest rate of 4.16% were outstanding.\nOn September 17, 1992, the Company completed an offering of $150,000,000 of 7.65% Senior Notes due September 15, 2002. Interest is payable semiannually on March 15 and September 15. There is no obligation to redeem, purchase or repay the Senior Notes prior to maturity.\nThe Revolving Credit Agreement and the Indenture covering the Senior Notes contain certain provisions limiting additional indebtedness, guarantees, liens, the payment of cash dividends on Common Stock and tangible net worth requirements. Additionally, the Revolving Credit Agreement contains certain ratio requirements and limitations on investments. At January 29, 1994, there were no retained earnings available to pay dividends on Common Stock.\nUnder the Company's Revolving Credit Agreement, the commitment may be utilized for letters of credit for the Company or any of its subsidiaries. At January 29, 1994, the Company's subsidiaries had letters of credit outstanding for inventory purchase commitments of approximately $3,600,000 under the line.\nNotes payable to banks at January 29, 1994 and January 30, 1993 under the Company's Revolving Credit Agreement approximate fair value, as the\nshort-term interest rates on the then outstanding balances were reset in December 1993 and 1992, respectively. Western Publishing Group, Inc.'s 7.65% Senior Notes had a fair value of approximately $142,000,000 at January 29, 1994 based on market interest rates. At January 30, 1993, the fair value of the Senior Notes approximated carrying value.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. OTHER CURRENT LIABILITIES\nOther current liabilities consisted of the following:\n1994 1993 (In thousands) Royalties payable $ 4,757 $ 6,445 Advertising and promotion 8,507 7,894 Other 14,078 16,218 ------- ------- $27,342 $30,557 ------- ------- ------- -------\n8. PREFERRED STOCK\nThe Company has 100,000 authorized preferred shares, no par value, including 20,000 shares of Convertible Preferred Stock, Series A. The Convertible Preferred Stock has a dividend rate of 8.5% per annum. The conversion price is $24 per share. The stock is redeemable at the option of the Company at any time for $500 a share plus all dividends (whether or not earned or declared) accrued and unpaid to the date fixed for redemption. Western Publishing Group, Inc. is obligated to redeem the stock no later than March 31, 1996. There is no significant difference between the carrying amount and approximate fair value of the Convertible Preferred Stock.\n9. EMPLOYEE STOCK OPTIONS\nIn March 1986, the Company adopted a stock option plan, which as amended, provides for the granting of options to purchase up to 2,100,000 shares of Common Stock through 1996 to employees of the Company and its subsidiaries. Options granted through February 3, 1990 become exercisable two years after the date of grant (50%) and three years after the date of grant (50%). Generally, options granted subsequent to February 3, 1990, except as noted below, become exercisable in their entirety five years after the date of grant.\nThe following table includes options to purchase 300,000 shares of Common Stock granted in 1991 to the Company's President. In accordance with his employment agreement, these options vest over a seven year period, expire in 2001 and are priced as follows: 60,000 each at $11.75, $10.00 and $15.00 and 120,000 at $12.50 per share.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAdditionally, the President of Western Publishing Company, Inc. has options to purchase 90,000 shares of Common Stock; of which 20,000 were granted in fiscal 1993 and 70,000 were granted in fiscal 1994 pursuant to his employment agreement. Such options vested immediately upon issuance and expire in 2002 and 2003, respectively.\nThe following data is presented in connection with the stock option plan:\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nOptions outstanding at January 29, 1994 expire as follows:\nExpiration Exercise Number of Date Price Options\nApril 21, 1996 $20.00 36,000 April 21, 1997 12.00 27,200 April 22, 1998 14.50 27,000 March 1, 1999 16.75 60,550 February 2, 2001 11.75 179,500 February 2, 2001 10.00 60,000 February 2, 2001 15.00 60,000 February 2, 2001 12.50 120,000 September 16, 2001 10.00 130,000 January 3, 2002 15.00 30,000 June 30, 2002 15.50 186,000 October 26, 2002 17.25 12,500 November 30, 2003 12.50 70,000 ------- 998,750 ------- -------\nIn addition to the shares reserved for the exercise of stock options, the Company has reserved 416,042 shares of Common Stock for the conversion of its Preferred Stock (see Note 8).\n10. LEASE COMMITMENTS\nThe Company leases certain facilities, machinery and vehicles under various noncancelable operating lease agreements over periods of one to 10 years. Future minimum lease payments required under such leases in effect at January 29, 1994, were as follows (by fiscal year):\n(In thousands) 1995 $ 5,638 1996 4,452 1997 3,959 1998 3,112 1999 2,712 2000 through 2007 7,917 ------- $27,790 ------- -------\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nTotal rental expense charged to operations was $8,330,000, $7,732,000 and $5,695,000 for the years ended January 29, 1994, January 30, 1993 and February 1, 1992, respectively.\n11. ROYALTIES AND OTHER INCOME\nRoyalties and other income consisted of the following:\n1994 1993 1992 (In thousands) Royalties $2,043 $1,771 $1,004 Interest income 807 836 1,019 Other 361 455 118 ------ ------ ------ $3,211 $3,062 $2,141 ------ ------ ------ ------ ------ ------\n12. INCOME TAXES\nIncome tax expense (benefit) (calculated in accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\") consisted of the following:\n1994 1993 1992 (In thousands) Currently (refundable) payable: Federal $(11,185) $ 7,700 $6,320 State (240) 2,240 2,030 Foreign (30) 710 900 -------- ------- ------ (11,455) 10,650 9,250 Deferred: -------- ------- ------ Federal (9,520) 230 (390) State (1,300) 80 (250) Foreign (20) (100) (30) -------- ------- ------ (10,840) 210 (670) -------- ------- ------ $(22,295) $10,860 $8,580 -------- ------- ------ -------- ------- ------\nIncome (loss) before income tax expense of Western Publishing Company, Inc.'s Canadian subsidiary was $(82,000), $1,122,000 and $1,963,000 for the years ended January 29, 1994, January 30, 1993 and February 1, 1992, respectively.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nA reconciliation of the statutory United States Federal income tax rate\nto the Company's effective income tax rate follows:\n1994 1993 1992\nStatutory rate 35.0% 34.0% 34.0% State income taxes, net of Federal benefit 1.6 5.5 5.3 Effect of foreign taxes (1.7) Effect of capital loss on write-down of division (1.8) Other - net .4 .5 (.8) ---- ---- ---- 35.2% 38.3% 38.5% ---- ---- ---- ---- ---- ----\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe income tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at January 29, 1994 and January 30, 1993 were as follows:\nJanuary 29, 1994 ----------------------------- Assets Liabilities Total (In thousands) Allowances for doubtful accounts and returns not currently deductible $ 5,222 $ 5,222 Inventories: Excess of book basis over tax basis due to purchase accounting $ (6,121) (6,121) Other 8,580 8,580 Advertising costs (1,259) (1,259) Accrued expenses not currently deductible 5,800 5,800 Provision for write-down of division 8,197 8,197 Other - net 404 404 ------- -------- ------- Current 28,203 (7,380) 20,823 ------- -------- ------- Property, plant and equipment: Excess of tax basis over acquisition accounting basis 3,934 3,934 Excess of tax over book depreciation (8,294) (8,294) Identified intangibles (4,486) (4,486) Deferred gain on sale of plant (693) (693) Deductible pension contributions in excess of pension expense (1,760) (1,760) Postretirement benefits 10,379 10,379 State NOL carryforwards 1,185 1,185 Other - net 1,174 1,174 ------- -------- ------- Noncurrent 16,672 (15,233) 1,439 ------- -------- ------- Total $44,875 $(22,613) $22,262 ------- -------- -------\n------- -------- -------\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nJanuary 30, 1993 ------------------------------- Assets Liabilities Total (In thousands) Allowances for doubtful accounts and returns not currently deductible $ 5,043 $ 5,043 Inventories: Excess of book basis over tax basis due to purchase accounting $ (5,969) (5,969) Other 9,632 9,632 Advertising costs (1,956) (1,956) Accrued expenses not currently deductible 4,402 4,402 Other - net 210 210 ------- --------- ------- Current 19,287 (7,925) 11,362 ------- --------- ------- Property, plant and equipment: Excess of tax basis over acquisition accounting basis 4,055 4,055 Excess of tax over book depreciation (6,949) (6,949) Identified intangibles (5,104) (5,104) Deferred gain on sale of plant (809) (809) Deductible pension contributions in excess of pension expense (1,703) (1,703) Other - net 1,070 1,070 ------- --------- ------- Noncurrent 5,125 (14,565) (9,440) ------- --------- ------- Total $24,412 $(22,490) $ 1,922 ------- --------- ------- ------- --------- -------\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n13. PENSION, POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS\nPension Benefits\nWestern Publishing Company, Inc. and its Canadian subsidiary have noncontributory defined benefit retirement plans covering substantially all domestic hourly and Canadian salaried and hourly employees. The benefits are generally based on a unit amount at the date of termination multiplied by the participant's credited service. The Companies' funding policy is to contribute amounts within the limits which can be deducted for income tax purposes.\nThe following tables set forth the plans' funded status and amounts recognized in the consolidated financial statements at January 29, 1994\nand January 30, 1993, and for each of the three years ended January 29, 1994:\n1994 1993 (In thousands) Actuarial present value of benefit obligations: Accumulated benefit obligations, including vested benefits of $14,177,000 and $13,480,000 $14,458 $13,682 ------- ------- ------- ------- Projected benefit obligations for service rendered $15,026 $14,248 Plan assets at fair value (primarily U.S. government securities, corporate bonds and equity mutual funds) 17,314 18,199 ------- ------- Projected benefit obligations less than plan assets 2,288 3,951 Unrecognized net loss (gain) 10 (233) Unrecognized prior service cost 2,516 1,261 Unamortized portion of unrecognized net (asset) at January 31, 1987 (414) (613) ------- ------- Prepaid pension costs recognized in accompanying balance sheets $ 4,400 $ 4,366 ------- ------- ------- -------\n1994 1993 1992 (In thousands) Net pension expense (income), included the following components: Service cost - benefits earned during the period $ 573 $ 530 $ 445 Interest cost on projected benefit obligations 1,104 1,078 1,017 Actual return on plan assets (1,836) (1,814) (3,428) Net amortization and deferral 211 33 2,012 ------- ------- ------- Net pension expense (income) for the year $ 52 $ (173) $ 46 ------- ------- ------- ------- ------- -------\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligations was 7.5% in 1994 and 1993. The expected long-term rate of return on assets was 10.0%.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPension expense charged to operations for these plans and for other multi-employer plans in which certain union employees of the Company's subsidiaries participate was $598,000, $314,000 and $565,000 for the years ended January 29, 1994, January 30, 1993 and February 1, 1992, respectively.\nSubsidiaries of the Company also maintain defined contribution contributory retirement plans for substantially all domestic employee groups. Under the plans, the companies make contributions based on\nemployee compensation and in certain cases based on specified levels of voluntary employee contributions. Western Publishing Company, Inc.'s Canadian subsidiary also maintains a profit sharing plan for certain salaried employees. Expense for these plans was $4,157,000, $3,819,000 and $3,484,000 for the years ended January 29, 1994, January 30, 1993 and February 1, 1992, respectively.\nPostretirement Benefits\nWestern Publishing Company, Inc. provides certain health care and life insurance benefits for substantially all of its retired employees. Effective January 31, 1993, the Company adopted Statement of Financial Accounting Standards (FASB) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" FASB No. 106 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. FASB No. 106 allows recognition of the cumulative effect of the liability in the year of adoption or the amortization of the obligation over a period of up to twenty years. The Company elected to recognize the cumulative effect of this obligation on the immediate recognition basis. As of January 31, 1993, the Company recognized the accumulated liability for such benefits (transition obligation). The cumulative effect of this change in accounting principle reduced net earnings by $24,300,000 ($14,800,000, net of income taxes).\nFor the year ended January 29, 1994, the incremental effect of adopting FASB No. 106 was to increase the loss before cumulative effect of change in accounting principle by approximately $990,000 ($.05 per share).\nThe Company's postretirement health care plans are not currently funded. The status of the plans is as follows:\nThe accrued postretirement benefits (actuarial present value of accumulated postretirement benefit obligation) at January 1, 1994 consisted of:\n(In thousands) Retirees currently receiving benefits $12,549 Current employees eligible to receive benefits 6,600 Current employees not yet eligible to receive benefits 8,500 Unrecognized net loss from past experience (1,700) ------- $25,949 ------- -------\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe net postretirement benefit cost for the year ended January 29, 1994 consisted of the following components:\n(In thousands) Service cost - benefits earned during the year $ 700 Interest cost on accumulated postretirement benefit obligation 1,900 Recognition of transition obligation 24,300 ------- $26,900 -------\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation as of January 1, 1994 was 8% for 1994 decreasing linearly to 5% in 2010; and remaining level thereafter.\nIf the health care cost trend rate were increased one percentage point in each year, the accumulated postretirement benefit obligation as of January 1, 1994 and the net postretirement cost would have increased by approximately 15% and 19%, respectively. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.5%.\nPrior to Fiscal 1994, the Company recognized postretirement health care and life insurance benefits as an expense as claims were paid. On that basis, the costs of such benefits were $926,000 and $1,175,000 for the years ended January 30, 1993 and February 1, 1992, respectively.\nPostemployment Benefits\nDuring November 1992, the FASB issued Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (FASB No. 112), which requires the cost of such benefits be accrued over the employee service period. The Company has reviewed its policies and practices to determine the applicability of FASB No. 112 and believes the adoption of FASB No. 112 in Fiscal 1995 will not have a material effect on its financial statements.\n14. INDUSTRY SEGMENT INFORMATION\nThe Company has two industry segments, Consumer Products and Commercial Products.\nThe Company is engaged in the creation, publication, printing and marketing of story and picture books, interactive electronic books, coloring books, activity books, books and games that feature special effects and prerecorded audio and video products for juveniles, as well as puzzles, games and special interest books for the entire family (see Note 2). The Company is also engaged in the manufacture and sale of decorated paper tableware, party goods, stationery and gift products. The Company's foreign operations within the Consumer Products Segment consist of a marketing subsidiary in Canada and a marketing branch in the United Kingdom.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company's Commercial Products Segment provides printing and creative publishing services and is engaged in the manufacture of advertising specialties including imprinted writing instruments, wearables and simulated leather items, such as wallets, folders and other promotional business products (see Note 2).\nOperating profit represents income before income taxes, interest expense and general corporate income and expense. Identifiable assets are those assets used specifically in the operations of each industry segment or which are allocated when used jointly. Corporate assets are principally comprised of cash and cash equivalents, deferred income taxes, prepaid pension costs and certain other assets. Domestic sales to foreign markets were less than 10% of total consolidated sales for the years ended January 29, 1994, January 30, 1993 and February 1, 1992.\nInformation by industry segment is set forth below:\n1994 1993 1992 (In thousands) Net sales: Consumer Products $535,603 $543,154 $438,706 Commercial Products 77,861 105,935 113,654 -------- -------- -------- $613,464 $649,089 $552,360 -------- -------- -------- -------- -------- -------- Operating profit (loss): Consumer Products $ 192 $ 53,625 $ 45,161 Commercial Products (2,558) (3,609) (3,694) -------- -------- -------- (2,366) 50,016 41,467\nOther income 1,168 1,291 1,137 General corporate expense (17,672) (12,591) (14,075) Provision for write-down of division (28,180) Interest expense (16,270) (10,358) (6,255) -------- -------- -------- (Loss) income before income taxes and cumulative effect of change in accounting principle $(63,320) $ 28,358 $ 22,274 -------- -------- -------- -------- -------- --------\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nConsumer Commercial Products Products Corporate Total (In thousands) Identifiable assets: 1994 $401,817 $38,731 $64,568 $505,116 1993 396,277 74,197 38,111 508,585 1992 281,745 72,729 36,491 390,965\nDepreciation and amortization: 1994 11,155 5,153 688 16,996 1993 7,851 5,059 394 13,304 1992 7,022 5,813 503 13,338\nCapital expenditures: 1994 33,524 2,443 1,392 37,359 1993 19,374 3,446 884 23,704 1992 6,978 4,241 641 11,860\nOther Information\nDuring Fiscal 1994, sales to the Company's two largest customers, Toys R Us, Inc., and Wal-Mart Stores, Inc., amounted to approximately 12% and 10% of consolidated net sales, respectively.\n15. NET (LOSS) INCOME PER COMMON SHARE\nNet (loss) income per common share was computed as follows:\n1994 1993 1992 (In thousands except for per share data) Net (loss) income $(55,825) $17,498 $13,694 Preferred dividend requirements (848) (848) (848) -------- ------- ------- (Loss) income applicable to Common Stock $(56,673) $16,650 $12,846 -------- ------- ------- -------- ------- ------- Weighted average common shares outstanding 20,956 20,899 20,864 -------- ------- ------- -------- ------- ------- Net (loss) income per common share $ (2.70) $ .80 $ .62 -------- ------- ------- -------- ------- -------\n* * * * * *\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED JANUARY 29, 1994 (IN THOUSANDS)\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM BORROWINGS THREE YEARS ENDED JANUARY 29, 1994 (IN THOUSANDS)\nCategory of Aggregate Short-Term Borrowings 1994 1993 1992\nNotes payable to banks: Balance at end of period $ -0- $ -0- $ 79,000\nWeighted average interest rate - - 5.4%\nMaximum amount outstanding during the period -0- $198,000 $128,400\nAverage amount outstanding during the period (a) $ -0- $ 94,895 $ 92,482\nWeighted average interest rate during the period (b) - 5.0% 6.6%\n(a) Average amount outstanding during the period computed by dividing the total of daily outstanding principal balances by number of days in the fiscal year.\n(b) Weighted average interest rate for the fiscal year computed by dividing the actual short-term interest expense by the average short-term borrowings outstanding.\nWESTERN PUBLISHING GROUP, INC. AND SUBSIDIARIES\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION THREE YEARS ENDED JANUARY 29, 1994 (IN THOUSANDS)\n1994 1993 1992\nMaintenance and repairs $ 9,257 $10,099 $ 9,484 Royalties 40,826 41,988 36,671 Advertising costs 31,035 35,114 28,397 Depreciation 11,442 8,506 8,128 Amortization of intangible assets 2,861 4,798 5,210\nAmounts for taxes, other than payroll and income taxes, are not presented as such amounts are less than 1% of net sales.","section_15":""}
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{"filename":"3146_1994.txt","cik":"3146","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nEnergen is a diversified energy holding company engaged primarily in the distribution, exploration, and production of natural gas.\nEnergen was incorporated in Alabama in 1978 in connection with the reorganization of its largest subsidiary, Alagasco. Alagasco was formed in 1948 by the merger of Alabama Gas Company into Birmingham Gas Company, the predecessors of which had been in existence since the late 1800's. Alagasco became a public company in 1953.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe information required by this item is incorporated by reference from Note 13 to the Consolidated Financial Statements of the 1994 Annual Report to Stockholders, and is attached herein as Part 1V, Item 14, Exhibit 13.\nNARRATIVE DESCRIPTION OF BUSINESS\n- - NATURAL GAS DISTRIBUTION\nGENERAL: Alagasco, Energen's principal subsidiary, is the largest natural gas distribution utility in the State of Alabama. Alagasco purchases natural gas through interstate and intrastate suppliers and distributes the purchased gas through its distribution facilities for sale to residential, commercial, industrial and other end-users of natural gas. Alagasco also provides transportation services to industrial and commercial customers located on its distribution system. These transportation customers, acting on their own or using Alagasco as their agent, purchase gas directly from producers or other suppliers and arrange for delivery of the gas into the Alagasco distribution system. Alagasco then charges a fee to transport this customer-owned gas through its distribution system to the customer's facility.\nAlagasco's service territory is located primarily in central and north Alabama and includes over 175 communities in 30 counties. Birmingham, the largest city in Alabama, and Montgomery, the state capital, are served by Alagasco. The counties in which Alagasco provides service have an aggregate area of more than 22,000 square miles and include the service territories of various municipal gas distribution systems.\nThe aggregate population of the counties served by Alagasco is estimated to be 2.4 million. During 1994 Alagasco served an average of 402,531 residential customers, 32,563 small commercial and industrial customers, and 43 large commercial and industrial customers. The Alagasco distribution system includes approximately 8,500 miles of main, more than 9,300 miles of service lines, odorization and regulation facilities, and customer meters. Alagasco also operates two liquefied natural gas facilities which it uses to meet peak demands.\nAPSC REGULATION: As a public utility in the state of Alabama, Alagasco is subject to regulation by the Alabama Public Service Commission (APSC), which has adopted several innovative approaches to rate regulation, including Alabama's Rate Stabilization and Equalization (RSE) rate-setting process. Implemented in 1983 and modified in 1985, 1987, and 1990, RSE replaces the traditional utility rate case\nwith APSC-monitored periodic rate adjustments presently designed to give Alagasco the opportunity to earn an average return on equity (ROE) at its fiscal year-end within a specified range. Under Alagasco's current RSE order, which became effective December 1990, Alagasco's allowed ROE range is 13.15 percent to 13.65 percent. The APSC conducts quarterly reviews to determine, based on Alagasco's budget and fiscal year-to-date performance, whether Alagasco's projected ROE for the fiscal year will be within the allowed range. Reductions in rates can be made quarterly to bring the projected ROE within the allowed range. Increases, however, are permitted only once each fiscal year effective on December 1, and cannot exceed 4 percent of prior-year revenues.\nRSE limits Alagasco's equity upon which a return is permitted to 60 percent of total capitalization and provides for a cost control measure designed to monitor Alagasco's operations and maintenance (O & M) expense. If increases in O & M expense per customer fall within 1.25 percent above or below the Consumer Price Index for all Urban Customers (index range), no adjustment is required. If, however, increases in O & M expense per customer exceed the index range, three-fourths of the difference is returned to customers. To the extent increases in O & M expense per customer are less than the index range, Alagasco will benefit by one-half of the difference through future rate adjustments.\nUnder its terms, Alagasco's current RSE order continues until, after notice to Alagasco, the APSC votes to either modify or discontinue its operation. On October 4, 1993, the APSC unanimously voted to defer review of the current RSE order until such time as certain hearings mandated by the Energy Policy Act of 1992 (Energy Act) in connection with integrated resource planning and demand side management programs are completed. The Energy Act proceedings are expected to conclude during 1995 at which time it is expected that the Commission will begin reviewing Alagasco's RSE. No time table for review has yet been established.\nFERC REGULATION: Alagasco's interstate pipeline suppliers, Southern Natural Gas Company (Southern) and Transcontinental Gas Pipeline Corporation (Transco), are subject to regulation by the Federal Energy Regulatory Commission (FERC). Among other things, FERC regulates the character of services that Southern and Transco can offer and the rates and fees they can charge Alagasco and other customers for gas sales and transportation; thus, FERC can directly affect Alagasco's services and operating expenses.\nEffective November 1, 1993, Southern substantially restructured its services pursuant to FERC Order 636 which required interstate pipelines to eliminate their role as a merchant of a \"bundled\" sales service; Transco unbundled its services prior to fiscal 1994. In place of the sales service formerly offered, Southern now provides unbundled contract storage service and various transportation services. As a result of the shift from merchant to transporter, Southern has and will incur transition costs, including the cost of buy-outs or buy-downs of long-term gas supply contracts. These costs, referred to as Gas Supply Realignment, or GSR, costs are recovered primarily by Southern from its firm customers, subject to prudence and eligibility review by FERC, in the form of a surcharge. Alagasco has received approval from the APSC to pass through the GSR surcharge to Alagasco's customers through the Gas Supply Adjustment (GSA) rider to Alagasco's tariff.\nIn addition, Order 636 required pipelines to change the methodology used to classify costs between the demand and commodity components for purposes of cost allocation and rate design from the Modified Fixed Variable (MFV) to the Straight Fixed Variable (SFV) methodology. The SFV method recovers more of the pipeline's fixed costs through the demand component of rates and causes cost shifts from customers with relatively high load factors to customers with relatively low load factors. Order 636 required that pipeline customers which were negatively affected by the use of SFV, such as Alagasco, must be provided mitigation measures to reduce the rate impact of restructuring. In accordance with Southern's restructuring order, Alagasco has been allowed to reduce its capacity demand during the six-month off-peak period in order to limit the rate impact of the SFV cost shift to less than 10 percent.\nAlagasco's GSA filing with the APSC, which became effective November 1, 1993, included all of the cost components for restructuring (GSR costs, mitigation of SFV, lower commodity cost of gas, costs of storage service, etc.). This adjustment to rates resulted in a modest rate reduction.\nAlthough Southern commenced its restructured services on November 1, 1993, there remain proceedings pending before FERC and the courts challenging the Southern restructuring order as well as the Order 636 process generally.\nGAS SUPPLY: The Alagasco distribution system is connected to and has firm transportation contracts with two major interstate pipeline systems--Southern and Transco. Effective November 1, 1993, Alagasco's pre-Order 636 contract demand and firm transportation with Southern converted to 250,924 Mcf (thousand cubic feet) per day of No-Notice Firm Transportation service for a period of 15 years, 91,946 Mcf per day of Firm Transportation service for 15 years, and 50,000 Mcf per day of Firm Transportation for five years. Southern also unbundled its existing storage capacity. Alagasco's pro rata share of this storage is 12,426,687 Mcf. Alagasco has a maximum withdrawal rate from storage of 250,924 Mcf per day and a maximum injection rate into storage of 95,590 Mcf per day. The Transco firm transportation contract, which expires in 2001, provides for maximum daily firm transportation of up to 100,000 Mcf. Thus the Company has a peak day firm interstate pipeline transportation capacity of 492,870 Mcf per day.\nAlagasco has replaced the sales service formerly provided by Southern with purchases from various gas producers and marketers including affiliates of Southern and Transco and from certain intrastate producers including Basin Pipeline Corp., an Energen subsidiary. Alagasco has contracts in place to purchase up to a total of 286,776 Mcf per day of firm supply, of which 271,946 is supported by firm transportation on the Transco and Southern systems, 14,830 Mcf provides redundant supply on the Southern system, and 30,000 Mcf is purchased at the city gate from intrastate suppliers. This volume along with Alagasco's maximum withdrawal from storage of 250,924 Mcf per day and 200,000 Mcf per day of liquefied natural gas peak shaving capacity gives Alagasco a peak day firm supply of 722,870 Mcf per day. Alagasco also utilizes the Southern and Transco pipeline systems to access spot market gas in order to supplement its firm system supply and serve its industrial transportation customers.\nCOMPETITION AND PRICING: The price of natural gas is a significant marketing factor in the territory served by Alagasco; propane, coal and fuel oil are readily available, and many major industrial customers have the capability to switch to alternate fuels. In the residential and small industrial and commercial markets, electricity is the principal competitor.\nNatural gas service available to Alagasco customers generally falls into two categories -- interruptible and firm. Interruptible service is contractually subject to interruption by Alagasco for various reasons, the most common of which is curtailment of industrial customers during periods of peak residential heating demand on the Alagasco system. Firm service is generally not subject to interruption and, therefore, is more expensive than interruptible service. Firm service is generally provided to residential and small commercial and industrial customers. Interruptible service is generally provided to large commercial and industrial customers which typically have the capacity to reduce consumption by adjusting their production schedules or by switching to alternate fuels during periods of interruption. Deliveries of sales and transportation gas totaled 97,531 MMcf (million cubic feet) in 1994.\nAlagasco has a Competitive Fuel Clause as part of its rate tariff which allows Alagasco to adjust large commercial and industrial prices on a case-by-case basis to compete with either alternate fuels or alternate sources of gas. The GSA rider to Alagasco's tariff increases the rates paid by other customers to recover the reduction in rates allowed under the Competitive Fuel Clause because the retention of any customer, particularly large commercial and industrial, benefits all customers by recovering a portion of the system's fixed cost. During 1994 approximately 23.9 percent (12,582 MMcf) of Alagasco's deliveries of gas to large commercial and industrial customers were made under the Competitive Fuel Clause.\nAlagasco also has a Transportation Tariff which allows the Company to transport gas for customers rather than buying and reselling gas to them. The Transportation Tariff is based on Alagasco's gas sales profit margin so that Alagasco's net income is not affected whether it transports or sells gas. The Transportation Tariff also may be adjusted under the Competitive Fuel Clause. Of Alagasco's total large commercial and industrial customer deliveries during 1994, 99.7 percent (37,678 MMcf) was from transportation of customer-owned gas.\nGROWTH: Alagasco has supplemented traditional service area growth with acquisitions of municipally-owned gas distribution systems. Since 1985 Alagasco has acquired 19 such systems, including the 2,200-customer gas system of Alabaster purchased in early fiscal 1995. More than 42,000 customers have been added through initial system purchases and subsequent customer additions, as Alagasco has increased the relatively low saturation rates in the acquired areas through a variety of marketing efforts including: offering natural gas service to propane customers already situated on the municipal system lines; extending the acquired municipal system into nearby neighborhoods which desire natural gas service; and marketing natural gas appliances to existing and new customers. Approximately 80 municipal systems remain in Alabama, and many are located in or near Alagasco's existing service territory. The Company is optimistic that additional acquisition opportunities will arise in the future.\nPower generation is a possible avenue of future growth for Alagasco. During 1994 Alagasco built a nine-mile pipeline to an Alabama Power Company electric peaking plant in order to provide natural gas to nine combustion turbine (CT) units scheduled to begin operation in 1995. The CT units will generate electricity during periods of peak demand, providing Alagasco with a new substantial summertime load.\nWEATHER: Alagasco's gas distribution business is highly seasonal since a material portion of Alagasco's total sales and delivery volumes is to customers whose use varies depending upon temperature, principally residential, small commercial and small industrial customers. Alagasco's rate tariff includes a temperature adjustment rider which is designed to mitigate the effect of departures from normal temperature on Alagasco's earnings. The calculation is performed monthly and adjustments are made to customer's bills in the actual month the weather variation occurs.\nENVIRONMENTAL MATTERS: Alagasco is in the chain of title of eight former manufactured gas plant sites, of which it still owns four, and five manufactured gas distribution sites, of which it still owns one. A preliminary investigation of the sites does not indicate the present need for remediation activities. Management expects that, should remediation of any such sites be required in the future, Alagasco's share, if any, of such costs will not materially affect the results of operations or financial condition of Alagasco.\n- - OIL AND GAS EXPLORATION AND PRODUCTION ACTIVITIES\nEnergen's oil and gas exploration and production activities are conducted by its subsidiary, Taurus Exploration, Inc. (Taurus), and involve the exploration for and the production of natural gas and oil from conventional and nonconventional reservoirs. Taurus's 1994 oil and gas production totaled 10.3 Bcf (with oil expressed in natural gas equivalents), and the average sales price was $1.94 per Mcf equivalent. Conventional oil and gas reserves of 42,261 MMcf equivalents plus nonconventional gas reserves of 26,712 MMcf combine for total oil and gas reserves at fiscal year-end of 68,973 MMcf equivalents.\nCONVENTIONAL: Taurus's conventional oil and gas strategy is to build a foundation of low-risk, income- producing properties through acquisitions and supplement its returns with exploration activities. Taurus has agreements with PMC Reserve Acquisition Company and General Atlantic Resources, Inc. which provide avenues for investment in producing properties. Taurus is continuing to independently evaluate other producing property acquisition opportunities. To help ensure a continuing flow of exploratory prospects, during 1994 Taurus entered into a multi-year joint venture with King Ranch and Holley Petroleum Inc.\nwhich will utilize newly available 3-D seismic data. The new 3-D data will provide coverage of more than 200 offshore Texas blocks, representing approximately one million acres of potential leasehold.\nTaurus's exploration activities are concentrated in the shallow waters of the Gulf of Mexico. Four successful discoveries during 1994 added reserves of 5.3 Bcf equivalents. Proved property acquisitions added reserves of 1.7 Bcf equivalents.\nNONCONVENTIONAL: Taurus's nonconventional gas strategy is to focus on operating the large projects in which it has a small working interest and operate for others; supplementing these activities, Taurus also consults on an international basis. Taurus does not anticipate additional major project development in the Black Warrior Basin, and results of an internally generated, comprehensive evaluation of North America for new coalbed methane exploration opportunities showed that available opportunities do not meet Taurus's current risk profile. Taurus does plan, however, to continue its operating and consulting activities.\nAt September 30, 1994, Taurus had working interests in 441 coalbed methane wells and royalty interests in an additional 216 wells, all located in Alabama's Black Warrior Basin. Gas produced from these wells through the year 2002 qualifies for the Section 29 tax credit for producing fuel from nonconventional sources. Net decreases to coalbed methane reserves in 1994 totaled 3.7 Bcf, and primarily reflect the effects of lower prices as of September 30, 1994.\nTaurus is the operator of more than 950 coalbed methane wells, including wells in an existing project owned by TECO Coalbed Methane, Inc., one of Taurus's coalbed methane associates in other projects. Under the terms of the agreement, Taurus provides technical, administrative and operating services and receives additional compensation based on the project's profitability.\nDuring 1994 Taurus signed a multi-year strategic alliance with Conoco, Inc. designed to enhance both companies' coalbed methane programs. Taurus will provide consulting and associated services relative to the acquisition, exploration and development of coalbed methane properties to complement Conoco's capabilities.\nSubstantially all of the gas produced from the coalbed methane wells in which Taurus has an interest is being sold under long-term contracts which provide markets for 100 percent of the wells' production capacity and is sold at prices indexed to the monthly Gulf Coast spot market. Contracts representing approximately one-third of this gas are subject to price renegotiation during 1995.\nENVIRONMENTAL MATTERS: Taurus is subject to various environmental regulations. Management believes that Taurus is in compliance with currently applicable standards of the environmental agencies to which it is subject and that potential environmental liabilities, if any, are minimal. Also, to the extent Taurus has operating agreements with various joint venture partners, environmental costs, if any, would be shared proportionately.\n- - PROPANE SALES\nPrior to June 1994, Energen had been involved in the retail propane distribution business through its subsidiary, W & J Propane Gas, Inc. (W & J). In June 1994, W & J sold substantially all of its assets.\n- - INTRASTATE GAS GATHERING AND TRANSMISSION\nEnergen operates an intrastate gas pipeline and gathering system through its subsidiary, Basin Pipeline Corp. (Basin). Basin's pipeline and gathering facilities primarily serve certain of Taurus's coalbed methane properties.\n- - COMBUSTION TECHNOLOGY\nPrior to May 1994, through its American Heat Tech, Inc. (Heat Tech) subsidiary, Energen owned a 41 percent equity interest in American Combustion, Inc. During May 1994, a substantial portion of this interest was sold leaving Heat Tech with approximately an 8 percent ownership interest. ACI designs, manufactures and markets high temperature combustion technology products.\nEMPLOYEES\nThe Company has 1,488 employees; Alagasco employs 1,318; Taurus employs 158; and Energen's other subsidiaries employ 12.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporate headquarters of Energen, Alagasco and Taurus are located in leased office space in Birmingham, Alabama.\nThe properties of Alagasco consist primarily of its gas distribution system, which includes more than 8,500 miles of main, more than 9,300 miles of service lines, odorization and regulation facilities, and customer meters. Alagasco also has two liquefied natural gas facilities, 23 commercial offices, nine service centers, and other related property and equipment, some of which are leased by Alagasco. Substantially all of Alagasco's fixed assets are subject to the lien of its first mortgage bonds. The Montgomery, Alabama service center also serves as collateral for a mortgage note, the terms of which are discussed in Note 2 to the Consolidated Financial Statements which is incorporated by reference from the 1994 Annual Report to Stockholders and is included in Part IV, Item 14, Exhibit 13, herein.\nFor a description of Taurus's oil and gas properties, see the discussion under Item 1 - -Business. Information concerning Taurus's production, reserves and development is included in Note 15 to the Consolidated Financial Statements which is incorporated by reference from the 1994 Annual Report to Stockholders and is included in Part IV, Item 14, Exhibit 13, herein. The proved reserve estimates are consistent with comparable reserve estimates filed by Taurus with any federal authority or agency.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material legal proceedings pending, other than routine litigation incidental to the Company's business, in which the Company or any of its subsidiaries is a party. There are no material legal proceedings to which any officer or director of the Company or any of its subsidiaries is a party or has a material interest adverse 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 security holders during the fourth quarter of 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANTS\nENERGEN CORPORATION\nName Age Position (1) ---- --- ------------\nRex J. Lysinger 57 Chairman of the Board and Chief Executive Officer (2)\nWm. Michael Warren, Jr. 47 President and Chief Operating Officer (3)\nGeoffrey C. Ketcham 43 Executive Vice President, Chief Financial Officer and Treasurer (4)\nDudley C. Reynolds 41 General Counsel and Secretary (5)\nGary C. Youngblood 51 Executive Vice President of Alagasco (6)\nJohn A. Wallace 50 Senior Vice President--Methane of Taurus (7)\nJames T. McManus 36 Vice President--Finance and Corporate Development (8)\nNOTES: (1) All executive officers of Energen have been employed by Energen for the past five years. Officers serve at the pleasure of its Board of Directors.\n(2) Served as Vice President of Alagasco from July 1975 to January 1977, when he was elected President. Elected President of Energen upon its formation in 1978. Elected Chairman of the Board of Energen and its subsidiaries September 1982. Currently Chairman of the Board and Chief Executive Officer of Energen and its subsidiaries. Serves as a Director of Energen and each of its subsidiaries.\n(3) Served as Senior Vice President and General Counsel of Alagasco from September 1983 to October 1984, when he was elected President and Chief Operating Officer of that corporation. Elected Executive Vice President of Energen June 1987 and elected President and Chief Operating Officer of Energen April 1, 1991. Elected President and Chief Operating Officer of all Energen subsidiaries (except W & J) January 1992. Serves as a Director of Energen and each of its subsidiaries.\n(4) Elected Controller of Alagasco November 1981, Vice President and Controller June 1984, Vice President--Finance and Planning of Alagasco June 1985 and Vice President--Planning of Energen August 1986. Elected Vice President--Finance and Treasurer of Energen and each of its subsidiaries June 1987. Elected Senior Vice President--Finance and Treasurer of Energen and each of its subsidiaries April 1989. Elected Executive Vice President, Chief Financial Officer and Treasurer of Energen and each of its subsidiaries April 1, 1991.\n(5) Served as Staff Attorney for Energen and its subsidiaries to November 1, 1984, when he was named Senior Attorney. Elected Assistant Secretary in 1985 and Secretary effective September 1986. Elected Vice President--Legal and Secretary of Energen and each of its subsidiaries June 1987. Elected General Counsel and Secretary of Energen and each of its subsidiaries April 1, 1991.\n(6) Served as District Manager--Birmingham District until June 1985, when he was elected Vice President--Birmingham Operations; Elected Senior Vice President--Administration April 1, 1991. Elected Executive Vice President October 1993.\n(7) Served as Manager, Methane Development of Taurus until August 1988, when he was elected Vice President Methane Operations of Taurus. Elected Vice President Methane Exploration and Production of Taurus November 1990. Elected Senior Vice President--Methane of Taurus February 1992.\n(8) Served as Director of Corporate Accounting of Energen until November 1988, when he was elected Controller of Energen; Elected Controller of Alagasco May 1989. Elected Assistant Vice President--Corporate Development of Energen June 1990. Elected Vice President--Finance and Corporate Development of Energen and Vice President--Finance and Planning of Alagasco effective April 1, 1991.\nALABAMA GAS CORPORATION\nName Age Position (1) ---- --- ------------\nRex J. Lysinger 57 Chairman of the Board and Chief Executive Officer (2)\nWm. Michael Warren, Jr. 47 President and Chief Operating Officer (2)\nGeoffrey C. Ketcham 43 Executive Vice President and Chief Financial Officer (2)\nDudley C. Reynolds 41 General Counsel and Secretary (2)\nGary C. Youngblood 51 Executive Vice President (2)\nRoy F. Etheredge 58 Senior Vice President--Operations (3)\nT. Irving Hawkins 60 Senior Vice President--Marketing Services (4)\nJames T. McManus 36 Vice President--Finance and Planning (2)\nGerald G. Turner 59 Vice President--Rates (5)\nNOTES: (1) All executive officers of Alagasco have been employed by Energen for the past five years. Officers serve at the pleasure of the Board of Directors.\n(2) See discussion of Energen officers above.\n(3) Elected Assistant Vice President in 1983, Vice President--Northern Division in 1984. Elected Vice President--State Operations in 1985. Elected Senior Vice President--Operations April 1, 1991.\n(4) Served as General Manager--Marketing of Alagasco until August 1, 1982, when he was elected Vice President--Marketing Services. Elected Senior Vice President--Marketing Services April 1, 1991.\n(5) Served as Director of Rates and Regulations until he was elected Assistant Vice President--Rates in June 1987. Elected Vice President--Rates May 1989.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe information regarding Energen's common stock and the frequency and amount of dividends paid during the past two years with respect to such stock is incorporated by reference from the 1994 Annual Report to Stockholders, page 52, and is included in Part IV, Item 14, Exhibit 13, herein. At October 29, 1994, there were approximately 6,000 holders of record of Energen's common stock. For restrictions on Energen's present and future ability to pay dividends, see Note 2 to the Consolidated Financial Statements which is incorporated by reference from the 1994 Annual Report to Stockholders and is included in Part IV, Item 14, Exhibit 13, herein.\nAt the date of this filing, Energen Corporation owns all the issued and outstanding common stock of Alabama Gas Corporation.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nEnergen Corporation\nThe information regarding selected financial data is incorporated by reference from the 1994 Annual Report to Stockholders, pages 54-55, and is included in Part IV, Item 14, Exhibit 13, herein.\nAlabama Gas Corporation (unaudited)\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 1994 Annual Report to Stockholders and is included in Part IV, Item 14, Exhibit 13, herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item for Energen Corporation and subsidiaries is incorporated by reference from the 1994 Annual Report to Stockholders and is included in Part IV, Item 14, Exhibit 13, herein. The information required by this item for Alabama Gas Corporation is contained in Part IV, Item 14, 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\nInformation regarding the executive officers of both Energen and Alagasco is included in Part I. The other information required by Item 10 is incorporated herein by reference from Energen's definitive proxy statement for the Annual Meeting of Stockholders to be held January 25, 1995. The proxy statement will be filed within 120 days after the end of the fiscal year covered by this Form 10-K. The directors and nominees for director\nof Alagasco are the same as those of Energen except the Alagasco directors do not have staggered terms, thus the entire Alagasco Board has been nominated for re-election to an annual term at the Annual Meeting.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information regarding executive compensation is incorporated herein by reference from Energen's definitive proxy statement for the Annual Meeting of Stockholders to be held January 25, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nA. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nThe information regarding the security ownership of the beneficial owners of more than five percent of Energen's common stock is incorporated herein by reference from Energen's definitive proxy statement for the Annual Meeting of Stockholders to be held January 25, 1995.\nB. SECURITY OWNERSHIP OF MANAGEMENT\nThe information regarding the security ownership of management is incorporated herein by reference from Energen's definitive proxy statement for the Annual Meeting of Stockholders to be held January 25, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information regarding certain relationships and related transactions is incorporated herein by reference from Energen's definitive proxy statement for the Annual Meeting of Stockholders to be held January 25, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nA. DOCUMENTS FILED AS PART OF THIS REPORT\n(1) FINANCIAL STATEMENTS The financial statements listed in the accompanying Index to Financial Statements and Financial Statement Schedules are filed as part of this report and are included in Part IV, Item 14, Exhibit 13, herein.\n(2) FINANCIAL STATEMENT SCHEDULES The financial statement schedules listed in the accompanying Index to Financial Statements and Financial Statement Schedules are filed as part of this report.\n(3) EXHIBITS The exhibits listed on the accompanying Index to Exhibits are filed as part of this report.\nB. 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 and Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized.\nENERGEN CORPORATION (Registrant)\nALABAMA GAS CORPORATION (Registrant)\nDecember 21, 1994 \/s\/Rex J. Lysinger - ----------------------- ------------------------------ DATE Rex J. Lysinger Chairman of the Board, Chief Executive Officer and Director\nSIGNATURES\nPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrants and in the capacities and on the dates indicated:\nDecember 21, 1994 \/s\/Rex J. Lysinger - ----------------------- -------------------------------- DATE Rex J. Lysinger Chairman of the Board, Chief Executive Officer and Director\nDecember 21, 1994 \/s\/Wm. Michael Warren, Jr. - ----------------------- -------------------------------- DATE Wm. Michael Warren, Jr. President, Chief Operating Officer and Director\nDecember 21, 1994 \/s\/Geoffrey C. Ketcham - ----------------------- -------------------------------- DATE Geoffrey C. Ketcham Executive Vice President, Chief Financial Officer and Treasurer\nDecember 21, 1994 \/s\/James T. McManus - ----------------------- -------------------------------- DATE James T. McManus Vice President--Finance and Corporate Development of Energen and Vice President--Finance and Planning of Alagasco\nDecember 21, 1994 \/s\/Dr. Stephen D. Ban - ----------------------- -------------------------------- DATE Dr. Stephen D. Ban Director\nDecember 21, 1994 \/s\/James S. M. French - ----------------------- -------------------------------- DATE James S. M. French Director\nDecember 21, 1994 \/s\/Harris Saunders, Jr. - ----------------------- -------------------------------- DATE Harris Saunders, Jr. Director\nDecember 21, 1994 \/s\/Dr. Judy M. Merritt - ----------------------- -------------------------------- DATE Dr. Judy M. Merritt Director\nENERGEN CORPORATION ALABAMA GAS CORPORATION AND FINANCIAL STATEMENT SCHEDULES\nITEM 14(A)\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.\nENERGEN CORPORATION ALABAMA GAS CORPORATION INDEX TO EXHIBITS ITEM 14(A)(3)\nExhibit Number Description - ------- -----------\n*3(a) Restated Certificate of Incorporation of Energen Corporation (formerly Alagasco, Inc.) which was filed as Exhibit 4(a) to Energen's Registration Statement on Form S-8 (Registration No. 33-14855).\n*3(b) Amendment to the Restated Certificate of Incorporation of Energen Corporation (formerly Alagasco, Inc.) adopted on July 18, 1985, which was filed as Exhibit 4(b) to Energen's Registration Statement on Form S-8 (Registration No. 33-14855).\n*3(c) Amendment to the Restated Certificate of Incorporation of Energen Corporation adopted on January 15, 1987, which was filed as Exhibit 4(c) to Energen's Registration Statement on Form S-8 (Registration No. 33-14855).\n*3(d) Amendment to the Restated Certificate of Incorporation of Energen Corporation adopted on January 25, 1989, which was filed as Exhibit 4(d) to Energen's Registration Statement on Form S-3 (Registration No. 33-70464).\n*3(e) Composite Restated Certificate of Incorporation of Energen Corporation, as amended through February 12, 1989, which was filed as Exhibit 4(e) to Energen's Registration Statement on Form S-3 (Registration No. 33-70464).\n*3(f) Certificate of Adoption of Resolutions designating Series A Junior Participating Preferred Stock (June 27, 1988) which was filed as Exhibit 4(e) to Energen's Registration Statement on Form S-2 (Registration No. 33-25435).\n*3(g) Bylaws of Energen Corporation, which were filed as Exhibit 4(e) to Energen's Registration Statement on Form S-8 (Registration No. 33-14855).\n*3(h) Joint Agreement of Merger, under the name Alabama Gas Corporation (November 19, 1948), which was filed as Exhibit 4(a) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(i) Alabama Gas Corporation, Certificate of Amendment to Joint Agreement of Merger which constitutes the Certificate of Incorporation of said Corporation (March 13, 1953), which was filed as Exhibit 4(b) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(j) Alabama Gas Corporation, Certificate of Amendment to the Certificate of Incorporation (April 22, 1954), which was filed as Exhibit 4(c) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(k) Alabama Gas Corporation, Certificate of Amendment to the Joint Agreement of Merger, as heretofore amended, which constitutes the Certificate of Incorporation of Alabama Gas Corporation (January 20, 1959), which was filed as Exhibit 4(d) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(l) Alabama Gas Corporation, Certificate of Amendment to the Joint Agreement of Merger, as heretofore amended, which constitutes the Certificate of Incorporation of Alabama Gas Corporation (January 26, 1968), which was filed as Exhibit 4(e) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(m) Alabama Gas Corporation, Certificate of Amendment to the Joint Agreement of Merger, as heretofore amended, which constitutes the Certificate of Incorporation of Alabama Gas Corporation (October 16, 1980), which was filed as Exhibit 4(f) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(n) Articles of Amendment to the Certificate of Incorporation of Alabama Gas Corporation (October 26, 1984), which was filed as Exhibit 4(g) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(o) Articles of Amendment to the Certificate of Incorporation of Alabama Gas Corporation (December 18, 1986), which was filed as Exhibit 4(h) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(p) Composite Joint Agreement of Merger under the name Alabama Gas Corporation, as Amended March 20, 1986, which was filed as Exhibit 4(i) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(q) Alabama Gas Corporation, Certificate filed pursuant to Section 33 of Act Number 414 of the Regular Session of the Legislature of the State of Alabama (August 26, 1965, reclassifying and authorizing $4.70 Series Cumulative Preferred Stock), which was filed as Exhibit 4(j) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*3(r) By-Laws of Alabama Gas Corporation, which was filed as Exhibit 4(k) to Alabama Gas' Registration Statement on Form S-3 (Registration No. 33-12841).\n*4(a) Rights Agreement, dated as of July 27, 1988, between Energen Corporation and AmSouth Bank, N.A., Rights Agent, which was filed as Exhibit 1 to Energen's Registration Statement on Form 8-A (File No. 1-7810).\n*4(b) Amendment of Rights Agreement, dated as of February 28, 1990, between Energen Corporation and AmSouth Bank, N.A., Rights Agent, which was filed as Exhibit 2 to Energen's Form 8 Amendment No. 2 to its Registration Statement on Form 8-A (File No. 1-7810).\n*4(c) Indenture, dated as of January 1, 1992, between Energen Corporation and Boatmen's Trust Company, Trustee, which was filed as Exhibit 4 to Energen's Amendment No. 1 to Registration Statement on Form S-3 (Registration No. 33-44936).\n*4(d) Indenture, dated as of March 1, 1993, between Energen Corporation and Boatmen's Trust Company, Trustee, which was filed as Exhibit 4 to Energen's to Registration Statement on Form S-3 (Registration No. 33-25435).\n*4(e) Ninth Supplemental Indenture, dated as of April 1, 1949, between Alabama Gas Corporation and Chemical Bank and Trust Company, Trustee, supplementing, amending, and restating the First Mortgage and Deed of Trust between Birmingham Gas Company and Chemical Bank and Trust Company, Trustee, dated April 1, 1941 (filed as Exhibit 7(a)(J) to Alabama Gas' Form S-1, Registration Statement 2-7910, effective March 26, 1949).\n*4(f) Nineteenth Supplemental Indenture dated as of December 1, 1985, between Alabama Gas Corporation and Chemical Bank and Trust Company, Trustee, which was filed as Exhibit 4(o) to Energen's Registration Statement on Form S-3 (Registration No. 33-70464).\n*4(g) Indenture dated as of October 1, 1989, between Alabama Gas Corporation and Boatmen's Trust Company, Trustee, which was filed as Exhibit 4(l) to Alabama Gas' Amendment No. 1 to Registration Statement on Form S-3 (Registration No. 33-31400).\n*4(h) Indenture dated as of November 1, 1993, between Alabama Gas Corporation and NationsBank of Georgia, National Association, Trustee, which was filed as Exhibit 4(k) to Alabama Gas's Registration Statement on Form S-3 (Registration No. 33-70466).\n*10(a) Form of Service Agreement Under Rate Schedule CSS (No. S10710), between Southern Natural Gas Company and Alabama Gas Corporation as filed as Exhibit 10(a) to Energen's Annual Report on Form 10-K for the year ended September 30, 1993.\n*10(b) Form of Service Agreement Under Rate Schedule IT (No. 790420), between Southern Natural Gas Company and Alabama Gas Corporation as filed as Exhibit 10(b) to Energen's Annual Report on Form 10-K for the year ended September 30, 1993.\n*10(c) Form of Service Agreement Under Rate Schedule FT-NN (No. 866941), between Southern Natural Gas Company and Alabama Gas Corporation as filed as Exhibit 10(c) to Energen's Annual Report on Form 10-K for the year ended September 30, 1993.\n*10(d) Form of Service Agreement Under Rate Schedule FT (No. 866940) between Southern Natural Gas Company and Alabama Gas Corporation as filed as Exhibit 10(d) to Energen's Annual Report on Form 10-K for the year ended September 30, 1993.\n*10(e) Form of Executive Retirement Supplement Agreement between Energen Corporation and certain executive officers as filed as Exhibit 10(f) to Energen's Annual Report on Form 10-K for the year ended September 30, 1993.\n10(f) Amendment to Executive Retirement Supplement Agreement effective as of June 22, 1994, between Energen Corporation and certain executive officers.\n*10(g) Restricted Stock Incentive Plan of Energen Corporation, which was filed as Exhibit 4 to Post Effective Amendment No. 2 to Energen Corporation's Registration Statement on Forms S-8 and S-3 (Registration No. 2-89855).\n*10(h) Severance Compensation Agreement between Energen Corporation and certain executive officers, which was filed as Exhibit 10(e) to Energen's Annual Report on Form 10-K for the year ended September 30, 1992.\n*10(i) Energen Corporation 1988 Stock Option Plan as filed as Exhibit 10(i) to Energen's Annual Report on Form 10-K for the year ended September 30, 1993.\n*10(j) Energen Corporation 1992 Long-Range Performance Share Plan, dated as of October 1, 1991, which was filed as Exhibit A to the Registrant's Proxy Statement for its January 22, 1992 Annual Meeting (File No. 1-7810).\n*10(k) Energen Corporation 1992 Directors Stock Plan, effective as of January 22, 1992, which was filed as Exhibit B to Energen's Proxy Statement for its January 22, 1992 Annual Meeting (File No. 1-7810).\n*10(l) Energen Corporation Director Fees Deferral Plan as filed as Exhibit 10(l) to Energen's Annual Report on Form 10-K for the year ended September 30, 1993.\n10(m) Energen Corporation Annual Incentive Compensation Plan, Revised 5\/90, as amended effective October 1, 1993.\n13 Information incorporated by reference from the Energen Corporation 1994 Annual Report to Stockholders\n21 Subsidiaries of Energen Corporation\n23(a) Consent of Independent Certified Public Accountants (Energen).\n23(b) Consent of Independent Certified Public Accountants (Alagasco).\n27.1 Financial Data Schedule of Alabama Gas Corporation (for SEC purposes only)\n27.2 Financial Data Schedule of Energen Corporation (for SEC purposes only)\n*Incorporated by reference\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS OF ALABAMA GAS CORPORATION:\nWe have audited the financial statements and the financial statement schedules of Alabama Gas Corporation listed in the index on pages 16 and 17 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 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 Alabama Gas Corporation as of September 30, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended September 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 12 to the financial statements, the Company changed its method of accounting for certain other postretirement benefits, effective October 1, 1993, and income taxes effective October 1, 1991.\nCoopers & Lybrand L.L.P. Birmingham, Alabama October 26, 1994\nSTATEMENTS OF INCOME ALABAMA GAS CORPORATION\nThe accompanying Notes to Financial Statements are an integral part of these statements.\nBALANCE SHEETS ALABAMA GAS CORPORATION\n============================================================================= YEARS ENDED SEPTEMBER 30, (IN THOUSANDS) 1994 1993 =============================================================================\nASSETS\nPROPERTY, PLANT AND EQUIPMENT Utility plant $464,593 $429,115 Less accumulated depreciation 231,327 215,892 - -----------------------------------------------------------------------------\nUtility plant, net 233,266 213,223 - -----------------------------------------------------------------------------\nOther property, net 183 83 - -----------------------------------------------------------------------------\nCURRENT ASSETS Cash 156 480 Accounts receivable Gas 22,209 23,563 Merchandise 1,326 1,256 Other 1,512 1,011 Allowance for doubtful accounts (2,000) (1,800) Inventories, at average cost Storage gas inventory 24,363 -- Materials and supplies 5,688 5,851 Liquified natural gas in storage 3,349 3,636 Deferred gas costs 1,460 2,966 Deferred income taxes 5,724 2,587 Prepayments and other 2,595 2,520 =============================================================================\nTotal current assets 66,382 42,070 - -----------------------------------------------------------------------------\nDEFERRED CHARGES AND OTHER ASSETS 9,074 9,172 - -----------------------------------------------------------------------------\nTOTAL ASSETS $308,905 $264,548 =============================================================================\nThe accompanying Notes to Financial Statements are an integral part of these statements.\nBALANCE SHEETS ALABAMA GAS CORPORATION\nThe accompanying Notes to Financial Statements are an integral part of these statements.\nSTATEMENTS OF RETAINED EARNINGS ALABAMA GAS CORPORATION\nThe accompanying Notes to Financial Statements are an integral part of these statements.\nSTATEMENTS OF CASH FLOW ALABAMA GAS CORPORATION\nThe accompanying Notes to Financial Statements are an integral part of these statements.\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAlabama Gas Corporation (Alagasco), a wholly-owned subsidiary of Energen Corporation, is the largest natural gas distribution utility in the State of Alabama, serving customers primarily in central and north Alabama. The following is a description of its significant accounting policies and practices.\nA. UTILITY PLANT AND DEPRECIATION\nUtility plant is stated at original cost which includes an allowance for funds used during construction. Maintenance is charged for the cost of normal repairs and the renewal or replacement of an item of property which is less than a retirement unit. When property which represents a retirement unit is replaced or removed, the cost of such property is credited to utility plant and, together with the cost of removal less salvage, is charged to the accumulated reserve for depreciation.\nDepreciation is provided on the straight-line method over the estimated useful lives of utility property at rates established by the Alabama Public Service Commission (APSC). Approved depreciation rates averaged approximately 4.3 percent in 1994 and 1993 and 4.4 percent in 1992.\nB. OPERATING REVENUE AND GAS COSTS\nIn accordance with industry practice, Alagasco records revenue on a monthly and cycle billing basis. The Company extends credit to its residential and industrial utility customers which are located primarily in central and north Alabama. The commodity cost of purchased gas applicable to gas delivered to customers but not yet billed under the cycle billing method is deferred as a current asset.\nC. INCOME TAXES\nAlagasco files a consolidated income tax return with its parent. The consolidated income taxes are allocated to the appropriate subsidiaries using the separate return method. Deferred income taxes reflect the impact of temporary differences between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes, and are measured in compliance with enacted tax laws. Investment tax credits have been deferred and are being amortized over the lives of the related assets.\nD. CASH EQUIVALENTS\nAlagasco includes highly liquid marketable securities and debt instruments purchased with an original maturity of three months or less in cash equivalents.\n2. LONG-TERM DEBT AND NOTES PAYABLE\nLong-term debt consists of the following:\nSubstantially all utility plant serves as collateral for the First Mortgage Bonds. In addition, utility plant having a net book value of $1,703,000 serves as collateral for the mortgage note payable which has a variable interest rate of 1.47 percent above the 91-day U.S. Treasury Bill rate, adjusted quarterly. The applicable year-end interest rate was 5.66 percent and 4.54 percent for 1994 and 1993, respectively.\nThe aggregate maturities of long-term debt for the next five years are as follows:\n=============================================================================== YEARS ENDING SEPTEMBER 30, (IN THOUSANDS) ===============================================================================\n1995 1996 1997 1998 1999 - ------------------------------------------------------------------------------- $2,823 $2,823 $2,823 $2,823 $8,173 ===============================================================================\nAlagasco is subject to various restrictions on the payment of dividends. The most restrictive provision is, under the 9 percent debentures, utility dividends or other distributions with respect to utility common stock may not be made unless the utility maintains a consolidated tangible net worth, as defined, of at least $50 million. At September 30, 1994, Alagasco had a tangible net worth of $115,364,000.\nEnergen and Alagasco have short-term credit lines and other credit facilities of $110 million available to either entity for working capital needs. The following is a summary of information relating to notes payable to banks:\nTotal interest expense in 1994, 1993 and 1992 was $8,320,000, $7,487,000, and $7,596,000, respectively.\n3. REGULATORY\nAs an Alabama utility, Alagasco is subject to regulation by the APSC which, in 1983, established the Rate Stabilization and Equalization (RSE) rate-setting process. RSE was extended for the third time on December 3, 1990, for a three-year period. Under the terms of that extension, RSE shall continue after November 30, 1993, unless, after notice to the Company, the Commission votes to either modify or discontinue its operation. On October 4, 1993, the Commission unanimously voted to extend RSE until such time as certain hearings mandated by the Energy Policy Act of 1992 (Energy Act) in connection with integrated resource planning and demand side management programs are completed. The Energy Act proceedings are expected to conclude during fiscal 1995 at which time it is expected that the Commission will begin reviewing Alagasco's RSE. No time table for review has yet been established.\nUnder RSE as extended, the APSC conducts quarterly reviews to determine, based on Alagasco's projections and fiscal year-to-date performance, whether Alagasco's return on equity for the fiscal year will be within the allowed range of 13.15 percent to 13.65 percent. Reductions in rates can be made quarterly to bring the projected return within the allowed range; increases, however, are allowed only once each fiscal year, effective December 1, and cannot exceed 4 percent of prior-year revenues. RSE limits the utility's equity upon which a return is permitted to 60 percent of total capitalization and provides for certain cost control measures designed to monitor the Company's operations and maintenance (O&M) expense. If O&M expense per customer falls within 1.25 percentage points above or below the Consumer Price Index For All Urban Customers (index range), no adjustment is required. If, however, O&M expense per customer exceeds the index range, three-quarters of the difference will be returned to the customers. To the extent O&M expense per customer is less than the index range, the utility will benefit by one-half of the difference through future rate adjustments. Effective December 15, 1990, the APSC approved a temperature adjustment to customers' monthly bills to mitigate the effect of departures from normal temperature on Alagasco's earnings. The calculation is performed monthly, and the adjustment to customer's bills is made in the same month the weather variation occurs.\nThe Company's rate schedules for natural gas distribution charges contained a Purchased Gas Adjustment (PGA) rider in 1993 which permitted the pass-through of changes in gas costs to customers. The APSC approved, effective October 4, 1993, the replacement of the PGA rider with the new Gas Supply Adjustment rider in order to accommodate changes in gas supply purchases resulting from implementation of FERC Order 636, including gas supply realignment surcharges imposed by the Company's suppliers.\nIn accordance with APSC-directed regulatory accounting procedures, Alagasco in 1989 began returning excess utility deferred taxes which resulted from a reduction in the federal statutory tax rate from 46 percent to 34 percent using the average rate assumption method. This method provides for the return to ratepayers of excess deferred taxes over the lives of the related assets. In 1993 those excess taxes were reduced as a result of a federal tax rate increase from 34 percent to 35 percent. Approximately $3.1 million of remaining excess utility deferred taxes is being returned to ratepayers over approximately 16 years.\n4. CAPITAL STOCK\nAlagasco's authorized common stock consists of 3 million, $0.01 par value common shares. At September 30, 1994 and 1993, 1,972,052 shares were issued and outstanding. Alagasco is authorized to issue 120,000 shares of preferred stock, par value $0.01 per share, in one or more series. On July 30, 1993, all outstanding shares of Alagasco's $4.70 Series cumulative preferred stock were redeemed.\n5. INCOME TAXES\nThe components of income taxes consist of the following:\nAs discussed in Note 12, Alagasco adopted Statement of Financial Accounting Standard (SFAS) No. 109 as of October 1, 1991.\nTemporary differences which give rise to a significant portion of deferred tax assets and liabilities for 1994 and 1993 are as follows:\n====================================================================== AS OF SEPTEMBER 30, 1994 (IN THOUSANDS) 1994 1993 ======================================================================\nDeferred tax assets: Deferred investment tax credits $ 1,567 $ 1,748 Regulatory liabilities 2,585 2,866 Deferred revenue 403 516 Self-insurance reserve 1,339 842 Unbilled revenue 1,454 1,426 Allowance for uncollectible accounts 878 669 Accrued vacation 981 903 Gas supply realignment costs 1,123 -- Other, net 1,170 430 - ----------------------------------------------------------------------\nSubtotal 11,500 9,400 Valuation allowance -- -- - ----------------------------------------------------------------------\nTotal deferred tax assets $11,500 $ 9,400 ======================================================================\nDeferred tax liabilities: Depreciation and basis differences $17,704 $16,893 Pension and other benefit costs 1,457 1,181 Purchased gas adjustment -- 988 Other, net 319 167 - ----------------------------------------------------------------------\nTotal deferred tax liabilities $19,480 $19,229 ======================================================================\nNo valuation allowance with respect to deferred taxes is deemed necessary, as the Company anticipates generating adequate future taxable income to realize the benefits of all deferred tax assets on the balance sheet.\nTotal income tax expense differs from the amount which would be provided by applying the statutory federal income tax rate to pretax earnings as illustrated below:\nThere were no tax-related balances due from Alagasco to affiliates at September 30, 1994; the tax-related balance due to affiliates from Alagasco as of September 30, 1993, was $1,239,000, and is included in the amounts payable to affiliates in Note 13.\n6. RETIREMENT INCOME PLANS AND OTHER BENEFITS\nAll information presented concerning retirement income and other benefit plans includes other affiliates of Energen Corporation as well as Alagasco.\nEnergen has two defined benefit non-contributory pension plans which cover substantially all employees. Benefits are based on years of service and final earnings. The Company's policy is to use the \"projected unit credit\" actuarial method for funding and financial reporting purposes. The expense (income) for the plan covering the majority of employees for the years ended September 30, 1994, 1993 and 1992 was $15,000, $(118,000), and $(278,000), respectively. The expense for the second plan covering employees under labor union agreements for 1994, 1993 and 1992 was $555,000, $557,000 and $503,000, respectively.\nThe funded status of the plans is as follows:\nAt September 30, 1994 and 1993, the discount rate used to measure the projected benefit obligation was 7.5 percent for both plans, and the annual rate of salary increase for the salaried plan was 5.5 percent. The expected long-term rate of return on plan assets was 8.25 percent for both plans in 1994 and 8 percent in 1993.\nThe components of net pension costs for 1994, 1993 and 1992 were:\nEnergen has deferred compensation plan agreements for certain key executives providing for payments upon retirement, death or disability. The deferred compensation expense under these agreements for 1994, 1993 and 1992 was $461,000, $650,000, and $528,000, respectively.\nIn addition to providing pension benefits, Energen provides certain post-retirement health care and life insurance benefits. Substantially all of Energen's employees may become eligible for such benefits if they reach normal retirement age while working for the Company. In a prior year, the company adopted SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, with respect to the accrual of such costs for salaried employees. During fiscal year 1994, the Company adopted SFAS 106 with respect to such costs for employees under collective bargaining agreements. There is no cumulative effect on the income statement resulting from the adoption of SFAS 106 as the Company elected to amortize transition costs over a 20-year period. On December 6, 1993, the APSC adopted Order 4-3454 which allows the Company to recover all costs accrued under SFAS 106 through rates.\nWhile the Company has not adopted a formal funding policy, all of its accrued post-retirement liability was funded at year-end. The expense for salaried employees for the years ended September 30, 1994, 1993 and 1992 was $2,319,000, $2,677,000, and $2,439,000, respectively. Prior to 1994, the Company recognized the cost of providing post-retirement benefits for union employees on a \"pay-as-you-go\" basis. These benefits were provided through a self-insurance arrangement and through insurance companies whose premiums were based on the benefits paid during the year. In 1994 the expense for union employees was $3,685,000, an increase of $2,246,000 over what would have been recognized under the \"pay-as-you-go\" method. Expense of $982,000 and $882,000 was incurred during 1993 and 1992, respectively. The \"projected unit credit\" actuarial method was used to determine the normal cost and actuarial liability.\nA reconciliation of the estimated status of the obligation is as follows:\nNet periodic post-retirement benefit cost for the years ended September 30, 1994, 1993 and 1992, included the following:\nThe weighted average health care cost trend rate used in determining the accumulated post-retirement benefit obligation was 8 percent in 1994 and in 1993 and 8.5 percent in 1992. That assumption has a significant effect on the amounts reported. For example, with respect to salaried employees, increasing the weighted average health care cost trend rate by 1 percent would increase the accumulated post-retirement benefit obligation by 3.8 percent and the net periodic post-retirement benefit cost by 4.7 percent. For union employees increasing the weighted average health care cost trend rate by 1 percent with respect to union employees would increase the accumulated post-retirement benefit obligation by 5.8 percent and the net periodic post-retirement benefit cost by 5.4 percent. The weighted average discount rate used in determining the accumulated post-retirement benefit obligation was 7.5 percent in 1994 and 1993 and 8 percent in 1992.\nEnergen has a long-term disability plan covering most salaried employees. Expense for the years ended September 30, 1994, 1993 and 1992 was $150,000, $129,000, and $129,000, respectively.\n7. COMMITMENTS\nAlagasco has various firm gas supply and firm gas transportation contracts, which expire at various dates through the year 2008. These contracts typically contain minimum demand charge obligations on the part of Alagasco.\nIn January 1989, Alagasco entered into an agreement with a financial institution whereby it can sell on an ongoing basis, with recourse, certain installment receivables related to its merchandising program up to a maximum of $15 million. During 1994 and 1993, Alagasco sold $6,784,000 and $5,608,000, respectively, of installment receivables. At September 30, 1994 and 1993, the balance of these installment receivables was $13,027,000 and $11,699,000, respectively. Receivables sold under this agreement are considered financial instruments with off-balance-sheet risk. Alagasco's exposure to credit loss in the event of non-performance by customers is represented by the balance of installment receivables.\n8. LEASES\nTotal payments related to leases included as operating expense in the accompanying statements of income amounted to $2,147,000, $2,332,000, and $2,447,000 in 1994, 1993 and 1992, respectively. Minimum future rental payments (in thousands) required after 1994 under leases with initial or remaining noncancelable lease terms in excess of one year are as follows:\n9. ENVIRONMENTAL MATTERS\nAlagasco is in the chain of title of eight former manufactured gas plant sites, of which it still owns four, and five manufactured gas distribution sites, of which it still owns one. A preliminary investigation of the sites does not indicate the present need for remediation activities. Management expects that, should remediation of any such sites be required in the future, Alagasco's share, if any, of such costs will not materially affect the results of operations or financial condition of Alagasco.\n10. SUPPLEMENTAL CASH FLOW INFORMATION\nSupplemental information concerning cash flow activities is as follows:\n11. SUMMARIZED QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following data summarize operating results for the four quarters of 1994 and 1993. Alagasco's business is seasonal in character and strongly influenced by weather conditions.\n12. ACCOUNTING CHANGE\nAs discussed more fully in Note 6, the Company adopted SFAS 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, with respect to the accrual of such costs for all employees under labor union agreements effective October 1, 1993. The Company adopted SFAS 106 with respect to salaried employees in a prior year.\nEffective October 1, 1991, Alagasco elected early adoption of SFAS No. 109, Accounting for Income Taxes, which was required to be adopted no later than its fiscal year ending September 30, 1994. Changes in Alagasco's deferred income taxes arising from the adoption have no effect on income, since the changes represent income taxes returnable through future rates over the life of the related assets and have been recorded as a regulatory liability on the balance sheets.\n13. TRANSACTIONS WITH RELATED PARTIES\nAlagasco purchased natural gas from affiliates amounting to $4,134,000, $4,874,000, and $6,332,000, in 1994, 1993, and 1992, respectively. These amounts are included in gas purchased for resale. Alagasco had payables to affiliates of $132,000 at September 30, 1994, and $1,252,000 at September 30, 1993.\n14. FINANCIAL INSTRUMENTS\nIn accordance with the requirements of SFAS No. 107 (Disclosures about Fair Value of Financial Instruments), the estimated fair values of Alagasco's financial instruments at September 30, 1994, were as follows:\n====================================================================== Carrying Fair AS OF SEPTEMBER 30, 1994 (IN THOUSANDS) Amount Value ======================================================================\nCash and cash equivalents $ 156 $ 156 Receivables, net of allowance account $23,047 $23,047 Short-term debt $ 4,000 $ 4,000 Long-term debt (including current maturities) $87,214 $81,021 ======================================================================\nThe following methods and assumptions were used to estimate the fair value of financial instruments:\n- - CASH AND CASH EQUIVALENTS: Fair value was considered to be the same as the carrying amount.\n- - RECEIVABLES: The Company believes that, in the aggregate, current and non-current net receivables were not materially different from the fair value of those receivables.\n- - SHORT-TERM DEBT: The fair value was determined to be the same as the carrying amount.\n- - LONG-TERM DEBT: The fair value of fixed-rate long-term debt was based on the market value of debt with similar maturities and with interest rates currently trading in the marketplace; the carrying amount of variable rate long-term debt was assumed to approximate fair value.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS OF ENERGEN CORPORATION:\nOur report on the consolidated financial statements of Energen Corporation and subsidiaries has been incorporated by reference in this Form 10-K from page 53 of the 1994 Annual Report to Stockholders of Energen Corporation 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 and 17 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects the information required to be included therein.\nCoopers & Lybrand L.L.P. Birmingham, Alabama October 26, 1994\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT ENERGEN CORPORATION AND SUBSIDIARIES\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT ENERGEN CORPORATION AND SUBSIDIARIES\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT ENERGEN CORPORATION AND SUBSIDIARIES\nSCHEDULE VI -- ACCUMULATED DEPRECIATION ENERGEN CORPORATION AND SUBSIDIARIES\n============================================================================= YEARS ENDED SEPTEMBER 30, (IN THOUSANDS) 1994 1993 1992 =============================================================================\nUTILITY PLANT Balance at beginning of year $215,892 $202,684 $187,490 - -----------------------------------------------------------------------------\nAdditions: Charged to expense: Operation 309 500 508 Depreciation 16,781 15,876 15,826 Charged to clearing accounts 221 208 200 Contribution received 521 136 717 Plant acquisition 348 -- 389 Acquisition adjustment -- -- -- Acquisition adjustment amortization 851 830 820 - -----------------------------------------------------------------------------\n19,031 17,550 18,460 - -----------------------------------------------------------------------------\nRetirements or sales, including removal costs, less salvage (3,596) (4,342) (3,266) - -----------------------------------------------------------------------------\nBALANCE AT END OF YEAR $231,327 $215,892 $202,684 =============================================================================\nOIL AND GAS PROPERTIES Balance at beginning of year $ 35,150 $ 29,485 $ 27,023 Additions charged to expense 8,080 5,852 6,157 Retirements (178) (187) (3,695) Other changes -- -- -- - -----------------------------------------------------------------------------\nBALANCE AT END OF YEAR $ 43,052 $ 35,150 $ 29,485 =============================================================================\nOTHER Balance at beginning of year $ 12,225 $ 10,760 $ 8,990 Additions charged to expense 1,907 2,072 2,813 Retirements (4,685) (607) (1,043) Other changes -- -- -- - -----------------------------------------------------------------------------\nBALANCE AT END OF YEAR $ 9,447 $ 12,225 $ 10,760 =============================================================================\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS ENERGEN CORPORATION AND SUBSIDIARIES\n============================================================================= YEARS ENDED SEPTEMBER 30, (IN THOUSANDS) 1994 1993 1992 =============================================================================\nALLOWANCE FOR DOUBTFUL ACCOUNTS Balance at beginning of year $1,927 $1,927 $1,943 - -----------------------------------------------------------------------------\nAdditions: Charged to income: 1,825 1,656 1,419 Recoveries and adjustments 153 81 120 - -----------------------------------------------------------------------------\n1,978 1,737 1,539 - -----------------------------------------------------------------------------\nLess uncollectible accounts written off 1,868 1,737 1,555 - -----------------------------------------------------------------------------\nBALANCE AT END OF YEAR $2,037 $1,927 $1,927 =============================================================================\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION ENERGEN CORPORATION AND SUBSIDIARIES\nCHARGED TO COSTS AND EXPENSES ============================================================================= YEARS ENDED SEPTEMBER 30, (IN THOUSANDS) 1994 1993 1992 =============================================================================\nTAXES, OTHER THAN PAYROLL AND INCOME TAXES Utility: City privilege $12,479 $11,350 $ 8,903 Gross receipts 7,539 7,190 6,770 Other 3,066 2,500 2,457 Oil and gas 991 955 719 Other 159 199 178 - -----------------------------------------------------------------------------\nTOTAL $24,234 $22,194 $19,027 =============================================================================\nOther items related to Schedule X are omitted, as the required information is included in the financial statements or notes thereto or are not present in amounts sufficient to require inclusion.\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT ALABAMA GAS CORPORATION\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT ALABAMA GAS CORPORATION\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT ALABAMA GAS CORPORATION\nSCHEDULE VI -- ACCUMULATED DEPRECIATION ALABAMA GAS CORPORATION\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS ALABAMA GAS CORPORATION\n============================================================================= YEARS ENDED SEPTEMBER 30, (IN THOUSANDS) 1994 1993 1992 =============================================================================\nALLOWANCE FOR DOUBTFUL ACCOUNTS Balance at beginning of year $1,800 $1,800 $1,800 - -----------------------------------------------------------------------------\nAdditions: Charged to income: 1,805 1,613 1,370 Recoveries and adjustments 263 78 113 - -----------------------------------------------------------------------------\n2,068 1,691 1,483 - -----------------------------------------------------------------------------\nLess uncollectible accounts written off 1,868 1,691 1,483 - -----------------------------------------------------------------------------\nBALANCE AT END OF YEAR $2,000 $1,800 $1,800 =============================================================================\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION ALABAMA GAS CORPORATION\nCHARGED TO COSTS AND EXPENSES ============================================================================= YEARS ENDED SEPTEMBER 30, (IN THOUSANDS) 1994 1993 1992 =============================================================================\nTAXES, OTHER THAN PAYROLL AND INCOME TAXES Utility: City privilege $12,479 $11,350 $ 8,903 Gross receipts 7,539 7,190 6,770 Other 3,066 2,500 2,457 - -----------------------------------------------------------------------------\nTOTAL $23,084 $21,040 $18,130 =============================================================================\nOther items related to Schedule X are omitted, as the required information is included in the financial statements or notes thereto or are not present in amounts sufficient to require inclusion.","section_15":""}
{"filename":"800082_1994.txt","cik":"800082","year":"1994","section_1":"Item 1. BUSINESS\nINTRODUCTION\nArgonaut Group, Inc. (\"Argonaut Group\") is a holding company whose subsidiaries are primarily engaged in the selling, underwriting, and servicing of workers compensation and other lines of property-casualty insurance. Workers compensation accounted for 86% of premiums in 1994. See \"Item 6. Selected Financial Data\" for certain financial information regarding industry segments in which the Company operates. Argonaut Group was incorporated in Delaware and was a wholly-owned subsidiary of Teledyne, Inc. (\"Teledyne\") until 1986, when Teledyne distributed to its shareholders all of the outstanding shares of common stock of Argonaut Group. Argonaut Group's executive offices are located at 1800 Avenue of the Stars, Suite 1175, Los Angeles, California 90067, telephone 310.553.0561. The term \"the Company\" refers to Argonaut Group and all its subsidiaries.\nArgonaut Insurance Company (\"Argonaut Insurance\"), Argonaut Group's larger insurance subsidiary, was established in California in 1948. Workers compensation is the primary line of insurance written by Argonaut Insurance and its subsidiaries: Argonaut-Midwest Insurance Company, Argonaut-Northwest Insurance Company, Argonaut-Southwest Insurance Company, and Georgia Insurance Company. Argonaut Insurance and these subsidiaries also write complementary lines of commercial insurance for their clients, primarily consisting of general and automobile liability.\nGreat Central Insurance Company (\"Great Central\") is Argonaut Group's other principal insurance subsidiary. Established in Illinois in 1948, Great Central specializes in providing commercial multiple peril insurance for certain classes of insureds. Argonaut Insurance is Great Central's immediate parent.\nAGI Properties, Inc. (\"AGI Properties\"), a non-insurance company, owns and leases certain real properties. AGI Properties was incorporated in California in 1970. Argonaut Insurance is AGI Properties' immediate parent.\nPRODUCTS\nThe Company has two primary product lines: workers compensation insurance and other property-casualty insurance. Incorporated herein by reference is the information appearing as \"Note 9 - Business Segments\" in the Notes to the Consolidated Financial Statements of the Annual Report. See Exhibit Index.\nWORKERS COMPENSATION\nWorkers compensation insurance is a statutory system which provides for compensation of a policyholder's employees and their dependents for injuries (other than self-inflicted wounds) arising out of or suffered in the course of the employee's\nemployment, even though the injuries may have resulted from the negligence or wrongful conduct of the employee himself or any other person. Workers compensation insurance is sold primarily by Argonaut Insurance. Premiums for this line of business were $240.2 million, $280.0 million, and $289.6 million, in 1994, 1993, and 1992, respectively.\nOTHER PROPERTY-CASUALTY INSURANCE\nThis product includes general and automobile liability, commercial multiple- peril, and various other insurance coverages.\nArgonaut Insurance offers general and automobile liability and other insurance to commercial clients in conjunction with workers compensation insurance. Liability insurance compensates third parties for damages resulting from the actions of the insured.\nCommercial multiple-peril insurance, Great Central's primary product, is a composite product designed for the small-to-medium sized business which needs basic insurance coverage and simple insurance administration. Commercial multiple-peril policies generally cover property, plant, inventory, general liability, and associated coverages. Premiums for these product lines were $39.5 million, $35.4 million, and $38.8 million, in 1994, 1993, and 1992, respectively.\nCEDED REINSURANCE\nThe Company's policy regarding reinsurance is based upon the capitalization of the subsidiaries. The goal is to limit the exposure to surplus from losses resulting from catastrophes and large or unusually hazardous risks.\nAs is the case with direct premiums written, premium revenue on reinsurance contracts is recognized ratably over the period to which the premium relates.\nArgonaut Insurance's limit of retention on its primary reinsurance treaty is $2 million. Great Central's limit of retention on its primary reinsurance treaty is $300,000.\nIncorporated herein by reference is the information appearing as \"Note 3 - Reinsurance\" in the Notes to the Consolidated Financial Statements of the Annual Report. See Exhibit Index.\nCOMPETITION\nThe property-casualty insurance industry is characterized by a large number of competing companies and modest market shares by industry participants. According to A.M. Best, a leading insurance industry rating and analysis firm, there are about 2,300 property-casualty insurance companies operating in the United States, with the 200 largest companies writing about 80% of the industry's premiums.\nThe Company's principal competitors cannot be easily classified. The Company's\nprincipal lines of business are written by numerous insurance companies. Competition for any one account may come from a very large national firm or a smaller regional company selling either directly or through agents and brokers. For the Company's principal line of business, workers compensation, additional competition comes from state workers compensation funds.\nREGULATION\nOn November 8, 1988, California voters passed an initiative known as Proposition 103. The Proposition, in part, provides for a roll-back of rates for certain lines of business (excluding workers compensation) to 20% below rate levels of November 8, 1987. The new California Insurance Commissioner has requested that the Company meet with the Insurance Department to resolve what liability, if any, it has under Proposition 103. While we have agreed to do so, management believes that the Company is in compliance with such roll-back requirements, and that any potential contingent liability would be immaterial. Therefore, there is no provision in the accompanying financial statements for any liability or loss related to Proposition 103.\nBeginning in 1994, the Company's insurance subsidiaries are subject to the Risk- Based Capital (RBC) for Insurers Model Act. The RBC calculation takes into account: (1) asset risk, (2) credit risk, (3) underwriting risk, and (4) all other relevant risks. The RBC for Insurers Model Act provides for four levels of regulatory authority: (1) Company Action Level Event, (2) Regulatory Action Level Event, (3) Authorized Control Level Event, and (4) Mandatory Control Level Event. These four levels of authority provide for ever increasing regulatory remedies for companies that fail to comply with the RBC for Insurers Model Act.\nAs of December 31, 1994, preliminary calculations show that the Company's insurance subsidiaries RBC coverage far exceeds the minimum required.\nThe Company's insurance subsidiaries are members of the statutorily created insolvency guarantee associations in all states where they are authorized to transact business. These associations were formed for the purpose of paying claims of insolvent companies. The Company is assessed its pro rata share of such claims based upon its premium writings, subject to a maximum annual assessment per line of insurance. Such costs can generally be recovered through surcharges on future premiums. The Company does not believe that assessments on current insolvencies will have a material effect on its financial condition or results of operations.\nThe Company has no policyholder dividend restrictions.\nUnder the provisions of the California Insurance Code, there is a maximum amount of shareholder dividends which can be paid without prior approval of the Insurance Commissioner. Under these provisions, as of December 31, 1994, Argonaut Insurance could pay to Argonaut Group a maximum dividend of $57.6 million without the Insurance Commissioner's approval.\nMARKETING\nArgonaut Insurance and Great Central Insurance operate in substantially different markets.\nArgonaut Insurance is licensed to write insurance in 50 states and the District of Columbia. Its products are distributed primarily through agents and brokers. Argonaut Insurance's target markets are companies whose workers compensation needs will result in annual premiums of between $250,000 and $5 million and classes of insurance which require specialized knowledge to (a) underwrite prudently and (b) control losses through cooperative efforts to enhance the safety of the workplace. These classes include (a) contractors, (b) wholesalers, retailers, light manufacturers and service firms, and (c) clients who use self-insurance plans to meet some or all of their insurance needs.\nArgonaut Insurance's primary line of business, workers compensation insurance, accounts for 91% of its premiums (81% of total consolidated premiums). These policies are written on a retrospectively rated basis. Argonaut Insurance's risk regarding inadequate price levels is mitigated to a certain extent as the insured will have to pay additional premiums (or will be refunded premiums) based upon their actual loss experience.\nGreat Central is authorized to operate in 33 states and considers itself to be a specialty company with a defined target market. Great Central's dominant product is commercial multiple-peril. Great Central's policies are marketed through agents.\nNeither Argonaut Insurance nor Great Central market any of their policies through managing general agents.\nRUN OFF LINES\nIncorporated herein by reference is the information appearing as \"Note 12 - Run Off Lines\" in the Notes to the Consolidated Financial Statements of the Annual Report. See Exhibit Index.\nLoss ratios for the run off line of business are not meaningful as there are no premiums associated with this line of business.\nINVESTMENTS\nThe Company's investment portfolio continues to emphasize high quality fixed income investments. As a percentage of the total investment portfolio, U.S. Treasury securities continue to comprise the majority of the Company's holdings. Obligations of states and political subdivisions have decreased from 1993 as a result of maturities and sales. The proceeds from these maturities and sales were re-invested in high quality non-redemptive preferred stocks. Corporate securities continue to decrease as a result of maturities.\nThe Company's investment policy is to invest only in investment-grade securities. We do not invest in high-yield or so called \"junk bonds\". We have no derivatives, speculative real estate, or mortgage obligations.\nIncorporated herein by reference is the information appearing as \"Note 2 - Investments\" and \"Note 7 - Net Investment Income\" in the Notes to the Consolidated Financial Statements of the Annual Report. See Exhibit Index.\nRESERVES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES\nIncorporated herein by reference is the information appearing as \"Note 4 - Reserves for Losses and Loss Adjustment Expenses\" in the Notes to the Consolidated Financial Statements of the Annual Report. See Exhibit Index.\nReserves for environmental claims were $23.4 million and $32.8 million at December 31, 1994 and 1993, respectively.\nThe following tables indicate the manner in which reserves for losses and loss adjustment expenses at the end of a particular year change as time passes. The first table presented is net of the effects of reinsurance. The second table presented includes only amounts related to direct insurance. Reserves for losses and loss adjustment expenses and cumulative paid amounts on direct insurance are not available prior to 1989; therefore, the second table reflects only the past 6 years development.\nThe first line shows the reserves as originally reported at the end of the stated year. The second section shows the cumulative amounts paid as of the end of successive years related to those reserves. The third section shows the original recorded reserves as of the end of successive years adjusted to reflect facts and circumstances later discovered. The last line, cumulative deficiency or redundancy, compares the adjusted reserves to the reserves as originally established and shows that the reserves as originally recorded were either inadequate or excessive to cover the estimated cost of claims as of December 31, 1994.\nConditions and trends that have affected the development of these reserves in the past will not necessarily recur in the future. It would not be appropriate to use this cumulative history in the projection of future performance.\nCAPITAL ADEQUACY\nSeveral measures of capital adequacy are common in the property-casualty industry. The two most often used are (a) premium-to-surplus (which measures pressures on capital from inadequate pricing) and, (b) reserves-to-surplus (which measures pressure on capital from inadequate loss and loss adjustment expense reserves).\nThe following table shows the consolidated premium-to-surplus and reserves-to- surplus ratios of the Company's insurance subsidiaries (on a statutory basis).\nYear Ended December 31, ------------------------------ 1994 1993 1992 ----- ----- ----- Ratio of: Premium-to-surplus 0.4 0.5 0.5 ==== ==== ====\nReserves-to-surplus 1.6 1.9 2.3 ==== ==== ====\nThe Company believes that its 1994 capital ratios are satisfactory.\nRATINGS\nThe Company's insurance subsidiaries are rated annually by A.M. Best. A.M. Best is generally considered to be the leading insurance rating agency, and its ratings are used by insurance buyers, agents and brokers, and other insurance companies as an indicator of financial strength and security, and are not intended to reflect the quality of the rated company for investment purposes. Argonaut Insurance and its pooled subsidiaries were awarded an \"A+\" (Superior) rating in 1994 and 1993. An \"A+\" rating is the second highest rating A.M. Best awards. Great Central is rated separately and was awarded an \"A-\" (Excellent) rating in both 1994 and 1993. \"A-\" is the fourth highest of A.M. Best's ratings.\nDuring 1994, Standard & Poor's assigned its \"AA+\" rating to the claims-paying ability of Argonaut Insurance and its pooled subsidiaries.\nEMPLOYEES\nAt December 31, 1994, the Company employed 631 full-time employees. Of this total, Argonaut Insurance employed 523 people (389 professional managerial and 134 clerical\/operational). Great Central employed 94 people (56 professional managerial and 38 clerical\/operational). Argonaut Group employed 14 people (11 professional managerial and 3 clerical\/operational). The Company is not a party to any collective bargaining agreements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nArgonaut Insurance's headquarters are located in a facility which consists of an office building on approximately two acres of land in Menlo Park, California. Great Central's headquarters are located in a facility in Peoria, Illinois. Argonaut Insurance and Great Central own the buildings in which their headquarters are located. In addition, the Company has entered into short term leases in conjunction with its operations at various locations throughout the country. The Company believes that its properties are adequate for its present needs.\nItem 3","section_3":"Item 3 LEGAL PROCEEDINGS\nThe insurance subsidiaries of Argonaut Insurance are parties to various legal proceedings which are considered routine and incidental to their business and are not material to the Company's 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 Argonaut Group'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\nMARKET INFORMATION\nThe Company's common stock is traded in the over-the-counter market and is included in the NASDAQ National Market System. The closing price on February 28, 1995 was $30.750 per share. The information on high and low common stock prices set forth under the caption \"Common Stock Market Prices\" in the Annual Report to Shareholders of Argonaut Group for the fiscal year ended December 31, 1994, is incorporated herein by reference. See Exhibit Index.\nHOLDERS OF COMMON STOCK\nThe number of holders of record of the Company's Common Stock as of February 28, 1995 was 10,291.\nDIVIDENDS\nThe information set forth under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition - Liquidity and Capital Resources\" in the Annual Report to Shareholders of Argonaut Group for the fiscal year ended December 31, 1994 and in \"Note 6 - Shareholders' Equity\" in the Notes to the Consolidated Financial Statements of the Annual Report, is incorporated herein by reference. See Exhibit Index.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe information set forth under the caption \"Selected Financial Data\" in the Annual Report to Shareholders of Argonaut Group for the fiscal year ended December 31, 1994, is incorporated herein by reference. See Exhibit Index.\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 Results of Operations and Financial Condition\" in the Annual Report to Shareholders of Argonaut Group for the fiscal year ended December 31, 1994, is incorporated herein by reference. See Exhibit Index.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Report of Independent Public Accountants and consolidated financial statements and related notes of Argonaut Group, Inc. and subsidiaries listed on the index to financial statements set forth in Item 14(a)1 of this Form 10-K Report are incorporated herein by reference to the Annual Report to Shareholders of Argonaut Group for the fiscal year ended December 31, 1994.\nThe Company does not identify each asset with any one line of business and any such allocation would be arbitrary.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated herein by reference is the information appearing under the captions \"Election of Directors\", \"Executive Officers\", and \"Security Ownership of Principal Shareholders and Management\" in the registrant's Proxy Statement to be filed with the Securities and Exchange Commission relating to the registrant's Annual Meeting of Shareholders to be held on April 25, 1995.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nIncorporated herein by reference is the information appearing under the captions \"Compensation of Executive Officers\", \"Indemnity Agreements\", \"Pension Plan\", and \"Compensation of Directors\" in the registrant's Proxy Statement to be filed with the Securities and Exchange Commission relating to the registrant's Annual Meeting of Shareholders to be held on April 25, 1995.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated herein by reference is the information appearing under the caption \"Security Ownership of Principal Shareholders and Management\" in the registrant's Proxy Statement to be filed with the Securities and Exchange Commission relating to the registrant's Annual Meeting of Shareholders to be held on April 25, 1995.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated herein by reference is the information appearing under the caption \"Compensation and Stock Option Committee Interlocks and Insider Participation\" in the registrant's Proxy Statement to be filed with the Securities and Exchange Commission relating to the registrant's Annual Meeting of Shareholders to be held on 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\nSelected Financial Data\nReport of Independent Public Accountants\nConsolidated Balance Sheets - December 31, 1994 and 1993\nConsolidated 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 Year Ended December 31, 1994, 1993, and 1992\nNotes to Consolidated Financial Statements\nQuarterly Financial Data (Unaudited)\nCommon Stock Market Prices (Unaudited)\nManagement's Discussion and Analysis of Results of Operations and Financial Condition\n(a)2. Financial Statement Schedules\nReport of Independent Public Accountants on Schedules\nSchedule I - Condensed Financial Information of Registrant December 31, 1994 and 1993\nSchedule V - Supplementary Insurance Information December 31, 1994, 1993, and 1992\nAll other schedules and notes specified under Regulation S-X are omitted because they are either not applicable, not required, or the information called for therein appears in response to the items of Form 10-K or in the financial statements or notes thereto.\n(a)3. Exhibits\nThe following exhibits are numbered in accordance with Item 601 of Regulation S- K and, except as noted, are filed herewith.\n2. Information Statement of Registrant (incorporated by reference to the Exhibit 2 to the Registrant's Form 10 Registration Statement dated September 3, 1986, filed with the Securities and Exchange Commission on September 4, 1986).\n3.1 Certificate of Incorporation of Registrant (incorporated by reference to the Exhibit 3.1 to the Registrant's Form 10 Registration Statement dated September 3, 1986, filed with the Securities and Exchange Commission on September 4, 1986).\n3.2 Bylaws of the Registrant (incorporated by reference to the Exhibit 3.2 to the Registrant's Form 10 Registration Statement dated September 3, 1986, filed with the Securities and Exchange Commission on September 4, 1986).\n10.1 Argonaut Group, Inc. 1986 Stock Option Plan (incorporated by reference to the Exhibit 10.1 to the Registrant's Form 10 Registration Statement dated September 3, 1986, filed with the Securities and Exchange Commission on September 4, 1986).\n10.2 Argonaut Group, Inc. Retirement Plan (incorporated by reference to the Exhibit 10.2 to the Registrant's Form 10 Registration Statement dated September 3, 1986, filed with the Securities and Exchange Commission on September 4, 1986).\n10.3 Tax Agreement by and among Registrant and its subsidiaries and Teledyne, Inc. (incorporated by reference to the Exhibit 10.3 to the Registrant's Form 10 Registration Statement dated September 3, 1986, filed with the Securities and Exchange Commission on September 4, 1986).\n10.4 1986 Stock Option Plan, as amended (incorporated by reference to the Exhibit 4.3 to the Registrant's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on February 13, 1987).\n10.5 401(k) Retirement Savings Plan (incorporated by reference to the Exhibit 10.4 to the Registrant's Form 10-K filed with the Securities and Exchange Commission on February 28, 1989).\n10.6 Employee Stock Investment Plan (incorporated by reference to the Exhibit 4.3 to the Registrant's Registration Statement on Form S-8 filed with the Securities and Exchange Commission on October 10, 1989).\n13. The following materials are excerpted from the Annual Report to Shareholders of Argonaut Group, Inc. for the fiscal year ended December 31, 1994:\na) Selected Financial Data b) Financial Statements c) Common Stock Market Prices d) Management's Discussion and Analysis of Results of Operations and Financial Condition\n21. Subsidiaries of Registrant (incorporated by reference to the Exhibit 21 to the Registrant's Form 10 Registration Statement dated September 3, 1986, filed with the Securities and Exchange Commission on September 4, 1986).\n23. Consent of Independent Public Accountants\n27. Financial Data Schedule for December 31, 1994 Form 10-K\n28P. Combined Statutory Schedule P of Argonaut Insurance Company and Great Central Insurance Company\n(b) Reports on Form 8-K\nThere were no Reports filed on Form 8-K 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 registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nARGONAUT GROUP, INC.\nBy \/s\/ Charles E. Rinsch -------------------------- Charles E. Rinsch President\nDate: 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 dates indicated.\nSignature Title Date - --------- ----- ----\n\/s\/ Charles E. Rinsch President, Chief Executive March 17, 1995 - ---------------------- Officer, and Director Charles E. Rinsch\n\/s\/ James B Halliday Vice President, Secretary, March 17, 1995 - ---------------------- and Treasurer (principal James B Halliday financial and accounting officer)\n\/s\/ George A. Roberts Director March 17, 1995 - ---------------------- George A. Roberts\n\/s\/ Henry E. Singleton Director March 17, 1995 - ---------------------- Henry E. Singleton\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo the Shareholders of Argonaut Group, Inc.\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Argonaut Group, Inc.'s annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 5, 1995. Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed in Part IV, Item 14(a)(2) are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in our audit of the basic consolidated financial statements and, in our opinion, are fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nSan Francisco, California January 5, 1995\nARGONAUT GROUP, INC. SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT ($ in millions)\nBALANCE SHEET December 31, 1994 1993 ------ ------ Assets Short-term investments $ - $ 9.8 Cash & cash equivalents 0.6 4.7 Investment in subsidiary 609.0 556.0 Cost in excess of net assets purchased 46.6 49.4 Deferred Federal income taxes receivable 87.6 105.6 Due from\/to subsidiaries (10.5) 3.7 Other assets 10.5 2.5 ------ ------ $743.8 $731.7 ====== ======\nLiabilities & Shareholders' Equity Income taxes payable (receivable) $ (1.8) $ (3.2) Other liabilities - 5.3 Shareholders' equity 745.6 729.6 ------ ------ $743.8 $731.7 ====== ======\nSTATEMENT OF OPERATIONS For The Year Ended December 31, 1994 1993 1992 ------ ------ ------ Revenues $ 3.2 $ 3.1 $ 3.2\nExpenses: Amortization of cost in excess of net assets 2.8 2.8 2.8 Other expenses 4.1 7.7 3.2 ------ ------ ------ Loss before tax and undistributed earnings (3.7) (7.4) (2.8) Provision for income taxes 14.8 (0.8) 5.7 ------ ------ ------ Net loss before equity in earnings of subsidiary (18.5) (6.6) (8.5) Equity in earnings of subsidiary 95.2 95.7 94.8 ------ ------ ------ Income before cumulative effect of change in accounting for income taxes 76.7 89.1 86.3 Cumulative effect of change in accounting for income taxes - - 61.8 ------ ------ ------ Net Income $ 76.7 $ 89.1 $148.1 ====== ====== ======\nARGONAUT GROUP, INC. SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT ($ in millions)\nSTATEMENT OF CASH FLOWS For The Year Ended December 31, 1994 1993 1992 ------ ------ ------ Cash flows from operating activities: Net income $ 76.7 $ 89.1 $148.1 Adjustments to reconcile net income to net cash provided by operations: Cumulative effect of change in accounting for income taxes - - (61.8) Amortization 2.8 2.8 2.8 Earnings in subsidiary (95.2) (95.7) (94.8) Dividend from subsidiary 31.6 31.5 31.5 Decrease in deferred Federal income taxes receivable 18.0 7.7 5.7 Decrease (increase) in due from\/ to subsidiaries 14.2 (2.5) (0.2) Decrease in income taxes payable 1.4 (8.1) (0.8) Other, net (13.1) 6.9 (0.2) ------ ------ ------ 36.4 31.7 30.3 ------ ------ ------ Cash flows from investing activities: Decrease (increase) in short-term investments 9.8 (9.8) - ------ ------ ------ 9.8 (9.8) - ------ ------ ------ Cash flows from financing activities: Repurchase of common stock (21.9) - (24.5) Payment of cash dividend (28.7) (24.6) (20.8) Exercise of stock options 0.3 1.1 0.5 ------ ------ ------ (50.3) (23.5) (44.8) ------ ------ ------ Increase (decrease) in cash & cash equivalents (4.1) (1.6) (14.5) Cash & cash equivalents, beginning of period 4.7 6.3 20.8 ------ ------ ------ Cash & cash equivalents, end of period $ 0.6 $ 4.7 $ 6.3 ====== ====== ======","section_15":""}
{"filename":"795748_1994.txt","cik":"795748","year":"1994","section_1":"Item 1. Business\nBalcor\/Colonial Storage Income Fund - 86 (the \"Registrant\") is a limited partnership formed in May 1986 under the laws of the State of Illinois, which raised $64,226,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of income-producing mini-warehouse and office\/warehouse facilities, and all financial information included in this report relates to that industry segment.\nThe principal purpose of the Registrant is to acquire and develop, own, maintain, operate, lease and hold for capital appreciation and current income, mini-warehouse facilities offering storage space for business and personal use and office\/warehouses offering a combination of office and commercial warehouse space. The Registrant acquired four mini-warehouse properties in 1986 and seven mini-warehouse properties in 1987, from affiliates of one of the General Partners. In addition, the Registrant acquired from non-affiliated entities four mini- warehouse facilities in 1987 and nine mini-warehouse facilities in 1988.\nThe Partnership Agreement provides that the proceeds of any sale, financing, or refinancing, will not be reinvested in new acquisitions, except that net proceeds may be used to purchase or finance improvements or additions to the Registrant's properties.\nThe real estate industry continues to experience cyclical downturns in many cities and regions of the country. Historically, 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 devaluation of real estate in particular markets. In light of the competitiveness in the rental markets, the General Partners' goals have been to maintain high occupancy levels, while increasing rents where possible, and to monitor and control operating expenses and capital improvements.\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 Partners are not aware of any potential liability due to environmental issues or conditions that would be material to the Registrant.\nThe officers, directors, and employees of Balcor Storage Partners-86 and Colonial Storage 86, Inc., the General Partners of the Registrant, and their affiliates perform certain services for the Registrant. The Registrant currently has 18 full time and 45 part-time 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 properties described below:\nNet Rentable Land Area No. of Area (Square Rentable Location (Acres) Feet) Spaces\n201 Cobb Parkway Marietta, Georgia 3.1 47,980 431\n6390 Winchester Road Memphis, Tennessee 2.3 39,444 360\n5675 Summer Avenue Memphis, Tennessee (1) 2.4 46,010 377\n2064 Briarcliff Atlanta, Georgia (2) 2.8 45,700 174\n4333 Jackson Drive Garland, Texas 3.1 72,572 612\n321 East Buckingham Road Garland, Texas 2.1 40,701 299\n3218 South Garnett Road Tulsa, Oklahoma 3.7 57,540 464\n5708 Fort Caroline Road Jacksonville, Florida 3.7 67,925 768\n3401 Avenue K Plano, Texas (3) 4.7 87,654 897\n4301 and 4324 Poplar Level Road Louisville, Kentucky 4.2 81,982 798\n2719 Morse Road Columbus, Ohio 4.3 62,190 518\n5036 Cleveland Avenue Fort Myers, Florida 5.0 65,086 583\n3281 Western Branch Boulevard Chesapeake, Virginia 5.5 75,201 747\n2300 Kangaroo Drive Durham, North Carolina 4.0 47,502 657\n28 W 650 Roosevelt Road Winfield, Illinois (4) 5.6 48,145 550\n1131 Semoran Boulevard Casselberry, Florida 3.9 67,159 641\n36 Pine Knoll Road Greenville, South Carolina (5) 4.2 50,325 446\n750 East Third Street Lexington, Kentucky 3.3 55,700 450\n1900 U.S. Highway 19 South Tarpon Springs, Florida 5.4 80,732 748\n7415 West Dean Road Milwaukee, Wisconsin (6) 11.7 205,190 1,107\nW229 N590 Foster Court and N5 W22966 Bluemound Road Waukesha, Wisconsin (7) 3.0 49,632 219\n3120 Breckenridge Lane Louisville, Kentucky 2.1 34,490 329\n2275 South Semoran Boulevard Orlando, Florida 1.9 30,050 345\n11195 Alpharetta Highway Roswell, Georgia 9.1 113,310 680\n(1) The property consists of 374 units of mini-warehouse space and 3 units of office\/warehouse space.\n(2) The property consists of 156 units of mini-warehouse space and 18 units of office\/warehouse space.\n(3) The property consists of 855 units of mini-warehouse space and 42 paved parking spaces.\n(4) The property consists of 455 units of mini-warehouse space and 95 parking spaces.\n(5) The property consists of 433 units of mini-warehouse space and 13 units of office\/warehouse space.\n(6) The property consists of 694 units of mini-warehouse space and 413 paved parking spaces.\n(7) The property consists of 209 units of mini-warehouse space and 10 units of office\/warehouse space.\nIn the opinion of the General Partners, the Registrant has provided for adequate insurance coverage for its real estate investment properties.\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 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. For information regarding previous distributions, see Statements of Partners' Capital, page, and Item 7. 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 8,961.\nItem 6.","section_6":"Item 6. Selected Financial Data\nYear Ended December 31 1994 1993 1992 1991 1990\nRental income $ 8,385,428 7,703,850 7,174,918 6,837,782 6,620,103\nInterest income $ 96,709 59,644 76,739 133,419 174,879\nNet income $ 3,909,878 3,149,115 2,650,263 2,338,757 2,403,443\nNet income per Limited Partnership Interest $ 15.07 12.14 10.21 9.01 9.26\nTaxable income $ 4,243,760 3,483,158 3,019,741 2,737,570 2,789,741\nTaxable income per Limited Partnership Interest $ 16.35 13.42 11.64 10.55 10.75\nCash and cash equivalents $ 3,242,344 2,648,551 2,611,021 2,391,363 2,432,503\nTotal mini- warehouse properties, net of accumulated depreciation $ 43,075,131 44,253,257 45,388,343 46,764,159 48,100,702\nTotal assets $ 46,504,585 47,121,971 48,385,013 49,914,775 51,645,621\nDistributions to Limited Partners $ 4,596,013 4,385,352 4,236,355 4,141,081 4,411,042\nDistributions per Limited Partnership Interest $ 17.89 17.07 16.49 16.12 17.17\nProperties owned on December 31 24 24 24 24 24\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nSummary of Operations\nImproved market conditions in cities where many of Balcor\/Colonial Storage Income Fund-86's (the \"Partnership\") properties are located as well as increased rental income resulting from ongoing capital improvement programs were primarily responsible for the increases in net income generated by the Partnership in 1994, 1993 and 1992. No material events occurred during these periods which significantly impacted the net income of the Partnership. Further discussion of the Partnership's operations is summarized below.\nOperations\n1994 Compared to 1993\nRental income increased during 1994 as compared to 1993 due to increased occupancies and rental rates, particularly in Kentucky, Tennessee, Georgia and Florida. As a result of this increase, property management fees also increased during this period.\nDue to higher interest rates and amounts available for investment, interest income on short term investments increased during 1994 as compared to 1993.\nIncreased payroll and maintenance expenses resulted in an increase in property operating expenses for 1994 as compared to 1993. Payroll expenses increased due to an increase in incentive payments to property managers and an increase in salary rates for new employees. Maintenance expenses increased due primarily to snow removal in February and March at sites in Wisconsin, Illinois, Ohio, Kentucky and Virginia.\nThe full amortization of non-compete agreements in 1993 resulted in a decrease in depreciation and amortization expenses in 1994 as compared to 1993.\nGeneral and administrative expenses increased during 1994 as compared to 1993 primarily due to an increase in accounting and asset management costs.\n1993 Compared to 1992\nRental income and, correspondingly, property management fees increased for 1993 as compared to 1992 due to increased occupancy levels and rental rates at certain of the Partnership's mini-warehouse facilities, particularly those located in Kentucky, Tennessee, Georgia and Virginia.\nDue to lower interest rates during 1993, interest income on short-term investments decreased during 1993 as compared to 1992.\nIncreases in legal fees and real estate taxes were the primary reasons for the increase in property operating expenses during 1993 as compared to 1992. The increase in legal expense was due to a settlement in 1992 which resulted in lower expenses for that year. Real estate taxes increased due to an increase in the assessed value and rates at certain of the Partnership's properties.\nDepreciation and amortization decreased as non-compete agreements were fully amortized during 1993.\nIncreased administrative salaries and portfolio management expenses resulted in an increase in general and administrative expenses for 1993 as compared to 1992.\nLiquidity and Capital Resources\nThe cash position of the Partnership increased from December 31, 1993 to December 31, 1994 as cash from operations exceeded distributions to Limited Partners and capital expenditures. The Partnership's cash flow provided by operating activities in 1994 was generated primarily by the operations of the mini-warehouse properties and interest income earned on the Partnership's short-term investments, which was partially offset by administrative expenses. This cash flow was used in investing activities to make capital improvements to the properties and in financing activities to provide distributions to the Limited Partners.\nIn January 1995, the Partnership paid $1,197,172 ($4.66 per Interest) to the Limited Partners, representing the distribution for the fourth quarter of 1994. Quarterly distributions increased from $4.44 per Interest for the first and second quarters of 1994 to $4.66 per Interest for the third and fourth quarters of 1994 due to improved operating results at several of the Partnership's mini-warehouse facilities. To date, the Partnership has distributed $126.31 per $250 Interest, of which $124.92 represents Net Cash Receipts and $1.39 represents Net Cash Proceeds. The General Partners believe the cash generated from property operations should enable the Partnership to continue making quarterly distributions to Limited Partners. However, the level of future cash distributions to Limited Partners will be dependent upon the amount of cash flow generated by the Partnership's properties as to which there can be no assurance. Pursuant to the Partnership Agreement, the General Partners are entitled to 10% of Net Cash Receipts available for distribution, subject to certain subordinations in the periods following the termination of the offering. From the inception of the offering through December 31, 1994, the General Partners' share of Net Cash Receipts totaled approximately $3,472,000, of which $3,135,000 is subordinated. The General Partners are entitled to receive such subordinated amounts only from distributed Net Cash Proceeds.\nThe General Partners intend to retain on behalf of the Partnership cash reserves deemed adequate to meet working capital requirements as they may arise.\nOne of the General Partners has recently completed the outsourcing of the 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. Each of these transactions occurred after extensive due diligence and competitive bidding processes. The General Partners do 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 revenue and real estate values.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee Index to Financial Statements on Page of 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 information is summarized as follows:\nDecember 31, 1994 December 31, 1993 Financial Tax Financial Tax Statements Return Statements Return\nTotal assets $ 46,504,585 57,361,197 47,121,971 57,644,701 Partners' capital accounts: General Partners $ 178,093 199,771 138,994 157,333 Limited Partners $ 45,340,046 56,174,980 46,065,280 56,679,691 Net income: General Partners $ 39,099 42,438 31,491 34,831 Limited Partners $ 3,870,779 4,201,322 3,117,624 3,448,327 Per Limited Partnership Interest $ 15.07 16.35 12.14 13.42\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 Storage Partners-86, one of the General Partners, has a Board of Directors.\nThe other General Partner, Colonial Storage 86, Inc., has a Board of Directors. The sole member is James R. Pruett (see b, c, e, & f below) who has been a director since the formation of Colonial Storage 86, Inc.\n(b,c, &e) The names, ages, and business experience of the executive officers and significant employees of the General Partners of the Registrant are as follows:\nBalcor Storage Partners-86\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. Alexander 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.\nColonial Storage 86, Inc.\nName Title\nJames R. Pruett President, Vice President, Director James N. Danford Secretary, Treasurer\nJames R. Pruett (September 1942) received his Bachelor of Science degree from McMurry College in Abilene, Texas, in 1965. He is the president, sole director, and sole shareholder of James R. Pruett, Inc., one of the corporate general partners of Colonial Storage Centers Group, Colonial Storage Centers Group II, and Colonial Storage Centers Group III, the managing general partner of Colonial Storage Centers I, Ltd. (Colonial I), Colonial Storage Centers II, Ltd. (Colonial II) and Colonial Storage Centers III, Ltd. (Colonial III), respectively. Mr. Pruett is also President and a Director of Colonial Storage 85, Inc., which serves as a General Partner of Balcor\/Colonial Storage Income Fund - 85 (BCSIF-85). Mr. Pruett developed the first Atlanta, Georgia, Colonial Self Storage mini-warehouse facility in 1972. Since that time, he has handled substantially all business aspects of mini-warehouse development, construction, operation, and management. Mr. Pruett has directed the site selection and development or acquisition of numerous locations for mini-warehouses and office warehouses, including the facilities of Colonial I, Colonial II and Colonial III. Mr. Pruett is President and a Director of Colonial Storage Management, Inc. (\"CSM\"), Colonial Properties Management, Inc. (\"CPM\"), Colonial Storage Management 85, Inc.(\"CSM- 85), and Colonial Storage Management 86, Inc.(\"CSM-86), which manage the properties of Colonial I and Colonial II, Colonial III, BCSIF-85, and the Registrant, respectively.\nJames N. Danford (January 1959) received his Bachelor of Business Administration degree from The University of Texas at Arlington. Mr. Danford was a senior accountant with a public accounting firm prior to joining Colonial Storage Centers in June of 1986. Mr. Danford is a Certified Public Accountant, member of the Texas Society of Certified Public Accountants, and is chief financial officer of CSM-86, Colonial I, Colonial II, Colonial III, Registrant, BCSIF-85, CSM, CPM, and CSM-85.\nThe sole director of Colonial Storage 86, Inc. is not a director in any company with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934 or subject to the requirements of Section 15 (b) of the Act or any company registered as an investment company under the Investment Company Act of 1940, but is a director of four other corporations which act as general partners of limited partnerships which have a class of securities registered pursuant to Section 12 of the Act.\n(d) There is no family relationship between any of the foregoing officers or director.\n(f) To the best of the Registrant's knowledge, there have been no events under any bankruptcy act, no criminal proceedings, and no judgements or injunctions material to the evaluation of the ability and integrity of any current director or executive officer of Colonial Storage Management 86, Inc., Colonial Storage 86, Inc., or any current executive officer of Balcor Storage Partners-86, during the past five years.\nItem 11.","section_11":"Item 11. Executive Compensation\n(a,b,c, d&e) The Registrant has not paid and does not propose to pay any remuneration to the executive officers and directors of the General Partners. Certain of these officers receive compensation from The Balcor Company and Colonial Storage 86, Inc. (but not from the Registrant) for services performed for various affiliated entities, which may include services performed for the Registrant. However, the General Partners believe that any such compensation attributable to services performed for the Registrant is immaterial to the Registrant. See Note 3 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 Storage Partners-86 and Colonial Storage 86, Inc. and their officers and director own no Limited Partnership Interests in the Registrant.\nRelatives and affiliates of the officers or director of the General Partners own twenty Limited Partnership Interests in the Registra- nt.\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 1 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\nSee Note 2 of Notes to Financial Statements for additional 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 on page of this Form 10-K.\n(3) Exhibits:\n(3) The Amended and Restated Agreement and Certificate of Limited Partnership set forth as Exhibit 3 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated October 10, 1986, (Registration No. 33-6669) is incorporated herein by reference.\n(4) Form of Subscription Agreement previously filed as Exhibit 4.1 included in the Amendment No. 1 to the Registrant's Registration Statement on Form S-11, dated October 10, 1986, (Registration No. 33-6669) and 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. 0-15639) are incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for the year ended December 31, 1994 is attached hereto.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed by the Registrant 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 on Page of this Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALCOR\/COLONIAL STORAGE INCOME FUND -86\nBy: \/s\/ James N. Danford James N. Danford Secretary\/Treasurer (Principal Financial and Accounting Officer) of Colonial Storage 86, Inc., a General Partner Date: 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 Title Date\nPresident and Chief Executive Officer (Principal Executive Officer) of Balcor \/s\/ Thomas E. Meador Storage Partners-86, a General Partner March 28, 1995 Thomas E. Meador\nExecutive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor Storage Partners-86, \/s\/ Allan Wood a General Partner March 28, 1995 Allan Wood\nPresident and Director of Colonial \/s\/ James Pruett Storage 86 Inc., a General Partner March 28, 1995 James Pruett\nSecretary\/Treasurer (Principal Financial and Accounting Officer) of Colonial \/s\/ James N. Danford Storage 86, Inc., a General Partner March 28, 1995 James N. Danford\nPages\nIndependent Auditors' Report\nFinancial Statements:\nBalance Sheets as of December 31, 1994 and 1993\nStatements of Income, years ended December 31, 1994, 1993 and 1992\nStatements of Partners' Capital, years ended December 31, 1994, 1993 and 1992\nStatements of Cash Flows, years ended December 31, 1994, 1993 and 1992\nNotes to Financial Statements to\nSchedules are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein.\nFinancial Statements and Supplementary Data\nINDEPENDENT AUDITORS' REPORT\nThe Partners Balcor\/Colonial Storage Income Fund - 86:\nWe have audited the financial statements of Balcor\/Colonial Storage Income Fund - 86 (an Illinois Limited Partnership) as listed in the accompanying index. 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, the financial statements referred to above present fairly, in all material respects, the financial position of Balcor\/Colonial Storage Income Fund - 86 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.\nKPMG Peat Marwick LLP\nFort Worth, Texas February 9, 1995\nBalcor\/Colonial Storage Income Fund - 86 (An Illinois Limited Partnership)\nBalance Sheets\nDecember 31, 1994 and 1993\n1994 1993 Assets Cash and cash equivalents $ 3,242,344 2,648,551 Accounts receivable, net of allowance for doubtful accounts of $20,781 and $23,136 in 1994 and 1993, respectively 72,413 82,903 Other 114,697 137,260 3,429,454 2,868,714\nMini-warehouse facilities, at cost: Land 16,925,647 16,925,647 Buildings 36,456,425 36,184,971 Furniture, fixtures and equipment 815,712 757,211 54,197,784 53,867,829 Less accumulated depreciation 11,122,653 9,614,572 Mini-warehouse facilities, net of accumulated depreciation 43,075,131 44,253,257 $ 46,504,585 47,121,971\nLiabilities and Partners' Capital Accounts payable $ 11,086 18,149 Due to affiliates (note 2) 154,794 51,913 Accrued liabilities, principally real estate taxes 382,684 394,271 Security deposits 93,321 130,736 Deferred income 344,561 322,628 Total liabilities 986,446 917,697 Partners' capital (256,904 Limited Partnership Interests issued and outstanding) 45,518,139 46,204,274 $ 46,504,585 47,121,971\nSee accompanying notes to financial statements.\nBalcor\/Colonial Storage Income Fund - 86 (An Illinois Limited Partnership)\nStatements of Income\nYears ended December 31, 1994, 1993 and 1992\n1994 1993 1992 Income: Rental $ 8,385,428 7,703,850 7,174,918 Interest 96,709 59,644 76,739 8,482,137 7,763,494 7,251,657\nExpenses: Property operating 2,207,178 2,118,600 2,032,809 Depreciation and amortization 1,508,081 1,704,614 1,853,239 Property management fees (note 2) 477,153 447,627 419,535 General and administrative (note 2) 379,847 343,538 295,811 4,572,259 4,614,379 4,601,394 Net income $ 3,909,878 3,149,115 2,650,263 Limited Partners' share of net income ($15.07, $12.14 and $10.21 per Interest for 1994, 1993 and 1992, respectively) $ 3,870,779 3,117,624 2,623,760 General Partners' share of net income 39,099 31,491 26,503 $ 3,909,878 3,149,115 2,650,263\nSee accompanying notes to financial statements.\nBalcor\/Colonial Storage Income Fund - 86 (An Illinois Limited Partnership)\nStatements of Partners' Capital\nYears ended December 31, 1994, 1993 and 1992\nLimited General Partners Partners Total\nBalance at December 31, 1991 $ 48,945,603 81,000 49,026,603\nNet income 2,623,760 26,503 2,650,263\nCash distributions ($16.49 per Interest) (4,236,355) - (4,236,355)\nBalance at December 31, 1992 47,333,008 107,503 47,440,511\nNet income 3,117,624 31,491 3,149,115\nCash distributions ($17.07 per Interest) (4,385,352) - (4,385,352)\nBalance at December 31, 1993 46,065,280 138,994 46,204,274\nNet income 3,870,779 39,099 3,909,878\nCash distributions ($17.89 per Interest) (4,596,013) - (4,596,013)\nBalance at December 31, 1994 $ 45,340,046 178,093 45,518,139\nSee accompanying notes to financial statements.\nBalcor\/Colonial Storage Income Fund - 86 (An Illinois Limited Partnership)\nStatements of Cash Flows\nYears ended December 31, 1994, 1993 and 1992\n1994 1993 1992 Operating activities: Net income $ 3,909,878 3,149,115 2,650,263 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,508,081 1,704,614 1,853,239 Net change in: Net accounts receivable 10,490 12,330 5,558 Other assets 22,563 (50,844) 38,546 Accounts payable (7,063) 7,442 (2,067) Due to affiliates 102,881 10,402 (10,748) Accrued liabilities (11,587) (63,197) 85,111 Security deposits (37,415) (27,874) (9,402) Deferred income 21,933 46,422 (6,564) Net cash provided by operating activities 5,519,761 4,788,410 4,603,936\nInvesting activities: Additions to mini-warehouse facilities (329,955) (365,528) (147,923) Net cash used in investing activities (329,955) (365,528) (147,923)\nFinancing activities: Distributions to Limited Partners (4,596,013) (4,385,352) (4,236,355) Net cash used in financing activities (4,596,013) (4,385,352) (4,236,355)\nNet change in cash and cash equivalents 593,793 37,530 219,658 Cash and cash equivalents at beginning of year 2,648,551 2,611,021 2,391,363 Cash and cash equivalents at end of year $ 3,242,344 2,648,551 2,611,021\nSee accompanying notes to financial statements.\nBalcor\/Colonial Storage Income Fund - 86 (An Illinois Limited Partnership)\nNotes to Financial Statements\nDecember 31, 1994, 1993 and 1992\n(1) Summary of Significant Accounting Policies\n(a) Description of Partnership\nBalcor\/Colonial Storage Income Fund - 86 (the \"Partnership\"), is a limited partnership formed in May 1986. The Partnership Agreement provides that Balcor Storage Partners-86 (an Illinois general partnership) and Colonial Storage 86, Inc. (a Texas corporation) are the General Partners of the Partnership and provides for the admission of Limited Partners through the sale of up to 400,000 Limited Partnership Interests at $250 per Interest, of which 256,904 ($64,226,000) Limited Partnership Interests were sold prior to the termination of the offering.\nThe principal purpose of the Partnership is to acquire, develop, own, maintain, operate, lease and hold for capital appreciation and current income, mini-warehouse facilities offering storage space for business and personal use and office\/warehouses offering a combination of office and commercial warehouse space. The Partnership acquired from affiliates four mini-warehouse facilities in 1986 and seven mini-warehouse facilities in 1987. Additionally, the Partnership acquired from nonaffiliated parties four mini- warehouse facilities in 1987 and nine mini-warehouse facilities in 1988.\n(b) Allocation of Net Income and Profits\nThe Partnership Agreement provides that net income (after a deduction for any incentive management fees) from operations shall be allocated 99% and 1% to the Limited Partners and General Partners, respectively.\nAdditionally, when a property is sold or otherwise disposed of, the General Partners will be allocated profits equal to the greater of 1% of total profits or the amount of Net Cash Proceeds distributable to the General Partners from the sale (in excess of subordinated Net Cash Receipts, note 1(c)).\nThe remainder of the profits will be allocated to the Limited Partners.\nBalcor\/Colonial Storage Income Fund - 86 (An Illinois Limited Partnership)\nNotes to Financial Statements\n(c) Cash Distributions\nNet Cash Receipts available for distribution from operations shall be distributed 90% to the Limited Partners and 10% to the General Partners, 9% as a partnership incentive management fee and 1% as their distributable share from operations. Distributions from operations to the General Partners are subordinated to receipt by the Limited Partners of a Cumulative Distribution of 6% of Adjusted Original Capital ($63,868,903 at December 31, 1994) during the first twelve month period following the termination of the offering of Interests, 8% during the second twelve month period following the termination of the offering of Interests, and 10% during each twelve month period thereafter.\nNet Cash Proceeds from sales or refinancings shall be distributed first to the Limited Partners until they have received an amount equal to their Original Capital plus any deferred portion of the Cumulative Distribution. If the receipt of any portion of the General Partners' 10% share of Net Cash Receipts from operations has been deferred (approximately $3,135,000 has been deferred as of December 31, 1994), then available Net Cash Proceeds shall thereafter be distributed to the General Partners to the extent of such deferred amounts. Thereafter, remaining Net Cash Proceeds shall be distributed 85% to the Limited Partners and 15% to the General Partners.\n(d) Cash and Cash Equivalents\nThe Partnership considers all highly liquid investments with maturities at date of purchase of three months or less to be cash equivalents.\n(e) Mini-Warehouse Facilities\nCosts associated with the appraisal and acquisition of mini- warehouse facilities are capitalized.\nThe buildings, furniture, fixtures and equipment are depreciated using the straight-line method over their estimated useful lives ranging from 5 to 25 years.\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\nBalcor\/Colonial Storage Income Fund - 86 (An Illinois Limited Partnership)\nNotes to Financial Statements\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 Partners determine that a permanent impairment in value has occurred, the carrying basis of the property is reduced to its estimated fair value.\nWhen properties are disposed of, the related costs and accumulated depreciation will be removed from the respective accounts, and any gain or loss on disposition will be recognized in accordance with generally accepted accounting principles.\n(f) Income Taxes\nTaxable income or loss of the Partnership is includable in the income tax returns of the individual partners; therefore, no provision for income taxes has been made in the accompanying financial statements.\nThe tax bases of the Partnership's assets and liabilities exceeded the amounts recorded in the Financial Statements at December 31, 1994 and 1993, by $10,856,612 and $10,522,730, respectively.\nBalcor\/Colonial Storage Income Fund - 86 (An Illinois Limited Partnership)\nNotes to Financial Statements\n(2) Transactions With Affiliates\nThe Partnership has an agreement with Colonial Storage Management 86, Inc., an affiliate of Colonial Storage 86, Inc., a General Partner, to supervise and direct the business and affairs associated with the mini- warehouse and office\/warehouse facilities for a fee of 6% and 5%, respectively, of the gross revenues of the facilities.\nFees and expenses paid and payable by the Partnership to affiliates for the years ended December 31, 1994, 1993 and 1992, are:\n1994 1993 1992 Paid Payable Paid Payable Paid Payable\nProperty management fees $ 396,555 118,743 444,086 38,145 421,204 34,604\nGeneral and administrative expenses $ 226,199 36,051 218,301 13,768 171,804 6,907","section_15":""}
{"filename":"109710_1994.txt","cik":"109710","year":"1994","section_1":"ITEM 1. BUSINESS\nClark Equipment Company, a Delaware corporation, is the successor to certain corporations the first of which was organized on December 24, 1902. Unless the context otherwise indicates, the terms \"Registrant\", \"Clark\" and \"Company\" when used in this Form 10-K refer to Clark Equipment Company and its consolidated subsidiaries.\nDescription of Business\nClark's business is the design, manufacture and sale of compact construction machinery, asphalt paving equipment, axles and transmissions for off-highway equipment and golf cars and utility vehicles.\nSkid steer loaders, compact excavators and a limited line of agricultural equipment are manufactured by Clark's Melroe Company Business Unit (\"Melroe\") which is headquartered in Fargo, North Dakota. Off-highway axles and transmissions are manufactured by the Company's Clark Hurth Components Company Business Unit (\"Clark Hurth\") which is headquartered in Statesville, North Carolina. Asphalt paving equipment is manufactured by the Company's subsidiary Blaw-Knox Construction Equipment Corporation (\"Blaw-Knox\") which is headquartered in Mattoon, Illinois. Golf cars and utility vehicles are manufactured by the Company's subsidiary, Club Car, Inc. (\"Club Car\") which is headquartered in Martinez, Georgia.\nOn March 13, 1995, the Company acquired 9,461,810 shares of Club Car, representing approximately 99% of the outstanding shares, for a cash price of $25 per share pursuant to a tender offer initiated by the Company on February 8, 1995. Club Car is one of the largest manufacturers of golf cars and light utility vehicles in the world and had sales in its fiscal year ending on September 25, 1994 of approximately $186 million. On March 17, 1995, the Company completed a merger of Club Car with another wholly-owned subsidiary of the Company. Upon consummation of the merger, Club Car became a wholly-owned subsidiary of the Company, and the shareholders of Club Car who did not tender their shares became entitled to receive $25 per share. The total purchase price for Club Car was approximately $242.6 million, after taking into account amounts paid with respect to certain outstanding stock options, tax benefits related to these stock options and certain transaction expenses. The financial statements which are included in this Form 10-K do not include Club Car.\nThe Company acquired Blaw-Knox on May 13, 1994 from White Consolidated Industries, Inc. for a purchase price of approximately $145 million. The Balance Sheet and results of operations of Blaw-Knox are included in the consolidated accounts of the Company subsequent to the acquisition date.\nOn May 13, 1994, the Company completed the initial public offering of the stock of Clark Automotive Products Corporation (\"CAPCO\"). CAPCO was engaged in the business of manufacturing transmissions, primarily for on-highway applications, for sale in Brazil and North America. The Company sold approximately 91 percent of its interest in CAPCO and received net proceeds of approximately $103 million, resulting in a gain of approximately $33 million. The results of CAPCO have been deconsolidated to reflect the operations of this segment on a discontinued basis in the Statements of Income contained in this Form 10-K for all periods presented.\nVME Group N.V. (\"VME\") is a joint venture owned 50% by the Company and 50% by A.B. Volvo of Sweden (\"Volvo\"). It is engaged in the manufacture and sale of construction and earthmoving equipment. On March 5, 1995, the Company entered into an agreement to sell all of its shares of VME to Volvo for a cash purchase price of $560 million. In addition, immediately prior to the sale, VME will pay a cash dividend to the Company of $13 million. The sale of the Company's VME shares to Volvo is expected to close early in April of 1995. VME is reflected as a discontinued operation in the Statements of Income which are included in this Form 10-K for all periods presented.\nOn July 31, 1992, the Company sold all of the outstanding stock of Clark Material Handling Company (\"CMHC\"), and certain other subsidiaries which comprised its material handling equipment business, to Terex Corporation (\"Terex\") for approximately $91 million. A gain of $8.5 million was recognized on the sale which has been included in discontinued operations. CMHC is reflected as a discontinued operation in the Statements of Income which are filed as a part of this Form 10-K. As a part of the sale, Terex and CMHC assumed substantially all of the obligations of the Company relating to the CMHC operation. In the event that Terex and CMHC fail to perform or are unable to discharge any of the assumed obligations, the Company could be required to discharge such obligations. This issue is discussed in more detail in the footnote captioned \"Contingencies\" in that portion of the Company's Annual Report to Stockholders which is attached hereto as Exhibit 13.\nBacklog Orders\nThe approximate dollar backlog of orders believed to be firm was $221 million (which includes $20 million for Blaw-Knox but does not include Club Car) at December 31, 1994 and $125 million at December 31, 1993. Generally, Clark's customers may cancel their orders without incurring significant cancellation charges, and, therefore, Clark's backlog is essentially a report of the recorded intentions to purchase its products, which could change before the sales are completed. The backlog figures stated above are based on orders to Clark's factories or warehouses from Clark's independent dealers and other customers who buy directly from Clark's factories or warehouses.\nManufacturing\nMelroe products are manufactured in the United States for sale throughout the world to a wide variety of users and industries, including the construction and agricultural industries. These products are distributed under the trademarks \"Melroe\" and \"Bobcat\". In addition, Melroe products are manufactured by a licensee in Australia.\nClark Hurth products are manufactured in the United States, Belgium and Italy for sale throughout the world primarily to the construction, mining and material handling equipment industries. In addition, Clark Hurth products are manufactured by licensees in South Africa and Brazil.\nBlaw-Knox products are manufactured in the United States and England for sale throughout the world primarily to the highway construction and asphalt paving industries.\nClub Car products are manufactured in the United States for sale throughout the world in the golf, recreational, commercial and industrial markets.\nDistribution\nClark Hurth products are sold directly to customers by employee sales representatives and through manufacturers representatives and independent distributors. Melroe and Blaw-Knox products are sold primarily through independent dealers. Club Car products are sold directly to customers by employee sales representatives and through independent distributors and dealers. Clark maintains a large modern central parts warehouse in Chicago, which, in conjunction with a communications network and electronic data processing equipment, provide expeditious shipment of customers' and dealers' orders for repair and replacement parts for Melroe and VME products. Clark Hurth, Blaw-Knox and Club Car parts are distributed from their respective manufacturing facilities.\nOperations Outside the United States\nOperations outside the United States are subject to, among other things, the laws and regulations of foreign governments relating to investments, operations and currency restrictions, import and export duties and revaluations and fluctuations of currencies. Operations outside the United States are also subject to changes in governments and economic policies.\nLicense fees from licensees outside the United States and Canada, other than from consolidated subsidiaries, and dividends from associated companies aggregated approximately $0.8 million in 1994, approximately $0.3 million in 1993 and approximately $0.4 million in 1992.\nRaw Materials and Components\nThe principal raw materials and components purchased by the Company are steel; castings; engines and accessories; hydraulic motors, pumps, valves and cylinders; fabricated metal parts; fabricated plastic parts; tires and tubes; electrical equipment; drive train components; brakes and brake components; bearings; forgings; fasteners; bushings; electric motors; gears and gear blanks; screw machine products; seals; clutch plates; torque convertors; synchronizer rings; steering arms; CV joints; cardan shafts; seats; paint; sealants and adhesives; antifreeze; batteries; radiators; oil coolers; springs; shocks; chain; sprockets; glass; filters; fabricated plastic parts; injection molded plastics; control cables; aluminum extrusions; and rotational and vacuum formed plastics.\nThe items described above are purchased from a number of different suppliers, both on an individual purchase commitment basis and on a one-year blanket order basis. Multiple sources for most items are available, but substitution of engines and accessories, hydraulic motors, electrical equipment, brake assemblies, pumps, and valves, in the event they were to become unavailable from the usual sources, would in some instances require engineering modifications to the product in which they are used.\nEnergy\nClark's manufacturing operations and those of its suppliers depend to a substantial extent upon the availability of natural gas, fuel oil, propane, electricity, coal, uranium and generating capacity. Clark presently expects that its plants will be able to operate with little or no interruption resulting out of scarcity of energy through 1995.\nEngineering and Product Development\nAn engineering staff is maintained at each of the principal manufacturing facilities of Clark. These staffs are supplemented by laboratories which provide technical support for product testing, materials research and process development. Approximately 225 engineering employees (engineers, designers, draftsmen and technicians) are presently engaged full time in engineering and product development activities. Approximately $15.6 million in 1994, $17.0 million in 1993 and $14.7 million in 1992 was spent on Company-sponsored activities relating to the development of new products and the improvement of existing products for Clark's continuing operations.\nApproximately 47 employees of Club Car are presently engaged full time in engineering and product development activities. Club Car spent approximately $2.2 million, $2 million and $1.9 million on Company- sponsored engineering and product development activities during its fiscal years ending on September 25, 1994, September 26, 1993 and September 27, 1992 respectively.\nAlthough Clark owns numerous patents and has patent applications pending, its business is not materially dependent upon patent protection.\nCompetition\nClark conducts its domestic and foreign operations under highly competitive conditions and its business is subject to cyclical influences and other factors. The customers for most of Clark's products are commercial, industrial or farm users who use the products in business for profit. Product performance and parts and service availability are primary considerations for these customers in the choice among competing products. Availability of rental and financing programs and warranty policies are also important considerations. In making a purchase decision, the above factors, plus the initial selling price, the date on which delivery can be made, and the general product reputation will be considered by the purchaser, and the order will normally be placed with the seller who comes closest to satisfying the purchaser's particular requirements of all of these factors.\nMelroe is the leading producer of skid steer loaders in the United States and has approximately 9 significant competitors worldwide. Melroe also has approximately 6 significant competitors in its excavator line and 3 significant competitors in its agricultural spraying equipment product line.\nClark Hurth has approximately 19 significant competitors and is also subject to potential competition from its customers.\nBlaw-Knox is the leading producer of asphalt paving equipment in the United States and has approximately 5 significant competitors in North America and 18 significant competitors in the rest of the world.\nClub Car is one of the two largest manufacturers of golf cars and utility vehicles in the world and has approximately 5 significant competitors in each product line.\nCustomers\nThe Company is not dependent upon a single customer or a few customers, the loss of any one or more of which would have a material adverse effect on its operations.\nSeasonality\nAlthough Clark experiences slight seasonal variations in its sales of Melroe, Clark Hurth and Blaw-Knox products, Clark does not consider any material part of those businesses to be seasonal.\nClub Car's peak sales of golf cars occur during the months of February through June when units are shipped to golf clubs at the beginning of their golf season. Warm weather states, such as California and Florida, have golf seasons beginning in the fall which stimulate fleet and retail sales during the fall. Sales of Club Car's utility vehicle products occur year-round but are heavier in the spring.\nEnvironmental Compliance\nClark's facilities are subject to environmental regulation by federal, state and local authorities. In 1994, the Company spent approximately $2.1 million in connection with environmental compliance and cleanup activities. Capital expenditures for environmental control activities are not expected to be material for the remainder of 1995 and 1996. Clark is also involved in environmental cleanup activities or litigation in connection with former waste disposal sites and current and former plant locations. The Company has and will continue to make provisions for these cleanup costs as necessary and when the Company's liability can be reasonably estimated. As of December 31, 1994, the Company had reserves of $16 million for potential future environmental cleanup costs. Although the Company cannot determine whether or not a material effect on future operations is reasonably likely to occur, it believes that the recorded reserve levels are appropriate estimates of its potential liability for environmental cleanup costs. The Company further believes that the additional maximum exposure level in excess of the recorded reserve level would not be material to the financial condition of the Company. Although settlement of the reserves will cause future cash outlays, it is not expected that such outlays will materially impact the Company's liquidity position.\nEmployees\nAs of December 31, 1994, Clark employed 2,919 persons in North America and 1,491 persons outside North America. A portion of Clark's production, maintenance and warehouse employees in the United States are represented by local unions affiliated with the International Brotherhood of Teamsters, the United Automobile, Aerospace and Agricultural Implement Workers of America and the United Paperworkers International Union, which are affiliated with the AFL-CIO.\nAt the end of its fiscal year ending on September 25, 1994, Club Car had 683 full time and 160 temporary employees, none of whom were covered by a collective bargaining agreement.\nIndustry Segment and Geographic Area Discussion\nIncorporated by reference to pages 38 and 39 of that portion of the Company's Annual Report which is attached hereto as Exhibit 13.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nClark or a subsidiary of Clark owns the following principal facilities in fee, except where a lease is indicated:\nTotal Floor Space Leased Floor Space Principal Products Approximate Sq.Ft. Approximate Sq. Ft. Manufactured Plant Office Plant Office (in thousands) (in thousands) Melroe Bismarck, ND 375 48 - - Gwinner, ND 420 99 - 54 Fargo, ND - 22 - 22 Lot, Belgium 144 38 - - Other Melroe - 4 - 4 Clark Hurth Bruges, Belgium 312 19 - - Statesville, NC 423 60 18 - Buchanan, MI 52 10 13 - Arco, Italy 199 78 - - Valsugana, Italy 83 7 - - Rovereto, Italy 35 3 35 3 Blaw-Knox Mattoon, IL 347 47 - - Rochester, England 216 47 - - Manchester, England 7 - - - Coatbridge, Scotland 6 - - - Club Car Martinez, GA 273 60 - - Other - 86 - 86 Other Business Locations Corporate Headquarters- - 36 - 36 South Bend, IN Records Retention- - 15 - 15 South Bend, IN Clark Distribution Services- Chicago, IL 507 58 - - Bedford Park, IL 91 2 91 2 3,490 739 157 222\nClark owns the production equipment and machines at its plants, except for an insignificant number of items which are leased. All of Clark's principal plants and warehouse facilities are in good operating condition. In 1994, Clark sold idle facilities in Georgetown, Kentucky, Atlanta, Georgia and South Bend, Indiana.\nIn 1994 Clark's manufacturing plants (not including Club Car) operated at approximately 91% of capacity.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the Matter of Industrial Pretreatment Violations at Melroe Company, Gwinner, North Dakota\nOn October 5, 1992, the United States Environmental Protection Agency (\"EPA\") issued a Finding of Violation and Order for Compliance (\"Order\") which alleges that the Company has failed to comply with the pretreatment regulations promulgated pursuant to Section 306 and 307 of the\nClean Water Act. The Order alleges that certain metal finishing wastewaters generated at the Company's Melroe facility in Gwinner, North Dakota were discharged into the Publicly Owned Treatment Works operated by the City of Gwinner in violation of the applicable pretreatment regulations. The Order also alleges that the Company failed to comply with certain reporting requirements set forth in the pretreatment regulations. The Order requires the Company to comply with the discharge limitations for metal finishing wastewater and all related reporting requirements. The Company has taken all actions required of it under the Order.\nOn April 29, 1994, the U.S. filed suit against the Company in the United States District Court for the District of North Dakota. The complaint seeks (i) to permanently enjoin the Company to comply fully with all applicable requirements of the Act and Regulations and (ii) civil penalties against the Company of up to $25,000 per day for each violation for (a) alleged discharges of pollutants in violation of the effluent limitations contained in the pretreatment regulations, (b) failure to submit timely and complete reports and (c) a failure to sample and analyze its regulated wastewater prior to discharge into the POTW. This case is now in the discovery phase.\nThe Company believes that its liability, if any, in connection with this lawsuit is adequately covered by its reserve for environmental liabilities. The Company does not expect that this lawsuit will have a material adverse effect on the Company's financial condition, results of operations or liquidity position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nEXECUTIVE OFFICERS OF THE REGISTRANT Name of Officer and Age as of Principal Occupation Positions\/Offices March 1, Date First and Employment During Presently Held 1995 Elected Past Five Years\nLeo J. McKernan* 57 5\/22\/86 Chairman, President and Chairman, President Chief Executive Officer of and Chief Executive Clark Equipment Company. Officer\nFrank M. Sims* 62 3\/17\/87 Senior Vice President of Senior Vice President Clark Equipment Company.\nPaul R. Bowles 57 9\/22\/89 Vice President - Corporate Vice President Development of Clark Equipment Company.\nThomas L. Doepker 51 7\/13\/84 Vice President and Vice President and Treasurer of Clark Treasurer Equipment Company.\nWilliam N. Harper 50 12\/09\/86 Vice President and Vice President and Controller of Clark Controller Equipment Company.\nBernard D. Henely 51 7\/13\/84 Vice President and Vice President, General Counsel of General Counsel and Clark Equipment Company. Secretary\nDavid D. Hunter 54 10\/24\/94 President of Blaw-Knox Vice President Construction Equipment Corporation, a Business Unit of Clark Equipment Company. Prior to October 1994, Managing Director of European Operations of Clark Hurth Components Company. Prior to April 1992, Executive Vice President of Talley Industries Inc.\nJames D. Kertz 58 2\/9\/93 President of Melroe Company, Vice President a Business Unit of Clark Equipment Company. Prior to September 1992, Executive Vice President of Melroe Company.\nJohn J. Reynolds 61 8\/13\/91 President of Clark Hurth Vice President Components Company, a Business Unit of Clark Equipment Company. Prior to April 1991, President of Cherry-Burrell Corporation- automatic packaging and processing equipment. * Member of the Board of Directors of the Company. Each officer's term expires at the annual meeting of the Board of Directors on May 9, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nIncorporated by reference to page 41 of that portion of the Company's Annual Report which is attached hereto as Exhibit 13.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated by reference to page 45 of that portion of the Company's Annual Report which is attached hereto as Exhibit 13.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated by reference to pages 1 through 11 of that portion of the Company's Annual Report which is attached hereto as Exhibit 13.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated by reference to pages 12 through 38, 40 and 41 of that portion of the Company's Annual Report which is attached hereto as Exhibit 13.\nAlso see Index to Financial Statements on page 13 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\nInformation regarding the directors of the Registrant is incorporated by reference to the section in the Company's Proxy Statement which is captioned \"Identification of Nominees for Director\". Information regarding the executive officers of the Registrant 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\nIncorporated by reference to the sections in the Company's Proxy Statement which are captioned \"Executive Compensation\", \"Stock Option\/SAR Tables\", \"Executive Employment Contracts\", \"Retirement Program\", \"Director Compensation Arrangements\", and \"Stock Acquisition Plan for Non-Employee Directors\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference to the section in the Company's Proxy Statement which is captioned \"Security Ownership of Certain Beneficial Owners and Management\".\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements: Incorporated by reference to pages 12 through 45 of that portion of the Company's Annual Report which is attached hereto as Exhibit 13.\n2. Financial Statement Schedule (see index on page 13 of this report).\n3. Exhibits:\nSee Exhibit List and Index attached. Exhibits numbered (10)(a) through (10)(aa) are management contracts and compensatory plans or arrangements.\n(b) Reports on Form 8-K:\n1. The Registrant filed a Form 8-K dated October 26, 1994 reporting on Item 5, OTHER EVENTS, and Item 7, FINANCIAL STATEMENTS AND EXHIBITS.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 31st day of March 1995.\nCLARK EQUIPMENT COMPANY\nBy \/s\/ Leo J. McKernan Leo J. McKernan 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. Each person whose signature appears below hereby authorizes B. D. Henely and John J. Moran, Jr. and each of them severally, with full power in each to act without the other and with full power of substitution and resubstitution, to execute in the name of each such person, and to file any amendments to this report as the registrant deems appropriate, and appoints such persons as attorneys-in-fact to sign on his behalf individually, and in each capacity stated below, and file all amendments to this report.\nSIGNATURE TITLE DATE\n\/s\/ Leo J. McKernan Chairman, President, Chief March 31, 1995 Leo J. McKernan Executive Officer and Director (Principal Executive Officer)\n\/s\/ William N. Harper Vice President and Controller March 31, 1995 William N. Harper (Principal Financial Officer and Principal Accounting Officer)\nDirectors\n\/s\/ James C. Chapman James C. Chapman Director )\n\/s\/ Donald N. Frey Donald N. Frey Director )\n\/s\/ James A.D. Geier James A.D. Geier Director )\n\/s\/ Gaynor N. Kelley Gaynor N. Kelley Director ) March 31, 1995\n\/s\/ Ray B. Mundt Ray B. Mundt Director )\n\/s\/ Frank M. Sims Frank M. Sims Director )\nCLARK EQUIPMENT COMPANY\nThe financial statements of Clark Equipment Company and its consolidated subsidiaries, together with the report thereon of Price Waterhouse LLP dated March 6, 1995, appearing on pages 12 through 45 of that portion of the Company's 1994 Annual Report which is attached hereto as Exhibit 13, are incorporated by reference in this Form 10-K Annual Report. The following additional financial data should be read in conjunction with such financial statements. Schedules not included with this additional financial data have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nThe consolidated financial statements of VME Group N.V. (VME) and its subsidiaries have been incorporated beginning on page 16 of this report. VME, at December 31, 1994, was a joint venture owned 50 percent each by Clark Equipment Company and A.B. Volvo of Sweden. The Company has agreed to sell its shares of VME to A.B. Volvo and the sale is expected to close in early April 1995.\nFinancial statements of other unconsolidated majority owned subsidiaries and 50% or less owned persons have been omitted because the proportionate share of the pre-tax income and total assets of each such company is less than 20% of the respective amounts for the registrant and its consolidated subsidiaries, and the investment in and advances to each company is less than 20% of total assets of the registrant and its consolidated subsidiaries.\nAdditional Information: Page\nReport of Independent Accountants on Financial Statement Schedule 14\nClark Equipment Company and Consolidated Subsidiaries- Schedule II 15\nVME Group N.V. and its subsidiaries Consolidated Financial Statements and Notes to Consolidated Financial Statements 16 through 43\nReport of KPMG Bohlins AB on the Financial Statements of VME Holding Sweden AB 44 AND 45\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nBoard of Directors Clark Equipment Company South Bend, Indiana\nOur audits of the consolidated financial statements referred to in our report dated March 6, 1995 appearing in the 1994 Annual Report to Stockholders of Clark Equipment 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, 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.\n\/s\/ Price Waterhouse\nPrice Waterhouse South Bend, Indiana March 6, 1995\nVME GROUP N.V.\nCONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1994\nVME GROUP N.V.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nFINANCIAL STATEMENTS\n* Report of Independent Accountants.\n* Consolidated Balance Sheet as of December 31, 1994 and 1993.\n* Consolidated Statement of Operations for each of the years in the three year period ended December 31, 1994.\n* Consolidated Statement of Cash Flows for each of the years in the three year period ended December 31, 1994.\n* Notes to Consolidated Financial Statements.\nSUPPLEMENTAL SCHEDULE\nII Valuation and Qualifying Accounts\nSCHEDULES OMITTED\n* Other schedules required by Regulation S-X are omitted because of absence of the conditions under which they are required or because information called for is shown in the financial statements and notes thereto.\nBP America Building Telephone 216 781 3700 200 Public Square 27th Floor Cleveland, Ohio 44114-2301\nPrice Waterhouse LLP\nReport of Independent Accountants\nTo the Board of Directors and Shareholders of VME Group N.V.\nIn our opinion, based upon our audits and the report of other auditors, the accompanying consolidated balance sheet and the related consolidated statements of operations and of cash flows present fairly, in all material respects, the financial position of VME Group N.V. 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 in the United States. 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 subsidiaries, which statements reflect total assets of $489,725,000 and $412,300,000 at December 31, 1994 and 1993, respectively, and total revenues of $648,270,000, $511,000,000 and $586,800,000 for the three years in the period ended December 31, 1994, respectively. Those statements were audited by other auditors whose report thereon has been furnished to us, and our opinion expressed herein, insofar as it relates to the amounts included for these subsidiaries, is based solely on the report of the other auditors. 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 and the report of other auditors provide a reasonable basis for the opinion expressed above.\nAs discussed in Notes 3 and 19, the Company changed its method of accounting for income taxes and postretirement benefits effective January 1, 1993.\n\/s\/ Price Waterhouse LLP\nCleveland, Ohio February 27, 1995, except as to Note 24, which is as of March 6, 1995\nVME GROUP N.V.\nCONSOLIDATED BALANCE SHEET (Amounts in millions, except share and per share amounts)\nDecember 31, 1994 1993 ASSETS Current assets: Cash and cash equivalents $ 58.9 $ 36.2 Receivables 213.0 167.9 Inventories 319.7 271.2 Other assets 68.8 48.0 Total current assets 660.4 523.3\nLong-term assets: Property, plant and equipment, net 158.9 152.8 Other assets 13.8 17.9 Goodwill 120.0 84.3 Total assets $ 953.1 $ 778.3 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY\nCurrent liabilities: Accounts payable $ 142.2 $ 90.3 Short-term debt 16.5 52.2 Current portion of long-term debt 8.3 4.3 Other liabilities 242.1 152.1 Total current liabilities 409.1 298.9\nLong-term liabilities: Debt 54.5 127.1 Shareholders' loans 70.0 70.0 Pension liability 58.6 80.9 Other 40.4 23.0 Total liabilities 632.6 599.9\nCommitments and contingencies\nMinority interests 10.1 20.0\nShareholders' equity: Common stock: $516 par value - 129.0 129.0 authorized 600,000 shares; issued and outstanding 250,000 shares Paid in capital 80.9 80.9 Retained earnings (deficit) 97.9 (34.2) Cumulative translation adjustments 26.1 7.0 Pension adjustments (23.5) (24.3) Total shareholders' equity 310.4 158.4 ________ ________ Total liabilities and shareholders' equity $ 953.1 $ 778.3 ======== ======== The accompanying notes are an integral part of these financial statements.\nVME GROUP N.V.\nCONSOLIDATED STATEMENT OF OPERATIONS (Amounts in millions, except per share amounts)\nYear Ended December 31, 1994 1993 1992\nSales $1,566.0 $1,239.3 $1,357.3 Cost of sales (1,141.8) (958.0) (1,169.3) Gross profit 424.2 281.3 188.0\nSelling, general and administrative expense (226.8) (211.3) (237.4) Restructuring cost - - (18.7) Other income (expense) 12.6 (5.3) (6.6) Operating income (loss) 210.0 64.7 (74.7)\nFinancial income and expense :\nInterest income 7.7 5.8 8.4 Interest expense (18.0) (32.2) (47.0)\nInterest expense, net (10.3) (26.4) (38.6)\nIncome (loss) before income taxes, minority interests and effect of change in accounting 199.7 38.3 (113.3)\nBenefit (provision) for income taxes (66.5) (17.9) 23.4\nIncome (loss) before minority interests and effect of change in accounting 133.2 20.4 (89.9)\nMinority interests (1.1) (2.7) (3.7)\nIncome (loss) before effect of change in accounting 132.1 17.7 (93.6)\nEffect of change in accounting for income taxes - 12.3 -\nNet income (loss) $ 132.1 $ 30.0 $ (93.6) ======== ======== ========\nPer share information : Income (loss) before effect of change in accounting $ 528.40 $ 70.95 $(374.47) Effect of change in accounting for income taxes - 49.14 -\nNet income (loss) $ 528.40 $120.09 $(374.47) ========= ========= =========\nThe accompanying notes are an integral part of these financial statements.\nVME GROUP N.V. CONSOLIDATED STATEMENT OF CASH FLOWS (Amounts in millions) Year Ended December 31, 1994 1993 1992 Cash flows from operating activities: Net income (loss) $ 132.1 $ 30.0 $ (93.6) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 31.0 31.5 42.5 Effect of change in accounting for income taxes - (12.3) - (Gain) loss on sale of fixed assets and subsidiaries (1.1) 0.3 (5.3) Minority interest in net income 1.1 2.7 3.7 Undistributed losses of affiliates - 0.3 0.2 Increase (decrease) in cash flow from changes in: Receivables (12.7) (32.9) 10.0 Inventories (23.3) 21.0 75.8 Accounts payable 16.2 25.6 23.5 Accrued expenses 80.9 16.8 (11.4) Pension liability (27.9) 5.6 9.8 Deferred taxes 5.4 3.7 (36.1) Other (9.5) (6.8) 0.7 Net cash provided by operating activities 192.2 85.5 19.8 Cash flows from investing activities: Proceeds from sale of fixed assets 2.6 14.1 19.2 Capital expenditures (24.7) (21.3) (29.8) Contribution received for joint venture interest 3.2 6.0 - Sale of subsidiaries - - 2.6 Purchase of minority interest in Zettelmeyer (39.9) - - Decrease (increase) in other assets 5.2 7.4 (16.9) Net cash provided by (used in) investing activities (53.6) 6.2 (24.9)\nCash flows from financing activities: Net payments on line of credit borrowings (39.8) (178.7) (21.5) Proceeds from issuance of debt 0.1 73.0 - Debt repayment (80.9) (46.2) (59.5) Proceeds from financing arrangements - - 59.1 Proceeds from shareholders' loans - - 70.0 Capital contribution - - 30.0 Net cash provided by (used in) financing activities (120.6) (151.9) 78.1\nEffect of exchange rate changes on cash 4.7 (4.9) (4.9) Net increase (decrease) in cash and cash equivalents 22.7 (65.1) 68.1 Cash and cash equivalents, beginning of year 36.2 101.3 33.2 Cash and cash equivalents, end of year $ 58.9 $ 36.2 $ 101.3 ======= ======= ======= The accompanying notes are an integral part of these financial statements.\nVME GROUP N.V.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in millions)\nNote 1 - Basis of Presentation and Principles of Consolidation\nVME Group N.V. (the Company, VME) is a Netherlands holding company formed on March 28, 1985 to hold, together with Clark Equipment Company (Clark) and AB Volvo, the common stock of its two significant operating subsidiaries, VME Americas Inc. (VMEA), a Delaware Corporation, and VME Holding Sweden AB (VMEHS), a Swedish corporation. AB Volvo and Clark until December 22, 1993, held equal cross-ownership positions in VMEA and VMEHS. On December 22, 1993, Clark and AB Volvo contributed their respective ownership interests in VMEA and VMEHS to VME Group N.V., which resulted in VMEA and VMEHS becoming wholly-owned subsidiaries of the Company. Such contributions were accounted for as transactions between entities under common control. Accordingly, financial statements of the Company have been prepared on a historical cost basis and reflect such contributions on a retroactive basis for all periods presented.\nInvestments and results of operations of companies in which the Company holds more than 50% of the issued capital stock, are included in the consolidated accounts. Companies in which the Company holds investments between 20% and 50% are accounted for utilizing the equity method of accounting and investments below 20% are accounted for at cost. All material balances and transactions between the entities comprising the Company have been eliminated.\nNote 2 - Description of Business\nThe Company is engaged in the design, manufacture and marketing of off-highway construction and earth-moving equipment in most world markets. This equipment is comprised of wheel loaders, articulated and rigid haulers and hydraulic excavators. The majority of sales are made to end users through a worldwide network of affiliated and independent distributors. The Company does not have significant exposure to any individual customer or distributor. The sale of replacement parts is an important component of the Company's business.\nNote 3 - Summary of Significant Accounting Policies\nRevenue Recognition Revenues are recognized upon shipment of units and service parts. A provision is made for discounts, returns and recourse obligations under dealer financing arrangements.\nInventories Inventories of non-U.S. operations are valued at the lower of cost utilizing the first-in, first-out (FIFO) method or market. Substantially all U.S. owned inventories are valued at the lower of cost utilizing the last-in, first-out (LIFO) method or market.\nNote 3 - Summary of Significant Accounting Policies (cont'd)\nProperties and Depreciation Property, plant and equipment are carried at cost. Expenditures for maintenance and repairs are charged to income as incurred and expenditures for major renewals and betterments are capitalized. Depreciation is provided over the useful lives of the assets using primarily the straight-line method. Properties retired or sold are removed from the property accounts with gains or losses on disposal included in income. The useful lives of the assets are primarily as follows :\nYears Buildings 25 - 50 Machinery and equipment 5 - 10 Motor vehicles 5 Furniture and fixtures 3\nGoodwill Goodwill represents the excess of the total costs of businesses acquired over the fair market value of their net assets. Goodwill is being amortized on the straight-line method over a period of 40 years. Accumulated amortization expense was $10.4 in 1994 and $6.3 in 1993.\nManagement periodically assesses the need to record provisions for the impairment of long-lived assets by comparing their best estimate of undiscounted future cash flows before interest payments to the net book value of significant assets or businesses, including goodwill. Management considers current business plans, the cyclical nature of the global earth-moving and construction equipment industry and other factors. If projected cash flows are less than the assets' recorded value, impairment would be recorded using a fair value concept. Fair value is computed utilizing a discounted cash flow model.\nManagement also periodically considers the appropriateness of the remaining economic life of goodwill.\nWarranties Provision is made currently for estimated future costs that are expected to be incurred under product warranties presently in force.\nPension Plans The Company accrues the cost of pension and retirement plans which cover substantially all employees. Benefits are based on employees' years of service and compensation. Pension costs, for defined benefit plans, are primarily computed using the unit credit method. Non-U.S. plans are funded in accordance with local laws and income tax regulations. The board of directors adopted a plan in 1994 to substantially decrease its underfunded U.S. pension status by 1996. U.S. plans' assets are invested primarily in listed stocks, guaranteed investment contracts and corporate bonds.\nProduct Liability The Company accrues its best estimate of the most likely amount of settlement or claim liability for all asserted claims. For unasserted claims, the Company records an estimate of liability for incurred but not reported claims based on historical amounts of claims and settlements and reporting lag time.\nNote 3 - Summary of Significant Accounting Policies (cont'd)\nIncome Taxes In January 1993, the Company adopted Statement of Financial Accounting Standard No. 109 (FAS 109) \"Accounting for Income Taxes\". The adoption of FAS 109 changes the method of accounting for income taxes from the deferred method (APB 11) to an asset and liability approach. Previously, the Company deferred the past tax effects of timing differences between financial reporting and taxable income. The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences or temporary differences between the carrying amount and the tax bases of assets and liabilities. The adoption resulted in the recognition of a net tax benefit of $12.3. No provision for income taxes is made on $160.4 of undistributed earnings from consolidated subsidiaries, which have been or will be reinvested, and it is not practicable to quantify the amount of such taxes if remitted.\nDerivative Financial Instruments The Company attempts to limit its financial exposure to the effects of potential currency exchange rate fluctuations on balance sheet positions and cash flows corresponding to expected cross border transactions. The Company utilizes currency swap contracts to hedge balance sheet positions, and forward exchange and purchased option contracts to hedge future cash flows and avoid speculative positions which may impact expected profitability. The Company limits its use of financial instruments so that it is reasonably assured that the transactions it intends to protect will occur. Because the Company bases its hedging on expected net currency cash flows and does not designate its currency contracts as hedges of specific balance sheet items or firm currency commitments, it does not achieve hedge accounting treatment. Accordingly, all exchange contracts are marked to market each period end and recognized as Other income (expense).\nFair Value of Financial Instruments Pursuant to Financial Accounting Standard No. 107, \"Disclosures about Fair Value of Financial Instruments\", the carrying amount of cash, trade receivables and payables approximates fair value because of the short maturity of those instruments. The carrying value of the Company's long-term debt is considered to approximate the fair value of these instruments based on the borrowing rates currently available to the Company for loans with similar terms and maturities.\nThe fair value of derivatives, which is equal to their carrying amount, generally reflects the estimated amounts that the Company would receive or pay to terminate the contracts at year end, thereby taking into account the current unrealized gains or losses of open contracts. Market quotes are available for all of the Company's derivative financial instruments.\nNote 3 - Summary of Significant Accounting Policies (cont'd)\nForeign Currency Translation Foreign currency translation of substantially all assets and liabilities of non-U.S. affiliates is computed using period end currency exchange rates; equity is translated utilizing historical rates. Income and expenses are tranlated using average exchange rates for the period. For subsidiaries whose business activities are based mainly on the U.S. dollar or who operate in a \"highly inflationary economy\", the financial statements are remeasured into U.S. dollars using: (1) current exchange rates at the balance sheet date for all liabilities and current assets except inventories and prepaid expenses, (2) exchange rates at the time of acquisition for prepaid expenses, inven- tories and properties, and (3) weighted average monthly exchange rates for the year for income and expense amounts, except depreciation and cost of goods sold. The resulting translation gains and losses are included in income.\nThe dollar is the functional currency for the U.S., Canadian and Brazilian subsidiaries. For all other subsidiaries, the local currency of the country in which the subsidiary operates and transacts its principal business is the relevant functional currency. Such countries include Sweden, Germany, Great Britain, France and Spain.\nExchange (gains) and losses included in the Consolidated Statement of Operations were $(3.0), $18.8 and $15.9 in 1994, 1993 and 1992, respectively.\nReclassifications Certain reclassifications have been made for all years presented in the Consolidated Financial Statements to conform to the classifications adopted in 1994.\nNote 4 - Acquisitions and Dispositions\nOn January 1, 1994, the Company increased its holding in Zettelmeyer Baumaschinen GmbH (Zettelmeyer) to 100% by acquiring the remaining 30% minority interest for $39.9. The fair value of the assets acquired and obligations assumed approximated their net book values; accordingly, the additional purchase consideration was charged principally to goodwill.\nDuring 1993, the Company contributed stock and the book value of specific assets and liabilities in return for an 80.5% ownership interest in a company established as a joint venture with Hitachi Construction Machinery Company, Ltd (HCMC). HCMC contributed cash equal to 19.5% of the total net assets. The joint venture company, Euclid-Hitachi Heavy Equipment, Inc (Euclid-Hitachi), is consolidated in the Company's financial statements. HCMC will increase its ownership interest in Euclid-Hitachi by purchasing additional shares from the Company and subscribing for new shares of Euclid-Hitachi prior to December 31, 1996. The terms of the joint venture agreement limit HCMC to an ownership interest of less than 50% in Euclid-Hitachi.\nNote 5 - Statement of Cash Flows\nVME considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nThe following payments were made for: Year Ended December 31, 1994 1993 1992 Interest $ 18.4 $ 35.2 $ 63.7 Income taxes 9.1 6.3 6.4\nNote 6 - Supplementary Information to Statement of Operations\nCosts and expenses include : Year Ended December 31, 1994 1993 1992 Research and development $ 49.3 $ 38.5 $ 59.9 Maintenance and repairs 26.3 21.8 28.0\nOther Income (expense) includes : 1994 1993 1992 Exchange gains (losses) $ 10.0 $ (0.9) $ (11.3) Gain (loss) on sales of assets 1.1 (0.3) 5.3 Other 1.5 (4.1) (0.6) $ 12.6 $ (5.3) $ (6.6) ====== ====== =======\nA charge in 1992 for restructuring costs of $18.7 has been made in costs and expenses relating to the decision to restructure the Group's distribution organization and production facilities in North America, to improve cost efficiency and increase the manufacturing productivity and to relocate the German distribution company. The remaining restructuring reserve relating to these activities was $4.3 and $5.9 at year end 1994 and 1993, respectively. The restructuring reserve relating to Akermans Verkstad AB aggregated $1.3 and $1.4 at year end 1994 and 1993, respectively.\nNote 7 - Distributor Financing Arrangements\nAs a service to distributors in selected geographic areas, the Company has financing agreements with certain financial institutions to assist in the financing of distributor inventory. In general, these agreements require the Company to make monthly interest payments to the financial institutions for a predetermined period or until the inventory is sold by the distributor, whichever occurs first.\nFinancing expenses incurred in conjunction with the above agreements were $8.7, $5.7 and $5.5 in 1994, 1993 and 1992, respectively, and were reflected in selling expenses. The interest rates charged on the above agreements are adjusted based on changes in the prime rate. The financial institutions' aggregate distributor receivable balances were $182.8 and $142.2 at December 31, 1994 and 1993, respectively. The Company's credit risk with respect to these receivable balances is not significant.\nNote 8 - Income Taxes The provision for income taxes is based on separate tax computations for each entity. Income (loss) before income taxes and minority interests is reported below: Year Ended December 31, 1994 1993 1992 Netherlands $ 0.9 $ 0.1 $ 0.7 U.S. 15.4 4.1 (16.0) Other, principally Sweden 183.4 34.1 (98.0) $ 199.7 $ 38.3 $(113.3) ======= ======= =======\nThe provision (benefit) for income taxes consists of the following:\nYear Ended December 31, Current tax expense: 1994 1993 1992 Netherlands - - - U.S. 3.8 7.9 - Other, principally Sweden 56.1 8.2 13.2 59.9 16.1 13.2 Deferred tax expense (benefit): Netherlands - - - U.S. 4.6 (1.5) - Other, principally Sweden 2.0 3.3 (36.6) 6.6 1.8 (36.6) _______ _______ _______\nTotal income tax expense (benefit) $ 66.5 $ 17.9 $ (23.4) ======= ======= ======= Tax legislation in Sweden and certain other countries allows companies to reduce their current taxable income through allocations to untaxed reserves at which time, deferred tax provisions are recorded. Reversal of such reserves generates current taxable income and a reduction of the deferred tax liabilities. Deferred income taxes apply to temporary differences primarily resulting from allocations to untaxed reserves (principally inventory and fixed assets related) and other differences between income before income taxes for financial reporting and tax purposes. Deferred tax benefits in 1992 are mainly comprised of the reversal of untaxed reserves of $21.6 and sale and lease-back of property in the amount of $13.3.\nFollowing is a reconciliation of income tax expense (benefit) from the U.S. statutory rate to the effective tax rate (the U.S. statutory rate is utilized as the Netherlands holding company does not generate significant taxable income) : Year Ended December 31, 1994 1993 1992 Provision (benefit) for taxes at US statutory rate $ 69.9 $ 13.1 $ (38.5) Effect of permanent differences between tax and financial income (1.6) 2.0 (0.5) Losses with no available tax benefits 1.2 2.0 17.6 Earnings taxed at other than U.S. rate (11.1) 0.1 (6.1) Change in valuation allowance resulting from utilization of net operating loss carryforwards (2.2) (7.5) - Accrual for potential disallowances 11.0 8.3 1.1 Other (0.7) (0.1) 3.0 Provision (benefit) for taxes at effective tax rate $ 66.5 $ 17.9 $ (23.4) ======== ======== =======\nNote 8 - Income Taxes (continued)\nDeferred tax assets and liabilities are comprised of the following: 1994 1993 Deferred tax assets relating to :\nAccounts receivable $ 0.5 $ 0.3 Inventories 6.7 6.0 Fixed assets 8.3 8.0 Pension and postretirement benefits 11.1 14.7 Expense accruals and reserves 13.7 11.5 Net operating loss and credit carryforwards 14.4 17.0 Other 6.1 5.0 Total deferred tax assets before valuation allowance 60.8 62.5 Deferred tax assets valuation allowance (27.2) (31.0) Net tax asset $ 33.6 $ 31.5 ====== ====== Deferred tax liabilties relating to :\nAccounts receivable $ 0.1 $ - Inventories 7.7 8.0 Fixed assets 13.0 12.7 Pensions 7.6 5.2 Other 11.9 5.2 Gross deferred tax liabilities $ 40.3 $ 31.1 ====== ======\nEuclid-Hitachi's Canadian subsidiary has $16 of loss carryforwards, which expire in 1998, available to reduce future taxable income. In addition, for Canadian income tax purposes, this subsidiary has available certain depreciation allowances aggregating $5.7, which may be utilized to reduce future taxable income in succeeding years. The amount of such depreciation allowance that may be deducted in any one specific year is subject to certain limitations.\nThe Company's Brazilian subsidiary has $1.9 in tax credits that can be offset against future income up to 1998.\nOther subsidiaries in the Company have $6.9 of operating loss carryforwards available to offset future taxable income, most of which expire in the years 1996 through 1998.\nNote 9 - Receivables December 31, Receivables consist of the following: 1994 1993\nNotes receivable - trade $ 24.5 $ 12.4 Trade receivables 196.2 158.8 Other receivables 6.1 6.9 Less: Allowance for doubtful accounts (13.8) (10.2) $ 213.0 $ 167.9 ======= =======\nNote 10 - Inventories December 31, Inventories consist of the following: 1994 1993\nSales products $ 198.9 $ 187.3 Work in process 80.7 57.4 Raw materials 73.0 59.5 Reserves (32.9) (33.0) $ 319.7 $ 271.2 ======= =======\nFIFO values of U.S. inventories exceeded LIFO values by $6.8 in 1994 and $6.9 in 1993. Inventories valued using the LIFO method comprised 20% and 17% of consolidated inventories in 1994 and 1993, respectively.\nNote 11 - Property, Plant and Equipment\nProperty, plant and equipment consist of the following:\nDecember 31, 1994 Accumulated Net Cost Depreciation Book Value Land and land improvements $ 16.1 $ 4.8 $ 11.3 Buildings 120.3 48.5 71.8 Machinery and equipment 260.4 184.6 75.8 $ 396.8 $ 237.9 $ 158.9 ======= ======= =======\nDecember 31, 1993 Accumulated Net Cost Depreciation Book Value Land and land improvements $ 14.6 $ 4.1 $ 10.5 Buildings 110.7 41.2 69.5 Machinery and equipment 234.7 161.9 72.8 $ 360.0 $ 207.2 $ 152.8 ======= ======= =======\nDepreciation expense, including amortization on capitalized leases, was $27.8, $29.1 and $39.6 for the years 1994, 1993 and 1992, respectively.\nNote 12 - Short-term Debt\nShort-term debt consists of the following:\nDecember 31, 1994 Line of Interest Credit Amount Currencies Rate * Available Outstanding\nNorth America - $ 2.5 $ - Europe USD,FRF,ESP,DEM 7.37% 103.3 8.2 Brazil USD 11.88% 28.0 8.3 Australia - 5.5 - $ 139.3 $ 16.5 ======= =======\nDecember 31, 1993 Line of Interest Credit Amount Currencies Rate * Available Outstanding\nEurope DEM,USD,ESP,FRF 6.84% $ 83.1 $ 43.6 Brazil USD 8.06% 21.7 5.1 Australia AUD 5.85% 5.5 3.5 $ 110.3 $ 52.2 ======= ======= * Represents weighted average year-end rates.\nThe line of credit arrangements require payment of variable interest rates and commitment fees ranging from zero to 0.75% per year of the individual line of credit.\nNote 13 - Other Current Liabilities\nOther current liabilities consist of the December 31, following: 1994 1993\nSalaries, wages and other employee costs $ 67.1 $ 50.7 Warranty obligations 35.1 28.7 Dealer discounts 5.8 5.4 Income taxes 71.1 18.1 Accrued expenses and deferred income 40.7 21.9 Other 22.3 27.3 $ 242.1 $ 152.1 ======= =======\nNote 14 - Long-Term Debt December 31, The following is a summary of long-term debt: 1994 1993 Swedish Kronor Bank notes with fixed and variable interest rates ranging from 6.8% to 13.2% payable in annual installments over a ten-year period $ 5.0 $ 5.6 Revolving Multi Currency Credit Agreement of $250.0 with variable interest rates ranging from 6.1% to 8.9% and for a term of three years - 44.1 Credit Facility Agreement with a German bank of DEM 45.0 with an interest rate of 10.6% and for a term of three years - 26.0 Capital lease obligations in various currencies with fixed and variable interest rates ranging from 6.8% to 11.8% payable through 2035 14.9 14.4 Financing obligation in Swedish Kronor under sale leaseback transaction to be repaid over 20 years ending August, 2012 bearing interest fixed at 10.05% through 1998 42.9 41.3 Total 62.8 131.4 Less: Current portion of long-term debt (8.3) (4.3)\nTotal long-term debt $ 54.5 $ 127.1 ======= ======= The Company leases buildings, land and equipment under capital lease and financing arrangements. The related net assets of $27.4 and $26.6 in 1994 and 1993, respectively, are recorded in property, plant and equipment.\nLong-term debt at December 31, 1994 matures as follows: 1995 $ 8.3 1996 4.9 1997 5.0 1998 5.0 1999 5.1 Thereafter 34.5 $ 62.8 ======= On December 22, 1994, the Company signed an unsecured $150 multicurrency revolving credit agreement with a group of banks for a term of five years. Borrowings on this facility will bear interest in a range from LIBOR +0.5% to LIBOR +0.9%. The Company is subject to leverage and cash flow covenants under this facility. In addtion, the Company is obligated to pay a commitment fee ranging from 0.25% to 0.45% on the undrawn and uncancelled amount of the facility. Concurrently, the Company cancelled the $250 revolving credit facility signed on February 22, 1993 and received release of assets pledged as security to this agreement.\nOn December 30, 1994, the Company paid and cancelled the DEM 45 credit facility agreement and thereby obtained release of the pledged shares in Zettelmeyer Baumaschinen GmbH.\nNote 15 - Shareholders' loans\nShareholders' loans totalling $70.0 with a term of three years were made by the shareholders to the Company at the end of 1992. The loans were subordinated to the $250.0 Revolving Credit Facility agreement and the DEM 45.0 Credit Facility agreement until 1994, at which time they were no longer subordinated. The loans bear interest of LIBOR plus 1.3% per annum and are due January 31, 1996.\nNote 16 - Leases and Commitments\nThe Company incurred rent expense of $ 20.1, $17.0 and $22.7 in 1994, 1993 and 1992, respectively. Future minimum rental commitments under noncancellable operating leases at December 31, 1994 are as follows:\n1995 $ 20.4 1996 16.5 1997 13.0 1998 6.5 1999 5.9 Thereafter 36.8\nThe Company rents equipment to others under operating lease agreements. In 1994, 1993 and 1992, the Company received rental income of $14.1, $11.9 and $9.5, respectively. The net book value of property leased to others aggregated $17.6 and $15.4 at December 31, 1994 and December 31, 1993, respectively. Future minimum rental income under noncancellable operating leases at December 31, 1994 is as follows:\n1995 $ 10.0 1996 1.4 1997 0.8 1998 0.5 1999 0.3 Thereafter 3.3\nNote 17 - Derivative Financial Instruments and Risk Management\nThe Company operates internationally, giving rise to significant exposure to fluctuations in currency exchange rates. Derivative financial instruments are utilized by the Company to reduce those risks. The Company does not hold or issue financial instruments for trading purposes.\nCounterparty credit risk\nThe risk associated with counterparty default on financial instruments is measured as the cost of replacing, at prevailing market prices, those contracts with a fair value in excess of their contractual amount at period end. The counterparties to the financial instruments listed below are major international financial institutions with high credit ratings. Accordingly, the Company believes its credit risk exposure to be insignificant.\nNote 17 - Derivative Financial Instruments and Risk Management (cont'd)\nCurrency risk management\nThe Company enters into various types of financial instruments in managing its currency exchange risk, as indicated in the following table :\nDecember 31, 1994 December 31, 1993 Contract Fair Contract Fair Amount Value Amount Value\nForward exchange contracts $ 232.6 $ 3.6 $ 205.0 $ 2.0 Currency options 305.5 10.3 56.0 - Currency swap contracts 135.6 (2.0) 53.4 0.9\nSee Note 3, \"Summary of Significant Accounting Policies - Fair Value of Financial Instruments\" for definition of fair value. Positive carrying amounts represent assets which are recorded in other current assets. Negative carrying amounts represent liabilities which are recorded in other current liabilities.\nThere are no deferred gains or losses on the contracts, all of which expire in the next year. The net unrealized currency gain recognized was $1.8 and $2.9 in 1994 and 1993, respectively.\nNote 18 - Pensions\nThe total pension expense charged to operations for 1994, 1993 and 1992 was $38.0, $33.8 and $47.8, respectively.\nIn Sweden, most of the plans are administered by governmental or quasi-governmental organizations. Such plans are accounted for in accordance with Financial Accounting Standard No. 87 (FAS 87). In Sweden, the Company accrues pension costs, but is only required to fund a portion of these costs. Annual pension costs include an interest factor on the unfunded obligations. Actuarial information, as supplied by the governmental agency for the plans they administer, indicates that the accrued pension costs approximate the actuarially computed value of vested and non-vested plan benefits.\nPension expense for the defined contribution plans, principally Swedish, was $28.1, $24.9 and $37.3 in 1994, 1993 and 1992, respectively. Certain employees are also covered by insured plans which supplement the benefits received from the defined contribution plans.\nIn the United States, Canada and for certain employee groups in Europe, principally Sweden, employees are covered by defined benefit plans.\nNote 18 - Pensions (continued)\nU.S. and European (Principally Swedish) Plans Net periodic pension cost on defined benefit plans consists of the following: Year ended December 31, 1994 1993 1992 Europe U.S. Europe U.S. Europe U.S. Service cost - benefits earned during the period $ 1.1 $ 0.9 $ 0.8 $ 1.0 $ 1.1 $ 0.9 Interest cost on projected benefit obligation 4.4 8.1 5.3 8.3 6.6 8.3 Actual return on plan assets - 0.6 - (5.0) - (3.2) Net amortization and deferral (0.7) (4.3) (0.6) (0.1) (0.7) (2.0) $ 4.8 $ 5.3 $ 5.5 $ 4.2 $ 7.0 $ 4.0 ===== ====== ====== ===== ====== ====== Assumptions used to develop the net periodic pension cost at the beginning of each year were as follows: Year ended December 31, 1994 1993 1992 Europe U.S. Europe U.S. Europe U.S. Discount rate 10.0% 7.5% 10.0% 8.5% 10.0% 8.5% Long term rate of return on plan assets - 9.1 - 9.1 - 9.1 Rate of increase in compensation levels 4.5 4.0 4.5 4.0 6.0 5.5\nThe following table sets forth the discount rates and funded status of these plans at: Year ended December 31, 1994 1993 Europe U.S. Europe U.S. Weighted average discount rate used in determining the benefit obligations below : 8.5% 8.7% 10.0% 7.5% ==== ==== ===== ==== Actuarial present value of accumulated benefit obligation: Vested benefits $ 43.8 $ 94.7 $ 47.0 $ 99.8 Non-vested benefits - 3.7 - 5.3 Accumulated benefit obligation $ 43.8 $ 98.4 $ 47.0 $105.1 ====== ====== ====== ======\nProjected benefit obligation $(47.2)$(101.1) $(47.4)$(109.1) Plan assets at fair value - 75.8 - 69.7 Projected benefit obligation in excess of plan assets (47.2) (25.3) (47.4) (39.4) Unrecognized net loss from actuarial experiences - 26.7 - 29.0 Unrecognized prior service cost - 0.1 - 0.1 Unamortized net(asset) liability existing at date of adoption of FAS 87 (5.5) 5.0 (5.5) 5.5 Liabilities for other plans (2.3) - (3.8) - Adjustment required to recognize minimum liability - (29.1) - (30.6) Total pension liability (55.0) (22.6) (56.7) (35.4) Less: current portion - 19.0 - 11.2 Total long-term pension liability $(55.0) $ (3.6) $(56.7) $(24.2) ====== ======= ======= =======\nNote 18 - Pensions (continued)\nCanadian Plans\nNet periodic pension income included the following :\nYear ended December 31, 1994 1993 1992 Service cost - benefits earned during the period $ 0.3 $ 0.2 $ 0.3 Interest cost on projected benefit obligation 0.5 0.3 1.0 Actual return on plan assets (0.8) (1.1) (1.5) Net amortization and deferral (0.2) (0.2) (0.3) Net periodic pension income $ (0.2) $ (0.8) $ (0.5) ======= ======= ======= Assumptions used to develop the net periodic pension income at the beginning of each year were as follows :\n1994 1993 1992\nDiscount rate 7.5% 9.5% 9.5%\nLong-term rate of return on plan assets 7.5% 9.5% 9.5%\nRate of increase in compensation levels 4.0% 5.5% 5.5%\nThe following table sets forth the Plans' funded status at:\nDecember 31, Actuarial present value of accumulated 1994 1993 benefit obligation : Vested benefits $ 5.3 $ 4.4 Non-vested benefits 0.4 0.3 Accumulated benefit obligation $ 5.7 $ 4.7 ====== ======\nProjected benefit obligation $ (6.0) $ (4.9) Plan assets at fair value 10.7 8.2 Plan assets in excess of projected benefit obligation 4.7 3.3 Unrecognized net gain from actuarial experiences (2.3) (1.7) Unrecognized prior service cost 0.9 0.7 Unamortized net asset existing at date of adoption of FAS 87 (0.9) (0.8) Prepaid pension asset $ 2.4 $ 1.5 ====== ======\nOther Plans\nCertain subsidiaries' pension plans and postretirement benefits are funded by a government-administered program. Contributions to the defined contribution pension plans are based on payroll costs and have been fully provided for through December 31, 1994.\nNote 19 - Postretirement and Postemployment Benefits\nThe Company adopted Statement of Financial Accounting Standard No. 106 \"Employers Accounting for Postretirement Benefits Other Than Pensions\" effective January 1, 1993. This statement requires the Company to recognize, during the working career of those employees who could become eligible for such benefits, the estimated cost of providing certain postretirement benefit costs (other than pensions) for those employees when they retire.\nThe Company and its subsidiaries provide certain health care and life insurance benefits for its U.S. retired employees. Substantially all of the Company's U.S. employees may become eligible for those benefits if they reach normal retirement age while still working for the Company. Those benefits and similar benefits for active employees are provided through an insurance company whose premiums are based on the benefits paid during the year. The total postretirement health care and life insurance expense charged to income was $11.7, $12.1 and $6.7 in 1994, 1993 and 1992, respectively.\nAnnual net postretirement benefit costs under the Company's benefit plan are determined on an actuarial basis. The Company's current policy is to pay these benefits as they become due. The Company has elected to recognize the transition obligation of $84.9 over a 20-year period.\nNet periodic postretirement benefit cost consists of the following : 1994 1993\nService cost $ 0.7 $ 0.7 Interest cost on projected benefit obligations 6.8 7.1 Amortization of transition obligation 4.2 4.3 Total net periodic pension cost $ 11.7 $ 12.1 ======= =======\nThe accumulated postretirement benefit obligation is comprised as follows:\nRetired participants $ 70.3 $ 79.3 Fully eligible active plan participants 4.9 6.5 Other active plan participants 7.5 11.6\nTotal accumulated postretirement benefit obligation $ 82.7 $ 97.4\nUnrecognized gain (loss) 5.1 (11.2) Unrecognized transition obligation (76.4) (80.6)\nAccrued postretirement benefit cost other than pensions $ 11.4 $ 5.6 ====== =======\nThe discount rate used in determining the accumulated benefit obligation was 8.8%. The assumed health care cost trend rates result in per capita net incurred medical claims increasing 11% under age 65 and 9% over age 65. These rates decrease to 7% for both over and under age 65 by the year 2005. If the assumed health care cost trend rate were increased by 1%, the accumulated postretirement benefit obligation as of December 31, 1994, would increase $10.4.\nNote 19 - Postretirement and Postemployment Benefits (continued)\nIn November 1992, the Financial Accounting Standards Board issued Statement of Financial Accouting Standard No. 112 \"Employers' Accounting for Postemployment Benefits\". This statement establishes accounting standards for employers who provide benefits such as supplemental unemployment compensation, severance benefits, salary continuation and other benefits to former or inactive employees after employment but before retirement.\nThe Company adopted this statement effective January 1, 1994 and recognized a liability of $0.5 for the year ended December 31, 1994.\nNote 20 - Shareholders' Equity\nVME Group N.V. acquired from AB Volvo and Clark Equipment Company all outstanding shares in VMEA and VMEHS on December 22, 1993 in exchange for newly issued shares in VME Group N.V. Shares of common stock in the amount of 250,000 were reflected as if outstanding for all periods reported.\nDividends are declared and paid in Dutch guilders. With the approval of the Supervisory Board, the Managing Board may determine that distributions be made payable in another currency.\nNote 20 - Shareholders' Equity (continued)\nKPMG Bohlins\nKPMG Bohlins AB Mail Address Telephone +46(31)614800 Norra Hamngatan 22 P.O. Box 11908 Telefax +46(31)152655 Gothenburg S-404 39 Gothenburg Telex 21762BJGS Sweden Sweden Corporate identity number 556043-4465\nIndependent Auditor's Report\nTo the Board of Directors of VME Holding Sweden AB:\nWe have audited the consolidated balance sheets of VME Holding Sweden AB and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income (loss) and cash flows for each of the years in the three year period ended December 31, 1994 (expressed in U.S. dollars and not presented separately herein). In connection with our audit of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule II, (expressed in U.S. dollars and not presented separately herein). 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 in Sweden which are similar in all material respects with auditing standards 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 included in the financial statements. An audit also includes 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 consolidated financial statements and financial statement schedule have been translated in accordance with the standards set forth in Statement of Financial Accounting Standards No. 52 from Swedish Kronor (the currency of the country where VME Holding Sweden AB is incorporated and in which it operates) into U.S. dollars for purposes of inclusion in the consolidated financial statements of VME Group N.V.\nIn our opinion, for purposes of inclusion in the consolidated financial statements of VME Group N.V., the translated financial statements present fairly, in all material respects, the consolidated financial position of VME Holding Sweden AB and subsidiaries at December 31, 1994 and 1993 and the consolidated 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 in the United States. Also,\nin our opinion, the related consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements, presents fairly in all material respects the information shown therein.\nGothenburg, Sweden February 27, 1995\n\/s\/ KPMG Bohlins AB\nKPMG Bohlins AB\nHead Office Mail address Tel +46+8+7239100 Member Firm of Tegelbacken 4, P.O. Box 16106 Fax +46+8+105258 Klynveld Peat Marwick Stockholm S-103 23 Stockholm Goerdeler Sweden Sweden\nEXHIBIT LIST AND INDEX\nFiled Herewith Unless Exhibit Description Otherwise Indicated\n(2)(a) Underwriting Agreement Incorporated by reference dated May 6, 1994 among to Exhibit (2)(a) to Automotive Products Company, Registrant's Form 8-K Clark Automotive Products filed on May 27, 1994 Corporation, and Clark with respect to Equipment Company and CS Registrant's disposition First Boston Corporation of Clark Automotive and Merrill, Lynch, Pierce, Products Corporation Fenner & Smith Incorporated as representatives of the Underwriters\n(2)(b) Subscription Agreement dated Incorporated by reference May 6, 1994 among Automotive to Exhibit (2)(b) to Products Company, Clark Registrant's Form 8-K Automotive Products Corporation, filed on May 27, 1994 Clark Equipment Company, CS with respect to First Boston Limited, Merrill Registrant's disposition Lynch International Limited, ABN of Clark Automotive AMRO Bank N.V., Banque Bruxelles Products Corporation Lambert S.A., Cazenove & Co., Dresdner Bank Aktiengesellschaft and UBS Limited\n(2)(c) Agreement of Purchase and Sale Incorporated by reference dated April 20, 1994 between to Exhibit (2) to Clark Equipment Company and Registrant's Form 8-K White Consolidated Industries filed on May 27, 1994 Inc. with respect to Registrant's acquisition of Blaw-Knox Construction Equipment Corporation\n(2)(d) Agreement and Plan of Merger Incorporated by reference dated as of February 3, 1995 by and to Exhibit (c)(1) to the among Clark Equipment Company, Clark Registrant's Schedule Acquisition Sub, Inc. and Club Car, 14D-1 and Schedule 13D Inc. dated February 8, 1995\n(2)(e) Stock Purchase Agreement dated as --- of March 5, 1995 by and among Aktiebolaget Volvo, Clark Equipment Company and Clark Hurth Components Marketing Company\n(3)(a) Restated Certificate of Incorporated by reference Incorporation to Exhibit (3)(a) to Registrant's Form 10-K for the year 1992\nFiled Herewith Unless Exhibit Description Otherwise Indicated\n(3)(b) By-laws, as amended ---\n(3)(c) Amended and Restated Rights Incorporated by reference Agreement, dated as of to Exhibit (3)(c) to August 14, 1990 between Registrant's Form 10-Q Clark Equipment Company and for the period ended Harris Trust and Savings Bank September 30, 1990\n(4)(a) Indenture dated as of August 1, Incorporated by reference 1983 between Clark Equipment to Exhibit (4)(a) to Company and Harris Trust and Registrant's Form 10-K Savings Bank as trustee, as to for the year 1992 which Pittsburgh National Bank is successor trustee, as supplemented by a First Supplemental Indenture dated as of February 1, 1991 and a Second Supplemental Indenture dated as of April 1, 1993\n(4)(b) Specimen form of 9-3\/4% Note Incorporated by reference issued pursuant to Exhibit to Exhibit (4)(b) to (4)(a) Registrant's Form 10-K for the year 1992\n(4)(c) Master Credit Agreement with --- Chemical Bank, as Agent, dated as of April 6, 1994\n(4)(d) Amendment No. 1 dated --- February 21, 1995 to Master Credit Agreement with Chemical Bank, as Agent, dated as of April 6, 1994\n(4)(e) Registrant is a party to several Pursuant to paragraph other long term debt agreements (4)(iii)(A) of Item under which, in each case, the 601(b) of Regulation total amount of securities S-K, Registrant agrees authorized does not exceed 10% to furnish a copy of of the assets of Registrant and these instruments to its consolidated subsidiaries the Securities and Exchange Commission upon request\n(10)(a) Employment contract with Leo Incorporated by reference J. McKernan, Chairman, President to Exhibit (10)(a) to and Chief Executive Officer, Registrant's Form 10-K dated November 12, 1992 for the year 1992\n(10)(b) Employment contract with Frank --- M. Sims, Director and Senior Vice President, dated February 15, 1995\nFiled Herewith Unless Exhibit Description Otherwise Indicated\n(10)(c) Employment contract with Thomas Incorporated by reference L. Doepker, Vice President and to Exhibit (10)(d) to Treasurer, dated November 12, Registrant's Form 10-K 1992 for the year 1992\n(10)(d) Employment contract with Bernard Incorporated by reference D. Henely, Vice President and to Exhibit (10)(e) to General Counsel, dated Registrant's Form 10-K November 12, 1992 for the year 1992\n(10)(e) Employment contract with William Incorporated by reference N. Harper, Vice President and to Exhibit (10)(f) to Controller, dated November 12, Registrant's Form 10-K 1992 for the year 1992\n(10)(f) Employment contract with Paul Incorporated by reference R. Bowles, Vice President, to Exhibit (10)(i) to dated March 13, 1992 Registrant's Form 10-K for the year 1991\n(10)(g) Employment contract with John Incorporated by reference J. Reynolds, Vice President, to Exhibit 10(i) to dated November 14, 1991 Registrant's Form 10-K for the year 1992\n(10)(h) 1985 Stock Option Plan Incorporated by reference to Exhibit 10(j) to Registrant's Form 10-K for the year 1991\n(10)(i) Stock Purchase Program (adopted Incorporated by reference as of May 10, 1994) to Exhibit (10)(a) to Registrant's Form 10-Q for the period ended June 30, 1994\n(10)(j) Stock Acquisition Plan for Incorporated by reference Non-Employee Directors to Exhibit A to Registrant's Proxy Statement for the Annual Meeting of Stockholders held on May 10, 1994\n(10)(k) 1994 Long Term Incentive Plan Incorporated by reference to Exhibit B to Registrant's Proxy Statement for the Annual Meeting of Stockholders held on May 10, 1994\nFiled Herewith Unless Exhibit Description Otherwise Indicated\n(10)(l) Incentive Compensation Plan --- for Corporate Office Management (amended and restated effective as of January 1, 1994)\n(10)(m) Incentive Compensation Plan --- for Business Unit Management (amended and restated effective as of January 1, 1994)\n(10)(n) Performance Unit Plan Incorporated by reference (effective November 9, 1992) to Exhibit (10)(s) to Registrant's Form 10-K for the year 1992\n(10)(o) Form of Grant Letter used to Incorporated by reference award Performance Units to Exhibit (10)(t) to pursuant to the Performance Registrant's Form 10-K Unit Plan (effective for the year 1992 November 9, 1992)\n(10)(p) Form of Grant Letter used to Incorporated by reference award Performance Units in to Exhibit (10)(u) to 1991 Registrant's Form 10-K for the year 1992\n(10)(q) Clark Equipment Company --- Deferred Benefit Trust\n(10)(r) Clark Equipment Company --- Supplemental Retirement Income Plan for Certain Executives\n(10)(s) Amendment No. 1 to Clark --- Equipment Company Supplemental Retirement Income Plan for Certain Executives\n(10)(t) Amendment No. 2 to Clark --- Equipment Company Supplemental Retirement Income Plan for Certain Executives\n(10)(u) Clark Equipment Company --- Supplemental Executive Retirement Trust\n(10)(v) Clark Equipment Company --- Supplemental Executive Retirement Plan\n(10)(w) Amendment No. 1 to Clark --- Equipment Company Supplemental Executive Retirement Plan\nFiled Herewith Unless Exhibit Description Otherwise Indicated\n(10)(x) Amendment No. 2 to Clark --- Equipment Company Supplemental Executive Retirement Plan\n(10)(y) Form of Participation Agreement --- for Clark Equipment Company Supplemental Retirement Income Plan for Certain Executives\n(10)(z) Form of Participation Agreement --- for Clark Equipment Company Supplemental Executive Retirement Plan\n(10)(aa) Retirement Plan for Outside --- Directors\n(13) Portions of Clark Equipment --- Company 1994 Annual Report to Stockholders which are incorporated by reference into this Form 10-K\n(22) Subsidiaries of Clark Equipment --- Company\n(23)(a) Consent of Independent Accountants- --- Price Waterhouse LLP\n(23)(b) Consent of Independent Accountants- --- KPMG Bohlins AB\n(27) Financial Data Schedules ---\n(99) Computation of Ratio of Earnings to --- Fixed Charges for the twelve months ended December 31, 1994","section_15":""}
{"filename":"86941_1994.txt","cik":"86941","year":"1994","section_1":"Item 1. Business\nSavannah Foods & Industries, Inc. (\"Registrant\") was incorporated in Delaware on February 19, 1969, as the successor to Savannah Sugar Refining Corporation, which was originally incorporated in New York in 1916.\nRegistrant and its subsidiaries collectively comprise one business segment and are engaged in the production, marketing, and distribution of food products, primarily refined sugar.\nRegistrant and its wholly-owned subsidiaries, Colonial Sugars, Inc. and Everglades Sugar Refinery, Inc., are engaged in the refining and marketing of a complete line of bulk, packaged and liquid sugars and sugar products, including edible molasses, liquid animal feeds and corn syrup blends. These products are marketed primarily in the southeastern portion of the United States, Louisiana, and Texas, but are also widely distributed into other states generally east of the Mississippi and south of New England. Packaged sugar is marketed under the trade names DIXIE CRYSTALS(R), COLONIAL(R), EVERCANE(R), but is also sold under Registrant's other controlled labels and under customers' private label brands. These products are marketed both by means of direct sales and through brokers and are primarily distributed directly to the customer by common carrier truck or railcar.\nMichigan Sugar Company, a wholly-owned subsidiary of Registrant, and its wholly-owned subsidiary, Great Lakes Sugar Company, are engaged in the processing of sugar beets into refined sugar and the production of beet pulp and molasses. The refined sugar is marketed primarily in the states of Michigan and Ohio, but is also distributed in the midwestern and eastern parts of the United States. Packaged sugar is marketed under the trade name PIONEER(R), but is also sold under customers' private label brands. These products are marketed both by means of direct sales and through brokers and are primarily distributed directly to the customer by common carrier truck or railcar. Most of the beet pulp is pelletized and sold for export. The balance is sold in the domestic market. The majority of the molasses is sold to Registrant's beet molasses desugarization facility for further processing to recover additional sugar.\nDixie Crystals(R) Foodservice, Inc., a wholly-owned subsidiary of Registrant, produces and markets a line of sugar envelopes and portion control items consisting of individual servings of salt, pepper, non-dairy creamer, etc., under the trade names DIXIE CRYSTALS(R) and PIONEER(R), and under various private labels. Foodservice also markets a saccharin-based sweetener under the trade name of SWEET THING(R) and an aspartame-based sweetener under\nthe trade name of SWEET THING II(R). These products are marketed to the food service trade through-out the United States both by means of direct sales and through brokers and are primarily shipped directly to customers by common carrier truck.\nKing Packaging Company, Inc. a wholly-owned subsidiary of Dixie Crystals(R) Foodservice, Inc., packs custom made meal kits for the food service industry and provides complimentary products to the portion control products manufactured at Registrant's other foodservice locations. These products are marketed to the food service trade through-out the United States both by means of direct sales and through brokers and are primarily shipped directly to customers by common carrier truck.\nRaceland Sugars, Inc., a wholly-owned subsidiary of Registrant, operates a raw sugar mill and is engaged in the business of producing raw sugar which is marketed in the Louisiana area. Additionally, the by-products, molasses and bagasse, are currently sold in the domestic market.\nDuring 1994, Registrant entered into agreements with a Mexican business group to conduct several joint ventures in the Mexican sweetener industry. The projects related to the joint ventures are in various stages of development, but as of the end of fiscal 1994, none were operational nor had a material amount of Registrant's assets been committed to the joint ventures.\nParent and Subsidiaries. The following list presents the relationship of Registrant to its subsidiaries at October 2, 1994:\n(a) *Michigan Sugar Company, a Michigan corporation, wholly-owned subsidiary.\n(b) *Great Lakes Sugar Company, an Ohio corporation, wholly-owned subsidiary of Michigan Sugar Company.\n(c) *Everglades Sugar Refinery, Inc., a Florida corporation, wholly-owned subsidiary.\n(d) *Food Carrier, Inc., a Georgia corporation, wholly-owned subsidiary.\n(e) *Dixie Crystals(R) Foodservice, Inc., a Delaware corporation, wholly-owned subsidiary.\n(f) *Biomass Corporation, a Delaware corporation, wholly-owned subsidiary.\n(g) *Colonial Sugars, Inc., a Delaware corporation, wholly-owned subsidiary.\n(h) *Savannah Sugar Refining Corporation, a Georgia corporation, wholly-owned subsidiary.\n(i) *Raceland Sugars, Inc., a Delaware corporation, wholly-owned subsidiary.\n(j) *Chatham Sugar Company, a Delaware corporation, wholly-owned subsidiary.\n(k) *South Coast Sugars, Inc., a Delaware corporation, wholly-owned subsidiary.\n(l) *Phoenix Packaging Corporation, a Delaware corporation, wholly-owned subsidiary.\n(m) *Pioneer Trading Company, a Virgin Islands corporation, wholly-owned subsidiary of Michigan Sugar Company.\n(n) *Savannah Investment Company, a Delaware corporation, wholly-owned subsidiary.\n(o) *King Packaging Company, Inc., a Georgia corporation, wholly-owned subsidiary of Dixie Crystals(R) Foodservice, Inc.\n(p) *Savannah International Company, a Delaware corporation, wholly-owned subsidiary.\n(q) *Savannah Packaging Company, a Delaware corporation, a wholly-owned subsidiary of Savannah International Company.\n(r) *Savannah Total Invert Company, a Delaware corporation, a wholly-owned subsidiary of Savannah International Company.\n(s) Refined Sugar Trading Institute, Inc., a Delaware corporation, an Export Trading Company, is a non-profit corporation owned jointly with a non-affiliated company.\n*Indicates subsidiaries included in consolidated financial statements.\nThe operations of Registrant and its wholly-owned subsidiaries, Everglades Sugar Refinery, Inc., Colonial Sugars, Inc., Michigan Sugar Company, Dixie Crystals(R) Foodservice, Inc., and Raceland Sugars, Inc. comprise Registrant's only significant product line which consists of sugar products.\nRaw Materials. A large portion of the raw sugar for Registrant's Savannah refinery and all the raw\nsugar for Registrant's wholly-owned subsidiary, Everglades Sugar Refinery, Inc., is normally supplied by cane sugar producers in the state of Florida. A large portion of the raw sugar for Registrant's subsidiary, Colonial Sugars, Inc., is normally supplied by cane sugar producers in the state of Louisiana. In the case of the Savannah refinery and Colonial Sugars, Inc., the remaining raw sugar requirements are purchased on the open market, and consist of off-shore cargoes purchased directly and through raw sugar trade houses. Registrant uses the futures market as a hedging mechanism, as circumstances warrant.\nMichigan Sugar Company and its subsidiary, Great Lakes Sugar Company, process sugar beets under annual contracts from Michigan and Ohio farmers. The land around the processing plants of the company is well suited to growing sugar beets, and the company has not experienced difficulty in obtaining a sufficient quantity of beets to support successful operation of its plants. Under the contracts with the farmers, certain sales expenses and other non-processing expenses are first deducted from the proceeds of refined sugar, pulp, and molasses sales after which the balance is divided between the company and the farmers.\nCompetition. All phases of the refined sugar business and all geographic markets of the business engaged in by Registrant and its subsidiaries are highly competitive. This Competition is not only with other cane sugar refiners and beet sugar processors, but also with corn sweeteners, artificial sweeteners, and with resellers who purchase all of these sweeteners. Competing cane sugar refineries are located in Florida, Louisiana, Maryland, New York, Texas, and California. Competing beet sugar processors are located in California, Colorado, Idaho, Michigan, Minnesota, Montana, Nebraska, North Dakota, Oregon, Texas, and Wyoming.\nCompetition is primarily based upon price, but is also based upon product quality and customer service. At times, the cane sugar refiners are at a competitive disadvantage to the beet sugar producers due to differing methods by which raw materials are purchased. In the beet industry, the beet farmers participate in any increase or decrease in the selling price of refined sugar. However, in the cane industry, refiners purchase raw sugar at prices which are kept artificially high by United States policy to support sugar farmers, and which do not fluctuate in tandem with refined sugar selling prices. Consequently, when competitive pressures reduce refined sugar prices, the margins of beet sugar producers are affected less adversely than those of cane sugar refiners.\nNumber of Employees. At October 2, 1994, Registrant and its subsidiaries had 2,095 full-time employees. In addition, Michigan Sugar Company, Great Lakes Sugar Company, and Raceland Sugars, Inc.\nemploy a number of seasonal workers during the beet and cane processing campaigns.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nRegistrant and its wholly-owned subsidiaries own and operate three cane sugar refineries, two sugar melt and transfer facilities, five sugar beet processing plants, a beet molasses desugarization facility, a raw sugar mill, and four foodservice production facilities.\nThe three cane sugar refineries are located in Port Wentworth, Georgia; Gramercy, Louisiana and Clewiston, Florida and are owned by Registrant, Colonial Sugars, Inc. and Everglades Sugar Refinery, Inc., respectively. The Port Wentworth facility borders the Savannah River and the Gramercy facility borders the Mississippi River. Both of these locations include a deep water dock with facilities for shipping and receiving ocean-going vessels.\nRegistrant owns sugar melt and transfer facilities in St. Louis, Missouri and Ludlow, Kentucky. The St. Louis facility borders on the Mississippi River and has a dock for receiving sugar and molasses shipments.\nMichigan Sugar Company owns and operates four sugar beet processing plants which are located in Caro, Carrollton, Sebewaing, and Croswell, Michigan. Great Lakes Sugar Company owns and operates a sugar beet processing plant in Fremont, Ohio and a storage facility in Findlay, Ohio. The beet molasses desugarization facility, which is owned by Registrant, is located in Fremont, Ohio.\nDixie Crystals(R) Foodservice, Inc. owns two production facilities, located in Perrysburg, Ohio and Visalia, California, and leases one facility in Savannah, Georgia. At the end of the lease term, Registrant may purchase the Savannah facility for $10.00. Also, King Packaging Company, Inc. owns and operates a packaging facility in Bremen, Georgia.\nRaceland Sugars, Inc. owns and operates a raw sugar mill in Raceland, Louisiana. In addition to its milling operations, Raceland produces and harvests sugar cane for use at its mill. These farming operations are done largely on leased land.\nThe facilities listed above provide Registrant with sufficient productive capacity to meet the demands of its current markets.\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 security holders during the fourth quarter of fiscal 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters.\nRegistrant's common stock, par value $.25 per share (\"Common Stock\"), is presently listed and traded on the New York Stock Exchange (\"NYSE\") under the symbol \"SFI\". (Until October 14, 1992, it was traded in the over-the-counter market under the symbol \"SVAN\".) The following table sets forth for the periods indicated the high and low sales prices on the NYSE composite tape for when the Common Stock was traded on the NYSE and the high and low bids for the Common Stock for when it was quoted on the NASDAQ National Market System. The bids set forth below do not include retail mark-ups, mark-downs, or commissions and the prices represent quotations between dealers and may not necessarily represent actual transactions. The information provided has been adjusted to the nearest 1\/8 and was compiled from quotations furnished by the National Association of Securities Dealers, Inc. and the New York Stock Exchange. Registrant has paid cash dividends on its common stock every year since 1924. The following information is for the twelve-month period ended January 3, 1993, the nine-month period ended October 3, 1993 and the twelve-month period ended October 2, 1994:\nAs of October 2, 1994, the following indicates the number of holders of record of equity securities:\nTitle of Class Number of Record Holders -------------- ------------------------ Common Stock 3,462\nItem 6.","section_6":"Item 6. Selected Financial Data.\nSee following pages.\nSAVANNAH FOODS & INDUSTRIES, INC. SUMMARY OF OPERATIONS\n(In thousands except for per share amounts and ratios)\n(1) On July 21, 1993, the Company changed its fiscal year end from the Sunday closest to December 31 to the Sunday closest to September 30. As a result, the fiscal period ended October 3, 1993 represents a nine-month period. For further information, see Note 2 to the accompanying consolidated financial statements.\n(2) The Company adopted FAS 109, \"Accounting for Income Taxes\" during the fiscal period ended October 3, 1993 and adopted FAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" during the fiscal period ended January 3, 1993. For more information, see Notes 7 and 10 to the accompanying consolidated financial statements.\n(3) Capital expenditures include $4,757 for the acquisition of King Packaging Company, Inc. fixed assets in July 1993 and $15,798 for the acquisition of Raceland Sugars, Inc. fixed assets in October 1991.\n(4) Based on shares outstanding at end of fiscal period.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of the Company's Financial Position and Results of Operations.\nChange in fiscal year end:\nOn July 21, 1993, the Company changed its fiscal year end from the Sunday closest to December 31 to the Sunday closest to September 30, beginning with the fiscal period ended October 3, 1993. The decision to change the fiscal year end was made to conform the Company's financial reporting year to the natural business year of the sugar industry. This is further discussed in Notes 1 and 2 to the consolidated financial statements.\nLiquidity\nIn 1994 the Company expanded its Total Quality Program to include a working capital reduction program. The purpose of this program is to minimize operating working capital, defined as non-cash assets and non-interest bearing liabilities including dividends payable, and to therefore improve liquidity. The program has been successful and the Company's liquidity improved by $24,758,000. The improved liquidity is primarily represented by an increase in cash and equivalents of $20,955,000 and a decrease in short-term debt of $26,300,000 net of a decrease in investments included in other current assets in 1993 of $19,733,000. Operating working capital decreased by $26,248,000. This decrease was primarily in inventories ($60,299,000) and accounts receivable ($11,254,000) net of a decrease in accounts payable ($49,457,000). During 1994 about $1,490,000 of the decrease in operating working capital was used to fund expenditures (primarily dividends and capital additions, net of asset sales) in excess of net income adjusted for non-cash transactions.\nCapital Resources\nLong-term debt, excluding the current portion, decreased $1,854,000 as a result of debt payments. Changes in debt and equity resulted in an increase from 42% to 43% in the ratio of long-term debt to total capital. At October 2, 1994, the Company had $145,000,000 in revolving credit facilities, of which $20,000,000 was outstanding as long-term debt. The Company had no short-term debt as of October 2, 1994. The remaining available balance of $125,000,000 is intended to meet working capital and other cash needs as they arise. All of the $145,000,000 of available facilities are committed through September 30, 1996. The revolving credit facilities, in general, enable the Company to borrow at the banks' cost of funds plus 1\/2%.\nIn addition, Michigan Sugar Company and Raceland Sugars, Inc. can borrow from the Commodity Credit Corporation against their respective sugar inventory balances to meet working capital requirements and to provide a hedge against reduced refined sugar selling prices.\nAt October 2, 1994, stockholders' equity was $188,174,000 compared to equity at October 3, 1993, of $194,714,000. Equity increased as a result of earnings of $5,743,000 for the year ended October 2, 1994, a\nreduction in the minimum pension liability of $1,243,000, and a reduction in the note receivable from the employee stock ownership plan of $643,000. Dividends decreased equity by $14,169,000.\nFixed asset additions during the year ended October 2, 1994, were $23,367,000 and proceeds from sale of fixed assets were $3,309,000. The capital expenditures were primarily upgrading and installing sugar packaging and production equipment and concentrated on cost saving or expansion projects which are expected to benefit the Company through increased efficiency, improved quality control and expanded operational capabilities. The Company expects that expenditures for fixed assets, net of cash receipts from disposals, in fiscal 1995 will approximate $17,000,000.\nEffective December 30, 1991, the first day of the year ended January 3, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 - Employers' Accounting for Postretirement Benefits Other Than Pensions (FAS 106). The cumulative effect of adopting FAS 106 was a one-time noncash charge of $18,170,000, net of tax benefits, or $.68 per share. This new accounting standard does not impact the cash flows of the Company. For further information, see Note 10 to the accompanying consolidated financial statements.\nEffective January 4, 1993, the first day of the nine-month period ended October 3, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 - Accounting for Income Taxes (FAS 109). The cumulative effect of adopting FAS 109 was a one-time noncash credit to income of $600,000, or $.02 per share. The credit was recorded as the cumulative effect of a change in an accounting principle. This new accounting standard does not impact the cash flows of the Company. For further information, see Note 7 to the accompanying consolidated financial statements.\nResults of Operations\nYear ended October 2, 1994 and nine months ended October 3, 1993\nThe Company's net income for the fiscal year ended October 2, 1994 (fiscal 1994) was $5,743,000, or $.22 per share, compared to income of $2,586,000, or $.10 per share, for the nine months ended October 3, 1993 (fiscal 1993). Income for fiscal 1993 includes a $3,030,000 charge to net income (a $4,900,000 increase in cost of sales, net of the associated $1,870,000 income tax benefit) related to a LIFO inventory liquidation at Michigan Sugar as further discussed in Note 2 to the consolidated financial statements and a $600,000 cumulative effect credit due to adopting FAS 109. Income for fiscal 1993 before the cumulative effect of adopting FAS 109 was $1,986,000 or $.08 per share. Average weekly sales volume and prices were down in fiscal 1994 compared to fiscal 1993 due to competitive pressure from beet sugar producers marketing a larger beet crop along with additional sugar carried over from the previous year.\nProductivity increased again in fiscal 1994 at the cane refineries. However, higher raw sugar costs caused by a low raw sugar quota reduced\naverage weekly operating income in this division compared to fiscal 1993.\nMichigan Sugar's average weekly sales volume increased 4% in fiscal 1994 due to a larger crop in Michigan and a carry over from the previous crop. However, average weekly operating income dropped from fiscal 1993 due to lower beet pulp prices and a smaller beet crop in Ohio.\nDixie Crystals Foodservice's average weekly operating income decreased from fiscal 1993 due to higher sugar costs and competitive pricing pressures. Cost cutting programs which lowered manufacturing costs helped minimize the impact of these negative factors.\nRaceland Sugars, Inc. showed a significant increase in average weekly operating income in fiscal 1994 compared to fiscal 1993 as a result of higher raw sugar prices in 1994.\nSelling, general and administrative expenses decreased 7% on an average weekly basis in fiscal 1994 from fiscal 1993 primarily due to a reduction in storage costs achieved through a production optimization program.\nInterest expense decreased slightly on an average weekly basis in fiscal 1994 due to lower short-term borrowings.\nThe effective income tax rate for fiscal 1994 was 33% compared to 37% in fiscal 1993. The lower tax rate in fiscal 1994 is primarily due to lower state income tax expense.\nThe outlook is brighter for fiscal 1995. On October 1, 1994, the U.S. Department of Agriculture implemented marketing allotments which should limit the amount of beet sugar which can be sold in the United States. The continued expansion of beet sugar and the resulting negative impact on refined sugar prices has depressed the Company's earnings over the last four years. Marketing allotments are intended to raise refined selling prices to prevent forfeiture of sugar under loan with the Commodity Credit Corporation.\nAdditionally, higher sugar content of beets in Michigan and Ohio, processing more sugar cane at our Raceland raw sugar mill, and an emphasis on reducing costs and promoting value-added products which are not impacted by government legislation should continue to add to the Company's profitability.\nNine months ended October 3, 1993 and year ended January 3, 1993\nThe Company's net income for the nine months ended October 3, 1993, (fiscal 1993) was $2,586,000, or $.10 per share, compared to income of $9,170,000, or $.35 per share, for the year ended January 3, 1993 (fiscal 1992). The Company's net income for fiscal 1992 includes the impact of adopting FAS 106. Income for fiscal 1992 before the cumulative effect of adopting FAS 106 was $27,340,000, or $1.03 per share. Average weekly sales volume and prices were down in fiscal 1993\ncompared to fiscal 1992 due to competitive pressure from beet sugar producers and cane refiners fighting for market share.\nProductivity at the cane refineries during fiscal 1993 was excellent. The Colonial refinery set an average daily production record, and the Savannah refinery just missed doing likewise.\nMichigan Sugar's average weekly sales volume increased 17% in fiscal 1993 due to a larger beet crop compared to fiscal 1992. However, sugar and byproduct pricing were down and average weekly operating income decreased from fiscal 1992.\nDixie Crystals Foodservice showed good improvements in sales and profits on an average weekly basis when compared to fiscal 1992. Lower manufacturing costs were achieved through the move of the Savannah facility to its new location.\nRaceland Sugars, Inc. showed an increase in average weekly operating income as a result of higher sales volume offset set by lower raw sugar prices.\nSelling, general and administrative expenses increased in fiscal 1993 on an average weekly basis due to higher selling costs at Michigan Sugar caused by a larger beet crop and higher administrative costs.\nInterest expense increased primarily due to the increased long-term debt acquired in the latter part of fiscal 1992 and the acquisition of King Packaging in July 1993.\nThe effective tax rate for fiscal 1993 was 37% compared to 33% in fiscal 1992. The higher tax rate in fiscal 1993 is due to a 1% increase in the statutory rate in 1993 and to the receipt of non-taxable life insurance proceeds in 1992.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\n(a) Financial Statements: Page ----\nReport of Independent Accountants 15\nConsolidated Balance Sheets at October 2, 1994 and October 3, 1993 16\nConsolidated Statements of Operations for the fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993 17\nConsolidated Statements of Changes in Stockholders' Equity for the fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993 18\nConsolidated Statements of Cash Flows for the fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993 19\nNotes to Consolidated Financial Statements 20\n(b) Financial Statement Schedules for the fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993:\nV - Property, Plant and Equipment 37\nVI - Accumulated Depreciation and Amortization of Property, Plant and Equipment 38\nOther schedules are omitted because they are not applicable, or the required information is shown in the financial statements or notes thereto.\nReport of Independent Accountants ---------------------------------\nNovember 18, 1994\nTo the Stockholders and Board of Directors of Savannah Foods & Industries, Inc.\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Savannah Foods & Industries, Inc. at October 2, 1994, and October 3, 1993, and the results of their operations and their cash flows for the fifty-two weeks ended October 2, 1994, the thirty-nine weeks ended October 3, 1993 and the fifty-three weeks ended January 3, 1993, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in Notes 7 and 10 to the financial statements, the Company changed its methods of accounting for income taxes and accounting for postretirement benefits other than pensions, during the thirty-nine weeks October 3, 1993 and the fifty-three weeks ended January 3, 1993, respectively.\nPRICE WATERHOUSE LLP\nSavannah, Georgia\nSAVANNAH FOODS & INDUSTRIES, INC. Consolidated Balance Sheets (In thousands except for shares and per share amounts)\n(The accompanying notes are an integral part of the financial statements.)\nSAVANNAH FOODS & INDUSTRIES, INC. Consolidated Statements of Operations (In thousands except for shares and per share amounts)\n(The accompanying notes are an integral part of the financial statements.)\nSAVANNAH FOODS & INDUSTRIES, INC. Consolidated Statements of Changes in Stockholders' Equity (In thousands except for shares and per share amounts)\n(The accompanying notes are an integral part of the financial statements.)\nSAVANNAH FOODS & INDUSTRIES, INC. Consolidated Statements of Cash Flows (In thousands of dollars)\n(The accompanying notes are an integral part of the financial statements.)\nSAVANNAH FOODS & INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1 - Summary of Significant Accounting Policies:\nFiscal year - As described in Note 2, the Company changed its fiscal year end from the Sunday closest to December 31 to the Sunday closest to September 30. The fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993 include 52 weeks, 39 weeks and 53 weeks, respectively.\nPrinciples of consolidation and business segments - The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. The Company has one primary business segment - Sugar Products.\nChanges in accounting principles - As discussed in Note 7, Statement of Financial Accounting Standards No. 109 - Accounting for Income Taxes (FAS 109) was prospectively adopted effective January 4, 1993, the first day of the fiscal period ended October 3, 1993. As discussed in Note 9, Statement of Financial Accounting Standards No. 106 - Employers' Accounting for Postretirement Benefits Other Than Pensions (FAS 106) was adopted effective December 30, 1991, the first day of the fiscal period ended January 3, 1993.\nCash equivalents - Cash equivalents include all investments purchased with an original maturity of 90 days or less which have virtually no risk of loss of value of the principal amount of the investment.\nInventories - Inventories are valued at the lower of cost or market. Cost is determined by the last-in, first-out (LIFO) method for sugar, packaging materials, and certain other items. Costs for maintenance parts, sugar cane and other non-sugar products are determined using the first-in, first-out (FIFO) and moving average methods.\nFutures transactions and interest rate swaps - The Company uses futures and other financial instruments as hedges in its inventory purchasing and cash management programs. Gains and losses on such transactions related to inventory are matched to specific inventory purchases and charged or credited to cost of sales as such inventory is sold. Gains and losses on transactions related to loans are included in interest expense during the period in which the related instruments are outstanding. In connection with the Company's futures trading activity, the Company maintains deposits with futures brokers. These deposits are included in \"Other current assets\".\nInvestments in marketable securities - At October 3, 1993, the Company had invested in marketable securities directly and through certain investment partnerships and mutual funds. The estimated fair market value of these investments approximated the carrying value of $19,733,000 based on quoted market prices and dealer quotes. These\ninvestments are included in \"Other current assets\" at October 3, 1993. No investments in marketable securities are held at October 2, 1994.\nAmortization of intangibles - The Company has intangible assets included in \"Other assets\" aggregating $8,031,000 and $10,648,000 at October 2, 1994 and October 3, 1993, respectively. These assets are being amortized over five years. Amortization expense for the fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993 was $2,617,000, $1,363,000 and $1,328,000, respectively.\nProperty, plant and equipment - Property, plant and equipment is valued at cost less accumulated depreciation and amortization. For financial reporting purposes, depreciation is computed on the straight-line method. Accelerated depreciation methods are used for tax purposes on $266,294,000 of equipment.\nAccrued expenses related to beet and sugar cane operations - The Company's beet and sugar cane processing plants are generally operated from October through February and then, from March through September, are repaired for the next processing cycle. As sugar is processed from October through February, the Company accrues estimated repair costs and other costs to be incurred in March through September and includes such costs in inventory and, as the sugar is sold, in cost of sales. In contrast, some sugar processors capitalize such costs and include them as prepaid expenses related to the next processing cycle.\nFair value of financial instruments - For cash, cash equivalents, accounts receivable, accounts payable, accrued expenses and short-term borrowings, the carrying amounts approximate fair value because of the short maturities of these instruments. See Note 6 for discussion of the fair value of long-term debt.\nRevenue recognition - The Company recognizes revenue as product is shipped.\nReclassifications - Certain prior year amounts have been reclassified to conform to current year presentation.\nNote 2 - Change in Fiscal Year End:\nIn July 1993, the Company changed its fiscal year end from the Sunday closest to December 31 to the Sunday closest to September 30 in order to conform the Company's financial reporting to the natural business year of the sugar industry. Inventory quantities are significantly lower at the end of the new fiscal year than at the end of a calendar year. Therefore, as a consequence of the change in fiscal year end the Company experienced a LIFO inventory liquidation and recorded a charge to operations of $3,030,000, net of tax of $1,870,000, during the fiscal period ended October 3, 1993. To aid comparative analysis, the Company has presented below results of operations (condensed) for the nine-month periods ended October 3, 1993 and September 27, 1992 (in thousands except for shares and per share amounts):\nAdditionally, to aid comparative analysis of the fiscal periods ended October 2, 1994 and January 3, 1993, the Company has presented below the pro forma condensed consolidated statements of operations through income before change in accounting principle for the fiscal year ended October 2, 1994 and for the fiscal year ended October 3, 1993, as included in the 1993 Annual Report. The amounts are presented without the LIFO charge discussed above (in thousands except for shares and per share amounts):\nNote 3 - Acquisition:\nOn July 7, 1993, the Company acquired the outstanding common stock of King Packaging Company, Inc., a supplier of plastic cutlery and customized meal kits to the foodservice and healthcare industries. The acquisition was accounted for as a purchase, and the acquisition costs of the assets acquired and the liabilities assumed are as follows (in thousands of dollars):\nCurrent assets $10,330 Inventories 1,770 Property, plant and equipment 4,757 Value of non-compete agreements 8,203 Other assets 290 ------- Assets acquired 25,350 Liabilities assumed (977) ------- $24,373 =======\nNote 4 - Inventories:\nA summary of inventories by method of pricing and class is as follows:\nDuring the fiscal period ended October 2, 1994, inventory quantities were reduced. This reduction resulted in a liquidation of LIFO inventory quantities carried at lower costs prevailing in prior years as compared with the cost of fiscal 1994 purchases, the effect of which decreased cost of goods sold by approximately $1,762,000 and increased net income by approximately $1,097,000 or $.04 per share.\nThe replacement cost of inventories exceeded reported cost by approximately $10,013,000 at October 2, 1994 and $11,616,000 at October 3, 1993.\nNote 5 - Property, Plant and Equipment:\nProperty, plant and equipment is summarized as follows:\nRepairs and maintenance expense was $31,584,000 for the fiscal period ended October 2, 1994, $26,706,000 for the fiscal period ended October 3, 1993 and $33,879,000 for the fiscal period ended January 3, 1993.\nNote 6 - Long-term Debt and Credit Arrangements:\nLong-term debt is summarized as follows:\nDuring the fiscal period ended January 3, 1993, the Company entered into a 10-year loan for $70,000,000 with three insurance companies. Series A for $50,000,000 has a fixed interest rate of 8.35% and Series B for $20,000,000 has a fixed interest rate of 7.15%. These funds were used to finance capital projects at existing production facilities and to repay long-term debt outstanding under the Company's revolving credit lines.\nAt October 2, 1994, the Company had $145,000,000 in revolving credit facilities with banks which are committed through September 1996. The Company has $20,000,000 outstanding under these facilities which it treats as long-term debt. The revolving credit facilities, in general, enable the Company to borrow funds at the banks' cost of funds plus approximately 1\/2%. The Company pays an annualized commitment fee of 3\/16% on the unused portion of these facilities.\nAt October 2, 1994, the Company had $15,500,000 in notes payable related to the Employee Stock Ownership Plan (ESOP). These notes carry a tax-advantaged rate of interest equal to about 85% of LIBOR. The rates averaged 3.08% and 3.40% during the fiscal periods ended October 2, 1994 and October 3, 1993, respectively. See further discussion of the ESOP at Note 10.\nThe $28,000,000 industrial revenue bonds consist of two issues of bonds for $4,500,000 each due in 2000, an issue for $3,500,000 due in 2003, an issue for $2,500,000 due in 2005, an issue for $6,000,000 due in 2007, and an issue for $7,000,000 due in 2017. The rate on these bonds can vary as frequently as every seven days in order to sell the bonds at par value. During the fiscal period ended October 2, 1994 and the fiscal period ended October 3, 1993, the average interest rate on these bonds was 2.7% and 2.5%, respectively. If the two $4,500,000 bonds cannot be sold, the Company has an agreement with a bank which acts as the marketing agent for the bonds whereby the bank would buy and hold the bonds until their maturity and would receive interest at a rate of 65% of the prime interest rate. If the other issues could not be\nsold by the bank, the Company would have an obligation to sell the bonds themselves or repurchase them. To enhance the marketability of the bonds, the bank\/marketing agent has issued letters of credit to guarantee payment of the bonds on the Company's behalf. The Company expects to be able to renew these letters of credit upon their expiration throughout the life of these bonds. Also, the bonds are secured by financing statements on project-related equipment, the cost of which approximates the bond amounts.\nThe Company uses interest rate exchange agreements, more commonly called interest rate swaps, to manage its interest rate exposure.\nThe effect of certain of the swap agreements is to fix the rate on the $20,000,000 long-term debt borrowed under revolving credit agreements, the $15,500,000 ESOP loans and the $28,000,000 industrial revenue bonds over the 2.5 years remaining on the swap contracts. The average fixed interest rate on this $63,500,000 of debt fixed through these swap agreements is 6.89%. These swaps were entered into to fix the interest rate on variable debt at rates which the Company considered attractive at the time the agreements were consummated. The Company did not enter into these agreements in anticipation of rate movements. When the Company entered into these agreements, it compared its anticipated interest costs to other long term borrowing sources such as private placements and other fixed rate borrowing options. Accordingly, the Company has realized its desired objectives in the use of these derivatives. If the Company had canceled these agreements as of October 2, 1994, it would have been required to pay the counter parties to the agreements an aggregate amount of $2,100,000.\nDuring the last quarter of the fiscal period ended January 3, 1993, the Company entered into agreements whereby it receives\/pays the difference between six month LIBOR and 4.54% on $50,000,000 for a three year period to reduce the interest rate on the Series A senior notes. The Company anticipated that short-term rates would continue to decline. If the Company had canceled these agreements as of October 2, 1994, it would have been required to pay the counter parties to the agreements an aggregate amount of approximately $830,000. Over the life of this transaction the Company expects to break-even. This agreement expires in October 1995.\nShort-term borrowings, including borrowings under the Company's revolving credit facilities which were for temporary working capital needs, are summarized as follows:\nThe Company's most restrictive loan covenants require that the Company maintain stockholders' equity of $174,703,000 plus 20% of consolidated net income beginning with fiscal year 1994 and ending with calendar year 1996 and that the Company maintain certain financial ratios. These financial ratio covenants include a requirement that the ratio of income before taxes, interest expense and lease expense to the sum of interest and lease expense be 1.4, or greater, through March 31, 1995 and 2.0, or greater, thereafter. The Company is in compliance with these requirements at October 2, 1994 and expects to be in compliance with such requirements in the future.\nInterest expense was $13,380,000 for the fiscal period ended October 2, 1994, $10,226,000 for the fiscal period ended October 3, 1993 and $10,526,000 for the fiscal period ended January 3, 1993. Cash payments of interest were $13,364,000 for the fiscal period ended October 2, 1994, $9,377,000 for the fiscal period ended October 3, 1993 and $9,336,000 for the fiscal period ended January 3, 1993.\nAnnual maturities of long-term debt each year for the next five fiscal years are $1,747,000 in 1995, $6,300,000 in 1996, $27,610,000 in 1997, $7,400,000 in 1998, $8,940,000 in 1999, and $89,870,000 in subsequent years through 2017.\nThe carrying value of the Company's long-term debt approximates its market value at October 2, 1994. Virtually all of the Company's debt had a fixed rate at October 2, 1994, either from the note terms or through interest rate swaps. The market value of fixed-rate long-term debt was estimated based on the present value of expected cash flows using current market rates and the Company's incremental borrowing rate for debt with similar terms.\nNote 7 - Income Taxes:\nThe Company prospectively adopted Statement of Financial Accounting Standards No. 109 - Accounting for Income Taxes (FAS 109) effective January 4, 1993, the first day of the fiscal period ended October 3, 1993. The adoption of FAS 109 changed the Company's method of accounting for income taxes from the deferred method (Accounting Principles Board Opinion No. 11) to an asset and liability approach. Previously the Company deferred the past tax effects of timing differences between financial reporting and taxable income. The asset and liability approach requires the recognition of deferred tax\nliabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities.\nUnder FAS 109, assets and liabilities acquired in business combinations accounted for under the purchase method are assigned their fair values, and deferred taxes are provided for lower or higher tax bases. Under APB 11, values assigned were net-of-tax. In adopting FAS 109, the Company adjusted the carrying amounts of the Michigan Sugar Company fixed assets and LIFO inventories acquired in 1984. Pretax income from operations for the fiscal period ended October 3, 1993 was reduced by $5,600,000 representing additional cost of sales and depreciation expense resulting from the higher carrying amounts.\nThe net adjustments to the January 4, 1993 balance sheet to adopt FAS 109 resulted in a $600,000 credit to net income. This amount is reflected in the accompanying consolidated statement of operations for the fiscal period ended October 3, 1993 as a cumulative effect of a change in accounting principle.\nPretax income from continuing operations for all periods presented was taxed exclusively in the United States. The provision for income taxes is comprised of the following:\nCash payments of income taxes amounted to $7,504,000 for the fiscal period ended October 2, 1994, $11,834,000 for the fiscal period ended October 3, 1993 and $16,774,000 for the fiscal period ended January 3, 1993.\nDeferred income tax liabilities (assets) are comprised of the following:\nThe components of the Company's deferred income tax provision calculated under APB 11 and the tax effects of each are summarized below:\nA reconciliation between the provision for income taxes and the amount computed by applying the U. S. federal income tax rate to income before income taxes and change in accounting principle is as follows:\nThe Company increased its deferred income tax liability in the last quarter of the fiscal period ended October 3, 1993 as a result of legislation enacted during 1993 increasing the corporate tax rate from 34% to 35% commencing in 1993.\nNote 8 - Stockholders' Equity:\nThe Certificate of Incorporation of the Company, as amended, authorizes a class of preferred stock to consist of up to 1,000,000 shares of $.50 par value stock. The Board of Directors can determine the characteristics of the preferred stock without further stockholder approval.\nNote 9 - Pension Plans:\nSubstantially all employees and retirees of the Company are covered by noncontributory defined benefit pension plans. The Company also provides supplemental pension benefits to certain retired employees. The supplemental pension benefits are determined annually by the Board of Directors.\nBenefits under the noncontributory defined benefit pension plans for bargaining employees are primarily based on years of service; benefits for other employees are generally based on years of service and the employee's highest consecutive three-year average earnings. The Company's policy is to contribute at least the minimum amount required by the Employee Retirement Income Security Act. At October 2, 1994, the assets of these plans are invested primarily in cash equivalents, mutual stock and bond funds, and common stocks including 217,587 shares of the Company's common stock with a market value of $2,611,000. The plan received $117,497 in dividends from these shares during the fiscal period ended October 2, 1994.\nThe following table sets forth the status of the Company's defined benefit pension plans and the pertinent assumptions used in computing this information as of the end of each respective period:\nThe table above is based on a discount rate of 8.5 % for the fiscal period ended October 2, 1994 and 7.5% for the fiscal period ended October 3, 1993, and projected salary increases of 4.5% for the fiscal period ended October 2, 1994 and 4% for the fiscal period ended October 3, 1993.\nPension expense for the fiscal period ended October 2, 1994, the fiscal period ended October 3, 1993 and the fiscal period ended January 3, 1993 is summarized as follows:\nThe expected long-term rate of return on plan assets used in determining \"Pension expense related to defined benefit plans\" as shown above was 9.5% for the fiscal period ended October 2, 1994, 10.5% for the fiscal period ended October 3, 1993, and 11% for the fiscal period ended January 3, 1993.\nThe Company sponsors a Supplemental Executive Retirement Plan (SERP) to supplement its qualified plan for certain management employees. The actuarially determined expense related to this plan was $1,255,000 for the fiscal period ended October 2, 1994, $800,000 for the fiscal period ended October 3, 1993, and $1,010,000 for the fiscal period ended January 3, 1993. Of these expenses, the interest portion amounted to $781,000 for the fiscal period ended October 2, 1994, $569,000 for the fiscal period ended October 3, 1993, and $707,000 for the fiscal period ended January 3, 1993. The remaining balance of the expense in each year is primarily service cost.\nThe table below summarizes the status of the SERP plan at the end of each respective period:\nThe table above is based on a discount rate of 8.5% for the fiscal period ended October 2, 1994 and 7.5% for the fiscal period ended October 3, 1993, and projected salary increases of 4.5% for the fiscal period ended October 2, 1994 and 4% for the fiscal period ended October 3, 1993.\nIn accordance with the provisions of Statement of Financial Accounting Standards No. 87 - Employers' Accounting for Pensions, the Company has recorded an additional minimum liability at October 2, 1994 and at October 3, 1993 representing the excess of the accumulated benefit obligation over the fair value of plan assets and accrued pension liability for its pension and SERP plans. The additional liability has been offset by an intangible asset which is included in \"Other assets\" to the extent of previously unrecognized prior service cost. Amounts in excess of previously unrecognized prior service cost are recorded net of the related deferred tax benefit as a reduction of stockholders' equity of $8,210,000 at October 2, 1994 and $9,453,000 at October 3, 1993.\nNote 10 - Other Retirement and Benefit Plans:\nThe Company sponsors a deferred compensation plan which permits directors and certain management employees to defer portions of their compensation and earn a guaranteed interest rate on the deferred amounts. The salaries which have been deferred since the plan's inception have been accrued, and the expense, other than salaries, related to this plan is interest on the deferred amounts. Interest expense during the fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993 includes $1,915,000, $1,247,000, and $1,196,000, respectively, related to this plan. The Company has included in \"Deferred employee benefits\" $15,176,000 at October 2, 1994 and $13,191,000 at October 3, 1993 to reflect its liability under this plan.\nIn connection with the deferred compensation plan and the SERP plan referred to in Note 9, the Company purchases whole-life insurance contracts on the related directors and employees. The Company has included in \"Other assets\" $15,496,000 at October 2, 1994 and $12,303,000 at October 3, 1993 which represent the capitalized value of these policies. If all of the assumptions regarding mortality, interest rates, policy dividends, and other factors are realized, the Company will ultimately realize its full investment plus a factor for the use of its money.\nThe Company sponsors 401(k) plans in which substantially all non-bargaining employees and certain bargaining unit employees are eligible to participate. These plans allow eligible employees to save a portion of their salary on a pre-tax basis. The Company makes annual contributions to these plans which aggregated $408,000, $320,000 and $345,000 for the fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993, respectively.\nThe Company also sponsors an Employee Stock Ownership Plan (ESOP) in which substantially all non-bargaining employees participate. Contributions may be made in the form of cash or Company stock. The Company has expensed contributions to the ESOP of $0, $1,235,000 and $1,500,000 for the fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993, respectively.\nThe Company maintains a profit-based incentive plan which currently covers approximately 1,100 qualified employees. Compensation under this plan was $0, $0 and $979,000 for the fiscal periods ended October 2, 1994, October 3, 1993 and January 3, 1993, respectively.\nThe Company also sponsors benefit plans that provide postretirement health care and life insurance benefits to certain employees who meet the applicable eligibility requirements. Effective December 30, 1991, the first day of the fiscal period ended January 3, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 - Employers' Accounting for Postretirement Benefits Other Than Pensions (FAS 106). This standard requires accrual of the expected cost of providing postretirement benefits to employees and their beneficiaries and covered dependents during the years that employees provide services. Prior to December 30, 1991, the Company expensed the costs of health care and\nlife insurance benefits provided to retirees in the period in which these costs were paid.\nThe cumulative effect of this change in accounting principle was a one-time charge of $28,841,000 before taxes, or $18,170,000 net of tax benefits calculated at an estimated effective tax rate of 37%. The cost of postretirement health care and life insurance benefits is summarized as follows:\nThe actuarial and recorded liabilities for these postretirement benefits, none of which has been funded, are as follows:\nThe assumed discount rate was 8.5% for the fiscal period ended October 2, 1994 and 7.5% for the fiscal period ended October 3, 1993. For the fiscal period ended October 2, 1994, the rate of increase in the per capita costs of covered health care benefits was assumed to be 8% for the first five years, 6% for the next five years and 5% thereafter. For the fiscal period ended October 3, 1993, the rate of increase was assumed to be 9% for the first five years, 7% for the next five years, and 5% thereafter. Increasing the health care cost trend rate assumption by one percentage point would increase the accumulated postretirement benefit obligation as of October 2, 1994 by approximately $3,390,000 and would increase postretirement benefit cost by approximately $355,000 for the fiscal period ended October 2, 1994.\nNote 11 - Commitments and Contingencies:\nThe Company has contracted for the purchase of a substantial portion of its future raw sugar requirements. Prices to be paid for raw sugar under these contracts are based in some cases on market prices during the anticipated delivery month. In other cases prices are fixed and, in these instances, the Company generally obtains commitments from\nits customers to buy the sugar prior to fixing the price, or enters into futures transactions to hedge the commitment.\nThe Company is exposed to loss in the event of non-performance by the other party to the interest rate swap agreements discussed in Note 6. However, the Company does not anticipate non-performance by the counter-parties to the transactions.\nIn May 1992, the United States Customs Service (Customs) issued a bill to the Company for approximately $7,500,000 seeking reimbursement for certain drawback claims filed by the Company with Customs during the period 1984 through 1988. Customs has alleged that drawback claims prepared by the Company for certain export shipments of sugar during these years are technically and\/or substantively deficient and that the Company, therefore, is not entitled to monies previously received under these drawback claims. The Company disputes Customs' findings and intends to vigorously protest the decision of Customs. While it is not certain how long the protest (administrative appeal) process will take, based upon the facts known to the Company at this time, the ultimate resolution of this matter is not expected to have a materially adverse effect on the Company's financial position or results of operations.\nIn July 1991, National Utility Service, Inc. (NUS) filed a complaint against the Company in the United States District Court for the District of New Jersey seeking compensation and damages arising from a contract between the Company and NUS for energy cost saving recommendations. On September 12, 1994, summary judgment was entered against the Company in the amount of $2,973,000 in this case. A motion is presently pending in that action to modify the judgment by the addition of prejudgment interest in an amount between $1,343,000 and $1,472,000. The Company has opposed the motion to modify and has appealed the judgment to the United States Court of Appeals for the Third Circuit. The Company intends to pursue the appeal vigorously and strongly contends that no amounts are due to NUS.\nNote 12 - Quarterly Financial Information (Unaudited):\nUnaudited quarterly financial information for the fiscal periods ended October 2, 1994 and October 3, 1993 is as follows:\nQuarterly results of operations for the fiscal period ended October 3, 1993 reflect the change in the Company's fiscal year end. The first quarter ended April 4, 1993 reflects the cumulative effect of adoption of FAS 109 of $600,000 effective January 4, 1993. The third quarter reflects a $4,900,000 increase in cost of sales and the associated $1,900,000 income tax benefit representing the liquidation of LIFO basis inventory acquired in 1984 as further explained in Note 2 to the financial statements.\nSAVANNAH FOODS & INDUSTRIES, INC. AND SUBSIDIARIES Schedule V Property, Plant and Equipment (In thousands of dollars)\n(1) Additions for the fiscal period ended October 3, 1993 include $10,446 for the write-up of assets at Michigan Sugar Company due to the adoption of FAS 109 (see Note 7 for further discussion) and $10,852 for the assets acquired as a result of the acquisition of King Packaging Company.\nSAVANNAH FOODS & INDUSTRIES, INC. AND SUBSIDIARIES Schedule VI Accumulated Depreciation and Amortization of Property, Plant and Equipment (In thousands of dollars)\n(1) Additions for the fiscal period ended October 3, 1993 include $7,754 for the write-up of assets at Michigan Sugar Company due to the adoption of FAS 109 (see Note 7 for further discussion) and $6,095 for the accumulated depreciation on assets acquired as a result of the acquisition of King Packaging Company.\nItem 9.","section_9":"Item 9. Change 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 information relating to the Directors of the Company is incorporated by reference from the \"ELECTION OF DIRECTORS\" section, pages 4 through 7, of the Company's Proxy Statement for its Annual Meeting of Stockholders to be held on February 16, 1995, to be filed pursuant to Section 14 of the Securities Exchange Act of 1934 (\"1995 Proxy Statement\"). The information relating to the Executive Officers of the Company is incorporated by reference from the \"MANAGEMENT OF SAVANNAH FOODS & INDUSTRIES, INC.\" section, page 8 of the 1995 Proxy Statement. The information relating to disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is incorporated by reference from the \"COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934\" section, page 12, of the 1995 Proxy Statement.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information relating to executive compensation is incorporated by reference from the \"EXECUTIVE COMPENSATION\" section, pages 9 and 10, the \"BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD\" section, page 14, the \"COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION\" section, pages 11 and 12, the \"COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\" section, page 12, and the performance graph, page 13, of the 1995 Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information relating to the security ownership of certain beneficial owners and management is incorporated by reference from the \"STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\" section, pages 2 and 3, of the 1995 Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information relating to certain relationships and related transactions is incorporated by reference from the \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\" section, page 14, and the \"COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\" section, page 12, 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) and (2): See index of Financial Statements, Item 8(a) and 8(b), page 14.\n(a)(3) Exhibits:\n* Indicates exhibits which are management contracts or compensatory agreements.\n(b) Reports on Form 8-K: None.\n(c) See (a)(3) Exhibits above.\n(d) Not applicable.\nUNDERTAKINGS\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 Number 2-63448, Monthly Investment Plan for Employees of Savannah Foods & Industries, Inc. (filed June 19, 1984 as amended on April 3, 1992); and Number 2-94678, Employee Retirement Savings Account Plan (filed December 22, 1984 as amended on October 18, 1994).\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 (the \"Act\") may be permitted to Directors, Officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a Director, Officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such Director, Officer or controlling persons 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.\nSIGNATURE\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.\nSAVANNAH FOODS & INDUSTRIES, INC.\nDated: December 20, 1994. By: \/S\/William W. Sprague, III ------------------ -------------------------- William W. Sprague, III President\nPursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons on behalf of Registrant in the capacities and on the dates indicated:","section_15":""}
{"filename":"74273_1994.txt","cik":"74273","year":"1994","section_1":"ITEM 1. BUSINESS\nBackground\nOld Stone Corporation (the \"Corporation\") is a general business corporation incorporated in 1969 under the laws of the State of Rhode Island. The principal offices of the Corporation are located at Four Davol Square, Suite 320, Providence, Rhode Island 02903.\nOn January 29, 1993, the Office of Thrift Supervision (\"OTS\") declared Old Stone Bank, a Federal Savings Bank, a federally chartered stock savings bank organized under the laws of the United States (the \"Bank\"), insolvent, and appointed the Resolution Trust Company (\"RTC\") as receiver (the \"Bank Closing\"). The RTC formed a bridge bank, Old Stone Federal Savings Bank (the \"Bridge Bank\") which assumed all of the deposit liabilities and substantially all of the other liabilities of the Bank and acquired substantially all of the assets of the Bank (including the stock of all of its subsidiaries). Immediately prior to the Bank Closing, the Bank constituted substantially all of the assets of the Corporation. Immediately following the Bank Closing, all of the officers of the Corporation resigned and were hired by the Bridge Bank. A limited slate of new officers was elected on March 8, 1993. See Item 10 below.\nThe Corporation continues to hold its equity interest in Old Stone Securities Company (\"Old Stone Securities\"). See \"Significant Subsidiary\" below. The Corporation has no equity interest in any other significant entity.\nSignificant Subsidiary\nThe Corporation's only surviving active subsidiary after the Bank Closing is Old Stone Securities, a registered securities broker-dealer which provides brokerage services to retail and institutional clients. In addition, Old Stone Securities participates in Rhode Island underwritings of tax-exempt securities, maintains an inventory of tax-exempt securities for resale, and also trades government securities both at auction and in the secondary market. See \"Regulation\" below.\nRegulation\nOld Stone Securities is subject to regulation by the Securities and Exchange Commission, the State of Rhode Island, and the National Association of Securities Dealers, Inc.\nEmployees\nAs of December 31, 1994, the Corporation had no employees. As of such date, Old Stone Securities employed 3 persons, all of whom were full-time.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe administrative offices of the Corporation and Old Stone Securities are located at Four Davol Square, Suite 320, in Providence, Rhode Island. Such offices are leased on a month-to-month basis at a per month rental of $2,600, which amount is paid by Old Stone Securities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Corporation is not aware of any pending or threatened legal proceedings against the Corporation or Old Stone Securities, except as noted in the counterclaim discussed below.\nOn January 29, 1993, the OTS declared the Bank insolvent, and appointed the RTC as receiver. See Item 1 above, \"Business--Background\".\nOn September 16, 1992, the Corporation and the Bank (\"Plaintiffs\") instituted a suit against the United States (\"Defendant\") in the U.S. Court of Federal Claims. In connection with certain government-assisted acquisitions by Plaintiffs in the 1980's, the Defendant (through its agencies the Federal Home Loan Bank Board (\"FHLBB\") and the Federal Savings and Loan Insurance Corporation) agreed to provide Plaintiffs with certain valuable capital credits and authorized Plaintiffs to treat those credits as regulatory capital. Following the passage of the Financial Institutions Reform, Recovery, and Enforcement Act in August, 1989, the OTS (successor in interest to the FHLBB) required the Bank to discontinue treating these capital credits as part of regulatory capital and caused the Bank to write off immediately approximately $75 million of such capital credits. In this suit Plaintiffs allege breach of contract by the United States, resulting in substantial injury to Plaintiffs, effecting a taking of Plaintiffs' property without just compensation, and unjustly enriching the Defendant at the expense of Plaintiffs. Plaintiffs seek compensation for the damages caused by the breach, just compensation for the property taken, and disgorgement of the amounts by which the Defendant has been unjustly enriched. The Defendant has filed a counterclaim against Plaintiffs for alleged breach of Plaintiffs' net worth maintenance agreement. The Plaintiffs have filed an answer denying such counterclaim. The case is one of several similar cases pending before the U.S. Court of Federal Claims. The case as to the Corporation has been stayed pending the outcome of such other suits. In addition, the impact of the Bank Closing on the claims made by the Bank is unclear since the Defendant now acts as receiver for the Bank. No prediction as to the outcome of this case can be made at this time.\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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nUntil January 29, 1993, the Corporation's Common Stock, $1.00 par value (the \"Common Stock\"), was quoted on the NASDAQ National Market and was traded under the symbol \"OSTN\". As of the date hereof, there is no established public trading market for the Common Stock. Book value per share of Common Stock after treating the Bank as a discontinued operation in light of the Bank Closing was ($2.37) on December 31, 1994, compared to ($2.30) on December 31, 1993. At March 17, 1995, there were 8,246,175 shares of Common Stock of the Corporation outstanding held by 40,319 shareholders of record.\nThe following table shows the Corporation's Common Stock activity. Indicated are the high and low bid quotations and dividends paid for each of the four quarters in 1992.\nHigh Low Dividend\nFirst quarter $6 1\/4 $2 7\/8 $0 Second quarter 4 3\/4 3 5\/8 0 Third quarter 3 7\/8 1 1\/4 0 Fourth quarter 4 1 1\/8 0\nThe Corporation discontinued dividends to holders of its Common Stock and its Cumulative Voting Convertible Preferred Stock, Series B (the \"Preferred Stock\"), during 1991 and does not expect to pay any dividends on such stock for the foreseeable future. As a result of the failure to pay dividends on the Preferred Stock for more than four quarters, the holders of the Preferred Stock collectively are entitled to elect a number of directors of the Corporation constituting twenty percent (20%) of the total number of directors of the Corporation at the next meeting of stockholders at which directors are to be elected. Until the aggregate deficiency is declared and fully paid on the Preferred Stock, the Corporation may not declare any dividends or make any other distributions on or redeem the Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nOn January 29, 1993, the OTS declared the Bank insolvent, and appointed the RTC as receiver. See Item 1 above, \"Business--Background\". Operations of the Bank, which accounted for substantially all of the Corporation's operations, have been reflected as discontinued operations in 1992. Bank operations are not included in 1993 or 1994 operations. The Corporation has recognized losses from discontinued operations of the Bank only to the extent of its investment in and advances to the former subsidiary savings and loan (determined on a basis consistent with generally accepted accounting principles). At December 31, 1993 and 1994 the Corporation's statements of financial condition do not include any assets or liabilities of the Bank.\nThe following schedule of selected financial information includes the three years ending December 31, 1992, 1993 and 1994. Financial information for the two years ending December 31, 1990 and 1991 are not included as the Corporation believes that disclosure of this information would no longer be meaningful in light of the Bank Closing.\nOld Stone Corporation three year comparison ($ in thousands, except for share and per share amounts):\nFiscal Year Ended: December 31, December 31, December 31, 1992 1993 1994 INCOME: Interest income $ 896 $ 51 $ 47 Other income (loss) 935 357 230 Total income (loss) 1,831 408 277\nEXPENSES: Interest expense 590 6 0 Provision for loan losses 112 0 0 Salaries and benefits 212 216 211 Other operating expenses 512 502 420 Total expense 1,426 724 631\nINCOME:\nIncome (loss) from continuing operations before income taxes $ 405 $ (316) $ (354) Income taxes (credit) (814) (7) 26 Income (loss) from continuing operations 1,219 (309) (380) Income (loss) from discontinued operations (57,211) 0 0\nNET LOSS ($55,992) (309) (317)\nNet loss available to common shareholders ($58,700) $ (3,017) $ (3,088) Loss per share: From continuing operations ($.18) ($.37) ($.37) From discontinued operations ($6.93) 0 0 Net loss ($7.11) ($.37) ($.37)\nAverage shares outstanding 8,261,306 8,246,175 8,246,175\nASSETS: Cash $ 30 $ 18 $ 32 Short-term investments 1,728 1,150 797 Loans receivable, net 116 122 117 Other assets 674 543 540\nTOTAL $2,548 $1,833 $1,486\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) LIABILITIES: Long-term debt 407 5 0 Other liabilities 1,285 1,281 1,319 Total liabilities 1,692 1,286 1,319\nRedeemable preferred stock 19,319 19,515 19,711 Stockholders' equity (deficit) (18,463) (18,968) (19,544) $2,548 $1,833 $1,486\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS\nOn January 29, 1993, the OTS declared the Bank insolvent, and appointed the RTC as receiver. See Item 1 above, \"Business--Background\". Operations of the Bank, which accounted for substantially all of the Corporation's operations, have been reflected as discontinued operations in 1992. Bank operations are not included in 1993 or 1994 operations. The Corporation has recognized losses from discontinued operations of the Bank only to the extent of its investment in and advances to the former subsidiary savings and loan (determined on a basis consistent with generally accepted accounting principles). At December 31, 1993 and 1994 the Corporation's statements of financial condition do not include any assets or liabilities of the Bank.\nCurrent Operations\nAs a result of the Bank Closing, the Corporation's present business activities include its only surviving significant subsidiary, Old Stone Securities, a registered securities broker-dealer which provides brokerage services to retail and institutional clients.\nOld Stone Securities' loss before income taxes was $150,311 for the year ended December 31, 1994, compared to $7,104 for the year ended December 31, 1993.\nManagement has invested, and intends in the future to invest, the Corporation's assets on a short-term basis. While the Corporation's Board of Directors has considered selling Old Stone Securities, the Board has determined not to do so at the present time. Various expense saving measures were instituted at Old Stone Securities during the fourth quarter of 1994, which are expected to improve operating results in 1995.\nSince the Bank Closing, and except for the operation of Old Stone Securities, the Corporation's primary expenses have been legal, insurance, accounting, and shareholder relations expenses.\nLiquidity and Capital Resources\nAt December 31, 1994, the Corporation had $1.5 million in assets, $1.3 million in total liabilities, $19.7 million in redeemable preferred stock, and a stockholder's deficit of ($19.5) million, compared to $1.8 million in assets, $1.3 million in total liabilities, $19.5 million in redeemable preferred stock and stockholders' deficit of ($19.0) million at December 31, 1993.\nThe Corporation's assets are currently being invested short-term, and expenses have been reduced to a level that management believes is commensurate with the Corporation's current activities pending resolution of any potential claims. See \"Current Operations\" above.\nResults for Year Ended December 31, 1994 Compared to Year Ended December 31,\nThe Corporation reported a loss of ($380,000) for the year ended December 31, 1994 compared to a total loss of ($309,000) for the year ended December 31, 1993.\nInterest income was $47,000 for the year ended December 31, 1994, compared to $51,000 for the year ended December 31, 1993.\nInterest expense was $-0- for the year ended December 31, 1994, compared to $6,000 for the year ended December 31, 1993. The reduction was primarily due to paydown of long term debt during 1994.\nOther income was $25,000 for the year ended December 31, 1994, compared to $33,000 for the year ended December 31, 1993.\nSince the Bank Closing, the Corporation's primary operating expenses have been legal, insurance and accounting expenses as well as the operating expenses of Old Stone Securities. Operating expenses (including salaries and benefits and excluding interest expense) were $631,000 for the year ended December 31, 1994, compared to $718,000 for the year ended December 31, 1993.\nSalaries and benefits for the year ended 1994 were $211,000 compared to $216,000 for 1993.\nThe loss per share from continuing operations was ($.37) for the year ended December 31, 1994 after the deduction of preferred dividends of $2.7 million. The loss per share from continuing operations was ($.37) for the year ended December 31, 1993 after the deduction of preferred dividends of $2.7 million. No preferred or common dividends have been paid since the second quarter of 1991 and the Corporation does not expect to pay dividends in the foreseeable future. Further, the Corporation is prohibited from paying dividends on the common stock until the aggregate deficiency on the preferred stock dividends is paid in full.\nThe Corporation had total assets of $1.5 million at December 31, 1994, compared to $1.8 million at December 31, 1993. The reduction in assets from 1993 was primarily due to the funding of the 1994 operating loss of ($380,000).\nResults for Year Ended December 31, 1993 Compared to Year Ended December 31,\nThe Corporation reported a loss of ($309,000) for the year ended December 31, 1993 compared to a total loss of ($56) million for the year ended December 31, 1992. Loss from continuing operations was ($309,000) for the year ended December 31, 1993, compared to income of $1.2 million for the year ended December 31, 1992. The Corporation lost ($57.2) million from discontinued operations in 1992.\nInterest income was $51,000 for the year ended December 31, 1993, compared to $896,000 for the year ended December 31, 1992. The reduction was primarily due to the lower amount of funds available for investment as well as the recognition of $648,000 of deferred interest income related to loans made on Old Stone Development projects in 1992.\nInterest expense was $6,000 for the year ended December 31, 1993, compared to $590,000 for the year ended December 31, 1992. The reduction was primarily due to the paydown of short-term and long-term debt during 1992.\nOther income was $33,000 for the year ended December 31, 1993, compared to $283,000 for the year ended December 31, 1992. The reduction was primarily due to management fee income earned by the Corporation from Old Stone Credit Corporation during 1992 in the amount of $156,000.\nSince the Bank Closing, the Corporation's primary operating expenses have been legal, insurance and accounting expenses as well as the operating expenses of Old Stone Securities. Operating expenses (including salaries and benefits and excluding interest expense and the provision for Loan losses) were $718,000 for the year ended December 31, 1993, compared to $724,000 for the year ended December 31, 1992.\nSalaries and benefits remained relatively level for the year ended 1993 compared to 1992 ($216,000 for 1993; $212,000 for 1992).\nThe loss per share from continuing operations was ($.37) for the year ended December 31, 1993 after the deduction of preferred dividends of $2.7 million. The loss per share from continuing operations was ($.18) for the year ended December 31, 1992 after the deduction of preferred dividends of $2.7 million. No preferred or common dividends have been paid since the second quarter of 1991 and the Corporation does not expect to pay dividends in the foreseeable future. Further, the Corporation is prohibited from paying dividends on the common stock until the aggregate deficiency on the preferred stock dividends is paid in full. The loss per share from discontinued operations for the year ended December 31, 1993 and 1992 were $-0- and ($6.93), respectively, bringing the total loss per share for those years to ($.37) and ($7.11) respectively.\nThe Corporation had total assets of $1.8 million at December 31, 1993, compared to $2.5 million at December 31, 1992. The reduction in assets from 1992 was primarily due to the paydown of long-term debt of $402,000 as well as the funding of the 1993 operating loss of ($309,000).\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Corporation's Consolidated Financial Statements for the year ended December 31, 1994 is filed as Exhibit 99 to this report.\nLGC&D has been engaged by the Corporation to audit the Corporation's financial statements for the year ended December 31, 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nIn January, 1994 the Corporation engaged Lefkowitz, Garfinkel, Champi and DeRienzo P.C. (\"LGC&D\") to audit the Corporation's financial statements for the year ended December 31, 1993. The engagement of LGC&D was approved by the Corporation's Board of Directors. As a result of a fee dispute, the Corporation did not engage Deloitte & Touche, which had audited the Corporation's financial statement for the years ended December 31, 1991 and 1992. Deloitte & Touche had not expressed an opinion on the Corporation's financial statements for 1992 due to the uncertainties resulting from the Bank Closing. However, it should be noted that there had been no disagreements with Deloitte & Touche on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedures.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information concerning the directors of the Corporation. There are no persons nominated or chosen to become directors of the Corporation. (See \"Market for the Registrant's Common Equity and Related Stockholder Matters\" for a discussion of the right of the holders of the Corporation's Preferred Stock to elect 20% of the directors of the Corporation.)\nDirector Term Name Age Principal Occupation Since Expires\nHoward W. Armbrust 67 Chairman and Chief Executive 1974 1995 Officer, Armbrust Corporation (chain and jewelry manufacturer)\nBernard V. Buonanno, Jr. 57 Partner, Edwards & Angell 1979 1994 (law firm) Director, A.T. Cross Company\nRobert E. DeBlois 61 Chairman, President and 1974 1995 Chief Executive Officer Officer, DeBlois Oil Company (oil distributor)\nThomas P. Dimeo 64 Chairman, The Dimeo Group of 1974 1995 Companies (construction industry)\nAllen H. Howland 74 Chairman and Chief Executive 1992* 1994 Officer, Original Bradford Soap Works, Inc. (manufacturer of private label soaps)\nBeverly E. Ledbetter 51 Vice President and General 1981 1995 Counsel, Brown University\nAlfred J. Verrecchia 52 Chief Operating Officer and 1987 1993 Director, Hasbro, Inc. (toy manufacturer)\nRichmond Viall, Jr. 75 Private Investor 1992** 1993\n* Also served as a Director from 1981 to 1991. ** Also served as a Director from 1974 to 1991.\nImmediately following the Bank Closing, all of the executive officers of the Corporation resigned and were hired by the Bridge Bank. A limited slate of new officers was elected by the Board of Directors on March 8, 1993, none of whom would be considered executive officers of the Corporation under the Rules.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nExecutive Compensation\nThe Act and the Rules require disclosure of certain information on Executive Compensation with respect to the Corporation and its subsidiaries for the year ended December 31, 1994. Immediately following the Bank Closing, all of the executive officers of the Corporation resigned and were hired by the Bridge Bank and a limited slate of new officers was elected on March 8, 1993. None of the new slate of officers elected on March 8, 1993 would be considered executive officers of the Corporation under the Rules.\nMeetings and Compensation of Board of Directors\nFor the fiscal year ended December 31, 1994, Directors received no compensation for serving on the Board or attending committee meetings.\nThe Stock Purchase Plan of Old Stone Corporation for Employees and Directors was originally approved by the shareholders of the Corporation on April 29, 1988, and amended by the Directors of the Corporation on December 28, 1988 (\"Stock Purchase Plan\"). Under the Stock Purchase Plan, Directors and employees were permitted to purchase Common Stock through payroll deductions. As of the date of the Bank Closing, all participation in the Stock Purchase Plan was discontinued.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPrincipal Stockholders of the Corporation\nThe following table sets forth information as to the only persons known to the Corporation to be beneficial owners of more than five percent (5%) of any class of outstanding voting securities of the Corporation.\nAmount and Nature of Beneficial Ownership of Common Stock (1)\nSole Shared Sole Shared Percent Voting Voting Dispositive Dispositive of Power Power Power Power Class(2)\nOld Stone Employee Stock Ownership Plan 0 0 0 2,065,175(3) 25.04 150 South Main Street Providence, RI 02903\n(1)This information with respect to beneficial ownership is based upon information obtained by the Corporation as of December 31, 1994 from the RTC as Trustee of the ESOP.\n(2)This percentage is calculated assuming that no outstanding options are exercised.\n(3)Employees have sole voting power over all shares of Common Stock which have been allocated to their accounts. Prior to December 31, 1991, shares of Common Stock purchased by the ESOP with borrowed funds were allocated to employees' accounts only as and to the extent that the ESOP's debt was amortized. Unallocated shares were held in a suspense account and, in accordance with the Ninth Amendment to the ESOP adopted on September 27, 1988, were at all times voted in the same proportion as allocated shares. The borrowings were paid in full during 1991, and as a result, 465,524.747 unallocated shares were allocated to employees' accounts, 826,000 unallocated shares were returned to the Corporation and 17,596.813 shares were held in a suspense account until July 6, 1992, at which time such shares were sold to pay Plan expenses. The Ninth Amendment also provides pass-through tender offer rights to Plan participants with respect to all allocated ESOP shares. The Trustee has sole dispositive power with respect to all ESOP shares in all circumstances other than a tender or exchange offer.\nSecurity Ownership of Directors\nThe following table sets forth information furnished to the Corporation by all present Directors regarding amounts of Common Stock of the Corporation owned by them on December 31, 1994. No director owns any shares of Preferred Stock. Except as noted, all such persons possess sole voting and investment power with respect to the securities listed below. An asterisk in the column listing the percentage of securities beneficially owned indicates the person owns less than one percent.\nName of Individual or Identity of and Number of Persons in Group Number of Shares Percent of Class\nHoward W. Armbrust 2,000 *\nBernard V. Buonanno, Jr. 4,613 *\nRobert E. DeBlois 4,742 *\nThomas P. Dimeo 11,000 (1) *\nAllen H. Howland 2,557 (2) *\nBeverly E. Ledbetter 333 *\nAlfred J. Verrecchia 1,526 *\nRichmond Viall, Jr. 10,000 (3) *\nAll current Directors of the Corporation as a group (8 persons) 36,771 (4) *\n(1)Excludes 1,000 shares owned by Mr. Dimeo's spouse, as to which he disclaims beneficial ownership. Includes 1,000 shares owned indirectly by Mr. Dimeo in the Dimeo Construction Company Profit Sharing Plan.\n(2)Excludes 100 shares owned by Mr. Howland's spouse, as to which he disclaims beneficial ownership.\n(3)Excludes 284 shares held by Mr. Viall's spouse, as to which he disclaims beneficial ownership.\n(4)Includes shares held jointly, or in other capacities, as to which, in some cases, beneficial ownership is disclaimed.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInterests of Directors, Officers and Others in Certain Transactions\nDuring 1994, directors of the Corporation and their associates were customers of, and had transactions, including loans, with, the Bank and other former subsidiaries of the Corporation in the ordinary course of business. All such loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and did not involve more than normal risk of collectibility or present other unfavorable features.\nMr. Buonanno is a partner of Edwards & Angell, a law firm retained by the Corporation on various legal matters. The dollar amount of fees paid to Edwards & Angell during 1994 did not exceed 5% of Edwards & Angell's gross revenues for 1994.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. and 2. List of Financial Statements and Financial Statement Schedules\n(1) The following consolidated financial statements and report of independent accountants of the Corporation and subsidiaries are filed as Exhibit 99 to this report.\nConsolidated Balance Sheets - December 31, 1994 and 1993\nConsolidated Statements of Operations - Years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Changes in Stockholders' Equity (Deficit) - Years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flow - Years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nIndependent Auditors' Report\nLetter from Management regarding 1992 consolidated financial statements\n(2) Schedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted.\n(3) List of Exhibits -- See Item 14(c) below.\n(b) Reports on Form 8-K\nNone\n(c) Exhibit Index.\nExhibit Page\n(21) Subsidiaries of the Registrant (Exhibit 21 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1994 is hereby incorporated by reference herein.)\n(99) Consolidated Financial Statements\n(d) All 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.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 STONE CORPORATION (Registrant)\nMarch 29, 1995 By:\/s\/ Geraldine Nelson Geraldine Nelson 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 March 29, 1995.\n\/s\/ Geraldine Nelson President and Treasurer Geraldine Nelson\n\/s\/ Howard W. Armbrust Director Howard W. Armbrust\n\/s\/ Bernard V. Buonanno, Jr. Director Bernard V. Buonanno, Jr.\n\/s\/ Robert E. DeBlois Director Robert E. DeBlois\n\/s\/ Thomas P. Dimeo Director Thomas P. Dimeo\n\/s\/ Allen H. Howland Director Allen H. Howland\nBeverly E. Ledbetter Director\n\/s\/ Alfred J. Verrecchia Director Alfred J. Verrecchia\n\/s\/ Richmond Viall, Jr. Director Richmond Viall, Jr.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 STONE CORPORATION (Registrant)\nMarch , 1995 By: Geraldine Nelson 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 March , 1995.\nPresident and Treasurer Geraldine Nelson\nDirector Howard W. Armbrust\nDirector Bernard V. Buonanno, Jr.\nDirector Robert E. DeBlois\nDirector Thomas P. Dimeo\nDirector Allen H. Howland\nDirector Beverly E. Ledbetter\nDirector Alfred J. Verrecchia\nDirector Richmond Viall, Jr.","section_15":""}
{"filename":"7974_1994.txt","cik":"7974","year":"1994","section_1":"ITEM 1. BUSINESS.\nThe following description of business is provided in accordance with General Instruction J.(2)(d).\nAssociates First Capital Corporation (\"First Capital\" or the \"Company\"), a Delaware corporation, is an indirect subsidiary of Ford Motor Company (\"Ford\"). All the outstanding Common Stock of First Capital is owned by Ford Holdings, Inc. (\"Holdings\"). First Capital's principal operating subsidiary is Associates Corporation of North America (\"Associates\"), the second largest independent finance company in the United States as of September 30, 1994. Unless the context otherwise requires, reference to First Capital or Associates includes each parent company and all its subsidiaries.\nAt December 31, 1994, First Capital had 1,473 branch offices in the United States and employed approximately 13,700 persons. Corporate headquarters are located in Irving, Texas.\nFirst Capital's primary business activities are consumer finance, commercial finance and insurance underwriting. See NOTE 17 to the consolidated financial statements for financial information by business segment.\nConsumer Finance\nConsumer finance consists of making and investing in residential real estate-secured loans to individuals, making secured and unsecured installment loans to individuals, purchasing consumer retail installment obligations, investing in credit card receivables, financing manufactured housing (\"MHO\") purchases and providing other consumer financial services. In addition, First Capital offers insurance to its consumer finance customers.\nLoans made to individuals are secured by mortgages on real property, by liens on personal property (the realizable value of which may be less than the amount of the loans secured) or are unsecured. At December 31, 1994, 77% of the gross outstanding balance of residential real estate-secured receivables was secured by first mortgages. At December 31, 1994, the gross consumer finance receivables included credit card receivables ($4.0 billion) owned or originated by Associates National Bank (Delaware), a subsidiary of First Capital.\nThe interest rates currently earned on all types of consumer finance receivables average approximately 17% simple interest per annum. At December 31, 1994, the interest rates charged on approximately 38% of the net consumer finance receivables outstanding varied during the term of the contract at specified intervals in relation to a base rate established at the time the loan was made. State laws establish maximum allowable finance charges for certain consumer loans; approximately 89% of the outstanding gross consumer finance receivables were either not subject to such state maximums, or if subject, such maximum finance charges did not, in most cases, materially restrict the interest rates charged. Original maturities of residential real estate-secured receivables average 149 months and original maturities of other consumer receivables, excluding credit card and manufactured housing receivables, average 33 months. Original maturities of manufactured housing receivables average 217 months.\nCommercial Finance\nCommercial finance consists of the purchase of time sales obligations and leases, direct leases and secured direct loans, and sales of other financial services, including automobile club, mortgage banking and relocation services. In addition, First Capital offers insurance to its commercial finance customers.\nThe types of equipment financed or leased are heavy-duty trucks, truck trailers, autos and other transportation equipment, construction equipment and machinery used in various manufacturing and distribution processes. Except for lease transactions in which First Capital owns the equipment, liens on the equipment financed secure the receivables. In many cases, First Capital obtains the endorsement or a full or limited repurchase agreement of the seller or the manufacturer of the goods, and in some cases, a portion of the purchase price of the installment obligations is withheld as a reserve.\nAt December 31, 1994, the interest rates charged on approximately 14% of the net commercial finance receivables were established to vary during the term of the contract in relation to a base rate. Commercial finance receivables are generally not subject to maximum finance charges established by state law, and where such restrictions apply, at the present time, they do not materially restrict the interest rates charged. The interest rates currently earned on all types of commercial finance receivables average approximately 9% simple interest per annum. Original maturities of the commercial receivables average 46 months.\nVolume of Financing\nThe following tables set forth the gross volume of finance business by major categories and average size and number of accounts based on gross finance receivables volume for the periods indicated:\nGross Volume of Finance Receivables Purchased and Loans Made\nCommercial Finance Consumer Finance Heavy-Duty Residential Installment, Truck and Real Estate- MHO and Industrial Secured Credit Card Equipment Total Receivables Receivables Receivables Gross (a) (a) (b) Volume (Dollar Amounts in Millions)\nYear Ended December 31 1994 $6,283.3 $12,568.2 $12,274.7 $31,126.2 20% 40% 40% 100% 1993 $4,518.2 $ 9,381.6 $ 9,955.1 $23,854.9 19% 39% 42% 100% 1992 $4,479.9 $ 6,939.6 $ 7,329.6 $18,749.1 24% 37% 39% 100% 1991 $5,193.8 $ 6,671.8 $ 6,697.3 $18,562.9 28% 36% 36% 100% 1990 $1,946.1 $ 5,153.0 $ 5,904.3 $13,003.4 15% 40% 45% 100%\n(a) Included in 1994 are $60.8 million of warehouse loan facilities purchased from First Collateral Services, Inc. and $416.0 million of credit card receivables purchased from Amoco Oil Company (\"Amoco\"). Included in 1993 are $182.2 million of gross residential real estate- secured and installment finance receivables attributable to the acquisition of Allied Finance Company and $215.9 million of credit card receivables purchased from Great Western Financial Corporation. Included in 1992 are $304.5 million of gross residential real estate- secured and installment finance receivables purchased from Signal Financial Corporation and $795.4 million of gross residential real estate-secured and installment finance receivables attributable to the acquisition of First Family Financial Services H.C., Inc. Included in 1991 are $2.7 billion of gross residential real estate-secured receivables and contracts for the purchase of manufactured housing purchased from Ford Motor Credit Company (\"Ford Credit\") and $336.5 million of gross installment finance receivables attributable to the acquisition of Kentucky Finance Co., Inc. Included in 1990 are $605.7 million in gross residential real estate-secured receivables and installment finance receivables attributable to the acquisition of Mellon Financial Services Corporation. (b) Included in 1993 are $596.9 million of gross heavy-duty truck and truck trailer finance receivables purchased from Mack Financial Corporation. Included in 1992 are $56.7 million of gross industrial equipment finance receivables attributable to the acquisition of Trans-National Leasing, Inc. Included in 1991 are $930.9 million of gross industrial equipment finance receivables attributable to the acquisition of Chase Manhattan Leasing Company (Michigan), Inc. (renamed \"Clark Credit\").\nAverage Size and Number of Accounts Based on Gross Finance Receivables Volume\nConsumer Finance Commercial Finance Residential Installment, Heavy-Duty Truck Real Estate- MHO and and Industrial Secured Credit Card Equipment Receivables Receivables Receivables (b)\nYear Ended December 31 1994 Average Size $46,283 $ 975 $51,447 Number of Accounts 135,757 12,889,405(a) 122,542 1993 Average Size $46,659 $1,527 $48,216 Number of Accounts 96,833 6,141,881 113,766 1992 Average Size $42,489 $1,511 $41,191 Number of Accounts 105,436 4,594,106 105,533 1991 Average Size $44,253 $1,588 $30,094 Number of Accounts 117,365 4,201,643 140,962 1990 Average Size $36,020 $1,647 $44,308 Number of Accounts 54,029 3,129,480 80,197\n(a) Includes 4.9 million accounts pertaining to the credit card receivables purchased from Amoco, which accounts had lower average balances than the remaining Associates receivables. (b) Excludes wholesale receivables.\nDuring the year ended December 31, 1994, 25% of the total gross volume of consumer loans, excluding credit card receivables, was made to current creditworthy customers that requested additional funds. The average balance prior to making an additional advance was $10,150 and the average additional advance was $3,589.\nFinance Receivables\nThe following tables set forth the amounts of gross finance receivables held at year end by major categories and average size and number of accounts held at year end for the years indicated:\nGross Finance Receivables Held at End of Year\nConsumer Finance Commercial Finance Residential Installment, Heavy Duty-Truck Total Real Estate- MHO and and Industrial Gross Secured Credit Card Equipment Finance Receivables Receivables Receivables Receivables (Dollar Amounts in Millions)\nAt December 31 1994 $12,002.7 $12,064.4 $10,878.4 $34,945.5 34% 35% 31% 100% 1993 $10,626.0 $ 9,869.8 $ 9,077.2 $29,573.0 36% 33% 31% 100% 1992 $ 9,820.0 $ 8,122.6 $ 7,672.0 $25,614.6 38% 32% 30% 100% 1991 $ 8,146.0 $ 7,188.7 $ 7,209.7 $22,544.4 36% 32% 32% 100% 1990 $ 4,900.5 $ 5,236.1 $ 6,310.2 $16,446.8 30% 32% 38% 100%\nAverage Size and Number of Accounts Based on Gross Finance Receivables Held at End of Year\nConsumer Finance Commercial Finance Residential Installment, Heavy-Duty Truck Real Estate- MHO and and Industrial Secured Credit Card Equipment Receivables Receivables Receivables\nAt December 31 1994 Average Size $38,690 $1,528 $35,884 Number of Accounts 310,230 7,894,845* 303,157 1993 Average Size $37,787 $2,489 $31,218 Number of Accounts 281,206 3,965,781 290,765 1992 Average Size $36,725 $2,551 $27,792 Number of Accounts 267,394 3,183,747 276,055 1991 Average Size $33,829 $2,469 $27,506 Number of Accounts 240,798 2,910,995 262,110 1990 Average Size $33,928 $2,097 $28,002 Number of Accounts 144,438 2,496,411 225,349\n* Includes 3.1 million accounts pertaining to the credit card receivables purchased from Amoco.\nThe Company has geographically dispersed finance receivables portfolios as further described in NOTE 3 to the consolidated financial statements. The ten largest customer accounts at December 31, 1994, other than accounts with affiliates (as described in NOTE 14 to the consolidated financial statements), represented 0.9% of the total gross finance receivables outstanding. Of such ten accounts (all of which were current at December 31, 1994), four were secured by truck leasing arrangements, three were secured by construction equipment, one was secured by a manufacturer's endorsement and related to communications equipment, one was secured by manufactured housing and one was secured by auto leasing arrangements. At December 31, 1994, the largest gross balance outstanding in such accounts was $54.4 million and the average gross balance was $30.5 million.\nCredit Loss and Delinquency Experience\nThe credit loss experience, net of recoveries, of the finance business for the years indicated is set forth in the following table (dollar amounts in millions):\nYear Ended or at December 31 1994 1993 1992 1991 1990\nNET CREDIT LOSSES Consumer Finance Amount $455.9 $371.3 $382.9 $354.2 $254.2 % of Average Net Receivables 2.33% 2.19% 2.64% 2.84% 3.06% % of Receivables Liquidated 3.09 3.41 4.57 5.65 5.51\nCommercial Finance Amount $ 8.4 $ 22.4 $ 41.8 $ 34.6 $ 23.4 % of Average Net Receivables .09% .30% .64% .60% .44% % of Receivables Liquidated .08 .26 .61 .61 .41\nTotal Net Credit Losses Amount $464.3 $393.7 $424.7 $388.8 $277.6 % of Average Net Receivables 1.62% 1.61% 2.02% 2.13% 2.03% % of Receivables Liquidated 1.84 2.03 2.80 3.24 2.69\nALLOWANCE FOR LOSSES Balance at End of Period $944.3 $808.9 $699.2 $590.9 $449.7 % of Net Receivables 3.03% 3.07% 3.06% 2.93% 3.02%\nThe Company maintains an allowance for losses on finance receivables at an amount which it believes is sufficient to provide adequate protection against future losses in the portfolios. The allowance is determined principally on the basis of historical loss experience, and reflects management's judgment of additional loss potential considering future economic conditions and the nature and characteristics of the finance receivables. Additions to the allowance are charged to the provision for losses on finance receivables. An analysis of changes in the allowance for losses is included in NOTE 4 to the consolidated financial statements. Collateral held for resale is not considered significant to total assets.\nFinance receivables are charged to the allowance for losses when they are deemed to be uncollectible. Additionally, Company policy generally provides for charge-off of various types of accounts on a contractual basis (described below). Consumer direct and other installment and credit card receivables are charged to the allowance for losses when they become 180 days delinquent. All other finance receivables are charged to the allowance for losses when any of the following conditions occur: (i) the related security has been converted or destroyed; (ii) the related security has been repossessed and sold or held for sale for one year; or (iii) the related security has not been repossessed and the receivable has become one year delinquent. A delinquent account is one on which the customer has not made payments as contractually agreed. Extensions are granted on receivables from customers with satisfactory credit and with prior approval of management. Recoveries on losses previously charged to the allowance are credited to the allowance at the time the recovery is collected. The following table shows total gross balances contractually delinquent 60 days and more by type of business at the dates indicated (dollar amounts in millions):\nInsurance Underwriting\nFirst Capital is engaged in the property and casualty and accidental death and dismemberment insurance business through Associates Insurance Company (\"AIC\") and in the credit life and credit accident and health insurance business through Associates Financial Life Insurance Company (\"AFLIC\"), principally for customers of the finance operations of First Capital. At December 31, 1994, AIC was licensed to do business in 50 states, the District of Columbia and Canada, and AFLIC was licensed to do business in 49 states and the District of Columbia. In addition, First Capital receives compensation for certain insurance programs underwritten by other companies.\nThe operating income produced by the finance operations' sale of insurance products is included in the respective finance operations' operating income.\nThe following table sets forth the net property and casualty insurance premiums written by major lines of business for the years indicated (in millions):\nYear Ended December 31 1994 1993 1992 1991 1990\nAutomobile Physical Damage $118.6 $ 97.6 $ 79.9 $ 69.2 $ 86.8 Fire and Extended Coverage 50.1 41.3 27.8 15.8 31.2 Other Casualty Coverage 35.5 20.1 25.0 23.6 17.0 Total Net Premiums Written $204.2 $159.0 $132.7 $108.6 $135.0\nThe following table sets forth the aggregate premium income relating to credit life, credit accident and health and accidental death and dismemberment insurance for the years indicated, and the life insurance in force at the end of each respective year (in millions):\nYear Ended or at December 31 1994 1993 1992 1991 1990\nPremium Income $ 136.1 $ 111.4 $ 92.6 $ 83.5 $ 79.7 Life Insurance in Force 8,306.3 7,133.9 6,110.4 5,533.6 4,770.4\nThe following table summarizes the revenue of the insurance operation from all lines of business for the years indicated (in millions):\nYear Ended December 31 1994 1993 1992 1991 1990\nPremium Revenue* $293.5 $242.2 $209.9 $202.5 $212.7 Investment Income 44.9 38.4 41.5 53.3 58.4 Total Revenue $338.4 $280.6 $251.4 $255.8 $271.1\n* Includes compensation for insurance programs underwritten by other companies.\nCompetition and Regulation\nThe interest rates charged for the various classes of receivables of First Capital's finance business vary with the type of risk and maturity of the receivable and are generally affected by competition, current interest rates and, in some cases, governmental regulation. In addition to competition with finance companies, competition exists with, among others, commercial banks, thrift institutions, credit unions and retailers.\nConsumer finance operations are subject to detailed supervision by state authorities under legislation and regulations which generally require finance companies to be licensed and which, in many states, govern interest rates and charges, maximum amounts and maturities of credit and other terms and conditions of consumer finance transactions, including disclosure to a debtor of certain terms of each transaction. Licenses may be subject to revocation for violations of such laws and regulations. In some states, the commercial finance operations are subject to similar laws and regulations. Customers may seek damages for violations of state and Federal statutes and regulations governing lending practices, interest rates and other charges. Federal legislation preempts state interest rate ceilings on first mortgage loans and state laws which restrict various types of alternative residential real estate-secured receivables, except in those states which have specifically opted out of such preemption. Certain Federal and state statutes and regulations, among other things, require disclosure of the finance charges in terms of an annual percentage rate, make credit discrimination unlawful on a number of bases, require disclosure of a maximum rate of interest on variable or adjustable rate mortgage loans, and limit the types of security that may be taken in connection with non-purchase money consumer loans. Federal and state legislation in addition to that mentioned above, in the past has been, and from time to time may be, introduced which seeks to regulate the maximum interest rate and\/or other charges on consumer finance receivables, including credit cards.\nAssociates National Bank (Delaware) (the \"Bank\"), is under the supervision of, and subject to examination by, the Office of the Comptroller of the Currency. In addition, the Bank is subject to the rules and regulations of the Federal Reserve Board and the Federal Deposit Insurance Corporation (\"FDIC\"). Associates Investment Corporation, a Utah industrial loan company, is regulated by the FDIC and the Utah Department of Financial Institutions. Areas subject to regulation by these agencies include capital adequacy, loans, deposits, consumer protection, the payment of dividends and other aspects of operations.\nThe insurance business is subject to detailed regulation, and premiums charged on certain lines of insurance are subject to limitation by state authorities. Most states in which insurance subsidiaries of First Capital are authorized to conduct business have enacted insurance holding company legislation pertaining to insurance companies and their affiliates. Generally, such laws provide, among other things, limitations on the amount of dividends payable by any insurance company and guidelines and standards with respect to dealings between insurance companies and affiliates.\nIt is not possible to forecast the nature or the effect on future earnings or otherwise of present and future legislation, regulations and decisions with respect to the foregoing, or other related matters.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe furniture, equipment and other physical property owned by First Capital and its subsidiaries represent less than 1% of total assets at December 31, 1994 and are therefore not significant in relation to total assets. The branch finance operations are generally conducted on leased premises under short-term operating leases normally not exceeding five years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nBecause the finance and insurance businesses involve the collection of numerous accounts, the validity and priority of liens, and loss or damage claims under many types of insurance policies, the finance and insurance subsidiaries of First Capital are plaintiffs and defendants in numerous legal proceedings, including class action lawsuits. Neither First Capital nor any of its subsidiaries is a party to, nor is the property thereof the subject of, any pending legal proceedings which depart from the ordinary routine litigation incident to the kinds of business conducted by First Capital and its subsidiaries or, if such proceedings constitute other than routine litigation, in which there is a reasonable possibility of an adverse decision which could have any material adverse effect upon the financial condition of First Capital. There are no proceedings pending or, to the Company's knowledge, threatened by or on behalf of any administrative board or regulatory body which would materially affect or impair the right of First Capital or any of its subsidiaries to carry on any of their respective businesses.\nPART II\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nOmitted in accordance with General Instruction J.(2)(c) to Form 10-K.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAll of the outstanding Common Stock of First Capital is owned by Ford Holdings, Inc. There is no market for First Capital stock.\nDividends on the Common Stock are paid when declared by the Board of Directors. Annual Common Stock dividends of $273.0 million and $226.0 million were paid during the years ended December 31, 1994 and 1993, respectively.\nAssociates, First Capital's principal operating subsidiary, is subject to various limitations under the provisions of its outstanding debt and revolving credit agreements, including limitations on the payment of dividends. See Liquidity\/Capital Resources under Item 7, herein, for a description of such limitations.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information that follows is being provided in lieu of the information called for by Item 6 of Form 10-K, in accordance with General Instruction J.(2)(a) to Form 10-K.\nThe following table sets forth selected consolidated financial information regarding the Company's financial position and operating results which has been extracted from the Company's consolidated financial statements for the five years ended December 31, 1994. The information should be read in conjunction with the Management's Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and accompanying footnotes included elsewhere in this report (dollar amounts in millions): Year Ended or at December 31 (a) 1994 1993 1992 1991 1990\nConsolidated Statement of Earnings Information Revenue $ 4,405.3 $ 3,705.6 $ 3,346.6 $ 3,187.1 $ 2,725.5 Interest Expense 1,558.2 1,340.5 1,281.4 1,347.8 1,217.3 Provision for Losses on Finance Receivables 577.5 476.1 512.6 434.2 309.6 Earnings Before Provision for Income Taxes 888.0 751.8 606.4 540.4 448.0 Net Earnings (b) 548.1 470.1 382.8 347.3 287.8 Ratio of Earnings to Fixed Charges (c) 1.57 1.56 1.47 1.40 1.37\nConsolidated Balance Sheet Information Finance Receivables Consumer Finance $24,067.1 $20,495.8 $17,942.6 $15,334.7 $10,136.6 Commercial Finance 10,878.4 9,077.2 7,672.0 7,209.7 6,310.2 Total Receivables 34,945.5 29,573.0 25,614.6 22,544.4 16,446.8 Unearned Finance Income 3,769.5 3,208.2 2,781.0 2,395.5 1,574.4 Allowance for Losses on Finance Receivables 944.3 808.9 699.2 590.9 449.7 Total Assets 32,247.0 27,695.6 24,034.3 21,551.3 16,880.5 Notes Payable 12,211.9 10,208.2 8,919.6 8,327.6 6,186.3 Long-term Debt 15,654.1 13,600.8 11,870.4 10,223.4 8,392.8 Stockholder's Equity 2,959.9 2,506.4 2,062.0 1,868.1 1,375.1\n(a) During 1994, 1993 and 1992, the Company acquired gross finance receivables approximating $0.5 billion, $1.0 billion and $1.2 billion, respectively. See NOTE 3 to the consolidated financial statements. During 1991 and 1990, the Company acquired gross finance receivables approximating $4.0 billion and $0.6 billion, respectively. (b) 1992 is net of a $10.4 million charge representing the cumulative effect of changes in accounting principles. (c) For purposes of computing the Ratio of Earnings to Fixed Charges, \"Earnings\" represent earnings before provision for income taxes and cumulative effect of changes in accounting principles, plus fixed charges. \"Fixed Charges\" represent interest expense and a portion of rentals representative of an implicit interest factor for such rentals.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following management's narrative analysis of the results of operations is provided in lieu of management's discussion and analysis, in accordance with General Instruction J.(2)(a) to Form 10-K.\nResults of Operations\nREVENUE - Total revenue for the year ended December 31, 1994 increased $699.7 million (19%), compared with the year ended December 31, 1993. The components of the increase were as follows:\nFinance charges increased $621.9 million (19%), primarily caused by an increase in average net finance receivables outstanding, and to a lesser extent, an increase in average revenue rates. Average net finance receivables outstanding were $28.6 billion and $24.4 billion for the years ended December 31, 1994 and 1993, respectively, a 17% increase. Total net finance receivables increased by approximately $4.8 billion (18%) from December 31, 1993 to December 31, 1994. Of the total growth, 29% was in the residential real estate-secured portfolio, 22% was in the direct installment and credit card portfolios, 16% was in the manufactured housing and other portfolios, 12% was in the heavy-duty truck portfolio and 21% was in the industrial equipment portfolio. The growth was primarily generated from internal sources, but included the acquisitions of net finance receivables of Amoco Oil Company ($416 million) in September 1994 and First Collateral Services, Inc. ($61 million) in December 1994, as described in NOTE 3 to the consolidated financial statements. The average revenue rates on aggregate net receivables were 13.6% and 13.4% for the years ended December 31, 1994 and 1993, respectively.\nInsurance premiums increased $51.3 million (21%) as a result of increased sales of insurance products, primarily in the credit life, credit accident and health, and casualty insurance products.\nInvestment and other income increased $26.5 million (14%), primarily due to an increase in fee-based financial services revenue (i.e. auto club fees, broker fees, affiliate guarantee fees, etc.), and an increase in interest income, primarily from investments in marketable securities due to a general increase in market rates. In June 1994, the Company sold its investment in mortgage servicing rights. The effect of this sale on future earnings of the Company will not be significant. Fees from mortgage servicing have been included as a component of investment and other income.\nEXPENSES - Total expenses for the year ended December 31, 1994 increased $563.5 million (19%), compared with the year ended December 31, 1993. The components of the increase were as follows:\nInterest expense increased $217.7 million (16%). This change was primarily caused by an increase in average outstanding debt, attributable to higher net finance receivables outstanding. The annual average interest rates on total debt, including amortization of discount and issuance expense, were as follows: For the Year Ended December 31 1994 1993\nShort-term Notes Payable 4.26% 3.11% Long-term Debt 7.35 8.03 Total Debt 6.01 5.94\nThe net interest margin was 8.18% and 7.92% for the years ended December 31, 1994 and 1993, respectively. The increase was primarily due to the aforementioned increase in average revenue rates.\nOperating expenses increased $215.2 million (21%), primarily as a result of increased salaries, employment benefits and other operating expenses generally related to increased volumes of business, including acquisitions.\nThe provision for loan losses increased $101.4 million (21%), primarily due to increased losses resulting from an increase in net finance receivables. Net credit losses, measured as a percent of average net finance receivables, were 1.62%, substantially unchanged from the prior year. The allowance for losses increased $135.4 million (17%) to $944.3 million at December 31, 1994 from $808.9 million at December 31, 1993. The increase primarily relates to the growth in net finance receivables. The allowance for losses, measured as a percent of net finance receivables, was 3.03% at December 31, 1994 as compared to 3.07% at December 31, 1993. The Company maintains an allowance for losses on finance receivables at an amount which it believes is sufficient to provide adequate protection against future losses in the portfolios. The allowance is determined principally on the basis of historical loss experience, and reflects management's judgment of additional loss potential considering future economic conditions and the nature and characteristics of the finance receivables.\nInsurance benefits paid or provided increased $29.2 million (25%) in 1994, primarily due to an increase in overall claims activity, and an increase in the reserve for credit accident and health, and casualty insurance claims.\nEARNINGS BEFORE PROVISION FOR INCOME TAXES - As a result of the aforementioned changes, earnings before provision for income taxes increased $136.2 million (18%) during 1994.\nPROVISION FOR INCOME TAXES - The provision for income taxes represented 38.3% and 37.5% of earnings before provision for income taxes for the years ended December 31, 1994 and 1993, respectively. The increase in the effective tax rate is primarily related to an increase in state taxes as described in NOTE 8 to the consolidated financial statements.\nNET EARNINGS - As a result of the aforementioned changes, net earnings increased $78.0 million (17%) during 1994.\nLiquidity\/Capital Resources\nThe following sets forth liquidity and capital resources for First Capital and its subsidiaries other than Associates and its subsidiaries.\nFirst Capital's primary sources of funds have been (i) borrowings from both commercial banks and the public and (ii) borrowings and dividends from Associates. The amount of dividends which may be paid by Associates is limited by certain provisions of its outstanding debt and revolving credit agreements. A restriction contained in one series of debt securities maturing August 1, 1996, generally limits payments of cash dividends on Associates Common Stock in any one year to not more than 50% of Associates consolidated net earnings for such year, subject to certain exceptions, plus increases in contributed capital and extraordinary gains. Any such amounts available for the payment of dividends in such fiscal year and not so paid, may be paid in any one or more of the five subsequent fiscal years. In accordance with this provision, at December 31, 1994, $453.6 million was available for dividends. A restriction contained in certain revolving credit agreements requires Associates to maintain a minimum tangible net worth, as defined, of $1.5 billion. At December 31, 1994, Associates tangible net worth was approximately $3.4 billion. A debt agreement of Associates limits the total of all affiliate-related receivables, as defined, to 7% of the aggregate gross receivables owned by Associates. An affiliate within the meaning of affiliate-related receivables includes First Capital, its parent corporation, and any corporation, other than Associates and its subsidiaries, of which First Capital or its parent corporation owns or controls at least 50% of its stock. The net total of all affiliate-related receivables which Associates owned at December 31, 1994 and 1993, amounted to 1.0% and 1.5%, respectively, of its aggregate gross receivables as of those dates.\nAt December 31, 1994, First Capital had contractually committed bank lines of credit of $90.0 million, and revolving credit facilities of $250.0 million, none of which was in use. During 1994, First Capital raised $321.4 million through public and private offerings of medium- and long-term debt.\nThe following sets forth liquidity and capital resources for Associates:\nAssociates endeavors to maximize its liquidity by diversifying its sources of funds, which include: (i) its operations; (ii) the issuance of commercial paper; (iii) the issuance of unsecured intermediate-term debt in the public and private markets; (iv) borrowings available from short-term and revolving credit facilities with commercial banks; and (v) receivables purchase facilities.\nIssuance of Short - and Intermediate-Term Debt\nCommercial paper, with maturities ranging from 1 to 270 days, is the primary source of short-term debt. The average commercial paper interest rate incurred during 1994 was 4.26%.\nAssociates issues intermediate-term debt publicly and privately in the domestic and foreign markets. During the year ended December 31, 1994, Associates raised $3.9 billion through public and private offerings at a weighted average effective interest rate and a weighted average term of 7.13% and 4.9 years, respectively.\nCredit Facilities and Related Borrowings\nAssociates policy is to maintain bank credit facilities in support of its net short-term borrowings consistent with market conditions. Bank credit facilities provide a means of refinancing maturing commercial paper obligations as needed. At December 31, 1994, short-term bank lines and revolving credit facilities with banks totaled $9.2 billion, none of which was in use at that date. These facilities represented 76% of net short-term borrowings outstanding at December 31, 1994. Bank lines and revolvers may be withdrawn only under certain standard conditions. Associates pays fees or maintains compensating balances or utilizes a combination of both to maintain the availability of its bank credit facilities. Fees are .05% to .25% of 1% per annum of the amount of the facilities.\nAt December 31, 1994 and 1993, Associates short-term debt, as defined, as a percent of total debt was 52%. Short-term debt, for purposes of this computation, includes the current portion of long-term debt but excludes short-term investments. See NOTES 5, 6 and 7 to the consolidated financial statements for a description of credit facilities, notes payable and long-term debt, respectively.\nRecent Accounting Pronouncements\nThe Financial Accounting Standards Board has 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\", both effective 1995. The American Institute of Certified Public Accountants has issued Statement of Position 93-7, \"Reporting on Advertising Costs\", which is effective in 1995. The adoption of these pronouncements is not expected to be significant to the Company's consolidated financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nREPORT OF INDEPENDENT ACCOUNTANTS\nBoard of Directors Associates First Capital Corporation\nWe have audited the accompanying consolidated balance sheets of Associates First Capital Corporation (an indirect subsidiary of Ford Motor Company) as of December 31, 1994 and 1993, and the related consolidated statements of earnings, changes in stockholder's 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 Associates First Capital Corporation 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 2 to the consolidated financial statements, effective January 1, 1992, the Company changed its methods of accounting for postretirement benefit costs other than pensions and income taxes.\nCOOPERS & LYBRAND L.L.P.\nDallas, Texas January 27, 1995\nASSOCIATES FIRST CAPITAL CORPORATION CONSOLIDATED STATEMENT OF EARNINGS (In Millions)\nYear Ended December 31 1994 1993 1992\nREVENUE Finance charges $3,898.2 $3,276.3 $2,960.3 Insurance premiums 293.5 242.2 209.9 Investment and other income 213.6 187.1 176.4 4,405.3 3,705.6 3,346.6\nEXPENSES Interest expense 1,558.2 1,340.5 1,281.4 Operating expenses 1,237.5 1,022.3 846.2 Provision for losses on finance receivables - NOTE 4 577.5 476.1 512.6 Insurance benefits paid or provided 144.1 114.9 100.0 3,517.3 2,953.8 2,740.2\nEARNINGS BEFORE PROVISION FOR INCOME TAXES AND CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES 888.0 751.8 606.4 PROVISION FOR INCOME TAXES - NOTE 8 339.9 281.7 213.2 EARNINGS BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES 548.1 470.1 393.2 CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES - NOTE 2 (10.4)\nNET EARNINGS $ 548.1 $ 470.1 $ 382.8\nSee notes to consolidated financial statements.\nASSOCIATES FIRST CAPITAL CORPORATION CONSOLIDATED BALANCE SHEET (In Millions)\nDecember 31 1994 1993\nASSETS\nCASH AND CASH EQUIVALENTS $ 410.0 $ 290.3 INVESTMENTS IN MARKETABLE SECURITIES - NOTE 16 605.1 633.7 FINANCE RECEIVABLES - NOTE 3 Consumer Finance 24,067.1 20,495.8 Commercial Finance 10,878.4 9,077.2 Total finance receivables 34,945.5 29,573.0 Less Unearned finance income 3,769.5 3,208.2 Allowance for losses on finance receivables - NOTE 4 944.3 808.9 30,231.7 25,555.9 OTHER ASSETS - NOTE 13 1,000.2 1,215.7\nTotal assets $32,247.0 $27,695.6\nLIABILITIES AND STOCKHOLDER'S EQUITY\nNOTES PAYABLE - NOTE 6 Commercial Paper $11,640.5 $ 9,735.8 Bank Loans 571.4 472.4 ACCOUNTS PAYABLE AND ACCRUALS 875.5 950.4 INSURANCE POLICY AND CLAIMS RESERVES 545.6 429.8 LONG-TERM DEBT - NOTES 7 and 9 15,654.1 13,600.8 STOCKHOLDER'S EQUITY Common Stock, no par value, 250 shares authorized, issued and outstanding, at stated value 47.0 47.0 Paid-in Capital - NOTE 14 1,104.4 904.4 Retained Earnings 1,826.1 1,551.0 Unrealized (Loss) Gain on Marketable Securities - NOTES 2 and 16 (17.6) 4.0 Total stockholder's equity 2,959.9 2,506.4\nTotal liabilities and stockholder's equity $32,247.0 $27,695.6\nSee notes to consolidated financial statements.\nASSOCIATES FIRST CAPITAL CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY (In Millions)\nUnrealized (Loss) Gain on Total Common Paid-in Retained Marketable Stockholder's Stock Capital Earnings Securities Equity\nDECEMBER 31, 1991 $47.0 $ 704.4 $1,114.1 $ 2.6 $1,868.1 Net Earnings 382.8 382.8 Cash Dividends (190.0) (190.0) Current Period Adjustment 1.1 1.1\nDECEMBER 31, 1992 47.0 704.4 1,306.9 3.7 2,062.0 Net Earnings 470.1 470.1 Contributions from Parent - NOTE 14 200.0 200.0 Cash Dividends (226.0) (226.0) Current Period Adjustment 0.3 0.3\nDECEMBER 31, 1993 47.0 904.4 1,551.0 4.0 2,506.4 Net Earnings 548.1 548.1 Contributions from Parent - NOTE 14 200.0 200.0 Cash Dividends (273.0) (273.0) Current Period Adjustment (21.6) (21.6)\nDECEMBER 31, 1994 $47.0 $1,104.4 $1,826.1 $(17.6) $2,959.9\nSee notes to consolidated financial statements.\nASSOCIATES FIRST CAPITAL CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (In Millions)\nSee notes to consolidated financial statements.\nASSOCIATES FIRST CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - THE COMPANY\nAssociates First Capital Corporation (\"First Capital\" or the \"Company\"), a Delaware corporation, is an indirect subsidiary of Ford Motor Company (\"Ford\"). All the outstanding Common Stock of First Capital is owned by Ford Holdings, Inc. (\"Holdings\"). Associates Corporation of North America (\"Associates\") is the principal operating subsidiary of First Capital.\nNOTE 2 - SIGNIFICANT ACCOUNTING POLICIES\nThe following is a summary of significant accounting policies:\nBASIS OF CONSOLIDATION\nThe accompanying consolidated financial statements consolidate First Capital and its subsidiaries. Amounts of goodwill relating to acquisitions are being amortized by the straight-line method over periods not exceeding forty years. All significant intercompany balances and transactions have been eliminated in consolidation. Certain prior period financial statement amounts have been reclassified to conform to the current year presentation.\nREVENUE RECOGNITION\nFinance charges on receivables are recognized as revenue using the interest (actuarial) method. Premiums and discounts on purchased receivables are considered as yield adjustments. The unamortized balance is included in finance receivables and the associated amortization is included in finance charge revenue. Finance charge accruals are generally suspended on accounts more than 30 days contractually delinquent. At December 31, 1994 and 1993, net finance receivables on which revenue was not accrued approximated $424.0 million and $366.5 million, respectively.\nInsurance premiums are recorded as unearned premiums when collected or when written and are subsequently amortized into income based on the nature and term of the underlying insurance contracts. The methods of amortization used are pro rata, sum-of-the-years-digits and a combination thereof.\nGains or losses on sales of debt securities are included in revenue when realized. Unrealized gains or losses on debt securities are reported as a component of stockholder's equity, net of tax. Realized and unrealized gains or losses on equity securities are included in revenue as incurred. The cost of debt and equity securities sold is determined by the specific identification method.\nALLOWANCE FOR LOSSES ON FINANCE RECEIVABLES\nThe Company maintains an allowance for losses on finance receivables at an amount which it believes is sufficient to provide adequate protection against future losses in the portfolios. The allowance is determined principally on the basis of historical loss experience, and reflects management's judgment of additional loss potential considering future economic conditions and the nature and characteristics of the finance receivables. Additions to the allowance are charged to the provision for losses on finance receivables.\nFinance receivables are charged to the allowance for losses when they are deemed to be uncollectible. Additionally, Company policy generally provides for charge-off of various types of accounts on a contractual basis (described below). Consumer direct and other installment and credit card receivables are charged to the allowance for losses when they become 180 days delinquent. All other finance receivables are charged to the allowance for losses when any of the following conditions occur: (i) the related security has been converted or destroyed; (ii) the related security has been repossessed and sold or held for sale for one year; or (iii) the related security has not been repossessed and the receivable has become one year delinquent. A delinquent account is one on which the customer has not made payments as contractually agreed. Extensions are granted on receivables from customers with satisfactory credit and with prior approval of management. Recoveries on losses previously charged to the allowance are credited to the allowance at the time the recovery is collected.\nINSURANCE RESERVES\nThe reserves for future benefits and refunds upon cancellation of credit life and health insurance and property and casualty insurance are provided for in the unearned premium reserve for such business. In addition, reserves for reported claims on credit accident and health insurance are established based on standard morbidity tables used in the insurance business for such purposes. Claim reserves for reported property and casualty insurance claims are based on estimates of costs and expenses to settle each claim. Additional amounts of reserves, based on prior experience and insurance in force, are provided for each class of insurance for claims which have been incurred but not reported as of the balance sheet date.\nFEDERAL INCOME TAXES\nFirst Capital and its subsidiaries are included in the consolidated Federal income tax return of Holdings. The provision for income taxes is computed on a separate-return basis. Deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nIn 1993, the Company entered into a tax-sharing agreement with Ford whereby state income taxes are provided on a separate-return basis. Prior to 1993, state income taxes were provided on a consolidated-return basis.\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. The amounts reported in the Consolidated Balance Sheet approximate fair value.\nDISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe consolidated financial statements present the information required by Statement of Financial Accounting Standards (\"SFAS\") No. 107, \"Disclosures about Fair Value of Financial Instruments\". Amounts disclosed represent estimates of fair values at a particular point in time. Significant assumptions regarding economic conditions, loss experience and risk characteristics associated with particular financial instruments and other factors were used for purposes of this disclosure. These assumptions are subjective in nature and involve matters of judgment. Changes in assumptions could have a material impact on these estimates.\nDERIVATIVE FINANCIAL INSTRUMENTS\nThe Company does not hold or issue derivative financial instruments for trading purposes. The Company's derivative activity is limited to currency swap transactions designed to hedge its currency risk on specific foreign currency-denominated loans to certain foreign affiliates denominated in British Sterling, and one interest rate swap transaction assumed in 1993 as a part of a business acquisition. Gains and losses on qualifying hedges are deferred and are recognized in income or as adjustments of carrying amounts when the hedged transaction occurs.\nCHANGES IN ACCOUNTING PRINCIPLES\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\". The adoption of this standard was not significant to the Company's consolidated financial statements. See NOTE 16 to the consolidated financial statements for additional information.\nEffective January 1, 1993, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" and SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts\". The adoption of these standards was not significant to the Company's consolidated financial statements.\nEffective January 1, 1992, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS No. 109, \"Accounting for Income Taxes\". The Company recorded a one-time cumulative effect of changes in accounting principles of $10.4 million consisting of a $40.2 million after-tax charge relating to SFAS 106 and a $29.8 million benefit relating to SFAS 109. See NOTES 11 and 8 to the consolidated financial statements for additional information.\nNOTE 3 - FINANCE RECEIVABLES\nCOMPOSITION OF FINANCE RECEIVABLES\nAt December 31, 1994 and 1993, finance receivables consisted of the following (in millions): 1994 1993\nConsumer Finance Residential real estate-secured receivables $12,002.7 $10,626.0 Direct installment and credit card receivables 7,200.4 6,060.2 Manufactured housing and other installment receivables 4,864.0 3,809.6 24,067.1 20,495.8\nCommercial Finance Heavy-duty truck receivables 5,001.6 4,333.7 Other industrial equipment receivables 5,876.8 4,743.5 10,878.4 9,077.2 34,945.5 29,573.0 Unearned Finance Income (3,769.5) (3,208.2) Net finance receivables $31,176.0 $26,364.8\nThe estimated maturities of gross finance receivables, at December 31, 1994, during subsequent years were as follows (in millions):\nConsumer Commercial Year Due Finance Finance Total\n1995 $ 3,842.8 $ 4,760.1 $ 8,602.9 1996 2,975.1 2,792.8 5,767.9 1997 2,539.0 1,873.0 4,412.0 1998 1,832.0 1,007.6 2,839.6 1999 and thereafter 12,878.2 444.9 13,323.1 $24,067.1 $10,878.4 $34,945.5\nEstimated maturities are based on contractual terms and do not give effect to possible prepayments.\nIncluded in other industrial equipment receivables are direct financing leases as follows (in millions): December 31 1994 1993\nMinimum lease rentals $2,291.4 $1,882.1 Unguaranteed residual values 52.4 26.4 Future minimum lease rentals 2,343.8 1,908.5 Unearned finance income (328.7) (256.2) Allowance for losses on finance receivables (46.8) (42.0) Net investment in direct financing leases $1,968.3 $1,610.3\nFuture minimum lease rentals on direct financing leases for each of the years succeeding December 31, 1994 are as follows (in millions): 1995 - $730.2; 1996 - - $617.2; 1997 - $476.2; 1998 - $328.0; 1999 - $144.7 and 2000 and thereafter - - $47.5.\nESTIMATED FAIR VALUE OF NET FINANCE RECEIVABLES\nThe estimated fair value of net finance receivables at December 31, 1994 and 1993 was approximately $33.4 billion and $27.8 billion, respectively. In order to determine the fair values of loans, the loan portfolio was segmented based on loan type, credit quality and repricing characteristics. The fair value was estimated by discounting the expected cash flows from such loans at discount rates which approximate gross finance charge rates that would achieve an expected return on assets with similar risk characteristics. The estimated fair value of the credit card receivables was based on the Company's experience in pricing similar portfolios for acquisition purposes.\nDISPERSION OF FINANCE RECEIVABLES\nThe Company has geographically dispersed finance receivables portfolios. At December 31, 1994, the finance receivables were dispersed among 50 states, with four percent or more of the receivables in the states of California (11%), Florida (6%), Texas (6%), Georgia (5%), North Carolina (5%), Pennsylvania (4%), New York (4%), Ohio (4%), Illinois (4%) and Tennessee (4%). The ten largest customer accounts at December 31, 1994, other than accounts with affiliates, represented 0.9% of the total gross finance receivables outstanding. The largest gross balance outstanding in such accounts was $54.4 million and the average gross balance was $30.5 million.\nACQUISITIONS OF FINANCE BUSINESSES AND FINANCE RECEIVABLES\nDuring the years ended December 31, 1994, 1993 and 1992, the Company made acquisitions of finance businesses and finance receivables, the most significant of which were as follows:\nIn September 1994, Associates acquired the credit card portfolio and certain other assets of Amoco Oil Company. The fair market value of assets acquired totaled $426 million. The transaction was accounted for as a purchase.\nIn December 1994, Associates acquired the assets of First Collateral Services, Inc., principally consisting of warehouse loan facilities extended to mortgage brokers secured by mortgage contracts. The fair market value of total assets acquired and liabilities assumed was $62 million and $3 million, respectively. The transaction was accounted for as a purchase.\nIn April 1993, Associates purchased the stock of Allied Finance Company, with assets primarily consisting of $146 million of net consumer finance receivables, principally comprised of residential real estate-secured, direct installment and indirect installment receivables. The fair market value of total assets acquired and liabilities assumed was $197 million and $112 million, respectively. The transaction was accounted for as a purchase.\nIn September 1993, Associates purchased the assets of Mack Financial Corporation, the financing division of Mack Trucks, Inc., consisting of $552 million of net commercial finance receivables, principally secured by heavy-duty trucks and truck trailers. The fair market value of total assets acquired and liabilities assumed was $587 million and $380 million, respectively. The transaction was accounted for as a purchase.\nIn September 1993, Associates acquired the credit card portfolio of Great Western Financial Corporation. The outstanding balances totaled $216 million.\nIn April 1992, Associates purchased from Signal Financial Corporation $290 million of net consumer finance receivables. The receivables consisted primarily of direct installment and residential real estate-secured loans. The fair market value of total assets acquired and liabilities assumed was $303 million and $2 million, respectively. The transaction was accounted for as a purchase.\nIn November 1992, Associates purchased substantially all the assets of First Family Financial Services H.C., Inc. Such assets included $546 million of net consumer finance receivables, principally residential real estate-secured and direct installment loans. The fair market value of total assets acquired and liabilities assumed was $697 million and $543 million, respectively. The transaction was accounted for as a purchase.\nIn December 1992, First Capital purchased the stock of Trans-National Leasing, Inc. Approximately $48 million of net commercial finance receivables relating to the financing of fleet vehicles was acquired in the transaction. The fair market value of assets acquired and liabilities assumed was $52 million and $45 million, respectively. The transaction was accounted for as a purchase. Trans-National Leasing, Inc. was subsequently merged with an affiliate and contributed by First Capital to Associates in December 1992. See NOTE 14 to the consolidated financial statements for additional information.\nNOTE 4 - ALLOWANCE FOR LOSSES ON FINANCE RECEIVABLES\nChanges in the allowance for losses on finance receivables during the periods indicated were as follows (in millions):\nYear Ended December 31 1994 1993 1992\nBalance at beginning of period $ 808.9 $ 699.2 $ 590.9 Provision for losses 577.5 476.1 512.6 Recoveries on receivables charged off 101.0 88.5 72.6 Losses sustained (565.3) (482.2) (497.3) Other adjustments, primarily reserves of acquired businesses 22.2 27.3 20.4\nBalance at end of period $ 944.3 $ 808.9 $ 699.2\nNOTE 5 - BANK CREDIT FACILITIES\nFirst Capital had contractually committed bank lines of credit of $90.0 million at December 31, 1994. Additionally, at December 31, 1994, Associates, the principal operating subsidiary of First Capital, had contractually committed lines of credit at 119 banks, aggregating $3.8 billion, with various maturities through December 31, 1995, none of which was utilized at December 31, 1994. Also at December 31, 1994, Associates had agreements with 105 banks extending revolving credit facilities of $4.4 billion, with maturity dates ranging from February 1, 1995 through January 1, 2000, and $1.0 billion of receivables purchase facilities, $500.0 million of which is available through April 30, 1995 and $500.0 million of which is available through April 15, 1997; none of these facilities was utilized as of December 31, 1994. At December 31, 1994, First Capital had revolving credit facilities of $250.0 million. The aggregate credit facilities available to Associates as of December 31, 1994 were $9.2 billion with 146 banks. Bank lines and revolvers may be withdrawn only under certain standard conditions. Associates pays fees or maintains compensating balances or utilizes a combination of both to maintain the availability of its bank credit facilities. Bank fees incurred during 1994, 1993 and 1992 approximated $11.0 million, $9.6 million and $6.8 million, respectively, and are .05% to .25% of 1% per annum of the amount of the facilities. At December 31, 1994, the Company had outstanding debt agreements that required compensating balances totaling $1.6 million.\nNOTE 6 - NOTES PAYABLE\nCommercial paper notes are issued by Associates in the minimum amount of $100,000 with terms from 1 to 270 days. Bank loan terms range from 4 to 7 days. Information pertaining to the Company's commercial paper notes and bank loans is set forth below for the periods indicated (dollar amounts in millions):\nCommercial Bank Paper Notes Loans\nEnding balance at December 31, 1994 $11,640.5 $571.4 Weighted average interest rate at December 31, 1994 5.88% 6.79%\nEnding balance at December 31, 1993 $ 9,735.8 $472.4 Weighted average interest rate at December 31, 1993 3.25% 3.84%\nEnding balance at December 31, 1992 $ 8,453.6 $466.0 Weighted average interest rate at December 31, 1992 3.35% 3.51%\nThe amounts reported in the Consolidated Balance Sheet approximate fair value.\nNOTE 7 - LONG-TERM DEBT\nOutstanding balances of long-term debt at December 31 were as follows (in millions):\nInterest Rate Range Maturities 1994 1993\nSenior: Notes 4.06-13.75% 1995-2010 $15,157.7 $13,007.5 Investment notes 4.15-10.50 1995-1999 354.6 351.4 15,512.3 13,358.9\nSubordinated and Capital: Subordinated 7.63- 8.15 1998-2009 141.2 241.2 Capital 4.68- 9.00 1995-2002 0.6 0.7 141.8 241.9\nTotal long-term debt $15,654.1 $13,600.8\nThe weighted average interest rate for total long-term debt was 7.24% at December 31, 1994 and 7.54% at December 31, 1993.\nThe estimated fair value of long-term debt at December 31, 1994 and 1993 was $15.1 billion and $14.5 billion, respectively. The fair value was determined by discounting expected cash flows at discount rates currently available to the Company for debt with similar terms and remaining maturities.\nLong-term borrowing maturities during the next five years, including the current portion of notes payable after one year are: 1995, $2,132.6 million; 1996, $2,772.1 million; 1997, $3,171.1 million; 1998, $1,820.7 million; 1999, $2,161.0 million and 2000 and thereafter, $3,596.6 million.\nCertain debt issues contain call provisions or may be subject to repayment provisions at the option of the holder on specified dates prior to the maturity date. At December 31, 1994, approximately 3,500 warrants were outstanding to purchase $154.8 million aggregate principal amount of senior notes at par with interest rates ranging from 7.00% to 10.50%. The warrants are exercisable at various dates through October 1, 1999 at prices ranging from $1,000 to $25,000,000 per warrant. All of the above issues are unsecured, except for a $50 million, 8.25% Senior Note due August 15, 2001, which is collateralized by First Capital's corporate offices.\nNOTE 8 - PROVISION FOR INCOME TAXES\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 (the \"Act\") was enacted. Among other changes, the Act increased the Federal income tax rate for corporations by one percentage point to 35% effective January 1, 1993. Net income for 1993 included a reduction of $2.1 million in the provision for income taxes as a result of restating deferred tax balances. The favorable effect reflects the higher tax rate applied to the Company's net deferred tax assets.\nEffective January 1, 1992, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\". The cumulative effect of the accounting change was recognized in the December 31, 1992 Consolidated Statement of Earnings as a one-time increase to net earnings in the amount of $29.8 million.\nThe following table sets forth the components of the provision for U.S. Federal and State income taxes and deferred income tax (benefit) for the periods indicated (in millions):\nFederal State Total\nYear Ended December 31, 1994 Current: $ 400.1 $31.5 $ 431.6 Deferred: Leasing transactions 29.2 29.2 Finance revenue (5.7) (5.7) Provision for losses on finance receivables and other (115.2) (115.2) $ 308.4 $31.5 $ 339.9\nYear Ended December 31, 1993 Current $337.1 $20.5 $ 357.6 Deferred: Leasing transactions 3.6 3.6 Finance revenue 3.9 3.9 Provision for losses on finance receivables and other (83.4) (83.4) $261.2 $20.5 $ 281.7\nYear Ended December 31, 1992 Current $226.0 $ 8.8 $ 234.8 Deferred: Leasing transactions 13.6 13.6 Finance revenue 12.9 12.9 Provision for losses on finance receivables and other (48.1) (48.1) $204.4 $ 8.8 $ 213.2\nAt December 31, 1994 and 1993, the components of the Company's net deferred tax asset were as follows (in millions):\n1994 1993\nDeferred tax assets: Provision for losses on finance receivables and other $ 517.2 $ 368.8 Postretirement and other employee benefits 74.0 68.1 591.2 436.9 Deferred tax liabilities: Leasing transactions (175.1) (145.9) Finance revenue and other (214.3) (192.6) (389.4) (338.5) Net deferred tax asset $ 201.8 $ 98.4\nDue to the Company's earnings level, no valuation allowance related to the deferred tax asset has been recorded. The effective tax rate differed from the statutory U.S. Federal income tax rate as follows: % of Pretax Income Year Ended December 31 1994 1993 1992\nStatutory tax rate 35.0% 35.0% 34.0% State tax rate 2.3 1.8 1.0 Other 1.0 0.7 0.2 Effective tax rate 38.3% 37.5% 35.2%\nNOTE 9 - DEBT RESTRICTIONS\nAssociates, First Capital's principal operating subsidiary, is subject to various limitations under the provisions of its outstanding debt and revolving credit agreements. The most significant of these limitations are summarized as follows:\nLIMITATION ON PAYMENT OF DIVIDENDS\nA restriction contained in one series of debt securities maturing August 1, 1996, generally limits payments of cash dividends on Associates Common Stock in any year to not more than 50% of Associates consolidated net earnings for such year, subject to certain exceptions, plus increases in contributed capital and extraordinary gains. Any such amounts available for the payment of dividends in such fiscal year and not so paid, may be paid in any one or more of the five subsequent fiscal years. In accordance with this provision, at December 31, 1994, $453.6 million was available for dividends.\nLIMITATION ON MINIMUM TANGIBLE NET WORTH\nA restriction contained in certain revolving credit agreements requires Associates to maintain a minimum tangible net worth, as defined, of $1.5 billion. At December 31, 1994, Associates tangible net worth was approximately $3.4 billion.\nLIMITATION OF AFFILIATE RECEIVABLES\nA debt agreement of Associates limits the total of all affiliate-related receivables, as defined, to 7% of the aggregate gross receivables owned by Associates. An affiliate within the meaning of affiliate-related receivables includes First Capital, its parent corporation, and any corporation, other than Associates and its subsidiaries, of which First Capital or its parent corporation owns or controls at least 50% of its stock. The net total of all affiliate-related receivables which Associates owned at December 31, 1994 and 1993, amounted to 1.0% and 1.5%, respectively, of its aggregate gross receivables as of those dates.\nNOTE 10 - LEASE COMMITMENTS\nLeases are primarily short-term and generally provide for renewal options not exceeding the initial term. Total rent expense for the years ended December 31, 1994, 1993 and 1992 was $48.7 million, $43.9 million, and $38.3 million, respectively. Minimum rental commitments as of December 31, 1994 for all noncancelable leases (primarily office leases) for the years ending December 31, 1995, 1996, 1997, 1998 and 1999 are $42.8 million, $34.8 million, $23.8 million, $16.2 million and $6.1 million, respectively, and $3.8 million thereafter.\nNOTE 11 - EMPLOYEE BENEFITS\nDEFINED BENEFIT PLANS\nThe Company sponsors various qualified and nonqualified pension plans (the \"Plan\" or \"Plans\"), which together cover substantially all permanent employees who meet certain eligibility requirements.\nNet periodic pension cost for the years indicated includes the following components (in millions): December 31 1994 1993 1992\nService cost $ 13.7 $ 10.0 $ 8.4 Interest cost 21.3 18.1 16.1 Actual return on Plan assets (0.4) (21.6) (10.0) Net amortization (10.9) 7.4 (2.5) Net periodic pension cost $ 23.7 $ 13.9 $ 12.0 Assumed discount rate, beginning of year 7.00% 8.00% 8.50%\nThe funded status of the Plan is as follows (in millions):\nDecember 31 1994 1993 Qualified Nonqualified Qualified Nonqualified Plan Plan Plan Plan\nActuarial present value of benefit obligation: Vested $187.6 $16.8 $197.9 $17.5 Nonvested 9.0 0.8 8.2 0.2 Accumulated benefit obligation 196.6 17.6 206.1 17.7 Effect of projected future salary increases 50.4 6.2 62.4 4.0 Projected benefit obligation 247.0 23.8 268.5 21.7 Plan assets at fair market value 204.7 197.5 Excess of plan obligation over plan assets 42.3 23.8 71.0 21.7 Unamortized transition obligation and amendments (6.5) (4.3) (9.4) (0.7) Unamortized net loss (13.3) (1.5) (42.5) (3.3) Accrued pension liability $ 22.5 $18.0 $ 19.1 $17.7 Assumed discount rate 8.25% 8.25% 7.00% 7.00% Projected compensation increases 6.00% 6.00% 6.00% 6.00% Expected return 9.00% 9.00% 9.50% 9.50% A determination of the Federal income tax status related to the qualified Pension Plan has not been requested. An application is expected to be filed in March 1995. If a favorable determination letter is not received, First Capital has agreed to make any changes required to receive a favorable determination letter.\nRETIREMENT SAVINGS AND PROFIT SHARING PLAN\nThe Company sponsors a defined contribution plan intended to provide assistance in accumulating personal savings for retirement and is designed to qualify under Sections 401(a) and 401(k) of the Internal Revenue Code. The savings plan has not been submitted to the Internal Revenue Service for approval as a qualified tax-exempt plan. Consequently, the plan provisions are subject to issuance of a favorable determination letter by the Internal Revenue Service (\"IRS\"). An application for determination is expected to be filed with the IRS in March 1995. For the years ended December 31, 1994, 1993 and 1992, the Company's pretax contributions to the plan were $15.9 million, $14.0 million and $12.1 million, respectively.\nEMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company provides certain postretirement benefits through unfunded plans sponsored by First Capital. These benefits are currently provided to substantially all permanent employees who meet certain eligibility requirements. The benefits or the plan can be modified or terminated at the discretion of the Company. The Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" in 1992. As of January 1, 1992, the Company recorded a one-time charge to net earnings of approximately $40.2 million, which represents the estimated accumulated postretirement benefit obligation on that date of $64.9 million, net of deferred income taxes of approximately $20.7 million and amounts recorded as purchase accounting adjustments of approximately $4.0 million. This amount has been reflected in the Consolidated Statement of Earnings as a component of the cumulative effect of changes in accounting principles.\nThe amount paid for postretirement benefits for the years ended December 31, 1994, 1993 and 1992 was approximately $1.8 million, $1.5 million and $2.1 million, respectively.\nNet periodic postretirement benefit cost for 1994 and 1993 includes the following components (in millions) December 31 1994 1993\nService cost $ 5.5 $ 4.2 Interest cost 6.3 6.3 Net amortization (1.0) (0.7) Net periodic postretirement benefit cost $10.8 $ 9.8 Assumed discount rate, beginning of year 7.50% 8.50%\nAccrued postretirement benefit cost at December 31, 1994 and 1993 is composed of the following (in millions): December 31 1994 1993 Accumulated postretirement benefit obligation (\"APBO\"): Retired participants $33.9 $ 33.6 Fully eligible participants 18.6 21.1 Other active participants 29.5 30.7 Total APBO 82.0 85.4 Unamortized amendments 9.8 11.5 Unrecognized actuarial loss (2.7) (16.8) Accrued postretirement benefit cost $89.1 $ 80.1 Assumed discount rate 8.75% 7.50%\nFor measurement purposes, a 12.10% and 12.50% weighted average annual rate of increase in per capita cost of covered health care benefits was assumed for 1994 and 1993, respectively, decreasing gradually to 5.50% by the year 2009. Increasing the assumed health care cost trend rate by one percentage point each year would increase the APBO as of December 31, 1994 and 1993 by $6.0 million and $6.2 million, respectively, and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost by $0.9 million and $0.8 million, respectively.\nNOTE 12 - COMMITMENTS AND CONTINGENCIES\nFirst Capital and its subsidiaries are defendants in various legal proceedings which arose in the normal course of business. In management's judgment (based upon the advice of counsel), the ultimate liabilities, if any, from such legal proceedings will not have a material adverse effect on the consolidated financial position or operations of First Capital.\nNOTE 13 - OTHER ASSETS\nThe components of Other Assets at December 31, 1994 and 1993 were as follows (in millions): December 31 1994 1993\nBalances with related parties - NOTE 14 $ 68.7 $ 170.4 Goodwill 362.0 382.2 Other 569.5 663.1 Total other assets $1,000.2 $1,215.7\nNOTE 14 - TRANSACTIONS AND BALANCES WITH RELATED PARTIES\nCAPITAL TRANSACTIONS\nIn both 1994 and 1993, First Capital received from Ford Holdings a capital contribution of $200.0 million in the form of cash.\nOTHER TRANSACTIONS AND BALANCES\nFirst Capital, through Associates, provides debt financing or advances to certain of its former foreign subsidiaries. At December 31, 1994 and 1993, amounts due from foreign affiliates totaled $68.7 million and $142.1 million, respectively, and were included in Other Assets. These receivables or advances bear fluctuating interest rates (as applicable) and are payable on demand. Interest income related to these transactions was $14.4 million, $21.3 million and $34.0 million for the years ended December 31, 1994, 1993 and 1992, respectively. The estimated fair value of these receivables was $70.4 million and $150.2 million at December 31, 1994 and 1993, respectively.\nThe Company provides certain services of an administrative nature, use of certain tangible and intangible assets, including trademarks, guarantees of debt and related interest, and other management services to certain of its foreign affiliates in Japan, Canada, Puerto Rico and the United Kingdom. Services and usage are charged to the affiliates based on the nature of the service. Fees for financial accommodations range from .25% to 1% of the average outstanding debt guaranteed. Management believes such charges reflect the market value for such services, usage and guarantees. The amounts paid or accrued under these arrangements for the years ended December 31, 1994, 1993 and 1992 were $53.7 million, $40.1 million and $35.5 million, respectively.\nThe Company provides certain auto club and relocation services to Ford. Revenues related to these services were $19.4 million, $12.1 million and $6.7 million for the years ended December 31, 1994, 1993 and 1992, respectively.\nAt December 31, 1994 and 1993, the Company was a guarantor on debt and related accrued interest of its foreign affiliates in Canada and Puerto Rico amounting to $339.9 million and $256.7 million, respectively.\nAt December 31, 1994 and 1993, First Capital's current income taxes payable to Holdings amounted to $30.4 million and $40.2 million, respectively.\nNOTE 15 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISKS\nThe Company maintains cash, cash equivalents, investments, and certain other financial instruments with various major financial institutions. To the extent such deposits exceed maximum insurance levels, they are uninsured.\nAmounts under currency and interest rate swap contracts at December 31, 1994 were approximately $95.7 million. The Company is at market and interest rate risk for any currency and\/or interest rate differential should a counterparty to these contracts fail to meet the terms of the contracts. At December 31, 1994, the Company estimates its exposure to loss resulting from currency and\/or interest rate differentials, in the event of nonperformance by certain counterparties, was $0.2 million; the Company estimates its benefit resulting from currency differentials in the event of nonperformance by certain counterparties, was $0.9 million. The estimated fair value of amounts under contract approximated $0.7 million. Such value was determined based on the foreign currency exchange rates\/interest rate for similar transactions in effect at the balance sheet date. It is the Company's policy that each counterparty's debt rating must be rated Aa3, AA- or better by at least two nationally recognized rating agencies at the time any such contract is entered into. The Company monitors such ratings on an ongoing basis.\nAssociates National Bank (Delaware) a subsidiary of First Capital, makes available credit lines to holders of their credit cards. The unused portion of the available credit is revocable by the bank under specified conditions. The unused portion of the available credit at December 31, 1994 and 1993 approximated $9.0 billion and $8.2 billion, respectively. The potential risk associated with, and the estimated fair value of, the unused credit lines are not considered to be significant.\nThe consumer operation grants revolving lines of credit to certain of its customers. At December 31, 1994 and 1993, the unused portion of these lines aggregated approximately $455.2 million and $712.4 million, respectively. The potential risk associated with, and the estimated fair value of, the unused credit lines are not considered to be significant.\nThe commercial operation grants lines of credit to certain dealers of truck, construction equipment and manufactured housing. At December 31, 1994 and 1993, the unused portion of these lines aggregated approximately $849.7 million and $684.6 million, respectively. The potential risk associated with, and the estimated fair value of, the unused credit lines are not considered to be significant.\nNOTE 16 - INVESTMENTS IN MARKETABLE SECURITIES\nDEBT SECURITIES\nThe Company invests in debt securities, principally bonds and notes, with the intention of holding them to maturity. However, if market conditions change, the Company may sell these securities prior to maturity. Accordingly, concurrent with the adoption of SFAS No. 115, the Company classified its investments in debt securities as available for sale and adjusted its recorded value to market. Prior to adoption of this standard, the Company carried these investments at amortized cost. The estimated market value at December 31, 1994 and 1993 was $563.2 million and $612.0 million, respectively. Amortized cost at December 31, 1994 and 1993 was $590.3 million and $598.7 million, respectively. During 1994, realized gains and losses on sales amounted to $2.1 million and $0.3 million, respectively. Unrealized gains or losses are reported as a component of stockholder's equity, net of tax. The following table sets forth, by type of security issuer, the amortized cost, gross unrealized holding gains, gross unrealized holding losses, and estimated market value at December 31, 1994 (in millions):\nGross Gross Unrealized Unrealized Estimated Amortized Holding Holding Market Cost Gains Losses Value\nU.S. Government obligations $422.4 $0.7 $(25.2) $397.9 Corporate obligations 66.8 0.2 (0.5) 66.5 Mortgage-backed 96.3 (2.3) 94.0 Other 4.8 4.8 Total debt securities $590.3 $0.9 $(28.0) $563.2\nThe amortized cost and estimated market value of debt securities at December 31, 1994, by contractual maturity, are shown below (in millions):\nEstimated Amortized Market Cost Value\nDue in one year or less $ 93.2 $ 92.1 Due after one year through five years 384.3 369.6 Due after five years through ten years 110.8 99.6 Due after ten years 2.0 1.9 $590.3 $563.2\nEQUITY SECURITIES\nEquity security investments, principally common stock held by the Company's insurance subsidiaries, are recorded at market value. Concurrent with the adoption of SFAS No. 115, the Company classified its investments in equity securities as trading securities and included in earnings unrealized gains or losses on such securities. Prior to adoption, unrealized gains or losses were reported as a component of stockholder's equity, net of tax. The estimated market value at December 31, 1994 and 1993 was $41.9 million and $35.0 million, respectively. Historical cost at December 31, 1994 and 1993 was $38.9 million and $28.9 million, respectively.\nEstimated market values of debt and equity securities are based on quoted market prices.\nNOTE 17 - BUSINESS SEGMENT INFORMATION\nFirst Capital's primary business activities are consumer finance, commercial finance and insurance underwriting. The consumer finance operation is engaged in making and investing in residential real estate-secured receivables, consumer direct installment and revolving credit receivables, including credit card receivables, primarily through a wholly-owned credit card bank, purchasing consumer retail installment obligations and providing other consumer financial services. The commercial finance operation is principally engaged in financing sales of transportation and industrial equipment and leasing, and sales of other financial services, including automobile club, mortgage banking and relocation services. The insurance operation is engaged in underwriting credit life, credit accident and health, property and casualty, and accidental death and dismemberment insurance, principally for customers of the finance operations, and such sales are the principal amounts included in the intersegment revenue shown below. The following table sets forth information by business segment (in millions):\nCapital expenditures and depreciation and amortization expense are not significant.\nNOTE 18 - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)\nCondensed unconsolidated financial information of Associates First Capital Corporation as of or for the years ended December 31, 1994, 1993 and 1992 were as follows (in millions):\nCONDENSED STATEMENT OF EARNINGS\nYear Ended December 31 1994 1993 1992\nRevenue Interest and other income $ 8.7 $ 6.7 $ 6.1 Dividends from subsidiaries 270.5 242.7 191.6 279.2 249.4 197.7\nExpenses Interest expense 54.8 51.1 56.5 Operating expenses 16.2 15.3 15.2 71.0 66.4 71.7\nIncome before credit for Federal income taxes and equity in net earnings of subsidiaries 208.2 183.0 126.0 Credit for Federal income taxes resulting from tax agreements with subsidiaries 21.7 21.2 21.7 Earnings before equity in undistributed earnings of subsidiaries 229.9 204.2 147.4 Equity in undistributed earnings of subsidiaries 318.2 265.9 235.1 Net earnings $548.1 $470.1 $382.8\nSee notes to condensed financial information.\nCONDENSED BALANCE SHEET\nDecember 31 1994 1993\nAssets Investment in and advances to subsidiaries, eliminated in consolidation, and other $3,829.4 $3,198.9 Total assets $3,829.4 $3,198.9\nLiabilities and Stockholder's Equity Accounts payable and accruals $ 33.0 $ 19.9 Notes payable and long-term debt (2) 836.5 672.7 Stockholder's equity (1) 2,959.9 2,506.3 Total liabilities and stockholder's equity $3,829.4 $3,198.9\nThe estimated fair value of notes payable and long-term debt at December 31, 1994 and 1993 was $829.4 million and $685.3 million, respectively. Fair values were estimated by discounting expected cash flows at discount rates currently available to the Company for debt with similar terms and remaining maturities.\nSee notes to condensed financial information.\nCONDENSED STATEMENT OF CASH FLOWS (In Millions)\nYear Ended December 31 1994 1993 1992\nCash Flows from Operating Activities Net earnings $ 548.1 $ 470.1 $ 382.8 Adjustments to net earnings for noncash items: Amortization and depreciation 0.1 0.1 0.1 Increase (decrease) in accounts payable and accruals 13.1 (6.5) (13.7) Equity in undistributed earnings of subsidiaries (318.2) (265.9) (235.1) Other (20.9) (0.6) 1.0 Net cash provided from operating activities 222.2 197.2 135.1 Cash Flows from Investing Activities Cash dividends from subsidiaries (1) 270.5 242.7 191.6 Increase in investments in and advances to subsidiaries (583.7) (402.7) (151.7) Net cash (used for) provided from investing activities (313.2) (160.0) 39.9 Cash Flows from Financing Activities Increase in notes payable and long-term debt (2) 352.7 231.6 241.8 Capital contribution from parent 200.0 200.0 Cash dividends paid (273.0) (226.0) (190.0) Retirement of long-term debt (188.9) (244.2) (228.4) Net cash provided from (used for) financing activities 90.8 (38.6) (176.6)\nDecrease in cash and cash equivalents (0.2) (1.4) (1.6) Cash and cash equivalents at beginning of period (0.9) 0.5 2.1\nCash and cash equivalents at end of period $ (1.1) $ (0.9) $ 0.5\nNOTES TO CONDENSED FINANCIAL INFORMATION:\n(1) The ability of the Company's subsidiaries to transfer funds to the Company in the form of cash dividends is restricted pursuant to the terms of certain debt agreements entered into by the Company's principal operating subsidiary, Associates Corporation of North America. See NOTE 9 to the consolidated financial statements for a summary of the most significant of these restrictions.\n(2) Notes payable and long-term debt bear interest at rates from 4.15% to 13.75%. The estimated maturities of the notes outstanding, at December 31, 1994, during subsequent years were as follows (in millions):\n1995 $351.1 1996 220.2 1997 151.0 1998 73.9 1999 40.3 $836.5\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. ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by Items 10-13 has been omitted in accordance with General Instruction J.(2)(c) to Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K.\n(a) Financial Statements Page\nReport of Independent Accountants 15 Consolidated Statement of Earnings for the years ended December 31, 1994, 1993 and 1992 16 Consolidated Balance Sheet at December 31, 1994 and 1993 17 Consolidated Statement of Changes in Stockholder's Equity for the years ended December 31, 1994, 1993 and 1992 18 Consolidated Statement of Cash Flows for the years ended December 31, 1994, 1993 and 1992 19 Notes to consolidated financial statements 20\n(b) Reports on Form 8-K.\nDuring the quarter ended December 31, 1994, First Capital filed no Current Reports on Form 8-K.\n(c) Exhibits\n(3) (a) Certificate of Incorporation. Incorporated by reference to Exhibit 3(a) to the Company's Form 10-K for the fiscal year ended October 31, 1986.\n(b) By-laws. Incorporated by reference to Exhibit 3 to the Company's Form 10-K for the year ended December 31, 1990.\n(4) Instruments with respect to issues of long-term debt have not been filed as exhibits to this annual report on Form 10-K as the authorized principal amount of any one of such issues does not exceed 10% of the total assets of the registrant and its consolidated subsidiaries. Registrant agrees to furnish to the Commission a copy of each such instrument upon its request.\n(12) Computation of Ratio of Earnings to Fixed Charges.\n(21) Subsidiaries of the registrant. Omitted in accordance with General Instruction J.(2)(b) to Form 10-K.\n(23) Consent of Independent Accountants.\n(24) Powers of Attorney.\n(27) Financial Data Schedule.\nSIGNATURES\nNo annual report to security holders or proxy material has been or will be sent to security holders. 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.\nASSOCIATES FIRST CAPITAL CORPORATION\nBy \/s\/ ROY A. GUTHRIE Senior Vice President and Comptroller 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 date indicated.\nSignature Title Date\nKEITH W. HUGHES* Chairman of the Board, (Keith W. Hughes) Principal Executive Officer and Director\nJAMES E. JACK* Senior Executive Vice President, (James E. Jack) Principal Financial Officer and Director\nROY A. GUTHRIE* Senior Vice President, March 21, 1995 (Roy A. Guthrie) Comptroller and Principal Accounting Officer\nHAROLD D. MARSHALL* Director (Harold D. Marshall)\nJOSEPH M. McQUILLAN* Director (Joseph M. McQuillan)\nBy signing his name hereto, Roy A. Guthrie signs this document on behalf of himself and each of the other persons indicated above pursuant to powers of attorney duly executed by such persons.\n*By \/s\/ ROY A. GUTHRIE Attorney-in-fact\nINDEX TO EXHIBITS\nSequentially Exhibit Numbered Number Exhibit Page\n(3) (a) Certificate of Incorporation. Incorporated by reference to Exhibit 3(a) to the Company's Form 10-K for the fiscal year ended October 31, 1986.\n(b) By-laws. Incorporated by reference to Exhibit 3 to the Company's Form 10-K for the year ended December 31, 1990.\n(4) Instruments with respect to issues of long-term debt have not been filed as exhibits to this annual report on Form 10-K as the authorized principal amount of any one of such issues does not exceed 10% of the total assets of the registrant and its consolidated subsidiaries. Registrant agrees to furnish to the Commission a copy of each such instrument upon its request.\n(12) Computation of Ratio of Earnings to Fixed Charges.\n(21) Subsidiaries of the registrant. Omitted in accordance with General Instruction J.(2)(b) to Form 10-K.\n(23) Consent of Independent Accountants.\n(24) Powers of Attorney.\n(27) Financial Data Schedule.\nEXHIBIT 12\nEXHIBIT 12\nASSOCIATES FIRST CAPITAL CORPORATION\nCOMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (Dollar Amounts In Millions)\nYear Ended December 31 1994 1993 1992 1991 1990\nFixed Charges (a) Interest expense $1,558.2 $1,340.5 $1,281.4 $1,347.8 $1,217.3 Implicit interest in rent 8.3 8.0 7.8 7.4 7.9 Total fixed charges $1,566.5 $1,348.5 $1,289.2 $1,355.2 $1,225.2\nEarnings (b) $ 888.0 $ 751.8 $ 606.4 $ 540.4 $ 448.0 Fixed charges 1,566.5 1,348.5 1,289.2 1,355.2 1,225.2 Earnings, as defined $2,454.5 $2,100.3 $1,895.6 $1,895.6 $1,673.2\nRatio of Earnings to Fixed Charges 1.57 1.56 1.47 1.40 1.37\n(a) For purposes of such computation, the term \"Fixed Charges\" represents interest expense and a portion of rentals representative of an implicit interest factor for such rentals. Prior year implicit interest amounts have been restated to conform to current calculation methodology.\n(b) For purposes of such computation, the term \"Earnings\" represents earnings before provision for income taxes and cumulative effect of changes in accounting principles, plus fixed charges.\nEXHIBIT 23\nEXHIBIT 23\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the registration statement of Associates First Capital Corporation on Form S-3 (No. 33-65752) of our report dated January 27, 1995, on our audits of the consolidated financial statements of Associates First Capital Corporation 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.\nDallas, Texas March 21, 1995\nEXHIBIT 24\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, an officer and\/or a director of ASSOCIATES FIRST CAPITAL CORPORATION (the \"Company\"), has made, constituted and appointed and by these presents does hereby make, constitute and appoint THOMAS E. DALE, ROY A. GUTHRIE AND CHESTER D. LONGENECKER, and each of them, his true and lawful attorneys, for him and in his name, place and stead, and in his office and capacity as aforesaid, to sign and file the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, and any and all amendments thereto and any and all other documents to be signed and filed with the Securities and Exchange Commission in connection therewith, hereby granting to said THOMAS E. DALE, ROY A. GUTHRIE AND CHESTER D. LONGENECKER, and each of them, full power and authority to do and perform each and every act and thing whatsoever requisite and necessary to be done in the premises, as fully, to all intents and purposes, as he might or could do if personally present, hereby ratifying and confirming in all respects all that said THOMAS E. DALE, ROY A. GUTHRIE AND CHESTER D. LONGENECKER, or any of them, as said attorneys, may or shall lawfully do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned has set his hand this 10th day of February, 1995.\nSIGNATURE:\/s\/ Keith W. Hughes Keith W. Hughes\nOFFICE: Chairman of the Board, Principal Executive Officer and Director\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, an officer and\/or a director of ASSOCIATES FIRST CAPITAL CORPORATION (the \"Company\"), has made, constituted and appointed and by these presents does hereby make, constitute and appoint THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., and each of them, his true and lawful attorneys, for him and in his name, place and stead, and in his office and capacity as aforesaid, to sign and file the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, and any and all amendments thereto and any and all other documents to be signed and filed with the Securities and Exchange Commission in connection therewith, hereby granting to said THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., and each of them, full power and authority to do and perform each and every act and thing whatsoever requisite and necessary to be done in the premises, as fully, to all intents and purposes, as he might or could do if personally present, hereby ratifying and confirming in all respects all that said THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., or any of them, as said attorneys, may or shall lawfully do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned has set his hand this 13th day of January, 1995.\nSIGNATURE:\/s\/ James E. Jack James E. Jack\nOFFICE: Senior Executive Vice President, Principal Financial Officer and Director\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, an officer and\/or a director of ASSOCIATES FIRST CAPITAL CORPORATION (the \"Company\"), has made, constituted and appointed and by these presents does hereby make, constitute and appoint THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., and each of them, his true and lawful attorneys, for him and in his name, place and stead, and in his office and capacity as aforesaid, to sign and file the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, and any and all amendments thereto and any and all other documents to be signed and filed with the Securities and Exchange Commission in connection therewith, hereby granting to said THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., and each of them, full power and authority to do and perform each and every act and thing whatsoever requisite and necessary to be done in the premises, as fully, to all intents and purposes, as he might or could do if personally present, hereby ratifying and confirming in all respects all that said THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., or any of them, as said attorneys, may or shall lawfully do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned has set his hand this 13th day of January, 1995.\nSIGNATURE:\/s\/ Harold D. Marshall Harold D. Marshall\nOFFICE: Director\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, an officer and\/or a director of ASSOCIATES FIRST CAPITAL CORPORATION the \"Company\"), has made, constituted and appointed and by these presents does hereby make, constitute and appoint THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., and each of them, his true and lawful attorneys, for him and in his name, place and stead, and in his office and capacity as aforesaid, to sign and file the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, and any and all amendments thereto and any and all other documents to be signed and filed with the Securities and Exchange Commission in connection therewith, hereby granting to said THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., and each of them, full power and authority to do and perform each and every act and thing whatsoever requisite and necessary to be done in the premises, as fully, to all intents and purposes, as he might or could do if personally present, hereby ratifying and confirming in all respects all that said THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., or any of them, as said attorneys, may or shall lawfully do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned has set his hand this 13th day of January, 1995.\nSIGNATURE:\/s\/ Joseph M. McQuillan Joseph M. McQuillan\nOFFICE: Director\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that the undersigned, an officer and\/or a director of ASSOCIATES FIRST CAPITAL CORPORATION (the \"Company\"), has made, constituted and appointed and by these presents does hereby make, constitute and appoint THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., and each of them, his true and lawful attorneys, for him and in his name, place and stead, and in his office and capacity as aforesaid, to sign and file the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, and any and all amendments thereto and any and all other documents to be signed and filed with the Securities and Exchange Commission in connection therewith, hereby granting to said THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., and each of them, full power and authority to do and perform each and every act and thing whatsoever requisite and necessary to be done in the premises, as fully, to all intents and purposes, as he might or could do if personally present, hereby ratifying and confirming in all respects all that said THOMAS E. DALE, ROY A. GUTHRIE, CHESTER D. LONGENECKER AND REECE A. OVERCASH, JR., or any of them, as said attorneys, may or shall lawfully do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, the undersigned has set his hand this 13th day of January, 1995.\nSIGNATURE:\/s\/ Roy A. Guthrie Roy A. Guthrie\nOFFICE: Senior Vice President, Comptroller and Principal Accounting Officer","section_15":""}
{"filename":"277795_1994.txt","cik":"277795","year":"1994","section_1":"Item 1. Business (GEICO Corporation and Subsidiaries).\nGEICO Corporation (the \"Corporation\") was organized as a Delaware corporation in 1978. In 1979 the Corporation became the parent of Government Employees Insurance Company (\"GEICO\" or the \"Company\"), its principal subsidiary, and is also the parent corporation of various additional subsidiaries which are in the business of providing insurance and financial services (collectively, the \"GEICO Companies\").\nGEICO was founded in 1936 and has been continuously engaged in the insurance business. GEICO is a multiple line property and casualty insurer, the principal business of which is writing private passenger automobile insurance primarily for preferred-risk government employees and military personnel. To a lesser extent, it also writes homeowners insurance, personal umbrella liability, and boat owners and fire insurance for all qualified applicants. GEICO General Insurance Company (\"GEICO General\") is a subsidiary of GEICO which, in 1987, began writing private passenger automobile insurance for preferred-risk drivers not associated with the government or the military. GEICO Indemnity Company (\"GI\"), a subsidiary of the Corporation, writes standard-risk private passenger automobile and motorcycle insurance. GEICO Casualty Company (the name of which was changed from Criterion Casualty Company effective January 6, 1994), a subsidiary of GI, writes nonstandard-risk private passenger automobile insurance. The insurance companies market their policies primarily through direct response methods. Currently, GEICO, GEICO General, GI and GEICO Casualty have an A. M. Best rating of A++ (Superior) and a Standard & Poor's claims paying ability rating of AAA (Superior).\nCriterion Life Insurance Company (\"Criterion Life\") was formed by GEICO in 1991 to offer structured settlement single premium annuities to claimants of its property\/casualty company affiliates. On December 31, 1991 Criterion Life assumed all the structured settlement annuity business in force from Garden State Life Insurance Company, which was also wholly-owned by GEICO until it was sold in June 1992. Criterion Life has an A. M. Best rating of A++ (Superior).\nOther active subsidiaries of the Corporation and the Company involved in the sale of insurance and insurance related products include: International Insurance Underwriters, Inc., which provides various insurance services to military personnel as they are transferred overseas or back to the United States; The Top Five Club, Inc., which offers travel-related benefits to military personnel in the top five military enlisted pay grades; GEICO Financial Services, GmbH, which sells automobile policies to American military personnel through offices in Germany and through agents in England, Germany, Italy, Portugal and Turkey; Insurance Counselors, Inc. and Insurance Counselors of Texas, Inc., formed primarily to facilitate the marketing of insurance products; and Safe Driver Motor Club, Inc., which offers motor club services to customers of subsidiaries of the Corporation and sponsors of motor clubs.\n- 3 - PAGE\nThe Corporation offers additional financial services through its subsidiary, Government Employees Financial Corporation (\"GEFCO\") which, directly or through one or more of its own subsidiaries, is in the business of consumer and business lending and loan servicing. The Corporation is in the process of winding down the business of GEFCO.\nOther subsidiaries of the Corporation include Plaza Resources Company, which is engaged in various investment ventures; and several other companies which serve various corporate purposes including real estate\/property companies, Maryland Ventures, Inc., and GEICO Facilities Corporation.\nResolute Reinsurance Company, a subsidiary of Resolute Group, Inc., in turn a subsidiary of the Corporation, wrote property and casualty reinsurance in the domestic and international markets until late 1987 when it suspended writing new and renewal reinsurance. Resolute is in the process of running off its claims obligations. Effective December 31, 1993 the Corporation sold Merastar Insurance Company and Southern Heritage Insurance Company, two small property casualty insurance companies which had been purchased in 1991.\nSeasonal variations in the business of the Corporation historically are not material. However, extraordinary weather conditions or other factors may have an impact on the frequency or severity of automobile or homeowners claims. Weather related catastrophes severely affected the Corporation's financial results in 1992 due to Hurricane Andrew and had a lesser impact in 1993 and 1994. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" at Item 7 for more information concerning the effect of, and the Corporation's response to, such catastrophes.\nAdditional information concerning the insurance regulatory environment, the settlement of the insurance subsidiaries' California Proposition 103 premium refund obligation in 1993, proposed modification or repeal of the McCarran-Ferguson Act, proposals to integrate the medical portion of automobile insurance into the general health care insurance system, and similar initiatives elsewhere intended to affect insurance premium rates generally without addressing the underlying factors upon which those rates are based, is presented in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" at Item 7 and such information is incorporated herein by reference.\nThe insurance industry is highly competitive. GEICO currently competes most directly with other companies, including mutual companies, that concentrate on preferred risk private passenger automobile insurance and, to a lesser extent, for standard and nonstandard risks. Because personal lines property and casualty insurance is so stringently regulated by each state in which the Companies do business, it is difficult for companies to differentiate their products. Additionally, some companies exacerbate price competition by selling their products at inadequate rates for a period of time, because long delays in reporting and settling certain claims result in underestimating ultimate loss costs, or the products are sold in anticipation of profits from their investment portfolios. Consequently, GEICO's business is very sensitive both to the price of the product and the perceived level of customer service it provides. Competition for preferred risks, which is substantial, tends to focus on issues of price and service, while price is a more significant factor to other risks. The GEICO Companies place great emphasis on customer\n- 4 - PAGE\nsatisfaction and write their auto business predominantly with six-month policies, allowing them to manage rate changes more effectively. GEICO also believes its reputation is a material asset and protects its name and other service marks through appropriate registrations.\nAlthough most insurance companies are stock companies like GEICO, in 1993 mutual companies wrote approximately one-third of all property and liability insurance in the United States. Mutual companies may have a competitive advantage in that certain earnings inure to the benefit of policyholders rather than to shareholders; in certain circumstances, however, stock companies do pay dividends to their policyholders.\nAs of December 31, 1994 the Corporation and its subsidiaries had 7,453 full-time employees and 698 part-time employees. A number of benefits are provided or made available for most full-time employees including profit sharing, pension and employee stock ownership plans and various insurance programs.\nPRINCIPAL BUSINESS SEGMENTS\nProperty and casualty insurance is the Corporation's dominant business segment, although other insurance and financial service products are offered.\nThe information concerning the Corporation's personal lines property and casualty insurance business and its other business segments required by the remainder of this Item 1, which is contained in its 1994 Annual Report to Shareholders under the caption \"Business Segments\" on pages 14 through 16 and Note O of the \"Notes to Consolidated Financial Statements\" contained on Page 43, is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nGEICO, the principal subsidiary of the Corporation, owns its GEICO Plaza headquarters building in Chevy Chase, Maryland, its Regional Office buildings in Woodbury, New York, Macon, Georgia, Dallas, Texas, and Stafford County near Fredericksburg, Virginia, certain of its claims drive- in facilities and certain additional properties. GEICO also leases its Regional Offices in San Diego, California and office space and drive-in claims facilities in various cities in the United States. These facilities will accommodate foreseeable space requirements.\nGEICO also maintains and continually upgrades sophisticated electronic data processing equipment and software and telecommunications facilities to enable it to process applications and claims efficiently.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no material legal proceedings to which the Corporation is a party or of which the property of the Corporation is the subject.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot Applicable.\n- 5 - PAGE\nExecutive Officers of the Registrant.\nInformation regarding executive officers of the Corporation is set forth below. Each officer holds such office until the next annual election of officers, which is held at the first meeting of the Board of Directors after the annual meeting of shareholders, which is scheduled to be held on May 10, 1995, and until his\/her successor is elected or appointed. To the best knowledge of the Corporation, there are no family relationships among any of such officers or among any of such officers and any directors nor is there any arrangement or understanding between any such officer and any other person pursuant to which any such officer was elected.\nMarion E. Byrd, 58, has been a director and Senior Vice President of GEICO since May 1989. He was a Vice President of GEICO from January 1980 to May 1989. He also is, or has served as, a director and\/or an officer of several subsidiaries of the Corporation and GEICO.\nCharles R. Davies, 54, was elected Vice President and General Counsel of the Corporation and GEICO and a director of GEICO in November 1992. He served as Vice President and Deputy General Counsel of both the Corporation and GEICO from March 1987 to November 1992 and Assistant Vice President and Deputy General Counsel from March 1982 to March 1987. Mr. Davies also is, or has served as, a director and\/or an officer of several subsidiaries of the Corporation and GEICO.\nJames M. Hitt, 50, was elected a Vice President of GEICO in August 1986 and has been an officer of GEICO since 1979. He also is or has served as an officer and\/or director of various subsidiaries of the Corporation and GEICO.\nDonald R. Lyons, 48, was elected a Vice President of GEICO in May 1992 and has been an officer since September 1985. He is also an officer of certain subsidiaries of GEICO.\nRobert M. Miller, 52, was elected a Vice President of GEICO in September 1987 and has been an officer since May 1980. He is also an officer of certain subsidiaries of GEICO.\nOlza M. Nicely, 51, was elected President and Chief Executive Officer - Insurance Operations of the Corporation in May 1993 and was elected a director of the Corporation in May 1990. He was also elected Chairman of the Board, President and Chief Executive Officer of GEICO in May 1993, having served as President and Chief Executive Officer of GEICO from January 1992 to May 1993 and as President of GEICO from August 1989 to January 1992. He has been a director of GEICO since September 1985. He had served as Executive Vice President of GEICO from June 1987 to August 1989. He has been an officer of GEICO since March 1973. Mr. Nicely also is, or has served as, a director and\/or an officer of several subsidiaries of the Corporation and GEICO.\nSimone J. Pace, 52, was elected a Senior Vice President of the Corporation and GEICO and a director of GEICO in August 1993. Prior to joining the Corporation, he had been president of Blue Cross\/Blue Shield of the National Capital Area from September 1992 to April 1993, Executive Vice President from October 1988 to August 1992 and Senior Vice President from January 1985 to October 1988, having first joined that Company in June 1971.\n- 6 - PAGE\nDavid H. Pushman, 46, was elected a Vice President of GEICO in May 1989. He has been an officer of GEICO since June 1986.\nDavid Schindler, 49, was elected a Vice President of GEICO in May 1988 and has been an officer of GEICO since August 1983. He is also, or has served as, an officer of several subsidiaries of GEICO.\nLouis A. Simpson, 58, was elected President and Chief Executive Officer - Capital Operations of the Corporation in May 1993, having served as Vice Chairman of the Board of Directors of the Corporation from July 1985 to May 1993. He has been a director of the Corporation since May 1983. Mr. Simpson is, or has served as, Chairman of the Board, a director and\/or an officer of several subsidiaries of the Corporation and GEICO. He has been a director of Potomac Electric Power Company since December 1990, of Salomon Inc since May 1993 and of Pacific American Income Shares Inc. since November 1994.\nW. Alvon Sparks, Jr., 59, was elected a director of the Corporation in November 1993 and has served as an Executive Vice President and Chief Financial Officer of the Corporation since August 1992. He was a Senior Vice President of the Corporation from September 1982 to August 1992. He was elected Executive Vice President of GEICO in February 1995, having served as a Senior Vice President since September 1982 and a director since May 1982. Mr. Sparks also is, or has served as, Chairman of the Board, a director and\/or an officer of several subsidiaries of the Corporation and GEICO.\nRichard C. VanEssendelft, 54, was elected a Vice President of GEICO in January 1992, having served as an Assistant Vice President from August 1979 to January 1992. He also is, or has served as, a director and\/or an officer of various subsidiaries of the Corporation.\nThomas M. Wells, 44, was elected a Group Vice President and Controller of the Corporation and GEICO in August 1992 and a director of GEICO in November 1992. He served as Vice President and Controller of the Corporation and GEICO from July 1985 to August 1992. Mr. Wells also serves as a director and\/or an officer of several subsidiaries of the Corporation and GEICO.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nIn response to this Item the material under the caption \"Common Stock\" (page 7) and the final paragraph of Note C (page 36) of the \"Notes to Consolidated Financial Statements\" in the Corporation's 1994 Annual Report to Shareholders are incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nIn response to this Item the material under the caption \"Selected Financial Data\" (pages 6 and 7) in the Corporation's 1994 Annual Report to Shareholders is incorporated herein by reference.\n- 7 - PAGE\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nIn response to this Item the material under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" (pages 17 through 26 and page 45) in the Corporation's 1994 Annual Report to Shareholders is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIn response to this Item the consolidated financial statements and the notes thereto contained in the Corporation's 1994 Annual Report to Shareholders (pages 27 through 43) and the Quarterly Highlights of Operating Results (page 44) 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 required by this Item pursuant to Item 401 of Regulation S-K with respect to directors of the Corporation is incorporated herein by reference from the Corporation's definitive proxy statement filed or to be filed with the Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 (the \"Act\"). The information required by this Item pursuant to Item 401 of Regulation S-K with respect to executive officers of the Corporation is included in Part I hereof. The information, if any, required by this Item pursuant to Item 405 of Regulation S-K is incorporated herein by reference from the Corporation's definitive proxy statement filed or to be filed with the Commission pursuant to the Act.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required by this Item is incorporated herein by reference from the Corporation's definitive proxy statement filed or to be filed with the Commission pursuant to Regulation 14A under the Act.\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 from the Corporation's definitive proxy statement filed or to be filed with the Commission pursuant to Regulation 14A under the Act.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information required by this Item is incorporated herein by reference from the Corporation's definitive proxy statement filed or to be filed with the Commission pursuant to Regulation 14A under the Act.\n- 8 - PAGE\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a)(1) and (2) List of Financial Statements and Financial Statement Schedules\nThe following consolidated financial statements of the Corporation and subsidiaries, included in the Corporation's Annual Report to Shareholders for the year ended December 31, 1994, are incorporated by reference 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 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.\n(a)(3) and (c) Exhibits\nThe following exhibits are included in response to Item 14(c). Management contracts and compensatory plans are indicated by an asterisk (*).\nExhibit No. Description Reference\n3-a Certificate of Incorporation, Exhibit 3-a to GEICO Corpo- as amended. ration's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n3-b Bylaws of GEICO Corporation, as Exhibit No. 3-b to GEICO amended. Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993\n4-a Specimen certificate representing Exhibit 6(c) to File the common stock, $1.00 par value. No. 2-63138 on Form S-14.\n(Copies of certain indentures, which in the aggregate do not represent securities worth as much as ten percent of the total consolidated assets of GEICO Corporation, will be furnished upon request.)\n9 Proxy Agreement between Berkshire Exhibit 9 to Form SE filed Hathaway Inc. and Sovran Bank\/ in connection with GEICO Maryland or its successors and Corporation's Annual Report assigns. on Form 10-K for the fiscal year ended December 31, 1986. - 9 - PAGE\n10-a* Form of Pension Plan for Non- Exhibit 10-a to GEICO Corpo- Employee Directors, as amended. ration's Annual Report on Form 10-K for the fiscal year ended December 31, 1988.\n10-b* Revised Stock Option Plan for Key Exhibit 10-b to GEICO Corpo- Employees of GEICO Corporation and ration's Annual Report on Its Subsidiaries (\"1992 Plan\"). Form 10-K for the fiscal year ended December 31, 1992.\n10-c* Form of Non-Qualified Stock Option Exhibit No. 10-c to GEICO Agreement under the 1992 Plan, as Corporation's Annual Report amended. on Form 10-K for the fiscal year ended December 31, 1993.\n10-d* Form of Incentive Stock Option Exhibit 10-d to GEICO Corpo- Agreement under the 1992 Plan. ration's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n10-e* Notice of Election to Exercise Exhibit 10-e to GEICO Corpo- Stock Options under the 1992 ration's Annual Report on Plan. Form 10-K for the fiscal year ended December 31, 1992.\n10-f* Revised Stock Option Plan for Key Exhibit 10-l to Form SE Employees of GEICO Corporation and filed in connection with Its Subsidiaries (\"1985 Plan\"). GEICO Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1986.\n10-g* Form of Non-Qualified Stock Option Exhibit 10-e to GEICO Corpo- Agreement under the 1985 Plan, ration's Annual Report as amended. on Form 10-K for the fiscal year ended December 31, 1989.\n10-h* Form of Incentive Stock Option Exhibit 10-g to GEICO Corpo- Agreement under the 1985 Plan. ration's Annual Report on Form 10-K for the fiscal year ended December 31, 1989.\n10-i* Form of Incentive Stock Option Exhibit 10-h to GEICO Corpo- Agreement with Stock Appreciation ration's Annual Report on Rights under the 1985 Plan. Form 10-K for the fiscal year ended December 31, 1989.\n- 10 - PAGE\n10-j* Notice of Election to Exercise Exhibit 10-o to Form SE Stock Options and\/or Stock filed in connection with Appreciation Rights under the GEICO Corporation's Annual 1985 Plan. Report on Form 10-K for the fiscal year ended December 31, 1985.\n10-k* Statement of 1994 Incentive Exhibit 10-l to GEICO Corpo- Bonus Program. ration's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n10-l* Statement of 1995 Incentive Page No. 29. Bonus Program.\n10-m* Deferred Compensation Plan, Exhibit 10-m to GEICO Corpo- as amended. ration's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n10-n* Performance Share Plan, as Exhibit 10-k to GEICO Corpo- amended. ration's Annual Report on Form 10-K for the fiscal year ended December 31, 1983.\n10-o* Equity Cash Bonus Plan. Page No. 30.\n13 Annual Report to Shareholders Page No. 34. for the year ended December 31, 1994 (only as to material specifically incorporated herein by reference).\n21 Subsidiaries of GEICO Corporation. Page No. 85.\n23 Consent of Accountants. Page No. 86.\n27 Financial Data Schedule Page No. 87. (Submitted as an exhibit pur- suant to the requirements of Item 601(b)(27) of Reg. S-K and not deemed filed for purposes of Section 11 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934.)\n28P Information from reports Exhibit 28P to Form SE furnished to state insurance filed in connection with regulatory authorities. GEICO Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1994.\n- 11 - PAGE\n99 Annual Report on Form 11-K for To be filed by amendment. the Revised Profit Sharing Plan for the Employees of the Govern- ment Employees Companies for the fiscal year ended December 31, 1994.\n(b) Reports on Form 8-K.\nGEICO Corporation did not file a report on Form 8-K during the three months ended December 31, 1994.\nThe following financial information is included in response to Item 14(d):\nReference\nReport of Independent Accountants Page No. 17.\nSchedule I - Summary of Investments - Other Than Investments in Related Parties Page No. 18.\nSchedule II - Condensed Financial Information of Registrant Page Nos. 19 - 22.\nSchedule III - Supplementary Insurance Information Page Nos. 23 - 24.\nSchedule IV - Reinsurance Page No. 25.\nSchedule V - Valuation and Qualifying Accounts Page No. 26.\nSchedule VI - Supplemental Information Concerning Property\/Casualty Insurance Operations Page Nos. 27 - 28.\nFinancial statements of unconsolidated affiliates and 50% or less owned persons accounted for by the equity method have been omitted because they do not, considered individually or in the aggregate, constitute a significant subsidiary.\n- 12 - PAGE\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGEICO CORPORATION\nMarch 31, 1995 By: \/s\/ W. Alvon Sparks, Jr. W. Alvon Sparks, Jr. Executive Vice President and Chief Financial Officer (Principal Financial Officer)\nMarch 31, 1995 By: \/s\/ Thomas M. Wells Thomas M. Wells Group Vice President and Controller (Principal Accounting Officer)\n- 13 - PAGE\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.\n\/s\/ Olza M. Nicely March 31, 1995 Olza M. Nicely Date President and Chief Executive Officer - Insurance Operations and Director (Co-Principal Executive Officer)\n\/s\/ Louis A. Simpson March 31, 1995 Louis A. Simpson Date President and Chief Executive Officer - Capital Operations and Director (Co-Principal Executive Officer)\n\/s\/ John H. Bretherick, Jr. March 31, 1995 John H. Bretherick, Jr. Date Director\n\/s\/ Norma E. Brown March 31, 1995 Norma E. Brown Date Director\n\/s\/ Samuel C. Butler March 31, 1995 Samuel C. Butler Date Director\n\/s\/ James E. Cheek March 31, 1995 James E. Cheek Date Director\n\/s\/ A. James Clark March 31, 1995 A. James Clark Date Director\n\/s\/ Delano E. Lewis March 31, 1995 Delano E. Lewis Date Director\n\/s\/ Coleman Raphael March 31, 1995 Coleman Raphael Date Director\n\/s\/ William J. Ruane March 31, 1995 William J. Ruane Date Director - 14 -\nSIGNATURES\n\/s\/ W. Alvon Sparks, Jr. March 31, 1995 W. Alvon Sparks, Jr. Date Director\n\/s\/ W. Reid Thompson March 31, 1995 W. Reid Thompson Date Director\n- 15 - PAGE\nANNUAL REPORT ON FORM 10-K\nITEM 14(d)\nFINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1994\nGEICO CORPORATION\nWASHINGTON, D. C.\n- 16 - PAGE\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo The Shareholders GEICO Corporation\nOur report on the consolidated financial statements of GEICO Corporation and subsidiaries has been incorporated by reference in this Form 10-K from page 27 of the 1994 Annual Report to Shareholders of GEICO Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page 12 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.\nAs discussed in Note A to the consolidated financial statements, GEICO Corporation changed its methods of accounting for postemployment benefits in 1994 and for income taxes, postretirement benefits other than pensions, and investments in debt securities in 1993.\nBy: COOPERS & LYBRAND L.L.P.\nWashington, D.C. February 17, 1995\n- 17 -\nSCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES\n(1) Fixed maturities at amortized cost and equity securities at original cost.\n- 18 - PAGE\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT GEICO CORPORATION (PARENT COMPANY) BALANCE SHEETS In Thousands\n(1) Eliminated in consolidation. See accompanying note to condensed financial statements. - 19 - PAGE\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT GEICO CORPORATION (PARENT COMPANY) STATEMENTS OF INCOME In Thousands\n(1) Eliminated in consolidation.\nSee accompanying note to condensed financial statements.\n- 20 - PAGE\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT GEICO CORPORATION (PARENT COMPANY) STATEMENTS OF CASH FLOWS In Thousands\n(1) Eliminated in consolidation. See accompanying note to condensed financial statements. - 21 - PAGE\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nGEICO CORPORATION (PARENT COMPANY)\nNOTE TO CONDENSED FINANCIAL STATEMENTS\nDecember 31, 1994\nThe condensed financial statements of GEICO Corporation (parent company) should be read in conjunction with the consolidated financial statements and notes thereto of GEICO Corporation and subsidiaries incorporated by reference in this Form 10-K Annual Report.\nIn 1994 the parent company received $133.0 million of dividends from its consolidated subsidiaries, consisting of $115.0 million of cash and $18.0 million of equity securities. In 1992 the parent company received $389.9 million of dividends from its consolidated subsidiaries, consisting of $232.9 million of cash, $68.8 million of equity securities and $88.2 million of the common stock of GEICO Indemnity Company, a consolidated subsidiary. The noncash portion of the dividends in 1994 and 1992 related to the acquisition of equity securities and the consolidated subsidiary are excluded from the parent company's statements of cash flows.\n- 22 - PAGE\nSCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION\nGEICO CORPORATION AND SUBSIDIARIES In Thousands\n- 23 -\nSCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION\nGEICO CORPORATION AND SUBSIDIARIES In Thousands\n(1) Includes interest on policyholders' funds of $3,972, $3,565 and $3,239 forthe years ended December 31, 1994, 1993 and 1992, respectively. - 24 - PAGE\nSCHEDULE IV - REINSURANCE\n* Includes premiums earned by life insurance and property\/casualty insurance subsidiaries. - 25 - PAGE\nSCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS\nGEICO CORPORATION AND SUBSIDIARIES In Thousands\n(1) Uncollectible Accounts Written Off, Net of Recoveries\n- 26 -\nPAGE\n- 27 - PAGE\n- 28 -","section_15":""}
{"filename":"70564_1994.txt","cik":"70564","year":"1994","section_1":"ITEM 1. Business\nNational-Standard Company, an Indiana corporation, and its subsidiaries (the \"Company\") have generally operated prior to 1992 in two business segments: (i) wire and related products and (ii) machinery and other products. As a result of divestitures prior to 1992, the Company currently operates in only the wire and related products segment.\nIn Fiscal Year 1994, there were no material changes to the Company's business. During the past three years, the Company disposed of various business units and product lines as described in the following report.\nWire and Related Products Segment\nThe Company produces tire bead wire, welding wire, wire cloth, hose reinforcing wire, stainless steel spring and specialty wire, plated wire, and nonwoven metal fiber materials. These products are generally sold directly to other manufacturers by Company salesmen. In addition, certain classes of wire are sold through various types of distributors.\nThe Company also produces filters for automotive air bag inflators, which are sold by Company salesmen to automotive air bag manufacturers.\nDuring 1994, the Company discontinued the manufacture of hose wire in North America and closed its Columbiana, Alabama facility. The North American hose wire market will be served from existing capacity available in the Company's Kidderminster, England facility. Sufficient bead wire manufacturing capacity to serve the Company's North American market has been relocated to the Company's other North American wire facilities. The Company provided $4,870,000 during the first quarter of 1994 for relocation of equipment, plant environmental stabilization, and employee severance. Approximately $2,700,000 of cash outlays related to the plant closure were made during 1994. Cash outlays during 1995 related to the closure are expected to be $700,000, primarily for plant environmental stabilization.\nIn 1993, the Company sold the Telford Wire Division, Telford, England and the Taydor Engineers business unit in Stourport, England. Proceeds of $1,344,000 were used to reduce its United Kingdom borrowings.\nWire and related products are supplied to major markets consisting of tire, air bag filtration, spring, automotive component, electric component, hydraulic hose, telecommunications, and fabricated metal products.\nDuring 1990, the Company entered into a joint venture with Toyota Tsusho America, Inc., and a group of Japanese wire weavers. The venture was established to ensure that the Company would have sufficient quantities of competitively priced woven wire cloth to maintain its position as a major\n- 3 -\nsupplier of filtration materials and filters for the automotive air bag market. During 1991, the venture was self-funding, requiring no cash contributions from the Company. During 1992, the Company contributed cash of $120,000 and equipment valued at $180,000 to the venture. No additional investments were made in the venture during 1993. During 1994, the Company announced that the joint venture would be expanded in 1995 to a second manufacturing site for the production of wire cloth for air bag inflator filters. This expansion is expected to be funded from the venture's operating cash flow and from external financing available to the venture. Future requirements will be dependent on market conditions.\nThe Company's wire products are generally highly competitive, with a number of other producers located both in the U.S. and in foreign countries. In some cases, the Company's customers are also manufacturing products for their own use similar to those produced by the Company. The Company remains the leading U.S. producer of tire bead wire for the tire industry. Bekaert Corporation, Delta Wire Corporation, and Amercord, Inc. are the Company s major bead wire competitors. The Company is the major supplier of air bag filtration materials in the U.S. While there are a limited number of manufacturers in the Company's line of filtration materials, the Company regards the field as highly competitive. Competitive factors for all of the Company s products are generally considered to be price, service and product quality.\nDuring 1994, the Company announced that additional air bag filter manufacturing capacity would be installed at a new leased facility in Mesa, Arizona early in 1995. The Company expects to spend approximately $800,000 for the additional capacity. This will be funded through available capital expenditure lines of credit.\nDuring 1993, the Company added air bag filter wire cloth weaving capacity at new leased facilities in Knoxville, Tennessee and Clearfield, Utah. In addition, certain air bag filtration products and manufacturing processes were relocated from the Corbin, Kentucky facility to the new facilities.\nAlthough wire and related products are generally basic materials or fabricated products which do not require assembly, production time is relatively short and backlog is not significant. There was a backlog of approximately $27,750,000 and $14,900,000 at September 30, 1994 and 1993, respectively.\nDuring 1988, the Company closed its strip steel and flat wire facility located in Clifton, New Jersey. Prior to 1992, the facility was included in the \"machinery and other products\" segment. During the past six years, the Company has undertaken to obtain New Jersey approval to transfer title for the property. Due to the environmental regulations in the State of New Jersey, title to real estate cannot be passed without the Department of Environmental Protection s written approval. This project has involved\n- 4 -\ndemolition of the buildings and continuing remediation of environmental problems from production wastes through use of an on-site landfill and off-site disposal. The cash outlays related to the property, which have been primarily environmental, were $285,000, $282,000, $380,000, $3,027,000, $712,000, and $3,028,000 in 1994, 1993, 1992, 1991, 1990, and 1989, respectively. These cash outlays, up to the estimated realizable value of the property, have been reported as other assets, with the balance charged to operations. In 1994, 1993, 1992, 1991 and 1990, the Company expensed $2,030,000, $0, $333,000, $3,898,000 and $2,933,000, respectively, associated with the project, primarily to adjust the property value to current market and to recognize the current estimated cost of soil remediation. The Company expects to spend $290,000 in 1995 on the project. Future cash outlays of approximately $2,469,000 will be needed prior to sale of the property. The Company intends to spend this amount in conjunction with or just prior to the sale.\nEnvironmental\nIn addition to amounts spent in connection with the Clifton, New Jersey facility, the Company had cash outlays of approximately $2,531,000 during the 1994 fiscal year, and $1,471,000 during the 1993 fiscal year on pollution control equipment and related operational environmental projects and procedures at the Company's seven U.S. plants. The largest annual cash outlays during 1994 and 1993 were $1,740,000 and $607,000, respectively, at the closed Columbiana facility, primarily for plant environmental stabilization in 1994, and environmental operational procedures in 1993. Compliance with federal, state, and local environmental regulations which have been enacted or adopted is estimated to require operational cash outlays of approximately $1,925,000 during 1995. In 1993, environmental expense provisions totaling $3,600,000 were recorded to (1) decommission hose wire plating equipment and dispose of hazardous materials normally used in the plating process, (2) provide for soil remediation at an unused fill site, and (3) provide for the closure of waste water surface impoundments which are no longer in use. The Company does not expect existing regulations will have any material effect on its net earnings or competitive position.\nThe Company has previously been designated a potentially responsible party (PRP) by the Environmental Protection Agency (EPA) for four actual or potential superfund sites, all of which have in excess of twenty other PRP's. The Company has completed or is undertaking all investigative work requested or required by the appropriate governmental agencies or by relevant statutes, regulations, or local ordinances at minimal out-of- pocket costs. In one instance, the Company has no record of participation at the site. In two instances, the Company's records indicate that it had only de minimus involvement. The Company has reviewed its involvement at the fourth site and has previously accrued $300,000 for its share of estimated site remediation based upon all information currently available.\n- 5 -\nThe Company does not believe future costs for these sites will have a materially adverse effect on the consolidated financial condition of the Company or its consolidated results of operations.\nGeneral\nThe Company's major raw material steel is purchased in several forms from domestic and foreign steel companies. Raw materials were readily available during the year and no shortages are anticipated for the 1995 fiscal year. The Company also purchases a variety of component parts for use in some of the products it manufactures. The Company believes that its sources of supply of these materials are adequate for its needs. The Company's major sources of energy needed in its operations are natural gas, fuel oil and electrical power. In certain locations where the Company believes its regular source of energy may be interrupted, it has made plans for alternative fuels.\nThe Company owns or is licensed under a number of patents covering various products and processes. Although these have been of value in the growth of the business and will continue to be of considerable value in its future growth, the Company's success or growth has not generally been dependent upon any one patent or group of related patents. The Company believes that the successful manufacture and sale of its products generally depend more upon its technological know-how and manufacturing skills. Seasonal activity has no material effect on the Company's level of business or working capital requirements. The Company's largest customers include the major producers of automotive air bag restraint systems, i.e., Morton International and TRW, and some of the major tire and rubber companies, i.e., the Cooper Tire and Rubber Company, the Dunlop Tire and Rubber Corporation (owned by Sumitomo), the Firestone Tire and Rubber Company (owned by Bridgestone), Gates Rubber Company, General Tire (owned by Continental), the Goodyear Tire and Rubber Company, and the Uniroyal-Goodrich Company (owned by Michelin). The Goodyear Tire and Rubber Company accounted for approximately 17%, and the ten largest customers, in the aggregate, accounted for approximately 62% of consolidated sales in the last fiscal year. Generally, business with these customers is on the basis of purchase orders without firm commitments to purchase specific quantities. No other material part of the Company's business is dependent upon any single customer or very few customers, the loss of which would have a material adverse effect upon the Company.\nDuring the 1994 fiscal year, the Company spent approximately $959,000 on research and development of new products and process alternatives compared to $982,000 and $994,000 for the years ended September 30, 1993 and 1992, respectively. These cash outlays are for Company sponsored activities.\nOnly three products, high carbon steel wire, low carbon steel wire, and air bag inflator filters, each account for 10% or more of total sales. High\n- 6 -\ncarbon and low carbon steel wire were, respectively, 38% and 21% of total sales in 1994; 51% and 20% of total sales in 1993; and 51% and 21% of total sales in 1992. Air bag inflator filters accounted for 12% of total sales in 1994, and less than 10% in prior years.\nDuring 1993, the Company experienced work stoppages by the United Steelworkers of America at the Niles, Michigan; Corbin, Kentucky; and Columbiana, Alabama plants. The Niles and Corbin strikes were settled during 1993 with modified health care benefits similar to the health benefits for salaried employees. The Columbiana plant was closed on June 1, 1994, and certain production equipment was relocated to other Company facilities. The Company continued to supply product during the work stoppages. Additional costs, including security services, additional wages, and air freight, were approximately $4,500,000 for the three work stoppages in 1993, and $4,266,000 for the work stoppage in Columbiana in 1994. Additionally, in 1993, as a result of the work stoppage in Columbiana, the Company discontinued hose wire plating in North America and wrote down the value of its hose wire plating equipment by $909,000.\nAt September 30, 1994, the Company employed 1,282 persons in its operations throughout the world.\nDuring 1993, the Company elected early adoption of The Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 106, \"Accounting for Postretirement Benefits Other than Pensions.\" The one-time transition obligation recognized at the time of adoption was $48,676,000. Primarily as a result of this accounting change, the Company has a negative net worth of $28,266,000.\nInternational Operations\nThe Company has foreign subsidiaries in Canada and the United Kingdom which are similar to certain of the Company's domestic operations and with generally the same markets. The financial information about foreign and domestic operations for the three years ended September 30, 1994 is included in Note 13 of Notes to Consolidated Financial Statements in Item 8, \"Financial Statements and Supplementary Data\" section of this Report (incorporated herein by this reference). Foreign operations are subject to the usual risks of doing business abroad, such as possible devaluation of currency, restrictions on the transfer of funds and, in certain parts of the world, political instability.\nAccounting principles dictate that results of operations for the Company's international operations are translated into U.S. dollars in accordance with the Statement of Financial Accounting Standards No. 52. A translation adjustment is recorded as a separate component of shareholders' equity, \"Cumulative Translation Adjustment.\" The Cumulative Translation Adjustment account, at the end of 1994, reflects a slight decrease of approximately\n- 7 -\n$300,000. This minor change is due to the U.S. dollar's position against the British pound and the Canadian dollar remaining substantially unchanged since the end of 1993. The change in exchange rates does not have a materially adverse effect on the cash flow of the international operations.\nIn October 1992, the Company sold its interest in its foreign affiliate in India, receiving $693,000 in net proceeds, which was used to reduce debt. A loss of $1,041,000 net of the 1992 equity in earnings of $165,000 was recorded at September 30, 1992 in anticipation of this transaction. The Company's accounts reflect its share of these results at the close of the fiscal year of this affiliate as other income.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Company conducts its domestic operations from facilities having an aggregate floor space of approximately 1,176,000 square feet. The domestic total includes principal facilities in Niles, Michigan (456,000 square feet); Stillwater, Oklahoma (314,000 square feet); Corbin, Kentucky (225,000 square feet); Mishawaka, Indiana (78,000 square feet); Knoxville, Tennessee (50,000 square feet); and Clearfield, Utah (53,000 square feet). The Knoxville and Clearfield facilities were leased in 1993 for five-year terms with renewal options.\nThe Company also operates from principal facilities in England (260,000 square feet) and Canada (107,000 square feet).\nThe majority of the Company's plants are of modern construction and the remaining older plants are well maintained and considered adequate for their current use. Manufacturing of wire and wire related products is conducted at all Company facilities. The Company's plants generally are operated on a multishift basis and, while particular plants may be operating at capacity levels, overall the Company's facilities are adequate to provide for a significant increase in unit volume due to the Company's ability to redistribute production of similar products between Company facilities with minimal cost or inconvenience.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Company is not involved in any material pending 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 since the last annual meeting held January 27, 1994.\nITEM 4A. Executive Officers of the Registrant (Furnished in accordance with Item 401(b) of Regulation S-K, pursuant to General Instruction G(3) of Form 10-K)\n- 8 -\nThe following table sets forth certain data concerning the Executive Officers of the Registrant, all of whom are elected annually by the Board of Directors. Some of the Officers of the Registrant also serve as Directors or Officers of the subsidiaries.\nAll of the above-named officers of the Registrant have been employees of the Company for more than five years.\n- 9 -\nPART II. ITEM 5.","section_5":"ITEM 5.Market for the Registrant's Common Equity and Related Shareholder Matters\nCommon stock market prices, information on stock exchanges and number of shareholders is included in Note 14 of Notes to Consolidated Financial Statements in Item 8, \"Financial Statements and Supplementary Data\" section of this Report (incorporated herein by this reference). No dividends were paid during fiscal 1994 or 1993, nor during the portion of fiscal 1995 prior to filing of this Report. Under current loan agreements, the Company is restricted from paying any dividends. Future dividends will be based on the Company's financial performance.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data (In thousands, except per share and employee 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. Specifically, discussions regarding accounting changes, divestitures, and other related information that affects the comparability of this data can be found in Items 7, 8, and 14 herein.\n- 11 -\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Dollars in thousands except share data)\nResults of Operations\nNet sales for the year of $217,916 were 4.6% above 1993, as sales of air bag inflator filtration products increased 68% over 1993 due to the significant growth of that market segment and the Company's position as the leading supplier of those materials in North America. The Company's weld wire product lines experienced 15% growth over 1993 due primarily to improving North American automotive sales. These increases were offset by a decline in hose wire sales as the Company ceased the manufacture of hose wire in North America during 1993, and a decline in bead wire sales due to the impact of the work stoppage at Columbiana early in 1994 and work stoppages at customer facilities at the end of 1994.\nNet sales for 1993 of $208,254 were 3.2% below 1992 and 10.5% below 1991 due to business units sold during 1992 and 1991. During 1993, the Company experienced increased demand for its air bag materials and weld wire product lines. 1993 sales in those product lines increased 51% and 11%, respectively, over 1992. Sales of hose wire decreased 22% due to the work stoppage in Columbiana, Alabama and subsequent discontinuation of hose wire plating in North America. During 1992, sales for remaining operations increased 6% due to increased sales of air bag filtration materials and welding wire. Growth in both products is expected to continue for at least the next several years.\nOver the past several years, the Company's strategy has been to focus on a core wire business and to develop the air bag filtration materials business. This strategy has led to the divestiture of the non-core specialty wire business and all of its non-wire related businesses. Proceeds from the divestitures have been utilized to fund investment in the remaining business and to reduce debt. Since September 30, 1990, debt has been reduced $15,710 and the air bag filtration materials sales have increased 161%. The effect of the divestiture activities on the Company's sales and gross margins is shown in the following table:\nGross profit margins change due to several factors. For the Company, the most significant factor is the level of sales and production. As production increases, a relatively lower level of fixed costs is associated with each unit, and the gross profit percentage increases. Similarly, as volume falls, fewer units are available to cover the fixed costs of manufacturing and the profit percentage decreases. In addition to volume, changes in product mix, selling prices, and costs also affect the gross margins. Although it would appear that prior to 1992 the divested businesses were more profitable than the remaining operations, these businesses increasingly required substantially higher selling and administrative expense and significant levels of working capital that, even considering the higher gross margins, resulted in lower net returns. The margin effect of divesting these businesses is shown in the table above. The effect of the increased selling and administrative costs of the divested businesses is reflected in the divested operations line in the table on page 11.\nDuring 1993, the Company experienced work stoppages by the United Steelworkers of America at the Niles, Michigan; Corbin, Kentucky; and Columbiana, Alabama plants. The Niles and Corbin strikes were settled during 1993 with modified health care benefits similar to the health benefits for salaried employees. The Columbiana plant was struck on June 1, 1993. The plant operated during the remainder of 1993 and through May 1994 with replacement workers and personnel from other Company facilities. The Company continued to supply product during the work stoppages. Additional costs including security services, additional wages, and air freight were approximately $4,500 for the three work stoppages in 1993. In addition, as a result of the work stoppage in Columbiana, the Company discontinued hose wire plating in North America in 1993 and wrote down the value of its hose wire plating equipment by $909.\nDuring 1994, the additional costs of operating the Columbiana facility including security services, additional wages, and freight were approximately $4,266. In addition, during 1994, the Company provided $4,870 for the closure of the Columbiana plant. The closure provision is included in selling and administrative expense as noted on page 11.\nDuring 1992, margins improved based upon the higher sales of the Company's core wire products and its air bag filtration materials business.\nThe political changes that occurred in the Eastern Bloc countries had a negative effect on business activity, and a general slowdown in the\n- 13 -\nCompany's Western European markets caused a 10% decline in volume of major product lines between 1990 and 1992. This decline caused capacity in international operations to be under-utilized in 1992. During 1993, sales to other worldwide markets from international operations increased 8%, resulting in better capacity utilization and improved operating results. During 1994, sales from international operations decreased 5% as new worldwide capacity was added in Copperply and bead wire and aggressive pricing affected bead and hose wire.\nIn recent years, the Company has not been able to raise prices in line with inflation and rising raw material costs due to the effects of worldwide overcapacity in the Company's major product lines and competitive pressure in the Company's automotive markets. Since 1989, inflation as measured by the Consumer Price Index has risen 20%, while average selling prices have risen only 7%. Had selling prices increased 20%, sales in 1994 would have been approximately $246,000.\nIn 1993, the Company sold the Telford Wire Division and Taydor Engineers business units in England. Proceeds of $1,344 were used to reduce its United Kingdom borrowings.\nIn 1993, environmental expense provisions totaling $3,600 were recorded to: (1) decommission hose wire plating equipment and dispose of hazardous materials normally used in the plating process, (2) provide for soil remediation at an unused fill site, and (3) provide for the closure of waste water surface impoundments which are no longer in use. In 1994, additional environmental expense provisions of $700 relating to the disposal of hazardous materials normally used in the hose wire plating process were recorded.\nDuring 1994 and 1993, the Company provided $2,832 and $4,651, respectively, for the estimated cost of compliance with environmental regulations and continuing modifications in operating requirements. The majority of the 1994 provisions were made in the Company's first quarter and are related to the closing of the Columbiana facility. The majority of the 1993 provisions were made in the Company's fourth quarter as a result of an expansion of clean-up operations and changes in estimated costs to complete. In addition to the amounts charged to earnings, $165 and $142 of costs were capitalized in the respective years. The Company's actual environmental related cash outlays for 1994 and 1993 were $2,816 and $1,753, respectively, of which $285 and $282 were spent on the Clifton, New Jersey property.\nThe Company has previously been designated a potentially responsible party (PRP) by the Environmental Protection Agency (EPA) for four actual or potential superfund sites, all of which have in excess of twenty other PRP's. The Company has completed or is undertaking all investigative work requested or required by the appropriate governmental agencies or by\n- 14 -\nrelevant statutes, regulations, or local ordinances at minimal out-of- pocket costs. In one instance, the Company has no record of participation at the site. In two instances, the Company's records indicate that it had only de minimus involvement. The Company has reviewed its involvement at the fourth site and has previously accrued $300 for its share of estimated site remediation based upon all information currently available. The Company does not believe future costs for these sites will have a materially adverse effect on the consolidated financial condition of the Company or its consolidated results of operations.\nThe Company has reviewed its current projects which are expected to be completed in 1995 and all environmental regulations and acts to ensure continuing compliance. In 1995, the Company expects to spend $290 on the Clifton, New Jersey project. Future cash outlays of approximately $2,469 will be needed prior to sale of the property. These amounts have already been accrued for financial statement purposes. Additionally, the Company expects to spend $1,925 on environmentally related capital and operational projects, of which $625 will be charged against 1995 earnings.\nIn 1989, in response to expected market changes, the Company adopted a strategy that included, among other things, the decision to exit non- strategic and\/or non-profitable businesses and to continually adapt general and administrative cost levels to the changing business.\nIn 1994, 1993, and 1992, $6,955, $2,390, and $2,677, respectively, the net cost of restructuring the Company in those years, including net loss on sale of fixed assets and product lines of $0, $196, and $1,451, respectively; the write-off of nonproductive facilities and obsolete inventory of $4,219, $909, and $681, respectively; severance costs of the salaried and hourly workforce, and provision for transferring manufacturing of certain product lines between plants, is included in selling and administrative costs. The 1994 net cost of restructuring also included $1,700 for the Columbiana plant environmental stabilization. The Company will incur no further material cash outflows related to the restructuring.\nThe following summary shows the changing level of selling and administrative expense and identifies selling and administrative expense directly attributable to divested operations and amounts attributable to restructuring activities.\nThe net effect of all the above elements is seen in the Company's operating profit (loss).\nOperating profit by Geographic Area is presented in Note 13 of Notes to Consolidated Financial Statements in Item 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe Report of Independent Auditors, Consolidated Financial Statements and Supplementary Schedules are set forth on pages 15 to 37 of this Report and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. Disagreements on Accounting and Financial Disclosure\nNot applicable.\n- 18 -\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant Identification of Directors\nInformation in respect of Directors as set forth under the caption \"Election of Directors\" in the annual Proxy Statement relating to the Annual Meeting of Shareholders scheduled for January 26, 1995 is incorporated herein by reference.\nIn respect of information as to the Company's Executive Officers, see the caption \"Executive Officers of the Registrant\" at the end of Part I of this report.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe information set forth under the caption \"Organization and Remuneration of the Board\" and the information relating to Executive Officers' compensation in the annual Proxy Statement relating to the Annual Meeting of Shareholders scheduled for January 26, 1995 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 captions \"Stock Ownership of Certain Beneficial Owners and Management\" and \"Election of Directors\" in the annual Proxy Statement relating to the Annual Meeting of Shareholders scheduled for January 26, 1995 is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nThe information set forth under the caption \"Information Regarding Other Transactions\" in the annual Proxy Statement relating to the Annual Meeting of Shareholders scheduled for January 26, 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) The following documents are filed as part of this report:\n1. Financial Statements and Schedules\nThe financial statements and schedules listed in the accompanying Index to Consolidated Financial Statements and Schedules are filed as part of this report.\n- 19 -\n2. Exhibits\nThe exhibits listed in the accompanying Exhibit Index and required by Item 601 of Regulation S-K (numbered in accordance with Item 601 of Regulation S-K) are filed or incorporated by reference as part of this Report.\n(b) There were no reports on Form 8-K filed during the three months ended September 30, 1994.\n- 20 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, National-Standard Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNATIONAL-STANDARD COMPANY\n\/s\/ Michael B. Savitske\nMichael B. Savitske President and Chief Executive Officer, Director\n\/s\/ William D. Grafer\nWilliam D. Grafer Vice President, Finance (Principal Financial and Accounting Officer)\nDated: December 1, 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:\nHAROLD G. BERNTHAL Director ) DAVID F. CRAIGMILE Director )-By: \/s\/ Rene J. VanSteelandt JOHN E. GUTH, JR. Chairman of the Board ) Rene J. VanSteelandt ERNEST J. NAGY Director ) Attorney-in-Fact CHARLES E. SCHROEDER Director ) DONALD F. WALTER Director ) December 1, 1994\n- 21 -\nNATIONAL-STANDARD COMPANY\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\n___________________________________________________________________________\nPage Reference in Report on Form 10-K ___________________________________________________________________________\nConsolidated Statements of Operations for the years ended September 30, 1994, 1993, and 1992 16\nConsolidated Statements of Shareholders' Equity for the years ended September 30, 1994, 1993, and 1992 17\nConsolidated Balance Sheets at September 30, 1994 and 1993 18\nConsolidated Statements of Cash Flows for the years ended 19 September 30, 1994, 1993, and 1992\nNotes to Consolidated Financial Statements 20-31\nReport of Independent Auditors 32\nSchedules: V. Property, Plant and Equipment 33 VI. Accumulated Depreciation of Property, Plant and Equipment 34 VIII. Valuation and Qualifying Accounts 35 IX. Short-Term Borrowings 36 X. Supplementary Income Statement Information 37\nSchedules other than those listed above have been omitted from this Annual Report because they are not required, are not applicable, or the required information is included in the consolidated financial statements or the notes thereto.\n- 22 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands Except Share Data)\nSee accompanying notes to consolidated financial statements.\n- 23 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Dollars in Thousands except Share Data)\nSee accompanying notes to consolidated financial statements.\n- 26 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (Dollars in Thousands except Share Data)\nSee accompanying notes to consolidated financial statements.\n- 27 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands except Share Data)\nSee accompanying notes to consolidated financial statements.\n- 29 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands except Share Data)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES Principles of Consolidation - The consolidated financial statements include the Company and all its subsidiaries (\"Company\"). Intercompany accounts and transactions have been eliminated in the consolidated financial statements. The Company's 50 percent investment in a domestic joint venture is carried at equity in underlying net assets. The Company's share of operations of this affiliated company is not material.\nRevenue Recognition - The Company's policy is to record sales when the product is shipped.\nTranslation of Currencies - The Company complies with the provisions of Statement of Financial Accounting Standards (SFAS) No. 52, \"Foreign Currency Translation.\" In the application of this accounting standard, exchange adjustments resulting from foreign currency transactions are recognized currently in income. Adjustments resulting from the translation of financial statements are reflected as a separate component of shareholders' equity.\nInventories - Inventories are stated at lower of cost or replacement market. Cost for the material content of domestic steel inventories is determined on the last-in, first-out (LIFO) method; the cost for other inventories is determined on the first-in, first-out (FIFO) method.\nProperty, Plant and Equipment - Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets. For tax purposes, depreciation has generally been computed on a straight-line basis over prescribed lives.\nResearch and Development - Research and development costs are expensed currently. The Company expended $959, $982 and $994 in 1994, 1993 and 1992, respectively, on research and development activities.\nEarnings Per Share - Earnings per share are based on the average number of shares of common stock outstanding during the year plus common stock equivalents for the dilutive effect of shares of common stock issuable upon the exercise of certain stock options. Nonleveraged unallocated shares in the Company Employee Stock Ownership Plan are not considered outstanding for purposes of calculating earnings per share. Common shares used in calculating earnings per share for 1994, 1993, and 1992 were 5,365,000, 5,085,000, and 4,379,000, respectively.\n- 30 -\nStatement of Cash Flows - For purposes of the 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.\nIncome Taxes - In February 1992, the Financial Accounting Standards Board (FASB) issued SFAS No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 requires a change from the deferred to the liability method of computing deferred income taxes. Under the liability method, deferred income taxes are generally determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax assets are recorded when it is more likely than not that such tax benefits will be realized.\nEffective October 1, 1992, the Company elected early adoption of SFAS No. 109. The adoption of SFAS No. 109 had no effect on the financial statements of the Company.\nPostretirement Benefits Other than Pensions - In December 1990, the FASB issued SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" SFAS No. 106 requires that the cost of postretirement benefits be recognized during an employee's years of service versus on a pay-as-you-go basis upon retirement. SFAS No. 106 was not required to be adopted by the Company until fiscal 1994; however, early adoption was elected effective October 1, 1992.\nReclassification - Certain 1993 and 1992 amounts in the Consolidated Financial Statements have been reclassified to conform with 1994 presentation.\n2. INVENTORIES\nThe material content of domestic steel inventories amounting to $13,854 and $10,877 at September 30, 1994 and 1993, respectively, is valued on a LIFO basis. Had the FIFO method been used, inventory would have been $4,009 and $3,909 higher than that reported at September 30, 1994 and 1993, respectively.\n3. PROPERTY, PLANT AND EQUIPMENT\nThe Company capitalized interest cost of $168 in 1994 and $100 in 1993 with respect to qualifying construction projects. Total interest cost incurred before recognition of the capitalized amounts was $4,053 and $3,842 in 1994 and 1993, respectively.\n4. RETIREMENT BENEFITS\nThe Company and its subsidiaries have several pension plans covering substantially all employees, including certain employees in foreign countries. The Company's policy is to fund the net periodic pension cost accrued for each plan year, but not more than the maximum deductible contribution nor less than the minimum required contribution.\nThe following table sets forth the pension plans' funded status and amounts recognized in the Company's consolidated balance sheet at September 30, 1994 and 1993:\nNet pension cost related to Company-sponsored plans included the following components:\nThe weighted average discount rate and rate of increase in future compensation levels used in determining the 1994 actuarial present\n- 33 -\nvalue of the projected benefit obligation were 8.75% and 5%, respectively, for U.S. plans. The 1993 rates were 7.75% and 5%, respectively. The 1994 and 1993 rates for foreign plans were 9% and 7%, respectively. The 1994 and 1993 expected long-term rate of return on assets was 10.5% for U.S. plans and 10% for foreign plans.\nIn August of 1992, the Internal Revenue Service temporarily waived the minimum funding standard for certain of the Company's domestic defined benefit pension plans for plan years ending December 31, 1990 and 1991. These waivers were granted in accordance with Section 412(d) of the Internal Revenue Code and Section 303 of the Employee Retirement Income Security Act of 1974. The Company made contributions to the plans in 1992 of $1,460. During 1993, the Company contributed $765 to the plans. In January 1993, the Company contributed 844,513 shares of previously authorized and unissued common stock valued at $2,745. The Company's pension plans owned shares of the Company's common stock representing slightly less than 10% of the plans' asset value immediately after the January 1993 contribution. The Company made contributions to the plans in 1994 of $238. The plans currently own 1,476,779 shares of the Company's common stock. The Company has made the contributions necessary to fully fund several of the plans which previously received funding waivers. For those plans with remaining waiver amortization bases, the Company intends to comply with all conditions of the waivers, including elimination of the waiver amortization bases in installments through 1996.\nThe Company has an Employee Stock Ownership Plan (ESOP) for its eligible domestic employees. The amount of Company contributions made to the ESOP and charged to expense was $248 for 1994, $1,191 for 1993, and $1,117 for 1992.\n5. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company provides certain health care and life insurance benefits for all eligible retirees. Eligible retirees include salaried retirees and certain groups of collectively bargained retirees. The health care plan is contributory, with all future retirees' and current salaried retirees' contributions subject to an annual indexing. The Company funds the cost of these benefits on a claims-paid basis which totalled $2,794 for 1994, $3,500 for 1993, and $2,465 for 1992.\nExcluding the one-time transition charge of $48,676 in 1993, the adoption of SFAS No. 106 effective October 1, 1992 had the effect of increasing the Company's net loss by $753 for 1993.\nThe following table sets forth the plan's funded status, reconciled with amounts recognized in the Company's consolidated balance sheet at September 30, 1994 and 1993:\n- 34 -\nThe accrued postretirement benefit cost includes approximately $3,000 and $4,150 of expected 1995 and 1994 payments, respectively, that are included in the balance sheet as a current liability.\nNet periodic postretirement benefit cost included the following components:\nFor measurement purposes, a 10% 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 5% for 2000 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 September 30, 1994 by $3,047 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year then ended by $434.\nThe 1994 and 1993 weighted-average discount rates used in determining the accumulated postretirement benefit obligation were 8.75% and 7.75%, respectively. The weighted-average discount rates used in determining the 1994 and 1993 net periodic postretirement benefit cost and the transition obligation were 7.75% and 8.25%, respectively.\n- 35 -\n6. OTHER ASSETS\nIn 1994, the Company closed its Columbiana, Alabama facility and is continuing its preparation for sale.\nDuring the past six years, the Company has undertaken a project to obtain New Jersey approval to transfer title for property it owns in Clifton, New Jersey. This project has involved demolition of the buildings and continuing environmental remediation from production wastes through use of an on-site landfill and off-site disposal. Cash outlays, primarily related to the remediation, have been capitalized to the extent that, when added to the estimated costs to complete the project, they do not exceed the estimated realizable sale value of the property. In 1994, 1993, and 1992, the Company expensed $2,030, $0, and $333, respectively, associated with the project.\n7. DEBT\nThe existing debt agreements are collateralized by substantially all assets and contain, among other things, provisions as to the maintenance of working capital and net worth, restrictions on cash dividends, redemptions of Company stock and incurrence of indebtedness. The revolving credit arrangement provides for maximum borrowing levels based on a percentage of qualified accounts receivable and inventory. Substantially all cash is restricted under existing debt agreements.\nAggregate maturities on long-term debt, based upon the credit agreements for the three fiscal years subsequent to September 30, 1995, amount to $2,992 in 1996, $31,311 in 1997, and $25 in 1998. There are no maturities extending beyond 1998.\n8. LEASES\nMinimum rental commitments under noncancellable operating leases, primarily machinery and equipment, in effect at September 30, 1994 were:\n1995 . . . . . . . . . . . . $ 3,983 1996 . . . . . . . . . . . . 3,156 1997 . . . . . . . . . . . . 2,249 1998 . . . . . . . . . . . . 1,695 1999 . . . . . . . . . . . . 1,183 Later years . . . . . . . . 0\nOperating lease rental expense was $2,626 in 1994, $2,485 in 1993, and $2,228 in 1992.\n9. INCOME TAXES\nThe domestic and foreign components of earnings (loss) before income taxes are as follows:\nThe provisions (benefits) for income taxes are as follows:\nAt September 30, 1994, the Company had tax loss carryforwards of $34,800 in the United States, $6,900 in the United Kingdom and $2,100 in Canada. The United Kingdom carryforward period is unlimited; however, if not utilized to offset future taxable income, $1,000 of the United States loss will expire in 2001, $8,900 in 2002, $3,500 in 2004, $8,100 in 2005, $12,400 in 2006, and $900 in 2008. The period for utilizing the majority of the Canadian loss will expire in 1996.\nAt September 30, 1994, and after giving full effect to the 35% post-1986 investment tax credit reduction required by the Tax Reform Act of 1986, the Company has total United States tax credit carryforwards of approximately $1,400, which expire as follows: 2000, $700; 2001, $500; 2002, $100; and 2003, $100.\nA reconciliation of differences between taxes computed at the federal statutory rate and the actual tax provisions is as follows:\nThe net deferred tax asset included the following components:\nThe undistributed earnings of foreign subsidiaries amounting to $2,491 are intended to be reinvested; however, those earnings remitted to the parent company should have little or no additional tax under relevant current statutes.\n10. OTHER INCOME (EXPENSE), NET\nThe 1992 foreign affiliate expense is the loss on the sale of the Company's interest in its Indian affiliate. This charge represents the cumulative decline in the value of the Company's investment due to the effects of foreign exchange rate fluctuations; $599 of the 1992 loss had previously been reported as adjustments to shareholders' equity within the cumulative translation adjustment account.\n11. LITIGATION\n- 39 -\nThe Company is involved in certain legal actions and claims arising in the ordinary course of business. After taking into consideration legal counsel's evaluation of such actions, management is of the opinion that their outcome will not have a material effect on the Company's consolidated financial statements.\n12. COMMON STOCK The status of the stock option plans which provide for the purchase of the Company's common stock by officers and key employees is summarized as follows:\nThe Long-Term Incentive Plan, under which all options were previously granted, expired September 17, 1990; however, during 1993, the National-Standard Stock Option Plan (the \"1993 Plan\") was approved. The 1993 Plan allows the Compensation Committee of the Board of Directors, which consists of four members who are not executive employees of the Company, to select employees who will be granted options to purchase shares of common stock at the fair market value on the date of grant. Under the 1993 Plan, 450,000 shares is the maximum amount available to be issued upon the exercise of options, and the term of each option is ten years from the date of the grant. During 1993, 320,500 options were granted to a group of 23 key management employees. The exercise price is $8-5\/8 for all options granted in 1993.\nA Restricted Stock Award Program (\"Plan\") was established in 1989. The Plan provides for grants of shares of common stock to selected\n- 40 -\nemployees, subject to forfeiture if employment terminates prior to the end of the prescribed restricted period. Such stock shall be made available from authorized and unissued shares of common stock or treasury stock of the Company. However, the maximum number of shares that may be issued at any time under the Plan is 250,000. At September 30, 1994, certain employees held 19,000 shares of restricted common stock of the Company. Awards for 8,500 of these shares were granted in 1994, with 1,000 subsequently vesting or being forfeited. The amount of compensation represented by the grant of restricted stock is amortized over a four-year vesting period.\nAll stock options outstanding at September 30, 1994 are currently exercisable.\n13. SEGMENT INFORMATION\nThe Company currently operates in one industry segment: Wire and Related Products.\nThe Wire and Related Products Segment manufactures and sells various types of wire used mainly by other manufacturers in their products. The major use of the wire is for reinforcing tires and other rubber products. The Segment also produces wire cloth and filters for automotive air bag inflators for the air bag manufacturing industry.\nPrior to 1992, the Company also operated in a Machinery and Other Products Segment. During 1991, the Company sold its tire drum and mold business located in Germany and its machinery business located in the United States, both of which made up the largest share of this segment in 1991. These divestitures and the reclassification of the air bag inflator filter business to the Wire and Related Products Segment have resulted in the Company no longer reporting a Machinery and Other Products Segment.\nThe Company operates its business segments primarily in two geographic areas -- United States and Europe. Due to its nature and relative immateriality, the operation in Canada has been combined with the operations in Europe and the combined total reported as foreign operations.\nIntersegment sales are billed at approximate market prices and are eliminated in consolidation. Sales to unaffiliated customers include the sales to one customer by both geographic areas in the total amount of $38,038 in 1994, $42,292 in 1993, and $40,946 in 1992.\nOperating profit is total sales less operating expenses and does not include general corporate expenses, interest, equity in income of affiliate, loss on sale of subsidiary, and income taxes. General\n- 41 -\ncorporate expense includes certain nonrecurring costs. Included in 1994, 1993 and 1992, respectively, are approximately $6,955, $2,390, and $2,344 of costs associated with divestitures and restructuring. Included in the divestiture and restructuring costs in 1994 and 1992, respectively, are $2,030 and $333 for costs associated with the Athenia Steel property project in Clifton, New Jersey. The information reported for geographic areas necessarily includes allocations of shared expenses and the cost of assets. Assets not identified to geographic areas are principally cash and investments.\nThe net assets of foreign subsidiaries included in the consolidated figures at appropriate rates of exchange are as follows:\n- 42 -\n14. QUARTERLY FINANCIAL DATA (UNAUDITED)\nCommon stock market prices are as reported in The Wall Street Journal. Common stock is traded on the New York Stock Exchange.\nAt September 30, 1994, there were 2,564 shareholders.\n- 43 -\nIndependent Auditors' Report\nThe Board of Directors National-Standard Company:\nWe have audited the consolidated financial statements of National-Standard Company 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 examinining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 National-Standard Company 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.\nAs discussed in note 1 to the consolidated financial statements, 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,\" in 1993.\nKPMG Peat Marwick LLP\nChicago, Illinois November 8, 1994\n- 44 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES\nSCHEDULE V PROPERTY, PLANT AND EQUIPMENT Years Ended September 30, 1994, 1993 and 1992\n- 45 -\n(1) Generally the rates of depreciation range from 7% to 12.5% for land improvements, 2% to 4% for buildings, 5% to 12.5% for machinery and equipment, 10% to 25% for automobiles and trucks and 10% to 16.7% for furniture and fixtures. (2) There are reclassifications within the various categories.\n- 46 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES\nSCHEDULE VI ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT Years Ended September 30, 1994, 1993 and 1992\n(1) There are reclassifications within the various categories.\n- 47 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES\nSCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS Years Ended September 30, 1994, 1993 and 1992\n- 48 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES\nSCHEDULE IX SHORT-TERM BORROWINGS\nNotes:\nShort-term borrowings during the years covered by this schedule consisted of amounts payable to banks for borrowing.\nThe weighted average interest rate during the year was computed by dividing the total interest on short-term borrowings by the monthly average of short-term borrowings outstanding.\n- 49 -\nNATIONAL-STANDARD COMPANY AND SUBSIDIARIES\nSCHEDULE X SUPPLEMENTARY INCOME STATEMENT INFORMATION For the Years Ended September 30, 1994, 1993 and 1992\n- 50 -\nNATIONAL-STANDARD COMPANY\nINDEX TO EXHIBITS\nExhibit (3)(i) Articles of Incorporation.\n(3)(ii) By-Laws.\n(10) Material Contracts.\n(a) Management Contracts and Remunerative Plans.\n(i) National-Standard Company Restricted Stock Award Plan (incorporated by reference to Exhibit (10)(a) to Registrant's Quarterly Report on Form 10-Q for the first quarter of 1989 filed January 30, 1989).\n(ii) National-Standard Company Supplemental Retirement Plan (incorporated by reference to Exhibit (10)(a)(ii) to Registrant's Annual Report on Form 10-K for 1991, filed January 31, 1992).\n(iii) National-Standard Spouse's Benefit Plan for Salaried Employees (incorporated by reference to Exhibit (10)(a)(iii) to Registrant's Annual Report on Form 10-K for 1991, filed January 31, 1992).\n(iv) Amended and Restated Supplemental Compensation Agreements (incorporated by reference to Exhibit (10)(a)(iv) to Registrant's Annual Report on Form 10-K for 1992, filed February 23, 1993).\n(v) Deferred Compensation Plan.\n(vi) National-Standard Stock Option Plan (incorporated by reference to Exhibit A to Registrant's annual Proxy Statement relating to the Annual Meeting of Shareholders held May 19, 1993, filed April 15, 1993).\n(b) Loan and Security Agreement by and between National-Standard Company and Foothill Capital Corporation dated as of May 24, 1994 (incorporated by reference to Exhibit (10) to Registrant's Quarterly Report on Form 10-Q for the third quarter of 1994, filed August 5, 1994).\n(11) Statement Regarding Earnings Per Share Calculation.\n- 51 -\n(21) Subsidiaries of National-Standard Company.\n(23) Consent of Independent Auditors.\n(24) Powers of Attorney.\n(27) Financial Data Schedule.\n- 52 -","section_15":""}
{"filename":"310764_1994.txt","cik":"310764","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal owned domestic facilities are located in Kalamazoo and Portage, Michigan. A 190,000 square foot Portage facility completed in 1992 houses manufacturing (80,000 square feet) and warehousing and distribution (25,000 square feet) for surgical instrument products, with the remaining portion of the facility used for Division offices. The Medical Division is located in two facilities, one in Portage which was completed in 1985 and contains manufacturing and warehousing (122,000 square feet) and Division offices (23,000 square feet), and another in Kalamazoo which contains manufacturing and warehousing (64,000 square feet) and offices (22,000 square feet). The Medical Division also leases 20,000 square feet of warehousing space in Kalamazoo.\nThe Company leases 185,000 square feet in an industrial park in Allendale, New Jersey for its orthopaedic implant business; 56,000 square feet in San Jose, California for its endoscopic systems business; 28,000 square feet in Clackamas, Oregon for production of maternity beds and furniture; 20,000 square feet in St. Louis, Missouri for its Medical service business; and 65,000 square feet in Arroyo, Puerto Rico for the assembly of disposable tubing sets and other manufacturing. The Company's 135 physical therapy clinics are all located in leased offices.\nThe Company's subsidiary, Matsumoto Medical Instruments, Inc. maintains its principal facilities in two buildings in Osaka, Japan, but also owns buildings used for branch warehousing and sales offices in eight other cities throughout Japan. Of the total owned 139,000 square feet, 74,000 square feet is devoted to warehousing, with the balance used for administrative offices. Matsumoto also leases 53,000 square feet at certain branch locations, with 30,000 square feet used for warehousing and 23,000 square feet used for administrative offices.\nIn Europe, the Company maintains 16,000 square feet in Bordeaux, France (5,000 of which is leased) for its spinal implant manufacturing operation. Manufacturing and warehousing account for 11,000 square feet of the total and the remainder is used for administrative offices. In addition, the Company maintains two buildings (one of which is leased) in Uden, The Netherlands. The 49,000 square foot owned facility is currently for sale. A 20,000 square foot leased facility contains 9,000 square feet used for manufacturing and warehousing with the balance used for administrative offices. The Company also leases other foreign sales and administration offices.\nIn addition, the Company leases 12,000 square feet in Kalamazoo, Michigan for its administrative offices.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a defendant and plaintiff in various legal actions arising in the normal course of business. The Company does not anticipate material losses as a result of these actions.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS\nCertain information with respect to the executive officers of the Company is set forth in Item 10 of this report.\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 on The Nasdaq Stock Market under the symbol STRY. Quarterly stock prices appearing under the caption \"Summary of Quarterly Data\" on page 40 of the 1994 Annual Report (page 55 of the EDGAR filing) and dividend information for the years ended December 31, 1993 and 1994 under the caption \"Ten Year Review\" on pages 22 and 23 of the 1994 Annual Report (page 35 of the EDGAR filing) are incorporated herein by reference. The Company's Board of Directors intends to consider a year-end cash dividend annually at its December meeting.\nOn December 31, 1994 there were 3,684 stockholders of record of the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe financial information for each of the five years in the period ended December 31, 1994 under the caption \"Ten Year Review\" on pages 22 and 23 of the 1994 Annual Report (pages 35 and 36 of the EDGAR filing) 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 Financial Condition and Results of Operations\" on pages 24 through 27 of the 1994 Annual Report (pages 37 through 40 of the EDGAR filing) is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Company and its subsidiaries and report of independent auditors, included on pages 28 through 41 of the 1994 Annual Report (pages 41 through 56 of the EDGAR filing) are incorporated herein by reference.\nQuarterly results of operations appearing under the caption \"Summary of Quarterly Data\" on page 40 of the 1994 Annual Report (page 55 of the EDGAR filing) 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\nInformation regarding the directors of the Company appearing under the caption \"Election of Directors\" and the information appearing under the caption \"Miscellaneous - Section 16 Reporting\" in the 1995 proxy statement is incorporated herein by reference.\nInformation regarding the executive officers of the Company appears below. All officers are elected annually. Reported ages are as of January 31, 1995.\nJohn W. Brown, age 60, has been Chairman of the Board since January 1981, and President and Chief Executive Officer of the Company since February 1977. He is also a director of Lunar Corporation, a medical products company, First of America, a bank, and the Health Industry Manufacturers Association and a Trustee of Kalamazoo College.\nDean H. Bergy, age 35, was appointed Controller upon joining the Company in June 1994. He had previously been a Senior Manager at Ernst & Young LLP, independent public accountants, since October 1988.\nRonald A. Elenbaas, age 41, was appointed President of the Surgical Group in 1985 and has been a Vice President of the Company since August 1983. Previously he was the Director of Surgical Sales since May 1982. Since joining the Company in September 1975 he has held various other positions, including Sales Representative, Marketing Product Manager, Plant Manager, Canadian Sales Director, Assistant to the President and Director of Customer Relations.\nWilliam T. Laube, III, age 55, was appointed President of Stryker Pacific Group in 1985 and has been a Vice President of the Company since March 1979. Since joining the Company in July 1975 he has held various international sales management positions.\nEdward B. Lipes, age 42, was appointed a Vice President of the Company in May 1994 and has been President of Osteonics Corp. since August 1989. He held the position of President, Physiotherapy Associates, Inc. upon joining the Company in April 1988.\nJulia M. Paradine-Rice, age 33, was appointed Treasurer of the Company in June 1994. She had previously held the position of Assistant Treasurer since 1990 and also held the position of Corporate Accounting Manager since joining the Company in 1988.\nDavid J. Simpson, age 48, was appointed Vice President, Chief Financial Officer and Secretary upon joining the Company in June 1987. He had previously been Vice President and Treasurer of Rexnord Inc., a manufacturer of industrial and aerospace products, since July 1985.\nThomas R. Winkel, age 42, was appointed President of Stryker Americas\/Middle East in March 1992 and has been a Vice President of the Company since December 1984. He had previously been Vice President, Administration since June 1987. Since joining the Company in October 1978 he has held various other positions, including Assistant Controller, Secretary and Corporate Controller.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding the compensation of the management of the Company appearing under the captions \"Director Compensation\" and \"Executive Compensation\" 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 under the captions \"Beneficial Ownership of More than 5% of the Outstanding Common Stock\" and \"Beneficial Ownership of Management\" in the 1995 proxy statement 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 (Executive compensation plans and arrangements are referenced as exhibits 10(i), (ii), (iii) and (iv).)\n(a)(1) and (2) - The response to this portion of Item 14 is submitted as a separate section of this report following the signature page.\n(a)(3) - Exhibits\nExhibit 2 - Plan of Acquisition (i) Offer to Purchase Shares of Matsumoto Medical Instruments, Inc. by Stryker Corporation dated June 6, 1994-- Incorporated by reference to Exhibit 2 to the Company's Form 10-Q for the quarter ended June 30, 1994 (Commission File No. 0-9165).\nExhibit 3 - Articles of Incorporation and By-Laws (i) Restated Articles of Incorporation and amendment thereto dated December 28, 1993--Incorporated by reference to Exhibit 3(i) to the Company's Form 10-K for the year ended December 31, 1993 (Commission File No. 0-9165).\n(ii) By-Laws--Incorporated by reference to Exhibit 3(ii) to the Company's Form 10-Q for the quarter ended June 30, 1988 (Commission File No. 0-9165).\nExhibit 4 - Instruments defining the rights of security holders, including indentures--The Company agrees to furnish to the Commission upon request a copy of each instrument pursuant to which long- term debt of the Company and its subsidiaries not exceeding 10% of the total assets of the Company and its consolidated subsidiaries is authorized.\nExhibit 10- Material contracts (i)* 1988 Stock Option Plan as amended-- Incorporated by reference to Exhibit 10(i) to the Company's Form 10-K for the year ended December 31, 1992 (Commission File No. 0-9165).\n(ii)* Supplemental Savings and Retirement Plan.\n(iii)* Supplemental Savings and Retirement Plan (as Amended Effective January 1, 1995).\n(iv)* Description of bonus arrangements between the Company and certain officers, including Messrs. Brown, Elenbaas, Laube, Lipes, Simpson and Winkel.\nExhibit 11- Statement re computation of per share earnings\n(i) Statement Re: Computation of earnings per share of common stock.\nExhibit 13- Annual report to security holders\n(i) Portions of the 1994 Annual Report that are incorporated herein by reference.\nExhibit 21- Subsidiaries of the registrant\n(i) List of Subsidiaries.\nExhibit 23- Consents of experts and counsel\n(i) Consent of Independent Auditors.\nExhibit 27- Financial data schedule\n(i) Financial data schedule (included in EDGAR filing only).\n(b) Reports on Form 8-K - No reports on Form 8-K were required to be filed in the fourth quarter of 1994.\n(c) Exhibits - The response to this portion of Item 14 is submitted as a separate section of this report following the signature page.\n(d) Financial statement schedules - The response to this portion of Item 14 is submitted as a separate section of this report following the signature page.\n*compensation 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.\nSTRYKER CORPORATION\nDate: 3\/20\/95 DAVID J. SIMPSON David J. Simpson, Vice President, Chief Financial Officer 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.\nJOHN W. BROWN 3\/20\/95 DAVID J. SIMPSON 3\/20\/95 John W. Brown, Chairman, President David J. Simpson, Vice President, and Chief Executive Officer Chief Financial Officer and (Principal Executive Officer) Secretary (Principal Financial Officer)\nHOWARD E. COX, JR. 3\/20\/95 DEAN H. BERGY 3\/20\/95 Howard E. Cox, Jr. - Director Dean H. Bergy, Controller (Principal Accounting Officer)\nDONALD M. ENGELMAN 3\/20\/95 RONDA E. STRYKER 3\/20\/95 Donald M. Engelman, Ph.D. - Director Ronda E. Stryker - Director\nJEROME H. GROSSMAN 3\/20\/95 WILLIAM U. PARFET 3\/20\/95 Jerome H. Grossman, M.D. - Director William U. Parfet - Director\nJOHN S. LILLARD 3\/20\/95 John S. Lillard - Director\nANNUAL REPORT ON FORM 10-K\nITEM 14(a)(1) and (2), (c) and (d)\nLIST OF FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES\nCERTAIN EXHIBITS\nFINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1994\nSTRYKER CORPORATION\nKALAMAZOO, MICHIGAN\nFORM 10-K--ITEM 14(a)(1), (2) AND (d)\nSTRYKER CORPORATION AND SUBSIDIARIES\nIndex to Financial Statements and Financial Statement Schedule\nThe following consolidated financial statements of Stryker Corporation and subsidiaries and report of independent auditors, included in the annual stockholders report of the registrant for the year ended December 31, 1994, are incorporated by reference in Item 8:\nReport of independent auditors\nConsolidated balance sheet--December 31, 1994 and 1993.\nConsolidated statement of earnings--years ended December 31, 1994, 1993 and 1992.\nConsolidated statement of 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 consolidated financial statements--December 31, 1994.\nThe following consolidated financial statement schedule of Stryker Corporation and subsidiaries is included in Item 14(d):\nSchedule II--Valuation and qualifying accounts\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\nFORM 10-K--ITEM 14(c)\nSTRYKER CORPORATION AND SUBSIDIARIES\nExhibit Index\nExhibit Page* (2) Plan of acquisition (i) Offer to Purchase Shares of Matsumoto Medical Instruments, Inc. by Stryker Corporation dated June 6, 1994 . . . . . . . . . . . . . . . . . . 12**\n(3) Articles of incorporation and by-laws (i) Restated Articles of Incorporation and amendment thereto dated December 28, 1993. . . . . . . . . 12**\n(ii) By Laws . . . . . . . . . . . . . . . . . . . . . 12**\n(10) Material contracts (i) 1988 Stock Option Plan as amended. . . . . . . . 12**\n(ii) Supplemental Savings and Retirement Plan . . . . 19\n(iii) Supplemental Savings and Retirement Plan (as Amended Effective January 1, 1995) . . . . . 26\n(iv) Description of bonus arrangements between the Company and certain officers, including Messrs. Brown, Elenbaas, Laube, Lipes, Simpson and Winkel . . . . . . . . . . . . . . . . . . . 33\n(11) Statement re computation of per share earnings (i) Statement Re: Computation of earnings per share of common stock. . . . . . . . . . . . . . . . . 34\n(13) Annual report to security holders (i) Portions of the 1994 Annual Report that are incorporated herein by reference . . . . . . . . 35\n(21) Subsidiaries of the registrant (i) List of Subsidiaries . . . . . . . . . . . . . . 57\n(23) Consents of experts and counsel (i) Consent of Independent Auditors . . . . . . . . 58\n(27) Financial data schedule (i) Financial data schedule (included in EDGAR filing only) . . . . . . . . . . . . . . . . . . 59\n* Page number in sequential numbering system where such exhibit can be found, or it is stated that such exhibit is incorporated by reference.\n** Incorporated by reference in this Annual Report on Form 10-K.\nEXHIBIT 10(ii)\nSTRYKER CORPORATION SUPPLEMENTAL SAVINGS AND RETIREMENT PLAN\n1. PURPOSE OF THE PLAN\nThe purpose of this Stryker Corporation Supplemental Savings and Retirement Plan is to provide a select group of the Company's executives with an opportunity to defer a portion of their annual pay and to receive the benefit of Company contributions, to the extent such benefits are unavailable to such executives under the Savings Plan (as hereinafter defined) as a result of limitations imposed by the Internal Revenue Code of 1986, as amended, or other limitations imposed by the terms of such plan.\n2. DEFINITIONS\n2.01 ACCOUNT shall mean the bookkeeping account maintained for a Participant to record his Pay Deferrals, Matching Contributions, and Company Discretionary Contributions, together with earnings thereon credited pursuant to Section 7.03.\n2.02 ADMINISTRATOR shall mean the Company. The Company may periodically delegate some or all its duties as Administrator to a committee appointed by the Board.\n2.03 BOARD shall mean the Board of Directors of the Company.\n2.04 CODE shall mean the Internal Revenue Code of 1986, as amended from time to time.\n2.05 COMPANY shall mean Stryker Corporation and any successor thereto. Where the context requires, \"Company\" shall also include any employer related to the Company any of whose employees ahve been designated as eligible to participate in the Plan.\n2.06 COMPANY DISCRETIONARY CONTRIBUTION shall mean the amount credited to a Participant's Account pursuant to Article 6.\n2.07 COMPENSATION shall mean \"Compensation\" as defined in the Savings Plan; provided, however, that for purposes of the Plan the limitation on a Participant's Compensation for a Plan Year shall be 200% of the Section 401(a)(17) Limitation for such Plan Year.\n2.08 DEFERABLE COMPENSATION shall mean a Participant's Compensation for a Plan Year that is ineligible for deferral under the Savings Plan because it is earned after the Participant's pay deferrals under the Savings Plan have attained the dollar limitation under Section 402(g)(1) of the Code (or such lesser limitation on pay deferrals as may apply to the Participant under the terms of the Savings Plan) for such Plan Year.\n2.09 DISCRETIONARY CONTRIBUTION PERCENTAGE shall mean the employer's discretionary contribution for a Plan Year under the Savings Plan, expressed as a percentage of a participant's includible compensation for such Plan Year under the Savings Plan.\n2.10 EFFECTIVE DATE shall mean January 1, 1994.\n2.11 EMPLOYEE shall mean an employee of the Company.\n2.12 ENTRY DATE shall mean January 1 of any Plan Year.\n2.13 INVESTMENT ELECTION shall mean a Participant's election under Article 7 of the investment fund or funds used to measure the investment performance of the Participant's Account.\n2.14 MATCHING CONTRIBUTION shall mean the amount credited to a Participant's Account pursuant to Article 5.\n2.15 PARTICIPANT shall mean an Employee who satisfies the requirements for participation in the Plan pursuant to Section 3.01 and whose Account has not been distributed.\n2.16 PAY DEFERRAL ELECTION shall mean a Participant's election pursuant to Section 4.01 to defer a portion of his Deferable Compensation.\n2.17 PAY DEFERRALS shall mean the amounts credited to a Participant's Account pursuant to Section 4.01.\n2.18 PLAN shall mean this Stryker Corporation Supplemental Savings and Retirement Plan, as amended from time to time.\n2.19 PLAN YEAR shall mean the calendar year.\n2.20 SAVINGS PLAN shall mean the Stryker Corporation Savings and Retirement Plan for Salaried, Clerical, and Technical Employees, as amended from time to time.\n2.21 SECTION 401(a)(17) LIMITATION shall mean the dollar limitation under Section 401(a)(17) of the Code in effect for a Plan Year.\n2.22 SELECT GROUP shall mean, with respect to a Plan Year, the select group of management or highly compensated Employees who are designated by the Board of Directors as eligible to participate in this Plan.\n2.23 UNFORESEEABLE EMERGENCY shall have the meaning ascribed thereto in Section 11.03.\n2.24 VALUATION DATE shall mean the last day of each calendar quarter.\n3. PARTICIPATION\n3.01 PARTICIPATION. Any Employee who is a member of the Select Group shall become eligible to participate in the Plan as of the Entry Date coincident with or next following the latest of (i) the Effective Date, (ii) the date he becomes eligible to participate in the Savings Plan, or (iii) the date he becomes a member of the Select Group. Participation in the Plan shall terminate when all amounts credited to a Participant's Account have been distributed.\n4. PAY DEFERRALS\n4.01 PAY DEFERRAL ELECTIONS\n(a) A Participant may elect to defer a portion of his Deferable Compensation otherwise payable during the Plan Year by making a written election on such form as the Administrator shall designate. Such election shall specify a whole percentage of the Participant's Deferable Compensation which the Participant elects to defer, which percentage may not exceed the maximum percentage of compensation that may be deferred by nonhighly compensated employees under the terms of the Savings Plan. Such election must be made prior to\nthe first day of such Plan Year or such earlier date as the Administrator may specify, and may not be modified or revoked after the commencement of such Plan Year except as provided in Sections 4.02 and 11.01.\n(b) An amount deferred pursuant to a Pay Deferral Election shall be withheld from the Deferable Compensation otherwise payable to the Participant, and shall be credited to the Participant's Account as of the date on which such amount was withheld.\n(c) A Pay Deferral Election applies only to the Deferable Compensation for the Plan Year to which such election relates. To defer a portion of his Deferable Compensation in a subsequent Plan Year a Participant must make a new Pay Deferral Election.\n4.02 SUSPENSION OF DEFERRALS. Notwithstanding anything to the contrary in this Article 4, in the event the Administrator approves a Participant's request for a suspension of deferrals pursuant to Section 11.01 on account of an Unforeseeable Emergency, the Participant's Pay Deferral Election shall be suspended (and the Participant shall be ineligible to make a new Pay Deferral Election) with respect to any Compensation otherwise payable during the period beginning on the date of such withdrawal or effective date of such approval and ending on the last day of the next succeeding Plan Year.\n5. MATCHING CONTRIBUTIONS\n5.01 For each Plan Year, the Company shall credit to the Account of each eligible Participant a Matching Contribution equal to the lesser of (i) 100% of such Participant's Pay Deferrals for such Plan Year or (ii) 4% of such Participant's Compensation in excess of the Section 401(a)(17) Limitation for such Plan Year. Such Matching Contribution shall be credited to the Participant's Account by the March 15 following the end of such Plan Year.\n5.02 A Participant shall be eligible for a Matching Contribution with respect to a Plan Year only if he is eligible for a matching contribution under the Savings Plan for such Plan Year.\n6. COMPANY DISCRETIONARY CONTRIBUTIONS\n6.01 For each Plan Year, the Company shall credit to the Account of each eligible Participant a Company Discretionary Contribution equal to such Participant's Compensation in excess of the Section 401(a)(17) Limitation for such Plan Year, multiplied by the Discretionary Contribution Percentage for such Plan Year. Such Company Discretionary Contribution shall be credited to the Participant's Account by the March 15 following the end of such Plan Year.\n6.02 A Participant shall be eligible for a Company Discretionary Contribution with respect to a Plan Year only if he is eligible for an employer discretionary contribution under the Savings Plan for such Plan Year.\n7. INVESTMENT PERFORMANCE ELECTIONS\n7.01 INITIAL ELECTION. Prior to the commencement of his participation in the Plan, each Participant shall file an initial Investment Election which shall designate from among the investment funds available for selection under the Plan the investment fund or funds which shall be used to measure the investment performance of the Participant's Account.\n7.02 CHANGE IN ELECTION. A Participant may change his Investment Election effective as of the first day of any calendar quarter by filing a written notice with the Administrator at least 30 days in advance of such date.\n7.03 CREDITING OF INVESTMENT RETURN. As of each Valuation Date, each Participant's Account shall, under such procedures as the Administrator shall establish, be credited with any income, and debited with any loss, that would have been realized if the amounts credited to his Account had been invested in accordance with his Investment Election. References in the Plan to Investment Elections are for the sole purpose of attributing hypothetical investment performance to each Participant's Account. Nothing herein shall require the Company to invest, earmark, or set aside its general assets in any specific manner.\n7.04 AVAILABLE INVESTMENT FUNDS. The investment funds available for selection under the Plan shall be the investment funds (other than the employer stock fund) available for investment under the Savings Plan.\n8. ACCOUNTS\n8.01 MAINTENANCE OF ACCOUNTS. The Administrator shall maintain or cause to be maintained records showing the individual balances of each Account. At least once per quarter each Participant shall be furnished with a statement setting forth the value of his Account.\n8.02 VESTING. A benefit shall be payable under this Plan only to the extent that it is vested. The portion of a Participant's Account attributable to Pay Deferrals, together with credited earnings or losses thereon, shall be fully vested at all times. The portion of a Participant's Account attributable to Matching Contributions and Company Discretionary Contributions, and credited earnings and losses with respect thereto, shall be vested only to the extent that matching contributions and employer discretionary contributions credited to the Participant's account under the Savings Plan are vested. The nonvested portion of a Participant's Account shall be forfeited at the same time, and under the same conditions, as the nonvested portion of his account under the Savings Plan is forfeited.\n9. DISTRIBUTION OF BENEFITS\n9.01 BENEFIT PAYMENT ELECTION. Prior to the commencement of his participation in the Plan, each Participant shall file a benefit payment election with the Administrator on such form as the Administrator shall prescribe specifying (i) whether the Participant's benefit is to be paid in a lump sum, in substantially equal annual installments, or in a combination thereof, (ii) the year in which such lump-sum payment is to be made or such installments are to commence, and (iii) if installments are elected, the number of such installments. Except as provided in Section 11.02, no portion of a Participant's benefit may be distributed prior to his separation from service. Lump-sum payments may not be made later than, and installment payments may not extend beyond, the tenth anniversary of the date of the Participant's separation from service.\n9.02 CHANGE IN ELECTION. A Participant's benefit payment election may be changed from time to time, provided, however, that no such change shall be effective if the Participant's separation from service from the Company occurs less than one year after the date such change is made. In such event the Participant's benefit shall be paid in\naccordance with his most recent election or change in election (other than a change in election made less than one year before his separation from service).\n9.03 DISTRIBUTION OF BENEFITS. Except as otherwise provided in Article 10 and Section 11.02, a Participant's Account shall be distributed in accordance with his benefit election made in accordance with Section 9.01 (after giving effect to any modifications to such election pursuant to Section 9.02). The payment of any installment or lump sum shall, in accordance with the Participant's election, be made either (i) within 90 days after the end of the calendar quarter during which the Participant separates from service or (ii) within the first 90 days of a calendar year commencing after the Participant separates from service.\n10. DEATH OF A PARTICIPANT\n10.01 Except as otherwise provided in Section 10.02, in the event of a Participant's death prior to the distribution of his entire Account balance, the remaining balance in his Account shall be distributed in accordance with his benefit payment election made pursuant to Section 9.01 (after giving effect to any modifications to such election pursuant to Section 9.02). Such distribution shall be made to the beneficiary designated by the Participant under the Savings Plan, unless the Participant has specifically designated a different beneficiary under this Plan in a writing filed with the Administrator.\n10.02 A Participant may elect to have any amount remaining in his Account upon his death paid to his beneficiary in a lump sum within 60 days after the Administrator has received notification of his death, rather than in accordance with his benefit payment election under Section 9.01. Such a lump-sum death benefit election may be made or revoked at any time, provided, however, that no such election or revocation shall be effective if made less than one year before the date of the Participant's death.\n11. UNFORESEEABLE EMERGENCIES\n11.01 SUSPENSION OF DEFERRALS. In the vent of a Participant's Unforeseeable Emergency, such Participant may request a suspension of his Pay Deferral in accordance with Section 4.02 (if a suspension is not already in effect pursuant to such section). Any such request shall be subject to the approval of the Administrator, which approval shall not be granted unless such need cannot be relieved (i) through reimbursement or compensation by insurance or otherwise or (ii) by liquidation of the Participant's assets (to the extent the liquidation of such assets would not itself cause severe financial hardship). If the request is granted, such suspension shall be effective as of such date as the Administrator shall prescribe.\n11.02 EMERGENCY WITHDRAWAL. In the event of a Participant's Unforeseeable Emergency, such Participant may request an emergency withdrawal from his Account. Any such request shall be subject to the approval of the Administrator, which approval (a) shall not be granted unless the Participant's Pay Deferral Election have been suspended pursuant to Section 4.02, (b) shall only be granted to the extent reasonably needed to satisfy the need created by the Unforeseeable Emergency, and (c) shall not be granted to the extent that such need may be relieved (i) through reimbursement or compensation by insurance or otherwise or (ii) by liquidation of the Participant's assets (to the extent the liquidation of such assets would not itself cause severe financial hardship).\n11.03 UNFORESEEABLE EMERGENCY. An \"Unforeseeable Emergency\" means severe financial hardship to the Participant resulting from a sudden and unexpected illness or accident of the Participant or his dependent, loss of the Participant's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the Participant's control. Examples of circumstances not qualifying as an Unforeseeable Emergency include the need to send a Participant's child to college and the desire to purchase a home.\n12. ADMINISTRATION\nThe Plan shall be administered by the Administrator, which shall have discretionary authority to determine eligibility for benefits and to construe the terms of the Plan. The Administrator's good-faith determination with respect to any issue relating to the interpretation of the Plan shall be conclusive and final.\n13. GENERAL PROVISIONS\n13.01 NO CONTRACT OF EMPLOYMENT. The establishment of the Plan shall not be construed as conferring any legal rights upon any Participant for a continuation of employment, nor shall it interfere with the rights of the Company to discharge a Participant and to treat him without regard to the effect which such treatment might have upon him as a Participant in the Plan.\n13.02 WITHHOLDING. As a condition to a Participant's entitlement to benefits hereunder, the Company shall have the right to deduct from any amounts otherwise payable to a Participant, whether pursuant to the Plan or otherwise, or otherwise to collect from the Participant, any required withholding taxes with respect to benefits under the Plan.\n13.03 NON-ASSIGNABILITY OF BENEFITS. Subject to any applicable law, no benefit under the Plan shall be subject in any manner to, nor shall the Company be obligated to recognize, any purported anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, or charge, and any attempt to do so shall be void. No such benefit shall in any manner be liable for or subject to garnishment, attachment, execution, or a levy, or liable for or subject to the debts, contracts, liabilities, engagements or torts of the Participant.\n13.04 SUCCESSOR EMPLOYERS. The Plan shall be binding upon the successors and assigns of the Company. The Company shall require any successor (whether direct or indirect, and whether by purchase, merger, consolidation, or otherwise) to all or substantially all of the business or assets of the Company, by written agreement to expressly assume and agree to perform the Company's obligations under the Plan in the same manner and to the same extent that the Company would be required to perform them if no such succession had taken place. The provisions of this Section 13.04 shall continue to apply to each subsequent employer of the Participant hereunder in the event of any subsequent merger, consolidation, or transfer of assets of such subsequent employer.\n13.05 GOVERNING LAW. The laws of the State of Michigan shall govern the construction of this Plan and the rights and the liabilities hereunder of the parties hereto.\n13.06 PRONOUNS. The masculine pronoun shall mean the feminine wherever appropriate.\n14. SOURCE OF BENEFITS\nThe Plan is an unfunded plan maintained by the Company for the purpose of providing deferred compensation for a select group of management or highly compensated employees. Benefits under the Plan shall be payable from the general assets of the Company except to the extent paid from the Stryker Corporation Supplemental Savings and Retirement Plan Trust (a grantor trust of the type commonly known as a \"rabbi trust\"). The Plan shall not be construed as conferring on a Participant any right, title, interest, or claim in or to any specific asset, reserve, account, or property or any kind possessed by the Company. To the extent that a Participant or any other person acquires a right to receive payments from the Company, such right shall be no greater than the right of an unsecured general creditor.\n15. EFFECTIVE DATE\nThis Plan shall be effective as of January 1, 1994.\n16. AMENDMENT OR TERMINATION\nThe Board of Directors of the Company reserves the right to amend or terminate this Plan at any time; provided, however, that without such Participant's written consent, no amendment or termination of the Plan shall adversely affect the right of any Participant to receive, or otherwise result in a material adverse effect on such Participant's rights under the Plan with respect to, his accrued vested benefits as determined as of the date of amendment or termination.\nIN WITNESS OF WHICH, the Company has adopted the Plan this 21st day of January 1994.\nSTRYKER CORPORATION\nBy: THOMAS R. WINKEL Thomas R. Winkel, Vice President\nEXHIBIT 10(iii)\nSTRYKER CORPORATION SUPPLEMENTAL SAVINGS AND RETIREMENT PLAN (as Amended Effective January 1, 1995)\n1. PURPOSE OF THE PLAN\nThe purpose of this Stryker Corporation Supplemental Savings and Retirement Plan is to provide a select group of the Company's executives with an opportunity to defer a portion of their annual pay and to receive the benefit of Company contributions, to the extent such benefits are unavailable to such executives under the Savings Plan (as hereinafter defined) as a result of limitations imposed by the Internal Revenue Code of 1986, as amended, or other limitations imposed by the terms of such plan.\n2. DEFINITIONS\n2.01 ACCOUNT shall mean the bookkeeping account maintained for a Participant to record his Pay Deferrals, Matching Contributions, and Company Discretionary Contributions, together with earnings thereon credited pursuant to Section 7.03.\n2.02 ADMINISTRATOR shall mean the Company. The Company may periodically delegate some or all its duties as Administrator to a committee appointed by the Board.\n2.03 BOARD shall mean the Board of Directors of the Company.\n2.04 CODE shall mean the Internal Revenue Code of 1986, as amended from time to time.\n2.05 COMPANY shall mean Stryker Corporation and any successor thereto. Where the context requires, \"Company\" shall also include any employer related to the Company any of whose employees have been designated as eligible to participate in the Plan.\n2.06 COMPANY DISCRETIONARY CONTRIBUTION shall mean the amount credited to a Participant's Account pursuant to Article 6.\n2.07 COMPENSATION shall mean \"Compensation\" as defined in the Savings Plan; provided, however, that for purposes of the Plan the limitation on a Participant's Compensation for a Plan Year shall be 200% of the Section 401(a)(17) Limitation for such Plan Year.\n2.08 DEFERABLE COMPENSATION shall mean a Participant's Compensation for a Plan Year that is ineligible for deferral under the Savings Plan because it is earned after the Participant's pay deferrals under the Savings Plan have attained the dollar limitation under Section 402(g)(1) of the Code (or such lesser limitation on pay deferrals as may apply to the Participant under the terms of the Savings Plan) for such Plan Year.\n2.09 DISCRETIONARY CONTRIBUTION PERCENTAGE shall mean the employer's discretionary contribution for a Plan Year under the Savings Plan, expressed as a percentage of a participant's includible compensation for such Plan Year under the Savings Plan.\n2.10 EFFECTIVE DATE shall mean January 1, 1994.\n2.11 EMPLOYEE shall mean an employee of the Company.\n2.12 ENTRY DATE shall mean January 1 of any Plan Year.\n2.13 INVESTMENT ELECTION shall mean a Participant's election under Article 7 of the investment fund or funds used to measure the investment performance of the Participant's Account.\n2.14 MATCHING CONTRIBUTION shall mean the amount credited to a Participant's Account pursuant to Article 5.\n2.15 PARTICIPANT shall mean an Employee who satisfies the requirements for participation in the Plan pursuant to Section 3.01 and whose Account has not been distributed.\n2.16 PAY DEFERRAL ELECTION shall mean a Participant's election pursuant to Section 4.01 to defer a portion of his Deferable Compensation.\n2.17 PAY DEFERRALS shall mean the amounts credited to a Participant's Account pursuant to Section 4.01.\n2.18 PLAN shall mean this Stryker Corporation Supplemental Savings and Retirement Plan, as amended from time to time.\n2.19 PLAN YEAR shall mean the calendar year.\n2.20 SAVINGS PLAN shall mean the Stryker Corporation 401(k) Savings and Retirement Plan, as amended from time to time.\n2.21 SECTION 401(a)(17) LIMITATION shall mean the dollar limitation under Section 401(a)(17) of the Code in effect for a Plan Year.\n2.22 SELECT GROUP shall mean, with respect to a Plan Year, the select group of management or highly compensated Employees who are designated by the Board of Directors as eligible to participate in this Plan.\n2.23 UNFORESEEABLE EMERGENCY shall have the meaning ascribed thereto in Section 11.03.\n2.24 VALUATION DATE shall mean the last day of each calendar quarter.\n3. PARTICIPATION\n3.01 PARTICIPATION. Any Employee who is a member of the Select Group shall become eligible to participate in the Plan as of the Entry Date coincident with or next following the latest of (i) the Effective Date, (ii) the date he becomes eligible to participate in the Savings Plan, or (iii) the date he becomes a member of the Select Group. Participation in the Plan shall terminate when all amounts credited to a Participant's Account have been distributed.\n4. PAY DEFERRALS\n4.01 PAY DEFERRAL ELECTIONS\n(a) A Participant may elect to defer a portion of his Deferable Compensation otherwise payable during the Plan Year by making a written election on such form as the Administrator shall designate. Such election shall specify a whole percentage of the Participant's Deferable Compensation which the Participant elects to defer, which percentage may not exceed the maximum percentage of compensation that may be deferred by nonhighly compensated employees under the terms of the Savings Plan. Such\nelection must be made prior to the first day of such Plan Year or such earlier date as the Administrator may specify, and may not be modified or revoked after the commencement of such Plan Year except as provided in Sections 4.02 and 11.01.\n(b) An amount deferred pursuant to a Pay Deferral Election shall be withheld from the Deferable Compensation otherwise payable to the Participant, and shall be credited to the Participant's Account as of the date on which such amount was withheld.\n(c) A Pay Deferral Election applies only to the Deferable Compensation for the Plan Year to which such election relates. To defer a portion of his Deferable Compensation in a subsequent Plan Year a Participant must make a new Pay Deferral Election.\n4.02 SUSPENSION OF DEFERRALS. Notwithstanding anything to the contrary in this Article 4, in the event the Administrator approves a Participant's request for a suspension of deferrals pursuant to Section 11.01 on account of an Unforeseeable Emergency, the Participant's Pay Deferral Election shall be suspended (and the Participant shall be ineligible to make a new Pay Deferral Election) with respect to any Compensation otherwise payable during the period beginning on the date of such withdrawal or effective date of such approval and ending on the last day of the next succeeding Plan Year.\n5. MATCHING CONTRIBUTIONS\n5.01 For each Plan Year, the Company shall credit to the Account of each eligible Participant a Matching Contribution equal to the lesser of (i) 50% of such Participant's Pay Deferrals for such Plan Year or (ii) 4% of such Participant's Compensation in excess of the Section 401(a)(17) Limitation for such Plan Year. Such Matching Contribution shall be credited to the Participant's Account by the March 15 following the end of such Plan Year.\n5.02 A Participant shall be eligible for a Matching Contribution with respect to a Plan Year only if he is eligible for a matching contribution under the Savings Plan for such Plan Year.\n6. COMPANY DISCRETIONARY CONTRIBUTIONS\n6.01 For each Plan Year, the Company shall credit to the Account of each eligible Participant a Company Discretionary Contribution equal to such Participant's Compensation in excess of the Section 401(a)(17) Limitation for such Plan Year, multiplied by the Discretionary Contribution Percentage for such Plan Year. Such Company Discretionary Contribution shall be credited to the Participant's Account by the March 15 following the end of such Plan Year.\n6.02 A Participant shall be eligible for a Company Discretionary Contribution with respect to a Plan Year only if he is eligible for an employer discretionary contribution under the Savings Plan for such Plan Year.\n7. INVESTMENT PERFORMANCE ELECTIONS\n7.01 INITIAL ELECTION. Prior to the commencement of his participation in the Plan, each Participant shall file an initial Investment Election which shall designate from among the investment funds available for selection under the Plan the investment fund or funds which shall be used to measure the investment performance of the Participant's Account.\n7.02 CHANGE IN ELECTION. A Participant may change his Investment Election effective as of the first day of any calendar quarter by filing a written notice with the Administrator at least 30 days in advance of such date.\n7.03 CREDITING OF INVESTMENT RETURN. As of each Valuation Date, each Participant's Account shall, under such procedures as the Administrator shall establish, be credited with any income, and debited with any loss, that would have been realized if the amounts credited to his Account had been invested in accordance with his Investment Election. References in the Plan to Investment Elections are for the sole purpose of attributing hypothetical investment performance to each Participant's Account. Nothing herein shall require the Company to invest, earmark, or set aside its general assets in any specific manner.\n7.04 AVAILABLE INVESTMENT FUNDS. The investment funds available for selection under the Plan shall be the investment funds (other than the employer stock fund) available for investment under the Savings Plan.\n8. ACCOUNTS\n8.01 MAINTENANCE OF ACCOUNTS. The Administrator shall maintain or cause to be maintained records showing the individual balances of each Account. At least once per quarter each Participant shall be furnished with a statement setting forth the value of his Account.\n8.02 VESTING. A benefit shall be payable under this Plan only to the extent that it is vested. The portion of a Participant's Account attributable to Pay Deferrals, together with credited earnings or losses thereon, shall be fully vested at all times. The portion of a Participant's Account attributable to Matching Contributions and Company Discretionary Contributions, and credited earnings and losses with respect thereto, shall be vested only to the extent that matching contributions and employer discretionary contributions credited to the Participant's account under the Savings Plan are vested. The nonvested portion of a Participant's Account shall be forfeited at the same time, and under the same conditions, as the nonvested portion of his account under the Savings Plan is forfeited.\n9. DISTRIBUTION OF BENEFITS\n9.01 BENEFIT PAYMENT ELECTION. Prior to the commencement of his participation in the Plan, each Participant shall file a benefit payment election with the Administrator on such form as the Administrator shall prescribe specifying (i) whether the Participant's benefit is to be paid in a lump sum, in substantially equal annual installments, or in a combination thereof, (ii) the year in which such lump-sum payment is to be made or such installments are to commence, and (iii) if installments are elected, the number of such installments.\nExcept as provided in Section 11.02, no portion of a Participant's benefit may be distributed prior to his separation from service. Lump-sum payments may not be made later than, and installment payments may not extend beyond, the tenth anniversary of the date of the Participant's separation from service.\n9.02 CHANGE IN ELECTION. A Participant's benefit payment election may be changed from time to time, provided, however, that no such change shall be effective if the Participant's separation from service from the Company occurs less than one year after the date such change is made. In such event the Participant's benefit shall be paid in accordance with his most recent election or change in election (other than a change in election made less than one year before his separation from service).\n9.03 DISTRIBUTION OF BENEFITS. Except as otherwise provided in Article 10 and Section 11.02, a Participant's Account shall be distributed in accordance with his benefit election made in accordance with Section 9.01 (after giving effect to any modifications to such election pursuant to Section 9.02). The payment of any installment or lump sum shall, in accordance with the Participant's election, be made either (i) within 90 days after the end of the calendar quarter during which the Participant separates from service or (ii) within the first 90 days of a calendar year commencing after the Participant separates from service.\n10. DEATH OF A PARTICIPANT\n10.01 Except as otherwise provided in Section 10.02, in the event of a Participant's death prior to the distribution of his entire Account balance, the remaining balance in his Account shall be distributed in accordance with his benefit payment election made pursuant to Section 9.01 (after giving effect to any modifications to such election pursuant to Section 9.02). Such distribution shall be made to the beneficiary designated by the Participant under the Savings Plan, unless the Participant has specifically designated a different beneficiary under this Plan in a writing filed with the Administrator.\n10.02 A Participant may elect to have any amount remaining in his Account upon his death paid to his beneficiary in a lump sum within 60 days after the Administrator has received notification of his death, rather than in accordance with his benefit payment election under Section 9.01. Such a lump-sum death benefit election may be made or revoked at any time, provided, however, that no such election or revocation shall be effective if made less than one year before the date of the Participant's death.\n11. UNFORESEEABLE EMERGENCIES\n11.01 SUSPENSION OF DEFERRALS. In the vent of a Participant's Unforeseeable Emergency, such Participant may request a suspension of his Pay Deferral in accordance with Section 4.02 (if a suspension is not already in effect pursuant to such section). Any such request shall be subject to the approval of the Administrator, which approval shall not be granted unless such need cannot be relieved (i) through reimbursement or compensation by insurance or otherwise or (ii) by liquidation of the Participant's assets (to the extent the liquidation of such assets would not itself cause severe financial hardship). If the request is granted, such suspension shall be effective as of such date as the Administrator shall prescribe.\n11.02 EMERGENCY WITHDRAWAL. In the event of a Participant's Unforeseeable Emergency, such Participant may request an emergency withdrawal from his Account. Any such request shall be subject to the approval of the Administrator, which approval (a) shall not be granted unless the Participant's Pay Deferral Election have been suspended pursuant to Section 4.02, (b) shall only be granted to the extent reasonably needed to satisfy the need created by the Unforeseeable Emergency, and (c) shall not be granted to the extent that such need may be relived (i) through reimbursement or compensation by insurance or otherwise or (ii) by liquidation of the Participant's assets (to the extent the liquidation of such assets would not itself cause severe financial hardship).\n11.03 UNFORESEEABLE EMERGENCY. An \"Unforeseeable Emergency\" means severe financial hardship to the Participant resulting from a sudden and unexpected illness or accident of the Participant or his dependent, loss of the Participant's property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the Participant's control. Examples of circumstances not qualifying as an Unforeseeable Emergency include the need to send a Participant's child to college and the desire to purchase a home.\n12. ADMINISTRATION\nThe Plan shall be administered by the Administrator, which shall have discretionary authority to determine eligibility for benefits and to construe the terms of the Plan. The Administrator's good-faith determination with respect to any issue relating to the interpretation of the Plan shall be conclusive and final.\n13. GENERAL PROVISIONS\n13.01 NO CONTRACT OF EMPLOYMENT. The establishment of the Plan shall not be construed as conferring any legal rights upon any Participant for a continuation of employment, nor shall it interfere with the rights of the Company to discharge a Participant and to treat him without regard to the effect which such treatment might have upon him as a Participant in the Plan.\n13.02 WITHHOLDING. As a condition to a Participant's entitlement to benefits hereunder, the Company shall have the right to deduct from any amounts otherwise payable to a Participant, whether pursuant to the Plan or otherwise, or otherwise to collect from the Participant, any required withholding taxes with respect to benefits under the Plan.\n13.03 NON-ASSIGNABILITY OF BENEFITS. Subject to any applicable law, no benefit under the Plan shall be subject in any manner to, nor shall the Company be obligated to recognize, any purported anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, or charge, and any attempt to do so shall be void. No such benefit shall in any manner be liable for or subject to garnishment, attachment, execution, or a levy, or liable for or subject to the debts, contracts, liabilities, engagements or torts of the Participant.\n13.04 SUCCESSOR EMPLOYERS. The Plan shall be binding upon the successors and assigns of the Company. The Company shall require any successor (whether direct or indirect, and whether by purchase, merger, consolidation, or otherwise) to all or substantially all of the business or assets of the Company, by written agreement to expressly assume and agree to perform the\nCompany's obligations under the Plan in the same manner and to the same extent that the Company would be required to perform them if no such succession had taken place. The provisions of this Section 13.04 shall continue to apply to each subsequent employer of the Participant hereunder in the event of any subsequent merger, consolidation, or transfer of assets of such subsequent employer.\n13.05 GOVERNING LAW. The laws of the State of Michigan shall govern the construction of this Plan and the rights and the liabilities hereunder of the parties hereto.\n13.06 PRONOUNS. The masculine pronoun shall mean the feminine wherever appropriate.\n14. SOURCE OF BENEFITS\nThe Plan is an unfunded plan maintained by the Company for the purpose of providing deferred compensation for a select group of management or highly compensated employees. Benefits under the Plan shall be payable from the general assets of the Company except to the extent paid from the Stryker Corporation Supplemental Savings and Retirement Plan Trust (a grantor trust of the type commonly known as a \"rabbi trust\"). The Plan shall not be construed as conferring on a Participant any right, title, interest, or claim in or to any specific asset, reserve, account, or property or any kind possessed by the Company. To the extent that a Participant or any other person acquires a right to receive payments from the Company, such right shall be no greater than the right of an unsecured general creditor.\n15. EFFECTIVE DATE\nThis Plan, as amended and restated as set forth herein, shall be effective as of January 1, 1995.\n16. AMENDMENT OR TERMINATION\nThe Board of Directors of the Company reserves the right to amend or terminate this Plan at any time; provided, however, that without such Participant's written consent, no amendment or termination of the Plan shall adversely affect the right of any Participant to receive, or otherwise result in a material adverse effect on such Participant's rights under the Plan with respect to, his accrued vested benefits as determined as of the date of amendment or termination.\nIN WITNESS OF WHICH, the Company has adopted the Plan this 14th day of December 1994.\nSTRYKER CORPORATION\nBy: THOMAS R. WINKEL Thomas R. Winkel, Vice President\nEXHIBIT (10)(iv)\nDESCRIPTION OF BONUS ARRANGEMENTS\nThe Company has entered into bonus arrangements with certain executive officers for 1995, including Mr. Brown, Mr. Elenbaas, Mr. Laube, Mr. Lipes, Mr. Simpson and Mr. Winkel, based on specific performance criteria including sales, profits and asset management. The aggregate amount of such bonuses is not expected to exceed $1,225,000.\nEXHIBIT (11)\nSTATEMENT RE: COMPUTATION OF EARNINGS PER SHARE OF COMMON STOCK\nYear Ended December 31 ----------------------------------- 1994 1993 1992 ---------- ---------- ----------\nAverage number of shares outstanding 48,367,000 48,356,000 47,716,000\nNet earnings $72,400,000 $60,205,000 $47,700,000 =========== =========== =========== Earnings per share of common stock: Net earnings $1.50 $1.25 $1.00 ===== ===== ===== Primary: Average shares outstanding 48,367,000 48,356,000 47,716,000\nNet effect of dilutive stock options, based on the treasury stock method using average market price 737,000 536,000 1,173,000 ----------- ---------- ---------- Total Primary Shares 49,104,000 48,892,000 48,889,000 ========== ========== ==========\nFully Diluted: Average shares outstanding 48,367,000 48,356,000 47,716,000\nNet effect of dilutive stock options, using the year-end market price, if higher then average market price 770,000 586,000 1,199,000 __________ __________ __________ Total Fully Diluted Shares 49,137,000 48,942,000 48,915,000 ========== ========== ==========\nNote: Shares subject to stock options are not included in the earnings per share computation because the present effect thereof is not materially dilutive.\nCONSOLIDATED STATEMENT OF CASH FLOWS STRYKER CORPORATION AND SUBSIDIARIES\nYears Ended December 31 (in thousands) 1994 1993 1992 -------------------------------------- -------- -------- -------- OPERATING ACTIVITIES Net Earnings $72,400 $60,205 $47,700 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation 18,717 13,048 10,214 Amortization 2,227 3,135 1,168 Minority interest 4,405 Provision for losses on accounts receivable 2,600 900 400 Deferred income taxes (credit) (3,818) (2,917) (4,171) Changes in operating assets and liabilities, net of effects of business acquisitions: Decrease (increase) in accounts receivable 2,862 (11,305) (20,563) Decrease in inventories 5,798 2,271 726 Increase (decrease) in accounts payable (8,594) 4,982 7,723 Increase (decrease) in income taxes (3,898) 11,092 632 Other 4,994 4,691 6,899 -------- -------- -------- Net Cash Provided by Operating Activities 97,693 86,102 50,728\nINVESTING ACTIVITIES Purchases of property, plant and equipment (29,239) (20,160) (31,618) Sales (purchases) of marketable securities 17,661 (54,264) (21,553) Business acquisitions, net of cash acquired (42,557) (34,654) (8,736) -------- -------- -------- Net Cash Used in Investing Activities (54,135) (109,078) (61,907)\nFINANCING ACTIVITIES Proceeds from borrowings 59,919 33,563 Payments on borrowings (31,771) (2,016) (7,418) Dividends paid (3,388) (2,898) (2,380) Proceeds from exercise of stock options 1,791 1,389 9,789 Repurchases of common stock (3,109) Other (1,307) (126) (376) -------- -------- -------- Net Cash Provided by (Used in) Financing Activities 22,135 29,912 (385) Effect of exchange rate changes on cash and cash equivalents 1,376 (315) 1,734 -------- -------- -------- Increase (Decrease) in Cash and Cash Equivalents 67,069 6,621 (9,830) Cash and cash equivalents at beginning of year 49,712 43,091 52,921 -------- -------- -------- Cash and Cash Equivalents at End of Year $116,781 $49,712 $43,091 ======== ======== ========\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS STRYKER CORPORATION AND SUBSIDIARIES December 31, 1994\n1. SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS: Stryker Corporation develops, manufactures and markets specialty surgical and medical products which are sold primarily to hospitals throughout the world.\nPRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and, effective in August 1994 (see Note 4), its 51% owned subsidiary, Matsumoto Medical Instruments, Inc., after elimination of all significant intercompany accounts and transactions. Minority interest represents the minority stockholders' equity in Matsumoto's net earnings since August 1994 and their equity in Matsumoto's net assets at December 31, 1994. The Company's 20% investment in Matsumoto during the period from August 1993 to July 1994 was accounted for by the equity method.\nREVENUE RECOGNITION: Revenue is recognized on the sale of products when the related goods have been shipped or services have been rendered.\nCASH EQUIVALENTS AND INVESTMENTS: Cash equivalents are highly liquid investments with a maturity of three months or less when purchased. Investments include marketable equity and debt securities classified as current assets and certain noncurrent investments included in other assets.\nThe Company's investments in marketable equity and debt securities are classified as \"available-for-sale\" and are carried at fair value, with the unrealized gains and losses, net of income taxes, reported as a separate component of stockholders' equity. Interest and dividends on these securities are included in other income.\nINVENTORIES: Inventories are stated at the lower of cost or market. Cost for approximately 75% (63% in 1993) of inventories is determined using the lower of first-in, first-out (FIFO) cost or market. Cost for certain domestic inventories is determined using the last-in, first-out (LIFO) cost method. The FIFO cost for all inventories approximates replacement cost.\nPROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment is stated at cost. Depreciation is computed by the straight-line or declining balance methods over the estimated useful lives of the assets.\nINTANGIBLE ASSETS: Intangible assets represent the excess of purchase price over fair value of tangible net assets of acquired businesses. Intangible assets, which include patents and intangibles not specifically identifiable, are being amortized using the straight-line method over periods of up to sixteen years.\nINCOME TAXES: Effective January 1, 1993, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 109, \"Accounting for Income Taxes\", which requires the use of the liability method of accounting for deferred 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 the enacted tax rates in effect for the years in which the differences are expected to reverse. Prior to the adoption of Statement 109, income tax expense was determined using the deferred method. Deferred tax expense was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated.\nEARNINGS PER SHARE: Earnings per share is based upon the average number of shares of common stock outstanding during each year. Shares subject to option are not included in earnings per share computations because the present effect thereof is not materially dilutive.\n2. INVESTMENTS\nEffective January 1, 1994, the Company adopted FASB Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities, \" for investments held as of or acquired after that date. In accordance with the Statement, prior period financial statements have not been restated to reflect the change in accounting principle. The beginning balance of stockholders' equity was increased by $1,180,000 (net of $751,000 in deferred income taxes) to reflect the net unrealized holding gains on securities classified as available-for-sale previously carried at cost.\nThe following is a summary of the Company's investments in marketable equity and debt securities at December 31, 1994 (in thousands):\nGross Unrealized Estimated Cost Gains\/(Losses) Fair Value ------- -------------- ----------\nDebt securities $87,490 ($2,081) $85,409 Equity securities 7,700 (119) 7,581 ------- ------- -------\n$95,190 ($2,200) $92,990 ======= ====== =======\n3. INVENTORIES\nInventories are as follows (in thousands):\nDecember 31 ------------------ 1994 1993 -------- ------- Finished goods $86,719 $45,338 Work-in-process 7,552 10,586 Raw material 28,784 28,455 -------- ------- FIFO cost 123,055 84,379 Less LIFO reserve 7,298 7,797 -------- ------- $115,757 $76,582 ======== =======\n4. BUSINESS ACQUISITIONS\nIn August 1994, the Company purchased 31% of the outstanding common stock of Matsumoto Medical Instruments, Inc., Osaka, Japan, thereby increasing its direct ownership interest in Matsumoto to 51%. Matsumoto is one of the largest distributors of medical devices in Japan and is the exclusive distributor of most Stryker products in that country. The cost of the 31% investment, which was based on net book value, was approximately 6.0 billion Yen ($60.7 million). Payment of approximately 847 million Yen ($8.5 million) of the purchase price has been deferred to April 1995. The acquisition was accounted for by the purchase method and the results of operations for Matsumoto were consolidated with Stryker beginning in August 1994. If the acquisition had occurred on January 1, 1993, pro forma net sales for the Company would have been $762,341,000 for 1994 and $694,923,000 for 1993. Pro forma net earnings would not have differed significantly from reported results.\nIn August 1993, the Company purchased 20% of the outstanding common stock of Matsumoto. The cost of the investment, which was based on net book value, was approximately 3.4 billion yen ($32.8 million). This initial investment was accounted for under the equity method until August 1994, when the additional 31% interest was acquired. The Company's share of Matsumoto's net earnings did not have a material impact on the Company's net earnings in 1993.\nIn June 1994, the Company purchased the Steri-Shield product line, which is a personal protection system for operating room personnel. The acquisition was accounted for by the purchase method at a total cost of $6,500,000, of which $5,500,000 in royalties will be paid over the next seven years. Intangible assets acquired, principally patents, are being amortized over seven to ten years. Pro forma consolidated results including the purchased business would not differ significantly from reported results.\nDuring 1994, 1993 and 1992, the Company's subsidiary, Physiotherapy Associates, Inc., purchased several physical therapy clinic operations. The aggregate purchase price of these clinics in 1994, 1993 and 1992 was approximately $7,600,000, $1,900,000 and $2,900,000, respectively. Intangible assets acquired, principally employment contracts and goodwill, are being amortized over periods ranging from one to fifteen years. Pro- forma consolidated results including the purchased businesses would not differ significantly from reported results.\nIn October 1992, the Company's subsidiary, Stryker France S.A., acquired Dimso S.A. and its subsidiary companies in France and Spain. Dimso designs and manufactures the Diapason and Stryker 2S Spinal Implant Systems and other orthopaedic products. The acquisition was accounted for by the purchase method at a total cost of $13,000,000, with approximately $7,000,000 to be paid over the following three years. Intangible assets acquired, principally patents, are being amortized over a ten year period. Pro forma consolidated results including the purchased business would not differ significantly from reported results.\n5. BORROWINGS\nThe Company and its subsidiaries have unsecured short-term line of credit arrangements with banks aggregating $20,000,000 domestically and $25,700,000 equivalent in foreign currencies. Borrowings under these lines at December 31, 1994 were $208,000 ($777,000 at December 31, 1993) in foreign funds at an average interest rate of 12.8% (12.5% in 1993). These lines generally expire on July 31, 1995.\nLong-term debt is as follows (in thousands):\nDecember 31 ----------------- 1994 1993 ------- ------- Bank loans $86,616 $30,736 Other 14,029 1,428 ------- ------- 100,645 32,164 Less current maturities 5,369 882 ------- ------- $95,276 $31,282 ======= =======\nThe bank loans represent two separate borrowings made to finance the acquisition of the Company's 51% interest in Matsumoto Medical Instruments, Inc. (see Note 4). Both loans are Japanese Yen denominated, are unsecured and mature in August 1998. The first loan is from the Chicago branch of The Sanwa Bank, Limited, has a principal balance of $34,442,000 ($30,736,000 at December 31, 1993) and bears interest at a fixed annual rate of 4.76%. The\nsecond loan is a floating rate loan from the Chicago branches of The Bank of Tokyo, Ltd., The Mitsubishi Bank Limited and The Sanwa Bank, Limited and has a principal balance of $52,174,000. The Company has fixed the effective annual interest rate of this debt at 4.17% using an interest rate swap with a notional amount and term equal to that of the related loan.\nMaturities of debt for the four years succeeding 1995 are: 1996 - $3,152,000; 1997 - $52,000; 1998 - $86,673,000 and 1999 - $5,070,000.\nThe carrying amounts of the Company's long-term debt and interest rate swap approximate their fair values based on the Company's current borrowing rates for similar types of borrowing agreements and quoted market rates, respectively.\nTotal interest expense, which is included in other income and approximates interest paid, was $3,677,000 in 1994, $1,067,000 in 1993 and $411,000 in 1992.\n6. CAPITAL STOCK\nThe Company has key employee and director Stock Option Plans under which options are granted at a price not less than fair market value at date of grant. The options are granted for periods of up to ten years and become exercisable in varying installments. A summary of stock option activity follows:\nOption Shares Price Per Share --------- --------------- Options outstanding at January 1, 1993 1,275,925 $3.20 - $38.75 Granted 867,500 22.38 - 25.50 Canceled (411,300) 6.75 - 38.75 Exercised (75,600) 3.20 - 14.63 --------- -------------- Options outstanding at December 31, 1993 1,656,525 3.20 - 34.25 Granted 37,500 25.88 - 28.00 Canceled (58,000) 6.75 - 34.25 Exercised (88,040) 3.20 - 25.50 --------- -------------- Options outstanding at December 31, 1994 1,547,985 $3.20 - $34.25 ========= ==============\nAt December 31, 1994, options for 750,085 shares were exercisable and 1,133,600 shares were reserved for future grants.\nThe Company has 500,000 authorized shares of $1 par value preferred stock, none of which are outstanding.\n7. RETIREMENT PLANS\nSubstantially all employees of the Company are covered by retirement plans. The majority of employees are covered by profit sharing or defined contribution retirement plans.\nThe Company's 51% owned subsidiary, Matsumoto Medical Instruments, Inc., has a noncontributory defined benefit plan covering all employees who are generally entitled, upon termination, to lump-sum or annuity payments of amounts determined by reference to the current level of salary, length of service, and the conditions under which the termination occurs. Matsumoto's funding policy for the plan is to contribute actuarially determined amounts on a monthly basis. In addition, certain officers of Matsumoto are customarily entitled to lump-sum payments under an unfunded retirement plan. An accrual has been provided for the expected cost of these benefits earned to date, although such payments\nare subject to the approval of Matsumoto's stockholders. Amounts accrued for both Matsumoto retirement plans, which provide for substantially all unfunded obligations under the plans, totaled $16,235,000 at December 31, 1994 and are recorded as other noncurrent liabilities in the consolidated balance sheet.\nRetirement plan expense under all of the Company's retirement plans totaled $6,753,000 in 1994, $5,302,000 in 1993 and $4,715,000 in 1992.\n8. INCOME TAXES\nEffective January 1, 1993, the Company adopted FASB Statement No. 109, \"Accounting for Income Taxes\", which requires the use of the liability method of accounting for income taxes (see Note 1). As permitted by Statement 109, the Company has elected not to restate the financial statements of any prior years. The cumulative effect of the change in the method of accounting on net earnings was not material.\nEarnings before income taxes and minority interest consist of the following (in thousands):\n1994 1993 1992 -------- ------- ------- United States operations $100,996 $88,181 $66,552 Foreign operations 26,579 7,884 10,388 -------- ------- ------- $127,575 $96,065 $76,940 ======== ======= =======\nThe components of the provision for income taxes follow (in thousands):\n1994 1993 1992 -------- ------- ------- Current: Federal $31,932 $26,114 $20,827 State, including Puerto Rico 5,133 10,372 7,973 Foreign 17,523 2,291 4,611 ------- ------- ------- 54,588 38,777 33,411 Deferred tax expense (credit) (3,818) (2,917) (4,171) ------- ------- ------- $50,770 $35,860 $29,240 ======= ======= =======\nA reconciliation of the statutory federal income tax rate to the Company's effective tax rate follows:\n1994 1993 1992 ----- ----- ----- U.S. statutory income tax rate 35.0% 35.0% 34.0% Add (deduct): State taxes, less effect of federal deduction 2.3 6.3 5.9 Foreign income taxes at rates different from the U.S. statutory rate 5.4 (.8) 1.0 Tax benefit relating to operations in Puerto Rico (2.0) (1.8) (1.9) U.S. research and development tax credit (.6) (1.4) (.9) Earnings of Foreign Sales Corporation (1.4) (1.4) (.8) Other 1.1 1.4 .7 ----- ----- ----- 39.8% 37.3% 38.0% ===== ===== =====\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. The tax effect of significant temporary differences which comprise the Company's deferred tax assets and liabilities are as follows (in thousands):\nDecember 31 ----------------- 1994 1993 ------- ------- Deferred tax assets: Inventories $34,475 $4,712 Accounts receivable and other assets 2,048 2,874 Other accrued expenses 18,165 6,662 State taxes 3,127 1,297 Other 2,226 920 ------- ------- Total deferred tax assets 60,041 16,465\nDeferred tax liabilities: Depreciation (1,681) (792) Other (2,244) (895) ------- ------- Total deferred tax liabilities (3,925) (1,687) ------- ------- Total net deferred tax assets $56,116 $14,778 ======= =======\nDeferred tax assets and liabilities are included in the consolidated balance sheet as follows (in thousands):\nDecember 31 ----------------- 1994 1993 ------- -------\nCurrent assets -- Deferred income taxes $54,333 $15,829 Noncurrent assets -- Other assets 4,438 Noncurrent liabilities -- Other liabilities (2,655) (1,051) ------- ------- Net deferred tax assets $56,116 $14,778 ======= =======\nNo provision has been made for U.S. federal and state income taxes or foreign taxes that may result from future remittances of the undistributed earnings ($152,619,000 at December 31, 1994) of foreign subsidiaries because it is expected that such earnings will be reinvested overseas indefinitely. Determination of the amount of any unrecognized deferred income tax liability on these unremitted earnings is not practicable.\nTotal income taxes paid were $51,898,000 in 1994, $27,641,000 in 1993 and $25,133,000 in 1992.\n9. GEOGRAPHIC DATA\nGeographic area information follows (in thousands):\n1994 1993 1992 -------- -------- -------- NET SALES United States operations: Domestic $405,549 $378,255 $330,782 Export 117,669 115,977 81,513 Foreign operations: Pacific 130,223 33,651 33,660 Europe 70,366 63,366 58,010 Other 12,094 11,987 9,522 Eliminations (53,981) (45,901) (36,433) -------- -------- -------- Net Sales $681,920 $557,335 $477,054 ======== ======== ========\nOPERATING INCOME United States operations $109,429 $90,726 $68,759 Foreign operations: Pacific 12,560 1,465 4,264 Europe 6,554 6,571 6,998 Other 1,686 1,660 213 -------- ------- ------- Total foreign operations 20,800 9,696 11,475\nCorporate expenses (9,753) (8,480) (6,533) -------- ------- -------\nTotal Operating Income $120,476 $91,942 $73,701 ======== ======= =======\n1994 1993 1992 -------- -------- -------- ASSETS United States operations $248,883 $225,587 $199,188 Foreign operations: Pacific 281,259 12,053 12,384 Europe 50,111 39,313 42,580 Other 9,801 4,067 2,741 Corporate 177,917 173,184 83,379 -------- -------- -------- Total Assets $767,971 $454,204 $340,272 ======== ======== ========\nIntercompany sales between geographic areas are included in export and foreign operations sales at agreed upon prices which include a profit element.\nFor the year ended December 31, 1993, sales to Matsumoto Medical Instruments, Inc. were $64,300,000 or 12% of total net sales. No customer accounted for 10% or more of the Company's sales in 1994 or 1992.\nGains (losses) on foreign currency transactions, which are included in other income, totaled $586,000, $(256,000) and $188,000 in 1994, 1993 and 1992, respectively.\nCorporate assets consist primarily of domestic cash and cash equivalents and marketable securities and, in 1993, the investment in affiliate.\n10. LEASES\nThe Company leases various manufacturing and office facilities and equipment under operating leases. Future minimum lease commitments under these leases are as follows (in thousands):\n1995 $10,076 1996 8,320 1997 5,625 1998 3,605 1999 1,823 Thereafter 1,766 ------- $31,215 =======\nRent expense totaled $14,644,000 in 1994, $10,950,000 in 1993 and $8,792,000 in 1992.\n11. CONTINGENCIES\nThe Company is involved in various claims and legal actions arising in the normal course of business. The Company does not anticipate material losses as a result of these actions.\nSALES ANALYSIS, QUARTERLY DATA (dollars in thousands, except per share data)\nPRODUCT LINE SALES (Unaudited) 1994 1993 1992 -------------- -------------- -------------- SURGICAL Orthopaedic Implants, Endoscopic Systems, Powered Surgical Instruments and Other Operating Room Devices $544,049 80% $447,042 80% $394,111 83%\nMEDICAL Patient Care and Patient Handling Equipment and Physical Therapy Services 137,871 20 110,293 20 82,943 17 -------- --- -------- --- -------- --- $681,920 100% $557,335 100% $477,054 100% ======== === ======== === ======== ===\nDOMESTIC\/INTERNATIONAL SALES (Unaudited) 1994 1993 1992 -------------- -------------- -------------- Domestic $405,549 59% $378,255 68% $330,782 69% International 276,371 41 179,080 32 146,272 31 -------- --- -------- --- -------- --- $681,920 100% $557,335 100% $477,054 100% ======== === ======== === ======== ===\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Stryker Corporation\nWe have audited the accompanying consolidated balance sheet of Stryker Corporation and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, 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 consolidated financial position of Stryker 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 Ernst & Young LLP\nKalamazoo, Michigan January 31, 1995 EXHIBIT (21)\nList of Subsidiaries\nState or Country of Name of Subsidiary Incorporation ---------------------------------------------------------------- Dimso Iberica S.A. France Dimso SA France Osteonics Corp. New Jersey Physiotherapy Associates, Inc. Michigan Stryker Australia Pty. Ltd. Australia Stryker B.V. The Netherlands Stryker (Barbados) Foreign Sales Corporation Barbados Stryker Canada Inc. Canada Stryker China Limited Hong Kong Stryker Corporation (Malaysia) SDN BHD Malaysia Stryker Deutschland GmbH Germany Stryker Far East, Inc. Delaware Stryker Foreign Sales Corporation U.S. Virgin Islands Stryker France SA France Stryker Italia SRL Italy Stryker Korea Ltd. Korea Stryker Mexico, S.A. de C.V. Mexico Stryker Pacific Limited Hong Kong Stryker Puerto Rico, Inc. Delaware Stryker SA Switzerland Stryker Sales Corporation Michigan Stryker Singapore Private Limited Singapore\nStryker Corporation is the immediate parent and owns 100% of the outstanding voting securities of each of the above-named subsidiaries.\nStryker is a 51% investor in: Matsumoto Medical Instruments, Inc. Japan\nStryker effectively controls: Stryker India Medical Equipment Private Limited India\nEXHIBIT 23--CONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of Stryker Corporation and subsidiaries of our report dated January 31, 1995, included in the 1994 Annual Report to Stockholders of Stryker Corporation and subsidiaries.\nOur audits also included the financial statement schedule of Stryker Corporation and subsidiaries listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In 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 set forth therein.\nWe also consent to the incorporation by reference in the Registration Statement Number 33-55662 on Form S-8 dated December 11, 1992, Registration Statement Number 2-96467 on Form S-8 dated April 4, 1985, and Registration Statement Number 33-32240 on Form S-8 dated November 20, 1989 and to the related prospectus for each of the registration statements, of our report dated January 31, 1995, with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K) of Stryker Corporation.\nERNST & YOUNG LLP\nKalamazoo, Michigan March 17, 1995 [ARTICLE] 5","section_15":""}
{"filename":"13610_1994.txt","cik":"13610","year":"1994","section_1":"ITEM 1. BUSINESS\nThe Registrant was incorporated in the State of New York in 1968. The Registrant and its subsidiaries are hereinafter collectively referred to as the Company, unless otherwise noted. The Company, through its subsidiaries, is engaged in providing the timely and accurate preparation and distribution of documentation related to corporate and governmental financing, information management and compliance documentation services throughout the United States and Canada and also in London, Paris, Hong Kong, Singapore and Mexico City, with affiliates worldwide.\nThe percentage of the Company's consolidated total sales attributable to each class of service offered by the Company for the last five years is set forth below.\nThe Company's financial printing includes registration statements, tax-exempt offering circulars, prospectuses, loan agreements, special proxy materials, tender offer materials and other documents related to corporate financings, acquisitions and mergers, as well as mutual funds. Corporate printing includes annual and interim reports and proxy materials prepared by corporations for distribution to stockholders, Securities and Exchange Commission reports on Form 10-K and stock exchange listing applications.\nThe Company's commercial printing includes business forms, sales aids and literature, point of purchase materials, market letters, newsletters and other custom-printed matter, prepared for customers engaged in general commerce. Legal printing consists of the printing of legal briefs and records for use by attorneys in trial, appellate and administrative proceedings.\nAlthough substantial investment in equipment and facilities is required, the Company's business is principally service-oriented. Financial and corporate printing services rendered by the Company normally begin with the receipt of customer copy, which may arrive as hard copy, on a diskette, magnetic tape or through electronic transfer and typically involve the rapid computer typesetting and printing of documents. Final copy for these documents is a composite resulting from drafting and editing by parties interested in each transaction, including corporate executives, investment bankers, attorneys and accountants. Prior to approval of final copy, numerous proofs are usually required to be supplied by the Company. When the parties have all agreed upon the contents of the document, last minute changes are made, final proofs are approved, and the job goes to press for printing. Thereafter, the document is bound into book form and delivered by various means to parties in diverse locations. Speed and accuracy are required at all stages, and frequently final alterations are made when pages of a document are on press. While the time pressures in connection with commercial and legal printing are not as great as in financial and corporate printing, the basic process and techniques employed are the same.\nThe Company maintains conference rooms and telecommunication capabilities at most of its offices for use by customers in conducting meetings associated with jobs in progress and provides customers with on-site conveniences which promote ease and speed of editorial copy changes and otherwise facilitate completion of assignments. In addition, the Company has developed and utilizes an extensive electronic communications network which facilitates document handling and makes collaboration by customers at different sites practicable.\nThe Company's operations are conducted principally in the United States and Canada. The Company also operates service centers in London, Paris, Hong Kong, Singapore and Mexico City to support its customers' multi-national transactions. Total sales, net income and identifiable assets attributable to the United States and Canada for fiscal 1994, 1993 and 1992 are shown in Note 12 of the Notes to Consolidated Financial Statements on page 21. Sales, income and assets attributable to the Company's operations outside the United States and Canada are not material.\nCOMPETITION\nThe Company renders printing services to a wide variety of customers, including business corporations, law firms, investment bankers, mutual funds, bond dealers and other financial institutions. Competition with respect to each of the services is intense and is based principally upon the ability to perform the services described with speed and accuracy. Price and the quality of supporting services are also important in this regard.\nThe Company competes directly with a number of other financial and corporate printers (some of which have multiple locations) having the same degree of specialization in these fields, some of which are subsidiaries or divisions of companies having greater financial resources than those of the Company. Although there is no published information available upon which to determine its share of the total financial and corporate printing market, the Company believes that it is the largest in these fields in terms of sales volume. Competition based upon speed, accuracy of service and location of facilities is particularly intense among financial and corporate printers. In addition, the Company has experienced intense competition for sales personnel and, to a lesser degree, production personnel relating to its financial and corporate printing services.\nIn the commercial and legal printing fields, the Company competes not only with other financial and corporate printers, but also with general, commercial and legal printers, which are far more numerous than those in the financial and corporate class. The Company's participation in and share of these markets are minor.\nRESEARCH AND DEVELOPMENT\nAs a result of technological developments in the field of computers and peripheral equipment, the Company and its principal competitors utilize computerized typesetting systems in the process of preparing documentation. A research and development capability is maintained by the Company to continually evaluate the advances in computer software, hardware and peripherals, computer networking and telecommunication systems as they relate to the Company's business and to develop and install enhancements to the Company's own proprietary system. The Company's research and development expenditures, determined in accordance with generally accepted accounting principles, are not material.\nMARKETING\nThe Company employs approximately 200 sales people. In addition to soliciting business from existing and prospective customers, the sales people act as a liaison between the customer and those in charge of service operations and provide advice and assistance to customers. The Company regularly advertises in financial newspapers and journals. Sales promotion is also carried on by mail.\nSEASONAL AND OTHER FACTORS AFFECTING THE COMPANY'S BUSINESS\nThe Company's business is generally affected by cyclical factors. A substantial portion of the Company's sales and net income depends upon the volume of public financings, particularly equity offerings, which is influenced by corporate funding needs, stock market fluctuations, prevailing interest rates, and general economic and political conditions. The above-mentioned factors also affect the volume of corporate acquisitions, consolidations, mergers and similar transactions, which in turn influence the demand for the Company's services. In addition, the Company's corporate printing business is seasonal to the extent that the greatest number of proxy statements and annual reports are required to be printed during the Company's fiscal quarter ending April 30.\nAs a result of the factors mentioned above, coupled with the general necessity for rapid implementation of printing jobs after delivery of copy by its customers, the Company must maintain physical plant and customer service staff sufficient to meet maximum work loads. Consequently, the Company does not always operate at full capacity.\nCUSTOMERS AND BACKLOG OF ORDERS\nThe Company has no significant long-term contracts with its customers. The Company has no backlog, within the common meaning of that term, which is normal throughout the industry. During the fiscal year ended October 31, 1994, no customer accounted for 10% or more of the Company's sales.\nEMPLOYEES\nAt October 31, 1994, the Company had 2,743 employees. Relations with the Company's employees generally are considered to be satisfactory. Approximately 20% of the Company's production employees are members of various unions, which represent different categories of workers. The subsidiaries of the Company which have union employees in their plants enter into separate contracts with various local unions. Such contracts include provisions for employer contributions to pension and welfare plans. The Company also provides pension, profit-sharing, certain insurance and other benefits to most non-union employees.\nSUPPLIERS\nThe Company purchases various materials and services from a number of suppliers, of which the most important items are paper and electrical energy. The Company purchases paper from a paper mill and paper merchants. Alternate sources of supply are presently available. No difficulty has been experienced to date in obtaining adequate amounts of paper or electrical energy. However, a severe paper or energy shortage could have an adverse effect upon the operations of the Company.\nPATENTS AND OTHER RIGHTS\nThe Company has no significant patents, licenses, franchises, concessions or other rights except its trademarks, nor does it have specialized machinery, facilities or contracts which are not available to other firms in the industry except a proprietary computer typesetting and telecommunications system.\nFOREIGN SALES\nThe Company's foreign operations are located in Canada, London, Paris, Hong Kong, Singapore and Mexico City. In addition, the Company has affiliations with certain printing firms abroad, but its sales and revenues derived from services rendered in foreign countries other than Canada were less than 5% of the Company's total sales in each of the past three fiscal years. See Note 12 of the Notes to Consolidated Financial Statements on page 21.\nRENEGOTIATION\nNo significant portion of the Company's sales is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nInformation regarding the material facilities of the Company, as of October 31, 1994, seven of which are leased and ten of which are owned in fee, is set forth below.\nAll of the properties described above are well maintained, in good condition and suitable for all presently anticipated requirements of the Company. Virtually all of the Company's equipment is owned outright, free and clear of any liens and encumbrances. A relatively minor amount of equipment utilized by the Company is rented on short-term leases, and no renewal problems are anticipated. All of the foregoing properties are used in the Company's printing business. Reference is made to Notes 8 and 11 of the Notes to Consolidated Financial Statements on pages 20 and 21.\nITEM 3.","section_3":"ITEM 3. PENDING LEGAL PROCEEDINGS\nThe Company is involved in no pending legal proceedings other than routine litigation incidental to the conduct of its business which is not material to its business. Reference is made to Note 13 of the Notes to Consolidated Financial Statements on page 22.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nInapplicable.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation regarding executive officers of the Registrant is presented in Part III below and incorporated here by reference.\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 \"BNE\". The following is the range of high and low sales prices and dividends paid per share for fiscal 1994 and 1993 by quarters.\nAs of October 31, 1994, there were approximately 1,500 stockholders of record of the Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table summarizes information with respect to the operations of the Company.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has a strong financial position, with excellent liquidity. On October 31, 1994, the Company had a working capital ratio of 3.08 to 1 and working capital of $106,497,000.\nCash generated from operations, available working capital and borrowings have been used to finance acquisitions, capital expenditures, payment of debt, purchase of treasury stock and payment of dividends. It is expected that such funds and the Company's borrowing capacity will be sufficient to finance the Company's growth, future capital expenditures, acquisition of treasury stock, payment of dividends and possible acquisitions.\nINFLATION\nThe Company has experienced the effects of inflation through increases in the costs of employee compensation and related fringe benefits, facilities, outside services, raw materials and other supplies. Due to price competition, the Company does not always fully recover all of its increased costs.\nRESULTS OF OPERATIONS\nThe Company provides printing services to produce the varied documentation required by major financial transactions, corporate periodic reports, restructuring plans for bankrupt companies, communication to shareholders and basic commercial printing. The sales value of each project is dependent, among other things, upon the size, complexity and type of document printed, the time allowed for completion and the level of changes required, and may be further impacted by the level of competition.\nThe Company's corporate printing business is seasonal to the extent that the greatest number of proxy statements and annual reports are required to be printed during the Company's second fiscal quarter ending April 30. In addition, the Company's business is generally affected by cyclical conditions in the capital markets.\nThe general necessity for rapid document processing after delivery of copy by its customers requires that the Company maintain physical plant and customer service staff sufficient to meet maximum work loads. Consequently, the Company does not always operate at full capacity. The costs for facilities, labor and equipment constitute a major portion of the costs of goods sold. These costs do not normally increase or decrease proportionally with changes in sales.\n1994 COMPARED WITH 1993\nSales increased 14% to $380,653,000. This increase was primarily attributable to increased sales of non-transactional printing to corporate, mutual funds and specialized commercial printing clients. Such non-transactional printing traditionally generates lower gross margins than transactional printing. Although intensive for the first six months, demand for transactional printing declined in the second half of 1994 and represented a lower proportion of total sales this year. In addition, the Company also experienced increases in production costs during 1994 as a result of the expansion of facilities and increases in the work force as well as general cost increases. Consequently, the gross margin percentage decreased from 48% to 42% and the gross margin decreased 1%, or $1,484,000.\nOther revenues increased $899,000 to $5,233,000 principally as a result of capital gains related to the sale of securities.\nSelling and administrative expenses increased $3,130,000, or 3%, to $93,452,000 principally as a result of increases in sales compensation and other expenses related to increases in sales as well as general increases in the costs of facilities and labor.\nDepreciation and amortization expenses increased $2,299,000, or 18%, primarily as a result of expansion of facilities and the acquisition of equipment.\nInterest expense decreased $1,206,000 due to the reduction of the Company's debt.\nThe effective overall income tax rate increased from 40% to 42% as a result of a higher effective tax rate on foreign earnings, a reduction in the amount of available credits and certain other adjustments.\nAs a result of the foregoing, income before income taxes decreased $4,808,000, or 8%, to $54,203,000 and net income decreased $4,079,000, or 12%, to $31,240,000.\n1993 COMPARED WITH 1992\nSales increased 18%, to $333,255,000, due to even higher levels of debt and equity offerings than a year earlier and increased levels of activity in mutual funds and merger and acquisition work. The overall increase in sales, combined with a relatively constant gross margin percentage, contributed to a $23,722,000 increase in gross margin.\nOther revenues increased $521,000 to $4,334,000 principally as a result of capital gains related to the sale of surplus property.\nSelling and administrative expenses increased $12,434,000, or 16%, to $90,322,000 principally as a result of increases in sales and incentive compensation and other expenses related to higher sales and profitability, and increases in the number of employees and the costs of facilities and labor.\nDepreciation and amortization expenses increased $381,000, or 3%, primarily as a result of expansion of facilities.\nInterest expense decreased $545,000 due to the reduction of the Company's debt.\nThe effective overall income tax rate remained relatively constant as the new higher tax rate contained in the Omnibus Budget Reconciliation Act of 1993 was partially offset by the increased proportion of income earned in state and foreign jurisdictions with lower tax rates.\nAs a result of the foregoing, income before income taxes increased $11,973,000, or 25%, to $59,011,000 and net income increased $7,051,000, or 25%, to $35,319,000.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Stockholders Bowne & Co., Inc.\nWe have audited the accompanying consolidated balance sheets of Bowne & Co., Inc. and Subsidiaries as of October 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 October 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 Bowne & Co., Inc. and Subsidiaries at October 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 October 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\nNew York, New York December 9, 1994\nBOWNE & CO., INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nOCTOBER 31, 1994 AND 1993\nASSETS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nBOWNE & CO., INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nOCTOBER 31, 1994 AND 1993\nLIABILITIES AND STOCKHOLDERS' EQUITY\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nBOWNE & CO., INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME YEARS ENDED OCTOBER 31, 1994, 1993 AND 1992\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nBOWNE & CO., INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED OCTOBER 31, 1994, 1993 AND 1992\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nBOWNE & CO., INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED OCTOBER 31, 1994, 1993 AND 1992\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nBOWNE & CO., INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- SUMMARY OF ACCOUNTING POLICIES\nA summary of the Company's significant accounting policies followed in the preparation of the accompanying financial statements is set forth below:\nPrinciples of consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All of the significant intercompany accounts and transactions are eliminated in consolidation.\nInventories\nInventories are valued at the lower of cost or market. Cost is determined by using purchase cost (first-in, first-out method) for materials and standard costs, which approximate actual costs, for work in process.\nReal estate, equipment and leasehold improvements\nReal estate, equipment and leasehold improvements are carried at cost. Maintenance and repairs are expensed as incurred.\nDepreciation for financial statement purposes, which is provided on the straight-line method, was $13,786,000 (1994), $11,373,000 (1993) and $10,914,000 (1992). Depreciation is calculated for tax purposes using accelerated methods.\nEstimated lives used in the calculation of depreciation for financial statement purposes are:\nExcess of cost of subsidiaries over net assets at date of acquisition\nCost in excess of net assets (\"goodwill\") of acquired businesses is being amortized using the straight-line method over forty years. Accumulated amortization was $4,140,000 (1994) and $3,445,000 (1993).\nIntangible assets\nTrademarks, tradenames and other intangible assets of acquired businesses, included in other assets, are amortized on the straight-line method over five years. Accumulated amortization was $4,646,000 (1994) and $5,169,000 (1993).\nIncome taxes\nEffective November 1, 1993, the Company prospectively adopted Statement of Financial Accounting Standards (FAS) No. 109 \"Accounting for Income Taxes.\" There was no material cumulative effect of this accounting change at the time of adoption.\nUnited States income tax has not been provided on the unremitted earnings of the Canadian subsidiary since it is the intention of the Company to reinvest these earnings in the growth of the Canadian business. Applicable Canadian income taxes have been provided. The cumulative amount of unremitted earnings on which the Company has not recognized United States income tax was $22,856,000 at October 31, 1994.\nBOWNE & CO., INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAlthough it is not practicable to determine the deferred tax liability on the unremitted earnings, credits for Canadian income taxes paid will be available to significantly reduce any U.S. tax liability if Canadian earnings are remitted.\nNet income per share\nNet income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the year. Shares which are issuable upon the exercise of stock options under the Company's Stock Option Plans have not entered into the computation because their inclusion would not be significant. The weighted average number of shares outstanding was 17,353,645 (1994), 17,231,847 (1993) and 17,117,010 (1992).\nNOTE 2 -- CASH AND CASH EQUIVALENTS\nThe Company's policy is to invest cash in excess of operating requirements in income producing investments. Cash equivalents of $28,558,000 (1994) and $22,127,000 (1993) are carried at cost, which approximates market, and include certificates of deposit and money market accounts, substantially all of which have maturities of three months or less.\nNOTE 3 -- INVENTORIES\nInventories consist of the following:\nNOTE 4 -- MARKETABLE SECURITIES\nMarketable securities, consisting of equity securities, notes and bonds, are carried at the lower of cost or market. These securities are held primarily for their interest or dividend yields. At October 31, 1994 and 1993, net unrealized gains were $956,000 and $4,600,000, respectively.\nNOTE 5 -- EMPLOYEE BENEFIT PLANS\nPension plans\nThe Company sponsors a defined benefit pension plan which covers substantially all of its United States employees not covered by union agreements. Benefits are based upon salary and years of service under the projected unit benefit method. The Company's policy is to fund each year's pension expense to the maximum allowable level. The Company has an unfunded supplemental retirement program for certain management employees. Employees covered by union agreements are included in separate multi-employer pension plans to which the Company makes contributions. Plan benefit and net asset data for these multi-employer pension plans are not available. Also, certain non-union Canadian employees are covered by defined contribution retirement plans.\nBOWNE & CO., INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nPension costs are summarized as follows:\nThe status of the Company's funded defined benefit pension plan is as follows:\nAt October 31, 1994, the projected benefit obligation under the unfunded supplemental retirement program amounted to $4,444,000 for retired employees and $1,728,000 for active employees, which amounts have been fully accrued. The plan contains covenants which prohibit retired participants from engaging in competition with the Company.\nThe discount rate used to calculate the projected benefit obligations was 7.25% in 1994 and 7.5% in 1993. The rate used to project future salary increases was 5.0% for 1994 and 5.5% for 1993. The long-term rate of return on plan assets was 9.0% (1994, 1993 and 1992). The assets of the funded plan consist primarily of equity and fixed income securities.\nProfit sharing plan\nCertain subsidiaries are participating companies in a qualified profit sharing plan covering substantially all employees of those subsidiaries who are not covered by union agreements. Amounts charged to income for the Profit Sharing Plan were $6,211,000 (1994), $6,960,000 (1993) and $5,925,000 (1992).\nStock purchase plan\nUnder the Employees' Stock Purchase Plan, participating subsidiaries match 50% of amounts contributed by employees. All contributions are invested in the common stock of the Company. The plan acquired 78,899\nBOWNE & CO., INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nshares (1994), 69,409 shares (1993) and 81,839 shares (1992) of the Company's common stock on the open market. At October 31, 1994, the Stock Purchase Plan held 466,427 shares of the Company's common stock. Charges to income amounted to $472,000 (1994), $385,000 (1993) and $414,000 (1992).\nNOTE 6 -- STOCK OPTION PLANS\nThe Company has two stock option plans, a 1981 Plan and a 1992 Plan. The 1981 Plan, which provided for the granting of 1,400,000 shares of the Company's common stock, expired December 15, 1991 except as to options then outstanding.\nThe Company's 1992 Stock Option Plan provides for the granting of Incentive Stock Options and Non-Qualified Options to purchase 850,000 shares of the Company's common stock to officers and key employees at a price not less than the fair market value on the date the option is granted.\nOptions become exercisable as determined at the date of grant by a committee of the Board of Directors. Options expire ten years after the date of grant unless an earlier expiration date is set at the time of grant.\nDetails of stock options are as follows:\nAt October 31, 1994, options to purchase 386,500 shares were available for grant under the 1992 Plan.\nBOWNE & CO., INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 7 -- INCOME TAXES\nThe provision for income taxes is summarized as follows:\nThe provision for income taxes differed from the U.S. Federal statutory rate for the following reasons:\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 October 31, 1994 calculated under FAS 109 are as follows:\nBOWNE & CO., INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFor 1993 and 1992, the deferred tax provisions, 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 1993 and 1992 were:\nCanadian income before income taxes, excluding any allocation of general corporate expenses, was $4,728,000 (1994), $3,519,000 (1993) and $1,031,000 (1992).\nNOTE 8 -- NOTES PAYABLE AND LONG-TERM DEBT\nNotes payable\nThe Company's Canadian subsidiary has agreements with Canadian banks which provide the funds to meet short-term working capital requirements. Borrowings under the agreements bear interest at prime plus .25% and are due on demand. At the end of 1994 the amount outstanding on these agreements was $2,556,000. The weighted average interest rate for 1994 was 6.0%. The carrying value of amounts outstanding at the end of 1994 approximates fair values due to their short-term nature. There were no amounts outstanding at the end of 1993.\nLong-term debt\nThe Company's senior notes, which bore interest at 8.45%, were paid during 1994.\nThe Company's other long-term debt of $3,683,000 consists primarily of a capital lease obligation, a mortgage and debt related to the Canadian subsidiary bearing interest from 8.5% to 11.4%. The debt is secured by land, buildings, machinery and equipment with a net book value of $3,804,000. The lease requires aggregate payments of $4,653,000 through 2002 with annual payments of $524,000 through 1996, $581,000 in 1997 and $660,000 in 1998 and 1999. Of the aggregate payments, $1,777,000 represents executory and interest costs and $2,876,000 represents the present value of the capital lease obligation.\nAggregate annual installments of both the notes payable and long-term debt due for the next five years are $3,061,000, $348,000, $335,000, $459,000 and $502,000 respectively.\nNOTE 9 -- DEFERRED EMPLOYEE COMPENSATION AND BENEFITS\nDeferred employee compensation and benefits consist of the following:\nBOWNE & CO., INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 10 -- OTHER REVENUE\nThe components of other revenue are summarized as follows:\nNOTE 11 -- LEASE COMMITMENTS\nThe Company's subsidiaries occupy premises and utilize equipment under leases which are classified as operating leases and expire at various dates to 2002. Many of the leases provide for payment of certain expenses and contain renewal and purchase options.\nRent expense relating to premises and equipment amounted to $7,034,000 (1994), $6,728,000 (1993) and $6,393,000 (1992). The minimum annual rental commitments under non-cancelable leases as at October 31, 1994 are summarized as follows:\nNOTE 12 -- SEGMENT AND GEOGRAPHIC DATA The Company is engaged in one line of business -- financial, corporate, legal and commercial printing. Information about the business of the Company by geographic area is presented in the table below. Sales or transfers between geographic areas and United States export sales were not material. General corporate expenses are included under the Company's domestic operations.\nBOWNE & CO., INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 13 -- LEGAL PROCEEDINGS\nIn January 1992, the Company commenced a legal action in the U.S. District Court for the Southern District of New York against Ambase Corporation to recover approximately $1.7 million owed to the Company for printing services rendered in 1991. In a response filed in March 1992, Ambase denied any obligations to pay the amounts owed to the Company and in a counterclaim against the Company asserted that as a result of the failure by the Company to complete the printing of certain proxy materials on time, Ambase was damaged in an amount in excess of $23 million. The Company believes this counterclaim is without merit and is pursuing its action for payment and is defending against the counterclaim vigorously. Accordingly, no provision has been made in the Company's financial statements with respect to the counterclaim against the Company. In the opinion of the Company's management, the ultimate resolution of these claims will not have a material adverse effect on the Company's financial position.\nNOTE 14 -- SELECTED QUARTERLY INFORMATION (UNAUDITED)\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\nRegarding the directors of the Registrant, reference is made to the information set forth under the caption \"Election of Directors\" in the Company's definitive Proxy Statement anticipated to be dated February 3, 1995, which information is incorporated by reference herein.\nThe principal executive officers of the Company and their recent business experience are as follows.\nThere are no family relationships between any of the executive officers, and there are no arrangements or understandings between any of the executive officers and any other person pursuant to which any of such officers was selected. The executive officers are normally elected by the Board of Directors at its first meeting following the Annual Meeting of Stockholders for a one-year term or until their respective successors are duly elected and qualify.\nTo the best of the Company's knowledge, none of the directors and officers of the Company failed to file on a timely basis any report on Forms 3, 4 and 5 which was required pursuant to Section 16(a) of the Securities Exchange Act of 1934 with respect to the Company's most recent fiscal year.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is made to the information set forth under the caption \"Executive Compensation\" appearing in the Company's definitive Proxy Statement anticipated to be dated February 3, 1995, 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 contained under the captions \"Principal Stockholders of the Company\" and \"Executive Compensation\" in the Company's definitive Proxy Statement anticipated to be dated February 3, 1995, which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInapplicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) DOCUMENTS FILED AS PART OF THIS REPORT:\n(1) Financial Statements:\n(2) Financial Statement Schedule -- Years Ended October 31, 1994, 1993 and 1992:\nAll other schedules are omitted because they are not applicable.\n(3) Exhibits:\n(B) No reports on Form 8-K were filed by the Company during the quarter ended October 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.\nBOWNE & CO., INC.\nDated: January 24, 1995 By RICHARD H. KOONTZ --------------------------- RICHARD H. KOONTZ Chairman of the Board 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.\nBOWNE & CO. INC. AND SUBSIDIARIES\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED OCTOBER 31, 1994, 1993 AND 1992\n- ---------------\n(a) Uncollectible accounts written off, net of recoveries.\nS-1\nEXHIBIT INDEX\nEXHIBIT NO. DESCRIPTION ------ -----------------------------------------------------------------\n21 Subsidiaries of the Company\n23 Consent of Independent Auditors\n27 Financial Data Schedule, which is submitted electronically to the Securities and Exchange Commission for information only and not filed.","section_15":""}
{"filename":"798246_1994.txt","cik":"798246","year":"1994","section_1":"Item 1. BUSINESS --------\nGeneral -------\nForstmann & Company, Inc., a Georgia corporation (the \"Company\" or \"Forstmann\"), is a leading designer, marketer and manufacturer of innovative, high quality fabrics which are used primarily in the production of brand-name and private label apparel for men and women. Forstmann's fabrics are used in suits, dresses, sportwear, trousers, sportcoats and outerwear made by some of the world's leading apparel manufacturers. The Company also produces specialty fabrics for use in billiard and gaming tables, sports caps and career uniforms. The Company's customers are demanding increasingly high levels of service and innovation from their suppliers. To create fabrics to meet shifting consumer tastes and stringent product specifications, the Company works in partnership with its customers through extensive product development and design efforts. To support its customer-oriented marketing strategy, the Company's manufacturing operations are designed to accommodate relatively short production runs of these customized fabrics. The Company manufactures fabrics produced from 100% wool and wool blends and, recently, of blends of other natural and man-made fibers. The Company believes that it is the largest manufacturer of domestically produced woolen fabrics and the second largest manufacturer of domestically produced worsted fabrics.\nDuring the Company's 1994 fiscal year (the fifty-two week period from November 1, 1993 through October 30, 1994) (\"Fiscal Year 1994\"), womenswear and outerwear fabrics accounted for approximately 64.0% of revenues and menswear fabrics accounted for approximately 28.5% of revenues. Specialty fabrics, including government and other, accounted for its remaining revenues.\nAlthough Forstmann was incorporated in December 1985, its predecessors have been in business for over 100 years. The Company is the successor to the business of the Woolen and Worsted Fabrics Division of J.P. Stevens & Co., Inc., the assets of which the Company acquired in February 1986.\nThe principal executive offices of the Company are located at 1185 Avenue of the Americas, New York, New York 10036, and its telephone number is (212) 642-6900.\nSignificant Events ------------------\nThe 1992 Recapitalization\nDuring fiscal year 1992, the Company completed a restructuring and recapitalization (the \"1992 Recapitalization\") whereby the Company (a) merged with an affiliated company (the \"Merger\"), which resulted in each issued and outstanding share of the Company's common stock and non-voting common stock prior to the Merger (except with respect to the shares held by dissenting shareholders. See Item 3. Legal Proceedings) being converted into 1\/2,172 of an identical share of common stock of the Company without any payment or other consideration in respect thereof (the \"Reverse Stock Split\"), (b) accepted $46,240,100 aggregate face amount of the Split Coupon Notes in exchange for $19,596,758 cash and 2,420,904 unregistered shares of the Company's common stock (the \"Exchange Offer\"), (c) completed an initial public offering and sold 2,750,000 shares of common stock at $8.37 net per share (the \"Public Offering\"), and (d) received from Odyssey $3,712,500 of the cash consideration Odyssey had received in the Exchange Offer as the purchase price for 412,500 unregistered shares of the Company's common stock. In connection with the Exchange Offer, in March 1992, the Company agreed that it would not exercise its rights of optional redemption with respect to the 14-3\/4% Senior Subordinated Notes and Split Coupon Notes due April 1999 (collectively, the \"Subordinated Notes\"). The 1992 Recapitalization reduced the Company's long-term indebtedness by $46.2 million (see Note 14 to the Financial Statements included in Item 8. of this Annual Report on Form 10-K).\nQuasi Reorganization\nThe Company, with approval from its Board of Directors, revalued its assets and liabilities to fair value as of the beginning of the Company's 1993 fiscal year (the fifty-two week period from November 2, 1992 through October 31, 1993) (\"Fiscal Year 1993\") pursuant to the principles of quasi- reorganization accounting (the \"Quasi Reorganization\"), which is a voluntary accounting procedure that permits an entity which has emerged from previous financial difficulty to restate its accounts to estimated fair values and to eliminate its retained deficit against additional paid-in capital. Quasi Reorganization fair value adjustments recorded during Fiscal Year 1993 resulted in a writedown of the Company's net assets of $22.5 million that was charged to the Company's retained deficit account. Subsequent to the fair value adjustments, the balance in the Company's retained deficit account of $59.6 million was eliminated against the Company's additional paid-in capital account. The fair value adjustments of the Quasi Reorganization had the effect of reducing shareholders' equity from $51.1 million to $28.6 million as of the beginning of Fiscal Year 1993.\nAt the effective date of the Quasi Reorganization, the Company had certain unresolved contingencies related to specific environmental matters and litigation with certain dissenting shareholders (the \"Dissenters' Proceeding\") (see Item 3. Legal Proceedings). In accordance with the principles of quasi-reorganization accounting, the difference between the actual costs subsequently incurred to resolve these matters and the liabilities recorded at the time of the Quasi Reorganization will be charged or credited to additional paid-in capital, as appropriate. During Fiscal Year 1994, $206,000 (net of income taxes) and $1,788,000 related to the environmental matters and Dissenters' Proceeding, respectively, were charged to additional paid-in capital as adjustments to the amounts initially recorded in the Quasi Reorganization (see Note 14 to the Financial Statements included in Item 8. of this Annual Report on Form 10-K).\nOther Financing Events\nThe Company, as of October 30, 1992, entered into a five-year, $100 million senior secured credit facility with General Electric Capital Corporation (\"GECC\"), as agent and lender (the \"GECC Facility\"). The GECC Facility consisted of a $15 million term loan (the \"Original Term Loan\") and an $85 million revolving line of credit (the \"Revolving Line of Credit\"). In April 1993, the Original Term Loan was prepaid in full. The initial borrowing under the GECC Facility, on November 13, 1992, repaid the Company's then existing $85 million senior secured credit facility, which was scheduled to expire in November 1994, and secured then outstanding letters of credit. See \"Financing Arrangements -- GECC Facility\".\nOn April 5, 1993, the Company issued an aggregate of $20 million Senior Secured Notes (the \"Original Senior Secured Notes\") and on March 30, 1994, the Company issued an aggregate of $10 million Senior Secured Notes (the \"Additional Senior Secured Notes\"), all of which are due October 30, 1997 (collectively the \"Senior Secured Notes\"). The net proceeds from the Original Senior Secured Notes were used to repay the Original Term Loan and to repay a portion of borrowings outstanding under the Revolving Line of Credit. The net proceeds from the Additional Senior Secured Notes were used to repay a portion of the borrowings outstanding under the Revolving Line of Credit. The Senior Secured Notes were issued pursuant to an indenture, dated April 5, 1993, which was amended and restated as of March 30, 1994 between the Company and Shawmut Bank Connecticut, National Association, as trustee (the \"Senior Secured Notes Indenture\"). See \"Financing Arrangements -- Senior Secured Notes\".\nSubsequent to Fiscal Year 1994 certain financial covenants under the GECC Facility, the Indenture to the Senior Secured Notes and the CIT Equipment Facility (see Financing Arrangements -CIT Equipment Facility) were further amended, in part to reflect the effect of rising interest rates, final settlement of claims with the Company's remaining dissenting shareholders as discussed in Item 3. Legal Proceeding -- Dissenters' Proceedings and the additional debt the Company incurred to fund higher working capital needs and capital expenditures. Also, the GECC Facility was further amended to provide the $7.5 million Term Loan and the CIT Equipment Facility (hereinafter defined) was amended to provide for up to $5.0 million of additional equipment financing. In January 1995, the Company borrowed $7.5 million under the Term Loan, the proceeds of which were used to repay outstanding borrowings under the Revolving Line of Credit.\nDescription of Business -----------------------\nMARKETS AND PRODUCTS. Forstmann fulfills many of the diverse fabric needs of leading men's, women's and outerwear apparel makers by offering a collection of wool, wool-blend, synthetic and synthetic-blend fabrics, as well as fabrics blended with natural fibers such as linen, cotton and silk. These fabrics are offered in a wide variety of styles, colors, weaves and weights which can be used in tailored clothing, sportswear, coats for men and women, as well as for specialty applications. The Company introduces new collections throughout the year to ensure that its customers are frequently exposed to the latest fabric offerings and to accommodate seasonal retail cycles. This has resulted in stronger, year-round customer relationships and more balanced manufacturing.\nWomenswear and Outerwear. The Company designs, markets and manufactures woolen and worsted fabrics for women's apparel in the moderate, better and bridge price range for sportswear, suits and dresses, as well as for women's outerwear. The fabric selection for women's apparel includes traditional fabrics, such as 100% wool gabardines, crepes and 100% wool flannels, meltons and velours, as well as additional fabrics made from 100% viscose and blends of wool\/nylon, wool\/viscose, and viscose\/linen. These additional fabrics enable the Company to serve its womenswear customers year-round. The Company is a dominant supplier of outerwear fabrics for women's woolen coats. In Fiscal Year 1994, womenswear and outerwear accounted for 64.0% of total revenue.\nMenswear. The Company designs, markets and manufactures fabrics in the moderate and better price range for men's apparel such as suits, sportcoats, blazers, trousers and formal wear. The fabric selection includes traditional fabrics, such as tropicals, gabardines and flannels in wool and wool blends, as well as fabrics made from wool, man-made fibers such as viscose and polyester and natural fibers such as silk, linen and cotton. These fabrics have allowed the Company to expand from its traditional base of tailored clothing manufacturers to new areas such as suit separates, casual sportswear and weekend wear. In Fiscal Year 1994, menswear accounted for 28.5% of total revenue.\nSpecialty Fabrics. The Company produces specialty fabrics for a wide variety of end uses, including billiard and gaming tables, sports caps and school uniforms. The Company is a leading billiard table fabric manufacturer in the United States, selling directly to manufacturers and distributors. In addition, during fiscal year 1992, the Company began distributing billiard table fabric in Europe. The Company also is the sole supplier of wool fabric used in the production of official major league baseball caps for on-field play. Recently the Company has begun marketing career uniform apparel designed to meet stringent requirements for comfort and durability and, in some cases, washability. Although specialty fabrics currently represent a small portion of total revenues, the Company considers its initiatives in the specialty fabrics division important to its overall strategy of product diversification and innovation.\nForstmann International. In July 1992, the Company formed its Forstmann International division and entered into a licensing, technical information and consulting arrangement with Compagnia Tessile, S.p.A., an Italian corporation, and its affiliate. Under the arrangement, the Company has the exclusive right to sell \"Carpini\/TM\/ USA\" fabrics for men's and women's apparel in the United States, Canada and nonexclusive rights in Mexico for an initial period of five years. These high quality fabrics, styled in Italy and manufactured in Georgia, are marketed through a specialized sales force to the designer and bridge apparel markets in North America. Additionally, the Company imports certain fabrics from Carpini and its affiliate which the Company markets in the United States and Canada.\nMERCHANDISING AND MARKETING. The Company's merchandising and marketing functions are integrated and include both the conceptualization (merchandising) and the sale (marketing) of the product line. The Company's merchandising and marketing functions are directed from its New York office and are organized around the Company's three customer end-use divisions.\nMANUFACTURING. The Company's vertically integrated facilities (which perform operations beginning with opening, blending and spinning raw stock into yarn through weaving, to dyeing and finishing fabric) enable the Company to produce, in addition to woolens and worsteds, a wide variety of other natural and synthetic-blend fabrics. The Company is the only major United States mill which produces fabrics on both the woolen and worsted systems.\nWoolen fabrics, such as flannels, are woven from yarns containing short, unstraightened wool fibers which remain in a haphazard arrangement, creating a \"fuzzy\" appearance. Worsted fabrics, such as gabardine and serge, are woven from yarns composed of longer wool fibers that have been combed to align the fibers in parallel and to remove shorter fibers.\nFor the production of woolen yarns, the Company purchases scoured (cleansed and degreased) wool, which is then blended and carded to remove impurities, disentangle locks and straighten individual fibers. The carded wool is then spun into woolen yarn. To produce worsted yarns, the Company purchases combed wool top, which is pin-drafted and straightened to produce long staple wool fibers spun into worsted yarn. Polyester or other synthetic fibers are, sometimes, combined with wool in the spinning process to produce a variety of woolen and worsted blends.\nWoolen, worsted or wool-blend yarns are woven to produce either greige or patterned fabrics. Other yarns, such as viscose, linen, silk, polyester or cotton (all of which the Company purchases from outside suppliers), are sometimes woven directly into non-wool fabrics or combined with woolen or worsted yarn.\nAfter weaving, most fabric is piece-dyed and finished to impart the desired color and feel (or \"hand\") to the fabric. Fabrics woven, dyed and finished in this manner are referred to as \"plain\" fabrics. Multicolored patterned fabrics, known as \"fancy\" fabrics, are woven from colored yarns which are dyed by the Company either as scoured wool prior to spinning or in packages of spun yarn. As with piece-dyed fabrics, fancy fabrics go through various finishing processes to achieve the appropriate \"hand\" or feel.\nThe Company maintains a physical testing laboratory to ensure product quality from blending through finishing. In addition, all fabrics go through multiple cleaning stages and a final quality inspection prior to packaging and shipping.\nThe Company's facilities are sufficiently flexible to allow the Company to perform both short and long runs of all types of fabrics it produces.\n---------------------------------------- Carpini is a trademark of Carpini S.r.l.\nCAPITAL INVESTMENT PROGRAM. During fiscal year 1992, the Company established a six-year, $100 million capital investment program. This program is designed to (i) reduce manufacturing costs, (ii) enhance product quality, (iii) provide greater manufacturing flexibility while maintaining operating efficiencies, (iv) improve the Company's technical capabilities to provide new blends, styles and colors of fabrics to be offered. Through the end of Fiscal Year 1994, the Company has made capital expenditures (including capital leased assets) of $42.3 million in connection with this program and entered into certain operating leases associated with machinery and equipment, constituting approximately one-half of its capital investment program. When completed, these investments will cover virtually every phase of the Company's manufacturing operations, from yarn manufacturing to weaving to fabric dyeing and finishing. The Company believes that the program will improve productivity and produce savings in the areas of labor, energy, raw material usage and asset maintenance. In light of increasing interest rates, as well as increased borrowings to fund its working capital needs, the Company is reassessing the timing of its capital investment program. The Company expects spending for capital expenditures, primarily machinery and equipment, in fiscal year 1995 to be slightly less than Fiscal Year 1994.\nThe Company has allocated approximately 35% of its planned expenditures to the yarn-making process, in which major projects include updating fiber- blending systems and modernizing spinning, card condenser and winding equipment. Approximately 22% of its planned expenditures will be in the area of weaving, in which major projects will include adding rapier looms. Approximately 28% of its planned expenditures will be in the area of dyeing and finishing, in which major projects will include adding a computerized dye house formula and control process and dyeing equipment that is highly flexible in batch size. The remaining planned expenditures will be for management information systems and facilities. During Fiscal Year 1994, the Company spent approximately $15.0 million on capital improvements, including the modernization of certain bin blending and yarn-handling equipment and the addition of certain yarn-making, dyeing and finishing equipment.\nRAW MATERIALS. The Company's raw material costs constituted approximately 31% of its cost of goods sold during Fiscal Year 1994. The primary raw material used by the Company is wool. As a result, the Company's costs are dependent on its ability to manage its wool inventory and control its wool costs. Approximately two-thirds of the Company's wool is imported from Australia and substantially all of the balance is purchased in the United States. The Company purchases its wool from brokers and is not dependent on a single supply source. The Company's foreign wool purchases are denominated in U.S. dollars and the Company generally does not incur any currency exchange risk. However, future changes in the relative exchange rates between United States and Australian dollars can materially affect the Company's results of operations for financial reporting purposes. Much of the Company's wool is purchased on extended payment terms. Recently, the cost of certain raw wool categories sourced from Australia has risen significantly, and a drought in Australia which has resulted in a reduction in sheep herds indicates that such costs will continue to increase in the near future. Based on the Company's forward purchase commitments and wool market trends, the Company expects wool costs to increase significantly in fiscal year 1995.\nCUSTOMERS. The Company has more than 571 active customers. In Fiscal Year 1994, no single customer accounted for 10% or more of the Company's revenues.\nSubstantially all of the Company's customers are located within the United States. During each of fiscal year 1992, Fiscal Year 1993 and Fiscal Year 1994, less than two percent of the Company's revenues arose from non- United States sales. In late 1994, a key executive was designated to create and implement a plan to develop international sales of Forstmann's products. Initially the Company will focus on developing export sales of its woolen products to Western Europe, Japan and Pacific Rim countries.\nBACKLOG. The Company's sales order backlog at January 1, 1995 was $61.3 million, a decrease of $12.0 million from the comparable period one year ago. Excluding government orders, which yield lower gross profit margins, the backlog at January 1, 1995 was $8.5 million less than the comparable period one year ago. The decline in the backlog, excluding government orders, is attributable to a decline in orders for women's outerwear, which was somewhat offset by increases in orders for menswear, specialty, converted and Carpini USA fabrics. The Company believes that the decline in orders for women's outerwear is due to the exceptionally warm temperatures registered across the country in the fall and early winter. Although the Company expects the effects of the warmer weather, which depressed retail sales of women's outerwear, to somewhat reverse itself during fiscal year 1995, there can be no assurance that such will occur. Sales of women's outerwear represented approximately 22% of net sales for Fiscal Year 1994. All of such backlog is expected to be filled during the current fiscal year.\nSEASONALITY. The wool fabric business is seasonal, with the vast majority of orders placed from December through April for manufacture and shipment from February through July to enable apparel manufacturers to produce apparel for retail sale during the fall and winter seasons. As a result of normal payment terms for sale of such fabrics, the Company receives the major portion of its payments thereon during July through October. The Company's worsted fabrics sales tend to be less seasonal because the lighter weight of such fabrics makes them suitable for retail sale in the spring and summer seasons as well as in the fall and winter seasons. The Company continues to develop and implement an aggressive marketing plan for the sale of blended fabrics and synthetics, which tend to be less seasonal.\nCOMPETITION. The textile business in the United States is highly competitive and the Company competes with many other textile companies, some of which are larger and have greater resources than the Company.\nThe Company believes that it is the largest domestic manufacturer of woolen fabrics and the second largest domestic manufacturer of worsted fabrics. The Company's principal competitors in the sale of woolen fabrics are Warshaw Woolen Associates, Inc. and Carleton Woolen Mills, Inc., and its principal competitors in the sale of worsted fabrics are Burlington Industries Equity Inc. and The Worcester Company, Inc. The Company believes that the principal competitive factors are fashion, quality, price and service, with the significance of each factor depending upon the product involved. The competitive position of the Company varies among the different fabrics it manufactures. The Company believes that its competitive advantages include its broad range of products, its ability to respond effectively to changing customer demands and its ability to deliver products in a timely manner.\nCurrently, imports of foreign-manufactured woolen and worsted fabrics face strict quotas and high import duties upon entering the United States. During calendar year 1993, imports of wool fabrics into the United States increased approximately 4.9% from calendar year 1992. The Company believes that such imports did not have a significant impact on its business since such imports were primarily of fabrics which normally are marketed in price ranges and are of a quality which are not within the price and quality ranges of the Company's fabrics.\nTwo major trading agreements evolved during the last year which, when implemented, are expected to have an impact on Forstmann's operations. The North American Free Trade Agreement (\"NAFTA\"), which became effective on January 1, 1994, is expected to have a long-term positive effect on the Company's growth. The Company believes that an increasing percentage of foreign-produced garments for sale in the United States, Canada and Mexico will be manufactured in Mexico, as compared to the Far East. In order for such garments to qualify for duty-free treatment into the United States and Canada, the fabric has to be sourced from the United States, Canada or Mexico. With limited wool fabric production capacity currently in Mexico and Canada, this requirement represents a major opportunity for woolen mills in the United States. The General Agreement on Trade and Tariffs (\"GATT\"), reduces tariffs on wool fabric from about one third, to 25%, over a ten-year period. In exchange for the tariff reduction, market access for products manufactured in the United States to countries that are parties to GATT is improved.\nThe Company believes that, overall, GATT will enable the Company to compete more effectively in the world market, thereby offsetting the effect of the tariff reductions.\nTRADEMARKS. The Company owns the Forstmann (R) name, which it uses as a trade name, as a trademark in connection with various merchandise, and as a service mark. The Company owns rights to various trademarks registered in the United States used in connection with its business and products, including Forstmann(R), Fast Forward(R), Casuwools(R) and Formula One(R). The Forstmann name is registered in various countries, including Austria, Australia, the Benelux countries, Canada, Denmark, France, Germany, Hong Kong, Ireland, Japan, Switzerland and the United Kingdom, under International Class 24. In addition, the Company has applied to register the Forstmann name in various countries, including Indonesia, Italy, Norway, Portugal, Spain and Sweden. The Company believes that no individual trademark or trade name, other than Forstmann(R), is material to the Company's business.\nEMPLOYEES. As of January 1, 1995, the Company employed approximately 2,450 hourly-paid, full-time skilled personnel at its plants and approximately 440 additional salaried, supervisory, management and administrative employees. None of the Company's employees is represented by a union or a labor organization. The Company has never experienced a strike and believes that its relations with its employees are good.\nEXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------\nThe executive officers of the Company are:\nPosition with the Name Age Company ---- --- ----------------\nChristopher L. Schaller 53 Chairman of the Board of Directors, President and Chief Executive Officer\nWilliam B. Towne 50 Executive Vice President and Chief Financial Officer\nFred D. Matheson 47 Executive Vice President-- Manufacturing\nRichard Pactor 57 Executive Vice President-- Product Development and President of the Forstmann International division\nPeter Roaman 44 Executive Vice President-- Marketing and Styling\nRodney J. Peckham 39 Vice President and Treasurer\nJane S. Pollack 49 Vice President, Secretary and General Counsel\nGary E. Schafer 43 Vice President and Corporate Controller\nThe business experience of each of the executive officers during the past five years is as follows:\nChristopher L. Schaller joined the Company in April 1990 as President and Chief Operating Officer, at which time he was also elected a director. Mr. Schaller became Chief Executive Officer in October 1990 and Chairman of the Board of Directors in March 1992. From 1988 until joining the Company, Mr. Schaller was President of the Apparel Fabrics Division of WestPoint Stevens, Inc. (a textile manufacturer).\nWilliam B. Towne joined the Company in June 1990 as Vice President and Chief Financial Officer. He also served as Treasurer from June 1990 to November 1990, and in March 1991, Mr. Towne was elected an Executive Vice President. Prior to joining the Company, Mr. Towne served with Tambrands, Ltd. (a manufacturer of consumer products), as Chief Financial Officer and Director of Finance-Europe from 1989 to June 1990.\nFred D. Matheson joined the Company in October 1990 as Executive Vice President--Manufacturing. Prior thereto, Mr. Matheson served with Fieldcrest Cannon Inc. (a manufacturer of consumer textiles and consumer products), as Executive Vice President.\nRichard Pactor joined the Company in December 1988 as Executive Vice President--Product Development, and was named President of the Forstmann International division in July 1992.\nPeter Roaman joined the Company in June 1989 as Vice President-- Womenswear and was elected Senior Vice President--Marketing in December 1990 and Executive Vice President--Marketing and Styling in July 1991.\nJane S. Pollack joined the Company in May 1993 as Vice President and General Counsel and was elected Secretary in September 1993. Prior thereto, Ms. Pollack was Associate General Counsel and Assistant Secretary of Athlone Industries, Inc. (a manufacturer of specialty steels and consumer products).\nRodney J. Peckham was elected a Vice President of the Company in January 1991 and Treasurer in March 1992. From August 1986 until he became Treasurer, Mr. Peckham was Corporate Controller, and from December 1992 to September 1993 he also served as Secretary.\nGary E. Schafer was elected Vice President and Corporate Controller of the Company in March 1992. In 1990, when Mr. Schafer joined the Company, he served as Director of Cost Accounting. Prior thereto, Mr. Schafer was Chief Financial Officer of Racal-Milgo Skynetworks (a telecommunications company).\nENVIRONMENTAL MATTERS. By the nature of its operations, the Company's manufacturing facilities are subject to various federal, state and local environmental laws and regulations, including the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act and the Comprehensive Environmental Response, Compensation and Liability Act. Although the Company occasionally has been subject to proceedings and orders pertaining to emissions into the environment, the Company believes that it is in substantial compliance with existing environmental laws and regulations.\nPursuant to Georgia's Hazardous Site Response Act (the \"Response Act\"), property owners in Georgia were required to notify the Environmental Protection Division of the Georgia Department of Natural Resources (the \"GDNR\") of known releases of regulated substances on their properties above certain levels by March 22, 1994. Pursuant to the Response Act, the Company notified the GDNR of two releases at the Dublin facility, one relating to the presence of trichloroethylene at the site, and one relating to another constituent near the southern property boundary. Based upon the Company's March 1994 notification, the GDNR has determined that a release exceeding a reportable quantity has occurred at the site. As a result, the site has been listed on the Georgia Hazardous Site Inventory (\"HSI\"), which currently consists of 277 other sites. The Company has also recently notified the GDNR of another possible release near the western property boundary of the Dublin facility, asserting vigorously that this release should not be listed on the HSI. This release was identified by the Company through the sampling procedures in connection with the Company's environmental remediation plan submitted to the GDNR in May 1992. The GDNR intends to evaluate the sites on the HSI to determine which sites need corrective action. The GDNR has finalized procedures for determining corrective action levels under the Response Act. In January 1995, the GDNR notified the Company that, pursuant to the Response Act, the Company is required to submit a compliance status report and compliance status certification with respect to the site by June 30, 1995. The GDNR has also informed the Company of its obligation to identify all other potentially responsible parties, and, in compliance therewith, the Company plans to identify the prior owner and operator of the Dublin facility.\nThe Company believes that, based on its review and after meetings with counsel and engineering specialists, no material liability, in excess of amounts already recorded by the Company will result from this matter. However, depending upon how the GDNR will implement its new corrective action regulations, the remedial expenditures required, in the aggregate, could be material.\nFinancing Arrangements ----------------------\nThe Company's long-term debt as of October 30, 1994, consists of indebtedness outstanding under the GECC Facility, the Senior Secured Notes, the CIT Equipment Facility (hereinafter defined), the capital lease obligations and the Subordinated Notes. (See Note 7 to the Financial Statements included in Item 8. of this Annual Report on Form 10-K.)\nGECC FACILITY. The Company entered into the GECC Facility as of October 30, 1992, for borrowings of up to $100 million. Subject to certain borrowing base limitations, the GECC Facility provides for a maximum available non- amortizing Revolving Line of Credit (which includes a $7.5 million letter of credit facility) of $85 million and had a term loan of $15 million (the \"Original Term Loan\"). On April 5, 1993, the Company issued the Senior Secured Notes in the aggregate principal amount of $20 million and prepaid in full the Original Term Loan. In January 1995, the GECC Facility was amended, subject to loan availability to provide the $7.5 million Term Loan. In January 1995, the Company borrowed $7.5 million under the Term Loan, the proceeds of which were used to repay a portion of outstanding borrowings under the Revolving Line of Credit.\nSENIOR SECURED NOTES. On April 5, 1993, the Company issued an aggregate of $20 million Senior Secured Notes. On March 30, 1994, the Company issued the Additional Senior Secured Notes in the aggregate principal amount of $10 million. The proceeds from the sale of the Senior Secured Notes were used to repay the Original Term Loan and to reduce outstanding borrowings under the Revolving Line of Credit.\nCIT EQUIPMENT FACILITY. On December 27, 1991, the Company entered into a loan and security agreement (as amended, the \"CIT Equipment Facility\") with the CIT Group\/Equipment Financing, Inc. (\"CIT\") to finance the acquisition of, and to refinance borrowings incurred to acquire, various textile machinery and equipment. CIT has made purchase money loans to the Company pursuant to the CIT Equipment Facility in the principal amount of\n$656,123 at an interest rate of 8.61% per annum on December 27, 1991, of $1,262,595 at an interest rate of 7.86% per annum on September 15, 1992, of $2,584,230 at an interest rate of 8.55% per annum on December 31, 1992, of $1,209,995 at an interest rate of 7.75% per annum on August 2, 1993, of $1,988,150 at an interest rate of 7.45% per annum on August 24, 1993, of $1,653,137 at an interest rate of 7.36% per annum on October 22, 1993 and of $1,113,005 at an interest rate of 7.74% per annum on December 29, 1993. The Company is obligated to provide CIT with irrevocable letters of credit in an amount equal to 25% of the original principal amount of each loan incurred after August 1, 1993 through December 31, 1993, which requirement expires on or after January 31, 1996. Subsequent to Fiscal Year 1994 the CIT Equipment Facility was amended to provide for up to two additional loans not to exceed an aggregate of $5.0 million of additional equipment financing equal to 80% of the acquisition cost of machinery and equipment, net of all taxes, freight, installation and certain other fees, costs and expenses. The commitment period ends on July 31, 1995. On December 22, 1994, the Company borrowed $2.5 million at an interest rate of 10.58%. The interest rate on the remaining loan available under the CIT Equipment Facility is fixed at the Treasury Rate (as defined) plus 287 basis points. Each loan under the CIT Equipment Facility is payable in 60 monthly installments. The Company may prepay all, but not less than all, of its loans under the CIT Equipment Facility after July 1995, at a premium of 400 basis points, declining ratably over the remaining loan term.\nSUBORDINATED INDEBTEDNESS. In April 1989, through an underwritten public offering, the Company sold $100 million of the Subordinated Notes which currently have an interest rate until maturity of 14-3\/4%. As of January 1, 1995, an aggregate of $100,000,000 face amount of the Subordinated Notes were outstanding - an aggregate of $43,365,100 of which are owned by the Company. The Subordinated Notes are subordinated to all existing senior indebtedness of the Company (which currently consist of the loans under the GECC Facility, the Senior Secured Notes and the CIT Equipment Facility) and any extensions, modifications or refinancings thereof. The Subordinated Notes Indenture limits, subject to certain financial tests, the incurrence of additional indebtedness and prohibits the incurrence of any indebtedness senior to the Subordinated Notes that is subordinated to the Company's then existing senior indebtedness. The Subordinated Notes Indenture contains restrictions relating to payment of dividends, the repurchase of capital stock and the making of certain other restricted payments, certain transactions with affiliates and subsidiaries, and certain mergers, consolidations and sales of assets. In addition, the Subordinated Notes Indenture requires the Company to make an offer to purchase (1) a portion of the Subordinated Notes if (a) the Company's adjusted tangible net worth (as defined) falls below $15 million at the end of any two consecutive fiscal quarters or (b) the Company consummates an asset sale (as defined) at certain times or (2) all of the Subordinated Notes if a change of control (as defined) occurs. In connection with the Exchange Offer, the Company acquired, and did not retire or cancel, $46,240,100 aggregate face amount of the Subordinate Notes. The Company used $2,875,000 of such Subordinated Notes to satisfy the January 31, 1993 mandatory redemption required in the Subordinated Notes Indenture. The Company is required to redeem on April 15, 1998, $50.0 million of the aggregate face amount of the Subordinated Notes at a redemption price equal to par, plus accrued interest to the redemption date. The remaining Subordinated Notes are due on April 15, 1999. The Company may use the remaining $43,365,100 of the Subordinated Notes acquired in the Exchange Offer to satisfy partially the April 15, 1998 mandatory redemption required in the Subordinated Notes Indenture.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES ----------\nInformation regarding the Company's manufacturing facilities, all of which are owned, is as follows:\n* The Nathaniel plant adjoins the Dublin plant and is located on the same property.\nThe Company owns a 24,000 square foot office building adjoining its Dublin plant, which is used for administrative offices.\nThe Company leases approximately 29,470 square feet of office space at 1185 Avenue of the Americas, New York City (the \"1185 Lease\"), for its principal executives offices, its styling, sales and marketing operations and its Forstmann International division. Such lease will expire in October 1996 and the Company believes it has adequate time to obtain suitable premises elsewhere.\nThe Company also leases storage facilities in Georgia and a regional sales office in Dallas, Texas, primarily on a short-term basis.\nThe Company believes that its facilities are adequate to serve its present needs and, with its planned capital expenditures, allow for expanded future production. Substantially all of the Company's properties, plants and equipment are encumbered by security interests under the GECC Facility and the Senior Secured Notes Indenture. See \"Business -- Financing Arrangements\" in Item 1 of this Annual Report on Form 10-K.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS -----------------\nThe Company is a party to legal actions arising out of the ordinary course of business. The Company has no material pending legal proceedings.\nDissenters' Proceeding ----------------------\nAs required under Georgia Statute O.C.G.A. (S)14-2-1330, the Company commenced, on July 10, 1992, a civil action against: Resolution Trust Corporation as receiver for Columbia Savings & Loan Association, F.A., (the\n\"RTC\"); James E. Kjorlien; Gary M. Smith; Grace Brothers, Ltd.; The Henley Group; Randall D. Smith, Jeffrey A. Smith and Russell B. Smith, as Trustees for Lake Trust dtd 9\/4\/91; (the Non-RTC defendants) and the record owners of the shares of the Non-RTC defendants (the \"Dissenters' Proceeding\"). The RTC and Non-RTC defendants were record owners or beneficial holders of an aggregate of 1,473,562 shares of the Company's then existing voting and non- voting common stock (the \"Pre-Merger Stock\") who dissented from the Merger. Under Georgia law, holders of the outstanding shares of Pre-Merger Stock who were deemed to have dissented from the Merger became entitled to payment of the \"fair value\" of their Pre-Merger Stock, determined as of a time immediately before consummation of the Merger plus interest on that amount from the date of the Merger.\nIn September 1994, the Company settled the claims of the RTC in exchange for payment by the Company of $475,000 and the issuance of 30,000 shares of the Company's common stock. In December 1994, in settlement of the remaining claims, the Company paid the Non-RTC defendants $365,000. The action has been dismissed and no claims remain pending in the Dissenters' Proceeding.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------\nDuring the fourth quarter of Fiscal Year 1994, no matters were submitted by the Company to a vote of its shareholders.\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 (\"NASDAQ-NMS\"), the automated quotation system of The National Association of Securities Dealers, Inc. (the \"NASD\") under the symbol \"FSTM\".\nThe following table sets forth the high and low sales prices for each quarterly fiscal period of the Common Stock on the NASDAQ-NMS, as reported by the NASD. These quotations represent prices between dealers, do not include retail markup, markdown or commission and may not necessarily represent actual transactions.\nAt December 31, 1994, the Company had 49 record holders of its Common Stock, including CEDE & Co., the nominee of Depositary Trust Company, that held 2,719,088 shares of Common Stock as nominee for an unknown number of beneficial holders.\nThe Company has not paid, and has no present intention to pay in the foreseeable future, any cash dividends in respect of its Common Stock. The GECC Facility prohibits and the Senior Secured Notes Indenture and the Subordinated Notes Indenture restrict the payment of cash dividends. The payment of future cash dividends, if any, would be made only from assets legally available therefor, and would generally depend on the Company's financial condition, results of operations, current and anticipated capital requirements, plans for expansion, if any, restrictions under its then existing credit and other debt instruments and arrangements, and other factors deemed relevant by the Company's Board of Directors, in its sole discretion.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA -----------------------\nPresented below are selected operating statement data for the Company for the fiscal years ended October 30, 1994, October 31, 1993, November 1, 1992, October 27, 1991 and October 28, 1990. Also presented are selected balance sheet data for the Company as of October 30, 1994, October 31, 1993, November 1, 1992, October 27, 1991 and October 28, 1990. The selected financial data have been derived from the audited financial statements of the Company, are not covered by the report of the Company's independent public accountants and should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in Item 7","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ---------------------------------------------------------------\nResults of Operations ---------------------\nThe Fifty-Two Week Period Ended October 30, 1994 (\"Fiscal Year 1994\") compared to the Fifty-Two Week Period ended October 31, 1993 (\"Fiscal Year 1993\")\nNet sales for Fiscal Year 1994 were $237.1 million, an increase of less than 2% from Fiscal Year 1993. Total yards of fabric sold decreased 1% during Fiscal Year 1994. The increase in sales is attributable primarily to an increase in the sale of menswear fabrics which the Company believes is the result of focusing the menswear product line on specific market niches over the last two years. A decline in the sale of womenswear fabrics somewhat offset the increase in the sale of menswear fabrics. Womenswear fabric sales declined due to an over-ordering of certain wool fabrics by the Company's customers in Fiscal Year 1993 which was somewhat offset by a shift from woolen to worsted fabrics due to changing fashion trends in Fiscal Year 1994. Excluding government sales ($2.9 million in Fiscal Year 1994 and $0.1 million in Fiscal Year 1993) which traditionally yield lower gross profit margins, net sales for Fiscal Year 1994 increased less than 0.5% from Fiscal Year 1993.\nCost of goods sold increased to $189.2 million from $182.3 million in Fiscal Year 1993. Gross profit decreased 6.2% in Fiscal Year 1994 to $47.9 million, and gross profit margin for Fiscal Year 1994 was 20.2% compared to 21.9% for Fiscal Year 1993. Production of certain fabrics and related yarns, particularly during the fourth quarter of Fiscal Year 1994, was slowed in response to the decline in womenswear fabrics. The lowering of production, its resultant lower absorption of manufacturing costs, as well as an unusually high increase in healthcare claims and workers' compensation expenses, adversely effected gross profit for the year. Fiscal Year 1994 and Fiscal Year 1993 include the effects of the Company's Quasi Reorganization (hereinafter defined) which was effected as of the beginning of Fiscal Year 1993.\nSelling, general and administrative expenses, excluding the provision for uncollectible accounts, increased 7.6% to $22.4 million in Fiscal Year 1994, compared to $20.7 million in Fiscal Year 1993. Human resources related expenses increased $0.3 million during Fiscal Year 1994 due to the hiring of personnel for marketing and in-house legal counsel and the lowering of the assumed discount rate used to measure the accumulated benefit obligation for the Company's hourly and salaried pension plans under SFAS No. 87, \"Employers' Accounting for Pensions,\" as of the end of Fiscal Year 1993. The increase in human resources related expenses was partially offset by a $1.0 million decline in incentive compensation expense in Fiscal Year 1994. Due to the modernization and computerization of the Company's styling, sales and marketing operations in New York, coupled with other computer equipment upgrades, facility, depreciation and amortization expenses were higher in Fiscal Year 1994 than in the Fiscal Year 1993. During the fourth quarter of Fiscal Year 1994, approximately $0.3 million in costs associated with potential acquisitions were expensed as such potential acquisitions did not materialize.\nThe provision for uncollectible accounts declined from $2.7 million in Fiscal Year 1993 to $2.2 million in Fiscal Year 1994. The provision for uncollectible accounts in Fiscal Year 1993 includes the effect of several of the Company's customers filing for protection under the Federal Bankruptcy Code, which customers, at the time of such filings, owed the Company an aggregate of $2.5 million.\nInterest expense for Fiscal Year 1994 was $17.5 million compared to $15.7 million in Fiscal Year 1993. The $1.8 million increase in interest expense in Fiscal Year 1994 primarily was due to higher interest rates and additional borrowings under the Company's various financing facilities. Increases in the Federal Reserve discount rates during Fiscal Year 1994 have resulted in the Company's interest rates applicable to borrowings under the Revolving Line of Credit and Senior Secured Notes increasing by approximately 1.5% per annum since the beginning of Fiscal Year 1994.\nIn Fiscal Year 1994, the Company recorded an income tax provision of $2.3 million. The Company's effective tax rate was 39.5% on income before taxes for Fiscal Year 1994, while the effective tax rate for Fiscal Year 1993 was 38.5%.\nAs a result of the foregoing, the Company's net income was $3.6 million in Fiscal Year 1994 compared to net income of $6.6 million in Fiscal Year 1993.\nPreferred stock in-kind dividends and accretion to redemption value was $230,000 in Fiscal Year 1994 compared to $209,000 in Fiscal Year 1993. As a result of the foregoing, the Company's income applicable to common shareholders was $3.3 million in Fiscal Year 1994, compared to income applicable to common shareholders of $6.4 million in Fiscal Year 1993.\nIn light of the Federal Reserve discount rates increasing during Fiscal Year 1994, which effect is expected to continue during fiscal year 1995, and the Company's higher borrowings under its floating interest rate debt facilities, the Company expects interest expense in fiscal year 1995 to be significantly higher than in Fiscal Year 1994. As further discussed in Liquidity and Capital Resources, during fiscal year 1995, the Company is ------------------------------- reassessing its capital investment program and is more closely monitoring its inventory levels. Further, the Company expects wool costs to increase significantly in fiscal year 1995 due to recent increases which the Company began to realize during the fourth quarter of Fiscal Year 1994 and a drought in Australia which has resulted in a reduction in sheep herds.\nThe Company's sales order backlog at January 1, 1995 was $61.3 million, $12.0 million less than the comparable period one year ago. Excluding government orders, which yield lower gross profit margins, the backlog at January 1, 1995 was $8.5 million less than the comparable period in the prior year. The decline in the backlog, excluding government orders, is attributable to a decline in orders for women's outerwear fabrics, which was somewhat offset by increases in orders for menswear, specialty, converted and Carpini\/TM\/ USA fabrics. The Company believes that the decline in orders for women's outerwear is due to the exceptionally warm temperatures registered across the country in the fall and early winter. Although the Company expects the effects of the warmer temperatures, which depressed retail sales of women's coats, to somewhat reverse itself during fiscal year 1995, there can be no assurance that such market inprovement will occur. Sales of women's outerwear fabrics represented approximately 22% of net sales for Fiscal Year 1994.\nThe Fifty-Two Week Period Ended October 31, 1993 (\"Fiscal Year 1993\") compared to the Fifty-Three Week Period Ended November 1, 1992 (\"Fiscal Year 1992\")\nThe Company, with approval from its Board of Directors, revalued its assets and liabilities to fair value as of the beginning of Fiscal Year 1993 pursuant to the principles of quasi-reorganization accounting (the \"Quasi Reorganization\"). The fair value adjustments were revised in the fourth quarter of Fiscal Year 1993 to adjust certain amounts initially recorded, which had been based upon estimates (principally the write-down of property, plant and equipment and the accrual of costs to effect the Quasi Reorganization). The Quasi Reorganization directly affected cost of goods sold, interest expense, income tax provision and preferred stock in-kind dividends and accretion for Fiscal Year 1993 and will affect future reported results of operations. As a result of the fair value adjustments made in the Quasi Reorganization (a) the value of inventories was reduced, which affects cost of goods sold to the extent such inventories are utilized, (b) the value of property, plant and equipment was reduced, which affects cost of goods sold as the related property is depreciated, (c) the value of the hourly pension plan's net assets was eliminated, which affects cost of goods sold to the extent such value would have been amortized, (d) an accrual for unfavorable (commitment price exceeded fair value) wool purchase commitments was recorded, which subsequently reduced cost of goods sold in the periods wool was delivered and subsequently sold as finished product, (e) interest expense was decreased as a result of the reduction of deferred financing costs and the valuation of long-term debt, (f) income tax provision was increased due to the effect of the above items, and (g) preferred stock in- kind dividends and accretion was reduced as a result of the decrease in value of the preferred stock. As a result of the Quasi Reorganization, the Company estimates that earnings per share during each of the next five years will be $0.18 higher, principally due to lower depreciation and interest charges. Additionally, the Company recognized a one-time benefit to cost of goods sold during Fiscal Year 1993 of $3.0 million ($1.8 million net of income taxes or $0.33 per share) related to the reversal of unfavorable wool purchase commitments recorded as a liability in connection with the Quasi Reorganization.\nSince Fiscal Year 1993 comprises fifty-two weeks and Fiscal Year 1992 comprises fifty-three weeks, and because of the effects of the Quasi Reorganization with respect to Fiscal Year 1993, the results for the respective fiscal years are not directly comparable. Because the Company's customers place orders based on their calendar month needs, the Company believes that net sales, unlike certain manufacturing and selling, general and administrative expenses, were not significantly impacted by one less week in Fiscal Year 1993 and were not affected by the Quasi Reorganization.\nNet sales for Fiscal Year 1993 were $233.4 million, an increase of 11.7% from Fiscal Year 1992. Total yards of fabric sold increased 12.5% during Fiscal Year 1993, which outpaced net sales growth, as volume continued to grow fastest in styles with per yard selling prices below last year's average per yard selling price. Excluding government sales (minimal during Fiscal Year 1993) which traditionally yield selling prices per yard in excess of the Company's average price per yard, but lower gross profit margins, net sales for Fiscal Year 1993 increased 14.0% from Fiscal Year 1992. Such increase was primarily attributable to an increase in womenswear (including outerwear) fabric sales, which comprised approximately two-thirds of net sales in both Fiscal Year 1993 and Fiscal Year 1992.\nCost of goods sold increased to $182.3 million in Fiscal Year 1993 from $169.1 million in Fiscal Year 1992. Gross profit increased 28.1% in Fiscal Year 1993 to $51.0 million from $39.8 million in Fiscal Year\n1992, and gross profit margin for Fiscal Year 1993 was 21.9%, compared to 19.1% for Fiscal Year 1992. This improvement was primarily attributable to the effects of the Quasi Reorganization, strategic raw wool purchasing, improved manufacturing efficiencies and an improved product mix.\nSelling, general and administrative expenses, excluding the provision for uncollectible accounts, increased 23.5% to $20.7 million in Fiscal Year 1993, compared to $16.8 million in Fiscal Year 1992. Such increase was due, in part, to the hiring of additional marketing and management information services personnel. In addition, the formation of Forstmann International, a licensing, technical information and consulting arrangement with Carpini (see Note 11 to the Financial Statements included in Item 8","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nIndependent Auditors' Report ...................................... 27\nBalance Sheets as of October 30, 1994 and October 31, 1993 .............................................. 28\nStatements of Operations for the Fifty-Two Weeks Ended October 30, 1994 and October 31, 1993 and the Fifty-Three Weeks Ended November 1, 1992................... 29\nStatements of Cash Flows for the Fifty-Two Weeks Ended October 30, 1994 and October 31, 1993 and the Fifty-Three Weeks Ended November 1, 1992................... 30\nStatements of Changes in Shareholders' Equity for the Fifty-Three Weeks Ended November 1, 1992 and the Fifty-Two Weeks Ended October 31, 1993 and October 30, 1994 ....................... 32\nNotes to Financial Statements for the Fifty-Two Weeks Ended October 30, 1994 and October 31, 1993, and the Fifty-Three Weeks Ended November 1, 1992 ............................................ 33\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Forstmann & Company, Inc.:\nWe have audited the accompanying balance sheets of Forstmann & Company, Inc. as of October 30, 1994 and October 31, 1993 and the related statements of operations, shareholders' equity and cash flows for the fifty-two weeks ended October 30, 1994 and October 31, 1993 and the fifty-three weeks ended November 1, 1992. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of Forstmann & Company, Inc. at October 30, 1994 and October 31, 1993 and the results of its operations and its cash flows for the fifty-two weeks ended October 30, 1994 and October 31, 1993 and the fifty-three weeks ended November 1, 1992, in conformity with generally accepted accounting principles.\nAs discussed in Note 14 to the financial statements, the Company effected a quasi reorganization as of November 2, 1992 (the beginning of fiscal year 1993) and revalued its assets and liabilities to fair value at such date and during the fifty-two weeks ended October 30, 1994, the Company recorded certain adjustments to the quasi reorganization related to unresolved contingencies as of the effective date of the quasi reorganization. As discussed in Note 9 to the financial statements, the Company changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109.\n\/s\/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP\nAtlanta, Georgia December 8, 1994 (January 23, 1995 as to paragraph 2 of Note 7)\nFORSTMANN & COMPANY, INC. - -------------------------------------------------------------------------------- BALANCE SHEETS OCTOBER 30, 1994 AND OCTOBER 31, 1993\nSee notes to financial statements.\nFORSTMANN & COMPANY, INC. - -------------------------------------------------------------------------------- STATEMENTS OF OPERATIONS FOR THE FIFTY-TWO WEEKS ENDED OCTOBER 30, 1994 AND OCTOBER 31, 1993 AND THE FIFTY-THREE WEEKS ENDED NOVEMBER 1, 1992\nSee notes to financial statements.\nFORSTMANN & COMPANY, INC. - -------------------------------------------------------------------------------- STATEMENTS OF CASH FLOWS FOR THE FIFTY-TWO WEEKS ENDED OCTOBER 30, 1994 AND OCTOBER 31, 1993 AND THE FIFTY-THREE WEEKS ENDED NOVEMBER 1, 1992\nFORSTMANN & COMPANY, INC. - -------------------------------------------------------------------------------- STATEMENTS OF CASH FLOWS (CONTINUED) FOR THE FIFTY-TWO WEEKS ENDED OCTOBER 30, 1994 AND OCTOBER 31, 1993 AND THE FIFTY-THREE WEEKS ENDED NOVEMBER 1, 1992\nSee notes to financial statements.\nFORSTMANN & COMPANY, INC. - -------------------------------------------------------------------------------- STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE FIFTY-THREE WEEKS ENDED NOVEMBER 1, 1992 AND THE FIFTY-TWO WEEKS ENDED OCTOBER 31, 1993 AND OCTOBER 30, 1994\nSee notes to financial statements.\nFORSTMANN & COMPANY, INC. - -------------------------------------------------------------------------------- NOTES TO FINANCIAL STATEMENTS FOR THE FIFTY-TWO WEEKS ENDED OCTOBER 30, 1994 AND OCTOBER 31, 1993 AND THE FIFTY-THREE WEEKS ENDED NOVEMBER 1, 1992\n1. LINES OF BUSINESS\nForstmann & Company, Inc. (the \"Company\") designs, manufactures and markets woolen, worsted and other fabrics primarily used in the production of brand name and private label apparel for men and women, as well as specialty fabrics for use in billiard and gaming tables, sports caps and career uniforms. A majority (50.4%) of the Company's common stock is owned by Odyssey Partners, L.P. (\"Odyssey\").\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFiscal Year - The Company has adopted a fiscal year ending on the Sunday nearest to October 31. The fiscal years ended October 30, 1994 and October 31, 1993 comprise fifty-two weeks (\"Fiscal Year 1994\" and \"Fiscal Year 1993\", respectively), whereas the fiscal year ended November 1, 1992 comprises fifty- three weeks (\"Fiscal Year 1992\").\nRevenue Recognition - Generally, sales and related costs are recognized when goods are sold and then shipped to the Company's customers. A portion of such sales is made on extended terms of up to 240 days. At October 30, 1994, $8.2 million of sales made on extended terms were included in accounts receivable under terms of specific sales.\nWhen customers, under the terms of specific orders, request that the Company manufacture, invoice and ship goods on a bill and hold basis, the Company recognizes revenue based on the completion date required in the order and actual completion of the manufacturing process. Accounts receivable included bill and hold receivables of $19.4 million at October 30, 1994 and $15.9 million at October 31, 1993.\nNone of the Company's customers accounts for 10% or more of the Company's revenues.\nAllowance for Uncollectible Accounts - Based on a review and assessment of the collectibility of aged balances included in accounts receivable, the Company establishes a specific allowance for uncollectible accounts. Additionally, the Company establishes a general allowance for uncollectible accounts based, in part, on historical trends and the state of the economy and its effect on the Company's customers. The Company also establishes allowances for estimated sales returns. The Company grants credit to certain customers, most of which are companies in apparel industries, which industries generally have experienced an economic downturn. The ability of such customers to honor their debts is somewhat dependent upon the apparel business sector. No individual customer's accounts receivable balance exceeded 7% of gross accounts receivable at October 30, 1994.\nInventories - Inventories are stated at the lower of cost, determined principally by the last-in, first-out (\"LIFO\") method, or market.\nProperty, Plant and Equipment - Property, plant and equipment is recorded at cost, net of accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets or the lease terms of certain capital lease assets. For income tax purposes, accelerated methods of depreciation are used. Maintenance and repairs are charged to income, and renewals or betterments are capitalized.\nDeferred Financing Costs - Costs incurred to obtain financing are included as other assets and amortized using the straight-line method over the expected maturities of the related debt.\nComputer Information Systems - Costs directly associated with the initial purchase, development and implementation of computer information systems are deferred and included as other assets. Such costs are amortized on a straight- line basis over the expected useful life of the systems, principally five years. Ongoing maintenance costs of computer information systems are expensed.\nEnvironmental Remediation Liabilities - The Company recognizes environmental remediation liabilities when a loss is probable and can be reasonably estimated. Estimates are developed in consultation with environmental consultants and legal counsel and are periodically revised based on expenditures against established reserves and the availability of additional information. Such liabilities are included on the balance sheet as accrued liabilities.\nEarnings Per Share - The computations of per share information for Fiscal Years 1994 and 1993 are based on actual shares outstanding during the years and on actual income applicable to common shareholders. Shares issuable upon the exercise of employee stock options do not have a material dilutive effect on earnings per share for the periods presented. The computation of per share information for Fiscal Year 1992 gives effect to (a) the 1992 Recapitalization (hereinafter defined, see Note 14) and (b) elimination of the income tax provision (benefit) arising from the ownership change for federal income tax purposes which is more fully described in Note 9, as if such transactions occurred at the beginning of Fiscal Year 1992 and as if such transactions were effected as a recapitalization of the Company.\nNew Accounting Standards - Statement of Financial Accounting Standards (\"SFAS\") No. 112, \"Employers' Accounting for Postemployment Benefits,\" establishes accounting standards for employers that provide benefits to former or inactive employees after employment but before retirement and is effective for fiscal years beginning after December 15, 1993. The Company expects that there will be no material effect upon implementing SFAS No. 112 on its financial position or results of operations.\nReclassifications - Certain prior years' financial statement balances have been reclassified to conform with the current year's presentations.\n3. INVENTORIES\nInventories consist of the following at October 30, 1994 and October 31, 1993 (in thousands):\nAlthough current replacement cost for inventories at October 31, 1993 was less than LIFO carrying value, the Company's management believed that the carrying value would be recovered through future sales which would yield normal profit margins.\n4. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consist of the following at October 30, 1994 and October 31, 1993 (in thousands):\nCapital lease assets (principally machinery and equipment) at October 30, 1994 and October 31, 1993 was $3,799,000 and $3,077,000, respectively. Accumulated amortization related to such capital lease assets at October 30, 1994 and October 31, 1993 was $1,278,000 and $587,000, respectively.\nDepreciation expense and amortization of capital lease assets was $11,945,000 for Fiscal Year 1994, $9,685,000 for Fiscal Year 1993 and $10,007,000 for Fiscal Year 1992.\nThe Company recognized a $963,000 loss from disposal and impairment of machinery and equipment during Fiscal Year 1993 related to the disposal and write-down of idle equipment to reflect its remaining future economic value.\n5. OTHER ASSETS\nOther assets consist of the following at October 30, 1994 and October 31, 1993 (in thousands):\n6. OTHER ACCRUED LIABILITIES\nOther accrued liabilities consist of the following at October 30, 1994 and October 31, 1993 (in thousands):\n7. LONG-TERM DEBT\nLong-term debt consists of the following at October 30, 1994 and October 31, 1993 (in thousands):\nCredit Facilities - The Company entered into a five-year loan agreement as of October 30, 1992 with General Electric Capital Corporation (\"GECC\"), as agent and lender, for borrowings up to $100 million (the \"GECC Facility\"). The GECC Facility provides revolving loans up to a maximum of $85 million (the \"Revolving Line of Credit\") (which includes a $7.5 million letter of credit facility) and provided a $15 million term loan (the \"Original Term Loan\"). In January 1995, the GECC Facility was amended, subject to loan availability (as defined), to provide a $7.5 million term loan (the \"Term Loan\"). On January 23, 1995, the Company borrowed $7.5 million under the Term Loan, the proceeds of which were used to repay a portion of outstanding borrowings under the Revolving Line of Credit.\nThe initial borrowings under the GECC Facility were used to repay the outstanding borrowings under the $85 million Senior Secured Revolving Credit Facility between the Company and various lenders (the \"Bank Facility\") and to secure previously issued letters of credit. The revolving loans under the Bank Facility were payable in full on November 2, 1994. Unamortized deferred financing costs of $1.9 million related to the Bank Facility were written off in Fiscal Year 1992 and such write-off, net of a $0.7 million deferred income tax benefit, was reflected as an extraordinary loss in the Company's statement of operations for Fiscal Year 1992.\nOutstanding borrowings (including outstanding letters of credit) under the Revolving Line of Credit cannot exceed the sum of (1) 85% of eligible accounts receivable (other than bill and hold accounts receivable), (2) the lesser of (a) $10 million, or (b) a percentage (based on aging) of eligible bill and hold accounts receivable, (3) 60% of eligible inventory (other than seconds and samples), and (4) the lesser of (a) $3 million, or (b) 60% of eligible inventory consisting of samples and seconds. The Company's borrowing base is subject to reserves determined by GECC. At October 30, 1994, the Company's loan availability as defined in the GECC Facility, in excess of its outstanding borrowings and letters of credit, was approximately $7.5 million.\nBorrowings under the Revolving Line of Credit bear interest, at the Company's option, at a floating rate (which is based on a defined index rate) or a fixed rate (which is based on LIBOR), payable monthly. The floating rate is 1.5% per annum above the index rate, and the fixed rate is 3.0% per annum above LIBOR. At October 30, 1994, the Revolving Line of Credit bore interest at the fixed rate of 8.25% per annum through December 31, 1994 and was adjusted to 8.98% per annum on January 1, 1995 through January 31, 1995.\nProceeds from the Company's ordinary operations are applied to reduce the principal amount of borrowings outstanding under the Revolving Line of Credit. Unused portions of the Revolving Line of Credit may be borrowed and reborrowed, subject to availability in accordance with the then applicable commitment and borrowing base limitations.\nThe Company's obligations under the GECC Facility are secured by liens on substantially all of the Company's assets. The GECC Facility expires in October 1997.\nSubject to certain exceptions, the GECC Facility restricts, among other things, the incurrence of indebtedness, the sale of assets, the incurrence of liens, the making of certain restricted payments, the making of specified investments, the payment of cash dividends and the making of certain fundamental corporate changes and amendments to the Company's corporate organizational and governance instruments. In addition, the Company is required to satisfy, among other things, certain financial performance criteria, including minimum tangible net worth levels, interest coverage, fixed charge and current ratios, minimum EBITDA levels, maximum leverage ratios, inventory and accounts receivable turnover ratios and maximum capital expenditure levels.\nThe Company pays GECC, for the account of each of the lenders party to the GECC Facility, a fee of 0.5% per annum on the average daily unused portion of the Revolving Line of Credit. In addition, the Company pays GECC, for its own account, an agency fee of $150,000 per annum and certain fees in connection with extending and making available letters of credit.\nSenior Secured Notes - On April 5, 1993, the Company issued an aggregate of $20 million Senior Secured Floating Rate Notes and on March 30, 1994, the Company issued an aggregate of $10 million Senior Secured Floating Rate Notes, all of which are due October 30, 1997 (collectively the \"Senior Secured Notes\"). The proceeds from the sale of the Senior Secured Notes were used to repay the Original Term Loan and to reduce outstanding borrowings under the Revolving Line of Credit.\nBorrowings under the Senior Secured Notes bear interest, at the Company's option, at a floating rate (which is based on the prime lending rate, as defined) or a fixed rate (which is based on LIBOR), payable quarterly. The floating rate is 1.75% per annum above the prime lending rate, as defined, and the fixed rate is 3.25% per annum above LIBOR. The Senior Secured Notes bear interest at the fixed rate of 8.94% per annum from October 30, 1994 through January 31, 1995.\nThe Senior Secured Notes require principal payments of $4.0 million on October 31, 1995, $5.0 million on October 31, 1996 and a final payment of the unpaid principal balance on October 30, 1997. The Company may redeem, on any interest payment date, all or any portion of the Senior Secured Notes at a redemption price of 100% of the principal amount to be redeemed.\nIn addition, under the Indenture to the Senior Secured Notes (the \"Senior Secured Notes Indenture\"), the net proceeds from the sale or other disposition by the Company of assets (excluding, among other things, the sales of inventory in the ordinary course of business and dispositions of equipment which are in excess of permitted sales of equipment, whereby the proceeds of such sales are used to purchase permitted assets) are required to be deposited with the Senior Secured Notes Indenture trustee. If the net proceeds deposited with the trustee aggregates $1.0 million in excess of the amount of such proceeds which will be reinvested within twelve months of deposit with the trustee, the Company is required to make an offer to redeem an applicable portion of the Senior Secured Notes. As of October 30, 1994, under the terms of the Senior Secured Notes Indenture, the Company had not deposited any net proceeds with the trustee.\nThe Company's obligations under the Senior Secured Notes are secured by liens on substantially all of the Company's assets. The Senior Secured Notes Indenture contains restrictions similar to that of the GECC Facility. Further, the Senior Secured Notes Indenture requires the Company to satisfy, among other things, certain financial performance criteria, including minimum adjusted tangible net worth levels, fixed charge and interest coverage ratios and minimum EBITDA levels. Generally, such financial performance criteria are less stringent than similar financial performance criteria required by the GECC Facility.\nSubordinated Notes - On April 20, 1989, through an underwritten public offering, the Company sold $100 million of 14-3\/4% Senior Subordinated Notes due\nApril 15, 1999 (the \"14-3\/4% Notes\") (effective rate 15%). In connection with a recapitalization of the Company in 1990 (the \"1990 Recapitalization\"), the Company amended the Indenture to the 14-3\/4% Notes (the \"Subordinated Notes Indenture\") and holders of 95.735% of the outstanding 14-3\/4% Notes agreed to a reduction in the interest rate payable on such 14-3\/4% Notes to 6% per annum for the period commencing October 16, 1990 through October 15, 1992 by accepting Split Coupon Redeemable Amended Senior Subordinated Notes (the \"Split Coupon Notes\") in exchange for the 14-3\/4% Notes. The Company issued additional Split Coupon Notes under the Subordinated Notes Indenture with a face value of $2,872,050 on November 19, 1990 in settlement of $2,273,706 of interest due to certain holders of the 14-3\/4% Notes on October 15, 1990. The interest rate reduction and issuance of additional notes in lieu of cash reduced the effective interest rate on the outstanding 14-3\/4% Notes and Split Coupon Notes (collectively the \"Subordinated Notes\") to 12.35% per annum.\nThe Subordinated Notes are subordinated to all existing and future senior indebtedness (as defined) of the Company. The Subordinated Notes Indenture limits, subject to certain financial tests, the incurrence of additional senior indebtedness and prohibits the incurrence of any indebtedness senior to the Subordinated Notes that is subordinated to the Company's then existing senior indebtedness. The Subordinated Notes Indenture contains restrictions relating to payment of dividends, the repurchase of capital stock and the making of certain other restricted payments, certain transactions with affiliates and subsidiaries, and certain mergers, consolidations and sales of assets. In addition, the Subordinated Notes Indenture requires the Company to make an offer to purchase (1) a portion of the Subordinated Notes if (a) the Company's adjusted tangible net worth (as defined) falls below $15 million at the end of any two consecutive fiscal quarters or (b) the Company consummates an asset sale (as defined) at certain times or (2) all of the Subordinated Notes if a change of control (as defined) occurs.\nIn connection with the Exchange Offer (hereinafter defined, see Note 14), the Company acquired, and did not retire or cancel, $46,240,100 aggregate face amount of the Subordinated Notes. The Company used $2,875,000 of such Subordinated Notes to satisfy the January 31, 1993 mandatory redemption required in the Subordinated Notes Indenture. The Company is required to redeem on April 15, 1998, $50.0 million of the aggregate face amount of the Subordinated Notes at a redemption price equal to par, plus accrued interest to the redemption date. The remaining Subordinated Notes are due on April 15, 1999. The Company may use the remaining $43,365,100 of the 14-3\/4% Notes acquired in the Exchange Offer to satisfy partially the April 15, 1998 mandatory redemption required in the Subordinated Notes Indenture.\nAs a result of the Exchange Offer, the effective interest rate on the outstanding Subordinated Notes increased from 12.35% to 12.55% per annum. Subsequently, as a result of the Quasi Reorganization (hereinafter defined, see Note 14), the Subordinated Notes were fair valued, which, for financial reporting purposes, resulted in the elimination of the previously existing deferred interest payable and debt discount, the creation of a debt premium of $5,663,000 and a decrease in the effective interest rate on the outstanding Subordinated Notes to 12.43% per annum.\nEquipment Facilities - The Company is a party to a loan and security agreement (the \"CIT Equipment Facility\") with the CIT Group\/Equipment Financing, Inc. (\"CIT\") which provides financing for the acquisition of, and to refinance borrowings incurred to acquire, various textile machinery and equipment. Pursuant to the CIT Equipment Facility, commencing on December 27, 1991 and through December 31, 1992, the Company borrowed an aggregate of $4,502,948 at interest rates ranging from 7.86% to 8.61% per annum.\nOn August 2, 1993, the CIT Equipment Facility was amended to permit up to four additional loans not to exceed an aggregate of $6.0 million with the commitment period ending on January 31, 1994. Through October 30, 1994, the Company borrowed an aggregate of $5,964,327 at interest rates ranging from 7.36% to 7.75% per annum. At October 30, 1994, an aggregate of $7,082,000 was\noutstanding under the CIT Equipment Facility. On December 22, 1994, the CIT Equipment Facility was further amended to permit up to two additional loans not to exceed an aggregate of $5.0 million with the commitment period ending on July 31, 1995. On December 22, 1994, the Company borrowed $2.5 million at an interest rate of 10.58%. The interest rate on the remaining loan available under the CIT Equipment Facility is fixed at the Treasury Rate (as defined) plus 287 basis points.\nEach loan under the CIT Equipment Facility is a five-year purchase money loan, secured by a first (and only) perfected security interest in the equipment, and is payable in 60 consecutive installments of principal plus interest, payable monthly in arrears.\nThe Company may prepay all, but not less than all, of its loans under the CIT Equipment Facility after July 1995, at a premium of 400 basis points, declining ratably over the remaining loan term. The Company is required to provide CIT with an irrevocable letter of credit in an amount equal to 25% of the original principal amount of each additional loan made under the $6.0 million amendment which requirement terminates on January 31, 1996 or thereafter.\nAggregate Maturities - At October 30, 1994, aggregate long-term debt maturities excluding capital lease obligations (see Note 11), are as follows (in thousands):\n8. REDEEMABLE PREFERRED STOCK\nThe Company's senior preferred stock, with a dividend rate of 5% per annum, is non-voting, except in limited circumstances, and ranks senior to any subsequently issued class or series of preferred stock. The Company is prohibited from paying cash dividends on the senior preferred stock under its existing financial arrangements (see Note 7), except that the Company may, at its option, pay such dividends through the issuance of additional shares of senior preferred stock with an aggregate liquidation preference equal to the dollar value of the required dividend. The senior preferred stock, plus accumulated unpaid dividends, is mandatorily redeemable on December 15, 2010 (and earlier under certain circumstances upon a change in control (as defined)) at a price equal to the liquidation preference thereof.\nAs a result of the Company effecting the Quasi Reorganization, the senior preferred stock was fair valued, resulting in a decrease in the carrying value of $2,944,000, which is being accreted to redemption value. The fair valuation resulted in an effective dividend rate of 10.11% per annum.\n9. INCOME TAXES\nAt the beginning of Fiscal Year 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" This statement supersedes SFAS No. 96, \"Accounting for Income Taxes,\" which the Company adopted in fiscal year 1988. The adoption of SFAS No. 109 did not have an effect on the Company's results of operations for Fiscal Year 1993.\nThe provision for income taxes, exclusive of the amounts related to extraordinary items, is as follows (in thousands):\nThe Company's statutory rate, including state income taxes (net of federal benefit), for Fiscal Years 1994, 1993 and 1992 was 39.5%, 38.5% and 38.0%, respectively. The Company's effective rate rose to 38.5% in Fiscal Year 1993 due to a change in the tax status of the Company. The Company's effective rate rose to 39.5% in Fiscal Year 1994 due to the Omnibus Budget Reconciliation Act of 1993 which increased the corporate income tax rate from 34% to 35% for taxable income in excess of $10.0 million, as well as made certain other changes to the corporate tax law.\nA reconciliation between federal income taxes at the statutory rate and the Company's income tax provision is as follows:\nAt October 30, 1994, the Company had cumulative net operating loss carryforwards for federal income tax purposes of $15.5 million, of which $7.4 million is available to offset future taxable income as discussed below. For federal income tax purposes, net operating loss carryforwards begin to expire in the year 2002.\nAs a result of the 1992 Recapitalization, the Company underwent an ownership change as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the \"Internal Revenue Code\"). This ownership change limits the Company's ability to utilize its net operating loss carryforwards. During Fiscal Year 1992, the Company recorded a non-cash deferred income tax provision of $6.0 million to reflect the recapture of previously recognized benefits of the Company's losses and credits incurred in prior years. Reducing the $6.0 million non-cash charge for Fiscal Year 1992 was a $1.8 million permanent income tax benefit resulting from certain events that occurred subsequent to the ownership change, which will enable the Company to utilize a portion of its net operating loss carryforwards existing prior to the ownership change.\nDeferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (b) operating loss and tax credit carryforwards. The tax effects of significant items comprising the Company's net deferred tax liability at October 30, 1994 and October 31, 1993 are as follows (in thousands):\nTo the extent that the book basis of the Company's assets and liabilities was adjusted in the Quasi Reorganization, the Company adjusted its deferred tax assets and liabilities pursuant to the principles of quasi-reorganization accounting.\nThe valuation allowance relates to operating loss carryforwards incurred prior to the Company's Quasi Reorganization that were charged to expense in Fiscal Year 1992 at the time of the ownership change for federal income tax purposes which resulted from the 1992 Recapitalization. Certain future events may result in such benefits being utilized in the Company's future income tax returns, which the Company will record as a reduction in the valuation allowance and, in accordance with the principles of quasi-reorganization accounting, a credit to additional paid-in-capital.\n10. EMPLOYEE BENEFIT PLANS\nThe Company has established and presently maintains qualified pension plans and qualified and non-qualified profit sharing and savings plans covering eligible hourly and salaried employees. The qualified noncontributory defined benefit pension plans cover substantially all salaried and hourly employees.\nPension plan assets consist primarily of common stocks, bonds and United States government securities. The plans provide pension benefits that are determined by years of service and for salaried plan participants are based on the plan participants' average compensation for the last five years of service and for hourly plan participants are based on the plan's applicable hourly rate for each specific participant's year of service. The Company's funding policy is to make the annual contribution required by applicable regulations and recommended by its actuary.\nNet periodic pension cost for the periods indicated include the following components at October 30, 1994, October 31, 1993 and November 1, 1992, (in thousands, except assumption percentages):\nThe following schedule sets forth the funded status of the hourly and salaried pension plans and the plan assets (accrued pension costs) included in the Company's balance sheets at October 30, 1994 and October 31, 1993, (in thousands):\nThe Company's assumed discount rate (\"discount rate\") used to measure the accumulated benefit obligation for its hourly and salaried pension plans under SFAS No. 87, \"Employers' Accounting for Pensions,\" as of the end of Fiscal Year 1994 was increased from 7.00% to 8.75% based on the composition of the accumulated benefit obligation and current economic conditions. As of the end of Fiscal Year 1993 the discount rate was lowered from 8.75% to 7.00% based on then prevailing economic conditions. The Company's hourly pension plan benefit obligation exceeds the plan assets at fair value at the end of Fiscal Year 1994 by $577,000. During Fiscal Year 1994, the Company reduced its accrued additional pension liability in excess of accumulated benefit obligation from $1,900,000 to $943,000 and reduced the $1,101,000 excess of additional pension liability over unrecognized prior service cost, net of $719,000 deferred tax benefit charged to shareholders' equity at the end of Fiscal Year 1993 to $526,000, net of $343,000 deferred tax benefit.\nThe Company has a qualified salaried employees' savings, investment and profit sharing plan under Section 401(k) of the Internal Revenue Code (the \"Qualified Plan\"). The Company has adopted a non-qualified salaried employees' savings, investment and profit sharing plan covering certain employees not covered under the Qualified Plan.\nOn September 18, 1992, the Company adopted the Forstmann & Company, Inc. Common Stock Incentive Plan, as subsequently amended (the \"Option Plan\"), for key employees of the Company, pursuant to which 450,000 shares of common stock were reserved for issuance by the Company. On March 30, 1994, the Company's shareholders increased the number of shares reserved for issuance by the Company under the Option Plan to 700,000. Options granted under the Option Plan may be either incentive stock options (\"ISOs\"), which are intended to meet the requirements of Section 422 of the Internal Revenue Code, or non-qualified stock options (\"NSOs\").\nThe Compensation Committee of the Company's Board of Directors may grant under the Option Plan (1) ISOs at an exercise price per share which is not less than the fair market value (as defined) of the common stock at the date of grant and (2) NSOs at an exercise price not less than $.001 per share. The Option Plan further provides that the maximum period in which options may be exercised will be determined by the Compensation Committee, except that ISOs may not be exercised after the expiration of ten years from the date of grant (five years in the case of an optionee who is a 10% shareholder). The Option Plan requires that ISOs terminate on the date the optionee's employment with the Company terminates, except in the case of death, disability, termination of employment without cause or a change of control (as defined) of the Company, as determined by the Compensation Committee. Options are non-transferable, except by will or by the laws of descent and distribution, and may be exercised upon the payment of the option price in cash or any other form of consideration acceptable to the Compensation Committee.\nThe following summarizes stock option activity:\nOn December 8, 1994, an additional 39,197 of the ISOs granted at an exercise price of $6.75 per share became exercisable. On January 6, 1995, the Compensation Committee granted an aggregate of 225,000 ISOs to 14 management level employees of the Company at an exercise price of $8.50 per share.\nFive senior officers of the Company were granted equity referenced deferred incentive awards (\"ERAs\") on March 4, 1992, which generally vest three years after grant and are exercisable only if, after vesting, the Company's common stock maintains a market price of at least $9.00 per share for a continuous period of 30 days provided that such event occurs before March 4, 1998. Upon exercise, the ERAs have a value of $9.00, multiplied by the number of shares covered by the senior officer's ISOs, thus permitting the officers to be reimbursed, on a pre-tax basis, for the exercise price of their ISOs. The senior officers will be entitled\nto exercise their ERAs even if they determine not to exercise their ISOs. At October 30, 1994, $919,000 had been accrued in connection with the ERAs.\nOn December 8, 1992, the Compensation Committee approved a supplemental retirement benefit plan (the \"SERP\") to provide additional retirement benefits to senior officers of the Company. The SERP provides supplemental retirement income benefits, supplemental welfare benefit coverage and death benefits to senior officers who have been selected by the Compensation Committee. The level of benefits a participant may receive depends upon the participant's accrued or projected benefits under the Company's tax-qualified pension plan, the participant's length of service with the Company and the circumstances under which the participant retires. If a participant is terminated from employment without cause or after a change in control (as defined), the participant will receive the same benefits which would have been provided by the SERP if the participant continued in the Company's employ until age 62. As of October 30, 1994, $55,000 of contributions have been made to the SERP. During Fiscal Years 1994 and 1993, $128,000 and $64,000, respectively, was expensed in connection with the SERP.\n11. COMMITMENTS AND CONTINGENCIES\nLease Commitments - Aggregate future minimum lease commitments under operating leases and capital leases with an initial or remaining non-cancellable term in excess of one year, together with the present value of the minimum capital lease payments at October 30, 1994, are as follows (in thousands):\nRental expense under operating leases was $2.2 million for Fiscal Year 1994 and Fiscal Year 1993 and $2.4 million for Fiscal Year 1992.\nLicense & Royalty Agreements - In July 1992, the Company formed its Forstmann International division and entered into a licensing, technical information and consulting arrangement with Compagnia Tessile, S.p.A., an Italian corporation, and its affiliate (collectively \"Carpini\/TM\/\"). Under the arrangement, the Company has the exclusive right to manufacture \"Carpini\/TM\/ USA for Forstmann International\" fabrics for women's and men's apparel for distribution and sale in the United States, Canada and Mexico for an initial period through December 31, 1997. The Company also has the right to acquire certain technical information. In consideration of the licensing and consulting arrangement, the Company has agreed to pay Carpini an annual royalty and guaranteed minimum fee as follows (in thousands):\nAdditionally, the Company is required to pay Carpini a sales fee equal to five percent (5%) of annual net sales of \"Carpini USA\" fabrics, after deducting the annual guaranteed minimum fee. Further, the arrangement permits the Company to purchase certain fabrics manufactured by Carpini which can be resold by the Company in the United States and Canada.\nPurchase Commitments - In the ordinary course of business, the Company has significant purchase orders for raw wool outstanding, which generally require the placement of an order six to nine months prior to delivery. Additionally, at October 30, 1994 the Company had outstanding commitments to purchase machinery and equipment with an approximate value of $8.5 million.\nLetters of Credit - At October 30, 1994, the Company had outstanding letters of credit aggregating $2,959,372.\nLitigation - The Company is a party to legal actions arising out of the ordinary course of business. In the opinion of management, after consultation with counsel, the resolution of these claims will not have a material adverse effect on the financial position or results of operations of the Company.\nEnvironmental - By the nature of its operations, the Company is subject to various governmental environmental regulations and occasionally has been subject to proceedings and orders pertaining to emissions into the environment. As part of its completion of the identification and valuation of the assets acquired and liabilities assumed in connection with the acquisition of the Company on December 13, 1988, the Company accrued $1.9 million for environmental matters based on the Company's estimate at that time that it would incur between $1.9 million and $3.5 million in costs to remove excess wastes accidentally released into the environment, to upgrade existing waste facilities and to monitor chemical levels in the groundwater.\nPursuant to the Georgia Hazardous Site Response Act (the \"Response Act\"), property owners in Georgia were required to notify the Environmental Protection Division of the Georgia Department of Natural Resources (the \"GDNR\") of known releases of regulated substances on their properties above certain levels by March 22, 1994. Pursuant to the Response Act, the Company notified the GDNR of two historical releases at the Company's Dublin, Georgia facility, one relating to the presence of trichloroethylene at the site and one relating to another constituent near the southern property boundary. Based upon the Company's March 1994 notification, the GDNR has determined that a release exceeding a reportable quantity has occurred at the site. As a result, the site has been listed on the Georgia Hazardous Site Inventory (\"HSI\"), which currently consists of 277 other sites. The Company has also recently notified the GDNR of another possible release near the western property boundary of the Dublin facility, asserting vigorously that this release should not be listed on the HSI. This release was identified by the Company through the sampling procedures in connection with the Company's Environmental Plan. The GDNR intends to evaluate most of the sites on the HSI to determine which sites need corrective action. The GDNR has finalized procedures for determining corrective action levels under the Response Act. In January 1995, the GDNR notified the Company that it is a Responsible Party for the site, and has informed the Company that, pursuant to the Response Act, the Company is required to submit a compliance status report and compliance status certification with respect to the site by June 30, 1995. The GDNR has also informed the Company of its obligation to identify all other potentially responsible parties, and, in compliance therewith, the Company plans to identify the prior owner and operator of the Dublin facility.\nBased on an environmental remediation plan that the Company submitted to the GDNR in May 1992 for investigation and remediation of groundwater, and additional soil and groundwater sampling (the \"Environmental Plan\"), and on advice of outside environmental consultants, the Company estimated that the remaining costs associated with the Environmental Plan as of October 30, 1994 was $589,000 and such amount was accordingly reflected in the Company's financial statements at that date. The Company believes that, based on its review as described above, costs incurred to date and after meetings with counsel and engineering specialists, no material liability, in addition to amounts already recorded by the Company, will result from these matters. However, depending upon how the GDNR will implement its new corrective action regulations, the remedial expenditures required, in the aggregate, could be material.\nDissenters' Proceeding - As required under Georgia Statute O.C.G.A. (S) 14-2- 1330, the Company commenced, on July 10, 1992, a civil action against: Resolution Trust Corporation as receiver for Columbia Savings & Loan Association, F.A. (the \"RTC\"); James E. Kjorlien; Gary M. Smith; Grace Brothers, Ltd.; The Henley Group; Randall D. Smith, Jeffrey A. Smith and Russell B. Smith, as Trustees for Lake Trust dtd 9\/4\/91; (the \"Non-RTC defendants\") and the record owners of the shares of the Non-RTC defendants (the \"Dissenters' Proceeding\"). The RTC and Non-RTC defendants were record owners or beneficial holders of an aggregate of 1,473,562 shares of the Company's then existing voting and non- voting common stock who dissented (the \"Pre-Merger Stock\") from the Merger (hereinafter defined, see Note 14). Under Georgia law, holders of the outstanding shares of Pre-Merger Stock who were deemed to have dissented from the Merger became entitled to payment of the \"fair value\" of their Pre-Merger Stock, determined as of a time immediately before consummation of the Merger plus interest on that amount from the date of the Merger.\nIn September 1994, the Company settled the claims of the RTC in exchange for payment by the Company of $475,000 and the issuance of 30,000 shares of the Company's common stock. In December 1994, in settlement of the remaining claims, the Company paid the Non-RTC defendants $365,000. The action has been dismissed and no claims remain pending in the Dissenters' Proceeding. Total costs of $1,788,000, including legal fees to settle the Dissenters' Proceeding, were charged to additional paid-in capital during Fiscal Year 1994 in accordance with the principles of quasi-reorganization accounting (see Note 14).\n12. PRO FORMA INCOME AND INCOME PER SHARE (UNAUDITED)\nThe following information for Fiscal Year 1992 gives effect to (a) the 1992 Recapitalization (see Note 14) and (b) the elimination of the income tax provision, net of benefit, arising from the ownership change for federal income tax purposes which is more fully described in Note 9, as if such transactions occurred at the beginning of Fiscal Year 1992 and as if such transactions were affected as a recapitalization of the Company (in thousands):\n13. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amount and estimated fair value of the Company's financial instruments at October 30, 1994 are as follows (in thousands):\nConsiderable judgement is required in developing the estimates of fair value presented herein. Accordingly, these estimates are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments:\nCash, accounts receivable, notes receivable and accounts payable - The carrying amount of these items is a reasonable estimate of their fair value.\nLong-term debt (other than capital lease obligations) - Based upon the nature of the Company's Revolving Line of Credit and Senior Secured Notes, the Company believes its carrying amount approximates fair value. The Company's Subordinated Notes are publicly traded on occasion, and the fair value is based on estimates of market value for instruments with similar terms and remaining maturities. Interest rates that are currently available to the Company for issuance of fixed rate debt with similar terms and remaining maturities are used to estimate the fair value of the Company's Equipment Facilities.\nSenior preferred stock - The discounted cash flow of the senior preferred stock based on estimates of market requirements for instruments with similar terms and remaining maturities as provided by a third-party financial institution is used to estimate the fair value of the Company's senior preferred stock.\n14. RECAPITALIZATION AND QUASI REORGANIZATION\nRecapitalization - During Fiscal Year 1992, the Company completed a restructuring and recapitalization (the \"1992 Recapitalization\") whereby the Company (a) merged with an affiliated company (the \"Merger\"), which resulted in each issued and outstanding share of the Company's common stock and non-voting common stock prior to the Merger (except with respect to the Pre-Merger Stock) being converted into 1\/2,172 of an identical share of common stock of the Company without any payment or other consideration in respect thereof (the \"Reverse Stock Split\"), (b) accepted $46,240,100 aggregate face amount of the Split Coupon Notes in exchange for $19,596,758 cash and 2,420,904 unregistered shares of the Company's common stock (the \"Exchange Offer\"), (c) completed an initial public offering and sold 2,750,000 shares of common stock at $8.37 net per share (the \"Public Offering\"), and (d) received from Odyssey $3,712,500 of the cash consideration Odyssey had received in the Exchange Offer as the purchase price for 412,500 unregistered shares of the Company's common stock.\nQuasi Reorganization - The Company, with approval from its Board of Directors, revalued its assets and liabilities to fair value as of the beginning of Fiscal Year 1993 pursuant to the principles of quasi-reorganization accounting (the \"Quasi Reorganization\"), which is a voluntary accounting procedure that permits an entity which has emerged from previous financial difficulty to restate its accounts to estimated fair values and to eliminate its retained deficit against additional paid-in capital. The Quasi Reorganization fair value adjustments recorded during Fiscal Year 1993 resulted in a write-down of the Company's net assets of $22,507,000 that was charged to the Company's retained deficit account. The assets and liabilities principally affected by the fair value adjustments and the amounts of such adjustments are as follows (in thousands):\nSubsequent to the fair value adjustments, the balance in the Company's retained deficit account of $59,599,000 was eliminated against the Company's additional paid-in capital account.\nAt the effective date of the Quasi Reorganization, the Company had certain unresolved contingencies related to specific environmental matters and the Dissenters' Proceeding (see Note 11). In accordance with the principles of quasi-reorganization accounting, the difference between the actual costs subsequently incurred to resolve these matters and the liabilities recorded at the time of the Quasi Reorganization will be charged or credited to additional paid-in capital, as appropriate. During Fiscal Year 1994, $206,000 (net of income taxes) and $1,788,000 related to the environmental matters and Dissenters' Proceeding, respectively, were charged to additional paid-in capital as adjustments to the amounts initially recorded in the Quasi Reorganization.\n15. QUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly financial data for Fiscal Year 1994 and Fiscal Year 1993 are summarized as follows (in thousands, except per share information):\nDuring the fourth quarter of Fiscal Year 1994, the Company accrued an additional amount for workers' compensation expense of approximately $550,000 and increased its inventory valuation by $1,165,000 for the effects of LIFO accounting. Also, during the fourth quarter of Fiscal Year 1994, the Company incurred significant unfavorable manufacturing variances resulting from a slowdown of production and a shift in product mix at its manufacturing facilities.\nDuring the fourth quarter of Fiscal Year 1993, the Company recognized a provision for uncollectible accounts of $900,000, an increase of $500,000 from the fourth quarter of Fiscal Year 1992. The additional provison was based on the Company's continuing review and assessment of the collectibility of aged balances included in accounts receivable. Also, during the fourth quarter of Fiscal Year 1993, the Company recognized $1,100,000 for incentive compensation expense.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ---------------------------------------------\nDeloitte & Touche LLP, independent public accountants, currently is, and for more than the Company's last two fiscal years has been, the Company's independent accounting firm. Since the beginning of such two fiscal year period, (i) Deloitte & Touche LLP has not expressed reliance, in its audit report, on the audit services of any other accounting firm, and (ii) there have been no reported disagreements between the Company and Deloitte & Touche LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure.\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 10 is incorporated by reference from the Company's definitive proxy statement to be filed with the Securities and Exchange Commission (the \"Commission\") pursuant to Regulation 14A under the Securities Exchange Act of 1934 (\"Regulation 14A\") within 120 days after the end of the Company's fiscal year covered by this Annual Report on Form 10-K.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION ----------------------\nThe information required for this Item 11 is incorporated by reference from the Company's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after the end of the Company's fiscal year covered by this Annual Report on Form 10-K.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------\nThe information required for this Item 12 is incorporated by reference from the Company's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after the end of the Company's fiscal year covered by this Annual Report on Form 10-K.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -------------------------\nThe information required for this Item 13 is incorporated by reference from the Company's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after the end of the Company's fiscal year covered by this 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) Documents filed as part of this Annual Report on Form 10-K:\n1. Financial Statements.\nAll financial statements required to be filed as part of this Annual Report on Form 10-K are filed under Item 8. A listing of such financial statements is set forth in Item 8, which listing is incorporated herein by reference.\n2. Schedules.\nSchedules for the Fifty-Three Weeks Ended November 1, 1992 and the Fifty-Two Weeks Ended October 31, 1993 and October 30, 1994.\nSCHEDULE NUMBER --------\nVIII. Valuation and Qualifying Accounts\nSchedules other than those listed above are omitted because (a) they are not required or are not applicable or (b) the required information is shown in the financial statements or notes related thereto.\n(b) No Current Report on Form 8-K was filed by the Company during the fourth quarter of its fiscal year ended October 30, 1994.\n(c) Exhibits\n3.1(a) Articles of Restatement setting forth the Amended and Restated Articles of Incorporation of the Company, as filed with the Secretary of State of Georgia on November 19, 1990 (Exhibit 3(i)1. to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994).\n3.1(b) Articles of Correction, as filed with the Secretary of State of Georgia on December 18, 1990 (Exhibit 3(i)2. to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994).\n3.1(c) Articles of Merger of Forstmann Georgia Corp. and the Company, as filed with the Secretary of State of Georgia on March 3, 1992 (Exhibit 3(i)3. to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994).\n3.1(d)* Articles of Amendment to the Articles of Incorporation of the Company, as filed with the Secretary of State of Georgia on April 5, 1994.\n3.2(a) By-Laws of the Company (Exhibit 4.4 to the Company's Registration Statement (No. 33-55770) on Form S-8).\n3.2(b) Amended and Restated By-Laws of the Company on March 30, 1994 (Exhibit 3(ii) to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994).\n4.1(a) Amended and Restated Indenture, dated as of November 19, 1990, relating to Senior Subordinated Notes due April 15, 1999 (Exhibit 2 to the Company's Current Report on Form 8-K dated November 19, 1990).\n4.1(b) First Supplemental Indenture, dated as of November 29, 1990, relating to Senior Subordinated Notes due April 15, 1999 (Exhibit 3 to the Company's Current Report on Form 8-K dated November 19, 1990).\n4.1(c) Second Supplemental Indenture, dated as of March 4, 1992, relating to Senior Subordinated Notes due April 15, 1999 (Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended February 2, 1992).\n4.2 Form of 14-3\/4% Senior Subordinated Note due April 15, 1999 (Exhibit A to Exhibit 4.1(a) hereof, as amended by Exhibits 4.1(b) and 4.1(c) hereof).\n4.3 Form of Amended Senior Subordinated Note due April 15, 1999 (Exhibit B to Exhibit 4.1(a) hereof, as amended by Exhibits 4.1(b) and 4.1(c) hereof).\n4.4(a) Loan Agreement, dated as of October 30, 1992, between the Company and General Electric Capital Corporation (\"GECC\"), as lender and agent for the lenders named therein (\"Loan Agreement\") (Exhibit 4.4(a) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n4.4(b) Security Agreement, dated as of November 13, 1992, by the Company, in favor of GECC, as lender and agent for the lenders named therein (Exhibit 4.4(b) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n4.4(c) Form of Trademark Security Agreement, dated as of November 13, 1992, by the Company, in favor of GECC, as lender and agent for the lenders named therein (Exhibit 4.4(c) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n4.4(d) Form of Deed to Secure Debt, Assignment of Leases and Rents, Security Agreement and Fixture Filing, dated as of November 13, 1992, between the Company and GECC, as agent (Exhibit 4.4(d) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n4.4(e) First Amendment, dated as of November 13, 1992, to the Loan Agreement (Exhibit 19.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993).\n4.4(f) Form of Promissory Note for the Loan Agreement (Exhibit 19.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993).\n4.4(g) Second Amendment, dated as of December 30, 1992, to the Loan Agreement (Exhibit 19.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993).\n4.4(h) Third Amendment, dated as of April 5, 1993, to the Loan Agreement (Exhibit 19.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993).\n4.4(i) Consent and Waiver Letter, dated as of June 10, 1994, to the Company from GECC (Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994).\n4.4(j) Fourth Amendment, dated as of June 11, 1993, to the Loan Agreement (Exhibit 19.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993).\n4.4(k) Fifth Amendment, dated as of August 2, 1992, to the Loan Agreement (Exhibit 4.4(j) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993).\n4.4(l) Sixth Amendment, dated as of October 29, 1993, to the Loan Agreement (Exhibit 4.4(k) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993).\n4.4(m) Seventh Amendment, dated as of March 30, 1994, to the Loan Agreement (Exhibit 4.9 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994).\n4.4(n)* Eighth Amendment, dated as of August 29, 1994, to the Loan Agreement.\n4.4(o) Consent and Waiver Letter, dated as of September 12, 1994, to the Company from GECC (Exhibit 4.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994).\n4.4(p)* Ninth Amendment, dated as of November 4, 1994, to the Loan Agreement.\n4.4(q)* Tenth Amendment, dated January 4, 1995, to the Loan Agreement.\n4.4(r)* Eleventh Amendment, dated as of January 23, 1995, to the Loan Agreement.\n4.5(a) Loan and Security Agreement (\"Loan and Security Agreement\"), dated December 27, 1991, between the Company and The CIT Group\/Equipment Financing, Inc. (\"CIT\") (Exhibit 28.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended February 2, 1992).\n4.5(b) Amendment, dated September 2, 1992, to the Loan and Security Agreement (Exhibit 4.5(b) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n4.5(c) Amendment, dated October 30, 1992, to the Loan and Security Agreement (Exhibit 4.5(c) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n4.5(d) Amendment, dated December 31, 1992, to the Loan and Security Agreement (Exhibit 4.5(d) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n4.5(e) Amendment, dated as of July 30, 1993, to the Loan and Security Agreement (Exhibit 4.5(e) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n4.5(f) Third Amendment to the Loan and Security Agreement, dated as of June 13, 1994 (Exhibit 4.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.)\n4.5(g) Fourth Amendment to the Loan and Security Agreement, dated as of September 12, 1994 (Exhibit 4.5 to the Company's Quarterly Report on Form 10-K for the quarter ended July 31, 1994).\n4.5(h)* Fifth Amendment to the Loan and Security Agreement, dated as of December 22, 1994.\n4.6(a) Indenture, dated as of April 5, 1993, between the Company and Shawmut Bank Connecticut, National Association (\"Shawmut\"), as trustee, relating to the Senior Secured Floating Rate Notes (\"Senior Secured Notes\") (Exhibit 4.6(a) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n4.6(b) Form of Senior Secured Note due October 30, 1997 (Exhibit 4.6(b) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n4.6(c) Form of Deed to Secure Debt, Assignments of Leases and Rents, Security Agreements and Fixture Filings, dated as of April 5, 1993, between the Company and Shawmut, as trustee (Exhibit 4.6(c) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n4.6(d) Security Agreement, dated as of April 5, 1993, between the Company and Shawmut, as trustee (Exhibit 4.6(d) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n4.6(e) Form of Trademark Security Agreement, dated as of April 5, 1993, between the Company and Shawmut, as trustee (Exhibit 4.6(e) to Post- Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n4.6(f) Form of Patent Security Agreement, dated as of April 5, 1993, between the Company and Shawmut, as trustee (Exhibit 19.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993).\n4.6(g) Amended and Restated Indenture, dated as of March 30, 1994, between the Company and Shawmut Bank of Connecticut, National Association, as trustee, relating to the Senior Secured Notes (Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994).\n4.6(h) Form of Original Senior Secured Note (incorporated herein by reference to Exhibit 4.6(g)).\n4.6(i) Form of Additional Senior Secured Note (incorporated herein by reference to Exhibit 4.6(g).\n4.6(j) Form of First Amendment to Deed to Secure Debt, Assignments of Leases and Rents, Security Agreements and Fixture Filings, dated as of March 30, 1994, between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994).\n4.6(k) First Amendment to Pledge and Security Agreement, dated as of March 30, 1994 between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994).\n4.6(l) First Amendment to Trademark Security Agreement (foreign), dated as of March 30, 1994, between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994).\n4.6(m) First Amendment to Trademark Security Agreement (U.S.), dated as of March 30, 1994, between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.7 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994).\n4.6(n) First Amendment to Patent Security Agreement, dated as of March 30, 1994, between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.8 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994).\n4.6(o)* Supplemental Indenture, dated as of January 23, 1995, between the Company and Shawmut Bank Connecticut, National Association, as trustee, relating to the Senior Secured Notes.\n10.1(a) J. P. Stevens & Co., Inc. Trademark Assignments to the Company, effective December 28, 1985, dated January 29, 1986 (Exhibit 10(h) to the Company's Registration Statement (No. 33-27296) on Form S-1).\n10.1(b) Lease, dated July 21, 1986, between the Company and 1185 Avenue of the Americas Associates (\"1185 Associates\") (Exhibit 10(t) to the Company's Registration Statement (No. 33-27296) on Form S-1).\n10.1(c) Lease Modification Agreement, dated December 5, 1991, between the Company and 1185 Associates (Exhibit 10.7 to the Company's Registration Statement (No. 33-44417) on Form S-1).\n10.1(d) Consent to Lease Modification Agreement, dated May 11, 1992, between the Company and 1185 Associates (Exhibit 10.2(c) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n10.1(e) Lease Modification Agreement, dated May 11, 1992, between the Company and 1185 Associates (Exhibit 10.1(d) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n10.2(a) Amended Note Registration Rights Agreement, dated as of November 19, 1990, among the Company and the parties thereto (Exhibit 10.4 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n10.2(b) Common Stock Registration Rights Agreement, dated as of November 19, 1990, among the Company, Columbia Savings & Loan Association, CSL Investments, Executive Life Insurance Company and the parties thereto (Exhibit 10.5 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n10.2(c) Preferred Stock Registration Rights Agreement, dated as of November 19, 1990, between the Company and Executive Life Insurance Company (Exhibit 10.6 to the Company's Registration Statement (No. 33-38520) on Form S-1).\n10.2(d)* Common Stock Registration Rights Agreement, dated as of September 9, 1994, between the Company and Resolution Trust Corporation as receiver for Columbia Savings & Loan Association, F.A.\n10.3(a)* Common Stock Incentive Plan as amended as of March 30, 1994.\n10.3(b) Form of Incentive Stock Option Agreement (Exhibit 4.2(a) to the Company's Registration Statement (No. 33-55770) on Form S-8).\n10.3(c) Alternative Form of Incentive Stock Option Agreement (Exhibit 4.2(b) to the Company's Registration Statement (No. 33-55770) on Form S-8).\n10.4(a) Form of Equity Referenced Deferred Incentive Award Agreement (\"ERA\") (Exhibit 10.13 to the Company's Registration Statement (No. 33-44417) on Form S-1).\n10.4(b)* Amendment, dated February 10, 1994, to the ERA Agreement, dated February 26, 1992.\n10.5(a) Form of Change in Control Agreement (Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n10.5(b) Employment Agreement dated December 16, 1993 between the Company and Christopher L. Schaller. (Exhibit 10.5(b) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993).\n10.5(c) Form of Employment Agreement for Executive Vice Presidents. (Exhibit 10.5(c) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993).\n10.6(a) Supplemental Retirement Benefit Plan (Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n10.6(b) Trust Agreement, dated December 30, 1993, of the Supplemental Retirement Benefit Plan Trust. (Exhibit 10.6(b) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993).\n10.7* Management Incentive Plan - Fiscal Year 1995.\n10.8 Non-Qualified Salaried Employees' Savings, Investment and Profit Sharing Plan (Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended November 1, 1992).\n10.9(a)* Form of Indemnity Agreement, effective as of February 7, 1994, between the Company and its corporate officers.\n10.9(b)* Form of Indemnity Agreement, effective as of February 7, 1994, between the Company and its directors.\n10.10(a)*License Agreement, dated July 1, 1992, between Campagia Tessile S.p.A. (\"licensor\") and the Company.\n10.10(b)*Guarantee Agreement, dated July 1, 1992, between the Licensor and the Company.\n10.10(c)*Italian Fabrics Purchase Agreement, dated July 1, 1992, between the Licensor and the Company.\n10.10(d)*Liquidated Damages Agreement, dated July 1, 1992, between the Licensor and the Company.\n10.10(e)*Use of the mark \"Carpini\" Agreement, dated July 1, 1992, between the Licensor and the Company.\n10.10(f)*Consultancy\/Sales Fee Agreement, dated July 1, 1992, between Woolverton Limited (\"Consultant\") and the Company.\n10.10(g)*Guarantee Agreement, dated July 1, 1992, between the Consultant and the Company.\n10.10(h)*Consultation for Purchase of Italian Fabrics Agreement, dated July 1, 1992, between the Consultant and the Company.\n10.10(i)*Liquidated Damages Agreement, dated July 1, 1992, between the Consultant and the Company.\n10.10(j)*Renegotiation of Sales Fee Arrangements for Non-Registration of Marks, dated July 1, 1992, between the Consultant and the Company.\n11.1* Computation of per share earnings.\n23.1* Consent of Deloitte & Touche LLP.\n27.1* Financial Data Schedule.\n* 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.\nDate: January 26, 1995 By: \/s\/ Christopher L. Schaller ---------------------------- Christopher L. Schaller 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\/ Christopher L. Schaller President and Chief January 26, 1995 - --------------------------------- Executive Officer Christopher L. Schaller and Director (Principal Executive Officer)\n\/s\/ William B. Towne Executive Vice January 26, 1995 - --------------------------------- President and William B. Towne Chief Financial Officer (Principal Financial and Accounting Officer)\n\/s\/ Stephen Berger Director January 26, 1995 - --------------------------------- Stephen Berger\n\/s\/ Cameron Clark, Jr. Director January 26, 1995 - --------------------------------- Cameron Clark, Jr.\n\/s\/ Steven M. Friedman Director January 26, 1995 - --------------------------------- Steven M. Friedman\n\/s\/ F. Peter Libassi Director January 26, 1995 - --------------------------------- F. Peter Libassi\n\/s\/ Alain Oberrotman Director January 26, 1995 - --------------------------------- Alain Oberrotman\nINDEPENDENT AUDITORS' REPORT\nTo The Board of Directors and Shareholders of Forstmann & Company, Inc.:\nWe have audited the financial statements of Forstmann & Company, Inc. as of October 30, 1994 and October 31, 1993 and the related statements of operations, shareholders' equity, and cash flows for the fifty-two weeks ended October 30, 1994 and October 31, 1993 and the fifty-three weeks ended November 1, 1992 and have issued our report thereon dated December 8, 1994 (January 23, 1995 as to paragraph 2 of Note 7)(which expresses an unqualified opinion and includes an explanatory paragraph relating to the Company's quasi reorganization and its changes in its method of accounting for income taxes)(included elsewhere in the Annual Report on Form 10-K). Our audits also included the financial statements listed in Item 14(a)2 of this Annual Report on Form 10-K. 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 faily in all material respects the information set forth therein.\n\/s\/Deloitte & Touche LLP - ------------------------\nDeloitte & Touche LLP\nAtlanta, Georgia December 8, 1994\nSCHEDULE VIII\nFORSTMANN & COMPANY, INC.\nVALUATION AND QUALIFYING ACCOUNTS THE FIFTY-THREE WEEKS ENDED NOVEMBER 1, 1992 AND THE FIFTY-TWO WEEKS ENDED OCTOBER 31, 1993 AND OCTOBER 30, 1994\n\/(1)\/ Accounts written off net of recoveries of accounts previously written off. \/(2)\/ Net reduction due to disposal of identified excess cloth and yarn inventories.\nEXHIBIT INDEX -------------\nSequential Exhibit No. Description Page No. - ----------- ------------ ----------\n3.1(a) Articles of Restatement setting forth the Amended and Restated Articles of Incorporation of the Company, as filed with the Secretary of State of Georgia on November 19, 1990 (Exhibit 3(i)1. to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994). *\n3.1(b) Articles of Correction, as filed with the Secretary of State of Georgia on December 18, 1990 (Exhibit 3(i)2. to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994). *\n3.1(c) Articles of Merger of Forstmann Georgia Corp. and the Company, as filed with the Secretary of State of Georgia on March 3, 1992 (Exhibit 3(i)3. to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994). *\n3.1(d) Articles of Amendment to the Articles of Incorporation of the Company, as filed with the Secretary of State of Georgia on April 5, 1994.\n3.2(a) By-Laws of the Company (Exhibit 4.4 to the Company's Registration Statement (No. 33-55770) on Form S-8). *\n3.2(b) Amended and Restated By-Laws of the Company on March 30, 1994 (Exhibit 3(ii) to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994). *\n4.1(a) Amended and Restated Indenture, dated as of November 19, 1990, relating to Senior Subordinated Notes due April 15, 1999 (Exhibit 2 to the Company's Current Report on Form 8-K dated November 19, 1990). *\n4.1(b) First Supplemental Indenture, dated as of November 29, 1990, relating to Senior Subordinated Notes due April 15, 1999 (Exhibit 3 to the Company's Current Report on Form 8-K dated November 19, 1990). *\n4.1(c) Second Supplemental Indenture, dated as of March 4, 1992, relating to Senior Subordinated Notes due April 15, 1999 (Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended February 2, 1992). *\n__________ *Incorporated herein by reference as indicated.\n(i)\nEXHIBIT INDEX -------------\nSequential Exhibit No. Description Page No. - ----------- ------------ ----------\n4.2 Form of 14-3\/4% Senior Subordinated Note due April 15, 1999 (Exhibit A to Exhibit 4.1(a) hereof, as amended by Exhibits 4.1(b) and 4.1(c) hereof). *\n4.3 Form of Amended Senior Subordinated Note due April 15, 1999 (Exhibit B to Exhibit 4.1(a) hereof, as amended by Exhibits 4.1(b) and 4.1(c) hereof). *\n4.4(a) Loan Agreement, dated as of October 30, 1992, between the Company and General Electric Capital Corporation (\"GECC\"), as lender and agent for the lenders named therein (\"Loan Agreement\") (Exhibit 4.4(a) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n4.4(b) Security Agreement, dated as of November 13, 1992, by the Company, in favor of GECC, as lender and agent for the lenders named therein (Exhibit 4.4(b) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n4.4(c) Form of Trademark Security Agreement, dated as of November 13, 1992, by the Company, in favor of GECC, as lender and agent for the lenders named therein (Exhibit 4.4(c) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n4.4(d) Form of Deed to Secure Debt, Assignment of Leases and Rents, Security Agreement and Fixture Filing, dated as of November 13, 1992, between the Company and GECC, as agent (Exhibit 4.4(d) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n4.4(e) First Amendment, dated as of November 13, 1992, to the Loan Agreement (Exhibit 19.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993). *\n4.4(f) Form of Promissory Note for the Loan Agreement (Exhibit 19.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993). *\n__________ *Incorporated herein by reference as indicated.\n(ii)\nEXHIBIT INDEX -------------\nSequential Exhibit No. Description Page No. - ----------- -------------- ----------\n4.4(g) Second Amendment, dated as of December 30, 1992, to the Loan Agreement (Exhibit 19.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993). *\n4.4(h) Third Amendment, dated as of April 5, 1993, to the Loan Agreement (Exhibit 19.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993). *\n4.4(i) Consent and Waiver Letter, dated as of June 10, 1994, to the Company from GECC (Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994). *\n4.4(j) Fourth Amendment, dated as of June 11, 1993, to the Loan Agreement (Exhibit 19.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993). *\n4.4(k) Fifth Amendment, dated as of August 2, 1992, to the Loan Agreement (Exhibit 4.4(j) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993). *\n4.4(l) Sixth Amendment, dated as of October 29, 1993, to the Loan Agreement (Exhibit 4.4(k) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993). *\n4.4(m) Seventh Amendment, dated as of March 30, 1994, to the Loan Agreement (Exhibit 4.9 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994). *\n4.4(n) Eighth Amendment, dated as of August 29, 1994, to the Loan Agreement.\n4.4(o) Consent and Waiver Letter, dated as of September 12, 1994, to the Company from GECC (Exhibit 4.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994). *\n4.4(p) Ninth Amendment, dated as of November 4, 1994, to the Loan Agreement.\n4.4(q) Tenth Amendment, dated January 4, 1995, to the Loan Agreement.\n4.4(r) Eleventh Amendment, dated as of January 23, 1995, to the Loan Agreement.\n__________ *Incorporated herein by reference as indicated.\n(iii)\nEXHIBIT INDEX -------------\nSequential Exhibit No. Description Page No. - ----------- ------------- ----------\n4.5(a) Loan and Security Agreement (\"Loan and Security Agreement\"), dated December 27, 1991, between the Company and The CIT Group\/Equipment Financing, Inc. (\"CIT\") (Exhibit 28.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended February 2, 1992). *\n4.5(b) Amendment, dated September 2, 1992, to the Loan and Security Agreement (Exhibit 4.5(b) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n4.5(c) Amendment, dated October 30, 1992, to the Loan and Security Agreement (Exhibit 4.5(c) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n4.5(d) Amendment, dated December 31, 1992, to the Loan and Security Agreement (Exhibit 4.5(d) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1). *\n4.5(e) Amendment, dated as of July 30, 1993, to the Loan and Security Agreement (Exhibit 4.5(e) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1). *\n4.5(f) Third Amendment to the Loan and Security Agreement, dated as of June 13, 1994 (Exhibit 4.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended July 31, 1994.) *\n4.5(g) Fourth Amendment to the Loan and Security Agreement, dated as of September 12, 1994 Exhibit 4.5 to the Company's Quarterly Report on Form 10-K for the quarter ended July 31, 1994). *\n4.5(h) Fifth Amendment to the Loan and Security Agreement, dated as of December 22, 1994.\n__________ *Incorporated herein by reference as indicated.\n(iv)\nEXHIBIT INDEX -------------\nSequential Exhibit No. Description Page No. - ----------- ------------- ----------\n4.6(a) Indenture, dated as of April 5, 1993, between the Company and Shawmut Bank Connecticut, National Association (\"Shawmut\"), as trustee, relating to the Senior Secured Floating Rate Notes (\"Senior Secured Notes\") (Exhibit 4.6(a) to Post-Effective Amend-ment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1). *\n4.6(b) Form of Senior Secured Note due October 30, 1997 (Exhibit 4.6(b) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1). *\n4.6(c) Form of Deed to Secure Debt, Assignments of Leases and Rents, Security Agreements and Fixture Filings, dated as of April 5, 1993, between the Company and Shawmut, as trustee (Exhibit 4.6(c) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1). *\n4.6(d) Security Agreement, dated as of April 5, 1993, between the Company and Shawmut, as trustee (Exhibit 4.6(d) to Post-Effective Amendment No. 4 to the Company's Registration Statement No. 33-38520) on Form S-1). *\n4.6(e) Form of Trademark Security Agreement, dated as of April 5, 1993, between the Company and Shawmut, as trustee (Exhibit 4.6(e) to Post-Effective Amendment No. 4 to the Company's Registration Statement (No. 33-38520) on Form S-1). *\n4.6(f) Form of Patent Security Agreement, dated as of April 5, 1993, between the Company and Shawmut, as trustee (Exhibit 19.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended August 1, 1993). *\n4.6(g) Amended and Restated Indenture, dated as of March 30, 1994, between the Company and Shawmut Bank of Connecticut, National Association, as trustee, relating to the Senior Secured Notes (Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994). *\n__________ *Incorporated herein by reference as indicated.\n(v)\nEXHIBIT INDEX -------------\nSequential Exhibit No. Description Page No. - ----------- ----------- ----------\n4.6(h) Form of Original Senior Secured Note (incorporated herein by reference to Exhibit 4.6(g)). *\n4.6(i) Form of Additional Senior Secured Note (incorporated herein by reference to Exhibit 4.6(g). *\n4.6(j) Form of First Amendment to Deed to Secure Debt, Assignments of Leases and Rents, Security Agreements and Fixture Filings, dated as of March 30, 1994, between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994). *\n4.6(k) First Amendment to Pledge and Security Agreement, dated as of March 30, 1994 between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994). *\n4.6(l) First Amendment to Trademark Security Agreement (foreign), dated as of March 30, 1994, between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994). *\n4.6(m) First Amendment to Trademark Security Agreement (U.S.), dated as of March 30, 1994, between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.7 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994). *\n4.6(n) First Amendment to Patent Security Agreement, dated as of March 30, 1994, between the Company and Shawmut Bank Connecticut, National Association, as trustee (Exhibit 4.8 to the Company's Quarterly Report on Form 10-Q for the quarter ended May 1, 1994). *\n4.6(o) Supplemental Indenture, dated as of January 23, 1995, between the Company and Shawmut Bank Connecticut, National Association, as trustee, relating to the Senior Secured Notes.\n__________ *Incorporated herein by reference as indicated.\n(vi)\nEXHIBIT INDEX -------------\nSequential Exhibit No. Description Page No. - ----------- ----------- ----------\n10.1(a) J. P. Stevens & Co., Inc. Trademark Assignments to the Company, effective December 28, 1985, dated January 29, 1986 (Exhibit 10(h) to the Company's Registration Statement (No. 33-27296) on Form S-1). *\n10.1(b) Lease, dated July 21, 1986, between the Company and 1185 Avenue of the Americas Associates (\"1185 Associates\") (Exhibit 10(t) to the Company's Registration Statement (No. 33-27296) on Form S-1). *\n10.1(c) Lease Modification Agreement, dated December 5, 1991, between the Company and 1185 Associates (Exhibit 10.7 to the Company's Registration Statement (No. 33-44417) on Form S-1). *\n10.1(d) Consent to Lease Modification Agreement, dated May 11, 1992, between the Company and 1185 Associates (Exhibit 10.2(c) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n10.1(e) Lease Modification Agreement, dated May 11, 1992, between the Company and 1185 Associates (Exhibit 10.1(d) to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n10.2(a) Amended Note Registration Rights Agreement, dated as of November 19, 1990, among the Company and the parties thereto (Exhibit 10.4 to the Company's Registration Statement (No. 33-38520) on Form S-1). *\n10.2(b) Common Stock Registration Rights Agreement, dated as of November 19, 1990, among the Company, Columbia Savings & Loan Association, CSL Investments, Executive Life Insurance Company and the parties thereto (Exhibit 10.5 to the Company's Registration Statement (No. 33-38520) on Form S-1). *\n10.2(c) Preferred Stock Registration Rights Agreement, dated as of November 19, 1990, between the Company and Executive Life Insurance Company (Exhibit 10.6 to the Company's Registration Statement (No. 33-38520) on Form S-1). *\n__________ *Incorporated herein by reference as indicated.\n(vii)\nEXHIBIT INDEX -------------\nSequential Exhibit No. Description Page No. - ----------- ------------- ----------\n10.2(d) Common Stock Registration Rights Agreement, dated as of September 9, 1994, between the Company and Resolution Trust Corporation as receiver for Columbia Savings & Loan Association,F.A.\n10.3(a) Common Stock Incentive Plan as amended as of March 30, 1994.\n10.3(b) Form of Incentive Stock Option Agreement (Exhibit 4.2(a) to the Company's Registration Statement (No. 33-55770) on Form S-8). *\n10.3(c) Alternative Form of Incentive Stock Option Agreement (Exhibit 4.2(b) to the Company's Registration Statement (No. 33-55770) on Form S-8). *\n10.4(a) Form of Equity Referenced Deferred Incentive Award Agreement (\"ERA\") (Exhibit 10.13 to the Company's Registration Statement (No. 33-44417) on Form S-1). *\n10.4(b) Amendment, dated February 10, 1994, to the ERA Agreement, dated February 26, 1992.\n10.5(a) Form of Change in Control Agreement (Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n10.5(b) Employment Agreement dated December 16, 1993 between the Company and Christopher L. Schaller. (Exhibit 10.5(b) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993). *\n10.5(c) Form of Employment Agreement for Executive Vice Presidents. (Exhibit 10.5(c) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993). *\n10.6(a) Supplemental Retirement Benefit Plan (Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n10.6(b) Trust Agreement, dated December 30, 1993, of the Supplemental Retirement Benefit Plan Trust. (Exhibit 10.6(b) to the Company's Annual Report on Form 10-K for the year ended October 31, 1993). *\n__________ *Incorporated herein by reference as indicated.\n(viii)\nEXHIBIT INDEX -------------\nSequential Exhibit No. Description Page No. - ----------- ------------ ----------\n10.7 Management Incentive Plan - Fiscal Year 1995.\n10.8 Non-Qualified Salaried Employees' Savings, Investment and Profit Sharing Plan (Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended November 1, 1992). *\n10.9(a) Form of Indemnity Agreement, effective as of February 7, 1994, between the Company and its corporate officers.\n10.9(b) Form of Indemnity Agreement, effective as of February 7, 1994, between the Company and its directors.\n10.10(a) License Agreement, dated July 1, 1992, between Campagia Tessile S.p.A. (\"licensor\") and the Company.\n10.10(b) Guarantee Agreement, dated July 1, 1992, between the Licensor and the Company.\n10.10(c) Italian Fabrics Purchase Agreement, dated July 1, 1992, between the Licensor and the Company.\n10.10(d) Liquidated Damages Agreement, dated July 1, 1992, between the Licensor and the Company.\n10.10(e) Use of the mark \"Carpini\" Agreement, dated July 1, 1992, between the Licensor and the Company.\n10.10(f) Consultancy\/Sales Fee Agreement, dated July 1, 1992, between Woolverton Limited (\"Consultant\") and the Company.\n10.10(g) Guarantee Agreement, dated July 1, 1992, between the Consultant and the Company.\n10.10(h) Consultation for Purchase of Italian Fabrics Agreement, dated July 1, 1992, between the Consultant and the Company.\n10.10(i) Liquidated Damages Agreement, dated July 1, 1992, between the Consultant and the Company.\n10.10(j) Renegotiation of Sales Fee Arrangements for Non-Registration of Marks, dated July 1, 1992, between the Consultant and the Company.\n11.1 Computation of per share earnings.\n23.1 Consent of Deloitte & Touche LLP.\n27.1 Financial Data Schedule.\n__________ *Incorporated herein by reference as indicated.\n(ix)","section_15":""}
{"filename":"726517_1994.txt","cik":"726517","year":"1994","section_1":"ITEM 1 - BUSINESS\nA chronology of events, including acquisitions, relating to MERCHANTS BANCSHARES, INC., (the Company) is as follows:\nJuly 1, 1983: Merchants Bancshares, Inc. was organized as a Vermont corporation, for the purpose of acquiring, investing in or holding stock in any subsidiary enterprise under the Bank Holding Company Act of 1956.\nJanuary 24, 1984: Company acquired The Merchants Bank, a Vermont chartered commercial bank.\nJune 2, 1987: Company shareholders approved a resolution to change the state of incorporation of the Company from Vermont to Delaware.\nOctober 4, 1988: Company organized Merchants Properties, Inc., whose mission is as described below.\nTHE MERCHANTS BANK, (the Bank) was organized in 1849, and assumed a national bank charter in 1865, becoming The Merchants National Bank of Burlington, Vermont. On September 6, 1974 the Bank converted its national charter to a state-bank charter, becoming known as The Merchants Bank. Since 1971 the Bank has acquired by merger seven Vermont banking institutions, and has acquired the deposits of an eighth bank located in St. Johnsbury, Vt. The last such acquisition occurred on June 4, 1993 at which time the Bank acquired the New First National Bank of Vermont, with thirteen banking offices, from the Federal Deposit Insurance Corporation Division of Liquidation. As of December 31, 1994 the Bank was the third largest commercial banking operation in Vermont, with deposits totalling $582.2 million, net loans of $490.6 million, and total assets of $694.8 million, on a consolidated basis.\nSince September 30, 1988, The Merchants Bank has participated as an equity partner in the development of several AFFORDABLE HOUSING PARTNERSHIPS which were formed to provide residential housing units within the State of Vermont. During the past four years these partnerships have developed 727 units of residential housing, 470 (65%) of which qualify as \"affordable housing units for eligible low income owners or renters\", and 257 (35%) of which are \"market rate units\". These partnerships have invested in 16 affordable and elderly housing projects within 13 Vermont communities: St. Albans, Middlebury, Williston, Winooski, Brattleboro, Montpelier, Burlington, Springfield, St. Johnsbury, Colchester, Swanton, Bradford and Hardwick.\nMERCHANTS PROPERTIES, INC., a wholly owned subsidiary of the Company, was organized for the purpose of developing and owning affordable rental housing units throughout the state of Vermont. As of December 31, 1994 the corporation owned one development located in Enosburg, Vermont, consisting of a 24-unit low income family rental housing project, which was completed and rented during 1989. This housing development is fully occupied at this time. Total assets of this corporation at December 31, 1994 were $1,309,983.\nThe Merchants Bank owns controlling interest in the MERCHANTS TRUST COMPANY, a Vermont corporation chartered in 1870 for the purpose of offering fiduciary services such as estate settlement, testamentary trusts, guardianships, agencies, intervivos trusts, employee benefit plans and corporate trust services. The Merchants Trust Company also operates a discount brokerage office, through Olde Discount Corporation, enabling investors to purchase or sell stocks and bonds on a discounted commission schedule. As of December 31, 1994, the Merchants Trust Company had fiduciary responsibilities for assets valued at market in excess of $365.5 million. Total revenue for 1994 was $1,809,991, total expense was $4,415,949, (including an extraordinary item totalling $3,246,100 as described in Part I, Item 4, page 9) resulting in a pre-tax net loss for the year of $2,605,958. This loss is included in the consolidated tax return of its parent company, The Merchants Bank.\nQUENESKA CAPITAL CORPORATION, a wholly-owned subsidiary of The Merchants Bank was established on April 4, 1988 as a Federal licensee under the Small Business Act of 1958 to provide small business enterprises with loans and\/or capital. As of December 31, 1994, the corporation had assets of $1,720,961, liabilities of $109,034 due to the parent company for accrued management fees, and equity capital of $1,611,928.\nQueneska Capital Corporation has no employees, relying on the personnel resources of its parent company to operate. As compensation for its services Queneska pays the Bank a management fee in the amount of 1.5% on annual average assets ($23,269) in 1994. This fee is eliminated in the financial statement consolidation of the parent company.\nQueneska's taxable income or loss is included in the consolidated tax return of its parent company, The Merchants Bank. Queneska computes its income tax provision of benefit on an individual basis and reimburses, or is reimbursed by, the parent company an amount equal to the annual provision or benefit.\nRETAIL SERVICES\nThe Merchants Bank offers a wide range of deposit and investment products including business checking accounts; Free 60 accounts; NOW checking accounts; NOW 50 accounts; regular checking and Super NOW accounts. In July 1994, the Bank offered a new type of personal account entitled \"bottom line checking\". This account features a flat monthly fee of $3.00 for twenty checks per statement period with no monthly minimum balance required. A charge of $.50 per check is assessed for more than twenty checks per month. The account can also be used for all electronic transactions including ATM transactions.\nThe Bank also offers Certificates of Deposit, Money Market accounts, savings accounts, individual retirement accounts and Christmas Club accounts, all at competitive rates and terms. ATF (automatic transfer of funds) provides overdraft protection benefits for personal checking accounts through electronic funds transfer. In addition, the bank offers cash management services for commercial account depositors who may have idle overnight or longer term balances to invest.\nThe bank provides strong customer support with thirty Automated Teller machines statewide, including one drive-up ATM; and 106 on-line electronic teller stations. The bank's expanded personal computer networks now connect each banking office to the mainframe AS\/400 computer with CRT capability, as well as, electronic mail and other PC software applications.\nAdditional retail services include safe deposit boxes, travelers and gift checks, bank drafts, personal money orders and several methods of automated money transfer, including Federal Reserve wire services.\nCOMMERCIAL SERVICES\nTypes of Credit Offerings: Consumer Loans: Financing is provided for new or used automobiles; boats; airplanes; recreational vehicles; new mobile homes; collateral loans, secured by savings accounts, listed equities or life insurance; personal loans. Home improvement and home equity lines of credit, as well as Master and Visa credit cards.\nReal Estate Loans: Financing is available for one-to-four family residential mortgages; multi- family mortgages; residential construction; mortgages for seasonal dwellings; commercial real estate mortgages. Mortgages for residential properties are offered on a long-term fixed-rate basis; alternatively, adjustable-rate mortgages are offered. Bi-weekly payment mortgages and graduated (two-step) payment mortgages are offered. Loans under the Farmers Home Administration Rural Guaranteed Housing Program provide up to 100% financing. The bank also participates with the Vermont Housing Finance Agency (VHFA) in providing mortgage financing for low- to moderate-income Vermonters. Most mortgage loan products are offered with as little as a 5% down payment to assist borrowers who qualify, providing the mortgagor(s) acquires private mortgage insurance.\nCommercial Loans: Financing for business inventory, accounts receivable, fixed assets, lines of credit for working capital, community development, irrevocable letters of credit, business credit cards, and U.S. Small Business Administration loans are available.\nOther miscellaneous commercial banking services include night depository, coin and currency handling and employee benefits management and related fiduciary services available through the Merchants Trust Company.\nEXPANSION EFFORTS\nThe Merchants Bank operates thirty-eight full-service banking facilities within Vermont; and a remote ATM unit located at the Burlington International Airport. Since 1963 the Bank has established eleven de novo offices, and since 1969 has acquired seven Vermont banks by merger. The Merchants Bank's most recent acquisition occurred in June of 1993 with the acquisition of the assets and assumption of deposits of the New First National Bank of Vermont from the FDIC. Through this acquisition the Merchants Bank extended its presence on the east side of the state gaining offices in Springfield, Windsor, E. Thetford, Fairlee, Bradford, Newbury and Groton and on the west side of the state an office in Fair Haven. This acquisition also resulted in The Merchants Bank increasing market share in Hardwick, St. Johnsbury and Northfield.\nEach decision to expand the branch network has been based upon strategic planning and analysis indicating that the new or acquired facility would provide enhanced banking resources within the community and insure the competitive viability of the Bank through potential growth of deposits and lending activities.\nOn March 14, 1994 The Merchants Bank opened a limited service office on the Wake Robin Retirement Community Campus in Shelburne, Vermont. During the fall of 1994, The Merchants Bank began restoration of the Old South Hero Inn on the corner of US Route 2 and South St., So. Hero, Vt. The Merchants Bank relocated its South Hero office to this historic site on January 17, 1995.\nCOMPETITION\nCompetition for financial services remains very strong in Vermont. As of December 31, 1994, there were eleven state chartered commercial banks, nine national banks, five savings banks and three savings and loan associations operating in Vermont. In addition, other financial intermediaries such as brokerage firms, credit unions, and out-of-state banks also compete for deposit, loan, and other ancillary financial activities.\nAt year-end 1994 The Merchants Bank was the third largest bank in Vermont, enjoying a strong competitive franchise within the state, with thirty-nine banking offices as identified in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Merchants Bank operates thirty-nine banking facilities as indicated in Schedule A below. Corporate administrative offices are located at 123 Church Street, Burlington, Vermont, and the operations data processing center is located at 275 Kennedy Drive, South Burlington, Vermont.\nSchedule B (below) indicates properties owned by the Bank as possible future expansion sites.\nA. SCHEDULE OF BANKING OFFICES BY LOCATION\nBurlington 123 Church Street Corporate offices 164 College Street Merchants Trust Co. 172 College Street Branch office 1014 North Avenue Branch office 12 Colchester Avenue *2 Branch office\nEssex Junction 54 Pearl Street Branch office\nSouth Burlington 50 White Street Branch office 947 Shelburne Road *1 Branch office 275 Kennedy Drive Operations Center Branch office Burlington Airport *1 ATM\nBristol 15 West Street Branch office\nBarre 105 North Main Street Branch office\nNorthfield Depot Square Branch office 2 Main St. Drive-up Facility\nSouth Hero South St. & Route 2 Branch office\nHardwick Wolcott Street Branch office\nHinesburg Route 116\/Shelburne Falls Rd Branch office\nVergennes Monkton Road Branch office\nWinooski 364 Main Street Branch office\nJohnson Main Street, Route 15 Branch office\nColchester 8 Porters Point Road *2 Branch office\nJericho Route 15 Branch office\nEnosburg Falls 155 Main Street Branch office\nNo. Bennington Bank Street Branch office\nManchester Ctr. 515 Main Street Branch office\nBrattleboro 205 Main Street *3 Branch office\nWilmington West Main Street Branch office\nBennington Putnam Square *2 Branch office\nWallingford Route 7 *2 Branch office\nSt. Johnsbury 90 Portland Street Branch office\nBradford 1 Main Street Branch office\nDanville Main Street Branch office\nFairlee U.S. Route #5 Branch office\nGroton U.S. Route #302 Branch office\nEast Thetford U.S. Route #5 & Vt 113 Branch office\nNewbury U.S. Route #5 Branch office\nFair Haven 97 Main Street Branch office\nSpringfield 56 Main Street Branch office Springfield Shopping Plaza Branch office\nWindsor 160 Main Street Branch office\nNotes: *1: Facilities owned by the bank are located on leased land. *2: Facilities located on leased land with improvements also leased. *3: As of December 31, 1994 a mortgage with an unpaid principal balance of $207,860 is outstanding on the Brattleboro office. This mortgage is being amortized at $1,736 per month, at a rate of 9% through the year 2020.\nB. SCHEDULE OF PROPERTIES OWNED FOR FUTURE EXPANSION *1\nYear Description Acquired Location Purpose ------------ -------- ----------------- ---------------- Land & Building 1973 117 Church St. Future Expansion Burlington, VT\nLand 1977 30 Main Street Future Expansion Burlington, VT\nLand 1977 45 College St. Future Expansion Burlington, VT\nLand & Building 1979 Plainfield, VT Future Expansion\nLand & Building 1981 8 White Street Future Expansion So. Burlington, VT\nLand & Building 1985 U.S. Route 7 Future Expansion Shelburne, VT\nLand & Building 1986 Pearl Street Future Expansion Essex Jct., VT\nLand & Building 1986 So. Summit St. Future Expansion Essex Jct., VT\nLand 1990 55 College Street Future Expansion Burlington, VT\nLand & Building 1990 60 Main Street Future Expansion Burlington, VT\nLand & Building 1993 Bradford Operations Future Expansion Building 1 Main St. Bradford, VT\nNote:\n*1: Buildings identified in Schedule B are all rented or leased to tenants. Leases are generally for short-term or medium term periods and are at varying rental amounts depending upon the location and the amount of space leased.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nDuring the fall of 1994, lawsuits were brought against the Company, the Bank, the Trust Company (collectively referred to as \"the Companies\") and certain directors of the Companies. These lawsuits relate to certain investments managed for Trust company clients and placed in the Piper Jaffray Institutional Government Income Portfolio. Separately, and before the suits were filed, the Companies had initiated a review of those investments. Outside consultants were retained to assist in this review. As a result of the review, the Trust Company paid to the affected Trust Company clients a total of approximately $9.2 million in December 1994. The payments do not constitute a legal settlement of any claims in the lawsuits. However, based on consultation with legal counsel, management believes that further liability, if any, of the Companies on account of matters complained of in the lawsuits will not have a material adverse affect on the consolidated financial position and results of operations of the Company. In December 1994, the Trust Company received a payment of $6,000,000 from its insurance carriers in connection with these matters. The Companies also intend to pursue all available claims against Piper Jaffray Companies, Inc. and others on account of the losses that gave rise to the $9.2 million payment by the Companies. Any recovery obtained as a result of such efforts is subject to the terms of an agreement between the Companies and the insurance carriers.\nThe attorneys representing the plaintiffs in one of the lawsuits discussed above have asked the Court to order the Trust Company's clients to pay fees to those attorneys in an amount of up to $500,000. The Trust Company has resisted the claims for payment of such fees by its clients, and as a result, the Trust Company has been directed to place the sum of $500,000 into escrow pending a ruling by the Court. Based upon consultation with legal counsel, management believes there is no substantial basis for any liability on the part of the Companies for payment of legal fees to those attorneys and, although there is the possibility that the Companies may be required to remit all or part of these funds, such an outcome is not considered likely.\nThe Bank is also involved in various legal proceedings arising in the normal course of business. Based upon consultation with legal counsel, management believes that the resolution of these matters will not have a material effect on the consolidated financial position and results of operations of the Company.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of calendar year 1994 no matters were submitted to a vote of security holders through a solicitation of proxies or otherwise.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of the Company is traded on the over-the- counter NASDAQ exchange under the trading symbol MBVT. Quarterly stock prices during the last eight quarters are as indicated below based upon quotations as provided by the National Association of Securities Dealers, Inc. Prices of transactions between private parties may vary from the ranges quoted below.\nCASH DIVIDEND QUARTER ENDING HIGH LOW PAID PER SHARE\nMarch 31, 1993 $17.00 $14.75 .20\nJune 30, 1993 16.50 10.25 *\nSeptember 30, 1993 16.00 11.25 *\nDecember 31, 1993 15.00 11.00 *\nMarch 31, 1994 14.75 9.00 *\nJune 30, 1994 13.50 9.00 *\nSeptember 30, 1994 17.00 11.25 *\nDecember 31, 1994 14.00 8.50 *\n*Cash dividends were suspended for the second, third and fourth quarters of 1993, and for all four quarters of 1994.\nAs of December 31, 1994 Merchants Bancshares, Inc. had 1,512 shareholders.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe supplementary financial data presented in the following tables and narrative contains information highlighting certain significant trends in the Company's financial condition and results of operations over an extended period of time.\nThe following information should be analyzed in conjunction with the year-end audited consolidated financial statements as contained in the 1994 Annual Report to Shareholders, a copy of which is attached as an addendum to this Form 10K.\nThe five-year summary of operations, interest management analysis, and management's discussion and analysis, all as contained on pages 23 through 30 in the 1994 Annual Report to Shareholders are herein incorporated by reference.\nTables included on the following pages 12 through 16 concern the following:\nDeposits; return on equity and assets; short-term borrowings; distribution of assets, liabilities, and stockholders' equity; analysis of changes in net interest income; and the composition and maturity of the loan portfolio.\nDEPOSITS\nThe following schedule shows the average balances of various classifications of deposits. Dollar amounts are expressed in thousands.\n1994 1993 1992\nDemand Deposits $ 91,853 $ 81,761 $ 68,494 Savings, Money Market and NOW Accounts 310,613 315,254 272,729 Time Deposits Over $100,000 18,135 17,752 18,170 Other Time Deposits 177,198 155,227 132,971 -------- -------- -------- Total Average Deposits $597,799 $569,994 $492,364 ======== ======== ========\nTime Deposits over $100,000 at December 31, 1994 had the following schedule of maturities (In Thousands):\nThree Months or Less $ 1,865 Over Three to Six Months 7,904 Over Six to Twelve Months 3,895 Over Twelve Months 2,943 Over Five Years 6,674 ------- Total $23,281 =======\nRETURN ON EQUITY AND ASSETS\nThe return on average assets, return on average equity, dividend payout ratio and average equity to average assets ratio for the three years ended December 31, 1994 were as follows:\n1994 1993 1992\nReturn on Average Total Assets -0.41% -0.82% 0.94% Return on Average Stockholders' Equity -6.24% -11.92% 11.01% Dividend Payout Ratio N\/A N\/A 58.48% Average Stockholders' Equity to Average Total Assets 6.53% 6.88% 8.56%\nSHORT-TERM BORROWINGS\nFor this information refer to notes 8 and 9 to the financial statements of the Company, as contained in the Annual Report to Shareholders, which is herein incorporated by reference.\nLOAN PORTFOLIO\nThe following tables display the composition of the Bank's loan portfolio for the consecutive five year period 1990 through 1994, along with a schedule profiling the loan maturity distribution over the next five years.\nCOMPOSITION OF LOAN PORTFOLIO\nThe table below presents the composition of the Bank's loan portfolio by type of loan as of December 31 for each of the past five years. All dollar amounts are expressed in thousands. Amounts are shown gross of net deferred loan fees of $1,132,494 in 1994, $1,310,416 in 1993, $1,183,400 in 1992, $1,098,100 in 1991 and $955,000 in 1990, which principally relate to real estate mortgages.\n----------------As of December 31,-------------- Type of Loan 1994 1993 1992 1991 1990\nCommercial, Financial & Agricultural $ 88,201 $ 98,936 $ 76,141 $120,033 $129,830 Industrial Revenue Bonds 4,411 6,695 8,721 11,968 16,296 Real Estate-Construction 21,992 30,526 18,776 16,392 23,763 Real Estate - Mortgage 377,429 413,112 305,513 294,769 288,845 Installment 18,086 22,836 18,332 20,930 25,070 Lease Financing 0 42 630 1,769 4,144 All Other Loans 436 1,324 1,422 4,287 7,452 -------- -------- -------- -------- -------- Total Loans $510,555 $573,471 $429,535 $470,148 $495,400\nPROFILE OF LOAN MATURITY DISTRIBUTION\nThe table below presents the distribution of the varying maturities or repricing opportunities of the loan portfolio at December, 1994. All dollar amounts are expressed in thousands.\nOver One One Year Through Over Five Or Less 5 Years Years Total --------- ---------- --------- -------- Commercial Loans, Industrial Revenue Bonds, Lease Financing and All Other Loans $ 59,012 $ 23,698 $10,338 $93,048 Real Estate Loans 237,270 96,197 65,954 399,421 Installment Loans 5,342 12,386 358 18,086 -------- -------- ------- -------- $301,624 $132,281 $76,650 $510,555 ======== ======== ======= ========\nResidential mortgage lending slowed during 1994 after two years of very heavy refinancing volume. Approximately 63% of the Bank's 1994 mortgage activity was for refinancing of existing debt. In 1994, a total of 490 one-to-four family residential mortgage loans were closed by the bank, totalling $44.8 million. Approximately 93% of these originations were sold on the secondary market and the remaining 7%, or $3.5 million were placed in the bank's portfolio. The bank currently services $335 million in residential mortgage loans, $259.3 of which it services for other investors such as federal government agencies (FNMA and FHLMC) and for financial investors such as insurance companies and pension funds located outside Vermont. At the end of 1994, the bank had 130 residential mortgage loans in various stages of processing. Approximately 40% of these loans were refinancings of existing debt.\nDuring 1994, the Bank remained an active participant in the U.S. Small Business Administration guaranteed loan program. Sixty- six new SBA loans totalling $8.22 million were originated during 1994 with SBA guarantees ranging from 70% to 90%. This volume of new lending activity represents an increase of 15% over originations during 1993.\nApproximately 79% of all new SBA loans originated during 1994 were sold to secondary market investors located outside Vermont. This selling activity has the positive effect on Vermont of importing capital into the State from other parts of the country. SBA guarantees are advantageous to the Bank because they reduce risk in the Bank's loan portfolio and allow the bank to increase it's commercial loan base and market share with minimal impact on capital.\nDuring 1994, the Bank originated 746 commercial loans totalling $134.6 million. This lending activity represented an increase of approximately 26% of new loan volume over that experienced in 1993. Commercial loans were originated throughout Vermont.\nLOAN REVIEW\nThe Bank's Board of Directors grants each loan officer the authority to originate loans on behalf of the Bank. The Board also establishes restrictions regarding the types of loans that may be granted and sets loan authority limits for each lender. These authorized lending limits are established at least annually and are based upon the lender's job assignment, training, and experience. Loan requests that exceed a lender's authority are referred to senior loan officers having higher lending authorities. All extensions of credit of $2.5 million to any one borrower, or related party interest, are reviewed and approved by the Bank's Board of Directors.\nBy using a variety of management reports, the Bank's loan portfolio is continuously monitored by the Board of Directors, senior loan officers, and the loan review department. The loan portfolio as a whole, as well as individual loans, are reviewed for loan performance, credit worthiness, and strength of documentation. Credit ratings are assigned to commercial loans and routinely reviewed.\nAll loan officers are required to service their own loan portfolios and account relationships. As necessary, loan officers or the loan workout function take remedial actions to assure full and timely payment of loan balances.\nLOAN QUALITY AND RESERVES FOR POSSIBLE LOAN LOSSES (RPLL)\nMerchants Bancshares, Inc. reviews the adequacy of the RPLL at least quarterly. The method used in determining the amount of the RPLL is not based upon maintaining a specific percentage of RPLL to total loans or total nonperforming assets, but rather a comprehensive analytical process of assessing the credit risk inherent in the loan portfolio. This assessment incorporates a broad range of factors which are indicative of both general and specific credit risk, as well as a consistent methodology for quantifying probable credit losses. As part of the Merchants Bancshares, Inc.'s analysis of specific credit risk, a detailed and extensive review is done on larger credits and problematic credits identified on the watched asset list, nonperforming asset listings, and credit rating reports.\nThe more significant factors considered in the evaluation of the adequacy of the RPLL based on the analysis of general and specific credit risk include:\n- Status of nonperforming loans - Status of adversely classified credits - Historic charge off experience by major loan category - Size and composition of the loan portfolio - Concentrations of credit risk - Renewals and extensions - Current local and general economic conditions and trends - Loan growth trends in the portfolio - Off-balance sheet credit risk relative to commitments to lend\nOverall, management maintains the RPLL at a level deemed to be adequate, in light of historical, current and prospective factors, to reflect the level of risk in the loan portfolio.\nAn analysis of the allocation of the RPLL follows. Both the specific and general components of the RPLL are grouped by loan categories. The allocation of the RPLL is based upon loan loss experience, loan portfolio composition, and an assessment of possible future loan losses in the categories shown.\nAllocation of the Reserve for Possible Loan Losses December 31, 1994 (000's omitted)\nPercent of loans in each Balance at End of Period Percent category to Applicable to: Amount Allocation total Loans ---------------------------------------------------------------------- Domestic: Commercial, Financial, and Agricultural & IRB's $5,000 25% 18% Real Estate - Construction 1,500 8% 4% Real Estate - Mortgage 13,000 65% 74% Installment Loans to Individuals 350 2% 4% All Other Loans 79 0% 0% ---------------------------------------------------------------------- Total: $19,929 100% 100% ======================================================================\nKey data that are used in the assessment of the loan portfolio and the analysis of the adequacy of the RPLL are presented in the tables and schedules that follow in this discussion. Loan loss experience and nonperforming asset data are presented and discussed in relation to their impact on the adequacy of the RPLL.\nThe table below reflects the Bank's loan loss experience and activity in the RPLL for the past five years. All dollar amounts are expressed in thousands.\nLOAN LOSSES AND RPLL RECONCILIATION Year Ended December 31, 1994 1993 1992 1991 1990 --------- --------- --------- --------- -------- Average Loans $514,843 $515,805 $441,291 $471,141 $488,792 ======== ======== ======== ======== ======== Reserve for Possible Loan Losses at Beginning of Year 20,060 7,412 6,650 5,075 5,151 Loans Charged Off (NOTE 1): -------- -------- -------- -------- ----- Commercial, Lease Financing and all Other Loans (3,356) (5,567) (2,938) (3,367) (2,318) Real Estate - Construction (1,159) (275) (253) (1,802) 0 Real Estate - Mortgage (7,673) (7,651) (4,096) (718) (2,236) Installment & Credit Cards (462) (459) (452) (617) (575) --------- --------- --------- -------- ------- Total Loans Charged Of (12,650) (13,952) (7,739) (6,504) (5,129) --------- --------- -------- -------- ------- Recoveries on Loans: Commercial, Lease Financing and all Other Loans 1,187 392 232 366 471 Real Estate - Construction 400 0 0 379 0 Real Estate - Mortgage 769 301 108 0 3 Installment & Credit Cards 163 85 111 91 87 --------- --------- --------- -------- -------- Total Recoveries on Loans $2,519 $778 $451 $836 $561 --------- --------- --------- -------- -------- Net Loans Charged Off ($10,131) ($13,174) ($7,288) ($5,668) ($4,568) --------- --------- -------- -------- -------- Provision for Loan Losses: Charged to Operations (NOTE 2) 10,000 23,822 8,050 7,243 4,492 Loan Loss Reserve (Note 3) 2,000 ------- ------- ------ ------ ------ Reserve for Possible Loan Losses at End of Year $19,929 $20,060 $7,412 $6,650 $5,075 ======= ======= ====== ====== ====== Loan Loss Reserve to Total Loans at Year End 3.90% 3.50% 1.73% 1.41% 1.03% Ratio of Net Charge Offs During the Year to Average Loans Outstanding During the Year 1.97% 2.28% 1.63% 1.20% 0.95%\nNOTE 1: Prior to 1991, loans secured by real estate were not broken out between construction and permanent financing for purposes of loan charge off and recovery analysis.\nNOTE 2: The loan loss provision is charged to operating expense. When actual losses differ from these estimates, and if adjustments are considered necessary, they are reported in operations in the periods in which they become known.\nNOTE 3: See Note 10 to the consolidated financial statements regarding the acquisition of New First National Bank of Vermont.\nThe slight decrease in the reserve for possible loan losses from $20,060,000 at December 31, 1993 to $19,929,000 at December 31, 1994, reflects management's in-depth analysis of the RPLL and efforts to maintain the reserve at an appropriate level to provide for potential loan losses based on the evaluation of known and inherent risks in the loan portfolio. The provision for loan losses decreased from $23,822,000 in 1993 to $10,000,000 in 1994. This was partly driven by net loans charged off by the Company in 1993 of $13,174,000.\nNONPERFORMING ASSETS\nThe following tables summarize the Bank's nonperforming assets. The first table shows a breakout of nonperforming assets covered by a loss sharing arrangement related to the acquisition of the NFNBV on June 4, 1993. The terms of the Purchase and Assumption Agreement related to the purchase of NFNBV require that the FDIC pay the Bank 80% of net charge-offs up to $41,100,000 on any loans that qualify as loss sharing loans for a period of three years from the date of the acquisition. If net charge offs on qualifying loss sharing loans exceed $41,100,000 during the three year period, the FDIC is required to pay 95% of such qualifying charge offs. This arrangement significantly reduces the exposure that the Bank faces on NPAs that are covered by loss sharing. Nonperforming assets (NPAs) covered by loss sharing totaled $10,455,000 and $17,469,000 at December 31, 1994 and 1993, respectively. The aggregate amount of loans covered by the loss sharing arrangement at December 31, 1994 was $95,802,000 and $132,879,208 at December 31, 1993.\nNonperforming assets as of December 31, 1994 were:\nSegregated Loans Loans Total ----------------------------------------------------------------------- Nonaccrual Loans $24,251,987 $7,948,632 $32,200,619 Restructured Loans 5,016,123 66,731 5,082,854 Loans Past Due 90 Days or More and Still Accruing 668,007 0 668,007 Other Real Estate Owned, Net 10,791,262 2,439,545 13,230,807 ----------- ----------- ----------- Total: $40,727,379 $10,454,908 $51,182,287 =========== =========== ===========\nThe following table shows nonperforming assets as of year end 1990 through 1994 (in thousands):\n1994 1993 1992 1991 1990 --------------------------------------------------------------------------- Nonaccrual Loans $32,200 $47,069 $12,148 $8,333 $2,914 Loans Past Due 90 Days or More and Still Accruing 668 715 7,251 8,613 5,908 Restructured Loans 5,083 2,841 1,838 5,679 0 ------ ------ ------ ------ ------ Total Nonperforming Loans: 37,951 50,625 21,237 22,625 8,822 ------ ------ ------ ------ ------ Other Real Estate Owned 13,231 13,674 12,662 6,110 4,652 ------ ------- ------- ------- ------- Total Nonperforming Assets: $51,182 $64,299 $33,899 $28,735 $13,474 ======= ======= ======= ======= ======= Percentage of Nonperforming Loans to Total Loans 7.43% 8.83% 4.94% 4.81% 1.78% Percentage of Nonperforming Assets to Total Loans plus Other Real Estate Owned 9.77% 10.95% 7.67% 6.03% 2.70% ======= ======= ======== ======= =======\nThe nonperforming assets table above showed an increasing trend in nonperforming assets until December 31, 1993. Historically, the Company has worked closely with borrowers and also pursued vigorous collection efforts. The Company continued its efforts to collect on troubled assets during 1994. The Company's enhanced Loan Review and Loan Workout functions provided resources to address collection strategies for nonperforming assets.\nBased upon the result of the Company's assessment of the factors affecting the RPLL, as noted in this discussion, management believes that the balance of the RPLL at December 31, 1994, is adequate.\nDISCUSSION OF 1994 EVENTS AFFECTING THE RESERVE FOR POSSIBLE LOAN LOSSES (RPLL)\nNonperforming assets declined from $64,299,000 at December 31, 1993 to $51,182,000 at December 31, 1994. Net charge offs during 1994 were $10,131,000 which accounted for part of the reduction. Paydowns, payoffs, return to performing status, and OREO sales resulted in a further decrease in NPAs.\n12-31-94 9-30-94 6-30-94 3-31-94 12-31-93 -------- -------- -------- -------- -------- Nonaccrual Loans $32,200 $28,385 $39,166 $43,091 $47,069 Loans Past Due 90 days or more and still Accruing 668 106 558 109 715 Restructured Loans 5,083 5,014 2,892 1,915 2,841 Other Real Estate Owned, Net 7,389 10,898 10,759 9,784 6,235 In-substance Foreclosure, Net 5,842 4,685 5,195 5,430 7,439 ------- ------- ------- ------- ------- Total: $51,182 $49,088 $58,570 $60,329 $64,299 ======= ======= ======= ======= =======\nThe more significant events affecting NPAs are discussed below:\nNONACCRUAL LOANS:\nNonaccrual loans declined from $47,069,000 at December 31, 1993 to $32,200,000 at December 31, 1994. The decline resulted from charge offs, payments, and return to accruing status. The increase in nonaccrual loans from September 30, 1994 to December 31, 1994 is due primarily to one borrowing relationship. This $5.8 million relationship was re-analyzed in the fourth quarter as the result of a softening in the market.\nLOANS PAST DUE 90 DAYS OR MORE AND STILL ACCRUING:\nThe Bank generally places loans that become 90 or more days past due on nonaccrual status. If the ultimate collectability of principal and interest is assured, loans may continue to accrue and be left in this category. The loan amount shown in this category was evaluated and full collection of principal and interest is probable.\nRESTRUCTURED LOANS:\nRestructured loans (TDRs) increased during 1994 from $2,841,000 at December 31, 1993 to $5,083,000 at December 31, 1994. Two relationships for $1,325,000 and $3,397,000, respectively, previously shown as nonaccruing were returned to accrual status. These two relationships migrated to the TDR category from non-accrual since performance after restructuring had not spanned a year end accounting period. One relationship for $1,323,000 which had performed at market rates and terms for fourteen (14) months was returned to performing status. Payoffs accounted for approximately $1 million in reduction in TDRs during 1994.\nOTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURE:\nThe Bank had notable success in 1994 in disposing of OREO and continues to aggressively market such properties. However, OREO increased from $6,235,000 at December 31, 1993 to $7,389,000 at December 31, 1994.\nLarger balance additions to OREO were:\n- an apartment complex for $1.5 million - a commercial building lot for $800,000 - a residential development for $2 million\nLarger balance reductions were:\n- a commercial office building for $637,000 - Five separate commercial buildings for $1,770,000 - A multi-function commercial building for $750,000\nThe fourth quarter reduction in OREO results from sales and from a $2.1 million provision to valuation reserves allocated against specific OREO properties.\nOREO includes specific assets to which legal title has been taken as the result of transactions related to real estate loans.\nIn-substance Foreclosures (ISF) decreased from $7,439,000 at December 31, 1993 to $5,842,000 at December 31, 1994. Payments or payoffs of approximately $1.2 million were received and one ISF was transferred to OREO for $2 million. Six loans were reclassified as ISF totalling approximately $1.4 million.\nThe criteria for designation of loans as in-substance foreclosures are that the debtor has little or no equity in the collateral, proceeds for repayment of the loan will come only from the operation or sale of the collateral, and the debtor has formally or effectively abandoned control of the assets or is not expected to rebuild equity in the collateral. The collateral underlying these loans is recorded at the lower of cost or market value less estimated selling costs.\nThe total amount of Other Real Estate Owned and In-Substance Foreclosures at December 31 in each of the last five years is as follows:\n1994 1993 1992 1991 1990 ---------------------------------------------- Other Real Estate Owned 7,389 6,235 3,874 2,650 1,968 In-Substance Foreclosure 5,842 7,439 8,787 3,460 2,684 ------- ------- ------- ------ ------ Total: $13,231 $13,674 $12,661 $6,110 $4,652 ======= ======= ======= ====== ======\nPOLICIES AND PROCEDURES RELATING TO THE ACCRUAL OF INTEREST INCOME\nThe Bank normally recognizes income on earning assets on the accrual basis, which calls for the recognition of income as earned, as opposed to when it is collected.\nThe Bank's policy is to discontinue the accrual of interest on loans when scheduled payments become contractually past due in excess of 90 days and the ultimate collectability of principal or interest becomes doubtful. Interest previously accrued is reversed if management deems the past due conditions to be an indication of uncollectability. Also, loans may be placed on a nonaccrual basis at any time prior to the period specified above if management deems such action to be appropriate.\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 Financial Condition and Results of Operations as contained on pages 25 through 30 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 balance sheets of Merchants Bancshares, Inc. as of December 31, 1994 and 1993, and the related consolidated statements of operations, changes in stockholders' equity and cash flows, for each of the three years in the period ended December 31, 1994 together with the related notes and the opinion of Arthur Andersen LLP, independent public accountants, all as contained on pages 5 through 33 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\nNone.\nPart III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nSection 16(a) of the Securities Exchange Act of 1934 requires the Company's executive officers, directors and ten percent shareholders to file initial reports of ownership and reports of changes of ownership of the Company's common stock with the Securities and Exchange Commission. Based upon a review of these filings, there were no late filings of SEC Form 4's during 1994.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is hereby made to pages 3 through 13 of the Company's Proxy Statement to Shareholders dated March 24, 1995, wherein pursuant to Regulation 14 A information concerning the above subjects (Items 10 through 13) is incorporated by reference.\nPursuant to Rule 12 b-23, definitive copies of the Proxy Statement will be filed within 120 days subsequent to the end of the Company's fiscal year covered by Form 10-K.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(1) The following consolidated financial statements as included in the 1994 Annual Report to Shareholders, are incorporated herein by reference:\nConsolidated Balance Sheets, December 31, 1994 and December 31, 1993.\nConsolidated Statements of Operations for years ended December 31, 1994, 1993, 1992.\nConsolidated Statements of Changes in Stockholder's Equity for years ended December 31, 1994, 1993, 1992.\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, 1993, 1992.\nNotes to Consolidated Financial Statements, December 31, 1994.\n(2) The following exhibits are either filed or attached as part of this report, or are incorporated herein by reference.\nExhibit Description\n(3a) Restated Certificate of Incorporation of the Company, filed on April 25, 1987 as Exhibit B to the Proxy Statement filed as part of the pre- effective amendment No. 1 to the Company's Registration Statement on Form S-14 (Registration No. 2-86103) is incorporated herein by reference.\n(3b) Amended By-Laws of the Company, filed on April 25, 1987 as Exhibit C to the Company's Proxy Statement is incorporated herein by reference.\n(4) Investments, defining the rights of security holders including indentures; incorporated by reference from the Registrant's Form S-14 Registration Statement (Registration No. 2-86103), as filed on September 14, 1983.\n(10) Material Contracts: The following are major contracts preceded by applicable number to Registrant's Form S-14 (Registration No. 2-86103) and are incorporated herein by reference.\n15 (10a) Service Agreement as amended between First Data Resources, Inc., and Registrant dated June 1993 (effective through May 1998) for Mastercard Services.\n17 (10c) 401(k) Employee Stock Ownership Plan of Registrant, dated January 1, 1990, for the employees of the Bank.\n19 (10d) Merchants Bank Pension Plan, as amended and restated on January 1, 1989, for employees of the Bank.\n20 (10e) Agreement between Specialty Underwriters, Inc., and Registrant dated January 12, 1993 for equipment maintenance services.\n(11) Statement re: computation of per share earnings.\n(13) 1994 Annual Report to Shareholders is furnished for the information of the Commission only and is not to be deemed filed as part of this report, except as expressly provided herein.\n(23) The Registrant's Proxy Statement to Shareholders for the calendar year ended December 31, 1994 will be filed within 120 days after the end of the Company's fiscal year.\nOther schedules are omitted because of the absence of conditions under which they are required, or because the required information is provided in the financial statements or notes thereto.\n(23a) Reports on Form 8-K The Company filed a Form 8-K with the Securities and Exchange Commission on June 4, 1993.\nThis report detailed the terms and conditions of a Purchase and Assumption Agreement among the Federal Deposit Insurance Corporation, Receiver of the New First National Bank of Vermont, National Association, the Federal Deposit Insurance Corporation and The Merchants Bank, dated June 4, 1993.\nINDEMNIFICATION UNDERTAKING BY REGISTRANT\nIn connection with Registrant's Form S-8 Registration Statement under the Securities Act of 1933 with respect to the Registrant's 401(k) Employee Stock Ownership Plan, the Registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into such Registration Statement on Form S-8:\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 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 it's behalf by the undersigned, thereunto duly authorized.\nMerchants Bancshares, Inc.\nDate March 24, 1995 by S\/Joseph L. Boutin ------------------ ---------------------------- Joseph L. Boutin, President & CEO\nPursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of MERCHANTS BANCSHARES, INC., and in the capacities and on the date as indicated.\nby S\/Joseph L. Boutin by S\/ Peter A. Bouyea ------------------------------- ------------------------------ Joseph L. Boutin, Director, President Peter A. Bouyea, Director & CEO of the Company and the Bank\nby by S\/Dudley H. Davis ------------------------------- ------------------------------ Charles A. Davis, Director Dudley H. Davis, Director Chairman of the Board of Directors\nby S\/ Jeffrey L. Davis by S\/Jack DuBrul, II ------------------------------- ------------------------------ Jeffrey L. Davis, Director Jack DuBrul,II, Director\nby S\/Michael G. Furlong by ------------------------------- ------------------------------ Michael G. Furlong, Director Thomas F. Murphy, Director\nby S\/Edward W. Haase by ------------------------------- ----------------------------- Edward W. Haase, Treasurer and Leo O'Brien, Jr, Director Chief Financial Officer of the Company Senior Vice President and Treasurer of the Bank\nby by S\/Patrick S. Robins ------------------------------- ------------------------------ Raymond C. Pecor, Jr., Director Patrick S. Robins, Director\nby by S\/Robert A. Skiff ------------------------------- ------------------------------ Benjamin F. Schweyer, Director Robert A. Skiff, Director\nby ------------------------------- Susan D. Struble, Director","section_15":""}
{"filename":"84792_1994.txt","cik":"84792","year":"1994","section_1":"ITEM 1. BUSINESS\nThe information indicated below appears in the 1994 Annual Report to Stockholders (Stockholders' Report) and is incorporated by reference:\nPage of Stockholders' Report ------------- Business operations: Polymers, Resins and Monomers .......................... 8 Plastics ............................................... 11 Performance Chemicals .................................. 14 Agricultural Chemicals ................................. 17\nIndustry segment information for years 1992-94 ............. 44\nForeign operations for years 1992-94 ....................... 44\nEmployees .................................................. 54\nRaw Materials\nThe company uses a variety of commodity chemicals as raw materials in its operations. In most cases, these raw materials are purchased from multiple sources under long-term contracts. Most of these materials are hydrocarbon derivatives such as propylene, acetone and styrene.\nCompetition\nThe principal market segments in which the company competes are described in the company's Annual Report to Stockholders on pages 8 through 18. The company experiences vigorous competition in each of these segments. The company's competitors include many large multinational chemical firms based in Europe, Japan and the United States. In some cases, the company competes against firms which are producers of commodity chemicals which the company must purchase as the raw materials to make its products. The company, however, does not believe this places it at any significant competitive disadvantage. The company's products compete with products offered by other manufacturers on the basis of price, product quality and specifications, and customer service. Most of the company's products are specialty chemicals which are sold to customers who demand a high level of customer service and technical expertise from the company and its sales force.\nResearch and Development\nThe company maintains its principal research and development laboratories at Spring House, Pennsylvania. Research and development expenses, substantially all company sponsored, totaled $201,000,000, $205,000,000 and $199,000,000 in 1994, 1993 and 1992, respectively. Approximately 15% of the company's employees were engaged in research and development activities in 1994 and 16% in 1993 and 1992.\nEnvironmental Matters\nA discussion of environmental matters is incorporated herein by reference to pages 27 through 29 of the Stockholders' Report and to Exhibit (13)(a), Note 22: Subsequent Event.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe company, its subsidiaries and affiliates presently operate 47 manufacturing facilities in 21 countries. A list identifying those facilities is found on page 60 of the company's Annual Report to Stockholders which is hereby incorporated by reference. Additional information addressing the suitability, adequacy and productive capacity of the company's facilities is found on page 30 of the company's Stockholders' Report and throughout the various business discussions of the company's industry segments found on pages 8 through 18 of the Stockholders' Report.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nA discussion of legal proceedings is incorporated herein by reference to page 51 of the Stockholders' Report and to Exhibit (13)(a), Note 22: Subsequent Event.\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 THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe company's common stock of $2.50 par value is traded on the New York Stock Exchange (Symbol: ROH). There were 4,889 registered common stockholders as of March 10, 1995. The 1994 and 1993 quarterly summaries of the high and low prices of the company's common stock and the amounts of dividends paid on common stock are presented on pages 32 and 33 of the Stockholders' Report and are incorporated in this Form 10-K by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe company's summary of selected financial data and related notes for the years 1990 through 1994 are incorporated in this Form 10-K by reference to pages 54 through 56 of the Stockholders' Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nManagement's discussion and analysis of 1992 to 1994 results is incorporated herein by reference to pages 22 through 31 of the Stockholders' Report. These items should be read in conjunction with the consolidated financial statements presented on pages 34 through 53 of the Stockholders' Report and Exhibit (13)(a), Note 22: Subsequent Event.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated balance sheets as of December 31, 1994, and 1993, and the related consolidated statements of earnings, stockholders' equity and cash flows for the years ended December 31, 1994, 1993, and 1992, are incorporated in this Form 10-K by reference to pages 34 through 53 of the Stockholders' Report and to Exhibit (13)(a), Note 22: Subsequent Event, together with the report of KPMG Peat Marwick LLP dated February 20, 1995, except as to Note 22 which is as of March 20, 1995, on page 6 of this Form 10-K. Supplementary selected quarterly financial data is incorporated in this Form 10-K by reference to pages 32 and 33 of the Stockholders' Report.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNo reports on Form 8-K were filed during 1994 or 1993 relating to any disagreements with 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\nAND\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information called for by Items 10 and 11 of this Form 10-K report for the fiscal year ended December 31, 1994, has been omitted, except for the information presented below, because the company on or about March 24, 1995, will file with the Securities and Exchange Commission a definitive Proxy Statement pursuant to regulation 14(a) under the Securities Exchange Act of 1934.\nExecutive Officers\nThe company's executive officers along with their present position, offices held and activities during the past five years are presented below. All officers normally are elected annually and serve at the pleasure of the Board of Directors. The company's non-employee directors and their business experience during the past five years are listed in the company's Proxy Statement.\nPaul J. Baduini, 47, vice president since 1993; business unit director for ion exchange resins since 1992; previously manager of the Southern Cone countries from 1990 to 1991 and general manager of Rohm and Haas Brazil from 1988 to 1991.\nAlbert H. Ceasar, 57, vice president since 1993; business unit director and president of AtoHaas North America Inc. since 1992; previously business unit director for performance plastics from 1989 to 1992.\nNance K. Dicciani, 47, vice president since 1993; business unit director for petroleum chemicals since 1991; previously general manager for business development and technology, chemicals group for Air Products and Chemicals, Inc. from 1990 to 1991.\nRobert M. Downing, 52, vice president since 1993; operations director for the North American region since 1986.\nDavid T. Espenshade, 56, vice president since 1993; director of materials management since 1990.\nJ. Michael Fitzpatrick, 48, vice president since 1993; director of research since 1993; previously general manager of Rohm and Haas (UK) Limited and business director for polymers and resins from 1990 to 1993.\nDonald C. Garaventi, 58, vice president since 1982; business group executive for polymers, resins and monomers and business unit director for polymers and resins since 1989.\nMarisa Guerin, 42, vice president since 1994; director of human resources since 1994; previously manager of training and development from 1991 to 1994 and director of human resources at the Philadelphia plant from 1990 to 1991.\nRajiv L. Gupta, 49, vice president since 1993; regional director of Pacific since 1993; previously business unit director for plastics additives from 1989 to 1993.\nHoward C. Levy, 51, vice president since 1993; business unit director for biocides since 1989.\nPhillip G. Lewis, 44, vice president since 1993; director of safety, health and environmental affairs and product integrity since 1993; previously director of safety, health and environmental affairs from 1989 to 1993 and corporate medical director from 1987 to 1993.\nEnrique F. Martinez, 57, vice president and regional director of Latin America since 1989.\nJohn P. Mulroney, 59, director since 1982; president and chief operating officer since 1986; director of Teradyne Inc. and Aluminum Company of America.\t\nRobert E. Naylor, 62, director since 1986; group vice president and regional director of North America since 1989; director of Airgas, Inc.\nRichard G. Peterson, 56, vice president since 1987; business group executive for performance chemicals since 1989.\nFrank R. Robertson, 54, vice president since 1991; business unit director for polymers and resins, North America, since 1989.\nFred W. Shaffer, 62, vice president since 1977; chief financial officer since 1978.\nWilliam H. Staas, 51, vice president since 1993; business unit director for monomers since 1990.\nJohn F. Talucci, 55, vice president and business group executive for agricultural chemicals since 1989.\nCharles M. Tatum, 47, vice president since 1990; business unit director of plastics additives since 1993; previously director of research from 1989 to 1993.\nBasil A. Vassiliou, 60, vice president since 1986; regional director of Europe since 1985; business group executive for plastics since 1991.\nRobert P. Vogel, 50, vice president since 1993; general counsel responsible for legal, insurance, tax and regulatory matters since 1994; previously associate general counsel, regulatory counsel and director of safety, health and environment and product integrity from 1991 to 1993 and associate general counsel and regulatory counsel from 1983 to 1990.\nJ. Lawrence Wilson, 59, director since 1977; chairman of the board and chief executive officer since 1988; director of The Vanguard Group of Investment Companies and Cummins Engine Company, Inc.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe security ownership of certain beneficial owners and management is incorporated in this Form 10-K by reference to pages 16 and 17 of the definitive Proxy Statement to be filed with the Securities and Exchange Commission on or about March 24, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for by Item 13 is incorporated in this Form 10-K by reference to pages 16 and 17 of the definitive Proxy Statement to be filed with the Securities and Exchange Commission on or about March 24, 1995.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this report:\n1. Financial Statements\nThe consolidated financial statements of Rohm and Haas Company are incorporated in this Form 10-K by reference to pages 34 through 53 of the Stockholders' Report, a complete copy of which follows page 6 of this report, and to Exhibit (13)(a), Note 22: Subsequent Event, together with the report of KPMG Peat Marwick LLP dated February 20, 1995, except as to Note 22, which is as of March 20, 1995, on page 6 of this Form 10-K.\n2. Financial Statement Schedule\nThe following supplementary financial information is filed in this Form 10-K and should be read in conjunction with the financial statements in the Stockholders' Report:\nPAGE\nIndependent Auditors' Report .............................. 6\nSchedule submitted:\nVIII - Valuation and qualifying accounts for the years 1994, 1993 and 1992 .................................. 7\nThe schedules not included herein are omitted because they are not applicable or the required information is presented in the financial statements or related notes.\n3. Exhibits\nExhibit (3), Certificate of Incorporation and By-Laws, reflecting amendments approved by the Board of Directors on October 13, 1994, is attached as pages 8 through 22 of this Form 10-K.\nExhibit (12), Computation of Ratio of Earnings to Fixed Charges for the company and subsidiaries, is attached as page 23 of this Form 10-K.\nExhibit (13), Annual Report to Stockholders, which follows page 6 of this Form 10-K.\nExhibit (13)(a), Note 22 to the Consolidated Financial Statements: Subsequent Event, is attached as page 24 of this Form 10-K.\nExhibit (22), Subsidiaries of the registrant, is attached as page 25 of this Form 10-K.\nExhibit (24), Consent of independent certified public accountants, is attached as page 27 of this Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, Rohm and Haas Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\n\/s\/ Fred W. Shaffer --------------------------------- Fred W. Shaffer Vice President and Chief Financial Officer\nMarch 27, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on March 27, 1995 by the following persons on behalf of the registrant and in the capacities indicated.\n------------------------------------------------------------------------------ SIGNATURE AND TITLE SIGNATURE AND TITLE ------------------------------------------------------------------------------\n\/s\/ J. Lawrence Wilson \/s\/ Sandra O. Moose ----------------------------------- ----------------------------------- J. Lawrence Wilson Sandra O. Moose Director, Chairman of the Board and Director Chief Executive Officer\n\/s\/ Fred W. Shaffer \/s\/ John P. Mulroney ----------------------------------- ----------------------------------- Fred W. Shaffer John P. Mulroney Vice President and Director Chief Financial Officer\n\/s\/ George B. Beitzel \/s\/ Robert E. Naylor, Jr. ----------------------------------- ----------------------------------- George B. Beitzel Robert E. Naylor, Jr. Director Director\n\/s\/ Daniel B. Burke \/s\/ Gilbert S. Omenn ----------------------------------- ----------------------------------- Daniel B. Burke Gilbert S. Omenn Director Director\n\/s\/ Earl G. Graves \/s\/ Ronaldo H. Schmitz ----------------------------------- ----------------------------------- Earl G. Graves Ronaldo H. Schmitz Director Director\n\/s\/ James A. Henderson \/s\/ Alan Schriesheim ----------------------------------- ----------------------------------- James A. Henderson Alan Schriesheim Director Director\n\/s\/ John H. McArthur \/s\/ Marna C. Whittington ----------------------------------- ----------------------------------- John H. McArthur Marna C. Whittington Director Director\n\/s\/ Paul F. Miller, Jr. ----------------------------------- Paul F. Miller, Jr. Director\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Rohm and Haas Company:\nWe have audited the consolidated balance sheets of Rohm and Haas Company and subsidiaries as of December 31, 1994 and 1993, and the related consolidated 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 consolidated financial statements, we also have audited the financial statement schedule on page 7. 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 Rohm and Haas Company 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.\nAs discussed in Notes 5 and 8 to the consolidated financial statements, the company adopted the provisions of Financial Accounting Standards Board Statement No. 112, \"Accounting for Postemployment Benefits\" in 1993, and the provisions of Financial Accounting Standards Board Statement No. 106, \"Accounting for Postretirement Benefits Other Than Pensions,\" and No. 109, \"Accounting for Income Taxes\" in 1992.\n\/s\/ KPMG PEAT MARWICK LLP --------------------------------- KPMG PEAT MARWICK LLP\nPhiladelphia, PA February 20, 1995, except as to Note 22, which is as of March 20, 1995","section_15":""}
{"filename":"78003_1994.txt","cik":"78003","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nPfizer Inc. (the \"Company\") is a diversified, research-based health care company with global operations. The Company discovers, develops, manufactures and sells technology-intensive products in four business segments: Health Care, which includes a broad range of prescription pharmaceuticals, orthopedic implants, medical devices and surgical equipment; Animal Health, which includes animal health products and feed supplements; Consumer Health Care, which includes a variety of nonprescription drugs and personal care products; and Food Science, which includes ingredients for the food and beverage industries. Additionally, the Company's Financial Subsidiaries include a banking operation in Europe and a small captive insurance operation.\nCOMPARATIVE SEGMENT AND GEOGRAPHIC DATA\nComparative segment and geographic data for the three years ended December 31, 1994 are set forth on pages 35 and 36, and in the Note \"Financial Subsidiaries\" on page 42 of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994 and are incorporated herein by reference.\nHEALTH CARE\nThe Company's Health Care business is comprised of pharmaceuticals and hospital products. The Company competes with numerous other health care companies in the discovery and development of new, technologically advanced pharmaceutical and hospital products; in seeking use of its products by the medical profession; and in the sale of its product lines to wholesale and retail outlets, public and private hospitals, managed care organizations, government and the medical profession.\nMethods of competition in health care vary with the product category. There are a significant number of innovative companies in the field. A critical factor in most markets in which the Company competes is the ability to offer technological advances over competitive products. The productivity of scientific discovery and clinical development efforts is central to long-term operational success since there are many companies that specialize in marketing products that no longer have patent or regulatory protection. Other important factors in these markets include the ability to transfer knowledge of technological advances to the medical community, product quality, prompt delivery and price.\nThe United States pharmaceutical marketplace has in recent years experienced intensified price competition, brought about by a range of market forces, including: new product development, increased generic competition, growth of managed care organizations and legislation requiring pharmaceutical companies to provide rebates and discounts to government purchasers. Similar competitive forces, in varying degrees, have also been present in various other countries in which the Company operates.\nPrescription pharmaceutical and hospital products, both in the United States and abroad, are promoted directly to physicians, as well as to a variety of managed care organizations. Pharmaceutical products are distributed in large part to wholesale and retail outlets, hospitals, clinics and managed care organizations. Hospital products are generally sold directly to medical institutions and, in some cases, through distributors and surgical supply dealers.\nPHARMACEUTICALS\nThe Company's worldwide pharmaceutical products are comprised primarily of drugs which fall into the following major therapeutic classes: cardiovascular agents, anti-infectives, central nervous system agents, anti-inflammatories and anti-diabetes agents. In 1994, pharmaceuticals made up 70%\nof the Company's consolidated net sales, an increase from 69% in 1993 and 63% in 1992. Increases in both United States and international pharmaceutical revenues in 1994 were principally the result of strong sales of products launched in the 1990s, including Norvasc (amlodipine besylate), Cardura (doxazosin mesylate), Diflucan (fluconazole), Zithromax (azithromycin) and Zoloft (sertraline).\nCardiovascular products are the Company's largest therapeutic product line accounting for 29% of the Company's consolidated 1994 net sales, an increase from 27% in 1993 and 23% in 1992. These products realized sales growth of 20% in 1994, including an 85% increase in sales of Norvasc, an intrinsically once-a-day calcium channel blocker for hypertension and angina, as well as a 27% increase in sales of Cardura, an alpha blocker for hypertension. A supplemental New Drug Application for the use of Cardura in the treatment of benign prostatic hyperplasia (\"BPH\") was approved by the United States Food and Drug Administration (\"FDA\") in February 1995. Sales of Procardia XL (nifedipine GITS), a once-a-day calcium channel blocker for hypertension and angina, increased by less than 1% in 1994. The Company's U.S. cardiovascular sales grew 12% and international sales of cardiovascular agents rose 38% in 1994.\nWorldwide anti-infective sales increased 7% in 1994 on the strength of Diflucan and Zithromax. U.S. anti-infective sales grew 14% while international sales rose by 3%. Diflucan, an antifungal agent, is indicated for use in a variety of fungal infections including certain types which afflict AIDS and immunosuppressed cancer patients. The product also received U.S. approval for the indication of vaginal candidiasis in 1994. Diflucan posted a sales increase of 14% in 1994 and Zithromax, an oral antibiotic, posted a sales increase of 43%. Total anti-infective sales accounted for 21% of the Company's consolidated 1994 net sales, compared to 22% in 1993 and 20% in 1992.\nSales of Pfizer's central nervous system agents rose 46% in 1994, reflecting increased sales of Zoloft, an anti-depressant introduced in the U.S. in 1992. Central nervous system agents grew to 13% of 1994 net pharmaceutical sales and 9% of the Company's consolidated 1994 net sales.\nThe Company's anti-inflammatory agents, including Feldene (piroxicam), accounted for less than 10% of the Company's consolidated 1994 net sales.\nThe Company's anti-diabetes agents, including Glucotrol (glipizide) and Glucotrol XL (glipizide GITS), a sustained release anti-diabetic approved in the U.S. in 1994, accounted for less than 10% of the Company's consolidated 1994 net sales.\nThe Company currently is seeking approval by the FDA for the following products for the indications listed:\nIn addition, the Company has marketing rights in the United States and Japan to XOMA Corporation, Inc.'s E5, a monoclonal antibody for the treatment of gram negative sepsis, which is undergoing FDA regulatory review.\nTo date, Diflucan has been launched in 62 countries and regulatory approvals have been obtained in 16 additional countries. Norvasc has been launched in 74 countries and approvals have been obtained in 14 additional countries. Cardura has been launched in 23 countries and approvals have been obtained in 35 additional countries. In addition, Cardura for BPH has been approved in five countries. Zithromax has been launched in 38 countries and approvals have been obtained in 24 additional countries. Zoloft has been launched in 31 countries for depression. Approvals have been obtained in an additional 16 countries. Applications for regulatory approval for the OCD indication have been made worldwide and approvals have been obtained in four additional countries, although it has not yet been launched in these countries. In addition to the United States, where regulatory approval is being sought for both the osteo- and rheumatoid arthritis indications, regulatory approvals for Enablex capsules for rheumatoid arthritis have been applied for in 29 countries and have been obtained in two countries. No launches of Enablex have yet taken place.\nHOSPITAL PRODUCTS\nThe Company's Hospital Products Group consists of two divisions -- Howmedica and Medical Devices. Howmedica manufactures and markets orthopedic implants. Medical Devices consists of three core businesses -- Valleylab, Schneider, and American Medical Systems and two smaller businesses -- Strato\/Infusaid and Biomedical Sensors.\nHowmedica's reconstructive hip, knee and bone cement products are used to replace joints which have deteriorated as a result of disease or injury. Major product lines are P.C.A. Hips, ABG Hips, Duracon Knees and Simplex Bone Cement. Howmedica's trauma products are used by orthopedic surgeons to aid in trauma surgery and in setting fractures and include the Gamma Nail, Luhr System and Alta System.\nSchneider, an international leader in angioplasty catheters, is also a market leader in vascular and non-vascular stent applications. In March 1995, the Company acquired NAMIC U.S.A. Corporation (\"NAMIC\"), a Company that designs, manufactures and markets a broad range of single-patient use medical products, primarily for use in the diagnosis of atherosclerotic cardiovascular disease. NAMIC's product lines complement those of Schneider and are expected to expand the opportunities for this business. Valleylab is a worldwide leader in electrosurgical devices. Valleylab continues to invest in new product lines to enhance patient and physician safety. American Medical Systems is a leader in impotence and incontinence implants. Its major product development activities in 1994 were focused on new therapies for the treatment of BPH and urological strictures.\nThe merger and the consolidation of operations of Strato Medical Corporation, a supplier of implantable vascular access ports, and Infusaid, an innovator of implantable infusion pumps, were completed in 1994. The combined operation will focus on advanced drug delivery systems. Biomedical Sensors grew in 1994 reflecting the full year launch of the Paratrend 7 intravascular continuous blood gas monitoring system, incorporating both electrochemical and fiberoptic technology.\nANIMAL HEALTH\nThe Company's Animal Health Group discovers, develops, manufactures and sells animal health products for the prevention and treatment of diseases in livestock, poultry and other animals. The principal products are: Dectomax (doramectin), the Company's new antiparasitic which was first launched in 1993 and is now available in much of Latin America, South Africa and the United Kingdom; Terramycin LA-200 (oxytetracycline) (marketed as TM\/LA outside of North America), a broad-spectrum injectable antibiotic; the Banminth (pyrantel tartrate), Nemex (pyrantel pamoate) and Paratect (morantel tartrate) anthelmintics; Coxistac and Posistac (salinomycin) anticoccidials primarily for poultry; Terramycin (oxytetracycline), a broad-spectrum antibiotic used for a variety of\nanimal diseases; Mecadox (carbadox), an antibacterial for pigs; and Advocin (danofloxacin), the Company's new antibacterial for treating respiratory diseases in livestock and poultry. Aviax (semduramicin), a potent, broad-spectrum ionophore anticoccidial used to prevent coccidiosis in poultry, is to be launched in 1995. Aviax is currently under regulatory review in many countries, with approvals already received in a number of countries, including the United States and Japan. In 1995, the Animal Health Group plans a total of 49 new market launches of Dectomax, Advocin and Aviax.\nAnimal health and nutrition products are sold through drug wholesalers, distributors, retail outlets and directly to users, including feed manufacturers, animal producers and veterinarians. Methods of competition with respect to animal health products vary somewhat but include product innovation, service, price, quality and effective transfer of technological advances to the market through advertising and promotion.\nIn January 1995, the Company acquired the SmithKline Beecham Animal Health (\"SBAH\") business. SBAH is a world leader in animal vaccines and companion animal health products, which complement the Company's existing animal health business in terms of product, species and regional sales coverage. SBAH's principal products are Stafac (virginiamycin), a feed additive anti-infective for poultry, cattle and swine; Valbazen (albendazole), a bovine parasiticide; Filaribits (diethylcarbamazine citrate), a pet parasiticide; and a variety of vaccines including BoviShield, Leukocell, RespiSure and Vanguard.\nA substantial number of other companies manufacture and sell one or more similar products for animal health use. There are hundreds of producers of animal health products throughout the world. The Company is a significant manufacturer of injectable antibiotics, anthelmintics and anticoccidial products for food animals. With the acquisition of SBAH, the Company became a significant manufacturer of biologicals and pet products as well.\nCONSUMER HEALTH CARE\nThe Company's Consumer Health Care Group's products include proprietary health items, baby care products and toiletries, Plax pre-brushing dental rinse, and a number of products sold only in selected international markets, including Vanart hair care products in Mexico and Migraleve over-the-counter (\"OTC\") migraine medication and the TCP line of antiseptic and germicidal products marketed primarily in the United Kingdom.\nAmong the better-known OTC brands manufactured and marketed by Consumer Health Care are Visine (tetrahydrozoline HCl) eyedrops, Ben-Gay topical analgesics, Desitin diaper rash ointments, Unisom (doxylamine succinate) sleep aids, Plax pre-brushing dental rinse, Rid anti-lice products and Barbasol shave creams and gels. Line extensions introduced in recent years include: Unisom SleepGels, soft liquid-filled gels with a maximum-strength sleep aid formula, Daily Care from Desitin, a lotion for the prevention of diaper rash and new formulations of Rid and Plax.\nMany other OTC companies, large and small, manufacture and sell one or more similar consumer products. The Company is a significant competitor in this extensive OTC market, and its principal methods of competition include product quality, product innovation, customer satisfaction, broad distribution capabilities, significant advertising and promotion and price. In general, the winning and retaining of consumer acceptance of the Company's consumer products involve heavy expenditures for advertising, promotion and marketing.\nFOOD SCIENCE\nThe Company's Food Science Group serves the global food processing industry with innovative food ingredients to meet worldwide trends toward convenient and healthful foods. Specialty ingredients with quality parameters of appeal, taste and freshness, coupled with Food Science's technical,\napplication and discovery skills, serve the needs of the worldwide food industry. Food Science's longer-term goals are linked to the Company's healthcare strategies by targeting a new generation of food ingredients to allow better health maintenance through diet.\nFood Science's specialty ingredients include: \"lite\" food ingredients such as Litesse (polydextrose); flavors (veltols); food protectants (erythorbates); and brewery ingredients. Currently under development are products for calorie control utilizing bulking agents; products for fat replacement and reduced calorie intake from fats; high temperature fat substitutes; intense sweeteners; food protectants; and flavors. In October 1994, Food Science acquired certain assets of Flavor Technology Inc., a company that specializes in the design, customization and manufacture of proprietary flavorings.\nThe Food Science business competes with other organizations for sales of most of its ingredients as well as substitute products. Some of these organizations produce and sell products that are either identical to, or serve the same function as, ingredients marketed by Food Science. The number of competitors varies with each particular ingredient. Methods of competition vary by ingredient but include innovation and quality, prompt delivery, ability to meet exacting specifications, technical service and cost.\nFINANCIAL SUBSIDIARIES\nIn 1992, the Company completed the transfer of its international banking operations from Puerto Rico to the Republic of Ireland. This subsidiary, Pfizer International Bank Europe (PIBE), operates under a full banking license from the Central Bank of Ireland. This reorganization and transfer was made in anticipation of the integration and unification of the European Union's financial markets. PIBE makes loans and accepts deposits in U.S. dollars in international markets and is an active Euromarket lender with a portfolio of loans, floating rate notes and Euronotes of high quality corporations and sovereigns. Loans are made primarily on a short- and medium-term basis, with floating interest rates.\nThe Company's insurance operation, The Kodiak Company Limited, reinsures certain assets, inland transport and marine cargo of Pfizer subsidiaries.\nINTERNATIONAL OPERATIONS\nOutside the United States, the Company has significant operations, both direct and through distributors that, in general, parallel its United States businesses. The Company's international businesses are subject, in varying degrees, to a number of risks inherent in carrying on business in certain countries outside the United States, including possible nationalization, expropriation and other restrictive government actions such as capital regulations. In addition, changes in the values of currencies take place from time to time and can be either favorable or unfavorable to the net income and net assets of the Company. It is impossible to predict future changes in foreign exchange values or the effect they will have on the Company. The Company actively manages its foreign exchange risk through routine transactional hedging programs. In addition, from time to time, the Company engages in hedging programs designed to protect selected balance sheet positions and future cash flow exposures. Further information with respect to the financial instruments used to carry out these hedging programs is incorporated by reference to the note entitled \"Financial Instruments and Concentrations of Credit Risk\" found on pages 42 and 43 of the Annual Report to Shareholders for the fiscal year ended December 31, 1994.\nTAX MATTERS\nFor tax years beginning after December 31, 1993, the Omnibus Budget Reconciliation Act of 1993 (\"OBRA\") reduced by 40% the benefits accruing to the Company under Section 936 of the Internal\nRevenue Code (the \"Puerto Rico tax credit\"). Such tax benefits will decline an additional 5% per year through 1998. For tax years beginning after December 31, 1997, the Puerto Rico tax credit will be fixed at 40% of the level allowed prior to the enactment of OBRA.\nThe Internal Revenue Service (\"IRS\") is currently auditing the years 1987 through 1989. In October 1994, the Company received a Notice of Proposed Adjustments from the IRS. The proposed adjustments relate primarily to the tax accounting treatment of certain swaps and related transactions undertaken by the Company in 1987 and 1988. These transactions resulted in the receipt of cash in those years, which the Company duly reported as income for tax purposes. In 1989 (in Notice 89-21), the IRS announced that it believed cash received in certain swap transactions should be reported as income for tax purposes over the life of the swaps, rather than when received. In the case of the Company, this would cause some of the income to be reported in years subject to the Tax Reform Act of 1986. The IRS proposed adjustment involves approximately $72 million in federal taxes for the years 1987 through 1989, plus interest. If the proposed adjustment is carried through to the maturity of the transactions in 1992, an additional tax deficiency of approximately $86 million, plus interest, would result. The Company disagrees with the proposed adjustment and continues to believe that its tax accounting treatment for the transactions in question was proper.\nWhile it is impossible to determine the final disposition, the Company is of the opinion that the ultimate resolution of this matter should not have a material adverse effect on the financial position or the results of operations of the Company.\nThe Company has satisfactorily resolved all issues with the Internal Revenue Service for the years through 1986. The Company believes that its accrued tax liabilities are adequate for all open years.\nPATENTS AND RESEARCH\nThe Company owns or is licensed under a number of patents relating to its products and manufacturing processes which, in the aggregate, are believed to be of material importance in its business. Based on current product sales, and in view of the vigorous competition with products sold by others, the Company does not consider any single patent or related group of patents to be significant in relation to the enterprise as a whole, except for the Procardia XL, Zithromax, Diflucan, Zoloft and Norvasc patents. Procardia XL employs a novel drug delivery system developed and patented by Alza Corporation. The Company holds an exclusive license to use this delivery system with nifedipine until 2003. Zithromax is a novel, broad spectrum macrolide antibiotic patented by Pliva and exclusively licensed to the Company for sales and marketing in all major countries of the world. The U.S. product patent on Zithromax (azithromycin) expires in 2005. The Company holds patents relating to Diflucan, Zoloft, and Norvasc.\nThe Company spent in excess of $1.1 billion in 1994, $974 million in 1993, and $863 million in 1992 on Company-sponsored research and development throughout the world. In 1995, the Company plans to spend approximately $1.4 billion on research and development. In 1991, the Company also established Pfizer Research and Development Company (PRDCO) in Ireland. In 1992, the Company provided PRDCO with an initial capitalization of approximately $1 billion to enable PRDCO to engage in research and development through a cost-sharing arrangement with Pfizer Ltd. (a Pfizer U.K. subsidiary) in exchange for PRDCO's receiving a portion of property rights relating to the development of specific products.\nCompetition in research, involving the development of new products and processes and the improvement of existing products and processes, is particularly significant and results from time to time in product and process obsolescence. The development of new and improved products is important to the Company's success in all areas of its business.\nEMPLOYEES\nApproximately 40,800 persons were employed by the Company, as of December 31, 1994, throughout the world as follows: United States, 15,700; Europe, 11,600; Asia, 7,500; Canada\/Latin America, 4,500; and Africa\/Middle East, 1,500. The Company has a good relationship with its employees.\nREGULATION\nMost of the Company's businesses are subject to varying degrees of governmental regulation in the countries in which operations are conducted. Such regulation in the United States involves a more complex product approval process than in many other countries and therefore often results in later marketing clearances and a corresponding increase in the expense of introducing new products in the United States. In many international markets, prices of pharmaceuticals are controlled by the government.\nThe 1990 Omnibus Budget Reconciliation Act requires pharmaceutical companies to extend rebates to state Medicaid agencies based on each state's reimbursement of pharmaceutical products under the Medicaid program. The Veterans Health Care Act, passed in 1992, requires manufacturers to provide discounts on purchases of pharmaceutical products by the Department of Veterans Affairs (DVA) and by certain entities funded by the Public Health Service. The Company's net sales in 1994 were reduced by Medicaid rebates and rebates under related state programs which amounted to $74 million. In addition, in 1994, Pfizer provided $56 million in discounts to the federal government, primarily to the DVA and the Department of Defense, for drugs purchased in accordance with the Veterans Health Care Act.\nIn 1990, the FDA announced a call for data for ingredients contained in products bearing anti-plaque and related claims. The call for data is part of the FDA's ongoing review, begun in 1972, of over-the-counter drug products. The FDA is taking this administrative approach to evaluate the safety and efficacy of anti-plaque products and has not proceeded further with regard to 1989 regulatory letters it issued to the Company and several other manufacturers of products bearing anti-plaque claims. The Company submitted its response to the call for data relating to Plax, its pre-brushing dental rinse, on June 17, 1991. This filing, as well as filings of other manufacturers, is still under review and is currently being considered by an FDA Advisory Panel.\nOn January 1, 1995, the new European Medicines Evaluation Agency (\"EMEA\") instituted a new drug-approval process for the member states of the European Union (\"EU\"). The EMEA provides two new drug-approval procedures. A \"centralized procedure\" allows for a single central approval that is valid in all EU states. A \"decentralized procedure\" provides for approval in all EU states through recognition of a first approval in one member state. The centralized procedure must be used for all biotechnology products (including products derived from recombinant DNA technology, hybridoma and monoclonal antibody methods) and is available at the applicant's option for other products. While it is envisioned that it will take several years for EMEA to be fully operational, it is expected that a harmonized, centralized regulatory agency in Europe would offer benefits to the human and veterinary drug industries.\nDuring 1994, Congress continued debate on reform of the U.S. health care system. While numerous health care reform bills were introduced, including the Administration's \"Health Security Act,\" Congress was unable to reach consensus on an approach to health care reform. Health care has been identified by the current Republican Congressional majority as a long-term priority item. The focus in Congress on balancing the Federal budget may have a more immediate impact on health care, however, if the Medicare and Medicaid programs are targeted for significant cuts. Medicaid managed care systems driven by budget concerns are already under consideration in several states. If the Medicare and Medicaid programs implement managed care systems that severely restrict the access of program participants to innovative new medicines, this could have a significant adverse effect on the Company.\nRAW MATERIALS AND ENERGY\nRaw materials essential to the business of the Company and its subsidiaries are generally obtainable from multiple sources. The Company did not experience any significant restrictions on availability of raw materials or supplies during the last year and none is expected in 1995. Energy was available to the Company in sufficient quantities to meet Company requirements and this condition is expected to continue in 1995.\nENVIRONMENT\nCertain of the Company's operations are affected by Federal, State and local laws and regulations relating to environmental quality. The Company has made and intends to continue to make the necessary expenditures for environmental protection. Compliance with such laws and regulations is not expected to have a material adverse effect on the financial position or the results of operations of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFollowing is a summary description of the Company's principal plants and properties:\nGroton Plant and Research Laboratories -- These facilities are located in Groton, Connecticut, and surrounding towns, on approximately 649 acres, and include a number of buildings of one to eight stories, containing approximately 3,250,000 square feet of floor space either existing or under construction.\nPrincipal products produced at Groton are bulk pharmaceuticals, specialty chemicals and food ingredients. Since acquiring the plant in 1946, the Company has made major improvements, including construction of production facilities, a powerhouse and generating equipment and a large research complex adjacent to the plant. In 1992, major improvements to plant facilities were initiated, including a process effluent and waste water treatment facility and a major pharmaceutical capacity replacement project. Both projects are expected to be completed by 1996. In the research complex, construction of significant new buildings is continuing, with major enlargement (116,000 square feet) of the pharmaceutical research and development facilities. These improvements are also scheduled for completion by 1996. Construction was completed in 1993 on several research expansions including a 156,000-square-foot drug-safety building addition, a 30,000-square-foot central-utilities building, and a 442,000-square-foot parking facility.\nBrooklyn Plant -- The Company's site in Brooklyn, New York, is on approximately 17 acres, including a number of buildings containing approximately 888,000 square feet of floor space. The primary operations, pharmaceutical dosage-form manufacturing and packaging, are housed in an eight-story production facility containing 545,000 square feet.\nVigo Plant and Research Facility -- These facilities, located in Vigo County near Terre Haute, Indiana, are on a site of approximately 2,100 acres owned in fee and consist of a number of buildings of\none to five stories containing approximately 740,000 square feet of floor space. Principal products produced at this plant are pharmaceutical products, bulk antibiotics, polydextrose and chymosin. Animal health research is also performed on this site.\nBarceloneta Plant -- Pfizer Pharmaceuticals Inc. is located on an 89-acre property owned by the Company at Barceloneta, Puerto Rico. An additional 151 acres of land adjacent to this property were purchased in 1991 for future utilization. Acquisition of an adjacent 9-acre site was recently approved. The facilities contain four major manufacturing buildings (of two to four floors) and twelve support buildings with a total approximate area of 403,000 square feet of floor space; and ten additional facilities (tank farms, electrical substations, cooling towers, etc.) with an approximate area of 81,000 square feet, for a total plant facilities area of approximately 484,000 square feet. The plant houses organic synthesis manufacturing, pharmaceutical dosage-form manufacturing and packaging facilities and the required service areas, such as bulk and drum liquid storage, laboratories, utilities, engineering shops, employee services and administration.\nOther U.S. Locations -- The Company also operates 15 other production facilities in the United States and has five regional sales and distribution centers in various parts of the country which are owned in fee.\nThe Company's world headquarters is located at 235 East 42nd Street, New York, NY. The Company owns this 33-story office building which contains approximately 650,000 square feet. The building stands on slightly less than one acre of land which is leased under an agreement expiring in 2057. In 1983, the Company purchased a nine-story office building located at 219 East 42nd Street, containing approximately 263,400 square feet which is immediately adjacent to the Company's headquarters. The Company also leases additional office space in New York City consisting of approximately 111,000 square feet.\nOutside the United States -- The Company's major manufacturing facilities outside the United States are located in Australia, Belgium, Brazil, France, Germany, Great Britain, India, Ireland, Italy, Japan, Mexico and Spain. The plants in these twelve countries have an aggregate of over two million square feet of floor space. Other plants are located in over 17 additional countries located in various parts of the world.\nSandwich -- A large medicinal and animal health research unit is located in Sandwich, England, where an 82,000-square-foot clinical-sciences building became operational in 1993 and a 99,000-square-foot animal-sciences building became operational in early 1994. Construction is in progress on a 97,000-square-foot pharmaceutical sciences building due for occupancy in 1996 and also on a 120,000-square-foot administration and services building which is scheduled for completion in early 1995. An effluent treatment plant is also under construction at this location.\nRingaskiddy -- The Ringaskiddy facility in Ireland comprises three important bulk organic synthesis manufacturing plants, two of which are now in full operation. The third has just been completed and is scheduled for startup in early 1995. Ringaskiddy manufactures the majority of bulk products required by the International Pharmaceuticals Group in its worldwide dosage-form operations. These manufacturing plants are computer controlled and among them provide considerable flexibility in supplying both the current and foreseeable requirements for the Group. Ringaskiddy's manufacturing operations are self-supported by a modern and efficient infrastructure, providing such services as utilities, quality assurance, environmental treatment systems and maintenance.\nNagoya -- The Nagoya facility in Japan encompasses several significant individual operations in addition to its research function. Fermentation, bulk organic synthesis and dosage-form manufacturing are important to the supply of the Company's operations in Japan (the country with the second largest sales after the United States) as well as elsewhere in the world. Various facilities on the site are computer controlled and, similar to Ringaskiddy, the manufacturing operations are self-supported by utility services, quality assurance, environmental treatment systems and maintenance functions.\nIn addition to the facilities outlined above, research laboratories also exist in France and Germany.\nThe Company's major manufacturing facilities in the U.S. and the other locations referred to above manufacture various products for all of the Company's businesses. These properties are maintained in good operating condition and the manufacturing facilities have capacities considered adequate to meet the Company's needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in a number of claims and litigations, including product liability claims and litigations considered normal in the nature of its businesses. These include suits involving various pharmaceutical and hospital products that allege either reaction to or injury from use of the product.\nAs previously disclosed, numerous claims have been brought against the Company and Shiley Incorporated, a wholly owned subsidiary, alleging either personal injury from fracture of 60(degree) or 70(degree) Shiley Convexo-Concave (C\/C) heart valves, or anxiety that properly functioning implanted valves might fracture in the future or, in a few cases, personal injury from a prophylactic replacement of a functioning valve.\nIn an attempt to resolve all claims alleging anxiety that properly functioning valves might fracture in the future, the Company entered into a settlement agreement in January 1992 in Bowling v. Shiley et al., a case brought in the United States District Court for the Southern District of Ohio that establishes a worldwide settlement class of people with C\/C heart valves and their spouses, except those who elect to exclude themselves. The settlement provides for a Consultation Fund of $90 to $140 million (depending on the number of claims filed) from which valve recipients who make claims will receive payments that are intended to cover their cost of consultation with cardiologists or other health care providers with respect to their valves. The settlement agreement establishes a second fund of at least $75 million to support C\/C valve-related research, including the development of techniques to identify valve recipients who may have significant risk of fracture, and to cover the unreimbursed medical expenses that valve recipients may incur for certain procedures related to the valves. The Company's obligation as to coverage of these unreimbursed medical expenses is not subject to any dollar limitation. Following a hearing on the fairness of the settlement, it was approved by the court on August 19, 1992. An appeal of the court's approval of the settlement was dismissed on December 20, 1993 by the United States Court of Appeals for the Sixth Circuit. A motion for rehearing en banc was denied on March 8, 1994, and the U.S. Supreme Court denied a writ of certiorari on October 4, 1994. It is expected that most of the costs arising from the Bowling class settlement will be covered by insurance and the proceeds of the sale of certain product lines of the Shiley businesses in 1992. Of approximately 900 implantees (and spouses of some of them) who opted out of the Bowling settlement class, eight have cases pending; approximately 792 have been resolved; and approximately 100 have never filed a case or claim.\nSeveral claims relating to elective reoperations of valve recipients are currently pending. Some of these claims relate to elective reoperations covered by the Bowling class settlement described above, and, therefore, the claimants are entitled to certain benefits in accordance with the settlement. Such claimants, if they irrevocably waive all of the benefits of the settlement, may pursue separate litigation to recover damages in spite of the class settlement. The Company is defending these claims.\nGenerally, the plaintiffs in all of the pending heart valve litigations discussed above seek money damages. Based on the experience of the Company in defending these claims to date, including available insurance and reserves, the Company is of the opinion that these actions should not have a material adverse effect on the financial position or the results of operations of the Company.\nOn September 30, 1993, Dairyland Insurance Co., a carrier providing excess liability coverage (\"excess carrier\") in the early 1980s, commenced an action in the California Superior Court in Orange County, seeking a declaratory judgment that it was not obligated to provide insurance coverage for\nShiley heart valve liability claims. On October 8, 1993, Pfizer filed cross-complaints against Dairyland and filed third-party complaints against 73 other excess carriers who sold excess liability policies covering periods from 1978 to 1985, seeking damages and declaratory judgments that they are obligated to pay for defense and indemnity to the extent not paid by other carriers.\nThe Company's operations are subject to federal, state and local environmental laws and regulations. Under the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended (\"CERCLA\" or \"Superfund\"), the Company has been designated as a potentially responsible party by the United States Environmental Protection Agency with respect to certain waste sites with which the Company may have had direct or indirect involvement. Similar designations have been made by some state environmental agencies under applicable state superfund laws. Such designations are made regardless of the extent of the Company's involvement. There are also claims that the Company is a potentially responsible party or participant with respect to several waste sites in Canada. Such claims have been made by the filing of a complaint, the issuance of an administrative directive or order, or the issuance of a notice or demand letter. These claims are in various stages of administrative or judicial proceedings. They include demands for recovery of past governmental costs and for future investigative or remedial actions. In many cases, the dollar amount of the claim is not specified. In most cases, claims have been asserted against a number of other entities for the same recovery or other relief as was asserted against the Company. The Company is currently participating in remedial action at a number of sites under federal, state and local laws.\nTo the extent possible with the limited amount of information available at this time, the Company has evaluated its responsibility for costs and related liability with respect to the above sites and is of the opinion that the Company's liability with respect to these sites should not have a material adverse effect on the financial position or the results of operations of the Company. In arriving at this conclusion, the Company has considered, among other things, the payments that have been made with respect to the sites in the past; the factors, such as volume and relative toxicity, ordinarily applied to allocate defense and remedial costs at such sites; the probable costs to be paid by the other potentially responsible parties; total projected remedial costs for a site, if known; existing technology; and the currently enacted laws and regulations. The Company anticipates that a portion of these costs and related liability will be covered by available insurance.\nThrough the early 1970s, Pfizer (Minerals Division) and Quigley Company, Inc., a wholly owned subsidiary, sold a minimal amount of one construction product and several refractory products containing some asbestos. These sales were discontinued thereafter. Although these sales represented a minor market share, the Company has been named as one of a number of defendants in numerous lawsuits. These actions, and actions related to the Company's sale of talc products in the past, claim personal injury resulting from exposure to asbestos-containing products, and nearly all seek general and punitive damages. In these actions, the Company or Quigley is typically one of a number of defendants, and both are members of the Center for Claims Resolution (the \"CCR\"), a joint defense organization that is defending these claims. The Company and Quigley are responsible for varying percentages of defense and liability payments for all members of the CCR. Prior to September 1990, the cases involving talc products were defended by the CCR, but the Company is now overseeing its own defense of these actions. A number of cases alleging property damage from asbestos-containing products installed in buildings have also been brought against Pfizer.\nOn January 15, 1993, a class action complaint and settlement agreement were filed in the United States District Court for the Eastern District of Pennsylvania involving all personal injury claims by persons who have been exposed to asbestos-containing products, but who have not yet filed a personal injury action against the 20 members of the CCR. The settlement agreement establishes a claims-processing mechanism that will provide historic settlement values upon proof of impaired medical condition as well as claims-processing rates over 10 years. In addition, the shares allocated to the CCR members eliminate joint and several liability. The court has determined that the settlement is fair and reasonable. Subsequently, the court entered an injunction enforcing its determination. An appeal from that injunction is pending in the United States Court of Appeals for the Third Circuit.\nConcurrently with the filing of the future claims class action, the CCR settled approximately 16,360 personal injury cases on behalf of Pfizer and Quigley. It is the CCR's intention to settle remaining and opt-out cases and claims on a similar basis to past settlements. The total pending number of cases as of December 31, 1994 is 14,543 asbestos cases against Quigley, 5,643 asbestos cases against Pfizer Inc. and 147 talc cases against Pfizer Inc.\nCosts incurred by the Company in defending the asbestos personal injury claims and the property damage claims, as well as settlements and damage awards in connection therewith, are largely insured against under policies issued by several primary insurance carriers and a number of excess carriers. The Company believes that its costs incurred in defending and ultimately disposing of the asbestos personal injury claims, as well as the property damage claims, will be largely covered by insurance policies issued by carriers that have agreed to provide coverage, subject to deductibles, exclusions, retentions and policy limits. In connection with the future claims settlement, the defendants have commenced a third-party action against their respective excess insurance carriers that have not agreed to provide coverage seeking a declaratory judgment that (a) the future claims settlement is fair and reasonable as to the carriers; (b) the carriers had adequate notice of the future claims class settlement; and (c) the carriers are obligated to provide coverage for asbestos personal injury claims. Based on the Company's experience in defending the claims to date and the amount of insurance coverage available, the Company is of the opinion that the actions should not ultimately have a material adverse effect on the financial position or the results of operations of the Company.\nIn connection with the divestiture of Minerals Technologies Inc. (MTI), to which the net assets of the Pfizer Minerals and the Quigley businesses were transferred, Pfizer and Quigley agreed to indemnify MTI against any liability with respect to products manufactured and sold prior to October 30, 1992, as well as against liability for certain environmental matters.\nThe Company has been named, together with numerous other manufacturers of brand name prescription drugs and certain companies that distribute brand name prescription drugs, in suits brought by retail pharmacy companies in federal and state courts. The federal cases consist principally of a class action by retail pharmacies (including approximately 30 named plaintiffs), as well as additional actions by approximately 1,900 individual retail pharmacies (the \"individual actions\"). These cases, all of which have been or are in the process of being transferred to the United States District Court for the Northern District of Illinois and coordinated for pretrial purposes, allege that the defendant drug manufacturers have violated the Sherman Act in that they have unlawfully agreed with each other (and, as alleged in some cases, with wholesalers) not to extend to retail pharmacy companies the same discounts allegedly extended to managed care companies, mail order pharmacies and certain other institutional purchasers. In addition, the individual actions also allege violations of the Robinson-Patman Act in that the manufacturers allegedly have unlawfully discriminated against retail pharmacy companies by not extending them such discounts.\nThe federal court has certified a class consisting of all persons or entities who, since October 15, 1989, bought prescription brand name drugs from any manufacturer or wholesaler defendant, but specifically excluding government entities, mail order pharmacies, HMOs, hospitals, clinics and nursing homes. The federal court had denied a motion for certification made by a purported class of Alabama consumers (in a case that was originally filed in state court, then removed to federal court). In the state cases, motions for class certification are anticipated, except in one Alabama action still in state court, where plaintiffs have stated that they intend to amend their complaint to withdraw their class allegations.\nThe Company believes that these cases are without merit and is vigorously defending them.\nFDA administrative proceedings relating to Plax are pending, principally an industry-wide call for data on all anti-plaque products by the FDA. The call for data notice specified that products that have been marketed for a material time and to a material extent may remain on the market pending FDA review of the data, provided the manufacturer has a good faith belief that the product is generally recognized as safe and effective and is not misbranded. The Company believes that Plax satisfied these\nrequirements and prepared a response to the FDA's request, which was filed on June 17, 1991. This filing, as well as the filings of other manufacturers, is still under review and is currently being considered by an FDA Advisory Committee.\nA consolidated class action on behalf of persons who allegedly purchased Pfizer common stock during the March 24, 1989 through February 26, 1990 period is pending in the United States District Court for the Southern District of New York. This lawsuit, which commenced on July 13, 1990, alleges that the Company and certain officers and former directors and officers violated federal securities law by failing to disclose potential liability arising out of personal injury suits involving Shiley heart valves and seeks damages in an unspecified amount. The defendants in this action believe that the suit is without merit and are vigorously defending it. A derivative action commenced on April 2, 1990 against certain directors and officers and former directors and officers alleging breaches of fiduciary duty and other common law violations in connection with the manufacture and distribution of Shiley heart valves is pending in the Superior Court, Orange County, California. The complaint seeks, among other forms of relief, damages in an unspecified amount. The defendants in the action believe that the suit is without merit and are vigorously defending it.\nOn January 28, 1993, a purported class action entitled Kearse v. Pfizer Inc. and Howmedica Inc. was commenced in the United States District Court for the Northern District of Ohio. Howmedica Inc. (\"Howmedica\") is a wholly owned subsidiary of the Company. The action sought monetary and injunctive relief, including medical monitoring, on behalf of patients implanted with the Howmedica P.C.A. one-piece acetabular hip component, which was manufactured by Howmedica from 1983 to 1990. The complaint alleged that the prostheses were defectively designed and manufactured and posed undisclosed risks to implantees. On August 3, 1993, a virtually identical purported class action, Bradshaw\/Davids v. Pfizer Inc. and Howmedica Inc., was brought and the Kearse case was subsequently voluntarily dismissed. The district court has denied the plaintiffs' motion to certify the case as a class action. The Company believes that the suit is without merit and is vigorously defending it.\nDuring 1994, seven purported class actions were filed against American Medical Systems (\"AMS\") in federal courts in South Carolina (later transferred to Minnesota), California, Minnesota (2), Indiana, Ohio and Louisiana. In January 1995, an additional purported class action was filed in state court in Louisiana, replicating the federal suit. The California and Indiana suits and one Minnesota suit also name Pfizer Inc. as a defendant, based on its ownership of AMS. The suits seek monetary and injunctive relief on the basis of allegations that implantable penile prostheses are prone to unreasonably high rates of mechanical failure and\/or various autoimmune diseases as a result of silicone materials. On September 30, 1994, the federal Judicial Panel on Multidistrict Litigation denied the various plaintiffs' motions to consolidate or coordinate the cases for pretrial proceedings. On February 28, 1995, the Court in the Ohio suit conditionally granted plaintiffs' motion for class certification and on March 3, 1995, the Court in the California suit denied plaintiffs' motion for class certification. The Company believes the suits are without merit and is vigorously defending them.\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\nInformation required by this item is incorporated by reference to the \"Quarterly Consolidated Statement of Income (Unaudited)\" found on page 53 and to page 58 of the Annual Report to Shareholders for the fiscal year ended December 31, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSELECTED CONSOLIDATED STATEMENT OF INCOME DATA\nSELECTED CONSOLIDATED BALANCE SHEET DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nInformation required by this item is incorporated by reference to the \"Financial Review\" on pages 26 through 33 of the 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\nInformation required by this item is incorporated by reference to the \"Independent Auditors' Report\" found on page 34 and to pages 35 through 53 of the Annual Report to Shareholders for the fiscal year ended December 31, 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\nInformation with regard to the Directors of the Company, including those of the following Executive Officers who are Directors, is incorporated by reference to pages 3 through 7 of the Company's Proxy Statement dated March 16, 1995.\nThe Board of Directors elects officers at its first meeting after each annual meeting of shareholders. The Board may also elect officers from time to time throughout the year. Elected officers of the Company hold office until their successors are chosen or until their earlier death, resignation or removal.\nBUSINESS EXPERIENCE OF NON-DIRECTOR OFFICERS\nBRIAN W. BARRETT\nMr. Barrett joined Pfizer Canada in 1966, where he served in various financial positions, including Chief Financial Officer of the Canadian subsidiary. In 1971, he was appointed Assistant Controller of Pfizer International in New York; in 1973, Director of International Planning and in 1976, Director of Planning. In 1980, Mr. Barrett was appointed Vice President -- Corporate Strategic Planning; in 1983, he became Vice President -- Finance for Pfizer International; in 1985, President -- Africa\/ Middle East and in 1991, President -- Asia\/Canada. In 1992, Mr. Barrett was elected Vice President of the Company. He assumed the responsibilities of his present position, President, Northern Asia, Australasia and Canada -- International Pharmaceuticals Group, in 1993.\nM. KENNETH BOWLER\nMr. Bowler joined the Company in 1989, and has been Vice President -- Federal Government Relations since 1990. He formerly served as Staff Director for the House Ways and Means Committee.\nC. L. CLEMENTE\nMr. Clemente joined the Company in 1964 and has served as Vice President; General Counsel and Secretary, Pfizer International, Inc. He has also held the position of Vice President of Coty, formerly Pfizer's fragrance and cosmetic division. In 1983, he was named Associate General Counsel of Pfizer Inc. In 1986, he was elected Vice President; General Counsel and Secretary of the Company. He became a member of the Corporate Management Committee of the Company in 1991. In 1992, he was elected Senior Vice President -- Corporate Affairs; Secretary and Corporate Counsel.\nBRUCE R. ELLIG\nMr. Ellig joined the Company in 1960. He progressed through a number of positions of increasing responsibility in the Corporate Personnel Division including Vice President -- Compensation and Benefits in 1978 and Vice President -- Employee Relations in 1983. In 1985, he was elected Vice President -- Personnel of the Company.\nDONALD F. FARLEY\nMr. Farley joined the Company in 1965 as Production Engineer for the Chemical Division. After serving in a number of positions of increasing responsibility within the Chemical Division, he was named its Vice President, Operations in 1982. In 1986 he became Senior Vice President of the Division, and in 1988, Executive Vice President -- Specialty Chemicals. In 1992, Mr. Farley was named President of the Food Science Group and in February 1993 was elected a Vice President of the Company.\nDAVID M. FITZGERALD\nMr. Fitzgerald joined the Company's Howmedica division in 1970 as Controller. In 1974, he was promoted to Corporate Controller of Howmedica. He served as Assistant General Manager and Vice President -- General Manager and in 1980 he assumed responsibility for Howmedica's worldwide orthopedics operations. In 1982, he was appointed Senior Vice President of Howmedica. In 1984, he became President of Howmedica and Senior Vice President of Hospital Products. In 1988, he became Executive Vice President of the Hospital Products Group. In 1992, Mr. Fitzgerald was elected Vice President of the Company.\nGEORGE A. FORCIER\nDr. Forcier joined the Company in 1966 as Analytical Research Chemist for the Company's Medical Research Laboratories. In 1970, he was named Project Leader, in 1979 Manager, and in 1981, Assistant Director of the Analytical Research Department. In 1986, he was named Director of the Analytical Research and Development Department and in 1991, he became Group Director. Dr. Forcier was elected Vice President -- Quality Control of the Company, effective January 1, 1994.\nP. NIGEL GRAY\nMr. Gray joined the Company in 1975 as Export Sales Manager for Howmedica U.K., Ltd. in England and progressed through a number of positions of increasing responsibility before being named Vice President, Marketing for Howmedica Europe in 1983. In 1987, Mr. Gray became Senior Vice President and General Manager of Howmedica International in Staines, England, then President of Howmedica International in 1992. In 1993, he came to New York as Executive Vice President of the Company's Hospital Products Division and President of the Medical Devices Division and in October 1994, he was elected a Vice President of the Company.\nWILLIAM E. HARVEY\nMr. Harvey joined the Company in 1966 as Assistant to the Treasurer of Pfizer International. In 1969, he was appointed Assistant Treasurer, International and in 1981, he became Assistant Treasurer of the Company. In 1990, Mr. Harvey was elected Vice President; Treasurer of the Company and served in this capacity until his retirement on December 31, 1994.\nGARY N. JORTNER\nMr. Jortner joined the Company in 1973 as a Systems Analyst for Pfizer Pharmaceuticals. In 1974, he transferred to product management and progressed through a series of promotions that resulted in his being named Group Product Manager for Pfizer Labs in 1978. In 1981, he became Vice President of Marketing for Pfizer Labs. In 1986, he was promoted to Vice President of Operations for Labs. In 1991, he was named Vice President and General Manager, Pfizer Labs Division. In 1992, Mr. Jortner was elected Vice President of the Company. In 1994, he was named Vice President; Group Vice President, Disease Management -- U.S. Pharmaceuticals Group.\nKAREN L. KATEN\nMs. Katen joined the Company in 1974 as a Marketing Associate for Pfizer Pharmaceuticals. Beginning in 1975, she progressed through a number of positions of increasing responsibility in the Roerig product management group which resulted in her being named Group Product Manager in 1978. In 1980, she transferred to Pfizer Labs as a Group Product Manager and later became Director, Product Management. In 1983, she returned to Roerig as Vice President -- Marketing. In 1986, she was named Vice President and General Manager -- Roerig Division. In 1992, she was elected Vice President of the Company. In May 1993, Ms. Katen became Executive Vice President of the U.S. Pharmaceuticals Group.\nALAN G. LEVIN\nMr. Levin joined the Company in 1987 as Senior Operations Auditor for the Controllers Division, and in 1988 joined the Treasurer's Division as Controller, Pfizer International Bank. He became Director -- Finance, International in 1991 and in 1993 was named Senior Director -- Finance, Asia. On January 1, 1995, Mr. Levin was elected Treasurer of the Company.\nHENRY A. MCKINNELL\nDr. McKinnell joined the Company in 1971. In 1977, he became Vice President -- Area Manager for Pfizer Asia. In 1979, he became Executive Vice President and in 1981, President of Pfizer Asia. In 1984, Dr. McKinnell was named Vice President -- Corporate Strategic Planning and in 1986, he was elected a Vice President of the Company. In 1990, Dr. McKinnell became the Company's Chief Financial Officer and was named Vice President -- Finance of the Company. In 1992, he became a member of the Corporate Management Committee of the Company. In that same year, he became Executive Vice President of the Company and President of the Company's Hospital Products Group, in addition to remaining the Company's Chief Financial Officer.\nBROWER A. MERRIAM\nMr. Merriam joined the Company in 1969 as Country Manager for Peru, and in 1971, he was appointed Country Manager for Argentina. In 1973, he was appointed President of Pfizer Latin America. He was appointed Director of Pfizer International in 1984, and in 1988 assumed the position of President for Latin America, Southeast Asia, Indo-Pacific and Canada. In 1990, he was appointed Executive Vice President of Pfizer International. In 1991, he became Executive Vice President of the Animal Health Group and in 1992 was appointed its President. Mr. Merriam was elected a Vice President of the Company in 1992.\nJOHN C. MESLOH\nMr. Mesloh joined Howmedica, Inc. as Controller in 1973. In 1974, he was appointed Vice President -- Finance and Treasurer of Howmedica, and in 1980 he was elected Corporate Controller of the Company. In 1989, Mr. Mesloh was elected Vice President of the Company. Mr. Mesloh was elected Vice President, Corporate Purchasing, effective January 1993.\nVICTOR P. MICATI\nMr. Micati joined the Company in 1965 as a Management Candidate for Pfizer Labs. Beginning in 1966, he progressed through a number of positions of increasing responsibility in the Pfizer Labs Division, which resulted in his being named Vice President -- Marketing in 1971. In 1972 he became Vice President of Pharmaceutical Development for International Pharmaceuticals. In 1980, he was named Executive Vice President of the European Management Center. He returned to the International Pharmaceutical Division in 1984 as Senior Vice President, and in 1990 was named President, Pfizer Europe. In 1992, Mr. Micati was elected Vice President of the Company.\nPAUL S. MILLER\nMr. Miller joined the Company in 1971 and was appointed an Assistant Secretary and Assistant General Counsel in 1975. In 1983, he was named Associate General Counsel. In 1986, he became Secretary of the Corporate Management Committee and in that same year he was elected Vice President; General Counsel of the Company. He became a member of the Corporate Management Committee of the Company in 1991. In 1992, Mr. Miller was elected Senior Vice President -- General Counsel of the Company.\nGEORGE M. MILNE, JR.\nDr. Milne joined the Company in 1970 as a Research Scientist. In 1973, he was named Senior Research Scientist and progressed through a number of positions of increasing responsibility which resulted in his being named Vice President, Research and Development Operations in 1985. In 1988, Dr. Milne became Senior Vice President, Research and Development, and in September 1993, he was elected Vice President of the Company and President, Central Research.\nROBERT NEIMETH\nMr. Neimeth joined the Company in 1962 as a management trainee, subsequently serving as Country Manager, Nigeria, as Vice President, Pharmaceutical Development in Asia, and then as President of Pfizer Asia from 1972 to 1977. He then served as Vice President and Director of Operations for Pfizer Labs in the U.S. In 1980 he became President, Pfizer Europe and, in 1983, Mr. Neimeth became a Vice President of the Company. In 1984, he was also elected Executive Vice President of Pfizer International Subsidiaries and assumed supervision of the pharmaceutical business in Africa and the Middle East, in addition to his responsibilities in Europe. In 1990, he was named President, Pfizer International Subsidiaries. In 1991, he became Chairman, President and Chief Executive Officer of Pfizer International. He also became a member of the Corporate Management Committee of the Company in 1991. In 1992, he was elected Executive Vice President of the Company, and President, International Pharmaceuticals Group. In this capacity, Mr. Neimeth supervises the Company's International Pharmaceutical and worldwide Animal Health operations.\nJOHN F. NIBLACK\nDr. Niblack joined the Company in 1967 and held various management positions in new-drug discovery operations before being appointed in 1984 as Vice President, Medicinal Products Research and in 1986 as Executive Vice President, Central Research. In 1990, Dr. Niblack was named President -- Central Research and elected a Vice President of the Company. In September 1993, Dr. Niblack was elected Executive Vice President -- Research and Development, and became a member of the Corporate Management Committee of the Company.\nWILLIAM J. ROBISON\nMr. Robison joined the Company in 1961 as a Sales Representative for Pfizer Labs. After serving in a number of positions of increasing responsibility in the Labs division, he was appointed Vice President of Sales in 1980, and Senior Vice President, Pfizer Labs in 1986. In 1990 he was appointed Vice President and General Manager of Pratt Pharmaceuticals, and in 1992 assumed his present position as President of the Consumer Health Care Group. In 1992, Mr. Robison was also elected Vice President of the Company.\nHERBERT V. RYAN\nMr. Ryan joined the Company in 1962 as Supervisor, Capital Assets. In 1964 he was named Supervisor, Corporate Ledger and in 1966 became Director, Corporate Accounting. In 1981 he was appointed Assistant Controller, Corporate Accounting. In 1993, Mr. Ryan was elected Controller.\nCRAIG SAXTON\nDr. Saxton joined the Company in 1976 as Clinical Projects Director for the Central Research Division of Pfizer Ltd. in Sandwich, England. In 1981, he was named Senior Associate Medical Director for the International Division of Pfizer Inc., and in 1982 became the Division's Vice President, Medical Director. Dr. Saxton became Senior Vice President, Clinical Research and Development for the Central Research Division in 1988. In September 1993, he was named Executive Vice President -- Central Research and was elected a Vice President of the Company.\nGERALD H. SCHULZE\nMr. Schulze joined the Company in 1971 as a Medical Service Representative for Roerig. He served in a number of positions of increasing responsibility in the Pharmaceuticals and International divisions before being named Vice President -- Business Development for the Consumer Products division in 1985. In 1987, he was named Vice President -- Business Development for Hospital Products, and in 1988, became that division's Senior Vice President. In 1992, he was elected a Vice President of the Company and was named Executive Vice President for the Hospital Products Group\nand President of the Medical Devices Division. In November 1993, Mr. Schulze was elected Vice President, Corporate Strategic Planning of the Company. In October 1994, he was elected Vice President, Pharmaceutical Planning.\nROBERT L. SHAFER\nMr. Shafer joined the Company in 1966 as Assistant to the Director of Government Relations. In 1967, he became Associate Director of Government Relations and in 1968, Director of Government Relations. In 1973, Mr. Shafer was elected a Vice President of the Company. In 1982, he was elected Vice President -- Public Affairs.\nDAVID L. SHEDLARZ\nMr. Shedlarz joined the Company in 1976 as Senior Financial Analyst for the Pharmaceuticals Division. After serving in a number of positions of increasing responsibility, he was named Production Controller in 1979 and Assistant Group Controller in 1981. In 1984, he became Group Controller and in 1989 was named Vice President of Finance for the Pharmaceuticals Group. In 1992, Mr. Shedlarz was elected Vice President -- Finance of the Company.\nFREDERICK W. TELLING\nDr. Telling joined the Company in 1977 as Associate Personnel Manager for the Pharmaceuticals Division and progressed through a number of positions of increasing responsibility before being named Director of Planning for the Pharmaceuticals Division in 1981. In 1987, he was named the Vice President of Planning and Policy, and in 1994, Senior Vice President of Planning and Policy for the Company's U.S. Pharmaceuticals Group. In October 1994, Dr. Telling was elected Vice President, Corporate Strategic Planning and Policy.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with regard to executive compensation is incorporated by reference to pages 8 through 19 of the Company's Proxy Statement dated March 16, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with regard to security ownership of certain beneficial owners and management is incorporated by reference to pages 2 through 7 of the Company's Proxy Statement dated March 16, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with regard to certain relationships and related transactions is incorporated by reference to pages 20 and 21 of the Company's Proxy Statement dated March 16, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe following is a list of all Financial Statement Schedules and Exhibits filed as a part of this Annual Report.\n(a)(1) Financial Statements\nSee Part II\n(a)(2) Financial Statement Schedule\nSchedules not listed above have been omitted for the reason that they are inapplicable or not required or the information is given elsewhere in the financial statements. The financial statements of unconsolidated subsidiaries are omitted on the basis that these subsidiaries, considered in the aggregate, would not constitute a significant subsidiary.\n(a)(3) Exhibits\n(b) The Company filed a report on Form 8-K dated December 13, 1994.\nExhibits to the Form 10-K are available upon request at the charges set out below. Requests should be directed to C. L. Clemente, Secretary, Pfizer Inc., 235 East 42nd Street, New York, N.Y. 10017.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPfizer Inc. (Registrant)\nBy \/s\/ C.L. CLEMENTE\n----------------------------------- C.L. Clemente (Secretary)\nDated: 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 date indicated.\nPFIZER INC. AND SUBSIDIARY COMPANIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nThe following trademarks, found in this report, are among those used by Pfizer Inc.\nCARDURA (DOXAZOSIN MESYLATE) DIFLUCAN (FLUCONAZOLE) ENABLE (TENIDAP) ENABLEX (TENIDAP) E5 (ANTI-ENDOTOXIN ANTIBODY) FELDENE (PIROXICAM) GLUCOTROL (GLIPIZIDE) GLUCOTROL XL (GLIPIZIDE GITS) NORVASC (AMLODIPINE BESYLATE) PROCARDIA (NIFEDIPINE) PROCARDIA XL (NIFEDIPINE GITS) REACTINE (CETIRIZINE) UNASYN (SULBACTAM\/AMPICILLIN) ZITHROMAX (AZITHROMYCIN) ZOLOFT (SERTRALINE) ABG ALTA DURACON GAMMA LUHR PARATREND P.C.A. SIMPLEX LITESSE (POLYDEXTROSE) ADVOCIN (DANOFLOXACIN) AVIAX (SEMDURAMICIN) BANMINTH (PYRANTEL TARTRATE) BOVISHIELD COXISTAC (SALINOMYCIN) DECTOMAX (DORAMECTIN) FILARIBITS (DIETHYLCARBAMAZINE CITRATE) LEUKOCELL MECADOX (CARBADOX) NEMEX (PYRANTEL PAMOATE) RESPISURE STAFAC (VIRGINIAMYCIN) TERRAMYCIN LA-200 (OXYTETRACYCLINE) TM\/LA (OXYTETRACYCLINE) PARATECT (MORANTEL TARTRATE) POSISTAC (SALINOMYCIN) VALBAZEN (ALBENDAZOLE) VANGUARD BARBASOL BEN-GAY DAILY CARE FROM DESITIN DESITIN PLAX RID UNISOM (DOXYLAMINE SUCCINATE) UNISOM SLEEPGELS VISINE (TETRAHYDROZOLINE HCI)\nEXHIBIT INDEX","section_15":""}
{"filename":"789933_1994.txt","cik":"789933","year":"1994","section_1":"ITEM 1. BUSINESS -----------------\nGeneral -------\nNACCO Industries, Inc. (\"NACCO\" or the \"Company\") is a holding company which owns four principal operating subsidiaries:\n(a) NACCO MATERIALS HANDLING GROUP. The Company owns approximately 97% of the outstanding capital stock of Hyster-Yale Materials Handling, Inc. (\"Hyster-Yale\"), which is the parent company of NACCO Materials Handling Group, Inc. (For convenience of reference NACCO Materials Handling Group, Inc. and Hyster-Yale hereinafter referred to as \"NMHG\"). NMHG markets two full lines of forklift trucks and related service parts under the Hyster(R) and Yale(R) brand names. NMHG accounted for 63% and 49% of NACCO's revenues and operating profits, respectively, in 1994.\n(b) HAMILTON BEACH\/PROCTOR-SILEX. The Company owns 80% of Hamilton Beach\/Proctor-Silex, Inc. (\"Hamilton Beach\/Proctor-Silex\"), one of the nation's leading manufacturers and marketers of small electric appliances. Hamilton Beach\/Proctor-Silex accounted for 20% and 19% of NACCO's revenues and operating profits, respectively, in 1994.\n(c) NORTH AMERICAN COAL. The Company's wholly owned subsidiary, The North American Coal Corporation, and its affiliated coal companies (collectively, \"North American Coal\"), mine and market lignite for use primarily as fuel for power generation by electric utilities. North American Coal accounted for 13% and 36% of NACCO's revenues and operating profits, respectively, in 1994.\n(d) KITCHEN COLLECTION. The Company's wholly owned subsidiary, The Kitchen Collection, Inc. (\"Kitchen Collection\"), is a national specialty retailer of kitchenware, small electric appliances and related accessories. Kitchen Collection accounted for 3% and 4% of NACCO's revenues and operating profits, respectively, in 1994.\nAdditional information relating to financial and operating data on a segment basis (including NACCO, which reduced operating profits by 8% in 1994) is set forth in Management's Discussion and Analysis of Results of Operations and Financial Condition on pages 24 through 53 contained in Part II hereof and in Note P to the Consolidated Financial Statements on pages through contained in Part IV hereof.\nNACCO was incorporated as a Delaware corporation in 1986 in connection with the formation of a holding company structure for a predecessor corporation organized in 1913.\nSignificant Events ------------------ In August 1994, NACCO and NMHG's two minority stockholders made pro rata cash capital contributions to NMHG aggregating $25.0 million. This cash contribution, along with internally generated funds and borrowings, enabled NMHG to call approximately $48.0 million face value of subordinated debentures at a price of 105.\nIn December 1994, NMHG called an additional $24.0 million face value of subordinated debentures at a price of 105 using internally generated funds and borrowings. At December 31, 1994, there remained outstanding subordinated debentures having a face value of approximately $78.5 million.\nOn February 28, 1995, NMHG entered into a new long-term credit agreement to replace its existing bank agreement and to refinance the majority of its existing long-term debt. The new agreement provided the company with an unsecured $350.0 million revolving credit facility to replace its current senior credit facility. The new credit facility has a five-year maturity with extension options and performance-based pricing comparable to its current senior credit facility which provides the company with reduced interest rates upon achievement of certain financial performance targets. With the new credit facility in place, the company has the ability to call the remaining $78.5 million outstanding subordinated debentures in 1995. In anticipation of the call, an extraordinary charge of $3.4 million will be recorded by NMHG in the first quarter of 1995 to write-off unamortized debt issuance costs and anticipated premiums.\nEffective February 28, 1995, George C. Nebel resigned as President and Chief Executive Officer of Hamilton Beach\/Proctor-Silex. While the search for Mr. Nebel's replacement is underway, Hamilton Beach\/Proctor-Silex will be managed by Alfred M. Rankin, Jr., Chairman, President and CEO of the Company, as nonexecutive chairman of the Hamilton Beach\/Proctor-Silex Board of Directors, with daily operations being overseen by an executive committee comprised of key Hamilton Beach\/Proctor-Silex executives from various disciplines.\nBusiness Segment Information ----------------------------\nA. NACCO Materials Handling Group ------------------------------\nNMHG is one of the leading worldwide designers, manufacturers and marketers of forklift trucks which comprise the largest segment of the materials handling equipment industry. NMHG accounted for 53% and 42% of NACCO's assets and liabilities, respectively, as of December 31, 1994, while its operations accounted for 63% and 49% of NACCO's revenues and operating profits, respectively, in 1994.\nThe Industry ------------\nForklift trucks are used in both manufacturing and warehousing environments. The materials handling industry, especially in industrialized nations, is generally a mature industry, which has historically been cyclical. Fluctuations in the rate of orders for forklift trucks reflect the capital investment decisions of the customers, which in turn depend upon the general level of economic activity in the various industries served by such customers.\nIn the most recent business cycle the North American market for forklift trucks reached its lowest level in 1991 and has increased each year since then to a record level in 1994. The European and Japanese markets generally had been in decline since 1990; they both showed some recovery in 1994. During this business cycle, however, the total worldwide lift-truck market was relatively stable.\nCompany Operations ------------------\nNMHG maintains product differentiation between Hyster(R) and Yale(R) brands of forklift trucks and distributes its products through separate worldwide dealer networks. Nevertheless, opportunities have been identified and addressed to improve the company's results by integrating overlapping operations and taking advantage of economies of scale in design, manufacturing and purchasing. NMHG provides all design, manufacturing and administrative functions. Products are marketed and sold through two separate dealer networks which retain the Hyster and Yale identities. In Japan, NMHG has a 50% owned joint venture with Sumitomo Heavy Industries Ltd. named Sumitomo-Yale Company Limited (\"S-Y\"). S-Y performs certain design activities and produces lift trucks and components which it markets in Japan and which are exported for sale by NMHG and its affiliates in the U.S. and Europe.\nProduct Lines -------------\nNMHG manufactures a wide range of forklift trucks under both the Hyster(R) and Yale(R) brand names. The principal categories of forklift trucks include electric rider, electric narrow-aisle and electric motorized hand forklift trucks primarily for indoor use, and internal combustion engine (\"ICE\") forklift trucks for indoor or outdoor use. Forklift truck sales accounted for approximately 82%, 80%, and 79% of NMHG's net sales in 1994, 1993, and 1992, respectively.\nNMHG also derives significant revenues from the sale of service parts for its products. Profit margins on service parts are greater than those on forklift trucks. The large population of Hyster(R) and Yale(R) forklift trucks now in service provides a market for service parts. In addition to parts for its own forklift trucks, NMHG has a program (termed UNISOURCE(TM) in North America and MULTIQUIP(TM) in Europe) designed to supply Hyster dealers with replacement parts for most competing brands of forklift trucks. NMHG has a similar program (termed PREMIER(TM)) for its Yale dealers in the Americas and Europe. Accordingly, NMHG dealers can offer their mixed fleet customers a \"one stop\" supply source. Certain of these parts are manufactured by and purchased from third party component makers. NMHG also manufactures some of these parts through reverse-engineering of its competitors' parts. Service parts accounted for approximately 18%, 20%, and 21% of NMHG net sales in 1994, 1993, and 1992, respectively.\nCompetition -----------\nThe forklift truck industry is highly competitive. The worldwide competitive structure of the industry is fragmented by product line and country. The principal methods of competition among forklift truck manufacturers are product performance, price, service and distribution networks. The forklift truck industry competes with alternative methods of materials handling, including conveyor systems, automated guided vehicle systems and hand labor. Global competition is also affected by a number of other factors, including currency fluctuations, variations in labor costs and effective tax rates, and the costs related to compliance with applicable regulations, including export restraints, antidumping provisions and environmental regulations.\nAlthough there is no official source for information on the subject, NACCO believes that NMHG is one of the top three manufacturers of forklift trucks in the world.\nNMHG's position is strongest in North America, where it believes it is the leader in unit sales of electric rider and ICE forklift trucks and has a significant share of unit sales of electric narrow-aisle and electric motorized hand forklift trucks. Although the European market is fragmented and competitive positions vary from country to country, NMHG believes that it has a significant share of unit sales of electric rider and ICE forklift trucks in Western Europe. Although NMHG's current market share in Asia-Pacific, including Japan, is lower than in other geographic areas it has been targeted for additional market share growth.\nTrade Restrictions ------------------\nA. United States -------------\nSince June 1988, Japanese-built ICE forklift trucks imported into the U.S., with lifting capacities between 2,000 and 15,000 pounds, including finished and unfinished forklift trucks, chassis, frames, and frames assembled with one or more component parts, have been subject to an antidumping duty order. Antidumping duty rates in effect through 1994 range from 4.48% to 56.81% depending on manufacturer or importer. The antidumping duty rate applicable to imports from S-Y is 51.33%, and is likely to continue unchanged for the foreseeable future, unless S-Y and NMHG decide to participate in proceedings to have it reduced. NMHG does not currently import for sale in the United States any forklift trucks or components subject to the antidumping duty order. This antidumping duty order will remain in effect until the Japanese manufacturers and importers satisfy the U.S. Department of Commerce (\"Commerce\") that they have not individually sold merchandise subject to the order in the United States below foreign market value for at least three consecutive years, or unless Commerce or the U.S. International Trade Commission finds that changed circumstances exist sufficient to warrant the revocation of the order. The legislation implementing the Uruguay round of GATT negotiations passed in 1994 provides that the anti-dumping order will be reviewed for possible revocation in 2000. All of NMHG's major Japanese competitors have either built or acquired manufacturing or assembly facilities in the United States. The company cannot predict with any certainty if there will be any negative effects to the company resulting from the Japanese sourcing of their forklift products in the United States.\nB. Europe ------\nFrom 1986 through 1994, Japanese forklift truck manufacturers were subject to informal export restraints on Japanese-manufactured electric rider, electric narrow-aisle and ICE forklift trucks shipped to Europe. These informal restraints are not expected to continue in 1995. Several Japanese manufacturers have announced either that they have established, or intend to establish, manufacturing or assembly facilities within the European Community. The company also cannot predict with any certainty if there will be any negative effects to NMHG resulting from the Japanese sourcing of their forklift products in Europe.\nProduct Design and Development ------------------------------\nNMHG spent $23.2 million, $20.7 million, and $21.9 million on product design and development activities in 1994, 1993, and 1992, respectively. The Hyster(R) and Yale(R) products are differentiated for the specific needs of their respective customer bases. NMHG continues to pursue opportunities to improve product costs by engineering new Hyster(R) and Yale(R) brand products with component commonality.\nCertain product design and development activities with respect to ICE forklift trucks and some components are performed in Japan by S-Y. S-Y spent approximately $4.5 million, $4.0 million, and $3.7 million on product design and development in 1994, 1993, and 1992, respectively.\nBacklog -------\nAs of December 31, 1994, NMHG's backlog of unfilled orders for forklift trucks was approximately 24,600 units, or $433 million. This compares to the backlog as of December 31, 1993 of approximately 12,100 units, or $206 million. Management believes NMHG's backlog level is consistent with overall increases in industry backlog levels. Backlog represents unit orders to NMHG's manufacturing plants from independent dealerships, retail customers and contracts with the U.S. Government. Although these\norders are believed to be firm, such orders may be subject to cancellation or modification.\nSources -------\nNMHG has adopted a strategy of obtaining its raw materials and principal components on a global basis from competitively priced sources. NMHG is dependent on a limited number of suppliers for certain of its critical components, including diesel and gasoline engines and cast-iron counterweights used on certain forklift trucks. There would be a material adverse effect on NMHG if it were unable to obtain all or a significant part of such components, or if the cost of such components was to increase significantly under circumstances which prevented NMHG from passing on such increases to its customers.\nDistribution ------------\nThe Hyster(R) and Yale(R) brand products are distributed through separate highly developed worldwide dealer networks. Each also sells directly to certain major accounts.\nIn Japan, forklift truck products are distributed by S-Y. In 1991, Yale reached a ten-year agreement with Jungheinrich Aktiengesellschaft AG (\"Jungheinrich\"), a German manufacturer of forklift trucks, to continue distribution of Yale brand products in Germany and Austria and to provide to Jungheinrich certain ICE and electric-powered products for sale in other major European countries under the Jungheinrich brand name.\nFinancing of Sales ------------------\nHyster U.S. dealer and direct sales are supported by leasing and financing services provided by Hyster Credit Company, a division of AT&T Commercial Finance Corporation, pursuant to an operating agreement which expires in 2000.\nNMHG is a minority stockholder of Yale Financial Services, Inc., a subsidiary of General Electric Capital Corporation, which offers Yale U.S. dealers wholesale and retail financing and leasing services for its forklift trucks. Such retail financing and leasing services are also available to Yale national account customers.\nEmployees ---------\nAs of February 28, 1995, NMHG had approximately 6,000 employees. Employees in the Danville, Illinois manufacturing and parts depot operations are unionized, as are tool room employees located in Portland, Oregon. A new three-year contract for the Danville union employees was signed in 1994, which will expire in June, 1997. A new three-year contract was signed in 1994 with the Portland tool room union which will expire in October 1997. Employees at the facilities in Berea, Kentucky; Sulligent, Alabama; and Greenville and Lenoir, North Carolina are not represented by unions.\nIn Europe, shop employees in the Craigavon, Northern Ireland facility are unionized. Employees in the Irvine, Scotland and Nijmegen, The Netherlands facilities are not represented by unions. The employees in Nijmegen have organized a works council, as required by Dutch law, which performs a consultative role on employment matters.\nNMHG's management believes its current labor relations with both union and non-union employees are generally satisfactory.\nGovernment Regulation ---------------------\nNMHG's manufacturing facilities, in common with others in industry, are subject to numerous laws and regulations designed to protect the environment, particularly with respect to disposal of plant waste. NMHG's products are also subject to various industry and governmental standards. NMHG's management believes that such requirements have not had a material adverse effect on its operations.\nPatents, Trademarks and Licenses --------------------------------\nNMHG is not materially dependent upon patents or patent protection. NMHG is the owner of the Hyster(R) trademark, which is currently registered in approximately 51 countries. The Yale(R) trademark, which is used on a perpetual royalty-free basis by NMHG in connection with the manufacture and sale of forklift trucks and related components, is currently registered in approximately 100 countries. NMHG's management believes that its business is not dependent upon any individual trademark registration or license, but that the Hyster(R) and Yale(R) trademarks are material to its business.\nB. Hamilton Beach\/Proctor-Silex ----------------------------\nGeneral -------\nThe Company believes that Hamilton Beach\/Proctor-Silex is one of the largest broad line manufacturers and marketers of small electric appliances in North America. Hamilton Beach\/Proctor-Silex's products are marketed primarily to retail merchants and wholesale distributors. Hamilton Beach\/Proctor-Silex accounted for 17% and 12% of NACCO's assets and liabilities, respectively, as of December 31, 1994, while its operations accounted for 20% and 19% of NACCO's revenues and operating profits, respectively, in 1994.\nSales and Marketing -------------------\nHamilton Beach\/Proctor-Silex manufactures and markets a wide range of small electric appliances, including motor driven appliances such as blenders, food processors, mixers and electric knives which are primarily marketed under the Hamilton Beach(R) brand name, and heat generating appliances such as toasters, irons, coffeemakers and toaster ovens which are primarily marketed under the Proctor-Silex(R) brand name. The company markets its products primarily in North America, but also sells in, South America, Latin America and Europe. Sales are generated by a network of sales employees and outside sales representatives to mass merchandisers, catalog showrooms, warehouse membership clubs, variety store chains, department stores and other retail outlets. Sales are also made through independent dealers and distributors. Principal customers include Wal-Mart, Target, K-Mart, Service Merchandise, Montgomery Ward, Caldor's, Sears, Canadian Tire and Zellers. The company also manufactures and sells certain private label brand products to third parties for resale. Sales promotional activities are primarily focused on cooperative advertising.\nBecause of the seasonal nature of the markets for small electric appliances, Hamilton Beach\/Proctor-Silex's management believes that backlog is not a meaningful indicator of performance nor is it a significant indicator of annual sales. Backlog of orders as of December 31, 1994 was approximately $8.2 million. This compares with the aggregate backlog as of December 31, 1993 of approximately $13.1 million. This backlog represents customer orders; customer orders may be cancelled at any time prior to shipment.\nHamilton Beach\/Proctor-Silex's warranty program to the consumer consists generally of a limited warranty lasting one or two years, depending on the product,\nfor domestic electric appliances, and two years for all Canadian electric appliances. Under these warranty programs, the company may repair or replace, at its option, those products found to contain manufacturing defects.\nRevenues and operating profit for Hamilton Beach\/Proctor-Silex are traditionally greater in the second half of the year as sales of small electric appliances increase significantly with the fall holiday selling season. Because of the seasonality of purchases of its products, Hamilton Beach\/Proctor-Silex incurs substantial short-term debt to finance inventories and accounts receivable.\nProduct Design and Development ------------------------------\nHamilton Beach\/Proctor-Silex spent $2.7 million in 1994 and 1993 and $2.5 million in 1992 on product design and development activities.\nSources -------\nThe principal raw materials used to manufacture and distribute Hamilton Beach\/Proctor-Silex's products are steel, aluminum, plastics and packaging materials. The company's management believes that adequate quantities of raw materials are available from various suppliers.\nOn November 28, 1994, the parent company of one of Hamilton Beach\/Proctor Silex's principal suppliers of molded plastic, Southern Tech Plastics Products, Inc., entered into Chapter 11 bankruptcy proceedings.\nOn March 3, 1995, Hamilton Beach\/Proctor-Silex entered into a nonbinding letter of intent to purchase the stock of Southern Tech Plastics Products, Inc. Subject to final agreement of the parties and the approval of the United States Bankruptcy Court, it is the company's intention to close this transaction in April and continue molding operations on its own, although there can be no assurance that this transaction will be consummated.\nCompetition -----------\nThe small electric appliance industry is highly competitive. Based on publicly available information about the industry, Hamilton Beach\/Proctor-Silex's management believes it is one of the largest producers of such appliances in North America.\nAs retailers generally purchase a limited selection of small electric appliances, Hamilton Beach\/Proctor-Silex competes with other suppliers for retail shelf space and focuses its marketing efforts on retailers rather than consumers. The company's management believes that the principal areas of competition with respect to its products are quality, price, product design, product features, merchandising, promotion and warranty. Hamilton Beach\/Proctor-Silex's management believes that it is competitive in all of these areas.\nGovernment Regulation ---------------------\nHamilton Beach\/Proctor-Silex, in common with other manufacturers, is subject to numerous Federal and state health, safety and environmental regulations. The company's management believes that the impact of expenditures to comply with such laws will not have a material adverse effect on Hamilton Beach\/Proctor-Silex. The company's products are subject to testing or regulation by Underwriters' Laboratories, the Canadian Standards Association, and various entities in foreign countries which review product design.\nPatents, Trademarks, Copyrights, and Licenses ---------------------------------------------\nHamilton Beach\/Proctor-Silex holds patents and trademarks registered in the United States and foreign countries for various products. The company's management believes that its business is not dependent upon any individual patent, trademark, copyright or license, but that the Hamilton Beach(R) and Proctor-Silex(R) trademarks are material to its business.\nEmployees ---------\nAs of February 28, 1995, Hamilton Beach\/Proctor-Silex's work force consisted of approximately 3,900 employees, none of which are represented by unions except for approximately 30 hourly employees at the Picton, Ontario facility. The Picton, Ontario employees are represented by an employee association which performs a consultative role.\nC. North American Coal -------------------\nGeneral -------\nNorth American Coal is engaged in the mining and marketing of lignite for use primarily as fuel for power generation by electric utilities. Substantially all of the sales by North American Coal are made through wholly owned project mining subsidiaries pursuant to long-term, cost plus a profit per ton contracts. The utility customers have arranged and guaranteed the financing of the development and operation of the project mining subsidiaries. There is no recourse to NACCO or North American Coal for the financing of these subsidiary mines. At December 31, 1994 North American Coal's operating mines consisted of mines where the reserves were acquired and developed by North American Coal, except for the South Hallsville No. 1 Mine whose reserves are owned by the customer. North American Coal also earns royalty income from the lease of various coal and gas properties. For further information as to the financing of the project mining subsidiaries, see Note H to the Consolidated Financial Statements on pages through contained in Part IV hereof. Project mining subsidiaries accounted for 24% and 29% of NACCO's assets and liabilities, respectively, as of December 31, 1994, while their operations accounted for 12% and 30% of the Company's revenues and operating profits, respectively, in 1994.\nSales and Markets -----------------\nThe principal customers of North American Coal are electric utilities and a synfuels plant. In 1994, sales to one customer, which supplies coal to four facilities, accounted for 45% of North American Coal's revenues compared with 46% and 44% in 1993 and 1992, respectively. The distribution of sales in the last five years has been as follows:\nThe contracts under which the project mining subsidiaries were organized provide that under certain conditions of default the customer(s) involved may elect to acquire the assets (subject to the liabilities) or the capital stock of the subsidiary, for an amount effectively equal to book value. In one case, the customer may elect to acquire the stock of the subsidiary after a specified period of time without reference to default, in exchange for certain payments on coal thereafter mined.\nThe location, customer, sales tonnage and contract expiration date for the mines operated by North American Coal in 1994 were as follows:\nNotes to preceding table: -------------------------\n(1) The contracts for these mines require the customer to cover the cost of the ongoing replacement and upkeep of the plant and equipment of the mine. (2) Although the term of the existing coal sales agreement terminates in 2007, the term may be extended for six (6) additional periods of five years, or until 2037, at the option of The Coteau Properties Company. (3) The amount represents the total (100%) of the 1994 joint venture tonnage.\nUnder terms of a lignite mining agreement entered into in 1985 with Utility Fuels, Inc. (\"UFI\"), a subsidiary of Houston Industries Incorporated, North American Coal has been retained to design, develop, construct and operate the proposed Trinity Mine in the Malakoff-Cayuga reserves near Malakoff, Texas. The Trinity Mine was expected to produce from 4.5 to 6.5 million tons of lignite annually. After several delays, however, the proposed Malakoff Generating Station was cancelled in July, 1994. North American Coal and its wholly-owned subsidiary, North American Coal Royalty Company (\"Royalty Company\"), have received certain management fees, minimum royalties and other payments in connection with the future development of the Trinity Mine project. In December 1992 the Lignite Lease and Sublease Agreement under which the minimum royalties were received was amended. The parties agreed that, in light of the delayed development of this mining project, effective January 1, 1993 UFI was no longer obligated to pay minimum royalties to Royalty Company. Termination of this obligation reduces North American Coal's annual net income approximately $2.4 million, after tax. Under the original agreement, these minimum royalty payments would have terminated at the end of the year 2005.\nGovernment Regulation ---------------------\nNorth American Coal, in common with other coal producers, continues to be subject to Federal and state health, safety and environmental regulations. The 1995 expenditures which will be required for compliance with the provisions of governmental regulations, including mined land reclamation and other air and water pollution abatement requirements, are estimated at $1.2 million for certain closed mines and are included in Self-Insurance Reserves and Other in NACCO's Consolidated Financial Statements in this Annual Report on Form 10-K. The active operations are required to make certain additional capital expenditures to comply with such governmental regulations, which expenditures will be recovered under the terms of the coal sales agreements with the utility customers.\nNorth American Coal's management believes that the Clean Air Act Amendments, which became effective in 1990, will not have a material adverse effect on its current operations, because substantially all of the power generating facilities operated or supplied by North American Coal's customers meet or exceed the requirements of the Clean Air Act.\nThe Federal Energy Regulatory Commission (\"FERC\") issued Order 636, effective in May 1992, which requires gas pipeline companies to separate their gas sales and gas transportation functions. As a result of this Order, the nation's natural gas pipeline companies, including the four which purchase gas produced by the Great Plains Synfuels Plant (the\n\"Synfuels Plant\"), which is supplied by the company's Coteau mining subsidiary, have much less need for gas supply under contract and are actively seeking to restructure or terminate many supply contracts. The four (4) pipeline companies which purchase gas from the Synfuels Plant have reached a tentative settlement agreement with the plant's operator, Dakota Gasification Company (\"DGC\"), over the dispute regarding their gas purchase contracts. Under the settlement agreement, the pipeline companies will pay DGC market-based prices, plus a fixed monthly demand payment for seven years, for the gas. FERC must approve the settlement with each of the four (4) pipeline companies. In December 1994, FERC approved the settlement with one of the pipeline companies. The affected customers of the four pipelines have been unsuccessful to date in court challenges to the arrangements although several challenges are presently pending on rehearing. Based on regulatory and judicial consideration to date, it does not appear that continued operation of the Synfuels Plant and Coteau's supply of coal to the Plant will be adversely affected in the near future. Coteau sold approximately 6.5 million tons of lignite to the Synfuels Plant in 1994.\nCompetition -----------\nThe coal industry competes with other sources of energy, particularly oil, gas, hydro-electric power and nuclear power. Among the factors that affect competition are the price and availability of oil and natural gas, environmental considerations, the time and expenditures required to develop new energy sources, the cost of transportation, the cost of compliance with governmental regulation of operations, and the impact of federal energy policies. The ability of North American Coal to market and develop its reserves will depend upon the interaction of these factors.\nThere is no official source of information on the subject, but company management believes that North American Coal is the seventh largest commercial coal producer in the United States.\nEmployees ---------\nAs of February 28, 1995, North American Coal had approximately 880 employees.\nD. Kitchen Collection ------------------\nKitchen Collection(R) is a national specialty retailer of kitchenware, small electric appliances and related accessories which operated 119 retail stores as of February 28, 1995. Stores are located primarily in factory outlet complexes that feature merchandise of highly recognizable name-brand manufacturers. Kitchen Collection's product mix includes a broad line of appliances from leading manufacturers, including Hamilton Beach\/Proctor-Silex appliances.\nKitchen Collection introduced a new store format in 1994, named Hearthstone(TM). These stores carry a distinctive mix of merchandise for the entire home, with particular emphasis on gift items and home decor. The product mix and store design at Hearthstone are distinctively different from the traditional Kitchen Collection store. This market differentiation will allow the two store formats to coexist within the same market.\nKitchen Collection accounted for 1% of NACCO's assets and liabilities as of December 31, 1994, while its operations accounted for 3% and 4% of NACCO's revenues and operating profits, respectively, in 1994.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties -------------------\nA. NMHG ----\nThe following table summarizes certain information with respect to the principal manufacturing, distribution and office facilities owned or leased by NMHG.\nIn 1994, NMHG sold one of its facilities located in Danville, Illinois and is currently leasing back a portion of the facility for its Hyster marketing and sales operations.\nB. Hamilton Beach\/Proctor-Silex ----------------------------\nThe following table summarizes certain information with respect to the principal manufacturing, distribution and office facilities owned or leased by Hamilton Beach\/Proctor-Silex.\nSales offices are also leased in several cities in the United States and Canada.\nC. North American Coal -------------------\nNorth American Coal's proven and probable coal reserves and deposits (owned in fee or held under leases which generally remain in effect until exhaustion of the reserves if mining is in progress) are estimated at approximately 2.2 billion tons, approximately 81% of which are lignite deposits in North Dakota.\nReserves are estimates of quantities of coal, made by the company's geological and engineering staff, that are considered mineable in the future using existing operating methods. Developed reserves are those which have been allocated to mines which are in operation; all other reserves are classified as\nundeveloped. The table which follows gives detailed information as to North American Coal's in-place reserves as of December 31, 1994 for the mines listed under Item 1 \"North American Coal\" on page 11. The reserves of the South Hallsville No. 1 Mine, which are listed on page 11, are owned and controlled by the customer and, therefore, have not been listed in the following table. Additional information concerning North American Coal is set forth in Item 1 \"North American Coal\".\nD. Kitchen Collection ------------------\nKitchen Collection owns the building housing its corporate headquarters, a warehouse\/distribution facility and a retail store in Chillicothe, Ohio. It leases warehouse\/distribution facilities in Chillicothe, Ohio and the remainder of its retail stores. A typical store is approximately 3,300 square feet.\nItem 3.","section_3":"Item 3. Legal Proceedings --------------------------\nNeither the Company nor any of its subsidiaries is a party to any material pending legal proceeding other than ordinary routine litigation incidental to its respective business.\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 of the Company.\nItem 4A. Executive Officers of the Registrant ----------------------------------------------\nThe information under this Item is furnished pursuant to Instruction 3 to Items 401(b) and 401(c) of Regulation S-K.\nThe table on the following pages sets forth the name, age, current position and principal occupation and employment during the past five years of the Company's executive officers.\nPART II -------\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related ------------------------------------------------------------- Stockholder Matters -------------------\nNACCO Industries, Inc. Class A common stock is traded on the New York Stock Exchange. The ticker symbol is NC. Because of transfer restrictions, no trading market has developed, or is expected to develop, for the Company's Class B common stock. The Class B common stock is convertible into Class A common stock on a one-for-one basis. The high and low market prices for the Class A common stock and dividends per share for both classes of stock for the past two years are presented in the table below:\nAt December 31, 1994, there were approximately 900 Class A common stockholders of record and 600 Class B common stockholders of record.\nItem 6.","section_6":"Item 6. Selected Financial Data --------------------------------\nNACCO Industries, Inc. and Subsidiaries\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial ------------------------------------------------------------ Condition and Results of Operations ----------------------------------- (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nFINANCIAL SUMMARY\nIncome before extraordinary charge for 1994 was $45.3 million, or $5.06 per share, compared with income before extraordinary charge of $11.6 million, or $1.30 per share, in 1993. Extraordinary charges of $3.2 million and $3.3 million, net-of-tax, or $0.36 per share and $0.37 per share, were recognized in 1994 and 1993, respectively, resulting in net income of $42.1 million, or $4.70 per share in 1994 and $8.3 million or $0.93 per share in 1993. These extraordinary charges relate to the retirement of portions of NACCO Materials Handling Group's Hyster-Yale 12 3\/8% subordinated debentures and are discussed in more detail in Note B to the consolidated financial statements on page and in this discussion and analysis on page 38.\nIncome before extraordinary charge for 1992 was $22.9 million, or $2.57 per share. In 1992, an extraordinary charge of $110.0 million, or $12.37 per share, was recognized as a result of the Coal Industry Retiree Health Benefit Act of 1992. The 1992 extraordinary charge is discussed in more detail in Note B to the consolidated financial statements on page and in this discussion and analysis on page 53.\nSEGMENT INFORMATION\nNACCO Industries, Inc. (\"NACCO,\" the parent company) has four operating subsidiaries, The North American Coal Corporation (\"North American Coal\"), NACCO Materials Handling Group, Inc. (\"NMHG\"), Hamilton Beach\/Proctor-Silex, Inc. (\"Hamilton Beach\/ Proctor-Silex\"), and The Kitchen Collection, Inc. (\"Kitchen Collection\"). These four subsidiaries function in distinct business environments, and the results of operations and financial condition are best discussed at the subsidiary level. Results by segment as reported in the financial statements are summarized in Note P to the consolidated financial statements on page of this annual report.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNORTH AMERICAN COAL\nNorth American Coal mines and markets lignite for use primarily as fuel for power generation by electric utilities. The lignite is surface mined in North Dakota, Texas and Louisiana. Total coal reserves approximate 2.2 billion tons, with 1.4 billion tons committed to electric utility customers pursuant to long-term contracts.\nFINANCIAL REVIEW\nNorth American Coal's three project mining subsidiaries (Coteau, Falkirk and Sabine) mine lignite for utility customers pursuant to long-term contracts at a price based on actual cost plus an agreed pretax profit per ton. Due to the cost-plus nature of these contracts, revenues and operating profits are impacted by increases and decreases in operating costs as well as sales tons. Net income of these project mines, however, is not significantly affected by changes in such operating costs. These operating costs include costs of operations, interest expense and certain other income and expense items. Because of the nature of the contracts at these mines, their results are best analyzed in terms of income before taxes and net income.\nNorth American Coal s results have been adjusted to include certain royalty and other payments previously classified with Bellaire, a non- operating subsidiary of NACCO, that are more appropriately classified with North American Coal.\nTons sold by North American Coal's four operating mines were as follows for the year ended December 31:\nRevenues, income before taxes, provision for taxes and net income were as follows for the year ended December 31:\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nFINANCIAL REVIEW - Continued\nNORTH AMERICAN COAL\n1994 Compared with 1993\nThe following schedule details the components of the changes in revenues, income before taxes and net income for 1994 compared with 1993:\nIncreases in customer demand due to higher customer fuel requirements resulted in increased tonnage volume at Coteau and Red River. In 1993, Falkirk's customer purchased additional tonnage for purposes of increasing the stockpile at the generating station which resulted in unfavorable tonnage volume in 1994 compared with 1993. At Red River, tons sold in excess of amounts specified in the contract yield a lower price, resulting in an unfavorable sales mix in 1994.\nThe increased tonnage at Red River resulted in volume efficiencies that favorably impacted operating costs. The increase in royalties and other income in 1994 is from royalties received relating to former coal properties, which royalties were not received in 1993.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNORTH AMERICAN COAL - Continued\nFINANCIAL REVIEW - Continued\n1993 Compared with 1992\nThe following schedule details the components of the changes in revenues, income before taxes and net income for 1993 compared with 1992:\nThe increase in revenues due to pass-through costs at Coteau primarily related to increased interest expense of $5.8 million. The loss of the minimum royalty payments (see \"Other\" which follows) related to Royalty Company reduced revenues and operating profit by approximately $3.6 million.\nOTHER INCOME AND EXPENSE\nBelow is a detail of other income (expense) for the year ended December 31:\nPROVISION FOR INCOME TAXES\nNorth American Coal's effective tax rate for 1994, 1993 and 1992 was 31.1 percent, 37.9 percent and 28.7 percent, respectively. In the third quarter of 1993, North American Coal recognized additional tax expense to reflect the impact on their deferred tax balances of the one percent increase in the statutory tax rate. This adjustment increased North American Coal's effective tax rate in 1993 relative to 1994 and 1992.\nOTHER\nIn December 1992, North American Coal Royalty Company (\"Royalty Company\"), a wholly owned subsidiary of North American Coal, and a public utility company agreed to amend an existing Lignite Lease and Sublease Agreement. The parties agreed, in light of the delayed development of the mining project to which such leases were assigned, the utility was no longer obligated to pay Royalty Company minimum royalties beginning January 1, 1993. These royalties amounted to approximately $3.6 million per year and termination of these payments reduced North American Coal's annual net income approximately $2.4 million, after tax, beginning in 1993.\nRESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNORTH AMERICAN COAL - Continued\nFINANCIAL REVIEW - Continued\n1995 OUTLOOK\nNorth American Coal's existing mines are expected to produce about the same number of total tons in 1995 as in 1994, as customer requirements appear level with the previous year. Several events have, however, occurred during 1994 which will provide for future growth at North American Coal. In the company's first venture outside of coal, a mining services contract was signed in December 1994 with White Rock Quarries near Miami, Florida, which produces limestone. North American Coal has contracted to provide mining services on the limestone reserves owned by White Rock. The project will begin generating revenues in 1996. In June 1994, Coteau amended the coal sales agreement with its customer, which gives Coteau the option to extend its contract for up to an additional 30 years, through 2037. This contract amendment was signed in exchange for reduced profits of approximately $1.0 million per year for ten years beginning in 1994. North American Coal is continuing its contract negotiations relating to a contract mining agreement for the Salt River Project in western New Mexico, and is continuing to look for other growth opportunities.\nLIQUIDITY AND CAPITAL RESOURCES\nNorth American Coal has in place a $50.0 million revolving credit facility. The expiration date of this facility (which currently is September 1997) can be extended one additional year, on an annual basis, upon the mutual consent of North American Coal and the bank group. North American Coal had $35.0 million of its revolving credit facility available at December 31, 1994.\nThe financing of the project mining subsidiaries, which is guaranteed by the utility customers, comprises long-term equipment leases, notes payable and non-interest-bearing advances from customers. The obligations of the project mining subsidiaries do not impact the short- or long-term liquidity of the company and are without recourse to NACCO or North American Coal. These arrangements allow the project mining subsidiaries to pay dividends in amounts equal to their retained earnings.\nExpenditures for property, plant and equipment by the project mining subsidiaries were $11.7 million in 1994 and $23.0 million in 1993, and are anticipated to be approximately $15.0 million in 1995. These expenditures relate to the development and improvement of the project mining subsidiaries' mines and are financed by the utility customers.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO MATERIALS HANDLING GROUP\nNACCO Materials Handling Group, 97 percent-owned by NACCO, designs, manufactures and markets forklift trucks and related service parts under the Hyster(R) and Yale(R) brand names.\nFINANCIAL REVIEW\nThe results of operations for NMHG were as follows for the year ended December 31:\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO MATERIALS HANDLING GROUP--Continued\nFINANCIAL REVIEW--Continued\n1994 Compared With 1993\nThe following schedule details the components of the changes in revenues, operating profit and net income (loss) for 1994 compared with 1993:\nRecord market size in North America and higher market shares in both the Americas and Europe resulted in record lift truck unit volume of 55,751 units at NMHG in 1994. Unit shipments were up approximately 25 percent and 30 percent in the Americas and in Europe, respectively. NMHG initiated modest price increases during the middle of 1994 which were accepted in the marketplace, favorably affecting operating results. The strong economy in North America and new marketing programs and new dealers in Europe improved the worldwide service parts business. During 1994, a weaker U.S. dollar caused translated revenues to be higher compared with 1993, while operating profit was adversely affected by the strong Japanese yen which increased the cost of products sourced from Japan.\nThe improvement in manufacturing cost is due to the favorable effect of increased manufacturing throughput partially offset by plant ramp-ups and vendor parts shortages which caused labor inefficiencies. Other operating expense increased in 1994 compared with 1993 due to higher costs associated with strategic marketing and product development programs, increased incentive-based payroll costs and additional warranty expenditures related to new products and increased volumes. The investments in strategic programs are expected to plateau in the next two years.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO MATERIALS HANDLING GROUP--Continued\nFINANCIAL REVIEW--Continued\n1993 COMPARED WITH 1992\nThe following schedule details the components of the changes in revenues, operating profit and net income (loss) for 1993 compared with 1992:\nImproved economic conditions in North America, partially offset by continued weakness in most of Europe and Japan, resulted in increased unit volume in 1993. While continued discounting prevented significant price improvements in 1993 in the forklift industry, pricing in North America and Europe was favorable when compared with 1992. Although sales mix changes to higher-priced products in both North America and Europe during 1993 had a favorable impact on revenues, the impact on operating profit was not proportionate because mix shifted to lower-margin products. NMHG also realized improved global market share in 1993.\nService parts business continued to recover in North America with higher volumes and sales of higher-margin service parts resulting in a favorable impact on revenues and operating profit during 1993. Higher revenues from the North American service parts business were partially offset by weak European markets. Favorable mix, however, reduced the impact of lower European volume on operating profit from the service parts business in 1993.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO MATERIALS HANDLING GROUP--Continued\nFINANCIAL REVIEW--Continued\n1993 Compared With 1992--Continued\nManufacturing costs were higher in 1993 compared with 1992 primarily as a result of start-up costs associated with new product introductions and unfavorable fixed manufacturing cost variances due to the lower level of production volume in Europe. A weaker British pound sterling in 1993 compared with 1992 resulted in lower translated sales and profits in Europe. In addition, a stronger Japanese yen in 1993 adversely affected operating profit because it increased the cost of products and parts sourced from Japan.\nOTHER INCOME AND EXPENSE\nBelow is a detail of other income (expense) for the year ended December 31:\nThe decrease in interest income in 1993 compared with 1992 is due primarily to lower levels of excess cash available for investment.\nThe debt restructurings and equity infusions in 1994 and 1993 reduced outstanding debt and lowered overall effective interest rates resulting in reduced interest expense in 1994 compared with 1993, and in 1993 compared with 1992 (see the \"Extraordinary Charge\" discussion which follows).\nOther-net consists primarily of equity in the earnings of the Sumitomo-Yale 50 percent-owned joint venture (\"S-Y\"), gains and losses on the sale of assets and grant income. In 1994, other-net included income of $0.5 million from S-Y compared with a loss of $3.9 million in 1993. The improved results at S-Y in 1994 are due to elevated sales volumes to NMHG and manufacturing cost reductions. The significant loss at S-Y in 1993 was caused by the increase in the value of the Japanese yen compared with other global currencies and the depressed European and Japanese markets. During, 1994 NMHG received $3.2 million of employment grant income related to additional hiring at the Craigavon, Northern Ireland, facility. During the second quarter of 1993, NMHG sold its former manufacturing site in Wednesfield, England, for $3.3 million, resulting in a net pretax gain of $2.1 million. During 1992, NMHG experienced sizable foreign currency exchange gains due to the decrease in the value of the British pound sterling compared with other currencies which have not been repeated.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO MATERIALS HANDLING GROUP--Continued\nFINANCIAL REVIEW--Continued\nPROVISION FOR INCOME TAXES\nNMHG's effective tax rate for 1994 was 47.7 percent. For 1993, the effective tax rate was not meaningful because expenses not deductible for tax purposes, primarily amortization of goodwill, resulted in a tax provision in 1993 despite a loss before income taxes. The higher level of pretax income in 1994 reduced the effect of these non-deductible expenses and resulted in an effective tax rate that is closer to the statutory tax rate. Also in 1993, NMHG began providing for U.S. taxes on foreign earnings taxed at overall lower rates in anticipation of future repatriations.\nIn 1992 the effective tax rate was 70.7 percent. The high effective tax rate in 1992 was due to the low level of pretax income in that year relative to the expenses not deductible for tax purposes.\nEXTRAORDINARY CHARGE\nThe extraordinary charges of $3.2 million and $3.3 million, net of $2.0 million in tax benefits, were recognized in the second quarters of 1994 and 1993, respectively. These charges represent the write-off of premiums and unamortized debt issuance costs associated with the retirement of approximately $70.0 million and $50.0 million face value of NACCO Materials Handling Group s Hyster-Yale 12 3\/8% subordinated debentures. These retirements were achieved using internally generated funds of NMHG and equity infusions from existing stockholders. Refer to Note G, Revolving Credit Agreements and Notes Payable, for additional information.\nBACKLOG\nNMHG's backlog of orders at December 31, 1994, was approximately 24,600 forklift truck units, compared with 12,100 units at December 31, 1993 and 1992. The increased order demand in 1994 and, to a lesser degree, vendor part shortages have extended delivery lead times and resulted in expanded backlog in 1994. Management believes that the NMHG backlog level is consistent with overall increases in industry backlog levels.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO MATERIALS HANDLING GROUP--Continued\n1995 OUTLOOK\nThe forklift truck industry has historically been cyclical. The economic conditions in the various markets in which the industry customers operate affect demand. Based on external economic forecasts and recent factory order levels, management expects economic activity in North America to continue to be strong in 1995. Europe has begun to recover from its recent recession and an expanded European market is anticipated in 1995. Many markets in the Asia-Pacific will continue to grow. The Japanese market is expected to show signs of improvement in 1995. Overall, NMHG anticipates increased shipments in 1995 compared with 1994.\nNMHG will introduce several new products in 1995 and will continue its efforts to increase worldwide market shares. Management is focused on alleviating manufacturing bottlenecks to improve the output of its plants and reduce delivery lead times. While NMHG does source certain product from Japan, management does not expect the recent earthquake, which did not damage S-Y's manufacturing facility, to have a material adverse affect on the company's supply of manufacturing materials. In addition, the recent floods in The Netherlands did not damage NMHG's facility in Nijmegen or seriously interrupt the plant s supply lines.\nLIQUIDITY AND CAPITAL RESOURCES\nIn connection with the 1994 retirement of subordinated debentures, NMHG further amended its existing senior bank credit agreement during the second quarter of 1994 to permit the accelerated use of $25.0 million to retire additional debentures. These funds were used to call additional debentures in December 1994.\nNMHG had available $67.0 million of its $100.0 million revolving credit facility at December 31, 1994. On February 28,1995, the company entered into a new long-term credit agreement to replace its existing bank agreement and to refinance the majority of its existing long-term debt. The new agreement provides the company with an unsecured $350.0 million revolving credit facility to replace its current senior credit facility. The new credit facility has a five-year maturity with extension options and performance-based pricing comparable to its current senior credit facility which provides the company with reduced interest rates upon achievement of certain financial performance targets. With the new credit agreement in place, the company has the ability to call the remaining $78.5 million outstanding Hyster-Yale 12 3\/8% subordinated debentures in 1995. In anticipation of the call, an extraordinary charge of $3.4 million will be recorded in the first quarter of 1995 to write-off unamortized debt issuance costs and anticipated premiums. The company believes it can adequately meet all of its current and long-term commitments and operating needs from operating cash flow and funds available under credit agreements.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO MATERIALS HANDLING GROUP--Continued\nLIQUIDITY AND CAPITAL RESOURCES--Continued\nExpenditures for property, plant and equipment were $25.9 million in 1994 and $20.2 million in 1993, and are anticipated to be approximately $40.0 million in 1995. These expenditures relate to investments in productive capacity because of the increased unit volumes, and new product development. NMHG is investing to improve production volumes at all of its plants and has undertaken expansion of its Craigavon, Northern Ireland, and Irvine, Scotland, production facilities. Capital for these expenditures has been and is expected to be provided primarily by internally generated funds and government assistance grants.\nDuring 1993, NMHG repatriated $18.3 million of earnings from certain foreign subsidiaries, which were used in operations. Taxes associated with these earnings were previously provided for financial reporting purposes. Future repatriations of foreign earnings may be affected by changes in currency exchange rates and foreign and U.S. tax rates.\nNMHG s capital expenditures in 1994, 1993 and 1992 of $25.9 million, $20.2 million and $24.3 million, respectively, are outpacing depreciation expense of $19.8 million in 1994, $18.9 million in 1993 and $19.1 million in 1992.\nNMHG s capital structure has improved with substantially less debt and is as follows for the year ended December 31:\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nHAMILTON BEACH PROCTOR-SILEX\nHamilton Beach\/Proctor-Silex, 80 percent-owned by NACCO, is a leading manufacturer of small electric appliances. The housewares business is seasonal. A majority of revenues and operating profit occurs in the second half of the year when sales of small electric appliances increase significantly for the fall holiday selling season.\nFINANCIAL REVIEW\nThe results of operations for Hamilton Beach\/Proctor-Silex were as follows for the year ended December 31:\n1994 COMPARED WITH 1993\nThe following schedule details the components of the changes in revenues, operating profit and net income (loss) for 1994 compared with 1993:\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nHAMILTON BEACH\/PROCTOR-SILEX--Continued\nFINANCIAL REVIEW--Continued\n1994 COMPARED WITH 1993--CONTINUED\nDuring 1994, Hamilton Beach\/Proctor-Silex experienced increased volumes in blenders, mixers, coffeemakers and food processors sold domestically and in most products sold in Canada. The increased volumes in these product lines were tempered somewhat by decreased steam grill and toaster sales domestically and lower toaster oven sales both domestically and in Canada. Contributing to the positive sales mix were increased sales of high-end toasters, irons and toaster ovens offset by a shift to lower-priced blender models. Hamilton Beach\/Proctor-Silex's improvements in pricing occurred in both the domestic and Canadian markets across most core heat and motor-driven product lines.\nThe successful completion of its manufacturing consolidation programs, level loading of its factories and reduced transportation costs favorably affected operating results at Hamilton Beach\/ Proctor-Silex by reducing manufacturing costs. Level loading maintains consistent production and staffing levels throughout the year, contributing favorably to manufacturing efficiencies by maintaining a more highly trained and experienced work force. Other operating expenses were unfavorable in 1994 compared with 1993 primarily due to higher selling and incentive compensation costs.\n1993 COMPARED WITH 1992\nThe following schedule details the components of the changes in revenues, operating profit and net income (loss) for 1993 compared with 1992:\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nHAMILTON BEACH\/PROCTOR-SILEX--Continued\nFINANCIAL REVIEW--Continued\n1993 COMPARED WITH 1992--Continued\nThe higher volume in 1993 was primarily the result of increased unit sales of coffeemakers, blenders, steam grills, food processors, toaster ovens and commercial roasters. A significant decrease in unit sales of juice extractors offset the increases in other product lines. The adverse sales mix in 1993 was the result of reduced juice extractor sales, which yielded improved margins in 1992, and a shift away from sales of full-size irons. In addition, the increased volume in blenders, food processors, toaster ovens and coffeemakers was primarily in opening price-point models. Foreign currency translation negatively influenced operating results in 1993 due to the drop in the value of the Canadian dollar in relation to the U.S. dollar. The increase in other operating expense in 1993 was primarily the result of higher marketing and selling costs.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nHAMILTON BEACH\/PROCTOR-SILEX--Continued\nFINANCIAL REVIEW--Continued\nOther Income and Expense\nBelow is a detail of other income (expense) for the year ended December 31:\nThe reduced interest expense in 1994 compared with 1993 is due to lower average interest rates partially offset by higher average borrowings. The reduction in interest expense in 1993 compared with 1992 was due to lower levels of borrowings.\nThe decrease in other-net in 1994 compared with 1993 resulted primarily from the settlement of certain litigation during 1993.\nPROVISION FOR INCOME TAXES\nHamilton Beach\/Proctor-Silex's effective tax rate for 1994 was 41.7 percent. The effective tax rate was not meaningful in 1993 and was 50.0 percent in 1992.\nExpenses not deductible for tax purposes, which include amortization of goodwill and other purchase price adjustments associated with the Hamilton Beach and Proctor-Silex acquisitions, were approximately level in 1994, 1993 and 1992. These non-deductible expenses resulted in a tax provision in 1993 despite break-even pretax earnings. Due to higher levels of pretax income in 1994 and 1992, relative to 1993, these non-deductible expenses had a smaller impact on the effective tax rate in 1994 and 1992.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nHAMILTON BEACH\/PROCTOR-SILEX--Continued\nFINANCIAL REVIEW--Continued\n1995 OUTLOOK\nHamilton Beach\/Proctor-Silex expects total industry unit shipments to be slightly higher in 1995 compared with 1994 in most core product lines. Management of Hamilton Beach<>Proctor-Silex expects increases in market share in its core products during 1995 as a result of new and redesigned products introduced during 1994 that should better meet consumer demand and increase product placements.\nLIQUIDITY AND CAPITAL RESOURCES\nHamilton Beach\/Proctor-Silex's credit agreement, as modified in May 1994, provides for a revolving credit facility (\"Facility\") that permits advances up to $135.0 million. At December 31, 1994, Hamilton Beach\/Proctor-Silex had $57.0 million available under this Facility. The expiration date of this Facility (which currently is May 1997) may be extended, on an annual basis, beginning in 1995 for one additional year upon the mutual consent of Hamilton Beach\/Proctor-Silex and the bank group. In conjunction with this modification, Hamilton Beach\/Proctor-Silex repaid the outstanding balance of its term note of $28.1 million in May 1994. At December 31, 1994, Hamilton Beach\/Proctor-Silex also had $0.4 million available under a separate facility.\nThe Facility, which is secured by substantially all assets of Hamilton Beach\/Proctor-Silex, allows borrowings to be made at either LIBOR or lender's prime rate plus a margin. At the date of modification the stated interest rate became LIBOR plus 1.00 percent compared with a stated interest rate at March 31 of LIBOR plus 1.75 percent. In addition, this modification allows Hamilton Beach\/Proctor-Silex to pay dividends, under certain conditions, to its stockholders. The borrowing rates can be reduced to as low as LIBOR plus 0.50 percent based upon achievement of predetermined interest coverage ratios. On July 15, 1994, Hamilton Beach\/ Proctor-Silex paid a $15.0 million dividend to its stockholders.\nExpenditures for property, plant and equipment were $13.4 million in 1994 and $12.2 million in 1993, and are anticipated to be approximately $12.8 million in 1995. The primary focus of these expenditures is to increase manufacturing efficiency and to acquire tooling for new and existing products. Capital for these expenditures has been and is expected to be provided primarily by internally generated funds and short-term borrowings.\nHamilton Beach\/Proctor-Silex's capital expenditures in 1994, 1993 and 1992 of $13.4 million, $12.2 million and $10.8 million, respectively, are outpacing depreciation expense of $11.5 million in 1994, $10.9 million in 1993 and $9.8 million in 1992.\nHamilton Beach\/Proctor-Silex's capital structure continues to be near its 35 percent target and is as follows for the year ended December 31:\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nKITCHEN COLLECTION\nKitchen Collection is a national specialty retailer of kitchenware, tableware, small electric appliances and related accessories. The specialty retail business is seasonal with the majority of its revenues and operating profit generated in the fourth quarter during the fall holiday selling season.\nFINANCIAL REVIEW\nThe results of operations for Kitchen Collection were as follows for the year ended December 31:\n1994 COMPARED WITH 1993\nThe following schedule details the components of the changes in revenues, operating profit and net income for 1994 compared with 1993:\nThe opening of 37 new stores in 1994 and 1993 contributed favorably to current year results. While gross profit showed a slight improvement in 1994 compared with 1993, operating profit as a percent of sales declined somewhat due primarily to store rent escalations and increased costs for renovations at comparable stores.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nTHE KITCHEN COLLECTION--Continued\nFINANCIAL REVIEW--Continued\n1993 Compared With 1992\nThe following schedule details the components of the changes in revenues, operating profit and net income for 1993 compared with 1992:\nKitchen Collection experienced mixed results during 1993. The net addition of 18 new stores during 1993 and a full year's operations of stores opened during 1992 resulted in increases to revenues and operating profits. Results at comparable stores were lower in 1993 compared with 1992 as the economic recovery did not impact specialty retailers. The use of markdowns on selected products to increase customer traffic and competitive pricing pressures on specific product lines negatively affected operating profit in 1993.\nOTHER INCOME AND EXPENSE\nInterest expense was $0.3 million, $0.1 million and $0.2 million in 1994, 1993 and 1992, respectively.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nTHE KITCHEN COLLECTION--Continued\nFINANCIAL REVIEW--Continued\nPROVISION FOR INCOME TAXES\nKitchen Collection's effective tax rate was 40.0 percent, 40.6 percent and 41.6 percent in 1994, 1993 and 1992, respectively.\nLIQUIDITY AND CAPITAL RESOURCES\nIn May, 1994, Kitchen Collection modified its credit arrangement to allow for an increase in the outstanding balance on its term loan to $5.0 million. At December 31, 1994, the outstanding balance was $5.0 million. In addition, the scheduled repayments, which previously were in annual installments through 1997, are now payable in two equal installments due January 15, 1999, and January 15, 2000. This modification also reduced Kitchen Collection's stated interest rate to LIBOR plus 0.75 percent from LIBOR plus 1.50 percent and allows for increased levels of dividends. During 1994, Kitchen Collection paid dividends of $5.6 million to NACCO.\nExpenditures for property, plant and equipment were $1.0 million in 1994 and $1.1 million in 1993, and are anticipated to be approximately $1.9 million in 1995. These expenditures are primarily for new store openings and improvements to existing facilities and are funded internally. At December 31, 1994, Kitchen Collection had available all of its $2.5 million line of credit. This credit line is renewable annually in May and has currently been extended through May 1995.\nKitchen Collection's capital structure approaches its 35 percent target and is as follows for the year ended December 31:\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO AND OTHER\nFINANCIAL REVIEW\n1994 COMPARED WITH 1993\nThe following schedule details the components of the changes in operating loss and net loss for 1994 compared with 1993:\nWhile the level of parent company personnel remained steady in 1994 compared with 1993, payroll-related expenses increased in 1994 due to higher incentive-based compensation, profit sharing and medical expenses.\n1993 COMPARED WITH 1992\nThe following schedule details the components of the changes in operating loss and net loss for 1993 compared with 1992:\nINTEREST RATE PROTECTION\nNMHG, Hamilton Beach\/Proctor-Silex, North American Coal and Kitchen Collection have entered into interest rate swap agreements and\/or purchased interest rate caps for portions of their floating rate debt. These interest rate swaps and caps provide protection against significant increases in interest rates. The Company evaluates its exposure to floating rate debt on an ongoing basis.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO AND OTHER--Continued\nENVIRONMENTAL MATTERS\nThe Company's manufacturing operations, like those of other companies engaged in similar businesses, involve the use, disposal and cleanup of substances regulated under environmental protection laws. The Company's North American Coal subsidiary is affected by the regulations of agencies under which it operates, particularly the federal Office of Surface Mining, the United States Environmental Protection Agency and associated state regulatory authorities. In addition, North American Coal is attentive to any changes which may arise due to proposed legislation concerning the Clean Air Act Amendments of 1990, reauthorization of the Resource Conservation and Recovery Act, the Clean Water Act, the Endangered Species Act and other regulatory actions.\nCompliance with these increasingly stringent standards results in higher expenditures for both capital improvements and operating costs. The Company's policies stress environmental responsibility and compliance with these regulations. Based on current information, management does not expect compliance with these regulations to have a material adverse effect on its financial condition or results of operations.\nLIQUIDITY AND CAPITAL RESOURCES\nAlthough the subsidiaries have entered into substantial debt agreements, NACCO has not guaranteed the long-term debt or any borrowings of its subsidiaries.\nThe NMHG debt agreement includes loan covenants which prohibit the payment of dividends to NACCO. The debt agreements at Hamilton Beach\/Proctor-Silex and Kitchen Collection allow for the payment of dividends under certain circumstances. The revised credit agreement entered into on February 28, 1995 at NMHG will allow the transfer of up to $25.0 million to NACCO. There are no restrictions for North American Coal, and its dividends and advances are the primary source of cash for NACCO.\nThe Company believes it can adequately meet all of its current and long-term commitments and operating needs. This outlook stems from amounts available under revolving credit facilities, the substantial prepayment of scheduled debt payments and the utility customers' funding of the project mining subsidiaries.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued (Tabular Amounts in Millions, Except Per Share, Store and Percentage Data)\nNACCO AND OTHER--Continued\nBELLAIRE CORPORATION\nBellaire Corporation (\"Bellaire\") is a non-operating subsidiary of NACCO. Bellaire's results primarily include mine closing activities related to the Indian Head Mine which ceased mining operations in April 1992 when its sales contract expired due to the exhaustion of its economically recoverable coal reserves. Bellaire's results have been adjusted to remove certain royalty and other payments that are now more appropriately classified with North American Coal's results.\nThe results of operations were as follows for the year ended December 31:\nDuring the third quarter of 1993, Bellaire recognized a non-recurring tax benefit of $2.3 million to reflect the impact of the one percent increase in the statutory tax rate on its deferred tax asset. This tax benefit increased Bellaire s income in 1993 relative to 1994 and 1992.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION NACCO INDUSTRIES, INC. AND SUBSIDIARIES--Continued\nNACCO AND OTHER--Continued\nBELLAIRE CORPORATION--Continued\nThe Coal Industry Retiree Health Benefit Act of 1992 requires Bellaire to incur additional costs for retiree medical expenses of certain United Mine Worker retirees. A charge of $110.0 million (net of $56.7 million of tax benefits) was recognized in 1992 to reflect the estimated future payments related to this legislation. Annual cash payments required by this legislation are expected to be in the range of $2.0 million to $4.0 million per year after tax. These payments could continue as long as 40 to 50 years, or as long as there are eligible participants. Payments in 1994 amounted to $4.6 million before-tax and included payments for 1994 and 1993. Management expects taxable earnings to continue to be sufficient to realize the full amount of the related deferred tax asset.\nThe condensed balance sheets for Bellaire were as follows at December 31:\nThe assets and liabilities of Bellaire represent the net assets of former mining operations, including Indian Head. The Obligation to United Mine Workers of America Combined Benefit Fund relates to the previously discussed extraordinary charge. The deferred taxes relate to the Obligation to United Mine Workers of America Combined Benefit Fund. The other liabilities are obligations related to other former mining operations.\nThe annual cash payments related to Bellaire's obligations, net of internally generated funds, are funded by NACCO and amounted to $4.7 million before-tax during 1994 and are anticipated to be approximately $3.9 million before-tax in 1995.\nEFFECTS OF INFLATION\nThe Company believes that inflation has not materially affected its results of operations in 1994 and does not expect inflation to be a significant item in 1995.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data --------------------------------------------------------\nThe information required by this Item 8 is set forth at pages through of the Financial Statements and Supplementary Data contained in Part IV 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 ------------------------------------------------------------\nInformation with respect to Directors of the Company is set forth in the 1995 Proxy Statement under the heading \"Business to be Transacted -- 1. Election of Directors,\" which information is incorporated herein by reference. Information regarding the executive officers of the Company is included as Item 4A of Part I as permitted by Instruction 3 to Item 401(b) of Regulation S-K.\nItem 11.","section_11":"Item 11. Executive Compensation --------------------------------\nInformation with respect to executive compensation is set forth in the 1995 Proxy Statement under the headings \"Business to be Transacted -- 1. Election of Directors -- Compensation of Directors,\" and \"Compensation of Executive Officers,\" which information is incorporated herein by reference.\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 set forth in the 1995 Proxy Statement under the heading \"Business to be Transacted -- 1. Election of Directors -- Beneficial Ownership of Class A Common and Class B Common,\" which information is incorporated herein 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 1995 Proxy Statement under the heading \"Business to be Transacted -- 1. Election of Directors -- Compensation Committee Interlocks and Insider Participation,\" 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) and (2) The response to Item 14(a)(1) and (2) is set forth beginning at page of this Annual Report on Form 10-K.\n(a) (3) Listing of Exhibits -- See the exhibit index beginning at page X-1 of this Annual Report on Form 10-K.\n(b) The Company has not filed any current reports on Form 8-K during the fourth quarter of 1994.\n(c) The response to Item 14(c) is set forth beginning at page X-1 of this Annual Report on Form 10-K.\n(d) Financial Statement Schedules -- The response to Item 14(d) is set forth beginning at page of this Annual Report on Form 10-K.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNACCO Industries, Inc.\nBy: Frank B. O'Brien ----------------------------------- Frank B. O'Brien Senior Vice President - Corporate Development and Chief Financial Officer (Principal Financial Officer)\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.\n*Frank B. O'Brien, by signing his name hereto, does hereby sign this Annual Report on Form 10-K on behalf of each of the above named and designated officers and directors of the Company pursuant to a Power of Attorney executed by such persons and filed with the Securities and Exchange Commission.\nFrank B. O'Brien March 31, 1995 ------------------------------------- Frank B. O'Brien, Attorney-in-Fact\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 AND FINANCIAL STATEMENT SCHEDULES\nFINANCIAL STATEMENTS\nFINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1994\nNACCO INDUSTRIES, INC.\nMAYFIELD HEIGHTS, OHIO\nForm 10-K\nITEM 14(a)(1) AND (2)\nNACCO INDUSTRIES, INC. AND SUBSIDIARIES\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of NACCO Industries, Inc. and Subsidiaries are included in Item 8:\nReport of Independent Public Accountants-Year ended December 31, 1994, 1993 and 1992\nConsolidated statements of income-Year ended December 31, 1994, 1993 and 1992.\nConsolidated balance sheets-December 31, 1994 and December 31, 1993.\nConsolidated statements of cash flows-Year ended December 31, 1994, 1993 and 1992.\nConsolidated statements of stockholders' equity-Year ended December 31, 1994, 1993 and 1992.\nNotes to consolidated financial statements.\nNACCO Industries, Inc. Report of Management.\nThe following consolidated financial statement schedules of NACCO Industries, Inc. and Subsidiaries are included in Item 14(d):\nSchedule I Condensed Financial Information of the Parent\nSchedule II Valuation and qualifying accounts\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of NACCO Industries, Inc.:\nWe have audited the accompanying consolidated balance sheets of NACCO Industries, 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. 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 NACCO Industries, 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.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in Item 14(a)(1) and (2) and Item 14(d) of Form 10-K are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic 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 Cleveland, Ohio February 28, 1995\nCONSOLIDATED BALANCE SHEETS\nNACCO INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nNACCO INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nNACCO INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS NACCO INDUSTRIES, INC. AND SUBSIDIARIES (Tabular Dollars in Millions, Except Per Share and Percentage Data)\nNOTE A--ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of NACCO Industries, Inc. (\"NACCO,\" the parent company) and its majority owned subsidiaries (NACCO Industries, Inc. and Subsidiaries - the \"Company\"). Intercompany accounts and transactions are eliminated.\nCASH AND CASH EQUIVALENTS: Cash and cash equivalents include cash in banks and highly liquid investments with original maturities of three months or less.\nINVENTORIES: Inventories are stated at the lower of cost or market. Cost is determined under the last-in, first-out (LIFO) method for manufacturing inventories in the United States and under the first-in, first-out (FIFO) method with respect to all other inventories.\nPROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are recorded at cost. Depreciation, depletion and amortization are provided in amounts sufficient to amortize the cost of the assets (including assets recorded under capital leases) over their estimated useful lives using the straight- line method. The units-of-production method is used to amortize certain coal-related assets based on estimated recoverable tonnages.\nGOODWILL: Goodwill represents the excess purchase price paid over the fair value of the net assets acquired. The amortization of goodwill is determined on a straight-line basis over a 40-year period. Management regularly evaluates its accounting for goodwill considering such factors as historical and future profitability and believes that the asset is realizable and the amortization period remains appropriate.\nDEFERRED FINANCING COSTS: Amortization of the costs related to manufacturing assets is calculated utilizing the interest method over the term of the related indebtedness. The costs incurred related to the coal assets are amortized utilizing the units-of-production method. Amortization of these costs is included in interest expense on the Company's consolidated statements of income.\nPRODUCT DEVELOPMENT COSTS: Expenses associated with the development of new products and changes to existing products are charged to expense as incurred. These costs amounted to $25.9 million, $23.4 million and $24.4 million in 1994, 1993 and 1992, respectively.\nCOMMON STOCK: The Class A common stock has one vote per share and the Class B common stock has 10 votes per share. The total number of authorized shares of Class A common stock and Class B common stock at December 31, 1994, was 25,000,000 shares and 6,756,176 shares, respectively. Treasury shares of Class A stock totalling 832,122 and 840,564 at December 31, 1994 and 1993, respectively, have been deducted from shares outstanding.\nFOREIGN CURRENCY: The financial statements of the Company's foreign operations are translated into U.S. dollars at year-end exchange rates for assets and liabilities, and at weighted average exchange rates during the year for revenues and expenses. The effect of changes in foreign exchange rates applied to these foreign financial statements is included as a separate component of stockholders' equity.\nNOTE A--ACCOUNTING POLICIES--Continued\nFINANCIAL INSTRUMENTS AND DERIVATIVE FINANCIAL INSTRUMENTS: The fair values of financial instruments have been determined through information obtained from quoted market sources and management estimates. The Company does not hold or issue financial instruments or derivative financial instruments for trading purposes. The Company enters into forward foreign exchange contracts with terms of one-to-twelve months. These contracts hedge certain foreign currency denominated receivables and payables and foreign currency commitments. Gains and losses on these contracts are deferred and recognized as part of the cost of the underlying transaction being hedged. The Company also enters into interest rate swap agreements with terms ranging from six months to five years. The differential between the floating interest rate and fixed interest rate which is to be paid or received is recognized in interest expense as the floating interest rate changes over the life of the agreement.\nEARNINGS PER SHARE: The calculation of net income per share is based on the weighted average number of shares outstanding during each period.\nRECLASSIFICATIONS: Certain amounts in the prior periods' consolidated financial statements have been reclassified to conform to the current period's presentation.\nNOTE B--EXTRAORDINARY CHARGE\n1994 AND 1993\nThe extraordinary charges of $3.2 million and $3.3 million, net of $2.0 million in tax benefits, were recognized in the second quarters of 1994 and 1993, respectively. These charges represent the write-off of premiums and unamortized debt issuance costs associated with the retirement of approximately $70.0 million and $50.0 million face value of NACCO Materials Handling Group s Hyster-Yale 12 3\/8% subordinated debentures. These retirements were achieved using internally generated funds of NMHG and equity infusions from existing stockholders.\nThe Coal Industry Retiree Health Benefit Act of 1992 requires Bellaire, a wholly-owned non-operating subsidiary of NACCO, to incur additional costs for retiree medical expenses of certain United Mine Worker retirees. A charge of $110.0 million (net of $56.7 million of tax benefits) was recognized in 1992 to reflect the estimated future payments related to this legislation. Annual cash payments required by this legislation are expected to be in the range of $2.0 million to $4.0 million per year after tax. These payments could continue as long as 40 to 50 years, or as long as there are eligible participants. Payments in 1994 amounted to $4.6 million and included payments for 1994 and 1993. Management expects taxable earnings to continue to be sufficient to realize the full amount of the related deferred tax asset.\nNOTE C--ACCOUNTS RECEIVABLE\nAllowances for doubtful accounts, returns, discounts and adjustments of $10.6 million and $11.1 million at December 31, 1994 and 1993, respectively, were deducted from accounts receivable.\nNOTE D--INVENTORIES\nInventories are summarized as follows:\nThe cost of manufacturing inventories has been determined by the LIFO method for 69% of such inventories at December 31, 1994 and 1993.\nNOTE E--PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment includes the following:\nTotal depreciation, depletion and amortization expense on property, plant and equipment was $63.2 million, $60.1 million and $53.6 million during 1994, 1993 and 1992, respectively.\nProven and probable coal reserves approximated 2.2 billion tons at December 31, 1994 and 1993.\nNOTE F--DEFERRED CHARGES\nAccumulated amortization of goodwill, patents and trademarks was $80.5 million and $66.4 million at December 31, 1994 and 1993, respectively. Total amortization expense of these items was $14.1 million, $14.3 million and $14.4 million during 1994, 1993 and 1992, respectively.\nTotal amortization expense of deferred financing costs was $3.0 million, $3.7 million and $4.0 million during 1994, 1993 and 1992, respectively.\nNOTE G--REVOLVING CREDIT AGREEMENTS AND NOTES PAYABLE\nNACCO has not guaranteed the long-term debt or any borrowings of its subsidiaries.\nREVOLVING CREDIT AGREEMENTS NACCO Materials Handling Group\nNMHG's credit agreement, as amended, provides for a term note and a revolving credit facility. The revolving credit facility permits advances and secured letters of credit to NMHG from time to time, up to an aggregate principal amount of $100.0 million. The following summarizes the revolving credit facility:\nIn connection with the 1994 retirement of subordinated debentures, NMHG further amended its existing senior bank credit agreement during the second quarter of 1994 to permit the accelerated use of $25.0 million to retire additional debentures. These funds were used to call additional debentures in December 1994.\nOn February 28, 1995, the company entered into a new long-term credit agreement to replace its existing bank agreement and to refinance the majority of its existing long-term debt. The new agreement provides the company with an unsecured $350.0 million revolving credit facility to replace its current senior credit facility. The new credit facility has a five year maturity with extension options and performance based pricing comparable to its current senior credit facility, which provides the company with reduced interest rates upon achievement of certain financial performance targets. With the new credit agreement in place, the company has the ability to call the remaining $78.5 million outstanding Hyster-Yale 12 3\/8% subordinated debentures in 1995. In anticipation of the call, an extraordinary charge of $3.4 million will be recorded in the first quarter of 1995 to write-off unamortized debt issuance costs and anticipated premiums.\nHAMILTON BEACH PROCTOR-SILEX\nHamilton Beach Proctor-Silex's credit agreement, as modified in May 1994, provides for a revolving credit facility (Facility) that permits advances up to $135.0 million. The following summarizes this Facility:\nAt December 31, 1994, Hamilton Beach Proctor-Silex had $78.0 million outstanding under this Facility, $70.0 million of which is classified as long- term because it is not expected to be repaid during 1995. The expiration date of this Facility (which currently is May 1997) may be extended, on an annual basis, beginning in 1995 for one additional year upon the mutual consent of Hamilton Beach Proctor-Silex and the bank group. In conjunction with this modification, Hamilton Beach Proctor-Silex repaid the outstanding balance of its term note of $28.1 million in May 1994. At December 31, 1994, Hamilton Beach Proctor-Silex also had $0.4 million available under a separate facility.\nNOTE G--REVOLVING CREDIT AGREEMENTS AND NOTES PAYABLE--Continued REVOLVING CREDIT AGREEMENTS--Continued\nThe Facility, which is secured by substantially all assets of Hamilton Beach Proctor-Silex, allows borrowings to be made at either LIBOR, or lender's prime rate plus a margin. At the date of modification, the stated interest rate became LIBOR plus 1.00%, compared with a stated interest rate at March 31 of LIBOR plus 1.75%. In addition, this modification allows Hamilton Beach Proctor-Silex to pay dividends, under certain conditions, to its stockholders. The borrowing rates can be reduced to as low as LIBOR plus 0.50% based upon achievement of predetermined interest coverage ratios. On July 15, 1994, Hamilton Beach Proctor-Silex paid a $15.0 million dividend to its stockholders.\nNORTH AMERICAN COAL\nNorth American Coal has in place a revolving credit facility summarized as follows:\nThe expiration date of this facility may be extended one additional year, on an annual basis, upon the mutual consent of North American Coal and the bank group.\nNOTES PAYABLE\nSubsidiary notes payable, less current maturities, consist of the following:\nNOTE G--REVOLVING CREDIT AGREEMENTS AND NOTES PAYABLE--Continued NOTES PAYABLE--Continued\nThe senior subordinated debentures are callable by NMHG prior to maturity at redemption prices (expressed as percentages of the principal amount) as follows: during the 12-month period beginning August 1, 1994; - 105.0 %; 1995 - 102.5%.\nThe maturities of the subsidiary notes payable for the next five years, including current maturities, are as follows:\nInterest paid was $44.0 million, $48.4 million and $54.4 million during 1994, 1993 and 1992, respectively.\nThe credit agreements for NMHG, Hamilton Beach Proctor-Silex, North American Coal and Kitchen Collection contain certain covenants and restrictions. Covenants require, among other things, maintenance of certain minimum amounts of net worth and certain specified ratios of working capital, debt to equity, interest coverage and fixed charge coverage. These ratios are calculated at the subsidiary level. Restrictions include limits on capital expenditures and dividends. At December 31, 1994, the subsidiaries were in compliance with all the covenants in their debt agreements.\nNOTE H--OBLIGATIONS OF PROJECT MINING SUBSIDIARIES\nNorth American Coal's project mining subsidiaries have entered into long-term contracts with various utility customers to provide lignite at a sales price based on cost plus a profit per ton. The utility customers have arranged and guaranteed the financing for the development and operation of these subsidiary mines. The obligations of these project mining subsidiaries included in the Company's consolidated balance sheets do not affect the short- or long-term liquidity of the company and are without recourse to NACCO or its North American Coal subsidiary.\nObligations of project mining subsidiaries, less current maturities, consist of the following at December 31:\nThe annual maturities of the promissory notes are: 1995 - $6.5 million; 1996 - $4.3 million; 1997 - $1.8 million; 1998 - $3.1 million; 1999 - $3.1 million; thereafter - $43.4 million. Advances from customers are used to develop, operate and provide for the ongoing working capital needs of certain project mining subsidiaries.\nNOTE H--OBLIGATIONS OF PROJECT MINING SUBSIDIARIES Continued\nInterest paid was $17.7 million, $17.5 million and $13.2 million during 1994, 1993 and 1992 respectively. Interest expense is included as part of the cost of coal which is passed through to the utility customers.\nThe project mining subsidiaries' lease obligations for mining equipment have the following future minimum lease payments at December 31, 1994:\nInterest expense and amortization in excess of annual lease payments are deferred and recognized in years when annual lease payments exceed interest expense and amortization.\nProject mining assets recorded under capital leases are included with property, plant and equipment and consist of the following at December 31:\nDuring 1994, 1993 and 1992, the project mining subsidiaries incurred capital lease obligations of $5.2 million, $22.4 million and $12.0 million, respectively, in connection with lease agreements to acquire plant and equipment.\nRental expense for all of the project mines' operating leases amounted to $0.2 million during 1994,1993 and 1992.\nThe above obligations are secured by substantially all owned assets of the respective project mining subsidiary and the assignment of all rights under its coal sales agreement.\nNOTE I--LEASE COMMITMENTS\nFuture minimum operating lease payments, excluding project mining subsidiaries, at December 31, 1994, are as follows:\nRental expense for all operating leases, excluding project mining subsidiaries, amounted to $16.9 million, $15.3 million and $13.7 million during 1994, 1993 and 1992, respectively.\nNOTE J--FINANCIAL INSTRUMENTS AND DERIVATIVE FINANCIAL INSTRUMENTS\nFINANCIAL INSTRUMENTS\nA financial instrument is cash or a contract that imposes an obligation to deliver, or conveys a right to receive, cash or another financial instrument. The fair value of financial instruments, except for NMHG's Hyster-Yale 12 3\/8% subordinated debentures, approximated carrying values at December 31, 1994. The fair value of the subordinated debentures was $82.5 million at December 31,1994, compared with the carrying value of $78.5 million.\nInterest Rate Derivatives\nThe Company's operating subsidiaries enter into interest rate swap agreements. The use of these allows these subsidiaries to enter into long-term credit agreements that have performance-based, floating rates of interest and then swap them into fixed rates, as opposed to entering into higher cost fixed-rate credit arrangements. These agreements are with major commercial banks; therefore, the risk of credit loss from nonperformance by the banks is minimal. The following table summarizes the notional amounts and related rates (including applicable margins) on interest rate swap agreements outstanding at December 31, 1994:\nNOTE J--FINANCIAL INSTRUMENTS AND DERIVATIVE FINANCIAL INSTRUMENTS--Continued\nFOREIGN CURRENCY DERIVATIVES\nNMHG and Hamilton Beach<>Proctor-Silex enter into forward foreign exchange contracts for purposes of hedging their exposure to foreign currency exchange rate fluctuations. These contracts are with major financial institutions. Therefore, the risk of credit loss from non-performance by these institutions is minimal. These contracts hedge primarily firm commitments and, to a lesser degree, forecasted commitments relating to cash flows associated with sales and purchases denominated in foreign currencies. The table below summarizes foreign exchange contracts outstanding as of December 31, 1994:\nNOTE K--CONTINGENCIES\nVarious legal proceedings and claims have been or may be asserted against NACCO and certain subsidiaries relating to the conduct of its business including product liability and environmental claims. These proceedings are incidental to their ordinary course of business. Management believes that it has meritorious defenses and will vigorously defend itself in these actions. Any costs that management estimates will be paid in these claims are accrued when the liability is considered probable and the amount can be reasonably estimated. Although the ultimate disposition of these proceedings is not presently determinable, management believes, after consultation with its General Counsel, the likelihood that material costs will be incurred in excess of accruals already recognized is remote.\nNMHG is subject to recourse or repurchase obligations under various financing arrangements for certain independently owned retail dealerships at December 31, 1994. Also, certain dealer loans are guaranteed by NMHG. When NMHG is the guarantor of the principal amount financed, a security interest is usually maintained in certain assets of parties for whom NMHG is guaranteeing debt. Total amounts subject to recourse or repurchase obligation at December 31, 1994, were $91.0 million. Losses anticipated under the terms of the recourse or repurchase obligations are not significant and have been provided for financial reporting purposes.\nNOTE L--STOCK OPTIONS\nThe 1975 and 1981 stock option plans as amended provide for the granting to officers and other key employees options to purchase Class A and Class B common stock of the Company at a price not less than the market value of such stock at the date of grant. Options become exercisable over a four-year period and expire 10 years from the date of the grant. At December 31, 1994, all stock options outstanding were exercisable. There were options for 80,701 Class A shares at December 31, 1994 and 1993, respectively, and 80,100 Class B shares at December 31, 1994 and 1993, respectively, available for grant under these plans. The Company does not, however, intend to issue any additional stock options. At December 31, 1994, there were options relating to Class A shares for 5,800 shares with an option price of $32.00 that were granted on January 12, 1989, and 25,000 shares at an option price of $35.56 granted on March 1, 1989.\nNOTE M--OTHER - NET\nItems included in other-net for the year ended December 31 are as follows:\nNOTE N--INCOME TAXES\nThe components of income before income taxes on a legal entity basis for the year ended December 31 are as follows:\nDomestic income before income taxes has been reduced by all of the amortization of goodwill and deferred financing costs, and substantially all interest expense.\nProvision for income taxes consists of the following for the year ended December 31:\nNOTE N--INCOME TAXES--Continued\nThe Company made income tax payments of $29.0 million, $16.3 million and $30.8 million during 1994, 1993 and 1992, respectively. During the same period, income tax refunds totaled $1.2 million, $5.1 million and $5.3 million, respectively.\nAt December 31, 1994, the Company had cumulative undistributed earnings at its foreign subsidiaries of $93.1 million. It is the Company's intention to reinvest $39.0 million of these undistributed earnings of its foreign subsidiaries and thereby indefinitely postpone their remittance. There has been no provision made for taxes, nor is it practicable to estimate the amount of taxes on the undistributed earnings which are reinvested indefinitely. The remaining undistributed earnings of $54.1 million can be remitted without a material charge to earnings.\nUpon remittance of earnings, certain foreign countries impose withholding taxes that are then available, subject to certain limitations, for use as credits against the Company's U.S. tax liability. The amount of withholding tax that would be payable upon remittance of the entire amount of undistributed earnings would approximate $5.7 million.\nA reconciliation of federal statutory and effective income tax for the year ended December 31 follows:\nNOTE N--INCOME TAXES--Continued\nA summary of the components of the net deferred tax asset (liability) in the Company's consolidated balance sheets at December 31 resulting from differences in the book and tax basis of assets and liabilities follows:\nThe Company and certain of its subsidiaries are currently under examination for federal and various state income tax returns. The Company has not been informed of any material assessment resulting from these examinations and will vigorously contest any material assessment. Management believes that any potential adjustment would not materially affect future earnings.\nNOTE O--RETIREMENT BENEFIT PLANS\nDefined Benefit Plans\nThe Company maintains various defined benefit pension plans covering its employees. These plans provide benefits based on years of service and average compensation during certain periods. The Company's policy is to make contributions to fund these plans within the range allowed by the applicable regulations. Contributions to the various plans were $6.9 million in 1994 and $5.2 million in 1993 and 1992. Plan assets consist primarily of publicly traded stocks, investment contracts and government and corporate bonds.\nSet forth below is a detail of consolidated worldwide net periodic pension expense and the assumptions used in accounting for the United States defined benefit plans for the year ended December 31. The United Kingdom plans used assumptions that are consistent with, but not identical to, those used by the United States plans.\nNOTE O--RETIREMENT BENEFIT PLANS--Continued\nThe following sets forth the funded status of the defined benefit plans and amounts recognized in the consolidated balance sheets at December 31:\nNOTE O--RETIREMENT BENEFIT PLANS--Continued\nDEFINED CONTRIBUTION PLANS NACCO and its subsidiaries have defined contribution plans for substantially all employees. For NACCO and certain subsidiaries, employee contributions are matched by the Company based on plan provisions. In addition, NACCO and certain other subsidiaries have profit sharing plans whereby the subsidiary's contribution is determined annually based on its operating results. Total contributions to these plans were $5.9 million in 1994, $5.5 million in 1993 and $4.6 million in 1992.\nRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT PLANS NACCO and certain of its subsidiaries have retirement health care and life insurance benefit plans. These plans provide benefits to pensioners and their survivors if they reach certain age and service requirements while working for NACCO or its subsidiaries. The amounts of expenses and liabilities related to these plans are not material.\nNOTE P--BUSINESS SEGMENTS\nThe Company has four operating subsidiaries. NMHG designs, manufactures and markets forklift trucks and related service parts under the Hyster(R) and Yale(R) brand names. Hamilton Beach-Proctor-Silex is a leading manufacturer of small electric appliances. North American Coal mines and markets lignite for use primarily as fuel in power generation by electric utilities. Kitchen Collection is a national specialty retailer of kitchenware and small electric appliances.\nSales between subsidiaries, which are minimal, are eliminated in consolidation. Information relating to the Company's operations at the subsidiary level is presented below. The results for North American Coal and Bellaire have been adjusted to reflect the reclassification of certain royalty and other payments previously classified with Bellaire that are more appropriately classified with North American Coal.\nNOTE P--BUSINESS SEGMENTS--Continued\nNOTE P--BUSINESS SEGMENTS--Continued\nNOTE P--BUSINESS SEGMENTS--Continued\nDATA BY GEOGRAPHIC AREA\nNACCO parent company expense reduced Americas operating profit by $9.9 million, $7.9 million and $8.2 million in 1994, 1993 and 1992, respectively. The Asia-Pacific category above does not include the operating results or assets of NMHG's 50% owned Japanese joint venture, Sumitomo-Yale, as it is accounted for using the equity method.\nNOTE Q--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nA summary of the unaudited quarterly results of operations for the year ended December 31 is as follows:\nNOTE Q--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)--Continued\nNOTE R--PARENT COMPANY CONDENSED BALANCE SHEETS\nThe condensed balance sheets of NACCO, the parent company, at December 31 are as follows:\nThe credit agreement at NMHG prohibits the transfer of assets to NACCO. The credit agreements at Hamilton Beach Proctor-Silex and Kitchen Collection allow the transfer of assets to NACCO under certain circumstances. The amount of NACCO s investment in NMHG, Hamilton Beach Proctor-Silex and Kitchen Collection that was restricted at December 31, 1994, totals approximately $400.8 million. The revised credit agreement at NMHG, see Note G--\"Revolving Credit Agreements and Notes Payable\" will allow the transfer of $25.0 million to NACCO. There are no restrictions on the transfer of assets from North American Coal and its dividends and advances are the primary source of cash for NACCO.\nNACCO INDUSTRIES, INC. REPORT OF MANAGEMENT\nTo the Stockholders of NACCO Industries, Inc.:\nThe management of NACCO Industries, Inc. is responsible for the preparation, content and integrity of the financial statements and related information contained within this report. The accompanying financial statements have been prepared in accordance with generally accepted accounting principles and include amounts that are based on informed judgments and estimates.\nThe Company's code of conduct, communicated throughout the organization, requires adherence to high ethical standards in the conduct of the Company s business.\nNACCO Industries, Inc. and each of its subsidiaries maintain a system of internal controls designed to provide reasonable assurance as to the protection of assets and the integrity of the financial statements. These systems are augmented by the selection of qualified financial management personnel. In addition, an internal audit function periodically assesses the internal controls.\nArthur Andersen LLP, independent certified public accountants, audits NACCO Industries, Inc. and its subsidiaries' financial statements. Its audits are conducted in accordance with generally accepted auditing standards and provide an objective and independent assessment that helps ensure fair presentation of the Company s operating results and financial position. The independent accountants have access to all financial records and related data of the Company, as well as to the minutes of stockholders' and directors' meetings.\nThe Audit Committee of the Board of Directors, composed of independent directors, meets regularly with the independent auditors and internal auditors to review the scope of their audit reports and to discuss any action to be taken. The independent auditors and the internal auditors have free and direct access to the Audit Committee. The Audit Committee also reviews the financial reporting process and accounting policies of NACCO Industries, Inc. and each of its subsidiaries.\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF THE PARENT NACCO INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO PARENT COMPANY FINANCIAL STATEMENTS For The Year Ended December 31, 1994, 1993 and 1992\nThe notes to consolidated financial statements, included elsewhere in this Form 10-K, are hereby incorporated by reference into these notes to parent company financial statements.\nNOTE A - LONG-TERM OBLIGATIONS AND GUARANTEES\nNACCO Industries, Inc. (\"NACCO\", the parent company) is a holding company which owns four operating subsidiaries. It is NACCO's policy not to guarantee the debt of such subsidiaries.\nNOTE B - CASH DIVIDENDS AND ADVANCES TO NACCO\nDividends received from the subsidiaries were $62.7 million in 1994 and $23.3 million in 1993 and 1992.\nNOTE C - CAPITAL CONTRIBUTIONS TO SUBSIDIARIES\nThe 1993 capital contribution to NMHG of $52.2 million includes the $26.7 million of cash contributed by NACCO to NMHG in 1993. In addition, NACCO contributed previously purchased Hyster-Yale 12 3\/8% debentures with a cost to NACCO of $25.5 million (face value of $23.7 million) to NMHG in 1993.\nNOTE D - UNRESTRICTED CASH\nThe amount of unrestricted cash available to NACCO, included in Investment in and advances from subsidiaries, net was $8.8 million at December 31, 1994.\nEXHIBIT INDEX\n(3) Articles of Incorporation and By-laws.\n(i) Restated Certificate of Incorporation of the Company is incorporated by reference to Exhibit 3(i) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n(ii) Restated By-laws of the Company are incorporated by reference to Exhibit 3(ii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n(4) Instruments defining the rights of security holders, including indentures.\n(i) The Company by this filing agrees, upon request, to file with the Securities and Exchange Commission the instruments defining the rights of holders of Long-Term debt of the Company and its subsidiaries where 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.\n(ii) The Mortgage and Security Agreement, dated April 8, 1976, between The Falkirk Mining Company (as Mortgagor) and Cooperative Power Association and United Power Association (collectively as Mortgagee) is incorporated by reference to Exhibit 4(ii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n(iii) Indenture, dated as of August 3, 1989, between the Company and United Trust Company of New York, Trustee, with respect to the 12-3\/8% Senior Subordinated Debentures due August 1, 1999 (the form of which Debenture is included in such Indenture) is incorporated herein by reference to Exhibit 4(ii) of the Hyster-Yale Materials Handling, Inc. (\"Hyster-Yale\") Annual Report on Form 10-K for the fiscal year ended December 31, 1989, Commission File Number 33-28812.\n(iv) Stockholders' Agreement, dated as of March 15, 1990, among the signatories thereto, the Company and Ameritrust Company National Association, as depository, is incorporated herein by reference to Exhibit 2 to the Schedule 13D filed on March 29, 1990 with respect to the Class B Common Stock, par value $1.00 per share, of NACCO Industries, Inc.\n(v) Amendment to Stockholders' Agreement, dated as of April 6, 1990, among the signatories thereto, the\nX-1 Company and Ameritrust Company National Association, as depository, is incorporated herein by reference to Exhibit 4 to the Amendment No. 1 of the Schedule 13D filed on April 11, 1990 with respect to the Class B Common Stock, par value $1.00 per share. of NACCO Industries, Inc.\n(vi) Amendment to Stockholders' Agreement, dated as of April 6, 1990, among the signatories thereto, the Company and Ameritrust Company National Association, as depository, is incorporated herein by reference to Exhibit 5 to the Amendment No. 1 of the Schedule 13D filed on April 11, 1990 with respect to the Class B Common Stock, par value $1.00 per share, of NACCO Industries, Inc.\n(vii) Amendment to Stockholders' Agreement, dated as of November 17, 1990, among the signatories thereto, the Company and Ameritrust Company National Association, as depository, is incorporated herein by reference to the Amendment No. 2 of the Schedule 13D filed on March 18, 1991 with respect to the Class B Common Stock, par value $1.00 per share, of NACCO Industries, Inc.\n(10) Material contracts.\n*(i) The NACCO Industries, Inc. 1975 Stock Option Plan (as amended and restated as of July 17, 1986) is incorporated herein by reference to Exhibit 10(i) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n*(ii) Form of Incentive Stock Option Agreement for incentive stock options granted before 1987 under The NACCO Industries, Inc. 1975 Stock Option Plan (as amended and restated as of July 17, 1986) is incorporated herein by reference to Exhibit 10(ii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n*(iii) Form of Incentive Stock Option Agreement for incentive stock options granted after 1986 under The NACCO Industries, Inc. 1975 Stock Option Plan (as amended and restated as of July 17, 1986) is incorporated herein by reference to Exhibit 10(iii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\nX-2 *(iv) Form of Non-Qualified Stock Option Agreement under The NACCO Industries, Inc., 1975 Stock Option Plan (as amended and restated as of July 17, 1986) is incorporated herein by reference to Exhibit 10(iv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n*(v) The NACCO Industries, Inc. 1981 Stock Option Plan (as amended and restated as of July 17, 1986) is incorporated herein by reference to Exhibit 10(v) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n*(vi) Form of Non-Qualified Stock Option Agreement under The NACCO Industries, Inc. 1981 Stock Option Plan (as amended and restated as of July 17, 1986) is incorporated herein by reference to Exhibit 10(vi) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n*(vii) Form of Incentive Stock Option Agreement for incentive stock options granted before 1987 under The NACCO Industries, Inc. 1981 Stock Option Plan (as amended and restated as of July 17, 1986) is incorporated herein by reference to Exhibit 10(vii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n*(viii) Form of Incentive Stock Option Agreement for incentive stock options granted after 1986 under The NACCO Industries, Inc. 1981 Stock Option Plan (as amended and restated as of July 17, 1986) is incorporated herein by reference to Exhibit 10(viii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n*(ix) The Retirement Benefit Plan for Alfred M. Rankin, Jr., effective as of January 1, 1994 is attached hereto as Exhibit 10 (ix).\n*(x) Amendment No. 1 to the Retirement Benefit Plan for Alfred M. Rankin, Jr., dated as of March 15, 1995, is attached hereto as Exhibit 10 (x).\n*(xi) The North American Coal Corporation Deferred Compensation Plan for Management Employees (formerly known as the NACCO Industries, Inc. Deferred Compensation Plan for Management Employees) dated\nX-3 December 1, 1989, is incorporated herein by reference to Exhibit 10(xiii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, Commission File Number 1-9172.\n*(xii) Instrument of Merger by and between North American Coal, Hamilton Beach\/Proctor-Silex and NACCO Materials Handling Group, Inc., effective as of December 31, 1994, relating to certain defined benefit plans, is attached hereto as Exhibit 10(xii).\n*(xiii) Amendment No. 3 to the NACCO Materials Handling Group, Inc. Cash Balance Plan, effective as of December 31, 1994, is incorporated herein by reference to Exhibit 10(ciii) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Commission File Number 33- 28812.\n*(xiv) Form of the North American Coal Annual Incentive Plan is attached hereto as Exhibit 10(xiv).\n(xv) Agreement of Merger, dated as of January 20, 1988, among NACCO Industries, Inc., Housewares Holding Company, WE-PS Merger, Inc. and WearEver-ProctorSilex, Inc., is incorporated herein by reference to pages 8 through 97 of Exhibit 2 to the Company's Current Report on Form 8-K, dated February 1, 1988, Commission File Number 1-9172.\n(xvi) Shareholders Agreement, dated January 20, 1988, among NACCO Industries, Inc. and the shareholders named therein is incorporated herein by reference to pages 98 through 108 of Exhibit 2 to the Company's Current Report on Form 8-K, dated February 1, 1988, Commission File Number 1-9172.\n*(xvii) Amendment No. 1 to the NACCO Industries, Inc. Deferred Compensation Plan for Management Employees, dated January 1, 1993, is incorporated by reference to Exhibit 10(xvii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n*(xviii) Amendment No. 1 to the Hyster-Yale Long-Term Incentive Compensation Plan, effective as of January 1, 1994, is incorporated herein by reference to Exhibit 10(lxxxviii) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Commission File Number 33-28812.\n(xix) Agreement and Plan of Merger, dated as of April 7, 1989, among NACCO Industries, Inc., Yale Materials\nX-4 Handling Corporation, Acquisition I, Esco Corporation, Hyster Company and Newesco, is incorporated herein by reference to Exhibit 2.1 to Hyster-Yale Materials Handling, Inc.'s Registration Statement on Form S-1 filed May 17, 1989 (Registration Statement Number 33-28812).\n(xx) Agreement and Plan of Merger, dated as of April 7, 1989, among NACCO Industries, Inc., Yale Materials Handling Corporation, Acquisition II, Hyster Company and Newesco, is incorporated herein by reference to Exhibit 2.2 to Hyster-Yale Materials Handling, Inc.'s Registration Statement on Form S-1 filed May 17, 1989 (Registration Statement Number 33-28812).\n*(xxi) Amendment No. 2 to the NACCO Materials Handling Group, Inc. Unfunded Benefit Plan (As Amended and Restated Effective October 1, 1994), effective as of January 1, 1995, is incorporated by reference to Exhibit 10(cvii) to Hyster- Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Commission File Number 33-28812.\n*(xxii) Instrument of Adoption and Merger for NACCO Industries, Inc. for the NACCO Materials Handling Group, Inc. Unfunded Benefit Plan (As Amended and Restated Effective October 1, 1994) dated December 30, 1994, is attached here to as Exhibit 10(xxii).\n*(xxiii) Instrument of Withdrawal and Transfer of Liabilities from The North American Coal Corporation Deferred Compensation Plan for Management Employees, effective as of December 31, 1994, is attached hereto as Exhibit 10(xxiii).\n*(xxiv) Amendment No. 4 to the NACCO Materials Handling Group, Inc. Profit Sharing Plan, dated as of November 30, 1994, is incorporated herein by reference to Exhibit 10(ci) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Commission File Number 33- 28812.\n*(xxv) The Hamilton Beach\/Proctor-Silex, Inc. Unfunded Benefit Plan (As Amended and Restated Effective as of January 1, 1995), is attached hereto as Exhibit 10(xxv).\n*(xxvi) Amendment No. 3 to the Hamilton Beach\/Proctor-Silex, Inc. Profit Sharing Retirement Plan, dated as of December 31, 1994, is attached hereto as Exhibit 10(xxvi).\nX-5 *(xxvii) Amendment No. 6 to The North American Coal Corporation Salaried Employees Pension Plan (As Amended and Restated as of January 1, 1989), effective December 31, 1994, is attached hereto as Exhibit 10(xxvii).\n*(xxviii) Instrument of Merger, Amendment and Transfer of Sponsorship of Benefit Plans, effective as of August 31, 1994, is attached hereto as Exhibit 10(xxviii).\n*(xxix) Amendment No. 1 to The Hamilton Beach\/Proctor-Silex, Inc. Unfunded Benefit Plan (As Amended and Restated Effective January 1, 1995), effective as of January 1, 1995, is attached hereto as Exhibit 10(xxix).\n*(xxx) Amendment No. 3 to The North American Coal Corporation Deferred Compensation Plan for Management Employees, effective as of January 1, 1995, is attached hereto as Exhibit 10(xxx).\n*(xxxi) Amendment No. 4 to The North American Coal Corporation Deferred Compensation Plan for Management Employees, effective April 1, 1995, is attached hereto as Exhibit 10(xxxi).\n*(xxxii) Amendment No. 5A to The North American Coal Corporation Salaried Employees Pension Plan, dated March 15, 1995, is attached hereto as Exhibit 10(xxxii).\n*(xxxiiii) Amendment No. 2A to The Hamilton Beach\/Proctor- Silex, Inc. Profit Sharing Retirement Plan, dated as of March 15, 1995, is attached hereto as Exhibit 10(xxxiii).\n*(xxxiv) Amendment No. 3 to The North American Coal Corporation Retirement Savings Plan (As Amended and Restated Effective as of January 1, 1993), dated as of November 30, 1994, is attached as Exhibit 10(xxxiv).\n*(xxxv) Amendment No. 5 to the NACCO Materials Handling Group, Inc. Profit Sharing Plan, dated March 15, 1995, is incorporated herein by reference to Exhibit 10(cii) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Commission File Number 33-28812.\n*(xxxvi) Amendment No. 2A to the NACCO Materials Handling Group, Inc. Cash Balance Plans,dated as of March 15, 1995, is incorporated herei by referene to Exhibit 10(cx) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Commission File Number 33-28812.\nX-6 (xxxvii)-(xlvii) Intentionally Left Blank\n(xlviii) Reorganization and Merger Agreement, dated as of October 11, 1990, among Housewares Holding Company, HB-PS Holding Company, Inc., Proctor-Silex, Inc., Precis [521] Ltd., Glen Electric, Ltd. and Hamilton Beach, Inc. is incorporated herein by reference to Exhibit 10(lv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172. The Company by this filing agrees, upon request, to file with the Securities and Exchange Commission any of the Exhibits and\/or Schedules to the Reorganization and Merger Agreement.\n(xlix) Shareholders Agreement, dated as of October 11, 1990, among Housewares Holding Company, HB-PS Holding Company, Inc., Precis [521] Ltd. and Hamilton Beach Inc. is incorporated herein by reference to Exhibit 10(lvi) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(l) Indemnity Agreement, dated as of October 11, 1990, among Hamilton Beach Inc., Glen Dimplex, Precis [521] Ltd. and Glen Electric, Ltd. is incorporated herein by reference to Exhibit 10(lvii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(li) Credit Agreement, dated as of October 11, 1990, among Hamilton Beach\/Proctor-Silex, Proctor-Silex Canada Inc. (\"Proctor-Silex Canada\"), Proctor-Silex S.A. de C.V. (\"PSM\"), the Lenders party thereto, The Chase Manhattan Bank (National Association), as United States agent for such Lenders (the United States Agent\"), and The Chase Manhattan Bank of Canada, as Canadian agent for such Lenders (the Canadian Agent\") is incorporated herein by reference to Exhibit 10(lviii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172. The Company by this filing agrees, upon request, to file with the Securities and Exchange Commission any of the Exhibits and\/or Schedules to the Credit Agreement.\n(lii) First Amendment to the Credit Agreement, dated as of December 31, 1990, among Hamilton Beach\/Proctor-Silex, Proctor-Silex Canada, PSM, the Lenders party thereto, the United States Agent, and the Canadian Agent is incorporated herein by reference to Exhibit 10(lvix) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\nX-7 (liii) Second Amendment to the Credit Agreement, dated as of March 1, 1991, among Hamilton Beach\/Proctor-Silex, Proctor-Silex Canada, PSM, the Lenders party thereto, the United States Agent and the Canadian Agent is incorporated herein by reference to Exhibit 10(lx) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(liv) Pledge Agreement re: 66% Pledge of PSC Stock, dated as of October 11, 1990, between Hamilton Beach\/Proctor-Silex and The Chase Manhattan Bank (National Association) is incorporated herein by reference to Exhibit 10(lx) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lv) Pledge Agreement re: 66% Pledge of PSM Stock, dated as of October 11, 1990, between Hamilton Beach\/Proctor-Silex and The Chase Manhattan Bank (National Association) is incorporated herein by reference to Exhibit 10(lxii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lvi) Pledge Agreement re: 34% pledge of PSC Stock, dated as of October 11, 1990, between Hamilton Beach\/Proctor-Silex and The Chase Manhattan Bank (National Association) is incorporated herein by reference to Exhibit 10(lxiii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lvii) Pledge Agreement re: 33.2% Pledge of PSM Stock, dated as of October 11, 1990, between Hamilton Beach Proctor\/Silex and The Chase Manhattan Bank (National Association) is incorporated herein by reference to Exhibit 10(lxiv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lviii) Pledge Agreement, dated as of October 11, 1990, between Housewares Holding Company and The Chase Manhattan Bank (National Association) is incorporated herein by reference to Exhibit 10(lxv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lix) Pledge Agreement, dated as of October 11, 1990, between HB-PS Holding Company, Inc. and The Chase Manhattan Bank (National Association) is incorporated\nX-8 herein by reference to Exhibit 10(lxvi) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lx) Security Agreement, dated as of October 11, 1990, between Hamilton Beach\/Proctor-Silex and The Chase Manhattan Bank (National Association), as the United States agent, is incorporated herein by reference to Exhibit 10(lxvii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxi) Collateral Assignment of Patents and Trademarks and Security Agreement, dated as of October 11, 1990, between Hamilton Beach\/Proctor-Silex and The Chase Manhattan Bank (National Association), as the United States agent, is incorporated herein by reference to Exhibit 10(lxviii) to the Company s Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxii) NACCO Supplemental Agreement, dated as of October 11, 1990, between NACCO and The Chase Manhattan Bank (National Association), as the United States agent, is incorporated herein by reference to Exhibit 10(lxix) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxiii) Housewares Supplemental Agreement, dated as of October 11, 1990, between Housewares Holding Company and The Chase Manhattan Bank (National Association), as the United States agent, is incorporated herein by reference to Exhibit 10(lxx) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxiv) Holdings Supplemental Agreement, dated as of October 11, 1990, between HB-PS Holding Company, Inc. and The Chase Manhattan Bank (National Association), as the United States agent, is incorporated herein by reference to Exhibit 10(lxxi) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxv) Override Agreement, dated as of October 11, 1990, among the Company, Housewares Holding Company, Glen Dimplex, Precis [521] Ltd., Glen Electric, Ltd. and The Chase Manhattan Bank (National Association), as the United States agent, is incorporated herein by reference to Exhibit 10(lxxii) to the Company's Annual Report on\nX-9 Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxvi) General Security Agreement, dated as of October 11, 1990, by Proctor-Silex Canada to and in favor of The Chase Manhattan Bank of Canada, as the Canadian agent, is incorporated herein by reference to Exhibit 10(lxxiii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n*(lxvii) The Hamilton Beach\/Proctor-Silex, Inc. Profit Sharing Retirement Plan (as amended and restated effective January 1, 1992) is incorporated by reference to Exhibit 10(lxvii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n*(lxviii) Form of the Hamilton Beach\/Proctor-Silex, Inc. Annual Incentive Compensation Plan is attached hereto as Exhibit 10(lxviii).\n*(lxix) Hamilton Beach\/Proctor-Silex, Inc. Long-Term Incentive Compensation Plan, effective January 1, 1993, is incorporated by reference to Exhibit 10(lxix) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n(lxx) Amendment to the Third Amended and Restated Operating Agreement, dated as of January 31, 1990, between Hyster Company and AT&T Commercial Finance Corporation is incorporated herein by reference to Exhibit 10(xlvii) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 33-28812.\n*(lxxi) The North American Coal Corporation Salaried Employees Pension Plan (As Amended and Restated as of January 1, 1989) is attached hereto as Exhibit 10(lxxi).\n*(lxxii) Amendment No. 1 to the North American Coal Corporation Salaried Employees Pension Plan (As Amended and Restated as of January 1, 1989), dated as of August 6, 1993, is attached hereto as Exhibit 10(lxxii).\n*(lxxiii) Amendment No. 2 to the North American Coal Corporation Salaried Employees Pension Plan (As Amended and Restated as of January 1, 1989), dated as of December 29, 1993, is attached hereto as Exhibit 10(lxxiii).\nX-10 (lxxiv) Short-Term Promissory Note, dated October 19, 1990, between the Company and Citibank, N.A. is incorporated herein by reference to Exhibit 10(lxxxi) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxxv) Commitment, dated as of October 1, 1990, between the Company and Morgan Guaranty Trust Company of New York is incorporated herein by reference to Exhibit 10(lxxxii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxxvi) Promissory Grid Note between the Company and Ameritrust Company National Association is incorporated herein by reference to Exhibit 10(lxxxiii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxxvii) First Amendment to the NACCO Supplemental Agreement, dated as of March 1, 1991, between the Company and The Chase Manhattan Bank (National Association), as the United States agent, is incorporated herein by reference to Exhibit 10(lxxxiv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxxviii) First Amendment to the Housewares Supplemental Agreement, dated as of March 1, 1991, between Housewares Holding Company and The Chase Manhattan Bank (National Association), as the United States agent, is incorporated herein by reference to Exhibit 10(lxxxv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxxix) First Amendment to the Holdings Supplemental Agreement, dated as of March 1, 1991, between HB-PS Holding Company and The Chase Manhattan Bank (National Association), as the United States agent, is incorporated herein by reference to Exhibit 10(lxxxvi) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n*(lxxx) The Yale Materials Handling Corporation Deferred Incentive Compensation Plan (also known as The Yale Materials Handling Corporation Short-Term Incentive Compensation Deferral Plan), dated March 1, 1984, is incorporated herein by reference to Exhibit 10(lxxi) to\nX-11 the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 33-28812.\n*(lxxxi) Hyster-Yale Materials Handling, Inc. Annual Incentive Compensation Plan is incorporated herein by reference to Exhibit 10(lxxxiii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n*(lxxxii) Hyster-Yale Materials Handling, Inc. Long-Term Incentive Compensation Plan, dated as of January 1, 1990, is incorporated herein by reference to Exhibit 10(lxxxix) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 1-9172.\n(lxxxiii)- (lxxxv) Intentionally Left Blank\n(lxxxvi) Amendment to the Third Amended and Restated Operating Agreement, dated as of November 7, 1991, between Hyster Company and AT&T Commercial Finance Corporation is incorporated herein by reference to Exhibit 10(1) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 33-28812.\n*(lxxxvii) Agreement and Plan of Merger dated as of December 20, 1993, between Hyster Company, an Oregon corporation, and Hyster Company, a Delaware corporation, is incorporated herein by reference to Exhibit 10(lxxviii) to Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n*(lxxxviii) Agreement and Plan of Merger dated as of December 20, 1993, between Yale Materials Handling Corporation, a Delaware corporation, Hyster Company, a Delaware corporation, and Hyster-Yale Materials Handling, Inc., a Delaware corporation, is incorporated herein by reference to Exhibit 10(lxxix) to Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n*(lxxxix) Form of NACCO Industries, Inc. Annual Incentive Compensation Plan is attached hereto as Exhibit 10(lxxxix).\n*(xc) Amendment No. 3 to The North American Coal Corporation Salaried Employees Pension Plan (As Amended and Restated as of January 1, 1989), dated as of March 11, 1994, is attached hereto as Exhibit 10(xc).\nX-12 *(xci) The NACCO Materials Handling Group, Inc. Unfunded Benefit Plan, Amended and Restated as of October 1, 1994, is incorporated herein by reference to Exhibit 10(cv) of the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Commission File Number 33-28812.\n(xcii) Credit Agreement, dated as of September 27, 1991, among the North American Coal Corporation, Citibank, N.A., Ameritrust Company National Association and Morgan Guaranty Trust Company of New York, as agent is incorporated herein by reference to Exhibit 10(xcii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n(xciii) Assumption Agreement, made as of December 20, 1991, between the Company and Citicorp North America, Inc., as agent is incorporated herein by reference to Exhibit 10(xciii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n(xciv) Subordination Agreement, dated September 27, 1991, among The North American Coal Corporation, the Company and Morgan Guaranty Trust Company of New York, as agent, is incorporated herein by reference to Exhibit 10(xciv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n(xcv)-(xcvi) Intentionally Left Blank\n(xcvii) Marketing Agreement, dated as of January 1, 1992, by and between, Yale Materials Handling Corporation and Jungheinrich Aktiengellschaft (AG) is incorporated herein by reference to Exhibit 10(lviii) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 33-28812.\n*(xcviii) The North American Coal Corporation Value Appreciation Plan, as amended on March 11, 1992 is incorporated herein by reference to Exhibit 10(xcviii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, Commission File Number 1-9172.\n*(xcix) Amendment No. 1 to The North American Coal Corporation Value Appreciation Plan, dated as of\nX-13 December 14, 1994, is attached hereto as Exhibit 10(xcix).\n(c)- (civ) Intentionally Left Blank\n*(cv) Master Trust Agreement between NACCO Industries, Inc. and State Street Bank and Trust Company, dated October 1, 1992, is incorporated by reference to Exhibit 10(cv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n*(cvi) Amendment No. 1 to the Master Trust Agreement between NACCO Industries, Inc. and State Street Bank and Trust Company, effective January 1, 1993, is attached hereto as Exhibit 10(cvi).\n*(cvii) The North American Coal Corporation Retirement Savings Plan (formerly known as the NACCO Industries, Inc. Savings Plan), effective January 1, 1993, is incorporated by reference to Exhibit 10(cvii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n(cviii)-(cix) Intentionally Left Blank\n*(cx) NACCO Industries, Inc. Executive Long-Term Incentive Compensation Plan, effective January 1, 1991, is incorporated by reference to Exhibit 10(cx) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n*(cxi) NACCO Industries, Inc. Non-Employee Directors' Equity Compensation Plan, effective January 1, 1992, is incorporated by reference to Exhibit 10(cxi) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 1-9172.\n(cxii)-(cxiii) Intentionally Left Blank\n*(cxiv) The Hyster-Yale Profit Sharing Plan, amended and restated as of November 11, 1992, is incorporated herein by reference to Exhibit 10(lxii) of the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 33-28812.\n(cxv) Intentionally Left Blank\n(cxvi) Amendment to the Third Amended and Restated Operating Agreement, dated as of January 31, 1990, between Hyster Company and PacifiCorp Credit, Inc. is incorporated herein by reference to Exhibit 10(xlvi) to\nX-14 the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 33-28812.\n*(cxvii) The Hyster-Yale Cash Balance Plan, is incorporated herein by reference to Exhibit 10(lxv) of the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 33-28812.\n(cxviii)-(cxxiii) Intentionally Left Blank\n*(cxxiv) Amendment No. 1 to the Hamilton Beach\/Proctor-Silex, Inc. Profit Sharing Retirement Plan, as restated effective January 1, 1989, is incorporated by reference to Exhibit 10(cxxiv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n*(cxxv) The Hamilton Beach\/Proctor-Silex, Inc. Employees' Retirement Savings Plan, as amended and restated effective January 1, 1994, is incorporated by reference to Exhibit 10(cxxv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n(cxxvi) Intentionally Left Blank\n*(cxxix) Amendment No. 1, dated as of May 13, 1993, to the Hyster-Yale Profit Sharing Plan (now known as the NACCO Materials Handling Group Profit Sharing Plan) is incorporated herein by reference to Exhibit 10 (lxxxi) of the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n*(cxxx) Amendment No. 2, dated effective January 1, 1994, to the Hyster-Yale Profit Sharing Plan (now known as the NACCO Materials Handling Group Profit Sharing Plan) is incorporated herein by reference to Exhibit 10 (lxxxv) of the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n*(cxxxi) Amendment No. 1 dated as of May 27, 1993 to the Hyster-Yale Cash Balance Plan (now known as the NACCO Materials Handling Group Cash Balance Plan) is incorporated herein by reference to Exhibit 10 (lxxxvi) of the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\nX-15 *(cxxxii) Amendment No. 2 effective as of December 31, 1993 to the Hyster-Yale Cash Balance Plan (now known as the NACCO Materials Handling Group Cash Balance Plan) is incorporated herein by reference to Exhibit 10 (lxxxvii) of the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n*(cxxxiii) Amendment No. 2 effective as of December 31, 1993 to the Hyster-Yale Materials Handling, Inc. Long-Term Incentive Compensation Plan is incorporated herein by reference to Exhibit 10 (lxxxxiii) of the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n*(cxxxiv) Amendment No. 1 effective as of January 1, 1994 to The North American Coal Corporation Retirement Savings Plan is incorporated herein by reference to Exhibit 10(cxxxiv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n*(cxxxv) Amendment No. 2 effective as of January 1, 1994 to The North American Coal Corporation Retirement Savings Plan is incorporated herein by reference to Exhibit 10(cxxxv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n*(cxxxvi) Amendment No. 1 effective as of January 1, 1994 to the Hyster-Yale Materials Handling, Inc. Annual Incentive Compensation Plan (now known as the NACCO Materials Handling Group, Inc. Annual Incentive Compensation Plan) is incorporated herein by reference to Exhibit 10(lxxxx) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n(cxxxvii) Intentionally Left Blank\n*(cxxxviii) Master Trust Agreement for Defined Benefit Plans between NACCO Industries, Inc. and State Street Bank and Trust Company, dated January 1, 1994 is incorporated herein by reference to Exhibit 10(cxxxviii)to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n*(cxxxix) Amendment No. 1 to the Master Trust Agreement for the Defined Benefit Plans between NACCO Industries, Inc. and State Street Bank and Trust Company, effective\nX-16 as of January 1, 1995, is attached hereto as Exhibit 10(cxxxix).\n(cxl) Amendment No. 4 dated as of June 24, 1993 to the Credit Agreement among Hamilton Beach\/Proctor-Silex, Inc., Proctor-Silex Canada, Inc., Proctor-Silex S.A. deC.V., the banks named on the signatory pages and The Chase Manhattan Bank is incorporated herein by reference to Exhibit (cxxxx) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n(cxli) Consent and Authorization with reference made to the Credit Agreement dated October 11, 1990, as amended among Hamilton Beach\/Proctor-Silex, Inc., Proctor-Silex Canada, Inc., Proctor-Silex S.A. de C.V., the banks named on the signatory pages and The Chase Manhattan Bank is incorporated herein by reference to Exhibit (cxxxxi) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n(cxlii) Amendment No. 5 to the Credit Agreement dated as of December 23, 1993 among Hamilton Beach\/Proctor-Silex, Inc., Proctor-Silex Canada, Inc., Proctor-Silex S.A. de C.V., the banks and financial institutions listed on the signature pages thereto, The Chase Manhattan Bank, a United States Agent, The Chase Manhattan Bank of Canada, as Canadian Agent is incorporated herein by reference to Exhibit 10(cxxxxii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n(cxliii) Amendment No. 1 to the Credit Agreement dated as of July 28, 1993 among The North American Coal Corporation and the banks listed on the signatory pages and Morgan Trust Company of New York, as Agent is incorporated herein by reference to Exhibit 10(cxxxxiii) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n(cxliv) Amendment No. 1 to the Term Loan Agreement, effective as of February , 1993, between The Kitchen Collection, Inc. and Society National Bank is incorporated herein by reference to Exhibit 10(cxxxxiv) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 1-9172.\n(cxlv) Amended and Restated Credit Agreement dated as of July 30, 1993 among Citicorp North America, Inc.,\nX-17 Hyster-Yale Materials Handling, Inc., and Hyster Company is incorporated herein by reference to Exhibit 10(lxxvi) to the Hyster-Yale Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, Commission File Number 33- 28812.\n(cxlvi) Reaffirmation Amendment and Acknowledgment Agreement dated July 30, 1993 among Hyster-Yale Materials Handling, Inc., Yale Materials Handling Corporation, Hyster Company, the Company and Citicorp North America, Inc., individually and as Agent for the various Lenders, is incorporated herein by reference to Exhibit 10(lxxx) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n(cxlvii) Amendment No. 1 dated as of December 31, 1993 to the Amended and Restated Credit Agreement dated as of July 30, 1993 among Hyster-Yale Materials Handling, Inc., Yale Materials Handling Corporation, Hyster Company, the Lenders party thereto, and Citicorp North America, Inc., individually and as Agent, is incorporated herein by reference to Exhibit 10(lxxxi) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n(cxlviii) Reaffirmation, Amendment and Acknowledgment Agreement dated as of December 31, 1993 among Hyster-Yale Materials Handling, Inc., Yale Materials Handling Corporation, Hyster Company and Citicorp North America, Inc., as Agent for the Lenders, is incorporated herein by reference to Exhibit 10(lxxxii) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n(cxlix) Reaffirmation, Amendment and Acknowledgment Agreement dated as of January 1, 1994 among Hyster-Yale Materials Handling, Inc., NACCO Materials Handling Group, Inc. and Citicorp North America, Inc. as Agent for the Lenders, is incorporated herein by reference to Exhibit 10(lxxxiii) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1993, Commission File Number 33-28812.\n(cl) Amended and Restated Credit Agreement, dated as of May 10, 1994 among Hamilton Beach#Proctor-Silex, Inc., Proctor-Silex Canada, Inc., Proctor-Silex S.A. DE C.V., the banks named on the signatory pages and the Chase Manhattan Bank is incorporated herein by reference to as\nX-18 Exhibit 10 (cl) to the NACCO Industries, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, Commission File Number 1-9172.\n(cli) Confirmation Agreement dated May 10, 1994 among Hamilton Beach#Proctor-Silex, Inc., Housewares Holding Company, Precis [521] Ltd., HB-PS Holding Company, Glen Dimplex, Glen Electric, Ltd., the banks named on the signatory pages, the Chase Manhattan Bank and the Chase Manhattan Bank of Canada is incorporated herein by reference to Exhibit 10 (cli) to the NACCO Industries, Inc. Quarterly Report on Form 10-Q for the quarter ended on June 30, 1994, Commission File Number 1-9172.\n(clii) Term Note Agreement dated May 10, 1994 by and between The Kitchen Collection, Inc. and Society National Bank is incorporated herein by reference to as Exhibit 10 (clii) to the NACCO Industries, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, Commission File Number 1-9172.\n*(cliii) Amendment No. 2 to The North American Coal Corporation Deferred Compensation Plan for Management Employees, effective January 1, 1994, is incorporated herein by reference to Exhibit 10 (cliii) to the NACCO Industries, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, Commission File Number 1- 9172.\n*(cliv) Amendment No. 2 to the Hamilton Beach#Proctor- Silex, Inc. Profit Sharing Retirement Plan, effective March 15, 1994 is incorporated herein by reference to as Exhibit 10 (cliv) to the NACCO Industries, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, Commission File Number 1-9172.\n(clv) Intentionally Left Blank\n*(clvii) Amendment No. 3 to The North American Coal Corporation Salaried Employees Pension Plan, effective March 15, 1994 is incorporated herein by reference to as Exhibit 10 (clvii) to the NACCO Industries, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, Commission File Number 1-9172.\n*(clviii) Amendment No. 2 to the Hyster-Yale Materials Handling, Inc. Annual Incentive Compensation Plan effective January 1, 1994 is incorporated herein by reference to Exhibit 10 (1xxxxiv) to the Hyster-Yale Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, Commission File Number 33-28812.\nX-19 *(clix) Amendment No. 3 to the Hyster-Yale Materials Handling, Inc. Long-Term Incentive Compensation Plan effective January 1, 1994 is incorporated herein by reference to Exhibit 10 (lxxxxv) to the Hyster-Yale Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, Commission File Number 33-28812.\n*(clx) Amendment No. 3 to the NACCO Materials Handling Group, Inc. Profit Sharing Plan effective January 1, 1994 is incorporated herein by reference to Exhibit 10 (lxxxxvi) to the Hyster-Yale Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, Commission File Number 33-28812.\n(clxi) Intentionally Left Blank\n*(clxii) Amendment No. 2, dated June 29, 1994, to the Amended and Restated Credit Agreement among Hyster-Yale Materials Handling, Inc., NACCO Materials Handling Group, Inc., the banks listed on the signatory page and Citicorp North America, Inc. is incorporated herein by reference to Exhibit 10 (lxxxxviii) to the Hyster-Yale Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, Commission File Number 33-28812.\n*(clxiii) Amendment No. 4 to the North American Coal Corporation Salaried Employees Pension Plan (As Amended and Restated as of January 1, 1989), effective January 1, 1994 is incorporated herein by reference to Exhibit 10 (clxiii) to the NACCO Industries, Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, Commission File Number 1-9172.\n*(clxiv) Amendment No. 5 to The North American Coal Corporation Salaried Employees Pension Plan (As Amended and Restated as of January 1, 1989) effective as of July 1, 1994 is incorporated herein by reference to as Exhibit (clxiv) to the NACCO Industries, Inc, Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, Commission File Number 1-9172.\n*(clxv) The North American Coal Corporation Supplemental Retirement Benefit Plan as amended and restated effective September 1, 1994 is incorporated by reference to Exhibit 10 (clxv) to the NACCO Industries, Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, Commission File Number 1- 9172.\n*(clxvi) Amendment No. 1 to The NACCO Materials Handling Group, Inc. Unfunded Benefit Plan (As Amended and Restated effective October 1, 1994) is incorporated\nX-20 herein by reference to Exhibit 10 (xcix) to the Hyster-Yale Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, Commission File Number 33-28812.\n(clxvii) Amendment dated as of January 1, 1994 to the Third Amendment and Restated Operating Agreement dated as of November 7, 1991, between NACCO Materials Handling Group and AT&T Commercial Finance Corporation is incorporated herein by reference to Exhibit 10(c) to the Hyster-Yale Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, Commission File Number 330-28812.\n(11) Statement re computation of per share earnings. The computation of earnings per share is attached hereto as Exhibit 11.\n(21) Subsidiaries. A list of the subsidiaries of the Company is attached hereto as Exhibit 21.\n(23) Consents of experts and counsel.\n(i) The consent of Arthur Andersen LLP, independent accountant, is attached hereto as Exhibit 23(i).\n(24) Powers of Attorney\n(i) A manually signed copy of a power of attorney for Owsley Brown II is attached hereto as Exhibit 24(i).\n(ii) A manually signed copy of a power of attorney for John J. Dwyer is attached hereto as Exhibit 24(ii).\n(iii) A manually signed copy of a power of attorney for Robert M. Gates is attached as Exhibit 24(iii)\n(iv) A manually signed copy of a power of attorney for E. Bradley Jones is attached hereto as Exhibit 24(iv).\n(v) A manually signed copy of a power of attorney for Dennis W. LaBarre is attached hereto as Exhibit 24(v).\n(vi) A manually signed copy of a power of attorney for Alfred M. Rankin, Jr. is attached hereto as Exhibit 24(vi).\n(vii) A manually signed copy of a power of attorney for John C. Sawhill is attached hereto as Exhibit 24(vii).\n(viii) A manually signed copy of a power of attorney for Britton T. Taplin is attached hereto as Exhibit 24 (viii).\nX-21 (ix) A manually signed copy of a power of attorney for Frank E. Taplin, Jr. is attached hereto as Exhibit 24 (ix).\n(x) A manually signed copy of a power of attorney for Steven M. Billick is attached hereto as Exhibit 24(x).\n(27) Financial Data Schedule -- filed electronically for SEC information purposes only.\n(99) Other exhibits not required to otherwise be filed.**\n(i) Audited Financial Statements for The North American Coal Corporation for the fiscal year ended December 31, 1994, are attached as Exhibit 99(i).\n(ii) Audited Financial Statements for Hamilton Beach\/Proctor-Silex, Inc. for the fiscal year ended December 31, 1994, are attached as Exhibit 99(ii).\n(iii) Audited Financial Statements for The Kitchen Collection, Inc. for the fiscal year ended December 31, 1994, are attached as Exhibit 99(iii).\n(iv) Audited Financial Statements for NACCO Materials Handling Group, Inc. for the fiscal year ended December 31, 1994, are incorporated herein by reference to Item 8, Item 14(A)(1) and (2), and Item 14(D) to the Hyster-Yale Annual Report on Form 10-K for the fiscal year ended December 31, 1994, Commission File Number 33-28812.\n______________________________ * Management contract or compensation plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of this Annual Report on Form 10-K.\n** Audited Financial Statements of subsidiary companies are not required disclosures and are included only for information. These statements do not reflect certain adjustments (including\nX-22 reclassifications and eliminations) that are required by GAAP in the preparation of NACCO Industries, Inc. and subsidiaries consolidated financial statements included in Part IV hereof, and should be read accordingly.\nExhibit.doc\nX-23","section_15":""}
{"filename":"814361_1994.txt","cik":"814361","year":"1994","section_1":"ITEM 1. BUSINESS\nOVERVIEW --------\nThe Timberland Company was incorporated in Delaware on December 20, 1978, and is the successor to Abington Shoe Company, which was incorporated in Massachusetts in 1933 (The Timberland Company, together with its subsidiaries, is referred to herein as \"Timberland\" or the \"Company,\" unless the context requires otherwise). The Company designs, develops, manufactures and markets men's and women's premium quality footwear, apparel and accessories under the Timberland [Registered] brand. These products are sold primarily through better-grade department stores and other retail stores in the United States and in more than 60 countries worldwide. In addition, the Company sells its products through specialty stores devoted exclusively to Timberland [Registered] products which are operated by the Company or its distributors in the United States, Europe, South America, Mexico and Asia and through specialty stores in Australia and New Zealand owned by its distributor in the Asia\/Pacific region. Timberland also sells its products through Company-operated factory stores in the United States, France, Germany and Italy.\nThe Company has built its product lines to reflect classic rugged styles which provide durability and quality. In marketing its products, the Company has consistently emphasized the workmanship and detailing incorporated into its products, which are designed to provide lasting protection from the elements.\nIn early 1994, the Company continued its strategic decision implemented in late 1993 to gain market share and to improve the price\/value proposition for the consumer by preemptively reducing prices on certain core footwear products. Effective June 1, 1994, the Company assumed the distribution of its own products in Italy and acquired certain assets of its Italian distributor. In January 1995, the Company appointed Inchcape plc as the exclusive distributor of Timberland products throughout most of the Asia\/Pacific region. This transaction included the sale to Inchcape plc of the Company's Australian and New Zealand subsidiaries.\nCURRENT PRODUCTS ----------------\nThe Company's two major product categories are footwear (shoes and boots) and apparel and accessories. The Company increased its sales to $637.5 million in 1994 from $418.9 million in 1993, an increase of 52.2%. During 1994, net sales attributable to the footwear category totaled $513.5 million, as compared to $349.5 million and $242.6 million in 1993 and 1992, respectively. During 1994, net sales attributable to the apparel and accessories category totaled $124.0 million, as compared to $69.4 million and $48.8 million in 1993 and 1992, respectively.\nFOOTWEAR\nIn 1973, the first pair of waterproof \"minibuck\" leather boots under the Timberland brand were produced. The Company currently offers a variety of styles of boots for men and women, including classic work and sporting boots, hiking boots and lightweight trail boots. The Company also offers men's and women's shoes featuring handsewn construction, premium waterproof leather, water resistant fabric uppers and selected use of waterproof fabric bootie construction,\nas well as performance sandals for men and women. The Company's shoes are based on classic styling and are designed for durability. In 1994, the Company introduced a variety of new styles in each of its men's and women's lines of boots and shoes, including its collection of weatherbucks, loafers, handsewn casuals, boat shoes, bush hikers, performance sandals, weather boots and other rugged casual styles.\nDuring 1994, the Company also introduced a new line of footwear products under the Timberland Work Division. These insulated, rugged boots, some with steel-toed safety construction, are designed to fit the needs of construction workers, carpenters, assembly-line workers and skilled workers in other crafts and trades who require durable and comfortable footwear in their work environments. Timberland [Registered] Work boots are currently sold in the United States through leading consumer product retailers like J.C. Penney and Sears.\nIn January 1995, the Company introduced its Active Comfort Technology [trademark] (ACT [trademark]), a comfort system that combines specially selected materials in a proprietary way that is designed to aggressively wick moisture away from the skin to keep feet warm and dry. The ACT system has been initially incorporated into the Company's high performance hunting boots and is expected to be introduced into other performance and core footwear products starting in the spring of 1996.\nAPPAREL AND ACCESSORIES\nTimberland offers premium quality apparel, consisting of rugged outerwear, sweaters, shirts, pants, shorts and skirts. Incorporated into such products are premium waterproof leathers, waterproof fabric, rust-proof hardware, canvas, denim, high quality specialty cotton, wool and other quality performance materials. During 1994, the Company expanded its men's line of rugged apparel to coordinate better with the Company's line of outerwear and expanded its women's line of apparel to incorporate a broader range of colors, fabrics and styles.\nTimberland's accessories collection consists of luggage, briefcases, handbags, belts, caps, hats, gloves and socks. For 1994, introductions in the accessories collection included an expanded line of waterproof leather handbags, travel bags and small leather goods.\nTIMBERLAND'S STRATEGY ---------------------\nDuring 1994, the Company pursued its strategy for growth by capitalizing on its core business and continuing to expand its domestic and international presence through building increased consumer awareness of the Timberland [Registered] brand. Timberland believes its integrated brand approach, which is based on showcasing Timberland brand apparel and accessories together with its footwear products in specialty stores and concept shops and corners, contributes to this strategy for growth. Specialty stores, which are operated by the Company or its distributors, sell only major product categories of Timberland [Registered] products. Concept shops or corners, which are operated by third-parties, are areas of stores dedicated exclusively to the presentation, merchandising and sale of Timberland products.\nThe Company continued to promote consumer demand for its products in 1994 through advertising campaigns which emphasized the workmanship and detailing of its footwear, apparel and accessories and the protection these products offer against the elements. Timberland believes that the premium quality, durability, functionality and classic styling of its products, combined with its reputation for high-performance products and increased consumer awareness of the Timberland [Registered] brand, will continue to increase consumer demand for its products.\nAdvertising through print and television campaigns is used to present Timberland as an integrated, world-class source of quality footwear, apparel and accessories for the rugged outdoors. The Company reinforces this advertising with a variety of in-store promotions, point-of-purchase displays, a cooperative advertising program with its retailers, as well as retail sales employee training programs focused on product knowledge, selling skills and visual merchandising.\nIn the first half of 1994, the Company continued to reduce prices on certain core footwear to improve the price\/value proposition for the consumer and to increase market share. The Company is currently evaluating the balance between manufacturing its own products and utilizing independent manufacturing alternatives to reduce costs while providing the consumer with premium quality footwear at the best prices. See \"Business--Manufacturing.\"\nThe Company intends to continue its growth through a combination of internal development and the development of business relationships with independent manufacturers, suppliers, distributors and retailers capable of reinforcing the Company's image and standards. The Company may, from time to time, consider the possibility of acquiring other companies which produce or distribute quality footwear, apparel, accessories or related products which complement the Company's existing product lines.\nDISTRIBUTION ------------\nUNITED STATES OPERATIONS\nIn 1994, 1993 and 1992, the Company generated 74%, 71% and 63%, respectively, of its net sales in the United States. The Company's strategy is to distribute its products through specialty stores and through retailers who reinforce the Timberland image of quality, performance and service. The Company's customer accounts within the United States range from better-grade department stores and retail stores to sporting goods stores, marinas and specialty retailers. The Company services these accounts through a combination of field and corporate-based sales teams.\nThe Company has six showrooms servicing its wholesale customers. The Company's principal showroom is located on Fifth Avenue in New York City. Its regional showrooms are located in Atlanta, Chicago, Dallas, Denver and Seattle.\nIn 1994, the Company's domestic retail operations accounted for 9% of net sales, compared to 8% in 1993 and 10% in 1992. The Company operates 15 Timberland [Registered] specialty stores located in Atlanta; Boston; Chestnut Hill, Massachusetts; Chicago; Dallas; Newport, Rhode Island; New York City; White Plains, New York; Los Angeles; San Francisco; Sausalito, California; Farmington, Connecticut; St. Louis; Short Hills, New Jersey; and Washington, D.C. The Company opened the specialty stores in Atlanta, Chestnut Hill, St. Louis, Farmington, Los Angeles and Short Hills during 1994 and the specialty store in White Plains in early 1995. All of the Company's specialty stores showcase the Timberland [Registered] brand as an integrated source of footwear, apparel and accessories. These stores also provide sales and consumer-trend information which assist the Company in developing its marketing strategies, including point of purchase materials. In addition, the training and customer service programs established in the Company's specialty stores serve as a model which may be adopted by the Company's other retail accounts. The Company also operates 19 factory stores located in the United States which typically sell factory-second and close-out product offerings to the public.\nThe Company carries material amounts of inventory in order to meet delivery and any other requirement of its customers. At December 31, 1994, the Company's inventory levels were $218.2 million, compared to $111.4 million at December 31, 1993. Generally, inventory levels were higher in 1994 than in 1993 to meet a higher level of sales. However, the Company's inventory positions were higher than anticipated because of sales growing at a slower rate than the Company had expected and the Company's misforecasting of specific customer demand at the unit product level. A majority of this inventory consists of classic Timberland [Registered] models in oversupply that the Company expects will be sold in the normal course of business.\nThe Company maintains distribution facilities in Portsmouth and Hampton, New Hampshire; Wilmington, Massachusetts; and Danville, Kentucky. The Danville distribution facility was established in 1994. Currently, orders are filled primarily from the Company's Hampton, Wilmington and Danville distribution facilities. The Company's distribution strategy is to control its points of distribution in order to reduce costs and increase responsiveness to consumer demand in the long-term.\nINTERNATIONAL OPERATIONS\nIn 1994, international sales accounted for 26% of Timberland's net sales, compared to 29% in 1993 and 37% in 1992. Timberland sells its products internationally through distributors, commission agents and six of its subsidiaries. The Company's subsidiaries located in England, France, Germany, Spain and Austria and its domestic subsidiary servicing Italy provide sales, administrative and, in certain instances, warehousing support for the sale of Timberland [Registered] products to retailers in their respective countries and, in certain instances, to distributors and commission agents in other countries. These subsidiaries also operate seven Timberland [Registered] specialty stores located in London; Milan; Munich; Dusseldorf; Vienna; Paris; and Lyon, France and three factory stores in Vallauris, France; Baierbrunn, Germany; and Pero, Italy. Additionally, the Company grants licenses to operate specialty stores to certain third parties. Retail distribution of the Company's products internationally also occurs through better-grade department stores and other retail stores.\nDuring 1994, the Company entered into a Distributorship Termination Agreement with its Italian distributor, pursuant to which the Company terminated the distributor's distribution rights and acquired certain of the distributor's assets. Timberland assumed the distribution of its own products in Italy effective June 1, 1994.\nOn January 26, 1995, the Company appointed Inchcape plc as the exclusive distributor and retailer of Timberland [Registered] products throughout most of the Asia\/Pacific region for a ten-year term. The transaction also included Inchcape's acquisition of Timberland's Australian and New Zealand subsidiaries and future consideration provided to Inchcape for a total sum of $24 million. The eight Timberland specialty stores and departments leased in retail stores located in Australia and New Zealand are owned and operated by Inchcape plc effective January 26, 1995.\nReference is hereby made to the information set forth in footnote 10, entitled \"Industry Segment and Geographical Area Information,\" appearing in the Company's 1994 Annual Report to Stockholders, which information is incorporated herein by reference.\nADVERTISING AND MARKETING -------------------------\nThe Company's advertising campaigns are designed to increase consumer brand awareness and emphasize that Timberland offers an integrated brand of footwear, apparel and accessories products that provide lasting protection from the elements. During 1994, the Company promoted the high quality, classic rugged style, durability and functionality of its products through national and regional advertising campaigns. On a national level, advertisements that featured the ability of the Company's products to perform under extreme conditions were placed in various active-lifestyle and sports-focused periodicals. In addition, advertisements designed to motivate consumers' social conscience and increase brand loyalty were featured in various national periodicals.\nThe Company's regional and trade publications advertising campaigns were built on the foundation of the national advertising campaigns and featured advertisements in print media that emphasized the value of purchasing authentic Timberland [Registered] products rather than products that attempt to imitate Timberland's style and design or products that focus more on fashion trends than on performance.\nInternationally, the Company participates in a variety of direct and cooperative advertising efforts. This advertising uses and adapts for the international markets many of the same promotional themes that are used in the United States.\nIn September 1994, the Company announced that it would no longer be the principal sponsor of the Iditarod [Registered] sled dog race due to changing business priorities. Currently, the Company supports programs dedicated to the responsible care and humane treatment of dogs, particularly sled dogs.\nTimberland continues to test its products in association with the members of Team Timberland. Team Timberland consists of a select group of individuals who support the Timberland Mission and--through either their adventures facing the elements, athletic performance or civic activities-- serve as educational role models for making a positive difference in the community and improving the environment in which we live.\nSEASONALITY -----------\nIn 1994, as has traditionally been the case, the Company's sales were higher in the last two quarters of the year than in the first two quarters. The Company expects this sales trend to continue in 1995.\nBACKLOG -------\nAt December 31, 1994, Timberland's backlog of orders from its customers was approximately $132 million, compared to $69 million at December 31, 1993. While all orders in the backlog are subject to cancellation by customers, the Company expects that the majority of such orders will be filled in 1995. The Company does not believe that its backlog of orders at year end is representative of the orders which will be filled during 1995 due to the shift towards \"at once orders\" being adopted by many retailers.\nMANUFACTURING -------------\nDuring 1994, approximately 60% of the Company's footwear unit volume was manufactured in the Company's leased facilities in Tennessee, North Carolina, Puerto Rico and the Dominican Republic, compared to 70% during 1993. The remainder of the Company's footwear unit volume and all of its apparel and accessories were sourced from independent manufacturers in Asia, Central America and the Caribbean, Europe, North America and South America. The Company believes that utilizing independent manufacturers provides greater production capacity and flexibility.\nDuring 1994, the Company continued certain cost savings programs implemented in 1993, such as modular manufacturing, to enhance materials management and to reduce manufacturing cycle times. The Company believes that further cost reductions can be obtained through better management of its raw materials purchasing and with increased utilization of independent manufacturers. The Company currently plans to retain an internal manufacturing capability to continue to benefit from the experience and expertise it has gained with respect to its manufacturing and research, design and development activities conducted in connection with its manufacturing. The Company is currently evaluating its manufacturing facilities and independent manufacturing alternatives to determine the appropriate size and scope of its manufacturing facilities to be more effective in delivering quality merchandise efficiently.\nTo the extent the Company manufactures outside the United States or is dependent upon foreign operations with unaffiliated parties, the Company is subject to the usual risks of doing business abroad. These risks potentially include United States import restrictions, anti-dumping investigations, political or labor disturbances, expropriation, acts of war and other similar risks.\nRAW MATERIALS -------------\nThe Company purchases its raw materials from a number of domestic and foreign sources. In 1994, the Company increased its utilization of foreign sources for supply of quality leather to reduce costs and to diversify its raw materials purchases. Based on its experience, the Company expects to consolidate its raw materials purchasing to fewer suppliers in 1995 than in 1994. The Company has no reason to believe that leather will not continue to be available from existing or alternative sources.\nTRADEMARKS AND TRADE NAMES; PATENTS; RESEARCH & DEVELOPMENT -----------------------------------------------------------\nThe Company's principal trade name is The Timberland Company and the Company's principal trademarks are Timberland and [TREE LOGO], which have been registered in the United States and in certain foreign countries. Other Company trademarks or registered trademarks are HydroTech; Weathergear; More Quality Than You May Ever Need; Where Is Your Outdoors?; Active Comfort Technology; ACT; Toporelief; Topozoic; Boots, Shoes, Clothing, Wind, Water, Earth & Sky; Wind, Water, Earth & Sky; Elements; Nothing Can Stop You; [GEAR LOGO]; TBL 30; Timberland 1049; Trail Grip; and Tims. The Company regards its trade name and trademarks as valuable assets and believes that they are important factors in marketing its products, particularly in the case of the Timberland [Registered] brand, which is essential to the Company's integrated brand strategy. It is the policy of the Company to protect and defend vigorously its trade name and trademarks against infringement under the laws of the United States and other countries. In addition, the Company seeks to protect and defend vigorously its patents, designs, copyrights and all other proprietary rights under applicable laws.\nThe Company conducts research, design and development efforts for its footwear, apparel and accessories. During 1994, the Company established an advanced research, design and development team to create and bring new concepts from the design stage to the marketplace in an expedient manner. While Timberland considers itself a leader in product innovation, its expenses relating to research, design and development have not represented a material expenditure relative to other expenses of the Company.\nTimberland tests a number of its products under actual field conditions to evaluate performance characteristics, including testing by members of Team Timberland. Through these and other relationships, Timberland is able to measure the performance of its products in the outdoors and to obtain ideas for improving its products' performance based upon the experience and competitive needs of these athletes.\nCOMPETITION -----------\nThe Company does not believe that it has any major competitors who offer a full complement of footwear, apparel and accessories which provide the same quality and performance as Timberland's integrated brand. The Company does, however, have a variety of separate major competitors in sales of its separate lines of footwear, apparel and accessories.\nThe Company's footwear lines are marketed in a highly competitive environment, and the footwear industry is subject to rapid changes in consumer preference. Although the footwear industry is fragmented to a great degree, many of the Company's competitors are larger and have substantially greater resources than the Company, including athletic shoe companies, many of which compete directly with the Company's products. In addition, the Company faces competition from retailers that are establishing products under private labels which compete with the Company's products.\nThe Company has at least five major competitors in classic boot sales, at least four major competitors in sport boot sales and at least six major competitors in hiking boot and performance sandal sales. Boat shoes produced by the Company face competition from at least five companies and other casual shoes produced by the Company face competition from at least eight other companies. The Company's major competitors for its footwear products are located principally in the United States. Internationally, the Company faces competition from many manufacturers of footwear. As in the United States, some of these manufacturers attempt to imitate the Company's styles.\nThe Company's line of men's apparel faces competition from at least three major apparel companies in the United States and from a variety of major apparel companies internationally. The Company's line of women's apparel faces competition from at least four major apparel companies in the United States and from several major apparel companies internationally.\nThe Company's men's and women's lines of footwear and apparel also face competition from at least two direct mail companies in the United States.\nThe Company's accessories line faces competition from at least seven major companies in the United States and from several major accessories companies internationally.\nProduct performance and quality, including continuing technological improvements, product identity through marketing and promotion, and product design, styling and pricing are all important elements of competition in the footwear, apparel and accessories markets served by the Company. Although changing fashion trends generally affect demand for particular footwear, apparel and accessories products, the Company believes that, because Timberland [Registered] products are designed primarily for functionality and performance, demand for Timberland products is less sensitive to changing trends in fashion than is demand for other products that are designed specifically to meet such trends.\nENVIRONMENTAL MATTERS ---------------------\nCompliance with federal, state and local environmental regulations have not had, nor are they expected to have, any material effect on the capital expenditures, earnings or competitive position of the Company.\nEMPLOYEES ---------\nAs of December 31, 1994, the Company had approximately 6,700 employees worldwide. Management considers its employee relations to be good. None of the Company's employees is represented by a labor union, and the Company has never suffered a material interruption of business caused by labor disputes.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns a facility in Hampton, New Hampshire which served as the Company's headquarters until November 1994 and currently is used for warehousing and distribution of certain of the Company's products. In connection with the purchase financing for such property, industrial revenue bonds are outstanding in the principal amount of $5,345,000.\nThese bonds are due in 2014 and bear interest at 6.20% through 1999 and thereafter at rates adjusted every five years, through maturity. These bonds are collateralized by a mortgage on such real estate and by a security interest on assets located there.\nThe Company also leases facilities in Danville, Kentucky and Wilmington, Massachusetts, for the distribution of certain products, under lease agreements which expire in January 1999 and April 1996, respectively.\nIn April 1994, the Company entered into a lease for property in Stratham, New Hampshire, that has served, since November 1994, as its principal executive offices. This lease expires in July 1999, with options to extend the expiration. The Company considers its current headquarters facilities adequate and suitable for its present needs. The Company leases its production facilities, which are located in Mountain City, Tennessee; Boone, North Carolina; Isabela, Puerto Rico; and Santiago, Dominican Republic. These production facilities are occupied under 13 leasing arrangements which expire at various times from November 1995 to February 1998. The Company is currently evaluating the suitability of its production facilities for its present and future needs. See \"Business--Manufacturing.\"\nThe Company leases 15 domestic specialty stores, seven international specialty stores, six domestic showrooms, 19 domestic factory stores, and three international factory stores. See \"Business--Distribution.\"\nThe Company's subsidiaries also lease office and warehouse spaces to meet their individual requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in various litigation and legal matters, including United States customs claims, which have arisen in the ordinary course of business. Management believes that the ultimate resolution of any existing matter will not have a material adverse effect on the Company's financial statements.\nOn June 21, 1994, the plaintiff in the stockholder lawsuit filed on February 15, 1994, against the Company and one of its officers, agreed voluntarily to withdraw the action, and the case was dismissed.\nThe Company and two of its officers and directors have been named as defendants in two actions filed in the United States District Court for the District of New Hampshire, one filed by Jerrold Schaffer on December 12, 1994, and the other filed by Gershon Kreuser on January 4, 1995. The suits, which are each brought by purchasers of the Company's Class A Common Stock (\"Common Stock\"), allege that the defendants violated the federal securities laws by making material misstatements and omissions in the Company's public filings and statements in 1994. Specifically, the complaints allege that such statements and omissions had the effect of artificially inflating the market price for the Company's Common Stock until the disclosure by the Company on December 9, 1994, of its expectation that results for the fourth quarter were not likely to meet analysts' anticipated levels. The suits seek class action status, with the SCHAFFER complaint embracing all purchasers of the Company's Common Stock between October 25, 1994 and December 9, 1994, and the KREUSER complaint including such purchasers between February 15, 1994 and December 9, 1994. Damages are unspecified. The plaintiffs have filed a motion, assented to by the defendants, to consolidate the two suits. The motion is pending before the District Court.\nWhile each action is in its preliminary stages, based on an initial review, and after consultation with counsel, management believes the allegations are without merit. Accordingly, management does not expect the outcome of such litigation to have a material adverse effect on the financial statements. The Company intends to defend these proceedings vigorously.\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 report, no matter was submitted to a vote of security holders through the solicitation of proxies or otherwise.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following information is submitted as to the executive officers of the Company:\nAll executive officers serve at the discretion of the Board of Directors.\nSidney W. Swartz has served the Company as Chairman of the Board, Chief Executive Officer and President since June 1986 when he and his family trust became the then sole stockholders of the Company. During the prior 20 years, Mr. Swartz, as the owner of 50% of the Company, was responsible for the manufacturing, marketing, distribution and financial aspects of the Company.\nJeffrey B. Swartz has served the Company as Executive Vice President since March 1990 and Chief Operating Officer since May 1991. From June 1986 to February 1990, Mr. Swartz served the Company in a variety of positions, including Senior Vice President of International Operations, Vice President-Operations\/Manufacturing, Vice President-International and General Manager of International Business. Jeffrey Swartz is the son of Sidney W. Swartz.\nKeith D. Monda joined the Company in December 1993 as Senior Vice President-Finance and Administration and Chief Financial Officer. From May 1990 to December 1993, Mr. Monda was Executive Vice President of Finance and Administration of J. Crew Group, Inc.; from July 1989 to May 1990, he was Senior Vice President and Chief Financial Officer of Bunge Corporation (an integrated food company); and from April 1986 to July 1989, he was Vice President of Finance and Chief Financial Officer of the Chemical Division of Pfizer, Inc.\nEdmund J. Feeley joined the Company in February 1993 as Senior Vice President-Manufacturing and Operations. Effective January 1, 1995, Mr. Feeley became Senior Vice President-General Manager Footwear. From May 1990 to January 1993, Mr. Feeley was a Principal of Booz, Allen and Hamilton, a general management and consulting firm, where he had also been a Senior Associate from May 1987 to April 1990.\nDon S. Maurer joined the Company in June 1994 as Senior Vice President-Worldwide Marketing. From July 1991 to May 1994, Mr. Maurer was Senior Vice President and Director of Account Management of Mullen Advertising, which has been Timberland's advertising and public relations agency since 1988. From October 1989 to July 1991, Mr. Maurer was the Senior Vice President, Director of Client Services for Margeotes, Fertitta and Weiss, New York.\nGregory W. VanWormer joined the Company in May 1994 as Senior Vice President-Retail. Effective January 1, 1995, Mr. VanWormer became Senior Vice President-General Manager Apparel. From August 1991 to April 1994, Mr. VanWormer was the Vice President-General Merchandise Manager of G.H. Bass & Co.; and from June 1988 to June 1991, he held the following positions with C.M.L. Inc.: Vice President-General Merchandise Manager of Carroll Reed (a retail company); and President of The Gokey Company (a retail, catalog and manufacturing company).\nKenneth A. Snyder joined the Company in June 1990 as Divisional Vice President of Domestic Sales. In February 1991, Mr. Snyder assumed the office of Senior Vice President-Domestic Sales. Effective January 1, 1995, Mr. Snyder became Senior Vice President-Footwear Sales. From October 1989 to May 1990, Mr. Snyder was Vice President of Sales of New Balance Athletic Company; and from November 1988 to September 1989, he was Vice President of Sales of Stride Rite Corporation.\nDennis W. Hagele joined the Company in October 1994 as Vice President- Finance and Corporate Controller (Chief Accounting Officer). From July 1993 to September 1994, Mr. Hagele was an independent financial consultant; and from August 1981 to June 1993, he was Assistant Controller of Sara Lee Corporation.\nJane E. Owens joined the Company in September 1992 as Vice President and General Counsel. From June 1990 to August 1992, Ms. Owens was Counsel for Reebok International Ltd.; and from March 1988 to June 1990, she was a partner in the law firm of Gaston & Snow.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required by this item is included in the Registrant's 1994 Annual Report to Stockholders under the caption \"Quarterly Market Information and Related Matters\" and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is included in the Registrant's 1994 Annual Report to Stockholders under the caption \"Five Year Summary of Selected Financial Data\" and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this item is included in the Registrant's 1994 Annual Report to Stockholders under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" 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 included in the Registrant's 1994 Annual Report to Stockholders 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\nReference is made to the information set forth under the caption, \"Executive Officers of the Registrant,\" in Item 4A of Part I of this report and to information under the caption, \"Information with Respect to Nominees\" in the Registrant's definitive proxy statement (the \"Registrant's 1995 Proxy Statement\") relating to its 1995 Annual Meeting of Stockholders, to be filed with the Commission within 120 days after the close of the Registrant's fiscal year ended December 31, 1994, which information is incorporated herein by reference. Reference is also made to the information set forth in the Registrant's 1995 Proxy Statement with respect to compliance with Section 16(a) of the Exchange Act, 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 \"Executive Compensation,\" in the Registrant's 1995 Proxy Statement, 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 caption, \"Security Ownership of Certain Beneficial Owners and Management,\" in the Registrant's 1995 Proxy Statement, which information is incorporated herein by reference. For purposes of calculating the aggregate market value of the Class A Common Stock on March 15, 1995, the shares owned by The Sidney W. Swartz 1982 Family Trust, The Swartz Foundation and The Sidney and Judith Swartz Charitable Remainder Unitrust have not been considered to have been owned by an affiliate.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to the information set forth under the caption, \"Certain Relationships and Related Transactions,\" in the Registrant's 1995 Proxy Statement, which information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nList of Financial Statements and Financial Statement Schedules.\n(a)(1) Financial Statements. The following financial statements appearing in the Company's Annual Report to Stockholders for the year ended December 31, 1994, are incorporated by reference in this Form 10-K:\nFor the years ended December 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 have therefore been omitted.\n(b) No reports on Form 8-K were filed by the Company during the fourth quarter of 1994.\n(c) Listed below are all the Exhibits filed as part of this Report, some of which are incorporated by reference from documents previously filed by the Company with the Securities and Exchange Commission in accordance with the provisions of Rule 12b-32 of the Securities Exchange Act of 1934, as amended.\n------------------------\n(1) Filed as an exhibit to Registration Statement on Form S-1, numbered 33-14319, and incorporated herein by reference.\n(2) Filed on July 9, 1991, as an exhibit to Registration Statement on Form S-8, numbered 33-41660, and incorporated herein by reference.\n(3) Filed as an exhibit to the Annual Report on Form 10-K for the fiscal year-ended December 31, 1991, and incorporated herein by reference.\n(4) Filed as an exhibit to the Annual Report on Form 10-K for the fiscal year-ended December 31, 1992, and incorporated herein by reference.\n(5) Filed as an exhibit to the Annual Report on Form 10-K for the fiscal year-ended December 31, 1993, and incorporated herein by reference.\n(6) Filed as an exhibit to the Quarterly Report on Form 10-Q for the fiscal period ended July 1, 1994, and incorporated herein by reference.\nPursuant to paragraph 4(iii) of Item 601, Regulation S-K, the Registrant has filed as Exhibits only the instruments defining the rights of holders of long-term debt of the Registrant and its consolidated subsidiaries with respect to which the total amount of securities authorized thereunder exceeds 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant agrees to furnish to the Commission upon its request copies of other instruments defining the rights of holders of long-term debt of the Registrant and its subsidiaries, with respect to which the total amount does not exceed 10% of such assets. The Registrant also agrees to furnish to the Commission upon its request copies of any omitted schedule or exhibit to any Exhibit filed herewith.\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.\nTHE TIMBERLAND COMPANY\nMarch 29, 1995 By: \/S\/ Sidney W. Swartz ---------------------------- Sidney W. Swartz, President\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this 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(d) INDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of The Timberland Company:\nWe have audited the consolidated financial statements of The Timberland Company as of December 31, 1994 and 1993, and for the three years in the period ended December 31, 1994, and have issued our report thereon dated February 9, 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 consolidated financial statements schedule of The Timberland Company, listed in Item 14. This financial 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.\n\/S\/ DELOITTE & TOUCHE LLP\nBoston, Massachusetts February 9, 1995\nSCHEDULE VIII\nTHE TIMBERLAND COMPANY\nVALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\n-------------------------------------------------------\nTimberland;[Tree Logo]; HydroTech; Weathergear; More Quality Than You May Ever Need; Where Is Your Outdoors?; Active Comfort Technology; ACT; Toporelief; Topozoic; Boots, Shoes, Clothing, Wind, Water, Earth & Sky; Wind, Water, Earth & Sky; Elements; Nothing Can Stop You;[Gear Logo]; TBL 30; Timberland 1049; Trail Grip; and Tims are trademarks or registered trademarks of The Timberland Company.\nIditarod is a registered trademark of the Iditarod Trail Committee, Inc.\n[Copyright]The Timberland Company 1995 All Rights Reserved.","section_15":""}
{"filename":"316709_1994.txt","cik":"316709","year":"1994","section_1":"Item 1. Business\n(a) General Development of Business. The Charles Schwab Corporation -------------------------------- (CSC) is a holding company engaged, through its subsidiaries, in securities brokerage and related investment services. CSC's principal operating subsidiary, Charles Schwab & Co., Inc. (Schwab), serves an estimated 42% of the discount brokerage market as measured by commission revenues. Another subsidiary, Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq securities, provides trade execution services to broker-dealers and institutional customers. During 1994, orders handled by M&S totaled over 5 billion shares, or over 6% of the total shares traded on Nasdaq. As used herein, the \"Company\" refers to CSC and subsidiaries. Schwab was incorporated in California in 1971 and adopted the name Charles Schwab & Co., Inc. after Mr. Charles R. Schwab became its owner and President. In September 1987, the Company raised $123 million in its initial public offering. Since becoming a publicly- owned entity, the Company has experienced significant growth in revenues, customer assets and number of accounts. This growth has been accomplished through investment in technology, product and service development, marketing programs and customer service delivery systems. In addition, the Company has broadened its service capability through the acquisition and development of additional businesses. In October 1989, Charles Schwab Investment Management, Inc. (CSIM) was formed as a subsidiary of CSC. In January 1990, CSIM became the general investment adviser (employing a sub-adviser to perform portfolio management for certain funds), as well as the administrator for three money market funds. Substantially all of the balances previously invested by Schwab customers in other money market funds having similar investment objectives were transferred to these money market funds in January 1990. Schwab subsequently introduced additional mutual funds. The Company refers to all funds for which CSIM is the investment adviser as the SchwabFunds (registered trademark). In response to the continued growth of customer trading activity in Nasdaq securities and a desire to secure a capability to execute customer trades in these and other securities, CSC acquired M&S in July 1991. Since the acquisition, M&S has executed substantially all the Nasdaq security trades originated by the customers of Schwab, which in 1994 accounted for approximately 17% of Schwab's total trading volume. Principal transaction revenues generated by M&S have contributed significantly to the Company's operating results. During July 1992, Schwab introduced nationally its no-transaction- fee mutual fund service, known as the Mutual Fund OneSource (trademark) service, which at December 31, 1994, enabled customers to trade 280 mutual funds in 28 well-known fund families without incurring brokerage transaction fees. In March 1992, CSC opened The Charles Schwab Trust Company (CSTC), which provides custody services for independent investment managers and serves as trustee for employee benefit plans (primarily 401(k) plans). CSTC's primary focus is to provide services to fee-based independent investment managers and 401(k) plan record keepers and administrators.\nDevelopments During 1994 and Early 1995\nDuring 1994, the Company experienced record revenues, net income and customer account openings. Net income for 1994 was $135 million, or $1.54 per share, up from $118 million, or $1.32 per share, in 1993, after a $.07 per share extraordinary charge for early debt retirement, and $81 million, or $.92 per share, in 1992. Schwab opened 736,000 new accounts during 1994, which contributed significantly to the $26.8 billion, or 28%, increase in assets held in Schwab customer accounts. The Company invested $32 million in various capital expenditures during 1994, including enhancements to its data processing and telecommunications systems, and a fourth regional customer telephone service center. The Company also opened 10 branch offices and made improvements to certain existing office facilities. Several financing transactions were completed during 1994. The Company repurchased 2,499,600 shares of its common stock for $47 million, prepaid its $35 million Senior Term Loan due in March 1995 and terminated a related interest rate exchange arrangement, issued $20 million in Medium-Term Notes and paid common stock dividends of $16 million. During the second half of 1994, Schwab commenced operation of five specialists' posts on the Pacific Stock Exchange. These posts make markets in over 240 common stocks. The Company expects to continue to expand its capacity to provide principal execution services to customers. In July 1994, the Securities and Exchange Commission (SEC) approved a National Association of Securities Dealers, Inc. (NASD) Interpretation to its Rules of Fair Practice governing the way in which market makers in Nasdaq securities handle the execution of limit orders accepted from certain types of customers. M&S has extended the benefits of the Interpretation to substantially all retail customer limit orders in Nasdaq securities received from broker-dealers for which it executes such orders. This Interpretation has caused principal transaction revenues to decline. Additional rule changes in this area currently under consideration by the NASD, such as the proposed Aqcess system, also may adversely impact principal transaction\n- 1 -\nrevenues. See also \"Regulation\" below. In December 1994, a $100 million letter of credit facility was established by CSC with a commercial bank to issue letters of credit (LOCs) to three of the SchwabFunds (registered trademark) money market funds. CSC has agreed to reimburse the bank for any payments made under the LOCs. At December 31, 1994, LOCs totaling $58.5 million were outstanding under this facility. See \"Commitments, Contingent Liabilities and Other Information\" in the Notes to Consolidated Financial Statements in the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report. In January 1995, the Company's Board of Directors declared a three- for-two stock split of the Company's common stock, effected in the form of a 50% stock dividend, payable March 1, 1995 to stockholders of record February 1, 1995. Share information throughout this report has been restated to reflect this transaction. Also in January 1995, the Board increased the Company's quarterly cash dividend 29% to $.060 per share payable February 15, 1995 to stockholders of record February 1, 1995. In the first quarter of 1995, Schwab's Mutual Fund OneSource (trademark) service was expanded and now includes over 335 mutual funds in 38 well-known fund families. In addition, Schwab introduced FundMap (trademark), a mutual fund selection software for Windows (registered trademark).\n(b) Financial Information About Industry Segments. The Company ----------------------------------------------- operates in a single industry segment: securities brokerage and related investment services. No material part of the Company's consolidated revenues is received from a single customer or group of customers, or from foreign operations. As of December 31, 1994, approximately 28% of Schwab's total customer accounts were located in California. The next highest geographic concentrations of total customer accounts were approximately 7% in each of New York and Florida.\n(c) Narrative Description of Business. Schwab provides securities ---------------------------------- brokerage and related investment services to more than 3.0 million active investor accounts. These accounts held $122.6 billion in assets at December 31, 1994. M&S operates four offices in four states offering trade execution services for Nasdaq securities to broker- dealers, including Schwab, and institutional customers. Schwab's primary focus is serving retail clients who seek a wide selection of quality investment services at fees that, in most cases, are substantially lower than those of full-commission firms. The table on the following page sets forth on a comparative basis the Company's revenues for the three years ended December 31, 1994. These revenue figures reflect developments in, and the composition of, the Company's business. Schwab provides its customers, most of whom are retail investors, with convenient and prompt execution of their orders to purchase and sell securities, and with rapid access to market-related information. A key to both the quality and speed of Schwab's service and to its ability to provide commission discounts is its sophisticated communications and information processing systems. Schwab primarily serves investors who wish to conduct their own research and make their own investment decisions and do not wish to pay, through brokerage commissions, for research or portfolio management. To attract and accommodate investors who want research and portfolio management services, however, Schwab offers a variety of fee-based (primarily third-party) research and portfolio management products. This customer segment has become increasingly significant to Schwab's growth in customer assets and accounts. During 1994, Schwab customer assets held in customer accounts managed by independent investment managers increased $9.7 billion (42%) to a total of $32.6 billion. Although Schwab does not generally maintain inventories of securities for sale to its customers or engage in principal transactions with its customers, it has recently expanded, through the acquisition of specialists' posts on the Pacific Stock Exchange, its capability to execute customer orders in listed securities on a principal basis. Other instances where Schwab acts as principal include: (1) having temporary positions resulting from execution errors, unavailability of the various exchanges' automated trade execution facilities or nonpayment by customers, (2) positioning of listed securities to accommodate institutional customers, and (3) engaging in certain riskless principal and other similar transactions where, in response to a customer order, Schwab will purchase securities (generally municipal and government securities) from another source and resell them to customers at a markup. Schwab's customer service delivery systems reduce dependency on the need for personal relationships between Schwab's customers and employees to generate orders. Schwab does not generally assign customers to individual employees. Each customer-contact employee has immediate access to the customer account and market-related information necessary to respond to any customer's inquiries, and for most customer orders, can enter the order and confirm the transaction. Customer orders involving certain types of transactions, such as those in fixed income securities and mutual funds, are handled by separate groups of registered representatives that specialize in such transactions. As a result of this approach, the departure of a registered representative generally does not result in a loss of customers for the firm. As a market maker in Nasdaq securities, M&S generally executes customer trades as principal. M&S business practices call for competitively priced customer executions generally defined as the highest bid price on a sell order and the lowest offer price on a buy order quoted through the network of NASD member firms that are market makers.\n- 2 -\nSources of Revenues (Dollar amounts in thousands)\nCustomer trades exceeding certain sizes are executed on a negotiated basis. In the normal course of its market-making activities, M&S maintains inventories in Nasdaq securities on both a \"long\" and \"short\" basis. While long inventory positions represent M&S' ownership of securities, short inventory positions represent obligations of M&S to deliver specified securities at a contracted price, which may differ from market prices prevailing at the time of completion of the transaction. Accordingly, long or short inventory positions may result in gains or losses to M&S as market values of these securities fluctuate. The securities brokerage industry is directly affected by fluctuations in volumes and price levels of securities transactions generally, which are affected by many national and international economic and political factors that cannot be predicted, including broad trends in business and finance, legislation and regulation affecting the United States and international business and financial communities, currency values, and the level and volatility of interest rates. Sustained low volumes of retail investment activity or of securities transactions generally, particularly if accompanied by low securities prices, could substantially reduce the Company's transaction-based revenues and could lead to reduced margin account balances, thus reducing interest revenue as well. Shifts in customer investment vehicle preferences from individual equity securities to products that have lower commissions per transaction, such as mutual funds, could also reduce transaction-based revenues. In connection with its information processing systems, its branch office network, its regional customer telephone service centers and other aspects of its business, the\n- 3 -\nCompany incurs substantial expenses that do not vary directly, at least in the short term, with fluctuations in securities transaction volumes and revenues. In the event of a material reduction in revenues, the Company may not reduce such expenses quickly and, as a result, the Company could experience reduced profitability or losses. Conversely, sudden surges in transaction volume can result in increased profits and profit margins. To ensure that it has the capacity to process projected increases in transaction volumes, the Company has historically made substantial capital and operating expenditures in advance of such projected increases, including during periods of low transaction volumes. In the event that such growth in transaction volumes does not occur, the expenses related to such investments could, as they have in the past, cause reduced profitability or losses.\nCompetition\nThe Company encounters rigorous competition from full-commission and discount brokerage firms, as well as from financial institutions, mutual fund sponsors, market makers in Nasdaq securities and other organizations. The general financial success within the securities industry over the past several years has strengthened existing competitors, and management believes that such success will continue to attract additional competitors such as banks, insurance companies and providers of on-line financial and information services. Some of these competitors are larger, more diversified, have greater capital resources, and offer a wider range of services and financial products than the Company. Particularly as financial services and products proliferate, to the extent such competitors are able to attract and retain customers on the basis of the convenience of one- stop shopping, the Company's business or its ability to grow could be adversely affected. In many instances, the Company is competing with such organizations for the same customers. Management believes that the main competitive factors are quality, convenience, price of services and products offered, and breadth of product line. Most discount brokerage firms charge commissions lower than Schwab. Full-commission brokerage firms also offer discounted commissions to selected retail brokerage customers. Many brokerage firms employ substantial funds in advertising and direct solicitation of customers to increase their market share of commission dollars and other securities-related income. If the well-capitalized brokerage firms pursue these competitive strategies successfully, Schwab's new account growth, commission revenues and profit margins could be adversely affected.\nMarketing and Promotion\nAdvertising plays a crucial role in obtaining new customers, which have constituted an important source of revenue and revenue growth for the Company. The Company's advertising and market development expense for the years ended December 31, 1994, 1993 and 1992 was $36 million, $41 million and $34 million, respectively. For the same years, the numbers of new accounts opened were approximately 736,000, 706,000 and 562,000, respectively. New account openings represent a significant portion of the growth in customer assets, which the Company believes is critical to growth in revenues. Accounts opened during 1994, 1993 and 1992 generated approximately 14%, 16% and 18% of total commission revenues during each of those years, respectively. The branch office network also plays a key role in building Schwab's business. Many customers prefer to open accounts in person in Schwab branch offices. With the customer service support of the regional customer telephone service centers and TeleBroker (registered trademark), branch personnel are able to focus a significant portion of their time on business development. Branch training programs and compensation plans emphasize identifying customer needs that can be satisfied with Schwab products and services, and increasing customer assets held in Schwab accounts. Schwab advertises regularly in financially-oriented newspapers and periodicals and occasionally in general circulation publications. Schwab advertisements appear regularly on national and local cable television and periodically on radio and independent television stations. Schwab employs volume-buying and other strategies to minimize the expense of broadcast advertising. Through these broadcast-buying strategies and by using Schwab employees to produce and buy print advertising, management believes Schwab realizes savings on its promotional expenses. Schwab also engages extensively in targeted direct mail advertising through monthly statement \"inserts\" and special mailings. Such efforts have increased Schwab's brand awareness among investors. In its advertising, as well as in promotional events such as press appearances, Schwab has aggressively promoted the name and likeness of its Chairman, Mr. Schwab. The Company believes there is a substantial benefit related to Mr. Schwab's association with the Company. The Company has an agreement with Mr. Schwab by which he, subject to certain limitations, has assigned to the Company and Schwab all service mark, trademark, and trade name rights in his name (and variations thereon) and likeness.\n- 4 -\nProducts and Services\nAccounts and Features. Each Schwab customer has a ---------------------- brokerage account through which securities may be purchased or sold. If approved for margin transactions, a customer may borrow a portion of the price of certain securities purchased through Schwab, or may sell securities short. Customers must have specific approval to trade options; as of December 31, 1994, approximately 149,000 accounts were so approved. To write uncovered options, customers must go through an additional approval process and must maintain a significantly higher level of equity in their brokerage accounts. Because Schwab does not pay interest on cash balances in basic brokerage accounts, it provides customers with an option to have cash balances in their accounts automatically swept into certain SchwabFunds (registered trademark) money market funds. In July 1994, Schwab instituted a $1,000 cash and\/or securities minimum opening balance requirement for basic brokerage accounts. A customer may receive additional services by qualifying for and opening a Schwab One (registered trademark) brokerage account. A customer may remove available funds from his or her Schwab One account either with a personal check or a VISA debit card. If a Schwab One customer is approved for margin trading, which most are, the checks and debit card also provide access to margin cash available. For cash balances awaiting investment, Schwab pays interest to Schwab One customers at a discretionary rate of interest. Alternatively, Schwab One customers seeking tax-exempt income may elect to have cash balances swept into one of three tax-exempt SchwabFunds money market funds. During 1994, the number of active Schwab One accounts increased 17% and the customer assets in all Schwab One accounts increased 26%. The Company considers customer accounts with cash balances, positions or trading activity within the preceding twelve months to be active. Schwab acts as custodian, as well as broker, for Individual Retirement Accounts (IRAs). In Schwab IRAs, cash balances are swept daily into one of three SchwabFunds money market funds. During 1994, active IRAs increased 26% and customer assets in all IRAs increased 29%. Schwab also acts as custodian and broker for Keogh accounts. During 1994, Schwab expanded its Schwab 500 Brokerage (trademark) service to attract and retain customers who trade frequently. This service provides discounts from Schwab's standard commission rates as well as customized services and information resources.\nCustomer Financing. Customers' securities transactions are effected ------------------- on either a cash or margin basis. Generally, a customer buying securities in a cash-only brokerage account is required to make payment by settlement date, usually five business days after the trade is executed. However, for purchases of certain types of securities, such as mutual fund shares, a customer must have a cash or money market fund balance in his or her account sufficient to pay for the trade prior to execution. When selling securities, a customer is required to deliver the securities, and is entitled to receive the proceeds, on settlement date. In an account authorized for margin trading, Schwab may lend its customer a portion of the market value of certain securities up to the limit imposed by the Federal Reserve Board, which for most equity securities is initially 50%. Such loans are collateralized by the securities in the customer's account. \"Short\" sales of securities represent sales of borrowed securities and create an obligation to purchase the securities at a later date. Customers may sell securities \"short\" in a margin account subject to minimum equity and applicable margin requirements and the availability of such securities to be borrowed and delivered. Interest on margin loans to customers provides an important source of revenue to Schwab. During the year ended December 31, 1994, Schwab's outstanding margin loans to its customers averaged approximately $2.7 billion, up from 1993's average of $2.2 billion. In permitting a customer to engage in transactions, Schwab takes the risk of such customer's failure to meet his or her obligations in the event of adverse changes in the market value of the securities positions in his or her account. Under applicable rules and regulations for margin transactions, Schwab, in the event of such an adverse change, requires the customer to deposit additional securities or cash, so that the amount of the customer's obligation is not greater than specified percentages of the cash and market values of the securities in the account. As a matter of policy, Schwab generally requires its customers to maintain higher percentages of collateral values than the minimum percentages required under these regulations. Schwab may use cash balances in customer accounts to extend margin credit to other customers. Under SEC Rule 15c3-3, the portion of such cash balances not used to extend margin credit (increased or decreased by certain other customer-related balances) must be held in segregated investment accounts. The balances in these segregated investment accounts must be invested in qualified interest-bearing securities. To the extent customer cash balances are available for use by Schwab at interest costs lower than Schwab's costs of borrowing from alternative sources (e.g., balances in Schwab One brokerage accounts) or at no interest cost (e.g., balances in other accounts and outstanding checks that have not yet cleared Schwab's bank), Schwab's cost of funds is reduced and its net income is enhanced. Such interest savings contribute substantially to Schwab's profitability and, if a significant reduction of customer cash balances were to occur, Schwab's borrowings from other sources would have to increase and such\n- 5 -\nprofitability would decline. To the extent Schwab's customers elect to have cash balances in their brokerage accounts swept into certain SchwabFunds money market funds, the cash balances available to Schwab for investments or for financing margin loans are reduced. However, Schwab receives mutual fund service fees from such funds based on the daily average invested balances. See also \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" in the Company's 1994 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report, and \"Regulation\" below.\nMutual Funds. CSIM provides investment advisory and administrative ------------- services to the SchwabFunds (registered trademark), which consisted of nine money market funds, including three that were added during 1994, a broad-based equity index fund, an international index fund, an index fund that attempts to track the performance of common stocks of the second 1,000 largest United States corporations and six bond funds at December 31, 1994. Customer assets invested in the SchwabFunds totaled approximately $23.3 billion at December 31, 1994, a 47% increase over the prior year. The Company intends to offer additional mutual funds to its customers in the future. Through its Mutual Fund Marketplace (registered trademark) program, Schwab purchases and redeems for its customers shares of over 900 mutual funds in over 100 fund families sponsored by third parties. At December 31, 1994, the Mutual Fund Marketplace totaled $31.0 billion in customer assets, including $12.5 billion in the Mutual Fund OneSource (trademark) service. The Mutual Fund Marketplace program provides Schwab's customers with the convenience of purchasing and redeeming mutual fund shares with a single telephone call and of using margin credit to purchase most mutual fund shares. Schwab charges a transaction fee on trades placed in the funds included in its Mutual Fund Marketplace (except as described below). Commissions from customer transactions in mutual fund shares comprised approximately 11% of Schwab's total commission revenues in 1994, compared to approximately 9% in 1993 and approximately 8% in 1992. At December 31, 1994, Schwab's Mutual Fund OneSource service enabled customers to trade 280 mutual funds in 28 well-known fund families without incurring brokerage transaction fees. The service is particularly attractive to investors who execute mutual fund trades directly with multiple mutual fund companies to avoid brokerage transaction fees and achieve investment diversity among fund families. While Schwab does not receive transaction fees (commissions) on customer transactions in the Mutual Fund OneSource program, it is compensated directly by the participating funds or their sponsors via fees received for providing record keeping and shareholder services. Such compensation is ongoing, based on daily balances of customer assets invested in the participating funds and held at Schwab.\nMarket Making In Nasdaq Securities. M&S provides trade execution ------------------------------------ services in Nasdaq securities to broker-dealers and institutional customers. These services feature highly automated, competitively priced executions of both Nasdaq and nonNasdaq stocks and warrants. In most instances, customer orders are routed directly to M&S' trading system and are executed automatically.\nServices for Independent Investment Managers. To attract the ------------------------------------------------ business of accounts managed by fee-based independent investment managers, Schwab has a dedicated group through which, among other things, it assigns specific, experienced registered representatives to individual managers and occasionally provides certain research materials for the benefit of the managed accounts. Independent investment managers participating in this program may use SchwabLink (trademark) to access information in their customers' accounts directly from Schwab's computer data bases and to enter their customers' trades on-line. During 1994, Schwab added over 500 independent investment managers to this program, which at December 31, 1994 totaled more than 4,700. Schwab's brokerage business generated by independent investment managers and other professional investors represented approximately 14% of Schwab's total commission revenues in 1994, 11% in 1993 and 10% in 1992. During 1994, CSC acquired Performance Technologies, Inc. (PT), the developer of Centerpiece (registered trademark), an investment software for independent investment managers. PT is located in Raleigh, North Carolina and had 11 employees at December 31, 1994.\nFixed Income. Fixed income investments available through Schwab -------------- include U.S. Treasuries, zero-coupon bonds, listed and OTC corporate bonds, municipal bonds, GNMAs, unit investment trusts and bond mutual funds. Schwab also makes available to its customers certificates of deposit (CDs) with specific financial institutions located in a variety of states. Such institutions pay Schwab fees for its services in making such CDs available and in transmitting funds and performing certain accounting functions. Schwab's customers do not pay any commission or fee when they purchase CDs.\nCustomer Service Delivery Systems\nBranch Office Network. Schwab believes that the existence of branch ---------------------- offices is important to increasing new account openings and maintaining high levels of customer\n- 6 -\nsatisfaction. At December 31, 1994, the Company maintained a network of 208 branches throughout the United States, including a branch office in the Commonwealth of Puerto Rico and the United Kingdom. Schwab plans to continue its branch expansion program in 1995 by opening approximately 20 to 25 new branches. Customers can use branch offices to obtain market information, place orders, open accounts, deliver and receive checks and securities, and obtain related customer services in person, yet most branch activities are conducted by telephone and mail. Branch offices remain open during normal market hours to service customers in person and by telephone. Many branch offices offer extended office hours. Customer calls received during nonbranch hours are routed to regional customer telephone service centers.\nRegional Customer Telephone Service Centers. Schwab's four regional -------------------------------------------- customer telephone service centers, located in Indianapolis, Denver, Phoenix and Orlando, handle calls to many of Schwab's toll-free numbers, customer calls that otherwise would have to wait for available registered representatives at branches during business hours, and calls routed from branches after hours and on weekends. Through the service centers, customers may place orders twenty-four hours a day, seven days a week, except for certain holidays. Customer orders placed during nonmarket hours are routed to appropriate markets the following business day. The capacity of the service centers allows new branches to be opened and maintained at lower staffing levels.\nElectronic Delivery Services. Schwab provides automated brokerage ----------------------------- services through which investors may place orders, receive account information and obtain securities market information. These services are designed to provide added convenience for customers and minimize Schwab's costs of responding to and processing routine customer transactions. Schwab's TeleBroker Service (registered trademark), which enables customers to place orders for stocks, options and certain mutual funds, as well as obtain real-time securities quotes and account information electronically from any touchtone telephone, was introduced in 1989 and was made available to customers nationally during 1991. TeleBroker (registered trademark), which provides customers with an additional 10% discount on commissions, has become increasingly important in providing customers access to Schwab, particularly during periods of heavy customer activity. In 1993, TeleBroker was enhanced to accommodate Mutual Fund OneSource (trademark) transactions. In December 1994 and March 1995, Schwab introduced TeleBroker in Spanish and Mandarin languages, respectively. On-line access to brokerage and investment information services is also available through Schwab's on-line trading software, StreetSmart (trademark) for Windows (trademark) and Macintosh (registered trademark), introduced in October 1993 and July 1994, respectively. During 1994, TeleBroker and other on-line brokerage services handled over half of Schwab's customer calls.\nInformation Systems\nSchwab's operations rely heavily on its information processing and communications systems. Schwab's system for processing a securities transaction is highly automated. Registered representatives equipped with on-line computer terminals can access customer account information, obtain securities prices and related information, and enter orders on-line. Most equity market orders are automatically executed and the representative is able to confirm execution to the customer while on the telephone. A written confirmation is generated automatically and is generally sent to the customer on the next business day. Under normal circumstances, most customer orders are executed without any Schwab employee filling out a single piece of paper. To support its customer service delivery systems, as well as other applications such as clearing functions, account administration, record keeping and direct customer access to investment information, Schwab maintains a sophisticated computer network connecting all of the branch offices and regional customer telephone service centers. Schwab's computers are also linked to the major registered United States securities exchanges, M&S, the National Securities Clearing Corporation and The Depository Trust Company. In 1979, Schwab obtained from Beta Systems, Inc. a non-exclusive license to use its basic software for executing brokerage functions. Since that time, Schwab has made substantial additions and modifications to that program. Schwab's computer systems also support on-line employee training, management information systems, software development activities and telecommunication network control functions. During periods of exceptionally high trading volume, the Company takes steps to provide customer service functions with maximum processing capacity. These steps include rescheduling processing jobs unrelated to customer trading functions and restricting on-line access to the Company's mainframe computer functions. The Company's computer capacity is continuously monitored and efforts are made to achieve an optimal balance between the costs of additional processing capacity and the customer service benefits it provides during high-volume periods. Failure of Schwab's information processing or communications systems for a significant period of time could limit Schwab's ability to process its large volume of transactions accurately and rapidly. This could cause Schwab to be unable to satisfy its obligations to customers and other securities firms, and could result in regulatory\n- 7 -\nviolations. External events, such as an earthquake or power failure, loss of external information feeds, such as security price information, as well as internal malfunctions, such as those that could occur during the implementation of system modifications, could render part of or all such systems inoperative. To enhance the reliability of the system and integrity of data, Schwab maintains carefully monitored backup and recovery functions. These include logging of all critical files intraday, duplication and storage of all critical data outside of its central computer site every 24 hours, and maintenance of facilities for backup and communications in San Francisco. They also include the maintenance and periodic testing of a disaster recovery plan that management believes would permit Schwab to recommence essential computer operations if its central computer site were to become inaccessible. To reduce the exposure to system failures caused by external factors, including earthquakes, the Company relocated its primary data center in 1993 from San Francisco to a newly constructed and owned site in Phoenix.\nClearing and Account Maintenance\nSchwab performs clearing services for all securities transactions in customer accounts. These services involve the confirmation, receipt, execution, settlement and delivery functions involved in securities transactions. Among other things, performing its own clearing services allows Schwab to provide margin loans to customers and use customer cash balances to finance them. During the year ended December 31, 1994, Schwab processed over 11 million trades. Schwab clears the vast majority of customer transactions through the facilities of the National Securities Clearing Corporation or the Options Clearing Corporation. Certain other transactions, such as mutual fund transactions and transactions in securities not eligible for settlement through a clearing corporation, are settled directly with the mutual funds or other financial institutions. Schwab is obligated to settle transactions with clearing corporations, mutual funds and other financial institutions even if Schwab's customer fails to meet his or her obligations to Schwab. In addition, for transactions that do not settle through a clearing corporation, Schwab takes the risk of the other party's failure to settle the trade. See \"Commitments, Contingent Liabilities and Other Information\" in the Notes to Consolidated Financial Statements in the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report. Customer securities are typically held by Schwab in its name, on deposit at one or more of the recognized securities industry depository trust companies, or in the case of government and certain other fixed-income securities and other instruments (e.g., certain limited partnership interests), at a custodial bank. Schwab collects dividends and interest on securities held in its name, making the appropriate credits to customer accounts. Schwab also facilitates exercise of subscription rights on securities held for customers. Schwab arranges for the transmittal of proxy and tender offer materials and company reports to customers.\nEmployees\nAs of December 31, 1994, the Company had approximately 6,500 employees and contractors. This amount includes full-time employees and full-time equivalents for part-time and temporary employees, as well as persons employed on a contract basis. None of the employees are represented by a union, and the Company believes its relations with its employees are good.\nRegulation\nThe securities industry in the United States is subject to extensive regulation under both Federal and state laws. The SEC is the Federal agency charged with administration of the Federal securities laws. Schwab and M&S are registered as broker-dealers with the SEC. Schwab and CSIM are registered as investment advisers with the SEC. Much of the regulation of broker-dealers has been delegated to self- regulatory organizations, principally the NASD and the national securities exchanges such as the New York Stock Exchange, Inc. (NYSE), which has been designated by the SEC as Schwab's primary regulator with respect to its securities activities. The NASD has been designated as M&S' primary regulator by the SEC with respect to its securities activities. During 1994, the American Stock Exchange was Schwab's designated primary regulator with respect to options trading activities. These self-regulatory organizations adopt rules (subject to approval by the SEC) governing the industry and conduct periodic examinations of broker-dealers. Securities firms are also subject to regulation by state securities authorities in the states in which they do business. Schwab is registered as a broker-dealer in 50 states, the District of Columbia and Puerto Rico. M&S is registered as a broker-dealer in 18 states as of December 1994. The principal purpose of regulations and discipline of broker- dealers and investment advisers is the protection of customers and the securities markets, rather than protection of creditors and stockholders of broker-dealers and investment advisers. The regulations to which broker-dealers and investment advisers are subject cover all aspects of the securities business, including sales methods, trading practices among broker-dealers, uses and safekeeping of\n- 8 -\ncustomers' funds and securities, capital structure of securities firms, record keeping, fee arrangements, disclosure to clients, and the conduct of directors, officers and employees. Additional legislation, changes in rules promulgated by the SEC and by self- regulatory organizations or changes in the interpretation or enforcement of existing laws and rules may directly affect the method of operation and profitability of broker-dealers and investment advisers. The SEC, self-regulatory organizations and state securities authorities may conduct administrative proceedings which can result in censure, fine, cease and desist orders, or suspension or expulsion of a broker-dealer or an investment adviser, its officers, or employees. Schwab and M&S have been the subject of such administrative proceedings. The Department of Justice, the SEC and the NASD have during the past year commenced a series of investigations and regulatory actions involving the activities of many market makers in Nasdaq securities. M&S is a significant participant in the Nasdaq market. As a result of such inves- tigations and actions, and possible future regulatory actions, changes are occurring in the manner in which this market conducts its business. Current practices may change as a consequence of rulemaking and improvements in technology or may be subject to increased disclosure requirements. New market systems, if approved, could significantly impact the manner in which business is currently conducted. Schwab and M&S are cooperating with the various investigations and have and will continue to work with regulators to respond to questions related to their businesses. These investigations and regulatory actions may have a material adverse impact on M&S' future business. The Company anticipates that it will adapt to any new market environment and intends to promote practices which are designed to benefit its customers. As registered broker-dealers and NASD member organizations, Schwab and M&S are required by Federal law to belong to the Securities Investor Protection Corporation (SIPC), which provides, in the event of the liquidation of a broker-dealer, protection for securities held in customer accounts held by the firm of up to $500,000 per customer, subject to a limitation of $100,000 on claims for cash balances. SIPC is funded through assessments on registered broker-dealers. In addition, in 1994, Schwab has purchased from private insurers additional account protection of up to $49.5 million per customer, as defined, for customer securities positions only. This account protection has increased from 1993's account protection of $24.5 million. Mutual funds, including money market funds, are considered securities for the purposes of SIPC coverage and the additional coverage. Neither SIPC coverage nor the additional coverage applies to fluctuations in the market value of securities. Schwab is also authorized by the Municipal Securities Rulemaking Board to effect transactions in municipal securities on behalf of its customers and has obtained certain additional registrations with the SEC and state regulatory agencies necessary to permit it to engage in certain other activities incidental to its brokerage business. For example, Schwab is registered with the SEC as a transfer agent in connection with certain services it provides to the SchwabFunds (registered trademark). Margin lending by Schwab and M&S is subject to the margin rules of the Board of Governors of the Federal Reserve System and the NYSE. Under such rules, broker-dealers are limited in the amount they may lend in connection with certain purchases and short sales of securities and are also required to impose certain maintenance requirements on the amount of securities and cash held in margin accounts. In addition, those rules and rules of the Chicago Board Options Exchange govern the amount of margin customers must provide and maintain in writing uncovered options. As a California state-chartered trust company, CSTC is authorized to conduct business in California, and is primarily regulated by the California State Banking Department. Since it provides employee benefit plan trust services, CSTC is also required to comply with the Employee Retirement Income Security Act of 1974 (ERISA) and, consequently, is subject to oversight by both the Internal Revenue Service and Department of Labor. CSTC is required under ERISA to maintain a fidelity bond for the protection of employee benefit trusts for which it serves as trustee. Charles Schwab Limited, a subsidiary of Schwab, is registered as an arranger with the Securities and Futures Authority in the United Kingdom, and engages in business development activities on behalf of Schwab.\nNet Capital Requirements\nAs registered broker-dealers, Schwab and M&S are subject to the Uniform Net Capital Rule (Rule 15c3-1) promulgated by the SEC (the Net Capital Rule), which has also been adopted through incorporation by reference in NYSE Rule 325. Schwab is a member firm of the NYSE and the NASD, and M&S is a member firm of the NASD. The Net Capital Rule specifies minimum net capital requirements for all registered broker- dealers and is designed to measure financial integrity and liquidity. Failure to maintain the required net capital may subject a firm to suspension or expulsion by the NYSE and the NASD, certain punitive actions by the SEC and other regulatory bodies, and ultimately may require a firm's liquidation. Because CSC itself is not a registered broker-dealer, it is not subject to the Net Capital Rule. However, Schwab's failure to maintain specified levels of net capital would constitute a default by CSC under certain debt covenants.\n- 9 -\n\"Net capital\" is essentially defined as net worth (assets minus liabilities), plus qualifying subordinated borrowings, less certain deductions that result from excluding assets that are not readily convertible into cash and from conservatively valuing certain other assets. These deductions include charges that discount the value of firm security positions to reflect the possibility of adverse changes in market value prior to disposition. The Net Capital Rule requires notice of equity capital withdrawals to be provided to the SEC prior to and subsequent to withdrawals exceeding certain sizes. Such rule prohibits withdrawals that would reduce a broker-dealer's net capital to an amount less than 25% of its deductions required by the Net Capital Rule as to its security positions. The Net Capital Rule also allows the SEC, under limited circumstances, to restrict a broker-dealer from withdrawing equity capital for up to 20 business days. Schwab and M&S have elected the alternative method of calculation under paragraph (a)(1)(ii) of the Net Capital Rule, which requires a broker-dealer to maintain minimum net capital equal to 2% of its \"aggregate debit items,\" computed in accordance with the Formula for Determination of Reserve Requirements for Brokers and Dealers (SEC Rule 15c3-3). \"Aggregate debit items\" are assets that have as their source transactions with customers, primarily margin loans. Under the alternative method of the Net Capital Rule, a broker-dealer may not (a) pay, or permit the payment or withdrawal of, any subordinated borrowings or (b) pay cash dividends or permit equity capital to be removed if, after giving effect to such payment, withdrawal, or removal, its net capital would be less than 5% of its aggregate debit items. Under NYSE Rule 326, Schwab is required to reduce its business if its net capital is less than 4% of aggregate debit items for more than 15 consecutive business days; NYSE Rule 326 also prohibits the expansion of business if net capital is less than 5% of aggregate debit items for more than 15 consecutive business days. The provisions of NYSE Rule 326 also become operative if capital withdrawals (including scheduled maturities of subordinated borrowings during the following six months) would result in a reduction of a firm's net capital to the levels indicated. If compliance with applicable net capital rules were to limit Schwab's or M&S' operations and Schwab's ability to repay its subordinated debt to the Company, this in turn could limit the Company's ability to repay debt, pay cash dividends and purchase shares of its outstanding stock. See \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" in the Company's 1994 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. At December 31, 1994, Schwab was required to maintain minimum net capital under the Net Capital Rule of $61 million and had total regulatory net capital of $315 million. At December 31, 1994, the amounts in excess of 2%, 4% and 5% of aggregate debit items were $254 million, $194 million and $164 million, respectively. At December 31, 1994, M&S was required to maintain minimum net capital under the Net Capital Rule of $1 million and had total regulatory net capital of $5 million. At December 31, 1994, the amount in excess of 2% of aggregate debit items exceeded $4 million. CSTC's capital requirement is established by the California Superintendent of Banks under the California Financial Code. The Code requires that CSTC's ratio of contributed capital, as defined, to accumulated deficit shall exceed 2.5 to 1. At December 31, 1994, the ratio of contributed capital to accumulated deficit was 2.7 to 1. If CSTC's capital declines, or if the Superintendent of Banks determines that additional capital is required for other reasons, CSC could be required to contribute additional capital to CSTC.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's corporate headquarters are located in a 28-story building at 101 Montgomery Street in San Francisco. The building contains approximately 296,000 square feet and is leased by Schwab under a term expiring in the year 2000. The current rental is approximately $8.7 million per year, subject to certain increases and obligations to pay certain operating expenses such as utilities, insurance and taxes. Schwab has three successive five-year options to renew the lease at the then market rental value. Schwab also leases space in other buildings for its San Francisco operations aggregating approximately 380,000 square feet at year-end 1994. M&S' headquarters are located in leased office space in Jersey City, New Jersey. The Company's primary data center is located in Phoenix in a 105,000 square feet facility owned by the Company. All of Schwab's branch offices and regional customer telephone service centers and M&S' branch offices are located in leased premises, generally with lease expiration dates five to ten years from inception.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe information required to be furnished pursuant to this item is set forth under the caption \"Commitments, Contingent Liabilities and Other Information\" in the Notes to the Consolidated Financial Statements in the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report.\n- 10 -\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 1994.\nItem 4a. Executive Officers of the Registrant\nSee Item 10 in Part III of this report.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe Company's common stock is listed on the New York and Pacific Stock Exchanges under the ticker symbol SCH. The number of common stockholders of record as of February 10, 1995 was 1,909. The other information required to be furnished pursuant to this item is set forth under the caption \"Quarterly Financial Information (Unaudited)\" in the Company's 1994 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information required to be furnished pursuant to this item is set forth under the captions \"Operating Results (for the year),\" \"Other (at year end)\" and \"Other (for the year)\" in the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required to be furnished pursuant to this item is set forth under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" in the Company's 1994 Annual Report to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of this report. Average balances and interest rates for the fourth quarters of 1994 and 1993 are summarized as follows (dollars in millions):\nAverage net interest margin increased 37 basis points from the fourth quarter of 1993 to the fourth quarter of 1994. Average balances of investments increased 13% and margin loans to customers increased 17% over this same period. The average yield on investments and margin loans to customers increased 188 basis points from the fourth quarter of 1993 to the fourth quarter of 1994. Over this same period, interest-bearing customer cash balances increased 16% and the average interest rate paid on funding sources increased 151 basis points.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information required to be furnished pursuant to this item is set forth in the Consolidated Financial Statements and under the caption \"Quarterly Financial Information (Unaudited)\" in the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report.\n- 11 -\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 directors of the Company required to be furnished pursuant to this item is incorporated by reference from portions of the Company's definitive proxy statement for its annual meeting of stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after December 31, 1994 (the Proxy Statement) under the captions \"Election of Directors\" (excluding all information under the subcaption \"Information about the Board of Directors and Committees of the Board\") and \"Principal Stockholders.\"\nExecutive Officers of the Registrant\nThe following table provides certain information about each of the Company's current executive officers. Executive officers are elected by and serve at the discretion of the Company's Board of Directors. However, Mr. Schwab has an employment agreement which expires on March 31, 1995. A new employment agreement, which has an initial term of five years and renews for an additional year at each anniversary, is scheduled to be submitted to the stockholders for approval at the May 8, 1995 Annual Meeting of Stockholders.\nExecutive Officers of the Registrant\nMr. Schwab has been Chairman and Chief Executive Officer and a director of the Company since its incorporation in November 1986. Mr. Schwab was a founder of Schwab in 1971 and has been its Chairman since 1978. Mr. Schwab is currently a director of The Gap, Inc., Transamerica Corporation, AirTouch Communications and a trustee of The Charles Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab Annuity Portfolios, all registered investment companies.\nMr. Stupski has been Vice Chairman of the Company since July 1992 and a director of the Company since its incorporation in November 1986. Mr. Stupski was Chief Operating Officer of the Company from November 1986 to March 1994 and the Company's President from November 1986 to July 1992. He also served as Chief Executive Officer and Chief Operating Officer of Schwab from July 1988 to July 1992. He served as Vice Chairman of Schwab from July 1992 to August 1994.\n- 12 -\nMr. Pottruck has been Chief Operating Officer and a director of the Company since March 1994, President of the Company and Chief Executive Officer of Schwab since July 1992, and President of Schwab since July 1988. Mr. Pottruck was Executive Vice President of the Company and Schwab from March 1987 to July 1992. Mr. Pottruck joined Schwab in March 1984.\nMr. Coghlan has been Executive Vice President of the Company and Schwab and General Manager of Schwab Institutional since July 1992. Mr. Coghlan joined Schwab in January 1986, became a Vice President in 1988 and became Senior Vice President in 1990.\nMr. Gambs has been Executive Vice President and Chief Financial Officer of the Company and Schwab since he joined the Company in March 1988.\nMs. Lepore has been Executive Vice President and Chief Information Officer of the Company and Schwab since October 1993. Ms. Lepore joined Schwab in September 1983 and became Senior Vice President in 1989.\nMr. Readmond has been Executive Vice President of the Company and Vice Chairman of Schwab since January 1995. From July 1992 to January 1995, he was Senior Executive Vice President of the Company and Schwab, as well as Chief Operating Officer of Schwab. From the time that Mr. Readmond joined the Company in August 1989 until July 1992, he was Executive Vice President - Operations, Trading and Credit of the Company and Schwab.\nMs. Sawi has been President of Charles Schwab Investment Management, Inc., Executive Vice President - Mutual Funds of the Company and Schwab since April 1994. Prior to that, she was Executive Vice President - Marketing and Advertising of the Company and Schwab from January 1992 to April 1994. Ms. Sawi joined Schwab in November 1982.\nMr. Seip has been Executive Vice President - Retail Brokerage of the Company and Schwab since January 1995. From April 1994 to January 1995 he was Senior Executive Vice President - Retail Brokerage of the Company and Schwab. He was President of Charles Schwab Investment Management, Inc. (CSIM) from July 1992 to April 1994 and Chief Operating Officer of CSIM from June 1991 to April 1994. From July 1992 to April 1994, he was Executive Vice President - Mutual Funds and Fixed Income Products of the Company and Schwab. Mr. Seip joined Schwab in January 1983. Prior to becoming Senior Vice President of Schwab and assuming his mutual fund responsibilities in June 1991, Mr. Seip was the divisional executive in charge of Schwab's retail branches east of the Mississippi.\nMr. Tognino has been Executive Vice President - Capital Markets and Trading of the Company and Schwab since October 1993. Prior to joining the Company in October 1993, Mr. Tognino was a Managing Director at Merrill Lynch in New York since 1991, and was based in London as Managing Director of equity products from 1990 to 1991. Mr. Tognino serves on the NASDAQ (registered trademark) Board of Governors.\nMr. Valencia has been Executive Vice President - Human Resources of the Company and Schwab since March 1994. Before joining the Company in March 1994, Mr. Valencia served as a Managing Director of Commercial Credit Corp., a subsidiary of the Travelers engaged in consumer finance for the Travelers, from January 1993 to February 1994. From 1975 to 1993, he held various positions with Citicorp, including President and Chief Executive Officer of Transaction Technology, a subsidiary of Citicorp, from 1990 to 1993.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under the captions \"Executive Compensation\" (excluding all information under the subcaption \"Board Compensation Committee Report on Executive Compensation\" and \"Performance Graph\") and \"Certain Transactions.\"\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required to be furnished pursuant to this item is incorporated by reference from portions of the Proxy Statement under the caption \"Principal Stockholders.\"\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required to be furnished pursuant to this item is incorporated by reference from a portion of the Proxy Statement under the caption \"Certain Transactions.\"\n- 13 -\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Documents filed as part of this Report --------------------------------------\n1. Financial Statements\nThe financial statements and independent auditors' report are set forth in the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report and are listed below:\nConsolidated Statement of Income Consolidated Balance Sheet Consolidated Statement of Cash Flows Consolidated Statement of Stockholders' Equity Notes to Consolidated Financial Statements Independent Auditors' Report\n2. Financial Statement Schedules\nThe financial statement schedules required to be furnished pursuant to this item are listed in the accompanying index appearing on page.\n(b) Reports on Form 8-K -------------------\nNone filed during the last quarter of 1994.\n- 14 -\n(c) Exhibits --------\nThe exhibits listed below are filed as part of this annual report on Form 10-K.\n- 15 -\n- 16 -\n- 17 -\n- 18 -\n* Incorporated by reference to the identically-numbered exhibit to Registrant's Registration Statement No. 33-16192 on Form S-1, as amended and declared effective on September 22, 1987.\n+ Management contract or compensatory plan.\n- 19 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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.\nTHE CHARLES SCHWAB CORPORATION (Registrant)\nBY: CHARLES R. SCHWAB \/s\/ --------------------------- Charles R. Schwab 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 indicated, on March 24, 1995.\n- 20 -\nTHE CHARLES SCHWAB CORPORATION\nIndex to Financial Statement Schedules\nSchedules not listed are omitted because of the absence of the conditions under which they are required or because the information is included in the Company's consolidated financial statements and notes in the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of this report.\nINDEPENDENT AUDITORS' REPORT ------------------------------\nTo the Stockholders and Board of Directors of The Charles Schwab Corporation:\nWe have audited the consolidated financial statements of The Charles Schwab Corporation and subsidiaries (the Company) 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 27, 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 schedules of the Company and subsidiaries appearing on pages through . 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.\nFebruary 27, 1995\nSCHEDULE I\nTHE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY)\nCondensed Financial Information of Registrant Condensed Balance Sheet (In thousands, except share data)\nSCHEDULE I\nTHE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY)\nCondensed Financial Information of Registrant Condensed Statement of Income and Retained Earnings (In thousands)\nSCHEDULE I\nTHE CHARLES SCHWAB CORPORATION (PARENT COMPANY ONLY)\nCondensed Financial Information of Registrant Condensed Statement of Cash Flows (In thousands)\nSCHEDULE II\nTHE CHARLES SCHWAB CORPORATION\nValuation and Qualifying Accounts (In thousands)","section_15":""}
{"filename":"5177_1994.txt","cik":"5177","year":"1994","section_1":"ITEM 1. BUSINESS\nAMDURA Corporation, a Delaware corporation (\"Amdura\" or the \"Company\"), through its subsidiaries, The Crosby Group, Inc., a Delaware corporation (\"Crosby\") and The Harris Waste Management Group, Inc., a Delaware corporation (\"Harris\"), is a specialty manufacturer of products for the overhead lifting and waste recycling and disposal markets. Amdura emerged from bankruptcy under Chapter 11 of the United States Bankruptcy Code (the \"Bankruptcy Code\") and its plan of reorganization, as amended and\/or modified (the \"Plan\") and confirmed by the United States Bankruptcy Court for the District of Colorado (the \"Bankruptcy Court\"), became effective after the close of business on October 23, 1991 (the \"Amdura Effective Date\"). Pursuant to the Plan, Amdura was reorganized around Crosby and Harris, which were not included in Amdura's Chapter 11 filing and were not in bankruptcy. See \"Item 3. Legal Proceedings\" and Notes 1 and 2 of the Notes to Consolidated Financial Statements included in Item 8 hereof.\nPRODUCTS AND DISTRIBUTION\nCrosby\nCrosby, headquartered in Tulsa, Oklahoma, designs and manufactures lifting equipment, hardware and accessories, including blocks, sheaves, hooks, shackles, turnbuckles, load binders and other fittings, for use with wire rope and chain. Crosby's lifting equipment hardware is used in energy, construction, manufacturing, marine and transportation applications. Products such as the Crosby ClipTM, Crosby(R) fittings, Lebus(R) load binders, McKissick(R) blocks, National Swage fittings and Bullard(R) hooks enjoy a reputation for unexcelled quality in their product categories.\nCrosby sells its products to authorized Crosby distributors through a sales force of 28 territorial representatives. Customers for Crosby products include original equipment manufacturers, sling fabricators and industrial supply houses. Currently, Crosby sells its products to approximately 2,600 distributors worldwide, of which approximately 70 percent are located in the United States.\nHarris\nHarris, headquartered in Peachtree City, Georgia, is primarily engaged in the manufacture and marketing of recycling and waste management equipment used in the plastic, waste paper, ferrous and non-ferrous scrap metal recycling industries and for solid waste disposal applications. Harris' major products include large capacity, high-reduction balers (sold under the mark HRB(R)), used for materials recovery and solid waste disposal facilities; metal shears and balers, used for processing scrap steel; a line of small to medium capacity balers sold under the mark Selco(R) used for baling waste materials; and a line of balers sold under the mark Mosley(R) primarily to municipalities. Harris also offers another related product line of high volume solid waste transfer station compactors sold under the mark of Transpak(R).\nHarris sells its products directly and through a network of distributors. A national sales force sells scrap steel recycling equipment directly to scrap processing companies. The Amfab(R), HRB(R) and Selco(R) product lines are sold through a network of 21 distributors. The distributors assist customers with the layout and installation of Harris machines as well as subsequent servicing requirements.\nHarris employs six regional sales managers to coordinate its relationships with distributors and to sell its product line of scrap steel recycling equipment.\nCOMPETITION\nCrosby\nCrosby is the world's leading manufacturer of forged fittings, blocks and sheaves for use with wire rope and chain. Crosby lifting and material handling hardware have applications in numerous industry segments, including the manufacturing, construction, marine, energy, transportation and government sectors.\nAlthough no single company competes in all of its markets, Crosby faces significant foreign and domestic competition. In addition, effective marketing requires a significant inventory investment to support various equipment configurations and a custom product order capability, which requires special design engineers and forging equipment.\nCrosby's principal methods of competition include the marketing of a full line of products through a network of nonexclusive distributors with an emphasis on innovative product features, quality, safety and education. Since Crosby's products are usually a critical component of the equipment used in its application, Crosby has developed a training program whereby its distributors and end users are educated in the proper use of its products. In 1992, Crosby became the first American company in its industry to achieve ISO 9001 certification, an international quality assurance program.\nHarris\nHarris is the largest manufacturer in the world of shears and balers used in the scrap metal and waste handling, recovery and recycling industries. In addition, Harris accounts for approximately 50 percent of total sales to the solid waste disposal and waste paper and materials recovery markets in the Western Hemisphere.\nThe Company believes that Harris has three principal competitors. The increased emphasis on recycling and the demand for more efficient scrap handling and processing equipment has resulted in increased competition in recent years. The markets for waste disposal products are primarily affected by the economic activity in the steel and the scrap metal industries and the secondary and solid waste processing markets.\nHarris' principal methods of competition include the utilization of a comprehensive distribution network and the frequent introduction of new product lines, sometimes using a new product development process that is driven by the customer. Harris employs a sales force organized around product lines; uses interactive, real time accounting and manufacturing control systems; and maintains an extensive file system on every piece of equipment ever manufactured by Harris. This system supports a high quality customer service level and provides for efficient sales of replacement parts.\nBACKLOG\nThe Company estimates that its order backlog was approximately $52,333,000 ($8,246,000 at Crosby and $44,087,000 at Harris) and $20,395,000 ($6,639,000 at Crosby and $13,756,000 at Harris) at December 31, 1994 and 1993, respectively. Included in the December 31, 1994 backlog at Harris is an order of approximately $10,700,000 from the Defense Nuclear Agency. Backlog consists of orders received that are believed to be firm but not yet shipped. The Company expects that substantially all the December 31, 1994 backlog will be filled during 1995.\nINVENTORY AND RAW MATERIALS PURCHASES\nPrincipal raw materials and purchased components for the Company's Crosby and Harris operations are obtained from numerous suppliers. Raw materials include steel plate and bar stock, iron and steel castings and forgings. These raw materials are readily available from multiple sources. Purchased components include bearings, cylinders, hydraulic pumps and motors. The Company's Crosby and Harris operations fabricate and machine a majority of the parts used in their respective operations.\nSIGNIFICANT CUSTOMERS\nNo single distributor or end-user accounts for a significant portion of Crosby's or Harris' gross sales.\nSEASONAL INFLUENCES\nThe Company's continuing manufacturing businesses generally are not subject to seasonal variances.\nPATENTS AND TRADEMARKS\nCrosby\nCrosby has approximately 25 U.S. patents and patent applications and 39 corresponding foreign patents and applications. Most are for unique fittings devices although certain are directed to block and sheave products. Crosby expects to receive additional patents, primarily as a result of its custom manufacturing efforts. Crosby owns a number of trademarks including those for the Crosby(R) name and for its McKissick(R), Crosby-Laughlin(R) and Lebus(R) products. Crosby has several proprietary processes, including the technique for \"roll-forging\" sheaves. Crosby aggressively defends its patents, trademarks and other intellectual properties.\nHarris\nHarris has approximately 19 U.S. patents and patent applications. Most are for unique baling designs and shearing processes. Harris expects to receive more patents as its research and development efforts continue. Harris owns 12 trademarks, including the following: HRB(R), Selco(R), Selco 2-Ram(R),\nMosley(R), Amfab(R) and Transpak(R). Harris aggressively defends its patents, trademarks and other intellectual properties.\nPRODUCT RESEARCH AND DEVELOPMENT\nThe Company's research and development program consists of applied engineering in the improvement of existing products and development of new products. Additional information required by this item is set forth in Note 15 of the Notes to Consolidated Financial Statements included in Item 8 hereto.\nEMPLOYEES\nThe Company had approximately 1,535 employees as of December 31, 1994. Of these, Crosby employed approximately 1,020 persons and Harris employed approximately 510 persons. Crosby is a party to three collective bargaining agreements covering 600 North American employees which expire in 1995 and 1996. The Company believes that its employee relations are satisfactory.\nFOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nInformation concerning the Company's sales, profitability and identifiable assets attributable to each of its geographic areas is set forth in Note 17 of the Notes to Consolidated Financial Statements included in Item 8 hereof.\nENVIRONMENTAL MATTERS\nThe Company is subject to various federal, state and local requirements for control of pollutants resulting from current operations and for remediation of the environmental effects of past practices in the management and disposal of industrial wastes, both at its facilities and at off-site locations. These requirements are frequently revised, generally in a manner which broadens their application and\/or increases their stringency. The Company believes that it is in substantial compliance with those requirements applicable to its operations and that costs associated with such compliance will not have a material adverse effect on its consolidated financial position, results of operations, level of capital expenditures or competitive position.\nIn recent years, the Company has received notices from certain environmental protection agencies and third parties claiming that the Company, alone or with other parties, is or may be a party responsible for action (or the cost of such action) to remediate environmental conditions alleged to exist at disposal sites on various properties or on properties of third parties. See \"Item 3. Legal Proceedings - Environmental Proceedings\". Although the financial impact on the Company from any such remedial actions cannot be determined until relevant procedures are completed and expense responsibilities are allocated among the parties involved, the Company does not believe that the costs thereof will have a material adverse effect on its consolidated financial position, results of operations, level of capital expenditures or competitive position.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporate offices of the Company are located at 900 Main Street South, Suite 2A, Building B, Southbury, Connecticut 06488.\nThe facilities of the Company and of Crosby and Harris are of varying ages and types of construction. Management believes that all such facilities are adequate for the purposes for which they are being used.\nCrosby owns and operates five manufacturing facilities and owns two and leases eight distribution centers. The manufacturing facilities are located in Tulsa, Oklahoma; Longview, Texas; Jacksonville, Arkansas; Brampton, Ontario, Canada; and Putte, Belgium. The distribution facilities are located in Arlington, Texas; Atlanta, Georgia; Chicago, Illinois; Harrisburg, Pennsylvania; Seattle, Washington; Los Angeles, California; Barnsley, U.K.; Brampton, Ontario, Canada; Putte, Belgium; and Paris, France.\nHarris owns and operates manufacturing facilities in Cordele, Georgia and Baxley, Georgia and leases and operates manufacturing facilities in Woodburn, Oregon. Harris leases its corporate headquarters, which is located in Peachtree City, Georgia.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nInformation concerning certain legal proceedings to which the Company and its subsidiaries have been or are subject to is set forth below. Additional information is set forth in Notes 1, 2 and 13 of the Notes to Consolidated Financial Statements included in Item 8 hereof.\nSECURITIES CLASS ACTIONS\nIn January 1990, an action styled Saul Jones, et al. vs. Amdura Corporation. et al., Case No 90-F-167 (the \"Jones Complaint\") was commenced in the United States District Court for the District of Colorado. This action purported to be brought on behalf of a class of all persons who purchased Amdura's old common stock during the \"class period\", December 27, 1988 through November 14, 1989, and alleged, under Section 10(b) and 2b(a) of the Securities Exchange Act of 1934, claims to the effect that Amdura's public business and financial disclosures were materially false or misleading during this period. The Jones complaint named Amdura and certain former directors as defendants. An action initially styled Amtax Company. et al. vs. Amdura Corporation. et al., case No 90-F-500 (the \"Amtax Complaint\") in the same forum and based on similar legal theories, for the \"class period\" December 27, 1988 through March 19, 1990, was commenced in March 1990 on behalf of holders of Amdura's old common stock and its old preferred stock, Series D. The Amtax Complaint named the same defendants and certain additional former Amdura directors as the Jones Complaint. Upon its 1990 filing of a petition for reorganization under Chapter 11 of the United States Bankruptcy Code, (see \"Chapter 11 Proceedings\", below) Amdura was severed from the Jones Complaint and the Amtax Complaint because of the automatic stay of actions pending against companies that file for bankruptcy. During the bankruptcy proceedings, both actions proceeded as to the individual defendants, and the plaintiffs and individual defendants subsequently reached a settlement agreement.\nAs a result of the consummation of the Plan, the plaintiffs' claims against Amdura were discharged, with their rights limited to distributions, if any, available to them under the Plan. In this regard, prior to the confirmation of the Plan, the Bankruptcy Court disallowed the \"class claims\" filed by the plaintiffs against Amdura as part of the bankruptcy cases, thereby leaving the individual class representatives, as opposed to the entire class, as the only parties with possible claims against Amdura.\nThe plaintiffs appealed the disallowance of such \"class claims\" as well as the order of the Bankruptcy Court confirming the Plan. On August 3, 1994, the United States District Court for the District of Colorado (the \"District Court\") issued an order reinstating the \"class claims\" which had been disallowed by the Bankruptcy Court. The order also purported to reverse the Bankruptcy Court's order confirming the Plan. The effectiveness of this order was initially stayed.\nOn August 31, 1994, Amdura entered into a definitive Stipulation of Settlement with the representatives of the plaintiff class in the Jones and Amtax Complaints. On November 22, 1994, the District Court approved the Stipulation of Settlement and dismissed the Jones and Amtax complaints; and, on December 1, 1994, the Bankruptcy Court approved the withdrawal of the \"class claims\". Pursuant to the Stipulation of Settlement, Amdura will pay $500,000 and issue 564,302 shares of its common stock in exchange for a full and final release of all claims under those complaints. The Company anticipates the distribution of the settlement proceeds to holders of proved claims in 1995. Amdura recognized a one-time special charge of $1,875,000 in the third quarter of 1994 as a result of this settlement.\nENVIRONMENTAL PROCEEDINGS\nSince its inception, Amdura and certain of its subsidiaries have engaged in various manufacturing operations and have owned or operated a number of manufacturing facilities. Amdura and these subsidiaries, including Crosby and Harris, are subject to environmental laws and regulations and, in the ordinary course of business, deal with various regulatory agencies concerning environmental issues that may arise in connection with their operations.\nPrior to the filing of its petition in the Bankruptcy Proceeding, Amdura and several of its subsidiaries were identified, generally by regulatory agencies, as potentially responsible parties with respect to the costs of remediating problems at various sites which Amdura or the subsidiary involved owned or operated or to which allegedly hazardous substances allegedly generated by Amdura or a subsidiary were alleged to have been transported.\nDuring the Bankruptcy Proceeding there were some sites for which no claims were filed, at other sites unsecured claims were filed and for certain sites both unsecured and administrative claims were filed. With one exception, if no claim was filed in the Bankruptcy Proceeding, then Amdura's potential liability was discharged. However, at the Portland Plant site, Amdura's obligations under an administrative order and consent were allegedly unaffected by the Bankruptcy Proceeding even though no claim was filed. Pursuant to such order, Amdura complied with a request to monitor groundwater conditions until certain criteria were met. The cost of such monitoring was minimal. Payment of claims filed against the estate in the Bankruptcy Proceeding in connection with such sites is governed by the Plan. Under the Plan, all of the unsecured claims remain solely the responsibility of the Amdura Liquidating Trust, and Amdura has no further liability to unsecured creditors for acts occurring prior to the date it filed its bankruptcy petition under the Bankruptcy Code. With respect to administrative claims filed against the estate in the Bankruptcy\nProceeding, the Plan provides that all allowed administrative claims must be paid in full by Amdura. At this point in Amdura's Bankruptcy Proceeding, all of the environmentally related administrative claims have been disallowed or settled in a manner that completely discharges Amdura from liability, except for the claims discussed below.\nAmdura settled the administrative claim filed by the Minnesota Pollution Control Agency (\"MPCA\") with respect to the CAP\/SKB Landfill by agreeing to perform certain remedial activities. During 1994, Amdura disbursed $621,000 on remediation activities at this site, and completed the construction phase of the remediation. According to the settlement with the MPCA, Amdura will perform monitoring activities at the site for two years after completion of the construction, after which time the MPCA will assume responsibility for monitoring activities. The Company estimates that its costs to perform monitoring procedures will be approximately $200,000.\nRecent court decisions indicate that a discharge in bankruptcy may not release the debtor from liabilities for environmental damages arising before the bankruptcy petition was filed. In these cases, claims were allowed due to insufficient notice of the bankruptcy to surrounding landowners, residents, subsequent titleholders, etc., or due to regulatory agencies' ability to assert nondischargable claims pursuant to injunctive provisions. It is the Company's position that remediation costs at sites which were subject to proper notification of its bankruptcy should be considered unsecured claims subject to discharge in its bankruptcy proceeding. Also, court decisions have indicated that a debtor may be required to participate in an environmental site for damages which occurred prior to the filing of the bankruptcy but which were not identified until after the debtor's reorganization plan was confirmed. Based on the limited number of such claims received since the effective date of the Plan, the Company believes that, if any such additional claims are asserted and adversely determined against the Company, there would be no material adverse effect on the Company's financial condition or results of operations as a result of such claims.\nCrosby has been identified as potentially responsible for the costs of remediating environmental problems at five sites to which Crosby is alleged to have transported allegedly hazardous substances. At two of such sites, Crosby has entered into agreements with appropriate environmental agencies and affected third parties pursuant to which it has already paid its identified share of the total remediation costs associated with the sites. Based on the Company's knowledge of the status and total estimated cost of the remediation and of amounts that have been paid to date, the Company expects that any future cost to Crosby associated with these sites will be immaterial. At two other of such sites, Crosby has made payments but its remaining liability has not been fixed, although based on past payments, any future obligations should not be material. At the fifth of such sites, Crosby has been identified as a potential generator, but no requests for payments have been received, and there have been no communications regarding this site directed to Crosby for several years.\nORDINARY LITIGATION INCIDENTAL TO THE BUSINESS\nAmdura and its subsidiaries from time to time are presented with claims arising out of their current and former manufacturing and other operations, including claims asserting personal injury arising out of the manufacture, sale and use of the products of those businesses based on various theories of recovery for products liability and for workers compensation. Amdura believes these claims will not have a material impact on the financial position and results of operations of the Company. Amdura and its subsidiaries vigorously defend all product liability claims, and believe that their products are safe and suitable for their intended uses. Crosby and Harris also have implemented product information practices to further reduce their exposure to such contingent liabilities. Amdura and\/or its subsidiaries have comprehensive general liability insurance under various programs which may afford total or partial coverage for certain product claims. Pre-petition claims identifying Amdura\nand any of the other debtors as a defendant were subject to the automatic stay under the Bankruptcy Code, and, to the extent provided therein, to discharge in bankruptcy. Claims against Crosby and Harris and other non-bankrupt subsidiaries were not stayed and have not been affected by confirmation of the Plan.\nUnder the terms of the agreement by which Amdura sold certain assets of its crane businesses to The American Crane Corporation (\"American Crane\"), American Crane agreed to indemnify Amdura for certain liabilities of such businesses which might otherwise be asserted against Amdura. Included among such liabilities are two environmental site matters and several product liability matters (including one group of a large number of related matters). If such indemnity were to become ineffective for any reason (including due to American Crane's financial condition), then the liabilities covered thereby could revert to Amdura.\nCHAPTER 11 PROCEEDINGS\nAmdura and certain of its subsidiaries each filed a voluntary petition for bankruptcy under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court on April 2, 1990. Amdura's Plan was confirmed by the Bankruptcy Court on September 19, 1991, and became effective on October 23, 1991.\nIn connection with the Amdura bankruptcy cases (the \"Bankruptcy Cases\"), the Bankruptcy Court entered a bar date order establishing January 10, 1991, as the date by which claimants or interest holders were required to have filed a proof of claim or interest in the bankruptcy cases, setting forth the nature and amount of that claim or interest. Substantial claims were filed through the bar date in respect of the debtors' bankruptcy estates. Generally, claims against Amdura and the other debtors fell into four categories: priority and administrative claims, secured claims, unsecured claims (including certain contingent or unliquidated claims) and equity claims.\nAs a result of the confirmation and consummation of the Plan pursuant to the Bankruptcy Code, except as otherwise provided in the bankruptcy plan confirmation orders entered into in connection with the Bankruptcy Cases or the Bankruptcy Code, Amdura has been discharged of and from each and every debt (as the term \"debt\" is defined in the Bankruptcy Code) and claim that arose against Amdura before September 19, 1991.\nThere remains pending against Amdura one administrative claim for which the parties have reached a settlement agreement subject to approval by the Bankruptcy Court. Amdura has a liability recorded in its financial statements equal to the amount it will be required to pay pursuant to this settlement agreement.\nParties holding claims that have been disallowed or ruled by the Bankruptcy Court to be unsecured may attempt to reassert their claims as administrative or priority claims, and some creditors may attempt to assert that their claims are not discharged and should continue as post-bankruptcy obligations of the Company. Based on the limited number of such claims received since the effective date of the Plan, the Company believes that, if any such additional claims are asserted and adversely determined against the Company, there would be no material adverse effect on the Company's financial condition or results of operations as a result of such claims.\nOTHER LITIGATION INCIDENTAL TO THE BANKRUPTCY CASES\nIn March 1992, Amdura National Distribution Company (f\/k\/a Farwell, Ozmun, Kirk & Co.) (\"Andco\"), a liquidating estate and former subsidiary of Amdura which filed suit in a voluntary petition for bankruptcy at the same time as the Company, filed suit in the Bankruptcy Court against Amdura seeking the recovery of approximately $1,050,000 then held in Amdura's former concentration account with Continental Bank, N.A. Such suit also requested the entry of a temporary restraining order and, after an appropriate hearing, a preliminary injunction enjoining Amdura's use of such funds until the ownership of such funds could be determined at a trial on the merits. In the suit Andco alleges that based on certain pre-petition payments made by it into such account, such funds belong to it, and not to Amdura. The Bankruptcy Court initially entered the temporary restraining order against Amdura, but following the preliminary injunction hearing the Bankruptcy Court dissolved the order. In its opinion dated April 9, 1992, denying Andco's request for a preliminary injunction, the Bankruptcy Court noted that it was not substantially likely that Andco's claim would be successful on the merits at a full trial, which is a procedural finding required to be made by a court granting a preliminary injunction. Subsequent to the issuance of the Bankruptcy Court's opinion, Andco filed a motion requesting a stay to maintain the status quo pending appeal of the order denying the preliminary injunction. Such motion was denied by the Bankruptcy Court at a hearing held on May 1, 1992 and by order dated May 9, 1992. Subsequent to that ruling, Andco filed a motion in the Federal District Court for the District of Colorado (the \"District Court\") requesting a stay of the Court's earlier ruling. On October 20, 1992, the Bankruptcy Court's denial was sustained by the District Court by its denial of Andco's motion for leave to appeal. On July 2, 1993, Amdura filed a motion for summary judgment. Andco filed its response and cross-motion for summary judgment on July 26, 1993. On September 13, 1993, the Bankruptcy Court issued its findings of fact and conclusions of law granting summary judgment in favor of Amdura and denying Andco's cross-motion for summary judgment. On September 22, 1993 Andco appealed the Bankruptcy Court's Findings of Fact and Conclusions of Law which granted summary judgment in favor of Amdura to the District Court. In December 1993, both Amdura and Andco filed briefs in connection with the appeal. On April 11, 1994, the District Court issued a judgment for Amdura and against Andco, affirming the Bankruptcy Court's earlier decisions. On May 10, 1994, Andco appealed the District Court's judgment in the United States Court of Appeals for the Tenth Circuit, and, in September 1994, both Amdura and Andco filed briefs in the United States Court of Appeals for the Tenth Circuit. Amdura intends to continue its vigorous defense of its rights in this case.\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 for trading on the New York Stock Exchange.\nAt February 15, 1995, 24,665,160 shares of Common Stock, par value $.01 per share (the \"Common Stock\") were issued and outstanding and held by approximately 2,200 holders of record.\nSince the Amdura Effective Date, the Company has not paid any cash dividends on the Common Stock. The Company is allowed to pay dividends on the Common Stock, subject to restrictions under its loan agreements.\nAdditional information required by this item is in Note 18 of the Notes to Consolidated Financial Statements included in item 8 hereto.\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 following discussion and analysis should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements, included in Items 6 and 8 hereof, respectively.\nFINANCIAL CONDITION\nREORGANIZATION, RESTRUCTURING AND REFINANCING\nOn April 2, 1990, Amdura Corporation (the \"Company\" or \"Amdura\") filed a voluntary petition for bankruptcy under Chapter 11 of the United States Bankruptcy Code. According to the Fifth Amended Joint Plan of Reorganization of Amdura (the \"Plan\"), which became effective October 23, 1991, Amdura and its wholly-owned subsidiaries, The Crosby Group, Inc. (\"Crosby\") and the Harris Waste Management Group, Inc. (\"Harris\"), which were not in bankruptcy, jointly issued $50,000,000 aggregate principal amount of term notes to Amdura's secured creditors (the \"Bank Group\"). The Bank Group was also issued approximately 86 percent of Amdura's post reorganization common stock. Effective December 31, 1992, Amdura, Crosby, Harris and the Bank Group entered into a restructuring whereby the unpaid interest and approximately 50 percent of the outstanding principal were converted into 11,966 shares of Series A Preferred Stock, which was in turn automatically converted into 11,966,159 shares of common stock in 1993. The remaining approximately 50 percent of outstanding term notes were converted to senior and subordinated secured debt. Effective September 30, 1994, the outstanding senior and subordinated secured debt were refinanced with a group of non-stockholder lenders.\nCHANGES IN FINANCIAL CONDITION\nThe financial condition of Amdura improved in 1994, as shown by an increase in income from operations of over 13 percent, from $5,012,000 to $5,673,000 for the years ended December 31, 1993 and 1994, respectively. Net income, however, decreased from $2,805,000 in 1993 to $1,347,000 in 1994, primarily due to an increase in income tax expense, caused by a change in Amdura's domestic tax position, and net special charges as explained in Results of Operations, below.\nTotal revenues increased 12 percent, resulting in increased accounts receivable and trade accounts payable. The Company also achieved increased sales by acquiring certain assets and manufacturing operations of companies engaged in similar businesses as discussed in the notes to consolidated financial statements. Also, during 1994, Amdura's Harris Waste Management Group was awarded a contract with the Defense Nuclear Agency to manufacture three baler-shears for the Russian government. The total sales price for these baler-shears is approximately $10,700,000, and the shipments will occur after December 31, 1994. These factors have resulted in an increase to inventories of 40 percent from December 31, 1993 to 1994.\nMatters remaining from Amdura's 1991 bankruptcy proceedings have also influenced the Company's financial condition. In 1994, Amdura made total contributions of $2,497,000 to the defined benefit pension plans in accordance with the settlement with the Pension Benefit Guaranty Corporation (\"PBGC\") and also paid $621,000 for environmental remediation of the CAP\/SKB Landfill. At December 31, 1994, the Company had an accrued liability of $1,586,000 (the majority of which will be satisfied by the issuance of common stock) related to the settlement of certain class action claims which remained from the bankruptcy proceedings. These factors, in addition to increases in operations\ndiscussed above, have resulted in a 14 percent increase in accrued expenses from December 31, 1993 to 1994.\nThe Company incurred a total of $2,132,000 of interest expense in 1994, $1,384,000 of which was paid to the Bank Group through September 30, 1994, when this long-term debt was refinanced as discussed below.\nLIQUIDITY REQUIREMENTS AND CAPITAL RESOURCES\nEffective September 30, 1994, Amdura refinanced its long-term debt. The related loan agreements provide for a $45,000,000 facility, which was limited to $35,000,000 at December 31, 1994.\nThe loan agreements provide for $11,000,000 in Term Loans, which mature on October 1, 2001, accrue interest at a floating rate which is due monthly and require quarterly principal payments of $393,000 commencing April 1, 1995. The loan agreements also provide for Revolving Credit Facilities, which had a total outstanding balance of $15,823,000 and an available balance of $6,987,000 at December 31, 1994. The Revolving Credit Facilities accrue floating rate interest which is due monthly, mature on October 1, 1997 and are subject to extension at the option of the lenders. Finally, the loan agreements provide for CAPEX Loans to be used solely for the purchase of equipment or real property, none of which were outstanding nor were unavailable at December 31, 1994.\nIn addition to the foregoing indebtedness, Amdura's foreign subsidiaries had working capital indebtedness of $1,886,000 as of December 31, 1994. These foreign subsidiaries have secured revolving credit lines with banks which provide for borrowings aggregating $5,186,000.\nAs of December 31, 1994, current assets of Amdura exceeded current liabilities by $33,556,000. The Company believes that cash flow from current operations is sufficient to meet liquidity requirements for its continuing operations. As noted above, the Company has access to a total of $12,173,000 in domestic and foreign revolving credit facilities to meet short-term liquidity requirements should the need arise.\nThe Company is the sponsor to certain defined benefit pension plans which have been frozen, and which were the subject of a settlement with the PBGC at the bankruptcy reorganization. At December 31, 1994, the estimated net underfunded liability of these plans was $3,310,000, $1,736,000 of which is estimated to be required to be contributed to the plans in 1995. The PBGC settlement also established the PBGC Grantor Trust, which had assets available for contributions to these plans of $1,747,000 at December 31, 1994, $860,000 of which are estimated to be disbursed in 1995. According to the terms of the PBGC settlement, Amdura is obligated to make contributions to these frozen plans of 50 percent of the required minimum funding contributions, up to $1,200,000 per year, while the PBGC Grantor Trust has assets. After the PBGC Grantor Trust assets have been fully utilized, the Company will be obligated to make 100 percent of the required minimum funding contributions. Amdura anticipates having adequate liquidity from current operations and other sources described above to meet the Company's contribution requirements of these pension plans.\nAmdura estimates that expenditures to address environmental matters will be approximately $250,000 in 1995. The Company disbursed $774,000 and $2,392,000 on environmental matters in 1994 and 1993, respectively.\nDuring 1994, the Company reached a settlement with the representatives of the plaintiff class in certain securities class action litigation which had been pending since 1990. The terms of the settlement\nrequire Amdura to pay $500,000 and issue 564,302 shares of its common stock. Amdura anticipates that the payment of cash and issuance of stock will occur in the second quarter of 1995.\nWhere the Company is able to estimate the results of legal proceedings and environmental and other claims, appropriate accruals have been established (which are recorded at the gross amount estimated to be paid, and not net of estimated insurance or other proceeds). However, with respect to certain legal proceedings and certain environmental and other claims, the Company is unable to estimate the eventual outcome and impact on the consolidated financial statements and no provision for any loss that may result from resolution of these matters has been made. In any event, the Company believes that current accruals and established sources of cash from operations and other sources are adequate to meet the requirements of reasonably expected payments regarding legal proceedings and environmental and other claims, and that these payments will have no material adverse effect on the Company's financial condition or results of operations.\nAt December 31, 1994, the Company had significant net operating loss carryforwards which originated prior to November 1, 1991. However, due to certain change of ownership requirements of the Internal Revenue Code, utilization of the net operating loss carryforwards is limited to approximately $39,000,000 at the rate of $2,734,000 per year through 2005. In addition, the Company has net operating loss carryforwards generated subsequent to October 31, 1991 of approximately $25,400,000 which expire through 2008. The utilization of these net operating loss carryforwards may be limited if changes in the Company's stock ownership, as defined in the Internal Revenue Code, exceed 50 percent of the value of the Company's stock during any three year period. The calculation of the limitation is based on the fair value of the Company, the federal long-term interest rate and the expiration periods of the existing net operating loss carryforwards. The calculation at December 31, 1994 reflects a change in ownership of approximately 45 percent during the previous three year period.\nRESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1994\nTotal revenues for 1994 were $145,159,000, consisting of $97,421,000 at Crosby and $47,738,000 at Harris. This increase in revenues of 12 percent over 1993 (nine percent at Crosby and 17 percent at Harris) is a result of the strong North American economies, the beginning of recovery in Europe from its recent recession and the addition of product lines from acquisitions.\nCost of products sold were $113,930,000 for 1994, compared to $103,832,000 for 1993. This ten percent increase is due to the growth in sales volume noted above. Gross margin increased $5,292,000, or 20 percent, over 1993. Gross margin as a percentage of revenues was 22 percent for 1994 and 20 percent for 1993, reflecting the realization of increased operating efficiencies at higher usage levels of manufacturing capacity.\nSelling and administration expenses for 1994 were $24,053,000, or 15 percent higher than 1993 due to the increase in sales volume. These increased expenses were partially offset by a favorable resolution of certain matters related to the Amdura bankruptcy reorganization which occurred during the second quarter of 1994. As a percentage of total revenues, selling and administration expenses were 17 percent in 1994 and 16 percent in 1993.\nDuring 1994, Amdura recorded net special charges of $1,503,000. This resulted from the recognition of $1,875,000 in expense from the settlement of class action litigation, offset by $372,000 in income related to the reversion of assets to the Company from certain terminated pension plans.\nInterest expense was $2,132,000 for 1994, an increase of three percent from 1993. This small increase was due to rising interest rates on floating rate loans experienced during 1994.\nIncome tax expenses for 1994 were $1,924,000, compared to $145,000 for 1993. Due to a change in the Company's domestic tax position at the beginning of 1994, Amdura was required to record deferred U.S. federal income taxes, even though net operating loss carryforwards provided that these taxes would not be required to be paid to the federal government. Foreign income taxes increased $233,000 and U.S. state income taxes increased $115,000 due to increased profitability of the Company's operations.\nIn 1994, the Company recorded a cumulative effect of change in accounting principle in conjunction with its implementation of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" of $270,000, net of a related income tax benefit of $166,000.\nNet income for the year ended December 31, 1994 was $1,347,000, compared to $2,805,000 for the prior year. The reason for this change was principally due to an increase in gross margin of $5,292,000, partially offset by increases in selling and administration expenses of $3,128,000, net special charges in 1994 of $1,503,000, an increase in income taxes of $1,779,000 and the 1994 recognition of a cumulative effect of change in accounting principle of $270,000.\nYEAR ENDED DECEMBER 31, 1993\nTotal revenues for 1993 were $129,769,000, consisting of $88,976,000 at Crosby and $40,793,000 at Harris. Compared to 1992, revenues increased two percent, due primarily to a four percent increase in sales at Crosby, offset by a two percent decrease in sales at Harris. Factors contributing to these changes included improved North American sales for Crosby and softening in the demand for scrap metal recycling equipment for Harris.\nCost of products sold were $103,832,000 for 1993, representing a reduction of two percent from that of the previous year. As a result, gross margin of $25,937,000 was 20 percent higher in 1993 than in 1992. This improvement was due to the overall increase in sales volume noted above (which allowed for higher levels of manufacturing efficiencies) and the realization of a full year's benefit from cost reduction measures implemented mid-year 1992.\nSelling and administration expenses for 1993 were $20,925,000, or 16 percent of total revenues, compared to 17 percent for 1992. After taking into account the expense related to the amortization of the fresh start intangible asset recognized in these two years, selling and administration expenses as a percent of revenues were substantially the same in 1993 and 1992.\nInterest expense for the year ended December 31, 1993 was $2,062,000, representing a reduction of 54 percent from that of the previous year. This decline was primarily due to the restructuring as of December 31, 1992, wherein approximately 50 percent of Amdura's long-term debt was converted to equity.\nNet income for the year ended December 31, 1993 was $2,805,000, compared to a net loss of ($18,052,000) for the year ended December 31, 1992. The 1992 net loss included an intangible asset adjustment of $10,029,000 and nonrecurring costs of $3,441,000.\nYEAR ENDED DECEMBER 31, 1992\nTotal revenues for 1992 were $127,250,000, consisting of $85,754,000 at Crosby and $41,496,000 at Harris. Cost of products sold were $105,591,000 in 1992, resulting in a gross margin of $21,659,000, or 17 percent of total revenues. Selling and administration expenses for 1992 were $21,543,000.\nThe Company recorded a $10,029,000 intangible asset adjustment in 1992 resulting from revisions to estimated discounted cash flows from projected future operations and $3,441,000 of nonrecurring costs associated with bankruptcy related matters, the suspension of certain pension plans and the relocation of Harris' corporate offices. Interest expense for 1992 was $4,507,000. The consolidated net loss for 1992 was ($18,052,000).\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of AMDURA Corporation:\nWe have audited the accompanying consolidated balance sheet of AMDURA Corporation (a Delaware corporation) and subsidiaries (the \"Company\") as of December 31, 1994, and the related consolidated statements of operations and cash flows for the year then ended. 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 audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of AMDURA 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.\nAs discussed in Note 11 to the accompanying financial statements, the Company is subject to certain claims not necessarily discharged during the bankruptcy proceedings. The ultimate outcome of these matters cannot be presently determined, and accordingly, except as indicated in Note 11, no provision for any additional loss that may result upon resolution of these matters has been made in the accompanying financial statements.\nAs discussed in Note 10 to the accompanying financial statements, effective January 1, 1994, the Company changed its method of accounting for postemployment benefits.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule included in Item 14 of this Form 10-K is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. The amounts for the year ended December 31, 1994, included in the schedule 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\nNew York, N.Y. February 17, 1995\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of AMDURA Corporation:\nWe have audited the accompanying consolidated balance sheet of AMDURA Corporation (the \"Company\" or \"Amdura\") and subsidiaries as of December 31, 1993 and the related consolidated statements of operations and cash flows for the years ended December 31, 1993 and 1992. Our audits also included the financial statement schedule for 1993 and 1992 listed in the Index at Item 14. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Amdura and subsidiaries at December 31, 1993 and the results of their operations and their cash flows for the years ended December 31, 1993 and 1992 in conformity with generally accepted accounting principles. Also, in our opinion such financial statement schedule for 1993 and 1992, 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 11 to the accompanying consolidated financial statements, the Company is subject to certain claims not necessarily discharged during the bankruptcy proceedings. The ultimate outcome of these matters cannot be presently determined, and accordingly, except as indicated in Note 11, no provision for any additional loss that may result upon resolution of these matters has been made in the accompanying 1993 and 1992 consolidated financial statements.\nDELOITTE & TOUCHE LLP\nTulsa, Oklahoma February 17, 1994\nAMDURA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands Except Share Amounts)\n(Continued)\nAMDURA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share Amounts)\nSee notes to consolidated financial statements\nAMDURA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Amounts)\nSee notes to consolidated financial statements\nAMDURA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)\nSee notes to consolidated financial statements\nAMDURA CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1. REORGANIZATION PROCEEDINGS AND BASIS OF PRESENTATION\nOn April 2, 1990, AMDURA Corporation (the \"Company\" or \"Amdura\") and certain of its wholly-owned subsidiaries, each filed a voluntary petition for bankruptcy under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the District of Colorado (the \"Bankruptcy Court\"). The subsidiaries that filed the voluntary petition were those related to the hardlines distribution businesses. Amdura and such subsidiaries are sometimes referred to as \"Debtors.\"\nThe Company's heavy manufacturing units, The Crosby Group, Inc. (\"Crosby\") and The Harris Waste Management Group, Inc. (\"Harris\"), and its vacuum coating unit, Vac-Tec Systems, Inc. were not included in the Chapter 11 filings and were not in bankruptcy. Since the Chapter 11 filings, the Company has divested itself of its hardlines distribution businesses through the sale of certain assets and of its vacuum coating unit through a conveyance to one of the liquidating trusts established for the benefit of Amdura's prepetition unsecured creditors.\nDuring 1991 Amdura filed a Fifth Amended Joint Plan of Reorganization (the \"Plan\") with the Bankruptcy Court. Under the Plan, Amdura retained and reorganized around its wholly-owned subsidiaries, Crosby and Harris. On September 19, 1991, the Bankruptcy Court entered an order confirming the Plan which became effective after the close of business on October 23, 1991 (the \"Effective Date\").\nThe 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 and, where applicable, in conformity with Statement of Position 90-7, \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,\" (\"SOP 90-7\") issued in November 1990, by the American Institute of Certified Public Accountants.\nIn accordance with the provisions of SOP 90-7, the Company adopted fresh start reporting as of October 31, 1991, since the reorganization value (approximate fair value at the date of reorganization) was less than the total of all post petition liabilities and allowed prepetition claims, and holders of existing voting shares before the Effective Date received less than 50 percent of the voting shares of the emerging entity. All assets and liabilities at October 31, 1991, were restated to reflect their reorganization value in accordance with procedures specified in Accounting Principles Board Opinion 16 \"Business Combinations\" (\"APB 16\") as required by SOP 90-7. The portion of the reorganization value that could not be attributed to specific tangible or identified intangible assets was classified as reorganization value in excess of amounts allocable to identifiable assets which is being amortized over fifteen years. In addition, the accumulated deficit of the Company was eliminated and its capital structure was recast in conformity with the Plan.\n2. REORGANIZATION\nUnder the Plan, as of the Effective Date, all shares of existing common stock and existing preferred stock and all common stock options and preferred stock purchase rights were cancelled. On the Effective Date, the Company filed a restated certificate of incorporation which authorized the issuance of 25,000,000 shares of common stock and 1,000,000 shares of preferred stock. As of the Effective Date, the Company issued 12,500,000 shares of common stock to certain creditors, previously existing stockholders and other equity claimants in accordance with the Plan.\nTerms of the Plan stipulate that substantially all assets of Amdura, except for Amdura's investment in its wholly-owned subsidiaries Coast, Coast America, Coast Holdings, Intertrade, Andco, Crosby and Harris be placed in a liquidating trust (the \"Liquidating Trust\") for the benefit of Amdura's prepetition unsecured creditors. The proceeds of the Liquidating Trust will be used for partial payment of Amdura's prepetition liabilities discharged by the bankruptcy proceedings. The Liquidating Trust is being governed and managed by a trustee unrelated to Amdura. Amdura continues to be responsible for the payment of its post petition liabilities.\nTerms of the Coast and Andco Plans stipulate that assets of these companies will be liquidated and used solely for the purposes of partial payment of their prepetition liabilities discharged by the bankruptcy proceedings and certain of their post petition liabilities. Coast and Andco are being governed by boards of directors that consist of designees of Coast's and Andco's unsecured creditors and, with respect to Coast, designees of members of a group of banks led by Continental Bank, N.A., to which Amdura and its subsidiaries owed $220,800,000, prior to the bankruptcy filings (the \"Bank Group\").\nThe disposition of Amdura assets transferred to the Liquidating Trust and all Coast and Andco assets are governed by bankruptcy proceedings which stipulate that they be used solely for the purpose of paying discharged prepetition liabilities. These liabilities will be settled only with the proceeds resulting from liquidating such assets. Because of these factors and because Amdura does not control the Liquidating Trust, Coast or Andco, the remaining assets and liabilities of the Liquidating Trust, Coast and Andco have been removed from the consolidated financial statements of Amdura.\nUnder the Plan, in partial settlement of prepetition amounts due to the Bank Group, Amdura issued $50,000,000 in term notes to the Bank Group. Due to the inability of the Company to meet the required principal and interest payments on the $50,000,000 in term notes, in the fourth quarter of 1992 the Company converted $24,910,000 in term notes payable to the Bank Group and $2,858,000 in related accrued interest into 11,966 shares of newly issued Series A Convertible Preferred Stock which were converted into 11,966,159 shares of newly issued common stock in 1993. In connection with this restructuring, the Company incurred costs of $1,371,000 which were charged directly to capital.\n3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION - The consolidated financial statements include the accounts of the Company, Crosby and Harris. All significant intercompany accounts and transactions have been eliminated in consolidation.\nCASH AND CASH EQUIVALENTS - Cash and cash equivalents include all cash and liquid debt instruments with maturities of three months or less at the date of purchase.\nACCOUNTS RECEIVABLE - Crosby and Harris grant credit to their customers generally in the form of short-term trade accounts receivable. The creditworthiness of customers is evaluated prior to the sale of inventory and advance payments are frequently received by Harris on large manufacturing orders prior to sale in an effort to minimize credit risk. There are no significant customer concentrations of credit risk at Crosby and Harris.\nINVENTORIES - Inventories are stated at the lower of cost or market. Cost for domestic inventories is determined by the last-in, first-out, (\"LIFO\") method. For foreign inventories, cost is determined by the first-in, first-out (\"FIFO\") method.\nPROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment is stated at fair value at the Effective Date, plus additions at cost thereafter, less accumulated depreciation. For financial reporting purposes, depreciation is provided using the straight-line method over the estimated useful lives of the various classes of assets.\nCOSTS IN EXCESS OF NET ASSETS ACQUIRED - Costs in excess of net assets acquired are amortized on a straight-line basis over periods not exceeding 40 years. In evaluating the value and future benefits of these costs, the recoverability from operating income is measured. Under this approach, the carrying value would be reduced if it is probable that management's best estimate of future operating income from related operations before amortization will be less than the carrying amount over the remaining amortization period.\nADVANCES FROM CUSTOMERS - Advances received from customers are offset against inventories to the extent costs are incurred. Advances in excess of costs incurred are included in accrued expenses.\nWARRANTIES AND PRODUCT LIABILITY - The accruals for potential product liability and warranty claims are based on the Company's known claims and historical claims' experience. Such costs are accrued as revenue is recognized.\nFOREIGN EXCHANGE - Balance sheet accounts of foreign subsidiaries are translated into U.S. dollars at the year-end exchange rate and revenue and expense accounts are translated at the weighted average exchange rate in effect throughout each reporting period. Adjustments resulting from translation of financial statements are reflected as a separate component of stockholders' capital.\nREVENUE RECOGNITION - Revenues from the sale of inventories are generally recognized upon shipment of products, whether to distributors or the end user.\nINCOME TAXES - The Company files consolidated Federal and state income tax returns. In 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"), which requires recognition of deferred tax assets and liabilities based on differences between the financial statement carrying amounts and income tax basis of assets and liabilities and the tax effects of income tax net operating loss carryforwards at currently enacted income tax rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.\nIncome tax expense reflects the taxes payable in Federal, state and foreign tax jurisdictions for the period and the change during the period in deferred tax assets and liabilities. Income taxes are not\nprovided on unremitted earnings of foreign subsidiaries, as it is intended that such earnings will be permanently invested or are expected to be remitted free of income taxes.\nNET INCOME (LOSS) PER SHARE - Net income (loss) per share is based on the weighted average number of common and common equivalent shares outstanding during each year, adjusted by assuming conversion of preferred stock, warrants and stock options, when such conversion is not anti- dilutive.\nRECLASSIFICATIONS - Certain reclassifications have been made to the 1993 and 1992 consolidated financial statements to conform to the classifications used in 1994.\n4. INVENTORIES\nInventories are valued at the lower of cost or market and consist of the following:\nInventories valued using the LIFO method comprised 85.7 percent and 81.1 percent of inventories at December 31, 1994 and 1993, respectively.\n5. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consists of the following:\nIncluded in the above amounts are equipment under capital leases of $517,000 and $202,000 at December 31, 1994 and 1993, respectively. Accumulated amortization related to equipment under capital leases was $172,000 and $85,000 at December 31, 1994 and 1993, respectively.\n6. ACCRUED EXPENSES\nAccrued expenses consist of the following:\n7. NOTES PAYABLE AND LONG-TERM DEBT\nThe Company's foreign subsidiaries have secured revolving credit lines with banks which provide for borrowings aggregating $5,186,000. The borrowings under the lines of credit bear interest at various floating rates, as defined. At December 31, 1994 and 1993, the interest rates ranged from 6.1 to 9.5 percent, and 8.1 to 8.5 percent, respectively, on borrowings of $1,886,000 and $1,816,000, respectively.\nInformation concerning notes payable and outstanding balances drawn on lines of credit is as follows:\nLong-term debt consists of the following:\nEffective September 30, 1994, Amdura refinanced $25,090,000 in long-term debt with Sanwa Business Credit Corporation, as Agent, and Bank of Oklahoma, N.A. (the \"Lenders\"). The previous group of lenders was composed of a group of certain stockholders of the Company which owned approximately 68 and 69 percent of the common stock of the Company at September 30, 1994 and December 31, 1993, respectively. Proceeds from the Loan Agreements, which were entered into by Crosby and Harris, with Amdura as guarantor were used to pay the outstanding principal and interest under the former Amended and Restated Senior and Subordinated Term Loan Agreements, loan closing fees and other costs incidental to the borrowing.\nEach of the Crosby and Harris Loan Agreements provide for a Revolving Credit Facility, a Term Loan and a CAPEX Loan. At the selection of the borrower, the loans may be divided into (a) Base Rate Loans, which accrue interest at one-half of one percent, for the Revolving Loan, and one percent, for the Term and CAPEX Loans, over the highest \"prime rate of interest\" quoted, from time to time, by The Wall Street Journal; or (b) LIBOR Rate Loans, which accrue interest at two percent, for the Revolving Loan, and two and one-half percent, for the Term and CAPEX Loans, over the London interbank offered rates for deposits in U.S. dollars quoted by selected banks. The Loan Agreements also require the payment of a 0.5 percent fee on the average unused available Revolving Loan balance and other annual fees. Interest and fees on the Revolving, Term and CAPEX Loans are generally payable monthly.\nThe total availability under the Loan Agreements is $45,000,000. This availability is subject to limitations such that, until such time as an additional financial institution(s) satisfactory to the Lenders and the Company shall commit at least $10,000,000 to the loans, the draws against the loans shall be limited to: (a) $24,000,000 on the Revolving Loans; (b) $11,000,000 on the Term Loans; and (c) $-0- on the CAPEX Loans.\nAccording to the Loan Agreements, the maximum allowable balances on the Revolving Loans are $16,000,000 and $14,000,000 for Crosby and Harris, respectively, but in total are currently limited to $24,000,000. The Revolving Loans are also subject to restrictions based on eligible accounts receivable and inventory, as defined by the Loan Agreements, and are also limited by outstanding letters of credit issued thereunder. As of December 31, 1994, the outstanding balances in the Revolving Loans for Crosby and Harris were $8,323,000 and $7,500,000, respectively, and the total available balance was $6,987,000. The Revolving Loans mature on October 1, 1997, and are subject to extension at the option of the Lenders.\nAccording to the Loan Agreements, the maximum allowable balances on the Term Loans are $8,000,000 and $3,000,000 for Crosby and Harris, respectively. As of December 31, 1994, these loans were fully utilized. The maturity date of the Term Loans is October 1, 2001, and the Loan Agreements provide for quarterly principal payments, which commence April 1, 1995, of $286,000 for Crosby and $107,000 for Harris.\nAccording to the Loan Agreements, advances under the CAPEX Loans shall be used solely for the purchase of equipment or real property, subject to limitations provided by the Loan Agreements. There were no balances outstanding on the CAPEX Loans as of December 31, 1994. Each advance under the CAPEX Loans shall be evidenced by separate installment notes and require repayment in 24 equal quarterly installments commencing six months or less from the date of advance.\nThe long-term debt is secured by substantially all of the assets of Amdura, Crosby and Harris. Covenants contained in the Loan Agreements require minimum consolidated tangible net worth, limit the total amount of funded debt and require that consolidated cash flow be sufficient to cover debt service. The Company, Crosby and Harris are in compliance with these covenants.\nPrior to September 30, 1994, the Company had outstanding $10,145,000 of floating rate senior secured term debt, bearing interest at 8.75 percent at September 30, 1994; and $14,945,000 of fixed rate secured subordinated debt, bearing interest at 6.01 percent at September 30, 1994. Interest on the senior secured term debt and the secured subordinated debt was payable quarterly.\nInterest of $1,282,000, $1,626,000, and $1,207,000 was paid to the Bank Group during the years ended December 31, 1994, 1993 and 1992, respectively. Fees of $102,000, $156,000, and $75,000 were paid to the Bank Group during the years ended December 31, 1994, 1993 and 1992, respectively.\n8. STOCKHOLDERS' CAPITAL\nEffective April 1, 1994, the Company issued 2,151 shares of Series B Cumulative Convertible Preferred Stock (\"Series B Preferred Stock\"), par value $.01 per share, in exchange for certain assets of a company engaged in similar manufacturing operations. Each share of Series B Preferred Stock is convertible into 1,000 shares of common stock at the option of the holder; any outstanding shares of Series B Preferred Stock will be automatically converted into common stock at that rate on April 1, 1997. Holders of Series B Preferred Stock are entitled to receive, and the Company has paid, cumulative quarterly cash dividends at an annual rate of $100 per share. The holders of Series B Preferred Stock have no voting rights other than that required by law, except in the event of a default in the payment of dividends or other events as defined in the Certificate of Designations of the Series B Preferred Stock. In the event of a liquidation, dissolution or winding up of the Company, the holders of Series B Preferred Stock are entitled to receive out of the assets\nof the Company $5,377,500 plus any accrued but unpaid dividends before any payment or distribution of assets is made to the holders of common stock.\nEffective December 23, 1992, the Company issued 11,966 shares of Series A Convertible Preferred Stock, par value $.01 per share which were automatically converted into 11,966,159 newly issued shares of common stock in 1993. Also, effective December 23, 1992, the Company issued in the form of a dividend, and at no cost to its non-Bank Group stockholders, one warrant for each share of common stock held by non-Bank Group stockholders at the close of business on January 8, 1993. Warrants related to a total of 2,176,982 shares of common stock were issued. Each warrant entitled the holders thereof to acquire 1.116 shares of common stock at an exercise price of $2.00 per share. Unexercised warrants expired on July 9, 1994. During 1994 and 1993, warrants relating to a total of 169,023 and 38,222 shares of common stock were exercised, and the Company received $338,000 and $76,000 in proceeds, respectively.\nChanges in Stockholders' Capital are summarized as follows:\nDuring 1992 the Board of Directors approved the 1992 Stock Option Plan which reserved options to purchase a total of 3,655,863 shares of the Company's common stock to be granted to key employees and directors. Options are granted at an exercise price per share of not less than the fair market value of the Company's stock at their respective dates of grant, are generally exercisable in\n20 percent annual increments and must be exercised within ten years from date of grant. All options granted under the 1992 Stock Option Plan expire no later than ten years after their dates of grant. At December 31, 1994, options covering 2,181,325 shares of common stock at $1.87 to $3.00 per share were outstanding and options to purchase 1,474,538 shares of common stock were available for grant.\nThe following represents option activity during the last three years:\n9. FOREIGN OPERATIONS\nOperations include foreign currency transaction gains of $30,000, $41,000 and $36,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nNet foreign assets were $11,140,000 and $11,767,000 at December 31, 1994 and 1993, respectively.\n10. RETIREMENT AND EMPLOYEE BENEFITS PLANS\nThe Company and its subsidiaries were contributing sponsors of three defined benefit pension plans which covered the domestic union and certain non-union hourly employees. The plans provided for benefits based upon a specified monthly amount for each year of service. Effective December 31, 1992, these plans were suspended and in February 1993, the Company settled the vested and non-vested benefit portion of the projected benefit obligation of $5,212,000 through the purchase of nonparticipating annuity contracts. As a result, the Company reduced a portion of the prepaid pension cost and recognized a special charge of $907,000 for the year ended December 31, 1992, determined as follows:\nDuring 1994, assets remaining after the purchase of nonparticipating annuity contracts of $192,000 were transferred to the trustees of certain defined contribution retirement savings plans to be used for future contributions for the former participants of the three defined benefit pension plans which had been terminated. An additional $577,000 of assets remaining after the purchase of nonparticipating annuity contracts was returned by the trustee of the plans to the Company, resulting in a reduction of special charges of $372,000 in 1994.\nIn addition, at December 31, 1993, the Company sponsored eight defined benefit pension plans for former employees of many of its discontinued operations. These plans have been frozen by the Company and its funding policy is to make minimum quarterly contributions as required by applicable regulations. The assets of the plans are primarily invested in money market, bond and equity funds. During 1994, four of these plans were merged to realize certain efficiencies over the administration of the five remaining plans.\nThe following sets forth the funded status and amounts recognized in the Company's consolidated balance sheets at December 31, 1994 and 1993 of the remaining frozen plans:\nThe Company's assumptions used as of December 31, 1994 and 1993 in determining the pension liabilities shown above were as follows:\nThe increase in discount rate used in the computation of the pension liability, from 7.00 to 8.50 percent as of December 31, 1994 was based on the Company's analysis of the future benefit payment obligations of the defined benefit pension plans, discounted at actual spot rates available at December 31, 1994 on Aa3 industrial sector bonds. In accordance with the provisions of SFAS No. 87, \"Employers' Accounting for Pensions\", this change in discount rate resulted in a decrease to the additional minimum pension liability and an increase of stockholders' capital of $1,221,000 as of December 31, 1994. The remaining future costs of $650,000 will be amortized over the average remaining life expectancy of the inactive participants.\nNet pension costs for both the suspended and frozen plans consist of:\nThe Company's assumptions used as of January 1, 1994 and 1993, in determining the pension costs shown above were as follows:\nDuring the Company's bankruptcy proceedings, pursuant to a settlement with the Pension Benefit Guaranty Corporation (the \"PBGC\") in 1991, the Company established an irrevocable grantor trust (\"PBGC Trust\") to fund past due and certain future contributions. In January 1992, the Company caused the PBGC Trust to pay $3,946,000, which represented all contributions due to the pension plans prior to 1992. In addition, the Company made contributions to these plans from the PBGC Trust and operating funds totalling $1,401,000, $1,825,000 and $1,327,000 during 1994, 1993 and 1992, respectively. At December 31, 1994 and 1993, the value of assets in the PBGC Trust was $1,747,000 and $3,122,000, respectively; of which $860,000 and $1,375,000, respectively, were reported as other current assets on the Company's consolidated balance sheets.\nAmdura adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\"), effective January 1, 1994. The adoption of this standard did not have a material effect on the Company's results of operations or financial position.\nDuring the period the PBGC Trust has assets, the Company will contribute to the pension plans during each calendar year commencing after 1992, an aggregate amount equal to the lesser of $1,200,000 or 50 percent of each required minimum funding contribution due with respect to the pension plans, subject to further limitations based on net cash flow of the Company as defined by the PBGC settlement. At the direction of the Company, the PBGC Trust will pay the balance of each required minimum funding contribution due with respect to the pension plans after taking into account the contributions made by the Company. After the PBGC Trust ceases to have assets, the Company will make such contributions to the pensions plans as may be necessary to satisfy the minimum funding requirements of ERISA.\nIn addition to the above frozen defined benefit plans, the Company has defined contribution retirement savings plans. Certain plans cover substantially all employees and provide for a matching contribution by the Company of amounts, limited to 3 percent of compensation, contributed by the plans' participants. Certain other plans provide for quarterly contributions ranging from 1 to 15 percent of a participant's eligible compensation based on the participant's age and years of service. The Company's contribution expense related to its defined contribution plans was $1,772,000, $1,003,000 and $745,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nWith respect to Crosby and Harris, in conjunction with the adoption of fresh start reporting, the Company followed the provisions of APB 16 which required the establishment of a $5,822,000 liability to provide certain post retirement health care and life insurance benefits to retired employees and to current employees, to the extent such benefits have been earned. With the establishment of this liability, the Company effectively adopted the provisions of Statement of Financial Accounting Standards No. 106 \"Employer's Accounting for Post Retirement Benefits other than Pensions\" (\"SFAS No. 106\").\nThese benefits provide certain health care and life insurance benefits for certain retired employees. Covered employees may become eligible for those benefits if they reach normal retirement age while working for the Company. The major provisions and assumptions used in developing the post retirement health care and life insurance liabilities are as follows:\n- -- The Company pays for certain hospital and physicians' benefits for non-Medicare retirees. The Company's retiree health care costs are reduced when the retiree enters the Medicare program at age 65. The Company also provides life insurance coverage for certain employees and retirees.\n- -- There is no prefunding for post retirement health and life insurance benefits. Payments of benefits are dependent on cash flows from operations.\n- -- The medical trend cost rates assumed an inflation rate of 11 percent for 1994 which decreases through 2015 and remains at six percent in 2016 and thereafter.\n- -- The trend of increasing health care costs continues to adversely affect the Company's cost of providing benefits to employees and retirees. To illustrate, the effect of a one percentage point increase in assumed health care cost trend rates for each future year on the aggregate of the service and interest cost would approximate $24,000 whereas the total accumulated post retirement obligation for health and life insurance benefits would increase by approximately $315,000 using the same one percent factor.\n- -- A weighted-average discount rate of 8.5 percent and 7.0 percent at December 31, 1994 and 1993, respectively, was used to present value all future health care and life insurance liabilities.\n- -- A table of expected retirement ages was developed which reflects the experience of the Company. This table had low retirement age beginning at 55 with all employees assumed to retire by age 65. The 1983 Group Annuity Forecast Mortality Table was also used.\nAt December 31, 1994 and 1993, the Company had $5,640,000 and $5,412,000 accrued for liabilities under SFAS No. 106, respectively. During the years ended December 31, 1994, 1993 and 1992, respectively, the Company recorded service and interest costs of $523,000, $514,000, and $693,000 respectively, and paid claims of $271,000, $212,000, and $707,000, respectively. Previously the Company had recorded the cost of such benefits on a pay-as-you-go basis which was allowed by generally accepted accounting principles.\nThe Company adopted the provisions of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS No. 112\"), in the first quarter of 1994. SFAS No. 112 requires the establishment of a liability for certain benefits provided by an employer to former or inactive employees after employment but before retirement.\nAt December 31, 1994, the Company had $439,000 accrued for liabilities under SFAS No. 112. The effects of adopting the provisions of SFAS No. 112 resulted in the recording of a cumulative effect of change in accounting principle of $270,000, net of a related income tax benefit of $166,000 as of January 1, 1994.\n11. COMMITMENTS AND CONTINGENCIES\nDuring the course of the Bankruptcy Proceedings, numerous priority, administrative and secured claims were filed against the Company by various third parties. Under the Plan, certain allowed priority, administrative and secured claims which were approved became the liability of Amdura. At December 31, 1994, there was one pending administrative claim outstanding, for which a settlement agreement had been reached, and for which the parties were awaiting approval of the settlement by the Bankruptcy Court. The amount of this claim and other resolved and unpaid claims are accrued at December 31, 1994. Parties holding claims that have been disallowed or ruled by the Bankruptcy Court to be unsecured may attempt to reassert their claims as administrative or priority claims, and, some creditors may attempt to assert that their claims are not discharged and should continue as post bankruptcy obligations of Amdura. Based on the limited number of such claims received since the effective date of the Plan, the Company believes that, if any such additional claims are asserted and adversely determined against the Company, there will be no material adverse effect on the its financial condition or results of operations as a result of such claims.\nDuring the Bankruptcy Proceedings, numerous administrative and priority claims were filed against the Company regarding the costs of remediating problems at numerous sites which the Company or its subsidiaries owned or operated or to which alleged hazardous substances generated by the Company or its subsidiaries were allegedly transported. Amdura has substantially completed remediation of the sites relating to those allowed claims which became the Company's responsibility pursuant to the Plan, and has accrued any estimated remaining costs thereof at December 31, 1994. Subsequent to the effective date of the Plan, Amdura has been advised of one site for which the Company is alleged to be responsible for remediation costs for which it believes the claim has been discharged in the Bankruptcy proceeding. Amdura is vigorously defending its rights to be\ndischarged from this claim, and it is the Company's position that remediation costs of this and other sites which were subject to proper notification of the bankruptcy should be considered unsecured claims subject to discharge in the Bankruptcy Proceeding. Based on the limited number of such claims received since the effective date of the Plan, the Company believes that, if any such additional claims are asserted and adversely determined against the Company,there will be no material adverse effect on the its financial condition or results of operations as a result of such claims.\nDuring 1992 Amdura National Distribution Company (\"Andco\"), a liquidating estate and former subsidiary of Amdura which filed a voluntary petition of bankruptcy at the same time as the Company, filed a lawsuit against the Company in Bankruptcy Court seeking approximately $1,050,000 previously held in a cash concentration account. During September 1993, the Bankruptcy Court granted summary judgement in favor of Amdura and denied Andco's cross motion for summary judgement. Andco subsequently appealed the Bankruptcy Court's decision in Federal District Court for the District of Colorado (the \"District Court\"). During May 1994, the District Court issued a judgement for Amdura and against Andco, affirming the Bankruptcy Court's earlier decisions. In September 1994, both Amdura and Andco filed briefs in the United States Court of Appeals for the Tenth Circuit. Amdura intends to continue vigorously defending its rights to such funds. Liability, if any, to the Company for repayment of the funds is presently not determinable.\nPrior to Amdura's bankruptcy filing, two class action suits were filed against the Company and certain former directors. It was Amdura's position that the claims of the plaintiffs have been discharged pursuant to the Plan, with the rights of the plaintiffs limited to distributions, if any, available to them under the Plan. The Bankruptcy Court disallowed the \"class claims\" filed by such plaintiffs against Amdura as part of the Bankruptcy Cases, thereby leaving the individual class representatives, as opposed to the entire class, as the only parties with possible claims against Amdura. The plaintiffs appealed such disallowances as well as the order of the Bankruptcy Court confirming the Plan. During August 1994, the District Court issued an order reinstating the \"class claims\" which had been disallowed by the Bankruptcy Court. The order also purported to reverse the Bankruptcy Court's order confirming the Plan. The effectiveness of this order was immediately stayed, and, upon the parties' reaching of the settlement discussed below, the order was vacated.\nOn August 31, 1994, Amdura entered into a definitive Stipulation of Settlement with the representatives of the plaintiff class in the two class action suits, and the District Court approved the Stipulation of Settlement in November 1994. Pursuant to the Stipulation of Settlement, Amdura will pay $500,000 in cash and issue 564,302 shares of its common stock in exchange for a full and final release of all claims under the complaints. The Company recognized a one-time special charge of $1,875,000 in the third quarter of 1994 as a result of this settlement.\nThe Company and its subsidiaries from time to time are presented with claims arising out of their current and former manufacturing and other operations, including claims asserting personal injury arising out of the manufacture, sale and use of the products of those businesses based on various theories of recovery for product liability and for workers compensation. The Company believes that no one such outstanding claim or group of related claims is material to the consolidated financial position of Amdura. Amdura and its subsidiaries vigorously defend all product liability claims, and believe that their products are safe and suitable for their intended uses. Amdura and its subsidiaries have comprehensive general liability insurance under various programs which may afford total or partial coverage for certain product claims. Prepetition claims identifying Amdura and any of the other Debtors as a defendant were subject to the automatic stay under the Bankruptcy Code and to\ndischarge in bankruptcy. Claims against Crosby and Harris were not stayed and have not been affected by confirmation of the Plan.\nUnder the terms of the agreement by which Amdura sold certain assets of its crane businesses to The American Crane Corporation (\"American Crane\"), American Crane agreed to indemnify Amdura for certain liabilities of such businesses which might otherwise be asserted against Amdura. Included among such liabilities are various environmental site and product liability matters (including one group of a large number of related matters). If such indemnity were to become ineffective for any reason (including due to American Crane's financial condition), then the liabilities covered thereby could revert to Amdura.\nThe Company is a defendant in three personal injury lawsuits that have been filed in Minnesota in 1994. The plaintiffs in each suit allege exposure to asbestos-containing products of various manufacturers. The Company has been named in each suit as an alleged successor-in-interest to another business entity. The Company purchased substantially all of the assets of the predecessor entity in 1967 and sold substantially all of the assets of the subject product line in 1969. The Company's liability in the three pending suits is allegedly predicated on the Company's having assumed the liabilities of the predecessor entity for acts that occurred prior to the asset acquisition. Based on a review of the facts currently available to the Company and of its defenses to the allegations of the lawsuits, the Company believes that the disposition of these lawsuits is not likely to have a material adverse effect on its financial condition or results of operations.\nWhere the Company is able to estimate the results of legal proceedings and environmental and other claims, appropriate accruals have been established. The Company had $7,961,000 at December 31, 1994, accrued for such items. However, with respect to certain legal proceedings, certain environmental and other claims and certain contingent liabilities, the Company is unable to estimate the eventual outcome and impact on the consolidated financial statements and no provision for any loss that may result from resolution of these matters has been made. In any event, the Company believes that current accruals and established sources of cash from operations and other sources are adequate to meet the requirements of reasonably expected payments regarding legal proceedings and environmental and other claims, and that these payments will not have a material adverse effect on the Company's financial condition or results of operations.\nThe Company has noncancellable commitments for rental of equipment under both capital and operating leases which expire at various dates through 2001.\nThe following is a schedule by year of future minimum lease commitments under all noncancellable leases:\nCertain of the operating leases require the payment of real estate taxes and insurance. Total rent expense was $1,358,000, $1,184,000, and $1,282,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\n12. INCOME TAXES\nAs discussed in Note 3, the Company adopted SFAS No. 109 in 1992. There was no cumulative effect of this change to record in 1992.\nThe provision for income taxes related to continuing operations consists of the following:\nThe tax effects of net operating loss carryforwards and the temporary differences between the financial statement carrying amounts and the tax bases of assets (liabilities), are as follows:\nIn connection with the adoption of fresh start accounting, net deferred tax assets, including tax loss carryforwards, were offset by a valuation allowance due to the uncertainty of future realization. SFAS No. 109 and SOP 90-7 require that a charge to income tax expense be made as these future tax benefits are realized, and the related reversal of the valuation allowance will be used first to reduce reorganization value in excess of amounts allocable to identifiable assets and other intangibles until exhausted and thereafter, be reported as a direct addition to capital. During 1994, the Company reduced reorganization value in excess of amounts allocable to identifiable assets by approximately $1,500,000. The future tax benefits to be realized from the utilization of deferred deductible temporary differences and net operating loss carryforwards will correspondingly reduce future tax payments to the Internal Revenue Service.\nA 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. The Company has established a valuation allowance for the deferred tax assets to the extent it is not offset by deferred tax liabilities due to the uncertainty surrounding the Company's ability to generate sufficient taxable income in order to realize these assets during the carryforward period.\nA reconciliation setting forth the difference between income taxes at the 34 percent Federal statutory rate and the Company's effective income tax rate on continuing operations is summarized as follows:\nAt December 31, 1994, the Company had significant net operating loss carryforwards which originated prior to November 1, 1991. However, due to certain change of ownership requirements of the Internal Revenue Code, utilization of the net operating loss carryforwards is limited to approximately $39,000,000 at the rate of $2,734,000 per year through 2005. In addition, the Company has net operating loss carryforwards generated subsequent to October 31, 1991 of approximately $25,400,000 which expire through 2008.\nThe utilization of these net operating loss carryforwards may be limited if changes in the Company's stock ownership, as defined in the Internal Revenue Code, exceed 50 percent of the value of the Company's stock during any three year period. The calculation of the limitation is based on the fair\nvalue of the Company, the Federal long-term interest rate and the expiration periods of the existing net operating loss carryforwards. The calculation at December 31, 1994 reflects a change in ownership of approximately 45 percent during the previous three year period.\n13. ACQUISITIONS\nDuring 1994, in two separate transactions, the Company acquired certain assets and assumed certain liabilities of companies engaged in similar manufacturing operations. The aggregate purchase price, including assumed liabilities of $1,460,000, was $6,628,000 and was allocated to the acquired assets based upon their fair value at the purchase dates with the excess of $2,457,000 being recorded as costs in excess of net assets acquired. The purchase price consisted of $1,250,000 and 2,151 shares of Series B Preferred Stock.\n14. INTANGIBLE ASSET ADJUSTMENT\nAs discussed in Note 2, in the fourth quarter of 1992, the Bank Group exchanged $27,768,000 in debt for additional stock in the Company. This debt restructuring was caused by reduced cash flows resulting from the negative impact of soft domestic and foreign economies and increased competition in certain markets. In connection with the exchange of stock for debt, and to reflect the impact of other changes in projected sales volume and cost structure, the Company revised the estimate of discounted cash flows from projected future operations originally prepared upon emergence from bankruptcy and determined that the revised discounted cash flows were not sufficient to support the recorded amount of the reorganization value in excess of amounts allocable to identifiable assets. Accordingly, the Company recorded a valuation adjustment in 1992 of $10,029,000 or $0.81 per share for the write-down of this intangible asset.\n15. COSTS AND EXPENSES\nThe Company incurred product research and development costs of $737,000, $498,000 and $1,136,000 for the years ended December 31, 1994, 1993, and 1992, respectively.\nThe Company incurred product advertising costs of $2,284,000, $1,621,000 and $1,337,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nThe Company recorded a $600,000 reduction of selling and administrative expenses as a result of the favorable resolution of certain matters related to the Amdura bankruptcy reorganization which occurred during the second quarter of 1994.\nThe Company recorded nonrecurring costs associated with bankruptcy related matters, suspension of certain pension plans, the relocation of Harris' corporate offices and other items totalling $3,441,000 in 1992.\n16. FINANCIAL INSTRUMENTS\nThe carrying amount of Amdura's financial instruments approximates fair value due to the short term maturity of cash and cash equivalents, the classification of PBGC Trust assets as trading\nsecurities pursuant to SFAS No. 115 and the refinancing of the Company's long-term debt on September 30, 1994.\n17. OPERATIONS BY GEOGRAPHIC AREA AND EXPORT SALES\nNet sales by geographic area consist of:\nIncome (loss) before income taxes by geographic area consists of:\nIdentifiable assets by geographic area consist of:\nU.S. export sales to unaffiliated customers by destination of sale consist of:\n18. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nFully diluted per share data is not presented because it would be anti-dilutive.\n(1) Loss per share for the fourth quarter of 1992 included a valuation adjustment of ($.81) related to the write-down of the reorganization value in excess of amounts allocable to identifiable assets as discussed in Note 14, and a special charge of ($.07) related to the suspension of three defined benefit pension plans as discussed in Note 10.\n* * * * *\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 this item is incorporated by reference to the information under the caption \"Election of Directors\" in the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required by this item is incorporated by reference to the information under the caption \"Executive Compensation\" in the 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 the information under 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\nInformation required by this item is incorporated by reference to the information under the caption \"Certain Relationships and Related Transactions\" in the Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) The financial statements required to be filed by \"Item 8 - -Financial Statements and Supplementary Data\" of this Annual Report on Form 10-K are included as part of Item 8 hereto. See the Index to Consolidated Financial Statements included as part of Item 8 here to which is hereby incorporated by reference herein.\n(2) The list of financial statement schedules required to be filed by \"Item 8 - -Financial Statements and Supplementary Data\" of this Annual Report on Form 10-K is as follows: Page ---- Schedule II--Valuation and Qualifying Accounts . . . . . . . . 47\nAll other schedules of the Company 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) The list of exhibits required to be filed with this Annual Report on Form 10-K is set forth in Item 14(c) hereof.\n(b) During the fourth quarter of 1994, Amdura filed the following current report on Form 8-K:\nCurrent Report on Form 8-K, dated October 13, 1994, filed with respect to items 5 and 7 on October 14, 1994.\n(c) The following exhibits are filed herewith or are incorporated herein by reference:\nExhibit No. Description - ------- -----------\n2.1 Debtors' Fifth Amended Joint Plan of Reorganization, filed with the Bankruptcy Court on June 12, 1991. (Incorporated by reference to Exhibit 2.3 of the Form 10-K filed by Amdura with the Commission on July 11, 1991.)\n3.1 Restated Certificate of Incorporation of Amdura Corporation as currently in effect. (Incorporated by reference to Exhibit 3.1 to the Form 10-K filed by Amdura with the Commission on March 30, 1994.)\n3.2 Amdura Corporation Bylaws and all amendments thereto as currently in effect. (Incorporated by reference to Exhibit 3.2 to the Form 10-K filed by Amdura with the Commission on March 30, 1994.)\n10.1 Parent Guaranty (excluding the schedules and exhibits thereto), dated as of September 30, 1994, by Amdura Corporation in favor of Sanwa Business Credit Corporation (Incorporated by reference to Exhibit 10.1 to the Form 10-Q filed by Amdura with the Commission on November 14, 1994.)\nExhibit No. Description - ------- -----------\n10.2 Loan Agreement (excluding the schedules and exhibits thereto), dated as of September 30, 1994, among The Crosby Group, Inc. as Borrower, the Lenders named therein and Sanwa Business Credit Corporation, as agent (Incorporated by reference to Exhibit 10.2 to the Form 10-Q filed by Amdura with the Commission on November 14, 1994.)\n10.3 Loan Agreement (excluding the schedules and exhibits thereto), dated as of September 30, 1994, among The Harris Waste Management Group, Inc. as Borrower, the Lenders named therein and Sanwa Business Credit Corporation, as agent (Incorporated by reference to Exhibit 10.3 to the Form 10-Q filed by Amdura with the Commission on November 14, 1994.)\n10.4 Amdura Corporation 1992 Stock Option Plan, as amended (Compensatory Plan). (Incorporated by reference to Exhibit 10.5 to the Form 10-K filed by Amdura with the Commission on March 30, 1994.)\n10.5 Registration Rights Agreement dated as of December 23, 1992, among Amdura Corporation and the Subordinated Term Loan Lenders. (Incorporated by reference to Exhibit 10.6 to the Form 8-K filed by Amdura with the Commission on December 28, 1992.)\n10.6 Amdura's Bonus Plan, general description. (Incorporated by reference to Exhibit 10.24 to the Form 10-K filed by Amdura with the Commission on December 11, 1990.) (Compensatory Plan).\n10.7 (i) Amdura Liquidating Trust Agreement No. 1 dated as of October 23, 1991, between Amdura and Tom H. Connolly, as Trustee; (ii) Amdura Liquidating Trust Agreement No. 2 dated as of October 23, 1991, between Amdura and Tom H. Connolly, as Trustee; (iii) Amdura Liquidating Trust Agreement No. 3 dated as of October 23, 1991, between Amdura and Tom H. Connolly, as Trustee; (iv) Amdura Liquidating Trust Agreement No. 4 dated as of October 23, 1991, between Amdura and Tom H. Connolly, as Trustee; (v) Amdura Liquidating Trust Agreement No. 5 dated as of October 23, 1991, between Amdura and Tom H. Connolly, as Trustee. (Incorporated by reference to Exhibit 10.8 to the Form 10-K filed by Amdura with the Commission on May 19, 1992.)\n10.8 (i) Indemnity Agreement between Amdura and James A. Bach effective as of March 24, 1992; (ii) Indemnity Agreement between Amdura and Marvin L. Dimond effective as of March 24, 1992; (iii) Indemnity Agreement between Amdura and Mark M. Metz effective as of March 24, 1992; (iv) Indemnity Agreement between Amdura and Paul C. Meyer effective as of March 24, 1992; (v) Indemnity Agreement between Amdura and Larry L. Postelwait effective as of March 24, 1992; (vi) Indemnity Agreement between Amdura and C. David Bushley effective as of July 8, 1993; (vii) Indemnity Agreement between Amdura and John W. Gildea effective as of July 8, 1993; (viii) Indemnity Agreement between Amdura and Tracey L. Rudd effective as of July 8, 1993; (ix) Indemnity Agreement between Amdura and Robert LeBuhn effective as of October 8, 1993; (x) Indemnity Agreement between Amdura and Frederick W. Whitridge, Jr. effective as of February 28, 1994. (Except for the parties thereto and the addresses of such parties for notice purposes, the above-referenced Indemnity Agreements are identical in all material respects. Accordingly, Amdura has filed a copy of only one such agreement). (Incorporated by reference to Exhibit 10.9 to the Form 10-K filed by Amdura with the Commission on May 19, 1992.)\nExhibit No. Description - ------- ----------- 10.9 (i) Registration Rights Agreement between Amdura and the Amdura Liquidating Trust No. 1 dated as of November 30, 1991; (ii) Registration Rights Agreement between Amdura and Continental Bank, N.A. dated as of November 30, 1991; (iii) Registration Rights Agreement between Amdura and Seattle-First National Bank dated as of November 30, 1991; (iv) Registration Rights Agreement between Amdura and Norwest Bank Minnesota, N.A. dated as of November 30, 1991; (v) Registration Rights Agreement between Amdura and Patricia Investments, Inc. dated as of November 30, 1991; (vi) Registration Rights Agreement between Amdura and Internationale Nederlanden Bank N.V. (a\/k\/a NMB Postbank Group N.V.) dated as of November 30, 1991; (vii) Registration Rights Agreement between Amdura and Generale Bank dated as of November 30, 1991; (viii) Registration Rights Agreement between Amdura and Pilgrim Prime Rate Trust dated as of November 30, 1991. (Except for the parties thereto, the above-referenced Registration Rights Agreements are identical in all material respects. Accordingly, Amdura has filed a copy of one such agreement). (Incorporated by reference to Exhibit 10.10 to the Form 10-K filed by Amdura with the Commission on May 19, 1992.)\n11.1 Calculation of Net Income (Loss) per Common Share and Common Equivalent Share.\n22.1 Subsidiaries of the Registrant. (Incorporated by reference to Exhibit 22.1 to the Form 10-K filed by Amdura with the Commission on March 30, 1994.)\n27.1 Financial Data Schedule.\nAMDURA CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (In Thousands)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMDURA CORPORATION\nDate: March 15, 1995 By \/s\/ James A. Bach ----------------------- James A. Bach, President and Chief Operating 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\/ Frederick W. Whitridge, Jr. -------------------------------- Frederick W. Whitridge, Jr., Chairman of the Board\nDate: March 15, 1995 \/s\/ James A. Bach -------------------------------- James A. Bach, Director, President and Chief Operating Officer\nDate: March 15, 1995 \/s\/ C. David Bushley -------------------------------- C. David Bushley, Senior Vice President, Finance and Administration and Chief Financial Officer (Principal Financial and Accounting Officer)\nDate: March 15, 1995 \/s\/ Marvin L. Dimond -------------------------------- Marvin L. Dimond, Director\nDate: March 15, 1995 \/s\/ John W. Gildea -------------------------------- John W. Gildea, Director\nDate: March 15, 1995 \/s\/ Robert LeBuhn -------------------------------- Robert LeBuhn, Director\nDate: March 15, 1995 \/s\/ Paul C. Meyer -------------------------------- Paul C. Meyer, Director\nDate: March 15, 1995 \/s\/ Tracey L. Rudd -------------------------------- Tracey L. Rudd, Director\nEXHIBIT INDEX","section_15":""}
{"filename":"73093_1994.txt","cik":"73093","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nFounded in 1879, the Company is a major mini-mill producer of structural steel products and rod and wire products. In contrast to integrated mills which produce steel from coke and iron ore through the use of blast furnaces and basic oxygen furnaces, mini-mills use electric arc furnaces to melt steel scrap and cast the resulting molten steel into long strands of various shapes in a continuous casting process. The Company's steel products include wide flange beams, light structural shapes and merchant bars. The Company's rod and wire products include nails, concrete reinforcing mesh, residential and agricultural fencing and a wide range of other wire products.\nThe Company pioneered the use of electric arc furnaces for steelmaking, installing its first electric arc furnace in 1936. The Company's three 400-ton electric arc furnaces are among the world's largest, providing the Company with considerable economies of scale in its steel scrap melting operations.\nThe Company's operations are located in Sterling and neighboring Rock Falls, Illinois (the \"Sterling Operations\") and Houston, Texas (the \"Houston Facility\"). The Sterling Operations consist primarily of a melt shop with three 400-ton electric arc furnaces with an annual scrap melting capacity in excess of 2.4 million tons, three continuous casters, three rolling and finishing mills and the Company's nail and wire operations. The Houston Facility consists of a wide flange beam rolling and finishing mill. The Company's continuous casters have sufficient capacity to cast semi-finished steel for all of the Company's rolling and finishing mills. The Company believes that its large and low-cost steel scrap melting capacity and its ability to satisfy all of the rod requirements of its Rod and Wire Products operations from its rod production give it a strategic cost advantage over its competitors.\nOPERATIONS\nThe Company's operations constitute one line of business with several classes of products. Operations are divided into the Steel Division and the Rod and Wire Products Division.\nThe Steel Division produces raw steel using the electric arc furnace process. Semi-finished products are then continuously cast into billets, blooms and beam blanks.\nFinished products are rolled from the semi-finished steel through a series of reduction mill processes. Such products\ninclude structural wide flange beams, channels and angle products and merchant bar and bar shapes, which are sold nationally to steel fabricators, distributors and original equipment manufacturers, including industrial and agricultural machinery manufacturers. The Company sells its output principally through Company personnel and independent sales agents to customers located throughout the United States. In addition, semi-finished products are sold to other steel producers.\nThe Rod and Wire Products Division produces rods for use in drawing to various wire gauges to produce nails, fence and a wide range of other fabricated wire products for shipments to hardware jobbers, agricultural cooperatives and the construction industry.\nThe Company has two wholly-owned subsidiaries: (i) Northwestern Steel and Wire Company, a Texas corporation (\"NSW-Texas\"), which operates the Houston Facility, as described above; and (ii) Northwestern Steel and Wire Company, a Delaware corporation (\"NSW-Delaware\"), which provides administrative services to the Company and NSW-Texas for which it receives payment from the Company and NSW-Texas. The administrative services performed by NSW-Delaware include the sales, finance, human resources and purchasing functions of the Company as well as the management of the Company's operating facilities and the leased fleet operation. All salaried individuals, as well as the leased fleet drivers of the Company, are employees of NSW-Delaware.\nCUSTOMERS AND MARKETS\nStructural steel products are used in a variety of commercial, industrial and residential construction applications, as well as infrastructure projects, such as roads and bridges, and public sector construction, such as schools and hospitals. In construction applications, structural steel products are used as beams, columns and girders which form the support structure of a building. In infrastructure construction, structural forms are combined to form bridge trusses and vertical highway supports. Original equipment manufacturers use light structural shapes in the fabrication of heavy equipment.\nApproximately two-thirds of the Company's steel rod production is utilized in the manufacture of the Company's rod and wire products, while the remaining one- third of the Company's rod production is sold to other manufacturers of rod and wire products. The Company sells its rod and wire products largely to hardware jobbers, agricultural cooperatives, hardware and other retailers serving the do- it-yourself market and the construction industry in the upper Midwest region of the United States. Manufacturers' wire is sold directly to manufacturers of a variety of products, such as fan guards, automotive door rods, shopping carts and dishwasher baskets. The Company believes that it is the largest single-site manufacturer of nails in the United States.\nCAPITAL IMPROVEMENTS\nOver the last decade, the Company has improved many of its steel manufacturing operations. At the Sterling Operations, capital improvements have included the modernization of the 12\" bar mill into a high-speed rod mill and the modernization of the 14\" rolling mill. Melt shop improvements at the Sterling Operations have included construction of both an 8-strand billet caster and a 6-strand bloom caster. Combined with the installation of beam blank casting technology, these improvements permit the Company to continuously cast 100% of its product at a significantly lower cost by eliminating ingot teeming and reheating and blooming mill operations. Other melt shop improvements have included the purchase and installation of a new ladle refining furnace, low impedance arms, and ladle transfer cars. The Company believes that these improvements have enabled it to lower its cost for both its structural steel products and rod and wire products.\nIn 1989, the Company acquired the Houston Facility for approximately $33 million and has since invested approximately $43 million in capital improvements. As part of the Houston Facility's refurbishment, all mechanical and electrical components in its mill were completely reconditioned and brought to operable condition. In 1991, the Company also installed a jumbo beam blank continuous caster at the Sterling Operations to produce near shape beam blanks for the Houston Facility.\nRAW MATERIALS\nThe Company's major raw material is steel scrap, which is generated principally from industrial, automotive, demolition and railroad sources and is purchased by the Company in the open market through a number of scrap brokers and dealers or by direct purchase. The cost of scrap is subject to market forces including demand by other steel producers. The cost of scrap to the Company can vary significantly, and product prices generally cannot be adjusted in the short-term to recover large increases in steel scrap costs. Over longer periods of time, however, product prices and scrap prices have tended to move in the same direction.\nThe long-term demand for ferrous scrap and its importance to the domestic steel industry can be expected to increase as steelmakers continue to expand scrap-based electric furnace capacity with additions to or replacements of existing integrated facilities. For the foreseeable future, however, the Company believes that supplies of scrap will continue to be available in sufficient quantities.\nENERGY\nSteelmaking is an electricity-intensive industry. Historically, the Company has been adequately supplied with\nelectricity and does not anticipate any curtailment in its operations resulting from energy shortages. The Company's second largest source of energy is natural gas. Historically, the Company has been adequately supplied with natural gas and an adequate supply is expected to be available in the future.\nCOMPETITION\nThe Company competes with a number of domestic and foreign mini-mill and integrated steel producers. In the structural steel market, the Company believes its principal competitors are Bethlehem Steel Corporation, an integrated steel producer, and Chaparral Steel Co. and Nucor Corporation, both of whom use an electric arc furnace-based steelmaking process. The Company has attempted to differentiate itself from its mini-mill competitors by taking advantage of its ability to produce small quantities and concentrating its efforts on the higher value-added steel fabricator market. Integrated producers generally operate at a competitive disadvantage to domestic mini-mill producers because of less efficient production techniques and higher labor costs. The relative weakness of the U.S. dollar to foreign currencies coupled with high shipping costs has reduced foreign exports of structural steel products to the United States when compared to the prior decade. However, the Company has seen foreign exports increase in fiscal 1994 when compared to fiscal 1993.\nAccording to the American Iron and Steel Institute, (\"AISI\"), the size of the U.S. structural steel market was approximately 5.5 million tons in calendar 1993. Because of their cost disadvantage, domestic integrated producers have reduced their structural steel production and foreign integrated producers have reduced their structural steel exports to the United States. This supply has been replaced by domestic mini-mills. Although integrated producers have been reducing their production levels, the Company believes that the market for structural steel products will increase, as the use of structural steel is expanding in various construction applications, replacing traditional materials such as concrete as a result of the flexibility and strength of steel products, and structural steel's speed of installation and resistance to earthquake damage. Based on information published by the AISI, the Company believes that its share of shipments by domestic mills in the U.S. structural steel market was approximately 16.0% for fiscal 1994. Within the market for wide flange beams, which tend to be the most profitable of the Company's structural steel products, the Company believes its share of shipments in the U.S. market by domestic mills was 25.1% for fiscal 1994 based on information published by the AISI.\nThe market for rod and wire products in which the Company competes is confined to the upper Midwest region of the United States in which the Sterling Operations are located. This confinement results from the relatively high freight costs as compared to product values. The Company's competitors in the rod market include Armco Inc., CF&I Steel L.P. (\"CF&I\"),\nKeystone Steel & Wire Co. (\"Keystone\") and North Star Steel Co. The Company's competitors in the wire market include Bekaert Corp., CF&I, Keystone, Insteel Industries, Inc., and Oklahoma Steel Corp.\nBACKLOG\nAs of September 30, 1994, order backlog, all of which is expected to be filled in fiscal 1995, totaled approximately $67 million compared with approximately $74 million as of September 30, 1993. The Company believes that the reduction in order backlog reflects the Company's more timely fulfillment of its customer's orders.\nSALES BY DIVISION\nDuring the fiscal years ended July 31, 1994 and 1993, no single customer accounted for more than 10% of total dollar net sales. Sales to the Company's ten largest customers accounted for approximately $130.1 million, or approximately 22% of total net sales in fiscal 1994. Total foreign sales accounted for approximately $7.3 million, or approximately 1% of total fiscal 1994 net sales.\nFor the fiscal years indicated below, the approximate percentage of net sales contributed by each class of similar products is as follows:\nEMPLOYEES\nAs of July 31, 1994, there were approximately 2,517 active employees of the Company. Approximately 2,123 of the Company's employees are represented by five collective bargaining units, with approximately 2,071 represented by three local unions affiliated with the United Steelworkers of America, (\"USWA\") and the remainder represented by one local union affiliated with the United Plant Guard Workers of America and one local union affiliated with the International Brotherhood of Teamsters. The Company is a party to a collective bargaining agreement with the USWA with respect to Locals 63 and 3720 covering approximately 1,842 of the Company's employees in Sterling and Rock Falls, Illinois which expires on August 1, 1996. The Company is a party\nto two collective bargaining agreements, with the USWA with respect to 229 employees at the Houston Facility, one of which expires on June 30, 1995 and the other August 1, 1996. The two remaining bargaining units are party to collective bargaining agreements with the Company covering a total of approximately 52 employees, each of which agreements expires in fiscal 1997.\nThrough the ESOP, various stock ownership plans and direct ownership, employees of the Company currently own approximately 19% of the outstanding Common Stock. In addition, pursuant to the Company's profit sharing plan, 5% of the Company's free cash flow (as defined therein) will be paid to eligible hourly employees in profit sharing. The Company provides similar benefits for eligible salaried employees covering 1.02% of the Company's free cash flow.\nENVIRONMENTAL COMPLIANCE\nThe Company is subject to a broad range of federal, state and local environmental requirements, including those governing discharges to the air and water, the handling and disposal of solid and\/or hazardous wastes and the remediation of contamination associated with releases of hazardous substances. Primarily because the melting process at the Sterling Operations produces dust that contains lead and cadmium, the Company is classified, in the same manner as other similar steel mills in its industry, as a generator of hazardous waste.\nBased on continuing review of applicable regulatory requirements by the Company's internal environmental compliance officer and advice from independent consultants, the Company believes that it is currently in substantial compliance with applicable environmental requirements and does not anticipate the need to make substantial expenditures for environmental control measures during fiscal 1995. Nevertheless, as is the case with steel producers in general, if a release of hazardous substances located on the Company's property occurs, the Company may be held liable and may be required to pay the cost of remedying the condition. The amount of any such liability and remedial cost could be material.\nThe Resource Conservation and Recovery Act (\"RCRA\") regulates the disposal of emission control sludge\/dust from electric arc furnaces (\"K061\"), a waste stream generated in significant quantities at the Sterling Operations. The Company is complying with RCRA with respect to K061 by chemically stabilizing this waste before its disposal. Conversion Systems, Inc. has been chemically stabilizing the K061 for the Company. Annual expenses in connection with such services are approximately $3.5 million per year. This chemical stabilization process allows the Company to use the fully permitted, hazardous waste landfill at the Sterling Operations for disposal of the stabilized K061.\nIn March of 1994, the Company received a modification to its Part B RCRA permit from the Illinois EPA to allow an expansion to its hazardous waste landfill. Phase I of the expansion took place during the summer of 1994 at a cost of approximately $1.5 million. Phase II of the expansion may be conducted during FY95 and its cost is expected to be less than $500,000. At July 31, 1994, the Company had approximately $2,150,000 in a trust fund designated for landfill closure costs. The Company also operates an on-site non-hazardous waste landfill. The Company expects to close this landfill in fiscal 1997. Regulations regarding steel and foundry non-hazardous landfills were finalized in September 1994. At this time, the Company is determining the cost of closing this landfill which the Company currently estimates may be as much as $2 million.\nA closed, pre-RCRA landfill at the Sterling Operations was used from 1974 to 1980. In 1992, the United States Environmental Protection Agency agreed with a Corrective Measures Study submitted by the Company and allowed continued groundwater monitoring at the site. The Company currently estimates the cost of this monitoring to be minimal; however, should the monitoring indicate a more serious problem, these corrective measures could be material.\nThe Company has occasionally exceeded the limits of its wastewater discharge permit at its Sterling Operations. The Company believes that modified operating procedures and certain equipment upgrades should eliminate the waste water discharge concerns of the State of Illinois and the EPA. The Company estimates that costs to implement equipment upgrades will be approximately $500,000 and will likely be incurred in fiscal 1995 and 1996.\nThe Houston Facility sporadically exceeds the limits of its wastewater permit, always due to high metal concentrations in city intake water. The Company intends to discuss the possibility of intake credits with the local environmental agencies. If additional control equipment is necessary, the Company believes its cost will not be material.\nThe Company possesses air emission permits for all major operations. Recent review of operations in connection with other requirements revealed certain operations which may require permits or permit modifications. The Company is in the process of applying for such permits or permit modifications.\nNew rules to be adopted under amendments to the 1990 Clean Air Act (\"CAA\") may impose significantly stricter air emissions standards on the Company. Because regulations applicable to the Company's operations have not yet been promulgated under the CAA, the Company cannot at this time determine the cost to comply with the new regulations. Because these standards will also apply to the Company's domestic competitors, they should not materially affect the Company's competitive position.\nBefore it was purchased by the Company in 1989, the Houston Facility was part of the Armco Houston Works (the \"AHW\"). The AHW is now closed, but is listed on CERCLIS, the EPA's list of suspected hazardous substance release sites. The EPA's concern appears to be related to a part of the AHW not purchased by the Company and the Company has not received any claims or notices related to the CERCLIS listing.\nPATENTS AND TRADEMARKS\nThe Company holds no patents, trademarks, licenses, franchises or concessions of material importance to its business.\nENTERPRISE ZONE DESIGNATION\nEffective March 30, 1988, the Company's property was designated to be within an Illinois Enterprise Zone (\"Enterprise Zone\") by the Illinois Department of Commerce and Community Affairs. The primary benefit to the Company of operating within an Enterprise Zone is the receipt of a state utility tax exemption on gas and electricity as well as an exemption on the Illinois Commerce Commission's administrative charge on these utilities. The Company has been able to demonstrate sufficient capital spending and thus is entitled to the utility tax exemption through July 31, 1998. This utility tax exemption is expected to save the Company approximately $2 million to $2.5 million per year through July 31, 1998.\nAn additional benefit to the Company of operating within the Enterprise Zone is the receipt of a state sales tax exemption on the purchase of consumable manufacturing supplies. Eligibility for the sales tax exemption was contingent upon the Company making a $40 million investment that causes the retention of 2,000 full time jobs in Illinois. The Company has been able to demonstrate sufficient capital spending and thus is entitled to the sales tax exemption through June 30, 1995. This sales tax exemption is expected to save the Company approximately $300,000 to $400,000 per year through June 30, 1995.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe executive offices of the Company and its steel producing facilities, designated as Plants 1, 2, 3, 5, and 6, are located on approximately 596 acres of land along the Rock River in Sterling, Illinois, and Plant 4 is on 8 acres of land located directly across the river in Rock Falls, Illinois. The Houston Facility is located on approximately 180 acres of land in Houston, Texas.\nPlant 1, comprising 641,081 square feet of floor space, consists of a wire mill with equipment for drawing, galvanizing and annealing wire, and machinery for manufacturing fence, netting, nails and other wire products.\nLocated in Plant 2 are liquid metal producing facilities, with 2,400,000 net tons annual capacity, consisting of three 400- ton electric furnaces, which are equipped with modern effluent controls. Also located at Plant 2 is a six strand bloom continuous caster, an eight strand billet continuous caster and a three strand jumbo beam caster having a combined annual capacity of 2,500,000 net tons, and a 12\" rod train having an annual capacity of 400,000 net tons. At present, this plant comprises 961,318 square feet of floor space.\nPlant 3 consists of a 24\" structural mill, with a total annual capacity of 440,000 net tons. The plant comprises approximately 900,000 square feet of floor space.\nManufacturing facilities for the production of welded wire products are located at the Rock Falls Plant 4, which consists of 397,880 square feet.\nThe 14\" merchant bar mill, comprising 434,740 square feet and having an annual capacity of 400,000 net tons, is located at Plant 5.\nPlant 6 consists of 48,304 square feet of floor space and is currently idle.\nThe Houston Facility consists of a wide flange structural mill and comprises approximately 860,000 square feet of floor space. The total annual capacity of the mill is 600,000 net tons. The Houston Facility consists generally of a 48\" wide flange beam finishing mill, a barge dock, and the corresponding real property on which these structures are located.\nAll buildings are owned by the Company and are of steel, brick or concrete construction. The Company believes that its plants and equipment are in good operating condition.\nDuring fiscal 1994, the Company's primary steelmaking facilities operated at approximately 81% of capacity. The Company's finishing facilities operated at approximately 80% of capacity.\nPursuant to the Company's existing credit facility, the Company has granted mortgages on all of the Company's real estate and security interests in its other assets, including equipment and fixtures.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is seeking a declaratory judgment in the Circuit Court of Cook County, Illinois that certain provisions of the state's revised workers' compensation regulations are unconstitutional. The effect of the revised regulations is to require the Company to increase the amount of security posted by the Company from $200,000 to $8.8 million to maintain the Company's self- insurance workers' compensation privilege. Upon\nthe posting of a $400,000 bond, the Company obtained a temporary restraining order which effectively restrains the imposition of this increased security requirement and the ability of the Illinois Industrial Commission (the \"Industrial Commission\") to terminate the Company's self-insurer status, pending further order of The Circuit Court of Cook County. If the Company is unsuccessful in its challenge to the Industrial Commission's actions or regulations and is unable to post the required bond, the Company would be required under the Illinois law to obtain insurance for its workers' compensation claims. Insurance would likely be much more expensive than the Company's self-insurance plan or may be unavailable and obtaining a letter of credit under the Senior Credit Facility would reduce the Company's borrowing capacity.\nA wrongful death action against the Company is pending in the 113th Judicial District Court of Harris County, Texas. The action stems from the death of an employee at the Company's Houston Facility. Defense of this action is currently being provided by the Company's insurers. The Company's insurance carriers will not make a determination regarding coverage until this action is settled; however, the Company believes that losses arising from the complaint, if any, will be covered by the Company's insurance carriers. The Company has not provided an accrual for these losses as the outcome cannot be predicted at this time.\nThe Company is not a party to any other significant pending legal proceedings other than routine litigation incidental to its business which the Company believes will not materially affect its financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAt October 20, 1994, 24,358,959 shares of Common Stock were issued and outstanding and held by 1,393 registered holders.\nThe Company does not expect to pay dividends on the Common Stock during the foreseeable future. The Amended By-Laws (as hereinafter defined) of the Company permit the payment of dividends, but the Company's Senior Credit Facility prohibits the payment of any dividends. The indenture relating to the 9 1\/2% Senior Notes due 2001 of the Company also restricts the payment of dividends.\nMARKET PRICE AND CASH DIVIDENDS\nThe following table presents the high and low market price by quarter for the last three fiscal years.\nAs of October 20, 1994 the closing price of Common Stock on The Nasdaq Stock Market (under the symbol NWSW) was $6.50. Since the initial public offering of June 12, 1993, there have been no dividends paid on the Common Stock.\n*Not Applicable\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nNotes for Summary of Selected Financial Data - -------------------------------------------- (1) EBITDA is defined as operating profit plus depreciation and amortization. The Company believes EBITDA provides additional information for determining its ability to meet debt service requirements. EBITDA does not represent net income or cash flow from operations as determined by generally accepted accounting principles, and is not necessarily an indication of whether cash flow will be sufficient to fund cash requirements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nNET SALES\nNet sales for fiscal 1994 increased by $64.4 million or 12% from fiscal 1993. The 12% increase in fiscal 1994 net sales resulted from several price increases during the fiscal year on many of the Company's products, together with a 3% increase in steel shipments. Many of the price increases resulted from the continued escalation of the Company's principal raw material, steel scrap; however, the Company experienced pricing strength above raw material price increases in some of its product lines. Pricing of structural products, the Company's principal market, remains competitive due to a relatively flat market and excess industry capacity.\nNet sales for fiscal 1993 increased $69.2 million or 15% from fiscal year 1992, primarily from the volume increase in net tons shipped of structural steel products at the Company's Houston Facility. A portion of this increase was also a result of strong levels of shipments in rod and wire products.\nCOST OF GOODS SOLD\nThe pricing on the Company's principal raw material, steel scrap, continued to escalate to record levels, up 24% compared to fiscal 1993. Despite this, cost of goods sold (excluding depreciation) as a percentage of net sales remained unchanged at 90% in fiscal 1994 compared to fiscal 1993. This resulted from a combination of improved operating efficiencies and increased selling prices. While the pricing of steel scrap moderated during the most recent fourth quarter, the Company is now experiencing renewed scrap pricing pressures in the marketplace.\nExcluding the effects of scrap, the Company continued to improve operating margins in fiscal 1994. Continued improvements in production costs at the Houston Facility resulted from increased yield and improved operating rates. Also contributing to production cost reductions were improvements in the Sterling Operations, primarily lower steelmaking costs resulting from record levels of semi-finished production.\nThe cost of goods sold as a percentage of net sales decreased from 93% in fiscal 1992 to 90% in fiscal 1993 due to production cost improvements at the Houston Facility and lower steelmaking costs at the Sterling Operations.\nSELLING AND ADMINISTRATIVE EXPENSES\nSelling and administrative expenses decreased from $11.6 million in fiscal 1993 to $10.9 million in fiscal 1994, primarily as a result of a $1.0 million reduction in management incentive program expense. These incentives are based on the Company's achieved versus\nplanned profitability for the fiscal year.\nSelling and administrative expenses were $11.6 million in fiscal 1993 compared to $6.9 in fiscal 1992. During fiscal 1992 selling and administrative expenses were unusually low due to a reduction in the valuation price for stock appreciation rights vesting during fiscal 1992 as well as a reduction in the valuation price for all outstanding stock appreciation rights.\nOPERATING PROFIT\nOperating profit increased 38% in fiscal 1994 to $29.8 million from $21.6 million in fiscal 1993. The fiscal 1993 operating profit increased $16.5 million from fiscal 1992, when the operating profit was $5.1 million. These increases were as a result of cost reductions due principally to increased capacity utilization and workforce reductions, in conjunction with revenue growth through market penetration, higher value-added products and customer service.\nINTEREST EXPENSE\nDuring late fiscal 1993, the Company significantly reduced its borrowing levels with the cash proceeds from an initial public offering of senior notes and Common Stock. As a result of reduced borrowing levels, interest expense in fiscal 1994 decreased $4.0 million to $19.2 million from $23.2 million in fiscal 1993. During early fiscal 1993, the Company significantly reduced its borrowing levels with the cash proceeds from a private placement. As a result of reduced borrowing levels, interest expense decreased $4.5 million to $23.2 million in fiscal 1993 from $27.7 million in fiscal 1992.\nNET INCOME\nFiscal 1994 net income of $10.0 million or $.40 per share compares to a fiscal 1993 net loss before extraordinary item and cumulative effect of accounting change of $1.5 million or $.08 per share. In fiscal 1994, the Company achieved its first profitable year since fiscal 1990 as a result of the various factors described above.\nFiscal 1993 net loss before extraordinary item and cumulative effect of accounting change of $1.5 million or $.08 per share compares to a fiscal 1992 net loss of $22.4 million or $1.72 per share.\nLIQUIDITY AND CAPITAL RESOURCES\nThe financial position of the Company continues to improve as discussed below. The Company achieved positive cash flow from operations for the ninth consecutive year and returned to profitability in fiscal 1994. As of July 31, 1994, the Company had cash on hand of approximately $12.8 million and approximately $64.9 million available under its revolving credit facility. The Company's current ratio continues to improve, increasing to 1.9:1 at July 31, 1994, compared to 1.8:1 at July 31, 1993. The consolidated debt-to-equity ratio remained unchanged at 3:1 at July 31, 1994 and 1993. This increased financial and operating flexibility has enabled the Company to better manage inventory levels that, when combined with the Company's enhanced product line, have enabled it to better serve its customers' needs.\nOn a longer term basis, the Company has significant future debt service obligations. The Company's ability to satisfy these obligations and to secure adequate capital resources in the future will be dependent on its ability to generate adequate cash flow. The Company expects that its cash flow from operations and available borrowings will be sufficient to fund future debt service.\nCAPITAL EXPENDITURES\nAmong the most important aspects of the Company's planning system is the identification of needs for capital expenditures. The system incorporates selective allocation of funds to projects that will lower operating costs through technological improvements and\/or increase capacity and maintain equipment and facilities. The Company assesses likely market, technological and other business changes in coming years and develops plans to ensure that it will be on the leading edge of such advances.\nIn view of the increased level of operations and resulting improved profitability, but more importantly due to the generation of adequate cash flow, the Company was able to increase capital expenditures to approximately $23 million during fiscal 1994 compared with $12 million in fiscal 1993 and $7 million in fiscal 1992. Consistent with the philosophy of maintaining efficient, low cost production facilities, the Company has announced plans to embark on an aggressive capital investment program of approximately $50 million during fiscal 1995. This plan is based upon internally generated funds with debt remaining at existing levels. With the continuing strengthening of our Company, we are now poised to effectively grow, compete and provide improvements in the quality and cost of our products as well as customer service.\nACCOUNTING STANDARDS\nStatement of Financial Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (SFAS 112), was issued in November 1992. SFAS 112 establishes standards of financial accounting and reporting for the estimated costs of benefits provided by an employer to former or inactive employees after employment but before retirement. The Company will adopt SFAS 112 during fiscal 1995; at the present time the Company has not determined the detailed effect of SFAS 112; however, preliminary indications are that the impact would not be material.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nFinancial statements and supplementary data of the Company are included in this Annual Report of Form 10-K beginning on page and are listed in Item 14 hereof.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM. 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDIRECTORS\nThe following table sets forth as of October 20, 1994 the directors of the Company, their ages, the years during which they became directors and their principal occupations. Unless otherwise indicated, each has held the occupation listed for more than the past five years. All directors will continue in office until their successors are elected at the 1994 Annual Meeting or until their prior resignation, death or removal.\nName Age Position - ---- --- -------------------------------- Robert N. Gurnitz (1) 55 Chairman of the Board, President and Chief Executive Officer\nWilliam F. Andrews (2)(3) 63 Director\nKim G. Davis (1) 40 Director\nDarius W. Gaskins, Jr. (2)(3)(4) 55 Director\nJames A. Kohlberg 36 Director\nJerome Kohlberg Jr. 69 Director\nChristopher Lacovara (1)(4) 30 Director\nGeorge W. Peck, IV (2)(3) 62 Director\nRichard F. Williams (4) 53 Director\n(1) Member of the Executive Committee\n(2) Member of the Audit Committee\n(3) Member of the Compensation Committee\n(4) Member of the Pension Committee\nWilliam F. Andrews. Mr. Andrews has been a Director of the Company since 1994. He is a consultant with the investment banking firm Investor International (U.S.), Inc. (formerly known as Providentia, Inc.). Mr. Andrews is also Chairman and Chief Executive Officer of Amdura Corp., a specialty manufacturer of products for the overhead lifting and waste recycling and disposal markets, and Chairman of Utica Corporation, a manufacturer of precision-forged turbine airfoils for both aircraft and land-based engines. From 1990 to 1992, Mr. Andrews was President and Chief Executive Officer of UNR Industries, Inc., a diversified manufacturer of steel products. Prior to 1990, Mr. Andrews was President of Massey Investment Company. Mr. Andrews is also a director of Harley-Davidson, Inc., Navistar, Inc, Southern New England Telephone Company, Corrections Corporation of America, Johnson Controls, Inc., Katy Industries and MB Communications.\nKim G. Davis. Mr. Davis has been a Director of the Company since August 1992. He has been a principal of Kohlberg & Co., L.P. (\"Kohlberg\") since 1988. Mr. Davis is also a director of ABC Rail Products Corporation, a manufacturer of replacement parts and original equipment for the freight railroad and transit industries (\"ABC\"), ABT Building Products Corporation, a specialty building products manufacturer (\"ABT\") and Welbilt Corporation, a manufacturer of commercial and consumer food service equipment (\"Welbilt\").\nDarius W. Gaskins, Jr. Mr. Gaskins has been a Director since 1994. He has been a partner of Carlisle, Fauth & Gaskins, Inc., a management and economics consulting firm since 1993, and a partner of High Street Associates, Inc., an investment partnership, since 1991. From 1989 through 1991, Mr. Gaskins was visiting professor at the John F. Kennedy School of Government at Harvard University. Mr. Gaskins is also a director of UNR, Inc., a manufacturer of steel tubing and Leaseway Corp.\nRobert N. Gurnitz. Mr. Gurnitz has been President and Chief Executive Officer and Director of the Company since 1991. In January 1994, Mr. Gurnitz was elected Chairman of the Board. From 1988 through 1990, Mr. Gurnitz was President and Chief Operating Officer of Webcraft Technologies, Inc. From 1985 through 1988, Mr. Gurnitz was President of Bethlehem Steel's Shape and Rail Products Division. Prior to that position, Mr. Gurnitz spent 19 years with Rockwell International, where he headed a number of their worldwide transportation components businesses.\nJames A. Kohlberg. Mr. Kohlberg has been a Director of the Company since August 1992. Mr. Kohlberg has been a principal of Kohlberg since 1987. From 1984 to 1987, he was an associate with Kohlberg Kravis Roberts & Co. Mr. Kohlberg is also a director of ABC, ABT and Welbilt.\nJerome Kohlberg Jr. Mr. Kohlberg has been a Director of the Company since August 1992. Mr. Kohlberg has been a principal of Kohlberg since 1987. From 1976 to 1987, he was a principal of Kohlberg Kravis Roberts & Co. Mr. Kohlberg is also a director of ABT. Mr. Kohlberg is the father of James A. Kohlberg.\nChristopher Lacovara. Mr. Lacovara has been a Director of the Company since August 1992. Mr. Lacovara has been an associate of Kohlberg since 1988. From 1987 through 1988, Mr. Lacovara was an associate of Lazard Freres & Co. Mr. Lacovara is also a director of ABC and Welbilt.\nGeorge W. Peck, IV. Mr. Peck has been a Director of the Company since August 1992. Mr. Peck has been a principal of Kohlberg since 1987. From 1963 to 1987, he was a director and Vice President of Canny, Bowen, Inc., an executive recruiting firm. Mr. Peck is also a director of ABC, ABT and Welbilt.\nRichard F. Williams. Mr. Williams has been a Director of the Company since 1994. He retired as an electrician from the Company in December 1992 after more than 30 years of service. Currently, Mr. Williams manages OMNI Investment Company.\nPursuant to the By-Laws of the Company, the Board of Directors has determined that the number of directors constituting the full Board of Directors shall be nine. Proxies are solicited in favor of the nominees named on the following pages and it is intended that the proxies will be voted for the nine nominees. In the event that any of the nominees should become unable or unwilling to serve as a director, it is intended that the proxies will be voted for the election of such other person, if any, as shall be designated by the Board of Directors. It is not anticipated that any of the nominees will be unable or unwilling to serve as a director. Each director to be elected will serve until the next Annual Meeting of Shareholders or until a successor is elected and shall qualify.\nINFORMATION REGARDING NOMINEES FOR ELECTION OF DIRECTORS\nIt is anticipated that at the 1994 Annual Meeting of Shareholders, Messrs. Andrews, Davis, Gaskins, Gurnitz, Kohlberg, Kohlberg, Lacovara and Peck will be nominated for reelection to the Board of Directors. One additional person to be designated by the participants in the Company's ESOP shall also be nominated.\nEXECUTIVE OFFICERS\nThe following table sets forth as of October 20, 1994, the executive officers of the Company, their ages, offices and the years during which they assumed their offices.\nRobert N. Gurnitz (55) Chairman of the Board, President and Chief Executive Officer (1994) President and Chief Executive Officer (1991)\nEdward G. Maris (58) Senior Vice President, Chief Financial Officer (1990) Vice President - Finance, Secretary and Treasurer (1987) Controller (1986)\nRichard D. Way (53) Senior Vice President - Sterling Operations (1994) Vice President - Steel Operations (1994)\nKenneth J. Burnett (50) Vice President of Operations - Houston (1994) Vice President of Operations - Steel Division (1990) Manager, Engineering and Services (1985)\nWilliam H. Hillpot (42) Vice President Materials Management and Business Development (1994) Vice President - Business Development (1993)\nRobert W. Martin (49) Vice President - Scrap\/Utilities Procurement and Environmental Affairs (1994) Vice President - Purchasing (1992)\nJohn C. Meyer (55) Vice President - Human Resources (1992)\nDavid C. Oberbillig (50) Vice President, Sales - Wire Products Division (1987) Manager of Sales, Wire Products Division (1984)\nEach of the executive officers named in the preceding table has been employed by the Company in an executive or managerial capacity for at least five years except as follows:\nRobert N. Gurnitz was elected President and Chief Executive Officer of the Company effective January 1, 1991 and Chairman of the Board in 1994. Prior to his appointment, he was associated with Webcraft Technologies, Inc. as President and Chief Operating Officer from 1988 through 1990. Prior to that time, Mr. Gurnitz was President of Bethlehem Steel's Shape and Rail Products Division.\nWilliam H. Hillpot joined the Company in 1993 as Vice President - Business Development and was appointed Vice President - Materials Management and Business Development in July 1994. From 1991 to 1992, he was Vice President - Materials and Information Management of Armco Steel Company, L.P. Prior to that time, Mr. Hillpot was Manager - Materials and Semi-Finished Sales at Bethlehem Steel.\nJohn C. Meyer joined the Company as Vice President - Human Resources in January 1992. Prior to that time, he was associated with Republic Engineered Steels as Vice President - Human Resources from May 1989 through January 1992. From 1986 through 1989, Mr. Meyer was General Manager of Employee Relations for LTV Steel.\nRichard D. Way joined the Company in January 1994 as Vice President of Operations - Steel Division and in July 1994 he was appointed to the position of Senior Vice President - Sterling Operations. Prior to that time, Mr. Way was Senior Vice President, Manufacturing, as well as General Manager, Aluminum Division at Shieldalloy Metallurgical Company.\nOTHER SIGNIFICANT EMPLOYEES\nThe following table sets forth the other significant employees of the Company, their ages, positions with the Company, and the years during which they assumed such positions.\nRaymond P. Bauer (46) Manager, General Sales - Steel Division (1991)\nRichard C. Bennett (64) General Manager of Operations Wire Products Division (1991) General Superintendent - 12\" Mill (1985)\nVernus L. Johnson (62) Manager, Fabricator Sales - Steel Division (1991) Manager, Sales (1978)\nThomas M. Vercillo (39) Manager of Corporate Accounting (1991) Manager of Accounting (1988) Financial Analyst (1985)\nDIRECTOR AND OFFICER SECURITIES REPORTS\nThe federal securities laws require the Company's directors and officers, and persons who own more than ten percent of the Company's Common Stock, to file with the Securities and Exchange Commission, the Nasdaq National Market and the Secretary of the Company initial reports of ownership and reports of changes in ownership of the Common Stock of the Company.\nTo the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and written\nrepresentations that no other reports were required, during the fiscal year ended July 31, 1994, all the Company's officers, directors and greater-than- ten-percent beneficial owners made all required filings.\nITEM 11.","section_9A":"","section_9B":"","section_10":"","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSUMMARY COMPENSATION TABLE\nThe following Summary Compensation Table discloses, for the fiscal years indicated, individual compensation information on Mr. Gurnitz and the four other most highly compensated executive officers in fiscal 1994 who were serving as executive officers at the end of fiscal 1994.\n(1) All of the fiscal 1993 bonus was accrued in fiscal 1993 and paid in fiscal 1994. 25% of the fiscal 1992 bonus was accrued in fiscal 1992 and paid in fiscal 1993, except for Mr. Meyer of which $10,769 was paid in fiscal 1992 and $8,462 of which was paid in fiscal 1993.\n(2) The closing price of the Common Stock on July 29, 1994 (the last business day of the fiscal 1994) was $9.25. The number and fair market value of the restricted Common Stock held by each of the named executives on July 29, 1994 was: Mr. Gurnitz 109,091 shares, $1,009,092; Mr. Maris 78,505 shares, $726,171; Mr. Burnett 3,750 shares, $34,688; Mr. Meyer 33,649 shares, $311,253; and Mr. Oberbillig 54,859 shares, $507,446.\n(3) Represents the value of cash and stock distributed on a deferred basis under the Northwestern Steel and Wire Company Stock Appreciation Rights Plan.\n(4) Includes reimbursement of moving expenses, retirement annuity, life insurance, 401(k) contributions made by the Company and car allowance. Moving expenses accounted for $5,682, $12,564 and $42,595 of the amount shown for fiscal years ended July 31, 1994, 1993 and 1992, respectively. Retirement annuity expenses accounted for $15,000 of the amount shown for each of the fiscal years ended July 31, 1994, 1993 and 1992.\n(5) Entire amount represents 401(k) contributions made by the Company.\n(6) Includes reimbursement of moving expenses and 401(k) contributions made by the Company. Moving expenses accounted for $20,000 for fiscal year ended July 31, 1994.\n(7) Mr. Meyer was hired effective February 10, 1992.\n(8) Includes reimbursement of moving expenses and 401(k) contributions made by the Company. Moving expenses accounted for $8,871 and $51,273 of the amount shown for fiscal years ended July 31, 1994 and 1993, respectively.\n(9) Entire amount represents reimbursement of moving expenses.\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nThe following table discloses, for Mr. Gurnitz and the other named executives, information regarding stock options and warrants granted during fiscal 1994 pursuant to the Company's 1994 Long Term Incentive Plan.\n(1) One-third of each option grant becomes exercisable on each of April 25, 1995, April 25, 1996 and April 25, 1997.\n(2) Amounts reflect certain assumed rates of appreciation set forth in the Securities and Exchange Commission's executive compensation disclosure rules. Actual gains, if any, on stock option exercises depend on future performance of the Common Stock and overall market conditions. Fair market value per share on the date of grant was $9.00 per share.\nOPTION EXERCISES AND FISCAL YEAR END VALUES FOR THE FISCAL YEAR ENDED JULY 31, 1994 (1)\nThe following table shows information regarding the exercise of stock options during fiscal 1994 by Mr. Gurnitz and the other named executives and the number and value of any unexercised stock options held by them as of July 31, 1994:\n[FN] (1) The closing price of the Common Stock on July 29, 1994 (the last business day of fiscal 1994) was $9.25.\nEMPLOYMENT AGREEMENT\nThe Company has entered into an amended and restated employment agreement (the \"Gurnitz Agreement\") with Robert N. Gurnitz for a term through January 1, 1996, and indefinitely thereafter on the terms set out therein. The Gurnitz Agreement establishes an annual base salary of not less than $305,000 per year plus an annual target bonus of not less than $195,700 per year. The amount of the bonus actually earned each year, if any, will be based on the Company's performance. The Gurnitz Agreement provides for the establishment of a nonqualified supplemental executive retirement plan which provides the additional benefits which would have been payable to Mr. Gurnitz under the Northwestern Steel and Wire Company's Pension Plan B and 401(k) Salary Deferral Plan if not for the limits imposed by the Internal Revenue Code (subject to certain limitations set out in the Internal Revenue Code and the plans themselves) and credits Mr. Gurnitz with an additional 1.5 years of service (reflective of his prior industrial service) up to age 65 for each year of service, beginning July 22, 1994. In addition, the Gurnitz Agreement requires the Company to continue to purchase a standard disability income policy for Mr. Gurnitz and to continue to pay Mr. Gurnitz in cash such amounts as are required to pay the annual premiums on a life insurance policy on the life of Mr. Gurnitz in the amount of $1,000,000 and to continue to\nprovide for certain other fringe benefits commensurate with Mr. Gurnitz's position as Chairman, President and Chief Executive Officer of the Company. The Gurnitz Agreement further provides that in the event Mr. Gurnitz's employment is terminated by the Company other than for cause or disability, or by Mr. Gurnitz for good reason (as such terms are defined in the Gurnitz Agreement), Mr. Gurnitz will be entitled to receive a single lump sum cash payment and to continue to participate in the employee benefit arrangements of the Company as are in effect at the time of his termination. The lump sum payment would equal the sum of (i) Mr. Gurnitz's annual base salary as then in effect and (ii) Mr. Gurnitz's annual target bonus as then in effect, and his participation in Company benefit arrangements would continue through the first anniversary of the date of his termination. If Mr. Gurnitz's employment is terminated by the Company for any reason or by Mr. Gurnitz for good cause, in either case within two years of a change in control (as defined in the Gurnitz Agreement), Mr. Gurnitz will be entitled to receive a single lump sum cash payment equal to twice the aggregate of Mr. Gurnitz's annual base salary and target bonus as then in effect. The Gurnitz Agreement also provides that Mr. Gurnitz is subject to a two year covenant not to compete upon termination of Mr. Gurnitz's employment unless such termination is by the Company without cause or within two years of a change in control or by the resignation of Mr. Gurnitz with good reason.\nThe Company entered into an employment arrangement (the \"Meyer Arrangement\") with John C. Meyer on an at will basis commencing on February 10, 1992 at an annual base salary of $130,000. The Meyer Arrangement provides that, in the event the Company terminates Mr. Meyer's employment other than for cause or disability, Mr. Meyer will continue to receive his base salary and benefits for a period of 12 months following such termination. The Meyer Arrangement also provides that Mr. Meyer may participate in the benefit plans offered by the Company from time to time during such period. The Meyer Arrangement also provides that Mr. Meyer is subject to a one year covenant not to compete upon termination of Mr. Meyer's employment except if his employment is terminated by the Company without cause.\nPENSION PLAN\nThe Company maintains a pension plan for all eligible employees. A participant who retires on or after turning 65 and has completed at least five years of service will qualify for an annual pension equal to 1.1% of the participant's average earnings for each year of service not in excess of 30 years and 1.2% of the participant's final average earnings for each year of service in excess of 30 years. Final average earnings are based on total compensation (exclusive of certain cost-of-living adjustments) during the participant's highest five consecutive years in the participant's last 15 years of service. A deferred vested pension benefit normally commencing at age 65 is provided for any employee who does not qualify for retirement under the plan but has completed at least five years of service.\nYears of service for purposes of the plan with respect to the officers named in the Summary Compensation Table are as follows: Mr. Gurnitz, 3 years; Mr. Maris, 8 years; Mr. Burnett, 31 years; Mr. Meyer, 2 years; and Mr. Oberbillig, 27 years.\nThe following table shows the projected annual pension benefits payable, under the pension plan at the normal retirement age of 65:\n[FN] (1) Normal pension benefits are formula based and are not subject to a social security offset. With exceptions not applicable to any of the officers named in the above compensation table, Sections 401(a)(17) and 415 of the Internal Revenue Code limit the annual pension earnings that can be considered under the plan to $150,000 and the annual benefits to $118,800 for benefit accrual and retirement after December 31, 1993.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nDuring fiscal 1994, the Compensation Committee of the Board of Directors was composed of William F. Andrews, Darius W. Gaskins, Jr. and George W. Peck IV.\nREPORT OF COMPENSATION COMMITTEE\nThis Report outlines the Company's management compensation philosophy and reviews the compensation decisions made in fiscal 1994 regarding Mr. Gurnitz and the other named executives.\nMANAGEMENT COMPENSATION PHILOSOPHY\nTo advance the interests of its shareholders, the Company has based its management compensation decisions on three principles.\nFirst, base salaries should be sufficient to attract and retain qualified management talent, without exceeding competitive practice at similar companies in the steelmaking and related industries.\nSecond, annual incentive programs should provide opportunity for significant increases in compensation, based on meeting or exceeding pre-determined performance targets.\nThird, a substantial portion of total compensation opportunity should reflect performance on behalf of the Company's shareholders, as measured by increases in the Company's stock price.\nCRITERIA USED FOR MAKING COMPENSATION DECISIONS IN FISCAL 1994\nThis section describes the criteria used by the Compensation Committee regarding compensation decisions affecting Mr. Gurnitz and the named executives.\nBase Salary\nIn April 1994, an independent compensation consulting firm conducted a study of competitive compensation levels for the Company's key executives. Following this study, the Compensation Committee approved salary midpoints for each executive position, which were based on the executive positions' size adjusted median competitive base salaries. The Committee then approved adjustments for selected executives. As part of these actions, the Committee increased Mr. Gurnitz's annual salary from $285,000 to $305,000, which reduced the gap between it and the salary midpoint, and thus brought it closer to size adjusted median competitive practice for the industry.\nAnnual Incentive Program\nIn December 1993, the Compensation Committee approved the fiscal 1994 incentive program for Mr. Gurnitz and other key executives (including the named executives). Target awards ranged from 20% of base salary midpoint to 50% of base salary midpoint (for Mr. Gurnitz). Awards were calculated by formula, based exclusively on the Company's adjusted operating income performance as compared to\nthe Company's business plan. The chart below summarizes the payout formula:\n% of Adjusted % of Operating Plan Target Award Achieved Earned -------------- ------------ [S] [C] Less than 85% 0% 85% 50% 100% 100% 125% 150% 150% 200%\nDespite an increase in fiscal 1994 of 38% in operating profit, the Company achieved less than 85% of its adjusted operating income plan. As a result, Mr. Gurnitz and the other named executives earned no annual incentive award for fiscal 1994.\nLong Term Incentive Program\nIn an effort to further increase the alignment of interests between key employees and shareholders, the 1994 Long Term Incentive Program was approved at the Annual Meeting of the Shareholders on January 20, 1994. On April 25, 1994, 50,000 stock options were awarded to Mr. Gurnitz and an aggregate of 21,000 stock options were awarded to the other named executives. All of these options were granted at an exercise price of $9.00 per share which was determined to be the fair market value of the Common Stock on the date of the grant. In determining the size of the grants to Mr. Gurnitz and the other named executives, the Committee considered median competitive practice and each executive's contribution to the Company's financial performance, as well as the motivational impact of the award on each individual's future efforts to increase shareholder value. In addition, in the case of Mr. Gurnitz's grant, the Committee provided an award below median competitive practice in order to make more options available to other grantees.\nRetirement Arrangements for Mr. Gurnitz\nAt its meeting on July 22, 1994, the Committee approved the retirement compensation arrangement for Mr. Gurnitz as described in the employment agreements. In approving this arrangement, the Committee had three objectives - first, to enable Mr. Gurnitz, upon reaching normal retirement age of 65, to receive a full pension from all sources, including retirement programs of previous employers; second, to provide Mr. Gurnitz with a pension benefit at age 65 that would be consistent with competitive practice for other Chief Executive Officers in the industry; and third, to safeguard shareholders' interests by providing such benefits only if Mr. Gurnitz continued to serve as the Company's Chief Executive Officer for the next several years.\nCompensation Committee Members as of July 31, 1994 - -------------------------------------------------- William F. Andrews Darius W. Gaskins, Jr. George W. Peck IV\nPERFORMANCE GRAPH\nThe following graph compares the cumulative total return on $100 invested on June 11, 1993 (the first day of public trading of the Common Stock) in the Common Stock of the Company, the S&P 400 Index and the S&P Steel Index. The return of the Standard & Poor's indices is calculated assuming reinvestment of dividends during the period presented. The Company has not paid any dividends. The stock price performance shown on the graph below is not necessarily indicative of future price performance.\nCOMPARISON OF CUMULATIVE TOTAL RETURN AMONG NORTHWESTERN STEEL AND WIRE, S&P 400 INDEX AND S&P STEEL INDEX\n[GRAPH APPEARS HERE]\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe table below sets forth certain information regarding beneficial ownership of Common Stock as of October 20, 1994, by each person or entity known to the Company who owns of record or beneficially five percent or more of the Common Stock, by each named executive officer and director nominee and all executive officers and director nominees as a group.\nPERCENTAGE OF NUMBER OF SHARES OUTSTANDING NAME OF COMMON STOCK COMMON STOCK - --------------------------------------- ---------------- ------------- KNSW Acquisition Company, L.P. (1) 8,687,000 34.3% United National Bank, as Trustee (2) 4,033,926 15.9 William F. Andrews 2,000 * Kenneth J. Burnett (4) 63,750 * Kim G. Davis (3) 8,687,000 34.3 Darius W. Gaskins, Jr. 15,000 * Robert N. Gurnitz (4) 409,091 1.6 James A. Kohlberg (3) 8,687,000 34.3 Jerome Kohlberg Jr. 8,687,000 34.3 Christopher Lacovara 0 0 Edward G. Maris (4) 90,505 * John C. Meyer (4) 49,649 * David C. Oberbillig (4) 58,859 * George W. Peck IV (3) 8,687,000 34.3 Richard F. Williams 340 *\nAll executive officers and director 9,485,892 37.4 nominees as a group (16 persons) (4)\n* Less than 1%.\n(1) KNSW Acquisition Company, L.P. (\"KNSW\") owns directly 8,687,000 shares of Common Stock. Kohlberg Associates, L.P., a Delaware limited partnership (\"Associates\"), is the general partner of KNSW. Kohlberg & Kohlberg, George W. Peck IV and Kim G. Davis are the general partners of Associates. Jerome Kohlberg Jr. and James A. Kohlberg are general partners of Kohlberg & Kohlberg. KNSW has agreed to use its reasonable best efforts to cause at least one designee of the ESOP to be nominated to the Board of Directors. Messrs. Kohlberg, Kohlberg, Peck and Davis may be deemed to share voting and dispositive power as to all shares of Common Stock owned by KNSW. Messrs. Kohlberg, Kohlberg, Peck and Davis disclaim beneficial ownership with respect to such shares. The address for KNSW is c\/o Kohlberg & Co., 111 Radio Circle, Mt. Kisco, NY 10549.\n(2) United National Bank is the trustee of the ESOP.\n(3) Includes the 8,687,000 shares of Common Stock owned by KNSW. See Note 1.\n(4) Includes shares issuable pursuant to options which may be exercised within 60 days after October 20, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN TRANSACTIONS AND RELATED TRANSACTIONS\nIn August 1992, the Company sold to KNSW 8,687,000 shares of Common Stock at $4.00 per share (the \"1992 Investment\"), which represented at such time approximately 52% of the outstanding Common Stock, giving KNSW effective voting control of the Company and control of the Board of Directors. As a result of the Company's initial public offering of Common Stock in June 1993, KNSW's interest has been diluted to approximately 34.2%. KNSW is an affiliate of Kohlberg & Co., L.P. (\"Kohlberg\"). At the time of the 1992 Investment, the Company and Kohlberg entered into a fee agreement (the \"Fee Agreement\") pursuant to which Kohlberg was reimbursed for certain costs in connection with placing the investment and agreed to provide such advisory and management services to the Company and its subsidiaries as the Board of Directors reasonably requests. Deferred at the time of the 1992 Investment, a fee of $2.0 million related to the 1992 Investment was paid by the Company to Kohlberg on August 12, 1993. In addition, beginning on August 12, 1992, in consideration for ongoing advisory and management services, the Company pays Kohlberg a fee of $43,435 per fiscal quarter at the beginning of each quarter. The Fee Agreement provides that Kohlberg, but not the Company, may terminate the Fee Agreement at any time. The Fee Agreement will terminate automatically on the earlier of the end of the fiscal year in which KNSW's percentage interest in the outstanding Common Stock is less than 25% and the tenth anniversary of the Fee Agreement. The Fee Agreement provides that, without the consent of a majority of the Company's directors not nominated by affiliates of Kohlberg, Kohlberg will not be paid any other fees by the Company. The Fee Agreement also provides that the Company will indemnify Kohlberg and its affiliates and their respective partners, officers, directors, stockholders, agents and employees against any third party claims arising from the Fee Agreement and the services provided thereunder, the 1992 Investment or their equity interest in the Company.\nPursuant to the terms of the ESOP, the Company is obligated to pay certain fees and expenses of the ESOP, which for the year ended July 31, 1994 aggregated $81,844.\nKNSW has agreed to use its reasonable best efforts to cause at least one designee of the ESOP to be nominated for election to the Board of Directors for so long as the ESOP holds 5% or more of the outstanding Common Stock on a fully- diluted basis. The nominee for the 1994 Annual Meeting of Shareholders has not been determined.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Financial Statements and Schedules\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Northwestern Steel and Wire Company\nWe have audited the accompanying consolidated balance sheets of Northwestern Steel and Wire Company and Subsidiaries as of July 31, 1994 and 1993 and the related consolidated statements of stockholders' equity, operations and cash flows for each of the three years in the period ended July 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 Northwestern Steel and Wire Company and Subsidiaries as of July 31, 1994 and 1993 and the consolidated results of their operations and cash flows for each of the three years in the period ended July 31, 1994 in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois September 16, 1994\nNORTHWESTERN STEEL AND WIRE COMPANY\nCONSOLIDATED BALANCE SHEETS (dollar amounts in thousands except share data)\nThe accompanying notes are an integral part of the consolidated financial statements\nNORTHWESTERN STEEL AND WIRE COMPANY\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\n(In thousands except share data)\nNORTHWESTERN STEEL AND WIRE COMPANY\nCONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except per share data)\nThe accompanying notes are an integral part of the consolidated financial statements\nNORTHWESTERN STEEL AND WIRE COMPANY\nCONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nThe accompanying notes are an integral part of the consolidated financial statements\nNORTHWESTERN STEEL AND WIRE COMPANY\nNOTES TO FINANCIAL STATEMENTS\nNorthwestern Steel and Wire Company (the \"Company\") operates in one business segment as an electric arc furnace producer of a comprehensive line of carbon steel products consisting primarily of structural shapes, bar and bar shapes, rods, wire and fabricated wire products.\nThe Company's outstanding indebtedness had increased significantly as a result of the leveraged buyout transaction in August 1988 (the \"Acquisition\") and the subsequent acquisition and refurbishment of the Houston Facility. In August 1992, an affiliate of Kohlberg & Co., a New York merchant banking firm (\"Kohlberg\"), purchased approximately 52% of the Company's Common Stock (the \"1992 Investment\"). In June 1993, the Company effected a recapitalization (the \"Recapitalization\") which included a Common Stock Offering and a concurrent Note Offering (collectively, the \"Offerings\").\n1. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES AND POLICIES\nCONSOLIDATION\nThe Company has two wholly-owned subsidiaries, Northwestern Steel and Wire Company (a Delaware corporation) which performs the sales, management and other administrative services and Northwestern Steel and Wire Company (a Texas corporation) which operates the Houston rolling mill. The consolidated financial statements include accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nCONCENTRATION OF CREDIT RISK\nThe Company grants credit to its customers, a substantial portion of whom are located in the Midwest, in the normal course of business. Credit limits, on-going credit evaluation and account monitoring procedures are utilized to minimize the risk of loss. Collateral is generally not required.\nINVENTORIES AND PRODUCTION COSTS\nInventories are valued at the lower of cost or market. Cost is determined on a monthly moving average method and includes materials, labor and certain components of conversion overhead.\nPLANT AND EQUIPMENT\nPlant and equipment is carried at cost and includes expenditures for new facilities and those which substantially increase the useful lives of existing plant and equipment. When properties are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts and any profit or loss on disposition is reflected in income.\nThe Company provides for depreciation of plant and equipment commencing when placed in service based on methods and rates designed to amortize the cost over the estimated useful lives (generally 40 years for buildings, 12 and 18 years for mill machinery and a 3 to 20 year range for all otherequipment). Depreciation is computed principally on the straight line method for financial reporting purposes while accelerated methods and straight line methods are used for income tax purposes.\nDEFERRED FINANCING COSTS\nThe Company defers direct costs of debt financing and amortizes such costs over the life of the loan arrangement.\nORGANIZATIONAL AND PRE-OPERATING COSTS\nThe Company defers organizational and pre-operating costs incurred prior to the opening of a new facility and amortizes such costs over 5 years, starting with the first shipments of product to customers.\nINCOME TAXES\nIncome taxes are accounted for in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\" for the years ended July 31, 1994 and 1993. The adoption of SFAS No. 109 for the year ended July 31, 1993 did not have a material effect upon the Company's financial position or net income. Prior years' financial statements were not restated to apply the provisions of SFAS No. 109. Income taxes are accounted for in accordance with Accounting Principles Board Opinion, (\"APB\") No. 11 for the year ended July 31, 1992.\nNET INCOME PER SHARE\nPer share amounts are based on the average shares outstanding of 25,185,389, 18,170,143, and 13,014,589 for each of the three years in the period ended July 31, 1994. Average shares outstanding for the year ended July 31, 1994 include the dilutive impact of shares issuable pursuant to the Company's stock option plans. The average shares outstanding for the\nyears ended July 31, 1993 and 1992 include the dilutive impact of shares issued pursuant to the 1992 Investment and the dilutive impact of shares issuable pursuant to the Management Stock Option Plan and the Employee Stock Purchase and Option Plan, such shares being issued or issuable and such options granted within one year prior to the initial public offering.\nIn accordance with Accounting Principles Board Opinion No. 15, net income per share for the fiscal year ended July 31, 1994 is $.41 as compared to a net loss of $2.72 and $2.78 for each of the two years in the period ended July 31, 1993. These per share amounts are based upon average shares outstanding of 24,679,249, 17,564,000 and 8,051,089 for each of the three years in the period ended July 31, 1994.\nBENEFITS FOR RETIRED EMPLOYEES\nThe Company provides pension benefits to substantially all hourly and salaried employees under noncontributory plans. The pension costs are funded by the Company in accordance with the requirements of ERISA. The estimated costs of the pension benefits are recognized based on annual cost determinations performed by the Company's independent actuarial firm.\nThe Company also provides postretirement welfare benefits (life insurance and medical) to substantially all its retired employees. These benefits are accounted for in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 106 for the years ended July 31, 1994 and 1993. Effective August 1, 1992, the Company adopted SFAS No. 106. Upon adoption, the Company elected to record the transition obligation as a one-time charge against earnings, rather than amortize it over a number of years. This charge was $39.8 million or $2.19 per share and represents the actuarially computed present value of estimated future benefits to current retirees plus that portion of benefits earned to date by active employees. The plan is unfunded and the Company pays for benefits on a current basis. The estimated costs of the postretirement benefits are recognized based on annual cost determinations performed by the Company's independent actuarial firm.\nAt the date of the Acquisition, the Company recorded a liability for the actuarially determined vested portion of these postretirement benefits for all retired and currently eligible to retire employees. Prior to 1993, the Company recorded an expense charge to maintain the discounted liability at a balance sufficient to provide the vested benefits to those remaining retirees who were in the August 16, 1988 population.\nCASH FLOWS\nCash and cash equivalents include cash on hand, amounts due from banks, and other liquid instruments purchased with an original maturity of three months or less.\nRECLASSIFICATIONS\nCertain prior year amounts have been reclassified to conform with the current year presentation. The reclassifications did not affect net operating results.\n2. EMPLOYEE BENEFIT PLANS\nThe provisions of SFAS No. 87 and SFAS No. 106 require the adjustment to the discount rate in line with current and expected to be available interest rates on high quality fixed-income instruments. Due to the recent trend in long-term interest rates, the Company reduced its assumed discount rate from 9% to 8.45% for fiscal 1994. In addition, the Company has also reduced its expected rate of increase in future compensation levels from 5% to 3.5% for its pension plans and reduced its ultimate trend rate for postretirement benefits from 5.1% to 4.6%.\nThe effect of the pension plan changes was a non-cash charge to shareholders' equity of $14,572,000 during fiscal 1994. Unlike SFAS No. 87, the changes described under SFAS No. 106 do not result in a charge to shareholders' equity.\nThe aggregate cost to the Company of the hourly and salaried pension plans retirement benefits for the three years ended July 31 were as follows:\nDeferred gains and losses are amortized over the average remaining future service periods (approximately 15 years).\nThe Company's pension plan assets include principally equity and fixed income securities. The following table presents a reconciliation of the funded status of the pension plans to the amounts included as accrued expenses and deferred employee benefit obligations in the accompanying balance sheets at July 31, 1994 and 1993.\nSignificant assumptions used in determining plan benefit obligations at the end of July 31, 1994 and 1993 include a discount rate of 8.45% and 9%, respectively, and a rate of projected compensation increase of 3.5% and 5% for 1994 and 1993, respectively. The assumed long-term rate of return on plan assets for determining net pension costs was 9% for 1994 and 1993.\nSummary information on the Company's postretirement plan other than pensions is as follows:\nThe discount rate used in determining the APBO was 8.45% and 9% at July 31, 1994 and 1993, respectively. The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 8.6% in 1994 for pre-65 retirees and 7.7% for post-65 retirees declining to an ultimate rate of 4.6% over a 10-year period for both populations. The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 9% in 1993 for pre-65 retirees and 8% for post-65 retirees declining to an ultimate rate of 5.1% over a 10-year period for both populations.\nIf the health care cost trend rate assumptions were increased by 1% each year, the APBO as of July 31, 1994, would be increased by $8,280,000 and the aggregate of the service and interest cost components of net periodic post retirement benefit cost for the year then ended would be increased by $884,000.\nFor the fiscal year ended July 31, 1992, expense was $4.1 million under previous accounting practices. The amounts paid for such benefits were $5.1 million, $5.4 million and $3.9 million for fiscal years ended July 31, 1994, 1993 and 1992, respectively.\n3. INCOME TAXES\nThe provision for income taxes consists of the following (in thousands):\nThe current provision reflects alternative minimum tax for which a deferred tax asset was not recognized.\nThe types of temporary differences resulting from the difference between the tax bases of assets and liabilities and their financial reporting amounts that give rise to the deferred tax liabilities and the deferred tax assets and their approximate tax effects are as follows (in thousands):\nThe Company has recorded a valuation allowance with respect to the future tax benefits and the net operating loss reflected as a deferred tax asset due to the uncertainty of their ultimate realization.\nAs of July 31, 1994, the Company had tax net operating loss carryforwards of approximately $39,032,000. These net operating loss carryforwards are available to offset future\ntaxable income, if any, through the indicated years: $14,791,000 in 2006, $20,238,000 in 2007, and $4,003,000 in 2008. The utilization of approximately $35,402,000 of tax loss carryforwards is limited to approximately $1,900,000 each year as a result of an \"ownership change\" (as defined by Section 382 of the Internal Revenue Code of 1986, as amended), which occurred in fiscal 1993.\nThe Company also has investment tax credit and alternative minimum tax credit carryforwards of approximately $3,000,000 and $2,489,000. The ability to utilize such investment tax credit carryforwards and $1,769,000 of the alternative minimum tax credit carryforwards are subject to yearly limitations under Internal Revenue Code Section 382.\nChemical Bank and certain other lenders provided financing (as so amended, the \"Senior Credit Facility\") to the Company in the form of four facilities: (i) a standby term loan in the amount of $70 million; (ii) an ESOP term loan in the amount of approximately $22 million; (iii) a rollover term loan in the amount of $50 million; and (iv) a revolving credit loan providing available borrowings up to $65 million. The revolving credit loan has a final maturity on May 9, 1997, but may be renewed on an annual basis thereafter with the unanimous approval of Chemical Bank and any other participating lenders. The interest rates indicated above are as of July 31, 1994.\nThe Senior Credit Facility contains various covenants, including covenants prohibiting or limiting the incurrence of additional indebtedness, the granting of liens or guarantees, sales of assets, and capital expenditures, as well as financial covenants requiring maintenance of a specified current ratio, a\nconsolidated interest expense coverage ratio, a fixed charge coverage ratio and a leverage ratio.\nThe rollover term loan is required to be repaid in quarterly installments beginning October 31, 1995, with final maturity on April 30, 1999. The Senior Credit Facility provides that the rollover term loan bears interest at a fixed annual rate of 13.07%, provided, that, through July 31, 1994, interest on the term loan is required to be paid at a floating annual rate equal to the Alternate Base Rate (as defined in the Senior Credit Facility) plus 1.5% and, provided further, that the difference between interest accrued at the fixed annual rate of 13.07% and interest paid as described above will be deferred monthly in arrears and added to the principal of the rollover term loan. Such deferred interest bears interest which is required to be paid monthly in arrears at a floating rate equal to the Alternate Base Rate plus 1.5%, and the deferred interest added to principal is required to be paid in full on the date of the final installment of principal of the rollover term loan. The Company is also required to prepay the rollover term loans to the extent of Excess Cash Flow (as defined in the Senior Credit Facility).\nThe loans under the Senior Credit Facility are collateralized by a lien on substantially all of the Company's assets, and all loans are cross- collateralized. The revolving credit loan under the Senior Credit Facility will be available to the extent that the Company satisfies certain borrowing base criteria. At July 31, 1994 there were no borrowings under the revolver loan and $64.8 million was available to the Company.\nIn connection with the Senior Credit Facility, the Company had previously agreed to pay Chemical Bank a fee of $5 million, which was to be deferred until the Houston Facility began to earn revenue (as described) and which would be payable thereafter in accordance with a formula. As a result of an amendment to the Senior Credit Facility in September 1991, the terms of the $5 million fee were modified to provide that the entire fee became due and payable immediately, but that Chemical Bank would defer payment until the principal amount of all loans under the Senior Credit Facility has been paid in full. The deferred fee bears interest at the adjusted LIBOR for the interest period then in effect plus 4% compounded monthly, with the payment of interest also being deferred until such principal amount has been paid in full.\nPursuant to the Senior Credit Facility, Chemical Bank receives a $200,000 annual administration fee and the lenders receive a quarterly commitment fee of 1\/2% per annum based on the average unused amount of the commitment of the lenders under the Senior Credit Facility.\nIn consideration for the September 1991 amendment to the Senior Credit Facility, the Company agreed to pay Chemical Bank approximately $238,000 which is deferred until the principal amount of all loans under the Senior Credit Facility has been paid in full.\nAt July 31, 1994, $114,320,000 (net of unamortized discount of $680,000) of Senior Notes were outstanding. The Senior Notes bear interest at the rate of 9.5% per annum, payable semi-annually on June 15 and December 15. The Company will be required to redeem on June 15, 2001 the aggregate principal amount of the Senior Notes plus accrued and unpaid interest. The Senior Notes may not be redeemed prior to June 15, 1997. On or after June 15, 1997, the Company may, at its option, redeem the Senior Notes in whole or in part at a premium plus accrued and unpaid interest. On or after June 15, 1999, the Company may redeem in whole or in part the Senior Notes at the aggregate principal amount plus accrued and unpaid interest.\nThe Senior Notes are unsecured obligations of the Company. They will be senior to all subordinated indebtedness of the Company and rank pari passu with all other existing and future senior indebtedness of the Company. Upon the occurrence of a change in control, the holders will have the option to cause the Company to repurchase all or a portion of the outstanding Senior Notes at 101% of the principal amount.\nThe Senior Notes contain certain restrictive covenants that, among other things, will limit the ability of the Company to incur additional indebtedness, create liens, issue preferred stock of subsidiaries, pay dividends, repurchase capital stock, make certain other restricted payments, engage in transactions with affiliates, sell assets, engage in sale and leaseback transactions and engage in mergers and consolidation.\nAnnual maturities of long term debt for the years subsequent to fiscal 1994 are; 1995, $90,000; 1996, $6,833,000; 1997, $8,025,000; 1998, $8,028,000; 1999, $28,824,000 and thereafter of $115,232,000.\nThe Company estimated the market value of its total debt by utilizing a discounted cash flow methodology.\n5. SUPPLEMENTAL BALANCE SHEET DATA\nThe following balance sheet information is provided as of July 31,:\n6. DESCRIPTION OF LEASING ARRANGEMENTS\nThe Company has entered into various operating leases for transportation equipment (principally over-the-road tractors and trailers for shipment of a portion of the Company's products) and other equipment. The majority of the transportation equipment leases expire during fiscal 1999.\nThe future minimum rental payments required for the noncancelable lease term of the operating leases as of July 31, 1994, were as follows:\nFiscal year ending July 31: (In thousands)\nRental expense under operating leases for the years ended July 31, 1994, 1993 and 1992 was approximately $4,300,000; $4,603,000; and $4,327,000, respectively.\n7. STOCKHOLDERS' EQUITY\nThe Company's authorized shares are as follows:\nCommon Stock ..................... 75,000,000 Preferred Stock .................. 1,000,000\nThe Company established an ESOP in 1988 which borrowed $25,000,000 from the Company (which borrowed an identical amount in the form of the ESOP term loan under the Senior Credit Facility) to fund the ESOP's purchase of 4,410,125 shares of Class A Common Stock (which after the 1992 Investment became Common Stock). The Company committed to make contributions to the ESOP to enable it to repay the loan from the Company. As the contributions were made, an equal amount of unearned ESOP compensation was charged to expense. Effective with the Recapitalization, the Company paid the final balance of the contributions to the ESOP. With this payment and the allocation of all remaining shares to ESOP participants, the unamortized balance of the unearned ESOP compensation of $3.2 million was charged to fiscal 1993 expense.\nPrior to the 1992 Investment on August 12, 1992, outside investors and senior management held 3,345,154 shares of Class B Common Stock which were reclassified in connection with the 1992 Investment into shares of Common Stock. On August 12, 1992, the Company sold 8,687,000 newly-issued shares of its Common Stock to Kohlberg. Simultaneously with the consummation of the sale, certain members of the Company's management purchased an aggregate of 63,000 newly-issued shares of Common Stock. In addition, the rights of members of senior management to receive shares of Common Stock pursuant to the Company's stock appreciation rights plan became fully vested with a grant price of zero. Accordingly, 425,481 shares of Common Stock (valued at approximately $1,702,000) were distributed and cash was paid totaling approximately $877,000 to the holders of the rights.\nAs of August 12, 1992, after the sale and distribution of Common Stock aggregating 9,175,481 shares, as discussed above, stockholders' equity was increased by $30,927,000, net of $5,775,000 of related costs of which $2,000,000 was paid on August 12, 1993.\nThe Company established a Management Stock Option Plan and reserved 900,000 shares of Common Stock for future grants at fair market value at the date of grant to certain members of senior management. Options to purchase an aggregate of 765,750 shares of Common Stock at an exercise price of $4.00 per share and 37,500 shares of Common Stock at an exercise price of $9.88 per share remain outstanding under the Management Stock Option Plan. At July 31, 1994, 549,750 exercisable options were outstanding. The remaining options granted will vest based upon the continued employment of the employees. The options granted pursuant to the Management Stock Option Plan expire on the earlier of ten years from date of grant or one year from the date of the employee's termination. The Company also approved the establishment of an Employee Stock Purchase and Option Plan, subject to applicable securities law requirements, for certain salaried and hourly employees which provides participants with a one-time opportunity to purchase up to 200,000 shares of Common Stock at $4.00 per share and the granting of options to purchase a total of 300,000 shares of Common Stock at an exercise price of $4.00 per share, plus subject to certain restrictions, those remaining shares not purchased at the time of the one-time purchase opportunity.\nAs of July 31, 1994, certain salaried and hourly employees purchased 114,595 shares of Common Stock pursuant to the Employee Stock Purchase and Option Plan at an exercise price of $4.00 per share. Options to purchase 185,653 shares of Common Stock at an exercise price of $4.00 per share remain outstanding under the Employee Stock Purchase and Option Plan.\nTwo-thirds of the options granted pursuant to the Employee Stock Purchase and Option Plan expired on September 30, 1994. The remainder expire on the earlier of August 12, 2002 or one year from the date of the employee's termination.\nEffective with the Recapitalization on June 11, 1993, the Company sold 7,000,000 shares of Common Stock. Stockholders' equity increased by $51,358,000, net of $4,642,000 of related costs. Within 30 days of the Initial Public Offering, the underwriters exercised their option to purchase up to an additional 15% of the Common Stock Offering on the same terms. After this sale and distribution of Common Stock aggregating 392,680 shares, stockholders' equity was increased by $2,921,000, net of $220,000 of related costs.\nDuring fiscal 1994, the Company approved the establishment of the 1994 Long-Term Incentive Plan (the \"1994 Plan\") and reserved 1,250,000 shares of Common Stock for issuance under the 1994 Plan. The 1994 Plan provides for the granting to key employees and other key individuals who perform services for the Company stock options, stock appreciation rights and restricted stock that the Board of Directors or a duly appointed committee thereof deems to be consistent with the purposes of the 1994 Plan. Options to purchase 137,000 shares of Common Stock at an exercise price of $9.00 per share are outstanding at July 31, 1994.\nThe Company also approved the establishment of the 1994 Director Stock Plan (\"the 1994 Director Plan\") and reserved 50,000 shares of Common Stock for issuance under the 1994 Director Plan. The 1994 Director Plan provides solely for the award of non-qualified stock options to Directors who are not employees of the Company or affiliates of Kohlberg & Co., L.P. Each eligible director will be awarded 2,500 stock options upon such director's election or reelection to the Board of Directors. Each such award will be at fair market value on the date of the grant. Options become exercisable six months after the date of the grant and generally expire five years following the date of the grant. Options to purchase an aggregate of 7,500 shares of Common Stock at an exercise price of $11.25 per share are outstanding.\nThere are no Shares of Preferred Stock outstanding.\nThe Company entered into a fee agreement with Kohlberg at the time of the closing of the sale of the Common Stock to Kohlberg pursuant to the Stock Purchase Agreement. Under the Fee Agreement, Kohlberg will provide such advisory and management services to the Company and its subsidiaries as the Board of Directors reasonably requests. The Company paid Kohlberg a fee of $2,000,000 on August 12, 1993. In addition, in consideration of the services being provided, the Company\npays Kohlberg a fee of $43,435 per quarter at the beginning of each quarter. Kohlberg, but not the Company, will be able to terminate the Fee Agreement at any time, and it will terminate automatically on the earlier of either the end of the fiscal year in which Kohlberg's percentage interest in the outstanding Common Stock falls below 25% or the tenth anniversary of the 1992 Investment.\nThe Company paid management fees of $75,000 and $36,000 to certain former Class B Stockholders for the fiscal years ended July 31, 1993 and 1992, respectively. No such fees were incurred in fiscal 1994.\n8. COMMITMENTS AND CONTINGENCIES\nAt July 31, 1994, the Company has commitments for capital expenditures of approximately $23,111,000. The major expenditures committed to include approximately $6,700,000 for improvements to the primary facility and $5,600,000 for a new mesh facility for our wire products group.\nThere are various claims and legal proceedings arising in the normal course of business pending against or involving the Company wherein monetary damages are sought. These claims and proceedings are generally covered by insurance, and it is management's opinion that the Company's liability, if any, under such claims or proceedings would not materially affect its financial position or results of operations.\nA wrongful death action against the Company is pending in the 113th Judicial District Court of Harris County, Texas. The action stems from the death of an employee at the Company's Houston Facility. Defense of this action is currently being provided by the Company's insurers. The Company's insurance carriers will not make a determination regarding coverage until this action is settled; however, the Company believes that losses arising from the complaint, if any, will be covered by the Company's insurance carriers. The Company has not provided an accrual for these losses as the outcome cannot be predicted at this time.\nThe Company is subject to a broad range of federal, state and local environmental requirements, including those governing discharges to the air and water, the handling and disposal of solid and\/or hazardous wastes and the remediation of contamination associated with releases of hazardous substances.\nPrimarily because the melting process at the Sterling Operations produces dust that contains lead and cadmium, the Company is classified, in the same manner as other similar steel mills in its industry, as a generator of hazardous waste.\nThe Company believes that it is currently in substantial compliance with applicable environmental requirements and does not anticipate the need to make substantial expenditures for environmental control measures during fiscal 1995. Nevertheless, as is the case with steel producers in general, if a release of hazardous substances located on the Company's property or used in general in the conduct of the Company's business occurs, the Company may be held liable and may be required to pay the cost of remedying the condition. The amount of any such liability and remedial cost could be material.\n9. QUARTERLY SALES AND EARNINGS DATA (Unaudited)\nThe following information is for the years ended July 31, 1994 and 1993:\nNotes: (1) Gross profit is defined here as net sales less cost of goods sold excluding depreciation.\n(2) As a result of the Recapitalization, the Company recorded an extraordinary loss related to the early retirement of debt.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Northwestern Steel and Wire Company\nOur report on the consolidated financial statements of Northwestern Steel and Wire Company and Subsidiaries is included on page of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index included in Item 14 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois September 16, 1994\nSchedule V\nNORTHWESTERN STEEL AND WIRE COMPANY\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED JULY 31, 1994, 1993 AND 1992\n(In thousands of dollars)\nSchedule VI\nNORTHWESTERN STEEL AND WIRE COMPANY\nSCHEDULE VI -- ACCUMULATED DEPRECIATION, DEPLETION, AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED JULY 31, 1994, 1993 AND 1992\n(In thousands of dollars)\nSCHEDULE VIII\nNORTHWESTERN STEEL AND WIRE COMPANY\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED JULY 31, 1994, 1993 AND 1992\n(In thousands of dollars)\nSCHEDULE X\nNORTHWESTERN STEEL AND WIRE COMPANY\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED JULY 31, 1994, 1993 AND 1992\n(In thousands of dollars)\nNOTE: Royalty expense, advertising costs and depreciation and amortization of intangible assets during the years ended July 31, 1994, 1993 and 1992 were not significant.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNORTHWESTERN STEEL AND WIRE COMPANY\nBy:\/s\/ Robert N. Gurnitz ------------------------ Robert N. Gurnitz Chairman of the Board, President and Chief Executive Officer\nDate: October 25, 1994\nPursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nEXHIBIT INDEX","section_15":""}
{"filename":"6474_1994.txt","cik":"6474","year":"1994","section_1":"Item 1. Business\n(a) General Development of Business\nThe Andersons (the \"Partnership\" or \"Company\") is engaged in grain merchandising and operates grain elevator facilities located in Ohio, Michigan, Indiana and Illinois. The Partnership is also engaged in the distribution of agricultural products such as fertilizers, seeds and farm supplies. The Partnership operates retail general stores; produces, distributes and markets lawn care products and corncob products; and repairs and leases rail cars.\nThe Partnership is the successor to other Ohio limited partnerships which have operated as \"The Andersons\" continuously since 1947. Except where the context otherwise requires, the terms \"Partnership,\" \"Company\" and \"The Andersons\" include The Andersons and all predecessor and successor entities.\nThe Andersons Management Corp. (the \"Corporation\") was formed in 1987 and is the sole General Partner of the Partnership. All of the common shares of the Corporation are owned by Limited Partners of the Partnership. The Corporation's Board of Directors has overall responsibility for the management of the Corporation, including its responsibilities as General Partner of the Partnership. The Corporation provides all management and labor services required by the Partnership in its operations under a Management Agreement entered into between the Partnership and the Corporation. See \"Item 13. Certain Relationships and Related Transactions - Management Agreement.\"\n(b) Financial Information About Industry Segments\nSee Note 12 to the Partnership's Consolidated Financial Statements for information regarding the Partnership's business segments.\n(c) Narrative Description of Business\nAgriculture Group\nThe agriculture group consists of grain operations, wholesale fertilizer operations, retail farm centers and farmer services.\nThe Partnership's grain operations involve merchandising grain and operating terminal grain elevator facilities, which includes purchasing, handling, processing and conditioning grain, storing grain purchased by the Partnership as well as grain owned by others, and selling grain. The principal grains sold by the Partnership are yellow corn, yellow soybeans and soft red and white wheat. The Partnership's total grain storage capacity aggregates approximately 67 million bushels.\nVirtually all grain merchandised by the Partnership is grown in the midwestern part of the United States and is acquired from country elevators, dealers and producers. The Partnership effects grain purchases at prices referenced to Chicago Board of Trade quotations. The Partnership competes for the purchase of grain with grain processors and feeders, as well as with other grain merchandisers.\nThe Partnership's grain business may be adversely affected by unfavorable weather conditions, disease, insect damage, the total acreage planted by farmers, government regulations and policies, and commodity price levels as they affect grower incentive or a supplier's decision when to deliver grain for sale. See \"Government Regulation.\" The grain business is seasonal coinciding with the harvest of the principal grains purchased and sold by the Partnership.\nDuring 1994, approximately 63% of the grain sold by the Partnership was purchased domestically by grain processors and feeders and approximately 37% was exported. Most of the exported grain was purchased by exporters for shipment to foreign markets. Some grain is shipped directly to foreign countries, mainly Canada. Almost all grain shipments are by rail or boat. Rail shipments are made primarily to grain processors and feeders, with some rail shipments made to exporters on the Gulf or east coast. All boat shipments are from the Toledo, Ohio port elevator.\nThe Partnership competes in the sale of grain with other grain merchants, other private elevator operators and farmer cooperatives which operate elevator facilities. Competition is based primarily on price, service and reliability. The Partnership believes that it is the largest terminal elevator operator in the Maumee\/Toledo area and that it accounts for substantial portions of the grain elevator business done in its other principal geographic areas of operations. Some of the Partnership's competitors are also its customers and many of its competitors have substantially greater financial resources than the Partnership.\nGrain sales are effected on a negotiated basis by the Partnership's merchandising staff. As with agricultural commodities generally, the volume and pricing of the Partnership's sales are sensitive to changes in supply and demand relationships, which in turn are affected by factors such as weather, crop disease and government programs, including subsidies and acreage allotments. The Partnership's business also is affected by factors such as conditions in the shipping industry, currency exchange fluctuations, government export programs and the relationships of other countries with the United States and similar considerations. Since the Partnership does not know the ultimate destination of the grain it sells for export, it is unable to determine the relative importance, in terms of sales, of the various countries to which grain is shipped by its customers.\nFixed price purchases and sales of cash grain expose the Partnership to adverse changes in price. Hedging of these purchase and sales positions provides protection from the potential adverse changes in price, avoiding unacceptable risk and the potential for significant loss.\nThe Partnership hedges fixed price purchase and sales transactions through the use of futures contracts with the Chicago Board of Trade (\"CBOT\"). The CBOT is a regulated commodity futures exchange that maintains futures markets for the grains merchandised by the Partnership (mainly corn, wheat and soybeans). Futures prices are determined by supply and demand.\nPurchases of grain can be made the day the grain is delivered to a terminal or via a forward contract made prior to actual delivery. Sales of grain are generally made by contract for delivery in a future period. When the Partnership purchases grain at a fixed price, the purchase is hedged with the sale of a futures contract on the CBOT. Similarly, when the Partnership sells grain at a fixed price, the sale is hedged with the purchase of a futures contract on the CBOT. At the close of business each day, the open fixed price cash positions as well as open futures positions, are marked-to- market. Gains\/Losses in value on the Partnership's cash positions from price changes are off-set by losses\/gains in value on the Partnership's futures positions.\nWhen a futures contract is entered into, an initial margin deposit must be sent to the CBOT. The amount of the margin deposit is set by the CBOT and varies by commodity. If the market price of a short futures contract increases, then an additional margin deposit, called a maintenance margin, would be required by the CBOT. Similarly, if the price of a long futures contract decreases, a maintenance margin deposit would be required to be sent to the CBOT. Subsequent price changes could require additional maintenance margins or could result in the return of maintenance margins by the CBOT. Significant changes in market prices--such as occurs when weather conditions are unfavorable for extended periods, can have an effect on liquidity and requires the Partnership to maintain appropriate short-term lines of credit.\nThe hedging program is designed to reduce the risk of changing commodity prices. In that regard, hedging transactions also limit potential gains from further changes in market prices. The Agriculture Group's profitability from its grain operation is derived from margins on grain sold and revenues generated from its other merchandising activities with its customers, not from its hedging transactions.\nAt any one time the Agriculture Group's purchase contract portfolio may approximate 60 million bushels for delivery to the Partnership over the next three years. Because of this volume, the Partnership relies heavily on its hedging program as the method for minimizing price risk in its grain inventories and contracts. The Agriculture Group has adopted a policy which specifies the key controls over the hedging program. This policy includes a description of the hedging programs, mandatory review of positions by key management outside of the trading function on a biweekly basis, daily position limits, modeling of positions for changes in market conditions, and other internal controls.\nThe Partnership's wholesale agricultural fertilizer operations involve purchasing, storing, formulating, and selling dry and liquid fertilizers; providing fertilizer warehousing and services to manufacturers and customers; and wholesale distribution of seeds and various farm supplies. The major fertilizer ingredients sold by the Partnership are nitrogen, phosphate and potassium, all of which are readily available from various sources.\nThe Partnership's wholesale agricultural fertilizer market area primarily includes Illinois, Indiana, Michigan and Ohio and customers for the Partnership's agricultural fertilizer products are principally retail dealers. Sales of agricultural fertilizer products are heaviest in the spring and fall.\nThe Partnership's aggregate wholesale storage capacity for dry fertilizer is 14 million cubic feet. The Partnership reserves 5 million cubic feet of this space for various fertilizer manufacturers and customers. The Partnership's aggregate storage capacity for liquid fertilizer is 31 million gallons and 6 million gallons of this space is reserved for manufacturers and customers. The agreements for reserved space provide the Partnership storage and handling fees and, generally, are for one year and are renewed at the end of each term.\nThe Partnership operates eight retail farm centers located throughout Michigan, Indiana and Ohio. These centers, often strategically located at or near the Partnership's grain or wholesale fertilizer facilities, offer agricultural fertilizer, custom application of fertilizer, and chemical seeds and supplies to the farmer. In addition, farmer services representatives based at the retail farm centers, provide a link between the grain and fertilizer operations and offer assistance with grain marketing and farm financial management.\nIn its agricultural products business, the Partnership competes with regional cooperatives; fertilizer manufacturers; multi-state retail\/wholesale chain store organizations; and other independent wholesalers of agricultural products. Many of these competitors have considerably larger resources than the Partnership. Competition in the agricultural products business of the Partnership is based principally on price, location and service. The Partnership believes that it is a strong competitor in these areas.\nRetail Group\nThe Partnership's retail store operations consist of six general stores located in the Columbus, Lima and Toledo, Ohio areas, which serve urban, rural and suburban customers. Major product categories in the general stores include: hardware, home remodeling and building supplies; automotive accessories and parts; small appliances, electronics and houseware products; work clothes and footwear; wine, specialty meats and cheeses, baked goods and produce; pet care products; lawn and garden supplies, nursery stock and Christmas decorations and trim; toys, sporting goods, bicycles and marine accessories. The general store concept features self-selection of a wide range and variety of brand name, quality merchandise. Each general store carries more than 70,000 different items, has over 100,000 square feet of in- store display space plus 40,000 square feet of outdoor garden center space, and has a center aisle that features do-it-yourself clinics, special promotions and varying merchandise displays.\nThe retail merchandising business is highly competitive. The Partnership competes with a variety of retail merchandisers, including numerous mass retailers, department and hardware stores, and farm equipment and supply companies. The principal competitive factors are quality of product, price, service and breadth of selection. In each of these areas the Partnership is an effective competitor. Its wide selection of brand names and other quality merchandise is attractively displayed in the Partnership's general stores. Each store is located on landscaped property with ample well- lit parking facilities. The Partnership's retail business is affected by seasonal factors with significant sales occurring during the Christmas season and in the spring.\nOther Activities\nThe Partnership produces more than 1000 granular retail and professional lawn care products for national distribution. The retail granular products are sold to mass merchandisers, small independent retailers and other lawn fertilizer manufacturers. The professional granular products are sold both direct and through distributors to lawn service applicators and to golf courses. The principal raw materials for the lawn care products are nitrogen, potash and phosphate, which are available from the Partnership's agriculture group. The lawn care industry is highly seasonal, with the majority of the sales occurring from early spring to early summer. Competition is based principally on merchandising ability, service and quality.\nThe Partnership is one of the largest producers of processed corncob products in the United States. These products serve the chemical carrier, animal bedding, industrial and sorbent markets and are distributed throughout the United States and Canada and into Europe and Asia. The unique absorption characteristics of the corncob has led to the development of \"sorbent\" products. Sorbents include products made from corncobs as well as synthetic and other materials and are used to absorb spilled industrial lubricants and other waste products. The principal sources for the corncobs are the Partnership's grain operations and seed corn producers.\nThe Partnership produces dog and cat foods, which are marketed through a joint venture partnership. The Partnership is also involved in repairing, buying, selling and leasing rail cars, the operation of seven auto service centers, a steel fabrication shop, a restaurant and an outdoor power equipment sales and service shop.\nResearch and Development\nThe Partnership's research and development program is mainly concerned with the development of improved products and processes, primarily lawn care products and corncob products. Approximately $490,000, $450,000, and $380,000 was expended on research and development during 1994, 1993 and 1992, respectively, including materials, salaries and outside consultants. Employees\nAll management and labor services are provided to the Partnership by the employees of the Corporation. The Partnership pays a management fee to the Corporation for these services. At December 31, 1994, there were 1,151 full- time and 1,982 part-time or seasonal employees of the Corporation providing services to the Partnership.\nGovernment Regulation\nGrain sold by the Partnership must conform to official grade standards imposed under a federal system of grain grading and inspection administered by the United States Department of Agriculture (\"USDA\").\nThe production levels, markets and prices of the grains which the Partnership merchandises are materially affected by United States government programs, including acreage control and price support programs of the USDA. Also, under federal law, the President may prohibit the export of any product, the scarcity of which is deemed detrimental to the domestic economy, or under circumstances relating to national security. Because a portion of the Partnership's grain sales are to exporters, the imposition of such restrictions could have an adverse effect upon the Partnership's operations.\nThe Partnership, like other companies engaged in similar businesses, is subject to a multitude of federal, state and local environmental protection laws and regulations including, but not limited to, laws and regulations relating to air quality, water quality, pesticides and hazardous materials. The provisions of these various regulations could require modifications of certain of the Partnership's existing plant and processing facilities and could restrict future facilities expansion or significantly increase their cost of operation. The Partnership made capital expenditures of approximately $600,000 in 1994 in order to comply with these regulations.\nEnvironmental Proceeding\nIn 1992, the Partnership was notified by the Ohio Environmental Protection Agency (the \"Agency\") that a water contamination discharge issue had been referred to the Ohio Attorney General. The issue involved the Partnership's Toledo, Ohio river elevator facility, built during the 1960's and 1970's on low lying land that had, in part, been filled by an unrelated corporation with material from its manufacturing operations. This material was the apparent source of the alleged contamination at issue. In November, 1994, a Consent Order was filed in the Lucas County Court of Common Pleas which resolved the on-going dispute. In addition, the Agency has reserved the right to investigate whether further action will be necessary at the river elevator facility.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Partnership's principal agriculture, retail and other properties are described below. Except as otherwise indicated, all properties are owned by the Partnership.\nAgriculture Facilities\nLocation Grain Wholesale Fertilizer\nBushel Dry Storage Liquid Storage Capacity (in cu. ft.) (in. gal.) Maumee, OH 18,800,000 6,333,000 2,600,000 Toledo, OH 6,300,000 2,000,000 3,000,000 Metamora, OH (2) 6,480,000 Lyons, OH (2) 380,000 Champaign, IL 13,000,000 833,000 Delphi, IN 6,580,000 1,667,000 Clymers, IN (1) 4,400,000 7,600,000 Dunkirk, IN 5,900,000 900,000 Poneto, IN 530,000 4,700,000 Logansport, IN 33,000 3,000,000 Walton, IN 433,000 6,500,000 Albion, MI 2,470,000 Potterville, MI 790,000 White Pigeon, MI 1,730,000 Webberville, MI 2,017,000 3,200,000 67,360,000 14,216,000 30,600,000\n(1) Facility leased - lease expires in 1998, provides an option to purchase (2) Facilities leased, option to purchase exercised in 1995\nThe grain facilities are mostly concrete and steel tanks, with some flat storage. The Partnership also owns grain inspection buildings and driers, a corn sheller plant, maintenance buildings and truck scales and dumps.\nAgricultural products properties consist mainly of fertilizer warehouse and distribution facilities for dry and liquid fertilizers. The Maumee, Ohio and Walton, Indiana locations have fertilizer mixing, bagging and bag storage facilities. The Partnership owns a seed processing facility in Delta, Ohio. The Partnership also operates eight retail farm centers (six under lease agreements) in Michigan, Indiana and Ohio. Aggregate storage capacity in the eight retail farm centers for liquid fertilizer and dry fertilizer is 1.4 million gallons and 240,000 cubic feet, respectively.\nRetail Store Properties\nName Location Sq. Ft. Maumee General Store Maumee, OH 128,000 Toledo General Store Toledo, OH 134,000 Woodville General Store (1) Northwood, OH 105,000 Lima General Store (1) Lima, OH 103,000 Brice General Store Columbus, OH 140,000 Sawmill General Store Columbus, OH 134,000 Warehouse (1) Maumee, OH 245,000\n(1) Leased\nThe leases for the two general stores and the warehouse facility are long-term leases with several renewal options and provide for minimum aggregate annual lease payments approximating $1,016,000. The general store leases provide for contingent lease payments based on achieved sales volume. With respect to the Brice General Store, see \"Item 13. Certain Relationships and Related Transactions - Alshire-Columbus.\" Other Properties\nThe Partnership owns lawn fertilizer production facilities and automated pet food production and storage facilities in Maumee, Ohio. It also owns corncob processing and storage facilities in Maumee, Ohio and Delphi, Indiana. The Partnership leases a lawn fertilizer production facility, a warehouse facility and four lawn products sales outlets. In its rail car leasing business, the Partnership owns or leases approximately 1600 rail cars (primarily covered hopper cars) with lease terms ranging from one to ten years and annual lease payments aggregating approximately $4,200,000. The majority of the cars controlled are leased to other companies, although some cars are maintained by the Partnership's Agriculture Division. The Partnership also owns a rail car repair facility, a steel fabrication facility, a service and sales facility for outdoor power equipment and the Partnership owns or leases seven auto service centers.\nThe Partnership's administrative office building is leased at an annual rental of $696,000 under a net lease expiring in 2000. See \"Item 13. Certain Relationships and Related Transactions - Management Agreement.\" The Partnership owns approximately 618 acres of land on which various of the above properties and facilities are located; approximately 363 acres of farmland and land held for future use; approximately 102 acres of improved land in an office\/industrial park held for sale; and certain other meeting and recreational facilities, dwellings and parcels. The Partnership also owns or leases a number of switch engines, cranes and other equipment.\nReal properties, machinery and equipment of the Partnership were subject to aggregate encumbrances of approximately $41,125,000 at December 31, 1994. Additions to property for the years ended December 31, 1994, 1993 and 1992, amounted to $26,300,359, $10,808,521, and $6,590,045, respectively. See Note 8 to the Partnership's Consolidated Financial Statements for information as to the Partnership's leases.\nThe Partnership believes that its properties, including its machinery, equipment and vehicles, are adequate for its business, well maintained and utilized, suitable for their intended uses and adequately insured.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Partnership is not involved in any material 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 Registrant's Common Equity and Related Stockholder Matters\n(a) Because of the form of its organization that includes restrictions on the transfer of Limited Partnership Interests, there is no market for the Limited Partnership Interests.\n(b) The number of holders of Limited Partnership Interests as of March 1, 1995, was 218.\n(c) The Partnership makes cash distributions and allocations of net income to Limited Partners, and to the General Partner in accordance with the terms of the Partnership Agreement. See \"Item 6.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nWorking capital at December 31, 1994 was $57 million, up $10 million from 1993. Cash provided by operating activities was $52 million in 1994 compared to a use of cash in 1993 of $51 million. The increase in cash provided by operating activities led to a decrease in short-term borrowings from $87.9 million at December 31, 1993 to $50 million at December 31, 1994.\nPartners' capital at December 31, 1994 totaled $64 million, up from $55.4 million at December 31, 1993. Net income in 1994 of $15.1 million was added to partners' capital, while partners added $733,675 to their capital accounts at the beginning of the year and withdrew $604,000. During 1994 quarterly cash distributions to partners totaled $1.1 million. This amount decreased from prior years due to partners' election to receive a reduced distribution. In addition, at the end of the year distributions to certain partners and charitable remainder trusts totaled $1.2 million and charitable contributions charged to partners' capital accounts totaled $782,000. Tax distributions to partners during 1994 totaled $3.3 million. An additional tax distribution of $474,000 was paid in January 1995. Quarterly cash distributions in 1995 are expected to be lower than 1994 distributions and 1995 tax distributions are also expected to be lower both as a result of partners electing not to take all of the distributions available to them.\nTax distributions are made to partners for purposes of making federal, state and local tax payments since the taxable income of the Partnership is taxable to the partners and not to the partnership. Tax distributions can fluctuate widely from year to year (see \"Item 6. Selected Financial Data\") due to changes in the amount and in the components of partnership taxable income due to the timing of required tax payments by partners and due to the elections made by partners to take all, none or a percentage of the tax distribution available to them. Tax distributions and taxable income for the last five years have been as follows:\nTaxable Year Distributions Income 1990 $ 278,000 $ 5,313,400 1991 3,700,000 3,880,200 1992 418,000 8,255,300 1993 4,200,000 11,855,970 1994 3,335,000 17,833,000\nThe 1990 tax distribution was based on 1989 taxable income of $1,559,500. The tax distributions in 1991 were considerably higher due to the increase in taxable income from 1989 to 1990 and due to the implementation of quarterly tax distributions paid to partners in April, June and September. Quarterly tax distributions were made to coincide with the timing of estimated tax payments due by partners. Tax distributions paid in 1992 decreased due to the decrease in taxable income from 1990 to 1991 and due to the quarterly tax payments made in 1991. In 1993, the tax distributions were very high due to the increase in taxable income in 1992, which also impacted the quarterly tax distributions needed by partners to meet their 1993 estimated tax payments. In 1994 tax distributions were lower than 1993 due to elections by partners to take smaller tax distributions.\nDuring 1994 the Partnership issued $639,000 Five-Year and $1.5 million Ten-Year debentures and additional debentures are being offered in 1995. Proceeds from the issuance of the debentures in 1994 were used to fund current maturities of long-term debt and for capital expenditures. The amount of proceeds to be realized in 1995 from the sale of debentures is unknown since the offering is not underwritten. Any proceeds realized will be added to working capital and used for such purposes as the funding of current maturities of long-term debt and for capital expenditures.\nThe Partnership finances part of its inventories through short-term borrowings under lines of credit which are also used from time to time for other Partnership purposes. Generally, the highest borrowings occur in the spring and are related to payments of grain payables, credit sales of agricultural products related to spring planting and a seasonal peak in credit sales of lawn care products. The amount of borrowings outstanding during the year, and from one year to another, may fluctuate widely depending upon inventory levels, and changes in hedged values which affect maintenance margin requirements. The Partnership has available lines of credit for unsecured short-term debt with banks aggregating $207,000,000. The credit arrangements, the amounts of which are adjusted from time to time to meet the Partnership's needs, are demand notes without termination dates but are reviewed at least annually for renewal. See Note 6 to the Partnership's Consolidated Financial Statements for additional information relating to the lines of credit. The Partnership also has a $20 million long-term revolving line of credit. See Note 7 to the Partnership's Consolidated Financial Statements.\nCertain of the Partnership's long-term indebtedness is secured by first mortgages on various facilities of the Partnership. Some of the Partnership's long-term borrowings include provisions that impose minimum levels of working capital and partnership equity (as defined); the addition of new long-term debt; restrict the Partnership from certain sale, lease, merger and consolidation transactions; require the Partnership to be substantially hedged in its grain transactions; and certain other requirements. At December 31, 1994, the Partnership was, and it believes it continues to be, in compliance with all terms and conditions of the secured borrowings and short and long term lines of credit. See Note 7 to the Partnership's Consolidated Financial Statements for further information with respect to long-term financing.\nThe Partnership periodically utilizes interest rate contracts to manage interest rate risk by locking in rates consistent with projected borrowing needs. There were no open interest rate contracts at December 31, 1994.\nThe Partnership's liquidity is enhanced by the fact that grain inventories are readily marketable. In management's opinion, the Partnership's liquidity is adequate to meet short and long-term needs.\nCapital expenditures were approximately $26 million in 1994 and are expected to be approximately $24 million in 1995. Anticipated capital expenditures in 1995 include $4.4 million for grain elevator and retail farm center acquisitions, $2.6 million for additional storage capacity, $3.5 million for store renovations, $5.9 million for plant upgrades and improvements and $2 million for information systems improvements. Funding for capital expenditures in 1995 is expected to come from cash generated from operations and additional long-term debt or new equity. Capital expenditures could be curtailed if necessary.\nResults of Operations\nYears ended December 31, 1994 and 1993:\nNet income in 1994 increased to $15 million from $11 million in 1993. Gross profit increased by $19 million or 15%. Operating, administrative and general expenses were up $13 million or about 11%, including an increase of $7.3 million (11%) in the management fee paid to the general partner. Most of the management fee increase was for salaries, wages and benefits. Additional facilities in the Agriculture Group added approximately $5 million to salaries, wages and benefits and a full year of operation at the Lima General Store added more than $1 million to salaries, wages and benefits in the Retail Group. Operating profit increased by $7.5 million.\nGrain sales and merchandising revenues were $551.8 million compared to $439.5 million in 1993, a 26% increase. Sales of grain commodities were up $110 million. Bushels sold increased almost 20% and the average selling price per bushel increased from $3.25 to $3.44. Cents per bushel sold (margin) increased 19%. Merchandising revenues increased from $23.2 million in 1993 to $25.5 million in 1994. Storage income was up $3.6 million, while basis income was down 1.4 million due to a larger than expected wheat and corn crop. Drying and mixing income was down $2 million during 1994, due in part to a better quality 1993 corn crop and 1994 wheat crop than those of the preceding crop years. Gross profit on grain sales and merchandising revenues was up $4.3 million or 13%.\nSales of wholesale fertilizer were up $22.8 million or 26% and retail fertilizer sales and sales of other agricultural products were up $7.6 million or 45%. Wholesale fertilizer tonnage increased by 11% and the average selling price increased 6%. Gross profit on wholesale fertilizer increased $5.3 million or 64% while retail and other agricultural products gross profit increased $2.1 million or 26%. Approximately one-half of the wholesale fertilizer gross profit increase was the result of the liquidation in 1994 of phosphate inventories purchased in 1993 when the market price of phosphate was depressed. In 1994, the market price appreciated significantly and the Partnership liquidated its inventory.\nSales in the Agriculture Group were $661.4 million compared to $520.9 million in 1993, while gross profit and operating profit increased $11.7 million and $4.3 million, respectively.\nSales in the Retail Group were $172 million in 1994 compared to $155 million in 1993. Sales in the Columbus stores were up $4.4 million and sales in the Toledo stores were up $3 million. Sales in the Lima store which opened in September 1993 were up $10 million. Margins increased by about 3%. Operating profit in the Retail Group was up $2.7 million.\nSales in the other businesses of the Partnership also increased. Sales of lawn care products totalled $47.6 million, up $9.5 million from 1993. Volume increased 27%, while average selling prices decreased 5%. Margins were down just a little. Sales of corn cob products were $14.6 million compared to $14.2 million in 1993. Volume was down in corn cob products and up in sorbent products. Railcar leasing activity doubled from 1993 and sales and repairs of railcars also increased. Sales from the Partnership's auto service centers were up, as were steel fabrication sales. Sales from the Partnership's outdoor power equipment and service shop also improved. Operating profit in the other businesses was up $570,000.\nYears ended December 31, 1993 and 1992:\nIncome from continuing operations was $11 million in 1993 compared to $10 million in 1992. Operating, administrative and general expenses were up $12 million or about 12%. Included is an increase of $5.7 million (10%) in the management fee paid to the general partner. The more significant items comprising the increase are additional salaries, wages and benefits for a new general store, as well as an expanded work force in several other operating areas and additional cash profit sharing and management performance payments as a result of improved net income. The management fee also increased as a result of the Corporation's adoption of Statement of Financial Accounting Standard No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The Corporation has elected to recognize the $8.4 million of accrued benefits as of January 1, 1993 (transition obligation) prospectively as a component of annual postretirement benefit cost over approximately 20 years. The additional annual cost incurred by the Corporation and passed on to the Partnership as part of the management fee was approximately $850,000 for 1993. By major business segment the results were as follows:\nGrain sales and merchandising revenues were $439.5 million compared to $440.6 million in 1992. Sales of grain commodities were down $7.5 million or 2%. Bushels sold increased 2% and the average selling price per bushel decreased 4% from $3.39 to $3.25. Cents per bushel sold (margin) decreased 11%. Most of these changes were a result of an increase in yields in 1993 as well as an improvement in the quality of the crops in the eastern corn belt. Merchandising revenues were up $6.4 million. Income earned in 1993 from holding owned grain was up from the depressed levels in 1992, due in part to the effects of the floods in 1993 and to a shortage of wheat in the first half of 1993. Income from drying and blending grain was also up in 1993, with most of the increase coming in the first six months of the year. This is a result of the high moisture content in the 1992 corn crop carried into 1993 and due to the depressed level of drying and blending income in the first six months of 1992. Gross profit on grain sales and merchandising revenues was up $5.7 million or 20%.\nSales of wholesale fertilizer were up $11.6 million or 11% and retail fertilizer sales and sales of other agricultural products were down $800,000 or 5%. Wholesale fertilizer tonnage increased by 19% and the average selling price decreased 3%. Gross profit on wholesale fertilizer increased $1.4 million or 16% while retail and other agricultural products gross profit increased $400,000 or 7%.\nSales in the Agriculture Group were $520.9 million compared to $517.6 million in 1992, while gross profit and operating profit increased $7.5 million and $2.9 million, respectively.\nSales in the retail group were $155 million in 1993, up 4% from 1992. Sales in the Columbus market were up 5%, sales in the Toledo market were down 2% and sales from a new store opened in Lima, Ohio, in the fourth quarter of 1993 accounted for the remainder of the sales increase. Gross profit was up about $1.2 million, or 3%, as a result of the sales increase along with a small decrease in margins due to the competitive pressures in the retail market. As a result of a $3.7 million (10%) increase in operating expenses, due to increased advertising and the costs associated with opening the new general store, operating profit decreased from $4 million in 1992 to $1.6 million in 1993.\nSales in the other businesses of the Partnership also increased. Sales of lawn products totalled $38 million, up 7% from 1992. Volume increased 2% and average selling prices increased 5%. Margins were up about 11%. In the industrial products area sales were $14.2 million, up 1%. Sales of sorbent products were up, due to volume increases, and sales of corncob products were down, due to a decrease in volume. Sales from the Partnership's auto service centers were up, as were steel fabrication sales. Railcar leasing activity improved, while railcar repairs for external customers were down due to utilizing the shop capacity for repairs to cars owned by the Partnership. Sales from the Partnership's outdoor power equipment and service shop were $4 million. In total, the operating profits of lawn and corn cob products and other businesses of the Partnership improved by $440,000.\nImpact of Inflation:\nAlthough inflation has slowed in recent years, it is still a factor in the economy and the Partnership continues to seek ways to cope with its impact. To the extent permitted by competition, the Partnership passes increased costs on through increased selling prices. Grain inventories are valued at the current replacement market price and substantially all purchases and sales of grain are hedged as a result of buying or selling commodity futures contracts. Consequently, grain inventories and cost of goods sold are not directly affected by inflation but rather by market supply and demand. If adjusted for inflation, net income would be lower than reported due primarily to increased depreciation costs resulting from the replacement costs associated with property, plant and equipment.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nReport of Independent Auditors\nPartners The Andersons\nWe have audited the accompanying consolidated balance sheets of The Andersons (a partnership) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, cash flows and changes in partners' capital 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Andersons 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.\n\/s\/ Ernst & Young LLP ERNST & YOUNG LLP Toledo, Ohio February 6, 1995\nThe Andersons and Subsidiaries Consolidated Statements of Income\nYear ended December 31 1994 1993 1992 Grain sales and revenues $551,836,287 $439,483,762 $440,553,476 Fertilizer, retail and other sales 400,922,131 336,973,308 312,613,276 Other income 2,608,671 3,763,737 3,834,457 955,367,089 780,220,807 757,001,209\nCost of grain sales and revenues 513,893,485 405,889,171 412,623,606 Cost of fertilizer, retail and other sales 292,258,780 244,254,571 227,130,480 806,152,265 650,143,742 639,754,086 Gross profit 149,214,824 130,077,065 117,247,123 Operating, administrative and general expenses (Note 2) 125,682,788 112,829,334 100,791,991 Interest expense 8,394,606 6,168,371 6,325,440 134,077,394 118,997,705 107,117,431 Income from continuing operations 15,137,430 11,079,360 10,129,692 Discontinued operations (Note 3): Loss from discontinued operations (396,177) Loss on sale of discontinued operations (2,097,767) Net income $ 15,137,430 $ 11,079,360 $ 7,635,748\nNet income (loss) was allocated to: General partner: From continuing operations $ 218,844 $ 145,526 $ 124,871 From discontinued operations - - (30,743) 218,844 145,526 94,128 Limited partners: From continuing operations 14,918,586 10,933,834 10,004,821 From discontinued operations (2,463,201) 14,918,586 10,933,834 7,541,620 $ 15,137,430 $ 11,079,360 $ 7,635,748\nNet income (loss) allocation per $1,000 of partners' capital: Weighted average capital for allocation purposes $ 52,696,376 $ 47,405,022 $ 43,101,473 Allocation per $1,000: From continuing operations $ 287 $ 234 $ 235 From discontinued operations (58) $ 287 $ 234 $ 177\nSee accompanying notes.\nThe Andersons and Subsidiaries Consolidated Balance Sheets\nDecember 31 1994 1993 Assets Current assets: Cash and cash equivalents (Note 10) $ 6,186,695 $ 3,936,955 Accounts receivable: Trade accounts, less allowance for doubtful accounts of $2,292,000 in 1994; $1,178,000 in 1993 55,157,316 60,036,382 Margin deposits (Note 10) 7,034,058 15,320,979 62,191,374 75,357,361 Inventories (Note 4) 198,635,026 211,023,651 Prepaid expenses 899,268 858,941 Total current assets 267,912,363 291,176,908\nOther assets: Notes receivable and other assets, less allowance for doubtful notes receivable of $717,000 in 1994 3,083,583 3,965,729 Investments in and advances to affiliates 1,591,673 942,053 4,675,256 4,907,782 Property, plant and equipment (Notes 5 and 7) 77,596,503 60,417,088 $350,184,122 $356,501,778 Liabilities and partners' capital Current liabilities: Notes payable (Note 6) $ 50,000,000 $ 87,900,000 Accounts payable for grain 83,843,840 83,712,076 Other accounts payable 60,990,810 58,896,317 Amounts due General Partner (Note 2) 4,700,699 4,173,287 Accrued expenses 7,708,295 7,496,181 Current maturities of long-term debt 3,615,000 1,992,000 Total current liabilities 210,858,644 244,169,861\nAmounts due General Partner (Note 2) 3,059,742 2,413,041 Long-term debt (Note 7) 71,217,308 52,259,120\nDeferred gain 1,145,151 Minority interest 1,070,878 1,103,892 Partners' capital: General partner 969,376 761,839 Limited partners 63,008,174 54,648,874 63,977,550 55,410,713 $350,184,122 $356,501,778\nSee accompanying notes.\nThe Andersons and Subsidiaries Consolidated Statements of Cash Flows\nYear ended 1994 1993 1992 Operating activities Net income $15,137,430 $11,079,360 $ 7,635,748 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 8,101,058 7,109,223 7,010,579 Provision for losses on accounts and notes receivable 2,682,904 909,724 763,677 Payments to minority interests (222,052) (166,198) (132,896) Minority interest in net income of subsidiaries 189,038 236,224 154,392 Gain on sale of property, plant and equipment (160,988) (1,107,707) (1,645,421) Amortization of deferred gain (43,823) (385,956) (373,238) Loss on sale of discontinued operations - - 1,582,630 Equity in undistributed loss of affiliates - - 4,255 Changes in operating assets and liabilities: Accounts receivable 10,483,083 (32,109,849) (5,866,574) Inventories 12,388,625 (61,137,730) 37,905,112 Prepaid expenses and other assets (1,006,667) (1,255,649) (501,424) Accounts payable for grain 131,764 18,966,696 (3,086,492) Other accounts payable and accrued expenses 4,451,416 6,719,097 5,074,170 Net cash provided by (used in) operating activities 52,131,788 (51,142,765) 48,524,518\nInvesting activities Purchases of property, plant and equipment (22,663,348) (10,808,521) (6,590,045) Proceeds from sale of investment 1,679,215 - - Proceeds from sale of property, plant and equipment 848,408 1,696,989 2,586,539 (Advances to) payments received from affiliates (640,000) 149,999 5,145 Proceeds from sale of discontinued operations - - 1,299,340 Net cash used in investing activities (20,775,725) (8,961,533) (2,699,021)\nFinancing activities Net increase (decrease) in short-term borrowings (37,900,000) 64,150,000 (45,330,000) Proceeds from issuance of long-term debt 35,508,820 22,753,656 16,022,652 Payments of long-term debt (20,144,550) (17,439,855) (17,887,109) Payments to partners and other deductions from capital accounts (7,304,268) (7,212,084) (3,177,162) Capital invested by partners 733,675 423,630 4,153,500 Net cash provided by (used in) financing activities (29,106,323 62,675,347 (46,218,119)\nIncrease (decrease) in cash and cash equivalents 2,249,740 2,571,049 (392,622) Cash and cash equivalents at beginning of year 3,936,955 1,365,906 1,758,528 Cash and cash equivalents at end of year $ 6,186,695 $ 3,936,955 $ 1,365,906\nNoncash investing and financing activities: Assumption of long-term debt in purchase of property, plant and equipment $ 5,216,918\nSee accompanying notes.\nThe Andersons and Subsidiaries Consolidated Statements of Changes in Partners' Capital\nYear ended December 31 1994 1993 1992 General partner capital Balance at beginning of year $ 761,839 $ 622,659 $ 531,322 Amounts credited (charged) to capital: Net income for the year 218,844 145,526 94,128 Charitable contributions (11,307) (6,346) (2,791) 207,537 139,180 91,337 Balance at end of year $ 969,376 $ 761,839 $ 622,659\nLimited partners' capital Balance at beginning of year $54,648,874 $50,497,148 $41,976,399 Amounts credited (charged) to capital: Net income for the year 14,918,586 10,933,834 7,541,620 Increase in invested capital 733,675 423,630 4,153,500 Charitable contributions (770,809) (476,772) (223,623) Withdrawals (1,759,072) (827,573) (899,793) Distributions (4,763,080) (5,901,393) (2,050,955) 8,359,300 4,151,726 8,520,749 Balance at end of year $63,008,174 $54,648,874 $50,497,148\nTotal partners' capital--at end of year $63,977,550 $55,410,713 $51,119,807\nSee accompanying notes.\nThe Andersons and Subsidiaries Notes to Consolidated Financial Statements December 31, 1994\n1. Significant Accounting Policies\nPrinciples of Consolidation and Related Matters\nThe consolidated financial statements include the accounts of The Andersons (the Partnership) and its subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation. Other affiliated entities are not material.\nCash and Cash Equivalents\nThe Partnership considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. The carrying value of these assets approximate their fair value.\nSecurities\nThe Partnership adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" in 1994. There was no cumulative effect as a result of the adoption.\nManagement 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 when there is positive intent and ability to hold the securities to maturity. Held-to- maturity securities are stated at amortized cost.\nMarketable equity securities and debt securities not classified as held-to- maturity are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of tax, reported in a separate component of partners' capital.\nInventories\nInventories of grain are hedged to the extent practicable and are valued on the basis of replacement market prices prevailing at the end of the year. Such inventories are adjusted for the amount of gain or loss (based on year-end market price quotations) on open grain contracts at the end of the year. Contracts in the commodities futures market, maintained for hedging purposes, are valued at market at the end of the year and income or loss to that date is recognized. Grain contracts maintained for other merchandising purposes are valued in a similar manner and net margins from these transactions are included in sales and merchandising revenues.\nAll other inventories are stated at the lower of cost or market. Cost is determined by the average cost method.\nProperty, Plant and Equipment\nLand, buildings and equipment are carried at cost. Depreciation is provided over the estimated useful lives of the individual assets principally by the straight-line method.\nAccounts Payable for Grain\nThe liability for grain purchases on which price has not been established (delayed price), has been computed on the basis of replacement market at the end of the year, adjusted for the applicable premium or discount.\nRevenue Recognition\nSales of grain and other products are recognized at the time of shipment. Revenues from merchandising activities are recognized as open contracts are marked to market or as services are provided.\nIncome Taxes\nNo provision has been made for federal income taxes on the Partnership's net income since such amounts are includable in the federal income tax returns of its partners. At December 31, 1994 and 1993, the Partnership s net assets for financial reporting purposes were approximately $1,800,000 and $3,800,000, respectively, greater than their corresponding tax bases, as a result of temporary differences in when revenues and expenses are recognized for financial reporting purposes and in determining taxable income.\nPreopening Expenses\nPreopening expenses are charged to income when incurred.\nDeferred Gain\nThrough January 31, 1994, the deferred portion of a gain from the sale and leaseback of a retail store was being amortized into income over the ten-year leaseback period by the straight-line method. On February 1, 1994 the store was reacquired and the remaining deferred gain was recorded as a component of the reacquisition cost.\nIncome Allocations and Cash Distributions to Partners\nThe Partnership Agreement reflects each partner's capital account as of the beginning of each year. Partners' capital, used in determining the allocation of net income or loss to each partner, is weighted to reflect cash and tax distributions made to partners and additional investments made by partners during the year. The general partner and each limited partner receive the same allocation of net income or loss per $1,000 of partners' capital.\nPartners may elect to receive quarterly cash distributions as declared by the general partner. Partners may also elect to receive quarterly tax distributions or an annual tax distribution. Final 1994 tax distributions of approximately $5,200,000 may be paid to partners in 1995 from the year end partners' capital balances upon each Partner's election.\nCharitable Contributions\nProvision is made in the Partnership Agreement for contributions to various charitable, educational and other not-for-profit institutions. It is the policy of the Partnership to account for charitable contributions as charges to partners' capital, and they are not deducted in determining Partnership net income.\nReclassifications\nCertain amounts in the 1993 and 1992 financial statements have been reclassified to conform with the 1994 presentation. These reclassifications had no effect on net income.\n2. Transactions with General Partner\nThe Andersons Management Corp. (the Corporation) is the sole general partner of the Partnership and provides all management and labor services to the Partnership. In exchange for providing these services, the Corporation charges the Partnership a management fee equal to: a) the salaries and cost of all employee benefits and other normal employee costs, paid or accrued for services performed by the Corporation's employees on behalf of the Partnership, b) reimbursable expenses incurred by the Corporation in connection with its services to the Partnership, or on the Partnership's behalf, and c) an amount based on an achieved level of return on partners' capital to cover the Corporation's general overhead and to provide an element of profit to the Corporation.\nEmployee benefit costs include the cost of pension and other postretirement benefits. In 1993, the Corporation changed its method of accounting for postretirement health insurance benefits. The Corporation now accrues for the cost of providing these benefits during the employees working career rather than recognizing the cost of these benefits as claims are paid. The Corporation has elected to recognize the accrued benefits earned by employees as of January 1, 1993 (transition obligation) prospectively, which means this cost will be recognized as a component of annual postretirement benefit costs over a period of approximately 20 years. The change in the method of accounting for these benefits increased management fees charged to the Partnership by approximately $840,000 and $850,000 for 1994 and 1993, respectively.\nThe Partnership generally pays the Corporation for salaries and employee benefits as those costs are paid by the Corporation. Amounts owed to the Corporation relating to postretirement benefits that will not be paid within one year have been classified as a long-term liability.\nThe Partnership leases office space from the Corporation under a lease expiring May 1, 2000. The net lease payments amounted to $635,714, $529,982 and $516,344 in 1994, 1993 and 1992, respectively.\nThe components of the management fee and rent incurred by the Partnership consisted of the following:\nYear ended December 31 1994 1993 1992 Salaries and wages $53,726,460 $47,706,731 $43,356,247 Employee benefits 15,673,685 14,619,453 13,426,059 Rent for office space and other reimbursable expenses 803,830 641,491 516,344 Achieved level of return of the Partnership 190,880 139,656 89,618 Totals $70,394,855 $63,107,331 $57,388,268\n3. Discontinued Operations\nIn April 1992, the Partnership decided to dispose of its pet products distribution business, which was represented by a majority investment in B&R Pet Supplies, Inc. (B&R). During 1992, the Partnership sold the operations of B&R for approximately $1,300,000, which resulted in a loss of $1,582,630. Losses from operations from April 1, 1992 to the date of sale amounted to $515,137. This transaction has been accounted for as a discontinued operation.\nSales from discontinued operations were approximately $9,780,000 for the year ended December 31, 1992.\n4. Inventories\nMajor classes of inventory are as follows:\nDecember 31 1994 1993 Grain $113,554,519 $135,346,670 Agricultural fertilizer and supplies 21,110,719 16,170,908 Merchandise 32,240,845 32,497,574 Lawn and corn cob products 20,992,385 20,579,022 Other 10,736,558 6,429,477 $198,635,026 $211,023,651\n5. Property, Plant and Equipment\nThe components of property, plant and equipment are as follows:\nDecember 31 1994 1993 Land $ 13,063,330 $ 9,457,460 Land improvements and leasehold improvements 22,569,686 19,378,810 Buildings and storage facilities 71,700,138 62,022,387 Machinery and equipment 87,308,030 80,141,615 Construction in progress 1,387,362 1,707,564 196,028,546 172,707,836 Less allowances for depreciation and amortization 118,432,043 112,290,748 $ 77,596,503 $ 60,417,088\n6. Banking and Credit Arrangements\nThe Partnership has available lines of credit for unsecured short-term debt with banks aggregating $207,000,000. The credit arrangements, the amounts of which are adjusted from time to time to meet the Partnership's needs, do not have termination dates but are reviewed at least annually for renewal. The terms of certain of these lines of credit provide for annual commitment fees.\nThe following information relates to borrowings under short-term lines of credit during the years indicated.\n1994 1993 1992\nMaximum borrowed $127,600,000 $100,500,000 $104,000,000 Average daily amount borrowed (total of daily borrowings divided by number of days in period) 72,182,603 60,404,384 50,341,667 Average interest rate (computed by dividing interest expense by average daily amount outstanding) 5.03% 4.15% 5.20%\n7. Long-Term Debt\nLong-term debt consists of the following:\nDecember 31 1994 1993 Note payable, 7.84%, payable $75,000 quarterly through October 1997, and $398,000 quarterly thereafter, due 2004 $14,850,000 $ - Notes payable relating to revolving credit facility 10,000,000 7,500,000 Note payable, variable rate (7.625% at December 31, 1994), payable $800,000 annually, due 1997 6,000,000 6,800,000 Note payable, variable rate (6.9375% at December 31, 1994), payable $72,470 monthly including interest, due 1996 4,661,089 - Other notes payable 795,686 888,409 Industrial development revenue bonds: 6.5%, due 1999 4,400,000 5,000,000 Variable rate (5.695% at December 31, 1994), due in annual installments of $881,000 in 1995 through 2004 8,114,000 8,114,000 Variable rate (5.85% at December 31, 1994), due 2025 3,100,000 3,100,000 Debenture bonds: 9.2% to 11.4%, due 1995 and 1996 6,088,000 7,586,000 6.5% to 8%, due 1997 through 1999 5,530,000 4,894,000 10% to 10.5%, due 1997 and 1998 2,117,000 2,849,000 10%, due 2000 and 2001 2,742,000 2,774,000 7.5% to 8.7%, due 2002 through 2004 5,590,000 4,061,000 Employee bonds, variable rate (18% at December 31, 1994) 233,312 59,581 Other bonds, 4% to 10% 611,221 625,130 74,832,308 54,251,120 Less current maturities 3,615,000 1,992,000 $71,217,308 $52,259,120\nThe Partnership has a $20,000,000 revolving line of credit with a bank which bears interest based on the LIBOR rate (4.345% at December 31, 1994). Borrowings under this agreement totalled $10,000,000 at December 31, 1994. The revolving line of credit expires on July 1, 1997.\nThe variable rate notes payable, the note payable due in quarterly installments and the industrial development revenue bonds are collateralized by first mortgages on certain facilities and related property with a cost aggregating approximately $80,640,000.\nThe various underlying loan agreements, including the Partnership's revolving line of credit, contain certain provisions which require the Partnership to, among other things, maintain minimum working capital of $32,000,000 and net Partnership equity (as defined) of $43,000,000, limit the addition of new long-term debt, and limit its unhedged grain position to 2,000,000 bushels.\nThe aggregate annual maturities, including sinking fund requirements, through 1999 of long-term debt are as follows: 1995--$3,615,000; 1996--$22,895,000; 1997--$10,388,000, 1998--$7,125,000 and 1999--$4,230,000.\nInterest paid (including short-term lines of credit) amounted to $8,175,747, $5,425,491 and $6,595,883 in 1994, 1993 and 1992, respectively.\n8. Leases\nThe Partnership and subsidiaries lease certain equipment and real property under operating leases, including rail cars which the Partnership subleases to third parties.\nNet rent expense under operating leases was as follows:\n1994 1993 1992 Total rent expense $8,442,535 $7,095,276 $7,400,356 Less rental income from subleases 2,805,440 1,320,544 1,312,205 Net rental expense $5,637,095 $5,774,732 $6,088,151\nFuture minimum rentals for all noncancelable operating leases and future rental income from subleases are as follows:\nFuture Future Minimum Sublease Rentals Income 1995 $ 7,803,420 $ 4,132,351 1996 6,281,504 3,505,671 1997 5,172,363 3,104,040 1998 4,661,835 2,863,620 1999 3,319,158 1,229,235 Future years 3,386,948 157,390 $30,625,228 $14,992,307\n9. Commitments and Risk Management\nThe Partnership has, in the normal course of its business, entered into contracts to purchase and sell grain inventories and has interest in other commodity contracts requiring performance in future periods. Contracts for purchase of grain inventories and other commodities from producers generally relate to the current or future crop years for delivery periods quoted by regulated commodity exchanges. Contracts for sale of grain inventories and other commodities to processors and other consumers generally do not extend beyond one year. The terms of these contracts are consistent with industry practice.\nThe Partnership utilizes futures contracts that are traded on a regulated futures exchange to hedge its net price exposure from grain inventories held and firm commitments to purchase or sell grain inventories and other commodities. The Partnership's policy is to hedge its net price exposure and at December 31, 1994, nearly 100% of the Partnership's grain inventories held and firm commitments under forward contracts were hedged with futures contracts. All grain inventories held, firm commitments under forward contracts and futures contracts are marked to market on a daily basis.\nThe Partnership periodically utilizes interest rate contracts to manage interest rate risk by converting variable interest rates on its short-term borrowings to short-term fixed interest rates. The notional amounts of these contracts are based upon the Partnership's projected short-term borrowing needs. Additional interest expense incurred in holding these instruments was $52,695, $92,545 and $1,783 in 1994, 1993 and 1992, respectively. There were no open interest rate contracts at December 31, 1994.\n10. Securities\nThe following is a summary of held-to-maturity securities which mature within one year as of December 31, 1994 and 1993:\nGross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 1994 Cash equivalent--commercial paper $4,700,000 $ - $ - $4,700,000 Margin deposits--U.S. Treasury securities 3,902,567 929 - 3,903,496 $8,602,567 $ 929 $ - $8,603,496\nDecember 31, 1993 Cash equivalent--U.S. Treasury securities $3,936,955 $ - $ - $3,936,955 Margin deposits--U.S. Treasury securities 4,731,172 - 15,015 4,716,187 $8,668,127 $ - $15,015 $8,653,142\n11. Fair Values of Financial Instruments\nThe fair values of the Partnership's financial instruments, consisting of cash equivalents, margin deposits, investments in and advances to affiliates and long and short-term debt, approximate their carrying values since the instruments either provide for short terms to maturity or interest at variable rates based on market indexes or, in the case of investments in affiliates, the investments are being carried on the equity method which approximate fair value. Certain long-term notes payable and the Partnership's debenture bonds bear fixed rates of interest and terms of five or ten years. Based upon current interest rates offered by the Partnership on similar bonds and rates currently available to the Partnership for long-term borrowings with similar terms and remaining maturities, the Partnership believes its long-term debt instruments outstanding at December 31, 1994 and 1993, have fair values as follows:\nCarrying Fair Amount Value Debenture bonds $22,144,000 $22,189,000 Long-term notes payable 52,688,000 51,316,000 $74,832,000 $73,505,000\nDebenture bonds $22,241,000 $23,750,000 Long-term notes payable 32,010,000 31,993,000 $54,251,000 $55,743,000\n12. Segments of Business\nThe Partnership operates three business segments: Agriculture, Retail Stores and Other. Agriculture includes grain merchandising, operation of terminal grain elevator facilities, and distribution of agricultural products, primarily fertilizer. Other includes production and distribution of lawn and corn cob products and rail car leasing and repair.\nPrior to 1994 the Partnership reported its agriculture business as two segments: Grain Operations and Agricultural Products. The Partnership elected to combine these operations into a single business segment based upon the similarities in the customer bases and geographic markets.\nSegment information for 1993 and 1992 has been restated to conform with the 1994 presentation.\nThe segment information includes the allocation of expenses shared by one or more segments. Although management believes such allocations are reasonable, the operating information does not necessarily reflect how such data might appear if the segments were operated as separate businesses.\nYear ended December 31 1994 1993 1992 Revenues: Agriculture: Sales to unaffiliated customers $661,369,917 $520,890,521 $517,598,783 Intersegment sales 3,105,953 2,978,856 2,709,350 Merchandising revenue and other income 30,446,394 27,350,033 20,007,958 694,922,264 551,219,410 540,316,091 Retail stores: Sales to unaffiliated customers 172,337,256 155,424,855 149,090,921 Other income 112,763 118,337 82,344 172,450,019 155,543,192 149,173,265 Other: Sales to unaffiliated customers 89,636,688 71,668,255 64,976,326 Intersegment sales 877,903 730,135 819,310 Other income 440,107 678,710 553,502 90,954,698 73,077,100 66,349,138 Other income 1,023,964 4,090,096 4,691,375 Eliminations--intersegment sales (3,983,856) (3,708,991) (3,528,660) Total revenues $955,367,089 $780,220,807 $757,001,209\nOperating profit: Agriculture $ 18,900,530 $ 14,571,601 $ 9,720,038 Retail stores 4,290,252 1,639,953 4,062,370 Other 5,529,419 4,958,651 4,517,401 Total operating profit 28,720,201 21,170,205 18,299,809\nOther income 863,147 2,090,567 2,533,177 Interest expense (8,394,606) (6,168,371) (6,325,440) General expenses (6,051,312) (6,013,041) (4,377,854) Income from continuing operations $ 15,137,430 $ 11,079,360 $ 10,129,692\nIdentifiable assets: Agriculture $217,462,318 $244,064,853 $168,917,991 Retail stores 64,551,540 56,558,711 48,174,786 Other 53,720,115 44,091,096 29,021,506 General assets 14,450,149 11,787,118 9,386,354 Total assets $350,184,122 $356,501,778 $255,500,637\nDepreciation and amortization expense: Agriculture $ 3,390,835 $ 3,252,151 $ 3,364,773 Retail stores 2,602,692 1,957,190 1,882,966 Other 1,699,610 1,512,000 1,211,566 General 407,921 387,882 551,274 Total depreciation and amortization expense $ 8,101,058 $ 7,109,223 $ 7,010,579\nCapital expenditures: Agriculture $ 6,688,988 $ 3,772,771 $ 2,420,837 Retail stores 12,985,881 4,228,566 728,538 Other 5,537,036 2,209,646 2,917,100 General 1,088,454 597,538 523,570 Total expenditures $ 26,300,359 $ 10,808,521 $ 6,590,045\nIntersegment sales are made at prices comparable to normal, unaffiliated customer sales. Operating profit is sales and merchandising revenues plus interest and other income attributable to the operating area less operating expenses, excluding interest and general expenses. Identifiable assets by segment include accounts receivable, inventories, advances to suppliers, property, plant and equipment and other assets that are directly identified with those operations. General assets consist of cash, investments, land held for investment, land and buildings and equipment associated with administration and Partnership services, assets of discontinued operations and other assets not directly identified with segment operations.\nAn unaffiliated customer accounted for grain operations sales of $85,900,000 in 1992. No unaffiliated customer accounted for more than 10% of sales and merchandising revenues in 1994 or 1993. Grain sales for export to foreign markets amounted to approximately $129,700,000 and $88,300,000, and $101,300,000 in 1994, 1993 and 1992, respectively.\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 is managed by the Corporation acting in its capacity as sole General Partner. The Board of Directors of the Corporation has overall responsibility for the management of the Corporation's affairs, including its responsibilities as General Partner of the Partnership. Day-to-day operating decisions, relative to the Partnership, have been delegated by the Board to the Corporation's Chief Executive Officer. The directors and executive officers of the Corporation are:\nName Age Position Thomas H. Anderson 71 Chairman of the Board (1)* (2)* (3)* Richard P. Anderson 65 Director; President and Chief Executive Officer (1)* (2)* (3)* Christopher J. Anderson 40 Vice President Business Development Group (3) Daniel T. Anderson 39 Director; General Merchandise Manager Retail Group (3) Donald E. Anderson 68 Director; Science Advisor (1) Michael J. Anderson 43 Director; Vice President and General Manager Retail Group (2) Richard M. Anderson 38 Director; Vice President and General Manager Industrial Products Group (2) John F. Barrett 45 Director Joseph L. Braker 44 Vice President and General Manager Agriculture Group (2) Dale W. Fallat 50 Director; Vice President Corporate Services (2) Richard R. George 45 Corporate Controller and Principal Accounting Officer (3) Paul M. Kraus 62 Director (1) Peter A. Machin 47 Vice President and General Manager Lawn Products Group (1) Beverly J. McBride 53 General Counsel and Corporate Secretary (2) Rene C. McPherson 70 Director (2) Donald M. Mennel 76 Director (1) (3) Larry D. Rigel 53 Vice President Marketing (1) Janet M. Schoen 35 Director (2) Gary L. Smith 49 Corporate Treasurer (1)\n(1) Member of Nominating and Advisory Committee (2) Member of Compensation Committee (3) Member of Audit Committee * Denotes Ex-officio member\nThomas H. Anderson - Held the position of Manager-Company Services of The Andersons for several years and was named Senior Partner in 1987. When the Corporation was formed in 1987, he was named Chairman of the Board. He served as a General Partner of The Andersons and a member of its Managing Committee from 1947 through 1987.\nRichard P. Anderson - He was Managing Partner of The Andersons from 1984 to 1987 when he was named Chief Executive Officer. Served as a General Partner of The Andersons and a member of its Managing Committee from 1947 through 1987 and has been a Director of the Corporation since its inception in 1987. He is also a director of Centerior Energy Corporation, First Mississippi Corp. and N-Viro, International Corp.\nChristopher J. Anderson - Began full-time employment with the Partnership in 1983. He held several positions in the Grain Group, including Planning Manager and Administrative Services Manager, until 1988 when he formed a private consulting business. He returned to the Company in 1990 in his present position.\nDaniel T. Anderson - Began full-time employment with The Andersons in 1979. He has served in various positions in the Retail Group since 1984, including Store Manager and Retail Operations Manager. In 1990, he assumed the position of General Merchandise Manager for the Retail Group. He was elected a Director in 1990.\nDonald E. Anderson - In charge of scientific research for the Partnership since 1980, he semi-retired in 1992. He served as a General Partner of The Andersons from 1947 through 1987 and has served the Corporation as a Director since its inception in 1987.\nMichael J. Anderson - Began his employment with The Andersons in 1978. He has served in several capacities in the Grain Group and he held the position of Vice President and General Manager Grain Group from 1990 to February 1994 when he was named Vice President and General Manager of the Retail Group. He has served as a Director of the Corporation since 1988.\nRichard M. Anderson - Began his employment with The Andersons in 1986 as Planning Analyst and was named the Manager of Technical Development in 1987. In 1990, he assumed his present position. He has served as a Director since 1988.\nJohn F. Barrett - He has served in various capacities at The Western and Southern Life Insurance Company, including Executive Vice President and Chief Financial Officer and President and Chief Operating Officer, and currently serves as Chief Executive Officer. He is a director of Cincinnati Bell, Inc. and Fifth Third Bancorp. He was elected a Director of the Corporation in 1992.\nJoseph L. Braker - Began his employment with the Partnership in 1968. He held several positions within the Grain area and in 1988, he was named Group Vice President Grain. In 1990, he was named Vice President and General Manager Ag Products Group and in February 1994 he was named Vice President and General Manager Agriculture Group. He served as a General Partner of The Andersons from 1985 to 1987.\nDale W. Fallat - Began his employment with The Andersons in 1967 and in 1988 was named Senior Vice President Law and Corporate Affairs. He assumed his present position in 1990. He served as a General Partner of The Andersons from 1983 through 1987 and a member of its Managing Committee in 1986 and 1987. He has served as a Director of the Corporation since its inception in 1987.\nRichard R. George - Began his employment with the Partnership in 1976 and has served as Controller since 1979.\nPaul M. Kraus - General partner in the law firm of Marshall & Melhorn. He has been a Director of the Corporation since 1988.\nPeter A. Machin - Began his employment with The Andersons in the Lawn Products Group in 1987 as Sales Manager of Professional Products. In 1988 he was promoted to Sales and Marketing Manager and assumed his present position in 1990.\nBeverly J. McBride - Began her employment with The Andersons in 1976. She has served as Assistant General Counsel, Senior Counsel and since 1987 as General Counsel and Corporate Secretary.\nRene C. McPherson - He has been a Director of the Corporation since 1988 and currently serves as a director of BancOne Corporation, Dow Jones & Company, Inc., Mercantile Stores Company, Inc., Milliken & Company, and Westinghouse Electric Corporation.\nDonald M. Mennel - Retired Chairman of the Board and Chief Executive Officer of The Mennel Milling Company. He began a private law practice in 1986. Elected as a Director in 1990.\nLarry D. Rigel - Began his employment with the Partnership in 1966. From 1987 to February 1994 was in charge of the Partnership's Retail operations and currently serves as Vice President Marketing for the Company.\nJanet M. Schoen - A former school teacher, she is currently a full-time homemaker. She was elected a Director of the Corporation in 1990.\nGary L. Smith - Began his employment with the Partnership in 1980 and has served as Treasurer since 1985.\nDonald E., Richard P. and Thomas H. Anderson are brothers; Paul M. Kraus is a brother-in-law. Christopher J. and Daniel T. Anderson are sons of Richard P. Anderson and Janet M. Schoen is a daughter of Thomas H. Anderson. Michael J. and Richard M. Anderson are nephews of the three brothers.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Corporation provides all management services to the Partnership pursuant to a Management Agreement entered into between the Partnership and the Corporation as further described under \"Item 13. Certain Relationships and Related Transactions - Management Agreement.\" The fee paid to the Corporation includes an amount equal to the salaries and cost of all employee benefits, and other normal employee costs, paid or accrued on behalf of the Corporation's employees who are engaged in furnishing services to the Partnership. The following table sets forth the compensation paid by the Corporation to the Chief Executive Officer and the four highest paid executive officers.\nSummary Compensation Table Annual Compensation All Other Name and Position Year Salary Bonus Compensation (a) Richard P. Anderson 1994 $335,000 $202,500 $4,620 President and Chief 1993 308,333 150,000 4,497 Executive Officer 1992 286,666 60,000 4,300\nThomas H. Anderson 1994 226,667 125,000 4,620 Chairman of the Board 1993 206,669 90,000 4,497 1992 190,004 35,000 4,364\nJoseph L. Braker 1994 224,071 150,000 4,620 Vice President and General 1993 194,634 70,000 4,497 Manager Agriculture Group 1992 181,408 30,000 4,364\nMichael J. Anderson 1994 200,765 100,000 4,620 Vice President and General 1993 161,962 100,000 4,497 Manager Retail Group 1992 146,978 30,000 4,364\nLarry Rigel 1994 171,981 25,000 4,620 Vice President Marketing 1993 162,558 15,000 4,497 1992 151,924 30,000 4,364\n(a) Corporation's matching contributions to its 401(k) retirement plan.\nPension Plan\nThe Corporation has a Defined Benefit Pension Plan (the \"Pension Plan\") which covers substantially all permanent and regular part-time employees. The amounts listed in the table below are payable annually upon retirement at age 65 or older. A discount of six percent per year is applied for retirement before age 65. The pension benefits are based on a single-life annuity and have been reduced for Social Security covered compensation. The compensation covered by the Pension Plan is equal to the employees' base pay, which in the Summary Compensation Table is the executive's salary, but beginning in 1989, was limited by the Internal Revenue Code to $200,000, adjusted for inflation, and beginning in 1994 is limited to $150,000, which will also be adjusted for inflation in future years. Each of the named executives has seven years of credited service.\nAverage Approximate Annual Retirement Benefit Based Five-Year Upon the Indicated Years of Service Compensation 5 Years 10 Years 15 Years 25 Years $ 50,000 $ 3,142 $ 6,284 $ 9,427 $ 15,711 100,000 6,892 13,784 20,677 34,461 150,000 10,642 21,284 31,927 53,211 200,000 14,392 28,784 43,177 71,961 250,000 18,142 36,284 54,427 90,711\nDirectors' Fees\nDirectors who are not employees of the Corporation and who are not members of the Anderson family receive an annual retainer of $15,000. Directors who are not employees of the Corporation receive a fee of $1,000 for each Board Meeting attended. There are three committees of the Board of Directors: the Audit Committee; the Nominating and Advisory Committee; and the Compensation Committee. The chairman of these committees receives a retainer of $3,000 provided they are not an employee of the Corporation, and members of the committees who are not employees of the Corporation receive $750 for each meeting attended.\nCompensation Committee Interlocks and Insider Participation\nThe Compensation Committee includes the following executive officers and directors: Michael J. Anderson, Richard M. Anderson, Richard P. Anderson (ex officio), Thomas H. Anderson (ex officio), Dale W. Fallat, Joseph L. Braker, Beverly J. McBride, Rene C. McPherson (chairman), and Janet M. Schoen. In addition, Charles E. Gallagher, Director of Personnel, is an ex officio member of the committee.\nCertain Transactions - Alshire-Columbus:\nThe Partnership and certain of the directors and executive officers of the Corporation were limited partners in Alshire-Columbus Limited Partnership (\"Alshire-Columbus\"), an Ohio limited partnership, which owned the Partnership's Brice General Store in Columbus, Ohio. The store was leased to the Partnership by Alshire-Columbus at an annual base rental of $732,000.\nThe Partnership contributed the land, at its cost ($1,367,000), for its original limited partner interest. The other limited partners of Alshire- Columbus contributed $1,450,000, representing 35 limited partnership units. None of the directors and executive officers of the Corporation or their family members owned more than one limited partnership unit, except for Richard P. Anderson, who owned two units.\nIn the aggregate, 8 3\/4 units were owned by directors and executive officers of the Corporation, and their family members owned an additional four units. The general partner of Alshire-Columbus experienced difficulties in refinancing the real property after the original seven year term of their note. During 1994, The Andersons obtained an independent appraisal of the property valued at $8.5 million and made an offer to purchase the property for that price. The initial lease term was scheduled to expire in 2000. The limited partners of Alshire-Columbus accepted the purchase offer from The Andersons. According to the partnership agreement, upon the sale of the real estate The Andersons received a preferential distribution from the proceeds of the sale equal to the original cost of the land contributed by The Andersons. The remaining proceeds from the sale, after payment of the debt and return of capital to limited partners, was distributed according to the partnership agreement which was 75% to the limited partners; 24% to The Andersons, as original limited partner; and 1% to the general partner. Each limited partner received approximately $33,400 per unit held from the proceeds of the sale.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) No Limited Partner beneficially owns as much as 5% of the Partnership's total capital. As of March 1, 1995, the descendants of Harold and Margaret Anderson, founders of the Partnership, beneficially held Partnership capital in the aggregate amount of $45,849,956, constituting 72% of the Partnership's total capital of $64,029,765 as of that date. All capital amounts as of March 1, 1995 are before the allocation of Partnership income for 1995. The Anderson family members also own a total of 80% of the Class A (non-voting) Shares and 78% of the outstanding Class B (voting) Shares of the Corporation.\n(c) The Partnership knows of no arrangements 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\nManagement Agreement\nThe Corporation provides all personnel and management services to the Partnership pursuant to a Management Agreement. The fee paid to the Corporation for its services is an amount equal to (a) the salaries and cost of all employee benefits, and other normal employee costs, paid or accrued on behalf of the Corporation's employees who furnish services to the Partnership, (b) reimbursable expenses incurred by the Corporation in connection with its services to the Partnership, or on the Partnership's behalf, and (c) an amount equal to $5,000 for each 1% of return on partners' capital up to a 15% annual return on partners' capital, plus $7,500 for each 1% of return on partners' capital between 15% and 25%, plus $10,000 for each 1% of return on partners' capital greater than a 25% annual return to cover that part of the Corporation's general overhead which is attributable to Partnership services and to provide an element of profit to the Corporation. The management fee incurred by the Partnership in 1994 totaled $70,394,855. See Note 2 to the Partnership's Consolidated Financial Statements. Management believes that the amount of the management fee paid to the Corporation is as favorable to the Partnership as it would be if paid to an unaffiliated third party providing similar management services. In this connection, approximately 85% of the limited partners in the Partnership are also shareholders in the Corporation and no one may own shares in the Corporation unless they are a limited partner in the Partnership. In addition to the fee payable to the Corporation, the Management Agreement also provides for certain other customary terms and conditions, including termination rights, and requires the Corporation to make its books and records available to the Partnership for inspection at reasonable times.\nSublease Arrangement\nThe office building utilized by the Partnership is leased by the Corporation from an unaffiliated lessor under a net lease expiring in 2000. The Partnership subleases approximately 90% of the building from the Corporation and pays the Corporation rent for the space it occupies. Under the terms of the sublease, the Partnership also is responsible for insurance, utilities, taxes, general maintenance, snow removal, lawn care and similar upkeep expenses for the entire building. The Corporation reimburses the Partnership for management and maintenance of the building, including the space it does not occupy. The amount paid by the Partnership to the Corporation for the portion of the building occupied by the Partnership is designed to reimburse the Corporation for its equivalent cost under the Corporation's lease. In 1994, the rental payments made by the Partnership to the Corporation, net of the reimbursement for management and maintenance of the building was $635,714, which is included in the total management fee referred to under \"Management Agreement\" above. See Note 2 to the Partnership's Consolidated Financial Statements.\nAlshire-Columbus\nSee \"Item 11. Executive Compensation - Compensation Committee Interlocks and Insider Participation - Certain Transactions - Alshire- Columbus.\"\nPART IV\nItem 14.","section_14":"Item 14. Financial Statement Schedules and Reports on Form 8-K\n(a) (1) The following consolidated financial statements of the registrant are included in Item 8:\nPage Report of Independent Auditors.............................. 14 Consolidated Statements of Income - years ended December 31, 1994, 1993 and 1992.......................... 15 Consolidated Balance Sheets - December 31, 1994 and 1993.... 16 Consolidated Statements of Cash Flows - years ended December 31, 1994, 1993 and 1992.......................... 17 Consolidated Statements of Changes in Partners' Capital - years ended December 31, 1994, 1993 and 1992............ 18 Notes to Consolidated Financial Statements.................. 19\n(2) The following consolidated financial statement schedule is included in Item 14(d):\nII. Consolidated Valuation and Qualifying Accounts - years ended December 31, 1994, 1993 and 1992.................... 34\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(3) Exhibits:\n3(a) Certificate of Limited Partnership filed by the Partnership on January 9, 1995 with the Secretary of the State of Ohio.\n3(b) The Andersons Partnership Agreement, dated as of January 1, 1994. (Incorporated by reference to the Partnership's Form 10-K dated December 31, 1993.)\n4(a) Form of Indenture dated as of October 1, 1985, between the Registrant and Ohio Citizens Bank, as Trustee. (Incorporated by reference to Exhibit 4(a) in Registration Statement No. 33-819.)\n4(b)(i) The Thirteenth Supplemental Indenture dated as of January 1, 1994, between The Andersons and Fifth Third Bank of Northwestern Ohio, N.A., successor Trustee to an Indenture between The Andersons and Ohio Citizens Bank, dated as of October 1, 1985. (Incorporated by reference to the Partnership's Form 10-K dated December 31, 1993.)\n10(a) Management Performance Program.* (Incorporated by reference to Exhibit 10(a) to the Partnership's Form 10-K dated December 31, 1990.)\n10(f) Management Agreement between The Andersons and The Andersons Management Corp., effective as of January 1, 1988. (Incorporated by reference to Exhibit 10(f) in Registration Statement No. 33-13538.)\n10(h) Business Property Sublease effective January 1, 1993, between The Andersons Management Corp. and The Andersons. (Incorporated by Reference to Exhibit 10(h) in Registration Statement 33-42680.)\n22 Subsidiaries of The Andersons. (Incorporated by Reference to the Partnership's Form 10-K dated December 31, 1993.)\n23 Consent of Independent Auditors\n28 Anderson Foundation Declaration of Trust, as amended. (Incorporated by reference to Exhibit 28 to Registrants Form 10-K dated December 31, 1992.)\n* Management contract or compensatory plan.\nThe Partnership agrees to furnish to the Securities and Exchange Commission a copy of any long-term debt instrument or loan agreement that it may request.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed during the last quarter of the year.\n(c) Exhibits:\nThe exhibits listed in Item 14(a)(3) of this report, and not incorporated by reference, follow \"Financial Statement Schedules\" referred to in (d) below.\n(d) Financial Statement Schedules:\nThe financial statement schedules listed in 14(a)(2) follow \"Signatures\".\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 Maumee, Ohio, on the 23rd day of March, 1995.\nTHE ANDERSONS (Registrant)\nBy The Andersons Management Corp. (General Partner)\nBy \/s\/Richard P. Anderson Richard P. Anderson 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 as Directors of the General Partner and on behalf of the Registrant on the 23rd day of March, 1995.\nSignature Title* Signature Title*\n\/s\/Richard P. Anderson Director Director Richard P. Anderson John F. Barrett\n\/s\/Daniel T. Anderson Director \/s\/Dale W. Fallat Director Daniel T. Anderson Dale W. Fallat\nDirector Director Donald E. Anderson Paul M. Kraus\n\/s\/Michael J. Anderson Director Director Michael J. Anderson Rene C. McPherson\n\/s\/Richard M. Anderson Director \/s\/Donald M. Mennel Director Richard M. Anderson Donald M. Mennel\n\/s\/Thomas H. Anderson Director Director Thomas H. Anderson Janet M. Schoen\n*Titles with The Andersons Management Corp.\nNo proxy statement of the Partnership is furnished to Limited Partners. Audited financial statements will be distributed to Limited Partners at a later date.\nEXHIBIT INDEX THE ANDERSONS\nExhibit Number\n3(a) Certificate of Limited Partnership filed by the Partnership January 9, 1995 with the Secretary of the State of Ohio.\n23 Consent of Independent Auditors","section_15":""}
{"filename":"815743_1994.txt","cik":"815743","year":"1994","section_1":"Item 1. Business.\nSears DC Corp. (\"SDC\"), a wholly-owned subsidiary of Sears, Roebuck and Co. (\"Sears\") organized under the laws of Delaware in January 1987, was formed to borrow in domestic and foreign debt markets and lend the proceeds of such borrowings to direct and indirect subsidiaries of Sears (\"SDC borrowers\") in exchange for unsecured notes. SDC raised funds through the sale of its medium-term notes and direct placement of commercial paper with corporate and institutional investors. Commercial paper was sold by Sears Roebuck Acceptance Corp., an affiliate of SDC, as agent, with expenses, but no fees, being paid by SDC.\nHistorically, the proceeds of SDC's borrowings were loaned to Sears Consumer Financial Corporation of Delaware (\"SCFCD\"), a wholly-owned subsidiary of Dean Witter, Discover & Co. (\"DWDC\"), to finance the accounts receivable generated by the Discover Card and consumer installment notes receivable. However, as a result of the strategic repositioning of Sears in 1993, the business of SDC changed significantly. In the last quarter of 1992, SDC stopped selling medium-term notes. On March 1, 1993, DWDC, until then a wholly-owned subsidiary of Sears, completed the sale of 19.9% of its outstanding capital stock through a primary initial public offering. Also in March 1993, SDC discontinued issuing commercial paper, and was repaid by SCFCD the amounts outstanding and owing to SDC. In June of 1993, Sears spun-off its 80.1% ownership interest in DWDC to Sears shareholders.\nOn March 9, 1993, SDC entered into a loan agreement with Sears for the investment of funds received upon the prepayment of the notes of SCFCD. The interest rate paid to SDC by Sears under this agreement is designed to produce earnings sufficient to cover SDC's fixed charges (principally interest on SDC's indebtedness) at least 1.005 times (reduced from the previous amount of 1.25 times in March 1994, since SDC is no longer actively involved in new financing). Required payments of principal and interest to SDC under the Sears borrowing agreement will be sufficient to allow SDC to make timely payments of principal and interest to the holders of its securities.\nThe Net Worth Maintenance Agreement between Sears and SDC is still in effect for the benefit of holders of debt securities issued by SDC. This agreement provides for Sears to maintain ownership of and positive stockholder's equity in SDC.\nAt February 28, 1995, SDC had no employees on its payroll and its officers and directors consisted of employees of affiliated companies. Its offices are located at 3711 Kennett Pike, Greenville, Delaware 19807.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nNone.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nNone.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\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 SDC's common stock. As of February 28, 1995, Sears owned all outstanding shares of SDC's common stock. The Board of Directors of SDC declared a $167.4 million dividend on December 20, 1993 to Sears, payable on December 30, 1993. The Board also approved payment to Sears on December 30, 1993 of $319.1 million out of Capital in Excess of Par Value; such payment is characterized as a dividend under the Delaware General Corporation Law. Payment was effected by reducing SDC's investment in the notes of Sears by $486.5 million.\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.\nFinancial Condition\nOn March 15, 1993, SDC received funds from DWDC's initial public offering, and a concurrent debt issuance, through SCFCD in amounts sufficient to repay the balances on the notes of SCFCD. SDC used these funds to repay short-term borrowings and current maturities of medium-term notes. SDC invested the remainder of these funds in the promissory notes of Sears, which pay interest sufficient to cover SDC's fixed charges 1.005 times, and in highly liquid short-term investments. As of December 31, 1994, the remaining proceeds of $1.6 billion were fully invested in the notes of Sears. SDC intends to use these funds to repay the maturities of its medium-term notes.\nIn March 1993, SDC discontinued issuing commercial paper. The last of SDC's commercial paper matured in October 1993. SDC had discontinued the sale of medium-term notes in the last quarter of 1992. The $1.5 billion in outstanding medium-term notes as of December 31, 1994 are not redeemable prior to their stated maturity except for notes having a stated maturity at the time of issue of more than seven years which may be redeemed under certain circumstances in the event of declining Discover Card receivables.\nThe financial information appearing in this annual report on Form 10-K is presented in historical dollars which do not reflect the decline in purchasing power that results from inflation. As is the case for most financial companies, substantially all of SDC's assets and liabilities are monetary in nature. Interest rates on SDC's investment in Sears notes are set to provide for a ratio of earnings to fixed charges of at least 1.005. This maintenance mechanism insulates SDC from bearing the effects of inflation-based interest rate increases.\nResults of Operations\nDue to the significant reduction in SDC's outstanding debt, interest and related expenses decreased 28.0% to $137.3 million in 1994 from $190.6 million in 1993. The Company's net income decreased significantly in 1994 from 1993 due to the reduction in the interest rate on Sears notes to produce earnings sufficient to cover SDC's fixed charges (principally interest on SDC's indebtedness) to at least 1.005 times from the 1993 amount of 1.25 times. Earnings covered fixed charges 1.005 times in 1994 and 1.32 times in 1993.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSEARS DC CORP.\nSTATEMENTS OF INCOME Year Ended December 31, millions 1994 1993 1992 ------- ------- ------- Revenues Earnings on notes of Sears $138.3 $196.9 $ - Earnings on notes of SCFCD - 52.6 289.4 Earnings on invested cash - 2.7 8.8 ------- ------- ------- Total revenues 138.3 252.2 298.2\nExpenses Interest and related expense 137.3 190.6 236.6 Operating expenses 0.3 1.5 1.9 ------- ------- ------- Total expenses 137.6 192.1 238.5 ------- ------- ------- Income before income taxes 0.7 60.1 59.7 Income taxes 0.2 21.0 20.3 ------- ------- ------- Net Income $ 0.5 $39.1 $39.4 ======= ======= =======\nRatio of earnings to fixed charges 1.005 1.32 1.25\nSee notes to financial statements.\nSEARS DC CORP.\nSTATEMENTS OF FINANCIAL POSITION\nDecember 31, millions 1994 1993 ------- ------- Assets Notes of Sears $1,552.6 $2,194.4 Cash and invested cash 0.1 0.1 Accrued interest and other assets 3.6 5.6 -------- -------- Total assets $1,556.3 $2,200.1 ======== ========\nLiabilities Medium-term notes $1,521.4 $2,147.8 Accrued interest and other liabilities 30.6 48.5 -------- -------- Total liabilities 1,552.0 2,196.3 -------- -------- Stockholder's Equity Capital stock, par value $1.00 per share 1,000 shares authorized,issued and outstanding - - Retained income 4.3 3.8 -------- -------- Total stockholder's equity 4.3 3.8 -------- -------- Total liabilities and stockholder's equity $1,556.3 $2,200.1 ======== ========\nSee notes to financial statements.\nSEARS DC CORP.\nSTATEMENTS OF SHAREHOLDER'S EQUITY Year Ended December 31, millions 1994 1993 1992 -------- -------- -------- Capital stock $ - $ - $ - -------- -------- --------\nCapital in excess of par value Beginning of year - 319.1 319.1 Return of capital paid to Sears - (319.1) - -------- -------- -------- End of year - - 319.1 -------- -------- --------\nRetained income Beginning of year 3.8 132.1 92.7 Net income 0.5 39.1 39.4 Dividend paid to Sears - (167.4) - -------- -------- -------- End of year 4.3 3.8 132.1 -------- -------- --------\nTotal shareholder's equity $ 4.3 $ 3.8 $451.2 ======== ======== ========\nSee notes to financial statements.\nSTATEMENTS OF CASH FLOWS Year Ended December 31, millions 1994 1993 1992 ------- ------- ------- Cash Flows From Operating Activities Net income $ 0.5 $ 39.1 $ 39.4 Adjustments to reconcile net income to net cash provided by (used in) operating activities Net change in accrued interest and other assets and accrued interest and other liabilities (15.9) 31.7 (0.7) ------- ------- ------- Net cash provided by (used in) operating activities (15.4) 70.8 38.7\nCash Flows From Investing Activities Decrease(increase) in notes of SCFCD - 4,622.4 (914.9) Decrease(increase) in notes of Sears 641.8 (2,680.9) - -------- -------- --------- Net cash provided by (used in) investing activities 641.8 1,941.5 (914.9)\nCash Flows From Financing Activities Decrease in commercial paper, primarily 90 days or less - (1,840.0) (225.5) Proceeds from medium-term notes - - 1,501.0 Repayments of medium-term notes (626.4) (257.6) (405.4) --------- --------- -------- Net cash provided by (used in) financing activities (626.4) (2,097.6) 870.1 --------- --------- --------\nNet decrease in cash and invested cash - (85.3) (6.1) Cash and invested cash, beginning of year 0.1 85.4 91.5 --------- --------- --------- Cash and invested cash, end of year $ 0.1 $ 0.1 $ 85.4 --------- --------- ---------\nSupplemental Disclosure of Cash Flow Information Cash paid during the year Interest $141.9 $181.7 $230.5 Income taxes 11.8 32.1 13.1\nSee notes to financial statements.\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nSears DC Corp. (\"SDC\"), a wholly-owned subsidiary of Sears, Roebuck and Co. (\"Sears\"), was principally engaged in the borrowing in domestic and foreign debt markets and lending the proceeds of such borrowings to certain direct and indirect subsidiaries of Sears in exchange for their unsecured notes. Effective May 26, 1993, the company's name was changed to Sears DC Corp. from Discover Credit Corp.\nHistorically, the proceeds of SDC's borrowings were loaned to Sears Consumer Financial Corporation of Delaware (\"SCFCD\"), a wholly-owned subsidiary of Dean Witter, Discover & Co. (\"DWDC\"), to finance the accounts receivable generated by the Discover Card and consumer installment notes receivable. However, as a result of the strategic repositioning of Sears, the business of SDC changed significantly. In the last quarter of 1992, SDC stopped selling medium-term notes. On March 1, 1993, DWDC, until then a wholly-owned subsidiary of Sears, completed the sale of 19.9% of its outstanding capital stock through a primary initial public offering. Sears spun-off its 80.1% ownership interest in DWDC to Sears shareholders in June 1993. Also in March 1993, SDC discontinued issuing commercial paper, and was repaid by SCFCD the amounts outstanding and owing to SDC.\nOn March 9, 1993, SDC entered into a loan agreement with Sears for the investment of funds received upon the prepayment of the notes of SCFCD. The interest rate paid to SDC by Sears under this agreement was designed to produce earnings sufficient to cover SDC's fixed charges (principally interest on SDC's indebtedness) at least 1.25 times. On March 22, 1994, the agreement was amended to reduce the fixed charge coverage to 1.005. Required payments of principal and interest to SDC under the Sears borrowing agreement will be sufficient to allow SDC to make timely payments of principal and interest to the holders of its securities.\nCash and invested cash is defined to include all highly liquid investments with maturities of three months or less. The return of capital and dividend totalling $486.5 million paid to Sears in 1993 were effected through a non-cash transaction as a reduction in SDC's investment in Sears Notes.\nThe results of operations of SDC are included in the consolidated federal income tax return of Sears. Tax liabilities and benefits are allocated as generated by SDC, whether or not such benefits would be currently available on a separate return basis. Taxes are provided based on the statutory federal income tax rate.\n2. BORROWINGS\nThe medium-term notes are not redeemable except for notes having a stated maturity at the time of issue of more than seven years which may be redeemed under certain circumstances in the event of declining Discover Card receivables. The fair market value of medium-term notes approximated $1,533.8 million and $2,297.5 million at December 31, 1994 and 1993, respectively, based on discounted cash flows using interest rates of comparable borrowings. Selected details of SDC's borrowings are shown below. Weighted average interest rates are based on the actual number of days in the year and borrowings net of unamortized discount. December 31, millions 1994 1993 -------- -------- 3.24% to 9.26% medium-term notes due 1994-2012 $1,521.4 $2,147.8 ======== ========\n-------------------- Maximum millions Average (month-end) -------------------- Commercial paper outstanding $ 546.8 $1,781.8\nAverage Year-end -------------------- Weighted Interest Rates 4.02% -\nAt December 31, 1994, medium-term note maturities for the next five years were as follows:\n1995 $292.7 1996 449.8 1997 335.1 1998 111.3 1999 119.5\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 applicable.\nItem 11.","section_11":"Item 11. Executive Compensation.\nNot applicable.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nNot applicable.\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 a part of this report:\n1. An \"Index to Financial Statements\" has been filed as a part of this report on page S-1 hereof.\n2. No financial statement schedules are included herein because they are not required or because the information is contained in the financial statements and notes thereto, as noted in the \"Index to Financial Statements\" filed as part of this report.\n3. An \"Exhibit Index\" has been filed as part of this report beginning on page E-1 hereof.\n(b) Reports on Form 8-K: There were no reports on Form 8-K filed by the Registrant during the 4th 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.\nSEARS DC CORP. (Registrant)\nBy Paul D. Melancon* Vice President and Controller\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.\nSignature Title Date\nAlice M. Peterson* Director, President and ) Chief Executive Officer ) (Principal Executive ) Officer) ) ) ) Paul D. Melancon* Vice President and Controller )March 28, 1995 (Principal Accounting ) Officer) ) ) ) Larry R. Raymond* Vice President and Treasurer ) (Principal Financial Officer)) ) James A. Blanda* Director ) ) ) James D. Constantine* Director ) )\n*By \/s\/ PAUL D. MELANCON Individually and as Attorney-in-Fact Paul D. Melancon\nSEARS DC CORP.\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nPAGE\nSTATEMENTS OF INCOME 4\nSTATEMENTS OF FINANCIAL POSITION 5\nSTATEMENTS OF STOCKHOLDER'S EQUITY 6\nSTATEMENTS OF CASH FLOWS 7\nNOTES TO FINANCIAL STATEMENTS 8-9\nREPORT OF INDEPENDENT CERTIFIED S-2 PUBLIC ACCOUNTANTS\nS-1\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Stockholder and Board of Directors Greenville, DE\nWe have audited the accompanying Statements of Financial Position of Sears DC Corp. (formerly Discover Credit Corp.) (a wholly-owned subsidiary of Sears, Roebuck and Co.) as of December 31, 1994 and 1993, and the related Statements of Income, Stockholder's 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 financial statements present fairly, in all material respects, the financial position of Sears DC Corp. 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.\nDeliotte & Touche LLP Chicago, Illinois February 24, 1995\nS-2\nEXHIBIT INDEX\n3(a) Certificate of Incorporation of Discover Credit Corp. dated January 9, 1987 [Incorporated by reference to Exhibit 3(a) to Form 10 of the Registrant (Form 10)*]\n3(b) Amendment to Certificate of Incorporation of Discover Credit Corp. dated April 9, 1987 [Incorporated by reference to Exhibit 3(b) to Form 10*]\n3(c) By-laws of Discover Credit Corp., as amended to May 22, 1992 [Incorporated by reference to Exhibit 3(c) to Annual Report on Form 10-K of the Registrant for the year ended December 31, 1992*]\n4(a) Net Worth Maintenance Agreement between Discover Credit Corp. and Sears, Roebuck and Co., dated as of November 13, 1987 [Incorporated by reference to Exhibit 4 to Form 10*]\n4(b) $1,850,000,000 Credit Agreement dated as of June 23, 1992, among Discover Credit Corp., the Banks Listed therein, The Lead Managers Referred to therein, The Co-Agents Referred to therein, and Chemical Bank, as Agent [Incorporated by reference to Exhibit 4(b) to Quarterly Report of the Registrant on Form 10-Q for the quarter ended June 30, 1992*]\n4(c) Forms of fixed rate Medium-Term Note and floating rate Medium-Term Note [Incorporated by reference to Exhibits 4.1 and 4.2 to Current Report on Form 8-K of the Registrant dated February 9, 1990*]\n4(d) Indenture, dated as of June 1, 1991 between Discover Credit Corp. and Bank of Delaware as Trustee [Incorporated by reference to Exhibit 4 to Registration Statement No. 33-40056]\n4(e) Forms of fixed rate Medium-Term Note Series II and floating rate Medium- Term Note Series II [Incorporated by reference to Exhibits 4.2 and 4.3 to Current Report on Form 8-K of the Registrant dated June 20, 1991*]\n4(f) Indenture, dated as of February 15, 1992, between Discover Credit Corp. and Harris Trust Company of New York [Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K of the Registrant dated February 28, 1992*]\n4(g) Forms of fixed rate Medium Term Note Series III and floating rate Medium Term Note Series III [Incorporated by reference to Exhibits 4.2 and 4.3 to Current Report on Form 8-K of the Registrant dated February 28, 1992*]\n4(h) The Registrant hereby agrees to furnish the Commission, upon request, with each instrument defining the rights of holders of long-term debt of the Registrant with respect to which the total amount of securities authorized does not exceed 10% of the total assets of the Registrant.\n_________________________________________ * SEC File No. 0-17955\nE-1\n10(a) Letter Agreement dated March 9, 1993 between Sears, Roebuck and Co. and Discover Credit Corp. [Incorporated by reference to Exhibit 10(g) to Annual Report on Form 10-K of the Registrant for the year ended December 31, 1992*]\n10(b) Amendment dated March 22, 1994 to letter Agreement dated March 9, 1993 between Sears, Roebuck and Co. and Discover Credit Corp.**\n12 Calculation of ratio of earnings to fixed charges**\n23 Consent of Deloitte & Touche LLP**\n24 Power of attorney**\n28(a) Current Report on Form 8-K of Sears, Roebuck and Co., for January 17, 1995 [Incorporated by reference, File No. 1-416]\n28(b) Current Report on Form 8-K of Sears, Roebuck and Co., for February 7, 1995 [Incorporated by reference, File No. 1-416]\n28(c) Annual Report on Form 10-K of Sears, Roebuck and Co. for the year ended December 31, 1994 [Incorporated by reference, File No. 1-416]\n______________________________ * SEC File No. 0-17955 ** Filed herewith\nExhibit 12\nSEARS DC CORP. CALCULATION OF RATIO OF EARNINGS TO FIXED CHARGES\nmillions\nYear Ended December 31 1994 1993 1992 NET INCOME $ 0.5 $ 39.1 $ 39.4 INCOME TAXES 0.2 21.0 20.3\nFIXED CHARGES, INTEREST AND RELATED CHARGES 137.3 190.6 236.6\n(i) EARNINGS AVAILABLE FOR FIXED CHARGES 138.1 250.7 296.3 (ii) FIXED CHARGES 137.3 190.6 236.6\nRATIO OF EARNINGS TO FIXED CHARGES (i\/ii) 1.005 1.32 1.25\nExhibit 23\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nWe consent to the incorporation by reference in Registration Statement No. 33-44671 of Sears DC Corp. (formerly Discover Credit Corp.) of our report dated February 24, 1995 appearing in this Annual Report on Form 10-K of Sears DC Corp. for the year ended December 31, 1994.\nDeloitte & Touche LLP Chicago, Illinois March 28, 1995\nExhibit 24\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each of the undersigned, being a director or officer, or both, of SEARS DC CORP., a Delaware corporation (the \"Corporation\"), does hereby constitute and appoint JAMES A. BLANDA, ALICE M. PETERSON, LARRY R. RAYMOND, PAUL D. MELANCON, RICHARD F. KOTZ and KEITH E. TROST, with full power to each of them to act alone as the true and lawful attorneys and agents of the undersigned, with full power of substitution and resubstitution to each of said attorneys, to execute, file and deliver any and all instruments and to do any and all acts and things which said attorneys and agents, or any of them, deem advisable to enable the Corporation to comply with the Securities Exchange Act of 1934, as amended, and any requirements of the Securities and Exchange Commission in respect thereto, relating to annual reports on Form 10-K, including specifically, but without limitation of the general authority hereby granted, the power and authority to sign his name in the name and on behalf of the Corporation or as a director or officer, or both, of the Corporation, as indicated below opposite his signature, to annual reports on Form 10-K or any amendment or papers supplemental thereto; and each of the undersigned does hereby fully ratify and confirm all that said attorneys and agents, or any of them, or the substitute of any of them, shall do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, each of the undersigned has subscribed these presents, as of this 28th day of March, 1995.\nNAME TITLE\n\/S\/ ALICE M. PETERSON Director, President and Alice M. Peterson Chief Executive Officer (Principal Executive Officer)\n\/S\/ LARRY R. RAYMOND Vice President and Treasurer Larry R. Raymond (Principal Financial Officer)\n\/S\/ PAUL D. MELANCON Vice President and Controller Paul D. Melancon (Principal Accounting Officer)\n\/S\/ JAMES A. BLANDA Director James A. Blanda\n\/S\/ JAMES D. CONSTANTINE Director James D. Constantine","section_15":""}
{"filename":"357294_1994.txt","cik":"357294","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nDuring fiscal 1989, the Company became aware that certain fire-retardant plywood commonly used in the roof construction of multi-family homes may contain a product defect causing accelerated deterioration of the plywood. The Company has determined that such plywood was used in 33 of its communities containing approximately 11,750 homes.\nCommon areas, including roofs, in each of the Company's multi-family condominium developments are governed and controlled by homeowners' associations for each development, rather than by individual homeowners. Certain of the 33 homeowners' associations in the affected developments have asserted claims against the Company. As of February 28, 1993, the Company had entered separate agreements with 31 of the 33 associations (the \"Settling Associations\"), covering 10,850 homes.\nIn August 1989 the Company brought suit in an action entitled K. Hovnanian at Bernards I, Inc., et al. v. Hoover Treated Wood Products, Inc., et al. (No. L-11822-89) against the plywood material manufacturers, treaters, suppliers and others (the \"Defendants\") to determine the proper responsibility for damages, to protect its interests and to recover its damages.\nIn November 1992 the Company and the Settling Associations entered into a settlement agreement with most of the Defendants. Based upon the settlement monies received, the use of the Settling Associations' roof shingle reserves, and the actual expenditures in performing the repairs, the Company believes the repair costs will not require it to set aside future reserves for such roof repairs.\nThe Company is continuing to litigate with the two non-settling associations which contain 900 homes. Because the litigation is in its early discovery stages, the Company is unable to predict at this time the ultimate outcome of the litigation. However, due to the small size of this remaining litigation, the Company does not believe an adverse decision will have a material effect on the Company.\nIn addition, the Company is involved from time to time in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on the Company.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of the year ended February 28, 1994, no matters were submitted to a vote of security holders. PART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS\nThe number of shares and all data presented on a per share basis in this Form 10-K have been adjusted to give effect to all stock splits. The Company's Class A Common Stock is traded on the American Stock Exchange and was held by approximately 1,200 shareholders of record at May 13, 1994. Prior to the Company's recapitalization in September 1992 the Company's Common Stock was also traded on the American Stock Exchange. (See \"Notes to Consolidated Financial Statements - Note 12\" for additional explanation on recapitalization.) The high and low sales prices were as follows for each fiscal quarter during the years ended February 28, 1994 and 1993:\nClass A Common Stock ---------------------------------- Common Stock Fiscal 1994 Fiscal 1993 Fiscal 1993 -------------- ---------------- --------------- Quarter High Low High Low High Low - - ------- ---- --- ---- --- ---- --- First........... $12.38 $10.50 -- -- $14.25 $ 9.25 Second.......... $14.13 $10.63 -- -- $12.38 $ 8.13 Third........... $18.13 $13.25 $11.25 $ 8.50 $10.75 $ 9.13 Fourth.......... $16.00 $13.00 $13.13 $10.63 -- --\nCertain debt instruments to which the Company is a party contain restrictions on the payment of cash dividends. As a result of the most restricted of these provisions, approximately $33,432,000 was free of such restrictions at February 28, 1994. The Company has never paid dividends nor does it currently intend to pay dividends.\nITEM 6","section_6":"ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA\nThe following table sets forth selected financial data for the Company and its consolidated subsidiaries and should be read in conjunction with the financial statements included elsewhere in this Form 10-K. Per common share data and weighted average number of common shares outstanding reflect all stock splits. Fiscal Year Ended Summary Consolidated February February February February February Income Statement Data 28, 1994 28, 1993 29, 1992 28, 1991 28, 1990 - - --------------------- -------- -------- -------- -------- -------- (In Thousands Except Per Share Data)\nRevenues................ $587,010 $429,315 $318,527 $275,428 $410,409 Costs and expenses..... 557,859 414,790 316,633 296,610 371,193 Income (loss) before income taxes, extraordinary loss and cumulative effect of change in accounting for income taxes..... 29,151 14,525 1,894 (21,182) 39,216 State and Federal income taxes................. 9,229 4,735 299 (5,937) 17,428 Extraordinary loss...... (1,277) -- -- -- -- Cumulative effect of change in accounting for income taxes...... -- -- 883 -- -- -------- -------- --------- -------- ------- Net income (loss)....... $ 18,645 $ 9,790 $ 2,478 $(15,245) $21,788 ======== ======== ======== ======== ========\nEarnings per common share: Income (loss) before extraordinary loss and cumulative effect of change in accounting for income taxes....... . $ .87 $ .43 $ .07 $ (.74) $ 1.05 Extraordinary loss.... (.05) -- -- -- -- Cumulative effect of change in account- ing for income taxes -- -- .04 -- -- -------- -------- -------- -------- ------- Net income (loss).... $ .82 $ .43 $ .11 $ (.74) $ 1.05 ======== ======== ======== ======== =======\nWeighted average number of common shares outstanding........... 22,821 22,775 21,988 20,695 20,834\nSummary Consolidated February February February February February Balance Sheet Data 28, 1994 28, 1993 29, 1992 28, 1991 28, 1990 - - -------------------- -------- -------- -------- -------- -------- (In Thousands) Total assets............ $539,602 $465,029 $399,455 $437,930 $457,567 Mortgages, and notes payable............... $ 68,244 $ 66,699 $105,071 $158,836 $121,420 Bonds collateralized by mortgages receivable. $ 30,343 $ 39,914 $ 49,879 $ 55,456 $ 60,677 Participating senior subordinated debent- ures and subordinated notes................. $200,000 $152,157 $ 67,723 $ 71,559 $ 81,794 Stockholders' equity.... $171,001 $151,937 $141,989 $125,421 $140,666\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCAPITAL RESOURCES AND LIQUIDITY\nThe Company's cash uses in fiscal 1994 were for operating expenses, seasonal increases in housing inventories, construction of commercial facilities, redemption of subordinated indebtedness, income taxes and interest. The Company provided for its cash requirements from outside borrowings, including the issuance of $100,000,000 of subordinated indebtedness, the revolving credit facility and land purchase notes, as well as from housing revenues. The Company believes that these sources of cash are sufficient to finance its working capital requirements and other needs.\nThe Company's bank borrowings are made pursuant to a revolving credit agreement (the \"Agreement\") which provides a revolving credit line of up to $130,000,000 through July 1996. The Company believes that it will be able either to extend the Agreement beyond July 1996 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. The Company currently is in compliance and intends to maintain compliance with its covenants under the Agreement. As of February 28, 1994, there were no borrowings outstanding under the Agreement.\nThe aggregate principal amount of subordinated indebtedness issued by the Company and outstanding as of February 28, 1994 was $200,000,000. On June 7, 1993, the Company issued $100,000,000 9 3\/4% Subordinated Notes due 2005. There are no sinking fund payments prior to maturity. In July 1993, the Company redeemed all of its outstanding 12 1\/4% Subordinated Notes due 2005 at a price of 102% of par.\nThe Company's mortgage banking subsidiary borrows under a bank warehousing arrangement. Other finance subsidiaries formerly borrowed from a multi-builder owned financial corporation and a builder owned financial corporation to finance mortgage backed securities but in fiscal 1988 decided to cease further borrowing from multi-builder and builder owned financial corporations. These non-recourse borrowings have been generally secured by mortgage loans originated by one of the Company's subsidiaries. As of February 28, 1994, the aggregate outstanding principal amount of such borrowings was $30,755,000.\nThe book value of the Company's inventories, rental condominiums, and commercial properties completed and under development amounted to the following:\nFebruary 28, ------------------------------ 1994 1993 ------------ ------------\nResidential real estate inventory......... $278,738,000 $243,391,000 Residential rental property............... 8,411,000 3,973,000 ------------ ------------ Total residential real estate......... 287,149,000 247,364,000 Commercial properties..................... 68,240,000 58,217,000 ------------ ------------ Combined Total........................ $355,389,000 $305,581,000 ============ ============\nTotal residential real estate increased $39,785,000 at February 28, 1994 from February 28, 1993 as a result of an inventory increase of $35,347,000 and a residential rental property increase of $4,438,000. The increase in residential real estate inventory was primarily due to the Company's increase in construction activities for increased deliveries next year and expansion within its existing markets. Residential homes under construction or completed and included in residential real estate inventory at February 28, 1994 are expected to be closed during the next twelve months. The Company's residential rental property increased during fiscal 1994 due to the Company's construction of senior citizen rentals amounting to $5,862,000 less liquidation of New Hampshire rentals through deep discount sales amounting to $1,424,000. The senior rentals consist of 96 homes. By building these homes and renting to seniors the Company expects to receive federal tax credits amounting to approximately $6,000,000 over the next ten years. Most residential real estate completed or under development is financed through the Company's lines of credit.\nThe following table summarizes housing lots included in the Company's total residential real estate:\nTotal Contracted Remaining Home Not Lots Lots Closed Available ------ ---------- ---------\nFebruary 28, 1994: Owned.......................... 8,255 1,643 6,612 Optioned....................... 12,898 283 12,615 ------- ---------- --------- Total 21,153 1,926 19,227 ====== ========== =========\nFebruary 28, 1993: Owned.......................... 8,983 1,379 7,604 Optioned....................... 9,785 70 9,715 ------- ---------- --------- Total 18,768 1,449 17,319 ====== ========== =========\nThe Company's commercial properties represent long-term investments in commercial and retail facilities completed or under development (see \"Rental Program\" and \"Other Operations\" under \"Results of Operations\"). When individual facilities are completed and substantially leased, the Company will have the ability to obtain long-term financing on such properties. At February 28, 1994 the Company had long-term non-recourse financing aggregating $18,474,000 on three commercial facilities, a decrease of $98,000 from February 28, 1993, due to principal amortization.\nThe Company's mortgages and notes receivable amounted to the following:\nFebruary 28, ------------------------------- 1994 1993 ----------- ----------- Collateralized mortgages receivable...... $30,755,000 $40,355,000 Residential mortgages receivable......... 50,673,000 34,108,000 Land and lot mortgages receivable........ 2,609,000 1,343,000 Notes from the sale of subsidiaries...... 1,199,000 3,047,000 ----------- ----------- Total Mortgages and Notes Receivable... $85,236,000 $78,853,000 =========== ===========\nThe collateralized mortgages receivable are pledged against non-recourse collateralized mortgage obligations. Residential mortgages receivable amounting to $43,502,000 and $25,868,000 at February 28, 1994 and 1993, respectively, are being temporarily warehoused and awaiting sale in the secondary mortgage market. The balance of such mortgages are being held as an investment by the Company. The Company may incur risk with respect to mortgages that are delinquent but only to the extent the losses are not covered by mortgage insurance or resale value of the house. Historically, the Company has incurred minimal credit losses. Land and lot mortgages are usually short term (5 years or less) and not subject to construction loan subordination. Notes from the sale of subsidiaries are secured by the assets or stock of the subsidiaries and amortized over ten years. (See \"Notes to Consolidated Financial Statements - Note 9\" for information on the writedown of a note from the sale of a subsidiary.)\nRESULTS OF OPERATIONS\nThe Company's operations consist primarily of residential housing development and sales in its Northeast Region (comprised primarily of New Jersey and eastern Pennsylvania), in southeastern Florida, North Carolina and metro Washington D. C. (northern Virginia). In addition, the Company develops and operates commercial properties as long-term investments in New Jersey, and, to a lesser extent, Florida. During the last three fiscal years, the Company's Northeast Region, North Carolina Division and metro Washington D. C. Division have produced operating profits. These profits have been reduced by losses from its other operations and the establishment of reserves to reduce the book value of certain residential properties to their estimated net realizable value. Over this time, the Company has improved its profitability from a net income in fiscal 1992 of $2,478,000 to a net income in fiscal 1994 of $18,645,000. Also over this time, net sales contracts have increased each year from 2,756 homes, or $348,032,000 in fiscal 1992, to 4,305 homes, or $606,601,000 in fiscal 1994. The Company sees this trend continuing and currently expects higher operating profits, net income and net sales contracts during the year ending February 28, 1995.\nThe following table sets forth, for the periods indicated, certain income statement items as percentages of total revenues:\nYear Ended ------------------------------------ February February February 28, 1994 28, 1993 29, 1992 -------- -------- --------\nTotal Revenues..................... 100.0% 100.0% 100.0% -------- -------- -------- Costs and Expenses: Construction, land, interest and operations..................... 77.6 77.3 78.0 Provision to reduce inventory to estimated net realizable value........................... -- .7 -- Selling, general and administrative................. 13.0 13.3 13.9 Mortgage banking and finance operations..................... 1.8 2.1 2.7 Rental and other operations...... 2.6 3.2 4.8 -------- -------- -------- Total costs and expenses....... 95.0 96.6 99.4 -------- -------- -------- Income Before Income Taxes, Extraordinary Item and Cumulative Effect of Change in Accounting for Income Taxes. 5.0 3.4 .6 Total Taxes........................ 1.6 1.1 .1 -------- -------- -------- 3.4 2.3 .5\nExtraordinary Loss................. (.2) -- -- Cumulative Effect of Change in Accounting for Income Taxes...... -- -- .3 -------- -------- -------- Net Income.................... 3.2% 2.3% .8% ======== ======== ========\nTOTAL REVENUES\nCompared to fiscal 1993, total fiscal 1994 revenues increased $157.7 million, or 36.7%, due to a $160.2 million housing revenue increase, a $6.8 million decrease in land and lot sales, and a $4.3 million increase in other revenue sources. Compared to fiscal 1992, total fiscal 1993 revenues increased $110.8 million, or 34.8%, due to a $105.6 million housing revenue increase, a $7.7 million increase in land and lot sales, and a $2.5 million decrease in other revenue sources.\nHOUSING OPERATIONS\nFiscal 1994 housing revenues increased by $160.2 million, or 40.3%, compared to fiscal 1993. Fiscal 1993 housing revenues increased by $105.6 million, or 36.2%, compared to fiscal 1992. Housing revenues are recorded at the time each home is delivered and title and possession have been transferred to the buyer.\nInformation on homes delivered by market area is set forth below:\nYear Ended ------------------------------------------ February 28, February 28, February 29, 1994 1993 1992 ------------ ------------ ------------ (Dollars in Thousands)\nNortheast Region(1): Housing Revenues........... $389,577 $311,347 $216,274 Homes Delivered............ 2,527 2,226 1,582\nNorth Carolina: Housing Revenues........... $ 72,639 $ 59,399 $ 45,698 Homes Delivered............ 580 517 420\nFlorida: Housing Revenues........... $ 48,780 $ 19,900 $ 20,512 Homes Delivered............ 405 184 282\nMetro Washington, D. C.: Housing Revenues........... $ 44,783 $ 3,327 $ -- Homes Delivered............ 288 28 --\nOther: Housing Revenues........... $ 1,710 $ 3,333 $ 9,271 Homes Delivered............ 28 44 99\nTotals: Housing Revenues........... $557,489 $397,306 $291,755 Homes Delivered........... 3,828 2,999 2,383\n(1) Excludes suspended operations in New York which are included with New Hampshire in \"Other\".\nThe increase in housing revenue during fiscal 1994 and 1993 was the result of more homes delivered and increased average sales prices. Increased deliveries are primarily the result of opening up more housing developments for sale over this period and expanding into eastern Pennsylvania and metro Washington, D. C. The increased average sales prices are primarily the result of diversifying the Company's product mix in the Northeast Region to include more detached single family homes and larger townhouses with garages designed for the move-up buyer. Also, average sales prices have increased in Florida because substantially all its new developments are detached single family homes.\nThe Company's contract backlog using base sales prices by market area is set forth below:\nFebruary 28, ------------------------ 1994 1993 --------- --------- (Dollars in Thousands) Northeast Region: Total Contract Backlog..................$173,430 $130,095 Number of Homes......................... 1,182 885\nNorth Carolina: Total Contract Backlog..................$ 55,620 $ 26,630 Number of Homes......................... 402 221\nFlorida: Total Contract Backlog..................$ 37,837 $ 28,461 Number of Homes......................... 278 234\nMetro Washington D. C.: Total Contract Backlog..................$ 10,377 $ 14,088 Number of Homes......................... 50 101\nOther: Total Contract Backlog..................$ 863 $ 477 Number of Homes......................... 14 8\nTotals: Total Contract Backlog..................$278,127 $199,751 Number of Homes 1,926 1,449\nThe Company has established reserves to reduce certain residential inventories to their estimated net realizable values including costs to carry and dispose. These reserves were established primarily because of lower property values due to economic downturns or a change in the marketing strategy to liquidate a particular property. The established reserves are reduced for carrying costs (i.e., property taxes, interest, etc.) incurred and upon property sale. During fiscal 1993, the Company established reserves of $3.1 million. The reserves were substantially attributable to two Florida developments where sales prices were reduced to accelerate their sellout. At February 28, 1994 and February 28, 1993, remaining reserves of $9.6 million and $13.8 million, respectively, reduced residential inventories. (See \"Notes to Consolidated Financial Statements - Note 1\" for an additional explanation of reserves.)\nConstruction, land, interest and operating expenses include such expenses for housing and land and lot sales. A breakout of construction, land, interest and operations expenses for housing sales and housing gross margin is set forth below:\nYear Ended -------------------------------- February February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars in Thousands) Housing Sales............................ $557,489 $397,306 $291,755 -------- -------- -------- Construction, land and operations expenses............................... 434,653 306,707 230,235 Interest expense......................... 17,424 15,671 15,584 -------- -------- -------- Total expenses......................... 452,077 322,378 245,819 -------- -------- -------- Housing gross margin..................... $105,412 $ 74,928 $ 45,936 Gross margin percentage.................. 18.9% 18.9% 15.7% ======== ======== ========\nWhile the Company's housing gross margin remained flat in fiscal 1994 compared to fiscal 1993, construction, land and operating expenses as a percentage of housing sales increased 0.8% to 78.0% from 77.2%. This increase is primarily the result of the decreased percentage of home revenues coming from the Northeast Region where gross margins are greater. The Northeast Region has declined to 69.9% of the Company's housing revenues in fiscal 1994 from 78.4% in fiscal 1993. In addition, the increase was also caused by sharply rising material costs (primarily lumber) as demand for such materials is greater than current supplies. The 1.7% reduction of these expenses as a percentage of housing sales in fiscal 1993 compared to fiscal 1992 (to 77.2% from 78.9%) was primarily the result of decreased land costs and increased average sales prices. This improvement was aided in fiscal 1993 by the reversal of $1.0 million of previously accrued post-development completion costs.\nHousing interest has declined 0.8% and 1.4% as a percentage of housing sales to 3.1% and 3.9% for fiscal 1994 and 1993, respectively. This decrease is primarily the result of the Company's increased inventory turnover and reduced average interest rates.\nSelling, general and administrative expenses increased $19.2 million in fiscal 1994 from fiscal 1993 and increased $12.7 million in fiscal 1993 from fiscal 1992. The increase in fiscal 1994 and 1993 was primarily due to increased selling expenses resulting from increased new sales contracts, home deliveries and the opening of the metro Washington, D. C. division. As a percentage of total revenues, such expenses decreased to 13.0% in fiscal 1994 from 13.3% in fiscal 1993, and from 13.9% in fiscal 1992.\nLAND AND LOT OPERATIONS\nA breakout of construction, land, interest and operating expenses for land and lot sales and gross margin is set forth below:\nYear Ended -------------------------------- February February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars in Thousands)\nLand and lot sales......................... $ 4,188 $ 10,946 $ 3,220 -------- -------- -------- Construction, land and operations expenses................................. 3,158 8,564 2,243 Interest expense........................... 198 789 316 -------- -------- -------- Total expenses........................... 3,356 9,353 2,559 -------- -------- -------- Land and lot sales Gross margin............................. $ 832 $ 1,593 $ 661 ======== ======== ========\nLand and lot sales are incidental to the Company's residential housing operations and are expected to continue in the future but may significantly fluctuate up or down. During fiscal 1994, land and lot sales consisted of four land sales and one lot sale community in the Northeast Region, one land sale in metro Washington, D. C. and one lot sale community in Florida. During fiscal 1993, land and lot sales consisted of three land sales and one lot sale community in the Northeast Region and two land sales and lot sales in Florida. During fiscal 1992 land and lot sales consisted of one land sale and one lot sale community in the Northeast Region and lot sales in Florida. The Florida land and lot sales are the result of the liquidation of lots in suspended communities or the sale of land not suited for its current product line.\nMORTGAGE BANKING AND FINANCE OPERATIONS\nMortgage banking and finance operations consisted primarily of originating mortgages from sales of the Company's homes, and selling such mortgages in the secondary market. Approximately 27%, 26% and 32% of the Company's customers obtained mortgages originated by the Company's wholly- owned mortgage banking and finance subsidiaries in fiscal 1994, 1993 and 1992, respectively. This represents a 40% increase in mortgage originations from fiscal 1992 to fiscal 1994 due to the increase in homes delivered by the Company. Such operations also include interest income and expense from the Company's collateralized mortgages receivable and related collateral mortgage obligations. Such operations are expected to operate at a slight profit. Most servicing rights on new mortgages originated by the Company will be sold as the loans are closed.\nRENTAL PROGRAM\nAt February 28, 1994, the Company owned and was leasing three office buildings, four office\/warehouse facilities, three retail centers and one mini-storage facility. During fiscal 1994, rental operations increased due to the completion and leasing of additional commercial properties and the acquisition of a retail center mid-year. During fiscal 1993, rental operations decreased primarily due to the sale of a retail center. Rental operations include interest expense amounting to $4.9 million, $5.8 million and $6.6 million for fiscal 1994, 1993, and 1992, respectively. The Company also rented residential homes in Florida, New York and New Hampshire but liquidated most of these rentals by the end of fiscal 1992. The Company expects such operations to operate at a loss after deducting interest and depreciation.\nOTHER OPERATIONS\nIn fiscal 1994, 1993 and 1992, other operations consisted primarily of title insurance activities, investment properties operations and other income from residential housing operations including interest income, contract deposit forfeitures and low and moderate income housing subsidies. The investment properties division supervises the construction of commercial properties and manages completed properties for the Company. Such properties, when completed, result in additional rental operations for the Company. During fiscal 1994, the Company sold a retail center in New Jersey. Included in other income is the pretax gain from this sale amounting to $538,000.\nTOTAL TAXES\nTotal taxes as a percentage of income before income taxes amounted to 31.7%, 32.5% and 15.8% in fiscal 1994, 1993 and 1992, respectively. The Company applied for and received a refund of federal income taxes for fiscal 1992 based on a loss carryback amounting to approximately $1.6 million. Deferred federal and state income tax assets for fiscal 1994 and 1993 primarily represents the deferred tax benefits arising from temporary differences between book and tax income which will be recognized in future years. (See \"Notes to Consolidated Financial Statements - Note 8\" for an additional explanation of taxes.)\nCUMMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR INCOME TAXES\nThe Company elected to adopt early application of Statement of Financial Accounting Standards No 109 - \"Accounting for Income Taxes\" (\"FAS 109\"). Among other things, FAS 109 changes the method of recognizing deferred tax assets. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. A valuation allowance is recognized if it is more likely than not that some portion of the deferred asset will not be recognized. The effect of initially applying FAS 109 in fiscal 1992, resulted in recording additional deferred tax assets and increasing net income by $0.9 million.\nEXTRAORDINARY LOSS\nIn July 1993, the Company redeemed all of its outstanding 12 1\/4% Subordinated Notes due 1998 at a price of 102% of par. The principal amount redeemed was $50,000,000 and the redemption resulted in an extraordinary loss of $1,277,000 net of income taxes of $658,000.\nINFLATION\nInflation has a long-term effect on the Company because increasing costs of land, materials and labor result in increasing sales prices of its homes. In general, these price increases have been commensurate with the general rate of inflation in the Company's housing markets and have not had a significant adverse effect on the sale of the Company's homes. A significant inflationary risk faced by the housing industry generally is that rising housing costs, including land and interest costs, will substantially outpace increases in the income of potential purchasers. In recent years, in the price ranges in which it sells homes, the Company has not found this risk to be a significant problem.\nInflation has a lesser short-term effect on the Company because the Company generally negotiates fixed price contracts with its subcontractors and material suppliers for the construction of its homes. These prices usually are applicable for a specified number of residential buildings or for a time period of between four to twelve months. Construction costs for residential buildings represent approximately 51% of the Company's total costs and expenses.\nItem 8","section_7A":"","section_8":"Item 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements of Hovnanian Enterprises, Inc. and its consolidated subsidiaries, are set forth herein beginning on page.\nItem 9","section_9":"Item 9 - CHANGES IN OR DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nDuring the past twenty-four months there have not been any changes in or disagreements with 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 called for by Item l0, except as set forth below under the heading \"Executive Officers of the Registrant\", is incorporated herein by reference to the Company's definitive proxy statement to be filed pursuant to Regulation l4A, in connection with the Company's annual meeting of shareholders to be held in July 1994, which will involve the election of directors.\nExecutive Officers of the Registrant\nThe executive officers of the Company are listed below and brief summaries of their business experience and certain other information with respect to them are set forth following the table.\nYear Started Name Age Position With Company\nKevork S. Hovnanian 71 Chairman of the Board, Chief l967 Executive Officer, and Director of the Company.\nAra K. Hovnanian 36 President and Director of l979 the Company.\nPaul W. Buchanan 43 Senior Vice President-Corporate l981 Controller and Director of the Company.\nTimothy P. Mason 53 Senior Vice President-Adminis- 1975 tration\/Secretary and Director of the Company.\nPeter S. Reinhart 44 Senior Vice President and General 1978 Counsel and Director of the Company.\nJohn J. Schimpf 45 Executive Vice President and 1981 Director of the Company.\nJ. Larry Sorsby 38 Senior Vice President-Finance\/ 1988 Treasurer\nMr. K. Hovnanian founded the predecessor of the Company in l959 (Hovnanian Brothers, Inc.) and has served as Chairman of the Board of the Company since its incorporation in l967. Mr. K. Hovnanian was also President of the Company from 1967 to April 1988.\nMr. A. Hovnanian was appointed President in April 1988, after serving as Executive Vice President from March 1983. Mr. A. Hovnanian was elected a Director of the Company in December l98l. Mr. A. Hovnanian is the son of Mr. K. Hovnanian.\nMr. Buchanan was appointed Senior Vice President-Corporate Controller in May l990, after serving as Vice President-Corporate Controller from March 1983. Mr. Buchanan was elected a Director of the Company in March l982.\nMr. Mason was appointed Senior Vice President of Administration\/ Secretary of the Company in March 1991, after serving as Vice President - Administration\/Treasurer and Secretary of the Company since March l982. Mr. Mason was elected a Director of the Company in 1980.\nMr. Reinhart was appointed Senior Vice President and General Counsel in April 1985 after serving as Vice President and Chief Legal Counsel since March l983. Mr. Reinhart was elected a Director of the Company in December l98l.\nMr. Schimpf was appointed Executive Vice President of the Company in April 1988 after serving as Senior Vice President from April 1985. Mr. Schimpf was elected a Director of the Company in June 1986.\nMr. Sorsby was appointed Senior Vice President-Finance\/Treasurer of the Company in March 1991, after serving as Vice President\/Finance of the Company since September l988.\nItem 11","section_11":"Item 11 - EXECUTIVE COMPENSATION\nThe information called for by Item ll is incorporated herein by reference to the Company's definitive proxy statement to be filed pursuant to Regulation l4A, in connection with the Company's annual meeting of shareholders to be held in July 1994, which will involve the election of directors.\nItem 12","section_12":"Item 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information called for by Item l2 is incorporated herein by reference to the Company's definitive proxy statement to be filed pursuant to Regulation l4A, in connection with the Company's annual meeting of shareholders to be held in July l994, which will involve the election of directors.\nItem 13","section_13":"Item 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for by Item l3 is incorporated herein by reference to the Company's definitive proxy statement to be filed pursuant to Regulation l4A, in connection with the Company's annual meeting of shareholders to be held in July 1994, which will involve the election of directors. PART IV\nItem 14","section_14":"Item 14 - EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nPage\nFinancial Statements:\nIndex to Consolidated Financial Statements....................... Independent Auditors' Report..................................... Consolidated Balance Sheets at February 28, 1994 and 1993........ Consolidated Statements of Income for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992............................................. Consolidated Statements of Stockholders' Equity for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992....................... Consolidated Statements of Cash Flows for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992......................................... Notes to Consolidated Financial Statements.......................\nFinancial Statement Schedules:\nVIII Valuation and Qualifying Accounts.......................... X Supplementary Income Statement Information................. XI Real Estate and Accumulated Depreciation...................\nAll other schedules are either not applicable to the Company or have been omitted because the required information is included in the financial statements or notes thereto.\nExhibits:\n3(a) Certificate of Incorporation of the Registrant.(1) 3(b) Certificate of Amendment of Certificate of Incorporation of the Registrant.(8) 3(c) Bylaws of the Registrant.(8) 4(a) Specimen Class A Common Stock Certificate.(8) 4(b) Specimen Class B Common Stock Certificate.(8) 4(c) Indenture dated as of April 29, 1992, relating to 11 1\/4% Subordinated Notes between the Registrant and First Fidelity Bank, including form of 11 1\/4% Subordinated Notes due April 15, 2002.(2) 4(d) Indenture dated as of May 28, 1993, relating to 9 3\/4% Subordinated Notes between Registrant and First Fidelity Bank, National Association, New Jersey, as Trustee, including form of 9 3\/4% Subordinated Note due 2005.(4) 10(a) Credit Agreement dated July 30, 1993 among K. Hovnanian Enterprises, Inc., Hovnanian Enterprises, Inc., certain Subsidiaries Thereof, Midlantic National Bank, Chemical Bank, United Jersey Bank\/Central, N.A., and NBD Bank, N.A.(7) 10(b) Description of Management Bonus Arrangements.(8) 10(c) Description of Savings and Investment Retirement Plan.(1) 10(d) Stock Option Plan.(6) 10(e) Management Agreement dated August 12, 1983 for the management of properties by K. Hovnanian Investment Properties, Inc.(1) 10(f) Agreement dated July 8, 1981 between Hovnanian Properties of Atlantic County, Inc. and Kevork S. Hovnanian.(2) 10(g) Management Agreement dated December 15, 1985, for the management of properties by K. Hovnanian Investment Properties, Inc.(3) 10(h) Description of Deferred Compensation Plan.(5) 22 Subsidiaries of the Registrant. (1) Incorporated by reference to Exhibits to Registration Statement (No. 2-85198) on Form S-1 of the Registrant. (2) Incorporated by reference to Exhibits to Registration Statement (No. 33-46064) on Form S-3 of the Registrant. (3) Incorporated by reference to Exhibits to Annual Report on Form 10 -K for the year ended February 28, 1986 of the Registrant. (4) Incorporated by reference to Exhibits to Registration Statement (No. 33-61778) on Forms S-3 of the Registrant. (5) Incorporated by reference to Exhibits to Annual Report on Form 10- K for the year ended February 28, 1990 of the Registrant. (6) Incorporated by reference to the Proxy Statement dated June 15, 1990. (7) Incorporated by reference to an Exhibit to Quarterly Report on Form 10-Q for the quarter ended August 31, 1993, of the Registrant. (8) Incorporated by reference to Exhibits to Annual Report on Form 10- for the year ended February 28, 1993 of the Registrant.\nReports on Form 8-K\nThe Company did not file any reports on Form 8-K during the quarter ended February 28, 1994.\nSIGNATURES\nPursuant to the requirements of Section l3 or l5(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.\nHovnanian Enterprises, Inc. By:\n\/S\/KEVORK S. HOVNANIAN Kevork S. Hovnanian Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of l934, 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\/ KEVORK S. HOVNANIAN Chairman of The Board 5\/20\/94 Kevork S. Hovnanian and Director Date\n\/S\/ ARA K. HOVNANIAN President and Director 5\/20\/94 Ara K. Hovnanian Date\n\/S\/ PAUL W. BUCHANAN Senior Vice President 5\/20\/94 Paul W. Buchanan Corporate Controller and Date Director\n\/S\/ TIMOTHY P. MASON Senior Vice President- 5\/20\/94 Timothy P. Mason Administration\/Secretary Date and Director\n\/S\/ PETER S. REINHART Senior Vice President and 5\/20\/94 Peter S. Reinhart General Counsel and Director Date\n\/S\/ JOHN J. SCHIMPF Executive Vice President 5\/20\/94 John J. Schimpf and Director Date\n\/S\/ J. LARRY SORSBY Senior Vice President\/ 5\/20\/94 J. Larry Sorsby Finance and Treasurer Date\nPART IV\nItem 14 - EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K Page Financial Statements:\nIndex to Consolidated Financial Statements..................... Independent Auditors' Report................................... Consolidated Balance Sheets at February 28, 1994 and 1993...... Consolidated Statements of Income for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992............................................ Consolidated Statements of Stockholders' Equity for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992...................... Consolidated Statements of Cash Flows for the Years Ended February 28, 1994, February 28, 1993 and February 29, 1992........................................ Notes to Consolidated Financial Statements.....................\nFinancial Statement Schedules:\nVIII Valuation and Qualifying Accounts.......................... X Supplementary Income Statement Information................. XI Real Estate and Accumulated Depreciation...................\nAll other schedules have been omitted because the required information of such other schedules 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.\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders and Board of Directors of Hovnanian Enterprises, Inc.\nWe have audited the consolidated balance sheets of Hovnanian Enterprises, Inc. and subsidiaries as of February 28, 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 February 28, 1994 and the schedules listed in the accompanying index. These financial statements and the schedules 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 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 financial statement and schedule 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 respect, the financial position of Hovnanian Enterprises, Inc. and subsidiaries as of February 28, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three year period ended February 28, 1994, in conformity with generally accepted accounting principles. Further, it is our opinion that the schedules referred to above present fairly the information set forth therein.\n\/S\/ Kenneth Leventhal and Company Kenneth Leventhal and Company\nNew York, New York April 21, 1994, except for Note 9 as to which the date is May 10, 1994\nHOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED FEBRUARY 28(29), 1994, 1993 AND 1992\n1. SUMMARY OF ACCOUNTING POLICIES\nOperations - The Company, a Delaware Corporation, principally develops housing communities in New Jersey, Pennsylvania, Florida, North Carolina and Virginia. In addition, the Company develops and operates income producing properties.\nPrinciples of Consolidation - The accompanying consolidated financial statements include the accounts of the Company and all wholly-owned or majority owned subsidiaries after elimination of all significant intercompany balances and transactions. The Company's investments in joint ventures in which the Company's interest is 50% or less are accounted for by the equity method of accounting. The financial statements for prior years have been conformed to the format used at February 28, 1994.\nThe Company reports income taxes in accordance with Statement of Financial Accounting No. 109 (\"FAS 109\"), \"Accounting For Income Taxes\". Among other things, FAS 109 changes the method of recognizing deferred tax assets. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future years and for carryforwards. A valuation allowance is recognized if it is more likely than not that some portion of the deferred asset will not be recognized. The effect of initially applying FAS 109 in fiscal 1992 resulted in recording additional deferred tax assets and increasing net income by $883,000, or $.04 per common share.\nIncome Recognition - Income from sales is recorded when title is conveyed to the buyer, subject to the buyer's financial commitment being sufficient to provide economic substance to the transaction.\nCash - Cash includes cash deposited in checking accounts, overnight repurchase agreements, certificates of deposit, Treasury bills and government money market funds.\nInventories - Inventories are recorded at the lower of cost or market. Market is defined as the estimated proceeds upon disposition less all future costs to complete and expected costs to sell. Construction costs are accumulated during the period of construction and charged to cost of sales under specific identification methods. Land, land development and common facility costs are amortized based upon the number of homes to be constructed in each housing community utilizing a relative sales value allocation method.\nInterest costs related to properties in progress are capitalized during the construction period and charged to cost of sales as the related inventories are sold (see Note 5).\nThe cost of land options is capitalized when incurred and either included as part of the purchase price when the land is acquired or charged to operations when the Company determines it will not exercise the option.\nDuring fiscal 1993, the Company provided for a $3.1 million reserve to reduce certain residential properties to their estimated net realizable values. This reserve is substantially attributable to two Florida communities where the Company significantly reduced sales prices. Although these communities have very few standing unsold houses, by reducing sales prices the Company plans to accelerate their buildout. The Company believes the rapid liquidation of these properties will enable it to concentrate on newer and more profitable developments. In addition, in years prior to fiscal 1992 the Company established similar reserves attributable to Florida, New Hampshire and New York communities.\nDuring fiscal 1994, 1993 and 1992, the Company charged $4,176,000, $5,245,000 and $7,525,000, respectively, against reserves for losses realized from the sales of certain homes. In fiscal 1994, 1993 and 1992, respectively, these charges consisted of $3,620,000, $4,459,000 and $5,678,000 of construction, and operations costs, $195,000, $201,000 and $476,000 of selling, general and administration expenses and $361,000, $583,000 and $1,371,000 of interest expenses. At February 28, 1994 and 1993, respectively, inventory and residential rental inventory have been reduced by an allowance of $9,591,000 and $13,767,000 to reflect the carrying amounts at estimated net realizable value.\nProperty - Various condominium homes, not yet under contract of sale, are rented under short-term leases. Such homes are reclassified from inventory and depreciated after a reasonable selling period not to exceed one year. Rental operations of the Company arise from these incidental rentals and from rental of commercial properties.\nPost Development Completion Costs - In those instances where a development is substantially completed and sold and the Company has additional construction work to be incurred, an estimated liability is provided to cover the cost of such work.\nDeferred Income Tax - Deferred income taxes are provided for temporary differences between amounts recorded for financial reporting and for income tax purposes.\nDepreciation - The straight-line method is used for both financial and tax reporting purposes for all assets except office furniture and equipment which are depreciated using the declining balance method over their estimated useful lives.\nPrepaid Expenses - Prepaid expenses which relate to specific housing communities are amortized to costs of sales as the applicable inventories are sold.\nPer Share Calculations - Per share amounts are calculated on a weighted average basis and reflect the recapitalization described in Note 12.\n2. PROPERTY\nOperating property consists of land, land improvements, buildings, building improvements, furniture and equipment used by the Company and its subsidiaries to conduct day to day business. Rental property consists of rental condominiums, three office buildings, four office warehouse facilities, three retail shopping centers, and a mini-storage facility. The condominiums located in New Hampshire, are either sold and waiting to close or being temporarily rented and are being actively marketed for sale.\n3. ESCROW CASH\nEscrow cash primarily represents customers' deposits which are restricted from use by the Company. The Company is able to release escrow cash by pledging letters of credit and as a result, $6,453,000 and $5,024,000 was released from escrow at February 28, 1994 and 1993, respectively. Escrow cash accounts are substantially invested in short-term certificates of deposit or time deposits.\n4. MORTGAGES AND NOTES RECEIVABLE\nThe Company's wholly-owned mortgage banking and finance subsidiaries originate mortgage loans, primarily from the sale of the Company's homes. Such mortgage loans are sold in the secondary mortgage market or in years prior to fiscal 1988 pledged against collateralized mortgage obligations (\"CMO's\"). At February 28, 1994 and 1993, mortgage loans owned by the Company amounted to $81,428,000 and $74,463,000, respectively, of which $30,755,000 and $40,355,000, respectively, were pledged against CMO's with the remainder held for sale. At February 28, 1994 and 1993, respectively, $43,502,000 and $25,868,000 of such mortgages were pledged against the Company's mortgage warehouse line (see \"Notes to Consolidated Financial Statements - Note 5\"). The Company may incur risk with respect to mortgages that are delinquent and not pledged against CMO's, but only to the extent the losses are not covered by mortgage insurance or resale value of the home. Historically, the Company has incurred minimal credit losses. The mortgage loans held for sale are carried at the lower of cost or market value, determined on an aggregate basis. There was no valuation adjustment at February 28, 1994.\nIn connection with certain bulk sales of condominium homes, land sales and the sale of certain subsidiaries, the Company made loans. At February 28, 1994 and February 28, 1993, such loans amounted to $3,808,000 and $4,890,000, respectively, with interest rates at February 28, 1994 ranging up to 12%.\n5. MORTGAGES AND NOTES PAYABLE\nSubstantially all of the land and construction mortgages are short-term borrowings. The mortgages secured by buildings, land and land improvements are installment obligations having annual principal maturities of approximately $1,107,000 in fiscal 1995, $186,000 in fiscal 1996, $205,000 in fiscal 1997, $225,000 in fiscal 1998, and $19,815,000 after fiscal 1998.\nThe Company has a Revolving Credit Agreement (\"Agreement\") with a group of banks which provides up to $130,000,000 through July 1996. Interest is payable monthly and at various rates of either prime plus 1\/2% or LIBOR plus 2%. In addition, the Company pays 3\/8% per annum on the weighted average unused portion of the line. The Company believes that it will be able either to extend the Agreement beyond July 1996 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. Interest costs incurred, expensed and capitalized were:\nYear Ended --------------------------------- February February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars in Thousands) Interest incurred (1): Residential(3)......................... $20,830 $15,990 $13,701 Commercial(4).......................... 5,138 6,165 6,762 ------- ------- ------- Total incurred......................... $25,968 $22,155 $20,463 ======= ======= =======\nInterest expensed: Residential(3)......................... $17,622 $16,460 $15,900 Commercial(4).......................... 4,908 5,809 6,557 ------- ------- ------- Total expensed......................... $22,530 $22,269 $22,457 ======= ======= =======\nInterest capitalized at beginning of year...................... $23,366 $24,062 $27,427 Plus: Interest incurred................. 25,968 22,155 20,463 Less: Interest expensed................. 22,530 22,269 22,457 Less: Charged to reserves............... 361 583 1,371 ------- ------- ------- Interest capitalized at end of year...... $26,443 $23,365 $24,062 ======= ======= =======\nInterest capitalized at end of year (5): Residential(3)......................... $20,209 $15,727 $16,780 Commercial(2).......................... 6,234 7,638 7,282 ------- ------- ------- Total interest capitalized............ $26,443 $23,365 $24,062 ======= ======= =======\n(1) Data does not include interest incurred by the Company's mortgage and finance subsidiaries. (2) Data does not include a reduction for depreciation. (3) Represents acquisition interest for construction, land and development costs which is charged to cost of sales. (4) Represents interest charged to rental operations. (5) Capitalized residential interest at February 28, 1994 includes $1,635,000 reported at February 28, 1993 as capitalized commercial interest. This reclassification was the result of the transfer of two parcels of land from commercial due to a change in the intended use to residential housing. Average interest rates and balances outstanding for short-term debt are as follows:\nFebruary February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars In Thousands)\nAverage outstanding borrowings.......... $ 39,632 $ 32,788 $110,910 Average interest rate during period(1).. 5.39% 6.21% 8.35% Average interest rate at end of period.. -- 6.50% 7.07% Maximum outstanding at any month end.... .$ 72,700 $ 68,350 $138,904\n(1) Total interest incurred for the year divided by average outstanding short term borrowings.\n6. SUBORDINATED NOTES\nOn June 24, 1988, the Company issued $50,000,000 principal amount of 12 1\/4% Subordinated Notes due June 15, 1998. Interest is payable semi- annually. Annual sinking fund payments of $10,000,000 are required to commence June 15, 1996, and are calculated to retire 40% of the issue prior to maturity. In July 1993, the Company redeemed all of these notes at a price of 102% of par. The redemption resulted in an extraordinary loss of $1,277,000 net of an income tax benefit of $658,000.\nOn April 29, 1992, the Company issued $100,000,000 principal amount of 11 1\/4% Subordinated Notes due April 15, 2002. Interest is payable semi- annually. Annual sinking fund payments of $20,000,000 are required to commence April 15, 2000, and are calculated to retire 40% of the issue prior to maturity.\nOn June 7, 1993, the Company issued $100,000,000 principal amount of 9 3\/4% Subordinated Notes due June 1, 2005. Interest is payable semiannually. The notes are redeemable in whole or in part at the Company's option, initially at 104.875% of their principal amount on or after June 1, 1999 and reducing to 100% of their principal amount on or after June 1, 2002.\nThe indentures relating to the subordinated notes and the Revolving Credit Agreement contain restrictions on the payment of cash dividends. At February 28, 1994, $33,432,000 of retained earnings were free of such restrictions.\n7. RETIREMENT PLAN\nOn December 1, 1982, the Company established a defined contribution savings and investment retirement plan. Under such plan there are no prior service costs. Plan costs charged to operations amount to $788,000 , $477,000 and $434,000 for the years ended February 28, 1994, February 28, 1993 and February 29, 1992, respectively.\n8. INCOME TAXES\nDeferred income taxes have been provided (reduced) due to temporary differences as follows: Year Ended -------------------------------- February February February 28, 1994 28, 1993 29, 1992 -------- -------- -------- (Dollars In Thousands)\nCapitalized interest................. $ (3) $ (16) $ (96) Homeowner association maintenance reserves.......................... 166 53 (117) Installment sales.................... (493) (578) (592) Provision to reduce inventory to net realizable value................... 1,324 954 2,563 Deferred expenses.................... (727) (608) (484) Depreciation......................... 298 Post development completion costs.... (1,988) Net operating losses................. (129) Other................................ (21) -------- -------- -------- Benefit (Provision) - total.......... $(1,573) $ (195) $ 1,274 ======== ======== ========\nThe deferred tax liabilities or assets have been recognized in the consolidated balance sheets due to temporary differences and loss carryforwards as follows: February February 28, 1994 28, 1993 -------- -------- (Dollars In Thousands) Deferred Tax Liabilities: Deferred interest....................... $ 252 $ 256 Installment sales....................... 784 1,278 Accelerated depreciation................ 1,104 807 -------- -------- Total................................. 2,140 2,341 -------- --------\nDeferred Tax Assets: Deferred income......................... 369 333 Maintenance guarantee reserves.......... 490 656 Provision to reduce inventory to net realizable value...................... 3,577 4,901 Uniform capitalization of overhead..... 2,018 1,579 Post development completion costs....... 1,988 Other................................... 793 394 -------- -------- Total................................. 9,235 7,863 -------- -------- Net Deferred Tax Assets................... $ (7,095) $ (5,522) ======== ========\nThe effective tax rates varied from the expected rate. The sources of these differences were as follows:\nFebruary February February 28, 1994 28, 1993 29, 1992 -------- -------- --------\nComputed \"expected\" tax rate.............. 35.0% 34.0% 34.0% State income taxes, net of Federal income tax benefit...................... 1.8% 7.3% 20.1% Loss carryforward of New Fortis subsidiary.............................. (2.1%) (2.6%) (26.5%) Other..................................... (3.0%) (6.2%) (11.8%) -------- -------- -------- Effective tax rate........................ 31.7% 32.5% 15.8% ======== ======== ========\nThe Company has available at February 28, 1994 a federal operating loss carryforward for financial reporting purposes and tax purposes of $274,000, which may provide future tax benefits. The carryforward expires during the years ended February 28, 2005 and 2006. The Company has state net operating loss carryforwards for financial reporting and tax purposes of $164,000,000 due to expire between the years February 28, 1995 and February 28, 2009.\n9. TRANSACTIONS WITH RELATED PARTIES\nThe Company's Board of Directors has adopted a general policy providing that it will not make loans to officers or directors of the Company or their relatives at an interest rate less than the interest rate at the date of the loan on six month U.S. Treasury Bills, that the aggregate of such loans will not exceed $2,000,000 at any one time, and that such loans will be made only with the approval of the members of the Company's Board of Directors who have no interest in the transaction. Notwithstanding the policy stated above, the Board of Directors of the Company concluded that the following transactions were in the best interests of the Company.\nOn March 1, 1990, the Company sold all the assets and liabilities of its wholly-owned engineering subsidiary Najarian and Associates (\"N & A\") to the employees of N & A for $3,600,000. One of these employees and former President of N & A was Tavit O. Najarian, the son-in-law of Mr. K. Hovnanian, Chairman of the Board and Director of the Company. The sale was approved by members of the Company's Board of Directors who were not related to Mr. Najarian. At the closing the Company received a cash payment of $720,000 and a $2,880,000 note. Originally the note carried an annual interest rate of 10% and was to amortize over ten years. As long as any portion of the note is outstanding, the Company receives 25% of the net cash flow. During fiscal 1992, N & A began to experience a significant decrease in business activity. As a result, the note was modified by changing the interest rate to prime, add accrued interest from September 1, 1991 to September 1, 1992 to principal and reschedule principal payments over the balance of the term of the note. As a result of continued financial difficulties, a committee consisting of independent directors of the Board of Directors of the Company (the \"Committee\") engaged an outside consultant to determine the fair market value of the above note. Based on the consultant's findings, the Committee recommended a reduction in the note including accrued interest from $2,983,000 to $1,100,000 at February 28, 1994. This reduction of the note was charged to operations in the current fiscal year. In addition, the Committee recommended a new term of ten years with annual interest on the note of 5% for the first two years adjusting to prime thereafter. Amortization would begin in year three with an annual minimum amount of 5%, ranging up to 30% in year 10, or 85% of cash flow after interest, whichever is greater. The Committee also recommended a $300,000 discount if the loan was paid in full during the first two years.\nThe Company provides property management services to various limited partnerships including two partnerships in which Mr. A. Hovnanian, President and a Director of the Company, is a general partner, and members of his family and certain officers and directors of the Company are limited partners. At February 28, 1994, these partnerships owed the Company $27,000.\nOn May 10, 1994, the Board of Directors approved the acquisition of the 10% minority interest in certain Florida subsidiaries owned by Paul W. Asfahl, President of the Company's Florida Division. For his 10% interest, the Company issued 45,000 shares of Class A Common Stock to Mr. Asfahl.\n10. STOCK OPTION PLAN\nThe Company has a stock option plan for certain officers and key employees. Options are granted by a Committee appointed by the Board of Directors. The exercise price of all stock options must be at least equal to the fair market value of the underlying shares on the date of the grant. Stock option transactions are summarized as follows:\nFebruary February February 28, 1994 28, 1993 29,1992 --------- --------- ---------\nOptions outstanding at beginning of year 1,004,000 530,500 590,949 Granted................................ -- 509,500 -- Exercised............................ 58,500 28,000 60,449 Cancelled.............................. 7,000 8,000 -- ---------- --------- --------- Options outstanding at end of year... 938,50 1,004,000 530,500 ========== ========= =========\nOptions exercisable at end of year..... 598,833 336,500 198,500\nPrice range of options exercised..... $3.00-$9.44 $5.13-$9.44 $3.00-$9.44\nPrice range of options outstanding....$5.13-$11.50 $3.00-$11.50 $3.00-$9.44\n11. COMMITMENTS AND CONTINGENT LIABILITIES\nDuring fiscal 1989, the Company became aware that certain fire-retardant plywood commonly used in the roof construction of multi-family homes may contain a product defect causing accelerated deterioration of the plywood. The Company has determined that such plywood was used in 33 of its communities containing approximately 11,750 homes.\nCommon areas, including roofs, in each of the Company's multi-family condominium developments are governed and controlled by homeowners' associations for each development, rather than by individual homeowners. Certain of the 33 homeowners' associations in the affected developments have asserted claims against the Company. As of February 28, 1993, the Company had entered separate settlement agreements with 31 of the 33 associations, (the \"Settling Associations\") covering 10,850 homes.\nIn August 1989 the Company brought suit against the plywood material manufacturers, treaters, suppliers and others (the \"Defendants\") to determine the proper responsibility for damages, to protect its interests and to recover its damages.\nIn November 1992, the Company and the Settling Associations entered into a settlement agreement with most of the Defendants. Based upon the settlement monies received, the use of the Settling Associations' roof shingle reserves and the actual expenditures in performing the repairs, the Company believes the repair costs will not require it to set aside future reserves for such roof repairs.\nThe Company is continuing to litigate with the two non-settling associations which contain 900 homes. Because the litigation is in its early discovery stages, the Company is unable to predict at this time the ultimate outcome of the litigation. However, due to the limited amount of this remaining litigation, the Company does not believe that the resolution of this litigation will have a material effect on the Company.\nIn addition, the Company is involved from time to time in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on the Company.\nAs of February 28, 1994 and 1993, respectively, the Company is obligated under various letters of credit amounting to $5,114,000 and $10,340,000.\n12. RECAPITALIZATION\nIn September 1992, the Company's stockholders approved a Plan of Recapitalization (the \"Recapitalization\"). The Recapitalization became effective September 11, 1992.\nOn the effective date, each outstanding share of the Company's common stock, par value $.01 per share, was converted into one-half of a share of \"Class A Common Stock\", par value $.01 per share having one vote per share, and one-half of a share of \"Class B Common Stock\", par value $.01 per share having ten votes per share. The amount of any regular cash dividend payable on a share of Class A Common Stock will be an amount equal to 110% of the corresponding regular cash dividend payable on a share of Class B Common Stock.\nIf a shareholder desires to sell shares of Class B Common Stock, such stock must be converted into shares of Class A Common Stock. Shareholders may convert their shares of Class B Common Stock into an equal number of shares of Class A Common Stock at any time. A holder of Class B Common Stock can wait until the time of sale and deliver the Class B Common Stock to a broker. The broker will then present the Class B Common Stock to the Company's transfer agent, which will issue the purchaser shares of Class A Common Stock.\n13. UNAUDITED SUMMARIZED CONSOLIDATED QUARTERLY INFORMATION\nSummarized quarterly financial information for the years ended February 28, 1994 and 1993 is as follows:\nThree Months Ended (In Thousands Except Per Share Data) ----------------------------------------- February November August May 28, 1994 30, 1993 31, 1993 31, 1993 -------- -------- -------- --------- Revenues........................... $257,691 $143,078 $123,291 $ 62,950 Costs and expenses................. $241,046 $136,157 $116,093 $ 64,563 Income (loss) before income taxes and extraordinary loss........... $ 16,645 $ 6,921 $ 7,198 $ (1,613) State and Federal income tax....... $ 5,277 $ 2,152 $ 2,426 $ (626) Income (loss) before extraordinary loss............................ $ 11,368 $ 4,769 $ 4,772 $ (987) Extraordinary loss from extinguishment of debt, net of income taxes.................. $ (1,277)\nNet income (loss).................. $ 11,368 $ 4,769 $ 4,772 $ (2,264) Earnings (loss) per common share: Income (loss) before extraordinary loss............. $ .50 $ .21 $ .21 $ (.05) Extraordinary loss............... $ (.05) Net income (loss).................. $ .50 $ .21 $ .21 $ (.10) Weighted average number of common shares outstanding........ 22,842 22,839 22,818 22,784 _____________________________________________________________________________\nThree Months Ended (In Thousands Except Per Share Data) ---------------------------------------- February November August May 28, 1993 30, 1992 31, 1992 31, 1992 -------- -------- -------- -------- - - - Revenues............................ $184,950 $115,594 $ 83,585 $ 45,186 Costs and expenses.................. $172,214 $112,486 $ 82,173 $ 47,917 Income (loss) before income taxes... $ 12,736 $ 3,108 $ 1,412 $ (2,731) State and Federal income tax....... $ 4,444 $ 1,152 $ 188 $ (1,049) Net income (loss)................... $ 8,292 $ 1,956 $ 1,224 $ (1,682) Earnings (loss) per common share....$ .36 $ .09 $ .05 $ (.07) Weighted average number of common shares outstanding......... 22,784 22,779 22,779 22,755\nSCHEDULE X HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES SUPPLEMENTAL INCOME STATEMENT INFORMATION\nCharged To Cost And Expenses ---------------------------------------- February 28, February 28, February 29, 1994 1993 1992 ----------------------------------------\nAdvertising..................... $8,587,000 $5,895,000 $4,776,000 Depreciation.................... $3,035,000 $2,924,000 $2,888,000 Maintenance guarantee reserves.. $1,237,000 $2,764,000 $1,257,000","section_15":""}
{"filename":"10795_1994.txt","cik":"10795","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nBecton, Dickinson and Company was incorporated under the laws of the State of New Jersey in November 1906, as successor to a New York business started in 1897. Its executive offices are located at 1 Becton Drive, Franklin Lakes, New Jersey 07417-1880 and its telephone number is (201) 847-6800. All references herein to \"the Company\" refer to Becton, Dickinson and Company and its domestic and foreign subsidiaries unless otherwise indicated by the context.\nThe Company is engaged principally in the manufacture and sale of a broad line of medical supplies and devices and diagnostic systems used by health care professionals, medical research institutions and the general public.\nBUSINESS SEGMENTS AND GEOGRAPHIC AREAS\nThe Company's operations are comprised of two worldwide business segments, Medical Supplies and Devices, and Diagnostic Systems. The countries in which the Company has local revenue-generating operations have been combined into the following geographic areas: United States (including Puerto Rico); Europe; and Other (which is comprised of Canada, Latin America, Japan and Asia Pacific).\nInformation with respect to revenues, operating income and identifiable assets attributable to each of the Company's business segments and geographic areas of operation, as well as capital expenditures and depreciation and amortization attributable to each of the Company's business segments, appears on pages 32-33 of the Company's Annual Report to Shareholders for the fiscal year ended September 30, 1994 (the \"1994 Annual Report\"), and is incorporated herein by reference.\nMEDICAL SUPPLIES AND DEVICES SEGMENT\nThe major products in this segment are hypodermic products, specially designed devices for diabetes care, prefillable drug delivery systems, vascular access products and surgical devices (including disposable scrubs, surgical gloves, specialty and surgical blades and pre-surgery patient prep kits).\nThis segment also includes specialty needles, drug infusion systems, elastic support products, thermometers, examination gloves and contract packaging services. The Company's contract packaging services are provided to pharmaceutical, cosmetic and toiletry companies.\nDIAGNOSTIC SYSTEMS SEGMENT\nThe major products in this segment are classical and instrumented microbiology products, blood collection products, instrumentation systems for cellular analysis, including flow cytometry and cellular imaging products, tissue culture labware, hematology instruments and other diagnostic systems, including immunodiagnostic test kits.\nFOREIGN OPERATIONS\nThe Company's products are manufactured and sold worldwide. The principal markets for the Company's products outside the United States are Europe, Japan, Mexico, Asia Pacific, Canada and Brazil. The principal products sold by the Company outside of the United States are hypodermic needles and syringes, diagnostic systems, VACUTAINER (R) brand blood collection products, HYPAK (R) brand prefillable syringe systems, and intravenous catheters. The Company has manufacturing operations in Australia, Belgium, Brazil, Canada, France, Germany, Ireland, Japan, Mexico, Singapore, Spain and the United Kingdom.\nForeign economic conditions and exchange rate fluctuations have caused the profitability on foreign revenues to fluctuate more than on domestic revenues. The Company believes its foreign business involves greater risk than its domestic business due to the foregoing factors as well as local political and governmental conditions.\nREVENUES AND DISTRIBUTION\nThe Company's products and services are marketed in the United States both through independent distribution channels and directly to end-users. The Company's products are marketed outside the United States through independent distributors and sales representatives, and in some markets directly to end- users. Sales to a distributor, which supplies the Company's products to many end-users, accounted for approximately 12% of total Company revenues in fiscal 1994, and were from both business segments. Order backlog is not material to the Company's business inasmuch as orders for the Company's products are generally received and filled on a current basis, except for items temporarily out of stock. Substantially all revenue is recognized when products are shipped to customers.\nRESEARCH AND DEVELOPMENT\nThe Company conducts its research and development activities at its operating units, its Research Center in Research Triangle Park, North Carolina and in collaboration with selected universities and medical centers. The Company also retains individual consultants to support its efforts in specialized fields. The Company spent $144,227,000 on research and development during the fiscal year ended September 30, 1994 and $139,141,000 and $125,207,000, respectively, during the two immediately preceding fiscal years.\nCOMPETITION\nA number of companies, some of which are more specialized than the Company, compete in the medical technology field. In each such case, competition involves only a part of the Company's product lines. Competition in the Company's markets is based on a combination of factors including price, quality, service, reputation, distribution and promotion. Ongoing investments in research, quality management, quality and product improvement and productivity improvement are required to maintain an advantage in the competitive environments in which the Company operates.\nNew companies have entered the medical technology field and established companies have diversified their business activities into this area. Other firms engaged in the distribution of medical technology products have become manufacturers as well. Some of the Company's competitors have greater financial resources than the Company. The Company is also faced with competition from products manufactured outside the United States.\nPATENTS, TRADEMARKS AND LICENSES\nThe Company owns numerous patents, patent applications and trademarks in the United States and other countries. The Company is also licensed under domestic and foreign patents, patent\napplications and trademarks owned by others. In the aggregate, these patents, patent applications, trademarks and licenses are of material importance to the Company's business.\nRAW MATERIALS\nThe Company purchases many different types of raw materials including plastics, glass, metals, yarn and yarn goods, paper products, agricultural products, electronic and mechanical sub-assemblies and various biological, chemical and petrochemical products. All but a few of the Company's principal raw materials are available from multiple sources.\nREGULATION\nThe Company's medical technology products and operations are subject to regulation by the federal Food and Drug Administration and various other federal and state agencies, as well as by a number of foreign governmental agencies. The Company believes it is in compliance in all material respects with the regulations promulgated by such agencies, and that such compliance has not had, and is not expected to have, a material adverse effect on its business.\nThe Company also believes that its operations comply in all material respects with applicable environmental laws and regulations. Such compliance has not had, and is not expected to have, a material adverse effect on the Company's capital expenditures, earnings or competitive position.\nEMPLOYEES\nAs of September 30, 1994, the Company had approximately 18,600 employees, of whom approximately 9,900 were employed in the United States. The Company believes that its employee relations are satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe executive offices of the Company are located in Franklin Lakes, New Jersey. The Company owns and leases approximately 11,670,000 square feet of manufacturing, warehousing, administrative and research facilities throughout the world. The domestic facilities, including Puerto Rico, comprise approximately 6,378,000 square feet of owned and 1,726,000 square feet of leased space. The foreign facilities comprise approximately 2,500,000 square feet of owned and 1,066,000 square feet of leased space. Sales offices and distribution centers included in the total square footage are also located throughout the world.\nOperations in both of the Company's business segments are carried on at both domestic and foreign locations. Primarily at foreign locations, facilities often serve both business segments and are used for multiple purposes, such as administrative\/sales, manufacturing and\/or warehousing\/distribution. The Company generally seeks to own its manufacturing facilities, although some, particularly at foreign locations, are leased. Most of the Company's administrative, sales and warehousing\/distribution facilities are leased.\nThe Company believes that its facilities are of good construction and in good physical condition, are suitable and adequate for the operations conducted at those facilities, and are, with minor exceptions, fully utilized and operating at normal capacity.\nThe domestic facilities are grouped as follows:\n--Eastern Sector includes facilities in Connecticut, Georgia, Maryland, Massachusetts, New Jersey, New York, North Carolina, South Carolina and Puerto Rico and is comprised of approximately 3,931,000 square feet of owned and 1,037,000 square feet of leased space.\n--Central Sector includes facilities in Illinois, Indiana, Michigan, Missouri, Nebraska, Ohio, Texas and Wisconsin and is comprised of approximately 1,043,000 square feet of owned and 481,000 square feet of leased space.\n--Western Sector includes facilities in California and Utah and is comprised of approximately 1,404,000 square feet of owned and 208,000 square feet of leased space.\nThe foreign facilities are grouped as follows:\n--Canada includes approximately 161,000 square feet of owned and 46,000 square feet of leased space.\n--Europe includes facilities in Belgium, France, Germany, Greece, Ireland, Italy, the Netherlands, Spain, Sweden, Switzerland and the United Kingdom and is comprised of approximately 1,315,000 square feet of owned and 725,000 square feet of leased space.\n--Latin America includes facilities in Brazil, Colombia, Mexico and Panama and is comprised of approximately 629,000 square feet of owned and 145,000 square feet of leased space.\n--Asia Pacific includes facilities in Australia, Hong Kong, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand and is comprised of approximately 395,000 square feet of owned and 150,000 square feet of leased space.\nThe table below summarizes property information by business segment:\n- --------\n(A) Facilities used by both business segments. (B) Aggregate square footage and number of facilities (noted in parentheses) by category used for manufacturing purposes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is a party to a number of federal proceedings in the United States brought under the Comprehensive Environmental Response, Compensation and Liability Act, also known as Superfund, and similar state laws. The Company is also involved in other legal proceedings and claims which arise in the ordinary course of business, both as a plaintiff and a defendant. The results of these matters, individually and in the aggregate, are not expected to have a material effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT (AS OF DECEMBER 1, 1994)\nThe following is a list of the executive officers of the Company, their ages and all positions and offices held by each of them during the past five years. There is no family relationship between any of the named persons.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's common stock is listed on the New York Stock Exchange. As of November 30, 1994, there were approximately 7,586 shareholders of record. The balance of the information required by this item appears under the caption \"Common Stock Prices and Dividends\" on page 52 of the Company's 1994 Annual Report and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by this item is included under the caption \"Six Year Summary of Selected Financial Data\" on pages 30-31 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 included in the text contained under the caption \"Financial Review\" on pages 23-29 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 appears on pages 32-33, 35-51 and under the caption \"Quarterly Data (Unaudited)\" on page 52 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.\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 directors required by this item will be contained under the captions \"Board of Directors\", \"Election of Directors\" and \"Continuing Directors\" in a definitive Proxy Statement involving the election of directors which the registrant will file with the Securities and Exchange Commission not later than 120 days after September 30, 1994 (the \"1995 Proxy Statement\"), and such information is incorporated herein by reference.\nThe information relating to executive officers required by this item is included herein in Part I under the caption \"Executive Officers of the Registrant\".\nThe information required pursuant to Item 405 of Regulation S-K will be contained under the caption \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the Company's 1995 Proxy Statement, and such information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this item will be contained under the captions \"Board of Directors\" and \"Executive Compensation\" in the Company's 1995 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 by this item will be contained under the caption \"Share Ownership of Management and Certain Beneficial Owners\" in the Company's 1995 Proxy Statement, and such information 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 following consolidated financial statements of the Company and the Report of Ernst & Young LLP, Independent Auditors, included in the Company's 1994 Annual Report at the pages indicated in parentheses, are incorporated by reference in Item 8 hereof:\nReport of Ernst & Young LLP, Independent Auditors (page 35)\nConsolidated Statements of Income--Years ended September 30, 1994, 1993 and 1992 (page 36)\nConsolidated Balance Sheets--September 30, 1994 and 1993 (page 37)\nConsolidated Statements of Cash Flows--Years ended September 30, 1994, 1993 and 1992 (page 38)\nNotes to Consolidated Financial Statements (pages 39-51)\n(A)(2) FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statement schedules of the Company are included herein at the pages indicated in parentheses:\nSchedule V--Property, Plant and Equipment (page 10) Schedule VI--Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment (page 11) Schedule VIII--Valuation and Qualifying Accounts (page 12) Schedule IX--Short-Term Borrowings (page 13) Schedule X--Supplementary Income Statement Information (page 14)\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities Exchange Act of 1934 are not required under the related instructions or are inapplicable, and therefore have been omitted.\n(A)(3) EXHIBITS\nSee Exhibit Index on pages 15-16 hereof for a list of all management contracts, compensatory plans and arrangements required by this item (Exhibit Nos. 10(a)(i) through 10(k)), and all other Exhibits filed or incorporated by reference as a part of this 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 REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nBecton, Dickinson and Company\n\/s\/ John W. Galiardo By___________________________________ (JOHN W. GALIARDO VICE CHAIRMAN OF THE BOARD AND GENERAL COUNSEL)\nDated: December 27, 1994\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW ON THE 27TH DAY OF DECEMBER, 1994 BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED.\nNAME CAPACITY ---- --------\n\/s\/ Harry N. Beaty, M.D. Director - ------------------------------------ (HARRY N. BEATY, M.D.)\n\/s\/ Henry P. Becton, Jr. Director - ------------------------------------ (HENRY P. BECTON, JR.)\n\/s\/ Clateo Castellini Director, Chairman of the Board, - ------------------------------------ President and Chief Executive (CLATEO CASTELLINI) Officer (Principal Executive Officer)\n\/s\/ Gerald M. Edelman, M.D. Director - ------------------------------------ (GERALD M. EDELMAN, M.D.)\n\/s\/ Edmund B. Fitzgerald Director - ------------------------------------ (EDMUND B. FITZGERALD)\n\/s\/ John W. Galiardo Director - ------------------------------------ (JOHN W. GALIARDO)\n\/s\/ Richard W. Hanselman Director - ------------------------------------ (RICHARD W. HANSELMAN)\n\/s\/ Thomas A. Holmes Director - ------------------------------------ (THOMAS A. HOLMES)\n\/s\/ Frank A. Olson Director - ------------------------------------ (FRANK A. OLSON)\n\/s\/ Gloria M. Shatto Director - ------------------------------------ (GLORIA M. SHATTO)\n\/s\/ Raymond S. Troubh Director - ------------------------------------ (RAYMOND S. TROUBH)\n\/s\/ Robert A. Reynolds Vice President--Finance and - ------------------------------------ Controller (Principal Financial (ROBERT A. REYNOLDS) and Accounting Officer)\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareholders and Board of Directors Becton, Dickinson and Company\nWe have audited the consolidated financial statements and related schedules of Becton, Dickinson and Company listed in the accompanying index to financial statements (Item 14(a)). These financial statements and related schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and related 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 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 provide a reasonable basis for our opinion.\nIn our opinion, the financial statements listed in the accompanying index to financial statements (Item 14(a)) present fairly, in all material respects, the consolidated financial position of Becton, Dickinson and Company at September 30, 1994 and 1993, and the consolidated results of its operations and its 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, 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 1 to the financial statements, in 1993 the Company changed its methods of accounting for postretirement benefits other than pensions, postemployment benefits, and income taxes.\n\/s\/Ernst & Young LLP Ernst & Young LLP\nHackensack, New Jersey November 8, 1994\nBECTON, DICKINSON AND COMPANY\nSCHEDULE V--PROPERTY, PLANT AND EQUIPMENT\nYEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (THOUSANDS OF DOLLARS)\n- -------- (A) Includes the following amounts related to acquisitions of businesses: 1992 - $7,115 (B) Reclassifications and currency translation adjustments and, in 1994, $1,135 of special charges.\nDepreciation and amortization are provided on a straight-line basis over the estimated useful lives, generally as follows:\nThe cost of leasehold improvements is being amortized over the terms of the respective leases or the lives of the assets, whichever is shorter.\nBECTON, DICKINSON AND COMPANY\nSCHEDULE VI--ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nYEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (THOUSANDS OF DOLLARS)\n- -------- (A) Reclassifications, currency translation adjustments and $4,484 and $15,655 in 1994 and 1993, respectively, of special charges.\nBECTON, DICKINSON AND COMPANY\nSCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED SEPTEMBER 30, 1994, 1993, AND 1992 (THOUSANDS OF DOLLARS)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\n- -------- (A) Accounts written off.\nBECTON, DICKINSON AND COMPANY\nSCHEDULE IX--SHORT-TERM BORROWINGS\nYEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (THOUSANDS OF DOLLARS)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\n- -------- (A) The maximum and average amount outstanding during the year was computed based on month-end amounts.\n(B) Commercial paper generally matures six months or less from date of issue with no provision for the extension of its maturity.\n(C) Notes payable to banks represent borrowings under credit arrangements that are subject to periodic renewal. Weighted average interest rates include the impact of borrowing in the currencies of countries with rates of inflation which vary from those in the United States.\nBECTON, DICKINSON AND COMPANY\nSCHEDULE X--SUPPLEMENTARY INCOME STATEMENT INFORMATION\nYEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (THOUSANDS OF DOLLARS)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nAmortization of intangible assets, taxes (other than payroll and income taxes) and royalties are less than one percent of revenues for all years presented. Advertising costs are less than one percent of revenues for 1994 and 1993.\nEXHIBIT INDEX\nCopies of any Exhibits not accompanying this Form 10-K are available at a charge of 25 cents per page by contacting: Investor Relations, Becton, Dickinson and Company, 1 Becton Drive, Franklin Lakes, New Jersey 07417- 1880, Phone: 1-800-284-6845.","section_15":""}
{"filename":"869739_1994.txt","cik":"869739","year":"1994","section_1":"ITEM 1. BUSINESS\nEach of the Grantor Trusts, (the \"Trusts\"), listed below, was formed by GMAC Auto Receivables Corporation (the \"Seller\") by selling and assigning the receivables and the security interests in the vehicles financed thereby to The First National Bank of Chicago, as Trustee, in exchange for Class A certificates representing an undivided ownership interest that ranges between approximately 91% and 93.5% in each Trust, which were remarketed to the public, and Class B certificates representing an undivided ownership interest that ranges between approximately 6.5% and 9% in each Trust, which were not offered to the public and initially were held by the Seller. The right of the Class B certificateholders to receive distribution of the receivables is subordinated to the rights of the Class A certificateholders.\nGRANTOR TRUST -------------\nGMAC 1991-B GMAC 1991-C GMAC 1992-A GMAC 1992-C GMAC 1992-D GMAC 1992-E GMAC 1992-F GMAC 1993-A GMAC 1993-B GMAC 1994-A _____________________\nPART II.\nITEM 7.","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nEach of the Grantor Trusts, listed in the table as shown below, was formed by GMAC Auto Receivables Corporation (the \"Seller\") pursuant to a Pooling and Servicing Agreement between the Seller and The First National Bank of Chicago, as Trustee. Each Trust acquired retail finance receivables from the Seller in the aggregate amount as shown below in exchange for certificates representing undivided ownership interests in each Trust. Each Trust's property includes a pool of retail instalment sale contracts secured by automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby.\nThe certificates for each of the following Trusts consist of two classes, entitled \"Asset-Backed Certificates, Class A\" and \"Asset-Backed Certificates, Class B\". The Class A Certificates represent in the aggregate an undivided ownership interest that ranges between approximately 91% and 93.5% of the Trusts and the Class B Certificates represent in the aggregate an undivided ownership interest that ranges between approximately 6.5% and 9% of the Trusts. Only the Class A Certificates have been remarketed to the public. The Class B Certificates have not been offered to the public and initially are being held by the Seller. The rights of the Class B Certificateholder to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A Certificateholders.\nOriginal Aggregate Amount ----------------------------------- Date of Pooling Retail Asset-Backed Certificates Grantor and Servicing Finance ------------------------- Trust Agreement Receivables Class A Class B ------- ----------------- ----------- -------- ------- (In millions of dollars)\nGMAC 1991-B September 17, 1991 1,007.4 916.7 90.7\nGMAC 1991-C December 16, 1991 1,326.4 1,207.0 119.4\nGMAC 1992-A January 30, 1992 2,001.4 1,851.3 150.1\nGMAC 1992-C March 26, 1992 1,100.3 1,012.3 88.0\nGMAC 1992-D June 4, 1992 1,647.6 1,499.3 148.3\nGMAC 1992-E August 20, 1992 1,578.0 1,436.0 142.0\nGMAC 1992-F September 29, 1992 1,644.6 1,496.6 148.0\nGMAC 1993-A March 24, 1993 1,403.0 1,297.8 105.2\nGMAC 1993-B September 16, 1993 1,450.6 1,341.8 108.8\nGMAC 1994-A June 28, 1994 1,151.9 1,077.0 74.9\nII-1\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (concluded)\nGeneral Motors Acceptance Corporation, the originator of the retail receivables, continues to service the receivables for each of the aforementioned Grantor Trusts and receives compensation and fees for such services. Investors receive monthly payments of the pro rata portion of principal and interest for each Trust as the receivables are liquidated.\n------------------------\nII-2\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCROSS REFERENCE SHEET\nExhibit No. Caption Page ----------- ---------------------------------------------- ------\n-- GMAC 1991-B Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-4 Data for the Year Ended December 31, 1994.\n-- GMAC 1991-C Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-9 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-A Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-14 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-C Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-19 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-D Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-24 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-E Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-29 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-F Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-34 Data for the Year Ended December 31, 1994.\n-- GMAC 1993-A Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-39 Data for the Year Ended December 31, 1994\n-- GMAC 1993-B Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-44 Data for the Year Ended December 31, 1994.\n-- GMAC 1994-A Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-49 Data for the period from June 28, 1994 to December 31, 1994.\n27.1 Financial Data Schedule for GMAC 1991-B Grantor Trust (for SEC electronic filing purposes only). --\n27.2 Financial Data Schedule for GMAC 1991-C Grantor Trust (for SEC electronic filing purposes only). --\n27.3 Financial Data Schedule for GMAC 1992-A Grantor Trust (for SEC electronic filing purposes only). --\n27.4 Financial Data Schedule for GMAC 1992-C Grantor Trust (for SEC electronic filing purposes only). --\n27.5 Financial Data Schedule for GMAC 1992-D Grantor Trust (for SEC electronic filing purposes only). --\n27.6 Financial Data Schedule for GMAC 1992-E Grantor Trust (for SEC electronic filing purposes only). --\n27.7 Financial Data Schedule for GMAC 1992-F Grantor Trust (for SEC electronic filing purposes only). --\n27.8 Financial Data Schedule for GMAC 1993-A, 1993-B and 1994-A Grantor Trusts (for SEC electronic -- filing purposes only). II-3\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1991-B Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1991-B Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1991-B Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the three years in the period ended December 31, 1994, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-4\nGMAC 1991-B GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) ................... 124.0 306.4 ------- -------\nTOTAL ASSETS ........................... 124.0 306.4 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ...................... 124.0 306.4 ------- -------\nTOTAL LIABILITIES ...................... 124.0 306.4 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-5\nGMAC 1991-B GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 182.4 276.3 340.7\nAllocable to Interest ............... 14.5 30.4 51.5 ------ ------ ------ Distributable Income ................... 196.9 306.7 392.2 ====== ====== ======\nIncome Distributed ..................... 196.9 306.7 392.2 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-6\nGMAC 1991-B GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1991-B Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn September 17, 1991, GMAC 1991-B Grantor Trust acquired retail finance receivables aggregating approximately $1,007.4 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing October 15, 1991. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 6.75% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-7\nGMAC 1991-B GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 53.0 4.9 57.9\nSecond quarter ..................... 50.1 3.9 54.0\nThird quarter ...................... 42.5 3.2 45.7\nFourth quarter ..................... 36.8 2.5 39.3 --------- -------- ----- Total ......................... 182.4 14.5 196.9 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 72.7 9.4 82.1\nSecond quarter ..................... 74.8 8.2 83.0\nThird quarter ...................... 68.3 7.0 75.3\nFourth quarter ..................... 60.5 5.8 66.3 --------- -------- ----- Total ......................... 276.3 30.4 306.7 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 87.1 15.1 102.2\nSecond quarter ..................... 89.5 13.6 103.1\nThird quarter ...................... 84.9 12.1 97.0\nFourth quarter ..................... 79.2 10.7 89.9 --------- -------- ----- Total ......................... 340.7 51.5 392.2 ========= ======== =====\nII-8\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1991-C Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1991-C Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1991-C Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the three years in the period ended December 31, 1994, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-9\nGMAC 1991-C GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) ................... 228.7 496.0 ------- -------\nTOTAL ASSETS ........................... 228.7 496.0 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ...................... 228.7 496.0 ------- -------\nTOTAL LIABILITIES ...................... 228.7 496.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-10\nGMAC 1991-C GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 267.3 378.5 451.8\nAllocable to Interest ............... 20.7 39.7 63.3 ------ ------ ------ Distributable Income ................... 288.0 418.2 515.1 ====== ====== ======\nIncome Distributed ..................... 288.0 418.2 515.1 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-11\nGMAC 1991-C GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1991-C Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn December 16, 1991, GMAC 1991-C Grantor Trust acquired retail finance receivables aggregating approximately $1,326.4 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing January 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.70% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-12\nGMAC 1991-C GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 75.2 6.7 81.9\nSecond quarter ..................... 74.0 5.6 79.6\nThird quarter ...................... 63.9 4.6 68.5\nFourth quarter ..................... 54.2 3.8 58.0 --------- -------- ----- Total ......................... 267.3 20.7 288.0 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 96.7 12.0 108.7\nSecond quarter ..................... 101.1 10.6 111.7\nThird quarter ...................... 95.2 9.2 104.4\nFourth quarter ..................... 85.5 7.9 93.4 --------- -------- ----- Total ......................... 378.5 39.7 418.2 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 120.6 18.3 138.9\nSecond quarter ..................... 115.3 16.6 131.9\nThird quarter ...................... 109.9 15.0 124.9\nFourth quarter ..................... 106.0 13.4 119.4 --------- -------- ----- Total ......................... 451.8 63.3 515.1 ========= ======== =====\nII-13\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-A Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-A Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period January 30, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-A Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period January 30, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-14\nGMAC 1992-A GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 89.4 370.7 ------- -------\nTOTAL ASSETS ...................................... 89.4 370.7 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 89.4 370.7 ------- -------\nTOTAL LIABILITIES ................................. 89.4 370.7 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-15\nGMAC 1992-A GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period January 30, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------- ------- ------- $ $ $ Distributable Income\nAllocable to Principal ............... 281.3 681.7 948.9\nAllocable to Interest ............... 11.0 35.4 72.0 ------- ------- ------- Distributable Income ................... 292.3 717.1 1,020.9 ======= ======= =======\nIncome Distributed ..................... 292.3 717.1 1,020.9 ======= ======= =======\nReference should be made to the Notes to Financial Statements.\nII-16\nGMAC 1992-A GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-A Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn January 30, 1992, GMAC 1992-A Grantor Trust acquired retail finance receivables aggregating approximately $2,001.4 million from the Seller in exchange for certificates representing undivided ownership interests of 92.5% for the Class A certificates and 7.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing February 18, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.05% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-17\nGMAC 1992-A GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 98.2 4.2 102.4\nSecond quarter ..................... 81.3 3.1 84.4\nThird quarter ...................... 60.0 2.2 62.2\nFourth quarter ..................... 41.8 1.5 43.3 --------- -------- ----- Total ......................... 281.3 11.0 292.3 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 206.9 12.4 219.3\nSecond quarter ..................... 192.5 9.8 202.3\nThird quarter ...................... 157.7 7.5 165.2\nFourth quarter ..................... 124.6 5.7 130.3 --------- -------- ----- Total ......................... 681.7 35.4 717.1 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 171.8 16.5 188.3\nSecond quarter ..................... 278.3 21.9 300.2\nThird quarter ...................... 263.6 18.4 282.0\nFourth quarter ..................... 235.2 15.2 250.4 --------- -------- ------- Total ......................... 948.9 72.0 1,020.9 ========= ======== =======\nII-18\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-C Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-C Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period March 26, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-C Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period March 26, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-19\nGMAC 1992-C GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 80.0 311.3 ------- -------\nTOTAL ASSETS ...................................... 80.0 311.3 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) .................................. 80.0 311.3 ------- -------\nTOTAL LIABILITIES ................................. 80.0 311.3 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-20\nGMAC 1992-C GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period March 26, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 231.3 405.0 384.0\nAllocable to Interest ............... 11.1 31.0 41.2 ------ ------ ------ Distributable Income ................... 242.4 436.0 425.2 ====== ====== ======\nIncome Distributed ..................... 242.4 436.0 425.2 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-21\nGMAC 1992-C GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-C Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn March 26, 1992, GMAC 1992-C Grantor Trust acquired retail finance receivables aggregating approximately $1,100.3 million from the Seller in exchange for certificates representing undivided ownership interests of 92% for the Class A certificates and 8% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing April 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.95% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-22\nGMAC 1992-C GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 76.0 4.3 80.3\nSecond quarter ..................... 68.1 3.1 71.2\nThird quarter ...................... 51.0 2.2 53.2\nFourth quarter ..................... 36.2 1.5 37.7 --------- -------- ----- Total ......................... 231.3 11.1 242.4 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 109.2 10.1 119.3\nSecond quarter ..................... 109.3 8.5 117.8\nThird quarter ...................... 99.7 6.9 106.6\nFourth quarter ..................... 86.8 5.5 92.3 --------- -------- ----- Total ......................... 405.0 31.0 436.0 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nSecond quarter ..................... 133.1 15.7 148.8\nThird quarter ...................... 129.8 13.7 143.5\nFourth quarter ..................... 121.1 11.8 132.9 --------- -------- ----- Total ......................... 384.0 41.2 425.2 ========= ======== =====\nII-23\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-D Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-D Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period June 4, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-D Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period June 4, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\/ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-24\nGMAC 1992-D GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------\n1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 300.7 702.0 ------- -------\nTOTAL ASSETS ...................................... 300.7 702.0 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 300.7 702.0 ------- -------\nTOTAL LIABILITIES ................................. 300.7 702.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-25\nGMAC 1992-D GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period June 4, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 401.3 568.4 377.2\nAllocable to Interest ............... 28.0 55.4 48.0 ------ ------ ------ Distributable Income ................... 429.3 623.8 425.2 ====== ====== ======\nIncome Distributed ..................... 429.3 623.8 425.2 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-26\nGMAC 1992-D GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-D Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn June 4, 1992, GMAC 1992-D Grantor Trust acquired retail finance receivables aggregating approximately $1,647.6 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing June 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.55% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-27\nGMAC 1992-D GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 113.3 9.2 122.5\nSecond quarter ..................... 108.5 7.7 116.2\nThird quarter ...................... 95.9 6.2 102.1\nFourth quarter ..................... 83.6 4.9 88.5 --------- -------- ----- Total ......................... 401.3 28.0 429.3 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 148.6 16.9 165.5\nSecond quarter ..................... 153.3 14.8 168.1\nThird quarter ...................... 140.7 12.8 153.5\nFourth quarter ..................... 125.8 10.9 136.7 --------- -------- ----- Total ......................... 568.4 55.4 623.8 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nSecond quarter ..................... 50.7 7.6 58.3\nThird quarter ...................... 166.9 21.4 188.3\nFourth quarter ..................... 159.6 19.0 178.6 --------- -------- ----- Total ......................... 377.2 48.0 425.2 ========= ======== =====\nII-28\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-E Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-E Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period August 20, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-E Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period August 20, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-29\nGMAC 1992-E GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, --------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 478.4 885.4 ------- -------\nTOTAL ASSETS ...................................... 478.4 885.4 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 478.4 885.4 ------- -------\nTOTAL LIABILITIES ................................. 478.4 885.4 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-30\nGMAC 1992-E GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period August 20, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 407.0 512.6 180.0\nAllocable to Interest ............... 32.6 55.1 23.9 ------ ------ ------ Distributable Income ................... 439.6 567.7 203.9 ====== ====== ======\nIncome Distributed ..................... 439.6 567.7 203.9 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-31\nGMAC 1992-E GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-E Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn August 20, 1992, GMAC 1992-E Grantor Trust acquired retail finance receivables aggregating approximately $1,578.0 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing September 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.75% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-32\nGMAC 1992-E GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 110.6 10.1 120.7\nSecond quarter ..................... 110.9 8.7 119.6\nThird quarter ...................... 97.9 7.5 105.4\nFourth quarter ..................... 87.6 6.3 93.9 --------- -------- ----- Total ......................... 407.0 32.6 439.6 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 128.3 16.1 144.4\nSecond quarter ..................... 134.8 14.5 149.3\nThird quarter ...................... 129.0 13.0 142.0\nFourth quarter ..................... 120.5 11.5 132.0 --------- -------- ----- Total ......................... 512.6 55.1 567.7 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nThird quarter ...................... 46.1 6.2 52.3\nFourth quarter ..................... 133.9 17.7 151.6 --------- -------- ----- Total ......................... 180.0 23.9 203.9 ========= ======== =====\nII-33\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-F Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-F Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period September 29, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-F Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period September 29, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-34\nGMAC 1992-F GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 442.6 908.7 ------- -------\nTOTAL ASSETS ...................................... 442.6 908.7 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 442.6 908.7 ------- -------\nTOTAL LIABILITIES ................................. 442.6 908.7 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-35\nGMAC 1992-F GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period September 29, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 466.1 584.1 151.8\nAllocable to Interest ............... 30.6 55.0 17.9 ------ ------ ------ Distributable Income ................... 496.7 639.1 169.7 ====== ====== ======\nIncome Distributed ..................... 496.7 639.1 169.7 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-36\nGMAC 1992-F GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-F Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn September 29, 1992, GMAC 1992-F Grantor Trust acquired retail finance receivables aggregating approximately $1,644.6 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing October 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.50% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-37\nGMAC 1992-F GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 129.5 9.7 139.2\nSecond quarter ..................... 124.8 8.3 133.1\nThird quarter ...................... 112.8 6.9 119.7\nFourth quarter ..................... 99.0 5.7 104.7 --------- -------- ----- Total ......................... 466.1 30.6 496.7 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 146.9 16.2 163.1\nSecond quarter ..................... 151.2 14.6 165.8\nThird quarter ...................... 147.3 12.9 160.2\nFourth quarter ..................... 138.7 11.3 150.0 --------- -------- ----- Total ......................... 584.1 55.0 639.1 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFourth quarter ..................... 151.8 17.9 169.7 ========= ======== =====\nII-38\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1993-A Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1993-A Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the year ended December 31, 1994 and the period March 24, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1993-A Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for the year ended December 31, 1994 and the period March 24, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-39\nGMAC 1993-A GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, --------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 379.4 845.9 ------- -------\nTOTAL ASSETS ...................................... 379.4 845.9 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 379.4 845.9 ------- -------\nTOTAL LIABILITIES ................................. 379.4 845.9 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-40\nGMAC 1993-A GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the year ended December 31, 1994 and the period March 24, 1993 (inception) through December 31, 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 466.5 557.0\nAllocable to Interest ...................... 25.2 35.6 -------- -------- Distributable Income .......................... 491.7 592.6 ======== ========\nIncome Distributed ............................ 491.7 592.6 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-41\nGMAC 1993-A GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1993-A Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn March 24, 1993, GMAC 1993-A Grantor Trust acquired retail finance receivables aggregating approximately $1,403.0 million from the Seller in exchange for certificates representing undivided ownership interests of 92.5% for the Class A certificates and 7.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing April 15, 1993. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.15% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-42\nGMAC 1993-A GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 144.3 8.3 152.6\nSecond quarter ..................... 127.0 6.8 133.8\nThird quarter ...................... 106.4 5.6 112.0\nFourth quarter ..................... 88.8 4.5 93.3 --------- -------- ----- Total ......................... 466.5 25.2 491.7 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nSecond quarter ..................... 196.7 13.9 210.6\nThird quarter ...................... 194.4 11.8 206.2\nFourth quarter ..................... 165.9 9.9 175.8 --------- -------- ----- Total ......................... 557.0 35.6 592.6 ========= ======== =====\nII-43\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1993-B Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1993-B Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the year ended December 31, 1994 and the period September 16, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1993-B Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for the year ended December 31, 1994 and the period September 16, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\/ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-44\nGMAC 1993-B GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ---------------------\n1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 679.2 1,269.0 ------- -------\nTOTAL ASSETS ...................................... 679.2 1,269.0 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 679.2 1,269.0 ------- -------\nTOTAL LIABILITIES ................................. 679.2 1,269.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-45\nGMAC 1993-B GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the year ended December 31, 1994 and the period September 16, 1993 (inception) through December 31, 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 589.8 181.6\nAllocable to Interest ...................... 39.0 13.9 -------- -------- Distributable Income .......................... 628.8 195.5 ======== ========\nIncome Distributed ............................ 628.8 195.5 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-46\nGMAC 1993-B GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1993-B Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn September 16, 1993, GMAC 1993-B Grantor Trust acquired retail finance receivables aggregating approximately $1,450.6 million from the Seller in exchange for certificates representing undivided ownership interests of 92.5% for the Class A certificates and 7.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing October 15, 1993. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.00% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-47\nGMAC 1993-B GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 173.9 12.1 186.0\nSecond quarter ..................... 158.1 10.4 168.5\nThird quarter ...................... 137.8 8.9 146.7\nFourth quarter ..................... 120.0 7.6 127.6 --------- -------- ----- Total ......................... 589.8 39.0 628.8 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFourth quarter ..................... 181.6 13.9 195.5 ========= ======== =====\nII-48\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1994-A Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1994-A Grantor Trust as of December 31, 1994 and the related Statement of Distributable Income for the period June 28, 1994 (inception) through December 31, 1994. These financial statements are the responsibility of the Trust'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.\nAs described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1994-A Grantor Trust at December 31, 1994 and its distributable income and distributions for the period June 28, 1994 (inception) through December 31, 1994, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-49\nGMAC 1994-A GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ------------ ASSETS $\nReceivables (Note 2) .............................. 901.8 -------\nTOTAL ASSETS ...................................... 901.8 =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 901.8 -------\nTOTAL LIABILITIES ................................. 901.8 =======\nReference should be made to the Notes to Financial Statements.\nII-50\nGMAC 1994-A GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the period June 28, 1994 (inception) through December 31, 1994 (in millions of dollars)\n----- $ Distributable Income\nAllocable to Principal ..................... 250.1\nAllocable to Interest ..................... 33.0 ----- Distributable Income ......................... 283.1 =====\nIncome Distributed ........................... 283.1 =====\nReference should be made to the Notes to Financial Statements.\nII-51\nGMAC 1994-A GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1994-A Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn June 28, 1994, GMAC 1994-A Grantor Trust acquired retail finance receivables aggregating approximately $1,151.9 million from the Seller in exchange for certificates representing undivided ownership interests of 93.5% for the Class A certificates and 6.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing July 15, 1994. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 6.30% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-52\nGMAC 1994-A GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nThird quarter ...................... 125.0 17.5 142.5\nFourth quarter ..................... 125.1 15.5 140.6 --------- -------- ----- Total ......................... 250.1 33.0 283.1 ========= ======== =====\nII-53\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) FINANCIAL STATEMENTS.\nIncluded in Part II, Item 8, of Form 10-K.\n(a) (2) FINANCIAL STATEMENT SCHEDULES.\nAll schedules have been omitted because they are not applicable or because the information called for is shown in the financial statements or notes thereto.\n(a) (3) EXHIBITS (Included in Part II of this report).\n-- GMAC 1991-B Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1991-C Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-A Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-C Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-D Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-E Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-F Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1993-A Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1993-B Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1994-A Grantor Trust Financial Statements for the period June 28, 1994 through December 31, 1994.\n-- Financial Data Schedule for GMAC 1991-B Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1991-C Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-A Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-C Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-D Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-E Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-F Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1993-A, 1993-B and 1994-A Grantor Trusts (for SEC electronic filing purposes only).\nIV-1\n(b) REPORTS ON FORM 8-K.\nNo current reports on Form 8-K have been filed by any of the above-mentioned Grantor Trusts during the fourth quarter ended December 31, 1994.\nITEMS 2, 3, 4, 5, 6, 9, 10, 11, 12 and 13 are not applicable and have been omitted.\nIV-2\nSIGNATURE\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Trustee has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nGMAC 1991-B GRANTOR TRUST GMAC 1991-C GRANTOR TRUST GMAC 1992-A GRANTOR TRUST GMAC 1992-C GRANTOR TRUST GMAC 1992-D GRANTOR TRUST GMAC 1992-E GRANTOR TRUST GMAC 1992-F GRANTOR TRUST GMAC 1993-A GRANTOR TRUST GMAC 1993-B GRANTOR TRUST GMAC 1994-A GRANTOR TRUST\nThe First National Bank of Chicago (Trustee)\ns\/ Steven M. Wagner ---------------------------------- (Steven M. Wagner, Vice President)\nDate: March 29, 1995 --------------\nIV-3","section_15":""}
{"filename":"771298_1994.txt","cik":"771298","year":"1994","section_1":"ITEM 1. BUSINESS\nFruit of the Loom, Inc. (\"Fruit of the Loom\" or the \"Company\") is a vertically integrated international basic apparel company, emphasizing branded products for consumers ranging from infants to senior citizens. It is the largest domestic producer of underwear and of activewear for the imprinted market, selling products principally under the FRUIT OF THE LOOM , BVD , SCREEN STARS , BEST , MUNSINGWEAR , WILSON , BOTANY 500 and JOHN HENRY brand names. Fruit of the Loom also manufactures and markets sports licensed apparel bearing the names, tradenames and logos of the National Football League, the National Basketball Association, Major League Baseball and the National Hockey League, professional sports teams and most major colleges and universities, as well as the likenesses of certain popular professional athletes under the PRO PLAYER , SALEM , SALEM SPORTSWEAR and OFFICIAL FAN brands. The Company manufactures and markets men's and boys' basic and fashion underwear, activewear for the imprint market, casualwear, jeanswear using the GITANO brand name, licensed sports apparel, women's and girls' underwear, infants' and toddlers' apparel and family socks. The Company is a fully integrated manufacturer, performing most of its own spinning, knitting, cloth finishing, cutting, sewing and packaging. Management believes that the Company is a low cost producer in the markets it serves. Management considers the Company's primary strengths to be its excellent brand recognition, low cost production, strong relationships with mass merchandisers and discount chains and its ability to effectively service its customer base.\nThe Company manufactures and markets underwear and activewear (which both include T-shirts). Management believes that consumer awareness of the value and excellent quality at competitive prices of FRUIT OF THE LOOM brand products will benefit the Company in the current retail environment where consumers are more value conscious.\nDuring the last five calendar years, the Company has been the market leader in men's and boys' underwear, with an annual market share ranging from approximately 38% to 40%. In 1994, the Company's share in the men's and boys' underwear market was approximately 38% compared to an approximate 33% share for its closest competitor.\nThe Company offers a broad array of men's and boys' underwear, including: briefs, boxer shorts, T-shirts and A-shirts, colored and \"high fashion\" (as well as RIBBED WHITES ) underwear. It sells all-cotton and cotton-blend underwear under its FRUIT OF THE LOOM and BVD brand names. Products sold under the BVD brand name are priced higher than those sold under the FRUIT OF THE LOOM brand name and are generally designed to appeal to a more premium market. Under licensing arrangements, the Company manufactures and markets men's and boys' underwear bearing the MUNSINGWEAR, KANGAROO , BOTANY 500 and JOHN HENRY trademarks as well as certain activewear bearing the MUNSINGWEAR and BOTANY 500 trademarks in the United States and certain foreign markets.\nManagement believes the Company is the largest of the domestic activewear manufacturers that supply screen printers and that it has a market share of approximately 33% of the screen print T-shirt market. The Company produces and sells blank shirts and fleecewear under the SCREEN STARS brand name and premium fleecewear and T-shirts under the FRUIT OF THE LOOM, LOFTEEZ and BEST BY\nITEM 1. BUSINESS - (Continued)\nFRUIT OF THE LOOM labels. These products are manufactured in a variety of styles and colors and are sold to distributors, screen printers and specialty retailers, who generally apply a decoration prior to sale at retail. Product quality, delivery responsiveness and price are important factors in the sale of activewear. Management believes that the Company's recent capacity additions and its low cost position afford it a competitive advantage in this market.\nThe Company markets casualwear under the FRUIT OF THE LOOM, BVD and MUNSINGWEAR brands. The Company markets a selection of jersey and fleece tops, shorts and bottoms. There are separate Spring and Fall lines with updated color selections for each of the men's, women's, boys' and girls' categories. A national marketing program includes national advertising and local cooperative advertising, promotions and in-store merchandising. The casualwear market is fragmented and has no dominant brands.\nIn 1993, twenty new styles were introduced in the casualwear line with more fashion treatments, color selections and heavier fabrics; sixty-three new styles were added in 1994 which emphasized casualwear tailored specifically for ladies and girls. Late in the fourth quarter of 1994, the Company reevaluated its continued expansion of the FRUIT OF THE LOOM casualwear line. As a result of the Company's reevaluation, a substantial number of slower moving or less profitable items have been removed from the line.\nIn March 1994, the Company purchased certain assets of the Gitano Group, Inc. (\"Gitano\"), including the GITANO and other trademarks. Gitano designs, manufactures (including contract manufacturing) and markets women's and men's jeanswear and jeans related sportswear. During 1994 and prior to the acquisition of the certain Gitano assets by the Company, Gitano provided certain merchandising, marketing and design functions for its largest customer which then directly contracted for the merchandise from third party sources. Following the acquisition by the Company, Gitano reverted to a traditional role of an apparel wholesaler, carrying and financing its jeanswear and jeans related product inventories and selling these goods to its customers. Accordingly, the former arrangement of providing merchandise, marketing and design services to its largest customer on a fee basis was terminated in late 1994. In addition to its core apparel products, Gitano licenses the production and sale of a variety of accessories and other products bearing the GITANO trademark.\nThe Company entered the imprinted licensed sportswear business through its acquisitions of Salem Sportswear Corporation (\"Salem\"), Artex Manufacturing Co. Inc. (\"Artex\") and Pro Player, Inc. (\"Pro Player\"), which were acquired in November 1993, January 1994 and August 1994, respectively. The Company designs, manufactures and markets sports apparel under licenses granted by major American sports leagues, professional players and many American colleges and universities. The Company sells a wide variety of quality sportswear, including T-shirts, sweatshirts, shorts and light outerwear under the SALEM, SALEM SPORTSWEAR and OFFICIAL FAN brands. The Company manufactures and markets a wide variety of decorated sportswear to retail stores, college book stores and mass merchants. The Company is currently one of only three companies using the \"dual\" license concept of combining licensed cartoon characters with the logos of major professional sports leagues. The Company has licenses from all the major professional sports leagues as well as from the Walt Disney Company and Warner Bros. for LOONEY TUNES . Under its PRO PLAYER brand, the Company\nITEM 1. BUSINESS - (Continued)\ndesigns and markets heavy jackets, light jackets, headwear and other outerwear bearing the logos or insignia of professional and college teams and leagues. In addition, the Company (under license agreements) manufactures and markets sportswear featuring the well known WILSON trademark. In late December 1994, the Company announced the closing of substantially all of the operating locations of Artex and the consolidation of these operations into existing Company facilities.\nThe Company produces women's and girls' underwear, in white and colors, under the FRUIT OF THE LOOM brand name. The Company introduced its women's and girls' lines in 1984 using the branded, packaged product strategy that it had successfully employed in the men's and boys' market. In 1994 the Company introduced a new panty program with all new product, new fit, new construction and re-designed packaging. The Company's products are packaged, typically three to a pack, making them convenient for the merchant to handle and display. During the last five calendar years, in the fragmented women's and girls' underwear market, the Company was one of the branded market leaders with a market share ranging from approximately 13% to 17%. In 1994, the Company's share in the women's and girls' underwear market was approximately 13% compared to a market share of 26% for the largest competing brand. No other competitor had more than a 4% market share in 1994.\nThe Company granted a license to Warnaco Inc. whereby Warnaco Inc. manufactures and sells bras, slips, camisoles and other products under the FRUIT OF THE LOOM brand name in North America. The Company also licenses the use of the FRUIT OF THE LOOM brand name to a select group of companies who manufacture a variety of products such as ladies athleticwear and sheer hosiery.\nThe Company offers a broad array of childrenswear including decorated underwear (generally with pictures of licensed movie or cartoon characters) under the FUNPALS and FUNGALS brand names and layette sets under the FRUIT OF THE LOOM brand and the recently developed WINNIE THE POOH license which includes both packaged and hanging sets.\nThe Company entered the basic family sock market in mid-1986 through acquisitions and management believes the Company is now one of the two largest domestic manufacturers and that no manufacturer has more than a 10% market share.\nMarketing and Distribution\nThe Company sells its products to over 22,000 accounts, including all major discount and mass merchandisers, wholesale clubs and screen printers. The Company also sells to many department, specialty, drug and variety stores, national chains, supermarkets and sports specialty stores. The Company's products are principally sold by a nationally organized direct sales force of full-time employees. Certain of the Company's imprinted sportswear products are sold through independent sales representatives. The Company's products are shipped from 17 primary distribution centers to over 82,000 customer locations.\nManagement believes that one of the Company's primary strengths is its excellent relationships with mass merchandisers and discount chains. These retailers accounted for approximately 66% of the men's and boys' underwear and\nITEM 1. BUSINESS - (Continued)\nMarketing and Distribution - (Concluded)\napproximately 58% of the women's and girls' underwear sold in the United States in 1994, up from approximately 56% and 54%, respectively, in 1990. The Company supplied approximately 50% of the men's and boys' underwear and approximately 20% of the women's and girls' underwear sold by discount and mass merchandisers in the United States in 1994. During the last several years many of the Company's principal customers have revamped their inventory and distribution systems requiring their suppliers to offer more flexible product deliveries. In response to these demands, the Company has invested heavily in warehousing and distribution facilities.\nSales to one customer amounted to approximately 15.6%, 13.4% and 11.8% of consolidated net sales in 1994, 1993 and 1992, respectively. Additionally, sales to a second customer amounted to approximately 11.8%, 12.3% and 10.2% of consolidated net sales in 1994, 1993 and 1992, respectively. Management does not believe the loss of any one customer would adversely affect its business as a large percentage of these sales would shift to other outlets due to the high degree of brand awareness and consumer loyalty to the Company's products. The Company's business is seasonal to the extent that approximately 56% of annual sales occur in the second and third quarters. Sales are generally the lowest in the first quarter.\nInternational Operations\nThe Company primarily sells activewear through its foreign operations, principally in the United Kingdom, continental Europe, Canada, Mexico and Japan. The Company's approach has generally been to establish production in foreign markets by both acquiring existing manufacturing facilities and building new plants in order to decrease the impact of foreign currency fluctuations on international sales and to better serve these markets. The Company has established manufacturing plants in Canada, the Republic of Ireland and Northern Ireland (United Kingdom) as a means of accomplishing these objectives. In addition, the Company has established manufacturing operations in Mexico, Honduras, El Salvador and Jamaica to assemble fabrics which have been manufactured and cut in the Company's United States' operations, as well as externally sourced fabric, into finished goods for sale principally in the United States. The Company has established manufacturing operations in Morocco where fabrics from the Republic of Ireland are cut and sewn and returned to Europe for sale.\nSince 1990, the Company's international sales have more than doubled. Sales from international operations during 1994 were $325,800,000 and were principally generated from products manufactured at the Company's foreign facilities. These international sales accounted for approximately 14.2% of the Company's net sales in 1994. Management believes international sales will continue to be a source of growth for the Company, particularly in Europe. This growth will depend on continued demand for the Company's products in diverse international marketplaces. See \"Business Segment and Major Customer Information\" in the Notes to Consolidated Financial Statements.\nITEM 1. BUSINESS - (Continued)\nManufacturing\nPrincipal manufacturing operations consist of spinning, knitting, cloth finishing, cutting, sewing and packaging. In addition, licensed sportswear products are generally produced by applying decorative images, most often by screen printing or embroidery, to blank garments. The Company knits yarn into fabric using a multiple-knitting technique that produces long tubes of fabric corresponding in weight and diameter to various sizes and styles required to make underwear and activewear. Substantially all of the Company's products are either bleached to remove the ecru color of natural cotton or dyed for colored products. To achieve certain colors, the fabric must be bleached and dyed.\nComputer controlled die cutting is used in all areas where management believes it is more efficient. Fabric is distributed to employees operating individual sewing machines. To increase efficiency, each employee specializes in a particular function, such as sewing waistbands on briefs. Quality checkpoints occur at many intervals in the manufacturing process, and each garment is inspected prior to packaging.\nCompetition\nAll of the Company's markets are highly competitive. Competition in the underwear and activewear markets is generally based upon quality, price and delivery. The Company's vertically integrated manufacturing structure, supplemented with some off-shore sewing of fabrics supplied by the Company's domestic knitting operations, allows it to produce high quality products at costs which management believes are among the lowest in the industry. The Company has recently invested additional capital in warehousing and distribution facilities to service its customer base effectively. In response to market conditions, the Company, from time to time, reviews and adjusts its product offerings and pricing structure. Where appropriate, the Company uses contract manufacturing to further minimize its costs. Such contract manufacturing accounted for less than 5% of the Company's total production in 1994.\nLicensing and Trademarks\nThe Company owns the FRUIT OF THE LOOM, BVD, SCREEN STARS, BEST, LOFTEEZ and certain other trademarks, which are registered or protected by common law in the United States and in many foreign countries. These trademarks are used on men's, women's and children's underwear and activewear and sportswear marketed by the Company. The Company owns the GITANO trademark which is registered in the United States and in many foreign countries for use principally in connection with women's jeanswear, sportswear and certain other apparel and accessory items.\nThe Company licenses properties from different companies for its decorated underwear products. Among the characters licensed are: THE LITTLE MERMAID , BEAUTY AND THE BEAST , 101 DALMATIANS , BATMAN , BATMAN FOREVER , LOONEY TUNES, SONIC THE HEDGEHOG , BIKER MICE FROM MARS , MIGHTY MORPHIN POWER RANGERS , LAMB CHOP , THE SWAN PRINCESS , VR TROOPERS , SKELETON WARRIORS , PEANUTS , POCAHONTAS and WINNIE THE POOH. The Company also has a license to use the MUNSINGWEAR, KANGAROO, BOTANY 500 and JOHN HENRY trademarks on its men's and\nITEM 1. BUSINESS - (Continued)\nLicensing and Trademarks - (Concluded)\nboys' underwear and certain activewear. The Company has a license to use the WILSON brand on its sweatshirts and sweatpants, T-shirts, shorts and other athletic activewear.\nIn addition, the Company owns the SALEM, SALEM SPORTSWEAR, OFFICIAL FAN and PRO PLAYER trademarks for its licensed sportswear business. The Company licenses properties, including team insignia, images of professional athletes and college logos, from the National Football League, the National Basketball Association, Major League Baseball, the National Hockey League, professional players' associations and certain individual players and many American colleges and universities. These owned and licensed trademarks are used on sports apparel, principally T-shirts, shorts, sweatshirts and jerseys, marketed by the Company. The Company also licenses properties from the Walt Disney Company and Warner Bros. for LOONEY TUNES for use in a dual license concept combining cartoon characters with major professional sports leagues.\nIn 1994, the Company entered into a licensing agreement with the Walt Disney Company whereby the Company's European subsidiary will offer for sale a variety of casualwear apparel products bearing the world famous DISNEY characters in Europe, Eastern Europe and the Middle East. Collections to be offered will include T-shirts, sweatshirts, sweatpants, shorts, shirts, turtlenecks, polos and leggings as well as a number of denim products. Products are expected to be available in retail stores in the Fall of 1995.\nImports\nThe Company did not experience a negative impact from the implementation of the North American Free Trade Agreement (NAFTA). NAFTA's strict rule of origin, which generally requires apparel to be made from North American spun yarn and North American knit or woven fabric, should continue to prevent Mexico from becoming an export platform for low-wage manufacturers from outside the region. The Company believes that its more capital and technology intensive yarn spinning, knitting and cloth finishing operations in the United States remain at an advantage to import competitors. Nonetheless, apparel imports from Mexico are increasing. As the Company produces more garments in total, the Company is increasing the capacity of its more labor intensive assembly operations in Mexico, the Caribbean and Central America. This action is necessary to help the Company remain competitive as import competition increases.\nAs with Mexico, imports from the Caribbean and Central America likely will continue to rise more rapidly than imports from other parts of the world. This is because Section 9802 (previously Section 807) of the United States tariff schedule grants preferential quotas for Caribbean and Central American countries when United States made and cut fabrics are used, and duty is paid only on the value added outside the United States. United States apparel and textile manufacturers, including the Company, will continue to use Section 9802 to compete with direct imports. The use of Section 9802 will accelerate if the United States Congress adopts the proposed \"NAFTA Parity\" for the countries of the Caribbean and Central America, which, among other things, would grant duty free treatment for apparel assembled in the region from United States components.\nITEM 1. BUSINESS - (Continued)\nImports - (Concluded)\nDirect imports accounted for approximately 21% of the United States men's and boys' underwear market (46% if Section 9802 imports are included) in 1994 and approximately 39% (81% including Section 9802 imports) of the women's and girls' underwear market. With regard to activewear and cotton socks, imports accounted for approximately 35% and 2.4% of these respective markets in 1993, the latest period for which data is available.\nU.S. tariffs and quotas established under the international agreement known as the Multifiber Arrangements (MFA) limit the growth of imports from low wage foreign suppliers such as China, India and Pakistan. Consequently, management does not believe that imports from these countries presently pose a significant threat to its business. Import competition will continue to increase and accelerate as MFA quotas are phased out. Quotas will be completely eliminated on January 1, 2005. The Company will monitor closely the impact of the MFA quota phase out and will respond as necessary to maintain its low-cost position.\nEmployees\nThe Company employs approximately 37,400 persons. Approximately 5,200 employees, principally international, are covered by collective bargaining agreements.\nMiscellaneous\nMaterials and Supplies. Materials and supplies used by the Company are available in adequate quantities. The primary raw materials used in the manufacturing processes are cotton and polyester which are subject to the price volatility of the commodity markets. The Company enters into futures contracts as hedges for its purchases of cotton for inventory.\nOther. The Company was incorporated under the laws of the state of Delaware in 1985. The principal executive offices of the Company are located at 233 South Wacker Drive, 5000 Sears Tower, Chicago, Illinois 60606, telephone (312)876-1724. As used in this Annual Report on Form 10-K, the term \"the Company\" refers to Fruit of the Loom, Inc. and its subsidiaries, together with its predecessor, Northwest Industries, Inc. (\"Northwest\"), unless otherwise stated or indicated by the context. Market share data contained herein are for domestic markets and are based upon information supplied to the Company by the National Purchase Diary, which management believes to be reliable.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. LEGAL PROCEEDINGS - (Continued)\naggregate, represent approximately 96% of the net reserve. Management believes it has adequately estimated the impact of remediating identified sites, the expected contribution from other potentially responsible parties and recurring costs for managing sites as well as the ultimate resolution of the product liability claims. Management currently estimates actual payments before recoveries to range from approximately $9,200,000 to $24,200,000 annually between 1995 and 1998 and $14,300,000 in total subsequent to 1998. Only the long-term monitoring costs of approximately $6,600,000 primarily scheduled to be paid in 1999 and beyond have been discounted. The discount rate used was 10%. The undiscounted aggregate long-term monitoring costs, to be paid over approximately the next 20 years, is approximately $17,800,000. Management believes that adequate reserves have been established to cover potential claims based on facts currently available and current Superfund Legislation. The Company has provided the foregoing information in accordance with Staff Accounting Bulletin 92.\nGenerators of hazardous wastes which were disposed of at offsite locations which are now superfund sites are subject to claims brought by state and Federal regulatory agencies under Superfund Legislation and by private citizens under Superfund Legislation and common law theories. Since 1982, the United States Environmental Protection Agency (the \"EPA\") has actively sought compensation for response costs and remedial action at offsite disposal locations from waste generators under the Superfund Legislation, which authorizes such action by the EPA regardless of fault, legality of original disposal or ownership of a disposal site. The EPA's activities under the Superfund Legislation can be expected to continue during 1995 and future years.\nIn February 1986, the Company completed the sale of stock of its then wholly owned subsidiary, Universal Manufacturing Corporation (\"Universal\"), to MagneTek, Inc., (\"MagneTek\"). At the time of the sale there was a suit pending against Universal and Northwest by L.M.P. Corporation (\"LMP\"). The suit (the \"LMP Litigation\") alleged that Universal and Northwest fraudulently induced LMP to sell its business to Universal and then suppressed the development of certain electronic lighting ballasts in breach of the agreement of sale, which required Universal to pay to LMP a percentage of the net profits from such business from 1982 through 1986. Two additional plaintiffs, Stevens Luminoptics Partnership and Calmont Technologies Inc., joined the litigation in 1986. In December 1989 and January 1990, a jury returned certain verdicts against Universal and also returned verdicts in favor of Northwest and on certain issues in favor of Universal. A judgment totalling $25,800,000, of which $7,500,000 represented punitive damages, reflecting these verdicts was entered by the Alameda County, California Superior Court in January 1990 against Universal.\nIn April 1992, the California Court of Appeals reversed the $25,800,000 judgment against Universal and affirmed those verdicts favorable to Universal and Northwest. In July 1992, the California Supreme Court denied the plaintiffs' petition for review. The case was then remanded to the trial court. In October 1994, following a retrial of the LMP Litigation, a jury returned a verdict of approximately $96,000,000 against Universal. The jury verdict included breach of contract and fraud damages and approximately $6,000,000 in punitive damages. The Company is obligated to indemnify Universal for damages incurred in this case.\nITEM 2. LEGAL PROCEEDINGS - (Continued)\nManagement of the Company believes that the jury's decision is incorrect and is contrary to the evidence. Based on discussions with counsel and on other information currently available, management believes that the court committed numerous errors during the trial and, accordingly, that the judgment will not stand on appeal. The Company intends to vigorously appeal this verdict.\nIn March 1988, a class action suit entitled Endo et al. v. Albertine, et al. was filed in the United States District Court for the Northern District of Illinois (the \"District Court\") against the Company, its then directors, certain of its then executive officers, its then underwriters and the Company's current independent auditors in connection with the Company's initial public offering of Class A Common Stock and certain debt securities in March 1987. The suit alleges, among other things, violations of Federal and state securities laws against all of the defendants, as well as breaches of fiduciary duties by the director and officer defendants, and seeks unspecified damages.\nMotions to dismiss the complaint were filed by all defendants. In December 1990, a magistrate judge recommended that the District Court dismiss all of the plaintiffs' claims with prejudice. On January 29, 1993, the District Court adopted in part and rejected in part the magistrate judge's recommendation for dismissal of the complaint. As a result, the litigation will continue as to various remaining counts of the complaint. Both the defendants and the plaintiffs filed motions for summary judgment which were denied in all material respects. Management and the Board of Directors believe that this suit is without merit and intend to continue to vigorously defend against this litigation.\nOn December 23, 1993, James J. Locke, as Trustee of Locke Family Trust, and I. Jack Saline filed a lawsuit against the Company and certain of its then officers and directors, including William Farley and John B. Holland, in the District Court. The lawsuit was then amended to add additional plaintiffs. On April 19, 1994, the District Court granted plaintiffs' motion for class certification. The plaintiffs claim that all of the defendants engaged in conduct violating Section 10b of the Securities Exchange Act of 1934, as amended (the \"Act\"), and that Mr. Farley and Mr. Holland also violated Section 20a of the Act. According to the plaintiffs, beginning before June 1992 and continuing through early June 1993, the Company, with the knowledge and assistance of the individual defendants, issued positive public statements about its expected sales increases and growth through 1993 and afterwards. They also allege that beginning in approximately mid-1992 and continuing afterwards, the Company's business was not as strong and its growth prospects were not as certain as represented. The plaintiffs further allege that during the end of 1992 and beginning of 1993, certain of the individual defendants traded the stock of the Company while in the possession of material, non-public information. The plaintiffs ask for unspecified amounts as compensatory damages, pre-judgment and post-judgment interest, attorneys' fees, expert witness fees and costs and ask the District Court to impose a constructive trust on the proceeds of the individual defendants' trades to satisfy any potential judgment. Management believes that this suit is without merit and management and the Company intend to vigorously defend against this litigation.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - (Concluded)\nManagement believes, based on information currently available, that the ultimate resolution of the aforementioned litigation will not have a material adverse effect on the financial condition or operations of the Company.\nIn March 1992, the Company received a refund of approximately $60,000,000 relating to Federal income taxes paid by Northwest plus interest thereon applicable to the tax years 1964-1968. However, in September 1992, the Internal Revenue Service (the \"IRS\") issued a statutory notice of deficiency in the amount of approximately $7,300,000 for the taxable years from which the March 1992 refund arose, exclusive of interest which would have accrued from the date the IRS asserted the tax was due until payment, presently a period of about 27 years. In October 1994 the United States Tax Court ruled in favor of the Company in the above case. In January 1995 the IRS filed an appeal with the United States Court of Appeals for the Seventh Circuit. The Company believes, based on information currently available, that the IRS position is without merit and that the Company will prevail in this appeal.\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\nWilliam Farley, an executive officer and director of the Company, holds 100% of the common stock of Farley Inc. (\"FI\"). William Farley and FI together own all of the Class B Common Stock of the Company outstanding. See \"Consolidated Statement of Common Stockholders' Equity\" in the Notes to Consolidated Financial Statements. William Farley also owns 318,000 shares of the Class A Common Stock of the Company. As of March 10, 1995, there were 2,593 registered holders of record of the Class A Common Stock of the Company.\nCommon Stock Prices and Dividends Paid\nThe Company's Class A Common Stock is listed on the New York Stock Exchange. Prior to December 3, 1993, the Company's Class A Common Stock was listed on the American Stock Exchange. The following table sets forth the high and low market prices of the Class A Common Stock for 1994 and 1993:\nNo dividends were declared on the Company's common stock issues during 1994 or 1993. The Company does not currently anticipate paying any dividends in 1995. For restrictions on the present or future ability to pay dividends, see \"Long-Term Debt\" in the Notes to Consolidated Financial Statements.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (In Millions, Except Per Share Data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe table below sets forth selected operating data (in millions of dollars and as percentages of net sales) of the Company:\nOperations\n1994 Compared to 1993\nNet sales increased 21.9% in 1994 compared to 1993. The increase in net sales in 1994 was primarily due to the results of the Company's new licensed sports apparel line, principally as a result of the acquisitions of Salem in November 1993, Artex in January 1994 and Pro Player in August 1994. Also, volume increases in certain of the Company's existing businesses reflecting improved demand and the introduction of new programs and products in 1994 contributed to the sales increase in 1994. In addition, the 1994 results include the operations of Gitano since April 1994. These increases were partially offset by the negative effects of lower average selling prices (principally for domestic activewear in the first six months of 1994).\nGross earnings decreased .1% in 1994 compared to 1993. The gross margin was 28.1% in 1994 compared to 34.4% in 1993. In December 1994, the Company announced the closing of substantially all of the operations of Artex, consolidating the manufacturing portion of those operations into existing Company-owned facilities. In addition, the Company's casualwear businesses, Fruit of the Loom casualwear and Gitano, undertook significant product line reduction programs during the fourth quarter, and administrative consolidations resulted in the elimination of the New York casualwear group. The Company also undertook a comprehensive review of its other domestic product offerings during the last quarter of 1994. As a result of this review, a substantial number of slower moving or less profitable items have been removed, principally from the casualwear and licensed sports apparel lines, and written down to net realizable value. The total of the various inventory related charges was approximately $40,000,000. In addition, gross earnings and gross margin have been impacted by the effects of lower prices and promotional activities, other general cost increases, including cotton cost increases, and manufacturing inefficiencies as certain sewing operations are transferred to offshore locations.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)\nOperations - (Continued) 1994 Compared to 1993 - (Continued)\nOperating earnings decreased 38.4% compared to 1993 while the operating margin decreased ten percentage points to 10.2% of net sales in 1994. The decreases in operating earnings resulted from higher selling, general and administrative expenses and goodwill amortization (from the acquisitions of Salem, Artex, Gitano and Pro Player) in 1994, coupled with the decrease in gross earnings. Selling, general and administrative expenses increased to 16.4% of net sales in 1994 compared to 12.7% of net sales in 1993. Higher selling and other administrative costs arose both from the acquisitions of Salem, Artex, Gitano and Pro Player and from the Company's continuing effort to improve customer service by making investments in added distribution capabilities, computer systems and other infrastructure required to service customers more effectively. In addition, selling, general and administrative expenses in 1994 include charges related to the consolidation of the Company's licensed sportswear operations.Costs associated with the closing of the Artex operations included the write-off of approximately $18,000,000 of intangibles. The increases in selling, general and administrative expenses also include higher royalty costs in 1994, principally due to the acquisitions of the Salem, Artex and Pro Player licensed sports apparel operations.\nInterest expense in 1994 increased 31.2% from 1993. The increase was principally attributable to the effect of higher debt levels in 1994. Higher debt levels were primarily due to the acquisitions of Salem, Artex, Gitano and Pro Player, which were financed through borrowings under the Company's $800,000,000 revolving line of credit (the \"New Credit Agreement\"), and higher working capital levels.\nIncluded in other expense - net in 1994 is $16,000,000 of service fee income from Gitano's operations which represented Gitano's transition to a marketing service organization from a traditional wholesaler base. These revenues are not expected to recur after 1994 as Gitano reverts to a traditional apparel wholesaler. This was partially offset by $12,500,000 of charges to provide for certain obligations of and legal expenses pertaining to litigation related to retained liabilities of former subsidiaries. In addition, other expense - net in 1994 and 1993 included approximately $8,100,000 and $7,900,000, respectively, of deferred debt fee amortization and bank fees.\nIn 1993 the Company received approximately $72,900,000 from Acme Boot representing the entire unpaid principal and liquidation preference (including accrued interest and dividends) on its investment in the securities of the affiliate. The Company recorded a pretax gain of $67,300,000 related to the investment in Acme Boot upon the receipt of the above mentioned proceeds. See \"Related Party Transactions\" in the Notes to Consolidated Financial Statements.\nThe effective income tax rate for 1994 and 1993 differed from the Federal statutory rate of 35% primarily due to the impact of goodwill amortization, a portion of which is not deductible for Federal income tax purposes, state income taxes and the provision for interest related to prior years' taxes.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)\nOperations - (Continued) 1994 Compared to 1993 - (Concluded)\nIn 1993 the Company recorded an extraordinary charge of $8,700,000 ($.11 per share) in connection with the refinancing of its bank credit agreements and the redemption of its 12-3\/8% Senior Subordinated Debentures due 2003 (the \"12-3\/8% Notes\"). The extraordinary charge consisted principally of the non- cash write-off of the related unamortized debt expense on the bank credit agreements, the 12-3\/8% Notes and other debt issues and the premiums paid in connection with the early redemption of the 12-3\/8% Notes, both net of income tax benefits.\nIn the first quarter of 1993, the Company recorded the cumulative effect of an accounting change related to the adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"Statement No. 109\"), resulting in a $3,400,000 ($.04 per share) benefit.\nEarnings per share before extraordinary items and cumulative effect of change in accounting principle decreased 71.8% to $.79 from $2.80 for 1993. Net earnings per share in 1993 were $2.73 and included an $.11 extraordinary charge related to the early retirement of debt and a $.04 benefit related to the cumulative effect of a change in accounting for income taxes.\nManagement believes that the relatively moderate rate of inflation over the past few years has not had a significant impact on the Company's sales or profitability.\n1993 Compared to 1992\nNet sales increased 1.6% in 1993 from 1992. The increased net sales for 1993 as compared to 1992 are due to volume increases in casualwear, international activewear and underwear combined with price increases (principally for domestic activewear and casualwear). These increases more than offset the adverse effects of volume declines in domestic activewear, unfavorable foreign currency exchange rate comparisons on international sales between the two periods and increased sales of promotional and closeout merchandise in 1993. With respect to international operations, the Company's approach has been to establish production in foreign markets by both acquiring existing manufacturing facilities and building new plants in order to better serve these markets. Management believes international sales will continue to be a source of growth for the Company, particularly in Europe. However, any such growth is subject to the risk that the Company's products in diverse international marketplaces will not be widely accepted.\nGross earnings decreased 2.0% in 1993 compared to 1992. The gross margin was 34.4% in 1993 compared to 35.6% in 1992. The decrease in gross earnings in 1993 is due primarily to the unfavorable effects of operating certain facilities on reduced production schedules in response to lower than expected consumer demand, inventory valuation adjustments and unfavorable changes in product mix due to promotions and closeouts. These decreases more than offset the favorable effects of the sales price and volume increases discussed above and lower raw material costs.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)\nOperations - (Concluded) 1993 Compared to 1992 - (Concluded)\nOperating earnings decreased 6.9% compared to 1992 and the operating margin decreased 1.9 percentage points to 20.2% in 1993. The decreases are due to lower gross earnings and gross margin as well as higher selling, general and administrative expenses. Selling, general and administrative expenses increased to 12.7% of net sales in 1993 compared to 12.1% in the prior year. The spending increase is primarily attributable to increased selling expenses resulting from increased royalty payments and increased shipping expenses. The shipping expense increase results from a shift in product mix to more casualwear and an increased number of shipments as customer order patterns have changed to include an increased number of smaller quantity shipments.\nInterest expense for 1993 decreased 11.4% from 1992. Lower interest expense is principally attributable to the effect of lower interest rates on the Company's debt instruments which more than offset the effects of higher average debt levels during 1993. The lower interest rates are principally due to the Company's refinancing of its 10-3\/4% Notes (as hereinafter defined) with a 7-7\/8% senior note issue in the fourth quarter of 1992. In addition, lower average prime and LIBOR interest rates on the Company's variable rate debt instruments in 1993 compared to 1992 contributed to the lower average interest rates.\nThe effective income tax rate before extraordinary items and cumulative effect of change in accounting principle for 1993 and 1992 differed from the Federal statutory rate of 35% and 34%, respectively, primarily due to the impact of goodwill amortization, which is not deductible for Federal income tax purposes, state income taxes and the provision for interest related to prior years' taxes.\nIn 1992, the Company redeemed all of its $280,000,000 principal amount of 10-3\/4% Senior Subordinated Notes due July 15, 1995 (the \"10-3\/4% Notes\"). The Company recorded an extraordinary charge of approximately $9,900,000 ($.13 per share) in connection with the redemption of the 10-3\/4% Notes, which consisted principally of the premiums paid in connection with the early redemption of the 10-3\/4% Notes and the non-cash write-off of the related unamortized debt expense, both net of income tax benefits.\nEarnings per share before extraordinary items and cumulative effect of change in accounting principle were $2.80 for 1993 compared to $2.48 for 1992, a 12.9% increase. Net earnings per share in 1993 were $2.73 and include an $.11 extraordinary charge related to the early retirement of debt and a $.04 benefit related to the cumulative effect of a change in accounting for income taxes. Included in earnings per share before extraordinary items and cumulative effect of change in accounting principle and net earnings per share in 1993 is the effect of a gain related to the Company's investment in Acme Boot of $.55 per share.\nLiquidity and Capital Resources\nFunds generated from the Company's operations are the major source of liquidity and are supplemented by funds obtained from capital markets including\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)\nLiquidity and Capital Resources - (Concluded)\nbank facilities. During 1994, the Company obtained bank revolving lines of credit for certain of its foreign operations and separate letter of credit facilities to replace certain letters of credit which were outstanding under the New Credit Agreement at December 31, 1993.\nIn connection with the verdict in the LMP Litigation, the Company posted a bond on November 9, 1994 in an amount equal to one and one-half times the value of the judgment as collateral for the judgment during the pendency of an appeal of the verdict. In order to obtain the bond, a $73,000,000 letter of credit was required which reduced the Company's borrowing availability under the New Credit Agreement.\nThe Company has available for the funding of its operations approximately $846,200,000 of revolving lines of credit. As of March 21, 1995 approximately $88,600,000 was available and unused under these facilities.\nNet cash provided by operating activities for the years ended December 31, 1994 and 1993 were $215,100,000 and $89,800,000, respectively. The primary components of cash provided by operating activities in 1994 were net earnings plus depreciation and amortization (totaling $216,100,000) partially offset by an increase in working capital of $3,600,000. In 1994, increases in trade accounts payable of $32,500,000 and other working capital declines (primarily increased other current liabilities) of $60,600,000 only partially offset increases in accounts receivable of $23,300,000 and inventories of $73,400,000. The primary components of cash provided by operating activities in 1993 were net earnings plus depreciation and amortization (totaling $329,100,000) partially offset by an increase in working capital of $152,200,000. The working capital increase in 1993 was principally caused by higher inventories of $130,700,000. The increases in inventory in both 1994 and 1993 reflected the Company's ongoing efforts to improve customer service and, in 1994, the effect of the acquisitions of Artex, Gitano and Pro Player. In 1993, the Company realized a gain from its investment in Acme Boot of approximately $67,300,000, the cash effect of which was included in investing activities for 1993.\nNet cash used for investing activities in 1994 and 1993 were $430,800,000 and $335,900,000, respectively. Capital expenditures, net of amounts attributable to capital leases of $40,600,000 and $2,900,000 in 1994 and 1993, respectively, were $246,400,000 and $259,600,000 in 1994 and 1993, respectively. In 1994 the Company used approximately $192,100,000 on the acquisitions of Artex, Gitano and Pro Player, the funds for which were provided by borrowings under the New Credit Agreement. In 1993, the Company used approximately $157,600,000 on the acquisition of Salem. Also in 1993, the Company received approximately $72,900,000 in proceeds from the investment in Acme Boot. Capital spending, primarily to enhance distribution and yarn manufacturing capabilities and to establish and support offshore assembly operations, is anticipated to approximate $125,000,000 to $140,000,000 in 1995.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Continued)\nLiquidity and Capital Resources - (Concluded)\nNet cash provided by financing activities in 1994 and 1993 was $190,900,000 and $262,900,000, respectively, and consisted principally of borrowings under the Company's bank credit agreements.\nIn September 1994 the Company entered into a five year operating lease agreement with two automatic annual renewal options, primarily for certain machinery and equipment. The total cost of the assets to be covered by the lease is limited to $200,000,000. The total cost of assets under lease as of December 31, 1994 was approximately $76,000,000. The lease provides for a substantial residual value guarantee by the Company at the termination of the lease and includes purchase and renewal options at fair market values.\nManagement believes the funding available to it is sufficient to meet anticipated requirements for capital expenditures, working capital and other needs.\nThe Company's debt instruments, principally its bank agreements, contain covenants restricting its ability to sell assets, incur debt, pay dividends and make investments and requiring the Company to maintain certain financial ratios. See \"Long-Term Debt\" in the Notes to Consolidated Financial Statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA FRUIT OF THE LOOM, INC. AND SUBSIDIARIES\nReport of Ernst & Young LLP, Independent Auditors . . . . . . . . . . . 25\nConsolidated Balance Sheet - December 31, 1994 and 1993 . . . . . . . . 26\nConsolidated Statement of Earnings for Each of the Years Ended December 31, 1994, 1993 and 1992 . . . . . . . . . . . . . . . . . . . . . . 28\nConsolidated Statement of Cash Flows for Each of the Years Ended December 31, 1994, 1993 and 1992 . . . . . . . . . . . . . . . . . . 29\nNotes to Consolidated Financial Statements . . . . . . . . . . . . . . . 30\nSupplementary Data (Unaudited) . . . . . . . . . . . . . . . . . . . . . 56\nFinancial Statement Schedule:\nSchedule II - Valuation and Qualifying Accounts . . . . . . . . . . . 65\nNote: All other schedules are omitted because they are not applicable or not required.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nTo the Board of Directors of Fruit of the Loom, Inc.\nWe have audited the accompanying consolidated balance sheet of Fruit of the Loom, Inc. and 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. 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 Fruit of the Loom, 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 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 in 1993.\nERNST & YOUNG LLP Chicago, Illinois February 14, 1995\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET\nSee accompanying notes.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS\nSee accompanying notes.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS\nSee accompanying notes.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSummary of Significant Accounting Policies\nPrinciples of Consolidation. The consolidated financial statements of the Company include the accounts of the Company and all of its subsidiaries. All material intercompany accounts and transactions have been eliminated.\nInventories. Inventory costs include material, labor and factory overhead. Inventories are stated at the lower of cost or market (net realizable value). Approximately 71.9% and 78.9% of year-end inventory amounts at December 31, 1994 and 1993, respectively, are determined using the last-in, first-out cost method. If the first-in, first-out method had been used, such inventories would have been $41,500,000 and $29,400,000 higher than reported at December 31, 1994 and 1993, respectively. The remainder of the inventories are determined using the first-in, first-out method.\nProperty, Plant and Equipment. Property, plant and equipment is stated at cost. Depreciation, which includes amortization of assets under capital leases, is based on the straight-line method over the estimated useful lives of depreciable assets. Interest costs incurred in the construction or acquisition of property, plant and equipment are capitalized.\nGoodwill. Goodwill is amortized using the straight-line method over periods ranging from 15 to 40 years.\nPre-operating Costs. Pre-operating costs associated with the start-up of significant new production facilities are deferred and amortized over three years.\nFutures Contracts. The Company periodically enters into futures contracts as hedges for its purchases of cotton for inventory. Gains and losses on these hedges are matched to inventory purchases and charged or credited to cost of sales as such inventory is sold.\nForward Contracts. The Company has entered into forward contracts to cover its principal and interest obligations on certain foreign currency denominated bank loans. The original discount on these contracts is amortized over the life of the contract and serves to reduce the effective interest cost of these loans. In addition, the Company has entered into forward contracts to cover the future obligations of certain foreign subsidiaries for certain inventory purchases. Gains and losses related to qualifying hedges of firm commitments are deferred and are matched to inventory purchases and charged or credited to cost of sales as such inventory is sold. Gains and losses related to anticipated transactions that do not qualify as hedges are recognized as components of other income or expense as they are incurred.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nSummary of Significant Accounting Policies - (Concluded)\nDeferred Grants. The Company has negotiated grants from the governments of the Republic of Ireland and of Northern Ireland. The grants are being used for employee training, the acquisition of property and equipment and other governmental business incentives such as general employment. Employee training grants are recognized in income in the year in which the costs to which they relate are incurred by the Company. Grants for the acquisition of property and equipment are netted against the related capital expenditure. Grants for property and equipment under operating leases are amortized to income as a reduction of rents paid. Unamortized amounts netted against fixed assets under these grants at December 31, 1994 and 1993 were $33,500,000 and $28,500,000, respectively. At December 31, 1994 and 1993, the Company has a contingent liability to repay, in whole or in part, grants received of approximately $54,300,000 and $43,500,000, respectively, in the event that the Company does not meet defined average employment levels or terminates operations in the Republic of Ireland or Northern Ireland.\nIncome Taxes. Effective January 1, 1993, the Company adopted Statement No. 109. Under Statement No. 109, the liability method is used in accounting for income taxes. Prior to the adoption of Statement No. 109, income tax expense was determined using the deferred method.\nPension Plans. The Company maintains pension plans which cover substantially all employees. The plans provide for benefits based on an employee's years of service and compensation. The Company funds the minimum contributions required by the Employee Retirement Income Security Act of 1974.\nAcquisitions\nIn late January 1994 the Company acquired Artex for approximately $45,000,000. In late March 1994 the Company acquired certain assets of Gitano for approximately $91,400,000. In August 1994 the Company acquired Pro Player for approximately $55,700,000, including approximately $14,200,000 of Pro Player debt which was repaid by the Company. The principals of Pro Player, who are also key employees of that business, may also be entitled to receive compensation based in part on the attainment of certain levels of operating performance by the acquired entity. In November 1993 the Company acquired Salem for approximately $157,600,000, including approximately $23,900,000 of Salem debt which was repaid by the Company. The aforementioned acquisitions (collectively, the \"Acquisitions\") were accounted for using the purchase method of accounting. Accordingly, the purchase prices were preliminarily allocated to assets and liabilities based on their estimated fair values as of the date of the Acquisitions. The cost in excess of the net assets acquired in the Acquisitions was approximately $215,000,000 and is being amortized over periods ranging from 15 to 20 years. The results of operations of Salem, Artex, Gitano and Pro Player are not material in relation to the Company's consolidated financial statements and, therefore, pro forma financial information has not been presented.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nCash, Cash Equivalents and Restricted Cash\nThe Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Short-term investments (consisting primarily of certificates of deposit, overnight deposits or Eurodollar deposits) totaling $4,100,000 and $16,100,000 were included in cash and cash equivalents at December 31, 1994 and 1993, respectively. These investments were carried at cost, which approximated quoted market value.\nIncluded in short-term investments at December 31, 1994 and 1993 was $1,500,000 and $6,400,000, respectively, of restricted cash collateralizing domestic subsidiaries' letters of credit and insurance obligations.\nShort-Term Notes Payable\nIn August 1993, the Company entered into the New Credit Agreement. See \"Long-Term Debt.\" Certain indebtedness of the Company under preexisting secured domestic bank agreements was refinanced with the proceeds of loans under the New Credit Agreement and the preexisting bank agreements were terminated at that time.\nPrior to August 1993, the Company's domestic bank agreements consisted of revolving lines of credit, bank term loans (the\"Term Loan Facilities\"), a special purpose loan, a capital expenditure facility (the \"Capital Expenditure Facility\") and a letter of credit facility (collectively, the \"Credit Agreements\"). All borrowings under the Credit Agreements represented loans to the Company's principal operating subsidiary.\nUnder the Credit Agreements, the Company had $350,000,000 available for the funding of its operations under revolving lines of credit (the \"Revolving Credit Facilities\"). The Revolving Credit Facilities were scheduled to expire on June 30, 1995. Borrowings under the Revolving Credit Facilities were due on demand and were collateralized under the terms of the Credit Agreements.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nLong-Term Debt (In thousands of dollars)\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nLong-Term Debt - (Continued)\nThe New Credit Agreement provides the Company with an $800,000,000 revolving line of credit which expires in June 1999 and includes a letter of credit facility. At December 31, 1994 approximately $73,000,000 of letters of credit were issued under the New Credit Agreement to secure a bond posted in connection with the appeal of the LMP Litigation. At December 31, 1993 approximately $59,800,000 of letters of credit were issued under the New Credit Agreement to secure certain insurance and debt obligations reflected in the accompanying Consolidated Balance Sheet, which letters of credit were replaced with separate letter of credit facilities in 1994. Borrowings under the New Credit Agreement bear interest at a rate approximating the prime rate (8.5% at December 31, 1994) or, at the election of the Company, at rates approximating LIBOR (6.5% at December 31, 1994) plus 30 basis points. The Company also pays a facility fee (the \"Facility Fee\") under the New Credit Agreement equal to 15 basis points on the aggregate commitments thereunder. Interest rates and the Facility Fee are subject to increase or decrease based upon the Company's unsecured debt rating. The weighted average interest rate for borrowings outstanding under the New Credit Agreement at December 31, 1994 was approximately 6.45%. Borrowings under the New Credit Agreement are guaranteed by certain of the Company's subsidiaries.\nIn 1994 the Company obtained $84,400,000 of standby letter of credit facilities from its bank lenders. At December 31, 1994 approximately $83,300,000 of letters of credit were issued under this facility to secure various insurance and other obligations reflected in the accompanying Consolidated Balance Sheet. In addition, the Company has $95,000,000 of trade letter of credit facilities. At December 31, 1994 the Company has $51,100,000 of documentary letters of credit outstanding under these facilities to finance various trade activities.\nIn August 1993, the Company's wholly-owned subsidiary, Fruit of the Loom Canada, Inc. issued an unsecured senior note due 2008 (the \"Canadian Note\") in a private placement transaction with certain insurance companies. The Canadian Note is fully guaranteed by the Company and its principal operating subsidiaries and ranks pari passu in right of payment with the New Credit Agreement.\nIn 1993, the Company redeemed its 12-3\/8% Notes. The Company recorded an extraordinary charge in 1993 of approximately $8,700,000 ($.11 per share) relating to the early extinguishment of debt, primarily in connection with the refinancing of the Credit Agreements and the redemption of the 12-3\/8% Notes. The extraordinary charge consists principally of the non-cash write-off of the related unamortized debt expense on the Credit Agreements, the 12-3\/8% Notes and other debt issues and the premiums paid in connection with the early redemption of the 12-3\/8% Notes, both net of income tax benefits.\nIn 1993, the Company issued $150,000,000 principal amount of its 6-1\/2% Notes due 2003 (the \"6-1\/2% Notes\") and $150,000,000 principal amount of its 7-3\/8% Debentures due 2023 (the \"7-3\/8% Debentures\"). The 6-1\/2% Notes and the 7-3\/8% Debentures will mature November 15, 2003 and November 15, 2023, respectively, and may not be redeemed by the Company prior to maturity. The\n35 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nLong-Term Debt - (Continued)\n6-1\/2% Notes and the 7-3\/8% Debentures are general, unsecured obligations of the Company. However, the obligations of the Company under the New Credit Agreement, the Canadian Note and the Foreign Credit Facilities are guaranteed by certain of the Company's subsidiaries and such debt effectively ranks ahead of the 6-1\/2% Notes and the 7-3\/8% Debentures with respect to such guarantees.\nIn addition to refinancing its Revolving Credit Facilities under the New Credit Agreement, the Company also refinanced its Term Loan Facilities and its Capital Expenditure Facility. Under the terms of the Credit Agreements, the Company had a term loan which required quarterly principal payments with final maturity at June 30, 1995. The Company also had an additional $100,000,000 term loan which had a final maturity of June 30, 1995. Borrowings under the Term Loan Facilities were collateralized under the terms of the Credit Agreements on a pari passu basis with borrowings under the Revolving Credit Facilities. All borrowings under the Term Loan Facilities were repaid through borrowings under the New Credit Agreement in 1993.\nUnder the Credit Agreements, the Company originally had a Capital Expenditure Facility of up to $75,000,000 to be drawn down at various times prior to March 31, 1991, if necessary, to finance capital expenditures. At December 31, 1992, $44,100,000 was outstanding under the Capital Expenditure Facility and no additional borrowings were available under this facility. The Capital Expenditure Facility required quarterly principal payments which commenced in June 1991 with final maturity scheduled on June 30, 1995. All borrowings under the Capital Expenditure Facility were repaid through borrowings under the New Credit Agreement in 1993.\nIn 1992, the Company issued $250,000,000 principal amount of its 7-7\/8% Senior Notes Due 1999 (the \"7-7\/8% Notes\"). The 7-7\/8% Notes will mature on October 15, 1999 and may not be redeemed by the Company prior to maturity. The 7-7\/8% Notes are general, unsecured obligations of the Company and rank pari passu in right of payment with all existing and future senior obligations of the Company. However, the obligations of the Company under the New Credit Agreement, the Canadian Note and the Foreign Credit Facilities are guaranteed by certain of the Company's subsidiaries and such debt effectively ranks ahead of the 7-7\/8% Notes with respect to such guarantees.\nIn 1992, the Company redeemed all of its 10-3\/4% Notes. The redemption was funded through borrowings under the Credit Agreements and the proceeds from the issuance of the 7-7\/8% Notes. The Company recorded an extraordinary charge of approximately $9,900,000 ($.13 per share) in connection with the redemption of the 10-3\/4% Notes, which consisted principally of the premiums paid in connection with the early redemption of the 10-3\/4% Notes and the non-cash write-off of the related unamortized debt expense, both net of income tax benefits.\nThe New Credit Agreement imposes certain limitations on, and requires compliance with covenants from, the Company and its subsidiaries including, among other things: (i) maintenance of certain financial ratios and compliance with certain financial tests and limitations; (ii) limitations on incurrence of additional indebtedness and granting of certain liens and guarantees; and (iii)\n36 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nLong-Term Debt - (Concluded)\nrestrictions on mergers, sale and leaseback transactions, asset sales and investments. The New Credit Agreement also allows the Company to pay dividends on its common stock so long as, among other things, the aggregate amount of such dividends paid since August 16, 1993 does not exceed the sum of $75,000,000 and fifty percent of the Company's consolidated net earnings since June 30, 1993.\nThe New Credit Agreement provides for the acceleration of amounts outstanding thereunder should any person or entity other than William Farley, or any person or entity controlled by William Farley, control more than 50% of the voting stock or voting rights associated with such stock of the Company.\nThe aggregate amount of scheduled annual maturities of long-term debt for each of the next five years is: $23,100,000 in 1995; $38,100,000 in 1996; $36,000,000 in 1997; $51,100,000 in 1998; and $780,600,000 in 1999.\nCash payments of interest on debt were $86,600,000, $67,100,000 and $89,700,000 in 1994, 1993 and 1992, respectively. These amounts exclude amounts capitalized.\nFinancial Instruments\nCertain of the Company's foreign subsidiaries enter into forward exchange contracts to hedge currency exposure relative to certain inventory purchases and principal and interest obligations of certain foreign currency denominated bank loans. The Company primarily sells European currencies and purchases United States dollars. As of December 31, 1994 the primary foreign currencies sold forward to hedge the foreign currency exposure relative to inventory purchases expressed in United States dollar equivalents were as follows: $1,800,000 Italian lira, $1,900,000 German marks, $2,000,000 British pounds and $1,800,000 French francs. At December 31, 1994, the Company had bought forward Greek drachma relative to its Greek drachma denominated debt obligations, the value of which was the United States dollar equivalent of $5,600,000. The original discount of the purchased forward contracts serves to reduce the effective interest cost of the drachma denominated loans and effectively makes these loans the equivalent of United States dollar based loans. All of the aforementioned contracts mature in less than one year.\nThe fair value of the Company s foreign exchange forward contracts was estimated based on quoted market prices of comparable contracts. At December 31, 1994 and 1993, the fair value for the Company's forward contracts approximated their face value.\nThe fair values of financial guarantees and letters of credit approximate the face value of the underlying instruments.\nThe fair values of the Company's non-publicly traded long-term debt were estimated using discounted cash flow analyses, based on the Company s current incremental borrowing rates for similar types of borrowing arrangements. Fair values for publicly traded long-term debt were based on quoted market prices\n37 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nFinancial Instruments - (Concluded)\nwhen available. At December 31, 1994 and 1993, the fair value of the Company's debt was approximately $1,369,000,000 and $1,305,800,000, respectively.\nThe Company monitors its positions with, and the credit quality of, the financial institutions which are counterparties to its off-balance-sheet financial instruments and does not anticipate nonperformance of the counterparties. The Company does not require collateral from its counterparties and management believes that the Company would not realize a material loss in the event of nonperformance by the counterparties.\nFinancial instruments which potentially subject the Company to concentrations of credit risk consist principally of trade receivables. The Company sells its products to most major discount and mass merchandisers, wholesale clubs and screen printers as well as many department, specialty, drug and variety stores, national chains, supermarkets and sports specialty stores. The Company performs ongoing credit evaluations of its customers and generally does not require collateral or other security to support customer receivables. The Company's ten largest customers accounted for approximately 40.2% of net sales in 1994 and approximately 29% of gross accounts receivable at December 31, 1994. The Company routinely assesses the financial strength of its customers and, as a consequence, management believes that its trade receivable credit risk exposure is limited.\nContingent Liabilities\nThe Company and its subsidiaries are involved in certain legal proceedings and have retained liabilities, including certain environmental liabilities, such as those under Superfund Legislation, in connection with the sale of certain discontinued operations, some of which were significant generators of hazardous waste. The Company and its subsidiaries have also retained certain liabilities related to the sale of products in connection with the sale of certain discontinued operations. The Company's retained liability reserves at December 31, 1994 related to discontinued operations consist primarily of certain environmental and product liability reserves of approximately $79,100,000. The Company has recorded receivables related to these environmental liabilities of approximately $36,700,000 which management believes will be recovered from insurance and other sources. Management and outside environmental consultants evaluate, on a site-by-site or a claim-by- claim basis, the extent of environmental damage, the type of remediation that will be required and the Company's proportionate share of those costs as well as the Company's liability in each case. The Company's retained liability reserves related to discontinued operations principally pertain to 11 specifically identified environmental sites and the aforementioned product liabilities. Five sites and the total product liabilities individually represent more than 10% of the net reserve and in the aggregate represent approximately 96% of the net reserve. Management believes they have adequately estimated the impact of remediating identified sites, the expected contribution from other potentially responsible parties and recurring costs for managing sites as well as the ultimate resolution of the product liability claims. Management currently estimates actual payments before recoveries to range from approximately $9,200,000 to $24,200,000 annually between 1995 and 1998 and\n38 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nContingent Liabilities - (Continued)\n$14,300,000 in total subsequent to 1998. Only the long-term monitoring costs of approximately $6,600,000, primarily scheduled to be paid in 1999 and beyond have been discounted. The discount rate used was 10%. The undiscounted aggregate long-term monitoring costs, to be paid over approximately the next 20 years, is approximately $17,800,000. Management believes that adequate reserves have been established to cover potential claims based on facts currently available and current Superfund Legislation. The Company has provided the foregoing information in accordance with Staff Accounting Bulletin 92.\nGenerators of hazardous wastes which were disposed of at offsite locations which are now superfund sites are subject to claims brought by state and Federal regulatory agencies under Superfund Legislation and by private citizens under Superfund Legislation and common law theories. Since 1982, the EPA has actively sought compensation for response costs and remedial action at offsite disposal locations from waste generators under the Superfund Legislation, which authorizes such action by the EPA regardless of fault, legality of original disposal or ownership of a disposal site. The EPA's activities under the Superfund Legislation can be expected to continue during 1995 and future years.\nIn February 1986, the Company completed the sale of stock of its then wholly owned subsidiary, Universal, to MagneTek. At the time of the sale there was a suit pending against Universal and Northwest by LMP. The suit alleged that Universal and Northwest fraudulently induced LMP to sell its business to Universal and then suppressed the development of certain electronic lighting ballasts in breach of the agreement of sale, which required Universal to pay to LMP a percentage of the net profits from such business from 1982 through 1986. Two additional plaintiffs, Stevens Luminoptics Partnership and Calmont Technologies Inc., joined the litigation in 1986. In December 1989 and January 1990, a jury returned certain verdicts against Universal and also returned verdicts in favor of Northwest and on certain issues in favor of Universal. A judgment totalling $25,800,000, of which $7,500,000 represented punitive damages, reflecting these verdicts was entered by the Alameda County, California Superior Court in January 1990 against Universal.\nIn April 1992, the California Court of Appeals reversed the $25,800,000 judgment against Universal and affirmed those verdicts favorable to Universal and Northwest. In July 1992, the California Supreme Court denied the plaintiffs' petition for review. The case was then remanded to the trial court.\nPursuant to the stock purchase agreement (the \"Stock Purchase Agreement\") under which Universal was sold, the Company agreed to indemnify MagneTek for a two-year period following the sale of Universal for certain contingent liabilities. MagneTek brought suit against the Company for declaratory and other relief in connection with the indemnification under the Stock Purchase Agreement. In April 1992, the Los Angeles County, California Superior Court found that the Company was obligated by the Stock Purchase Agreement to indemnify MagneTek for any liability that may be assessed against MagneTek or Universal in the LMP Litigation and to reimburse MagneTek for, among other things, its costs and expenses in defending that case. The court entered a\n39 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nContingent Liabilities - (Continued)\njudgment requiring the Company to reimburse and indemnify MagneTek in two stages: currently, to reimburse MagneTek for costs of defense and related expenses in the LMP Litigation, plus costs of litigating the indemnity case with the Company; and at a later date, if and when any liability in the LMP Litigation is finally determined or a settlement is reached in that case, to reimburse and\/or indemnify MagneTek for that amount as well. In 1993 the Company paid approximately $9,600,000 in settlement of its obligations to MagneTek related to the litigation expenses incurred by MagneTek.\nIn October 1994, following a retrial of the LMP Litigation, a jury returned a verdict of approximately $96,000,000 against Universal. The jury verdict included breach of contract and fraud damages and approximately $6,000,000 in punitive damages. The Company is obligated to indemnify Universal for damages incurred in this case.\nManagement of the Company believes that the jury's decision is incorrect and is contrary to the evidence. Based on discussions with counsel and on other information currently available, management believes that the court committed numerous errors during the trial and, accordingly, that the judgment will not stand on appeal. The Company intends to vigorously appeal this verdict.\nIn March 1988, a class action suit entitled Endo et al. v. Albertine, et al. was filed in the District Court against the Company, its then directors, certain of its then executive officers, its then underwriters and the Company's current independent auditors in connection with the Company's initial public offering of Class A Common Stock and certain debt securities in March 1987. The suit alleges, among other things, violations of Federal and state securities laws against all of the defendants, as well as breaches of fiduciary duties by the director and officer defendants, and seeks unspecified damages.\nMotions to dismiss the complaint were filed by all defendants. In December 1990, a magistrate judge recommended that the District Court dismiss all of the plaintiffs' claims with prejudice. In January 1993, the District Court adopted in part and rejected in part the magistrate judge's recommendation for dismissal of the complaint. As a result, the litigation will continue as to various remaining counts of the complaint. Both the defendants and the plaintiffs filed motions for summary judgment which were denied in all material respects. Management and the Board of Directors believe that this suit is without merit and intend to continue to vigorously defend against this litigation.\nOn December 23, 1993, James J. Locke, as Trustee of Locke Family Trust, and I. Jack Saline filed a lawsuit against the Company and certain of its then officers and directors, including William Farley and John B. Holland, in the District Court. The lawsuit was then amended to add additional plaintiffs. On April 19, 1994, the District Court granted plaintiffs' motion for class certification. The plaintiffs claim that all of the defendants engaged in conduct violating Section 10b of the Securities Exchange Act of 1934 and that Mr. Farley and Mr. Holland also violated Section 20a of the Act. According to the plaintiffs, beginning before June 1992 and continuing through early June\n40 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nContingent Liabilities - (Concluded)\n1993, the Company, with the knowledge and assistance of the individual defendants, issued positive public statements about its expected sales increases and growth through 1993 and afterwards. They also allege that beginning in approximately mid-1992 and continuing afterwards, the Company's business was not as strong and its growth prospects were not as certain as represented. The plaintiffs further allege that during the end of 1992 and beginning of 1993, certain of the individual defendants traded the stock of the Company while in the possession of material, non-public information. The plaintiffs ask for unspecified amounts as compensatory damages, pre-judgment and post-judgment interest, attorneys' fees, expert witness fees and costs and ask the District Court to impose a constructive trust on the proceeds of the individual defendants' trades to satisfy any potential judgment. Management believes that this suit is without merit and management and the Company intend to vigorously defend against this litigation.\nManagement believes, based on information currently available, that the ultimate resolution of the aforementioned litigation will not have a material adverse effect on the financial condition or operations of the Company.\nIn August 1991, two creditors of a former subsidiary of Northwest, Lone Star Steel Company, Inc. (a wholly owned subsidiary of Lone Star Technologies, Inc., a publicly owned company) brought suit against the Company in the Superior Court of the State of Delaware. In this suit, the creditors sought damages of approximately $13,100,000, plus interest, against the Company for what they alleged was the remaining liability under certain leases. In January 1993, the Superior Court of Delaware issued an Opinion and Order finding that the leases were in default, but made no findings as to the amount of damages. The Company appealed the ruling and on June 4, 1993 the Supreme Court of Delaware entered an order affirming the Opinion and Order of the Superior Court of Delaware issued in January 1993. In December 1993, the Company paid the lessors approximately $9,500,000 in settlement of this suit.\nIn 1992, the Company was named in a suit seeking to enforce the terms of a former subsidiary's lease on which the Company was contingently obligated. The Company paid approximately $17,500,000 in 1992 in settlement of the suit and its contingent obligations under the lease.\nIn June 1994, pursuant to authorization from the Company's Board of Directors, the Company guaranteed a loan from a bank in an amount up to $12,000,000 to Mr. Farley, the Company's Chairman of the Board and Chief Executive Officer. In exchange for the guarantee the Company received an annual fee from Mr. Farley equal to 1% of the value of the loan covered by the guarantee. The guarantee is secured by a second lien on certain shares of the Company held by the bank for other loans made to Mr. Farley. See \"Related Party Transactions.\"\nIn connection with the Company's transaction with Acme Boot during 1993, the Company guaranteed, on an unsecured basis, the repayment of debt incurred or created by Acme Boot under Acme Boot's bank credit facility. See \"Related Party Transactions.\" At December 31, 1994 Acme Boot has a bank credit facility\nwhich provides for up to $30,000,000 of loans and letters of credit, subject to a borrowing base. Acme Boot's bank credit facility is secured by first liens on substantially all of the assets of Acme Boot and its subsidiaries (which are approximately $71,900,000 at December 31, 1994). At December 31, 1994 approximately $9,300,000 in loans and letters of credit were outstanding under Acme Boot's bank credit facility.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nLease Commitments\nThe Company and its subsidiaries lease certain manufacturing, warehousing and other facilities and equipment. The leases generally provide for the lessee to pay taxes, maintenance, insurance and certain other operating costs of the leased property. The leases on most of the properties contain renewal provisions.\nIn September 1994, the Company entered into a five year operating lease agreement with two automatic annual renewal options, primarily for certain machinery and equipment. The total cost of the assets to be covered by the lease is limited to $200,000,000. The total cost of assets under lease as of December 31, 1994 was approximately $76,000,000. The lease provides for a substantial residual value guarantee by the Company at the end of the initial lease term and includes purchase and renewal options at fair market values. The table of future minimum operating lease payments which follows below excludes any payment related to the residual value guarantee which is due upon termination of the lease. The Company has the right to exercise a purchase option with respect to the leased equipment or the equipment can be sold to a third party. The Company expects the fair market value of the leased equipment, subject to the purchase option or sold to a third party, to substantially reduce or eliminate the Company's payment under the residual value guarantee. The Company is obligated to pay the difference between the maximum amount of the residual value guarantee and the fair market value of the equipment at the termination of the lease. At December 31, 1994 the maximum amount of the residual value guarantee relative to the assets under the lease at December 31, 1994 is approximately $50,900,000.\nFollowing is a summary of future minimum payments under capitalized leases and under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 1994 (in thousands of dollars):\n43 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nLease Commitments - (Concluded)\nAssets recorded under capital leases are included in Property, Plant and Equipment as follows (in thousands of dollars):\nRental expense for operating leases amounted to $20,200,000, $11,600,000 and $9,100,000 in 1994, 1993 and 1992, respectively.\nStock Plans\nAt December 31, 1994 and 1993, approximately 1,494,700 and 1,546,600 shares, respectively, of Class A Common Stock were reserved for issuance under the Company's 1987 Stock Option Plan (the \"Plan\"). Under the terms of the Plan, options may be granted to eligible employees of the Company, its parent and its subsidiaries at a price not less than the market price on the date of grant. Option shares must be exercised within the period prescribed by the Compensation Committee of the Board of Directors at the time of grant but not later than ten years and one day from the date of grant. The Plan provides for the granting of qualified and nonqualified stock options.\nThe following summarizes the activity of the Plan for 1994:\nIn 1994 the Company established the Executive Incentive Compensation Plan (the \"1994 Plan\"). The 1994 Plan provides for the granting of non-qualified stock options, incentive stock options, performance shares and annual incentive awards. The 1994 Plan is administered by the Compensation Committee of the Board of Directors and provides for the granting of up to 3,600,000 shares\n44 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nStock Plans - (Continued)\nunder the plan, which shares are reserved and available for purchase under the provisions of the plan. Stock options may be granted under the 1994 Plan to eligible employees of the Company, its parent and its subsidiaries at a price not less than the market price on the date of grant. Options granted vest at such time as prescribed by the Compensation Committee, but in no event may any option be exercisable prior to six months following its grant. No option granted shall be exercisable later than the tenth anniversary date of its grant. The Company granted 664,100 options to eligible employees in 1994 at prices ranging from $24.75 to $30.88.\nPerformance shares may be granted to eligible employees of the Company, its parent and its subsidiaries. Each performance share shall have a value equal to the market price of the Company's Class A Common Stock on the date the performance share is earned. The Compensation Committee of the Board of Directors sets performance goals to be achieved over performance periods of not less than two years. The extent to which performance goals based on total shareholder return over a two year period are met will determine the number of performance shares earned by participants. Payment of earned performance shares shall be made in either cash or shares of Class A Common Stock within seventy five days following the close of the performance period.\nIn 1993, the Company's stockholders approved the Company's Directors' Stock Option Plan (the \"Directors' Plan\"). The Directors' Plan provides for the issuance of options to purchase up to 175,000 shares of Class A Common Stock, which shares are reserved and available for purchase upon the exercise of options granted under the Directors' Plan. Only directors who are not employees of the Company, any parent or subsidiary of the Company or Farley Industries, Inc. (\"FII\") are eligible to participate in the Directors' Plan. The Directors' Plan is administered by the Company's Board of Directors. Under the Directors' Plan each non-employee director is initially granted an option to purchase 7,500 shares of Class A Common Stock. On the date of each annual meeting at which such person is elected or after which the person continues as a non-employee director, such non-employee director shall be granted an option to purchase 2,500 shares of Class A Common Stock (the \"Annual Options\"). The options are exercisable at a price per share equal to the fair market value per share of the Class A Common Stock on the date of grant. Option shares must be exercised not later than ten years from the date of grant and do not become exercisable until the first anniversary of the date of grant.\nThe following summarizes the activity of the Directors' Plan for 1994:\n45 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nStock Plans - (Concluded)\nIn 1992, the Company established the 1992 Executive Stock Option Plan (the \"1992 Plan\"). The 1992 Plan provides for the issuance of options to purchase up to 975,000 shares of Class A Common Stock, which shares are reserved and available for purchase upon the exercise of stock options granted under the 1992 Plan. The 1992 Plan is administered by the Compensation Committee of the Board of Directors. In 1992, options to purchase 975,000 shares of Class A Common Stock were granted under the 1992 Plan to two directors of the Company who are also employees of the Company. The options are exercisable at a price of $28.88 per share (which was the closing price of the Class A Common Stock on the date of grant). Pursuant to the terms of the grants, options for the shares vest (subject to acceleration under certain circumstances) as follows: (i) one-third of the options granted vest immediately upon grant; (ii) one-third of the options granted vest if the closing price of the Class A Common Stock reaches or exceeds $45 per share for 90 consecutive days within six years from the date of grant; and (iii) the remaining one-third of the options granted vest if the closing price of the Class A Common Stock reaches or exceeds $60 per share for 90 consecutive days within six years from the date of grant. All vested options expire 10 years and one day after the date of grant. Options which do not vest because the Company's stock price has not reached the targeted price levels for vesting expire six years after the date of grant. As of December 31, 1994, 325,000 of these options are exercisable and none of these options have been exercised or canceled.\nIn July 1991, the Company granted an option to purchase 50,000 shares of the Class A Common Stock to a director of the Company who is also an employee of FII at a purchase price of $10.25 per share. The exercise period of the option terminates ten years and one day from the date of grant. As of December 31, 1994, none of these options have been exercised or canceled.\nAt December 31, 1994 and 1993, approximately 238,800 and 268,000 shares, respectively, of Class A Common Stock were reserved for issuance under the Company's 1989 Stock Grant Plan. Under the terms of this plan, eligible employees of the Company, its parent and its subsidiaries are awarded shares, subject to forfeitures or certain restrictions which generally expire three years from the date of the grant. Shares are awarded in the name of the employee, who has all the rights of a shareholder, subject to the above mentioned restrictions. The Company canceled 11,400 previously issued shares during 1994. The Company granted approximately 40,600 shares to eligible employees during 1994.\nAt December 31, 1994 and 1993, approximately 298,600 and 344,900 shares, respectively, of Class A Common Stock were reserved for issuance under the Company's 1987 Long-Term Bonus Plan. Under the terms of this plan, eligible employees of the Company's operating subsidiary participate in cash and stock bonus pools for four year plan periods. Awards under this plan are payable in a combination of cash and stock. No new four year plan period began subsequent to December 31, 1990. The Company issued approximately 46,300 shares to eligible employees during 1994.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nConsolidated Statement of Common Stockholders' Equity\nHolders of Class A Common Stock are entitled to receive, on a cumulative basis, the first dollar per share of dividends declared. Thereafter, holders of Class A Common Stock and Class B Common Stock will share ratably in any dividends declared. Each share of Class A Common Stock is entitled to one vote and each share of Class B Common Stock is entitled to five votes. The Class B Common Stock is convertible into the Class A Common Stock on a share for share basis.\nApproximately 9.2% of the Company's common stock at December 31, 1994 is held by FI and William Farley. Because these affiliates hold all of the Class B Common Stock of the Company outstanding, which has five votes per share, they control approximately 32.9% of all voting rights of the Company. All actions submitted to a vote of stockholders are voted on by holders of Class A Common Stock and Class B Common Stock voting together as a single class, except for the election of directors. With respect to the election of directors, holders of the Class A Common Stock vote as a separate class and are entitled to elect 25% of the total number of directors constituting the entire Board of Directors\n47 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nConsolidated Statement of Common Stockholders' Equity - (Concluded)\nand, if not a whole number, then the holders of the Class A Common Stock are entitled to elect the nearest higher whole number of directors that is at least 25% of the total number of directors. If, at the record date for any stockholder meeting at which directors are elected, the number of shares of Class B Common Stock outstanding is less than 12.5% of the total number of shares of both classes of common stock outstanding, then the holders of Class A Common Stock would vote together with the holders of Class B Common Stock to elect the remaining directors to be elected at such meeting, with the holders of Class A Common Stock having one vote per share and the holders of Class B Common Stock having five votes per share. At December 31, 1994, FI and William Farley's combined ownership of Class B Common Stock is approximately 8.8% of the total common stock of the Company outstanding. As a result, Mr. Farley does not have the sole ability to elect those members of the Company's Board of Directors who are not separately elected by the holders of the Company's Class A Common Stock.\nBusiness Segment and Major Customer Information\nThe Company operates in only one business segment consisting of the manufacturing and marketing of basic apparel. Sales to one customer amounted to approximately 15.6%, 13.4% and 11.8% of consolidated net sales in 1994, 1993 and 1992, respectively. Additionally, sales to a second customer amounted to approximately 11.8%, 12.3% and 10.2% of consolidated net sales in 1994, 1993 and 1992, respectively.\nSales, operating earnings and identifiable assets are as follows (in thousands of dollars):\nCorporate assets presented above consist primarily of cash and other short-term investments, deferred financing costs and, in 1994, a receivable related to anticipated environmental recoveries and, in 1992, the investment in Acme Boot. Corporate assets in 1994 and 1993 also include Federal income taxes receivable.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nPension Plans\nPension expense was $11,700,000, $5,500,000 and $4,900,000 in 1994, 1993 and 1992, respectively. The net pension expense is comprised of the following (in thousands of dollars):\nThe following table sets forth the funded status of the plans and amounts recognized in the Company's Consolidated Balance Sheet (in thousands of dollars):\nThe discount rate for purposes of determining the funded status of the plans at December 31, 1994 and 1993 was 8.25% and 7.75%, respectively.\n50 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nPension Plans - (Concluded)\nPlan assets, which are primarily invested in United States Government, international and domestic corporate debt securities, equity securities, real estate and venture capital funds, are commingled in a master trust which includes the assets of the pension plans of substantially all affiliated companies controlled directly and indirectly by William Farley (the \"Master Trust\"). Plan assets, except those that are specifically identified to a particular plan, are shared in different proportions by each of the plans in the Master Trust (\"Allocated Assets\"). Any gains and losses associated with the Allocated Assets are spread among each of the plans based on each plan's respective share of the Allocated Assets market value. The Company's plan assets represent approximately 69.3% and 51.8% of the Master Trust Allocated Assets at December 31, 1994 and 1993, respectively.\nIncluded in the Master Trust Allocated Assets at December 31, 1994 and 1993 were 647,852 shares (with a cost of $5,100,000 and a market value of $17,500,000 and $15,600,000, respectively) of the Company's Class A Common Stock.\nAs of December 31, 1994 and 1993, the Master Trust holds 348,012 shares (with a cost of $7,700,000 and a market value of $9,400,000 and $8,400,000, respectively) of the Company's Class A Common Stock that is specifically identified to the retirement plans of FI. Any change in market value associated with these shares is allocated entirely to the FI plans and does not effect the Master Trust Allocated Assets.\nDepreciation Expense\nDepreciation expense, including amortization of capital leases, approximated $107,600,000, $84,300,000 and $67,800,000 in 1994, 1993 and 1992, respectively.\nAdvertising Expense\nAdvertising, which is expensed as incurred, approximated $70,800,000, $52,800,000 and $62,500,000 in 1994, 1993 and 1992, respectively.\nIncome Taxes\nIncome taxes are included in the Consolidated Statement of Earnings as follows (in thousands of dollars):\nIncluded in earnings before extraordinary items and cumulative effect of change in accounting principle are foreign losses of $15,500,000 in 1994 and foreign earnings of $17,000,000 and $34,600,000 in 1993 and 1992, respectively.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nIncome Taxes - (Continued) The components of income tax expense (benefit) related to earnings before extraordinary items and cumulative effect of change in accounting principle were as follows (in thousands of dollars):\nDeferred income taxes related to earnings before extraordinary items and cumulative effect of change in accounting principle were as follows (in thousands of dollars):\nThe income tax rate on earnings before extraordinary items and cumulative effect of change in accounting principle differed from the Federal statutory rate as follows:\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nIncome Taxes - (Continued)\nDeferred income taxes are provided for temporary differences between income tax and financial statement recognition of revenues and expenses. Deferred tax liabilities (assets) are comprised of the following (in thousands of dollars):\nEffective January 1, 1993, the Company recorded the cumulative effect of a change in accounting principle related to the initial adoption of Statement No. 109 resulting in a $3,400,000 ($.04 per share) benefit.\nIn 1993, the Company paid the IRS approximately $28,300,000 in settlement of Federal income tax assessments for the tax periods ended December 31, 1984 and July 31, 1985 (the final predecessor tax periods). This amount included approximately $14,800,000 of accrued interest. The Company had previously established reserves for these matters and these payments did not have an impact on the 1993 tax provision.\nThe IRS previously asserted income tax deficiencies, excluding statutory interest which accrues from the date the tax was due until payment, for the Company of approximately $93,000,000 for the years 1978-1980 and $15,400,000 for the years 1981-1983. The Company had protested the IRS's asserted tax deficiencies for these six years with respect to a number of issues and also had raised certain affirmative tax issues that bear on these years. Settlement agreements with respect to all the 1978-1980 and 1981-1983 protested and affirmative issues resulted in the Company receiving a refund of approximately $5,900,000, including interest, in January 1993.\nIn an unrelated matter, the IRS declined to seek United States Supreme Court review of a decision by the United States Court of Appeals for the Third Circuit which reversed a lower court ruling and directed the lower court to order a refund to the Company of approximately $10,500,000 in Federal income taxes collected from a predecessor of the Company, plus approximately $49,400,000 in interest thereon applicable to the tax years 1964-1968. The Company received the full refund of approximately $60,000,000 in March 1992. However, in September 1992 the IRS issued a statutory notice of deficiency in\n54 FRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nIncome Taxes - (Concluded)\nthe amount of approximately $7,300,000 for the taxable years from which the March 1992 refund arose, exclusive of interest which would accrue from the date the IRS asserted the tax was due until payment, presently a period of about 27 years. In October 1994, the United States Tax Court ruled in favor of the Company in the above case. In January 1995 the IRS filed an appeal with the United States Court of Appeals for the Seventh Circuit. The Company believes, based on information currently available, that the IRS position is without merit and that the Company will prevail in this appeal.\nCash payments for income taxes were $49,000,000, $137,500,000 and $131,600,000 in 1994, 1993 and 1992, respectively.\nOther Expense-Net\nIncluded in other expense-net in 1994 is $16,000,000 of service fee income from Gitano's operations which represent Gitano's transition to a marketing service organization from a traditional wholesaler base. These revenues are not expected to recur after 1994 as Gitano reverts to a traditional apparel wholesaler. This service fee revenue was partially offset by $12,500,000 of charges to provide for certain obligations of and legal expenses pertaining to litigation related to retained liabilities of former subsidiaries. In addition, included in other expense-net in 1994, 1993 and 1992 was deferred debt fee amortization and bank fees of approximately $8,100,000, $7,900,000 and $10,100,000, respectively.\nEarnings Per Share\nPrimary earnings per share are based on the weighted average number of common shares and equivalents outstanding during the year.\nRelated Party Transactions\nUnder the terms of a management agreement between FII and the Company, FII provides the Company, to the extent that the Company may request, (i) general management services which include, but are not limited to, financial management, legal, tax, accounting, corporate development, human resource and personnel advice; (ii) investment banking services in connection with the acquisition or disposition of the assets or operations of a business or entity; (iii) financing services in connection with the arrangement by FII of public or private debt (including letter of credit facilities); and (iv) other financial, accounting, legal and advisory services rendered outside the ordinary course of the Company's business. FII is owned and controlled by Mr. Farley; its approximately 60 employees provide services to companies owned or controlled by Mr. Farley, including the Company. Certain of the executive officers of the Company are employed by, and receive their compensation from, FII. These officers devote their time as needed to those companies owned and controlled by Mr. Farley and, accordingly, do not devote full time to any single company, including the Company.\nIn consideration for investment banking and financing services, the Company pays FII fees established by FII and determined to be reasonable by FII in relation to (i) the size and complexity of the transaction; and (ii) the\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Concluded)\nRelated Party Transactions - (Concluded)\nfees customarily charged by other advisors for similar investment banking and financing services; provided, such fees shall not exceed two percent of the total consideration paid or received by the Company or two percent of the aggregate amount available for borrowing or use under the subject agreement or facility. Fees for investment banking and financing services are generally payable to FII upon the closing of the subject transaction or agreement.\nEffective January 1994, the Company entered into a new management agreement (the \"Management Agreement\") with FII pursuant to which FII agreed to render substantially similar services to the Company as under the prior management agreements. Under the terms of a management agreement, the Company pays a fee to FII based on FII's cost of providing management services. The Company paid management fees to FII of approximately $8,800,000 in 1994, approximately $9,900,000 in 1993 and approximately $7,000,000 in 1992. At December 31, 1994 approximately $600,000 was owed for management services related to 1994, which amount was paid in February 1995. The Company also paid a financing fee of approximately $2,500,000 to FII in 1994 for financing services related to 1993, which costs were capitalized as deferred financing costs in 1994. The Company paid a financing fee to FII during 1992 of approximately $2,300,000, which costs were capitalized as deferred financing costs in 1992. It is anticipated that the Company will enter into a management agreement for 1995 under substantially the same terms and conditions as the Management Agreement.\nConcurrently with entering into the management agreement with FII in 1992, the Company's Board of Directors determined to employ Mr. Farley directly as Chairman and Chief Executive Officer of the Company. Mr. Farley did not receive compensation in 1994, 1993 or 1992 from FII for his services as Chairman and Chief Executive Officer of the Company.\nIn June 1994, pursuant to authorization from the Company's Board of Directors, the Company guaranteed a loan from a bank in an amount up to $12,000,000 to Mr. Farley, the Company's Chairman of the Board and Chief Executive Officer. In exchange for the guarantee the Company received an annual fee from Mr. Farley equal to 1% of the value of the loan covered by the guarantee. The guarantee is secured by a second lien on certain shares of the Company held by the bank for other loans made to Mr. Farley. See \"Contingent Liabilities\".\nThe Company completed the sale of the stock of Acme Boot at book value, which approximated fair market value, to an affiliate in June 1987 for an aggregate of $38,400,000 of cash and preferred stock and subordinated debentures of the affiliate. The Company recognized no earnings in 1992 related to its investment in the securities of the affiliate because of the inability of the affiliate to make payments under the terms of the securities. In the fourth quarter of 1993, the Company received approximately $72,900,000 from Acme Boot representing the entire unpaid principal and liquidation preference (including accrued interest and dividends) on its investment in the securities of the affiliate. The Company recorded a pretax gain of approximately $67,300,000 in connection with the investment in Acme Boot upon the receipt of the above mentioned proceeds. See \"Contingent Liabilities.\"\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES SUPPLEMENTARY DATA\nQuarterly Financial Summary (Unaudited) (In millions of dollars, except per share amounts)\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 of the Company as of December 31, 1994 were as follows:\nName Age Position William Farley 52 Chairman of the Board and Chief Executive Officer John B. Holland 62 President and Chief Operating Officer Richard C. Lappin 50 Vice-Chairman of the Board Richard M. Cion 51 Senior Executive Vice President-Corporate Development Larry K. Switzer 51 Executive Vice President and Chief Financial Officer Michael F. 40 Vice President and Controller Bogacki Burgess D. Ridge 50 Vice President-Administration Earl C. Shanks 38 Vice President and Treasurer\nOfficers serve at the discretion of the Board of Directors. Messrs. Lappin, Cion, Switzer, Bogacki, Ridge and Shanks are employed by FII which provides management services to companies owned or managed by Mr. Farley. They devote their time to those companies as needed and, accordingly, do not devote full time to any single company, including the Company. Certain of the executive officers, as noted below, are also executive officers of FI and were executive officers of VBQ, Inc. (\"VBQ\"), formerly a defense contractor and an affiliate of FI. Certain of the executive officers, as noted below, were also executive officers of Valley Fashions Corp. (formerly West Point Acquisition Corp. and currently West Point Stevens, Inc.). During 1992, FI and Valley Fashions Corp. emerged from bankruptcy proceedings and VBQ became the subject of a Chapter 7 liquidation.\nWilliam Farley. Mr. Farley has been Chairman of the Board and Chief Executive Officer of the Company since May 1985. Mr. Farley has also been Chairman and a director of Acme Boot for more than the past five years. During the past five years, Mr. Farley has also been Chairman and Chief Executive Officer of FII. He has held substantially similar positions with FI since 1982, VBQ from 1984 until January 1992, West Point-Pepperell, Inc. (\"West Point\") from April 1989 until October 1992 and Valley Fashions Corp. from March 1989 until October 1992.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - (Continued)\nJohn B. Holland. Mr. Holland has been a director of the Company since November 1992 and President of the Company since May 1992. Mr. Holland has served as Chief Operating Officer of the Company for more than the past five years. Mr. Holland served as Vice Chairman of West Point from April 1989 until September 1992 and as a director of West Point from April 1989 until September 1992. Mr. Holland served as Vice Chairman of Valley Fashions Corp. from March 1989 until June 1990. Mr. Holland is also a director of Dollar General Corp. and First Kentucky National Corp.\nRichard C. Lappin. Mr. Lappin has been a director of the Company since December 1990 and Vice Chairman of the Company since October 1991. Mr. Lappin has been Vice Chairman and Chief Executive Officer of Acme Boot since February 1991 and a director of Acme Boot since December 1993. Mr. Lappin has been President and Chief Operating Officer of FII since February 1991. From October 1989 to February 1991, Mr. Lappin served in various capacities with FI, including President and Chief Executive Officer of the Doehler Jarvis and Southern Fastening Systems divisions of FI.\nRichard M. Cion. Mr. Cion has been Senior Executive Vice President of the Company since June 1990, of FII and Acme Boot since February 1990 and of West Point from February 1990 until October 1992. Mr. Cion was also a director of West Point from April 1989 until October 1992. Mr. Cion served as a director of Valley Fashions Corp. from April 1989 until June 1992. Mr. Cion was also Senior Executive Vice President of Valley Fashions Corp. from March 1992 until October 1992. From April 1988 to February 1990, Mr. Cion was a Managing Director with Drexel Burnham Lambert Incorporated, an investment banking firm.\nLarry K. Switzer. Mr. Switzer has been Senior Executive Vice President and Chief Financial Officer of the Company, FII and FI since May 1994. From September 1992 to March 1993 Mr. Switzer was Executive Vice President and Chief Financial Officer of Alco Standard Corporation, a manufacturer and marketer of office equipment and supplies. Mr. Switzer was Senior Vice President and Chief Financial Officer of S.C. Johnson & Son, Inc., a manufacturer and marketer of household cleaning and pest control products, from before 1990 to August 1992.\nMichael F. Bogacki. Mr. Bogacki has been Corporate Controller of the Company, FII and FI since October 1988. Mr. Bogacki was appointed Vice President of FII in November 1989, of the Company in May 1990 and of FI in June 1990 and of Acme Boot in February 1991. In June 1991, Mr. Bogacki was appointed Assistant Secretary of the Company. Mr. Bogacki was Corporate Controller of Valley Fashions Corp. from March 1989 until November 1992. Mr. Bogacki was also Vice President of Valley Fashions Corp. from June 1991 until November 1992.\nBurgess D. Ridge. Mr. Ridge was Assistant Treasurer of the Company, FII and FI from before 1990 until October 1991. Mr. Ridge was appointed Vice President Administration of FII and FI in August 1991 and of the Company in October 1991.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - (Concluded)\nEarl C. Shanks. Mr. Shanks served as Vice President-Taxes and Assistant Secretary of the Company, FII and FI from before 1990 until June 1991. In June 1991, Mr. Shanks became Treasurer of the Company, FII, Acme Boot and FI. Mr. Shanks was Vice President and Assistant Secretary of West Point from April 1989 until November 1992. Mr. Shanks served as Vice President-Taxes and Assistant Secretary of Valley Fashions Corp. from March 1989 until June 1991. Mr. Shanks was Vice President and Treasurer of Valley Fashions Corp. from June 1991 until November 1992. During the past five years Mr. Shanks has been Vice President of Acme Boot. Mr. Shanks was Vice President-Taxes of VBQ from before 1990 to January 1992.\nInformation relating to the directors of the Company is set forth in the Registrant's proxy statement for its Annual Meeting of Stockholders to be held on May 16, 1995 (the \"Proxy Statement\") to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, and is hereby incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to executive compensation is set forth in the Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, and is hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation relating to the security ownership of certain beneficial owners and management is set forth in the Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, and is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nUnder the terms of a management agreement between FII and the Company, FII provides the Company, to the extent that the Company may request, (i) general management services which include, but are not limited to, financial management, legal, tax, accounting, corporate development, human resource and personnel advice; (ii) investment banking services in connection with the acquisition or disposition of the assets or operations of any business or entity; (iii) financing services in connection with the arrangement by FII of public or private debt (including letter of credit facilities); and (iv) other financial, accounting, legal and advisory services rendered outside the ordinary course of the Company's business. FII is owned and controlled by Mr. Farley; its approximately 60 employees provide services to companies owned or controlled by Mr. Farley, including the Company. Certain of the executive officers of the Company are employed by, and receive their compensation from, FII. These officers devote their time as needed to those companies owned and controlled by Mr. Farley and, accordingly, do not devote full time to any single company, including the Company.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - (Concluded)\nIn consideration for investment banking and financing services, the Company pays FII fees established by FII and determined to be reasonable by FII in relation to (i) the size and complexity of the transaction; and (ii) the fees customarily charged by other advisors for similar investment banking and financing services; provided, such fees shall not exceed two percent of the total consideration paid or received by the Company or two percent of the aggregate amount available for borrowing or use under the subject agreement or facility. Fees for investment banking and financing services are generally payable to FII upon the closing of the subject transaction or agreement.\nEffective January 1994, the Company entered into the Management Agreement with FII pursuant to which FII agreed to render substantially similar services to the Company as under the prior management agreements. Under the terms of a management agreement, the Company pays a fee to FII based on FII's cost of providing management services. The Company paid management fees to FII of approximately $8,800,000 in 1994, approximately $9,900,000 in 1993 and approximately $7,000,000 in 1992. At December 31, 1994 approximately $600,000 was owed for management services related to 1994, which amount was paid in 1995. The Company also paid a financing fee of approximately $2,500,000 to FII in 1994 for financing services related to 1993, which costs were capitalized as deferred financing costs in 1994. The Company paid a financing fee to FII during 1992 of approximately $2,300,000, which costs were capitalized as deferred financing costs in 1992. It is anticipated that the Company will enter into a management agreement for 1995 under substantially the same terms and conditions as the Management Agreement.\nConcurrently with entering into the new management agreement with FII in 1992, the Company's Board of Directors determined to employ Mr. Farley directly as Chairman and Chief Executive Officer of the Company. Mr. Farley did not receive compensation in 1994, 1993 or 1992 from FII for his services as Chairman and Chief Executive Officer of the Company.\nIn June 1994, pursuant to authorization from the Company's Board of Directors, the Company guaranteed a loan from a bank in an amount up to $12,000,000 to Mr. Farley, the Company's Chairman of the Board and Chief Executive Officer. In exchange for the guarantee, the Company received an annual fee from Mr. Farley equal to 1% of the value of the loan covered by the guarantee. The guarantee is secured by a second lien on certain shares of the Company held by the bank for other loans made to Mr. Farley.\nThe Company completed the sale of the stock of Acme Boot at book value, which approximated fair market value, to an affiliate in June 1987 for an aggregate of $38,400,000 of cash and preferred stock and subordinated debentures of the affiliate. The Company recognized no income in 1992 related to its investment in the securities of the affiliate because of the inability of the affiliate to make payments under the terms of the securities. In the fourth quarter of 1993, the Company received approximately $72,900,000 from Acme Boot representing the entire unpaid principal and liquidation preference (including accrued interest and dividends) on its investment in the securities of the affiliate. The Company recorded a pretax gain of approximately\n$67,300,000 in connection with the investment in Acme Boot upon the receipt of the above mentioned proceeds. See \"Contingent Liabilities.\"\nInformation relating to certain relationships and related transactions is set forth in the Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, and is hereby incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\n(a) Financial statements, financial statement schedule and exhibits\n1. Financial Statements\nThe financial statements listed in the Index to Financial Statements and Supplementary Data on page 24 are filed as part of this Annual Report.\n2. Financial Statement Schedule\nThe schedule listed in the Index to Financial Statements and Supplementary Data on page 24 are filed as part of this Report.\n3. Exhibits\nThe exhibits listed in the Index to Exhibits on pages 66 and 67 are filed part of this Annual Report.\n(b) Reports on Form 8-K\nNo report on Form 8-K was 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, in the City of Chicago, State of Illinois, on March 28, 1995.\nFRUIT OF THE LOOM, INC.\nBY: LARRY K. SWITZER (Larry K. Switzer Executive Vice President and Chief Financial Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated on March 28, 1995. Name Capacity\nWILLIAM FARLEY Chairman of the Board and (William Farley) Chief Executive Officer (Principal Executive Officer) and Director\nLARRY K. SWITZER Executive Vice President (Larry K. Switzer) and Chief Financial Officer (Principal Financial Officer)\nMICHAEL F. BOGACKI Vice President and (Michael F. Bogacki) Controller (Principal Accounting Officer)\nOMAR Z. AL ASKARI Director (Omar Z. Al Askari)\nDENNIS S. BOOKSHESTER Director (Dennis S. Bookshester)\nJOHN B. HOLLAND Director (John B. Holland)\nLEE W. JENNINGS Director (Lee W. Jennings)\nHENRY A. JOHNSON Director (Henry A. Johnson)\nRICHARD C. LAPPIN Director (Richard C. Lappin)\nA. LORNE WEIL Director (A. Lorne Weil)\nSIR BRIAN G. WOLFSON Director (Sir Brian G. Wolfson)\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1994, 1993 and 1992 (In thousands of dollars)\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES INDEX TO EXHIBITS (Item 14(a)(3) and 14(c))\nDescription 3(a)* - Restated Certificate of Incorporation of the Company and Certificate of Amendment of the Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993). 3(b)* - By-Laws of the Company (incorporated herein by reference to Exhibit 4(b) to the Company's Registration Statement on Form S-2, Reg. No. 33-8303 (the \"S-2\")). 4(a)* - $800,000,000 Credit Agreement dated as of August 16, 1993, among the several banks and other financial institutions from time to time parties thereto (the \"Lenders\"), Bankers Trust Company, a New York banking corporation, as administrative agent for the Lenders thereunder, Chemical Bank, NationsBank of North Carolina N.A., The Bank of New York and the Bank of Nova Scotia, as co-agents (incorporated herein by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-3, Reg. No. 33-50567 (the \"1993 S- 3\")). 4(b)* - Subsidiary Guarantee Agreements dated as of August 16, 1993 by each of the guarantors signatory thereto in favor of the beneficiaries referred to therein (incorporated herein by reference to Exhibit 4.4 to the 1993 S-3). 10(a)* - Fruit of the Loom 1989 Stock Grant Plan dated January 1, 1989 (incorporated herein by reference to Exhibit 10(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1988). 10(b)* - Fruit of the Loom 1987 Stock Option Plan (incorporated herein by reference to Exhibit 10(b) to the S-2). 10(c)* - Fruit of the Loom, Inc. Stock Option Agreement for Richard C. Lappin (incorporated herein by reference to Exhibit 10(d) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991). 10(d)* - Fruit of the Loom 1992 Executive Stock Option Plan (incorporated herein by reference to the Company's Registration Statement on Form S-8, Reg. No. 33-57472). 10(e)* - Fruit of the Loom, Inc. Directors' Stock Option Plan (incorporated herein by reference to the Company's Registration Statement on Form S-8, Reg. No. 33-50499). 10(f)* - Fruit of the Loom, Inc. Executive Incentive Compensation Plan (incorporated herein by reference to Exhibit A to the Company's Proxy Statement for its annual meeting on May 17, 1994). 10(g)* - Guarantee of Payment dated as of June 27, 1994 by Fruit of the Loom, Inc. and NationsBank of Florida N.A. (incorporated herein by reference to Exhibit 10(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994(the \"10-Q\")).\nSee footnotes on following page.\nFRUIT OF THE LOOM, INC. AND SUBSIDIARIES INDEX TO EXHIBITS - (Concluded) (Item 14(a)(3) and 14(c))\nDescription 10(h)* - Stock Pledge Agreement dated as of June 27, 1994 between William F. Farley and Fruit of the Loom, Inc. (incorporated herein by reference to Exhibit 10(b) to the 10-Q). 10(i)* - Management Agreement between Farley Industries, Inc. and the Company dated as of January 1, 1994 (incorporated herein by reference to Exhibit 10(c) to the 10-Q). 10(j) - Employment Agreement between Fruit of the Loom, Inc. and William Farley. 10(k) - Employment Agreement between Fruit of the Loom, Inc. and John B. Holland. 10(l) - Employment Agreement between Farley Industries, Inc., Fruit of the Loom, Inc. and Richard C. Lappin. 10(m) - Employment Agreement between Farley Industries, Inc., Fruit of the Loom, Inc. and Richard M. Cion. 10(n) - Employment Agreement between Farley Industries, Inc., Fruit of the Loom, Inc. and Earl C. Shanks. 10(o) - Employment Agreement between Farley Industries, Inc., Fruit of the Loom, Inc. and Larry K. Switzer. 11 - Computation of Earnings Per Common Share. 22 - Subsidiaries of the Company. 24 - Consent of Ernst & Young LLP. 27 - Financial Data Schedule.\n* Document is available at the Public Reference Section of the Securities and Exchange Commission, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 (Commission file #1-8941).\nThe Registrant has not listed or filed as Exhibits to this Annual Report certain instruments with respect to long-term debt representing indebtedness of the Company and its subsidiaries which do not individually exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. Pursuant to Item 601(b)(4)(iii) of Regulation S-K, the Registrant agrees to furnish such instruments to the Securities and Exchange Commission upon request.","section_15":""}
{"filename":"882234_1994.txt","cik":"882234","year":"1994","section_1":"ITEM 1. BUSINESS\nEach of the Grantor Trusts, (the \"Trusts\"), listed below, was formed by GMAC Auto Receivables Corporation (the \"Seller\") by selling and assigning the receivables and the security interests in the vehicles financed thereby to The First National Bank of Chicago, as Trustee, in exchange for Class A certificates representing an undivided ownership interest that ranges between approximately 91% and 93.5% in each Trust, which were remarketed to the public, and Class B certificates representing an undivided ownership interest that ranges between approximately 6.5% and 9% in each Trust, which were not offered to the public and initially were held by the Seller. The right of the Class B certificateholders to receive distribution of the receivables is subordinated to the rights of the Class A certificateholders.\nGRANTOR TRUST -------------\nGMAC 1991-B GMAC 1991-C GMAC 1992-A GMAC 1992-C GMAC 1992-D GMAC 1992-E GMAC 1992-F GMAC 1993-A GMAC 1993-B GMAC 1994-A _____________________\nPART II.\nITEM 7.","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nEach of the Grantor Trusts, listed in the table as shown below, was formed by GMAC Auto Receivables Corporation (the \"Seller\") pursuant to a Pooling and Servicing Agreement between the Seller and The First National Bank of Chicago, as Trustee. Each Trust acquired retail finance receivables from the Seller in the aggregate amount as shown below in exchange for certificates representing undivided ownership interests in each Trust. Each Trust's property includes a pool of retail instalment sale contracts secured by automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby.\nThe certificates for each of the following Trusts consist of two classes, entitled \"Asset-Backed Certificates, Class A\" and \"Asset-Backed Certificates, Class B\". The Class A Certificates represent in the aggregate an undivided ownership interest that ranges between approximately 91% and 93.5% of the Trusts and the Class B Certificates represent in the aggregate an undivided ownership interest that ranges between approximately 6.5% and 9% of the Trusts. Only the Class A Certificates have been remarketed to the public. The Class B Certificates have not been offered to the public and initially are being held by the Seller. The rights of the Class B Certificateholder to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A Certificateholders.\nOriginal Aggregate Amount ----------------------------------- Date of Pooling Retail Asset-Backed Certificates Grantor and Servicing Finance ------------------------- Trust Agreement Receivables Class A Class B ------- ----------------- ----------- -------- ------- (In millions of dollars)\nGMAC 1991-B September 17, 1991 1,007.4 916.7 90.7\nGMAC 1991-C December 16, 1991 1,326.4 1,207.0 119.4\nGMAC 1992-A January 30, 1992 2,001.4 1,851.3 150.1\nGMAC 1992-C March 26, 1992 1,100.3 1,012.3 88.0\nGMAC 1992-D June 4, 1992 1,647.6 1,499.3 148.3\nGMAC 1992-E August 20, 1992 1,578.0 1,436.0 142.0\nGMAC 1992-F September 29, 1992 1,644.6 1,496.6 148.0\nGMAC 1993-A March 24, 1993 1,403.0 1,297.8 105.2\nGMAC 1993-B September 16, 1993 1,450.6 1,341.8 108.8\nGMAC 1994-A June 28, 1994 1,151.9 1,077.0 74.9\nII-1\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (concluded)\nGeneral Motors Acceptance Corporation, the originator of the retail receivables, continues to service the receivables for each of the aforementioned Grantor Trusts and receives compensation and fees for such services. Investors receive monthly payments of the pro rata portion of principal and interest for each Trust as the receivables are liquidated.\n------------------------\nII-2\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCROSS REFERENCE SHEET\nExhibit No. Caption Page ----------- ---------------------------------------------- ------\n-- GMAC 1991-B Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-4 Data for the Year Ended December 31, 1994.\n-- GMAC 1991-C Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-9 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-A Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-14 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-C Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-19 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-D Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-24 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-E Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-29 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-F Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-34 Data for the Year Ended December 31, 1994.\n-- GMAC 1993-A Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-39 Data for the Year Ended December 31, 1994\n-- GMAC 1993-B Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-44 Data for the Year Ended December 31, 1994.\n-- GMAC 1994-A Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-49 Data for the period from June 28, 1994 to December 31, 1994.\n27.1 Financial Data Schedule for GMAC 1991-B Grantor Trust (for SEC electronic filing purposes only). --\n27.2 Financial Data Schedule for GMAC 1991-C Grantor Trust (for SEC electronic filing purposes only). --\n27.3 Financial Data Schedule for GMAC 1992-A Grantor Trust (for SEC electronic filing purposes only). --\n27.4 Financial Data Schedule for GMAC 1992-C Grantor Trust (for SEC electronic filing purposes only). --\n27.5 Financial Data Schedule for GMAC 1992-D Grantor Trust (for SEC electronic filing purposes only). --\n27.6 Financial Data Schedule for GMAC 1992-E Grantor Trust (for SEC electronic filing purposes only). --\n27.7 Financial Data Schedule for GMAC 1992-F Grantor Trust (for SEC electronic filing purposes only). --\n27.8 Financial Data Schedule for GMAC 1993-A, 1993-B and 1994-A Grantor Trusts (for SEC electronic -- filing purposes only). II-3\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1991-B Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1991-B Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1991-B Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the three years in the period ended December 31, 1994, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-4\nGMAC 1991-B GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) ................... 124.0 306.4 ------- -------\nTOTAL ASSETS ........................... 124.0 306.4 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ...................... 124.0 306.4 ------- -------\nTOTAL LIABILITIES ...................... 124.0 306.4 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-5\nGMAC 1991-B GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 182.4 276.3 340.7\nAllocable to Interest ............... 14.5 30.4 51.5 ------ ------ ------ Distributable Income ................... 196.9 306.7 392.2 ====== ====== ======\nIncome Distributed ..................... 196.9 306.7 392.2 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-6\nGMAC 1991-B GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1991-B Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn September 17, 1991, GMAC 1991-B Grantor Trust acquired retail finance receivables aggregating approximately $1,007.4 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing October 15, 1991. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 6.75% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-7\nGMAC 1991-B GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 53.0 4.9 57.9\nSecond quarter ..................... 50.1 3.9 54.0\nThird quarter ...................... 42.5 3.2 45.7\nFourth quarter ..................... 36.8 2.5 39.3 --------- -------- ----- Total ......................... 182.4 14.5 196.9 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 72.7 9.4 82.1\nSecond quarter ..................... 74.8 8.2 83.0\nThird quarter ...................... 68.3 7.0 75.3\nFourth quarter ..................... 60.5 5.8 66.3 --------- -------- ----- Total ......................... 276.3 30.4 306.7 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 87.1 15.1 102.2\nSecond quarter ..................... 89.5 13.6 103.1\nThird quarter ...................... 84.9 12.1 97.0\nFourth quarter ..................... 79.2 10.7 89.9 --------- -------- ----- Total ......................... 340.7 51.5 392.2 ========= ======== =====\nII-8\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1991-C Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1991-C Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1991-C Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the three years in the period ended December 31, 1994, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-9\nGMAC 1991-C GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) ................... 228.7 496.0 ------- -------\nTOTAL ASSETS ........................... 228.7 496.0 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ...................... 228.7 496.0 ------- -------\nTOTAL LIABILITIES ...................... 228.7 496.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-10\nGMAC 1991-C GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 267.3 378.5 451.8\nAllocable to Interest ............... 20.7 39.7 63.3 ------ ------ ------ Distributable Income ................... 288.0 418.2 515.1 ====== ====== ======\nIncome Distributed ..................... 288.0 418.2 515.1 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-11\nGMAC 1991-C GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1991-C Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn December 16, 1991, GMAC 1991-C Grantor Trust acquired retail finance receivables aggregating approximately $1,326.4 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing January 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.70% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-12\nGMAC 1991-C GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 75.2 6.7 81.9\nSecond quarter ..................... 74.0 5.6 79.6\nThird quarter ...................... 63.9 4.6 68.5\nFourth quarter ..................... 54.2 3.8 58.0 --------- -------- ----- Total ......................... 267.3 20.7 288.0 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 96.7 12.0 108.7\nSecond quarter ..................... 101.1 10.6 111.7\nThird quarter ...................... 95.2 9.2 104.4\nFourth quarter ..................... 85.5 7.9 93.4 --------- -------- ----- Total ......................... 378.5 39.7 418.2 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 120.6 18.3 138.9\nSecond quarter ..................... 115.3 16.6 131.9\nThird quarter ...................... 109.9 15.0 124.9\nFourth quarter ..................... 106.0 13.4 119.4 --------- -------- ----- Total ......................... 451.8 63.3 515.1 ========= ======== =====\nII-13\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-A Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-A Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period January 30, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-A Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period January 30, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-14\nGMAC 1992-A GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 89.4 370.7 ------- -------\nTOTAL ASSETS ...................................... 89.4 370.7 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 89.4 370.7 ------- -------\nTOTAL LIABILITIES ................................. 89.4 370.7 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-15\nGMAC 1992-A GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period January 30, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------- ------- ------- $ $ $ Distributable Income\nAllocable to Principal ............... 281.3 681.7 948.9\nAllocable to Interest ............... 11.0 35.4 72.0 ------- ------- ------- Distributable Income ................... 292.3 717.1 1,020.9 ======= ======= =======\nIncome Distributed ..................... 292.3 717.1 1,020.9 ======= ======= =======\nReference should be made to the Notes to Financial Statements.\nII-16\nGMAC 1992-A GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-A Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn January 30, 1992, GMAC 1992-A Grantor Trust acquired retail finance receivables aggregating approximately $2,001.4 million from the Seller in exchange for certificates representing undivided ownership interests of 92.5% for the Class A certificates and 7.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing February 18, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.05% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-17\nGMAC 1992-A GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 98.2 4.2 102.4\nSecond quarter ..................... 81.3 3.1 84.4\nThird quarter ...................... 60.0 2.2 62.2\nFourth quarter ..................... 41.8 1.5 43.3 --------- -------- ----- Total ......................... 281.3 11.0 292.3 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 206.9 12.4 219.3\nSecond quarter ..................... 192.5 9.8 202.3\nThird quarter ...................... 157.7 7.5 165.2\nFourth quarter ..................... 124.6 5.7 130.3 --------- -------- ----- Total ......................... 681.7 35.4 717.1 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 171.8 16.5 188.3\nSecond quarter ..................... 278.3 21.9 300.2\nThird quarter ...................... 263.6 18.4 282.0\nFourth quarter ..................... 235.2 15.2 250.4 --------- -------- ------- Total ......................... 948.9 72.0 1,020.9 ========= ======== =======\nII-18\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-C Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-C Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period March 26, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-C Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period March 26, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-19\nGMAC 1992-C GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 80.0 311.3 ------- -------\nTOTAL ASSETS ...................................... 80.0 311.3 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) .................................. 80.0 311.3 ------- -------\nTOTAL LIABILITIES ................................. 80.0 311.3 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-20\nGMAC 1992-C GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period March 26, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 231.3 405.0 384.0\nAllocable to Interest ............... 11.1 31.0 41.2 ------ ------ ------ Distributable Income ................... 242.4 436.0 425.2 ====== ====== ======\nIncome Distributed ..................... 242.4 436.0 425.2 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-21\nGMAC 1992-C GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-C Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn March 26, 1992, GMAC 1992-C Grantor Trust acquired retail finance receivables aggregating approximately $1,100.3 million from the Seller in exchange for certificates representing undivided ownership interests of 92% for the Class A certificates and 8% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing April 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.95% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-22\nGMAC 1992-C GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 76.0 4.3 80.3\nSecond quarter ..................... 68.1 3.1 71.2\nThird quarter ...................... 51.0 2.2 53.2\nFourth quarter ..................... 36.2 1.5 37.7 --------- -------- ----- Total ......................... 231.3 11.1 242.4 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 109.2 10.1 119.3\nSecond quarter ..................... 109.3 8.5 117.8\nThird quarter ...................... 99.7 6.9 106.6\nFourth quarter ..................... 86.8 5.5 92.3 --------- -------- ----- Total ......................... 405.0 31.0 436.0 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nSecond quarter ..................... 133.1 15.7 148.8\nThird quarter ...................... 129.8 13.7 143.5\nFourth quarter ..................... 121.1 11.8 132.9 --------- -------- ----- Total ......................... 384.0 41.2 425.2 ========= ======== =====\nII-23\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-D Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-D Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period June 4, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-D Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period June 4, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\/ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-24\nGMAC 1992-D GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------\n1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 300.7 702.0 ------- -------\nTOTAL ASSETS ...................................... 300.7 702.0 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 300.7 702.0 ------- -------\nTOTAL LIABILITIES ................................. 300.7 702.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-25\nGMAC 1992-D GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period June 4, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 401.3 568.4 377.2\nAllocable to Interest ............... 28.0 55.4 48.0 ------ ------ ------ Distributable Income ................... 429.3 623.8 425.2 ====== ====== ======\nIncome Distributed ..................... 429.3 623.8 425.2 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-26\nGMAC 1992-D GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-D Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn June 4, 1992, GMAC 1992-D Grantor Trust acquired retail finance receivables aggregating approximately $1,647.6 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing June 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.55% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-27\nGMAC 1992-D GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 113.3 9.2 122.5\nSecond quarter ..................... 108.5 7.7 116.2\nThird quarter ...................... 95.9 6.2 102.1\nFourth quarter ..................... 83.6 4.9 88.5 --------- -------- ----- Total ......................... 401.3 28.0 429.3 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 148.6 16.9 165.5\nSecond quarter ..................... 153.3 14.8 168.1\nThird quarter ...................... 140.7 12.8 153.5\nFourth quarter ..................... 125.8 10.9 136.7 --------- -------- ----- Total ......................... 568.4 55.4 623.8 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nSecond quarter ..................... 50.7 7.6 58.3\nThird quarter ...................... 166.9 21.4 188.3\nFourth quarter ..................... 159.6 19.0 178.6 --------- -------- ----- Total ......................... 377.2 48.0 425.2 ========= ======== =====\nII-28\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-E Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-E Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period August 20, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-E Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period August 20, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-29\nGMAC 1992-E GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, --------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 478.4 885.4 ------- -------\nTOTAL ASSETS ...................................... 478.4 885.4 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 478.4 885.4 ------- -------\nTOTAL LIABILITIES ................................. 478.4 885.4 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-30\nGMAC 1992-E GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period August 20, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 407.0 512.6 180.0\nAllocable to Interest ............... 32.6 55.1 23.9 ------ ------ ------ Distributable Income ................... 439.6 567.7 203.9 ====== ====== ======\nIncome Distributed ..................... 439.6 567.7 203.9 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-31\nGMAC 1992-E GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-E Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn August 20, 1992, GMAC 1992-E Grantor Trust acquired retail finance receivables aggregating approximately $1,578.0 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing September 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.75% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-32\nGMAC 1992-E GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 110.6 10.1 120.7\nSecond quarter ..................... 110.9 8.7 119.6\nThird quarter ...................... 97.9 7.5 105.4\nFourth quarter ..................... 87.6 6.3 93.9 --------- -------- ----- Total ......................... 407.0 32.6 439.6 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 128.3 16.1 144.4\nSecond quarter ..................... 134.8 14.5 149.3\nThird quarter ...................... 129.0 13.0 142.0\nFourth quarter ..................... 120.5 11.5 132.0 --------- -------- ----- Total ......................... 512.6 55.1 567.7 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nThird quarter ...................... 46.1 6.2 52.3\nFourth quarter ..................... 133.9 17.7 151.6 --------- -------- ----- Total ......................... 180.0 23.9 203.9 ========= ======== =====\nII-33\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-F Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-F Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period September 29, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-F Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period September 29, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-34\nGMAC 1992-F GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 442.6 908.7 ------- -------\nTOTAL ASSETS ...................................... 442.6 908.7 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 442.6 908.7 ------- -------\nTOTAL LIABILITIES ................................. 442.6 908.7 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-35\nGMAC 1992-F GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period September 29, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 466.1 584.1 151.8\nAllocable to Interest ............... 30.6 55.0 17.9 ------ ------ ------ Distributable Income ................... 496.7 639.1 169.7 ====== ====== ======\nIncome Distributed ..................... 496.7 639.1 169.7 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-36\nGMAC 1992-F GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-F Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn September 29, 1992, GMAC 1992-F Grantor Trust acquired retail finance receivables aggregating approximately $1,644.6 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing October 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.50% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-37\nGMAC 1992-F GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 129.5 9.7 139.2\nSecond quarter ..................... 124.8 8.3 133.1\nThird quarter ...................... 112.8 6.9 119.7\nFourth quarter ..................... 99.0 5.7 104.7 --------- -------- ----- Total ......................... 466.1 30.6 496.7 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 146.9 16.2 163.1\nSecond quarter ..................... 151.2 14.6 165.8\nThird quarter ...................... 147.3 12.9 160.2\nFourth quarter ..................... 138.7 11.3 150.0 --------- -------- ----- Total ......................... 584.1 55.0 639.1 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFourth quarter ..................... 151.8 17.9 169.7 ========= ======== =====\nII-38\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1993-A Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1993-A Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the year ended December 31, 1994 and the period March 24, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1993-A Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for the year ended December 31, 1994 and the period March 24, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-39\nGMAC 1993-A GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, --------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 379.4 845.9 ------- -------\nTOTAL ASSETS ...................................... 379.4 845.9 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 379.4 845.9 ------- -------\nTOTAL LIABILITIES ................................. 379.4 845.9 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-40\nGMAC 1993-A GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the year ended December 31, 1994 and the period March 24, 1993 (inception) through December 31, 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 466.5 557.0\nAllocable to Interest ...................... 25.2 35.6 -------- -------- Distributable Income .......................... 491.7 592.6 ======== ========\nIncome Distributed ............................ 491.7 592.6 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-41\nGMAC 1993-A GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1993-A Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn March 24, 1993, GMAC 1993-A Grantor Trust acquired retail finance receivables aggregating approximately $1,403.0 million from the Seller in exchange for certificates representing undivided ownership interests of 92.5% for the Class A certificates and 7.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing April 15, 1993. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.15% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-42\nGMAC 1993-A GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 144.3 8.3 152.6\nSecond quarter ..................... 127.0 6.8 133.8\nThird quarter ...................... 106.4 5.6 112.0\nFourth quarter ..................... 88.8 4.5 93.3 --------- -------- ----- Total ......................... 466.5 25.2 491.7 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nSecond quarter ..................... 196.7 13.9 210.6\nThird quarter ...................... 194.4 11.8 206.2\nFourth quarter ..................... 165.9 9.9 175.8 --------- -------- ----- Total ......................... 557.0 35.6 592.6 ========= ======== =====\nII-43\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1993-B Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1993-B Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the year ended December 31, 1994 and the period September 16, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1993-B Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for the year ended December 31, 1994 and the period September 16, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\/ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-44\nGMAC 1993-B GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ---------------------\n1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 679.2 1,269.0 ------- -------\nTOTAL ASSETS ...................................... 679.2 1,269.0 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 679.2 1,269.0 ------- -------\nTOTAL LIABILITIES ................................. 679.2 1,269.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-45\nGMAC 1993-B GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the year ended December 31, 1994 and the period September 16, 1993 (inception) through December 31, 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 589.8 181.6\nAllocable to Interest ...................... 39.0 13.9 -------- -------- Distributable Income .......................... 628.8 195.5 ======== ========\nIncome Distributed ............................ 628.8 195.5 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-46\nGMAC 1993-B GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1993-B Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn September 16, 1993, GMAC 1993-B Grantor Trust acquired retail finance receivables aggregating approximately $1,450.6 million from the Seller in exchange for certificates representing undivided ownership interests of 92.5% for the Class A certificates and 7.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing October 15, 1993. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.00% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-47\nGMAC 1993-B GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 173.9 12.1 186.0\nSecond quarter ..................... 158.1 10.4 168.5\nThird quarter ...................... 137.8 8.9 146.7\nFourth quarter ..................... 120.0 7.6 127.6 --------- -------- ----- Total ......................... 589.8 39.0 628.8 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFourth quarter ..................... 181.6 13.9 195.5 ========= ======== =====\nII-48\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1994-A Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1994-A Grantor Trust as of December 31, 1994 and the related Statement of Distributable Income for the period June 28, 1994 (inception) through December 31, 1994. These financial statements are the responsibility of the Trust'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.\nAs described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1994-A Grantor Trust at December 31, 1994 and its distributable income and distributions for the period June 28, 1994 (inception) through December 31, 1994, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-49\nGMAC 1994-A GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ------------ ASSETS $\nReceivables (Note 2) .............................. 901.8 -------\nTOTAL ASSETS ...................................... 901.8 =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 901.8 -------\nTOTAL LIABILITIES ................................. 901.8 =======\nReference should be made to the Notes to Financial Statements.\nII-50\nGMAC 1994-A GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the period June 28, 1994 (inception) through December 31, 1994 (in millions of dollars)\n----- $ Distributable Income\nAllocable to Principal ..................... 250.1\nAllocable to Interest ..................... 33.0 ----- Distributable Income ......................... 283.1 =====\nIncome Distributed ........................... 283.1 =====\nReference should be made to the Notes to Financial Statements.\nII-51\nGMAC 1994-A GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1994-A Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn June 28, 1994, GMAC 1994-A Grantor Trust acquired retail finance receivables aggregating approximately $1,151.9 million from the Seller in exchange for certificates representing undivided ownership interests of 93.5% for the Class A certificates and 6.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing July 15, 1994. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 6.30% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-52\nGMAC 1994-A GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nThird quarter ...................... 125.0 17.5 142.5\nFourth quarter ..................... 125.1 15.5 140.6 --------- -------- ----- Total ......................... 250.1 33.0 283.1 ========= ======== =====\nII-53\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) FINANCIAL STATEMENTS.\nIncluded in Part II, Item 8, of Form 10-K.\n(a) (2) FINANCIAL STATEMENT SCHEDULES.\nAll schedules have been omitted because they are not applicable or because the information called for is shown in the financial statements or notes thereto.\n(a) (3) EXHIBITS (Included in Part II of this report).\n-- GMAC 1991-B Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1991-C Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-A Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-C Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-D Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-E Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-F Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1993-A Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1993-B Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1994-A Grantor Trust Financial Statements for the period June 28, 1994 through December 31, 1994.\n-- Financial Data Schedule for GMAC 1991-B Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1991-C Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-A Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-C Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-D Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-E Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-F Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1993-A, 1993-B and 1994-A Grantor Trusts (for SEC electronic filing purposes only).\nIV-1\n(b) REPORTS ON FORM 8-K.\nNo current reports on Form 8-K have been filed by any of the above-mentioned Grantor Trusts during the fourth quarter ended December 31, 1994.\nITEMS 2, 3, 4, 5, 6, 9, 10, 11, 12 and 13 are not applicable and have been omitted.\nIV-2\nSIGNATURE\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Trustee has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nGMAC 1991-B GRANTOR TRUST GMAC 1991-C GRANTOR TRUST GMAC 1992-A GRANTOR TRUST GMAC 1992-C GRANTOR TRUST GMAC 1992-D GRANTOR TRUST GMAC 1992-E GRANTOR TRUST GMAC 1992-F GRANTOR TRUST GMAC 1993-A GRANTOR TRUST GMAC 1993-B GRANTOR TRUST GMAC 1994-A GRANTOR TRUST\nThe First National Bank of Chicago (Trustee)\ns\/ Steven M. Wagner ---------------------------------- (Steven M. Wagner, Vice President)\nDate: March 29, 1995 --------------\nIV-3","section_15":""}
{"filename":"922591_1994.txt","cik":"922591","year":"1994","section_1":"ITEM 1. BUSINESS\nOn January 5, 1994, in a private placement transaction, FM 1993A Corp. (the \"Issuer\") issued and sold $70,000,000 aggregate principal amount of notes, which were subsequently exchanged for registered notes (the \"Notes\"). Proceeds from the issuance of the notes were used to purchase two secured promissory notes issued by CRC-I Limited Partnership (\"CRC-I\") and CRC-II Limited Partnership (\"CRC-II\"), in the principal amounts of $30,172,952 and $39,827,048, from CRC-I and CRC-II, respectively (the \"CRC-I Note\" and the \"CRC-II Note\", respectively; collectively, the \"CRC Notes\") for a purchase price of $28,633,100 for the CRC-I Note and $37,794,505 for the CRC-II Note.\nThe proceeds from the purchase of the CRC Notes were used by CRC-I and CRC-II to enable each of them to acquire from Foodmaker estates for years to expire on November 30, 2028 (the \"Estates For Years\"; individually, an \"Estate For Years\") in: (1) in the case of CRC-I, 38 existing Jack In The Box restaurants (the \"CRC-I Assets\"), and (2) in the case of CRC-II, four existing Jack In The Box restaurants and 34 to-be-constructed Jack In The Box restaurants (the \"CRC-II Assets\"), all which have been substantially completed; (collectively, the Properties\").\nThe purchase price for each of the CRC Notes has been disbursed in full. A portion of the purchase price for each such note was held as collateral security for the Notes by the trustee acting on behalf of the holders of Notes, pursuant to the terms of an indenture agreement dated December 15, 1993, by and between the FM 1993A Corp., as principal and agent for CRC-I Limited Partnership and CRC-II Limited Partnership, and State Street Bank and Trust Company, as amended, (the \"Indenture\"), and released by the trustee to Foodmaker from time to time as Foodmaker acquired fee title to the subject properties and conveyed an Estate For Years therein to CRC-I or CRC-II and met certain other conditions.\nConcurrently with the acquisition by CRC-I and CRC-II of the Estate For Years in the subject properties, CRC-I and CRC-II leased such properties to Foodmaker, Inc. (\"Foodmaker\") pursuant to a long-term, triple-net master lease (the \"CRC-I Lease\" or the \"CRC-II Lease\", respectively; collectively, the CRC Leases).\nSince January 5, 1994, Foodmaker has been responsible for rental payments on all of the properties under the CRC Leases regardless of whether CRC-I and CRC-II had acquired the Estates For Years in such properties. The aggregate payments required to be made by Foodmaker under the CRC Leases should be sufficient to pay interest and principal on the Notes by the end of the basic term.\nThe CRC Leases require Foodmaker through 2002 to make payments semi-annually under the CRC Leases to a trustee of approximately $3.4 million and special payments of approximately $0.7 million, which effectively cover interest and sinking fund requirements, respectively, on the Notes. Immediately prior to the principal payment dates on the Notes, Foodmaker must make rejectable offers to reacquire 50% of the properties at each date at a price which is sufficient, in conjunction with previous sinking fund deposits, to retire the Notes. If CRC-I or CRC-II reject the offers, Foodmaker may purchase the properties at less than fair market value or cause CRC-I or CRC-II to fund the remaining principal payments on the Notes and, at Foodmaker's option, cause CRC-I or CRC-II to acquire Foodmaker's residual interest in the properties. If CRC-I or CRC-II are allowed to retain the estates for years, Foodmaker has available options to extend the leases for total terms of up to 35 years, at which time the ownership of the property will revert to Foodmaker.\nAs collateral security for the CRC Notes, CRC-I and CRC-II have assigned to the Issuer their rights under the CRC Leases and granted a security interest in and lien upon the Estates For Years in the properties. The CRC Notes and the collateral therefor have been pledged and assigned to the trustee for the benefit of holders of Notes. Foodmaker's remaining interest in the properties has been pledged to secure the Notes. In addition, each of CRC-I and CRC-II has executed and delivered to the Trustee a guaranty of the Notes which guaranties are nonrecourse to the general partners of each of CRC-I and CRC-II.\nFoodmaker owns, operates and franchises the Jack In The Box restaurant concept. Jack In The Box, with system-wide sales of approximately $1 billion in fiscal 1994, has restaurants located principally in the Western and Southwestern United States. In addition, Foodmaker owns approximately 40% of Family Restaurants, Inc., the operator of full service family restaurants located primarily in California and parts of the Southwest under the Carrow's and Coco's formats and full service Mexican restaurants nationwide operated under the Chi-Chi's, El Torito and Casa Gallardo names.\nThe Issuer\nGeneral\nThe Issuer is a special purpose corporation, incorporated in the State of Delaware on December 22, 1993 for the benefit of Foodmaker in connection with the transactions described herein. The purposes of the Issuer are limited to: (i) issuing and selling the Notes, as principal and as agent for CRC-I and CRC-II, and entering into the Indenture in connection therewith (the \"Financing\"); (ii) acquiring, owning and holding obligations of CRC-I and CRC-II, accounts, investments and other property to be pledged as collateral for the Notes and pledging such property as collateral for the Notes; and (iii) engaging in any other activities that are necessary, suitable, or convenient to accomplish the matters set forth in the foregoing clauses (i) and (ii). In furtherance of such limited purposes, the Issuer may not create, incur or assume any indebtedness other than pursuant to or in connection with its original financing and the transactions contemplated thereby, or incur, assume, or guarantee the indebtedness of any person or entity, including, without limitation, pursuant to any purchase or repurchase agreement, capital lease, indemnity, or any keep-well, take-or-pay, through-put, or other arrangement having the effect of assuring or holding harmless any third person or entity against loss with respect to any obligation of such other person or entity, unless such indebtedness is an invoice, statement of account, check, work request, purchase order or other similar document representing expenses relating to the permitted activities of the Issuer described above. The principal executive offices of the Issuer are located at 9330 Balboa Avenue, San Diego, California 92123, and the Issuer's telephone number is (619) 571-2470.\nEmployees\nPursuant to the terms of the Indenture, the Issuer does not employ any employees.\nCRC-I\nGeneral\nCRC-I is a Massachusetts special purpose limited partnership which was organized solely for the purpose of participating in the aforementioned transactions. The original Certificate of Limited Partnership of CRC-I was filed with the Secretary of State of the Commonwealth of Massachusetts on December 8, 1993. The latest date upon which CRC-I is to dissolve is December 31, 2043. The charter documents of CRC-I do not require it to, nor does it intend to, hold annual meetings. The purposes of CRC-I are limited to (i) acquiring, owning, holding and selling or otherwise transferring (subject to the provisions of Section 1.06 of those certain Deeds of Trust and Mortgages that have been entered into by CRC-I in connection with the transactions specified in (ii) below) Estates For Years\nin the properties owned by it; (ii) the sale of mortgage notes to the Issuer and encumbering, hypothecating, mortgaging and pledging its interest in the subject properties as security for or in partial satisfaction of such mortgage notes and certain other mortgage notes issued by CRC-II; (iii) leasing the subject properties to Foodmaker pursuant to the terms of a master lease; and (iv) engaging in any other activities which are necessary to accomplish the foregoing purposes or are incidental thereto or connected therewith. In furtherance of such limited purposes, CRC-I is not permitted to engage in any activities other than those required to accomplish the foregoing. The General Partner of CRC-I, CRC-I Corp. incorporated in the Commonwealth of Massachusetts on December 8, 1993, is responsible for the management of CRC-I, transacts all business for CRC-I and has complete discretion in its management of all aspects of CRC-I's affairs. The principal executive offices of CRC-I are located at 9330 Balboa Avenue, San Diego, California 92123 and CRC-I's telephone number is (619)571-2470.\nEmployees\nCRC-I has no operations and does not employ any employees.\nCRC-II\nGeneral\nCRC-II is a Massachusetts special purpose limited partnership which was organized solely for the purpose of effecting the aforementioned transactions. The original Certificate of Limited Partnership of CRC-II was filed with the Secretary of State of the Commonwealth of Massachusetts on December 1, 1993. The latest date upon which CRC-II is to dissolve is December 31, 2043. The charter documents of CRC-II do not require it to, nor does it intend to, hold annual meetings. The purposes of CRC-II are limited to (i) acquiring, owning, holding and selling or otherwise transferring (subject to the provisions of Section 1.06 of those certain Deeds of Trust and Mortgages entered into by CRC-II in connection with the transactions specified in (ii) below) Estates For Years in the properties owned by it; (ii) selling mortgage notes to the Issuer and encumbering, hypothecating, mortgaging and pledging its interest in such properties as security for or in partial satisfaction of such mortgage notes and certain other mortgage notes issued by CRC-I; (iii) leasing its properties to Foodmaker pursuant to the terms of a master lease; and (iv) engaging in any other activities which are necessary to accomplish the foregoing purposes or are incidental thereto or connected therewith. In furtherance of such limited purposes, CRC-II is not permitted to engage in any activities other than those required to accomplish the foregoing. The General Partner of CRC-II, CRC-II Corp. incorporated in the Commonwealth of Massachusetts on November 30, 1993, is responsible for the management of CRC-II, transacts all business for CRC-II and has complete discretion in its management of all aspects of CRC-II's affairs. The principal executive offices of CRC-II are located at 9330 Balboa Avenue, San Diego, California 92123 and CRC-II's telephone number is (619)571-2470.\nEmployees\nCRC-II has no operations and does not employ any employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe properties in which CRC-I and CRC-II own Estates For Years and in which the Issuer has been granted a security interest are listed hereafter. The usable area of a typical building constructed on a property consists of approximately 50% kitchen space and 50% dining space and includes approximately 20-30 uncovered outdoor parking places. These properties are operated as Jack In The Box restaurants.\nCRC-I Assets\nSEQ REST Open # No. Location City ST Date\n----------------------------------------------------------- 1 1112 901 East Curry Road Tempe AZ 09\/90 2 1116 1001 North 24th Street Phoenix AZ 09\/90 3 1121 1180 Highway 20 Cottonwood AZ 09\/90 4 1160 1402 East Ash Globe AZ 10\/75 5 0021 4751 El Cajon Blvd. San Diego CA 05\/61 6 0250 2701 Brooklyn Avenue Los Angeles CA 02\/65 7 0273 23813 South Avalon Carson CA 05\/66 8 0293 465 South Fairfax Los Angeles CA 08\/67 9 3174 13369 Firestone Blvd. Norwalk CA 03\/86 10 3251 315 South Brea Brea CA 10\/91 11 3306 57930 Twenty Nine Palms Yucca Valley CA 04\/93 12 1402 1180 Nameoki Road Granite IL 07\/69 13 1403 41 E. Edwardsville Road Woodriver IL 10\/69 14 1405 1649 Washington Alton IL 03\/70 15 1410 1800 North Illinois Swansea IL 04\/88 16 1412 1360 Highway 50 O'Fallon IL 10\/89 17 1413 830 Edwardsville Road Troy IL 05\/90 18 1414 300 South Buchanan Edwardsville IL 09\/90 19 4007 15354 Manchester Road Ellisville MO 10\/69 20 4031 7520 Manchester Maplewood MO 04\/70 21 4052 322 Taylor Hazelwood MO 09\/90 22 0624 5801 Bellaire Boulevard Houston TX 12\/66 23 0633 1395 Federal Road Houston TX 02\/69 24 0635 2101 9th Avenue North Texas City TX 04\/69 25 0640 4400 West Fuqua Houston TX 05\/69 26 0641 7447 Spencer Highway Pasadena TX 06\/69 27 0654 2210 North Alexander Baytown TX 04\/70 28 0662 3333 Red Bluff Pasadena TX 04\/73 29 0672 8767 South Main Houston TX 09\/84 30 0676 1010 Richmond Wharton TX 08\/74 31 0678 916 S. Sam Houston Dr. Huntsville TX 10\/74 32 0685 839 East Mulberry St. Angleton TX 06\/77 33 0691 419 South Washington Cleveland TX 10\/78 34 3605 11080 Scarsdale Blvd. Houston TX 07\/86 35 3641 3317 First Street Rosenberg TX 08\/92 36 3642 15919 JFK Houston TX 09\/92 37 3648 5107 I-10 Baytown TX 04\/93 38 8409 479 Ranier Avenue South Renton WA 10\/69\nCRC-II Assets\nSEQ REST Open # No. Location City ST Date\n----------------------------------------------------------- 1 1123 10685 Fortuna Road Yuma AZ 07\/94 2 3019 1471 No. Santa Fe Vista CA 07\/94 3 3254 7503 E. Slauson Commerce CA 04\/94 4 3296 24820 Pico Canyon Rd. Santa Clarita CA 06\/94 5 3304 3830 W. Sierra Way Acton CA 05\/94 6 3314 919 So. China Lake Blvd. Ridgecrest CA 09\/94 7 3316 205 Trask St. Bakersfield CA 09\/94 8 3409 1951 Lander Road Turlock CA 03\/94 9 3427 1081 S. Main Street Manteca CA 08\/94 10 3646 590 Washington Beaumont TX 10\/94 11 3647 5601 College Beaumont TX 04\/94 12 3649 15824 Northwest Frwy Houston TX 04\/94 13 3651 7247 E. I-10 Orange TX 06\/94 14 3653 322 S. 77 Sunshine Strip Harlingen TX 06\/94 15 3654 321 F.M. 359 South Brookshire TX 09\/94 16 3655 1401 E. Expwy 83 Mission TX 05\/94 17 3657 1250 Lake Woodlands Dr. Woodlands TX 06\/94 18 3659 1406 W. Tyler Ave. Harlingen TX 04\/94 19 3660 909 Pecan McAllen TX 07\/94 20 3661 151 Nolana Loop McAllen TX 05\/94 21 3665 2901 Airline Drive Houston TX 06\/94 22 3666 1908 E. Main Street League City TX 08\/94 23 3667 902 Raul Longoria Rd. San Juan TX 09\/94 24 3668 8832 S. Hwy 146 Mont Belvieu TX 09\/94 25 3669 14540 Westheimer Houston TX 08\/94 26 3670 101 FM 528 Friendswood TX 08\/94 27 3672 7810 FM 1960 Humble TX 01\/95 28 3674 5120 Padre Island Hwy Brownsville TX 09\/94 29 3675 Silber & I-10 Houston TX 03\/95* 30 3737 2085 N. Hwy 360 Grand Prairie TX 05\/94 31 3739 7260 N. Stemmons Frwy Dallas TX 09\/94 32 3742 3355 Harwood Rd. Bedford TX 09\/94 33 3749 183 & Regal Row Dallas TX 04\/95* 34 8451 1467 Olney Avenue Port WA 11\/88 35 8455 610 So. Burlington Blvd Burlington WA 05\/90 36 8470 4717 Evergreen Everett WA 09\/92 37 8474 20746 108th Ave. Kent WA 11\/92 38 8477 15114 Pacific Ave. So. Spanaway WA 10\/94\n*Estimated opening date\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Issuer, CRC-I and CRC-II have no legal proceedings pending at this time.\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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Issuer is a closely held corporation and its common stock has no established market value. The Issuer has not paid and does not expect to pay dividends in the foreseeable future. CRC-I and CRC-II are partnerships.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected data presented in the following table for and as of the year ended December 31, 1994, summarizes certain financial information concerning the Issuer, CRC-I and CRC-II and is derived from financial statements, which have been audited by KPMG Peat Marwick LLP, independent certified public accountants, and are included elsewhere in this filing. Although the entities were organized in December 1993, operations commenced January 5, 1994.\n(In thousands) 1994 ---------- Statement of Operations Data:\nThe Issuer: Interest and other income $ 7,189 Interest and other expense 7,189 Net earnings 0\nCRC-I: Interest and other income $ 3,102 Interest and other expense 3,102 Net earnings 0\nCRC-II: Interest and other income $ 4,087 Interest and other expense 4,087 Net earnings 0\nBalance Sheet Data (at end of period):\nThe Issuer: Total assets, principally long-term notes receivable $69,023 Long-term notes payable 69,023\nCRC-I: Total assets, principally long-term lease receivables $29,437 Long-term notes payable 28,793 Sinking fund liability 644\nCRC-II: Total assets, principally long-term lease receivables $38,856 Long-term notes payable 38,005 Sinking fund liability 850\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nThe Issuer is a special purpose corporation, incorporated in the State of Delaware in December 1993 for the benefit of Foodmaker in connection with the financing of certain of its restaurant properties through CRC-I and CRC-II limited partnerships, which were organized in December 1993 under the laws of the Commonwealth of Massachusetts. Operations commenced on January 5, 1994 with the issuance and sale, in a private placement transaction, of $70 million aggregate principal amount of notes. The net sales proceeds from the sale of the Private Placement Notes were approximately $68.9 million, which proceeds were used to purchase the CRC-I Note, issued in the principal amount of approximately $30.2 million, and the CRC-II Note, issued in the principal amount of approximately $39.8 million, for approximately $66.4 million. The closing costs paid by the Issuer were approximately $2.5 million. In September 1994, the Private Placement Notes were exchanged for substantially identical registered notes. The Notes are due November 1, 2003, with interest only payments at the rate of 9.75% per annum due semi-annually on the first business day of each January and July and continuing through the first business day of July 2003. A mandatory prepayment of 50% of the original balance of the Notes is due on the first business day of January 2003. The\nCRC Notes' payment and interest terms are equivalent to and structured to coincide with the Notes such that funds will be available to make payments on the Notes. In addition, the CRC Notes require semi-annual sinking fund payments to a trustee of approximately $0.7 million, which will be utilized to partially fund the 50% prepayment due in January 2003. The proceeds of the CRC Notes (of which approximately 43% relates to CRC-I and 57% to CRC-II) have been used by CRC-I and CRC-II to purchase estates for years in various Foodmaker restaurant properties and, in a transaction accounted for as a financing, CRC-I and CRC-II lease back such properties to Foodmaker on terms which are calculated to provide the funds required to make the necessary payments on CRC Notes. The Notes are secured by, among other things, the CRC Notes, the CRC leases to Foodmaker, first priority liens on the leased properties and any sinking fund or other amounts held in trust.\nSince the Issuer has equivalent notes receivable (the CRC Notes) and notes payable (the Notes), including face amounts, net proceeds and stated interest rates, interest income and expense should equate to approximately $7.2 million annually, including amortization of approximately $.4 million of original issue discount and, as applicable, deferred finance charges on the respective notes. The Issuer has elected to be taxed as a Sub-chapter S Corporation under the Internal Revenue Code and, as a result, has no federal income tax liability.\nCRC-I and CRC-II reflect the financing lease obligations of Foodmaker as 9.75% lease receivables and have equivalent notes payable to FM 1993A Corp. (the CRC Notes), with approximate face amounts and net proceeds, respectively, of $30.2 million and $28.6 million for CRC-I and $39.8 million and $37.8 million for CRC-II. As a result, interest income and expense, inclusive of amortization of approximately $.2 million of original issue discount, will each be approximately $3.1 million for CRC-I and approximately $4.1 million for CRC-II. No provision for income taxes has been made as the liability for such taxes is that of the partners rather than the partnership.\nLiquidity and Capital Resources\nThe Issuer's only source of liquidity is payments on the CRC Notes by CRC-I and CRC-II, which, in turn, are dependent upon Foodmaker's payments on the CRC leases. The basic amounts payable on the CRC leases and CRC Notes are equal to, and timed to coincide with, the payments required to be made on the Notes. The CRC leases and CRC Notes also require sinking fund payments to the Trustee, which, in addition to the value of the leased properties, should provide an increasing amount of security through 2002 of the Notes. If Foodmaker were to fail to make payments to CRC-I and CRC-II on the CRC leases, CRC-I and CRC-II would be unable to make payments on the CRC Notes. The Issuer would then be required to initiate proceedings to gain possession of, liquidate or obtain tenants for the leased properties. There can be no assurance that such collateral could be re-leased or liquidated, if necessary, in sufficient amounts or at the times required to satisfy all scheduled principal and interest payments.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and related financial information required to be filed are indexed on page and are incorporated 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 table sets forth the name, age and position with the Issuer of each of the persons designated to serve as directors and executive officers of the Issuer. Additional information with respect to each such individual is contained below under \"Background of Directors and Executive Officers.\" Each Director of the Issuer will hold office until the next annual meeting of stockholders of the Issuer or until his successor has been elected and qualified. Officers of the Issuer are elected by the Board of Directors of the Issuer and serve at the discretion of the Board. Robert H. Key owns all of the outstanding shares of Common Stock of the Issuer, and has sole voting power with respect to the election of directors. See, however, \"Certain Relationships and Related Transactions - Corporate Governance.\"\nName Age Position(s) ---- --- ----------- Charles W. Duddles 54 President, Treasurer, Secretary and Director\nCharles F. MacGill 72 Director\nBackground of Directors and Executive Officers\nMr. Duddles has been a director and President, Treasurer and Secretary of the Issuer, CRC-I Corp. and CRC-II Corp. since December 1993. Mr. Duddles is also a director, Executive Vice President and Chief Financial and Administrative Officer of Foodmaker and has been since at least 1988.\nMr. MacGill is a director of the Issuer, CRC-I Corp. and CRC-II Corp. and has been since May 1994. Mr. MacGill is also President and Chairman of the Board of Chartwell Properties Corporation, a real estate investment company, and has been since 1987.\nCRC-I and CRC-II have no directors or officers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNone of the directors or officers of the Issuer receive any compensation for their services in these capacities.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of February 28, 1995, the beneficial ownership of the Issuer's Common Stock.\nShares of Name of Beneficial Common Percent Owner Stock ------------------ --------- ------- Robert H. Key 100 100%\nThe general partners of CRC-I and CRC-II are CRC-I Corp. and CRC-II Corp., respectively.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCorporate Governance\nEach of the Issuer, CRC-I Corp. and CRC-II Corp., and their shareholders (the \"Shareholders\"), Foodmaker, a designated individual who is both an officer and director of Foodmaker (the \"Designated Officer\") and an individual unaffiliated with the Issuer, CRC-I Corp or CRC-II Corp. (the \"Independent Director\") have entered into the Agreement Regarding Corporate Governance, amended and restated as of May 4, 1994 (the \"Corporate Governance Agreement\"), which sets forth the respective rights and responsibilities of the parties with respect to specific corporate governance issues relating to the Issuer, CRC-I Corp. and CRC-II Corp. Pursuant to the terms of the Corporate Governance Agreement, the Shareholders are obligated to elect the Designated Officer (or his successor) and the Independent Director (or his successor) as the two directors of each of the Issuer, CRC-I Corp. and CRC-II Corp. The Independent Director and the Designated Officer have agreed, in their capacities as directors of the Issuer, CRC-I Corp. and CRC-II Corp., to elect the Designated Officer to all officer positions of each of the Issuer, CRC-I Corp. and CRC-II Corp.\nFoodmaker and the Designated Officer have agreed that the Designated Officer (or his successor), in the capacity of Designated Officer of the Issuer, CRC-I Corp. and CRC-II Corp., will not take any of the following actions without the prior written consent of (i) the holders of 51% or more of the limited partnership interests in CRC-I or CRC-II, in the case of an action proposed to be taken by either of CRC-I or CRC-II, (ii) the holders of 51% or more of the limited partnership interests of each of CRC-I and CRC-II, in the case of an action proposed to be taken by the Issuer: (a) any waiver, amendment or consent to a deviation by Foodmaker relating to any of the terms of the transaction described above; (b) any action to accept or reject the Year Nine Offer or the Termination Date Rejectable Offer (as those terms are defined in the CRC leases) by Foodmaker; or (c) any action which would constitute or result in a breach by the Issuer, CRC-I Corp. or CRC-II Corp. of any of the agreements described above. The Designated Officer (or his successor) is also obligated to take any other action on behalf of the Issuer, CRC-I Corp. and CRC-II Corp. upon receipt of the same written consent requirements noted above, provided that such action is not in violation of the organizational documents of the Issuer, CRC-I Corp. or CRC-II Corp. Foodmaker also agreed to take, and agrees to cause the Designated Officer (or his successor) to take (at Foodmaker's expense), all necessary action to ensure that the Issuer, CRC-I Corp. and CRC-II Corp. remain at all times in compliance with the agreements to which they are a party, and to effectuate transfers of the limited partnership interests in either CRC-I or CRC-II upon the request of at least 51% of the holders of the limited partnership interest of the affected entity.\nThe Issuer's Certificate of Incorporation provides that its directors shall not be personally liable to the Issuer or its stockholders for monetary damages arising as a result of a director's breach of his or her fiduciary duty.\nIn addition, the Indenture provides that subject to certain exceptions set forth therein, neither the Trustee nor the Holders of Notes may seek or obtain judgment against the Issuer or any of the Issuer's officers, directors, shareholders or employees for payment of principal or interest under the Notes, or any sums payable under the Indenture, and the sole recourse of the Trustee and the Holders of Notes against the Issuer for any default in the payment of such principal or interest or other sums shall be limited to the Trust Estate.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nITEM 14(a)(1) Financial Statements. See the index to financial statements and schedules on page of this report.\nITEM 14(a)(2) Financial Statement Schedules. See the index to financial statements and schedules on page of this report.\nITEM 14(a)(3) Exhibits\nNumber Description ------ ----------- 3.1 Certificate of Incorporation of FM 1993A Corp. (1)\n3.2 Bylaws of FM 1993A Corp. (1)\n4.1 Indenture Agreement dated as of December 15, 1993, by and between the FM 1993A Corp., as principal and agent for CRC-I Limited Partnership and CRC-II Limited Partnership, and State Street Bank and Trust Company (1)\n4.1.1 Amendment dated as of July 15, 1994 to Indenture Agreement (including Form of Series B 9.75% Senior Secured Notes)\n4.2 CRC-I Limited Partnership Guarantee dated as of December 15, 1993 (1)\n4.3 CRC-II Limited Partnership Guarantee dated as of December 15, 1993 (2)\n4.4 Form of Assignment of Lessor's Interest in Leases, dated as of December 15, 1993, by CRC-I Limited Partnership (with schedule regarding substantially identical assignment by CRC-II Limited Partnership) (2)\n10.1 Master Leases (incorporated by reference from Foodmaker's Quarterly Report on Form 10-Q for the quarter ended January 23, 1994) (1)\n10.2 Amended and Restated Agreement Regarding Corporate Governance dated as of May 4, 1994 (2)\n27 Financial Data Schedule (included only with electronic filing)\n------------------- (1) Previously filed and incorporated by reference from registrant's Registration Statement on Form S-11 (No. 33-53455) filed on May 3, 1994.\n(2) Previously filed and incorporated by reference from Amendment No. 1 on Form S-4 to registrant's Registration Statement on Form S-11 (No. 33-53455) filed on July 12, 1994.\nITEM 14(b) Reports on Form 8-K - None.\nITEM 14(c) All required exhibits are filed herein or incorporated by reference as described in Item 14(a)(3).\nITEM 14(d) Supplemental schedules are omitted as they are inapplicable or because the required information is included in the financial statements or notes thereto.\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.\nCRC-I LIMITED PARTNERSHIP By: CRC-I Corp., General Partner\nBy: CHARLES W. DUDDLES -------------------------- Charles W. Duddles, President, Treasurer and Clerk (Duly Authorized Signatory)\nPursuant to the requirements of the 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 W. DUDDLES Director, President, March 31, 1995 ------------------------ Treasurer and Clerk Charles W. Duddles of CRC-I Corp. (Principal Executive, Financial and Accounting Officer)\nCHARLES F. MacGILL Director of CRC-I Corp. March 31, 1995 ----------------------- Charles F. MacGill\nPage FM 1993A CORP. ---- -------------- For the Periods ended December 31, 1994 and December 31, 1993: Independent Auditors' Report Balance Sheets Statements of Operations Statements of Stockholder's Equity Statements of Cash Flows Notes to Financial Statements\nCRC-I LIMITED PARTNERSHIP ------------------------- For the Periods ended December 31, 1994 and December 31, 1993: Independent Auditors' Report Balance Sheets Statements of Operations Statements of Partners' Capital Statements of Cash Flows Notes to Financial Statements\nCRC-II LIMITED PARTNERSHIP -------------------------- For the Periods ended December 31, 1994 and December 31, 1993: Independent Auditors' Report Balance Sheets Statements of Operations Statements of Partners' Capital Statements of Cash Flows Notes to Financial Statements\nSUPPLEMENTAL INFORMATION\nNo annual report other than this Report on Form 10-K has been sent to security holders.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors FM 1993A Corp.:\nWe have audited the accompanying balance sheets of FM 1993A Corp. as of December 31, 1994 and December 31, 1993, and the related statements of operations, stockholder's equity, and cash flows for the year ended December 31, 1994 and for the period from December 22, 1993 (inception) through 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 FM 1993A Corp. as of December 31, 1994 and December 31, 1993, and the results of its operations and its cash flows for the year ended December 31, 1994 and for the period from December 22, 1993 (inception) through December 31, 1993 in conformity with generally accepted accounting principles.\nKPMG PEAT MARWICK LLP\nSan Diego, California March 13, 1995\nFM 1993A CORP.\nBALANCE SHEETS\nDecember 31\nASSETS\n1994 1993 ----------- ----------- Cash . . . . . . . . . . . . . . . . . . . . $ 100 $ 100 Long-term notes receivable . . . . . . . . . 66,798,171 -- Deferred finance charges . . . . . . . . . . 2,224,982 -- ----------- ----------- TOTAL. . . . . . . . . . . . . . . . . . . . $69,023,253 $ 100 =========== ===========\nLIABILITIES AND STOCKHOLDER'S EQUITY\nLong-term notes payable. . . . . . . . . . . $69,023,153 $ -- Stockholder's equity: Common stock, no par value, 1,000 shares authorized, 100 shares issued and outstanding. . . . 100 100 ----------- ----------- TOTAL. . . . . . . . . . . . . . . . . . . . $69,023,253 $ 100 =========== ===========\nSee accompanying notes to financial statements.\nFM 1993A CORP.\nSTATEMENTS OF OPERATIONS\nFor the Year Ended December 31, 1994 and the Period from December 22, 1993 (Inception) to December 31, 1993\n1994 1993 ----------- ----------- Revenues: Interest income. . . . . . . . . . . . . . $ 7,138,691 $ -- Administrative fee income. . . . . . . . . 50,000 -- ----------- ----------- 7,188,691 -- ----------- -----------\nExpenses: Interest expense . . . . . . . . . . . . . 7,138,891 -- Administrative fee expense . . . . . . . . 50,000 -- ----------- ----------- 7,188,891 -- ----------- ----------- Net earnings . . . . . . . . . . . . . . . . $ -- $ -- =========== ===========\nSee accompanying notes to financial statements.\nFM 1993A CORP.\nSTATEMENTS OF STOCKHOLDER'S EQUITY\nFor the Year Ended December 31, 1994 and the Period from December 22, 1993 (Inception) to December 31, 1993\n1994 1993 ----------- ----------- Balance at beginning of period . . . . . . . $ 100 $ --\nIssuance of common stock . . . . . . . . . . -- 100\nNet earnings for the period. . . . . . . . . -- -- ----------- ----------- Balance at end of period . . . . . . . . . . $ 100 $ 100 =========== ===========\nSee accompanying notes to financial statements.\nFM 1993A CORP.\nSTATEMENTS OF CASH FLOWS\nFor the Year Ended December 31, 1994 and the Period from December 22, 1993 (Inception) to December 31, 1993\n1994 1993 ----------- ----------- Cash flows from operations: Net earnings . . . . . . . . . . . . . . . $ -- $ -- ----------- ----------- Cash flows provided by operations. . . . -- -- ----------- -----------\nCash flows from investing activities: Long-term notes receivable purchased . . . (66,427,605) -- ----------- ----------- Cash flows used in investing activities. (66,427,605) -- ----------- -----------\nCash flows from financing activities: Proceeds from issuance of long-term notes payable. . . . . . . . . . . . . . 68,908,000 -- Finance charges incurred in issuance of long-term notes payable. . . (2,480,395) -- Issuance of Common Stock . . . . . . . . . -- 100 ----------- ----------- Cash flows provided by financing activities. . . . . . . . . 66,427,605 100 ----------- ----------- Net increase in cash . . . . . . . . . . . . -- 100 Cash at beginning of period. . . . . . . . . 100 -- ----------- -----------\nCash at end of period. . . . . . . . . . . . $ 100 $ 100 =========== =========== Supplemental disclosure of cash flow information: Interest paid during the year. . . . . . $ 6,768,125 $ -- =========== ===========\nSee accompanying notes to financial statements.\nFM 1993A CORP.\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION\nFM 1993A Corp. (the \"Company\") was incorporated in the State of Delaware on December 22, 1993 for the purpose of: (i) issuing and selling debt obligations (\"Notes\"), as principal and as agent for CRC-I Limited Partnership (\"CRC-I\") and CRC-II Limited Partnership (\"CRC-II), Massachusetts limited partnerships, and (ii) acquiring, owning and holding obligations of CRC-I and CRC-II as well as accounts, investments and other property to be pledged as collateral for the Notes. The Company may not engage in any other activities other than those required to accomplish the foregoing.\nCRC-I and CRC-II (collectively, \"CRC\") are special purpose limited partnerships organized to (i) acquire, own, hold and sell or transfer estates for years in various existing and to-be-constructed Foodmaker, Inc. (\"Foodmaker\") restaurant properties, (ii) sell mortgage notes to the Company accompanied by a pledge of the foregoing estates for years, and (iii) lease the restaurant properties to Foodmaker. CRC-I and CRC-II may not engage in any other activities other than those required to accomplish the foregoing.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCash Equivalents, for the purposes of statements of cash flows, are considered to be all highly liquid investments with a maturity of three months or less when purchased.\nAmortization - Original issue discount and deferred finance charges are amortized using the effective interest method over the life of the related notes and have been included as a component of interest income and interest expense.\nIncome taxes - The Company has elected to be taxed as a Sub-chapter S Corporation under the Internal Revenue Code and, as a result, has no federal income tax liability.\nBasis of Presentation - Information presented in the financial statements for the year ended in 1993 reflect the period from the Company's inception on December 22, 1993 to its fiscal year ended on December 31, 1993.\n3. SIGNIFICANT TRANSACTIONS\nOn January 5, 1994, in a private placement transaction, FM 1993A Corp. issued and sold $70 million aggregate principal amount of notes (the \"Private Placement Notes\") for $68.9 million, less offering expenses of $2.5 million, which proceeds were used to purchase for $66.4 million, notes receivable from CRC-I and CRC-II with an aggregate principal amount of $70 million (collectively, the \"CRC Notes\"). In September 1994, the Private Placement Notes were exchanged for substantially identical registered notes (the \"Notes\"). The Notes are due November 1, 2003, payable interest only at the rate of 9.75% per annum semi-annually on July 1 and January 1 each year, with a mandatory prepayment of 50% of the original principal on the first business day of January 2003. The CRC Notes' payment and interest terms are equivalent to and structured to coincide with the Notes such that funds will be available to make payments on the Notes. In addition, the CRC Notes require semi-annual sinking fund payments to a trustee of $747 thousand, which will be utilized to partially fund the 50% prepayment in January 2003. CRC-I and CRC-II used the proceeds of the CRC Notes (of which approximately 43% relates to CRC-I and 57% to CRC-II) to purchase estates for years in various Foodmaker restaurant properties and, in a transaction accounted for as a financing, will lease back such properties to Foodmaker on terms which will provide the funds necessary to make the CRC Notes' payments. The Notes are secured by, among other things, the CRC Notes, the CRC leases to Foodmaker, first priority liens on the underlying properties and any sinking fund or other amounts held in trust.\nThe Company's only source of liquidity is payments on the CRC Notes, which, in turn, are dependent upon Foodmaker's payments on the CRC leases. If Foodmaker were to fail to make payments to CRC-I and CRC-II on the financing leases. CRC-I and CRC-II would be unable to make payments on the CRC Notes. The Company would then be required to initiate proceedings to gain possession of, liquidate or obtain tenants for the restaurant properties. There can be no assurance that such collateral could be liquidated, if necessary, in sufficient amounts or at times required to satisfy all scheduled principal and interest payments.\nINDEPENDENT AUDITORS' REPORT\nThe Partners CRC-I Limited Partnership.:\nWe have audited the accompanying balance sheets of CRC-I Limited Partnership, a limited partnership, as of December 31, 1994 and December 31, 1993, and the related statements of operations, partners' capital, and cash flows for the year ended December 31, 1994 and for the period from December 8, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CRC-I Limited Partnership as of December 31, 1994 and December 31, 1993, and the results of its operations and its cash flows for the year ended December 31, 1994 and for the period from December 8, 1993 (inception) through December 31, 1993 in conformity with generally accepted accounting principles.\nKPMG PEAT MARWICK LLP\nSan Diego, California March 13, 1995\nCRC-I LIMITED PARTNERSHIP\nBALANCE SHEETS\nDecember 31\nASSETS\n1994 1993 ----------- ----------- Cash . . . . . . . . . . . . . . . . . . . . $ 100 $ 100 Long-term lease receivables. . . . . . . . . 28,792,829 -- Sinking fund deposits. . . . . . . . . . . . 644,324 -- ----------- ----------- TOTAL. . . . . . . . . . . . . . . . . . . . $29,437,253 $ 100 =========== ===========\nLIABILITIES AND PARTNERS' CAPITAL\nLong-term notes payable. . . . . . . . . . . $28,792,829 $ -- Sinking fund liability . . . . . . . . . . . 644,324 -- Partners' Capital: General Partner. . . . . . . . . . . . . 1 1 Limited Partner. . . . . . . . . . . . . 99 99 ----------- ----------- TOTAL. . . . . . . . . . . . . . . . . . . . $29,437,253 $ 100 =========== ===========\nSee accompanying notes to financial statements.\nCRC-I LIMITED PARTNERSHIP\nSTATEMENTS OF OPERATIONS\nFor the Year Ended December 31, 1994 and the Period from December 8, 1993 (Inception) to December 31, 1993\n1994 1993 ----------- ----------- Revenues: Interest income. . . . . . . . . . . . . . $ 3,077,077 $ -- Administrative fee income. . . . . . . . . 25,000 -- ----------- ----------- 3,102,077 -- ----------- -----------\nExpenses: Interest expense . . . . . . . . . . . . . 3,077,077 -- Administrative fee expense . . . . . . . . 25,000 -- ----------- ----------- 3,102,077 -- ----------- ----------- Net earnings . . . . . . . . . . . . . . . . $ -- $ -- =========== ===========\nSee accompanying notes to financial statements.\nCRC-I LIMITED PARTNERSHIP\nSTATEMENTS OF PARTNERS' CAPITAL\nFor the Year Ended December 31, 1994 and the Period from December 8, 1993 (Inception) to December 31, 1993\nGeneral Limited Partner Partner Total ------- ------- ----- Initial capital contributions. . . . . . . . $ 1 $ 99 $ 100 ----- ----- ----- Balance at December 31, 1993 . . . . . . . . 1 99 100\nNet earnings for the period. . . . . . . . . -- -- -- ----- ----- ----- Balance at December 31, 1994 . . . . . . . . $ 1 $ 99 $ 100 ===== ===== =====\nSee accompanying notes to financial statements.\nCRC-I LIMITED PARTNERSHIP\nSTATEMENTS OF CASH FLOWS\nFor the Year Ended December 31, 1994 and the Period from December 8, 1993 (Inception) to December 31, 1993\n1994 1993 ----------- ----------- Cash flows from operations: Net earnings . . . . . . . . . . . . . . . $ -- $ -- ----------- ----------- Cash flows provided by operations. . . . -- -- ----------- -----------\nCash flows from investing activities: Long-term lease receivables purchased. . . (28,633,100) -- Increase in sinking fund deposits. . . . . (644,324) -- ----------- ----------- Cash flows used in investing activities. (29,277,424) -- ----------- -----------\nCash flows from financing activities: Proceeds from issuance of long-term notes payable. . . . . . . . . . . . . . 28,633,100 -- Increase in sinking fund liability . . . . 644,324 -- Initial capital contributions. . . . . . . -- 100 ----------- ----------- Cash flows provided by financing activities. . . . . . . . . 29,277,424 100 ----------- ----------- Net increase in cash . . . . . . . . . . . . -- 100 Cash at beginning of period. . . . . . . . . 100 -- ----------- -----------\nCash at end of period. . . . . . . . . . . . $ 100 $ 100 =========== =========== Supplemental disclosure of cash flow information: Interest paid during the year. . . . . . $ 2,917,348 $ -- =========== ===========\nSee accompanying notes to financial statements.\nCRC-I LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION\nCRC-I Limited Partnership (\"CRC-I\") and another similar special purpose limited partnership, CRC-II Limited Partnership (\"CRC-II\"), (collectively, \"CRC\") were organized December 8, 1993 to (i) acquire, own, hold and sell or transfer estates for years in various existing and to-be-constructed Foodmaker, Inc. restaurant properties, (ii) sell mortgage notes to the FM 1993A Corp. accompanied by a pledge of the foregoing estates for years, and (iii) lease the restaurant properties to Foodmaker. CRC-I and CRC-II may not engage in any other activities other than those required to accomplish the foregoing.\nFM 1993A Corp. was incorporated in the State of Delaware on December 22, 1993 for the purpose of: (i) issuing and selling debt obligations (\"Notes\"), as principal and as agent for CRC-I and CRC-II, Massachusetts limited partnerships, and (ii) acquiring, owning and holding obligations of CRC-I and CRC-II as well as accounts, investments and other property to be pledged as collateral for the Notes. FM 1993A Corp. may not engage in any other activities other than those required to accomplish the foregoing.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCash Equivalents, for the purposes of statements of cash flows, are considered to be all highly liquid investments with a maturity of three months or less when purchased.\nAmortization - Original issue discount is amortized using the effective interest method over the life of the related notes and has been included as a component of interest income and interest expense.\nIncome taxes - No provision for income taxes has been made as the liability for such taxes is that of the partners rather than the partnership.\nBasis of Presentation - Information presented in the financial statements for the year ended in 1993 reflect the period from the Company's inception on December 8, 1993 to its fiscal year ended on December 31, 1993.\n3. SIGNIFICANT TRANSACTIONS\nOn January 5, 1994, in a private placement transaction, FM 1993A Corp. issued and sold $70 million aggregate principal amount of notes (the \"Private Placement Notes\") for $68.9 million, less offering expenses of $2.5 million, which proceeds were used to purchase for $66.4 million, notes receivable from CRC-I and CRC-II with an aggregate principal amount of $70 million (collectively,the \"CRC Notes\"). In September 1994, the Private Placement Notes were exchanged for substantially identical registered notes (the \"Notes). The Notes are due November 1, 2003, payable interest only at the rate of 9.75% per annum semi-annually on July 1 and January 1 each year, with a mandatory prepayment of 50% of the original principal on the first business day of January 2003. The CRC Notes' payment and interest terms are equivalent to and structured to coincide with the Notes such that funds will be available to make payments on the Notes. In addition, the CRC Notes require semi-annual sinking fund payments to a trustee of $747 thousand, which will be utilized to partially fund the 50% prepayment in January 2003. CRC-I and CRC-II used the proceeds of the CRC Notes (of which approximately 43% relates to CRC-I and 57% to CRC-II) to purchase estates for years in various Foodmaker restaurant properties and, in a transaction accounted for as a financing, lease back such properties to Foodmaker on terms which provide the funds necessary to make the CRC Notes' payments. The Notes are secured by, among other things, the CRC Notes, the CRC leases to Foodmaker, first priority liens on the underlying properties and any sinking fund or other amounts held in trust.\nCRC's only source of liquidity is collection of Foodmaker's payments on the CRC leases. If Foodmaker were to fail to make payments to CRC on the financing leases, CRC would be unable to make payments on the CRC Notes. CRC would then be required to initiate proceedings to gain possession of, liquidate or obtain tenants for the restaurant properties. There can be no assurance that such collateral could be liquidated, if necessary, in sufficient amounts or at times required to satisfy all scheduled principal and interest payments.\nINDEPENDENT AUDITORS' REPORT\nThe Partners CRC-II Limited Partnership.:\nWe have audited the accompanying balance sheets of CRC-II Limited Partnership, a limited partnership, as of December 31, 1994 and December 31, 1993, and the related statements of operations, partners' capital, and cash flows for the year ended December 31, 1994 and for the period from December 8, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CRC-II Limited Partnership as of December 31, 1994 and December 31, 1993, and the results of its operations and its cash flows for the year ended December 31, 1994 and for the period from December 8, 1993 (inception) through December 31, 1993 in conformity with generally accepted accounting principles.\nKPMG PEAT MARWICK LLP\nSan Diego, California March 13, 1995\nCRC-II LIMITED PARTNERSHIP\nBALANCE SHEETS\nDecember 31\nASSETS\n1994 1993 ----------- ----------- Cash . . . . . . . . . . . . . . . . . . . . $ 100 $ 100 Long-term lease receivables. . . . . . . . . 38,005,341 -- Sinking fund deposits. . . . . . . . . . . . 850,480 -- ----------- ----------- TOTAL. . . . . . . . . . . . . . . . . . . . $38,855,921 $ 100 =========== ===========\nLIABILITIES AND PARTNERS' CAPITAL\nLong-term notes payable. . . . . . . . . . . $38,005,341 $ -- Sinking fund liability . . . . . . . . . . . 850,480 -- Partners' Capital: General Partner. . . . . . . . . . . . . 1 1 Limited Partner. . . . . . . . . . . . . 99 99 ----------- ----------- TOTAL. . . . . . . . . . . . . . . . . . . . $38,855,921 $ 100 =========== ===========\nSee accompanying notes to financial statements.\nCRC-II LIMITED PARTNERSHIP\nSTATEMENTS OF OPERATIONS\nFor the Year Ended December 31, 1994 and the Period from December 8, 1993 (Inception) to December 31, 1993\n1994 1993 ----------- ----------- Revenues: Interest income. . . . . . . . . . . . . . $ 4,061,613 $ -- Administrative fee income. . . . . . . . . 25,000 -- ----------- ----------- 4,086,613 -- ----------- -----------\nExpenses: Interest expense . . . . . . . . . . . . . 4,061,613 -- Administrative fee expense . . . . . . . . 25,000 -- ----------- ----------- 4,086,613 -- ----------- ----------- Net earnings . . . . . . . . . . . . . . . . $ -- $ -- =========== ===========\nSee accompanying notes to financial statements.\nCRC-II LIMITED PARTNERSHIP\nSTATEMENTS OF PARTNERS' CAPITAL\nFor the Year Ended December 31, 1994 and the Period from December 8, 1993 (Inception) to December 31, 1993\nGeneral Limited Partner Partner Total ------- ------- ----- Initial capital contributions. . . . . . . . $ 1 $ 99 $ 100 ----- ----- ----- Balance at December 31, 1993 . . . . . . . . 1 99 100\nNet earnings for the period. . . . . . . . . -- -- -- ----- ----- ----- Balance at December 31, 1994 . . . . . . . . $ 1 $ 99 $ 100 ===== ===== =====\nSee accompanying notes to financial statements.\nCRC-II LIMITED PARTNERSHIP\nSTATEMENTS OF CASH FLOWS\nFor the Year Ended December 31, 1994 and the Period from December 8, 1993 (Inception) to December 31, 1993\n1994 1993 ----------- ----------- Cash flows from operations: Net earnings . . . . . . . . . . . . . . . $ -- $ -- ----------- ----------- Cash flows provided by operations. . . . -- -- ----------- -----------\nCash flows from investing activities: Long-term lease receivables purchased. . . (37,794,505) -- Increase in sinking fund deposits. . . . . (850,480) -- ----------- ----------- Cash flows used in investing activities. (38,644,985) -- ----------- -----------\nCash flows from financing activities: Proceeds from issuance of long-term notes payable. . . . . . . . . . . . . . 37,794,505 -- Increase in sinking fund liability . . . . 850,480 -- Initial capital contributions. . . . . . . -- 100 ----------- ----------- Cash flows provided by financing activities. . . . . . . . . 38,644,985 100 ----------- ----------- Net increase in cash . . . . . . . . . . . . -- 100 Cash at beginning of period. . . . . . . . . 100 -- ----------- -----------\nCash at end of period. . . . . . . . . . . . $ 100 $ 100 =========== =========== Supplemental disclosure of cash flow information: Interest paid during the year. . . . . . $ 3,850,777 $ -- =========== ===========\nSee accompanying notes to financial statements.\nCRC-II LIMITED PARTNERSHIP\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION\nCRC-II Limited Partnership (\"CRC-II\") and another similar special purpose limited partnership, CRC-I Limited Partnership (\"CRC-I\"), (collectively, \"CRC\") were organized December 8, 1993 to (i) acquire, own, hold and sell or transfer estates for years in various existing and to-be-constructed Foodmaker, Inc. restaurant properties, (ii) sell mortgage notes to the FM 1993A Corp. accompanied by a pledge of the foregoing estates for years, and (iii) lease the restaurant properties to Foodmaker. CRC-I and CRC-II may not engage in any other activities other than those required to accomplish the foregoing.\nFM 1993A Corp. was incorporated in the State of Delaware on December 22, 1993 for the purpose of: (i) issuing and selling debt obligations (\"Notes\"), as principal and as agent for CRC-I and CRC-II, Massachusetts limited partnerships, and (ii) acquiring, owning and holding obligations of CRC-I and CRC-II as well as accounts, investments and other property to be pledged as collateral for the Notes. FM 1993A Corp. may not engage in any other activities other than those required to accomplish the foregoing.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCash Equivalents, for the purposes of statements of cash flows, are considered to be all highly liquid investments with a maturity of three months or less when purchased.\nAmortization - Original issue discount is amortized using the effective interest method over the life of the related notes and has been included as a component of interest income and interest expense.\nIncome taxes - No provision for income taxes has been made as the liability for such taxes is that of the partners rather than the partnership.\nBasis of Presentation - Information presented in the financial statements for the year ended in 1993 reflect the period from the Company's inception on December 8, 1993 to its fiscal year ended on December 31, 1993.\n3. SIGNIFICANT TRANSACTIONS\nOn January 5, 1994, in a private placement transaction, FM 1993A Corp. issued and sold $70 million aggregate principal amount of notes (the \"Private Placement Notes\") for $68.9 million, less offering expenses of $2.5 million, which proceeds were used to purchase for $66.4 million, notes receivable from CRC-I and CRC-II with an aggregate principal amount of $70 million (collectively, the \"CRC Notes\"). In September 1994, the Private Placement Notes were exchanged for substantially identical registered notes (the \"Notes). The Notes are due November 1, 2003, payable interest only at the rate of 9.75% per annum semi-annually on July 1 and January 1 each year, with a mandatory prepayment of 50% of the original principal on the first business day of January 2003. The CRC Notes' payment and interest terms are equivalent to and structured to coincide with the Notes such that funds will be available to make payments on the Notes. In addition, the CRC Notes require semi-annual sinking fund payments to a trustee of $747 thousand, which will be utilized to partially fund the 50% prepayment in January 2003. CRC-I and CRC-II used the proceeds of the CRC Notes (of which approximately 43% relates to CRC-I and 57% to CRC-II) to purchase estates for years in various Foodmaker restaurant properties and, in a transaction accounted for as a financing, lease back such properties to Foodmaker on terms which provide the funds necessary to make the CRC Notes' payments. The Notes are secured by, among other things, the CRC Notes, the CRC leases to Foodmaker, first priority liens on the underlying properties and any sinking fund or other amounts held in trust.\nCRC's only source of liquidity is collection of Foodmaker's payments on the CRC leases. If Foodmaker were to fail to make payments to CRC on the financing leases, CRC would be unable to make payments on the CRC Notes. CRC would then be required to initiate proceedings to gain possession of, liquidate or obtain tenants for the restaurant properties. There can be no assurance that such collateral could be liquidated, if necessary, in sufficient amounts or at times required to satisfy all scheduled principal and interest payments.","section_15":""}
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{"filename":"14827_1994.txt","cik":"14827","year":"1994","section_1":"Item 1. Business.\nGeneral\nBrowning-Ferris Industries, Inc. is one of the largest publicly- held companies engaged in providing waste services. Subsidiaries and affiliates collect, transport, treat and\/or process, recycle and dispose of commercial, residential and municipal solid waste and industrial wastes. BFI's subsidiaries are also involved in re- source recovery, medical waste services, portable restroom services, and municipal and commercial sweeping operations.\nThe terms \"BFI\" and \"Company\" refer to Browning-Ferris Industries, Inc., a Delaware corporation incorporated on October 26, 1970, and are used herein to include its subsidiaries, affiliates and predecessors, unless the context requires otherwise. BFI's executive offices are located at 757 N. Eldridge, Houston, Texas 77079. The Company's mailing address is P.O. Box 3151, Houston, Texas 77253, and its telephone number is (713) 870-8100.\nThe Company's subsidiaries and affiliates operate in approximately 400 locations in North America and approximately 250 locations outside North America (including locations of unconsolidated affiliates), and employ approximately 37,000 persons (including employees of unconsolidated affiliates). No single customer or district accounts for a material amount of BFI's revenue or net income.\nThe Company's solid waste operating subsidiaries in North America are aligned, for management oversight purposes, into six regions. Each region is further divided into a number of divisions and local districts within each division. Each region is headed by a regional vice president responsible for the operating and financial performance of that region. Divisional vice presidents are responsible for managing growth opportunities in their geographic markets, including acquisitions, business development and municipal contracting opportunities. Under this management structure, the regional vice president, divisional vice presidents and staff oversee and assist local district managers within each region. Regional responsibility for local district operations is exercised by assisting with the development and approval of each district's capital budget, the review and implementation of profit, pricing and corporate development goals and the monitoring of performance. Each district's operation is a distinct, localized service business that is managed, on a day-to-day basis, at the local level. The Company's regions and operating locations are responsible, with support and resources provided by the corporate office, for compliance with all applicable rules and regulations. Selective company-wide uniform operating procedures are being implemented when BFI's management believes the procedures will result in improved operating efficiency.\nThe business strategies currently being implemented by BFI's management are designed to: (i) continue expansion, both domestically and internationally, through an aggressive market development program; (ii) capitalize on opportunities resulting from regulatory, legislative, competitive and economic developments; (iii) expand participation and pursue new business opportunities resulting from the continued segmentation of the municipal and industrial waste streams; (iv) continue to improve both operating efficiencies and management of costs while effectively allocating resources; and (v) continue to selectively implement uniform operating procedures when management believes it will improve operating efficiency.\nThe Company's business is subject to extensive federal governmental regulation and legislative initiative. Further, in some states and local jurisdictions, its business is also subject to environmental regulation, mandatory recycling laws, medical waste regulation, preclusion of certain waste from landfills and restrictions on the flow of solid waste. Due to continuing public awareness and influence regarding waste and the environment, and uncertainty with respect to the enactment and enforcement of future laws, the Company can not always accurately project the impact any future regulation or legislative initiative may have on its operations. See \"Regulation\" and \"Legal Proceedings - Environmental Proceedings\" for additional information.\nThe table below reflects the total revenues contributed by the Company's principal lines of business for each of the three years ended September 30, 1994.\nContribution to Consolidated Revenues (in millions) Year Ended September 30,(1)\n1994 1993 1992 ---- ---- ----- North American Operations\nCollection Services - Solid Waste $2,360 $2,138 $2,038\nDisposal and Transfer - Solid Waste 885 787 753\nMedical Waste Services 161 146 119\nRecycling Services 359 240 175\nServices Group 83 79 106\nElimination of Affiliated Companies' Revenues (392) (339) (304)\nTotal North American Operations 3,456 3,051 2,887\nInternational Operations 859 428 391\nTotal Company $4,315 $3,479 $3,278\n_____________ (1)Certain reclassifications have been made in prior years' amounts to conform to the current year presentation.\nTotal assets at September 30, 1994, 1993 and 1992 were $5,797 million, $4,296 million and $4,068 million, respectively.\nSolid Waste Services\nCollection\nBFI collects solid waste in approximately 430 operating locations in 45 states, Australia, Canada, Finland, Germany, Italy, Kuwait, the Netherlands, New Zealand, Puerto Rico, Spain and the United Kingdom. These operations provide solid waste collection services for numerous commercial establishments, industrial plants and governmental and residential units. BFI uses approximately 1.1 million steel containers and approximately 12,400 specially equipped collection trucks in its waste collection operations.\nThe Company's commercial and industrial solid waste collection services are typically performed pursuant to service agreements providing for one-year to three-year initial terms and specified successive terms thereafter. Residential collection contracts with individual homeowners, homeowner groups and municipalities are generally for periods of one to five years. Solid waste residen- tial collection contracts with governmental units are usually awarded after competitive bidding.\nOperating costs, disposal costs and collection fees vary widely throughout the geographic areas of the Company's operations. Prices for solid waste collection services are determined locally, principally by the volume, weight and type of wastes collected, treatment required, risks involved in handling or disposing of the wastes, collection frequency, disposal costs, distance to final disposal sites, amount and type of equipment furnished to the customer and competitive factors. The Company's ability to pass on cost increases is often influenced by competitive and other factors. Long-term residential solid waste collection contracts often contain a formula, generally based on published price indices, for adjustments of fees to cover increases in certain operating costs.\nSolid Waste Transfer and Disposal\nBFI operates approximately 110 solid waste transfer stations, approximately 50 of which it owns, where solid wastes are compacted for transfer to final disposal facilities. Transfer stations are used for the purpose of either (i) reducing costs associated with transporting waste to final disposal sites, or (ii) better utilizing the Company's disposal sites.\nLandfilling is the primary method employed by the Company for final disposal of the solid waste stream which is not recycled. BFI currently operates 97 landfill sites in North America, 14 of which are operated under contracts with municipalities or others. BFI does not currently own or lease a landfill site in every metropolitan area in which it is engaged in solid waste collection; however, the Company intends to continue to seek, where practicable, ownership, lease or other arrangements to use disposal facilities in all such areas. To date, the Company has not experienced excessive difficulty securing the use of disposal facilities owned or operated by others in those communities in which it does not operate its own landfill sites.\nThe U.S. Environmental Protection Agency (\"EPA\") promulgated its Subtitle D landfill regulations in October 1991, with the regulations becoming generally effective on October 9, 1993, for most landfills not closed prior to that date. The impact on the solid waste disposal market was downward pressure on pricing of disposal services for the last several years. However, the longer- term impact on the disposal market is expected to be a reduction in the number of operating landfill sites in the United States and a firming of prices. See \"Business - Regulation\" and \"Business - Waste Disposal Risk Factors.\"\nMedical Waste\nThe Company is the largest provider of medical waste services in North America. Approximately 100 of the Company's operating locations provide medical waste services involving the collection and disposal of infectious and pathological waste materials from approximately 114,000 customers. In the last five years, most states have enacted laws regulating medical waste. The Company is pursuing new opportunities to provide needed services created by these regulations. The Company owns or operates 28 treatment sites using either incineration or autoclaving (steam sterilization) technology. One additional treatment site is in the construction stage and another site is in the permitting process. The Company is pursuing the development of various healthcare markets, including but not limited to clinical and home healthcare markets, shipboard waste disposal, mail disposal and spill kit and other related markets. The Company believes the implementation of new Clean Air Act guidelines relating to medical waste incinerators could have a positive impact on the Company's medical waste operations.\nRecycling\nThe Company provides recycling services for certain materials streams in approximately 230 of its North American operating locations for approximately 5 million households, including curbside customers, and for approximately 166,000 commercial and industrial customers. Recycling continued as one of the fastest- growing segments of the Company's business in fiscal 1994. The Company's recycling business has 104 recycleries in North America and 32 such facilities outside North America. The Company also engages in the organic materials recycling and\/or disposal business, tire recycling and other alternative energy concepts such as biomass fuels. In fiscal 1994, the Company added 17 processing centers to further expand its processing capacity. BFI also acquired a company that is a producer and marketer of decorative bark, mulch, compost and organic soils to secure a market for organic materials collected. In response to public demand, recycling is increasingly required through legislation and regulation at all levels of government. In the case of many recycled materials, these requirements and the public's interest in recycling have resulted in an excess supply of recovered materials in some markets. Recognizing that the recycling momentum would involve necessary markets for recovered materials, the Company has developed relationships with numerous other companies to assure municipalities and other customers of continuous and diversified markets. To improve the marketing of recycled commodities, the Company operates a centralized materials marketing group. This group has enhanced the Company's ability to anticipate changing market conditions and establish longer-term customer relationships and agreements.\nOther Services\nThe Company is also involved in street and parking lot sweeping and the rental and servicing of portable restroom facilities. During fiscal 1993 and the first quarter of fiscal 1994, the Company sold a portion of its portable restroom and sweeping businesses, but has retained most of its operations located on the southern and western coasts of the United States. These locations are operated as part of the solid waste regions. The Company may also participate, to a limited extent, in the end-use development of certain BFI landfills which have reached permitted capacity and other real and personal property in which it has an interest. From time to time, the Company sells or otherwise disposes of surplus land and other real or personal property and reflects any gain or loss from such transactions in the results of operations for the period in which the transactions occur.\nInternational Operations\nSubsidiaries or affiliates of the Company are involved in waste collection, processing, disposal and\/or recycling operations in approximately 250 locations (including locations of unconsolidated affiliates) in Australia, Finland, Germany, Italy, Hong Kong, Kuwait, the Netherlands, New Zealand, Spain and the United Kingdom. European operations comprise the largest number of operating loca- tions outside of North America, and the Company believes that its operations in the Netherlands constitute the largest waste systems operation in that country.\nThe Company currently operates 49 landfill sites in its international operations (including those operated through unconsolidated affiliates). The Company also has 32 recycleries in its international operations.\nOn February 3, 1994, the Company acquired 50% of the stock of Otto Entsorgungsdienstleistung GmbH (\"Otto Waste Services\"), marking the Company's entry into the German solid waste market. Otto Waste Services is primarily engaged in providing collection and recycling services under long-term contracts with municipalities and Duales System Deutschland GmbH, the non-governmental organization responsible for the collection of recyclable materials in Germany. The purchase price for the 50% interest in Otto Waste Services was approximately $400 million, including approximately 3.9 million shares of Common Stock. See \"Business-Financing and Capital Expenditures\" and Note (3) of Notes to Consolidated Financial Statements. During fiscal 1994, the Company reported consolidated revenues of $344 million applicable to the Otto Waste Services acquisition.\nIn addition to being subject to many similar business risks generally encountered in the Company's domestic operations, the Company's operations outside of North America are subject to other risks, such as currency fluctuations, currency control regulations, the recruitment of non-resident labor, changes in foreign laws, social instability, war, invasion, compliance with foreign immigration laws, political changes, international tensions and problems associated with foreign governmental appropriation processes.\nThe financial performance of the Company's international operations has been lower than that of its North American operations, due primarily to (i) the higher concentration of collection activities (which have lower margins than disposal activities) in international operations, (ii) the inability to pass through certain disposal and other cost increases, particularly in Italy, and (iii) the assets being used in international operations having been recently acquired as compared to the assets being used in North American operations. For information concerning revenues, income from operations and identifiable assets applicable to foreign operations (including those in Canada), see Note (16) of Notes to Consolidated Financial Statements.\nResource Recovery\nThe Company and Air Products and Chemicals, Inc. (\"Air Products\"), headquartered in Allentown, Pennsylvania, are each 50% general partners in a partnership which designs, builds, owns and operates facilities that burn solid waste and recover energy and other materials. This partnership markets its capabilities under the name American Ref-Fuel (\"American Ref-Fuel\"). Three of the facilities owned by American Ref-Fuel partnerships utilize the solid waste mass-burning technology of the German firm, Deutsche Babcock Industrie AG (\"DBA\"), for which American Ref-Fuel is the exclusive licensee in North America. This technology has been utilized successfully for over 30 years in Europe and elsewhere. American Ref-Fuel pays for the right to utilize this technology. The fourth facility, located in Niagara Falls, New York, utilizes a refuse-derived fuel technology; however, a significant modification and expansion of the plant to employ the DBA mass-burning technology is currently under construction. The estimated construction cost of this project ranges from approximately $150 million to $200 million and the plant's capacity is expected to be approximately 2,250 tons per day. This project will be financed with tax exempt bonds to the extent feasible.\nIn each American Ref-Fuel project, a partnership is formed by indirect wholly-owned subsidiaries of Air Products and the Company. Separate American Ref-Fuel partnerships are operating resource recovery facilities in Hempstead, New York; Essex County, New Jersey; Niagara Falls, New York; and Preston, Connecticut. In connection with the existing projects, both the Company and Air Products have delivered, and in connection with any future projects may be required to deliver, support agreements for certain project indebtedness of each of the respective subsidiary partners. See Note (9) of Notes to Consolidated Financial Statements for information concerning these obligations.\nThe Company's equity investment in American Ref-Fuel's resource recovery projects was approximately $160 million at September 30, 1994. American Ref-Fuel's business is very capital intensive and its ability to raise capital is an important factor in its competitiveness in the waste services industry. When feasible, American Ref-Fuel attempts to finance its projects with tax exempt bonds due to the lower interests costs. The Company plans to expand its investment in American Ref-Fuel in fiscal 1995 by undertaking the significant modification and expansion of the Niagara Falls, New York, facility and permitting a new resource recovery project near Albany, New York, as well as pursuing a number of domestic and international acquisition opportunities, especially in Holland and Germany.\nAll resource recovery facilities must meet rigid environmental laws and regulations. Existing laws and regulations can be changed or administered so as to affect the design, construction, startup or operation of such facilities. Management believes that the DBA mass-burning technology is capable of meeting anticipated future changes in laws and regulations; however, there can be no assurance that required environmental and other permits will be issued for any planned project.\nAlthough the Company believes that each of the existing operating facilities are viable since each facility generates significant cash flows relative to the Company's investment in the facility, the economic viability of certain resource recovery facilities may be adversely affected by (i) the availability of commercially reasonable energy sales contracts; (ii) the availability of landfills for the disposal of ash residue, bypass and nonprocessible waste; (iii) existing and proposed governmental standards applicable to the disposal of ash residue that could limit the number of sites available for such disposal; (iv) air emission standards applicable to the facilities, (v) the possible lower cost of other alternatives for waste disposal and (vi) the recent decision by the U.S. Supreme Court which invalidates local flow control laws. Resource recovery facilities may also be adversely affected by many of the same factors that are currently impacting other waste disposal facilities. See \"Business - Regulation\" and \"Business - Waste Disposal Risk Factors.\"\nRegulation\nAll of the Company's principal business activities are governed by federal, state and local laws and regulations pertaining to public health and the environment, as well as transportation laws and regulations. These regulatory systems are complex and are subject to change.\nThe U.S. Congress and certain states have considered legislation, and some states are taking action, to ban or otherwise restrict the interstate transportation of wastes for disposal, to impose discriminatory fees on such transported wastes, to limit the types of wastes that may be disposed of at existing disposal facilities, and to mandate waste minimization initiatives, recycling quotas and composting of yard wastes. The Company's waste collection, transportation, treatment and disposal operations may be adversely affected by these developments.\nIn recent years, a number of communities have instituted \"flow control\" requirements, which typically require that waste collected within a particular area be deposited at a designated facility. In May 1994, the U.S. Supreme Court ruled that a flow control ordinance was inconsistent with the Commerce Clause of the Constitution of the United States. A number of lower federal courts have struck down similar measures. Congress recently considered, but did not adopt, legislation that would have partially overturned the Supreme Court's decision. The 1995 Congress may also examine bills that immunize particular governmental actions (for example, flow control that results from franchises or municipal contracts) from Commerce Clause scrutiny. In the absence of federal legislation, certain local laws that seek to direct waste flows to designated facilities may be unenforceable.\nSimilarly, the U.S. Supreme Court has consistently held that state and local measures that seek to restrict the importation of extraterritorial waste or tax imported waste at a higher rate are unconstitutional. To date, congressional efforts to enable states to, under certain circumstances, impose differential taxes on out- of-state waste or restrict waste importation have not been successful. In the absence of federal legislation, discriminatory taxes and importation restrictions should continue to be subject to judicial invalidation.\nBecause a major component of the Company's business is the collection and disposal of solid waste in an environmentally sound manner, a material amount of the Company's capital expenditures are related (directly or indirectly) to environmental protection measures, including compliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment. There are costs that are associated with facility upgrading, corrective actions, facility closure and post-closure care in addition to other costs normally associated with the Company's waste management activities. The majority of these expenditures are made in the normal course of the Company's business, and do not place the Company at any competitive disadvantage.\nIn October 1991, the EPA issued its final regulations under Subtitle D of the Resource Conservation and Recovery Act of 1976 (\"RCRA\"), which set forth minimum federal performance and design criteria for municipal solid waste landfills. These regulations also incorporated provisions under the Clean Air Act relating to landfill operations. All Subtitle D regulations are in effect, except for the ground-water monitoring requirements which are to be phased in over a five-year period and the financial assurance requirements which the EPA has now requested be effective in April 1996. Management of BFI believes that, as described below, these regulations will have a favorable long-term impact on its landfill operations, but meeting these new regulatory requirements is resulting in increased costs.\nUnder the Clean Air Act, the EPA proposed regulations in May 1991 which would require extensive methane gas collection systems to be installed at many of the Company's landfills. Although these regulations are not expected to be finalized until the Spring of 1995, the Company has proceeded to design, permit and install gas extraction and control systems at many of its facilities. The Company believes these systems substantially comply with the proposed regulations under the Clean Air Act. The Company is also seeking operating and other applicable permits for its activities and is pursuing a strategy of reducing emissions from both mobile and stationary sources. Implementation of certain provisions of the Clean Air Act will result in additional stringent control for those areas of the country that are placed in \"nonattainment status\".\nIncreasing regulation of solid waste management activities may also offer the Company expanded opportunities. The federal Subtitle D landfill regulations have resulted in the closure of a number of smaller, older existing landfills, which has increased the demand for solid waste capacity at other landfills that are in compliance with the regulations. Also, the regulations allow for the deposit of certain non-hazardous industrial wastes into solid waste landfills, thus increasing the volume of waste eligible for disposal in solid waste landfills. Medical waste regulations, mining waste regulations, ash regulations, municipal waste combustion regulations, and regulations for other industrial solid wastes (including waste water) will provide new opportunities for waste management facilities. While recycling regulations and procurement requirements for recycled goods will continue to create business opportunities in the recycling area, they will also diminish the volume of waste otherwise available for disposal in landfills.\nFinancial responsibility regulations, adopted in various forms by many states, require owners or operators of waste disposal facilities and underground storage tanks to demonstrate financial ability to respond to and correct for sudden and accidental pollution occurrences, as well as for non-sudden or gradual pollution occurrences. To meet these requirements, the Company has secured Environmental Impairment Liability (\"EIL\") insurance coverage in amounts the Company believes are in compliance with federal and state law. Under the current EIL policy, which is collateralized, the Company must reimburse the carrier for any losses. It is possible that the Company's net income could be adversely affected in a specific reporting period in the event of significant environmental impairment claims.\nMany state regulations also require owners or operators of waste disposal facilities to provide assurance of their financial ability to cover the estimated costs of proper closure and post-closure monitoring and maintenance of these facilities. The federal Subtitle D regulations require all states to adopt financial assurance regulations that meet the federal standards. The Company has generally relied upon its consolidated financial position to issue corporate guarantees, or has utilized letters of credit or surety bonds to satisfy these requirements. The EPA has proposed a financial test and corporate guarantee for use by private Subtitle D facilities, which, if adopted, would afford the Company a highly cost effective method to satisfy the financial assurance requirements. The Company has also established a captive insurance company that is being used to provide insurance as a recognized means of demonstrating this financial assurance. The Company is continuing its efforts to get this captive insurance company admitted in certain states, after which it can serve as a low-cost alternative to certain other forms of financial assurance, including letters of credit.\nMany of the states and local jurisdictions in which the Company operates have enacted \"fitness\" statutes that allow agencies having jurisdiction over waste service contracts or facility permits to refuse to award such contracts or to revoke or deny such permits on the basis of the applicant's (or permit holder's) environmental or other legal compliance history. The underlying intent of these statutes is to ensure that entities which engage in waste management activities merit and maintain the public confidence and trust. These statutes authorize the agencies to make determinations of an applicant's \"fitness\" to be awarded the waste service contract or to operate the particular waste facility and to revoke or deny that facility's operating permit, absent a showing that the applicant has been rehabilitated through its adoption of various operating practices, policies and procedures to ensure compliance with all applicable laws of that jurisdiction. Certain of the Company's subsidiaries with past violations of environmental or other laws, or affiliates of such subsidiaries, have to respond to these requirements. In addition, the federal Clean Water Act provides for debarment of contractors for violations of its provisions.\nIn 1988, the EPA issued regulations under RCRA which require an owner or operator of underground storage tanks that contain or contained petroleum to meet certain design, operating and performance standards for such tanks and to demonstrate financial responsibility for any appropriate corrective action and third- party compensation. The Company has conducted an analysis of its tanks, and the majority of its underground tanks will have been removed by 1998. Tanks that need replacing are being replaced by either above- or below-ground systems that meet the new standards.\nWith respect to international operations, the profitability and risks associated with these operations can be affected by changes in national business, financial and political policies, war, invasion, social instability, currency fluctuations and other risk factors associated with operations in foreign countries. In its international operations, the Company has noted a trend toward increased environmental regulation, particularly in those countries within the European Economic Community. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Environmental Matters.\"\nCompetition\nBFI competes with both larger and smaller publicly-held companies and numerous small privately-owned waste services companies that are primarily engaged in offering all or part of the waste services that BFI provides. This competition is intense and has increased in recent years. BFI believes that neither it nor any other waste services company has a significant portion of any major aspect of the solid waste services markets. In some geographic areas, all or part of the solid waste collection, processing and disposal services offered by BFI may also be provided by municipalities or by governmental authorities with regional or multi-county jurisdiction. Generally, however, governmental units do not provide significant commercial or industrial solid waste collection or disposal services. Because solid waste services provided by municipal or regional governmental authorities are generally subsidized by tax revenues and utilize major equipment and facili- ties that are financed with proceeds from the sale of tax-exempt bonds, these authorities may provide such services at lower prices (though not necessarily at lower costs) than those of private companies.\nCompetition is encountered primarily from publicly-held and numerous locally-owned private solid waste services companies and, to a lesser degree, from municipalities and other governmental units with respect to residential solid waste collection and solid waste sanitary landfills. Intense competition in pricing and type and quality of services offered is encountered. Some competitors in certain markets have increased competitive pressure by their willingness to accept lower profit margins to maintain market share.\nWaste Disposal Risk Factors\nThere are serious, sometimes unforeseeable, business risks and potentially substantial cost exposures associated with the establishment, ownership and operation of solid waste sanitary landfill sites and other types of waste processing and disposal facilities. These risk factors include, but are not limited to: (i) the difficulty of obtaining permits to expand or establish new sites and facilities and public and private opposition to the location, expansion and operation of these facilities, (ii) govern- mental actions at all levels that seek to restrict the interstate movement of waste for disposal, which can result in declining volumes of waste available for disposal at some facilities, (iii) costs associated with liner requirements, groundwater monitoring, leachate and landfill gas control, surface water control, post- closure monitoring, site cleanup, other remedial work and maintenance and long-term care obligations, (iv) the obligation to manage possible adverse effects on the environment, (v) regulations requiring demonstration of financial responsibility (see \"Business - - Regulation\") and conformance to prescribed or changing standards and methods of operation, (vi) judicial and administrative proceedings regarding alleged possible adverse environmental and health effects of landfills or other treatment and disposal facilities, and (vii) reduction in the volume of solid waste available for direct landfill disposal in certain states because of governmental incentives to reduce the daily volume of waste that may be disposed of, initiatives that require waste recycling, minimization or composting and because of incineration in large waste-to-energy facilities. See also \"Business - Resource Recovery\", \"Business - Regulation\" and \"Legal Proceedings - Environmental Proceedings.\"\nSome of the issues faced by the Company and the waste industry generally include (i) opposition to the siting and operation of new or expanded waste facilities, (ii) public concern regarding the potential for adverse effects on public health and the environment attributable to the waste managed at such facilities, (iii) the cost of complying with complex and changing regulations, (iv) governmental restraints on interstate shipment of waste or discriminatory taxes on waste imports, (v) differential enforcement of laws and regulations by governmental agencies, and (vi) a desire on the part of many waste generators to maintain or increase control over their wastes by managing their wastes. See also \"Legal Proceedings-Environmental Proceedings.\"\nBFI has periodically undertaken or been required, and may in the future undertake or be required, to cease or to alter substantially its operations at existing waste disposal sites, to implement new construction standards at existing facilities and to add additional monitoring, post-closure maintenance or corrective measures at waste disposal sites. The Subtitle D regulations have required costly, additional expenditures by the Company and may in the future require substantial expenditures, which could have a negative impact on operations. See \"Business - Regulation\" for information concerning capital expenditures relating to environmental and health laws and regulations and Notes (1) and (6) of Notes to Consolidated Financial Statements.\nIf the Company were unable to continue disposing of planned volumes of wastes at existing solid waste landfills and unable to either expand existing landfills or establish new sites, it would be required to obtain the rights to use other disposal facilities or to suspend or curtail solid waste collection or disposal activities. Any such actions would have an adverse impact on the Company's collection business and could substantially reduce the Company's revenues and income from operations and increase the risk of impairing the value of the Company's investment in existing or proposed facilities. These developments could also result in accelerating the recognition of closure costs and post-closure monitoring cost accruals for those landfills, with a corresponding negative impact on the Company's net income.\nCertain geographic regions in the United State have, at times, experienced shortages of suitable solid waste disposal facilities. Without long term planning, many private and governmental solid waste collection companies operating in the affected areas, including BFI, could be required to curtail or even suspend land disposal operations, or seek other, more distant sites. In other cases, collection companies, including those owned by BFI, may be excluded from disposing of solid waste in landfills or waste-to- energy facilities either because of regulation or because of the owners' desire to preserve the remaining capacity for their own disposal needs.\nCorporate Development\nOn September 20, 1994, BFI Acquisitions plc (\"BFI (UK)\"), a subsidiary of the Company, announced the terms of cash offers to acquire all of the outstanding ordinary shares (including ordinary shares represented by American Depositary Shares) of Attwoods plc (\"Attwoods\"), a United Kingdom company, and convertible preference shares of Attwoods (Finance) N.V., a Netherlands Antilles company and finance subsidiary of Attwoods. On November 17, 1994, the Company announced its increased and final cash offers (\"Final Offers\") expiring on December 2, 1994. The Final Offers, denominated in pounds sterling, are 116.75 pence per ordinary share (583.75 pence per ADS) and 92 pence per preference share (an aggregate of approximately U.S. $611 million based on exchange rates prevailing on November 29, 1994). The Final Offers also provide for a recommended final dividend of 3.25 pence per ordinary share payable to Attwoods shareholders.\nAttwoods is a provider of waste management services operating principally in the United States, the United Kingdom, the Caribbean and mainland Europe, primarily Germany, and also has mineral extraction operations in the United Kingdom.\nThe Final Offers are subject to the satisfaction of various conditions, including acceptance by the holders of not less than 50% of the ordinary shares and satisfaction of applicable requirements under the Hart-Scott-Rodino Anti-Trust Improvements Act (\"HSR Act\"). The Company has an agreement in principle with the U.S. Department of Justice (\"DOJ\") respecting satisfaction of the requirements of the HSR Act and expects to reach a definitive agreement prior to expiration of the Final Offers.\nOn November 29, 1994, the Company announced that the holders of approximately 42.6% of the ordinary shares (including ADS) had accepted the Final Offers.\nThe Company's corporate development program will continue to focus on opportunities to expand its customer base by entering into new domestic and international markets, by broadening the type of services offered, by pursuing municipal contracting opportunities, and by acquiring businesses and properties. Developing suitable new solid waste processing and disposal facilities will continue to be an important strategy. When investing in capital-intensive facilities such as landfills, the Company faces the risk that required permits will not be obtained or renewed. If permits are not ultimately obtained and maintained, the value of such facilities can be substantially impaired, which could result in a reduction of future net income. See \"Business - Solid Waste Services - Disposal\" and \"Business - Regulation.\" The Company will also pursue project opportunities for its services in foreign markets. See \"Business - International Operations.\"\nThe Company has continued to acquire from unaffiliated persons, in negotiated transactions, businesses and properties engaged primarily in or related to one or more aspects of the solid waste services industry. BFI intends to continue pursuing opportunities to acquire such businesses using BFI Common Stock, cash, agreements for the payment of royalties and indebtedness. There can be no assurance that BFI will be successful in making additional acquisitions. See \"Business-Financing and Capital Expenditures.\"\nFinancing and Capital Expenditures\nCapital Expenditures\nCapital expenditures were approximately $1.3 billion in fiscal 1994, which included $611 million for acquired businesses, including the acquisition of 50% of Otto Waste Services. Reflected in the $611 million is the fair market value of common stock issued in connection with four business combinations which met the criteria to be accounted for as poolings-of-interests. Additionally, approximately $218 million was expended in connection with the development of existing operations, municipal contracts and investment in unconsolidated subsidiaries. The remainder of capital expenditures for 1994 related to additions and replacements of capital items for existing operations. See Notes (3) and (5) of Notes to Consolidated Financial Statements.\nSubject to Board of Director approval and excluding the proposed Attwoods transaction, the capital appropriations budget will be approximately $1.2 billion for fiscal 1995. This includes amounts for corporate development and the normal replacement of assets and expansion within existing operations. A change in national economic conditions, regulatory or other factors could result in a revised level of capital expenditures. The Company believes that the amounts budgeted to replace assets, if expended, are sufficient to maintain the level of its existing assets through 1995. It is currently anticipated that the funds required for fiscal 1995 capital expenditures will be provided from internally generated sources and from outside sources of capital, including borrowings. See \"Business - Resource Recovery\", \"Business - International Operations\" and \"Business - Corporate Development\". See \"Business - - Regulation\" for information concerning capital expenditures relating to evolving environmental and health laws and regulations. Management of the Company believes that there are ample provisions in the capital appropriations budget for business opportunities that may arise in the ordinary course of business.\nDuring the next five years, the Company currently expects that internally generated funds will be sufficient to finance most of its anticipated capital expenditures in the ordinary course of business. Any shortfall in funds required for these purposes (including the funds required to meet the Company's share of the several American Ref-Fuel project obligations and commitments; see \"Business - Resource Recovery\") will have to be obtained from outside sources of capital, including borrowings.\nFinancings and Credit Facilities\nOn September 20, 1994, the Company announced the terms of a cash offer (the \"Offers\") to acquire all the ordinary shares of Attwoods plc, a United Kingdom company, and all of the preferred shares of Attwoods (Finance) N.V., a Netherlands Antilles company. On September 19, 1994, the Company entered into a letter agreement providing for the borrowing by the Company of up to 500 million pounds sterling (or its equivalent) to finance the Offers. The facility is to be used to assist in funding the Offers and to fund the working capital requirements and refinance any existing indebtedness of Attwoods, including any existing obligations of Attwoods that become due and payable as a result of the Offers becoming unconditional. Borrowings under the facility are conditional on the Offers having become (or in certain circumstances, having been declared) unconditional in all respects under United Kingdom law. The payment of dividends or other distributions on the Company's Common Stock will be limited by the provisions of this credit agreement; these provisions will be somewhat more restrictive than the restrictions imposed on the payment of dividends and other distributions pursuant to the Revolving Credit Agreement discussed below and in Note (7) of Notes to Consolidated Financial Statements. See \"Market for the Registrant's Common Equity and Related Stockholder Matters\" for a discussion of the Company's dividend history.\nThe Company has a bank credit agreement providing for borrowings of up to $1 billion (the \"Revolving Credit Agreement\"). The Company had no borrowings under this bank credit agreement at November 29, 1994. The borrowing capacity under this agreement will be available, if needed, to assist the Company in meeting its requirements for outside sources of capital. The payment of dividends or other distributions on the Company's Common Stock is limited by the provisions of the Revolving Credit Agreement. The Company's long-term objective is to maintain most of its indebtedness in fixed interest rate obligations. See \"Market for the Registrant's Common Equity and Related Stockholder Matters\" and Notes (7), (8) and (17) of Notes to Consolidated Financial Statements for more detailed information concerning these agreements and the Company's other indebtedness.\nThe Company has a commercial paper program authorizing the issuance of up to $1 billion in commercial paper. At November 29, 1994, the Company had $45.5 million in commercial paper outstanding. Borrowings under the commercial paper program may not exceed the available credit under the Company's Revolving Credit Agreement. The commercial paper program is available to provide the Company with external financing to meet its capital requirements.\nIn March 1994, the Company completed a public offering of 15,525,000 shares of its Common Stock. The net proceeds of approximately $434.7 million received by the Company were used to redeem the $100 million 8 1\/2% Sinking Fund Debentures due 2017 outstanding, to repay indebtedness associated with the acquisition of the Company's 50% interest in Otto Waste Services and other working capital requirements. See \"Management's Discussion and Analysis - Liquidity and Capital Resources\" for additional information.\nExecutive Officers of the Company\nThe executive officers of the Company, their positions (including their principal areas of responsibility with the Company) and their respective ages are as follows:\nName Position Age*\nWilliam D. Ruckelshaus Chairman of the Board, 62 Chief Executive Officer and Director (1)\nBruce E. Ranck President, Chief 45 Operating Officer and Director (1)\nNorman A. Myers Vice Chairman, Chief 58 Marketing Officer and Director (1)\nJeffrey E. Curtiss Senior Vice President and 46 Chief Financial Officer\nHugh J. Dillingham, III Senior Vice President 45 (Disposal Operations)\nJ. Gregory Muldoon Senior Vice President 40 (Corporate Development)\nRufus Wallingford Senior Vice President 54 and General Counsel\nDavid R. Hopkins Vice President, Controller 51 and Chief Accounting Officer\nLouis A. Waters Chairman and President of 56 BFI International, Inc. and Director (1)(2) ________________\n*As of November 30, 1994. (1) Serves on the Executive Committee of the Board of Directors. (2) Serves on the Finance Committee of the Board of Directors.\nMr. Ruckelshaus was elected a director in June 1987 and Chairman of the Board and Chief Executive Officer in September 1988. Mr. Ruckelshaus also serves as a director of Cummins Engine Company, Monsanto Company, Nordstrom, Inc., Texas Commerce Bancshares, Inc. and Weyerhaeuser Company. He also serves as a director or trustee of several educational and charitable organizations.\nMr. Ranck became President and Chief Operating Officer in November 1991, having served as Executive Vice President (Solid Waste Opera- tions-North America) of the Company since October 1989 and a director since March 1990. Prior to that time, he served the Company as a Regional Vice President in one of the Company's regions for a period in excess of five years. He also serves as a director of Furon Co. and Junior Achievement of Southeast Texas, Inc.\nMr. Myers was elected a director in 1978, Chief Marketing Officer in March 1981 and Vice Chairman of the Board in December 1982. He was initially elected a Vice President in December 1970 and became an Executive Vice President in July 1976. Mr. Myers is a director of My Friends, a foundation for children in crisis.\nMr. Curtiss became Senior Vice President and Chief Financial Officer of the Company in January 1992. Before that time, he served from August 1989 to January 1992 as Executive Vice President, Chief Financial Officer and a director of Heritage Media Corporation, an American Stock Exchange-listed company based in Dallas.\nMr. Dillingham was elected Senior Vice President (Disposal Operations) in March 1993, having served as Vice President (Disposal Operations) since December 1991. Prior to his election, he served as Divisional Vice President of Disposal Operations in one of the Company's regions, and has over sixteen years of experience with the Company in landfill operations. Mr. Dillingham serves as a director of the Wildlife Habitat Enhancement Council.\nMr. Muldoon was elected Senior Vice President (Corporate Development) in September 1992, having served as Vice President (Operations) since December 1991. He had joined the Company in 1980 as a market development representative and from 1983 to 1988, he had served as district manager in several locations. From early 1989 until October 1990, he served as President of CECOS International, Inc., a subsidiary of the Company, through the discontinuation of its hazardous waste business. He then served as Regional Vice President of one of the Company's regions from October 1990 to November 1991.\nMr. Wallingford became Senior Vice President and General Counsel of the Company in January 1994. Prior to that time, he was a senior partner with the law firm of Fulbright & Jaworski L.L.P., Houston, Texas, for a period in excess of five years. Mr. Wallingford also serves as a director of St. Luke's Episcopal Hospital and the Children's Museum Foundation in Houston, Texas.\nMr. Hopkins, who was a Divisional Vice President and Assistant Controller prior to becoming Controller of the Company in September 1986, joined the Company in September 1980. He was elected a Vice President and named Chief Accounting Officer in December 1986. From September 1991 to January 1992, he served as acting Chief Financial Officer of the Company.\nMr. Waters has served as Chairman of the Finance Committee since September 1988, has served as Chairman of BFI International, Inc. since May 1991 and has served as President of BFI International, Inc. since March 1993. He also serves as a member of the Executive Committee of the Company's Board of Directors, and served as Chairman of the Executive Committee from September 1980 until 1988. He served as Chairman of the Board of the Company from August 1969 to September 1980. Mr. Waters serves as a director or trustee of several business, educational and charitable organizations.\nAll officers of the Company (including executive officers) are elected by the Board of Directors, generally at its meeting held the day of the annual meeting of stockholders or as soon thereafter as practicable. Each officer is elected to hold office until his successor shall have been chosen and shall have qualified or until his death or the effective date of his resignation or removal. The annual meeting of stockholders is scheduled to be held March 1, 1995 in Houston, Texas.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nIn their operations, subsidiaries and affiliates of the Company use specially-equipped trucks, steel containers and stationary compactors. The Company also owns and\/or operates sanitary landfill sites throughout the United States and Canada, and in the United Kingdom, Germany, the Netherlands, Spain, Australia and Italy. See \"Business - Solid Waste Services - Collection\" and \"Business - Solid Waste Services - Solid Waste Transfer and Disposal,\" and Notes (4) and (6) of Notes to Consolidated Financial Statements.\nThe Company's executive offices are located at 757 N. Eldridge, Houston, Texas. The Company owns real estate, buildings and other physical properties, which it employs in its daily operations in a large number of its operating locations. The Company also leases a substantial portion of its transfer stations, offices, storage and shop space. See Notes (4) and (9) of Notes to Consolidated Financial Statements.\nBFI believes that the property and equipment of its subsidiaries and affiliates are well-maintained and adequate for its current needs, although substantial investments are expected to be made in additional property and equipment for expansion, for replacement of assets as they reach the end of their useful lives and in connection with corporate development activities. See \"Business - Corporate Development,\" \"Business - Financing and Capital Appropriations\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" Certain of the property and equipment of BFI's subsidiaries and affiliates is subject to mortgages and liens securing payment of portions of their indebtedness. See Notes (7) and (9) of Notes to Consolidated Financial Statements for information with respect to mortgage and lease obligations on these properties.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nOn November 7, 1990, a lawsuit styled Leonard Eisner Profit Sharing Plan et al. v. Browning-Ferris Industries, Inc. et al. was filed in the United States District Court for the Southern District of Texas. Another purported class action styled Jerry Krim, on behalf of himself and all others similarly situated v. Browning-Ferris Industries, Inc., et. al. was filed on September 9, 1991, in the United States District Court for the Southern District of Texas. It is a purported class action on behalf of those persons who purchased BFI Common Stock during the period from December 17, 1990 through September 9, 1991. Thereafter, several other purported class actions were also filed. These cases were consolidated into a lawsuit styled In Re Browning-Ferris Industries, Inc. Securities Litigation, which is pending in the United States District Court for the Southern District of Texas. The suit generally alleges violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder by allegedly prepar- ing, issuing and disseminating materially false and misleading information to plaintiffs and the investing public. The amended consolidated suit seeks unquantified damages and attorneys' and other fees. On June 11, 1993, the trial court certified the class action and two classes of persons who purchased the Company's common stock. The first class period is from August 9, 1990 through November 5, 1990, and the second class period is from November 6, 1990 through September 3, 1991. On June 30, 1994, the plaintiffs filed a motion for leave to file an amended complaint to broaden the allegations in the suit. This motion has been denied. The defendants have filed motions for summary judgment as to both classes, which motions are still pending. The defendants have also filed a motion to dismiss as class action or, in the alternative, to decertify the classes. This motion has not been ruled on by the court. The Company is vigorously defending these cases.\nThe case of Gary David Harding, et al. v. Browning-Ferris Industries, Inc., et al. was filed in the 229th Judicial District Court of Duval County, Texas, on February 28, 1994. The approximately 356 plaintiffs allege that they reside in the vicinity of a landfill in San Patricio County, Texas, and they allege that they have sustained personal injuries and other damages from allegedly contaminated groundwater and other alleged pathways of exposure. Although the complaint does not specify the amount of damages sought in the case, the plaintiffs' attorneys have informally notified the Company that they will \"seek damages greatly exceeding ten percent of BFI's current consolidated assets.\" This lawsuit was first filed in the 105th Judicial District Court of Nueces County, Texas on September 23, 1992, with respect to approximately 171 plaintiffs. The plaintiffs moved to have the Nueces County lawsuit dismissed by the trial court without prejudice. This motion was granted by the trial court. The plaintiffs from the Nueces Court case along with numerous new plaintiffs refiled the litigation in Duval County. The Company has filed a motion that seeks to transfer venue in the litigation back to Nueces County, Texas. This motion has not been ruled on by the court in Duval County. The Company is vigorously defending against the allegations in the litigation.\nOn May 18, 1994, a lawsuit styled Ogden Projects, Inc., et al. v. New Morgan Landfill Company, Inc. (\"New Morgan\") was filed in the United States District Court for the Eastern District of Pennsylvania. The suit alleges that a subsidiary of the Company did not obtain a permit to construct and operate a landfill under provisions of the Clean Air Act. The plaintiffs, who are private parties without regulatory authority, seek a declaratory judgment, an order enjoining the subsidiary from continuing the construction and\/or operation of the landfill without a permit, and civil penalties of $25,000 for each day New Morgan has constructed and\/or operated the landfill without a permit under the provisions of the Clean Air Act. The Company believes the suit is without merit and is vigorously defending the case.\nIn addition to the above-described litigation, the Company and certain subsidiaries are involved in various other administrative matters or litigation, including original or renewal permit application proceedings in connection with the establishment, operation, expansion, closure and post-closure activities of certain landfill disposal facilities, environmental proceedings relating to governmental actions resulting from the involvement of various subsidiaries of the Company with certain waste sites (including Superfund sites) (see \"Environmental Proceedings\"), personal injury and other civil actions, as well as other claims and disputes that could result in additional litigation or other adversary proceedings.\nWhile the final resolution of any such litigation or such other matters may have an impact on the Company's consolidated financial results for a particular reporting period, management believes that the ultimate disposition of such litigation or such other matters will not have a materially adverse effect upon the consolidated financial position of the Company.\nEnvironmental Proceedings\nThe Company strives to conduct its operations in compliance with applicable laws and regulations, including environmental rules and regulations, and has as its goal 100% compliance. However, management believes that in the normal course of doing business, companies in the waste disposal industry, including the Company, are faced with governmental enforcement proceedings and resulting fines or other sanctions and will likely be required to pay civil penalties or to expend funds for remedial work on waste disposal sites. The possibility always exists that such expenditures could be substantial, which would have a negative impact on earnings for a particular reporting period. Management of BFI believes that the existence of these proceedings does not provide an accurate reflection of the Company's operating policies, procedures and capabilities, although the Company will have to respond to those issues in filings required to be made in jurisdictions which have enacted \"fitness\" statutes. See \"Business - Regulation.\" In any event, management of the Company believes that the ultimate resolution of such proceedings will neither individually nor in the aggregate have a materially adverse effect upon the consolidated financial position of the Company.\nSubsidiaries of the Company are continuously engaged in various original or renewal permit application proceedings in connection with the establishment, operation, expansion, closure and post- closure activities relating to waste treatment and disposal facilities, properties and activities. These proceedings, which are a necessary and routine part of waste disposal activities, are held before a variety of regulatory and judicial agencies at the federal, state and local level. In these proceedings, legal challenges are routinely raised by private parties and by the regulatory agencies, alleging a variety of adverse consequences (including adverse effects on the environment, in some instances with particular reference to the inequitable distribution of environmental burdens among various social groups and classes) if the proposed permits are granted or renewed. Opposition is also routinely encountered in connection with proposed changes in zoning designations, operating procedures, remedial or upgrading actions and post-closure activities at waste processing and disposal facilities. See \"Business - Regulation.\"\nVarious subsidiaries of the Company are participating in potentially responsible party (\"PRP\") groups at 84 sites listed on the EPA's National Priority List, which sites may be subject to remedial action under the Comprehensive Environmental Response, Compensation and Liability Act (also known as \"Superfund\"). Complete settlements with other members of the PRP groups and\/or the EPA have been negotiated with respect to 61 of these sites. Partial settlements have been negotiated with regard to ten of the sites. These settlements had no material effect on the Company's results of operations or consolidated financial position. Further, various subsidiaries of the Company have received information requests relating to 64 additional sites on the EPA's National Priority List. For 35 of these sites, the Company has determined that it is not a PRP. The Company's PRP status at the remaining 29 sites has not yet been determined. The number of Superfund sites with which the Company's subsidiaries are involved may increase or decrease depending upon the EPA's findings from responses to these information requests and any future information requests which may be received. Superfund legislation permits strict joint and several liability to be imposed without regard to fault, and as a result, one company might be required to bear significantly more than its proportional share of the cleanup costs if it is unable to obtain appropriate contributions from other responsible parties.\nManagement routinely reviews each site requiring corrective action (including Superfund sites) in which the Company's subsidiaries are involved, considers each subsidiary's role with respect to each site and the relationship to the involvement of other parties at the site, the quantity and content of the waste with which it was associated, and the number and financial capabilities of the other parties at the various sites. Based on reviews of the various sites, currently available information and management's judgment and significant prior experience related to similarly situated facilities, expense accruals are provided by the Company for its share of estimated future costs associated with corrective actions to be implemented at certain of these sites and existing accruals are revised as deemed necessary. The final negotiated settlement relating to the large majority of Superfund sites occurs several years after a party's identification as a potentially responsible party, due to the many complex issues that must be addressed in determining the magnitude of the contamination at the site. The process for addressing contamination at a site usually includes technical investigations, selection of a remedy and implementation of the remedy selected. In many cases, the expenditures related to actual corrective action may be incurred over a number of years. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Environmental Matters.\"\nManagement believes that the ultimate disposition of these environmental matters will not have a materially adverse effect upon the liquidity, capital resources or consolidated financial position of the Company, although the resolution of one or more of these matters could have a significant negative impact on the Company's consolidated financial results for a particular reporting period. It can be reasonably expected that various subsidiaries of the Company will become involved in additional remedial actions and Superfund sites in the future.\nA subsidiary of a Company, CECOS International, Inc. (\"CECOS\"), is a party to a consent order with the U.S. Environmental Protection Agency, one aspect of which concerns a leachate pretreatment system that CECOS agreed to construct at one of its closed facilities. By letter dated March 16, 1994, the USEPA has demanded $528,500 in stipulated penalties due to CECOS's alleged failure to commence timely start-up of the leachate pretreatment system that is presently operating. CECOS is vigorously defending the imposition of this proposed penalty. Management of the Company is unable to conclude whether the ultimate monetary sanction in this matter, if any, will be more than $100,000.\nOn March 6, 1991, Region VI of the EPA filed an administrative proceeding entitled In the Matter of Chemical Reclamation Services, Avalon, Texas. The complaint alleges that Chemical Reclamation Services (\"CRS\"), a former subsidiary of the Company, failed to comply with certain notification requirements under RCRA and under regulations established under the Texas hazardous waste management program. The complaint seeks a proposed monetary sanction against CRS in the amount of $229,500. A claim for indemnity has been made against the Company. Management of the Company is currently unable to determine whether the ultimate monetary sanction, if any, will be more than $100,000, and whether the Company will be obligated for any part of the monetary sanction, if any, that may ultimately be imposed upon CRS.\nOn March 9, 1991, CECOS was named in a civil administrative complaint, entitled In the Matter of CECOS International, Inc., initiated by Region II of the EPA. This complaint alleges that CECOS landfilled certain waste generated by General Motors Corporation, that by definition contained polychlorinated biphenyls in excess of the regulatory limit, rather than incinerating such waste, and that CECOS failed to test the waste in accordance with the requirements of its permits. The complaint seeks a monetary sanction against CECOS in the amount of $14,150,000. CECOS is vigorously contesting the allegations in the complaint. Management of the Company is currently unable to determine whether the ultimate monetary sanction, if any, will be more than $100,000.\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 report, no matter was submitted 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.\nBFI's Common Stock is traded on the New York Stock Exchange, the Chicago Stock Exchange, the Pacific Stock Exchange and The International Stock Exchange of the United Kingdom and Republic of Ireland Ltd. The table below sets forth by fiscal quarter, for the fiscal years ended September 30, 1993 and 1994, the high and low sales prices of BFI's Common Stock on the New York Stock Exchange - Composite Transactions, as reported in The Wall Street Journal.\nFiscal Year 1993 Fiscal Year 1994 High Low High Low\nFirst Quarter $ 27-1\/8 $ 21-5\/8 27-1\/2 20-7\/8 Second Quarter 28-5\/8 25-3\/4 30-1\/4 24-1\/4 Third Quarter 28 24 32-1\/4 24-5\/8 Fourth Quarter 27-7\/8 22-3\/8 32-7\/8 29\nAs of November 29, 1994, there were approximately 20,000 holders of record of BFI Common Stock.\nIn June 1988, the Company's Board of Directors adopted a Preferred Stock Purchase Rights Plan and in connection therewith declared a dividend of one Preferred Stock Purchase Right (a \"Right\") on each outstanding share of the Company's Common Stock and on each share subsequently issued until separate Rights certificates are distributed or the Rights expire or are redeemed. See Note (11) of Notes to Consolidated Financial Statements for more detailed information concerning these Rights.\nBFI has paid cash dividends on its Common Stock each year since 1950. Cash dividends are paid quarterly. During each of fiscal 1993 and 1994, 68 cents was paid in dividends on each share of Common Stock. The most recently declared quarterly cash dividend on the Common Stock was 17 cents per share. The payment of dividends or other distributions on, or with respect to, the Common Stock is limited by provisions of the Company's Revolving Credit Agreement. See Note (7) of Notes to Consolidated Financial Statements. The amount available for payment of dividends or distributions on or with respect to Common Stock pursuant to such limitation was approximately $1.3 billion on September 30, 1994, after giving effect to cash dividends paid or declared through September 30, 1994. The provisions of the credit agreement for 500 million pounds sterling to finance the acquisition of Attwoods will be somewhat more restrictive with respect to the payment of dividends. See \"Financing and Capital Expenditures -Financings and Credit Facilities\" for a description of this credit agreement. BFI currently expects to continue the payment of dividends, although future dividend payments will depend on BFI's earnings, financial needs and other factors.\nDue to the nature of the Company's business, the Company or its competitors receives unfavorable publicity from time to time, which can result in aberrational market conditions for the Company's securities.\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III.\nItems 10, 11, 12 and 13 of Part III (except for information required with respect to executive officers of the Company which is set forth under \"Business - Executive Officers of the Company\" in Part I of this report) 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 its fiscal year, a definitive 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.\nItem 6.","section_6":"Item 6. - Selected Financial Data\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nSELECTED FINANCIAL DATA\nThe following is a summary of certain consolidated financial information regarding the Company for the five years ended September 30, 1994.\n- ----------------------------------------------------------------------------- Year Ended September 30, ---------------------------------------------------------- 1994 1993 1992 1991 1990 - ----------------------------------------------------------------------------- (In Thousands Except for Per Share Amounts) Operating State- ment Data: - ----------------\nRevenues(1) $4,314,541 $3,478,830 $3,277,635 $3,174,899 $2,957,880\nIncome from contin- uing operations before special charges and extra- ordinary item $ 283,973 $ 213,910 $ 175,607 $ 221,642 $ 298,053\nIncome from contin- uing operations before extra- ordinary item $ 283,973 $ 197,440 $ 175,607 $ 65,177 $ 256,786\nNet income (loss) $ 278,710 $ 197,440 $ 175,607 $ 65,177 $ (44,743)\nIncome (loss) per common and common equivalent share - Income from continuing operations before extra- ordinary item $ 1.52 $ 1.15 $ 1.11 $ .42 $ 1.68\nNet income (loss) $ 1.49 $ 1.15 $ 1.11 $ .42 $ (.29)\nCash dividends per common share $ .68 $ .68 $ .68 $ .68 $ .64\n(Continued on Following Page)\n- ----------------------------------------------------------------------------- Year Ended September 30, ---------------------------------------------------------- 1994 1993 1992 1991 1990 - ----------------------------------------------------------------------------- (In Thousands Except for Per Share Amounts)\nBalance Sheet Data: - ------------------\nProperty and equipment, net $3,049,767 $2,515,709 $2,263,653 $2,140,203 $1,988,221\nTotal assets $5,796,955 $4,295,642 $4,067,524 $3,655,892 $3,573,573\nSenior long-term debt $ 713,680 $ 333,689 $ 349,183 $ 406,987 $ 447,581\nConvertible subordinated debentures $ 744,949 $ 744,949 $ 744,949 $ 744,959 $ 744,959\nCommon stock- holders' equity $2,391,680 $1,532,603 $1,460,406 $1,114,299 $1,161,929\nCash Flow Data: - --------------\nCapital expendi- tures - continuing operations $ 694,475 $ 606,240 $ 531,239 $ 477,632 $ 440,850\nCash flows from operating activities $ 693,928 $ 613,965 $ 577,007 $ 685,664 $ 593,010\n- -----------\n(1) Certain reclassifications have been made in prior year amounts to conform to the current year presentation.\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\nThe fiscal 1994 results reflected significant improvement over the prior year as the Company capitalized on opportunities for growth in North America and expanded its international operations. Revenues compared with fiscal 1993 increased 24% to $4.3 billion while net income increased to $279 million from $197 million or 41% over the prior year. Fiscal 1994 results included an extraordinary charge of $5.3 million, net of tax, related to the early retirement of debt, and fiscal 1993 net income included a pre-tax reorganization charge of $27 million ($16.5 million, net of tax). Current year net income before considering the extraordinary item was $284 million, an increase of 33% over prior year net income of $214 million excluding the reorganization charge. The increase in net income before charges was largely the result of increased profitability in the Company's domestic disposal and transfer services and recycling operations, and improved earnings from international operations.\nInternational results have been favorably affected by improved overall performance in Europe, and include the recent acquisition of a 50% interest in one of the largest waste services companies in Germany. In February 1994, the Company paid approximately $400 million, consisting of 3.9 million shares of the Company's common stock and the remainder in Deutsche Mark, to acquire a 50% interest in Otto Waste Services. This purchase represents the single largest acquisition in the history of the Company. Otto Waste Services is an integrated waste services company operating throughout Germany that is principally engaged in providing collection and recycling services under long-term contracts to municipalities. The Otto Waste Services' group of companies includes in excess of 50 wholly owned and partially owned subsidiaries. The revenues and earnings of these companies and partially owned subsidiaries have been included in the Company's results for the year ended September 30, 1994 from the date of acquisition in February 1994.\nThe Company reported consolidated revenues of $344 million during fiscal year 1994 applicable to the Otto Waste Services acquisition, representing over 40% of the growth in year-to-year revenues. Fiscal 1994's higher revenues were also due in part to the success of the Company's North American acquisition activities. Further, revenue growth from additional volume was significant during the year, particularly in the collection, landfill and recycling businesses. Excluding the Otto Waste Services acquisition, international revenue growth was primarily the result of market development activities in Germany and the Netherlands and the reconsolidation of certain operations in Spain in May 1993.\nIn addition to reviewing its financial results by geographic area (region, division, district), the Company analyzes its results by reported line of business: collection, disposal and transfer, recycling, medical waste and international. As the various lines of business become integrated within numerous markets, separate business line analysis becomes less meaningful than aggregate marketplace profitability relative to the investment deployed in the market. Despite this shortcoming, analyzing financial results by line of business remains the most feasible method of explaining business performance for the Company.\nNorth American collection services revenues increased 10% primarily due to acquisition activities and volume growth from sales efforts and increases in service provided to existing customers. Total revenue change in North American collection due to pricing was slightly negative, a clear reflection of the continued industry competitive climate. Average unit price was negatively impacted to an extent by price reductions in markets where landfill tip fees declined, faster growth in lower than average priced markets and certain acquisitions and municipal contracts which had a lower unit price than that of the average unit price of the collection business as a whole. Pricing of new business appeared to improve somewhat in the latter part of the fiscal year as the Company initiated higher overall pricing levels on new business sold during the third and fourth quarters of fiscal year 1994. The ability to increase pricing in the collection business continues to represent a significant challenge and opportunity for the Company. In addition, during the current fiscal year the Company concluded an extensive study which identified opportunities for profit improvement of the Company. The Company has recently begun to implement a number of these profit improvement initiatives. The goal of these initiatives, which will be implemented over the next two to three years, is to increase per unit revenues and decrease per unit costs, with a principal focus on the collection services line of business.\nNorth American landfills were a principal driver of improved domestic operating results. Increased earnings in the landfill business were generally attributable to increased disposal volumes. Total landfill volume increased by 13% in fiscal 1994. Volume growth was due principally to increased flow to existing and new sites, internalization of volumes at the Company's landfills, general volume growth from the closing of landfill facilities by municipalities and other companies as a result of Subtitle D landfill regulations and the improving economy in general. Total non-special waste volumes (generally municipal solid waste) were 12% over the prior year and special waste volumes (such as sludges, ash volumes, nonhazardous chemical wastes and contaminated soils) increased 22%. The Company intends to make special waste opportunities an area of emphasis in fiscal 1995. Average landfill pricing to unaffiliated customers was almost flat compared with the prior year, despite the negative impact of (i) a shift in mix of waste disposed from contaminated soils at higher tipping fees to other types of special and municipal wastes which carry a lower tipping fee and (ii) a shift in the mix of waste disposed from landfills in the northern section of the United States to landfills in the southern and southeastern sections of the United States which receive lower tipping fees. In fiscal 1994, the Company internalized approximately 42% of collection services volumes, similar to the 44% internalized in fiscal 1993. Short-term fluctuations in the percent of waste disposed at Company landfills were primarily timing issues related to the opening and closing of sections or cells of individual facilities. The Company's current goal is to internalize 50% of collected volumes, a strategy which both conserves cash and lessens exposure to, and dependency on, outside disposal sites. In fiscal 1995, the Company will continue to focus on increasing volumes, controlling operating costs and managing capital expenditures in order to increase cash flow and earnings. Improved profitability is also dependent in part on increased tip fee flexibility.\nRecycling initiatives within the Company were launched in earnest several years ago when the Company recognized that legislation was segmenting and prioritizing the treatment of waste streams, customers were demanding changes in the way waste was serviced, and consumers of recyclable materials were planning capital projects. The Company's investment in recycling reflected improved results this year as the recycling business continued to contribute a significant percentage of the growth in total Company revenues in fiscal 1994. Revenues from recycling services grew 50% during fiscal 1994 to $359 million. Operating margins in this business improved over the prior year due in large part to an increase in commodity prices paid for the products sold and volume throughput at the Company's processing centers. Increased commodity prices were most notable for corrugated cardboard and newspaper. Prices for these commodities climbed in the early months of calendar 1994 and reached their highest levels in the fourth quarter. Total revenues increased from the sale of commodities and increased volumes of material processed over fiscal 1993. The Company also added a number of processing centers during the year to further expand processing capacity. Recycling collection services continued to grow as the number of residential customers serviced grew 36% and the number of commercial accounts grew 25% over fiscal 1993. The Company has recently begun to enter into long-term contracts with floor prices to minimize its exposure to any future downturn in commodity pricing that may occur. The Company expects to pursue new waste segmentation opportunities in recycling during 1995, with emphasis on organics processing and further segmentation of waste paper streams.\nThe Company's medical waste services line of business enjoyed double-digit growth in revenues (up 10% to $161 million). Margins declined slightly from the prior year due to continued price pressure and higher operating costs. However, the Company is well positioned to benefit from the upcoming implementation of certain provisions of the Clean Air Act as hospitals across the United States assess their medical waste treatment technology and determine whether to invest significant capital in improving technology or contract for the treatment and disposal of medical waste streams. Areas of focus in the coming year include providing for more efficient transportation of waste flows, centralization of certain purchasing functions, and continued revenue growth through acquisitions and marketing initiatives.\nThe Company's international business experienced the most significant revenue growth of any business type in fiscal 1994, due primarily to the acquisition of the 50% interest in Otto Waste Services discussed previously, and other market development activity. Otto Waste Services contributed 80% of the total international revenue growth and over 40% of total Company revenue growth in the current year. Operating results in the Netherlands improved as revenue grew 10% to $237 million, due largely to acquisition activity, and operating margins improved over the prior fiscal year. Some profit improvement was also noted in the Company's United Kingdom operations. Revenues in Spain increased approximately 138% over the prior year due to the reconsolidation of Spanish operations in May 1993 when the Company increased its investment in its Spanish affiliate. Margins in Spain were negatively affected by the competitive environment and a weak economy in the Barcelona area. International operating results continue to be negatively affected by operating losses of the Company's wholly-owned solid waste Italian operations. Results from these Italian operations improved slightly over the course of the year, but significant improvement in these operations will depend on greater stability in the country's political climate and the Company's ability to rebid business at improved margins. Results of the Company's Italian joint venture industrial waste operations improved significantly over the previous year.\nThe Company plans to continue to focus on acquisition and other market development opportunities, improving pricing and controlling operating and SG&A costs in order to achieve improved performance in fiscal year 1995. The Company believes that continued segmentation of waste streams, industry consolidation due in part to increasing capital intensity and regulation, and the bundling of various integrated waste services are industry trends which will benefit the Company in the years to come. Over the past several years, the Company has geographically diversified its business by investing in select foreign countries, such as Germany, Spain and the Netherlands, and investing within North America in many southern markets, including market areas in Georgia, Alabama, Arizona and Texas. The Company has also pursued vigorously municipal contract business in the United States and acquired companies with significant contractual waste arrangements, such as Otto Waste Services. Municipal contract waste service tends to be counter cyclical as revenues are usually set on a per home basis while costs vary with the amount of waste collected and many of such contracts remain in effect for five or more years. Further, during the past two years, the Company has experienced significant asset expansion coupled with improved returns on its average assets employed (on a pre-tax, pre-interest basis and excluding reorganization charge) in both its North American and international business areas as it has focused on growth in its business and emphasized controlling operating and SG&A costs.\nThe proposed Attwoods acquisition, if consummated, will further diversify the Company as Attwoods' domestic business is principally in southern states, its United Kingdom business would expand the Company's operations in Europe and much of its business is of a municipal contract nature. See \"Liquidity and Capital Resources\" and Note (9) of Notes to Consolidated Financial Statements.\nResults of Operations - --------------------- Revenues - --------\nRevenues for fiscal 1994 were $4.3 billion, a 24% increase over fiscal 1993 revenues of $3.5 billion. The following table reflects the contribution to total revenues of the Company's principal lines of business for the last three fiscal years (in millions):\nYear Ended September 30, ------------------------------- 1994 1993 (1) 1992 (1) -------- -------- -------- North American Operations - ------------------------- Collection Services - Solid Waste $2,360 $2,138 $2,038 Disposal and Transfer - Solid Waste Unaffiliated customers 493 448 449 Affiliated companies 392 339 304 ------ ------ ------ 885 787 753 Medical Waste Services 161 146 119 Recycling Services 359 240 175 Services Group and other 83 79 106 Elimination of affiliated companies' revenues (392) (339) (304) ------ ------ ------ Total North American Operations 3,456 3,051 2,887\nInternational Operations (2) 859 428 391 - ------------------------ ------ ------ ------ Total Company $4,315 $3,479 $3,278 ====== ====== ======\nPercentage Increase from Prior Year 24% 6% 3%\n- --------------- (1) Certain reclassifications have been made in prior year amounts to conform to the current year presentation.\n(2) Revenues from Canadian operations are excluded from international revenues and are combined with North American revenues.\nFor the first time since 1989, the Company exceeded 20% top-line growth as revenues increased 24% versus the prior year. Growth was primarily caused by an aggressive acquisition and market development program highlighted most notably by the purchase of 50% of Otto Waste Services, one of the largest waste services companies in Germany. Increased volumes from existing customers, primarily in the collection, disposal and transfer, and recycling businesses also contributed a significant portion of revenue growth. Revenue growth due to increased pricing was limited in most lines of business due to the continued industry competitive climate and resistance to price increases.\nIn fiscal 1993, the Company's revenue growth rate exceeded the revenue growth rate of the prior year for the first time since fiscal 1987. Revenue growth was due almost exclusively to acquisitions and increased volumes in the collection, recycling and medical waste lines of business. The impact of pricing on revenue growth was negligible for the second straight year in fiscal 1993 due to economic weakness and competitive pressures in many of the markets in which the Company competes, both domestically and globally.\nAs the table below reflects, revenue growth in fiscal year 1994 was due primarily to acquisitions and volume increases. Consistent with fiscal years 1993 and 1992, pricing impact on total revenue growth was minimal. Change in Revenues -------------------------------- 1994 1993 1992 ------ ------ ------ Price 1% --% --% Volume (1) 7 2 1 Acquisitions (2) 16 4 2 ---- ---- ---- Total Percentage Increase 24% 6% 3% ==== ==== ==== - -----------------\n(1) Includes the negative impact of foreign currency exchange rates.\n(2) Includes purchased companies and the impact of the reconsolidation of Spanish operations in fiscal 1993, and the fiscal 1992 deconsolidation of certain Italian operations.\nWeighted average per unit pricing edged upward in fiscal 1994 due to positive price movement which occurred in the recycling business as the commodity price of newspapers and cardboard sold by the Company's recycling processing centers increased during 1994. Collection systems (such as solid waste collection, medical waste collection and recyclables collection) and the unaffiliated disposal and transfer business line continued to experience negative or only slightly positive pricing versus prior periods. Although the solid waste collection line of business reflected a negative change in pricing versus the prior year, indications in the commercial systems late in the fiscal year appeared to suggest that the ability to increase pricing was improving. Given the sizeable increases in collection volumes over the past few years due to acquisition and volume growth, any significant improvement in per unit pricing would likely have a favorable impact on earnings.\nEvery line of business enjoyed strong volume growth in fiscal 1994. Total revenue growth due to increased volume was 7%; the largest dollar contributions came from the collection, disposal and transfer, and recycling lines of business. Both the medical waste and disposal and transfer lines approached double digit percentage revenue growth due to volume in the current year while recycling revenues grew 26% due to volume improvement. Collection revenues expanded by 5% due to volume growth with increases most evident in the rear load residential and rolloff systems. The rolloff system services the large containers used, for example, at construction sites and large businesses.\nRevenue growth from acquisitions was 16% with approximately two-thirds of the increase coming from the purchase of a 50% interest in Otto Waste Services, one of the largest waste services companies in Germany. The majority of North America acquisition activity occurred in the collection and, to a lesser extent, recycling lines of business. Internationally, absent the Otto Waste Services transaction, acquisition activity was centered in the Netherlands and Germany.\nCost of Operations - ------------------\nCost of operations increased $598 million (24%) in fiscal 1994, $152 million (6%) in fiscal 1993, and $161 million (7%) in fiscal 1992 over the prior year. Fiscal 1994 cost of operations was 72.4% of revenues, down slightly from the fiscal 1993 level and flat when compared with fiscal 1992. Disposal costs (which are the single largest component of operating expenses) increased international operating expenses (primarily due to the Otto Waste Services transaction), and increased collection business activity contributed to the increase in operating expenses in fiscal 1994. Disposal costs, which include landfill and transfer station operating expenses, increased 23%, 4% and 10% over the prior year in fiscal years 1994, 1993, and 1992, respectively. More than half of the fiscal 1994 increase in disposal cost originated internationally, due principally to the Otto Waste Services consolidation. Domestically, increased volumes in the collection, landfill and recycling businesses were the main factors in the higher disposal cost results.\nNon-disposal operating expenses increased 24%, 9% and 5% over the prior year in fiscal years 1994, 1993 and 1992, respectively. The majority of the increase in these costs during 1994, comprised primarily of employee, equipment and facility-related costs, occurred in the international segment, as well as the collection and recycling businesses. The primary cause of the increase in the international expense was the impact of the consolidation of the Otto Waste Services operations beginning in February 1994. In North America, non-disposal operating expense increases in the collection and recycling lines of business were chiefly the result of volume and acquisition growth. Similarly, in 1993, the principal businesses responsible for the non-disposal operating expense increase were the collection and recycling businesses, again due to volume gains and acquisitions.\nSelling, General and Administrative Expense (SG&A) - --------------------------------------------------\nSelling, general and administrative expense increased by $88 million (16%) in fiscal 1994 versus fiscal 1993. SG&A decreased $5 million (-1%) in fiscal 1993 versus fiscal 1992 and increased $26 million (5%) in fiscal 1992 versus the prior year. The SG&A increase in fiscal 1994 was due principally to the consolidation of Otto Waste Services in February 1994 as well as additional acquisition and market development activity domestically, principally in the collection and recycling lines of business. The decrease in SG&A in fiscal 1993 was a result of a concerted effort at all levels of the Company to control general and administrative expenses in particular. That effort continued during fiscal 1994 as well, as SG&A expenses as a percent of revenue declined to 15% from 16% in fiscal 1993 and 17% in fiscal 1992. The Company continues to address consolidation of administrative support functions and other cost control measures to successfully manage SG&A costs.\nReorganization Charge - ---------------------\nA reorganization charge of $27 million (an after-tax charge of approximately $.10 per share), which was announced in June 1993, was recorded in the third quarter of fiscal year 1993 to cover the estimated expense of reorganizing the Company's regional structure in the United States to better plan and coordinate its business operations, capitalize on new growth opportunities and more efficiently serve its customers in the Company's major market areas. The reorganization included the designation of a divisional vice president with responsibility for each market area, the closing of three regional offices, the opening of one new regional office and the relocation of one regional office, which reduced the number of United States regional offices from seven to five. The reorganization charge included employee severance and relocation costs and other employee, organization and transition related costs.\nInterest Expense and Income - ---------------------------\nInterest expense for the last three fiscal years was as follows (in thousands): 1994 1993 1992 -------- -------- -------- Gross interest expense $104,759 $ 89,563 $ 86,908 Interest capitalized (11,600) (18,669) (15,812) -------- -------- -------- Interest expense $ 93,159 $ 70,894 $ 71,096 ======== ======== ========\nFiscal year 1994 interest expense increased to $93 million compared with $71 million for the prior year, principally a result of the acquisition of 50% of Otto Waste Services. The Company also experienced a reduction in interest capitalized due to the completion of construction of a number of significant market development projects late in the prior year and early in the current fiscal year. Fiscal year 1993 interest expense varied only slightly from fiscal year 1992. Increased interest expense due to foreign acquisitions and new domestic revenue bonds was largely offset by an increase in capitalized interest associated principally with the Company's landfill market development projects in 1993.\nFiscal year 1994 interest income of $11 million declined $3 million from the prior year due to lower weighted average investment balances outstanding during the year, offset partially by increased interest income associated with the consolidation of Otto Waste Services. Fiscal year 1993 interest income increased to $15 million from $9 million in fiscal year 1992, principally due to the higher weighted average balance of short-term investments outstanding over the prior year.\nEquity in Earnings of Unconsolidated Affiliates - -----------------------------------------------\nEquity in earnings of unconsolidated affiliates increased $21 million from fiscal year 1993 due principally to improvement in earnings of American Ref-Fuel and certain international affiliates and as a result of the Company's acquisition of a 50% interest in Otto Waste Services in February 1994. During 1993, American Ref-Fuel acquired a resource recovery facility in Niagara Falls, New York, which contributed significantly to this improvement. In fiscal year 1993, equity in earnings of unconsolidated affiliates increased $6 million from the prior year, also principally a result of improved earnings of American Ref-Fuel and certain international affiliates. For further information, see Note (5) of Notes to Consolidated Financial Statements.\nMinority Interest in Income of Consolidated Subsidiaries - --------------------------------------------------------\nThe increase in minority interest in income of consolidated subsidiaries in fiscal year 1994 over the prior year of $15 million is the result of the Company's acquisition of a 50% interest in Otto Waste Services in February 1994.\nIncome Taxes - ------------\nThe Company's effective income tax rates for fiscal years 1994, 1993, and 1992 were 40.0%, 39.6%, and 39.0%, respectively. The increases in the income tax rate in fiscal years 1994 and 1993 are the result of an increase in the U.S. income tax rate effective January 1, 1993. Additionally, in November 1994, the Company reached an agreement with the Internal Revenue Service, settling all material issues raised in the May 1993 Revenue Agent's Report, principally related to the deductibility of intangible assets. For further information concerning income taxes, see Note (14) of Notes to Consolidated Financial Statements.\nProfitability Ratios - --------------------\nThese ratios (shown as a percent of revenues, except for the return on assets ratio) reflect certain profitability trends for the Company's operations. The effect of general inflation, as measured by the average consumer price index, did not have a material effect on the Company's overall financial position or results of operations.\nYear Ended September 30, ------------------------- 1994 1993 1992 ------ ------ ------ Gross profit margin 27.6% 27.4% 27.6% Income from operations before reorganization charge 12.6% 11.3% 10.4% Income from operations 12.6% 10.6% 10.4% Income before income taxes, minority interest and extraordinary item 11.6% 9.4% 8.8% Net income before reorganization charge and extraordinary item 6.6% 6.1% 5.4% Net income 6.5% 5.7% 5.4% Pre-tax, pre-interest return on average total assets, excluding reorganization charge 11.5% 9.8% 9.1%\nProfitability ratios improved in fiscal year 1994 due principally to increased earnings in the landfill and recycling businesses, higher operating margins associated with the Otto Waste Services operations and the Company's ability to control the growth in SG&A. Profitability ratios improved in fiscal year 1993 due principally to lower SG&A. Increases in profitability in fiscal year 1993 were due to lower landfill operating expenses and increased recycling processing center capacity utilization, offset by continued price compression as a result of the economy, competitive pressure, and waste minimization efforts. In many markets, disposal cost increases (due primarily to increased container utilization by customers) were not fully recoverable due to the competitive nature of the market.\nDuring fiscal 1994, total assets of the Company increased by approximately $1.5 billion, principally a result of acquiring 50% of Otto Waste Services, foreign currency translation, the adoption of the new standard related to accounting for income taxes and capital expenditures. Despite the significant increase in total assets, pre-tax, pre-interest return on average total assets (excluding the reorganization charge) increased over 17% to 11.5% for fiscal 1994 compared with 9.8% for the prior year.\nDuring fiscal 1995, management will focus on acquisition and other market development opportunities, operating and SG&A cost controls and improvements in pricing. These efforts are intended to favorably impact margins in fiscal 1995.\nEnvironmental Matters - ---------------------\nAs of September 30, 1994 and 1993, included in the Company's balance sheet were accrued environmental costs of $688 million and $729 million associated with its obligations for closure and post-closure of its operating and closed landfills and for remediation and corrective actions at Superfund sites and other facilities which are discussed in the following paragraphs. See Notes (1) and (6) of Notes to Consolidated Financial Statements for a discussion of the Company's environmental and landfill accounting policies and other financial information related to environmental and landfill accruals.\nThe Company's landfills are subject to specific operating permit requirements and the applicable existing regulatory requirements of the national, state and local jurisdictions in which they are operated. On an ongoing basis, the Company, based on input from its engineers, estimates its future cost requirements for closure and post-closure management of its landfills based on its interpretations of these regulations and standards. Accruals for these costs are typically provided as the remaining permitted airspace of these facilities is consumed. Engineering reviews of the future cost requirements for closure and post-closure monitoring and maintenance for the Company's operating landfills are performed at least annually and are the basis upon which the Company's estimates of these future costs and the related accruals are revised. In its foreign operations, the Company has noted a trend toward increased landfill regulation, particularly in those countries within the European Economic Community. While increasing regulation often presents new business opportunities to the Company, it likewise often results in increased operating costs in those jurisdictions in which such regulatory changes occur and could potentially have a negative impact on operations.\nThe Company is also responsible for a significant number of closed solid waste landfills, principally in North America, which require varying levels of inspection, maintenance, environmental monitoring and from time to time corrective action. An overall program of management has been implemented to provide a systematic and routine standard of care and maintenance and to ensure environmental compliance at these closed facilities.\nIn fiscal year 1990, the Company announced its withdrawal from the hazardous waste collection, treatment and disposal business principally because the Company believed its resources would be better utilized if they were directed toward developing opportunities in the solid waste business. Anticipated cash expenditures related principally to remediation and post- closure monitoring at certain closed sites are expected to be required over a long period of time with no significant amounts anticipated to be paid in any single year. In addition, these future cash expenditures will be offset in part by the realization of related income tax benefits.\nVarious subsidiaries of the Company are participating in potentially responsible party (\"PRP\") groups at 84 waste disposal sites listed on the U.S. Environmental Protection Agency's National Priority List, which may be subject to remedial action under Superfund. Certain of these subsidiaries have negotiated settlements with other members of the PRP groups and the EPA with respect to 61 of these 84 Superfund sites. Partial settlements have been negotiated with regard to ten of the remaining sites. These settlements had no material effect on the Company's liquidity, results of operations or financial position. Further, various subsidiaries have received information requests relating to 64 additional sites on the EPA's National Priority List. For 35 of these sites, the Company has determined it is not a PRP; the Company's PRP status at the remaining 29 sites has not yet been determined. The number of Superfund sites with which the Company's subsidiaries are involved may increase or decrease depending upon the EPA's findings from responses to these information requests and any future information requests which may be received. Superfund legislation permits strict joint and several liability to be imposed without regard to fault, and as a result, one company may be required to bear significantly more than its proportional share of the cleanup costs if it is unable to obtain appropriate contributions from other responsible parties. The final negotiated settlement relating to the large majority of Superfund sites occurs several years after a company has been identified as a PRP due to the many complex issues that must be addressed in determining the magnitude of contamination present, the cause of the contamination and the recommended remedial action to be taken. In many cases, the expenditures related to actual remediation may also occur over a number of years.\nThe Company has implemented programs to promote compliance with the laws, regulations and permit requirements governing its landfills and has as its goal 100% compliance. Even with these programs, management believes that in the normal course of doing business, companies in the waste disposal industry are faced with governmental enforcement proceedings resulting in fines or other sanctions and will likely be required to pay civil penalties or to expend funds for remedial work on waste disposal sites. These programs include systematic site reviews and evaluations of each site requiring corrective action (including Superfund sites) in which the Company's subsidiaries are involved, considering each subsidiary's role with respect to each site and the relationship to the involvement of other parties at the site, the quantity and content of the waste with which the subsidiary was associated, and the number and financial capabilities of the other parties at the various sites. Based on reviews of the various sites, currently available information, and management's judgment and significant prior experience related to similarly situated facilities, expense accruals are provided by the Company for its share of estimated future costs associated with corrective actions to be implemented at certain of these sites and existing accruals are revised as deemed necessary. Management also routinely reviews the realization of its investments in operating landfills and the adequacy of its accruals for the future costs of closure and post-closure monitoring and maintenance at its operating and closed landfills and adjusts its asset values and accruals as deemed appropriate.\nManagement believes that the ultimate disposition of these environmental matters will not have a materially adverse effect upon the liquidity, capital resources, business or consolidated financial position of the Company, though resolution of one or more of these matters could have a significant negative impact on the Company's consolidated financial results for a particular reporting period. Due to the nature of the Company's business and the increasing emphasis of government in all jurisdictions and the public on environmental issues relating to the waste disposal industry, it can be reasonably expected that various subsidiaries of the Company will become involved in additional remediation actions and Superfund sites in the future. Management attempts to anticipate future changes in laws, regulations and operating permit requirements which may affect its operations; however, there is no assurance that such future changes will not significantly affect its operations.\nLIQUIDITY AND CAPITAL RESOURCES - -------------------------------\nThe Company's working capital and related ratios at the end of the last three years were as follows:\nAs of September 30, ---------------------------- 1994 1993 1992 ------- ------- --------\nWorking capital (in thousands) $ 7,104 $ 1,042 $250,833 Working capital ratios 1.0:1 1.0:1 1.3:1\nWorking capital was affected favorably in the current fiscal year by the adoption of SFAS No. 109, \"Accounting for Income Taxes\" (see Note (14) of Notes to Consolidated Financial Statements) and increased profitability, offset largely by current year acquisitions and the use of cash for capital expenditures during fiscal 1994. The Company's unusually high level of working capital at September 30, 1992 resulted principally from investing the net proceeds of $283 million from the sale of 14,000,000 shares of the Company's common stock in June 1992 which were not utilized during fiscal year 1992. The Company's long-term strategy in managing working capital is to maintain substantial available commitments under bank credit agreements or other financial agreements to finance short-term capital requirements in excess of internally generated cash while minimizing working capital.\nIn January 1994, the Company filed a universal shelf registration statement with the Securities and Exchange Commission to provide for the registration of up to $700 million of unsecured debt securities, preferred stock, common stock or warrants to purchase unsecured debt securities, preferred stock or common stock. In March 1994, the Company issued 15,525,000 shares of its common stock under this universal shelf registration statement in concurrent public offerings in the United States and outside the United States. The Company used approximately $106 million of the net proceeds of approximately $434 million during April 1994 to redeem its $100 million 8 1\/2% Sinking Fund Debentures due 2017 (see Note (7) of Notes to Consolidated Financial Statements). The balance of the proceeds was used to repay indebtedness associated with the February 1994 acquisition of the 50% interest in Otto Waste Services and other working capital requirements.\nIn July 1994, the Company closed a $100 million master equipment leasing program. A portion of the commitments under this program was drawn at closing and the proceeds were used to pay indebtedness and for working capital purposes. The balance of the commitments will be drawn on or before March 31, 1995.\nOn September 20, 1994, the Company announced the terms of a cash offer (\"Attwoods Offers\") to acquire all the ordinary shares of Attwoods plc, a UK company, and all of the preferred shares of Attwoods (Finance) N.V., a Netherlands Antilles company. On September 19, 1994, the Company entered into a letter agreement providing for the borrowing by the Company, under a credit agreement to be entered into pursuant to the letter agreement, of up to 500 million pounds sterling (or its equivalent) to finance the Attwoods Offers. The facility is to be used to assist in funding the Attwoods Offers and to fund the working capital requirements and refinance any existing indebtedness of Attwoods including any existing obligations of Attwoods that become due and payable as a result of the Attwoods Offers becoming unconditional. Borrowings under the facility are conditional on the Attwoods Offers having become (or in certain circumstances, having been declared) unconditional in all respects under United Kingdom law. The payment of dividends or other distributions on the Company's Common Stock will be limited by the provisions of this credit agreement which will be somewhat more restrictive than the most restrictive provisions at September 30, 1994. See Note (9) of Notes to Consolidated Financial Statements.\nThe Company's bank credit agreement provides total committed credit capacity of $1 billion. The available credit capacity under this facility, which matures in August 1996, is used principally to support the Company's commercial paper program, established in January 1990, authorizing the issuance of up to $1 billion in commercial paper. Borrowings under the commercial paper program may not exceed the available credit under the Company's existing bank credit agreement. There were approximately $43 million of commercial paper borrowings outstanding as of September 30, 1994.\nIn February 1990, the Company initiated a program for the issuance of up to $100 million principal amount of medium-term notes, but has not yet utilized this program. In March 1991, the Company filed a shelf registration statement with the Securities and Exchange Commission to provide for the future issuance of up to $300 million of additional debt securities, $200 million of which was unutilized at September 30, 1994.\nAs of September 30, 1994, the Company's unused committed borrowing capacity under its primary bank credit agreement was $957 million. Such capacity may be used to refinance amounts outstanding under short-term facilities, for financing requirements in connection with foreign exchange contracts or for other capital requirements. Of the $1.5 billion of the Company's long-term indebtedness outstanding (including the $745 million of Convertible Subordinated Debentures) at September 30, 1994, 89% was at fixed interest rates for a period of at least 12 months. Management's long-term objective is to maintain most of its indebtedness in fixed interest rate obligations, although variable rate debt has been and will likely continue to be used to meet short-term and certain longer term financing needs. The Company's weighted average cost of indebtedness increased slightly to approximately 7.9% for fiscal 1994 from 7.7% for fiscal year 1993.\nLong-term indebtedness (including $428 million of Otto Waste Services debt, which has not been guaranteed by the Company, and $745 million of Convertible Subordinated Debentures) as a percentage of total capitalization declined from 41% at September 30, 1993 to 38% at September 30, 1994, principally a result of the March 1994 common stock offering.\nSubject to the Board of Director approval and excluding the proposed Attwoods transaction, the capital appropriations budget for fiscal year 1995 will be established at $1.2 billion, of which $579 million is intended to provide for normal replacement requirements and to provide new assets to support planned revenue growth within all consolidated businesses. The remaining $590 million is designated for corporate market development activities which principally include new or expanded solid waste transfer and disposal facilities, recycling processing centers, acquisitions of solid waste businesses and other investments in both North American and international operations. Over $50 million of the Company's capital requirements in fiscal 1995 are expected to be financed through master leasing programs. Further, the Company has announced the terms of its Attwoods Offers discussed above. See Note (9) of Notes to Consolidated Financial Statements.\nExcluding the specific financing arrangements associated with the Attwoods Offers, the Company believes that its cash flows from operations and its access to cash from banks and other external sources, including the public markets, are more than sufficient for its financing needs.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Browning-Ferris Industries, Inc.:\nWe have audited the accompanying consolidated balance sheet of Browning-Ferris Industries, Inc. (a Delaware corporation) and subsidiaries as of September 30, 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 September 30, 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 Browning-Ferris Industries, Inc. and subsidiaries as of 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.\nAs discussed in Notes 1 and 14 to the consolidated financial statements, effective October 1, 1993, the Company changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedules II, V, VI and VIII listed in the index of financial statements 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 November 30, 1994\nItem 8.","section_7A":"","section_8":"Item 8. - Financial Statements and Supplemental Data\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF INCOME\nFor The Three Years Ended September 30, 1994\n(In Thousands Except for Per Share Amounts)\n------------------------------------------------------------------------- Year Ended September 30, ------------------------------------ 1994 1993 1992 -------------------------------------------------------------------------\nRevenues $4,314,541 $3,478,830 $3,277,635 Cost of operations 3,123,375 2,525,023 2,372,658 ---------- ---------- ----------\nGross profit 1,191,166 953,807 904,977 Selling, general and administrative expense 647,256 559,419 564,708 Reorganization charge -- 27,000 -- ---------- ---------- ----------\nIncome from operations 543,910 367,388 340,269 Interest expense 93,159 70,894 71,096 Interest income (11,288) (14,633) (8,880) Equity in earnings of unconsolidated affiliates (37,084) (16,060) (9,827) ---------- ---------- ----------\nIncome before income taxes, minority interest and extraordinary item 499,123 327,187 287,880 Income taxes 199,649 129,726 112,273 Minority interest in income of consolidated subsidiaries 15,501 21 -- ---------- ---------- ---------- Income before extraordinary item 283,973 197,440 175,607\nExtraordinary item - loss on early retirement of debt, net of income tax benefit of $2,833 5,263 -- -- ---------- ---------- ---------- Net income $ 278,710 $ 197,440 $ 175,607 ========== ========== ========== Number of common and common equivalent shares used in computing earnings per share 187,621 171,496 158,662 ========== ========== ==========\n(Continued on Following Page) BROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF INCOME\nFor The Three Years Ended September 30, 1994\n(In Thousands Except for Per Share Amounts)\n------------------------------------------------------------------------- Year Ended September 30, ------------------------------------ 1994 1993 1992 -------------------------------------------------------------------------\nEarnings per common and common equivalent share:\nIncome before extraordinary item $ 1.52 $ 1.15 $ 1.11 Extraordinary item (.03) -- -- ------- ------- ------- Net income $ 1.49 $ 1.15 $ 1.11 ======= ======= ======= Cash dividends per common share $ .68 $ .68 $ .68 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET\nASSETS (In Thousands) - -------------------------------------------------------------------------- September 30, ----------------------------- 1994 1993 - -------------------------------------------------------------------------- CURRENT ASSETS: Cash $ 79,131 $ 22,871 Short-term investments 61,993 208,674 Receivables - Trade, net of allowances of $33,284 and $21,870 for doubtful accounts 752,686 556,456 Other 60,934 58,090 Inventories 32,811 26,508 Deferred income taxes 114,925 -- Prepayments and other 83,613 52,899 ---------- ---------- Total current assets 1,186,093 925,498 ---------- ----------\nPROPERTY AND EQUIPMENT, at cost, less accumulated depreciation and amortization of $2,046,604 and $1,742,362 3,049,767 2,515,709 ---------- ----------\nOTHER ASSETS: Cost over fair value of net tangible assets of acquired businesses, net of accumulated amortization of $62,527 and $41,234 954,378 310,065 Other intangible assets, net of accumulated amortization of $156,080 and $158,693 113,059 138,844 Deferred income taxes 97,998 113,615 Investments in unconsolidated affiliates 292,579 222,698 Other 103,081 69,213 ---------- ----------\nTotal other assets 1,561,095 854,435 ---------- ----------\nTotal assets $5,796,955 $4,295,642 ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET\nLIABILITIES AND COMMON STOCKHOLDERS' EQUITY (In Thousands Except for Share Amounts) - -------------------------------------------------------------------------- September 30, ----------------------------- 1994 1993 - -------------------------------------------------------------------------- CURRENT LIABILITIES: Current portion of long-term debt $ 49,841 $ 95,953 Accounts payable 400,177 245,555 Accrued liabilities - Salaries and wages 101,530 75,162 Taxes, other than income 44,129 30,912 Other 373,978 313,687 Income taxes 53,642 27,678 Deferred revenues 155,692 135,509 ---------- ---------- Total current liabilities 1,178,989 924,456 ---------- ---------- DEFERRED ITEMS: Accrued environmental and landfill costs 529,501 631,690 Deferred income taxes 78,678 -- Other 159,478 128,255 ---------- ---------- Total deferred items 767,657 759,945 ---------- ---------- LONG-TERM DEBT, net of current portion 713,680 333,689 ---------- ---------- CONVERTIBLE SUBORDINATED DEBENTURES 744,949 744,949 ---------- ---------- COMMITMENTS AND CONTINGENCIES\nCOMMON STOCKHOLDERS' EQUITY: Common stock, $.16 2\/3 par; 400,000,000 shares authorized; 197,084,755 and 174,231,747 shares issued 32,854 29,044 Additional paid-in capital 1,351,919 743,265 Retained earnings 1,009,132 761,325 Treasury stock, 743,497 and 686,826 shares, at cost (2,225) (1,031) ---------- ---------- Total common stockholders' equity 2,391,680 1,532,603 ---------- ---------- Total liabilities and common stockholders' equity $5,796,955 $4,295,642 ========== ==========\nThe accompanying notes are an integral part of these financial statements.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF COMMON STOCKHOLDERS' EQUITY\nFor The Three Years Ended September 30, 1994 (In Thousands Except for Share Amounts) - ------------------------------------------------------------------------------- Common Stock, $.16 2\/3 Par Additional -------------------- Paid-In Retained Treasury Shares Amount Capital Earnings Stock - -------------------------------------------------------------------------------\nBALANCE, as of September 30, 1991 153,537,025 $25,595 $ 341,492 $ 748,125 $ (913) Stock options - Exercises 489,348 81 4,769 -- -- Income tax benefit from exercises -- -- 781 -- -- Common stock issuances related to - Public offering, net of expenses 14,000,000 2,334 280,656 -- -- Dividend Reinvestment Plan 158,425 26 3,334 -- -- BFI Employee Stock Owner- ship and Savings Plan 605,767 101 12,398 -- -- Acquisitions 526,619 88 10,842 -- -- Net income -- -- -- 175,607 -- Cash dividends -- -- -- (109,389) -- Foreign currency translation adjustment -- -- -- (37,826) -- Other 243 -- 2,418 -- (113) ----------- ------- ---------- --------- --------\nBALANCE, as of September 30, 1992 169,317,427 28,225 656,690 776,517 (1,026) Stock options - Exercises 1,057,434 176 15,907 -- (8) Income tax benefit from exercises -- -- 1,677 -- -- Common stock issuances related to - Dividend Reinvestment Plan 115,283 19 2,941 -- -- BFI Employee Stock Owner- ship and Savings Plan 432,753 72 11,041 -- -- Acquisitions 2,294,299 382 28,130 -- 3 Additional investment in Spanish operations 1,000,000 167 25,333 -- -- Net income -- -- -- 197,440 -- Cash dividends -- -- -- (116,358) -- Foreign currency translation adjustment -- -- -- (96,274) -- Other 14,551 3 1,546 -- -- ----------- ------- ---------- --------- --------\n(Continued on Following Page)\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF COMMON STOCKHOLDERS' EQUITY\nFor The Three Years Ended September 30, 1994 (In Thousands Except for Share Amounts) - ------------------------------------------------------------------------------- Common Stock, $.16 2\/3 Par Additional --------------------- Paid-In Retained Treasury Shares Amount Capital Earnings Stock - -------------------------------------------------------------------------------\nBALANCE, as of September 30, 1993 174,231,747 29,044 743,265 761,325 (1,031) Stock options - Exercises 866,809 145 15,579 -- (1,192) Income tax benefit from exercises -- -- 1,949 -- -- Common stock issuances related to - Public offering, net of expenses 15,525,000 2,588 431,307 -- -- Dividend Reinvestment Plan 95,817 16 2,587 -- -- BFI Employee Stock Owner- ship and Savings Plan 597,108 100 16,628 -- -- Acquisitions 5,707,845 951 139,788 -- -- Net income -- -- -- 278,710 -- Cash dividends -- -- -- (126,818) -- Foreign currency translation adjustment -- -- -- 95,915 -- Other 60,429 10 816 -- (2) ----------- ------- ---------- ---------- -------\nBALANCE, as of September 30, 1994 197,084,755 $32,854 $1,351,919 $1,009,132 $(2,225) =========== ======= ========== ========== =======\nThe accompanying notes are an integral part of these financial statements.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS\nFor The Three Years Ended September 30, 1994 (In Thousands) - ------------------------------------------------------------------------------ Year Ended September 30, -------------------------------- 1994 1993 1992 - ------------------------------------------------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $278,710 $197,440 $175,607 -------- -------- -------- Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 444,192 366,481 365,122 Reorganization charge -- 27,000 -- Deferred income tax expense (benefit) 23,458 732 (2,455) Amortization of deferred investment tax credit (706) (1,023) (2,138) Provision for losses on accounts receivable 31,346 18,657 17,944 Gains on sales of fixed assets (5,167) (667) (2,641) Equity in earnings of unconsolidated affiliates, net of dividends received (19,442) (16,060) (9,827) Increase (decrease) in cash from changes in assets and liabilities excluding effects of acquisitions: Trade receivables (112,586) (46,605) (52,442) Inventories 2,606 508 (411) Other assets (14,563) 13,316 984 Other liabilities 66,080 54,186 87,264 -------- -------- -------- Total adjustments 415,218 416,525 401,400 -------- -------- -------- Net cash provided by operating activities 693,928 613,965 577,007 -------- -------- --------\nCASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (694,475) (606,240) (531,239) Payments for businesses acquired (398,734) (83,786) (21,644) Investments in unconsolidated affiliates (54,342) (52,035) (69,362) Proceeds from disposition of assets 74,797 24,554 87,980 Purchases of short-term investments -- (30,003) (213,867) Sales of short-term investments 147,424 173,922 -- Receipts from unconsolidated affiliates 30,431 49,497 43,619 -------- -------- -------- Net cash used in investing activities (894,899) (524,091) (704,513) -------- -------- --------\n(Continued on Following Page)\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS\nFor The Three Years Ended September 30, 1994 (In Thousands) - ------------------------------------------------------------------------------ Year Ended September 30, -------------------------------- 1994 1993 1992 - ------------------------------------------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuances of common stock 450,876 45,337 291,087 Proceeds from issuances of indebtedness 175,111 51,468 16,848 Repayments of indebtedness (246,761) (76,455) (84,835) Dividends paid (122,944) (115,519) (106,725) -------- -------- -------- Net cash provided by (used in) financing activities 256,282 (95,169) 116,375 -------- -------- --------\nEFFECT OF EXCHANGE RATE CHANGES 949 (6,516) 1,945 -------- -------- -------- NET INCREASE (DECREASE) IN CASH 56,260 (11,811) (9,186) CASH AT BEGINNING OF YEAR 22,871 34,682 43,868 -------- -------- -------- CASH AT END OF YEAR $ 79,131 $ 22,871 $ 34,682 ======== ======== ========\nSUPPLEMENTAL DISCLOSURE OF CASH PAID FOR: Interest, net of capitalized amounts $ 97,996 $ 72,960 $ 70,692 Income taxes $174,005 $138,498 $ 68,797\nThe accompanying notes are an integral part of these financial statements.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) Summary of significant accounting policies -\nPrinciples of consolidation.\nThe consolidated financial statements include the accounts of Browning- Ferris Industries, Inc. and its subsidiaries (the \"Company\"). All significant intercompany accounts and transactions have been eliminated. Investments in which the Company does not exercise control over the affiliated companies operations are not consolidated and are accounted for under the equity method or the cost method, as appropriate. Foreign currencies have been translated into United States dollars at appropriate exchange rates.\nShort-term investments.\nShort-term investments are carried at cost, which approximates the aggregate market value. At September 30, 1994 and 1993, short-term investments included approximately $61.7 million and $89.6 million, respectively, invested in time deposits. The remainder of these balances was invested principally in marketable securities comprised of money market funds, preferred stocks, tax-exempt securities or U.S. government securities.\nInventories.\nInventories consisting principally of equipment parts, materials and supplies are valued under a method which approximates the lower of cost (first- in, first-out) or market.\nProperty and equipment.\nProperty and equipment are recorded at cost. Capitalized landfill costs include expenditures for land and related airspace, permitting costs and preparation costs. Landfill permitting and preparation costs represent only direct costs related to these activities, including legal, engineering, construction of landfill improvements, cell development costs and the direct costs of Company personnel dedicated for these purposes. Interest is capitalized on landfill permitting and construction projects and other projects under development while the assets are undergoing activities to ready them for their intended use. The interest capitalization rate is based on the Company's weighted average cost of indebtedness. Interest capitalized during fiscal years 1994, 1993 and 1992 was $11,600,000, $18,669,000 and $15,812,000, respectively. Management routinely reviews its investment in operating landfills, transfer stations and other significant facilities to determine whether the costs of these investments are realizable.\nLandfill costs, excluding the estimated residual value of land, are typically amortized as permitted airspace of the landfill is consumed. Certain landfill preparation costs related specifically to cell development are amortized as airspace of the related cell is consumed, generally over not more than two to five\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nyears. Units-of-production amortization rates applicable to each of the Company's operating landfills are determined annually. The rates are based on estimates provided by the Company's engineers and accounting personnel, and consider the information provided by aerial surveys which are generally performed annually. Depreciation of property and equipment, other than landfills, is provided on the straight-line method based upon the estimated useful lives of the assets, generally estimated as follows: buildings, 20 to 40 years and vehicles and equipment, 3 to 12 years.\nExpenditures for major renewals and betterments are capitalized and expenditures for maintenance and repairs are charged to expense as incurred. During 1994, 1993, and 1992, maintenance and repairs charged to cost of operations were $247,143,000, $210,673,000, and $201,670,000, respectively. When property is retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in income.\nIntangible assets.\nThe cost over fair value of net tangible assets of acquired businesses (\"goodwill\") is amortized on the straight-line method over periods not exceeding 40 years. Other intangible assets, substantially all of which are customer lists and covenants not to compete, are amortized on the straight-line method over their estimated lives, typically no more than seven years. Amortization expense for fiscal years 1994, 1993, and 1992 related to goodwill and other intangible assets was $52,553,000, $46,862,000 and $49,532,000, respectively.\nDeferred income taxes.\nEffective October 1, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109 - \"Accounting for Income Taxes\". Under SFAS No. 109, deferred tax assets and liabilities reflect the impact of temporary differences between the financial reporting basis and tax basis of assets and liabilities. Such amounts are recorded using presently enacted tax rates and regulations. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. As permitted under SFAS No. 109, prior years' financial statements have not been restated to apply the provisions of SFAS No. 109. The adoption of SFAS No. 109 had no material effect on the Company's results of operations; however, it did affect the classification of deferred tax assets and liabilities resulting in an increase in working capital of $90.3 million and increases in both total assets and liabilities of $128.4 million as of October 1, 1993. In prior years, deferred income taxes were determined under Accounting Principles Board (\"APB\") Opinion No. 11, which required use of the deferral method. Under that method, deferred income taxes resulted from differences in the timing of the recognition of certain revenue and expense items for income tax and financial reporting purposes. Such amounts were recorded using\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nthe tax rate in effect when the timing difference originated.\nDeferred revenues.\nAmounts billed to customers prior to providing the related services are deferred and later reported as revenues in the period in which the services are rendered.\nDeferred items.\nAccrued environmental and landfill costs -\nAccrued environmental and landfill costs includes the non-current portion of accruals associated with obligations for closure and post-closure of the Company's operating and closed landfills, corrective actions and remediation at certain of these landfill facilities and corrective actions at Superfund sites. The Company, based on input from its engineers, estimates its future cost requirements for closure and post-closure monitoring and maintenance for solid waste operating landfills in the United States based on its interpretation of the technical standards of the U.S. Environmental Protection Agency's Subtitle D regulations and the proposed air emissions standards under the Clean Air Act as they are being applied on a state-by-state basis. Closure and post-closure monitoring and maintenance costs represent the costs related to cash expenditures yet to be incurred when a landfill facility ceases to accept waste and closes. Accruals for closure and post-closure monitoring and maintenance requirements in the U.S. 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. Certain of these environmental costs, principally capping and methane gas control costs, are also incurred during the operating life of the site in accordance with the landfill operation requirements of Subtitle D and the proposed air emissions standards. Future cost requirements for closure and post-closure monitoring and maintenance of foreign operating landfills are determined based on the country or local landfill regulations governing the facility. The Company typically provides accruals for these costs as the remaining permitted airspace of such facilities is consumed. Engineering reviews of the future cost requirements for closure and post-closure monitoring and maintenance for the Company's operating landfills are performed at least annually and are the basis upon which the Company's estimates of these future costs and the related accrual rates are revised.\nAn overall program of management of closed solid waste landfills, principally in North America, previously owned or operated by the Company has been implemented to provide a systematic and routine standard of care and maintenance and to ensure environmental compliance at closed facilities which require varying levels of inspection, maintenance, environmental monitoring and from time to time corrective action. Additionally, the Company routinely reviews and evaluates each landfill site requiring\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\ncorrective action (including Superfund sites) in which the Company's subsidiaries are involved, considering each subsidiary's role with respect to each site and the relationship to the involvement of other parties at the site, the quantity and content of the waste with which the subsidiary was associated and the number and financial capabilities of the other parties at the various sites. Based on reviews of the various sites, currently available information, and management's judgment and significant prior experience related to similarly situated facilities, expense accruals are provided by the Company for its share of estimated future costs associated with corrective actions to be implemented at certain of these sites and existing accruals are revised as deemed necessary. Expense accruals related to post-closure care of previously owned or operated solid waste landfills are also reviewed on a periodic basis and revised as necessary.\nAccruals for closure, post-closure and certain other liabilities related to hazardous waste disposal were provided in fiscal 1990 when the Company discontinued its hazardous waste operations. The Company reviews the adequacy of these accruals on a periodic basis to determine whether any revisions in the accruals provided at that time are required.\nOther deferred items -\nDeferred items as of September 30, 1994 and 1993 were as follows (in thousands): 1994 1993 -------- -------- Self-insurance accruals $ 69,453 $ 57,189 Accrued pension costs 42,176 28,868 Unamortized investment tax credits 21,807 22,541 Other 26,042 19,657 -------- -------- $159,478 $128,255 ======== ========\nThe Company amortizes investment tax credits under the deferral method over the estimated useful lives of the related assets as they are placed in service. No investment tax credits have been generated since fiscal year 1992. For the year ended September 30, 1992, the total estimated investment tax credits generated by the Company's resource recovery partnerships, which qualified for the credit under a special provision of the Tax Reform Act of 1986, were $1,091,000. Included in other accrued liabilities at September 30, 1994 and 1993 was the current portion of self-insurance accruals of $64,998,000 and $63,143,000, respectively, and accrued pension costs of $1,547,000 and $1,076,000, respectively.\nForeign exchange contracts.\nThe Company enters into foreign exchange contracts as a hedge against certain of its net investments in foreign subsidiaries and purchase commitments from time to time. Realized and unrealized\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\ngains and losses on these contracts and the amortization of any premiums or discounts are deferred and included with translation adjustments in the separate component of common stockholders' equity or reflected as a deferred asset or liability associated with the anticipated purchase commitment. When deemed appropriate, the Company enters into foreign exchange contracts as a hedge against certain advances to foreign subsidiaries, which are to be repaid in the foreseeable future. Realized and unrealized gains and losses associated with these contracts are reflected in income for each period such contracts are outstanding. There were no significant foreign exchange contracts outstanding at September 30, 1994 and none were outstanding at the end of fiscal 1993.\nCash flow information.\nThe Consolidated Statement of Cash Flows provides information about changes in cash and excludes the effects of non-cash transactions, principally related to business combinations discussed in Note (3).\nReclassifications.\nCertain reclassifications have been made in prior years' financial statements to conform to the fiscal year 1994 presentation.\n(2) Reorganization charge -\nA reorganization charge of $27 million (an after-tax charge of approximately $.10 per share) was included in fiscal year 1993 results of operations. The charge, which was announced in June 1993, was recorded to cover the estimated expense of reorganizing the Company's regional structure in the United States to better plan and coordinate its business operations, capitalize on new growth opportunities and more efficiently serve its customers in the Company's major market areas. The reorganization included the designation of a divisional vice president with responsibility for each market area, the closing of three regional offices, the opening of one new regional office and the relocation of one regional office, which reduced the number of United States regional offices from seven to five. The reorganization charge included employee severance and relocation costs and other employee, organizational and transition related costs.\n(3) Business combinations -\nIn February 1994, the Company acquired 50% of the share capital of Otto Waste Services, a company engaged in the solid waste services business in Germany, which has been accounted for as a purchase. The Company paid approximately $400 million, consisting of 3,928,075 shares of the Company's common stock valued at $117.4 million and the remainder in Deutsche Mark, for its interest in Otto Waste Services.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nDuring its current fiscal year, the Company paid approximately $179.5 million (including liabilities assumed and additional amounts payable to former owners of $31.4 million and 752,049 shares of the Company's common stock valued at $21.4 million) to acquire 111 solid waste businesses, which were accounted for as purchases, in addition to the Otto Waste Services transaction discussed above. The Company also exchanged 1,027,721 shares of its common stock and assumed liabilities and equity of $7.0 million in connection with four business combinations which met the criteria to be accounted for as poolings-of-interests. As the aggregate effect of these four business combinations was not significant, prior period financial statements were not restated.\nDuring the prior fiscal year, the Company paid approximately $119.1 million (including liabilities assumed and additional amounts payable to former owners of $18.9 million and 726,931 shares of the Company's common stock (including 1,993 shares of treasury stock) valued at $17.7 million) to acquire 107 solid waste businesses, which were accounted for as purchases. The Company also exchanged 1,569,361 shares of its common stock and assumed liabilities and equity of $22.8 million in connection with three business combinations which met the criteria to be accounted for as poolings-of-interests. As the aggregate effect of these three business combinations was not significant, prior period financial statements were not restated.\nThe results of all businesses acquired in fiscal years 1994 and 1993 have been included in the consolidated financial statements from the dates of acquisition. In allocating purchase price, the assets acquired and liabilities assumed in connection with Otto Waste Services and many of the Company's other acquisitions have been initially assigned and recorded based on preliminary estimates of fair value and may be revised as additional information concerning the valuation of such assets and liabilities becomes available. As a result, the financial information included in the Company's consolidated financial statements and in the pro forma information below is subject to adjustment as subsequent revisions in estimates of fair value, if any, are necessary.\nThe Company's consolidated results of operations on an unaudited pro forma basis, as though the businesses acquired during fiscal year 1994 had been acquired on October 1, 1992, are as follows (in thousands, except per share amounts):\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nYear Ended September 30, -------------------------- 1994 1993 (Unaudited) (Unaudited) ----------- ----------- Pro forma revenues $4,596,208 $4,146,053 Pro forma income before extraordinary item $ 289,936 $ 209,515 Pro forma net income $ 284,673 $ 209,515 Pro forma income per common and common equivalent share - Income before extraordinary item $ 1.52 $ 1.15 Net income $ 1.49 $ 1.15\nThe pro forma effect of the acquisitions consummated during the prior fiscal year was not material. These pro forma results are presented for informational purposes only and do not purport to show the actual results which would have occurred had the business combinations been consummated on October 1, 1992, nor should they be viewed as indicative of future results of operations.\nFor certain business combinations accounted for as poolings-of-interests, the Company received additional income tax basis based on the fair market value of the acquired assets. The tax benefit of this additional basis is treated as an increase in additional paid-in capital when realized. Taxes on the recapture of depreciation resulting from such tax basis adjustments are charged to additional paid-in capital when the taxes are paid.\n(4) Property and equipment -\nProperty and equipment at September 30, 1994 and 1993, was as follows (in thousands):\n1994 1993 ---------- ---------- Land and improvements $ 232,732 $ 188,414 Buildings 425,775 328,173 Landfills 1,472,565 1,313,366 Vehicles and equipment 2,847,902 2,331,094 Construction-in-progress 117,397 97,024 ---------- ---------- Total property and equipment 5,096,371 4,258,071 Less accumulated depreciation and amortization 2,046,604 1,742,362 ---------- ---------- Property and equipment, net $3,049,767 $2,515,709 ========== ==========\nIncluded in property and equipment, net are $173,353,000 and $210,040,000 as of September 30, 1994 and 1993, respectively, related to solid waste landfill market development projects, including landfill permitting costs, for which amortization has not\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nyet commenced. The Company reviews the realization of these projects on a periodic basis.\n(5) Investments in unconsolidated affiliates -\nThe Company uses the equity method of accounting for investments in unconsolidated affiliates over which it exercises control of 20% - 50%. The summarized combined balance sheet and income statement information presented in the table below (and the Company's related investments and earnings) includes amounts primarily related to the following significant equity investees: American Ref-Fuel Company of Hempstead, Inc. (New York) (50%), American Ref-Fuel Company of Essex County, Inc. (New Jersey) (50%), American Ref-Fuel Company of Southeastern Connecticut, Inc. (50%), American Ref-Fuel Company of Niagara, L.P. (New York) (50%), Browning-Ferris Industries Iberica, S.A. (Spain) (50% - for the period December 31, 1990 through May 10, 1993, at which time the Company issued 1,000,000 shares and paid approximately $6.8 million to acquire an additional 31% ownership in this entity, resulting in reconsolidation of the Company's Spanish operations), Servizi Industriali Group (Italy) (50% - since December 31, 1991), Swire BFI Waste Services, Ltd. (Hong Kong) (50%), Pfitzenmeier & Rau (Germany) (50% - since February 3, 1994) and Congress Development Company (Chicago, Illinois) (50%) (in thousands).\n1994 1993 ---------- ---------- Combined Balance Sheet Information as of Fiscal Yearend: Assets - Current assets $ 211,382 $ 196,206 Noncurrent assets 1,122,711 1,041,059 ---------- ---------- $1,334,093 $1,237,265 ========== ==========\nLiabilities and Net Worth - Current liabilities $ 155,048 $ 135,155 Noncurrent liabilities 804,544 774,175 Net worth 374,501 327,935 ---------- ---------- $1,334,093 $1,237,265 ========== ==========\nCompany's Investments in and Advances to Equity Investees (including subordinated notes receivable of $71,453 and $56,182, respectively) $ 268,404 $ 219,712 ========== ==========\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n1994 1993 1992 -------- -------- --------\nCombined Income Statement Informa- tion for the Fiscal Year Ended: Revenues $398,753 $330,899 $267,466 Gross profit $162,870 $133,624 $114,811 Net income $ 74,804 $ 25,538 $ 2,862\nCompany's Equity in Earnings of Equity Investees (1) $ 37,084 $ 16,060 $ 9,827\n- ---------------- (1) Differences between the equity in earnings of equity investees reported by the Company and the Company's proportionate share of the combined earnings of the related equity investees have resulted principally from accounting differences in the recognition of income and the elimination of intercompany transactions.\nDuring fiscal year 1994, the Company received $17.6 million in dividends from unconsolidated affiliates. No significant dividends were received in fiscal years 1993 and 1992.\n(6) Accrued environmental and landfill costs -\nAccrued environmental and landfill costs at September 30, 1994 and 1993 were as follows (in thousands):\n1994 1993 -------- -------- Accrued costs associated with open landfills (including landfills under expansion) $328,920 $414,021\nAccrued costs associated with closed landfills and corrective action costs (including Superfund sites) 197,754 125,162\nAccrued costs of closure, post-closure and certain other liabilities associated with discontinued operations 161,531 189,947 -------- -------- Total 688,205 729,130\nLess current portion (included in other accrued liabilities) 158,704 97,440 -------- -------- Accrued environmental and landfill costs $529,501 $631,690 ======== ========\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nFor a discussion of the Company's significant accounting policies related to these environmental and landfill costs, see Note (1) - \"Summary of significant accounting policies\" - \"Deferred items\" - \"Accrued environmental and landfill costs\".\nOpen landfills.\nThe Company operates 93 solid waste landfills in the United States, 14 of which are operated under contracts with municipalities or others. The Company also operates 53 landfills outside of the United States. The Company is responsible for closure and post-closure monitoring and maintenance costs at most of these landfills which are currently operating or are engaged in expansion efforts. Estimated aggregate closure and post-closure costs are to be fully accrued for these landfills at the time that such facilities cease to accept waste and are closed. Considering existing accruals at the end of fiscal 1994, approximately $300-$325 million of additional accruals are to be provided over the remaining lives of these facilities. Estimated additional environmental costs ranging from $450-$475 million, principally related to capping and methane gas control activities expected to occur during the operating lives of these sites, are also to be expensed over the remaining lives of these landfill facilities. In addition, during fiscal year 1994, in excess of $85 million of these accruals was transferred to accrued costs associated with closed landfills and corrective action costs in connection with the closing of a number of landfills.\nClosed landfills and corrective action costs (including Superfund sites).\nThese costs relate to closure and post-closure activities or corrective actions at closed solid waste landfills owned or previously operated by the Company as well as a number of Superfund sites where subsidiaries of the Company are participating in potentially responsible party groups or are otherwise involved.\nDiscontinued operations.\nThese costs relate to closure and post-closure activities or corrective actions at hazardous waste landfills owned or previously operated by the Company as well as a number of Superfund sites where subsidiaries of the Company previously disposed of hazardous waste and are participating in potentially responsible party groups or are otherwise involved.\n(7) Long-term debt -\nLong-term debt at September 30, 1994 and 1993 was as follows (in thousands):\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n1994 1993 -------- -------- Senior indebtedness: 9 1\/4% Debentures $100,000 $100,000 8 1\/2% Sinking Fund Debentures, net of unamortized discount of $1,499 at yearend 1993 -- 98,501 Dfl. 125 million 6 1\/2% Notes -- 68,200 Solid waste revenue bond obligations 114,031 79,977 Other notes payable, primarily 5.0%-14.0% 366,145 82,964 -------- -------- 580,176 429,642 Commercial paper and short-term facilities to be refinanced 183,345 -- -------- -------- Total long-term debt 763,521 429,642 Less current portion 49,841 95,953 -------- -------- Long-term debt, net of current portion $713,680 $333,689 ======== ========\nThe long-term portion of the debt outstanding at September 30, 1994, matures as follows: 1996, $325,530,000; 1997, $65,656,000; 1998, $38,074,000; 1999, $23,560,000 and in subsequent years, $260,860,000.\n9 1\/4% Debentures.\nIn March 1991, the Company filed a shelf registration statement with the Securities and Exchange Commission to provide for the future issuance of up to $300 million of debt securities. The Company may issue these securities from time to time in one or more series. Maturities, terms, covenants and other conditions will be determined prior to the offering and sale of any series of these securities. In May 1991, the Company issued $100 million of 9 1\/4% Debentures which mature on May 1, 2021. The debentures may not be redeemed prior to maturity and are not subject to any sinking fund.\n8 1\/2% Sinking Fund Debentures.\nIn April 1994, the Company called for redemption of its $100 million 8 1\/2% Sinking Fund Debentures due 2017 which were originally issued in January 1987. As a result, the Company recorded an after-tax loss of $5,263,000, which has been reflected in the Company's consolidated statement of income as an extraordinary item.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nDfl. 125 million 6 1\/2% Notes.\nIn November 1988, Browning-Ferris Industries Finance B.V., an indirect wholly-owned subsidiary of the Company, issued Dfl. 125,000,000 of 6 1\/2% Notes at 100 1\/2% of their face amount, which were guaranteed by the Company. The notes, listed on the Amsterdam Stock Exchange, were unsecured obligations on which interest was payable annually. The notes matured on November 1, 1993 and were repaid from available funds.\nBank credit agreement.\nDuring September 1992, the Company modified the terms of its two existing bank credit agreements to provide, among other things, for the merger of the two agreements into one agreement and extended the maturity of the facility to August 1996. The agreement provides total committed credit capacity of $1 billion. The facility can be utilized to borrow U.S. domestic dollars or Eurodollars on a committed basis. At the option of the Company and the participating banks, U.S. dollar and Eurodollar loans bear a rate of interest based on the London Interbank Offered Rate (\"LIBOR\"), the prime rate, the federal funds rate or a certificate of deposit rate, plus a margin. The $1 billion Revolving Credit Agreement with Texas Commerce Bank National Association as administrative agent and Credit Suisse First Boston Limited as co-agent for a group of U.S. and international banks, requires a facility fee of .2% per annum on the total commitment, whether used or unused. The bank credit agreement is used primarily to support the Company's commercial paper program which was established in January 1990. The agreement contains a net worth requirement of $1 billion, which increases annually after September 30, 1992 by 25% of the consolidated net income of the preceding year and excludes the effect of any foreign currency translation adjustments on net worth. The agreement also restricts the incurrence or assumption of additional debt if the debt to capitalization ratio after considering such additional debt exceeds .65 to 1. At September 30, 1994 and 1993, the Company had no outstanding borrowings under its bank credit agreement.\nAt September 30, 1994, distributions from retained earnings could not exceed $1.3 billion under the bank credit agreement's net worth maintenance requirement (the covenant of the Company's debt agreements which is most restrictive regarding dividends).\nMedium-Term Notes, Series A.\nIn February 1990, the Company supplemented an existing shelf registration statement to provide for the registration of a program to issue up to $100 million of Medium-Term Notes, Series A. Under this program the Company may offer notes for sale from time to time in one or more series. The notes may have maturities ranging from one year to 30 years from the date of issue, as selected by the purchaser and agreed to by the Company, and will bear interest at a fixed rate agreed to by the Company at the date of issuance. No notes have yet been issued under this program.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nUniversal shelf registration statement.\nIn January 1994, the Company filed a universal shelf registration statement with the Securities and Exchange Commission to provide for the registration of up to $700 million of unsecured debt securities, preferred stock, common stock or warrants to purchase unsecured debt securities, preferred stock or common stock. In March 1994, the Company utilized a portion of these registered securities when it issued 15,525,000 shares of its common stock in concurrent public offerings in the United States and outside the United States. The Company used approximately $106 million of the net proceeds of approximately $434 million to redeem its $100 million 8 1\/2% Sinking Fund Debentures, due 2017 during April 1994. The balance of the proceeds was used to repay indebtedness associated with the February 1994 acquisition of the fifty percent interest in Otto Waste Services and other working capital requirements. The Company may offer the remaining securities available under the universal shelf registration statement from time to time, either jointly or separately, at prices and on terms to be determined at or prior to the time of sale.\nSolid waste revenue bond obligations.\nCertain subsidiaries of the Company have entered into agreements under which they receive proceeds from the sale by government authorities of solid waste revenue bonds. These subsidiaries are obligated to make payments sufficient to pay the interest and retire the bonds. The weighted average interest rate of these issues is approximately 6.1%. These issues mature at various dates through the year 2027. The solid waste revenue bond obligations of the subsidiaries are guaranteed by the Company.\nOther notes payable.\nOther notes payable includes mortgages payable and other secured debt, unsecured debt and capitalized lease obligations of the Company. Approximately $288 million of this indebtedness relates to a large number of separate company debt instruments of Otto Waste Services and its consolidated subsidiaries, in which the Company acquired a 50% interest in February 1994. A substantial portion of the Otto Waste Services debt is secured by assets of the related companies and is payable in Deutsche Mark.\nCommercial paper and short-term facilities to be refinanced.\nIn January 1990, the Company established a commercial paper program, authorizing the issuance of up to $1 billion in commercial paper through Goldman, Sachs Money Markets, Inc. and Shearson Lehman (a division of Shearson Lehman Brothers, Inc.). The Company may use proceeds from borrowings under this program to refinance existing indebtedness and for general corporate purposes, including interim financing of business acquisitions and funding working capital requirements. Borrowings under the commercial paper program may not exceed the available credit under the Company's\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nbank credit agreement which provides for aggregate borrowings of up to $1 billion. At September 30, 1994, the Company had commercial paper and other outstanding borrowings of $183,345,000 classified as long-term debt. At September 30, 1993, the Company had no borrowings outstanding under the commercial paper program. It is the Company's intention to refinance the commercial paper and other outstanding borrowings classified as long-term debt through the use of its existing committed long-term bank credit agreements or medium-term note program in the event that alternative long-term refinancing is not arranged. A summary by country of the commercial paper and other outstanding borrowings to be refinanced as of September 30, 1994 is as follows (amounts in thousands):\n---------------------------- Amount to be Interest Rate Refinanced at Yearend ------------ ------------- United States - Commercial paper $ 43,482 5% Germany 139,863 8-12% -------- $183,345 ========\nIt is the Company's practice to maintain bank accounts with certain banks through which cash collections and disbursements are made in the ordinary course of business. The cash balances in these operating accounts may also serve as compensating balances for loans and various services provided by the banks.\n(8) Convertible Subordinated Debentures -\nIn August 1987, the Company issued to the public $345 million of 6 1\/4% Convertible Subordinated Debentures due 2012. Each $1,000.00 debenture is convertible by the holder, at any time, into the Company's common stock, at a conversion price of $41.00 per share. On August 15, 1990, the debentures became redeemable at the option of the Company, in whole or in part, at an initial redemption price of 104.375% of the principal amount, which decreases in equal increments annually through August 15, 1997 and remains at 100.0% thereafter. The debentures are subject to an annual sinking fund obligation in an amount equal to 5% of the originally issued principal amount beginning on August 15, 1997.\nIn July 1990, the Company issued $400 million of 6 3\/4% Convertible Subordinated Debentures due 2005. The debentures are convertible by a holder into shares of the Company's common stock at a conversion price of $52.50 per share. These debentures are subject to redemption, at the option of the Company, in whole or in part, at any time on and after July 18, 1993 at an initial redemption price of 103% of the principal amount, which decreases in equal increments annually through July 18, 1996 and remains at 100% thereafter.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n(9) Commitments and contingencies -\nLegal proceedings.\nSince early November 1990, several lawsuits have been filed in the United States District Court for the Southern District of Texas. These suits, seeking unquantified damages and attorneys' and other fees, are class actions on behalf of those persons who purchased the Company's common stock during specified periods beginning August 9, 1990 through September 3, 1991. The suits generally allege that the Company violated the Securities Exchange Act of 1934 by allegedly preparing, issuing and disseminating materially false and misleading information to plaintiffs and the investing public. Two classes (August 9, 1990 to November 5, 1990 and November 6, 1990 to September 3, 1991) were certified by the trial courts. The Company is vigorously defending these matters.\nIn addition to the above-described litigation, the Company and certain subsidiaries are involved in various other administrative matters or litigation, including personal injury and other civil actions, as well as other claims and disputes that could result in additional litigation or other adversary proceedings.\nWhile the final resolution of any matter may have an impact on the Company's consolidated financial results for a particular reporting period, management believes that the ultimate disposition of these matters will not have a materially adverse effect upon the consolidated financial position of the Company.\nEnvironmental proceedings.\nCalifornia judicial and regulatory authorities suspended the Company's ability to accept decomposable household waste at certain portions of its Azusa, California landfill in January 1991. The Company has continued to use the facility for the disposal of primarily inert waste. Since January 1991, the Company has sought and received the ability to dispose of certain additional non-municipal solid waste streams at the facility. The ultimate realization of the Company's total investment of approximately $100 million is dependent upon continued disposal of current and future acceptable waste streams while continuing to pursue all possible alternative uses of the property to maximize its value.\nThe Company and certain subsidiaries are involved in various other environmental matters or proceedings, including original or renewal permit application proceedings in connection with the establishment, operation, expansion, closure and post-closure activities of certain landfill disposal facilities, and proceedings relating to governmental actions resulting from the involvement of various subsidiaries of the Company with certain waste sites (including Superfund sites), as well as other matters or claims that could result in additional environmental proceedings.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nWhile the final resolution of any matter may have an impact on the Company's consolidated financial results for a particular reporting period, management believes that the ultimate disposition of these matters will not have a materially adverse effect upon the consolidated financial position of the Company.\nInsurance matters.\nUnder its insurance policies, the Company generally has self-insured retention limits ranging from $1,000,000 to $5,000,000 and has obtained fully insured layers of coverage above such self-retention limits. In November 1992, a wholly-owned insurance subsidiary of the Company received a Certificate of Authority from the Colorado Division of Insurance to operate as a captive insurance company. It currently writes insurance to meet financial assurance obligations related to closure and post-closure of certain landfills of the Company. At September 30, 1994, no claims had been made relative to this insurance operation, and no claim reserves had been posted.\nIn order to meet existing governmental requirements, the Company has been able to secure an environmental impairment liability insurance policy in amounts which the Company believes are in compliance with the amounts required by federal and state law. Under this policy, the Company must reimburse the carrier for losses incurred by the Company.\nResource recovery projects.\nSubsidiaries of the Company and Air Products and Chemicals, Inc. (\"Air Products\") each have 50% ownership interests in American Ref-Fuel partnerships that construct, own and operate facilities which generate and sell electricity from the incineration of solid waste. The four facilities currently in commercial operation are located in Hempstead, New York, Essex County in New Jersey, Preston, Connecticut and Niagara Falls, New York. Financing arrangements for these projects include parent company support arrangements under which the Company and Air Products generally have agreed to each severally fund one-half of partnership cash deficiencies resulting from the partnership's failure to meet certain obligations during construction and, to a lesser extent, operation of each of the facilities. In all cases except Niagara Falls, the Company and Air Products generally are not obligated to fund cash deficiencies associated with waste deliveries by the sponsoring municipality below certain minimum levels, changes in law or termination of incineration service for reasons other than default by the respective partnership. In the event of a partnership default which results in termination of incineration service, the Company may limit its financial obligations as follows:\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nHempstead, New York - Funding of 50% of periodic payments related to outstanding debt. At September 30, 1994, $227 million of total unamortized project debt was outstanding, which matures on various dates between 1994 and 2010. Average annual debt service on 50% of the debt over the next five years is $13 million.\nEssex County in New Jersey - Funding of 50% of cash deficiencies including debt service until facility has passed its acceptance tests. The facility has not yet passed certain of its final acceptance tests. At September 30, 1994, total outstanding debt included unamortized project debt of $178 million and $10 million of additional partnership debt (of which $5 million is guaranteed by the Company). Upon final acceptance of the facility, the Company will be obligated to fund one-half of cash deficiencies up to $50 to $100 million, depending upon the circumstances. Average annual debt service on 50% of the debt over the next five years is $10 million.\nPreston, Connecticut - Funding of 50% of periodic payments re- lated to outstanding debt. At September 30, 1994, total outstanding debt included $95 million of unamortized project debt and $44 million of additional partnership debt (of which $22 million is guaranteed by the Company). Such outstanding indebtedness matures on various dates between 1994 and 2023. Average annual debt service on 50% of the debt over the next five years is $6 million.\nNiagara Falls, New York - Funding of 50% of partnership cash deficiencies, including debt service. At September 30, 1994, $35 million of total unamortized project debt was outstanding. Average annual debt service on 50% of the debt over the next five years is $3 million.\nOperating leases.\nThe Company and its subsidiaries lease substantial portions of their office and other facilities under various lease agreements. At September 30, 1994, total minimum rental commitments becoming payable under all noncancellable operating leases are as follows (in thousands):\n1995 $ 36,993 1999 $ 24,259 1996 $ 32,882 2000 - 2004 $ 99,988 1997 $ 29,269 2005 - 2009 $102,366 1998 $ 26,111 All years thereafter $ 45,379\nTotal rental expenses for fiscal years 1994, 1993 and 1992, substantially all of which related to fixed amount rental agreements, were $58,667,000, $55,667,000 and $49,178,000, respectively.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nOther matters.\nOn September 20, 1994, BFI Acquisition plc (\"BFI (UK)\"), a subsidiary of the Company, announced the terms of cash offers to acquire all of the outstanding ordinary shares (including ordinary shares represented by American Depositary Shares) of Attwoods plc (\"Attwoods\") and convertible preference shares of Attwoods (Finance) N.V., a finance subsidiary of Attwoods. On November 17, 1994, BFI (UK) announced increased and final offers (\"Final Offers\") for Attwoods. The Final Offers, denominated in pounds sterling, are 116.75 pence per ordinary share (583.75 pence per American Depositary Share) and 92 pence per preference share (an aggregate of approximately U.S. $611 million based on exchange rates prevailing on November 29, 1994). The Final Offers also provide for a recommended final dividend of 3.25 pence per ordinary share payable to Attwoods shareholders. Attwoods is a provider of waste management services operating principally in the United States, the United Kingdom, the Caribbean and mainland Europe, primarily Germany, and also has mineral extraction operations in the United Kingdom. The Final Offers are subject to the satisfaction of various conditions, including acceptance by the holders of not less than 50% of the ordinary shares and satisfaction of applicable requirements under the Hart-Scott-Rodino Anti-Trust Improvements Act. The expiration date of the Final Offers is December 2, 1994.\n(10) Preferred stock -\nThe Company is authorized by its Restated Certificate of Incorporation to issue 25 million shares of preferred stock, the terms and conditions to be determined by the Board of Directors in creating any particular series.\n(11) Preferred Stock Purchase Rights Plan -\nIn June 1988, the Board of Directors of the Company adopted a Preferred Stock Purchase Rights Plan (the \"Plan\") and in connection therewith declared a dividend of one Preferred Stock Purchase Right (a \"Right\") on each outstanding share of the Company's common stock and on each share subsequently issued until separate Rights certificates are distributed, or the Rights expire or are redeemed. When exercisable, each Right will entitle a holder to purchase one one-hundredth of a share of a new series of the Company's Preferred Stock at an exercise price of $110.00, subject to adjustment.\nThe Plan, as subsequently amended in March 1990, provides that if the Company is acquired in a business combination transaction on or at any time after the date on which a person obtains ownership of stock having 10% or more of the Company's general voting power, provision generally must be made prior to the consummation of such transaction to entitle each holder of a Right to purchase at the exercise price a number of the acquiring company's common shares having a market value at the time of such transactions of two times the exercise price of the Right. The Plan also provides that upon the occurrence of certain other specific matters, each holder of a Right will have the right to receive, upon payment of the exercise\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nprice, shares of the new series of Preferred Stock having a market value of two times the exercise price of a Right. The Company has a right to redeem the Rights for $.05 per Right (subject to adjustment) prior to the time they become exercisable. The Rights will expire on June 13, 1998.\n(12) Common stock -\nEarnings per share.\nThe following table reconciles the number of common shares shown as outstanding on the consolidated balance sheet with the number of common and common equivalent shares used in computing primary earnings per share (in thousands): Year Ended September 30, ---------------------------- 1994 1993 1992 ------- ------- ------- Common shares outstanding 196,341 173,545 168,629\nEffect of using weighted average common and common equivalent shares outstanding (9,788) (2,962) (10,846)\nEffect of shares issuable under stock option plans based on the treasury stock method 1,068 913 879 ------- ------- ------- Shares used in computing primary earnings per share 187,621 171,496 158,662 ======= ======= =======\nThe difference between shares for primary and fully diluted earnings per share was not significant in any year. Conversion of the 6 3\/4% Convertible Subordinated Debentures issued in July 1990, which were determined not to be common stock equivalents, was not assumed in the computation of fully diluted earnings per share because the debentures had an anti-dilutive effect.\nEarnings per common and common equivalent share were computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding during each year. Common stock equivalents include stock options and the Company's 6 1\/4% Convertible Subordinated Debentures issued in August 1987. The effect of the debentures on earnings per share was anti-dilutive for each of the years presented and, accordingly, has not been included in the computations.\nStock incentive plans.\nThe Company presently maintains five stock option plans affording employees, directors and other persons affiliated with the Company the right to purchase shares of its common stock. At September 30, 1994, options were available for future grants only under four plans, the Company's 1987, 1990 and both of its 1993\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nplans. At September 30, 1994, 236,350 of the options outstanding were incentive stock options and 9,669,518 were non-qualified stock options.\nThe exercise price, term and other conditions applicable to each option granted under the Company's plans are generally determined by the Compensation Committee at the time of the grant of each option and may vary with each option granted. No option may be granted at a price less than the stock's fair market value on the date of the grant.\nTransactions under all stock option plans are summarized below:\nYear Ended September 30, ---------------------------------------- 1994 1993 1992 ---------- ---------- ---------- Options outstanding at beginning of year 9,708,547 9,202,726 7,719,664 Options granted 1,697,000 1,865,400 2,127,500 Options terminated (632,870) (302,145) (155,090) Options exercised (866,809) (1,057,434) (489,348) ---------- ---------- ---------- Options outstanding at end of year 9,905,868 9,708,547 9,202,726 ========== ========== ========== Options exercisable at end of year 5,939,033 5,341,527 5,189,576 Options available for future grants at end of year 6,501,573 380,657 1,944,052 Total option price of options outstanding at end of year $249,683,713 $242,054,596 $219,553,936 Option price range: Options granted $25.44-$31.69 $24.81-$27.75 $17.31-$23.56 Options terminated $17.31-$43.38 $ 9.90-$43.38 $17.31-$43.38 Options exercised $ 7.00-$29.84 $ 7.00-$31.75 $ 4.68-$24.06 Options outstanding at end of year $ 9.34-$43.38 $ 7.00-$43.38 $ 7.00-$43.38\nUnder the 1993 Stock Incentive Plans, restricted common stock of the Company may be granted to officers, other key employees and certain non-employee directors. Shares granted are subject to certain restrictions on ownership and transferability. Such restrictions on current restricted stock grants lapse 2 years from the date of grant for officers and key employees and three years for non-employee directors. The deferred compensation expense related to restricted stock grants is amortized to expense on a straight-line basis over the period of time the restrictions are in place and the unamortized portion is classified as a reduction of additional paid-in capital in the Company's consolidated balance sheet. Additionally, the 1993 stock incentive plans provide for common stock awards. Restricted stock grants and common stock awards reduce stock options otherwise available for future grant.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nOf the 500,000 shares which may be awarded principally to officers and key employees as restricted stock grants or stock awards, approximately 15,000 restricted shares were issued during the current year and were outstanding as of September 30, 1994. No common stock awards were granted as of September 30, 1994.\nDividend Reinvestment Plan.\nThe Company has a Dividend Reinvestment Plan which provides registered common stockholders an opportunity to reinvest automatically their dividends in shares of the Company's common stock. Each participant in the plan may also make additional cash payments of not less than $25 per remittance and not more than $60,000 per calendar year to be invested in such common shares pursuant to the plan. The plan provides that newly issued shares may be acquired from the Company, purchased on the open market or purchased under a combination of the two alternatives.\n(13) Foreign currency translation -\nIncreases (decreases) in the equity component for each period's translation adjustments are as follows (in thousands):\nYear Ended September 30, ----------------------------------- 1994 1993 1992 ---------- ---------- --------- Beginning cumulative translation adjustment $(136,659) $ (40,385) $ (2,559) --------- --------- -------- Adjustments for the fiscal year: Foreign currency translation adjustments 95,915 (96,274) 8,155 Adjustments related to foreign exchange hedging contracts -- -- (45,981) --------- --------- -------- Total adjustments 95,915 (96,274) (37,826) --------- --------- -------- Ending cumulative translation adjustment $ (40,744) $(136,659) $(40,385) ========= ========= ========\n(14) Income taxes -\nIn the first quarter of fiscal 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\" effective October 1, 1993. As permitted under SFAS No. 109, prior years financial statements have not been restated to apply the provisions of SFAS No. 109. Information shown below for prior years was determined under the provisions of Accounting Principles Board Opinion No. 11.\nThe components of (i) earnings before income taxes, minority BROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\ninterest and extraordinary item and (ii) the income tax provision for each of the three fiscal years ended September 30, are as set forth below (in thousands). 1994 1993 1992 -------- -------- -------- Domestic $421,620 $305,023 $285,869 Foreign (1) 77,503 22,164 2,011 -------- -------- -------- $499,123 $327,187 $287,880 ======== ======== ======== - ---------- (1) Amounts are net of intercompany interest for fiscal years 1994, 1993 and 1992 of $23,838,000, $20,216,000 and $32,106,000, respectively. The Company maintains a capital structure with respect to its foreign operations designed to minimize worldwide income and other tax costs.\nState Federal Foreign & Local Total -------- -------- -------- -------- 1994: Current $116,164 $ 42,107 $ 18,626 $176,897 Deferred 34,646 (220) (10,968) 23,458 Amortization of investment tax credit (706) -- -- (706) -------- -------- -------- -------- $150,104 $ 41,887 $ 7,658 $199,649 ======== ======== ======== ========\n1993: Current $ 90,861 $ 18,790 $ 20,366 $130,017 Deferred 11,859 (3,320) (7,807) 732 Amortization of investment tax credit (1,023) -- -- (1,023) -------- -------- -------- -------- $101,697 $ 15,470 $ 12,559 $129,726 ======== ======== ======== ========\n1992: Current $ 95,378 $ 10,865 $ 10,623 $116,866 Deferred (2,803) (711) 1,059 (2,455) Amortization of investment tax credit (2,138) -- -- (2,138) -------- -------- -------- -------- $ 90,437 $ 10,154 $ 11,682 $112,273 ======== ======== ======== ========\nThe following is a reconciliation between the effective income tax rate and the applicable statutory federal income tax rate for each of the three fiscal years in the period ended September 30, 1994:\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n1994 1993 1992 ------- ------- ------- Income tax - statutory rate 35.00% 34.75% 34.00% Amortization of investment tax credit (.14) (.31) (.74) Federal effect of state income taxes (.54) (1.33) (1.38) Effect of foreign operations .89 2.51 3.01 All other, net 3.26 .19 .05 ------ ------ ------ Federal and foreign 38.47 35.81 34.94 State income taxes 1.53 3.84 4.06 ------ ------ ------ Effective income tax rate 40.00% 39.65% 39.00% ====== ====== ======\nThe tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and liabilities at September 30, 1994, are as follows (in thousands):\nDeferred Deferred Tax Tax Assets Liabilities ----------- ------------ Depreciation and amortization $103,971 $403,891 Accrued environmental and landfill costs 193,373 -- Accruals related to discontinued operations 79,345 -- Self-insurance accruals 49,814 -- Net operating loss carryforwards 116,660 -- Other 192,819 78,446 -------- -------- Deferred tax assets and liabilities 735,982 $482,337 ======== Valuation allowance 119,400 -------- Deferred tax assets, net of valuation allowance $616,582 ========\nThe valuation allowance applies principally to a substantial portion of the net operating loss carryforwards which could expire prior to utilization by the Company. Foreign net operating loss carryforwards of approximately $172 million are available to reduce future taxable income of the applicable foreign entities for periods which generally range from 1995 to 1999. Domestic state net operating loss carryforwards of approximately $718 million (the tax benefit of which is calculated at rates ranging generally from 5%-10%) are available to reduce future taxable income of the applicable entities taxable in such states for periods which range from 1995 to 2009. The net change in the total valuation allowance for the year ended September 30, 1994, was an increase of $8.9 million.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nDeferred income taxes have not been provided as of September 30, 1994, on approximately $320 million of undistributed earnings of foreign affiliates which are considered to be permanently reinvested.\nThe components of the deferred income tax expense (benefit) for each of the two years ended September 30, are as follows (in thousands): 1993 1992 -------- -------- Depreciation expense for income tax purposes in excess of amounts for financial reporting purposes $ 34,565 $ 24,187 Environmental compliance and other landfill related costs recognized for financial reporting purposes but deferred for income tax purposes, net (14,775) (16,664) Reorganization charge (8,340) -- Other, net (10,718) (9,978) -------- -------- Deferred income tax expense (benefit) $ 732 $ (2,455) ======== ========\nThe Company's consolidated federal income tax returns for fiscal years 1986, 1987 and 1988 have been under audit by the Internal Revenue Service. In May 1993, the Company received a Revenue Agent's Report proposing that the Company pay additional taxes of approximately $22 million (plus interest of approximately $19 million as of September 30, 1994) relating to disallowed deductions in those income tax returns. The principal issue involved, which extends as well to the Company's subsequent taxable years, is the deductibility of amortization relating to customer lists and covenants not to compete associated with acquisitions consummated by the Company in fiscal years 1986, 1987 and 1988. Pursuant to a Congressional order, the IRS developed the Intangible Settlement Initiative and is seeking to settle outstanding claims with affected companies. In April 1994, the IRS proposed to settle substantially all of the Company's pending issues related to intangible assets from acquisitions. In November 1994, the Company reached an agreement with the IRS under the Intangible Settlement Initiative which had no material effect on the Company's results of operations or financial position. As a result of this settlement, all material issues raised in the May 1993 Revenue Agent's Report were resolved.\n(15) Employees' benefit plans -\nEmployee stock ownership and savings plan.\nThe Company sponsors an employee stock ownership and savings\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nplan which incorporates deferred savings features permitted under IRS Code Section 401(k). The plan covers substantially all U.S. employees with one or more years of service except for certain employees subject to collective bargaining agreements. Eligible employees may make voluntary contributions to one or more of five investment funds through payroll deductions which, in turn, will allow them to defer income for tax purposes. The Company matches these voluntary contributions at a rate of $.50 per $1.00 on the first 5% of total earnings contributed by each participating employee. The Company matches the voluntary contributions through open market purchases or issuances of shares of the Company's common stock. The Company expenses its contributions to the employee stock ownership and savings plan which for fiscal years 1994, 1993 and 1992 were $9,430,000, $9,072,000, and $8,160,000, respectively.\nEmployees' retirement plans.\nThe Company and its domestic subsidiaries have two defined benefit retirement plans covering substantially all U.S. employees except for certain employees subject to collective bargaining agreements. The benefits for these plans are based on years of service and the employee's compensation. The Company's general funding policy for these plans is to make annual contributions to the plans equal to or exceeding the actuary's recommended contribution.\nThe Company also has employees in various foreign countries that are covered by defined benefit pension plans. The benefits for these plans are based generally on years of service and the employee's compensation. Under the Company's funding policy, annual contributions are made in order to fund the plans over the participants' total expected periods of service in conformity with the requirements of local law or custom.\nThe components of net periodic pension cost for fiscal years 1994, 1993 and 1992 for the defined benefit plans were as follows (in thousands):\n1994 1993 1992 ------- ------- ------- U.S. Plans: Service cost (benefits earned during the period) $11,260 $11,257 $11,866 Interest cost on projected benefit obligation 10,329 10,515 9,952 Investment gain on plan assets (11,728) (29,121) (9,934) Net amortization and deferral (1,534) 18,102 (84) ------- ------- ------- Net periodic pension cost $ 8,327 $10,753 $11,800 ======= ======= =======\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n1994 1993 1992 ------- ------- ------- Non-U.S. Plans: Service cost (benefits earned during the period) $ 1,118 $ 994 $ 1,223 Interest cost on projected benefit obligation 1,004 1,054 1,032 Investment loss (gain) on plan assets (62) (2,788) 1,064 Net amortization and deferral (1,766) 767 (2,918) ------- ------- ------- Net periodic pension cost $ 294 $ 27 $ 401 ======= ======= =======\nThe following table sets forth the funded status and amounts recognized in the Company's consolidated balance sheet as of September 30, 1994 and 1993, and the significant assumptions used in accounting for the defined benefit plans (in thousands):\n1994 1993 -------------------- ------------------- U.S. Non-U.S. U.S. Non-U.S. --------- -------- --------- -------- Actuarial present value of accumulated benefit obligations, including vested benefits of $114,878, $5,158, $96,418, and $5,615, respectively $(115,780) $ (5,746) $(111,195) $ (6,130) ========= ======== ========= ======== Actuarial present value of projected benefit obligation $(132,275) $(14,295) $(150,364) $(14,880) Plan assets at fair value, primarily commercial paper, common stocks (including 22,000 shares of the Company's common stock for U.S. plans at both dates) and mutual funds 150,175 20,800 142,491 18,837 --------- -------- --------- -------- Projected benefit obligation (in excess of) less than plan assets 17,900 6,505 (7,873) 3,957 Unrecognized net gain (29,147) (1,403) (11,868) (1,570) Unrecognized prior service cost (16,562) -- 453 -- Unrecognized net (asset) obligation at transition (1,873) 1,526 (2,066) 2,050 --------- -------- --------- -------- Prepaid (accrued) pension costs $ (29,682) $ 6,628 $ (21,354) $ 4,437 ========= ======== ========= ========\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n1994 1993 -------------------- ------------------- U.S. Non-U.S. U.S. Non-U.S. --------- -------- --------- -------- Discount rate 8.25% 6.5-9.5% 7.0% 6.5-8.0% Rate of increase in compensation levels 4.5% 3.5-7.5% 4.5% 3.5-6.5% Expected long-term rate of return on assets 9.5% 7.0-10.5% 9.5% 7.0-9.5%\nTermination indemnity plan.\nThe employees of the Company's Italian operations are covered by a termination indemnity plan. Benefits under the plan, which are based on periods of service and the employee's compensation, are payable in a lump sum upon (1) retirement, (2) termination, (3) death after 10 years of credited service or (4) disability after 10 years of credited service. Expense for fiscal years 1994, 1993 and 1992 related to this unfunded plan was $1,202,677, $1,224,040 and $1,509,070, respectively.\nOther postretirement benefits.\nThe Company currently maintains an unfunded postretirement benefit plan which provides for employees participating in its medical plan to receive a monthly benefit after retirement based on years of service. Effective October 1, 1993, the Company adopted SFAS No. 106 - \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", which requires the accrual of such benefits over the active service period of the employee. Prior to October 1, 1993, such benefits were expensed when paid. As permitted under SFAS No. 106, the Company has chosen to recognize the transition obligation (the actuarially-determined accumulated postretirement benefit obligation of approximately $11.9 million at September 30, 1994) over a 20-year period. Current year expense associated with the adoption of this standard was not material to the Company's results of operations.\nPostemployment benefits.\nThe Company maintains no plans which provide significant benefits to former or inactive employees after employment but before retirement.\n(16) Operations by industry segment and geographic area -\nThe Company's revenues and income are derived principally from one industry segment, which includes the collection, processing\/recovery and disposal of solid wastes. This segment renders services to a variety of commercial, industrial, governmental and residential customers. Substantially all revenues represent income from unaffiliated customers.\nThe table below reflects certain geographic information relat-\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\ning to the Company's operations. For purposes of this table, general corporate expenses have been included in the computation of income from operations and are classified under \"United States and Puerto Rico\" (in thousands).\nUnited States and Puerto Rico Foreign Consolidated ------------ ---------- ------------ Revenues 1994 $3,293,297 $1,021,244 $4,314,541 1993 2,881,150 597,680 3,478,830 1992 2,706,507 571,128 3,277,635\nIncome from operations 1994 426,499 117,411 543,910 1993 316,313(1) 51,075(2) 367,388 1992 294,291 45,978(2) 340,269\nDepreciation and amortization 1994 349,189 95,003 444,192 1993 304,968 61,513 366,481 1992 307,191 57,931 365,122\nIdentifiable assets 1994 3,626,134 2,170,821(2) 5,796,955 1993 3,370,508 925,134(3) 4,295,642 1992 3,248,110 819,414(3) 4,067,524\n- -----------------\n(1) Income from operations for the United States and Puerto Rico operations has been reduced by a reorganization charge incurred in the third quarter of fiscal 1993 of $27.0 million. See Note (2).\n(2) In excess of $1.0 billion of the increase in identifiable assets since fiscal yearend 1993 is attributable to consolidated assets of Otto Waste Services. The Company acquired a 50% interest in Otto Waste Services in February 1994.\n(3) Included in foreign income from operations is approximately $8.0 million, $13.9 million and $13.8 million of operating losses from Italian operations for fiscal 1994, 1993 and 1992, respectively; the Company's investment in Italian operations at September 30, 1994 and 1993 was approximately $154 million and $149 million, respectively.\n(17) Fair value of financial instruments -\nThe following disclosures of the fair value of financial instruments are presented in accordance with the requirements of SFAS No. 107, \"Disclosures About Fair Value of Financial Instruments\". The estimated fair value amounts have been determined by the\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nCompany using available market data and valuation methodologies. Considerable judgment is required in developing the methodologies used to determine the estimates of fair value and in interpreting available market data and, accordingly, the estimates presented herein are not necessarily indicative of the values of such financial instruments in a current market exchange. Additionally, under certain financing agreements, the Company is prohibited from redeeming certain of the long-term debt before its maturity.\nAs of September 30, --------------------------------------- 1994 1993 ------------------ ------------------ Book Fair Book Fair Value Value Value Value -------- -------- -------- -------- Debt - (In Thousands) 9 1\/4% Debentures $100,000 $101,000 $100,000 $125,500 8 1\/2% Sinking Fund Debentures -- -- 98,501 113,125 Dfl. 125 million 6 1\/2% Notes -- -- 68,200 68,200 Solid waste revenue bond obligations 114,031 110,639 79,977 86,986 Other notes payable 366,145 380,330 82,964 93,887 Commercial paper and short-term facilities to be refinanced 183,345 189,373 -- -- Convertible subordinated debentures 744,949 714,101 744,949 750,174\nThe book values of cash, short-term investments, trade accounts receivables, trade accounts payable and financial instruments included in other receivables, other assets and accrued liabilities approximate their fair values principally because of the short-term maturities of these instruments.\nThe estimated fair value of long-term debt and convertible subordinated debentures is based on quoted market prices where available or on present value calculations which are calculated using current rates for similar debt with the same remaining maturities.\nIn the normal course of business, the Company has letters of credit, performance bonds and other guarantees which are not reflected in the accompanying consolidated balance sheets. In the past, no significant claims have been made against these financial instruments. Management believes that the likelihood of performance under these financial instruments is minimal and expects no material losses to occur in connection with these financial instruments.\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\n(18) Related party transactions -\nOne of the Company's directors is affiliated with Otto Holding International B.V. (\"OHI\") which owns the other 50% interest of Otto Waste Services. The Company, primarily through its 50% ownership of Otto Waste Services, is engaged in various transactions through the ordinary course of business with OHI, its subsidiaries and unconsolidated affiliates (\"OHI Group\"). The OHI Group leased containers and equipment under operating leases and provided certain administrative services to Otto Waste Services during the current fiscal year. Charges for these services were approximately $3.5 million for the period since Otto Waste Services was acquired in February 1994. The Company, including Otto Waste Services, also purchased or entered into capital leases for approximately $25.4 million of containers from the OHI Group during fiscal year 1994. Included in the balance sheet at September 30, 1994, are the following amounts relating to transactions with the OHI Group (in thousands):\nAccounts receivable - other $ 5,227,000 Accounts payable 3,388,000 Capital lease obligations 31,515,000 Notes payable, interest payable at 8% 11,569,000\n(19) Quarterly financial information (Unaudited) -\nFirst Second Third Fourth Quarter Quarter Quarter Quarter -------- -------- ---------- ----------- (In thousands except for per share amounts)\nRevenues 1994 $928,292 $984,154 $1,160,632 $1,241,463 1993 $845,131 $822,813 $ 887,500 $ 923,386\nGross profit 1994 $252,002 $270,177 $ 318,510 $ 350,477 1993 $235,002 $230,155 $ 242,282 $ 246,368\nIncome from 1994 $107,627 $119,087 $ 154,545 $ 162,651 operations 1993 $ 97,279 $ 93,374 $ 77,996(1) $ 98,739\nIncome taxes 1994 $ 39,327 $ 42,905 $ 57,648 $ 59,769 1993 $ 33,429 $ 32,502 $ 26,365 $ 37,430\nIncome before extraordinary item 1994 $ 58,991 $ 61,918 $ 80,813 $ 82,251 1993 $ 52,287 $ 50,836 $ 41,238 $ 53,079\nNet income 1994 $ 58,991 $ 56,655(2) $ 80,813 $ 82,251 1993 $ 52,287 $ 50,836 $ 41,238 $ 53,079\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nFirst Second Third Fourth Quarter Quarter Quarter Quarter -------- -------- ---------- ----------- (In thousands except for per share amounts) Earnings per share: Income before extraordinary item 1994 $ .34 $ .34 $ .41 $ .42 1993 $ .31 $ .30 $ .24 $ .31\nNet income 1994 $ .34 $ .31 $ .41 $ .42 1993 $ .31 $ .30 $ .24 $ .31\n- -------------\n(1) In the third quarter of fiscal year 1993, a reorganization charge of $27.0 million was taken by the Company to cover the estimated expense of reorganizing the Company's regional structure in the United States. See Note (2).\n(2) In the second quarter of fiscal year 1994, the Company recorded an after-tax loss of $5.3 million associated with the early retirement of indebtedness, which was reflected in the Company's consolidated statement of income as an extraordinary item. See Note (7).\n(This page intentionally left blank.)\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.\nFinancial Statements\nBrowning-Ferris Industries, Inc. and Subsidiaries:\nReport of independent public accountants.\nConsolidated statement of income for the three years ended September 30, 1994.\nConsolidated balance sheet--September 30, 1994 and 1993.\nConsolidated statement of common stockholders' equity for the three years ended September 30, 1994.\nConsolidated statement of cash flows for the three years ended September 30, 1994.\nNotes to consolidated financial statements.\nSchedules\nII Amounts receivable from directors, officers and employees for the three years ended September 30, 1994.\nV Property and equipment for the three years ended September 30, 1994.\nVI Accumulated depreciation and amortization of property and equipment for the three years ended September 30, 1994.\nVIII Allowance for doubtful accounts for the three years ended September 30, 1994.\nSchedules, other than those listed above, are omitted because of the absence of conditions under which they are required, or because the information is included in the financial statements or notes thereto.\nExhibits\n3(a) Restated Certificate of Incorporation of BFI, dated October 7, 1991. (Exhibit 3(a) of Form 10-K for the fiscal year ended September 30, 1993, is hereby incorporated by reference.)\n3(b) By-laws of BFI, as amended through March 3, 1993. (Exhibit 3(b) of Form 10-K for the fiscal year ended September 30, 1993, is hereby incorporated by reference.)\n4.1 Rights Agreement, dated June 1, 1988, between BFI and Texas Commerce Bank National Association. (Exhibit 3.3 of Form 10-K for the fiscal year ended September 30, 1988, is hereby incorporated by reference.)\n4.2 First Amendment, dated March 1, 1989, to Rights Agree- ment, dated as of June 1, 1988, between BFI and Texas Commerce Bank National Association. (Exhibit 10.1 of Form 10-Q for the quarter ended June 30, 1989, is hereby incorporated by reference.)\n4.3 Second Amendment, dated March 7, 1990, to Rights Agree- ment, dated as of June 1, 1988, between the Registrant and First Chicago Trust Company of New York as successor Rights Agent. (Exhibit 4.1 of Form 10-Q for the quarter ended March 31, 1990, is hereby incorporated by reference.)\n4.4 Amended and Restated Revolving Credit Agreement, dated as of September 10, 1992, among BFI and Texas Commerce Bank National Association, as Administrative Agent, and the other banks named therein. (Exhibit 4.4 of Form 10-K for the fiscal year ended September 30, 1992, is hereby incorporated by reference.)\n4.5 Restated Indenture, dated as of September 1, 1991, between First City, Texas-Houston, National Association, Trustee, and BFI. (Exhibit 4.8 of Form 10-K for the fiscal year ended September 30, 1991, is hereby incorporated by reference.)\n4.6 Indenture, dated as of August 1, 1987, between First RepublicBank Houston, National Association, Trustee, and BFI. (Exhibit 4.1 to Registration Statement on Form S-3 No. 33-16537 is hereby incorporated by reference.)\n4.7 First Supplemental Indenture, dated as of January 11, 1994, between Nations Bank of Texas, National Association, Trustee, and BFI. (Exhibit 4(f) to Registration Statement on Form S-3 No. 33-58790 is hereby incorporated by reference.)\n4.8 Indenture, dated as of July 16, 1990, between BFI and Morgan Guaranty Trust Company of New York, as Trustee. (Exhibit 4.1 of Form 10-Q for the quarter ended June 30, 1990, is hereby incorporated by reference.)\n4.9 First Supplemental Indenture, dated as of December 26, 1990, to Indenture, dated as of July 16, 1990, between BFI and Morgan Guaranty Trust Company of New York, as Trustee. (Exhibit 4.1 of Form 10-Q for the quarter ended December 31, 1990, is hereby incorporated by reference.)\n*4.10 Agreement dated September 20, 1994, between BFI Acquisition plc and Laidlaw Inc. and each of the subsidiaries of Laidlaw Inc. listed on Schedule I thereto.\n*4.11 Agreement dated September 20, 1994, between BFI and Laidlaw Inc.\n*4.12 Agreement dated September 20, 1994, among BFI Acquisitions plc, Laidlaw Inc. and Laidlaw International Investments B.V.\n4.13 Commitment Letter dated September 19, 1994, between Credit Suisse and BFI.\n10.1 Employment Agreement, dated July 10, 1989, between BFI and William D. Ruckelshaus. (Exhibit 10.3 of Form 10-K for the fiscal year ended September 30, 1989, is hereby incorporated by reference.)\n10.2 First Amendment, dated September 1, 1993, to the Employment Agreement, dated as of July 10, 1989, between BFI and William D. Ruckelshaus. (Exhibit 10 of Form 10-Q for the quarter ended December 31, 1993, is hereby incorporated by reference.)\n*10.3 Second Amendment, dated September 7, 1994, to the Employment Agreement, dated as of July 10, 1989, between BFI and William D. Ruckelshaus.\n10.4 Deferral Agreement, dated December 28, 1988, between BFI and William D. Ruckelshaus. (Exhibit 10.2 of the Form 10-Q for the quarter ended December 31, 1988, is hereby incorporated by reference.)\n10.5 Employment Agreement, dated July 10, 1989, between BFI and Harry J. Phillips, Sr. (Exhibit 10.5 of Form 10-K for the fiscal year ended September 30, 1989, is hereby incorporated by reference.)\n10.6 First Amendment, dated January 21, 1992, to the Employment Agreement, dated as of July 10, 1989, between BFI and Harry J. Phillips, Sr. (Exhibit 10.6 to Registration Statement on Form S-4 No. 33-52240 is hereby incorporated by reference.)\n10.7 Second Amendment, dated December 7, 1993, to the Employment Agreement, dated as of July 10, 1989, between BFI and Harry J. Phillips, Sr. (Exhibit 10 of the Form 10-Q for the quarter ended December 31, 1993, is hereby incorporated by reference.)\n10.8 Form of Employment Agreement between BFI and each of Norman A. Myers, Bruce E. Ranck and certain other officers and former officers (Exhibit 10.6 of Form 10-K for the fiscal year ended September 30, 1989, is hereby incorporated by reference.)\n10.9 Employment Agreement, dated as of November 1, 1991 be- tween BFI and Louis A. Waters. (Exhibit 10.7 of Form 10-K for the fiscal year ended September 30, 1991, is hereby incorporated by reference.)\n10.10 First Amendment, dated December 7, 1993, to the Employment Agreement, dated as of November 1, 1991, between BFI and Louis A. Waters. (Exhibit 10 of the Form 10-Q for the quarter ended December 31, 1993, is hereby incorporated by reference.)\n10.11 Executive Officer Form of Employment Agreement between BFI and certain executive officers, beginning in January 1993. (Exhibit 10.9 of Post-Effective Amendment No. 1 to Registration Statement on Form S-4 No. 33-52240 is hereby incorporated by reference.)\n10.12 Trust Agreement, dated September 7, 1988, between BFI and Texas Commerce Bank, National Association with Louis A. Waters as Beneficiary. (Exhibit 10.9 of Form 10-K for the fiscal year ended September 30, 1988, is hereby incorporated by reference.)\n10.13 Browning-Ferris Industries, Inc. 1993 Stock Incentive Plan. (Exhibit 4(d) to Registration Statement on Form S- 8 No. 33-53393 is hereby incorporated by reference.)\n10.14 Browning-Ferris Industries, Inc. 1993 Non-Employee Director Stock Plan (Exhibit 4(e) to Registration Statement on Form S-8 No. 33-53393 is hereby incorporated by reference.)\n10.15 Browning-Ferris Industries, Inc. 1990 Stock Option Plan. (Exhibit 10.9 of Form 10-K for the fiscal year ended September 30, 1991, is hereby incorporated by reference.)\n10.16 Browning-Ferris Industries, Inc. 1987 Stock Option Plan. (Exhibit 10.11 of Form 10-K for the fiscal year ended September 30, 1988, is hereby incorporated by refer- ence.)\n10.17 Browning-Ferris Industries, Inc. 1983 Stock Option Plan, as amended on December 2, 1986. (Exhibit 10.7 of Form 10-K for the fiscal year ended September 30, 1986, is hereby incorporated by reference.)\n*10.18 Browning-Ferris Industries, Inc.'s Cash Balance and Retirement Plan, as amended and restated pursuant to an indenture dated September 15, 1994.\n10.19 BFI Employee Stock Ownership and Savings Plan, as amend- ed through December 1, 1986. (Exhibit 10.10 of Form 10- K for the fiscal year ended September 30, 1986, is hereby incorporated by reference.)\n10.20 Fifth Amendment dated June 8, 1988, to the BFI Employee Stock Ownership and Savings Plan. (Exhibit 10.16 of Form 10-K for the fiscal year ended September 30, 1988, is hereby incorporated by reference.)\n10.21 Sixth Amendment, dated December 23, 1988, to the BFI Employee Stock Ownership and Savings Plan. (Exhibit 10.4 of the Form 10-Q for the quarter ended December 31, 1988, is hereby incorporated by reference.)\n10.22 Seventh, Eighth and Ninth Amendments, dated as of May 31, 1989, June 7, 1989 and October 31, 1991, respectively, to the BFI Employee Stock Ownership and Savings Plan. (Exhibit 10.20 of Form 10-K for the fiscal year ended September 30, 1991, is hereby incorporated by reference.)\n10.23 Tenth Amendment, dated September 7, 1993, to the BFI Employee Stock Ownership and Savings Plan. (Exhibit 10.22 of Form 10-K for the fiscal year ended September 30, 1993, is hereby incorporated by reference.)\n10.24 Amended and Restated Partnership Agreement, dated as of January 25, 1991, between Air Products Ref-Fuel, Inc. and BFI Ref-Fuel, Inc. (Exhibit 10.23 of Form 10-K for the fiscal year ended September 30, 1993, is hereby incorporated by reference.)\n*10.25 BFI Management Incentive Compensation Plan.\n10.26 Purchase and Transfer Agreement between Otto Holding International B.V., the Registrant and BFI Atlantic GmbH, dated September 27, 1993. (Exhibit 10.25 of Form 10-K for the fiscal year ended September 30, 1993, is hereby incorporated by reference.)\n*10.27 BFI Deferred Compensation Agreement.\n*10.28 BFI Convertible Annual Incentive Award Plan.\n*12 Computation of Ratio of Earnings to Fixed Charges of Browning-Ferris Industries, Inc. and Subsidiaries.\n*21 Subsidiaries of the Registrant.\n*23.1 Consent of Arthur Andersen LLP.\n*27 Financial Data Schedule.\n________________ *Filed herewith.\nReports on Form 8-K\nDuring the quarter ended September 30, 1994, the Company did not file a Current Report on Form 8-K.\n_________________\nNOTE: Upon the request of a holder of the Company's securities directed to Browning-Ferris Industries, Inc., P.O. Box 3151, Houston, Texas 77253, Attn: Secretary, the Company will furnish a copy of any exhibit for ten cents per page to cover the cost of copying and mailing. _________________\nSCHEDULE II\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nAMOUNTS RECEIVABLE FROM DIRECTORS, OFFICERS AND EMPLOYEES\nFor the Three Years Ended September 30, 1994 (Table Amounts In Thousands) - ----------------------------------------------------------------------------- Balance Balance Deductions End of Year Beginning Amounts Amounts ----------------- Interest of Coll- Written Not Rate Year Additions ected Off Current Current - ----------------------------------------------------------------------------- 1994 - W. Bestreich -- $ 256 $ -- $ 66 $ -- $ 190 (1) $ -- B. Blaisdell 12% 49 -- 49 -- -- (2) -- R. Daniels -- 115 -- -- 115 -- (3) -- D. Neukam -- 227 -- 37 -- 41 (4) 149 R. Pfeifer -- 179 -- 54 -- 60 (5) 65 M. Saleski -- 227 -- 37 -- 41 (4) 149 D. Sutherland- Yoest 6% 276 (10) 138 128 -- (6) -- ------ ------ ----- ----- ----- ---- $1,329 $ (10) $ 381 $ 243 $ 332 $363 ====== ====== ===== ===== ===== ==== 1993 - L. Appleton 8% $ 84 $ -- $ 84 $ -- $ -- (7) $ -- W. Bestreich -- -- 256 -- -- 66 (1) 190 B. Blaisdell 12% 49 -- -- -- 49 (2) -- R. Daniels -- -- 115 -- -- 41 (3) 74 D. Neukam -- -- 227 -- -- 37 (4) 190 R. Pfeifer -- -- 179 -- -- 54 (5) 125 M. Saleski -- -- 227 -- -- 37 (4) 190 D. Sutherland- Yoest 6% 295 (19) -- -- 276 (6) -- ------ ------ ----- ----- ----- ---- $ 428 $ 985 $ 84 $ -- $ 560 $769 ====== ====== ===== ===== ===== ==== 1992 - L. Appleton 8% $ 105 $ (9) $ 12 $ -- $ 84 (7) $ -- R. Berres 12% 100 -- 100 -- -- (8) -- B. Blaisdell 12% 115 -- 66 -- -- (2) 49 G. Lawrence 12% -- 165 165 -- -- (8) -- D. Sutherland- Yoest 6% 354 (33) 26 -- 295 (6) -- ------ ------ ----- ----- ------ ---- $ 674 $ 123 $ 369 $ -- $ 379 $ 49 ====== ====== ===== ===== ====== ==== ------------------ (1) Contingent on future performance of the individual, a $300,000 non- interest bearing note related to employee relocation is due in annual installments of $60,000, half of the amount to be deducted from the employee's annual incentive award and half to be forgiven by the Company. For reporting purposes, interest is imputed on these notes at 10%. These notes are secured by a lien on the employee's residence. The remaining principal balance was collected in October 1994.\n(Continued on Following Page)\nSCHEDULE II (Continued)\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nAMOUNTS RECEIVABLE FROM DIRECTORS, OFFICERS AND EMPLOYEES\nFor the Three Years Ended September 30, 1994\n(2) This note was secured by a lien on the employee's residence. The remaining principal balance was collected in October 1993.\n(3) This note, held by a majority owned subsidiary formed to pursue a market development project, was secured by a lien on the employee's residence or other property. During fiscal year 1994, this note and other amounts associated with this subsidiary were removed from the Company's books when the Company withdrew from the project.\n(4) Contingent on satisfactory future performance of the respective individual, the non-interest bearing notes related to employees' relocation are due in annual installments of $60,000, half of the amount to be deducted from the employee's annual incentive award and half to be forgiven by the Company. For reporting purposes, interest is imputed on these notes at 10%. Each note is secured by a lien on the employee's residence.\n(5) Contingent on satisfactory future performance of the respective individual, the non-interest bearing note related to employee relocation is due in annual installments of $72,091, half of the amount to be deducted from the employee's annual incentive award and half to be forgiven by the Company. For reporting purposes, interest is imputed on this note at 10%. The note is secured by a lien on the employee's residence.\n(6) A settlement agreement and mutual release between Mr. Sutherland-Yoest and the Company was entered into in January 1994. A payment was received in April 1994 and the remaining balance was written-off at that time. The foreign exchange gain\/(loss) on this note, which is denominated in Canadian dollars, has been reflected in current period additions.\n(7) This note initially in the amount of 200,000 Canadian dollars, was replaced by a note in the amount of 150,000 Canadian dollars after receipt of the first annual installment of 50,000 Canadian dollars. The foreign exchange gain\/(loss) has been reflected in 1992 additions. The remaining principal balance was collected in October 1992.\n(8) These notes were secured by liens on employees' residences or other property.\nSCHEDULE V\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nPROPERTY AND EQUIPMENT\nFor the Three Years Ended September 30, 1994 (In Thousands)\n---------------------------------------------------------------------------- Effect Additions Sales, of of Pooled Retire- Foreign Balance Addi- Companies ments Currency Balance Beginning tions Not or Trans- End of of Year at Cost Restated Transfers lation Year ---------------------------------------------------------------------------- 1994 - Land and im- provements $ 188,414 $ 41,733 $ 971 $ (1,119) $ 2,733 $ 232,732\nBuildings 328,173 93,471 274 (2,960) 6,817 425,775\nLandfills 1,313,366 192,902 -- (37,945) 4,242 1,472,565\nVehicles and equipment 2,331,094 623,370 12,688 (152,065) 32,815 2,847,902\nConstruction -in-progress 97,024 18,314(1) -- -- 2,059 117,397 ---------- -------- ------- --------- -------- ---------- $4,258,071 $969,790 $13,933 $(194,089) $ 48,666 $5,096,371 ========== ======== ======= ========= ======== ==========\n1993 - Land and im- provements $ 169,948 $ 25,477 $ 1,673 $ (5,153) $ (3,531) $ 188,414\nBuildings 298,616 35,169 4,744 (3,750) (6,606) 328,173\nLandfills 1,167,915 239,025 -- (71,111) (22,463) 1,313,366\nVehicles and equipment 2,071,946 328,643 24,718 (51,182) (43,031) 2,331,094\nConstruction -in-progress 89,976 5,825(1) -- 1,696 (473) 97,024 ---------- -------- ------- --------- -------- ---------- $3,798,401 $634,139 $31,135 $(129,500) $(76,104) $4,258,071 ========== ======== ======= ========= ======== ==========\n(Continued on Following Page)\nSCHEDULE V (Continued)\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nPROPERTY AND EQUIPMENT\nFor the Three Years Ended September 30, 1994 (In Thousands)\n----------------------------------------------------------------------------- Effect Additions Sales, of of Pooled Retire- Foreign Balance Addi- Companies ments Currency Balance Beginning tions Not or Trans- End of of Year at Cost Restated Transfers lation Year ----------------------------------------------------------------------------- 1992 - Land and im- provements $ 149,497 $ 27,495 $ -- $ (8,072) $ 1,028 $ 169,948\nBuildings 338,149 45,073 -- (88,255) 3,649 298,616\nLandfills 987,791 182,761 -- (2,806) 169 1,167,915\nVehicles and equipment 1,862,791 266,448 -- (62,406) 5,113 2,071,946\nConstruction -in-progress 97,453 (7,634)(1) -- (27) 184 89,976 ---------- -------- ------ --------- ------- ---------- $3,435,681 $514,143 $ -- $(161,566) $10,143 $3,798,401 ========== ======== ====== ========= ======= ==========\n- ---------------------\n(1) Represents net change during the period.\nSCHEDULE VI\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT\nFor the Three Years Ended September 30, 1994 (In Thousands)\n- ------------------------------------------------------------------------------ Effect Additions Sales, of Additions of Pooled Retire- Foreign Balance Charged Companies ments Currency Balance Beginning to Not or Trans- End of of Year Income Restated Transfers lation Year - ------------------------------------------------------------------------------ 1994 -\nLand and im- provements $ 17,934 $ 4,390 $ -- $ (355) $ 64 $ 22,033\nBuildings 80,989 17,668 175 (1,447) 467 97,852\nLandfills 360,247 118,101 189 (21,303) 832 458,066\nVehicles and equipment 1,283,192 256,269 9,381 (87,685) 7,496 1,468,653 ----------- -------- ------- --------- -------- ---------- $1,742,362 $396,428 $ 9,745 $(110,790) $ 8,859 $2,046,604 ========== ======== ======= ========= ======== ==========\nLand and im- provements $ 15,263 $ 3,309 $ -- $ (527) $ (111) $ 17,934\nBuildings 68,517 14,948 1,459 (2,807) (1,128) 80,989\nLandfills 314,809 87,129 -- (37,900) (3,791) 360,247\nVehicles and equipment 1,136,159 212,628 13,429 (62,696) (16,328) 1,283,192 ---------- -------- ------- --------- -------- ---------- $1,534,748 $318,014 $14,888 $(103,930) $(21,358) $1,742,362 ========== ======== ======= ========= ======== ==========\n(Continued on Following Page)\nSCHEDULE VI (Continued)\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT\nFor the Three Years Ended September 30, 1994 (In Thousands)\n- ------------------------------------------------------------------------------ Effect Additions Sales, of Additions of Pooled Retire- Foreign Balance Charged Companies ments Currency Balance Beginning to Not or Trans- End of of Year Income Restated Transfers lation Year - ------------------------------------------------------------------------------ 1992 -\nLand and im- provements $ 12,815 $ 2,914 $ -- $ (460) $ (6) $ 15,263\nBuildings 66,926 15,304 -- (14,063) 350 68,517\nLandfills 244,899 82,099 -- (12,340) 151 314,809\nVehicles and equipment 970,838 217,424 -- (52,366) 263 1,136,159 ---------- -------- ------- --------- -------- ---------- $1,295,478 $317,741 $ -- $ (79,229) $ 758 $1,534,748 ========== ======== ======= ========= ======== ==========\n- ----------------- For financial reporting purposes, depreciation is computed on the straight-line method based upon the estimated useful lives of the assets as follows: buildings, 20 to 40 years, and vehicles and equipment, 3 to 12 years. Landfill costs include expenditures for land and related airspace, permitting costs and preparation costs. These landfill costs, excluding the estimated residual value of land, are typically amortized as permitted airspace of the landfill is consumed.\nSCHEDULE VIII\nBROWNING-FERRIS INDUSTRIES, INC. AND SUBSIDIARIES\nALLOWANCE FOR DOUBTFUL ACCOUNTS\nFor the Three Years Ended September 30, 1994 (In Thousands)\n------------------------------------------------------------------------ Additions Balance Charged Deductions Balance Beginning to from End of of Year Income Reserves Year ------------------------------------------------------------------------ 1994 $21,870 $31,346 $(19,932) $33,284\n1993 $16,172 $18,657 $(12,959) $21,870\n1992 $17,858 $17,944 $(19,630) $16,172\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBROWNING-FERRIS INDUSTRIES, INC. (Registrant)\nDATE: November 30, 1994 By: \/s\/ William D. Ruckelshaus William D. Ruckelshaus Chairman of the Board, 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 date indicated.\n\/s\/ William D. Ruckelshaus William D. Ruckelshaus Chairman of the Board, Chief Executive Officer and Director\n\/s\/ Norman A. Myers Norman A. Myers, Vice Chairman, Chief Marketing Officer and Director\n\/s\/ Bruce E. Ranck Bruce E. Ranck, President, Chief Operating Officer and Director\n\/s\/ Jeffrey E. Curtiss Jeffrey E. Curtiss, Senior Vice President and Chief Financial Officer\n\/s\/ David R. Hopkins David R. Hopkins, Vice President, Controller and Chief Accounting Officer\n\/s\/ William T. Butler William T. Butler, Director\n\/s\/ C. Jackson Grayson, Jr. C. Jackson Grayson, Jr., Director\n\/s\/ Gerald Grinstein Gerald Grinstein, Director\n\/s\/ Ulrich Otto Ulrich Otto, Director\n\/s\/ Harry J. Phillips, Sr. Harry J. Phillips, Sr., Director\n\/s\/ Joseph L. Roberts, Jr. Joseph L. Roberts, Jr., Director\n\/s\/ Marc J. Shapiro Marc J. Shapiro, Director\n\/s\/ Robert M. Teeter Robert M. Teeter, Director\n\/s\/ Louis A. Waters Louis A. Waters, Director\n\/s\/ Marina v.N. Whitman Marina v.N. Whitman, Director\n\/s\/ Peter S. Willmott Peter S. Willmott, Director\nNovember 30, 1994.","section_15":""}
{"filename":"750274_1994.txt","cik":"750274","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral\nBuffets, Inc., a Minnesota corporation, was organized in 1983. Its executive offices are located at 10260 Viking Drive, Eden Prairie, Minnesota 55344. References herein to the \"Company\" are to Buffets, Inc. and its subsidiaries, Evergreen Buffets Inc., OCB Restaurant Co., OCB Realty Co., OCB Purchasing Co., OCB Property Co., Texas Buffets, Inc. (until it merged into OCB Restaurant Co. in July 1994), and Southland Buffets, Inc. (until its merger into the Company in May 1992), unless the context indicates otherwise.\nThe Company is principally engaged in the development and operation of \"buffet\" restaurants under the name \"Old Country Buffet\" (\"Country Buffet\" in the state of Colorado). The Company obtained a federal trademark registration covering the words \"Old Country Buffet\" in June of 1985.\nThe Company presently operates 225 company-owned restaurants in 31 states (including 17 opened since year end). The Company contemplates that approximately 35 to 40 Company-owned restaurants will be opened in 1995. In addition, six franchised Old Country Buffet restaurants are in operation in Nebraska and Oklahoma.\nThe Company's restaurants offer a wide variety of freshly prepared menu items, including soups, salads, entrees, vegetables, non-alcoholic beverages and desserts, presented in a self-service buffet format in which customers select the items and portions of their choice. The restaurants' typical dinner entrees include chicken, carved roast beef and ham, and two or three other hot entrees such as casseroles, shrimp and fish. Chicken, fish and two or three other entrees usually are offered at lunch. The Company's restaurants utilize uniform menus, recipes and ingredient specifications, except for certain variations adopted in response to regional preferences.\nThe Company's restaurants range in size from approximately 8,000 to 13,850 square feet, seat from 260 to 390 people, and generally include areas that can be partitioned to accommodate private meetings and group outings. The decor is attractive and informal. To date, the Company has located its restaurants primarily within or adjacent to strip or neighborhood shopping centers. The Company's restaurants generally are open from 11:00 a.m. to 8:00 p.m. or 9:00 p.m. A majority of the Company's restaurants also serve breakfast from 8:00 a.m. to 11:00 a.m. on weekends.\nScatter System Format\nMenu items generally are presented to diners using a \"scatter system\" rather than a conventional straight buffet serving line. Under the scatter system, six to eight separate food islands or counters are used to present various courses of each meal to diners (for example, salads on one island, desserts on another), with diners able to proceed directly to those islands presenting the menu items they desire at the time. The scatter system promotes easier food access and has helped reduce the long lines that often occurred during peak hours in the Company's restaurants utilizing the conventional straight-line serving format. The scatter system was introduced by the Company in August 1989 and has been utilized in all of its restaurants developed since March 1990. In addition, because of the success of the scatter system, the Company pursued a remodeling program from February 1990 through 1994 with the goal of converting substantially all of its 71 then-existing restaurants from the conventional straight-line format to the scatter system. To date, the Company's experience with converted restaurants indicates that these restaurants generally achieve higher sales following conversion.\nSmall Batch Preparation\nTo ensure freshness, hot foods and bakery items are prepared repeatedly throughout the day in relatively small batches. Restaurant managers closely monitor the servicing area for the quality and availability of all items. The Company believes the freshness achieved through small batch preparation contributes significantly to the high quality of its food.\nAll-Inclusive Price\nThe Company's restaurants currently charge, depending on the market area, $4.99 to $5.79 for lunch Monday through Saturday and $6.49 to $7.59 for dinner Monday through Sunday. On Saturday and Sunday, certain restaurants serve breakfast at prices ranging from $4.99 to $5.99. Reduced prices are available to senior citizens who purchase an annual senior club card for $1.00 per year and to children under the age of ten or twelve depending on the market area. Children's prices for all meals are $.35 to $.55 per year of their age from two through ten or twelve. Customers pay prior to entering the dining area and are assisted to tables by restaurant employees. They may return for second helpings and additional beverages and desserts without additional charge.\nRestaurant Operations and Controls\nGENERAL. In order to maintain a consistently high level of food quality and service in all of its restaurants, the Company has established uniform operational standards which are implemented by the managers of each restaurant. All restaurants are required to be operated in accordance with rigorous standards and specifications relating to the quality of ingredients, preparation of food, maintenance of premises and employee conduct.\nMENU SELECTION AND PURCHASING. Headquarters personnel prepare and periodically revise standard recipes and menus and a list of approved ingredients and supplies based upon the quality, availability, cost and customer acceptance of various menu items. Food quality is maintained through centralized coordination with suppliers and frequent restaurant visits by district managers and other management personnel.\nThe Company purchases its food and beverage inventories and restaurant supplies from independent suppliers approved by headquarters personnel, who negotiate quality specifications, delivery schedules and pricing and payment terms (typically 28 days) directly with the suppliers. Although all supplier invoices are paid from Company headquarters, restaurant managers place orders for inventories and supplies with, and receive shipments directly from, suppliers. Restaurant managers approve invoices before forwarding them to Company headquarters for payment. To date, the Company has not experienced any difficulties in obtaining food and beverage inventories or restaurant supplies, and the Company does not anticipate that any material difficulties will develop in the foreseeable future.\nRESTAURANT MANAGEMENT. Each restaurant typically employs a general manager, an associate general manager, and one to three assistant managers. Each of the Company's restaurant general managers has primary responsibility for day-to-day operations in one of the Company's restaurants, including customer relations, food service, cost controls, restaurant maintenance, personnel relations, implementation of Company policies and the restaurant's profitability. A substantial portion of each general manager's and associate general manager's compensation depends directly on the restaurant's profitability. In addition, restaurant managers receive stock options under the Company's current stock option program entitling them to acquire an equity interest in the Company. The Company believes that its compensation policies have been important in attracting, motivating and retaining qualified operating personnel.\nEach restaurant general manager reports to a district manager, each of whom in turn reports to a regional director (currently six persons). Each regional director reports to the Company's Executive Vice President of Operations.\nThe Company maintains centralized financial and accounting controls for its restaurants. On a daily basis, restaurant managers forward customer counts, sales, labor costs and deposit information to Company headquarters. On a weekly basis, restaurant managers forward a summarized profit and loss statement, sales report, and supplier invoices. Payroll data is forwarded every two weeks.\nMANAGEMENT TRAINING. All new managers are required to complete an extensive nine-week training program which focuses on the operating skills and management functions necessary to successfully manage an Old Country Buffet restaurant. This training is broken down into three phases. Phase one starts the program with the first two weeks spent in a Company restaurant learning skills needed for hourly positions. Phase two, the next four weeks of the program, is conducted at the Company's training center located in Eden Prairie, Minnesota. At the training center, managers-in-training participate in a series of seminars designed to further develop skills in food production, personnel management, and professional development. Phase three, the remaining three weeks of training, is spent in a Company restaurant using the management and operational skills learned at the training center under actual restaurant conditions. Training and development of managers continues beyond the first nine weeks. Managers continue to phase four, a self paced training program designed to further develop their proficiency in management supervisory skills. Before a manager is promoted to General Manager the phase four program must be completed. The Company currently requires all new managers to have at least two years' prior management experience or the equivalent in education.\nFranchising and Joint Ventures\nThere currently are six franchised Old Country Buffet restaurants in Nebraska and Oklahoma, owned by two franchisees. The Company's franchise agreements generally have initial terms of 15 years and require the franchisee to pay an initial fee of $25,000 and continuing royalties equal to four percent of the franchisee's sales. The Company has an agreement with each franchisee whereby the Company has options exercisable at various times over the next several years to repurchase the Old Country Buffet restaurants developed by such franchisee at a predetermined formula price based principally on restaurant gross sales.\nThe Company has taken advantage of joint venture opportunities from time to time, principally as a means of entering new geographic markets. The Company currently has only one 90%-owned joint venture subsidiary, developing and operating Old Country Buffet restaurants in Washington and Oregon (established in November 1988). Similar to the Company's repurchase options with its franchisees, the Company has included a mechanism for repurchasing the minority interest in its existing joint venture subsidiary at a predetermined formula price based principally on restaurant gross sales.\nThe Company at present is not actively seeking to grant additional franchises or enter into additional joint ventures.\nCompetition\nThe food service industry is highly competitive. Menu, price, service, convenience, location and ambience are all important competitive factors, with the relative importance of many such factors varying among different segments of the consuming public.\nBy providing a wide variety of food and beverages at reasonable prices in an attractive and informal environment, the Company seeks to appeal to a broad range of value-oriented consumers. The Company believes that its primary competitors in this market segment are other buffet and cafeteria restaurants, and traditional casual dining restaurants with full menus and table service. The Company believes that its success to date has been due to its particular approach combining pleasant ambience, high food quality, breadth of menu, cleanliness and reasonable prices with satisfactory levels of service and convenience.\nThe Company believes its sales may be somewhat seasonal, with a lower percentage of annual sales occurring in most of its current market areas during the winter months.\nAdvertising and Promotion\nTo date the Company has relied primarily on customers' word-of-mouth recommendations to promote its business. As a result, prior to 1993, annual advertising costs never exceeded 1.1% of restaurant sales, such costs being incurred primarily for menu cards, brochures and a limited amount of local newspaper, radio and television advertising. Based on favorable results, the Company increased its rate of expenditures on advertising to 1.4% of restaurant sales in 1993, primarily for increased radio and television advertising. The Company lowered its spending to 1.3% in 1994 due to the decision in the fourth quarter to spend those dollars in food and labor to better serve the guest. The Company expects to spend approximately 1.0% on advertising in 1995. The Company is prepared to increase its advertising expenditures in the future if it determines that further increases are likely to generate sufficient additional revenues. The Company believes its senior citizen discount program has encouraged many senior citizens to eat at the Company's restaurants.\nRegulation\nThe Company's restaurants must be constructed to meet federal, state and local building and zoning requirements and must be operated in accordance with state and local regulations relating to the preparation and serving of food. The Company is also subject to various federal and state labor laws which govern its relationships with its employees, including those relating to minimum wages, overtime and other working conditions. Environmental regulations have not had a material effect on the operations of the Company. The Company to date has been successful in obtaining all necessary permits and licenses and complying with applicable regulations, and does not expect to encounter any material difficulties in the future with respect to these matters.\nTrademarks\nIn June 1985, the Company obtained a federal trademark registration covering the words \"Old Country Buffet.\" The Company has subsequently obtained trademark protection for additional marks used in its business. Generally, federal registration of a trademark gives the registrant the exclusive use of the trademark in the United States in connection with the goods or services associated with the trademark, subject to the common law rights of any other person who began using the trademark (or a confusingly similar mark) prior to the date of federal registration. Because of the common law rights of such a pre-existing restaurant in certain portions of Colorado, the Company's restaurants in that state use the name \"Country Buffet.\" The Company intends to take appropriate steps to develop and protect its marks.\nEmployees\nAs of March 8, 1995, the Company employed approximately 15,915 persons, including 915 supervisory and administrative, 250 managerial, and 14,750 restaurant employees. Approximately 75% of the Company's restaurant employees work part-time. Relations with employees have been satisfactory and no work stoppages due to labor disputes have occurred. The Company anticipates that its work force will increase by more than 15% by the end of 1995.\nRestaurant Development\nGENERAL. The Company opened 34 restaurants in 1994 and expects to open approximately 35 to 40 restaurants in 1995, of which 17 were open as of March 20, 1995. The Company intends to pursue expansion during 1995 in both existing and new markets.\nThe ability of the Company to open new restaurants depends on a number of factors, including its ability to find suitable locations and negotiate acceptable leases and land purchases, its ability to attract and retain a sufficient number of qualified restaurant managers, and the availability of capital. The Company actively and continuously attempts to identify and negotiate leases and land purchases for additional new locations, and expects that it will be able to achieve its intended development schedule for 1995, though there is no assurance that this will be the case.\nGEOGRAPHIC EXPANSION STRATEGY. The Company initially concentrated its restaurant development in the Midwest, and then after several years expanded to other regions of the country. The Company currently operates in 31 states and opened its first restaurants in Kentucky, New Jersey and North Carolina during 1994. The Company attempts to cluster its restaurants in geographic areas to achieve economies of scale in costs of supervision, marketing and purchasing.\nSITE SELECTION CRITERIA. The primary criteria considered by the Company in selecting new locations are a high level of customer traffic, convenience to both lunch and dinner customers in demographic groups (such as families and senior citizens) that tend to favor the Company's restaurants, and the occupancy cost of the proposed restaurant. The Company has found that these criteria frequently are satisfied by well-located strip shopping centers that benefit from cotenancy with strong national retailers and visibility to high traffic roads. All but 35 of the Company's current restaurants are located in such centers. Twenty of the other 35 restaurants are located in regional or other enclosed shopping malls and fifteen are located in free-standing structures. The Company anticipates that free-standing locations will likely comprise a larger percentage of its new restaurants in the future. The Company typically requires a population density of at least 100,000 within five miles of each new location, and currently is concentrating its development efforts on urban areas that can accommodate a number of Company restaurants. Because an Old Country Buffet restaurant typically draws a significant volume of customers and because of the Company's financial strength, the Company often has been able to negotiate favorable lease terms.\nRESTAURANT CONSTRUCTION. In an effort to better control costs and improve quality, the Company is closely involved in the construction of its restaurants, and also in the acquisition and installation of fixtures and equipment. The Company acts as its own general contractor, using restaurant designs prepared by the Company's own architectural staff. The Company normally satisfies the equipment and other restaurant supply needs of its new restaurants from inventory acquired directly from manufacturers and stored at the Company's warehouse in Eden Prairie, Minnesota. Restaurants located in shopping centers typically open approximately 11 weeks after construction begins, while free-standing restaurants typically open approximately 17 weeks after construction begins. The average cost to develop an Old Country Buffet restaurant located in a shopping center during fiscal 1994 was approximately $615,000 for leasehold improvements (net of landlord contributions); and approximately $644,000 for equipment and furnishings. Free-standing owned restaurants developed in 1994 and the first part of 1995 entailed an average land cost of $606,000 and a projected average building cost of $1,200,000. It is expected the increased development of free-standing restaurants will increase the average cost per unit and associated capital requirements in 1995.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices are located in approximately 30,000 square feet of leased space in Eden Prairie, Minnesota, for a term ending October 31, 1997. The Company also leases a 22,200 square foot warehouse and training center in Eden Prairie, Minnesota for a term ending January 31, 1997. The Company owns a 72,000 square foot facility in Marshfield, Wisconsin which it utilizes for the fabrication of cabinetry and fixtures for restaurants.\nMost of the Company's restaurants are located in leased facilities, although land purchases for free-standing restaurants are increasingly being relied upon in instances where more competitive locations can be acquired. Fifteen restaurants are located in free-standing buildings, 20 are located in regional or other enclosed shopping malls, and the rest are located in strip or neighborhood shopping centers. Most of the leases provide for a minimum annual rent and additional rent calculated as a percentage of restaurant sales, generally 3% to 5%, if the rents so calculated exceed the minimum. The initial terms of the Company's leases generally range from ten to fifteen years, and the leases usually have renewal options for additional five to ten year periods.\nThe Company owns substantially all of the equipment, furniture and fixtures in its restaurants. Leasehold improvements made by the Company in leased premises usually become the property of the landlord upon expiration or termination of the lease. To date, most of the Company's strip mall landlords have agreed to bear a portion of the cost of leasehold improvements by way of either rent concessions or cash contributions.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIN RE BUFFETS, INC. SECURITIES LITIGATION, United States District Court for the District of Minnesota, Master No. 3-94-1447. This action is a consolidation of four separate lawsuits. The first lawsuit was commenced by ZSA Asset Allocation Fund and ZSA Equity Fund on or about November 7, 1994. Three other substantially similar actions were filed shortly thereafter by alleged shareholders Marc Kushner, Trustee for Service Lamp Corp. Profit Sharing Plan, Jerrine Fernandes, and John J. Nuttall. By Pretrial Order No. 1, entered in early January 1995, the District Court ordered that the four lawsuits be consolidated into the single pending action and that plaintiffs serve and file a Consolidated Amended Class Action Complaint (the \"Complaint\"), which was served on or about January 31, 1995. The Complaint is against the Company and several of its officers and directors. In the Complaint, plaintiffs seek to represent a putative class consisting of all persons and entities (excluding defendants and certain others) who purchased shares of the Company's Common Stock during the period commencing October 26, 1993 and ending October 25, 1994 (the \"Class Period\").\nThe Complaint alleges that the defendants made misrepresentations and omissions of material fact during the Class Period with respect to the Company's operations and restaurant development activities, as a result of which the price of the Company's stock allegedly was artificially inflated during the Class Period. The Complaint further alleges that certain defendents made sales of Common Stock of the Company during the Class Period while in possession of material undisclosed information about the Company's operations and restaurant development activities. The Complaint alleges that the defendents' conduct violated the Securities Exchange Act of 1934 and seeks compensatory damages in an unspecified amount, prejudgment interest, and an award of attorneys' fees, costs and expenses. On March 14, 1995 the defendents filed a joint motion to dismiss the Complaint. This motion will be briefed by the parties and is scheduled to be definitively submitted to the Court on or about May 1, 1995 for its decision. Management of the Company believes that\nthe action is without merit and intends to defend it vigorously. Although the outcome of this proceeding cannot be predicted with certainty, the Company's management believes that while the outcome may have a material effect on earnings in a particular period, the outcome should not have a material effect on the financial condition of the Company.\nFrom time to time, the Company is involved in litigation relating to claims arising from its operations in the normal course of business. Neither the Company nor any of its subsidiaries is currently a party to any legal proceedings the adverse outcome of which would, in management's opinion, have a material adverse effect on the Company's results of operations or 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 of the Company during the fourth quarter of the fiscal year covered by this report.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe executive officers are elected annually by the Board of Directors to serve until the next annual meeting of the Board. The following table contains information regarding the present executive officers, and all persons chosen to become executive officers, of the Company.\nExecutive Principal Occupation and Officer Business Experience Name and Age Since For Last Five Years ------------------------------------------------------------------------------- Roe H. Hatlen (51) 1983 Founder and Chairman and Chief Executive Officer of the Company since December 1983; President of the Company, May 1989 to August 1992; Treasurer of the Company, November 1983 to May 1986.\nClark C. Grant (43) 1986 Executive Vice President of Finance and Administration since December 1994 and Treasurer of the Company since May 1986; Vice President of Finance of the Company, January 1991 to December 1994; Controller of the Company, July 1984 to April 1989.\nCraig V. Abraham (39) 1991 Vice President of Construction of the Company since January 1991; Director of Development of the Company, July 1986 to January 1991; Construction Supervisor of the Company, April 1985 to July 1986.\nExecutive Principal Occupation and Officer Business Experience Name and Age Since For Last Five Years ------------------------------------------------------------------------------- Jean C. Rostollan (43) 1991 Executive Vice President of Purchasing since December 1994 and Assistant Secretary of the Company since February 1992; Vice President of Purchasing and Distribution of the Company, September 1992 to December 1994; Vice President of Purchasing and Marketing of the Company, January 1991 to August 1992; Director of Purchasing and Marketing of the Company, June 1987 to January 1991; Director of Purchasing of the Company, October 1986 to June 1987.\nRick H. White (37) 1993 Executive Vice President of Operations of the Company since December 1994; Vice President of Operations of the Company, September 1992 to December 1994; Regional Director of the Company, October 1990 to August 1992; District Manager of the Company, February 1988 to September 1990; Restaurant General Manager of the Company, January 1986 to February 1988.\nMarguerite C. Nesset (38) 1994 Vice President of Accounting since July 1994 and Controller of the Company since April 1989; Assistant Controller of the Company, April 1987 to April 1989.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information set forth under the caption \"Market for the Company's Common Stock and Related Stockholder Matters\" on page 19 of the 1994 Annual Report is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe information set forth under the caption, \"Selected Consolidated Financial Data\" on page 4 of the 1994 Annual Report is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nThe information set forth under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on pages 5 through 8 of the Company's 1994 Annual Report is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required under this Item 8 is incorporated herein by reference to pages 9 through 19 of the Company's 1994 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.\nIncorporated herein by reference to the sections captioned \"Number and Election of Directors\", and \"Certain Information Regarding Board of Directors of the Company\" in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended December 28, 1994. For information concerning executive officers, see Item 4A of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nIncorporated herein by reference to the section captioned \"Compensation of Executive Officers\" in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended December 28, 1994; provided, however, that the subsection thereof entitled \"Compensation Committee Report on Executive Compensation\" is not incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nIncorporated herein by reference to the similarly captioned section in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended December 28, 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) The following documents are filed as part of this Report.\n1. Financial Statements\nConsolidated Balance Sheets at December 29, 1993 and December 28, 1994*\nConsolidated Statements of Earnings for the Years Ended December 30, 1992, December 29, 1993 and December 28, 1994*\nConsolidated Statements of Stockholders' Equity for the Years Ended December 30, 1992, December 29, 1993, and December 28, 1994*\nConsolidated Statements of Cash Flows for the Years Ended December 30, 1992, December 29, 1993, and December 28, 1994*\nNotes to Consolidated Financial Statements*\nIndependent Auditors' Report*\n-------------------------\n*Incorporated herein by reference to pages 9 through 19 of the Company's 1994 Annual Report\n2. Supplemental Financial Schedules\nNone\n3. Exhibits\n3 (a) Composite Amended and Restated Articles of Incorporation (1)\n3 (b) By-laws of the Company (2)\n10(a) 1985 Stock Option Plan (3)*\n10(b) 1988 Stock Option Plan (4)*\n10(c) Amended and Restated Credit Agreement by and between First Bank National Association and the Company dated as of April 16, 1993 (1)\n10(d) Amendment No. 1 to Amended and Restated Credit Agreement dated as of June 29, 1993 between the Company and First Bank National Association (5)\n10(e) Letter dated July 8, 1993 from First Bank National Association to the Company amending Amended and Restated Credit Agreement (5)\n10(f) Amendment No. 2 to Amended and Restated Credit Agreement dated as of March 24, 1994 between the Company and First Bank National Association (6)\n10(g) Amendment No. 3 to Amended and Restated Credit Agreement dated as of April 8, 1994 between the Company and First Bank National Association (6)\n10(h) Amendment No. 4 to Amended and Restated Credit Agreement dated as of June 30, 1994 between the Company and First Bank National Association (7)\n10(i) Separation Agreement and Release dated March 2, 1995 between the Company and Joseph A. Conti, Sr.*\n11 Statement Regarding Computation of Per Share Earnings\n13 Annual Report to Shareholders for the fiscal year ended December 28, 1994\n21 Subsidiaries of the Company\n23 Consent of Deloitte & Touche, LLP March 23, 1995\n27 Financial Data Schedule\n*Management contract or compensatory plan or arrangement required to be filed pursuant Item 14(c) of Form 10-K.\n------------------------------- (1) Incorporated by reference to Exhibits to the Registration Statement on Form S-3 dated June 2, 1993 (Registration No. 33-63694.)\n(2) Incorporated by reference to Exhibits to Annual Report on Form 10-K for fiscal year ended December 29, 1993.\n(3) Incorporated by reference to Exhibits to the Registration Statement on Form S-1 of the Company, File No. 33-171.\n(4) Incorporated by reference to Exhibits to Annual Report on Form 10-K for fiscal year ended December 30, 1992.\n(5) Incorporated by reference to Exhibits to the Quarterly Report on Form 10-Q for the quarter ended July 14, 1993.\n(6) Incorporated by reference to Exhibits to the Quarterly Report on Form 10-Q for the quarter ended April 20, 1994.\n(7) Incorporated by reference to Exhibits to the Quarterly Report on Form 10-Q for the quarter ended July 13, 1994.\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.\nANNUAL REPORT AND PROXY STATEMENT\nWith the exception of the matters specifically incorporated herein by reference to the Company's 1994 Annual Report to Shareholders or to the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on May 9, 1995, no other portions of such 1994 Annual Report to Shareholders or Proxy Statement are deemed to be filed as part of 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.\nBuffets, Inc.\nMARCH 23, 1995 By \/s\/ Roe H. Hatlen ----------------- Date Roe H. Hatlen 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 CAPACITY DATE\n\/s\/ Roe H. Hatlen Chairman of the Board March 23, 1995 ------------------------ and Chief Executive -------------- Roe H. Hatlen Officer, (Principal Executive Officer)\n\/s\/ Clark C. Grant Executive Vice President March 23, 1995 ------------------------ of Finance and -------------- Clark C. Grant Administration and Treasurer, (Principal Financial Officer)\n\/s\/ Marguerite C. Nesset Vice President and March 23, 1995 ------------------------ Controller (Principal -------------- Marguerite C. Nesset Accounting Officer)\n\/s\/ Alan S. McDowell Director March 23, 1995 ------------------------ -------------- Alan S. McDowell\n\/s\/ Raymond A. Lipkin Director March 23, 1995 ------------------------ -------------- Raymond A. Lipkin\n\/s\/ Keith H. Erickson Director March 23, 1995 ------------------------ -------------- Keith H. Erickson\n\/s\/ David Michael Winton Director March 23, 1995 ------------------------ -------------- David Michael Winton\nEXHIBIT INDEX\nExhibits Page -------- ---- 3 (a) Composite Amended and Restated Articles of Incorporation (1)\n3 (b) By-laws of the Company (2)\n10(a) 1985 Stock Option Plan (3)\n10(b) 1988 Stock Option Plan (4)\n10(c) Amended and Restated Credit Agreement by and between First Bank National Association and the Company dated as of April 16, 1993 (1).\n10(d) Amendment No. 1 to Amended and Restated Credit Agreement dated as of June 29, 1993 between the Company and First Bank National Association (5).\n10(e) Letter dated July 8, 1993 from First Bank National Association to the Company amending Amended and Restated Credit Agreement (5).\n10(f) Amendment No. 2 to Amended and Restated Credit Agreement dated as of March 24, 1994 between the Company and First Bank National Association (6).\n10(g) Amendment No. 3 to Amended and Restated Credit Agreement dated as of April 8, 1994 between the Company and First Bank National Association (6).\n10(h) Amendment No.4 to Amended and Restated Credit Agreement dated as of June 30, 1994 between the Company and First Bank National Association (7).\n10(i) Separation Agreement and Release dated March 2, 1995 between the Company and Joseph A. Conti, Sr..............................\n11 Statement Regarding Computation of Per Share Earnings...................................\n13 Annual Report to Shareholders for the fiscal year ended December 28, 1994..........................\n21 Subsidiaries of the Company......................\n23 Consent of Deloitte & Touche, LLP ...............\n27 Financial Data Schedule .........................\n-------------------- (1) Incorporated by reference to Exhibits to the Registration Statement on Form S-3 dated June 2, 1993 (Registration No. 33-63694.)\n(2) Incorporated by reference to Exhibits to Annual Report on Form 10-K for fiscal year ended December 29, 1993.\n(3) Incorporated by reference to Exhibits to the Registration Statement on Form S-1 of the Company, File No. 33-171.\n(4) Incorporated by reference to Exhibits to Annual Report on Form 10-K for fiscal year ended December 30, 1992.\n(5) Incorporated by reference to Exhibits to Quarterly Report on Form 10-Q for the quarter ended July 14, 1993.\n(6) Incorporated by reference to Exhibits to Quarterly Report on Form 10-Q for the quarter ended April 20, 1994.\n(7) Incorporated by reference to Exhibits to Quarterly Report on Form 10-Q for the quarter ended July 13, 1994.","section_15":""}
{"filename":"6176_1994.txt","cik":"6176","year":"1994","section_1":"ITEM 1 - BUSINESS - -----------------\n(a) GENERAL DEVELOPMENT OF BUSINESS\nAmpco-Pittsburgh Corporation (the \"Corporation\") was incorporated in Pennsylvania in 1929. The Corporation currently operates four businesses which manufacture engineered equipment: Buffalo Pumps, Inc. and Aerofin Corporation, acquired in 1981, headquartered in North Tonawanda, New York and Lynchburg, Virginia, respectively, and Union Electric Steel Corporation and New Castle Industries, Inc., acquired in 1984, headquartered in Carnegie and New Castle, Pennsylvania, respectively.\nIn 1993, Amersham International plc acquired United States Biochemical Corporation, a small private company in which the Corporation owned a 20% interest. As a result of that transaction, the Corporation received cash and stock of Amersham. In 1994, the Corporation sold most of its investment in Amersham. It also sold a portion of its investment in Northwestern Steel and Wire Company and currently owns approximately 3.5% of that company.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe sales and operating profit of the Corporation's only segment and the identifiable assets attributable to it for the three years ended December 31, 1994 are set forth in Note 16 (Business Segment Information) on p. 15 of the accompanying Annual Report which is incorporated herein by reference.\n(c) NARRATIVE DESCRIPTION OF BUSINESS\nThe Corporation produces finned tube heat exchange coils and pumps for the construction, electric utility, refrigeration, chemical processing and marine defense industries, feed screws and other machine parts for the plastics industry and forged hardened steel rolls for producers of cold rolled steel,\naluminum and other metals. These products are heavily dependent on engineering, principally custom designed and are sold to sophisticated commercial and industrial users in the United States and, to a lesser extent, in foreign countries.\nNo one customer's purchases were material to the Corporation. Contracts that may be subject to renegotiation or termination are not material to the Corporation. The Corporation's business is not seasonal but is subject to the cyclical nature of the industries and markets served. For additional information on the products produced and financial information about the business, see pp. 2 through 4 and Note 16 on p. 15 of the accompanying Annual Report which are incorporated herein by reference.\nRaw Materials -------------\nRaw materials are generally available from many sources and the Corporation is not dependent upon any single supplier for any raw material. Certain of the raw materials used by the Corporation have historically been subject to variations in price. The Corporation generally does not purchase or arrange for the purchase of raw materials significantly in advance of the time it requires them.\nPatents -------\nWhile the Corporation holds some patents, trademarks and licenses, in the opinion of management they are not material to the Corporation's business other than in protecting the goodwill associated with the names under which its products are sold.\nWorking Capital ---------------\nThe Corporation maintains levels of inventory, which generally reflect its normal requirements and are believed to reflect the practices of its\nindustries. Production is generally to custom order and requires inventory levels of raw materials or semi-finished products with only a limited level of finished products.\nBacklog -------\nThe backlog of orders at December 31, 1994 was approximately $70,200,000 compared to a backlog of $56,300,000 at year end 1993. Most of those orders are expected to be filled in 1995.\nCompetition -----------\nThe Corporation faces considerable competition from a large number of companies. The Corporation believes, however, that it is a significant factor in each of the principal markets which it serves.\nBuffalo Pumps, Inc. produces a line of centrifugal pumps and competes with many other producers. Aerofin Corporation produces finned tube heat exchange coils and competes in commercial and industrial markets with a broad product line. There are several major competitors in these markets. Union Electric Steel Corporation is considered the largest producer of forged hardened steel rolls in the United States. In addition to several domestic competitors, European and Japanese manufacturers also compete in both the domestic and foreign markets. New Castle Industries primarily produces feed screws and other machine parts for use in the plastics industry and competes with a number of small regional companies. Competition in all of the Corporation's businesses is based on quality, service, price and delivery.\nResearch and Development ------------------------\nThe Corporation operates in mature industries and does not expend material amounts for research and development. The activities that are undertaken are primarily designed to improve existing products, reduce costs and adapt products to specific customer requirements.\nEnvironmental Protection Compliance Costs -----------------------------------------\nExpenditures for environmental control matters were not material in 1994 and such expenditures in 1995 are not expected to be material. However, with increasing regulatory activity, such expenditures may increase.\nEmployees ---------\nIn December, 1994, the Corporation had 955 employees, of whom 318 were sales, executive, administrative, engineering and clerical personnel. All production and craft employees are covered by negotiated labor agreements with various unions.\n(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nThe Corporation's only foreign operation is a manufacturing plant located in Belgium that principally serves the European markets. For financial information relating to foreign and domestic operations see Note 16 (Business Segment Information) on p. 15 of the accompanying Annual Report which is incorporated herein by reference.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES - -------------------\nThe Corporation is in one segment that produces engineered products. The location and general character of the principal locations, all of which are owned, are as follows:\n- ----------\n(1) The Corporation holds properties of discontinued operations for sale in Monaca and Coraopolis, PA; Longview, TX; Plymouth, MI and Chicago, IL.\n(2) The Corporate office space is leased as are domestic sales offices. Union Electric Steel also leases approximately 40,000 square feet of manufacturing space. All of the owned facilities are adequate and suitable for their respective purposes. There were no facilities idled during 1994.\n(3) The Corporation estimates that all of its facilities were operated within 75% to 95% of their normal capacity during 1994. Normal capacity is defined as capacity under approximately normal conditions with allowances made for unavoidable interruptions, such as lost time for repairs, maintenance, breakdowns, set-up, failure, supply delays, labor shortages and absences, Sundays, holidays, vacation, inventory taking, etc. The number of work shifts are also taken into consideration.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS - --------------------------\nThe Corporation has been involved in various claims and lawsuits incidental to its business. In the opinion of management, the Corporation has meritorious defenses in those cases and believes that, in the aggregate, any liability will not have a material effect on the financial position of the Corporation.\nThree lawsuits were commenced in May, 1991 against the Corporation and its subsidiary, Vulcan, Inc. (\"Vulcan\"), arising out of the filing of a petition under Chapter 11 of the United States Bankruptcy Code in October, 1990 by Valley-Vulcan Mold Company (the \"Partnership\"), a 50\/50 partnership formed in September, 1987 between Vulcan and Valley Mould Corporation, a subsidiary of Microdot, Inc. Microdot and Valley are unrelated to the Corporation and were also defendants in the lawsuits. The Partnership acquired the ingot mold businesses of each of the partners. On June 10, 1993, Microdot also filed a Petition under Chapter 11 of the United States Bankruptcy Code. In October, 1994, Microdot's Chapter 11 case was converted to a Chapter 7 liquidation. As previously reported, two of those lawsuits have been settled.\nOfficial Unsecured Creditors' Committee of Valley-Vulcan Mold Company v. ------------------------------------------------------------------------ Microdot, Inc., Valley Mould Corporation, Ampco-Pittsburgh Corporation and -------------------------------------------------------------------------- Vulcan, Inc. The plaintiff, allegedly on behalf of the debtor Partnership, ----------- filed this proceeding in the United States Bankruptcy Court for the Northern District of Ohio against Microdot, Valley, Vulcan and the Corporation, seeking to set aside the Corporation's liens on the Partnership's assets, to hold all defendants liable for the debts of the Partnership, and return of all money received by any of the defendants from the Partnership and out of the proceeds of a loan to the Partnership by a third-party lender, alleged to be at least $9.35 million. The Corporation's liens secure a guaranty that it was required to give with respect to a Vulcan obligation that was assumed by the Partnership, and a $500,000 loan made to the Partnership.\nThe trial of this lawsuit was held the week of October 4, 1993. In April, 1994 the Court issued a judgment in favor of the Corporation. Under the Court's decision, all claims against the Corporation were denied. All claims against Vulcan were also denied except for its liability as a general partner. Vulcan's only asset is its interest in the partnership and accordingly the judgment will not have any adverse effect on the Corporation. In May, 1994, plaintiff appealed to the United States District Court, Northern District of Ohio, Eastern Division. Briefs have been filed and the appellate Court has not yet rendered its decision.\nThe Corporation is involved in various environmental proceedings which all involve discontinued operations. In some of those proceedings, the Corporation has been designated as a Potentially Responsible Party (\"PRP\"). However, the Corporation believes that in most instances it is either a de minimis participant based on information known to date and the estimated quantities of waste at these sites and\/or that it is entitled to indemnity from the successors of the operations alleged to be involved. Based on the current estimate of cleanup costs and proposed allocation of that cost among the various PRP groups, for all environmental matters considered in the aggregate, the liability to the Corporation would not be material.\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.\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 set forth on p. 20 of the Annual Report to Shareholders for the year ended December 31, 1994 which is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA - --------------------------------\nThe information called for by this item is set forth on p. 20 of the Annual Report to Shareholders for the year ended December 31, 1994 which 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 called for by this item is set forth on pp. 16 through 18 of the Annual Report to Shareholders for the year ended December 31, 1994 which are incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThe information called for by this item is set forth on pp. 5 through 15 and pp. 19 and 20 of the Annual Report to Shareholders for the year ended December 31, 1994 which are incorporated herein by reference.\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 - ------------------------------------------\n(a) IDENTIFICATION OF DIRECTORS\nName, Age, Tenure as a Director, Position with the Corporation (1), Principal Occupation, Business Experience Past Five Years, and Other Directorships in Public Companies - -----------------------------------------------------------------------------\nLouis Berkman (age 86, Director since 1960; current term expires in 1996). He has been Chairman of the Board of the Corporation since September 20, 1994. He is also Chairman of the Executive Committee of the Corporation and has been for more than five years. He is also President and a director of The Louis Berkman Company (steel products, fabricated metal products, building and industrial supplies). (2)(4)\nRobert A. Paul (age 57, Director since 1970; current term expires in 1997). He has been President and Chief Executive Officer of the Corporation since September 20, 1994. For more than five years before 1994, he was President and Chief Operating Officer of the Corporation. He is also an officer and director of The Louis Berkman Company and a director of Integra Financial Corporation. (2)\nWilliam D. Eberle (age 71, Director since 1982; current term expires in 1997). He is a private investor and consultant and is Chairman of Manchester Associates, Ltd. and Showscan, Inc. He is also a director of Mitchell Energy & Development Co., America Service Group and Fiberboard Corporation, and was Special Representative for Trade Negotiations with the rank of Ambassador. (3)(4)\nWilliam P. Hackney (age 70, Director since 1979; current term expires in 1996). For more than five years prior to 1992 he had been a partner in the law firm of Reed Smith Shaw & McClay. As of January 1, 1992, he retired and became of counsel to the law firm. (3)\nAlvin G. Keller (age 85, Director since 1961; current term expires in 1995). He is a private investor who, prior to his retirement, served as a Vice President of Mellon Bank, N.A. (N)(2)(3)(4)\nCarl H. Pforzheimer, III (age 58, Director since 1982; current term expires in 1996). For more than five years he has been Managing Partner of Carl H. Pforzheimer & Co. (member of the New York and American Stock Exchanges). (3)\nErnest G. Siddons (age 61, Director since 1981; current term expires in 1995). He has been Executive Vice President and Chief Operating Officer of the Corporation since September 20, 1994. For more than five years before 1994, he was Senior Vice President Finance and Treasurer of the Corporation. (N)(2)\n- --------------- (N) Nominee for election at the April 25, 1995 Annual Meeting of Shareholders. (1) Officers serve at the discretion of the Board of Directors. (2) Member of Executive Committee. (3) Member of Audit Committee. (4) Member of Salary Committee.\nMr. Siddons is an officer of Valley-Vulcan Mold Company, a partnership that filed for bankruptcy in October 1990. He also serves as a director and officer of Vulcan, Inc., a wholly-owned subsidiary of the Corporation, which is a 50% general partner in Valley-Vulcan. The other 50% general partner is unrelated to the Corporation.\n(b) IDENTIFICATION OF EXECUTIVE OFFICERS\nIn addition to Louis Berkman, Robert A. Paul and Ernest G. Siddons (see \"Identification of Directors\" above) the following are also Executive Officers of the Corporation:\nName, Age, Position with the Corporation (1), Business Experience Past Five Years - ------------------------------------------------------------------------\nRose Hoover (age 39). Secretary of the Corporation since December, 1990. For more than five years before 1990, she was a Legal Assistant for the Corporation.\nRobert J. Reilly (age 38). Treasurer of the Corporation since September, 1994. He has been Controller of the Corporation since January, 1994. For five years before September, 1994 he was Assistant Treasurer.\nRobert F. Schultz (age 47). Vice President Industrial Relations and Senior Counsel of the Corporation since December, 1990. From January, 1987 to December 1990 he was Director of Industrial Relations.\n- --------------- (1) Officers serve at the discretion of the Board of Directors and none of the listed individuals serve as a director of a public company.\n(c) IDENTIFICATION OF CERTAIN SIGNIFICANT EMPLOYEES\nNone.\n(d) FAMILY RELATIONSHIPS\nLouis Berkman is the father-in-law of Robert A. Paul. There are no other family relationships among the Directors and Officers.\nEXECUTIVE COMPENSATION\nThe following table sets forth certain information as to the total remuneration received for the past three years by the five most highly compensated executive officers of the Corporation, including the Chief Executive Officer (the \"Named Executive Officers\"):\nSUMMARY COMPENSATION TABLE\n- --------------- (1) Marshall Berkman died in September, 1994. In connection with his death, his widow will receive pension payments of $5,506 per month and supplemental payments totalling $183,923 from October 1994 through September 30, 1995.\n(2) Value of the term portion of a split dollar life insurance policy. The Corporation remains entitled to the cash surrender value of such policy.\n(b) COMPENSATION PURSUANT TO PLANS\nThe Corporation has a tax qualified retirement plan (the \"Plan\") applicable to the Executive Officers, to which the Corporation makes annual contributions in amounts determined by the Plan's actuaries. The Plan does not have an offset for Social Security and is fully paid for by the Corporation. Under the Plan, employees become fully vested after five years of participation and normal retirement age under the Plan is age 65 but actuarially reduced benefits may be available for early retirement at age 55. The benefit formula is 1.1% of the highest consecutive five year average earnings in the final ten years, times years of service. Federal law requires that any active employee start receiving a pension no later than April 1 following the calendar year in which the age 70-1\/2 is reached. Louis Berkman is currently receiving $3,060 a month pursuant to the Plan. As an active employee, Mr. Berkman continues to receive credit for additional service rendered after age 70-1\/2.\nThe Corporation adopted a Supplemental Executive Retirement Plan (SERP) in 1988 for all officers listed in the compensation table, except Louis Berkman, and certain key employees, covering retirement after completion of ten years of service and attainment of age 55. The combined retirement benefit at age 65 provided by the Plan and the SERP is 50% of the highest consecutive five year average earnings in the final ten years of service. The participants are eligible for reduced benefits for early retirement at age 55. A benefit equal to 50% of the benefit otherwise payable at age 65 is paid to the surviving spouse of any participant, who has had at least five years of service, commencing on the later of the month following the participant's death or the month the participant would have reached age 55. In addition, there is an offset for pensions from other companies. Certain provisions, applicable if there is a change of control, are discussed below under Termination of Employment and Change of Control Arrangement.\nThe following shows the estimated annual pension that would be payable, without offset, under the Plan and the SERP to the individuals named in the compensation table assuming continued employment to retirement at age 65, but no change in the level of compensation shown in such table:\n- ----------- (1) Mr. Berkman is currently receiving a pension pursuant to the Plan as described above.\n(2) See Footnote (1) to Summary Compensation Table\n(c) COMPENSATION OF DIRECTORS\nIn 1994, each Director who was not employed by the Corporation received $2,000 for each Board meeting attended and $500 for each Committee meeting attended. Directors received one-half of those amounts if not in attendance or if participation was by telephonic connection.\n(d) TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL ARRANGEMENTS\nThe Chairman, President, and Executive Vice President have two year contracts (which automatically renew for one year periods unless the Corporation chooses not to extend) providing for compensation equal to five times their annual compensation (with a provision to gross up to cover the cost of any federal excise tax on the benefits) in the event their employment is terminated (including a voluntary departure for good cause) and the right to equivalent office space and secretarial help for a period of one year after a change in control. In addition, the remaining officer named in the compensation table and certain key employees have two year contracts providing for three times their annual compensation in the event their employment is\nterminated after a change in control (including a voluntary departure for good cause). Both types of contracts provide for the continuation of employee benefits, for three years for the three senior executives and two years for the others, and the right to purchase the leased car used by the covered individual at the Corporation's then book value. The same provisions concerning change in control that apply to the contracts apply to the SERP and vest the right to that pension arrangement. A change of control triggers the right to a lump sum payment equal to the present value of the vested benefit under the SERP.\n(e) SALARY COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION DECISIONS\nA Salary Committee is appointed each year by the Board of Directors. Committee members abstain from voting on matters which involve their own compensation arrangements. The Salary Committee for the year 1994 was comprised of three Directors: Louis Berkman, William D. Eberle and Alvin G. Keller.\nLouis Berkman is Chairman of the Board of Directors and the Executive Committee. He is also the President and a Director of The Louis Berkman Company. The Corporation's President and Chief Executive Officer is also an officer and director of The Louis Berkman Company.\nThe Louis Berkman Company and William D. Eberle had certain transactions with the Corporation which are more fully described under \"Certain Relationships and Related Transactions.\"\n(f) SALARY COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe Salary Committee approves salaries for executive officers within a range from $150,000 up to $200,000 and increases in the salary of any executive officer, which would result in such officer earning a salary within such range. Salaries of $200,000 per year and above must be approved by the Board\nof Directors or its Executive Committee after a recommendation by the Salary Committee. Salaries for executive officers below the level of $150,000 are set by the Chairman, President and Executive Vice President of the Corporation. Bonuses are discretionary and determined in the same manner as set forth above. All executive compensation is reviewed by the Salary Committee at intervals ranging between twelve and twenty-four months.\nThe compensation of the Chief Executive Officer of the Corporation, as well as the other applicable executive officers, is based on an analysis conducted by the Salary Committee in 1992 and reviewed and, to the extent provided above, approved by the Board of Directors. The Committee does not specifically link remuneration solely to quantitative measures of performance because of the cyclical nature of the industries and markets served by the Corporation. In setting compensation, the Committee also considers various qualitative factors, including competitive compensation arrangements of other companies within relevant industries (based primarily on the 1992 analysis), individual contributions, leadership ability and an executive officer's overall performance. In this way, it is believed that the Corporation will attract and retain quality management, thereby benefiting the long-term interest of shareholders.\nIn 1994, as a result of the sudden death of the Corporation's then Chairman and Chief Executive Officer, the Board of Directors elected Louis Berkman as Chairman, Robert A. Paul as President and Chief Executive Officer and Ernest G. Siddons as Executive Vice President and Chief Operating Officer. Because of this change in management, the Salary Committee approved increases to the named individuals' salaries, and bonuses, consistent with the duties and responsibilities associated with those new positions.\nThis report of the Salary Committee shall not be deemed incorporated by reference by any general statement incorporating by reference this 10-K report into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934, except to the extent that the Corporation specifically incorporates this report and the information contained herein by reference, and shall not otherwise be deemed filed under such Acts.\nLouis Berkman William D. Eberle Alvin G. Keller\n(g) STOCK PERFORMANCE GRAPH\nComparative Five-Year Total Returns* Ampco-Pittsburgh (\"AP\"), S&P 500, Peer Group (Performance results through 12\/31\/94)\n[GRAPH APPEARS HERE] COMPARISON OF FIVE YEAR CUMULATIVE RETURN AMONG AP, S&P 500 INDEX AND PEER GROUP INDEX\nAssumes $100 invested at the close of trading on the last trading day preceding January 1 of the fifth preceding fiscal year in AP common stock, S&P 500, and Peer Group.\n*Cumulative total return assumes reinvestment of dividends.\nIn the above graph, the Corporation has used Value Line's Metals: Steel, Integrated Industry for its peer comparison. The diversity of products produced by subsidiaries of the Corporation made it difficult to match to any one product-based peer group. The Steel Industry was chosen because it is impacted by some of the same end markets that the Corporation ultimately serves, such as the automotive, appliance and construction industries.\nHistorical stock price performance shown on the above graph is not necessarily indicative of future price performance.\nITEM 12","section_11":"","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------\n(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nAs of March 7, 1995, Louis Berkman owned directly 213,888 shares (2.23%) of the Common Stock of the Corporation. As of the same date, The Louis Berkman Company, P. O. Box 576, Steubenville, OH 43952 owned beneficially and of record 1,626,089 shares (16.98%) of the Common Stock of the Corporation. Louis Berkman, an officer and director of The Louis Berkman Company, owns directly 62.90% of its common stock. Robert A. Paul, an officer and director of The Louis Berkman Company, disclaims beneficial ownership of the 18.93% of its common stock owned by his wife. Louis Berkman and Robert Paul are trustees of The Louis and Sandra Berkman Foundation and disclaim beneficial ownership of the 1,266 shares of the Corporation's Common Stock held by such Foundation.\nThe Corporation has received two Schedules 13G filed with the Securities and Exchange Commission disclosing that as of December 31, 1994 Norwest Corporation, Sixth & Marquette, Minneapolis, MN 55479 (in various fiduciary and agency capacities) owned 1,588,850 shares or 16.6% and that AT&T Master Pension Trust, through The Northern Trust Company, as Trustee of the AT&T Master Pension Trust, 50 LaSalle Street, Chicago, IL 60675, owned 626,000 shares or 6.54%. The Corporation previously received a Schedule 13G disclosing that C.S. McKee & Co., Inc., One Gateway Center, Pittsburgh, PA 15222, owned 611,050 shares or 6.38% of the Corporation's common stock as of December 31, 1993 and on June 7, 1989, GAMCO Investors, Inc. and affiliates, Corporate Center at Rye, Rye, NY 10580, filed a Schedule 13D showing they owned 1,872,875 shares or 19.55%. No further filings have been made by C.S. McKee and Co. or GAMCO Investors, Inc.\n(b) SECURITY OWNERSHIP OF MANAGEMENT\nThe following table sets forth as of March 7, 1995 information concerning\nthe beneficial ownership of the Corporation's Common Stock by the Directors and Named Executive Officers and all Directors and Executive Officers of the Corporation as a group:\n- --------------- *less than .1%\n(1) Includes 213,888 shares owned directly, 1,626,089 shares owned by The Louis Berkman Company and 1,266 shares held by The Louis and Sandra Berkman Foundation of which Louis Berkman and Robert A. Paul are trustees, in which shares Mr. Berkman disclaims beneficial ownership.\n(2) The Louis Berkman Company owns beneficially and of record 1,626,089 shares of the Corporation's Common Stock (16.98%). Louis Berkman is an officer and director of The Louis Berkman Company and owns directly 62.90% of its common shares. Robert A. Paul, an officer and director of The Louis Berkman Company, disclaims beneficial ownership of the 18.93% of its common stock owned by his wife. The number of shares shown in the table for Robert A. Paul does not include any shares held by The Louis Berkman Company.\n(3) Includes 42,889 shares owned directly and the following shares in which he disclaims beneficial ownership: 13,767 shares owned by his wife and 1,266 shares held by The Louis and Sandra Berkman Foundation of which Robert A. Paul and Louis Berkman are Trustees.\n(4) Includes 5,333 shares owned directly, 3,000 shares owned jointly with his wife, and 1,420 shares owned by his wife, in which shares he disclaims beneficial ownership.\n(5) Includes 1,000 shares owned directly, 1,600 shares held by a trust of which he is a principal beneficiary, and 133 shares held by his daughter, in which shares he disclaims beneficial ownership.\n(6) The shares are owned jointly with his wife.\n(7) Excludes double counting of shares deemed to be beneficially owned by more than one Director.\nUnless otherwise indicated the individuals named have sole investment and voting power.\n(c) CHANGES IN CONTROL\nThe Corporation knows of no arrangements which may at a subsequent date result in a change in control of the Corporation.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nIn 1994 the Corporation bought industrial supplies from The Louis Berkman Company in transactions in the ordinary course of business amounting to approximately $930,000. Additionally, The Louis Berkman Company paid the Corporation $187,500 for certain administrative services. Louis Berkman and Robert A. Paul are officers and directors, and Louis Berkman is a shareholder, in that company. These transactions and services were at prices generally available from outside sources. Transactions between the parties will take place in 1995.\nIn 1989, certain subsidiaries of the Corporation and Tertiary, Inc., a corporation owned by the children of William Eberle, formed three 50\/50 partnerships, to manage, develop and operate hotel properties and a subsidiary of the Corporation also invested as a limited partner in one of the operating partnerships. In 1992, Tertiary purchased two of the 50\/50 partnerships. In 1993, Tertiary paid the remaining $100,000 from such purchase. In 1994, one of the limited partnerships accrued a fee of $30,129 payable to William Eberle for his guarantee of a mortgage loan. At December 31, 1994, there were\npromissory notes outstanding from certain of the partnerships to subsidiaries of the Corporation totaling $880,000. These notes are due in 1996.\nPART IV ITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - ------------------------------------------------------------------------- (a) 1. FINANCIAL STATEMENTS\nThe consolidated financial statements, together with the report thereon of Price Waterhouse LLP, appearing on pp. 5 through 15 of the accompanying Annual Report are incorporated by reference in this Form 10-K Annual Report.\n3. EXHIBITS\nExhibit No.\n(3) Articles of Incorporation and By-laws\na. Restated Articles of Incorporation\nIncorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1983\nb. Amendments to Articles of Incorporation\nIncorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1984, the Quarterly Report on Form 10-Q for the quarter ended March 31, 1985 and the Quarterly Report on Form 10-Q for the quarter ended March 31, 1987\nc. Amended and Restated By-laws\nIncorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1994\n(4) Instruments defining the rights of securities holders\na. Rights Agreement between Ampco-Pittsburgh Corporation and Mellon Bank, N.A. dated as of November 1, 1988\nIncorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1988\nb. Revolving Credit Agreement dated as of September 30, 1993\nIncorporated by reference to the Quarterly Report on Form 10-Q for quarter ended September 30, 1993\n(10) Material Contracts\na. 1988 Supplemental Executive Retirement Plan\nIncorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1988\nPart IV; Item 14 - EXHIBITS (cont')\nExhibit No.\n(10) Material Contracts (cont')\nb. Category 1 and 2 Severance Agreements between Ampco-Pittsburgh Corporation and certain officers and employees of Ampco-Pittsburgh Corporation\nIncorporated by reference to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1988 and the Quarterly Report on Form 10-Q for the quarter ended September 30, 1994\nc. Amendment to Category 1 Severance Agreement between Ampco- Pittsburgh Corporation and Ernest G. Siddons\nd. Guaranty of William D. and Jeffrey L. Eberle\nIncorporated by reference to the Annual Report on Form 10-K for fiscal year ended December 31, 1989\n(13) Annual Report to Shareholders for the fiscal year ended December 31,\n(21) Significant Subsidiaries\n(27) Financial Data Schedule\n(b) Reports on Form 8-K -------------------\nNo reports on Form 8-K were filed in the fourth quarter of 1994.\nNote: With the exception of the Corporation's 1994 Annual Report to Shareholders, none of the Exhibits listed in Item 14 are included with this Form 10-K Annual Report. The Corporation will furnish copies of Exhibits upon written request to the Secretary at the address on the cover of the Form 10-K Annual Report accompanied by payment of $3.00 for each Exhibit requested.\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.\nAMPCO-PITTSBURGH CORPORATION (Registrant)\nMarch 23, 1995\nBy s\/Louis Berkman ---------------------------------------- Director, Chairman of the Board - Louis Berkman\nBy s\/Robert A. Paul ---------------------------------------- Director, President and Chief Executive Officer - Robert A. Paul\nBy s\/Ernest G. Siddons ---------------------------------------- Director, Executive Vice President and Chief Operating Officer - Ernest G. Siddons\nBy s\/Robert J. Reilly ---------------------------------------- Treasurer and Controller (Principal Financial Officer) - Robert J. Reilly\nPursuant to 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 their capacities as Directors, as of the date indicated.\nMarch 23, 1995\nBy s\/William P. Hackney ---------------------------------------- William P. Hackney\nBy s\/Alvin G. Keller ---------------------------------------- Alvin G. Keller\nBy s\/William D. Eberle ---------------------------------------- William D. Eberle\nBy s\/Carl H. Pforzheimer, III ---------------------------------------- Carl H. Pforzheimer, III\nEXHIBIT INDEX\n*Previously Filed and Incorporated by Reference","section_15":""}
{"filename":"310142_1994.txt","cik":"310142","year":"1994","section_1":"ITEM 1. BUSINESS - Food\nUniversal Foods Corporation (the \"Company\") was incorporated in 1882 in Wisconsin. Its principal executive offices are located at 433 East Michigan Street, Milwaukee, Wisconsin 53202, telephone (414) 271-6755. The Company engages in the international development, manufacture and distribution of value-added ingredients and ingredient systems to food products and other items. Principal products of the Company include food, beverage and dairy flavors; certified and natural colors for foods, cosmetics and pharmaceuticals; dehydrated vegetable products; a diverse line of yeast products; and flavor enhancers, secondary flavorings and other bioproducts. The Company exited the frozen potato business during Fiscal 1994.\nThe following material from the Universal Foods Corporation 1994 Annual Report to Shareholders is incorporated by reference:\n\"Management's Analysis of Operations and Financial Condition\" on Pages 18 through 22.\nNote A of Notes to Consolidated Financial Statements - \"Summary of Significant Accounting Policies\" on Page 27.\nNote I of Notes to Consolidated Financial Statements - \"Foreign Operations\" on Page 32.\nDescription Flavor\nThe Company conducts its food flavor business through its wholly- owned subsidiary Universal Flavor Corporation (\"Universal Flavor\"). Universal Flavor manufactures and supplies flavors and ingredient systems to the dairy, food processor and beverage industries worldwide and is a recognized leader in the dairy and beverage flavor markets. It operates plants located in Kearny, New Jersey; Amboy, Illinois; Indianapolis, Indiana; and Fenton, Missouri. Universal Flavor has eleven additional plants in Canada, Mexico, Belgium, Great Britain, Italy, Spain, Australia, New Zealand, Hong Kong and the Philippines. Products are sold primarily through employee sales representatives with some assistance from food brokers.\nStrategic acquisitions have expanded Universal Flavor's product lines and processing capabilities. In April 1990, the Company acquired the international flavor business of Felton Worldwide, a subsidiary of Harrisons and Crosfield, PLC, of Great Britain. This acquisition strengthened Universal Flavor's position as a major flavor producer in Great Britain and gave Universal Flavor a larger presence on the European continent and in the Pacific Rim. In September 1991, the Company acquired Fantasy Flavors, Inc. Combining Fantasy's product lines with the Company's existing BlankeBaer operation positions Universal Flavor as the premier dairy ingredient systems supplier in North America. The January 1992 acquisition of Curt Georgi Imes, S.P.A. brought particular strength in the Italian bakery and dairy flavor markets, as well as experienced research and development and sophisticated analytical capabilities. The January 1994 acquisition of Destillaciones Garcia de la Fuente, S.A. (DGF), based in Granada, Spain, provided a depth of expertise for expanding into aroma chemicals and essential oils, both of which are used to create flavors as well as fragrances. In July 1994, Universal Flavors, through its international subsidiary, purchased its partner's 51% interest in Azteca en Ambesco de Mexico. This purchase brought beverages and dairy flavor technology to the Company's other existing Mexican flavor business.\nColor\nThe Company, through its subsidiary Warner-Jenkinson Company (\"W-J\"), is the world's leading manufacturer of certified food colors. It also has a growing share of the international natural color market. Its products, sold under such brand names as RED SEAL and SPECTRACOAT, are used by producers of soft drinks, bakery products, processed foods, confections, pet foods, alcoholic beverages and pharmaceuticals. W-J is headquartered in St. Louis, Missouri, the site of its major manufacturing facilities. Latin American customers are served by W-J de Mexico, S.A. de C.V., a manufacturing and sales subsidiary located just outside of Mexico City. W-J Canada (formerly Dyeco Ltd.) operates out of Kingston, Ontario. Other manufacturing facilities are located in King's Lynn, Norfolk, England; Amersfoort, The Netherlands; and Tullamarine, Victoria, Australia. Domestically, the W-J product line is sold principally by the Company's own sales force. International sales are made through distributors and directly by the Company.\nRecent acquisitions have strengthened the business internationally which operates as W-J International. In August 1991, the Company acquired the international food and cosmetic color operations of Morton International, Inc. which provided additional technology in cosmetic colors and a worldwide distribution network. In June 1992, the Company acquired Butterfield Food Ingredients, Ltd., a British food color manufacturer with particular expertise in natural colors and pharmaceutical applications and additional international distribution, particularly in the Far East. During 1993, the Company acquired Spectrum S.A., a Mexican food color distributor with approximately 20% market share in that country.\nDehydrated Products\nThe Company's subsidiary, Rogers Foods, Inc. (\"Rogers\"), produces dehydrated onion and garlic and the Company believes it to be the third largest producer of these products in the United States. These items are marketed under the trademark ROGERS FOODS and private labels. Rogers also produces and distributes chili powder, chili pepper, paprika, dehydrated vegetables such as parsley, celery and spinach, and oleoresin (a liquid chili pepper used as a highly concentrated coloring agent) under the brand name CHILI PRODUCTS. Rogers believes it is one of the largest producers of these products.\nRogers sells dehydrated products directly and through brokers to food manufacturers for use as ingredients and also for repackaging under private labels for sale to the retail market and to the food service industry. Rogers' processing facilities are located in Turlock, Livingston and Greenfield, California.\nDuring 1994, the Company acquired a leading European processor of air and freeze-dried vegetables. The acquisition gives the Company a base from which to expand its dehydrated products business internationally. This acquisition in Ireland from Campbell Soup Company also expands the Company's dehydrated technology base to include freeze drying and \"puffing,\" an air-steam process. Vegetables processed using these technologies are premium products because they have a short reconstitution time, a benefit in today's convenience foods such as soups, snacks and other dry foods.\nThe Irish operation consists of two companies managed as a single entity in Midleton, County Cork. The group employs about 120 people and now operates as Mallow Foods Ltd.\nYeast\nThe Company specializes in the production of compressed, active dry and nutritional yeast products for sale to industrial, institutional and retail accounts under the RED STAR trademark. Compressed yeast and cream yeast must be refrigerated and used soon after production. Active dry yeast is a dehydrated product which has the advantages of longer shelf life, lower shipping costs and ease of handling. Nutritional yeast is a rich source of B-complex vitamins and proteins. Other yeast strains are produced specifically for the wine industry, and the Company purchases a number of allied products, including bakery mixes and baking powder, from others and distributes them.\nThe largest market for yeast is the domestic baking industry. In addition, active dry yeast is sold to food processors for inclusion in bread, pizza and similar mixes. The compressed, active dry and fast-acting dry yeast products of the Company bearing the RED STAR and RED STAR QUICK RISE trademarks are sold in ready-to-use packages to retail stores and in two pound packages for food service use. The Company believes it is the largest North American supplier of yeast to the commercial bakery market and the second largest supplier to the retail market.\nThe business also exports yeast and allied products throughout the world and manages investments in companies operating yeast and allied product facilities in 12 offshore locations, two of which are wholly-owned subsidiaries. The Company receives revenues in the form of dividends and technical assistance fees from these foreign affiliates.\nCompany owned yeast plants are located in Milwaukee, Wisconsin; Baltimore, Maryland; Dallas, Texas; and Oakland, California. The Company distributes its fermentation products largely through its own sales force from its distribution branches. In 1994, the Company purchased a 20% stock interest in and entered an agreement with Minn-Dak Yeast Company, Inc. for contract manufacturing by Minn-Dak under the Red Star label and for Minn-Dak to supply molasses, a major raw material in yeast production, to the Company.\nBioProducts\nDuring 1994, the Company created the Red Star BioProducts Division from its existing Red Star Specialty Products Division and two acquisitions. Red Star Specialty Products had been established as a small, stand-alone profit center in 1989 out of the Company's Fermentation group. With internally developed expertise, the group focused on highly technical product development using extracts from brewer's and baker's yeast. During 1993, Universal BioVentures, the Company's biotechnology group, was integrated into Red Star Specialty Products. This group was given the mission to develop new biotechnological products utilizing the Company's extensive expertise in fermentation, and its research strengths in the molecular biology of microorganisms.\nThe 1994 acquisitions of Champlain Industries Limited and the Biolux Group expanded the division's product lines and international presence, making the division a more significant part of the Company.\nChamplain Industries Limited produces savory flavorings and flavor enhancers from vegetable proteins, yeast, meats and milk protein. It is a leading producer of hydrolyzed vegetable proteins (HVP) in North America. The company has operations in Canada, the U.S., and the United Kingdom.\nThe Biolux Group is a leading European producer of food, nutritional and feed ingredients derived from brewer's yeast. The acquisition makes the Company a world leader in brewer's yeast extract technology, production and sales. The Biolux Group consists of New Biolux in Belgium and Vitalevor in France. Its products include flavor enhancers, health foods, feed ingredients and nutrients for pharmaceutical and biotechnology processes. The Biolux Group is a major purchaser and processor of brewer's yeast in the European market.\nThe expanded Red Star BioProducts Division serves the food processing, fermentation, agriculture, aquaculture and chemical intermediates industries as a diversified supplier of natural extracts and specialty cultures. It supplies various natural extracts from brewer's yeast, baker's yeast, vegetable proteins, meat, casein and other naturally occurring materials. These specialty extracts function primarily as flavor and texture modifiers and enhancers, and secondary flavorings in the food processing industries. They also enjoy widespread use as palatability enhancers in the pet food and animal foodstuffs markets. The nutritional and functional properties of Red Star BioProducts extracts are the basis for their use in cheese starter and pharmaceutical fermentations and in personal care applications.\nThe Company believes Red Star BioProducts is the leading supplier of yeast extracts and second in the supply of HVPs in the U.S. market. The products are marketed under a number of Red Star and Champlain trademarks. Commercial production and export of a new product named RED STAR Phaffia Yeast began in 1993. The yeast Phaffia rhodozyma is a source of the red carotenoid compound called astaxanthin which is the natural pigment found in salmon, trout and shellfish. This product was developed for use as an ingredient for feeds given to salmon produced by aquaculture. The purchase of the technological properties of ZeaGen from ACX Technologies, Inc in 1993 provides other processes for development.\nThe expanded division operates production facilities in Milwaukee and Juneau, Wisconsin; Harbor Beach, Michigan; Clifton, New Jersey; and in Canada, the United Kingdom, Belgium and France. More than half of the Division's products are now produced outside of the United States. Its products are marketed through technically trained sales personnel directly to the customer and through distributors in some international markets.\nFrozen Foods\nOn August 1, 1994, the Company completed the sale of Universal Frozen Foods Company, a wholly owned subsidiary of the Company (\"Frozen Foods\"), to ConAgra, Inc. for a base consideration of $163 million and an earnout consideration of approximately $57 million, payable over a five year period. The sale was a major step in Universal Foods' strategic transition to a focus on value-added ingredients and ingredient systems for foods and other products.\nFrozen Foods produced frozen potato products for U.S. and international markets, selling most of its product to the food service industry. It did have a share of the retail market with branded and private labeled products. It operated processing facilities in Twin Falls, Idaho; Hermiston, Oregon; and Pasco, Washington.\nResearch and Development\/Quality Assurance\nThe Company believes that its competitive advantage and ability to develop and deliver value-added products is based on its technical expertise in the processing and application of its technology for foods and other products. Therefore, the Company provides an above-industry average investment in research, development and quality assurance, and is committed to the training and development of its people.\nThe Company employs approximately 300 people in research and quality assurance. Over the past five years, research and development expenditures have increased an average of 10.4%. Expenditures in fiscal 1994 increased 13.0% over fiscal 1993 to $32.2 million from $28.5 million. Expenditures in fiscal 1993 increased 7.1% to $28.5 million from $26.6 million in fiscal 1992. The Company's commitment to research and product development continues at a level significantly higher than the food industry average. Of the aforesaid amounts, approximately $17.3 million in fiscal 1992, $17.9 million in fiscal 1993 and $20.4 million in fiscal 1994, were research and development expenses as defined by the Financial Accounting Standards Board.\nTo improve its research and development capabilities, the Company has been upgrading its technical facilities. In 1991, the Company refurbished much of its Technical Center located in Milwaukee, Wisconsin, to enhance its capabilities in product and process areas related to fermentation, including microbial genetics work carried out to develop improved strains of bakers yeast and engineering development facilities for process development and new product production scale-up activities. In 1992, an $8 million Fermentation Development Facility was completed at the Technical Center to scale-up new biotechnological products for the Red Star BioProducts Division. Two 10,000-gallon pure culture fermenters in this facility produce sufficient volumes to test market new products in order to establish them as commercially acceptable prior to investment in a full-scale production plant.\nIn 1992, the Company completed a new research center for seed genetics and tissue culture at Livingston, California, for Dehydrated Products, and the Company enlarged food flavor research laboratories in Kearny, New Jersey. During 1993, beverage flavor laboratories in Indianapolis were enlarged, new modern laboratories for research on color products at W-J's production site in St. Louis, Missouri were completed, and a new facility for quality assurance and technical customer services was added to the Turlock, California complex. All of these facilities are designed to meet the specialized, strategic needs of the Company's operating units.\nThe Company has a massive training program designed to introduce all personnel to team problem solving using statistical process control, teamwork and communication procedures under a program named \"The Universal Way.\" This program promotes the Company's commitment to continuous quality improvement of its products and services as a primary Company objective.\nAs part of its commitment to quality as a competitive advantage, the Company has undertaken efforts to achieve certification to quality standards established by the International Organization for Standardization in Geneva, Switzerland, through its ISO 9000 series. Red Star BioProducts believes it was the first North American ingredients supplier to receive ISO 9002 certification. Universal Flavor facilities in Indiana and New Jersey in the United States and facilities in The Netherlands and United Kingdom have also been certified.\nCompetition\nAll Company products are sold in highly competitive markets. Some competitors have more product lines and greater resources than the Company has. Since the Company and its competitors utilize similar methods of production, marketing and delivery, the Company competes primarily on technical product development, process expertise, quality and service. The Company competes in many market niches where price is not the most important variable.\nWith the evolution of food processing as a global business, competition to supply the industry has taken on an increasingly global nature. Universal Foods competes with only a few companies across multiple ingredient lines, and is more likely to encounter competition specific to individual businesses.\nIn the worldwide flavor market, the Company's principal competition comes from other U.S. and European producers. Building an international presence is a key goal for Universal Flavor as witnessed by the acquisitions of the international flavor business of Felton Worldwide in 1990, Curt Georgi Imes, S.P.A. in 1992 and Destillaciones Garcia de la Fuente, S.A. in 1994; and the completion of a new plant in Belgium in order to meet increasing international flavor demands.\nThe Company believes W-J is a leading producer of certified colors in North America and Western Europe; state of the art equipment, the latest process technology, and the most complete range of synthetic and natural colors constitute the basis for its market leadership position. Acquisitions have resulted in product and process technology synergies, particularly in the cosmetic color market, as well as a growing international presence.\nFor Dehydrated Products, the acquisition in Ireland begins an international expansion and strengthens export opportunities for U.S. based operations. Some price competition has been evident in the United States as a domestic competitor seeks to gain market share and a new competitor is adding capacity to the industry. Red Star Yeast & Products continues to experience pricing pressures as a result of industry overcapacity. Competition in Red Star BioProducts comes primarily from European producers.\nNew Product Activity\nWith the Company's strategic focus on value-added ingredients and ingredient systems, the Company's emphasis has shifted from the development of major new products to application activities and processing improvements in the support of its customers' numerous new and reformulated products.\nThese activities include a line of stable aqueous dispersion of colors for foods and pharmaceutical products. Patents have been granted on the products marketed under the SPECTRASPRAY label and applied for on the SPECTRABLEND label. The development of natural food colors continues to expand and is a growth opportunity for W-J.\nA variety of activities at Universal Flavor focus on the development of flavor solutions for low-fat and no-fat applications. The group has developed a reaction flavor for imparting animal fat flavor to nutritionally preferred vegetable oils. A new technology was installed for production of aseptically processed fruits for frozen yogurt and other products requiring fruit pieces. Emphasis has been placed on the development of low-fat dairy flavor systems. In 1993, a low-fat, cholesterol-free program was introduced for frozen desserts. New flavored fruit pieces have also been developed to provide new textures, flavors and unique performance properties in bakery items.\nIn 1992, Red Star BioProducts introduced RED STAR Phaffia Yeast. This is the only commercially viable natural source of pink pigmentation for farm-raised salmon which achieve their flesh color through dietary supplements. Three other processes to provide natural coloring and nutrients for aquaculture and agribusiness are currently under development. In 1993 Red Star BioProducts introduced the FlavorMate 950 series, the most potent flavor enhancer on the market, and the SavoryMate series, which are flavor enhancers designed for specific areas such as beef, poultry, pork, etc.\nIn addition, the discussion of operational activities on Pages 6, 8, 10, 12 and 14 of the 1994 Annual Report to Shareholders is incorporated by reference (but not any photographs or related captions included thereon).\nRaw Materials\nThe principal raw material used in the production of yeast products is molasses, which is purchased through brokers and producers under yearly fixed-price contracts. Processes have been developed to permit partial replacement of molasses with alternate, readily available substrates for use if molasses supplies should become limited. In 1994, the Company entered a supply agreement with Minn-Dak Yeast Company, Inc., a major North American molasses supplier, to provide additional assurances of adequate supplies.\nChili peppers, onion, garlic and other vegetables are acquired under annual contracts with numerous growers in the western United States and Ireland. Chemicals and petrochemicals used to produce certified colors are obtained from several domestic and foreign suppliers. Raw materials for natural colors, such as carmine, beta carotene, annatto and tumeric, are purchased from overseas and U.S. sources. In the production of flavors, the principal raw materials include essential oils, aroma chemicals, botanicals, fruits and juices and are obtained from local vendors. Flavor enhancers and secondary flavors are produced from spent brewer's yeast, baker's yeast from the Company's own operations, and vegetable materials such as corn and soybeans. The acquisition of the Biolux Group in 1994 provides long-term contracts on supplies of spent brewer's yeast for European production needs.\nThe Company believes that its required raw materials are generally in adequate supply and available from numerous competitively priced sources.\nPatents, Formulae and Trademarks\nThe Company owns or controls many patents, formulae and trademarks related to its businesses. The businesses are not materially dependent upon patent or trademark protection; however, trademarks, patents and formulae are important for the continued consistent growth of the Company.\nEmployees\nAs of September 30, 1994, the Company employed about 4,100 persons worldwide (which includes approximately 200 seasonal employees). Approximately 821 employees are represented by one of 17 unions with whom the Company has collective bargaining relationships. The Company considers its employee relations to be good.\nRegulation\nCompliance with government provisions regulating the discharge of material into the environment, or otherwise relating to the protection of the environment, did not have a material adverse effect on the Company's operations for the year covered by this report nor is such compliance expected to have a material effect in the succeeding two years. As is true with the food industry in general, the production, packaging, labeling and distribution of the products of the Company are subject to the regulations of various federal, state and local governmental agencies, in particular the Food & Drug Administration.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDomestically, the Company had seventeen manufacturing and processing plants in nine states as of September 30, 1994. Four plants produced bakers yeast, four facilities provided flavor enhancers and bioproducts, three produced dehydrated products, two plants produced colors and four plants produced flavors. None of these properties is held subject to any material encumbrances. The Company also has investments in fifteen companies operating yeast and allied product facilities located in twelve offshore locations. The Company operates five color plants, eleven flavor plants, five bioproducts facilities and one dehydrated vegetable plant in thirteen foreign countries. For information regarding lease commitments, see Note I of Notes to Consolidated Financial Statements - Commitments and Contingencies, on Page 32 of the 1994 Annual Report to Shareholders, which is hereby incorporated by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to various legal proceedings of a character regarded as normal to its business and in which, the Company believes, adverse decisions, in the aggregate, would not subject the Company to damages of a material amount.\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 fiscal 1994.\nITEM 4(a). EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the registrant and their ages as of December 1, 1994 are as follows:\nEXECUTIVE OFFICERS\nName Age Position\nGuy A. Osborn 58 Chairman, Chief Executive Officer and Director Richard Carney 44 Vice President - Human Resources\nThomas J. Degnan 46 President, Red Star Yeast & Products Division\nJohn E. Heinrich 50 Vice President and Chief Financial Officer Geoffrey J. Hibner 45 Vice President - Finance\nRichard F. Hobbs 47 Vice President - Administration and Corporate Controller Kenneth P. Manning 52 President, Chief Operating Officer and Director\nTerrence M. O'Reilly 49 Vice President, Secretary and General Counsel\nJames F. Palo 54 President, Dehydrated Products Division Dr. Gary W. Sanderson 59 Vice President, Technologies\nKenneth G. Scheffel 58 Vice President, Red Star BioProducts Division\nMichael A. Wick 51 President, Color Division\nAll of these individuals have been employed by the Company in an executive capacity for more than five years, except Richard Carney.\nMr. Carney was elected Vice President - Human Resources in April, 1993. He joined the Company in 1981 as Treasury Manager and held various positions in the Treasurer's Department until 1986 when he assumed the Director of Benefits responsibilities which he performed until being elected a Vice President.\nMr. Heinrich passed away on December 6, 1994.\nMr. Hibner will resign as Vice President-Finance effective January 2, 1995. Mr. Hobbs is currently serving as principal accounting and chief financial officer.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe principal market in which the common stock of the Company is traded is the New York Stock Exchange. The range of the high and low sales prices as quoted in the New York Stock Exchange - Composite Transaction tape for the common stock of the Company and the amount of dividends declared for fiscal 1994 appearing under \"Quarterly Financial Data\" on Page 22 of the 1994 Annual Report of the Company are incorporated by reference. Common stock dividends were paid on a quarterly basis, and it is expected that quarterly dividends will continue to be paid in the future. In addition to the restrictions contained in its Restated Articles of Incorporation, the Company is subject to restrictions on the amount of dividends which may be paid on its common stock under the provisions of various credit agreements. On the basis of the consolidated financial statements of the Company as of September 30, 1994, $27,258,000 is available for the payment of dividends on the common stock of the Company under the most restrictive loan covenants.\nThe Company had a stock repurchase program, initially announced June 7, 1984, under which the authorization terminated in fiscal 1994. Consequently, on January 27, 1994 the Board of Directors established a new share repurchase program which authorizes the Company to repurchase up to 2.5 million shares. As of September 30, 1994, no shares had been repurchased under the new authorization.\nOn September 8, 1988 the Board of Directors of the Company adopted a common stock shareholder rights plan which is described at Note E of Notes to Consolidated Financial Statements - Shareholders' Equity on Pages 29 and 30 of the 1994 Annual Report to Shareholders and which is incorporated by reference.\nThe number of shareholders of record on December 2, 1994 was 6,351.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nLong-term obligations at September 30 were as follows: 1994: $172,235,000; 1993: $171,907,000; 1992: $167,746,000; 1991: $152,213,000; and 1990: $122,454,000. Remaining information in response to this item is incorporated by reference from the \"Five-Year Review\" and the notes thereto of the 1994 Annual Report to Shareholders on Page 34.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nManagement's Analysis of Operations and Financial Condition is incorporated by reference from Pages 18 through 21 of the 1994 Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe supplementary financial information and financial statements required by this item are set forth on Pages 22 through 33 of the 1994 Annual Report to Shareholders and are incorporated by reference.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation regarding directors and officers appearing under \"Election of Directors\" (ending before \"Committees of the Board of Directors\") and \"Other Matters\" on Pages 3 through Page 6 and Page 16, respectively, of the Notice of Annual Meeting and Proxy Statement of the Company dated December 16, 1994, is incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to compensation of directors and officers is incorporated by reference from \"Director Compensation and Benefits,\" and \"Compensation and Development Committee Report\" and \"Executive Compensation\" on Pages 7 through 14 of the Notice of Annual Meeting and Proxy Statement of the Company dated December 16, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe discussion of securities ownership of certain beneficial owners and management appearing under \"Principal Shareholders\" on Pages 8 through 9 of the Notice of Annual Meeting and Proxy Statement of the Company dated December 16, 1994, is incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere are no family relationships between any of the directors, nominees for director and officers of the Company nor any arrangement or understanding between any director or officer or any other person pursuant to which any of the nominees has been nominated. No director, nominee for director or officer had any material interest, direct or indirect, in any business transaction of the Company or any subsidiary during the period October 1, 1993 through September 30, 1994, or in any such proposed transaction. In the ordinary course of business, the Company engages in business transactions with companies whose officers or directors are also directors of the Company. These transactions are routine in nature and are conducted on an arm's-length basis. The terms of any such transactions are comparable at all times to those obtainable in business transactions with unrelated persons.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed:\n1. and 2. Financial Statements and Financial Statement Schedules. (See following \"List of Financial Statements and Financial Statement Schedules.\")\n3. Exhibits. (See Exhibit Index on the last page of this report.) (No instruments defining the rights of holders of long-term debt of the Company and its consolidated subsidiaries are filed herewith because no long-term debt instrument authorizes securities exceeding 10% of the total consolidated assets of the Company. The Company agrees to furnish a copy of any such instrument to the Securities and Exchange Commission upon request.)\n(b) Reports on Form 8-K: None\nList Of Financial Statements and Financial Statement Schedules\nPage Reference in 1994 Annual Report to Shareholders 1. FINANCIAL STATEMENTS\nThe following consolidated financial statements of Universal Foods Corporation and Subsidiaries are incorporated by reference to the Annual Report to Shareholders for the year ended September 30, 1994.\nIndependent Auditors' Report 33 Consolidated Balance Sheets - 24 September 30, 1994 and 1993 Consolidated Earnings - years ended 23 September 30, 1994, 1993 and 1992 Consolidated Shareholders' Equity - 25 years ended September 30, 1994, 1993 and 1992 26 Consolidated Cash Flows - years ended September 30, 1994, 1993 and 1992 27 - 32 Notes to Consolidated Financial Statements\nPage Reference 2. FINANCIAL STATEMENT SCHEDULES in Form 10-K Independent Auditors' Report 15 Schedule V - Property, Plant and Equipment 16 Schedule VI - Accumulated Depreciation and 17 Amortization of Plant and Equipment Schedule VIII - Valuation and Qualifying 18 Accounts and Reserves Schedule IX - Short-Term Borrowings 19 Schedule X - Supplementary Earnings 20 Statement Information\nAll other schedules are omitted because they are inapplicable, not required by the instructions or the information is included in the consolidated financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders and Directors of Universal Foods Corporation\nWe have audited the consolidated financial statements of Universal Foods Corporation as of September 30, 1994 and 1993 and for each of the three years in the period ended September 30, 1994, and have issued our report thereon dated November 10, 1994, which report expresses an unqualified opinion and includes an explanatory paragraph relating to the change in methods of accounting for postretirement benefits other than pensions and postemployment benefits to conform with Statements of Financial Accounting Standards No. 106 and No. 112, respectively; 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 Universal Foods Corporation, listed in Item 14. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP\nNovember 10, 1994\nSCHEDULE V\nSCHEDULE VI\nSIGNATURES\nPURSUANT to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, duly authorized.\nUNIVERSAL FOODS CORPORATION\n\/s\/ T. M. O'Reilly T. M. O'Reilly, Vice President Secretary & General Counsel\nDated: December 16, 1994\nPURSUANT to the requirements of the Securities Exchange Act of 1934, this report has been signed below on December 16, 1994, by the following persons on behalf of the Registrant and in the capacities indicated.\n\/s\/ Guy A. Osborn Chairman and Chief Executive Officer Guy A. Osborn\n\/s\/ Kenneth P. Manning President & Chief Operating Officer Kenneth P. Manning Director\n\/s\/ Richard F. Hobbs Vice President - Corporate Richard F. Hobbs Controller\n\/s\/ Michael E. Batten Director Michael E. Batten\n\/s\/ John F. Bergstrom Director John F. Bergstrom\n\/s\/ James L. Forbes Director James L. Forbes\n\/s\/ Dr. Olan D. Forker Director Dr. Olan D. Forker\n\/s\/ Dr. Carol I. Waslien Ghazaii Director Dr. Carol I. Waslien Ghazaii\n\/s\/ Leon T. Kendall Director Leon T. Kendall\n\/s\/ James H. Keyes Director James H. Keyes\n\/s\/ Charles S. McNeer Director Charles S. McNeer\n\/s\/ John L. Murray Director John L. Murray\n\/s\/ William U. Parfet Director William U. Parfet\n\/s\/ Essie Whitelaw Director Essie Whitelaw\nUNIVERSAL FOODS CORPORATION EXHIBIT INDEX 1994 ANNUAL REPORT ON FORM 10-K\nIncorporated Exhibit Herein by Filed Number Description Reference Herewith\n3.1 Restated Articles of (Previouly filed at Exhibit Incorporation 3.1 to the 1993 Annual Report on Form 10-K)\n3.2 Restated Bylaws (Previously filed at Exhibit 3.2 to the 1993 Annual Report on Form 10-K)\n4 Shareholders Rights (Previously filed on Form Plan 8-A dated September 15, 1988 as amended by Exhibit 3 to Form 8 dated December 22, 1988 and by Exhibits 4 and 5 to Form 8 dated September 14, 1990)\n* 10 Material Contracts\n(a) Executive (Previously filed at Exhibit Employment 10(a) to the 1985 Annual Contract Report on Form 10-K)\n(b) 1981 Incentive (Previously filed with the Stock Option Plan Notice of Annual Meeting & Proxy Statement dated December 5, 1981)\n(c) 1985 Stock Plan (Previously filed with the for Executive Notice of Annual Meeting & Employees Proxy Statement dated December 12, 1985)\n(d) 1990 Employee (Previously filed with the Stock Plan Notice of Annual Meeting & Proxy Statement dated December 18, 1989)\n(e) Director Stock (Previously filed as Exhibit Grant Plan, as 10(e) to the 1991 Annual amended Report on Form 10-K)\n(f) Management Income (Previously filed as Exhibit Deferral Plan 10(f) to the 1991 Annual Report on Form 10-K)\n(g) Executive Income (Previously filed as Exhibit Deferral Plan 10(g) to the 1991 Annual Report on Form 10-K)\n(h) Executive (Previously filed as Exhibit Employment and 10(h) to the 1991 Annual Severance Report on Form 10-K) Agreement\n(i) Trust Agreement (Previously filed as Exhibit dated January 18, 18 to Amendment No. 1 of the 1988 between the Company's Schedule 14D-9 Company and filed December 9, 1988) Marshall & Ilsley Trust Company\n(j) Trust Agreement (Previously filed as Exhibit dated January 18, 19 to Amendment No. 1 of the 1988 between the Company's Schedule 14D-9 Company and filed December 9, 1988) Marshall & Ilsley Trust Company\n(k) Trust Agreement (Previously filed as Exhibit dated September 20 to Amendment No. 1 of the 18, 1988 between Company's Schedule 14D-9 the Company and filed December 9, 1988) Marshall & Ilsley Trust Company (Previously filed as Exhibit 10(i) to the 1991 Annual (l) Management Report on Form 10-K) Incentive Plan for Major Corporate (Previously filed on Form Executives S-8 dated September 12, 1994) (m) 1994 Employees Stock Option Plan\n13 Portions of Annual Report to Shareholders for the year ended X September 30, 1994 that are incorporated by reference\n21 Significant Subsidiaries of Universal Foods X Corporation\n23 Consent of Deloitte & Touche LLP X\n27 Financial Data Schedule X\n99 Notice of Annual (Previously filed on Meeting and Proxy December 15, 1994 as the Statement, dated Company's Schedule 14A) December 16, 1994\n* Indicates management contracts or compensatory plans.","section_15":""}
{"filename":"40864_1994.txt","cik":"40864","year":"1994","section_1":"Item 1. Business\nGTE California Incorporated (the Company) was incorporated in California in 1929. The Company is a wholly-owned subsidiary of GTE Corporation (GTE) and provides communications services in Southern and Central California.\nThe Company has a wholly-owned subsidiary, GTEL. GTEL comprises the majority of the Company's nonregulated operations including marketing telecommunications equipment and other deregulated products and services.\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 California 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 access charges for access to the facilities of the long distance carriers. 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 3,339,531 on January 1, 1990 to 3,825,768 on December 31, 1994.\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 13,074 employees. The Company has written agreements with the Communications Workers of America (CWA) covering substantially all hourly employees. The current agreement between the Company and the CWA expires in March 1996 and the agreement between GTEL and the CWA expires in April 1997.\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 California Public Utilities Commission (CPUC) as to its intrastate business operations and by the Federal Communications Commission (FCC) as to its interstate business operations. Information regarding the Company's activities with the various regulatory agencies and revenue arrangements with other telephone companies can be found in Note 12 of the Company's consolidated financial statements included in Item 8.\nDuring 1994, the Company began implementation of a three-year $445 million re-engineering plan that will redesign and streamline processes. In the initial year of the plan, $113 million was expended to 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 Communications 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. In 1994, GTE announced plans to build a new video network over the next 10 years which will pass seven million homes in 66 key GTE markets. GTE has requested FCC approval to construct facilities in the initial three markets, including Ventura County, California, and expects to begin construction in 1995.\nIn Cerritos, California, GTE concluded testing of the capabilities of copper wire, coaxial cable and fiber optics for both video and telephony delivery. In July, 1994, GTE moved to a business-as-usual operation of the Cerritos video network, including the continued provision of near pay-per-view (Center Screen(sm)) and interactive (mainStreet(tm)) services. In order to continue to\nprovide these services and video signal transport to the local cable operator, GTE challenged the constitutionality of the federal statute which barred the participation of telephone companies and their affiliates in the delivery of video programming directly to customers within their telephone service territories. As a result of that challenge, the United States District Court for the Eastern District of Virginia ruled in favor of GTE and declared the federal statute unconstitutional. 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 Los Angeles, California, 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.\nDuring 1993, the CPUC approved a New Regulatory Framework (NRF) settlement agreement allowing GTE California to retain 100% of any earnings up to 15.5%, beginning in 1994. Under its prior agreement, GTE California was required to share 50% of any earnings over a 13% rate of return and refund 100% of any earnings over 16.5%. In September 1994, the CPUC issued a final order that authorized intraLATA toll competition (without pre-subscription) in California, effective January 1, 1995. It also provides for rate rebalancing with significant rate reductions for toll service and access charges while increasing basic local exchange rates closer to the actual cost of providing such service. Although the rate rebalancing is intended to be revenue neutral, its ultimate effect on revenue will depend, in part, on the extent to which rate reductions result in increased calling volumes. The decision does not permit rate increases to compensate for competitive losses of market share. GTE believes that the CPUC has over-estimated the calling volume that will be stimulated by reduced toll rates and has requested reconsideration of this aspect of the decision.\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 also 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 (80%), company facilities (13%), customer premises equipment (1%) and other (6%). From January 1, 1990 to December 31, 1994, the Company made gross property additions of $2.6 billion and property retirements of $1.8 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 California's Common Stock and 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 California Incorporated and Subsidiary\n__________\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 $445.2 million pretax charge for restructuring costs which reduced net income by $274.2 million.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nBUSINESS OPERATIONS\nGTE California Incorporated (the Company), a wholly-owned subsidiary of GTE Corporation (GTE), provides local exchange, network access and long distance telecommunications services throughout Southern and Central California. The Company serves over 3.8 million access lines in its operating territories with a substantial number of those lines in Southern California. The Company also markets telecommunications equipment and other deregulated products and services through GTEL, a wholly-owned subsidiary.\nRESULTS OF OPERATIONS\nNet income in 1994 was $435 million as compared to $73 million in 1993. The results for 1993 include one-time after-tax charges totaling $315 million to restructure operations and complete enhanced early retirement and voluntary separation programs and for the early retirement of high-coupon debt.\nExcluding these special items, net income increased 12% or $47 million in 1994 and 7% or $27 million in 1993. The 1994 increase is primarily the result of ongoing quality and cost control programs and a decrease in interest expense. The 1993 decrease reflected lower operating revenues due to voluntary rate reductions and 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.\nOPERATING REVENUES\nOperating revenues were $2.88 billion and $2.87 billion in 1994 and 1993, respectively. This reflects an increase of less than 1% or $7 million in 1994 and a decrease of 2% or $46 million in 1993.\nLocal network service revenues are comprised mainly of fees charged to customers for providing local exchange service. These revenues for 1994 and 1993 were $965 million and $976 million, respectively. This reflects a decrease of 1% or $11 million in 1994 compared to an increase of 4% or $38 million in 1993. The 1994 decrease is primarily due to a rate reduction related to the price cap index and the new regulatory framework (NRF) review partially offset by continued customer growth, as experienced through an increase in access lines of 3%. The 1993 increase was primarily due to a rate increase related to the Company's 1993 price cap index under the NRF, continued customer growth, as experienced through a 3% increase in access lines, and increased revenue from CentraNet(R) and other enhanced features.\nNetwork access service revenues are fees charged to interexchange carriers 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. These revenues for 1994 and 1993 were $670 million and $616 million, respectively. This reflects an increase of 9% or $54 million in 1994 compared to a decrease of 7% or $47 million in 1993. The 1994 increase is due to an 8% increase in minutes of use, driven in part by natural disasters in the first half of 1994, partially offset by lower rates while the 1993 decrease was primarily the result of lower interstate rates.\nThe Company's revenues for long distance services are provided under settlement arrangements with various telephone companies. These revenues were $961 million and $1.0 billion in 1994 and 1993, respectively. This reflects decreases of 4% or $43 million in 1994 and 2% or $19 million in 1993. The 1994 decrease is primarily due to rate reductions related to the price cap index and NRF review. The 1993 decrease was primarily due to a change in calling patterns.\nEquipment sales and service revenues for 1994 and 1993 were $158 million and $164 million, respectively. This reflects decreases of 3% or $6 million in 1994 and 9% or $17 million in 1993. The 1994 decrease is primarily the result of a reduction in revenues related to the Cerritos project, GTE's testing facility in California for various video services, and a decline in revenues from sales and rental of single line and key telephone systems, partially offset by an increase in revenue from voice messaging services. The 1993 decrease was primarily the result of a decline in revenues related to the CALNET project, a large government contract for various video services, and a decline in revenues from sales and rental of single line and key telephone systems, partially offset by an increase in revenue from voice messaging services. Revenue from the CALNET project is recognized on the percentage of completion method.\nOther operating revenues for 1994 and 1993 were $129 million and $116 million, respectively. This represents an increase of 11% or $13 million in 1994 compared to a decrease of 1% or $1 million in 1993. The 1994 increase is primarily due to the lower provisions for uncollectible accounts.\nOPERATING EXPENSES\nCost of sales and services for 1994 and 1993 was $634 million and $667 million, respectively. This represents decreases of 5% or $33 million in 1994 and 2% or $12 million in 1993. These decreases are primarily the result of ongoing quality and cost control programs resulting in a reduction in workforce. The 1994 decrease also reflects lower switched access expenses and installation and maintenance costs. The 1993 decrease was partially offset by costs associated with the adoption of SFAS No. 106 effective January 1, 1993. As a result of the adoption of the new standard, cost of sales and services increased $51 million.\nDepreciation and amortization was $580 million and $583 million in 1994 and 1993, respectively. This reflects a decrease of 1% or $3 million in 1994 compared to an increase of 3% or $20 million in 1993. The 1994 decrease is primarily due to lower average depreciation rates partially offset by higher average plant balances. The 1993 increase was primarily due to higher average plant balances and depreciation rates.\nMarketing, selling, general and administrative expenses were $842 million and $897 million in 1994 and 1993, respectively. The 1993 expenses include a one-time charge of $35 million associated with the enhanced early retirement and voluntary separation programs offered to eligible employees during the second quarter of 1993. Excluding this charge, marketing, selling, general and administrative expenses decreased 2% or $20 million and 4% or $40 million in 1994 and 1993, respectively. These decreases are primarily the result of ongoing quality and cost control programs resulting in a reduction in\nworkforce. The 1993 decrease was also due to lower advertising costs, partially offset by costs of $27 million associated with the adoption of SFAS No. 106.\nOTHER (INCOME) DEDUCTIONS\nInterest expense was $103 million and $121 million in 1994 and 1993, respectively. This represents a decrease of 15% or $18 million in 1994 and 8% or $10 million in 1993. These decreases are due to lower average long-term debt levels and lower average interest rates.\nIncome tax expense was $293 million and $71 million in 1994 and 1993, respectively. This reflects an increase of $222 million in 1994 compared to a decrease of $167 million in 1993. The changes are primarily due to corresponding changes in pretax income.\nCAPITAL RESOURCES AND LIQUIDITY\nManagement believes that the Company has adequate internal and external resources available to meet ongoing operating requirements for construction of new plant, modernization of facilities and payment of dividends. The Company generally funds its construction program from operations, although external financing is available. Short-term borrowings can be obtained through commercial paper borrowings or borrowings from GTE. In addition, a $2.8 billion line of credit is available to the Company through shared lines of credit with GTE and other affiliates to support short-term financing needs.\nThe Company's primary source of funds was cash from operations of $862 million in 1994 compared to $992 million in 1993. The decrease is primarily the result of an increase in receivables, partially offset by an increase in accounts payable and improved results from operations.\nCapital expenditures represent the largest use of funds during 1994, reflecting the Company's continued growth in access lines and modernization of current facilities and provisioning of new products and services. The Company's capital expenditures during 1994 were $468 million compared to $504 million during 1993. The Company's construction costs for 1995 are expected to approximate those of 1994. During 1994, the Company received approximately $14 million of proceeds from the sale of 5,400 access lines in California to Citizens Utilities Company.\nCash used in financing activities was $377 million in 1994 compared to $506 million in 1993. The Company retired $36 million in long-term debt in 1994 compared to $176 million in 1993. In November 1993, the Company called $785 million of high-coupon first mortgage bonds with proceeds from commercial paper borrowings. These bonds had coupons ranging from 8.5% to 11%. The cost of calling these bonds was reflected as an extraordinary after-tax charge of $20.2 million in the Consolidated Statements of Income. In February, 1994, the Company issued $300 million of 5 5\/8% Debentures, due 2001 to refinance a portion of the bonds being called. In March and April, 1994, respectively, the Company issued $250 million of 6 3\/4% Debentures due 2004 and $250 million of 8.07% Debentures due 2024 to refinance commercial paper. Dividends of $370 million were paid to the shareholders in 1994 compared to $297 million in 1993.\nREGULATORY AND COMPETITIVE TRENDS\nREGULATORY DEVELOPMENTS\nFundamental changes continue to significantly impact the telecommunications industry. During 1994, telecommunications legislation that would have changed the way the industry does business passed the House of Representatives, but was subsequently withdrawn from consideration. Telecommunications legislation has been introduced again in 1995. Federal and state regulatory activity directed toward changing the traditional cost-based rate of return regulatory framework for intrastate and interstate telephone services has also continued.\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.\nFurther information regarding the Company's activities with the various regulatory agencies is discussed in Note 12 of the Company's consolidated financial statements included in Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nCONSOLIDATED STATEMENTS OF INCOME GTE California Incorporated and Subsidiary\n(a) Includes billings to affiliates of $124,704, $136,800 and $135,043 for the years 1994 - 1992, respectively. (b) Includes billings from affiliates of $190,692, $174,743 and $178,125 for the years 1994 - 1992, respectively.\nCONSOLIDATED STATEMENTS OF REINVESTED EARNINGS\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED BALANCE SHEETS GTE California Incorporated and Subsidiary\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS GTE California Incorporated and Subsidiary\nSee Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS GTE California Incorporated and Subsidiary\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of GTE California Incorporated (the Company) and its wholly-owned subsidiary, GTEL. 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 $81.9 million, $152.7 million and $126.0 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 $190.7 million, $174.7 million and $178.1 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 $124.7 million, $136.8 million and $135.0 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 California Public Utilities Commission (CPUC) and adopted by the Federal Communications Commission (FCC). The provisions for depreciation and amortization were equivalent to composite annual rates of 7.1%, 7.4% and 7.4% 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 CPUC and Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of\nRegulation.\" 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. Long-term contracts are generally accounted for using the percentage-of-completion method with revenues recognized in the proportion that costs incurred bear to the estimated total costs to completion. Expected losses, if any, are charged to income currently.\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 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 8, 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\ntax 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 $109 million. The estimated fair value of long-term debt as of December 31, 1993, exceeded the carrying value by approximately $9 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.\nPRIOR YEARS' FINANCIAL STATEMENTS\nReclassifications of prior year data have been made in the financial statements where appropriate to conform to the 1994 presentation.\n2. RESTRUCTURING COSTS\nResults for 1993 included a one-time pretax restructuring charge of $445.2 million, which reduced net income by $274.2 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 $171.6 million to upgrade or replace existing customer service and administrative systems and enhance network software, $193.4 million for employee separation benefits associated with workforce reductions and $52.5 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 $113.4 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 $34.7 million which reduced net income by $21.2 million.\n3. PROPERTY REPOSITIONING\nOn December 31, 1994 the Company sold 5,400 access lines in the state of California to Citizens Utilities Company for $14 million in cash. This represents less than 1% of the Company's access lines. The transaction was accounted for as a sale.\n4. PREFERRED STOCK\nCumulative preferred stock, not subject to mandatory redemption, exclusive of amounts held in treasury, as of December 31, 1994 and 1993 is as follows:\n* Thousands of Dollars\nThere were no retirements, redemptions or other activity for the years 1994-1992.\nAt the Company's option, these series of preferred stock are redeemable at premiums, in whole or in part, on thirty days notice.\nThe 4 1\/2% Series (1945 issue) is entitled to one vote per share, with the right to vote cumulatively in the election of directors. Otherwise, the preferred shareholders have no voting rights.\nNo shares of preferred stock were reserved for officers and employees, or for options, warrants, conversions or other rights. The Company is not in arrears in its dividend payments at December 31, 1994.\n5. COMMON STOCK\nThe authorized common stock of the Company consists of 100,000,000 shares with a par value of $20 per share. 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, $4.8 million was restricted as to the payment of cash dividends on common stock under the terms of the Articles of Incorporation.\n6. LONG-TERM DEBT\nLong-term debt outstanding, exclusive of current maturities, is as follows:\nIn November 1993, the Company called $785 million of high-coupon first mortgage bonds with proceeds from commercial paper borrowings. These bonds had coupons ranging from 8.5% to 11%. The cost of calling these bonds is reflected as an extraordinary after-tax charge of $20.2 million in the Consolidated Statements of Income. In February 1994, the Company issued $300 million of 5 5\/8% Debentures, due 2001 to refinance a portion of the bonds being called. The Company issued in March and April of 1994, $250 million of 6 3\/4% Debentures due 2004 and $250 million of 8.07% Debentures due 2024 also to refinance the bonds called.\nThe aggregate principal amounts of bonds and debentures that may be issued is subject to the restrictions and provisions of the Company's indentures. None 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 (excluding amounts to be satisfied by securities held by the Company) 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.\n7. SHORT-TERM DEBT\nThe Company finances part of its construction program through the use of interim short-term loans, which are generally refinanced at a later date, or equity. Information relating to short-term borrowings is as follows:\nUnused lines of credit available to the Company to support outstanding commercial paper and other short-term financing needs are $2.0 million. In addition, a $2.8 billion credit line is available to the Company through shared lines of credit with GTE and other affiliates. These arrangements require payment of annual commitment fees of .1% of the unused lines of credit.\n8. 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 net unamortized regulatory asset balance at December 31, 1994 of $57.1 million and the net unamortized regulatory asset balance at December 31, 1993 of $2.8 million are reflected as other assets 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:\n9. 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 regulatory adjustment reflects the use of the aggregate cost method as required by the CPUC and results in $310.0 million and $263.7 million at December 31, 1994 and 1993, respectively, being reflected in other deferred credits in the accompanying Consolidated Balance Sheets.\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 $888.3 million and $979.7 million and vested benefit obligations of $794.1 million and $887.5 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 $16.0 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% 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 $3.4 million and the accumulated postretirement benefit obligations at December 31, 1994 by $44.5 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, among others, 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 $132.7 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 $9.9 million, $10.2 million and $11.2 million in 1994-1992, respectively.\n10. LEASE COMMITMENTS\nThe Company has noncancelable leases covering certain buildings, office space and equipment that contain varying renewal options for terms up to 26 years. Rental expense was $37.4 million, $31.3 million and $35.5 million in 1994-1992, respectively. Minimum rental commitments for noncancelable leases through 1999 do not exceed $14.0 million annually and aggregate $9.5 million thereafter.\n11. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment, which is stated at cost, is summarized as follows at December 31:\n12. REGULATORY MATTERS\nThe Company is subject to regulation by the FCC for interstate business and the CPUC for intrastate operations.\nINTRASTATE SERVICES\nEffective January 1, 1990 the CPUC adopted the new regulatory framework (NRF) for the Company. The new framework replaced the traditional \"rate case\" process with a framework that was centered around a Price Cap Index (PCI) mechanism with \"sharing\" of intrastate earnings (those earnings subject to the CPUC regulation) above a benchmark rate of return. This plan is designed to stimulate productivity and efficiencies with a portion of these gains flowing directly to the customer. In May 1992, the CPUC initiated a proceeding to review the NRF plan. On September 1, 1993, the CPUC ordered that modifications be made to the Company's NRF plan. Effective January 1, 1994, the Company is required to refund to customers all earnings over a 15.5% rate of return. As part of the settlement agreement approved by the CPUC, the CPUC eliminated the previous sharing mechanism where half of any earnings over the 13% rate of return benchmark would be refunded to ratepayers and the Company agreed to reduce its rates by $53 million. On December 17, 1993, the CPUC approved the Company's 1994 price cap index filing which resulted in a rate reduction of approximately $100 million. This reduction includes the $53 million rate reduction agreed to by the Company in the NRF review.\nUnder NRF, rates are adjusted annually by the PCI which is based on inflation minus a productivity improvement factor. Rates for partially competitive services (i.e. Centrex and custom calling features) may be priced below the price cap within a range set by the CPUC. Rates are also adjusted for exogenous events that are beyond the control of management as defined in this plan. Fully competitive services (eg., directory advertising) are not subject to pricing limits set by the CPUC.\nThe 1992 index adjustment resulted in a rate reduction of approximately $30 million, which the CPUC approved in an order issued December 18, 1991. The 1993 price cap index adjustment resulted in a rate increase of $11 million, which the CPUC approved in an order issued December 16, 1992. In 1992 and 1993 the Company refunded to its customers approximately $30 million and $33 million, respectively, in accordance with the \"sharing mechanism\" of the NRF. The refunds represented 50% of the Company's 1991 and 1992 intrastate earnings over the 13% rate of return benchmark.\nIn September 1994, the CPUC issued a final order that authorized intraLATA toll competition (without pre-subscription) in California, effective January 1, 1995. It also provides for rate rebalancing with significant rate reductions for toll service and access charges while increasing basic local exchange rates closer to the actual cost of providing such service. Specifically, the CPUC reduced rates for the Company's toll services by an average of 42% and its switched access rates by more than 50% while offsetting the revenue impacts by increasing other rates closer to cost. Monthly service rates for flat-rated residential customers increased from $11.21 to $17.25 while measured business customers rates increased from $10.46 to $19.22. Although the rate rebalancing is intended to be revenue neutral, its ultimate effect on revenue will depend, in part, on the extent to which rate reductions result in increased calling volumes. The decision does not permit rate\nincreases to compensate for competitive losses of market share. GTE believes that the CPUC has over-estimated the calling volume that will be stimulated by reduced toll rates and has requested reconsideration of this aspect of the decision.\nThe CPUC adopted pricing standards and contracting rules which provide the Company increased flexibility to respond to competition. Tariff prices for competitive services can be decreased on ten days notice from a pre-set ceiling and can subsequently be increased up to the ceiling on 30 days notice. Contracts can utilize a new \"express contracting procedure\" which allows contracts to be effective in 14 days rather than the 40 days previously required. In addition, \"express contracts\" do not require CPUC approval.\nOn October 12, 1994, the CPUC issued a decision which authorizes further proceedings to be held with regard to a previous Commission decision that adopted accrual accounting for SFAS 106. The previous CPUC decision permitted the Company recovery of its SFAS 106 costs as an exogenous factor in annual price cap filings. This decision reaffirmed the CPUC decision to adopt SFAS 106 for ratemaking purposes. However, the issue of exogenous recovery will be further reviewed and any revenues collected in rates subsequent to October 12, 1994, are subject to refund pending further investigation. The Company is currently recovering $42 million annually in rates for SFAS 106 costs. No amounts related to this matter have been reserved.\nIn December, 1994, the CPUC issued a decision which adopts an initial procedural plan to facilitate opening local exchange telecommunications markets to competition by January 1, 1997. This plan allows parties until March 31, 1995 to negotiate a settlement on implementation issues. If the parties are unable to resolve the issues, the CPUC will intervene. Concerns to be addressed include issuing two orders in early 1995 to resolve Open Network Architecture (ONA) technical issues on expanded interconnection and local transport restructure. The second order would adopt a methodology for developing long-run incremental cost studies. One docket will be launched addressing Universal Service Issues and another docket will be launched addressing pre-subscription issues. Interested parties will be allowed to provide recommendations on the scope and content of interim rules for local competition. The next NRF review proceeding will be initiated in May 1995, if no settlement can be reached.\nOn December 7, 1994, the CPUC issued Decision 94-12-003 approving and adopting, without modification, new depreciation rates for the Company effective January 1, 1995. This decision represents the Company's first uncontested approval of depreciation rates since the inception of the NRF.\nIn March 1991, the merger of the Company's parent, GTE, and Contel Corporation (Contel) was consummated. In a decision issued on March 13, 1991 the CPUC approved a stipulation agreement which tentatively approved the merger of GTE and Contel. The decision also established a second phase of the proceeding in which GTE was directed to show that the merger meets certain California statutory requirements. GTE was also ordered to submit a plan for the merger of the Contel and GTE regulated California subsidiaries. On September 14, 1992 the Company and Contel of California, Inc. joined with GTE and Contel in filing a comprehensive plan with the CPUC to merge Contel of California, Inc. into the Company.\nOn December 23, 1993, an Administrative Law Judge issued a proposed Phase II order allowing the merger of Contel of California, Inc. and the Company. The proposed order would add a third phase to the merger proceeding in which the issues of a start-up revenue requirement for Contel's pre-merger operations and rate integration of the respective company tariffs will be considered.\nOn April 20, 1994 the CPUC issued a decision giving final approval to the merger of Contel of California, Inc. into the Company. The decision requires the merging companies to flow through to their ratepayers all of the estimated savings that will be produced from the merger. This flow through requirement is based on the CPUC's interpretation of certain statutory requirements. The CPUC, however, provided the parties with the opportunity to supplement the evidentiary record to show why the estimated merger savings should be apportioned between ratepayers and shareholders. That filing was made on April 29, 1994. By making the filing, the effective date of the decision approving the merger has been delayed. The Company and other interested parties filed reports and comments pursuant to this proceeding.\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 return above 12.25% up to 16.25%, and all returns higher than 16.25%, by temporarily lowering 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 $11.1 million effective July 1, 1992, $6.3 million effective July 17, 1992, $17.6 million effective October 2, 1992 and $45.0 million effective December 15, 1992.\nSIGNIFICANT CUSTOMER\nRevenues received from AT&T Corp. include amounts for access, billing and collection and interexchange leased facilities revenues during the years 1994-1992 under various arrangements and amounted to $281.6 million, $282.4 million and $349.1 million, respectively.\n13. 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:\n14. QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized 1994 and 1993 quarterly financial data is as follows:\n(a) Net income includes a $20.2 million extraordinary charge for the early retirement of debt. Income before extraordinary charge was $86.8 million. (b) Net operating income includes a $445.2 million pretax charge for restructuring costs which reduced net income by $274.2 million.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of GTE California Incorporated:\nWe have audited the accompanying consolidated balance sheets of GTE California Incorporated (a California 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 California 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 Accounts. 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 organization 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.\nC. MICHAEL CRAWFORD 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\nReference is made to the Registrant's Proxy Statement covering the Annual Meeting of Shareholders to be held April 12, 1995, pages 3 and 4, which is incorporated herein by reference. A complete list of executive officers of the Registrant as of March 1, 1995 is provided below.\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.\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) C. Michael Crawford 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.\n3) Charles J. Somes was elected Secretary replacing Kenneth J. Okel who was appointed Assistant Vice President and Associate General Counsel - Regional Operations - Western, GTE Telephone Operations.\nItem 11.","section_11":"Item 11. Executive Compensation\nReference is made to the Registrant's Proxy Statement covering the Annual Meeting of Shareholders to be held April 12, 1995, pages 4 to 16, which is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nReference is made to the Registrant's Proxy Statement covering the Annual Meeting of Shareholders to be held April 12, 1995, page 16, which is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nReference is made to the Registrant's Proxy Statement covering the Annual Meeting of Shareholders to be held April 12, 1995, pages 3, 4 and 17, which 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 GTE California 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 the one 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 September 10, 1992 between GTE California Incorporated and Contel of California, Inc. (Exhibit 2.1 of the 1993 Form 10-K. File No. 1-6417).\n3* Articles of Incorporation and Bylaws (Exhibit 3 of the 1988 Form 10-K, File No. 1-6417).\n4* Indenture dated as of December 1, 1993 between GTE California 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. 33-51541).\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 CALIFORNIA INCORPORATED AND SUBSIDIARY\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Thousands of Dollars)\nNOTES:\n(1) Charges for purpose for which reserve was created. (2) Recoveries of previously written-off amounts. (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 CALIFORNIA INCORPORATED ----------------------------- (Registrant)\nDate March 24, 1995 By C. MICHAEL CRAWFORD -------------- ----------------------------------- C. MICHAEL CRAWFORD 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 -------------\n2.1* Agreement of Merger, dated September 10, 1992 between GTE California Incorporated and Contel of California, Inc. (Exhibit 2.1 of the 1993 Form 10-K. File No. 1-6417).\n3* Articles of Incorporation and Bylaws (Exhibit 3 of the 1988 Form 10-K, File No. 1-6417).\n4* Indenture dated as of December 1, 1993 between GTE California 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. 33-51541).\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":"15840_1994.txt","cik":"15840","year":"1994","section_1":"Item 1. Business\n(a) General Development of Business\nThe Company was founded as a partnership in 1901. It was incorporated in Missouri in 1902 and reincorporated in Delaware in 1969. Its corporate headquarters are located in Kansas City, Missouri, and principal plants and offices are operated throughout the continental United States. Principal international operations are conducted through Butler Building Systems, Ltd., a wholly owned United Kingdom subsidiary acquired in 1991, and a Saudi Arabian joint venture.\nThe Company and its subsidiaries are primarily engaged in the design, manufacture and sale of systems and components for nonresidential structures. Products and services fall into three principal business segments: (1) Building Systems, consisting primarily of custom designed and pre-engineered steel and wood frame building systems for commercial, community, industrial and agricultural uses; (2) Construction and construction management services for purchasers of large, complex or multiple site building projects; and (3) Other Building Products for low, medium and high-rise nonresidential buildings, consisting primarily of curtain wall and storefront systems, skylights and roof vents. This group also includes the manufacture and sale of grain storage bins and the distribution of grain handling and conditioning equipment.\nThe Company's products are sold primarily through numerous independent dealers. Other Company products are sold through a variety of distribution arrangements.\n(b) Financial Information about Industry Segments\nThe information required by Item 1(b) is hereby incorporated by reference to page 20 and 21 of the Company's Annual Report furnished to the Commission pursuant to Rule 14a-3(b) and attached as Exhibit 13.0 to this report (see also items 6, 7, and 8 of this report).\n(c) Narrative Description of Business\nBuilding Systems The Company's largest segment, Building Systems, includes the U.S. steel and wood frame pre-engineered building systems; Butler European operations consisting of 100% wholly owned subsidiaries in the United Kingdom, France, and Germany; and a 30% owned Saudi Arabian joint venture (Saudi Building Systems, Ltd.), all of which manufacture and market pre-engineered steel frame building systems; Butler Real Estate, Inc. a real estate developer; a 45% owned Japanese joint venture marketing pre-engineered building systems to Japanese firms to meet their U.S. and international building requirements; sales offices in Canada and Mexico; and representative offices in China.\nThe Company's building systems consist primarily of custom designed and pre-engineered one to five-story steel and one to two-story wood framed buildings for commercial, community, industrial and agricultural uses such as office buildings, manufacturing facilities, warehouses, schools, shopping centers and farm buildings. Principal product components of the systems are structural members and a variety of pre-engineered wall and roof components. These are fabricated according to standard or customer specifications and shipped to building sites for\nassembly by independent dealers. Building components are manufactured in plants located at Galesburg and Charleston, Illinois; Laurinburg, North Carolina; Birmingham, Alabama; Visalia, California; Annville, Pennsylvania; San Marcos, Texas; Lester Prairie, Minnesota; Ottawa, Kansas; and Clear Brook, Virginia.\nButler Building Systems, Ltd. manufactures and markets the Company's pre-engineered steel frame buildings primarily for the United Kingdom and European markets from its facility in Kirkcaldy, Scotland. Saudi Building Systems, Ltd. manufactures and markets pre-engineered steel frame buildings for Middle Eastern markets at manufacturing facilities located in Jeddah, Saudi Arabia. The Company serves the Canadian market through a branch office in Burlington, Ontario.\nBuilding Systems' products are distributed throughout the world by independent Butler dealers. The dealers provide construction services and in many cases complete design and engineering capabilities.\nNonresidential pre-engineered buildings compete with ordinary forms of building construction in the low-rise commercial, community, industrial and agricultural markets. Competition is primarily based upon cost, time of construction, appearance, thermal efficiency and other specific customer requirements.\nThe Company also competes with numerous pre-engineered steel frame building manufacturers doing business within the United States, Canada, and the United Kingdom. Approximately five of these manufacturers account for the majority of industry sales. The Company believes that its 1994 sales of steel frame pre-engineered buildings within the United States exceeded those of any other nonresidential steel frame pre-engineered buildings manufacturer, with its next largest competitors being Varco-Pruden Buildings, a division of United Dominion Industries Ltd., Ceco and Star Buildings Systems combined, a division of Robertson - Ceco Corporation, American Buildings Company, and NCI Building Systems, Inc. Competition among manufacturers of pre-engineered buildings is based primarily upon price, service, product design and performance, and marketing capabilities.\nThe Company's Lester wood frame buildings business ranks second in sales to the industry leader, Morton Buildings, Inc., a major manufacturer which sells direct to the end user.\nButler Real Estate, Inc., a wholly-owned subsidiary of the Company, provides real estate development services in cooperation with Butler dealers. On the basis of commitments to lease obtained from credit worthy customers, Butler Real Estate, Inc. acquires building sites, arranges with Butler dealers for construction of project improvements, and then sells the completed projects to investors.\nBMC Real Estate, Inc., a wholly-owned subsidiary of the Company, participates solely in four land development ventures. Three of the ventures are partnerships with ownership interests ranging from 35% to 50%. The fourth venture is wholly-owned.\nConstruction Services The Company's Construction Services segment consists of a wholly-owned construction subsidiary, BUCON, Inc. which provides comprehensive design, planning, execution and construction management services to major purchasers of construction. Revenues of the segment are derived primarily from general contracting. In addition, the Construction\nServices segment performs \"furnish and erect\" and \"materials only\" subcontracts using products from several Company divisions, predominantly the Company's Buildings Division. Competition is primarily based upon price, time necessary to complete a project, design, and product performance. Construction Services competes with national, regional, and local general contracting firms, and whenever possible, performs projects in conjunction with independent Butler dealers.\nOther Building Products This segment includes the operations of the Vistawall, Walker and Grain Systems Divisions. The Walker business was sold December 6, 1993. The Vistawall business designs, manufactures and markets architecturally oriented component systems for the nonresidential construction market. The Grain Systems' business manufactures and markets grain storage bins and also distributes grain conditioning and handling equipment.\nThe Vistawall Division designs, manufactures and sells aluminum curtain wall systems for mid and high-rise office markets, and entry doors and other standard storefront products for low-rise retail and commercial markets. The products are distributed on a material supply basis to either curtain wall erection subcontractors or general contractors, and through distribution warehouses to glazing contractors for the storefront and entry door products. Manufacturing and distribution facilities are located in Lincoln, Rhode Island; Atlanta, Georgia; Modesto and Hayward, California; Cincinnati and Cleveland, Ohio; Terrell, Houston and Dallas, Texas; Tampa, Florida; Washington, D.C.; Chicago, Illinois; and St. Louis, Missouri. The Division operates in highly competitive markets with other national manufacturers which operate multiple plants and distribution facilities, and with regional manufacturers. Competition is primarily based on cost, delivery capabilities, appearance and other specific customer requirements.\nThe Vistawall Division at its Terrell, Texas location also designs, manufactures and installs Naturalite skylights of all types, from the more standard designs used in commercial and industrial buildings, to highly complex engineered solutions for monumental building projects. In addition, the Division designs and manufactures roof accessories, such as smoke and heat vents, for conventional and pre-engineered buildings. The Division markets its Naturalite products through its existing independent representative organization. There are numerous competitors in this industry with competition primarily based on price, engineering and installation capabilities, delivery, and other specific customer requirements.\nThe Walker Division, which was sold to The Wiremold Company in December, 1993, manufactured a full array of power, lighting, electronics and communication distribution systems for office, retail, and institutional buildings. Principal products consisted of underfloor duct and cellular floor systems.\nThe Grain Systems Division manufactures and markets grain storage bins from its Kansas City, Missouri plant. It also distributes grain conditioning and handling equipment. The Division's products are sold primarily to farmers and commercial grain elevators through a nationwide network of independent dealers. Products are also manufactured for export. Grain systems are sold in highly competitive markets in direct competition with national companies and smaller regional manufacturers. Competition is principally based on price,\ndelivery schedules, and product performance.\nManufacturing and Materials The Company's manufacturing operations include most conventional metal fabricating operations, such as punching, shearing, welding, extruding and forming of sheet and structural steel and aluminum. The Company also operates painting and anodizing lines for structural steel and aluminum components, respectively. Wood frame manufacturing operations include sawing and truss fabrication. The principal materials used in the manufacture of the Company's products include steel, aluminum, wood, and purchased parts. All materials are presently available to the Company in sufficient quantities to meet current needs.\nSeasonal Business Historically, the Company's sales and net earnings have been affected by cycles in the general economy which influence nonresidential construction markets (see in particular Item 7 of this report). In addition, the Company's sales usually reach a peak during the summer when construction activity is highest. Sales for the first, second, third and fourth quarters of 1994 were $117 million, $175 million, $190 million and $210 million, respectively.\nBacklog The Company's backlog of orders believed to be firm was $237 million at December 31, 1994 and $140 million at December 31, 1993. The Construction Services segment, where margins are significantly lower than those associated with product sales, accounted for $33 million of the year-end 1994 backlog and $25 million of the year-end 1993 backlog.\nEmployees At December 31, 1994 the Company employed 3,564 persons, 2,565 of whom were non-union employees, and 999 were hourly paid employees who were members of four unions. At December 31, 1993 the Company employed 3,064 persons. A labor agreement with the union at the Buildings Division Galesburg, Illinois plant will expire in 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal plants and physical properties of the Company consist of the manufacturing facilities described under Item 1, and the Company's executive offices in Kansas City. The 142,000 square foot Vistawall facility located in Lincoln, Rhode Island which has light manufacturing and fabrication operations is classified under \"Assets held for sale\". The 144,000 square foot Garland, Texas facility previously used for the operations of Naturalite was sold in January, 1995 and was recorded in \"Investments and other assets\". The proceeds from the sale were used to retire the existing mortgage on the property. Through a subsidiary, the Company also owns a land development venture with property located on a 108 acre site in San Marcos, Texas. The property is recorded in \"Assets held for sale\" and described in the \"Real Estate Subsidiaries\" footnote on page 19 in the Company's Annual Report. All other plants and offices described under Item 1 are utilized by the Company and are generally suitable and adequate for the business activity conducted therein. The Company's manufacturing facilities described under Item 1, along with current outsourcing agreements with various fabricators, have production capabilities sufficient to meet current and foreseeable needs.\nExcept for leased facilities listed below, all of the Company's principal plants and offices are owned:\n(1) Leased space used for the Company's executive offices in Kansas City, Missouri (104,524 sq. ft. lease expiring in the year 2001 with an option to renew).\n(2) Leased space used for the Vistawall Division plant in Terrell, Texas (145,000 sq. ft. and 121,000 sq. ft. with leases expiring in 2006 and 1995, respectively, both containing options to renew), and fabrication and distribution facilities in Dallas and Houston, Texas; St. Louis, Missouri; Chicago, Illinois; Washington, D.C.; Cincinnati and Cleveland, Ohio; Atlanta, Georgia; Tampa, Florida; and Modesto and Hayward, California (215,000 sq. ft. leased with various expiration dates).\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no material legal or environmental proceedings pending as of March 9, 1995. Proceedings which are pending consist of matters normally incident to the business conducted by the Company and taken together do not appear to be material.\nItem 4.","section_4":"Item 4. Submissions of Matters to a Vote of Security Holders.\nNo matters have been submitted to a vote of stockholders since the last annual meeting of shareholders on April 19, 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nIncorporated by reference to the information under \"Quarterly Financial Information (Unaudited)\", \"Price Range of Common Stock (Unaudited)\" and \"Historical Review 1994-1990\" on pages 26 and 28 of the Annual Report.\nIn September, 1994 the Board of Directors approved the resumption of a regular cash dividend, at an indicated annual rate of 40 cents per share. The initial 10 cent quarterly payment was made in October 1994. The Company has limited restrictions on the payment of dividends based on certain debt covenants of the Note Agreement dated June 1, 1994, between the Company and four insurance companies (incorporated by reference to the Form 10-Q for the quarter ended June 30, 1994, as indicated under Item 14). As of December 31, 1994 the Company had approximately $23.4 million of retained earnings available for cash dividends.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nIncorporated by reference to the information under \"Historical Review 1994-1990\" on page 28 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 to the information under \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 12 and 13 of the Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIncorporated by reference to the consolidated financial statements and related notes on pages 14 through 27 of the 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 as to Directors is incorporated herein by reference to pages 3 through 5 of the Proxy Statement. The Executive Officers, their ages, their positions and offices with the Company and their principal occupations during the past five years are shown below:\nCorporate Executive Officers\nRobert H. West - age 56, Chairman of the Board and Chief Executive Officer; Chairman of the Executive Committee and member of the Board Organization Committee. He joined the Company in 1968, became President in 1978 and Chairman of the Board in 1986. Mr. West is a director of Commerce Bancshares, Inc., Santa Fe Pacific Corp., Kansas City Power & Light Company, and St. Luke's Hospital. He is a trustee of the University of Missouri at Kansas City.\nDonald H. Pratt - age 57, President; member of the Executive Committee. He joined Butler in 1965, became Executive Vice President in 1980, and President of the Company in 1986. Mr. Pratt is also a director of Union Bancshares, Inc., Wichita, Kansas, and is a trustee of the Kansas City Art Institute and Midwest Research Institute. He serves on the FFA Sponsors Advisory Board.\nRichard O. Ballentine - age 58, Vice President, General Counsel, and Secretary since 1978. He joined Butler in 1975 as Vice President - Legal.\nJohn T. Cole - age 44, Controller since 1990. He joined Butler in 1977 and previously was Corporate Audit Manager.\nJohn J. Holland - age 44, Vice President - Finance since 1990. He joined Butler in 1980 and became Vice President - Controller in 1986.\nJohn W. Huey - age 47, Vice President - Administration since 1993 and Assistant Secretary since 1987. He joined Butler in 1978 and was previously Assistant General Counsel.\nLarry C. Miller - age 38, Treasurer since 1989. He joined Butler in 1980 and became Assistant Treasurer in 1985.\nDivision Executive Officers\nMoufid (Mike) Alossi - age 52, President, Butler World Trade since 1993. He joined Butler in 1968 and previously was Vice President-International Sales and Marketing.\nWilliam D. Chapman - age 52, President, International Operations since 1992. He joined Butler in 1979 and was previously Vice President, International Operations.\nThomas J. Hall - age 49, President, Butler Real Estate, Inc. since 1991. He joined Butler in 1969, and was named Vice President and General Manager of Butler Real Estate, Inc. in 1987.\nLarry D. Hayes - age 56, President, Lester Building Systems Division since 1991. He joined Butler in 1975 and previously was President, Rural Systems Division.\nRichard S. Jarman - age 48, President, Buildings Division since 1986. He joined Butler in 1974.\nWilliam L. Johnsmeyer - age 47, President Butler Construction (Bucon, Inc.) since 1990. He joined Butler in 1982 and became President, Walker Division in 1984.\nRobert J. Kronschnabel - age 59, President, Grain Systems Division since 1994. He joined Butler in 1979 and was previously President, Naturalite\/EPI in 1988 and became Vice President and General Manager, Grain Systems Division in 1991.\nNelson R. Markel - age 48, Managing Director, Butler Europe since 1991 and was previously Marketing Manager, Buildings Division.\nRonald F. Rutledge - age 53, President Vistawall Division since 1984 when he joined Butler.\nItem 11.","section_11":"Item 11. Executive Compensation.\nIncorporated by reference to the information under \"Report on Executive Compensation\", \"Summary Compensation Table\" and \"Aggregated Option\/SAR Exercises and Fiscal Year-End Option\/SAR Value Table\" on pages 7 through 11 of the Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nIncorporated by reference to the information under \"Beneficial Ownership Table\" on pages 13 and 14 of the Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nIncorporated by reference to the information under \"Election of Class C Directors\" on pages 2 through 9 and \"Report on Executive Compensation\" in the Proxy Statement.\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:\nConsolidated Balance Sheets as of December 31, 1994 and 1993.\nConsolidated Statements of Earnings and Retained Earnings - Years Ended December 31, 1994, 1993 and 1992.\nConsolidated Statements of Cash Flow - Years Ended December 31, 1994, 1993 and 1992.\nNotes to Consolidated Financial Statements.\nThe foregoing have been incorporated by reference to the Annual Report as indicated under Item 8.\n(b) Financial Statement Schedules:\nAuditors' Report on Financial Statement Schedule\nIX - Valuation and Qualifying Accounts\nAll other schedules are omitted because they are not applicable or the information is contained in the consolidated financial statements or notes thereto.\n(c) Exhibits:\n3.1 Certificate of Incorporation (incorporated by reference to Exhibit 3.5 to Company's Form 10-K for year ended, December 31, 1986).\n3.2 Bylaws of Butler Manufacturing Company (incorporated by reference to Exhibit 3.7 to Company's Form 10-K for year ended December 31, 1987).\n4.1 Note Agreement between the Company and four Insurance Companies dated as of June 1, 1994 (incorporated by reference to Exhibit 4 of the Company's Form 10-Q for the quarter ended June 30, 1994).\n10.1 Butler Manufacturing Company Executive Deferred Compensation Plan as amended (incorporated by reference to Exhibit 10.2 to the Company's Form 10-K for the year ended December 31, 1989).\n10.2 Butler Manufacturing Company Stock Incentive Plan for 1987, as amended (incorporated by reference to Exhibit 10.1 to the Company's Form 10-K for the year ended December 31, 1990).\n10.3 Butler Manufacturing Company Stock Incentive Plan of 1979, as amended (incorporated by reference to Exhibit 10.2 to the Company's Form 10-K for the year ended December 31, 1990).\n10.4 Form of Change of Control Employment Agreements, as amended, between the Company and each of six executive officers (incorporated by reference to Exhibit 10.3 to the Company's Form 10-K for the year ended December 31,1990).\n10.5 Copy of Butler Manufacturing Company Supplemental Benefit Plan as amended and restated.\n10.6 Form of Butler Manufacturing Company Split Dollar Life Insurance Agreement (Collateral Assignment Method; Bonus Arrangement) entered into between the Company and certain executive officers.\n10.7 Form of Butler Manufacturing Company Split Dollar Life Insurance Agreement (Collateral Assignment Method; Roll Out Arrangement) entered into between the Company and certain executive officers.\n13.0 Butler Manufacturing Company 1994 Annual Report (only the information expressly incorporated herein by reference).\n22.0 Set forth below is a list as of March 9, 1995 of subsidiaries of the Company and their respective jurisdictions of incorporation. Subsidiaries not listed, when considered in the aggregate as a single subsidiary, do not constitute a significant subsidiary.\nJurisdiction of Subsidiary Incorporation ---------- ------------- Butler Export, Inc. Barbados Butler Building Systems, Ltd. Scotland Butler Bausysteme GmbH Germany Butler Systemes de Construction SARL France BMC Real Estate, Inc. Delaware BUCON, Inc. Delaware Butler Real Estate, Inc. Delaware Butler Holdings, Inc. Delaware Lester's of Minnesota, Inc. Minnesota\n24.0 Power of Attorney to sign this Report by each director.\n27.0 Financial Data Schedule\nNo reports on Form 8-K were filed by the Company during the quarter ended December 31, 1994.\nThe calculation of the aggregate market value of the Common Stock of the Company held by non-affiliates as reflected on the front of the cover page is based on the assumption that non-affiliates do not include directors. Such assumption does not reflect a belief by the Company or any director that any director is an affiliate 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 on this 8th day of March, 1995.\nBUTLER MANUFACTURING COMPANY\nBY \/S\/ Robert H. West --------------------------------- Robert H. West Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on the dates indicated.\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nThe Board of Directors Butler Manufacturing Company\nWe consent to the incorporation by reference in Registration Statements Nos. 33-14464, 2-63830, 2-55753 and 2-36370 on Form S-8 and the related Prospectus dated June 11, 1987, with Appendix dated March 7, 1995, of Butler Manufacturing Company of our report dated February 3, 1995 which contained an explanatory paragraph regarding the adoption of Statements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and No. 109, \"Accounting for Income Taxes\", relating to the consolidated balance sheets of Butler Manufacturing Company and subsidiaries as of December 31, 1994, and 1993, and the related consolidated statements of earnings and retained earnings and cash flows and the related schedule for each of the years in the three-year period ended December 31, 1994, which reports appear in or are incorporated by reference in the Annual Report on Form 10-K of Butler Manufacturing Company for the fiscal year ended December 31, 1994. We also consent to the reference to our firm under the heading \"Experts\" in the Prospectus to the Registration Statements.\n\/S\/ KPMG PEAT MARWICK LLP ------------------------- KPMG PEAT MARWICK LLP Kansas City, Missouri March 24, 1995\nBUTLER MANUFACTURING COMPANY AND SUBSIDIARIES KANSAS CITY, MISSOURI\nConsolidated Financial Statement Schedules (Form 10-K)\nDecember 31, 1994, 1993 and 1992\n(With Auditors' Report Thereon)\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Butler Manufacturing Company:\nUnder date of February 3, 1995, we reported on the consolidated balance sheets of Butler Manufacturing Company and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings and retained earnings and cash flows for each of the years in the three-year period ended December 31, 1994, as contained in the 1994 Annual Report. That report included an explanatory paragraph regarding the adoption of Statements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and No. 109, \"Accounting for Income Taxes\". 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. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this consolidated financial statement schedule based on our audits.\nIn our opinion, such schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material aspects, the information set forth therein.\n\/S\/ KPMG PEAT MARWICK LLP ------------------------- KPMG PEAT MARWICK LLP Kansas City, Missouri February 3, 1995\nS-1\nSCHEDULE IX\nBUTLER MANUFACTURING COMPANY AND SUBSIDIARIES\nValuation and Qualifying Accounts\n(Thousands of Dollars)\n(A) Includes acquisition and disposition of divisions and subsidiaries.\n(B) \"Credited to earnings\" reflects adjustments to the original estimated loss provision for receivables. This adjustment is due to a reassessment of the collection status of trade receivables made during the year.\nS-2","section_15":""}
{"filename":"846657_1994.txt","cik":"846657","year":"1994","section_1":"ITEM 1. BUSINESS\nBACKGROUND\nGENERAL\nEljer Industries, Inc. through its subsidiaries (\"Eljer Industries\" or the \"Company\"), is a leading manufacturer of high quality building products for residential and commercial construction, remodeling, repair and do-it-yourself markets. Eljer Industries manufactures and markets plumbing and heating, ventilating and air conditioning (\"HVAC\") products in North America and HVAC products in Europe. The Company markets its products through wholesale distribution channels and, in North America, directly to building products retailers. In North America, Eljer Industries is one of three leading full-line suppliers of bath and kitchen fixtures and faucets and is a leading supplier of registers, grilles and venting systems. In Europe, Eljer Industries is a leading manufacturer of prefabricated chimneys and venting systems. During fiscal years 1993, 1992 and 1991, revenues from sales of plumbing products comprised approximately 59%, 54% and 56%, respectively, of the Company's revenues, and the balance of its revenues was derived from HVAC products.\n. North American Operations\nEljer Plumbingware manufactures and markets a full line of plumbing fixtures, including vitreous china toilets and lavatories and enameled cast iron tubs, whirlpools, sinks and lavatories. It also markets faucets manufactured by United States Brass Corporation (\"U.S. Brass\"), an indirect wholly-owned subsidiary of Eljer Industries.\nU.S. Brass manufactures and markets a full range of faucets, plumbing supplies, connectors and polybutylene plumbing systems in the United States.\nSelkirk and Dry manufacture and market HVAC products, including registers, grilles, venting systems, prefabricated chimneys, air diffusers and fireplaces. Combined, Selkirk and Dry (\"Selkirk\/Dry\") are a market leader for registers, grilles and venting systems in North America.\n. European Operations\nSelkirk Europe manufactures and markets a full line of prefabricated chimneys and venting systems for commercial, industrial and residential, repair, fuel conversion and new construction. The conversion from coal to oil and gas for energy is a major source of demand for Selkirk Europe's venting products. Selkirk Europe is a market leader for sales of these products in Europe, and also sells the products in many other markets around the world. The Europa chimney, one of Selkirk Europe's leading products, can be used to vent exhaust from furnaces and boilers and is particularly well suited for \"fast track\" construction, which is used in Europe.\nHISTORY\nThe \"Eljer\" business name traces its origin to a plumbing supply manufacturing business formed in 1904. The Company's North American HVAC products business originated in 1925, U.S. Brass became a plumbing company in 1962 and the Company's European business dates from 1964. Through various transactions in the 1980's, Household International, Inc. (\"Household\") acquired these businesses that now make up Eljer Industries.\nEljer Industries itself was organized under the laws of the State of Delaware on January 26, 1989, as a wholly-owned subsidiary of Household. On April 14, 1989 (the \"Distribution Date\"), all of the outstanding shares of common stock of Eljer Industries were distributed to holders of Household common stock (the \"spin-off\"). Prior to the Distribution Date, the entities now operating the Eljer Industries businesses were\nsubsidiaries and divisions of Household Manufacturing, Inc. (\"HMI\"), or Household Manufacturing, Limited, wholly-owned subsidiaries of Household. Pursuant to a Reorganization and Distribution Agreement, entered into by Household, Eljer Industries and other companies, Eljer Industries declared and paid a cash dividend to Household and made other cash payments to repay certain HMI revolving bank debt. Household agreed through a reimbursement agreement to provide Eljer Industries with beginning equity of $84.4 million after all payments and reimbursements were made. In mid-January 1993, the Company initiated discussions with Household to recover damages allegedly incurred by the Company in connection with the spin-off by Household in 1989. Household commenced a lawsuit on February 5, 1993, in the Delaware Chancery Court for a declaratory judgment that Household has no liability to the Company arising out of the spin-off. On February 11, 1993, the Company sued Household in state court in Dallas County, Texas, claiming that Household breached the contractual agreements in connection with the spin-off and is seeking to recover unspecified monetary damages. See Note 14 to the Consolidated Financial Statements in Item 8 for further discussion.\nRECENT DEVELOPMENTS\nPENDING LEGAL PROCEEDINGS\nOn March 14, 1994, the Company announced an agreement in principle to settle for $3.4 million the class action securities litigation against the Company and certain present and former members of its Board of Directors pending in the United States District Court for the Northern District of Texas. The proposed settlement is subject to negotiation and execution of a definitive settlement agreement among the parties and approval by the court. The Company believes that a significant portion of the proposed settlement amount would be paid by its liability insurance carrier, with the remainder covered by litigation reserves previously established. The suit, originally filed as four purported class action suits in December 1991 and later consolidated into one, asserted causes of action based on alleged inadequate disclosures in the Company's 1989 and 1990 annual reports to shareholders and, in particular, disclosures with respect to the litigation involving the Qest polybutylene plumbing system manufactured and sold by U.S. Brass and with respect to the availability of insurance coverage therefor. The plaintiffs sought unspecified actual and punitive damages, as well as costs and attorneys' fees. In 1992 the court certified a plaintiff class consisting of all purchasers of the Company's common stock during the period from March 30, 1990 through August 8, 1991.\nThe Company is currently involved in significant legal proceedings including a number of lawsuits and claims which involve the Qest polybutylene plumbing system manufactured and sold by U.S. Brass since 1979. Information regarding legal proceedings of the Company is set forth herein in \"History\" and \"Environmental Regulation\" in Item 1, \"Legal Proceedings\" in Item 3 and Notes 13 and 14 to the Consolidated Financial Statements in Item 8, and is incorporated herein by these references.\nSTRATEGY\nEljer Industries' business strategy is to continue to focus on two significant issues: (1) operational performance and (2) management of legal issues and related expenses in connection with polybutylene cases and other litigation. Operating performance is benefitting from the continued implementation of the Company's previous strategic programs and plans. Litigation costs, most of which relate to non-operating issues arising from business conducted prior to the Company's spin-off by Household in 1989, increased substantially during 1993 and will continue to reduce the full effect of improving earnings. The Company is committed to realizing its operating potential while managing these significant litigation issues and their related expenses to a successful conclusion.\nIn 1992, the Company received a favorable federal appeals court ruling on the timing and availability of insurance coverage for polybutylene-related liabilities. Based upon this ruling, the Company believes that substantially all such liabilities are covered by insurance or by adequate reserves. However, many of the\nCompany's excess insurance carriers who were not directly involved in that litigation have raised issues that have required the Company and U.S. Brass to enter into costly litigation to establish the coverage. The Company continues to be exposed to protracted polybutylene litigation and may suffer adverse court verdicts in polybutylene lawsuits, which include the possibility of punitive damage awards for which insurance coverage may not be available; may not receive complete and timely reimbursement from its excess insurance carriers; and may not obtain interim funding arrangements from its insurers. Given these possibilities, the Company believes, as previously reported, that payment of such litigation costs may materially and adversely affect its liquidity.\nAs previously disclosed, the Company and U.S. Brass are exploring several proactive measures to fully resolve these polybutylene-related liabilities. The Company is continuing to press its suit against Household and is seeking to hold Household responsible for a portion of these liabilities, in addition to other damages. The Company is also exploring other options including the reorganization of U.S. Brass under federal bankruptcy laws. Such a proceeding could provide a means of maximizing the return to creditors of U.S. Brass and systematically resolving the issues raised in the polybutylene-related litigation. The Company has been party to an Amended and Restated Credit Agreement (the \"Credit Agreement\") which included a default provision which might have been triggered in the event of a U.S. Brass bankruptcy proceeding. The Company and its lenders executed, as of March 25, 1994, the First Amendment to Amended and Restated Credit Agreement (the \"Amendment\"). Under the terms of the Amendment, the filing of such a proceeding would no longer constitute an event of default.\nEXTENSION OF TERM DEBT\nAs of March 25, 1994, the maturity date covering the term portion of the Company's debt and the letters of credit supporting industrial revenue bonds and other obligations was extended to April 30, 1996, pursuant to the terms of the Amendment. A $6.0 million principal payment was made at the closing date of the Amendment, with scheduled principal payments of $2.0 million, $4.0 million and $11.0 million due on October 5, 1994, December 30, 1994 and December 29, 1995, respectively, subject to certain criteria. In addition, the interest rate was increased 0.5% at the closing date of the Amendment and will be increased by 0.5% at six-month intervals to maturity. The Company will be working toward some manner of debt restructuring prior to the maturity of the Amendment in April 1996. Neither the Company nor any of its subsidiaries has any commitment with respect to restructurings or other sources of financing and there can be no assurance that any such commitments can be obtained prior to the maturity of the existing Credit Agreement, as amended. In connection with the Amendment, the maturity date related to the accounts receivable sale program was accelerated to September 30, 1994. The Company is currently having discussions with other potential lenders to replace this facility and, while there can be no assurance in this regard, anticipates it will be successful. The structure of the new facility may be different than the current program. See Management's Discussion and Analysis of Financial Condition and Results of Operations-- \"Liquidity and Capital Resources\" in Item 7 and Notes 2, 3, 7 and 13 to the Consolidated Financial Statements in Item 8 for further discussion.\nDESCRIPTION OF BUSINESS\nPRODUCTS\nPlumbing Fixtures. Eljer Plumbingware manufactures and markets enameled cast iron and vitreous china plumbing fixtures for residential and commercial applications. These fixtures include toilets, lavatories, sinks, bathtubs and whirlpools. Eljer Plumbingware also markets faucets and acrylic bathtubs and whirlpools for these applications. Eljer Plumbingware's line of products includes bathroom and kitchen fixtures for new and remodeled construction. Eljer Plumbingware regularly updates its products, monitoring color and style trends and developing new products with growth potential.\nCast iron and vitreous china fixtures are sold under the Eljer trademark. The Company manufactures vitreous china fixtures in two domestic plants and imports certain specialized fixtures from Thailand. Enameled cast iron fixtures are manufactured at one domestic plant. See \"Properties\" in Item 2 for a description of these facilities.\nEljer Plumbingware has been a leader in developing and manufacturing low water consumption 1.6 gallon toilets, which are now statutorily mandated throughout the United States. Eljer Plumbingware offers a broad line of such products.\nFaucets, Plumbing Supplies and Systems. U.S. Brass manufactures a wide range of faucets, plumbing supplies and plumbing systems for residential and commercial construction, remodeling and do-it-yourself applications. U.S. Brass markets these products under the Valley, Eastman and Qest trademarks. The Valley trademark applies to faucets. In recent years, U.S. Brass has introduced the Valley Plus faucet line, directed to the middle and luxury markets, and (Valley) Colourburst, a collection of high style, affordable faucets, directed to remodeling and custom home markets. Eljer Plumbingware markets, under the Eljer trademark, faucets manufactured by U.S. Brass that complement its fixture line. Eastman plumbing supplies include supply tubes and valves, fittings, air gaps and flexible gas and water connectors. Qest plumbing systems, incorporating polybutylene pipe and metal connective fittings, offer ease of installation, freeze tolerance and cost reduction to builders and plumbing contractors. U.S. Brass also manufactures several private label faucets for large retailers and other faucet manufacturers.\nVarious lawsuits have been filed against U.S. Brass, the Company and Eljer Manufacturing, Inc., a wholly-owned subsidiary of Eljer Industries (\"Eljer Manufacturing\"), regarding polybutylene plumbing systems using acetal fittings manufactured and sold for residential site-built installations from 1979 through 1986 and for other installations from about 1975 through 1990. Metal fittings are currently used for the polybutylene plumbing systems which the Company manufactures and markets and which it believes have performed satisfactorily. See \"Recent Developments\" in Item 1, \"Legal Proceedings\" in Item 3 and Note 13 to the Consolidated Financial Statements in Item 8.\nHeating, Ventilating and Air Conditioning Products. The Company, through Selkirk\/Dry and Selkirk Europe, manufactures and markets, in the United States, Canada and Europe, prefabricated chimneys, venting systems, registers, grilles and other related specialty items.\nThe Company believes it is a leading manufacturer of venting systems of its type in both North America and Europe. These venting systems are used in residential, commercial and industrial construction primarily to provide venting of discharge from a furnace, appliance, boiler or diesel engine to the outside. Eljer Industries' brands in North America are sold primarily under the Metalbestos, Airmate, P.S. Chimney and SEL-VENT trademarks and in Europe under the Selkirk and Europa trademarks.\nSelkirk\/Dry also manufactures and markets registers, grilles and diffusers. These products are used primarily in new residential and commercial construction and are marketed in the United States under the Airmate and Selaire trademarks and in Canada under the Lloydaire trademark. They are also sold into the retail market under the Showcase trademark. The Company also manufactures other specialty products, including gas and wood-burning fireplaces, and products made from fiber reinforced materials.\nMARKETS AND DISTRIBUTION\nPlumbing. Plumbing products are sold domestically and are exported primarily through two major channels of distribution: (1) plumbing wholesalers; and (2) retail outlets.\nEljer Industries' sales force is comprised of both agents and direct salesmen. Eljer Industries markets plumbing products primarily in North America. The Company also sells plumbing products through wholesale distributors in the Far East and Middle East. Eljer Industries supports its product lines with a variety of advertising, including national and trade magazines.\nPlumbing products sold by the Company are used primarily in new home construction and repair\/remodeling; therefore, demand for plumbing products is closely related to both the rate of new housing starts and remodeling and repair activities. The housing market is cyclical and is affected by, among other\nthings, interest rates, consumer confidence and the availability of mortgage loans. Another major end use of plumbing products is in the repair and remodeling markets which represent a different source of demand for plumbing products, reducing the Company's reliance on new home construction. Both housing starts and the repair and remodeling market experienced increases in 1993, and many published forecasts indicate further improvements in 1994. The other major end use of plumbing products is in the commercial market, which consists of hotels, health care facilities, educational and penal institutions and office buildings.\nThe markets for plumbing products are highly competitive. Competition is based on brand recognition, design and quality of the product, product performance, price and service, with the relative importance of such factors varying among products and markets. Eljer Industries, Kohler Company and American Standard, Inc. are the better recognized companies selling fixtures in the United States. The Company believes that overall it has the third largest market share in the plumbing fixtures market. Eljer Industries also is a supplier in the faucet market, where there are numerous major domestic and import manufacturers, several of which are substantially larger than Eljer Industries.\nHVAC. Eljer Industries' HVAC products are used in the residential, industrial and commercial construction markets for new construction and repair and remodeling applications. HVAC products are sold primarily to regional wholesalers and through retailers and contractors. Sales of these products are subject to customer demand and general business conditions in these markets and the North American and European economies. Participation in eastern Europe markets, as they convert to natural gas, represents a strong market potential in the future, depending on economic conditions.\nIn all major HVAC product lines, there are a variety of competitors who aggressively compete for market share. Competition is based primarily on brand recognition, product design, product quality, range of product line, price, service and engineering support. Eljer Industries believes that it is competitive with respect to each of these factors.\nRAW MATERIALS\nThe manufacture of plumbing products requires clay, iron, brass, copper and plastics, including polybutylene resin. Other than polybutylene resin, which is currently produced only by Shell Chemical Company, a subsidiary of Shell Oil Company, these materials are, and have been, readily available from several sources. The Company has not experienced difficulty in obtaining polybutylene resin from Shell Oil Company as needed.\nThe major raw materials used in the manufacture of HVAC products are cold- rolled steel, galvanized steel, stainless steel coils and aluminum coils. These materials are readily available from several sources and the Company has experienced no difficulties with respect to availability of these materials.\nENVIRONMENTAL REGULATION\nGeneral. Like many industrial facilities, Eljer Industries' plants may generate hazardous and nonhazardous waste, disposal of which is subject to federal and state regulation. Due to the Company's and its predecessors' longtime presence in the industry, business practices followed many years ago could potentially become the focus of environmental actions. Several facilities have been required to implement programs to remedy the effects of past waste disposal. Although a number of plants have not been the focus of comprehensive environmental studies, Eljer Industries is aware of no instances of noncompliance with currently applicable safety, health and environmental laws and regulations which might have a significant adverse effect on the Company's financial condition or results of operations except as set forth below. With respect to current operating procedures, Eljer Industries believes that it is in material compliance with such applicable laws and regulations. The Company has established accruals of approximately $13.0 million at the end of 1993 (see discussion of individual sites below) pertaining to environmental, health and safety matters. The Company believes these accruals are adequate; however, given the significance of these matters, there\nmay be costs in excess of amounts accrued that could have a material and adverse effect on individual future years' operating results .\nAlthough the monitoring of environmental issues is an integral part of the Company's operations, Eljer Industries estimates that its capital expenditures for environmental control facilities during fiscal years 1994 and 1995 will not be material. The Company's capital expenditures for environmental control facilities during fiscal years 1993 and 1992 were also not material.\nSolid and Hazardous Wastes. The past disposal of hazardous and nonhazardous waste generated at the Company's plants may now be subject to the requirements of the federal Resource Conservation and Recovery Act and comparable state statutes. Several facilities have been required to implement programs to remedy the effects of past waste disposal.\nA consent decree between the Company and the United States Environmental Protection Agency (\"EPA\" or \"U.S. EPA\") was entered into in October 1990, regarding the Company's Salem, Ohio, facility. The decree requires, among other things, a closure plan to be approved by the Ohio Environmental Protection Agency (\"Ohio EPA\") for the clean-up and closure of an area at that plant. In December 1992, the Company and the Ohio EPA reached agreement on the proposed closure plan and a joint settlement statement was filed in January 1993. The Company submitted a revised closure plan on April 30, 1993, and has not yet received either approval of, or comments on, the proposed plan. The Company has begun closure and has paid $1.6 million to complete an interim closure of the area and expects to pay approximately $1.8 million for additional closure and post-closure costs. The Company has established accruals which it believes are adequate to provide for these costs.\nAt the Company's Marysville, Ohio, facility, which was closed in 1987, the Ohio EPA has entered a negotiated administrative order requiring the Company to close an on-site disposal area holding foundry sand containing lead. In addition, certain solvents have been reported to be present in the soil and \"perched\" water in an on-site former drum accumulation area. The Company submitted a draft closure plan for remediation on December 16, 1993. Assuming the plan is approved in its current form, the Company's environmental consultant estimates the cost of its implementation, including post-closure care, to be approximately $9.4 million; however, there is no assurance that the plan will be approved. In connection with the closure plan, an environmental consultant has assessed the groundwater at the site and concluded that there is no adverse impact on aquifers at the site. This report was presented to the Ohio EPA on January 10, 1994. The ultimate cost to complete the closure of the facility will depend on the nature and extent of the substances there and the remediation technology ultimately agreed upon by the Ohio EPA. The Company has established accruals which it believes are adequate to provide for these costs.\nUnder the terms of the consent decree regarding the Company's Salem, Ohio, facility, discussed above, and related federal and state laws and regulations, the Company is required to demonstrate financial responsibility for closure, post-closure care and third-party liability with respect to the Salem site and the Marysville site. Primarily as a result of the unusual items recorded in 1991 and the extraordinary item and cumulative effect of changes in accounting principles recorded in 1992, the Company was unable to continue making the required demonstration of financial responsibility after March 1992. On March 31, 1992, the Company notified the Ohio EPA that it could not make the required demonstration at that time, and was pursuing alternative means of satisfying the financial responsibility requirements. On October 9, 1992, the Company received from the Ohio EPA a notice of violation with respect to its failure to demonstrate financial responsibility. On October 12, 1992, the Company again notified both the U.S. EPA and the Ohio EPA of its inability to meet the financial responsibility requirements and asserted the unfavorable district court decision in 1991 on timing and availability of insurance coverage and its effect on the Company's financial position as an event of force majeure. The Company received letters from the Ohio EPA dated June 21, 1993 and February 24, 1994, advising that the Company was in violation of financial assurance requirements for the Salem and Marysville sites.\nThe Company pursued negotiations with the U.S. EPA with regard to alternatives to the Company's financial responsibility requirements under the Salem consent decree. In September 1993, however, the U.S. EPA informed the Company that it was withdrawing a proposed settlement offer that might have resolved the matter without the imposition of any penalties and was referring the matter of the Company's alleged noncompliance with the Salem consent decree to the U.S. Department of Justice (\"DOJ\"). The Company obtained a letter of credit effective September 28, 1993, to meet the closure and post-closure financial responsibility requirements relative to the Salem facility. On February 8, 1994, the DOJ sent the Company a letter demanding that the Company pay $1.1 million in stipulated penalties covering the period during which it was not able to meet the financial responsibility requirements associated with closure and post-closure care of its Salem facility. The Company disputes the amount and imposition of penalties and has entered into negotiations with the DOJ with respect thereto. The Company has recently obtained third-party liability coverage for the Salem facility.\nThe Company has been unable to renew closure, post-closure or third-party liability financial responsibility assurances for the Marysville site. On June 21, 1993, the Ohio EPA informed the Company that this matter was being referred to the U.S. EPA, but the Company has not heard from the U.S. EPA on this matter.\nThe Salem consent decree provides for a stipulated penalty of $2,000 per day for each failure to comply with a financial assurance provision (with lesser penalties of $500 to $1,000 per day during the first month of noncompliance). An Ohio statute provides generally for fines of $10,000, with higher fines for second convictions or reckless violations of its regulations. Federal law allows the imposition of civil penalties of up to $25,000 per day for violation of federal regulations and makes certain violations subject to criminal penalties. The government may attempt to impose statutory penalties on the Company for its failure to comply with the financial responsibility requirements at the Marysville site and additional penalties with regard to the Salem facility. In the Company's opinion, after consultation with counsel, any penalties ultimately imposed are likely to be less than the maximum potential penalties authorized under the law. The Company believes that it has meritorious defenses to the imposition of any penalties and intends to vigorously defend against such penalties.\nSuperfund. The federal Comprehensive Environmental Response, Compensation and Liability Act (commonly referred to as \"Superfund\" or the \"Superfund Act\") and similar state laws subject certain parties to liability for the clean-up of contaminated waste treatment or disposal sites. Liability under the Superfund Act is considered \"joint and several\", meaning that any one responsible party theoretically could be liable for all clean-up costs, which are often substantial. However, the Superfund Act provides for the allocation of liability in an equitable manner among responsible parties and for contribution among them.\nCertain of the Company's plants may have disposed of waste at sites which have or may become a part of federal Superfund clean-up efforts. The Company has received notice that eight of these sites are the subject of federal, and two are the subject of state, remedial investigations or activities, for which the Company has not resolved its alleged liability. In 1992 and 1993 the Company resolved its alleged liability at three additional sites. At nine of the sites still being addressed, the Company considers itself to be a de minimis contributor to the volume of waste. With regard to the remaining site, the American Zinc Company site in Dumas, Texas, the Company is conducting a preliminary investigation of its connection, if any, to a former owner of the site. On October 6, 1993, the Texas Natural Resource Conservation Commission (\"TNRCC\") informed the Company that it may be in the position of being named as a potentially responsible party (\"PRP\") with regard to this site. The Company has responded to a TNRCC request for information concerning the Company's connection, if any, to the site. If the site listing on the Texas Superfund Registry were finalized, the PRPs would be jointly and severally liable for any clean-up costs. The Company is assessing the position it will take in responding to the TNRCC. At this early stage it is not reasonably possible for the Company to determine the environmental condition of the site or the nature and cost of any remediation that may be required. Similarly, with respect to another site as to which the Company was\nrecently notified that it may be a de minimis PRP, no determination of its share of the costs of any remediation can currently be made. The Company has established accruals which it believes are adequate to provide for any liabilities it may have with respect to the other eight sites.\nAir and Water. Air and water emissions by the Company's plants have in the past received the attention of regulatory authorities and may require capital expenditures in the future. During 1991 the Company received from the EPA an administrative order citing it with a violation of the Clean Water Act for unpermitted discharge of wastewater streams at the Salem, Ohio, plant. The Company has been in negotiations with the EPA since then and has filed a sampling plan and tendered the sampling results to the EPA. In January 1993 the Company received notice from the DOJ that it intended to file a civil action seeking penalties for alleged violations of the Clean Water Act from at least 1988. The government advised the Company that it was seeking a civil penalty of approximately $1 million and requested a good faith settlement offer from the Company to avoid filing a lawsuit. The Company has negotiated with the government a settlement in principle of the proposed civil action. Under the settlement in principle, the details of which will be reduced to writing in a consent decree, the Company would pay a $300,000 cash penalty and conduct certain remediation work estimated to cost approximately $690,000. The Company has established accruals which it believes are adequate to provide for these costs.\nOther Matters. In October 1991, Eljer Manufacturing sold a facility located in Atlanta to joint venture partners Toto Ltd., Mitsui & Co., Ltd. and Mitsui & Co. (USA), Inc. (\"Toto and Mitsui\"). Toto and Mitsui have given Eljer Manufacturing notice that certain soil and groundwater sampling allegedly revealed several areas of contamination for which they claim indemnity under their purchase agreement. Eljer Manufacturing could be responsible for the costs of remediation, up to a contractual limit of $750,000, if this contamination resulted from an unlawful release of hazardous substances or disposal of solid waste or hazardous waste at the facility prior to October 1991. The sufficiency of the notice given is being disputed and Eljer Manufacturing has proposed conducting additional environmental assessments. In addition, Eljer Manufacturing has notified the prior owner of the facility, JP Industries, Inc., (\"JP Industries\") of Eljer Manufacturing's claims under the indemnity provisions of its purchase agreement with JP Industries. Eljer Manufacturing believes that it has meritorious challenges to Toto and Mitsui's claims as well as valid claims against JP Industries should it be liable for any contamination at this site.\nIn anticipation of the possible sale of the Company's Wilson, North Carolina, manufacturing plant, an environmental investigation was performed of that plant. One monitoring well on the property showed the presence of some hazardous substances. This finding was reported to the State of North Carolina and a follow-up investigation was performed. The Company is now in the process of preparing a report and action plan to be submitted to the state. Another well on the property was found to contain trichloroethene, another hazardous substance. Based on the location of the well and the direction of groundwater flow, and the Company's understanding that it has not used trichloroethene at the plant, it is presently the Company's belief that any trichloroethene on the property originated from off-site sources. The Company has established accruals which it believes are adequate to provide for the costs of investigation and remediation, if any.\nOn December 15, 1992, the Attorney General of the State of California, the Natural Resources Defense Council and the Environmental Law Foundation filed lawsuits against the Company, U.S. Brass and approximately 15 other manufacturers and sellers of residential and commercial brass faucets alleging violations of California's Safe Drinking Water and Toxic Enforcement Act of 1986 (\"Proposition 65\"). The lawsuits allege that the Company, U.S. Brass and other plumbing manufacturers did not provide clear and reasonable warning to California purchasers prior to knowingly and intentionally exposing persons to lead, a chemical known to the State of California to cause reproductive toxicity, and that the Company, U.S. Brass and other plumbing manufacturers knowingly discharged or released lead into drinking water in violation of Proposition 65. The lawsuits claim that the alleged exposures and discharges occur from the leaching of lead into drinking water from brass faucets manufactured by the companies. The Company and U.S. Brass, if found liable, could be subject to a civil penalty not to exceed $2,500 per day for a violation of the warning\nrequirement and $2,500 per day for a violation of the discharge requirement. Allegations are also made that the same conduct constitutes unfair business practices, misrepresentation, fraud and deceit, breach of contract and warranties, and negligence. The Company and U.S. Brass intend to defend the lawsuits vigorously, and while they will continue to do so, they have also engaged in settlement discussions with the plaintiffs. The Company and U.S. Brass do not expect the resolution of these lawsuits to have a material adverse effect on its financial condition or results of operations.\nFOREIGN AND DOMESTIC OPERATIONS\nSee Note 15 to the Consolidated Financial Statements in Item 8 for geographic segment financial data.\nGENERAL\nCustomers. Eljer Industries is not dependent upon any single customer, or upon any single group of customers, the loss of which would have a material adverse effect on Eljer Industries.\nBacklog of Orders and Inventory. The backlog of unshipped factory orders at the end of fiscal years 1993 and 1992 was approximately $15.3 million and $17.4 million, respectively. The decline is primarily attributable to a downturn in the Company's European business, which continued to experience reduced sales volumes at the end of 1993 (see Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 for additional discussion). Eljer Industries expects that all of the orders in backlog at the end of fiscal year 1993 will be shipped during 1994. Eljer Industries must carry inventory of certain products to meet rapid delivery requirements of its customers.\nEmployees. Eljer Industries employs approximately 3,900 people, approximately 1,400 of whom are covered by collective bargaining agreements with various labor unions. The collective bargaining agreement at the manufacturing plant in Nampa, Idaho, expired July 8, 1991. The plant has been operating without a contract since that date. The expirations of current collective bargaining agreements range from 1994 to 1996. A new three-year agreement was reached at the Company's cast iron foundry manufacturing plant in Salem, Ohio, effective March 5, 1993, without production interruption. A new three-year agreement was also reached at the Company's vitreous china plant in Tupelo, Mississippi, effective October 25, 1993, without production interruption. A new three-year agreement was reached at the Company's Logan, Ohio, plant effective February 3, 1994, without production interruption, the only location for which an agreement expired in 1994. In general, relations with employees have been satisfactory.\nPatents and Trademarks. Eljer Industries has a number of United States and foreign patents and also holds a number of patent applications, licenses, trademarks and trade names, including the trademarks mentioned herein. Except for certain trademarks mentioned herein, none of the foregoing is believed to be material to Eljer Industries.\nOther. No material portion of the businesses of Eljer Industries is subject to renegotiation of profits or termination of contracts at the election of the federal government. The Company's businesses in total are not significantly seasonal, although many products experience increased sales during the second and third quarters of the year due to larger housing construction activity, and certain HVAC products often experience higher sales in the autumn months.\nITEM 1A.","section_1A":"ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the names, ages, titles with Eljer Industries and principal occupations and employment for the past five years of the persons serving as executive officers of Eljer Industries.\nITEM 2.","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table sets forth the location, approximate square footage and use of each of the principal manufacturing plants of Eljer Industries, separated by the division or subsidiary which operates the facility. Except as indicated in the table, all of the plants are owned by Eljer Industries.\n- -------- * Leased until December 1994--the Company is currently negotiating a renewal of this lease. ** Leased until 1997. *** Leased until 2066.\nIn general, the manufacturing facilities for plumbing products are in good condition and are operating at capacities which range from approximately 40% to 100%. The facility used for the manufacture of fiberglass products in Wilson, N.C., which the Company is actively trying to sell, is also in good condition but is operating at lower capacity levels.\nThe manufacturing facilities for gas vents and chimney systems are presently operating at approximately 60% to 75% capacity, except Canada, which is operating at a lower capacity level. The plants, which are used to manufacture registers, grilles and other specialty items, are presently operating at approximately 75% capacity. Each of these facilities is in good condition.\nAll Selkirk\/Dry and Eljer Plumbingware properties, with the exception of Salem, Ohio, secure the domestic bank term loans. The Commerce, Texas, location secures certain industrial revenue bond obligations. All owned properties in England secure both the revolving credit agreement and the term debt in the United Kingdom. See Note 7 to the Consolidated Financial Statements in Item 8 for further discussion.\nIn addition to the foregoing, Eljer Industries owns or leases a number of warehouse distribution centers throughout the United States.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nInformation regarding legal proceedings of the Company is set forth herein in \"History\", \"Recent Developments\" and \"Environmental Regulation\" appearing in Item 1, and in Notes 13 and 14 to the Consolidated Financial Statements in Item 8, and is incorporated herein by these references.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of stockholders of Eljer Industries during the fourth quarter of fiscal year 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION FOR COMMON STOCK\nEljer Industries' common stock is traded principally on the New York Stock Exchange. The following table reflects the range of high and low selling prices of Eljer Industries' common stock by quarter for 1993 and 1992. This information is based on closing prices as reported by the New York Stock Exchange.\nHOLDERS\nAt March 18, 1994, there were approximately 9,820 holders of record of common stock.\nDIVIDENDS\nNo dividends were declared in fiscal 1993 or 1992. The Board of Directors intends to review its dividend policy regularly with the intent of restoring a cash dividend when appropriate; however, Eljer Industries is currently restricted by certain debt covenants from paying dividends during the term of its restructured U.S. credit agreement. See Note 7 to the Consolidated Financial Statements in Item 8.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents selected financial data of Eljer Industries. Results for fiscal year 1989 are not necessarily indicative of the financial position of Eljer Industries had it been autonomous. This historical data should be read in conjunction with the Consolidated Financial Statements and the related notes thereto in Item 8 and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nYear ended January 2, 1994 (\"1993\"), compared with year ended January 3, 1993 (\"1992\")\nNet sales decreased 2.5% or $9.8 million from the 1992 level. 1993 sales benefitted from successful new product introductions and a strong retail market in the United States with North American sales rising $11.5 million or 3.8% over the 1992 level. However, sales declined approximately $21.3 million in Europe, of which approximately $9.7 million resulted from unfavorable exchange rates due to the strong U.S. dollar. The\nplanned elimination of low-margin product lines also contributed to the slight sales reduction. The downward trend in European sales is anticipated to continue well into 1994.\nGross profit margins for 1993 improved in North America to 25.6% from 24.1% in 1992. This is attributable to the continuation of a management strategy to reduce costs and increase margins on major product lines and eliminate those product lines with lower margins. As an example of eliminating a lower margin product line, in September 1993, Eljer Industries sold its Valdosta, Georgia, fiberglass and acrylic plant, and no longer sells under the GlasTec trade name. The Company has entered into negotiations to sell its Wilson, North Carolina, fiberglass plant. Gross profit margins of the Company's North American plumbing products alone rose from 19.7% in 1992 to 23.0% in 1993 due in part to reduced costs and increased sales of higher margin products, particularly in the last half of 1993, and improved burden absorption on the higher volume.\nThe reduced level of European sales resulted in a gross profit margin reduction from 41.4% in 1992 to 39.2% in 1993. The resurgence in North American plumbing sales, improved product quality and lower costs related to workers' compensation, medical insurance and new processes and products in 1993 contributed to offsetting the European margin decline and maintained the 28.2% 1992 margin level on a consolidated basis.\nTotal selling and administrative expenses were $3.0 million or 3.6% lower than the 1992 level ($80.9 million in 1993; $83.9 million in 1992), primarily as a result of lower selling expenses in Europe. In addition, costs incurred in 1992 related to the bank debt restructuring were not present in the 1993 results. Conversely, litigation costs were $2.3 million higher in 1993 than in 1992 due primarily to higher litigation costs incurred in the Company's suits against its insurance carriers and costs incurred for a suit against Household, the Company's former parent.\nOverall, North American income from operations increased $6.3 million in 1993, despite the increased litigation costs, compared to 1992. The increase was more than offset by the $8.6 million decline in European operating income in 1993.\nOther expense, net, was relatively stable, rising only $248,000 in 1993. Interest expense was also stable, decreasing only $94,000 in 1993. Interest income was $542,000 lower in 1993 compared to 1992. This is due to lower cash investments, due to litigation payments and related costs, and lower interest rates in 1993.\nTax expense, including tax on repatriation of foreign earnings and a loss of tax benefit on indemnified liabilities, was approximately $9.0 million lower in 1993 than 1992. Tax expense in 1993 decreased due to lower European earnings, which are taxed at rates higher than those in the United States, and the Company's ability to utilize deferred tax benefits in the United States. In addition, the 1992 tax expense included $7.3 million of charges related to the 1989 spin-off from Household.\nNet income for the year increased $6.0 million over the 1992 $2.1 million loss before the extraordinary item and effects of changes in accounting principles, resulting in the Company's best performance since 1989.\n1992 Compared with year ended December 29, 1991 (\"1991\")\nNet sales remained relatively stable during 1992, decreasing only $5.2 million or 1.3% from the 1991 level. Sales of the plumbing product lines were reduced by $8.9 million or 4.0%. This reduction was partially offset by a $3.7 million or 2.1% increase in sales of HVAC products. The reductions in sales of plumbing products was primarily a result of a three-year management strategy to exit from low margin activities. The Company was also adversely affected by negative publicity concerning its financial condition during part of the year, which particularly slowed the conversion of potential new accounts to the Eljer brand. The successful insurance case appeal and bank debt restructuring provided the bases for the Company to reverse this decline in the fourth quarter of 1992, in which sales of plumbing products exceeded the fourth quarter 1991 sales. Although European sales were slightly higher in 1992 over 1991, fourth quarter 1992 sales in\nEurope were substantially below the prior year due to deteriorating economic conditions, particularly in Germany.\nGross profit margin increased from 26.2% to 28.2% in 1992. This improvement was the result of the implementation of the three-year management strategy which increased margins earned on most major product lines. Several key improvements by the Company included substantial reductions of fixed costs and excess capacity through the disposition of three plants in 1991, the planned decline or elimination of low margin products, reduction in the cost of medical insurance programs and the increase in sales of HVAC products, which yield higher margins. The impact of these improvements was partially offset by the Company's adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" as of the beginning of 1992. The implementation of SFAS No. 106 resulted in an additional $1.9 million reduction in gross margin and continues to have an unfavorable financial impact.\nTotal selling and administrative expenses were $0.9 million or 1.1% higher than the 1991 level and litigation costs were $1.5 million higher than the 1991 level. In total, legal, professional and bank restructuring fees were approximately $3.7 million higher in 1992 than in the previous year. This increase was partially offset by reductions in sales commissions and other selling costs.\nOperating profit before unusual items was $23.4 million or 5.9% of sales in 1992, compared to $19.0 million or 4.7% of sales in 1991. For the fourth quarter of 1992, operating profit before unusual items was $6.6 million or 6.2% of sales, compared to $5.5 million or 5.3% of sales in the fourth quarter of 1991. These improvements occurred despite the impact of implementing SFAS No. 106, which reduced operating profit by $2.1 million in 1992 and $0.5 million in the fourth quarter of 1992.\nThe Company recorded the following unusual items in 1991 which were not repeated in 1992:\n1) During 1991, management completed its previously disclosed reevaluation of the Company's vacuum forming production line at its Salem, Ohio, foundry which had experienced significant operating problems. In performing its final evaluation, management determined that the system could not produce cast iron products in a cost efficient manner and therefore was written off. The write-off totaled $9.0 million.\n2) As previously disclosed, the Company also began implementation of various steps to restructure its business in 1991, including plant idlings and closings, debt restructuring, product line rationalization and downsizing of certain operations. The total cost associated with the Company's restructuring was approximately $7.6 million.\n3) As discussed in Note 13 to the Consolidated Financial Statements in Item 8, as a result of the June 1991 adverse district court decision (which has since been overturned on appeal) regarding the timing and availability of primary insurance coverage relating to the Qest polybutylene plumbing system manufactured and sold by U.S. Brass, the Company fully reserved for receivables from its insurance carriers, resulting in a $14.6 million 1991 charge. The Company also established an additional reserve of $6.7 million in 1991 for prior settlements, judgments on appeal and other related costs.\n4) During 1991, the Company established additional environmental remediation reserves of $9.9 million including reserves to cover potential additional environmental clean-up costs associated with the closed Marysville, Ohio, facility, and the completion of the closure plan at its Salem, Ohio, facility.\n5) During early 1991 management implemented a program to offer incentives to turn inventories identified as slow moving. Based upon the results of these efforts, management decided to discontinue certain products and a $5.0 million reserve was established during the fourth quarter of 1991 to reflect these items at their estimated fair market value.\nOther expense, net in 1992 of $1.1 million was $1.3 million lower than the 1991 level due primarily to favorable foreign exchange gains recognized in 1992 and lower expense attributable to the receivables sales program discussed in Note 3 to the Consolidated Financial Statements in Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nELJER INDUSTRIES, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders of Eljer Industries, Inc.:\nWe have audited the accompanying consolidated balance sheets of Eljer Industries, Inc. (a Delaware corporation) and subsidiaries as of January 2, 1994, and January 3, 1993, and the related consolidated statements of income, shareholders' 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 financial statements referred to above present fairly, in all material respects, the financial position of Eljer Industries, Inc. 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.\nAs discussed further in Notes 2 and 13, the Company and its indirect, wholly- owned subsidiary, United States Brass Corporation (\"U.S. Brass\"), are defendants in a number of lawsuits and are the subject of certain claims which involve the Qest polybutylene plumbing system manufactured and sold by U.S. Brass since 1979. In addition, the nature and extent of the Company's insurance coverage related to potential losses arising from these claims and lawsuits is currently being contested by many of its insurance carriers. Management believes its insurance coverage is adequate, however, the ultimate outcome of these matters is uncertain at this time. Management is exploring various avenues to resolve the polybutylene-related liabilities, including the reorganization of U.S. Brass under federal bankruptcy laws. A reorganization of U.S. Brass would create a substantial doubt about the ability of U.S. Brass to continue as a going concern. The ultimate outcome of these matters is uncertain and the financial statements do not include any adjustments that might result from the outcome of these uncertainties.\nAs discussed further in Notes 1, 9 and 11 to the Consolidated Financial Statements, effective December 30, 1991, the Company changed its methods of accounting for postretirement benefits other than pensions, postemployment benefits and income taxes.\nARTHUR ANDERSEN & CO.\nDallas, Texas, March 31, 1994\nELJER INDUSTRIES, INC.\nCONSOLIDATED STATEMENTS OF INCOME\n(IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nELJER INDUSTRIES, INC.\nCONSOLIDATED BALANCE SHEETS\n(IN THOUSANDS, EXCEPT SHARE DATA)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nELJER INDUSTRIES, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(IN THOUSANDS)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nELJER INDUSTRIES, INC.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\n(IN THOUSANDS)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nBasis of Consolidation\nThe Consolidated Financial Statements include the assets, liabilities, revenues and expenses of Eljer Industries, Inc., a Delaware corporation, and all wholly-owned subsidiaries (\"Eljer Industries\" or the \"Company\"). Prior to April 14, 1989 (the \"Distribution Date\"), the entities now comprising Eljer Industries were subsidiaries and divisions of Household Manufacturing, Inc. (\"HMI\") or Household Manufacturing, Limited, wholly-owned subsidiaries of Household International, Inc. (\"Household\"). The Company operates in a single business segment--the manufacturing and marketing of building products for commercial and residential construction and remodeling. All significant intercompany accounts and transactions have been eliminated.\nCertain reclassifications to the prior years financial statements have been made to conform to the 1993 presentation.\nFiscal Year\nThe Company reports on a 52-53 week fiscal year ending on the Sunday nearest to December 31. Fiscal year 1993 had 52 weeks, which ended on January 2, 1994. Fiscal years 1992 and 1991 had 53 and 52 weeks, respectively, which ended on January 3, 1993 and December 29, 1991, respectively.\nTemporary Cash Investments\nTemporary cash investments are primarily bank deposits, commercial paper, treasury bills and bankers' acceptances, with original maturities of three months or less. These investments are carried at cost, which approximates market.\nRestricted Cash\nRestricted cash is comprised of insurance reimbursements and funds securing letters of credit which are legally restricted as to use. The restricted funds are either related to current liabilities, or the Company anticipates that the funds will become unrestricted within a 12-month period.\nInventories\nInventories are stated at the lower of cost or market and include the appropriate elements of material, labor and manufacturing overhead expenses. Cost is determined using the last-in, first-out (\"LIFO\") method for substantially all domestic inventories and the first-in, first-out (\"FIFO\") method for all foreign inventories.\nProperties and Equipment\nProperties and equipment, including items financed through capital leases, are recorded at cost and depreciated over their estimated useful lives, using principally the straight-line method for financial reporting purposes and accelerated methods for tax reporting purposes. Useful lives range from 20 to 40 years, or lease terms, for buildings and leasehold improvements and from 3 to 12 years, or lease terms, for machinery, fixtures and equipment.\nFair Value of Financial Instruments\nThe Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards (\"SFAS\") No. 107, \"Disclosure about Fair Value of Financial Instruments\", which requires the\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) disclosure of the fair market value of off- and on-balance-sheet financial instruments. As discussed in Note 7, the Company is party to an interest rate swap agreement. The differential to be paid or received is accrued as interest rates change and is recognized over the life of the agreement. The estimated fair value of the liability, which has no carrying value at the end of 1993, was approximately $2.2 million. The carrying value of all remaining financial instruments, including long-term and short-term debt and cash and temporary cash investments, approximates their fair value at yearend.\nCost of Businesses Acquired\nCost in excess of net tangible assets acquired is amortized using the straight-line method over 40 years. The amortization recorded for 1993, 1992 and 1991 was $443,000, $583,000 and $865,000, respectively. The amount of accumulated amortization was $5.8 million and $5.7 million at the end of 1993 and 1992, respectively.\nRevenue Recognition\nThe Company recognizes revenues from the sale of products at the time the products are shipped.\nConcentrations of Credit Risk\nFinancial instruments which potentially expose the Company to concentrations of credit risk, as defined by SFAS No. 105, \"Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk\", consist primarily of trade accounts receivable and temporary cash investments.\nThe Company's customer base for plumbing products is comprised of plumbing wholesalers and retail outlets primarily in North America. Heating, ventilating and air conditioning products were sold primarily to regional distributors, as well as through retail channels of distribution in the United States, Canada and Europe. Although the Company is directly affected by the well-being of the construction and remodeling and repair industries, and the North American and European economies in general, management does not believe significant credit risk exists at the end of 1993.\nThe Company places its temporary cash investments with high credit worthy financial institutions and does not believe significant credit risk exists with respect to these securities at the end of 1993.\nEquity\nThe Company has foreign subsidiaries located primarily in Canada, Germany and the United Kingdom. Assets and liabilities of the foreign subsidiaries are translated into United States dollars at the exchange rate prevailing at the balance sheet date. Revenue and expense accounts for these subsidiaries are translated using the weighted average exchange rate during the period. These translation methods give rise to cumulative foreign currency translation adjustments which are a component of Equity. In 1993, 1992 and 1991, net foreign currency transaction gains (losses) of approximately $(120,000), $762,000 and $224,000, respectively, are included in other expense, net.\nChanges in Accounting Principles\nIn December 1990, the FASB issued SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The standard mandated a significant change in the method of expensing these benefits, requiring companies to charge the expected cost of these benefits to expense during the years employees render services rather than expensing these costs as benefits are paid. The statement was effective for fiscal\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) years beginning after December 15, 1992, however, the Company elected early adoption of the statement as of the beginning of 1992. The cumulative effect of this change in accounting principle in 1992 was approximately $38.7 million. See Note 9 for further discussion.\nSFAS No. 109, \"Accounting for Income Taxes\", was issued by the FASB in February 1992, effective for fiscal years beginning after December 15, 1992, with earlier adoption encouraged. The Company elected to adopt the new standard effective the beginning of 1992. Under SFAS No. 109, deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted tax rate. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. Prior to 1992, deferred income tax expenses or credits were recorded to reflect the tax consequences of timing differences between the recording of income and expenses for financial reporting purposes and for purposes of filing federal income tax returns at income tax rates in effect when the difference arose. As permitted under SFAS No. 109, prior years' financial statements have not been restated. The effect of the application of this standard, which was immaterial, was recorded as a cumulative effect of change in accounting principle in 1992. See Note 11 for further discussion.\nIn November 1992, the FASB issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\", which established accounting standards for employers who provide benefits to former or inactive employees after employment but before retirement. This statement requires employers to accrue a liability for employees' compensation for future absences if certain conditions are met. The FASB mandated application of this statement for fiscal years beginning after December 15, 1993, however, the Company elected early adoption of the statement effective the beginning of 1992. The cumulative effect of initially applying this statement was a charge of approximately $500,000 in 1992 and was reported in these financial statements as an effect of a change in accounting principle in that period.\n(2) LIQUIDITY & CAPITAL RESOURCES:\nPolybutylene Litigation\nAs discussed in Note 13, the Company is currently involved in significant legal proceedings including a number of lawsuits and claims which involve Qest polybutylene plumbing systems manufactured and sold by its indirect, wholly- owned subsidiary, United States Brass Corporation (\"U.S. Brass\"). It may suffer adverse court verdicts in polybutylene lawsuits, which include the possibility of punitive damage awards for which insurance coverage may not be available; may not receive complete and timely reimbursement from its excess insurance carriers; and may not obtain interim funding arrangements from its insurers. Given these possibilities, the Company believes, as previously reported, that payment of such litigation losses and expenses may materially and adversely affect its liquidity.\nAs previously disclosed, the Company and U.S. Brass are exploring other means of resolving the polybutylene-related liabilities. The Company is continuing to press its suit against Household and is seeking to hold Household responsible for a portion of these liabilities, in addition to other damages. The Company is also exploring other options including the reorganization of U.S. Brass under federal bankruptcy laws. Such a proceeding could provide a means of maximizing the return to creditors of U.S. Brass and systematically resolving the issues raised in the polybutylene-related litigation. The Company has been party to an Amended and Restated Credit Agreement (the \"Credit Agreement\") which included a default provision which might have been triggered in the event of a U.S. Brass bankruptcy proceeding (see Note 7 for discussion). The Company and its lenders executed, as of March 25, 1994, the First Amendment to Amended and Restated Credit Agreement (the \"Amendment\"). Under the terms of the Amendment, the filing of such a proceeding would no longer constitute an event of default. In 1993, U.S. Brass' sales totaled $74.1 million and its assets totaled $46.8 million at the end of 1993.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nRestricted Cash\nRestricted cash relates to cash that is legally restricted as to its use. At yearend 1993, the Company had several components of restricted cash. Approximately $6.3 million of the restricted cash balance relates to the previously disclosed reimbursement by the Travelers Indemnity Company of Illinois (\"Travelers\") of certain settlement and litigation payments previously made by or on behalf of U.S. Brass. The cash is restricted as to its use by the Credit Agreement only for the payment of settlements, judgments, appeal bonds and deposits, attorneys' fees, and related expenses in the polybutylene plumbing system and other litigation. In addition, the Company maintained restricted cash balances of approximately $9.7 million at yearend 1993 and approximately $3.0 million at yearend 1992 to secure letters of credit.\nExtension of Term Debt\nThe Company has been party to the Credit Agreement since it restructured its debt in December 1992. The Credit Agreement provided, among other things, a maturity date of April 30, 1995, for the Company's restructured term debt and letters of credit supporting industrial revenue bonds and other obligations. The Company has also been a party to a $13.0 million accounts receivable sale program, discussed in Note 3, which had the same maturity date. The Company and its lenders executed, as of March 25, 1994, the Amendment under the terms of which the maturity date covering the term portion of the debt and the letters of credit supporting industrial revenue bonds and other obligations was extended to April 30, 1996; and filing of a bankruptcy proceeding relative to U.S. Brass no longer constitutes an event of default. A $6.0 million principal payment was made at the closing date of the Amendment, with scheduled principal payments of $2.0 million, $4.0 million and $11.0 million due on October 5, 1994, December 30, 1994 and December 29, 1995, respectively, subject to certain criteria. The interest rate under the Credit Agreement was the prime rate, plus a margin of 1.0% (or 7.0%) at the end of 1993. However, upon execution of the Amendment, the rate increased to the prime rate, plus a margin of 1.5% and will be increased by 0.5% at six-month intervals to maturity. The Company will be working toward some manner of debt restructuring prior to the maturity of the Amendment in April 1996. Neither the Company nor any of its subsidiaries has any commitment with respect to restructurings or other sources of financing and there can be no assurance that any such commitments can be obtained prior to the maturity of the existing Credit Agreement, as amended. The amended Credit Agreement is secured by substantially all the assets of the Company's domestic operations, excluding U.S. Brass and by the stock of certain of the Company's subsidiaries. See Note 7 for additional discussion of debt.\nIn connection with the Amendment, the maturity date related to the accounts receivable sale program (discussed in Note 3) was accelerated to September 30, 1994. The Company is currently having discussions with other potential lenders to replace this facility and, while there can be no assurance in this regard, anticipates it will be successful. The structure of the new facility may be different than the current program.\n(3) TRADE ACCOUNTS RECEIVABLE:\nThe Company was party to an agreement with a financial institution whereby the Company sold on an ongoing basis an undivided interest in certain of its trade receivables. On December 11, 1992, the Company and the financial institution amended the original agreement in its entirety. The terms under the amended agreement are similar to the original agreement. In accordance with the amended agreement, the maturity date was extended to April 30, 1995. As discussed in Note 2, as of March 25, 1994, the maturity date for the accounts receivable sale facility was accelerated to September 30, 1994. Under this agreement, an undivided fractional interest in new invoices is sold daily to maintain a constant participation interest as collections reduce the previously sold balance. The amount of trade receivables sold under this agreement was $13 million at the end of 1993, with no further additions available. The costs associated with the sale are based on the financial institution's prime rate and are recorded in other expense in the accompanying financial\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) statements. The agreement requires the maintenance of certain financial ratios, including ratios based on write-offs and past due balances and the financial covenants required in the Credit Agreement discussed in Note 7 with which the Company is in compliance at yearend 1993.\n(4) INVENTORIES:\nInventories consisted of the following (in thousands):\nIncluded in finished goods, work in process and raw materials are inventories valued on the LIFO method of $46.1 million at the end of both 1993 and 1992.\nIf inventories valued on the LIFO method had been valued at their current cost, they would have been $8.4 million and $9.1 million higher at the end of 1993 and 1992, respectively.\nDuring 1993, 1992 and 1991 inventory quantities were reduced. These reductions resulted in liquidations of LIFO inventory quantities carried at lower costs prevailing in prior years as compared with the cost of 1993, 1992 and 1991 purchases, the effect of which decreased cost of goods sold by approximately $0.7 million, $0.4 million and $1.6 million, respectively. The Company also recorded a $5 million reserve for inventory discontinued in 1991. Charges against the reserve in 1993 and 1992 were approximately $2.1 million and $1.1 million, respectively.\n(5) PROPERTIES AND EQUIPMENT:\nProperties and equipment, net, consisted of assets owned and leased under capital lease arrangements and were as follows (in thousands):\n(6) ACCRUED EXPENSES:\nAccrued expenses consisted of the following (in thousands):\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (7) DEBT:\nShort-Term Facilities\nEffective May 13, 1992, U.S. Brass entered into a financing arrangement with a financing institution not a party to the debt restructuring discussed below. The arrangement expires in May 1995 with annual renewals thereafter. Borrowings of up to $20 million are available under these agreements, limited by eligible amounts of accounts receivable and inventory. Substantially all the assets of U.S. Brass with the exception of property and equipment, have been pledged as security under these agreements. These agreements require the maintenance of certain financial covenants, including tangible net worth, working capital and capital expenditure requirements. At the end of 1993, the Company was in compliance with all covenants under these agreements. The total principal amount owed by U.S. Brass related to these agreements at yearend 1993 and 1992 was approximately $3.9 million and $10.7 million, respectively. Interest related to these agreements is 2% over prime per annum (8.0% at yearend 1993 and 1992). In addition, $0.1 million in facility fees and closing costs were paid in 1993 compared to $0.3 million in 1992.\nThe Company's Selkirk U.K. subsidiary is party to an agreement with a bank which includes a revolving credit facility whereby the subsidiary may borrow the British Pounds Sterling or Deutsche Mark equivalent of approximately $6.9 million. The revolver, which expires in September 1997, is secured by substantially all the Selkirk subsidiary's assets as defined in the facility agreement between the subsidiary and the bank. Financial covenants are consistent with the long-term U.K. foreign bank term loan discussed below. There were no balances outstanding at yearend 1993 under this facility. The total principal amount owed by the subsidiary related to this agreement at yearend 1992 was approximately $5.6 million. Interest is calculated based upon LIBOR plus an additional approximate 1.5% to 2.0%, depending on operating cash flow as compared to total debt servicing payments. Interest rates were 7.0% and 9.0% per annum at the end of 1993 and 1992, respectively. Commitment fees are calculated at 0.75% per annum payable quarterly and in arrears on any undrawn portion of the revolving credit facility.\nIn addition, the Company's Selkirk subsidiary in Germany had unsecured credit lines with three German banks totaling approximately $6.6 million at yearend 1993, and had unsecured lines with two German banks totaling $4.6 million at yearend 1992. There are no scheduled expiration dates on these lines, however, they are reviewed annually by the banks for renewal. The total amount outstanding related to these credit lines at the end of 1993 and 1992 was approximately $1.2 million and $3.2 million, respectively. Interest was calculated on debt outstanding at annual yearend rates ranging from 9.0% to 10.25% in 1993 and 11.25% to 12.25% in 1992.\nThe average amounts of short-term borrowings outstanding during 1993 and 1992 were approximately $14.6 million and $29.8 million, respectively. The maximum amounts outstanding during 1993 and 1992 were approximately $19.9 million and $39.4 million, respectively. The weighted average interest rates during 1993 and 1992 were approximately 9.6% and 9.0%, respectively, on these borrowings.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nLong-Term Facilities\nLong-term debt consisted of the following (in thousands):\nThe Company's Credit Agreement and related agreements were amended in early 1994. See Note 2 for discussion of amendment terms.\nAs discussed above, the Company's Selkirk subsidiary in the United Kingdom is party to financing arrangements with a European bank. The financing includes a term loan portion and a revolving credit facility. The term debt matures on June 30, 1999, and provides for scheduled semiannual principal payments. This facility bears interest at varying rates based upon LIBOR plus an additional approximate 1.5% to 2% based upon operating cash flows as compared to debt servicing payments. Borrowings are made in either British Pounds Sterling or German Deutsche Marks and are secured by substantially all the assets of the U.K. subsidiary as defined in the facility agreement.\nBoth the foreign and domestic term loans are subject to certain financial covenants with which the Company is in compliance at yearend 1993. These covenants include tangible net worth, operating cash flow and various other debt service, fixed charge and current ratio requirements. In addition, the Company is restricted by certain covenants from paying dividends during the term of its Credit Agreement, as amended.\nThe Company is party to an interest rate swap agreement which has effectively fixed the interest rates on $65 million related to the previous bank term loans and other floating rate obligations. The fixed rate payable under this agreement is 10.290% in exchange for six-month LIBOR, with the term expiring in April 1994. The six-month LIBOR rate in effect under the swap agreement at yearend 1993 was 3.375%.\nAggregate maturities of long-term debt and capital lease obligations for each of the next five years and thereafter are as follows (in thousands):\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Cash paid for interest during 1993, 1992 and 1991 was $14.2 million, $14.5 million and $14.2 million, respectively.\n(8) EMPLOYEE BENEFIT PLANS:\nSubstantially all of the Company's employees are covered under various defined benefit pension plans maintained by the Company and by Household. Plan benefits are based primarily on years of service. Under a Labor and Benefits Agreement between Household and the Company, on March 31, 1989, Household assumed the assets and liabilities in connection with pension plans covering Company employees prior to that date, and Household is responsible for all pension benefits accrued as of and prior to that date. All employees became 100% vested in the Household plans at that time. The Company established new employee benefit plans similar to those previously in effect and is responsible for all funding subsequent to March 31, 1989. The Company's funding policy is based on an actuarially determined cost method allowable under Federal tax law. Since Household retained all assets from the previous benefit plans, the Company has incurred pension expense for the new plans since the Distribution Date.\nThe Company's net periodic pension cost includes the following components (in thousands):\nThe projected benefit obligations assumed an annual discount rate of 7.5% to 9.0% in 1993 and 7.75% to 9.0% in 1992. The annual rate of compensation increase ranged from 4.0% to 7.0% in 1993 and in 1992. The expected long-term annual rate of return on plan assets was 8.5% to 10% in 1993 and 9.0% to 10.0% in 1992. The amortization period for prior service cost is 14 to 18 years, depending on the plan, which approximates the average remaining service period of the employee work force. The funded status of the plans is as follows (in thousands):\nThe Company also has a defined contribution plan in which each participant's contribution is matched in part by the Company up to a maximum of 3% of the participant's compensation. The Company's matching contribution for this plan was approximately $715,000 in 1993, $666,000 in 1992 and $644,000 in 1991.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(9) OTHER POSTRETIREMENT BENEFITS:\nThe Company sponsors three defined benefit postretirement plans which provide for certain health care and life insurance benefits to retired employees in the United States. Life insurance and comprehensive medical benefits are available to active employees who, immediately upon retirement, receive a pension under the Company's retirement plan. Postretirement benefits are also continued for former employees who are currently receiving Company pension benefits. The medical program covers dependents of retirees in addition to former employees. Employee contributions are required in the case of medical benefits for those employees who retired on and after January 1, 1975. No contributions are necessary for employees retiring prior to that date and for certain surviving spouses.\nEffective the beginning of 1992, the Company adopted SFAS No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions\" which requires that the expected cost of these benefits be charged to expense during the years that the employees render service. This was a significant change from the Company's previous policy of recognizing these costs as benefits were paid. The Company recorded a cumulative catch-up adjustment in 1992 which resulted in the immediate recognition of approximately $38.7 million of transition liability in that year.\nThe following table sets forth the plans' combined funded status reconciled with the amount shown in the Company's financial statement at the end of 1993 and 1992 (in thousands of U.S. dollars). Since the Company funds these plans on a \"pay-as-you-go\" basis, the Company's postretirement health care plans are underfunded.\nNet periodic postretirement benefit cost for 1993 and 1992 included the following components (in thousands):\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nFor measurement purposes, health care cost trend rates for various services varied from 9.5% annually for 1993 and 1992, decreasing gradually to 4.5% by 2007, and remain at that level thereafter. Increasing the health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation at the end of 1993 and 1992 by $5.3 million and $5.5 million, respectively and the aggregate of the service and interest cost components of net postretirement health care cost for 1993 and 1992 by $0.5 and $0.7 million, respectively. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation at the end of 1993 and 1992 was 7.0% and 8.5%, respectively. There were no plan assets at yearend.\n(10) SHAREHOLDERS' EQUITY:\nCommon Stock\nThe Company has 50,000,000 shares of $1 par value common stock authorized with 7,186,875 shares issued and 7,092,326 shares outstanding at yearend 1993. Treasury stock totaled 94,549 and 118,482 shares at the end of 1993 and 1992, respectively, and is accounted for under the par value method.\nPreferred Stock\nThe Company has 10,000,000 shares of $1 par value preferred stock authorized, of which none are issued or outstanding.\nStock Rights\nPursuant to a Stockholder Rights Plan adopted by the Company on the Distribution Date and amended on July 31, 1989, January 4, 1990 and November 5, 1991, each outstanding share of the Company's common stock carries with it a common stock purchase right (the \"Right\"). In the event of an acquisition by a person or group of 15% or more of the Company's common stock, each Right (other than Rights owned by the person or group triggering the event, which will become void) will become exercisable to purchase one share of the Company's common stock at 50% of its then market value. The Rights will not become exercisable, however, if the person or group meeting the 15% threshold does so through an all-cash tender offer in which it becomes the owner of at least 80% of the Company's stock. The Rights are subject to adjustment in the event of certain changes in the Company or its common stock, including the merger of the Company with another entity. The Rights will expire on May 1, 1999, unless previously exercised or redeemed, or unless the Company extends the expiration date.\nStock Options\nThe Company has a Long-Term Executive Incentive Compensation Plan (the \"Plan\") whereby awards, including stock options (the \"Options\"), can be granted to key employees. The Options are exercisable in 25% increments over a four- year period beginning one year after the date of grant. Options are generally granted for a term of no more than ten years and one day from the date of grant. The Options exercise price per share is not less than the fair market value of the Company's common stock at the date of grant. However, certain Options were granted in 1989 to employees in exchange for options for Household common stock which they forfeited as a result of the spin-off. These Options have special terms as to exercisability and purchase prices based on the value of the options forfeited.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe following table summarizes the Options activity:\nAt the Distribution Date, the Company had reserved 500,000 shares of common stock to cover grants under the Plan. During 1993, 350,000 additional shares were made available. As of the end of 1993 there were 332,358 shares available for grant under the Plan.\n(11) INCOME TAXES:\nIncome (loss) before taxes and income taxes in 1993, 1992 and 1991 are shown below (in thousands):\nAs discussed in Note 1, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\", at the beginning of 1992 and the $27,000 cumulative effect of this change is reported in the accompanying financial statements. Deferred income taxes (credit) for 1993 and 1992 reflect the impact of \"temporary differences\" between amounts of assets and liabilities for financial reporting and tax purposes as measured using enacted tax rates. These temporary differences are determined in accordance with SFAS No. 109 and are more inclusive in nature than \"timing differences\" as determined under previously applicable accounting principles.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nTemporary differences and carryforwards which give rise to a significant portion of deferred tax assets and liabilities for 1993 and 1992 are as follows:\nAt the end of 1993 and 1992, valuation allowances were provided for the net deferred tax assets as required under SFAS No. 109. The valuation allowance increased approximately $0.7 million and $6.4 million during 1993 and 1992, respectively.\nThe Company has a tax basis alternative minimum tax credit carryforward of approximately $1.2 million at yearend 1993, which is available to reduce future federal income taxes. The Company no longer has a net operating loss (\"NOL\") carryforward for domestic federal income tax purposes as foreign dividends depleted the NOL.\nThe difference between the provisions for income taxes and income taxes computed using the statutory federal income tax rate at yearend were as follows (in thousands):\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) A $3.0 million assessment, recorded in 1992, was received by the Company from Household, pursuant to a Tax Sharing Agreement which pertains to the Internal Revenue Service audits of years 1983 through 1985 (prior to the Distribution Date) for which no indemnification exists. No payment has been made related to this assessment. Additional assessments may be made by Household for other years prior to the 1989 spin-off.\nIn 1993, the Company provided for $0.6 million of tax expense for repatriating those earnings which are no longer considered permanently reinvested in foreign subsidiaries. In accordance with the Company's accounting policy, U.S. deferred taxes have not been provided on approximately $9.0 million of undistributed earnings of foreign subsidiaries at the end of 1993, as the Company intends to reinvest these earnings permanently in the foreign operations or to repatriate such earnings only when to do so would be tax effective. The amount of the unrecognized tax liability for these undistributed earnings is not material at the end of 1993 due to the availability of foreign tax credits.\nUnder an agreement with Household, the Company is entitled to the tax deduction associated with certain liabilities, currently estimated to be approximately $54 million, which are indemnified by Household. The Company, in turn, contributes an amount equivalent to the tax benefit of such items when paid, regardless of whether the Company is in a tax paying position. Payments associated with approximately $34.1 million in liabilities have been made through the end of 1993. These payments normally have no impact on the financial results of the Company; however, an impact did occur due to the net operating losses of the Company in the United States in 1993 and 1992, when a total of $1.3 million and $4.6 million, respectively, of such payments were made. The impact of future payments will be dependent on the tax paying position of the Company.\nCash paid for income taxes in 1993, 1992 and 1991 was $3.6 million, $7.0 million and $4.7 million, respectively.\n(12) LEASES:\nRental expense under operating leases was $6.2 million in 1993 and $6.3 million in both 1992 and 1991.\nFuture minimum lease commitments under noncancelable operating leases at the end of 1992 were as follows (in thousands):\n(13) CONTINGENCIES:\nPolybutylene Litigation\nU.S. Brass is a defendant (together, in some cases, with the Company, Household, Eljer Manufacturing, Inc. (\"Eljer Manufacturing\") and Qest Products, Inc.) in a number of lawsuits filed by homeowners, homeowner associations, developers, builders and plumbing contractors which involve the Qest polybutylene plumbing system (the \"system\" or the \"Qest system\") manufactured and sold by U.S. Brass or a predecessor\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) company for residential site-built installations from 1979 through 1986 and for other installations from about 1975 through 1990. The Company does not currently engage and has never engaged in the manufacture and sale of the Qest system in the United States; the manufacture and sale of the system has been made by the Company's subsidiary U.S. Brass. As discussed below, based upon an August 1992 ruling of the federal appeals court regarding the timing and availability of insurance coverage relating to Qest system claims, the Company believes that substantially all losses arising from Qest claims are either covered by insurance or are covered by adequate reserves. However, as discussed below, certain of the Company's excess insurance carriers are contesting the nature and extent of coverage. In addition, insurance coverage may not be available for future punitive damages, if any, assessed in the underlying Qest system litigation.\nOther defendants in the Qest system lawsuits are Shell Chemical Company (\"Shell Chemical\"), a subsidiary of Shell Oil Company, the manufacturer of polybutylene resin from which U.S. Brass extrudes the pipe used in the system, Celanese Specialty Resins, a unit of Hoechst Celanese Corporation (\"Celanese\") and the manufacturer of a resin from which U.S. Brass injection molded the Celcon acetal fittings formerly used in the system, other pipe and fittings manufacturers, and builders, developers and plumbing contractors. These lawsuits allege that the Qest system leaked and seek recovery based on negligence, breach of warranty, strict tort liability and, in some cases, fraud or misrepresentation. Most of the claims involved systems that began to leak after installation, although a limited number of claims involve systems that have not leaked. Plaintiffs typically claim compensation for replacement of allegedly defective plumbing systems, but frequently also seek recovery for property damage, diminution in value, punitive and statutory damages and attorneys' fees and occasionally seek recovery for personal injuries. In cases in which systems have leaked, the vast majority of the failures experienced to date have involved the Celcon acetal fittings, rather than the polybutylene pipe. U.S. Brass stopped selling these fittings for residential site-built construction after 1986 and began selling copper and brass insert fittings which have performed satisfactorily. U.S. Brass has estimated that approximately 860,000 Qest systems were sold for residential installations (including site-built, manufactured housing and mobile homes) from 1979 through 1986. The number of Qest installations has been estimated based on the average number of fittings used in a typical residence, which is an imprecise method and does not take into account, among other things, such variables as mixed manufacturers' products in one installation, repairs, sales through consumer channels for various uses, etc., but is the best available method of estimation.\nThrough the end of 1993, 202 lawsuits (representing approximately 26,700 residential installations) and approximately 11,000 homeowner claims not involving litigation have been settled at a total cost to all defendants of approximately $114.5 million. The total amount paid by U.S. Brass has been approximately $61 million, of which approximately $49 million was reimbursed by the Company's primary and excess insurance carriers. Through yearend 1993, the approximately 37,700 settled homeowner claims have been resolved at an average cost of approximately $3,000 per claim. At the end of 1993, an additional 109 lawsuits involving approximately 23,600 residential claims remained pending, not including purported class members in Arizona, California and Nevada. Taken as a percentage of estimated Qest residential installations (including site- built, manufactured housing and mobile homes) for the period 1979 through 1990, approximately 4.6% of Qest installations are the subject of claims. Not all leak claims have involved the Qest system. Some claims have involved competitors' systems, and many claims have involved mixed systems, containing both Qest components and components manufactured by competitors. In addition, U.S. Brass and its insurers were not the sole contributors to the settlements described above. U.S. Brass did not sell the Qest system directly to the homeowners, but rather sold the system to wholesalers who, in turn, resold the system to plumbing contractors and ultimately to homeowners. These factors, plus the method of estimation described above, make the estimates difficult to calculate and verify.\nA number of cases asserting class action allegations are pending against U.S. Brass. Included among these cases are three purported class actions, collectively encompassing owners of homes (site-built, mobile\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) and modular\/manufactured), apartment buildings and commercial buildings located in San Diego County, California, containing polybutylene pipe and acetal fittings. Two of these class actions, whose classes are further limited to persons who have not filed individual actions or participated in other class actions, have been conditionally certified. A case has been filed against U.S. Brass as a purported class action brought on behalf of all persons in Arizona who have not filed individual actions, and who purchased single family residences, single family condominiums, multi-family residences or apartments, or manufactured homes containing polybutylene pipe systems with acetal insert fittings. An opt-in class action consisting of a class of homeowners residing in the northern counties of Nevada who have purchased homes containing Qest brand polybutylene plumbing products has been certified. A second case has been filed in Nevada purporting to be a class action on behalf of similarly situated persons in the southern counties of Nevada. U.S. Brass has denied substantive allegations in each of the class action complaints and has opposed certification of each such class action.\nA limited number of the homeowner claims resolved and pending involve Qest systems installed in manufactured housing, including mobile homes and recreational vehicles. As discussed above, the vast majority of failures to date have involved the Celcon acetal fittings, rather than the polybutylene pipe. U.S. Brass stopped selling these fittings for manufactured housing, mobile homes and recreational vehicle applications in 1990. U.S. Brass estimates that an additional 480,000 systems were sold for mobile home installations beginning in 1987 through 1990, and approximately 675,000 recreational vehicle installations occurred during the period from 1981 through 1990. U.S. Brass is unable to estimate the percentage of claims involving leaks in manufactured housing, including mobile homes and recreational vehicles except that the number of such claims has been small compared to the number of installations. The average cost to repair or replace a Qest system installed in a recreational vehicle or mobile home unit is approximately $200 to $1,000.\nThrough the end of 1993, only five lawsuits have been adjudicated. In 1988 a jury returned a verdict in favor of 90 homeowners against U.S. Brass, Shell Chemical, Celanese and a developer in the amount of approximately $2.0 million actual damages plus approximately $1.2 million statutory damages. U.S. Brass' share of the total verdict is approximately $2.1 million. Both plaintiffs and defendants, including U.S. Brass, appealed the verdict. In May 1990 another jury returned a verdict in favor of 104 homeowners, and the court entered a judgment in the amount of approximately $1.1 million in actual and statutory damages, of which U.S. Brass' share was approximately $700,000. U.S. Brass appealed the verdict. In September 1993 the Texas Court of Appeals reduced U.S. Brass' share of these two judgments from approximately $2.8 million to approximately $2.3 million, excluding post-judgment interest. The Company has appealed these judgments. The Company believes these judgments are covered by insurance. The Company's excess insurance carrier, Travelers, provided the bonds necessary for the appeals and has acknowledged its responsibility to pay the judgments. In February 1991 another jury returned a verdict in favor of 36 homeowners against U.S. Brass, Shell Chemical, Celanese and other defendants of approximately $1.3 million in actual and punitive damages, the largest portion of which represented punitive damages assessed against Celanese. Shell Chemical, Celanese and other defendants reached a settlement with the plaintiffs prior to the entry of a judgment on the verdict. A judgment on the verdict was entered against U.S. Brass in the approximate amount of $75,000, which amount U.S. Brass tendered to the plaintiffs, but the plaintiffs refused. The plaintiffs appealed the judgment and the Texas Court of Appeals affirmed the trial court judgment rejecting plaintiff's appeal. The plaintiffs have again appealed. In November 1992 a California jury entered a verdict against U.S. Brass in the amount of approximately $65,000 compensatory damages and $65,000 punitive damages on behalf of 15 homeowners. As a result of the credit applied to the compensatory damages verdict due to a settlement by co-defendant Celanese, a judgment was entered against U.S. Brass for only the punitive damage award. The parties have appealed the judgment.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nOn March 30, 1993, a California jury awarded approximately $290,000 against the Company and U.S. Brass for compensatory damages on behalf of 41 plaintiff homeowners and indemnity for the developer. The Company's compensatory damage liability to the plaintiff homeowners was reduced from $190,000 to zero by virtue of credits received from prior settling defendants. The Company, Eljer Manufacturing and U.S. Brass were also found by the jury to have violated the California Song-Beverly Consumer Warranty Act, under which they may be liable for the plaintiffs' costs and attorneys' fees which are believed to be approximately $400,000 to $600,000. In addition, the Company, Eljer Manufacturing and U.S. Brass, as well as Shell Chemical and Celanese, were found by the jury to be liable to the plaintiffs for fraud. The jury assessed punitive damages in the amount of $48 million against defendants Shell Chemical, Celanese and the Company, Eljer Manufacturing and U.S. Brass and in favor of the cross-plaintiff developer, Coles Development Corp. However, this amount was reduced by the court to $2 million, and the Company, Eljer Manufacturing and U.S. Brass' share thereof was reduced from $3.1 million to $129,000. The developer accepted the reduction in lieu of a new trial. The jury also assessed $190,000 in punitive damages against the Company, Eljer Manufacturing and U.S. Brass and in favor of the plaintiff homeowners. The parties have appealed the judgment. The Company's general liability insurance carrier has refused to provide indemnity coverage for the punitive damage awards. Reimbursement of future punitive awards, if any, may also be denied by insurance carriers.\nU.S. Brass continues to defend the pending suits vigorously but also to settle cases where practical and where payments from its insurance carriers are available. In early 1988 U.S. Brass established a toll-free telephone service to handle calls from homeowners who have Qest polybutylene plumbing systems which have experienced failures. U.S. Brass, with assistance from Shell Chemical and Celanese, settled claims and performed repairs and replacements using a professional claims handler and local plumbing contractors. As a result of the financial impact on the Company of the federal district court ruling in June 1991 discussed below, U.S. Brass, in July 1991, withdrew its administrative and financial participation in the toll-free telephone service. Since then, a similar service has continued to be operated by Shell Chemical, Celanese and E.I. duPont de Nemours & Company. Shell Chemical and Celanese have advised U.S. Brass that they intend to seek reimbursement in the future from U.S. Brass for a share of claim settlements and administrative costs depending, in part, on the availability of insurance coverage for such claims (see discussion below). On February 4, 1994, Shell Chemical and Celanese notified U.S. Brass that they believe they have made expenditures on behalf of U.S. Brass totaling approximately $35.3 million. However, insufficient information supporting this amount has been provided to U.S. Brass, and when and if sufficient information is ultimately provided, U.S. Brass believes that it has grounds to seek substantial reductions in any such amount or to avoid any liability for such demands. U.S. Brass believes that the amount, if any, for which it may ultimately be responsible should be covered by its general liability insurance and, as such, no liability has been recorded in the accompanying financial statements.\nOn August 14, 1992, the U.S. Court of Appeals for the Seventh Circuit ruled in favor of the Company in an appeal from a declaratory judgment decision relating to the timing and availability of primary insurance coverage. The appeals court decision reversed a 1991 federal district court decision involving Liberty Mutual Insurance Company (\"Liberty Mutual\"), the Company's primary comprehensive general liability carrier for policy years 1979 through 1988, and Highlands Insurance Company and Travelers, the Company's first-layer excess insurance carriers during the same period who had intervened in that lawsuit. The appeals court ruled that losses incurred by the Company in the defense and settlement of claims involving the Qest system should be allocated to a particular insurance policy based on the date of installation of the Qest system (the \"trigger of coverage\") and not upon the date of leaks or repair and\/or replacement of the system, as the lower court had ruled. The insurers' petitions for rehearing were denied on November 5, 1992. On February 3, 1993, Liberty Mutual and Travelers filed a joint petition for a writ of certiorari with the United States Supreme\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Court, seeking review of the appeals court ruling. On March 29, 1993, the Supreme Court declined to review the appeals court's ruling.\nAs a consequence of the appeals court ruling, and in accordance with the parties' reimbursement agreements, Liberty Mutual, Highlands Insurance Company and Travelers have commenced reallocation of payments previously made by them and by the Company for defense and settlement of Qest claims that had been assigned to policy years based upon dates of discovery of leaks, to policy years based upon dates of installation of the systems. On August 27, 1993, Travelers paid U.S. Brass the amount of approximately $6.9 million pursuant to the reimbursement agreements. On December 13, 1993, Travelers paid U.S. Brass the additional amount of approximately $92,000 pursuant to those agreements. U.S. Brass believes that Travelers owes additional amounts, and has informed Travelers of its position. U.S. Brass may be obligated to reimburse certain amounts previously paid by the two other insurers who are parties to the agreements. Travelers' payments were made under a reservation of rights.\nFive insurance coverage lawsuits are now pending in various courts with respect to the polybutylene plumbing litigation:\n(1) On July 18, 1993, the Company, Eljer Manufacturing and U.S. Brass filed suit in the United States District Court for the Northern District of Illinois against 18 insurance carriers, seeking declaratory relief and damages relating to coverage for the polybutylene plumbing litigation both for costs of defense and the amounts of any settlements or judgments. That court is within the jurisdiction of the United States Court of Appeals for the Seventh Circuit, which issued the decision in the Company's favor discussed above concerning trigger of coverage. No substantive rulings have yet been issued in this matter; certain discovery activities have commenced. A number of insurers have moved to refer the matter to the Illinois state court, but no decision has been rendered on that motion. Trial is now set for on or about May 1, 1995.\n(2) On September 6, 1991, Travelers filed a declaratory judgment action against the Company in the Circuit Court of Cook County, Illinois, seeking, among other relief, a declaratory judgment that Travelers is not obligated to defend or indemnify the Company for claims involving Qest systems, that Travelers is not obligated to reimburse the Company for punitive, exemplary or treble damages incurred, and that payments made by Travelers for claims which are not covered or excluded from coverage must be reimbursed by the Company. The Company has filed an answer denying the material allegations of the complaint and asking for entry of judgment in its favor. It has also asserted a counterclaim seeking in excess of $2 million in overdue insurance proceeds from Travelers for insurable losses previously paid by the Company under a sharing agreement to which both were parties. In December 1992, following the appeals court ruling in the Company's favor, Travelers agreed to defend and indemnify the Company for Qest claims where the systems were installed from 1982 through 1986, unless and until Travelers obtains a contrary ruling in its state court litigation. The court has issued one ruling concerning the entitlement of U.S. Brass to insurance coverage from the Travelers: that ruling upheld U.S. Brass' position that Travelers, which had participated in the previous insurance coverage litigation in federal court in Illinois, was bound to the ruling concerning trigger of coverage issued in that federal litigation by the United States Court of Appeals for the Seventh Circuit. Thus, the policies issued by Travelers will be triggered for purposes of coverage where the Qest product which has given rise to the claim against U.S. Brass was installed during the course of a year during which a Travelers policy was in effect. The court has not yet addressed numerous other issues and defenses asserted by Travelers concerning its obligation to provide coverage. The court also stated on the record that if Travelers had not participated in the prior federal litigation, the court would have felt bound by rulings issued by Illinois intermediate appellate courts to find that Travelers' policies would not have been triggered for coverage purposes until the Qest system first leaked. Such a position, if applied to carriers other than Travelers, would substantially diminish the amount of insurance proceeds available to U.S. Brass.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (3) Another excess carrier, Gibraltar Casualty Company (\"Gibraltar\"), has filed an action in the Circuit Court of Cook County, Illinois, on March 16, 1992, seeking a declaratory judgment that Gibraltar has no obligation to defend or indemnify the Company for Qest claims. Hartford Accident & Indemnity Company (\"Hartford\"), and Allstate Insurance Company, two other excess insurance carriers, have been granted leave to intervene in the Gibraltar action and seek a similar declaratory judgment.\n(4) On September 21, 1993, California Union Insurance Company (\"California Union\"), which was named as a defendant in the federal litigation now pending in the United States District Court for the Northern District of Illinois, filed suit against the Company, Eljer Manufacturing and U.S. Brass in the Superior Court of Orange County, California. On October 7, 1993, each of these entities removed the case to the United States District Court for the Central District of California, and on March 1, 1994, the case was transferred to the United States District Court for the Northern District of Illinois, where the first insurance coverage action discussed above, which was brought by the Company, is now pending.\n(5) On November 12, 1993, four insurance carriers, National Surety Corporation, First State Insurance Company, Hartford, and Old Republic Insurance Company, brought suit in the Circuit Court of Cook County, Illinois against the Company, Eljer Manufacturing and U.S. Brass, and against 22 other insurance carriers who issued policies under which the Company has sought coverage for polybutylene plumbing claims. The Company has moved to dismiss this action, or for a stay, based on the prior pendency in the United States District Court for the Northern District of Illinois of the first insurance coverage case discussed above. Briefing on the Company's motion is now complete, but no decision has been rendered. The case has been consolidated with the action filed by the Travelers discussed above.\nThe Company intends to litigate these insurance coverage suits vigorously and believes it should ultimately prevail; however, the insurers have raised a number of defenses to the Company's demands for coverage, and the ultimate outcome of these matters is not certain at this time. Accordingly, no provisions for any liabilities that may result upon an unfavorable resolution of the insurance coverage matter have been made in the Company's financial statements.\nBoth Gibraltar and Hartford have refused to make any interim payments on account of defense or indemnity for Qest claims where the systems were installed in 1980 and 1981 pending resolution of the state court action. The Company may bear all or a portion of the costs of defense and settlement of litigation involving Qest systems installed in those years. The Company is currently negotiating with these two, and other, carriers for interim funding arrangements. California Union, which issued policies at coverage levels in 1982 and 1983 that the Company believes have now been reached, has disputed its obligations to provide coverage but is making certain amounts available with respect to payments of indemnity, but not for costs of defense.\nOn December 28, 1993, Celanese filed suit in the Superior Court of New Jersey against Household and two subsidiaries of the Company, Eljer Manufacturing and U.S. Brass. The suit alleges a scheme to induce Celanese to sell and continue to sell raw materials for use in polybutylene plumbing systems and to divert to Celanese the defendants' liability for claims and litigation arising from alleged failures in the plumbing systems. In addition, Celanese alleges that Household interfered with sharing arrangements between the Company's subsidiaries and Celanese for handling product liability claims by rendering the Company's subsidiaries incapable of meeting their respective obligations as a result of the spin-off of the Company by Household in 1989. In the lawsuit, Celanese seeks compensatory and punitive damages from the defendants and a declaration that Household and Eljer Manufacturing are liable for all obligations of U.S. Brass arising out of the sharing agreements and the polybutylene plumbing system actions. The Company denies any wrongdoing on the part of its subsidiaries.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nEnvironmental Matters\nLike many industrial facilities, the Company's plants may generate hazardous and nonhazardous waste, disposal of which is subject to federal and state regulation. Due to the Company's and its predecessors' longtime presence in the industry, business practices followed many years ago could potentially become the focus of environmental actions. Several facilities have been required to implement programs to remedy the effects of past waste disposal. Although a number of plants have not been the focus of comprehensive environmental studies, the Company is aware of no instances of noncompliance with currently applicable safety, health and environmental laws and regulations which might have a significant adverse effect on the Company's financial condition or results of operations except as set forth below. With respect to current operating procedures, the Company believes that it is in material compliance with such applicable laws and regulations. The Company has established accruals of approximately $13.0 million at the end of 1993 (see discussion of individual sites below) pertaining to environmental, health and safety matters. The Company believes these accruals are adequate; however, given the significance of these matters, there may be costs in excess of amounts accrued that could have a material and adverse effect on individual future years' operating results.\nThe past disposal of hazardous and nonhazardous waste generated at the Company's plants may now be subject to the requirements of the federal Resource Conservation and Recovery Act and comparable state statutes. Several facilities have been required to implement programs to remedy the effects of past waste disposal.\nA consent decree between the Company and the United States Environmental Protection Agency (\"EPA\" or \"U.S. EPA\") was entered into in October 1990, regarding the Company's Salem, Ohio, facility. The decree requires, among other things, a closure plan to be approved by the Ohio Environmental Protection Agency (\"Ohio EPA\") for the clean-up and closure of an area at that plant. In December 1992, the Company and the Ohio EPA reached agreement on the proposed closure plan and a joint settlement statement was filed in January 1993. The Company submitted a revised closure plan on April 30, 1993, and has not yet received either approval of, or comments on, the proposed plan. The Company has begun closure and has paid $1.6 million to complete an interim closure of the area and expects to pay approximately $1.8 million for additional closure and post-closure costs. The Company has established accruals which it believes are adequate to provide for these costs.\nAt the Company's Marysville, Ohio, facility, which was closed in 1987, the Ohio EPA has entered a negotiated administrative order requiring the Company to close an on-site disposal area holding foundry sand containing lead. In addition, certain solvents have been reported to be present in the soil and \"perched\" water in an on-site former drum accumulation area. The Company submitted a draft closure plan for remediation on December 16, 1993. Assuming the plan is approved in its current form, the Company's environmental consultant estimates the cost of its implementation, including post-closure care, to be approximately $9.4 million; however, there is no assurance that the plan will be approved. In connection with the closure plan, an environmental consultant has assessed the groundwater at the site and concluded that there is no adverse impact on aquifers at the site. This report was presented to the Ohio EPA on January 10, 1994. The ultimate cost to complete the closure of the facility will depend on the nature and extent of the substances there and the remediation technology ultimately agreed upon by the Ohio EPA. The Company has established accruals which it believes are adequate to provide for these costs.\nUnder the terms of the consent decree regarding the Company's Salem, Ohio, facility, discussed above, and related federal and state laws and regulations, the Company is required to demonstrate financial responsibility for closure, post-closure care and third-party liability with respect to the Salem site and the Marysville site. Primarily as a result of the unusual items recorded in 1991 and the extraordinary item and\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) cumulative effect of changes in accounting principles recorded in 1992, the Company was unable to continue making the required demonstration of financial responsibility after March 1992. On March 31, 1992, the Company notified the Ohio EPA that it could not make the required demonstration at that time, and was pursuing alternative means of satisfying the financial responsibility requirements. On October 9, 1992, the Company received from the Ohio EPA a notice of violation with respect to its failure to demonstrate financial responsibility. On October 12, 1992, the Company again notified both the U.S. EPA and the Ohio EPA of its inability to meet the financial responsibility requirements and asserted the unfavorable district court decision in 1991 on timing and availability of insurance coverage and its effect on the Company's financial position as an event of force majeure. The Company received letters from the Ohio EPA dated June 21, 1993 and February 24, 1994, advising that the Company was in violation of financial assurance requirements for the Salem and Marysville sites.\nThe Company pursued negotiations with the U.S. EPA with regard to alternatives to the Company's financial responsibility requirements under the Salem consent decree. In September 1993, however, the U.S. EPA informed the Company that it was withdrawing a proposed settlement offer that might have resolved the matter without the imposition of any penalties and was referring the matter of the Company's alleged noncompliance with the Salem consent decree to the U.S. Department of Justice (\"DOJ\"). The Company obtained a letter of credit effective September 28, 1993, to meet the closure and post-closure financial responsibility requirements relative to the Salem facility. On February 8, 1994, the DOJ sent the Company a letter demanding that the Company pay $1.1 million in stipulated penalties covering the period during which it was not able to meet the financial responsibility requirements associated with closure and post-closure care of its Salem facility. The Company disputes the amount and imposition of penalties and has entered into negotiations with the DOJ with respect thereto. The Company has recently obtained third-party liability coverage for the Salem facility.\nThe Company has been unable to renew closure, post-closure or third-party liability financial responsibility assurances for the Marysville site. On June 21, 1993, the Ohio EPA informed the Company that this matter was being referred to the U.S. EPA, but the Company has not heard from the U.S. EPA on this matter.\nThe Salem consent decree provides for a stipulated penalty of $2,000 per day for each failure to comply with a financial assurance provision (with lesser penalties of $500 to $1,000 per day during the first month of noncompliance). An Ohio statute provides generally for fines of $10,000, with higher fines for second convictions or reckless violations of its regulations. Federal law allows the imposition of civil penalties of up to $25,000 per day for violation of federal regulations and makes certain violations subject to criminal penalties. The government may attempt to impose statutory penalties on the Company for its failure to comply with the financial responsibility requirements at the Marysville site and additional penalties with regard to the Salem facility. In the Company's opinion, after consultation with counsel, any penalties ultimately imposed are likely to be less than the maximum potential penalties authorized under the law. The Company believes that it has meritorious defenses to the imposition of any penalties and intends to vigorously defend against such penalties.\nThe federal Comprehensive Environmental Response, Compensation and Liability Act (commonly referred to as \"Superfund\" or the \"Superfund Act\") and similar state laws subject certain parties to liability for the clean-up of contaminated waste treatment or disposal sites. Liability under the Superfund Act is considered \"joint and several\", meaning that any one responsible party theoretically could be liable for all clean-up costs, which are often substantial. However, the Superfund Act provides for the allocation of liability in an equitable manner among responsible parties and for contribution among them.\nCertain of the Company's plants may have disposed of waste at sites which have or may become a part of federal Superfund clean-up efforts. The Company has received notice that eight of these sites are the subject\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) of federal, and two are the subject of state, remedial investigations or activities, for which the Company has not resolved its alleged liability. In 1992 and 1993 the Company resolved its alleged liability at three additional sites. At nine of the sites still being addressed, the Company considers itself to be a de minimis contributor to the volume of waste. With regard to the remaining site, the American Zinc Company site in Dumas, Texas, the Company is conducting a preliminary investigation of its connection, if any, to a former owner of the site. On October 6, 1993, the Texas Natural Resource Conservation Commission (\"TNRCC\") informed the Company that it may be in the position of being named as a potentially responsible party (\"PRP\") with regard to this site. The Company has responded to a TNRCC request for information concerning the Company's connection, if any, to the site. If the site listing on the Texas Superfund Registry were finalized, the PRPs would be jointly and severally liable for any clean-up costs. The Company is assessing the position it will take in responding to the TNRCC. At this early stage it is not reasonably possible for the Company to determine the environmental condition of the site or the nature and cost of any remediation that may be required. Similarly, with respect to another site as to which the Company was recently notified that it may be a de minimis PRP, no determination of its share of the cost of any remediation can currently be made. The Company has established accruals which it believes are adequate to provide for any liabilities it may have with respect to the other eight sites.\nAir and water emissions by the Company's plants have in the past received the attention of regulatory authorities and may require capital expenditures in the future. During 1991 the Company received from the EPA an administrative order citing it with a violation of the Clean Water Act for unpermitted discharge of wastewater streams at the Salem, Ohio, plant. The Company has been in negotiations with the EPA since then and has filed a sampling plan and tendered the sampling results to the EPA. In January 1993 the Company received notice from the DOJ that it intended to file a civil action seeking penalties for alleged violations of the Clean Water Act from at least 1988. The government advised the Company that it was seeking a civil penalty of approximately $1 million and requested a good faith settlement offer from the Company to avoid filing a lawsuit. The Company has negotiated with the government a settlement in principle of the proposed civil action. Under the settlement in principle, the details of which will be reduced to writing in a consent decree, the Company would pay a $300,000 cash penalty and conduct certain remediation work estimated to cost approximately $690,000. The Company has established accruals which it believes are adequate to provide for these costs.\nIn October 1991, Eljer Manufacturing sold a facility located in Atlanta to joint venture partners Toto Ltd., Mitsui & Co., Ltd. and Mitsui & Co. (USA), Inc. (\"Toto and Mitsui\"). Toto and Mitsui have given Eljer Manufacturing notice that certain soil and groundwater sampling allegedly revealed several areas of contamination for which they claim indemnity under their purchase agreement. Eljer Manufacturing could be responsible for the costs of remediation, up to a contractual limit of $750,000, if this contamination resulted from an unlawful release of hazardous substances or disposal of solid waste or hazardous waste at the facility prior to October 1991. The sufficiency of the notice given is being disputed and Eljer Manufacturing has proposed conducting additional environmental assessments. In addition, Eljer Manufacturing has notified the prior owner of the facility, JP Industries, Inc., (\"JP Industries\") of Eljer Manufacturing's claims under the indemnity provisions of its purchase agreement with JP Industries. Eljer Manufacturing believes that it has meritorious challenges to Toto and Mitsui's claims as well as valid claims against JP Industries should it be liable for any contamination at this site.\nIn anticipation of the possible sale of the Company's Wilson, North Carolina, manufacturing plant, an environmental investigation was performed of that plant. One monitoring well on the property showed the presence of some hazardous substances. This finding was reported to the State of North Carolina and a follow-up investigation was performed. The Company is now in the process of preparing a report and action plan to be submitted to the state. Another well on the property was found to contain trichloroethene, another hazardous substance. Based on the location of the well and the direction of groundwater flow, and the\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Company's understanding that it has not used trichloroethene at the plant, it is presently the Company's belief that any trichloroethene on the property originated from off-site sources. The Company has established accruals which it believes are adequate to provide for the costs of investigation and remediation, if any.\nKowin Development and Related Litigation\nThe federal appeals court in Chicago on January 31, 1994, affirmed substantially all of a previously-announced arbitration award and judgment thereon in favor of Kowin Development Company (\"Kowin\") against Eljer Manufacturing arising from a failed manufacturing joint venture in the People's Republic of China. The appeals court vacated a portion of the damages award in the amount of $1 million, which together with approximately $725,000 of associated interest charges will reduce the aggregate award of damages, interest and attorneys' fees, if it becomes final, from approximately $13.2 million to approximately $11.5 million. Both Eljer Manufacturing and Kowin filed petitions for rehearing with the appeals court which were denied on March 4, 1994. Eljer Manufacturing intends to file a petition for certiorari to the United States Supreme Court. Eljer Manufacturing previously posted $13.2 million cash in lieu of an appeal bond against any payments it might ultimately owe in this litigation. The arbitration award and related costs were included in a charge against earnings in 1992.\nThe arbitration proceedings originated with claims filed in 1988 in a lawsuit brought by Kowin in federal district court in the Central District of California, which was stayed pending the arbitration proceedings. In May, 1993, Kowin was allowed to add additional causes of action, plaintiffs and defendants (including the Company, three current or former officers of Eljer Manufacturing, Household and certain of its current or former directors and officers) to the lawsuit; however, in October, 1993, the court entered an order dismissing with prejudice all federal law claims of Kowin and of the additional plaintiffs. No appeal was taken from the dismissal.\nCroft Investments, Ltd. (\"Croft\"), an affiliate of Kowin, the holder of 25% interest in the failed China joint venture, filed a demand for arbitration before the American Arbitration Association in Chicago of its claims for $8 million in lost profits and other unspecified damages. Croft had sought to litigate these claims in the Kowin lawsuit in California, but in the May, 1993, order of that court (discussed above) was denied permission to be added as an additional plaintiff on the basis that Croft's claims should have been brought in the arbitration proceedings initiated by Kowin in 1989. The Company and Eljer Manufacturing then filed a motion to permanently stay the Croft demand for arbitration and to bar Croft's claims on the same grounds as the court had relied upon in refusing to add Croft as a plaintiff in this lawsuit. On August 26, 1993, the court denied this motion on the basis that it lacked jurisdiction to entertain it. On September 27, 1993, the Company and Eljer Manufacturing filed an appeal of this ruling with the Ninth Circuit Court of Appeals. That appeal is still pending.\nEljer Manufacturing has been advised by its Chinese counsel that the Beijing High People's Court has confirmed a judgment previously entered in the amount of approximately $1.2 million against it and in favor of its former Chinese joint venture partner. Eljer Manufacturing has taken a further appeal from this decision and, based upon advice of counsel, believes it also has substantial procedural defenses against any effort to enforce this judgment in the United States. Eljer Manufacturing believes its reserves adequate to provide for any liability ultimately incurred in this matter.\nThe claims in the Chinese litigation relate to the joint venture interest sold in April 1988 by HMI to Simonds Industries, Inc. (\"Simonds\") and involve none of Eljer Manufacturing's current business operations. Prior to the sale in 1988, the assets sold to Simonds were operated by a separate division of HMI which was unrelated to the other operating divisions of HMI which subsequently became a part of the Company. Despite this fact, no indemnification for these claims was received from Household, the former parent corporation of\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) the Company, in connection with the spin-off of the Company, including its Eljer Manufacturing subsidiary, to Household's stockholders in April 1989. The Company has an agreement with Simonds, a successor to HMI in the Chinese joint venture, under which claims related to the joint venture performance after April 15, 1988 (the date of the sale of HMI's interests to Simonds) are the responsibility of Simonds. The Company is not presently able to determine what amount, if any, of the amount awarded in the Chinese proceeding or in the Kowin litigation is properly the responsibility of Simonds.\nShareholder Suits\nDuring the second quarter of 1991, four lawsuits (later consolidated into one) were filed in the Delaware Chancery Court against the Company and the individual members of its Board of Directors, alleging breach of fiduciary duties in conjunction with the Board's decision to defer discussion of the May 7, 1991 acquisition proposal from Jacuzzi, Inc. until its regularly scheduled meeting on June 18, 1991. No monetary damages were specified in the suits. The suits were voluntarily dismissed on March 29, 1993.\nOn March 14, 1994, the Company announced an agreement in principle to settle for $3.4 million the class action securities litigation against the Company and certain present and former members of its Board of Directors pending in the United States District Court for the Northern District of Texas. The proposed settlement is subject to negotiation and execution of a definitive settlement agreement among the parties and approval by the court. The Company believes that a significant portion of the proposed settlement amount would be paid by its liability insurance carrier, with the remainder covered by litigation reserves previously established. The suit, originally filed as four purported class action suits in December 1991 and later consolidated into one, asserted causes of action based on alleged inadequate disclosures in the Company's 1989 and 1990 annual reports to shareholders and, in particular, disclosures with respect to the litigation involving the Qest polybutylene plumbing system manufactured and sold by U.S. Brass and with respect to the availability of insurance coverage therefor. The plaintiffs sought unspecified actual and punitive damages, as well as costs and attorneys' fees. In 1992 the court certified a plaintiff class consisting of all purchasers of the Company's common stock during the period from March 30, 1990 through August 8, 1991.\nOther Matters\nOn December 15, 1992, the Attorney General of the State of California, the Natural Resources Defense Council and the Environmental Law Foundation filed lawsuits against the Company, U.S. Brass and approximately 15 other manufacturers and sellers of residential and commercial brass faucets alleging violations of California's Safe Drinking Water and Toxic Enforcement Act of 1986 (\"Proposition 65\"). The lawsuits allege that the Company, U.S. Brass and other plumbing manufacturers did not provide clear and reasonable warning to California purchasers prior to knowingly and intentionally exposing persons to lead, a chemical known to the State of California to cause reproductive toxicity, and that the Company, U.S. Brass and other plumbing manufacturers knowingly discharged or released lead into drinking water in violation of Proposition 65. The lawsuits claim that the alleged exposures and discharges occur from the leaching of lead into drinking water from brass faucets manufactured by the companies. The Company and U.S. Brass, if found liable, could be subject to a civil penalty not to exceed $2,500 per day for a violation of the warning requirement and $2,500 per day for a violation of the discharge requirement. Allegations are also made that the same conduct constitutes unfair business practices, misrepresentation, fraud and deceit, breach of contract and warranties, and negligence. The Company and U.S. Brass intend to defend the lawsuits vigorously, and while they will continue to do so, they have also engaged in settlement discussions with the plaintiffs. The Company and U.S. Brass do not expect the resolution of these lawsuits to have a material adverse effect on its financial condition or results of operations.\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) On October 13, 1993, the Company reported that a federal court jury in Oklahoma City, Oklahoma, had rendered a verdict against U.S. Brass in a lawsuit filed by two local businessmen, who manufactured and marketed a modified Vise Grip as a \"crimping tool\" to be used in the installation of polybutylene plumbing systems. The jury found that U.S. Brass attempted to monopolize the market for crimping tools used in the installation of U.S. Brass' Qest polybutylene plumbing systems, tied the sale of warranted Qest polybutylene plumbing products to the purchase of U.S. Brass' own crimping tools, and interfered with the plaintiffs' business relationships. The jury awarded the plaintiffs damages for violation of federal and state antitrust laws which, if not set aside, would be $600,000 after trebling. In addition, the jury awarded $300,000 in actual damages and $300,000 in punitive damages for the plaintiffs' claim that U.S. Brass interfered with their business and contractual relationships. U.S. Brass believes that the jury's award for both antitrust and interference with business claims is tantamount to double recovery and erroneous as a matter of law. U.S. Brass believes that the jury findings, which were confirmed by a court judgment on November 10, 1993, were not supported by the evidence presented at trial and has asked the court to set aside or substantially reduce the awards. If post-judgment motions are unsuccessful, U.S. Brass intends to appeal. Plaintiffs have asked for award of attorney's fees in an amount of approximately $450,000 and taxable court costs. The parties have stipulated to the amount of taxable court costs. The Company, however, has opposed the application for attorney's fees. The matter is under submission to the court.\n(14) RELATIONSHIP WITH HOUSEHOLD:\nOn February 5, 1993, Household filed an action in the Delaware Chancery Court against the Company, Eljer Manufacturing and U.S. Brass seeking declaratory relief against the defendants for any claims alleging any breach of fiduciary duty which Household owed to the defendants during the time they were wholly- owned subsidiaries of Household and for any claims arising out of the distribution of the stock of the Company to stockholders of Household in April 1989. The action also seeks a declaration that Delaware law applies to any claims of the defendants against Household, arising from or related to such distribution, and an injunction against the defendants' commencing or maintaining any lawsuit outside Delaware against Household relating to such distribution. On March 16, 1993, Household amended its complaint to seek additional declaratory relief that it is not liable to the Company for any breach of fiduciary duty at or after the spin-off. The Company believes the action is without merit and will vigorously defend its interests.\nIn two opinions dated April 22, 1993 and May 5, 1993, the Delaware Chancery Court denied the Company's motion to dismiss or stay the case and partially denied Household's motion to stay the Texas case referred to below. The court only granted Household a limited injunction preventing the Company, Eljer Manufacturing and U.S. Brass from seeking an order in any state court other than Delaware to enjoin, preclude or otherwise prohibit or delay the prosecution of Household's action in the Delaware Chancery Court.\nThe Company, Eljer Manufacturing and U.S. Brass sought and obtained review in the Delaware Supreme Court of the Delaware Chancery Court's orders. Household also sought and obtained review of the Chancery Court's denial of its motion for a stay of litigation outside Delaware. On December 22, 1993, the Delaware Supreme Court issued an order remanding the case to the Delaware Chancery Court for the purpose of clarifying the record on appeal. The Chancery Court was instructed to determine if there are any known claims for alleged breaches of fiduciary duties by Household. If there are no such claims, then the Chancery Court was further directed to determine what, if any, other bases there may be to invoke the Chancery Court's equitable jurisdiction. If no such basis exists, the Chancery Court was directed to determine whether Household's action for a declaratory judgment should be either dismissed or transferred to the Delaware Superior Court. On March 18, 1994, the Chancery Court issued its report and recommendation to the Supreme Court of Delaware. The Chancery Court concluded that it did not have subject matter\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) jurisdiction over Household's action for a declaratory judgment, but also concluded that under Delaware law, Household had a right to transfer the case to the Delaware Superior Court. The Company intends to continue its appeal of the remaining issues before the Delaware Supreme Court.\nOn February 11, 1993, the Company and Eljer Manufacturing filed an action against Household in the District Court of Dallas County, Texas, alleging claims for breach of contract based upon Household's breach of the Reimbursement Agreement, dated as of April 14, 1989, and the Reorganization and Distribution Agreement, dated as of March 15, 1989, executed in connection with the distribution of the Company's stock to holders of Household's stock in April 1989. Household appeared on March 15, 1993, to raise the defense of lack of personal jurisdiction over it. In September 1993, the Delaware Chancery Court enjoined the Company and Eljer Manufacturing from proceeding with its action in Texas pending hearing and determination of the Delaware Supreme Court appeal. The Company intends to pursue vigorously its claims against Household.\n(15) GEOGRAPHIC SEGMENTS:\nData on the Company's geographic segments, based on the locations of the Company's operations, are as follows (in thousands):\nELJER INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n(16) QUARTERLY FINANCIAL DATA (UNAUDITED AND IN THOUSANDS EXCEPT PER SHARE AMOUNTS):\nThe unaudited quarterly financial data above have been restated from the Company's previously filed Forms 10-K and 10-Q to reflect certain reclassifications from cost of sales to selling and administrative costs.\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 section entitled \"Election of Directors\" appearing in the Registrant's proxy statement for the annual meeting of stockholders to be held on June 21, 1994, sets forth certain information with respect to the directors of the Registrant and is incorporated herein by reference. Certain information with respect to persons who are or may be deemed to be executive officers of the Registrant is set forth under the caption \"Executive Officers of the Registrant\" in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe section entitled \"Executive Compensation and Certain Transactions\" appearing in the Registrant's proxy statement for the annual meeting of stockholders to be held on June 21, 1994, sets forth certain information with respect to the compensation of management of the Registrant and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe sections entitled \"Voting Securities and Principal Stockholders\" and \"Election of Directors\" appearing in the Registrant's proxy statement for the annual meeting of stockholders to be held on June 21, 1994, set forth certain information with respect to the ownership of the Registrant's Common Stock and are incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe section entitled \"Executive Compensation and Certain Transactions\" appearing in the Registrant's proxy statement for the annual meeting of stockholders to be held on June 21, 1994, sets forth certain information with respect to certain business relationships and transactions between the Registrant and its directors and officers and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES & REPORTS ON FORM 8-K\n(1) FINANCIAL STATEMENTS\nThe financial statements filed as part of this report are listed on the Index to Consolidated Statements on page 18.\n(2) FINANCIAL STATEMENT SCHEDULES\nIndex to Consolidated Financial Statement Schedules\nAll other Schedules have been omitted because the required information is shown in the consolidated financial statements or notes thereto or they are not applicable.\n(3) EXHIBITS\n- -------- *Incorporated by reference to the Registrant's Registration Statement on Form 10 filed February 14, 1989, as amended by Forms 8 filed March 14, 1989, March 23, 1989, March 27, 1989, August 3, 1989, January 10, 1990, May 2, 1990 and November 19, 1991 (File No. 0-10181).\n**Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1989 filed March 29, 1990.\n***Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Fiscal Year Ended December 30, 1990 filed March 25, 1991.\n****Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the Quarterly Period Ended March 31, 1991 filed May 14, 1991.\n*****Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the Quarterly Period Ended September 29, 1991 filed November 12, 1991.\n******Incorporated by reference to the Registrant's Annual Report on Form 10-K for the Fiscal Year Ended January 3, 1993, filed April 1, 1993.\n*******Incorporated by reference to the Registrant's Registration Statement on Form S-8 filed December 16, 1993 (registration no. 33-51527).\n(4) REPORTS ON FORM 8-K\nA report on Form 8-K was filed on November 17, 1993, related to the announcement of a settlement of a lawsuit brought in April 1993, by Kohler Company against the Company and its subsidiary, Eljer Manufacturing, for unfair competition, design patent and trade dress infringement in the manufacture and sale of plumbing products.\nA report on Form 8-K was filed on October 22, 1993, related to (1) the Illinois State Court judge's ruling on the insurance dispute with the Travelers, and (2) the verdict against U.S. Brass in a federal district court in Oklahoma City, Oklahoma.\nSUBSEQUENT REPORTS ON FORM 8-K\nA report on Form 8-K was filed on January 7, 1994, related to the announcement that Celanese filed suit in the Superior Court of New Jersey against Household, the former parent of the Company, Eljer Manufacturing and U.S. Brass. See Note 13 for a discussion of the lawsuit.\nA report on Form 8-K was filed on February 11, 1994, related to the announcement that the federal appeals court in Chicago had affirmed substantially all of a previously-announced arbitration award in favor of Kowin Development and against Eljer Manufacturing. See Note 13 for additional discussion.\nA report on Form 8-K was filed on March 25, 1994, related to the March 14, 1994, announcement of an agreement in principle to settle the class action securities litigation against the Company and certain present and former members of the Board of Directors pending in a federal court in Texas. See Note 13 for a discussion of the proposed settlement.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders of Eljer Industries, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Eljer Industries, Inc. and subsidiaries included in this Form 10-K, and have issued our report thereon dated March 31, 1994. Our report on the consolidated financial statements includes an explanatory paragraph with respect to the outcome of lawsuits, claims and related insurance coverage involving the Qest polybutylene plumbing systems manufactured and sold by the Company's indirect, wholly-owned subsidiary, United States Brass Corporation. This matter is discussed further in Notes 2 and 13 to the consolidated financial statements. Our report on the consolidated financial statements includes an additional explanatory paragraph with respect to the changes in the methods of accounting for postretirement benefits other than pensions, postemployment benefits and income taxes as discussed in Notes 1, 9 and 11 to the consolidated financial statements. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed in the index to Item 14 are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic 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.\nDallas, Texas,March 31, 1994\nELJER INDUSTRIES, INC.\nSCHEDULE V--PROPERTIES AND EQUIPMENT\n(IN THOUSANDS)\n- -------- (1) Amounts represent primarily foreign currency translation adjustments related to the Company's foreign entities.\nSCHEDULE VI--ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTIES AND EQUIPMENT\n(IN THOUSANDS)\n- -------- (1) Amounts represent primarily foreign currency translation adjustments related to the Company's foreign entities.\nELJER INDUSTRIES, INC.\nSCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS\n(IN THOUSANDS)\n- -------- (1) Includes primarily write-offs of uncollectible accounts and customer discounts taken. (2) Includes primarily collection of proceeds from insurance carriers. (3) Established in conjunction with the implementation of SFAS No. 109.\nSCHEDULE X--SUPPLEMENTARY INCOME STATEMENT INFORMATION\n(IN THOUSANDS)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: March 31, 1994\nEljer Industries, Inc.\n\/s\/ Henry W. Lehnerer By: _________________________________ Henry W. Lehnerer 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.","section_15":""}
{"filename":"740763_1994.txt","cik":"740763","year":"1994","section_1":"ITEM 1. BUSINESS.\nGilbert Associates, Inc. (the \"registrant\") was organized as a\nholding company in 1984. Through its operating subsidiaries, the\nlargest of which is Gilbert\/Commonwealth, Inc. (\"G\/C\"), the registrant\nis engaged in the businesses of providing professional services and\nthe manufacture and sale of communication equipment. G\/C, formerly\nknown as \"Gilbert Associates, Inc.,\" was organized in 1942. The\nregistrant and its subsidiaries are sometimes referred to herein\ncollectively as the \"Gilbert companies.\"\nThe holding company structure separates the administrative and\nfinancing activities of the registrant from the activities of its\noperating subsidiaries. The revenues, operating profits and\nidentifiable assets of the registrant's professional services and\ncommunication equipment segments for each of the last three years are\nstated in Note 14 to the consolidated financial statements contained\nin Part II, Item 8 of this report.\nPROFESSIONAL SERVICES\nThe professional services business segment, formerly called the\nengineering and consulting segment and renamed to more accurately\nreflect the revenue stream, consists of the registrant's largest\nsubsidiary, G\/C, and its subsidiaries, together with United Energy\nServices Corporation (\"UESC\"), Resource Consultants, Inc. (\"RCI\") and\nSRA Technologies, Inc. (\"SRA\"), which are wholly-owned subsidiaries of\nthe registrant. The operations of these subsidiaries have been\nconsolidated for reporting purposes.\nG\/C, based in Reading, Pennsylvania, provides a wide range of\nengineering and consulting services, including electrical, mechanical,\nstructural and nuclear engineering, construction management,\nprocurement, and consulting services. G\/C's major services are the\ndesign, engineering and supervision of the construction of electric\npower generating stations and electric transmission and distribution\nsystems as well as upgrading and retrofitting existing power plants.\nIt also renders services to industrial clients and various\ngovernmental agencies. UESC, based in Atlanta, Georgia, primarily\nprovides operations and engineering consulting services to the\nnuclear power industry. RCI, based in Vienna, Virginia,\nprovides engineering, outplacement services, technical and other\nprogram support services to U.S. defense agencies, principally the\nU.S. Navy and Army, and other U.S. Government agencies. SRA, based in\nFalls Church, Virginia, provides research and consulting services in\nlife and environmental sciences, engineering and related technical\nareas, principally to U.S. Government agencies.\nDuring 1994, the registrant recorded a charge to income of\n$15,800,000 (net of $2,000,000 income tax benefit) or $2.26 per share,\nassociated with its nuclear service business. The charge is comprised\nof a $12,200,000 or $1.74 per share goodwill write-off and $1,025,000\nor $.15 per share for severance and idled leased facility costs to\nreflect the current market conditions. The charge also includes\n$2,575,000 or $.37 per share to increase reserves to cover contractual\nissues on contracts completed in prior years. The total charge is\nincluded in selling, general and administrative expenses. The entire\ncharge, including the goodwill write-off, will not have a material\nimpact on future results of operations.\nThe $12,200,000 goodwill write-off represents the entire goodwill\namount associated with United Energy Services Corporation and\nits subsidiaries.\nThe goodwill write-off stems primarily from the deterioration of\nthe commercial nuclear power market. Market forces, including\nderegulation of the electric utility industry, the emergence of\nindependent power producers and technological advances making fossil\nplants more efficient, have particularly affected the commercial\nnuclear industry, resulting in a dramatic decline in the demand for and\npricing of services. These changing market conditions have resulted\nin increased competition on those services typically provided by UESC.\nUESC incurred substantial losses late in 1993 and continued to operate\nat a loss through 1994. For these reasons, and the continued\nuncertainty surrounding UESC's nuclear business returning to a level\nof profitability sufficient to recover the carrying value of\ngoodwill, it became apparent to management that UESC's goodwill was\npermanently impaired and no longer had any value.\nThere were no other significant new business developments relating\nto the professional services segment during the fiscal year ended\nDecember 30, 1994.*\nThe services of G\/C and UESC in the professional services industry\nare not divisible into classes because the projects undertaken by G\/C\nand UESC require the utilization, in varying proportions depending\nupon the project, of the skills and talents of staff members who are\nqualified in a variety of disciplines. For example, a single project\nmay involve the utilization of the services of mechanical engineers,\nelectrical engineers, structural engineers, draftspeople, clerical\npersonnel and others.\n* All references to particular years in the balance of this report refer to the fiscal year ended on or about December 31 of such year. Thus, the fiscal year ended December 30, 1994 is from time to time referred to as simply \"1994\" elsewhere in this report.\nThe following table sets forth for the past three fiscal years the\nrevenues derived from the listed categories of professional services\nrendered.\nProfessional Services Revenues (in thousands of dollars)\n1994 1993 1992\nDesign and Related Services $111,359 $123,945 $127,844\nOperations Services 34,921 61,834 85,351\nDefense Related Services 63,092 57,624 51,027\nLife and Environmental Sciences Services 20,515 - -\nOperating profit and identifiable assets for the last three years\nwithin the professional services segment are disclosed in Note 14 to\nthe consolidated financial statements in Part II, Item 8 of this\nreport.\nThe following table sets forth the approximate percentage of\noperating revenues derived from the principal markets served by the\nprofessional services segment during 1994 and the approximate\npercentage of backlog as of December 30, 1994 represented by work\narrangements with clients in such markets:\nPercentage of Percentage of Backlog Market for Services 1994 Revenues as of December 30, 1994\nU.S. Private Industry 39% 16%\nU.S. Federal, State and Local Governments and Agencies 58 82\nForeign Governments and Businesses 3 2\nThe work arrangements of this segment, while varying, are\nessentially either cost-plus or fixed-price. G\/C, UESC, RCI and SRA\nhave limited the number and extent of their fixed-price commitments in\nlight of their experience that extended periods of performance and\nchanges in governmental requirements tend to make it difficult to make\nadequate allowance for escalation and contingencies in fixed-price\nquotations. The majority of the Gilbert companies' professional\nservices revenues was attributable to contracts other than fixed-price\narrangements in each of the last three years. In addition, fixed-\nprice contracts represent less than a majority of the backlog\nattributable to such segment at December 30, 1994. The ability to\ncontinue to sell services on a basis other than fixed-price will,\nhowever, depend upon a number of factors including the state of the\nnational economy, the level of actual and planned capital and\noperating expenditures by prospective clients, and the trend of\ncontracting practices in the markets in which such services are\nrendered.\nInventory is not essential to the operations of the Gilbert\ncompanies' professional services segment.\nThe subsidiaries comprising the Gilbert companies' professional\nservices segment own various patents and trademarks and have pending\napplications for other patents. However, such patents and trademarks\nare not individually or cumulatively significant to the business of\nsuch segment.\nAlthough the professional services segment is not dependent upon\nany single client, its five largest clients have generally accounted\nfor approximately three-fifths of its total revenues. During 1994,\nthe United States Government and the Tennessee Valley Authority\n(\"TVA\") accounted for 34% and 13%, respectively, of total professional\nservices revenues. During 1993, the United States Government and TVA\naccounted for 24% and 16%, respectively, of total professional services\nrevenues. These amounts represent revenue earned by the registrant as\nprime contractor. No other client or its affiliate accounted for 10%\nor more of such revenues in 1994 or 1993.\nA substantial portion of the business of the professional services\nsegment is obtained from clients served for a number of years. In the\nyears 1994 and 1993, services rendered to clients who had been served\nat least four years earlier accounted for 89% and 83%, respectively,\nof the Gilbert companies' professional services revenues. There is no\nassurance that work authorizations from such clients will account for\na similar percentage of total revenues in the future.\nAs of December 30, 1994 and December 31, 1993, respectively, the\nsubsidiaries comprising the Gilbert companies' professional services\nsegment had backlogs of contracts or work authorizations from which\nthey had then anticipated estimated aggregate future revenues of\napproximately $301,000,000 and $407,000,000. The backlog of RCI and\nSRA accounted for approximately 77% of the total segment backlog at\nDecember 30, 1994 and December 31, 1993. Substantially all of the\nbacklog of RCI and SRA at such dates represents work to be performed\non government contracts for which funding has not yet been authorized.\nSuch funding authorizations are generally issued by the government in\nperiodic increments during the contract term. The subsidiaries\ncomprising the professional services segment anticipate that\napproximately $138,000,000 of the revenues to be recognized by them\nunder work authorizations outstanding at December 30, 1994 will be\nearned within the fiscal year ending December 29, 1995 and that\nadditional revenues will be earned in 1995 from work authorizations\nreceived during the year.\nConsistent with standard industry practice for professional services\norganizations, work authorizations for the Gilbert companies' professional\nservices segment are terminable by their clients upon relatively brief notice,\nwhether by the express terms of such work authorizations or otherwise.\nThe completion dates for a number of projects have been extended in\nthe past, thereby lengthening the period of time during which the\nbacklog of estimated revenues for those projects was to be earned.\nWith the continued unsettled conditions in the industries served by\nthis segment, it is possible that one or more projects included in the\nbacklog at December 30, 1994 might be extended or even canceled. Work\nauthorizations from the largest client included in such backlog total\n$88,000,000 for work on several U.S. Navy programs, of which\n$70,000,000 is subject to government funding.\nSince the majority of the operating costs of the subsidiaries\ncomprising the Gilbert companies' professional services segment are\npayroll and payroll-related costs, and since their business is\ndependent upon the reputation and experience of their personnel, the\nquality of the services they render and their ability to maintain an\norganization which is qualified and adequately staffed to undertake\nand efficiently discharge assignments in the various fields in which\nsuch subsidiaries render services, a reasonable backlog is important\nfor the scheduling of their operations and for the maintenance of a\nreasonably staffed level of operations.\nTo the best of the knowledge of the registrant, no reliable data\nare available with respect to the total size of the market for\nprofessional services for the full range of fields in which the\nregistrant's subsidiaries are engaged. The registrant's professional\nservices subsidiaries compete with a number of firms in each of the\nfields in which they are active, and some of their competitors have\nsubstantially larger total revenues, greater financial resources and\nmore diversified businesses. Competition is based primarily on\nquality, reputation, experience and available skills and services.\nFrequently, however, formal or informal bidding procedures result in price\ncompetition. In terms of the number of employees rendering professional\nservices (excluding those incident to construction and technician services),\nthe registrant believes that its professional services segment is one of\nthe largest firms, but it is unable to determine its relative size\nwithin this group. Moreover, since there are a great many firms\nrendering similar services as a portion of their businesses or to\naffiliated companies only, the registrant believes it does not\nconstitute a substantial part of the total market for such services.\nA number of the professional services segment's clients utilize\ntheir own staffs to do all or a major part of their own engineering\nwork. Thus, the future business of the professional services segment\nof the Gilbert companies will be affected by the extent to which\nclients and potential clients utilize the services of outside\nprofessional services firms. Such future business will also be\naffected by factors such as the rate of growth of the electric utility\nindustry, the demand for new power generation facilities, and the\nlevel of expenditure for capital goods in the United States.\nReductions in United States government defense expenditures have\nrecently been made and further reductions may follow. Although the\nregistrant has not been adversely affected by these events, it is\nunable to estimate the degree or nature of the future impact of any\nsuch reductions on the professional services segment.\nThe Energy Policy Act of 1992 includes various provisions\nwhich are expected to result in further deregulation of, and\ncompetition within, the electric utility industry and\ndevelopment of independent power production facilities. The\neffect of these provisions on the registrant's business is not\ncertain. In addition, the Act contains amendments to the Atomic Energy Act\ndesigned to provide for standardization of nuclear plant designs and to\notherwise simplify the nuclear power plant licensing process and\nthereby encourage development of nuclear power reactors by utilities.\nNo new nuclear power plants have been ordered by utilities since 1978,\nand the effect of these amendments to the Atomic Energy Act on the\nregistrant's future business is considered to be uncertain pending\nsatisfactory resolution of, among other things, nuclear waste disposal issues.\nThe registrant's professional services subsidiaries do not engage\nin any material company-sponsored research activities relating to the\ndevelopment of new products or services or the improvement of existing\nproducts or services. In the process of performing professional\nservices, some personnel of such subsidiaries are periodically\ninvolved in customer-sponsored research activities for the improvement\nof products or services, but few employees are engaged in such\nactivities on a full-time basis and they are not a material part of\nthe Gilbert companies' professional services business.\nOn December 30, 1994, the professional services segment had a total\nof 3,033 employees, of which 2,126 employees were professional and\ntechnical personnel. In comparison, such segment had a total of 3,428\nemployees on December 31, 1993, of which 2,459 employees were\nprofessional and technical personnel.\nCOMMUNICATION EQUIPMENT\nThe communication equipment segment of the business of the Gilbert\ncompanies consists of the sale and customizing of communications\nequipment and related systems by GAI-Tronics Corporation (\"GAI-\nTronics\"), a wholly-owned subsidiary of the registrant.\nGAI-Tronics is principally engaged in the development, assembly and\nmarketing of communication systems for industrial operations. In\nserving such customers, GAI-Tronics provides custom services by\nadapting communication systems to operate under extraordinary plant\nconditions such as excessive dust and explosive atmospheres. GAI-\nTronics also designs and manufactures land mobile radio\ncommunication devices.\nThe value of orders for GAI-Tronics' systems may range from a\nminimal amount to several hundred thousand dollars. GAI-Tronics'\nsignificant class of products or services is the design and assembly\nof communication systems.\nThe approximate percentage of GAI-Tronics' sales derived from the\nprincipal markets for its products during 1994 and the approximate\npercentage of its backlog as of December 30, 1994 represented by\ncontracts with clients in such markets, were as follows:\nPercentage of Percentage of Backlog Market for Products 1994 Revenues as of December 30, 1994\nU.S. Private Industry 79% 53%\nForeign Governments and Businesses 21 47\nRevenue, operating profit and identifiable assets for the last three\nyears within the communication equipment segment are disclosed in Note\n14 to the consolidated financial statements in Part II, Item 8 of this\nreport.\nGAI-Tronics is continually modifying its products and attempting to\nfurther expand its product line. GAI-Tronics manufactures relatively\nfew of the basic components employed in its equipment; instead, it\nprimarily designs and assembles its equipment and systems by use of\nstandard or special components manufactured by others. Several sources\nof supply exist for such components so that GAI-Tronics is not\ndependent upon any single supplier.\nGAI-Tronics maintains a substantial inventory of components to\nsatisfy its customers' requirements because GAI-Tronics provides\nmainly customized communication systems for specialized uses.\nGAI-Tronics owns various patents and trademarks. However, such\npatents and trademarks are of less significance to GAI-Tronics'\noperations than its experience and reputation.\nGAI-Tronics' business is not dependent upon a single customer or a\nvery few customers. An insubstantial amount of GAI-Tronics' sales in\n1994 were made for installation in projects or to customers for which\nsubsidiaries comprising the professional services segment had served\nas consulting engineer. (See \"Business - Professional Services\".)\nA substantial part of GAI-Tronics' business is obtained from\ncustomers to whom it has made previous sales. In 1994 and 1993, sales\nmade to customers who had made purchases at least four years earlier\naccounted for approximately 94% of GAI-Tronics' total net sales.\nThere is no assurance that sales to such customers will account for a\nsimilar percentage of total revenues in the future. Many of GAI-\nTronics' sales are made as a result of proposals submitted in response\nto competitive bidding invitations.\nAs of December 30, 1994 and December 31, 1993, GAI-Tronics had a\nbacklog of contracts from which it had anticipated estimated future\nrevenue of approximately $5,954,000 and $6,850,000, respectively.\nGAI-Tronics anticipates that substantially all of the goods reflected in its\nbacklog at December 30, 1994, will be shipped in 1995. GAI-Tronics\nanticipates that the vast majority of its revenues earned in 1995 will be\nfrom orders received during the year.\nGAI-Tronics competes with a number of other organizations that\ndevelop and market specialized telephonic and communication systems.\nSome of its competitors have larger total sales, greater financial\nresources, larger research and development organizations and\nfacilities and a more diversified range of communications services and\nproducts. GAI-Tronics' management believes that GAI-Tronics' history\nof quality, its reputation, experience and service are the most\nimportant factors in its being asked to submit bids and in purchasing\ndecisions made by its customers.\nGAI-Tronics spent approximately $1,727,000, $1,734,000 and\n$1,309,000 during 1994, 1993 and 1992, respectively, on company-\nsponsored product development and improvement. Several of GAI-\nTronics' professional employees routinely engage in company-sponsored\nproduct development and improvement on a full-time basis. GAI-Tronics\nhas not made material expenditures on product development and\nimprovement projects sponsored by customers in the last three years.\nOn December 30, 1994, GAI-Tronics had a total of 394 employees, of\nwhich 169 employees were professional and technical personnel. In\ncomparison, GAI-Tronics had a total of 420 employees on December 31,\n1993, of which 174 were professional and technical personnel.\nMISCELLANEOUS\nThe registrant expects no material effect on the capital\nexpenditures, earnings and competitive position of the registrant and\nits subsidiaries from its or their compliance with federal, state or\nlocal laws or regulations controlling the discharge of materials into\nthe environment or otherwise relating to the protection of the\nenvironment, although it does expect its professional services\nsubsidiaries to undertake engineering work for many of their clients\nto support them in complying with such provisions.\nA portion of the revenue of the Gilbert companies is derived from\ncustomers or projects located outside the United States. All foreign\nrevenues were from work authorizations with customers unaffiliated\nwith the Gilbert companies. Certain services rendered to foreign\nclients have been undertaken in association with financing supplied or\nguaranteed by the U.S. Government or by U.S. or international banking\ninstitutions such as the U.S. Agency for International Development.\nCurtailment of such financing or guarantees could tend to reduce\nrevenues from foreign sources. The countries providing the largest\nportion of foreign revenues in 1994 were Egypt and Canada.\nThe businesses of the registrant's subsidiaries are not seasonal\nto any material extent.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe physical properties owned and leased within the professional\nservices segment consist primarily of office space and furniture and\nequipment. Certain subsidiaries of the registrant own land and\nseveral buildings containing approximately 618,000 square feet of\noffice space, located in and near Reading, Pennsylvania and in\nHuntsville, Alabama. Most of this office space is in buildings\nsituated on approximately 40 acres of a 530 acre tract. Located in\nthese buildings are the headquarters of the registrant and G\/C, as\nwell as G\/C's engineering and design and related operations, and\noffices of UESC and GAI-Tronics.\nRCI leases a total of 168,000 square feet of office space,\nprimarily in the Washington, D.C. area, used for engineering and\ntechnical support activities under leases expiring between 1995 and\n1997. Of this total, 78,600 square feet is leased under two separate\nagreements with limited partnerships in which certain officers and an\nemployee of RCI hold limited partnership interests representing\napproximately 26% of the total equity of the partnerships which\nexisted prior to the registrant's acquisition of RCI. These leases\nexpire in 1996 and 1997.\nSRA leases from unrelated parties a total of 120,000 square feet\nof both office and laboratory space primarily in the Washington, D.C.\narea used for various engineering and biomedical research activities\nunder leases expiring between 1995 and 2005.\nUESC leases, from unrelated parties, approximately 60,000 square\nfeet of office space primarily in the Louisville, Tennessee and\nAtlanta, Georgia areas used for engineering activities under leases\nexpiring in 1995 and 1999, respectively.\nGAI-Tronics' plants are located near Reading, Pennsylvania, and in\nMemphis, Tennessee. The plant near Reading, Pennsylvania, which is\nused to design and assemble communication systems, is owned by GAI-\nTronics and consists of approximately 74,000 square feet and is\nlocated on a 17 acre tract of land owned by GAI-Tronics. The plant\nlocated in Memphis, Tennessee, which is used to design and assemble\nland mobile radio communication devices is leased by GAI-Tronics and\nconsists of approximately 50,000 square feet with the lease expiring\nin 2000.\nGreen Hills Management Company, the registrant's wholly-owned real\nestate development and management subsidiary, owns a 130,000 square\nfoot office building to be leased to third parties. As of the end of\n1994, approximately 48,000 square feet of space is occupied under\nleases which expire in 2003. In addition, Green Hills Management\nCompany leases to unrelated parties approximately 105,000 square feet\nof space within the buildings in the Reading, Pennsylvania area\ndescribed earlier. The largest of these leases, 96,000 square feet,\nexpires in 2004. The remaining leases expire in 1996.\nCertain subsidiaries of the registrant lease, from unrelated\nparties, facilities used for branch and project offices. None of\nthese leased facilities is material in relation to the total space\noccupied by the registrant and its subsidiaries.\nThe registrant and its subsidiaries believe that their existing\nfacilities are suitable and adequate for their present purposes.\nThe registrant and its subsidiaries own the majority of the office\nfurniture and equipment used by them; however, they also lease a\nsubstantial amount of equipment under agreements generally for terms\nnot in excess of five years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe registrant and its subsidiaries are involved in various\ndisputes which have resulted in pending litigation arising in the\nordinary course of business as to which, in the opinion of the\nmanagement of the registrant, no material adverse effect on the\nregistrant's financial statements is expected to result.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matter required to be reported pursuant to this item was\nsubmitted to security holders in the fourth quarter of 1994.\nITEM 4A. EXECUTIVE OFFICERS OF REGISTRANT.\nThe names, ages, positions and previous experience to the extent\nrequired to be presented herein of all current executive officers of\nthe registrant are as follows:\nName * Position and Previous Experience Age\nTimothy S. Cobb Mr. Cobb has been Chief Executive Officer 53 since March 1994 and President and Chief Operating Officer since October 1993. Mr. Cobb served as President of Gilbert\/ Commonwealth, Inc. (subsidiary of registrant) from January 1991 to September 1993. He served as President of GAI-Tronics Corporation (subsidiary of registrant) from October 1988 to December 1990.\nJames R. Itin Mr. Itin has been Vice President and 62 Chief Financial Officer since May 1979.\nNone of the above officers has a family relationship with another\nsuch officer. None of the officers was selected as a result of any\narrangement or understanding with any other person other than\ndirectors of the registrant acting solely in their capacities as such.\n* On March 1, 1994, Timothy S. Cobb succeeded Alexander F. Smith as Chief Executive Officer. Mr. Smith remains Chairman of the Board of Directors.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS.\nThe registrant's Class A Common Stock is traded in the over-the-\ncounter market. Price quotations are available through the NASDAQ\nsystem under the symbol GILBA. The following tabulation sets forth\nthe high and low price quotations by quarter as reported by the NASDAQ\nStock Market and cash dividends declared on each share of Class A and\nClass B Common Stock. Prices quoted represent high and low closing\nsale prices on the NASDAQ National Market System.\n1994 1993 Dividends High Low High Low 1994 1993\n$18.75 $16.50 $21.50 $19.25 First Quarter $.20 $.18 17.75 14.75 21.75 20.25 Second Quarter .20 .18 15.50 14.00 21.50 16.25 Third Quarter .20 .20 15.00 12.00 17.00 14.50 Fourth Quarter .20 .20\nAt December 30, 1994, the approximate number of record holders of Class A common stock was 3,500.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nExcluding all adjustments, net income decreased $3,867,000 and\nearnings per share decreased $.49, or 49% and 45%, respectively, in\n1994 as compared to 1993. Prior to adjustments, net income for 1993\ndecreased $1,085,000, or 12% from 1992, and earnings per share\ndecreased $.11 or 9% in the same period. The decreases relate\nprimarily to lower operating results within the professional services\nsegment, formerly called the engineering and consulting segment. The\ndecline in net income was greater than the decline in earnings per\nshare due to fewer shares outstanding. Revenue declined 3% in both\n1994 and 1993 due to declines within the professional services\nsegment, offset in part by higher revenue within the communication\nequipment segment. Adjustments for 1994 included a third quarter\ncharge to income of $15,800,000 (net of $2,000,000 income tax benefit)\nor $2.26 per share, associated with the nuclear operations (Note 9).\nThis charge will not have a significant impact on future operations.\nAdjustments also included a $75,000 increase in net income, or $.01\nper share, in the second quarter of 1994 relative to closing foreign\nsubsidiaries and settlement of certain contractual issues (Note 9).\nAdjustments for 1993 included a $1,320,000 reduction in net income or\n$.18 per share in the second quarter of 1993 to increase reserves for\nclaims filed by former employees (Note 9), and a $200,000 reduction in\nnet income or $.03 per share in the first quarter of 1993 for changes\nin accounting principles (Notes 3 and 6).\nThe professional services segment, renamed to more accurately\nreflect the revenue stream, reported a 6% decrease in revenue in 1994\nas compared to 1993. The decrease is due primarily to large declines\nin volume of services provided to the nuclear power market, offset\nlargely by revenue derived from SRA Technologies, Inc. (SRA), which\nwas acquired on December 10, 1993. The gross profit percentage was\n22% in 1994, a decrease from 24% in the prior year. The decrease is\ndue primarily to competitive pressures within the nuclear market and the\nprofessional services segment in general. Revenue decreased 8% in 1993\nas compared to 1992, due primarily to declines in the volume of services\nprovided to the nuclear power market, offset by increases in U.S. defense\nrelated revenue. The gross profit percentage was 24% in 1993 and 1992.\nThe communication equipment segment revenue increased 10% in 1994\nas compared to 1993. The increase relates primarily to revenue\nderived from Instrument Associates, Inc. (IAI), which was acquired on\nDecember 28, 1993. The gross profit percentage decreased to 32% in\n1994 from 34% in 1993 due primarily to IAI, and to a lesser extent,\ncosts associated with consolidating manufacturing operations. IAI is\nstructured to operate on lower margins than other operations within\nthis segment, but has lower selling, general and administrative\nexpenses which more than offset the impact of lower gross profit.\nRevenue volume increased 30% in 1993 as compared to 1992 due primarily\nto revenue derived from the acquisition of the Femco Division of Mark\nIV Industries in late 1992. The gross profit margin decreased 2% in\n1993 to 34% due primarily to sales of lower margin products.\nOther income increased 6% in 1994 as compared to 1993, and 31% in\n1993 as compared to 1992. The increases relate primarily to income\nderived from a joint venture within the professional services segment\nwhich has earned income, prior to income taxes, of $2,080,000,\n$1,406,000 and $715,000 in 1994, 1993 and 1992, respectively.\nSelling, general and administrative expenses decreased 1% in 1994\nas compared to 1993 after excluding the adjustments mentioned above.\nSelling, general and administrative expenses relative to the recent\nacquisitions of SRA and IAI were offset by lower expenses within the\nprofessional services segment. Also excluding the above adjustments,\nthese expenses were substantially unchanged in 1993 from 1992.\nDepreciation and amortization increased 8% in 1994 as compared to 1993\ndue primarily to amortization associated with the recent acquisitions.\nDepreciation and amortization increased 12% in 1993 compared to 1992\ndue primarily to depreciation on the office facility completed in late\n1992. Interest expense was not significant in 1994, 1993 or 1992.\nIncome before provision for taxes on income and cumulative effect\nof changes in accounting principles decreased 46% from 1993 to 1994,\nexcluding the adjustments mentioned above. The decrease relates\nprimarily to lower operating results within the professional services\nsegment, particularly the nuclear power market. Income before\nprovision for taxes on income and cumulative effect of changes in\naccounting principles in 1993 decreased 11% compared to 1992 after\nexcluding the aforementioned adjustments. The decrease relates\nprimarily to lower operating results within the professional services\nsegment, particularly the nuclear power market, offset in part by\nhigher operating results within the communication equipment segment.\nThe provision for taxes on income, prior to all adjustments,\nincreased to an effective tax rate of 43% in 1994 from 40% in 1993.\nThe increase is due primarily to a higher effective state tax rate,\nwhich in part is due to limitations in loss carrybacks and\ncarryforwards in certain jurisdictions. In 1993, the effective tax\nrate increased to 40% from 39% in 1992 due primarily to the enacted\nincrease in the statutory federal income tax rate to 35%.\nWorking capital decreased $6,829,000, or 14% in 1994. The decline\nrelates primarily to lower operating results. Cash and cash\nequivalents declined $3,289,000 during the year due primarily to lower\nborrowings. The company does not anticipate requiring long-term\nfinancing during the next year. Available cash and cash equivalents,\ncombined with amounts generated from operations and short-term lines\nof credit, should provide adequate working capital to satisfy\noperating requirements, contractual and lease obligations related to\nthe third quarter 1994 charge mentioned above, the contingent payout\nto IAI principals and the ongoing program to repurchase the company's\nClass A common stock, of which approximately $3,500,000 remains.\nUnused lines of credit with three banks aggregating $14,205,000 are also\navailable for short-term cash needs. No restrictions on cash transfers\nbetween the company and its subsidiaries exist.\nOn December 9, 1994, the registrant announced that it had engaged\na New York investment banking firm to assist the registrant in\nassessing various potential opportunities to enhance shareholder\nvalues. The investment bankers' assistance includes a wide range of\ninvestigation and analysis of alternative business strategies\nincluding an in-depth review of our subsidiary operations to determine\nwhether any divestitures might be appropriate, identifying possible\nacquisition candidates and consideration of possible joint venture\npartners.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nManagement's Report on Responsibility for Financial Reporting\nThe accompanying consolidated financial statements and notes thereto are the responsibility of, and have been prepared by, management of the company in accordance with generally accepted accounting principles. Management believes the consolidated financial statements reflect fairly the results of operations and financial position of the company in all material respects. The consolidated financial statements include certain amounts that are based upon management's best estimates and judgment regarding the ultimate outcome of transactions which are not yet complete.\nManagement believes that the accounting systems and related systems of internal control are sufficient to provide reasonable assurance that assets are safeguarded, transactions are properly authorized and included in the accounting records, and that those records provide a reliable basis for preparation of the company's consolidated financial statements. Reasonable assurance is based upon the concept that the cost of a system of internal control must be related to the benefits derived. The company maintains an internal audit function that periodically assesses the effectiveness of the systems of internal control and makes recommendations for possible improvement.\nThe company's financial statements have been audited by Coopers & Lybrand, independent accountants, as stated in their report below. They have been elected to perform this function by the stockholders of the company. Management has made available to Coopers & Lybrand all of the company's financial records and related data, as well as the minutes of stockholders' and directors' meetings.\nT. S. Cobb President and Chief Executive Officer\nJ. R. Itin Vice President and Chief Financial Officer\nReport of Independent Accountants\nTo the Stockholders and Board of Directors, Gilbert Associates, Inc.:\nWe have audited the accompanying consolidated balance sheets of Gilbert Associates, Inc. and Subsidiaries as of December 30, 1994 and December 31, 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 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 Gilbert Associates, Inc. and Subsidiaries as of December 30, 1994 and December 31, 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 30, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Notes 3 and 6 to the consolidated financial statements, the Company changed its method of accounting for income taxes and postretirement benefits other than pensions in 1993.\n2400 Eleven Penn Center Philadelphia, Pennsylvania February 3, 1995 COOPERS & LYBRAND L.L.P.\nGILBERT ASSOCIATES, INC. AND SUBSIDIARIES\nConsolidated Balance Sheets December 30, 1994 and December 31, 1993\nASSETS December 30, December 31, 1994 1993\nCurrent assets: Cash and cash equivalents $ 7,427,000 $ 10,716,000 Accounts receivable, net of allowance for doubtful accounts of $2,677,000 in 1994 and $3,427,000 in 1993 33,452,000 38,526,000 Unbilled revenue 19,570,000 23,480,000 Inventories 6,761,000 6,402,000 Deferred income taxes 4,420,000 4,205,000 Other current assets 5,918,000 5,751,000 ----------- ----------- Total current assets 77,548,000 89,080,000 ----------- ----------- Property, plant and equipment, at cost: Land 3,693,000 3,702,000 Buildings 43,002,000 41,885,000 Furniture and equipment 46,907,000 43,888,000 ----------- ----------- 93,602,000 89,475,000 Less accumulated depreciation and amortization 51,534,000 46,924,000 ----------- ----------- 42,068,000 42,551,000 ----------- ----------- Deferred income taxes 1,610,000 1,100,000 Other assets 2,441,000 2,117,000\nGoodwill 23,418,000 35,399,000 ----------- ----------- Total Assets $147,085,000 $170,247,000 =========== ===========\nThe accompanying notes are an integral part of the consolidated financial statements.\nGILBERT ASSOCIATES, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n1. SIGNIFICANT ACCOUNTING POLICIES:\nFISCAL YEAR: The company uses a 52-53 week fiscal year ending on the Friday nearest December 31. The 1994, 1993 and 1992 fiscal years comprised 52 weeks each and ended on December 30, 1994, December 31, 1993 and January 1, 1993, respectively.\nPRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the company and its subsidiaries. All material intercompany transactions have been eliminated. Investments in joint ventures where the company does not have a controlling interest are accounted for under the equity method.\nRECOGNITION OF REVENUE: The company recognizes revenue on contracts entered into for professional services as the work is performed. Costs and expenses are charged to operations as incurred. Losses, estimated to be sustained upon completion of contracts, are charged to income in the year such estimates are determinable.\nINSURANCE PROGRAMS: The company's overall insurance coverages, excluding professional liability, contain provisions for large deductibles and funding on a claims paid basis. Necessary accruals, which relate primarily to health care and workers' compensation, aggregate $3,494,000 and $3,262,000 at December 30, 1994 and December 31, 1993, respectively, and are included in other accrued liabilities on the consolidated balance sheets.\nThe accrual for reported claims and for claims incurred but not yet reported relating to professional liability insurance is estimated on the basis of historical claims experience. This accrual is reflected on the consolidated balance sheets as self-insured retention.\nPROPERTY, PLANT AND EQUIPMENT AND ACCUMULATED DEPRECIATION AND AMORTIZATION: For financial reporting purposes, the company provides for depreciation and amortization of property, plant and equipment, including assets under capital leases, on the straight-line method over the estimated useful lives of the various classes of assets. For income tax purposes, the company uses accelerated depreciation where permitted.\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 the item and related accumulated depreciation are removed from the accounts and any gain or loss is included in income.\nInterest cost capitalized in 1992 amounted to $420,000.\nGOODWILL: Substantially all of the goodwill is being amortized by charges to operations on a straight-line basis over 40 years, and such amortization amounted to $842,000 in 1994, $778,000 in 1993 and $605,000 in 1992. Accumulated amortization amounted to $3,264,000 at December 30, 1994 and $4,775,000 at December 31, 1993.\nThe company periodically reviews goodwill to assess recoverability, and impairments would be recognized in operating results if a permanent diminution in value were to occur.\nINVENTORIES: Inventory values are determined on the first-in, first- out (FIFO) method and are stated at the lower of cost or market.\nINCOME TAXES: The company utilizes the liability method of accounting for income taxes. Under this method, deferred income taxes are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates.\nSTATEMENTS OF CASH FLOWS: For purposes of the consolidated statements of cash flows, the company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.\nRECLASSIFICATION: The consolidated balance sheets and consolidated statements of cash flows have been reclassified to conform with current year presentation.\n2. ACQUISITIONS:\nOn December 10, 1993, the company acquired all of the outstanding capital stock of SRA Technologies, Inc. (SRA) for $6,500,000 in cash. The company also paid $1,500,000 in cash for other intangible assets, which resulted in a total purchase price of $8,000,000. On December 28, 1993, the company acquired the net assets of Instrument Associates, Inc. (IAI) for $5,704,000 in cash plus an additional amount to be paid based upon the achievement of certain earnings objectives. Any additional amount will increase goodwill and will not exceed $1,000,000.\nOn December 21, 1992, the company acquired the net assets of the Femco Division of Mark IV Industries, Inc. (Femco) for $8,782,000 in cash.\nDuring the first quarter of 1994, the company paid the former stockholders of GENSYS Corporation $1,500,000 in cash as part of the April 1, 1991 purchase agreement, which resulted in an increase in goodwill.\nAll acquisitions were accounted for as purchases, and goodwill was determined based upon the fair values of assets acquired and liabilities assumed. At the dates of acquisition, such liabilities aggregated $6,336,000 and $1,342,000 in 1993 and 1992, respectively. Goodwill for SRA, IAI and Femco was $3,563,000, $5,639,000 and $5,752,000, respectively, which is being amortized on a straight-line basis over 40 years. The company's consolidated statements of operations include the results of operations of the acquired businesses since the dates of acquisition.\n3. INCOME TAXES:\nIn the first quarter of 1993, the company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). As a result of this change, net income increased $700,000 or $.09 per share due to the recording of deferred income tax assets not previously recognized. This adjustment was recorded as a cumulative effect of change in accounting principles.\nIncome tax provisions consist of the following:\n1994 1993 1992 ---- ---- ---- Current: Federal $ 790,000 $ 5,035,000 $ 6,585,000 State and foreign 395,000 475,000 829,000 ---------- ---------- ---------- 1,185,000 5,510,000 7,414,000 ---------- ---------- ----------\nDeferred: Federal (620,000) (900,000) (1,285,000) State (105,000) (100,000) (220,000) ---------- ---------- ---------- (725,000) (1,000,000) (1,505,000) ---------- ---------- ---------- $ 460,000 $ 4,510,000 $5,909,000 ========== ========== ========== The components of the net deferred income tax asset are as follows:\nDecember 30, December 31, 1994 1993 ------------ ------------ Net current deferred income tax asset $ 4,420,000 $ 4,205,000 Net non-current deferred income tax asset 1,610,000 1,100,000 ---------- --------- Net deferred income tax asset $ 6,030,000 $ 5,305,000 ========== ========= The tax effects of temporary differences which comprise the deferred tax assets and liabilities are as follows:\nDecember 30, December 31, 1994 1993 Deferred income tax assets: ------------ ------------\nReserves for contract disallowances and bad debts $ 3,295,000 $ 2,540,000 Retirement liabilities 2,634,000 2,366,000 Self-insured retention 2,239,000 1,865,000 Vacation accrual 995,000 1,276,000 Legal claims reserves 934,000 950,000 Workers' compensation reserves 898,000 682,000 Other 1,971,000 2,596,000 ---------- ---------- 12,966,000 12,275,000 ---------- ----------\nDecember 30, December 31, 1994 1993 Deferred income tax liabilities: ------------ ------------\nDepreciation $ 2,936,000 $ 2,937,000 Contract retention 2,214,000 2,509,000 Other 1,786,000 1,524,000 ---------- ---------- 6,936,000 6,970,000 ---------- ---------- Net deferred income tax asset $ 6,030,000 $ 5,305,000 ========== ==========\nA reconciliation of the statutory income tax rate to the effective tax rate follows:\n1994 1993 1992 ---- ---- ----\nFederal statutory tax rate (34.0)% 35.0% 34.0% Closure of foreign subsidiaries (4.1) - - State and foreign taxes 2.1 2.2 2.7 Amortization and write-off of goodwill 39.0 2.1 1.4 Other, net 1.1 1.1 1.4 ---- ---- ---- Effective tax rate 4.1% 40.4% 39.5% ==== ==== ====\nThe 1991 sale of stock of Gilbert\/Commonwealth Inc. of Michigan resulted in a capital loss for federal income tax purposes of $10,225,000. As of December 30, 1994, $8,758,000 of capital loss remains available to offset future capital gains before its expiration in 1996. Due to the uncertainty of future utilization of this capital loss, no deferred income tax asset has been recorded.\n4. LONG-TERM DEBT:\nLong-term debt consists of the following obligations:\nDecember 30, December 31, 1994 1993 --------- --------- Note payable, $15,000 due monthly including interest at 7.15% $ - $ 248,000 Note payable, $6,000 due monthly to 1996, including interest at 8% 111,000 171,000 Capital lease obligation, with principal payments not exceeding $9,000 due monthly to 2007, plus interest at variable rates not exceeding prime + 1\/2%. 871,000 927,000 -------- --------- 982,000 1,346,000 Less current maturities (111,000) (280,000) -------- --------- $ 871,000 $1,066,000 ======== =========\nThe aggregate maturities of long-term debt, including the capital lease obligation, in each of the five years subsequent to 1994 are as follows:\n1995 $111,000 1996 81,000 1997 48,000 1998 53,000 1999 58,000\nThe company leases a building under a noncancelable capital lease which expires in 2007. The agreement includes an option to purchase the building for a nominal amount upon expiration of the lease.\nIn connection with the aforementioned capital lease, the company has pledged as collateral the following: December 30, ----------- Land and building $ 980,000 Less accumulated depreciation (227,000) --------- $ 753,000 =========\nAt December 30, 1994, minimum future lease payments under the capital lease and the present value of minimum lease payments are as follows:\n1995 $ 117,000 1996 117,000 1997 117,000 1998 117,000 1999 117,000 2000 and thereafter 862,000 --------- Total minimum lease payments 1,447,000 Less amount representing interest (576,000) --------- Present value of minimum lease payments $ 871,000 =========\nThe company and its subsidiaries have arrangements with several banks whereby unused lines of credit aggregating $14,205,000 are available at December 30, 1994 for short-term financing, with interest charges based upon the banks' prime lending rates.\n5. INVENTORIES:\nInventories consist of the following:\nDecember 30, December 31, 1994 1993 ---------- ---------- Raw materials $3,278,000 $2,985,000 Work in process and finished goods 3,483,000 3,417,000 --------- --------- $6,761,000 $6,402,000 ========= =========\n6. POSTRETIREMENT BENEFITS:\nSubstantially all regular, full-time employees of the company and its subsidiaries are participants in various defined contribution retirement plans. Employer contributions under these plans are generally at the discretion of the company, based upon profits and employees' voluntary contributions to the plans. Company contributions charged to operations in 1994, 1993 and 1992 totaled $4,231,000, $4,369,000 and $5,121,000, respectively.\nIn the first quarter of 1993, the company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (SFAS 106). As a result, a $900,000 charge (net of $600,000 income tax benefit) or $.12 per share was recorded by the company as a cumulative effect of a change in accounting principles. This statement requires an accrual of the cost of providing postretirement benefits during the active service period of employees. Certain subsidiaries of the company currently provide life insurance benefits for retirees. The company is self- insured for these benefits, which consist primarily of $5,000 policies. Under the current program, the accumulated benefit obligation related to the life insurance policies is approximately $1,800,000 as of December 30, 1994. The accumulated benefit obligation is primarily unfunded. The discount factor used in computing the accumulated benefit obligation is 6%. The adoption of SFAS 106 did not have a material impact on current operations.\n7. CAPITAL STOCK:\nExcept for voting privileges, shares of Class A and Class B common stock are identical. Class B stockholders must be either directors of the company, or active employees of the company or its subsidiaries. They may not sell or transfer such stock without having first extended an offer of sale to the company. There were 12,000,000 authorized shares of Class A and Class B common stock as of December 30, 1994 and December 31, 1993.\n8. STOCK OPTION, AWARD AND PURCHASE PLANS:\nUnder the 1989 Gilbert Stock Option Plan, the company may grant to officers and other key management employees, incentive or non- qualified stock options to purchase an aggregate of 250,000 shares of common stock at a price not less than seventy-five percent of the fair market value at the date of grant. The term within which each option may be exercised is at the discretion of the company. In no case shall this term exceed ten years. Options to purchase 63,550 shares were granted at fair market value during 1994 and are exercisable between March 18, 1996 and March 18, 1999 at $17.50 per share. At December 30, 1994, 77,150 shares remain available for future grants.\nA summary of stock option activity related to this plan and the 1982 and 1987 stock option plans which are no longer granting options is as follows:\nNumber of Number of Option Price Shares Shares Per Share Exercisable --------- ------------ ----------- Outstanding at Jan. 3, 1992 295,345 $ 8.16-$26.50 213,137 Granted 52,050 $20.00 Exercised (12,500) $ 8.16-$17.20 Expired (8,375) $17.20-$26.50 ------- Outstanding at Jan. 1, 1993 326,520 $11.84-$26.50 240,321 Granted 57,000 $21.00 Exercised (18,375) $11.84-$17.20 Expired (32,424) $17.20-$26.50 ------- Outstanding at Dec. 31, 1993 332,721 $11.84-$26.50 237,172 Granted 63,550 $17.50 Exercised (62,500) $11.84-$17.20 Expired (54,824) $17.50-$26.50 ------- Outstanding at Dec. 30, 1994 278,947 $12.00-$26.50 178,098 =======\nThe company has an Equity Award Plan whereby the company may grant to officers and other key management employees, awards to purchase an aggregate of 234,375 shares of common stock at a price equal to fair market value on the date of purchase. Unless accepted, the awards expire fifteen days from the date of grant. To date, awards to purchase 195,331 shares of the company's common stock have been granted and accepted at prices ranging from $11.04 to $22.20 per share. As a result of subsequent sales by participants, 72,495 of these shares remain outstanding at December 30, 1994. For a period of ten years subsequent to the date of purchase, the company is required, if requested by the participant, to repurchase shares under the plan for an amount equal to 90% of the original purchase price.\nUnder the Stock Bonus Purchase Plan, employees may use up to 50% of their annual incentive compensation to purchase shares of common stock at fair market value. Employees purchasing shares will receive a stock bonus as determined by the Board of Directors each year. The company may grant an aggregate of 200,000 shares under this plan. During 1994, 6,202 shares were issued under this plan. To date, 41,104 shares have been issued, and 158,896 shares remain available for future grants as of December 30, 1994.\n9. SPECIAL CHARGES:\nIn the third quarter of 1994, the company recorded a charge to income of $15,800,000 (net of $2,000,000 income tax benefit) or $2.26 per share, associated with its nuclear service business. The charge is comprised of a $12,200,000 or $1.74 per share goodwill write-off and $1,025,000 or $.15 per share for severance and idled leased facility costs to reflect the current market conditions. The charge also includes $2,575,000 or $.37 per share to increase reserves to cover contractual issues on contracts completed in prior years. The total charge is included in selling, general and administrative expenses. The entire charge, including the goodwill write-off, will not have a material impact on future results of operations.\nThe $12,200,000 goodwill write-off represents the entire goodwill amount associated with United Energy Services Corporation (UESC) and its subsidiaries. UESC provides consulting services principally to the nuclear power industry.\nThe goodwill write-off stems primarily from the deterioration in the commercial nuclear power market. Market forces, including deregulation of the electric utility industry, the emergence of independent power producers and technological advances making fossil plants more efficient, have particularly affected the commercial nuclear industry, resulting in a dramatic decline in the demand and pricing of services. These changing market conditions have resulted in increased competition on those services typically provided by UESC. UESC incurred substantial losses late in 1993 and continued to operate at a loss through 1994. For these reasons, and the continued uncertainty surrounding UESC's nuclear business returning to a level of profitability sufficient to recover the carrying values of goodwill, it became apparent to management that UESC's goodwill is permanently impaired and no longer has any value.\nDuring the second quarter of 1994, the company closed foreign subsidiaries and settled certain contractual issues which had been previously reserved. The combination of these two events increased net income by $75,000 or $.01 per share. Income(Loss) before provision for taxes on income(loss) and cumulative effect of changes in accounting principles was reduced by $525,000. Of this amount, $1,100,000 related primarily to a reserve for a lease obligation and severance costs, which was partially offset by a $700,000 favorable outcome on the aforementioned contract settlement. These amounts were recorded in selling, general and administrative expenses. The provision for taxes on income(loss) was reduced by $600,000 primarily due to a federal income tax deduction associated with the closure of foreign subsidiaries.\nIn the second quarter of 1993, the company recorded a charge to income of $2,200,000 to increase reserves for costs associated with resolving a series of claims filed by former employees of a subsidiary which was closed in 1988. This reserve is recorded in other accrued liabilities on the consolidated balance sheet. After the income tax benefit of $880,000, net income was reduced by $1,320,000 or $.18 per share. The company is contesting these matters vigorously and is in the process of pursuing various legal actions. The timing of the final resolution is not yet known.\n10. OPERATING LEASES:\nThe company leases, as lessee, facilities, data processing equipment, office equipment, automobiles and aircraft charter services under leases expiring during the next eleven years. Total rental expense under operating lease agreements amounted to $7,000,000 in 1994, $5,900,000 in 1993 and $5,700,000 in 1992. Minimum future rentals under noncancelable operating leases with initial or remaining terms in excess of one year at December 30, 1994 are as follows:\n1995 $ 5,999,000 1996 4,488,000 1997 2,576,000 1998 2,019,000 1999 1,754,000 2000 and thereafter 6,256,000 ---------- Total minimum rentals $23,092,000 ==========\nThe company leases, as lessor, office space to unrelated parties under leases expiring between 1995 and 2004. Minimum future rentals under noncancelable operating leases at December 30, 1994 are as follows:\n1995 $ 2,714,000 1996 2,531,000 1997 2,461,000 1998 2,520,000 1999 2,492,000 2000 and thereafter 11,108,000 ---------- Total minimum rentals $23,826,000 ==========\n11. FINANCIAL INSTRUMENTS:\nLetters of credit and performance bonds are issued by the company during the ordinary course of business through major domestic banks and insurance companies. The company has outstanding letters of credit and performance bonds, not reflected in the consolidated financial statements, in the amount of $5,814,000 at December 30, 1994 and $5,369,000 at December 31, 1993.\nFinancial instruments which potentially subject the company to the concentration of credit risk, as defined by SFAS No. 105, consist principally of accounts receivable. Concentration of credit risk with respect to receivables is limited due to the majority of customers being comprised of either public utilities or the U.S. Government.\n12. CONTINGENCIES:\nVarious lawsuits, claims and other contingent liabilities arise in the ordinary course of the company's business. While the ultimate disposition of these contingencies is not determinable at this time, management believes that any liability resulting therefrom will not materially affect the consolidated financial statements of the company.\n13. QUARTERLY FINANCIAL DATA (UNAUDITED):\nNOTES: The results of operations for the quarter ended September 30, 1994 includes a charge to income of $15,800,000 (net of $2,000,000 income tax benefit) or $2.26 per share, associated with the nuclear service business.\nResults of operations for the quarter ended July 1, 1994 was increased by $75,000 or $.01 per share due to the closure of foreign subsidiaries and the settlement of certain contractual issues.\nResults of operations for the quarter ended July 2, 1993 includes a charge to income of $1,320,000 (net of $880,000 income tax benefit), or $.18 per share, for costs associated with resolving a series of claims filed by former employees.\nThe changes in accounting principles result from the company's adoption of Statements of Financial Accounting Standards for Income Taxes and Postretirement Benefits Other Than Pensions.\n14. SEGMENT INFORMATION:\nThe company and its subsidiaries are primarily engaged in providing professional services to public utilities, governmental agencies and a variety of other customers. GAI-Tronics Corporation, a subsidiary, is engaged in the development, assembly and marketing of communication equipment. Information about the company's operations by segment for the years 1994, 1993 and 1992 is as follows:\n14. SEGMENT INFORMATION (continued)\n14. SEGMENT INFORMATION (continued)\nRevenue by segment consists of sales to unaffiliated customers; intersegment sales are not significant. Operating profit(loss) is total revenue less operating expenses, and excludes interest expense, general corporate expenses and other income. Other income excludes $2,080,000, $1,406,000 and $715,000 in 1994, 1993 and 1992, respectively, relative to a joint venture, which is reflected in the professional services operating profit. Prior year segment information has been restated to be consistent with current year presentation. Although the company receives professional services revenue from many customers, two major customers accounted for revenues of $107,000,000, $98,000,000 and $79,000,000 in 1994, 1993 and 1992, respectively. Of these amounts, approximately $77,000,000, $58,000,000 and $54,000,000 was received from several United States governmental agencies in 1994, 1993 and 1992, respectively.\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 and cash equivalents, an office facility and in prior years, short-term investments. Capital expenditures for the office facility were $393,000, $831,000 and $7,104,000 in 1994, 1993 and 1992, respectively, and are excluded from the capital expenditures above. Depreciation on the office facility amounted to $619,000, $598,000 and $164,000 in 1994, 1993 and 1992, respectively, and is also excluded from the depreciation and amortization above.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None.\nPART III\nOther than portions of Item 10, which are included in Item 4A\nhereof, this Part (i.e., 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 financial statements filed herewith under Part II,\nItem 8, include the consolidated balance sheets at\nDecember 30, 1994 and December 31, 1993, and the\nconsolidated statements of operations, consolidated\nstatements of stockholders' equity and consolidated\nstatements of cash flows for the years 1994, 1993 and 1992\nof Gilbert Associates, Inc. and its subsidiaries.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed by the registrant during\nthe last quarter of 1994.\n(c) Exhibits.\n3.1 Restated Certificate of Incorporation of Gilbert\nAssociates, Inc. as currently in effect.\nIncorporated by reference to Exhibit 3(a) of Annual\nReport of the registrant on Form 10-K for the fiscal\nyear ended December 29, 1989 (File No. 0-12588).\n3.2 By-laws of Gilbert Associates, Inc. as currently in\neffect. Incorporated by reference to Exhibit 28 to\nthe Quarterly Report of the registrant on Form 10-Q\nfor the period ended March 30, 1990 (File No. 0-\n12588).\nThe following Exhibits 10.1 through 10.5 are\ncompensatory plans or arrangements required to be\nfiled as exhibits to this Annual Report on Form 10-K\npursuant to Item 14(c):\n10.1 Gilbert Associates, Inc. Equity Award Plan.\nIncorporated by reference to Exhibit 4 to\nRegistration Statement on Form S-8 filed by\nregistrant under the Securities Act of 1933 (No. 33-\n15289).\n10.2 1989 Gilbert Stock Option Plan. Incorporated by\nreference to Exhibit 4(a) to Registration Statement\non Form S-8 filed by registrant under the Securities\nAct of 1933 (No. 33-32288).\n10.3 Gilbert Associates, Inc. Stock Bonus Purchase Plan.\nIncorporated by reference to Exhibit 4 to\nRegistration Statement on Form S-8 filed by registrant\nunder the Securities Act of 1933 (No. 33-37793).\n10.4 Gilbert Associates, Inc. Benefit Equalization Plan,\neffective January 1, 1989. Incorporated by\nreference to Exhibit 10(g) of Annual Report of the\nregistrant on Form 10-K for the fiscal year ended\nJanuary 1, 1993 (File No. 0-12588).\n10.5 Gilbert Associates, Inc. split dollar life insurance\npolicy for an officer of the company. Incorporated\nby reference to Exhibit 10(h) of Annual Report of\nthe registrant on Form 10-K for the fiscal year\nended January 1, 1993 (File No. 0-12588).\n21 A complete list of the registrant's subsidiaries.\n23 Consent of Coopers & Lybrand L.L.P., registrant's\nindependent accountants, to the use of their report\non the consolidated financial statements.\n27 Financial Data Schedules for the year ended\nDecember 30, 1994.\n99.1 Annual Report on Form 11-K, pursuant to Section\n15(d) of the Securities Exchange Act of 1934, of the\nStock Purchase Program for Employees of Gilbert\nAssociates, Inc. and its subsidiaries for the year\nended December 31, 1994. (To be filed by\namendment.)\n99.2 Annual Report on Form 11-K, pursuant to Section\n15(d) of the Securities Exchange Act of 1934, of the\nRetirement Savings Plan for Employees of Gilbert\nAssociates, Inc. and its subsidiaries for the year\nended December 31, 1994. (To be filed by\namendment.)\n99.3 Annual Report on Form 11-K, pursuant to Section\n15(d) of the Securities Exchange Act of 1934, of\nUnited Energy Services Corporation 401(k) Profit\nSharing Plan for the year ended December 31, 1994.\n(To be filed by amendment.)\n99.4 Annual Report on Form 11-K, pursuant to Section\n15(d) of the Securities Exchange Act of 1934, of\nResource Consultants, Inc. 401(k) Profit Sharing\nPlan for the year ended December 31, 1994. (To be\nfiled by amendment.)\n(d) Financial Statement Schedules, as required, are filed herewith.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Gilbert Associates, Inc.\nOur report on the consolidated financial statements of Gilbert Associates, Inc. and subsidiaries is included in Part II of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedules included on Part IV, Item 14 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania February 3, 1995\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the\nSecurities Exchange Act of 1934, the registrant has duly caused this\nreport to be signed on its behalf by the undersigned, thereunto duly\nauthorized this 24th day of February 1995.\nGILBERT ASSOCIATES, INC.\nBy \/s\/T. S. Cobb T. S. Cobb President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of\n1934, this report has been signed below by the following persons on\nbehalf of the registrant and in the capacities and on the dates\nindicated.\nSignature Title Date\nChairman of the Board \/s\/A. F. Smith and Director February 24, 1995 A. F. Smith President and Chief Executive Officer (Principal Executive \/s\/T. S. Cobb Officer) and Director February 24, 1995 T. S. Cobb\nVice President and Chief Financial Officer (Principal Financial and Accounting Officer) \/s\/J. R. Itin and Director February 24, 1995 J. R. Itin\n\/s\/J. W. Boyer, Jr. Director February 24, 1995 J. W. Boyer, Jr.\n\/s\/D. E. Lyons Director February 24, 1995 D. E. Lyons\n\/s\/J. W. Stratton Director February 24, 1995 J. W. Stratton\n\/s\/J. A. Sutton Director February 24, 1995 J. A. Sutton\n\/s\/D. K. Wilson, Jr. Director February 24, 1995 D. K. Wilson, Jr.","section_15":""}
{"filename":"79166_1994.txt","cik":"79166","year":"1994","section_1":"Item 1. Business --------\nThe Registrant is and for many years has been engaged in the business of publishing and distributing advanced scientific and technical material. The Registrant publishes and distributes books and journals and creates and maintains databases for which it receives royalties from unrelated organizations providing access to such materials throughout the world under the imprints of Plenum Press, Consultants Bureau, DaCapo Press, IFI\/Plenum Data, J.S. Canner & Company, and Human Sciences Press. The Registrant and its subsidiaries maintain offices in New York, New York; Wilmington, Delaware; Needham Heights, Massachusetts; Wilmington, North Carolina; London, England; and Moscow, Russia; and warehouse facilities in Edison, New Jersey. The Registrant's principal markets are public and private libraries, technically oriented corporations, research organizations and individual scientists, engineers, research workers, other professionals and graduate students throughout the world. Except as to the sale of reprints and tradebooks, the Registrant does not generally sell to book stores. The Registrant's principal methods of marketing are by direct mail and by advertising in scientific publications, including its own journals. The Registrant makes a wide distribution of its catalogs of published material, as well as plans for new publications. In certain foreign markets, the Registrant utilizes the services of independent distributors and agents. The Registrant generally secures copyrights on its publications in its own name or in the name of its subsidiaries. In some cases, pursuant to written agreement, the copyright is secured in the name of the author of the publication or a learned society or other organization. Copyrights on translations of foreign journals are limited to English language translations and do not cover the original foreign language works. Those translations of Russian journals as to which the Registrant is the distributor but not the publisher are copyrighted in the name of the publisher. Most publications printed by the Registrant's DaCapo Press subsidiary are reprints of works in the public domain which are not subject to copyright protection or are works published by others who have sold to the Registrant certain rights for publication, either for a fixed payment or under a royalty agreement. The Registrant does not perform any printing operations. It uses outside printing and binding services, with much of the material being prepared by the Registrant for printing. Preparations by the Registrant include editing, creation of a suitable design and typesetting. The following table sets forth the total revenues contributed by each class of similar products and services, and the income (loss) generated from securities owned by the Registrant.\nSubscription Journals ---------------------\nDuring 1994, the Registrant published a total of 222 journals. 74 were translations of Russian language scientific journals, 100 were published in the English Language Journal Program, and 48 were published by the Registrant's subsidiary, Human Sciences Press, Inc. The Registrant also distributed translations of 21 Russian scientific journals (see below).\nTranslations of Russian Language Journals -----------------------------------------\nThe translation journals are in the fields of physical sciences, mathematics, engineering and life sciences. In December 1993, the Registrant entered into a Journal Production and Distribution Agreement (the \"Distrib- ution Agreement\") with the Russian Academy of Sciences (the \"Academy\") and other interested parties pursuant to which litigation then pending, relating to the translation of Russian scientific journals, was ended, and Registrant's role as publisher and distributor of certain of such journals was altered. The Distribution Agreement extends from 1994 through 2006. Pursuant to the Distribution Agreement, in 1994 the Registrant distributed for MAIK Nauka (\"MN\"), an entity owned in part by Pleiades Publishing, Inc. and the Academy, 21 Russian scientific journals in English (the \"MN Journals\"). MN became the exclusive publisher of such journals. Prior thereto, the Registrant had translated, published and distributed these journals under a contract with the Copyright Agency of the former Soviet government, and under contracts with the individual institutes publishing the journals. It paid royalties based in part upon the number of subscribers. Under the Distribution Agreement, the Registrant continues to promote and distribute these journals throughout the world, and continues to deal with and collect from subscribers to the journals, retaining a portion of such revenues for performing its function. In 1994, the Registrant retained 35% of the revenue. The portion retained is included in subscription revenue. The amount will gradually be reduced to 30% in 1999 and will remain at that level for the balance of the term of the Distribution Agreement. Under the Distribution Agreement, in 1995 MN has under taken the publication of the English translations of 14 additional Russian journals, to be promoted and distributed by the Registrant. In 1996, MN will undertake the publication of the English translations of 3 additional Russian journals, and may elect to publish the English translations of up to 14 additional Russian journals, to be promoted and distributed by the Registrant. As to each additional journal which is published by MN and distributed by the Registrant under the Distribution Agreement, the Registrant will retain 35% of the revenue in the initial year of distribution, with the amount gradually being reduced to 30% over a six-year period. The journals published by MN are translated and published in Russia. The Registrant expects to continue its activities in translating, publishing and distributing both the journals subject to the Distribution Agreement until they are published by MN and the 43 English Translation Russian Journals not subject to the Agreement. These activities are undertaken pursuant to the Registrant's existing English translation and publication contracts with the individual entities publishing the Russian language journals which generally extend through 2001. The journals published by MN are distributed by the Registrant under the MAIK Nauka\/Interperiodica imprint, and it is indicated in each journal that it is distributed worldwide by Plenum\/Consultants Bureau. Those journals translated and published by the Registrant continue to be published under the Registrant's \"Consultant's Bureau\" imprint. In 1994, revenues from subscription journals decreased as a result of the Registrant's altered status with respect to the translation journals covered by the Distribution Agreement, and also as a result of the political and economic situation in Russia and in the other republics of the former Soviet Union. Management expects further decreases to occur hereafter as a result of the same factors. See Item 7, \"Management's Discussion and --------------------------- Analysis of Financial Condition and Results of Operations.\" ---------------------------------------------------------- The translation work required for the publication of the Registrant's non-MN Journals is done primarily by scientists and technical persons in the United States and elsewhere who have other principal occupations. The Registrant maintains relationships with approximately 130 such persons, most of whom have been rendering translation services to the Registrant for several years. The Registrant has been able to obtain the required translators to enable it to meet its needs. The number of trans- lators reflects a reduction from previous years since the Registrant, under the Distribution Agreement, translates fewer journals.\nPlenum Press Journals ---------------------\nThe Registrant published 100 journals in its English Language Journal Program in 1994. The journals are published under the Registrant's \"Plenum Press\" imprint, and include titles in chemistry, physics, mathematics, computer science, engineering, biology, medicine, psychiatry, social sciences and law. Each journal is published under the direction of an editorial board composed of professionals specializing in the fields of research covered by the journal.\nHuman Sciences Press Journals -----------------------------\nThe Registrant's subsidiary, Human Sciences Press, Inc., publishes 48 journals, under the \"Human Sciences Press\" imprint. These journals are primarily in the health, behavioral and social science fields.\nOutside Journals ----------------\nIn April 1993, an American learned society with which the Registrant had a contract to produce English translations of 11 Russian language journals for publication by that society gave notice that it would not exercise the option of renewing the contract beyond the term ending with the 1993 volume year. For 1994, the amount of revenue generated from the production of these 11 journals was approximately $527,000. Such revenue ceased during the second quarter of 1994. The Registrant, through its Boston-based J.S. Canner & Company, Inc. subsidiary, engages in the purchase and sale of backissue periodicals to libraries, colleges, universities and other users.\nBooks -----\nThe Registrant's Plenum Press division publishes scientific, technical and medical books for use by scientists, engineers, research workers, other professionals and graduate students, and their supporting libraries, research laboratories and institutions. During 1994, the division published 263 new titles as part of this program, and had an active backlist of approximately 3,800 titles as of December 31, 1994. During 1993, 288 new titles were published. Titles include comprehensive treatises, monographs and other advanced text-reference works, as well as proceedings of meetings reporting original scientific research, works surveying the state of the art in various scientific fields and specialized bibliographies and data compilations. In recent years, a number of books treating scientific topics of interest to the general reader have also been published. The Registrant's DaCapo Press, Inc. subsidiary publishes a line of academic\/trade paperbacks in the arts, biography and history. During 1994, this subsidiary published 62 titles compared to 40 titles in the prior year. As of December 31, 1994, this subsidiary had an active backlist of approximately 1,400 titles, of which approximately 500 titles were academic\/trade paperbacks, and 900 were hardcover reprints of books in music, dance, visual arts and the social sciences, which were published by DaCapo in prior years. The Registrant's Human Sciences Press, Inc. subsidiary had an active backlist of approximately 400 titles as of December 31, 1994. The Registrant has no immediate plans to publish new titles under the Human Sciences imprint, but will continue to publish the backlist under such imprint. The Human Sciences books are primarily in the health, behavioral and social science fields, and are sold mainly to libraries and professionals in these fields.\nDatabase Products -----------------\nThe Registrant's IFI\/Plenum Data Corporation subsidiary (\"IFI\") is primarily involved in providing to major industrial users on-line access to the IFI Comprehensive Data Base of Patents, a computerized index file containing references to all United States chemical and chemical related patents issued since January 1950. The Registrant's customers generally use terminals at their own facilities to obtain the information through several international database networks. The file is further utilized by IFI in its performance of patent searches for law firms and other customers. IFI produces other on-line databases for searching chemical, general, electrical and mechanical United States patents, and publishes in book format the Patent Intelligence and Technology Report. IFI also offers other online database products including Mental Health Abstracts and Information Science Abstracts. The Registrant's subsidiary, Career Placement Registry, Inc. (\"CPR\"), which had developed a database system of information concerning college graduates and experienced personnel who are seeking employment opportunities, discontinued business due to insufficient use of the system and was dissolved during 1994. Since its creation in 1981, the operations of CPR did not have a significant impact on the Registrant's earnings, nor did its discontinuance.\nOther Publishing Activities ---------------------------\nPlenum Publishing Company Limited, the Registrant's English subsidiary, provides sales representation for the Registrant in the United Kingdom and European markets. Plenum Publishing Company Limited also performs editorial procurement services for the scientific book and journal publishing programs of the Registrant.\nCompetition -----------\nThe market in which the Registrant operates both for the procurement of manuscripts and the sale of its products is highly competitive. The Registrant is one of the leading publishers and distributors of English translations of Russian scientific journals. However, several other companies with English translation capabilities have relationships with individuals and entities responsible for the publication of scientific and technical material in the former Soviet Union. In addition, other publishers in the United States and abroad with greater financial resources than the Registrant are engaged in the publication of original English language scientific materials and database products, as well as the reprint of out-of-print books and other books generally not available.\nExport Sales ------------\nThe Registrant's sales derived from customers outside the United States aggregated approximately $20,590,000 in 1994 (approximately 39% of consolidated sales). Sales derived from customers outside the United States were approximately $23,217,000 in 1993 and $21,214,000 in 1992 (approximately 43% and 39%, respectively, of consolidated sales). The Registrant generally prices its products sold abroad in U.S. dollars.\nInvestments in Securities -------------------------\nIn 1994, the Registrant's dividends, interest income, net realized and unrealized gains\/losses on marketable securities, and equity in the net income (loss) of Gradco Systems, Inc. (the foregoing items net of interest expense and other investment-related expenses) represented 21% of the Registrant's pre-tax income. In 1993, such items (net of interest expense and other investment-related expenses) represented 3.2% of pre-tax income. The Registrant's excess cash is invested principally in a portfolio of marketable securities. Market conditions and the nature of the investments have an impact on the performance of the portfolio. Excess cash is also invested in part, from time to time, in short-term investments such as time deposits, money market funds and commercial paper, and in the past has been invested in U.S. Government securities. The investments of excess cash are available for corporate purposes, and have been so used periodically. The Registrant owns 913,000 shares of Common Stock of Gradco Systems, Inc. (\"Gradco\"), an office automation company, which were acquired by the Registrant during the period October, 1989 through August, 1991. The acquisitions by the Registrant have been reported in a Statement on Schedule 13D and amendments thereto filed jointly with the Securities and Exchange Commission by the Registrant and by its Chairman, Martin E. Tash, and his wife, who as of the date hereof had acquired a total of 250,672 shares. Mr. Tash also has currently exercisable options to purchase 50,000 additional shares. The filings are required because the Registrant and Mr. and Mrs. Tash as a group (the \"Group\") beneficially own more than 5% of the outstanding shares of Gradco (11.7% by the Company and 3.8% by Mr. and Mrs. Tash, inclusive of his currently exercisable options, as of the date hereof, for a total of 15.5%). In October 1990, in a proxy contest, a five-person slate of directors was nominated by the Group in opposition to the nominees of Gradco's then current management. The slate consisted of Martin E. Tash (Registrant's Chairman of the Board and Chief Executive Officer), Bernard Bressler (Secretary and a director of Registrant) and three other individuals not affiliated with Registrant. Three nominees of the Group (including Messrs. Tash and Bressler) were elected to directorships, constituting a majority of the Board. The newly named Board named Mr. Tash as Gradco's Chairman and Chief Executive Officer. The Group may be deemed to have obtained control of Gradco in October 1990, as a result of the fact that its nominees were elected as a majority of Gradco's Board of Directors. Gradco's current five-person Board, elected without any opposing nominees at its September 1994 Annual Meeting, consists of Messrs. Tash and Bressler, and three other persons. All of the nominees were designated as such at the request of the Group, which therefore may be deemed to continue to have control of Gradco. Registrant has not undertaken any obligations in connection with Gradco's operations or advanced any funds to it and does not otherwise engage in business through Gradco. The Registrant's investment in Gradco is reflected in the Financial Statements included herein using the equity method of accounting. Gradco, the Registrant and Mr. Tash were defendants in a lawsuit which had been brought by certain former management employees of Gradco. In March 1995, this lawsuit was settled with all but one of the plaintiffs by the exchange of general releases. See Item 3, Legal Proceedings. ----------------- In view of the securities investments described above, the Registrant evaluates its status under the Investment Company Act of 1940, as amended (the \"Company Act\"), on an annual basis. The Company Act requires the registration with the Securities and Exchange Commission of, and imposes various substantive restrictions on, any \"investment company.\" The Company Act defines the term \"investment company\" to include a company that engages primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities. An \"investment company\" may also include a company which engages or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities and which owns or proposes to acquire investment securities (which for this purpose excludes U.S. Government securities) having a value that exceeds 40% of the value of such company's total assets (excluding cash items and U.S. Government securities), unless the company is primarily engaged in a business or businesses other than that of investing, reinvesting, owning, holding or trading in securities. The Registrant's principal business continues to be publishing and distributing advanced scientific and technical material, and the Registrant is not primarily engaged in investing, reinvesting or trading in securities. As of December 31, 1994, investment securities represented less than 40% of the value of the Registrant's total assets (exclusive of cash items), and in any event the Registrant continued to be exempt from status as an investment company pursuant to Rule 3a-1 under the Company Act because less than 45% of the value of its total assets (exclusive of cash items) consisted of, and less than 45% of its net income after taxes for the last four fiscal quarters combined was derived from, securities.\nMiscellaneous Information -------------------------\nThe Registrant currently employs approximately 285 full time employees. Backlog is not significant in the Registrant's business because orders are filled on a current basis. The Registrant does receive payments and on occasion records receivables from journal subscribers in advance of the issuance of journals, and the amounts appearing on the Registrant's Consolidated Balance Sheets as \"Deferred Subscription Income\" represent these items. See Note 1 of Notes to Consolidated Financial Statements. The business of the Registrant is not seasonal. No material portion of the business of the Registrant is subject to renegotiation of profits or termination of contracts at the election of the Government. Compliance with the provisions enacted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment does not have an effect upon the Registrant.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ----------\nAs of December 31, 1994, the Registrant had leases at the following principal locations:\nExpiration Annual Address Size Date of Lease Rent ------- ---- ------------- ------ 233 Spring Street 61,650 sq. ft. 2007 $270,336 in 1995, New York, NY and increasing to a maximum of $340,512 in 2006.\n150 Bay Street 10,000 sq. ft. 1997 $49,400 in 1995 Jersey City, NJ and thereafter\n10 Charles Street 20,800 sq. ft. 1996 $125,073 in 1995 Needham Heights, MA and thereafter\n90 Middlesex Street 2,400 sq. ft. 1996 $46,000 in 1995 London, U.K. and thereafter\nVarious of the leases referred to above provide for additional payments or increases in rent over the base rental specified above under different circumstances. In addition to the leases referred to above, the Registrant or its subsidiaries have leases on space at various locations with a total annual rental of approximately $17,000. The Registrant's warehouse operations are conducted at a 69,000 square foot warehouse in Edison, New Jersey which is owned by the Registrant.\nItem 3.","section_3":"Item 3. Legal Proceedings -----------------\n(a) Stewart, et al. v. Gradco Systems, Inc., Plenum Publishing ----------------------------------------------------------- Corporation, et al. -------------------\nThis litigation, which was previously reported in the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993, was agreed to be settled in March 1995 by Keith Stewart, and by all but one of the other remaining plaintiffs. The settlement will involve a release of all claims and cross-claims, without any payment by any of the parties. The settlement documents have not yet been filed with the Court, but this is expected to occur imminently. Management of the Registrant, after consultation with counsel, believes that the pending action by the non-settling plaintiff will not result in a material loss to the Registrant and intends to vigorously defend against it. Pre-trial discovery is being conducted, and the discovery cutoff date is April 30, 1995. The trial date has been set for May 30, 1995.\n(b) Waterman v. Calt and DaCapo Press, Inc. --------------------------------------- This civil action was filed by an individual residing in Oxford, Mississippi, by Complaint dated January 5, 1995. DaCapo Press, Inc. (a wholly-owed subsidiary of the Registrant) published a book entitled I'd Rather be the Devil: Skip James and the Blues -------------------------------------------------- about a deceased blues singer (the \"Book\"). The plaintiff, the singer's former manager, has alleged that he was libeled by the Book. He seeks compensatory damages in the amount of $1,500,000 and punitive damages in the amount of $1,500,000 against DaCapo and the book's author, Stephen Calt. Plaintiff also seeks $20,000 in damages for the alleged unauthorized use of a photograph. The case was removed to the United States District Court for the Western District of Tennessee, from Tennessee State Court where it had been filed. Defendants have filed an answer, and intend to defend the case vigorously.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- Not applicable.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related ----------------------------------------------------- Stockholder Matters -------------------\nThe Common Stock of the Registrant is traded on the NASDAQ National Market System. The following table sets forth, for the calendar quarters indicated, information furnished by the NASD, Inc. as to the high and low sale prices for the Registrant's Common Stock as reported on the NASDAQ National Market System under the symbol PLEN. The table also sets forth dividends declared during such periods. There were approximately 573 record holders of the Registrant's Common Stock on March 16, 1995. The number of holders as so stated does not include individual participants in security position listings.\nDividends Calendar Year Ended December 31, High Low Per Share -------------------------------- ---- --- --------- ---- First Quarter.................... 27-1\/2 25 $ .28 Second Quarter................... 27 22-1\/4 .28 Third Quarter.................... 27-1\/4 23-1\/2 .28 Fourth Quarter................... 32-1\/4 24-3\/4 .28\nDividends Calendar Year Ended December 31, High Low Per Share -------------------------------- ---- --- --------- ---- First Quarter.................... 30-1\/2 25-3\/4 $ .27 Second Quarter................... 30 25-1\/2 .27 Third Quarter.................... 27-3\/4 22-3\/4 .27 Fourth Quarter................... 26-1\/4 22-1\/2 .27\nThe Registrant has paid cash dividends on its Common Stock in each year since 1974. The payment and amount of future dividends are dependent upon the Registrant's earnings, general financial condition and the requirements of the business and upon declaration of the dividend from time to time by the Board of Directors.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations ---------------------\nResults of Operations --------------------- 1994 Compared to 1993 ---------------------\nRevenues from the Company's publishing operations decreased by 3%. Revenues from subscriptions and outside journals decreased by 5.2% primarily due to the following: (a) cessation of the publication of 11 Russian language journals under a contract with an American learned society (which ended with the 1993 volume year - see below); (b) the decrease in revenues from the translation journals resulting from the Company's altered status with respect to the journals covered by the Journal Production and Distribution Agreement (see below); (c) non-renewals of subscriptions partially attributable to the reduced buying power of libraries and to changes in the market for the Company's translation of Russian language journals, offset by higher selling prices; (d) fewer journal issues being published. In December 1993, the Company entered into a Journal Production and Distribution Agreement (the \"Distribution Agreement\") with the Russian Academy of Sciences (the \"Academy\") and other interested parties pursuant to which litigation then pending, relating to the translation of Russian scientific journals, was ended, and the Company's role as publisher and distributor of certain of such journals was altered. The Distribution Agreement extends from 1994 through 2006. The new arrangement resulted in decreased revenues from subscription journals for fiscal 1994, since the publication of most of the affected journals for the 1994 volume year commenced during the second quarter of fiscal 1994. Management expects that in 1995 and thereafter, further decreases in the Company's revenues from subscription journals will occur as a result of the Company's altered status with respect to the journals covered by the Distribution Agreement, and also as a result of the political and economic situation in Russia and in the other republics of the former Soviet Union. In April 1993, an American learned society with which the Company had a contract to produce English translations of 11 Russian language journals for publication by that society gave formal notice that it would not exercise the option of renewing the contract beyond the term ending with the 1993 volume year. The amount of revenue generated from the production of these 11 journals was approximately $527,000 for fiscal 1994, compared to approximately $1,261,000 for fiscal 1993. Such revenues ceased during the second quarter of fiscal 1994. Despite the reduction in the number of book titles being published, revenues from book sales increased by 4.5%, primarily due to an increase in backlist sales. The cost of sales as a percentage of revenues increased from 40.1% to 40.4%, principally due to a lower gross margin on certain Russian scientific journals published by the Russian Academy of Sciences under the Distribution Agreement and the cessation of the publication of 11 Russian language journals under a contract with an American learned society, which had an above average gross margin, offset by increased sales of backlist books. The Company provides for obsolescence by writing down the inventory values of backlist books, resulting in higher gross margins on backlist sales, as compared to frontlist sales. Under the Distribution Agreement, there were no royalties payable on certain Russian scientific journals published by the Academy of Sciences, resulting in decreased royalty expenses. The decrease in selling, general and administrative expenses was primarily due to decreased professional fees, advertising expenditures and mailing expenses. The decrease in interest income was principally due to lower interest rates and decreased investment in U.S. Government securities, arising mainly because of the decrease in investment assets utilized for redemption of the Company's 6 1\/2% Convertible Subordinated Debentures (the \"Debentures\") on April 30, 1993. The decrease in dividend income was due to decreased investment in marketable securities. The Company had a net realized gain of $2,160, and an unrealized gain of $2,523,173 on marketable securities for fiscal 1994, as compared to a net realized gain of $801,387 and an unrealized loss of $1,713,197 on marketable securities for fiscal 1993. The decrease in interest expense was primarily due to the redemption of the Debentures on April 30, 1993. The increase in net income in fiscal 1994 was principally attributable to the increase in investment income as discussed in the preceding paragraph, and the extraordinary loss from early retirement of the Debentures for fiscal 1993, offset by decreased income from publishing operations in fiscal 1994.\n1993 Compared to 1992 ---------------------\nRevenues from the Company's publishing operations increased by 0.7% to $54,098,246. Revenues from subscriptions and outside journals increased by 2.4%, primarily attributable to more journal issues being published and higher selling prices, offset by non-renewals of subscriptions partially due to the reduced buying power of libraries. Revenues from book sales decreased by 6.2% primarily due to fewer book titles being published. In December 1993, the Company entered into the Distribution Agreement regarding translation journals. This modified arrangement began to take effect in 1994 (see above). The cost of sales as a percentage of revenues increased from 39.82% to 40.08%, primarily due to higher salaries and employee benefit costs, offset by a more favorable mix of revenues from subscriptions and outside journals, and book sales. The increase in royalty expenses was principally due to increased royalty rates. The decrease in selling, general and administrative expenses was primarily attributable to decreased professional fees and bad debt expense, offset by higher salaries, employee benefit costs and sales commissions. The decrease in interest income was principally due to lower interest rates and decreased investments in Government securities, time deposits and money market funds, arising in large part because of the decrease in investment assets utilized for redemption of the Debentures on April 30, 1993. The increase in dividend income resulted from the increase in average investment in marketable securities in 1993. The Company had a net realized gain of $801,387 on marketable securities and recorded a provision of $1,713,197 for net unrealized losses on marketable securities for 1993, as compared to a net realized gain of $2,476,916 on marketable securities for 1992. The decrease in interest expense was primarily due to the redemption of the Debentures. The decrease in net income was principally attributable to the decrease in investment income as discussed in the preceding paragraph and the extraordinary loss from early retirement of the Debentures. The provision for income taxes as a percentage of income decreased in 1993 as compared to 1992 because in 1992 the Company recorded an additional provision for state and local income taxes for assessments of such taxes expected with respect to prior years.\nLiquidity and Sources of Capital -------------------------------- The ratio of current assets to current liabilities is 5.1 to 1 at December 31, 1994 compared to 6.3 to 1 at December 31, 1993. Management anticipates that internally generated funds will exceed the requirements of the operations of the business. The Company also has funds of approximately $56,066,000 at December 31, 1994 invested in marketable securities and in cash and cash equivalents, which are available for corporate purposes.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -------------------------------------------\nResponse to this Item is contained in Item 14(a).\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 --------------------------------------------------- (a) The following table sets forth the name of each director and executive officer of the Registrant, the date on which his present term as a director will expire, and the nature of all positions and offices with the Registrant held by him at present. The term of office of all executive officers expires at the next Annual Meeting of Stockholders of the Registrant, which is to be held in June 1995.\nPresent Term as Director Name Expires Position ---- ------------- --------\nMartin E. Tash 1996 President and Chairman of the Board of Directors\nMark Shaw 1996 Executive Vice President and Director\nBernard Bressler 1996 Secretary and Director\nEarl Ubell 1995 Director\nN. Bruce Hannay 1995 Director\nHoward F. Mathiasen 1995 Director\nGhanshyam A. Patel ---- Treasurer and Chief Financial Officer; Assistant Secretary\nThe Registrant's Board of Directors is divided into two classes. Each class currently consists of three members, and is elected in alternate years for a term of two years. The term of one class (consisting of Dr. Hannay and Messrs. Mathiasen and Ubell) expires at the 1995 Annual Meeting of Stockholders. In March 1995, the Board amended the By-laws, effective as of the 1995 Annual Meeting, to increase this class to four members, thereby increasing the total number of directors to seven. Dr. Hannay will be retiring from the Board and, accordingly, will not stand for re-election. The Board has designated Messrs. Mathiasen and Ubell, together with Nathan Tash and Dr. Israel Gitman, as the four nominees for election at the 1995 Annual Meeting. The term of office of the other class (consisting of Messrs. Shaw, Bressler, and Martin E. Tash) expires in 1996. (b) The following is a brief account of the recent business experience of each director and executive officer, each nominee to serve as a director, and directorships held with other companies which file reports with the Securities and Exchange Commission.\nName Director Since Business Experience ---- -------------- ------------------- Martin E. Tash, 1972 Mr. Tash has been actively age 54 engaged in the Registrant's business since 1971. He has been Chairman of the Board and President since July 15, 1977, and served as Treasurer and Chief Financial Officer from 1971 until September 29, 1986. Mr. Tash is also Chairman of the Board and Chief Executive Officer of Gradco Systems, Inc.\nMark Shaw, 1977 Mr. Shaw has been actively age 56 engaged in the Registrant's business since 1963. He has been Executive Vice President since July 15, 1977, and man- ages the Registrant's book and journal publication program.\nBernard Bressler, 1962 Mr. Bressler has been a age 67 practicing attorney since 1952, and is presently a member of the firm of Bressler, Amery & Ross, counsel to the Registrant. Mr. Bressler is also a director of Gradco Systems, Inc.\nEarl Ubell, 1972 Mr. Ubell has been the Health age 68 and Science Editor of WCBS-TV since September 11, 1978. Between August 1976 and September 1978, Mr. Ubell was the Producer of Special Events and Document- aries for NBC News. For more than three years prior to that time, Mr. Ubell was the Director of News of WNBC-TV.\nN. Bruce Hannay, 1977 Dr. Hannay is retired. From age 74 1982 - 1994, Dr. Hannay was a business and technical consultant. Prior thereto, he had been employed by Bell Laboratories, Incorporated since 1944 and served as Vice President - Research and Patents from 1972 - 1982. Dr. Hannay is a director of a group of mutual funds sponsored by Alex. Brown & Sons, Inc.\nHoward F. Mathiasen, 1978 Mr. Mathiasen is retired. age 57 From July 1982 to June 1987 Mr. Mathiasen was Senior Vice President of National Westminster Bank U.S.A. (formerly known as The National Bank of North America). Between June 1979 and July 1982 he was Vice President of that Bank. Between May 1, 1978 and April 1979, Mr. Mathiasen was Senior Vice President of Nassau Trust Company. Between January 1975 and May 1978, Mr. Mathiasen was Vice President of Chemical Bank.\nGhanshyam A. Patel, -- Mr. Patel has been Treasurer age 58 and Chief Financial Officer of the Registrant since September 29, 1986. Prior to that he was with the accounting firm of Ernst & Whinney (predecessor to Ernst & Young) from April 1970 and served in the capacity of Senior Manager commencing June 1977.\nIsrael Gitman, -- Dr. Gitman is a nominee to age 55 serve as a director of the Registrant. For the past twenty years, he has been a consultant to Fortune 500 companies in the development of advanced commun- ications systems and technology and in the formulation of systems strategies. From 1979 to 1994, he was Chairman and President of DVI Communications, Inc., a systems engineering and consulting company that he co-founded. Prior thereto, he was active in research and development in the areas of computer communications and artif- icial intelligence. Dr. Gitman has published widely in scientific and technical journals, and has been a speaker and chairman in national and international conferences.\nNathan A. Tash, -- Mr. Tash is a nominee to serve as age 32 a director of the Registrant. From 1990 through 1992, Mr. Tash, who is an attorney, was associated with the law firm of McKenna & Cuneo in Washington, D.C. From 1993 to the present, he has been engaged in private business, providing legal and investment advice to private clientele regarding real estate matters.\n(c) Nathan Tash is the son of Martin E. Tash, the Company's Chairman and President.\nItem 11.","section_11":"Item 11. Executive Compensation ---------------------- (a) Summary Compensation Table. The following table sets forth all compensation awarded to, earned by or paid to the following persons through March 16, 1995 for services rendered in all capacities to the Registrant and its subsidiaries during each of the fiscal years ended December 31, 1994, 1993 and 1992: (1) the Registrant's Chief Executive Officer, and (2) each of the other executive officers whose total compensation for the fiscal year ended December 31, 1994 required to be disclosed in column (c) and (d) below exceeded $100,000. SUMMARY COMPENSATION TABLE --------------------------\n(a) (b) (c) (d)1 (e)2 Name and All Other Principal Position Year Salary ($) Bonus ($) Compensation ($) ------------------ ---- ---------- --------- ---------------- Martin E. Tash 1994 305,000 353,525 27,657 Chairman of the 1993 290,000 295,400 30,000 Board and President 1992 275,000 335,650 30,000 (Chief Executive Officer)\nMark Shaw 1994 305,000 252,375 27,657 Executive Vice 1993 290,000 211,000 30,000 President 1992 275,000 239,750 30,000\nGhanshyam A. Patel 1994 143,000 40,000 23,173 Treasurer and Chief 1993 136,000 33,000 22,868 Financial Officer 1992 130,000 37,500 20,839\nFootnotes to Summary Compensation Table ---------------------------------------\n1-Represents amounts paid to the named executive officer, for the applicable fiscal year, under the Registrant's Incentive Compensation Plan. For each fiscal year an amount equal to 5% of the Registrant's Income from Operations as reported in the Registrant's year-end financial statements (together with, when applicable, 5% of the excess of cumulative Investment Profit over cumulative Investment Loss) is distributed to key employees. Thirty-five percent of such amount is distributed to the chief executive officer and 25% is distributed to the next senior officer. The balance of such amount is distributed as determined by the chief executive officer. Since cumulative Investment Profit (as defined) earned after 1990, through December 31, 1992, exceeded Investment Loss (as defined) incurred in 1990, the excess was added to Income from Operations for the purpose of calculating incentive compensation for 1992. Since there was Investment Profit (as defined) in 1993 and 1994, the amount of such Profit was added to Income from Operations for the purpose of calculating incentive compensation for 1993 and 1994.\n2-Represents amount of contribution made to or accrued for the account of the named executive officer, in respect of the applicable fiscal year, in the Registrant's Profit Sharing Plan (a defined contribution plan qualified under the Internal Revenue Code). The Plan is maintained for all full-time employees who have completed certain minimum periods of service. The Registrant contributes to the Plan specified amounts based upon its after tax income as a percentage of gross revenue. The Registrant's contribution to the Plan for each employee is determined by his salary level and length of service. Contributions are invested by the Plan Trustee in stock of the Registrant and\/or in a variety of other investment options, depending upon the employee's election. Interests in the Plan become vested to the extent of 20% after three years of service and vest at the rate of an additional 20% for each year of service thereafter and in any event become 100% vested at death or at the \"normal retirement age\" of 55 as specified in the Plan. Each employee (or his beneficiary) is entitled to receive the value of his vested interest upon his death or retirement. He may also receive the value of such interest upon prior termination of his services with the Registrant, or if he elects at any time to withdraw his interest. The interests of Messrs. Tash, Shaw and Patel are fully vested.\nThe aggregate contributions made or accrued by the Registrant through the end of fiscal 1994 for Messrs. Tash, Shaw and Patel under this Plan are $433,307, $453,182 and $132,867, respectively; these contributions have been invested in the manner set forth above, and (as to Mr. Shaw) a portion of the investments was transferred from the Plan into a private profit sharing plan of which Mr. Shaw is the beneficiary.\n(b) Compensation of Directors. -------------------------\nDirectors fees for Dr. N. Bruce Hannay and Messrs. Earl Ubell and Howard F. Mathiasen are currently at the rate of $10,000 per annum each. Directors of the Registrant who are also officers of the Registrant receive no additional compensation for their services as directors.\n(c) Termination of Employment and Change of Control Arrangements Regarding Named Executive Officers. ------------------------------------------------\n(i) See footnote (2) to table in Item 11(a) for information as to entitlement of Messrs. Tash, Shaw and Patel to receive certain distributions under the Registrant's Profit Sharing Plan upon termination of their employment. (ii) On September 22, 1989, the Registrant adopted Amended Contingent Compensation Agreements with Martin Tash and Mark Shaw (executive officers of the Registrant named in the table in item 11(a)) and with Harry Allcock and Marshall Lebowitz (officers of subsidiaries of the Registrant). The Amended Agreements supersede the Contingent Compensation Agreements, adopted on October 8, 1986, and provide that if (a) during the officer's employment or within six months after his employment terminates, there is a sale of 75% of the book value of the Registrant's operating assets (as defined), or if any person or group becomes the owner of over 25% of the Registrant's outstanding stock, and (b) the officer's employment is terminated at or prior to the end of the sixth month after such event, then the Registrant or a successor in interest to the Registrant shall pay the terminated officer cash equal to 290% of the officer's average annual taxable compensation over the preceding five calendar years. On December 14, 1993, the Registrant entered into Contingent Compensation Agreements with Ghanshyam Patel (an executive officer of the Registrant named in the table in item 11(a)) and Ken Derham (an officer of a subsidiary of the Registrant) on the same terms as the Amended Agreements described above.\n(d) Indemnification Agreements. ---------------------------\nIn September 1987, the Registrant's liability insurance for its directors and officers expired and was not renewed due to the significantly increased cost. In light of this development, and to provide increased protection, the Registrant's By-Laws were amended on November 18, 1987 to require the Registrant to advance expenses of directors or officers in defending a civil or criminal action as such expenses are incurred, subject to certain conditions. Furthermore, on that date the Registrant entered into a contract with each of its directors and executive officers, requiring indemnification for expenses, judgments, fines and amounts paid in settlement, in accordance with the By-Laws as amended, or any future By-Laws which provide greater indemnification. (On December 14, 1993, the Registrant entered into a substantially identical contract with an officer of one of its subsidiaries.) The present By-Laws provide for such indemnification, in connection with claims arising from service to the Registrant, or to another entity at Registrant's request, except where it would be prohibited under applicable law.\n(e) Compensation Committee Interlocks and Insider Participation ----------------------------------------------------------- The Registrant's Board of Directors has no compensation committee (or other Board committee performing equivalent functions); compensation policies applicable to executive officers are determined by the Board. During the fiscal year ended December 31, 1994, the officers of the Registrant participating in the Board's deliberations concerning executive compensation were Martin E. Tash, Mark Shaw and Bernard Bressler (who are members of the Board). During the fiscal year ended December 31, 1994, Martin E. Tash (an executive officer of the Registrant) served as a member of the Board of Directors of Gradco Systems, Inc. (\"Gradco\"). Gradco has no compensation committee (or other Board committee performing equivalent functions); compensation policies applicable to executive officers are determined by its Board. Mr. Tash is an executive officer of Gradco and is the only such executive officer who also served on Registrant's Board. Bernard Bressler (Secretary and a director of Registrant) is an officer and director of Gradco, but he is not an executive officer of either entity. During the period since January 1, 1994, there were no transactions between the Registrant and Gradco of the type required to be disclosed under Item 13, Certain Relationships and Related Transactions.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management --------------------------------------------------------------- (a) The following table sets forth information regarding persons known to the Registrant to be the beneficial owners of more than 5% of the Registrant's voting securities as of March 16, 1995, based on 3,944,069 shares of Common Stock, $.10 par value, outstanding as of such date.\nAmount and Nature of Name and Address of Beneficial Percentage Title of Class Beneficial Owner Ownership of Class -------------- ------------------- ---------- ---------- Common Stock Martin E. Tash 423,402 $.10 par value 233 Spring Street shares(1) 10.7% New York, NY 10013\nArlene S. Tash 298,229 17049 Northway Circle shares(2) 7.6% Boca Raton, FL 33496\nSoutheastern Asset 321,000 Management, Inc. shares(3) 8.1% 860 Ridgelake Boulevard Memphis, TN 38120\nQuest Advisory Corp. 411,450 and Quest Management shares(4) 10.4% Company as a Group 1414 Avenue of the Americas New York, NY 10019\nMellon Bank Corp. 284,449 7.2% One Mellon Bank Center shares(5) Pittsburgh, PA 15258\nFootnotes ---------\n(1) Includes 112,253 shares held by the Registrant's Profit Sharing Plan, as to which Mr. Tash has voting and investment power. Of the aggregate of 423,402 shares shown, Mr. Tash has sole voting and investment power as to 125,173, and shared voting and investment power with his wife as to 298,229.\n(2) Shares are owned jointly by Mrs. Tash with her husband, Martin E. Tash, and she shares voting and investment power with him. Shares are included in the 423,402 shares shown as owned by Mr. Tash.\n(3) Number of shares as shown in beneficial owner's Amendment No. 3 to Schedule 13G dated January 31, 1995, filed with the Securities and Exchange Commission, reporting ownership as of December 31, 1994. According to such Schedule 13G, South eastern Asset Management, Inc. is an Investment Adviser registered under the Investment Advisers Act of 1940. It has sole voting and dispositive power as to 211,000 of the shares shown, and shared voting and dispositive power as to 110,000 of said shares. According to the Schedule 13G, all of the aforesaid securities \"are owned legally by Southeastern's investment advisory clients and none are owned directly or indirectly by Southeastern. As permitted by Rule 13d-4, the filing of this statement shall not be construed as an admission that Southeastern is the beneficial owner of any of [such] securities.\" The Schedule 13G was also filed by O. Mason Hawkins, Chairman of the Board and President of South eastern \"in the event he could be deemed to be a controlling person of that firm as the result of his official position with or ownership of voting securities. The existence of such control is expressly disclaimed. Mr. Hawkins does not own directly or indirectly any securities covered by this statement for his own account. As permitted by Rule 13d-4, the filing of this statement shall not be construed as an admission that Mr. Hawkins is the beneficial owner of any of the securities covered by this statement.\" The Schedule 13G reflects that Mr. Hawkins has voting or dispositive power as to none of the Registrant's shares.\n(4) Number of shares as shown in beneficial owner's Amendment No. 2 to Schedule 13G dated February 10, 1995, reporting ownership as of December 31, 1994. According to such Schedule 13G, each of Quest Advisory Corp. (\"Quest\") and Quest Management Company (\"QMC\") is an Investment Adviser registered under the Investment Advisers Act of 1940. Quest has sole voting and dispositive power as to 386,950 of the shares shown above, representing 9.8% of the outstanding Common Stock, and QMC has sole voting and dispositive power as to 24,500 of the shares shown above, representing .6% of the outstanding Common Stock. The Schedule 13G also includes Charles M. Royce as part of the Group and indicates that he may be deemed to be a controlling person of Quest and QMC, and as such may be deemed to beneficially own the shares of the Registrant beneficially owned by Quest and QMC. Mr. Royce owns no shares of the Registrant outside of Quest and QMC and has disclaimed beneficial ownership of the shares reported above.\n(5) According to Schedule 13G dated February 7, 1995, the Dreyfus Trust Company, a wholly-owned subsidiary of Mellon Bank Corporation, as trustee of the Registrant's Profit Sharing Plan (the \"Plan\"), was the record owner of 252,449 shares of the Registrant's Common Stock as of December 31, 1994. Each employee participating in the Plan is entitled to instruct the Trustee as to the voting and disposition of all shares of Common Stock allocated to the employee's account. To the extent that the voting right is not exercised or shares are held by the Trustee which are not allocated to participant accounts, the Trustee votes these shares in the same proportion as those shares for which the Trustee receives voting instructions from employees. Mellon Bank Corporation (including shares held by its subsidiaries) reported that, excluding Plan shares, it held an aggregate of 32,000 other shares of Common Stock of the Company, as to which such entities had sole or shared voting and dispositive power.\n(b) The following table sets forth information regarding the voting securities of the Registrant beneficially owned by each director of the Registrant, each nominee for director, each of the executive officers named in the Summary Compensation table in item 11, Executive Compensation, and all executive officers and directors as a group, without naming them (7 persons), as of March 16, 1995. Amount and Nature of Name and Address of Beneficial Percentage Title of Class Beneficial Owner Ownership of Class -------------- ------------------- ---------- ---------- Common Stock Martin E. Tash 423,402 $.10 par value 233 Spring Street shares (1) 10.7% New York, NY 10013\nMark Shaw 80,667 233 Spring Street shares (2) 2.0% New York, NY 10013\nEarl Ubell 1,000 WCBS-TV shares * 524 West 57th Street New York, NY 10019\nHoward F. Mathiasen 28,125 10276 Totem Run shares * Littleton, CO 80125\nBernard Bressler 12,809 Bressler, Amery & shares (3) * Ross 90 Broad Street New York, NY 10004\nN. Bruce Hannay 1,000 201 Condon Lane shares(4) * Port Ludlow, WA 98365\nIsrael Gitman (5) -- 12 West 72nd Street New York, NY 10023\nNathan Tash (5) -- 3303 Pine Heights Drive N.E. Atlanta, GA 30324\nGhanshyam A. Patel 10,041 233 Spring Street shares(6) * New York, NY 10013\nAll Executive 557,044 14.1% Officers and Directors shares as a Group (comprising 7 of the persons shown above)\n* Less than 1%.\n(1) See footnote (1) to table in Item 12(a).\n(2) Includes 50,625 shares held in trust for adult children. Of the aggregate of 80,667 shares shown, Mr. Shaw has sole voting and dispositive power as to 67,085 and shared voting and dispositive power with his wife as to 13,582.\n(3) Includes 572 shares held by a trustee for Mr. Bressler under an Individual Retirement Account. Does not include 12,497 shares held by Mr. Bressler's wife as to which he disclaims beneficial ownership.\n(4) Shares are held in the name of Dr. Hannay's wife and comprise community property. Dr. Hannay therefore has a direct beneficial ownership interest in the shares. He and his wife have shared voting and dispositive power.\n(5) Not currently a director; has been nominated (together with Messrs. Mathiasen and Ubell, who are currently directors) to stand for election at 1995 Annual Meeting of Stockholders, to be held in June 1995.\n(6) Includes 4,691 shares held by the Registrant's Profit Sharing Plan, as to which Mr. Patel has sole voting and dispositive power. As to the balance of 5,350 shares, Mr. Patel shares voting and dispositive power with his wife.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions ----------------------------------------------\nBernard Bressler, Secretary and a director of the Registrant, is a member of the law firm of Bressler, Amery & Ross, counsel to the Registrant. During the 1994 fiscal year, the Registrant paid legal fees of $92,701, to such firm.\nPART IV Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ---------------------------------------------------------------\n(a) See index to financial statements and financial statement schedules. See list of exhibits in paragraph (c) below. (b) 8-K reports - None. (c) Exhibits - 3.1 Certificate of Incorporation of the Registrant has been filed as part of Exhibit 3 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986.\n3.2 (a) By-Laws of the Registrant, as amended November 18, 1987, have been filed as Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.(1)\n(b) Section 2.1 of By-Laws, as amended March 10, 1995 - filed herewith.\n10.1 Journal Production and Distribution Agreement dated November 29, 1993 among the Registrant, MAIK Nauka, Interperiodica, Pleiades Publishing, Inc., the Russian Academy of Sciences and Vo Nauka, has been filed as Exhibit 99 to the Registrant's Report on Form 8-K dated December 13, 1993.(1)\n10.2 Incentive Compensation Plan for Executive Officers and Key Employees of Registrant as amended on June 18, 1985 has been filed as part of Exhibit 10 to the Registrant's Report on Form 10-K for the fiscal year ended December 31, 1985.(1)\n10.3 Amendment adopted on December 5, 1990 to Plan referred to in Item 10.3 has been filed as exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.(1)\n10.4 Amended Contingent Compensation Agreements dated September 22, 1989 between the Registrant and Martin Tash, Mark Shaw, Harry Allcock and Marshall Lebowitz have been filed as Exhibit 10.4 to the Registrant's Annual Report on form 10-K for the fiscal year ended December 31, 1989.(1) The Registrant has entered into identical agreements as of December 14, 1993, with Ghanshyam Patel and Ken Derham. To avoid unnecessary duplication, such additional agreements have been omitted from the exhibit filing.\n10.5 Indemnification Agreement dated as of November 18, 1987 between the Registrant and Martin E. Tash has been filed as Exhibit 10.6 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.(1) The Registrant has entered into identical agreements as of the same date with each of the following persons: Howard F. Mathiasen, Mark Shaw, Earl Ubell, Dr. N. Bruce Hannay, and Bernard Bressler. The Registrant entered into a substantially identical agreement dated March 9, 1988 with Ghanshyam A. Patel and dated December 14, 1993 with Ken Derham. To avoid unnecessary duplication, such additional agreements have been omitted from the exhibit filing.\n10.6 Amendment dated March 9, 1988 to Indemnification Agreements referred to in Item 10.6 between the Registrant and Martin E. Tash has been filed as Exhibit 10.7 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.(1) The Registrant has entered into identical amendments of the same date with Mark Shaw and Bernard Bressler. To avoid unnecessary duplication, such identical amendments were omitted from the exhibit filing.\n11 Statement re: computation of per share earnings - filed herewith.\n21 Subsidiaries of Registrant\n(i) Plenum Publishing Co., Ltd. (United Kingdom)\n(ii) Da Capo Press, Incorporated (New York)\n(iii) J.S. Canner & Company, Inc. (Massachusetts)\n(iv) Plenum International Sales Corporation (Virgin Islands)\n(v) IFI\/Plenum Data Corporation (Delaware)\n(vi) Human Sciences Press, Inc. (Delaware)\n27 Financial Data Schedule - filed herewith\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.\nPLENUM PUBLISHING CORPORATION (Registrant)\nBy: \/s\/ Martin E. Tash ------------------- Martin E. Tash Chairman of the Board of Directors and 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:\nBy: \/s\/ Martin E. Tash ------------------- Martin E. Tash Chairman of the Board of Directors and President (Principal Executive Officer)\nDated: March 29, 1995\nBy: \/s\/ Mark Shaw ------------------- Mark Shaw Executive Vice President and a Director\nDated: March 29, 1995\nBy: \/s\/ Ghanshyam A. Patel ----------------------- Ghanshyam A. Patel Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)\nDated: March 29, 1995\nBy: \/s\/ Bernard Bressler --------------------- Bernard Bressler Secretary and a Director\nDated: March 29, 1995\nBy: \/s\/ Earl Ubell --------------------- Earl Ubell Director\nDated: March 29, 1995\nBy: \/s\/ N. Bruce Hannay --------------------- N. Bruce Hannay Director\nDated: March 29, 1995\nBy: \/s\/ Howard F. Mathiasen ----------------------- Howard F. Mathiasen Director\nDated: March 29, 1995\nPlenum Publishing Corporation and Subsidiary Companies\nForm 10-K Item 14(a)(1) and (2)\nand Financial Statement Schedules\nThe following consolidated financial statements of Plenum Publishing Corporation and subsidiary companies are included in Item 8:\nReport of Independent Auditors......................... S- 1 Consolidated Balance Sheets--December 31, 1994 and 1993 S- 2 Consolidated Statements of Income--Years ended December 31, 1994, 1993 and 1992....................... S- 4 Consolidated Statements of Stockholders' Equity--Years ended December 31, 1994, 1993 and 1992 S- 6 Consolidated Statements of Cash Flows-Years ended December 31, 1994, 1993 and 1992 S- 7 Notes to Consolidated Financial Statements S- 9\nThe following consolidated financial statement schedule of Plenum Publishing Corporation and subsidiary companies is included in Item 14(d):\nSchedule:\nII Valuation and Qualifying Accounts S-23\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.\nReport of Independent Auditors\nStockholders and Board of Directors Plenum Publishing Corporation\nWe have audited the accompanying consolidated balance sheets of Plenum Publishing Corporation and subsidiary companies 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Plenum Publishing Corporation and 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. 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.\nNew York, New York March 20, 1995\nAcquisition of treasury stock is net of $930,875 payable at December 31, 1994 (see Note 9).\nSee accompanying notes.\nPlenum Publishing Corporation and Subsidiary Companies\nNotes to Consolidated Financial Statements\nDecember 31, 1994\n1. Summary of Significant Accounting Policies ---------------------------------------------\nBasis of Presentation ---------------------\nThe accompanying financial statements include the accounts of the Plenum Publishing Corporation (the \"Company\") and its domestic and foreign subsidiaries, which are wholly-owned. The accounts of the foreign subsidiaries are not material. Intercompany items and transactions are eliminated in consolidation.\nThe Company accounts for its investment in Gradco Systems, Inc. under the equity method (see Note 4).\nThe Company and its subsidiaries are engaged in the publishing and distribution of advanced scientific and technical materials in the United States and in foreign countries. Export sales aggregated approximately $20,590,000 (1994), $23,217,000 (1993) and $21,214,000 (1992).\nInventories -----------\nInventories are stated at the lower of cost (principally average cost or specific invoice cost) or market (based on selling market).\nDepreciation and Amortization -----------------------------\nDepreciation is provided for by the straight-line method or by the declining- balance method over estimated useful lives ranging from 4 to 35 years. Amortization of leasehold improvements is provided for by the straight-line method generally over the terms of the related leases or the estimated useful lives of the improvements, whichever period is shorter.\nThe excess of cost of assets acquired over book amount thereof (which arose in connection with various acquisitions by the Company in prior years, other than Gradco Systems, Inc.) is being amortized by the straight-line method principally over forty years.\nDeferred expenses relating to issuance of long-term debt were being amortized by the straight-line method over the term of the related debt (see Note 5).\nThe cost of the subscription lists of Human Sciences Press and Agathon journals is being amortized by the straight-line method over estimated useful lives ranging from 12 to 20 years.\nOther assets include the cost of rights to produce and distribute certain journals, which is being amortized by the straight-line method, primarily over a period of fifteen years.\nDeferred Subscription Income ----------------------------\nThe Company bills subscribers to certain publications and patent information services in advance of issuance thereof. The publications are generally issued over a one-year period and subscription revenues are taken into income by the straight-line method based on the relationship of the number of publications issued to the number ordered by subscribers. Patent information service revenues are taken into income when published.\nThe portion of advance billings which will require use of financial resources within one year is not practicable to determine and, accordingly, no portion thereof is included in current liabilities; expenditures at balance sheet dates in respect of such advance billings have similarly been excluded from current assets.\nMarketable Securities ---------------------\nAs determined by management, marketable securities are classified as trading securities and are stated at fair market value. Gains and losses, both realized and unrealized, are included as a component of current earnings. Realized gains and losses on marketable securities are determined based on specific identification of securities sold.\nCash Equivalents and Supplemental Cash Flow Information -------------------------------------------------------\nThe Company considers all highly liquid financial instruments with a maturity of three months or less when purchased to be cash equivalents. As of December 31, 1994, the Company had time deposits, commercial paper and money market accounts totalling approximately $30,981,000 substantially on deposit with three financial institutions. As of December 31, 1993, the Company had time deposits and money market accounts of approximately $1,442,000 on deposit with five financial institutions.\nAt December 31, 1994, cash equivalents included commercial paper totaling $20,500,000. The commercial paper is held to maturity and, as such, it is recorded at amortized cost which approximates fair value.\nThe Company paid income taxes in 1994, 1993 and 1992 of approximately $6,442,000, $6,029,000 and $5,962,000, respectively. In addition, the Company paid interest in 1994, 1993 and 1992 of approximately $20,000, $1,565,000 and $3,023,000, respectively.\n2. Accounting Changes ---------------------\nIn February 1992, the Financial Accounting Standards Board issued Statement No. 109, \"Accounting for Income Taxes\" (the \"Statement\"). The Company adopted the provisions of the new standard in its financial statements for the year ended December 31, 1992. As permitted by the Statement, prior year financial statements have not been restated to reflect the change in accounting method. The cumulative effect as of January 1, 1992 of adopting the Statement increased net income by $1,179,950 or $.25 per share ($.19 per share on a fully diluted basis).\nUnder the Statement, 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 the Statement, income tax expense was determined using the liability method prescribed by Financial Accounting Standards Board Statement No. 96 (\"Statement 96\"), which is superseded by the Statement. Among other matters, the Statement changes the recognition and measurement criteria for deferred tax assets included in Statement 96. In accordance with the Statement, all of the income tax benefits on the excess of book over tax deductions (for example, depreciation, allowance for doubtful accounts, etc.) are deferred (see Note 6). The cumulative effect on prior years of the change has been shown in the income statement for 1992.\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.\" The Company adopted the provisions of the new standard for investments held as of or acquired after January 1, 1994. Accordingly, the Company has classified its marketable equity securities held as trading securities on the basis of its intent to trade such securities and has carried them at fair market value, with unrealized gains and losses reported as a component of current earnings.\nSince at December 31, 1993, the Company valued marketable equity securities at market with unrealized losses reported as a component of 1993 earnings, there was no cumulative effect on net income as of January 1, 1994 of adopting Statement 115.\n3. Inventories --------------\nInventories at December 31 are comprised of:\n1994 1993 ----------------------------- Finished publications $3,164,658 $3,612,257 Work in process 471,643 566,928 ----------------------------- $3,636,301 $4,179,185 =============================\n4. Investment in Gradco Systems, Inc. -------------------------------------\nAs of December 31, 1994 and 1993, the Company owned 913,000 common shares of Gradco Systems, Inc. (\"Gradco\"), a company engaged in the development and marketing of photocopier machine technology, representing approximately 11.7% of its outstanding common stock. Gradco stock is publicly traded on the NASDAQ National Market System. The aggregate market value of this investment as of December 31, 1994 and 1993 amounted to approximately $3,196,000 and $2,739,000, respectively.\nSelected financial data of Gradco as of and for the 12 months ended December 31, 1994, 1993 and 1992 is as follows and has been extracted from unaudited financial information as filed by Gradco with the Securities and Exchange Commission (in thousands):\n1994 1993 1992 ----------------------------- Balance sheet data Total assets $54,800 $38,863 $44,019 Working capital 12,744 9,147 7,198 Noncurrent liabilities, including minority interest and excluding current installments 17,689 15,669 12,387 Shareholders' equity 12,477 9,767 10,914\nStatement of operations data Net revenues 71,458 55,773 55,635 Net income (loss) 878 233 (863)\nThe President and Chairman of the Board of the Company, Mr. Martin E.Tash, is also the President and Chairman of the Board of Gradco.\n5. Long-Term Debt ----------------- Long-term debt at December 31, 1992 consisted of 6-1\/2% Convertible Subordinated Debentures (the \"Debentures\") due April 15, 2007. The Debentures were issued in April and May 1987.\nIn 1993 and 1992, the Company purchased Debentures in the principal amount of $1,149,000 and $6,808,000, respectively, for an aggregate cost(including the write-off of related deferred issuance costs of approximately $28,000 and $173,000, respectively) of approximately $1,143,000 and $6,149,000, respectively.\nOn April 30, 1993 (the\"Redemption Date\"), pursuant to a notice of election to redeem which had been given to the holders on March 24, 1993, the Company redeemed the Debentures which were outstanding on the Redemption Date. In accordance with the terms of the Debentures and the applicable Trust Indenture, the redemption price was equal to 102.60% of the principal amount of outstanding Debentures, and the holders were also paid accrued interest for the period from April 15, 1993 (the date on which the last semiannual installment of interest was paid) to the Redemption Date. Prior to the Redemption Date, Debentures in the aggregate principal amount of $80,000 were converted into 2,560 shares of Common Stock at the applicable conversion rate of $31.25 per $1,000 of principal amount. On the Redemption Date, Debentures in the aggregate principal amount of $39,598,000 were outstanding, requiring a total payment to the holders of approximately $40,735,000 (including accrued interest). This amount was funded by liquidating a portion of the Company's investments of its excess cash, and from short-term borrowing on the Company's margin account with a broker. The premium paid for the Debentures, and the write-off of related deferred issuance costs of approximately $956,000, and professional fees of approximately $13,000 incurred for redemption, net of applicable income tax benefit of $675,000 totalled approximately $1,323,000, which has been accounted for as an extraordinary loss.\n6. Income Taxes ---------------\nEffective January 1, 1992, the Company changed its method of accounting for income taxes to the liability method required by FASB Statement No. 109, \"Accounting for Income Taxes\" (see Note 2-\"Accounting Change\").\nIncome taxes for the years ended December 31 consist of the following:\n------------------------------------- Current Deferred Total ------------------------------------- Federal $4,883,664 $ 838,336 $5,722,000 State and local 1,519,282 224,718 1,744,000 ------------------------------------- $6,402,946 $ 1,063,054 $7,466,000 =====================================\n------------------------------------- Current Deferred Total ------------------------------------- Federal $5,424,809 $ (874,809) $4,550,000 State and local 1,652,470 (266,470) 1,386,000 ------------------------------------- $7,077,279 $(1,141,279) $5,936,000 =====================================\n------------------------------------- Current Deferred Total ------------------------------------- Federal $5,084,206 $ (84,206) $5,000,000 State and local 2,871,540 (21,540) 2,850,000 ------------------------------------- $7,955,746 $ (105,746) $7,850,000 =====================================\nDeferred income taxes result from the recognition of the income tax effect of timing differences in reporting transactions for financial and tax purposes. A description of the differences and the related tax effect follows:\n1994 1993 1992 ----------------------------------- Valuation of inventories $ (129,727) $ (337,711) $ (95,457) Depreciation 207,181 (77,000) (102,600) Allowance for doubtful accounts, etc. (45,100) (26,768) 92,311 Adjustments applicable to net unrealized gains (losses) 1,030,700 (699,800) - ------------------------------------- $1,063,054 $(1,141,279) $(105,746) =====================================\nSignificant components of the Company's deferred tax assets as of December 31 are as follows:\n1994 1993 ----------------------------- Valuation of inventories $2,247,438 $ 2,117,711 Depreciation 863,128 1,070,309 Allowance for doubtful accounts, etc. 158,280 113,180 Net unrealized (gains) losses (330,900) 699,800 Equity in losses of Gradco 1,962,400 1,998,400 ----------------------------- Total deferred tax assets 4,900,346 5,999,400 Valuation allowance (1,962,400) (1,998,400) ----------------------------- Net deferred tax assets $2,937,946 $ 4,001,000 =============================\nThe Company has recorded a valuation allowance for the entire value of the deferred tax asset attributable to the equity in losses of Gradco, since management believes the realization of such asset is not reasonably assured. The change in the valuation allowance in 1994, 1993 and 1992 was $(36,000), $(1,600) and $34,000, respectively.\nA reconciliation of the computed \"expected\" tax expense at the Federal statutory rate and the actual tax expense for the years shown below is as follows:\nExhibit 3.2(b) --------------\nBy-laws - Section 2.1 (as amended 3\/10\/95) ------------------------------------------\n2.1 Number, Qualification, Election ------------------------------- and Term of Directors. ---------------------- The business of the Company shall be managed by the Board, which shall consist of seven directors unless and until such number is changed by resolution of a majority of the entire Board or by the shareholders entitled to vote, provided that in no event may there be fewer than seven directors, and that no decrease in the number of directors effected at any time may shorten the term of any incumbent director. The directors shall each be at least 21 years old. Subject to the provisions of the certificate of incorporation of the Company, the directors shall be divided into two classes, with one class consisting of four directors and the other consisting of three directors. Each class of directors shall be elected at alternate annual meetings of shareholders by a plurality of the votes cast and shall hold office until the second annual meeting of shareholders after their election and until the election of their respective successors.","section_15":""}
{"filename":"831331_1994.txt","cik":"831331","year":"1994","section_1":"Item 1. Business\nGeneral JetStream II, L.P. (the \"Partnership\") is a limited partnership organized under the laws of the State of Delaware on October 15, 1987. The general partners of the Partnership (the \"General Partners\") are CIS Aircraft Partners, Inc., the Managing General Partner (\"CAP\"), a Delaware corporation that is an affiliate of Continental Information Systems Corporation, and Jet Aircraft Leasing Inc., the Administrative General Partner, a Delaware corporation that is an affiliate of Lehman Brothers Inc. (\"Lehman\") (See Item 10).\nAlthough the Partnership was organized on October 15, 1987, the Partnership conducted no activities and recognized no revenues, profits or losses prior to January 14, 1988, at which time the Partnership commenced operations. During the period between January 15, 1988 and February 25, 1988 the Partnership acquired for cash nine used commercial aircraft (together, the \"Aircraft\"). For a description of the investments in the Aircraft, please refer to the \"Portfolio Review\" section on page 3 and Note 4 to the Financial Statements on pages 8 - 10, respectively, of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994, which is filed as an exhibit under Item 14 and incorporated herein by reference.\nOn November 10, 1987, the Partnership commenced an offering (the \"Offering\") on a \"best efforts basis\" of $96,750,000 of limited partnership depositary units (\"Units\"). The closing of the offering occurred on February 24, 1988, with a total of 4,837,505 Units being sold at a price of $20.00 per Unit, for a total of approximately $96,750,000 of Units. The net proceeds of the offering after payment of offering and organization costs and acquisition fees aggregated $85,938,000.\nNarrative Description of Business The Partnership is engaged in the business of managing a portfolio of used commercial aircraft subject to triple net operating leases with commercial air carriers. The Partnership is required to dissolve and distribute all of its assets not later than December 31, 2027. The Partnership may reinvest the proceeds of sales of Aircraft occurring prior to February 24, 1999; thereafter, the net proceeds of sales of Aircraft will be distributed to the partners, after deductions of amounts necessary for working capital and certain reserves.\nThe Partnership's investment objectives are to:\n(1) generate quarterly cash distributions to holders of Units (the \"Unitholders\"), substantially tax-sheltered during the initial years of the Partnership's operations, initially at a rate of approximately 12%, subject to conditions stated in the prospectus pursuant to which the Units were offered and sold (the \"Prospectus\"), dated November 10, 1987;\n(2) preserve and protect the value of the Partnership's assets.\nThe following table describes the Partnership's portfolio of Aircraft as of December 31, 1994. This table provides certain operational statistics and estimated market values for the Aircraft in the portfolio. The estimated market values of the Aircraft are affected by, and subject to, future changes in a variety of factors, including, but not limited to, the Aircrafts' usage, age and lease rate, the credit worthiness of the lessee, government noise regulation and the supply and demand of aircraft in the market place with similar lift capacity. Reference is made to the \"Portfolio Review\" section on page 3 and Note 4 to the Financial Statements on pages 8 - 10, respectively, of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994, for a discussion of the lease terms for each Aircraft. Reference is also made to page 1 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994, for an overview of the aircraft leasing industry.\nAging Aircraft Maintenance - The Federal Aviation Administration (the \"FAA\"), acting on recommendations from industry trade groups, has adopted a series of Airworthiness Directives (\"AD's\") for certain Boeing and McDonnell Douglas aircraft models. AD's are mandates requiring the airline to perform a specific maintenance task within a specified period of time. The FAA imposes strict requirements governing aircraft inspection and certification maintenance, equipment requirements, corrosion control, noise levels and general operating and flight rules. In addition to mandating more intensive inspections of certain structural components, including the fuselage, wing and tail sections, certain of these AD's mandate that structural modifications to certain aircraft be completed within specified periods, generally not less than 48 months from the effective date of the relevant AD. Aircraft are generally subject to these structural modification requirements based on flight cycle, flight hour and chronological age thresholds.\nThe Partnership's three B-727-200 aircraft, one of which is currently on-lease to TWA, are subject to AD's mandating structural modification. AD's presently applicable to the Boeing aircraft owned by the Partnership require extensive repetitive inspections of such aircraft. There can be no assurance that such inspections will not lead to mandatory structural modifications similar to those noted above.\nThe Partnership's existing leases require the lessees to maintain the Partnership's Aircraft in accordance with FAA approved maintenance programs during the lease term. At the end of the leases, each lessee is required to return the Aircraft in airworthy condition, including compliance with all AD's for which action is mandated by the FAA during the lease term. Thus, certain of the modifications required by the new AD's may not be effected by the Partnership's lessees prior to the expiration of the current leases since, in many cases, the relevant AD will not require action before the expiration of the lease term.\nIn negotiating future leases or in selling aircraft now owned by the Partnership, the Partnership may be required to bear some or all of the costs of compliance with future AD's or AD's that have been issued but which did not mandate action during the previous lessee's lease term or in respect of which the previous lessee failed to comply. The ultimate effect on the Partnership of compliance with these standards is not determinable at this time and will depend upon a variety of factors, including, but not limited to, the state of the commercial aircraft market, the status of availability of capable repair facilities and the effect, if any, that such compliance may have on the service lives of the affected aircraft. As described above, the cost to the Partnership of such compliance may be reduced to the extent that current or future lessees of the Partnership's Aircraft effect such modifications under the terms of the current or future operating leases.\nAircraft Noise - Beginning in 1985, the FAA and various airport industry task forces released reports suggesting various alternatives for reducing the number of Stage 2 aircraft operating in the United States, including a proposed requirement to bring all aircraft operating in the United States into compliance with Stage 3 requirements in the 1990s or shortly thereafter. The FAA has categorized aircraft types according to engine noise decibel levels. Stage 1 aircraft, which have the highest noise level, are no longer allowed to operate from civil airports in the United States. Stage 2 aircraft meet current FAA requirements. Stage 3 aircraft are the most quiet and will be the future standard of all aircraft. Only one of the Aircraft owned by the Partnership is Stage 3, the remainder are Stage 2 aircraft.\nEffective November 6, 1990, Congress passed the Airport Noise and Capacity Act of 1990 (the \"Act\") which required the development of a National Noise Policy. On September 25, 1991, final regulations (the \"Regulations\") were announced and became effective immediately. The Regulations provide, among other things, phase-out and non-addition rules under which the number of Stage 2 aircraft operated by domestic carriers would be limited to 75% of 1990 base levels by the end of 1994, 50% of 1990 base levels by the end of 1996, and 25% of 1990 base levels by the end of 1998. The Regulations would allow the issuance of transferable Stage 2 operating rights that expire in increments over the life of the phase-out period. These transferable rights would allow an operator that at any time reduced its Stage 2 fleet below that required by the phase-out schedule to transfer the \"unused\" base level to another operator.\nSeveral modification programs to hush-kit or re-engine an aircraft to meet Stage 3 requirements have been announced, including programs for the B-727 series, the B-737 and the DC-9 series. Hush-kitting is a procedure for retrofitting existing engines to comply with Stage 3 requirements. Re-engining is the replacement of existing engines with technologically-advanced engines complying with Stage 3 requirements. The decision whether to hush-kit or re-engine an aircraft will depend upon a variety of factors, including, without limitation, the differential effects of the two approaches on the operating costs of the aircraft, the relative costs and feasibility of the two approaches and the General Partners' assessment of the remaining useful life and fair market value of the aircraft. Where available, hush-kits currently cost up to $3.0 million per aircraft while the costs of re-engining programs are significantly higher. No assurances are possible in respect of the actual cost which t he Partnership would be required to pay in order to effect a hush-kit or re-engining modification as now available or as may be developed in the future. The General Partners will continue to evaluate the potential benefits of hush-kitting or re-engining some or all of the Partnership's Stage 2 aircraft.\nIn addition to FAA activity in noise abatement, other countries have adopted or are considering adopting noise compliance standards which would have a similar effect of the ability of an airline to operate Stage 2 aircraft in such jurisdictions. In 1989, the European Economic Community adopted a non-addition rule 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 are in operation before November 1, 1990, although adoption of rules requiring eventual phase-out of Stage 2 aircraft in the member countries is anticipated. The Partnership does not currently have any aircraft on lease to airlines outside the United States. The effect of these regulations on the ability of the Partnership to re-lease or remarket its Aircraft in the future is not determinable at this time.\nCompetition. The aircraft leasing industry is highly competitive and the success of any lessor is largely dependent primarily upon the nature of the aircraft within its portfolio. The Partnership competes with aircraft manufacturers, distributors, airlines, and other operators, equipment managers, leasing companies, financial institutions and other parties engaged in leasing, managing, and marketing aircraft. Such competitors may lease or sell aircraft at lower rates or prices than the Partnership and provide benefits, such as direct maintenance crews, and support services which the Partnership cannot provide. Competition may include certain affiliates of the General Partners.\nSince the Partnership's Aircraft are subject to operating leases, the Partnership will be required to re-lease or sell such Aircraft after the expiration of the current lease terms. Conditions in the market for commercial aircraft have remained intensely competitive in recent years as the number of Stage 2, narrow-body commercial aircraft which are being offered for sale or re-lease has remained in excess of demand.\nWithin this intensely competitive environment, the General Partners' ability to renew leases or to sell the Aircraft owned by the Partnership is dependent upon among other factors: (a) general economic conditions and economic conditions effecting the airline industry in particular; (b) the current operating profile of the aircraft, encompassing the age of the aircraft and the number of hours and cycles flown and compliance with all issued AD's as well as the general maintenance conditions of the aircraft; (c) the current fleet plans of the major end-users of the aircraft type; (d) any costs required to refurbish aircraft and to reconfigure aircraft to comply with all issued AD's and to conform with similar aircraft within a potential lessee's fleet; (e) any cost required to conform the aircraft to future Stage 3 noise restrictions; (f) the availability to the lessee or potential lessee of other similar aircraft from the Partnership's competition; and (g) the ability of the Managing Gen eral Partner to effectively market the aircraft. It is possible that any future lease renewals might be at lower lease rates than the Partnership currently receives, adversely impacting revenue.\nEmployees The Partnership has no employees. The officers, directors and employees of the General Partners and their affiliates perform services on behalf of the Partnership. The General Partners are entitled to certain fees and reimbursement of certain out-of-pocket expenses incurred in connection with the performance of these management services. Reference is made to Note 6 to the Financial Statements on page 10 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994, for a discussion of the fees and reimbursable expenses paid to the General Partners.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties Incorporated by reference to the \"Portfolio Review\" section on page 3 and Note 4 to the Financial Statements on pages 8 - 10, respectively, of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994.\nItem 3.","section_3":"Item 3. Legal Proceedings The Partnership has filed an administrative claim against Pan Am in the Bankruptcy Court as a result of Pan Am's return of the Partnership's aircraft in November 1991. The aircraft was subsequently sold in February 1992. The Partnership is seeking to recover certain rent and maintenance costs associated with Pan Am's failure to comply with the return provisions of its lease. Given the status of Pan Am's estate, the General Partners are doubtful that the Partnership will obtain a significant recovery.\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, through the solicitation of proxies or otherwise, during the fourth quarter of 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for Partnership's Limited Partnership Interest and Related Security Holder Matters The Units represent the economic rights attributable to limited partnership interests in the Partnership.\nThere is no established public trading market for the purchase and sale of Units. As of December 31, 1994, the number of Unitholders was approximately 6,957.\nInformation concerning the quarterly cash distributions paid per limited partnership unit is incorporated herein by reference to the \"Table of Contents\" page and the Message to Investors and Note 5 of the Notes to Financial Statements on page 10 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994.\nItem 6.","section_6":"Item 6. Selected Financial Data Incorporated by reference to the \"Financial Results\" section on page 2 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations\nLiquidity and Capital Resources As of December 31, 1994, the Partnership had six of its eight aircraft on lease. There were three aircraft on lease to Northwest Airlines, Inc. (\"Northwest\"), one aircraft on lease to Trans World Airlines, Inc. (\"TWA\"), one aircraft on lease to Delta Air Lines, Inc. (\"Delta\"), and one aircraft on lease to Continental Airlines, Inc. (\"Continental\"). The Partnership's two remaining aircraft, previously on lease to TWA, are currently in storage. At December 31, 1994, all airlines were current on their lease obligations.\nThe leases with TWA for the Partnership's three 727-200 aircraft expired in September and October 1994. While the General Partners reached an agreement with TWA to extend the leases for all of the aircraft at a reduced monthly lease rate of $32,500 per aircraft, two of the extensions were short-term and expired on October 31, 1994 and December 19, 1994, respectively. Both aircraft were subsequently returned to the Partnership and are currently in storage. The lease for the third aircraft was extended through April 1995, with TWA retaining the option of leasing the aircraft thereafter on a month to month basis. The General Partners are pursuing efforts to re-lease the aircraft with another airline. However, in light of the continued difficulties in the aircraft leasing industry and limited leasing opportunities for Stage 2 aircraft, there can be no assurance that such efforts will be successful. In the event that efforts to re-lease the aircraft are unsuccessful, the General Partn ers will pursue other alternatives including the possible sale of the aircraft.\nThe leases with Northwest for the Partnership's three DC-9-30 aircraft were previously scheduled to expire on January 31, 1995 (two aircraft) and April 21, 1995 (one aircraft). During the fourth quarter of 1994, the Partnership reached an agreement with Northwest to extend each of the leases for a term of one year. Under the terms of the extensions, Northwest continues to make monthly lease payments to the Partnership of $35,000 per aircraft.\nPursuant to the terms of the lease agreement executed with Continental in February 1994, the Partnership agreed to provide up to $600,000 of financing to the airline to perform modification work on the Partnership's MD-80 Series aircraft, including advanced avionics, interior furnishings and exterior paint. On June 7, 1994, the Partnership made its first advance to Continental in the amount of $302,525. The modification financing is repayable over the life of the lease at an interest rate of 8% per annum for advances made before February 1, 1996, and, with respect to advances made after February 1, 1996, a rate per annum equal to the yield to maturity of United States Treasury Notes having a maturity closest to the remaining terms of the lease, plus 4.25 percent. As of December 31, 1994, Continental had made principal payments on the loan totalling $41,550.\nThe Partnership is faced with an intensely competitive environment in the aircraft leasing industry which has had an immediate and material impact on the business of the Partnership. In particular, the large oversupply of aircraft available for lease has resulted in significant reductions in market lease rates thereby impacting the lease rates obtained by the Partnership as leases for the aircraft have been either renewed or extended.\nAt December 31, 1994, the Partnership had cash and cash equivalents of $2,978,631 as compared to $1,104,004 at December 31, 1993. The $1,874,627 increase in cash and cash equivalents is mainly attributable to the transfer of $1,539,699 from restricted cash to operating cash, and to cash generated from operations being in excess of the payment of cash distributions. The Partnership's restricted cash totalled $1,047,475 at December 31, 1994, compared to $3,639,699 at December 31, 1993. The $2,592,224 decrease is due to: (i) the $750,000 payment to Continental in February 1994; (ii) $302,525 loaned to Continental on June 7, 1994 in accordance with their new lease agreement; and (iii) the transfer of $1,539,699 from restricted cash to operating cash in the fourth quarter of 1994. At December 31, 1994, the Partnership's restricted cash is comprised of: (i) $750,000 which is to be used in connection with performing various airworthiness directives mandated by the Federal Aviation Admini stration, and (ii) $297,475 in maintenance reserves.\nThe aforementioned payment to Continental of $750,000 in February 1994 is the reason for the decease in the Partnership's maintenance payable balance to $0 at December 31, 1994.\nDuring the year ended December 31, 1994, the Partnership paid distributions to the Unitholders for the period from October 1, 1993 to December 31, 1993 and the first three quarters of 1994, in the amounts of $904,004 and $3,573,369, respectively, which represents approximately $.19 and approximately $.73 per Unit, respectively. At December 31, 1994, the Partnership had a distribution payable of $1,288,932, or approximately $.26 per Unit. This amount reflects the 1994 fourth quarter cash distribution which was funded from cash flow from operations. This distribution was subsequently paid on February 2, 1995. Future cash distributions will be determined on a quarterly basis after an evaluation of the Partnership's current and expected financial position.\nAt December 31, 1994, deferred revenue totalled $160,833 as compared to $315,500 at December 31, 1993. The decrease is attributable to the expiration of the TWA leases on October 31, 1994 and December 19, 1994, and to the change in the timing of the TWA lease rental payments on the remaining aircraft in accordance with the amended lease agreement. The decrease was partially offset by the timing of the Continental rental payments in accordance with the new lease agreement.\nResults of Operations\nSubstantially all of the Partnership's revenue was generated from the leasing of the Partnership's aircraft to commercial air carriers under triple net operating leases. The balance of the Partnership's revenue consisted of interest income.\n1994 compared to 1993 For the twelve months ended December 31, 1994, the Partnership reported a net loss of $575,105 as compared to a net loss of $14,797,472 for the corresponding period in 1993. The decrease in net loss is primarily attributable to the write-down of the net book values of the Partnership's aircraft in December 1993. Excluding the write-down, the Partnership would have recorded net income of $753,804 for the year ended December 31, 1993.\nRental income for the twelve months ended December 31, 1994 was $5,417,086 as compared to $5,112,882 for the corresponding period in 1993. The increase is due to the new lease agreement with Continental effective March 15, 1994, partially offset by a reduction in income resulting from the new lease agreements with TWA and Northwest.\nInterest income for the twelve months ended December 31, 1994 was $134,581 as compared to $148,444 for the corresponding period in 1993. The decrease is due to lower cash balances maintained by the Partnership during 1994 as compared to 1993. This decrease is partially offset by interest received from Continental for the balance outstanding on their loan.\nOther income for the twelve months ended December 31, 1994 was $55,380, as compared to $2,139,699 for the corresponding period in 1993. Upon the expiration of the previous lease with Continental in April 1993, $2,139,699 remaining in the maintenance reserve, previously established to provide funding for maintenance on the Partnership's MD-80 Series aircraft, was retained by the Partnership in accordance with the terms of the lease agreement and recognized as other income.\nDepreciation expense for the twelve months ended December 31, 1994 totalled $5,451,744 as compared to $5,980,380 for the corresponding period in 1993. The decrease is due to the write-down of the net book values of the Partnership's aircraft in December 1993.\nManagement fees for the twelve months ended December 31, 1994 were $479,773 as compared to $388,374 for the corresponding period in 1993. Management fees are based on rental income and operating cash flow. The increase is attributable to the higher rental income during 1994 due mainly to the new lease agreement with Continental.\nOperating expenses for the twelve months ended December 31, 1994 were $56,937, as compared to $84,687 for the corresponding period in 1993. The Partnership incurred substantial costs for storage, maintenance and insurance for the MD-80 Series aircraft in storage from May 1993 through March 1994. The 1993 costs were mainly for insurance, storage and maintenance, while the 1994 costs also include consulting and documentation to prepare the aircraft for re-leasing.\n1993 versus 1992 For the year ended December 31, 1993, the Partnership reported a net loss of $14,797,472, as compared to net income of $2,350,915 for the corresponding period in 1992. The decrease was primarily attributable to the write-down of the net book values of the Partnership's aircraft and, to a lesser extent, lower rental income from the Partnership's operating leases. Excluding the write-down, the Partnership would have recorded net income of $753,804 for the year ended December 31, 1993. The write-down was also the primary reason for the $15,314,590 increase in total expenses to $22,198,497 at December 31, 1993 from $6,883,907 at December 31, 1992.\nAfter adding back non-cash expenses including depreciation and the write-down of the total carrying value of the Partnership's aircraft in 1993, Partnership operations generated net cash flow of $5,591,459 and $7,848,774 for the years ended December 31, 1993 and 1992.\nRental income for the year ended December 31, 1993, was $5,112,882 as compared to $9,074,600 for the corresponding period in 1992. The decreases are primarily the result of: (i) TWA, Delta and Northwest paying lower rental rates pursuant to the airlines' amended lease agreements; and (ii) the expiration of the previous lease with Continental on April 28, 1993.\nOther income for the year ended December 31, 1993, was $2,139,699 as compared to $0 for the year ended December 31, 1992. The increase is attributable to the expiration of the previous lease with Continental. In accordance with the terms of the lease agreement, upon the expiration of the lease, $2,139,699 remaining in the maintenance reserve previously established to provide funding for maintenance on the Partnership's MD-80 Series aircraft were retained by the Partnership and recognized as other income.\nDepreciation was $5,980,380 for the year ended December 31, 1993, virtually unchanged from $5,994,682 for the corresponding period in 1992.\nManagement fees for the twelve months ended December 31, 1993, were $388,374 as compared to $415,129 for the corresponding period in 1992. Management fees are based on rental income and operating cash flow. The decrease is the result of a decrease in rental revenue and operating cash flow. Off-setting the decreases, effective July 14, 1992, the incentive management fee rate paid to the Managing General Partner increased to 4.5% of operating cash flow from 1.5% of operating cash flow, and a re-lease fee of 3.5% of revenue generated by renewed leases is paid to the General Partners, in accordance with the Partnership Agreement.\nGeneral and administrative expenses for the twelve months ended December 31, 1993, were $193,780 as compared to $449,114 for the corresponding period in 1992. The decreases are primarily due to lower legal expenses. Substantial legal fees were incurred during 1992 in connection with the Continental and TWA bankruptcies and litigation with Continental regarding whether certain repairs were reimbursable from the Maintenance Reserves.\nOperating expenses for the twelve months ended December 31, 1993, was $84,687 as compared to $24,982 for the corresponding period in 1992. The increase in operating expenses is attributable to additional insurance and storage costs with respect to the MD-80 Series aircraft that came off lease on April 28, 1993.\nInflation and Changes in Prices Inflation has had no material impact on the operations or financial condition of the Partnership from inception through December 31, 1994. However, inflation and changing prices in addition to other factors, such as the solvency of the Partnership's lessees, may affect leasing rates and the eventual selling price of the aircraft.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data Incorporated by reference to pages 4 - 12 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994.\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 Partnership The Partnership has no officers or directors. The General Partners jointly manage and control the affairs of the Partnership and have general responsibility and authority in all matters affecting its business. Information concerning the directors and executive officers of the General Partners are as follows:\nJet Aircraft Leasing, Inc.\nName Office \tMoshe Braver\tDirector and President \tJohn Stanley\tVice President and Chief Financial Officer \tAndrew Falk\tVice President\nCertain officers and directors of Jet Aircraft Leasing, Inc. are now serving (or in the past have served) as officers or directors of entities which act as general partners of a number of limited partnerships which have sought protection under the provisions of the Federal Bankruptcy Code. The partnerships sought the protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure.\nMoshe Braver, 41, is currently a Managing Director of Lehman Brothers and has held such position since October 1985. During this time, he has held positions with the Business Analysis Group, International and Capital Markets Administration and currently, with the Diversified Asset Group. Mr. Braver joined Shearson Lehman Brothers in August 1983 as Senior Vice President. Prior to joining Shearson, Mr. Braver was employed by the accounting firm of Coopers & Lybrand from January 1975 through August 1983 as an Audit Manager. He received a Bachelor of Business Administration degree from Bernard Baruch College in January 1975 and is a Certified Public Accountant.\nJohn D. Stanley, 32, Vice President, has worked with the Diversified Asset Group since October 1988. Mr. Stanley received a B.A. in Economics from the University of Wisconsin-Madison in 1984 and a Master of Management Degree in Finance and Marketing from Northwestern University in 1988. From 1984 to 1986, Mr. Stanley worked as a Financial Analyst for Kidder, Peabody and Co.\nAndrew Falk, 28, is an Assistant Vice President of Lehman Brothers Inc. in its Diversified Asset Group and has been employed by Lehman since March of 1991. From July of 1989, Mr. Falk was employed by GA\/Partners, the real estate consulting and advisory unit of Arthur Andersen & Company, as a Research Analyst. Mr. Falk earned a Master of Science degree in Real Estate Investment from New York University in 1993 and a B.A. degree in Economics from Duke University in 1989.\n\tCIS Aircraft Partners, Inc. \t Name Office \tThomas J. Prinzing\tDirector, President and Treasurer \tFrank J. Corcoran\tDirector, Vice President and Treasurer \tDaniel L. Wieneke\tDirector, Vice President and Secretary \tRobin A. Konicek\tVice President\nAs reported on the Partnership's Current Report on Form 8-K, dated February 28, 1989, on Friday, January 13, 1989, Continental Information Systems Corporation, and certain of its subsidiaries, including CIS Corporation, filed voluntary petitions for reorganization under Chapter 11 of the Federal Bankruptcy Code. As described below, various directors and executive officers of CAP hold similar positions for Continental Information Systems Corporation, CIS Corporation and such subsidiaries.\nOn November 29, 1994, the Bankruptcy Court for the Southern District of New York confirmed the Trustee's Proposed Joint Plan of Reorganization. The approved Plan became effective on December 21, 1994. As a result of the reorganization, the Directors and Officers of CAP resigned from and took on various directorships for Continental Information Systems Corporation, CIS Corporation and their subsidiaries.\nThomas J. Prinzing, 49, is President of CIS Aircraft Partners, Inc. From 1989 to 1991, Mr. Prinzing was Senior Vice President of the CIS Capital Equipment Group. Mr. Prinzing was Chief Financial Officer of Continental Information Systems Corporation from November 1984 until January 1989. Mr. Prinzing, a Certified Public Accountant, received a Bachelor of Commerce degree from the University of Windsor.\nFrank J. Corcoran, 44, joined CIS Corporation in November 1994 as Senior Vice President and Chief Financial Officer. From 1992 until joining CIS Corporation, Mr. Corcoran was Vice President and General Manager of Unisys Finance Corporation, an equipment leasing and finance subsidiary of Unisys Corporation. Previously, he served as Chief Financial Officer and Controller of Unisys Finance Corporation. Prior to that, Mr. Corcoran held positions of Corporate Tax Manager at Unisys Corporation; Controller, U.S. Operations of Lucas Industries, Inc.; Financial Analyst with Detroit Edison Company; and a Senior Accountant with KPMG Peat Marwick. Mr. Corcoran holds a B.S. in Business Administration from Wayne State University, an M.S. in Taxation from Walsh College, and is a Certified Public Accountant.\nDaniel L. Wieneke, 49, is Senior Vice President, General Counsel and Secretary of CIS Corporation. He has been employed at CIS Corporation since January 1992 and prior to that was Senior Vice President, General Counsel and Secretary of MetLife Capital Credit Corporation. Mr. Wieneke received a B.A. Degree from St. Mary's College and his Juris Doctor from William Mitchell College of Law.\nRobin A. Konicek, 38, is a Vice President of CIS Aircraft Partners, Inc. and is responsible for domestic and international aircraft marketing. She has been active in the financing, trading and management of aircraft since 1982. Prior to joining CIS in 1986, Ms. Konicek was a Vice President of Crocker Bank Airlines and Aerospace Group, with major responsibility for developing the U.S. market. She holds an A.B. from Stanford University and an M.B.A. from the University of California, Los Angeles.\nItem 11.","section_11":"Item 11. Executive Compensation No compensation was paid by the Partnership to the officers and directors of the General Partners. See Item 13 below for a description of the compensation and fees paid to the General Partners and their affiliates by the Partnership.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management As of the date hereof, no person is known by the Partnership to be the beneficial owner of more than five percent of the Units of the Partnership.\nThe Partnership has no directors or officers, and neither of the General Partners of the Partnership owns any Units. The Assignor Limited Partners for the Partnership, CIS Assignor L.P.A., Inc. (an affiliate of CAP), owns 5 Units.\nNone of the directors or officers of the General Partners owned any Units as of December 31, 1994.\nOther than as described herein, the Partnership knows of no arrangements, the operation of the terms 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 The General Partners and their affiliates received or will receive certain types of compensation, fees, or other distributions in connection with the operation of the Partnership. The fees and compensation were not determined by, and may not necessarily reflect, arm's length negotiations. None of the officers and directors of the General Partners received any compensation from the Partnership. The Shareholder Services Group provides partnership accounting and investor relations services for the Partnership. Prior to May 1993, these services were provided by an affiliate of a general partner. Transfer agent services and certain tax reporting services are provided by Service Data Corporation, an unaffiliated company. For additional information on fees paid to the General Partners and affiliates, reference is made to Note 6 of the Notes to the Financial Statements on page 10 of the Partnership's Annual Report to Unitholders for the year ended December 31, 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: Page Number\nBalance Sheets - December 31, 1994 and 1993 (1)\nStatements of Operations - For the years ended December 31, 1994, 1993 and 1992 (1)\nStatements of Partners' Capital (Deficit) - For the years ended December 31, 1994, 1993 and 1992 (1)\nStatements of Cash Flows - For the years ended December 31, 1994, 1993 and 1992 (1)\nNotes to Financial Statements (1)\nReport of Independent Public Accountants (1)\n(1) Incorporated by reference to pages 4 - 12 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994.\n\t2.\tFinancial Statement Schedules: No schedules are presented because the information is not applicable or is included in the Financial Statements or the notes thereto.\n\t3.\tExhibits\n(3) Articles of Incorporation and bylaws (Incorporated by reference to the Partnership's Prospectus filed with the Commission on April 17, 1987.)\n(4) Depositary Agreement (Incorporated by reference to Exhibit 4.5 to the Partnership's Registration Statement on Form S-1 filed with the Commission on April 17, 1987.)\n(10) Escrow Agreement (Incorporated by reference to Exhibit 10.12 to the Partnership's Registration Statement on Form S-1 filed with the Commission on April 17, 1987.)\n(13.1) Annual Report to Unitholders for the year ended December 31, 1994.\n(b) The Partnership filed no current reports on Form 8-K during the last quarter of the period covered on this Report.\nSIGNATURES \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.\nJETSTREAM II, L.P.\nBY: Jet Aircraft Leasing Inc. Administrative General Partner\nDate:\tMarch 28, 1995 BY: \/s\/ Moshe Braver Name: Moshe Braver Title: Director and President\nBY: CIS Aircraft Partners, Inc. Managing General Partner\nDate:\tMarch 28, 1995 BY: \/s\/ Thomas J. Prinzing Name: Thomas J. Prinzing Title: Director 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.\nCIS AIRCRAFT PARTNERS, INC. A General Partner\nDate:\tMarch 28, 1995 BY: \/s\/ Thomas J. Prinzing Thomas J. Prinzing Director and President\nDate:\tMarch 28, 1995 BY: \/s\/ Frank J. Corcoran Frank J. Corcoran Director, Vice President and Treasurer\nDate:\tMarch 28, 1995 BY: \/s\/ Daniel L. Wieneke Daniel L. Wieneke Director, 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.\nJET AIRCRAFT LEASING INC. A General Partner\nDate:\tMarch 28, 1995 BY: \/s\/ Moshe Braver Moshe Braver Director and President\nDate:\tMarch 28, 1995 BY: \/s\/ John Stanley John Stanley Vice President and Chief Financial Officer\nDate:\tMarch 28, 1995 BY: \/s\/ Andrew Falk Andrew Falk Vice President\n\tJetStream II, L.P. EXHIBIT 13.1\n\tJetStream II, L.P. 1994 Annual Report\nJetStream II, L.P. commenced operations in 1988, and was formed to acquire used commercial aircraft subject to triple net operating leases with commercial aircraft carriers. Since inception, limited partners have received cash distributions totalling approximately $13.44 per $20.00 limited partnership unit (\"Unit\"). The following table provides the quarterly cash distributions per Unit paid by the Partnership for the years ended December 31, 1994 and 1993.\nQuarter Declared 1994 1993\n1st Quarter $ .207 $ .325 2nd Quarter .286 .520 3rd Quarter .238 .180 4th Quarter .263 .185\nTOTAL $ .994 $ 1.210\nAdministrative Inquiries Performance Inquiries\/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: Chris Irrera - Financial Communications (800) 223-3464 (800) 223-3464\n\t Contents\n\t1\tMessage to Investors \t3\tPortfolio Review \t4\tFinancial Statements \t7\tNotes to Financial Statements 12 Report of Independent Public Accountants\nMessage to Investors\nPresented for your review is the 1994 Annual Report for JetStream II, L.P. (the \"Partnership\"). In this report, we provide a discussion of conditions in the airline industry and an update on the leasing status of the Partnership's aircraft.\nIndustry Overview Intense competition continued to dominate the U.S. airline industry during 1994. Ongoing fare wars and increased operating and maintenance costs inhibited any significant improvement in overall operating results for the industry which, despite showing some improvement from 1993, remained weak. The competitive environment and years of heavy losses have forced the major U.S. airlines to implement cost-cutting measures, including employee layoffs and the elimination of unprofitable routes, in an effort to improve cash flow, restore profitability and compete more effectively against low-cost, short-haul air carriers. While many industry analysts believe that conditions in the U.S. airline industry will improve gradually in the coming year as a result of the airlines' efforts to streamline operations, the level of improvement is expected to be modest. Additionally, efforts to increase passenger traffic, which was up approximately 3% in 1994 as compared to 1993, could be hindered by con cerns over flight safety and aircraft maintenance as well as the advent of new communications technologies, such as video conferencing, which have reduced the need for many business travelers to fly.\nThe leasing market for Stage 2 aircraft, such as the Partnership's, has also been severely impaired in recent years by the 1991 implementation of noise compliance regulations developed in accordance with the Airport Noise and Capacity Act of 1990. These regulations provide, among other things, phase-out and non-addition rules under which the number of Stage 2 aircraft operated by domestic carriers would be limited to 75% of 1990 base levels by the end of 1994, 50% of 1990 base levels by the end of 1996, and 25% of 1990 base levels by the end of 1998. Furthermore, opportunities for leasing Stage 2 aircraft abroad are limited primarily due to the age of the existing fleet and non-compliance with noise regulations. For example, Stage 2 aircraft are precluded from operating in many European countries which have implemented stringent Stage 3 noise regulations.\nThese conditions, combined with the recent trend of decreasing capacity in the domestic commercial aircraft fleet and the lingering oversupply of aircraft available for lease, have had a substantial and long lasting impact on the aircraft leasing industry and on residual aircraft values. These factors have also led to declines in market lease rates for aircraft in recent years, particularly older narrow-body Stage 2 models.\nPortfolio Update As we have discussed in recent reports, the remaining lease with Trans World Airlines (\"TWA\") for one of the Partnership's three 727-200 aircraft is scheduled to expire in April 1995. TWA currently pays a monthly lease rate of $32,500. While TWA retains the option of leasing the aircraft on a month-to-month basis subsequent to the upcoming lease expiration, it is uncertain at present whether the airline will exercise this option. The General Partners are currently attempting to locate a replacement lessee for the Partnership's two remaining 727-200 aircraft, which TWA returned to the Partnership after their leases expired in October and December 1994.\nIn the event efforts to re-lease any or all of the aforementioned aircraft are unsuccessful, the Partnership's future cash flow and, consequently, the level of cash available for distribution to limited partners will be reduced. Furthermore, even if the planes are re-leased, it will likely be at lower rates which would also have a negative impact on cash flow. Please refer to the Portfolio Review section on page 3 of this report for information on the leasing status of the Partnership's remaining aircraft.\nFinancial Results The following table summarizes the Partnership's financial results for the years ended December 31, 1994, 1993, 1992, 1991 and 1990. For additional information, please refer to the financial statements and notes to the financial statements beginning on page 4 of this report.\n1994 1993 1992 1991 1990\nRental Revenues $ 5,417,086 $ 5,112,882 $ 9,074,600 $11,324,311 $13,274,225 Write-down of Aircraft - 15,551,276 - - - Total Expenses 6,182,152 22,198,497 6,883,907 10,967,546 7,426,225 Net Income (Loss) (575,105)(14,797,472) 2,350,915 658,506(1) 6,220,691 Net Income (Loss) per Limited Partnership Unit(2) (0.12) (3.03) .48 .13(1) 1.27 Total Assets 27,689,193 33,618,546 57,722,748 65,480,570(1) 74,700,982 Partners' Capital 26,013,542 31,450,948 52,136,949 58,825,816(1) 69,283,800 Net cash provided by operating activities 6,612,97 5,591,459 7,848,774 9,960,224 12,186,863 Cash distributions per Unit(2)(3) .994 1.21 1.85 2.275 2.40\n(1) Includes a provision for loss of $3,742,302 on disposition of assets reflecting the February 13, 1992 sale of the Boeing 727-200 previously on lease to Pan Am.\n(2) 4,837,505 Units outstanding.\n(3) Distribution amounts are reflected in the year for which they are declared. The Partnership's fourth quarter cash distribution is paid in January of the following year.\n- Rental revenues for the year ended December 31, 1994 increased by approximately 6% from the year ended December 31, 1994, primarily due to the lease executed with Continental Airlines in February 1994.\n- The highly competitive and weakened conditions in the aircraft leasing industry have had a significant negative impact on the residual value of the Partnership's fleet of aircraft. It is the General Partners' belief that the total value has declined substantially. Accordingly, as of December 31, 1993, the General Partners reduced the carrying value of the aircraft by $15,551,276. Excluding the write-down, the Partnership would have recorded net income of $753,804 for the year ended December 31, 1993. The write-down is also the primary reason for the increase in total expenses during 1993.\nSummary The Partnership continues to be faced with an extremely difficult and competitive environment in the aircraft leasing industry. The General Partners' strategy is to try and maintain the Partnership's aircraft on-lease and generating revenue. Accordingly, our primary focus at this time is re-leasing the Partnership's two idle aircraft and the TWA aircraft subsequent to the expiration of its lease. However, in light of the limited leasing opportunities for Stage 2 aircraft as discussed above, there can be no assurances that such efforts will be successful. In the event efforts to re-lease the aircraft are unsuccessful, the General Partners will pursue other alternatives including the possible sale of the aircraft.\nSince the total return from your investment in the Partnership is dependent upon the aircrafts' ultimate selling prices, declines in residual values have had an adverse impact on your investment. The future performance of the Partnership will be dependent upon the General Partners' ability to keep the remaining aircraft on-lease, which, in turn, is dependent on the strength of the airline industry and the stabilization of the supply and demand for aircraft. We will update you on the status of our efforts to re-lease the Partnership's aircraft in forthcoming reports.\nVery truly yours,\nJet Aircraft Leasing Inc.\t\tCIS Aircraft Partners, Inc. A General Partner A General Partner \t\t \/s\/Moshe Braver \/s\/Thomas J. Prinzing Moshe Braver Thomas J. Prinzing President President\nMarch 28, 1995\nPorfolio Review\nFollowing is a review of lease activity during 1994:\n- Continental Airlines - In February 1994, an agreement was reached to re-lease the Partnership's MD-80 Series aircraft with Continental for a term of four years. The lease agreement, which commenced March 15, 1994, requires Continental to make monthly lease payments to the Partnership of $180,000. In conjunction with the execution of the lease agreement, the Partnership agreed to loan the airline up to $600,000 to perform modification work on the aircraft. On June 7, 1994, the Partnership made its first advance to Continental, in the amount of $302,525. The financing is repayable on a monthly basis over the life of the lease at an interest rate of 8% per annum.\n- Delta Airlines - In May 1994, Delta extended its lease for the Partnership's 737-200 advanced aircraft through December 1996. Delta pays the Partnership a monthly lease rate of $95,000. Under the terms of the lease, Delta has the option of returning the aircraft prior to the lease expiration provided it gives the Partnership seven months notice. To date, Delta has not given the Partnership notice of its intent to return the aircraft. As a result, the aircraft will remain on lease with Delta through at least October 1995.\n- Northwest Airlines - Lease extensions were executed with Northwest in October 1994 for the Partnership's three DC-9-30 aircraft. Under the extended leases, which expire in January 1996 for two aircraft and April 1996 for the third, Northwest will continue to make monthly lease payments to the Partnership of $35,000 per aircraft.\n- TWA - The leases with TWA for the Partnership's three 727-200 aircraft expired in September and October 1994. While the General Partners reached an agreement with TWA to extend the leases for all of the aircraft at a reduced monthly lease rate of $32,500 per aircraft, two of the extensions were short-term and expired on October 31, 1994 and December 19, 1994, respectively. Both aircraft were subsequently returned to the Partnership and are currently in storage. The lease for the third aircraft was extended through April 1995, with TWA retaining the option of leasing the aircraft thereafter on a month to month basis. The General Partners are currently exploring the potential of re-leasing the idle 727-200 aircraft with another airline. However, in light of the continued difficulties in the aircraft leasing industry, there can be no assurance that such efforts will be successful. In the event that efforts to re-lease the aircraft are unsuccessful, the General Partner may pursue a sale of the aircraft.\nThe following table highlights the Partnership's portfolio of aircraft as of December 31, 1994 and includes estimated market values as of that date. Estimated Aircraft Model Acquisition Market Lease Noise Year Delivered Lessee Cost(1) Value(2) Expiration(3) Compliance\nMD-80 Series Continental $27,313,020 $17,500,000 3-15-98 Stage 3 DC-9-30 Northwest 7,230,460 1,600,000 4-21-96 Stage 2 DC-9-30 Northwest 7,230,460 1,600,000 1-31-96 Stage 2 DC-9-30 Northwest 7,230,461 1,600,000 1-31-96 Stage 2 B-737-200 ADV Delta 14,380,390 4,500,000 12-15-96 Stage 2 B-727-200 N\/A(4) 5,451,231 500,000 N\/A Stage 2 B-727-200 N\/A(4) 5,451,231 500,000 N\/A Stage 2 B-727-200 TWA 5,451,231 500,000 4-30-95 Stage 2\n(1) Includes a 1.5% fee paid to the Managing General Partner at the acquisition of the aircraft.\n(2) Estimated market values for the aircraft are based upon several factors including independent appraisals, third party publications, the General Partners' own experience and the unique circumstances regarding the equipment and the lessees. These estimates are subject to a variety of assumptions. Additionally, there can be no assurance that the Partnership would receive an amount equal to the market value shown above upon the sale of any of the aircraft.\n(3) Lease expiration dates do not include renewal options.\n(4) Reference is made to the discussion above regarding the idle status of the two aircraft previously on-lease with TWA.\nFinancial Statements\nBalance Sheets December 31, 1994 and 1993\nAssets 1994 1993\nAircraft, at cost $28,843,000 $28,843,000 Less-accumulated depreciation 5,451,744 -\n23,391,256 28,843,000\nCash and cash equivalents 2,978,631 1,104,004 Restricted cash 1,047,475 3,639,699 Accounts receivable 9,941 - Loan receivable 260,975 - Interest receivable 915 9,769 Prepaid expenses - 22,074\nTotal Assets $27,689,193 $33,618,546\nLiabilities and Partners' Capital\nLiabilities: Accounts payable and accrued expenses $ 225,886 $ 198,094 Maintenance payable - 750,000 Distribution payable 1,288,932 904,004 Deferred revenue 160,833 315,500\nTotal Liabilities 1,675,651 2,167,598\nPartners' Capital (Deficit): General Partners (706,374) (652,000) Limited Partners (4,837,505 units outstanding) 26,719,916 32,102,948\nTotal Partners' Capital 26,013,542 31,450,948\nTotal Liabilities and Partners' Capital $27,689,193 $33,618,546\nStatements of Partners' Capital (Deficit) For the years ended December 31, 1994, 1993 and 1992\nLimited General Total Partners' Partners' Partners' Capital (Deficit) Capital\nBalance at January 1, 1992 $59,204,066 $ (378,250) $58,825,816 Net Income 2,327,406 23,509 2,350,915 Cash distributions (8,949,384) (90,398) (9,039,782)\nBalance at December 31, 1992 52,582,088 (445,139) 52,136,949 Net Loss (14,649,497) (147,975) (14,797,472) Cash distributions (5,829,643) (58,886) (5,888,529)\nBalance at December 31, 1993 32,102,948 (652,000) 31,450,948 Net Loss (569,354) (5,751) (575,105) Cash distributions (4,813,678) (48,623) (4,862,301)\nBalance at December 31, 1994 $26,719,916 $ (706,374) $26,013,542\nStatements of Operations For the years ended December 31, 1994, 1993 and 1992\nIncome 1994 1993 1992\nRental $ 5,417,086 $ 5,112,882 $ 9,074,600 Interest 134,581 148,444 160,222 Other (Note 4) 55,380 2,139,699 -\nTotal Income 5,607,047 7,401,025 9,234,822\nExpenses\nDepreciation 5,451,744 5,980,380 5,994,682 Management fees 479,773 388,374 415,129 General and administrative 193,698 193,780 449,114 Operating 56,937 84,687 24,982 Write-down of aircraft (Note 2) - 15,551,276 -\nTotal Expenses 6,182,152 22,198,497 6,883,907\nNet Income (Loss) $ (575,105) $(14,797,472) $ 2,350,915\nNet Income (Loss) Allocated:\nTo the General Partners $ (5,751) $ (147,975) $ 23,509 To the Limited Partners (569,354) (14,649,497) 2,327,406\n$ (575,105) $(14,797,472) $ 2,350,915\nPer limited partnership unit (4,837,505 outstanding) $ (0.12) $ (3.03) $ 0.48\nStatements of Cash Flows For the years ended December 31, 1994, 1993 and 1992\nCash Flows from Operating Activities: 1994 1993 1992\nNet income (loss) $ (575,105) $(14,797,472) $ 2,350,915 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 5,451,744 5,980,380 5,994,682 Write-down of aircraft - 15,551,276 - Restricted cash 2,592,224 1,246,478 - Increase (decrease) in cash arising from changes in operating assets and liabilities: Accounts receivable (9,941) - - Interest receivable 8,854 (2,891) 15,833 Prepaid expenses 22,074 (18,654) 608 Accounts payable and accrued expenses 27,792 (97,761) 63,247 Maintenance payable (750,000) (2,011,177) - Deferred revenue (154,667) (258,720) (576,511)\nNet cash provided by operating activities 6,612,975 5,591,459 7,848,774\nCash Flows from Investing Activities:\nLoan receivable (260,975) - - Proceeds from sale of aircraft - net - - 485,000\nNet cash provided by (used for) investing activities (260,975) - 485,000\nCash Flows from Financing Activities:\nCash distributions (4,477,373) (6,939,072) (9,772,738)\nNet cash used for financing activities (4,477,373) (6,939,072) (9,772,738)\nNet increase (decrease) in cash and cash equivalents 1,874,627 (1,347,613) (1,438,964) Cash and cash equivalents at beginning of period 1,104,004 2,451,617 3,890,581\nCash and cash equivalents at end of period $ 2,978,631 $ 1,104,004 $ 2,451,617\nSee accompanying notes to the financial statements.\nNotes to Financial Statements December 31, 1994, 1993 and 1992\n1. Organization JetStream II, L.P. (\"the Partnership\"), a Delaware limited partnership was formed on October 15, 1987, for the purpose of acquiring and leasing used commercial aircraft. The Managing General Partner of the Partnership is CIS Aircraft Partners, Inc. (\"CIS\"), a third-tier, wholly owned subsidiary of Continental Information Systems Corporation. The Administrative General Partner is Jet Aircraft Leasing, Inc. (\"JAL\"), formerly Hutton Aircraft Leasing, Inc., an affiliate of Lehman Brothers Inc.\nOn July 31, 1993, Shearson Lehman Brothers Inc. sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson Lehman Brothers Inc. changed its name to Lehman Brothers Inc. (\"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 October 22, 1993, the Hutton Aircraft Leasing, Inc. General Partner changed its name to delete any reference to Hutton.\nUpon formation of the Partnership, the General Partners each contributed $500, and the initial Limited Partner contributed $100 for five limited partner units. An additional 4,837,500 limited partnership depositary units were then sold at a price of $20.00 per unit. The Partnership had an interim closing on January 14, 1988 and a final closing on February 24, 1988, and received gross offering proceeds of $96,750,000.\nThe Partnership is required to dissolve and distribute all of its assets no later than December 31, 2027. The Partnership may reinvest the proceeds from sales of aircraft occurring prior to February 24, 1999. Thereafter, the net proceeds of any sales of aircraft will be distributed to the partners.\nTitle to the leased aircraft owned by the Partnership is held by nonaffiliated trusts of which the Partnership is the beneficiary. The purpose of this method of holding title is to satisfy certain registration requirements of the Federal Aviation Administration.\n2. Significant Accounting Policies\nAccounting Method. The Partnership maintains its accounting records, prepares financial statements and files its tax returns on the accrual basis of accounting.\nCash and Cash Equivalents. Cash equivalents consist of highly liquid debt instruments purchased with a maturity of three months or less from the date of purchase.\nRestricted Cash. Restricted cash consists of funds the General Partner believes will be incurred by the Partnership to comply with regulatory and maintenance requirements.\nMaintenance Reserve. Funds One of the Partnership's operating leases, Continental Airlines, Inc. (\"Continental\"), required the lessee to make specified payments to maintenance reserve funds administered by the Partnership. The Partnership reimbursed the lessee for specified maintenance costs out of the reserve funds to the extent there were sufficient funds available. Reimbursements, if any, were made upon submission of appropriate evidence documenting the maintenance costs incurred by the lessee. The Partnership paid interest earned on the balance of the reserve funds at a specified rate (90-day Chase Rate) to the lessee. This interest rate was 3.00% at December 31, 1992.\nAircraft and Depreciation. The aircraft were recorded at cost, which includes acquisition costs. Through December 31, 1993, depreciation to an estimated salvage value of 10% was computed using the straight-line method over an estimated average economic life of 12 years for all aircraft owned by the Partnership. Beginning in 1994, depreciation was computed using the straight-line method over an estimated remaining economic life of two to six years for all aircraft owned by the Partnership.\nThe highly competitive and weakened conditions in the aircraft leasing industry have had a significant and negative impact on the residual value of the Partnership's fleet of aircraft. It is the General Partners' belief that the total value of the Partnership's fleet of aircraft has declined substantially. The General Partners' estimated market values for the aircraft, as of December 31, 1993, is based upon independent appraisals, third-party publications, the General Partners' own experience and the unique circumstances regarding the equipment and the Lessee. Accordingly, the General Partners reduced the carrying value of the Partnership's fleet by $15,551,276 and, therefore, established a new cost basis of $28,843,000 at December 31, 1993.\nImprovements to aircraft required to comply with regulatory requirements will be capitalized when incurred and depreciated over the useful life of the improvement.\nOperating Leases. The aircraft leases are accounted for as operating leases. Lease revenues are recognized over the terms of the related leases.\nDeferred Revenue. Some of the Partnership's operating leases require rental payments to be paid in advance. Rental payments received in advance are deferred and then recognized as income when earned.\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 (Note 7).\n3. Partnership Allocations\nThe Partnership Agreement (\"Agreement\") substantially provides the following:\nCash Distributions Cash flow from operations, at the discretion of the General Partners, will be distributed on a quarterly basis, 99% to the Limited Partners and 1% to the General Partners. Cash flow is defined in the Partnership Agreement as including cash receipts from operations and interest income earned, less expenses incurred and paid in connection with the operation and ownership of the aircraft. Distributable proceeds from sales of aircraft in liquidation of the Partnership will be distributed in accordance with the partners' capital accounts after all allocations of income and losses.\nAllocation of Income and Losses Generally, income and losses for any year are allocated 99% to the Limited Partners and 1% to the General Partners. Gains on sales of aircraft shall first be allocated to the General Partners until they have been allocated an amount of gain equal to the lesser of their respective deficit account balances or 1.01% of all capital contributions by Limited Partners. Any additional gain recognized by the Partnership upon the sale of aircraft shall be allocated 99% to the Limited Partners and 1% to the General Partners.\nDissolution of Partnership If, upon dissolution of the Partnership, the General Partners have a negative Capital account, they shall contribute capital equal to the lesser of their respective capital deficit account balances or 1.01% of all capital contributed by the Limited Partners.\n4. Aircraft under Operating Leases\nTrans World Airlines, Inc. On January 15, 1988, the Partnership acquired three Boeing 727-200 aircraft for a total purchase price of $16,353,693. These aircraft are subject to operating leases with Trans World Airlines, Inc. (\"TWA\"), the terms of which were amended on May 31, 1991. The original leases required monthly payments in advance for each of the aircraft, which were equal to $82,000 through July 1, 1989, and $100,000 thereafter through the remainder of the lease. The amendment provides for a reduction of rent to $55,000 per month (subject to certain required maintenance checks), commencing June 1, 1991 and continuing through July 31, 1993, for two aircraft and August 31, 1993 for the third aircraft. The amendment further required that rent for the period June 1, 1991 through May 31, 1992 be prepaid using a discount rate of 6% and thereafter quarterly in advance. On January 31, 1992, TWA filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. In Au gust 1993, the General Partners and TWA agreed to amend the original leases. As a result, TWA paid the Partnership rent of $40,000 per month per aircraft in advance quarterly commencing September 1, 1993 and continuing through September 30, 1994, for two aircraft and October 31, 1994 for the third aircraft.\nOn September 30, 1994, TWA agreed to extend the lease on one of the aircraft to April 30, 1995. Thereafter, TWA may continue to lease the aircraft on a month-to-month basis. The leases for the two remaining aircraft were extended on a short-term basis and expired on October 31, 1994 and December 19, 1994. The aircraft were returned to the Partnership in the fourth quarter of 1994. Pursuant to the lease extension agreement, the rental rates have been reduced to $32,500 per month per aircraft paid in advance.\nPan American World Airways, Inc. On February 13, 1992, the Partnership sold the Boeing 727-200 previously on lease to Pan Am. The gross proceeds from the sale totaled $500,000, which resulted in a loss of $3,742,302. This loss was reflected as a reserve for loss on disposition of aircraft as of December 31, 1991.\nNorthwest Airlines, Inc. The Partnership acquired three McDonnell Douglas DC-9-30 aircraft for a total purchase price of $21,691,381. These aircraft are subject to operating leases with Northwest Airlines, Inc. (\"Northwest\"). The first aircraft was acquired on January 20, 1988. Rental payments for this aircraft were due monthly in advance in the amount of $110,000 through November 1990, $97,417 for one month and $95,000 during the remainder of the term of the lease, which expired in November 1992. The remaining two aircraft were acquired on February 25, 1988. Rental payments for each of these aircraft were due monthly in advance in the amount of $95,000 and $93,000, respectively, through the terms of the leases, which expired in November 1992 and December 1992, respectively. On October 28, 1992, the General Partners and Northwest agreed to extend the lease agreements for the three aircraft from November 1, 1992 (two aircraft) and December 21, 1992 (for the third aircraft) to Augu st and September, 1993, and January, 1994, respectively. Under the amended lease agreements, Northwest's monthly payments were reduced to $42,000 per plane. Lease extensions were executed with Northwest in late December 1993 for the Partnership's three DC-9-30 aircraft. Under the lease extensions, which were scheduled to expire in January 1995 for two aircraft and April 1995 for the third, Northwest made monthly lease payments to the Partnership of $35,000 per aircraft.\nIn October 1994, Northwest Airlines exercised its option to extend their current lease agreements by one year. The new expiration dates are January 1996 for two aircraft and April 1996 for the third aircraft. The monthly lease payments remain at $35,000 per aircraft, paid in advance.\nDelta Air Lines, Inc. On February 25, 1988, the Partnership acquired a Boeing 737-200 advanced aircraft for a total purchase price of $14,380,390. This aircraft is subject to an operating lease with Delta Air Lines, Inc. (\"Delta\"). Under the original terms of the lease, rental payments in the amount of $170,000 per month were required to be paid monthly in advance through September 1992. In September 1992, the General Partners and Delta agreed to amend the original lease. The amendment provided for a reduction of rent to $95,000 per month through the expiration date in December 1994. However, in early May 1994, Delta exercised its option to extend the lease for a term of two years from the previous expiration date, with the remaining terms of the lease unchanged. Under the terms of the lease, Delta has the option of returning the aircraft prior to the lease expiration provided it gives the Partnership seven months notice. To date, Delta has not given the Partnership notice of it s intent to return the aircraft. As a result, the aircraft will remain on lease with Delta through at least October 1995.\nContinental Airlines, Inc. On January 26, 1988, the Partnership acquired a McDonnell Douglas MD-80 Series aircraft for a total purchase price of $27,313,020. This aircraft was subject to an operating lease with Continental Airlines, Inc. (\"Continental\"), the term of which expired on April 28, 1993. Rental payments were to be made monthly in advance, with adjustment (upward or downward) made semiannually based on the six-month London Interbank Offered Rate (\"LIBOR\") at the time of adjustment. The base rental payment was initially $210,000 per month and decreased to $190,000 per month in May 1991. Monthly rental amounts were $168,720 as of April 28, 1993 and December 31, 1992.\nThe prior lease agreement with Continental provided that upon the expiration of the lease, the amounts remaining in the maintenance reserve funds are to be retained by the Partnership. Therefore, $2,139,699 was recognized as Other Income in the accompanying Statements of Operations during 1993, with the balance of $750,000 distributed to Continental in accordance with the terms of a new lease dated February 1994.\nOn February 9, 1994, Continental entered into a new lease agreement. The agreement between Continental and the Partnership provides for Continental to lease the plane for a term of four years. Effective March 15, 1994, Continental shall pay $180,000 per month in advance. In addition, the Partnership made a onetime payment of $750,000 in March 1994 to perform various maintenance work on the plane. Also, the Partnership has agreed to provide up to $600,000 of financing to Continental to perform modification work on the aircraft, including advanced avionics, interior furnishings and exterior paint. The modification financing is repayable over the life of the lease at an interest rate of 8% per annum for advances made before February 1, 1996, and with respect to advances made after February 1, 1996, a rate per annum equal to the yield to maturity of United States Treasury Notes having a maturity closest to the remaining term of the lease, plus 4.25 percent. On June 7, 1994, the Partner ship made its first advance to Continental in the amount of $302,525.\nThe aircraft leases are triple net operating leases, requiring the lessees to pay substantially all expenses associated with the aircraft during the term of the leases.\nRevenues from each of the airlines as a percentage of the Partnership's total rental revenues are as follows:\nPercent of Rental Revenues\nAirline 1994 1993 1992\n\tNorthwest \t23.4%\t29.3%\t34.9% TWA 24.0 35.2 21.8 \tContinental\t31.6\t13.2\t23.7 Delta 21.0 22.3 19.6\nThe following is a schedule, by year, of future minimum rental income under the leases as of December 31, 1994.\n\tYear \t\t\tAmount\n1995 $ 4,690,000 1996 3,452,000 1997 2,160,000 1998 450,000\nTotal $10,752,000\nThe above schedule of future minimum rental income is based on the existing terms of the leases and does not include the rental income that may result from the renewal of existing leases or the re-leasing of the aircraft, if any.\n5. Distributions\nDistributions paid or payable aggregated $4,862,301 (approximately $1.00 per unit), $5,888,529 (approximately $1.21 per unit) and $9,039,782 (approximately $1.85 per unit) for the years ended December 31, 1994, 1993 and 1992, respectively, of which $500,000 in 1992 represented proceeds from sale of aircraft. As of December 31, 1994, the Partnership had declared a distribution of $1,288,932, of which $1,276,043 (approximately $.26 per unit) was paid to the Limited Partners and $12,889 was paid to the General Partners on February 2, 1995.\n6. Transactions with Affiliates\nCash. Cash reflected on the Partnership's balance sheet at December 31, 1994 was on deposit with an affiliate of the General Partner. Cash reflected on the Partnership's balance sheet on December 31, 1993 was on deposit with an unaffiliated party.\nBase Management Fee. The General Partners received a quarterly fee subordinated to the Limited Partners receiving their Preferred Return (8% simple interest per annum cumulative, but not compounded), in an amount generally equal to 1.5% of gross aircraft rentals. Of this amount, 1.0% is payable to CIS and .5% is payable to JAL. During the years ended December 31, 1994, 1993 and 1992, the general partners earned base management fees of $78,412, $74,999 and $135,849, respectively. Of these fees, $19,721, $14,634 and $28,438 were unpaid at December 31, 1994, 1993 and 1992, respectively.\nIncentive Management Fee. CIS received a quarterly fee of 4.5% of quarterly cash flow (prior to July 14, 1992, the fee was 2.15%) subordinated to the Limited Partners receiving their Preferred Return. During the years ended December 31, 1994, 1993 and 1992, CIS earned incentive management fees of $211,763, $200,395, and $261,273, respectively. Of these fees, $58,213, $42,520 and $78,893 were unpaid at December 31, 1994, 1993 and 1992, respectively.\nRe-lease Fee. The General Partners receive a quarterly fee subordinated to the Limited Partners receiving their Preferred Return, for re-leasing aircraft or renewing a lease in an amount equal to 3.5% of the gross rentals from such re-lease or renewal for each quarter for which such payment is made. Of this amount, 2.5% is payable to CIS, and 1.0% is payable to JAL. During the years ended December 31, 1994, 1993 and 1992, the General Partners earned base management fees of $189,598, $112,980 and $18,007, respectively. Of these fees, $47,685, $35,385 and $16,345 were unpaid at December 31, 1994, 1993 and 1992.\nResale Fee. CIS will receive a subordinated fee with respect to each aircraft sold by the Partnership in an amount equal to the lesser of (i) 3% of the contract sales price of the aircraft or (ii) an amount that is competitive with fees charged by nonaffiliates rendering comparable services. Such fee will be reduced (but not below zero) for any resale fees or commissions payable to third parties. During 1992, $15,000 was accrued based on 3% of the sale proceeds totalling $500,000 from the sale of one Boeing 727-200. The resale fee is subordinate to the Limited Partners receiving a priority return equal to their contribution plus their preferred return. No resale fees were earned during 1994 or 1993.\nGeneral and Administrative Expenses. Under the terms of the Partnership Agreement, the Partnership reimburses the Administrative 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 $42,811, $42,311 and $46,101, respectively. At December 31, 1994, 1993 and 1992, $20,653, $22,588 and $23,400, respectively, were due to the Administrative General Partner for the performance of these services.\n7. Reconciliation of Difference between Net Income (Loss) in the Financial Statements (Accrual Basis - Generally Accepted Accounting Principles) and Net Loss in the Partnership's Tax Return\n1994 1993 1992\nNet income (loss), as reported $ (575,105) $(14,797,472) $ 2,350,915\nAdjustments- Write-down of Aircraft - 15,551,276 - Loss on sale of asset - - (1,121,603) Deferred revenue (154,667) (258,720) (576,511) Maintenance reserve fund (Note 2) (750,000) (2,011,177) 177,265 Depreciation differential between the Modified Accelerated Cost Recovery System and depreciation for financial reporting purposes (1,663,457) (1,130,307) (1,405,529) Legal fees, net of amortization (5,297) (5,528) 10,825 Prepaid Insurance 22,074 (18,654) 608\nTotal adjustments (2,551,347) 12,126,890 (2,914,945)\nNet loss, per the Partnership's tax return $(3,126,452) $ (2,670,582) $ (564,030)\nThe net loss determined on the income tax basis is allocated to the partners as follows:\nLimited partners (4,837,505 units) $(3,095,187) $ (2,643,876) $ (558,390) General partners (31,265) (26,706) (5,640)\n$(3,126,452) $ (2,670,582) $ (564,030)\nTaxable loss per limited partner unit $ (0.64) $ (0.55) $ (0.12)\nReport of Independent Public Accountants\nTo the Partners of JetStream II, L.P.:\nWe have audited the accompanying balance sheets of JetStream II, L.P. (a Delaware 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 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, the financial statements referred to above present fairly, in all material respects, the financial position of JetStream II, 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.\n\t\t\tARTHUR ANDERSEN LLP\nBoston, Massachusetts January 20, 1995","section_15":""}
{"filename":"822419_1994.txt","cik":"822419","year":"1994","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nContel Cellular Inc. (the \"Company\"), through its subsidiaries and through partnerships, provides or participates in the provision of cellular telephone service in various metropolitan statistical areas (\"MSAs\") and rural service areas (\"RSAs\") throughout the United States. As of March 13, 1995, the Company had interests in cellular telephone systems in the United States representing approximately 23.9 million \"POPs\". (\"POPs\" refer to the population of a market area multiplied by the Company's percentage ownership in the cellular system serving that market).\nThe Company was incorporated in Delaware on September 24, 1980, but did not commence operations as a cellular communications provider until February 1984. The Company is a ninety percent (90%) owned, indirect subsidiary of GTE Corporation (\"GTE\"), the fourth-largest publicly held telecommunications company in the world.\nIn addition to the Company, GTE has a wholly-owned subsidiary, GTE Mobilnet Incorporated (\"GTE Mobilnet\"), which provides cellular service throughout the United States. The management, operations and properties of the Company and GTE Mobilnet remain independent and separate. Shareholders of the Company do not have an interest in the properties owned by GTE Mobilnet.\nThe Company's corporate headquarters is located at 245 Perimeter Center Parkway, Atlanta, Georgia 30346, and its phone number is (404) 804-3400.\nOn December 27, 1994, the board of directors of the Company (the \"Board of Directors\") approved an Agreement and Plan of Merger (as amended, the \"Merger Agreement\") pursuant to which Contel Cellular Acquisition Corporation, a Delaware corporation (\"CCI Acquisition\") and an indirect wholly owned subsidiary of GTE, will be merged into and with the Company (the \"Merger\"). In the Merger, (i) each outstanding share of the Class A Common Stock of the Company, par value $1.00 per share (each a \"Class A Share\") (other than Class A Shares as to which appraisal rights have been properly exercised under the Delaware General Corporation Law), will be converted into the right to receive $25.50 in cash, without interest, subject to back-up withholding taxes (the \"Merger Consideration\"), (ii) each Class A Share held by the Company and each outstanding share of the common stock of CCI Acquisition will be cancelled, and no payment will be made with respect thereto and (iii) each outstanding share of the Class B Common Stock of the Company, par value $1.00 per share (each a \"Class B Share\"), will continue to be outstanding.\nThe Company anticipates that the Merger will be completed on or about April 28, 1995. As a result of the Merger, there will cease to be any public market for the Class A Shares, and after the filing of a certificate of merger with the Secretary of State of the state of Delaware (\"Effective Time\"), the Class A Shares will cease to be quoted on the Nasdaq National Market. When the Merger occurs, the Company, who will be the corporation that survives the Merger (the \"Surviving Corporation\") is expected to file with the Securities Exchange Commission (the \"Commission\") a Certification and Notice of Termination of Registration of the Class A Shares under the Securities Exchange Act of 1934 (the \"Certification\"). Upon filing of the Certification, the Surviving Corporation will no longer be required to file reports and other information under the Securities Exchange Act of 1934 (the \"Exchange Act\"). Once the Certification has been filed, the Exchange Act (including the proxy solicitation provisions of Section 14(a), the periodic reporting requirements of Section 13 and the short swing trading provisions of Section 16(b)) will no longer apply to the Surviving Corporation. Additionally, upon the termination of the registration of the Class A Shares, the shares will no longer constitute \"margin securities\" under the regulations of the Board of Governors of the Federal Reserve System.\nThe Company's 23.9 million POPs include cellular systems which the Company controls or manages and cellular systems operated by partnerships in which the Company is not the controlling partner. As of March 13, 1995, approximately 19.5 million of the Company's 23.9 million POPs were located in 59 MSAs. The Company owned a controlling interest in and managed cellular systems servicing 32 of these 59 MSAs (representing approximately 69% of the Company's MSA POPs). The Company owned a non-controlling interest in cellular systems servicing the remaining 27 MSAs.\nThe remaining 4.4 million of the Company's 23.9 million POPs were located in 52 RSAs. As of March 13, 1995, the Company owned controlling interests in entities licensed to provide cellular service in 24 RSAs, owned non-controlling interests in and managed 10 RSA markets and held non-controlling interests\nin 18 RSAs. Most of the Company's RSA POPs are in areas adjacent to MSAs currently served by the Company.\nCELLULAR INTERESTS\nThe Company's controlled MSA interests, non-controlled MSA interests, controlled RSA interests, managed, non-controlled RSA interests and non-controlled RSA interests as of December 31, 1994 are set forth below.\n--------------- (1) Population figures are derived from the 1994 Donnelly marketing population estimates for counties comprising MSAs and RSAs as defined by the Federal Communications Commission.\nTHE CELLULAR TELEPHONE INDUSTRY\nBackground. In 1983, the Federal Communications Commission (the \"FCC\") issued the first license to provide cellular telephone service in the United States. Since that time, cellular telephone service has become available to all 305 MSAs and 428 RSAs and is available to most of the population of the United States.\nCellular telephone service was developed as a response to the shortcomings of conventional mobile telephone systems. By providing high quality, high capacity communication to and from vehicle-mounted telephones (\"mobiles\") and hand-held radio telephones (\"portables\"), the cellular telephone industry has grown at a very rapid pace and, as of year-end 1994, exceeded 22 million subscribers. In 1994, the cellular telephone industry recorded an overall growth rate of approximately 37%.\nTechnology. Cellular telephone service achieves its high quality and capacity capability by dividing the radio spectrum allocated to it by the FCC into smaller groups or \"sets\" of frequencies and re-using those frequencies many times in geographically distant parts of the network. Each set of frequencies is allocated to a specific geographic area called a \"cell.\" Adjacent cells must use a different set of frequencies to avoid cell-to-cell frequency interference. Cells which are sufficiently distant from one another may use the same frequencies because the radio signals naturally decay over distance until they reach a low enough level that does not cause interference. Therefore, by use of frequency planning techniques, the radio spectrum allocated to a cellular provider can be re-used many times in various parts of the system to achieve high overall call capacities and very low call interference rates.\nThe cells in a system are connected to a computer-controlled switch called a mobile telephone switching office (\"MTSO\"). The MTSO monitors all calls to all cell sites within the system and routes them to their intended destinations. Once a call request is received, it is directed to the cell site where the signal strength is greatest, and is then continuously monitored for quality signal strength. If the signal strength begins to decline as a vehicle travels through the radio coverage area of one cell, the MTSO recognizes the cell which is getting weaker in signal strength and which is the next cell in the path of the vehicle where signal strength is increasing. At the appropriate point in time, the MTSO instructs the new cell to take over the call and the original cell to release the call. This allows an in-process call to achieve a cell-to-cell handoff with no interruption in the conversation. The MTSO is capable of achieving this handoff as many times as necessary for each call.\nToday's cellular systems utilize digital switching equipment, digital connections between the switch and the cells, and analog radio frequency (\"RF\") technology between the cells and the mobile units. The analog RF technology is limited because a finite number of channels can be used at any one cell within a system without causing system problems. The capacity of the system can be increased in areas with heavy call traffic by either cell splitting or cell sectoring. Cell splitting involves constructing numerous cells to serve the coverage area of the original cell. If a large cell is split into four smaller cells, the total channels available within the original coverage area is increased up to four times. Cell sectoring is accomplished by replacing a cell's omni-directional antennas with either three or six directional antennas. This allows for different sets of channels to be used in each sector. The advantage of this method is that capacity can be increased in the cell without increasing system interference and that the same frequency sets can be reused at closer spacing.\nThe cellular telephone industry is moving toward implementing digital RF technology in existing cellular systems. Two technologies are currently under consideration by major cellular providers -- Time Division Multiple Access (\"TDMA\") and Code Division Multiple Access (\"CDMA\"). Either technology will offer a considerable capacity increase over today's technology.\nMarket Structure. Historically, FCC regulations provided that licenses would be granted to two cellular service providers in each MSA and RSA; a wireline licensee and a non-wireline licensee. Each of the two licensees has 25 MHz of radio spectrum allocated to it, and each further subdivides this spectrum into 415 two-way channels. Each license is granted for a period of ten years and is subject to renewal at the end of that period. FCC rules require all cellular system operators to provide, on a nondiscriminatory basis, cellular\nservice to resellers who may purchase blocks of numbers at a wholesale rate and resell such service to the public.\nThe FCC is in the process of auctioning additional licenses for the provision of personal communications services in the 1.8 GHz to 1.99 GHz frequency band. These auctions will not be completed until later this year and will result in new licensees in each of the Company's service areas. The first part of the auction was completed on March 13, 1995, and resulted in the purchase of 99 licenses by 18 entities. A GTE subsidiary, GTE Macro Communications Corporation, purchased four licenses (Atlanta, Seattle, Cincinnati and Denver).\nTHE COMPANY'S CELLULAR OPERATIONS\nGeneral. The Company, or partnerships which the Company controls or manages, provides cellular service in 32 MSAs and 34 RSAs (\"Company Controlled Systems\" or \"Company Controlled Markets\"). Company Controlled Systems represent approximately 72% of the Company's total POPs. The information provided below with respect to the Company's cellular operations applies only to the Company Controlled Systems because these are the only systems whose operations the Company controls. The Company's non-controlled cellular interests are described below in \"Non-Controlled Systems.\"\nThe Company obtained the right to provide cellular service in the Company Controlled Markets either (i) as the result of the FCC's licensing process, or (ii) through an acquisition program. Since the Company was an affiliate of a wireline telephone company, it had the right to apply for the wireline cellular license in any area served by its landline affiliate. As a result of this licensing process, the Company is the wireline licensee in 43 Company Controlled Markets (approximately 8.7 million POPs). As a result of its acquisition program, the Company is the non-wireline licensee in 23 Company Controlled Markets (approximately 8.6 million POPs).\nIn acquiring and developing these cellular telephone systems, the Company has utilized a strategy of focusing on coastal and sun belt areas where the Company believes the demographics and business climate are favorable to the development of cellular systems. In addition, the Company has attempted to develop cellular systems in regional clusters of significant size.\nThe cellular telephone systems originally licensed to the Company as part of the FCC licensing process for MSAs and RSAs are generally located in 5 geographic areas: Virginia, California, the Midwest, Texas\/New Mexico, and the Gulf of Mexico. The cellular telephone systems acquired by the Company are located in Tennessee, Alabama and Kentucky.\nAcquisitions and Divestitures. To further its strategy of acquiring and developing large regional clusters in economically strong areas, the Company has developed and followed a program of selling certain properties which are not strategically located and purchasing certain other properties which are strategic. For a description of certain acquisitions and divestitures by the Company in 1994 see \"ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Acquisitions and Dispositions of Interests in Cellular Systems.\" After such acquisitions and dispositions described above, the Company will provide or participate in the provision of cellular services in 56 MSA markets and 49 RSA markets with total combined POPs of approximately 23.3 million.\nCellular Exchange Transaction. The Company, GTE Mobilnet Incorporated, GTE Mobilnet of Oregon Limited Partnership, GTE Mobilnet of Northwest Oregon Limited Partnership and GTE Mobile Communications Service Corporation (the \"GTE Parties\") have entered into an Asset Exchange Agreement dated February 3, 1995 (the \"Asset Exchange Agreement\") with US WEST NewVector Group, Inc. (\"NewVector\"). Pursuant to the Asset Exchange Agreement, the GTE Parties will exchange certain cellular assets currently owned by them for 100% of the assets, including the non-wireline cellular license, currently owned by NewVector in San Diego, California. The Company's assets included in the exchange are its 49% interest in the cellular assets, including the wireline cellular license, in Albuquerque, New Mexico, and its 30% interest in the cellular assets, including the wireline cellular license, in Minneapolis, Minnesota. The assets of the other GTE Parties consist of (i) 91.4% of the assets of the cellular system serving the MSAs of Portland\nand Salem, Oregon, (ii) 100% of the assets of the cellular system serving Oregon RSA 1, and (iii) either a 10% partnership interest in the partnership providing cellular service in Seattle, Bremerton and Tacoma, Washington or a 10% interest in the assets of that system. The Company will acquire a 28% interest, as a tenant-in-common, in the San Diego assets received from NewVector, and will operate the system pursuant to a management agreement with the other GTE Parties.\nOperations\nPartnerships. A substantial number of the Company's cellular systems in MSAs are owned by limited partnerships in which the Company is a general partner (\"MSA Partnerships\"). Most of these partnerships are governed by partnership agreements with similar terms, including, among other things, customary provisions concerning capital contributions, sharing of profits and losses, and dissolution and termination of the partnership. Most of these partnership agreements vest complete operational control of the partnership with the general partner. The general partner typically has the power to manage, supervise and conduct the affairs of the partnership, make all decisions appropriate in connection with the business purposes of the partnership, and incur obligations and execute agreements on behalf of the partnership. The general partner also may make decisions regarding the timing and amount of cash contributions and distributions, and the nature, timing and extent of construction, without the consent of the other partners. The Company owns more than fifty percent (50%) of almost all of the MSA Partnerships.\nA substantial number of the Company's cellular systems in RSAs are also owned by limited or general partnerships in which the Company is either the general or managing partner (the \"RSA Partnerships\"). These partnerships are governed by partnership agreements with varying terms and provisions. In many of these partnerships, the non-controlling partners have the right to vote on major issues such as the annual budget and system design. In addition, in certain of these partnerships, the partners have the right to build, under certain circumstances, independent cells in areas of the RSA not served by the partnership. Finally, in a few of these partnerships, the Company's management position is for a limited term (similar to a management contract) and the other partners in the partnership have the right to change managers, with or without cause. The Company owns less than fifty percent (50%) of many of the RSA Partnerships.\nThe partnership agreements for both the MSA Partnerships and RSA Partnerships generally contain provisions granting all partners a right of first refusal in the event a partner desires to transfer a partnership interest. This restriction on transfer can make these partnership interests difficult to sell to a third party.\nProvision of Services by GTE Personal Communications Services. During 1993, the Company maintained a headquarters staff and two regional staffs which provided strategic as well as day-to-day operational support to the Company's operations in its 66 Company Controlled Markets. In 1994, the Company implemented a new organizational structure pursuant to which the two regional staffs were replaced with eight area staffs which are located in the Company's eight clusters of MSAs and RSAs. These eight areas are Virginia, Tennessee, Kentucky, Alabama, the Midwest, Texas\/New Mexico, the Gulf of Mexico and California. The purpose of this reorganization was to move essential, customer impacting resources closer to the marketplace to enhance the Company's competitive advantage and position the Company for future growth.\nThe Company also receives general and administrative as well as functional support from GTE Personal Communications Services (\"GTE PCS\"), a division of GTE. Pursuant to an agreement dated May 1, 1991, as amended, between GTE Mobile Communications Service Corporation (\"GTEMC\") and the Company (the \"Services Agreement\"), GTE PCS provides finance, accounting, tax, human resources, legal, regulatory and information management services to the Company. The Services Agreement provides that the Company is allocated a portion of GTE PCS expenses based on a two-step process. The first step is the designation of GTE PCS expenses as cellular or non-cellular. The second step is the allocation of cellular expenses between the Company and GTE Mobilnet (a GTE subsidiary also engaged in the cellular communications business) based on a cost-causative allocation methodology. Under this methodology, pools of costs are allocated to operating units based on one of several factors. The factors were developed and applied to cost categories in an effort to allocate the cost to areas in proportion to the use and benefit of the cost. Under this Services\nAgreement, the Company was allocated approximately 34% of GTE PCS's cellular expenses for the twelve months ended December 31, 1994.\nConstruction and Maintenance. The construction and maintenance of cellular systems is capital intensive. Although all of the Company's MSA and RSA systems were operational in 1994, the Company continually adds cells to increase coverage, provide additional capacity and improve the quality of these systems. In 1994, the Company completed construction of 153 new cells in Company Controlled Systems. In addition the Company completed a replacement program for most of its older technology cell site equipment. The newer technology equipment provides higher quality and increased flexibility in providing analog services, as well as positions a platform that supports deployment of future digital technologies. Total capital expenditures related to Company Controlled Systems were approximately $253 million in 1994 and are anticipated to be approximately $315 million in 1995.\nMarketing\nGeneral. The Company markets its cellular telephone services through several distribution channels, including independent agents, its direct sales force and retail outlets. Agents are independent contractors who solicit customers on a commission basis exclusively for the Company. The Company's agents are diverse in size and type of business. Most are agents for the Company within a limited geographic area, while a few agents sell the Company's cellular service regionally or nationally. Some of the Company's agents sell cellular products and services exclusively, while others sell a variety of products (such as radio and electronics equipment). Finally, some of the Company's agents are small shops, while others are large retail stores. The Company's agents generally receive a commission payment for each cellular subscriber they add to the Company's systems.\nThe Company's direct sales force is made up of sales people who are employees of the Company and are compensated on an incentive basis. These employees earn a portion of their compensation as a guaranteed salary and receive additional payments for each subscriber added. These employees are required to meet certain quotas set by the Company. Another distribution channel utilized by the Company is retail outlets, including kiosks and retail stores. The retail outlets are staffed by salaried employees, part-time employees and temporary employees who receive a base salary and incentive compensation for each unit sold. Finally, the Company is constantly attempting to develop new distribution channels, including telemarketing, co-promotions with various other industry leaders and door-to-door sales.\nNational Industry Alliance. During the past several years, cellular providers have been forming industry alliances to market cellular service nationwide. Many cellular providers holding non-wireline licenses have become Cellular One(R) franchisees. Many cellular providers holding wireline licenses have joined a consortium to market under the brand name, MobiLink(R), a registered mark of B-Side Carriers L.P. Because the Company holds both wireline and non-wireline licenses, it participates in both of these alliances.\nSubscribers\nTotal Number. The Company had 789,580 subscribers at December 31, 1994, an increase of 51.5% over its subscribers at December 31, 1993. The Company's subscribers at December 31, 1994 were distributed as follows: 33% in Tennessee, 21% in Virginia and 46% in all other markets combined.\nCost of Acquisition. The sales and marketing costs of obtaining new subscribers are substantial. The Company not only has to pay for advertising, but also incurs a direct expense for most new subscribers, either in the form of a commission payment to an agent or a salary\/incentive payment to a direct sales person. In addition, the Company periodically runs promotions which discount the cost of cellular telephone equipment, or provide some amount of initial access or airtime free to new subscribers. Each of these promotions results in costs to the Company. Although the Company has continued to lower the cost of acquisition per subscriber, it remains one of the Company's single largest expenses.\nChurn. A factor common throughout the cellular industry is that many subscribers either completely discontinue cellular service or switch from one cellular provider to another. In 1994, this monthly turnover or \"churn\" in the Company's subscribers averaged 2.7% of all subscribers per month.\nSubscriber Revenue. The Company charges its subscribers for access to its systems, for minutes of use and for enhanced services, such as voice mail and Mr. RescueSM. A subscriber may purchase each of these services separately for a set price or may purchase any number of rate plans which bundle these services in different ways. For example, a high usage subscriber may purchase a pre-determined number of minutes of use per month for a set fee rather than pay a fixed amount per minute. Similarly, a user who purchases cellular service for security reasons may choose a plan with a low monthly access fee but higher per minute usage fees. Rates charged by the Company and the number and type of rate plans vary from market to market.\nThe average monthly revenue the Company receives per subscriber has been declining over the last several years. The Company believes that this industry trend is caused in part by an increase in the number of casual and security cellular users. The Company expects this trend to continue in 1995 and future years.\nRoaming\nRoamers. The Company also provides cellular service to cellular users who are customers of other carriers but who are visiting and wish to use their cellular phone in the Company's service area (\"roamers\"). When roamers enter the Company's service area and attempt to use their cellular phones, the Company, through participation in an industry clearinghouse, establishes the identity and validity of the roamer and provides cellular service. The Company then bills the roamer's home cellular carrier for the service. Likewise, subscribers of the Company use their cellular phones in areas outside the Company's service areas.\nRoaming Revenue. The charges applicable to roamers are determined by agreements between the Company and other carriers in the industry and vary among markets and carriers. Roaming revenue has increased over the last several years and for the year ending December 31, 1994 represented approximately 18.6% of the Company's total service revenues. This increase is a result of the higher number of cellular subscribers nationwide and the Company's larger service areas due to an increasing number of cell sites. The Company believes that roaming will become more frequent in future years due to advances in intelligent networking which will simplify roaming procedures and make roaming transparent to the roamer.\nRoamer Fraud. Roamer fraud remains a cellular industry problem. Roamer fraud occurs when cellular telephone equipment is programmed to conceal the true identity and location of the user. While the Company and the industry have implemented an extensive fraud control process, they have not been able to eliminate fraud altogether.\nEmployees\nAt December 31, 1994, the Company had 2,387 employees. Of these, 230 were employed in the Company's headquarters offices in Atlanta and the remaining 2,157 were employed throughout the Company's Controlled Markets.\nNON-CONTROLLED SYSTEMS\nThe Company participates as a non-controlling general or limited partner in 27 MSAs and 18 RSAs. These interests represent approximately 28% of the Company's total POPs and are typically limited partnership interests in partnerships providing cellular service to the larger MSAs, such as Los Angeles, San Francisco, Washington D.C., Minneapolis and Houston. The partnership agreements which govern these partnerships are similar to those described above in \"-- The Company's Cellular Operations -- Operations -- Partnerships\". Since these partnership agreements vest the power to manage, supervise and conduct the affairs of the partnership with someone other than the Company, there can be no assurance that decisions made by these partnerships would be the same as those made by the Company under similar circumstances.\nINTERNATIONAL INTERESTS\nThe Company owns a 10% interest in a corporation which provides cellular service in the Sonora and Sinaloa regions of Mexico. The Company currently receives services related to international ventures from GTE PCS.\nCOMPETITION\nThe cellular telephone industry is part of the much broader telecommunications industry. Direct competition is in the form of the other cellular licensee in any given market. Competition between the two cellular licensees is principally on the basis of service quality, price and coverage area. In addition to the direct cellular competitor in each market, there will also be competition from newly emerging Enhanced Specialized Mobile Radio (\"ESMR\") operators who generally provide dispatch and other private radio systems. With new digital technology it may be possible for ESMR operators to provide services in the future that may be difficult to distinguish from traditional cellular service.\nIn 1993, the FCC announced that it would license additional frequencies in the 1.8 GHz to 1.99 GHz frequency band to enable up to six additional wireless competitors to enter each market. These new licenses consist of two licenses in each of 51 large, often multi-state, geographical areas known as Major Trading Areas (\"MTAs\") and four licenses in each of 492 smaller geographical areas known as Basic Trading Areas (\"BTAs\"). Auctions for such licenses began in 1994 and will continue in 1995. The first part of the auction was completed on March 13, 1995, and resulted in the purchase of 99 licenses by 18 entities. A GTE subsidiary, GTE Macro Communications Corporation, purchased four licenses (Atlanta, Seattle, Cincinnati and Denver).\nREGULATION\nGeneral. The FCC regulates the licensing, construction, operation, sale and acquisition of cellular carriers as well as interconnection arrangements between cellular carriers. In addition, certain aspects of cellular system operation also may be subject to public utility regulation in the state in which service is provided. Changes in federal or state regulation of the Company's and its competitors' activities, such as increased rate regulation or deregulation of interconnection arrangements, could adversely affect the Company's results. A brief summary of federal and applicable state regulation of cellular service is set forth below.\nFederal Regulation. The FCC initially authorized cellular telephone service in 1981 by allocating 40 MHz of spectrum for two competing cellular systems in each market. A 20 MHz block of spectrum was given to each carrier. Due to cellular's rapid growth, the FCC allocated to each carrier an additional 5 MHz of spectrum in 1986.\nThe initial cellular licenses granted by the FCC expire ten years from their date of issuance and are renewable upon application to, and approval by, the FCC. The FCC has established the criteria under which existing licensees may have their cellular licenses renewed. Basically, a comparative preference will be given to any current cellular licensee who can prove that it substantially used its spectrum for its intended purpose, complied with applicable FCC rules, and did not engage in substantial relevant misconduct. This preference will be the most important factor to be considered by the FCC during its hearing on each license renewal request in comparing the current licensee's application with any competing applications. Failure to comply with FCC rules can be raised as an issue during the license renewal proceedings and could result in termination of the license.\nThe first of the Company's cellular licenses came up for renewal in October 1994. The Company filed renewal applications for its licenses in Mobile, Alabama, El Paso, Texas and Richmond and Norfork, Virginia in August 1994. No entity filed competing applications or oppositions to any of those renewal applications. The remainder of the Company's licenses will expire over the next several years, including two which expire in\n1995, seven which expire in 1996 and eleven which expire in 1997. All of the licenses expiring between 1995 and 1997 are MSA licenses. The Company expects to file renewal applications for such licenses upon their expiration.\nThe FCC is currently in the process of auctioning additional licenses in the 1.8 GHz to 1.99 GHz range for the provision of personal communications services. Existing cellular companies are eligible to bid at auction for new licenses. Existing cellular companies may bid for an MTA license where they have no current substantial cellular holdings and one BTA license in all BTA's, including areas where they are currently the cellular provider. The first part of the auction was completed on March 13, 1995, and resulted in the purchase of 99 licenses by 18 entities. A GTE subsidiary, GTE Macro Communications Corporation, purchased four licenses (Atlanta, Seattle, Cincinnati and Denver).\nIn addition to regulating cellular service, the FCC also regulates point-to-point microwave facilities which are often utilized by cellular providers to link base stations to each other and to the MTSO. The Company holds certain microwave licenses for these purposes. Such licenses, which are issued for a ten year period, were all renewed by the Company in 1991 for an additional ten year period. The FCC has issued regulations pursuant to which a significant portion of the Company's microwave licenses may have to be relocated to a higher spectrum at the request of a party receiving a license to use such spectrum for a new technology. The regulations currently provide that incumbent microwave licensees will be reimbursed for expenses associated with this relocation by the new licensee.\nState Regulation. In 1981, the FCC preempted the states from exercising jurisdiction in the areas of cellular technical standards and market structure. Under the Communications Act of 1934, as amended, however, certain aspects of the economic regulation of common carriers were reserved to the states. The states had exclusive jurisdiction with respect to charges, classifications, practices and service or facilities for or in connection with intrastate communications. Although many states have deregulated cellular service, some still require the filing of tariffs and operational reports pursuant to statutes governing public utilities.\nIn August 1994, certain provisions of the Omnibus Budget Reconciliation Act of 1993 (the \"Omnibus Act\") became effective. These provisions prohibited the states from continuing to exercise jurisdiction over rates and entry into the wireless telecommunications business. The Omnibus Act did, however, provide that states could file a petition with the FCC to continue rate jurisdiction. Only two states in which the Company provides service, California and New York, filed to continue such regulation. All states may continue to regulate other aspects of cellular service not preempted by federal law, although it is unclear at this time the extent to which the other states will continue to do so.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nIn each of the cellular systems managed or controlled by the Company, the Company or its subsidiaries or partnerships own or lease the sites on which the MTSO and all cells are located. In addition, in most of its markets, the Company leases space for its sales and customer service operations, as well as numerous retail locations. The Company also leases office space for its corporate headquarters in Atlanta, Georgia and for its eight regional offices.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nPROCEEDINGS INVOLVING THE COMPANY AS A NAMED PARTY\nOn November 18, 1992, Alan R. Kahn, a shareholder of the Company (\"Kahn\"), filed a shareholder derivative action in the Court of Chancery of the State of Delaware in and for New Castle County against the Company, Contel Corporation, GTE and each member of the Company's Board of Directors. The complaint alleges that the defendants breached their fiduciary duties to the Company by causing the Company to enter into four specified transactions that the plaintiff alleges were disadvantageous to the Company. These transactions were (i) the allocation of reorganization costs which resulted from the 1991 merger of GTE and Contel Corporation, (ii) the resignation of Paul Kozlowski from the Company in 1991 to become the head of GTE's combined cellular businesses, (iii) the tax sharing arrangement between the Company and GTE, and\n(iv) the financing of the Company's debt obligations by GTE, which resulted in finance charges to the Company. The lawsuit was dismissed with prejudice on July 27, 1994.\nOn October 5, 1993, Sparky, Inc., d\/b\/a Don Cook's Cellular (\"Don Cooks\"), Air Mobile Communications, Inc., Red Monkey Communications, and Vincent's Communications, Inc. filed suit in the Superior Court in the County of Fresno, California against Contel Cellular of California, Inc. (\"Contel-California\"), Fresno MSA Limited Partnership, GTE California Corporation and GTE Mobilnet. Don Cooks was an agent of the Fresno MSA Limited Partnership until its contract expired in February 1993. Each of the other plaintiffs was a subagent of Don Cooks. The suit alleges breach of contract, fraud and deceit through affirmative misrepresentations, fraud and deceit through concealment of material facts, breach of implied covenant of good faith and fair dealing, discrimination, price fixing, unfair, fraudulent and deceptive business practices and illegal restraint of trade, anti-trust and price fixing, bad faith refusal to consent to assignment, misappropriation of confidential business information and certain statutory claims relating to the California Unfair Practices Act. These causes of action are based on allegations that Contel-California (i) failed to provide separate accounting of fees and residuals earned by Don Cooks and each of the three subagents, (ii) failed to provide Don Cooks with leads and instead provided leads to other agents and its direct sales force, (iii) failed to provide adequate market support and training to its agents, (iv) refused to sell equipment to its agents at cost, (v) failed to pay a $100 bonus per activation which Don Cooks alleged was an oral commitment intended to last the length of the written contract, (vi) failed to treat information received from its agents as confidential, (vii) unfairly discriminated against Don Cooks by unreasonably insisting that Don Cooks' potential customers pay security deposits before obtaining service, (viii) competed directly with Don Cooks for potential subscribers, (ix) sold telephone equipment to subscribers below cost, (x) unlawfully tied the sale of equipment to the sale of cellular service, (xi) unreasonably refused to allow Don Cooks to assign its contract to another agent, (xii) fraudulently concealed its alleged plan to reduce the involvement of agents in the sale of cellular service, (xiii) charged $31 as its basic rate, which was the same basic rate charged by the competitor, and (xiv) met with representatives of the competitor to fix prices at industry meetings and at meetings to discuss the sale of certain other cellular properties originally owned by the competitor and sold to the Company. The plaintiffs are seeking $5.5 million in damages.\nOn November 24, 1993, Arthur Garabedian d\/b\/a Western Mobile Telephone Company brought an action in the Superior Court of the State of California for the County of Orange on behalf of himself and all persons or entities who have subscribed to cellular radio service in the Los Angeles Standard Metropolitan Statistical Area against Los Angeles SMSA Limited Partnership (the \"LA Partnership\"), Pacific Telesis Group, AirTouch Cellular (formerly Pactel Cellular) (\"AirTouch\"), AirTouch Communications Inc., GTE Mobilnet Incorporated, the Company and U.S. Cellular Corporation. The Company is an 11.2% limited partner in the LA Partnership. The complaint alleges retail and wholesale price fixing of cellular radio service. The plaintiff is seeking in excess of $100 million in damages. The ultimate outcome of this suit is unclear at this time because discovery has not been completed. In addition, it is unclear whether the Company will remain as a named party in this lawsuit or will be involved only because of its limited partnership interest in the LA Partnership.\nOn September 8 and 9, 1994, four separate shareholders of the Company; Blimy Itkowitz, Airmont Plaza Associates, Paul Gambal and Arnel Gonzalez, filed lawsuits on behalf of all shareholders against the Company, the Company's directors and GTE alleging that the announced purchase price of $22.50 per Class A Share to be paid in connection with the proposed Merger was grossly inadequate. All four lawsuits were filed in the Court of Chancery in the State of Delaware in and for New Castle County. On December 23, 1994, a tentative settlement agreement was reached with plaintiffs in all four suits, subject to confirmatory discovery. The tentative settlement approves an increased price of $25.50 per Class A Share and the payment by GTE of $525,000 in plaintiffs' counsel fees and expenses. The confirmatory discovery was subsequently completed by plaintiffs' counsel and all documentation necessary to effect the settlement was approved by the parties to the lawsuits and their counsel. Such documentation is in the process of being submitted to the court. Following submission, a date will be set for a final hearing to approve the settlement.\nPROCEEDINGS INVOLVING PARTNERSHIPS IN WHICH THE COMPANY IS A LIMITED PARTNER\nOn October 7, 1993, AirTouch was served with an Orange County Superior Court complaint filed by Goldenwest Cellular Corporation, an agent of Los Angeles Cellular Telephone Company (\"LACTC\"), the non-wireline cellular carrier in Los Angeles, California. The complaint was filed against LACTC, the LA Partnership, AirTouch and The Good Guys!, a retail agent of LACTC. On February 15, 1994, AirTouch was served with an Orange County Superior Court complaint filed by Autophone, Inc., another agent of LACTC. This complaint was filed against LACTC, the LA Partnership and AirTouch. The Company is an 11.2% limited partner in the LA Partnership. The two cases were consolidated on April 5, 1994. The complaints contain causes of actions which set forth violations of California's Cartwright Act and Unfair Practices Act and involve allegations that the LA Partnership conspired with LACTC to increase the commissions paid to the \"larger\" agents so that those agents could use the larger commissions to reduce the price of cellular equipment below cost, thereby increasing their sales of cellular equipment and their sales of cellular service. The complaints also contain allegations that the LA Partnership and LACTC conspired to fix the rate at which cellular service is sold at both retail and wholesale. The damages for each cause of action are alleged to be $50,000 \"or more to be shown according to proof at trial\", and plaintiff is seeking to have these amounts trebled pursuant to statute.\nOn May 5, 1994, Cellular Activators and numerous other agents of LACTC filed suit in the Superior Court of the State of California in and for the County of Orange against LACTC, the LA Partnership, AirTouch, AirTouch Communications Inc., and certain agents of LACTC. The Company is a limited partner and owns 11.2% of the LA Partnership. The complaint alleges numerous causes of actions, only one of which is against the LA Partnership. This cause of action is a conspiracy to fix prices for cellular service in violation of the California Business and Professions Code. Plaintiffs base this cause of action on their allegation that the rates charged by LACTC and the LA Partnership for cellular service are the same and have not changed over time. The plaintiffs are seeking damages in excess of $100,000 for each of the plaintiff agents.\nOn July 18, 1994, AirTouch was served with a lawsuit filed by Intercell Communications, Inc., an agent for AirTouch in certain California markets. The lawsuit was filed in the Superior Court of the State of California for the County of San Diego on behalf of itself and all authorized agents of AirTouch in California. AirTouch is the general partner of the LA Partnership in which the Company is an 11.2% limited partner. The complaint alleges breach of contract, fraud and deceit and violations of the California Business and Professions Code and the Unfair Practices Act. The allegations involve selling cellular equipment below cost, tying the sale of below-cost cellular equipment to the purchase of cellular service, failing to provide adequate support to agents, increasing the direct sales channel and paying higher commissions to certain retail agents. The plaintiff is seeking damages in excess of $1.6 million per agent, plus statutory treble damages.\nOn October 17, 1994, Richard Kagan and Monica Sifuentes filed a lawsuit in the United States District Court for the Central District of California against LACTC, the LA Partnership and AirTouch. The suit was filed on behalf of all persons or entities similarly situated who have subscribed to cellular service in the Los Angeles market at any time since March 1, 1987 and alleges that the defendants conspired to fix the rates of cellular service in the Los Angeles market. The complaint seeks unspecified damages. An order granting summary judgment against the named plaintiffs was entered in favor of the LA Partnership and AirTouch on March 20, 1995.\nOn November 30, 1994, Eurus Cady filed a lawsuit in the Superior Court of the State of California in and for the County of Orange against LACTC, the LA Partnership and AirTouch. The suit was filed on behalf of all persons or entities similarly situated who have subscribed to cellular service provided by the LA Partnership since March 1, 1987 and alleges that the defendants conspired to fix the rates of cellular service in the Los Angeles market. The complaint seeks unspecified damages.\nOn October 6, 1994, Barbara Curtice filed a lawsuit in the Superior Court of the State of California for the County of San Francisco against GTE Mobilnet and Bay Area Cellular Inc. GTE Mobilnet is the general partner of the GTE Mobilnet of California Limited Partnership in which the Company is an 11.3% limited partner. The suit was filed on behalf of cellular telephone users in San Francisco, Santa Rosa, Oakland and\nSan Jose MSAs and alleges that GTE Mobilnet and Bay Area Cellular Inc. fixed the price for cellular service in violation of the California Business and Professions Code. The complaint seeks unspecified damages.\nThe Company's potential financial liability in connection with all of the lawsuits against partnerships in which the Company is a limited partner is uncertain at this time. Because the Company is involved only as a limited partner, it is not involved in the strategic analysis of these cases with litigation counsel and does not direct the litigation decisions made by these partnerships. In addition, it is unclear whether any portion of an adverse judgement could be passed to the Company, as a limited partner.\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 Class A Shares are publicly traded in the over the counter market and quoted on the Nasdaq National Market under the symbol \"CCXLA\". There is no established trading market for the Class B Shares. As of March 13, 1995, the Company had 378 Class A Stockholders of record. The Class A common stockholders are entitled to one vote per share and the Class B common stockholder is entitled to 5 votes per share. Hence GTE, through Contel, controls approximately 97.8% of the aggregate voting power of the Company through its ownership of all 90 million outstanding Class B Shares. The Company has not paid any cash dividends on the Class A Shares or Class B Shares, and it is not anticipated that the Company will pay any cash dividends in the foreseeable future.\nThe following table indicates the high and low sales prices for the Class A Shares during the designated periods:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected consolidated financial data presented below as of December 31, 1990-1994 and for each of the years then ended have been derived from the audited consolidated financial statements of the Company. The 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, have been included in this Annual Report on Form 10-K on pages 24 to 45. This financial information should be read in conjunction with such financial statements and notes thereto.\n--------------- (1) The operating loss in 1991 includes approximately $12 million of integration costs associated with the merger of Contel with a wholly owned subsidiary of GTE.\n(2) In 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\" In 1992, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and No. 109, \"Accounting for Income Taxes.\"\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nContel Cellular Inc. (the \"Company\"), through its subsidiaries or through partnerships, provides cellular telephone services in various metropolitan statistical areas (\"MSAs\") and rural service areas (\"RSAs\") throughout the United States. As of March 13, 1995, the Company owned controlling interests in and managed cellular systems in 32 MSAs and owned non-controlling interests in cellular systems serving 27 other MSAs. In addition, the Company held controlling interests in cellular systems in 24 RSAs, held non-controlling interests in and managed cellular systems in 10 RSAs, and held non-controlling interests in cellular systems in 18 other RSAs and one cellular system in Mexico. All of the Company's systems were operational at March 13, 1995. Included in the consolidated statements of operations are all revenues and expenses of the MSA and RSA systems in which the Company holds a controlling interest. The Company's pro rata share of the net income or losses of the MSA and RSA systems in which the Company holds a non-controlling interest, regardless of whether the Company manages the system, is included in \"Equity in earnings of unconsolidated partnerships\" in the consolidated statements of operations.\nBACKGROUND\nIn March 1991, Contel Corporation (\"Contel\"), the Company's parent, merged with a subsidiary of GTE Corporation (\"GTE\") in a tax-free exchange. The Company is a 90% owned subsidiary of Contel, which became a wholly owned subsidiary of GTE. During 1991, many of the staff and support functions previously performed separately by the Company were consolidated under GTE Mobile Communications Service Corporation (\"GTEMC\") and allocated to the Company under an interim cost allocation methodology. In January 1992, a finalized cost allocation methodology was implemented.\nIn January 1993, a new management structure was announced, under which the GTEMC structure was functionally eliminated. Certain functions previously provided by GTEMC are now provided by GTE Personal Communications Services, a division of GTE. Certain other functions, such as marketing and engineering, are performed directly by the Company. Refer to Note 10 of the \"Notes to Consolidated Financial Statements\" for additional information regarding related party transactions.\nIn December 1994, an Agreement and Plan of Merger (as amended, the \"Merger Agreement\") was executed between the Company and GTE after the Company's Board of Directors voted to accept GTE's proposal to acquire the remaining 10% ownership of the Company. Under the terms of the agreement, a GTE subsidiary will merge into the Company and the Company will survive the merger. The holders of the approximately 10 million Class A Shares will receive $25.50 per share in cash. The Company's Class B Shares owned by GTE will remain outstanding.\nThe Company anticipates that the Merger will be completed on or about April 28, 1995. As a result of the Merger, there will cease to be any public market for the Class A Shares and the Class A Shares will cease to be quoted on the Nasdaq National Market.\nACQUISITIONS AND DISPOSITIONS OF INTERESTS IN CELLULAR SYSTEMS\nThe Company regularly evaluates its properties to assess their strategic attributes in terms of meeting its financial goals and objectives. The Company will purchase properties where the demographics and business climate are favorable to the development of core and contiguous cellular systems and will pursue the sale of properties which are deemed to be non-strategic.\nOn February 3, 1995, the Company signed a definitive agreement relating to the cellular exchange of certain of the Company's cellular assets in the Minneapolis, Minnesota MSA and the Albuquerque, New Mexico MSA for a portion of US WEST NewVector Group, Inc.'s cellular assets in the San Diego, California MSA (\"San Diego MSA\") (the \"Exchange\"). The Exchange will give the Company a 28 percent interest as a tenant-in-common in the assets of the cellular system serving the San Diego MSA. The Exchange will\nreduce the Company's POPs (\"POPs\" refers to the population of a market area multiplied by a company's percentage ownership in the cellular system serving that market) by approximately 290,000. The transaction is subject to regulatory approvals and is expected to close during 1995.\nIn 1994, the Company purchased 100% of the cellular system serving Tennessee RSA 2, the remaining 51% interest in the cellular system serving Tennessee RSA 3, and 100% of the cellular systems serving the Huntsville, Alabama MSA and Alabama RSA 2, representing an aggregate increase of approximately 831,000 POPs. Through the purchase of the Huntsville, Alabama MSA, the Company gained an 80% interest in the partnership that currently operates the cellular system in Alabama RSA 1A pursuant to an interim operating license. Additionally, the Company increased its ownership interests in the cellular systems serving the Tuscaloosa, Alabama MSA, Indiana RSAs 7, 8 and 9, and Alabama RSA 1B, representing an aggregate increase of approximately 33,000 POPs.\nAlso during 1994, the Company sold its interest in several northeastern cellular properties (the \"Northeast Properties\"), pursuant to the agreement signed in December 1993 with NYNEX Mobile Communications Company (\"NYNEX\"), including the cellular systems serving Manchester, New Hampshire and Burlington, Vermont MSAs; New Hampshire RSA 2, Vermont RSAs 1 and 2A, and New York RSA 2. The Company recognized a pretax gain of approximately $80.0 million, on the sale of these Northeast Properties representing approximately 734,000 POPs. Additional sales completed during 1994 include the Company's interest in Iowa RSAs 1, 8 and 14, Oregon RSA 5, South Dakota RSAs 5B1 and 6B1, North Carolina RSA 1, Kentucky RSA 11, California RSA 7 and Alabama RSA 1B. The Company recognized an aggregated pretax gain of approximately $14.3 million with respect to these additional sales, representing approximately 711,000 POPs.\nAdditionally, as part of the agreement, NYNEX will purchase the Company's interests in the Binghamton and Elmira, New York MSAs, Pennsylvania RSAs 3A and 4A, and New York RSA 3 pending certain regulatory approvals, which are expected to be completed in 1995.\nAfter the acquisitions and dispositions described above, the Company will provide or participate in the provision of cellular services in 56 MSA markets and 49 RSA markets with total combined POPs of approximately 23.3 million.\nDuring 1993, the Company purchased 100% of the cellular systems serving Tennessee RSAs 6 and 9, representing approximately 202,000 POPs. In addition, the Company increased its ownership interests in the cellular systems serving the Tuscaloosa, Alabama MSA, the San Francisco, San Jose, Vallejo, Santa Rosa, Santa Cruz, and Salinas, California MSAs and New York RSA 3, representing an aggregate increase of approximately 21,000 POPs.\nAlso during 1993, the Company sold its interests in a number of non-strategic RSAs, primarily in Arizona, Minnesota and Washington, as well as its interests in the cellular systems serving the Rapid City, South Dakota MSA, and the Orange County and Poughkeepsie, New York MSAs. The pretax gain on the sale of these cellular interests was approximately $48.0 million and represented approximately 686,000 POPs.\nOn December 31, 1992, the Company sold its stock in Contel Cellular of Arkansas, Inc. to Alltel Mobile Communications, Inc. Included in the sale were the Company's interests in the MSAs serving Fort Smith and Fayetteville, Arkansas RSAs 1 and 8, and Oklahoma RSA 4, resulting in a pretax gain of $60.8 million.\nRefer to Note 5 of the \"Notes to Consolidated Financial Statements\" for additional information regarding the acquisitions and dispositions of cellular interests.\nRESULTS OF OPERATIONS\nService revenues, which include airtime, access, roaming, long-distance and other service revenues, increased $178.3 million in 1994 and $84.0 million in 1993. These increases are primarily attributable to revenues generated from subscriber gains and roaming revenues. The Company's subscriber base, net of the\nsubscribers sold, increased from 521,200 as of December 31, 1993 to 789,600 as of December 31, 1994, an annual growth rate of 51% in 1994 compared to 59% in 1993 and 39% in 1992. Rates for airtime and access remained relatively unchanged from 1992 to 1994. Partially offsetting the increases in revenues resulting from subscriber growth were declines in average usage per subscriber. The declines in usage per subscriber are attributable to the increased number of casual users in the subscriber base, and are consistent with the industry. Average revenue per subscriber per month for 1994, 1993 and 1992 was $70, $73 and $78, respectively.\nCost of services, which includes network expenses, facilities and maintenance, and the cost of long-distance, increased $37.2 million in 1994 and $6.3 million in 1993. The 1994 and 1993 increases are primarily the result of increased usage, cell sites and cost of toll, as well as increased salaries and other employee-related costs to support the increased network investment. Increased salaries, other employee costs and cost of toll represented approximately $14.9 million of the 1994 increase. Additionally, roaming related expenses increased from $1.9 million in 1993 to $9.8 million in 1994 primarily due to increased roaming usage and additional charges associated with offering subscribers lower roaming rates in other carriers' markets. Cost of services as a percent of service revenues was between 14 percent and 16 percent for each of the past three years.\nNegative equipment margins of 106%, 79%, and 54% for the years ended December 31, 1994, 1993 and 1992, respectively, continue to reflect the intensely competitive market environment and the fact that equipment promotions are frequently used to attract new subscribers. Equipment unit sales for 1994, 1993 and 1992 were approximately 292,000, 165,000 and 99,000 which represent an annual increase for 1994 and 1993 of 77% and 67%, respectively.\nSelling, general and administrative expenses increased $46.1 million and $34.6 million in 1994 and 1993, respectively. Employee commissions, related compensation benefits and agent commissions associated with the acquisition of new subscribers and higher marketing and promotional fees related to expanding the type and number of distribution channels accounted for $23.5 million and $25.5 million of the increase in 1994 and 1993, respectively. These increases are directly related to the increase in customer additions during 1994 and 1993. The 1994 increase also includes an additional $8.4 million of bad debt expenses primarily attributable to increased sales and $3.7 million of relocation expenses associated with implementing a new organization structure that involved relocating and adding resources to eight new strategic market areas (Kentucky, Midwest, Tennessee, Virginia, California, Alabama, Gulf Coast and Southwest).\nDepreciation expense increased $11.3 million in 1994 compared to an increase of $12.2 million in 1993. These increases were primarily due to higher property and equipment balances resulting from enhancements to and expansion of existing cellular systems required to support the growth in the number of subscribers and quality of service expectations.\nInterest expense increased $16.3 million in 1994 and $14.8 million in 1993. The 1994 increase is primarily attributable to higher effective interest rates in 1994 of approximately 9.3% versus 8.8% in 1993 and increased variable-rate, affiliated debt. The rates of interest on both the variable-rate and the fixed-rate debt approximate the rate that the Company could obtain in the marketplace from non-affiliated lenders. The 1993 increase is primarily due to higher effective interest rates in 1993 of approximately 8.8% versus 8.1% in 1992 and a result of the refinancing through GTE of variable-rate debt to fixed-rate debt at higher market-based rates. Refer to Note 10 of the \"Notes to Consolidated Financial Statements\" for further information related to cash management and financing.\nEquity in earnings of unconsolidated partnerships increased $25.4 million in 1994 and $8.3 million in 1993. These increases are a result of improved operating results primarily in unconsolidated partnerships such as the Los Angeles SMSA Limited Partnership and the Washington D.C. SMSA Limited Partnership (the \"Washington D.C. Partnership\"). The increase in the 1993 earnings was partially offset by reduced equity in earnings in the Washington D.C. Partnership of $3.8 million resulting from a legal settlement against the Washington D.C. Partnership, which settlement was subsequently reduced to $1.9 million during 1994. Refer\nto Note 4 of the \"Notes to Consolidated Financial Statements\" for further information relating to unconsolidated partnerships.\nThe Company recognized combined federal and state income tax expense of $14.2 million for 1994 compared with income tax benefits recognized during 1993 and 1992 of $27.7 million and $33.5 million, respectively. The 1994 effective tax rate was impacted by $4.9 million of state income taxes related to the gains on sales of cellular interests and the amortization of goodwill. The reduced benefit rate in 1993 is primarily due to the change in the federal income tax rate from 34% to 35% subsequent to the enactment of the Omnibus Budget Reconciliation Act of 1993. Refer to Note 6 of the \"Notes to Consolidated Financial Statements\" for further information relating to federal and state income taxes expense.\nDuring the fourth quarter of 1993, the Company adopted Statement of Financial Accounting Standards (\"FAS\") 112, \"Employers' Accounting for Postemployment Benefits\". As a result of the adoption of FAS 112, a one-time, non-cash charge of $241 thousand was recorded to give effect to past service costs. During the fourth quarter of 1992, the Company adopted FAS 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" and FAS 109, \"Accounting for Income Taxes,\" retroactive to January 1, 1992. As a result of the adoption of FAS 106, a one-time, non-cash charge of $2.1 million was recorded to give effect to past service costs. The adoption of FAS 109 had no impact on the financial statements in 1992. Refer to Note 3 of the \"Notes to Consolidated Financial Statements\" for additional information.\nThe Company has experienced losses prior to the year ended December 31, 1994. The Company's results are highly affected by (a) interest expense and amortization of carrying costs associated with past acquisitions, (b) the cost of constructing the Company's network, and (c) the cost of acquiring new subscribers. The Company expects to continue to aggressively acquire new subscribers. As the subscriber base continues to grow, the Company believes that the higher level of revenues generated coupled with the operating efficiencies achieved will ultimately lead to more profitable results. The Company has achieved an average subscriber growth rate of approximately 50% for the past three years, while the industry has experienced a growth rate of approximately 43%. Additionally, management has taken steps to reduce its acquisition costs per subscriber through the introduction of innovative distribution channels and methods. This year's improved performance is reflected in the Company's operating income which increased $69.3 million, from an operating loss of $28.3 million in 1993 to operating income of $41.0 million in 1994.\nFINANCIAL CONDITION\nThe Company requires capital to construct and enhance its cellular systems, make periodic interest payments on outstanding debt, fund operating costs for systems which the Company manages, fund acquisitions and continue investments in unconsolidated partnerships.\nCash provided from operating activities in 1994 was $21.8 million, an increase of $17.2 million from the prior year. This increase was primarily attributable to the increase in revenues, partially offset by additional cost of services and selling, general and administrative expenses. Cash provided from operating activities in 1993 was $4.6 million, a decrease of $33.6 million from the prior year. This decrease was primarily due to increased interest payments on outstanding debt as well as reduced income tax benefits, partially offset by improved cash flow margins resulting from higher revenues.\nCapital expenditures were $255.2 million, $130.0 million and $183.5 million in 1994, 1993 and 1992, respectively. Capital expenditures are primarily for network expansion and enhancements to maintain system capacity, quality and coverage as the customer base increases and demands greater service performance. Total capital expenditures for consolidated and unconsolidated markets for 1995 are estimated to be approximately $314 million. As the Company positions itself for the future, additional capital is required to expand network capacity, provide portable grade coverage in all core markets, enhance system quality and coverage, and position the network for digital technology in order to provide high value wireless communications services. It is currently estimated that these capital expenditures will be funded by additional borrowings from GTE, contributions from minority partners and cash provided from operations.\nThe Company is required to fund its proportionate share of the construction and working capital requirements in unconsolidated partnerships. Funds contributed to unconsolidated partnerships for the year ended December 31, 1994, were $15.1 million compared to $13.8 million and $12.6 million for 1993 and 1992,\nrespectively. The increase in funds used is primarily attributable to increased construction requirements for unconsolidated partnerships.\nIn certain unconsolidated partnerships where the Company is managing partner, funds required for construction and working capital may be advanced by the Company and subsequently reimbursed from the limited partners or from operating results. Alternatively, the Company may request that capital contributions be made to the partnerships in advance of expenditures. Funds provided by changes in advances to unconsolidated partnerships for the year ended December 31, 1994, were $12.4 million compared to $6.9 million for 1993 and funds used of $0.6 million for 1992, respectively. The improvement in 1994 and 1993 is primarily the result of improved timing of the collection of advances from unconsolidated partnerships in managed RSAs.\nIn order to minimize the volatility associated with interest rate fluctuations, the Company's Board of Directors adopted a policy of maintaining variable-rate debt within a target range of 5% to 20% of total debt. In September 1992, the Company converted $300 million of variable-rate debt to $150 million of fixed-rate debt with a five-year maturity, and $150 million of fixed-rate debt with a seven-year maturity. In December 1992, the Company converted an additional $400 million of variable-rate debt to $200 million of fixed-rate debt with a three-year maturity and $200 million of fixed-rate debt with a four-year maturity. In August 1994, the Company converted $75 million of variable-rate debt to $75 million fixed-rate debt with a six-year maturity. Terms, interest rates and other information regarding affiliated debt are included in Note 10 of the \"Notes to Consolidated Financial Statements.\"\nIn addition to fixed-rate debt, the Company maintains a line of credit arrangement with GTE. Effective January 1, 1993, GTE adopted a policy wherein rates charged for variable-rate debt changed from GTE's cost of borrowing such debt plus 1.5% per annum, to the prime rate quoted in The Wall Street Journal plus 0.75% per annum. This change increased the Company's cost of borrowing variable-rate debt by 1.5% effective January 1, 1993.\nDuring 1994, the Company borrowed an additional $159.6 million under its line of credit arrangement primarily to fund network capital requirements and the Huntsville acquisition. At December 31, 1994, the Company had borrowed approximately $511.3 million through its intercompany borrowing arrangements at variable rates. Total borrowings are expected to increase in 1995 and for several years in the future, as the Company borrows to fund interest payments on its debt and fund network capital requirements due to growth and development of its operations.\nIn Company controlled and managed markets, the Company maintains adequate financing through the line of credit arrangement with GTE to ensure proper management of the operations. A portion of this financing is reimbursed through contributions from minority partners. During 1994, the Company received $6.4 million from minority partners for collection of capital calls. The Company expects to continue making capital contributions to the unconsolidated partnerships and receiving capital contributions from minority partners. The timing and amounts of such contributions and advances are subject to future construction and working capital requirements of these partnerships as determined by the managing partner.\nOver the past three years, the capital required to enhance the existing cellular network and to finance the carrying costs of acquisitions and new investments has been substantially provided from operations, sales of non-strategic properties, and GTE or the Company's minority partners. Although net income before depreciation and amortization has increased over the past three years, additional financing will be required to fund the Company's growth and its debt service for the foreseeable future. These requirements are expected to be funded largely by GTE as a 90% owner of the Company and a major investor and operator of cellular networks nationwide and the Company's minority partners. Additionally, in January 1995, GTE provided the Company with a letter stating that GTE had no plans or intentions to discontinue providing financial support to the Company through intercompany credit facilities to meet ongoing operating and capital requirements, and that GTE would not demand payment under intercompany credit facilities before June 30, 1996.\nRefer to Notes 4 and 8 of the \"Notes to Consolidated Financial Statements\" for information regarding legal and regulatory matters affecting the Company and its unconsolidated partnerships.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of Contel Cellular Inc.:\nWe have audited the consolidated balance sheets of CONTEL CELLULAR INC. (a Delaware corporation and majority owned subsidiary of GTE Corporation) AND SUBSIDIARIES as of December 31, 1994 and 1993 and the related consolidated statements of operations, changes in stockholders' 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 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 unconsolidated partnerships as described in Note 4 to the financial statements. The investment in these partnerships is reflected in the accompanying balance sheets using the equity method of accounting and represented $102,618,000 and $82,140,000 (or 4%) of total consolidated assets at December 31, 1994 and 1993, respectively. The equity in their earnings is included in the statements of operations and represented $39,806,000, $28,024,000, and $20,070,000 for the years ended December 31, 1994, 1993, and 1992, respectively. The summarized financial information contained in Note 4 to the consolidated financial statements includes financial information for the aforementioned partnerships. The financial statements of these unconsolidated partnerships were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for these unconsolidated partnerships, 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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, based on our audits and the reports of the other auditors, the financial statements (pages 24 to 45) referred to above present fairly, in all material respects, the financial position of Contel Cellular 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.\nA report of other auditors referred to above indicates that the Los Angeles SMSA Limited Partnership is involved in litigation with several agents as discussed in Note 4 and with cellular subscribers as discussed in Notes 4 and 8, the outcome of which cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been made in the accompanying financial statements.\nAs discussed in Note 4, the cellular partnership in San Francisco, California, of which the Company holds a non-controlling interest, is involved in litigation with a class of cellular subscribers, the outcome of which cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been made in the accompanying financial statements.\nAs discussed in Note 3 to the financial statements, effective January 1, 1992, the Company changed its method of accounting for postretirement benefits other than pensions.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. 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 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.\n\/s\/ Arthur Andersen LLP --------------------------------------------------------- Arthur Andersen LLP\nAtlanta, Georgia March 13, 1995\nCONTEL CELLULAR INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS (THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these financial statements.\nCONTEL CELLULAR INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS)\nThe accompanying notes are an integral part of these financial statements.\nCONTEL CELLULAR INC.\nCONSOLIDATED BALANCE SHEETS (THOUSANDS, EXCEPT SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements.\nCONTEL CELLULAR INC.\nCONSOLIDATED BALANCE SHEETS (THOUSANDS, EXCEPT SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements.\nCONTEL CELLULAR INC.\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT (THOUSANDS)\nThe accompanying notes are an integral part of these financial statements.\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION AND NATURE OF BUSINESS\nThe Company, a 90-percent-owned subsidiary of Contel, was incorporated in Delaware on September 24, 1980. Contel is a wholly owned subsidiary of GTE. The Company, through its subsidiaries or through partnerships, provides or participates in providing cellular telephone services in various metropolitan statistical areas (\"MSAs\") and rural service areas (\"RSAs\") throughout the United States. Refer to the \"Interests in MSAs and RSAs\" following the Notes to Consolidated Financial Statements for additional information.\nA definitive agreement dated as of December 27, 1994 was executed between the Company and GTE based on the approval by the Company's Board of Directors to accept the proposal by GTE to acquire the remaining 10 percent ownership of the Company. Under the terms of the agreement, a GTE subsidiary will merge into the Company and the holders of the approximately 10 million Class A common shares will receive $25.50 per share in cash. The Company's Class B common shares owned by GTE will be converted into shares of the merged entity.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include all wholly owned subsidiaries and partnerships in which the Company holds a controlling interest. Investments in partnerships in which the Company does not hold a controlling interest are accounted for using the equity method of accounting. Significant intercompany transactions are eliminated in consolidation.\nREVENUE RECOGNITION\nThe Company earns service revenues by providing access to its cellular systems (\"access revenue\") and usage of its cellular systems (\"airtime revenue\"). Access and airtime revenue, including roaming and long-distance, is recognized when the service is rendered. Other service revenues are recognized after services are performed and include connection and installation revenues. Equipment sales are recognized upon delivery of the equipment to the customer.\nPROPERTY, EQUIPMENT AND DEPRECIATION\nThe Company records depreciation using the straight-line method over the estimated useful life of the asset, which is 20 years for buildings, 15 years for towers, 7 to 10 years for cell and switching equipment, and 3 to 5 years for furniture and fixtures. The Company removes the cost and accumulated depreciation of retirements from the accounts and recognizes the related gain or loss upon the disposition or disposal of assets.\nINTEREST EXPENSE\nInterest expense related to construction activity is capitalized as a cost of construction. Interest capitalized amounted to $4.1 million, $2.5 million and $2.6 million for 1994, 1993 and 1992, respectively.\nINCOME TAXES\nIncome tax expense (benefit) is based on reported income (loss) before income taxes. Deferred taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. In 1992, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). In accordance with FAS 109, deferred income taxes have been established for all temporary differences between the book and tax basis of assets and liabilities, including those which had not been\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\npreviously recognized. In addition, deferred tax balances are adjusted to reflect tax rates, based on currently enacted tax laws, that will be in effect in the years in which the temporary differences are expected to reverse.\nNET INCOME (LOSS) PER SHARE\nNet income (loss) per share for all years presented was computed using the weighted average number of Class A and Class B Common Stock outstanding in accordance with Accounting Principles Board Opinion No. 15.\nCASH EQUIVALENTS\nThe Company considers all highly liquid unrestricted cash investments with an original maturity of three months or less to be cash equivalents.\nINVENTORIES\nInventories include cellular telephone equipment held for sale and are valued at the lower of cost or market. Cost is determined using the specific identification method. Accessories are expensed when purchased and are not material in amount.\nLONG-TERM NOTES RECEIVABLE\nLong-term notes receivable consist primarily of amounts and accrued interest due from partnerships disposed of between 1992 and 1994. The notes bear interest at rates ranging from a fixed-rate of 8% to a variable-rate of prime plus 3% (the prime rate at December 31, 1994 was 8.5%) and mature in varying amounts between the years 1997 and 2002.\nFCC LICENSES, GOODWILL AND OTHER INTANGIBLES\nCosts incurred in connection with the acquisition of partnership interests in excess of the net tangible assets acquired are capitalized as Federal Communications Commission (\"FCC\") license costs, customer base or goodwill and are amortized on a straight-line basis. FCC license costs and goodwill are amortized over 40 years based on the high probability that the licenses will be renewed upon expiration of their initial terms. Customer base is amortized over 4 years.\nASSETS UNDER CONSTRUCTION\nThe Company's network construction expenditures are recorded as assets under construction until the system or assets are placed in service. When the assets are placed in service, they are transferred to the appropriate property and equipment category and depreciation begins. The Company's construction employees' salaries, benefits and travel expenses, as well as other related departmental expenses, are capitalized to assets under construction during the construction period.\nFINANCIAL INSTRUMENTS\nThe fair values of financial instruments, other than long-term obligations, closely approximate their carrying value. The estimated market value of long-term obligations, based on either reference to quoted market prices or an option pricing model, was approximately $54 million below the carrying value at December 31, 1994, and exceeded the carrying value by approximately $74 million at December 31, 1993. The change in the market value between years was caused by rising interest rates during 1994.\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nPRESENTATION\nCertain prior year amounts have been reclassified to conform to the current year presentation.\n3. ACCOUNTING CHANGES\nDuring the fourth quarter of 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"FAS 112\"). FAS 112 requires the expected cost of postemployment benefits to be recognized during the years that employees render service. Prior to adoption, the cost of these benefits was charged to expense on a pay-as-you-go basis. As a result of adoption, a one-time, non-cash charge of $241 thousand (net of deferred tax benefits) was recorded to recognize the annual effect of this change in accounting principle.\nDuring the fourth quarter of 1992, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\") and FAS 109, retroactive to January 1, 1992.\nFAS 106 requires the expected cost of postretirement health care and life insurance benefits to be recognized during the years that employees render service. Prior to adoption, the cost of these benefits was charged to expense on a pay-as-you-go basis. The Company elected to adopt FAS 106 on the immediate recognition basis. As a result, a one-time, non-cash charge of $2.1 million (net of deferred tax benefits of $1.1 million), or $.02 per share, was recorded to give effect to past service costs.\n4. INVESTMENT IN AND ADVANCES TO UNCONSOLIDATED PARTNERSHIPS\nThe Company holds non-controlling interests in various MSA and RSA partnerships (referred to as \"Unconsolidated Partnerships\") which were formed to provide cellular telephone services. Unconsolidated Partnerships are accounted for using the equity method of accounting. Refer to Note 5 for information regarding acquisitions and dispositions of cellular interests.\nCombined condensed results of operations and net assets of the Company's Unconsolidated Partnerships are as follows:\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe managing partner of each of the Unconsolidated Partnerships generally has the authority to manage, supervise and conduct the affairs of the partnership, make all decisions appropriate in connection with the business purposes of the partnership and incur obligations and execute agreements on behalf of the partnership. Under the terms of the partnership agreements, the Company is entitled to review and audit the records of the partnership in those Unconsolidated Partnerships it does not manage.\nIn certain of the Unconsolidated RSA Partnerships, the Company serves as the managing partner. In such cases, the Company retains all other rights and responsibilities of a non-controlling partner. As managing partner, the Company may provide the initial capital, through cash advances, required to meet the financial obligations of the partnerships. Alternatively, the Company may request capital contributions to be invested by the partnerships in advance of expenditures. At December 31, 1994, the Company had a payable to limited partners of approximately $1.5 million, of which approximately $0.7 million represents the Company's proportionate share. The remainder represents a current payable to other partners and is included in Accounts payable -- affiliates in the accompanying consolidated balance sheets. At December 31, 1993, the Company had provided cash advances of $12.7 million, of which approximately $4.7 million, represents the Company's proportionate share. The remainder represents a current receivable from the other partners or the partnerships and is included in Advances to unconsolidated partnerships in the accompanying consolidated balance sheets.\nThe amount of undistributed earnings of Unconsolidated Partnerships included in Accumulated deficit in the accompanying consolidated statements of changes in stockholders' deficit was approximately $84.1 million, $48.7 million and $31.2 million at December 31, 1994, 1993 and 1992, respectively. There were no restricted earnings of Unconsolidated Partnerships at December 31, 1994, 1993 or 1992.\nIn January 1992, the California Public Utilities Commission (\"CPUC\") commenced an investigation of all cellular companies operating in the state of California to determine their compliance with General Order number 159 (\"G.O. 159\"). The investigation will address whether cellular utilities have complied with local, state or federal regulations governing the approval and construction of cellular sites in the state. The CPUC may advise other agencies of violations in their jurisdictions. Presently, the Los Angeles SMSA Limited Partnership (the \"L.A. Partnership\") and the GTE Mobilnet of California Limited Partnership (the \"California Partnership\") have prepared and filed the information requested by the CPUC. The CPUC will review the information and, if violations of G.O. 159 are found, it may assess penalties against these partnerships.\nOn October 7, 1993, and February 15, 1994, two agents of the competing carrier have named the L.A. Partnership in several complaints against the carrier. The general allegations include violations of California Unfair Practices Act and price fixing.\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nOn November 24, 1993, October 17, 1994 and November 30, 1994, three separate class action (not yet certified) suits were filed against the L.A. Partnership alleging conspiracy with a competing carrier to fix the price of cellular service in violation of state and federal antitrust laws. The plaintiffs are seeking injunctive relief and substantial monetary damages in excess of $100 million before trebling.\nIn May 1994, several former and current agents of the competing carrier have named the L.A. Partnership in only one cause of action. This cause of action alleges a conspiracy with the competing carrier to fix the prices of cellular service in violation of state antitrust laws. The plaintiffs are seeking damages in excess of $100,000 for each of the plaintiff agents.\nOn July 18, 1994, AirTouch Cellular was served with a class action (not yet certified) suit on behalf of the L.A. Partnership's authorized agents. The complaint alleges \"predatory practices\" and seeks damages in excess of $1.6 million per agent, plus statutory treble damages.\nOn October 10, 1994, the California Partnership in which the Company holds an 11.3% limited interest was served a complaint on behalf of users of cellular service in the San Francisco, California area. The Complaint alleges that the California Partnership has violated the California Business and Profession Code by taking various actions to restrain trade, prevent competition and fix prices.\nThe Company's potential financial liability in connection with all of the lawsuits discussed above is uncertain at this time because the Company is involved in these lawsuits only as a limited partner. As a limited partner, the Company is not involved in the strategic analysis of these cases with litigation counsel and does not direct the litigation decisions made by these partnerships. In addition, it is unclear whether any portion of an adverse judgment would be passed to the Company, as a limited partner. For these reasons, no provision for any liability that may result has been made in the accompanying financial statements.\n5. ACQUISITIONS AND DISPOSITIONS OF CELLULAR INTERESTS\nThe Company regularly evaluates its properties to assess their strategic attributes in terms of meeting its financial goals and objectives. The Company will purchase properties where the demographics and business climates are favorable to the development of core and contiguous cellular systems and will pursue the sale of properties deemed to be non-strategic.\nOn February 3, 1995, the Company signed a definitive agreement to exchange its cellular assets (the \"Exchange\") in the Minneapolis, Minnesota MSA and the Albuquerque, New Mexico MSA for a portion of US WEST NewVector Group, Inc.'s cellular assets in the San Diego, California MSA (\"San Diego MSA\"). The Exchange will give the Company a 28 percent interest, as a tenant-in-common, in the assets of the cellular system serving the San Diego MSA. The Exchange will reduce the Company's POPs by approximately 290,000. The transaction is subject to regulatory approvals and is expected to close during 1995.\nIn December 1993, the Company signed a definitive agreement whereby NYNEX Mobile Communications Company (\"NYNEX\") agreed to purchase the Company's interest in the MSA systems serving Orange County, Poughkeepsie, Binghamton and Elmira, New York; Manchester, New Hampshire; and Burlington, Vermont. Also included are New Hampshire RSA 2; Vermont RSAs 1 and 2A; New York RSAs 2 and 3; and Pennsylvania RSAs 3A and 4A. The Orange County and Poughkeepsie MSAs were sold in 1993. During 1994, the Company sold its interests in the Manchester, New Hampshire and Burlington, Vermont MSAs, New Hampshire RSA 2 , Vermont RSAs 1 and 2A and New York RSA 2. Additionally, as part of the agreement, NYNEX will purchase the Company's interest in the Binghamton and Elmira, New York MSAs, Pennsylvania RSAs 3A and 4A, and New York RSA 3 pending the receipt of certain regulatory approvals.\nIn addition to the acquisitions and dispositions that occurred between 1992 and 1994, the Company purchased 13 MSAs located in Tennessee, Kentucky and Alabama (the \"Southeast Properties\") from McCaw Cellular Communications Inc. (\"McCaw\") for approximately $1.32 billion during 1990. The\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nacquisition was financed through an interim intercompany loan from Contel Capital Corporation (\"Contel Capital\"), a wholly owned subsidiary of Contel. Refer to Note 10 for additional information regarding this loan.\nAcquisition and disposition transactions completed as of December 31, 1994, by the Company are included in the table below.\n--------------- (1) Population figures are reported by the Donnelly marketing population estimates each year for counties comprising FCC defined MSAs and RSAs.\nNote: Population figures and dollar amounts are in thousands.\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\n---------------\n(1) Population figures are reported by the Donnelly marketing population estimates each year for counties comprising FCC defined MSAs and RSAs.\nNote: Population figures and dollar amounts are in thousands.\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\n6. INCOME TAXES\nIn 1994, 1993 and 1992, the Company was included in the consolidated federal income tax return of GTE. In accordance with GTE's tax sharing policy, the Company computes its federal income taxes on a separate company return basis without regard to separate company utilization of operating losses. GTE reimburses its subsidiaries for utilization of taxable losses on a quarterly basis. Refer to Note 10 for further information regarding income taxes payable to affiliates.\nThe net expense (benefit) from income taxes consists of the following:\nThe following is a summary of the items which caused recorded income taxes to differ from taxes computed using the statutory federal income tax rate:\nThe Omnibus Budget Reconciliation Act of 1993 was enacted on August 10, 1993 and includes a provision for an increase in the corporate federal income tax rate by 1% to 35%, retroactive to January 1, 1993. As a result, $3.3 million of additional deferred tax expense was recorded in September, 1993. Gains on sales of cellular interests during 1994 attributed approximately $4.9 million of state income taxes, net of federal tax benefit.\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nA summary of the components of the deferred income tax provision is as follows:\nDeferred tax assets and liabilities are comprised of the following:\n7. EMPLOYEE BENEFIT PLANS\nRETIREMENT PLANS\nAs of January 1, 1992, all of the Company's employees began participating in GTE Service Corporation's defined benefit pension plan. The benefits to be paid under this plan are generally based on years of credited service and average final earnings. GTE's funding policy, subject to the minimum funding requirements of employee benefit and tax laws, is to contribute such amounts as are determined on an actuarial basis to provide the plan with assets sufficient to meet the benefit obligations of the plan. The assets of the plan consist primarily of corporate equities, government securities and corporate debt securities.\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe net pension cost included in consolidated operations for the years ended December 31, 1994, 1993 and 1992 included the following components:\nThe expected long-term rate of return on plan assets was 8.5% for 1994 and 8.25% for each of 1993 and 1992.\nThe funded status of the plan at December 31, 1994 and 1993 was as follows:\nThe projected benefit obligations at December 31, 1994 and 1993 include accumulated benefit obligations of $4.7 million and $2.1 million, respectively and vested benefit obligations of $2.5 million and $0.8 million, respectively.\nAssumptions used to develop the projected benefit obligations for 1994 and 1993 were as follows:\nPOSTRETIREMENT 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 Company plans are generally based on comprehensive hospital, medical and surgical benefit provisions.\nThe postretirement benefit cost for the years ended December 31, 1994, 1993 and 1992 included the following components:\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe following table sets forth the funded status and accrued obligation as of December 31, 1994 and 1993:\nThe assumed discount rates used to measure the accumulated postretirement benefit obligation were 8.25% and 7.5% at December 31, 1994 and 1993, respectively. The assumed health care cost trend rates in 1994 and 1993 were 12% and 13%, respectively for pre-65 participants and 9.0% and 9.5%, respectively 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 rates for each future year would have increased 1994 postretirement benefit cost by approximately $7 thousand and the accumulated postretirement benefit obligation as of December 31, 1994 by approximately $47 thousand.\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, among others, newly established limits to the Company's annual contribution to postretirement medical costs and a revised sharing schedule based on a retiree's years of service. The net effect of these changes reduced the accumulated benefit obligation at December 31, 1993 by $3.9 million. The resulting unrecognized prior year service benefit is being amortized over the average remaining lives of the employees.\n8. COMMITMENTS AND CONTINGENCIES\nLEASES\nLease expense relates to the lease of office space, tower facilities, real estate, office equipment and vehicles. Rents charged to expense were $11.9 million, $8.8 million and $6.9 million for 1994, 1993 and 1992, respectively.\nAt December 31, 1994, future minimum lease payments under noncancelable operating leases are as follows (thousands):\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nCONSTRUCTION AND CAPITAL COMMITMENTS\nCapital expenditures for markets controlled and managed by the Company are expected to be funded with additional borrowings from affiliates, internally generated funds, contributions from minority partners and net distributions from Unconsolidated Partnerships.\nThe Company also intends to fund its share of future capital requirements of the Unconsolidated Partnerships. The timing and amounts of such contributions are subject to the future capital requirements as determined by the managing partner, and therefore cannot be accurately estimated by the Company.\nLEGAL AND REGULATORY MATTERS\nOn November 24, 1993, Arthur Garabedian d.b.a. Western Mobile Telephone Company brought a class action lawsuit on behalf of himself and on behalf of all persons or entities who have subscribed to cellular radio service in the Los Angeles area against the L.A. Partnership, Pacific Telesis Group, AirTouch Communications Inc., AirTouch Cellular, GTE Mobilnet Incorporated, Contel Cellular Inc. and U.S. Cellular Corporation. The complaint alleges retail and wholesale price fixing of cellular radio service. The plaintiff is seeking in excess of $100 million in damages. The ultimate outcome of this suit is unclear at this time because discovery has not been completed. In addition, it is unclear whether the Company will remain as a named party in this lawsuit or will be involved only because of its limited ownership in the L.A. Partnership.\nThe Company is subject to legal and regulatory matters in the normal course of business. No provision for any liability that may result has been made in the accompanying financial statements.\nLINE OF CREDIT\nRefer to Note 10 for information regarding the Company's line of credit arrangements with GTE.\n9. OTHER LONG-TERM OBLIGATIONS\nOther long-term obligations are as follows:\nOn December 28, 1993, the Company issued long-term promissory notes in the amount of approximately $6.5 million at a fixed interest rate of 9% in connection with the acquisition of 100% interest in Tennessee RSA 9. Accrued interest on the outstanding principal amount of this note shall be paid quarterly on the first day of January, April, July and October of each year.\nIn July 1991, the Company issued $28.0 million of 8% long-term promissory notes in connection with the acquisition of 100% interests in Tennessee RSAs 5 and 7. The notes are guaranteed by GTE and include\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nvarious covenants, none of which are expected to restrict future operations. Aggregate annual repayments of this debt are $6.0 million in 1995 and $10.0 million in 1996.\nThe Industrial Development Revenue Bonds are floating\/fixed-rate bonds secured by irrevocable letters of credit issued by the Bank of Nova Scotia which begin to expire December 1, 1996, unless otherwise extended. The letters of credit carry a commitment fee of 1\/2 of 1% per annum. The Company may, upon written notice to the bond trustee, convert the interest rate to a fixed market rate. Until converted to a fixed rate, the bonds bear interest, payable quarterly, at a rate equal to a variable percentage (ranging from 65% to 71% at December 31, 1994) of the Trust Company Bank of Atlanta's prime interest rate.\nRefer to Note 10 for information regarding the Notes Payable to Affiliates.\n10. RELATED PARTY TRANSACTIONS\nGENERAL SERVICES\nPrior to the 1991 merger of GTE and Contel, the Company operated under a general services agreement with Contel. Subsequent to the merger, a new management structure was put in place. The Company's field operations, properties and corporate officers continue to remain separate from those of GTE Mobilnet Incorporated (\"Mobilnet\"), GTE's wholly owned cellular subsidiary. GTE Mobile Communications Service Corporation (\"GTEMC\") consolidated many of the staff and support functions previously performed separately by the Company and Mobilnet. On May 1, 1991, the Company entered into a services agreement with GTEMC whereby support for major functions such as accounting, information management, human resources, legal, marketing, network and technology planning were provided to the Company.\nA new management structure was implemented in January 1993, under which the GTEMC headquarters structure was functionally eliminated. Marketing and network functions, previously provided by GTEMC, are now provided directly by the Company, while the remaining functions are provided by GTE Personal Communication Services (\"GTE PCS\"), a division of GTE. During 1994 and 1993, costs for these services were allocated from GTE PCS to the Company. The costs allocated under the 1994 and 1993 structure do not differ significantly from the costs allocated to the Company under the 1992 methodology.\nAmounts expensed by the Company for these services were approximately $50 million, $45 million and $44 million for the years 1994, 1993 and 1992, respectively. In management's opinion, the cost allocation methodology for all periods is reasonable.\nCASH MANAGEMENT AND FINANCING\nThe following table summarizes the Company's Notes Payable -- Affiliates:\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nAs of January 1, 1992, the Company began using cash management services provided by GTE. The notes payable to GTE are due on demand. The line of credit with GTE may be renegotiated at any time based on the Company's working capital and construction requirements. Based on the expressed intent and ability of GTE to make funds available to the Company on a long-term basis, the accompanying consolidated balance sheets reflect the Notes payable-affiliates as long-term obligations. As of December 31, 1994, outstanding borrowings from GTE under this line of credit were $511.3 million. The interest rate on the borrowings was approximately 9.25% on December 31, 1994. This rate represents the prime rate at December 31, 1994, as quoted in the Wall Street Journal, plus a .75% per annum fee on the outstanding balance. Prior to January 1993, the rate was calculated based on GTE's cost of borrowing the funds, plus 1.5% per annum. Interest expense relating to the line of credit, which is payable monthly in arrears, was $30.8 million, $19.4 million and $23.5 million for the years 1994, 1993 and 1992, respectively.\nDuring 1991, the Company's $1.3 billion loan previously provided by Contel Capital was replaced with a combination of fixed- and variable-rate intercompany notes as follows: (i) $700 million at 10.47% payable to GTE, due March 1, 1998; (ii) $150 million at 9.22% payable to GTE Finance Corporation, a wholly owned subsidiary of GTE, due February 25, 1997; and (iii) $450 million due to GTE under the same terms and provisions as borrowings under GTE's line of credit facility. Included in the interest rates above was an additional 1.5% per annum, which the Company agreed to pay GTE and GTE Finance Corporation, for GTE's agreement to become obligated under these financings.\nOn September 25, 1992, the Company refinanced $300 million variable-rate debt with two $150 million fixed-rate notes, at 8.97% and 8.38% payable to GTE Finance Corporation, due on September 27, 1999 and September 25, 1997, respectively. Additionally, on December 31, 1992, the Company refinanced the variable-rate $450 million note mentioned in (iii) above with a $200 million fixed-rate note at 8.08% payable to GTE, due December 31, 1995 (as evidenced by a letter dated January 25, 1995, GTE intends to refinance this note at maturity), and a $200 million fixed-rate note at 8.56% payable to GTE, due December 31, 1996. The remaining $50 million is included in the line of credit facility previously discussed.\nOn February 25, 1993, the Company refinanced the $150 million fixed-rate note mentioned in (ii) above with a $150 million fixed-rate note bearing interest at 7.71% payable to GTE Finance Corporation, due on February 25, 1997. On August 17, 1994, the Company refinanced $75 million of variable-rate debt with a $75 million fixed-rate note bearing interest at 9.90% payable to GTE Finance Corporation, due on August 17, 2000.\nEffective June 1992, the Company is charged the comparable Treasury Rate plus 3.0% per annum upon conversion of variable-rate debt to fixed-rate debt. This rate closely approximates rates that would be charged by non-affiliated commercial lenders to corporations of similar credit quality for fixed-rate debt.\nInterest expense for these notes payable to affiliates is payable to GTE semi-annually and amounted to $148.0 million, $145.4 million, and $121.0 million in 1994, 1993 and 1992, respectively. The effective interest rate under these borrowings was approximately 9.3% for the year ended December 31, 1994.\nPURCHASES\nThe Company purchased cellular telephone equipment and accessories during 1994 and 1993 from GTE PCS, and during 1992 from GTEMC, totaling $56.9 million, $45.7 million and $29.6 million, respectively, which approximates cost.\nTRANSFER OF INTERESTS IN RSA MARKETS\nDuring 1988 and 1989, the Company participated in the FCC's license award process to provide cellular service in 428 RSAs throughout the country. At that time, the Company and Contel entered into an agreement whereby other subsidiaries of Contel were given the right to control or hold interests in RSA\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nmarkets where the Company chose not to participate. In 1990, Contel decided to maintain all cellular interests within one company. Accordingly, in the third quarter of 1990, Contel transferred, at book value, its interests in 49 RSAs to the Company. None of the RSAs were operational. The Company agreed that if any of these RSA interests were sold within a three-year period expiring August 1, 1993, the Company would remit the proceeds of such sales, net of the Company's investment, to Contel. Accordingly, no gain or loss would be recognized by the Company in connection with the sale of any such interest. The Company did not sell any interests in the transferred RSA markets from January 1, 1993 to August 1, 1993. In 1992, the Company sold interests in two such RSA markets and remitted to Contel $2.5 million in net proceeds in 1993.\nACCOUNTS PAYABLE -- AFFILIATES\nIn addition to the affiliated financing agreements disclosed above, the Company has affiliated accounts payable of $3.9 million for accrued income taxes and $0.8 million for accounts payable to limited partners at December 31, 1994, and $23.6 million for accrued income taxes at December 31, 1993.\n11. COMMON STOCK\nThe Company's Class A and Class B Common Stock are identical in all respects except for the following: 1) The Class A common stockholders are entitled to one vote per share and the Class B common stockholders are entitled to five votes per share; 2) the holders of each class of stock will be entitled to receive stock dividends only of the same class of stock; and, 3) shares of Class B Common Stock are convertible into Class A Common Stock at the option of the holder at any time.\nBoth classes of the common stock have non-cumulative voting rights. Dividends may be declared and paid to one class only if an equal per share dividend is declared and paid to the other class. Both classes share equally on a pro rata basis in the event of liquidation or dissolution. GTE, through Contel, owns all shares of Class B Common Stock, or 90% of the total number of shares outstanding and approximately 98% of the combined voting power of both classes of stock.\nThe Company also has 3 million authorized shares of preferred stock (the \"Preferred Stock\") which may be issued in one or more series at the discretion of the Board of Directors. The Board of Directors is authorized to determine the terms, rights, privileges, preferences and restrictions of any unissued series of Preferred Stock prior to issuance. The Company presently has no plans to issue any shares of Preferred Stock.\n12. STOCK OPTIONS AND RESTRICTED STOCK UNITS\nIn accordance with the 1987 Key Employee Stock Plan (the \"Stock Plan\"), the Company may grant stock options, stock appreciation rights and restricted stock units related to Class A Common Stock to key employees. The maximum number of shares of Class A Common Stock reserved for issuance under the Stock Plan is 1,000,000 of which 916,900 shares were available for future grants as of December 31, 1994.\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe following schedule summarizes stock option transactions under the Stock Plan:\nOf the 83,100 stock options outstanding at December 31, 1994, 43,850 were exercisable. Included in the total number of options outstanding at December 31, 1994, are 51,950 shares which include 2\/3 tandem stock appreciation rights. Stock appreciation rights provide the right to surrender all or a portion of a stock option for cash or additional shares of stock equal to the excess of fair market value on the date of exercise over the option price. The 2\/3 tandem provision requires that for every two shares of stock surrendered for the appreciation right attached, one share of stock be purchased at the option price.\nCONTEL CELLULAR INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\n13. QUARTERLY INFORMATION (UNAUDITED)\nCONTEL CELLULAR INC.\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON COMPILATION OF COMBINED FINANCIAL STATEMENTS\nTo the Board of Directors and Stockholders of Contel Cellular Inc.:\nThe accompanying combined financial statements as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, have been prepared from the separate financial statements of the Los Angeles SMSA Limited Partnership, the Washington D.C. SMSA Limited Partnership, the GTE Mobilnet of California Limited Partnership, the GTE Mobilnet of South Texas Limited Partnership, the San Antonio SMSA Limited Partnership, and the Albucell Limited Partnership as described in Note 1 to the combined financial statements. We have audited the financial statements (not presented separately herein) of the GTE Mobilnet of California Limited Partnership, the GTE Mobilnet of South Texas Limited Partnership, and the Albucell Limited Partnership as of December 31, 1994 and 1993, and for the years then ended, as set forth in our reports included elsewhere in this document. Our report on the financial statements of the GTE Mobilnet of California Limited Partnership contains an explanatory paragraph with respect to the matter discussed in Note 8 to the combined financial statements. We did not audit the financial statements (also not presented separately herein) of the Los Angeles SMSA Limited Partnership, the Washington D.C. SMSA Limited Partnership, and the San Antonio SMSA Limited Partnership as of December 31, 1994 and 1993 and for the years then ended, which statements reflect assets and revenues of 55% and 63%, respectively, of the related combined 1994 totals. These statements were audited by other auditors, as set forth in their reports also included elsewhere in this document. The report of other auditors of the Los Angeles SMSA Limited Partnership contains an explanatory paragraph with respect to the matters discussed in Note 8 to the accompanying combined financial statements.\nBecause of the significance of the amounts of the combined assets and revenues that have been audited by other auditors, we are unable to express, and we do not express, any opinion with respect to the fairness of the presentation of the accompanying combined financial statements. However, we have checked, for compilation only, the accompanying combined financial statements and, in our opinion, those statements have been properly compiled from the separate financial statements of the Los Angeles SMSA Limited Partnership, the Washington D.C. SMSA Limited Partnership, the GTE Mobilnet of California Limited Partnership, the GTE Mobilnet of South Texas Limited Partnership, the San Antonio SMSA Limited Partnership, and the Albucell Limited Partnership on the basis described in Note 1 to the combined financial statements.\n\/s\/ Arthur Andersen LLP --------------------------------------------------------- Arthur Andersen LLP\nAtlanta, Georgia March 13, 1995\nLOS ANGELES SMSA LIMITED PARTNERSHIP WASHINGTON D.C. SMSA LIMITED PARTNERSHIP GTE MOBILNET OF CALIFORNIA LIMITED PARTNERSHIP GTE MOBILNET OF SOUTH TEXAS LIMITED PARTNERSHIP SAN ANTONIO SMSA LIMITED PARTNERSHIP ALBUCELL LIMITED PARTNERSHIP\nCOMBINED STATEMENTS OF OPERATIONS (AMOUNTS IN THOUSANDS)\nUNAUDITED\nThe accompanying notes to the combined financial statements are an integral part of these statements.\nLOS ANGELES SMSA LIMITED PARTNERSHIP WASHINGTON D.C. SMSA LIMITED PARTNERSHIP GTE MOBILNET OF CALIFORNIA LIMITED PARTNERSHIP GTE MOBILNET OF SOUTH TEXAS LIMITED PARTNERSHIP SAN ANTONIO SMSA LIMITED PARTNERSHIP ALBUCELL LIMITED PARTNERSHIP\nCOMBINED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)\nUNAUDITED\nThe accompanying notes to the combined financial statements are an integral part of these statements.\nLOS ANGELES SMSA LIMITED PARTNERSHIP WASHINGTON D.C. SMSA LIMITED PARTNERSHIP GTE MOBILNET OF CALIFORNIA LIMITED PARTNERSHIP GTE MOBILNET OF SOUTH TEXAS LIMITED PARTNERSHIP SAN ANTONIO SMSA LIMITED PARTNERSHIP ALBUCELL LIMITED PARTNERSHIP\nCOMBINED BALANCE SHEETS (AMOUNTS IN THOUSANDS)\nUNAUDITED\nThe accompanying notes to the combined financial statements are an integral part of these statements.\nLOS ANGELES SMSA LIMITED PARTNERSHIP WASHINGTON D.C. SMSA LIMITED PARTNERSHIP GTE MOBILNET OF CALIFORNIA LIMITED PARTNERSHIP GTE MOBILNET OF SOUTH TEXAS LIMITED PARTNERSHIP SAN ANTONIO SMSA LIMITED PARTNERSHIP ALBUCELL LIMITED PARTNERSHIP\nCOMBINED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (AMOUNTS IN THOUSANDS)\nUNAUDITED\nThe accompanying notes to the combined financial statements are an integral part of these statements.\nLOS ANGELES SMSA LIMITED PARTNERSHIP WASHINGTON D.C. SMSA LIMITED PARTNERSHIP GTE MOBILNET OF CALIFORNIA LIMITED PARTNERSHIP GTE MOBILNET OF SOUTH TEXAS LIMITED PARTNERSHIP SAN ANTONIO SMSA LIMITED PARTNERSHIP ALBUCELL LIMITED PARTNERSHIP\nNOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED)\n1. ORGANIZATION AND BASIS OF COMBINATION\nThe accompanying combined financial statements represent a combination of the financial statements of the Los Angeles SMSA Limited Partnership (the \"Los Angeles Partnership\"), the Washington D.C. SMSA Limited Partnership (the \"Washington D.C. Partnership\"), the GTE Mobilnet of California Limited Partnership (the \"California Partnership\"), the GTE Mobilnet of South Texas Limited Partnership (the \"South Texas Partnership\"), the San Antonio SMSA Limited Partnership (the \"San Antonio Partnership\") and the Albucell Limited Partnership (the \"Albucell Partnership\") collectively referred to as the \"Partnerships\" and individually as a \"Partnership.\" Contel Cellular Inc. (the \"Company\") is a minority limited partner in each of the Partnerships, and accounts for its investment in the Partnerships using the equity method of accounting. These combined financial statements have been prepared to present the combined financial position, results of operations and cash flows of the Partnerships and the Company's interest in the Partnerships to comply with certain disclosure requirements of the Securities and Exchange Commission (the \"SEC\"). Under these SEC rules, each Partnership qualified as a significant equity investee of the Company in 1994.\nEach Partnership was formed to provide cellular telephone service in its respective standard metropolitan statistical area (\"MSA\"). The California, South Texas and Albucell Partnerships provide cellular service in the San Francisco, Houston and Albuquerque MSAs, respectively.\nThe partners' ownership interests in the Partnerships are as follows (the general partners' interests include the limited partnership interests if the general partner also participates as a limited partner):\nThe general partners in the Los Angeles, Washington D.C., California, South Texas, San Antonio and Albucell Partnerships are AirTouch Cellular (formerly Pactel Cellular), Bell Atlantic Mobile Systems of Washington, Inc. (\"BAMS\"), GTE Mobilnet Incorporated, GTE Mobilnet of Houston Inc., Southwestern Bell Mobile Systems, Inc. and US WEST NewVector Group, Inc., respectively.\nProfits, losses, contributions and distributable cash are allocated to the individual partners based on the respective partnership interests of each of the partners. The Los Angeles Partnership represents the most significant portion of combined total assets and net income for the years presented.\n2. SIGNIFICANT ACCOUNTING POLICIES\nRevenue Recognition\nGenerally the Partnerships earn service revenues by providing access to their cellular network (\"access revenue\") and for usage of their cellular network (\"airtime revenue\"). Access revenue is billed one month in\nLOS ANGELES SMSA LIMITED PARTNERSHIP WASHINGTON D.C. SMSA LIMITED PARTNERSHIP GTE MOBILNET OF CALIFORNIA LIMITED PARTNERSHIP GTE MOBILNET OF SOUTH TEXAS LIMITED PARTNERSHIP SAN ANTONIO SMSA LIMITED PARTNERSHIP ALBUCELL LIMITED PARTNERSHIP\nNOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED) -- CONTINUED\nadvance and recognized when earned. Airtime (including roaming) revenue is recognized when the service is rendered. Equipment sales are recognized upon delivery of the equipment to the customer.\nIncome Taxes\nUnder the provisions of the Internal Revenue Code and related state statutes, the Partnerships are not taxable entities for income tax purposes. The individual partners include their share of Partnership income or loss in their respective income tax returns. Accordingly, no provision for income taxes has been made in the accompanying combined financial statements.\nDepreciation and Amortization\nDepreciation and amortization are calculated using the straight-line method over the estimated useful lives of related assets. Upon sale or retirement of property, plant and equipment, the cost of such assets and related accumulated depreciation or amortization are eliminated from the accounts and any related gain or loss is reflected in the combined statements of operations.\nCash Equivalents\nCash equivalents include amounts which are readily convertible into cash and which are not subject to significant risk from fluctuations in interest rates.\nReclassifications\nCertain accounts of the Partnerships have been reclassified to conform to a consistent presentation.\n3. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consists of the following at December 31 (in thousands):\nLOS ANGELES SMSA LIMITED PARTNERSHIP WASHINGTON D.C. SMSA LIMITED PARTNERSHIP GTE MOBILNET OF CALIFORNIA LIMITED PARTNERSHIP GTE MOBILNET OF SOUTH TEXAS LIMITED PARTNERSHIP SAN ANTONIO SMSA LIMITED PARTNERSHIP ALBUCELL LIMITED PARTNERSHIP\nNOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED) -- CONTINUED\n4. LEASE COMMITMENTS\nFuture minimum rental payments required under operating leases (primarily for real estate) with initial or remaining noncancelable lease terms in excess of one year as of December 31, 1994, are as follows (in thousands):\nRent expense was approximately $27.4 million, $29.0 million and $17.3 million for the years ended December 31, 1994, 1993 and 1992, respectively.\n5. RELATED PARTY TRANSACTIONS\nIn accordance with the Partnership agreements, the general partners are reimbursed by the Partnerships for costs incurred by the general partners on behalf of the Partnerships. These costs are expensed in the accompanying combined statements of operations and include accounting, information systems, cash management, human resources, legal, operations, marketing and other administrative services. Total charges billed by the general partners to the Partnerships were $149.4 million, $115.7 million and $106.4 million included in the accompanying combined statements of operations as selling, general and administrative expenses, and $66.6 million, $44.3 million and $34.6 million included in the accompanying combined statements of operations as cost of services and sales for the years ended December 31, 1994, 1993 and 1992, respectively.\nCertain general partners advance funds to the Partnerships as necessary to finance operations. Interest expense is charged to the Partnerships on these advances at rates consistent with the general partners' average borrowing rates.\n6. MAJOR CUSTOMERS AND SUPPLIERS\nThe Los Angeles Partnership purchases substantially all its equipment from one supplier.\n7. REGULATORY INVESTIGATIONS\nLos Angeles Partnership\nOn December 21, 1993, the California Public Utilities Commission (\"CPUC\") adopted a new Order Instituting Investigation into the regulation of mobile telephone service and wireless communications, Order Number I.93-12-007. The investigation proposes a regulatory program which would encompass all forms of mobile telephone service.\nOn August 22, 1994, the CPUC issued an interim Decision that imposes a methodology in which existing cellular carriers be subject to rate cap regulation and other regulations, and requiring carriers, upon request, to permit resellers to operate reseller switches interconnected to the cellular carrier's facilities, to unbundle\nLOS ANGELES SMSA LIMITED PARTNERSHIP WASHINGTON D.C. SMSA LIMITED PARTNERSHIP GTE MOBILNET OF CALIFORNIA LIMITED PARTNERSHIP GTE MOBILNET OF SOUTH TEXAS LIMITED PARTNERSHIP SAN ANTONIO SMSA LIMITED PARTNERSHIP ALBUCELL LIMITED PARTNERSHIP\nNOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED) -- CONTINUED\ncellular access charges to resellers on a market basis and to subsidize resellers' roaming revenues. The Decision further authorized the CPUC to file a petition with the Federal Communications Commission to extend the CPUC's jurisdiction over cellular carriers for at least 18 months. Application for Rehearing and Suspension has been filed by various carriers and is pending with the CPUC. Currently, the Los Angeles Partnership is unable to quantify the precise impact of this Order on its future operations, but that impact may be material to the Los Angeles Partnership under certain circumstances.\nIn January 1992, the CPUC commenced a separate investigation of all cellular companies operating in California to determine their compliance with General Order number 159 (\"G.O. 159\"). The investigation addresses whether cellular utilities have complied with local, state or federal regulations governing the approval and construction of cellular sites in California. The CPUC may advise other agencies of violations in their jurisdictions. Currently, certain other carriers have agreed to monetary settlements as a result of this investigation.\nThe Los Angeles Partnership has prepared and filed the information requested by the CPUC. The CPUC will review the information provided by the Los Angeles Partnership and, if violations of G.O. 159 are found, it may assess penalties against the Los Angeles Partnership. The outcome of this investigation is uncertain and, accordingly, no accrual for this matter has been made.\nCalifornia Partnership\nThe California Partnership has also submitted information requested by the CPUC regarding compliance with G.O. 159. The CPUC will review the information provided by the California Partnership, and if violations of G.O. 159 are found, it may assess penalties against the California Partnership. The 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 California Partnership's financial statements.\n8. CONTINGENCIES\nLos Angeles Partnership\nTwo agents of the competing carrier have named the Los Angeles Partnership in several complaints against the carrier. The general allegations include violations of California Unfair Practices Act and price fixing. At a recent mandatory settlement conference, plaintiffs asked for $6 million from all defendants to settle the above claims ($2.5 million from AirTouch Cellular, including the Los Angeles Partnership). The proposed settlement offer has not been accepted.\nOn November 24, 1993, October 17, 1994 and November 30, 1994, three separate class action (not yet certified) suits were filed against the Los Angeles Partnership alleging conspiracy with a competing carrier to fix the price of cellular service in violation of state and federal antitrust laws. The plaintiffs are seeking injunctive relief and substantial monetary damages in excess of $100 million before trebling.\nIn May 1994, several former and current agents of the competing carrier have named the Los Angeles Partnership in only one cause of action. This cause of action alleges a conspiracy with the competing carrier to fix the prices of cellular service in violation of state antitrust laws. The plaintiffs are seeking damages in excess of $100,000 for each of the plaintiff agents.\nLOS ANGELES SMSA LIMITED PARTNERSHIP WASHINGTON D.C. SMSA LIMITED PARTNERSHIP GTE MOBILNET OF CALIFORNIA LIMITED PARTNERSHIP GTE MOBILNET OF SOUTH TEXAS LIMITED PARTNERSHIP SAN ANTONIO SMSA LIMITED PARTNERSHIP ALBUCELL LIMITED PARTNERSHIP\nNOTES TO COMBINED FINANCIAL STATEMENTS (UNAUDITED) -- CONTINUED\nOn July 18, 1994, AirTouch Cellular was served with a class action (not yet certified) suit on behalf of the Los Angeles Partnership's authorized agents. The complaint alleges \"predatory practices\" and seeks damages in excess of $1.6 million per agent, plus statutory treble damages.\nWashington D.C. Partnership\nDuring 1992 and 1993, BAMS was involved in litigation with a former sales agent in the Superior Court of Washington D.C. In December 1993, BAMS entered into a settlement agreement with the plaintiff for $11.4 million. As a result of this agreement, the Washington D.C. Partnership was allocated $10.4 million and $0.4 million (included in selling, general and administrative expenses) for their portion of the settlement and interest expense, respectively. Subsequently, in 1994 a dispute arose between BAMS and the Company because of the portion allocated to the Washington D.C. Partnership. On December 30, 1994, BAMS and the Company entered into a settlement agreement wherein BAMS agreed to reduce the allocated settlement of $10.8 million and associated legal fees by fifty percent. This resulted in a reduction to the general and administrative expenses in 1994 of $5.8 million.\nSouth Texas Partnership\nAn agent of the South Texas Partnership brought suit against the South Texas Partnership alleging that the South Texas Partnership is in violation of its agency contract. The agent alleges that the South Texas Partnership failed to comply with a provision contained in the agent contract which allegedly requires the South Texas Partnership to offer to the plaintiff commission payments offered to any other South Texas Partnership agents which are substantially and materially better than the commission payments set forth in the plaintiff's contract.\nIn early 1994, a jury trial returned a verdict in favor of the plaintiff in an amount which is to be determined in the judgment. The exposure may be up to $7 million. The general partner believes that the trial court committed several reversible errors which may result on appeal in either a reversal or a new trial. The ultimate outcome of this litigation is unknown at the present time; however, in management's opinion, the final outcome will not have a material adverse effect on the South Texas Partnership's financial statements.\nCalifornia Partnership\nOn October 10, 1994 a class action suit was filed on behalf of the cellular users in the San Francisco market against the two cellular carriers serving the area. The plaintiffs allege unlawful combination and collusion by the carriers resulting in a lack of rate reduction for cellular users which has led to excessive profits for the carriers. The complaint seeks a restraining order concerning basic rates for cellular service, treble damages, plus interest and attorney's fees. At this time the general partner has not discovered any fact which supports the plaintiffs' claims and believes that any prediction of the outcome would be premature. Accordingly, no provision for any liability that might result has been made in the California Partnership's 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\nDIRECTORS OF THE REGISTRANT\nDirectors of the Company are elected annually by the shareholders of the Company.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nExecutive officers of the Company are elected annually by, and serve at the pleasure of, the Company's Board of Directors.\nBiographical information regarding each executive officer is set forth below:\nDennis L. Whipple. Mr. Whipple has served as President and Chief Executive Officer of the Company since March 1991. From April 1990 to March 1991, he served as Vice President -- Marketing and Business Planning of GTE Mobile Communications. From June 1987 to April 1990, Mr. Whipple served as General Manager -- Florida for GTE Mobilnet.\nPamela F. Lopez. Ms. Lopez was elected Vice President -- Marketing in December 1993. Prior to becoming an officer of the Company, Ms. Lopez was Marketing and Distribution Manager of the Company's National Region, a position she held from March 1991 to December 1993. From September 1987 to March 1991 Ms. Lopez was the Regional Agent Manager in the Company's Virginia operations.\nRandall L. Crouse. Mr. Crouse was elected Vice President -- Network Operations in January 1993. Prior to becoming an officer of the Company, Mr. Crouse was Director -- Technology Projects for GTEMC (from March 1991 to January 1993) and Director -- Advanced Technology Planning for GTEMC (from August 1987 to March 1991).\nTheodore J. Carrier. Mr. Carrier has served as Chief Financial Officer and Treasurer of the Company since March 1991. From 1989 to March 1991, he served as Controller of the Company. Mr. Carrier served as Assistant Controller -- Financial Planning and Analysis of Contel Corporation from 1987 to 1989, and he was employed by Contel as Director of Budgets and Financial Planning and Analysis from 1986 to 1987.\nJay M. Rosen. Mr. Rosen became Secretary of the Company in April 1991. He also currently serves as Vice President -- Government Affairs and General Counsel for GTE Telecommunications Products and Services, a position he has held since April 1991. From 1989 to April 1991, Mr. Rosen served as Vice President and Associate General Counsel -- GTE Electrical Products and Government Systems Group. From 1986 to 1989, Mr. Rosen was employed by GTE as Vice President and Associate General Counsel -- GTE Diversified Products and Systems Group.\nLaura E. Binion. Ms. Binion became General Counsel and Assistant Secretary of the Company in March 1991. From October 1986 to March 1991, Ms. Binion was Corporate Counsel for Contel Corporation.\nDIRECTORS AND OFFICER SECURITIES REPORTS\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 written representations that no other reports were required, all persons subject to these reporting requirements filed the required reports on a timely basis.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nDIRECTOR'S COMPENSATION\nRetainer and Meeting Fees\nDirectors who are also employees of the Company, GTE or any subsidiary of GTE are not paid any fees or other remuneration, as such, for service on the Board of Directors or on any committee of the Board of Directors (a \"Committee\").\nEach nonemployee director receives an annual retainer for service on the Board of Directors equal to $12,000. In addition, each nonemployee director receives $1,000 for each Board of Directors or Committee meeting such director attends. Nonemployee directors are not eligible to participate in the employee incentive programs, savings plans, or stock purchase plans.\nAll directors receive reimbursement of all out-of-pocket expenses they incur in attending meetings of the Board of Directors or its Committees.\nIn connection with the proposed Merger, a Special Committee of independent directors of the Board of Directors was formed to negotiate the Merger on behalf of the holders of Class A Shares and make a recommendation to the Board of Directors in connection with this transaction. Members of the Special Committee each received a fee of $35,000 and the Chairman received a fee of $45,000.\nEXECUTIVE COMPENSATION\nReport of the Compensation Committee\nThe original compensation committee (the \"Original Committee\") of the Board of Directors of the Company was established on December 3, 1992. The Original Committee was formed to review and approve the annual compensation of the Company's Chief Executive Officer and senior management personnel (the \"Executive Group\"). On December 27, 1994, in conjunction with the approval by the Board of Directors of the Merger, the Board of Directors created a second compensation committee (the \"Second Committee\"; the Original Committee and the Second Committee are sometimes collectively referred to herein as the \"Committees\") to perform certain, but not all, of the functions of the Original Committee. The Second Committee was formed to review the base and incentive compensation of the Executive Group. The Original Committee retained the authority to determine any stock-based awards to be granted to the Executive Group. Both Committees have the same compensation philosophy.\nCompensation Philosophy. The Committees believe that the compensation for the Executive Group should attract superior individuals, reward sustained performance and maximize shareholder value. The Committees also believe that because the Company is a majority owned subsidiary of GTE, the compensation for the Executive Group should be compatible with the compensation of other GTE subsidiaries. This compatibility allows employees to transfer from the Company to other GTE business units and in turn allows the Company to draw superior employees from other parts of GTE, thereby providing vital workforce renewal.\nGTE has a uniform system of compensation among all of its subsidiaries designed to compensate executives at competitive compensation levels of comparable companies. This system is modified within each subsidiary, including the Company, based on the unit's unique business demands and comparable industry statistics. Information about GTE's compensation system has been provided to the Committees by representatives of GTE.\nTo determine how GTE's uniform system of compensation should be modified and applied to the Company, the Company participates in surveys conducted by nationally recognized compensation consultants. Based on these surveys, the Committees believe that the Company's executives are compensated at or near the median of the range of comparable companies.\nThe companies participating in these surveys include the cellular subsidiaries of the Regional Bell Operating Companies (\"RBOC Subsidiaries\") as well as independent publicly traded cellular companies. The companies included in the compensation surveys are not identical to the companies included in the Industry\nPeer Group utilized in the Performance Graph on page 69 because the RBOC Subsidiaries are included in the compensation surveys but not in the Industry Peer Group. The RBOC Subsidiaries are included in the compensation surveys because they are in the same industry as the Company and are frequently competitors of the Company. They are not included in the Industry Peer Group because the stocks of the RBOC Subsidiaries are not publicly traded independently of the stocks of their parent holding companies.\nAlthough the Committees have attempted to keep the Company's executive compensation uniform with GTE's other subsidiaries, the Committees recognize that the Company is not wholly owned by GTE. This fact requires some deviations from GTE's standard practices. These deviations are noted, as applicable, throughout the following description of the Company's executive compensation.\nIn keeping with the compensation philosophy of the Committees, the Executive Group's compensation is comprised of three components: base salary, incentive pay and stock awards.\nBase Compensation. The first component of executive pay is base salary. Each management position is given a grade level with an attendant salary range. The grade levels are determined using the Hay Job Evaluation System, an orderly and widely recognized job leveling system. The individual's performance, years of experience and prior salary increase history determine where within the salary range the individual's base salary falls.\nThe base salary of each member of the Executive Group is determined by reviewing the individual's performance as well as the duties and responsibilities of the respective executive management position. The grade levels of the Executive Group are generally comparable to other similar management positions within GTE. However, because the Company is not wholly owned by GTE, the Committee reviews the grade levels and the base salary of each member of the Executive Group.\nThe base compensation of Dennis L. Whipple, Chief Executive Officer of the Company, was increased from $170,700 to $190,000 effective January 3, 1994. This increase was the decision of the Original Committee. This change represented an 11.3% increase in Mr. Whipple's base salary and was based upon both the performance of the Company and Mr. Whipple in 1993. This increase also reflected a job grade adjustment based on industry trends regarding executive compensation. The Original Committee reviewed the Company's and Mr. Whipple's performance with respect to objectives related to revenue, operating income, net income, capital expenditures, reduction in bad debt, service revenue, year-end subscribers, annual subscriber churn rate, revenue per subscriber, network quality, acquisition costs and facilities costs. The Original Committee also reviewed certain qualitative objectives of Mr. Whipple including network improvement, increased customer satisfaction, increased market share, margin improvement and revenue enhancement. Each of Mr. Whipple's objectives were of substantially equivalent importance.\nThe base compensation of each member of the Executive Group was also increased during 1994. The percentage increases ranged from 5% to 6% and were based upon the Company's performance of the objectives outlined above, each individual's performance, each individual's position in the assigned salary range and general industry trends regarding base compensation. All of these salary increases were determined by the Original Committee.\nThe base salaries of the Chief Executive Officer and the other four most highly compensated officers of the Company are included under the \"Salary\" column of the Summary Compensation Table on page 66.\nIncentive Compensation. The second component of compensation of the Executive Group is incentive pay. The Chief Executive Officer participates in the GTE Executive Incentive Plan. Each other member of the Executive Group participates in the GTE Unit Incentive Plan. Under both of these plans, awards are made based upon the Company's performance during the last fiscal year and upon the individual participant's achievement of certain objectives. Both of these plans are administered by the Executive Compensation and Organization Structure Committee of the Board of Directors of GTE. However, because the Company is not a wholly owned subsidiary of GTE, decisions with respect to the amount of any award is made by the Committees. Awards for the year 1994 were determined by the Second Committee.\nThe award to Mr. Whipple under the GTE Executive Incentive Plan (\"EIP\") was $110,300 for 1994. This award represented approximately 37% of Mr. Whipple's total cash compensation for the year and was based on both the performance of the Company and Mr. Whipple with respect to certain quantitative and qualitative objectives. The objectives reviewed by the Second Committee to determine Mr. Whipple's EIP award were essentially the same as those reviewed to determine the merit increase in his base salary. The Second Committee determined that Mr. Whipple met or exceeded the majority of these objectives.\nEach other member of the Executive Group also received an award under the GTE Unit Incentive Plan (\"UIP\") for 1994 performance. The total amount of these awards was $139,600. The Second Committee determined the amount of these awards based upon the same performance objectives for the Company as used to determine Mr. Whipple's EIP award, as well as each individual's performance with respect to certain pre-established goals.\nEIP and UIP awards for the Chief Executive Officer and the other four most highly compensated officers of the Company are included in the \"Bonus\" column of the Summary Compensation Table on page 66.\nStock-Based Awards. The third and final component of compensation of the Executive Group is eligibility to receive certain stock-based awards under the Contel Cellular Inc. 1987 Key Employee Stock Plan (the \"Option Plan\"). The plan authorizes the Board of Directors or duly authorized committee thereof to grant stock options, stock appreciation rights and restricted stock units to key employees of the Company. The Board of Directors has given the Original Committee the authority to grant stock-based awards. The exercise price per share cannot be less than 100% of the fair market value of a share of Class A Common Stock on the date of grant.\nThis component is designed to be a long-term incentive program for key executives of the Company which provides a direct link between the performance of the Company stock and the compensation of the Executive Group. This component is also designed to be equivalent to the stock options granted under GTE's 1991 Long Term Incentive Plan (\"LTIP\") for the executives of GTE's other business units. Under the LTIP, GTE grants executive and other management employees at certain levels a specified number of GTE stock options on an annual basis. Because the Company is not a wholly owned subsidiary of GTE, key executives of the Company receive Contel Cellular Inc. option grants, instead of GTE option grants. In determining the number of stock options granted, the Original Committee considered the value of long-term incentives granted by comparable companies and attempted to award option grants in amounts designated to ensure that the members of the Executive Group were compensated competitively within the industry. The Original Committee did not consider the number of options or other forms of long-term compensation currently held by any individual participant in the Option Plan, since such action may create an incentive to accelerate the exercise of such options and sale of shares.\nMr. Whipple received a grant of 7,100 stock options and the Executive Group collectively received a grant of 9,100 stock options at an exercise price of $16.25 on March 22, 1994 under the Option Plan.\nThe Summary Compensation Table and the Option\/SAR Grants in Last Fiscal Year Table on page 66 and 67, respectively, summarize stock under this Plan.\nNew Internal Revenue Service Rules. In late December 1993, the Internal Revenue Service issued proposed regulations limiting the deduction a publicly held corporation may take for compensation paid to its chief executive officer and its four other most highly compensated officers. The IRS regulations limit the amount that a company may deduct to one million dollars per person unless the compensation constitutes \"performance based\" compensation. Final rules have not yet been issued. Currently no Company executive receives compensation which would subject the Company to this regulation.\nOther Compensation. Employees of the Company also participate in various broad-based GTE employee benefit plans. Members of the Executive Group participate in these plans on the same terms as eligible non-executive employees, subject to any legal limits on the amounts that may be contributed or paid to executives under the plans. GTE offers an Employees' Stock Plan pursuant to the provisions of Section 423 of the Internal Revenue Code of 1986, as amended (the \"Code\") under which employees may purchase GTE Common Stock at a discount. The GTE Savings Plan (the \"Savings Plan\") offered pursuant to provisions of\nSection 401(k) of the Code permits employees to invest in a variety of funds on a pre- or after-tax basis. Matching contributions under the Savings Plan are made in GTE Common Stock. Company employees participate in pension plans, insurance and other benefit plans.\nOriginal Committee\nRussell E. Palmer, Chairman Terry S. Parker Irwin Schneiderman\nSecond Committee\nCharles R. Lee Michael T. Masin Nicholas L. Trivisonno\nDate: March 28, 1995\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe directors whose names appear at the conclusion of the Report of the Compensation Committee currently serve as either members of the Original Committee or the Second Committee. Mr. Russell E. Palmer is a member of the Board of Directors of GTE. During the time period discussed in the Report of the Compensation Committee, Mr. Terry S. Parker was Senior Vice President of GTE, Chairman of the Company and President of Personal Communications Services, a division of GTE. Mr. Parker will retire from GTE and resigned his positions with GTE and the Company effective March 1, 1995. Mr. Charles R. Lee is the Chairman of the Board of Directors of GTE and its Chief Executive Officer. Mr. Michael T. Masin is the Vice Chairman of the Board of Directors of GTE. Mr. Nicholas L. Trivisonno is Executive Vice President -- Strategic Planning of GTE and Group President.\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 Chief Executive Officer and each of the other four executive officers of the Company at December 31, 1994 for services in all capacities to the Company and its subsidiaries.\n---------------\n(1) Company executives are paid bi-weekly. As a result of this cycle, executives received 27 payments of base salary in 1992, rather than the usual 26. The data in the table includes the extra payment and, accordingly, overstates the 1992 base salary rate by 1\/26th, or 3.8%. (2) Two-thirds of the stock options granted allow stock appreciation rights to be substituted for the corresponding options. (3) The Company has not adopted a long-term incentive plan. (4) All other compensation for 1994 includes Company contributions to the GTE Savings Plan and Company contributions to the GTE Executive Salary Deferral Plan. (5) Mr. Eliason became Vice President -- Operations on January 3, 1994. Prior to that time he was Vice President\/General Manager -- National Region effective August 1992. The 1992 salary listed in the table for Mr. Eliason reflects only his salary for the portion of the year he was employed by the Company. Mr. Eliason became President -- GTE Telecommunications Services, Inc. effective January 16, 1995. Accordingly, Mr. Eliason resigned as Vice President -- Operations of the Company effective January 16, 1995. (6) Mr. Crouse became Vice President -- Network Operations on January 18, 1993. The 1993 salary listed in the table for Mr. Crouse reflects only his salary for the portion of the year he was employed by the Company. (7) Ms. Binion became an officer of the Company on January 18, 1993. (8) Ms. Lopez became Vice President -- Marketing on December 6, 1993.\nOPTIONS\/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. The options and SARs were granted under the Option Plan. Pursuant to Securities and Exchange (the \"SEC\") rules, the table also shows the value of the options granted at the end of the option term (ten years) if the stock price were to appreciate annually by 5% and 10% respectively.\n---------------\n(1) Two-thirds of the stock options granted allow SARs to be substituted for the corresponding options. (2) Since Mr. Eliason resigned from his position with the Company on January 16, 1995 to become President -- GTE Telecommunications Services, Inc., all options granted to Mr. Eliason have lapsed.\nGTE intends to acquire the Company's Class A Common Stock through the Merger. In the Merger, each share of Class A Common Stock will be converted into the right to receive $25.50 in cash. Accordingly, the price of the Company's Class A Common Stock is not expected to increase above its current level.\nIn connection with the Merger, GTE has offered to make cash payments to the holders of the options granted under the Option Plan who agree to surrender all of their options. Each optionholder who agrees to surrender all of his or her options will receive a cash payment for each option canceled, whether or not currently vested (so long as the exercise period has not lapsed), equal to $25.50 multiplied by the number of Class A Shares subject to such options, less the exercise price for such option. If the vesting of the options is accelerated and if all of the options are surrendered, the maximum amount paid to Messrs. Whipple and Crouse and Ms. Lopez and Ms. Binion will be $168,388, $30,425, $15,725, and $16,660, respectively.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION\/SAR VALUES\nThe following table provides information as to options and stock appreciation rights exercised by each of the named executive officers of the Company during 1994 and the value of options and stock appreciation rights held by such officers at fiscal year end measured in terms of the closing price of the Class A Shares on December 31, 1994.\n---------------\n(1) The SARs granted may be substituted for the corresponding stock options. (2) Since Mr. Eliason resigned from his position with the Company on January 16, 1995 to become President -- GTE Telecommunications Services, Inc., all options granted to Mr. Eliason have lapsed.\nRETIREMENT PROGRAMS\nPension Plans\nEmployees of the Company participate in the pension plan maintained by GTE Service Corporation (the \"GTE Pension Plan\"), which is a non-contributory pension plan based on years of service. The estimated annual benefits payable, calculated on a single life annuity basis, under the GTE Pension Plan at normal retirement at age 65, based upon final average earnings and years of employment, is illustrated in the table below:\nPENSION PLAN TABLE\nPension benefits to be paid from the GTE Pension Plan and contributions to the GTE Pension Plan are related to basic salary exclusive of overtime, differentials, incentive compensation (except as otherwise described) and other similar types of payment. Under the GTE Pension Plan, pensions are computed on a two-rate formula basis of 1.15% to 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 Social Security Act), and the 1.45% service credit being applied to that portion of the average annual salary that exceeds said level. As of March 15, 1995, the credited years of service under the GTE Pension Plans for Messrs. Whipple, Eliason and Crouse and for Ms. Lopez and Ms. Binion are 23, 18, 30, 8 and 8, respectively.\nUnder federal law, an employee's benefits under a qualified pension plan such as the GTE Pension Plan are limited to certain maximum amounts. Certain qualified employees of the Company also participate in the\nGTE Supplemental Executive Retirement Plan (\"SERP\") which supplements the benefits of any participant in the qualified pension plan by direct payment of a lump sum or by an annuity, on an unfunded basis, of the amount by which any participant's benefits under the GTE Pension Plan are limited by law. In addition, the SERP includes a provision permitting the payment of additional retirement benefits determined in a similar manner as under the qualified pension plan on remuneration accrued under the management incentive plans. The amounts of the additional payments are included in the Pension Plan Table set forth above under the column entitled \"Final Average Earnings\". In 1994, Messrs. Whipple, Eliason and Crouse and Ms. Lopez and Ms. Binion participated in SERP.\nExecutive Retired Life Insurance Plan\nMessrs. Whipple and Eliason also participated in the GTE Executive Retired Life Insurance Plan (\"ERLIP\"), which provides for a post-retirement life insurance benefit of up to three times final base salary. Upon retirement, ERLIP benefits may be paid as life insurance, or, optionally, an equivalent amount may be paid as a lump sum payment equal to the present value of life insurance amount (based on actuarial factors and the interest rate then in effect), as an annuity or as installment payments. If an optional payment method is selected, the ERLIP benefit will be based on the actuarial equivalent of the present value of the life insurance amount.\nTRANSITION ARRANGEMENTS\nIn order to provide a degree of continuity during the merger transition process, GTE has entered into a Transition Bonus Agreement with two executives, Dennis L. Whipple, President and Chief Executive Officer of the Company, and Theodore J. Carrier, Treasurer and Chief Financial Officer of the Company. If Mr. Whipple agrees to remain with GTE from the date of the Merger until December 31, 1995 or such earlier date as the parties may determine, he will be eligible for a transition bonus equal to 100% of the sum of his final GTE annual base rate of pay and the average of his GTE Executive Incentive Plan (\"EIP\") awards for the 1993 and 1994 plan years. If Mr. Carrier agrees to remain with GTE through December 31, 1995, he will be eligible for a transition bonus equal to 100% of the sum of his final GTE annual base rate of pay and the average of his EIP awards for the 1992, 1993, and 1994 plan years. In addition, Mr. Whipple will receive an initial bonus of $20,000. In 1995, Mr. Whipple will participate in the 1994-1995 and 1994-1996 GTE Long-Term Incentive Plan performance bonus award cycles and the 1995-1997 cycle. If Mr. Whipple remains on the payroll to the end of the agreed upon period then, in lieu of an award for the 1995-1997 bonus award cycle, he will receive an equivalent bonus award prorated to December 31, 1995.\nAny executive officer whose employment is involuntarily terminated will receive an enhanced retirement benefit paid out of GTE's qualified pension assets pursuant to the terms of the GTE's Involuntary Separation Plan (\"ISEP\"). ISEP provides for a benefit based on length of service and\/or grade level and the benefit will not exceed 120% of one year's salary. Mr. Whipple's and Mr. Carrier's ISEP benefits also include a non-qualified benefit attributable to their EIP award for the three previous years.\nPERFORMANCE GRAPH(1)\nThe following table shows a comparison of the total return to holders of the Class A Shares of the Company, its Industry Peer Group, and the Nasdaq Composite Index (\"NASDAQ Index\").\n[GRAPH]\n(1) Assumes $100 invested on December 29, 1989. (2) Industry Peer Group is comprised of LIN Broadcasting Corp., United States Cellular, Inc., Vanguard Cellular Systems and McCaw Cellular Communications, Inc.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nCERTAIN BENEFICIAL OWNERS\nThe following table contains certain information regarding the only persons known to the Company as of February 13, 1995 to be beneficial owners of more than 5% of any class of the Company's voting securities:\n--------------- (1) This information was obtained from a Schedule 13G filed with the SEC on February 13, 1995 by CS First Boston, Inc.\n(2) The Schedule 13G filed by CS First Boston, Inc. discloses that CS First Boston, Inc. exercises sole voting power and sole dispositive power over these shares.\n(3) GTE acquired beneficial ownership of these shares as a result of the merger of a subsidiary of GTE into Contel. Contel remains the holder of record of these shares. The address of Contel is One Stamford Forum, Stamford, Connecticut 06904.\n(4) GTE, through Contel, exercises sole voting power and sole dispositive power over these shares.\nDIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nThe number of Class A Shares and shares of GTE Common Stock owned by each director and executive officer of the Company as of February 13, 1995 is set forth in the table below. Unless otherwise indicated, all persons shown in the table have sole voting and investment power with respect to the shares shown.\n--------------- (1) Each of these amounts, and all of them in the aggregate, represented less than 1% of the outstanding Class A Shares as of February 13, 1995.\n(2) Each of these amounts, and all of them in the aggregate, represented less than 1% of the outstanding shares of GTE Common Stock as of January 31, 1995.\n(3) Included in the number of shares beneficially owned by Messrs. Johnson, Lee, Masin, Trivisonno, Whipple and Ms. Binion and the Executive Group are: 633,300; 553,399; 72,599; 170,233; 5,300; 816; and 1,461,279 shares, respectively, which such persons have the right to acquire within 60 days pursuant to stock options.\n(4) This amount includes shares acquired through participation in GTE's Consolidated Employee Stock Ownership Plan and\/or Savings Plan.\n(5) In addition to the shares of GTE Common Stock shown above, Mr. Masin owns 10,088 GTE Common Stock Units, which are payable in cash under the Deferred Compensation Plan and Phantom Stock Plan for Nonemployee Members of the Board of Directors of GTE Corporation (the \"Deferred Compensation Plan\"). Mr. Masin was a non-employee director of GTE prior to joining GTE as Vice Chairman in 1993.\n(6) In addition to the shares of GTE Common Stock shown above, Mr. Palmer owns 1,294 GTE Common Stock Units, which are payable in cash under the Deferred Compensation Plan.\n(7) In addition to the shares of GTE Common Stock shown above, Mr. Walter owns 121,116 GTE Common Stock Units, which are payable in cash under the Deferred Compensation Plan.\n(8) Included in the number of shares beneficially owned by Messrs. Whipple and Crouse and Ms. Lopez and Ms. Binion and the Executive Group are 18,650, 3,100, 1,700, 1,700 and 40,150 shares, respectively, which such persons have the right to acquire upon the exercise of certain stock options. Pursuant to an offer made by the Company in connection with the Merger, such options, whether or not currently vested, may be surrendered for a cash payment equal to $25.50 times the number of shares issuable upon exercise thereof, less the exercise price applicable thereto. If Messrs. Whipple and Crouse and Ms. Lopez and Ms. Binion and the Executive Group agree to surrender the options they hold, the maximum amount payable to those individuals and the Executive Group is $168,388, $30,425, $15,725, $16,600 and $290,898, respectively.\n(9) Since Mr. Eliason resigned from his position with the Company on January 16, 1995 to become President -- GTE Telecommunications Services, Inc., all options granted to Mr. Eliason have lapsed and are not included in this table.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nARRANGEMENTS AND TRANSACTIONS WITH CONTEL AND GTE\nThe Company was initially formed as a wholly owned subsidiary of Contel Corporation. On March 14, 1991, GTE Exchange Corporation, a wholly owned subsidiary of GTE, merged into and with Contel (the \"Contel Merger\"), and Contel became a wholly owned subsidiary of GTE. On January 7, 1993, Contel adopted a Plan of Merger pursuant to which Contel will merge into and with GTE no later than December 31, 1995.\nGTE, through Contel, currently owns all of the Company's Class B Common Stock, which constitutes approximately 90% of the Company's outstanding capital stock. As a result of the disproportionate voting rights between Class A Common Stock and Class B Common Stock (one vote for each share of the Class A Common Stock compared with five votes for each share of the Class B Common Stock), GTE controls approximately 97.8% of the combined voting power of both classes of the Company's capital stock. Eight of the Company's eleven members of the Board of Directors of the Company are currently executive officers or directors of GTE, or one of its subsidiaries. Based on its continuing ownership of Class B Common Stock, GTE will continue to have the ability, without the approval of the Company's public stockholders, to elect all of the Company's directors, to direct or substantially influence the Company's affairs and policies, to amend the Company's Amended and Restated Certificate of Incorporation, to effect a merger, sale of assets, or other corporate transaction and to defeat any hostile tender offer.\nOn December 27, 1994, the Company's Board of Directors approved the Merger and the Merger Agreement pursuant to which (i) each Class A Share (other than Class A Shares as to which appraisal rights have been properly exercised under the Delaware General Corporation Law), will be converted into the right to receive $25.50 in cash, without interest, subject to back-up withholding taxes, (ii) each Class A Share held by the Company and each outstanding share of the common stock of CCI Acquisition will be cancelled, and no payment will be made with respect thereto and (iii) each outstanding share of the Class B Common Stock of the Company, par value $1.00 per share, will continue to be outstanding.\nThe Company, Contel and GTE have a number of financial, operating and other arrangements and have engaged in certain transactions believed to be of mutual benefit. The terms of these arrangements have been established by Contel and GTE in consultation with the Company but are not the result of arms-length negotiations. The following is a summary of the principal arrangements and transactions among the Company, Contel and GTE.\nTaxes. The Company and GTE have a tax sharing arrangement under which the Company and its subsidiaries are included in the consolidated federal income tax returns and in certain state income and\nfranchise tax returns of GTE. Tax payments, if applicable, are made by the Company to GTE on a quarterly basis using methods prescribed by GTE. When the Company and its subsidiaries generate a federal tax loss or excess credits (credits exceeding tax liability), the Company is reimbursed by GTE on a quarterly basis based on the actual loss or credit which may be utilized in the consolidated GTE federal tax returns.\nWith respect to states permitting unitary or combined tax filings, GTE includes the Company and its subsidiaries in its unitary or combined tax filing. The Company pays to GTE an amount equal to the state income or franchise tax that would have been payable by the Company or its subsidiaries if a separate tax return had been filed.\nFinancing and Cash Management. During 1994, the Company relied on GTE for its short term and long term cash needs. The Company's long term cash needs are mainly the result of its acquisition in February 1990 of the cellular telephone properties previously owned by McCaw Cellular Communications, Inc. in Kentucky, Alabama and Tennessee (the \"Southeast Properties\") for approximately $1.3 billion and subsequent borrowings to pay interest on such amount. The $1.3 billion was originally funded by a loan from Contel Capital Corporation, which at that time was a wholly owned subsidiary of Contel, which became due in July 1991. This original loan was replaced in 1991 with (i) a $700 million loan from GTE to the Company bearing interest at 10.47% and maturing on March 1, 1998, (ii) a $150 million loan from GTE Finance Corporation (\"GTE Finance\"), a wholly owned subsidiary of GTE, bearing interest at 9.22% and maturing on February 15, 1993 (subsequently refinanced as set forth below), and (iii) a variable rate note from GTE bearing interest at one and one-half percentage points above GTE's external cost of borrowing these funds. The interest rate on the notes described in (i) and (ii) above include an additional one and one-half percentage point of interest in excess of the interest paid by GTE for these funds.\nDuring 1992, the Company began a program of converting a portion of its variable rate debt, including a portion of the debt incurred in connection with the acquisition of the Southeast Properties, to fixed rate debt. As a result of this program, the Company entered into the following loans in 1992, 1993 and 1994: (i) a $150 million loan from GTE Finance to the Company bearing interest at 8.38% and maturing on September 25, 1997, (ii) a $150 million loan from GTE Finance to the Company bearing interest at 8.97% and maturing on September 27, 1999, (iii) a $200 million loan from GTE to the Company bearing interest at 8.56% and maturing on December 31, 1996, (iv) a $200 million loan from GTE to the Company bearing interest at 8.08% and maturing on December 31, 1995, (v) a $150 million loan from GTE Finance to the Company bearing interest at 7.71% and maturing on February 25, 1997 and (vi) a $75 million loan from GTE Finance to the Company bearing interest at 9.90% and maturing on August 17, 2000. The interest rates on these loans were comparable to rates for United States Treasury securities of similar maturity plus 3% per annum at the time such loans were entered into and are the rates which GTE believes approximate the interest rates the Company could have obtained in the marketplace from nonaffiliated lenders. These rates exceed the interest paid by GTE for these funds. As of December 31, 1994, the Company has borrowed approximately $1.63 billion from GTE and GTE Finance in fixed rate debt.\nThe Company fulfills its immediate cash needs with an intercompany note from GTE (the \"ICN\"). The amount borrowed and the rate of interest on the ICN fluctuate daily. As of December 31, 1994 the amount of the ICN was approximately $495 million. During 1994, the interest rate on the ICN was the daily Prime Rate quoted in The Wall Street Journal plus .75%, which is the interest rate which GTE believes approximates the interest rate the Company could have obtained in the marketplace from nonaffiliated lenders and exceeds the interest paid by GTE for these funds.\nIn January 1995, GTE provided the Company with a letter stating that GTE had no plans or intentions to discontinue providing financial support to the Company through intercompany credit facilities to meet ongoing operating and capital requirements, and that GTE would not demand payment under intercompany credit facilities before June 30, 1996.\nDuring 1994, the Company also received cash management services from GTE.\nTrademark License Agreement. The Company and Contel have entered into an agreement under which the Company has been granted a non-exclusive, non-transferrable license and right to use the trademark,\nservice mark and design \"CONTEL CELLULAR\". This grant may be terminated at the sole discretion of Contel and will automatically terminate if Contel no longer owns a majority of the outstanding common stock of the Company.\nGeneral Services. During 1994, the Company received numerous services, both primary and supplemental, from GTE PCS pursuant to the Services Agreement between the Company and GTEMC. These services were also provided to GTE's wholly owned cellular subsidiary, GTE Mobilnet, and included accounting, finance, marketing, human resources, legal, regulatory, governmental relations, international, engineering, network design and maintenance services. In exchange for these services, the Company reimbursed GTE PCS for its expenses in accordance with a cost causative allocation formula which allocated pools of costs to operating units based on one of several factors. These factors were developed and applied to cost categories in an effort to allocate expenses to operating units in proportion to the use and benefit of the underlying cost. Under this Services Agreement, the Company paid GTE PCS approximately $49.8 million in 1994, which was approximately 34% of all of the expenses of GTE PCS.\nInsurance. The Company and its officers, directors and employees are insured under a master contract negotiated by GTE with a private insurance carrier. The premium due the insurance carrier under this master policy is allocated among all GTE subsidiaries based on the loss history, total payroll and total number of vehicles owned by each subsidiary. The premium is paid directly to the private insurance carrier by each subsidiary.\nCompetition. The Company, Contel and GTE have entered into the Competition Agreement pursuant to which Contel and GTE have agreed that they will not engage in the cellular business except in accordance with the terms of the Competition Agreement. Under the Competition Agreement, GTE Mobilnet may continue to engage in the cellular business. However, the Company has a right of first refusal with respect to future acquisitions by GTE of cellular businesses except for (i) acquisitions of minority interests in cellular properties held by GTE Mobilnet and (ii) acquisitions contemplated at the time of the Contel Merger which were specifically listed in the Competition Agreement. After the Merger is effective, the Competition Agreement will be terminated.\nGovernment Systems Contract. In 1994 the Company entered into an agreement with GTE Government Systems Corporation (\"GTE Systems\") pursuant to which GTE Systems will construct not less than 40 cell sites for the Company in 1994 and 50 cell sites in 1995. The cost to be charged the Company in 1994 will consist of (i) an administrative fixed fee of $3.1 million, (ii) reimbursement of materials and equipment estimated to be $7.8 million and (iii) reimbursement of external labor costs estimated to be $3.0 million. Contract pricing in 1995 will be agreed upon by the parties.\nCellular Exchange Transaction. The Company and the GTE Parties entered into an Asset Exchange Agreement dated February 3, 1995. Under the terms of the Asset Exchange Agreement the Company will receive a 28% interest in the San Diego MSA in exchange for certain cellular assets in Albuquerque, New Mexico and Minneapolis, Minnesota. The Company will operate the San Diego system pursuant to a management agreement with the other GTE Parties. See \"BUSINESS -- The Company's Cellular Operations\".\nPAYMENTS TO OPTIONHOLDERS\nCertain officers and employees of the Company are participants under the Option Plan. Options were granted under the Option Plan at prices ranging from $15.00 to $22.81. In connection with the Merger, the Company has offered to make cash payments to those holders of options to purchase Class A Shares issued pursuant to the Option Plan who agree to surrender all of their options. Each optionholder who agrees to surrender all of his or her options will receive a cash payment for each option cancelled, whether or not currently vested (so long as the exercise period has not lapsed), equal to $25.50 multiplied by the number of Class A Shares subject to such options, less the exercise price for such option. If the vesting of the options is accelerated and if all of the options are surrendered as described above, Dennis L. Whipple will receive $168,388. No other officer will receive an amount greater than $60,000.\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 Contel Cellular Inc. are included in Part II, Item 8:\n(a) (2) Financial Statement Schedules\nAll other schedules are omitted because they are not applicable, not required, or because the required information is included in the accompanying financial statements or notes thereto.\n(a) (3) Exhibits\n(b) Report 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.\nCONTEL CELLULAR INC.\nBy: \/s\/ THEODORE J. CARRIER ------------------------------------ Theodore J. Carrier Treasurer and Principal Financial and 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 the registrant and in the capacities and on the dates indicated.","section_15":""}
{"filename":"837290_1994.txt","cik":"837290","year":"1994","section_1":"ITEM 1.BUSINESS\nGENERAL\nKey Production Company, Inc. (Key or the Company) is an independent oil and gas company engaged in oil and gas exploration, development and production in the continental United States. The Company's exploration interests are spread over 13 states with primary focus areas in the Rocky Mountain region, the Anadarko Basin of Oklahoma and the Gulf Coast. The Company was incorporated in Delaware on June 22, 1988, and maintains its corporate offices in Denver, Colorado. Key opened regional exploration offices in Tulsa, Oklahoma and Houston, Texas in October 1994 and March 1995, respectively. The Company's common stock trades on The Nasdaq Stock Market under the symbol KPCI.\nBUSINESS DURING 1994\nProduction during 1994 totaled 504 Mbbls of oil and 4,522 MMcf of gas. Oil and gas production increased 142 percent and 18 percent, respectively, as a result of the acquisition of producing properties on April 29, 1994, and due to production from new drilling. Product prices averaged $14.27 per barrel of oil and $1.98 per Mcf of gas.\nThe majority of Key's spot market gas production is marketed by Apache Corporation (Apache) and is sold to Natural Gas Clearinghouse (NGC). Sales to NGC accounted for 38 percent of Key's 1994 oil and gas revenues. Eighty-Eight Oil Company (Eighty-Eight Oil) was the largest purchaser of Key's crude oil production. Approximately 19 percent of 1994 revenues resulted from crude oil sales to Eighty-Eight Oil. No other single purchaser accounted for more than 10 percent of revenues in 1994.\nKey has working interests in approximately 1,258 gross (89 net) wells located primarily in the Anadarko Basin of Oklahoma, Wyoming, southern Texas, Louisiana and offshore Gulf of Mexico. In addition, Key has royalty or overriding royalty interests in approximately 60 properties in the Midcontinent region, 60 properties in the Gulf Coast region and 1,750 properties in the Rocky Mountain region. At year end, Key held approximately 90,800 net acres of developed leasehold located primarily in Oklahoma, Wyoming, Texas and Louisiana. Key also held approximately 533,000 net acres of undeveloped leasehold located in the Rocky Mountain region.\nIn 1994, the Company spent $23 million on acquisitions of producing and non- producing oil and gas properties and $6.9 million on exploration and development activities. Key participated in drilling 45 gross (6.25 net) wells in 1994. During 1994, 38 gross (3.95 net) wells were completed as producers and 7 gross (2.29 net) wells were dry. Sales of producing properties were not significant in 1994.\nCOMPETITION\nThe oil and gas industry is highly competitive. As an independent oil and gas company, Key must compete against companies with substantially larger financial and other resources for a variety of opportunities including reserve and lease acquisitions and marketing agreements.\nNATURAL GAS AND OIL PRICES\nKey's gas price averaged $1.98 per Mcf in 1994, $.21 lower than the prior year average of $2.19 per Mcf. Key's average realized oil price fell to $14.27 per barrel in 1994, down from $15.36 in the prior year. Key's business will continue to be affected by future changes in domestic and international oil and gas prices. No assurances can be given as to the trend in, or level of, future oil and gas prices.\nRESERVE VALUE CEILING TEST\nKey reviews the carrying value of its oil and gas properties on a quarterly basis under the full cost accounting rules of the Securities and Exchange Commission (SEC or the Commission). Under the full cost\naccounting rules, capitalized costs of oil and gas properties may not exceed the present value of estimated future net revenues from proved reserves, discounted at 10 percent, plus the lower of cost or fair market value of unproved properties, as adjusted for related tax effects and deferred tax reserves. Application of this rule generally requires pricing future revenues at the unescalated prices in effect at the end of each fiscal quarter and requires a write-down if the \"ceiling\" is exceeded, even if prices declined for only a short period of time. If a write-down were required, the one-time charge to earnings would not impact cash flow from operating activities. Key did not record any write-downs in the three years ended December 31, 1994.\nREGULATION OF OIL AND GAS\nKey's exploration, production and marketing are regulated extensively at the federal, state and local levels. Oil and gas exploration, development and production activities are subject to various laws and regulations governing a wide variety of matters. For example, the states in which Key produces oil and gas have statutes or regulations addressing production practices that may affect Key's operations and limit the quantity of hydrocarbons Key may produce and sell. Other regulated matters include the marketing and transportation of oil and gas and the valuation of royalty payments.\nAmong other regulated matters on the federal level, the Federal Energy Regulatory Commission (FERC) regulates interstate transportation of natural gas under the Natural Gas Act. Key's gas sales are affected by regulation of intrastate and interstate gas transportation. In an attempt to promote competition, FERC has issued a series of orders which have significantly altered the marketing and transportation of natural gas. To date, Key has not experienced any material adverse effect on gas marketing as a result of these FERC orders. However, the Company cannot predict what effect subsequent regulations may have on its future gas marketing.\nENVIRONMENTAL\nKey, as an owner of interests in oil and gas properties, is subject to various federal, state, and local laws and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on the lessee under an oil and gas lease for the cost of pollution clean-up resulting from operations, subject the lessee to liability for pollution damages, require suspension or cessation of operations in affected areas and impose restrictions on the injection of liquids into subsurface aquifers that may contaminate groundwater.\nKey has made and will continue to make expenditures in its efforts to comply with these requirements, which it believes are necessary business costs in the oil and gas industry. These costs are inextricably connected to normal operating expenses such that the Company is unable to separate the expenses related to environmental matters. However, the Company does not believe any such additional expenses will materially affect its business. Although environmental requirements do have a substantial impact upon the energy industry, generally these requirements do not appear to affect Key any differently or to any greater or lesser extent than other companies in the industry.\nThe Company is not aware of any environmental claims existing as of December 31, 1994, which would have a material impact upon the Company's financial condition or the results of operations. Key does not believe that compliance with federal, state or local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will have such an impact.\nEMPLOYEES\nOn December 31, 1994, Key had 21 full-time employees.\nOFFICES\nKey's principal executive offices are located at One Norwest Center, 20th Floor, 1700 Lincoln Street, Denver, Colorado 80203-4520.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2.PROPERTIES\nPRODUCTIVE WELLS AND ACREAGE\nThe number of productive gas and oil wells in which Key has working interests as of December 31, 1994, is set forth below. All of these properties are operated by other owners.\nIn addition, Key has royalty or overriding royalty interests in approximately 60 properties in the Midcontinent region, 60 properties in the Gulf Coast region and 1,750 properties in the Rocky Mountain region. As of December 31, 1994, Key held approximately 90,800 net developed acres. Approximately 70,500 net acres are located in the Rocky Mountains with the remainder located in the Midcontinent and Gulf Coast regions.\nGROSS WELLS DRILLED\nThe following table sets forth the number of wells drilled during 1994 and 1993 in which the Company participated. Drilling in 1992 was not significant.\nAt December 31, 1994, 9 gross (.95 net) wells were in the process of being drilled.\nUNDEVELOPED ACREAGE\nAs of December 31, 1994, Key held an interest in approximately 533,000 net undeveloped acres located in the Rocky Mountain region.\nPRODUCTION AND PRICING INFORMATION\nThe following table describes, for each of the last three fiscal years, oil and gas production and pricing data for the Company.\nRESERVE VALUE INFORMATION\nThe estimated proved oil and gas reserves of Key, as of December 31, 1994, 1993 and 1992, and the standardized measure of discounted future net cash flows attributable thereto at December 31, 1994, 1993 and 1992, are included in Supplemental Oil and Gas Disclosures to Financial Statements appearing on pages 24 through 26 of this Form 10-K. Supplemental Oil and Gas Disclosures also include Key's net revenues from production (including royalty and working interest production) of oil and natural gas for the three years ended December 31, 1994.\nFuture reserve values are based on year-end prices except in those instances where the sale of gas is covered by contract terms providing for determinable escalations. Operating costs, production and ad valorem taxes and future development costs are based on current costs with no escalations.\nEstimated future net cash flows at December 31, 1994, are expected to be received as shown in the following years:\nNo major discovery or other favorable or adverse event is believed to have occurred since December 31, 1994, which would cause significant change in the estimated proved reserves reported herein. The above estimates are based on year-end pricing in accordance with Commission guidelines and do not reflect current prices. Since January 1, 1994, no oil or gas reserve information has been filed with, or included in any report to, any federal authority or agency other than the SEC and\/or the Energy Information Administration.\nITEM 3.","section_3":"ITEM 3.LEGAL PROCEEDINGS\nThe Company is not subject to any pending litigation that, in the opinion of the Company's management, will materially affect the financial position 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 submitted for a vote of security holders during the fourth quarter of 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nFRANCIS H. MERELLI, 59, has been chairman of the board of directors, president and chief executive officer of the Company since September 9, 1992. From July 1991 to September 1992, Mr. Merelli was engaged as a private consultant in the oil and gas industry. Mr. Merelli was president and chief operating officer of Apache Corporation, and president, chief operating officer and a director of Key from June 1988 to July 1991, at which time he resigned from those positions in both companies. He was president of Terra Resources, Inc. from 1979 to 1988.\nMONROE W. ROBERTSON, 45, has been with the Company since September 10, 1992. Since February 1994, he has served as senior vice president and corporate secretary and prior to that time as vice president and corporate secretary. From August 1988 to July 1992, he was employed by Apache Corporation in various capacities, the most recent of which was director of operational planning. From 1986 to 1988, Mr. Robertson was director of corporate planning for Terra Resources, Inc. From 1973 to 1986, Mr. Robertson was employed by Gulf Oil Corporation.\nCATHY L. ANDERSON, 39, has been controller of the Company since January 15, 1993. From July 1985 to January 1993, Ms. Anderson was employed by Arthur Andersen & Co., a public accounting firm, in various capacities, the most recent of which was audit manager.\nSTEPHEN P. BELL, 40, has been vice president--land of the Company since February 2, 1994. From March 1991 to February 1994, he was president of Concord Reserve, Inc., a privately-held independent oil and gas company. He was employed by Pacific Enterprises Oil Company (formerly Terra Resources, Inc.) as midcontinent regional manager from February 1990 to February 1991 and as land manager from August 1985 to January 1990.\nPART II\nITEM 5.","section_5":"ITEM 5.MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nKey's common stock, par value $.25 per share, trades on The Nasdaq Stock Market under the symbol KPCI. No dividends were paid in 1994 or in 1993. The table below shows the market price of the common stock for 1994 and 1993:\nThe closing price of Key's common stock as reported on The Nasdaq Stock Market for March 13, 1995, was $4.75. At March 13, 1995, the Company's 9,171,999 shares of common stock outstanding were held by 6,074 stockholders of record and approximately 5,100 beneficial owners.\nITEM 6.","section_6":"ITEM 6.SELECTED FINANCIAL DATA\nThe following table sets forth selected financial data of the Company for each of the years in the five-year period ended December 31, 1994, which information has been derived from the Company's audited financial statements. This information should be read in connection with and is qualified in its entirety by the more detailed information and financial statements under Item 8 below.\n- -------- (a) Net income for 1993 includes a non-recurring gain of $1,603,000 ($.16 per share) due to a change in the method of accounting for income taxes and an extraordinary loss on early extinguishment of debt of $122,000 ($.01 per share).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL RESULTS\nKey is reporting 1994 net income of $2.9 million, or $.30 per share. On a per share basis, this represents a 58 percent increase from the $2 million income from continuing operations ($.19 per share) reported in 1993, and is eleven times the $267,000 net income reported in 1992. Earnings for 1994, 1993 and 1992 are based on oil and gas revenues of $16.3, $11.7 and $17.6 million, respectively.\nNet income for 1993 was $3.5 million ($.34 per share) and includes a $1.6 million non-recurring benefit resulting from the adoption of Statement of Financial Accounting Standards No. 109 in January 1993 and $122,000 loss on early extinguishment of debt.\nREVENUES\nOil and gas revenues increased by $4.6 million, or 40 percent to reach $16.3 million in 1994. The increase is the result of the Company's second quarter 1994 acquisition and the positive impact that wells drilled or recompleted since last year are having on oil and gas production.\nBetween 1993 and 1992, oil and gas revenues dropped by 34 percent to $11.7 million. The decrease in 1993 was the result of sizeable property sales made in 1993 and 1992 and normal production declines on the remaining properties.\nGas sales for 1994 increased by 7 percent to $9.0 million. The increase in gas sales is the result of gas volumes climbing 18 percent between 1994 and 1993. Daily production volumes went from 10,470 Mcf per day in 1993 to 12,389 Mcf per day in 1994 and had a positive impact of $1.5 million. This was more than enough to offset the effect of falling prices in the latter part of 1994. Key's average gas price dropped from $2.19 per Mcf in 1993 to $1.98 per Mcf in 1994.\nKey's 1993 gas sales of $8.4 million reflected a 26 percent decrease from the previous year. While prices increased by $.36 to $2.19 per Mcf in 1993 and had a positive impact of $1.4 million, it was not enough to offset the effect of declining volumes. The average daily gas volume was 10,470 Mcf in 1993 versus 17,006 Mcf in 1992. Lower volumes account for $4.4 million of the $3 million total decline in gas sales.\nSpurred on by the acquisition, 1994 oil sales increased by $4 million to $7.2 million. Daily oil production more than doubled, going from 569 barrels per day in 1993 to 1,382 barrels per day in 1994. Production increases added $4.6 million to sales, while a 7 percent dip in prices reduced sales by $.6 million. The average price for oil was $14.27 per barrel in 1994 compared to $15.36 per barrel in 1993.\nThe Company's oil sales for 1993 dropped 47 percent to $3.2 million. Key received an average price of $15.36 per barrel in 1993 compared to $17.18 per barrel in 1992. Price contributed a negative $.4 million to the overall decline. The effect of production declines was more significant than pricing. Daily volumes fell from 960 barrels per day in 1992 to 569 barrels per day in 1993 and reduced sales by $2.4 million.\nProduct sales from gas processing plants contributed $140,000, $106,000 and $198,000 to oil and gas production revenues in 1994, 1993 and 1992, respectively. In terms of product mix, Key derived 55 percent of its 1994 oil and gas revenues from gas, 44 percent from oil and the balance from plant product sales.\nOther revenues for 1994 include proceeds from a gas contract settlement in the amount of $300,000.\nCOSTS AND EXPENSES\nDepreciation, depletion and amortization (DD&A) expense increased by 37 percent between 1994 and 1993. The increase is due to relatively higher oil and gas sales and net properties in 1994. Reserve additions from the acquisition and drilling helped reduce the amortization rate to 32.1 percent of revenue from 33.1 percent in the prior year. DD&A expense for 1993 declined 48 percent from the previous year to $3.9 million as a result of reduced oil and gas sales and a lower amortization rate. Key's amortization rate for 1993 was 33.1 percent of sales compared to 42.5 percent in 1992. The lower rate in 1993 was due to improved pricing, property sales and the addition of reserves from revisions and drilling.\nKey's operating expenses for 1994 increased by 59 percent to $5.1 million. The increase is largely due to the second quarter acquisition and is in line with the boost to oil and gas revenues. On a unit of production basis, operating expenses for 1994 are $.68 per EMcf, up from $.63 per EMcf in 1993. This increase is due to\nthe fact that the acquired properties have a higher oil percentage than the other Key properties and oil properties generally have higher lifting costs than gas properties. Operating expenses decreased $2.5 million between 1993 and 1992 primarily due to reduced lease operating expense resulting from the sale of oil and gas properties. Production taxes also declined in direct correlation with the drop in oil and gas revenues. Based on units of production, operating expenses decreased to $.63 per EMcf in 1993, down from $.69 in 1992. The decrease on an EMcf basis is largely attributable to the sale of lower-value properties in the first quarter of 1993.\nAdministrative, selling and other costs in 1994 declined 7 percent from a year ago to $1.4 million, while comparable costs in 1993 declined 59 percent from 1992. The slight decline in administrative expenses occurred in 1994 despite the costs associated with administering a larger asset base. On a units of production basis, administrative expense decreased to $.19 per EMcf, compared to $.30 per EMcf in 1993. In 1993, Apache provided accounting and administrative services to Key for the first four months. Key paid Apache $300,000 for services provided and this amount is included in the 1993 total. The dramatic drop in expenses between 1992 and 1993 is attributable to the sale of lower-value properties in the first quarter of 1993 and the assumption of all administrative and accounting duties by Key.\nIn the second quarter of 1994, Key entered into a $50 million credit facility with NationsBank of Texas, N.A. The Company elected an $18 million borrowing base and drew $12.5 million to fund the acquisition. The Company had repaid $2.5 million as of December 31, 1994. Annual interest for 1994 increased from $125,000 to $446,000 as a result of this new borrowing. Interest expense decreased significantly between 1992 and 1993 as a result of Key's aggressive, pre-acquisition plan of debt reduction. Interest was reduced from $461,000 in 1992 to $125,000 in 1993.\nInterest was capitalized for borrowings associated with the undeveloped leasehold recently acquired. No capitalized interest was recorded for 1993 or 1992.\nInterest income of $110,000, $282,000 and $40,000 was recorded for the years 1994, 1993 and 1992, respectively. The high interest income in 1993 reflects the investment of property sales proceeds from the first quarter of 1993. Interest income for 1994 declined due to a decrease in the average cash balance. Available cash was used to partially fund the acquisition.\nCASH FLOW AND LIQUIDITY\nLiquidity refers to the ability of an enterprise to generate adequate amounts of cash to satisfy its financial commitments. Key's primary needs for cash are to fund oil and gas exploration, development and acquisition activities and for payment of existing obligations and trade commitments related to oil and gas operations. The Company's primary sources of liquidity are cash flows from operating activities and proceeds from financing activities. Management believes that the overall sources of funds available to Key will continue to be more than sufficient to satisfy the Company's financial obligations.\nCash from operating activities increased $4.9 million to $11.6 million in 1994. Most of this increase can be traced to Key's 1994 acquisition and active drilling program. The resulting higher oil and gas production translates into elevated oil and gas revenues and a boost to cash from operating activities. Between 1992 and 1993, cash from operating activities fell by $1 million, or 13 percent. The decrease was consistent with the declines in oil and gas revenues in 1993.\nCash expenditures for exploration and development for 1994 totaled $6.1 million, or 53 percent of cash from operating activities. This compares to $1.9 million and 29 percent of cash from operating activities expended on drilling activity in 1993. Beginning in the second quarter of 1993, the Company implemented its strategy to increase production and reserves through selective drilling. In 1992, Key spent only $1.4 million\nor 18 percent of cash from operating activities and primarily focused on recompletions and maintaining production on older wells. During 1994, Key expanded its drilling program to 45 gross wells (6.25 net) compared to 27 gross wells (.6 net) drilled in 1993.\nIn the second quarter of 1994, Key completed a transaction to acquire assets in the Rocky Mountain region for $22.75 million. As of the October 1, 1993 effective date, the acquisition included 2.6 million barrels of oil, 8 billion cubic feet of natural gas and approximately 980,000 net undeveloped acres.\nPrior to January 1, 1993, Key was a limited partner in Apache Petroleum Company Operating Partnership (APCOP). Apache Corporation (Apache) was general partner of APCOP. On January 1, 1993, APCOP was dissolved and Key was assigned its pro-rata interest in the oil and gas properties and certain other assets and liabilities of APCOP.\nAt December 31, 1992, long-term debt, including current maturities, totaled almost $3 million. In connection with the dissolution transaction, Apache assumed APCOP's share of the \"1986 Limited Recourse Notes\" and \"Offshore Venture Financing\" which had the effect of reducing Key's long-term debt by approximately $800,000. Subsequent to the dissolution, Key's total outstanding debt was comprised of its share of the 9 percent convertible subordinated debentures due 2001. The debentures were redeemed at 101 percent of par value on July 15, 1993, using cash on hand. In the second quarter of 1994, Key drew $12.5 million on its credit facility with NationsBank to partially fund the acquisition. The Company repaid $2.5 million of the loan using cash from operations in the second half of 1994.\nIn 1993, the Company received $3.9 million in proceeds from the sale of approximately 1,100 low value oil and gas properties, the sale of a net profit reversionary interest and the sale of a negative reversionary interest. The properties and net profit interests were sold to Apache to reduce the administrative expense Key would incur accounting for numerous low-value properties. Key sold selected oil and gas properties in 1992 for $3.7 million.\nIn 1994, Key purchased 292,171 shares of its own stock for $1.3 million, or an average of $4.58 per share. In addition, in a non-cash transaction, Key re- acquired 800,000 shares of its own stock from Apache in exchange for approximately 200,000 net undeveloped acres that Key owned in the Green River Basin of Wyoming. During 1992, Key purchased 528,929 shares of its own stock on the open market for $1.7 million, an average of $3.14 per share. The purchases were primarily made using cash from operations and proceeds from property sales. Transactions for the purchase of shares in 1993 were immaterial.\nIn September 1992, Key's Board of Directors discontinued the payment of semiannual dividends and redirected cash flow to increase its reserve base. The Company paid cash dividends of $1.6 million ($.15 per share) in 1992.\nThe Company's cash balance is down substantially from the $9.2 million carried at December 31, 1993. Cash combined with bank financing was used to complete the second quarter 1994 property acquisition. The Company's ratio of current assets to current liabilities at year-end was 1 to 1, down from 7.4 to 1 at year-end 1993.\nManagement believes that cash on hand at year-end, net cash generated from operations and remaining amounts available under the existing line of credit will be adequate to meet future liquidity needs, including satisfying the Company's financial obligations and funding operations, exploration and development activities.\nFUTURE TRENDS\nThe Company intends to continue to expand its exploration and development activities. In October 1994, Key opened a regional exploration office in Tulsa, Oklahoma. Four employees are currently assigned to this\noffice. Their focus is to identify opportunities associated with Key's existing acreage position in Oklahoma and to find additional exploration opportunities in this region. In March 1995, Key opened a regional exploration office in Houston, Texas. Personnel in this office will be looking for ways to expand Key's exploration activities in the Gulf Coast area.\nExpanded exploration and development activities in the Rocky Mountain area are also being pursued. In connection with its 1994 acquisition, the Company acquired working and royalty interests in producing properties in the Rocky Mountain region, as well as a significant undeveloped leasehold position in that region. At December 31, 1994, Key held interests in approximately 533,000 net undeveloped acres in the Rocky Mountains. The Company intends to pursue various methods of maximizing the value of this acreage including drilling for its own account and participating with others to develop the acreage. Sales of portions of the acreage will be pursued and acreage in areas where the Company does not see significant development potential will be allowed to expire.\nAt December 31, 1994, Key did not operate any oil and gas properties. As the Rocky Mountain acreage is developed and as opportunities arise in other areas, Key intends to assume an operating role in those situations where it feels controlling operations is advantageous.\nThe Company intends to continue to consider acquisition and joint venture opportunities as they arise. As in the past, transactions of this type may be consummated if the economic and strategic factors appear favorable.\nKey experienced significant growth in personnel during 1994. The Company employed 21 full-time employees at December 31, 1994, compared to only 9 employees at the same point a year ago. The Company expects the number of employees to continue to increase as its exploration program grows and as it takes on operations.\nThe currently depressed price of natural gas will impact the cash provided by operations. However the Company still expects that cash on hand, net cash generated by operating activities and amounts available under the credit facility will be adequate to meet future liquidity needs under current corporate policies. Management believes that the overall sources of funds available to Key will continue to be sufficient to satisfy the Company's financial obligations and to provide resources for exploration, development and acquisition activities.\nITEM 8.","section_7A":"","section_8":"ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee following Index\nKEY PRODUCTION COMPANY, INC.\nINDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES\nAll other supplemental information and schedules have been omitted because they are not applicable or the information required is shown in the financial statements or related notes thereto.\nKEY PRODUCTION COMPANY, INC.\nSTATEMENT OF INCOME\nThe accompanying Summary of Significant Accounting Policies and Notes to Financial Statements are integral parts of this statement.\nKEY PRODUCTION COMPANY, INC.\nSTATEMENT OF CASH FLOWS\nThe accompanying Summary of Significant Accounting Policies and Notes to Financial Statements are integral parts of this statement.\nKEY PRODUCTION COMPANY, INC.\nBALANCE SHEET\nThe accompanying Summary of Significant Accounting Policies and Notes to Financial Statements are integral parts of this statement.\nKEY PRODUCTION COMPANY, INC.\nSTATEMENT OF STOCKHOLDERS' EQUITY\nThe accompanying Summary of Significant Accounting Policies and Notes to Financial Statements are integral parts of this statement.\nKEY PRODUCTION COMPANY, INC.\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFORMATION OF KEY PRODUCTION COMPANY, INC.\nKey Production Company, Inc. (Key or the Company) was formed in 1988 to succeed to a portion of the assets and liabilities of Apache Petroleum Company L.P. (APC). From 1988 through the third quarter of 1992, the Company used operating cash flow and property sales proceeds to reduce debt, repurchase shares of its common stock and pay dividends. In light of its depleting reserves and increasingly disproportionate general and administrative costs, the Company began evaluating strategic alternatives for its future.\nSince inception, all of Key's operating and managerial functions had been performed by Apache Corporation (Apache) under the terms of a management agreement between Key and Apache. On September 9, 1992, Key's board of directors announced its intention to establish a management team independent of Apache and to engage the Company in active operations. They elected a board of directors unrelated to Apache. The newly-elected board announced its intention to discontinue semiannual dividend payments and use the Company's cash flows to actively pursue alternatives for increasing its reserve base.\nApache subsequently gave Key notice of its intent to dissolve APC Operating Partnership L.P. (APCOP) and, effective January 1, 1993, the parties entered into an agreement covering the distribution of APCOP's assets. Under the terms of the agreement, Apache assumed the majority of APCOP's trade payables and accrued liabilities plus a portion of its long-term debt in exchange for a portion of APCOP's current assets. In addition, Key sold its interest in approximately 1,100 properties to Apache. The properties sold were primarily those with low individual values. These properties were sold to reduce the overhead Key would subsequently incur by accounting for numerous low-value properties. APCOP's remaining assets were distributed to Apache and Key in accordance with their respective partnership interests.\nBASIS OF PRESENTATION\nThe accompanying financial statements include the accounts of Key for 1994, 1993 and 1992 and its proportionate share of APCOP for 1992.\nOIL AND GAS PROPERTIES\nThe Company follows the full cost method of accounting for its investment in oil and gas properties and, accordingly, capitalizes all exploration and development costs incurred for the purposes of finding oil and gas reserves, including dry hole costs, geological and geophysical costs and direct overhead related to exploration and development activities. Payroll and other internal costs capitalized include salaries and related benefits paid to employees directly engaged in the acquisition, exploration and development of oil and gas properties, as well as other specifically identifiable internal costs. No gains or losses are normally recognized on the sale or disposition of oil and gas properties under full cost accounting.\nKey computes the provision for depreciation, depletion and amortization (DD&A) of oil and gas properties on a quarterly basis using the future gross revenue method. The quarterly provision is calculated by multiplying the quarter's oil and gas revenues by an overall rate determined by dividing the total unamortized cost of oil and gas properties (excluding the cost of investments in unproved and unevaluated properties) by the total estimated future oil and gas revenues.\nKey limits the capitalized costs of oil and gas properties, net of accumulated DD&A, to the estimated future net cash flows from proved oil and gas reserves discounted at ten percent, plus the lower of cost or fair market value of unproved properties as adjusted for related tax effects. If capitalized costs exceed this limit, the excess is charged to DD&A expense. The Company has not recorded any such write-downs of capitalized costs for the three years ended December 31, 1994.\nThe costs of certain unevaluated leasehold acreage and wells in the process of being drilled are not being amortized. Amortization will commence when such costs are evaluated or upon completion of wells in progress. Costs not being amortized are periodically assessed for possible impairments or reductions in value. If a reduction in value has occurred, the portion of the carrying cost in excess of the current value is included in the costs subject to amortization. Interest costs related to undeveloped properties are also capitalized. Financing costs were reduced by capitalized interest totaling $309,000 in 1994. No interest was capitalized during 1993 and 1992.\nOffice furniture and equipment are recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets which range from five to ten years.\nREVENUE RECOGNITION\nKey uses the sales method of accounting for natural gas revenues. Under this method, revenues are recognized based on actual volumes of gas sold to purchasers. The volumes of gas sold may differ from the volumes to which Key is entitled based on its interests in the properties. Differences between volumes sold and volumes based on entitlements create gas imbalances which are reflected as adjustments to reported gas reserves and future cash flows. Adjustments for gas imbalances reduced Key's proved gas reserves by approximately 9 percent at December 31, 1994.\nINCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 requires an asset and liability approach to accounting for income taxes. A deferred tax liability or asset is determined based on the temporary differences between the financial reporting and tax basis of assets and liabilities as measured by the enacted tax rates. A valuation allowance must be established for any portion of a deferred tax asset for which it is more likely than not that a tax benefit will not be realized. In 1993, the Company recognized a one-time cumulative benefit of the accounting change on prior years of $1,603,000 and established a valuation allowance for its deferred tax assets.\nNET INCOME PER SHARE\nNet income per share amounts are based on the weighted average number of common shares outstanding during each year. The effects of common stock equivalents, which includes shares issued upon the exercise of outstanding stock options, are considered in this calculation. For all the periods presented, the common stock equivalents were either antidilutive or their inclusion did not materially effect the net income per share amounts.\nSTATEMENT OF CASH FLOWS\nThe Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. These investments earned 5.3 percent and 3.1 percent rates of interest at December 31, 1994 and 1993, respectively, with cost approximating market.\nRECLASSIFICATION\nCertain prior year amounts have been reclassified to conform with the 1994 presentation.\nTREASURY STOCK\nTreasury shares were acquired in 1994 and 1992 under the Company's policy of repurchasing shares when market conditions appear favorable. Treasury stock is recorded at cost.\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS 1.ACQUISITIONS AND DIVESTITURES\nOn April 29, 1994, Key completed a transaction to purchase all the assets of a privately-held independent oil and gas company for $22.75 million. As of the effective date, October 1, 1993, the assets included 2.6 million barrels of oil, 8 billion cubic feet of natural gas and approximately 980,000 net undeveloped acres. Key used cash on hand and a $12.5 million draw on its credit facility to fund the acquisition.\nEffective January 1, 1993, Key sold its interest in approximately 1,100 properties to Apache for $3.9 million. The properties sold were those with low individual values. During 1992, APCOP sold selected oil and gas properties for which Key received $3.7 million.\nThe following unaudited pro forma information was prepared as if the acquisition and property sales occurred on January 1, 1992. The pro forma data presented is based on numerous assumptions and is not necessarily indicative of future operations.\n2.DEBT\nBank Financing--The bank financing is a $50 million revolving credit facility with NationsBank of Texas, N.A. The Company entered into the agreement on April 25, 1994, to fund the above-mentioned acquisition and any future acquisition and drilling opportunities. The Company elected an $18 million borrowing base, which was significantly less than the total borrowing base that could have been requested under the terms of the agreement.\nInterest on amounts borrowed is charged at NationsBank's prime rate or at London Interbank Offered Rates (LIBOR) plus .5 to 1.125 percent, at the Company's option. The factor added to LIBOR rates is determined by the Company's debt to capitalization ratio at the time of borrowing. The average interest rate on the various maturities of debt outstanding at December 31, 1994, was 6.41 percent. Key pays a .25 percent fee on the unused portion of the borrowing base, as well as other fees of approximately $10,000 per year in return for the bank's commitment to maintain the availability of those funds. On April 1, 1997, the borrowing converts from a revolver to a term note. At that point, if not renegotiated before then, the Company must commence quarterly principal payments in addition to paying interest. The entire facility matures on January 1, 2000.\nAggregate maturities of long-term debt outstanding at December 31, 1994, are as follows:\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) The Company had no outstanding debt at December 31, 1993.\n3.INCOME TAXES\nThe cumulative effect of the change in the method of accounting for income taxes attributable to fiscal years prior to 1993 was an increase in net earnings of $1,603,000 or $.16 per share, which has been reflected as a change in accounting method in the accompanying financial statements.\nDeferred tax liabilities and assets are comprised of the following components at December 31, 1994 and 1993:\nThe Company had net tax operating loss carryforwards of approximately $3.3 million at December 31, 1994, which expire in the years 2003 through 2008. The Company has provided a valuation allowance to the extent it may not be able to fully utilize its net operating loss carryforwards due to the possible tax effect of future exploratory drilling costs.\nIncome tax expense consisted of the following:\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) At inception, the Company's tax basis in its assets exceeded the basis reported for financial purposes. Through December 31, 1992, this excess basis was being amortized which resulted in a combined effective rate which was less than the statutory rate.\n4.NON-CASH INVESTING AND FINANCING ACTIVITIES\nSupplemental Disclosure of Cash Flow Information\nSupplemental Disclosure of Non-Cash Investing and Financing Activities\nOn July 19, 1994, the Company exchanged approximately 200,000 net undeveloped acres in the Green River Basin in Wyoming for 800,000 shares of Key common stock held by Apache and the formation of an exploration joint venture which gives Key the right to explore on all of Apache's non-Green River Basin acreage in Wyoming and access to all of Apache's seismic and other data in Wyoming. The trade involved approximately 25 percent of Key's Rocky Mountain acreage. The transaction value was based on the price for the Company's common stock at that date and, accordingly, Key reduced the carrying value of its undeveloped properties by $3.3 million.\n5.STOCK OPTIONS\nThe Key Production Company, Inc. 1992 Stock Option Plan reserves 1,000,000 shares of common stock for issuance to the Company's officers and employees. A total of 480,000 options were outstanding at year end. The options expire at various dates through 2004 and are at prices ranging from $2.50 to $4.125 per share with an aggregate exercise price of $1,501,250.\nThe Key Production Company, Inc. Stock Option Plan for Non-Employee Directors reserves 180,000 shares of common stock for issuance to the Company's non- employee directors. There were 90,000 options outstanding at year-end at an aggregate exercise price of $258,750. These options expire in 2002. No options were granted in 1994 or 1993.\nThe Company's president was granted options for 500,000 shares of the Company's common stock in 1992 in accordance with the terms of his employment agreement. These outstanding options were granted at an exercise price of $3.00 and expire in 2002.\nAll options granted had an exercise price equal to or above fair market value on the date of grant. Subject to accelerated vesting under certain circumstances such as death of the employee or change in control of the Company, one-third of the options vest in each of the three years following the date of grant. At December 31, 1994, a total of 483,333 outstanding options were vested.\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe following table summarizes the changes in stock options for the year and the number of common shares available for grant at year-end.\n6.EMPLOYEE BENEFIT PLANS\nRetirement Plan--The Company provides a 401(k) retirement\/savings plan for all employees. This plan allows participants to contribute up to 10 percent of their compensation, with Key matching contributions up to a maximum of 4 percent of their compensation. The Company's contribution is made in the form of Key common stock. Employees vest in the Company's contribution at the rate of 25 percent per year. Total expenses for the Company's matching contribution were $33,029, $18,505 and $3,533 in 1994, 1993 and 1992, respectively. In connection with the annual testing required on all 401(k) plans, Key made an $11,980 qualified non-elective contribution for the benefit of all non-highly compensated employees. The contribution was required to keep the plan qualified due to the top heavy status of the plan. No comparable contributions were required for 1993 or 1992.\nDeferred Compensation Plan--Effective December 1, 1993, the Company established the Key Production Company, Inc. Deferred Compensation Plan. This plan is intended to provide a mechanism whereby certain management employees of the Company may defer compensation. The Company intends this plan to provide the eligible employees with the opportunity to defer compensation in cases where deferrals under the 401(k) plan may be limited by applicable provisions of the Internal Revenue Code of 1986.\nIncome Continuance Plan--Effective June 1, 1994, the Company established the Key Production Company, Inc. Income Continuance Plan. This plan provides for the continuation of salary and benefits for certain employees in the event of a change in control of the Company.\nThe administrative, compliance, and legal costs associated with administering these plans are paid by Key. Such expenses were not significant in 1994, 1993 or 1992.\n7.COMMITMENTS AND CONTINGENCIES\nLease Commitments--The Company has leases for office space with varying expiration dates through 1997. Rental expense was $52,683 and $13,746 for 1994 and 1993, respectively.\nAs of December 31, 1994, minimum rental commitments under these leases are payable in the following years:\nLitigation--The Company is involved in litigation claims and is subject to governmental and regulatory controls arising in the ordinary course of business. It is the opinion of the Company's management that all\nKEY PRODUCTION COMPANY, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) claims and litigation involving the Company are not likely to have a material adverse effect on its financial position or results of operations.\nEnvironmental--The Company is not aware of any environmental claims existing as of December 31, 1994, which would have a material impact upon the Company's financial condition or the results of operations. Key does not believe that compliance with federal, state or local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will have such an impact.\n8.TRANSACTIONS WITH RELATED PARTIES\nIn connection with the APCOP dissolution, Key entered into an agreement with Apache whereby Apache provided accounting and administrative services to Key for the first four months of 1993. Key paid Apache $300,000 for services provided under this agreement. Prior to 1993, Apache was entitled to one or more types of compensation and reimbursements for defined costs from APCOP in accordance with predecessor agreements. Key's share of this compensation was $3.8 million in 1992.\nDuring 1994, Key entered into three other transactions with Apache. As discussed in Note 4, in July 1994, Key exchanged approximately 200,000 net undeveloped acres in the Green River Basin of Wyoming for 800,000 shares of Key's common stock held by Apache. Later in July, 1994, Key purchased 200,000 shares of its common stock from Apache at a price of $4.50 per share and in December, 1994, Key purchased an additional 91,000 shares from Apache at $4.75 per share.\n9.CUSTOMER INFORMATION\nThe following parties purchased 10 percent or more of Key's oil and gas production:\nEffective January 1, 1993, Key entered into an agreement with Apache under which Key pays Apache a fee to market the majority of its gas production that is not subject to traditional gas contract arrangements. During 1994 and 1993, the majority of Key's gas production marketed by Apache was sold to Natural Gas Clearinghouse (NGC). In 1992, Key's spot market production was either sold to, or marketed by NGC. NGC was an affiliate of Apache through May 1992.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Key Production Company, Inc.:\nWe have audited the accompanying balance sheet of Key Production Company, Inc. (a Delaware corporation) as of December 31, 1994 and 1993, and the related 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 Key Production Company, 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.\nAs explained in Note 3 to the financial statements, effective January 1, 1993, the Company changed its method of accounting for income taxes.\nArthur Andersen LLP\nDenver, Colorado, February 24, 1995.\nKEY PRODUCTION COMPANY, INC.\nSUPPLEMENTAL OIL AND GAS DISCLOSURES\nOil and Gas Operations--The following tables contain revenues and direct cost information relating to the Company's oil and gas exploration and production activities for the periods indicated. Key has no long-term supply or purchase agreements with governments or authorities in which it acts as producer.\nCapitalized Costs--The following table sets forth the capitalized costs and related accumulated depreciation, depletion and amortization relating to the Company's oil and gas production, exploration and development activities.\nCosts Not Being Amortized--Oil and gas property costs not being amortized at December 31, 1994, consist of $7,953,000 of leasehold cost. Of the total, approximately $74,000 was incurred in 1993 and the balance was incurred in 1994.\nOil and Gas Reserve Information--Proved oil and gas reserve quantities are based on estimates prepared by the Company's engineers, and were audited by Ryder Scott Company Petroleum Engineers, independent\npetroleum engineers, in accordance with guidelines established by the Securities and Exchange Commission (SEC). Reserve estimates are based on economic and operating conditions existing at December 31 of each year presented.\nThere are numerous uncertainties inherent in estimating quantities of proved reserves and projecting future rates of production and timing of development expenditures. The following reserve data represents estimates only and should not be construed as being exact. All of the Company's reserves are located in the continental or offshore United States.\nFuture Net Cash Flows--Future revenues are based on year-end prices except in those instances where the sale of gas is covered by contract terms providing for determinable escalations. Operating costs, production and ad valorem taxes and future development costs are based on current costs with no escalation.\nThe following table presents information concerning future net cash flows from the production of oil and gas reserves net of income tax expense. Income tax expense has been computed using expected future tax rates and giving effect to permanent differences and credits which, under current laws, relate to oil and gas producing activities. This information does not purport to present the fair market value of Key's oil and gas assets, but does present a standardized disclosure concerning possible future net cash flows that will result under the assumptions used.\nDISCOUNTED FUTURE NET CASH FLOWS AND CHANGES RELATING TO PROVED RESERVES AT DECEMBER 31,\nThe following are the principal sources of change in the discounted future net cash flows:\nImpact of Pricing--The estimates of cash flows and reserve quantities shown above are based on year-end oil and gas prices, except in those cases where future gas sales are covered by contracts at specified prices. Fluctuations are largely due to the seasonal pricing nature of natural gas, supply perceptions for natural gas and significant worldwide volatility in oil prices.\nUnder SEC rules, companies that follow full cost accounting methods are required to make quarterly \"ceiling test\" calculations. Under this test, capitalized costs of oil and gas properties may not exceed the present value of estimated future net revenues from proved reserves, discounted at 10 percent, plus the lower of cost or fair market value of unproved properties, as adjusted for related tax effects and deferred tax reserves. Application of these rules during periods of relatively low oil and gas prices, even if of short-term duration, may result in write-downs.\nKEY PRODUCTION COMPANY, INC.\nSUPPLEMENTAL QUARTERLY FINANCIAL DATA\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information set forth under the caption \"Information About Nominees for Election as Directors\" in the Company's proxy statement relating to the Company's 1995 annual meeting of stockholders (Proxy Statement) is incorporated herein by reference. Certain information with regard to the executive officers of the Company is set forth under the caption \"Executive Officers of the Registrant\" in Part I of this report.\nITEM 11.","section_11":"ITEM 11.EXECUTIVE COMPENSATION\nThe information set forth under the captions \"Summary Compensation Table,\" \"Aggregated Option Exercises In The Last Fiscal Year and Fiscal Year-End Option Values,\" \"Director Compensation,\" \"Employment Agreements\" and \"Board Compensation Committee Report on 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 captions \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" 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 \"Transactions with Affiliates\" 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\n(a)1.The following financial statements are included in Item 8 to this 10-K.\nStatement of income for each of the three years in the period ended December 31, 1994.\nStatement of cash flows for each of the three years in the period ended December 31, 1994.\nBalance sheet as of December 31, 1994 and 1993.\nStatement of changes in stockholders' equity for each of the three years in the period ended December 31, 1994.\nSummary of significant accounting policies.\nNotes to financial statements.\nReport of independent public accountants.\nSupplemental oil and gas disclosures.\nSupplemental quarterly financial data.\n2.Schedules: None.\n3.Exhibits:\nExhibits not incorporated by reference to a prior filing are designated by an asterisk (*) and are filed herewith; all exhibits not so designated are incorporated by reference to a prior SEC filing as indicated.\nExhibits designated by a plus sign (+) are management contracts or compensatory plans or arrangements required to be filed herewith pursuant to Item 14.\n(b)Reports on Form 8-K:\nNo reports on Form 8-K were filed 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.\nKey Production Company, Inc.\n\/s\/ F. H. MERELLI By: _________________________________ F. H. MERELLI CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER\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.\nSIGNATURES TITLE DATE\n\/s\/ F. H. MERELLI Director, Chairman, March 27, 1995 - ------------------------------------- President and Chief F. H. MERELLI Executive Officer (Principal Executive Officer)\n\/s\/ MONROE W. ROBERTSON Senior Vice March 27, 1995 - ------------------------------------- President and MONROE W. ROBERTSON Secretary (Principal Financial Officer)\n\/s\/ CATHY L. ANDERSON Controller March 27, 1995 - ------------------------------------- (Principal CATHY L. ANDERSON Accounting Officer)\n\/s\/ CORTLANDT S. DIETLER Director March 20, 1995 - ------------------------------------- CORTLANDT S. DIETLER\n\/s\/ TIMOTHY J. MOYLAN Director March 20, 1995 - ------------------------------------- TIMOTHY J. MOYLAN","section_15":""}
{"filename":"778977_1994.txt","cik":"778977","year":"1994","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nLevi Strauss Associates Inc. (the Company) acquired Levi Strauss & Co. (LS&CO.) in 1985 and is the world's largest brand-name apparel manufacturer. It designs, manufactures and markets apparel for men, women and children, including jeans, slacks, shirts, jackets, skirts and fleece. Most of its products are marketed under the Levi's(R) and Dockers(R) trademarks and are sold in the United States and in many other locations throughout North and South America, Europe, Asia and Oceania. These products are produced throughout the world by the Company at owned and operated facilities or by independent contractors.\nThe Company's revenues are derived mostly from the sale of jeans and jeans- related products. Jeans are casual pants, which typically have a four or five pocket construction and are made of 100 percent cotton denim. Jeans can also be made of corduroy, twill and other fabrics. These and other jeans-related products generated approximately 72 percent of the Company's total sales in 1994 ($4.4 billion of $6.1 billion) and are the mainstays of the Company's profitability. Casual sportswear (mostly natural fiber pants and tops marketed under the Dockers(R) brand) have also become an important source of revenues in the U.S.\nThe worldwide apparel market is characterized by constant change and diversity. It is affected by demographic fluctuations in the consumer population, frequent shifts in prevailing fashions and styles, international trade and economic developments, and retailer practices. The Company has historically enjoyed its largest brand share and customer base for jeans among men, especially those aged 15-24 years old, and, to a lesser extent, those aged 25 and over. The demographics of the U.S. and many other industrialized countries outside the U.S. reflect aging populations and declining target markets.\nThe Company's market success is dependent on the Company's ability to quickly and effectively initiate and\/or respond to changes in market trends and other consumer preferences, especially now that consumers worldwide are becoming more price and value conscious and many competitors are offering lower priced and innovative products. This increasing price consciousness is putting pressure on brand and product loyalty. The ongoing competitive nature of the apparel industry and market trends present a continuous risk that new products or market segments may emerge and compete with the Company's existing products and\/or markets.\nThe Company's business is also dependent on the quality of service the Company provides to its customers. Retailers are striving to maintain lower inventory positions and place orders closer in time to requested delivery dates. Retailers are also demanding increasing levels of floor-ready and receipt-ready programs and enhanced store merchandising support. As a result, the Company has faced increasing pressure from worldwide retailers to improve its product support and delivery performance. Additionally, the U.S. retail market has changed in recent years, resulting in more centralized buying practices and potentially greater credit exposures from customers.\nORGANIZATION STRUCTURE\nThe Company's current operating structure consists of two principal organizations: Levi Strauss North America (LSNA) and Levi Strauss International (LSI).\nLSNA encompasses the Company's businesses in the U.S., Canada and Mexico. As part of a strategic initiative, the Company aligned its U.S. marketing divisions according to the Company's Levi's(R), Dockers(R) and Brittania(R) brands (see Strategic Initiatives section). The LSNA operating structure currently consists of five principal marketing and\/or operating divisions: Levi's(R), Dockers(R), Canada, Mexico and Brittania Sportswear Ltd. The Levi's(R) division markets jeans and jeans-related products for men, women and youth. The Dockers(R) division markets Dockers(R) products and casual products for men, women and youth. The Canada and Mexico divisions market mostly jeans, jeans-related products and Dockers(R) products. Brittania Sportswear Ltd. markets the Brittania(R) line of men's and women's jeans, tops and casual sportswear in the U.S. Levi's(R) and Dockers(R) men's products are the Company's most important source of U.S. sales and earnings.\nLSI markets jeans and related apparel outside North America and is a major source of operating income for the Company. LSI is organized along geographic lines consisting of the Europe, Latin America and Asia Pacific divisions. Europe is the largest LSI division in terms of sales and profits with the Company's affiliates in Germany and Italy being the two largest contributors. Asia Pacific is the second largest LSI division, principally due to the size of its Japanese operations.\nThe following table presents U.S. and non-U.S. sales for 1994, 1993 and 1992.\nFor additional financial information concerning the U.S. and non-U.S. operations of the Company, see Note 2 to the Consolidated Financial Statements.\nSTRATEGIC INITIATIVES\nThe Company is continuing its process of examining and re-engineering various aspects of its brand marketing, customer service and operations\/distribution strategies in response to current market and economic trends and in accordance with its Business Vision (see Business Vision section). The Company believes its initiatives are essential to staying competitive and meeting the changing needs of its customers. Summaries of these initiatives are as follows:\nGlobal Brand Alignment\nThe Company's strategy, as outlined in its Business Vision, is to position its brands to ensure consistency of image and values to consumers around the world. The Company is taking the following actions to implement this strategy:\nThe Company aligned its U.S. marketing divisions according to the Company's Levi's(R), Dockers(R) and Brittania(R) brands.\nThe Company is continuing to analyze its customer base and product distribution in all markets to ensure that its retail distribution is consistent with its brand image.\nThe Company is planning to operate retail stores in the U.S. that sell only Levi's(R) and Dockers(R) brand products (see U.S. Company-Owned Retail and Outlet Stores\/Retail Joint Venture caption).\nThe Company's trademarks and brands differentiate its products from those of competitors. Due to the increasingly global nature of the marketplace, brands that are marketed in divergent distribution channels in different countries may confuse retailers and customers and dilute the Company's brand image. To align its global brand image, the Company is altering its distribution and marketing procedures. Retailers may react adversely to changes in product distribution, service levels or other aspects of their customer relationship with the Company. However, the Company believes that consistent brand image, on a global basis, is essential to its long-term success and attainment of overall objectives.\nCustomer Service\nThe Company believes that retailer expectations for service from manufacturers are increasing in worldwide markets. These expectations and requirements relate to all aspects of the relationship between the manufacturer and retailer. Retailers want manufacturers to develop, deliver and replenish products faster, deliver retail floor-ready merchandise, participate in retail floor product presentation and provide ongoing support for the products on the retail floor. Additionally, manufacturers are expected to establish information systems that would be compatible with retailer systems and to coordinate invoicing and payment methods, accordingly. The Company believes that superior customer service, as well as its product development and marketing ability, will be an essential element of competitive strength in the coming years. The Company is engaged in various customer service initiatives in the U.S. and in many non-U.S. businesses.\nU.S. Customer Service Initiative\nThe Company is reorganizing and re-engineering its entire U.S. operations to improve customer service, forge stronger relationships with its retail customers and suppliers and reduce the time it takes to develop products and fill customer orders. The reorganization will affect the Company's entire U.S. supply chain, including product development, production and sourcing, sales and distribution processes, and its information resource systems.\nThe Company is upgrading its national distribution network and regionally linking its manufacturing, finishing and distribution facilities. This entails the modernization, reconfiguration and expansion of facilities, including purchases of new facilities and equipment. The Company plans to utilize several regional customer service centers to carry core products and replenishable seasonal products of each brand for each consumer segment. The Company also intends to use a national center to store one-time seasonal products.\nAdditionally, the Company's initiatives will require information system changes to support the changes in its business processes, organization and distribution network. Common data and on-line access for all parts of the supply chain are critical to reducing leadtimes and building alliances with customers and suppliers.\nThe Company's immediate reengineering efforts will focus on delivering continuing products timely and accurately and delivering floor-ready products to selected customers so they can make them available to consumers immediately. In addition, the Company will then focus on changing the process for forging relationships with suppliers and customers, developing new products, updating continuing products, replenishing seasonal products, and offering products and programs to assist customers in differentiating the Company's products from competitor products.\nSince 1993 and over the next several years, the Company plans to incur total capital expenditures of over $400.0 million to support the new U.S. distribution network, expanded system requirements, organization and manufacturing changes. Included in this total capital expenditure projection is over $290.0 million related to the construction, renovation and retrofitting of new and existing customer service centers. The total capital expenditure projection amount includes previously recognized capital expenditures of approximately $81.0 million.\nAdditionally, the Company plans to spend approximately $450.0 million for transitional expenses, including costs related to the implementation of new software applications, reengineering design and planning, implementation of organization and process changes, training, education and other related expenses. The total amount for transitional expenses include previously recognized expenses of approximately $70.0 million. These costs will be recognized ratably throughout the implementation period and\/or as expenses occur, depending on the nature of the cost and the decisions made related to this initiative.\nLSI Customer Service Initiatives\nThe LSI customer service initiatives began in late 1993 and encompasses the Company's affiliates in the Europe, Latin America and Asia Pacific divisions. The objective of the LSI initiatives is to build the capabilities within the LSI organization to make customer service a competitive advantage. The LSI customer service initiatives will be highly selective and focused with a varying degree of impact and modification to affiliate organizations. It is too early to determine the amount of capital expenditures and transitional expenses the Company will incur for the LSI initiatives until the design phase is completed. It is expected, however, that the total cost will be less than the costs for the U.S. initiative. These initiatives are expected to be completed over the next several years.\nRationalization of Supplier Base\nIn connection with the Company's initiative on customer service, the Company has been analyzing its supplier base to establish relationships with a reduced number of suppliers. This analysis involved identifying the Company's current and future needs, assessing the Company's current suppliers, identifying the suppliers that could best meet the Company's needs and developing strong relationships with these suppliers. During 1994, the Company selected the U.S. fabric and sundries suppliers that will support the U.S. Levi's(R) and Dockers(R) product lines.\nThe selected suppliers will be the primary suppliers the Company will do business with in the future. The Company is currently working on transition plans to transfer its fabric and sundries business to the selected suppliers with minimal disruption to the Company and its suppliers (see Risks of Strategic Initiatives section).\nAlternative Manufacturing Systems\nAlternative Manufacturing Systems (AMS) have been implemented in substantially all of the Company's U.S. sewing plants. Similar programs have been implemented in the Company's Canada and Brazil facilities. AMS is a team-based approach to manufacturing, replacing the traditional assembly line. Team-based manufacturing is designed to improve quality, increase flexibility and morale, reduce absenteeism and turnover, shorten leadtimes, and decrease repetitive motion related injuries. The intent of AMS is to enable the Company to respond more quickly to retail accounts and market trends, while at the same time reducing production costs. The Company's efforts have contributed to lowering workers' health and safety costs. The Company continues to modify and refine AMS in order to maximize benefits associated with the program.\nAdditionally, the Company continues to benefit from \"F.A.S.T.\" in the U.S., which links specific sewing plants to certain finishing centers and customer service centers to reduce leadtimes, address quality issues on a more timely basis and decrease the response time in filling customer orders.\nU.S. Company-Owned Retail and Outlet Stores\/Retail Joint Venture\nAs part of its efforts to create consistent brand image, the Company is planning to own and operate retail and outlet stores in the U.S. that sell only Levi's(R) and Dockers(R) brand products. These stores will include Original Levi's(R) Stores, Dockers(R) Shops and separate outlet stores, in all cases selling only Levi's(R) or Dockers(R) products. The Company expects to open approximately 190 of these stores within the next five years. The Company plans to operate flagship (premier) stores only in key markets and locations most able to help the Company achieve its primary focus of maintaining a high brand image, such as downtown urban locations and selected high visibility regional malls. The Company plans to operate outlet stores dedicated to each brand in areas outside major markets in key outlet malls. The Company expects to spend approximately $90.0 million for capital expenditures during the next few years in connection with this program.\nThis program is in addition to the plans the Company has with Designs, Inc. to establish a joint venture that will own and operate, in the northeastern U.S., approximately 50 Original Levi's(R) Stores selling only Levi's(R) jeans and jeans-related products. The Company will have a 30 percent equity interest in the U.S. joint venture. Venture establishment was approved by the Federal Trade Commission subsequent to year-end. The venture formed and began operations in January 1995.\nRisks of Strategic Initiatives\nThe Company is assuming substantial risks in undertaking these initiatives. For example, it faces disruption of its ongoing business operations during implementation. Management, other personnel and job definition changes may distract employees and adversely affect employee\nmorale. The Company may incur unplanned additional implementation costs, with a resulting impact on cash flow and earnings.\nThe Company will face challenges in developing the information systems necessary to support new business processes and customer service requirements. The Company will rely on new materials handling technologies in the new customer service centers, and must successfully integrate the software that operates the equipment with its business systems. The Company must also successfully manage the transition of employees to new positions and train them to meet the requirements of those positions, including operating effectively in a more team- based and technology-oriented environment. The changes will occur at the same time the Company implements a new compensation program that is intended to align employee efforts with overall Company strategies (see Partners in Performance caption under Item 11. Director and Executive Compensation).\nMore broadly, these initiatives involve fundamental changes in the way the Company operates its business. There are numerous commercial, operating, financial, legal and other risks and uncertainties presented by the design and implementation of such programs. Furthermore, the Company is not aware of undertakings of comparable magnitude in the apparel industry, and cannot predict with certainty the outcome of these initiatives. Although there can be no assurance that the Company will successfully design and implement these new business processes, or that the costs of these initiatives will not exceed estimates, the Company believes that the re-engineering initiative is essential to maintain its global competitive position. Additionally, the Company believes it is important to implement these initiatives at a time when the Company's market and financial performance is strong.\nU.S. OPERATIONS\nThe Company's U.S. operations are currently organized by its Levi's(R), Dockers(R) and Brittania(R) brands that, along with Canada and Mexico, constitute the LSNA organization. Each U.S. division maintains its own merchandising, sales and advertising staff.\nMarkets\nThe Company's current U.S. apparel market is directly affected by consumer spending, the retail environment and competition. The recovering U.S. economic environment is experiencing moderate inflation growth, relatively strong consumer confidence and a strengthening employment situation. Consumer spending is strong; however, apparel sales are still sluggish, and consumers remain price sensitive and extremely \"value\" oriented. Retailers are responsive to consumer spending patterns and are offering more private label products and demanding higher levels of service and support from their vendors. Additionally, competitors are also becoming more aggressive by offering lower priced products.\nThe Company's strategy in responding to current market conditions focuses on brand positioning, sensitivity to fashion changes and consumer preferences, brand enhancement, timely product development, innovative marketing activities and enhanced relations with retailers and suppliers. As previously described, superior customer service and efficient product development and manufacturing are integral elements of the Company's business strategy.\nThe U.S. jeans market in 1994 was stable with 1993 levels, with no real growth expected in 1995. The Company continues to hold a significant market share in the young men's market. Demand for finished jeans products (garments that have been laundered or otherwise treated after assembly), including stonewashed and other wet-processed garments, continues to increase. Over the years, jeans demand by the male consumer has also included substitute products such as casual slacks, shorts and fleecewear. The Company believes that these trends are in part a function of the broad demographic changes noted above. The women's jeans market tends to be more fragmented among major competitors than jeans for men.\nIn recognition of the ongoing changes in the jeans market, the Company continues to add new designs, finishes, fabrications and colors to its traditional product lines. Ongoing efforts are placed on coordinating with laundry contractors, textile producers and other companies throughout the world to develop concepts and processes to promote finishing development leadership and finished product shade consistency. The growth in new product lines is reflected by the fact that in 1994 traditional \"rigid denim\" products sold by the Levi's(R) men's and youth brands provided 5 percent of total unit sales of those divisions, compared to 68 percent in 1985.\nThe casual sportswear market is dynamic, characterized by continuous product innovation and lower margins than those prevailing in the young men's jeans market due to higher labor content. The sportswear market, like the jeans market, is affected by demographic changes and changes in consumer lifestyles and buying habits. Market research indicates that the male consumer remains highly brand conscious and brand loyal, and more value-oriented, than the female consumer who is more price conscious.\nProducts and Strategy\nThe Company manufactures and markets basic jeans, branded casual products and jeans-related products in a wide range of moderately-priced apparel categories. The 501(R) family of jeans, other basic denim jeans and related jeans products have traditionally been the Company's key products. In addition to the 501(R) products, the Levi's(R) men's brand also markets the Red Tab(TM), Orange Tab(TM) and silverTab(TM) product lines. The Levi's(R) women's brand markets jeans and knit and woven tops for the 501(R), Red Tab(TM), Orange Tab(TM) and silverTab(TM) product lines. The Levi's(R) Youth brand markets jeans and casual youthwear products for the 501(R), Orange Tab(TM), silverTab(TM) and Little Levi's(TM) product lines. The men's Dockers(R) brand organization manufactures and markets men's casual and dress slacks and men's knit and woven shirts, under the Dockers(R) brand name and Levi's(R) Action and Levi's(R) Travelers product lines. Both the women's and youth Dockers(R) brand markets casual sportswear under the Dockers(R) product line. Brittania Sportswear Ltd. manufactures and markets men's and women's jeans, tops and casual sportswear under the Brittania(R) and Brittgear(TM) labels.\nU.S. unit sales of the 501(R) family of jeans decreased 5 percent from 1993 and decreased 21 percent when comparing 1993 with 1992. The decrease in unit sales for the 501(R) family of jeans is related to the success of other Company jeans products, such as Orange Tab(TM) and other Red Tab(TM) products. In addition, this decrease also related to 501(R) family of products price increases and various counter-diversion tactics (see Risks of Non-U.S. Operations caption). The Company's dollar sales for total U.S. jeans offerings totaled approximately $2.9 billion in 1994. The Company expects 1995 sales of products marketed by the Levi's(R) men's brand to be relatively stable, compared with 1994.\nLevi's(R) jeans for women product line dollar and unit sales are expected to be higher in 1995 compared to 1994 due to the offering of more tops, Orange Tab(TM) products and special sizes. In addition, the line will add emphasis on the misses market. The Levi's(R) jeans for women product line will be supported by a new version of the \"Women in Motion\" advertising campaign in 1995. Levi's(R) jeans for women are the number one selling jeans in the junior market.\nThe Company sells Levi's(R) for youth to the boys' and girls' markets. Traditional blue denim and colored denim bottoms and shorts, loose silhouettes and coordinating tops were prominent products sold by this division during 1994 and will continue in 1995.\nThe Dockers(R) product line was one of the most rapidly growing and successful lines in the U.S. apparel industry since its introduction in 1986. However, 1994 sales of Dockers(R) products declined due to the Company's late entry into the wrinkle-free market coupled with finishing capacity limitations for men's Dockers(R) and the repositioning of the women's Dockers(R) business. Unit sales of Dockers(R) products decreased 21 percent from 1993 and decreased 4 percent when comparing 1993 with 1992. The Company's 1994 market share of the U.S. casual market dropped slightly due to the late entry into the growing wrinkle- free market. The Company expects that sales of Dockers(R) products will be slightly higher in the 1995 fiscal year due to increased sales for wrinkle- resistant products.\nThe Company's Dockers(R) men's product line and men's Levi's(R) loose-fitting jeans represent a response to demographic and fashion changes. The Company continues to expand the Dockers(R) product line with new product innovations. \"Performance cottons\" include knit tops (made of fine quality cotton treated to reduce fading, twisting and shrinking) and wrinkle-resistant products. Another new product innovation entitled \"well worn\" includes products that are heavily abraded and washed down. During 1995, the Dockers(R) brand will be repositioning the Dockers(R) Authentics product line extension that was launched early in 1994. This repositioning will specifically target men ages 25-30, the younger end of the core Dockers(R) target market that are loyal Levi's(R) men's jeans consumers. The revised positioning of the Dockers(R) Authentics product line is intended to capture the attention of this consumer in department stores by providing a shopping environment similar to the shopping environment for the Company's men's jeans products. The products will be developed and marketed similarly to men's jeans products, based on a narrow fit strategy with fabric and finish variations.\nThe women's Dockers(R) product line has suffered from a very weak retail environment for moderate sportswear products. The Company hopes to see long- term benefits from its newly repositioned core pants strategy developed earlier in 1994, which builds off the success of the men's Dockers(R) brand business. However in the short-term, dollar and unit sales for women's Dockers(R) products are expected to be slightly lower in 1995.\nThe Dockers(R) brand for youth markets casual bottoms and tops only in the boy's market. During 1994 this division successfully introduced cotton wrinkle- resistant bottoms.\nDollar sales of Levi's(R) men's jeans products accounted for 33 percent in both 1994 and 1993 and 31 percent in 1992 of the worldwide sales of the Company. U.S. sales of non-jeans-related casual apparel products represented 14 percent, 19 percent and 21 percent of worldwide dollar\nsales in those years. For additional financial information on U.S. operations, see Note 2 to the Consolidated Financial Statements.\nThe Brittania(R) brand represents the Company's presence in the growing mass merchant channel. This channel currently comprises nearly half of the jeans market. Brittania Sportswear Ltd. offers low-priced, high quality products to major mass merchant accounts and is a component of the overall U.S. marketing strategy. The Brittania(R) business is an independent business unit within LSNA and in 1994 moved its headquarters to Renton, Washington. This decision was intended to lower costs and strengthen the brand's competitive position in its marketplace by centralizing operations, sourcing, marketing, accounts receivable management and distribution functions.\nCompetition\nThe Company and its largest competitor in the U.S. jeans market, VF Corporation, account for approximately one-half of the units sold in the U.S. jeans market. The Company believes that the combined brand share of its Levi's(R) and Brittania(R) products in the U.S. jeans market is second only to the combined share of VF Corporation's four principal brands, Wrangler(R), Lee(R), Rustler(R) and Lee Riders(R).\nThe casual apparel market for men and women is characterized by intense competition, among manufacturers and retailers, and ease of entry for new producers. Import competition is more prevalent in the casual apparel market than in the jeans market. Apparel imports have generally lower labor costs and may exert downward pressure on prices of casual wear products. This situation is limited by U.S. trade policies that restrict apparel imports through quotas and tariffs (see Global Sourcing section).\nCotton wrinkle-resistant slacks were introduced by competitors in 1993 and have changed the casual pants market. Competitor wrinkle-resistant products (e.g., Haggar and Savane) are in direct competition with the Company's products. However, wrinkle-resistant casual pant products offered in the Dockers(R) product line in 1994 have been widely accepted by consumers due to their quality (e.g., softness content) and the overall consumer confidence in the brand. (See Products and Strategy caption.)\nThe Company is expecting its U.S. unit sales in 1995 to be slightly higher than 1994 due to the strength of the Levi's(R) women's and men's Dockers(R) brands, despite value-conscious consumers and increased competition, particularly from private-label products (e.g., Arizona Jean Company(R) brand by J.C. Penney Company, Inc. and Anchor Blue(R) brand by Miller's Outpost).\nDistribution\nThe Company distributes its products through retail stores that satisfy its account selection criteria and sell directly to the retail consumer. The Company does not sell its first quality \"in season\" products to wholesalers, jobbers or distributors, and maintains a compliance program to enforce its distribution policy and to control unauthorized diversionary sales of its products (see Risks of Non-U.S. Operations caption). The principal channels of distribution of the Company's products are department stores, specialty stores and national chains, including J.C. Penney Company, Inc., Sears Roebuck & Co. and Mervyn's Inc. The Company believes that industry leadership and brand strength of the Company's core products are maintained through\nthe use of traditional distribution channels. U.S. sales to the Company's top 5 retail customers represented 39 percent of total 1994 U.S. dollar sales. The Company's top 25 customers accounted for approximately 66 percent of the Company's total U.S. dollar sales. The Company has no long-term contracts or commitments with any of its customers other than with its retail joint venture partnership (see U.S. Company-Owned Retail and Outlet Stores\/Retail Joint Venture caption). The loss of any of these major customers could have an adverse effect on the Company's results and operations. Retail accounts are currently serviced by approximately 384 sales representatives for the U.S. divisions.\nThe Company will also continue developing dedicated U.S. distribution channels, such as stores that sell only Levi's(R) brand products (see Strategic Initiatives section) and in-store shops at retailer locations, consistent with its Business Vision (see Business Vision section).\nThe Company distributes Brittania(R) products principally through mass merchant channels, including Kmart Corporation and Target Stores. These two customers represent approximately 64 percent of Brittania Sportswear Ltd. total sales. The loss of either of these customers could have an adverse effect on Brittania Sportswear Ltd.'s results and operations, but not a material effect on the Company's total results. Brittania Sportswear Ltd. has no long-term contracts or commitments with any of its customers. Mass merchandisers comprise approximately 6 percent of the Company's U.S. unit sales for jeans.\nAdvertising\/Marketing\nThe Company devotes substantial resources to advertising and marketing programs. In the United States, the Company advertises extensively on radio and television and in national publications as well as on billboards and other outdoor displays. It also participates in local co-operative advertising and visual merchandising programs under which the Company shares advertising costs with retailers.\nIn 1994, the Company launched a new 501(R) product line campaign entitled \"501(R) Mystery\" and continued several advertising campaigns including a campaign for loose-fitting jeans for both Levi's(R) men's and Levi's(R) youth product lines. In addition, during 1994 the Dockers(R) brand launched national, regional and outdoor advertising campaigns for men's, women's and youth Dockers(R) products, respectively. In 1994, U.S. advertising expense was $233.5 million, a 5 percent decrease from 1993.\nThe Company is increasing its use of in-store \"shop\" presentations in which the Company influences the way its products are presented at the retail level. The Company assists retailers in displaying products in a manner intended to enhance the product's image and promote its quality, and present a consistent brand message directly to the consumer.\nOPERATIONS OUTSIDE THE U.S. Organization and Products\nOperations outside the U.S. were the Company's most profitable businesses on a per unit basis in 1994. Generally, businesses outside the U.S. record higher gross profit as a percent of sales than businesses in the U.S., mostly due to higher overall average unit selling prices. These operations are generally organized by country, and manufacture and market jeans and related products outside the U.S.\nEach country's operations within the Europe division are generally responsible for certain marketing activities, sales, distribution, finance and information systems. The European headquarters coordinates production, advertising and merchandising activities for core products and also manages certain information systems development activities. Merchandising and sourcing activities for non- core products are decentralized and located in various individual countries. Canada, Mexico (both included in the LSNA organization), and the countries of the Latin America and Asia Pacific divisions are primarily staffed with their own merchandising, sourcing, sales and finance personnel.\nSales for operations outside the U.S. are derived primarily from basic lines of jeans (particularly the 501(R) product line, other Red Tab(TM) and Orange Tab(TM) products), tops and other denim apparel. These operations sell directly to retailers in established markets. Retail accounts are currently serviced by approximately 399 sales representatives and 30 independent sales agents. Also, in 1994, the Company continued the rollout of the Dockers(R) line of products in Europe and New Zealand as well as continuing to offer Dockers(R) products in the Philippines and Hong Kong. Dollar and unit sales of these products increased substantially compared to 1993 due to the increased investment in this business line in 1994.\nManufacturing and distribution activities for non-U.S. marketing divisions are independent of the Company's U.S. operations. However, in 1994 non-U.S. operations purchased $124.0 million of products from the Company's U.S. divisions. This amount is expected to remain stable in 1995.\nThe Company explores and evaluates new markets on an ongoing basis. In 1994, the Company commenced operations in India and announced plans to establish operations in South Africa.\nIn 1994, net sales from non-U.S. operations were $2.4 billion compared to $2.2 billion in 1993. The Company believes its success in these markets reflects the Company's brand image and reputation, the continuing focus on core jeans products and the quality of its retail distribution, including stores that sell only Levi's(R) products. Considering the continuous changing needs of customers and consumers, and economic and trade developments (see Global Sourcing section), there can be no long-term assurances that the Company will maintain such profitability in these markets. For additional financial information about non-U.S. operations see Note 2 to the Consolidated Financial Statements.\nThe Markets, Competition and Strategy\nThe Company markets products in over 40 countries. As in the U.S., demand for jeans outside the U.S. is affected by a variety of factors that vary in importance in different countries, including socio-economic and political conditions such as consumer spending rates, unemployment, fiscal policies and inflation. In many countries, jeans are generally perceived as a fashion item rather than a basic, functional product and, like most apparel items, are higher-priced relative to the U.S. The non-U.S. jeans markets are more sensitive to fashion trends than the U.S. market.\nAdditionally, the retail industry differs from country to country. In certain countries the Company's primary retail customers are large \"chain\" retailers with centralized buying power. In other countries, the retail industry is comprised of numerous smaller, less centralized shops.\nSome non-U.S. customers are stores that sell only the Company's products and are independent of the Company. The Company distributes to approximately 1,100 stores outside the U.S. that sell only Levi's(R) brand products. These stores are strategically positioned in prime locations around the world and offer a broad selection of premium Levi's(R) products using special retail fixtures and visual merchandising. Considering the increasingly competitive retail environment, the Company believes these stores are of strategic importance in enhancing the brand image of Levi's(R) products. To further enhance the Levi's(R) brand image, the Company opened one owned and operated \"flagship\" store in London during 1994 and plans to open two more stores in Milan and Madrid in 1995.\nOther general factors, including the relative strength or weakness of the U.S. dollar and competition from local manufacturers, also affect the Company's financial results in markets outside the U.S. The Company has the largest brand share and strongest brand image in virtually all of its established non-U.S. markets. There are numerous local competitors of varying strengths in most of the Company's principal markets outside the U.S., but there is no single competitor with a comparable global market presence. However, VF Corporation is increasing its activity in markets outside the U.S.\nIn Europe, consumer demand has been less affected by demographic changes compared to the U.S. Core denim jeans, especially the 501(R) family of products, continue as key products in Europe and Canada. However, to meet the service commitments the Company makes to its customers around the world, and consistent with the customer service initiative in the U.S., the Company is launching a customer service initiative for the non-U.S. divisions. (See Strategic Initiatives section.)\nSales in the Asia Pacific division, particularly in Japan, have declined during the current year, due to soft retail conditions as well as the introduction by competitors of a lightweight rayon jean. However, sales in other Asia Pacific affiliates, namely the Philippines and Korea, have increased. The Levi's(R) brand continues to be the market share leader in Mexico. The Company's Latin America division activities are mainly in Brazil.\nOutside the U.S., advertising themes and strategies vary by country depending on the culture in each country, while maintaining consistency with the global positioning of the Levi's(R) brand. The Company utilizes media and point of sale advertising outside the U.S. Additionally, the Company sponsors concerts and events. Advertising expenditures for non-U.S. operations were $139.2 million in 1994, a 7 percent increase from 1993.\nRisks of Non-U.S. Operations\nThe Company's non-U.S. operations, including its use of non-U.S. manufacturing sources (see Global Sourcing section), are subject to the usual risks of doing business outside the U.S. These risks include adverse fluctuations in currency exchange rates, changes in import duties or quotas, disruptions or delays in shipments and transportation, labor disputes, and socio-economic and political instability. The occurrence of any of these events or circumstances could adversely affect the Company's operations and results. The Company continually evaluates the risk of non-U.S. operations when considering capital and reinvestment alternatives. The Company also uses various currency hedging strategies to mitigate the effects of currency fluctuations. In addition, it is not possible to accurately predict the effect that changing political and economic\nconditions in Russia and Eastern Europe will have on the Company's ability to expand those operations.\nIn many non-U.S. countries, the appeal of Levi's(R) products, particularly the 501(R) family of products, has generated higher prices than those in the U.S., which encourages diversion of Levi's(R) products. Accumulators usually buy products in the U.S. and ship them to non-U.S. countries for sale at a higher price, but lower than the retail prices charged by authorized retailers in those countries. Diverters usually procure products in the U.S. at wholesale costs and ship them to other countries for sale at a profit. These diversion tactics reduce the availability of products for U.S. consumers and negatively affect the Company's and retailers' results outside the U.S.\nHigher average unit selling prices in the U.S. for certain products have narrowed the pricing gap between certain U.S. and non-U.S. jeans products, thus discouraging diversion. However, the risks of increasing prices in the U.S. for certain products include retailer and consumer resistance to pricing that exceeds their perception of the value of the Company's products. This is of particular concern in an environment characterized by difficult economic conditions and, in the U.S., increasing acceptance of lower priced or private label products. Also, the Company's distribution policy requires retailers to limit the number of certain jean products a customer can purchase in U.S. metropolitan-area stores. The Company ceases business relations with retailers known to cooperate with diverters.\nAdditionally, sales of counterfeit Levi's(R) products, mostly made in the People's Republic of China, occur in key markets on a regular basis. The Company is concerned about the loss of its reputation with consumers, who may unknowingly buy counterfeit products, and damage to its business in those markets. The Company actively searches for and investigates counterfeit products. It seeks to protect its trademarks and has filed numerous legal actions against counterfeiters.\nThe January 16, 1995 earthquake in Kobe, Japan did not affect the Company's operations in Japan. However, some customers were affected. The Company does not expect this event to materially impact the Consolidated Financial Statements of the Company.\nGLOBAL SOURCING\nApparel manufacturing in less-developed countries continues to affect global apparel markets, including the U.S. market. These less-developed countries have lower labor costs and, in some cases, such as in the production of shirts, access to less expensive fabrics. The Company's U.S. owned and operated manufacturing base is trying to stay competitive in jeans production by achieving shorter leadtimes, production flexibility, meeting production requirements through AMS (see Alternative Manufacturing Systems caption), focusing on quality and aggressive cost reduction and productivity improvement.\nThe Company's imports into the U.S. have significantly increased in the past seven years in response to overall sales growth in casual wear apparel. These casual wear products require more sewing and construction time and are, therefore, not as cost competitive when sourced from the Company's U.S. owned and operated facilities.\nIn 1994 and 1993, approximately 50 percent and 54 percent, respectively, of the apparel production units of the Company's U.S. operations were manufactured by independent contractors. Approximately 45 percent of non-U.S. products in 1994 were manufactured by independent contractors, compared to 49 percent in 1993. In 1994 and 1993, independent contractors were used for the finishing process for approximately 70 percent and 72 percent, respectively, of the finished units of U.S. operations. Approximately 53 percent and 55 percent of the finishing process for non-U.S. finished units in 1994 and 1993 was performed by independent contractors.\nThe Company has a few long-term contracts with certain of its manufacturing sources and competes with other companies for production facilities and import quota capacity. Although the Company believes that it has established close relationships with its manufacturing sources, the Company's future success will depend in some measure upon its ability to maintain such relationships and, more broadly, to develop and implement a long-term sourcing plan.\nThe Company established its Global Sourcing Guidelines (GSG) to provide direction for selecting contractors and suppliers that provide labor and\/or material utilized in the manufacturing and finishing of its products. These guidelines address issues that contractors and suppliers can control, for example, sharing the Company's ethical standards and commitment to the environment, providing workers with a safe and healthy work environment, maintaining fair employment practices and complying with legal requirements. The GSG also prohibits operating in countries that would have an adverse effect on global brand image or trademarks, expose employees or representatives to unreasonable risks, violate basic human rights, or threaten the Company's commercial interests due to political or social turmoil. The GSG possibly limits some of the Company's sourcing options as well as its access to certain lower cost production.\nTextile trade policy of developed countries has increased the cost of importing apparel products produced in countries with lower labor costs through quotas and high tariffs. However, this protection of apparel manufacturers in developed countries, particularly the U.S., Canada, Australia, the European Free Trade Association countries and the European Economic Community (EEC), is gradually being reduced.\nThe North American Free Trade Agreement (NAFTA) was effective January 1, 1994. Quotas and tariffs will be phased out on specific goods of North American origin over a six-to-seven year period. The effect of NAFTA on the sourcing of goods to and from Mexico will have the most immediate impact on the Company. Once NAFTA is fully phased-in, the impact on the Company will be an approximate 5 to 18 percent reduction of tariffs on apparel imports from Mexico, and a 20 percent reduction in tariffs on apparel imports from the U.S. to Mexico.\nOn December 1, 1994, the U.S. Congress passed the legislation for the U.S. approval of the General Agreement on Tariffs and Trade (GATT) Uruguay Round; the agreement was implemented on January 1, 1995. The major provision of the agreement, which may effect the Company, is the phase-out of the textile and apparel quota system, the Multifiber Arrangement (MFA). Quotas will be eliminated on textile and apparel products over a 10 year period. However, the products selected for the first stage of the quota phase-out (1995-1997) do not include basic apparel items such as pants and shirts. Therefore, the Company does not expect\nthat the GATT phase-out of quotas will have an immediate impact on the Company's sourcing decisions.\nTrade legislation which may significantly impact the Company in 1995 would be the passage of NAFTA-like preferential tariffs for the Caribbean Basin countries (CBI countries). Legislation for \"CBI parity\" is likely to be brought before the U.S. Congress in 1995. The Company sources units in CBI countries and is assessed duties of 5-18 percent. If the CBI parity legislation were to pass Congress in 1995, the Company would save between $20 million to $30 million in annual duties paid to U.S. Customs.\nRAW MATERIALS\nThe Company's primary raw materials include fabrics made from cotton. Synthetics and blends of synthetics with cotton or wool are used in certain product lines. Fabric is purchased mostly from U.S. textile producers for U.S. operations, and from both U.S. and non-U.S. textile producers for operations outside the U.S. Cone Mills Corp. and Burlington Industries supplied approximately 29 percent and 14 percent, respectively, of the total volume of fabrics purchased by the Company for U.S. operations in 1994. Cone Mills Corp. and Dominion Textiles Incorporated (including Swift Manufacturing Co., its wholly-owned subsidiary) supplied approximately 17 percent and 8 percent, respectively, of the Company's fabric purchases for non-U.S. operations in 1994. Cone Mills Corp. is the sole supplier of 01 denim, the fabric used in manufacturing 501(R) jeans.\nThe Company has not recently experienced and does not expect any substantial difficulty in obtaining raw materials. Its only long-term raw materials contract with a principal supplier is with Cone Mills Corp. The loss of one or more of the Company's principal suppliers could have an adverse effect on the Company's results and operations. As part of its U.S. re-engineering effort, the Company is rationalizing its supplier base to reduce the number of suppliers it uses for certain fabrics. The Company also purchases large quantities of thread and trim (buttons, zippers, snaps, etc.) but is not dependent on any one supplier for such items.\nUNSHIPPED ORDERS AND INVENTORIES\nAs of November 27, 1994, the Company's unshipped order position for all products was approximately 105 million units, representing an increase of approximately 10 percent over the comparable date last year. The increase in unshipped orders was primarily attributable to the U.S. brands in anticipation of stronger first half 1995 U.S. sales.\nThe Company's finished goods inventory was approximately $494.6 million at year- end 1994, which was below the prior year's level. (See Inventories caption under Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations for additional information.)\nUnit cancellations in 1994 decreased 15 percent from 1993, mostly due to improved inventory management. Additionally, retailers were keeping less inventory on hand and had been relying on suppliers to provide products on a more timely basis. This practice by retailers resulted in the high number of order cancellations in 1993. The Company's initiative on customer service is expected to result in more accurate demand forecasting and reduced inventory leadtimes, which in turn are expected to lower order cancellations.\nTRADEMARKS AND LICENSING AGREEMENTS\nThe Company has a general program concerning the protection and enforcement of its trademark rights. The Company has registered the Levi's(R) trademark, one of its most valuable assets, in over 150 countries. The Company owns and has widely registered other trademarks that it uses in marketing jeans and other products, the most important of which in terms of product sales are the 501(R), Dockers(R), Pocket \"TAB\" Device and ARCUATE Design trademarks. The Company vigorously defends its trademarks against infringement, including initiating litigation to protect such trademarks when necessary.\nThe Company has licensing agreements permitting third parties to manufacture and market Levi's(R) branded products in countries where the Company has elected not to, or is unable to, manufacture or market on a direct basis. Additionally, it has agreements permitting third parties to manufacture and distribute certain other products, such as shoes, socks and belts, under the Levi's(R), Dockers(R) and Brittania(R) trademarks.\nSEASONALITY\nThe apparel industry in the United States generally has four selling seasons-- Spring, Summer, Fall and Holiday. New styles, fabrics and colors are introduced on a regular basis, based on anticipated consumer preferences, and are timed to coincide with these retail selling seasons. Historically, seasonal selling schedules to retailers have preceded the related retail season by two to eight months. Outside the U.S., the apparel industry typically has two seasons-- Spring and Fall. The Company's business is impacted by the general seasonal trends that are characteristic of the apparel industry.\nEMPLOYEES\nThe Company employs approximately 36,500 people, a majority of whom are production workers. A substantial number of production workers are employed in plants where the Company has collective bargaining agreements with recognized labor unions. The Company considers its employees to be an important asset of the Company and believes that its relationships with employees are satisfactory.\nSOCIAL RESPONSIBILITY\nSocial responsibility is a matter of strong conviction on the part of the Company. The Company has a longstanding commitment to equal employment opportunity, affirmative action and minority purchasing programs. The Company seeks to be an active corporate citizen in the communities in which it operates and maintains a Worldwide Code of Business Ethics.\nThe Company has traditionally supported charitable social investment programs and intends to maintain its historical practice of charitable giving. During 1994, the Company made a donation of $12.4 million to the Levi Strauss Foundation. The Company also contributed $.3 million to support matching gifts to the Red Tab Foundation, which was established to provide emergency financial assistance to the Company's employees and retirees in the United States. The Red Tab Foundation is currently in the process of expanding to non-U.S. affiliates.\nThe Levi Strauss Foundation made current grant commitments totaling approximately $9.2 million in 1994 and the Company made additional corporate charitable contributions of $5.2 million, primarily for international programs. These include grants in three community\npartnership giving (or staff-directed) areas: AIDS and Disease Prevention, economic development (projects which seek to enhance the economic options and opportunities of low-income individuals) and social justice (Project Change, a race relations program in four U.S. communities). Also included are grants through the Community Involvement Team program (in which groups of employees or retirees volunteer their time to review local community needs and then develop and implement projects to meet those needs), the Corporate Childcare Fund and the Social Benefits Program (matching gifts and volunteer service programs). Contributions by the Levi Strauss Foundation have averaged over $8.0 million for each of the last three years.\nBUSINESS VISION\nThe Company developed its Business Vision to identify its goals and provide direction for prioritizing all its initiatives and strategies. The Business Vision is as follows:\nWe will strive to achieve responsible commercial success in the eyes of our constituencies, which include stockholders, employees, consumers, customers, suppliers and communities. Our success will be measured not only by growth in shareholder value, but also by our reputation, the quality of our constituency relationships, and our commitment to social responsibility. As a global company, our businesses in every country will contribute to our overall success. We will leverage our knowledge of local markets to take advantage of the global positioning of our brands, our product and market strengths, our resources and our cultural diversity. We will balance local market requirements with a global perspective. We will make decisions which will benefit the Company as a whole rather than any one component. We will strive to be cost effective in everything we do and will manage our resources to meet our constituencies' needs. The strong heritage and values of the Company as expressed through our Mission and Aspiration Statements will guide all of our efforts. The quality of our products, services and people is critical to the realization of our business vision.\nWe will market value-added, branded casual apparel with Levi's(R) branded jeans continuing to be the cornerstone of our business. Our brands will be positioned to ensure consistency of image and values to our consumers around the world. Our channels of distribution will support this effort and will emphasize the value-added aspect of our products. To preserve and enhance consumers' impressions of our brands, the majority of our products will be sold through dedicated distribution, such as Levi's(R) Only-Stores and in-store shops. We will manage our products for profitability, not volume, generating levels of return that meet our financial goals.\nWe will meet the service commitments that we make to our customers. We will strive to become both the \"Supplier of Choice\" and \"Customer of Choice\" by building business relationships that are increasingly interdependent. These relationships will be based upon a commitment to mutual success and collaboration in fulfilling our customers' and suppliers' requirements. All business processes in our supply chain--from product design through sourcing and distribution--will be aligned to meet these commitments. Our sourcing strategies will support and add value to our marketing and service objectives. Our\nworldwide owned and operated manufacturing resources will provide significant competitive advantage in meeting our service and quality commitments. Every decision within our supply chain will balance cost, customer requirements, and protection of our brands, while reflecting our corporate values.\nThe Company will be the \"Employer of Choice\" by providing a workplace that is safe, challenging, productive, rewarding and fun. Our global work force will embrace a culture that promotes innovation and continuous improvement in all areas, including job skills, products and services, business processes, and Aspirational behaviors. The Company will support each employee's responsibility to acquire new skills and knowledge in order to meet the changing needs of our business. All employees will share in the Company's success and commitment to its overall business goals, values and operating principles. Our organization will be flexible and adaptive, anticipating and leading change. Teamwork and collaboration will characterize how we address issues to improve business results.\nSTATEMENT OF COMPANY MISSION AND ASPIRATIONS\nThe Company believes that shared goals are as critical to the Company's success as providing quality products and service and being a leader in the apparel industry. In order to identify and focus these shared goals, the Company adopted the following \"Statement of Mission and Aspirations\":\nMission Statement\nThe mission of the Company is to sustain responsible commercial success as a global marketing company of branded casual apparel. We must balance goals of superior profitability and return on investment, leadership market positions, and superior products and service. We will conduct our business ethically and demonstrate leadership in satisfying our responsibilities to our communities and to society. Our work environment will be safe and productive and characterized by fair treatment, teamwork, open communications, personal accountability and opportunities for growth and development.\nAspirations for the Company\nWe want a Company that our people are proud of and committed to, where all employees have an opportunity to contribute, learn, grow and advance based on merit, not politics or background. We want our people to feel respected, treated fairly, listened to and involved. Above all, we want satisfaction from accomplishments and friendships, balanced personal and professional lives, and to have fun in our endeavors.\nWhen we describe the kind of company we want in the future what we are talking about is building on the foundation we have inherited: affirming the best of our Company's traditions, closing gaps that may exist between principles and practices and updating some of our values to reflect contemporary circumstances. In order to make our aspirations a reality, we need:\nNew Behaviors: Leadership that exemplifies directness, openness to influence, commitment to the success of others, willingness to acknowledge our own contributions to problems, personal accountability, teamwork and trust. Not only must we model these behaviors but we must coach others to adopt them.\nDiversity: Leadership that values a diverse workforce (age, sex, ethnic group, etc.) at all levels of the organization, diversity in experience and a diversity in perspectives. We are committed to taking full advantage of the rich backgrounds and abilities of all our people and to promote a greater diversity in positions of influence. Differing points of view will be sought; diversity will be valued and honesty rewarded, not suppressed.\nRecognition: Leadership that provides greater recognition--both financial and psychic--for individuals and teams that contribute to our success. Recognition must be given to all who contribute: those who create and innovate and also those who continually support the day-to- day business requirements.\nEthical Management Practices: Leadership that epitomizes the stated standards of ethical behavior. We must provide clarity about our expectations and must enforce these standards throughout the corporation.\nCommunication: Leadership that is clear about Company, unit, and individual goals and performance. People must know what is expected of them and receive timely, honest feedback on their performance and career aspirations.\nEmpowerment: Leadership that increases the authority and responsibility of those closest to our products and customers. By actively pushing responsibility, trust and recognition into the organization we can harness and release the capabilities of all our people.\nThe Company is providing Aspirations training to employees and attempts to hold managers and employees accountable for behaviors that are in accordance with these objectives.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's headquarters are located at Levi's Plaza in San Francisco, California. It currently leases approximately 627,000 square feet, of which 81,000 square feet is subleased to others. The Company owns approximately 204,000 square feet of office space adjacent to Levi's Plaza, commonly known as the Icehouse Building. Currently 198,000 square feet of this office space is used by the Company and approximately 6,000 square feet is being leased to others. The Company also leases 137,000 square feet in other locations in San Francisco and surrounding areas as well as 460,000 square feet in various parts of the U.S.\nThe Company owns or leases 91 manufacturing, warehousing and distribution facilities, aggregating to approximately 9,835,200 square feet, as shown in the following table:\n_________________ \/(1)\/ Includes properties under capital lease.\nThe Company believes that its existing facilities are in good operating condition. The amounts shown in the table include approximately 141,000 square feet of manufacturing capacity and 667,246 square feet of distribution capacity currently subleased to others or not in use. See Note 9 to the Consolidated Financial Statements for additional information about material leases.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company does not consider any pending legal proceeding to be material. In the ordinary course of its business the Company has pending, various cases involving contractual matters, employee-related matters, distribution questions, product liability claims, trademark infringement and other matters. The Company believes that these cases are not material in the aggregate in light of the strength of its legal positions in such matters.\nThe Company evaluates environmental liabilities on an ongoing basis and, based on currently available information, does not consider any environmental exposure to be material to the Company's consolidated financial statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone, during the 1994 fourth quarter.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's outstanding Class L common stock is held primarily by members of the families of certain descendants of the Company's founder and certain members of the Company's management. Class E common stock is currently held by the trustee for the Employee Investment Plan of Levi Strauss Associates Inc. (\"EIP\"), the Levi Strauss Associates Inc. Employee Long Term Investment and Savings Plan (\"ELTIS\") and employees who purchased stock through the Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc. (ESAP) (see Note 12 to the Consolidated Financial Statements). There is no established public trading market for either class of common stock and no shares of common stock are convertible into shares of any other classes of stock or other securities. All holders of Class L common stock are parties to, and bound by, an agreement restricting transfer of the Class L common stock. Additionally, management Class L stockholders are parties to contracts with the Company providing for in-service, employment separation-related and post-separation stock purchases (see Note 17 to the Consolidated Financial Statements for information relating to the Management Liquidity Program). The outstanding shares of Class E common stock are subject to restrictions on transfer imposed by the EIP, ELTIS and ESAP. On January 16, 1995, there were approximately 203 Class L stockholders and 1,204 Class E stockholders.\nSee Note 20 to the Consolidated Financial Statements for stock valuation and dividend information.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents historical income statement data and balance sheet data of the Company for the past five fiscal years. This data has been derived from the consolidated financial statements of the Company, which have been audited by Arthur Andersen LLP, independent public accountants. Unless otherwise indicated, references to years in this Form 10-K refer to the fiscal years of the Company.\n\/(1)\/ Fiscal years 1994 and 1993 each contained 52 weeks and ended on November 27, 1994 and November 28, 1993, respectively. Fiscal year 1992 contained 53 weeks and ended on November 29, 1992. Fiscal years 1991 and 1990 each contained 52 weeks and ended on November 24, 1991 and November 25, 1990, respectively.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following summary of results of operations, financial condition and liquidity discusses data contained in the Consolidated Financial Statements of the Company. The discussion focuses on 1994, 1993, and 1992 comparisons and includes analyses of major components of net income, specific balance sheet items, liquidity and capital resources. (Fiscal years 1994 and 1993 each contained 52 weeks, while fiscal year 1992 contained 53 weeks.)\nRESULTS OF OPERATIONS\nSummary\nDuring 1994, the Company 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\" (see Notes 3 and 11 to the Consolidated Financial Statements). The after-tax net impact of this adoption reduced 1994 net income by $236.5 million. Excluding the effects of adopting both SFAS Nos. 106 and 109, the Company would have achieved record net income results, exceeding 1993 net income by 13 percent.\nNet income for 1994 was $321.0 million, a decrease of 35 percent from 1993. Contributing to 1994 net income were record sales, lower cost of goods sold, higher other operating income and lower interest expense. These favorable results were more than offset by the adoption of SFAS No. 106, higher marketing, general and administrative expenses and greater 1994 net foreign currency transaction losses.\nNet income for 1993 increased $131.6 million from 1992 mostly due to a stock option charge that negatively affected 1992 net income (see Stock Option Charge caption). Excluding the effects of the stock option charge, 1993 net income would have increased $16.6 million from 1992, due to higher 1993 sales volume, a lower effective tax rate and lower interest expense. The 1993 net income increase was partially offset by lower other operating income compared to 1992.\nNet income for fiscal year 1995 is expected to be higher than 1994 mostly due to the negative effect of adopting SFAS No. 106 in 1994. The Company expects dollar sales in 1995 to increase only slightly due to continued consumer price sensitivity and value consciousness. Additionally, planned costs in 1995 associated with the Company's U.S. initiative on customer service will also affect net income (see Additional Information section).\nNet Sales\nRecord dollar sales for 1994 of $6.1 billion increased 3 percent over the prior year amount of $5.9 billion mostly due to a 6 percent increase in average unit selling prices that offset a 3 percent decrease in unit sales. Contributing to the 1994 results were record dollar and unit sales performances by the Europe division and the U.S. Levi's(R) brand product line. Sales in 1993 increased 6 percent over 1992 sales of $5.6 billion due to record 1993 unit sales and higher average unit selling prices. Additionally, fiscal years 1994 and 1993 each contained 52 weeks compared to 53 weeks in 1992.\nU.S. dollar sales of $3.7 billion for 1994 were flat with the previous year due to a 5 percent increase in average unit selling prices that was offset by a 5 percent decrease in unit sales. Contributing to these results were record overall dollar and unit sales in the Levi's(R) brand product line that were offset by lower dollar and unit sales in the Dockers(R) product line. The U.S. Levi's(R) brand achieved record dollar sales for the Levi's(R) men, women and youth product lines. The Dockers(R) product line decrease reflected finishing capacity limitations during 1994 for wrinkle-resistant bottoms and the repositioning of the women's Dockers(R) product line. In the U.S., the Company's top 25 retail customers currently account for approximately 66 percent of dollar sales, which represents a 2 percentage point increase over the previous two years. U.S. dollar sales in 1993 of $3.7 billion increased 7 percent over 1992 mostly due to higher average unit selling prices.\nRecord dollar sales outside the U.S. of $2.4 billion for 1994 increased 8 percent over the 1993 amount of $2.2 billion substantially due to record dollar and unit sales in the Europe division, principally higher results by the Company's affiliates in Italy and Germany. Dollar sales for the Asia Pacific division were flat compared to the prior year mostly due to the slow economic recovery, increased product competition (particularly private label) and a market shift to lower margin products, all occurring in Japan. Dollar sales outside the U.S. of $2.2 billion in 1993 increased 4 percent over 1992 due to an increase in unit sales.\nTotal Company dollar and unit sales for 1995 are expected to increase slightly from 1994, due to projected increases in dollar and unit sales for the Europe division, U.S. Levi's(R) women's brand and U.S. Dockers(R) men's brand.\nGross Profit\nAs a percent of sales, the 1994 gross profit percentage of 40 percent was two percentage points higher than 1993 and 1992. In dollars, 1994 gross profit increased 8 percent compared to the prior year period, primarily due to lower U.S. production costs and higher overall average unit selling prices. Gross profit for 1993, in dollars, increased 5 percent from 1992 due to higher average unit selling prices and unit sales.\nLower 1994 U.S. production costs reflected the reversals of $85.9 million of 1994 and prior years workers' health and safety cost accruals. New state workers' compensation legislation in Texas, the Company's safety programs and alternative manufacturing systems implementation all had a positive effect on lowering workers' health and safety costs. These adjustments were partially offset by 1994 charges of $31.9 million for ongoing postretirement benefit expenses related to SFAS 106 (see Postretirement Benefits caption). In response to consumer demand for lower priced products, gross profit was additionally impacted by the U.S. men's Levi's(R) brand producing a higher percentage of lower margin Orange Tab(TM) products and a lower percentage of certain higher margin silverTab(TM) and 501(R) products compared to 1993. This trend is expected to continue in 1995.\nThe businesses outside the U.S. continue to record higher gross profit as a percent of sales than businesses in the U.S., mostly due to higher overall average unit selling prices. Additionally, compared to the U.S., the non-U.S. businesses sell a greater proportion of higher margin denim bottoms (predominately 501(R) and Red Tab(TM) products). The 1994 gross margin percentage for the businesses outside the U.S. was flat compared to the prior year period. Higher gross margin\npercentages in the Company's affiliates in the Far East (principally Korea and the Philippines) offset inventory markdowns for basic denim products in Japan. The markdowns resulted from a change in consumers' preferences from heavy weight basic denim products to more light-weight denim\/rayon blend products. (See Inventories caption for additional information.)\nThe businesses outside the U.S. contributed 39 percent of total Company dollar sales, compared to 37 percent for 1993 and 1992. Additionally, the non-U.S. businesses represented 50 percent of the Company's 1994 profit contribution before corporate expenses and taxes, compared to 54 percent in 1993 and 53 percent in 1992. The lower 1994 profit contribution percentage was primarily due to lower 1994 U.S. production costs compared to 1993.\nMarketing, General and Administrative Expenses\nAs a percentage of sales, marketing, general and administrative expenses of 25 percent for 1994 was 1 percentage point higher than 1993 and 1992. Marketing, general and administrative expenses, in dollars, for 1994 increased 7 percent over 1993. This increase was mostly due to higher administrative, selling and information resource expenses. Marketing, general and administrative expenses in 1993 increased 6 percent over 1992 due to higher advertising, administrative, marketing and information resource expenses.\nAdministrative expense for 1994 increased 12 percent from the comparable 1993 period mostly due to compensation expense related to the adoption of the Management Liquidity Program (see Management Liquidity Program caption for additional information), expenses related to customer service initiatives in the U.S., higher earnings-related compensation costs and varied costs from non-U.S. affiliates. Administrative expense for 1993 increased 8 percent from 1992 mostly due to volume related commissions expense and higher office facility costs.\nSelling expense for 1994 increased 22 percent over 1993 primarily due to higher 1994 sales and increased staffing required to support new and existing product lines in the U.S. Selling expense for 1993 increased slightly over 1992. Marketing expense for 1994 decreased 1 percent from 1993. Marketing expense for 1993 increased 7 percent from 1992, primarily due to additional U.S. merchandising personnel and higher costs associated with the use of sample products in the U.S.\nInformation resource expense for 1994 increased 8 percent compared to the prior year primarily due to increased compensation and professional fees incurred in connection with the Company's U.S. initiative on customer service. Information resource expense for 1993 increased 8 percent from 1992 due to higher lease costs related to certain telecommunications equipment and depreciation related to new mainframe computer equipment. The majority of systems and software costs related to the Company's U.S. initiative to improve customer service are not expected to occur until 1995 and 1996 (see Additional Information section).\nAdvertising expense for 1994 decreased 1 percent from the prior year mostly due to planned reductions in media production expenditures and cooperative advertising in the U.S. that were partially offset by increased advertising expense for the Company's affiliates in Germany and Korea. Advertising expense for 1993 increased 8 percent over 1992 substantially due to U.S.\nand Europe advertising campaigns and increased point-of-sale and media advertising in Europe. (See Business section, under Item 1, for additional information.)\nStock Option Charge\nDuring 1992, the Company offered a special payment arrangement under the 1985 Stock Option Plan to facilitate the exercise by optionholders of their outstanding options. As a result of this arrangement, holders of 65 percent of all outstanding options participated in this arrangement and the Company recognized a pre-tax stock option charge of $158.0 million for all outstanding options during 1992. Separately, the Company also recorded compensation expense for related exercise bonuses and the accelerated use of presently non-vested options. Additionally, the Company disbursed $41.9 million to pay related withholding taxes for optionholders and $4.4 million for related exercise bonuses. A total of 532,368 shares of Class L treasury shares were reissued and 392,755 shares of treasury stock were retired. There were 499,749 options still outstanding and exercisable after this transaction.\nThe net change in Stockholders' Equity in 1992 due to these stock option transactions (including the after-tax effect of the stock option charge) was an increase of $9.2 million.\nOther Operating (Income) Expense, Net\nOther operating income, net for 1994 increased $28.9 million from 1993 mostly due to expenses incurred in 1993 for idle facilities, relocation of certain operations and costs recognized for a decline in value on existing capital assets as a result of the Company's U.S. initiative to improve customer service. Additionally, the Company recorded higher 1994 licensee income. The operating income increase was partially offset by the recognition in 1994 of costs associated with environmental-related soil remediation of a facility previously owned by the Company and income recognized in 1993 from joint ventures. There was no joint venture income in 1994 due to the consolidation of certain joint ventures (see Inventory caption for additional information).\nOther operating expense, net for 1993 increased $14.3 million from 1992 mostly due to costs recognized for a decline in value on existing capital assets related to the Company's U.S. initiative to improve customer service, costs related to idle facilities, relocating certain operations and establishing new operations outside the U.S.\nInterest Expense\nInterest expense decreased 47 percent from 1993 primarily due to lower 1994 average debt balances. Interest expense in 1993 was 30 percent lower than 1992 due to lower interest rates and lower average debt balances. Cash flows from operations were used to reduce debt levels over the last two years, resulting in the lower average debt balances. (See Liquidity and Capital Resources caption for additional information.)\nThe average interest rate in 1994 was approximately 18 percent compared to 9 percent in 1993 and 10 percent in 1992. The increase over last year reflects the high interest markets of non-U.S. countries where most of the Company's debt resides. The average interest rate also reflects the negative impact of the Company's use of interest rate swap transactions (which were all terminated by the end of 1994) to hedge interest rate fluctuations. The interest rate swap transactions were cancelled due to lower average U.S. debt levels. The gains and losses\nrecognized from these cancellations were recorded as other (income) expense, net. (See Note 6 to the Consolidated Financial Statements.)\nThe Company expects 1995 interest expense related to borrowings to be lower than 1994 due to anticipated lower 1995 average debt levels (see Liquidity and Capital Resources caption).\nOther (Income) Expense, Net\nOther expense, net increased $35.1 million in 1994 from the prior year period mostly due to greater 1994 net foreign currency transaction losses and costs associated with foreign currency exchange contracts. The net foreign currency transaction losses were mostly due to the weakening of the U.S. dollar compared to European currencies and the Japanese Yen during 1994. (See Notes 1 and 7 to the Consolidated Financial Statements regarding foreign currency exchange contracts.) Additionally, higher 1994 translation losses were recorded by the Company's affiliate in Turkey, which operates in a high inflationary environment. Higher 1994 interest income on investments partially offset the increase in 1994 other expense, net.\nThe $6.7 million increase in other income, net for 1993 compared to 1992 was primarily attributable to lower interest rate swap termination costs and fewer terminations of lease agreements with tenants. The increase was partially offset by lower interest income on investments.\nProvision for Taxes\nThe increase in the 1994 provision for taxes compared to 1993 was due to higher 1994 earnings. The 1994 effective tax rate was 40 percent compared to 41 percent in 1993 and 43 percent in 1992. The lower 1994 rate was primarily due to a change in the mix of U.S. and non-U.S. earnings, lower state taxes and a decrease in taxes on undistributed earnings of non-U.S. subsidiaries.\nThe increase in the 1993 provision for taxes compared to 1992 was substantially due to lower 1992 earnings caused by the stock option charge. The 1993 effective tax rate was 41 percent compared to 43 percent in 1992. The reduction in the 1993 effective tax rate from 1992 was primarily due to the mix of non- U.S. and U.S. earnings and the negative effects of the one time stock option charge in 1992. The stock option charge produced a tax benefit of only 27 percent because of its negative impact on the utilization of foreign tax credits in 1992. In addition, the 1993 effective tax rate would have been lower, except for the 1993 U.S. tax bill that increased the U.S. statutory tax rate to 35 percent from 34 percent and, therefore, resulted in a 1 percent increase to the Company's 1993 full year effective tax rate.\nThe Company complied with the provisions of SFAS No. 109 \"Accounting for Income Taxes\", which requires an asset and liability approach for financial accounting and reporting of income taxes as of November 29, 1993. The adoption resulted in an $11.9 million credit to income, which was recorded as a cumulative effect of changes in accounting principles on the Consolidated Statements of Income. Upon adoption, deferred tax assets and deferred tax liabilities were adjusted accordingly. (See Note 3 to the Consolidated Financial Statements for additional information.)\nPostretirement Benefits\nThe Company recorded a one-time, non-cash charge against earnings of $402.3 million before taxes and $248.4 million after taxes due to the adoption of SFAS No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" effective November 29, 1993. This charge was recorded as a cumulative effect of a change in accounting principles, net of income tax effects, on the Consolidated Statements of Income with a corresponding amount recorded to employee related benefits on the Consolidated Balance Sheet. The adoption of SFAS No. 106 also resulted in additional ongoing expenses for service and interest costs related to postretirement benefits, which were $43.0 million in 1994 (see Note 11 to the Consolidated Financial Statements).\nFINANCIAL CONDITION AND LIQUIDITY\nThe following discussion compares the liquidity position and certain balance sheet items of the Company as of year-end 1994 and 1993.\nTrade Receivables\nTrade receivables increased 6 percent from 1993 reflecting record fourth quarter 1994 dollar sales. This increase included higher non-U.S. trade receivables as a result of increased dollar sales in the Company's affiliates in Italy and Germany. As a percent of sales, trade receivables for year-end 1994 decreased 4 percent from 1993 due to improved collections as a result of the recovering U.S. economic environment.\nInventories\nInventories at year-end 1994 decreased 1 percent from the prior year period reflecting a 6 percent decrease in U.S. inventories that was mostly offset by an 11 percent increase in non-U.S. inventories. Inventory turnover for 1994 increased 6 percent from 1993 mostly resulting from sales outpacing inventory growth in the U.S. Levi's(R) brand.\nThe reduction in U.S. inventories was due to lower Levi's(R) and Brittania(R) product line inventories that were partially offset by higher Dockers(R) product line inventories. The Company's efforts to reduce inventory levels, including improved production planning, resulted in the lower Levi's(R) brand inventories at year end. Levi's(R) brand inventories are expected to rise during the first half of 1995 to meet anticipated demand. The impact of longer leadtimes on wrinkle-resistant products in 1994 and an anticipated increase in sales during the first half of 1995 caused the men's Dockers(R) brand work-in-process inventories to increase during 1994 from year-end 1993.\nThe increase in inventories outside the U.S. was mostly due to higher projected 1995 sales demand (consisting primarily of denim bottoms) in the Company's affiliates in Italy and Germany. In addition, inventories in the Europe division grew in 1994 due to the consolidation of entities that were previously accounted for by the equity method of accounting.\nInventories in Japan at year-end 1994 were relatively flat compared to 1993. During 1994, the Company's Japanese affiliate shifted some of its product mix to denim\/rayon blend products in response to a change in consumers' preferences from basic denim products to light-weight products. As a result of this shift, inventory markdowns for basic denim products were recorded in Japan during 1994. The Company is monitoring inventory levels in Japan for 1995.\nAt year-end 1994, unshipped orders were 10 percent above the previous year and order cancellations decreased 15 percent from 1993, both mostly due to stronger anticipated first half 1995 sales in the U.S.\nProperty, Plant and Equipment\nProperty, plant and equipment, net for 1994 increased 13 percent from year-end 1993 due to capital expenditures that were partially offset by depreciation expense during the period. Capital expenditures were $176.4 million in 1994 and $142.8 million in 1993.\nApproximately $71.0 million of 1994 capital expenditures was related to the Company's U.S. initiative on customer service primarily for the purchase of land and equipment, and design and engineering costs, for one remodeled and two new customer service centers. Additionally, U.S. business expenditures included equipment and leasehold improvements in connection with the data center relocation outside of California, in accordance with the Company's disaster recovery plan.\nOutside the U.S., a significant portion of capital expenditures were for the construction of a distribution and administrative office facility and purchase of new equipment in Germany. This facility is being built to both modernize work processes and respond to changing customer service needs. Other capital expenditures outside the U.S. included distribution facility upgrades in France and Italy, water treatment upgrades for European manufacturing and finishing facilities, and ongoing expenditures to support non-U.S. affiliates needs.\nAt year-end 1994, the Company had capital expenditure purchase commitments outstanding of approximately $249.5 million. Approximately 89 percent of these commitments are related to the Company's U.S. initiative on customer service and approximately 6 percent are for other equipment needs in North America. The remaining commitments are for worldwide general office and facilities needs. During 1994, the Company negotiated and signed an equipment contract with Computer Aided Systems, Inc. relating to the purchase and installation of materials handling systems (including research and development activities) for the new U.S. customer service centers. Additionally, the Company negotiated and signed a design, engineering, procurement and construction services agreement with Fluor Daniel, Inc. relating to the design and construction of the U.S. customer service center buildings.\nThe Company anticipates authorizations for capital expenditures of approximately $196.0 million for new 1995 projects. Spending on projects during the 1995 year (which included authorizations from previous years) is expected to be $353.0 million, including approximately $207.0 million related to the Company's U.S. initiative on customer service. Spending requirements have not yet been determined for the Levi Strauss International (LSI) customer service initiatives. (See Additional Information section).\nWorking Capital\nWorking capital of $1.6 billion at the end of 1994 increased $550.4 million from year-end 1993 with the current ratio increasing to 2.4 from 1.9. The increase in working capital was substantially due to higher cash and cash equivalents from operations.\nLiquidity and Capital Resources\nThe increase of $560.6 million in cash and cash equivalents from year-end 1993 was mostly due to cash provided by operations that was partially used for purchases of property, plant and equipment and the net repayment of debt. Remaining cash balances were invested in money market interest bearing investments maturing under one year. Additionally, the Company anticipates utilizing a portion of this cash in 1995 to fund costs relating to its global initiatives on customer service and other capital expenditure projects (see Additional Information section).\nDuring 1994, the Company renegotiated and amended its primary credit agreement to reduce its $500.0 million unsecured working capital facility to a $200.0 million 364 day revolving line of credit, which is convertible at the option of the Company into a three-year term loan. This amendment reflects the lower financing needs of the Company. Also during 1994, the Company repaid $50.0 million on its working capital loan and repaid its second and third series of dividend notes payable to Class L stockholders totaling $38.6 million, plus accrued interest of $2.0 million. At November 27, 1994, the Company had no borrowings outstanding on its primary credit agreement. At year-end 1994, the Company's total outstanding debt balance was $66.4 million (mostly outside the U.S.), 54 percent lower than year-end 1993.\nSubsequent to year-end, the Company repaid its fourth and final series of dividend notes to Class L stockholders for an aggregate amount of $20.6 million, plus interest accrued of $1.9 million (see Notes 6 and 22 to the Consolidated Financial Statements for additional information).\nThe Company uses forward and option currency contracts to reduce the risks of foreign currency fluctuations on its non-U.S. dollar denominated operations. The Company's market risk is directly related to fluctuations in the currency exchange rates. The Company's credit risk is limited to the currency rate differential for each agreement if a counterparty failed to meet the terms of the contract. These instruments are executed with credit worthy financial institutions and the Company does not anticipate nonperformance by any counterparties. (See Notes 1 and 6 to 8 to the Consolidated Financial Statements for additional information.)\nFor information regarding the sale of Class E common stock to the Company's employee investment plans, see Note 12 to the Consolidated Financial Statements.\nStock Appreciation Rights Grant\nIn November 1994, the Board of Directors granted 90,000 stock appreciation rights (SARs) to certain executives at an initial grant value of $129 per SAR. In addition, stock based awards, based on a valuation of $129 per share, were granted to two of the five most highly compensated executive officers of the Company. These executives were given the choice to receive 40,000 SARs each or participate in a Class L stock purchase arrangement in which the Company would loan each of these two executives approximately $4.9 million to purchase Class L stock. These executives have until the end of April 1995 to make their decision. (See Note 15 to the Consolidated Financial Statements.)\nRepurchase of Class L Common Stock\nDuring the first quarter of 1994, the Company purchased 83,949 shares of Class L common stock, for a total of $9.6 million, held by certain management stockholders that have left the\nemployment of the Company. The purchase price of $114 per share was the appraised value as determined by a valuation obtained in November 1993 from an independent investment banking firm for the Company's employee stock plans. (See Note 20 to the Consolidated Financial Statements.)\nManagement Liquidity Program\nDuring 1994, the Board of Directors and stockholders approved a stock liquidity program (the \"Liquidity Program\") for management holders of Class L common stock. The Liquidity Program allowed the Company to enter into contracts with then-existing management holders of Class L common stock relating to in-service, employment separation-related and post-separation stock purchases. Holders of 1,047,280 shares of Class L common stock (including outstanding options) participate in this program. They may annually sell a specified amount of their stock to the Company, subject to certain limitations and conditions. The program also entitles the Company to purchase all of the shares held by a management holder at the time of separation from employment.\nParticipating shares were classified on the balance sheet \"outside\" of stockholders' equity due to the liquidity feature. As a result of this Liquidity Program, the Company incurred a pre-tax compensation expense for participating stock options and related exercise bonus of $6.0 million and $13.2 million, respectively, (based on the current appraised stock value of $134 per share). In addition, the Company reclassified common stock outside of stockholders' equity of approximately $138.6 million and recorded a reduction in stockholders' equity of approximately $132.6 million. Future changes in the stock valuation will result in periodic adjustments to compensation expense for participating stock options, participating share balances and retained earnings. Actual purchases of stock by the Company under the Liquidity Program will result in cash outflows.\nSubsequent to year-end, the Company repurchased and subsequently retired 70,842 shares of management Class L common stock, pursuant to the Liquidity Program, at the current appraised stock value of $134 per share totaling $9.5 million. (See Note 17 to the Consolidated Financial Statements.)\nPayment of Dividends on Common Stock\nIn June 1994, the Board of Directors declared a dividend of $.65 per share (totaling $.9 million), which was paid on August 31, 1994 to Class E stockholders of record on July 29, 1994. On November 17, 1994, the Board of Directors declared a dividend of $.65 per share (totaling $.9 million), which was paid on December 15, 1994 to Class E stockholders of record on December 1, 1994. There were no dividends declared on Class L common stock during 1994. (See Notes 20 and 22 to the Consolidated Financial Statements for additional information.)\nADDITIONAL INFORMATION Strategic Initiatives\nThe Company is continuing its process of examining and re-engineering various aspects of its brand marketing, customer service and operations\/distribution strategies. These initiatives include: aligning the Company's U.S. marketing divisions according to its Levi's(R), Dockers(R) and Brittania(R) brands, developing a customer base and product distribution system that is consistent with its brand image, reconfiguring the organization from a functional to a process\norientation, implementing a team-based approach to manufacturing and opening Company owned and joint venture retail stores. (See Strategic Initiatives caption of the Business section, under Item 1, for additional information.)\nU.S. Customer Service Initiative\nThe Company is currently focusing on certain aspects of the U.S. initiative to be completed within the original time frame of November 1996. The Company will focus on other areas of the initiative after the initial areas are completed to mitigate disruption to the Company's ongoing business and strain on Company resources, including its employees.\nSince 1993 and over the next several years, the Company plans to incur total capital expenditures of over $400.0 million to support the new U.S. distribution network, expanded system requirements, organization and manufacturing changes. Included in this total capital expenditure projection is over $290.0 million related to the construction, renovation and retrofitting of new and existing customer service centers. The total capital expenditure projection amount includes previously recognized capital expenditures of approximately $81.0 million.\nAdditionally, the Company plans to spend approximately $450.0 million for transitional expenses, including costs related to the implementation of new software applications, reengineering design and planning, implementation of organization and process changes, training, education and other related expenses. The total amount of transitional expenses include previously recognized expenses of approximately $70.0 million. These costs will be recognized ratably throughout the implementation period and\/or as expenses occur, depending on the nature of the cost and the decisions made related to this initiative. (See Strategic Initiatives caption of the Business section, under Item 1, for additional information.)\nLSI Customer Service Initiatives\nThe LSI customer service initiatives began in late 1993 and encompasses the Company's affiliates in the Europe, Latin America and Asia Pacific divisions. The objective of the LSI initiatives is to build the capabilities within the LSI organization to make customer service a competitive advantage. The LSI customer service initiatives will be highly selective and focused with a varying degree of impact and modification to affiliate organizations. It is too early to determine the amount of capital expenditures and transitional expenses the Company will incur for the LSI initiatives until the design phase is completed. It is expected, however, that the total cost will be less than the costs for the U.S. initiative. These initiatives are expected to be completed over the next several years. (See Strategic Initiatives caption of the Business section, under Item 1, for additional information.)\nU.S. Company-Owned Retail and Outlet Stores\/Retail Joint Venture\nThe Company is planning to own and operate retail and outlet stores in the U.S. that sell only Levi's(R) and Dockers(R) brand products. These stores will include Original Levi's(R) Stores, Dockers(R) Shops and separate outlet stores, in all cases selling only Levi's(R) or Dockers(R) products. The Company expects to open approximately 190 of these stores within the next five years. The Company plans to operate flagship (premier) stores only in key markets and locations most able to help the Company achieve its primary focus of maintaining a high brand image, such as downtown urban locations and selected high visibility regional malls. The\nCompany plans to operate outlet stores dedicated to each brand in areas outside major markets in key outlet malls. The Company expects to spend approximately $90.0 million for capital expenditures during the next few years in connection with this program.\nThis program is in addition to the plans the Company has with Designs, Inc. to establish a joint venture that will own and operate, in the northeastern U.S., approximately 50 Original Levi's(R) Stores selling only Levi's(R) jeans and jeans-related products. The Company will have a 30 percent equity interest in the U.S. joint venture. Venture establishment was approved by the Federal Trade Commission subsequent to year-end. The venture formed and began operations in January 1995. (See Strategic Initiatives caption of the Business section, under Item 1, for additional information.)\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nInformation required by this item and not presented on the following pages is contained in the Supplemental Financial Schedules that are included in this Form 10-K.\nCONSOLIDATED FINANCIAL STATEMENTS\nLEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES\nFor the Years Ended November 27, 1994, November 28, 1993 and November 29, 1992\nLEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollars In Thousands Except Per Share Data)\n\/(1)\/ Fiscal years 1994 and 1993 each contained 52 weeks. Fiscal year 1992 contained 53 weeks.\nThe accompanying notes are an integral part of these financial statements.\nPage 1 of 2 LEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)\nThe accompanying notes are an integral part of these financial statements.\nPage 2 of 2 LEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in Thousands)\nThe accompanying notes are an integral part of these financial statements.\nPage 1 of 3 LEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in Thousands)\nThe accompanying notes are an integral part of these financial statements.\nPage 2 of 3 LEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in Thousands)\nThe accompanying notes are an integral part of these financial statements.\nPage 3 of 3 LEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in Thousands)\nThe accompanying notes are an integral part of these financial statements.\nPage 1 of 2 LEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)\nThe accompanying notes are an integral part of these financial statements.\nPage 2 of 2 LEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)\nThe accompanying notes are an integral part of these financial statements.\nLEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1 SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation\nThe consolidated financial statements include the accounts of Levi Strauss Associates Inc. (LSAI or the Company) and all subsidiaries. All significant intercompany items have been eliminated.\nDepreciation and Amortization Methods\nProperty, plant and equipment is carried at cost, less accumulated depreciation. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the related assets. In the case of certain property under capital lease, depreciation is computed over the lesser of the useful life or the lease term.\nIncome Taxes\nDeferred income taxes result from timing differences in the recognition of revenue, expense and credits for income tax and financial statement purposes. U.S. Federal income tax and foreign withholding taxes are provided on the undistributed earnings of non-U.S. subsidiaries to the extent that taxes on the distribution of such earnings would not be offset by tax credits.\nEffective November 29, 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\". This statement requires a change from the deferral method of accounting for income taxes under Accounting Principles Board Opinion No. 11 to the asset and liability method of accounting for income taxes. Under SFAS No. 109, deferred tax assets and liabilities are established at the balance sheet date in amounts that are expected to be recoverable or payable when the difference in the tax bases and financial statement carrying amounts of assets and liabilities (\"temporary differences\") reverse. The 1994 adoption was recorded as a cumulative effect of a change in accounting principles on the Consolidated Statements of Income.\nRestructuring Costs\nRestructuring costs for severance are accrued when formal plans to restructure are adopted, the information has been communicated to affected employees, the plan specifically identifies certain employee information and involuntary terminations are expected to occur within one year from the date the plan was approved. In absence of a formal plan of restructuring for severance, costs are expensed as incurred. Employee retraining and relocation costs are not considered restructuring costs and are expensed as incurred. Other costs will be expensed as incurred or earlier depending on their nature.\nPostretirement Benefit Plans\nThe Company adopted SFAS No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" effective November 29, 1993. SFAS No. 106 requires the Company to recognize an expense to establish a \"transition obligation\", representing the value at the beginning of the year of the postretirement benefit obligation earned by employees and retirees\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 1 (continued) SIGNIFICANT ACCOUNTING POLICIES Postretirement Benefit Plans (continued)\nin prior periods. This transaction was recorded as a cumulative effect of a change in accounting principles, net of income taxes, on the Consolidated Statements of Income. Additionally, the Company recorded an expense for 1994 net periodic costs.\nIncome Per Common Share\nIncome per common share is computed by dividing income (after deducting dividends on preferred stock, if any) by the average number of common shares outstanding for the period.\nCash Equivalents\nAll highly liquid investments with an original maturity of three months or less are included as cash equivalents.\nInventory Valuation\nInventories are valued at the lower of average cost or market and include materials, labor and manufacturing overhead. Market is calculated on the basis of anticipated selling price less allowances to maintain the normal gross margin for each product.\nCommon Stock - Employee Stock Purchase and Award Plan and Management Liquidity Program\nStock held by participants of the Employee Stock Purchase and Award Plan (ESAP) and Management Liquidity Program are classified outside stockholders' equity due to the put rights attached to Class E and Class L common stock, respectively (see Notes 12 and 17).\nTranslation Adjustment\nThe functional currency for most of the Company's foreign operations is the applicable local currency. For those operations, assets and liabilities are translated into U.S. dollars at period-end exchange rates, and income and expense accounts are translated at average monthly exchange rates. Net exchange gains or losses resulting from such translation are accumulated as a separate component of stockholders' equity. The U.S. dollar is the functional currency for foreign operations in countries with highly inflationary economies, for which both translation adjustments and gains and losses on foreign currency transactions are included in other (income) expense, net.\nForeign Exchange Contracts\nThe Company enters into foreign exchange contracts to hedge against known foreign currency denominated exposures, particularly dividends and intracompany royalties, loans and other transactions from its foreign affiliates and licensees. Market value gains and losses on hedge instruments are recognized and offset foreign exchange gains or losses on existing exposures. The effects of exchange rate changes on transactions designated as hedges of net investments are included in the separate component of stockholders' equity. At November 27, 1994, the net effect of exchange rate changes due to net investment hedge transactions was a $28.5 million decrease to translation adjustment.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 1 (continued) SIGNIFICANT ACCOUNTING POLICIES Foreign Exchange Contracts (continued)\nGains or losses resulting from foreign currency exchange transactions (including certain foreign currency hedge transactions) and translation adjustments of foreign operations in countries with highly inflationary economies are included in other (income) expense, net, and amounted to losses of $51.6 million, $10.0 million and $10.2 million for 1994, 1993 and 1992, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 2 OPERATIONS\nThe following table presents information concerning U.S. and non-U.S. operations (all in the apparel industry).\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 3 INCOME TAXES\nThe U.S. and non-U.S. components of income before taxes and cumulative effects of changes in accounting principles are as follows:\nThe provision for taxes consists of the following:\nAt November 27, 1994, cumulative non-U.S. operating losses of $14.6 million generated by the Company are available to reduce future taxable income primarily between the years 1995 and 1999. The Company utilized all of its remaining foreign tax credit carryforwards in 1993.\nIncome tax expense (benefit) included in translation adjustment was $3.3 million, $(0.1) million and $(8.1) million for 1994, 1993 and 1992, respectively.\nSFAS No. 109 \"Accounting for Income Taxes\" requires an asset and liability approach for financial accounting and reporting of income taxes. Under SFAS No. 109, deferred tax assets\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 3 (continued) INCOME TAXES\nand liabilities are established at the balance sheet date in amounts that are expected to be recoverable or payable when the difference in the tax bases and financial statement carrying amounts of assets and liabilities (\"temporary differences\") reverse. The Company complied with the provisions of SFAS No. 109 as of November 29, 1993. The adoption resulted in an $11.9 million credit to income, which was recorded as a cumulative effect of changes in accounting principles on the Consolidated Statements of Income. Upon adoption, deferred tax assets and deferred tax liabilities were adjusted accordingly.\nUnder SFAS No. 109, adopted as of November 29, 1993, temporary differences which gave rise to deferred tax assets and liabilities at November 27, 1994 were as follows:\nThe net deferred tax assets at November 27, 1994 were $270.7 million.\nUnder the provisions of APB No. 11, the approximate tax effects of timing differences giving rise to deferred income tax expense (benefit) resulted from:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 3 (continued) INCOME TAXES\nThe Company's effective income tax rate in 1994, 1993 and 1992 differs from the statutory federal income tax rate as follows:\n\/(1)\/ The stock option charge, which occurred during the third quarter of 1992, produced a tax benefit of only 27.2 percent in 1992 because of its negative impact on the current utilization of foreign tax credits.\nThe tax aspects of the Omnibus Budget Reconciliation Act of 1993 that was signed into law by President Clinton on August 10, 1993 will not materially affect the Company's future tax expense. The primary impact of the new tax law is a one percent increase in the statutory tax rate.\nThe consolidated U.S. income tax returns of the Company for 1983 through 1985 are under examination by the Internal Revenue Service (IRS). The examination includes the review of certain transactions relating to the 1985 leveraged buyout by the Company of Levi Strauss & Co. The IRS has not yet concluded its examination. The Company believes it has made adequate provision for income taxes and interest for all prior periods.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 4 PROPERTY, PLANT AND EQUIPMENT\nThe components of property, plant and equipment, including both leased and owned assets stated at cost, are as follows:\nThe Company has idle facilities and equipment (all in the U.S.), including closed plants and certain other properties, that are not being depreciated. The book value of these idle facilities and equipment was $6.9 million at November 27, 1994 and $30.6 million at November 28, 1993. The carrying values of idle facilities and equipment are not in excess of net realizable value. These facilities are being offered for sale or lease.\nDepreciation expense for 1994, 1993 and 1992 was $94.2 million, $85.5 million and $73.1 million, respectively.\nThe Company plans to spend over $400.0 million for capital expenditures over the next few years in conjunction with its initiative to improve customer service. (See Business section, under Item 1, for additional information.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 5 INTANGIBLE ASSETS\nThe components of intangible assets are as follows:\nGoodwill, resulting from the 1985 acquisition of Levi Strauss & Co. by Levi Strauss Associates Inc., is being amortized through the year 2025. Acquisition intangibles include trained workforce, leasehold interest, research and development, and licenses. Acquisition intangibles and tradenames were valued as a result of the 1985 acquisition.\nIntangible pension asset is not amortized, but is adjusted each year to correspond to changes in the minimum pension liability.\nAmortization expense for 1994, 1993 and 1992 was $20.5 million, $24.0 million and $24.0 million, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 6 DEBT AND LINES OF CREDIT\nDebt and unused lines of credit are summarized below:\nPrimary Credit Agreement\nDuring 1994, the Company renegotiated and amended its primary credit agreement to reduce its $500.0 million unsecured working capital facility to a $200.0 million 364 day revolving line of credit, which is convertible at the option of the Company into a three-year term loan. Under the new revolving line of credit, commitment fees and interest rate basis points are lower than under the prior working capital facility.\nThe primary credit agreement requires the Company to maintain minimum levels of net worth, leverage and interest coverage. All borrowings under the primary credit agreement bear interest based on either the lending banks' base rate, the certificate of deposit rate or the LIBOR rate (at the Company's option) plus an incremental percentage. The interest rate on borrowings related to the primary credit agreement was 3.6 percent during 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 6 (continued) DEBT AND LINES OF CREDIT Primary Credit Agreement (continued)\nThe Company's prior credit agreement established in 1993 provided for a $500.0 million unsecured working capital facility with more favorable terms than the previous credit agreement. Commitment fees were paid on the unused portion of the amounts available for borrowing.\nJapanese Yen Credit Line Agreements\nIn 1993 the Company repaid all its outstanding 4.8 billion Japanese Yen loan amounts (U.S. dollar equivalent of $38.6 million at the time of repayment) and subsequently cancelled its two unsecured line of credit agreements with two Japanese banks for a total of 6.9 billion Japanese Yen.\nOther Debt\nDuring 1993, the Company issued four series of notes payable collectively totaling $77.1 million to Class L stockholders in partial payment of a dividend declared in November 1992. These notes were payable in four semi-annual installments commencing June 15, 1993 and bear an interest rate incrementally above the six-month Treasury Bill rate. During 1993, the Company repaid the first series of dividend notes to Class L stockholders for an aggregate amount of $18.0 million, plus accrued interest of $.4 million. During 1994, the Company repaid the second and third series of dividend notes to Class L stockholders totaling $38.6 million, plus accrued interest of $2.0 million. Subsequent to year-end on December 15, 1994, the Company repaid the fourth and final series of dividend notes to Class L stockholders for an aggregate amount of $20.6 million, plus accrued interest of $1.9 million.\nPrincipal Debt Payments\nThe required aggregate long-term debt principal payments, excluding capitalized leases, for the next five years and thereafter are as follows:\nShort-Term Credit Lines and Stand-By Letters of Credit\nThe Company has unsecured and uncommitted short-term credit lines available at various interest rates from various U.S. and non-U.S. banks. These credit arrangements may be cancelled by the lenders upon notice and generally have no compensating balance requirements or commitment fees.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 6 (continued) DEBT AND LINES OF CREDIT Short-Term Credit Lines and Stand-By Letters of Credit (continued)\nThe Company has $96.6 million of standby letters of credit with various international banks to serve as guarantees by the creditor banks to cover workers' compensation claims. The Company pays fees on the standby letters of credit and any borrowings against the letters of credit are subject to interest at various rates.\nInterest Rate Swaps\nThe Company entered into interest rate swap transactions to hedge existing floating-rate or fixed-rate liabilities for fixed rates or floating rates. The net interest to be received or paid on the transactions was recorded as an adjustment to interest expense.\nIn 1994, due to lower debt levels, the Company terminated its remaining $100.0 million of interest rate swap agreements that hedged floating-rate liabilities for fixed rates. The termination resulted in a loss of $2.6 million that was included in other (income) expense, net.\nIn 1993, due to lower average debt levels, the Company terminated $100.0 million of interest rate swap agreements and assigned to a third party a $50.0 million interest rate swap agreement that hedged fixed-rate liabilities for floating rates. Additionally, the Company terminated $50.0 million and assigned to a third party $50.0 million of interest rate swap agreements that hedge floating- rate liabilities for fixed rates. The Company also terminated a $25.0 million one-way floating-rate swap transaction. These 1993 transactions resulted in a net gain of $.4 million that was included in other (income) expense, net. At year-end 1993, the Company had $100.0 million of interest rate swaps that hedge floating-rate liabilities for fixed rates.\nIn 1992, the Company terminated $150.0 million of swap agreements for a net loss of $5.6 million, included in other (income) expense, net.\nOther\nThe weighted average interest rate on short-term borrowings outstanding at year- end 1994 and 1993 was 19.0 percent and 20.4 percent, respectively. These rates were relatively high in 1994 and 1993 as approximately 65 percent and 69 percent of the short-term borrowings balance outstanding at the end of 1994 and 1993, respectively, were related to borrowings in Eastern Europe, where the average interest rate was substantially higher than other Company borrowings.\nNote 7 COMMITMENTS AND CONTINGENCIES\nThe Company has forward currency contracts to buy the aggregate equivalent of $124.4 million of the following foreign currencies: Netherlands Guilders, Italian Lire, British Pounds, Finnish Markkaa, French Francs, German Marks, Swiss Francs and Belgian Francs to hedge currency exposures resulting from intercompany transactions.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 7 (continued) COMMITMENTS AND CONTINGENCIES\nThe Company has forward currency contracts to sell the aggregate equivalent of $530.9 million of the following foreign currencies: Japanese Yen, Swedish Kroner, Spanish Pesetas, Norwegian Kroner, Netherlands Guilders, Italian Lire, British Pounds, Finnish Markkaa, French Francs, Danish Kroner, German Marks, Swiss Francs and Belgian Francs. These contracts hedge currency exposures resulting from sourcing operations as well as net investment positions, intercompany royalties and dividend payments. In addition, the Company has Belgian Franc forward currency contracts to sell the aggregate equivalent of $132.5 million of the following foreign currencies: German Marks, French Francs, British Pounds, Greek Drachma, Italian Lire, Netherlands Guilders, Spanish Pesetas and Swedish Kroner. These contracts hedge currency exposures resulting from intercompany receivables and payables.\nThese contracts are at various exchange rates and expire at various dates through 1996.\nIn addition, the Company has the right to sell Japanese Yen for $10.0 million. This contract expires March 1995 and hedges the Company's net investment in its Japanese affiliate.\nRealized and unrealized transaction losses on these contracts included in other (income) expense, net in 1994 were $21.1 million and $19.0 million, respectively.\nThe Company's market risk is directly related to fluctuations in the currency exchange rates. The Company's credit risk is limited to the currency rate differential for each agreement, if a counterparty failed to meet the terms of the contract. These instruments are executed with credit worthy financial institutions and the Company does not anticipate nonperformance by the counterparties. See Note 8 for additional information.\nThe Company evaluates environmental liabilities on an ongoing basis and, based on currently available information, does not consider any environmental exposure to be material. Additionally, the Company does not consider any pending legal proceedings to be material.\nNote 8 FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair value amounts of certain financial instruments have been determined by the Company, using available market information and appropriate valuation methodologies. However, considerable judgment 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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 8 (continued) FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amount and estimated fair value of the Company's financial instruments, on the balance sheet, at November 27, 1994 and November 28, 1993 are as follows:\nQuoted market prices or dealer quotes are used to determine the estimated fair value of the majority of interest rate swap agreements, forward exchange contracts and option contracts. Other techniques, such as the discounted value of future cash flows, replacement cost, and termination cost have been used to determine the estimated fair value for long term debt and the remaining financial instruments. The estimated fair value of the ESAP and management liquidity program common stock is based on the latest valuation of Class E common stock.\nThe carrying values of cash and cash equivalents, trade receivables, current assets, current maturities of long-term debt, short-term borrowings, taxes and dividends payable are assumed to approximate fair value. All investments mature in 90 days or less, therefore the carrying values are considered to approximate market value.\nThe fair value estimates presented herein are based on pertinent information available to the Company as of November 27, 1994 and November 28, 1993. Although the Company is not aware of any factors that would substantially affect the estimated fair value amounts, such amounts have not been updated since that date and, therefore, the current estimates of fair value\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 8 (continued) FAIR VALUE OF FINANCIAL INSTRUMENTS\nat dates subsequent to November 27, 1994 and November 28, 1993 may differ substantially from these amounts. Additionally, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.\nNote 9 LEASES\nThe Company is obligated under both capital and operating leases for facilities, office space and equipment.\nAt November 27, 1994, obligations under long-term leases are as follows:\nThe total minimum lease payments on capital and operating leases have not been reduced by estimated future income of $14.8 million from noncancelable subleases.\nIn general, leases relating to real estate include renewal options of up to 20 years. Some leases contain escalation clauses relating to increases in operating costs. Certain operating leases provide the Company with an option to purchase the property after the initial lease term at the then-prevailing market value. Rental expense for 1994, 1993 and 1992 was $84.3 million, $75.1 million and $67.1 million, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 10 RETIREMENT PLANS\nThe Company has numerous non-contributory defined benefit retirement plans covering substantially all employees. It is the Company's policy to fund its retirement plans based on actuarial recommendations consistent with applicable laws and income tax regulations. Plan assets, which may be denominated in foreign currencies and issued by foreign issuers, are invested in a diversified portfolio of securities including stocks, bonds, real estate investment funds and cash equivalents. The weighted average expected long-term rate of return on assets is 9.0 percent. Benefits payable under the plans are based on either years of service or final average compensation.\nThe funded status of the plans, as of November 27, 1994 and November 28, 1993, reconciles with amounts recognized on the balance sheet as follows:\nUnrecognized net liabilities at transition (established 1988) are being amortized primarily on a straight-line basis over 15 years. Past service costs are amortized on a straight line basis over the average remaining service period of employees expected to receive benefits.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 10 (continued) RETIREMENT PLANS\nThe weighted average discount rate and the rate of increase in future compensation levels used to determine the actuarial present value of the projected benefit obligations for the plans were 8.0 percent and 7.0 percent, respectively, for 1994, 6.6 percent and 6.0 percent, respectively, for 1993 and 7.6 percent and 7.0 percent, respectively, for 1992. Changes in the discount rate and the rate of increase in future compensation levels used to measure the 1994 pension obligations resulted in increases to those obligations as compared to the prior year.\nDuring 1994, the Company recorded a minimum liability of $1.8 million for one of its pension plans. The Company also recorded a corresponding intangible asset of $1.1 million and, since the required intangible asset exceeded the related prior service cost, an adjustment to stockholders' equity of $.7 million.\nNet pension expense includes the following components:\nNote 11 POSTRETIREMENT BENEFIT PLANS\nThe Company adopted SFAS No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" effective November 29, 1993. The statement requires the Company to accrue postretirement benefits (other than pensions) over the period that an employee becomes fully eligible for benefits. Previously, the Company used a \"pay-as-you-go\" method whereby expenses were recorded as claims were incurred.\nUpon adoption of SFAS No. 106, the Company recorded a one-time, non-cash charge against earnings of $402.3 million before taxes and $248.4 million after taxes. This transition obligation represents the actuarially determined value, at November 29, 1993, of the present value of the postretirement benefit obligation earned by retirees and employees in prior periods. The transition obligation was recorded in 1994 as a cumulative effect of a change in accounting principles, net of income tax effects, on the Consolidated Statements of Income.\nThe Company maintains two plans that provide postretirement defined benefits, principally health care benefits, to substantially all domestic retirees and their qualified dependents. These plans have been established with the intention and expectation that they will continue indefinitely.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 11 (continued) POSTRETIREMENT BENEFIT PLANS\nHowever, the Company retains the right to amend, curtail or discontinue any aspect of the plans at any time. Under the Company's current policies, employees become eligible for these benefits when they reach age 55 with 15 years of credited service. The plans are contributory as well as containing certain cost- sharing features, such as deductibles and coinsurance. The plans also provide for reimbursement of Medicare Part B premiums to participants over age 65. The accounting for retiree health care benefits anticipates future cost-sharing changes to the written plan consistent with the Company's expressed intent to limit, over time, the Medicare Part B premium reimbursement to 50% of the annual increase in the premium cost. The Company's policy is to fund postretirement benefits as claims and premiums are paid.\nPostretirement benefit costs for 1994, exclusive of the transition obligation, include the following components:\nThe actuarial present value of the Accumulated Postretirement Benefits Obligation (APBO) and amounts recognized on the Company's Consolidated Balance Sheets at November 27, 1994 are as follows:\nThe discount rate used to determine the APBO was 8.0% and 6.5% at November 27, 1994 and November 29, 1993, respectively. An 11.9% and 5.9% annual rate of increase in the health care trend rate and Medicare Part B trend rate, respectively, was assumed for 1994, declining gradually to 5.0% and 2.5% by the year 2008 and remaining at that rate thereafter. A one\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 11 (continued) POSTRETIREMENT BENEFIT PLANS\npercentage point increase in the assumed health care trend rate for each future year would have increased the service cost and interest cost components of net postretirement benefit costs by approximately $9.0 million and would have increased the APBO as of November 27, 1994 by approximately $66.1 million.\nNote 12 EMPLOYEE INVESTMENT PLANS\nThe Company maintains three employee investment plans. The Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc. (ESAP) is a non- qualified employee equity program for highly compensated (as defined by the Internal Revenue Code) employees. The Employee Investment Plan of Levi Strauss Associates Inc. (EIP) and the Levi Strauss Associates Inc. Employee Long-Term Investment and Savings Plan (ELTIS) are two qualified plans that cover non- highly compensated Home Office employees and U.S. field employees.\nESAP\nUnder the ESAP, eligible employees may invest up to 10 percent of their annual compensation, through payroll deductions, to directly purchase and hold shares of Class E common stock. Employee contributions are made on an after-tax basis. The Company may match 75 percent of the contributions made by employees in stock. Employees are always 100 percent vested in the Company match. Employees may elect to have their withholding taxes deducted from their match shares contributed by the Company. There are various put, call and first refusal rights associated with Class E common stock obtained through the ESAP. The ESAP generally prohibits all transfers of shares other than to the Company. Put rights associated with ESAP entitle participants to sell shares back to the Company in specified circumstances subject to certain restrictions and penalties. It also entitles the Company to buy back shares upon termination of the participant's employment. In all cases, shares are repurchased at the current appraised value of the shares during the semi-annual employee purchase periods. The intent of ESAP is to be a long-term investment plan and therefore the Company does not expect to repurchase large amounts of ESAP shares at any given time. See Note 20 for stock valuation information.\nShares held by participants of the ESAP are classified outside stockholders' equity due to the put rights attached to Class E common stock sold through the ESAP. The redemption value at the time of repurchase would be based on the latest valuation of Class E common stock.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 12 (continued) EMPLOYEE INVESTMENT PLANS ESAP (continued)\nThe following summary presents ESAP activity for the years ended November 27, 1994, November 28, 1993 and November 29, 1992:\n- -------------------------- \/(1)\/ includes adjustment due to the reissuance of treasury stock purchased in 1993 and 1992, respectively\nOn January 18, 1995, employees under ESAP purchased 33,362 shares of Class E common stock from the Company, at $134 per share as determined by the valuation of an independent\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 12 (continued) EMPLOYEE INVESTMENT PLANS ESAP (continued)\ninvestment banking firm. The Company contributed 21,181 matching shares before taxes to these employees at a cost of approximately $2.8 million, which was included in fiscal 1994 compensation expense.\nEIP\/ELTIS\nUnder the qualified plans, eligible employees may contribute up to 10 percent of their annual compensation to various investment funds, including a fund that invests in Class E common stock. The Company may match 50 percent of the contributions made by employees to the fund that invests in Class E common stock. Effective for fiscal 1994 contributions, the Company may match 50 percent of the contributions made by employees to all funds maintained under the qualified plans. The additional compensation expense associated with this change was minimal.\nEmployees are always 100 percent vested in the Company match. The ELTIS also includes a company profit sharing provision with payments made at the sole discretion of the Board of Directors. The EIP allows employees a choice of either pre-tax or after-tax contributions. Employee contributions under the ELTIS are on a pre-tax basis only.\nDuring 1994, certain assets of the EIP were transferred to, held by and under the control of a new trustee, Fidelity Management Trust Company. EIP participants may currently direct investments among a series of mutual funds offered under the EIP and managed by the new trustee. These mutual funds provide participants investment alternatives similar to those previously available under the EIP as well as increasing participant flexibility in managing their investments.\nDuring 1994, the qualified plans collectively purchased 10,208 shares at $114 per share as determined by the valuation of an independent investment banking firm at the time of purchase. There were no shares purchased at $129 per share due to cash needs of the plan. In addition, the Company contributed 35,367 shares to these plans. It is anticipated that there may be similar cash requirements for both qualified plans in 1995.\nDuring 1993, the qualified plans collectively purchased 47,351 shares and 14,436 shares at $116 and $138 per share, respectively, as determined by the valuation of an independent investment banking firm at the time of purchase (the $116 price was based on the independent valuation of $119 per share, less a $3 per share dividend paid after the valuation was issued but before the stock purchase). In addition, the Company contributed 38,263 shares to these plans. During 1992, the qualified plans purchased 35,997 shares and 13,283 shares at $84 and $122 per share, respectively, and the Company contributed 78,867 matching shares.\nIt is the Company's intent to have semi-annual sales of Class E common stock to the EIP, ELTIS and ESAP. However, the frequency of these sales may be dependent upon business and economic conditions.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 12 (continued) EMPLOYEE INVESTMENT PLANS EIP\/ELTIS (continued)\nOn January 18, 1995, ELTIS purchased 2,109 shares of Class E common stock from the Company at $134 per share as determined by the valuation of an independent investment banking firm. There were no shares purchased from the EIP due to cash needs of the plan. In addition, the Company contributed 11,202 shares (which included a portion related to ELTIS profit sharing) to these plans at a cost of $1.5 million, which was included in fiscal 1994 compensation expense.\nHome Office Cash Performance Sharing Plan\nThe Company has a Cash Performance Sharing Plan for all Home Office payroll employees that pays out based on a percentage of base salary and certain Company earnings criteria. Participants in the management incentive plan can receive up to 8 percent, while other Home Office employees can receive up to 12 percent, of their covered compensation (fiscal year salary and non-long-term performance plan bonus) under this plan. In 1995, the Company will implement a new performance and pay program replacing this program for salaried employees. (See Partners in Performance caption under Item 11 for additional information.)\nThe aggregate cost of providing all aspects of these plans, along with other savings and compensation plans in 1994, 1993 and 1992 were $52.2 million, $45.4 million and $46.0 million, respectively.\nNote 13 MANAGEMENT INCENTIVE PLAN\nThe Company's Management Incentive Plan (\"MIP\") provides selected employees with incentive compensation and provides a tool for recruiting and retaining selected employees. Under the MIP, the Personnel Committee of the Board of Directors, as administrator of the MIP, may award discretionary cash payments to selected employees. Such awards are made on the basis of various factors, including profit levels, return on investment, salary grade and individual performance. The amounts charged to expense for the MIP in 1994, 1993 and 1992 were $15.8 million, $13.8 million and $12.8 million, respectively. This plan will be replaced by a new performance and pay program in 1995 (see Partners in Performance caption under Item 11 for additional information).\nNote 14 LONG-TERM PERFORMANCE PLAN\nThe Company has a Long-Term Performance Plan (\"LTPP\"), to provide incentive and reward performance over time and potential future contributions, for certain directors, officers and key employees. Under this plan, a number of performance units are granted to each participant. The value assigned to each unit is based on the Company achieving a target performance measure over a three-year period, as determined by a committee of the Board of Directors. Awards are paid in one- third increments on the third, fourth and fifth anniversaries of the date of the grant. The amounts charged to expense for the plan in 1994, 1993 and 1992 were\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 14 (continued) LONG-TERM PERFORMANCE PLAN\n$29.8 million, $25.7 million and $27.9 million, respectively. This plan will be replaced by a new performance and pay program in 1996 (see Partners in Performance caption under Item 11 for additional information).\nNote 15 EXECUTIVE STOCK APPRECIATION RIGHTS PLAN\nThe Levi Strauss Associates Inc. Executive Stock Appreciation Rights Plan was established in 1992. A total of 90,000 stock appreciation rights (SARS) were granted in 1994 to certain executives at an initial grant value of $129 per SAR. These SARs vest over several years and become exercisable commencing in 1997. In addition, stock based awards, based on a valuation of $129 per share, were granted to two of the five most highly compensated executive officers of the Company. These executives were given the choice to receive 40,000 SARs each or participate in a Class L stock purchase arrangement in which the Company would loan each of these two executives approximately $4.9 million to purchase Class L stock. These executives have until the end of April 1995 to make their decision.\nAlso during 1994, 17,000 stock appreciation rights granted in 1992 were forfeited. There were no SAR grants during 1993. A total of 114,000 SARs were granted in 1992 at an initial grant value of $84 per SAR. The 1992 SARs vest over several years and become exercisable commencing in 1995. The amounts charged to expense for the plan (net of forfeitures) in 1994, 1993 and 1992 were $1.8 million, $.9 million and $.5 million, respectively.\nNote 16 STOCK OPTION PLAN\nThe Company has a 1985 Stock Option Plan (the \"Plan\") for Class L common stock under which options are granted at an exercise price determined on the date of grant by a committee of the Board of Directors. Options under the Plan expire ten years from the date of grant and become exercisable as determined by the committee.\nDuring the fourth quarter of 1994, all outstanding options became subject to the terms of the management liquidity program (see Note 17).\nIn 1992, the Board of Directors approved a special payment arrangement under the Plan to facilitate the exercise by optionholders of their outstanding options. This arrangement accelerated vesting on all non-vested options and allowed each optionholder to exercise outstanding options by surrendering a portion of these outstanding options in full payment of the exercise price and related tax obligations. Holders of 65 percent of all outstanding options participated in this arrangement. The special arrangement required the recognition of a fiscal 1992 pre-tax stock option charge of $158.0 million for all outstanding options (the amount equal to the difference between the fair market value of the underlying shares at the exercise date and at the grant date). Separately, the Company also recognized compensation expense for related exercise bonuses and the accelerated use of presently non-vested options. The Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 16 (continued) STOCK OPTION PLAN\ndisbursed $41.9 million to pay related withholding taxes for optionholders (in exchange for an equal amount of surrendered options) and $4.4 million for related exercise bonuses. The optionholders participating in this arrangement exercised 925,123 options resulting in 532,368 reissued treasury shares of Class L common stock. The Company also retired 392,755 shares of treasury stock, which was equal to the number of options surrendered. The net change in Stockholders' Equity (including the after-tax effect of the stock option charge) was an increase of $9.2 million.\nThe following summary presents stock option activity for the years ended November 29, 1992, November 28, 1993 and November 27, 1994:\nNote 17 MANAGEMENT LIQUIDITY PROGRAM\nDuring 1994, the Board of Directors and stockholders approved a stock liquidity program (the \"Liquidity Program\") for management holders of Class L common stock. The Liquidity Program allowed the Company to enter into contracts with then-existing management holders of Class L common stock relating to in-service, employment separation-related and post-separation stock purchases. Holders of 1,047,280 shares of Class L common stock (including outstanding options) participate in this program. They may annually sell a specified amount of their stock to the Company, subject to certain limitations and conditions. The program also entitles the Company to purchase all of the shares held by a management holder at the time of separation from employment.\nParticipating shares were classified on the balance sheet \"outside\" of stockholders' equity due to the liquidity feature. As a result of this Liquidity Program, the Company incurred a pre-tax compensation expense for participating stock options and related exercise bonus of $6.0 million and $13.2 million, respectively, (based on the current appraised stock value of $134 per share).\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 17 (continued) MANAGEMENT LIQUIDITY PROGRAM\nIn addition, the Company reclassified common stock outside of stockholders' equity of approximately $138.6 million and recorded a reduction in stockholders' equity of approximately $132.6 million. Future changes in the stock valuation will result in periodic adjustments to compensation expense for participating stock options, participating share balances and retained earnings. Actual purchases of stock by the Company under the Liquidity Program will result in cash outflows.\nSubsequent to year-end, the Company repurchased and subsequently retired 70,842 shares of management Class L common stock, pursuant to the Liquidity Program, at the current appraised stock value of $134 per share totaling $9.5 million.\nNote 18 LONG-TERM EMPLOYEE RELATED BENEFITS\nThe components of long-term employee related benefits are as follows:\nIncluded in workers compensation are accrued expenses related to the Company's program that provides for early identification and treatment of employee injuries. During 1994, the Company reduced its Workers' Compensation expense by $85.9 million, which represents a reversal of previously estimated costs for years 1994 and prior. The reduction was due to the positive effects of new state workers' compensation legislation in Texas and the Company's safety programs and alternative manufacturing systems implementation. Other deferred employee benefits include accrued liabilities for the Company's long-term performance plan, deferred compensation, benefit restoration, pension and other plans.\nNote 19 SERIES A AND SERIES B PREFERRED STOCK\nDuring 1992, the Company redeemed for cash and permanently retired all outstanding shares of Series A preferred stock at $170 per share, for an aggregate of $82.3 million, plus accrued and unpaid dividends of $1.1 million. The Company used cash from operations to purchase the shares. Dividend distributions of $4.3 million were paid in 1992. During 1992, all shares of Series B preferred stock were redeemed and permanently retired during 1992 at $54 per share for an aggregate of $76.5 million, plus accrued and unpaid dividends of $3.2 million. Dividend distributions of $3.2 million were paid in 1992.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 20 COMMON STOCK Restated Certificate of Incorporation\nDuring 1993, holders of a majority of outstanding shares (approximately 60 percent) of the Company approved, by written consent, an amendment and restatement of the Company's Certificate of Incorporation (the \"Restatement\"). The Restatement simplifies and shortens the capital stock provisions of the Certificate of Incorporation. It removes the Company's authority to issue, and eliminates all references to, Class F common stock, Series A preferred stock and Series B preferred stock. It does not affect any provisions relating to Class E common stock or Class L common stock, or make any other changes in the Certificate of Incorporation.\nCurrently, the Company has an authorized capital structure consisting of: 270,000,000 shares of common stock, par value $.10 per share, of which 100,000,000 shares are designated Class E common stock and 170,000,000 shares are designated Class L common stock; plus 10,000,000 shares of preferred stock, par value $1.00 per share. Class L common stock is subject to a stockholders' agreement (expiring in April 2001), which limits transfers of the shares. Additionally, management Class L stockholders are parties to contracts with the Company providing for in-service, employment separation-related and post- separation stock purchases (see Note 17 for information relating to the Management Liquidity Program). The outstanding shares of Class E common stock are subject to restrictions on transfer imposed by the EIP, ELTIS and ESAP.\nDividends\nIn November 1994, the Board of Directors declared a dividend of $.65 per share (totaling $.9 million), which was paid on December 15, 1994 to Class E stockholders of record on December 1, 1994. In June 1994, the Board of Directors declared a dividend of $.65 per share (totaling $.9 million), which was paid on August 31, 1994 to Class E stockholders of record on July 29, 1994. There were no dividends declared on Class L common stock during 1994.\nOn November 18, 1993, the Board of Directors declared a dividend of $.55 per share (totaling $.7 million), which was paid on December 15, 1993 to Class E stockholders of record on December 1, 1993. In June 1993, the Board of Directors declared a dividend of $.55 per share, for an aggregate of $.7 million, which was paid on August 27, 1993 to Class E stockholders of record on July 30, 1993. There were no dividends declared on Class L common stock during 1993.\nIn November 1992, the Board of Directors declared a dividend of $3.00 per share (totaling $2.9 million), which was paid on December 15, 1992, to Class E stockholders of record on December 1, 1992. Also in November 1992, the Board of Directors declared a dividend of $3.00 per share to Class L stockholders of record on December 1, 1992, $1.50 of which (totaling $77.1 million) was paid on December 15, 1992 and $1.50 of which (totaling $77.1 million) is payable in four semi-annual installments commencing June 15, 1993. The notes issued for these dividends bear an interest rate incrementally above the six-month Treasury Bill rate.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 20 (continued) COMMON STOCK Dividends (continued)\nIn June 1992, the Board of Directors declared a common stock dividend of $.40 per share (totaling $21.0 million), which was paid on August 14, 1992, to Class E and Class L stockholders of record on July 31, 1992.\nThe declaration of future dividends on Class E and Class L common stock is within the discretion of the Board of Directors of the Company and will depend upon business conditions, earnings, the financial condition of the Company and other factors.\nTreasury Stock Reissuance\/Retirement\nAs a result of the special payment arrangement under the 1985 Stock Option Plan (see Note 16), 532,368 shares of Class L treasury stock were reissued and 392,755 shares of Class L treasury stock were retired during 1992. The net change in Stockholders' Equity (including the after-tax effect of the stock option charge) was an increase of $9.2 million.\nCommon Stock - Employee Investment Plans\nClass E common stock held by participants of the ESAP (see Note 12) are classified outside stockholders' equity due to the put rights attached to ESAP Class E common stock sold. There were no Class E common shares offered for purchase to ESAP participants prior to 1992. The redemption amount of common stock sold through the ESAP represents the latest independent valuation of $134 per share.\nClass E common stock is appraised, usually twice a year, by an independent investment banking firm. The latest appraised value of Class E common stock is used as the price for selling or repurchasing Class E common stock from the EIP and ELTIS trustee and ESAP participants. The latest appraised value of Class E common stock is also used as the value for Class L common stock, including participating shares of the Management Liquidity Program. The investment firm is instructed to value stock as though there had been a public trading market for the stock on the valuation date, and to not give consideration to an acquisition or control premium, or to a private market discount. There is, however, no assurance that the Company's stock would trade at the price determined through the independent investing banking firm valuation had there been a public trading market for the shares on the valuation date.\nCommon Stock - Management Liquidity Program\nParticipating Class L shares under the Management Liquidity Program (the Program) are classified outside stockholders' equity due to the liquidity feature under the Program (see Note 17). Program shares are shown on the balance sheet valued at the latest independent valuation of $134 per share.\nRepurchase of Class L Common Stock\nDuring the first quarter of 1994, the Company purchased 83,949 shares of Class L common stock, for a total of $9.6 million, held by certain management stockholders who left the\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNote 20 (continued) COMMON STOCK Repurchase of Class L Common Stock (continued)\nemployment of the Company. The purchase price of $114 per share was the appraised value as determined by a valuation obtained in November 1993 from an independent investment banking firm for the Company's employee stock plans.\nNote 21 RELATED PARTIES\nSee Item 13, Other Transactions, for related parties information.\nNote 22 SUBSEQUENT EVENTS Management Liquidity Program\nDuring the first quarter of 1995, the Company repurchased and subsequently retired 70,842 shares of management Class L common stock, pursuant to the management liquidity program, at the current appraised stock value of $134 per share totaling $9.5 million (see Note 17).\nRepayment of Dividend Notes\nOn December 15, 1994, the Company repaid its fourth and final series of dividend notes to Class L stockholders for an aggregate amount of $20.6 million, plus interest accrued of $1.9 million. (See Note 6 for additional information.)\nPayment of Dividends\nOn December 15, 1994, the Company paid to Class E stockholders of record dividends of $.65 per share, for an aggregate amount of $.9 million. (See Note 20 for additional information.)\nDeclaration of Dividends\nIn February 1995, the Board of Directors declared a dividend of $.75 per share (for an aggregate amount of approximately $39.5 million), payable on March 15, 1995 to Class E and Class L stockholders of record on March 1, 1995.\nSale of Class E Common Stock to Employee Investment Plans\nDuring January 1995, the Company's employee investment plans, collectively, purchased 35,471 shares of Class E common stock from the Company and the Company contributed 32,383 matching shares before taxes to these plans. (See Note 12 for additional information.)\nPartners in Performance\nIn early 1995, the Company implemented a new performance and pay program, Partners in Performance. This program replaces the current cash performance sharing plan and management incentive plan in 1995 and will replace the long- term performance plan in 1996. The added cost of this plan is estimated to be an additional expense of approximately $5.0 million in 1995. (See Partners in Performance caption under Item 11 for additional information.)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Levi Strauss Associates Inc.:\nWe have audited the accompanying consolidated balance sheets of Levi Strauss Associates Inc. (a Delaware corporation) and Subsidiaries as of November 27, 1994 and November 28, 1993, and the related consolidated statements of income, stockholders' equity and cash flows for the years ended November 27, 1994, November 28, 1993 and November 29, 1992. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Levi Strauss Associates Inc. and Subsidiaries as of November 27, 1994 and November 28, 1993, and the results of their operations and their cash flows for each of the three years in the period ended November 27, 1994, in conformity with generally accepted accounting principles.\nAs explained in Notes 3 and 11 to the Consolidated Financial Statements, effective November 29, 1993, the Company changed its method of accounting for income taxes and postretirement benefit plans.\nARTHUR ANDERSEN LLP\nSan Francisco, California, January 19, 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 table below identifies the current directors and executive officers of the Company, along with their offices, positions and ages.\n- -------------------------- \/(1)\/ Robert D. Haas is the son of Walter A. Haas, Jr.; Walter A. Haas, Jr. is the brother of Peter E. Haas, Sr. and Rhoda H. Goldman, and the uncle of Peter E. Haas, Jr. \/(2)\/ Member, Corporate Ethics and Social Responsibility Committee \/(3)\/ Member, Audit Committee \/(4)\/ Member, Personnel Committee Note: John F. Kilmartin retired December 5, 1993 and was replaced by Angela Glover Blackwell.\nDirectors are divided into three classes of equal number. All directors are and will be elected by holders of a majority of the outstanding shares of the Company entitled to vote in the election of directors. Stockholders vote separately for the election of directors in each class. The first class of directors consists of Mr. R. D. Haas, Mrs. Goldman, Ms. Blackwell and Mr. Friedman and the term of office expires at the 1996 annual meeting. The second class consists of Mr. P.E. Haas, Jr., Mr. W. A. Haas, Jr., Mr. Hellman and Ms. Pineda and the term of office expires at the 1997 annual meeting. The third class consists of Mr. Tusher, Mr. P. E. Haas,\nSr., Mr. Gaither and Mr. Koshland and the term of office expires at the 1995 annual meeting of stockholders.\nDirectors who are elected at an annual meeting of stockholders to succeed those whose terms then expire will be identified as being directors of the same class as those they succeed. Staggered board provisions result in the election of only one-third of the Board at each annual meeting. This arrangement limits the ability of a person holding enough stock to control the election process from effecting a rapid change in board composition and therefore may have the effect of delaying, deferring or preventing a change in control of the Company. Executive officers serve at the discretion of the Board of Directors.\nAll members of the Haas family and Mrs. Goldman are direct descendants of the founder of LS&CO., Levi Strauss.\nWalter A. Haas, Jr. became Honorary Chairman of the Board of LS&CO. and the Company in 1985. He joined LS&CO. in 1939 and held the positions of President from 1958 to 1970 and Chief Executive Officer from 1958 to 1976. He served as Chairman of the Board from 1970 to 1981 and Chairman of the Executive Committee from 1976 until 1985.\nMr. W.A. Haas, Jr. is a trustee of the Business Enterprise Trust. He was formerly a director of UAL, Inc., United Airlines, Inc., BankAmerica Corporation and Bank of America, NT & SA. He was appointed to the National Commission on Public Service, is a former member of the Citizens Commission on Private Philanthropy and Public Need, a former member of the Trilateral Commission, a former trustee of the Ford Foundation and has served on the Presidential Advisory Council for Minority Enterprise. Mr. Haas is also owner and Managing General Partner of the Oakland Athletics.\nPeter E. Haas, Sr. assumed his present position as Chairman of the Executive Committee of the Board of Directors in March 1989 after serving as Chairman of the Board of LS&CO. since 1981, and of the Company since 1985. He joined LS&CO. in 1945 and became President in 1970 and Chief Executive Officer in 1976. He has served on the Board of LS&CO. since 1948 and has been a director of the Company since its inception in 1985.\nMr. P.E. Haas, Sr. is a former Associate of the Smithsonian National Board and a trustee and former Chairman of the Board of Trustees of the San Francisco Foundation. He is a former director of the Northern California Grantmakers, Crocker National Corporation and Crocker National Bank, and American Telephone and Telegraph Co. He is a former President of the United Way of the Bay Area, the Jewish Community Federation, Aid to Retarded Citizens and the Rosenberg Foundation and a former member of the Board of Governors of the United Way of America.\nRobert D. Haas assumed his present position as Chairman of the Board of Directors of the Company and LS&CO. in March 1989. Since 1984, he has served as Chief Executive Officer of the Company and LS&CO., and was President of the Company from its inception in 1985 to March 1989. Since he joined LS&CO. in 1973, Mr. Haas served in a number of positions, including Marketing Director and Group Vice President of LSI, Director of Corporate Marketing Development, Senior Vice President of Corporate Planning and Policy and President of the New\nBusiness Group. He became President of the Operating Groups in 1980 and was named Executive Vice President and Chief Operating Officer in 1981. He was elected to the LS&CO. Board of Directors in 1980 and has been a director of the Company since its inception in 1985.\nMr. R.D. Haas is an active participant in business and community organizations and is currently Chairman of the Board of Directors of the Levi Strauss Foundation, a trustee of the Ford Foundation, an honorary trustee of the Brookings Institution and an honorary director of the San Francisco AIDS Foundation. He is also a member of the Conference Board, the Council on Foreign Relations, the Trilateral Commission, the Bay Area Council, the California Business Roundtable and a former Director of the American Apparel Association.\nThomas W. Tusher, President and Chief Operating Officer, joined LS&CO. in 1969, was elected Executive Vice President and Chief Operating Officer in 1984 and became President and a director of the Company in March 1989. He previously served as President of the Europe Division, Executive Vice President of the International Group and was appointed President of LSI in 1980. He was elected a Vice President of LS&CO. in 1976 and a Senior Vice President in 1977 and was a director of LS&CO. from 1979 until 1985.\nMr. Tusher is a director of Cakebread Cellars and a former director of Great Western Financial Corporation and the San Francisco Chamber of Commerce. He is a member and former Chairman of the Walter A. Haas School of Business Advisory Board, University of California Berkeley and a member of the Bay Area Sports Hall of Fame Committee.\nAngela Glover Blackwell, elected to the Board in February 1994, is the founder and former President of Urban Strategies Council, established in 1987. As of January 23, 1995, she assumed the vice-presidency of the Rockefeller Foundation in New York. Previously, she served as staff attorney and managing attorney for Public Advocates, Inc. and served on the board for Common Cause. Ms. Blackwell currently serves on the boards of the James Irvine Foundation, Children Now, the Center on Budget and Policy Priorities, the Foundation for Child Development and the Urban Institute. She also co-chairs the Commission for Positive Change in the Oakland Public Schools.\nTully M. Friedman, a director since 1985, has been a managing partner of the private investment firm of Hellman & Friedman since its inception in 1984. From 1979 until 1984, he was a general partner and, later, managing director of Salomon Brothers Inc. Currently, he is a director of Mattel, Inc., McKesson Corporation, Western Wireless Corporation, American President Companies, Ltd. and MobileMedia Corporation. He is a member of the Advisory Committee of Falcon Cable TV, a trustee and member of the Executive Committee of the American Enterprise Institute and a director of Stanford Management Company. He is a former President of the San Francisco Opera Association and a former Chairman of Mount Zion Hospital and Medical Center.\nJames C. Gaither, a director since April 1988, is a partner of the law firm of Cooley, Godward, Castro, Huddleson & Tatum, San Francisco, California. Prior to beginning his law practice with the firm in 1969, he served as law clerk to the Honorable Earl Warren, Chief Justice of the United States, Special Assistant to the Assistant Attorney General in the U.S. Department of Justice and Staff Assistant to the President of the United States, Lyndon B.\nJohnson. Mr. Gaither is the former President of the Board of Trustees at Stanford University and is a member of the Board of Trustees of the Carnegie Endowment for International Peace and for The RAND Corporation. He was formerly Chairman of the Board of Trustees for the Center for Biotechnology Research and has served as Chairman of the Board of many educational and philanthropic organizations in the San Francisco Bay Area. Mr. Gaither is currently a director of Basic American Inc., the James Irvine Foundation and has served as a director of several other public and private companies.\nRhoda H. Goldman, a director since 1985, devotes substantial time to public service. She is a director of Mount Zion Health Systems and a former trustee of Mount Zion Medical Center of the University of California, San Francisco, Vice President of the Board of Governors of the San Francisco Symphony, a member of Foster McGaw Prize Committee, the Goldman Environmental Foundation, the Walter A. Haas School of Business Advisory Board, University of California Berkeley, the ARCS Foundation and the Levi Strauss Foundation. She is past President of Congregation Emanu-El, San Francisco. Additionally, she is Chairperson of the Stern Grove Festival Association and has served as Chairperson of the Distribution Committee of the San Francisco Foundation and the Mayor's Holocaust Memorial Committee.\nPeter E. Haas, Jr., a director since 1985, joined LS&CO. in 1972 as Director of the Minority Purchasing Program. He later transferred to LSI, where he held the positions of Manager of Financial Analysis, Inventory Planning Manager and General Merchandising Manager. He became a Vice President and General Manager in the Menswear Division in 1980, Director of Materials Management for Levi Strauss USA in 1982 and was Director of Product Integrity of The Jeans Company from 1984 to February 1989. Mr. P.E. Haas, Jr. is a former President of the Board of Trustees of Marin Academy and is President of the Board of Directors of the Red Tab Foundation. Additionally, he is director of the following Boards: Vassar College, Levi Strauss Foundation, Novato Youth Center (former President), North Bay Bancorp and The Stern Grove Festival Foundation.\nF. Warren Hellman, a director since 1985, has been a managing partner of the private investment firm of Hellman & Friedman since its inception in 1984. Previously, he was Managing Director of Lehman Brothers Kuhn Loeb, Inc. Mr. Hellman is currently a director of American President Companies, Ltd., Williams- Sonoma, Inc., Franklin Resources, Inc., Il Fornaio America Corporation, DN&E Walter Co., Children Now, Eagle Industries, Inc., Great America Management & Investment, Inc., The California Higher Education Policy Center and University of California San Francisco (UCSF) Foundation. He is a trustee of the Brookings Institution, a member of the University of California Berkeley Foundation and Honorary Lifetime Trustee of Mills College.\nJames M. Koshland, a director since 1985, is a partner of the law firm of Gray, Cary, Ware & Freidenrich, a Professional Corporation, Palo Alto, California, with which he has been associated since 1978. Mr. Koshland is Chairman of the Corporate and Securities Group and a member of the Executive Board of the firm. He is a director of the Giarretto Institute, the Foundation for the Future of Menlo-Atherton High School, the Senior Coordinating Council of the Palo Alto area, and the Executive Committee of the Board of Visitors of Stanford Law School.\nPatricia Salas Pineda, a director since 1991, is General Counsel and Assistant Corporate Secretary of New United Motor Manufacturing, Inc., with which she has been associated since 1984. She is currently a trustee of Mills College and The RAND Corporation. She was formerly a member and served as President of the Port of Oakland Commission and was a former member of the KQED, Inc. Board of Directors and the San Francisco Ballet Association.\nThomas J. Bauch, Senior Vice President, General Counsel and Secretary, joined LS&CO. in 1977. He was named General Counsel in 1981, elected a Vice President of LS&CO. in 1982 and assumed his current position as Senior Vice President in 1985. Mr. Bauch has served on the Board of Governors of the Commonwealth Club and the Board of Visitors of the University of Wisconsin Law School. He has served on the Board of Directors of the Urban School of San Francisco, the American Corporate Counsel Association, the Medical Research Institute and as a legal advisor to the City of Belvedere and the Multicultural Alliance. He was Chairman of the Bay Area General Counsel Association in 1984.\nR. William Eaton, Jr., Senior Vice President and Chief Information Officer, joined LS&CO. in 1978 as Manager of Information Systems. He became Vice President for Information Resources of LSI in 1983, was elected a Vice President of LS&CO. in 1986, was named Chief Information Officer in 1988 and assumed his current position of Senior Vice President in February 1989. Mr. Eaton is a former member of the Commonwealth Club and the King's Mountain Community Association.\nDonna J. Goya, Senior Vice President, Human Resources, joined LS&CO. in 1970 and became the Director of Equal Employment Opportunity and Personnel Policy in 1980. She became Director of Employee Relations and Policy in 1983 and Vice President of Corporate Personnel in 1984. She was elected a Senior Vice President in 1986. Ms. Goya is a director of INROADS and is a member of the Human Resources Roundtable and the National Academy of Human Resources.\nPeter A. Jacobi, President of Levi Strauss International, joined the Company in 1970 and was named President of the Youthwear Division in 1981. In 1984, he became Executive Vice President of the Jeans Company and was subsequently named President of the Men's Jeans Division. Mr. Jacobi became President of the European Division of LSI in 1988. In 1991, he assumed the position of President of Global Sourcing and was elected Senior Vice President. In 1993, he assumed his current position. Mr. Jacobi is past President of the South-West Apparel and Textile Manufacturers Association and also served on the Board of Directors for the Men's Fashion Association. He is a member of the Board of Directors of the Textile\/Clothing Technology Corporation, Advisory Board to the University of Michigan School of Engineering and the U.C. Berkeley\/St. Petersburg (Russia) School of Management Project.\nGeorge B. James, Senior Vice President and Chief Financial Officer, joined the Company and LS&CO. in 1985. From 1984 to 1985, he was Executive Vice President and Group President of Crown Zellerbach Corporation and from 1982 to 1984, he held the position of Executive Vice President and Chief Financial Officer of Crown Zellerbach Corporation. From 1972 to 1982, he was Senior Vice President and Chief Financial Officer of Arcata Corporation. Mr. James is a director of Basic Vegetable Products, Inc., Fiberboard Corp., the San Francisco Chamber of Commerce, the World Affairs Council, California Pacific Medical Center Foundation and the\nCommittee for Economic Development. In addition, he is a trustee of the San Francisco Ballet Association and serves as trustee for the Stern Grove Festival Association and the Zellerbach Family Fund.\nRobert D. Rockey, Jr., President of Levi Strauss North America, joined LS&CO. in 1979 and became President of the Womenswear Division in 1983. In 1984, he was named President of the Europe Division of LSI and, in 1988, he was appointed President of the Men's Jeans Division. During 1991, Mr. Rockey became President of U.S. Marketing Divisions and later was elected Senior Vice President. In 1992, he assumed the position of President of Levi Strauss North America. Mr. Rockey is a director and former President of the South-West Apparel and Textile Manufacturers Association.\nInsider Report Filings\nThe Company's executive officers and directors are not obligated, under Section 16(a) of the Securities Exchange Act of 1934, to file initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission.\nITEM 11.","section_11":"ITEM 11. DIRECTOR AND EXECUTIVE COMPENSATION\nCOMPENSATION OF DIRECTORS\nDirectors of the Company who are also stockholders or employees of the Company do not receive any additional compensation for their services as director. Directors who are not stockholders or employees [Messrs. Kilmartin (before his retirement effective December 5, 1993) and Gaither and Mss. Blackwell and Pineda] receive approximately $36,000 in annual compensation during each of their first five years of service and, beginning in their sixth year of service, are expected to receive annual compensation of approximately $42,000. Such payments include an annual cash retainer of $30,000 for each of the first three years, $20,000 for the fourth year, $10,000 for the fifth year, and $6,000 thereafter. The payments also include fees of $500 per Board and Board committee meeting attended and award payments under the Company's Long-Term Performance Plan (\"LTPP\"). The amount of each type of payment varies depending on the year of service and the actual value of the LTPP units. Mr. Gaither and Mss. Blackwell and Pineda each received grants of 350 performance units under the LTPP in 1994. In 1994, Messrs. Gaither and Kilmartin and Ms. Pineda received payments under the LTPP of $99,894, $97,448 and $31,633, respectively. Directors who are not employees or stockholders also receive travel accident insurance while on Company business and are eligible to participate in a deferred compensation plan. (See LTPP and deferred compensation plan captions.)\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nF. Warren Hellman and Tully M. Friedman, directors of the Company, are general partners of Hellman & Friedman, an investment banking firm. Hellman & Friedman provides financial advisory services to the Company and received $300,407 for such services in 1994. At November 27, 1994 Messrs. Hellman and Friedman and their families and other partners of Hellman & Friedman beneficially owned an aggregate of 1,081,442 shares of Class L common stock. See Item 12, Security Ownership of Certain Beneficial Owners and Management, for additional information concerning Mr. Hellman's and Mr. Friedman's beneficial ownership of Class L common stock.\nSUMMARY COMPENSATION TABLE FOR EXECUTIVE OFFICERS\nThe following table sets forth summary compensation information for 1994, 1993 and 1992 for each of the five most highly compensated executive officers of the Company:\n____________________ \/(1)\/ Fiscal 1994 and 1993 each contained 52 weeks. Fiscal year 1992 contained 53 weeks. \/(2)\/ Bonuses are paid pursuant to the Company's Management Incentive Plan (\"MIP\") and Cash Performance Sharing Plan. The bonuses include amounts based upon 1994, 1993 and 1992 performance that will be or were paid in 1995, 1994 and 1993, respectively (see Management Incentive Plan and Home Office Cash Performance Sharing Plan captions). Amounts paid to Mr. Haas relating to MIP bonuses were $1,197,500, $1,010,000 and $935,000 for 1994, 1993 and 1992, respectively. Amounts paid to Mr. Haas relating to Cash Performance Sharing bonuses were $176,558, $152,795 and $147,711 for 1994, 1993 and 1992, respectively. Amounts paid to Mr. Tusher relating to MIP bonuses were $675,000, $580,000 and $545,000 for 1994, 1993 and 1992, respectively. Amounts paid to Mr. Tusher relating to Cash Performance Sharing bonuses were $110,953, $97,063 and $97,003 for 1994, 1993 and 1992, respectively. Amounts paid to Mr. James relating to MIP bonuses were $300,000, $265,000 and $240,000 for 1994, 1993 and 1992, respectively. Amounts paid to Mr. James relating to Cash Performance Sharing bonuses were $56,039, $48,231 and $47,650 for 1994, 1993 and 1992, respectively. Amounts paid to Mr. Rockey, Jr. relating to MIP bonuses were $389,112, $271,188 and $254,651 for 1994, 1993 and 1992, respectively. Amounts paid to Mr. Rockey, Jr. relating to Cash Performance Sharing bonuses were $57,931, $46,536 and $42,842 for 1994, 1993 and 1992, respectively. Amounts paid to Mr. Jacobi relating to MIP bonuses were $327,250, $240,043 and $211,449 for 1994, 1993 and 1992, respectively. Amounts paid to Mr. Jacobi relating to Cash Performance Sharing bonuses were $49,406, $41,370 and $40,348 for 1994, 1993 and 1992, respectively. \/(3)\/ Other annual compensation represents partial tax reimbursement cash bonuses related to certain stock option exercises under the 1985 Stock Option Plan (see 1985 Stock Option Plan caption). \/(4)\/ See detail table under 1992 Stock Appreciation Rights Plan section. \/(5)\/ Amounts are paid pursuant to the Company's Long-Term Performance Plan (\"LTPP\"). The LTPP amounts shown in the table include amounts based on LTPP units granted in 1989, 1990 and 1991 that were paid in 1992, 1993 and 1994 or deferred to later years (see LTPP caption).\n\/(6)\/ All other compensation consists of amounts contributed under the Company's Employee Stock Purchase and Award Plan (ESAP) and amounts contributed under the Company's benefit restoration plans (BRP). The Internal Revenue Code (the \"Code\") limits the amount of benefits that may be paid under plans qualified by the Code. The BRP will pay any benefits that exceed such limitations. (See Benefits Plan section for more information about both plans.) Amounts contributed to Mr. Haas relating to ESAP were $165,295, $155,958 and $148,646 for 1994, 1993 and 1992, respectively. Amounts contributed to Mr. Haas relating to BRP were $825,566, $715,102 and $476,368 for 1994, 1993 and 1992, respectively. Amounts contributed to Mr. Tusher relating to ESAP were $103,808, $99,054 and $108,868 for 1994, 1993 and 1992, respectively. Amounts contributed to Mr. Tusher relating to BRP were $362,116, $525,456 and $371,516 for 1994, 1993 and 1992, respectively. Amounts contributed to Mr. James relating to ESAP were $52,403, $49,140 and $54,876 for 1994, 1993 and 1992, respectively. Amounts contributed to Mr. James relating to BRP were $135,796, $111,493 and $52,296 for 1994, 1993 and 1992, respectively. Amounts contributed to Mr. Rockey, Jr. relating to ESAP were $54,214, $47,424 and $47,420 for 1994, 1993 and 1992, respectively. Amounts contributed to Mr. Rockey, Jr. relating to BRP were $186,026, $132,146 and $87,608 for 1994, 1993 and 1992, respectively. Amounts contributed to Mr. Jacobi relating to ESAP were $46,270, $42,072 and $34,746 for 1994, 1993 and 1992, respectively. Amounts contributed to Mr. Jacobi relating to BRP were $187,916, $121,640 and $104,009 for 1994, 1993 and 1992, respectively.\nSTOCK OPTION AND STOCK APPRECIATION RIGHTS PLANS\n1985 Stock Option Plan\nIn 1985, the Board of Directors of the Company adopted the 1985 Stock Option Plan (the \"1985 Plan\"). The 1985 Plan is administered by the Personnel Committee of the Board of Directors (the \"Administrator\"). A total of 5,000,000 shares of Class L common stock may be issued upon exercise of options under the 1985 Plan to eligible employees or non-employee directors of the Company selected by the Board. Options granted under the 1985 Plan are non-qualified stock options and expire ten years from the date of grant. The Board or the Administrator determines the exercise price, exercise schedule, the manner in which payment occurs and any provision for a cash bonus to be paid at or about the time of exercise of the option. In addition the administrator retains discretion, subject to plan limits, to modify the terms (e.g., acceleration or elimination of vesting requirements of outstanding options). There were no option grants during 1994 or 1993.\nDuring 1994, the Board of Directors and stockholders approved a stock liquidity program for management holders of Class L common stock (including outstanding stock options). (See Management Liquidity Program caption under Item 13., Certain Relationships and Related Transactions.)\nIn 1992, the Board of Directors approved a special payment arrangement under the Plan to facilitate the exercise by optionholders of their outstanding options. This arrangement accelerated vesting on all non-vested options and allowed each optionholder to exercise outstanding options by surrendering a portion of these outstanding options in full payment of the exercise price and related tax obligations. Holders of 65 percent of all outstanding options participated in this arrangement. The special arrangement required the recognition of a fiscal 1992 pre-tax stock option charge of $158.0 million for all outstanding options (the amount equal to the difference between the fair market value of the underlying shares at the exercise date and at the grant date). Separately, the Company also recognized compensation expense for related exercise bonuses and the accelerated use of presently non-vested options. The Company disbursed $41.9 million to pay related withholding taxes for optionholders (in exchange for an equal amount of surrendered options) and $4.4 million for related exercise bonuses. The optionholders participating in this arrangement exercised 925,123 options resulting in 532,368 reissued treasury shares of Class L common stock. The Company also retired 392,755 shares of treasury stock, which was equal to the number of options surrendered. The net change in Stockholders' Equity (including the after-tax effect of the stock option charge) was\nan increase of $9.2 million. See Note 16 to the Consolidated Financial Statements for additional stock option plan information.\n1992 Stock Appreciation Rights Plan\nIn 1992, the Board of Directors of the Company adopted the 1992 Executive Stock Appreciation Rights Plan of Levi Strauss Associates Inc. The purpose of the 1992 Executive Stock Appreciation Rights Plan is to attract, retain, motivate and reward certain executives by giving them an opportunity to participate in the future success of the Company. The \"stock appreciation rights\" (SARs), are tied to and based on changes in the value of the Company's Class E common stock (Class E common stock is appraised, usually twice a year, by an independent investment banking firm). Upon exercise, the holder is entitled to receive a cash payment from the Company equal to the difference in the fair market value of stock on grant date and exercise date, less related tax withholding. A total of 500,000 rights may be granted under this plan. SARs awarded under the Company's plan may not be transferred.\nThe plan is administered by a committee of at least two members of the Board of Directors of the Company who are disinterested persons. The administrative committee for SARs determines the initial values of the SARs, the exercise schedule and any other terms or conditions applicable to the SARs that may be appropriate. In addition, the administrative committee retains discretion, subject to plan limits, to modify the terms (e.g., acceleration or elimination of vesting requirements) of SARs.\nA total of 90,000 SARs were granted in 1994 to certain executives at an initial grant value of $129 per SAR. The 1994 grant of SARs vest and become exercisable over several years commencing in 1997. Twenty percent of these SARs will be exercisable in 1997, an additional 30 percent in 1998 and the remaining 50 percent in 1999. In addition, stock based awards, based on a valuation of $129 per share, were granted to Robert D. Rockey, Jr. and Peter A. Jacobi. These executives were given the choice to receive 40,000 SARs each or participate in a Class L stock purchase arrangement in which the Company would loan each of these two executives approximately $4.9 million to purchase Class L stock. These executives have until the end of April 1995 to make their decision.\nAlso during 1994, 17,000 SARs granted during 1992 were forfeited. There were no SAR grants during 1993.\nA total of 114,000 SARs were granted in 1992 at an initial grant value of $84 per SAR. The 1992 grant of SARs vest and become exercisable over several years commencing in 1995. One-third of these SARs will be exercisable in 1995, one- third in 1996 and the remaining third in 1997.\nThe following table presents information for the year ended November 27, 1994 regarding aggregated options\/SARs of executive officers of the Company listed in the Summary Compensation Table.\nLONG-TERM PERFORMANCE PLAN\nThe Company has a Long-Term Performance Plan (\"LTPP\") for outside directors, officers and other key employees, under which performance units are granted to each participant. The value assigned to each unit is determined at the discretion of the Personnel Committee of the Board of Directors. The performance unit value guidelines selected by the Personnel Committee with respect to existing grants are based on the Company's three-year cumulative net earnings before tax. Under such guidelines (which are subject to change by the Personnel Committee), the current forecast value of the units granted in 1994, 1993 and 1992 is $100, $220 and $220 per unit, respectively. The units vest and are paid in cash in one-third increments on the third, fourth and fifth anniversaries of the date of grant or the amounts can be deferred at the election of the participant. The Company will implement a new performance management and pay program replacing this program in 1996. (See Partners in Performance caption for additional information.)\nThe following table sets forth information relating to Long-Term Performance Plan units granted in 1994 for the executive officers of the Company listed in the Summary Compensation Table:\n_________________ \/(1)\/ The basis for measuring long-term performance is a corporate three-year cumulative earnings performance calculation (e.g., an internal calculation of earnings from operations). \/(2)\/ The units vest in three years and are paid out in cash in one-third increments payable in June 1997, June 1998 and June 1999. \/(3)\/ Each LTPP unit is valued at $100.00 if the Company achieves a target level of corporate earnings performance over a three-year period. Performance above target levels will produce increases in award values. There is no cap on the award value; however, the award formula is directly related to the Company's earnings performance. \/(4)\/ Under the terms of the LTPP, the Personnel Committee retains discretion, subject to plan limits, to modify the terms of outstanding awards to take into account the effect of unforeseen or extraordinary events and accounting changes.\nMANAGEMENT INCENTIVE PLAN\nThe Company's Management Incentive Plan (\"MIP\") provides selected employees with incentive compensation and provides a tool for recruiting and retaining selected employees. Under the MIP, the Personnel Committee of the Board of Directors, as administrator of the MIP, may\naward discretionary cash payments to selected employees. Such awards are made on the basis of various factors, including profit levels, return on investment, salary grade and individual performance. In 1995, the Company will implement a new performance management and pay program replacing this program. (See Partners in Performance caption for additional information.)\nHOME OFFICE CASH PERFORMANCE SHARING PLAN\nThe Company has a Cash Performance Sharing Plan for all Home Office payroll employees that pays out based on a percentage of base salary and certain Company earnings criteria. This cash plan was a transition program for 1991 and 1992 and was extended to 1994. Participants in the MIP can receive up to 8 percent, while other Home Office employees can receive up to 12 percent, of their covered compensation (fiscal year salary and non-LTPP bonus) under this plan. In 1995, the Company will implement a new performance management and pay program replacing this program for salaried employees. (See Partners in Performance caption for additional information.)\nPARTNERS IN PERFORMANCE\nIn 1995, the Company will implement a new performance and pay program, Partners in Performance, for all salaried employees worldwide. This program was designed to align the objectives of all employees with the strategic objectives of the Company and interests of the Company shareholders.\nTo accomplish this goal, all eligible employees will have the opportunity to earn incentives, both short and long term. The short-term incentive plan will begin in 1995 and rewards performance measured by business unit and corporate financial results against pre-established targets. The long-term incentives will begin in 1996 and are based on a performance unit plan measured by a three- year cumulative earnings performance calculation and relative total shareholder return. Partners in Performance will replace the current management incentive plan, long-term incentive plan and cash performance sharing plan.\nDEFERRED COMPENSATION PLAN\nThe Company has an unfunded Deferred Compensation Plan under which a selected group of employees may elect to defer receipt until termination of employment of up to 33 percent of their base salary and 100 percent of their bonus. The amounts deferred under this plan, plus interest, may be paid prior to termination in certain hardship circumstances specified in the plan. When electing to defer a bonus, eligible employees in certain salary grades may also elect to receive in-service payments of the deferred bonus in five annual installments. Additionally, amounts deferred under this plan are considered compensation covered for defined benefit pension purposes (see Home Office Pension Plan caption). The Company also maintains a similar deferred compensation plan for outside directors.\nBENEFIT PLANS\nHome Office Pension Plan\nGenerally, all Home Office payroll employees, including executive officers, participate in the Company's Home Office Pension Plan (the \"Pension Plan\") after completing one year of service. The Pension Plan, subject to Internal Revenue Service (IRS) limitations, provides pension benefits based on an individual's years of service and final average covered compensation\n(generally, base salary plus bonuses awarded for the five consecutive fiscal years out of the individual's last ten years of service that produces the highest average). Contributions by the Company to the Pension Plan cannot be separately calculated for individual executive officers.\nThe following table shows the estimated annual benefits payable upon retirement under the Pension Plan, the benefit restoration plans and Deferred Compensation Plan to persons in various compensation and years-of-service classifications prior to mandatory offset of Social Security benefits:\nThe preceding table assumes retirement at the age of 65, with payment to the employee in the form of a single-life annuity. As of year-end 1994, the credited years of service for Messrs. R.D. Haas, Tusher, James, Rockey, Jr. and Jacobi were 21, 25, 9, 15 and 24, respectively. The 1994 compensation covered by the Pension Plan, benefit restoration plans and Deferred Compensation Plan for Messrs. R.D. Haas, Tusher, James, Rockey, Jr. and Jacobi was $2,206,979, $1,386,915, $700,491, $724,143, and $617,569, respectively. The 1994 compensation covered by the Pension Plan consists of fiscal year 1994 cash salary and 1993 bonus paid in 1994 (not including LTPP). These amounts correspond to the amounts on the Summary Compensation table (see Summary Compensation Table caption).\nThe Code limits the amount of pension benefits that may be paid under plans qualified under the Code such as the Pension Plan. The Company maintains separate unfunded benefit restoration plans (see the Benefit Restoration Plans caption) that will pay any retirement benefits under\nthe Pension Plan that exceed such limitations. The five individuals named in the Summary Compensation Table are participants in the benefit restoration plans.\nThe Company has unfunded supplemental pension agreements with Messrs. Tusher and James which provide specific benefits upon retirement. The cost to the Company in 1994 of the agreements for Messrs. Tusher and James was $395,400 and $30,400, respectively.\nBenefit Restoration Plans\nThe Company has two unfunded benefit restoration plans, the Supplemental Benefit Restoration Plan and the Excess Benefit Restoration Plan, collectively called the \"BRP\", that provide eligible employees with benefits that would have been payable from tax-qualified plans (both defined benefit and defined contribution) of the Company except for limitations imposed on such benefits under the Internal Revenue Code (the \"Code\"). The BRP also provides for the deferral of an eligible employee's current compensation to the extent that such compensation cannot be contributed to the Company's investment plans, due to these limitations, and the restoration of Company matching contributions that could not be credited under those plans as a result. All employees who are subject to such limitations are eligible to participate in the BRP. The BRP is administered by the Administrative Committee of the Retirement Plans.\nEmployee Investment Plans\nThe Company maintains three employee investment plans. Two of these plans, the Employee Investment Plan of Levi Strauss Associates Inc. (EIP) and the Levi Strauss Associates Inc. Employee Long-Term Investment and Savings Plan (ELTIS), are qualified plans that cover Home Office employees and U.S. field employees, respectively. The third plan, the Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc. (ESAP) is a non-qualified employee equity program for highly compensated (as defined by the Code) Home Office employees. Effective December 1990, highly compensated employees were no longer eligible to contribute to the EIP due to amendments to the EIP, which were made to comply with certain changes to the Code. The ESAP commenced in 1992 to allow highly compensated employees to participate in equity ownership.\nThe ESAP is administered by the Personnel Committee of the Board of Directors. The Pension Plan and the EIP are administered by the Administrative Committee of the Retirement Plans of the Company. The Personnel Committee has delegated most of its routine administrative functions to the Administrative Committee and to the Employee Benefits Department. The Administrative Committee is appointed by the Board of Directors and has the general responsibility for the administration and operation of the plans, including compliance with reporting and disclosure requirements, establishing and maintaining plan records and determining and authorizing payments of benefits under the plans.\nThe qualified plans also established an Investment Committee appointed by the Board of Directors. The Investment Committee's duties and responsibilities include (i) reviewing the performance of the trustee under the plans; (ii) appointing, removing and reviewing the performance of investment managers who may be delegated the authority to manage plan assets; (iii) establishing investment standards and policies based upon the objectives of the plans as communicated by the Administrative Committee; and (iv) performing such other functions as are specifically assigned to the Investment Committee under the plans.\nThe foregoing descriptions of the Company's benefit plans and agreements are only summaries and are qualified in their entirety by reference to such agreements and plans.\nAdditional information about certain Company employee plans is contained in Notes 12 through 16 to the Consolidated Financial Statements.\nContracts with Management Holders of Class L Common Stock\nThe management liquidity program (the \"Liquidity Program\") was approved by the Board of Directors and stockholders in 1994. The Liquidity Program allows the Company to enter into contracts with management holders of Class L common stock relating to in-service, employment separation-related and post-separation stock purchases. This program allows participating management stockholders to annually sell a specified amount of their stock to the Company, subject to certain limitations and conditions. The program also entitles the Company to purchase all of the shares held by a management holder at the time of separation from employment. (See Management Liquidity Program caption under Item 13., Certain Relationships and Related Transactions.)\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of January 16, 1995, certain information with regard to the beneficial ownership of Class L common stock and Class E common stock by each person who beneficially owns more than 5 percent of these outstanding shares, each of the directors, each of the five most highly compensated executive officers and all directors and executive officers of the Company as a group. The business address of all persons listed is 1155 Battery Street, San Francisco, California 94111.\n- ----------- Note: Class E common stock represents 3 percent of all outstanding common stock. Employees of the Company may invest in Class E common stock under the Company's employee investment plans. The Boston Safe Deposit and Trust Company, trustee for the Company's qualified stock investment plans, holds approximately 69 percent of all outstanding Class E common stock. The business address for the Boston Safe Deposit and Trust Company is 1 Cabot Road, Mail Zone WTO4G, Medford, Massachusetts, 02155-5158. See Employee Investment Plan caption under Item 11. \/ (1)\/ The percentage of shares outstanding is not shown for those amounting to less than one percent. \/ (2)\/ Includes 526,674 shares owned by the spouse and daughter of Mr. Haas and by trusts for the benefit of his daughter. Mr. Haas disclaims beneficial ownership of such shares.\n\/ (3)\/ Mr. Haas, as trustee, has sole voting and investing power with respect to these shares. These shares are held by a trust for the benefit of Mr. Haas' nieces and nephews. Mr. Haas disclaims beneficial ownership of such shares. \/ (4)\/ Does not include 158,996 shares held by a trust for the benefit of the sons of Mr. Tusher. Mr. Tusher has neither voting nor investing powers with respect to such shares. \/ (5)\/ Represents shares subject to presently exercisable options. \/ (6)\/ Does not include 3,000,200 shares owned by Miriam L. Haas, the spouse of Mr. Haas. Mr. Haas disclaims beneficial ownership of such shares. \/ (7)\/ Includes 2,903,167 shares in which Mrs. Josephine B. Haas has sole investing power and Mr. Haas has sole voting rights; and 58,800 shares held in trusts for the benefit of his grandnieces and grandnephew in which Mr. Haas has sole voting and investing power. Mr. Haas disclaims beneficial ownership of such shares. \/ (8)\/ Represents shares owned by the Evelyn and Walter Haas, Jr. Fund in which Mr. Haas has shared voting and investing powers. \/ (9)\/ Does not include 4,600 shares held by a trust for the benefit of Mr. Friedman's stepson. Mr. Friedman does not have voting or investing powers with respect to such shares and disclaims beneficial ownership of such shares. \/(10)\/ Represents shares in which Mr. Friedman has sole voting and investing powers. These shares are held by the Friedman Family Partnership for the benefit of Mr. Friedman's daughter and stepson and Cherry Street Partners for the benefit of Mr. Friedman's former spouse. Mr. Friedman disclaims beneficial ownership of such shares. \/(11)\/ Includes 1,000,000 shares owned by Mrs. Goldman's spouse. Mrs. Goldman disclaims beneficial ownership of such shares. Does not include 2,891,267 shares held by trusts for the benefit of Mrs. Goldman's children, grandchildren and great-grandchildren. Mrs. Goldman neither has voting nor investing rights with respect to such shares. \/(12)\/ Includes 2,371,872 shares held by trusts for the benefit of Mr. Haas' children and 150,000 shares held by Peter E. Haas and Joanne C. Haas Charitable Annuity Lead Trust and 102 shares by the spouse of Mr. Haas. Mr. Haas disclaims beneficial ownership of such shares. \/(13)\/ Represents shares held by a trust for the benefit of Michael S. Haas in which Mr. Haas has sole voting and investing powers. Mr. Haas disclaims beneficial ownership of such shares. \/(14)\/ Mr. Hellman's shares are held in trusts. \/(15)\/ Mr. Hellman has voting and investing powers with respect to these shares which are held by a trust for the benefit of the daughter of Robert D. Haas. Mr. Hellman disclaims beneficial ownership of such shares. \/(16)\/ James M. Koshland is the son of Daniel E. Koshland, Jr. \/(17)\/ Represents shares held by trusts for the benefit of James M. Koshland's children. Mr. Koshland disclaims beneficial ownership of such shares. \/(18)\/ Includes 333,000 shares owned by the spouse of Mrs. Geballe. Mrs. Geballe disclaims beneficial ownership of such shares. \/(19)\/ Includes 2,903,167 shares in which Mrs. Haas has sole investing powers and Mr. Peter E. Haas, Sr. has sole voting rights. \/(20)\/ Includes 1,447,855 shares in which Mrs. Haas has shared voting and investing powers and 777,439 shares in which Mrs. Haas has sole voting and investing powers. These shares are held by trusts for the benefit of the son and daughter of Mrs. Haas. Mrs. Haas disclaims beneficial ownership of such shares. \/(21)\/ Does not include 8,754,426 shares owned by Peter E. Haas, Sr., the spouse of Mrs. Haas. Mrs. Haas disclaims beneficial ownership of such shares. \/(22)\/ Margaret E. Jones is the daughter of Peter E. Haas, Sr. and Josephine B. Haas. \/(23)\/ Represents shares owned by The Koshland Foundation in which Mr. Koshland has sole voting rights. \/(24)\/ Includes 9,300 shares held by trusts for the benefit of Mr. Jacobi's children. \/(25)\/ Includes 63,096 shares held by The James Family Trust and 11,600 shares held by The James Family Limited Partnership in which Mr. James shares voting and investing powers. \/(26)\/ Includes 499,749 shares subject to presently exercisable options. \/(27)\/ As of January 16, 1995, the Company has 203 and 1,204 record owners of Class L and Class E common stock, respectively.\nHolders of and Transfer Restrictions on Common Stock.\nThere is no trading market for outstanding shares of Class E and Class L common stock. The outstanding shares of Class E common stock are currently held by the trustee of the ELTIS and EIP and by certain employees under the ESAP. Class E common stock is subject to certain restrictions on transfer as provided in the various employee plans. See the Employee Investment Plans caption under Item 11 for additional information. Class L common stock is primarily held by members of the families of certain descendants of the Company's founder and certain members of the Company's Board of Directors and management. Under a stockholder agreement that expires in April 2001, transfer of Class L common stock is prohibited except to certain transferees, specified members of the stockholder's family, trusts, charities or other Class L stockholders. Additionally, management Class L stockholders are parties to contracts with the Company providing for in-service, employment separation-related and post-separation stock purchases (see Management Liquidity Program caption under Item 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nMANAGEMENT LIQUIDITY PROGRAM\nDuring 1994, the Board of Directors and stockholders approved a stock liquidity program (the \"Liquidity Program\") for management holders of Class L common stock. The Liquidity Program allowed the Company to enter into contracts with then-existing management holders of Class L common stock relating to in-service, employment separation-related and post-separation stock purchases. Holders of 1,047,280 shares of Class L common stock (including outstanding options) participate in this program. They may annually sell a specified amount of their stock to the Company, subject to certain limitations and conditions. The program also entitles the Company to purchase all of the shares held by a management holder at the time of separation from employment.\nParticipating shares were classified on the balance sheet \"outside\" of stockholders' equity due to the liquidity feature. As a result of this Liquidity Program, the Company incurred a pre-tax compensation expense for participating stock options and related exercise bonus of $6.0 million and $13.2 million, respectively, (based on the current appraised stock value of $134 per share). In addition, the Company reclassified common stock outside of stockholders' equity of approximately $138.6 million and recorded a reduction in stockholders' equity of approximately $132.6 million. Future changes in the stock valuation will result in periodic adjustments to compensation expense for participating stock options, participating share balances and retained earnings. Actual purchases of stock by the Company under the Liquidity Program will result in cash outflows.\nThe following table presents information as of November 27, 1994 regarding the interests of the five most highly compensated executive officers of the Company in the Management Liquidity Program. The value of the shares listed were calculated using the most recent valuation by Morgan Stanley & Co. Incorporated ($134 per share as of November 18, 1994).\n___________ \/(1)\/ This amount includes outstanding options held by Mr. Tusher to purchase 499,749 shares. Those shares, if acquired, are subject to the Program.\nSubsequent to year-end, the Company repurchased and subsequently retired 70,842 shares of management Class L common stock, pursuant to the Liquidity Program, at the current appraised stock value of $134 per share totaling $9.5 million.\nESTATE TAX REPURCHASE POLICY\nThe Board of Directors has a policy under which the Company will, subject to certain conditions, offer to repurchase a portion of the shares of Class L common stock held by the estate of a deceased stockholder in order to assist the estate in meeting estate tax liabilities. The purchase price will be based on periodic valuations of Class L common stock conducted by an investment banking or appraisal firm (see Note 19 to the Consolidated Financial Statements). Purchases will be made at a discount price reflecting the non-liquidity of large blocks of stock; the discount will be established by the investment banking or appraisal firm. Estate repurchase transactions will be subject to, among other things, compliance with applicable laws governing stock repurchases, satisfaction of certain financial ratios specified in the resolutions adopting the policy, and compliance with any limitations on stock repurchases contained in the Company's credit agreements.\nOTHER TRANSACTIONS\nRhoda H. Goldman is a director of the Company; her son, John Goldman, is the controlling person of Richard N. Goldman and Company (RNG), which acts as an insurance broker for the Company. In 1994, the Company paid RNG approximately $380,625 in fees and commissions for the placement of insurance programs. RNG's insurance programs represent approximately 55 percent of worldwide annual premiums paid by the Company for 1994 property casualty coverage, not including workers' compensation coverage. The Company believes the premiums paid to RNG are competitive. At November 27, 1994, Rhoda H. Goldman had no equity interest in RNG and beneficially owned 3,725,007 shares of the Company's Class L common stock.\nJames C. Gaither is a partner of the law firm of Cooley, Godward, Castro, Huddleson & Tatum. Cooley, Godward, Castro, Huddleson & Tatum provided legal services to the Company in 1994. James M. Koshland is a partner of the law firm of Gray, Cary, Ware & Freidenrich. Gray, Cary, Ware & Freidenrich provided legal services to the Company in 1994.\nSee Compensation Committee Interlocks and Insider Participation under Item 11 for additional information.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) FINANCIAL STATEMENTS Consolidated Statements of Income, Years Ended November 27, 1994, November 28, 1993 and November 29, 1992\nConsolidated Balance Sheets, November 27, 1994 and November 28, 1993\nConsolidated Statements of Stockholders' Equity, Years Ended November 27, 1994, November 28, 1993 and November 29, 1992\nConsolidated Statements of Cash Flows, Years Ended November 27, 1994, November 28, 1993 and November 29, 1992\nNotes to Consolidated Financial Statements\nReport of Independent Public Accountants\n(2) FINANCIAL STATEMENT SCHEDULES II Reserves\nAll other schedules have been omitted because they are inapplicable, not required or the information is included in the financial statements or notes thereto.\n(3) MANAGEMENT CONTRACTS AND COMPENSATORY ARRANGEMENTS 1985 Stock Option Plan and forms of related agreements, exhibit 10a.\nLong Term Performance Plan, exhibit 10b.\nManagement Incentive Plan, exhibit 10c.\nLevi Strauss Associates Inc. Excess Benefit Restoration Plan, exhibit 10d.\nLevi Strauss Associates Inc. Supplemental Benefit Restoration Plan, exhibit 10e.\nAmendment dated February 9, 1993 to the Levi Strauss Associates Inc. Excess Benefit Restoration Plan and Levi Strauss Associates Inc. Supplemental Benefits Restoration Plan, exhibit 10f.\nLevi Strauss Associates Inc. Deferred Compensation Plan for Executives (as amended and restated through August 22, 1994), exhibit 10g.\nAmendment and Restatement dated August 22, 1994 to the Levi Strauss Associates Inc. Deferred Compensation Plan for Executives, exhibit 10h.\nRevised Home Office Pension Plan of Levi Strauss Associates Inc., exhibit 10j.\nAmendment dated November 22, 1994 to the Revised Home Office Pension Plan, exhibit 10k.\nRevised Employment Retirement Plan and December 20, 1991 Amendment thereto, exhibit 10l.\nAmendment dated January 10, 1995 to the Revised Employee Retirement Plan, exhibit 10m.\nEmployee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc., exhibit 10p.\nAmendments dated August 5, 1992, March 31, 1992 and January 1, 1992 to the Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc., exhibit 10q.\nAmendment dated February 9, 1993 to the Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc., exhibit 10r.\nAmendment effective as of March 1, 1993 to the Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc., exhibit 10s.\nSupplemental Pension Agreement dated April 16, 1985 between Levi Strauss & Co. and Thomas W. Tusher, exhibit 10y.\nSupplemental Pension Agreement dated November 12, 1985 between Levi Strauss & Co. and George B. James, exhibit 10z.\nLetter Agreement dated August 29, 1985 between the Company and Thomas W. Tusher, exhibit 10aa.\nHome Office Cash Performance Sharing Plan of Levi Strauss Associates Inc., exhibit 10cc.\nLevi Strauss Associates Inc. 1992 Executive Stock Appreciation Rights Plan, exhibit 10ee.\nForm of Stock Purchase Agreement between Levi Strauss Associates Inc. and Individual Management Holder of Class L common stock, exhibit 10jj.\nForm of Manager Family Member Stock Purchase Agreement between Levi Strauss Associates Inc. and Thomas W. Tusher, exhibit 10kk.\nForm of Manager Family Member Stock Purchase Agreement between Levi Strauss Associates Inc. and George B. James, exhibit 10ll.\nPartners in Performance Annual Incentive Plan of Levi Strauss Associates Inc. and Subsidiaries, exhibit 10mm.\nPartners in Performance Long-Term Incentive Plan of Levi Strauss Associates Inc. and Subsidiaries, exhibit 10nn.\n(4) EXHIBITS 3a Restated Certificate of Incorporation, incorporated by reference from Exhibit 4 of Form 10-Q filed with the Securities and Exchange Commission on April 13, 1993.\n3b Amended By-Laws of the Company, incorporated by reference from Exhibit 3b of Form 10-K filed with the Securities and Exchange Commission on February 20, 1992.\n4a Form of Series D dividend note, dated as of December 15, 1992, among the Company and note holders, incorporated by reference from Exhibit 4d of Form 10-K filed with the Securities and Exchange Commission on February 25, 1993.\n4b Form of Class L Stockholders' Agreement, incorporated by reference from Exhibit (c)(5) of the Company's Issuer Tender Offer Statement on Schedule 13E-4, including all amendments thereto, initially filed with the Securities and Exchange Commission on March 4, 1991.\n4c Restated Credit Agreement, dated March 17, 1994, among the Company, Levi Strauss & Co., Bank of America N.T. & S.A. and other financial institutions named therein, incorporated by reference from Exhibit 4 of Form 10-Q filed with the Securities and Exchange Commission on April 11, 1994.\n4d Amended and Restated Agreement of Master Trust effective as of May 1, 1989 between Levi Strauss Associates Inc. and Boston Safe Deposit and Trust Company, incorporated by reference from Exhibit 4.6 to the Company's Registration Statement on Form S-1, filed with the Securities and Exchange Commission on March 9, 1989 (Reg. No. 33- 27465).\n10a 1985 Stock Option Plan and forms of related agreements, incorporated by reference from Exhibit 10.4 to the Company's Registration Statement on Form S-1, filed with the Securities and Exchange Commission on March 9, 1989 (Reg. No. 33-27465).\n10b Long Term Performance Plan, incorporated by reference from Exhibit 10.7 to the Company's Registration Statement on Form S-1, filed with the Securities and Exchange Commission on March 9, 1989 (Reg. No. 33-27465).\n10c Management Incentive Plan, incorporated by reference from Exhibit 10.12 to the Company's Registration Statement on Form S-1, filed with the Securities and Exchange Commission on March 9, 1989 (Reg. No. 33-27465).\n10d Levi Strauss Associates Inc. Excess Benefit Restoration Plan, incorporated by reference from Exhibit 10e of Form 10-K filed with the Securities and Exchange Commission on February 20, 1992.\n10e Levi Strauss Associates Inc. Supplemental Benefit Restoration Plan, incorporated by reference from Exhibit 10f of Form 10-K filed with the Securities and Exchange Commission on February 20, 1992.\n10f Amendment dated February 9, 1993 to the Levi Strauss Associates Inc. Excess Benefit Restoration Plan and Levi Strauss Associates Inc. Supplemental Benefits Restoration Plan, incorporated by reference from Exhibit 10d of Form 10-Q filed with the Securities and Exchange Commission on July 13, 1993.\n10g Levi Strauss Associates Inc. Deferred Compensation Plan for Executives (as amended and restated through August 22, 1994), incorporated by reference from Exhibit 10b of Form 10-Q filed with the Securities and Exchange Commission on October 11, 1994.\n10h Amendment and Restatement dated August 22, 1994 to the Levi Strauss Associates Inc. Deferred Compensation Plan for Executives.\n10i Deferred Compensation Plan for Outside Directors, incorporated by reference from Exhibit 10.9 to the Company's Registration Statement on Form S-1, filed with the Securities and Exchange Commission on March 9, 1989 (Reg. No. 33-27465).\n10j Revised Home Office Pension Plan of Levi Strauss Associates Inc., incorporated by reference from Exhibit 10j of Form 10-K filed with the Securities and Exchange Commission on February 23, 1994.\n10k Amendment dated November 22, 1994 to the Revised Home Office Pension Plan.\n10l Revised Employee Retirement Plan, incorporated by reference from Exhibit 10k of Form 10-K filed with the Securities and Exchange Commission on February 23, 1994.\n10m Amendment dated January 10, 1995 to the Revised Employee Retirement Plan.\n10n Levi Strauss Associates Inc. Retirement Plan for Over the Road Truck Drivers and Dispatchers, incorporated by reference from Exhibit 10l of Form 10-K filed with the Securities and Exchange Commission on February 23, 1994.\n10o Levi Strauss & Co. Supplemental Unemployment Benefit Plan and related amendments, incorporated by reference from Exhibit 10m of Form 10-K filed with the Securities and Exchange Commission on February 23, 1994.\n10p Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc., incorporated by reference from Exhibit 4.2 to the Company's Registration Statement on Form S-8, filed with the Securities and Exchange Commission on June 24, 1991 (Reg. No. 33- 41332).\n10q Amendments dated August 5, 1992, March 31, 1992 and January 1, 1992 to the Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc., incorporated by reference from Exhibit 10q of Form 10-K filed with the Securities and Exchange Commission on February 25, 1993.\n10r Amendment dated February 9, 1993 to the Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc., incorporated by reference from Exhibit 10a of Form 10-Q filed with the Securities and Exchange Commission on July 13, 1993.\n10s Amendment effective as of March 1, 1993 to the Employee Stock Purchase and Stock Award Plan of Levi Strauss Associates Inc., incorporated by reference from Exhibit 10e of Form 10-Q filed with the Securities and Exchange Commission on July 13, 1993.\n10t Levi Strauss Associates Inc. Employee Long-Term Investment and Savings Plan, incorporated by reference from Exhibit 4.2 to the Company's Registration Statement on Form S-8, filed with the Securities and Exchange Commission on February 9, 1990 (Reg. No. 33- 33415), with amendments incorporated by reference from Exhibit 4.2 to the Company's Registration Statement on Form S-8, filed with the Securities and Exchange Commission on May 31, 1991 (Reg. No. 33- 40947).\n10u Amendments dated July 21, 1992 and March 31, 1992 to the Levi Strauss Associates Inc. Employee Long-Term Investment and Savings Plan, incorporated by reference from Exhibit 10s of Form 10-K filed with the Securities and Exchange Commission on February 25, 1993.\n10v Amendment dated February 9, 1993 to the Levi Strauss Associates Inc. Employee Long-Term Investment and Savings Plan, incorporated by reference from Exhibit 10c of Form 10-Q filed with the Securities and Exchange Commission on July 13, 1993.\n10w Amendment dated September 26, 1994 to the Levi Strauss Associates Inc. Employee Long-Term Investment and Savings Plan.\n10x Employee Investment Plan of Levi Strauss Associates Inc.\n10y Supplemental Pension Agreement dated April 16, 1985 between Levi Strauss & Co. and Thomas W. Tusher, incorporated by reference from Exhibit 10.13 to the Company's Registration Statement on Form S-1, filed with the Securities and Exchange Commission on March 9, 1989 (Reg. No. 33-27465).\n10z Supplemental Pension Agreement dated November 12, 1985 between Levi Strauss & Co. and George B. James, incorporated by reference from Exhibit 10.14 to the Company's Registration Statement on Form S-1, filed with the Securities and Exchange Commission on March 9, 1989 (Reg. No. 33-27465).\n10aa Letter Agreement dated August 29, 1985 between the Company and Thomas W. Tusher, incorporated by reference from Exhibit 10.15 to the Company's Registration Statement on Form S-1, filed with the Securities and Exchange Commission on March 9, 1989 (Reg. No. 33- 27465).\n10bb Agreement dated as of May 1, 1989 between the Company and Boston Safe Deposit and Trust Company, incorporated by reference from Exhibit 10.17 to the Company's Registration Statement on Form S-1, filed with the Securities and Exchange Commission on March 9, 1989 (Reg. No. 33-27465).\n10cc Home Office Cash Performance Sharing Plan of Levi Strauss Associates Inc., incorporated by reference from Exhibit 10z of Form 10-K filed with the Securities and Exchange Commission on February 23, 1994.\n10dd Field Profit Sharing Award Plan of Levi Strauss Associates Inc., incorporated by reference from Exhibit 10aa of Form 10-K filed with the Securities and Exchange Commission on February 23, 1994.\n10ee Levi Strauss Associates Inc. 1992 Executive Stock Appreciation Rights Plan, incorporated by reference from Exhibit 10aa of Form 10-K filed with the Securities and Exchange Commission on February 25, 1993.\n10ff Supply Agreement dated as of March 30, 1992, between Levi Strauss & Co. and Cone Mills Corporation, incorporated by reference from Exhibit 10bb of Form 10-K filed with the Securities and Exchange Commission on February 25, 1993.\n10gg First Amendment to Supply Agreement dated as of March 30, 1992, between Levi Strauss & Co. and Cone Mills Corporation, incorporated by reference from Exhibit 10dd of Form 10-K filed with the Securities and Exchange Commission on February 23, 1994.\n10hh Master Trust Agreement between Levi Strauss Associates Inc. and Fidelity Management Trust Company, incorporated by reference from Exhibit 10a of Form 10-Q filed with the Securities and Exchange Commission on October 11, 1994.\n10ii Materials Handling System Agreement dated October 31, 1994, between Levi Strauss & Co. and Computer Aided Systems, Inc.\n10jj Form of Stock Purchase Agreement between Levi Strauss Associates Inc. and Individual Management Holder of Class L common stock.\n10kk Form of Manager Family Member Stock Purchase Agreement between Levi Strauss Associates Inc. and Thomas W. Tusher.\n10ll Form of Manager Family Member Stock Purchase Agreement between Levi Strauss Associates Inc. and George B. James.\n10mm Partners in Performance Annual Incentive Plan of Levi Strauss Associates Inc. and Subsidiaries.\n10nn Partners in Performance Long-Term Incentive Plan of Levi Strauss Associates Inc. and Subsidiaries.\n21 Subsidiaries of Levi Strauss Associates Inc.\n23 Consent of Independent Public Accountants.\n(b) REPORTS ON FORM 8-K There were no Reports on Form 8-K filed with the Commission 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, in the City of San Francisco, State of California, on February 9, 1995.\nLEVI STRAUSS ASSOCIATES INC.\nBy Robert D. Haas --------------------------------- Robert D. Haas Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of Section 13 or 15(d) of 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 on February 9, 1995.\nSignature Title --------- -----\nDirector, Honorary Chairman of the Board of Walter A. Haas, Jr. Directors ____________________________________ (Walter A. Haas, Jr.)\nDirector, Peter E. Haas, Sr. Chairman of the Executive Committee ____________________________________ (Peter E. Haas, Sr.)\nDirector, Chairman of the Board of Directors and Robert D. Haas Chief Executive Officer ____________________________________ (Robert D. Haas)\nSignature Title --------- -----\nAngela G. Blackwell Director _____________________________________ (Angela G. Blackwell)\nDirector _____________________________________ (Tully M. Friedman)\nJames C. Gaither Director _____________________________________ (James C. Gaither)\nRhoda H. Goldman Director _____________________________________ (Rhoda H. Goldman)\nPeter E. Haas, Jr. Director _____________________________________ (Peter E. Haas, Jr.)\nF. Warren Hellman Director _____________________________________ (F. Warren Hellman)\nSignature Title --------- -----\nPatricia S. Pineda Director _____________________________________ (Patricia S. Pineda)\nJames M. Koshland Director _____________________________________ (James M. Koshland)\nDirector, Thomas W. Tusher President and Chief Operating Officer _____________________________________ (Thomas W. Tusher)\nSenior Vice President and George B. James Chief Financial Officer _____________________________________ (George B. James)\nVice President, Controller and Richard D. Murphy Chief Accounting Officer _____________________________________ (Richard D. Murphy)\nSCHEDULE II LEVI STRAUSS ASSOCIATES INC. AND SUBSIDIARIES RESERVES (In Thousands)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Levi Strauss Associates Inc.:\nWe have audited in accordance with generally accepted auditing standards, the financial statements of Levi Strauss Associates Inc. included in this Form 10-K and have issued our report thereon dated January 19, 1995. Our audit was made for the purpose of forming an opinion on those 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 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\nSan Francisco, California, January 19, 1995\nSUPPLEMENTAL INFORMATION\nThe 1995 Proxy will be furnished to security holders subsequent to this filing.\nCORPORATE DIRECTORY\nExecutive Office\nRobert D. Haas, Chairman of the Board of Directors and Chief Executive Officer Thomas W. Tusher, President and Chief Operating Officer\nHonorary Chairman of the Board of Directors\nWalter A. Haas, Jr.\nChairman of the Executive Committee of the Board of Directors\nPeter E. Haas, Sr.\nCorporate Executive Officers\nThomas J. Bauch -- Senior Vice President, General Counsel & Secretary R. William Eaton, Jr. -- Senior Vice President, Chief Information Officer Donna J. Goya -- Senior Vice President, Human Resources George B. James -- Senior Vice President, Chief Financial Officer Robert D. Rockey, Jr. -- Senior Vice President, President of Levi Strauss North America Peter A. Jacobi -- Senior Vice President, President of Levi Strauss International\nDirectors\nAngela Glover Blackwell -- Vice President, Rockefeller Foundation\/(1)\/\/(3)\/ Tully M. Friedman -- General Partner, Hellman & Friedman\/(1)\/\/(3)\/ James C. Gaither -- Partner, Cooley, Godward, Castro, Huddleson & Tatum\/(2)\/\/(3)\/ Rhoda H. Goldman\/(2)\/\/(3)\/ Peter E. Haas, Sr.\/(3)\/ Peter E. Haas, Jr.\/(1)\/\/(3)\/ Robert D. Haas\/(3)\/ Walter A. Haas, Jr.\/(3)\/ F. Warren Hellman -- General Partner, Hellman & Friedman\/(1)\/\/(2)\/ James M. Koshland -- Partner, Gray, Cary, Ware & Freidenrich\/(2)\/\/(3)\/ Patricia Salas Pineda -- General Counsel, New United Motor Manufacturing, Inc.\/(1)\/\/(2)\/ Thomas W. Tusher\/(3)\/\n\/(1)\/ Member, Audit Committee \/(2)\/ Member, Personnel Committee \/(3)\/ Member, Corporate Ethics and Social Responsibility Committee\nExecutive Offices:\nLevi's Plaza 1155 Battery Street San Francisco, California 94111 (415) 544-6000\nQuestions and communications regarding employee investments should be sent to the Director of Employee Benefits at the above address.\nIndependent Public Accountants:\nArthur Andersen LLP","section_15":""}
{"filename":"718082_1994.txt","cik":"718082","year":"1994","section_1":"Item 1. BUSINESS -----------------\n(a) General Development of Business -------------------------------\n(a) (1) General. The primary business of Big O Tires, Inc. (the \"Company\") is to franchise Big O retail stores (\"Retail Stores\") and supply Retail Stores with tires and related automotive products. On a limited basis, the Company engages in site selection and real estate development for new, franchised Retail Stores, and the Company also owns and operates Retail Stores. As used herein, the term Retail Stores also includes the Company-owned Retail Stores unless a distinction is warranted for clarification. Each independently owned corporation, partnership and sole proprietorship that has entered into a Franchise Agreement with the Company is hereinafter referred to as a \"Franchisee\" or collectively as the \"Franchisees.\"\nAs shown on the following page, at January 31, 1995, the Company had 378 Retail Stores, 374 of which were franchised and 4 of which were Company-owned. The Company also distributes its products at wholesale prices to 37 unaffiliated retail tire stores in British Columbia, Canada, with which the Company has a user agreement (the \"Canadian Licensees\").\nThe Company sells its Franchisees and Canadian Licensees an exclusive line of premium private label Big O brand passenger, light truck, recreational and high performance tires that are primarily manufactured by Kelly-Springfield Tire Company (a division of The Goodyear Tire & Rubber Company) (\"Kelly- Springfield\") and secondarily for a limited time by General Tire, Inc. (a subsidiary of Continental AG) (\"General\"). The Company currently distributes tires, its exclusive ProComp high performance wheels and other automotive products through its Regional Sales and Service Centers (\"RSC\") located in the states of California, Colorado, Idaho, Indiana and Nevada. In June 1993, the Company adopted a plan to consolidate three (3) of its RSCs into a single facility located near Las Vegas, Nevada (the \"Las Vegas RSC\"). The Las Vegas RSC opened on March 6, 1995. One of the three RSCs that was consolidated into the Las Vegas facility is the Denver, Colorado, RSC, which closed on March 24, 1995. In December 1994, the Company sold its Denver RSC to an unrelated third party. The Denver RSC sale was consummated with a $242,000 down payment, certain rent concessions, and the assignment of the Company's promissory note and mortgage on the facility from the existing mortgage. The other two RSCs that are to be or have been consolidated into the Las Vegas RSC are in the cities of Ontario and Vacaville, California. The Ontario RSC is scheduled to close on or around May 1, 1995. The Company is obligated under the lease on the Ontario warehouse until June 24, 1998. In June 1994, the Company leased the entire Vacaville, California, RSC under an agreement that will continue through March 31, 2000.\nThe following table sets forth the number of Retail Stores, by marketing region, as of January 31, 1995:\n* The Company, through its wholly-owned subsidiary, Big O Retail Enterprises, Inc., a Colorado corporation, also enters into retail joint ventures with existing Franchisees so that additional Retail Stores can be opened and, in certain selected cases, may buy an interest in existing Retail Store(s) through an existing joint venture. The Company looks to its joint venture partner to manage the Retail Store and to purchase the Retail Store from the joint venture after three (3) years of operation using a formula allowing for a determination of the purchase price to be paid to the Company.\nIn 1994, twenty-six (26) Franchisee owned Retail Stores were opened and nine (9) were closed. The Company sold five (5) of its Company-owned Retail Stores located in the states of Colorado, Kentucky and Oklahoma to Franchisees, and the Company acquired four (4) previously franchised Retail Stores in Kentucky, two (2) of which continue to be operated as Company-owned Retail Stores. The Company closed four (4) Company-owned Retail Stores located in the states of Colorado, Oklahoma and Kentucky that the Company acquired in 1993 and 1994.\nThe Company continues to look to convert existing retail tire stores and retail tire store chains to the Big O system as part of its growth strategy, but has met with limited success using this growth strategy. The Company has not emphasized the use of Company-owned Retail Stores as part of its business, but in certain circumstances the Company may acquire tire stores and\/or retail tire store chains as a means to grow its business.\nInvestment Banker. At the Annual Meeting of Shareholders held in June 1994, the shareholders adopted a resolution calling for the Company to engage an investment banker to explore all alternatives for enhancing the value of the Company. In implementing this resolution, the Company's Board of Directors established the Investment Committee of the Board which retained PaineWebber Incorporated to fulfill this shareholder proposal. In September 1994, the proponent of the June 1994 shareholder proposal, upon invitation by the Board, began assisting the Investment Committee in this process. On December 23, 1994, the Company announced that the Investment Committee had agreed to enter into a period of exclusive negotiations with, and agreed to pay certain expenses of, a group of Company officers, managers and Franchisees (\"Dealer- Management Group\") that made an offer to acquire the outstanding shares of the Company for $18.50 per share. The Dealer-Management Group originally made the offer to acquire the Company on December 2, 1994, subject to certain conditions including the Dealer-Management Group's ability to obtain the necessary financing. The proposed transaction would have taken the Company private\nand was led by the Company's President, other officers and managers and Franchisees acting on behalf of certain of the Company's Franchisees. On February 7, 1995, the Company was notified that the Dealer-Management Group elected not to continue negotiations to acquire the Company due to the difficulties in obtaining commitments for the elements of financing necessary to consummate the acquisition and the inability of the representatives of the Franchisees and management to reach mutual understandings on certain fundamental issues relating to the acquisition. The Dealer-Management Group expenses the Investment Committee agreed to pay totalled $115,000.\nAt the time the Dealer-Management Group withdrew the offer to acquire the Company, the Company was also informed by representatives of management that they continue to be interested in completing a purchase of the Company on mutually agreeable terms to shareholders, management, certain Franchisees and the Board. The Company has advised the management representatives that it will consider carefully credible proposals but the Board of Directors will continue to review alternatives to enhance the value of the Company. In the meantime, management of the Company has been restructured, creating the Office of the Chief Executive. Members of the Office of the Chief Executive consist of the Company's Chairman, Vice-Chairman and President. The Board of Directors is permitting the Company's President to devote a portion of his time to efforts to acquire the Company until such time as the Board of Directors advise otherwise. In a Schedule 13D, as amended, the Company was notified that certain members of management and certain members of Franchisees met on March 2 and 3, 1995, and evaluated the possibility of re-opening negotiations with the Investment Committee regarding the acquisition of all of the outstanding shares of the Company. Those persons stated that they determined to contact the Investment Committee regarding such negotiations and that they believed that if an agreement is to be reached regarding such a transaction, the price per share of common stock of the Company must be below the price of $18.50 per share previously discussed. As of March 24, 1995, the Investment Committee has not been approached by these persons. The Company has also been notified in two additional amended Schedule 13D filings, one of which was prepared by the Balboa Investment Group, L.P., a California limited partnership and Mr. Kenneth W. Pavia, Sr., the sole general partner of this partnership, collectively the \"Balboa Group\", and the other amended filing was prepared by those persons mentioned above, that the Balboa Group has entered into a confidentiality agreement with certain Company Franchisees who have expressed an interest in acquiring the Company. The amended filings indicate that the Company's Franchisees intend to discuss with the Balboa Group the possibility of acquiring the Company's common stock owned or controlled by the Balboa Group, contingent upon, among other things, the completion of the acquisition of the Company. Those talks would cover the possibility of selling the Balboa Group's common stock in the Company to certain of the Company's Franchisees.\n(a) (2) Information Required From Registrants on Form S-1 -------------------------------------------------\nNot applicable.\n(b) Financial Information About Industry Segments ---------------------------------------------\nDuring the three years ended December 31, 1994, over ninety percent (90%) of the Company's revenues, operating profit and identifiable assets have been attributable to one industry segment, i.e., ownership, operation and franchising of Retail Stores and the related wholesale and retail marketing of tires and other automotive aftermarket products to or through such Retail Stores. During this same three year period, less than ten percent (10%) of the Company's revenues, operating profit and identifiable assets have been attributable to the Company's development of real estate sites for Retail Stores through its wholly-owned subsidiary, Big O Development, Inc. (\"Development\"), and one partnership.\n(c) Narrative Description of Business ---------------------------------\nThe Company's principal business is franchising of Retail Stores and supplying these stores with tires and related automotive aftermarket products through the Company's RSCs. The Retail Stores are located primarily in the western United States as indicated on the chart on page 3. The Company also distributes its products to the 37 Canadian Licensees (see \"Canadian Operations\" on page 6).\nIn March 1994, the Company became a member of Summit Tire and Battery, Inc. (\"Summit\"), an independently owned buying group based in Brandon, Florida. In certain parts of the country, Summit provides the Company\nexclusive access to the Heritage line of passenger and light truck tires. The Heritage brand is manufactured by Kelly-Springfield.\nIn June 1994, subject to certain Company established limitations for development activities, the Company formulated a real estate development program involving the sale of Retail Store sites to prospective Franchisees that qualify for Small Business Administration (\"SBA\") guaranteed loans. In certain instances, the Company may provide subordinated loans (as to collateral) not to exceed $50,000 for the prospective Franchisee to qualify for this SBA guaranteed funding. The Company anticipates that this financing will be repaid to the Company by the Franchisee, amortized monthly over five (5) years. Another component of the Company's real estate development program is site selection and development of the site. The Company anticipates that this construction financing will be repaid if the financing through the SBA guaranteed source is obtained by the prospective Franchisee.\nThe Company has also assisted in obtaining financing for new Retail Store development with an unrelated third party financing company by providing debt guarantees for joint ventures. The Company also has provided lease guarantees to developers on behalf of Franchisees and straight debt financing for Retail Stores developed internally.\nIn June 1994, the Company opened the RSC located in New Albany, Indiana, at a total cost of approximately $1,985,000. Change orders associated with the completion of this RSC totalled $73,000. In February 1995, the Company acquired the Las Vegas RSC at a total cost of approximately $7.7 million. At March 20, 1995, change orders associated with the completion of this RSC totalled approximately $300,000. The Las Vegas RSC opened on March 6, 1995.\n(i) Products, Services and Marketing. ---------------------------------\nFranchise Operations: ---------------------\nWith respect to the Company's franchise operations, the primary products provided and services related thereto are described in the franchise agreement with each Franchisee (the \"Franchise Agreement\"). The Franchise Agreement essentially grants to the Franchisee a ten (10) year license to sell Big O brand tires and to use Company trademarks and trade secrets in the operation of a Retail Store at a specific location within a trade area defined in the Franchise Agreement.\nFranchisees are generally required to capitalize their business with $153,500 to $335,600 which covers the initial franchise fee, inventories, equipment, working capital, certain deposits and initial advertising costs. Initial franchise fees range between $7,000 to $21,000 depending on the Company's classification of the prospective Franchisee, as defined in the Franchise Agreement. In addition to the initial franchise fee, all Franchisees are required to pay monthly royalty fees of 2% of each Retail Store's prior month's gross sales, as defined in the Franchise Agreement.\nThe Company offers a unique franchise program characterized by high standards, quality products and ongoing support designed to establish and grow successful Retail Stores. Most Franchisees are owner\/operators, instead of passive investors. Management believes that a Franchisee's active involvement in the day-to-day operation of a Retail Store enhances its performance. The Company provides (i) training to the Franchisee and its supervisory personnel, (ii) assistance in store design and site and equipment selection, (iii) insurance programs, standardized manuals and computerized accounting systems, (iv) Big O brand and other approved tires and related automotive aftermarket products, and (v) continuing support with respect to operations, marketing, merchandising and new product introductions. The Company also promotes local advertising groups and regional accounting centers, which may be nonprofit corporations, cooperatives, mutual benefit corporations, or trusts designed to provide assistance to the Franchisees. The Company also provides certain materials, e.g., broadcast and print advertising materials, point of sale materials, a point of sale cash register system, equipment, uniforms and other wearables and services to each Franchisee at varying costs and assistance in obtaining financing through unaffiliated financing companies.\nThe Company has established and requires Franchisees to meet certain uniform guidelines for physical characteristics, inventories, efficiency, speed and courteous service. Each new Franchisee or manager is required to attend formal training covering sales, service, financial management, personnel, business ethics, legal compliance, merchandising and other management skills. In addition, Franchisees are to perform in accordance with written standards outlined in manuals provided pursuant to the Franchise Agreement. After the initial training requirements are met, the Company offers regional training classes to maintain and improve this expertise.\nThe Company's growth depends to a large measure on its ability to attract, retain and maintain good relationships with suitable Franchisees. Any change in that relationship could cause existing Franchisees to purchase less merchandise from the Company and more from its competitors or to decline to renew their franchises upon expiration. Factors beyond the Company's control may adversely affect the Company's relationship with its Franchisees. In addition, there is no assurance that the Company will be able to continue to attract and retain suitable Franchisees. The Company also loses franchises from time to time due to financial and other problems of Franchisees. Accordingly, while a significant part of the Company's strategy is to increase the number of its franchised Retail Stores, there is no assurance that it will be able to do so. In 1994, one (1) Franchise Agreement expired and the Franchisee has reapplied for a new Franchise Agreement but has not yet been renewed. During 1995, six (6) Franchise Agreements are due to expire, and in 1996 three (3) Franchise Agreements are due to expire, with the remaining Franchise Agreements expiring in the eight years thereafter, including 107 Franchise Agreements which will expire in 1999.\nIn 1994, the Company continued its development of a master franchise program whereby the Company intends to sell master franchises for specific areas where the master franchisee will be authorized to offer franchises for Retail Stores, be required to provide certain services in the specific area, and have the opportunity to function as a distributor of the Company's products. The Master Franchise Program will be used primarily to expand Retail Stores in areas of the eastern United States where the Company does not yet have established franchised stores and distribution, and possibly to expand internationally. As of March 24, 1995, the Company has not yet sold any master franchises.\nCanadian Operations: --------------------\nSince 1962, certain Canadian retail tire stores within the Province of British Columbia, Canada, have been using the Company's tradename and previous versions of the Company's trademarks, logos and colors. As of March 24, 1995, 37 Canadian Licensees have signed user agreements for the Company's new trademark, logo and colors, and efforts continue to sign additional Canadian tire stores. While the Company has invited the Canadian Licensees to become Franchisees under the Company's franchise system, the Canadian Licensees have chosen to look to the Company only as a wholesale supplier.\nDuring 1994, the Company sold $72,000 in goods to 37 Canadian Licensees. The Company distributes to the Canadian Licensees through the Company's Boise, Idaho, RSC and through The Goodyear Tire & Rubber Company's British Columbia warehouse.\nDistribution: -------------\nThe Company distributes Big O branded passenger and light truck tires, other approved brands of tires and automotive aftermarket products and certain material and equipment used in the operation of Retail Stores. Retail Stores may stock and sell other tires and automotive aftermarket products which have been previously approved by the Company even though such products are not distributed by the Company. The Company does not manufacture any of the products it sells. During 1994, approximately 77% of the Big O branded tires were manufactured by Kelly-Springfield, with the remainder produced primarily by General. In July 1994, the Company and General terminated the May 1993 Marketing Agreement wherein General had agreed to supply Big O branded tires to the Company. The termination agreement also provides that General will continue to discharge its obligation to the Company and its Franchisees under a special warranty program until July 26, 1995. Thereafter, all subsequent adjustments will be subject to General's\nthen current warranty adjustment policy. General is continuing to provide and sell tires to Tire Marketers Association (\"TMA\"), a division of the Company that supplies tires to distributors predominantly based in the eastern United States. Prior to March 31, 1995, the Company anticipates closing on a $65,000 cash sale of the assets, trademarks and copyrights of TMA to an unrelated third party. TMA has been an operating division of the Company that markets non-Big O branded products to retailers outside the Big O system, and was acquired by the Company in June 1993. The proceeds from this sale will be used by the Company for general corporate purposes.\nIn March 1994, the Company became a member of Summit, an independently owned buying group based in Brandon, Florida. This agreement provides that Summit will provide the Company exclusive access to the Heritage line of passenger and light truck tires. The Heritage brand is manufactured by Kelly-Springfield.\nIn August 1991, the Company entered into a supply agreement with Kelly- Springfield for the manufacture and sale to the Company of Big O branded tires (the \"Kelly Supply Agreement\"). The term of the Kelly Supply Agreement is a calendar year, which is automatically renewed for the next calendar year unless either party elects to terminate upon three (3) months prior written notice. The Kelly Supply Agreement was automatically renewed for 1993, 1994 and 1995. Under the Kelly Supply Agreement, the Company is required to provide Kelly-Springfield with monthly non-binding estimates of the Company's tire requirements, by line and type, for the succeeding three months, and on August 1 of each year, an itemized non- binding forecast of the quantities of tires the Company will require during the next calendar year.\nAs a result of entering into the Kelly Supply Agreement, the Company believes that it has adequate supply arrangements to meet anticipated demand, subject to industry wide shortages or disaster. However, the Kelly Supply Agreement only commits Kelly-Springfield to fill those portions of the Company's monthly orders that Kelly-Springfield agrees to fill. The obligation of Kelly-Springfield is also subject to circumstances causing delay that are outside of its reasonable control.\nBig O Brand Marketing Program: ------------------------------\nIn July 1994, the Company implemented its \"Cost-U-Less\/TM\/\" marketing program. This program provided, along with a marketing message of competitive pricing on all products and services, a reduction in the cost of Big O brand tires to the Company's Franchisees (without a similar reduction in cost from the Company's suppliers). This allowed the Franchisees to offer Big O brand products to retail customers at lower retail pricing which generally allowed the Franchisees to be more competitive in their markets.\nIn order to differentiate the Company's products in a commodity market, all Big O brand tires are sold with a \"Premium Tire Service Policy\" and a \"Limited Warranty for Free Replacement\" (certain exceptions apply to non- recreational vehicle light truck tires).\nThe Premium Tire Service Policy provides certain services and products free of charge, which are generally provided for as additional charges from other tire stores. These include free mounting and balancing of the new tires, free wheel weights and new rubber valve stems, free flat repair, free rotations and any necessary rebalancing throughout the tire's legal life.\nThe Limited Warranty for Free Replacement provides \"no charge for proration\" (except for non-recreational light truck tires) and \"no charge\" for mounting and balancing the replacements of such tires that fail during the legal life of the tire tread due to workmanship, material defects or road hazards, without any limitation as to time and mileage.\nIn July 1994, the Company authorized an 80,000 mile prorated warranty on the Premium Legacy Plus 70 Series, which is a Kelly-Springfield manufactured tire. It is anticipated that the financial impact to the Company will be minimal because the majority of the Retail Stores do not offer this particular mileage warranty.\nThe Company's suppliers have financial responsibility for workmanship and material defect claims during the first 2\/32 of an inch of tread in the case of Kelly-Springfield supplied tires, and the first 10% of the tread life in the case of General supplied tires, with prorations to the Company thereafter. General has also increased reimbursement to the Company for certain workmanship and materials warranty adjustment returns. The Kelly Supply Agreement provides maximum limits on workmanship and material defects for which the Company will have any financial responsibility on each line and size of Big O branded products. The Company or the Retail Stores have financial responsibility for substantially all of the other costs associated with the Premium Tire Service Policy and Limited Warranty for Free Replacement programs beyond these prorations.\nThe Company's sales by product in 1994 were as follows (in thousands):\nThe Company believes that a Franchisee's decision to purchase Big O brand products is based on several factors, including product profitability, knowledge of Big O products, services and programs, the level of product support provided by the Company, and the availability of products that meet the quality demands of the Retail Store's customers. The Company plans to meet these requirements and thereby increase sales of Big O brand products to Retail Stores by continuing to provide (i) a broad line of quality products that command higher margins for Retail Stores and that meet changing consumer demands, (ii) extensive training for store personnel, (iii) support of Retail Store operations, marketing, merchandising, and new product introductions, and (iv) upgraded product quality, particularly as measured by the industry's Uniform Tire Quality Grading Standards. Unit sales of Big O brand tires increased by 6.5% in 1994 as compared to 1993, following 1993's Big O brand unit sales decrease of 3.9% as compared to 1992.\n(ii) Status of Product or Segment. -----------------------------\nThe Company has made no announcement of, nor has the Company otherwise made public any information about any new product or industry segment requiring investment of a material amount of the Company's total assets or which is otherwise material to the Company's operations, other than its ongoing investment in new product lines to meet Retail Store needs, the Company's planned consolidation of some of its warehouse facilities, and a retail site development program by Development.\n(iii) Raw Materials. --------------\nThe Company does not manufacture any products. The Company orders Big O brand tires anywhere from 18 - 180 days before the beginning of the month in which they are produced. Manufacturers normally produce these tires and ship them directly to the appropriate RSCs thereby eliminating manufacturers' inventories of Big O brand product. Because of the lack of \"safety stock,\" any unforecasted change in sales trends or interruptions in production schedules may result in inventory shortages.\nIf the Company should lose Kelly-Springfield as a supplier at a time when there is sufficient production capacity within the tire manufacturing industry, management believes the Company could accomplish a rapid and orderly transition to new supplier(s). If, however, production capacity were limited, such as was experienced in 1988 and 1989, a change in suppliers could be extremely difficult and could cause the Company to again experience significant product shortages.\nWhile the Company cannot completely assess the impact on its financial performance if an industry-wide shortage, labor strike or natural disaster should occur, such circumstances might result in higher costs, higher sales prices and possibly lower demand.\nIn 1994, the Company received price increases from its suppliers of between 3% and 4% on tires and other products. In March 1995, the Company received an approximate 3% price increase. This increase in cost, over a sustained period, may be significant to the overall cost of sales and working capital requirements of the Company, particularly if costs increase and\/or sales decrease. However, the tire industry in general, and the Company specifically, generally raise prices in response to such increases. As the cost of raw materials increases for all manufacturers, the resulting costs are passed through, in the form of higher prices, to the manufacturers' customers, i.e., distributors and retailers, such as the Company. Such distributors and retailers, in turn, increase their prices, and therefore the price increases are ultimately borne by the consumer. Because demand in the replacement tire market is viewed to be relatively inelastic, little disruption in demand has occurred due to these increases.\nManagement believes that these increases will be borne proportionately throughout the industry, as the pricing formula used usually results in percentage margins which actually increase gross profit (dollars) for distributors and retailers. Gross profit percentages should continue to stay relatively constant as management does not expect such increases to adversely affect the Company's performance.\nSince price increases are initiated by manufacturers and are then subject to competitive pressures, the original announced increases are sometimes reduced.\n(iv) Patents, Trademarks, Licenses, and Franchises. ----------------------------------------------\nAt January 31, 1995, the Company had 374 franchised Retail Stores operating pursuant to Franchise Agreements. Please refer to \"Products, Services and Marketing\" above, for a further explanation of the Company's franchises and \"Canadian Operations\" above, for further explanation of the Canadian Licensees. The existence of the Franchise Agreements is of extreme importance to the Company since almost all of the Company's revenue is generated from sales to these Franchisees and from monthly royalty fees.\nThe Company is the owner of various United States, Canadian and state trademark and service mark registrations and applications for marks used in connection with the Company's tires and tire retailing concepts. These trademarks and service marks include the Company's house mark, \"Big O\", and numerous secondary marks for individual products and advertising slogans.\nThe Company is aware that a retail tire company operating \"Big 10\" outlets in Houston, Texas, and in areas of Alabama, Arkansas, Florida, Georgia, and Mississippi has raised issues regarding the Company's use of \"Big O\" in such areas. The Company does not currently have any Retail Stores operating in territories served by the other company and the matter does not affect the Company's ability to use the name \"Big O\" where currently used. When the Company begins franchising locations that overlap or are proximate to those served by the other company, it is possible that such company may contest usage of the Company's tradename and trademarks in such areas.\nThe Company does not own any United States or foreign issued patents or pending patent applications.\n(v) Seasonality. ------------\nThe Retail Stores experience some seasonal variation in product sales because tire sales are generally greater during the summer than in the winter months. The Company generally experiences some seasonality, although not to the same extent that the Retail Stores do, as the Company maintains sales to certain Retail Stores, e.g., snow tires, that offset the trend on a national basis.\n(vi) Working Capital Items. ----------------------\nOf the Company's $3,926,000 in notes receivable at December 31, 1994, $1,432,000 relate to the sale of Company-owned Retail Stores to Franchisees. Another portion of these notes receivable relates to trade receivables that have been placed on notes as a financial strategy to maintain sales to financially limited, franchised Retail Stores which, at December 31, 1994, totaled $1,599,000. By placing these Retail Stores on level monthly payments, and with the development of a business plan for each such Retail Store, management is attempting to assist the Franchisees in reaching financial success while improving repayment options and timing. In 1994, the Company sold approximately $3 million of notes receivable to an unrelated third party and plans to sell additional notes in the future.\nThe Company targets a 60-day inventory of Big O brand tires, and lesser inventory levels for other tires, wheels, and related automotive aftermarket products. Big O brand inventory levels are greater than those normally carried by tire distributors because of the limited availability due to production scheduling and lack of supplier floor stocks. At certain times, the Company has increased its Big O brand inventory due to anticipated shortages, potential strikes and minimum production runs required by suppliers. Subsequent to the Company's July 1994 implementation of the Company's Cost-U-Less\/TM\/ marketing program and the addition of several lines of Big O and other private branded tires, inventory needs increased by approximately $2.5 million. In lieu of obtaining extended payment terms generally provided by manufacturers, the Company has negotiated lower net pricing from suppliers. The Company periodically obtains extended payment terms on purchases while maintaining this lower net pricing. As a whole, the tire industry generally sells product on varying extended payment terms, up to and including 180 days. The standard credit terms extended by the Company to the Retail Stores are 3%\/15, 2%\/30, COD\/31. Through arrangements with manufacturers regarding shocks and struts, the Company has arranged terms to encourage Retail Stores to stock sufficient quantities and varieties. These payment terms are more limited than the industry \"norms\" and are structured to reduce the Company's credit risk and working capital requirements. For certain items, primarily snow tires, the Company provides extended payment terms similar to those offered by wholesalers.\nAs part of the Company's warranty and marketing programs, Retail Stores have the right to return certain merchandise to the RSCs for credit. The Company believes that its warranty program provides certain significant marketing advantages, but it also results in higher warranty expense to the Company than is normal in the industry. Some of this expense has been and will be offset by payments from manufacturers.\nThe decrease in net warranty cost for 1994 primarily resulted from the establishment of certain programs negotiated with suppliers which continued to limit the Company's financial exposure for warranty claims, the elimination of the two product lines that created the greatest expense under the Company's warranty program in previous years, and the institution of a more stringent program for the review and verification of warranty claims for compliance with the terms and conditions of its warranty program.\nDuring 1994, management of the Company formulated a developmental program involving the sale of Retail Store sites to Franchisees that qualify for Small Business Administration guaranteed loans. In certain instances, the Company may provide subordinated loans (as to collateral) not to exceed $50,000, in order for the prospective Franchisees to qualify for this SBA guaranteed funding. The Company anticipates that this financing will be repaid to the Company by the Franchisee, amortized monthly over five (5) years. Another component of the Company's real estate development program is site selection and development of the site by Development. This has and will require significant financing by the Company, which is planned to be repaid if the financing through the SBA guaranteed source is obtained by the prospective Franchisee. At December 31, 1994, Development had $2,000,000 invested in acquisition and construction in progress for nine (9) sites, which was primarily financed by the sale of approximately $3 million of notes receivable, mentioned above. The Company anticipates that this real estate developmental program will result in an increase in the number of Retail Stores. As additional Retail Stores are added, additional working capital for accounts receivable, inventories, and certain real estate financing will be needed. Accounts receivable financing is anticipated to be supplied through the Company's existing credit facilities;\ninventory growth will be financed partially by the Company's suppliers and partially through the Company's existing credit facilities; and real estate financing will be provided by a combination of the Company's revolving line of credit and limited permanent (term) financing.\n(vii) Customer Dependence. --------------------\nSince the Company primarily sells its products to 374 Franchisees and 37 Canadian Licensees, its customer group is very limited. Of this customer group, the Company does not depend upon a single customer, or a limited number of customers, for its revenues, the loss of any one or more of which would have a material adverse effect on the Company. However, certain Franchisees (and Franchisee groups) continue their individual growth and are becoming more significant customers.\nApproximately 33% of the Company's sales were made to Retail Stores located in the State of California (which includes sales made to the Company's largest Franchisee who is affiliated with thirty-one (31) Retail Stores) which constitutes about 38% of the Retail Stores. As a result, a high portion of the Company's receivables and credit risks are concentrated in California with the result that adverse conditions or adverse publicity affecting retail operations in California could more significantly affect the operating results of the Company than if the stores were more geographically diversified. In addition, at December 31, 1994, receivables and financial guarantees totaling $4,179,000 were associated with five (5) Franchisees who own and operate multiple Big O Retail Stores. Adverse financial results with these Franchisees could adversely affect the Company more significantly than if the credit risks were less concentrated.\n(viii) Backlog of Orders. ------------------\nAt March 24, 1995 and March 25, 1994, there were no material backlogs of orders. Any sustained backlog the Company experiences with its suppliers creates a backlog in fulfilling orders from the Retail Stores and Canadian Licensees.\n(ix) Government Contracts. ---------------------\nThe Company is not involved with any contracts or subcontracts with the government which may allow for the renegotiation of profits or the termination of such contracts at the election of the government.\n(x) Competition. ------------\nSince the Company is primarily a distributor to its Retail Stores and the Canadian Licensees, its success depends on the retail success of its Franchisees and Canadian Licensees. Both the tire aftermarket and under- car service businesses are highly competitive. Through the Retail Stores and Canadian Licensees, the Company competes with major tire manufacturers who have retail tire stores, national and regional tire chains, traditional department stores, independent merchants, and general, full range, discount and warehouse club stores. Many of the Company's competitors are larger in terms of sales volume, have access to greater capital and management resources, and have been operating longer in particular geographic areas. Management believes that price competition in the geographical markets served by the Company continues to intensify.\nRetail competition comes in the form of price, service, warranty, product performance, product innovation, or differing variations of each of these issues. Although competition varies by geographic area, the Company believes that it generally has a favorable competitive position in terms of price, product line, value, merchandising, warranty and customer service. With the implementation of the Company's Cost-U-Less\/TM\/ program on its Big O brand products, which include the Premium Tire Service Policy and the Limited Warranty for Free Replacement, the Company believes that these three marketing facets are equal to or exceed any such programs offered by its competitors.\nFranchise sales are also highly competitive as the Company competes with other franchisors, some of which are larger, have better name recognition and access to larger capital resources and have been operating\nlonger than the Company. Management believes that the competition for the sale of franchises has increased and will intensify due, in part, to the entry of new franchisors and the growth of existing franchisors.\nThe competitive conditions for real estate development differ substantially from those the Company faces in the retail tire and franchise markets. The success of the Company's real estate development lies in obtaining sites that can be developed into store facilities that meet Franchisees' requirements at reasonable rental rates or sales prices. Since the prime customers for the Company's real estate development are its Franchisees, development of real estate can affect the growth of Retail Stores. Competition for real estate development comes from many sources, including other retail tire companies, other franchisors, e.g., fast food restaurants and gas stations, and other retailers.\n(xi) Research and Development. -------------------------\nThe Company does not engage in any significant research and development activities, and no material amount was spent by the Company on research and development activities.\n(xii) Environmental Regulations. --------------------------\nThe Company is subject to the ever expanding purview of federal, state and local environmental laws relating to spillage, noise, air quality and disposal of waste products. The Company believes it is in general compliance with all applicable environmental laws and has adopted a policy of requiring Phase I environmental studies associated with any new projects or the acquisition of any existing locations before such transactions are consummated. The Company is not aware of any requirements to develop environmental control facilities and has not made any material capital expenditures for such facilities and does not anticipate doing so at this time. The Company has periodically been involved with minor clean-ups associated with certain Retail Stores in which the Company has been a tenant or subtenant. Generally, the costs of these clean-ups have not been material. Many states have enacted specific tire disposal laws that, among other requirements, assess fees for each tire disposed and designate specific locations for tire disposal. This impacts the Company, its Franchisees and the retail customers as such costs are usually passed on to the customers.\n(xiii) Employees. ----------\nAt March 24, 1995, the Company employed 211 persons on a full-time basis and 39 persons on a part-time basis.\n(d) Financial Information About Foreign and Domestic Operations and Export ---------------------------------------------------------------------- Sales -----\nSales to Canadian Licensees totaled $72,000, $994,000 and $1,708,000, which resulted in gross profits of $8,000, $97,000 and $169,000 in 1994, 1993 and 1992, respectively. In 1994, the Company negotiated sales of its Big O branded product to be distributed through a subsidiary of The Goodyear Tire & Rubber Company. As a result of this negotiation, the Company no longer recognizes sales to its Canadian Licensees. The Company has not maintained any identifiable assets in Canada.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES ------------------\n(1) The Company also owns, in fee simple, approximately five acres of land immediately adjacent to this property. In June 1994, the Company leased the entire warehouse until the year 2000. When the Vacaville warehouse space was fully leased to an unrelated third party, the Ontario, California, RSC began servicing the Retail Stores in the Western region. (2) The Company owns, in fee simple, approximately seven acres of land immediately adjacent to this RSC, which can be used for expansion. (3) Includes distribution to 37 Canadian Licensees. (4) The New Albany, Indiana, RSC was completed in June 1994. This facility is servicing the Retail Stores which were being serviced by the Kentucky and Sellersburg, Indiana, warehouses. The cost of land acquisition and construction of this facility was $1,985,000. (5) This RSC will be replaced by the single warehouse facility located near Las Vegas, Nevada, which opened on March 6, 1995. The Las Vegas RSC contains approximately 294,000 square feet of warehouse space and 6,000 square feet of office space, and it will service the Retail Stores which have been serviced by the Denver, Ontario and Vacaville RSCs. (6) In anticipation of the opening of the Las Vegas RSC, the Company sold its Denver RSC to an unrelated third party in December 1994. This sale was consummated with a $242,000 down payment, certain rent concessions, and the assumption of the Company's promissory note and mortgage on the facility from the existing mortgage. The Company remains obligated on this mortgage in the event that the purchaser defaults. (7) The Company anticipates that the Ontario RSC operations will be fully converted to the Las Vegas RSC by May 1995. The Company is obligated under the lease for the Ontario warehouse until June 24, 1998. This warehouse space is currently being marketed for lease. (8) The Vacaville California, Boise, Idaho and Las Vegas, Nevada, properties are all collateral for $8 million of senior, secured notes sold by the Company in April 1994. The proceeds from these notes were used to pay the previous mortgage on the Boise, Idaho RSC, a term loan with the previous primary lender, and the balance (approximately $4.2 million) was placed in a restricted cash account for the purpose of providing financing for the acquisition of the Las Vegas RSC.\nThe Company also has a lease for a 35,000 square foot warehouse and general office space in Santa Ana, California, which was assigned to a joint venture in which a subsidiary of the Company was a 50% joint venture partner. The initial term of this lease expires in October 1996. In 1993, the subsidiary of the Company agreed to sell its 50% interest in the joint venture to the other joint venturer which assumed all obligations under this lease through the 1996 termination of the initial term of the lease. Thus the Company will remain contingently liable for this lease obligation through October 1996.\nAs of March 14, 1995, the Company is also responsible for leases on approximately sixty-one (61) Retail Store locations, of which thirty-four (34) locations are subleased to Franchisees, six (6) locations are operated as Company owned or joint venture Retail Stores and the leases for sixteen (16) Retail Stores are guaranteed by the Company. The Company, in accordance with lease guaranty provisions, is also responsible for the lease obligations on five (5) closed Retail Store locations.\nIn addition, the Company owns five (5) Retail Store locations which are leased directly to Franchisees.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS --------------------------\nAs of March 24, 1995, the Company has been named as a defendant in approximately twenty-seven (27) pending lawsuits which are incidental to its business and which the Company believes will be subject to indemnification and\/or covered by insurance if the Company is held liable, and eight (8) lawsuits which are incidental to its business and for which the Company does not believe it is liable, but which are not covered by insurance. The Company believes that the ultimate outcome of these matters will not have a material adverse effect on its financial statements.\nIn December 1994, the Company and its nine directors were named in two proposed stockholder class action lawsuits (Knopf vs. Big O Tires, Inc. and Zucker vs. Big O Tires, Inc., Second Judicial District Court of the State of Nevada, County of Washoe) each similarly requesting the court to enjoin the sale of the Company to a Dealer-Management Group, enjoin the implementation of the recently adopted shareholder rights plan, obtain specified damages, require the disclosure of the Company's internal forecasts and award plaintiffs' their attorneys' fees and costs, including experts fees. The lawsuits also request that the court order the directors to carry out their fiduciary duties to the plaintiffs and the other members of the class by announcing their intention to cooperate and do all that is necessary to encourage the buyout or takeover of the Company by enhancing the Company's attractiveness as a merger\/acquisition candidate, effectively exposing the Company to the marketplace in an effort to create an active action of the Company, act independently and resolve all conflicts of interest in the best interests of the class. If the contemplated transaction with the Dealer-Management Group is consummated, the court is asked to rescind the transaction and, among other actions, award rescissionary damages. The Company moved to dismiss both lawsuits, which have been consolidated, as being frivolous and not in the interests of the stockholders as a class. Counsel for the plaintiffs have filed a motion to dismiss both lawsuits without prejudice. As of March 24, 1995, the Company has not received notice that these dismissals have occurred.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ------------------------------------------------------------\nDuring the fourth quarter of 1994, the Company did not submit any matters to a vote of the security holders.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ------------------------------------------------------------------------------\n(a) Market Information\nThe Company's Common Stock is reported on the NASDAQ National Market System. The principal market for the stock is the over-the-counter market.\nThe quotations in the table below were obtained from NASDAQ and reflect high and low bid prices of the Company's Common Stock. The prices reflect inter- dealer prices without retail mark-up, mark-down or commission. The prices have been rounded to the nearest eighth and may not necessarily represent actual transactions.\n________________\n(b) Holders\nAs of March 24, 1995 the Company had 707 shareholders of record as indicated on the Company's transfer records.\n(c) Dividends\nThe Company has not declared cash dividends on its Common Stock during the last two fiscal years and there is no present intent to pay a cash dividend. Certain covenants contained in the credit agreements with the Company's primary lender preclude the general declaration or payment of cash dividends and preclude the general purchase, redemption, retirement or other acquisition of the Company's capital stock, or the return of capital or distribution of assets to its shareholders, without the prior written consent of the lender.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA -------------------------------\nThe following table presents selected financial data concerning the Company, which should be read in conjunction with the financial statements appearing elsewhere herein. Amounts are in thousands (000's) except per share data.\nFor the Years Ended December 31 -----------------------------------\n\/(1)\/ Adjusted to reflect the 1 for 5 reverse split of the Company's $0.10 par value common stock that was effective June 15, 1992.\n\/(2)\/ Total assets for years prior to 1992 have been restated to reflect the reclassification of vendor receivables to accounts payable.\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\nNet Sales. Net sales consist principally of product, equipment and service sales, initial franchise fees and royalty fees. Net sales in 1994 were $127,678,000 which represented an increase of $4,718,000 (or 3.8%) over 1993. This increase in sales was primarily due to higher sales of Big O brand tires which resulted from the Company's \"Cost-U-Less\" marketing program that was implemented on July 1, 1994. This program provided a significant reduction in the cost of Big O brand tires to the Company's Franchisees (without a similar reduction in cost from the Company's suppliers). This allowed the Franchisees to offer Big O brand products to their customers at lower retail pricing which generally allowed the Franchisees to be more price competitive in their markets. The improvement in product mix is particularly significant since the sale of Big O brand tires provides higher gross margins as compared to the Company's other tire products and represented 69.8% of the Company's total product sales for the last six months of 1994, an increase of 5.0% as compared to the first six months of 1994.\nWholesale sales of Big O brand tires increased by approximately 85,800 units (6.5%) in 1994; based on this increase and an increase in the average selling price of $.10 per unit or .2%, revenues increased by $5,027,000 in 1994. The sale of other new tires increased by approximately 9,300 units or 1.5% as compared to 1993. The sale of wheels, shocks, and other accessories also increased by approximately 3,600 units or .3% which, along with an increase in the average selling price of $1.06, increased revenues by $1,454,000 in 1994. These wholesale sales increases were partially offset by a reduction of $2,137,000 in retail sales at Company-owned Retail Stores.\nDuring 1994, the Company continued its efforts to improve the operations of its existing Retail Stores and add new stores to its distribution system. During the year, 26 new Retail Stores were added, but 18 existing Retail Stores were closed. Accordingly, sales to new franchised Retail Stores increased by $5,342,000, sales to existing franchised retail stores increased by $4,129,000, and higher retail sales generated a $658,000 increase in royalty fees. Offsetting these sales increases were reductions in sales of $2,137,000 at Company-owned Retail Stores, $1,225,000 from the closure of nine (9) franchised Retail Stores, $922,000 from decreased sales to the Canadian licensees, and $1,080,000 from a decrease in other wholesale sales.\nThe Company also receives royalties from the Extra Care service program at Retail Stores which consists of alignment, brake work, front-end repair, shock absorber and strut replacement, lubrication and oil changes. Extra Care service program royalty fees in 1994 were $1,976,000, up $190,000 or 10.6% from 1993. While these fees continued to increase, they are growing at a slower rate as the Company continues to focus its marketing efforts towards tire sales and, specifically, Big O brand tire sales through its \"Cost-U-Less\" marketing program.\nThe Company's revenues are primarily dependent on sales to its network of Retail Stores. The continuation of these franchises during the ten year term of each Franchise Agreement is extremely important to the Company as is the renewal of these franchises upon their expiration period. In 1994, one (1) Franchise Agreement expired and has reapplied for a new Franchise Agreement, but has not yet been renewed. During 1995, six (6) Franchise Agreements will expire. In 1996, three (3) Franchise Agreements are due to expire, with the remaining Franchise Agreements expiring in the years thereafter.\nThe Company's Franchisees are independent business operators who are entitled to establish their own policies within certain guidelines established by the Company and who are directly responsible for supervision of their employees. Of the 374 franchised Retail Stores at December 31, 1994, thirteen (13) are owned by partnerships in which a subsidiary of the Company owns a 50% interest but has no managerial control over day-to-day operations. The Company prescribes certain operating procedures in business and ethical standards; however, Franchisees are responsible for complying with these procedures and standards as well as all applicable laws and regulations.\nGross Profit. Cost of goods sold consists primarily of the cost of products and equipment sold and the cost of labor to deliver services at Company-owned Retail Stores. Gross profit in 1994 was $30,131,000, an increase of $2,500,000 or 9.0% over 1993. Gross profit increased $1,113,000 due to increased sales volumes, and increased $1,387,000 due to the 1.1% increase in gross margin. Also contributing to this 1.1% increase in gross margin was an increase in continuing royalties, additional cash discounts earned, and increased profits associated with price changes. Partially offsetting these increases were additional purchasing incentives provided to Franchisees and a decrease in promotional funds provided by the Company's suppliers.\nThe gross margin was 23.6% in 1994 as compared to 22.5% in 1993. An increase of .8% in the gross margin was attributable to the increase in sales of Big O brand tires which carry higher gross margins than other tire products.\nWarranty adjustment expense decreased by 3.2% in 1994 to $4,709,000. The product quality produced by the Company's present supplier has continued to reduce the Company's financial exposure for warranty claims. In addition, products that have shown excessive adjustments have been discontinued and on- hand inventories have been returned to suppliers for liquidation outside existing market areas or distribution channels. The Company has also continued its stringent program for the review and verification of warranty claims for compliance with the terms and conditions of its warranty program.\nIn 1994, the Company limited its exposure to foreign exchange gains and losses by renegotiating the distribution channel of product sold to its Canadian Licensees. Since this arrangement resulted in an override paid by the supplier on such sales, sales for the Company were reduced, although gross profits on such sales remained essentially the same and profitability increased as a result of the reduced foreign exchange expenses.\nNet Expenses. Net expenses increased by $1,139,000 or 4.7% to $25,490,000 in 1994. An increase in net expenses of $674,000 was associated with the implementation of the shareholder proposal, and increased expenses of $677,000 resulted from losses on the sale or closure of Retail Stores.\nNet expenses also increased by $614,000 in product delivery expense which primarily resulted from the additional freight costs associated with the Company's consolidation of its warehouse operations in California, $784,000 which resulted from increased promotional expense in connection with the Company's new marketing program, and $824,000 which resulted from the operation of Company-owned Retail Stores. However, these increases were partially offset by a decrease of $1,927,000 in expenses related to Company-owned Retail Stores which were sold, and a reduction of $149,000 in the provision for uncollectible receivables.\nNet expenses (excluding offering costs, warehouse consolidation costs, shareholder proposal expense, and losses on sale or closure of Retail Stores) (\"Operating Expense\") in 1994 were 18.6% of net sales, down slightly from 18.7% in 1993. The Company anticipates that Operating Expense in 1995 will decrease as a result of a restructuring plan which was adopted in February 1995 and the consolidation of the Colorado and California warehouse operations into a new distribution facility near Las Vegas, Nevada, which began operations in March 1995. This planned decrease in Operating Expense, when combined with anticipated sales increases, is expected to result in a lower Operating Expense as a percentage of sales for the last six months in 1995. However, increased ownership of Retail Stores may add significantly to the growth of Operating Expense as each store can add as much as $600,000 of Operating Expense annually. While the Company's current strategic plan does not contemplate the operation of additional Company-owned Retail Stores, beyond the four Retail Stores presently in operation, the Company recognizes that it will generally operate some Company-owned Retail Stores until such stores can be sold to Franchisees. In most cases, it is beneficial for the Company to continue to operate a store, even if reacquired from a Franchisee due to financial failure, in an effort to maintain market presence and thereby allow the store to be resold to a Franchisee as opportunities arise. In 1994, five (5) Company-owned Retail Stores were sold to Franchisees which resulted in a pretax loss of $117,000.\nThe Company's primary growth strategy is to accelerate growth in the number of franchised Retail Stores. This will cause expenditures for advertising, locating, and developing new franchised locations to increase at a rate faster than overall sales increases. However, the Company believes that development of these new stores, especially based on its relatively fixed overhead structure, could increase profitability and margins as these fixed costs (which are planned to be reduced by the Company's restructuring plan and the warehouse consolidation project) are spread over more units sold due to increased outlets. To the extent that new store openings do not materialize, these additional expenses may reduce overall profitability and reduce the Company's return on assets.\nInterest expense increased by 20.2% in 1994 to $1,465,000. Although interest expense decreased due to reduced borrowings resulting from lower working capital requirements, this reduction was offset by an increase in interest expense attributable to an increase in the \"prime\" rate and, therefore, in the Company's borrowing rate, and the sale of 8.71% Senior Secured Notes in the aggregate principal amount of $8,000,000 in April 1994.\n1993 COMPARED TO 1992\nNet Sales. Net sales in 1993 increased by $3,161,000 or 2.6% over 1992 to $122,960,000 primarily due to higher sales from a line of private brand, price point tire products which were introduced in late 1992. Big O brand unit sales decreased by approximately 53,800 units or 3.9% while the average selling price increased by $1.13 per unit or 2.0%. The sale of other new tires increased by approximately 115,200 units or 22.1% which increased revenues by $4,026,000. The increase in net sales included $5,854,000 attributable to increased sales to new franchised Retail Stores, increased sales at Company-owned Retail Stores of $2,482,000, and $258,000 from increased royalty fees. These sales increases were partially offset by a reduction in sales of $871,000 due to the sale or closure of\nCompany-owned Retail Stores, $1,676,000 from the closure of franchised Retail Stores, and $1,675,000 from a decrease in sales to existing Franchisees. Sales of product to 37 unaffiliated retail stores in Canada (the \"Canadian Licensees\") also decreased by $698,000 in 1993 as compared to 1992 due to adverse changes in the foreign currency exchange rates which resulted in higher pricing.\nRoyalties from the Extra Care service program in 1993 were $1,786,000, up $24,000 or 1.4% from 1992. Sales of ProComp wheels totalled $2,533,000 in 1993 which represented an increase of $205,000 or 8.8% from 1992, which resulted from the Company's success in reducing inventories of slow moving styles and increasing sales by concentrating its efforts in building sales in the faster moving lines.\nGross Profit. Gross profit in 1993 decreased by $18,000 or 0.1% from 1992 to $27,631,000, primarily due to a reduction of 0.6% in gross margin which was partially offset by increased sales volumes. Also contributing to the decrease in gross profit were additional reserves for product obsolescence, decreased profits associated with price changes, and an increase in freight costs. Partially offsetting these decreases were improved profits associated with a significant decrease in the Company's warranty adjustment expense, increased royalty income, additional cash discounts earned, and increased promotional funds provided by the Company's suppliers.\nGross Margin was 22.5% in 1993 as compared to 23.1% in 1992. A decrease of 0.3% in the gross margin was attributable to the decrease in sales of Big O brand tires, and the gross margin was reduced by an additional 0.3% from increased sales of a line of price-point tire products which carry significantly lower margins as compared to the Big O brand products. However, the decrease in gross margin was partially offset by a decrease of 7.8% in warranty adjustment expense in 1993 to $4,565,000.\nNet Expenses. Operating Expense increased by $151,000 or 0.7% to $23,034,000 in 1993, primarily due to an increase of $2,284,000 in Operating Expense incurred by the operation of eleven (11) Company-owned Retail Stores in 1993 as compared to seven (7) stores in 1992. Operating Expense also increased by $193,000 as a result of losses incurred by the Company's joint venture operations and the losses of subsidiaries, $635,000 as a result of increased franchise development costs and $132,000 as a result of additional expense associated with the operation of the Franchisee training center. Operating Expense decreased by $887,000 due to reduced promotional expenses, $689,000 from a reduction in the provision for uncollectible receivables, $429,000 from reduced compensation and $178,000 from reduced amortization of intangibles. Operating Expense in 1993 was 18.7% of net sales as compared to 19.1% in 1992.\nInterest expense increased by 4.2% in 1993 to $1,219,000. Although interest expense decreased due to reduced borrowings resulting from lower working capital requirements and a reduction in the Company's borrowing rate, this reduction was offset by an increase in interest expense attributable to the $6 million supplier note used to finance most of the General stock and warrant repurchase.\nIn 1993, the Company withdrew its registration statement for the sale of 1,300,000 shares of the Company's $.10 par value common stock which resulted in an expense of $281,000 for the offering costs associated with the registration statement. In addition, the Company adopted a plan in 1993 to consolidate three of its RSCs into a single facility located in Nevada and recorded an expense of $607,000 which represented the net amount of the estimated facility relocation costs, employee compensation expenses, gain (or loss) on disposal of assets, and other related expenses associated with the consolidation plan. The Company also adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, as of January 1, 1993 which decreased net income by $285,000 for the cumulative effect of this change in accounting principle.\nLIQUIDITY AND CAPITAL RESOURCES\nShareholder Proposal. In June 1994, the shareholders adopted a proposal requesting the Board of Directors to engage an investment banker to evaluate all alternatives to enhance the value of the Company. In implementing this shareholder proposal, the Board of Directors established the Investment Committee of the Board who retained PaineWebber Incorporated (PaineWebber) to fulfill this shareholder proposal.\nThe result of this process has led to two offers to acquire the Company, neither of which has been successful as of March 15, 1995. However, an offer for the Company may be received in the future and, if accepted by the shareholders, could result in a significant change in the Company's liquidity and need for capital resources. In the meantime, management of the Company has been restructured, creating the Office of the Chief Executive. The purpose of this restructuring is to achieve aggressive growth and to enhance the value of the Company. As these strategies are currently being developed, their impact on the liquidity and capital resources of the Company has not been determined. However, management of the Company is aware of the limited capital resources available and will act prudently and conservatively in establishing and implementing growth plans and operating strategies.\nWorking Capital. The Company's working capital (defined as current assets less current liabilities) more than doubled in 1994, increasing to $24.7 million at December 31, 1994, versus $11.9 million in working capital at December 31, 1993. Sources of working capital included earnings, payments on and sales of notes receivable, sales of property and equipment, and the issuance of long term debt. Uses of working capital included purchases of property and equipment and principal payments on long term debt.\nSignificant changes in the components of working capital consisted of the following:\ni. Trade accounts receivable increased by $1.15 million primarily due to the addition of franchised Retail Stores, an increase in sales resulting from the success of the Cost-U-Less marketing program and a reduction in the allowance for doubtful accounts.\nii. Inventories increased by approximately $2.5 million as a result of additional inventory needs resulting from increased sales associated with the Cost-U-Less marketing program and the addition of several lines of Big O and other private branded tire lines.\niii. Accounts payable decreased by approximately $3 million primarily because of differences in credit terms and pricing from the current principal supplier as compared to those offered by the previous principal supplier. To take advantage of cash discounts offered by the new supplier, the Company accelerated payments of invoices.\nThe Company anticipates that it will meet its working capital needs in 1995 through the internal generation of funds from operations and from financing available from its new primary lender (See Existing Credit Facilities). The Company has embarked on a significant real estate development program that is planned to result in an increase in the number of Retail Stores (See Real Estate Development). As additional Retail Stores are added, additional working capital for accounts receivable, inventories, and certain real estate financing will be needed. Accounts receivable financing is anticipated to be supplied through the Company's existing credit facilities; inventory growth will be financed partially by the Company's suppliers and partially through the Company's existing credit facilities; and real estate financing will be provided by a combination of the Company's revolving line of credit and limited permanent (term) financing.\nThe Company significantly reduced the amount of accounts receivable transferred to long term notes receivable during 1994. The Company has established a successful program for the transfer of such receivables, although this transfer limits the Company's access to cash that would have been generated from earlier collection of these receivables. The Company was successful in selling approximately $3 million of notes receivable in 1994 and plans to sell additional notes in the future.\nReal Estate Development. In the Company's ongoing effort to significantly increase the number of Retail Stores, the Company has continually been called upon to guarantee certain leases for prospective Franchisees at new locations. Management has been adverse to providing these guarantees primarily due to the significant financial impact on the Company when these guarantees are enforced. (For example, of the $1,106,000 loss on sale or closure of Retail Stores incurred in 1994, $881,000 related to the remaining lease obligations for certain leases involving the Company.)\nThe Company previously developed Retail Store sites by use of real estate joint ventures, wherein the Company would provide the tenant (prospective Franchisee) and the developer would provide the site locations and develop the real estate. While this arrangement resulted in most of the debt not being included on the Company's balance sheet, the Company was still contingently obligated on these development loans.\nIn an effort to significantly reduce the lease guarantee requirements or retention of these assets and liabilities, management formulated a developmental program involving the sale of Retail Store sites to Franchisees that qualify for Small Business Administration (SBA) guaranteed loans. In certain instances, the Company may provide a small loan (not to exceed $50,000) as subordinated debt in order for the Franchisee to qualify for this SBA guaranteed funding.\nThe key component of this developmental program is site selection by the Company and development of the site by one of the Company's subsidiaries. This has and will require significant financing by the Company, which is planned to be repaid if the financing through the SBA guaranteed source is obtained by the prospective Franchisee. At December 31, 1994, the Company's subsidiary had $2 million invested in construction in progress for nine (9) sites, which was primarily financed by the sale of approximately $3 million of notes receivable. This program carries considerable developmental risk as the Company will be required to hold these assets, and related liabilities, if the properties cannot be sold. The Company has secured construction and permanent financing commitments for this development as detailed under Existing Credit Facilities.\nExisting Retail Store real estate and developmental sites may be sold to third parties. Management will attempt to sell these without any lease guarantees.\nIn approving this developmental program, the Board of Directors established certain financial limitations for development activities. Accordingly, future development will only be allowed to the extent that funding can be obtained, developed Retail Store sites have been sold, and the criteria established by the Board of Directors is met.\nExisting Credit Facilities. The Company's current operations are funded through its revolving line of credit with a new primary lender - The First National Bank of Chicago (First Chicago). First Chicago provided a $20 million revolving credit line which was used to pay off the previous credit facility in January 1995. The First Chicago credit line has a 1995 sub-limit of $6 million which can be used for construction and permanent financing pursuant to the real estate development program described above.\nLimited financing for the Company's real estate and retail store joint venture operations is provided by AT&T Capital Corporation (AT&T). Previously, two credit facilities were offered by AT&T to meet each of these two developmental needs. However, AT&T renewed this financing by providing one revolving credit line totalling $11.75 million which can be used for both purposes. Prepayments under this credit line associated with real estate development activities are required during the first three years of such financing, unless an SBA guaranteed loan is placed with AT&T's Small Business Lending unit. At December 31, 1994, $5.3 million was outstanding under this AT&T facility. $412,000 was included as a liability on the Company's books, with the remainder being an off balance sheet liability related to financing provided to joint ventures of the Company which had been guaranteed by the Company and its joint venture partners.\nIn April 1994, the Company successfully sold $8 million of senior, secured notes providing for quarterly interest only payments through July 1998 and then equal principal payments of $333,000, plus interest, per quarter with the unpaid balance due May 2004. The proceeds from these notes were used to pay the previous mortgage on the Boise, Idaho RSC, the term loan with the previous primary lender, and the balance (approximately $4.2 million) was placed in a restricted cash account for the purpose of providing financing for the acquisition of the Las Vegas, Nevada RSC (Las Vegas RSC) in early 1995. Financing for the Indiana RSC was converted from the construction loan into a permanent loan in 1994. This loan amortizes over 7 years with such amortization starting October 1994.\nIn 1993 the Company borrowed $6 million from Kelly-Springfield to finance the acquisition and retirement of 400,000 shares of the Company's common stock and certain warrants from General. The loan was renegotiated\nin September 1994, eliminating the balloon payment due in August 1995 and extending the note through November 1997 based on scheduled principal payments.\nManagement's discretion with respect to certain business matters is limited by financial and other covenants contained in loan agreements with First Chicago, AT&T, the senior note holders, and Kelly-Springfield. These covenants, among other things, limit or prohibit the Company from (i) paying dividends on its capital stock, (ii) incurring additional indebtedness, (iii) creating liens on or selling certain assets, (iv) making certain loans, investments, or guarantees, (v) violating certain financial ratios (vi) repurchasing shares of its common stock, and (vii) making certain capital expenditures. At December 31, 1994, the Company was either in compliance with all of these covenants or had received waivers from the appropriate lender.\nAdvances from First Chicago are limited to a portion of eligible collateral as defined in the Revolving Credit Agreement and are further reduced by the amount of any outstanding letters of credit issued on behalf of the Company. This credit facility extends through January 23, 1998. The Company anticipates that short term cash needs can be met through this credit facility. As noted above, limited Retail Store development costs can be met, on a short term basis, for acquisition, construction, and renovation costs. However, financing through this facility for both real estate development and operations will be subject to the formula borrowing base and the above-mentioned covenant limitations. Financing beyond these needs, principally for capital expenditures, will need to be obtained through other credit facilities.\nProposed Financing. The Company is currently working on the following three financing proposals:\ni. Management is negotiating for the sale of additional promissory notes receivable. It is presently anticipated that an additional $1 million of these notes may be sold in 1995.\nii. In conjunction with the conversion to the Las Vegas RSC, management is evaluating whether to acquire or lease certain equipment, computer hardware, and computer software.\niii. Management is also seeking to secure additional permanent real estate financing in the event that the SBA guaranteed financing, described in Real Estate Development, is not obtained by the prospective Franchisee. Currently, real estate development activities will be limited to the extent that permanent financing can be provided by First Chicago or AT&T.\nFinancial Commitments. The Company has provided financial guarantees to third party lenders, equipment lessors, and other sources of financing provided to certain franchised Retail Stores which, at December 31, 1994, approximated $4.7 million and at December 31, 1993 approximated $2.4 million. In conjunction with the sale of the notes receivable in the amount of approximately $3 million, the Company guaranteed 50% of such notes based on the balance outstanding for these notes at December 31 of the previous fiscal year. At December 31, 1994, this amounted to an additional $1.5 million. Lease guarantees provided to landlords by the Company amounted to approximately $4.8 million at December 31, 1994.\nIn November 1993, the Company guaranteed a promissory note on behalf of the Big O Tires, Inc. Employee Stock Ownership Plan (ESOP) which refinanced three previously existing promissory notes. The next annual payment is due in April 1995, in the amount of $240,000 plus accrued interest and the final installment is due in April 1996. The Company is required to make contributions to the ESOP in an amount equal to these principal and interest payments. Contributions are anticipated to meet or exceed these debt service requirements; however, contributions exceeding these payments are at the discretion of the Board of Directors.\nIn December 1994, the Company sold its Denver RSC to an unrelated third party in connection with the conversion to the Las Vegas RSC, as noted in the section below. This sale was consummated with a down payment of $242,000, certain rent concessions, and the assignment of the Company's promissory note and mortgage on the facility from the existing mortgagee. The financial obligations under this mortgage were not released by the mortgagee, so the Company remains obligated on this mortgage in the event that the purchaser defaults. At December 31, 1994, this financial commitment amounted to $2.8 million. The Company is required to vacate the\nwarehouse portion of the premises by March 31, 1995. As part of the sale agreement, the Company will maintain usage of the corporate office space for three (3) years.\nLas Vegas RSC Conversion. In June 1993, the Company announced a plan to consolidate three of its RSCs (Vacaville, California, Ontario, California and Denver, Colorado, as noted above) into a 300,000 square foot facility located near Las Vegas, Nevada. The purpose of this consolidation was to continue the Company's efforts to reduce selling, administrative, and product delivery expense (S&A Expense). In May 1994, the Company closed its RSC in Vacaville, California and consolidated its operations into the Ontario RSC. The Vacaville warehouse was leased to an unrelated third party, which lease continues until March 2000. The warehouse and lease are currently being marketed for sale. Upon the sale, the cash proceeds will be used to reduce the outstanding loan balance with First Chicago.\nIt is presently anticipated that the Ontario RSC operations will be fully converted to the Las Vegas RSC by May 1995. The Company is obligated under the lease for the Ontario warehouse until May 1998. This warehouse space is currently being marketed for lease.\nAfter all operations have been successfully consolidated at the Las Vegas RSC, S&A Expense is anticipated to be reduced. However, during the first six months of 1995, S&A Expenses are anticipated to remain approximately at current levels until the Denver and Ontario RSC's are closed. The lease costs associated with the Ontario warehouse have been accrued for the first twelve months of vacancy after the facility is closed. Costs associated with the lease after that time are currently expected to be absorbed by the subtenant, if one is secured; if not, the Company will incur additional expense.\nCapital Expenditures. In February 1995, the Company acquired the Las Vegas RSC at a total cost of approximately $7.7 million. Change orders associated with the completion of this facility currently amount to an additional $300,000. New equipment including computer hardware and software to operate this facility will add an additional estimated $650,000 to 1995 capital expenditures.\nAdditional capital expenditures are anticipated in connection with the real estate development activities described above. While it has been anticipated that the Boise RSC would be expanded in 1995, this expansion has been deferred. Acquisition and implementation of a new computer hardware and software system for the Company continues to be evaluated.\nAdditional Issues That Could Impact Liquidity. Expenses associated with the warranty program offered by the Company have reduced profitability over the past seven (7) years. While negotiated programs with suppliers have aided the Company in reducing the financial impact of this warranty program during the last four years, certain agreements with the Company's previous supplier have been limited as to future application. The Company now has 77% of its private brand product produced by Kelly-Springfield and it is anticipated that nearly all of this product will be produced by Kelly-Springfield by the end of 1995.\nThe Company continues to have a significant portion of its Franchisees located in California. The Company will continue to grow in this significant market, but is also looking to expand Retail Store development in other states, principally Washington, Oregon, and Arizona in 1995. In 1993 the Company and its Franchisees experienced adverse publicity in the state of California, which may have had an impact on retail sales during 1994. Retail sales and the ability to franchise new locations within California may be impacted in the future, although the exact extent, if any, cannot be forecast at this time.\nA portion of the Company's growth strategy involves the addition of master Franchisees (both domestically and internationally) and conversion of existing tire chains to the Big O system. While the Company is prepared to offer certain financial arrangements to assist in a conversion, the Company cannot estimate the exact financial commitment that such a conversion will require since it is based both on the number of stores converted as well as the financing provided with each such conversion.\nIn 1994, the Company assisted in one environmental issue located in California. The Company settled this matter at a negligible cost. The Company has periodically been involved with minor clean ups associated with certain Retail Stores in which the Company has been a tenant or subtenant. Generally, the costs of these clean ups have been less than $10,000; however, there is no assurance that such environmental remediations in the future can be limited to this amount. As a result of these environmental concerns and the Company's real estate development strategy, the Company has adopted a policy requiring that all new projects have Phase I environmental studies conducted before the project is approved and the location is acquired.\nMarket risks associated with changes in interest rates could have an impact on the Company's profitability due to the significant amounts of financing tied to variable interest rates. Increases in consumer interest rates could have an adverse effect on the sales of the Company's products to its Retail Stores, since such Retail Stores sell a portion of their products and services to the consumer on credit. Management established a credit card system and financing program with American General Finance, Inc. to assist in the maintenance of credit availability for the consumer. There is no assurance that this finance company, or any other finance company, will continue to offer an acceptable financing program in the event that interest rates increase.\nAs noted earlier, closures of Retail Stores can have significant financial impact on the Company's operations and cash flows. While the cost of certain lease guarantees were reserved and expensed in 1994, the cash flow requirements from these leases will continue until the lease has expired. Further, the failure of any Retail Stores for which the Company has guaranteed a lease will result in reduced financial performance and a resulting impact on future cash flows.\nSEASONALITY\nThe Retail Stores experience some seasonal variation of product sales because tire sales are generally greater during the summer than in the winter months. The Company generally experiences some degree of seasonality, although not to the same extent that Retail Stores do, as the Company maintains sales to certain Retail Stores that offset this trend on a national basis through the sale of such products as snow tires and chains. The Company has historically generated operating losses or lower profits during the first quarter of each fiscal year because of lower sales volumes and higher expenses as a percentage of sales.\nINFLATION AND PRICE CHANGES\nAs a matter of industry practice, most tire distributors adjust the selling price of inventories when prices increase (decrease) which result in gross profit increases (decreases) associated with the sale of existing inventories at these higher (lower) prices. However, management has recently noted that certain \"discount\" distributors may defer this price increase on their existing inventory in an effort to increase market share.\nPrice increases contributed approximately $360,000, $90,000 and $712,000 to the Company's gross profits for 1994, 1993 and 1992, respectively. The Company received price increases from its suppliers of between 3 and 4% on tires and other products in 1994. Manufacturers implemented a 3% price increase starting March 1995. The Company is unsure as to whether this price increase will be supported by the industry, although initial indications are that it will. Since price increases are initiated by manufacturers and are then subject to competitive pressures, management cannot predict any future increases for 1995 or thereafter.\nACCOUNTING STANDARDS\nThe Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standard (FAS) No. 107, Disclosures About Fair Value of Financial Instruments, which is required to be implemented for the Company's fiscal year ending December 31, 1995. Since this FAS only requires additional disclosure of the fair value of certain financial instruments for which it is practicable to estimate such value, the earlier adoption of this FAS would not have materially affected the Company's financial position nor results of operations for the year ended December 31, 1994.\nThe FASB has issued two additional financial accounting standards, FAS No. 114, Accounting by Creditors for Impairment of a Loan, and FAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures, which are required to be implemented for the Company's fiscal year ending December 31, 1995. The earlier adoption of these FAS's would not have materially affected the Company's financial position nor results of operations for the year ended December 31, 1994.\nThe FASB has also issued FAS No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments, which is required to be implemented for the Company's fiscal year ending December 31, 1996. At December 31, 1994, the Company did not hold any derivative financial instruments for trading or other purposes, and the Company did not purchase any such instruments during the year then ended. Accordingly, the earlier adoption of this FAS would not have materially affected the Company's financial position nor results of operations for the year ended December 31, 1994.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAll Financial Statements and Financial Statement Schedules required to be filed hereunder are listed under Item 14 and are attached hereto following the signature page.\n(a) Selected Quarterly Financial Data (in thousands except per share data):\n(b) Information about Oil and Gas Producing Activities\nNot applicable.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nItems 10 through 13 of this Form 10-K are omitted by the Company and are incorporated by reference to the Company's definitive Proxy Statement for the Company's 1995 Annual Meeting of Shareholders which will be filed with the United States Securities and Exchange Commission not later than 120 days after the close 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) (1) List of Financial Statements\nThe following is a list of financial statements which, along with the auditors' report, accompany this Form 10-K:\n- Independent Auditors' Report - Deloitte & Touche LLP - 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) List of Schedules Required by Item 8 and Item 14 (d)\nNone.\n(a) (3) List of Exhibits Required by Item 601 of Regulation S-K\nEXHIBIT NUMBER\n(3.1) Certificate of Amendment to Restated Articles of Incorporation of Big O Tires, Inc. dated June 10, 1992 and Restated Articles of Incorporation of Big O Tires, Inc. dated August 17, 1987 (incorporated by reference to Exhibit 3 to Quarterly Report on Form 10-Q for quarter ended June 30, 1992).\n(3.2) Amended and Restated Bylaws of Big O Tires, Inc., a Nevada corporation, as amended, August 26, 1994 (incorporated by reference to Exhibit 2 to Current Report on Form 8-K dated August 26, 1994).\n(4.1) Rights Agreement dated as of August 26, 1994, between Big O Tires, Inc. and Interwest Co., Inc., as Rights Agent (incorporated by reference to Exhibit 1 to Current Report on Form 8-K dated August 26, 1994).\n(10.1) 1994 Restatement of Employee Stock Ownership Plan and Trust Agreement of Big O Tires, Inc. (incorporated by reference to Exhibit 10.3 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 1994).\n(10.2) Big O Tires, Inc. Director and Employee Stock Option Plan (incorporated by reference to Exhibit 10.11 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1988).\n(10.3) First Amendment to the Big O Tires, Inc. Director and Employee Stock Option Plan (incorporated by reference to Exhibit 10.10 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1989).\n(10.4) Amendment No. 2 to the Big O Tires, Inc. Director and Employee Stock Option Plan (incorporated by reference to Exhibit 10.16 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1992).\n(10.5) Ultimate Net Loss Agreement between Big O Tires, Inc. and FBS Business Finance Corporation dated January 13, 1989 (incorporated by reference to Exhibit 10.34 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1988).\n(10.6) Purchase Agreement effective June 30, 1987, and related documents including Promissory Notes, Modification Agreements, Security Agreements, Guaranty Agreement, and Subleases in connection with a purchase by C.S.B. Partnership and three individuals including Ronald D. Asher, of three Big O Franchise Retail Tire Stores in California from Security\/Cal, Inc., a wholly-owned subsidiary of the Company, and H.R.I., Inc., a wholly-owned subsidiary of Security\/Cal, Inc. (incorporated by reference to Exhibit 10.63 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1987).\n(10.7) Purchase Agreement effective November 1, 1987, and related documents including Promissory Notes, Security Agreements, Guaranty Agreements, Subleases, and Franchise Agreements in connection with a purchase by C.S.B. Partnership and its three general partners, including Ronald D. Asher, of two Big O Franchise Retail Tire Stores in California from Security\/Cal, Inc. and H.R.I., Inc. (Seller) (incorporated by reference to Exhibit 10.45 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1988).\n(10.8) Purchase Agreements effective July 5, 1988, October 1, 1988, and November 14, 1988, and related documents including Promissory Notes, Security Agreements, Guaranty Agreements, and Subleases in connection with a purchase by C.S.B. Partnership and three individuals including Ronald D. Asher of three Big O Franchise Retail Tire Stores in California from Big O Tires, Inc., Security\/Cal, Inc., a wholly-owned subsidiary of the Company, and H.R.I., Inc., a wholly-owned subsidiary of Security\/Cal, Inc. (incorporated by reference to Exhibit 10.46 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1988).\n(10.9) Agreement and Release dated October 31, 1989, and related documents including Promissory Note, related Subleases, Assignment of Lease Rights, and Performance Guarantee in connection with the purchase by C.S.B. Partnership and its general partners, including Ronald D. Asher, of two (2) Big O franchise retail tire stores in California, owned by GEM Tire, Inc. from the Company (incorporated by reference to Exhibit 10.57 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1989).\n(10.10) Ultimate Net Loss Agreement, dated as of December 1, 1990, by and between Big O Tires, Inc. and Northcross Financial Services, Inc., ICON Capital Corp., in its individual capacity and on behalf of ICON Cash Flow Partners, L.P., Series A, ICON Cash Flow Partners, L.P., Series B and any future partnerships on which it may be the general partner and\/or manager (incorporated by reference to Exhibit 10.70 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1990).\n(10.11) Loan and Security Agreement dated October 15, 1991, with its former lender together with exhibits and appendices (incorporated by reference to Exhibit 10.57 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n(10.12) Assignment for Security (Trademarks and Trademark Licenses), dated October 15, 1991, providing collateral assignment of Big O Tires, Inc.'s and its subsidiaries' trademark and trademark licenses to its\nformer lender (incorporated by reference to Exhibit 10.58 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n(10.13) Stock Pledge Agreement dated October 15, 1991, whereunder Big O Tires, Inc. pledged stock holdings of its subsidiary companies to its former lender (incorporated by reference to Exhibit 10.59 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n(10.14) Continuing Guaranty Agreement dated October, 15, 1991, providing the guarantee by certain of Big O Tires, Inc.'s subsidiary companies for the obligations of Big O Tires, Inc. under the Loan and Security Agreement with its former lender (incorporated by reference to Exhibit 10.60 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n(10.15) First Amendment to Loan and Security Agreement, dated as of November 18, 1991, with its former lender (incorporated by reference to Exhibit 10.62 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n(10.16) Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing dated as of November 19, 1991, for the benefit of its former lender which now enjoys a first lien position on Big O Tires, Inc.'s Vacaville, California Regional Sales and Service Center (incorporated by reference to Exhibit 10.65 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n(10.17) Secured Promissory Note dated April 3, 1992, in the original principal amount of $3,000,000, payable to the order of its former lender which evidences Big O Tires, Inc.'s $3,000,000 term loan facility (incorporated by reference to Exhibit 10.67 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n(10.18) 1994 Incentive Bonus Plans (incorporated by reference to Exhibit 10.43 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1993).\n(10.19) Agreement of Joint Venture of Big O\/C.S.B. Joint Venture dated as of June 1, 1992, by and between Big O Retail Enterprises, Inc., a wholly- owned subsidiary of Big O Tires, Inc., and C.S.B. Partnership, a California general partnership (incorporated by reference to Exhibit 10.70 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n(10.20) Amendment No. 1 to Agreement of Joint Venture of Big O\/C.S.B. Joint Venture dated as of May 15, 1993 (incorporated by reference to Exhibit 10.27 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1993).\n(10.21) Purchase Agreement for Private Brand Name Tires between Big O Tires, Inc. and The Kelly-Springfield Tire Co., dated August 16, 1992 (incorporated by reference to Exhibit 10.71 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1991).\n(10.22) Big O Tires, Inc. Long Term Incentive Plan (incorporated by reference to Exhibit 55 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1992).\n(10.23) Amendment No. 1 to Big O Tires, Inc. Long Term Incentive Plan (incorporated by reference to Exhibit 56 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1992).\n(10.24) Amendment No. 2 to Big O Tires, Inc. Long Term Incentive Plan (incorporated by reference to Exhibit 57 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1992).\n(10.25) Agreement of Joint Venture of Big O\/S.A.N.D.S. Joint Venture (incorporated by reference to Exhibit 58 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1992).\n(10.26) Commitment Letters dated July 22, 1992, from AT&T Capital Corporation (incorporated by reference to Exhibit 64 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1992).\n(10.27) Agreement dated as of November 15, 1992, among Peerless Trading Company, Limited, Delaware Liquidators, Inc. dba Trade Center Imports, and Big O Tires, Inc.; Purchase Money Non-Negotiable Promissory Note dated as of November 15, 1992, from Peerless Trading Company, Limited to Big O Tires, Inc.; and amendment dated January 19, 1993 to the Agreement dated November 15, 1992 (incorporated by reference to Exhibit 66 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1992).\n(10.28) Marketing Agreement for Private Brand Tires between Big O Tires, Inc. and General Tire, Inc., dated May 14, 1993 (incorporated by reference to Exhibit 10.1 to Big O Tires, Inc.'s Current Report on Form 8-K dated April 30, 1993).\n(10.29) Closing Agreement between General Tire, Inc. and Big O Tires, Inc., dated May 14, 1993 (incorporated by reference to Exhibit 10.2 to Big O Tires, Inc.'s Current Report on Form 8-K dated April 30, 1993).\n(10.30) Second Amendment to Loan and Security Agreement by and among its former lender and Big O Tires, Inc., Big O Retail Enterprises, Inc. and Big O Tire of Idaho, Inc., dated May 14, 1993 (incorporated by reference to Exhibit 10.3 to Big O Tires, Inc.'s Current Report on Form 8-K dated April 30, 1993).\n(10.31) Inventory Financing Agreement between The Kelly-Springfield Tire Company and Big O Tires, Inc. and\/or Big O Tire of Idaho, Inc. and\/or Big O Retail Enterprises, Inc., dated May 14, 1993 (incorporated by reference to Exhibit 10.4 to Big O Tires, Inc.'s Current Report on Form 8-K dated April 30, 1993).\n(10.32) Demand Note in the original principal amount of $6,000,338.67 with The Kelly-Springfield Tire Co. as Holder and Big O Tires, Inc., Big O Retail Enterprises, Inc. and Big O Tire of Idaho, Inc., as Maker (incorporated by reference to Exhibit 10.50 to Big O Tires, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1993).\n(10.33) Purchase Agreement by and among Tire Brands, Inc. and Big O Tires, Inc., dated as of April 30, 1993 (incorporated by reference to Exhibit 10.5 to Big O Tires, Inc.'s Current Report on Form 8-K dated April 30, 1993).\n(10.34) Consolidation and Modification Agreement among Big O Tires (successor in interest to H.R.I., Inc. and Security\/Cal, Inc.) and Big O Retail Enterprises, Inc. and C.S.B. Partnership (incorporated by reference to Exhibit 10.51 to Big O Tires, Inc.'s Registration Statement No. 33- 65852).\n(10.35) Modification of Consolidation and Modification Agreement by and between C.S.B. Partnership and Big O Tires, Inc. (incorporated by reference to Big O Tires, Inc.'s Form 10-K for the year ended December 31, 1993).\n(10.36) Registration Rights Agreement dated June 28, 1993, between the Selling Shareholder and Big O Tires, Inc. (incorporated by reference to Exhibit 10.52 to Big O Tires, Inc.'s Registration Statement No. 33- 65852).\n(10.37) Loan Agreement and Promissory Note in the original principal amount of $155,000.00 with C.S.B. Partnership as Maker (incorporated by reference to Exhibit 10.44 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.38) Loan Agreement and Promissory Note in the original principal amount of $70,000.00 with Big O\/C.S.B Joint Venture as Maker (incorporated by reference to Exhibit 10.45 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.39) Loan Agreement and Promissory Note in the original principal amount of $75,000.00 with Big O\/S.A.N.D.S. Joint Venture as Maker (incorporated by reference to Exhibit 10.46 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.40) Commercial Note and Loan Agreement, Commercial Mortgage and Environmental Certificate between Big O Development, Inc. and National City Bank, Kentucky, and Guaranty Agreement of Big O Tires, Inc. guaranteeing the obligations of Big O Development, Inc. to National City Bank, Kentucky in connection with the borrowing of $1,500,000 for construction of the Company's Regional Sales and Service Center in New Albany, Indiana (incorporated by reference to Exhibit 10.47 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.41) Construction Agreement between Big O Development, Inc. and Koetter Construction, Inc. to construct the Regional Sales and Service Center in Floyd County, Indiana (incorporated by reference to Exhibit 10.48 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.42) Purchase and Sale Agreement and Joint Escrow Instructions by and between Western Realco and Big O Tires, Inc. for the purchase of the Company's Regional Sales and Service Center in Clark County, Nevada (incorporated by reference to Exhibit 10.49 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.43) Lease between Big O Tires, Inc. and Simpson Dura-Vent Company, Inc., dated January 24, 1994 for property located at 877 Cotting Court, Vacaville, California and related election of option to accelerate occupation (incorporated by reference to Exhibit 10.51 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.44) Letter dated January 26, 1994 from General Tire, Inc. to the Company terminating the Marketing Agreement for Private Brand Name Tires between Big O Tires, Inc. and General Tire, Inc. dated May 14, 1993 (incorporated by reference to Exhibit 10.52 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.45) Purchase Agreement by and between Caps Tire Limited Liability Company and Intermountain Big O Realty for the Big O Tires Retail Store located at 8151 East Arapahoe Road, Englewood, Colorado (incorporated by reference to Exhibit 10.53 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.46) Third and Fourth Amendments to Loan and Security Agreement by and between Big O Tires, Inc. and its primary lender (incorporated by reference to Exhibit 10.54 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.47) Limited Partnership Agreement by and between Donald J. Horton, General Partner, Thomas L. Staker, General Partner, and Big O Tires, Inc., Limited Partner, dated as of December 31, 1993 (incorporated by reference to Exhibit 10.56 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.48) Loan Agreement and Guaranty, Promissory Note and Security Agreement with Big O Tires, Inc. Employee Stock Ownership Plan (\"ESOP\") as Borrower, Big O Tires, Inc., as Guarantor, and Key Bank of Wyoming, as Lender, in connection with the refinancing of the ESOP debt in the amount of $960,000 (incorporated by reference to Exhibit 10.57 to Big O Tires, Inc.'s Form 10-K for the fiscal year ended December 31, 1993).\n(10.49) Amendment to Partnership Agreement dated August 25, 1994, by and between Big O Development, Inc., a Colorado corporation, a wholly- owned subsidiary of Big O Tires, Inc. and Mill Creek Associates, Ltd., a Colorado limited partnership (incorporated by reference to Exhibit 10.2 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 1994).\n(10.50) Agreement dated July 1, 1994, by and between General Tire, Inc., an Ohio corporation and Big O Tires, Inc. (incorporated by reference to Exhibit 10.4 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q dated September 30, 1994).\n(10.51) Consulting Agreement by and between Big O Tires, Inc., and Horst K. Mehlfeldt (incorporated by reference to Exhibit 10.5 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q dated September 30, 1994).\n(10.52) Letter Agreement dated January 10, 1995, amending the Consulting Agreement by and between Big O Tires, Inc. and Horst K. Mehlfeldt (incorporated by reference to Exhibit 10.3 to Big O Tires, Inc.'s Current Report on Form 8-K dated January 10, 1995).\n(10.53) Letter Agreement dated July 12, 1994, by and between Big O Tires, Inc. and PaineWebber Incorporated (incorporated by reference to Exhibit 10.6 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q dated September 30, 1994).\n(10.54) Letter Agreement dated March 23, 1994, by and between Big O Tires, Inc. and The CIT Group\/Equipment Financing, Inc., a New York corporation (incorporated by reference to Exhibit 10.7 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q dated September 30, 1994).\n(10.55) Ultimate Net Loss Agreement dated October 21, 1994, by and between Big O Tires, Inc. and The CIT Group\/Equipment Financing, Inc., a New York corporation (incorporated by reference to Exhibit 10.8 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q dated September 30, 1994).\n(10.56) Fifth Amendment to Loan and Security Agreement by and between Big O Tires, Inc. and its former lender dated April 29, 1994 (incorporated by reference to Exhibit 10.1 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q dated September 30, 1994).\n(10.57) Agreement by the Investment Committee of the Board of Directors and the Management\/Dealer participants dated September 22, 1994 (incorporated by reference to Exhibit 10.1 to Big O Tires, Inc.'s Current Report on Form 8-K dated December 6, 1994).\n(10.58) Letter dated September 13, 1994, to the Investment Committee of Big O Tires, Inc. and the Management participants and Dealer representatives (incorporated by reference to Exhibit 10.2 to Big O Tires, Inc.'s Current Report on Form 8-K dated December 6, 1994).\n(10.59) Letter dated February 7, 1995, from the Dealer-Management Group to the Company's Board Chairman (incorporated by reference to Exhibit 10.1 to Big O Tires, Inc.'s Current Report on Form 8-K dated January 10, 1995).\n(10.60) Agreement between the Company and the Management\/Dealer participants dated January 20, 1995 (incorporated by reference to Exhibit 10.2 to Big O Tires, Inc.'s Current Report on Form 8-K dated January 10, 1995).\n(10.61) Form of Franchise Agreement currently in use.\n(10.62) Multi-Tenant Lease NNN dated December 1, 1994 between Botac VI Leasing L.L.C., a Utah Limited Liability Company and Big O Development, Inc .\n(10.63) Assignment and Assumption Agreement dated December 2, 1994 by Big O Development, Inc., Big O Tires, Inc. and Botac VI Leasing, L.L.C. and Allstate Life Insurance Company.\n(10.64) Guarantee Agreement dated December 2, 1994 by Big O Tires, Inc., Big O Development, Inc. and Allstate Life Insurance Company.\n(10.65) Closing Agreement dated December 2, 1994 by Big O Development, Inc., Big O Tires, Inc., Botac VI Leasing, L.L.C., and Allstate Life Insurance Company.\n(10.66) Commercial contract to Buy and Sell Real Estate dated March 17, 1994 between Bailey's Moving and Storage and Big O Tires, Inc.\n(10.67) Confidentiality Agreement dated September, 1994 between Big O Tires, Inc. and Kenneth W. Pavia, Sr.\n(10.68) Amendment No. 1 to the Big O Tires, Inc. Employee Stock Ownership Plan and Trust Agreement dated September 12, 1994.\n(10.69) Development Management Agreement dated September, 1994 between Ross Development Management Group, Inc. and Big O Development, Inc. and Big O Tires, Inc.\n(10.70) Letter Agreement dated February 20, 1995 terminating the Consulting Agreement between Big O Tires, Inc. and Horst K. Mehlfeldt.\n(10.71) 1995 Incentive Bonus Plans\n(10.72) Commitment Letter dated February 16, 1994 between Big O Tires, Inc. and AT&T Commercial Finance Corporation for real estate financing.\n(10.73) Commitment Letter dated February 16, 1994 between Big O Tires, Inc. and AT&T Commercial Finance Corporation for equipment financing.\n(10.74) Extension letter dated December 9, 1994 between Big O Tires, Inc. and AT&T Commercial Finance Corporation to extend existing lines of credit through December 31, 1995.\n(10.75) Resignation letter dated February 27, 1995 from Robert L. Puckett.\n(10.76) Resignation letter dated February 24, 1995 from David W. Dwyer.\n(10.77) Revolving Credit Agreement dated January 23, 1995 between Big O Tires, Inc. and The First National Bank of Chicago.\n(10.78) Consent, Acknowledgement and Access Agreement dated January 23, 1995 between The Bank of Cherry Creek, N.A., Kenneth B. Buckius and The First National Bank of Chicago.\n(10.79) Note Purchase Agreement dated April 27, 1994 between Big O Tires, Inc. and USG Annuity & Life Company and Republic Western Insurance Company.\n(10.80) Franchise Agreement dated October 7, 1994 between Big O Tires, Inc. and OK Tires, Inc. for the Retail Store located at 2830 West 3500 South, West Valley City, Utah 84119.\n(10.81) Franchise Agreement dated November 26, 1993 between Big O Tires, Inc. and CAPS Tire Limited Liability Company for the Retail Store located at 8151 East Arapahoe Road, Englewood, Colorado 80112.\n(10.82) Form of Confidentiality Agreement signed by dealers dated October 19, 1994.\n(10.83) Ultimate Net Loss Agreement dated November 30, 1994, by and between Big O Tires, Inc. and The CIT Group\/Equipment Financing, Inc., a New York corporation.\n(10.84) Inventory Financing Agreement together with a Demand Note dated September 30, 1994, by and between The Kelly-Springfield Tire Company and Big O Tires, Inc., Big O Retail Enterprises, Inc. and Big O Tire of Idaho, Inc.\n(10.85) Supplemental Executive Retirement Plan dated December 7, 1994, by Big O Tires, Inc., effective January 1, 1994.\n(10.86) Forms of Stock Appreciation Rights Agreement dated February 15, 1995, between Big O Tires, Inc. and the Members of the Chief Executive Office.\n(10.87) Letter Agreement dated March 24, 1995, regarding severance package, between Big O Tires, Inc., and John E. Siipola.\n(10.88) Letter Agreement dated March 24, 1995, regarding severance package, between Big O Tires, Inc., and Horst K. Mehlfeldt.\n(21.1) Big O Tires, Inc. Subsidiaries.\n(25.1) Powers of Attorney executed by each of the Directors of Big O Tires, Inc.\n(27.1) Big O Tires, Inc.'s Financial Data Schedule.\n(99.1) October 31, 1994 press release issued by AKH Company, Inc., a California based retail tire chain, doing business as \"Discount Tire Centers\" and \"Evans Tire and Service Centers\" (incorporated by reference to Exhibit 99.1 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q dated September 30, 1994).\n(99.2) November 1, 1994 press release issued by Big O Tires, Inc. (incorporated by reference to Exhibit 99.2 to Big O Tires, Inc.'s Quarterly Report on Form 10-Q dated September 30, 1994). __________ * All executive compensation plans and arrangements required to be filed as exhibits to the Form 10-K pursuant to Item 601.\n(b) Reports on Form 8-K\n1. In a Current Report on Form 8-K, dated December 2, 1994, the Company reported on two proposals with contingencies to acquire the outstanding shares of the Company. No assurances were given that either of the proposals would be consummated.\n2. In a Current Report on Form 8-K, dated December 6, 1994, the Company reported that the Investment Committee of the Board of Directors agreed to enter into a period of exclusive negotiations with a group of officers, managers and franchised dealers (\"Dealer-Management Group\") that recently made an offer to acquire the outstanding shares of the Company and that AKH Company, Inc., who had made a previous offer to acquire the Company had advised the Investment Committee it was contemplating deferring any further proposal as long as the Dealer-Management Group's bid remains under active consideration. The Company also reported that two separate class action lawsuits had been filed against the Company and its nine directors similarly requesting, among other things, the court to enjoin the sale of the Company to the Dealer-Management Group.\n(c) Exhibits\nExhibits required by Item 601 of Regulation S-K are listed above under (a) (3) of this Item 14.\n(d) Financial Statement Schedules\nFinancial Statement Schedules are listed above under (a) (2) of this Item 14.\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.\nDated: March 29, 1995\nBIG O TIRES, INC., a Nevada corporation\nBy: \/s\/ JOHN E. SIIPOLA ---------------------------------- John E. Siipola Member of the Office of the Chief Executive and Chairman\nBy: \/s\/ HORST K. MEHLFELDT ---------------------------------- Horst K. Mehlfeldt Member of the Office of the Chief Executive and Vice-Chairman\nBy: \/s\/ STEVEN P. CLOWARD ---------------------------------- Steven P. Cloward Member of the Office of the Chief Executive and President\nBy: \/s\/ JOHN B. ADAMS ---------------------------------- John B. Adams Principal Accounting Officer\nBy: \/s\/ JOHN B. ADAMS ---------------------------------- John B. Adams 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.\nMarch 29, 1995 By: \/s\/ JOHN B. ADAMS ---------------------------------- John B. Adams Attorney-in-Fact\nIndependent Auditors' Report ----------------------------\nTo the Shareholders and Board of Directors of Big O Tires, Inc. Englewood, Colorado\nWe have audited the accompanying consolidated balance sheets of Big O Tires, Inc. 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, 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 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\nDenver, Colorado March 13, 1995\nBIG O TIRES, INC. ----------------- CONSOLIDATED BALANCE SHEETS --------------------------- DECEMBER 31, 1994 AND 1993 -------------------------- (000s except for share amounts) -------------------------------\nSee consolidated notes to financial statements.\nBIG O TIRES, INC. ----------------- CONSOLIDATED BALANCE SHEETS --------------------------- DECEMBER 31, 1994 AND 1993 -------------------------- (000s except for share amounts) -------------------------------\nSee notes to consolidated financial statements.\nBIG O TIRES, INC. ----------------- CONSOLIDATED STATEMENTS OF INCOME --------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 ---------------------------------------------------- (000s except for share and per share amounts) ---------------------------------------------\n-See notes to consolidated financial statements.-\nBIG O TIRES, INC. ----------------- CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ----------------------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 ---------------------------------------------------- ($ only in 000s) ----------------\n-See notes to consolidated financial statements.-\nBIG O TIRES, INC. ----------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 ---------------------------------------------------- (000s) ------\n-See notes to consolidated financial statements.-\nBIG O TIRES, INC. ----------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 ---------------------------------------------------- (000s) ------\n-See notes to consolidated financial statements.-\nBIG O TIRES, INC. ----------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 ----------------------------------------------------\n1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:\nOperations ----------\nThe Company is the franchisor of Big O Tire stores and sells tires, wheels, and related products directly to franchised Big O dealers (\"Franchisees\"), to licensees in Canada and to retail customers at its Company owned retail tire stores. The Company is active in promoting certain programs and sales techniques to its Franchisees.\nUnder a Franchise Agreement, the Company grants the right to operate a retail tire store using the Big O trademarks, service marks and associated logos and symbols in exclusive marketing territories. Depending on certain qualifications, the initial franchise fee ranges from $7,000 to a maximum of $21,000. Assignment or transfer of a Franchise Agreement provides a transfer fee of up to $21,000. Initial franchise fees are deferred and recognized when all material services or conditions relating to the sale or transfer of the franchise have been substantially completed. The Franchisees must also pay the Company a continuing royalty fee of 2% based upon the Franchisees' monthly gross sales as that term is defined in the Franchise Agreement. Continuing royalty fees are recognized when the fees are earned and become receivable from the Franchisee. The initial franchise and royalty fees included in sales were $6,772,000, $6,116,000 and $5,856,000 for 1994, 1993 and 1992, respectively. The Franchise Agreement also allows for the Company to collect a 1% fee to be used for national advertising; however, this fee is currently limited to $.10 for each Big O brand tire purchased from the Company.\nOne member of the Company's Board of Directors had ownership of or interests in thirty-one (31) Big O Retail Stores during 1994 and 1993, and two members of the Company's Board of Directors had ownership of or interests in twenty-seven (27) Big O Retail Stores in 1992. Three officers of the Company each had ownership interests in a Big O Retail Store during 1994, two officers each had an ownership interest in a Big O Retail Store in 1993, and one officer had an ownership interest in a Big O Retail Store in 1992. Sales to these stores were approximately $9,372,000, $8,122,000, and $9,176,000 during 1994, 1993 and 1992, respectively. These sales were made under the same terms and conditions as those with unrelated parties. As of December 31, 1994 and 1993, outstanding accounts and notes receivable from these stores totalled $803,000 and $1,609,000, respectively. The Company has also provided equipment lease guarantees to certain of these stores totalling $531,000 at December 31, 1994. During 1993, an officer of the Company purchased real property from a joint venture in which the Company holds a 50% interest. The sale resulted in a pretax gain of $38,000 for the joint venture.\nSignificant Accounting Policies: -------------------------------\nConsolidation and Reclassifications -\nAll significant majority-owned subsidiaries are consolidated and all significant intercompany transactions are eliminated. Certain reclassifications have been made to 1993 and 1992 financial information to make the presentation consistent with that of the current year. These reclassifications had no impact on net income.\nCash -\nCash and cash equivalents include time deposits, certificates of deposit and marketable securities with original maturities of three months or less.\nAt December 31, 1994 cash in the amount of $4,228,000 was restricted for use by the Company for the acquisition of the Las Vegas distribution center which was under construction.\nInventories -\nInventories consist of finished goods only. New and recapped tire inventories of Big O Tire of Idaho, Inc. (\"Idaho\"), a subsidiary of the Company, and the inventories purchased pursuant to the November 1988 Kentucky and Indiana merger (see Note 2), are valued at the lower of last-in, first-out (LIFO) cost or market. All other inventories are valued at the lower of first-in, first-out (FIFO) cost or market. Inventories of $4,657,000 and $3,864,000 at December 31, 1994 and 1993, respectively, are valued at LIFO. Under the FIFO method of inventory valuation, these inventories would have been approximately $44,000 and $341,000 higher at December 31, 1994 and 1993, respectively.\nProperty, Plant and Equipment -\nProperty, plant and equipment are carried at cost. Depreciation is computed using the straight-line and double declining balance methods over estimated useful lives of the assets ranging from three to 40 years.\nOrdinary maintenance and repairs are charged to operations, while expenditures which extend the physical or economic life of property and equipment are capitalized. Gains and losses on disposition of property and equipment are recognized in operations in the year of disposition and the related asset and accumulated depreciation accounts are adjusted accordingly.\nIntangible Assets -\nDistribution rights, which represent the excess purchase cost over the fair market value of net assets acquired in certain mergers and acquisitions (see Note 2) are capitalized and are being amortized by charges to operations on a straight line basis over 40 years.\nWarranty Reserve -\nThe Company maintains a reserve for future warranty claims on Big O brand tires based on historical experience.\nEarnings Per Share -\nEarnings per share is computed using the weighted-average number of outstanding shares during each period presented. Inclusion of common stock equivalents did not have a material effect on the computation.\n2. ACQUISITIONS AND MERGERS:\nIn November 1988 the Company acquired Big O Tire of Louisville, Inc. (\"Louisville\") at a cost of $3,031,000. Louisville had the distribution rights to the Kentucky and Indiana market of 24 Big O Retail Stores. The Company issued 204,200 shares of its common stock and paid $1,443,000 in cash for this acquisition. The stock was valued at $7.70 per share which approximated management's estimate of the market value of such unregistered shares as of the date of the transaction. In accordance with the purchase method of accounting, the purchase price was allocated to the net assets acquired based on fair values at the date of acquisition with $1,114,000 being assigned to distribution rights and $600,000 to a non-compete agreement. In connection with this acquisition, the Company also had an obligation to provide additional securities, or obtain the return of a portion of those securities, based upon the trading price of the Company's common stock at specified dates through November 1994.\nIn August 1990 the Company modified the agreement with the former shareholders of Louisville whereby the Company guaranteed that the former shareholders would receive, under certain circumstances, a value of $25.00 per share (subject to adjustment depending on when payment is received) from the sale of the Big O common stock issued to them in connection with the acquisition of Louisville, and the former shareholders provided the Company with an option of paying cash in lieu of issuing additional securities pursuant to this obligation. In 1993 and 1992, cash payments of $788,000 and $501,000, respectively, were made to the former shareholders of Louisville under the terms of this obligation which were capitalized as additional costs of distribution rights. In June 1993, the Company completed an equity offering which included the sale of 81,667 shares of Big O common stock held by\nthe former shareholders of Louisville. With the sale of this stock and the cash payment of $788,000, the Company's obligation to the former shareholders was fully satisfied.\n3. JOINT VENTURES:\nIn August 1992 the Company sold its interest in a joint venture involving a wholly owned subsidiary, Big O Distributors, Inc. (Distributors) and received a five-year promissory note for $231,000 in exchange for its interest. The Company incurred a loss of approximately $73,000 on the sale. Although the buyer, Aspen Enterprises, Inc., is now primarily responsible for obligations under the building lease, Distributors remains liable through 1996 for up to $287,000 in future rentals if the joint venture defaults. These future rents are not included in the future minimum rental payments disclosed in Note 8.\nPrior to 1992 the Company and one of its subsidiaries, Big O Development, Inc. (Development), entered into three separate joint venture agreements with independent parties for the purpose of developing real estate sites for Big O Retail Stores. The Company accounts for its 50% investment in these joint ventures using the equity method. During 1993, the Company acquired the remaining 50% interest in one of the joint ventures at a cost of $266,000. The joint venture was then liquidated and the net assets were transferred to Development. At December 31, 1994 and 1993, $573,000 and $467,000, respectively, were recorded as investments in these joint ventures including $9,000 in pretax loss for 1994 and $10,000 and $23,000 in net pretax income for 1993, and 1992, respectively.\nIn 1993 and 1992, the Company and one of its subsidiaries, Big O Retail Enterprises, Inc., entered into separate joint venture agreements with five of its franchisees to operate retail stores in Arizona, California, Colorado, and Wyoming. Generally, the Company contributed inventories in the amount of $55,000 and guaranteed certain financing arrangements in exchange for a 50% interest in each joint venture.\n4. SALES AND CLOSURES OF RETAIL STORES:\nIn 1994, the Company sold five retail stores for cash and notes. Assets with a net book value of $765,000 were sold for $648,000 resulting in a pretax loss of $117,000. The Company also closed four retail stores. In connection with the closure of these stores and the estimated future lease costs associated with two additional closed locations, one time charges of $989,000 were accrued to cover estimated closing and future lease costs.\nIn 1993, the Company sold five retail stores to franchisees for cash and notes. Assets with a net book value of $798,000 were sold for $648,000, resulting in a pretax loss of $150,000. The Company also closed one retail store. In connection with this closure and the estimated future lease costs associated with three other closed locations, one time charges of $279,000 were accrued to cover estimated closing and future lease costs.\nIn 1992, the Company sold four retail stores to a franchisee for a promissory note. Inventories, property, equipment and other assets with a net book value of $481,000 were sold for $612,000. Because the transaction was considered a highly leveraged transaction, it has not been recorded as a sale of assets, and no gain has been recognized during 1994, 1993 or 1992. The note receivable arising from the transfer of assets has been reflected in the financial statements as other assets, net of the deferred gain of $131,000.\n5. NOTES RECEIVABLE:\nNotes receivable at December 31, 1994 and 1993, consisted of the following (in thousands):\n6. LONG-TERM DEBT:\nLong-term debt at December 31, 1994 and 1993, consisted of the following (in thousands):\n(a) The amount of borrowing availability for the line of credit is determined by application of a predefined formula to the collateral base on a weekly basis. The ranges of permitted borrowings for 1994, 1993 and 1992 were as follows (in thousands):\nIn October 1991, the Company executed a Loan and Security Agreement with its primary lender that provided a revolving line of credit of $12,000,000 (which was limited to a portion of eligible collateral and was further reduced by the amount of any outstanding letters of credit issued by the lender on behalf of the Company) and a term loan of $3,000,000. Interest was computed on the outstanding borrowings at the prime rate plus 1\/2% on the line of credit and at the prime rate plus 1% on the term loan. The credit facility was collateralized by receivables, inventories, equipment and certain real estate. The agreement contained various covenants and restrictions (including a restriction which precludes the payment of cash dividends or the return of capital to shareholders) with which the Company was in compliance at December 31, 1994.\nIn January 1995, the Company executed a Revolving Credit Agreement with another primary lender which provides a revolving line of credit of $20,000,000 (which is limited to a portion of eligible collateral and is further reduced by the amount of any outstanding letters of credit issued on behalf of the Company). This credit facility replaced the previous credit agreement and the borrowings under the previous agreement were repaid.\n(b) Interest rate reductions of up to 2.5% may be earned by meeting certain purchase requirements defined in the lending agreement.\n(c) In 1994 the Company sold the real property collateralizing these mortgage loans. Under the terms of the transactions, the new owners assumed the mortgage liability. The Company has guaranteed the loans.\nThe annual maturities of long-term debt for succeeding years are as follows (in thousands):\n(d) Includes $2,985,000 outstanding under a line of credit which was replaced in January 1995 with a credit facility which matures January 1998.\n7. CAPITAL LEASES:\nThe Company leases certain equipment and a building under capital lease arrangements. Leased assets under these arrangements at December 31, 1994 and 1993 were as follows (in thousands):\nAt December 31, 1994, future minimum lease commitments under these leases for succeeding years were as follows (in thousands):\n8. OPERATING LEASES:\nThe Company's operating leases are primarily for real property. Rental expense for the years ended December 31, 1994, 1993 and 1992 was $1,218,000, $1,253,000 and $765,000 respectively after deducting sublease income of $1,571,000 for 1994, $1,448,000 for 1993 and $1,618,000 for 1992.\nFuture minimum rental payments required under these leases for succeeding years are as follows (in thousands):\nThe Company is contingently liable for future rentals on a building lease currently occupied by a former joint venture partner (See Note 3). In the event of a default, the Company remains liable for up to $287,000 in future rentals. These future rents are not included in the future minimum rental payments above.\nCertain lease agreements provide the Company with the option to purchase the leased property at its fair market value at the end of the lease term. Additionally, certain lease agreements contain renewal options ranging from five to fifteen years with terms similar to the original lease agreements.\nIn November 1988 the Company received a distribution of its interest in the Ontario, California distribution center from the limited partnership and subsequently sold its interest to an unrelated third party. As part of this transaction, the distribution center's ten year lease was also transferred, resulting in a sale-leaseback. The Company's share of the gain on the sale of the property is being deferred and amortized over the remaining lease term.\n9. INCOME TAXES:\nThe Company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (SFAS No. 109) as of January 1, 1993. SFAS No. 109 is an asset and liability approach that, among other provisions, 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 considers all expected future events other than enactments or changes in the law or rules.\nThe total cumulative effect of adopting SFAS No. 109 is an increase in deferred tax liabilities of $285,000 at January 1, 1993 and has been reported as a charge against income in the 1993 consolidated statement of income.\nThe tax effects of temporary differences which give rise to the deferred tax assets and liabilities as of December 31, 1994 and 1993 are as follows (in thousands):\nThe following is a summary of the income tax provision for the years ended December 31, 1994 and 1993 under SFAS No. 109 (in thousands):\nThe following is a summary of the income tax provision for the year ended December 31, 1992, under the Company's former method of accounting for income taxes (in thousands):\nThe net deferred income taxes charged to operations at December 31, 1992 consist of the following (in thousands):\nA reconciliation of the provision for income taxes to the statutory Federal tax rate of 34% on income before income taxes is as follows (in thousands):\n10. EMPLOYEE STOCK OWNERSHIP PLAN:\nThe Company has an employee stock ownership plan (\"ESOP\") in which all non- retail employees, 18 years of age or older and having 1,000 hours of service in a fiscal year, are eligible to participate. The ESOP generally provides for 20% vesting after three years of service with an additional 20% each year of service thereafter, until a participant is 100% vested. Annual contributions are at the discretion of the Board of Directors, subject to the ESOP provision that the Company is required to make contributions equal to principal and interest payments on debt issued by the ESOP to acquire securities. Contributions recorded in 1994, 1993 and 1992 were $357,000, $697,000 and $664,000, respectively.\nIn 1991, the ESOP purchased 461,008 shares of the Company's $.10 par value common stock from four of the Company's shareholders at market value in exchange for cash and notes. In 1993, the ESOP refinanced the remaining three notes with a new note payable in five annual installments of principal and interest fixed at 9.0%. The Company's financial statements at December 31, 1994 and 1993 reflect the ESOP's obligations as a liability and a corresponding reduction of shareholders' equity.\n11. SHAREHOLDERS' EQUITY:\nShareholder Rights Plan -\nIn August 1994, the Board of Directors adopted a shareholder rights plan and declared a dividend of one right for each outstanding share of the Company's common stock. Each right entitles the shareholder to purchase from the Company one share of the Company's common stock at a discounted price (which varies depending upon the circumstances, determined according to the plan). The rights are not and will not become exercisable unless certain change of control events occur. None of the rights are exercisable as of December 31, 1994.\nStock Compensation Plans -\nIn August 1988 the Company adopted the Big O Tires, Inc. Director and Employee Stock Option Plan (\"the Option Plan\") which allows the Company's directors and employees to forego a portion of their compensation in order to acquire options for the purchase of the Company's common stock in accordance with the provisions of the Option Plan. Options are granted to the participants on January 1 of each year, in an amount equal to the foregone compensation divided by 90% of the fair market value of the Company's $0.10 par value common stock. The remaining 10% of the fair market value then becomes the exercise price of the options. The options are exercisable one year after the grant date and expire ten years after grant.\nIn June 1991 the Company adopted the Big O Tires, Inc. Long Term Incentive Plan (\"the Incentive Plan\") which allows the Company to make long-term awards of stock options and restricted stock grants to selected officers and employees of the Company and to make long-term awards of stock options to selected directors of the Company. The stock options are generally not exercisable for at least three years following their award date and awards of restricted common stock are subject to vesting requirements.\nStock option transactions for the years ended December 31, 1994, 1993 and 1992 are as follows:\n12. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN:\nEffective January 1, 1994, the Company adopted a supplemental executive retirement plan (\"SERP\") which is maintained for the purpose of providing deferred compensation for a select group of highly compensated employees. The 1994 contribution to the SERP was $11,000 and was determined by multiplying the Board approved ESOP contribution rate by the ESOP qualified compensation exceeding $150,000. This plan is unfunded and the contribution was made only for 1994.\n13. COMMITMENTS AND CONTINGENCIES:\nDuring 1992, the Company entered into an agreement with a lender to provide equipment, inventory and real estate financing to various joint ventures in which the Company was a 50% joint venture partner. The agreement requires the Company and the other joint venture partners to guarantee repayment of the loans. In February 1994, this agreement was amended to provide a total of up to $9,750,000 of real estate financing and up to $2,000,000 for inventory and equipment financing.\nThe Company previously entered into two separate equipment leasing programs for its franchisees with two equipment leasing companies. The Company entered into agreements with these leasing companies which require the Company to pay up to $1,000,000 and $500,000 respectively, under certain franchisee contract defaults. These commitments are collateralized by the leased equipment. In addition, the Company entered into a similar leasing program with another equipment leasing company which does not require a financial guarantee, but does require the Company to assist in the re-marketing of the leased equipment, if necessary.\nIn December 1989 the Company also entered into an agreement with an independent franchise finance company to provide financing to its franchisees for inventories and equipment. This agreement requires the Company to guarantee payment of up to $750,000 under certain franchisee contract defaults. This commitment is collateralized by the inventories and equipment which have been financed and franchise rights.\nIn 1994, the company sold certain notes receivable which had a remaining principal balance of $2,962,000, plus accrued interest, to an investor. In connection with the sale of these notes, the Company executed an Ultimate Net Loss Agreement which limits the Company's guarantee for payment of these notes to fifty percent of the aggregate unpaid balance of the purchased notes at the end of each prior year. No gain or loss was recorded in connection with the sale of these notes, but the Company incurred transaction costs of $55,000.\nAt December 31, 1994 and 1993, the Company had no post-retirement or post- employment benefits which would require the recording of an accrued or contingent liability under the provisions of SFAS No. 106 and No. 112, respectively.\n14. FINANCIAL GUARANTEES AND CREDIT RISK:\nThe Company has provided financial guarantees associated with franchisee financing and real estate leases for its franchisees. The guarantees were issued in the normal course of business to meet the financing needs of the Company and its franchisees. However, these financial guarantees represent additional credit risk in excess of the amounts which are already reflected in the balance sheet as of December 31, 1994.\nThe Company's maximum exposure to credit loss in the event of nonperformance by the beneficiaries of the financial guarantees at December 31, 1994 is represented by the contractual amount of the guarantees as indicated below (in thousands):\nThe financing and lease guarantees are conditional commitments issued by the Company to guarantee the repayment of amounts which are owed to third parties by certain of its franchisees and joint ventures. Most of the financing and lease guarantees extend for more than five years and expire in decreasing amounts through 2002.\nThe credit risk associated with these guarantees is essentially the same as that involved in extending loans to the Company's franchisees or partners. The Company evaluates each franchisee's creditworthiness on an individual basis, and it is the Company's policy to require that sufficient collateral (primarily inventories and equipment) and security interests be obtained by the third parties in connection with the financing and lease obligations (except for real estate obligations) for which the guarantees are issued. There are no cash requirements associated with these guarantees except in the event that an actual financial loss is subsequently incurred by the Company in connection with these guarantees.\n15. SIGNIFICANT CONCENTRATIONS OF CREDIT RISK:\nAlthough the Company has franchised and Company-owned retail stores located in 18 states, approximately 38% of these stores are located in the State of California, and nearly 33% of the Company's sales were made to the California retail stores. In addition, all of the Company's operations and identifiable assets are attributable to the wholesale and retail marketing of tires and other automotive aftermarket products primarily to franchised, Company-owned (and Canadian licensed) retail stores. Accordingly, the Company's receivables and its guarantees of obligations are concentrated within a single industry segment and a significant portion of its credit risk is also concentrated within a single state.\nIn addition, the Company had receivables and financial guarantees totalling $4,179,000 at December 31, 1994 which were associated with five of its franchisees.\n16. AGREEMENTS WITH GENERAL TIRE, INC.:\nIn September 1989, the Company entered into a Master Loan Agreement and a Stock and Warrants Purchase Agreement with General Tire, Inc. (\"General\"), a related party through May 1993. Under the Master Loan Agreement, General provided the Company with a revolving line of credit of up to $7,500,000 which was collateralized by receivables, inventories and equipment. Under the Stock and Warrants Purchase Agreement, General acquired 400,000 shares of the Company's common stock (approximately 11.4% of the then outstanding shares), and acquired warrants to purchase an additional 1,000,000 shares.\nIn May 1993, the Company and General entered into an agreement which terminated the 1989 agreements, and which resulted in the Company's repurchase of the 400,000 shares of the Company's common stock which had been owned by General, the repurchase and cancellation of the warrants held by General for the purchase of an additional 1,000,000 shares, and the repayment of the outstanding balance of the revolving line of credit in the amount of $1,764,000.\n17. SHAREHOLDER LITIGATION:\nIn December 1994, the Company and its nine directors were named in two proposed stockholder class action lawsuits each similarly requesting the court to enjoin the sale of the Company to a Dealer-Management Group, enjoin the implementation of the recently adopted shareholder rights plan, obtain specified damages, require the disclosure of the Company's internal forecasts and award plaintiffs' their attorneys' fees and costs, including experts fees. The lawsuits also request that the court order the directors to carry out their fiduciary duties to the plaintiffs and the other members of the class by announcing their intention to cooperate and do all that is necessary to encourage the buyout or takeover of the Company by enhancing the Company's attractiveness as a merger\/acquisition candidate, effectively exposing the Company to the marketplace in an effort to create an active action of the Company, act independently and resolve all conflicts of interest in the best interests of the class. If the contemplated transaction with the Dealer-Management Group is consummated, the court is asked to rescind the transaction and, among other actions, award rescissionary damages. The Company moved to dismiss both lawsuits, which have been consolidated, as being frivolous and not in the interests of the stockholders as a class. Counsel for the plaintiffs have filed a motion to dismiss both lawsuits without prejudice. The Company has not received notice that these dismissals have occurred. The Company cannot predict the outcome or the effect, if any, on the Company's financial statements if such litigation continues.\nEXHIBIT INDEX","section_15":""}
{"filename":"357301_1994.txt","cik":"357301","year":"1994","section_1":"Item 1. Business\nGeneral\nTrustCo Bank Corp NY (\"TrustCo\") is a one-bank holding company having its principal place of business at 320 State Street, Schenectady, New York 12305. TrustCo was organized in 1981 to acquire all of the outstanding stock of Trustco Bank, National Association, formerly known as Trustco Bank New York, and prior to that The Schenectady Trust Company. Following the necessary regulatory approvals, TrustCo commenced business on July 1, 1982. Through policy and practice, TrustCo continues to emphasize that it is an equal opportunity employer. There were 435 full-time equivalent employees at year-end. TrustCo had 4,501 shareholders of record as of December 31, 1994, and the closing price of the stock at that date was $20.25.\nBank Subsidiary\nOn November 16, 1994 TrustCo initiated the process to convert its banking subsidiary, Trustco Bank New York, a New York state chartered trust company, to a national banking association operating under the name Trustco Bank, National Association (the Bank ). The conversion was undertaken to facilitate the Bank's regulatory processes and minimize duplicative federal\/state compliance issues. The conversion became effective on February 1, 1995. The Bank is a national bank engaged in a general commercial banking business serving individuals, partnerships, corporations, municipalities and governments of New York. The largest part of such business consists of accepting deposits and making loans and investments. The Bank provides a wide range of both personal and business banking services. The Bank is a member of the Federal Reserve system and its deposits are insured by the Federal Deposit Insurance Corporation to the extent permitted by law. The Bank accounted for substantially all of TrustCo's 1994 consolidated net income and average assets.\nThe trust department of the Bank acts as executor of estates and trustee of personal trusts, gives estate planning and related advice, provides custodial services and acts as trustee of various types of employee benefit plans and corporate pension and profit sharing trusts. The aggregate market value of the assets under trust, custody or management was approximately $634 million as of December 31, 1994.\nThe daily operations of the Bank remain the responsibility of its Board of Directors and officers, subject to the overall supervision of TrustCo. TrustCo, as the parent corporation, derives most of its income from dividends paid to it by its subsidiary Bank. TrustCo's Bank subsidiary is included in TrustCo's consolidated financial statements.\nORE Subsidiary\nDuring 1993, TrustCo created ORE Subsidiary Corp., a New York corporation, to hold and manage certain foreclosed properties. The accounts of this subsidiary are included in TrustCo's consolidated financial statements.\nCompetition\nThe Bank encounters keen competition from other commercial banks, including New York City-based holding companies which are some of the largest and most competitive institutions in the United States. In addition, savings banks, savings and loan associations, credit unions and other financial and related institutions compete for the banking, trust, investment and other financial services which the Bank offers. On a regular basis, TrustCo has discussions with other financial institutions relative to potential merger or acquisition opportunities.\nSupervision and Regulation\nBanking is a highly regulated industry, with numerous federal and state laws and regulations governing the organization and operation of banks and their affiliates. As a bank holding company under the Bank Holding Company Act of 1956, as amended (the \"Act\"), TrustCo is regulated and examined by the Board of Governors of the Federal Reserve System (the \"Board\"). The Act requires that TrustCo obtain prior Board approval for bank and non-bank acquisitions and restricts the business operations permitted to TrustCo. The Bank is subject to regulation and examination by the Office of the Comptroller of the Currency.\nVirtually all aspects of TrustCo's and the Bank's business are subject to regulation and examination by the Board, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency. Most of TrustCo's revenues consist of cash dividends paid to TrustCo by its subsidiary Bank, payment of which is subject to various regulatory limitations. (Note 1 of the consolidated financial statements contained in TrustCo's Annual Report to Shareholders for the year ended December 31, 1994, which appears on pages 30 and 31 thereof and contains information concerning restrictions of TrustCo's ability to pay dividends, is hereby incorporated by reference.) In addition, the Federal Deposit Insurance Corporation and the Board have established guidelines with respect to the maintenance of appropriate levels of capital by a bank holding company under their jurisdictions. Compliance with the standards set forth in such guidelines could also limit the amount of dividends which a bank or a bank holding company may pay. The banking industry is also affected by the monetary and fiscal policies of the federal government, including the Board, which exerts considerable influence over the cost and availability of funds obtained for lending and investing.\nProposals to change various laws and regulations governing the operation and taxation of banks, bank holding companies and financial institutions are frequently raised in Congress and before various federal and state regulatory authorities. Most recently, on September 29, 1994 the Interstate Banking and Branching Efficiency Act of 1994 was enacted which permits beginning one year from date of enactment, bank holding companies to acquire banks in any state (subject to state and nationwide deposit limitations) and for full interstate branching commencing June 1, 1997.\nForeign Operations\nNeither TrustCo nor the Bank engage in material operations in foreign countries or have any outstanding loans to foreign debtors.\nStatistical Information Analysis\nThe \"Management Discussion and Analysis\" on pages 5 through 23 of TrustCo's Annual Report to Shareholders for the year ended December 31, 1994, which contains a presentation and discussion of statistical data relating to TrustCo, are hereby incorporated by reference. The information with respect to such tables should not be construed to imply any conclusion on the part of the management of TrustCo that the results, causes or trends indicated therein will continue in the future. The nature and effects of governmental monetary policy, supervision and regulation, future legislation, inflation and other economic conditions and many other factors which affect interest rates, investments, loans, deposits and other aspects of TrustCo's operations are extremely complex and could make historical operations, earnings, assets and liabilities not indicative of what may occur in the future.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nTrustCo's executive offices are located at 320 State Street, Schenectady, New York, 12305. The Bank operates 45 offices, of which 20 are owned and 25 are leased from others. These properties, when considered in the aggregate, are not material to the operation of TrustCo.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe nature of TrustCo's business generates a certain amount of litigation against TrustCo and its subsidiaries involving matters arising in the ordinary course of business. In the opinion of management of TrustCo, there are no proceedings pending to which TrustCo or either of its subsidiaries is a party, or of which its property is the subject which, if determined adversely to TrustCo or such subsidiary, would be material in relation to TrustCo's consolidated stockholders' equity and financial condition.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone.\nExecutive Officers of TrustCo\nThe following is a list of the names and ages of the executive officers of TrustCo and their business history for the past five years:\nYear First Became Name, Age and Principal Occupations Executive Position Or Employment Since Officer of With TrustCo January 1, 1989 TrustCo\nRobert A. McCormick, 58, President and Chief Executive 1984 President and Chief Officer,TrustCo Bank Corp NY. Executive Officer President and Chief Executive Officer, Trustco Bank, National Association.\nRobert T. Cushing, 39, Vice President and Chief 1994 Vice President and Financial Officer, Chief Financial Offier TrustCo Bank Corp NY since 1994. Senior Vice President and Chief Financial Officer, Trustco Bank, National Association since 1994. Partner, KPMG Peat Marwick LLP (1978 - 1994).\nNancy A. McNamara, 45, Vice President, TrustCo Bank 1992 Vice President Corp NY since 1992. Senior Vice President, Trustco Bank, National Association since 1988. Director of TrustCo Bank Corp NY and Trustco Bank, National Association since December 1991. Joined Trustco Bank, National Association in 1971.\nWilliam F. Terry, 53, Secretary, TrustCo Bank Corp NY 1990 Secretary since 1990. Senior Vice President, Trustco Bank, National Association since 1987. Secretary, Trustco Bank, National Association since 1990.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe inside front cover of TrustCo's Annual Report to Shareholders for the year ended December 31, 1994, is incorporated herein by reference. The closing price for the Corporation's common stock on December 31, 1994, was $20.25.\nItem 6.","section_6":"Item 6. Selected Financial Data\nPage 19 of TrustCo'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\nPages 5 through 23 of TrustCo's Annual Report to Shareholders for the year ended December 31, 1994, are incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements, together with the report thereon of KPMG Peat Marwick LLP on pages 25 through 39 of TrustCo's Annual Report to Shareholders for the year ended December 31, 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. Director and Executive Officers of Registrant\nThe information under the captions \"Information on TrustCo Directors and Nominees\" and \"Information on TrustCo Executive Officers Not Listed Above\" on pages 3 through 5, and \"Compliance With Section 16(a) Of The Securities Exchange Act Of 1934 \" on page 22, of TrustCo's Proxy Statement for its Annual Meeting of Shareholders to be held May 15, 1995, is incorporated herein by reference. The required information regarding TrustCo's executive officers is contained in PART I in the item captioned \"Executive Officers of TrustCo.\"\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information under the captions \"TrustCo and Trustco Bank Executive Officer Compensation\" and \"TrustCo Retirement Plans\" on pages 6 through 11 of TrustCo's Proxy Statement for its Annual Meeting of Shareholders to be held May 15, 1995, is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information under the captions \"Information on TrustCo Directors and Nominees,\" \"Information on TrustCo Executive Officers Not Listed Above,\" on pages 3 through 5 and \"Ownership Of TrustCo Common Stock By Certain Beneficial Owners\" on page 22 of TrustCo's Proxy Statement for its Annual Meeting of Shareholders to be held May 15, 1995, is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information under the caption \"Transactions with TrustCo and Trustco Bank Directors, Officers and Associates\" on page 22 of TrustCo's Proxy Statement for its Annual Meeting of Shareholders to be held May 15, 1995, 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 of TrustCo and its consolidated subsidiaries, and the accountants' report thereon are incorporated herein by reference.\nConsolidated Financial Statements.\nConsolidated Statements of Condition--December 31, 1994 and 1993.\nConsolidated Statements of Income--Years Ended December 31, 1994, 1993 and 1992.\nConsolidated Statements of Changes in 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.\nFinancial Statement Schedules--Not Applicable.\nAll required schedules for TrustCo and its subsidiaries have been included in the consolidated financial statements or related notes thereto\nThe following exhibits are filed herewith:*\nReg S-K Exhibit No. Description =================== =========== 3(i) Amended and Restated Certificate of Incorporation of TrustCo.\n3(ii) Amended and Restated Bylaws of TrustCo.\n10(a) Employment Agreement dated January 1, 1992 and Amendment No. 1 dated November 16, 1993, among TrustCo, the Bank and Robert A. McCormick.\n10(b) Amendment No. 2 dated September 1, 1994, and Amendment No. 3 dated February 13, 1995, among TrustCo, the Bank and Robert A. McCormick.\n10(c) Employment Agreement dated June 21, 1994, and Amendment No. 1 dated February 14, 1995, among TrustCo, the Bank and Robert T. Cushing.\n10(d) Restated Employment Agreement dated June 21, 1994, and Amendment No. 1 dated February 14, 1995, among TrustCo, the Bank and Nancy A. McNamara.\n10(e) Restated Employment Agreement dated June 21, 1994, and Amendment No. 1 dated February 14, 1995, among TrustCo, the Bank and William F. Terry.\n10(f) Restated Employment Agreement dated June 21, 1994, and Amendment No. 1 dated February 14, 1995, among TrustCo, the Bank and Ralph A. Pidgeon.\n10(g) Restated Employment Agreement dated July 15, 1992, Amendment No. 1 dated November16, 1993, and Amendment No. 2 dated February 14, 1995, among TrustCo, the Bank and Peter A. Zakriski.\n10(h) TrustCo Bank Corp NY Amended and Restated 1985 Stock Option Plan.\n10(i) TrustCo Bank Corp NY Directors Stock Option Plan.\n________________ *The exhibits included under Exhibit 10 constitute all management contracts, compensatory plans and arrangements required to be filed as an exhibit to this form pursuant to Item 14(c) of this report.\nThe following exhibits are filed herewith: (continued)\nReg S-K Exhibit No. Description =============== =============== 11 Computation of Net Income Per Common Share.\n13 Annual Report to Security Holders of TrustCo for the year ended December 31, 1994.\n21 List of Subsidiaries of TrustCo.\n23 Independent Auditors' Consent of KPMG Peat Marwick LLP.\n24 Power of Attorney.\n27 Financial Data Schedules.\n99 Independent Auditors' Report of KPMG Peat Marwick LLP.\nReports on Form 8-K:\nOn January 26, 1995, TrustCo filed a Current Report on Form 8-K reporting the fourth quarter and year-end December 31, 1994, results.\nOn February 21, 1995, TrustCo filed a Current Report on Form 8-K reporting the declaration of a cash dividend.\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the TrustCo Bank Corp NY(the \"Corporation\") pursuant to the foregoing provisions, or otherwise, the Corporation 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 Corporation of expenses incurred or paid by a director, officer or controlling person of the Corporation 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 Corporation 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 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.\nTrustCo Bank Corp NY\nBy\/s\/Robert A. McCormick ------------------------- Robert A. McCormick President and Chief Executive Officer (Principal Executive Officer)\nBy\/s\/Robert T. Cushing ------------------------- Robert T. Cushing Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\nDate: March 21, 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.\nSignature Title Date\n* Director March 21, 1995 Barton A. Andreoli\n* Director March 21, 1995 Lionel O. Barthold\n* Director March 21, 1995 M. Norman Brickman\n* Director March 21, 1995 Charles W. Carl, Jr.\n* Director March 21, 1995 Robert A. McCormick\n* Director March 21, 1995 Nancy A. McNamara\n* Director March 21, 1995 Dr. John S. Morris\n* Director March 21, 1995 Dr. James H. Murphy\n* Director March 21, 1995 Richard J. Murray, Jr.\n* Director March 21, 1995 Kenneth C. Petersen\n* Director March 21, 1995 William J. Purdy\n\/s\/William F. Terry Director March 21, 1995 - ------------------ William F. Terry\n* Director March 21, 1995 Philip J. Thompson\nBy\/s\/William F. Terry *William F. Terry, as Agent Pursuant to Power of Attorney\nEXHIBIT INDEX\nReg S-K Item 601 Exhibit No. Exhibit _________________________________________________________________ 3(i) Amended and Restated Certificate of Incorporation of TrustCo filed as Exhibit 3(i) to TrustCo Bank Corp NY's Annual Report on Form 10-K (File No. 000-10592) filed on March 30, 1994, incorporated herein by reference.\n3(ii) Amended and Restated Bylaws of TrustCo, with amendments through February 21, 1995.\n10(a) Employment Agreement dated January 1, 1992 and Amendment No. 1 dated November 16, 1993, among TrustCo, the Bank and Robert A. McCormick, filed as Exhibit 10(a) to TrustCo Bank Corp NY s Annual Report on Form 10-K (file No. 000-10592) filed on March 30, 1994, incorporated herein by reference.\n10(b) Amendment No. 2 dated September 1, 1994, and Amendment No. 3 dated February 13, 1995, to the Employment Agreement dated November 16, 1993 among TrustCo, the Bank and Robert A. McCormick.\n10(c) Employment Agreement dated June 21, 1994, and Amendment No. 1 dated February 14, 1995, among TrustCo, the Bank and Robert T. Cushing.\n10(d) Restated Employment Agreement dated June 21, 1994, and Amendment No. 1 dated February 14, 1995, among TrustCo, the Bank and Nancy A. McNamara.\n10(e) Restated Employment Agreement dated June 21, 1994, and Amendment No. 1 dated February 14, 1995, among TrustCo, the Bank and William F. Terry.\n10(f) Restated Employment Agreement dated June 21, 1994, and Amendment No. 1 dated February 14, 1995, among TrustCo, the Bank and Ralph A. Pidgeon.\n10(g) Restated Employment Agreement dated July 15, 1992, Amendment No. 1 dated November 16, 1993, and Amendment No. 2 dated February 14, 1995, among TrustCo, the Bank and Peter A. Zakriski.\n10(h) Restated 1985 TrustCo Bank Corp NY Stock Option Plan as amended and restated effective July 1, 1994.\n10(i) TrustCo Bank Corp NY Directors Stock Option Plan filed as Exhibit 10(g) to TrustCo Bank Corp NY's Annual Report on Form 10-K (File No. 000-10592) filed on March 30, 1994, incorporated herein by reference.\n11 Computation of Net Income Per Common Share.\n13 Annual Report to Security Holders of TrustCo for the year ended December 31, 1994.\nGRAPHICS APPENDIX\nCross References to Page of Omitted Charts Annual Report _________________________________________________________________\n1 Net Interest Margin............... 5\n2 Non-Performing Assets............. 14\n3 Efficiency Ratio.................. 18\n4 Dividends Per Share............... 21\n21 List of Subsidiaries of TrustCo.\n23 Independent Auditors' Consent of KPMG Peat Marwick LLP.\n24 Power of Attorney.\n27 Financial Data Schedules.\n99 Independent Auditors' Report of KPMG Peat Marwick LLP.\nExhibit 3(ii)\nBY-LAWS OF TRUSTCO BANK CORP NY\n(a New York State Corporation) (As Amended Through February 21, 1995) _____________________________________________________\nARTICLE 1\nDEFINITIONS\nAs used in these By-Laws, unless the context otherwise requires, the term:\n1.1 \"Board\" means the Board of Directors of the Corporation\n1.2 \"Business Corporation Law\" means the Business Corporation Law of the State of New York, as amended from time to time.\n1.3 \"By-Laws\" means the initial By-Laws of the Corporation, as amended from time to time.\n1.4 \"Certificate of Incorporation\" means the initial certificate of incorporation of the Corporation, as amended, supplemented or restated from time to time.\n1.5. \"Corporation\" means TrustCo Bank Corp NY.\n1.6 \"Directors\" means directors of the Corporation.\n1.7 \"Entire Board\" means the total number of directors which the Corporation would have if there were no vacancies.\n1.8 \"Chief Executive Officer\" means the Chief Executive Officer of the corporation.\n1.9 \"Chairman\" means chairman of the Board of the Corporation.\n1.10 \"President\" means the President of the Corporation.\n1.11 \"Secretary\" means the Secretary of the Corporation.\n1.12 \"Vice President\" means the Vice President of the Corporation. ARTICLE 2\nSHAREHOLDERS\n2.1 PLACE OF MEETINGS. Every meeting of shareholders shall be held at such place within or without the State of New York as shall be designated by the Board of Directors in the notice of such meeting or in the waiver of notice thereof.\n2.2 ANNUAL MEETING. A meeting of shareholders shall be held annually for the election of Directors and the transaction of other business at such hour and on such business day as may be determined by the Board. Written notice of such meeting, stating the place, date and hour thereof, shall be given, personally or by mail, not less than ten nor more than fifty days before the date of such meeting, to each shareholder certified to vote at such meeting.\n2.3 SPECIAL MEETINGS. A special meeting of shareholders, other than those regulated by statute, may be called at any time by the Board or by the Chief Executive Officer. It shall also be the duty of the Chief Executive Officer to call such a meeting whenever requested in writing so to do by shareholders owning two thirds of the issued and outstanding share entitled to vote at such a meeting. Written notice of such meeting, stating the place, date, hour and purpose thereof, and indicating that it is being given by the person or persons calling such meeting, shall be given, personally or by mail, not less than ten nor more than fifty days before the date of such meeting, to each shareholder certified to vote at such meeting.\n2.4 QUORUM AND VOTING REQUIREMENTS; ADJOURNMENT. Except with respect to a special meeting for the election of Directors as required by law, or as otherwise provided in these By- Laws, (a) the holders of at least a majority of the outstanding shares of the Corporation shall be present in person or by proxy at any meeting of the shareholders in order to constitute a quorum for the transaction of any business, and (b) the votes of the holders of at least a majority of the outstanding shares of the Corporation shall be necessary at any meeting of shareholders for the transaction of any business or specified item of business, other than the changing, amending or repealing of any provision of the Certificate of Incorporation or By- Laws which shall require the affirmative vote of two-thirds of the Corporation's voting stock; provided, however, that when a specified item of business is required to be voted on by a class or series (if the Corporation shall then have outstanding shares or more than one class or series), voting as a class, the holders of a majority of the shares of such class or series shall constitute a quorum (as to such class or series) for the transaction of such item of business. The holders of a majority of shares present in person or represented by proxy at any meeting of shareholders, including an adjourned meeting, whether or not a quorum is present, may adjourn such meeting to another time and place.\n2.5 INSPECTORS AT MEETINGS. Two or more inspectors shall be appointed by the Board or the Executive Committee prior to each Annual Meeting of Shareholders, to serve at the meeting or any adjournment thereof. In case any person appointed fails 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.\n2.6 ORGANIZATION. At every meeting of shareholders, the Chief Executive Officer, or in his absence, an officer of the Corporation designated by the Board or the Chief Executive Officer, shall act as Chairman of the meeting. The Secretary, or in his absence, one of the Vice Presidents not acting as Chairman of the meeting, shall act as Secretary of the meeting. In case none of the officers above designated to act as Chairman or Secretary of the meeting, respectively, shall be present, a Chairman or a Secretary of the meeting, as the case may be, shall be chosen by a majority of the votes cast at such meeting by the holders of shares present in person, or represented by proxy and entitled to vote at the meeting.\n2.7 ORDER OF BUSINESS. The order of business at all meetings of shareholders shall be as determined by the Chairman of the meeting, but the order of business to be followed at any meeting at which a quorum is present may be changed by a majority of the votes cast at such meeting by the holders of shares present in person or represented by proxy and entitled to vote at the meeting.\nARTICLE 3\nDIRECTORS\n3.1 BOARD OF DIRECTORS. Except as otherwise provided in the Certificate of Incorporation, the affairs of the Corporation shall be managed and its corporate powers exercised by its Board. In addition to the powers expressly conferred by the By-Laws, the Board may exercise all powers and perform all acts which are not required, by the By-Laws or the Certificate of Incorporation or by law, to be exercised and performed by the shareholders.\n3.2 NUMBER; QUALIFICATION; TERM OF OFFICE. Subject to Section 702(b) of the Business Corporation Law, the number of Directors constituting the Entire Board may be changed from time to time by action of the shareholders or the Board, provided that such number shall not be less than twelve nor more than fifteen. The Directors shall be divided into three classes as nearly equal in number as may be, one class to be elected each year for a term of three years and until their successors are elected and qualified. A Director attaining 72 years of age shall cease to be a Director and that office shall be vacant. A director who was an employee of the Corporation at the time of his election, shall vacate his office when he ceases to be a full-time employee of the Company and shall not be eligible for reelection. 3.3 ELECTION. Directors shall be elected by the affirmative vote of the holders of a majority of the Company's outstanding voting stock.\n3.4 NEWLY CREATED DIRECTORSHIP AND VACANCIES. Newly created directorships resulting from an increase in the number of Directors and vacancies occurring in the Board for any reason, may be filled by vote of a majority of the Directors then in office, although less than a quorum, at any meeting of the Board. Directors elected by the Board shall hold office until the next meeting of shareholders at which the election of directors is in the regular order of business, and until their successors have been elected and qualified.\n3.5 RULES AND REGULATIONS. The Board of Directors may adopt such Rules and Regulations for the conduct of its meetings and the management of the affairs of the Company as it may deem proper, not inconsistent with the laws of the State of New York, or these By-Laws.\n3.6 REGULAR MEETINGS. Regular meetings of the Board shall be held on the third Tuesday of February, May, August and November, unless otherwise specified by the Board, and may be held at such times and places as may be fixed from time to time by the Board, and may be held without notice.\n3.7 SPECIAL MEETINGS. Special meetings of the Board shall be held whenever called by the Chief Executive Officer, and a special meeting shall be called by the Chief Executive Officer or the Secretary at the written request of any seven Directors. Notice of the time and place of each special meeting of the Board shall, if mailed, be addressed to each Director at the address designated by him for that purpose or, if none is designated, at his last known address at least three days before the date on which the meeting is to be held; or such notice shall be sent to each Director at such address by telegraph, or similar means of communication, or be delivered to him personally, not later than the day before the date on which such meeting is to be held.\n3.8 WAIVERS OF NOTICE. Anything in these By-Laws or in any resolution adopted by the Board to the contrary notwithstanding, notice of any meeting of the Board need not be given to any Director who submits a signed waiver of such notice, whether before or after such meeting, or who attends such meeting without protesting, prior thereto or at its commencement, the lack of notice to him.\n3.9 ORGANIZATION. At each meeting of the Board, the Chief Executive Officer of the Corporation, or in the absence of the Chief Executive Officer, a Chairman chosen by the majority of the Directors present, shall preside. The Secretary, or in the absence of the Secretary, a Vice President, shall act as Secretary at each meeting of the Board.\n3.10 QUORUM AND VOTING. A majority of the Entire Board shall constitute a quorum for the transaction of business or of any specified item of business at any meeting of the Board. The affirmative vote of a majority of the Entire Board shall be necessary for the transaction of any business or specified item of business at any meeting of the Board, except that the affirmative vote of two-thirds of the Entire Board shall be necessary to change, amend or repeal any provision of the Certificate of Incorporation or By-Laws.\n3.11 WRITTEN CONSENT OF DIRECTORS WITHOUT A MEETING. Any action required or permitted to be taken by the Board may be taken without a meeting if all members of the Board consent in writing to the adoption of a resolution authorizing the action. The resolution and the written consents thereto by the members of the Board shall be filed with the minutes of the proceedings of the Board.\n3.12 PARTICIPATION IN MEETING OF BOARD BY MEANS OF CONFERENCE TELEPHONE OR SIMILAR COMMUNICATIONS EQUIPMENT. Any one or more members of the Board may participate in a meeting of the Board by means of a conference telephone or similar communications equipment allowing all persons participating in the meeting to hear each other at the same time. Participation by such means shall constitute presence in person at a meeting.\nARTICLE 4 COMMITTEES\n4.1 EXECUTIVE COMMITTEE. There shall be an Executive Committee consisting of not more than nine Directors, of which four shall constitute a quorum. All but six of the members of such Executive Committee shall be appointed by the Board of Directors, shall be known as permanent members and shall hold office until the organization of the Board after the annual election next succeeding their respective appointments. Six places on the Executive Committee shall be filled by the Directors, other than the permanent members of the Executive Committee, in rotation according to alphabetical order, each panel of six rotating members serving for one calendar month. In the event that any member of the Executive Committee is unable to attend a meeting, the Chief Executive Officer may invite any other Director to take his place for such meeting. The Executive Committee shall possess and exercise all of the delegable powers of the Board, except when the latter is in session. It shall keep a record of its proceedings, and the same shall be subject to examination by the Board at any time. All acts done and powers and authority conferred by the Executive Committee from time to time, within the scope of its authority, shall be and be deemed to be and may be certified as being the act and under the authority of the Board. Meetings of the Executive Committee shall be held at such times and places and upon such, if any, notice as the Executive Committee shall determine from time to time, provided that a special meeting of the Executive Committee may be called by the Chief Executive Officer, in his discretion, and shall be called by the Chief Executive Officer or Secretary on the written request of any three members, three days' notice of the time and place of which shall be given in the same manner as notices of special meetings of the Board of Directors, except that if such notice is given otherwise than by mail, it shall be sufficient if given at any time on or before the day preceding the meeting.\n4.2 OTHER COMMITTEES. The Board, by resolution adopted by a majority of the Entire Board, may designate from among its members such other standing or special committees as may seem necessary or desirable from time to time.\nARTICLE 5 OFFICERS\n5.1 OFFICERS. The Board may elect or appoint a Chairman and shall elect or appoint a President, either of which it shall designate the Chief Executive Officer and shall elect or appoint one or more Vice Presidents and a Secretary, and such other officers as it may from time to time determine. All officers shall hold their offices, respectively, at the pleasure of the Board. The Board may require any and all officers, clerks and employees to give a bond or other security for the faithful performance of their duties, in such amount and with such sureties as the Board may determine.\n5.2 CHIEF EXECUTIVE OFFICER. The Chief Executive Officer of the Corporation shall have general supervision over the business of the Corporation, subject, however, to the control of the Board and of any duly authorized committee of Directors. The Chief Executive Officer shall, if present, preside at all meetings of the shareholders, at all meetings of the Board and shall supervise the carrying out of policies adopted or approved by the Board. He may, with the Secretary or any other officer of the Corporation, sign certificates for shares of the Corporation. He may sign and execute, in the name of the Corporation, deeds, mortgages, bonds, contracts and other instruments, subject to any restrictions imposed by the By-Laws, Board or applicable laws, and, in general, he shall perform all duties incident to the office of the Chief Executive Officer and such other duties as from time to time may be assigned to him by the Board.\n5.3 CHAIRMAN AND PRESIDENT. Either the Chairman or the President shall be designated the Chief Executive Officer of the Corporation. The one not so designated shall perform such duties as from time to time may be assigned to him by the Board or by the Chief Executive Officer.\n5.4 OTHER OFFICERS. All the other officers of the Corporation shall perform all duties incident to their respective offices, subject to the supervision and direction of the Board, the Chief Executive Officer, and the Executive Committee, and shall perform such other duties as may from time to time be assigned them by the Board or by the Chief Executive Officer. The President and any Vice President may also, with the Secretary, sign and execute, in the name of the Corporation, deeds, mortgages, bonds, contracts and other instruments, subject to any restrictions imposed by the By-Laws, Board or applicable laws.\nARTICLE 6 CONTRACTS, LOANS, ETC\n6.1 EXECUTION OF CONTRACTS. The Board may authorize any officer, employee or agent, in the name and on behalf of the Corporation, to enter into any contract or execute and satisfy any instrument, and any such authority may be general or confined to specific instances, or otherwise limited.\n6.2 LOANS. The Chief Executive Officer or any other officer, employee or agent authorized by the Board may effect loans and advances at any time for the Corporation from any bank, trust company or other institution or from any firm, corporation or individual, and for such loans and advances may make, execute and deliver promissory notes, bonds or other certificates or evidences of indebtedness of the Corporation, and when authorized so to do may pledge and hypothecate or transfer any securities or other property of the Corporation as security for any such loans or advances.\n6.3 SIGNATURE AUTHORITY. The Chief Executive Officer shall from time to time authorize the appropriate officers and employees of the Corporation who are to sign, execute, acknowledge, verify and deliver or accept all agreements, conveyances, transfers, obligations, authentications, certificates and other documents and instruments and to affix the seal of the Corporation to any such document or instrument and to cause the same to be attested by the Secretary or Assistant Secretary.\nARTICLE 7 SHARES\n7.1 STOCK CERTIFICATES. Certificates representing shares of the Corporation, in such form as shall be determined from time to time by the Board, shall be signed by the Chief Executive Officer, the Chairman, the President, or any Vice President and the Secretary, and may be sealed with the seal of the Corporation or a facsimile thereof.\n7.2 TRANSFER OF SHARES. Transfers of shares shall be made only on the book of the Corporation by the holder thereof or by his duly authorized attorney or a transfer agent of the Corporation, and on surrender of the certificate or certificates representing such shares properly endorsed for transfer and upon payment of all necessary transfer taxes. Every certificate exchanged, returned or surrendered to the Corporation shall be marked \"Canceled\", with the date of cancellation, by the Secretary or the transfer agent of the Corporation. A person in whose name shares shall stand on the books of the Corporation in whose name shares shall stand on the books of the Corporation shall be deemed the owner thereof to receive dividends, to vote as such owner and for all other purposes as respects the Corporation. No transfer of shares shall be valid as against the Corporation, its shareholders and creditors for any purpose, except to render the transferee liable for the debts of the Corporation to the extent provided by law, until such transfer shall have been entered on the books of the Corporation by an entry showing from and to whom transferred.\n7.3 CLOSING OF TRANSFER BOOKS. The Board may prescribe a period prior to any shareholders' meeting or prior to the payment of any dividend, not exceeding fifty days, during which no transfer of stock on the books of the Corporation may be made and may fix a day as provided by the Business Corporation Law as of which shareholders entitled to notice and to vote at such meeting shall be determined.\n7.4 TRANSFER AND REGISTRY AGENTS. The Corporation may from time to time maintain one or more transfer offices or agents and registry officer or agents at such place or places as may be determined from time to time by the Board.\n7.5 LOST, DESTROYED, STOLEN AND MUTILATED CERTIFICATES. If the holder of any shares shall notify the Corporation of any loss, destruction, theft or mutilation of the certificate or certificates representing such shares, the Corporation may issue a new certificate or certificates to replace the old, upon such conditions as may be specified by the Board consistent with applicable laws.\nARTICLE 8 EMERGENCIES\n8.1 OPERATION DURING EMERGENCY. In the event of a state of emergency declared by the President of the United States or the person performing his functions or by the Governor of the State of New York or by the person performing his functions, the officers and employees of the Corporation shall continue to conduct the affairs of the Corporation under such guidance from the Directors as may be available except as to matters which by statute require specific approval of the Board of Directors and subject to conformance with any governmental directives during the emergency.\n8.2 OFFICERS PRO TEMPORE DURING EMERGENCY. The Board of Directors shall have power, in the absence or disability of any officer, or upon the refusal of any officer to act, to delegate and prescribe such officer's powers and duties to any other officer for the time being.\n8.3 DISASTER. In the event of a state of emergency resulting from disaster of sufficient severity to prevent the conduct and management of the affairs and business of the Corporation by the Directors and officers as contemplated by these By-Laws, any two or more available members of the Executive Committee shall constitute a quorum of that committee for the full conduct and management of the affairs and business of the Corporation, notwithstanding any other provision of these By-Laws, and such committee shall further be empowered to exercise all powers reserved to any and all other committees of the Board established pursuant to Article 4 of these By-Laws. In the event of the unavailability, at such time, of at least two members of the Executive Committee, any three available Directors may constitute themselves the Executive Committee pro tem for the full conduct and management of the affairs and business of the Corporation in accordance with the provisions of this Article, until such time as the incumbent Board or a reconstituted Board is capable of assuming full conduct and management of such affairs and business.\nARTICLE 9 SEAL\n9.1 SEAL. The Board may adopt a corporate seal which shall be in the form of a circle and shall bear the full name of the Corporation and the year and State of its incorporation.\nARTICLE 10 FISCAL YEAR\n10.1 FISCAL YEAR. The fiscal year of the Corporation shall be determined, and may be changed, by resolution of the Board.\nARTICLE 11 VOTING OF SHARES HELD\n11.1 VOTING OF SHARE HELD BY THE CORPORATION. Unless otherwise provided by resolution of the Board and excepting the shares of any subsidiary company of the Corporation which are to be voted in accordance with the resolution of the Board, the Chief Executive Officer may from time to time appoint one or more attorneys or agents of the Corporation, in the name and on behalf of the Corporation, to cast the votes which the Corporation may be entitled to cast as a shareholder or otherwise in any other corporation, any of whose shares or securities may be held by the Corporation, at meetings of the holders of the shares or other securities of such other corporation and to consent in writing to any action by any such other corporation, and may instruct the person or persons so appointed as to the manner of casting such votes or giving such consent, and may execute or cause to be executed on behalf of the Corporation and under its corporate seal, or otherwise, such written proxies, consents, waivers or other instruments as he may deem necessary or proper in the premises; or the Chief Executive Officer may himself attend any meeting of the holders of the shares or other securities of any such other corporation and thereat vote or exercise any or all other powers of the Corporation as the holder of such shares or other securities of such other corporation.\nARTICLE 12 AMENDMENTS TO BY-LAWS\n12.1 AMENDMENTS. The By-Laws or any of them may be altered, amended, supplemented or repealed, or new By-Laws may be adopted by a vote of the holders of at least two-thirds of the shares entitled to vote at any regular or special meeting of shareholders, or by a vote of at least two- thirds of the Entire Board of Directors at any regular or special meeting thereof, provided notice of such proposed changes has been set forth in the notice of meeting of shareholders or Directors.\nARTICLE 13 INDEMNIFICATION OF DIRECTORS AND OFFICERS\n13.1 In addition to authorization provided by law, the Directors are authorized, by resolution, to provide indemnification or to advance expenses to any Officer or Director seeking such indemnifica- tion or the advancement of such expenses. They may also, by resolution, authorize agreements providing for indemnification.\n13.2 The indemnification and advancement authorized by this Article shall be subject to each of the conditions or limitations set forth in the succeeding subdivisions(s) of this Section.\n13.2.1 No indemnification may be made to or on behalf of any Director or Officer if a judgment or other final adjudication adverse to the Officer or Director establishes that his acts were committed in bad faith or were the result of an act of deliberate dishonesty and 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 entitled.\n13.3 Officers and Directors of any wholly owned subsidiary serve at the request of the Corporation for the purpose of this Article.\n13.4 The Directors may by resolution, authorize the Corporation's Officers and Directors to serve as a Director or Officer of any other corporation of any type or kind, domestic or foreign, of any partnership, joint venture, trust, employee benefit plan or other enterprise for the purpose of the indemnification provisions of this Article. The failure to enact such a resolution shall not, in itself, create a presumption that such service was not authorized.\nI, William F. Terry, Secretary of TrustCo Bank Corp NY, Schenectady, New York, hereby certify that the foregoing is a complete, true and correct copy of the By-Laws of TrustCo Bank Corp NY, and that the same are in full force and effect at this date.\n\/s\/William F. Terry _____________________________________ Secretary\nMarch 23, 1995 _____________________________________ Date\nExhibit 10(a) Employment Agreement between TRUSTCO BANK NEW YORK and TRUSTCO BANK CORP NY and ROBERT A. McCORMICK\nEmployment Agreement\nAGREEMENT, dated as of January 1, 1992, (the Agreement ), by and between TRUSTCO BANK NEW YORK, a New York banking corporation (the Bank ) and TRUSTCO BANK CORP NY, a New York business corporation (the company ) (hereinafter referred to collectively as the Companies ), with principal offices at 320 State Street, Schenectady, New York 12301, and ROBERT A. McCORMICK (the Executive ), residing at 16 Greenlea Drive, Clifton Park, New York 12065. 1 . Engagement. The Companies agree to engage the Executive and the Executive agrees to serve the Companies as President and Chief Executive Officer. 2 . Term. The term of this Agreement shall commence on January 1, 1992 and shall continue until December 31, 1994. Beginning on January 1, 1995, and on January 1 of each and every year thereafter, this Agreement shall renew, automatically, for the succeeding three year term, unless the Executive is notified by the method described in Paragraph 10 herein to the contrary ( Nonrenewal Notice ). Nothing contained herein, however, shall be construed to extend the Executive s right to employment beyond the age of 65 years or the then mandatory retirement age in effect at the Companies, whichever shall be greater. 3 . Services. The Executive shall exert his best efforts and devote substantially all of his time and attention to the affairs of the Companies. The Executive shall be the President and Chief executive Officer of the Companies, and shall have full authority and responsibility for the operation of the Companies, subject to the general direction, approval, and control of the Boards of Directors of the Companies, for formulating policies and administering the Companies in all respects. His powers shall include the authority to hire and fire personnel of the Companies, including employees who are also members of the Boards of Directors, and to retain consultants when he deems necessary in order to implement the Companies policies. 4 . Compensation. For purposes of this Agreement, Annual Compensation shall be deemed to include Executive s Annual Base Salary plus executive incentive. During the first twelve months of employment pursuant to this Agreement, the Executive shall be paid by the Companies the Annual Base Salary provided on Schedule A attached hereto, which Annual Base Salary shall be paid biweekly, plus executive incentive. Thereafter, Annual Compensation shall be negotiated between the parties hereto and shall be deemed a part of this Agreement, provided, however, that Annual Compensation shall not be less than Executive s Annual Compensation for the immediately preceding calendar year. 5 . Retirement, Pension and Profit Sharing. As further compensation for the services of the Executive, the Executive shall be allowed to participate fully in any disability, death benefit, retirement, pension or profit sharing plans maintained by the Companies, pursuant to the terms of such plans. 6 . Termination of Employment. In the event there is a Termination (as hereinafter defined) of the Executive for any reason other than for good cause (as hereinafter defined), death, retirement or disability, the Executive shall receive, upon his Termination of employment with either of the Companies, the Termination Benefits set forth hereinbelow. The Executive s Termination for good cause shall be limited to the Executive s having committed an act of fraud, embezzlement, or theft constituting a felony, or an act intentionally against either of the Companies which causes either Company material injury, or a final determination by a court that the Executive has committed a material breach of his duties and responsibilities in connection with rendering services to either of the Companies pursuant to this Agreement. 7 . Termination. Termination shall include, but is not limited to, (i) any reduction in the Executive s Annual Compensation, disability, death, retirement, pension or profit sharing benefits (unless such reduction shall have been applied to all Bank employees as part of a validly adopted plan of cost containment), responsibilities or duties, or (ii) either Company s relocation or a change in the Executive s base location, or (iii) a Nonrenewal Notice given pursuant to Paragraph 2 of this Agreement, or (iv) the unilateral election of the Executive to terminate the Agreement. Such election shall be communicated to the Companies by the method described in Paragraph 10 hereof. 8 . Termination Benefits. The following benefits shall be Termination Benefits: (a ) The Companies shall pay to the Executive the Executive s full Annual Compensation through the effective date of his Termination at the rate in effect at the time notice of termination is given or at the time of Termination, if earlier, and in addition (b ) The Companies shall pay to the Executive, at Executive s option, either: (i) within ten (10) days of his Termination an additional lump sum amount equal to three (3) times the Annual Compensation then in effect pursuant to paragraph 4 above, which sum shall be reduced to present value as determined by a certified public accountant to be agreed upon between the parties, or (ii) three equal payments each in an amount equal to the Executive s Annual Compensation then in effect, the first such payment to be made within ten (10) days of the Termination and each subsequent payment to be made annually on the anniversary date of the initial payment and in addition (c ) The Companies shall pay to the Executive all benefits payable to the Executive under the Companies retirement, pension and profit sharing plans, and in addition (d ) The Companies shall pay the Executive all legal fees and expenses incurred by the Executive as a result of such Termination, and in addition (e ) The Companies shall provide the Executive, for the greater of one year or the remaining term of this Agreement following his Termination, health insurance and group life insurance benefits substantially similar to those the Executive was receiving immediately prior to his Termination. 9 . Indemnity. The Companies shall indemnify the Executive and hold him harmless for any acts or decisions made by him in good faith while performing services for either of the Companies and shall use their best efforts to obtain coverage for him under any insurance policy now in force or hereinafter obtained during the term of this Agreement covering the other officers and directors of the Companies against lawsuits. The Companies will pay all expenses, including attorneys fees, actually and necessarily incurred by the Executive in connection with the defense of such act, suit or proceeding and in connection with any appeal thereon including the cost of court settlements. 10 . Notices. All notices, requests, demands and other communications provided for by this Agreement shall be in writing and shall be deemed to have been given at the time when mailed at any general or branch United States Post Office enclosed in a certified post paid envelope and addressed to the address of the respective party stated below or to such changed address as such party may have fixed by notice: To the Companies: TrustCo Bank Corp NY Trustco Bank New York 320 State Street Schenectady, NY 12301\nTo the Executive: Robert A. McCormick 16 Greenlea Drive Clifton Park, NY 12065\nprovided, however, that any notice of change of address shall be effective only upon receipt. 11 . Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Companies, their successors and assigns, including, without limitation, any person or entity which may acquire all or substantially all of either Company s assets or business or into which either Company may be consolidated or merged, and the Executive, his heirs, executors, administrators and legal representatives. The Executive may assign his right to payment under this Agreement, but not his obligations under this Agreement. 12 . Governing Law. This Agreement shall be governed by the laws of the State of New York. 13 . Modification. This Agreement supersedes all prior understandings and agreements between the parties, and may not be amended or modified orally, but only by a writing signed by the parties hereto.\nTRUSTCO BANK CORP NY BY\/s\/M. Norman Brickman\nTRUSTCO BANK NEW YORK BY\/s\/M. Norman Brickman\n\/s\/Robert A. McCormick Robert A. McCormick\nC011091BC1\nSchedule A to Agreement among Companies and Robert A. McCormick\nCalendar Year Annual Salary Approval of Companies 1992 $550,000 1993 $650,000 \/s\/William F. Terry 1994 $700,000 \/s\/William F. Terry 1995 $720,000 \/s\/William F. Terry\nTRUSTCO BANK CORP NY BY\/s\/M. Norman Brickman\nTRUSTCO BANK NEW YORK BY\/s\/M. Norman Brickman\nAGREEMENT OF EXECUTIVE BY\/S\/Robert A. McCormick Robert A. McCormick\nAMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT BETWEEN TRUSTCO BANK NEW YORK AND TRUSTCO BANK CORP NY AND ROBERT A. MCCORMICK\nWHEREAS, Trustco Bank New York and TrustCo Bank Corp NY (herein referred to as the Companies ) entered into an Employment Agreement dated as of January 1, 1992, (herein referred to as the Agreement ); with Robert A. McCormick (herein referred to as the Executive ); and\nWHEREAS, the Companies and the Executive desire to amend the Agreement, effective as of November 16, 1993;\nNOW, THEREFORE, the Agreement is hereby amended effective June 21, 1993, in the following respect:\nSection 5 of the Agreement is hereby deleted in its entirety and the following is substituted in lieu thereof:\n5. Retirement, Pension and Profit Sharing. as further compensation for the services of the Executive:\na. The Executive shall be allowed to participate fully in any disability, death benefit, retirement, pension or profit sharing plans maintained by the Companies, pursuant to the terms of such plans; and\nb. Upon termination of the Executive s employment due to retirement or disability (both as defined in the Retirement Plan of Trustco Bank New York), the Companies shall provide to the Executive and his spouse, for the life of the Executive, the health insurance benefits provided to retirees by the Companies under their medical insurance plan. The Companies shall provide to the Executive for his life the life insurance benefits provided to retirees by the Companies under their life insurance plan. The obligations of the Companies pursuant to this subparagraph b. shall survive the termination of this Agreement.\nIN WITNESS WHEREOF, the Companies and the Executive have executed this Amendment No. 1 this 16 day of November, 1993.\nTRUSTCO BANK NEW YORK TRUSTCO BANK CORP NY BY\/s\/William F. Terry BY\/s\/William F. Terry Secretary Secretary\n\/s\/Robert A. McCormick Robert A. McCormick\nExhibit 10(b) AMENDMENT NO. 2 TO EMPLOYMENT AGREEMENT AMONG TRUSTCO BANK NEW YORK AND TRUSTCO BANK CORP NY AND ROBERT A. MCCORMICK\nWHEREAS, Trustco Bank New York and TrustCo Bank Corp NY (herein referred to as the Companies ) entered into an Employment Agreement dated as of January 1, 1992, (herein referred to as the Agreement ); with Robert A. McCormick (herein referred to as the Executive ); and\nWHEREAS, the Companies and the Executive desire to amend the Agreement, effective as of June 21, 1994;\nNOW, THEREFORE, the Agreement is hereby amended effective as of June 21, 1994, in the following respects:\nI.\nThe following subparagraph (f) is hereby added to Section 8 of the Agreement:\n(f) In the event of Termination (as described in Sections 6 and 7 herein), if the Termination Benefits paid to the Executive under this Agreement or any other agreement are subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986 (the Excise Tax ), then the Companies will pay to the Executive, within ten (10) days after the date the Excise Tax is determined to be due, an additional amount ( Gross Up ) such that the net amount retained by the Executive after (i) deduction of any Excise Tax on the Termination Benefits and any other benefits subject to the Excise Tax, and (ii) any Federal, state and local income taxes and Excise Tax upon the payment provided for in this subparagraph (f), shall be equal to the Termination Benefits. For purposes of determining the amount of the Gross Up, the Executive shall be deemed to pay Federal, State and local income taxes at the highest marginal rate of taxation in the calendar year in which the Termination Benefits are to be made. State and local income taxes shall be determined based upon the state and locality of the Executive s domicile on Termination. The determination of whether such Excise Tax is payable and the amount thereof shall be based upon the opinion of tax counsel selected by the Companies and acceptable to the Executive. If such opinion is not finally accepted by the Internal Revenue Service upon audit, then appropriate adjustments shall be computed (without interest but with Gross Up, if applicable) by such tax counsel based upon the final amount of the Excise Tax so determined. The adjusted amount shall be paid by the appropriate party in one lump cash sum within thirty (30) days of such computation.\nIN WITNESS WHEREOF, the Companies and the Executive have executed this Amendment NO. 2 this 1st day of September, 1994.\nTRUSTCO BANK NEW YORK TRUSTCO BANK CORP NY BY:\/s\/William F. Terry BY:\/s\/William F. Terry Secretary Secretary\n\/s\/Robert A. McCormick Robert A. McCormick\nAMENDMENT NO. 3 TO EMPLOYMENT AGREEMENT BETWEEN TRUSTCO BANK NEW YORK AND TRUSTCO BANK CORP NY AND ROBERT A. McCORMICK\nWHEREAS, Trustco Bank New York (herein referred to as the \"Company\") and TrustCo Bank Corp NY (herein referred to as \"TrustCo\") entered into an Employment Agreement (herein referred to as the \"Agreement\") with Robert A. McCormick (herein referred to as the \"Executive\"); and WHEREAS, by statutory conversion the Company converted from a state chartered trust company to a national bank, and in connection with the conversion the name of the Company changed to Trustco Bank, National Association effective February 1, 1995; and WHEREAS, the Company, TrustCo and the Executive desire to amend the Agreement to reflect the name change; NOW, THEREFORE, effective February 1, 1995, the Agreement is hereby amended by changing \"Trustco Bank New York\" to \"Trustco Bank, National Association\" in each place where it appears therein. IN WITNESS WHEREOF, the Company has caused this Amendment No. 3 to be executed this 13th day of February, 1995. TRUSTCO BANK, NATIONAL TRUSTCO BANK CORP NY ASSOCIATION\nBy:\/s\/William F. Terry By:\/s\/William F. Terry Title: Secretary Title: Secretary\n\/s\/Robert A. McCormick Robert A. McCormick\nExhibit 10(c)\nEMPLOYMENT AGREEMENT\namong\nTRUSTCO BANK NEW YORK\nand\nTRUSTCO BANK CORP NY\nand\nROBERT T. CUSHING\nEMPLOYMENT AGREEMENT\nAGREEMENT, dated as of June 21, 1994 (the \"Agreement\"), by and among Trustco Bank New York (the \"Bank\"), a New York banking corporation, and TrustCo Bank Corp NY (the \"Company\"), a New York business corporation (hereinafter referred to collectively as the \"Companies\"), with principal offices at 192 Erie Boulevard, Schenectady, New York 12305-1808, and Robert T. Cushing (the \"Executive\"), residing at 6 Carriage Hill Drive, Latham, New York 12211.\nEngagement. The Companies agree to engage the Executive and the executive agrees to serve the Companies as an Executive.\n1. Term. The term of this Agreement shall commence on June 21, 1994 and shall continue until December 31, 1994. Beginning on January 1, 1995, and on January 1 of each and every year thereafter, this Agreement shall automatically renew for an additional year on the same terms and conditions, except to the extent modified in writing, unless the Executive is notified by the method set forth in Paragraph 11 herein that Executive has been terminated (\"Nonrenewal Notice\"). Nothing contained herein, however, shall be construed to extend the Executive's right to employment beyond the age of 65 years or the then mandatory retirement age in effect, whichever shall be greater.\n2. Purpose and Effect. The purpose of this Agreement is to provide Termination Benefits, as defined in Paragraph 9 hereof, in the event of a Termination, as defined in Paragraph 8 hereof.\n3. Service. The Executive shall exert Executive's best efforts and devote substantially all of Executive's time and attention to the affairs of the Bank. The Executive shall perform all the services and duties necessary or appropriate for the management of the Bank's businesses, subject to the general direction, approval, and control of the Chief Executive Officer and his designees.\n4. Compensation. For purposes of this Agreement, Annual Compensation shall be deemed to be the Executive's Annual Base Salary. Commencing May 20, 1994, Executive shall be paid by the Companies, the Annual Base Salary established on Schedule A attached hereto (which base salary shall be paid in bi-weekly installments). Thereafter, Annual Base Salary shall continue at such level or such other level as may have been agreed to among the parties and evidenced as provided in this Paragraph, until renegotiated among the parties hereto and either confirmed in a writing signed by either the Chief Executive Officer of or a member of the Board of Directors of the Companies, or endorsed on Schedule A and signed by either the Chief Executive Officer of or by a member of the Board of Directors of the Companies.\n5. Retirement, Pension and Profit Sharing. As further compensation for the services of the Executive:\n6. The Executive shall be eligible to participate fully in any retirement, executive incentive compensation, pension or profit sharing plans maintained by the Companies, pursuant to the terms of such plans. Nothing in this agreement shall be construed as a waiver of any of the terms of or conditions precedent to participation in such plans; and\n7. Upon termination of the Executive's employment due to retirement or disability (both as defined in the Retirement Plan of Trustco Bank New York), the Companies shall provide to the Executive and his spouse, for the life of the Executive, the health insurance benefits provided to retirees by the Companies under their medical insurance plan. The Companies shall provide to the Executive for his life the life insurance benefits provided to retirees by the Companies under their life insurance plan. The obligations of the Companies pursuant to this subparagraph (b) shall survive the termination of this Agreement.\n8. Termination of Employment.\n9. If there shall be a Termination (as defined in Paragraph 8 hereof) of the Executive from the Companies within two (2) years after a change in control of either Company, for any reason other than for good cause, death, retirement at the mandatory retirement age, or disability, the Executive shall receive upon his Termination with either of the Companies, the Termination Benefits set forth herein. The Executive's Termination for good cause shall be limited to the Executive's having committed an act of fraud, embezzlement, or theft, constituting a felony or any act intentionally against either of the Companies which causes either Company material injury, or a final determination by a court that the Executive has committed a material breach of his duties and responsibilities in connection with rendering services to either of the Companies pursuant to this Agreement.\n10. A \"change in control\" of either Company means any of the following events: (i) any individual, corporation (other than either Company), partnership, trust, association, pool, syndicate, or any other entity or any group of persons acting in concert becomes the beneficial owner, as that concept is defined in Rule 13d-3 promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, of securities of either Company possessing twenty percent (20%) or more of the voting power for the election of directors of either Company; (ii) there shall be consummated any consolidation, merger or other business combination involving either Company or the securities of either Company in which holders of voting securities of either Company immediately prior to such consummation own, as a group, immediately after such consummation, voting securities of either Company (or, if either Company does not survive such transaciton, voting securities of the corporation or corporations surviving such transaction) having less than fifty percent (50%) of the total voting power in an election of directors of either Company (or such other surviving corporation or corporations); (iii) during any period of two consecutive years, individuals who at the beginning of such period constitute the directors of either Company cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by either Company's shareholders, of each new director of either Company was approved by a vote of at least two-thirds of the directors of the applicable Company then still in office who were directors of such Company at the beginning of any such period; (iv) removal by the stockholders of all or any of the incumbent directors of either Company other than a removal for cause; and (v) there shall be consummated any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all, of the assets of either Company (on a consolidated basis) to a party which is not controlled by or under common control with the Companies.\n11. Notice of Termination shall be communicated by the terminating party to the other parties to this Agreement pursuant to Paragraph 11 hereof.\n12. Termination. Termination shall include, but is not limited to, (i) any reduction in the Executive's Annual Base Salary, executive incentive compensation, disability, death, retirement, pension or profit sharing benefits (unless such reductions shall have been applied to all Bank employees as a part of a validly adopted plan of cost containment), responsibilities or duties, or (ii) either Companies' relocation or a change in the Executive's base location, or (iii) a Nonrenewal Notice given pursuant to Paragraph 2 of this Agreement, or (iv) the unilateral election of the Executive to terminate the Agreement. Such election shall be communicated to the Companies pursuant to Paragraph 11 hereof.\n13. Termination Benefits. The following benefits shall be Termination Benefits:\n14. The Companies shall pay to the Executive the Executive's full compensation through the effective date of his Termination at the rate in effect at the time notice of Termination is given or at the time of Termination, if earlier, and in addition\n15. The Companies shall pay to the Executive within ten (10) days of Termination a lump sum amount equal to two (2) times the Executive's Annual Base Salary then in effect, and in addition\n16. The Companies shall pay to the Executive all benefits payable to the Executive under the Companies' retirement, executive incentive compensation, pension and profit sharing plans, and in addition\n17. The Companies shall pay to the Executive all legal fees and expenses incurred by the Executive as a result of such Termination, and in addition\n18. The Companies shall provide the Executive, for one year following his Termination, Health Insurance and Group Life Insurance benefits substantially similar to those the Executive was receiving immediately prior to his Termination, and in addition\n19. In the event the Termination Benefits paid to the Executive under this Agreement or any other agreement are subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986 (the \"Excise Tax\"), then the Companies will pay to the Executive, within ten (10) days after the date the Excise Tax is determined to be due, an additional amount (\"Gross Up\") such that the net amount retained by the Executive after deduction of (i) any Excise Tax on the Termination Benefits and any other benefits subject to the Excise Tax, and (ii) any Federal, State and local income taxes and Excise Tax upon the payment provided for in this subparagraph (f), shall be equal to the Termination Benefits. For purposes of determining the amount of the Gross Up, the Executive shall be deemed to pay Federal, State and local income taxes at the highest marginal rate of taxation in the calendar year in which the Termination Benefits are to be made. State and local income taxes shall be determined based upon the state and locality of the Executive's domicile on Termination. The determination of whether such Excise Tax is payable and the amount thereof shall be based upon the opinion of tax counsel selected by the Companies and acceptable to the Executive. If such opinion is not finally accepted by the Internal Revenue Service upon audit, then appropriate adjustments shall be computed (without interest but with Gross Up, if applicable) by such tax counsel based upon the final amount of the Excise Tax so determined. The adjusted amount shall be paid by the appropriate party in one lump cash sum within thirty (30) days of such computation.\n20. Indemnity. The Companies shall indemnify the Executive and hold Executive harmless for any acts or decisions made by Executive in good faith while performing services for either of the Companies and shall use their best efforts to obtain coverage for Executive under any insurance policy now in force or hereinafter obtained during the term of this Agreement covering the other officers and directors of the Companies against lawsuits. The Companies will pay all expenses, including attorney's fees, actually and necessarily incurred by the Executive in connection with any appeal thereon including the cost of court settlements.\n21. Notices. All notices, requests, demands and other communications provided for by this Agreement shall be in writing and shall be deemed to have been given at the time when personally delivered or mailed at any general or branch United States Post Office enclosed in a post paid envelope and addressed to the address of the respective party stated below or to such changed address as such party may have fixed by notice.\nTo the Companies : TrustCo Bank Corp NY Trustco Bank New York 192 Erie Boulevard Schenectady, NY 12305-1808\nTo the Executive : Robert T. Cushing 6 Carriage Hill Drive Latham, NY 12211\nProvided, however, that any notice of change of address shall be effective only upon receipt.\n22. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Companies, their successors and assigns, including without limitation, any person or entity which may acquire all or substantially all of either Company's assets or business or into which either Company may be consolidated or merged, and the Executive, as well as Executive's heirs, executors, administrators and legal representatives. The Executive may assign the right to payment under this Agreement, but not obligations under this Agreement.\n23. Governing Law. This Agreement shall be governed by the laws of the State of New York.\n24. Complete Agreement. This Agreement supersedes all prior understandings and agreements between the parties, and may not be amended or modified orally, but only by a writing signed by the parties hereto. IN WITNESS WHEREOF, the parties hereto have executed this Agreement on June 21, 1994.\nTRUSTCO BANK CORP NY\nATTEST: By:\/s\/Robert M. Mccormick \/s\/William F. Terry President and Chief Executive Secretary Officer \"Company\"\nTRUSTCO BANK NEW YORK\nATTEST: By:\/s\/Robert M. McCormick \/s\/William F. Terry President and Chief Executive Secretary Officer \"Bank\"\n\/s\/Robert T. Cushing Robert T. Cushing\nSchedule A to Agreement among Companies and Robert T. Cushing\nCalendar Year Annual Salary Approval of Companies 1994 $230,000.00 \/s\/Robert A. McCormick 1995 $240,000.00 \/s\/Robert A. McCormick\nTRUSTCO BANK CORP NY\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nTRUSTCO BANK NEW YORK\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nAGREEMENT OF EXECUTIVE\n\/s\/Robert T. Cushing Robert T. Cushing\nAMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT BETWEEN TRUSTCO BANK NEW YORK AND TRUSTCO BANK CORP NY AND ROBERT T. CUSHING\nWHEREAS, Trustco Bank New York (herein referred to as the \"Company\") and TrustCo Bank Corp NY (herein referred to as \"TrustCo\") entered into an Employment Agreement (herein referred to as the \"Agreement\") with Robert T. Cushing (herein referred to as the \"Executive\"); and WHEREAS, by statutory conversion the Company converted from a state chartered trust company to a national bank, and in connection with the conversion the name of the Company changed to Trustco Bank, National Association effective February 1, 1995; and WHEREAS, the Company, TrustCo and the Executive desire to amend the Agreement to reflect the name change; NOW, THEREFORE, effective February 1, 1995, the Agreement is hereby amended by changing \"Trustco Bank New York\" to \"Trustco Bank, National Association\" in each place where it appears therein.\nIN WITNESS WHEREOF, the Company has caused this Amendment No. 1 to be executed this 14th day of February, 1995.\nTRUSTCO BANK, NATIONAL TRUSTCO BANK CORP NY ASSOCIATION\nBy:\/s\/Robert A. McCormick By:\/s\/Robert A. McCormick Title:President and CEO Title:President and CEO\n\/s\/Robert T. Cushing Robert T. Cushing\nExhibit 10(d) RESTATED EMPLOYMENT AGREEMENT\namong\nTRUSTCO BANK NEW YORK\nand\nTRUSTCO BANK CORP NY\nand\nNANCY A. McNAMARA\nRESTATED EMPLOYMENT AGREEMENT\nWHEREAS, Trustco Bank New York (the \"Bank\"), a New York banking corporation, and TrustCo Bank Corp NY (the \"Company\"), a New York business corporation (herein referred to collectively as the \"Companies\") entered into an Employment Agreement dated July 15, 1992 (herein referred to as the \"Agreement\") with Nancy A. McNamara (herein referred to as the \"Executive\"); and\nWHEREAS, the Companies and the Executive desire to amend and restate the Agreement in its entirety effective as of June 21, 1994;\nNOW, THEREFORE, the Agreement is hereby amended and restated in its entirety effective June 21, 1994, so that it shall read as follows:\nEngagement. The Companies agree to engage the Executive and the executive agrees to serve the Companies as an Executive.\n1. Term. The term of this Agreement shall commence on July 15, 1992 and shall continue until December 31, 1992. Beginning on January 1, 1993, and on January 1 of each and every year thereafter, this Agreement shall automatically renew for an additional year on the same terms and conditions, except to the extent modified in writing, unless the Executive is notified by the method set forth in Paragraph 11 herein that Executive has been terminated (\"Nonrenewal Notice\"). Nothing contained herein, however, shall be construed to extend the Executive's right to employment beyond the age of 65 years or the then mandatory retirement age in effect, whichever shall be greater.\n2. Purpose and Effect. The purpose of this Agreement is to provide Termination Benefits, as defined in Paragraph 9 hereof, in the event of a Termination, as defined in Paragraph 8 hereof.\n3. Service. The Executive shall exert Executive's best efforts and devote substantially all of Executive's time and attention to the affairs of the Bank. The Executive shall perform all the services and duties necessary or appropriate for the management of the Bank's businesses, subject to the general direction, approval, and control of the Chief Executive Officer and his designees.\n4. Compensation. For purposes of this Agreement, Annual Compensation shall be deemed to be the Executive's Annual Base Salary. Commencing January 1, 1992, Executive shall be paid by the Companies, the Annual Base Salary established on Schedule A attached hereto (which base salary shall be paid in bi-weekly installments). Thereafter, Annual Base Salary shall continue at such level or such other level as may have been agreed to among the parties and evidenced as provided in this Paragraph, until renegotiated among the parties hereto and either confirmed in a writing signed by either the Chief Executive Officer of or a member of the Board of Directors of the Companies, or endorsed on Schedule A and signed by either the Chief Executive Officer of or by a member of the Board of Directors of the Companies.\n5. Retirement, Pension and Profit Sharing. As further compensation for the services of the Executive:\n(a) The Executive shall be eligible to participate fully in any retirement, executive incentive compensation, pension or profit sharing plans maintained by the Companies, pursuant to the terms of such plans. Nothing in this agreement shall be construed as a waiver of any of the terms of or conditions precedent to participation in such plans; and\n(b) Upon termination of the Executive's employment due to retirement or disability (both as defined in the Retirement Plan of Trustco Bank New York), the Companies shall provide to the Executive and her spouse, for the life of the Executive, the health insurance benefits provided to retirees by the Companies under their medical insurance plan. The Companies shall provide to the Executive for her life the life insurance benefits provided to retirees by the Companies under their life insurance plan. The obligations of the Companies pursuant to this subparagraph (b) shall survive the termination of this Agreement.\n6. Termination of Employment.\n(a) If there shall be a Termination (as defined in Paragraph 8 hereof) of the Executive from the Companies within two (2) years after a change in control of either Company, for any reason other than for good cause, death, retirement at the mandatory retirement age, or disability, the Executive shall receive upon her Termination with either of the Companies, the Termination Benefits set forth herein. The Executive's Termination for good cause shall be limited to the Executive's having committed an act of fraud, embezzlement, or theft, constituting a felony or any act intentionally against either of the Companies which causes either Company material injury, or a final determination by a court that the Executive has committed a material breach of her duties and responsibilities in connection with rendering services to either of the Companies pursuant to this Agreement.\n(b) A \"change in control\" of either Company means any of the following events: (i) any individual, corporation (other than either Company), partnership, trust, association, pool, syndicate, or any other entity or any group of persons acting in concert becomes the beneficial owner, as that concept is defined in Rule 13d-3 promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, of securities of either Company possessing twenty percent (20%) or more of the voting power for the election of directors of either Company; (ii) there shall be consummated any consolidation, merger or other business combination involving either Company or the securities of either Company in which holders of voting securities of either Company immediately prior to such consummation own, as a group, immediately after such consummation, voting securities of either Company (or, if either Company does not survive such transaction, voting securities of the corporation or corporations surviving such transaction) having less than fifty percent (50%) of the total voting power in an election of directors of either Company (or such other surviving corporation or corporations); (iii) during any period of two consecutive years, individuals who at the beginning of such period constitute the directors of either Company cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by either Company's shareholders, of each new director of either Company was approved by a vote of at least two-thirds of the directors of the applicable Company then still in office who were directors of such Company at the beginning of any such period; (iv) removal by the stockholders of all or any of the incumbent directors of either Company other than a removal for cause; and (v) there shall be consummated any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all, of the assets of either Company (on a consolidated basis) to a party which is not controlled by or under common control with the Companies.\n(c) Notice of Termination shall be communicated by the terminating party to the other parties to this Agreement pursuant to Paragraph 11 hereof.\n7. Termination. Termination shall include, but is not limited to, (i) any reduction in the Executive's Annual Base Salary, executive incentive compensation, disability, death, retirement, pension or profit sharing benefits (unless such reductions shall have been applied to all Bank employees as a part of a validly adopted plan of cost containment), responsibilities or duties, or (ii) either Companies' relocation or a change in the Executive's base location, or (iii) a Nonrenewal Notice given pursuant to Paragraph 2 of this Agreement, or (iv) the unilateral election of the Executive to terminate the Agreement. Such election shall be communicated to the Companies pursuant to Paragraph 11 hereof.\n8. Termination Benefits. The following benefits shall be Termination Benefits:\n(a) The Companies shall pay to the Executive the Executive's full compensation through the effective date of her Termination at the rate in effect at the time notice of Termination is given or at the time of Termination, if earlier, and in addition\n(b)The Companies shall pay to the Executive within ten (10) days of Termination a lump sum amount equal to two (2) times the Executive's Annual Base Salary then in effect, and in addition\n(c) The Companies shall pay to the Executive all benefits payable to the Executive under the Companies' retirement, executive incentive compensation, pension and profit sharing plans, and in addition\n(d) The Companies shall pay to the Executive all legal fees and expenses incurred by the Executive as a result of such Termination, and in addition\n(e) The Companies shall provide the Executive, for one year following her Termination, Health Insurance and Group Life Insurance benefits substantially similar to those the Executive was receiving immediately prior to her Termination, and in addition\n(f) In the event the Termination Benefits paid to the Executive under this Agreement or any other agreement are subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986 (the \"Excise Tax\"), then the Companies will pay to the Executive, within ten (10) days after the date the Excise Tax is determined to be due, an additional amount (\"Gross Up\") such that the net amount retained by the Executive after deduction of (i) any Excise Tax on the Termination Benefits and any other benefits subject to the Excise Tax, and (ii) any Federal, State and local income taxes and Excise Tax upon the payment provided for in this subparagraph (f), shall be equal to the Termination Benefits. For purposes of determining the amount of the Gross Up, the Executive shall be deemed to pay Federal, State and local income taxes at the highest marginal rate of taxation in the calendar year in which the Termination Benefits are to be made. State and local income taxes shall be determined based upon the state and locality of the Executive's domicile on Termination. The determination of whether such Excise Tax is payable and the amount thereof shall be based upon the opinion of tax counsel selected by the Companies and acceptable to the Executive. If such opinion is not finally accepted by the Internal Revenue Service upon audit, then appropriate adjustments shall be computed (without interest but with Gross Up, if applicable) by such tax counsel based upon the final amount of the Excise Tax so determined. The adjusted amount shall be paid by the appropriate party in one lump cash sum within thirty (30) days of such computation.\n9. Indemnity. The Companies shall indemnify the Executive and hold Executive harmless for any acts or decisions made by Executive in good faith while performing services for either of the Companies and shall use their best efforts to obtain coverage for Executive under any insurance policy now in force or hereinafter obtained during the term of this Agreement covering the other officers and directors of the Companies against lawsuits. The Companies will pay all expenses, including attorney's fees, actually and necessarily incurred by the Executive in connection with any appeal thereon including the cost of court settlements.\n10. Notices. All notices, requests, demands and other communications provided for by this Agreement shall be in writing and shall be deemed to have been given at the time when personally delivered or mailed at any general or branch United States Post Office enclosed in a post paid envelope and addressed to the address of the respective party stated below or to such changed address as such party may have fixed by notice.\nTo the Companies: TrustCo Bank Corp NY Trustco Bank New York 192 Erie Boulevard Schenectady, NY 12305-1808\nTo the Executive: Nancy A. McNamara 26 Berkshire Drive West Clifton Park, NY 12065\nProvided, however, that any notice of change of address shall be effective only upon receipt.\n11. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Companies, their successors and assigns, including without limitation, any person or entity which may acquire all or substantially all of either Company's assets or business or into which either Company may be consolidated or merged, and the Executive, as well as Executive's heirs, executors, administrators and legal representatives. The Executive may assign the right to payment under this Agreement, but not obligations under this Agreement.\n12. Governing Law. This Agreement shall be governed by the laws of the State of New York.\n13. Complete Agreement. This Agreement supersedes all prior understandings and agreements between the parties, and may not be amended or modified orally, but only by a writing signed by the parties hereto.\nIN WITNESS WHEREOF, the parties hereto have executed this Restated Agreement on June 21, 1994.\nTRUSTCO BANK CORP NY\nATTEST: By:\/s\/Robert A. McCormick President and Chief Executive \/s\/William F. Terry Officer \"Company\" Secretary\nTRUSTCO BANK NEW YORK ATTEST: By:\/s\/Robert A. McCormick President and Chief Executive \/s\/William F. Terry Officer \"Bank\" Secretary\n\/s\/Nancy A. McNamara Nancy A. McNamara\nSchedule A to Agreement among Companies and Nancy A. Mcnamara\nCalendar Year Annual Salary Approval of Companies\n1992 $160,000.00 \/s\/Robert A. McCormick 1993 200,000.00 \/s\/Robert A. McCormick 1994 230,000.00 \/s\/Robert A. McCormick 1995 240,000.00 \/s\/Robert A. McCormick\nTRUSTCO BANK CORP NY\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nTRUSTCO BANK NEW YORK\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nAGREEMENT OF EXECUTIVE \/s\/Nancy A. McNamara Nancy A. McNamara\nAMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT BETWEEN TRUSTCO BANK NEW YORK AND TRUSTCO BANK CORP NY AND NANCY A. McNAMARA\nWHEREAS, Trustco Bank New York (herein referred to as the \"Company\") and TrustCo Bank Corp NY (herein referred to as \"TrustCo\") entered into an Employment Agreement (herein referred to as the \"Agreement\") with Nancy A. McNamara (herein referred to as the \"Executive\"); and WHEREAS, by statutory conversion the Company converted from a state chartered trust company to a national bank, and in connection with the conversion the name of the Company changed to Trustco Bank, National Association effective February 1, 1995; and WHEREAS, the Company, TrustCo and the Executive desire to amend the Agreement to reflect the name change; NOW, THEREFORE, effective February 1, 1995, the Agreement is hereby amended by changing \"Trustco Bank New York\" to \"Trustco Bank, National Association\" in each place where it appears therein. IN WITNESS WHEREOF, the Company has caused this Amendment No. 1 to be executed this 14th day of February, 1995. TRUSTCO BANK, NATIONAL TRUSTCO BANK CORP NY ASSOCIATION\nBy: \/s\/Robert A. McCormick By:\/s\/Robert A. McCormick Title: President and CEO Title: President and CEO\n\/s\/Nancy A. McNamara Nancy A. McNamara\nExhibit 10(e)\nRESTATED EMPLOYMENT AGREEMENT\namong\nTRUSTCO BANK NEW YORK\nand\nTRUSTCO BANK CORP NY\nand\nWILLIAM F. TERRY\nRESTATED EMPLOYMENT AGREEMENT\nWHEREAS, Trustco Bank New York (the \"Bank\"), a New York banking corporation, and TrustCo Bank Corp NY (the \"Company\"), a New York business corporation (herein referred to collectively as the \"Companies\") entered into an Employment Agreement dated July 15, 1992 (herein referred to as the \"Agreement\") with William F. Terry (herein referred to as the \"Executive\"); and\nWHEREAS, the Companies and the Executive desire to amend and restate the Agreement in its entirety effective as of June 21, 1994;\nNOW, THEREFORE, the Agreement is hereby amended and restated in its entirety effective June 21, 1994, so that it shall read as follows:\nEngagement. The Companies agree to engage the Executive and the executive agrees to serve the Companies as an Executive.\n1. Term. The term of this Agreement shall commence on July 15, 1992 and shall continue until December 31, 1992. Beginning on January 1, 1993, and on January 1 of each and every year thereafter, this Agreement shall automatically renew for an additional year on the same terms and conditions, except to the extent modified in writing, unless the Executive is notified by the method set forth in Paragraph 11 herein that Executive has been terminated (\"Nonrenewal Notice\"). Nothing contained herein, however, shall be construed to extend the Executive's right to employment beyond the age of 65 years or the then mandatory retirement age in effect, whichever shall be greater.\n2. Purpose and Effect. The purpose of this Agreement is to provide Termination Benefits, as defined in Paragraph 9 hereof, in the event of a Termination, as defined in Paragraph 8 hereof.\n3. Service. The Executive shall exert Executive's best efforts and devote substantially all of Executive's time and attention to the affairs of the Bank. The Executive shall perform all the services and duties necessary or appropriate for the management of the Bank's businesses, subject to the general direction, approval, and control of the Chief Executive Officer and his designees.\n4. Compensation. For purposes of this Agreement, Annual Compensation shall be deemed to be the Executive's Annual Base Salary. Commencing January 1, 1992, Executive shall be paid by the Companies, the Annual Base Salary established on Schedule A attached hereto (which base salary shall be paid in bi-weekly installments). Thereafter, Annual Base Salary shall continue at such level or such other level as may have been agreed to among the parties and evidenced as provided in this Paragraph, until renegotiated among the parties hereto and either confirmed in a writing signed by either the Chief Executive Officer of or a member of the Board of Directors of the Companies, or endorsed on Schedule A and signed by either the Chief Executive Officer of or by a member of the Board of Directors of the Companies.\n5. Retirement, Pension and Profit Sharing. As further compensation for the services of the Executive:\n(a) The Executive shall be eligible to participate fully in any retirement, executive incentive compensation, pension or profit sharing plans maintained by the Companies, pursuant to the terms of such plans. Nothing in this agreement shall be construed as a waiver of any of the terms of or conditions precedent to participation in such plans; and\n(b) Upon termination of the Executive's employment due to retirement or disability (both as defined in the Retirement Plan of Trustco Bank New York), the Companies shall provide to the Executive and his spouse, for the life of the Executive, the health insurance benefits provided to retirees by the Companies under their medical insurance plan. The Companies shall provide to the Executive for his life the life insurance benefits provided to retirees by the Companies under their life insurance plan. The obligations of the Companies pursuant to this subparagraph (b) shall survive the termination of this Agreement.\n6. Termination of Employment.\n(a) If there shall be a Termination (as defined in Paragraph 8 hereof) of the Executive from the Companies within two (2) years after a change in control of either Company, for any reason other than for good cause, death, retirement at the mandatory retirement age, or disability, the Executive shall receive upon his Termination with either of the Companies, the Termination Benefits set forth herein. The Executive's Termination for good cause shall be limited to the Executive's having committed an act of fraud, embezzlement, or theft, constituting a felony or any act intentionally against either of the Companies which causes either Company material injury, or a final determination by a court that the Executive has committed a material breach of his duties and responsibilities in connection with rendering services to either of the Companies pursuant to this Agreement.\n(b) A \"change in control\" of either Company means any of the following events: (i) any individual, corporation (other than either Company), partnership, trust, association, pool, syndicate, or any other entity or any group of persons acting in concert becomes the beneficial owner, as that concept is defined in Rule 13d-3 promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, of securities of either Company possessing twenty percent (20%) or more of the voting power for the election of directors of either Company; (ii) there shall be consummated any consolidation, merger or other business combination involving either Company or the securities of either Company in which holders of voting securities of either Company immediately prior to such consummation own, as a group, immediately after such consummation, voting securities of either Company (or, if either Company does not survive such transaction, voting securities of the corporation or corporations surviving such transaction) having less than fifty percent (50%) of the total voting power in an election of directors of either Company (or such other surviving corporation or corporations); (iii) during any period of two consecutive years, individuals who at the beginning of such period constitute the directors of either Company cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by either Company's shareholders, of each new director of either Company was approved by a vote of at least two- thirds of the directors of the applicable Company then still in office who were directors of such Company at the beginning of any such period; (iv) removal by the stockholders of all or any of the incumbent directors of either Company other than a removal for cause; and (v) there shall be consummated any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all, of the assets of either Company (on a consolidated basis) to a party which is not controlled by or under common control with the Companies.\n(c) Notice of Termination shall be communicated by the terminating party to the other parties to this Agreement pursuant to Paragraph 11 hereof.\n7. Termination. Termination shall include, but is not limited to, (i) any reduction in the Executive's Annual Base Salary, executive incentive compensation, disability, death, retirement, pension or profit sharing benefits (unless such reductions shall have been applied to all Bank employees as a part of a validly adopted plan of cost containment), responsibilities or duties, or (ii) either Companies' relocation or a change in the Executive's base location, or (iii) a Nonrenewal Notice given pursuant to Paragraph 2 of this Agreement, or (iv) the unilateral election of the Executive to terminate the Agreement. Such election shall be communicated to the Companies pursuant to Paragraph 11 hereof.\n8. Termination Benefits. The following benefits shall be Termination Benefits:\n(a) The Companies shall pay to the Executive the Executive's full compensation through the effective date of his Termination at the rate in effect at the time notice of Termination is given or at the time of Termination, if earlier, and in addition\n(b) The Companies shall pay to the Executive within ten (10) days of Termination a lump sum amount equal to two (2) times the Executive's Annual Base Salary then in effect, and in addition\n(c) The Companies shall pay to the Executive all benefits payable to the Executive under the Companies' retirement, executive incentive compensation, pension and profit sharing plans, and in addition\n(d) The Companies shall pay to the Executive all legal fees and expenses incurred by the Executive as a result of such Termination, and in addition\n(e) The Companies shall provide the Executive, for one year following his Termination, Health Insurance and Group Life Insurance benefits substantially similar to those the Executive was receiving immediately prior to his Termination, and in addition\n(f) In the event the Termination Benefits paid to the Executive under this Agreement or any other agreement are subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986 (the \"Excise Tax\"), then the Companies will pay to the Executive, within ten (10) days after the date the Excise Tax is determined to be due, an additional amount (\"Gross Up\") such that the net amount retained by the Executive after deduction of (i) any Excise Tax on the Termination Benefits and any other benefits subject to the Excise Tax, and (ii) any Federal, State and local income taxes and Excise Tax upon the payment provided for in this subparagraph (f), shall be equal to the Termination Benefits. For purposes of determining the amount of the Gross Up, the Executive shall be deemed to pay Federal, State and local income taxes at the highest marginal rate of taxation in the calendar year in which the Termination Benefits are to be made. State and local income taxes shall be determined based upon the state and locality of the Executive's domicile on Termination. The determination of whether such Excise Tax is payable and the amount thereof shall be based upon the opinion of tax counsel selected by the Companies and acceptable to the Executive. If such opinion is not finally accepted by the Internal Revenue Service upon audit, then appropriate adjustments shall be computed (without interest but with Gross Up, if applicable) by such tax counsel based upon the final amount of the Excise Tax so determined. The adjusted amount shall be paid by the appropriate party in one lump cash sum within thirty (30) days of such computation.\n9. Indemnity. The Companies shall indemnify the Executive and hold Executive harmless for any acts or decisions made by Executive in good faith while performing services for either of the Companies and shall use their best efforts to obtain coverage for Executive under any insurance policy now in force or hereinafter obtained during the term of this Agreement covering the other officers and directors of the Companies against lawsuits. The Companies will pay all expenses, including attorney's fees, actually and necessarily incurred by the Executive in connection with any appeal thereon including the cost of court settlements.\n10. Notices. All notices, requests, demands and other communications provided for by this Agreement shall be in writing and shall be deemed to have been given at the time when personally delivered or mailed at any general or branch United States Post Office enclosed in a post paid envelope and addressed to the address of the respective party stated below or to such changed address as such party may have fixed by notice.\nTo the Companies: TrustCo Bank Corp NY Trustco Bank New York 192 Erie Boulevard Schenectady, NY 12305-1808\nTo the Executive: William F. Terry 29 St. Agnes Lane Loudonville, NY 12211\nProvided, however, that any notice of change of address shall be effective only upon receipt.\n11. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Companies, their successors and assigns, including without limitation, any person or entity which may acquire all or substantially all of either Company's assets or business or into which either Company may be consolidated or merged, and the Executive, as well as Executive's heirs, executors, administrators and legal representatives. The Executive may assign the right to payment under this Agreement, but not obligations under this Agreement.\n12. Governing Law. This Agreement shall be governed by the laws of the State of New York.\n13. Complete Agreement. This Agreement supersedes all prior understandings and agreements between the parties, and may not be amended or modified orally, but only by a writing signed by the parties hereto.\nIN WITNESS WHEREOF, the parties hereto have executed this Restated Agreement on June 21, 1994.\nTRUSTCO BANK CORP NY\nATTEST: By:\/s\/Robert A. McCormick President and Chief Executive \/s\/William F. Terry Officer \"Company\" Secretary\nTRUSTCO BANK NEW YORK\nATTEST: By:\/s\/Robert A. McCormick President and Chief Executive \/s\/William F. Terry Officer \"Bank\" Secretary\n\/s\/William F. Terry William F. Terry\nSchedule A to Agreement among Companies and William F. Terry\nCalendar Year Annual Salary Approval of Companies\n1992 $160,000.00 \/s\/Robert A. McCormick 1993 200,000.00 \/s\/Robert A. McCormick 1994 230,000.00 \/s\/Robert A. McCormick 1995 240,000.00 \/s\/Robert A. McCormick\nTRUSTCO BANK CORP NY\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nTRUSTCO BANK NEW YORK\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nAGREEMENT OF EXECUTIVE\n\/s\/William F. Terry William F. Terry\nAMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT BETWEEN TRUSTCO BANK NEW YORK AND TRUSTCO BANK CORP NY AND WILLIAM F. TERRY\nWHEREAS, Trustco Bank New York (herein referred to as the \"Company\") and TrustCo Bank Corp NY (herein referred to as \"TrustCo\") entered into an Employment Agreement (herein referred to as the \"Agreement\") with William F. Terry (herein referred to as the \"Executive\"); and WHEREAS, by statutory conversion the Company converted from a state chartered trust company to a national bank, and in connection with the conversion the name of the Company changed to Trustco Bank, National Association effective February 1, 1995; and WHEREAS, the Company, TrustCo and the Executive desire to amend the Agreement to reflect the name change; NOW, THEREFORE, effective February 1, 1995, the Agreement is hereby amended by changing \"Trustco Bank New York\" to \"Trustco Bank, National Association\" in each place where it appears therein. IN WITNESS WHEREOF, the Company has caused this Amendment No. 1 to be executed this 14th day of February, 1995. TRUSTCO BANK, NATIONAL TRUSTCO BANK CORP NY ASSOCIATION\nBy:\/s\/Robert A. McCormick By:\/s\/Robert A. McCormick Title: President and CEO Title: President and CEO\n\/s\/William F. Terry William F. Terry\nExhibit 10(f)\nRESTATED EMPLOYMENT AGREEMENT\namong\nTRUSTCO BANK NEW YORK\nand\nTRUSTCO BANK CORP NY\nand\nRALPH A. PIDGEON\nRESTATED EMPLOYMENT AGREEMENT\nWHEREAS, Trustco Bank New York (the \"Bank\"), a New York banking corporation, and TrustCo Bank Corp NY (the \"Company\"), a New York business corporation (herein referred to collectively as the \"Companies\") entered into an Employment Agreement dated July 15, 1992 (herein referred to as the \"Agreement\") with Ralph A. Pidgeon (herein referred to as the \"Executive\"); and\nWHEREAS, the Companies and the Executive desire to amend and restate the Agreement in its entirety effective as of June 21, 1994;\nNOW, THEREFORE, the Agreement is hereby amended and restated in its entirety effective June 21, 1994, so that it shall read as follows:\nEngagement. The Companies agree to engage the Executive and the executive agrees to serve the Companies as an Executive.\n1. Term. The term of this Agreement shall commence on July 15, 1992 and shall continue until December 31, 1992. Beginning on January 1, 1993, and on January 1 of each and every year thereafter, this Agreement shall automatically renew for an additional year on the same terms and conditions, except to the extent modified in writing, unless the Executive is notified by the method set forth in Paragraph 11 herein that Executive has been terminated (\"Nonrenewal Notice\"). Nothing contained herein, however, shall be construed to extend the Executive's right to employment beyond the age of 65 years or the then mandatory retirement age in effect, whichever shall be greater.\n2. Purpose and Effect. The purpose of this Agreement is to provide Termination Benefits, as defined in Paragraph 9 hereof, in the event of a Termination, as defined in Paragraph 8 hereof.\n3. Service. The Executive shall exert Executive's best efforts and devote substantially all of Executive's time and attention to the affairs of the Bank. The Executive shall perform all the services and duties necessary or appropriate for the management of the Bank's businesses, subject to the general direction, approval, and control of the Chief Executive Officer and his designees.\n4. Compensation. For purposes of this Agreement, Annual Compensation shall be deemed to be the Executive's Annual Base Salary. Commencing January 1, 1992, Executive shall be paid by the Companies, the Annual Base Salary established on Schedule A attached hereto (which base salary shall be paid in bi-weekly installments). Thereafter, Annual Base Salary shall continue at such level or such other level as may have been agreed to among the parties and evidenced as provided in this Paragraph, until renegotiated among the parties hereto and either confirmed in a writing signed by either the Chief Executive Officer of or a member of the Board of Directors of the Companies, or endorsed on Schedule A and signed by either the Chief Executive Officer of or by a member of the Board of Directors of the Companies.\n5. Retirement, Pension and Profit Sharing. As further compensation for the services of the Executive:\n(a) The Executive shall be eligible to participate fully in any retirement, executive incentive compensation, pension or profit sharing plans maintained by the Companies, pursuant to the terms of such plans. Nothing in this agreement shall be construed as a waiver of any of the terms of or conditions precedent to participation in such plans; and\n(b) Upon termination of the Executive's employment due to retirement or disability (both as defined in the Retirement Plan of Trustco Bank New York), the Companies shall provide to the Executive and his spouse, for the life of the Executive, the health insurance benefits provided to retirees by the Companies under their medical insurance plan. The Companies shall provide to the Executive for his life the life insurance benefits provided to retirees by the Companies under their life insurance plan. The obligations of the Companies pursuant to this subparagraph (b) shall survive the termination of this Agreement.\n6. Termination of Employment.\n(a) If there shall be a Termination (as defined in Paragraph 8 hereof) of the Executive from the Companies within two (2) years after a change in control of either Company, for any reason other than for good cause, death, retirement at the mandatory retirement age, or disability, the Executive shall receive upon his Termination with either of the Companies, the Termination Benefits set forth herein. The Executive's Termination for good cause shall be limited to the Executive's having committed an act of fraud, embezzlement, or theft, constituting a felony or any act intentionally against either of the Companies which causes either Company material injury, or a final determination by a court that the Executive has committed a material breach of his duties and responsibilities in connection with rendering services to either of the Companies pursuant to this Agreement.\n(b) A \"change in control\" of either Company means any of the following events: (i) any individual, corporation (other than either Company), partnership, trust, association, pool, syndicate, or any other entity or any group of persons acting in concert becomes the beneficial owner, as that concept is defined in Rule 13d-3 promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, of securities of either Company possessing twenty percent (20%) or more of the voting power for the election of directors of either Company; (ii) there shall be consummated any consolidation, merger or other business combination involving either Company or the securities of either Company in which holders of voting securities of either Company immediately prior to such consummation own, as a group, immediately after such consummation, voting securities of either Company (or, if either Company does not survive such transaction, voting securities of the corporation or corporations surviving such transaction) having less than fifty percent (50%) of the total voting power in an election of directors of either Company (or such other surviving corporation or corporations); (iii) during any period of two consecutive years, individuals who at the beginning of such period constitute the directors of either Company cease for any reason to constitute at least a majority thereof unless the election, or the nomination for election by either Company's shareholders, of each new director of either Company was approved by a vote of at least two-thirds of the directors of the applicable Company then still in office who were directors of such Company at the beginning of any such period; (iv) removal by the stockholders of all or any of the incumbent directors of either Company other than a removal for cause; and (v) there shall be consummated any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all, of the assets of either Company (on a consolidated basis) to a party which is not controlled by or under common control with the Companies.\n(c) Notice of Termination shall be communicated by the terminating party to the other parties to this Agreement pursuant to Paragraph 11 hereof.\n7. Termination. Termination shall include, but is not limited to, (i) any reduction in the Executive's Annual Base Salary, executive incentive compensation, disability, death, retirement, pension or profit sharing benefits (unless such reductions shall have been applied to all Bank employees as a part of a validly adopted plan of cost containment), responsibilities or duties, or (ii) either Companies' relocation or a change in the Executive's base location, or (iii) a Nonrenewal Notice given pursuant to Paragraph 2 of this Agreement, or (iv) the unilateral election of the Executive to terminate the Agreement. Such election shall be communicated to the Companies pursuant to Paragraph 11 hereof.\n8. Termination Benefits. The following benefits shall be Termination Benefits:\n(a) The Companies shall pay to the Executive the Executive's full compensation through the effective date of his Termination at the rate in effect at the time notice of Termination is given or at the time of Termination, if earlier, and in addition\n(b) The Companies shall pay to the Executive within ten (10) days of Termination a lump sum amount equal to two (2) times the Executive's Annual Base Salary then in effect, and in addition\n(c) The Companies shall pay to the Executive all benefits payable to the Executive under the Companies' retirement, executive incentive compensation, pension and profit sharing plans, and in addition\n(d) The Companies shall pay to the Executive all legal fees and expenses incurred by the Executive as a result of such Termination, and in addition\n(e) The Companies shall provide the Executive, for one year following his Termination, Health Insurance and Group Life Insurance benefits substantially similar to those the Executive was receiving immediately prior to his Termination, and in addition\n(f) In the event the Termination Benefits paid to the Executive under this Agreement or any other agreement are subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986 (the \"Excise Tax\"), then the Companies will pay to the Executive, within ten (10) days after the date the Excise Tax is determined to be due, an additional amount (\"Gross Up\") such that the net amount retained by the Executive after deduction of (i) any Excise Tax on the Termination Benefits and any other benefits subject to the Excise Tax, and (ii) any Federal, State and local income taxes and Excise Tax upon the payment provided for in this subparagraph (f), shall be equal to the Termination Benefits. For purposes of determining the amount of the Gross Up, the Executive shall be deemed to pay Federal, State and local income taxes at the highest marginal rate of taxation in the calendar year in which the Termination Benefits are to be made. State and local income taxes shall be determined based upon the state and locality of the Executive's domicile on Termination. The determination of whether such Excise Tax is payable and the amount thereof shall be based upon the opinion of tax counsel selected by the Companies and acceptable to the Executive. If such opinion is not finally accepted by the Internal Revenue Service upon audit, then appropriate adjustments shall be computed (without interest but with Gross Up, if applicable) by such tax counsel based upon the final amount of the Excise Tax so determined. The adjusted amount shall be paid by the appropriate party in one lump cash sum within thirty (30) days of such computation.\n9. Indemnity. The Companies shall indemnify the Executive and hold Executive harmless for any acts or decisions made by Executive in good faith while performing services for either of the Companies and shall use their best efforts to obtain coverage for Executive under any insurance policy now in force or hereinafter obtained during the term of this Agreement covering the other officers and directors of the Companies against lawsuits. The Companies will pay all expenses, including attorney's fees, actually and necessarily incurred by the Executive in connection with any appeal thereon including the cost of court settlements.\n10. Notices. All notices, requests, demands and other communications provided for by this Agreement shall be in writing and shall be deemed to have been given at the time when personally delivered or mailed at any general or branch United States Post Office enclosed in a post paid envelope and addressed to the address of the respective party stated below or to such changed address as such party may have fixed by notice.\nTo the Companies: TrustCo Bank Corp NY Trustco Bank New York 192 Erie Boulevard Schenectady, NY 12305-1808\nTo the Executive: Ralph A. Pidgeon 925 Marion Avenue Schenectady, NY 12303\nProvided, however, that any notice of change of address shall be effective only upon receipt.\n11. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Companies, their successors and assigns, including without limitation, any person or entity which may acquire all or substantially all of either Company's assets or business or into which either Company may be consolidated or merged, and the Executive, as well as Executive's heirs, executors, administrators and legal representatives. The Executive may assign the right to payment under this Agreement, but not obligations under this Agreement.\n12. Governing Law. This Agreement shall be governed by the laws of the State of New York.\n13. Complete Agreement. This Agreement supersedes all prior understandings and agreements between the parties, and may not be amended or modified orally, but only by a writing signed by the parties hereto.\nIN WITNESS WHEREOF, the parties hereto have executed this Restated Agreement on June 21, 1994.\nTRUSTCO BANK CORP NY\nATTEST: By:\/s\/Robert A. McCormick President and Chief Executive \/s\/William F. Terry Officer \"Company\" Secretary\nTRUSTCO BANK NEW YORK\nATTEST: By:\/s\/Robert A. McCormick President and Chief Executive \/s\/William F. Terry Officer \"Bank\" Secretary\n\/s\/Ralph A. Pidgeon Ralph A. Pidgeon\nSchedule A to Agreement among Companies and Ralph A. Pidgeon\nCalendar Year Annual Salary Approval of Companies\n1992 $160,000.00 \/s\/Robert A. McCormick 1993 200,000.00 \/s\/Robert A. McCormick 1994 230,000.00 \/s\/Robert A. McCormick 1995 240,000.00 \/s\/Robert A. McCormick\nTRUSTCO BANK CORP NY\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nTRUSTCO BANK NEW YORK\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nAGREEMENT OF EXECUTIVE\n\/s\/Ralph A. Pidgeon Ralph A. Pidgeon\nAMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT BETWEEN TRUSTCO BANK NEW YORK AND TRUSTCO BANK CORP NY AND RALPH A. PIDGEON\nWHEREAS, Trustco Bank New York (herein referred to as the \"Company\") and TrustCo Bank Corp NY (herein referred to as \"TrustCo\") entered into an Employment Agreement (herein referred to as the \"Agreement\") with Ralph A. Pidgeon (herein referred to as the \"Executive\"); and WHEREAS, by statutory conversion the Company converted from a state chartered trust company to a national bank, and in connection with the conversion the name of the Company changed to Trustco Bank, National Association effective February 1, 1995; and WHEREAS, the Company, TrustCo and the Executive desire to amend the Agreement to reflect the name change; NOW, THEREFORE, effective February 1, 1995, the Agreement is hereby amended by changing \"Trustco Bank New York\" to \"Trustco Bank, National Association\" in each place where it appears therein. IN WITNESS WHEREOF, the Company has caused this Amendment No. 1 to be executed this 14th day of February, 1995. TRUSTCO BANK, NATIONAL TRUSTCO BANK CORP NY ASSOCIATION\nBy:\/s\/Robert A. McCormick By:\/s\/Robert A. McCormick Title:President and CEO Title: President and CEO\n\/s\/Ralph A. Pidgeon Ralph A. Pidgeon\nExhibit 10(g)\nEMPLOYMENT AGREEMENT\nbetween\nTRUSTCO BANK NEW YORK\nand\nTRUSTCO BANK CORP NY\nand\nPeter A. Zakriski\nEMPLOYMENT AGREEMENT\nAGREEMENT, dated as of July 15, 1992, (the Agreement ), by and between Trustco Bank New York (the \"Bank\"), a New York banking corporation, and TrustCo Bank Corp NY (the \"Company\"), a New York business corporation (hereinafter referred to collectively as the \"Companies\"), with principal offices at 320 State Street, Schenectady, New York and Peter A. Zakriski ( the Executive ), residing at 86 St. Stephen's Lane West, Scotia, New York 12302.\n1. Engagement. The Companies agree to engage the Executive and the Executive agrees to serve the Companies as an Executive.\n2. Term. The term of this Agreement shall commence on the date first above written and shall continue until December 31, 1992. Beginning on January 1, 1993, and on January 1 of each and every year thereafter, this Agreement shall automatically renew for an additional year on the same terms and conditions, except to the extent modified in writing, unless the Executive is notified by the method set forth in Paragraph 11 herein that Executive has been terminated (\"Nonrenewal Notice\"). Nothing contained herein, however, shall be construed to extend the Executive's right to employment beyond the age of 65 years or the then mandatory retirement age in effect, whichever shall be greater.\n3. Purpose and Effect. The purpose of this Agreement is to provide Termination Benefits, as defined in Paragraph 9 hereof, in the event of a Termination, as defined in Paragraph 8 hereof.\n4. Service. The Executive shall exert Executive's best efforts and devote substantially all of Executive's time and attention to the affairs of the Bank. The Executive shall perform all the services and duties necessary or appropriate for the management of the Bank's businesses, subject to the general direction, approval, and control of the Chief Executive Officer and his designees.\n5. Compensation. For purposes of this Agreement, Annual Compensation shall be deemed to be the Executive's Annual Base Salary. Commencing January 1, 1992, Executive shall be paid by the Companies, the Annual Base Salary established on Schedule A attached hereto, (which base salary shall be paid in bi-weekly installments). Thereafter, Annual Base Salary shall continue at such level or such other level as may have been agreed to among the parties and evidenced as provided in this Paragraph, until renegotiated among the parties hereto and either confirmed in a writing signed by either the Chief Executive Officer of or a member of the Board of Directors of the Companies, or endorsed on Schedule A and signed by either the Chief Executive Officer of or by a member of the Board of Directors of the Companies.\n6. Retirement, Pension and Profit Sharing. As further compensation for the services of the Executive, the Executive shall be eligible to participate fully in any retirement, executive incentive compensation, pension or profit sharing plans maintained by the Companies, pursuant to the terms of such plans. Nothing in this Agreement shall be construed as a waiver of any of the terms of or conditions precedent to participation in such plans.\n7. Termination of Employment. If there shall be a Termination (as hereinafter defined) of the Executive for any reason other than for good cause, death, retirement at the mandatory retirement age, or disability, the Executive shall receive upon his Termination with either of the Companies, the Termination Benefits set forth herein. The Executive's Termination for good cause shall be limited to the Executive's having committed an act of fraud, embezzlement, or theft, constituting a felony or any act intentionally against either of the Companies which causes either Company material injury, or a final determination by a court that the Executive has committed a material breach of his duties and responsibilities in connection with rendering services to either of the Companies pursuant to this Agreement.\n8. Termination. Termination shall include, but is not limited to, (i) any reduction in the Executive's Annual Base Salary, retirement other than at the mandatory retirement age, executive incentive compensation, pension or profit sharing benefits, (unless such reductions shall have been applied to all Bank employees as a part of a validly adopted plan of cost containment), responsibilities or duties, or (ii) either Companies' relocation or a change in the Executive's base location, or (iii) a nonrenewal notice given pursuant to Paragraph 2 of this Agreement, or (iv) the unilateral election of the Executive to terminate the Agreement. Such election shall be communicated to the Companies pursuant to Paragraph 11 hereof.\n9. Termination Benefits. The following benefits shall be Termination Benefits:\n(a) The Companies shall pay to the Executive the Executive's full compensation through the effective date of his termination at the rate in effect at the time notice of termination is given or at the time of Termination, if earlier, and in addition\n(b) The Companies shall pay to the Executive within ten (10) days of Termination an additional lump sum amount equal to that Executive's Annual Base Salary then in effect, and in addition\n(c) The Companies shall pay to the Executive all benefits payable to the Executive under the Companies' retirement, executive incentive compensation, pension and profit sharing plans, and in addition\n(d) The Companies shall pay to the Executive all legal fees and expenses incurred by the Executive as a result of such Termination, and in addition\n(e) The Companies shall provide the Executive, for one year following his Termination, Health Insurance and Group Life Insurance benefits substantially similar to those the Executive was receiving immediately prior to his Termination.\n10. Indemnity. The Companies shall indemnify the Executive and hold Executive harmless for any acts or decisions made by Executive in good faith while performing services for either of the Companies and shall use their best efforts to obtain coverage for Executive under any insurance policy now in force or hereinafter obtained during the term of this Agreement covering the other officers and directors of the Companies against lawsuits. The Companies will pay all expenses, including attorney's fees, actually and necessarily incurred by the Executive in connection with any appeal thereon including the cost of court settlements.\n11. Notices. All notices, requests, demands and other communications provided for by this Agreement shall be in writing and shall be deemed to have been given at the time when personally delivered or mailed at any general or branch United States Post Office enclosed in a post paid envelope and addressed to the address of the respective party stated below or to such changed address as such party may have fixed by notice.\nTo the Companies: TrustCo Bank Corp NY Trustco Bank New York 320 State Street Schenectady, NY 12305\nTo the Executive: Peter A. Zakriski 86 St. Stephen's Lane West Scotia, NY 12302\nProvided, however, that any notice of change of address shall be effective only upon receipt.\n12. Successors and Assigns. This Agreement shall inure to the benefit of and be binding upon the Companies, their successors and assigns, including, without limitation, any person or entity which may acquire all or substantially all of either Company's assets or business or into which either Company may be consolidated or merged, and the Executive, as well as Executive's heirs, executors, administrators and legal representatives. The Executive may assign the right to payment under this Agreement, but not obligations under this Agreement.\n13. Governing Law. This Agreement shall be governed by the laws of the State of New York.\n14. Complete Agreement. This Agreement supersedes all prior understandings and agreements between the parties, and may not be amended or modified orally, but only by a writing signed by the parties hereto.\nIN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the 15th Day of July, 1992\nTRUSTCO BANK CORP NY\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer \"Company\"\nTRUSTCO BANK NEW YORK\nATTEST: By:\/s\/Robert A. McCormick President and Chief Executive \/s\/William F. Terry Officer \"Bank\" Secretary\n\/s\/Peter A. Zakriski Peter A. Zakriski\nSchedule A to Agreement among Companies and Peter A. Zakriski\nCalendar Year Annual Salary Approval of Companies\n1992 $110,000.00 \/s\/Robert A. McCormick 1993 115,000.00 \/s\/Robert A. McCormick 1994 120,000.00 \/s\/Robert A. McCormick 1995 125,000.00 \/s\/Robert A. McCormick\nTRUSTCO BANK CORP NY\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nTRUSTCO BANK NEW YORK\nBy:\/s\/Robert A. McCormick President and Chief Executive Officer\nAGREEMENT OF EXECUTIVE\n\/s\/Peter A. Zakriski Peter A. Zakriski\nAMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT BETWEEN TRUSTCO BANK NEW YORK AND TRUSTCO BANK CORP NY AND PETER A. ZAKRISKI\nWHEREAS, Trustco Bank New York and Trustco Bank Corp NY (herein referred to as the companies ) entered into an Employment Agreement dated as of July 15, 1992, (herein referred to as the Agreement ); with Peter A. Zakriski (herein referred to as the Executive ); and\nWHEREAS, the Companies and the Executive desire to amend the Agreement, effective as of November 16, 1993;\nNOW, THEREFORE, the Agreement is hereby amended effective June 21, 1993 in the following respect:\nSection 6 of the Agreement is hereby deleted in its entirety and the following is substituted in lieu thereof:\n6. Retirement, Pension and Profit Sharing. As further compensation for the services of the Executive:\na. The Executive shall be eligible to participate fully in any retirement, executive incentive compensation, pension or profit sharing plans maintained by the Companies, pursuant to the terms of such plans. Nothing in this agreement shall be construed as a waiver of any of the terms of or conditions precedent to participation in such plans; and,\nb. Upon termination of the Executive's employment due to retirement or disability (both as defined in the Retirement Plan of Trustco Bank New York), the Companies shall provide to the Executive and his spouse, for the life of the Executive, the health insurance benefits provided to retirees by the Companies under their medical insurance plan. the Companies shall provide to the Executive for his life the life insurance benefits provided to retirees by the Companies under their life insurance plan. The obligations of the Companies pursuant to this subparagraph b. shall survive the termination of this Agreement.\nIN WITNESS WHEREOF, the Companies and the Executive have executed this Amendment No. 1 this 16 day of November, 1993.\nTRUSTCO BANK NEW York TRUSTCO BANK NY By:\/s\/Robert A. McCormick By:\/s\/Robert A. McCormick\n\/s\/Peter A. Zakriski Peter A. Zakriski\nAMENDMENT NO. 2 TO EMPLOYMENT AGREEMENT BETWEEN TRUSTCO BANK NEW YORK AND TRUSTCO BANK CORP NY AND PETER A. ZAKRISKI\nWHEREAS, Trustco Bank New York (herein referred to as the \"Company\") and TrustCo Bank Corp NY (herein referred to as \"TrustCo\") entered into an Employment Agreement (herein referred to as the \"Agreement\") with Peter A. Zakriski (herein referred to as the \"Executive\"); and WHEREAS, by statutory conversion the Company converted from a state chartered trust company to a national bank, and in connection with the conversion the name of the Company changed to Trustco Bank, National Association effective February 1, 1995; and WHEREAS, the Company, TrustCo and the Executive desire to amend the Agreement to reflect the name change; NOW, THEREFORE, effective February 1, 1995, the Agreement is hereby amended by changing \"Trustco Bank New York\" to \"Trustco Bank, National Association\" in each place where it appears therein. IN WITNESS WHEREOF, the Company has caused this Amendment No. 2 to be executed this 14th day of February, 1995. TRUSTCO BANK, NATIONAL TRUSTCO BANK CORP NY ASSOCIATION\nBy:\/s\/Robert A. McCormick By:\/s\/Robert A. McCormick Title:President and CEO Title: President and CEO\n\/s\/Peter A. Zakriski Peter A. Zakriski\nExhibit 10(h) RESTATED\n1985 TRUSTCO BANK CORP NY\nSTOCK OPTION PLAN\nWHEREAS, TrustCo Bank Corp NY (the \"Company\") established the 1985 TrustCo Bank Corp NY Stock Option Plan (the \"Plan\"); and\nWHEREAS, the Company desires to amend said Plan effective as of July 1, 1994, and to restate the Plan in its entirety;\nNOW, THEREFORE, the Company does hereby amend the Plan effective July 1, 1994, and restates the Plan in its entirety so that it will read as follows:\nSECTION 1: PURPOSE\nThis 1985 Stock Option Plan (the \"Plan\") has been established by TrustCo Bank Corp NY (the \"Company\") to advance the interests of the Company and its stockholders by providing to certain key employees an opportunity to acquire equity ownership in the Company and the incentive advantages inherent in that equity ownership.\nSECTION 2: DEFINITIONS\nWhen capitalized and used in this Plan, each of the following terms or phrases has the indicated meaning, unless a different meaning is clearly implied by the content:\n\"Adoption Date\" means the date this plan is duly adopted by the Board.\n\"Board\" means the Company's Board of Directors.\n\"Code\" means the Internal Revenue Code of 1986, as amended.\n\"Committee\" means the Committee to be appointed by the Board from time to time and to consist of three or more members of the Board who have not been eligible to receive options under the Plan at any time within a period of one year immediately preceding the date of their appointment to such Committee.\n\"Company\" means TrustCo Bank Corp NY and its subsidiaries.\n\"Disability\" means a Participant's termination of employment by the Company or a Participating Subsidiary by reason of his permanent and total disability, as defined in Code Section 22(e)(3).\n\"Eligible Employee\" means any executive or other key managerial employee of the Company or any Participating Subsidiary who has been designated by the Board as eligible to participate in the Plan and who is a full-time, salaried employee of the Company or any Participating Subsidiary, provided he is so employed at the date any Stock Option is granted to him.\n\"Fair Market Value\" means the current fair market value of any Stock subject to a Stock Option. During such time as the Stock is not listed on an established stock exchange, fair market value per share shall be the mean between the closing dealer \"bid\" and \"ask\" prices for the Stock as quoted by NASDAQ for the day of the grant and if \"bid\" and \"ask\" prices are quoted for the day of the grant, the fair market value shall be determined by reference to such prices on the next preceding day on which such prices were quoted. If the Stock is listed on an established stock exchange or exchanges, the fair market value shall be deemed to be the highest closing price of the Stock on such stock exchange or exchanges on the day the option is granted or, if no sale of Stock has been made on any stock exchange on that day, the fair market value shall be determined by reference to such price for the next preceding day on which a sale occurred. In the event that Stock is not traded on an established stock exchange, and no closing dealer \"bid\" and \"ask\" prices are available, then the purchase price shall be 100 percent of the fair market value of one share of Stock on the day the option is granted, as determined by the Committee in good faith. The purchase price shall be subject to adjustment only as provided in Section 9 of the Plan.\n\"Incentive Stock Option\" means an option granted to a Participant under this Plan to purchase the Company's Stock, which is designated as an Incentive Stock Option and which satisfies the requirements of Code ?422, as amended.\n\"Nonqualified Stock Option\" means an option granted to a Participant under this Plan to purchase the Company's Stock and which is not an Incentive Stock Option.\n\"Option Agreement\" means the written agreement executed between the Participant and the Company evidencing the award of Stock Options under this Plan, as more particularly described in Section 7.\n\"Participant\" means any Eligible Employee who has been awarded any Stock Option(s) under this Plan and his heirs, legatees, or personal representatives who may succeed to his interests under any Option Agreement at his death.\n\"Participating Subsidiary\" means a Subsidiary some or all of whose employees have been designated as Eligible Employees by the Board. \"Plan\"means the Restated 1985 TrustCo Bank Corp NY Stock Option Plan as embodied in this document including all amendments to this document made from time to time.\n\"Shareholder-Employee\" means any Eligible Employee who at the time an Incentive Stock Option is to be granted to him under this Plan owns (within the meaning of Code Section 422(b)(6) and (c)(5)) more than 10 percent of the combined voting power of all classes of the Company's Stock or of its parent or subsidiary companies (if any).\n\"Stock\" means shares of the Company's common stock.\n\"Stock Appreciation Right\" means a right, granted to a Participant concurrently with the grant of a Nonqualified Stock Option, to receive a cash payment from the Company upon the partial or complete cancellation of that option by a Participant. Each Option Agreement may provide that the Participant may from time to time elect to cancel all or any portion of the Option then subject to exercise, in which event the Company's obligation in respect of such Option may be discharged by payment to the Participant of an amount in cash equal to the excess, if any, of the fair market value at the time of cancellation of the shares subject to the Option or the portion thereof so cancelled, over the aggregate purchase price for such shares as set forth in the Option Agreement. In the event of such a cancellation, the number of shares as to which such Option was cancelled shall not become available for use under the Plan.\n\"Stock Option\" or \"Option\" means a right granted under this Plan to purchase Company Stock, including a Nonqualified Stock Option or an Incentive Stock Option.\n\"Subsidiary\" means a corporation of which stock possessing 50% or more of the total combined voting power of all classes of its stock entitled to vote generally in the election of directors is owned in the aggregate by the Company directly or indirectly through one or more Subsidiaries.\nSECTION 3: PLAN ADMINISTRATION\nThe Plan is to be administered by the Committee except as otherwise provided in the Plan. Subject to all other Plan provisions, the Committee is expressly empowered to:\n1. select the Eligible Employees who are to receive Stock Options and Stock Appreciation Rights under this Plan from time to time and grant those Options and Stock Appreciation Rights;\n2. determine the time(s) at which Stock Options and Stock Appreciation Rights are to be granted;\n3. determine the number of shares of Stock to be subject to a Stock Option granted to any Participant;\n4. determine the option price and term of each Stock Option granted under this Plan (including whether it is to be an Incentive Stock Option or Nonqualified Stock Option) and all other terms and conditions to be included in the Option Agreement relating to any Stock Options under this Plan;\n5. determine the duration and purposes of leaves of absence which may be granted to a Participant without constituting a termination of employment or service for purposes of the Plan;\n6. determine all matters of interpretation of the Plan and any Option Agreement, and the Committee's decision is to be binding and conclusive on all persons;\n7. determine, in its sole discretion, whether the Company is to accept Stock previously acquired by a Participant as payment of the option price for Stock Options granted under this Plan;\n8. prescribe, amend and rescind all rules and regulations relating to the Plan and its operations;\n9. in the event of the Company's or a Participating Subsidiary's merger, consolidation, dissolution or liquidation, accelerate the exercise date and expiration date for any unexercised Stock Options then outstanding; and\n10. make all other determinations and decisions and take all further actions deemed necessary or advisable for the Plan's administration.\nNotwithstanding any conflicting Plan provision, the Board reserves the right, by written resolution duly adopted by the Board, to terminate from time to time any and all powers delegated to the Committee by the express Plan provisions and, in that event, those Committee powers so terminated by the Board shall revert to and be fully exercisable by the Board to the same extent as they were exercisable by the Committee, provided that no termination of the Committee's powers shall be retroactively effective. Any termination of the Committee's powers under this Plan shall not be deemed a Plan amendment. No Committee or Board member may participate in the decision to award any Stock Option or Stock Appreciation Right under this Plan to himself. Neither the Board nor the Committee may, without the Participant's consent, change the terms and conditions of any Option Agreement after its execution, except to the extent that the Agreement may, by its terms, be so amended.\nSECTION 4: PLAN EFFECTIVE DATE AND DURATION\nThis Plan is effective as of the Adoption Date, subject, however, to the Plan's approval by the Company's shareholders either on or before the Adoption Date or within the 12-month period following the Adoption Date. If shareholder approval is not so obtained, all Stock Options, Stock Appreciation Rights and Option Agreements granted under this Plan shall automatically be null and void, ab initio. No Stock Option may be granted under this Plan at any date which is 10 years or more after the Adoption Date.\nSECTION 5: AMENDMENTS AND TERMINATIONS\nThis Plan may be amended, suspended, terminated or reinstated, in whole or in part, at any time by the Board; provided, however, that without the approval of the Company's stockholders, the Board may not:\n1. except as provided in Section 9, increase the number of shares of Stock subject to Stock Options issued under this Plan;\n2. extend the maximum period during which a Stock Option may be exercised;\n3. extend the maximum period during which Incentive Stock Options may be granted under this Plan; or\n4. change the class of Eligible Employees.\nSECTION 6: SHARES SUBJECT TO THE PLAN\nThe total number of shares available for grants of Stock Options under this Plan is 428,703, subject to the adjustments under Section 9. If a Stock Option or a portion thereof expires or terminates for any reason without being exercised in full, the unpurchased shares covered by the Option are to be available for future Stock Option grants under this Agreement.\nSECTION 7: GRANTS OF OPTIONS\nNonqualified Stock Options may be granted to any Eligible Employee, at the time(s) and upon such terms and conditions as may be selected by the Committee. At the time of grant of a Nonqualified Stock Option, the Committee may, in its discretion, also grant to the Eligible Employee Stock Appreciation Rights for the total number of shares subject to that Option. The grant of a Nonqualified Stock Option and, if appropriate, Stock Appreciation Rights shall be evidenced by an Option Agreement between the Eligible Employee and the Company containing any terms and conditions specified by the Committee, but including the terms described in Section 8.\nIncentive Stock Options may be granted to any Eligible Employee, at the time(s) and upon such terms and condition as may be selected by the Committee, subject, nevertheless to the following:\n1. With respect to Incentive Stock Options granted prior to January 1, 1987, the aggregate Fair Market Value (as of the date the Incentive Stock Option is granted) of the Stock subject to Incentive Stock Options granted to any Eligible Employee during one calendar year (under this Plan and all other plans of the Company and its Subsidiaries providing \"incentive stock options\" within the meaning of Code Section 422A(b)) shall not exceed the sum of: (i) $100,000; and (ii) the amount of any \"unused limit carryover\" which may be taken into account for that calendar year with respect to that Eligible Employee under Code Section 422(A)(c)(4).\n2. With respect to Incentive Stock Options granted after December 31, 1986, the aggregate fair market value, determined at the time the Incentive Stock Option is granted, of the shares with respect to which Incentive Stock Options are exercisable for the first time by an Eligible Employee during any calendar year (under all stock option plans of the Company and its Subsidiaries to which the provisions of Section 422 of the Code apply) shall not exceed $100,000.\n3. The grant shall be evidenced by an Option Agreement between the Company and the Eligible Employee containing any terms and conditions specified by the Committee, except that those terms and conditions must conform with Section 8 and must be consistent with the requirements for an \"incentive stock option\" as described in Code Section 422(b).\nSECTION 8: TERMS OF OPTIONS AGREEMENT\nAll Option Agreements issued under this Plan must include terms that are consistent with the following:\n1. The Participant shall be entitled to purchase the number of shares subject to the Stock Option, upon his exercise of that Option, at a price no less than 100% of the Stock's Fair Market Value at the date of the grant; provided, however, that in the case of an Incentive Stock Option granted to a Shareholder-Employee, the option price is to be no less than 110% of that Fair Market Value.\n2. At the option's exercise, the option price may be paid in cash or cash equivalent--that is, by certified check, bank draft or postal or express money orders made payable to the Company's order in U.S. dollars. Alternatively, in the Committee's sole discretion, the option price may be paid, in whole or in part, by the Participant's exchange of Company Stock previously acquired by him, based on that Stock's Fair Market Value at the date of exchange. However, no Company Stock may be accepted in payment of the option price upon exercise of an Incentive Stock Option, if that Stock was acquired by the Participant's previous exercise of an Incentive Stock Option unless that Stock has been held by the Participant for more than 2 years after the date that previous Option was granted and more than 1 year after the date that previous Option was exercised.\n3. (i) The Option may not be exercisable after the earlier of the following dates:\n(a) If the Participant is not a Shareholder-- Employee at the date of grant or the Option is not an Incentive Stock Option, the date 10 years after the date of grant;\n(b) If the Participant is a Shareholder- Employee at the date of grant and the Option is an Incentive Stock Option, the date 5 years after the date of grant;\n(c) If the Participant's employment terminates for reasons other than his death or Disability or retirement, the date three months after the date his employment terminates.\n(d) If the Participant terminates employment as a result of Disability or retirement, the date described in Item 3(i)(a) or 3(i)(b), whichever is applicable.\n(e) If the Participant dies, the date prescribed by the Committee, except that no Option shall be exercisable after the date described in Item 3(i)(a) or 3(ii)(b) of Section 8, whichever is applicable.\n(f) If the Option is an Incentive Stock Option and the Participant's employment terminates due to Disability or retirement, the tax treatment available pursuant to Code Section 422 upon the exercise of an Incentive Stock Option will not be available to a Participant who exercises any Incentive Stock Option more than (a) three months after the date of the termination of employment due to retirement or (b) twelve months after the date of termination of employment due to Disability. If the Option is an Incentive Stock Option and the Participant dies, the tax treatment available pursuant to Code Section 422 upon the exercise of an Incentive Stock Option will not be available to the Participant's estate or any person who acquires the Option by bequest or inheritance or by reason of the death of the Participant unless the Participant was eligible for such tax treatment at the time of his death.\nNotwithstanding the foregoing, the committee, in its discretion, may further limit the period during which all or any portion of a Stock Option may be exercised and may accelerate the time at which an Option maybe exercised.\n4. Acceleration and the immediate right to exercise options in full will occur if any one or more the following takes place:\n(i) a contract providing for a merger or consolidation of the Company with or into another entity (except in the case where the Company is the surviving entity and the merger does not affect the stock interest of the stockholders of the Company) or a sale of substantially all the assets of the Company is executed;\n(ii) a single entity or individual (including any related parties to such entity or individual) acquires 20% or more of the outstanding stock of the Company; or\n(iii) a situation occurs in which, during any period of 12 consecutive months, individuals who at the beginning of such period were members of the Board cease for any reason to constitute at least a majority of the Board, unless the nomination or election of each new director was approved by at least two-thirds of the directors then still in office who were directors at the beginning of such period.\n5. The Stock Option(s) and any related Stock Appreciation Rights may be exercised during such Participant's lifetime, only by the Participant and, after his death, only by his heirs legatees or personal representatives who succeed to his interest under the Option Agreement. The Option Agreement, the Stock Options and the Stock Appreciation Rights issued under this Plan shall not be transferable by the Participant other than by will or by the laws of descent and distribution; provided, however, in addition to non-transferable Stock Options, the Committee may grant Nonqualified Stock Options that are transferable, without payment of consideration, to (i) revocable trusts for the benefit of immediate family members which qualify as grantor trusts for Federal income tax purposes, (ii) by gift to immediate family members, and (iii) to partnerships whose only partners are immediate family members. The Committee may also amend outstanding Nonqualified Stock Options to provide for such transferability. Notwithstanding the foregoing, in the event that a transferable Nonqualified Stock Option is transferred as permitted herein, such Nonqualified Stock Option(s) may be exercised by such transferee. The transferee of a transferable Nonqualified Stock Option is subject to all conditions applicable to the transferable Nonqualified Stock Option prior to its transfer.\n6. Notwithstanding anything else to the contrary, no Incentive Stock Option may be exercised while there is outstanding (within the meaning of former Code Section 422(c)(7)) any \"incentive stock option\" (within the meaning of former Code Section 422(b)) to purchase stock of the Company or any Subsidiary which was granted to the Participant prior to the grant of the Option sought to be exercised. The provisions of this Item 6 shall apply only to Incentive Stock Options granted prior to January 1, 1987.\n7. In the case of Nonqualified Stock Options, the Option may be exercised while there is outstanding another Stock Option to purchase Stock of the company or a Subsidiary which was granted to the Participant prior to the grant of the Option sought to be exercised.\n8. The aggregate fair market value (determined at the time the Option is granted) of the stock with respect to which Incentive Stock Options are exercisable for the first time by such individual during any calendar year (under all such plans of the individual's employer corporation and its parent and subsidiary corporation) shall not exceed $100,000. The provisions of this Item 8 shall apply to Incentive Stock Options granted after December 31, 1986.\n9. The acceleration provisions of Section 8, Items 4 and 10 of the Plan shall override restrictions contained in Section 8, Item 8.\n10. As to each Option granted a Participant since November 19, 1985, if the Participant's employment terminates by his death, Disability or retirement, the exercise of each such Option shall accelerate and become exercisable in full upon such termination, and shall remain exercisable throughout the period permitted for exercise as described in Item 3 of this Section 8.\n11. If a Participant dies during the period which he or she could have exercised an Option under Item 3 of Section 8 of the Plan, then the Option may be exercised by the executors or administrators of the Participant's estate, or by any person or persons who may have acquired the Option, directly from the Participant by bequest or inheritance within a period prescribed by the Committee after the Participant's death, except that no Option shall be exercisable after its expiration date as defined in Item 3(i) or 3(ii) of Section 8, whichever is applicable.\nSECTION 9: RECAPITALIZATION\nThe number of shares of Stock subject to this Plan, the number of shares of Stock covered by each outstanding Option (and any corresponding Stock Appreciation Rights), and the price per share in each Option, are to be proportionately adjusted for any increase or decrease in the number of issued shares of Company Stock resulting from a subdivision or consolidation of shares or the payment of a stock dividend (but only on the Company's common stock) or any other increase or decrease in the number of those shares effected without receipt of consideration by the Company.\nSubject to any required action by the Stockholders if the Company shall be the surviving corporation in any merger or consolidation, each outstanding Stock Option (and any corresponding Stock Appreciation Rights) shall pertain to and apply to the securities to which a holder of the number of shares of stock subject to that Option would have been entitled. A dissolution or liquidation of the Company, a proposed sale of substantially all of the assets of the Company, or a merger or consolidation in which the Company is not the surviving Corporation, shall cause each outstanding Option (and any corresponding stock Appreciation Rights) to terminate as of a date to be fixed by the Board; provided that no less than 30 days written notice of the date so fixed shall be given to each Optionee, and each Optionee shall have the right, during the period of 30 days preceding such termination, to exercise his option as to all or any part of the shares covered thereby, including shares as to which such option would not otherwise be exercisable.\nThe foregoing adjustments shall be made by the Committee. Fractional shares resulting from any adjustment in options pursuant to this Section 9 may be settled as the Committee or the Board (as the case may be) shall determine.\nSECTION 10: GOVERNMENT AND OTHER REGULATIONS\nNo Option shall be exercisable, no Stock shall be issued, no certificate for shares of Stock shall be delivered, and no payment shall be made under this Plan except in compliance with all applicable federal and state laws and regulations. The Company shall have the right to rely on the opinion of its counsel as to such compliance. Any share certificate issued to evidence Stock for which an Option is exercised may bear such legends and statements as the Committee may deem advisable to assure compliance with federal and state laws and regulations. No Option shall be exercisable, no Stock shall be issued, no certificate for shares shall be delivered, and no payment shall be made under this Plan until the Company has obtained such consent or approval as the Committee may deem advisable from regulatory bodies having jurisdiction over such matters.\nSECTION 11: INDEMNIFICATION OF COMMITTEE\nIn addition to such other rights of indemnification that they may have as officers or directors, the Committee members shall be indemnified by the Company against the reasonable expenses, including attorneys' fees actually and necessarily incurred in connection with the Plan's administration and the defense of any action, suit, or proceeding, or in connection with any appeal therein, to which they or any of them may be a party by reasons of any action taken or failure to act under or in connection with the Plan or any Option or Stock Appreciation Right granted thereunder. The Committee members are also to be indemnified against all amounts paid by them in settlement thereof (provided that settlement is approved by independent legal counsel selected by the Company) or paid by them in satisfaction of a judgment in any such action, suit or proceeding, except in relation to matters as to which it shall be adjudged in such action, suit or proceeding that such Committee member is liable for gross negligence or willful misconduct in the performance of his\/her duties; provided that within 60 days after institution of any such action, suit or proceeding a Committee member shall in writing offer the Company the opportunity, at its own expense, to handle and defend the same.\nSECTION 12: MISCELLANEOUS\nThe adoption of this Plan, its operation, or any documents describing or referring to this Plan (or any part thereof) shall not confer upon any employee any right to continue in the employ of the Company or in any way affect any right and power of the Company to terminate the employment of any employee at any time with or without assigning a reason thereof.\nAny liability of the Company to any person with respect to any grant under this Plan shall be based solely upon any contractual obligations which may be created pursuant to this Plan. No such obligation of the Company shall be deemed to be secured by any pledge of, or other encumbrance on, any property of the Company.\nThe Plan shall be administered in the State of New York and the validity, construction, interpretation, administration and effect of the Plan shall be determined solely in accordance with the laws of that State.\nIN WITNESS WHEREOF, the Company has caused this Plan to be executed on this 18th day of October, 1994.\nTRUSTCO BANK CORP NY\nBy: \/s\/ William F. Terry\nTitle: Secretary\nExhibit 11 TRUSTCO BANK CORP NY\n1994 FORM 10-K\nComputation of Net Income Per Common Share\nYear Ended December 31\n1994 1993 1992 Net Income $22,888,000 $20,325,000 $17,503,000 Weighted Daily average number of common shares outstanding 14,886,000 14,803,000 14,606,000 Net Income Per Common Share $1.54 $1.37 $1.20\n====== ====== ======\nNote: Daily average shares outstanding for all years have been adjusted to reflect a 10% stock dividend in October 1994, the 2 for 1 stock split in November 1993, and the 5 for 4 stock split in November 1992.\nExhibit 13 Presidents Message\nDear Shareholder:\nThe good news is 1994 was another record year at TrustCo. The bad news is a significant segment of the banking industry is encountering difficulty in the area of interest rate hedging or \"derivatives.\" TrustCo has no derivative exposure and our policy of \"plain vanilla\" in the management of our Company appears to have carried us through unscathed once again. We are grateful to our staff and Board of Directors for their continuing enthusiasm and support. During 1994, shareholder values continued in the right direction with net income at $22.9 million, up a significant 13% over 1993. TrustCo's most important ratio, return on shareholders' equity, was 17.01%, up from 16.18% in 1993. We are committed to insuring that return on equity compares favorably in any peer group, and we are comfortable that it does. TrustCo's five year ROE was 16.78% and we plan an increase to 18% for the current fiscal year. During 1994, we increased our cash dividend by 10% and then issued a 10% stock dividend maintaining the increased cash dividend level on the newly issued shares, effectively increasing dividend income for TrustCo owners by 21%. The quarterly cash dividend has increased at a 25% compound annual rate over the last five years, a major accomplishment. It is our intention to continue monitoring our internal generation of capital; should excess capital exist, we would recommend steps to the Board to correct that situation. These steps could include special dividends, stock buy back, or any other measures that would return excess capital to TrustCo's owners. Daniel J. Rourke, M.D., retired from the Bank and Holding Company boards during 1994. We thank Dan for his many contributions over the years and wish him well in his retirement. I think it appropriate to thank all our Board members for their continued guidance throughout the year. We note with sorrow the passing of Herman R. Hill, Honorary Director, who served the Board with distinction for many years. Senior staff additions during 1994 include Robert T. Cushing, appointed Senior Vice President and Chief Financial Officer about mid-year. Bob managed the banking practice at KPMG Peat Marwick for many years and adds an important level of experience to our senior management ranks. Henry C. Collins was appointed Vice President & General Counsel and Carroll E. Winch was named Administrative Vice President and Senior Trust Officer. These additions should add significant strength to our senior management. The TrustCo branch expansion program continues and we anticipate opening three additional branches during 1995. Our plans call for two to three branch openings a year until we have filled the gaps in our market territory. The targeted upgrading continues with each branch receiving a major review and renovation at approximately seven year intervals. During 1994, we evaluated and discussed a number of acquisition opportunities. Unfortunately, our discussions were not successful. Our approach to acquisitions is quite simple we are extremely careful to avoid damage to shareholder value in the existing TrustCo franchise. We would prefer that the benefits of an acquisition be shared by all the owners of the emerging company, and that does make for difficult negotiations on occasion. Since its inception, Trustco Bank has been a New York State chartered institution regulated by the Federal Reserve Bank of New York and the New York State Banking Department. During the first quarter of 1995, we completed a change from our New York State charter to a national charter. We think changes in the industry suggest the most appropriate direction for the future is a national charter regulated by the Office of the Comptroller of the Currency. TrustCo's Affordable Housing Program, which was designed to assist with homeownership, continues to be a success in new markets. We consider this program a model for community reinvestment and one of the most effective in the State. Occasionally, TrustCo has been described as \"boring\" because we are able to avoid most industry difficulties. Well, 1994 was another boring year during which we were able to benefit all important constituencies -- the owners, employees, and community. We expect to be equally tiresome in 1995. 1995 should provide income and growth success with emphasis continuing on the Home Equity Loan and Home Equity Credit Line products and our improved NOW account on the deposit side. Our Trust Department, which currently manages assets in excess of $630 million has ambitious expectations, and the impetus to move forward under new management. 1995 and beyond should benefit from the solid performance of the superb employee team here at TrustCo. For 1994 the often quoted efficiency ratio for our Company was 41.82% at a time when most banking companies would like to see 60.00%. This level of performance efficiency will benefit us through reduced operating expense for years to come. Net interest margins are another interesting ongoing benefit. During 1994, we recognized $8,877,000 of security losses and still had record net income. We have always described security losses as the deferral of income into future periods. To dramatize that point, net interest margin for the month of December 1993 was 3.78%. In December 1994 TrustCo's net interest margin was 4.63% and accelerating. This year-to-year increase of 85 basis points provides dramatic pre-tax income opportunities for the future. The quality of the loan portfolio is excellent, and our reserve for loan loss has a coverage ratio 14 times non-performing loans, an important area of reserve. Community needs have expanded and TrustCo has responded appropriately. TrustCo has provided increased employee and management participation in charitable and community organizations, increased its corporate charitable contributions throughout the Capital District, and our Affordable Housing Program continues to grow. We have an enthusiastic view of TrustCo's future. It is the intention at every level in the Company to continue our past success into the future. Our products are tailored to the needs of our community, we have an unmatched employee team to deliver them, and a management style that can adapt almost immediately to any change the marketplace may bring. Though we are not certain what the banking environment of the future will be, we are sure the combination mentioned above and the enthusiastic commitment of the Board of Directors will ensure our continuing success in the years ahead.\nSincerely,\n\/s\/ Robert A. McCormick\nRobert A. McCormick, President and Chief Executive Officer\nManagement's Discussion and Analysis of Operations\nThe financial review which follows will focus on the factors affecting the financial condition and results of operations of TrustCo Bank Corp NY (the \"Company\" or \"TrustCo\") and Trustco Bank, National Association (the \"Bank\" or \"Trustco\") during 1994 and, in summary form, the preceding two years. Net interest income and net interest margin are presented in this discussion on a taxable equivalent basis. Balances discussed are daily averages unless otherwise described. The consolidated financial statements and related notes and the quarterly reports to shareholders for 1994 should be read in conjunction with this review. Certain amounts in years prior to 1994 have been reclassified to conform with the 1994 presentation.\nOverview\nTrustCo recorded net income of $22,888,000 or $1.54 per share for the year ended December 31, 1994, compared to $20,325,000 or $1.37 per share for the year ended December 31, 1993. This represents an increase of 13% in the full year earnings and a 12% increase in the per share results.\nDuring 1994 TrustCo achieved:\n* taxable equivalent net interest income of $81.1 million, an increase of almost 10% over 1993,\n* a reserve coverage ratio of non-performing loans of 14 times. The reserves set aside for problem loans were 3.37% of loans at year end 1994, compared to 3.21% for 1993,\n* an efficiency ratio of 41.82% for the year. Industry goals look for the attainment of a 60% efficiency ratio. TrustCo outperformed this ratio for both 1993 and 1994,\n* an increase in the net interest margin from 4.04% in 1993 to 4.26% in 1994, the net interest margin for the fourth quarter of 1994 was 4.55%; and\n* a dividend payout ratio of 64% of net income.\nNet Interest Margin\n1992 3.98% 1993 4.04% 1994 4.26%\nAsset\/Liability Management\nTrustCo's objectives in managing its balance sheet are to manage the sensitivity of net interest income to actual or potential changes in interest rates and to enhance profitability through strategies that promise sufficient reward for understood and controlled risk. The Company has established guidelines for liquidity so as to maintain adequate levels in light of loan and deposit demands. TrustCo does not engage in any high risk investing activities nor does it invest in financial derivatives. The Company relies on traditional banking investment instruments and its large base of \"core\" deposits to help in asset\/liability management.\nEarning Assets\nAverage earning assets during 1994 were $1.9 billion, which is $68 million, or 4%, over the prior year. Increases in the balance of average earning assets is dependent on three factors:\n* growth in funding sources (deposits and borrowings),\n* movement of assets from non-earning to earning categories, and\n* the internal generation of capital retained by the Company.\nTo account for the $68 million of growth in average earning assets, TrustCo increased the funding sources by $40 million, converted $20 million from non-earning asset categories, and retained $11 million in capital during 1994. A small amount of the growth in these areas was directed to a decrease of $4 million in various other liabilities.\nThe table, \"Mix of Average Earning Assets\" shows how the mix of the earning assets has changed over the last three years. While growth in earning assets is critical to improved profitability, changes to the mix of earning assets can also have a significant impact on profitability.\nLoans: Average total loans increased $88.1 million, or 8.6% during 1994. Net loans grew from 55.7% of average earning assets in 1993 to 58.4% of average earning assets in 1994. The steady growth of the loan portfolio as a component of its asset mix, as well as the continued high quality of the portfolio, have contributed significantly to the Company's superior operating results for 1994.\nLoan products related to residential real estate continued to exhibit significant growth during 1994. Average residential mortgage loan outstandings rose $99.3 million, or 18.0%, during 1994. TrustCo also continued to experience success in the marketing of home equity loans and home equity credit lines during the year.\nThe overwhelming majority of TrustCo's real estate loans are secured by properties within the Bank's market area. Management's specific knowledge of local market conditions and trends enhances the quality of the loan portfolio. During 1994, management continued its established practice of retaining all new real estate loan originations in the Bank's portfolio rather than packaging them for sale in the secondary mortgage market.\nAverage commercial loan and commercial real estate loan outstandings were largely unchanged during 1994. New loan originations were slightly outpaced by amortizations and problem loan resolutions, a portfolio trend reflective of general economic uncertainty.\nTrustCo's commercial lending activities are focused on balancing the Company's commitment to meeting the credit needs of businesses within its market area with the necessity of maintaining a high quality loan portfolio. In accordance with these ideals, the Bank has consistently emphasized the origination of loans within its trade area. The portfolio contains no foreign loans, nor does it contain any concentrations of credit extended to any particular borrower or specific industry. The Bank's commercial portfolio is a reflection of the diversity found in the Capital Region's economy.\nTrustCo continues to offer a full range of consumer credit products. However, as has been the case in the recent past, the unfavorable tax treatment of installment loan interest curbed demand in 1994. In addition, the artificially low rates offered by other lenders have affected origination volume for the year.\nDuring 1994, the Bank commenced a program to promote its credit card products. This program, which combined aggressive marketing and attractive pricing, resulted in significant growth in credit card receivables during 1994.\nSecurities available for sale and investment securities: The Company adopted new accounting standards during 1994 for its securities portfolio. The Company has now identified securities available for sale and those securities that are for investment purposes and will be held to maturity. The following tables identify certain information related to these securities.\nSecurities Available for Sale: During 1994, the portfolio of securities available for sale was actively managed by the Company to take full advantage of the increases in interest rates available during that time period. At December 31, 1994, securities available for sale amounted to $117.5 million compared to $240.7 million at year-end 1993. Near the end of 1994, TrustCo liquidated a large portion of the securities available for sale and reinvested the proceeds in federal funds sold, which ended the year at $263.0 million, or $114.0 million more than the balance at year-end 1993.\nFor 1994, the average balance of securities available for sale was $337.1 million, almost double the average amount for 1993. The average rates earned during 1994 were 6.30% compared to 7.07% in 1993. During 1994, certain of the high coupon securities in this portfolio at year-end 1993 were disposed of. As noted earlier, the portfolio of securities available for sale was actively managed during 1994. Consequently, $8.9 million of securities losses were recognized as compared to securities gains of $6.2 million in 1993. The objective of recognizing these losses was to insure that the resulting portfolio of earning assets took advantage of the higher yields that were in the marketplace at year-end 1994. Management's actions resulted in an average yield on the securities available for sale portfolio for the fourth quarter of 1994 of 6.93%, compared to 5.81% for the comparable fourth quarter period in 1993. Absent these actions, the average yield in the year-end 1994 portfolio would have been significantly less, thereby resulting in lower future earnings. Therefore, these actions are consistent with the longstanding Company philosophy of taking actions designed to insure the future growth of net income.\nThis portfolio is heavily weighted to U.S. Treasuries and Agency obligations because these issuers provide a consistent source of liquidity for the bonds and are readily accepted from a credit risk perspective.\nTrustCo has never invested in derivative products, structured notes or in any other exotic investment vehicles. By actively managing a portfolio of high quality securities the objectives of asset\/liability management and liquidity can be met, while at the same time producing a constant earnings stream that meets or exceeds rates offered in the marketplace.\nSecurities available for sale are recorded at their fair value with any unrealized gains or losses, net of taxes, recognized as a component of shareholders' equity. At year-end 1994, the market value of Trustco's portfolio of securities available for sale was 99.94% of the amortized cost basis, thereby demonstrating an ability to take full advantage of the top of the current interest rate market.\nDuring 1994, approximately $213 million of securities available for sale were transferred to the held to maturity investment securities portfolio. At the time of the transfer, the amortized cost of the securities transferred approximated market value.\nInvestment Securities: This portfolio had a balance of $347.9 million at year-end 1994 compared to $416.8 million at year-end 1993. The average balance of investment securities during 1994 was $250.8 million and produced an average yield of 6.81%, compared to an average balance in 1993 of $455.1 million and a yield of 6.48%.\nAt year end 1994, 42% of the investment securities portfolio was invested in U.S. Treasuries and Agency issues, 41% was invested in mortgage-backed securities (all of which are agency guaranteed), 13% was in municipal securities and the remainder in other bonds. Therefore, virtually all of the investment securities portfolio is supported by some form of U.S. Government or subdivision guarantee. All securities in the portfolio are investment grade securities.\nCertain portions of income earned on certain commercial loans, U.S. Government obligations, obligations of states and political subdivisions, and equity securities are exempt from federal and state taxation. Appropriate adjustments have been made to reflect the equivalent amount of taxable income that would have been necessary to generate an equal amount of after tax income. Federal and New York State tax rates used to calculate income on a tax equivalent basis were 35.0 percent and 10.13 percent for 1994, 35.0 percent and 10.35 percent for 1993, and 34.0 percent and 10.35 percent for 1992. The average balances of securities available for sale is calculated using market values for these securities. For 1994, the average market value was $2.4 million greater than original costs.\nFederal Funds Sold: During 1994, the average balance of these funds was $203.9 million up from the $163.6 million in 1993. The average rate earned on these funds was 4.44% for 1994, and 3.00% for 1993. TrustCo utilized this category of earning assets during 1994 as a means of keeping strong liquidity during the year as interest rates in the securities markets rose. Rather than invest this excess liquidity during 1994, the Company chose to invest these funds in overnight federal funds sold. This decision had the short term effect of suppressing the potential earnings for 1994, but positioned TrustCo to take advantage of higher interest rates offered near the end of 1994 and into 1995. The increase in federal funds balances during 1994 is not expected to continue during 1995 as the Company reinvests this excess liquidity into higher yielding securities.\nInterest Bearing Sources of Funds: TrustCo utilizes various traditional sources of funds to support its asset portfolio. The following table \"Average Sources of Funding\" presents the various categories of funds used and the corresponding average balances for each of the last two years.\nDeposits: The average of total deposits (including time deposits greater than $100 thousand) was $1.808 billion in 1994 compared to $1.768 billion in 1993. Deposit increases centered in the retail deposit categories of time deposit under $100 thousand (an increase of $39.1 million), and NOW accounts (an increase of $3.5 million). Growth was also experienced in time deposits greater than $100 thousand, which increased by $11.0 million. These increases were offset by decreases in average deposits in regular savings accounts ($3.8 million) and money market deposit accounts ($10.0 million). TrustCo experienced the same trend noted by other financial institutions, namely depositors switching from regular savings type accounts to time deposit products. This was an attempt by depositors to lock in higher rates than those offered on regular savings accounts. By year-end 1994, demand deposits, regular savings, NOW accounts, and money market accounts were down $79.0 million from year-end 1993, while all other deposit accounts increased $74.6 million. The average rate on deposit accounts was 3.50% in 1994, compared to 3.64% in 1993 and 4.74% in 1992. The dramatic reduction in rates from 1992 to 1994 more than offset the modest increases in average balances during this time period thereby producing interest expense that was $15.1 million less in 1994 than it was in 1992, and $848 thousand less than in 1993. For 1995, TrustCo anticipates interest expense to rise as competitive pressures and the depositors desire for higher rates becomes more of a reality. Mutual funds, and the stock and bond markets all compete with financial institutions for the same funds. TrustCo has developed plans for 1995 to add 3 new branches. These new retail outlets will provide new sources of funding and additional opportunities for cross selling to a new deposit base.\nMaturity of 1994 Year end Time deposits over $100 thousand (in thousands)\nUnder 3 months $ 16,547 3 to 6 months 4,099 6 to 12 months 11,132 over 12 months 30,733 -------- $ 62,511\nOther Funding Sources: The Company had $18.1 million of average short-term borrowings and $2.8 million of long-term debt outstanding during 1994. Total purchased liabilities (which includes time deposits over $100 thousand) was $69.6 million in 1994 compared to $59.0 million in 1993. The average rate on short-term borrowings was 2.54% in 1994 and 2.18% in 1993; the average rate on the long-term debt was 7.15% in 1994 and 9.22% in 1993.\nNet Interest Income\nTaxable equivalent net interest income for 1994 was $81.1 million, up $7.1 million or 9.5% over 1993. The yield on average earning assets rose 6 basis points to 7.45% during the year while the rate paid on average interest bearing liabilities dropped 13 basis points to 3.50%. Together, this resulted in a 19 basis point increase in the net spread to 3.95%. While spread is an important consideration, net interest margin is generally viewed as the most significant measure of earning asset performance. The net interest margin increased 22 basis points to 4.26% during 1994.\nAllowance for Loan Losses\nThe balance in the allowance for loan losses has been accumulated over the years through periodic provisions, and is available to absorb losses on loans which have been determined to be uncollectible. The adequacy of the allowance is evaluated continuously, with particular emphasis on non-performing and other loans that management believes warrant special attention. The balance of the allowance is maintained at a level that is, in management's judgment, representative of the amount of risk inherent in the loan portfolio given present and anticipated future conditions.\nThe table \"Summary of Loan Loss Experience\" includes an analysis of the changes to the allowance for the past five years. Loans charged off in 1994 were $4.8 million, compared to $6.7 million in 1993. Recoveries were $1.5 million in 1994, and $2.3 million in 1993. The provisions recorded in 1994 and 1993 were $8.1 million and $11.6 million, respectively.\nNon-Performing Assets (in millions)\n1992 $34.0 1993 $21.1 1994 $17.0\nNet charge-offs as a percentage of average loans were .30% in 1994 and .43% in 1993, while the allowance as a percentage of loans outstanding grew to 3.37% in 1994 from 3.21% in 1993. The Company has a policy of recognizing charge-offs early in a loan's deterioration and then aggressively pursuing collection efforts. This policy of early intervention has proven to be a cornerstone of the strong lending performance that TrustCo has achieved.\nIn 1993, the Financial Accounting Standards Board issued Statement No. 1 14 \"Accounting by Creditors for Impairment of a Loan\" which is effective for TrustCo for 1995. This statement prescribes recognition criteria for loan impairment and measurement methods for certain impaired loans and loans whose terms have been the subject of a renegotiation. TrustCo will adopt the new pronouncement in 1995, and does not anticipate that it will have any material impact on the financial condition or operating results of the Company. A significant percentage of loans that have been identified as in-substance foreclosed real estate and included in real estate owned as of December 31, 1994, will be reclassified to loans under Statement 114.\nInterest Rate Risk\nManagement of interest rate risk involves continual monitoring of the relative sensitivity of asset and liability portfolios to changes in rate due to maturities or repricing. Forecasting models are utilized to quantify the impact of changes in rates on the Company's net income. Specific targets for interest rate sensitivity have been established by the Company.\nInterest rate sensitivity is a function of the repricing of assets and liabilities through maturity and interest rate changes. The objective is to maintain an appropriate balance between income growth and the risk associated with maximizing income through the mismatch of the timing of interest rate changes between assets and liabilities. Perfectly matching this funding can eliminate interest rate risk but net interest income is not always enhanced.\nOne measure of interest rate risk, the so called \"gap,\" is illustrated in the table \"Interest Rate Sensitivity.\"\nThe table measures the incremental and cumulative gap, or the difference between assets and liabilities subject to repricing during the periods indicated. For purposes of this analysis the maturity and repricing of loans is based on the stated maturity or earliest repricing date. For securities available for sale and investment securities, the earlier of average life or stated maturity is used. NOW, money market deposits and regular savings accounts are presented with a maturity or repricing cycle over the full interest rate cycle even though they are subject to immediate withdrawal. Time deposit accounts are presented based upon their maturity dates.\nAt December 31, 1994, the Company's gap position indicates an excess of assets repricing in the 0-90 day period of $462.9 million. This positive gap position is significantly enhanced by the $263.0 million federal funds balance at year end. The gap position turns negative in the 91 to 365 day period and in the 1 to 5 year period. This situation reflects the significant amount of time deposits that mature in these timebands. Over 5 years, the gap position again reflects an excess of repricing assets over liabilities of $490.3 million.\nIn evaluating interest rate sensitivity at year-end 1994, the Company would benefit from an increase in interest rates, as the Bank would be able to redeploy short-term assets that are repricing into higher yielding investments. Conversely, the Company would be negatively affected by a decrease in interest rates, since the assets that are repricing would do so at lower interest rates.\nThe Company's gap position is constantly under evaluation in relation to products, services and the marketplace. The positive gap position at year-end was designed by management to position the Bank to take full advantage of increased interest rates available at that time.\nThere are some shortcomings inherent in the method of analysis presented in the Interest Rate Sensitivity table. For example, although certain assets and liabilities have similar periods to maturity or to repricing, they may react in different degrees to changes in market rates. Also, 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. Additionally, certain assets have features which restrict changes in interest rates on a short-term basis and over the life of the asset (certain annual caps and lifetime caps). Further, in the event of significant change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the table. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase. Management takes these factors into account when reviewing the Bank's gap position and establishing future asset\/liability strategy.\nLiquidity Risk\nTrustCo seeks to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. In addition to serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer initiated needs. Many factors affect the ability to meet liquidity needs, including variations in the markets served by the TrustCo network of branches, the mix of assets and liabilities, and general economic conditions.\nThe Company actively manages its liquidity position through target ratios established under the Asset\/Liability Management policies. Continual monitoring of these ratios, both historically and through forecasts under multiple interest rate scenarios, allows TrustCo to employ strategies necessary to maintain adequate liquidity levels. Management has also developed various liquidity alternatives should abnormal situations arise.\nThe Company achieves its liability-based liquidity objectives in a variety of ways. Net liabilities can be classified into three categories for the purposes of managing liability based liquidity; net core deposits, purchased money and capital market funds. TrustCo seeks deposits that are dependable and predictable, ones that are based as much on interest rate as they are on the level and quality of service. At December 31, 1994, core deposits representing total deposits less those deposits greater than $100,000, amounted to $1.727 billion. Average balances of core deposits are detailed in the table \"Average Sources of Funding.\"\nIn addition to core deposits another funding source available to TrustCo is purchased money. These are principally long and short term borrowings, federal funds purchased, securities sold under repurchase agreements and time deposits greater than $100,000. The average balances of these purchased money instruments are detailed in the table \"Average Sources of Funding.\" During 1994 the average balance in purchased money instruments was $69.6 million, in 1993 it was $59.0 million and in 1992 it was $75.1 million.\nOff-Balance Sheet Risk\nCommitments to extend credit: TrustCo makes contractual commitments to extend credit and extends lines of credit, which are subject to the Bank's credit approval and monitoring procedures. At December 31, 1994 and 1993 commitments to extend credit in the form of loans, including unused lines of credit amounted to $217.3 million and $200.9 million respectively. In the opinion of management, there are no material commitments to extend credit that represent unusual risk.\nLetters of credit and standby letters of credit: TrustCo guarantees the obligations or performance of customers by issuing letters of credit and standby letters of credit to third parties. These letters of credit are frequently issued in support of third party debt, such as corporate debt issuances, industrial revenue bonds and municipal securities. The risk involved in issuing letters of credit and standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off balance sheet products. At December 31, 1994 and 1993 outstanding letters of credit and standby letters of credit were approximately $20.8 million and $21.4 million respectively.\nOther Off-Balance Sheet Risk: TrustCo does not engage in activities involving interest rate swaps, forward placement contracts, options or any other instrument commonly referred to as a \"derivative.\" Management believes these instruments pose a high degree of risk and that investing in them is unnecessary.\nNoninterest Income and Expense\nNoninterest Income: Noninterest income is a significant source of revenue for the Company and an important factor in the overall results for the year. Total noninterest income was $4.6 million for 1994 compared to $19.2 million in 1993. Included in the 1994 results are $8.9 million of securities losses compared to securities gains of $6.2 million during the comparable period in 1993. Excluding these securities transactions, noninterest income would have been $13.4 million and $12.9 million in 1994 and 1993, respectively. As noted earlier, these securities losses for 1994 were realized in an effort to maintain the available for sale portfolio at the year-end higher interest rates. Therefore, future periods will benefit from these enhanced rates.\nThe Trust Department contributes the largest recurring portion of noninterest income through fees generated by the performance of fiduciary services. Income from these fiduciary activities totalled $4.9 million in 1994 and $4.3 million in 1993. This increase was the result of changes in the fees charged on trust accounts.\nThe changes in the other categories of noninterest income reflect the fee scale used by the Bank for pricing its services.\nNoninterest Expense: Noninterest expense was $40.6 million in 1994, $43.5 million in 1993 and $42.8 million in 1992. TrustCo's operating philosophy stresses the importance of monitoring and controlling the level of noninterest expense. The efficiency ratio is a strong indicator of how well controlled and monitored these expenses are for a banking enterprise. The TrustCo efficiency ratio was 41.82% for 1994, 44.63% for 1993 and 51.96% for 1992.\nSalaries and employee benefits are the most significant component of noninterest expense. At year-end 1994, these expenses amounted to $18.3 million compared to $16.6 million and $15.9 million for 1993 and 1992, respectively. The increase in salaries and employee benefits reflect merit increases and raises given to the Bank staff. In addition, increased costs for benefits, such as health insurance and retirement benefits, account for the remainder of the increase.\nExpenses associated with the portfolio of other real estate decreased from $4.7 million in 1993 to $1.0 million in 1994. During 1993 the Company recognized significant write-downs and expenses associated with other real estate properties so as to facilitate their eventual disposition.\nContinued operating efficiency is a cornerstone to TrustCo's operating philosophy. TrustCo is committed to continuing cost control and to the reduction of noninterest expense where possible.\nEfficiency Ratio 1992 51.96% 1993 44.63% 1994 41.82%\nIncome Tax\nIn 1994, TrustCo recognized income tax expense of $12.6 million as compared to $12.5 million in 1993 and $9.3 million in 1992. The tax expense on the Company's income was lower than tax expense at the statutory rate of 35% primarily due to tax exempt income and other permanent differences.\nPrior to January 1, 1993, when it adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" the Company accounted for income taxes under APB No. 11. Statement 109, which calls for an asset\/liability, or balance sheet approach in determining income tax expense, has changed the Company's method of accounting for income taxes from that required under ABP No. 11, which had been the deferred method or income statement approach. Adoption of the new accounting literature did not have any material impact on the results of operation for the year of adoption.\nCapital Resources\nConsistent with its long-term goal of operating a sound and profitable financial organization, TrustCo strives to maintain strong capital ratios. New issues of equity securities have not been required, since most of the Company's capital requirements have been provided through retained earnings.\nPart of the operating philosophy of TrustCo is that the Company will not retain any excess capital. All capital that is generated by the Company that is in excess of the levels considered by management to be necessary for the safe and sound operations of the Company will be distributed to the shareholders in the form of recurring or special cash dividends. Consequently, the capital ratios that are maintained are adequate but not excessive. This philosophy has led to a dividend payout ratio for 1994 of 63.71%, 1993 of 57.93% and 1992 of 51.05%. These are significant payouts to the Company shareholders and are considered by management to be a prudent use of the retained capital in TrustCo. As to the likelihood of future dividends, the philosophy stated above will continue into 1995 and where appropriate the Board of Directors will declare dividends consistent with that operating philosophy.\nDividends Per Share\n1992 $0.62 1993 $0.80 1994 $0.98\nAt December 31, 1994 TrustCo's Tier 1 capital was $139.3 million or 12.08% of risk adjusted assets. The Tier 1 capital to total assets or the leverage ratio at December 31, 1994 was 7.05% as compared to 6.59% in 1993 and 6.19% in 1992. At December 31, 1994 the subsidiary bank, Trustco Bank met the regulatory definition of a \"well capitalized\" institution.\nThe Bank has converted to a nationally chartered bank, and in early 1995 changed its legal name to Trustco Bank, National Association. All of the current operations of the Bank are consistent with those allowed of a nationally chartered bank. Therefore, management does not believe that the operations will be inhibited in any fashion. The national charter allows the Bank to streamline its regulatory process by having the Office of the Comptroller of the Currency as the primary bank regulator.\nAs mentioned earlier, Trustco will be expanding its branch network by three locations in 1995. It is not anticipated that additional capital will be required to support this expansion program. Likewise, operating costs during 1995 can be expected to rise modestly as a result of these new branches, but will be offset by the additional revenue the new branches will generate.\nImpact of Inflation and Changing Prices\nThe consolidated financial statements 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 the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increasing costs of operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary. As a result, interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation, since interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.\nImpact of Changes in Accounting Standards\nACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS: On January 1, 1993, the Company adopted Statement 106 \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" In implementing the new accounting standard, the Company recorded a one time transition charge of $3.3 million, net of tax benefits, which is reflected as a cumulative effect of a change in accounting principle in the 1993 consolidated statement of income.\nACCOUNTING FOR INCOME TAXES: On January 1, 1993, the Company adopted Statement 109 \"Accounting for Income Taxes.\" Statement 109 significantly changed the method of accounting for income taxes for financial statement purposes without affecting the actual cash tax liability. In adopting Statement 109, the Company elected not to restate prior period financial results. The implementation of Statement 109 had no material impact on the 1993 results of operations. The Company's complete disclosure related to Statement 109 is included in the notes to the consolidated financial statements.\nACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN: In May 1993, Statement 114 \"Accounting by Creditors for Impairment of a Loan\" was issued. The Statement is effective for fiscal years beginning after December 15, 1994 (for TrustCo this statement will be effective for 1995). This Statement requires that an impaired loan be measured based on the present value of expected future cash flows or, for a loan whose repayment is collateral dependent, based on the collateral's observable market price. The Statement also narrows the application of the concept of in-substance foreclosures to situations where the creditor has received physical possession of the debtor's collateral regardless of whether formal foreclosure proceedings have taken place. The adoption of Statement 114 is not anticipated to have a material impact on the financial condition or results of operation of the Company. Upon adoption, a significant percentage of the loans identified at year-end 1994 as in-substance foreclosures will be reclassified into the loan portfolio.\nACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. The Company adopted Statement 115 \"Accounting for Certain Investments in Debt and Equity Securities\" effective January 1, 1994. Upon adoption of Statement 115, the Company identified securities that are \"available for sale\" and those that are \"held to maturity\" (the Company has no trading account assets as prescribed by Statement 115). Securities classified as available for sale are those that can be sold in response to changes in market interest rates, liquidity requirements, or other investment alternatives. Securities classified as held to maturity are not available for sale and are held until contractual maturity or call. Securities available for sale are recorded at market value with the unrealized appreciation and depreciation, net of tax, recorded as an element of shareholders' equity. Securities identified as held to maturity are recorded at amortized cost.\nGlossary of Terms\nBook Value Per Share Total shareholders' equity divided by shares outstanding on the same dates. This provides an indication of the value of a share of stock.\nCash Dividends Per Share Total cash dividends declared divided by average shares outstanding for the period.\nDerivative Investments These are investments in futures contracts, forwards, swaps, or option contracts, or other investments with similar characteristics.\nEarning Assets The sum of interest-bearing deposits with banks, securities available for sale, investment securities, loans in accrual status and federal funds sold.\nEarnings Per Share Net income divided by the average shares of common stock outstanding during the period including the effect of stock options.\nEfficiency Ratio Noninterest expense (excluding nonrecurring charges and other real estate expense) divided by taxable equivalent net interest income plus noninterest income (excluding securities transactions). This is an indicator of the total cost of operating the Company in relation to total income generated.\nInterest-Bearing Liabilities The sum of interest-bearing deposits, federal funds purchased, securities sold under agreements to repurchase, other short term borrowings and long term debt.\nInterest Rate Spread The difference between the taxable equivalent yield on earning assets and the rate paid on interest bearing liabilities.\nLiquidity The ability to meet both loan commitments and deposit withdrawals as they come due.\nNet Interest Margin Fully taxable equivalent net interest income as a percentage of average earning assets.\nNet Loans Charged Off Reductions to the allowance for loan losses written off as losses, net of the recovery of loans previously charged off.\nNon-Accrual Loans Loans for which no periodic accrual of interest income is recognized.\nNon-Performing Assets The sum of non-performing loans plus real estate owned.\nNon-Performing Loans The sum of loans on a non-accrual basis (for purposes of interest recognition) plus loans whose repayment criteria have been renegotiated to less than market terms due to the inability of the borrowers to repay the loan in accordance with their original terms plus loans 90 days or more past due as to principal or interest payments.\nParent Company A company that owns or controls a subsidiary through the ownership of voting stock.\nReal Estate Owned Real estate acquired in either formal or, where the borrower's circumstances appear to make actual foreclosure likely, in-substance foreclosures.\nReturn on Average Assets Net income as a percentage of average total assets.\nReturn on Average Equity Net income as a percentage of average equity, excluding the impact of the mark to market adjustment for securities available for sale.\nTaxable Equivalent (TE) Tax exempt income which has been adjusted to an amount that would yield the same after tax income had the income been subject to taxation at the statutory Federal and\/or state income tax rates.\nManagement's Statement of Responsibilities\nThe management of TrustCo Bank Corp NY (the \"Company\") is responsible for the preparation, content and integrity of the financial statements and other statistical data and analyses compiled for this report. The consolidated financial statements and related notes have been prepared in conformity with generally accepted accounting principles and, in the judgment of management, present fairly and consistently the Company's financial position, results of operations and cash flows. Management also believes that financial information elsewhere in this report is consistent with that in the financial statements. The amounts contained in the financial statements are based on management's best estimates and judgments.\nThe Company maintains a system of internal controls and accounting procedures designed to provide reasonable assurance as to the protection of assets and the integrity of the financial statements. These procedures include management's evaluation of asset quality, organizational arrangements that provide an appropriate division of responsibilities, and a program of internal audits to evaluate independently the adequacy and application of financial and operating controls.\nThe Board of Directors discharges its responsibility for TrustCo's financial statements through its Audit Committee which is composed entirely of outside directors and has responsibility for the recommendation of the independent auditors.\nManagement has made an assessment of the Company's internal control structure and procedures, covering financial reporting using established and recognized criteria. On the basis of this assessment, management believes that the Company maintained an effective system of internal control for financial reporting as of December 31, 1994.\nRobert A. McCormick President and Chief Executive Officer\nRobert T. Cushing Vice President and Chief Financial Officer\nJanuary 27, 1995\nIndependent Auditors' Report\nThe Board of Directors and Shareholders of TrustCo Bank Corp NY:\nWe have audited the accompanying consolidated statements of condition of TrustCo Bank Corp NY and subsidiaries 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 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 TrustCo Bank Corp NY 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 4 to the consolidated financial statements, in 1994 the Company adopted the provisions of Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" which changed its method of accounting for certain investments in debt and equity securities. As discussed in notes 1 and 8 to the consolidated financial statements, in 1993 the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" which changed its method of accounting for income taxes. As discussed in note 9 to the consolidated financial statements, the Company also 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\" in 1993 which changed its method of accounting for postretirement benefits other than pensions.\nAlbany, New York January 27, 1995\nNotes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies\nBasis of Presentation\nThe accounting and financial reporting policies of TrustCo Bank Corp NY (Company or TrustCo) and Trustco Bank, National Association (Bank or Trustco) conform to general practices within the banking industry and are in accordance with generally accepted accounting principles. A description of the more significant policies follows. The Bank has converted to a national banking association from the previous charter as a state banking association. Upon conversion, the Bank changed its name to TRUSTCO BANK, NATIONAL ASSOCIATION. The conversion was finalized during the first quarter of 1995 and will have no effect on the Bank's operations.\nConsolidation\nThe consolidated financial statements of the Company include the accounts of the subsidiaries after elimination of all significant intercompany accounts and transactions.\nSecurities Available for Sale\nSecurities available for sale are carried at market value (for 1994) and lower of cost or market (for 1993) with any unrealized appreciation or depreciation of value, net of tax, (for 1994) included as an element of the capital accounts. Management maintains an available for sale portfolio in order to provide maximum flexibility in future balance sheet management. The designation of available for sale is made at the time of purchase based upon management's intent to hold the securities for an indefinite period of time. These securities, however, would be available for sale in response to changes in market interest rates, related changes in liquidity needs or changes in the availability of and yield on alternative investments. Unrealized losses on securities that reflect a decline in value which is other than temporary, if any, are charged to income. Nonmarketable equity securities (principally stock of the Federal Reserve Bank and the Federal Home Loan Bank) are included in securities available for sale at cost since there is no readily available market value.\nGains and losses on the sale of securities available for sale are based on the amortized cost of the specific security sold.\nInvestment Securities\nSecurities classified as investment securities are held to maturity to meet longer term investment objectives, including yield and liquidity purposes. At the time of purchase, securities are identified as held for investment based upon the Company's intention and ability to hold the securities to maturity. Investment securities are carried at cost, adjusted for amortization of premium and accretion of discounts on a method that equates to the level yield. Unrealized losses on securities that reflect a decline in value which is other than temporary, if any, are charged to income.\nLoans\nLoans are carried at the principal amount outstanding net of unearned income and unamortized loan fees and costs, which are amortized into income over the applicable loan period.\nNon-performing loans include non-accrual loans, restructured loans and loans which are 90 days or more past due and still accruing interest. Generally, loans are placed on non-accrual status, either due to the delinquency status of principal and\/or interest payments, or a judgment by management that, although payments of principal and\/or interest are current such action is prudent. Future payments received on non-performing loans are recorded as interest income or principal reductions based upon management's ultimate expectation for collections.\nAllowance for Loan Losses\nAn allowance for loan losses is maintained at a level considered adequate by management to provide for potential loan losses based on analysis of the credit risk of the loan portfolio including a review of past loan experience, current economic conditions and the underlying collateral value. The allowance is increased by provisions charged against income and reduced by net charge-offs.\nIn addition, various regulatory agencies as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowances based on their judgments of information available to them at the time of their examination.\nBank Premises and Equipment\nPremises and equipment are stated at cost less accumulated depreciation and amortization computed on either the straightline or accelerated methods over the remaining useful lives of the assets.\nReal Estate Owned\nReal estate owned includes assets received from foreclosures and in-substance foreclosures. A loan is considered an in-substance foreclosure when little or no equity of the borrower is present in the underlying collateral, considering the current fair value of the collateral; proceeds for repayment of the loan can be expected to come only from the operation or sale of the collateral; control of the collateral is effectively abandoned, or because of the current financial condition it is doubtful that equity will be rebuilt or the loan repaid in the foreseeable future.\nForeclosed assets, including in-substance foreclosures, held for sale are recorded on an individual basis at the lower of (1) fair value minus estimated costs to sell or (2) \"cost\" (defined as the fair value at initial foreclosure). When a property is acquired or identified as in-substance foreclosure, the excess of the loan balance over fair value is charged to the allowance for loan losses. Subsequent write downs are included in other noninterest expense.\nIncome Taxes\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" and has chosen not to restate prior year financial statements. 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.\nDividend Restrictions\nBanking regulations restrict the amount of cash dividends which may be paid during a year by the Bank to the Parent Company without the written consent of the appropriate bank regulatory agency. Based on these restrictions, the Bank could pay $29.8 million plus 1995 net profits. For all practical purposes, TrustCo could not declare dividends to shareholders materially in excess of the aggregate amount of dividends that could be paid by the Bank.\nPension Plan\nThe Company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employee's compensation. The cost of this program is being funded currently.\nReclassification of Prior Year Statements\nIt is the Company's policy to reclassify prior year financial statements to conform to the current year presentation.\n(2) Balances at Other Banks\nThe Bank is required to maintain certain reserves of vault cash and\/or deposits with the Federal Reserve Bank. The amount of this reserve requirement, included in cash and due from banks, was approximately $14,576,000 and $15,986,000 at December 31, 1994 and 1993, respectively.\n(3) Securities Available for Sale\nThe amortized cost and approximate market value of the securities available for sale are as follows:\nThe anticipated maturity schedule of amortized cost and market value of securities available for sale at December 31, 1994, follows:\nProceeds from sales of securities available for sale during 1994 and 1993 were approximately $1,015,688,000, and $99,475,000, respectively. During 1992 there were no sales of securities available for sale.\nThe gross realized gains on sales of securities available for sale in 1994 and 1993 were approximately $5,799,000 and $5,867,000, respectively.\nGross realized losses on the sales of securities available for sale in 1994 and 1993 were $14,682,000 and $2,000, respectively.\nThe amortized cost of securities available for sale that have been pledged to secure public deposits and for other purposes required by law amounted to $44,430,000, and $41,219,000 at December 31, 1994 and 1993, respectively.\n(4) Investment Securities\nThe book value and approximate market value of the investment securities are as follows:\nThe anticipated maturity schedule of book values and market values of investment securities at December 31, 1994 follows:\nThe maturity of mortgage-backed securities is based on the security's average life. There were no sales of investment securities during 1994. Proceeds from sales of investment securities during 1993 and 1992 were $1,877,000 and $107,639,000, respectively. Gross realized gains on sales of equity instruments in 1993 were approximately $229,000.The gross realized gains on sales and calls of investment securities in 1992 were $3,346,000. Gross realized losses on sales of equity instruments in 1993 were approximately $21,000. Gross realized losses on the sales and calls of debt instruments for 1992 were $407,000.\nThe book value of investment securities pledged to secure public deposits and for other purposes required by law amounted to $135,050,000, and $85,634,000 at December 31, 1994 and 1993, respectively.\nThe Company adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" as of January 1, 1994. The Company classified certain of the investment securities as being available for sale and reclassified these balances to a separate line on the consolidated statement of condition. Securities included in the available for sale category may be sold in response to changes in market interest rates and related changes in a security's prepayment risk, needs for liquidity, changes in the availability of and the yield on alternative investments or changes in funding sources and terms. These securities are recorded at market value with any net unrealized gains (losses) shown as a component of shareholders' equity.\nIn addition, the Company has identified a portfolio of investment securities which are being held to maturity. In accordance with Statement 115 these securities cannot be sold except in very limited circumstances as described in the Statement.\n(5) Loans and Allowance for Loan Losses\nAt December 31, 1994 and 1993, loans to executive officers, directors and to associates of such persons aggregated $7,641,000 and $11,163,000, respectively. During 1994, new loans of $4,638,000 were made and repayments of loans totalled $8,160,000. In the opinion of management, such loans 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. These loans do not involve more than normal risk of collectibility or present other unfavorable features.\nTrustCo primarily lends in the Capital District region of New York State and in the geographic territory surrounding its borders. Although the loan portfolio is diversified, a substantial portion of its debtors ability to repay is dependent upon the economic conditions existing in New York State.\nThe following table sets forth the information with regard to non-performing loans:\nInterest on non-accrual and restructured loans of $222 thousand, $1 thousand and $79 thousand, would have been earned in accordance with the original contractual terms of the loans in 1994, 1993 and 1992, respectively. Approximately $35 thousand, $1 thousand and $61 thousand of interest on non-accrual and restructured loans was collected and recognized as income in 1994, 1993 and 1992, respectively. There are no commitments to extend further credit on non-accrual or restructured loans.\nTransactions in the allowance for loan losses accounts are summarized as follows:\nOn May 31, 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan.\" Statement 114, which is effective for financial statements issued for fiscal years beginning after December 15, 1994, prescribes recognition criteria for loan impairment and measurement methods for certain impaired loans and loans whose terms are modified in troubled-debt restructurings. Statement 114 will be adopted effective January 1, 1995. At that time, a significant amount of the assets currently identified as in- substance foreclosures will be reclassified to loans, and, for the most part, included in the category of impaired loans. Other than this reclassification of the balances of in-substance foreclosure loans, the adoption of Statement 114 is not anticipated to have a material impact on the results of operations of the Company.\nThere are $8.4 million and $11.4 million of loans pledged for various purposes at December 31, 1994 and 1993, respectively.\n(6) Bank Premises and Equipment\nA summary of premises and equipment at December 31, 1994 and 1993 follows:\nDepreciation and amortization expense approximated $2,749,000, $2,373,000 and $2,245,000 for the years 1994, 1993 and 1992, respectively. Occupancy expense of Bank premises included rental expense of $1,053,000, $1,388,000 and $1,430,000 for the years 1994, 1993 and 1992, respectively.\n(7) Short-term Borrowings\nShort-term borrowings, consisting primarily of Securities sold under agreements to repurchase with maturities of generally less than ninety days, was as follows:\nThe Company has available $202.3 million of unused lines of credit at December 31, 1994.\n(8) Income Taxes\nA summary of income tax expense (benefit) included in the consolidated statements of income follows:\nPrior to 1993, the Company accounted for income taxes under APB11. Under APB 11, deferred tax expense (benefit) resulted from timing differences in the recognition of revenue and expense for tax and financial statement purposes. Effective January 1, 1993, the Company adopted Statement 109. The effect of adoption was not material to the financial statements.\nThe sources of these differences and the tax effect for 1992 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 is presented below.\nThe valuation allowance as established by management takes into consideration the historical level of taxable income in the prior years as well as the time period that the items giving rise to the deferred tax assets turn around.\nThe effective tax rates differ from the statutory federal income tax rate. The reasons for these differences are as follows:\nIn addition to the deferred tax asset described in the preceding table, the Company also has a deferred tax asset of $29,000 relating to the unrealized loss on securities available for sale.\n(9) Employee Benefits\nThe Company maintains a trusteed non-contributory pension plan covering employees that have completed one year of employment and 1,000 hours. The benefits are based on the sum of (a) a benefit equal to a prior service benefit plus the average of the employees' highest five consecutive years compensation in the ten years preceding retirement multiplied by a percentage of service after a specified date plus (b) a benefit based upon career average compensation. The amounts contributed to the plan are determined annually on the basis of (a) the maximum amount that can be deducted for federal income tax purposes or (b) the amount certified by a consulting actuary as necessary to avoid an accumulated funding deficiency as defined by the Employee Retirement Income Security Act of 1974. 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. Assets of the plan are primarily invested in common stock and fixed income common funds administered by the Bank. The following table sets forth the plans' funded status and amounts recognized in the Company's consolidated statements of condition at December 31, 1994 and 1993:\nThe actuarial assumptions used in determining the actuarial present value of projected benefit obligations and the net pension costs were as follows:\nThe Company also has an unfunded defined contribution supplementary pension plan under which additional retirement benefits are accrued for eligible senior and executive officers. The expense recorded for this plan was $1,780,000, $489,000 and $392,000 in 1994, 1993 and 1992, respectively.\nThe Company provides a profit-sharing plan for substantially all employees. The expense of this plan, which is based on management discretion as defined in the plan, amounted to $1,230,000, in 1994, $1,470,000 in 1993, and $1,344,000 in 1992.\nThe Company also has an executive incentive plan. The expense of this plan is based on the Bank's performance and estimated distributions to participants are accrued during the year and generally paid in the following year. The expense recorded for this plan was $1,291,000, $419,000 and $393,000 in 1994, 1993 and 1992 respectively.\nUnder the terms of the Company's Stock Option Plan the following table presents a summary of activity with respect to this plan:\nUnder the terms of the Directors' Stock Option Plan, 110,000 shares are reserved for director options. As of December 31, 1994, 34,100 options remain issued and outstanding with an average exercise price of $19.83.\nIn December 1990, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Statement 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 that employees render service to earn the benefits. The Company permits retirees under age 65 to participate in the Company's medical plan by paying the same premium as the active employees. At age 65, the Bank provides a Medicare Supplemental Program to retirees.\nSince these benefits are currently being provided, the Company adopted Statement 106 effective January 1, 1993, and has reported the cumulative effect of that change in the December 31, 1993 Consolidated Statement of Income.\nAccumulated postretirement benefit obligation at December 31, 1994 and 1993:\nNet periodic postretirement benefit cost for 1994 and 1993 includes the following components:\nExpense for 1993 related to the transition obligation was $5.3 million, with an after-tax cost of $3.3 million. Periodic benefit cost amounted to $467 thousand for 1993. The Company funded the plan in full through the use of a benefit trust during the first quarter of 1993. As a result, periodic benefit costs in future years are expected to decrease. Assets of the plan are primarily invested in common stock and fixed income common funds administered by the Bank.\nThe trust holding the plan assets is subject to federal income taxes at a 35.0 percent tax rate. The expected long term rate of return on plan assets, after estimated income taxes was 4.2 percent and 3.3 percent for the years ended December 31, 1994 and 1993, respectively.\nFor measurement purposes, a 12 percent annual rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) was assumed for 1994; the rate was assumed to decrease gradually to 5.75 percent by the year 2002 and remain at that level thereafter.\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 accumulated postretirement benefit obligation as of December 31, 1994, by approximately $1.4 million, and the aggregate of the service and the interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1994, by approximately $274 thousand. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 6.75 percent at December 31, 1994 and 1993.\n(10) Lease Commitments and Contingent Liabilities\n(A) LEASES\nThe Bank leases certain banking premises. These leases are accounted for as operating leases with minimum rental commitments in the amounts presented below. The majority of these leases contain options to renew.\n(B) LITIGATION\nExisting litigation arising in the normal course of business is not expected to result in any material loss to the Company.\n(11) Off-Balance-Sheet Financing\nLoan commitments 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 a fee.\nCommitments sometimes expire without being drawn upon, therefore the total commitment amounts do not necessarily represent future cash requirements. These arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Bank's normal credit policies including obtaining collateral. The Bank's exposure to credit loss for loan commitments including unused lines of credit outstanding at December 31, 1994 and 1993 was $217.3 million and $200.9 million, respectively.\nStandby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These arrangements have credit risk essentially the same as that involved in extending loans to customers and are subject to the Bank's normal credit policies including the obtaining of collateral. The Bank's exposure to credit loss for standby letters of credit outstanding at December 31, 1994 and 1993 was $20.8 million and $21.4 million, respectively. No losses are anticipated as a result of loan commitments or standby letters of credit.\n(12) Fair Value of Financial Instruments\nThe fair values shown below represent management's estimates of values at which the various types of financial instruments could be exchanged in transactions between willing, unrelated parties. They do not necessarily represent amounts that would be received or paid in actual trades of specific financial instruments.\nThe specific estimation methods and assumptions used can have a substantial impact on the resulting fair values ascribed to financial instruments. Following is a brief summary of the significant methods and assumptions used in the above table:\nCash and Cash Equivalents\nThe carrying values of these financial instruments approximates fair values.\nSecurities\nFair values for all securities portfolios are based upon quoted market prices, where available. The carrying value of certain local, unrated municipal obligations was used as an approximation of fair value.\nLoans\nThe fair values of all loans are estimated using discounted cash flow analyses with discount rates equal to the interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.\nDeposit Liabilities\nThe fair values disclosed for noninterest-bearing deposits, NOW accounts, savings accounts and money market accounts are, by definition, equal to the amount payable on demand at the balance sheet date. The carrying value of all variable rate certificates of deposit is assumed to approximate fair value. The fair value of all other fixed rate certificates of deposit are estimated using discounted cash flow analyses with discount rates equal to the interest rates currently being offered on certificates of similar size and remaining maturity. At December 31, 1994, the fair value of fixed rate certificates of deposit are assumed to equal carrying value due to the interest rate environment at year-end 1994.\nBorrowings and Other Financial Instruments\nThe fair value of all borrowings and other financial instruments is assumed to be the carrying value.\nFinancial Instruments with Off-Balance Sheet Risk\nThe Company is a party to financial instruments with off-balance sheet risk. Such financial instruments consist of commitments to extend financing and letters of credit. If the commitments are exercised by the prospective borrowers, these financial instruments will become interest-earning assets of the Company. If the commitments expire, the Company retains any fees paid by the prospective borrower. The fair value of commitments is estimated based upon fees currently charged to enter into similar agreements, taking into consideration the remaining terms of the agreements and the present credit-worthiness of the borrower. For fixed rate commitments, the fair value estimation takes into consideration an interest rate risk factor. The fair value of these off-balance sheet items at December 31, 1994 and 1993 approximates the recorded amounts of the related fees, which are considered to be immaterial.\nThe Company has no derivative investment products at year-end 1994 and 1993, nor has the Company ever invested in such investment vehicles. Therefore, the disclosures as required by Statement of Financial Accounting Standards No. 119 \"Disclosures about Derivative Financial Instruments and Fair Value of Financial Instruments\" is not presented except as it relates to fair value disclosures in this footnote.\n(13) Parent Company Only\nThe following statements pertain to TrustCo Bank Corp NY (Parent Company):\nTrustCo Bank Corp NY Officers and Board of Directors\nOfficers\nPRESIDENT AND CHIEF EXECUTIVE OFFICER Robert A. McCormick\nVICE PRESIDENT AND CHIEF FINANCIAL OFFICER Robert T. Cushing\nVICE PRESIDENT Nancy A. McNamara\nSECRETARY William F. Terry\nBoard of Directors\nBarton A. Andreoli President Towne Construction and Paving Co.\nLionel O. Barthold Vice-Chairman, Power Technologies, Inc. (Consulting Engineers)\nM. Norman Brickman President, D. Brickman, Inc. (Wholesale Fruit and Produce)\nCharles W. Carl, Jr. Retired, Former President, The Carl Company (Department Store)\nRobert A. McCormick President and Chief Executive Officer Trustco Bank\nNancy A. McNamara Senior Vice President Trustco Bank\nDr. John S. Morris President Emeritus, Union College and Former Chancellor, Union University\nJames H. Murphy, D.D.S. Orthodontist\nRichard J. Murray, Jr. President, R.J. Murray Co., Inc. (Air Conditioning Distributors)\nKenneth C. Petersen President Schenectady International, Inc.\nWilliam J. Purdy President Welbourne & Purdy Realty, Inc.\nWilliam F. Terry Senior Vice President and Secretary Trustco Bank\nPhilip J. Thompson Retired, Former Vice President, and Director New York Telephone\nDirectors of TrustCo Bank Corp NY are also Directors of Trustco Bank\nHONORARY DIRECTORS Donald E. Craig Dr. Caryl P. Haskins Bernard J. King H. Gladstone McKeon William H. Milton, III Daniel J. Rourke, M.D. Anthony M. Salerno Edwin O. Salisbury Harry E. Whittingham, Jr. Henry D. Wright\nTrustco Bank Officers\nPRESIDENT AND CHIEF EXECUTIVE OFFICER Robert A. McCormick\nSENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER Robert T. Cushing\nSENIOR VICE PRESIDENT Nancy A. McNamara\nSENIOR VICE PRESIDENT Ralph A. Pidgeon\nSENIOR VICE PRESIDENT AND SECRETARY William F. Terry\nAUDITOR John C. Fay\nACCOUNTING\/FINANCE, DATA PROCESSING, GENERAL SERVICES Senior Vice President and Chief Financial Officer Robert T. Cushing\nACCOUNTING\/FINANCE Administrative Vice President Linda C. Christensen\nDATA PROCESSING Administrative Vice President William H. Milton\nSenior Information Services Officer Daneille M. Eddy\nGENERAL SERVICES Administrative Vice President Peter A. Zakriski\nHUMAN RESOURCES, LEGAL COUNSEL, LOAN DIVISION, MANAGEMENT INFORMATION SERVICES, QUALITY CONTROL Senior Vice President Nancy A. McNamara\nHUMAN RESOURCES, MANAGEMENT INFORMATION SERVICES, QUALITY CONTROL Vice President Ann M. Noble\nManagement Information Officer Lynn D. Hackler\nLEGAL COUNSEL Vice President Henry C. Collins\nVice President George W. Wickswat\nLOAN DIVISION\nCOMMERCIAL LOANS Administrative Vice President Donald J. Csaposs\nSenior Commercial Loan Officer John H. Cunningham\nCommercial Loan Officers Timothy C. Larson Richard G. Roberts\nMORTGAGE LOANS Senior Mortgage Officer Elinore J. Vine\nBRANCHES, INSTALLMENT LOANS\/CREDIT CARDS, RETIREMENT\/GOVERNMENT ACCOUNTS Senior Vice President Ralph A. Pidgeon\nBRANCH OFFICERS Richard E. Bailey Thomas H. Lauster\nINSTALLMENT LOANS\/CREDIT CARDS Senior Installment Loan Officer Thomas M. Poitras\nBANK OPERATIONS, MARKETING\/COMMUNITY RELATIONS, TRUST DEPARTMENT Senior Vice President William F. Terry\nBANK OPERATIONS Administrative Vice President James D. McLoughlin\nMARKETING\/COMMUNITY RELATIONS Vice President Madeline S. Busch\nTRUST DEPARTMENT Administrative Vice President Carroll E. Winch\nVice President and Senior Trust Officer James Niland\nVice President and Senior Trust Officer Matthew G. Waschull\nTrust Officer John P. Fulgan\nInvestment Officer Robert Scribner\nBranch Locations\nAltamont Ave. Office 1400 Altamont Ave. Schenectady Telephone: 356-1317\nAltamont Ave. West Office 1900 Altamont Ave. Rotterdam Telephone: 355-1900\nBay Road Office 292 Bay Road Queensbury Telephone: 792-2691\nBrandywine Office State St. at Brandywine Ave. Schenectady Telephone: 346-4295\nCentral Avenue Office 163 Central Ave. Albany Telephone: 426-7291\nClifton Park Office 1018 Route 146 Clifton Park Telephone: 371-8451\nClifton Country Road Office 7 Clifton Country Road Clifton Park Telephone: 371-5002\nColonie Office 1892 Central Ave. Colonie Plaza, Colonie Telephone: 456-0041\nDelmar Office 167 Delaware Ave. Delmar Telephone: 439-9941\nEast Greenbush Office 501 Columbia Turnpike Rensselaer Telephone: 479-7233\nGlens Falls Office 3 Warren Street Glens Falls Telephone: 798-8131\nGreenwich Office 131 Main St. Greenwich Telephone: 692-2233\nGuilderland Office 3900 Carman Road Schenectady Telephone: 355-4890\nHalfmoon Office Country Dollar Plaza Halfmoon Telephone: 371-0593\nHoosick Falls Office 47 Main St. Hoosick Falls Telephone: 686-5352\nHudson Office 507 Warren St. Hudson Telephone: 828-9434\nHudson Falls Office 3376 Burgoyne Avenue Hudson Falls Telephone: 747-0886\nLatham Office 1 Johnson Road Latham Telephone: 785-0761\nLoudon Plaza Office 372 Northern Blvd. Albany Telephone: 462-6668\nMadison Avenue Office 1084 Madison Ave. Albany Telephone: 489-4711\nMain Office 320 State St. Schenectady Telephone: 377-3311\nMalta Mall 43 Round Lake Road Ballston Lake Telephone: 899-1558\nMayfair Office Saratoga Road at Mayfair Glenville Telephone: 399-9121\nMont Pleasant Office Crane St. at Main Ave. Schenectady Telephone: 346-1267\nNew Scotland Office 301 New Scotland Ave. Albany Telephone: 438-7838\nNewton Plaza Office 588 New Loudon Road Latham Telephone: 786-3687\nNiskayuna-Woodlawn Office 3461 State St. Schenectady Telephone: 377-2264\nPlaza Seven Office 1208 Troy-Schenectady Road Latham Telephone: 785-4744\nQueensbury Office 33 Quaker Road Queensbury Telephone: 798-7226\nRotterdam Office Curry Road Shopping Ctr. Rotterdam Telephone: 355-8330\nRotterdam Square Office 2 Campbell Road Rotterdam Telephone: 377-2393\nRoute 9 Office-Latham 754 New Loudon Rd. Latham Telephone: 786-8816\nSheridan Plaza Office 1350 Gerling St. Schenectady Telephone: 377-8517\nShoppers' World Office Old Rte. 146 and Plank Rd. Clifton Park Telephone: 383-6851\nState Farm Road Office 2050 Western Ave. Guilderland Telephone: 452-6913\nState Street Office 112 State St. Albany Telephone: 436-9043\nStuyvesant Plaza Office Western Ave. at Fuller Road Albany Telephone: 489-2616\nTanners Main Office 345 Main Street Catskill Telephone: 943-2500\nTanners West Side Office 238 West Bridge St. Catskill Telephone: 943-5090\nTroy Office 5th Ave. and State St. Troy Telephone: 274-5420\nUnion Street East Office 1700 Union St. Schenectady Telephone: 382-7511\nUpper New Scotland Office 583 New Scotland Ave. Albany Telephone: 438-6611\nUpper Union Street Office 1620 Union St. Schenectady Telephone: 374-4056\nWilton Mall Office Route 50 Saratoga Springs Telephone: 583-1716\nWolf Road Office 34 Wolf Road Albany Telephone: 458-7761\nGeneral Information\nANNUAL MEETING Monday, May 15, 1995 12:00 Noon Glen Sanders Mansion One Glen Avenue Scotia, New York 12302\nCORPORATE HEADQUARTERS 320 State Street Schenectady, New York 12305 (518-377-3311)\nDIVIDEND REINVESTMENT PLAN A Dividend Reinvestment Plan is available to shareholders of TrustCo Bank Corp NY. It provides for the reinvestment of cash dividends and optional cash payments to purchase additional shares of TrustCo stock. The Plan is free of administrative charges, and provides a convenient method of acquiring additional shares. Trustco Bank, our wholly owned bank subsidiary, acts as administrator for this service, and has designated Glens Falls National Bank and Trust Company to act as agent for shareholders in these transactions. Shareholders who want additional information may contact the TrustCo Shareholder Services Department (518-381-3699, ext. 1292).\nEQUAL OPPORTUNITY AT TRUSTCO Trustco Bank is an Affirmative Action Equal Opportunity Employer.\nFORM 10-K TrustCo Bank Corp NY will provide without charge a copy of its Form 10-K upon written request. Requests and related inquiries should be directed to William F. Terry, Secretary, TrustCo Bank Corp NY, P.O. Box 1082, Schenectady, New York 12301-1082.\nNASDAQ SYMBOL: TRST The Corporation's common stock is traded on the NASDAQ National Market System.\nSUBSIDIARIES: Trustco Bank, National Association Schenectady, New York Member FDIC ORE Subsidiary Corp. Schenectady, New York\nTRANSFER AGENT Trustco Bank Securities Department P.O. Box 380 Schenectady, New York 12301-0380\nExhibit 21\nLIST OF SUBSIDIARIES OF TRUSTCO\nTrustco Bank, National Association.........Nationally chartered banking association ORE Subsidiary Corp........................New York corporation\nExhibit 23\nKPMG Peat Marwick LLP 74 North Pearl Street Albany, NY 12207\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nThe Board of Directors TrustCo Bank Corp NY:\nWe consent to incorporation by reference in the Registration Statements, Form S-8 (No. 33-43153) filed on October 3, 1991, Form S-8 (No. 33-67176) filed on August 6, 1993, and Form S-8 (No. 33-43153) filed on March 21, 1995 of TrustCo Bank Corp NY and subsidiaries of our report dated January 27, 1995, relating to the consolidated statements of condition of TrustCo Bank Corp NY and subsidiaries 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 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 TrustCo Bank Corp NY. Our report refers to the adoption of the provisions of 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. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\"\n\/s\/ KPMG Peat Marwick LLP\nAlbany, New York March 27, 1995\nExhibit 24 POWER OF ATTORNEY\nThe undersigned persons do hereby appoint William F. Terry or Robert T. Cushing as a true and lawful Attorney In Fact for the sole purpose of affixing their signatures to the 1994 Annual Report (Form 10-K) of TrustCo Bank Corp NY to the Securities and Exchange Commission.\n\/s\/Barton A. Andreoli \/s\/Lionel O. Barthold Barton A. Andreoli Lionel O. Barthold\n\/s\/M. Norman Brickman \/s\/Charles W. Carl, Jr . M. Norman Brickman Charles W. Carl, Jr.\n\/s\/Robert A. McCormick \/s\/Nancy A. McNamara Robert A. McCormick Nancy A. McNamara\n\/s\/Dr. John S. Morris \/s\/Dr. James H. Murphy Dr. John S. Morris Dr. James H. Murphy\n\/s\/Richard J. Murray, Jr. \/s\/Kenneth C. Petersen Richard J. Murray, Jr. Kenneth C. Petersen\n\/s\/William J. Purdy \/s\/William F. Terry William J. Purdy William F. Terry\n\/s\/Philip J. Thompson Philip J. Thompson\nSworn to before me this 21st day of March 1995\nBy\/s\/Joan Clark\nJoan Clark Notary Public, State of New York Qualified in Albany County No. 01CL4822282 Commission Expires Nov. 30, 1996\nFinancial Data Schedules to 10-K Exhibit 27\nPERIOD-TYPE 12-MOS FISCAL-YEAR-END DEC-31-1994 PERIOD-END DEC-31-1994 CASH 52,479 INT-BEARING-DEPOSITS 1,696,335 FED-FUNDS-SOLD 263,000 TRADING-ASSETS 0 INVESTMENTS-HELD-FOR-SALE 117,458 INVESTMENTS-CARRYING 347,858 INVESTMENTS-MARKET 334,455 LOANS 1,152,632 ALLOWANCE 38,851 TOTAL-ASSETS 1,975,677 DEPOSITS 1,789,831 SHORT-TERM 12,713 LIABILITIES-OTHER 30,300 LONG-TERM 3,550 COMMON 15,018 PREFERRED-MANDATORY 0 PREFERRED 0 OTHER-SE 124,265 TOTAL-LIABILITIES-AND-EQUITY 1,975,677 INTEREST-LOAN 93,873 INTEREST-INVEST 46,409 INTEREST-OTHER 0 INTEREST-TOTAL 140,282 INTEREST-DEPOSIT 60,034 INTEREST-EXPENSE 60,698 INTEREST-INCOME-NET 71,528 LOAN-LOSSES 8,056 SECURITIES-GAINS (8,877) EXPENSE-OTHER 40,560 INCOME-PRETAX 35,528 INCOME-PRE-EXTRAORDINARY 35,528 EXTRAORDINARY 0 CHANGES 0 NET-INCOME 22,888 EPS-PRIMARY 1.54 EPS-DILUTED 1.54 YIELD-ACTUAL 426 LOANS-NON> 1,057 LOANS-PAST 803 LOANS-TROUBLED 910 LOANS-PROBLEM 0 ALLOWANCE-OPEN 34,087 CHARGE-OFFS 4,824 RECOVERIES 1,532 ALLOWANCE-CLOSE 38,851 ALLOWANCE-DOMESTIC 0 ALLOWANCE-FOREIGN 0 ALLOWANCE-UNALLOCATED 38,851\nExhibit 99\nKPMG Peat Marwick LLP 74 North Pearl Street Albany, NY 12207\nIndependent Auditors' Report ------------------------------------\nThe Board of Directors and Shareholders of Trustco Bank Corp NY:\nWe have audited the accompanying consolidated statements of condition of TrustCo Bank Corp NY and subsidiaries 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 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 TrustCo Bank Corp NY 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 4 to the consolidated financial statements, in 1994 the Company adopted 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\" which changed its method of accounting for certain investments in debt and equity securities. As discussed in notes 1 and 8 to the consolidated financial statements, in 1993 the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" which changed its method of accounting for income taxes. As discussed in note 9 to the consolidated financial statements, the Company also 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\" in 1993 which changed its method of accounting for postretirement benefits other than pensions.\n\/s\/KPMG Peat Marwick LLP January 27, 1995","section_15":""}
{"filename":"34471_1994.txt","cik":"34471","year":"1994","section_1":"ITEM 1 - BUSINESS\n(a) The Precision Sheet Metal (PSM) plant in Los Angeles, California completed the phase-out of all operations during 1993. The net sales for PSM for the years ended December 31, 1993 and 1992 were $1,016,000 and $30,880,000, respectively. The operating income for the year ended December 31, 1992 was $3,156,000. Identifiable assets of PSM at December 31, 1994 included $1,361,000 for property and plant held for sale which are carried in Other Assets - Non-Current at December 31, 1994.\nOn June 4, 1992 the assets of the VR\/Wesson Industrial Supply warehouse in Beckley, West Virginia were sold. The Beckley operation was not significant to the overall operating performance of the Company.\n(b) Incorporated by reference from the Notes to Consolidated Financial Statements pages 35 through 37.\n(c)(1)(i) Fansteel is a specialty metals manufacturer of products for use in the metalworking; automotive; energy (coal mining, oil and gas drilling); military and commercial aircraft, aerospace and weapon systems; agricultural machinery; and electrical equipment industries. The principal products of the Industrial Tools business segment include tungsten carbide cutting tools, milling tools, toolholding devices, mining tools and accessories, construction tools, and wear resistant parts. The principal products of the Metal Fabrications business segment include titanium, nickel base and alloy steel forgings; high integrity aluminum and magnesium sand mold castings; carbon steel, stainless steel, brass and aluminum special wire forms and fasteners; and brass, bronze and ferrous alloy investment castings.\nSales of the Company's products are made through a direct sales organization and through distributors, representatives and agents. In the Industrial Tools and Metal Fabrications business segments, distributors and agents account for the majority of sales.\nThe percentage of net sales for classes of similar products which equaled or exceeded ten percent of the Company's consolidated net sales for the years indicated is set forth below: Consolidated Net Sales Products Business Segment 1994 1993 1992\nTungsten carbide cutting tools Industrial Tools 29% 25% 18% Pressure vessels Metal Fabrications - 1 15 Non-ferrous forgings Metal Fabrications 12 8 11 Investment castings Metal Fabrications 13 7 7\nITEM 1 - BUSINESS (Contd.)\n(c)(1)(ii) At this time, there are no new products in production or in the development stage that require investment of a material amount of the Company's assets.\n(iii) The most important raw materials used by the Company are\ntungsten carbide powder, cobalt, titanium, magnesium, aluminum, columbium and alloy steel. Prices of some of these raw materials have been volatile in recent years, and changes in raw material prices have had an impact on the Company's dollar sales volume. Several of the raw materials used, including cobalt, are purchased principally from foreign sources, many of them located in developing countries, and availability can be affected by political developments and trade restrictions, both domestic and foreign. The Company believes that the sources and availability of these materials are adequate for present needs, although spot shortages of certain raw materials may occur from time to time.\n(iv) The Company owns a number of patents which relate to a wide range of products and processes and is licensed under certain patents. The Company does not consider any of its patents or group of patents to be material to either of its business segments taken as a whole.\n(v) None of the operations of any business segment are seasonal.\n(vi) Working capital requirements for both business segments are substantial, but the Company's investment in working capital is fairly typical of the specialty metals manufacturing industry.\n(vii) Because of the nature of the Company's business, substantial sales for the Metal Fabrications segment are concentrated in a relatively small customer base. The loss of any individual customer within this base could have an adverse effect on the Company. Relations with these customers have existed for years and the Company believes them to be sound.\nITEM 1 - BUSINESS (Contd.)\n(c)(1)(vii) Atlantic Research Corporation was a principal customer of the Company's PSM facility during 1992 due to the phase-out of operations and accounted for 11% of the Company's net sales for the year ended December 31, 1992.\n(viii) The backlog of orders not shipped and believed to be firm as of the dates shown are set forth below (in thousands):\nDecember 31, 1994 1993\nIndustrial Tools $ 4,487 $ 4,016 Metal Fabrications 22,787 19,573\n$ 27,274 $ 23,589\nIn the Industrial Tools segment, virtually all backlog is shipped in less than 12 months, generally within 3 months. In the Metal Fabrications segment, shipments are typically made between 1 and 24 months after an order is received. The Company believes that approximately 93% of the backlog at December 31, 1994 will be shipped before the end of 1995.\nBecause of the substantial size of some orders received by the Company - particularly orders for products sold by the Metal Fabrications segment - the Company's backlog can fluctuate substantially from one fiscal period to another. Because of\nthe differences in lead-time for filling orders among the Company's business segments, overall backlogs at different times will not necessarily be comparable as predictors of the Company's near-term sales.\n(ix) The Company's Metal Fabrications segment has orders subject to termination at the election of the government. The Company would be compensated for costs up to the date of termination if terminated for the convenience of the government. Termination without compensation could result if the Company was in default as determined by the government. The Company is not aware of any current orders which would be terminated for default.\n(x) In general, the Company competes in its markets on the basis of technical expertise, product reliability, quality, sales support, availability and price. Most of the Company's products are sold in highly competitive markets, and some of the Company's competitors are larger in size and have greater financial resources than Fansteel.\n(c)(1)(xi) The development of new products and processes and the improvement of existing products and processes is conducted by each operating unit.\nITEM 1 - BUSINESS (Contd.)\n(c)(1)(xi) The Company has a staff of technically trained people who support sales, manufacturing and quality assurance. The majority of the Company's products and processes require technically sophisticated application engineering and process control. This kind of technical support is charged to the cost of products sold.\n(xii) The Company expensed $170,000 to continuing operations in 1994 for costs related to compliance with government environmental regulations.\nCapital expenditures in 1994 included $361,000 at the Wellman Dynamics facility in Creston, Iowa for thermal sand reclamation equipment to comply with state environmental regulations.\nDuring 1994, the Company charged $339,000 for continuing operations, and $698,000 for discontinued operations, against reserves for environmental reclamation and decommissioning established in previous years. Reserves for environmental reclamation and decommissioning were $641,000 for continuing operations, and $5,078,000 for discontinued operations, at December 31, 1994. A written decommissioning plan for the Muskogee site was submitted, as required by government regulations, in 1994. As of December 31, 1994, the decommissioning plan had not been formally approved by the appropriate governmental agencies. Based upon continuing assessment of the decommissioning plan, taking into consideration the most current information, existing technology and regulations in effect, management believes that the amounts reserved at December 31, 1994 are adequate to cover the costs of environmental reclamation and decommissioning.\nThe Company's intent is to comply with all applicable federal\nenvironmental statutes and regulations promulgated thereunder, as well as all state law counterparts, which include but are not limited to the Resource Conservation and Recovery Act, 42 U.S.C., Section 6901 et. seq., Comprehensive Environmental Response Compensation and Liability Act, 42 U.S.C., Section 9601 et. seq., Water Pollution Control Act, 33 U.S.C., Section 1251 et. seq., and Nuclear Regulatory Commission regulations regarding storage of low-level source material.\nAll of the Company's facilities are generally in compliance with applicable air pollution control regulations and possess the required permits from the appropriate state air pollution control agency in which they operate.\n(xiii) The Company employed 867 persons as of December 31, 1994.\n(d) Net sales, income and identifiable assets of foreign operations and export sales are not significant. The Company considers the United States as one inseparable geographic area for its domestic operations.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nManufacturing facility locations and corresponding square footage are as follows:\nBusiness Square Feet Location Segment Owned Leased Total\nPlantsville, Connecticut Industrial 59,000 0 59,000 Tools\nGulfport, Mississippi Industrial 16,000 0 16,000 Tools\nLatrobe, Pennsylvania Industrial 37,000 0 37,000 Tools\nLexington, Kentucky Industrial 98,000 6,000 104,000 Tools\nLos Angeles, California Metal 33,000 15,000 48,000 Fabrications\nSarasota, Florida Metal 6,000 0 6,000 Fabrications\nAddison, Illinois Metal 0 46,000 46,000 Fabrications\nCreston, Iowa Metal 293,000 10,000 303,000 Fabrications\nWashington, Iowa Metal 71,000 0 71,000 Fabrications\nAll plants are well-maintained and in good operating order. The plants have sufficient capacity to meet present market requirements. All of the properties described above are fully utilized on a 1 or 2 shift basis.\nThe Company owns properties in North Chicago, Illinois and\nMuskogee, Oklahoma associated with operations discontinued in prior years. These properties are included as part of Net Assets of Discontinued Operations. The Company's PSM facility in Los Angeles, California completed the phase out of all operations in 1993. The remaining property and plant has been reclassified as property held for sale as part of Other Assets -Non-Current.\nThe Company's executive offices are located in North Chicago, Illinois.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nThere are no pending legal proceedings to which the Company or its subsidiaries are a party or of which any of their property is the subject other than ordinary routine litigation incidental to the Company's business. None of these legal proceedings are material.\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 AND DIRECTORS OF THE REGISTRANT\nSet forth below are the principal executive officers and directors of the Company:\nYears of Service In Position with the Company and With Present Name Age Principal Occupation Fansteel Position\nKeith R. 63 Director, Chairman of the Board 40 11 Garrity and Chief Executive Officer\nBetty B. 71 Director; Director of HBD 11 11 Evans Industries, Inc.\nEdward P. 52 Director; Personal Investments 9 3 Evans\nRobert S. 50 Director; Chairman and Chief 3 3 Evans Executive Officer, Crane Co.\nThomas M. 84 Director; Director of HBD 18 18 Evans Industries, Inc.\nThomas M. 57 Director; Personal Investments 9 9 Evans, Jr.\nWilliam D. 42 President and Chief Operating 2 0 Jarosz Officer\nR. Michael 41 Vice President and Chief 15 4 McEntee Financial Officer\nMichael J. 41 Vice President, Secretary 9 8 Mocniak and General Counsel\nJack S. 65 Director; Consultant, 10 10 Petrik Turner Broadcasting System, Inc.\nCharles J. 64 Director; Partner, Kirkpatrick 13 13 Queenan, Jr. and Lockhart (Attorneys)\nEdward P. Evans, Robert S. Evans, and Thomas M. Evans, Jr. are the sons of Thomas M. Evans. Betty B. Evans is the wife of Thomas M. Evans. Additional information as to Directors of the Company is herein incorporated by reference to the information under the caption \"Nominees for Election as Directors\" in the Company's definitive proxy statement for the annual meeting of shareholders on April 26, 1995.\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 upon which the shares of the Company are traded.\nThe number of shareholders of the Company as of February 14, 1995 were 993.\nPer share stock market and dividend information for each quarter of the last two fiscal years are set forth below:\nCash Dividends High Low Declared\n1994: First Quarter $8 $7 1\/8 $.10 Second Quarter 7 3\/4 6 5\/8 .10 Third Quarter 7 1\/4 6 1\/2 .10 Fourth Quarter 7 1\/4 6 1\/8 .10\n1993: First Quarter $8 7\/8 $7 3\/4 $.10 Second Quarter 8 1\/8 6 3\/4 .10 Third Quarter 8 1\/8 7 1\/8 .10 Fourth Quarter 8 3\/4 7 1\/8 .10\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nSelected financial data for the Company for the five year period ended December 31, 1994 are as follows:\nYears Ended December 31, (thousands of dollars except per share data) 1994 1993 1992 1991 1990\nOperating Results\nNet Sales $ 89,287 $ 89,387 $127,145 $134,943 $168,808 Income (Loss) from Continuing Operations 3,609 2,516 5,232 (9,238) 6,882\n(Loss) from Disc. Operations - (1,676) - (4,118) - Net Income (Loss) 3,609 906 5,232 (13,356) 6,882 Per Share of Common Stock: Income (Loss) from Continuing Operations .42 .29 .61 (1.07) .80 (Loss) from Discontinued Operations - (.19) - (.48) - Net Income (Loss) .42 .11 .61 (1.55) .80 Cash Dividends .40 .40 .50 .50 .75 Shareholders' Equity 5.83 5.82 6.12 6.01 8.06\nFinancial Position Working capital $ 21,101 $ 36,321 $ 34,071 $ 34,518 $ 47,774 Net property, plant and equipment 9,364 9,661 13,776 14,891 17,740 Total assets 72,881 73,291 78,307 81,483 96,920 Long-term debt - - 600 1,575 2,579 Shareholders' equity 50,172 50,083 52,617 51,684 69,340\nOther Data Common shares outstanding 8,598,858 8,598,858 8,598,858 8,598,858 8,598,858 Number of shareholders 1,055 1,094 1,099 1,122 1,128 Number of employees 867 799 955 1,190 1,565\nNumber of shareholders consists of the approximate shareholders of record which include nominees and street name accounts.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations - 1994 Compared to 1993\nNet sales for the year ended December 31, 1994 were $89,287,000 which is a decrease of $100,000 from 1993 net sales of $89,387,000. Net sales of ongoing businesses in 1994 were $89,287,000 compared to $88,371,000 in 1993, an increase in 1994 of $916,000 or 1%.\nIndustrial Tools business segment net sales for the twelve months of 1994 were $43,558,000 compared to $38,604,000 for 1993, an increase of $4,954,000 or 13%. The increase in sales within this business segment is primarily due to the tungsten carbide wear parts product lines. These product lines, which include rod and blanks, nozzles and compacts, and die blanks and bushings, increased 33% compared to 1993 sales. Also demonstrating sales improvement within this business segment in 1994 were the tungsten carbide cutting tools product lines, which include inserts, blanks, and Tantung. Tungsten carbide cutting tools sales for 1994 were higher than 1993 by 6%. Together, tungsten carbide wear parts and tungsten carbide cutting tools account for 78% of sales in this business segment. A factor in the sales increase is the improved domestic manufacturing economy; however, the positive impact of the Company's capital investment and new product development must also be credited. The continued sales growth of the tungsten carbide wear parts product lines together with the rebounding sales performance of the tungsten carbide cutting tools product lines provides optimism for the continuing growth of this business segment. Sales in certain other product lines were less encouraging. Mining tools and accessories, and construction tools product lines experienced sales decreases from 1993. Mining product lines were negatively impacted by stiff price\ncompetition. Construction products were adversely affected by inadequate market coverage. During 1994, the Company changed its sales strategy from a direct sales force to agents and manufacturer representatives. As the sales coverage becomes more solidified in 1995, sales within this product line should recover.\nMetal Fabrications business segment net sales for the year ended December 31, 1994 were $45,729,000 compared to $50,783,000 for the twelve months of 1993, a decrease of $5,054,000 or 10%. Included in 1993 were $1,016,000 of sales from the Precision Sheet Metal (PSM) facility in Los Angeles, California, where operations were phased out in 1993. Thus, sales for comparable facilities in 1994 decreased $4,038,000 or 8% from 1993 results. Those product lines which conduct a significant percent of business with the defense and\/or aerospace industries were responsible for the decline in sales. Product lines utilizing the sand mold castings process and those that manufacture forgings experienced sales declines in 1994 of $4,993,000 and $3,520,000, respectively. Improved manufacturing techniques, which include significant capital expenditures, are being introduced in the sand mold castings product lines to further the application of these product lines to commercial industries. Additional sales agents have been designated to introduce the forgings product line to a larger customer base with an emphasis on commercial industries. Investment castings product line increased net sales in 1994 by $5,076,000 or 80%. Sales to customers in commercial industries, including automotive, construction, basic industrial and firearm, have increased in 1994 primarily due to the expanding domestic economy. Sales of special wire forms, principally to outdoor products and automotive markets, increased 10% from 1993. Sales in this product line have been strong for several years and consistent growth is expected to continue.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Contd.)\nOrder backlog at December 31, 1994 was $27,274,000, an increase of $3,685,000 or 16% from backlog at December 31, 1993 of $23,589,000. Industrial Tools business segment backlog was $4,487,000 at December 31, 1994 compared to $4,016,000 at December 31, 1993, an increase of $471,000. Tungsten carbide cutting tools product lines showed significant improvement in sales order performance with backlog increases for inserts, tools and blades, and Tantung products from year end 1993. Orders for mining tools and accessories and construction product lines were down in 1994 compared to 1993. Backlog of wear parts product lines remained strong. Metal Fabrications business segment backlog at December 31, 1994 was $22,787,000, an increase of $3,214,000 from December 31, 1993 backlog of $19,573,000. Backlog of orders for almost all product lines in this business segment increased in 1994, including those product lines which have suffered in the recent past from the decreased business in the defense and aerospace industries. Backlogs for the forgings product line and product lines utilizing the sand mold casting process at December 31, 1994 both increased 9% from December 31, 1993. Although orders from customers in aerospace markets were up slightly, this is not indicative of a recovery in this market. The increase in backlog for sand mold castings, however, is related to the introduction of a new production process formulated to better serve commercial customers. Investment castings made significant strides in 1994; backlog in this product line increased 85% from year-end 1993. Expansion in the commercial economy, primarily in the automotive and basic industrial markets, fueled the improved performance in this product line. Wire forms product lines maintained a solid pace, increasing an already strong backlog by 20%.\nCost of products sold for the twelve months ended December 31, 1994 was $72,033,000 compared to $73,579,000 for the year ended December 31, 1993, a decrease of $1,546,000 or 2%. As a percent of sales, cost of products sold for the year ended December 31, 1994 was 80.7% compared to 82.3% for the same period of 1993. Cost of sales of ongoing operations for 1994 was $72,033,000, a decrease of $530,000 from 1993 cost of sales of $72,563,000. Cost of sales as a percent of sales for ongoing operations for the twelve months of 1994 was 80.7%\ncompared to 82.1% for the year ended December 31, 1993. The decrease in cost of products sold is due to a program of internal improvements instituted over the last three years, concentrating on reduction of expenses, maximum utilization of manpower, and strategic asset investment.\nSelling, general and administrative expenses for the twelve months ended December 31, 1994 were $12,602,000 compared to $13,250,000 for the like period of 1993, a decrease of $648,000 or 5%. As a percent of net sales, selling, general and administrative expenses were 14.1% for the year ended December 31, 1994 compared to 14.8% for the year ended December 31, 1993. Strict expense controls, combined with more efficient sales strategies, have succeeded in improving selling, general and administrative expenses in relation to sales volume.\nOperating income for the twelve months ended December 31, 1994 was $4,652,000 compared to $2,558,000 for the same period of 1993, an increase of $2,094,000 or 82%. Operating income for the Industrial Tools business segment was $2,857,000 for the year ended December 31, 1994, an increase of $858,000 from the prior year operating income of $1,999,000. Metal Fabrications business segment operating income was $1,232,000 greater in 1994 than in 1993, increasing from $577,000 in 1993 to $1,809,000 in 1994 despite lower sales volume. Cost controls initiated in the last three years to offset the loss of\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Contd.)\nsales volume have had a positive effect on the profitability of the Company. As additional penetration is made into existing markets and as new markets are opened, operating performance should continue to improve.\nOther income for the year ended December 31, 1994 was $1,294,000 compared to $1,616,000 for the same period of 1993, a decrease of $322,000. Interest income decreased $307,000 as interest on an income tax refund was received in 1993. Other income in 1993 included a gain on the sale of marketable securities of $386,000; there was no similar gain in 1994. Interest expense decreased $260,000 as the remaining balance of long-term debt was paid in 1994 and long- term environmental liabilities were not discounted in 1994.\nNet income of $3,609,000 or $.42 per share was reported for 1994 compared to net income of $906,000 or $.11 per share for 1993. Net income for 1993 included a loss from discontinued operations of $1,676,000 or $.19 per share as a result of additional provisions to eliminate any future impact due to the recording of discounted estimated costs in prior years and to eliminate previously estimated unrealized recoveries. Net income for 1993 also included a favorable adjustment of $66,000 or $.01 per share for the effect of a change in accounting principle.\nInflation factors did not, and generally do not, significantly affect the overall operations of the Company.\nResults of Operations - 1993 Compared to 1992\nNet sales in 1993 were $89,387,000 compared to $127,145,000 in 1992, a decrease of $37,758,000 or 30%. Both the Industrial Tools and Metal Fabrications business segments reported declines in net sales compared to 1992 with a significant portion of the decline related to operations which were sold or phased out in 1992 and 1993. Net sales of ongoing businesses in 1993 and 1992 were $88,371,000 and $93,681,000, respectively, posting a decrease of $5,310,000 or 6%.\nIndustrial Tools business segment net sales in 1993 were $38,604,000, which was a decrease of $3,574,000 from 1992 net sales of $42,178,000. The Company's industrial supply warehouse in Beckley, West Virginia, sold in 1992, accounted for $2,584,000 of 1992 net sales; thus, the decline in sales of ongoing\noperations was $990,000. The majority of the decline was within the tungsten carbide cutting tools product line as compared to the prior year. Cutting tools continued to feel the effect of downsizing activities initiated by several major customers, primarily in the aerospace industry. In recent years, sales of tungsten carbide cutting tools and holding devices had been flat. However, current trends indicated that these products might show a resurgence in the near term. Tungsten carbide wear parts continued to exhibit a growth capability in this business segment. Sales within the wear parts product lines showed significant strength for the year ended December 31, 1993 as compared to the same period in 1992. Customer demand for tungsten carbide nozzles and compacts, as well as tungsten carbide rod and blanks, was heavy in 1993 and was expected to remain so in the next year. Sales in the construction tools product line rebounded in 1993, posting a 14% improvement as compared to 1992. The construction product line, which involves road construction, began to show increased sales activity. As the economy improved in the manufacturing sector, sales performance in all of the Industrial Tools business segment product lines gathered momentum.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Contd.)\nNet sales in 1993 for the Metal Fabrications business segment were $50,783,000, which was a $34,183,000 or 40% decrease from net sales in 1992 of $84,966,000. Net sales by the phased out PSM operation for the twelve months of 1992 were $30,880,000 as compared to $1,016,000 finally shipped in 1993. Net sales of ongoing operations in the Metal Fabrications business segment for the twelve months ended December 31, 1993 were $49,767,000 as compared to $54,086,000 for the same period of 1992, which was a decrease of $4,319,000 or 8%. Product lines utilizing the sand mold castings process experienced a decrease in net sales in 1993 as compared to 1992 of $3,849,000. Decreased sales in the aerospace industry, especially engine castings and missile castings purchased by U.S. defense procurement agencies, continued in 1993. However, sales of new tooling for sand mold castings applicable to the V22 Osprey program were higher in the year ended December 31, 1993 as compared to the same period of 1992. Sales of forgings applicable to defense-related production also showed a slight decrease in 1993 compared to 1992. Investment castings product line sales declined in 1993, as the lingering effects of a flat industrial economy had a detrimental effect on the sales performance of this product line. Increased sales order activity at the end of 1993 indicated improved sales performance in the near term for the investment castings product line. Sales performance for the wire forming product lines was about the same in 1993 compared to 1992. Both years showed sustained strength in the markets served.\nAt December 31, 1993, the backlog of unfilled orders for the Company was $23,589,000 as compared to $31,789,000 at the same date of 1992, a decrease of $8,200,000. The backlog for the Industrial Tools business segment at December 31, 1993 was $4,016,000, an increase of $780,000 from December 31, 1992. Orders of tungsten carbide rod increased in 1993; backlog in this product line at year- end 1993 was up 113% over December 31, 1992. Drill parts and construction tools product lines also showed increases in backlog from prior year-end. Metal Fabrications business segment backlog decreased $8,980,000, from $28,553,000 at December 31, 1992 to $19,573,000 at December 31, 1993. The largest decrease in backlog was experienced in the forgings product line. The shrinking aerospace industry was responsible for the order decline. Many customers reverted to smaller order quantities and just-in-time delivery schedules. Sand mold castings also experienced a decline in backlog related to lagging sales to military aerospace customers. The investment castings product line, however, showed first signs of recovery as backlog at December 31, 1993 increased significantly over year-end 1992. The backlog for wire-formed products was strong, but showed little change from year-end 1992.\nCost of products sold in the year ended December 31, 1993 totaled $73,579,000, a decrease of $30,433,000 from 1992 cost of sales of $104,012,000. As a percent of net sales, cost of products sold for the twelve months ended December 31,\n1993 was 82.3% compared to 81.8% for the same period of 1992. Cost of products sold in 1992 included cost credits of $802,000 and $3,070,000 in the Industrial Tools and Metal Fabrications business segments, respectively, due to LIFO inventory liquidations for the change in the reserve to state certain inventories at LIFO cost. The LIFO cost credits for the Metal Fabrications business segment pertained to the closing of the PSM facility. For ongoing operations, cost of sales as a percent of sales in 1993 was 82.1%; for comparable operations in 1992, cost of sales as a percent of sales was 81.7%. Cost containment measures, including inventory management, expense reductions and employee reorganizations continued throughout 1993 to maximize efficiencies within the Company.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Contd.)\nSelling, general and administrative expenses were $13,250,000 for the twelve months ended December 31, 1993, as compared to $15,350,000 for the year ended December 31, 1992, a decrease of $2,100,000. The shutdown of the PSM operation accounted for $1,087,000 of the decrease in selling, general and administrative expenses in 1993. Additional cost savings were realized in 1993 by adherence to the Company's cost saving measures, including staff reductions and strict expense control. Selling, general and administrative expenses as a percent of net sales of ongoing operations were 15.0% in 1993, compared to 13.7% in 1992. Thus, cost reduction measures implemented did not fully offset the decline in sales volume.\nOperating income for the twelve months ended December 31, 1993 was $2,558,000 as compared to $7,783,000 for the same period of 1992, which was a decrease of $5,225,000. Phased-out or sold operations accounted for $3,516,000 of the operating income in 1992, but did not affect operating income in 1993. Operating income of the Industrial Tools business segment of $1,999,000 improved 19% compared to 1992 on lower sales volume. Improved efficiencies, cost reductions and favorable raw material prices contributed to the 1993 performance. Operating income of the Metal Fabrications business segment was $577,000 for 1993 compared to $5,947,000 for 1992. The substantially lower operating income in this segment was related directly to the loss of sales volume due to the depressed aerospace and defense industries and the closing of the PSM facility.\nOther income in 1993 totaled $1,616,000 as compared to $723,000 in 1992, an increase of $893,000. Interest income increased $546,000 as the Company invested cash and overnight securities into more lucrative U.S. Treasury Notes, U.S. Treasury Bills and bank investment arrangements, and realized interest income on income tax refunds relating to prior years. The gain on the sale of capital assets in 1993 was $3,184,000; however, $2,914,000 of this gain was related to phased out and discontinued operations and was reserved for plant shutdown costs and environmental clean-up. The gain on the sale of marketable securities in 1993 totaled $386,000; there was no such gain in 1992.\nIncome from continuing operations for 1993 was $2,516,000 or $.29 per share compared to $5,232,000 or $.61 per share in 1992, a decrease of $2,716,000. Operations phased out or sold in 1992 contributed $2,225,000 of the 1992 net income or $.26 per share with no effect on net income in 1993.\nThe loss from discontinued operations in 1993 was $1,676,000 or $.19 per share. This loss was a result of additional provisions to eliminate any future impact as a result of recording discounted estimated costs in prior years and to eliminate previously estimated unrealized recoveries.\nNet income of $906,000 or $.11 per share was reported for 1993 compared to net income of $5,232,000 or $.61 per share in 1992.\nOutlook\nThe improved industrial economy, combined with modernization of the Company's production processes, new product development and capital equipment investment, provide a foundation for growth in commercial markets. The Company has a strong balance sheet, which allows for additional investment in each of these areas as required.\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Contd.)\nThe Company recognizes that its ability to endure the impact of economic recession and the substantial decline of the defense and aerospace business, in particular, was due in large part to decisions focused on cost containment. As the Company continues to pursue avenues to increase sales and profits, cost control programs based on intelligent use of available resources will remain active throughout the Company.\nThe Company is continuing to place its primary focus on a transition from military to commercial markets. Internal growth of formerly defense-related operating units is expected commensurate with the Company's ability to achieve greater participation in commercial markets. Capital equipment investment has been initiated and modernized production techniques employed to facilitate this transition.\nLiquidity and Capital Resources\nCash and cash equivalents totaled $9,429,000 at December 31, 1994, a decrease of $1,215,000 from December 31, 1993. Operating activities provided $4,307,000 in the year. Adjustments to reconcile net income of $3,609,000 to cash provided by operating activities included depreciation of $1,975,000, a deferred income tax charge of $1,302,000, and gains on the sale of capital assets of $292,000. Inventories increased $1,426,000. Investing activities used $1,506,000 in the year, including $1,654,000 for capital expenditures to automate equipment and modernize processes. Financing activities in 1994 included the final payment on long-term debt of $600,000 and dividend payments to shareholders of $3,440,000.\nCurrent assets of the Company at December 31, 1994 exceeded current liabilities by a 2.2 to 1 margin as compared to 3.1 to 1 at December 31, 1993. Certain marketable securities were included in non-current assets at December 31, 1994, in accordance with FASB Statement No. 115. At December 31, 1993 all marketable securities were classified as current assets.\nCash flow from operations in 1995 is expected to be adequate to cover operating requirements. If the need for additional funds arises, the Company has strong long-term relationships with several large banking institutions.\nAt December 31, 1994, the Company had established reserves of $5,078,000 for environmental clean-up costs for discontinued operations. The Company, in association with outside consultants, has developed a decommissioning plan for the site involved. This decommissioning plan has not been approved by the appropriate government agencies as of December 31, 1994. Before decommissioning procedures begin, the Company plans to extract materials within the residue storage ponds at the site, such as tantalum, columbium and scandium, which have a commercial value.\nThe processing of the residues to extract the materials having a commercial value is in the development stages. A method has been developed which is being tested, evaluated, and refined. After the required regulatory approvals are received, equipment will be acquired to begin extraction and processing. The estimated value of materials to be extracted is based on analysis of samples taken from the residues in the various ponds and a market value of such materials using current market prices discounted to reflect possible price decreases, including those which could result from the increased quantities of\ncertain of these materials made available for sale. The\nITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Contd.)\nestimated costs of extracting and processing the residues were developed by Company personnel and independent consultants using third party evaluations based on the pilot testing performed. Current expectations are that eight to ten years will be required to extract and process the contents of all residue storage areas. The removal of the contents of the first residue storage pond is expected to start after licensing approval is received near the end of 1995. The provisions for discontinued operations reflect management's belief that, at this point in time, the current value of the extracted materials will at least equal the estimated costs of obtaining these materials, including estimated costs for disposal of hazardous waste from the residues. Decommissioning is expected to begin on a pond by pond basis immediately after the extraction of the residue from each pond. Based upon continuing assessment of the decommissioning plan, taking into consideration the most current information, existing technology and regulations in effect, management believes that the amounts reserved at December 31, 1994 are adequate to cover the costs for environmental reclamation and decommissioning.\nThe Company's Precision Sheet Metal (PSM) operation within the Metal Fabrications business segment was phased out in 1993. The remaining land and buildings are carried as Other Assets - Property held for sale. The cost of preparing the property for sale, principally environmental clean-up, will be capitalized. Management believes that proceeds from the sale of the property will be adequate to recover its costs, including costs of preparing the property for sale.\nThe Company's Escast operation, located in Addison, IL, included in the Metal Fabrications business segment, has been named as a responsible party for the clean-up costs of certain hazardous wastes. A cost sharing agreement with the former owner of Escast is in place for any future clean-up costs. At this time, the amount of the clean-up costs is not fixed and determinable. However, the Company believes the established reserves of $641,000 are adequate to cover its share of the clean-up costs.\nEnvironmental matters arising at other operating units are routinely reviewed and handled through operations. The Company believes that the ultimate disposition of any other pending environmental matters will not have a material adverse effect upon the consolidated financial position of the Company.\nREPORT OF INDEPENDENT AUDITORS\nTo the Board of Directors and Shareholders of Fansteel Inc.:\nWe have audited the accompanying consolidated balance sheet of Fansteel Inc. 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)(2). These financial statements and schedule are the responsibility of Fansteel Inc. 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\nthe amounts and disclosures in the financial statements. An audit also includes 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 Fansteel Inc. 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.\n\\s\\Ernst & Young LLP Chicago, Illinois January 18, 1995\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCONSOLIDATED STATEMENT OF OPERATIONS\nFor the Years Ended December 31, 1994 1993 1992\nNet Sales $ 89,287,336 $ 89,387,486 $127,144,839 Cost and Expenses Cost of products sold 72,033,115 73,579,091 104,012,109 Selling, general and administrative 12,601,816 13,250,265 15,349,511 84,634,931 86,829,356 119,361,620\nOperating Income 4,652,405 2,558,130 7,783,219\nOther Income (Expense) Interest income 1,076,740 1,383,941 837,709 Interest expense (17,769) (277,826) (231,706) Other 235,002 509,593 117,265 1,293,973 1,615,708 723,268 Income From Continuing Operations Before Income Taxes 5,946,378 4,173,838 8,506,487\nIncome Tax Provision 2,337,000 1,658,000 3,274,000\nIncome From Continuing Operations 3,609,378 2,515,838 5,232,487\n(Loss) From Discontinued Operations - (1,676,000) -\nIncome Before Cumulative Effect of Accounting Change 3,609,378 839,838 5,232,487\nCumulative Effect to January 1, 1993 of Change in Accounting for Income Taxes - 66,000 -\nNet Income $ 3,609,378 $ 905,838 $ 5,232,487\nIncome (Loss) Per Common Share Continuing operations $.42 $.29 $.61\nDiscontinued operations - (.19) - Cumulative Effect of Accounting Change - .01 -\nNet Income $.42 $.11 $.61\nSee Notes to Consolidated Financial Statements.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nCONSOLIDATED BALANCE SHEET\nAt December 31, 1994 1993 ASSETS Current Assets Cash and cash equivalents $ 9,429,031 $ 10,644,413 Marketable securities 293,367 15,095,026 Accounts receivable, less allowance of $276,000 in 1994 and 1993 13,048,394 12,325,810 Income tax refunds receivable - 208,450 Inventories Raw material and supplies 3,135,098 3,058,053 Work-in-process 11,376,665 10,825,005 Finished goods 5,256,355 4,785,717 19,768,118 18,668,775 Less: Reserve to state certain inventories at LIFO cost 6,987,569 7,313,972 Total inventories 12,780,549 11,354,803 Other assets - current Deferred income taxes 1,981,749 2,837,807 Other 949,479 998,380 Total Current Assets 38,482,569 53,464,689 Net Assets of Discontinued Operations 522,637 522,637 Property, Plant and Equipment Land 872,641 872,641 Buildings 8,721,261 8,721,261 Machinery and equipment 43,305,113 41,798,514 52,899,015 51,392,416 Less accumulated depreciation 43,535,103 41,731,258 Net Property, Plant and Equipment 9,363,912 9,661,158 Other Assets Marketable securities 15,001,512 - Prepaid pension asset 7,942,741 7,789,566 Deferred income taxes 175,476 365,832 Property held for sale 1,361,008 1,453,810 Other 31,063 33,642 Total Other Assets 24,511,800 9,642,850\n$ 72,880,918 $ 73,291,334\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nCONSOLIDATED BALANCE SHEET (Contd.)\nAt December 31, 1994 1993\nLIABILITIES AND SHAREHOLDERS' EQUITY\nCurrent Liabilities Accounts payable $ 7,607,591 $ 5,193,599 Accrued liabilities 9,716,919 10,827,199 Income taxes 57,481 523,304 Current maturities of long-term debt - 600,000 Total Current Liabilities 17,381,991 17,144,102 Other Liabilities Discontinued operations 4,255,000 5,175,000 Deferred income taxes 965,079 753,085 Obligations under capital leases 107,057 135,666 Total Other Liabilities 5,327,136 6,063,751 Shareholders' Equity Preferred stock without par value Authorized and unissued 1,000,000 shares - - Common stock, par value $2.50 Authorized 12,000,000 shares; issued and outstanding 8,598,858 shares 21,497,145 21,497,145 Retained earnings 28,756,171 28,586,336 Unrealized (loss) on securities (81,525) - Total Shareholders' Equity 50,171,791 50,083,481\n$ 72,880,918 $ 73,291,334\nSee Notes to Consolidated Financial Statements.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nCONSOLIDATED STATEMENT OF CASH FLOWS\nFor the Years Ended December 31, 1994 1993 1992\nCash Flows From Operating Activities Net income $ 3,609,378 $ 905,838 $ 5,232,487 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,975,038 2,198,185 2,135,115 Net pension (credit) (153,175) (333,114) (372,995) Deferred income tax charge (credit) 1,301,924 (378,607) 1,561,570 Gain from disposals of property, plant and equipment (291,852) (270,678) (531,913) Gain on sale of marketable securities - (386,409) - Provisions for environmental costs and other liabilities - 2,717,000 - Change in assets and liabilities: (Increase) in marketable securities (169,988) (169,225) (78,096) (Increase) decrease in accounts receivable (722,584) 3,792,044 793,699 Decrease in income tax refunds receivable 208,450 646,805 6,768,745 (Increase) decrease in inventories (1,425,746) 1,315,392 1,254,126\nDecrease (increase) in other assets - current 48,901 (399,755) 1,953,460 Increase (decrease) in accounts payable and accrued liabilities 389,570 (8,376,122) (3,167,641) (Decrease) increase in income taxes payable (465,823) 114,565 (1,500,145) Decrease in other assets 2,579 67,267 93,098\nNet cash provided by operating activities 4,306,672 1,443,186 14,141,510\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nCONSOLIDATED STATEMENT OF CASH FLOWS (Contd.)\nFor the Years Ended December 31, 1994 1993 1992\nCash Flows From Investing Activities Investment in marketable securities (14,104,906) (19,847,705) (9,992,188) Proceeds from disposition of marketable securities 13,950,000 15,378,597 - Proceeds from sale of property, plant and equipment 303,513 4,557,921 699,897 Capital expenditures (1,654,453) (435,997) (1,188,166)\nNet cash (used in) investing activities (1,505,846) (347,184) (10,480,457)\nCash Flows From Financing Activities Payments on long-term debt (600,000) (975,432) (1,003,338) Proceeds from capital leases 113,924 197,690 - Principal payments for capital leases (90,589) (10,083) - Dividends paid (3,439,543) (3,439,543) (4,299,429) Net cash (used in) financing activities (4,016,208) (4,227,368) (5,302,767)\nNet (Decrease) In Cash And Cash Equivalents (1,215,382) (3,131,366) (1,641,714) Cash And Cash Equivalents At Beginning Of Year 10,644,413 13,775,779 15,417,493\nCash And Cash Equivalents At End Of Year $ 9,429,031 $ 10,644,413 $ 13,775,779\nInterest Paid $ 13,000 $ 46,000 $ 96,000\nSee Notes to Consolidated Financial Statements.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY\nUnrealized Years Ended Common Retained (Loss) on December 31, Stock Earnings Securities Total\nBalance at January 1 $ 21,497,145 $ 30,186,983 $ - $ 51,684,128 Net income - 5,232,487 - 5,232,487 Dividends ($.50 per share) - (4,299,429) - (4,299,429)\nBalance at December 31 21,497,145 31,120,041 - 52,617,186\nNet income - 905,838 - 905,838 Dividends ($.40 per share) - (3,439,543) - (3,439,543)\nBalance at December 31 21,497,145 28,586,336 - 50,083,481\nNet income - 3,609,378 - 3,609,378 Unrealized (loss) on securities - - (81,525) (81,525) Dividends ($.40 per share) - (3,439,543) - (3,439,543)\nBalance at December 31 $ 21,497,145 $ 28,756,171 $ (81,525) $ 50,171,791\nSee Notes to Consolidated Financial Statements.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Significant Accounting Policies\nThe consolidated financial statements include the accounts of Fansteel Inc. and its subsidiaries (the \"Company\").\nThe Company considers all investments purchased with a maturity of three months or less to be cash equivalents. On December 31, 1994 and 1993, the Company had purchased $8,800,000 and $9,700,000, respectively, of U.S. Government securities under agreements to resell on January 3, 1995 and January 3, 1994, respectively. Due to the short-term nature of the agreements, the Company did not take possession of the securities which were instead held in the Company's safekeeping accounts at the banks.\nEffective January 1, 1994, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Accordingly for 1994, marketable securities are classified as held-to-maturity or available-for-sale. The Company determines the appropriate classification at time of purchase and reevaluates such designation as of each balance sheet date. Securities are classified as held-to-maturity\nwhen the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at cost, adjusted for amortization of premiums and discounts to maturity. Marketable securities not classified as held-to-maturity are classified as available-for-sale. Available- for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported as a separate component of shareholders' equity. The cost of securities available-for-sale is adjusted for amortization of premiums and discounts to maturity. Interest and amortization of premiums and discounts for all securities are included in interest income. Realized gains and losses are included in other income. Application of this standard did not have a significant impact on the Company's results of operations. In accordance with Statement No. 115, the Company has not restated the financial statements for prior years. For 1993, marketable securities are carried at cost plus accrued interest and amortized discount, where applicable.\nInventories are valued at the lower of cost, determined principally on the \"last-in, first-out\" (LIFO) basis, or market. Costs include direct material, labor and applicable manufacturing overhead. Inventories valued using the LIFO method comprised 94% and 92% of inventories at current cost at December 31, 1994 and 1993, respectively.\nAcquisitions of properties and additions to existing facilities and equipment are recorded at cost. Accelerated depreciation is the principal method used for both financial reporting and income tax purposes.\nEffective January 1, 1993, the Company adopted FASB Statement 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. Prior to 1993, the provision for income taxes was based on income and expenses included in the consolidated statements\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nof operations. As permitted by Statement No. 109, the Company has elected not to restate prior years' financial statements. The cumulative effect of the change increased net income by $66,000 or $.01 per share for 1993.\nEffective January 1, 1993, the Company adopted FASB Statement No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions,\" which requires employers to accrue the cost of such retirement benefits during the employee's service with the Company. Prior to 1993, the cost of providing these benefits to retirees was recognized as a charge to operations as claims were received, when employees retired or facilities closed. Adoption of Statement No. 106 resulted in excess accrued retiree life insurance of $475,000. The transition asset for the excess retiree life insurance is being amortized over the average remaining working lifetime to full benefit eligibility, which was estimated at 17 years. Therefore, the adoption of Statement No. 106 did not have a material effect on the Company's 1993 results of operations.\nCertain reclassifications have been made to prior years' financial statements to conform with the 1994 presentation.\n2. Marketable Securities\nAt December 31, 1994, the Company held investments in marketable securities which it classified as either available-for-sale or held-to-maturity, depending upon the security.\nSecurities classified as available-for-sale at December 31, 1994 included both securities due within one year and securities with maturity dates beyond one year. Securities with a maturity date within one year are classified as Marketable Securities as a part of Current Assets and are stated at fair value plus accrued interest. Securities with a maturity date beyond one year are included in Other Non-Current Assets and are stated at fair value. These available-for-sale securities at December 31, 1994 included the following:\nAmortized Fair Cost Value\nMarketable Securities - Current: Northern Trust Advantage investment portfolio consisting of government securities and municipal bonds $ 35,599 $ 35,599\nAccrued interest 257,768 257,768\n$ 293,367 293,367\nMarketable Securities - Non-Current: Northern Trust Advantage investment portfolio consisting of government securities and municipal bonds $ 5,153,711 5,028,670\nNet Book Value - Available- for-Sale Securities: $ 5,322,037\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nSecurities classified as held-to-maturity are stated at amortized cost and are included in Other Non-Current Assets on the December 31, 1994 Consolidated Balance Sheet. These held-to-maturity securities at December 31, 1994 included the following:\nAmortized Fair Cost Value\nU.S. Treasury Note, face value of $5,000,000, interest at 5.125%, due April 30, 1998 $ 4,972,842 $ 4,606,250\nU.S. Treasury Note, face value of $5,000,000, interest at 6.250%, due January 31, 1997 5,000,000 $ 4,860,938\nNet Book Value - Held-to- Maturity Securities: $ 9,972,842\nIn 1994, transactions in marketable securities decreased cash by $154,906. Investment in held-to-maturity securities totaled $5,000,000 while investments in available-for-sale securities were $9,104,906. Proceeds from the disposition of available-for-sale securities amounted to $13,950,000 with sales and maturities of available-for-sale securities providing $250,000 and $13,700,000, respectively.\nIn accordance with FASB Statement No. 115, the Company has not restated the financial statements of prior years. The Company had the following marketable\nsecurities stated at amortized cost plus accrued interest and classified as a part of Current Assets at December 31, 1993:\nAmortized Fair Cost Value\nU.S. Treasury Note, face value of $5,000,000, interest at 5.125%, due April 30, 1998 $ 4,964,683 $ 5,012,500\nU.S. Treasury Bill, face value of $5,000,000, due February 24, 1994 4,976,854 4,977,849\nNorthern Trust Advantage investment portfolio consisting of government securities and municipal bonds 5,037,007 5,045,055\n14,978,544 15,035,404 Accrued interest 116,482 116,482\n$ 15,095,026 $ 15,151,886\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nThe calculation of gross unrealized loss for the year ended December 31, 1994 is as follows: Gross Unrealized Fair Value Cost (Loss)\nAvailable-for-sale securities $ 5,064,269 $ 5,189,310 $ (125,041)\nHeld-to-maturity securities: U.S. Treasury Note, face value of $5,000,000, interest at 5.125%, due April 30, 1998 4,606,250 4,972,842 (366,592)\nU.S. Treasury Note, face value of $5,000,000, interest at 6.250%, due January 31, 1997 4,860,938 5,000,000 (139,062)\nGross Unrealized (Loss) $ (630,695)\nNet unrealized losses on held-to-maturity securities have not been recognized in the accompanying consolidated financial statements. Net unrealized loss on available-for-sale securities included in shareholders' equity at December 31, 1994 was $81,525, consisting of gross unrealized loss of $125,041 net of deferred income taxes.\nNet unrealized gain at December 31, 1993 was $56,860, consisting of aggregate market value of $15,035,404 and aggregate cost of $14,978,544. Net unrealized gain at December 31, 1993 is not included in the accompanying consolidated financial statements, as allowed by FASB Statement No. 115.\nNet realized gains on marketable securities for the year ended December 31, 1993 were $386,409. There were no realized gains or losses for the years ended December 31, 1994 or 1992.\n3. Accrued Liabilities\nAccrued liabilities at December 31, 1994 and 1993 include the following:\n1994 1993 Payroll and related costs $ 2,683,209 $ 2,162,140 Taxes, other than income 266,960 358,001 Profit sharing 556,208 465,879 Insurance 3,862,646 4,098,675 Plant shutdown costs 992,078 2,612,027 Other 1,355,818 1,130,477 $ 9,716,919 $ 10,827,199\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\n4. Discontinued Operations, Contingent Liabilities and Other Liabilities\nThe Company discontinued its Metal Products business segment in 1989. Environmental reclamation and decommissioning is required for the segment's primary plant that processed certain ores which are subject to regulations of several government agencies. The residues from these processed ores were stored on site. Remaining assets were written down to estimated realizable value, and provisions were made for the estimated costs for decommissioning. Application has been made to the appropriate agencies for a portion of the site to be decommissioned. A decommissioning plan for the remainder of the site, including the residue storage areas, has been submitted to the appropriate governmental agencies for approval. Before decommissioning procedures begin for the residue storage areas, the Company plans to extract materials within the residues, such as tantalum, columbium and scandium, which have a commercial value.\nThe processing of the residues to extract the materials having a commercial value is in the development stages. A method has been developed which is being tested, evaluated, and refined. After the required regulatory approvals are received, equipment will be acquired to begin extraction and processing. The estimated value of materials to be extracted is based on analysis of samples taken from the residues in the various settling ponds and a market value of such materials using current market prices discounted to reflect possible price decreases, including those which could result from the increased quantities of certain of these materials made available for sale. The estimated costs of extracting and processing the residues were developed by Company personnel and independent consultants using third party evaluations based on the pilot testing performed. Current expectations are that eight to ten years will be required to extract and process the contents of all residue storage areas. The removal of the contents of the first residue storage area is expected to start after licensing approval is received near the end of 1995. The annual recovery values are estimated to be in a range of $2,000,000 to $3,000,000. The provisions for discontinued operations reflect management's belief that, at this point in time, the current value of the extracted materials will at least equal the estimated costs of obtaining these materials, including total project estimated costs of $1,000,000 for disposal of hazardous waste from the residues. Definitive plans for extracting and processing of the residues are being developed; therefore, the costs and related value of recoveries are difficult to determine with exact precision. Decommissioning is expected to begin on a pond by pond basis immediately after the extraction of the residue from each pond.\nExpenditures for environmental reclamation and decommissioning were $1,061,000, $1,986,000 and $1,001,000 in 1994, 1993, and 1992, respectively. Costs of $763,000 which are expected to be incurred within the next year are included as plant shutdown costs in Accrued Liabilities. Costs expected to be incurred after one year are reflected on the balance sheet in Discontinued Operations as part of Other Liabilities. Based upon continuing assessment of the decommissioning plan, taking into consideration the most current information, existing technology and regulations in effect, management believes that the amounts reserved at December 31, 1994 are adequate to cover the costs for environmental reclamation and decommissioning.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nIn 1993, a provision of $2,717,000 ($1,676,000 after tax) was recorded to eliminate the impact of having discounted estimated costs for decommissioning in prior years since the timing and amount of costs expected to be incurred were not fixed and determinable and to eliminate previously estimated unrealized recoveries.\nThe net assets of discontinued operations at December 31, 1994 and 1993 include the following (in thousands of dollars):\nLand $ 110 Buildings 5,218\n5,328 Less accumulated depreciation 4,805\nNet assets of discontinued operations $ 523\nThe Company's Precision Sheet Metal (PSM) operation within the Metal Fabrications business segment was phased out in 1993. The remaining land and buildings are carried as Other Assets - Property held for sale. The cost of preparing the property for sale, principally environmental clean-up, will be capitalized. Management believes that proceeds from the sale of the property will be adequate to recover its costs, including costs of preparing the property for sale. The Company believes the reserves established for other costs associated with the close-down of PSM are adequate to cover such costs.\nThe Company's Escast operation, located in Addison, IL, included in the Metal Fabrications business segment, has been named as a responsible party for the clean-up costs of certain hazardous wastes. A cost sharing agreement with the former owner of Escast is in place for any future clean-up costs. At this time, the amount of the clean-up costs is not fixed and determinable. However, the Company believes the established reserves of $641,000 are adequate to cover its share of the clean-up costs.\nEnvironmental matters arising at other operating units are routinely reviewed and handled through operations. The Company believes that the ultimate disposition of any other pending environmental matters will not have a material adverse effect upon the consolidated financial position of the Company.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\n5. Income Taxes\nDeferred income taxes reflect the net tax effect of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Significant components of the Company's deferred tax assets and liabilities at December 31, 1994 and 1993 are as follows:\n1994 1993 Deferred tax assets - current: Plant shutdown, idle facilities and environmental costs $ 256,078 $ 906,635 Self-insurance accruals 860,201 917,877 Vacation accruals 314,368 425,826 State income taxes 321,615 421,475 Other 229,487 165,994\n$1,981,749 $2,837,807\nDeferred tax assets (liabilities) - noncurrent: State income tax net operating loss carryforwards net of valuation allowance $ 427,378 $ 501,028 State income taxes (251,902) (135,196)\n$ 175,476 $ 365,832\nDeferred tax (assets) liabilities - noncurrent: Pension credits $2,504,006 $2,648,452 Plant shutdown, idle facilities and environmental costs (1,459,287) (1,844,027) Other (79,640) (51,340)\n$ 965,079 $ 753,085\nAt December 31, 1994 and 1993, the Company had state income tax benefits of $1,023,000 and $1,141,000, respectively, from net operating loss carryforwards that expire in various years through 2008. For financial reporting purposes, valuation allowances of $596,000 and $640,000 at December 31, 1994 and 1993, respectively, were recognized for net operating loss carryforwards not anticipated to be realized before expiration.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nDetails of the provision (benefit) for income taxes in the consolidated statements of operations are as follows:\n1994 1993 1992 Current taxes Federal $ 900,000 $ 574,000 $ 1,173,000 State and other 331,000 450,000 272,000 1,231,000 1,024,000 1,445,000 Deferred income tax charge (credit) Federal 950,000 (378,000) 1,562,000 State 156,000 ( 95,000) 267,000\n1,106,000 (473,000) 1,829,000 Total 2,337,000 551,000 3,274,000\nAllocated to discontinued operations - (1,041,000) -\nCumulative effect to January 1, 1993 of change in accounting for income taxes - (66,000) -\nContinuing operations $ 2,337,000 $ 1,658,000 $ 3,274,000\nThe deferred income tax charge in 1994 results primarily from payments for certain plant shutdown, idle facilities and environmental costs accrued in prior years.\nThe deferred income tax credit in 1993 results primarily from provisions for certain plant shutdown, idle facilities and environmental costs in excess of payments for these costs, reduced by deferred income tax charges of $259,000 for pension credits and self-insurance accruals.\nThe deferred income tax charge in 1992 results primarily from certain plant shutdown costs accrued in prior years and paid in 1992.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nA reconciliation of the total provision for income taxes with amounts determined by applying the statutory U.S. federal income tax rate to combined income (loss) from continuing and discontinued operations before income tax provision is as follows:\n1994 1993 1992 Income tax provision at statutory rate $ 2,022,000 $ 495,000 $ 2,892,000 Add (deduct): State income taxes, net of federal income tax provision 321,000 109,000 356,000 Cumulative effect to January 1, 1993 of change in accounting for income taxes - (66,000) - Other, net (6,000) 13,000 26,000\nTotal income tax provision $ 2,337,000 $ 551,000 $ 3,274,000\nIncome taxes paid for each of the three years in the period ended December 31, 1994 amounted to $1,610,000, $1,131,000 and $1,454,000, respectively. Income tax refunds received during the three years in the period ended December 31, 1994 amounted to $319,000, $831,000 and $6,859,000, respectively.\n6. Retirement Plans\nThe Company has several non-contributory defined benefit plans covering approximately 32% of its employees. Benefits for salaried plans are generally based on salary and years of service, while hourly plans are based upon a fixed benefit rate in effect at retirement date and years of service. The Company's funding of the plans is equal to the minimum contribution required by ERISA.\nContributions to defined benefit plans totaled $108,435 in 1994 with no payments in 1993 and 1992.\nThe net pension (credits) in 1994, 1993 and 1992 are comprised of:\n1994 1993 1992\nService cost $ 376,000 $ 388,000 $ 417,000 Interest cost on projected benefit obligations 3,003,000 3,005,000 2,979,000 Actual return on Plan assets 823,000 (3,638,000) (2,786,000) Net amortization and deferral (4,355,000) (59,000) (983,000) Net pension (credit) $ (153,000) $ (304,000) $ (373,000)\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nThe following table sets forth the plans' funded status and amounts recognized in the balance sheet at December 31:\n1994 1993 Actuarial present value of benefit obligations Vested $ 36,397,643 $ 38,683,950 Non-vested 587,679 692,747\nTotal accumulated benefit obligations $ 36,985,322 $ 39,376,697\nProjected benefit obligations for services rendered to date $ 38,675,554 $ 41,224,330 Plan assets at fair value, primarily U.S. Government securities and publicly traded stocks and bonds 39,315,399 43,403,750 Plan assets in excess of projected benefit obligations 639,845 2,179,420 Effect of change in assumptions, net gains and losses 10,050,722 9,038,445 Unrecognized net excess plan assets at January 1, 1986 being recognized over approximately 15 years (2,747,826) (3,428,299)\nPrepaid pension asset $ 7,942,741 $ 7,789,566\nThe assumptions used in determining the actuarial present value of projected benefit obligations were as follows:\n1994 1993 1992\nDiscount rate 8.5% 7.5% 8.0%\nRate of increase in future compensation levels 5.5% 5.5% 5.5%\nExpected long-term rate of return on assets 8.0% 8.0% 8.0%\nThe Company has several defined contribution plans covering approximately 69% of its employees. The defined contribution plans have funding provisions which, in certain situations, require Company contributions based upon formulae relating to employee gross wages, participant contributions or hours worked. The defined contribution plans also allow for additional discretionary Company contributions based upon profitability. The costs of these plans included in continuing operations for 1994, 1993 and 1992 were $839,000, $714,000 and $1,185,000, respectively.\nThe Company makes medical insurance available and provides limited amounts of life insurance to retirees. Retirees electing to be covered by Company sponsored health insurance pay the full cost of such insurance. For 1994 and 1993, the Company accrued the cost of the retiree life insurance benefits in relation to the employee's service with the Company. Prior to 1993, the cost\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nof retiree life benefits were recognized when employees retired or facilities closed. Cost of postretirement benefits other than pensions for the years ended December 31, 1994, 1993 and 1992 were $44,000, $86,000 and $199,000, respectively.\n7. Business Segments\nThe Company is a specialty metals manufacturer. For financial reporting purposes, the Company classifies its products into the following two business segments:\nIndustrial Tools:\nTungsten carbide cutting tools, milling tools, toolholding devices, mining tools and accessories, construction tools, wear parts and related industrial parts.\nMetal Fabrications:\nTitanium, nickel base and high alloy steel forgings; aluminum and magnesium sand mold castings; special wire products and investment castings.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nFinancial information concerning the Company's segments for the years ended December 31, 1994, 1993 and 1992 is as follows:\n1994 1993 1992 NET SALES:\nINDUSTRIAL TOOLS -\nSales $ 43,558,081 $ 38,607,023 $ 42,193,615\nIntersegment sales - (2,934) (15,169)\n43,558,081 38,604,089 42,178,446\nMETAL FABRICATIONS -\nSales 45,783,951 50,796,887 85,013,581\nIntersegment sales (54,696) (13,490) (47,188)\n45,729,255 50,783,397 84,966,393\n$ 89,287,336 $ 89,387,486 $127,144,839\nOPERATING INCOME (LOSS):\nINDUSTRIAL TOOLS $ 2,856,607 $ 1,998,794 $ 1,677,023\nMETAL FABRICATIONS 1,809,048 576,534 5,947,435\nCORPORATE (13,250) (17,198) (30,239)\n$ 4,652,405 $ 2,558,130 $ 7,594,219\nIntersegment sales are accounted for at prices equivalent to the competitive market prices for similar products. Atlantic Research Corporation was a principal customer of the Company's Precision Sheet Metal (PSM) facility within the Metal Fabrications business segment and accounted for 11% of the Company's net sales for the year ended December 31, 1992.\nThe PSM facility in Los Angeles, California, completed the phase-out of all operations during 1993. The effect of this action did not have a significant impact on the Company's financial position. The net sales of PSM for the years ended December 31, 1993 and 1992 were $1,016,000 and $30,880,000, respectively. Operating income for the year ended December 31, 1992 was $3,156,000. The change in the reserve to state certain inventories at LIFO cost due to LIFO inventory liquidations increased operating income by $3,085,000 for the year ended December 31, 1992. Gain of $2,238,000 from disposal of PSM equipment in 1993 was deferred to cover anticipated plant shutdown costs. Identifiable assets of PSM included $1,361,000 for property and plant which are carried in Other Non-Current Assets at December 31, 1994. Depreciation on the property, plant and equipment was $119,000 and $482,000 for the years ended December 31, 1993 and 1992, respectively.\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\nOperating income of the Industrial Tools business segment in 1992 includes profits from LIFO inventory liquidations for the change in the reserve to state certain inventories at LIFO cost of $802,000.\nOperating income of the Metal Fabrications business segment in 1992 includes profits from LIFO inventory liquidations for the change in the reserve to state certain inventories at LIFO cost of $3,070,000.\nThe percentages of net sales for classes of similar products which exceeded ten percent of the Company's consolidated net sales, for the period indicated, are set forth below: Percentage of Consolidated Net Sales Products Business Segments 1994 1993 1992\nTungsten carbide cutting tools Industrial Tools 29% 25% 18%\nPressure vessels Metal Fabrications -% 1% 15%\nNonferrous forgings Metal Fabrications 12% 8% 11%\nInvestment castings Metal Fabrications 13% 7% 7%\nThe identifiable assets, depreciation and capital expenditures for the years ended December 31, 1994, 1993 and 1992 are as follows:\n1994 1993 1992 Identifiable assets Industrial Tools $14,007,160 $12,212,684 $12,135,501 Metal Fabrications 22,089,022 23,235,416 30,547,941 Corporate\/Discontinued 36,784,736 37,843,234 35,623,265\nTotal assets $72,880,918 $73,291,334 $78,306,707\nDepreciation Industrial Tools $ 716,800 $ 692,728 $ 455,649 Metal Fabrications 1,258,238 1,505,457 1,679,466 Corporate\/Discontinued - - -\nTotal depreciation $ 1,975,038 $ 2,198,185 $ 2,135,115\nCapital expenditures Industrial Tools $ 1,055,600 $ 109,310 $ 654,811 Metal Fabrications 598,853 326,687 533,355 Corporate\/Discontinued - - -\nTotal capital expenditures $ 1,654,453 $ 435,997 $ 1,188,166\nITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Contd.)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Contd.)\n8. Lease Commitments\nThe Company leases data processing, transportation and other equipment, as well as certain facilities, under operating leases. Such leases do not involve contingent rentals, nor do they contain significant renewal or escalation clauses.\nTotal minimum future rentals under noncancelable leases at December 31, 1994 were $1,540,000, including $584,000 in 1995, $510,000 in 1996, $259,000 in 1997, $185,000 in 1998, and $2,000 in 1999 and thereafter. Rental expense of the continuing operations was $1,187,000 in 1994, $2,024,000 in 1993, and $2,091,000 in 1992.\nProperty, plant and equipment included $312,000 and $198,000 in machinery and equipment from capital leases at December 31, 1994 and 1993, respectively. Future minimum payments including interest are $104,000 in 1995, $98,000 in 1996 and $9,000 in 1997.\nSUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\n(thousands of dollars except per share data) Mar. 31, Jun. 30 , Sep. 30, Dec. 31,\nNet sales $ 21,813 $ 22,053 $ 22,319 $ 23,102 Gross profit 4,288 4,413 4,121 4,432\nNet income 853 844 1,012 900 Net income per common share .10 .10 .12 .10\nNet sales $ 23,526 $ 23,281 $ 21,831 $ 20,749 Gross profit 4,265 4,131 3,681 3,731 Income from continuing operations 910 645 367 594 Net income (loss) 976 645 367 (1,082) Income per common share from continuing operations .10 .08 .04 .07 Net income (loss) per common share .11 .08 .04 (.12)\nThe third quarter, 1994 net income included $152,000 net gain on the sale of property at the Precision Sheet Metal (PSM) facility, the operations of which were phased out in 1993.\nThe fourth quarter, 1993 net income was reduced by a loss from discontinued operations of $1,676,000 from the revaluation of environmental liabilities from present value to gross cost.\nAmounts presented above for 1993 have been adjusted from those previously reported to conform with the 1994 classifications.\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\nInformation regarding the Company's directors and executive officers is included in Part I page 8.\nAdditional information concerning the Company's directors is incorporated by reference to information under the caption \"Nominees for Election as Directors\" in the Company's definitive proxy statement for the annual meeting of shareholders to be held on April 26, 1995.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nIncorporated herein by reference to information under the caption \"Compensation of Directors and Executive Officers\" in the Company's definitive proxy statement for the annual meeting of shareholders to be held on April 26, 1995.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a)(b)(c) The information required by this Item 12 is incorporated herein by reference to the information under the captions \"Voting Securities and Principal Holders Thereof\" and \"Nominees for Election as Directors\" in the Company's definitive proxy statement for the annual meeting of shareholders to be held on April 26, 1995.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated herein by reference to the information under the caption \"Nominees for Election as Directors\" in the Company's definitive proxy statement for the annual meeting of\nshareholders to be held on April 26, 1995.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS\n(a)(1) Index to Consolidated Financial Statements: Form 10-K Page\nReport of Independent Auditors. 18\nConsolidated Statement of Operations for each of the three years in the period ended December 31, 1994. 19\nConsolidated Balance Sheet at December 31, 1994 and 1993. 20-21\nConsolidated Statement of Cash Flows for each of the three years in the period ended December 31, 1994. 22-23\nConsolidated Statement of Shareholders' Equity for each of the three years in the period ended December 31, 1994. 24\nNotes to Consolidated Financial Statements. 25-38\nSummary Quarterly Financial Data for the years ended December 31, 1994 and 1993. 38\n(a)(2) Index to Consolidated Financial Statement Schedule:\nConsolidated Financial Statement Schedule for each of the three years ended December 31, 1994:\nII. Valuation and qualifying accounts 41\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 and Notes thereto.\n(a)(3) The following exhibits required by Item 601 of Regulation S-K are submitted as follows:\nExhibit 3.1 - Certificate of Incorporation\nExhibit 3.2 - By-Laws\nExhibit 22 - Subsidiaries of the Registrant\nAll other exhibits are omitted since the required information is not present or is not present in amounts sufficient to require submission.\n(b) No reports have been filed on Form 8-K during the last quarter of the year ended December 31, 1994.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nAdditions Balance at Charged to Balance Beginning Cost and Deductions at End of Year Expenses (1) of Year\nAllowance for Doubtful Accounts:\nYear ended 12\/31\/94 $ 276,440 $ (21,929) $ (21,929) $ 276,440\nYear ended 12\/31\/93 $ 324,440 $ 57,464 $ 105,464 $ 276,440\nYear ended 12\/31\/92 $ 324,440 $ 403,206 $ 403,206 $ 324,440\n(1) 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.\nFANSTEEL INC. Registrant\nDate: March 6, 1995 By: \\s\\ Keith R. Garrity Keith R. Garrity, 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 on the dates indicated:\nSignature Title Date Director, Chairman of the Board and Chief Executive \\s\\ Keith R. Garrity Officer March 6, 1995 Keith R. Garrity\nVice President and Chief \\s\\ R. Michael McEntee Financial Officer March 6, 1995 R. Michael McEntee\n\\s\\ Betty B. Evans Director March 13, 1995 Betty B. Evans\n\\s\\ Edward P. Evans Director March 23, 1995 Edward P. Evans\n\\s\\ R. S. Evans Director March 21, 1995 Robert S. Evans\n\\s\\ T. M. Evans Director March 13, 1995 Thomas M. Evans\n\\s\\ Thomas M. Evans, Jr. Director March 27, 1995 Thomas M. Evans, Jr.\n\\s\\ Jack S. Petrik Director March 17, 1995 Jack S. Petrik\n\\s\\ C. J. Queenan, Jr. Director March 7, 1995 Charles J. Queenan, Jr.\nINDEX TO EXHIBITS\nThe following Exhibits to this report are filed herewith or, if marked with an asterisk (*), are incorporated by reference:\nExhibit Prior Filing or Sequential No. Page Number Herein\n3.1 Certificate of Incorporation Company's Form 10-K filed March 31, 1993 (*)\n3.2 By-Laws Annex II to the Company's annual proxy statement dated March 15, 1985, File No. 1-8676 (*)\n22 Subsidiaries of the Registrant 44","section_15":""}
{"filename":"701856_1994.txt","cik":"701856","year":"1994","section_1":"ITEM 1. BUSINESS.\nRollins Environmental Services, Inc. through its subsidiaries (herein collectively referred to as the \"Company\" unless the context indicates otherwise), transports, treats and disposes of industrial chemical waste by incineration and other methods at five facilities located in Colorado, Louisiana (2), New Jersey and Texas. The Company operates waste processing, recycling and repackaging facilities in Missouri and California and has analytical laboratories in California, Colorado, Louisiana, Michigan, New Jersey and Texas.\n(a) General Development of Business\nFor the second consecutive year, the Company's earnings were adversely affected by continued weak conditions in the commercial hazardous waste incineration industry resulting in market declines in both incineration pricing and available volumes of hazardous waste. The second quarter fiscal year 1994 results included a special charge before taxes of $14,500,000 relating primarily to the write-off of various engineering and other expenditures on projects no longer considered viable in the current business climate and estimated expenditures for capping of a closed landfill. The Company has taken new initiatives in its efforts to improve competitive position and profitability. (See \"Management's Discussion and Analysis\" on page 9 of this 1994 Annual Report on Form 10-K.)\nOtherwise, there have been no significant changes in the business of the Company since September 30, 1993.\n(b) Financial Information about Industry Segments\nThe business of the Company, essentially all of which is conducted in the United States, consists solely of industrial waste treatment and disposal. Financial information concerning this business is included on pages 8 to 11 and 16 to 26 of this 1994 Annual Report on Form 10-K.\n(c) Narrative Description of Business\nThe Company treats and disposes industrial chemical waste at its facilities in Baton Rouge, Louisiana; Bridgeport, New Jersey and Deer Park, Texas, (hereinafter the \"Plants\"). In addition, the Company provides secure land disposal services for a variety of treated wastes and treatment residues at its Deer Trail, Colorado landfill (hereinafter the \"Landfill\"). Aqueous waste streams are treated and disposed of at a deep injection well (the \"Injection Well\") located in Plaquemine, Louisiana. The Plants, Landfill and Injection Well are operated by wholly owned subsidiaries. The Company also treats, stores, recycles or repackages industrial chemical wastes at its facilities in Los Angeles, California and Tipton, Missouri (hereinafter the \"TSDs\") for disposal at the Plants, Landfill or other disposal facilities.\nThe Company incinerates wastes at each of the Plants. High temperature incineration effectively eliminates organic wastes such as herbicides, plastics, halogenated solvents, pesticides, pharmaceuticals and refinery wastes, regardless of whether they are gases, liquids, sludges or solids.\nFederal and state incineration regulations require a destruction and removal efficiency of 99.99% for organic wastes and 99.9999% for polychlorinated biphenyls (\"PCBs\"). The Company's four rotary kiln incinerators and the Rollins Rotary Reactor meet or exceed these requirements, however, only one of the Company's incinerators at Deer Park, Texas has a permit to burn PCBs.\nThe Landfill disposes of a variety of treated wastes, such as incinerator ash, industrial residues and sludges, contaminated soils, catalysts and contaminated construction debris, in landfills meeting or exceeding the requirements of state and federal regulations. The Landfill offers state-of-the-art stabilization and encapsulation technology, solidification and other appropriate treatment of organic hazardous waste, secure landfill disposal of solid and previously solidified materials, and oil\/solvent collection, blending and material storage.\nWhile most waste is transported to the Company's facilities by truck, waste can also be received by rail at the Baton Rouge and Deer Park plants and by barge at the Injection Well.\nThe Company provides analytical services through laboratories operated at its incineration facilities in Baton Rouge, Louisiana; Bridgeport, New Jersey and Deer Park, Texas and by other subsidiaries located in Ann Arbor, Michigan; Deer Trail, Colorado and Los Angeles, California.\nThe Company conducts business with more than 1,100 customers. These customers are primarily engaged in the chemical processing industry and are located throughout the United States. No one customer currently accounts for more than 4% of the Company's consolidated revenues. The Company believes the principal considerations for customers choosing between incineration and other methods of disposal are current and anticipated state and Federal regulation, price and concern over long-term liability.\nThe Company is working vigorously with both the States and Federal EPA to regulate additional waste streams into the incineration market and to establish standards that will equitably regulate the commercial hazardous waste incineration industry and cement kiln industry incineration of hazardous waste. Recent actions by these agencies are supportive of the Company's arguments to have fair and even application of the law to both commercial hazardous waste incinerators and cement kilns, to preserve the environment through strict emission standards, to provide for occupational health and safety at sites managing hazardous waste and to ensure continued improvement of technology. Stricter regulation of these kilns should result in disposal of greater quantities of hazardous wastes at commercial hazardous waste incineration facilities.\nCompetitors operate large-scale incinerators in El Dorado, Arkansas (Environmental Systems Company); Sauget, Illinois and Port Arthur, Texas (Chemical Waste Management, Inc.); Coffeyville, Kansas and Aragonite, Utah (Westinghouse Electric Corporation); East Liverpool, Ohio (Waste Technologies, Inc.); Grafton, Ohio (Ross Incineration Services, Inc.); Rockhill, South Carolina and Cohoes, New York (ThermalKem, Inc.) and Calvert City, Kentucky (LWD). The Clive, Utah facility (USPCI) has received its permit but must conduct a test burn prior to operation. Other companies have applied for or received permits to construct and operate hazardous waste incinerators. In addition, competition is also provided by cement kilns. The Plants, Landfill, TSDs and Injection Well are intensively regulated by the United States Environmental Protection Agency (\"USEPA\") and by the applicable state regulatory agencies.\nEnvironmental laws and regulations require hazardous waste disposal facilities to obtain permits which generally outline the procedures under which the facility must be operated. Violations of permit conditions or of the regulations, even if immaterial or unintentional, may result in fines, shutdowns, remedial work or revocation of the permit. On a number of occasions during the past five years, the Company has been fined for alleged violations of federal and state laws. Such fines have not been material individually or in the aggregate. The Company believes it is in compliance with the requirements of all of its operating permits and related federal and state regulations.\nThe Federal Resource Conservation and Recovery Act (\"RCRA\") created a comprehensive scheme for the regulation of hazardous waste facilities and for the storage, treatment and disposal of hazardous wastes. The USEPA has adopted regulations under RCRA governing the management and disposal of hazardous wastes, including standards for storage areas, incinerators (including destruction standards) and landfills. RCRA also imposes financial responsibility standards to ensure the availability of funds to maintain sites after closing.\nUnder RCRA, applicants who filed Part A applications with the USEPA received interim status for their hazardous waste treatment facilities in November 1980. If the USEPA (or the state agency which has been delegated this authority by the USEPA) is satisfied with an application describing the proposed characteristics, equipment and operation of a facility, it may issue a Part B operating permit valid for up to ten years. All new facilities will require a Part B permit before commencing operations. Part B permits were granted to the Deer Park plant on March 15, 1988, to the Bridgeport plant on March 31, 1989 and to the Baton Rouge plant on February 8, 1993. The Injection Well was granted a Part B permit on January 10, 1994.\nPlants operated under Part B permits must meet stringent RCRA and permit standards. Operators with Part B permits or interim status are required to certify to regulatory agencies that they (1) meet specified groundwater monitoring conditions; (2) post financial security for the closure and, with certain permits, post-closure maintenance of their facilities; and (3) provide insurance protection for other parties in the event of environmental damage. Such certifications were made for all Company facilities. In this regard, the Company has supplied financial assurance to regulatory agencies and others in the aggregate amount of $44,171,000 at September 30, 1994, which included letters of credit of $20,656,000. The balance is satisfied principally by a combination of insurance and trust funds.\nIn order to qualify the Bridgeport, New Jersey; Baton Rouge, Louisiana and the Deer Park, Texas plants to accept and dispose of waste under the Superfund program, the Company's subsidiaries Rollins Environmental Services (NJ) Inc. (\"RES (NJ)\"), Rollins Environmental Services (LA) Inc. (\"RES (LA)\") and Rollins Environmental Services (TX) Inc. (\"RES (TX)\") entered into Consent Agreements with the USEPA under Section 3008(h) of RCRA. The agreements provide for a thorough evaluation and assessment of\nthe facilities and contain procedures under which RES (NJ), RES (LA) and RES (TX) will undertake certain corrective actions. The cost of certain corrective actions required under Section 3008(h) has been included in Accrued Remediation and Other Costs in the Consolidated Balance Sheet on page 18 of this 1994 Annual Report on Form 10-K.\nIn November 1988, the Company acquired Oil, Inc. (name changed to Rollins O.P.C. Inc. in 1992), a small company that operates a hazardous waste storage, treatment and transfer facility in Los Angeles, California. In August 1990, Oil, Inc. was granted a Part B permit allowing it to handle most of the EPA waste codes as well as to upgrade the facility for drum storage, repacking, bulking and blending.\nIn January 1989, the Company acquired a hazardous waste storage and container processing facility in Tipton, Missouri, which was incorporated as Tipton Environmental Technology, Inc. On April 22, 1994, this facility was granted a Part B permit to store and bulk certain hazardous waste regulated under RCRA along with the storage and processing of certain PCB- contaminated wastes.\nIn July 1994, the Company acquired Highway 36 Land Development Company, a secure landfill in Deer Trail, Colorado. This facility operates under a Part B permit which was granted on April 2, 1987.\nWith the addition of the Part B permits received at the Injection Well and the Tipton, Missouri facility, the Company now has all of its disposal facilities and TSDs operating under RCRA Part B permits.\nThe Company has approximately 1,295 employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company maintains its headquarters in space leased from Rollins Properties, Inc., a wholly owned subsidiary of Rollins Truck Leasing Corp. at 2200 Concord Pike, Wilmington, Delaware.\nIn addition to pollution control equipment, each subsidiary owns the number of acres of land following its name: RES (NJ) 532 acres; RES (LA) 820 acres; Rollins Environmental Services of Louisiana, Inc. 20 acres; RES (TX) 1,200 acres; Rollins Environmental Services (CA) Inc. 3,693 acres; ENCOTEC, Inc. 7 acres; Tipton Environmental Technology, Inc. 60 acres; Custom Environmental Transport, Inc. 5 acres and Highway 36 Land Development Company 6,010 acres. Administrative and service offices are located in owned or leased facilities in 17 states.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIn the opinion of management, based on the advice of counsel, the outcome of the unsettled claims and litigation listed below and various other claims and legal actions pending against the Company which are not listed are only remotely likely to be material.\n(a) Bridgeport Rental & Oil Service Superfund Site\nOn April 3, 1989, RES (NJ) was served with a Directive by the NJDEPE in which it is alleged that RES (NJ), during the period 1970 through 1977,\ndischarged hazardous wastes into a lagoon at a facility operated by Bridgeport Rental & Oil Service (\"BROS\") in Logan Township, New Jersey. RES (NJ) believes the allegations are unfounded and inaccurate. RES (NJ), now and in the future, intends to defend itself vigorously against the allegations. It has been alleged by the United States Environmental Protection Agency (\"USEPA\") that the lagoon covered 13 acres and contained some 70,000,000 gallons of contaminated liquids and 85,000 cubic yards of contaminated soils and sludges. On August 29, 1989, RES (NJ) was served with a demand letter by the USEPA in which it alleged that RES (NJ) was liable for its share of $17,800,000 in past costs incurred by the USEPA at the BROS site.\nIn late 1970, RES (NJ) completed the construction of its hazardous waste disposal plant located in Bridgeport, New Jersey. At the time, RES (NJ) did not have sufficient tank storage space on site to store all of the liquid hazardous waste received from a substantial number of customer- generators. As a consequence, in late 1970, RES (NJ) rented tank storage space at BROS. Thereafter, some of the liquid waste material received at the Bridgeport plant was transferred to the rented BROS storage tanks for storage pending disposal at the Bridgeport plant.\nRES (NJ) did not knowingly discharge any waste materials from these rented storage tanks into the BROS lagoon or on the ground surrounding the tanks. The waste material was returned to RES (NJ)'s Bridgeport plant for disposal. RES (NJ) does, however, have records relative to three spills which occurred at the BROS site. It is believed that only one spill which occurred in 1971 may possibly have found its way into the lagoon. The other two spills were in negligible amounts and were cleaned up immediately.\nAlthough the NJDEPE is aware that only a minuscule portion of the material in the lagoon resulted from the storage tank operations of RES (NJ), the NJDEPE has nonetheless taken the position that the act of storing waste in the tanks rented from BROS constituted a \"discharge\" of the waste. Thus the NJDEPE contends that RES (NJ) and its customers are responsible for partial payment of the clean up costs even though their waste was removed by RES (NJ) from the storage tanks at BROS and disposed at RES (NJ)'s Bridgeport plant.\nIn 1978, RES (NJ) completed the construction of a new tank farm at its Bridgeport plant. In 1980, RES (NJ) emptied and cleaned each and every one of the storage tanks that it had under lease at the BROS site. During the cleaning process, each and every tank was inspected carefully to determine its integrity. As each tank was determined to be empty and clean, the use of each tank was then returned to BROS. Each and every tank was determined to be structurally sound with no leaks of any type.\nA comprehensive investigation of the historical uses of the BROS site was begun in 1989 and is still continuing. The investigation has produced proof that the contributors of the vast majority of hazardous substances to the BROS site were departments and\/or agencies of the United States. On March 20, 1992, RES (NJ) and others filed suit against the United States and its responsible departments and agencies, seeking cost recovery and a declaration as to the liability of the United States with respect to the site.\nOn July 10, 1992, the United States filed suit against RES (NJ) and six (6) other defendants in the U.S. District Court of New Jersey. The suit seeks recovery of costs incurred by the United States at the BROS site in the amount of $29,000,000 in past response costs, plus interest, as well as a declaration that the defendants are jointly and severally liable for future response costs. RES (NJ) will contest this action vigorously, emphasizing its suit against the United States as the contributor of the overwhelming percentage of hazardous substances to the BROS site. The Court has placed the case on parallel litigation and settlement tracks. The presiding U.S. Magistrate Judge has ordered the parties to engage in mediation as part of the settlement track, and this process has been an intensive and on-going one in the effort to achieve settlement. The major issues to be resolved involve the U.S. government's contribution to the site vs. the private parties' contribution and the propriety of the USEPA's chosen remedy. It is not possible at this time to determine what amounts, if any, will be payable by RES (NJ) with respect to this matter.\n(b) Helen Kramer Superfund Site\nIn October 1990, RES (NJ) was served with a third-party complaint alleging RES (NJ)'s use of the Helen Kramer Landfill during the mid-1970s. The Helen Kramer Landfill (\"Site\") is a USEPA Superfund site which is currently being remediated under the supervision of the USEPA. In 1989, the United States filed suit against 25 parties for cost recovery. A number of those original defendants have commenced this third-party action against RES (NJ) and approximately 160 other parties. RES (NJ) does have a connection to the Site based on the disposal of lagoon sludge from a customer's facility. RES (NJ)'s portion of the Site remediation is expected to be minimal. Virtually all parties, including RES (NJ), have been involved in a lengthy and complex settlement process which has yet to produce an allocation plan. Recently, while requiring the allocation process to continue, the failure of the United States and the direct defendants to reach a settlement has caused the Court to order that the discovery phase of the litigation commence.\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.\nSTOCK PRICES AND DIVIDENDS\nThe range of per 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 (1) 1994 1993 1994 1993 High Low High Low Fiscal Quarter First ........ $6 1\/2 $4 7\/8 $12 7\/8 $10 7\/8 None $.0250 Second ....... 6 3\/8 4 5\/8 13 1\/8 7 1\/2 None .0250 Third ........ 5 1\/2 4 1\/4 8 3\/8 7 None .0250 Fourth ....... 6 3\/8 4 7 1\/2 5 3\/4 None .0250\nAt September 30, 1994, there were 6,791 holders of record of the Common Stock.\n(1) The Company's Board of Directors suspended the payment of cash dividends at its October 29, 1993 meeting. The Board of Directors periodically reviews this decision.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nFive Year Selected Financial Data (Dollars in Thousands, Except Per Share Amounts)\nFiscal Year Ended September 30, 1994 1993 1992 1991 1990\nRevenues $181,468 $214,843 $240,477 $220,759 $200,043 Earnings (loss) before income taxes $(16,876)(1) $ 19,155 $ 49,215 $ 40,020 $ 42,532 Income taxes (benefit) (6,942)(2) 7,231 17,203 14,083 14,640 Net earnings (loss) $ (9,934)(1)(2) $ 11,924 $ 32,012 $ 25,937 $ 27,892 Earnings (loss) per share $ (.16)(1)(2) $ .20 $ .53 $ .43 $ .46\nCash dividends per share(3) $ - $ .10 $ .0925 $ .09 $ .0825 Working capital $ 66,369 $ 64,864 $ 68,898 $ 60,891 $ 50,966 Property and equipment $166,383 $180,998 $169,285 $151,446 $139,379 Total assets $273,386 $278,641 $283,318 $257,968 $233,667 Long-term debt $ 3,970 $ 4,632 $ 5,444 $ 7,945 $ 5,766 Shareholders' equity $202,961 $212,807 $206,572 $179,809 $159,119\n(1) Includes special charge of $14,500 ($9,031 after tax benefit or $.15 per share). (2) Includes benefit of $543 or $.01 per share from the adoption of SFAS No. 109 - Accounting for Income Taxes. (3) The Company's Board of Directors suspended the payment of cash dividends at its October 29, 1993 meeting.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nResults of Operations\nThe Company's revenues, summarized by method of disposal or other service provided, are as follows: % of % of % of (Dollars in Thousands) 1994 Revenues 1993 Revenues 1992 Revenues Incineration $135,559 74.7 $170,171 79.2 $192,068 79.9 Transportation 15,922 8.8 18,148 8.4 18,078 7.5 Chempak services (net) 9,930 5.5 10,006 4.7 10,632 4.4 Other 20,057 11.0 16,518 7.7 19,699 8.2 $181,468 100.0 $214,843 100.0 $240,477 100.0\nEach caption in the above table includes the portion of the revenues of the Company's subsidiaries related to that particular service. ________________________________________________________________________\nFiscal Year 1994 vs. 1993\nRevenues for the year decreased by $33,375,000 (16%) mainly due to the weak conditions in the hazardous waste treatment market and the impact of severe weather conditions in the Northeast and Midwest earlier in 1994. The revenue reduction resulted from a combination of lower average prices, lower volume and change in incineration mix.\nOperating expenses decreased by $12,775,000 (9%) reflecting the reduced level of revenues along with the impact of the Company's cost containment program. Operating costs as a percentage of revenues increased to 74% in 1994 from 68% in 1993 mainly due to the decrease in revenues.\nA special charge of $14,500,000 ($9,031,000 after tax benefit or $.15 per share) was recorded in the second quarter of fiscal year 1994. The charge included: (1) various engineering and other expenditures ($8,200,000) on projects no longer considered viable in the current business climate; (2) estimated expenditures ($5,000,000) for capping of a closed landfill and related activities and (3) miscellaneous items ($1,300,000).\nDepreciation increased by $2,365,000 (12%) due to the Company's capital expenditure program to upgrade equipment, improve operating efficiency and comply with changing regulations.\nSelling and administrative expenses decreased by $1,389,000 (5%) mainly due to lower compensation and travel expenses related to the personnel cutbacks under the Company's cost containment program. As a percentage of revenues, selling and administrative expenses were 15% in 1994 and 13% in 1993 mainly due to the lower revenues.\nThe income tax benefit recorded for the year was based on an estimated effective income tax rate of 38% of the loss before income taxes. The income tax provision for 1993 was based on an estimated effective income tax rate of 38%.\nThe net loss for the year was $9,934,000 or $.16 per share compared with net earnings of $11,924,000 or $.20 per share in 1993. Exclusive of the special charge and the cumulative effect of the change in accounting principle related to income taxes, the Company reported a net loss of $1,446,000 or $.02 per share.\nAlthough weak conditions in the hazardous waste treatment market have continued, the Company has taken new initiatives in 1994 to improve its competitive position and profitability. First, a major Company-wide cost containment program was implemented which included personnel cutbacks and elimination of salary increases. Second, the Company is working to restructure its organization and expand the services offered to its customers. To this end, in June the Company signed a letter of intent with Molten Metal Technology, Inc. to construct Rollins' first hazardous waste recycling unit; in July the Company acquired Highway 36 Land Development Company, a treatment, storage and disposal facility near Denver, Colorado; and, in August the Company signed a letter of intent to acquire Aptus, Inc. (see \"Liquidity and Capital Resources\"). Third, the Company is continuing to work vigorously with the States and the EPA to regulate additional waste streams into the incineration market and establish standards which will\nequitably regulate the commercial hazardous waste incineration industry and cement kiln industry incineration of hazardous waste.\nFiscal Year 1993 vs. 1992\nRevenues decreased by $25,634,000 (11%) due mainly to a change in incineration mix and lower average prices which resulted from the continued softness in the commercial hazardous waste treatment market. Volume processed at the Company's Texas incineration plant was higher than that processed in 1992 when the plant was closed for part of the 1992 first quarter due to a fire. Total volume at the New Jersey and Louisiana plants was comparable to that processed in 1992.\nOperating expenses increased by $4,252,000 (3%) due mainly to higher payroll, property taxes, insurance and maintenance costs, offset in part by cost reduction programs. Operating expenses as a percentage of revenues increased to 68% from 59% in 1992. The increase in the operating cost ratio was due mainly to the decrease in revenues.\nThe increase in depreciation of $2,706,000 (15%) is attributable to the Company's capital expenditure program to upgrade its equipment, improve its operating efficiency, increase capacity and comply with changing regulations.\nSelling and administrative expenses decreased by $2,261,000 (7%). Expenses were reduced through cost reduction efforts and lower commissions and other compensation expenses related to the lower level of revenues. As a percentage of revenues, selling and administrative expenses were 13% in 1993 and 1992.\nIncome taxes, which are based on the estimated effective tax rate for the fiscal year, were 38% of earnings before income taxes in 1993 and 35% in 1992. The higher rate in 1993 was due to higher state income taxes. The new tax law enacted in 1993 did not materially impact fiscal year 1993 results.\nNet earnings for 1993 decreased by 63% to $11,924,000 or $.20 per share from the $32,012,000 or $.53 per share reported for 1992. The decline in earnings was due mainly to the decreased revenues noted above and to the increased operating and depreciation expenses.\nLiquidity and Capital Resources\nThe Company's operations have required substantial capital investments which have been financed with the cash flows from operations and available cash. Expenditures for land, buildings and equipment (\"capital assets\") were $18,002,000 in 1994, $32,993,000 in 1993 and $37,376,000 in 1992. Commitments for the purchase of capital assets amounted to $5,244,000 at September 30, 1994. Such commitments were mainly to complete projects in process. The Company plans capital expenditures of up to $29,000,000 in fiscal year 1995 to upgrade its facilities. Such expenditures will include improvements to electrical power and water systems; waste collection, storage and processing facilities; and other equipment modernization programs.\nIn addition, the Company spent $2,874,000, $3,902,000 and $4,138,000, respectively, on remediation projects in 1994, 1993 and 1992. The Company believes the amounts accrued for remediation and other costs are adequate to cover the cost of the mandated remediation and other corrective actions required to be completed at its facilities.\nThe Company's projected capital and remediation expenditures in fiscal year 1995 are expected to be financed with the cash flows from operations and funds on hand.\nOn August 23, 1994, the Company signed a letter of intent to acquire Aptus, Inc., a wholly owned subsidiary of Westinghouse Electric Corporation, for $160,000,000.\nFor additional information on the pending acquisition and a discussion of environmental issues, see \"Notes to the Consolidated Financial Statements - Commitments and Contingent Liabilities\".\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 referenced on the Index to the Consolidated Financial Statements and Schedules on page 15.\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 27, 1995.\nExecutive Officers of the Registrant. As of October 31, 1994, the executive officers of the registrant were:\nName Position Age Term of Office\nMichael B. Kinnard General Counsel and 37 10\/94 to date Secretary\nNicholas Pappas President, Chief Operating 64 7\/91 to date Officer and Director\nLeo F. Rattigan, Jr. Vice President-Finance 53 1\/92 to date and Treasurer Chief Financial Officer Chief Accounting Officer\nJohn W. Rollins Chairman of the Board, 78 7\/88 to date Chief Executive Officer and 10\/88 to date Chairman of the Executive 4\/82 to date Committee\nJohn W. Rollins, Jr. Senior Vice Chairman 52 1\/88 to date of the Board Vice Chairman of the Board 5\/83 to 1\/88\nHenry B. Tippie Chairman of the Executive 67 10\/88 to date Committee, Chairman of the Finance and Audit Committees and Director 4\/82 to 10\/88\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 27, 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 January 27, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nDuring the fiscal year ended September 30, 1994, the following officers and\/or directors of the Company were also officers and\/or directors of Rollins Truck Leasing Corp.; Patrick J. Bagley; John C. Peet, Jr. (retired effective September 30, 1994), William B. Philipbar, Jr., 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 10.9% and 12.0% of the Common Stock of Rollins Truck Leasing Corp. and Matlack Systems, Inc., respectively at October 31, 1994. The description of transactions between the Company and Rollins Truck Leasing Corp. and between the Company and Matlack Systems, Inc. appearing under the caption \"Transactions with Related Parties\" is on pages 23 and 24 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. (a) Financial Statements, Financial Statement Schedules and Exhibits.\n(1) Financial Statements - See accompanying Index to Consolidated Financial Statements and Schedules on page 15.\n(2) Financial Statement Schedules - See accompanying Index to Consolidated Financial Statements and Schedules on page 15.\n(3) Exhibits:\n(3)(a) Restated Certificate of Incorporation of Rollins Environmental Services, Inc. as last amended on January 29, 1988 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 Environmental Services, Inc. as amended and in effect on December 3, 1993 as filed with the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 1993 is incorporated herein by reference.\n(4) Instrument Defining Rights of Security Holders. 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) Rollins Environmental Services, Inc. 1982 Incentive Stock Option Plan, as filed with Amendment No. 1 to the Company's Registration Statement No. 2-84139 on Form S-1 dated June 24, 1983, is incorporated herein by reference.\n(10)(b) Rollins Environmental Services, Inc. 1993 Stock Option Plan, as filed with the Company's Proxy Statement for the Annual Meeting of Shareholders held January 28, 1994, is incorporated herein by reference.\n(21) Rollins Environmental Services, Inc. Subsidiaries at September 30, 1994.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by Rollins Environmental Services, Inc. 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, John C. Peet, Jr. resigned his position as Vice President-General Counsel and Secretary and Director of the Company. Effective on the same date, Michael B. Kinnard was appointed General Counsel and Secretary 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.\nDATED: November 29, 1994 ROLLINS ENVIRONMENTAL SERVICES, INC. (Registrant)\nBY: \/s\/ John W. Rollins John W. Rollins Chairman of the Board, 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:\n\/s\/ Michael B. Kinnard General Counsel and November 29, 1994 Michael B. Kinnard Secretary\n\/s\/ Nicholas Pappas President, Chief Operating November 29, 1994 Nicholas Pappas Officer and Director\n\/s\/ Leo F. Rattigan, Jr. Vice President-Finance and November 29, 1994 Leo F. Rattigan, Jr. Treasurer Chief Financial Officer Chief Accounting Officer\n\/s\/ John W. Rollins, Jr. Senior Vice Chairman of the November 29, 1994 John W. Rollins, Jr. Board and Director\n\/s\/ Henry B. Tippie Chairman of the Executive November 29, 1994 Henry B. Tippie Committee and Director\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\n(1) Consolidated\nPage Nos.\nIndependent Auditors' Report on Financial Statements and Financial Statement Schedules 16\nConsolidated Statement of Operations for the years ended September 30, 1994, 1993 and 1992 17\nConsolidated Balance Sheet at September 30, 1994 and 1993 18\nConsolidated Statement of Cash Flows for the years ended September 30, 1994, 1993 and 1992 19\nNotes to the Consolidated Financial Statements 20 to 26\n(2) Financial Statement Schedules:\nConsolidated\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 27\nSchedule V - Property, Plant and Equipment for the years ended September 30, 1994, 1993 and 1992 28\nSchedule VI - Accumulated Depreciation of Property, Plant and Equipment for the years ended September 30, 1994, 1993 and 1992 29\nSchedule VIII - Valuation and Qualifying Accounts for the years ended September 30, 1994, 1993 and 1992 30\nSchedule X - Supplementary Income Statement Information for the years ended September 30, 1994, 1993 and 1992 31\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 Environmental Services, Inc.\nWe have audited the consolidated financial statements of Rollins Environmental Services, 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 Rollins Environmental Services, Inc. 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.\nAs discussed in the Notes to the Consolidated Financial Statements, in fiscal year 1994, the Company changed its method of accounting for income taxes.\nKPMG Peat Marwick LLP\nPhiladelphia, Pennsylvania October 26, 1994\nCONSOLIDATED STATEMENT OF OPERATIONS\nYear Ended September 30, (Dollars in 000s) 1994 1993 1992\nRevenues $181,468 $214,843 $240,477 Expenses: Operating 134,053 146,828 142,576 Special charge 14,500 - - Depreciation 22,760 20,395 17,689 Selling and administrative 26,649 28,038 30,299 Interest 382 427 698 198,344 195,688 191,262\nEarnings (Loss) Before Income Taxes (Benefit) and Cumulative Effect of Change in Accounting Principle (16,876) 19,155 49,215 Income taxes (benefit) (6,399) 7,231 17,203\nEarnings (Loss) Before Cumulative Effect of Change in Accounting Principle (10,477) 11,924 32,012\nCumulative effect (to September 30, 1993) of adoption of SFAS No. 109 543 - -\nNet Earnings (Loss) $ (9,934) $ 11,924 $ 32,012\nEarnings (Loss) Per Share: Earnings (loss) before cumulative effect of change in accounting principle $ (.17) $ .20 $ .53 Cumulative effect of adoption of SFAS No. 109 .01 - - Earnings (Loss) Per Share $ (.16) $ .20 $ .53\nAverage common shares and equivalents outstanding 60,377 60,364 60,567\n_________________________________________________________________________\nThe Notes to the Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED BALANCE SHEET\nSeptember 30, (Dollars in 000s) 1994 1993 ASSETS\nCurrent Assets Cash and cash equivalents (includes short-term investments of: 1994-$45,437; 1993-$44,218) $ 54,772 $ 47,487 Accounts receivable, net of allowance for doubtful accounts: 1994-$724; 1993-$422 28,727 30,311 Deferred income taxes 6,170 3,514 Income taxes recoverable 3,827 1,446 Other current assets 6,538 6,612 100,034 89,370 Property and Equipment, at cost, net of accumulated depreciation 166,383 180,998 Other Assets 6,969 8,273 $273,386 $278,641\nLIABILITIES AND SHAREHOLDERS' EQUITY\nCurrent Liabilities Accounts payable $ 9,591 $ 7,067 Accrued liabilities 17,556 12,119 Accrued remediation and other costs 5,895 4,697 Current maturities of long-term debt 623 623 33,665 24,506\nLong-term Debt 3,970 4,632 Accrued Remediation and Other Costs 13,516 16,358 Other Liabilities 5,331 4,964 Deferred Income Taxes 13,943 15,374\nCommitments and Contingent Liabilities (see Notes to the Consolidated Financial Statements)\nShareholders' Equity Preferred stock, $1 par value - Outstanding - None Common stock, $1 par value Shares outstanding: 1994-60,375,811; 1993-60,350,254 60,376 60,350 Capital in excess of par value 4,650 4,588 Retained earnings 137,935 147,869 202,961 212,807 $273,386 $278,641\n________________________________________________________________________\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\nCash Flows From Operating Activities: Net earnings (loss) $(9,934) $11,924 $32,012 Reconciliation of net earnings (loss) to net cash flows from operating activities, net of acquisition: Special charge 14,500 - - Expenditures charged to accrued remediation and other costs (2,874) (3,902) (4,138) Depreciation 22,760 20,395 17,689 Current and deferred income taxes (6,468) (407) 2,261 Decrease (increase) in accounts receivable 2,636 9,134 (2,358) Increase (decrease) in accounts payable and accrued liabilities 5,643 (5,370) 2,424 Other, net (477) 721 1,869 Net cash flows from operating activities 25,786 32,495 49,759\nCash Flows From Investing Activities: Purchase of property and equipment (18,002) (32,993) (37,376) Proceeds from sales of equipment 75 119 2,011 Net cash used in investing activities (17,927) (32,874) (35,365)\nCash Flows From Financing Activities: Repayment of long-term debt (662) (1,565) (2,874) Dividend payments - (6,033) (5,575) Exercise of stock options 88 344 326 Net cash used in financing activities (574) (7,254) (8,123)\nCash and Cash Equivalents: Net increase (decrease) in cash and cash equivalents 7,285 (7,633) 6,271 Beginning of period 47,487 55,120 48,849 End of period $54,772 $47,487 $55,120\nSupplemental information: Interest paid $ 549 $ 624 $ 947 Income taxes (recovered) paid $ (472) $ 8,902 $14,943\n_________________________________________________________________________ The Notes to the Consolidated Financial Statements are an integral part of these statements.\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nSummary of Accounting Policies\nThe consolidated financial statements include the accounts of all subsidiaries with appropriate elimination of intercompany transactions and balances.\nThe business of the Company, essentially all of which is conducted in the United States, consists solely of industrial waste treatment and disposal.\nRevenues from waste treatment and disposal are recognized when the material is delivered to the Company and treatment and disposal costs are recognized concurrently with revenues.\nEarnings per common share are computed assuming the conversion of all potentially dilutive securities, namely outstanding options to purchase common stock of the Company.\nThe Company provides for depreciation on a straight-line, specific item basis net of salvage or residual values over the assets' estimated useful lives, which range from three to twenty-five years. Major additions and improvements are capitalized and depreciated over the remaining lives of the assets. Repairs and maintenance are charged to expense as incurred. Where landfill disposal operations have been conducted on the same parcels of land where the Company conducts its incineration and other treatment operations, land is carried at cost and expenditures in connection with the preparation and operation of landfills are charged to expense as incurred. Where landfill operations are conducted on subsequently acquired parcels of land, the cost of the land and landfill preparation costs are deferred and charged to expense as the airspace in the landfill is filled.\nCash equivalents, carried at cost which approximates fair market value, represent short-term investments with an original maturity at purchase of three months or less.\nThe Company records accruals for environmental remediation at hazardous waste sites not owned by the Company when it is both probable a liability has been incurred and a reasonable estimate of the costs can be determined.\nThe Company records accruals for certain environmental remediation activities at its facilities where commitments have been made and reasonable cost estimates are possible. The cost of operating and maintaining systems and equipment constructed for environmental remediation, as well as the cost of treating recovered groundwater, are charged to operating expense as incurred.\nSpecial Charge\nA special charge of $14,500,000 ($9,031,000 after tax benefit or $.15 per share) was recorded in the second quarter of fiscal year 1994. The charge included: (1) various engineering and other expenditures ($8,200,000) on projects no longer considered viable in the current business climate; (2) estimated expenditures ($5,000,000) for capping of a closed landfill and related activities and (3) miscellaneous items ($1,300,000).\nProperty and Equipment\nThe property and equipment accounts are as follows:\nSeptember 30, (Dollars in 000s) 1994 1993 Land $ 28,790 $ 27,861 Buildings 32,360 28,150 Equipment and vehicles 190,785 186,075 Site improvements 29,072 25,406 Construction in progress 13,063 20,409 Accumulated depreciation (127,687) (106,903) $166,383 $180,998\nCommitments for the purchase of capital assets amounted to $5,244,000 at September 30, 1994.\nIncome Taxes\nThe income tax provisions (benefit) for the three years ended September 30, 1994 are comprised as follows:\nYear Ended September 30, (Dollars in 000s) 1994 1993 1992 Current: Federal $(3,242) $4,578 $14,179 State 639 870 557 Deferred: Federal (2,228) 1,783 2,467 State (1,568) - - Income taxes (benefit) $(6,399) $7,231 $17,203\nA reconciliation of the income tax provisions (benefit) for the three years ended September 30, 1994 with amounts calculated by applying the statutory federal income tax rates (35% for 1994, 34 3\/4% for 1993 and 34% for 1992) for those years to earnings (loss) before income taxes is as follows:\nYear Ended September 30, (Dollars in 000s) 1994 1993 1992 Federal tax (benefit) at statutory rate $(5,907) $6,657 $16,733 State income taxes (604) 568 368 Other 112 6 102 Income taxes (benefit) $(6,399) $7,231 $17,203\nThe tax effect of temporary differences which comprise the current and non-current deferred income tax amounts shown on the balance sheet are as follows:\nSeptember 30, (Dollars in 000s) 1994 1993 Excess of tax over book depreciation $22,086 $23,648 Accrued remediation and closure costs (7,455) (8,060) Expense deductible when paid (5,977) (4,120) State net operating loss benefits, expiring 1995-2009 (1,176) - Other 295 392 Deferred income taxes, net $ 7,773 $11,860\nAs of October 1, 1993, the Company adopted SFAS No. 109 - Accounting for Income Taxes which requires the use of the liability method of accounting for deferred income taxes. The cumulative effect on prior years of this adoption was a reduction of the 1994 net loss by $543,000 ($.01 per share). Prior to October 1, 1993, the Company followed APB No. 11 when accounting for income taxes. The deferred federal income tax provisions resulting from accounting for certain income and expense items differently for tax purposes than for financial statement purposes in the prior periods were:\nYear Ended September 30, (Dollars in 000s) 1993 1992 Excess of tax over book depreciation $1,136 $1,420 Accrued remediation and closure costs 1,298 1,274 Expense deductible when paid (634) (163) Other (17) (64) Deferred federal tax provision $1,783 $2,467\nAccrued Liabilities\nAccrued liabilities are as follows: September 30, (Dollars in 000s) 1994 1993 Employee compensation $ 2,942 $ 2,737 Taxes other than income 4,410 3,735 Insurance and legal 4,356 3,683 Landfill capping costs 4,037 - Other 1,811 1,964 $17,556 $12,119\nShareholders' Equity\nChanges in the components of shareholders' equity are as follows:\n$1 Par Value Capital in Total Common Excess of Retained Shareholders' (Dollars in 000s) Stock Par Value Earnings Equity Balance at 9\/30\/91 $60,192 $4,076 $115,541 $179,809 Net earnings 32,012 32,012 Dividends of $.0925 per share (5,575) (5,575) Exercise of stock options 95 231 326 Balance at 9\/30\/92 60,287 4,307 141,978 206,572 Net earnings 11,924 11,924 Dividends of $.10 per share (6,033) (6,033) Exercise of stock options 63 281 344 Balance at 9\/30\/93 60,350 4,588 147,869 212,807 Net loss (9,934) (9,934) Exercise of stock options 26 62 88 Balance at 9\/30\/94 $60,376 $4,650 $137,935 $202,961\nThe Company is authorized to issue 120,000,000 shares of its $1 Par Value Common Stock and 1,000,000 shares of its $1 Par Value Preferred Stock. The terms and conditions of each issue of preferred stock are determined by the Board of Directors. No preferred stock has been issued.\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 15% 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 $200 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 $.01 per Right.\nUnder the Company's stock option plan, options to purchase common stock of the Company have been granted to officers and key employees at not less than 100% of the fair market value at the date of grant.\nThe number of shares and related prices per share covering all activity with respect to stock options for each of the years in the three-year period ended September 30, 1994 are as follows:\nYear Ended September 30, 1994 1993 1992 Number of options Outstanding at beginning of year 674,660 757,917 689,296 Granted 200,610 - 171,000 Exercised (25,557) (62,882) (95,714) Expired or canceled (190,845) (20,375) (6,665) Outstanding at 9\/30 658,868 674,660 757,917 At 9\/30 Options available for grant 717,390 - - Options exercisable 317,900 333,609 288,492\nPer share prices Options granted $4.63 to $ 5.75 - $8.88 to $12.25 Options exercised $3.47 $3.38 to $ 8.88 $1.16 to $ 7.50 Options outstanding $4.63 to $12.80 $3.47 to $12.80 $3.38 to $12.80\nTransactions with Related Parties\nCertain directors and officers of the Company are also directors and officers of Rollins Truck Leasing Corp. and Matlack Systems, Inc.\nThe Company purchased transportation services from subsidiaries of Matlack Systems, Inc. in the amount of $3,175,000 in 1994, $1,714,000 in 1993 and $1,464,000 in 1992. The cost of these services has been included in operating expense in the Consolidated Statement of Operations.\nThe Company also purchased fuel for its vehicles, information systems services, and rented transportation equipment and office space from Rollins Truck Leasing Corp., its subsidiaries and affiliates. The aggregate cost of these materials, services and rents, which have been included in operating expense or selling and administrative expense, as appropriate, in the Consolidated Statement of Operations, was $6,551,000 in 1994, $7,359,000 in 1993 and $6,579,000 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 $5,156,000 in 1994, $5,635,000 in 1993 and $5,578,000 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.\nIndebtedness\nLong-term debt consists of real estate purchase money mortgage obligations payable in installments to 2001, at interest rates of 9% and 10%. Land with a carrying value of $5,504,000 is pledged as collateral.\nThe aggregate amounts of maturities for all indebtedness over the next five years are as follows: 1995-$623,000; 1996-$662,000; 1997-$662,000; 1998-$662,000 and 1999-$662,000.\nPension Plan\nThe Company maintains a non-contributory pension plan for full-time employees. Costs of this plan are funded in accordance with the provisions of the Internal Revenue Code.\nThe components of net periodic pension cost are as follows:\nYear Ended September 30, (Dollars in 000s) 1994 1993 1992 Service cost $1,777 $1,295 $1,044 Interest cost 1,032 801 664 Return on plan assets (420) (1,494) (960) Net amortization and deferral (492) 673 321 Net periodic pension cost $1,897 $1,275 $1,069\nThe following table sets forth the plan's funded status and the amounts recognized in the Company's balance sheets:\nSeptember 30, (Dollars in 000s) 1994 1993 Actuarial present value of accumulated benefit obligation: Vested $10,250 $ 8,513 Non-vested 1,154 1,138 $11,404 $ 9,651\nProjected benefit obligation $15,162 $12,939 Plan assets at market value 11,967 10,179 Projected benefit obligation in excess of plan assets 3,195 2,760 Unrecognized gain 1,026 1,141 Unrecognized prior service (89) (96) Unamortized unfunded projected benefit obligation at adoption (844) (921) Accrued pension liability $ 3,288 $ 2,884\nThe assumptions used in accounting for the plan are as follows:\n1994 1993 1992 Discount rate 8.0% 8.0% 8.5% Rate of assumed compensation increase 5.0% 5.0% 5.0% Expected long-term rate of return on assets 9.5% 9.5% 10.0%\nThe assets of the plan at September 30, 1994 were invested 67% in equity securities, 23% in fixed income securities and the balance in other interest bearing accounts.\nCommitments and Contingent Liabilities\nOn August 23, 1994, the Company signed a letter of intent with Westinghouse Electric Corporation whereby the Company will acquire all the stock of Aptus, Inc. for $160,000,000. Aptus has incineration operations in Kansas and Utah and a transfer and storage facility in Minnesota. It is expected at closing the Company will pay $3,000,000 in cash and incur various forms of long-term debt totaling $157,000,000. A portion of this debt may be converted by the holder into common stock of the Company. Various terms and conditions must be agreed to before a definitive agreement is executed. The Company is presently engaged in its due diligence review.\nEnvironmental laws and regulations require hazardous waste disposal facilities to obtain operating permits which generally outline the procedures under which the facility must be operated. Violations of permit conditions or of the regulations, even if immaterial or unintentional, may result in fines, shutdowns, remedial work or revocation of the permit. The Company believes it is in compliance with the requirements of all of its operating permits and related federal and state regulations.\nThe Company is the subject of various lawsuits and claims by government agencies with respect to clean-up of hazardous waste sites not owned by the Company. While the Company does not expect to make any significant cash outlays relative to the above matters, management believes any payments which may be required will ultimately be substantially recoverable from insurance coverage. The Company believes that it is only remotely likely that the ultimate resolution of these lawsuits and claims would be material.\nAccrued remediation and other costs were $19,411,000 and $21,055,000 at September 30, 1994 and 1993, respectively. Major elements of cost in these reserves include groundwater recovery systems, slurry wall or alternative containment systems, excavation and disposal of soil and waste material, and engineering study and report costs associated with the remedial activities. These major cost elements are segregated according to facility location and are based on studies performed for the Environmental Protection Agency and the states where the facilities operate. Changing federal or state standards as well as technological developments and alternative engineering solutions may affect the cost estimates in the future. Based on the status of the various remedial programs at the facilities, it is expected that most, if not all, of the remedial work will occur within the next five years. The Company believes that the ultimate costs associated with these remediation activities will not be material.\nRegulatory agencies normally require operators with temporary or long- term permits to provide insurance protection for other parties in the event of environmental damage and to provide for continued maintenance after operations are terminated. The Company has supplied financial assurance to regulatory agencies and others in the aggregate amount of $44,171,000 at September 30, 1994, which included letters of credit of $20,656,000. The balance is satisfied principally by a combination of insurance and trust funds.\nLease Commitments\nThe Company leases some of the premises and equipment used in its operations. All leases are classified as operating leases and expire over the next eight years. Total rental expense for all operating leases except those with terms of a month or less was $4,392,000 in 1994, $5,783,000 in 1993 and $4,802,000 in 1992.\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:\n(Dollars in 000s) Year Ending September 30,\n1995 $ 3,788 1996 2,727 1997 2,235 1998 1,359 1999 972 Later years 1,991 Total minimum payments required $13,072\nQuarterly Results (Unaudited) December March June September 1994 31 31 30 30 Revenues $47,515 $ 41,363 $46,650 $45,940 Gross profit $ 6,983 $ 1,408 $ 8,220 $ 6,166 Earnings (loss) before income taxes (benefit) $ 227 $(19,690)(1) $ 2,479 $ 108 Earnings (loss) from operations $ 106 $(12,373)(1) $ 1,568 $ 222 Cumulative effect (to September 30, 1993) of adoption of SFAS No. 109 $ 543 $ - $ - $ - Net earnings (loss) $ 649 $(12,373)(1) $ 1,568 $ 222\nEarnings (loss) per share: From operations $ - $ (.20)(1) $ .02 $ .01 Adoption of SFAS No. 109 $ .01 $ - $ - $ - Earnings (loss) per share $ .01 $ (.20)(1) $ .02 $ .01\nRevenues $58,985 $ 54,614 $51,563 $49,681 Gross profit $16,377 $ 11,580 $10,559 $ 7,438 Earnings before income taxes $ 9,464 $ 4,691 $ 3,964 $ 1,036 Net earnings $ 6,066 $ 2,881 $ 2,457 $ 520 Earnings per share $ .10 $ .05 $ .04 $ .01\n(1) Includes special charge of $14,500 ($9,031 after tax benefit or $.15 per share) relating primarily to various engineering and other expenditures on projects no longer considered viable in the current business climate and estimated expenditures for capping of a closed landfill.\n[FN] (1) Formerly Rollins\/Matlack Administrative Services, Inc. (2) Non-interest bearing advance with no fixed repayment terms.\n[FN] (1) Includes special charge write-offs of ($11,524) and assets of acquired subsidiary $936.\n[FN] (1) Includes special charge write-offs of ($1,047) and a reclassification of $210. (2) Reclassification.\n[FN] (1) Subsidiary balance at date of acquisition.\nROLLINS ENVIRONMENTAL SERVICES, INC. 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 $10,540 $13,793 $13,261\nDepreciation $22,760 $20,395 $17,689\nTaxes other than Payroll and Income Taxes Real Estate $ 3,593 $ 3,256 $ 2,408 Other $ 1,714 $ 1,261 $ 2,014\nROLLINS ENVIRONMENTAL SERVICES, INC.\nExhibits to Form 10-K\nFor Fiscal Year Ended September 30, 1994\nIndex to Exhibits Page Nos.\nExhibit 21 Rollins Environmental Services, Inc. Subsidiaries at September 30, 1994\nExhibit 21\nROLLINS ENVIRONMENTAL SERVICES, INC. Subsidiaries of the Registrant September 30, 1994\nJURISDICTION OF NAME INCORPORATION\nCustom Environmental Transport, Inc. Delaware\nENCOTEC, INC. Delaware\nHighway 36 Land Development Company Colorado\nRollins O.P.C. Inc. California\nRollins CHEMPAK, Inc. Delaware\nRollins Environmental Services (DE) Inc. Delaware\nRollins Environmental Services (LA) Inc. Delaware\nRollins Environmental Services of Louisiana, Inc. Delaware\nRollins Environmental Services (NJ) Inc. Delaware\nRollins Environmental Services (TX) Inc. Delaware\nTipton Environmental Technology, Inc. Delaware\nRollins Environmental Services (CA) Inc. Delaware","section_15":""}
{"filename":"850033_1994.txt","cik":"850033","year":"1994","section_1":"ITEM 1. BUSINESS\nDESCRIPTION OF THE TRUST\nBP Prudhoe Bay Royalty Trust (the \"Trust\"), a grantor trust, was created as a Delaware business trust. The Trust has been established by The Standard Oil Company (\"Standard Oil\") and is administered by The Bank of New York, as trustee (collectively with the co-trustee located in Delaware, the \"Trustee\"), pursuant to the BP Prudhoe Bay Royalty Trust Agreement dated February 28, 1989 by and among Standard Oil, BP Exploration (Alaska) Inc. (the \"Company\") and the Trustee (the \"Trust Agreement\"). The Company and Standard Oil are indirect, wholly owned subsidiaries of The British Petroleum Company p.l.c. (\"BP\"). The Trustee's offices are located at 101 Barclay Street, New York, New York 10286 and its telephone number is (212) 815-5092.\nUpon creation of the Trust, the Trust acquired an overriding royalty interest (the \"Royalty Interest\"), which entitles the Trust to a Per Barrel Royalty, as defined herein, on 16.4246% of the first 90,000 barrels of the average actual daily net production of oil and condensate per quarter (the \"Royalty Production\") from the Company's working interest in the Prudhoe Bay Unit (the \"PBU\"). The Royalty Interest was conveyed to Standard Oil pursuant to the terms of an Overriding Royalty Conveyance dated February 27, 1989 (the \"Overriding Conveyance\") and from Standard Oil to the Trust by a Trust Conveyance dated February 28, 1989 (the \"Trust Conveyance\"). The Overriding Conveyance and the Trust Conveyance are herein collectively referred to as the \"Conveyance\". The Royalty Interest is free of any exploration and development expenditures. The Trust is a passive entity, and the Trustee has been given only such powers as are necessary for the collection and distribution of revenues from the Royalty Interest and the payment of Trust liabilities and expenses. The Trust has been formed under the Delaware Trust Act, which entitles holders of the Units of Beneficial Interest (the \"Trust Units\") to the same limitation of personal liability as stockholders of a corporation are afforded under Delaware law. The Trust Units evidence undivided interests in the Trust and are listed on the New York Stock Exchange under the ticker symbol \"BPT\".\nThe Trust Units are not an interest in or obligation of the Company, Standard Oil or BP. The ultimate value of the Royalty Interest will be dependent on the Royalty Production and the Per Barrel Royalty for each day. The \"Per Barrel Royalty\" for any day will equal the per barrel price of West Texas Intermediate crude oil, less scheduled chargeable costs, as adjusted, and production taxes. See \"Description of the Royalty Interest.\" In certain circumstances, the Royalty Interest provided for a minimum royalty payment of $8.92 per barrel of Royalty Production, if any, from the PBU for each quarter through September 30, 1991; for all quarters thereafter there is no minimum royalty payment. Pursuant to a Support Agreement among BP, the Company, Standard Oil and the Trust, BP has\nguaranteed the performance by the Company of its payment obligations with respect to the Royalty Interest.\nThe only assets of the Trust are (i) the Royalty Interest assigned to the Trust and, (ii) from time to time, cash reserves and cash equivalents being held by the Trustee for distribution. Subject to compliance with certain conditions, additional royalty interests may be assigned to the Trust. See \"Description of the Trust Units and the Trust Agreement- Additional Conveyances.\"\nThe value of the Trust Units is substantially dependent upon estimates of proved reserves, production and the value of oil. Estimates of proved reserves are inherently imprecise and subjective and are revised over time as additional data becomes available. Such revisions may often be substantial. See \"Report of Miller and Lents, Ltd.\", independent petroleum consultants, included herein.\nThe Company shares control of the operation of the PBU with the other working interest owners, and has no obligation to continue production from the PBU or to maintain production at any level and may interrupt or discontinue production at any time. In addition, the operation of the PBU is subject to normal operating hazards incident to the production and transportation of oil in Alaska. In the event of damage to the PBU which is covered by insurance, the Company has no obligation to use insurance proceeds to repair such damage and may elect to retain such proceeds and close damaged areas to production.\nThe financial statements of the Trust contained in this Annual Report on Form 10-K include information regarding amounts distributed to Trust Unit holders with respect to 1994, 1993, and 1992. This Annual Report also includes information with respect to 1994 production and production in past periods. Amounts distributed with respect to 1994, 1993, and 1992, production in 1994 and in the past, and the most recent estimates of proved reserves attributable to the Trust are not indicative of amounts to be distributed in the future.\nThe following information is subject to the detailed provisions of the Trust Agreement, the Overriding Conveyance, and the Trust Conveyance.\nThe provisions governing the Trust are complex and extensive, and no attempt has been made below to describe all of such provisions. The following is a general description of the basic framework of the Trust and reference is made to the Trust Agreement for detailed provisions concerning the Trust.\nDESCRIPTION OF THE TRUST UNITS AND THE TRUST AGREEMENT\nCREATION AND ORGANIZATION OF THE TRUST\nThe Trust holds the Royalty Interest pursuant to the terms of the Trust Agreement and the Conveyance, subject to the laws of the States of\nAlaska and Delaware. The beneficial interest in the Trust created by the Trust Agreement is divided into equal undivided portions called Trust Units. See the discussion below under \"Trust Units\".\nThe Bank of New York (Delaware) has been appointed co-trustee in order to satisfy certain requirements of the Delaware Trust Act, but The Bank of New York alone is able to exercise the rights and powers granted to the Trustee in the Trust Agreement.\nASSETS OF THE TRUST\nThe Royalty Interest is the only asset of the Trust, other than cash being held for the payment of expenses and liabilities and for distribution to the holders of Trust Units. See \"Duties and Limited Powers of Trustee\".\nLIABILITY OF THE TRUST\nBecause of the passive nature of the Trust's assets and the restrictions on the power of the Trustee to incur obligations, it is anticipated that the only liabilities the Trust will incur will be those for routine administrative expenses, such as Trustee's fees, and accounting, legal and other professional fees. However, if a court were to hold that the Trust is an association taxable as a corporation, as more fully discussed in \"Certain Tax Considerations-Federal Income Tax- Classification of the Trust\", the Trust would incur substantial income tax liabilities in addition to its other expenses. In addition, if the Trust were required to make allocations of income and deductions other than on a quarterly basis, the administrative expenses of the Trust might increase. See \"Certain Tax Considerations-Federal Income Tax-Taxation of Trust Unit Holders\". The administrative fees and expenses of the Trust for the years ended December 31, 1994, 1993, 1992, 1991, 1990 and 1989 were approximately $660,000, $555,000, $415,000, $415,000, $460,000 and $170,000, respectively, including fees paid by the Trust to accountants, petroleum consultants and counsel. Future administrative fees and expenses will depend, among other things, on the number of Trust Unit holders and the fees of accountants, petroleum consultants, counsel and other experts, if any, engaged by the Trust.\nDUTIES AND LIMITED POWERS OF TRUSTEE\nThe duties of the Trustee are as specified in the Trust Agreement and by the laws of the State of Delaware. The basic function of the Trustee is to collect income from the Royalty Interest, to pay out of the Trust's income and assets all expenses, charges and obligations and to pay available cash to holders of Trust Units.\nThe Trustee may establish a cash reserve for the payment of material liabilities of the Trust which may become due, if the Trustee has determined that it is not practical to pay such liabilities on subsequent Quarterly Record Dates (as defined below) out of funds anticipated to be available on such dates and that, in the absence of such reserve, the trust\nestate is subject to the risk of loss or diminution in value or The Bank of New York is subject to the risk of personal liability for such liabilities, provided that, except in certain limited circumstances, it has received an opinion of counsel to the effect that the establishment and maintenance of such reserve will not adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes or cause the income from the Trust to be treated as unrelated business taxable income for federal income tax purposes. The Trustee is obligated, subject to certain conditions, to borrow funds required to pay liabilities of the Trust, if they become due, and pledge or otherwise encumber the Trust's assets, if it determines that the cash on hand is insufficient to pay such liabilities and that it is not practical to pay such liabilities on subsequent Quarterly Record Dates out of funds anticipated to be available on such dates, provided that, except in certain limited circumstances, it has received an opinion of counsel to the effect described above. Borrowings must be repaid in full before any further distributions are made to holders of Trust Units.\nAll distributable cash of the Trust will be distributed on a quarterly basis. To date, and until certain requirements of the Trust Agreement are met concerning the status of the assets of the Trust for purposes of certain Department of Labor regulations, all distributions to Trust Unit holders must be made as soon as practicable and the Trustee must hold cash received uninvested pending such distribution. The Trustee is required to invest any cash being held by it for distribution on the next distribution date or being held by it as a reserve for liabilities in U.S. Obligations or, if U.S. Obligations having a maturity date on the next distribution date are not available, repurchase agreements with banks, including The Bank of New York, secured by U.S. Obligations and meeting certain specified requirements. Any U.S. Obligation or any such repurchase agreement must mature on the next distribution date or on the due date of the liability with respect to which the reserve is established, if known, and subject to certain exceptions, will be held to maturity. The Trustee is required, in certain circumstances, to invest the cash being held by it in an overnight time deposit with a bank, including The Bank of New York. Amounts being held by the Trustee after the date fixed for distribution of assets upon termination of the Trust, however, must be held uninvested.\nThe Trust Agreement grants the Trustee only such rights and powers as are necessary to achieve the purposes of the Trust. The Trust Agreement prohibits the Trust from engaging in any business, commercial or, with certain exceptions, investment activity of any kind and from using any portion of the assets of the Trust to acquire any oil and gas lease, royalty or other mineral interest. The Trustee may sell Trust properties only as authorized by a vote of the holders of Trust Units, or when necessary, to provide for the payment of specific liabilities of the Trust then due (if, among other things, the Trustee determines that it is not practicable to submit such sale to a vote of the holders of Trust Units, and it receives an opinion of counsel to the effect that such sale will not adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes), or upon termination of the Trust. Pledges or\nother encumbrances to secure borrowings are permitted without a vote of holders of Trust Units if the Trustee determines such action is advisable. Any sale of Trust properties must be for cash unless otherwise authorized by the holders of Trust Units, and the Trustee is obligated to distribute the available net proceeds of any such sale to the holders of Trust Units after establishing reserves for liabilities of the Trust.\nLIABILITIES OF TRUSTEE\nExcept in the circumstances described below, in which the Company will indemnify the Trustee and The Bank of New York in its individual capacity, the Trustee and The Bank of New York in its individual capacity will be indemnified out of the assets of the Trust for any liability, expense, claim, damage or other loss incurred by it in the performance of its duties unless such loss results from its negligence, bad faith, or fraud or from its expenses in carrying out such duties exceeding the compensation and reimbursement it is entitled to under the Trust Agreement. The Trustee and The Bank of New York in its individual capacity will be indemnified by the Company for liabilities to the extent described above (a) whenever the assets of the Trust are insufficient or not permitted by applicable law to provide such indemnity and (b) after the termination of the Trust, to the extent that the Trustee did not have knowledge or should not have reasonably known of a potential claim against the Trustee for which a reserve could have been established and used to satisfy such claim prior to the final distribution of assets of the Trust upon its termination. In no event will the Trustee be deemed to have acted negligently, fraudulently or in bad faith if it takes or suffers action in good faith in reliance upon and in accordance with the written advice of counsel or other experts.\nThe Trustee is not entitled to indemnification from the holders of Trust Units except in certain limited circumstances related to the replacement of mutilated, destroyed, lost or stolen certificates. In addition, the Company has agreed to indemnify and hold the Trustee and the Trust harmless from certain liabilities under the federal securities laws.\nRESIGNATION OR REMOVAL OF TRUSTEE\nThe Trustee may resign at any time or be removed with or without cause by the holders of a majority of the outstanding Trust Units. Its successor must be a corporation organized and doing business under the laws of the United States, any state thereof or the District of Columbia authorized under such laws to exercise trust powers, or a national banking association domiciled in the United States, in either case having a combined capital, surplus and undivided profits of at least $50,000,000 and subject to supervision or examination by federal or state authorities. Unless the Trust already has a trustee that is a resident of or has a principal office in the State of Delaware, then any successor trustee will be such a resident or have such a principal office. No resignation or removal of the Trustee shall become effective until a successor trustee shall have accepted such appointment.\nDURATION OF TRUST\nThe Trust is irrevocable and the Company has no power to terminate the Trust or, except with respect to certain corrective amendments agreed to by the Trustee, to alter or amend the terms of the Trust Agreement. The Trust will terminate upon the first to occur of the following events or times: (a) upon a vote of holders of not less than 70% of the outstanding Trust Units, on or prior to December 31, 2010, in accordance with the procedures described under \"Voting Rights of Holders of Trust Units\" below, or (b) after December 31, 2010 either (i) at such time as the net revenues from the Royalty Interest for two successive years commencing after 2010 are less than $1,000,000 per year, unless the net revenues during such period have been materially and adversely affected by an event constituting force majeure, or (ii) upon a vote of holders of not less than 60% of the outstanding Trust Units. Upon the dissolution of the Trust, the Trustee will continue to act in such capacity until completion of the winding up of the affairs of the Trust. Upon termination of the Trust, the Trustee will sell Trust properties in one or more sales for cash, unless holders representing 70% of the Trust Units outstanding (60% if the decision to terminate the Trust is made after December 31, 2010) authorize the sale for a specified non-cash consideration in which event the Trustee may, but is not obligated to, consummate such non-cash sale, but only if the Trustee shall have received a ruling from the Internal Revenue Service (the \"IRS\") or an opinion of counsel to the effect that such non-cash sale will not adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes or cause the income from the Trust to be treated as unrelated business taxable income for federal income tax purposes. Prior to such sale the Trustee will obtain an opinion of an investment banking firm or other entity qualified to give such opinion as to the fair market value of the assets of the Trust on the day of termination of the Trust. The Trustee will effect any such sale pursuant to procedures or material terms and conditions approved by the vote of holders of 70% of the outstanding Trust Units (60% if the sale is made after December 31, 2010) in accordance with the procedures described under \"Voting Rights of Holders of Trust Units\" below, unless the Trustee determines that it is not practicable to submit such procedures or terms to a vote of the holders of Trust Units, and the sale is effected at a price which is at least equal to the fair market value of the trust estate as set forth in the opinion mentioned above and pursuant to terms and conditions deemed commercially reasonable by the investment banking firm or other entity rendering such opinion. Upon dissolution of the Trust, the Company will have an option to purchase the Royalty Interest at a price equal to the greater of (i) the fair market value of the trust estate as set forth in the opinion mentioned above, or (ii) the number of then outstanding Trust Units multiplied by (a) the closing price of Trust Units on the day of termination of the Trust on the stock exchange on which the Trust Units are listed, or (b) if the Trust Units are not listed on any stock exchange but are traded in the over-the-counter market, the closing bid price on the day of termination of the Trust as quoted on the National Market System of the National Association of Securities Dealers Automated Quotation System. If the Trust Units are neither listed nor traded in the over-the-counter\nmarket, the price will be the fair market value of the trust estate as set forth in the opinion mentioned above. After satisfying all existing liabilities and establishing adequate reserves for the payment of contingent liabilities, the Trustee will distribute all available proceeds to the holders of Trust Units on the date specified in a notice given by the Trustee, which date will be no later than 10 days after delivery of such notice.\nThe Trustee cannot predict what amount it will be able to receive for the Trust's assets if the Trust terminates or the expenses which the Trust may incur in attempting to sell the assets.\nVOTING RIGHTS OF HOLDERS OF TRUST UNITS\nAlthough holders of Trust Units possess certain voting rights, their voting rights are not comparable to those of shareholders of a corporation. For example, there is no requirement for annual meetings of holders of Trust Units or annual or other periodic reelection of the Trustee.\nMeetings of holders of Trust Units may be called by the Trustee at any time at its discretion and must be called by the Trustee at the written request of holders of not less than 25% of the then outstanding Trust Units or at the request of the Company or as may be required by law or applicable regulation. The presence of a majority of the outstanding Trust Units is necessary to constitute a quorum, and holders may vote in person or by proxy.\nNotice of any meeting of holders of Trust Units must be given not more than 60 nor fewer than 10 days prior to the date of such meeting. The notice must state the purpose or purposes of the meeting and no other matter may be presented or acted upon at the meeting.\nThe Trust Agreement may be amended without a vote of the holders of Trust Units to cure an ambiguity, to correct or supplement any provision of the Trust Agreement that may be inconsistent with any other such provision or to make any other provision with respect to matters arising under the Trust Agreement that do not adversely affect the holders of Trust Units. The Trust Agreement may also be amended with the approval of a majority of the outstanding Trust Units at any duly called meeting of holders of Trust Units. However, no such amendment may alter the relative rights of Trust Unit holders unless approved by the affirmative vote of 100% of the holders of Trust Units and by the Trustee or reduce or delay the distributions to the holders of Trust Units or effect certain other changes unless approved by the affirmative vote of 80% of the holders of Trust Units and by the Trustee. No amendment will be effective until the Trustee has received a ruling from the IRS or an opinion of counsel to the effect that such modification will not adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes or cause the income from the Trust to be treated as unrelated business taxable income for federal income tax purposes.\nRemoval of the Trustee will require the affirmative vote of the holders of a majority of the Trust Units represented at a duly called meeting of the holders of Trust Units. A successor trustee may be appointed by the holders of Trust Units at such meeting. If the Trustee has given notice of its intention to resign, a successor trustee will be appointed by the Company.\nThe sale of all or any part of the Royalty Interest must be authorized by the affirmative vote of the holders of 70% of the outstanding Trust Units (60% if such sale is to be effected after December 31, 2010), provided that if such sale is effected in order to provide for the payment of specific liabilities of the Trust then due and involves a part, but not all or substantially all, of the assets of the Trust, such sale may be approved by the affirmative vote of holders of a majority of the outstanding Trust Units. However, subject to certain conditions, the Trustee may, without a vote of the holders of Trust Units, sell all or any part of the Trust assets if necessary to provide for the payment of specific liabilities of the Trust then due or upon termination of the Trust. The Trust can be terminated by the holders of Trust Units only if the termination is approved by the holders of 70% of the Trust Units (on or prior to December 31, 2010) or of 60% of the Trust Units (after December 31, 2010). The Trust may also be terminated after December 31, 2010 if the net revenues from the Royalty Interest for two successive years commencing after 2010 are less than $1,000,000 per year, unless the net revenues have been materially and adversely affected by an event constituting force majeure.\nThe Company and Standard Oil will vote or cause to be voted any Trust Units held of record or beneficially by the Company, Standard Oil or any affiliate of either of them in the same proportion as the Trust Units voted by other holders of Trust Units at such meeting.\nTRUST UNITS\nEach Trust Unit represents an equal undivided share of beneficial interest in the Trust. Trust Units are evidenced by transferable certificates issued by the Trustee. If at any time there is assigned to the Trust an Additional Royalty Interest, the beneficial interest in the Trust will thereafter be considered to be divided into a number of Trust Units equal to the sum of the number of Trust Units existing prior to such assignment and the number of Trust Units created upon such assignment. The Trust Units will not represent an interest in or obligation of the Company, Standard Oil or any of their respective affiliates. Except in the limited circumstances described under \"Additional Conveyances\" each Trust Unit will entitle its holder to the same rights as the holder of any other Trust Unit, and the Trust will have no other authorized or outstanding class of equity securities. There are 21,400,000 Trust Units outstanding.\nDISTRIBUTIONS OF INCOME\nThe Company will pay the Trust amounts due pursuant to the Royalty Interest on a quarterly basis on the fifteenth day after the end of each calendar quarter (or, if such day is not a business day, on the next succeeding business day) unless due to applicable law or stock exchange rules a different payment day is required. Distributions of Trust income are currently made as soon as practicable after receipt of such amounts by the Trustee. After certain requirements of the Trust Agreement concerning the status of the assets of the Trust under certain Department of Labor regulations are met, distributions of Trust income will be made on the fifth day (or if such day is not a business day, on the next succeeding business day) after the Trustee's receipt in same day finally collected funds of amounts to be received on a Quarterly Record Date for each Quarter (defined below) in each year during the term of the Trust. Such distribution will be made to the person in whose name the Trust Unit (or any predecessor Trust Unit) is registered at the close of business on the immediately preceding January 15, April 15, July 15, or October 15 (or, if such day is not a business day, on the next succeeding business day), as the case may be, unless the Trustee determines that a different date is required to comply with applicable law or stock exchange rules (each a \"Quarterly Record Date\"). A \"Quarter\", for purposes of the Trust Agreement, is a period of approximately three months beginning on the day after a Quarterly Record Date and continuing through and including the next succeeding Quarterly Record Date. The aggregate quarterly distribution of income (the \"Quarterly Income Amount\") will be the excess of (i) revenues from the Royalty Interest plus any decrease in cash reserves previously established for estimated liabilities and any other cash receipts of the Trust over (ii) the expenses and payments of liabilities of the Trust plus any net increase in cash reserves for estimated liabilities. If prior to the end of a Quarter the Trustee makes a determination of the Quarterly Income Amount which it anticipates will be distributed to holders of Trust Units on the Quarterly Record Date for such Quarter, based on notice provided to the Trustee by the Company, and the Quarterly Income Amount is not equal to the amount so determined due to late payment, the Trustee will treat such amounts when received as if they were received on such Quarterly Record Date. Payment of the respective pro rata portion of the aggregate quarterly distribution of income to each holder of Trust Units will be made by check mailed to each such holder, provided that holders of Trust Units may arrange for payments of $100,000 or more to be made by wire transfer in immediately available funds.\nTRANSFERS\nThe Trustee acts as registrar and transfer agent for the Trust Units. Subject to the limitations set forth below and to the limitation described under \"Additional Conveyances\" below, Trust Units may be transferred by surrender of the certificates duly endorsed, or accompanied by a written instrument of transfer, in form satisfactory to the Trustee, duly executed by the holder of the Trust Unit or his attorney duly authorized in writing. No service charge will be made for any registration of transfer of Trust\nUnits, but the Trustee may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection with any registration of transfer. Until a transfer is made in accordance with the regulations prescribed by the Trustee, the Trustee may conclusively treat as the owner of any Trust Unit, for all purposes, the holder shown by its records (except in the event of a purchase by the Company or a designee thereof of Trust Units subject to the Trustee's right of redemption, as described under \"Possible Divestiture of Trust Units\" below). Any transfer of a Trust Unit will vest in the transferee all rights of the transferor at the date of transfer, except that the transfer of a Trust Unit after the Quarterly Record Date for distribution will not transfer the right of the transferor to such distribution. The Trustee is specifically authorized to rely upon the application of Article 8 of the Uniform Commercial Code, the Uniform Act for Simplification of Fiduciary Security Transfers and other statutes and rules with respect to the transfer of securities, each as adopted and then in force in the State of Delaware, as to all matters affecting title, ownership, warranty or transfer of certificates and the Trust Units represented thereby.\nMUTILATED, DESTROYED, LOST OR STOLEN CERTIFICATES\nIf a mutilated certificate is surrendered to the Trustee, the Trustee will execute and deliver in exchange therefor a new certificate. If there shall be delivered to the Trustee evidence of the destruction, loss or theft of a certificate and such security or indemnity as may be required to hold the Trust and the Trustee harmless, then, in the absence of notice to the Trustee that such certificate has been acquired by a bona fide purchaser, the Trustee will execute and deliver, in lieu of any such lost, stolen or destroyed certificate, a new certificate. In connection with the issuance of any new certificates, the Trustee may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto and any other expenses (including fees and expenses of the Trustee) in connection therewith.\nREPORTS TO HOLDERS OF TRUST UNITS\nAs promptly as practicable following the end of each calendar year, but no later than 90 days thereafter, the Trustee will mail to each person who was a holder of record at any time during such calendar year a report containing sufficient information to enable holders of Trust Units to make all calculations necessary for federal and Alaska income tax purposes, including the calculation of any depletion or other deduction which may be available to them for such calendar year. As promptly as practicable following the end of each Quarter, but no later than 60 days following the end of such Quarter, during the term of the Trust, the Trustee will mail a report for such Quarter showing in reasonable detail on a cash basis the assets and liabilities, receipts and disbursements and income and expenses of the Trust and the Royalty Production for such Quarter to holders of Trust Units of record on the last Quarterly Record Date immediately preceding the mailing thereof. Within 90 days following the end of each calendar year, the Trustee will mail an annual report containing (a)\naudited financial statements of the Trust, (b) a statement as to whether or not all fees and expenses of the Trustee were calculated and paid in accordance with the Trust Agreement, (c) such information as the Trustee deems appropriate from a letter of the independent public accountants engaged by the Trustee as to compliance with certain terms of the Conveyance and any Additional Conveyances and computation of the amounts payable to the Trust in respect of the Royalty Interest, (d) a letter of the independent petroleum engineers engaged by the Trust setting forth a summary of such firm's determinations regarding the Company's methods, procedures and estimates referred to in the Conveyance concerning proved reserves and other related matters, and (e) a copy of the latest annual report with respect to the Trust Units filed with the Securities and Exchange Commission (the \"Commission\") or information furnished to the Trustee pursuant to the Conveyance, to holders of Trust Units of record on the last Quarterly Record Date immediately preceding the mailing thereof.\nThe Trustee will mail to holders of Trust Units any other reports or statements required to be provided to Trust Unit holders by applicable law or governmental regulations or by the requirements of any stock exchange on which the Trust Units may be listed.\nIn the Trust Agreement, holders of Trust Units have waived the right to seek or secure any portion or distribution of the Royalty Interest or any other asset of the Trust or any accounting during the term of the Trust or during any period of liquidation and winding up.\nLIABILITY OF HOLDERS OF TRUST UNITS\nThe Trust Agreement provides that the holders of Trust Units will, to the full extent permitted by Delaware law, be entitled to the same limitation of personal liability extended to stockholders of private corporations for profit under Delaware law.\nPOSSIBLE DIVESTITURE OF TRUST UNITS\nThe Trust Agreement imposes no restrictions on nationality or other status of the persons or other entities which are eligible to hold Trust Units. However, the Trust Agreement provides that if at any time the Trust or the Trustee is named a party in any judicial or administrative proceeding seeking the cancellation or forfeiture of any property in which the Trust has an interest because of the nationality, or any other status, of any one or more holders the following procedures will be applicable:\n(i) The Trustee will give written notice of the existence of such proceedings to each holder whose nationality or other status is an issue in the proceeding. The notice will contain a reasonable summary of such proceeding and will constitute a demand to each such holder that he dispose of his Trust Units within 30 days to a party not of the nationality or other status at issue in the proceeding described in the notice.\n(ii) If any holder fails to dispose of his Trust Units in accordance with such notice, the Trustee shall have the right to redeem and shall redeem at any time during the 90-day period following the termination of the 30-day period specified in the notice, any Trust Unit not so transferred for a cash price per unit equal to the closing price of the Trust Units on the stock exchange on which the Trust Units are then listed or, in the absence of any such listing, the closing bid price on the National Market System of the National Association of Securities Dealers Automatic Quotation System if the Trust Units are so quoted or, if not, the mean between the closing bid and asked prices for the Trust Units in the over-the-counter market, in either case as of the last business day prior to the expiration of the 30-day period stated in the notice. If the Trust Units are neither listed nor traded in the over-the-counter market, the price will be the fair market value of the Trust Units as determined by a recognized firm of investment bankers or other competent advisor or expert.\n(iii) The Trustee will cancel any Trust Unit redeemed by the Trustee in accordance with the foregoing procedures.\n(iv) The Trustee may, in its sole discretion, cause the Trust to borrow any amount required to redeem the Trust Units.\nIf the purchase of Trust Units from an ineligible holder by the Trustee would result in a non-exempt \"prohibited transaction\" under the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\"), or under the Internal Revenue Code of 1986, as amended (the \"Code\"), the Trust Units subject to the Trustee's right of redemption will be purchased by the Company or a designee thereof, at the above-described purchase price.\nADDITIONAL CONVEYANCES\nAdditional royalty interests (\"Additional Royalty Interests\") identical in all respects to the initial Royalty Interest except for the identity of the parties (other than the Trust) (provided that the entity which will make payments to the Trust under any Additional Royalty Interest is the same entity making payments to the Trust under the initial Conveyance), the effective date (which must be on the first day of a calendar quarter and must be the date of delivery thereof to the Trustee) and the percentage set forth in the definition of Royalty Production in the related additional conveyance, may be assigned by the Company or an affiliate thereof to the Trust from time to time, through the execution of additional conveyances (each an \"Additional Conveyance\"). In consideration of the grant of an Additional Royalty Interest, the Trustee will issue to the order of the Company or such affiliate, a number of Trust Units, not to exceed a total of 18,600,000 additional Trust Units, equal to (i) the product of (a) the percentage set forth in the definition of \"Royalty Production\" in the related Additional Conveyance and (b) 21,400,000, (ii) divided by 16.4246%. In connection with such issuance, the recipients of such Trust Units and their transferees will not be treated as holders of Trust Units of record entitled to distributions with respect to the Quarterly Income Amount for the Quarterly Record Date which occurs during\nthe month in which such Additional Conveyance is effective and will not be entitled to transfer such Trust Units (other than to the Company or one of its affiliates) on or prior to such Quarterly Record Date, and the certificates representing such Trust Units will prominently so state.\nThe acceptance by the Trustee of any such assignment will be subject to the conditions that the Trustee shall have received a ruling from the IRS to the effect that neither the existence nor the exercise of the right to assign the Additional Royalty Interest or the power to accept such assignment will adversely affect the classification of the Trust as a \"grantor trust\" for federal income tax purposes, and rulings from the IRS or an opinion of counsel to the effect that such assignment will not cause the income from the Trust to be treated as unrelated business taxable income for federal income tax purposes, or the holders of Trust Units to recognize income, gain or loss attributable to the Royalty Interest as a result of such assignment, except to the extent of any gain or loss attributable to any cash received by the Trust in connection with such assignment.\nIn addition, the Trustee will require that the Company or its affiliate contribute a cash reserve computed by reference to the value of the cash reserve for future liabilities existing on the date the Additional Conveyance is effective. The Trustee will invest any cash so contributed as described under \"Duties and Limited Powers of Trustee\" above, and will distribute the cash so contributed and any interest earned thereon to holders of Trust Units of record on the Quarterly Record Date which occurs during the month in which the related Additional Conveyance becomes effective, except to holders of Trust Units issued upon the assignment of the Additional Conveyance.\nAny Additional Royalty Interest assigned to the Trust will constitute a part of the trust estate and, to the extent permitted by law, will be treated by the Trustee, together with the initial Royalty Interest and all other Additional Royalty Interests previously assigned to the Trust, as constituting one Royalty Interest held for the benefit of all holders of Trust Units.\nDESCRIPTION OF THE ROYALTY INTEREST\nThe Trust property consists of a Royalty Interest entitling the Trust to a Per Barrel Royalty on 16.4246% of the first 90,000 barrels of the average actual daily net production of oil and condensate per quarter (the \"Royalty Production\") from the Company's working interest in the PBU. There are 21,400,000 Trust Units outstanding. If additional Trust Units are issued, the Royalty Interest percentage will be increased proportionately. The net production referred to herein pertains only to the Ivishak and PESS formations collectively known as the Prudhoe Bay (Permo-Triassic) Reservoir, and does not pertain to the Lisburne and Endicott formations. The Company's average daily net production from its working interest in the PBU during 1994 was approximately 369,900 barrels of oil and condensate.\nAs is true of net profits royalty interests generally, the Royalty Interest is a property right under applicable principles of Alaska law which burdens production, but there is no other security interest in the reserves or production revenues to which the Royalty Interest is entitled.\nThe royalty payable to the Trust under the Royalty Interest is the product of the Royalty Production and the Per Barrel Royalty for each day.\nPER BARREL ROYALTY\nThe Per Barrel Royalty in effect for any day will equal the WTI Price for such day less the sum of (i) the product of the Chargeable Costs and the Cost Adjustment Factor and (ii) Production Taxes.\nWTI PRICE\nThe \"WTI Price\" for any trading day means (i) the latest price (expressed in dollars per barrel) for West Texas Intermediate crude oil of standard quality having a specific gravity of 40 degrees API for delivery at Cushing, Oklahoma (\"West Texas Crude\"), quoted for such trading day by the Dow Jones International Petroleum Report (which is published in The Wall Street Journal) or if the Dow Jones International Petroleum Report does not publish such quotes, then such price as quoted by Reuters, or if Reuters does not publish such quotes, then such price as quoted in Platt's Oilgram Price Report, or (ii) if for any reason such publications do not publish such price, then the WTI Price will mean, until (i) is again applicable, the simple average of the daily mean prices (expressed in dollars per barrel) quoted for West Texas Crude by one major oil company, one petroleum broker and petroleum trading company, in each case unaffiliated with BP. Such major oil company, petroleum broker and petroleum trading company must have substantial U.S. operations and will be designated by the Company from time to time in an officer's certificate delivered to the Trustee. In the event that prices for West Texas Crude are not quoted so as to permit the calculation of the WTI Price, \"West Texas Crude,\" for the purposes of calculating the WTI Price first for (i) and then (ii) above, will mean such other light sweet domestic crude oil of standard quality as is designated by the Company in an officer's certificate delivered to the Trustee and approved by the Trustee in the exercise of its reasonable judgment, with appropriate allowance for transportation costs to the Gulf Coast (or other appropriate location) to equilibrate such price to the WTI Price. The WTI Price for any day which is not a trading day will be the WTI Price for the next preceding day which is a trading day.\nCHARGEABLE COSTS\nThe \"Chargeable Costs\" per barrel of Royalty Production were $4.50 per barrel through December 31, 1991, $6.00 per barrel from January 1, 1992 through December 31, 1992, $6.75 per barrel from January 1, 1993 through December 31, 1993, $8.00 per barrel from January 1, 1994 through\nDecember 31, 1994 and will be the amount set forth in the following table opposite the calendar year stated:\nChargeable Costs are multiplied by the Cost Adjustment Factor as defined below.\nChargeable Costs will be reduced up to a maximum of $1.20 per barrel in any given year subsequent to 1995 based on the following tests of the Company's additions of Proved Reserves to Current Reserves. Current Reserves are defined as the Company's Proved Reserves of crude oil and condensate as of December 31, 1987 (2035.6 million stock tank barrels (\"STB\")) and before taking into account any production therefrom and before any reduction that may result from the creation of the Trust.\n(a) If, by December 31, 1995, 100,000,000 or more STB of Proved Reserves have not been added to Current Reserves, then for each year 1996 through 2000, inclusive, Chargeable Costs as set forth in the table above shall be reduced, as of January 1 in each such year, by an amount equal to the lesser of (A) $1.20 or (B) the product of $1.20 and a fraction, the numerator of which shall be the difference between 100,000,000 STB of Proved Reserves and the actual number of STB of Proved Reserves so added to Current Reserves from January 1, 1988 through December 31, 1995 and the denominator of which shall be 100,000,000 STB of Proved Reserves. The Company added approximately 42,000,000 STB to Proved Reserves during 1988, approximately 45,500,000 STB during 1989, approximately 24,000,000 STB during 1990, approximately 116,000,000 STB during 1991, approximately 144,000,000 STB during 1992, approximately 206,000,000 STB during 1993 and approximately 90,000,000 STB during 1994.\n(b) If between January 1, 1996 and December 31, 2000 an additional 200,000,000 STB of Proved Reserves (that is, 200,000,000 STB of Proved Reserves in addition to the 100,000,000 STB of Proved Reserves that are referred to in (a)) have not been added to Current Reserves, then for each year from 2001 through 2005, inclusive, Chargeable Costs as set forth in the table above shall be reduced, as of January 1 in each such year, by an amount equal to the lesser of (A) $1.20 or (B) the product of $1.20 and a fraction, the numerator of which shall be the difference between (1) 200,000,000 STB of Proved Reserves and (2) the sum of (i) the actual number of STB of Proved Reserves so added to Current Reserves from January 1, 1996 through December 31, 2000 plus (ii) the excess, if any, of the number of STB of Proved Reserves so added to Current Reserves from January 1, 1988 through December 31, 1995 over 100,000,000 STB of Proved Reserves (provided that the sum of (i) and (ii) shall not exceed 200,000,000 STB of Proved Reserves) and the denominator of which shall be 200,000,000 STB of Proved Reserves.\n(c) The tests set forth in (i) and (ii) below will be utilized to calculate the reduction, if any, in Chargeable Costs for the year 2006 and each year thereafter. If the calculation under one of such tests produces a reduction in Chargeable Costs but the calculation under the other test does not, the calculation that produces the reduction shall apply. In applying the tests below, it is the intention of the Company that test (i) allow as a credit toward the 400,000,000 STB of Proved Reserves that must be added to Current Reserves during the period set forth in such test an amount equal to the excess, if any, of the number of STB of Proved Reserves added to Current Reserves prior to December 31, 2000 over 300,000,000 STB of Proved Reserves while test (ii) sets a level of only 100,000,000 STB of Proved Reserves that must be added to Current Reserves during the period set forth in such test, but does not allow a credit for additions of STB of Proved Reserves accrued prior to December 31, 2000.\n(i) If, between January 1, 2001 and December 31, 2005, an additional 400,000,000 STB of Proved Reserves (that is, 400,000,000 STB of Proved Reserves in addition to the 100,000,000 STB of Proved Reserves that are referred to in (a) and the 200,000,000 STB of Proved Reserves that are referred to in (b)) have not been added to Current Reserves, then for the year 2006 and each year thereafter Chargeable Costs as set forth in the table above shall be reduced, as of January 1 of each such year, by an amount equal to the lesser of (A) $1.20 or (B) the product of $1.20 and a fraction, the numerator of which shall be the difference between (1) 400,000,000 STB of Proved Reserves and (2) the sum of (x) the actual number of STB of Proved Reserves so added to Current Reserves from January 1, 2001 through December 31, 2010 plus (y) the excess, if any, of the number of STB of Proved Reserves so added to Current Reserves from January 1, 1988 through December 31, 2000 over 300,000,000 STB of Proved Reserves (provided that the sum of (x) and (y) shall not exceed 400,000,000 STB of Proved Reserves) and the denominator of which shall be 400,000,000 STB of Proved Reserves.\n(ii) If, between January 1, 2001 and December 31, 2005, an additional 100,000,000 STB of Proved Reserves (that is, 100,000,000 STB of Proved Reserves in addition to any and all STB of Proved Reserves that are added to Current Reserves prior to January 1, 2001) have not been added to Current Reserves, then for the year 2006 and each year thereafter, Chargeable Costs as set forth in the table above shall be reduced, as of January 1 of each such year, by an amount equal to the lesser of (A) $1.20 or (B) the product of $1.20 and a fraction, the numerator of which shall be the difference between 100,000,000 STB of Proved Reserves and the number of STB of Proved Reserves added to Current Reserves from January 1, 2001 through December 31, 2005 and the denominator of which shall be 100,000,000 STB of Proved Reserves.\nCOST ADJUSTMENT FACTOR\nThe \"Cost Adjustment Factor\" is the ratio of (1) the Consumer Price Index (\"CPI\") published for the most recently past February, May, August or November, as the case may be, to (2)121.1 (the Consumer Price Index for January 1989); provided, however, that (a) if for any calendar quarter the average WTI Price is $18.00 or less, then in such event the Cost Adjustment Factor for such quarter shall be the Cost Adjustment Factor for the immediately preceding quarter, and (b) the Cost Adjustment Factor for any calendar quarter in which the average WTI Price exceeds $18.00, after a calendar quarter during which the average WTI Price is equal to or less than $18.00, and for each following calendar quarter in which the average WTI Price is greater than $18.00, shall be the product of (x) the Cost Adjustment Factor for the most recently past calendar quarter in which the average WTI Price is equal to or less than $18.00 and (y) a fraction, the numerator of which shall be the Consumer Price Index published for the most recently past February, May, August or November, as the case may be, and the denominator of which shall be the Consumer Price Index published for the most recently past February, May, August or November during a quarter in which the average WTI Price is equal to or less than $18.00. The \"Consumer Price Index\" is the U.S. Consumer Price Index, all items and all urban consumers, U.S. city average, 1982-84 equals 100, as first published, without seasonal adjustment, by the Bureau of Labor Statistics, Department of Labor, without regard to subsequent revisions or corrections by such Bureau.\nPRODUCTION TAXES\n\"Production Taxes\" are the sum of any severance taxes, excise taxes (including windfall profit tax, if any), sales taxes, value added taxes or other similar or direct taxes imposed upon the reserves or production, delivery or sale of Royalty Production. For this purpose, such taxes will be computed at defined statutory rates. In the case of taxes based upon wellhead or field value, the Overriding Conveyance provides that the WTI Price less the product of $4.50 and the Cost Adjustment factor will be deemed to be the wellhead or field value. At the present time, the\nProduction Taxes payable with respect to the Royalty Production are the Alaska Oil and Gas Properties Production Tax (\"Alaska Production Tax\") and the Alaska Oil and Gas Conservation Tax (\"Alaska Conservation Tax\"). For the purposes of the Royalty Interest, the Alaska Production Tax will be computed without regard to the \"economic limit factor\", if any, as the greater of the \"percentage of value amount\" (based on the statutory rate and the wellhead value as defined above) and the \"cents per barrel amount\" as such terms are used with respect to such tax. As of the date of this report, the statutory rate for the purpose of calculating the \"percentage of value amount\" is 15%, and the Alaska Conservation Tax is a tax of $0.004 per barrel of net production. A surcharge to the Alaska Production Tax increased Production Taxes by $0.05 per barrel of net production effective July 1, 1989. However, beginning with the second calendar quarter (April- June) of 1995, $0.02 per barrel of this surcharge will be suspended because the State spill response fund will have reached $50 million. In the event the balance of that fund falls below $50 million, the $0.02 per barrel will be reinstated until the fund balance again reaches $50 million. The remaining $0.03 per barrel is not effected by the fund's balance and will continue to be imposed at all times.\nROYALTY PRODUCTION\nThe Royalty Production for each day in a calendar quarter will be 16.4246% of the first 90,000 barrels of the average of the Company's actual daily net production of oil and condensate for such quarter as produced from the company's oil rim and gas cap participation as of February 28, 1989 or as modified thereafter by any redetermination provided under the terms of the Prudhoe Bay Unit Operating Agreement and the Prudhoe Bay Unit Agreement. The Royalty Production will be based upon oil produced from the oil rim and condensate produced from the gas cap, but not upon gas production or natural gas liquids production. The Company's actual average daily net production of oil and condensate for any calendar quarter will be the total production of oil and condensate for such quarter, net of the State of Alaska royalty, divided by the number of days in such quarter.\nCALCULATION OF ROYALTY AMOUNT\nThe Royalty Interest for each calendar quarter is the sum of the product of each day in such quarter of (i) the Royalty Production and (ii) the Per Barrel Royalty; provided that the payment under the Royalty Interest for any calendar quarter will not be (1) less than zero or (2) more than the aggregate value of the total production of oil and condensate from the Company's current working interest in the PBU for such calendar quarter, net of the State of Alaska royalty and less the value of any applicable payments made to affiliates of the Company.\nMINIMUM ROYALTY\nThe Royalty Interest provided for a Minimum Per Barrel Royalty for the period from February 28, 1989 to September 30, 1991 of $8.92 per barrel (the \"Minimum Per Barrel Royalty\"); for all periods thereafter there is no Minimum Per Barrel Royalty.\nThe \"Average Per Barrel Royalty\" for each of the first three calendar quarters of 1991 was the average of the Per Barrel Royalty for each of the days in such quarter and in the three preceding quarters. During 1989, 1990, and 1991 through and including October 15, 1991, the Trust's distributions were based on the Average Per Barrel Royalty and not on the Minimum Per Barrel Royalty.\nPOTENTIAL CONFLICTS OF INTEREST BETWEEN THE COMPANY AND TRUST\nThe interests of the Company and the Trust with respect to the PBU could at times be different. In particular, because the Per Barrel Royalty will be based on the WTI Price and Chargeable Costs rather than the Company's actual price realized and actual costs, the actual per barrel profit received by the Company on the Royalty Production could differ from the Per Barrel Royalty to be paid to the Trust. It is possible, for example, that the relationship between the Company's actual per barrel revenues and costs could be such that the Company may determine to interrupt or discontinue production in whole or in part even though a Per Barrel Royalty may otherwise have been payable to the Trust pursuant to the Royalty Interest. This potential conflict of interest could affect the royalties paid to Trust Unit holders, although the Company will be subject to the terms of the Prudhoe Bay Unit Operating Agreement.\nHolders of Trust Units will have certain voting rights with respect to the administration of the Trust, but will have no voting rights with respect to, and no control over, any operating matters related to the PBU. The Company will retain the sole right to control all matters relating to its working interest in the PBU, subject to the terms of the Prudhoe Bay Unit Operating Agreement.\nDESCRIPTION OF THE BP SUPPORT AGREEMENT\nBP has agreed pursuant to the terms of a Support Agreement, dated February 28, 1989, among BP, the Company, Standard Oil and the Trust (the \"Support Agreement\"), to provide financial support to the Company in meeting its payment obligations under the Royalty Interest.\nWithin 30 days of notice to BP pursuant to Article XI of the Trust Agreement, BP will ensure that the Company is in a position to perform its payment obligations under the Royalty Interest and to satisfy its payment obligations to the Trust under the Trust Agreement (including, without limitation, the obligation to make payments as indemnification), including, without limitation, contributing to the Company such funds as are necessary\nto make such payments. BP's obligations under the Support Agreement are unconditional and directly enforceable by Trust Unit holders.\nExcept as described below, no assignment, sale, transfer, conveyance, mortgage or pledge or other disposition of the Royalty Interest will relieve BP of its obligations under the Support Agreement.\nNeither BP nor the Company may transfer or assign its rights or obligations under the Support Agreement without the prior written consent of the Trust, except that BP can arrange for its obligations under the Support Agreement to be performed by any affiliate of BP, provided that BP remains responsible for ensuring that such obligations are performed in a timely manner.\nThe Company may sell or transfer all or part of its working interest in the PBU, although such a transfer will not relieve BP of its responsibility to ensure that the Company's payment obligations with respect to the Royalty Interest and under the Trust Agreement and the Conveyance are performed.\nBP will be released from its obligation under the Support Agreement upon the sale or transfer of all or substantially all of the Company's working interest in the PBU if the transferee is of Equivalent Financial Standing and unconditionally agrees to assume and be bound by BP's obligation under the Support Agreement in a writing in form and substance reasonably satisfactory to the Trustee. A transferee of \"Equivalent Financial Standing\" is defined in the Support Agreement as an entity having a rating assigned to outstanding unsecured, unsupported long term debt from Moody's Investors Service of at least A3 or from Standard & Poor's Corporation of at least A- or an equivalent rating from at least one nationally-recognized statistical rating organization (after giving effect to the sale or transfer to such entity of all or substantially all of the Company's working interest in the PBU and the assumption by such entity of all of the Company's obligations under the Conveyance and of all BP's obligations under the Support Agreement).\nDESCRIPTION OF THE PROPERTY\nBACKGROUND\nThe Prudhoe Bay field (the \"Field\") is located on the North Slope of Alaska, 250 miles north of the Arctic Circle and 650 miles north of Anchorage. The Field extends approximately 12 miles by 27 miles and contains nearly 150,000 productive acres. The Field, which was discovered in 1968 by BP and others, has been in production since 1977 and during 1989, 1990, 1991, 1992, 1993 and 1994, produced on average 1.4 million, 1.3 million, 1.3 million, 1.2 million, 1.1 million and 1 million barrels of oil and condensate per day, respectively. The Field is the largest producing field in North America. As of January 1, 1995, approximately 8.64 billion STB of oil and condensate had been produced from the Field. The Company estimates that production will decline at an average rate of approximately\n10% per year. Field development is well advanced with approximately $16.3 billion gross capital spent and a total of about 1,227 wells drilled. Other large fields located in the same area include the Kuparuk, Endicott, and Lisburne fields. Production from those fields is not included in the Royalty Interest.\nSince several oil companies hold acreage within the Field, the PBU was established to optimize Field development. The Prudhoe Bay Unit Operating Agreement specifies the allocation of production and costs to PBU owners. The Company and a subsidiary of the Atlantic Richfield Company (\"Arco\") are the two Field operators. Other Field owners include affiliates of Exxon Corporation (\"Exxon\"), Mobil Corporation (\"Mobil\"), Phillips Petroleum Company (\"Phillips\") and Chevron Corporation (\"Chevron\").\nGEOLOGY\nThe principal hydrocarbon accumulations at Prudhoe Bay are in the Ivishak sandstone of the Sadlerochit Group at a depth of approximately 8,700 feet below sea level. The Ivishak is overlain by four minor reservoirs of varying extent which are designated the Put River, Eileen, Sag River and Shublik (collectively, \"PESS\") formations. Underlying the Sadlerochit Group are the oil-bearing Lisburne and Endicott formations. The net production referred to herein pertains only to the Ivishak and PESS formations, collectively known as the Prudhoe Bay (PermoTriassic) Reservoir, and does not pertain to the Lisburne and Endicott formations.\nThe Ivishak sandstone was deposited some 250 million years ago during the Permian and Triassic geologic ages. The sediments in the Ivishak are composed of sandstones, conglomerate and shales which were deposited by a massive braided river\/delta system that flowed from an ancient mountain system to the north. Oil was trapped in the Ivishak by a combination of structural and stratigraphic trapping mechanisms.\nGross reservoir thickness is 550 feet, with a maximum oil column thickness of 425 feet. The original oil column is bounded on the top by a gas-oil contact, originally at 8,575 feet below sea level across the main field, and on the bottom by an oil-water contact at approximately 9,000 feet below sea level. A layer of heavy oil\/tar overlays the oil-water contact in the main field and has an average thickness of around 40 feet.\nHYDROCARBONS IN PLACE\nThe reservoir contained approximately 22 billion STB of original oil in place, of which approximately 19 billion STB were in the light oil column. The light oil in the reservoir is a medium grade, low sulfur crude with an average specific gravity of 27 degrees API.\nOriginal gas in place was approximately 46 trillion standard cubic feet (\"TSCF\") (equivalent to approximately 8 billion barrels of oil on a BTU basis), with 30 TSCF in the gas cap and 16 TSCF solution gas. The gas cap gas has an average specific gravity of 0.85 and is composed of 70 to\n80% methane, 10 to 20% carbon dioxide and the remainder ethane and heavier components. The gas cap composition is such that, upon surfacing, a liquid hydrocarbon phase, known as condensate, is formed.\nThe interests of the Trust Unit holders are based upon oil produced from the oil rim and condensate produced from the gas cap, but not upon gas production (which is currently uneconomic) or natural gas liquids production stripped from gas produced.\nPRUDHOE BAY UNIT OPERATION AND OWNERSHIP\nSince several companies hold acreage within the Field's limits, a unit was established to ensure optimum development of the Field. The Prudhoe Bay Unit, which became effective on April 1, 1977, divided the Field into two operating areas. The Company is the operator of the Western Operating Area (\"WOA\") and Arco Alaska Inc. is the operator of the Eastern Operating Area (\"EOA\"). Oil and condensate production comes from both the WOA and EOA.\nThe Prudhoe Bay Unit Operating Agreement specifies the allocation of production and costs to the working interest owners. The Prudhoe Bay Unit Operating Agreement also defines operator responsibilities and voting requirements and is unusual in its establishment of separate participating areas for the gas cap and oil rim.\nThe Prudhoe Bay Unit ownership by participating area is summarized in the following table:\nPRUDHOE BAY UNIT OWNERSHIP BY PARTICIPATING AREA (AS OF JANUARY 1, 1995)\nOIL RIM REDETERMINATION\nThe Prudhoe Bay Unit Operating Agreement, which was entered into in 1977, required a final redetermination of participating interests in the oil rim, based upon improved technical knowledge of the reservoir as a result of Field operations. In 1982, the Company, Arco and Exxon (the three major interest owners holding a total of approximately 94% of the oil\nrim) reached an agreement regarding final redetermination of participating interests in the Field.\nIn October 1982, Exxon initiated arbitration proceedings regarding final redetermination of participating interests in the oil rim. As a result of the arbitration proceedings, which were concluded in 1985, the Company's participating interest in the oil reservoir was 50.68%. At the current maximum allowable production rate, this resulted in the Company's interest becoming 655,200 net barrels of oil per day (\"BOPD\"). Also to adjust its share of cumulative total production since the inception of commercial production, the Company overlifted about 13,500 net BOPD for a two-year period ending in August, 1987. After the arbitration award, MPC challenged the award through litigation. Mobil, Phillips and Chevron agreed in principle in October 1990 to end their challenge to the 1985 arbitration on their participating area interest in exchange for a cash settlement from BP, ARCO and Exxon. This settlement became effective on completion of a definitive binding agreement between all PBU owners, known as the Issues Resolution Agreement (\"IRA\").\nThe Company has advised the Trustee that the IRA addresses, among other things, final determination of the Original Condensate Reserve (\"OCR\"), agreement on allocation of the OCR over time, agreement on an additional gas handling expansion project (GHX-2), extension of an existing Enhanced Oil Recovery (\"EOR\") project to the end of field life and the establishment of a plan of additional development.\nThe IRA is an agreement among the owners of the Prudhoe Bay Unit which is designed to promote cooperation, reduce conflicts, increase efficiency of operations, and resolve a number of issues that were previously subject to negotiation, arbitration, or litigation among the Unit owners. The Company has advised that final approval of the IRA has now been obtained from all Unit owners.\nThe Company has further advised that the OCR was finally determined to be 1,175 million stock tank barrels (\"STB\") for the Prudhoe Bay Unit, and that this OCR determination resulted in a reallocation of approximately 500 million STB of crude oil reserves to condensate reserves, for the Prudhoe Bay Unit. The Company has also advised that because BP owns 50.68% of the crude oil and 13.84% of the condensate, this OCR settlement alone results in a BP net reserve reduction. The Company has advised the Trustee, however, that the establishment of the OCR at this level when combined with the other elements of the agreement described above should result in no significant change to BP's net reserves, and that the changes agreed to by the Prudhoe Bay Unit owners, including the attendant increased production, are expected to have limited impact on the point at which the company's net production of oil and condensate would fall below 90,000 barrels per day.\nPRODUCTION AND RESERVES\nProduction began on June 19, 1977, with the completion of the Trans Alaska Pipeline System (\"TAPS\"). Initially 750,000 BOPD was the TAPS limit, but after start-up, pipeline capacity was increased and in November 1979 a production rate of 1.5 million BOPD was achieved.\nAs of January 1, 1995, there were about 995 producing oil wells, 35 gas reinjection wells, 55 water injection wells and 117 water and miscible gas injection wells in the Field. In terms of individual well performance, oil production rates range from 100 to 6,500 BOPD. Currently, the average well production rate is about 965 BOPD.\nThe Company's share of the hydrocarbon liquids production from the Field includes oil, condensate and natural gas liquids. Using the production allocation procedures from the Prudhoe Bay Unit Operating Agreement, the Field's production and the Company's 1994 share of oil and condensate (net of State of Alaska royalty) was as follows:\nPRUDHOE BAY UNIT 1994 PRODUCTION (BARRELS PER DAY)\nThe Company's net proved remaining reserves of oil and condensate in the PBU as of December 31, 1994 were 1,395,000,000 STB. This current estimate of reserves is based upon various assumptions, including a reasonable estimate of the allocation of hydrocarbon liquids between oil and condensate pursuant to the procedures of the Prudhoe Bay Unit Operating Agreement. The Company anticipates that its net production from its current proved reserves will exceed 90,000 barrels per day until the year 2014. The Company also projects continued economic production thereafter, at a declining rate, until the year 2030; however, for the economic conditions and reserve estimates as of December 31, 1994 the Per Barrel Royalty will be zero following the year 2009. For years subsequent to 1995, Chargeable Costs will be reduced up to a maximum amount of $1.20 per barrel in each year if additions of Proved Reserves to Current Reserves (as defined in CHARGEABLE COSTS) do not meet certain specific levels (see CHARGEABLE COSTS). The Company has added and anticipates adding to its proved reserves. Even if expected reservoir performance does not change, the estimated reserves, economic life, and future revenues attributable to the BP Prudhoe Bay Royalty Trust may change significantly in the future. This may result from changes in the West Texas Intermediate Price or from\nchanges in other prescribed variables utilized in calculations defined by the Overriding Royalty Conveyance. See Report of Miller and Lents, Ltd., Independent Petroleum Consultants, below.\nMILLER AND LENTS, LTD. OIL AND GAS CONSULTANTS\nTWENTY-SEVENTH FLOOR 1100 LOUISIANA HOUSTON, TEXAS 77002-5216\nTelephone 713 651-9455 Telefax 713 654-9914\nFebruary 28, 1995\nThe Bank of New York Trustee, BP Prudhoe Bay Royalty Trust 101 Barclay Street 21 W New York, New York 10286\nRe: Estimates of Proved Reserves, Future Production Rates, and Future Net Revenues for the BP Prudhoe Bay Royalty Trust As of December 31, 1994\nGentlemen:\nThis letter report is a summary of investigations performed in accordance with our engagement by you as described in Section 4.8(d) of the Overriding Royalty Conveyance dated February 27, 1989, between BP Exploration (Alaska) Inc., and The Standard Oil Company. The investigations included reviews of the estimates of Proved Reserves and production rate forecasts of oil and condensate made by BP Exploration (Alaska) Inc. attributable to the BP Prudhoe Bay Royalty Trust as of December 31, 1994. Additionally, we reviewed calculations of the resulting Estimated Future Net Revenues and Present Value of Estimated Future Net Revenues attributable to the BP Prudhoe Bay Royalty Trust.\nThe estimates and calculations reviewed are summarized in the report prepared by BP Exploration (Alaska) Inc. and transmitted with a cover letter dated February 17, 1995, addressed to Ms. Marie Trimboli of The Bank of New York and signed by Mr. David K. Woodward. Reviews were also performed by Miller and Lents, Ltd. during this year or in previous years of (1) the procedures for estimating and documenting Proved Reserves, (2) the estimates of in-place reservoir volumes, (3) the estimates of recovery factors and production profiles for the various areas, pay zones, projects, and recovery processes that are included in the estimate of Proved Reserves, (4) the production strategy and procedures for implementing that strategy, (5) the sufficiency of the data available for making estimates of Proved Reserves and production profiles, and (6) pertinent provisions of\nMILLER AND LENTS, LTD.\nthe Prudhoe Bay Unit Operating Agreement, the Issues Resolution Agreement, the Overriding Royalty Conveyance, the Trust Conveyance, the BP Prudhoe Bay Royalty Trust Agreement, and other related documents referenced in the Form Registration Statement filed with the Securities and Exchange Commission on August 7, 1989, by BP Exploration (Alaska) Inc.\nProved Reserves were estimated by BP Exploration (Alaska) Inc. in accordance with the definitions contained in Securities and Exchange Commission Regulation S-X, Rule 4-10(a). Estimated Future Net Revenues and Present Value of Estimated Future Net Revenues are not intended and should not be interpreted to represent fair market values for the estimated reserves.\nThe Prudhoe Bay (Permo-Triassic) Reservoir is defined in the Prudhoe Bay Unit Operating Agreement. The Prudhoe Bay Unit is an oil and gas unit situated on the North Slope of Alaska. The BP Prudhoe Bay Royalty Trust is entitled to a royalty payment on 16.4246 percent of the first 90,000 barrels of the actual average daily net production of oil and condensate for each calendar quarter from the BP Exploration (Alaska) Inc. working interest in the Prudhoe Bay Unit. The payment amount depends upon the Per Barrel Royalty which, in turn, depends upon the West Texas Intermediate Price, the Chargeable Costs, the Cost Adjustment Factor, and Production Taxes, all of which are defined in the Overriding Royalty Conveyance. \"Barrel\" as used herein means Stock Tank Barrel as defined in the Overriding Royalty Conveyance.\nOur reviews do not constitute independent estimates of the reserves and annual production rate forecasts for the areas, pay zones, projects, and recovery processes examined. We relied upon the accuracy and completeness of information provided by BP Exploration (Alaska) Inc. with respect to pertinent ownership interests and various other historical, accounting, engineering and geological data.\nAs a result of our cumulative reviews, based on the foregoing, we conclude that:\n1. A large body of basic data and detailed analyses are available and were used in making the estimates. In our judgment, the quantity and quality of currently available data on reservoir boundaries, original fluid contacts, and reservoir rock and fluid properties are sufficient to indicate that any future revisions to the estimates of total original in-place volumes should be minor. Furthermore, the data and analyses on recovery factors and future production rates are sufficient to support the Proved Reserves estimates.\n2. The methods and procedures employed to accumulate and evaluate the necessary information and to estimate, document, and reconcile reserves, annual production rate forecasts, and future net revenues are effective and are in accordance with generally\nMILLER AND LENTS, LTD.\naccepted geological and engineering practice in the petroleum industry.\n3. Based on our limited independent tests of the computations of reserves, production flowstreams, and future net revenues, such computations were performed in accordance with the methods and procedures described to us.\n4. The estimated net remaining Proved Reserves attributable to the BP Prudhoe Bay Royalty Trust as of December 31, 1994, of 81.0 million barrels of oil and condensate are, in the aggregate, reasonable. All 81.0 million barrels are Proved Developed Reserves.\n5. Utilizing the specified procedures outlined in Financial Accounting Standards Board Statement of Financial Accounting Standards No. 69, BP Exploration (Alaska) Inc. calculated that as of December 31, 1994, production of the Proved Reserves will result in Estimated Future Net Revenues of $257 million and Present Value of Estimated Future Net Revenues of $163 million to the BP Prudhoe Bay Royalty Trust. These estimates are reasonable.\n6. BP Exploration (Alaska) Inc. estimated that, as of December 31, 1994, 668.0 million barrels of Proved Reserves have been added to Current Reserves. This estimate is reasonable. Current Reserves are defined in the Overriding Royalty Conveyance as net Proved Reserves of 2,035.6 million barrels as of December 31, 1987. Net additions to Proved Reserves after December 31, 1987 affect the Chargeable Costs that are used to calculate the Per Barrel Royalty paid to the BP Prudhoe Bay Royalty Trust.\n7. The BP Exploration (Alaska) Inc. projection that its net production of oil and condensate from Proved Reserves will continue at an average rate exceeding 90,000 barrels per day until the year 2014 is reasonable. As long as the Per Barrel Royalty has a positive value, average daily production attributable to the BP Prudhoe Bay Royalty Trust will remain constant until the net production falls below 90,000 barrels per day; thereafter, production attributable to the BP Prudhoe Bay Royalty Trust will decline with the BP Exploration (Alaska) Inc. production. However, the Per Barrel Royalty will not have a positive value if the West Texas Intermediate Price is less than the sum of the per barrel Chargeable Costs and per barrel Production Taxes, appropriately adjusted in accordance with the Overriding Royalty Conveyance. Under such circumstances, average daily production attributable to the BP Prudhoe Bay Royalty Trust will have no value and therefore will not contribute to the reserves regardless of the BP Exploration (Alaska) Inc. net production level.\nMILLER AND LENTS, LTD.\n8. Based on the West Texas Intermediate Price of $17.75 per barrel on December 31, 1994, current Production Taxes, and the Chargeable Costs adjusted as prescribed by the Overriding Royalty Conveyance, the projection that royalty payments will continue through the year 2009 is reasonable. BP Exploration (Alaska) Inc. expects continued economic production at a declining rate through the year 2030; however, for the economic conditions and production forecast as of December 31, 1994, the Per Barrel Royalty will be zero following the year 2009. Therefore, no reserves are currently attributed to the BP Prudhoe Bay Royalty Trust after that date.\n9. Even if expected reservoir performance does not change, the estimated reserves, economic life, and future revenues attributable to the BP Prudhoe Bay Royalty Trust may change significantly in the future. This may result from changes in the West Texas Intermediate Price or from changes in other prescribed variables utilized in calculations defined by the Overriding Royalty Conveyance.\nEstimates of ultimate and remaining reserves and production scheduling depend upon assumptions regarding expansion or implementation of alternative projects or development programs and upon strategies for production optimization. BP Exploration (Alaska) Inc. has continual reservoir management, surveillance, and planning efforts dedicated to (1) gathering new information, (2) improving the accuracy of its reserves and production capacity estimates, (3) recognizing and exploiting new opportunities, (4) anticipating potential problems and taking corrective actions, and (5) identifying, selecting, and implementing optimum recovery program and cost reduction alternatives. Given this significant effort and ever-changing economic conditions, estimates of reserves and production profiles will change periodically.\nThe current estimate of Proved Reserves includes only those projects or development programs that are deemed reasonably certain to be implemented, given current economic and regulatory conditions. Future projects, development programs, or operating strategies different from those assumed in the current estimates may change future estimates and affect recoveries. However, because several complementary and alternative projects are being considered for recovery of the remaining oil in the reservoir, a decision not to implement a currently planned project may allow scope expansion or implementation of another project, thereby increasing the overall likelihood of recovering the reserves.\nFuture production rates will be controlled by facilities limitations and upsets, well downtime, and the effectiveness of programs to optimize production and costs. BP Exploration (Alaska) Inc. currently expects continued economic production from the reservoir at a declining rate through the year 2030. Additional drilling, workovers, facilities modifications, new recovery projects, and programs for production enhancement and optimization are expected to mitigate but not eliminate\nMILLER AND LENTS, LTD.\nthe anticipated future decline in gross oil and condensate production capacity.\nIn making its future production rate forecasts, BP Exploration (Alaska) Inc. provided for normal downtime and planned facilities upsets. Although allowances for unplanned upsets are also considered in the estimates, the studies do not provide for any impediments to crude oil production as a consequence of major disruptions.\nUnder current economic conditions, gas from the Alaskan North Slope, except for minor volumes, cannot be marketed commercially. Oil and condensate recoveries are expected to be greater as a result of continued reinjection of produced gas than the recoveries would be if major volumes of produced gas were being sold. No major gas sale is assumed in the current estimates. If major gas sales are determined to be economically viable in the future, BP Exploration (Alaska) Inc. estimates that such sales would not actually commence until eight to ten years after such a determination. In the event that major gas sales are initiated, ultimate oil and condensate recoveries may be reduced from the current estimates unless recovery projects other than those included in the current estimates are implemented.\nLarge volumes of natural gas liquids are likely to be produced and marketed in the future whether or not major gas sales become viable. Natural gas liquids reserves are not included in the estimates cited herein. The BP Prudhoe Bay Royalty Trust is not entitled to royalty payments from production or sales of natural gas or natural gas liquids.\nThe evaluations presented in this report, with the exceptions of those parameters specified by others, reflect our informed judgments based on accepted standards of professional investigation but are subject to those generally recognized uncertainties associated with interpretation of geological, geophysical, and engineering information. Government policies and market conditions different from those reflected in this study or disruption of existing transportation routes or facilities may cause the total quantity of oil or condensate to be recovered, actual production rates, prices received, or operating and capital costs to vary from those reviewed in this report.\nMiller and Lents, Ltd., is an independent oil and gas consulting firm. None of the principals of this firm have any direct financial interests in BP Exploration (Alaska) Inc. or its parent or any related companies or in the BP Prudhoe Bay Royalty Trust. Our fee is not contingent upon the results of our work or report, and we have not performed other services for\nMILLER AND LENTS, LTD.\nBP Exploration (Alaska) Inc. or the BP Prudhoe Bay Royalty Trust that would affect our objectivity.\nVery truly yours,\nMILLER AND LENTS, LTD.\nBy \/s\/ William P. Koza --------------------------------------------- William P. Koza Vice President\nWPK\/hsd\nEstimates of proved reserves are inherently imprecise and subjective and are revised over time as additional data becomes available. Such revisions may often be substantial. Information regarding estimates of proved reserves attributable to the combined interests of the Company and the Trust were based on Company prepared reserve estimates.\nThe reserves attributable to the Trust are only a part of the overall above stated reserves. There is no precise method of allocating estimates of physical quantities of reserve volumes between the Company and the Trust, since the Royalty Interest is not a working interest and the Trust does not own and is not entitled to receive any specific volume of reserves from the Field. Reserve volumes attributable to the Trust were estimated by allocating to the Trust its share of estimated future production from the Field, based on the WTI Prices on December 31, 1994 ($17.75 per barrel), December 31, 1993 ($14.15 per barrel), December 31, 1992 ($19.50 per barrel), December 31, 1991 ($19.10 per barrel), and December 31, 1990 ($28.45 per barrel). Because the reserve volumes attributable to the Trust are estimated using an allocation of reserve volumes based on estimated future production, the current WTI Price, no future movement in the CPI, and no future additions by the Company of Proved Reserves to Current Reserves, a change in the timing of estimated production, a change in the WTI Price, future movement in the CPI, or future additions by the Company of Proved Reserves to Current Reserves will result in a change in the Trust's estimated reserve volumes. Therefore, the estimated reserve volumes attributable to the Trust will vary if different production estimates and prices are used. See \"Financial Statements\" and Note 5 thereto.\nEstimated net proved reserves allocable to the Trust as of December 31, 1994, December 31, 1993 and December 31, 1992 were 80,991,000 barrels, 43,193,000 barrels and 94,306,000 barrels, respectively. See \"Financial Statements\" and Note 5 thereto. The decrease from December 31, 1992 to December 31, 1993 reflects the excess of production over additions and changes in timing of production and the decrease in the WTI Price from $19.50 per barrel on December 31, 1992 to $14.15 per barrel on December 31, 1993. The increase from December 31, 1993 to December 31, 1994 reflects the increase in the WTI Price from $14.15 per barrel on December 31, 1993 to $17.75 per barrel on December 31, 1994. Proved developed reserves allocable to the Trust as of December 31, 1994, December 31, 1993 and December 31, 1992 were 80,991,000 barrels, 43,193,000 barrels and 79,420,000 barrels, respectively.\nThe Company is under no obligation to make investments in development projects which would add additional non-proved resources to proved reserves and cannot make such investments without the concurrence of the PBU working interest owners. However, several such investments which would augment Prudhoe Bay projects are already in process. These include additional drilling, waterflood expansions and miscible injection continuation\/ expansion projects. Other possible investments could include expanded gas cycling, miscible\/waterflood infill drilling, miscible injection supply increases to peripheral areas, heavy oil tar recovery and development of the smaller reservoirs. While there is no assurance that the PBU working\ninterest owners will make any such investments, they do regularly assess the technical and economic attractiveness of implementing further projects to increase PBU proved reserves.\nAs noted above, the Company's reserve estimates and production assumptions and projections are predicated upon a reasonable estimate of hydrocarbon allocation between oil and condensate. The Company's share of Prudhoe Bay production is the sum of 50.68% of the gross oil production and 13.84% of the gross condensate production from the Field. Oil and condensate are physically produced in a commingled stream of hydrocarbon liquids. The allocation of hydrocarbon liquids between the oil and condensate from the Field is a theoretical calculation performed in accordance with procedures specified in the Prudhoe Bay Unit Operating Agreement. Due to the differences in percentages between oil and condensate, the Company's overall share of oil and condensate production will vary over time according to the proportions of hydrocarbon liquid being allocated as condensate or as oil under the Prudhoe Bay Unit Operating Agreement allocation procedures. Under the terms of the IRA effective October 4, 1990 the present allocation procedures will be adjusted in 1995 to generally allocate condensate in a manner which approximates the anticipated decline in the production of oil until the agreed condensate reserve of 1.175 billion STB has been allocated to the Working Interest Owners. The Company believes this is a reasonable estimate of hydrocarbon allocation between oil and condensate.\nThe occurrence of major gas sales could accelerate the time at which the Company's net production would fall below 90,000 barrels per day, due to the consequent decline in reservoir pressure.\nIn the event of changes in the Company's current assumptions, oil and condensate recoveries may be reduced from the current estimates, unless recovery projects other than those included in the current estimates are implemented.\nRESERVOIR MANAGEMENT\nThe Prudhoe Bay Field is a complex, combination-drive reservoir, with widely varying reservoir properties. Reservoir management involves directing Field activities and projects to maximize the economic value of Field reserves.\nSeveral different oil recovery mechanisms are currently active in the Field, including pressure depletion, gravity drainage\/gas cap expansion, waterflooding and miscible gas flooding. Separate yet integrated reservoir management strategies have been developed for the areas impacted by each of these recovery processes.\nTRANSPORTATION OF PRUDHOE BAY OIL\nProduction from the Field is carried to Pump Station 1, which is the starting point for TAPS, through two 34-inch diameter transit lines, one\nfrom each half of the Field. At Pump Station 1, Alyeska Pipeline Service Company, the pipeline operator, meters the oil and pumps it south to Valdez where it is either loaded onto marine tankers or stored temporarily. It takes the oil about six days to make the trip in the 48-inch diameter pipeline.\nDuring 1989, analysis of data gathered by newly developed corrosion monitoring pigs revealed areas of corrosion previously undetected on TAPS. All of the corrosion found during 1989 was clustered largely in 13.5 miles, or less than 2%, of the pipeline length.\nIn 1989, analysis of data gathered by sophisticated corrosion monitoring pigs identified previously undetected corrosion on TAPS. An innovative approach enabled an 8.5 mile section of pipe to be replaced in 1991 without disrupting shipments from the terminal to Valdez. In 1992, instead of being replaced, a two mile section near Chandalar received specific repairs. This and other developments have cut the cost of repairs on the main line. Pump station piping corrosion costs have also been reduced significantly. The State of Alaska filed protests to the 1990, 1991, 1992, 1993, 1994 and 1995 TAPS tariffs, seeking to exclude corrosion costs from the tariffs charged to ship oil through TAPS. The State of Alaska and the other parties have agreed to continue attempts to resolve the dispute among themselves. Additional protests were filed by the State of Alaska in 1994 challenging the inclusion of certain public affairs and other expenses in such tariffs. A further protest has been filed by the State of Alaska relating to the 1995 tariff challenging the inclusion of certain expenses incurred in remediation of matters connected with National Electrical Codes.\nHISTORICAL PRODUCTION OF OIL AND CONDENSATE\nThe following table sets forth information concerning the production of oil and condensate for the periods indicated. The amounts listed are the Company's share of production, net of royalties to the State of Alaska.\nHISTORICAL PRODUCTION\n(a) Reflects an overlifting of 13,500 barrels per day through August 31, 1987 resulting from the redetermination of the MPC group ownership of the PBU. See \"Oil Rim Redetermination\" above.\nINDUSTRY CONDITIONS\nThe production of oil and gas in Alaska is affected by many state and federal regulations with respect to allowable rates of production, marketing, environmental matters and pricing. Future regulations could change allowable rates of production or the manner in which oil and gas operations may be lawfully conducted.\nIn general, the Company's oil and gas activities are subject to laws and regulations relating to environmental quality and pollution control. The Company believes that the equipment and facilities currently being used in its operations generally comply with the applicable legislation and regulations. During the past few years, numerous environmental laws and regulations have taken effect at the federal, state and local levels. Oil and gas operations are subject to extensive federal and state regulation and to interruption or termination by governmental authorities due to ecological and other considerations. Although the existence of legislation and regulation has had no material adverse effect on the Company's current method of operations, existing and future legislation and regulations could result in the Company experiencing delays and uncertainties in commencing projects. The ultimate impact of such legislation and regulations cannot generally be predicted.\nOil prices are subject to international supply and demand. Political developments (especially in the Middle East) and the outcome of meetings of OPEC can particularly affect world oil supply and oil prices.\nCERTAIN TAX CONSIDERATIONS\nThe following is a summary of the principal tax consequences to the Trust Unit holders resulting from the ownership and disposition of Trust Units. The laws or regulations affecting these matters are subject to change by future legislation or regulations or new interpretations by the IRS, state taxing authorities or the courts, which could adversely affect Trust Unit holders. In addition, there may be differences of opinion as to the applicability or interpretation of present tax laws or regulations. BP and the Trust have not requested from the IRS any rulings on the tax treatment described below, and no assurance can be given that such tax treatment will be available.\nTaxpayers are urged to consult their tax advisors on the application of the following discussion to their specific circumstances.\nEMPLOYEES\nThe Trust has no employees. Administrative functions of the Trust are performed by the Trustee.\nFEDERAL INCOME TAX\nCLASSIFICATION OF THE TRUST\nThe Trust files its federal tax return as a \"grantor trust\" rather than as \"an association taxable as a corporation.\" If the Trust were determined to be an association taxable as a corporation, it would be treated as an entity taxable as a corporation on the taxable income from the Royalty Interest, the Trust Unit holders would be treated as shareholders, and distributions to Trust Unit holders would not be deductible in computing the Trust's tax liability as an association. The following discussion is based on the legal conclusion that the Trust will be classified as a grantor trust under current law.\nTAXATION OF THE TRUST\nA grantor trust is not subject to tax, and its beneficiaries (the Trust Unit holders in the case of the Trust) are considered for tax purposes to own its income and corpus. A grantor trust files an information return reporting all items of income or deduction. The Trust, therefore, will pay no federal income tax, but will file an information return.\nTAXATION OF TRUST UNIT HOLDERS\nThe income of the Trust will be deemed to have been received or accrued by the Trust Unit holders at the time such income is received or accrued by the Trust and not when distributed by the Trust. Income will be recognized by a Trust Unit holder consistent with its method of accounting and without regard to the accounting period or method employed by the Trust.\nThe Trust will make quarterly distributions to Trust Unit holders of record on each Quarterly Record Date. See \"Description of the Trust Units and the Trust Agreement--Distributions of Income.\" The terms of the Trust Agreement as described above, seek to assure to the extent practicable that taxable income attributable to such distributions will be reported by the Trust Unit holder who receives such distributions, assuming that such holder is the owner of record on the Quarterly Record Date. In certain circumstances, however, a Trust Unit holder may be required to report taxable income attributable to its Trust Units, but the Trust Unit holder will not receive the distribution attributable to such income. For example, if the Trustee establishes a reserve or borrows money to satisfy debts and liabilities of the Trust income used to establish such reserve or to repay such loan must be reported by the Trust Unit holder, even though such income is not distributed to the Trust Unit holder.\nThe Trust intends to allocate income and deductions to Trust Unit holders based on record ownership at Quarterly Record Dates. It is unknown whether the IRS will accept such allocation or will require income and deductions of the Trust to be determined and allocated daily or require some method of daily proration, which could result in an increase in the administrative expenses of the Trust.\nIt is anticipated that each Trust Unit holder will be entitled to a deduction for cost depletion and certain other deductions for state and local taxes imposed upon the Trust or a Trust Unit holder and administrative expenses of the Trust. A Trust Unit holder's deduction for cost depletion in any year will be calculated by multiplying the holder's adjusted tax basis in the Trust Units (generally its cost less prior depletion deductions) by Royalty Production during the year and dividing that product by the sum of Royalty Production during the year and estimated remaining Royalty Production as of the end of the year. Trust Unit holders acquiring units on or after October 12, 1990 are possibly permitted to utilize percentage depletion with respect to such Units. Percentage depletion is based on the Trust Unit holders gross income from the Trust rather than on his adjusted basis in his Units. Any deduction for cost depletion or percentage depletion allowable to a Trust Unit holder will reduce its adjusted basis in its Trust Units for purposes of computing subsequent depletion or gain or loss on any subsequent disposition of Trust Units.\nEach Trust Unit holder must maintain records of its adjusted basis in the Trust Units, make adjustments for depletion deductions to such basis, and use such basis for the computation of gain or loss on the disposition of the Trust Units.\nTAXATION OF NONRESIDENT ALIEN INDIVIDUALS, PARTNERSHIPS AND FOREIGN CORPORATIONS\nGenerally, nonresident alien individuals, partnerships and foreign corporations (i.e., Foreign persons) are subject to a tax of 30 percent on gross income from sources within the U.S. that are not from a U.S. trade or business. Income from the Trust is considered income which is not effectively connected with a U.S. trade or business. As a result, Foreign persons would be subject to a 30 percent tax on their gross income from the Trust, without deductions. Usually such tax is to be withheld at the source of payment by the withholding agent. However, if there is a treaty in effect between the U.S. and the country of residence of the foreign person, such treaty may reduce the rate of withholding.\nA holder of Trust Units who is a Foreign person may make an election pursuant to Internal Revenue Code Section 871 (d) or 882(d), or pursuant to any similar provisions of applicable treaties, to treat the income (which constitutes income from real property) from the Trust as income which is effectively connected with a U.S. trade or business. If this election is made such a holder of Trust Units will not be subject of withholding but\nwill, however, be taxed on such income in the same manner as a U.S. person (i.e. U.S. individual, partnership or corporation). As a result, such holder of Trust Units will be taxed on his net income as opposed to his gross income from the Trust. Also, under such an election, any gain or loss upon the disposition of a Trust Unit will be deemed to be connected with a U.S. trade or business and taxed in the manner described above. If a Foreign person owns a greater than 5 percent interest in the Trust, that interest is a U.S. real property interest as provided under Internal Revenue Code Section 897. Gain on disposition of that interest will be taxed as if the holder of Trust Units were a U.S. person. In addition, Foreign persons subject to Internal Revenue Code Section 897 who are nonresident alien individuals will be subject to a minimum tax of 26 percent or 28 percent (depending on filing status and taxable income) on the lesser of:\n1. the individual's alternative minimum taxable income for the taxable year, or\n2. the net gain from the disposal of the Trust Unit.\nGain or loss on the disposition is determined by subtracting the adjusted basis of the Trust Units from the proceeds received. If the Foreign person is a corporation which made an election under Internal Revenue Code Section 882(d), the corporation would also be subject to a 30 percent tax under Internal Revenue Code Section 884. This tax is imposed on U.S. branch profits of a foreign corporation that are not reinvested in the U.S. trade or business. This tax is in addition to the tax on effectively connected income. The branch profits tax may be either reduced or eliminated by treaty.\nSALE OF TRUST UNITS\nGenerally, a Trust Unit holder will realize gain or loss on the sale or exchange of his Trust Units measured by the difference between the amount realized on the sale or exchange and his adjusted basis for such Trust Units. Gain on the sale of Trust Units by a holder that is not a dealer with respect to such Trust Units will be treated as ordinary income to the extent of any depletion deductions taken by such holder and the balance, if any, of the gain will be treated as capital gain.\nBACKUP WITHHOLDING\nA payor must withhold 31 percent of any reportable payment if the payee fails to furnish his taxpayer identification number (\"TIN\") to the payor in the required manner or if the Secretary of the Treasury notifies the payor that the TIN furnished by the payee is incorrect. A Unit holder will avoid backup withholding by furnishing his correct TIN to the Trustee in the form required by law.\nREPORTS\nThe Trustee will furnish the Trust Unit holders of record quarterly and annual reports described above under \"Description of the Trust Units and the Trust Agreement-Reports to Holders of Trust Units\" in order to permit computation of tax liability by the Trust Unit holders.\nSTATE INCOME TAXES\nUnit holders may be required to report their share of income from the Trust to their state of residence or commercial domicile. However, only corporate Unit holders will need to report their share of income to the State of Alaska does not impose an income tax on individuals or estates and trusts. Corporate Unit holders should be advised that all Trust income is Alaska source income and should be reported accordingly.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nReference is made to \"Item I.- Business\" for the information required by this item.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot applicable.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF UNIT HOLDERS\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR TRUST UNITS\nThe Trust Units are listed on the New York Stock Exchange (\"NYSE\"). The following table represents the high and low per unit sales prices for the Trust Units as reported on the consolidated tape for 1993 and 1994 and the distributions paid by the Trust for the periods presented.\nAs of March 21, 1995, there were 1,708 registered holders of Trust Units.\nFuture payments of cash distributions are dependent on such factors as the prevailing WTI Price, the relationship of the rate of change in the WTI Price to the rate of change in the Consumer Price Index, the Chargeable Costs, the rates of Production Taxes prevailing from time to time, and the actual production from the PBU.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nReference is made to \"Item 1. - Report of Miller and Lents, Ltd., Independent Petroleum Consultants\" of this Annual Report on Form 10-K.\nThe following table presents in summary form selected financial information regarding the Trust.\nBP PRUDHOE BAY ROYALTY TRUST Statements of Cash Earnings and Distributions For each of the years in the five-year period ended December 31, 1994, 1993, 1992, 1991 and 1990 and for the period of February 28, 1989 (date of formation) to December 31, 1989 (In thousands, except unit data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION\nThe Trust is a passive entity with the Trustee having only such powers as are necessary for the collection and distribution of revenues from the Royalty Interest, the payment of Trust liabilities and expenses and the protection of the Royalty Interest. All royalty payments received by the Trustee are distributed, net of Trust expenses, to Trust Unit holders. Accordingly, a discussion of liquidity or capital resources is not applicable.\nRESULTS OF OPERATIONS\nPayments to the Trust with respect to the Royalty Interest are generally payable on the fifteenth day after the end of the calendar quarter (or the next succeeding business day if such fifteenth day is not a business day) in an amount equal to the per barrel WTI Price for each day during the calendar quarter less the sum of (i) the product of the per barrel Chargeable Costs and the Cost Adjustment Factor (such product hereinafter referred to as \"Adjusted Chargeable Costs\") and (ii) the per barrel Production Taxes, multiplied by the Royalty Production.\nACTUAL RESULTS\nDuring 1994 the Trust received payments with respect to the Royalty Interest in the aggregate amount of $32,401,000 and made distributions to Unit holders in the aggregate amount of $31,743,000. The payment with respect to the Royalty Interest for the calendar quarter ended December 31, 1994, which was paid to the Trust on January 17, 1995, was $8,478,000. The following table sets forth with respect to each calendar quarter the average WTI price, the per barrel Chargeable Costs, the Cost Adjustment Factor, the per barrel Adjusted Chargeable Costs, the per barrel Production Taxes, and the Per Barrel Royalty.\nCALENDAR YEARS 1994, 1993, AND 1992\n(All Figures after rounding)\nAs discussed above in Part I \"Industry Conditions\" the production of oil and gas in Alaska is affected by many state and federal regulations. Existing and future legislation and regulations could result in the Company's experiencing delays and uncertainties, although the ultimate impact cannot generally be predicted. Per barrel royalty payments will also remain subject to oil prices, to the WTI Price, to Chargeable Costs, which increase in accordance with the schedule contained above under \"Description of the Royalty Interest-Chargeable Costs\", to the Cost Adjustment Factor, which is based on CPI, and to Production Taxes, which increased in accordance with the discussion above under \"Production Taxes\".\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nBP PRUDHOE BAY ROYALTY TRUST\nINDEPENDENT AUDITORS' REPORT\nTrustee and Holders of Trust Units of BP Prudhoe Bay Royalty Trust:\nWe have audited the accompanying statements of assets, liabilities and Trust Corpus of BP Prudhoe Bay Royalty Trust as of December 31, 1994 and 1993, and the related statements of cash earnings and distributions and changes in Trust Corpus for each of the years in the three-year period ended December 31, 1994. These financial statements are the responsibility of the Trustee. 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 Trustee, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs described in note 2 to the financial statements, these financial statements have been prepared on a modified basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities and Trust Corpus of BP Prudhoe Bay Royalty Trust as of December 31, 1994 and 1993, and its cash earnings and distributions and its changes in Trust Corpus for each of the years in the three-year period ended December 31, 1994, on the basis of accounting described in note 2.\nKPMG Peat Marwick LLP\nNew York, New York March 22, 1995\nBP PRUDHOE BAY ROYALTY TRUST\nStatements of Assets, Liabilities and Trust Corpus\nDecember 31, 1994 and 1993 (In thousands, except unit data)\nSee accompanying notes to financial statements.\nBP PRUDHOE BAY ROYALTY TRUST\nStatements of Cash Earnings and Distributions\nFor the Years Ended December 31, 1994, 1993 and 1992 (In thousands, except unit data)\nSee accompanying notes to financial statements.\nBP PRUDHOE BAY ROYALTY TRUST\nStatements of Changes in Trust Corpus\nFor the Years Ended December 31, 1994, 1993 and 1992 (In thousands)\nSee accompanying notes to financial statements.\nBP PRUDHOE BAY ROYALTY TRUST\nNotes to Financial Statements\nDecember 31, 1994, 1993 and 1992\n(1) FORMATION OF THE TRUST AND ORGANIZATION\nBP Prudhoe Bay Royalty Trust (the \"Trust\") was formed pursuant to a Trust Agreement dated February 28, 1989 among The Standard Oil Company (\"Standard Oil\"), BP Exploration (Alaska) Inc. (the \"Company\"), The Bank of New York and a co-trustee (collectively, the \"Trustee\"). Standard Oil and the Company are indirect wholly owned subsidiaries of the British Petroleum Company p.l.c. (\"BP\").\nOn February 28, 1989, Standard Oil conveyed an overriding royalty interest (the \"Royalty Interest\") to the Trust. The Trust was formed for the sole purpose of owning and administering the Royalty Interest. The Royalty Interest represents the right to receive, effective February 28, 1989, a per barrel royalty (the \"Per Barrel Royalty\") on 16.4246% of the lesser of (a) the first 90,000 barrels of the average actual daily net production of oil and condensate per quarter or (b) the average actual daily net production of oil and condensate per quarter from the Company's working interest in the Prudhoe Bay Field (the \"Field\") located on the North Slope of Alaska. Trust Unit holders will remain subject at all times to the risk that production will be interrupted or discontinued or fall, on average, below 90,000 barrels per day in any quarter. BP has guaranteed the performance by the Company of its payment obligations with respect to the Royalty Interest.\nThe co-trustees of the Trust are The Bank of New York, a New York corporation authorized to do a banking business, and The Bank of New York (Delaware), a Delaware banking corporation. The Bank of New York (Delaware) serves as co-trustee in order to satisfy certain requirements of the Delaware Trust Act. The Bank of New York alone is able to exercise the rights and powers granted to the Trustee in the Trust Agreement.\nThe Per Barrel Royalty in effect for any day is equal to the price of West Texas Intermediate crude oil (the \"WTI Price\") for that day less scheduled Chargeable Costs (adjusted in certain situations for inflation) and Production Taxes (based on statutory rates then in existence). During the period from February 28, 1989 (date of formation) to September 30, 1991, the Royalty Interest provided for a minimum royalty in certain situations. For years subsequent to 1995, Chargeable Costs will be reduced up to a maximum amount of $1.20 per barrel in each year if additions to the Field's proved reserved from January 1, 1988 do not meet certain specific levels.\nThe Trust is passive, with the Trustee having only such powers as are necessary for the collection and distribution of revenues, the payment of Trust liabilities and the protection of the Royalty Interest. The Trustee, subject to certain conditions, is obligated to establish cash reserves and borrow funds to pay liabilities of the Trust when they become due. The Trustee may sell Trust properties only (a) as authorized by a vote of the Trust Unit holders, (b) when necessary to provide for the payment of specific liabilities of the Trust then due (subject to certain conditions) or (c) upon termination of the Trust. Each Trust Unit issued and outstanding represents an equal undivided share of beneficial interest in the Trust. Royalty payments are received by the Trust and distributed to Trust Unit holders, net of Trust expenses, in the month succeeding the end of each calendar quarter. The Trust will terminate upon the first to occur of the following events:\n(a) On or prior to December 31, 2010: upon a vote of Trust Unit holders of not less than 70% of the outstanding Trust Units.\n(b) After December 31, 2010: (i) upon a vote of Trust Unit holders of not less than 60% of the outstanding Trust Units, or (ii) at such time the net revenues from the Royalty Interest for two successive years commencing after 2010 are less than $1,000,000 per year (unless the net revenues during such period are materially and adversely affected by certain events).\n(Continued)\nBP PRUDHOE BAY ROYALTY TRUST\nNotes to Financial Statements\n(2) BASIS OF ACCOUNTING\nThe financial statements of the Trust are prepared on a modified cash basis and reflect the Trust's assets, liabilities and Trust Corpus and the earnings and distributions as follows:\n(a) Revenues are recorded when received (generally within 15 days of the end of the preceding quarter) and distributions to Trust Unit holders are recorded when paid.\n(b) Trust expenses (which include accounting, engineering, legal, and other professional fees, trustees' fees and out-of-pocket expenses) are recorded when incurred.\n(c) Amortization of the Royalty Interest is calculated based on the units of production attributable to the Trust over the production of estimated proved reserves attributable to the Trust at the beginning of the fiscal year (approximately 43,193,000, 94,306,000 and 98,141,000 barrels were used to calculate the amortization of the Royalty Interest for the years ended December 31, 1994, 1993 and 1992, respectively), is charged directly to the Trust Corpus, and does not affect cash earnings. The rate for amortization per net equivalent barrel of oil was $12.39, $5.67 and $5.45 for the years ended December 31, 1994, 1993 and 1992, respectively. The remaining unamortized balance of the net overriding Royalty Interest at December 31, 1994 is not necessarily indicative of the fair market value of the interest held by the Trust.\nWhile these statements differ from financial statements prepared in accordance with generally accepted accounting principles, the cash basis of reporting revenues and distributions is considered to be the most meaningful because quarterly distributions to the Unit holders are based on net cash receipts\nThe conveyance of the Royalty Interest by Standard Oil to the Trust was accounted for as a purchase transaction. On February 28, 1989, Standard Oil sold 13,360,000 Trust Units to a group of institutional investors for $334 million in a private placement. For financial reporting purposes, the Trust's management valued the remaining Trust Units owned by Standard Oil (8,040,000 units) at a per unit value equivalent to the amount paid by the investors in the private placement.\n(3) INCOME TAXES\nThe Trust files its federal tax return as a grantor trust subject to the provisions of subpart E of Part I of Subchapter J of the Internal Revenue Code of 1986, as amended, rather than as an association taxable as a corporation. The Unit holders are treated as the owners of Trust income and Corpus, and the entire taxable income of the Trust will be reported by the Unit holders on their respective tax returns.\nIf the Trust were determined to be an association taxable as a corporation, it would be treated as an entity taxable as a corporation on the taxable income from the Royalty Interest, the Trust Unit holders would be treated as shareholders, and distributions to Trust Unit holders would not be deductible in computing the Trust's tax liability as an association.\n(Continued)\nBP PRUDHOE BAY ROYALTY TRUST\nNotes to Financial Statements\n(4) SUMMARY OF QUARTERLY RESULTS (UNAUDITED)\nA summary of selected quarterly financial information for the years ended December 31, 1994 and 1993 is as follows (in thousands, except unit data):\n(5) SUPPLEMENTAL RESERVE INFORMATION AND STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOW RELATING TO PROVED RESERVES (UNAUDITED)\nPursuant to Statement of Financial Accounting Standards No. 69 - \"Disclosures About Oil and Gas Producing Activities\" (\"FASB 69\"), the Trust is required to include in its financial statements supplementary information regarding estimates of quantities of proved reserves attributable to the Trust and future net cash flows.\nEstimates of proved reserves are inherently imprecise and subjective and are revised over time as additional data becomes available. Such revisions may often be substantial. Information regarding estimates of proved reserves attributable to the combined interests of the Company and the Trust were based on Company-prepared reserve estimates. The Company's reserve estimates are believed to be reasonable and consistent with presently known physical data concerning the size and character of the Field.\nThere is no precise method of allocating estimates of physical quantities of reserve volumes between the Company and the Trust, since the Royalty Interest is not a working interest and the Trust does not own and is not entitled to receive any specific volume of reserves from the Field. Reserve volumes attributable to the Trust were estimated by allocating to the Trust its share of estimated future production from the Field, based on the WTI Price on December 31, 1994 ($17.75 per barrel), December 31, 1993 ($14.15 per barrel) and December 31, 1992 ($19.50 per barrel). Because the reserve volumes attributable to the Trust are estimated using an allocation of reserve volumes based on estimated future production and on the current WTI Price, a change in the timing of estimated production or a change in the WTI price will result in a change in the Trust's estimated reserve volumes. Therefore, the estimated reserve volumes attributable to the Trust will vary if different production estimates and prices are used.\n(Continued)\nBP PRUDHOE BAY ROYALTY TRUST\nNotes to Financial Statements\n(5), Continued\nIn addition to production estimates and prices, reserve volumes attributable to the Trust are affected by the amount of Chargeable Costs that will be deducted in determining the Per Barrel Royalty. The Royalty Interest includes a provision under which, in years subsequent to 1995, if additions to the Field's proved reserves from January 1, 1988 do not meet certain specified levels, Chargeable Costs will be reduced up to a maximum amount of $1.20 per barrel in each year. Under the provisions of FASB 69, no consideration can be given to reserves not considered proved at the present time. Accordingly, in estimating the reserve volumes attributable to the Trust, Chargeable Costs were reduced by the maximum amount in years subsequent to 1995, after considering the amount of reserves that have been added to the Field's proved reserves from January 1, 1988.\nNet proved reserves of oil and condensate attributable to the Trust as of December 31, 1994, 1993 and 1992 based on the Company's latest reserve estimate at such time, the WTI Prices on December 31, 1994, 1993 and 1992 and a reduction in Chargeable Costs in years subsequent to 1995, were estimated to be 81, 43 and 94 million barrels, respectively (of which 81, 43 and 79 million barrels, respectively, are proved developed).\nThe standardized measure of discounted future net cash flow relating to proved reserves disclosure required by FASB 69 assigns monetary amounts to proved reserves based on current prices. This discounted future net cash flow should not be construed as the current market value of the Royalty Interest. A market valuation determination would include, among other things, anticipated price increases and the value of additional reserves not considered proved at the present time or reserves that may be produced after the currently anticipated end of field life. At December 31, 1994, 1993 and 1992 the standardized measure of discounted future net cash flow relating to proved reserves attributable to the Trust (estimated in accordance with the provisions of FASB 69), based on the WTI Prices on those dates of $17.75, $14.15 and $19.50, respectively, were as follows (in thousands):\n(a) The standardized measure of discounted future net cash flow relating to proved reserves, estimated without reducing Chargeable Costs in years subsequent to 1995, would be $154,200, $65,174 and $228,566 at December 31, 1994, 1993 and 1992, respectively.\n(Continued)\nBP PRUDHOE BAY ROYALTY TRUST\nNotes to Financial Statements\n(5), Continued\nThe following are the principal sources of the change in the standardized measure of discounted future net cash flows (in thousands):\n(b) Royalty income received for 1994, 1993 and 1992 includes the royalty applicable to the period October 1, 1994 through December 31, 1994 ($8,478), October 1, 1993 through December 31, 1993 ($9,172) and October 1, 1992 through December 31, 1992 ($15,209), which was received by the Trust in January 1995, 1994 and 1993, respectively.\nThe changes in quantities of proved oil and condensate were as follows (thousands of barrels):\nITEM 9.","section_9":"ITEM 9. CHANGES IN ACCOUNTANTS\nThe Trust dismissed Ernst & Whinney as its independent accountants on June 15, 1989 and, as of the same date, engaged KPMG Peat Marwick (now KPMG Peat Marwick LLP) as independent accountants.\nA Form Registration Statement (Registration No. 33-27923) filed by BP, the Company, and Standard Oil contained a single financial statement of the Trust audited by Ernst & Whinney, namely, a Statement of Assets and Trust corpus as of February 28,1989. The report of Ernst & Whinney on the Statement of Assets and Trust corpus contained in Registration Statement No. 33-27923 did not contain an adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles. During the period from February 28, 1989 through June 15, 1989 there were no disagreements with Ernst & Whinney on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to the satisfaction of Ernst & Whinney would have caused them to make reference thereto in their report on the Statement of Assets and Trust corpus as of February 28, 1989. During the period from February 28, 1989 through June 15, 1989, there were no reportable events (as defined in Regulation S-K Item 304(a)(1)(v)) with Ernst & Whinney. Ernst & Whinney has furnished the Trust with a copy of a letter addressed to the Securities and Exchange Commission stating that it agreed with the above statements.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS\nThe Trust has no directors or executive officers. The Trustee has only such rights and powers as are necessary to achieve the purposes of the Trust.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNot applicable.\nITEM 12.","section_12":"ITEM 12. UNIT OWNERSHIP\n(a) Unit Ownership of Certain Beneficial Owners.\nAs of March 21, 1995 the Trustee does not know of any person beneficially owning 5% or more of the Trust Units except based on filings with the Securities and Exchange Commission dated as of December 31, 1994, which filings set forth the following:\n(1) Amount known to be Units with respect to which beneficial owner has the right to acquire beneficial ownership: None.\n(b) Unit Ownerships of Management\nNeither the Company, Standard Oil, nor BP owns any Units. Neither The Bank of New York, as Trustee, or in its individual capacity, nor The Bank of New York (Delaware), as co-trustee, or in its individual capacity, owns any Units.\n(c) Change in Control\nThe Trustee knows of no arrangement, including the pledge of Units, the operation of which may at a subsequent date result in a change in control of the Trust.\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) FINANCIAL STATEMENTS\nThe following financial statements of the Trust are included in Part II, Item 8:\n(b) FINANCIAL STATEMENT SCHEDULES\nAll financial statement schedules have been omitted because they are either not applicable, not required or the information is set forth in the financial statements or notes thereto.\n(c) EXHIBITS\nALL OTHER EXHIBITS HAVE BEEN OMITTED BECAUSE THEY ARE EITHER NOT APPLICABLE OR NOT REQUIRED.\n(d) REPORTS ON FORM 8-K\nNo reports on Form 8-K were filed with the Securities and Exchange Commission by the Trust during the quarter ending in December 31, 1994.\nSIGNATURE\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.\nBP PRUDHOE BAY ROYALTY TRUST\nTHE BANK OF NEW YORK, as Trustee\nBy: \/s\/ Walter Gitlin --------------------------------------- Walter Gitlin Vice President\nMarch 29, 1995\nThe Registrant, BP Prudhoe Bay Royalty Trust, has no principal executive officer, principal financial officer, board of directors or persons performing similar functions. Accordingly, no additional signatures are available and none have been provided.\nEXHIBIT INDEX -------------","section_15":""}
{"filename":"93444_1994.txt","cik":"93444","year":"1994","section_1":"ITEM 1. BUSINESS (Thousands of dollars)\nSPS Technologies, Inc. and subsidiaries (the Company) was incorporated in Pennsylvania in 1903. The Company is engaged in the design, manufacture and marketing of high-strength precision mechanical fasteners and precision components (fasteners); and superalloys in ingot form and magnetic materials (materials).\nIn 1994, the Company completed programs that reduced the Company's cost structure and improved its operating performance. The Company completed a 10 percent reduction in its non-direct workforce, which included significant reductions in corporate and executive staff. In addition, the Company relocated its corporate offices to a smaller leased facility and sold its corporate headquarters in Newtown, Pennsylvania and the Company aircraft. The Company also exited certain historically unprofitable product lines of its fastener segment. Additional information regarding the restructuring plan is provided in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and in Note 3 to the Company's Consolidated Financial Statements on pages 11 and 12 in the 1994 Annual Report to Shareholders and is incorporated herein by reference.\nThe Company is multinational in operation. In addition to nine manufacturing plants in the United States, it operates six manufacturing facilities in three different countries: the United Kingdom, Ireland and Australia. The Company also has a 50 percent interest in a manufacturing operation in Adelanto, California, and has minority interests in manufacturing operations in Brazil and India. Marketing operations are carried on by subsidiaries and an affiliate in five other countries.\nThe Company sells directly to original equipment manufacturers and industrial, commercial and governmental users, and also sells through independent stocking distributors and dealers. There were no changes in these methods of distribution during 1994.\nPrincipal fastener markets include aerospace, machine tool and industrial machinery, automotive, and off-highway equipment. Principal markets for materials include the precision investment casting, powdered metal, aerospace, medical equipment, automotive, computer and communications industries.\nPrincipal fastener products are SPS(Registered Trademark) aerospace fasteners, MULTIPHASE(Registered Trademark) alloy fasteners, and other aerospace fasteners; UNBRAKO(Registered Trademark) brand socket screws, hex keys, dowel pins, shaft collars, spring pins and pressure plugs; engineered fasteners for gasoline and diesel engines, other critical automotive applications, and off-highway equipment and HI-LIFE(Registered Trademark) thread roll dies and other metal-working tools.\nPrincipal materials products are air and vacuum-melted iron, cobalt, and nickel-based superalloys, including CMSX(Registered Trademark) single-crystal alloys; and metallic and ceramic permanent magnets, wound and pressed powder magnetic components, and magnetic ultra-thin foil and strip products.\nThe Company's business is highly competitive. Competition is based primarily on technology, price, service, product quality and performance. The Company believes that its favorable competitive position is based upon its high-quality product performance and service to its customers, supported by its commitment to research and development which has yielded proprietary products to the extent indicated below.\nNo material part of the Company's business is dependent upon a single customer. In 1994, the five largest customers accounted for 20% of the Company's reported consolidated sales.\nThe backlog of orders at December 31 was as follows:\n1994 1993 ---- ---- Fastener segment $72,983 $72,389 Materials segment 25,467 16,584 ---------- ---------- Total .......... $98,450 $88,973 ========== ==========\nNo material portion of the Company's business in either segment is seasonal.\nThe principal sources of raw materials for the fastener and materials segments include major and specialty steel producers, and non-ferrous metal producers, converters and distributors. The Company anticipates it will have no significant problem with respect to sources or availability of the raw materials essential to the conduct of its business.\nThe Company considers its proprietary position important to the two segments of its business. During 1994, approximately 30% of Company sales were related to patents and licenses held, and manufacturing know-how. Generally, the patents and licenses of the Company expire at various times over the next 17 years.\nTotal expenditures during 1994, 1993 and 1992 for Company-sponsored research and development were $4,727, $5,050, and $6,604 respectively. In 1994, approximately 65% of the expenditures were for the Company's fastener segment.\nCapital expenditures for property, plant and equipment are planned at $20.6 million in 1995, exclusive of any business acquisition.\nThere were approximately 2,933 and 640 persons employed by the Company at December 31, 1994 in the fastener and materials segments, respectively.\nFor financial information concerning industry segments and the foreign and domestic operations, see Note 19 to the Company's Consolidated Financial Statements on pages 21 and 22 in the 1994 Annual Report to Shareholders, which is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns or leases the manufacturing properties described below. All properties are in good condition.\nLOCATION\nOwned Square Feet ------- -------------- Jenkintown, Pennsylvania 683,000(a) Cleveland, Ohio ......... 413,000(a) Santa Ana, California ... 305,000(a)(g) Salt Lake City, Utah .... 86,000(a) Marengo, Illinois ....... 442,000(b) Muskegon, Michigan ...... 110,000(b) Norfolk, Nebraska ....... 103,000(b) Sevierville, Tennessee .. 65,000(b) Ogallala, Nebraska ...... 26,000(b) Anasco, Puerto Rico ..... 129,000(a)(h) Coventry, England ....... 240,000(a) Birmingham, England ..... 137,000(a) Leicester, England ...... 88,000(a) Melbourne, Australia .... 44,000(a)\nLeased Lease Expires Square Feet -------- -------------- ------------ Leicester, England (c) 38,000(a) Shannon, Ireland (d)(e)(f) 233,000(a)\n-------------------- (a) Fastener segment (b) Materials segment (c) Lease for 38,000 square feet expires January 12, 1997. (d) Lease for 54,000 square feet expires April 1, 1996. (e) Lease for 75,000 square feet expires November 15, 2010. (f) Lease for 104,000 square feet expires November 13, 2010. (g) Approximately 70,000 square feet used for manufacturing purposes, with the remaining 235,000 square feet held for lease. (h) Closed and held for sale.\nIndustrial Development Revenue Bonds were issued to finance the acquisition and improvement of the Salt Lake City, Utah, facility. These bonds are collateralized by a first mortgage on this facility and a bank letter of credit.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFor discussion of legal proceedings, see Note 11 to the Company's Consolidated Financial Statements on pages 14 and 15 in the 1994 Annual Report to Shareholders 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 security holders during the fourth quarter of 1994, through the solicitations of proxies or otherwise.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nAll executive officers of the Company are named below and are appointed by the Board of Directors. The date that each officer was first appointed to his present position is indicated. No officer listed was appointed as a result of any arrangement between him and any other person as that phrase is understood under the Securities Exchange Act regulations. No family relationship exists among the executive officers of the Company.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nInformation regarding the principal markets on which SPS Technologies common stock is traded, the high and low sales price for the stock on the New York Stock Exchange for each quarterly period during the past 2 years, the quarterly cash dividends declared by SPS Technologies with respect to its common stock during the past 2 years, and the approximate number of holders of common stock at March 6, 1995 is included under the caption entitled \"Common Stock Information\" on page 23 in the 1994 Annual Report to Shareholders and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nA summary of selected financial data for SPS Technologies for the years and year ends specified is included under the caption entitled \"Selected Financial Data\" on page 23 in the 1994 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\nInformation regarding SPS Technologies financial condition, changes in financial condition and results of operations is included under the caption entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 24 through 29 in the 1994 Annual Report to Shareholders and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated Financial Statements for SPS Technologies included on pages 6 through 22 in the 1994 Annual Report to Shareholders, together with required supplementary data \"Summary of Quarterly Results\" on page 23 in the 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\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(a) Identification of directors:\nInformation regarding directors is incorporated by reference to the Definitive Proxy Statement, Election of Directors, if filed with the Securities and Exchange Commission (SEC) within 120 days after December 31, 1994. To the extent not so filed, such information will be provided on a Form 10-K\/A filed with the SEC.\n(b) Identification of executive officers:\nInformation regarding executive officers is contained in Part I of this report (page 4).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding executive compensation is incorporated by reference to the Definitive Proxy Statement, Executive Compensation and Board Meetings, Committees and Compensation, if filed with the SEC within 120 days after December 31, 1994. To the extent not so filed, such information will be provided on a Form 10-K\/A filed with the SEC.\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 by reference to the Definitive Proxy Statement, Ownership of Voting Securities, if filed with the SEC within 120 days after December 31, 1994. To the extent not so filed, such information will be provided on a Form 10-K\/A filed with the SEC.\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 part of this Report:\n1. The Consolidated Financial Statements and related notes to consolidated financial statements set forth on pages 6 through 22 of the 1994 Annual Report to Shareholders are incorporated by reference (See Exhibit 13). The Report of Independent Accountants, which covers both the Consolidated Financial Statements and the financial statement schedule, appears on page 9 of this report.\n2. Financial Statement Schedules:\nThe following supplemental schedule is located in this Report on the page indicated.\nPage ---- VIII Valuation and Qualifying Accounts 10\nSchedules other than those listed above are omitted for the reason that they are either not applicable or not required or because the information required is contained in the financial statements or notes thereto.\n3. Exhibits:\n3a Amended and Restated Articles of Incorporation. Exhibit 3a to the Annual Report on Form 10-K for the year ended December 31, 1990, is hereby incorporated by reference.\n3b By-Laws as amended, effective April 29, 1993. Exhibit 3 to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1993, is hereby incorporated by reference.\n4a Rights Agreement dated November 11, 1988, is incorporated by reference to Form 8-K filed November 17, 1988. Amendment No. 1 to Rights Agreement dated January 22, 1991, is incorporated by reference to Form 8-K filed January 25, 1991. Form of Amendment No. 2 to Rights Agreement dated November 16, 1994, is incorporated by reference to Exhibit 4.8 of Form S-3 filed August 26, 1994.\n4b Form of Registration Rights Agreement between the Company, the Purchasers and the Investors dated December 23, 1994. Exhibit 4.5 to the Form S-3 filed August 26, 1994, is hereby incorporated by reference.\n10a SPS 1988 Long Term Incentive Stock Plan as amended, effective February 2, 1989. Exhibit 10a to the Annual Report on Form 10-K for the year ended December 31, 1988, is hereby incorporated by reference.\n10b SPS Exempt Employees Savings and Investment Plan as Amended and Restated, effective November, 1991. Exhibit 10b to the Annual Report on Form 10-K for the year ended December 31, 1991, is hereby incorporated by reference.\n10c SPS Technologies, Inc. Non-Exempt Employees Savings and Investment Plan as Amended and Restated, effective November, 1991. Exhibit 10c to the Annual Report on Form 10-K for the year ended December 31, 1991, is hereby incorporated by reference.\n10d SPS Technologies, Inc. Management Incentive Plan as Amended and Restated, effective April 26, 1994.\n10e Form of standby Purchase Agreement dated November 16, 1994. Exhibit 10.1 to the Form S-3\/A filed November 17, 1994, is hereby incorporated by reference.\n10f Retirement Benefit Agreement, dated February 28, 1979. Exhibit 10f to the Annual Report on Form 10-K for the year ended December 31, 1991, is hereby incorporated by reference.\n10g Fee Arrangement with Former Directors, effective November 29, 1984. Exhibit 10g to the Annual Report on Form 10-K for the year ended December 31, 1990, is hereby incorporated by reference.\n10h Form of Employment Agreements between SPS Technologies, Inc. and certain employees, as amended and restated effective December 14, 1992. Exhibit 10h to the Annual Report on Form 10-K for the year ended December 31, 1992, is hereby incorporated by reference.\n10i SPS Technologies, Inc. Executive Deferred Compensation Plan, as amended and restated, effective December 14, 1992. Exhibit 10i to the Annual Report on Form 10-K for the year ended December 31, 1992, is hereby incorporated by reference.\n10j SPS Technologies, Inc. Executive Deferred Compensation Plan II, as amended and restated effective December 1, 1993. Exhibit 10j to the Annual Report on Form 10-K for the year ended December 31, 1993, is hereby incorporated by reference.\n10k SPS Technologies, Inc. Supplemental Executive Retirement Plan, as amended and restated effective December 14, 1992. Exhibit 10k to the Annual Report on Form 10-K for the year ended December 31, 1992, is hereby incorporated by reference.\n10l Employment Agreement between SPS Technologies, Inc. and Charles W. Grigg, Chairman and Chief Executive Officer, effective December 1, 1993. Exhibit 10l to the Annual Report on Form 10-K for the period ended December 31, 1993, is hereby incorporated by reference.\n10m Form of Indemnification Agreements between SPS Technologies, Inc. and officers and directors dated February 2, 1987. Exhibit 10m to the Annual Report on Form 10-K for the period ended December 31, 1992, is hereby incorporated by reference.\n10n Split Dollar Insurance Agreements regarding certain officers and directors effective April 2, 1990, and November 27, 1991. Exhibit 10n to the Annual Report on Form 10-K for the year ended December 31, 1991, is hereby incorporated by reference.\n10o SPS Technologies, Inc. Senior Executive Severance Plan, effective December 14, 1992. Exhibit 10o to the Annual Report on Form 10-K for the year ended December 31, 1992, is hereby incorporated by reference.\n10p Agreement with Retiring Executive, approved December 14, 1992. Exhibit 10p to the Annual Report on Form 10-K for the year ended December 31, 1992, is hereby incorporated by reference.\n10q SPS Technologies, Inc. Benefit Equalization Plan, as amended and restated effective December 14, 1992. Exhibit 10 to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1993, is hereby incorporated by reference.\n11 Computation of dilution (anti-dilution) of earnings per share resulting from common stock equivalents.\n13 1994 Annual Report to Shareholders (With the exception of the information expressly incorporated by reference in items 1, 3, 5, 6, 7, 8 and 14 of Form 10-K, the 1994 Annual Report to Shareholders is not deemed \"filed\" with the SEC or otherwise subject to the liabilities of Section 18 of the Securities and Exchange Act of 1934).\n21 Subsidiaries of the Registrant.\n23 Consent of Independent Accountants.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K:\nNo Reports on Form 8-K were filed during the three months ended December 31, 1994.\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.\nSPS TECHNOLOGIES, INC. ---------------------------- (Registrant)\n\/s\/ William M. Shockley ---------------------------- William M. Shockley Controller\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.\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Shareholders and Board of Directors SPS Technologies, Inc.:\nWe have audited the consolidated financial statements of SPS Technologies, Inc. and subsidiaries as of December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994, which financial statements are included on pages 6 through 22 of the 1994 Annual Report to Shareholders of SPS Technologies, Inc. and subsidiaries and incorporated by reference herein. We have also audited the financial statement schedule as listed in Item 14(a)2 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 SPS Technologies, 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, present fairly, in all material respects, the information required to be included therein.\nAs discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for income taxes and postretirement benefits other than pensions in 1992.\nCOOPERS & LYBRAND L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania 19103 February 10, 1995\nSCHEDULE VIII\nSPS TECHNOLOGIES, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS\n(Thousands of dollars)\n------------ (a) Write off of uncollectible receivables, net of recoveries.\nEXHIBIT INDEX -------------","section_15":""}
{"filename":"78239_1994.txt","cik":"78239","year":"1994","section_1":"Item 1. Business\nGeneral Overview\nPhillips-Van Heusen Corporation (the \"Company\") is a vertically integrated manufacturer, marketer and retailer of men's and women's apparel and men's, women's and children's footwear. The Company's products include shirts, sweaters and shoes and, to a lesser extent, neckwear, furnishings, bottoms, outerwear and leather and canvas accessories. The Company's principal brand names are \"Van Heusen\", the best-selling dress shirt brand in the United States; \"Bass\", the leading casual shoe brand in the United States; and \"Geoffrey Beene\", the best-selling designer dress shirt label in the United States. The Company is also a leading manufacturer and distributor of private label shirts and sweaters.\nThe Company is primarily engaged in the manufacture and procurement (both domestically and overseas) of its products and the marketing and distribution of its products through four apparel divisions and one footwear division, each of which has both a wholesale and retail component. The Company's goals are to design, manufacture and source products which offer consumers \"value\", thus satisfying the consumers' desire for fashion, quality and fair prices, and to market those products to reach the broadest spectrum of consumers possible.\nWholesale distribution consists of the marketing and sale of the Company's products to major department stores, specialty and independent retailers, chain stores and catalog merchants, as well as its own retail stores. The Company's wholesale customers for branded and designer apparel include May Co., Federated, Dayton Hudson, JCPenney, Macy's, Younkers and Mercantile. Wholesale customers for its private label shirts include JCPenney, Bloomingdale's, Lord & Taylor, Lands' End, Sears and Target, while the wholesale customers of the Company's private label sweater and golf apparel division include Lands' End, JCPenney, May Co., L.L. Bean, Federated and Sears. G.H. Bass & Co. (\"Bass\"), the Company's footwear division, counts May Co., Dillard's, Federated, Macy's and Dayton Hudson as its principal wholesale customers. In fiscal 1993, no one customer accounted for more than 10% of the Company's sales.\nThrough its retail operations, the Company sells its products directly to consumers in 780 Company-owned stores operated in five different formats located primarily in manufacturers' outlet malls. The Company plans to open 101 stores in fiscal 1994 (net of store closings).\nThe Company believes that its recent success has been due in large part to its strategy of developing multiple channels of distribution for its branded, designer and private label merchandise. These channels include an increasing number of Company-owned outlet stores as well as the Company's traditional wholesale customers. These diverse channels have enabled the Company to strengthen the competitive position of its brands and to extend its brands into new product lines. In addition, the Company's outlet stores have created additional opportunities for the Company both to sell its products, thereby providing the Company with the means to achieve full absorption of factory overhead, which results in low-cost and efficient production, and to control the distribution of any excess production. The Company also believes that the continued development of its product design, manufacturing and sourcing organizations, enhancement and expansion of the use of its inventory management and electronic data interchange systems and refinement of its promotional and advertising activities will result in further strengthening of its brand images, decreased risks of excess production and more efficient utilization of its production facilities and outside suppliers.\nThe Company has experienced substantial growth in sales and earnings per share over the past seven years. The Company's growth has occurred despite a difficult business environment in the apparel and footwear industries as well as in the general economy. The Company's growth is attributable primarily to the acquisition of Bass in 1987 and the growth in the number of the Company's retail stores from 214 immediately after the acquisition of Bass to 780 at the end of fiscal 1993. Over the same period, the Company's \"Van Heusen\" shirt brand has increased its share of the United States men's dress shirt market from 7.0% to 10.5% according to research conducted by MRCA Information Services (\"MRCA\") based on unit sales. Including its branded, designer and private label offerings, the Company believes its overall share of the United States men's dress shirt market is the largest of any single company.\nThe Company was incorporated in the State of Delaware in 1976 as the successor to a business begun in 1881, and, with respect to Bass, a business begun in 1876. The Company's principal executive offices are located at 1290 Avenue of the Americas, New York, New York 10104; its telephone number is (212) 541-5200.\nRetail Development\nThe decision to develop and expand its own retail operations, concurrent with the growth of the manufacturers' outlet retailing industry, has permitted the Company to position itself as a major value-oriented retailer. The Company's retail operations have enabled it to increase sales by offering its products in geographic markets where they were not previously widely available, selling to consumers who favor value-oriented retailers and selling products bearing its brand names and designer labels that are not marketed to its traditional wholesale customers. As a consequence of these increased sales, the Company has improved its overall corporate profit margins and improved cash flow. In addition, by providing direct contact with the consumer, the Company's stores allow it better and more directly to monitor consumer trends and sales of its products and showcase or test market new products.\nCritical to the Company's vertically integrated strategy was the choice of manufacturers' (\"factory\") outlet centers as the venue to pursue its retailing business. Manufacturers' outlet centers, usually located in tourist\/vacation areas or on major highways to these areas, provide a large customer base with significant disposable income and a positive attitude toward shopping and a base of business in locations that limit conflict with the Company's traditional wholesale customers. The development of manufacturers' outlet centers is a key component to the success of the Company. The success of a new outlet mall is heavily dependent on its location and the attraction of a well known group of tenants and, therefore, the Company actively cooperates with developers in the site and tenant selection processes. The Company believes that as a result of its strong presence and success in manufacturers' outlet retailing, developers seek and welcome the Company's input into such processes.\nThe increased demand for the Company's products as a result of sales through Company-owned stores permits the Company to run its factories at higher levels of productivity, thereby lowering overall production costs and increasing the ability of the Company to provide continuous employment for its employees. The Company's stores also provide the opportunity to liquidate excess and out-of-date inventory and factory \"seconds\", thereby substantially reducing the need to sell such merchandise to discounters or jobbers at severely marked down prices. The ability to control the sale of such merchandise also prevents the damage to the image of the Company's brands which can result when they are sold by discounters with inferior presentation and advertising.\nThe Company has developed a retail component for each marketing division, which has enhanced the Company's ability to reach a broad array of consumers for its branded, designer and private label products. At the same time, it has allowed the Company to expand its brands to other compatible products not carried in its regular wholesale lines. The Company's success in expanding the types of products available under its brand names and designer labels has led to an increase in the product lines available in its store formats and has enabled the Company to offer in its stores additional products which are not available in the Company's traditional wholesale product lines. For example, the Company now offers men's and women's sportswear and accessories in 58 of its Bass stores. Also, the Company opened 14 stores offering Geoffrey Beene women's wear late in the summer of 1993. In addition, the Company plans to expand on its initial offering of a line of Bass Kids apparel merchandise in 1994.\nThe Company's retail formats are managed to allow each to enjoy its own focus without infringing on the other formats, thereby enabling all formats to co-exist in one outlet center. Thus, even though Van Heusen, Windsor Shirt and Geoffrey Beene stores each carry the same type of men's apparel products, each targets and markets to a different consumer base: Van Heusen - the American brand, moderate price and moderate fashion consumer; Windsor Shirt - the better traditional consumer; and Geoffrey Beene - the better fashion forward consumer. In addition, all aspects of each retail format - store design, presentation, sales personnel, packaging, product and price - reinforce the Company's focus on value-oriented retailing to that particular store format's target consumer.\nThe Company's retail stores show a high level of profitability resulting from low overhead and staffing costs, low rental and common area maintenance charges, short-term leases enabling exit from poorly performing stores, the elimination of accounts receivable carrying costs as all sales are for cash or on third party credit cards, high inventory turnover rates and low fixturing costs. Stores in each of the Company's formats are typically profitable within the year of opening. This is in contrast to traditional mall stores which typically undergo a significant start-up period before becoming profitable. Immediate cash flow generation is an important advantage of outlet mall stores over traditional mall stores, as is the ability to build and open stores in a comparatively short period of time.\nAcquisitions\nThe Company intends to pursue acquisitions which would enable it to offer quality brand name products which are marketable through both traditional retailers and outlet stores designed around the brand names. The Company believes that opportunities exist to acquire companies which produce products with distinctive images which, due to distribution or other problems, are not gaining full access to the target consumer. The Company further believes that it can improve the distribution of such products by marketing through a multi-channel distribution operation. The ability of the Company to acquire product lines which can be marketed through new outlet store formats and carry a recognized brand name which can be readily expanded into additional product lines would provide the Company with the opportunity to increase its presence in and its share of sales from outlet malls. While no such acquisition is immediately contemplated, the Company is continuously reviewing and considering possible acquisitions.\nWholesale Operations\nWhile much of the Company's focus has been on developing the retail aspect of its business, it has also placed significant emphasis on strengthening its wholesale distribution operations. The Company merged the manufacturing, warehousing, distribution, administrative and finance functions of its shirt divisions in 1985. In 1990, the Company merged the administrative and finance functions of its knitwear division with those of the shirt divisions. In 1992, the Company's Bass wholesale division was merged into this group to take advantage of the synergies between these businesses. The Company believes that this consolidation has achieved economies of scale and resulted in stronger operational support for each of the wholesale divisions, while allowing each division to retain its distinctive marketing identity.\nIn order to provide its customers with products covering a full range of price points and styles, the Company has designed new branded and designer dress shirts. For example, the Company developed the \"Editions\" sub-brand under the \"Van Heusen\" label to cover the price point just above typical private label shirts and created its \"Cezani\" line of designer shirts to fill the niche for an all-cotton, upper moderate priced, designer dress shirt. The Company also markets Bass dress shirts which are designed as a traditionally styled American line. In addition, the Company has strengthened its private label operations by increasing its design staff, developing additional private label offerings and focusing on high volume accounts. The Company believes that by expanding its product offerings, it enables its wholesale customers to market to consumers brand name, designer and private label dress shirts at various price points.\nIn 1993, the Company continued to expand usage of the PVH Pulse System. This quick response system uses an electronic data interchange system which provides a computer link between the Company and its wholesale customers that enables both the customer and the Company to track sales, inventory and shipments. Use of the system also reduces the amount of time it takes a customer to determine its inventory needs and order replenishment merchandise and for the Company to respond to the customer's order.\nThe Company believes that these efforts have helped strengthen its relationships with its traditional wholesale customers, at the same time as the Company has enhanced the image and increased the exposure of its products.\nDesign, Manufacturing and Sourcing\nIntegral to the success of the Company's growth strategy was the development of a dependable and flexible design, manufacturing and sourcing program. The Company formed PVH International (\"PVH-I\") to develop, design and administer the manufacture and distribution of its \"retail only\" apparel products. PVH-I's design and product development personnel are divided into groups, each group having responsibility for one of the Company's apparel store formats. This enables the PVH-I designers, working with the retail buyers, to develop products consistent with the image of their respective store formats. Sourcing operations are consolidated to provide for efficient use of the Company's resources and to achieve economies of scale. By bringing these services \"in-house\", the Company is able to realize certain cost savings and maintain control of the production of \"retail only\" products from conception through in-store delivery.\nOnce product design is complete, PVH-I sources the product and tracks it through state-of-the-art management information systems. These systems enable the Company to quickly respond to its customers' needs and monitor all other aspects of inventory management. In addition, PVH-I monitors production and the quality and timely distribution of the Company's products manufactured by outside suppliers.\nApparel Business\nThe marketing of the Company's apparel products is conducted through four separate divisions: Van Heusen; Designer; Private Label Dress and Sport Shirts; and Knitwear. Substantially all of the Company's apparel, including traditional wholesale products and the additional products available only in the Company's retail stores, is designed \"in-house.\" Approximately 35% of the wholesale apparel products are manufactured in the Company's facilities in the United States, Puerto Rico and the Caribbean Basin. The remaining products are sourced through contractors throughout the world, but primarily in the Far East.\nVan Heusen\nThe Van Heusen Company division markets branded apparel, consisting of men's traditional dress shirts and men's woven and knit sport shirts, in the moderate to better price range. Van Heusen markets its products at wholesale to major department stores and men's specialty stores nationwide, including May Co., Younkers, JCPenney and Mercantile.\n\"Van Heusen\" is the best-selling men's dress shirt brand in the United States, according to research conducted by MRCA based on unit sales. \"Van Heusen's\" share of the dress shirt market has risen through the years and has increased from 7.0% in 1987 to 10.5% in 1993. The growth in sales of \"Van Heusen\" shirts is the result of continued sales to traditional customers, the commencement of sales of \"Van Heusen\" branded shirts to JCPenney in June 1990 and the overall growth in the number of Van Heusen outlet stores. In addition to the \"Van Heusen\" label, branded products are marketed under the sub-brands \"417\", \"Hennessy\", \"Players\", \"Over Easy\", \"Corporate Casuals\", \"Winter- weights\" and \"Editions.\"\nVan Heusen outlet stores offer a full collection of first quality men's traditional, classic and contemporary dress furnishings (including dress shirts, belts, hosiery and neckwear), men's sportswear (including sports shirts, sweaters and bottoms) and ladies sportswear (including coordinates and separates) and men's and women's activewear. Other than men's dress shirts, sport shirts and sweaters, such apparel is not marketed or produced for sale to the Van Heusen division's wholesale customers.\nThe product mix targeted for Van Heusen stores is intended to satisfy the key apparel needs of men from dress furnishings to casual wear, and of women for casual wear. Van Heusen stores' merchandising strategy is focused on achieving a classic and\/or updated traditional look in a range of primarily moderate price points. Target customers represent the broadest spectrum of the American consumer.\nDesigner\nThe Designer Group division markets at wholesale men's designer label dress shirts in the upper moderate to better price range to major department stores and men's specialty stores nationwide, including Dayton Hudson, Federated, Macy's and May Co.\nThe Designer Group primarily manufactures its shirts under the \"Geoffrey Beene\" label through a licensing agreement with that designer, but also markets dress shirts under the \"Etienne Aigner\" label and dress shirts and neckwear under the Company-owned \"Cezani\" label. During 1993, this division began selling a line of \"Bass\" label dress shirts. \"Geoffrey Beene\" shirts are the best-selling men's designer dress shirts in the United States, according to MRCA research.\nThe Company opened its first Geoffrey Beene stores in November 1990 and has continuously expanded this format nationwide since that time. Geoffrey Beene stores offer a distinctive collection of men's \"Geoffrey Beene\" labelled designer products, including dress and sport shirts, neckwear, furnishings, outerwear, bottoms and sportswear. As with Van Heusen outlet stores, the products sold in Geoffrey Beene stores, other than \"Geoffrey Beene\" dress shirts, consist of products which are not also sold through the Company's wholesale distribution channels.\nThrough their product mix, the Geoffrey Beene stores seek to meet the full needs of men's wardrobes (excluding suits) from dress furnishings to casual wear. The merchandising strategy is focused on an upscale, fashion forward consumer in the upper moderate price range.\nDuring 1993, the Company began offering Geoffrey Beene women's wear in 14 of its stores. Stores offering these products carry a full line of women's casual apparel bearing the designer's name. The Company plans to continue expanding this product offering in the future.\nPrivate Label Dress and Sport Shirts\nThe Pickwick Company division markets at wholesale men's dress and sport shirts under private labels to major national retail chains, department stores and catalog merchants, including JCPenney, Bloomingdale's, Lord & Taylor, Lands' End, Sears and Target. The Company believes that The Pickwick Company is one of the largest marketers of private label shirts in the United States. Career Apparel, a division of The Pickwick Company, markets shirts to companies in service industries, including major airlines and food chains.\nPrivate label programs offer the retailer the ability to create its own line of exclusive merchandise and give the retailer control over distribution of the product. Each of The Pickwick Company's customers work with the Company's designers to develop shirts in the styles, sizes and cuts which the customers desire to sell in their stores with their particular store names or private labels. The dress shirts that The Pickwick Company designs with and for its customers fall within both the traditional and designer dress shirt categories. Private label programs offer the consumer quality product and offer the retailer the opportunity to enjoy higher margins. Private label products, however, do not have the same level of consumer recognition as branded products and private label manufacturers do not generally provide retailers with the same services and support as branded manufacturers.\nIn February 1990, the Company acquired Windsor Shirt Company, a private label retail company. Prior thereto, Windsor Shirt had been a significant customer of The Pickwick Company.\nThe Company believes that Windsor Shirt fills a niche currently missing in outlet retailing. Prior to the acquisition, Windsor Shirt operated traditional men's dress shirt stores, primarily in regional malls and strip centers. Since the acquisition, the Company has closed the Windsor Shirt stores in regional malls, strip centers and other unprofitable locations, and has focused on developing this format in a manufacturers' outlet venue. In addition, the Company has totally reconfigured the stores and upgraded the quality and improved the presentation of the products sold in its stores. Windsor Shirt stores now offer a full line of men's traditional and fashionable apparel, including dress shirts, neckwear, bottoms, sportswear, hosiery and accessories.\nThe Windsor Shirt target customer is a professional male who desires updated traditional merchandise at value prices, although its products also appeal to a broad spectrum of consumers. The Windsor Shirt merchandising strategy focuses on offering an assortment of traditional and fashionable styles of men's dress furnishings and sportswear. Through attention to design and construction details, the Company seeks to ensure that the merchandise offered will be consistent in fashion and quality. The stores offer merchandise in the upper moderate price ranges.\nKnitwear\nThe Company's Somerset division is a leading manufacturer and marketer of primarily men's private label sweaters and golf apparel. Somerset markets its products at wholesale to traditional department and specialty stores, national retail chains and catalog merchants, including Lands' End, JCPenney, May Co., L.L. Bean, Federated and Sears.\nIn 1993, Somerset conducted highly-successful launches of Geoffrey Beene sweaters and Van Heusen Players golf apparel. In the prior year, Somerset successfully introduced Van Heusen branded sweaters. The marketing of these branded products, combined with completing a 1992 restructuring which included a transfer of its sweater production to lower cost facilities, has improved Somerset's operating margins in 1993.\nSomerset also markets its products through the Company's own sweater and knitwear outlet stores called \"Cape Isle Knitters.\" Cape Isle Knitters stores offer a select line of men's and women's knitwear products, including sweaters and knit tops, both being complemented with pants and shorts, and hosiery.\nThe merchandising strategy for Cape Isle Knitters stores is focused on achieving an updated traditional look which emphasizes easy to understand fashion and styling. Emphasis is also placed on natural product and timeless appeal. Stores offer merchandise in the moderate to upper moderate price range.\nCompetition in the Apparel Industry\nThe apparel industry is highly competitive due to its fashion orientation, its mix of large and small producers, the flow of imported merchandise and the wide diversity of retailing methods. Competition has been exacerbated by the recent consolidations and closings of major department store groups. Based on the variety of the apparel marketed by the Company and the various channels of distribution it has developed, the Company believes it is well-positioned in the industry, although the Company has many diverse competitors in both manufacturing and retailing.\nThe Company's apparel wholesale divisions experience competition in branded, designer and private label products. Some of the larger competitors include: Bidermann Industries (\"Arrow\" brand); Salant Corporation (\"Perry Ellis\" and \"John Henry\" brands); Warnaco (\"Hathaway\" and \"Christian Dior\" brands); Smart Shirt (private label shirt division of Kellwood); Capital Mercury (private label shirts); Oxford Industries (private label shirts); and VF Corporation (\"Jantzen\" branded sweaters). While several apparel manufacturers currently operate outlet stores, management believes that none offers a similar selection of product in the variety of formats offered by the Company.\nFootwear Business\nThe Company's footwear business, conducted through its G.H. Bass & Co. division, consists of the manufacture and marketing of a full line of traditional men's, women's and children's casual shoes under the \"Bass\" brand name in the moderate to better price range. Various sub-brands are utilized, the most important ones being \"Weejun\", \"Sunjun\" and \"Compass.\" \"Bass\" is the leading brand of casual shoes in the United States, according to research conducted by Footwear Market Insights (\"FMI\") based on pairs of shoes sold. FMI's research shows Bass with a 6.0% share of the casual shoe market.\nBass' traditional wholesale customers are major department stores and specialty shoe stores throughout the United States, including Federated, May Co., Dillard's, Macy's and Dayton Hudson. In 1992, Bass began marketing its footwear internationally and is now selling footwear to leading retailers in Europe, Mexico, Canada, South America and the Far East.\nAll of the Company's footwear is designed \"in-house.\" Approximately 33% of the Bass wholesale footwear products are manufactured in the Company's facilities in the United States, Puerto Rico and the Dominican Republic, with the remainder being sourced through manufacturers primarily located in the Far East and Brazil.\nBass Retail operates stores located primarily in manufacturers' outlet malls; these stores typically carry an assortment of \"Bass\" shoes, in the moderate to upper moderate price range, as well as complementary products not sold by Bass to its traditional wholesale customers. In addition, the Company has expanded many of its Bass retail stores to sell Bass apparel and accessories consistent with the Bass \"lifestyle.\" As these stores have enjoyed a strong period of initial success, the Company plans to continue expanding the offering of Bass apparel into stores which currently offer footwear only. To a lesser extent, the Bass Retail division operates \"image\" stores, located primarily in large upscale regional malls, typically offering a narrower assortment of \"Bass\" shoes than that carried in Bass Retail outlet stores.\nBass' merchandising strategy is focused on achieving an American classic look which emphasizes classic and traditional footwear design. The stores emphasize the design interpretation \"The Look That Never Wears Out\" in creating an image for its products.\nIn 1994, the Company plans to expand on its initial offering of a line of Bass Kids apparel merchandise.\nCompetition in the Shoe Industry\nThe shoe industry is characterized by fragmented competition. Consequently, retailers and consumers have a wide variety of choices regarding brands, style and price. However, over the years, Bass has maintained its important position in the traditional casual footwear market. Bass does not compete directly in fashion footwear or performance athletic footwear. In the casual footwear market, the Company's primary competitors include Dexter, Rockport, Timberland, Sperry and Sebago. The Company believes, however, that it manufactures a more extensive line of footwear for both genders and in a broader price range than any of its competitors.\nCurrently, Bass Retail outlet stores have few direct footwear competitors. Dexter, and to an even lesser extent Timberland, are the most prominent casual footwear companies that are competing in the outlet environment. However, multi-branded outlet footwear retailers, such as Bannister and Little Red Shoe Store, compete on price and assortment.\nMerchandise Design, Manufacturing and Product Procurement\nApproximately 35% of the Company's wholesale apparel products and 33% of its wholesale footwear products are manufactured in Company-owned facilities while the remainder is directly sourced by the Company through suppliers located world-wide. All of the apparel and footwear merchandise manufactured by the Company as well as the vast majority of its sourced products are planned and designed through the efforts of its various merchandise\/product development groups. These groups consist of designers, product line builders and merchants who consider consumer taste, fashion, history and the economic environment when creating a product plan for a particular season. The Company's growing retail presence has, in addition, provided a direct means to gauge consumer preferences which enables the Company to forecast consumer desires more accurately. The Company's apparel and footwear retail buying groups work closely with their wholesale counterparts to be certain that each product classification within the Company's retail stores provides an adequate array of merchandise to satisfy consumer demand.\nApparel and footwear product lines are developed primarily for two major selling seasons, spring and fall. However, certain of the Company's product lines require more frequent introductions of new merchandise, and some of the Company's more fashionable product lines have as many as two to four supplemental offerings.\nThe process from initial design to finished product varies greatly, but generally spans nine to 12 months prior to each selling season. Raw materials and production commitments are generally made four to 12 months prior to production and quantities are finalized at that time. In addition, sales are monitored regularly at both the retail and wholesale levels and modifications in production can be made both to increase or reduce availability. The Company's substantial efforts in the area of quick response to sales trends (through the development of the PVH Pulse System) maximize its inventory flexibility and minimize production overruns.\nShirts and sweaters are manufactured in the Company's domestic apparel manufacturing facilities in Alabama, Arkansas and Puerto Rico. The Company also operates facilities in Costa Rica, Guatemala and Honduras. Additionally, the Company contracts for apparel merchandise with vendors principally in the Far East, Middle East and Caribbean areas which meet its quality and cost requirements. Footwear is manufactured in the Company's factories located in Maine, Puerto Rico and the Dominican Republic. In addition, the Company contracts for footwear merchandise which meet its requirements from overseas vendors, principally in Brazil and the Far East.\nThe Company's foreign offices, located principally in Hong Kong, Korea, Taiwan, Singapore and Brazil, enable the Company to monitor the quality of the goods manufactured by, and the delivery performance of, its suppliers. The Company continually seeks additional suppliers throughout the world for its sourcing needs and places its orders to limit the risk that a disruption of production at any one facility could cause a serious inventory problem. The Company has experienced no significant production delays or difficulties in importing goods. However, from time to time the Company has incurred added costs by shipping goods by air freight in order for it to meet certain delivery commitments to its customers. The Company's purchases from its suppliers are effected through individual purchase orders specifying the price and quantity of the items to be produced. The Company does not have any long-term, formal arrangements with any of the suppliers which manufacture its products. The Company believes that it is the largest customer of many of its manufacturing suppliers and considers its relations with its suppliers to be satisfactory. No single supplier is critical to the Company's production needs, and the Company believes that an ample number of alternative suppliers exist should the Company need to secure additional or replacement production capacity.\nThe Company purchases raw materials, including shirting fabric, buttons, thread, labels, yarn, piece goods and leather, from domestic and foreign sources based on quality, pricing (including quotas and duties) and availability factors. The Company believes it is one of the largest procurers of shirting fabric world-wide and purchases the majority of its shirting fabric from overseas manufacturers, due, at least in part, to decreased domestic production. The Company monitors factors affecting textile production and imports and remains flexible in order to exploit advantages in obtaining materials from different suppliers and different geographic regions. Rawhide leather for Bass' footwear products is procured mainly from domestic suppliers. The leather used in Bass shoes is a by-product of beef production and its availability has remained stable over the past several years as a result of the stability of the beef market. Bass monitors the leather market and makes purchases on the spot market or through blanket contracts with suppliers as price trends dictate. No single supplier of raw materials is critical to the Company's production needs and the Company believes that an ample number of alternative suppliers exist should the Company need to secure additional or replacement raw materials.\nThe Company's PVH-I division serves as the apparel design and sourcing center for all of the apparel retail operations. PVH-I has developed merchandising organizations (both designers and administrators) dedicated to each apparel store format to develop and plan the apparel products which are sold in the Company's stores but which are not marketed by the wholesale arm of that division.\nAdvertising and Promotion\nThe Company has used national advertising to communicate the Company's marketing message since the 1920's. The Company believes that this effort has helped create strong brand awareness and a high recognition factor among American consumers and has contributed to the overall success of the Company. The Company advertises primarily in national print media including fashion, entertainment\/human interest, business, men's, women's and sports magazines. Brand awareness is further supplemented by the Company's co-op advertising program through which the Company and individual retailers combine their efforts and share the cost of store radio, television and newspaper advertisements and in-store advertising and promotional events featuring the Company's branded products.\nThe Company relies upon local outlet mall developers to promote traffic for their centers. Outlet center developers employ multiple formats including signage (highway billboards, off-highway directional signs, on-site signage and on-site information centers), print advertising (brochures, newspapers and travel magazines), direct marketing (to tour bus companies and travel agents), radio and television, and special promotions. Trademarks\nThe Company has the exclusive right to use the \"Van Heusen\" name in North, Central and South America as well as the Philippines, and the exclusive worldwide right to use \"Bass\" for footwear. The Company has registered or applied for registration of a multitude of other trademarks for use on a variety of items of apparel and footwear and apparel and footwear-related products and owns many foreign trademark registrations. It presently has pending a number of applications for additional trademark registrations. The Company regards its trademarks and other proprietary rights as valuable assets and believes that they have significant value in the marketing of its products.\nLicensing\nThe Company is licensing the \"Van Heusen\" name for apparel products in Canada and in most of the South and Central American countries. In the United States, the Company currently licenses the use of the \"Van Heusen\" name for various products that it does not manufacture or procure, including boy's apparel, sleepwear, eyeglasses, neckwear and other accessories and is exploring the possibility of licensing the name for use on other products. The Company also has a licensing and distribution agreement for \"Bass\" footwear in Japan.\nRetail Stores\nAs of January 30, 1994, the Company operated 780 stores in five different formats: Van Heusen, Bass, Geoffrey Beene, Windsor Shirt and Cape Isle Knitters. The Company's stores are located primarily in manufacturers' outlet malls, except for the Bass Retail \"image\" stores. Store layouts and designs differ among the five retail formats in order to maximize the effectiveness of the product and pricing strategy directed toward each format's specific target customer.\nHistorically, the geographic dispersement of the Company's retail stores has been focused in the northeast and southeast regions of the United States. As outlet mall retailing in these areas is maturing, it is the Company's intent to focus on opening new stores throughout other regions of the United States. Primary emphasis will be on the western part of the United States, although the Company will continue to \"back-fill\" stores in outlet malls in the northeastern and southeastern parts of the United States.\nManufacturers' outlet malls are a growing segment of the retail industry, and the Company is a leading operator of outlet mall stores. Other branded apparel manufacturers who have entered the outlet mall sector include Ralph Lauren, Liz Claiborne, Bugle Boy, Gant, Izod, J. Crew, Jockey, Donna Karan, Leslie Fay, Jones New York, Nautica, Tommy Hilfiger, Calvin Klein and Anne Klein.\nThe following table sets forth the number of openings and closings of the Company's retail stores by fiscal year since 1989 and the number of stores operated at the end of each fiscal year:\nFiscal Fiscal Fiscal Fiscal Fiscal 1993 1992 1991 1990(1) 1989\nStore openings:. . . . . . . . . . . . 126 116 126 166 93 Store closings:. . . . . . . . . . . . 51 47 40 40 33 Total stores operated at year end: . . 780 705 636 550 424\n(1) Includes 46 Windsor Shirt stores acquired during fiscal 1990.\nThe Company plans to add an additional 101 stores in fiscal 1994 (net of store closings). To meet this growth goal, the Company must be able to open multiple stores in new malls, \"back-fill\" its store formats in a sufficient number of existing outlet malls and\/or develop new store formats. The primary short-term source of the Company's retail expansion will be the opening of multiple store formats in new malls. There are currently approximately 40 new malls (including mall additions) scheduled to open in 1994 and the Company intends to feature several store formats in almost all of them. A large portion of the retail expansion will come from these new malls and existing mall expansions. In addition, retail expansion will come from \"back-filling\", which entails adding one or more of the Company's store formats to malls in which the Company already operates stores in one or more other formats. Future growth will also come from the development of new store formats, such as the Geoffrey Beene stores offering casual apparel for women which opened late in the summer of 1993. The addition of these, as well as any other new formats will provide the Company with the opportunity to increase the number of stores the Company operates in existing and new malls. Performance of all stores is reviewed on a regular basis, and poorly performing stores are closed when appropriate.\nThe Company maintains a real estate department which works with the store planning and design department in opening new stores. The real estate department locates appropriate sites based on information regarding area demographics, model store size, available lease arrangements and projected volume and operating returns. In preparation for opening, the store planning and design department coordinates interior plans with landlords, division heads, contractors and developers. As construction is completed, a project manager supervises fixture installation as well as ensures the quality workmanship demanded by the Company. Field management then begins the merchandising process. All of these efforts culminate with the opening of each new store.\nThe retail distribution strategy has evolved to allow the Company the opportunity to market directly to consumers while limiting the disruption of sales to the Company's traditional wholesale customers by locating primarily in manufacturers' outlet malls in locations such as tourist destination areas. As a leading outlet retailer, the Company has the ability to secure favorable lease terms and locations for its stores.\nThe Company's plans with respect to expansion are frequently reviewed and revised in light of changing conditions. It is possible that not all of the plans described above will be completed and that other projects may be added.\nTariffs and Import Restrictions\nA substantial portion of the Company's products are manufactured by contractors located outside the United States. These products are imported and are subject to United States Customs laws, which impose tariffs as well as import quota restrictions established by the Department of Commerce. However, a significant portion of the Company's apparel products are imported from its Caribbean Basin manufacturing facilities and are therefore eligible for certain duty-advantaged programs commonly known as \"807 Programs.\" While importation of goods from certain countries from which the Company obtains goods may be subject to embargo by United States Customs authorities if shipments exceed quota limits, the Company closely monitors import quotas and can, in most cases, shift production to contractors located in countries with available quotas or to domestic manufacturing facilities. The existence of import quotas has, therefore, not had a material effect on the Company's business.\nEmployees\nThe Company currently employs approximately 10,200 persons on a full-time basis and approximately 2,900 persons on a part-time basis. Of the approximately 13,100 persons employed by the Company, 66% are employed in the apparel business, 32% are employed in the footwear business and 2% are corporate employees. Approximately 4% of the Company's total employees are represented for the purpose of collective bargaining with three different unions. Additional persons, some represented by these three unions, are employed from time to time based upon the Company's manufacturing schedules and retailing seasonal needs. The Company believes that its relations with its employees are satisfactory. Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company maintains its principal executive offices at 1290 Avenue of the Americas, New York, New York, occupying approximately 80,000 square feet under a sub-lease which expires on December 30, 1998. The Company also maintains an administrative facility in Bridgewater, New Jersey, where the Company occupies a building of approximately 153,000 square feet under a lease which expires on July 30, 2007. The following tables summarize the other manufacturing facilities, warehouses and distribution centers, administrative offices and retail stores of the Company:\nApparel Business\nSquare Feet of Floor Space (000's)\nOwned Leased Total\nManufacturing Facilities . . . . . . . . . . . . . . 276 329 605 Warehouses and Distribution Centers. . . . . . . . . 815 568 1,383 Administrative . . . . . . . . . . . . . . . . . . . 0 65 65 Retail Stores. . . . . . . . . . . . . . . . . . . . 0 1,619 1,619\n1,091 2,581 3,672\nFootwear Business Owned Leased Total\nManufacturing Facilities . . . . . . . . . . . . . . 274 115 389 Warehouses and Distribution Centers. . . . . . . . . 127 184 311 Administrative . . . . . . . . . . . . . . . . . . . 20 138 158 Retail Stores. . . . . . . . . . . . . . . . . . . . 9 1,138 1,147\n430 1,575 2,005\nLeases for these apparel and footwear facilities have expiration dates through December 2003. Information with respect to minimum annual rental commitments under leases in which the Company is a lessee is incorporated herein by reference to the note entitled \"Leases\" in the Notes to Consolidated Financial Statements incorporated by reference in Item 8 of this report.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is a party to certain litigation which, in the Company's judgment based on the opinion of legal counsel, 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\nNone.\nExecutive Officers of the Registrant\nThe following table sets forth certain information concerning the Company's Executive Officers:\nName Position Age\nLawrence S. Phillips Chairman of the Board of Directors 67 Bruce J. Klatsky President; Chief Executive Officer; Director 45 Irwin W. Winter Vice President, Finance; Chief Financial Officer; Director 60 Walter T. Rossi Chairman, PVH Retail Group 51 Allen E. Sirkin Chairman, The PVH Apparel Group 51 Mark Weber Vice President; President of PVH International 45\nMr. Lawrence S. Phillips has been employed by the Company in various capacities over the last 46 years, and has been Chairman of the Company for more than the past five years. Mr. Phillips has served as a director of the Company since 1951.\nMr. Bruce J. Klatsky has been employed by the Company in various capacities over the last 22 years, and has been President of the Company since 1987. Mr. Klatsky has served as a director of the Company since 1985 and was named Chief Executive Officer in June of 1993.\nMr. Irwin W. Winter joined the Company in July 1987 as Vice President, Finance and Chief Financial Officer. Mr. Winter has served as a director of the Company since 1987.\nMr. Walter T. Rossi joined the Company in November of 1992 as Chairman, PVH Retail Group. For more than the last five years prior to joining the Company, he served as Chairman and CEO of Mervyn's, a division of Dayton Hudson.\nMr. Allen E. Sirkin has been employed by the Company since 1985. From 1988 to 1990, he was President of The Van Heusen Company and The Designer Group. He has served as Chairman, The PVH Apparel Group since 1990.\nMr. Mark Weber has been employed by the Company in various capacities over the last 22 years, and has been Vice President of the Company since 1988 and President of PVH International since 1989.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Security Holder Matters\nInformation with respect to the market for the Company's common stock and related security holder matters which appears under the heading \"Selected Quarterly Financial Data\" in the 1993 Annual Report to Stockholders, is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected Financial Data which appears under the heading \"Seven Year Financial Summary\" in the 1993 Annual Report to Stockholders, is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nManagement's Discussion and Analysis of Financial Condition and Results of Operations which appears under the heading \"Financial Review\" in the 1993 Annual Report to Stockholders, is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated financial statements, which appear in the 1993 Annual Report to Stockholders, 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 required by Item 10 is incorporated herein by reference to the section entitled \"Election of Directors\" of the Company's proxy statement for the Annual Meeting of Stockholders to be held on June 14, 1994.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation with respect to Executive Compensation is incorporated herein by reference to the sections entitled \"Executive Compensation\", \"Compensation Committee Report on Executive Compensation\" and \"Performance Graph\" of the Company's proxy statement for the Annual Meeting of Stockholders to be held on June 14, 1994.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation with respect to the Security Ownership of Certain Beneficial Owners and Management is incorporated herein by reference to the section entitled \"Security Ownership of Certain Beneficial Owners and Management\" of the Company's proxy statement for the Annual Meeting of Stockholders to be held on June 14, 1994.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation with respect to Certain Relationships and Related Transactions is incorporated herein by reference to the sections entitled \"Election of Directors\" and \"Compensation of Directors\" of the Company's proxy statement for the Annual Meeting of Stockholders to be held on June 14, 1994.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a)(1) The following consolidated financial statements are incorporated by reference in Item 8 of this report:\nConsolidated Statements of Income--Years Ended January 30, 1994, January 31, 1993 and February 2, 1992 Consolidated Balance Sheets--January 30, 1994 and January 31, 1993 Consolidated Statements of Cash Flows--Years Ended January 30, 1994, January 31, 1993 and February 2, 1992 Consolidated Statements of Changes in Common Stockholders' Equity-- Years Ended January 30, 1994, January 31, 1993 and February 2, 1992 Notes to Consolidated Financial Statements\n(a)(2) See page for a listing of financial statement schedules submitted as part of this report.\n(a)(3) The following exhibits are included in this report:\nExhibit Number\n3.1 Certificate of Incorporation (incorporated by reference to Exhibit 5 to the Company's Annual Report on Form 10-K for the fiscal year ended January 29, 1977).\n3.2 Amendment to Certificate of Incorporation, filed June 27, 1984 (incorporated by reference to Exhibit 3B to the Company's Annual Report on Form 10-K for the fiscal year ended February 3, 1985).\n3.3 Amendment to Certificate of Incorporation, filed June 2, 1987 (incorporated by reference to Exhibit 3(c) to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1988).\n3.4 Amendment to Certificate of Incorporation, filed September 4, 1992.\n3.5 Amendment to Certificate of Incorporation, filed June 1, 1993.\n3.6 By-Laws of PVH (incorporated by reference to Exhibit 6 to the Company's Annual Report on Form 10-K for the fiscal year ended January 29, 1977).\n3.7 Amendment to Section 4 of Article II of the By-Laws of PVH (incorporated by reference to Exhibit 28.3 to the Company's Report on Form 8-K filed on September 5, 1987).\n4.1 Specimen of Common Stock certificate (incorporated by reference to Exhibit 4 to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1981).\n4.2 Preferred Stock Purchase Rights Agreement (the \"Rights Agreement\"), dated June 10, 1986 between PVH and The Chase Manhattan Bank, N.A. (incorporated by reference to Exhibit 3 to the Company's Quarterly Report as filed on Form 10-Q for the period ended May 4, 1986).\n4.3 Amendment to the Rights Agreement, dated March 31, 1987 between PVH and The Chase Manhattan Bank, N.A. (incorporated by reference to Exhibit 4(c) to the Company's Annual Report on Form 10-K for the year ended February 2, 1987).\nExhibit Number\n4.4 Supplemental Rights Agreement and Second Amendment to the Rights Agreement, dated as of July 30, 1987, between PVH and The Chase Manhattan Bank, N.A. (incorporated by reference to Exhibit (c)(4) to the Company's Schedule 13E-4, Issuer Tender Offer Statement, dated July 31,1987).\n4.5 Credit Agreement, dated as of December 16, 1993, among PVH, Bankers Trust Company, The Chase Manhattan Bank, N.A., Citibank, N.A., The Bank of New York, Chemical Bank and Philadelphia National Bank, and Bankers Trust Company, as agent.\n4.6 Note Agreement, dated October 1, 1992, among PVH, The Equitable Life Assurance Society of the United States, Equitable Variable Life Insurance Company, Unum Life Insurance Company of America, Nationwide Life Insurance Company, Employers Life Insurance Company of Wausau and Lutheran Brotherhood (incorporated by reference to Exhibit 4.21 to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\n4.7 Indenture, dated as of November 1, 1993, between PVH and The Bank of New York, as Trustee (incorporated by reference to Exhibit 4.01 to the company's Registration Statement on Form S-3 (Reg. No. 33- 50751) filed on October 26, 1993).\n10.1 Sublease, dated as of August 5, 1987, between Telemundo Group, Inc. and PVH (incorporated by reference to Exhibit 28.2 to the Company's Report on Form 8-K filed on September 5, 1987).\n* 10.2 1987 Stock Option Plan, including all amendments through March 30, 1993.\n* 10.3 1973 Employees' Stock Option Plan (incorporated by reference to Exhibit 1 to the Company's Registration Statement on Form S-8 (Reg. No. 2-72959) filed on July 15, 1981).\n* 10.4 Supplement to 1973 Employees' Stock Option Plan (incorporated by reference to the Company's Prospectus filed pursuant to Rule 424(c) to the Registration Statement on Form S-8 (Reg. No. 2-72959) filed on March 31, 1982).\n* 10.5 Phillips-Van Heusen Corporation Special Severance Benefit Plan (incorporated by reference to the Company's Report on Form 8-K filed on January 16, 1987).\n* 10.6 Phillips-Van Heusen Corporation Capital Accumulation Plan (incorporated by reference to the Company's Report on Form 8-K filed on January 16, 1987).\n* 10.7 Phillips-Van Heusen Corporation Amendment to Capital Accumulation Plan (incorporated by reference to Exhibit 10(n) to the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 1987).\n* 10.8 Form of Agreement amending Phillips-Van Heusen Corporation Capital Accumulation Plan with respect to individual participants (incorporated by reference to Exhibit 10(1) to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1988).\n* 10.9 Phillips-Van Heusen Corporation Supplemental Defined Benefit Plan, dated January 1, 1991, as amended and restated on June 2, 1992 (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1993).\nExhibit Number\n* 10.10 Phillips-Van Heusen Corporation Supplemental Savings Plan, dated as of January 1, 1991 and amended and restated as of January 1, 1992 (incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 1992).\n11. Statement re: Computation of Earnings Per Share.\n13. Sections of the 1993 Annual Report to Stockholders for the fiscal year ended January 30, 1994 which are included in Parts I and II of this Form 10-K. These sections are Selected Quarterly Financial Data, Seven Year Financial Summary, Financial Review and the consolidated financial statements.\n21. Subsidiaries of the Company.\n24. Consent of Independent Auditors.\n(b) The Company filed no reports on Form 8-K during the fourth quarter of the fiscal year ended January 30, 1994.\n(c) Exhibits: See (a)(3) above for a listing of the exhibits included as part of this report.\n(d) Financial Statement Schedules: See page for a listing of the financial statement schedules submitted as part of this report.\n(e) The Company agrees to furnish to the Commission upon request a copy of each agreement with respect to long-term debt where the total amount of securities authorized thereunder does not exceed 10% of the total consolidated assets of the Company.\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this form pursuant to Item 14(c) of this report.\nFORM 10-K-ITEM 14(a)(2)\nPHILLIPS-VAN HEUSEN CORPORATION\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statement schedules of Phillips-Van Heusen Corporation and subsidiaries are included herein:\nSchedule II - Amounts Receivable from Related Parties and Underwriters, Promoters and Employees Other Than Related Parties . . . . . . . . . . .\nSchedule VIII - Valuation and Qualifying Accounts. . . . . . . .\nSchedule IX - Short-Term Borrowings. . . . . . . . . . . . . .\nSchedule X - Supplementary Income Statement Information . . .\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPHILLIPS-VAN HEUSEN CORPORATION\nBruce J. Klatsky By:.................................. Bruce J. Klatsky President, Chief Executive Officer and Director\nDate: April 19, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date\nLawrence S. Phillips Chairman of the Board of Directors April 19, 1994 Lawrence S. Phillips\nBruce J. Klatsky President, Chief Executive Officer April 19, 1994 Bruce J. Klatsky and Director (Principal Executive Officer)\nIrwin W. Winter Vice President, Finance and April 19, 1994 Irwin W. Winter Director (Principal Financial Officer)\nEmanuel Chirico Vice President and Controller April 19, 1994 Emanuel Chirico (Principal Accounting Officer)\nEdward H. Cohen Director April 19, 1994 Edward H. Cohen\nEstelle Ellis Director April 19, 1994 Estelle Ellis\nJoseph B. Fuller Director April 19, 1994 Joseph B. Fuller\nMaria Elena Lagomasino Director April 19, 1994 Maria Elena Lagomasino\nBruce Maggin Director April 19, 1994 Bruce Maggin\nEllis E. Meredith Director April 19, 1994 Ellis E. Meredith\nSteven L. Osterweis Director April 19, 1994 Steven L. Osterweis\nWilliam S. Scolnick Director April 19, 1994 William S. Scolnick\nPeter J. Solomon Director April 19, 1994 Peter J. Solomon\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPHILLIPS-VAN HEUSEN CORPORATION\nBy:.................................. Bruce J. Klatsky President, Chief Executive Officer and Director\nDate: April , 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date\nChairman of the Board of Directors April , 1994 Lawrence S. Phillips\nPresident, Chief Executive Officer April , 1994 Bruce J. Klatsky and Director (Principal Executive Officer)\nVice President, Finance and April , 1994 Irwin W. Winter Director (Principal Financial Officer)\nVice President and Controller April , 1994 Emanuel Chirico (Principal Accounting Officer)\nDirector April , 1994 Edward H. Cohen\nDirector April , 1994 Estelle Ellis\nDirector April , 1994 Joseph B. Fuller\nDirector April , 1994 Maria Elena Lagomasino\nDirector April , 1994 Bruce Maggin\nDirector April , 1994 Ellis E. Meredith\nDirector April , 1994 Steven L. Osterweis\nDirector April , 1994 William S. Scolnick\nDirector April , 1994 Peter J. Solomon\nSCHEDULE II\nPHILLIPS-VAN HEUSEN CORPORATION\nAMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES\nEXHIBIT 21\nSUBSIDIARIES OF THE REGISTRANT\nThe following table lists all of the subsidiaries of the Company and the jurisdiction of incorporation of each subsidiary. Except as otherwise indicated, each subsidiary does business under its corporate name indicated in the table.\nName State or Other Jurisdiction of Incorporation\nG. H. Bass Franchises Inc. Delaware\nG. H. Bass Caribbean Inc. Delaware\nCaribe M&I Ltd. Cayman Islands\nGHB (Far East) Limited Hong Kong\nVan Heusen Transportation Corporation Delaware\nTejidos De Coamo, Inc. Delaware\nEnvoy Pacific Limited Hong Kong\nTowell Import & Export Limited Hong Kong\nAbese Limited Hong Kong\nConfecciones Imperio, S.A. Costa Rica\nCamisas Modernas, S.A. Guatemala\nG. H. Bass Comercio Exportacacao Ltda. Brazil\nWindsor Shirt Company Pennsylvania\nEXHIBIT 24\nConsent of Independent Auditors\nWe consent to the incorporation by reference in this Annual Report on Form 10-K of Phillips-Van Heusen Corporation of our report dated March 17, 1994, included in the Annual Report to Stockholders of Phillips-Van Heusen Corporation.\nOur audits also included the financial statement schedules of Phillips-Van Heusen Corporation listed in Item 14(a). These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. 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 herein.\nWe also consent to the incorporation by reference in the Registration Statement (Form S-3 No. 33-46770), Registration Statement (From S-8 No. 33-59602), Registration Statement (Form S-8 No. 33-38698), Post-Effective amendment No. 1 to the Registration Statement (Form S-8 No. 33-24057), Post- Effective amendment No. 2 to the Registration Statement (Form S-8 No. 2-73803), Post-Effective amendment No. 4 to the Registration Statement (Form S-8 No. 2-72959), Post-Effective amendment No. 6 to the Registration Statement (Form S-8 No. 2-64564), and Post-Effective amendment No. 13 to the Registration Statement (Form S-8 No. 2-47910), of Phillips-Van Heusen Corporation and in the related Prospectuses of our report dated March 17, 1994, with respect to the consolidated financial statements and schedules of Phillips-Van Heusen Corporation included in this Form 10-K for the year ended January 30, 1994.\nERNST & YOUNG\nNew York, New York April 26, 1994","section_15":""}
{"filename":"737468_1994.txt","cik":"737468","year":"1994","section_1":"ITEM 1. BUSINESS ---------------- Washington Trust Bancorp, Inc. ------------------------------ Washington Trust Bancorp, Inc. (the \"Corporation\") is a publicly-owned, registered bank holding company, organized in 1984 under the laws of the state of Rhode Island, whose subsidiaries are permitted to engage in banking and other financial services and businesses. The Corporation conducts its business through its wholly-owned subsidiary, The Washington Trust Company (the \"Bank\"), a Rhode Island chartered commercial bank. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (\"FDIC\").\nThe Corporation was formed in 1984 under a plan of reorganization in which outstanding common shares of The Washington Trust Company were exchanged for common shares of Washington Trust Bancorp, Inc. At December 31, 1994 the Corporation had total consolidated assets of $516 million, deposits of $441 million and equity capital of $46 million.\nThe Washington Trust Company ---------------------------- The Washington Trust Company was originally chartered in 1800 as the Washington Bank and is the oldest banking institution headquartered in its market area. Its current corporate charter dates to 1902. See \"Market Area and Competition\" below for further information.\nA broad range of financial services are provided by the Bank, including:\n- Residential mortgages - Commercial and consumer demand deposits - Commercial loans - Savings, NOW and money market deposits - Construction loans - Certificates of deposit - Installment loans - Retirement accounts - Home equity lines of credit - Electronic funds transfer - VISA and Mastercard accounts - Safe deposit boxes - Merchant credit card services - Trust and investment services\nThe Bank's primary source of income is net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing deposits and other borrowed funds. Sources of noninterest income include fees for management of customer investment portfolios, trusts and estates, service charges on deposit accounts, merchant processing fees and other banking-related fees. Noninterest expenses include the provision for loan losses, salaries and employee benefits, occupancy, equipment, office supplies deposit taxes and assessments, foreclosed property costs and other administrative expenses.\nAutomated teller machines (ATM's) are located at each of the Bank's six banking offices. The Bank is a member of the NYCE, Yankee 24, Plus, and Cashstream ATM networks.\nData processing for most of the Bank's deposit and loan accounts and other applications is conducted internally using owned equipment. Application software is primarily obtained through purchase or licensing agreements.\nThe Bank's Trust and Investment Department provides fiduciary services as trustee under wills and trust agreements; as executor or administrator of estates; as a provider of agency and custodial investment services to individuals and institutions; and as a trustee for employee benefit plans. The market value of total trust assets amounted to $389 million as of December 31, 1994.\nThe following is a summary of the relative amounts of income producing functions as a percentage of gross operating income during the past five years:\nThe percentage of gross income derived from interest and fees on loans was 72% and 71% in 1994 and 1993, respectively, down from a five-year high of 85% in 1990, primarily as a result of the low interest rate environment that existed in 1993 and 1994.\nMarket Area and Competition --------------------------- The Bank's market area includes most of southern Rhode Island (Washington County) and a portion of New London County in southeastern Connecticut. The Bank's six banking offices are located in the following Rhode Island communities:\n- Westerly (2) - Charlestown - New Shoreham (Block Island) - Richmond - Narragansett\nThe Bank's offices in Charlestown and on Block Island are the only bank facilities in those communities. The Block Island office was acquired from another Rhode Island bank in 1984. The Charlestown office was opened in 1988 and the Narragansett office was opened in 1989.\nThe Bank faces strong competition from branches of major Rhode Island and regional commercial banks, local branches of certain Connecticut banks, as well as various credit unions, savings institutions and, to some extent, finance\ncompanies. The principal methods of competition are through interest rates, financing terms and other customer conveniences. The Washington Trust Company had 36% of total deposits reported by financial institutions for banking offices within its market area as of June 30, 1994. The two closest competitors held 16% each, and the third closest competitor held 6% of total deposits in the market area. The Corporation believes that being the largest commercial banking institution headquartered within the market area provides a competitive advantage over other financial institutions. The Bank has a marketing department which is responsible for the review of existing products and services and the development of new products and services.\nEmployees --------- As of December 31, 1994 the Corporation employed approximately 241 full-time and 53 part-time employees. Management believes that its employee relations are good.\nSupervision and Regulation -------------------------- General - The business in which the Corporation and the Bank are engaged is subject to extensive supervision, regulation, and examination by various bank regulatory authorities and other agencies of federal and state government. The supervisory and regulatory activities of these parties are often intended primarily for the protection of customers or are aimed at carrying out broad public policy goals that may not be directly related to the financial services provided by the Corporation and the Bank, nor intended for the protection of the Corporation's shareholders. Proposals to change regulations and laws which affect the banking industry are frequently raised at the federal and state level. The potential impact on the Corporation of any future revisions to the supervisory or regulatory structure cannot be determined.\nThe Corporation and the Bank are required by various authorities to file extensive periodic reports of financial and other information and such other reports as the regulatory and supervisory authorities may require. The Corporation is also subject to the reporting and other requirements of the Securities Exchange Act of 1934.\nThe Corporation is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the \"BHC Act\"). As a bank holding company, the activities of the Corporation are regulated by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"). The BHC Act requires that the Corporation obtain prior approval of the Federal Reserve Board to acquire control over a bank or certain nonbank entities and restricts the activities of the Corporation to those closely related to banking. Federal law also regulates transactions between the Corporation and the Bank, including loans or extensions of credit.\nThe Bank is subject to the supervision of, and examination by, the FDIC. As a state chartered institution, The Washington Trust Company is also subject to various Rhode Island business and banking regulations.\nFederal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) - FDICIA was enacted in December 1991 and has resulted in extensive changes to the federal banking laws. Among other things, FDICIA requires the federal banking regulators to take prompt corrective action with respect to depository\ninstitutions that do not meet minimum capital requirements.\nFDICIA established five capital tiers, ranging from \"well-capitalized\" to \"critically undercapitalized.\" A depository institution is well-capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure. Under FDICIA, an institution that is not well- capitalized is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market. In addition, \"pass through\" deposit insurance coverage may not be available for certain employee benefit accounts. At December 31, 1994, the Bank's capital ratios placed it in the well-capitalized category.\nAnother primary purpose of FDICIA was to recapitalize the Bank Insurance Fund (BIF). The FDIC adopted a risk-related premium system for the assessment period beginning January 1, 1993. Under this new system, each institution's assessment rate is based on its capital ratios in combination with a supervisory evaluation of the risk the institution poses to the BIF. Banks deemed to be well-capitalized and who pose the lowest risk to the BIF will pay the lowest assessment rates, while undercapitalized banks, who present the highest risk, will pay the highest rates.\nFDICIA contains other significant provisions that require the federal banking regulators to establish standards for safety and soundness for depository institutions and their holding companies in three areas: (i) operational and managerial; (ii) asset quality, earnings and stock valuation; and (iii) management compensation. The legislation also requires that risk-based capital requirements contain provisions for interest rate risk, credit risk and risks of nontraditional activities. FDICIA also imposes expanded accounting and audit reporting requirements for depository institutions. In addition, FDICIA imposes numerous restrictions on state-chartered banks, including those which generally limit investments and activities to those permitted to national banks, and contains several consumer banking law provisions.\nThe provisions of FDICIA are being phased in over several years. While final rules have been issued on most provisions, others have yet to be issued.\nRiegle-Neal Interstate Banking and Branching Efficiency Act of 1994 - On September 30, 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 was signed into law. Effective one year after enactment, adequately capitalized bank holding companies will be permitted to acquire banks in any state subject to certain concentration limits and other conditions. Also, on a phased-in basis over three years from the date of its enactment, other limitations on interstate bank mergers, consolidations and branching will be eased, subject to a state's ability to \"opt out\" of certain provisions of the law by passage of state law. No legislation has been introduced in Rhode Island for the 1995 legislative session that would constitute an \"opt out\" election by the State.\nDividend Restrictions -The Corporation's revenues consist of cash dividends paid to it by the Bank. Such payments are restricted pursuant to various state and federal regulatory limitations. Reference is made to Note 16 to the Corporation's Consolidated Financial Statements included in its 1994 Annual Report to Shareholders incorporated herein by reference for additional discussion of the Corporation's ability to pay dividends.\nCapital Guidelines - Regulatory guidelines have been established that require bank holding companies and banks to maintain minimum ratios of capital to risk- adjusted assets. Banks are required to have minimum core capital (Tier 1) of 4% and total risk-adjusted capital (Tier 1 and Tier 2) of 8%. For the Corporation, Tier 1 capital is essentially equal to shareholders' equity excluding the net unrealized gain on securities available for sale. Tier 2 capital consists of a portion of the reserve for possible loan losses (limited to 1.25% of total risk- weighted assets). As of December 31, 1994, net risk-weighted assets amounted to $342.5 million, the Tier 1 capital ratio was 12.55% and the total risk-based capital ratio was approximately 13.82%.\nThe Tier 1 leverage ratio is defined as Tier 1 capital (as defined under the risk-based capital guidelines) divided by average assets (net of intangible assets and excluding the effects of accounting for securities available for sale under SFAS No. 115). The minimum leverage ratio is 3% for banking organizations that do not anticipate significant growth and that have well-diversified risk (including no undue interest rate risk), excellent asset quality, high liquidity and strong earnings. Other banking organizations are expected to have ratios of at least 4 - 5%, depending on their particular condition and growth plans. Higher capital ratios could be required if warranted by the particular circumstances or risk profile of a given banking organization. The Corporation's Tier 1 leverage ratio was 8.45% as of December 31, 1994. The Federal Reserve has not advised the Corporation of any specific minimum Tier 1 leverage capital ratio applicable to it.\nGUIDE 3 STATISTICAL DISCLOSURES ------------------------------- The following tables contain additional consolidated statistical data about the Corporation and its subsidiary.\nI. Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential ------------------------------------------------------------- A. Average balance sheets are presented on page 28 of the Corporation's 1994 Annual Report to Shareholders under the caption \"Average Balances\/Net Interest Margin (Fully Taxable Equivalent Basis)\", and are incorporated herein by reference. Nonaccrual loans are included in average loan balances. Average balances are based upon daily averages.\nB. An analysis of net interest earnings, including interest earned and paid, average yields and costs, and net yield on interest-earning assets is presented on page 28 of the Corporation's 1994 Annual Report to Shareholders under the caption \"Average Balances\/Net Interest Margin (Fully Taxable Equivalent Basis)\", and is incorporated herein by reference.\nInterest income is reported on the fully taxable-equivalent basis. Tax exempt income is converted to a fully taxable equivalent basis by assuming a 34% marginal federal income tax rate adjusted for applicable state income taxes net of the related federal tax benefit. For dividends on corporate stocks, the 70% federal dividends received deduction is also used in the calculation of tax equivalency. Interest on nonaccrual loans is included in the analysis of net interest earnings to the extent that such interest income has been recognized in the Consolidated Statements of Income. See Guide 3 Item III.C.1.\nC. An analysis of rate\/volume changes in interest income and interest expense is presented on page 29 of the Corporation's 1994 Annual Report to Shareholders under the caption \"Volume\/Rate Analysis - Interest Income and Expense (Fully Taxable Equivalent Basis)\", and is incorporated herein by reference. The net change attributable to both volume and rate has been allocated proportionately.\nII. INVESTMENT SECURITIES AND SECURITIES AVAILABLE FOR SALE ------------------------------------------------------- A. The carrying amounts of investment securities as of the dates indicated are presented in the following table:\nThe December 31, 1992 balance of mortgage-backed securities includes $19,209,775 of securitized mortgages originated by the Bank which were previously classified as loans in the Corporation's 1992 consolidated financial statements.\nThe carrying amounts of securities available for sale as of the dates indicated are summarized in the table below. Effective January 1, 1994, the Corporation adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS No. 115). The Statement requires that securities available for sale be reported at fair value, with any unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity, net of tax, until realized. Therefore, the carrying value of securities available for sale at December 31, 1994 presented below is equal to market value. Prior to the adoption of SFAS No. 115, securities available for sale were carried at the lower of aggregate cost, adjusted for amortization of premium or accretion of discount in the case of debt securities, or market value.\nB. Maturities of debt securities as of December 31, 1994 are presented in the following tables. Mortgage-backed securities are included based on their weighted average maturities, adjusted for anticipated future prepayments. Yields on tax exempt obligations were not computed on a tax equivalent basis.\nC. Not applicable.\nIII. LOAN PORTFOLIO -------------- A. Types of Loans\nB. An analysis of the maturity and interest rate sensitivity of real estate construction and commercial and other loans as of December 31, 1994 follows:\nMaturity analysis:\nSensitivity to changes in interest rates for all such loans due after one year is as follows:\nC. Risk Elements Reference is made to the caption \"Asset Quality\" included in Management's Analysis of Financial Statements on pages 25-27 of the Corporation's 1994 Annual Report to Shareholders incorporated herein by reference. Included therein is a discussion of the Corporation's credit review and collection practices. Also included therein is information concerning property acquired through foreclosure and in-substance foreclosures held at December 31, 1994 and the Corporation's ongoing efforts to dispose of such properties.\n1. Nonaccrual, Past Due and Restructured Loans. (a). Nonaccrual loans as of the dates indicated were as follows:\nFor years 1994, 1993 and 1992, loans, with the exception of credit card loans, were placed on nonaccrual status and interest recognition was suspended when such loans were 90 days or more overdue with respect to principal and\/or interest. Interest previously accrued, but not collected on such loans was reversed against current period income. Cash receipts on nonaccrual loans were recorded as interest income, or as a reduction of principal if full collection of the loan was doubtful or if impairment of the collateral was identified. Loans were removed from nonaccrual status when they had been current as to principal and interest for a period of time, the borrower had demonstrated an ability to comply with repayment terms, and when, in management's opinion, the loans were considered to be fully collectible.\nIn years prior to 1992, commercial loans were placed on nonaccrual status and interest recognition was suspended when they were 90 days or more overdue. Residential mortgages and consumer loans were placed on nonaccrual status when, in management's judgment, the probability of collection was deemed insufficient to warrant further income recognition.\nFor the year ended December 31, 1994, the gross interest income that would have been recognized if loans on nonaccrual status had been current in accordance with their original terms was approximately $628,000. Interest recognized on these loans amounted to approximately $287,000.\nThere were no significant commitments to lend additional funds to borrowers whose loans were on nonaccrual status at December 31, 1994.\n(b). Loans contractually past due 90 days or more and still accruing for the dates indicated were as follows:\n(c). Restructured accruing loans for the dates indicated were as follows:\nRestructured accruing loans include those for which concessions, such as reduction of interest rates other than normal market rate adjustments or deferral of principal or interest payments, have been granted due to a borrower's financial condition. Interest on restructured loans is accrued at the reduced rate. Loans restructured during 1994 amounted to $525,809, of which $160,985 is included in nonaccrual loans reported in Section III.C.1.(a) above.\n2. Potential Problem Loans. Potential problem loans consist of certain accruing commercial loans that were less than 90 days past due at December 31, 1994, including certain loans classified as either substandard, doubtful or loss by the Bank's primary regulator during their most recent examination conducted during the fourth quarter of 1994 and loans identified by management of the Bank as potential problem loans. Such loans are characterized by weaknesses in the financial condition of borrowers or collateral deficiencies. Based on historical experience, the credit quality of some of these loans may improve as a result of collection efforts, while the credit quality of other loans may deteriorate, resulting in some amount of losses. These loans are not included in the analysis of nonaccrual, past due and restructured loans in III.C.1 above.\nAt December 31, 1994, potential problem loans which were contractually current amounted to $4.9 million. In addition, potential problem loans that were 30-89 days past due amounted to approximately $2.3 million at December 31, 1994. The Corporation's loan policy provides guidelines for the review of such loans in order to facilitate collection.\nDepending on future events, the potential problem loans referred to above, and others not currently identified, could be classified as nonperforming in the future.\n3. Foreign Outstandings. None\n4. Loan Concentrations. The Corporation has no concentration of loans which exceed 10% of its total loans except as disclosed by types of loan in Section III.A.\nD. Other Interest-Bearing Assets: None\nIV. SUMMARY OF LOAN LOSS EXPERIENCE ------------------------------- A. The reserve for possible loan losses is available for future credit losses inherent in the loan portfolio. The level of the reserve is based on management's ongoing review of the growth and composition of the loan portfolio, net charge-off experience, current and expected economic conditions, and other pertinent factors. Loans (or portions thereof) deemed to be uncollectible are charged against the reserve and recoveries of amounts previously charged off are added to the reserve. Loss provisions charged to earnings are added to the reserve to bring it to the desired level. Loss experience on loans is presented in the following table for the years indicated.\nAnalysis of the Reserve for Possible Loan Losses ------------------------------------------------\nB. The following table presents the allocation of the allowance for loan losses.\nV. DEPOSITS -------- A. Average deposit balances outstanding and the average rates paid thereon are presented in the following table:\nB. Not Applicable\nC. Not Applicable\nD. The maturity schedule of time deposits in amounts of $100,000 or more at December 31, 1994 was as follows:\nE. Not applicable\nVI. RETURN ON EQUITY AND ASSETS ---------------------------\nVII. SHORT-TERM BORROWINGS --------------------- The average balance of short-term borrowings during the reported periods was less than 30% of shareholders' equity at the end of each reported period. ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ------------------ As of December 31, 1994 the Corporation was operating six facilities including its main office located in Westerly, Rhode Island and five branch banking facilities located in Westerly, Charlestown, Narragansett, Richmond and Block Island, Rhode Island. All sites are owned, except for the Block Island branch facility, which is leased. The main office premises, containing the corporate offices and a banking facility, consists of a five story building and an adjacent two story building. The buildings, which are connected, contain approximately 50,000 square feet of space, 42,000 square feet of which is occupied by the Corporation. The remaining space is leased to merchant and professional tenants under short-term lease arrangements and could be used for expansion of the Corporation's offices. The main office location also contains a three level retail parking garage with 80,000 square feet of space.\nThe Corporation has made a substantial investment in its branch office facilities. The Charlestown banking office opened in 1988 in a newly constructed facility. The Narragansett banking office began operations in June 1989 in a building which had been acquired in 1988 and was completely renovated. A major renovation and expansion of the Richmond banking office was completed in January of 1990. The Richmond site also contains a separate building operated as a restaurant by a restaurant chain under a long-term lease.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS ------------------------- Neither the Corporation nor its subsidiary is a party to any material pending legal proceedings, other than routine litigation incidental to their business activities.\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 year ended December 31, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------\nFollowing is a list of all executive officers of the Corporation and the Bank with their titles, ages, and length of service with the Corporation as of December 31, 1994. (Service prior to 1984 for all executive officers of the Corporation was with the Bank.) Years Officers of the Corporation Age of service --------------------------- --- ---------- Joseph J. Kirby President 63 32\nJoseph H. Potter Executive Vice President 61 36\nDavid V. Devault, CPA Vice President and Chief Financial Officer 40 8\nLouis J. Luzzi Vice President and Treasurer 53 34\nHarvey C. Perry, II Vice President and Secretary 44 20\nJoseph H. Potter and Louis J. Luzzi are first cousins.\nJoseph J. Kirby joined the Bank in 1963 as an Investment Officer. He was elected Vice President and Investment Officer in 1965 and Executive Vice President in 1972. He was elected president in 1982.\nJoseph H. Potter joined the Bank in 1958 and was elected Secretary in 1967. He was elected Vice President and Secretary in 1973 and Executive Vice President in 1982.\nDavid V. Devault joined the Bank in 1986 as Controller. He was elected Vice President and Chief Financial Officer of the Corporation and the Bank in 1987. He was elected Senior Vice President and Chief Financial Officer of the Bank in 1990. Prior to joining the Bank he was a Senior Manager with the firm of KPMG Peat Marwick.\nLouis J. Luzzi joined the Bank in 1960 and was elected Assistant Vice President in 1969. He was elected Vice President in 1979 and Vice President and Treasurer in 1983.\nHarvey C. Perry, II joined the Bank in 1974 and was elected Assistant Trust Officer in 1977, Trust Officer in 1981 and Secretary and Trust Officer in 1982. He was elected Vice President and Secretary of the Corporation and the Bank in 1984, and Senior Vice President and Secretary of the Bank in 1990.\nYears Officers of the Bank Age of service -------------------- --- ---------- Vernon F. Bliven Senior Vice President - 45 22 Human Resources\nRobert G. Cocks, Jr. Senior Vice President - Lending 50 2\nLouis W. Gingerella, Jr. Senior Vice President - 42 4 Credit Administration\nB. Michael Rauh, Jr. Senior Vice President - 35 3 Retail Banking\nVernon F. Bliven joined the Bank in 1972 and was elected Assistant Vice President in 1980, Vice President in 1986 and Senior Vice President - Human Resources in 1993.\nRobert G. Cocks, Jr. joined the Bank in 1992 as Senior Vice President - Lending. Prior to joining the Bank he served as Executive Vice President at Bay Bank South from 1987 to 1991. From 1991 to 1992 he worked as an independent consultant.\nLouis W. Gingerella, Jr. joined the Bank in 1990 as Vice President - Credit Administration. He was elected Senior Vice President - Credit Administration in 1992. Prior to joining the Bank he held the position of Senior Vice President with Bank of New England since 1988.\nB. Michael Rauh, Jr. joined the Bank in 1991 as Vice President - Marketing and was promoted in 1993 to Senior Vice President - Retail Banking. Prior to joining the Bank he was Executive Vice President with the advertising agency of Chaffee & Partners since 1989.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS ------------------------------------------------------------- The Corporation's common stock has traded on the NASDAQ Small-Cap Market since June 19, 1992. Previously, the Corporation's common stock had been listed on the NASDAQ Over-The-Counter Market system since June 1987.\nThe quarterly common stock price ranges and dividends paid per share for the years ended December 31, 1994 and 1993 are presented in the following table. The stock prices are based on the high and low sales prices during the respective quarter. Stock price and dividend amounts have been restated to reflect a 3-for-2 stock split paid in the form of a stock dividend on August 31, 1994.\nThe Corporation will continue to review future common stock dividends based on profitability, financial resources and economic conditions. The Corporation has recorded consecutive quarterly dividends for over one hundred years. On March 16, 1995, the Corporation's Board of Directors declared a cash dividend of $.22 per share, an increase of 10% over the previous dividend amount. The dividend is payable April 17, 1995 to shareholders of record as of April 3, 1995.\nThe Corporation's primary source of funds for dividends paid to shareholders is the receipt of dividends from the Bank. A discussion of the restrictions on the advance of funds or payment of dividends to the Corporation is included in Note 16 to the Consolidated Financial Statements included in the 1994 Annual Report to Shareholders which is incorporated herein by reference.\nAt December 31, 1994 there were 1,216 holders of record of the Corporation's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ------------------------------- Selected consolidated financial data for the five years ended December 31, 1994 appears under the caption \"Five Year Summary of Selected Consolidated Financial Data\" on page 22 of the Corporation's 1994 Annual Report to Shareholders which 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 appears under the caption \"Management's Analysis of Financial Statements\" on pages 23-34 of the Corporation's 1994 Annual Report to Shareholders which is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA --------------------------------------------------- The financial statements and supplementary data are contained in the Corporation's 1994 Annual Report to Shareholders, filed as Exhibit 13, on the pages indicated in the following table, and are incorporated herein by reference.\nPage of 1994 Annual Report ------------- Consolidated Balance Sheets 35 Consolidated Statements of Income 36 Consolidated Statements of Changes in Shareholders' Equity 38 Consolidated Statements of Cash Flows 37 Notes to Consolidated Financial Statements 39 Parent Company Financial Statements 55 Independent Auditor's Report 57 Summary of Unaudited Quarterly Financial Information 58\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 ----------------------------------------------------------- Required information regarding directors is presented under the caption \"Nominee and Director Information\" in the Corporation's Proxy Statement dated March 20, 1995 prepared for the 1995 Annual Meeting of Shareholders and incorporated herein by reference.\nRequired information regarding executive officers of the Corporation is included in Part I under the caption \"Executive Officers of the Registrant\".\nInformation required with respect to compliance with Section 16(a) of the Exchange Act appears under the caption \"Compliance with Section 16(a) of the Exchange Act\" in the Corporation's Proxy Statement dated March 20, 1995 prepared for the 1995 Annual Meeting of Shareholders which is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ------------------------------- The information required by this Item appears under the caption \"Compensation of Directors and Executive Officers - Executive Compensation\" in the Corporation's Proxy Statement dated March 20, 1995 prepared for the 1995 Annual Meeting of Shareholders which is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ------------------------------------------------- The information required by this Item appears under the caption \"Nominee and Director Information\" in the Corporation's Proxy Statement dated March 20, 1995 prepared for the 1995 Annual Meeting of Shareholders which is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ------------------------------------------------------- The information required by this Item is incorporated herein by reference to the caption \"Indebtedness and Other Transactions\" of the Corporation's Proxy Statement dated March 20, 1995 prepared for the 1995 Annual Meeting of Shareholders.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ------------------------------------------------------------------------ (a) 1. The financial statements of Washington Trust Bancorp, Inc. required in response to this Item are listed in response to Item 8 of this Report and are incorporated herein by reference.\n2. Financial Statement Schedules. All schedules normally required by Article 9 of Regulation S-K and all other schedules to the consolidated financial statements of the Corporation have been omitted because the required information is either not required, not applicable, or is included in the consolidated financial statements or notes thereto.\n(b) No reports on Form 8-K have been filed during the fourth quarter of the year ended December 31, 1994.\n(c) Exhibit Index.\nExhibit Number -------------- 3.(i) Restated articles of incorporation 3.(ii) By-laws of the Corporation **\n* 10.1 Supplemental Pension Benefit and Profit Sharing Plan * 10.2 Outside Director's Retainer Continuation Plan * 10.3 Plan for Deferral of Director's Fees * 10.4 Amended and Restated 1988 Stock Option Plan * 10.5 Short Term Incentive Plan ***\n11 Computation of Earnings per share\n13 1994 Annual Report to Shareholders\n21 Subsidiaries of the Registrant\n23 Consent of Independent Auditors\n27 Financial Data Schedule\n* Management contract or compensatory plan or arrangement.\n** Incorporated herein by reference to Exhibit 3 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, previously filed with the Commission.\n*** Incorporated herein by reference to Exhibit 10 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, previously filed with the Commission.\n(d) Financial Statement 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.\nWASHINGTON TRUST BANCORP, INC. ------------------------------ (Registrant)\nMarch 16, 1995 Joseph J. Kirby Date ________________ By ______________________________________ Joseph J. Kirby, President, Principal Executive Officer and Director\nMarch 16, 1995 David V. Devault Date ________________ By ______________________________________ David V. Devault, Vice President, Chief 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.\nMarch 16, 1995 Joseph H. Potter Date ________________ ______________________________________ Joseph H. Potter, Executive Vice President and Director\nMarch 16, 1995 Gary P. Bennett Date ________________ ______________________________________ Gary P. Bennett, Director\nDate ________________ ______________________________________ Steven J. Crandall, Director\nMarch 16, 1995 Richard A. Grills Date ________________ ______________________________________ Richard A. Grills, Director\nMarch 16, 1995 Larry J. Hirsch Date ________________ ______________________________________ Larry J. Hirsch, Director\nMarch 16, 1995 Katherine W. Hoxsie Date ________________ ______________________________________ Katherine W. Hoxsie, Director\nMarch 16, 1995 Mary E. Kennard Date ________________ ______________________________________ Mary E. Kennard, Director\nMarch 16, 1995 James W. McCormick, Jr. Date ________________ ______________________________________ James W. McCormick, Jr., Director\nMarch 16, 1995 Thomas F. Moore Date ________________ ______________________________________ Thomas F. Moore, Director\nMarch 16, 1995 Brendan P. O'Donnell Date ________________ ______________________________________ Brendan P. O'Donnell, Director\nMarch 16, 1995 Victor J. Orsinger, II Date ________________ ______________________________________ Victor J. Orsinger, II, Director\nMarch 16, 1995 Anthony J. Rose, Jr. Date ________________ ______________________________________ Anthony J. Rose, Jr., Director\nMarch 16, 1995 James P. Sullivan Date ________________ ______________________________________ James P. Sullivan, Director\nMarch 16, 1995 Neil H. Thorp Date ________________ ______________________________________ Neil H. Thorp, Director","section_15":""}
{"filename":"77543_1994.txt","cik":"77543","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral\nPerini Corporation and its subsidiaries (the \"Company\" unless the context indicates otherwise) is engaged in two principal businesses: construction and real estate development. The Company, incorporated in 1918 as a successor to businesses which had been engaged since 1894 in providing construction services, celebrated its 100th anniversary in 1994.\nThe Company provides general contracting, construction management and design-build services to private clients and public agencies throughout the United States and selected overseas locations. Historically, the Company's construction business involved four types of operations: civil and environmental (\"heavy\"), building, international and pipeline. However, the Company sold its pipeline construction business in January, 1993 (see Note 1 to the Consolidated Financial Statements).\nThe Company's real estate development operations are conducted by Perini Land & Development Company, a wholly-owned subsidiary with extensive development interests concentrated in historically attractive markets in the United States - Arizona, California, Florida, Georgia and Massachusetts, but has not commenced the development of any new real estate projects since 1990.\nBecause the Company's results consist in part of a limited number of large transactions in both construction and real estate, results in any given quarter can vary depending on the timing of transactions and the profitability of the projects being reported. As a consequence, quarterly results may reflect such variations.\nIn 1988, the Company, in conjunction with two other companies, formed a new entity called Perland Environmental Technologies, Inc. (\"Perland\"). Perland provides consulting, engineering and construction services primarily on a turn-key basis for hazardous material management and clean- up to both private clients and public agencies nationwide. The outlook for this business on a long-term basis appears to be attractive because of the environmental protection laws enacted by Congress. During the fourth quarter of 1991 and early in 1992, Perland repurchased its stock owned by the other outside investors, resulting in an increase in the Company's ownership from its original investment of 47 1\/2% to slightly more than 90%. During the fourth quarter of 1994, the Company acquired the remaining outside interest in Perland.\nIn March 1992, Majestic sold its 41%-interest in Monenco, a company primarily involved in providing engineering services in Canada and throughout the world, resulting in a pretax gain to the Company of approximately $2 million.\nIn January 1993, the Company sold its 74%-ownership in Majestic, its Canadian pipeline construction subsidiary, for $31.7 million which resulted in an after tax gain of approximately $1.0 million.\nAlthough these companies were profitable in both 1992 and 1991, they participated in sectors of the construction business that were not directly related to the Company's core construction operations. The sale of these companies served to generate liquid assets which improved the Company's financial condition without affecting its core construction business.\nEffective July 1, 1993, the Company acquired Gust K. Newberg Construction Co.'s (\"Newberg\") interest in certain construction projects and related equipment. The purchase price for the acquisition was (i) approximately $3 million in cash for the equipment paid by a third party leasing company, which in turn simultaneously entered into an operating lease agreement with the Company for the use of said equipment, (ii) the greater of $1 million or 25% of the aggregate pretax earnings during the period from April 1, 1993 through December 31, 1994, net of payments accruing to Newberg as described in (iii) below, and (iii) 50% of the aggregate of net profits earned from each project from April 1, 1993 through December 31, 1994 and, with regard to one project, through December 31, 1995. This acquisition has been accounted for as a purchase.\nInformation on lines of business and foreign business is included under the following captions of this Annual Report on Form 10K for the year ended December 31, 1994. Annual Report On Form 10K Caption Page Number\nSelected Consolidated Financial Page 19 Information\nManagement's Discussion and Analysis Page 20 Footnote 13 to the Consolidated Financial Page 47 Statements, entitled Business Segments and Foreign Operations\nWhile the \"Selected Consolidated Financial Information\" presents certain lines of business information for purposes of consistency of presentation for the five years ended December 31, 1994, additional information (business segment and foreign operations) required by Statement of Financial Accounting Standards No. 14 for the three years ended December 31, 1994 is included in Note 13 to the Consolidated Financial Statements.\nA summary of revenues by product line for the three years ended December 31, 1994 is as follows:\nRevenues (in thousands) Year Ended December 31, 1994 1993 1992\nConstruction:\nBuilding $ 621,567 $ 736,116 $ 620,628 Heavy 329,317 294,225 288,158\nPipeline - - 100,929 Engineering Services - - 13,559 ---------- ---------- ----------\nTotal Construction Revenues $ 950,884 $1,030,341 $1,023,274 ---------- ---------- ----------\nRevenues (in thousands) Year Ended December 31, 1994 1993 1992\nReal Estate:\nSales of Real Estate $ 33,188 $ 40,053 $ 12,636\nBuilding Rentals 16,388 19,313 24,208 Interest Income 7,031 6,110 6,452\nAll Other 4,554 4,299 4,282 ---------- ---------- ---------- Total Real Estate Revenues $ 61,161 $ 69,775 $ 47,578 ---------- ---------- ----------\nTotal Revenues $1,012,045 $1,100,116 $1,070,852 ========== ========== ==========\nConstruction\nThe general contracting and construction management services provided by the Company consist of planning and scheduling the manpower, equipment, materials and subcontractors required for the timely completion of a project in accordance with the terms and specifications contained in a construction contract. The Company was engaged in over 165 construction projects in the United States and overseas during 1994. The Company has three principal construction operations: heavy, building, and international, having sold its Canadian pipeline construction business in January 1993, and its interest in an engineering services business in March 1992. The Company also has a subsidiary engaged in hazardous waste remediation.\nThe heavy operation undertakes large civil construction projects throughout the United States, with current emphasis on major metropolitan areas, such as Boston, New York City, Chicago and Los Angeles. The heavy operation performs construction and rehabilitation of highways, subways, tunnels, dams, bridges, airports, marine projects, piers and waste water treatment facilities. The Company has been active in heavy operations since 1894, and believes that it has particular expertise in large and complex projects. The Company believes that infrastructure rehabilitation is and will continue to be a significant market in the 1990's.\nThe building operation provides its services through regional offices located in several metropolitan areas: Boston and Philadelphia, serving New England and the Mid-Atlantic area; Detroit and Chicago, operating in Michigan and the Midwest region; and Phoenix, Las Vegas, Los Angeles and San Francisco, serving Arizona, Nevada and California. In 1992, the Company combined its building operations into a new wholly-owned subsidiary, Perini Building Company, Inc. This new company combines substantial resources and expertise to better serve clients within the building construction market, and enhances Perini's name recognition in this market. The Company undertakes a broad range of building construction projects including health care, correctional facilities, sports complexes, hotels, casinos, residential, commercial, civic, cultural and educational facilities.\nThe international operation engages in both heavy and building construction services overseas, funded primarily in U.S. dollars by agencies of the United States government. In selected situations, it pursues private work internationally.\nConstruction Strategy\nThe Company plans to continue to increase the amount of heavy construction work it performs because of the relatively higher margin available on such work. The Company believes the best opportunities for growth in the coming years are in the urban infrastructure market, particularly in Boston, metropolitan New York, Chicago, Los Angeles and other major cities where it has a significant presence, and in other large, complex projects. The Company's acquisition during 1993 of Chicago-based Newberg referred to above is consistent with this strategy. The Company's strategy in building construction is to maximize profit margins; to take advantage of certain market niches; and to expand into new markets compatible with its expertise. Internally, the Company plans to continue both to strengthen its management through management development and job rotation programs, and to improve efficiency through strict attention to the control of overhead expenses and implementation of improved project management systems. Finally, a department was formed in 1992 to improve the Company's focus on strategic planning, construction project development and project finance, and marketing.\nBacklog\nAs of December 31, 1994, the Company's construction backlog was $1.54 billion compared to backlogs of $1.24 billion and $1.17 billion as of December 31, 1993 and 1992, respectively. Backlog (in thousands) as of December 31,\n1994 1993 1992\nNortheast $ 803,967 52% $ 552,035 45% $ 451,746 39% Mid-Atlantic 26,408 2 34,695 3 34,840 3\nSoutheast 783 - 34,980 3 53,971 5 Midwest 293,168 19 143,961 12 211,649 18\nSouthwest 174,984 11 314,058 25 256,973 22\nWest 192,996 13 143,251 11 123,384 10 Canada - - - - 711 -\nOther Foreign 45,473 3 15,161 1 36,279 3 ---------- ---- ---------- ---- ---------- ---- Total $1,538,779 100% $1,238,141 100% $1,169,553 100% ========== ==== ========== ==== ========== ====\nThe Company includes a construction project in its backlog at such time as a contract is awarded or a firm letter of commitment is obtained. As a result, the backlog figures are firm, subject only to the cancellation provisions contained in the various contracts. The Company estimates that approximately $718.7 million of its backlog will not be completed in 1995.\nThe Company's backlog in the Northeast region of the United States remains strong and continues to increase because of its ability to meet the needs of the growing infrastructure construction and rehabilitation market in this region, particularly in the metropolitan Boston and New York City areas. The increase in the Midwest region primarily reflects an increase in building work in that area. Other fluctuations in backlog are viewed by management as transitory.\nTypes of Contracts\nThe four general types of contracts in current use in the construction industry are:\n- Fixed price contracts (\"FP\"), which include unit price contracts, usually transfer more risk to the contractor but offer the opportunity, under favorable circumstances, for greater profits. With the Company's increasing move into heavy and publicly bid building construction in response to current opportunities, the percentage of fixed price contracts continue to represent the major portion of the backlog.\n- Cost-plus-fixed-fee contracts (\"CPFF\") which provide greater safety for the contractor from a financial standpoint but limit profits.\n- Guaranteed maximum price contracts (\"GMP\") which provide for a cost-plus-fee arrangement up to a maximum agreed price. These contracts place risks on the contractor but may permit an opportunity for greater profits than cost-plus-fixed-fee contracts through sharing agreements with the client on any cost savings.\n- Construction management contracts (\"CM\") under which a contractor agrees to manage a project for the owner for an agreed-upon fee which may be fixed or may vary based upon negotiated factors. The contractor generally provides services to supervise and coordinate the construction work on a project, but does not directly purchase contract materials, provide construction labor and equipment or enter into subcontracts.\nHistorically, a high percentage of company contracts have been of the fixed price type. Construction management contracts remain a relatively small percentage of company contracts. A summary of revenues and backlog by type of contract for the most recent three years follows:\nRevenues Year Ended Backlog As Of December 31, December 31,\n1994 1993 1992 1994 1993 1992\n54% 56% 68% Fixed Price 68% 65% 64% 46% 44 32 CPFF, GMP or CM 32% 35 36 ---- ---- ---- ---- ---- ----\n100% 100% 100% 100% 100% 100% ==== ==== ==== ==== ==== ====\nClients\nDuring 1994, the Company was active in the building, heavy and international construction markets. The Company performed work for over 100 federal, state and local governmental agencies or authorities and private customers during 1994. No material part of the Company's business is dependent upon a single or limited number of private customers; the loss of any one of which would not have a materially adverse effect on the Company. As illustrated in the following table, the Company continues to serve a significant number of private owners. During the period 1992- 1994, the portion of construction revenues derived from contracts with various governmental agencies remained relatively constant at, 57% in 1992, 54% in 1993, and 56% in 1994.\nRevenues by Client Source\nYear Ended December 31,\n1994 1993 1992\nPrivate Owners 44% 46% 43% Federal Governmental Agencies 11 12 6\nState, Local and Foreign 45 42 51 Governments ---- ---- ---- 100% 100% 100% ==== ==== ====\nAll Federal government contracts are subject to termination provisions, but as shown in the table above, the Company does not have a material amount of such contracts.\nGeneral\nThe construction business is highly competitive. Competition is based primarily on price, reputation for quality, reliability and financial strength of the contractor. While the Company experiences a great deal of competition from other large general contractors, some of which may be larger with greater financial resources than the Company, as well as from a number of smaller local contractors, it believes it has sufficient technical, managerial and financial resources to be competitive in each of its major market areas.\nThe Company will endeavor to spread the financial and\/or operational risk, as it has from time to time in the past, by participating in construction joint ventures, both in a majority and in a minority position, for the purpose of bidding on projects. These joint ventures are generally based on a standard joint venture agreement whereby each of the joint venture participants is usually committed to supply a predetermined percentage of capital, as required, and to share in the same predetermined percentage of income or loss of the project. Although joint ventures tend to spread the risk of loss, the Company's initial obligations to the venture may increase if one of the other participants is financially unable to bear its portion of cost and expenses. For a possible example of this situation, see \"Legal Proceedings\" on page 18. For further information regarding certain joint ventures, see Note 2 of the Notes to Consolidated Financial Statements.\nWhile the Company's construction business may experience some adverse consequences if shortages develop or if prices for materials, labor or equipment increase excessively, provisions in certain types of contracts often shift all or a major portion of any adverse impact to the customer. On fixed price type contracts, the Company attempts to insulate itself from the unfavorable effects of inflation by incorporating escalating wage and price assumptions, where appropriate, into its construction bids. Gasoline, diesel fuel and other materials used in the Company's construction activities are generally available locally from multiple sources and have been in adequate supply during recent years. Construction work in selected overseas areas primarily employs expatriate and local labor which can usually be obtained as required. The Company does not anticipate any significant impact in 1995 from material and\/or labor shortages or price increases.\nEconomic and demographic trends tend not to have a material impact on\nthe Company's heavy construction operation. Instead, the Company's heavy construction markets are dependent on the amount of heavy civil infrastructure work funded by various governmental agencies which, in turn, may depend on the condition of the existing infrastructure or the need for new expanded infrastructure. The building markets in which the Company participants are dependent on economic and demographic trends, as well as governmental policy decisions as they impact the specific geographic markets.\nThe Company has minimal exposure to environmental liability as a result of the activities of Perland Environmental Technologies, Inc. (\"Perland\"), a 100%-owned subsidiary of the Company. Perland provides hazardous waste engineering and construction services to both private clients and public agencies nationwide. Perland is responsible for compliance with applicable law in connection with its clean up activities and bears the risk associated with handling such materials.\nIn addition to strict procedural guidelines for conduct of this work, the Company and Perland generally carry insurance or receive satisfactory indemnification from customers to cover the risks associated with this business.\nThe Company also owns real estate nationwide, most of which is residential, and as an owner, is subject to laws governing environmental responsibility and liability based on ownership. The Company is not aware of any environmental liability associated with its ownership of real estate property.\nThe Company has been subjected to a number of claims from former employees of subcontractors regarding exposure to asbestos on the Company's projects. None of the claims have been material. The Company also operates construction machinery in its business and will, depending on the project or the ease of access to fuel for such machinery, install fuel tanks for use on-site. Such tanks run the risk of leaking hazardous fluids into the environment. The Company, however, is not aware of any emissions associated with such tanks or of any other environmental liability associated with its construction operations or any of its corporate activities.\nProgress on projects in certain areas may be delayed by weather conditions depending on the type of project, stage of completion and severity of the weather. Such delays, if they occur, may result in more volatile quarterly operating results.\nIn the normal course of business, the Company periodically evaluates its existing construction markets and seeks to identify any growing markets where it feels it has the expertise and management capability to successfully compete or withdraw from markets which are no longer economically attractive.\nReal Estate\nThe Company's real estate development operations are conducted by Perini Land & Development Company (\"PL&D\"), a wholly-owned subsidiary, which has been involved in real estate development since the early 1950's. PL&D engages in real estate development in Arizona, California, Florida, Georgia and Massachusetts. However, in 1993, PL&D significantly reduced its staff in California and has suspended any new land acquisition in that area. PL&D's development operations generally involve identifying attractive parcels, planning and development, arranging financing, obtaining needed zoning changes and permits, site preparation, installation of roads and utilities and selling the land. Originally,\nPL&D concentrated on land development. In appropriate situations, PL&D has also constructed buildings on the developed land for rental or sale.\nFor the past four to five years PL&D has been severely affected by the reduced liquidity in real estate markets brought on by the cutbacks in real estate funding by commercial banks, insurance companies and other institutional lenders. Many traditional buyers of PL&D properties are other developers or investors who depend on third party sources for funding. As a result, some potential PL&D transactions have been cancelled, altered or postponed because of financing problems. Over this period, PL&D looked to foreign buyers not affected by U.S. banking policies or in some cases, provided seller financing to complete transactions. PL&D also experienced slowdowns in negotiations in the sale of PL&D developed income properties or residential units because of economic uncertainties and the reluctance of some buyers to commit to acquisitions in the current environment. Based on a weakening in property values which has come with the industry credit crunch and the national real estate recession, PL&D took a $31 million pre-tax net realizable value writedown against earnings in 1992. The charge affected those properties which PL&D had decided to sell in the near term. Currently it is management's belief that its remaining real estate properties are not carried at amounts in excess of their net realizable values. To achieve full value for some of its real estate holdings, in particular its investments in Rincon Center and the Resort at Squaw Creek, the Company may have to hold those properties several years and currently intends to do so.\nReal Estate Strategy\nSince 1990, PL&D has taken a number of steps to minimize the adverse financial impact of current market conditions. In early 1990, all new real estate investment was suspended pending market improvement, all but critical capital expenditures were curtailed on on-going projects and PL&D's workforce was cut by over 60%. Certain project loans were extended, with such extension usually requiring paydowns and increased annual amortization of the remaining loan balance. Going forward, PL&D will operate with a reduced staff and adjust its activity to meet the demands of the market.\nPL&D's real estate development project mix includes planned community, industrial park, commercial office, multi-unit residential, urban mixed use, resort and single family home developments. Given the current real estate environment, PL&D's emphasis is on the sale of completed product and also developing the projects in its inventory with the highest near term sales potential. It may also selectively seek new development opportunities in which it serves as development manager with limited equity exposure, if any.\nReal Estate Properties\nThe following is a description of the Company's major development projects and properties by geographic area:\nFlorida\nWest Palm Beach and Palm Beach County - At year end, PL&D had completed the sale of all of the original 1,428 acres located in West Palm Beach at the development known as \"The Villages of Palm Beach Lakes\". During 1994, the final 21 acres were sold. \"The Villages\" is a planned community development that, when completed, will provide approximately\n6,750 residential dwelling units and related commercial developments, clustered around two championship golf courses designed by Jack Nicklaus.\nFrom 1982 to 1989, Burg & DiVosta, one of Florida's largest privately-owned building firms, built and sold 2,264 townhouse units in \"The Villages\". Burg & DiVosta also delivered 575 zero-lot-line three bedroom, two bath, single-family homes within several subdivisions of \"The Villages\" and 480 mid-rise condominium units.\nIn 1991, the final 57 of 83 lots at Bear Lakes Estates, an upscale single family neighborhood within \"The Villages\", were sold to a residential developer who is currently building out the development.\nIn 1993, PL&D sold tracts totaling approximately 52 acres and in 1994, the final 21 acres were sold. Recent sales within the development have been almost totally made to residential multi-unit rental developers. PL&D's only continuing interest in the project will be its ownership in the Bear Lakes Country Club which under agreement with the membership can be turned over to the members when membership reaches 650. Current membership is 437.\nAt Metrocentre, a 51-acre commercial\/office park at the intersection of Interstate 95 and 45th Street in West Palm Beach, two sites totalling 8 acres were sold in 1994 and all remaining financing on the project was repaid. One site is being developed by a national restaurant chain, the other was acquired by an existing property owner within the park for expansion. At year-end, a third site is in negotiation with a possible closing sometime in 1995. The park consists of 17 parcels, of which 3 remain unsold at year-end. The park provides for 570,500 square feet of mixed commercial uses.\nMassachusetts\nPerini Land and Development or Paramount Development Associates, Inc. (\"Paramount\"), a wholly-owned subsidiary of PL&D, owns the following projects:\nRaynham Woods Commerce Center, Raynham - In 1987, Paramount acquired a 409 acre site located in Raynham, Massachusetts, on which it had done preliminary investigatory and zoning work under an earlier purchase option period. During 1988, Paramount secured construction financing and completed infrastructure work on a major portion of the site (330 acres) which is being developed as a mixed-use corporate campus style park known as \"Raynham Woods Commerce Center\". During 1989, Paramount completed the sale of a 24-acre site to be used as a headquarters facility for a division of a major U.S. company. During 1990, construction was completed on this facility. In 1990 construction was also completed on two new commercial buildings by Paramount. During 1992, a 17-acre site was sold to a developer who was working with a major national retailer. The site has since been developed into the first retail project in the park. No new land sales were made in 1993, but in 1994, an 11 acre site was sold to the same major U.S. company which had acquired land in 1989. Although the two Paramount commercial buildings owned within the park experienced some tenant turnover in 1994, they remained 90% occupied at year-end. The park is planned to eventually contain 2.5 million square feet of office, R&D, light industrial and mixed commercial space.\nRobin Hill, Marlborough - The Robin Hill project is located at the intersection of Routes 495 and 290 in Marlborough, Massachusetts. The major portion of this property was sold in 1985-1987. Paramount exercised its option to purchase an additional 53 acres of contiguous property in\n1989. In 1993, this site was identified as the potential location for a new retail center and was sold by Paramount in 1994.\nEaston Business Center, Easton - In 1989, Paramount acquired a 40-acre site in Easton, Massachusetts, which had already been partially developed. Paramount completed the work in 1990 and is currently marketing the site to commercial\/industrial users. No sales were closed in 1994.\nWareham - In early 1990, Paramount acquired an 18.9 acre parcel of land at the junction of Routes 495 and 58 in Wareham, Massachusetts. The property is being marketed to both retail and commercial\/industrial users. No sales were closed in 1994.\nEaston Industrial Park, Easton - In 1992, PL&D acquired four single-story industrial\/office buildings located in the Easton Industrial Park with an aggregate square footage of 110,000. The buildings, originally developed by Paramount, were acquired from Pacific Gateway Properties (formerly Perini Investment Properties) in 1992 as part of an overall settlement agreement. Late in 1993, these buildings were put under a contract of sale and were sold in early 1994.\nGeorgia\nThe Villages at Lake Ridge, Clayton County - During 1987, PL&D (49%) entered into a joint venture with 138 Joint Venture partners to develop a 348-acre planned commercial and residential community in Clayton County to be called \"The Villages at Lake Ridge\", six miles south of Atlanta's Hartsfield International Airport. By year end 1990, the first phase infrastructure and recreational amenities were in place. In 1991, the joint venture completed the infrastructure on 48 lots for phased sales of improved lots to single family home builders and sold nine. During 1992, the joint venture sold an additional 60 lots and also sold a 16-acre parcel for use as an elementary school. During 1993, unusually wet weather in the spring delayed construction on improvements required to deliver lots as scheduled. As a result, the sale of an additional 58 lots in 1993 were below expectation. Although 1994 started off strong, rising interest rates created a slowdown in activity later in the year. For the year, 52 lots were sold. Because most of the homes built within the development are to first time buyers, demand is highly sensitive to mortgage rates and other costs of ownership. Financing restrictions generally require the joint venture to allow developers to take down finished lots only as homes built on previously acquired lots are sold. As a result, any slowdown in home sales will influence joint venture sales quickly thereafter. The development plan calls for mixed residential densities of apartments and moderate priced single-family homes totalling 1,158 dwelling units in the residential tracts plus 220,000 square feet of retail and 220,000 square feet of office space in the commercial tracts.\nGarden Lakes - During 1994 PL&D (49.5%), in joint venture, sold this 278-unit apartment complex on an 18.5 acre tract within the Villages of Lake Ridge.\nThe Oaks at Buckhead, Atlanta - Sales commenced on this 217-unit residential condominium project at a site in the Buckhead section of Atlanta near the Lenox Square Mall in 1992. The project consists of 201 residences in a 30-story tower plus 16 adjacent three-story townhome residences. At year end 123 units were either sold or under contract. Fifty-three of these units were sold in 1994, up from 35 the previous year. PL&D (50%) is developing this project in joint venture with a subsidiary of a major Taiwanese company.\nCalifornia\nRincon Center, San Francisco - Major construction on this mixed-use project in downtown San Francisco was completed in 1989. The project, constructed in two phases, consists of 320 residential rental units, approximately 423,000 square feet of office space, 63,000 square feet of retail space, and a 700-space parking garage. Following its completion in 1988, the first phase of the project was sold and leased back by the developing partnership. The first phase consists of about 223,000 square feet of office space and 42,000 square feet of retail space. The Phase I office space continues to be close to 100% leased with the regional telephone directory company as the major tenant on leases which run into early 1998. The retail space was 90% leased at year end. Phase II of the project, which began operations in late 1989, consists of approximately 200,000 square feet of office space, 21,000 square feet of retail space, a 14,000 square foot U.S. postal facility, and 320 apartment units. At year end, close to 100% of the office space, 94% of the retail space and all but 9 of the 320 residential units were leased. The major tenant in the office space in Phase II is the Ninth Circuit Federal Court of Appeals which is leasing approximately 176,000 square feet. That lease expires at the end of 1996 with the tenant holding an option for two additional years. Currently efforts are underway to determine whether those options will be exercised. PL&D currently holds a 46% interest in and is managing general partner of the partnership which is developing the project. The land related to this project is being leased from the U.S. Postal Service under a ground lease which expires in 2050.\nIn addition to the project financing and guarantees disclosed in the first, second and third paragraphs of Footnote 11 to Notes to the Consolidated Financial Statements, the Company has advanced approximately $72.4 million to the partnership through December 31, 1994, of which approximately $1.4 million was advanced during 1994, primarily to paydown some of the principal portion of project debt which was renegotiated during 1993. In 1994, operations before principal repayment of debt created a positive cash flow on an annual basis for the first time.\nTwo major loans on this property in aggregate totaling over $75 million were scheduled to mature in 1993. During 1993 both loans were extended for five additional years. To extend these loans, PL&D provided approximately $6 million in new funds which were used to reduce the principal balances of the loans. In 1994 and over the next four years, additional amortization will be required, some of which may not be covered by operating cash flow and, therefore, at least 80% of those funds not covered by operations will be provided by PL&D as managing general partner. Lease payments and loan amortization obligations at Rincon Center through 1997 are as follows: $6.9 million in 1995; $7.5 million in 1996; $7.3 million in 1997. Based on Company forecasts, it could be required to contribute as much as $10.4 million to cover these requirements not covered by project cash flow through 1997. Although management believes operating expenses will be covered by operating cash flow at least through 1997, the Company's share of project depreciation, which could be as much as $2 million annually, will not be covered through operating profit and, therefore, will continue to reduce the Company's reported earnings by that amount. In addition, interest rates on much of the debt financing covering Rincon Center are variable based on various rate indices. With the exception of approximately $20 million of the financing, none of the debt has been hedged or capped and is subject to market fluctuations. From time to time the, Company reviews the costs and anticipated benefits from hedging Rincon Center's interest rate commitments. Based on current costs to further hedge rate increases, the Company has elected not to provide any additional hedges at this time.\nAs part of the Rincon One sale and operating lease-back transaction, the joint venture agreed to obtain an additional financial commitment on behalf of the lessor to replace at least $33 million of long-term financing by January 1, 1998. If the joint venture has not secured a further extension or new commitment for financing on the property for at least $33 million, the lessor will have the right under the lease to require the joint venture to purchase the property for a stipulated amount of approximately $18.8 million in excess of the then outstanding debt. Management believes it will be able to extend the financing or refinance the building such that this sale back to the Company will not occur.\nDuring 1993 PL&D agreed, if necessary, to lend Pacific Gateway Properties (PGP), the other General Partner in the project, funds to meet its 20% share of cash calls. In return PL&D receives a priority return from the partnership on those funds and penalty fees in the form of rights to certain distributions due PGP by the partnership controlling Rincon. During 1993 and 1994, PL&D advanced $1.7 million and $.3 million, respectively, under this agreement, primarily to meet the principal payment obligations of the loan extensions described above.\nDuring 1994, a major commercial tenant with a lease running through 1996 indicated it may be vacating all or a portion of its 180,000 square feet of office space on or before the end of its lease. Although the exact status of the current tenant's intentions are still unknown, the space is being shown to potential tenants for possible 1997 occupancy.\nThe Resort at Squaw Creek - During 1990, construction was completed on the 405-unit first phase of the hotel complex of this major resort-conference facility. In mid-December of that year, the resort was opened. In 1991, final work was completed on landscaping the golf course, as well as the remaining facilities to complete the first phase of the project. The first phase of the project includes a 405-unit hotel, 36,000 square feet of conference facilities, a Robert Trent Jones, Jr. golf course, 48 single-family lots, all but three of which had been sold or put under contract by early 1993, three restaurants, an ice skating rink, pool complex, fitness center and 11,500 square feet of various retail support facilities. The second phase of the project is planned to include an additional 409-unit hotel facility, 36 townhouses, 27,000 square feet of conference space, 5,000 square feet of retail space and a parking structure. No activity on the second phase will begin until stabilization is attained on phase one and market conditions warrant additional investment.\nWhile PL&D has an effective 18% ownership interest in this joint venture, it has additional financial commitments as described below.\nIn addition to the project financing and guarantees disclosed in paragraphs four and five of Note 11 to Notes to the Consolidated Financial Statements, the Company has advanced approximately $72.6 million to the joint venture through December 31, 1994, of which approximately $3.2 million was advanced during 1994, for the cost of operating expenses and interest payments. Further, it is anticipated the project may require additional funding by PL&D before it reaches stabilization which may take several years. During 1992, the majority partner in the joint venture sold its interest to a group put together by an existing limited partner. As a part of that transaction, PL&D relinquished its managing general partnership position to the buying group, but retained a wide range of approval rights. The result of the transaction was to strengthen the financial support for the project and led to an extension of the bank financing on the project to mid-1995. The $48 million of bank financing on the project currently matures in May, 1995. Preliminary conversations have taken place with the project's lead bank and management anticipates extension or replacement of the loan. However, as with any real estate financing, there is no assurance that an extension or replacement financing will be available. In the event that were to happen, the property would be subject to foreclosure and possible sale at a value below the Company's present investment basis.\nAs part of Squaw Creek Associates partnership agreement, either partner may initiate a buy\/sell agreement on or after January 1, 1997. Such buy\/sell agreement, which is similar to those often found in real estate development partnerships, provides for the recipient of the offer to have the option of selling its share or purchasing its partners share at the proportionate amount applicable based on the offer price and the specific priority of payout as called for under the partnership agreement based on a sale and termination of the partnership. The Company does not anticipate such a circumstance, because until the end of the year 2001, the partner would lose the certainty of a $2 million annual preferred return currently guaranteed by the Company. However, an exercise of the buy\/sell agreement by its partner could force the Company to sell its ownership at a price possibly significantly less than its full value should the Company be unable to buy out its partner and were forced to sell at the price initiated by its partner.\nThe operating results of this project are weather sensitive. For example, a large snowfall in late 1994 helped improve results in the fourth quarter of 1994 and, for the full year the resort showed marked improvement over the previous year with funds available for debt service doubling as compared to 1993.\nCorte Madera, Marin County - After many years of intensive planning, PL&D obtained approval for a 151 single-family home residential development on its 85-acre site in Corte Madera and, in 1991, was successful in gaining water rights for the property. In 1992, PL&D initiated development on the site which was continued into 1993. This development is one of the last remaining in-fill areas in southern Marin County. In 1993, when PL&D decided to scale back its operations in California, it also decided to sell this development in a transaction which closed in early 1994. The transaction calls for PL&D to get the majority of its funds from the sale of residential units or upon the sixth anniversary of the sale whichever takes place first and, although indemnified, to leave in place certain bonds and other assurances previously given to the town of Corte Madera guaranteeing performance in compliance with approvals previously obtained. By year-end 1994, most of the infrastructure related to the development had been completed by the purchaser using equity funds. PL&D has agreed to subordinate its debt to a commercial lender who will be financing the building of housing units.\nArizona\nI-10 West, Phoenix - In 1979, I-10 Industrial Park Developers (\"I-10\"), an Arizona partnership between Paramount Development Associates, Inc. (80%) and Mardian Development Company (20%), purchased approximately 160 acres of industrially zoned land located immediately south of the Interstate 10 Freeway, between 51st and 59th Avenues in the City of Phoenix. The project experienced strong demand through 1988. With the recent downturn in the Arizona real estate markets, sales have slowed. No sales were made in 1994, leaving approximately 13 acres unsold.\nAirport Commerce Center, Tucson - In 1982, the I-10 partnership purchased 112 acres of industrially zoned property near the Tucson International Airport. During 1983, the partnership added 54 acres to that project, bringing its total size to 166 acres. This project has experienced a low level of sales activity due to an excess supply of industrial property in the marketplace. However, the partnership built and fully leased a 14,600 square foot office\/warehouse building in 1987 on a building lot in the park, which was sold during 1991. In 1990, the partnership sold 14 acres to a major airline for development as a processing center and, in 1992, sold a one acre parcel adjacent to the existing property. After experiencing no new sales in 1993, approximately 12 acres were sold in 1994 and currently an additional 9 acres are under agreement for sale in 1995. At year end, approximately 111 acres remain to be sold.\nPerini Central Limited Partnership, Phoenix - In 1985, PL&D (75%) entered into a joint venture with the Central United Methodist Church to master plan and develop approximately 4.4 acres of the church's property in midtown Phoenix. Located adjacent to the Phoenix Art Museum and near the Heard Museum, the project is positioned to become the mixed use core of the newly formed Phoenix Arts District. In 1990, the project was successfully rezoned to permit development of 580,000 square feet of office, 37,000 square feet of retail and 162 luxury apartments. Plans for the first phase of this project, known as \"The Coronado\" have been put on hold pending improved market conditions. In 1993, PL&D obtained a three-year extension of the construction start date required under the original zoning and for the present is continuing to hold the project in abeyance.\nGrove at Black Canyon, Phoenix - The project consists of an office park complex on a 30-acre site located off of Black Canyon Freeway, a major Phoenix artery, approximately 20 minutes from downtown Phoenix. When complete, the project will include approximately 650,000 square feet of office, hotel, restaurant and\/or retail space. Development, which began in 1986, is scheduled to proceed in phases as market conditions dictate. In 1987, a 150,000 square foot office building was completed within the park and now is 97% leased with approximately half of the building leased to a major area utility company. During 1993, PL&D (50%) successfully restructured the financing on the project by obtaining a seven-year extension with some amortization and a lower fixed interest rate. The annual amortization commitment is not currently covered by operating cash flow, which has caused PL&D to have to provide approximately $1.2 million in 1994 to cover the shortfall. In the near term it appears approximately $800,000 per year of support to cover loan amortization will continue to be required. No new development within the park was begun in 1994 nor were any land sales consummated. However, the lease covering space occupied by the major office tenant was extended an additional seven years to the year 2004 on competitive terms.\nSabino Springs Country Club, Tucson - During 1990, the Tucson Board of Supervisors unanimously approved a plan for this 410-acre residential golf course community close to the foothills on the east side of Tucson. In 1991, that approval which had been challenged, was affirmed by the Arizona Supreme Court. When developed, the project will consist of 496 single-family homes and an 18-hole Robert Trent Jones, Jr. designed championship golf course and club. In 1993, PL&D recorded the master plat on the project and sold a major portion of the property to an international real estate company. Although it will require some infrastructure development before sale, PL&D still retains 33 estate lots for sale in future years.\nCapitol Plaza, Phoenix - In 1988, PL&D acquired a 1 3\/4-acre parcel of land located in the Governmental Mall area of Phoenix. Original plans were to either develop a 200,000 square foot office building on the site to be available to government and government related tenants or to sell the site. The project has currently been placed on hold pending a change in market conditions.\nGeneral\nThe Company's real estate business is influenced by both economic conditions and demographic trends. A depressed economy may result in lower real estate values and longer absorption periods. Higher inflation rates may increase the values of current properties, but often are accompanied by higher interest rates which may result in a slowdown in property sales because of higher carrying costs. Important demographic trends are population and employment growth. A significant reduction in either of these may result in lower real estate prices and longer absorption periods.\nThe well publicized problems in the commercial bank and savings and loan industries over the past several years have resulted in sharply curtailed credit available to acquire and develop real estate; further, the current national real estate recession has significantly slowed the pace at which PL&D has been able to proceed on certain of its development projects and its ability to sell developed product. In some or all cases, it has also reduced the sales proceeds realized on such sales and\/or required extended payment terms.\nGenerally, there has been no material impact on PL&D's real estate development operations over the past 10 years due to interest rate increases. However, an extreme and prolonged rise in interest rates could create market resistance for all real estate operations in general, and is always a potential market obstacle. PL&D, in some cases, employs hedges or caps to protect itself against increases in interest rates on any of its variable rate debt and, therefore, is insulated from extreme interest rate risk on borrowed funds, although specific projects may be impacted if the decision has been made not to hedge or to hedge at higher than current rates.\nThe Company has been replacing relatively low cost debt-free land in Florida acquired in the late 1950's with land purchased at current market prices. In the future, as the mix of land sold contains proportionately less low cost land, the gross margin on real estate revenues will decrease.\nInsurance and Bonding\nAll of the Company's properties and equipment, both directly owned or owned through partnerships or joint ventures with others, are covered by insurance, and management believes that such insurance is adequate. However, due to conditions in the insurance market, the Company's California properties, both directly owned and owned in partnership with others, are not fully covered by earthquake insurance.\nIn conjunction with its construction business, the Company is often required to provide various types of surety bonds. The Company has dealt with the same surety for over 75 years and it has never been refused a bond. Although from time-to-time the surety industry encounters limitations affecting the bondability of very large projects, the Company has not encountered any limit on its bonding ability that has adversely impacted its operations.\nEmployees\nThe total number of personnel employed by the Company is subject to seasonal fluctuations, the volume of construction in progress and the relative amount of work performed by subcontractors. During 1994, the maximum number of employees employed was approximately 2,900 and the minimum was approximately 2,100.\nThe Company operates as a union contractor. As such, it is a signatory to numerous local and regional collective bargaining agreements, both directly and through trade associations, throughout the country. These agreements cover all necessary union crafts and are subject to various renewal dates. Estimated amounts for wage escalation related to the expiration of union contracts are included in the Company's bids on various projects and, as a result, the expiration of any union contract in the current fiscal year is not expected to have any material impact on the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nProperties applicable to the Company's real estate development activities are described in detail by geographic area in Item 1. Business on pages 8 through 15. All other properties used in operations are summarized below: Owned or Approximate Approximate Principal Offices Leased by Acres Square Feet Perini of Office Space\nFramingham, MA Owned 9 110,000\nPhoenix, AZ Owned 1 22,000 Southfield, MI Leased - 13,900\nSan Francisco, CA Leased - 3,500 Hawthorne, NY Leased - 12,500\nWest Palm Beach, FL Leased - 5,000\nLos Angeles, CA Leased - 2,000 Las Vegas, NV Leased - 3,000\nAtlanta, GA Leased - 1,700 Chicago, IL Leased - 14,700\nPhiladelphia, PA Leased - 2,100 -- -------\n10 190,400 == ======= Principal Permanent Storage Yards\nBow, NH 70 Owned Framingham, MA 6 Owned\nE. Boston, MA 6 Owned\nLas Vegas, NV 2 Leased Novi, MI 3 Leased --\n==\nThe Company's properties are generally well maintained, in good condition, adequate and suitable for the Company purpose and fully utilized.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn July 30, 1993, the U.S. District Court (D.C.) upheld the Contracting Officer's terminations for default, both dated May 11, 1990, on two adjacent contracts for subway construction between Mergentime-Perini (two joint ventures) and the Washington Metropolitan Area Transit Authority (\"WMATA\") and found the Mergentime Corporation, Perini Corporation and the Insurance Company of North America, the surety, jointly and severally liable to WMATA for damages in the amount of $16.5 million, consisting primarily of excess reprocurement costs. The court deferred ruling on the net value of the joint ventures' major claims against WMATA. Any such amounts awarded to the joint ventures could serve to offset the above damages award. Originally Mergentime Corporation was the sponsor and manager of both joint ventures with a 60% interest in each. Perini held the remaining 40%. The contracts were awarded in 1985 and 1986 but subsequently in 1987, Perini and Mergentime entered into an agreement whereby Perini withdrew from the joint ventures, but remained obligated to WMATA under the contracts. At that point, Mergentime assumed full control over the performance of both projects. After the termination of the joint ventures' contracts in May of 1990, Perini Corporation, acting independently, was awarded a separate contract by WMATA to finish these projects, both of which were successfully completed on schedule.\nMergentime may be unable to meet its financial obligations under the award. In such event the Company, as a joint venture partner, could be liable for the entire amount. Currently, both parties have filed post- trial motions with the District Court attacking the decision and award. The successor judge is treating the judgement as one that is not a final judgment and thus not one from which an appeal lies pending rulings on the motions. It is anticipated that the Court's review of the case and the motions will require substantial time and effort. The Court has indicated that it intends to give the case the consideration it deserves. No date has been set for the continuation of the case.\nThe ultimate financial impact, if any, of this judgment is not yet determinable, and therefore, no impact is reflected in the 1993 or 1994 financial statements.\nIn the ordinary course of its construction business, the Company is engaged in other lawsuits. The Company believes that such lawsuits are usually unavoidable in major construction operations and that their resolution will not materially affect its results of future operations and 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 STOCK AND RELATED STOCKHOLDER\nMATTERS\nThe Company's common stock is traded on the American Stock Exchange under the symbol \"PCR\". The quarterly market price ranges (high- low) for 1994 and 1993 are summarized below: 1994 1993 Market Price Range per High Low High Low Common Share: Quarter Ended March 31 13 7\/8 - 11 1\/4 18 5\/8 - 14 1\/8 June 30 13 3\/8 - 10 7\/8 14 7\/8 - 13 September 30 11 1\/2 - 9 1\/8 13 1\/2 - 9 7\/8 December 31 11 1\/8 - 9 1\/8 12 3\/4 - 10 1\/8\nFor information on dividend payments, see Selected Financial Data in Item 6","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nMANAGEMENT'S DISCUSSION AND ANALYSIS\nRESULTS OF OPERATIONS - 1994 COMPARED TO 1993\nThe Company's 1994 operations resulted in net income of $.3 million on revenues of $1.0 billion and a loss of 42 cents per common share (after giving effect to the dividend payments required on its preferred stock) compared to net income of $3.2 million or 24 cents per common share on revenues of $1.1 billion in 1993. In spite of the overall decrease in revenues during 1994, income from operations increased slightly compared to 1993 results. An increase in interest expense in 1994 and the non- recurring $1 million net gain after tax in 1993 from the sale by the Company of its 74%-ownership interest in Majestic Contractors Limited (\"Majestic\"), its Canadian pipeline subsidiary, contributed to the overall decrease in net income.\nRevenues were down from the record level established last year and amounted to $1.012 billion in 1994 compared to $1.100 billion in 1993, a decrease of $88 million (or 8%). This decrease resulted primarily from a net decrease in construction revenues of $79 million (or 8%) from $1.030 billion in 1993 to $.951 billion in 1994 due to a decrease in volume from building operations of $126 million (or 17%), from $752 million in 1993 to $626 million in 1994. The decrease in revenue from building operations was primarily due to the prolonged start-up phases on certain projects. This decrease was partially offset by an increase in revenues from civil and environmental construction operations of $47 million (or 17%), from $278 million in 1993 to $325 million in 1994, due to an increased heavy construction backlog going into 1994. In addition to the overall decrease in construction revenues, revenues from real estate operations decreased $8.6 million (or 12%), from $69.8 million in 1993 to $61.2 million in 1994, due primarily to the non-recurring sale ($23.2 million) in 1993 of a\npartnership interest in certain commercial rental properties in San Francisco and a $5.2 million decrease in land sales in Arizona. The decrease in real estate revenues was partially offset from the sale of two investment properties in 1994 ($8.3 million) and increased land sales in Massachusetts ($5.4 million) and California ($4.9 million).\nIn spite of the 8% decrease in total revenues, the gross profit in 1994 decreased only $1.0 million (or 2%), from $52.8 million in 1993 to $51.8 million in 1994. The gross profit from construction operations decreased $1.1 million (or 2.3%), from $49.1 million in 1993 to $48.0 million in 1994, due to the negative profit impact from the reduction in building construction revenues referred to above and a loss from international operations resulting from unstable economic and political conditions in a certain overseas location where the Company is working. These decreases were partially offset by slightly higher margins on the construction work performed in 1994 (5.0% in 1994 compared with 4.8% in 1993) and a slight overall increase ($.1 million) in the gross profit from real estate operations, from $3.7 million in 1993 compared to $3.8 million in 1994.\nTotal general, administrative and selling expenses decreased by $1.2 million (or 3%) in 1994, from $44.2 million in 1993 to $43.0 million in 1994 due to several factors, the more significant ones being a $2.1 million expense for severance incurred in 1993 in connection with re- engineering some of the business units, which was partially offset by the full year impact of expenses related to the acquisition referred to in Note 1 to Notes to the Consolidated Financial Statements.\nThe decrease in other income (expense), net of $6.1 million, from income of $5.2 million in 1993 to a net loss of $.9 million in 1994 is primarily due to the pretax gain in 1993 of $4.6 million on the sale of Majestic and, to a lesser degree, an increase in other expenses in 1994, primarily bank fees.\nThe increase in interest expense of $1.8 million (or 32%), from $5.7 million in 1993 to $7.5 million in 1994 primarily results from higher interest rates during 1994 and higher average level of borrowings.\nLooking ahead, we must consider the Company's construction backlog and remaining inventory of real estate projects. The overall construction backlog reached a record $1.539 billion at the end of 1994, an increase of $301 million (or 24%), from the $1.238 billion at the end of 1993. This backlog is well balanced over the various business units included in both the building and civil and environmental operating groups. Approximately 70% of this increase in backlog can be attributable to an increase in the backlog of heavy construction contracts. This increase could indicate a relative increase in higher margin heavy construction revenues in the future.\nWith the sale of the final 21 acres during 1994, the Company's Villages of Palm Beach Lakes, Florida land inventory is completely sold out. Because of its low book value, sales of this acreage have provided a major portion of the Company's real estate profit in recent years. With this property fully sold, the Company's ability to generate profit from real estate sales and the related gross margin will be reduced. Between 1989 and 1994, property prices in general have fallen substantially due to the reduced liquidity in real estate markets and reduced demand. Recently, the Company has noted improvement in some property areas. This trend has had some effect on residential property sales which were closed in 1994. However, this trend is still not widespread nor proven to be sustainable. The Company's profitability will also be affected by the continuation of approximately $3 million of annual depreciation recognized through its\nshare of ownership in joint venture properties which to date has not been fully covered by operating profit.\nRESULTS OF OPERATION - 1993 COMPARED TO 1992\nThe improved operating results in 1993 resulted in net income of $3.2 million (or $.24 per common share) compared to a net loss in 1992 of $17 million (or $4.69 per common share). The primary reason for this improvement was the nominal profit generated by real estate operations in 1993 compared to a $47 million operating loss in 1992 which included a $31.4 million pretax net realizable value writedown on certain real estate assets management decided to liquidate in the near term. However, profits from construction operations decreased due primarily to the mix of work performed in 1993, relatively more of the lower margin building work and relatively less of the higher margin heavy and pipeline construction work, the latter being due to the sale by the Company of its 74%-ownership interest in Majestic in January 1993.\nRevenues reached a new record for the second consecutive year and amounted to $1.100 billion in 1993 compared to $1.071 billion in 1992, an increase of $29 million (or 3%). This increase resulted primarily from a net increase in construction revenues of $7 million from $1.023 billion in 1992 to $1.030 billion in 1993 due primarily to an increase in volume from building operations of $113 million (or 19%), from $604 million in 1992 to $717 million in 1993 due to an increased backlog going into 1993 and certain fast-track hotel\/casino projects included in the backlog, and to a lesser degree, a small increase in heavy construction revenues. These increases more than offset the $101 million decrease in revenues from pipeline construction due to the sale referred to above and a $14 million decrease from engineering services due to the sale of Monenco Group Ltd. (\"Monenco\") in the first quarter of 1992. In addition, revenues from real estate operations increased by $22.2 million, from $47.6 million in 1992 to $69.8 million in 1993 due primarily to the sale of a partnership interest in certain commercial rental properties in San Francisco ($23.2 million) and, to a lesser degree, a $7 million increase in land sales in Florida.\nGross profit in 1993 increased by $30.6 million, from $22.2 million in 1992 to $52.8 million in 1993 due primarily to a $47.2 million increase from real estate operations, from a $43.5 million loss in 1992 to a $3.7 million profit in 1993. This improvement from real estate operations is due primarily to the non-recurring $31.4 million pretax net realizable value writedown in 1992 referred to previously, the profitable sale of certain commercial rental properties in San Francisco, profitable land sales in Florida and a $1.3 million improvement in results from a major ongoing operating property, the Resort at Squaw Creek. This increase in gross profit was offset by a decrease in gross profit from construction operations of $16.6 million, from $65.7 million in 1992 to $49.1 million in 1993 due primarily to the sale of Majestic and Monenco referred to above, a combined $18 million decrease.\nTotal general, administrative and selling expenses increased by $2.9 million (or 7%) in 1993, from $41.3 million in 1992 to $44.2 million in 1993 due to several factors, including $2.2 million related to the acquisition referred to in Note 1 to Notes to the Consolidated Financial Statements, a $2.1 million expense for severance incurred in connection with reengineering some of the business units, and additional personnel for the Company's ongoing heavy construction operations. These increases were partially offset by the $5.1 million decrease resulting from the sale of Majestic referred to above.\nThe increase in other income of $4.8 million, from $.4 million in 1992 to\n$5.2 million in 1993 is due to the gain of $4.6 million on the sale of Majestic and a decrease in the deduction for minority interest, both of which were partially offset by the nonrecurring gain of $2 million from the sale of Monenco in 1992.\nThe decrease in interest expense of $2 million (or 26%), from $7.7 million in 1992 to $5.7 million in 1993, primarily results from lower interest rates during 1993 and lower average borrowings due to the continued pay down of real estate and other debt, and, to a lesser degree, less interest expense related to Majestic due to the sale.\nThe higher-than-normal tax rate in 1993 is due to additional tax provided on the gain on the sale of Majestic for the difference between the book and tax bases of the Company's investment in this subsidiary.\nFINANCIAL CONDITION\nCASH AND WORKING CAPITAL\nDuring 1994, the Company used $15.6 million in cash for investment activities, primarily to fund construction and real estate joint ventures; $7.4 million for financing activities, primarily to pay down company debt; and $5.0 million to fund operating activities, primarily changes in working capital. In the future, the Company has additional financial commitments to certain real estate joint ventures as described in Note 11 to Notes to the Consolidated Financial Statements.\nDuring 1993, the Company used $39.1 million of cash for investment activities, primarily to fund construction and real estate joint ventures; $3 million for financing activities, primarily to pay down Company debt; and $1.6 million to fund operating activities, primarily changes in working capital.\nDuring 1992, the Company provided $55.4 million of cash from operations and $14.2 million of cash from the sale of its investment in Monenco. Of this amount, $29.9 million was used for investing activities, primarily in two real estate joint ventures and, to a lesser degree, real estate properties used in operations; $7.1 million was used for financing activities, primarily to pay down Company debt; and the remaining amount ($31.7 million, net) increased cash on hand.\nSince 1990, the Company has paid down $43.0 million of real estate debt on wholly-owned real estate projects (from $50.9 million to $7.9 million), utilizing proceeds from sales of property and general corporate funds. Similarly, real estate joint venture debt has been reduced by $151 million over the same period. As a result, the Company has reached a point at which revenues from further real estate sales that, in the past, have been largely used to retire real estate debt will be increasingly available to improve general corporate liquidity. With the exception of the major properties referred to in Note 11 to Notes to the Consolidated Financial Statements, this trend should continue over the next several years with debt on projects often being fully repaid prior to full project sell-out. On the other hand, the softening of the national real estate market coupled with problems in the commercial banking industry have significantly reduced credit availability for both new real estate development projects and the sale of completed product, sources historically relied upon by the Company and its customers to meet liquidity needs for its real estate development business. The Company has addressed this problem by relying on corporate borrowings, extending certain maturing real estate loans (with such extensions usually requiring pay downs and increased annual amortization of the remaining loan balance), suspending the acquisition of new real estate inventory, significantly reducing development expenses on certain projects, utilizing\ntreasury stock in partial payment of amounts due under certain of its incentive compensation plans, utilizing cash internally generated from operations and, during the first quarter of 1992, selling its interest in Monenco. In addition, in January 1993, the Company sold its majority interest in Majestic for approximately $31.7 million in cash. Since Majestic had been fully consolidated, the net result to the Company was to increase working capital by $8 million and cash by $4 million. In addition, the Company implemented a company-wide cost reduction program in 1990, and again in 1991 and 1993 to improve long-term financial results and suspended the dividend on its common stock during the fourth quarter of 1990. Also, the Company increased the aggregate amount available under its revolving credit agreement from $70 million to $125 million during 1994. Management believes that cash generated from operations, existing credit lines and additional borrowings should probably be adequate to meet the Company's funding requirements for at least the next twelve months. However, the withdrawal of many commercial lending sources from both the real estate and construction markets and\/or restrictions on new borrowings and extensions on maturing loans by these very same sources cause uncertainties in predicting liquidity. In addition to internally generated funds, the Company has access to additional funds under its $5 million short-term line of credit and its $125 million long-term revolving credit facility. At December 31, 1994, the Company has $5 million available under its short-term lines of credit and $63 million available under its revolving credit facility.\nThe full amount available under the credit facilities may be borrowed during any fiscal quarter. However, financial covenants limiting the debt to equity ratio contained in the agreements governing these facilities limit the amount of borrowings which may be outstanding at the end of any fiscal quarter. Based on these covenants, $11 million of additional borrowing capacity was available at December 31, 1994. The financial covenants to which the Company is subject include minimum levels of working capital, debt\/net worth ratio, net worth level and interest coverage, all as defined in the loan documents. The Company is in compliance with all of its covenants as of the most recent balance sheet date.\nThe working capital current ratio stood at 1.13:1 at the end of 1994, compared to 1.17:1 at the end of 1993 and to 1.14:1 at the end of 1992. Of the total working capital of $29.9 million at the end of 1994, $10 million may not be converted to cash within the next 12-18 months.\nLONG-TERM DEBT\nLong-term debt was $77 million at the end of 1994 which represented a decrease of $5.4 million compared with $82.4 million at the end of 1993, which was a decrease of $3.4 million from the $85.8 million at the end of 1992. The ratio of long-term debt to equity improved to .58:1 at the end of 1994 compared to .63:1 at the end of 1993 and .70:1 at the end of 1992.\nSTOCKHOLDERS' EQUITY\nThe Company's book value per common share stood at $23.79 at December 31, 1994, compared to $24.49 per common share and $23.29 per common share at the end of 1993 and 1992, respectively. The major factors impacting stockholders' equity during the three-year period under review were results of operations, preferred dividends and treasury stock issued in partial payment of incentive compensation.\nAt December 31, 1994, there were 1,449 common stockholders of record based on the stockholders list maintained by the Company's transfer agent.\nDIVIDENDS\nThere were no cash dividends declared during the three year period ended December 31, 1994 on the Company's outstanding common stock. It is management's intent to recommend reinstating dividends on common stock once it is prudent to do so. In 1987, the Company issued 1,000,000 depositary convertible exchangeable preferred shares, each depositary share representing ownership of 1\/10 of a share of $21.25 convertible exchangeable preferred stock. During the three-year period ended December 31, 1994, the Board of Directors declared regular quarterly cash dividends of $5.3125 per share for the annual total of $21.25 per share (equivalent to quarterly dividends of $.53125 per depositary share for an annual total of $2.125 per depositary share). Dividends on preferred shares are cumulative and are payable quarterly before any dividends may be declared or paid on the common stock of the Company (see Note 7 to Notes to the Consolidated Financial Statements).\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Reports of Independent Public Accountants, Consolidated Financial Statements, and Supplementary Schedules, are set forth on the pages that follow in this Report and are hereby incorporated herein.\nITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III.\nITEM 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 definitive proxy statement involving election of directors in connection with the Annual Meeting of Stockholders to 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 and Exchange Act of 1934, as amended.\nListed below are the names, offices held, ages and business experience of all executive officers of the Company.\nYear First Elected to Present Name, Offices Held and Age Office and Business Experience\nDavid B. Perini, Director, He has served as a Director, Chairman, President and Chief President, Chief Executive Officer Executive Officer - 57 and Acting Chairman since 1972. He became Chairman on March 17, 1978 and has worked for the Company since 1962 in various capacities. Prior to being elected President, he served as Vice President and General Counsel.\nRichard J. Rizzo, He has served in this capacity since Executive Vice President, January, 1994, which entails overall Building Construction - 51 responsibility for the Company's building construction operations. Prior thereto, he served as President of Perini Building Company (formerly known as Mardian Construction Co.) since 1985, and in various other operating capacities since 1977.\nJohn H. Schwarz, Executive He has served as Executive Vice Vice President, Finance and President, Finance and Administration Administration of the Company since August, 1994, and as Chief and Chief Executive Officer Executive Officer of Perini Land and of Perini Land and Development Company, which entails Development Company - 56 overall responsibility for the Company's real estate operations since April, 1992. Prior to that, he served as Vice President, Finance and Controls of Perini Land and Development Company. Previously, he served as Treasurer from August, 1984, and Director of Corporate Planning since May, 1982. He joined the Company in 1979 as Manager of Corporate Development.\nDonald E. Unbekant, Executive He has served in this capacity since Vice President, Civil and January, 1994, which entails overall Environmental Construction - responsibility for the Company's 63 civil and environmental construction operations. Prior thereto, he served in the Metropolitan New York Division of the Company as President since 1992, Vice President and General Manager since 1990 and Division Manager since 1984.\nThe Company's officers are elected on an annual basis at the Board of Directors Meeting immediately following the Shareholders Meeting in May, to hold such offices until the Board of Directors Meeting following the next Annual Meeting of Shareholders and until their respective successors have been duly appointed or until their tenure has been terminated by the Board of Directors, or otherwise.\nITEM 11. EXECUTIVE COMPENSATION\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn response to Items 11-13, reference is made to the information to be set forth in the section entitled \"Election of Directors\" in the Proxy Statement, which is incorporated herein by reference.\nPART IV.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nPERINI CORPORATION AND SUBSIDIARIES\n(a)1. The following financial statements and supplementary financial information are filed as part of this report: Pages Financial Statements of the Registrant\nConsolidated Balance Sheets as of December 31, 1994 and 29 - 30\nConsolidated Statements of Operations for the three years 31 ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Stockholders' Equity for the 32 three years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the three years 33 - 34 ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements 35 - 48\nReport of Independent Public Accountants 49\n(a)2. The following financial statement schedules are filed as part of this report:\nPages\nReport of Independent Public Accountants on Schedules 50\nSchedule II -- Valuation and Qualifying Accounts and 51 Reserves\nAll other schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated Financial Statements or in the Notes thereto.\nSeparate condensed financial information of the Company has been omitted since restricted net assets of subsidiaries included in the consolidated financial statements and its equity in the undistributed earnings of 50% or less owned persons accounted for by the equity method do not, in the aggregate, exceed 25% of consolidated net assets.\n(a)3. Exhibits\nThe exhibits which are filed with this report or which are incorporated herein by reference are set forth in the Exhibit Index which appears on pages 52 and 53. The Company will furnish a copy of any exhibit not included herewith to any holder of the Company's common and preferred stock upon request.\n(b) During the quarter ended December 31, 1994, the Registrant made no filings on Form 8-K.\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, hereunto duly authorized.\nPERINI CORPORATION (Registrant)\nDated: March 22, 1995 David B. Perini Chairman, President 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 Company and in the capacities and on the dates indicated. Signature Title Date\n(i) Principal Executive Officer David B. Perini Chairman, President and Chief Executive Officer --------------------- March 22, 1995 David B. Perini\n(ii) Principal Financial Officer John H. Schwarz Executive Vice President, Finance & Administration ---------------------- March 22, 1995 John H. Schwarz\n(iii) Principal Accounting Officer Barry R. Blake Vice President and Controller ------------------------- March 22, 1995 Barry R. Blake (iv) Directors\nDavid B. Perini ) Joseph R. Perini ) By Richard J. Boushka ) Marshall M. Criser ) --------------------- Thomas E. Dailey ) David B. Perini Albert A. Dorman ) Arthur J. Fox, Jr. ) Attorney in Fact Nancy Hawthorne ) Dated: March 22, 1995 John J. McHale ) Jane E. Newman ) Bart W. Perini )\nConsolidated Balance Sheets December 31, 1994 and 1993\n(In thousands except per share data)\nAssets 1994 1993 CURRENT ASSETS: Cash, including cash equivalents of $3,518 and $ 7,841 $ 35,871 $20,354 (Note 1) Accounts and notes receivable, including retainage 151,620 123,009 of $63,344 and $45,084 Unbilled work (Note 1) 20,209 14,924 Construction joint ventures (Notes 1 and 2) 66,346 61,156 Real estate inventory, at the lower of cost or 11,525 11,666 market (Note 1)\nDeferred tax asset (Notes 1 and 5) 6,066 7,702 Other current assets 3,041 3,274 -------- -------- Total current assets $266,648 $257,602 -------- --------\nREAL ESTATE DEVELOPMENT INVESTMENTS: Land held for sale or development (including land development costs) at the lower of cost or market $ 43,295 $ 48,011 (Note 1) Investments in and advances to real estate joint ventures (Notes 1, 2 and 11) 148,843 138,095 Real estate properties used in operations, less accumulated depreciation of $3,698 and $3,638 6,254 12,678 Other 80 - -------- -------- Total real estate development investments $198,472 $198,784 -------- --------\nPROPERTY AND EQUIPMENT, at cost: Land $ 1,134 $ 1,451 Buildings and improvements 12,505 15,566 Construction equipment 16,397 16,440 Other equipment 12,552 11,625 -------- -------- $ 42,588 $ 45,082 Less - Accumulated depreciation (Note 1) 29,082 28,986 -------- -------- Total property and equipment, net $ 13,506 $ 16,096 -------- --------\nOTHER ASSETS: Other investments $ 2,174 2,188 Goodwill (Note 1) 1,700 1,708 -------- -------- Total other assets $ 3,874 $ 3,896 -------- --------\n$482,500 $476,378 ======== ========\nThe accompanying notes are an integral part of these financial statements.\nLiabilities and Stockholders' Equity\n1994 1993 CURRENT LIABILITIES: Current maturities of long-term debt (Note 4) $ 5,022 $ 7,617 Accounts payable, including retainage of $52,224 140,454 136,231 and $45,508 Deferred contract revenue (Note 1) 38,929 25,867 Accrued expenses 52,295 47,827 Accrued income taxes (Notes 1 and 5) - 3,183 --------- -------- Total current liabilities $236,700 $220,725 --------- --------\nDEFERRED INCOME TAXES AND OTHER LIABILITIES $ 33,488 $ 38,794 (Notes 1 and 5) -------- ---------\nLONG-TERM DEBT, less current maturities included above (Note 4): Real estate development $ 6,502 $ 11,382 Other 70,484 70,984 --------- --------- Total long-term debt $ 76,986 $ 82,366 --------- ---------\nMINORITY INTEREST (Note 1) $ 3,297 $ 3,350 --------- ---------\nCONTINGENCIES AND COMMITMENTS (Note 11)\nSTOCKHOLDERS' EQUITY (Notes 1, 7, 8, 9 and 10): Preferred stock, $1 par value - Authorized - 1,000,000 shares Issued and outstanding - 100,000 shares ($25,000 aggregate liquidation preference) $ 100 $ 100 Series A junior participating preferred stock, $1 par value - Authorized - 200,000 - - Issued - none Common stock, $1 par value - Authorized - 15,000,000 and 7,500,000 shares Issued - 4,985,160 shares 4,985 4,985 Paid-in surplus 59,001 59,875 Retained earnings 81,772 83,594 ESOT related obligations (6,009) (6,982) --------- --------- $139,849 $141,572\nLess - Common stock in treasury, at cost - 7,820 10,429 490,674 shares and 654,353 shares --------- ---------\nTotal stockholders' equity $132,029 $131,143 -------- ---------\n$482,500 $476,378 ======== ========\nConsolidated Statements of Operations For the years ended December 31, 1994, 1993 & 1992\n(In thousands, except per share data)\n1994 1993 1992\nREVENUES (Notes 2 and 13) $1,012,045 $1,100,116 $1,070,852 ----------- ----------- -----------\nCOSTS AND EXPENSES (Notes 2 and 10): Cost of operations $ 960,248 $1,047,330 $1,048,663 General, administrative and 42,985 44,212 41,328 selling expenses ----------- ----------- ----------- $1,003,233 $1,091,542 $1,089,991 ----------- ----------- -----------\nINCOME (LOSS) FROM OPERATIONS $ 8,812 $ 8,574 $ (19,139) (Note 13) ----------- ----------- -----------\nOther income (expense), net (856) 5,207 436 (Note 6) Interest expense, net of (7,473) (5,655) (7,651) capitalized amounts ----------- ----------- ----------- (Notes 1, 3 and 4)\nINCOME (LOSS) BEFORE INCOME TAXES $ 483 $ 8,126 $ (26,354)\n(Provision) credit for income (180) (4,961) 9,370 taxes (Notes 1 and 5) ----------- ----------- -----------\nNET INCOME (LOSS) $ 303 $ 3,165 $ (16,984) ========== ========== ===========\nEARNINGS (LOSS) PER COMMON SHARE $ (.42) $ .24 $ (4.69) (Note 1) =========== ========== ===========\nThe accompanying notes are an integral part of these financial statements.\n*Equivalent to $2.125 per depositary share (see Note 7).\nThe accompanying notes are an integral part of these financial statements.\nConsolidated Statements of Cash Flows For the years ended December 31, 1994, 1993 & 1992\n(In thousands)\n1994 1993 1992\nCash Flows from Operating Activities: Net income (loss) $ 303 $ 3,165 $(16,984)\nAdjustments to reconcile net income (loss) to net cash from operating activities - Depreciation and amortization 2,879 3,515 6,297\nNon-current deferred taxes and other (5,306) 11,239 (13,236) liabilities\nDistributions greater (less) than earnings of joint ventures 2,995 (2,821) 9,412 and affiliates Writedown of certain real estate - - 31,368 properties\nGain on sale of Monenco (Note 6) - - (1,976) Gain on sale of Majestic - (4,631) - (Notes 1 and 6)\nGain on sale of fixed assets (105) (299) (570)\nMinority interest, net (53) (78) 2,001 Cash provided from (used by) changes in components of working capital other than cash, notes payable and (14,119) (19,653) 35,819 current maturities of long-term debt\nReal estate development investments 11,451 10,908 6,253 other than joint ventures\nOther non-cash items, net (3,073) (2,922) (2,972) --------- --------- ---------\nNET CASH FROM OPERATING ACTIVITIES $ (5,028) $ (1,577) $ 55,412 --------- --------- ---------\nCash Flows from Investing Activities:\nProceeds from sale of property and $ 989 $ 1,344 $ 1,890 equipment Cash distributions of capital from unconsolidated joint ventures 13,112 4,977 3,413\nAcquisition of property and equipment (2,493) (4,387) (4,044)\nImprovements to land held for sale or (334) (4,227) (4,341) development Improvements to and acquisitions of real estate properties used in (140) (614) (6,310) operations\nCapital contributions to (20,199) (24,579) (8,425) unconsolidated joint ventures Advances to real estate joint (6,559) (16,031) (12,091) ventures, net\nProceeds from sale of Monenco shares - - 14,180\nProceeds from sale of Majestic, net - 4,377 - of subsidiary's cash Investments in other activities 14 - (3) --------- --------- ---------\nNET CASH USED BY INVESTING ACTIVITIES $(15,610) $(39,140) $(15,731) --------- --------- --------- Consolidated Statements of Cash Flows (Continued) For the years ended December 31, 1994, 1993 & 1992\n(In thousands)\nCash Flows from Financing Activities:\nProceeds from long-term debt $ 3,127 $ 8,014 $ 9,571 Repayment of long-term debt (10,129) (11,600) (17,590)\nCash dividends paid (2,125) (2,125) (2,125) Treasury stock issued 1,735 2,736 3,043 --------- --------- ---------\nNET CASH USED BY FINANCING ACTIVITIES $ (7,392) $ (2,975) $ (7,101) --------- --------- ---------\nEffect of Exchange Rate Changes on Cash $ - $ - $ (831) --------- --------- ---------\nNet Increase (Decrease) in Cash $(28,030) $(43,692) $ 31,749 Cash and Cash Equivalents at Beginning 35,871 79,563 47,814 of Year --------- --------- ---------\nCash and Cash Equivalents at End of $ 7,841 $ 35,871 79,563 Year ========= ========= =========\nSupplemental Disclosures of Cash Paid During the Year For:\nInterest, net of amounts capitalized $ 7,308 $ 5,947 $ 10,995 ========= ========= ========= Income tax payments (refunds) $ 1,176 $ 843 $ (2,603) ========= ========= ========\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 1993, 1992 & 1991\n[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n[a] Principles of Consolidation The consolidated financial statements include the accounts of Perini Corporation, its subsidiaries and certain majority-owned real estate joint ventures (the \"Company\"). All subsidiaries are wholly-owned except Majestic Contractors Limited (\"Majestic\"), which was approximately 74%- owned and Perland Environmental Technologies, Inc. (\"Perland\"), which was approximately 90%-owned until October 1994 when it became 100%-owned. All significant intercompany transactions and balances have been eliminated in consolidation. Non-consolidated joint venture interests are accounted for on the equity method with the Company's share of revenues and costs in these interests included in \"Revenues\" and \"Cost of Operations,\" respectively, in the accompanying consolidated statements of operations. All significant intercompany profits between the Company and its joint ventures have been eliminated in consolidation. Taxes are provided on joint venture results in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\".\nIn January 1993, the Company sold its 74%-ownership in Majestic, its Canadian pipeline construction subsidiary, for $31.7, million, which resulted in an after tax gain of approximately $1.0 million.\nEffective July 1, 1993, the Company acquired Gust K. Newberg Construction Co.'s (\"Newberg\") interest in certain construction projects and related equipment. The purchase price for the acquisition was (i) approximately $3 million in cash for the equipment paid by a third party leasing company, which in turn simultaneously entered into an operating lease agreement with the Company for the use of said equipment, (ii) the greater of $1 million or 25% of the aggregate pretax earnings during the period from April 1, 1993 through December 31, 1994, net of payments accruing to Newberg as described in (iii) below, and (iii) 50% of the aggregate of net profits earned from each project from April 1, 1993 through December 31, 1994 and, with regard to one project, through December 31, 1995. This acquisition has been accounted for as a purchase. If this acquisition had been consummated as of January 1, 1992, the 1992 and 1993 pro forma results would have been, respectively, Revenues of $1,164,444,000 and $1,134,264,000 and Net Income (Loss) of $(14,935,000) ($(4.18) per common share) and $3,724,000 ($.37 per common share).\n[b] Translation of Foreign Currencies The accounts of the former Canadian subsidiary were translated in accordance with Statement of Financial Accounting Standards (SFAS) No. 52, under which translation adjustments are accumulated directly as a separate\ncomponent of stockholders' equity. Gains and losses on foreign currency transactions are included in results of operations during the period in which they arise.\n[c] Method of Accounting for Contracts Profits from construction contracts and construction joint ventures are generally recognized by applying percentages of completion for each year to the total estimated profits for the respective contracts. The percentages of completion are determined by relating the actual cost of the work performed to date to the current estimated total cost of the respective contracts. When the estimate on a contract indicates a loss, the Company's policy is to record the entire loss. The cumulative effect of revisions in estimates of total cost or revenue during the course of the work is reflected in the accounting period in which the facts that caused the revision became known. An amount equal to the costs attributable to unapproved change orders and claims is included in the total estimated revenue when realization is probable. Profit from claims is recorded in the year such claims are resolved.\nIn accordance with normal practice in the construction industry, the Company includes in current assets and current liabilities amounts related to construction contracts realizable and payable over a period in excess of one year. Unbilled work represents the excess of contract costs and profits recognized to date on the percentage of completion accounting method over billings to date on certain contracts. Deferred contract revenue represents the excess of billings to date over the amount of contract costs and profits recognized to date on the percentage of completion accounting method on the remaining contracts.\n[d] Methods of Accounting for Real Estate Operations All real estate sales are recorded in accordance with SFAS No. 66. Gross profit is not recognized in full unless the collection of the sale price is reasonably assured and the Company is not obliged to perform significant activities after the sale. Unless both conditions exist, recognition of all or a part of gross profit is deferred.\nThe gross profit recognized on sales of real estate is determined by relating the estimated total land, land development and construction costs of each development area to the estimated total sales value of the property in the development. Real estate investments are stated at the lower of cost, which includes applicable interest and real estate taxes during the development and construction phases, or market. The market or net realizable value of a development is determined by estimating the sales value of the development in the ordinary course of business less the estimated costs of completion (to the stage of completion assumed in determining the selling price), holding and disposal. Estimated sales values are forecast based on comparable local sales (where applicable), trends as foreseen by knowledgeable local commercial real estate brokers or others active in the business and\/or project specific experience such as offers made directly to the Company relating to the property. If the net realizable value of a development is less than the cost of a development, a provision is made to reduce the carrying value of the development to net realizable value. A provision (or writedown to net realizable value) amounted to $31.4 million in 1992. At present, the Company believes its remaining real estate properties are carried at amounts at or below their net realizable values considering the expected timing of their disposal.Interest expense incurred by the Company and capitalized during the development or construction phase amounted to zero in 1994 and $.2 million per year in 1993 and 1992.\n[e] Depreciable Property and Equipment Land, buildings and improvements, construction and computer-related equipment and other equipment are recorded at cost. Depreciation is\nprovided primarily using accelerated methods for construction and computer-related equipment and the straight-line method for the remaining depreciable property.\n[f] Goodwill Goodwill represents the excess of the costs of subsidiaries acquired over the fair value of their net assets as of the dates of acquisition. These amounts are being amortized on a straight-line basis over 40 years.\n[g] Income Taxes The Company follows Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" (see Note 5).\nIt is the policy of the Company to accrue appropriate U.S. and foreign income taxes on earnings of foreign subsidiaries which are intended to be remitted to the Company.\n[h] Earnings (Loss) Per Common Share Computations of earnings (loss) per common share amounts are based on the weighted average number of common shares outstanding during the respective periods. During the three-year period ended December 31, 1994, earnings (loss) per common share reflect the effect of preferred dividends accrued during the year. Common stock equivalents related to additional shares of common stock issuable upon exercise of stock options (see Note 9) have not been included since their effect would be immaterial or antidilutive. Earnings (loss) per common share on a fully diluted basis are not presented because the effect of conversion of the Company's depositary convertible exchangeable preferred shares into common stock is antidilutive.\n[i] Cash and Cash Equivalents Cash equivalents include short-term, highly liquid investments with original maturities of three months or less.\n[j] Reclassifications Certain prior year amounts have been reclassified to be consistent with the current year classifications.\n[2] JOINT VENTURES\nThe Company, in the normal conduct of its business, has entered into certain partnership arrangements, referred to as \"joint ventures,\" for construction and real estate development projects. Each of the joint venture participants is usually committed to supply a predetermined percentage of capital, as required, and to share in a predetermined percentage of the income or loss of the project. Summary financial information (in thousands) for construction and real estate joint ventures accounted for on the equity method for the three years ended December 31, 1994 follows:\nCONSTRUCTION JOINT VENTURES\nFinancial position at December 31, 1994 1993 1992\nCurrent assets $232,025 $241,905 $216,568 Property and equipment, net 19,386 17,228 18,203 Current liabilities (132,326) (151,181) (155,026) --------- --------- --------- Net assets $119,085 $107,952 $ 79,745 ========= ========= =========\nOperations for the year ended December 31, 1994 1993 1992\nRevenue $544,546 $626,327 $487,758 Cost of operations 505,347 574,383 445,494 --------- -------- -------- Pretax income $ 39,199 $ 51,944 $ 42,264 ========= ========= =========\nCompany's share of joint ventures Revenue $241,784 $293,547 $254,265 Cost of operations 224,039 272,137 231,564 --------- -------- -------- Pretax income $ 17,745 $ 21,410 $ 22,701 ========= ========= =========\nEquity $ 66,346 $ 61,156 $ 29,654 ========= ========= =========\nREAL ESTATE JOINT VENTURES\nFinancial position at December 31, 1994 1993 1992\nProperty held for sale or $ 28,885 $ 35,855 $ 17,902 development Investment properties, net 177,258 191,606 243,477 Other assets 62,101 61,060 59,688 Long-term debt (77,968) (103,090) (151,538) Other liabilities* (277,184) (256,999) (229,865) --------- --------- --------- Net assets (liabilities) $(86,908) $(71,568) $(60,336) ========= ========= =========\nOperations for the year ended 1994 1993 1992 December 31,\nRevenue $ 58,326 $ 83,710 $ 64,776 --------- --------- -------- Cost of operations - Depreciation $ 7,245 $ 8,660 $ 9,469 Other 71,211 92,963 86,354 --------- --------- --------- $ 78,456 $101,623 $ 95,823 --------- --------- --------- Pretax income (loss) $(20,130) $(17,913) $(31,047) ========= ========= =========\nCompany's share of joint ventures Revenue $ 27,059 $ 43,590 $ 27,118 --------- --------- --------- Cost of operations - Depreciation $ 3,323 $ 4,033 $ 4,581 Other 26,682 40,716 36,105 --------- --------- --------- $ 30,005 $ 44,749 $ 40,686 --------- --------- --------- Pretax income (loss) $ (2,946) $ (1,159) $(13,568) ========= ========= =========\nEquity ** $(33,091) $(27,768) $(23,542) ========= ========= =========\n* Included in \"Other liabilities\" are advances from joint venture partners in the amount of $207.4 million in 1992, $236.8 million in 1993, and $259.3 million in 1994. Of the total advances from joint venture partners, $150.6 million in 1992, $165.9 million in 1993, and $181.9 million in 1994 represented advances from the Company.\n** When the Company's equity in a real estate joint venture is combined with advances by the Company to that joint venture, each joint venture has a positive investment balance at December 31, 1994.\n[3] NOTES PAYABLE TO BANKS\nDuring 1994 and 1993, the Company maintained unsecured short-term lines of credit totaling $18 million. In support of these credit lines, the Company paid fees approximating 1\/4 of 1% of the amount of the lines. All but $5 million of such lines were canceled as of December 12, 1994 upon the effective date of the expanded credit agreement referred to in Note 4 below. Information relative to the Company's short-term debt activity under such lines in 1994 and 1993 follows (in thousands):\n1994 1993 Borrowings during the year: Average $10,992 $ 8,451 Maximum $18,000 $18,000 At year-end $ - $ -\nWeighted average interest rates: During the year 7.4% 6.2% At year-end - -\n[4] LONG-TERM DEBT\nLong-term debt of the Company at December 31, 1994 and 1993 consists of the following (in thousands):\n1994 1993\nReal Estate Development:\nIndustrial revenue bonds, at 65% of prime, $ 1,310 $ 1,683 payable in semi-annual installments Mortgages on real estate, at rates ranging from prime plus 1 1\/2% to 10.82%, payable in 6,588 16,027 installments ------- ------- Total $ 7,898 $17,710 Less - current maturities 1,396 6,328 ------- ------- Net real estate development long-term debt $ 6,502 $11,382 ======= =======\nOther:\nRevolving credit loans at an average rate of $62,000 $60,000 8.6% in 1994 and 5.8% in 1993 ESOT Notes at 8.24%, payable in semi-annual 5,396 6,238 installments (Note 7) Industrial revenue bonds at various rates, 4,000 4,000 payable in installments to 2005\nTotal $74,110 $72,273 Less - current maturities 3,626 1,289 ------- ------- Net other long-term debt $70,484 $70,984 ======= =======\nPayments required under these obligations amount to approximately $5,022 in 1995, $1,945 in 1996, $63,999 in 1997, $4,841 in 1998, $2,201 in 1999 and $4,000 for the years 2000 and beyond.\nEffective December 12, 1994, the Company entered into a new revolving credit agreement with a group of major banks which provides for, among other things, the Company to borrow up to an aggregate of $125 million (aggregate limit under previous agreements was $85 million), with a $25 million maximum of such amount also being available for letters of credit. The Company may choose from three interest rate alternatives including a prime-based rate, as well as other interest rate options based on LIBOR (London inter-bank offered rate) or participating bank certificate of deposit rates. Borrowings and repayments may be made at any time through December 6, 1997, at which time all outstanding loans under the agreement must be paid or otherwise refinanced. The Company must pay a commitment fee of 1\/2 of 1% annually on the unused portion of the commitment.\nThe aggregate $125 million commitment is subject to permanent partial reductions based on certain events, as defined, such as proceeds from real estate sales over a defined annual minimum, certain claims and future equity offerings.\nThe revolving credit agreement, as well as certain other loan agreements, provides for, among other things, maintaining specified working capital and tangible net worth levels and, additionally, imposes limitations on indebtedness and future investment in real estate development projects.\n[5] INCOME TAXES\nThe Company accounts for income taxes in accordance with SFAS No. 109. This standard determines deferred income taxes based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities, given the provisions of enacted tax laws.\nThe (provision) credit for income taxes is comprised of the following (in thousands):\nFederal Foreign State Total Current $ - $ - $ (21) $ (21) Deferred (108) - (51) (159) -------- -------- -------- -------- $ (108) $ - $ (72) $ (180) ======== ======== ======== ========\nCurrent $(2,824) $ - $ (430) $(3,254) Deferred (1,808) - 101 (1,707) -------- -------- -------- -------- $(4,632) $ - $ (329) $(4,961) ======== ======== ======== ========\nCurrent $ - $(5,486) $ (325) $(5,811)\nDeferred 13,236 814 1,131 15,181 ------- -------- ------- -------- $13,236 $(4,672) $ 806 $ 9,370 ======= ======== ======= ========\nThe domestic and foreign components of income (loss) before income taxes are as follows (in thousands):\nU.S. Foreign Total\n1994 $ 483 $ - $ 483\n1993 $ 8,126 $ - $ 8,126\n1992 $(42,238) $15,884 $(26,354)\nThe table below reconciles the difference between the statutory federal income tax rate and the effective rate provided in the statements of operations.\n1994 1993 1992\nStatutory federal income 34% 34% (34)% tax rate State income taxes, net of 4 2 (1) federal tax benefit Sale of Canadian - 24 - subsidiary Goodwill and other (1) 1 (1) ---- ----- ---- 37% 61% (36)% ==== ===== =====\nThe following is a summary of the significant components of the Company's deferred tax assets and liabilities as of December 31, 1994 and 1993 (in thousands):\n1994 1993\nDeferred Deferred Deferred Deferred Tax Tax Tax Tax Assets Liabilities Assets Liabilities\nProvision for estimated $ 6,203 $ - $ 9,684 $ - losses Contract losses 887 - 2,841 - Joint ventures - - 8,088 - 6,996 construction Joint ventures - real - 25,668 - 18,078 estate Timing of expense 13,867 - 5,012 - recognition Capitalized carrying - 1,776 - 2,301 charges Net operating loss 5,960 - 916 - carryforwards Alternative minimum tax 2,300 - 3,567 - credit carryforwards General business tax 3,637 - 4,038 - credit carryforwards\nForeign tax credit 978 - 1,352 - carryforwards Other, net 685 - 422 - -------- -------- -------- -------- $34,517 $35,532 $27,832 $27,375 Valuation allowance for (1,846) - (2,251) - deferred tax assets -------- -------- -------- -------- Total $32,671 $35,532 $25,581 $27,375 ======== ======== ======== =========\nThe net of the above is deferred taxes in the amount of $2,861 in 1994 and $1,794 in 1993 which is classified in the respecitve Consolidated Balance Sheets as follows:\n1994 1993 Long-term deferred tax liabilities (included in $8,927 $9,496 \"Deferred Income Taxes and Other Liabilities\") Short-term Deferred Tax Asset 6,066 7,702 ------ ------ $2,861 $1,794 ====== ======\nThe valuation allowance for deferred tax assets is principally attributable to the net operating loss carryforwards of Perland Environmental Technologies, Inc. and foreign tax credit carryforwards resulting from the 1993 sale of the Company's Canadian subsidiary. Any portion of the valuation allowance attributable to these deferred tax assets for which benefits are subsequently recognized will be applied to reduce income tax expense.\nAt December 31, 1994, the Company has unused tax credits and net operating loss carryforwards for income tax reporting purposes which expire as follows (in thousands):\nUnused Investment Foreign Net Operating Loss Tax Credits Tax Credits Carryforwards\n1995-1998 $ 20 $ 978 $ - 1999-2004 3,617 - 823 2005-2009 - - 16,705 ------ ------- ------- $3,637 $ 978 $17,528 ====== ======= =======\nApproximately $2.7 million of the net operating loss carryforwards can only be used against the taxable income of the corporation in which the loss was recorded for tax and financial reporting purposes.\n[6] OTHER INCOME (EXPENSE), NET\nOther income (expense) items for the three years ended December 31, 1994 are as follows (in thousands):\n1994 1993 1992\nInterest and dividend income $ 205 $ 624 $ 1,783 Minority interest (Note 1) 24 167 (3,039)\nGain on sale of Majestic (Note 1) - 4,631 - Gain on sale of investment in Monenco - - 1,976 Bank fees (1,100) (584) (571) Miscellaneous income (expense), net 15 369 287 -------- ------- -------- $ (856) $5,207 $ 436 ======== ====== ======== [7] CAPITALIZATION\nIn July 1989, the Company sold 262,774 shares of its $1 par value common stock, previously held in treasury, to its Employee Stock Ownership Trust (\"ESOT\") for $9,000,000. The ESOT borrowed the funds via a placement of 8.24% Senior Unsecured Notes (\"Notes\") guaranteed by the Company. The Notes are payable in 20 equal semi-annual installments of principal and interest commencing in January 1990. The Company's annual contribution to the ESOT, plus any dividends accumulated on the Company's common stock held by the ESOT, will be used to repay the Notes. Since the Notes are guaranteed by the Company, they are included in \"Long-Term Debt\" with an offsetting reduction in \"Stockholders' Equity\" in the accompanying Consolidated Balance Sheets. The amount included in \"Long-Term Debt\" will be reduced and \"Stockholders' Equity\" reinstated as the Notes are paid by the ESOT.\nIn June 1987, net proceeds of approximately $23,631,000 were received from the sale of 1,000,000 depositary convertible exchangeable preferred shares (each depositary share representing ownership of 1\/10 of a share of $21.25 convertible exchangeable preferred stock, $1 par value) at a price of $25 per depositary share. Annual dividends are $2.125 per depositary share and are cumulative. Generally, the liquidation preference value is $25 per depositary share plus any accumulated and unpaid dividends. The preferred stock of the Company, as evidenced by ownership of depositary shares, is convertible at the option of the holder, at any time, into common stock of the Company at a conversion price of $37.75 per share of common stock. The preferred stock is redeemable at the option of the Company at any time after June 15, 1990, in whole or in part, at declining premiums until June 1997 and thereafter at $25 per share plus any unpaid dividends. The preferred stock is also exchangeable at the option of the Company, in whole but not in part, on any dividend payment date into 8 1\/2% convertible subordinated debentures due in 2012 at a rate equivalent to $25 principal amount of debentures for each depositary share.\n[8] SERIES A JUNIOR PARTICIPATING PREFERRED STOCK\nUnder the terms of the Company's Shareholder Rights Plan, as amended, the Board of Directors of the Company declared a distribution on September 23, 1988 of one preferred stock purchase right (a \"Right\") for each outstanding share of common stock. Under certain circumstances, each Right will entitle the holder thereof to purchase from the Company one one-hundredth of a share (a \"Unit\") of Series A Junior Participating Cumulative Preferred Stock, $1 par value (the \"Preferred Stock\"), at an exercise price of $100 per Unit, subject to adjustment. The Rights will not be exercisable or transferable apart from the common stock until the occurrence of certain events viewed to be an attempt by a person or group to gain control of the Company (a \"triggering event\"). The Rights will not have any voting rights or be entitled to dividends.\nUpon the occurrence of a triggering event, each Right will be entitled to that number of Units of Preferred Stock of the Company having a market value of two times the exercise price of the Right. If the Company is acquired in a merger or 50% or more of its assets or earning power is sold, each Right will be entitled to receive common stock of the acquiring company having a market value of two times the exercise price of the Right. Rights held by such a person or group causing a triggering event\nmay be null and void.\nThe Rights are redeemable at $.02 per Right by the Board of Directors at any time prior to the occurrence of a triggering event and will expire on September 23, 1998.\n[9] STOCK OPTIONS\nAt December 31, 1994 and 1993, 481,610 shares of the Company's authorized but unissued common stock were reserved for issuance to employees under its 1982 Stock Option Plan. Options are granted at fair market value on the date of grant and generally become exercisable in two equal annual installments on the second and third anniversary of the date of grant and expire eight years from the date of grant. The options for the 240,000 shares common stock granted in 1992 become exercisable on March 31, 2001 if the Company achieves a certain profit target in the year 2000; may become exercisable earlier if certain interim profit targets are achieved; and to the extent not exercised, expire 10 years from the date of grant. A summary of stock option activity related to the Company's stock option plan is as follows:\nNumber of Number of Option Price Shares Shares Per Share Exercisable\nOutstanding at 438,825 $11.06-$33.06 91,075 December 31, 1992 Granted - - Canceled (4,400) $11.06-$33.06 Outstanding at 434,425 $11.06-$33.06 143,000 December 31, 1993 Granted 20,000 $13.00 Canceled (32,900) $11.06-$33.06 Outstanding at 421,525 $11.06-$33.06 251,525 December 31, 1994\nWhen options are exercised, the proceeds are credited to stockholders' equity. In addition, the income tax savings attributable to nonqualified options exercised is credited to paid-in surplus.\n[10] EMPLOYEE BENEFIT PLANS\nThe Company and its U.S. subsidiaries have a defined benefit plan which covers its executive, professional, administrative and clerical employees, subject to certain specified service requirements. The plan is noncontributory and benefits are based on an employee's years of service and \"final average earnings\", as defined. The plan provides reduced benefits for early retirement and takes into account offsets for social security benefits. All employees are vested after 5 years of service. Net pension cost for 1994, 1993 and 1992 follows (in thousands):\n1994 1993 1992\nService cost - benefits earned during $1,178 $1,000 $ 896 the period Interest cost on projected benefit 2,936 2,862 2,314 obligation Return on plan assets: Actual 1,229 (4,002) (1,220) Deferred (3,839) 1,309 (1,043) Other - 19 19 ------- ------- -------\nNet pension cost $1,504 $1,188 $ 966 ======= ======= =======\nActuarial assumptions used: Discount rate 8 3\/4%* 7 1\/2%* 8 1\/2% Rate of increase in compensation 5 1\/2% 5 1\/2%* 6 1\/2% Long-term rate of return on assets 8% 8%* 9%\n*Rate was changed effective December 31, 1994 and resulted in a net decrease of $5.6 million in the projected benefit obligation referred to below.\n**Rates were changed effective December 31, 1993 and resulted in a net increase of $3.1 million in the projected benefit obligation referred to below.\nThe Company's plan has assets in excess of accumulated benefit obligation. Plan assets generally include equity and fixed income funds. The status of the Company's employee pension benefit plan is summarized below (in thousands):\nDecember 31, 1994 1993 Assets available for benefits: Funded plan assets at fair value $31,762 $32,795 Accrued pension expense 3,610 3,780 -------- -------- Total assets $35,372 $36,575 -------- --------\nActuarial present value of benefit obligations: Accumulated benefit obligations, $30,537 $32,463 including vested benefits of $30,179 and $31,837 Effect of future salary increases 4,546 6,468 -------- -------- Projected benefit obligations $35,083 $38,931 -------- --------\nAssets available more (less) than $ 289 $(2,356) projected benefits ======= ========\nConsisting of: Unamortized net liability existing at $ (36) $ (41) date of adopting SFAS No. 87 Unrecognized net loss (268) (2,260) Unrecognized prior service cost 593 (55) -------- -------- $ 289 $(2,356) ======== ========\nThe Company's policy is generally to fund currently the costs accrued under the pension plan and the Section 401(k) plan described below.\nThe Company also has noncontributory Section 401(k) and employee stock ownership plans (ESOP) which cover its executive, professional, administrative and clerical employees, subject to certain specified service requirements. Under the terms of the Section 401(k) plan, the\nprovision is based on a specified percentage of profits, subject to certain limitations. Contributions to the related employee stock ownership trust (ESOT) are determined by the Board of Directors and may be paid in cash or shares of Company common stock.\nThe Company also has an unfunded supplemental retirement plan for certain employees whose benefits under principal salaried retirement plans are reduced because of compensation limitations under federal tax laws. Pension expense for this plan was $.2 million in 1994 and $.1 million per year in 1993 and 1992. At December 31, 1994, the projected benefit obligation was $1.0 million. A corresponding accumulated benefit obligation of $.6 million has been recognized as a liability in the consolidated balance sheet and is equal to the amount of the vested benefits.\nIn addition, the Company has an incentive compensation plan for key employees which is generally based on achieving certain levels of profit within their respective business units.\nThe aggregate amounts provided under these employee benefit plans were $9.2 million in 1994, $8.5 million in 1993, and $10.8 million in 1992.\nThe Company also contributes to various multiemployer union retirement plans under collective bargaining agreements, which provide retirement benefits for substantially all of its union employees. The aggregate amounts provided in accordance with the requirements of these plans were $12.4 million in 1994, $5.2 million in 1993, and $11.2 million in 1992. The Multiemployer Pension Plan Amendments Act of 1980 defines certain employer obligations under multiemployer plans. Information regarding union retirement plans is not available from plan administrators to enable the Company to determine its share of unfunded vested liabilities.\n[11] Contingencies and Commitments\nIn connection with the Rincon Center real estate development joint venture, the Company's wholly-owned real estate subsidiary has guaranteed the payment of interest on both mortgage and bond financing covering a project with loans totaling $61 million; has issued a secured letter of credit to collateralize $3.7 million of these borrowings; has guaranteed amortization payments up to $9.1 million on these borrowings; and has guaranteed a master lease under a sale operating lease-back transaction. In calculating the potential obligation under the master lease guarantee, the Company has an agreement with its lenders which employs a 10% discount rate and no increases in future rental rates beyond current lease terms. Based on these assumptions, management believes its additional future obligation will not exceed $3.0 million. The Company has also guaranteed $5.0 million of the subsidiary's $9.1 million amortization guaranty and any obligation under the master lease during the next four years. As part of the sale operating lease-back transaction, the joint venture, in which the Company's real estate subsidiary is a 46% general partner, agreed to obtain a financial commitment on behalf of the lessor to replace at least $43 million of long-term financing by July 1, 1993. To satisfy this obligation, the partnership successfully extended existing financing to July 1, 1998. To complete the extension, the partnership had to advance funds to the lessor sufficient to reduce the financing from $46.5 million to $40.5 million. Subsequent payments through 1994 have further reduced the loan to $39.3 million. In addition, as part of the obligations of the extension, the partnership will have to further amortize the debt from its current level to $33 million through additional lease payments over the next four years. If by January 1, 1998, the joint venture has not received a further extension or new commitment for financing on the property for at least $33 million, the lessor will have the right under the lease to require the joint venture to purchase the property for approximately $18.8 million in excess of the then outstanding debt.\nIn 1993, the joint venture also extended $29 million of the $61 million financing then outstanding through October 1, 1998. This extension required a $.6 million up front paydown. Subsequent payments through 1994 further reduced the loan by $1.0 million. The joint venture is required to amortize up to $11.3 million more of the principal. Under certain conditions, that amortization could be as low as $8.5 million. Total lease payments and loan amortization obligations at Rincon Center through 1997 are as follows: $6.9 million in 1995, $7.5 million in 1996, and $7.3 million in 1997. It is expected that some but not all of these requirements will be generated by the project's operations. The Company's real estate subsidiary and, to a more limited extent, the Company, is obligated to fund any of the loan amortization and\/or lease payments at Rincon in the event sufficient funds are not generated by the property or contributed to by its partners. Based on current Company forecasts, it is expected the maximum exposure to service these commitments in each of the years through 1997 is as follows: $2.0 million in 1995, $2.4 million in 1996, and as much as $6.0 million in 1997 based on possible tenanting expenses during that year.\nIn a separate agreement related to this same property, the 20% co-general partner has indicated it does not currently have nor does it expect to have the financial resources to fund its share of capital calls. Therefore, the Company's wholly-owned real estate subsidiary agreed to lend this 20% co-general partner on an as-needed basis, its share of any capital calls which the partner cannot meet. In return, the Company's subsidiary receives a priority return from the partnership on those funds it advances for its partner and penalty fees in the form of rights to certain other distributions due the borrowing partner from the partnership. The severity of the penalty fees increases in each succeeding year for the next several years. The subsidiary advanced $.3 million in 1994 and $1.7 million in 1993 under this agreement.\nIn connection with a second real estate development joint venture known as the Resort at Squaw Creek, the Company's wholly-owned real estate subsidiary has guaranteed the payment of interest on mortgage financing with a total bank loan value currently estimated at $48 million; has guaranteed $10 million of loan principal; has posted a letter of credit for $1.0 million as its part of credit support required to extend the maturity of the $48 million loan to May 1995, which letter of credit is guaranteed by both the Company and its subsidiary; and has guaranteed leases which aggregate $1.5 million on a present value basis as discounted at 10%. The $48 million of bank financing on the project matures on May 1, 1995. Preliminary discussions have taken place with the Resort's lead bank and management anticipates extension or replacement of the loan. However, as with any real estate financing, there is no assurance that any extension or replacement financing will be available. In the event that were to happen, the property would be subject to foreclosure and possibly sale at a value below the Company's present investment basis. It is also possible an extension or new financing could require the joint venture to make additional amortization payments either on extension or over the life of such an extension, which could create additional financial requirements for the Company's wholly-owned real estate subsidiary.\nThe subsidiary also has an obligation through the year 2001 to cover approximately a $2 million per year preferred return at the Resort if the funds are not generated from hotel operations. Although results have shown improvement since the Resort opened in late 1990, it is not expected that hotel operations will contribute to the obligation during 1995. Although the results of the hotel's operations can be somewhat weather dependent, management believes that operations should contribute increasing amounts toward the coverage of the preferred return over the next two to three years and will, at some point during that period, fully cover it.\nIncluded in the loan agreements related to the above joint ventures, among other things, are provisions that, under certain circumstances, could limit the subsidiary's ability to transfer funds to the Company. In the opinion of management, these provisions should not affect the operations of the Company or the subsidiary.\nOn July 30, 1993, the U.S. District Court (D.C.), in a preliminary opinion, upheld terminations for default on two adjacent contracts for subway construction between Mergentime-Perini, under two joint ventures, and the Washington Metropolitan Area Transit Authority (\"WMATA\") and found the Mergentime Corporation, Perini Corporation and the Insurance Company of North America, the surety, jointly and severally liable to WMATA for damages in the amount of $16.5 million, consisting primarily of excess reprocurement costs to complete the projects. Many issues were left partially or completely unresolved by the opinion, including substantial joint venture claims against WMATA. Any such amounts awarded to the joint ventures could serve to offset the above damages awarded. The ultimate financial impact, if any, of this judgement is not yet determinable, and therefore, no impact is reflected in either the 1993 or 1994 financial statements.\nContingent liabilities also include liability of contractors for performance and completion of both company and joint venture construction contracts. In addition, the Company is a defendant in various lawsuits (some of which are for significant amounts). In the opinion of management, the resolution of these matters will not have a material effect on the accompanying financial statements.\n[12] UNAUDITED QUARTERLY FINANCIAL DATA\nThe following table sets forth unaudited quarterly financial data for the years ended December 31, 1994 and 1993 (in thousands, except per share amounts):\n1994 by Quarter\n1st 2nd 3rd 4th\nRevenues $174,391 $243,105 $304,776 $289,773\nNet income (loss) $ 792 $ (2,649) $ 984 $ 1,176\nEarnings (loss) per $ .06 $ (.73) $ .10 $ .15 common share\n1993 by Quarter\n1st 2nd 3rd 4th\nRevenues $258,043 $348,004 $274,795 $219,274\nNet income $ 745 $ 965 $ 679 $ 776\nEarnings per common share $ .05 $ .10 $ .04 $ .05\n[13] BUSINESS SEGMENTS AND FOREIGN OPERATIONS\nThe Company is currently engaged in the construction and real estate development businesses. The following tables set forth certain business and geographic segment information relating to the Company's operations for the three years ended December 31, 1994 (in thousands):\nBusiness Segments Revenues 1994 1993 1992\nConstruction $ 950,884 $1,030,341 $1,023,274 Real Estate 61,161 69,775 47,578 ----------- ----------- ----------- $1,012,045 $1,100,116 $1,070,852 =========== ========== ==========\nIncome (Loss) From Operations 1994 1993 1992\nConstruction $ 13,989 $ 15,164 $ 34,387 Real Estate 732 240 (47,206) Corporate (5,909) (6,830) (6,320) ----------- ----------- ----------- $ 8,812 $ 8,574 $ (19,139) =========== =========== ===========\nAssets 1994 1993 1992\nConstruction $ 262,850 $ 219,604 $ 214,089 Real Estate 209,635 218,715 204,713 Corporate* 10,015 38,059 51,894 ------------ ---------- ----------- $ 482,500 $ 476,378 $ 470,696 ============ =========== ===========\nCapital Expenditures 1994 1993 1992\nConstruction $ 2,491 $ 4,387 $ 4,042 Real Estate 10,274 23,590 29,131 ----------- ----------- ----------- $ 12,765 $ 27,977 $ 33,173 ========== =========== ===========\nDepreciation 1994 1993 1992\nConstruction $ 2,551 $ 2,552 $ 5,489 Real Estate** 328 963 808 ----------- ----------- ----------- $ 2,879 $ 3,515 $ 6,297 =========== =========== ===========\nGeographic Segments Revenues 1994 1993 1992\nUnited States $ 996,832 $1,064,380 $ 909,358 Canada - - 107,709 Other Foreign 15,213 35,736 53,785 ----------- ----------- ----------- $1,012,045 $1,100,116 $1,070,852 =========== =========== ===========\nIncome (Loss) From Operations 1994 1993 1992\nUnited States $ 17,275 $ 17,249 $ (28,994) Canada - - 12,812 Other Foreign (2,554) (1,845) 3,363 Corporate (5,909) (6,830) (6,320) ----------- ----------- ----------- $ 8,812 $ 8,574 $ (19,139) =========== =========== ===========\nAssets 1994 1993 1992\nUnited States $ 467,298 $ 433,488 $ 365,997\nCanada - - 46,089 Other Foreign 5,187 4,831 6,716 Corporate* 10,015 38,059 51,894 ----------- ----------- ----------- $ 482,500 $ 476,378 $ 470,696 =========== =========== ===========\n*In all years, corporate assets consist principally of cash, cash equivalents, marketable securities and other investments available for general corporate purposes.\n**Does not include approximately $3 to 4 million of depreciation that represents its share from real estate joint ventures. (See Note 2 to Notes to the Consolidated Financial Statements.)\nContracts with various federal, state, local and foreign governmental agencies represented approximately 56% of construction revenues in 1994, 54% in 1993 and 57% in 1992.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Perini Corporation:\nWe have audited the accompanying consolidated balance sheets of PERINI CORPORATION (a Massachusetts 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Perini 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.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts February 10, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo the Stockholders of Perini Corporation:\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 February 10, 1995. Our audits were made for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The supplemental schedules listed in the accompanying index are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state, in all material respects, the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts February 10, 1995\nSCHEDULE II PERINI CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS OF DOLLARS)\nAdditions Balance at Charged Charged to Deductions Balance Beginning to Costs Other from at End Description of Year & Expenses Accounts Reserves of Year\nYear Ended December 31, 1994 Reserve for $ 351 $ - $ - $ - $ 351 doubtful accounts ======= ======= ==== ====== =======\nReserve for $ 3,637 $ 328 $ - $ 267 (2) $ 3,698 depreciation on ======= ======= ==== ====== ======= real estate properties used in operations\nReserve for real $20,838 $ - $ - $9,367 (2) $11,471 estate ======= ======== ===== ====== ======= investments\nYear Ended December 31, 1993 Reserve for $ 351 $ - $ - $ - $ 351 doubtful accounts ======= ======= ===== ======= =======\nReserve for depreciation on real estate $ 3,181 $ 920 $ - $ 464 (2) $ 3,637 properties used ======= ======= ==== ====== ======= in operations\nReserve for real estate $29,968 $ - $ - $9,130 (2) $20,838 investments ======= ======= ===== ====== =======\nYear Ended December 31, 1992 Reserve for $ 742 $ - $ - $ 391 (1) $ 351 doubtful accounts ======= ======= ==== ====== =======\nReserve for depreciation on real estate $ 2,428 $ 974 $ - $ 221 (2) $ 3,181 properties used ======= ======= ==== ====== ======= in operations\nReserve for real estate $ 4,732 $31,368 $ - $6,132 (2) $29,968 investments ======= ======= ==== ====== ======\n(1) Represents write-off of uncollectible accounts and reversal of reserves no longer required.\n(2) Represents sales of real estate properties.\nEXHIBIT INDEX\nThe following designated exhibits are, as indicated below, either filed herewith or have heretofore been filed with the Securities and Exchange Commission under the Securities Act of 1933 or the Securities Act of 1934 and are referred to and incorporated herein by reference to such filings.\nExhibit 3. Articles of Incorporation and By-laws\n3.1 Restated Articles of Organization - As amended through July 7,\nFiled herewith\nIncorporated herein by reference:\n3.2 3.2By-laws - As amended through September 14, 1990 - Exhibit 3.2 to 1991 Form 10K, as filed.\nExhibit 4. Instruments Defining the Rights of Security Holders, Including Indentures\nIncorporated herein by reference:\n4.1 Certificate of Vote of Directors Establishing a Series of a Class of Stock determining the relative rights and preferences of the $21.25 Convertible Exchangeable Preferred Stock - Exhibit 4(a) to Amendment No. 1 to Form S-2 Registration Statement filed June 19, 1987; SEC Registration No. 33-14434.\n4.2 Form of Deposit Agreement, including form of Depositary Receipt - Exhibit 4(b) to Amendment No. 1 to Form S-2 Registration Statement filed June 19, 1987; SEC Registration No. 33-14434.\n4.3 Form of Indenture with respect to the 8 1\/2% Convertible Subordinated Debentures Due June 15, 2012, including form of Debenture - Exhibit 4(c) to Amendment No. 1 to Form S-2 Registration Statement filed June 19, 1987; SEC Registration No. 33-14434.\n4.4 Shareholder Rights Agreement and Certificate of Vote of Directors adopting a Shareholders Rights Plan providing for the issuance of a Series A Junior Participating Cumulative Preferred Stock purchase rights as a dividend to all shareholders of record on October 6, 1988, incorporated by reference from Current Report on Form 8-K filed on May 25, 1990.\nExhibit 10. Material Contracts\nIncorporated herein by reference:\n10.1 1982 Stock Option and Long Term Performance Incentive Plan - Registrant's Proxy Statement for Annual Meeting of Stockholders dated April 27, 1987.\n10.2 Perini Corporation Amended and Restated General Incentive Compensation Plan - Exhibit 10.2 to 1991 Form 10K, as filed.\n10.3 Perini Corporation Amended and Restated Construction Business Unit Incentive Compensation Plan - Exhibit 10.3 to 1991 Form 10K, as filed.\nEXHIBIT INDEX (Continued)\n10.4 $125 million Credit Agreement dated as of December 6, 1994 among Perini Corporation, the Banks listed herein, Morgan Guaranty Trust Company of New York, as Agent, and Shawmut Bank, N.A., Co-Agent.\nFiled herewith\nExhibit 22. Subsidiaries of Perini Corporation\nFiled herewith\nExhibit 23. Consent of Independent Public Accountants\nFiled herewith\nExhibit 24. Power of Attorney\nFiled herewith\nExhibit 27. Financial Data Schedule\nFiled Herewith\nEXHIBIT 3.1\nPERINI CORPORATION\nRESTATED ARTICLES OF ORGANIZATION (As Amended Through July 7, 1994)\n1. The name by which the corporation shall be known is:\nPERINI CORPORATION\n2. The purpose for which the corporation is formed are as follows:\nTo carry on a general contracting and construction business; to carry\non a general mining business; to carry on a general business with respect to oil, gas and other natural resources; to carry on a general real estate development and operations business; to carry on a general business of promoting, conducting or producing any one or more lawful athletic or amusement activities and exhibitions; to carry on a general business of manufacturing or otherwise producing, acquiring, preparing for market, buying and selling, dealing in and with and disposing of any and all kinds of construction, sporting and amusement equipment, materials and supplies and any and all products and by-products thereof, any and all ingredients, supplies and items in any stage of production, used or useful in combination with, in substitution for or otherwise in connection with or of which any one or more such products, by-products, ingredients, supplies or items form, or are suitable to form, a component part and all related machinery, appliances, apparatus and tools; to acquire, hold, use and dispose of property of whatever kind and wherever situated, and rights and interests therein, including going enterprises and the acquisition of interests in and obligations of other concerns (wherever and however organized) or of individuals, and while the owner thereof to exercise all the rights, powers and privileges of ownership in the same manner and to the same extent that an individual might; to discover, invent or acquire rights and interests in inventions, designs, patents, patent rights and licenses, trademarks, trade names, copyrights and trade secrets in any field, whether or not cognate to any other activity of the corporation and to hold, use, sell, license the use of or otherwise utilize, deal in or dispose of the same; to lend money, credit or security to, to guarantee or assume obligations of and to aid in any other manner other concerns (whatever and however organized) or individuals, any obligation of which or any interest in which is held by this corporation or in the affairs or prosperity of which this corporation has a lawful interest, and to do all acts and things designed to protect, improve or enhance the value of any such obligation or interest; to join with others in any enterprise conducive to the success of the corporation, in such manner and on such terms and conditions as may be agreed upon; and in general, whether as principal or as agent or contractor for others and in any manner, to do every act and thing and to carry on any and all businesses and activities in any way connected with any of the foregoing which may lawfully be done or carried on by business corporations wherever such one or more businesses or activities may be so done and to exercise all the powers conferred by the laws of The Commonwealth of Massachusetts upon business corporations, provided, however, that the corporation is not organized for any purpose which prevents the provisions of Chapter 156 B of the General Laws of said Commonwealth and acts in amendment thereof and in addition thereto, from being applicable to it.\n3. The total number of shares and the par value, if any, of each class of stock which the corporation is authorized to issue is as follows:\nWithout Par Value With Par Value\nNumber of Number of Class of Stock Shares Shares Par Value\nCommon None 15,000,000 $ 1.00 Preferred None 1,000,000 1.00\nSeries of Preferred Stock\n$ 21.25 Convertible Exchangeable Preferred Stock None 100,000 1.00\n$ Series A Junior Participating Cummulative None 200,000 1.00 Preferred Stock\nTwo classes of stock are authorized, Common Stock having a par value of $1.00 per share and Preferred Stock having a par value of $1.00 per share. Stock of any class or series authorized pursuant hereto may be issued from time to time by authority of the Board of Directors for such consideration as from time to time may be fixed by vote of the Board of Directors.\nI. The Preferred Stock may consist of one or more series. The Board of Directors may, from time to time, establish and designate the different series and the variations in the relative rights and preferences as between the different series as provided in Section II hereof, but in all other respects all shares of the Preferred Stock shall be identical. In the event that at any time the Board of Directors shall have established and designated one or more series of Preferred Stock consisting of a number of shares less than all of the authorized number of shares of Preferred Stock, the remaining authorized shares of Preferred Stock shall be deemed to be shares of an undesignated series of Preferred Stock until designated by the Board of Directors as being a part of a series previously established or a new series than being established by the Board of Directors.\nII. Subject to the provisions of this Description of Classes of Stock, the Board of Directors is authorized to establish one or more series of Preferred Stock and, to the extent now or hereafter permitted by the laws of the Commonwealth of Massachusetts to fix and determine the preferences, voting powers, qualifications and special or relative rights or privileges of each series including, but not limited to:\n(a) the number of shares to constitute such series and the distinctive designation thereof;\n(b) the dividend rate on the shares of such series and the preferences, if any, and the special and relative rights of such shares of such series as to dividend;\n(c) whether or not the shares of such series shall be redeemable, and, if redeemable, the price, terms and manner of redemption;\n(d) the preference, if any, and the special and relative rights of the shares of such series upon liquidation of the corporation;\n(e) whether or not the shares of such series shall be subject to the operation of a sinking or purchase fund and, if so, the terms and provisions of such fund;\n(f) whether or not the shares of such series shall be convertible into shares of any other class or of any other series of the same or any other class of stock of the corporation and, if so, the conversion price or ratio and other conversion rights;\n(g) the conditions under which the shares of such series shall have separate voting rights or no voting rights; and\n(h) such other designations, preferences and relative, participating, optional or other special rights and qualifications, limitations or restrictions of such series to the full extent now and hereafter permitted by the laws of the Commonwealth of Massachusetts.\nNotwithstanding the fixing of the number of shares constituting a particular series, the Board of Directors may at any time authorize the issuance of additional shares of the same series.\nIII. Holders of Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors, but only out of funds legally available for the payment of dividends, cash dividends at the rates fixed by the Board of Directors for the respective series, payable on such dates in each year as the Board of Directors shall fix for the respective series as provided in Section II (hereinafter referred to as \"dividend dates\"). Until all accrued dividends on each series of Preferred Stock shall have been paid through the last preceding dividend date of each such series, no dividend or distribution shall be made to holders of Common Stock other than a dividend payable in Common Stock of the corporation. Dividends on shares on any cumulative series of Preferred Stock shall accumulate form and after the day on which such shares are issued, but arrearages in the payment thereof shall not bear interest. Nothing herein contained shall be deemed to limit the right of the corporation to purchase or otherwise acquire at any time any shares of its capital stock.\nFor purposes of this Description of Class of Stock, the amount of dividends \"accrued\" on any shares on any cumulative series of Preferred Stock as at any dividend date shall be deemed to be the amount of any unpaid dividends accumulated thereon to and including such dividend date, whether or not earned or declared. The amount of dividends \"accrued\" on any noncumulative series of Preferred Stock shall mean only those dividends declared by the Board of Directors, unless otherwise specified for such series by the Board of Directors pursuant to Section II.\nIV. Upon the voluntary or involuntary liquidation of the corporation, before any payment or distribution of the assets of the corporation shall be made to or set apart for any other class of stock, the holders of Preferred Stock shall be entitled to payment of the amount of the preference payable upon such liquidation of the corporation shall be insufficient to pay in full to the holders of the Preferred Stock the preferential amount aforesaid, then such assets, or the proceeds thereof, shall be distributed among the holders of each series of Preferred Stock ratably in accordance with the sums which would be payable on such distribution if all sums payable were discharged in full. The voluntary sale, conveyance, exchange or transfer of all or substantially all of the property and assets of the corporation, the merger or consolidation of the corporation into or with any other corporation, or the merger of any other corporation into it, shall not be deemed to be a liquidating of the corporation for the purpose of this Section IV.\nV. Any shares of Preferred Stock which shall at any time have been redeemed or which shall at any time have been surrendered for conversion or exchange or for cancellation, pursuant to any sinking or purchase fund provisions with respect to any series of Preferred Stock, shall be retired and shall thereafter have the status of authorized and unissued shares of Preferred Stock undesignated as to series.\nVI. The Common Stock shall have exclusive voting power except as required by law and except to the extent the Board of Directors shall, at the time any series of Preferred Stock is established, determine that the shares of such series shall vote (i) together as a single class with shares of Common Stock and\/or with shares of Preferred Stock (or one or more other series thereof) on all or certain matters presented to the stockholders and\/or upon the occurrence of any specified event or condition, and\/or (ii) exclusively on certain matters or, upon the occurrence of any specified event or condition, on all or certain matters. The Board of Directors, in establishing a series of Preferred Stock and fixing the voting rights thereof, may determine that the voting power of each share of such series may be greater or less than the voting power of each share of the Common Stock or of other series of Preferred Stock notwithstanding that the shares of such series of preferred Stock may vote as a single class with the shares of other series of Preferred Stock and\/or with the shares of Common Stock.\n4. If more than one class is authorized, a description of each of the different classes of stock with, if any, the preferences, voting powers, qualifications, special or relative rights or privileges as to each class thereof and any series now established:\nSee Article 3 above.\n5. The restrictions, if any, imposed by the articles of organization upon the transfer of shares of stock of any class are as follows:\nNone.\n6. Other lawful provisions for the conduct and regulation of the business and affairs of the corporation, of its voluntary dissolution, or for limiting, defining, or regulating the powers of the corporation, or of its directors or stockholders, or of any class of stockholders are as follows:\n6.1. The directors may make, amend or repeal the bylaws in whole or in part, except with respect to any provision thereof which by law or the by-laws requires action by the stockholders.\n6.2. Meetings of the stockholders may be held anywhere in the United States.\n6.3. Except as specifically authorized by statute, no stockholder shall have any right to examine any property or any books, accounts or other writings of the corporation if there is reasonable ground for belief that such examination will for any reason be adverse to the interest of the corporation, and a vote of the board of directors refusing permission to make such examination and setting forth that in the opinion of the board of directors such examination would be adverse to the interests of the corporation shall be prima facie evidence that such examination would be adverse to the interests of the corporation. Every such examination shall be subject to such reasonable regulations as the board of directors may establish in regard thereto.\n6.4. The board of directors may specify the manner in which the accounts of the corporation shall be kept and may determine what constitutes net earnings, profits and surplus, what amounts, if any, shall be reserved for any corporation purpose, and what amounts, if any, shall be declared as dividends. Unless the board of directors otherwise specifies, the excess of the consideration for any share of its capital stock with par value issued by it over such par value shall be paid in surplus. All surplus shall be available for any corporate purpose, including the payment of dividends.\n6.5 The corporation may purchase or otherwise acquire, hold, sell or otherwise dispose of shares of its own capital stock, and such purchase or holding shall not be deemed a reduction of its capital stock. The corporation may reduce its capital stock in any manner authorized by law. Such reduction may be effected by the cancellation and retirement of any shares to its capital stock held by it. Upon any reduction of capital or capital stock, no stockholder shall have any right to demand any distribution from the corporation, except as and to the extent that the stockholders shall so have provided at the time of authorizing such reduction.\n6.6. Each director and officer of the corporation shall, in the performance of his duties, be fully protected in relying in good faith upon the books of account of the corporation, reports made to the corporation by any of its officers of employees or by counsel, accountants, appraisers or other experts or consultants selected with reasonable care by the directors, or upon other records of the corporation.\n6.7. The directors shall have the power to fix from time to time their compensation.\n6.8. The corporation may enter into contracts and otherwise transact business as vendor, purchaser or otherwise with its directors, officers and stockholders and with corporations, joint stock companies, trusts, firms and associations in which they are or may be or become interested as directors, officers, shareholders, members, trustees, beneficiaries or otherwise as freely as though such adverse interest did not exist even though the vote, action or presence of such director, officer or stockholder may be necessary to obligate the corporation upon such contract or transactions; and no such contract or transaction shall be avoided and no such director, officer or stockholder shall be held liable to account to the corporation of to any creditor or stockholder of the corporation for any profit or benefit realized by him through any such contract or transaction by reasons of such adverse interest nor by reason of any fiduciary relationship of such director, officer or stockholder to the corporation arising out of such office or stock ownership; provided (in the case of directors and officers but not in the case of any stockholder who is not a director or not in the case of any stockholder who is not a director or officer of the corporation) the nature of the interest of such director of officer, though not necessarily the details or extend thereof, be known by or disclosed to the directors. Ownership or beneficial interest in a minority of the stock or securities of another corporation, joint stock company, trust, firm or association shall not be deemed to constitute an interest adverse to this corporation in such other corporation, joint stock company, trust, firm or association and need not be disclosed. A general notice that a director or officer of the corporation is interested in any corporation, joint stock company, trust, firm or association shall\nbe a sufficient disclosure as to such director or officer with respect to all contracts and transactions with that corporation, joint stock company, trust, firm of association. In any event the authorizing or ratifying vote of a majority of the capital stock of the corporation outstanding and entitled to vote passed at a meeting duly called and held for the purpose shall validate any such contract or transaction as against all stockholders of the corporation, whether of record or not at the time of such vote, and as against all creditors and other claimants, under the corporation, and no contract or transaction shall be avoided by reason of any provision of this paragraph which would be valid but for these provisions.\n6.9. The terms and conditions upon which a sale or exchange of all the property and assets, including the good will of the corporation, or any part thereof, is voted may include the payment thereof in whole or in part on shares, notes, bonds or other certificated of interest or indebtedness of any voluntary association, trust, joint stock company or corporation.\nSuch vote or a subsequent vote may in the event of or in contemplation of proceedings for the dissolution of the corporation also provide, subject to the rights of creditors and preferred stockholders, for the distribution pro rate among the stockholders of the corporation, of the proceed of any such sale or exchange, whether such proceeds be in cash or in securities as aforesaid (at values to be determined by the board of directors).\n6.10. No director of this corporation shall be personally liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director notwithstanding any provision of law imposing such liability; provided, however, that this Article shall not eliminate or limit any liability of a director (i) for any breach 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 of a knowing violation of law, (iii) under Sections 61 or 62 of the Massachusetts Business Corporation Law, or (iv) with respect to any transaction from which the director derived an improper personal benefit.\nNo amendment or repeal of this Article shall adversely affect the rights and protection afforded to a director of this corporation under this Article for acts or omissions occurring while this Article is in effect.\nEXHIBIT 10.4\n[CONFORMED COPY]\n$125,000,000\nCREDIT AGREEMENT\ndated as of\nDecember 6, 1994\namong\nPerini Corporation\nThe Banks Listed Herein\nMorgan Guaranty Trust Company of New York, as Agent\nShawmut Bank, N.A., Co-Agent\nPage ARTICLE I DEFINITIONS\nSECTION 1.01. Definitions. . . . . . . . . . . . . . . . . . . . 1 SECTION 1.02. Accounting Terms and Determinations. . . . . . . 17 SECTION 1.03. Types of Borrowings. . . . . . . . . . . . . . . 17\nARTICLE II THE CREDITS\nSECTION 2.01. The Loans. . . . . . . . . . . . . . . . . . . . 17 SECTION 2.02. Method of Borrowing. . . . . . . . . . . . . . . 18 SECTION 2.03. Notes. . . . . . . . . . . . . . . . . . . . . . 19 SECTION 2.04. Maturity of Loans. . . . . . . . . . . . . . . . 20 SECTION 2.05. Interest Rates. . . . . . . . . . . . . . . . . 21 SECTION 2.06. Commitment Fees. . . . . . . . . . . . . . . . . 24 SECTION 2.07. Participation Fee. . . . . . . . . . . . . . . . 24 SECTION 2.08. Agency Fee. . . . . . . . . . . . . . . . . . . . 25 SECTION 2.09. Optional Termination or Reduction of Commitments. . . . . . . . . . . . . . . . . . . . 25 SECTION 2.10. Mandatory Termination or Reduction of Commitments. . . . . . . . . . . . . . . . . . . . 25 SECTION 2.11. Optional Prepayments. . . . . . . . . . . . . . . 27 SECTION 2.12. General Provisions as to Payments. . . . . . . . 27 SECTION 2.13. Funding Losses. . . . . . . . . . . . . . . . . . 27 SECTION 2.14. Computation of Interest and Fees. . . . . . . . . 28 SECTION 2.15. Maximum Interest Rate. . . . . . . . . . . . . . 28 SECTION 2.16. Letters of Credit. . . . . . . . . . . . . . . . 29 SECTION 2.17. Termination of the Security Interest. . . . . . . 34\nARTICLE III CONDITIONS\nSECTION 3.01. Effectiveness. . . . . . . . . . . . . . . . . . 35 SECTION 3.02. Credit Events. . . . . . . . . . . . . . . . . . 37\nARTICLE IV REPRESENTATIONS AND WARRANTIES\nSECTION 4.01. Corporate Existence and Power. . . . . . . . . . 38 SECTION 4.02. Corporate and Governmental Authorization; No Contravention. . . . . . . . . . . . . . . . . . . 38 SECTION 4.03. Binding Effect; Liens of Collateral Documents. . . . . . . . . . . . . . . . . . . . . 38 SECTION 4.04. Financial Information. . . . . . . . . . . . . . 39 SECTION 4.05. Litigation. . . . . . . . . . . . . . . . . . . . 39 SECTION 4.06. Compliance with ERISA. . . . . . . . . . . . . . 40 SECTION 4.07. Environmental Matters. . . . . . . . . . . . . . 40 SECTION 4.08. Taxes. . . . . . . . . . . . . . . . . . . . . . 42 SECTION 4.09. Subsidiaries. . . . . . . . . . . . . . . . . . . 42 SECTION 4.10. Not an Investment Company. . . . . . . . . . . . 42 SECTION 4.11. No Burdensome Restrictions. . . . . . . . . . . . 42 SECTION 4.12. Full Disclosure. . . . . . . . . . . . . . . . . 42 SECTION 4.13. Ownership of Property; Liens. . . . . . . . . . . 43\nARTICLE V COVENANTS\nSECTION 5.01. Information. . . . . . . . . . . . . . . . . . . 43 SECTION 5.02. Payment of Obligations. . . . . . . . . . . . . . 46 SECTION 5.03. Maintenance of Property; Insurance. . . . . . . . 46 SECTION 5.04. Conduct of Business and Maintenance of Existence. 47 SECTION 5.05. Compliance with Laws. . . . . . . . . . . . . . . 47 SECTION 5.06. Inspection of Property, Books and Records. . . . 47 SECTION 5.07. Current Ratio. . . . . . . . . . . . . . . . . . 47 SECTION 5.08. Debt. . . . . . . . . . . . . . . . . . . . . . . 47 SECTION 5.09. Minimum Consolidated Tangible Net Worth. . . . . 48 SECTION 5.10. Interest Coverage. . . . . . . . . . . . . . . . 48 SECTION 5.11. Negative Pledge. . . . . . . . . . . . . . . . . 48 SECTION 5.12. Consolidations, Mergers and Sales of Assets. . . 49 SECTION 5.13. Use of Proceeds. . . . . . . . . . . . . . . . . 50 SECTION 5.14. Restricted Payments. . . . . . . . . . . . . . . 50 SECTION 5.15. Real Estate Investments. . . . . . . . . . . . . 51 SECTION 5.16. Other Investments. . . . . . . . . . . . . . . . 51 SECTION 5.17. Further Assurances. . . . . . . . . . . . . . . . 51\nARTICLE VI DEFAULTS\nSECTION 6.01. Events of Default. . . . . . . . . . . . . . . . 52 SECTION 6.02. Cash Cover. . . . . . . . . . . . . . . . . . . . 55\nARTICLE VII THE AGENT\nSECTION 7.01. Appointment and Authorization. . . . . . . . . . 56 SECTION 7.02. Agent and Affiliates. . . . . . . . . . . . . . . 56 SECTION 7.03. Action by Agent. . . . . . . . . . . . . . . . . 56 SECTION 7.04. Consultation with Experts. . . . . . . . . . . . 56 SECTION 7.05. Liability of Agent. . . . . . . . . . . . . . . . 56 SECTION 7.06. Indemnification. . . . . . . . . . . . . . . . . 57 SECTION 7.07. Credit Decision. . . . . . . . . . . . . . . . . 57 SECTION 7.08. Successor Agent. . . . . . . . . . . . . . . . . 57\nSECTION 7.09. Collateral Documents. . . . . . . . . . . . . . . 58\nARTICLE VIII CHANGE IN CIRCUMSTANCES\nSECTION 8.01. Basis for Determining Interest Rate Inadequate or Unfair. . . . . . . . . . . . . . . . 58 SECTION 8.02. Illegality. . . . . . . . . . . . . . . . . . . . 59 SECTION 8.03. Increased Cost and Reduced Return. . . . . . . . 59 SECTION 8.04. Base Rate Loans Substituted for Affected Fixed Rate Loans. . . . . . . . . . . . . . . . . . . . . 61\nARTICLE IX MISCELLANEOUS\nSECTION 9.01. Notices. . . . . . . . . . . . . . . . . . . . . 62 SECTION 9.02. No Waivers. . . . . . . . . . . . . . . . . . . . 62 SECTION 9.03. Expenses; Documentary Taxes; Indemnification. 63 SECTION 9.04. Sharing of Setoffs. . . . . . . . . . . . . . . . 64 SECTION 9.05. Amendments and Waivers. . . . . . . . . . . . . . 64 SECTION 9.06. Successors and Assigns. . . . . . . . . . . . . . 65 SECTION 9.07. Collateral. . . . . . . . . . . . . . . . . . . . 66 SECTION 9.08. Governing Law; Submission to Jurisdiction. . . . 66 SECTION 9.09. Counterparts; Integration. . . . . . . . . . . . 67 SECTION 9.10. WAIVER OF JURY TRIAL. . . . . . . . . . . . . . . 67\nCREDIT AGREEMENT\nAGREEMENT dated as of December 6, 1994 among PERINI CORPORATION, the BANKS listed on the signature pages hereof and MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Agent.\nARTICLE I\nDEFINITIONS\nSECTION 1.01. Definitions. The following terms, as used herein, have the following meanings:\n\"Adjusted CD Rate\" has the meaning set forth in Section 2.05(b).\n\"Adjusted London Interbank Offered Rate\" has the meaning set forth in Section 2.05(c).\n\"Administrative Questionnaire\" means, with respect to each Bank, the administrative questionnaire in the form submitted to such Bank by the Agent and submitted to the Agent (with a copy to the Borrower) duly completed by such Bank.\n\"Agent\" means Morgan Guaranty Trust Company of New York in its capacity as agent for the Banks under the Financing Documents, and its successors in such capacity.\n\"Applicable Lending Office\" means, with respect to any Bank, (i) in the case of its Domestic Loans, its Domestic Lending Office and (ii) in the case of its Euro-Dollar Loans, its Euro-Dollar Lending Office.\n\"Assessment Rate\" has the meaning set forth in Section 2.05(b).\n\"Assignee\" has the meaning set forth in Section 9.06(c).\n\"Available LC Amount\" means at any time an amount equal to the lesser of (x) $25,000,000 or (y) the excess, if any, of (i) the aggregate amount of the Tranche A Commitments over (ii) the aggregate outstanding principal amount of the Tranche A Loans.\n\"Bank\" means each bank listed on the signature pages hereof, each Assignee which becomes a Bank pursuant to Section 9.06(c), and their respective successors.\n\"Base Rate\" means, for any day, a rate per annum equal to the higher of (i) the Prime Rate for such day and (ii) the sum of 1\/2 of 1% plus the Federal Funds Rate for such day.\n\"Base Rate Loan\" means a Tranche A Loan to be made by a Bank as a Base Rate Loan pursuant to the Applicable Notice of Borrowing or Article VIII.\n\"Benefit Arrangement\" means at any time an employee benefit plan within the meaning of Section 3(3) of ERISA which is not a Plan or a Multiemployer Plan and which is maintained or otherwise contributed to by any member of the ERISA Group.\n\"Borrower\" means Perini Corporation, a Massachusetts corporation, and its successors.\n\"Borrower's 1993 Form 10-K\" means the Borrower's amended annual report on Form 10-KA for 1993, as filed with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934.\n\"Borrower Pledge Agreement\" means the Borrower Pledge Agreement in substantially the form of Exhibit E between the Borrower and the Agent as executed and delivered pursuant to Section 3.01(c) and as the same may be amended from time to time as permitted herein and in accordance with the terms thereof.\n\"Borrower Security Agreement\" means the Borrower Security Agreement in substantially the form of Exhibit D between the Borrower and the Agent, as executed and delivered pursuant to Section 3.01(c) and as the same may be amended from time to time as permitted herein and in accordance with the terms thereof.\n\"Borrowing\" has the meaning set forth in Section 1.03.\n\"CD Base Rate\" has the meaning set forth in Section 2.05(b).\n\"CD Loan\" means a Tranche A Loan to be made by a Bank as a CD Loan pursuant to the applicable Notice of Borrowing.\n\"CD Margin\" has the meaning set forth in Section 2.05(b).\n\"CD Reference Banks\" means Shawmut Bank, N.A., Fleet Bank of Massachusetts, N.A. and Morgan Guaranty Trust Company of New York.\n\"CERCLA\" means the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended from time to time, and any rules or regulations promulgated thereunder.\n\"Class\" refers to a determination whether a Loan is a Tranche A Loan or a Tranche B Loan (or whether a Borrowing is to be comprised of, or a Commitment relates to the making of, Tranche A Loans or Tranche B Loans).\n\"Collateral\" means all property, real and personal, tangible and intangible, with respect to which Liens are created or are purported to be created pursuant to the Collateral Documents.\n\"Collateral Documents\" means the Borrower Security Agreement, the Borrower Pledge Agreement, the Subsidiary Security Agreement, the Deeds of Trust and all other supplemental or additional security agreements, pledge agreements, mortgages or similar instruments delivered pursuant hereto or thereto.\n\"Commitment\" means a Tranche A Commitment or a Tranche B Commitment and \"Commitments\" means all or any combination of the foregoing, as the context may require.\n\"Consolidated Capital Base\" means, at any date, the Consolidated Tangible Net Worth of the Borrower at such date plus 75% of the principal amount of any Special Subordinated Debt outstanding at such date.\n\"Consolidated Current Assets\" means at any date the consolidated current assets of the Borrower and its Consolidated Subsidiaries excluding costs related to Claims, all determined as of such date. For purposes of this definition, \"Claims\" mean the amount (to the extent reflected in determining such consolidated current assets) of disputed or unapproved change orders in regards to scope and\/or price that, in Perini project management's opinion (and approved by Perini senior management), will not be resolved in the normal course of business (i.e. through the change order process and without resort to litigation or arbitration) and which have not been previously reflected in the consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as of September 30, 1994.\n\"Consolidated Current Liabilities\" means at any date the consolidated current liabilities of the Borrower and its Consolidated Subsidiaries, determined as of such date.\n\"Consolidated Earnings Before Interest and Taxes\" means for any period Consolidated Net Income for such period (x) less (i) the Borrower's equity share of income (or plus the Borrower's equity share of loss) of unconsolidated joint ventures for such period and (ii) capitalized real estate taxes for such period, to the extent not permitted to be capitalized in accordance with generally accepted accounting principles as in effect on the date hereof, and (y) plus (i) cash distributions of earnings from unconsolidated joint ventures for such period and (ii) the aggregate amount deducted in determining such Consolidated Net Income in respect of Consolidated Interest Charges and income taxes.\n\"Consolidated Interest Charges\" means for any period the aggregate interest expense of the Borrower and its Consolidated Subsidiaries for such period including, without limitation, (i) the portion of any obligation under capital leases allocable to interest expense in accordance with generally accepted accounting principles, (ii) the portion of any debt discount that shall be amortized in such period and (iii) any interest accrued during such period which is capitalized in accordance with generally accepted accounting principles, and without any reduction on account of interest income.\n\"Consolidated Net Income\" means for any period the consolidated net income (or loss) of the Borrower and its Consolidated Subsidiaries for such period.\n\"Consolidated Subsidiary\" of any Person means at any date any Subsidiary of such Person or other entity the accounts of which would be consolidated with those of such Person in its consolidated financial statements if such statements were prepared as of such date.\n\"Consolidated Tangible Net Worth\" of any Person means at any date the consolidated stockholders' equity of such Person and its Consolidated Subsidiaries less their consolidated Intangible Assets, all determined as of such date. For purposes of this definition \"Intangible Assets\" means the amount (to the extent reflected in determining such consolidated stockholders' equity) of (i) all write-ups (other than write-ups resulting from foreign currency translations and write-ups of assets of a going concern business made within twelve months after the acquisition of such business) subsequent to September 30, 1994 in the book value of any asset owned by the Borrower or a Consolidated Subsidiary and (ii) all unamortized debt discount and expense, capitalized real estate taxes (to the extent not permitted to be capitalized in accordance with generally accepted accounting principles as in effect on the date hereof), goodwill, patents, trademarks, service marks, trade names, copyrights, organization or developmental (other than real estate developmental) expenses and other intangible items.\n\"Construction Claim\" means a construction claim listed in Schedule IV.\n\"Credit Event\" means the making of a Loan or the issuance of a Letter of Credit or the extension of an Evergreen Letter of Credit.\n\"Debt\" of any Person means at any date, without duplication, (i) all obligations of such Person for borrowed money, (ii) all obligations of such Person evidenced by bonds, debentures, notes or other similar instruments, (iii) all obligations of such Person to pay the deferred purchase price of property or services, except trade accounts payable arising in the ordinary course of business, (iv) all obligations of such\nPerson as lessee which are capitalized in accordance with generally accepted accounting principles, (v) all Debt secured by a Lien on any asset of such Person, whether or not such Debt is otherwise an obligation of such Person, and (vi) all Debt of others Guaranteed by such Person; provided that advances to the Borrower or a Subsidiary by a joint venture out of the Borrower's or such Subsidiary's share of the undistributed earnings of such joint venture shall not constitute Debt.\n\"Deeds of Trust\" means the Deed of Trust, Assignment of Leases and Rents, Security Agreement and Financing Statement dated as of December 6, 1994 for each of the Mortgaged Facilities, each substantially in the form of Exhibits H-1 and H-2 hereto.\n\"Default\" means any condition or event which constitutes an Event of Default or which with the giving of notice or lapse of time or both would, unless cured or waived, become an Event of Default.\n\"Domestic Business Day\" means any day except a Saturday, Sunday or other day on which commercial banks in New York City or Massachusetts are authorized by law to close.\n\"Domestic Lending Office\" means, as to each Bank, its office located at its address set forth in its Administrative Questionnaire (or identified in its Administrative Questionnaire as its Domestic Lending Office) or such other office as such Bank may hereafter designate as its Domestic Lending Office by notice to the Borrower and the Agent; provided that any Bank may so designate separate Domestic Lending Offices for its Tranche A Base Rate Loans and Tranche B Loans, on the one hand, and its CD Loans, on the other hand, in which case all references herein to the Domestic Lending Office of such Bank shall be deemed to refer to either or both of such offices, as the context may require.\n\"Domestic Loans\" means CD Loans, Tranche A Base Rate Loans or Tranche B Loans.\n\"Domestic Reserve Percentage\" has the meaning set forth in Section 2.05(b).\n\"Effective Date\" means the date this Agreement becomes effective in accordance with Section 3.01.\n\"Environmental Laws\" means any and all federal state, local and foreign statutes, laws, judicial decisions, regulations, ordinances, rules, judgments, orders, decrees, plans, injunctions, permits, concessions, grants, franchises, licenses, agreements and other governmental restrictions relating to the environment, the effect of the environment on human health or to emissions, discharges or releases of pollutants, contaminants, Hazardous Substances or wastes into the environment including, without limitation, ambient air, surface water, ground water, or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, Hazardous Substances or wastes or the clean-up or other remediation thereof.\n\"Environmental Liabilities\" means any and all liabilities of or relating to the Borrower or any of its Subsidiaries (including any liabilities derived from an entity which is, in whole or in part, a predecessor of the Borrower or any of its Subsidiaries), whether vested or unvested, contingent or fixed, actual or potential, known or unknown, which arise under or relate to matters covered by Environmental Laws.\n\"ERISA\" means the Employee Retirement Income Security Act of 1974, as amended, or any successor statute.\n\"ERISA Group\" means the Borrower, any Subsidiary and all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which, together with the Borrower or any Subsidiary, are treated as a single employer under Section 414 of the Internal Revenue Code.\n\"Euro-Dollar Business Day\" means any Domestic Business Day on which commercial banks are open for international business (including dealings in dollar deposits) in London.\n\"Euro-Dollar Lending Office\" means, as to each Bank, its office, branch or affiliate located at its address set forth in its Administrative Questionnaire (or identified in its Administrative Questionnaire as its Euro-Dollar Lending Office) or such other office, branch or affiliate of such Bank as it may hereafter designate as its Euro-Dollar Lending Office by notice to the Borrower and the Agent.\n\"Euro-Dollar Loan\" means a Tranche A Loan to be made by a Bank as a Euro-Dollar Loan pursuant to the applicable Notice of Borrowing.\n\"Euro-Dollar Margin\" has the meaning set forth in Section 2.05(c).\n\"Euro-Dollar Reference Banks\" means the principal London offices of Bank of America National Trust and Savings Association and Morgan Guaranty Trust Company of New York.\n\"Euro-Dollar Reserve Percentage\" has the meaning set forth in Section 2.05(c).\n\"Event of Default\" has the meaning set forth in Section 6.01.\n\"Evergreen Letter of Credit\" has the meaning set forth in Section 2.16(b).\n\"Exempt Group\" means (i) any employee benefit plan of the Borrower or any Subsidiary, (ii) any entity or Person holding shares of common stock of Borrower organized, appointed or established by the Borrower or any Subsidiary for or pursuant to the terms of any such plan or (iii) The Perini Memorial Foundation, Inc., The Joseph Perini Memorial Foundation, or any of the various trusts established under the wills of Lewis R. Perini, Senior, Joseph R. Perini, Senior or Charles B. Perini, Senior.\n\"Existing Credit Agreements\" means the Primary Credit Agreement and the Credit Agreement dated as of March 9, 1994 among the Borrower, the banks listed therein and Morgan Guaranty Trust Company of New York, as agent for such banks, as amended to the Effective Date.\n\"Federal Funds Rate\" means, for any day, the rate per annum (rounded upward, if necessary, to the nearest 1\/100th of 1%) equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers on such day, as published by the Federal Reserve Bank of New York on the Domestic Business Day next succeeding such day, provided that (i) if such day is not a Domestic Business Day, the Federal Funds Rate for such day shall be such rate on such transactions on the next preceding Domestic Business Day as so published on the next succeeding Domestic Business Day, and (ii) if no such rate is so published on such next succeeding Domestic Business Day, the Federal Funds Rate for such day shall be the average rate quoted to Morgan Guaranty Trust Company of New York on such day on such transactions as determined by the Agent.\n\"Financial Letter of Credit\" means any Letter of Credit which constitutes a financial standby letter of credit within the meaning of Appendix A to Regulation H of the Board of Governors of the Federal Reserve System or other applicable capital adequacy guidelines promulgated by bank regulatory authorities (including without limitation workmen's compensation letters of credit).\n\"Financing Documents\" means this Agreement, the Subsidiary Guarantee Agreement, the Notes and the Collateral Documents.\n\"Fixed Rate Borrowing\" means a CD Borrowing or a Euro-Dollar Borrowing.\n\"Fixed Rate Loans\" means CD Loans or Euro-Dollar Loans or both.\n\"Guarantee\" by any Person means any obligation, contingent or otherwise, of such Person directly or indirectly guaranteeing any Debt of any other Person and, without limiting the generality of the foregoing, any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt (whether arising by virtue of partnership arrangements, by agreement to keep-well, to purchase assets, goods, securities or services, to take-or-pay, or to maintain financial statement conditions or otherwise) or (ii) entered into for the purpose of assuring in any other manner the holder of such Debt of the payment thereof or to protect such holder against loss in respect thereof (in whole or in part), provided that the term Guarantee shall not include endorsements for collection or deposit or bid and performance bonds and guarantees in the ordinary course of business. The term \"Guarantee\" used as a verb has a corresponding meaning.\n\"Hazardous Substances\" means any toxic, radioactive, caustic or otherwise hazardous substance, including petroleum, its derivatives, by-products and other hydrocarbons, or any substance having any constituent elements displaying any of the foregoing characteristics.\n\"Indemnitee\" has the meaning set forth in Section 9.03(b).\n\"Interest Period\" means: (1) with respect to each Euro-Dollar Borrowing, the period commencing on the date of such Borrowing and ending one, two, three or six months thereafter, as the Borrower may elect in the applicable Notice of Borrowing; provided that: (a) any Interest Period which would otherwise end on a day which is not a Euro-Dollar Business Day shall be extended to the next succeeding Euro-Dollar Business Day unless such Euro-Dollar Business Day falls in another calendar month, in which case such Interest Period shall end on the next preceding Euro-Dollar Business Day;\n(b) any Interest Period which begins on the last Euro-Dollar Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall, subject to clause (c) below, end on the last Euro-Dollar Business Day of a calendar month; and\n(c) any Interest Period which would otherwise end after the Termination Date shall end on the Termination Date;\n(2) with respect to each CD Borrowing, the period commencing on the date of such Borrowing and ending 30, 60 or 90 days thereafter, as the Borrower may elect in the applicable Notice of Borrowing; provided that:\n(a) any Interest Period (other than an Interest Period determined pursuant to clause (b) below) which would otherwise end on\na day which is not a Euro-Dollar Business Day shall be extended to the next succeeding Euro-Dollar Business Day; and\n(b) any Interest Period which would otherwise end after the Termination Date shall end on the Termination Date; and\n(3) with respect to each Tranche A Base Rate Borrowing or Tranche B Borrowing, the period commencing on the date of such Borrowing and ending 30 days thereafter; provided that:\n(a) any Interest Period (other than an Interest Period determined pursuant to clause (b) below) which would otherwise end on a day which is not a Euro-Dollar Business Day shall be extended to the next succeeding Euro-Dollar Business Day; and\n(b) any Interest Period which would otherwise end after the Termination Date shall end on the Termination Date.\n\"Internal Revenue Code\" means the Internal Revenue Code of 1986, as amended, or any successor statute.\n\"Investment\" means any investment in any Person, whether by means of share purchase, capital contribution, loan, Guarantee, time deposit or otherwise.\n\"LC Bank\" means BayBank Boston, N.A. or such other Bank as the Borrower may designate from time to time (with the consent of such other Bank).\n\"LC Exposure\" means, at any time and for any Bank, an amount equal to such Bank's Percentage of the aggregate amount of Letter of Credit Liabilities in respect of all Letters of Credit at such time.\n\"Letter of Credit\" has the meaning set forth in Section 2.16(a).\n\"Letter of Credit Liabilities\" means, at any time and in respect of any Letter of Credit, the sum, without duplication, of (i) the amount available for drawing under such Letter of Credit plus (ii) the aggregate unpaid amount of all Reimbursement Obligations in respect of previous drawings made under such Letter of Credit.\n\"Lien\" means, with respect to any asset, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind, or any other type of preferential arrangement that has the practical effect of creating a security interest, in respect of such asset. For the purposes of this Agreement, the Borrower or any Subsidiary shall be deemed to own subject to a Lien any asset which it has acquired or holds subject to the interest of a vendor or lessor under any conditional sale agreement, capital lease or other title retention agreement relating to such asset.\n\"Loan\" means a Domestic Loan or a Euro-Dollar Loan and \"Loans\" means Domestic Loans or Euro-Dollar Loans or both.\n\"Loan Commitment\" means for any Bank at any time an amount equal to the excess, if any, of such Bank's Commitment at such time over such Bank's LC Exposure at such time.\n\"London Interbank Offered Rate\" has the meaning set forth in Section 2.05(c).\n\"Material Plan\" means at any time a Plan or Plans having aggregate Unfunded Liabilities in excess of $10,000,000.\n\"Material Subsidiary\" means at any time a Subsidiary which as of such time meets the definition of a \"significant subsidiary\" contained as of the date hereof in Regulation S-X of the Securities and Exchange Commission.\n\"Modified Parent Company Debt\" means at any date the Debt of the Borrower (other than Debt payable to any Wholly-Owned Consolidated Subsidiary) determined on an unconsolidated basis as of such date, less 75% of the principal amount of any Special Subordinated Debt outstanding on such date.\n\"Mortgaged Facilities\" means the properties described on Schedule III.\n\"Multiemployer Plan\" means at any time an employee pension benefit plan within the meaning of Section 4001(a)(3) of ERISA to which any member of the ERISA Group is then making or accruing an obligation to make contributions or has within the preceding five plan years made contributions, including for these purposes any Person which ceased to be a member of the ERISA Group during such five year period.\n\"Notes\" means promissory notes of the Borrower, substantially in the form of Exhibit A hereto, evidencing the obligation of the Borrower to repay the Loans, and \"Note\" means any one of such promissory notes issued hereunder.\n\"Notice of Borrowing\" has the meaning set forth in Section 2.02.\n\"Notice Time\" has the meaning set forth in Section 2.16(b).\n\"Obligor\" means each of the Borrower and the Subsidiary Guarantors, and \"Obligors\" means all of the foregoing.\n\"Paramount Development Associates\" means Paramount Development Associates, a Massachusetts corporation.\n\"Parent\" means, with respect to any Bank, any Person controlling such Bank.\n\"Participant\" has the meaning set forth in Section 9.06(b).\n\"PBGC\" means the Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions under ERISA.\n\"Percentage\" means, with respect to each Bank, the percentage that such Bank's Tranche A Commitment constitutes of the aggregate amount of the Tranche A Commitments.\n\"Performance Letter of Credit\" means a Letter of Credit which constitutes a performance standby letter of credit within the meaning of Appendix A to Regulation H of the Board of Governors of the Federal Reserve system or other applicable capital adequacy guidelines promulgated by bank regulatory authorities.\n\"Perini Building Company\" means Perini Building Company, Inc., an Arizona corporation.\n\"Perini International\" means Perini International Corporation, a Massachusetts corporation.\n\"Perini Land and Development\" means Perini Land and Development Company, a Delaware corporation.\n\"Permitted Encumbrances\" means, with respect to any real property owned or leased by the Borrower or any of its Subsidiaries:\n(a) Liens for taxes, assessments or other governmental charges not yet due or which are being contested in good faith and by appropriate proceedings if adequate reserves with respect thereto are maintained on the books of the Borrower or such Subsidiary, as the case may be, in accordance with generally accepted accounting principles;\n(b) carriers', warehousemen's, mechanics', materialmens', repairmens' or other like Liens arising by operation of law in the ordinary course of business so long as (A) the underlying obligations are not overdue for a period of more than 60 days or (B) such Liens are being contested in good faith and by appropriate proceedings and adequate reserves with respect thereto are maintained on the books of the Borrower or such Subsidiary, as the case may be, in accordance with generally accepted accounting principles; and\n(c) other Liens or title defects (including matters which an accurate survey might disclose) which (x) do not secure Debt; (y) do not materially detract from the value of such real property or materially impair the use thereof by the Borrower or such Subsidiary in the operation of its business; and (z) are set forth in the title reports referred to in Section 3.01(h) hereof.\n\"Permitted Liens\" means the Liens permitted to exist under Section 5.11.\n\"Person\" means an individual, a corporation, a partnership, an association, a trust or any other entity or organization, including a government or political subdivision or an agency or instrumentality thereof.\n\"Plan\" means at any time an employee pension benefit plan (other than a Multiemployer Plan) which is covered by Title IV of ERISA or subject to the minimum funding standards under Section 412 of the Internal Revenue Code and either (i) is maintained, or contributed to, by any member of the ERISA Group for employees of any member of the ERISA Group or (ii) has at any time within the preceding five years been maintained, or contributed to, by any Person which was at such time a member of the ERISA Group for employees of any Person which was at such time a member of the ERISA Group.\n\"Pledged Instrument\" has the meaning set forth in Section 1 of the Borrower Pledge Agreement.\n\"Primary Credit Agreement\" means the Credit Agreement dated as of May 10, 1993 among the Borrower, the banks listed therein and Morgan Guaranty Trust Company of New York, as agent for such banks, as amended to the Effective Date.\n\"Prime Rate\" means the rate of interest publicly announced by Morgan Guaranty Trust Company of New York in New York City from time to time as its Prime Rate.\n\"Real Estate Investment\" means (i) the acquisition, construction or improvement of any real property, other than real property used by the Borrower or a Consolidated Subsidiary in the conduct of its construction business or (ii) any Investment in any Person (including Perini Land and Development or another Consolidated Subsidiary, but without duplication of any Real Estate Investment made by such Person with the proceeds of such Investment) engaged in real estate investment or development or whose\nprincipal assets consist of real property; provided that the Debt contemplated by Section 5.08(b)(ii) shall not constitute Real Estate Investments.\n\"R. E. Dailey & Co.\" means R. E. Dailey & Co., a Michigan corporation.\n\"Reference Banks\" means the CD Reference Banks or the Euro-Dollar Reference Banks, as the context may require, and \"Reference Bank\" means any one of such Reference Banks.\n\"Refunding Borrowing\" means a Borrowing which, after application of the proceeds thereof, results in no net increase in the outstanding principal amount of Loans made by any Bank.\n\"Regulated Activity\" means any generation, treatment, storage, recycling, transportation or Release of any Hazardous Substance.\n\"Regulation U\" means Regulation U of the Board of Governors of the Federal Reserve System, as in effect from time to time.\n\"Reimbursement Obligations\" means at any date the obligations of the Borrower then outstanding under Section 2.16 to reimburse any Bank for the amount paid by such Bank in respect of a drawing under a Letter of Credit.\n\"Release\" means any discharge, emission or release, including a Release as defined in CERCLA at 42 U.S.C. Section 9601(22). The term \"Released\" has a corresponding meaning.\n\"Required Banks\" means at any time Banks having at least 60% of the aggregate amount of the Commitments or, if the Commitments shall have been terminated, holding Notes evidencing at least 60% of the aggregate unpaid principal amount of the Loans.\n\"Restricted Payment\" means (i) any dividend or other distribution on any shares of the Borrower's capital stock (except dividends payable solely in shares of its capital stock) or (ii) any payment on account of the purchase, redemption, retirement or acquisition of (a) any shares of the Borrower's capital stock or (b) any option, warrant or other right to acquire shares of the Borrower's capital stock; provided that none of the following shall constitute Restricted Payments: (i) the declaration and payment of dividends on preferred stock of the Borrower in an aggregate amount with respect to any four consecutive fiscal quarters not exceeding $5,125,000, (ii) the exchange of Special Subordinated Debt for the Borrower's $21.25 Convertible Exchangeable Preferred Shares, (iii) the redemption, for an aggregate redemption price not exceeding $200,000, of the \"Rights\" issued pursuant to the Shareholder Rights Agreement dated as of September 23, 1988, as amended, between the Borrower and State Street Bank & Trust Company, as Rights Agent or (iv) cash payments in the ordinary course of business in full or partial settlement of employee stock options or similar incentive compensation arrangements.\n\"Special Subordinated Debt\" means the 8 1\/2% Convertible Subordinated Debentures due 2012 of the Borrower issuable in exchange for the Borrower's $21.25 Convertible Exchangeable Preferred Shares in accordance with the terms of the Certificate of Vote of Directors Establishing a Series of a Class of Stock fixing the relative rights and preferences of such Shares as originally filed with the Secretary of the Commonwealth of Massachusetts.\n\"Subsidiary\" of any Person means any corporation or other entity of which securities or other ownership interests having ordinary voting\npower 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\"Subsidiary Guarantor\" means each of Perini Building Company, Perini International, Perini Land and Development, R. E. Dailey & Co., Paramount Development Associates and each other Subsidiary of the Borrower which becomes a party to the Subsidiary Guarantee Agreement pursuant to Section 3.01 thereof, and their respective successors.\n\"Subsidiary Guarantee Agreement\" means the Subsidiary Guarantee Agreement in substantially the form of Exhibit F among the Borrower, the Subsidiary Guarantors party thereto and the Agent, as executed and delivered pursuant to Section 3.01(b) and as the same may be amended from time to time as permitted herein and in accordance with the terms thereof.\n\"Subsidiary Security Agreement\" means the Subsidiary Security Agreement in substantially the form of Exhibit G among the Borrower, the Subsidiary Guarantors party thereto and the Agent, as executed and delivered pursuant to Section 3.01(c) and as the same may be amended from time to time as permitted herein and in accordance with the terms thereof.\n\"Temporary Cash Investment\" means investment of cash balances in United States Government securities or other short-term money market investments.\n\"Termination Date\" means December 6, 1997 (or if such date is not a Euro-Dollar Business Day, the next preceding Euro-Dollar Business Day).\n\"Tranche A Commitment\" means, with respect to each Bank, the amount set forth opposite the name of such Bank on the signature pages hereof as its Tranche A Commitment, as such amount may be reduced from time to time pursuant to Section 2.09 and Section 2.10.\n\"Tranche A Loan\" means a Loan made by a Bank pursuant to Section 2.01(a).\n\"Tranche B Commitment\" means, with respect to each Bank, the amount set forth opposite the name of such Bank on the signature pages hereof as its Tranche B Commitment, as such amount may be reduced from time to time pursuant to Section 2.09 and Section 2.10.\n\"Tranche B Loan\" means a Loan made by a Bank pursuant to Section 2.01(b).\n\"Unfunded Liabilities\" means, with respect to any Plan at any time, the amount (if any) by which (i) the value of all benefit liabilities under such Plan, determined on a plan termination basis using the assumptions prescribed by the PBGC for purposes of Section 4044 of ERISA, exceeds (ii) the fair market value of all Plan assets allocable to such liabilities under Title IV of ERISA (excluding any accrued but unpaid contributions), all determined as of the then most recent valuation date for such Plan, but only to the extent that such excess represents a potential liability of a member of the ERISA Group to the PBGC or any other Person under Title IV of ERISA.\n\"Usage\" means, at any date, the sum of the aggregate outstanding principal amount of the Loans at such date plus the aggregate amount of Letter of Credit Liabilities at such date with respect to all Letters of Credit.\n\"Wholly-Owned Consolidated Subsidiary\" means any Consolidated\nSubsidiary of the Borrower all of the shares of capital stock or other ownership interests of which (except directors' qualifying shares) are at the time directly or indirectly owned by the Borrower.\nSECTION 1.02. Accounting Terms and Determinations. Unless otherwise specified herein, all accounting terms used herein shall be interpreted, all accounting determinations hereunder shall be made, and all financial statements required to be delivered hereunder shall be prepared in accordance with generally accepted accounting principles as in effect from time to time, applied on a basis consistent (except for changes concurred in by the Borrower's independent public accountants) with the most recent audited consolidated financial statements of the Borrower and its Consolidated Subsidiaries delivered to the Banks.\nSECTION 1.03. Types of Borrowings. The term \"Borrowing\" denotes the aggregation of Loans of one or more Banks to be made to the Borrower pursuant to Article II on a single date and for a single Interest Period. Borrowings are classified for purposes of this Agreement by reference to the Class of Loans comprising such Borrowing (e.g., a \"Tranche A Borrowing\" is a Borrowing comprised of Tranche A Loans) or by reference to the pricing of Loans comprising such Borrowing (e.g., a \"Euro-Dollar Borrowing\" is a Borrowing comprised of Euro-Dollar Loans).\nARTICLE II\nTHE CREDITS\nSECTION 2.01. The Loans.\n(a) Tranche A Loans. From time to time prior to the Termination Date, each Bank severally agrees, on the terms and conditions set forth in this Agreement, to lend to the Borrower from time to time amounts not to exceed in the aggregate at any one time outstanding the amount of its Tranche A Loan Commitment. Each Borrowing under this Section shall be in an aggregate principal amount of $1,000,000 or any larger multiple of $500,000 (except that any such Borrowing may be in the aggregate amount of the unused Tranche A Commitments) and shall be made from the several Banks ratably in proportion to their respective Tranche A Commitments. Within the foregoing limits, the Borrower may borrow under this Section, repay, or to the extent permitted by Section 2.10 or Section 2.11, prepay Tranche A Loans and reborrow at any time prior to the Termination Date under this Section.\n(b) Tranche B Loans. From time to time prior to the Termination Date each Bank severally agrees, on the terms and conditions set forth in this Agreement, to lend to the Borrower from time to time amounts not to exceed in the aggregate at any one time outstanding the amount of its Tranche B Commitment. Each Borrowing under this Section shall be in an aggregate principal amount of $1,000,000 or any larger multiple of $500,000 (except that any such Borrowing may be in the aggregate amount of the unused Tranche B Commitments) and shall be made from the several Banks ratably in proportion to their respective Commitments. Within the foregoing limits, the Borrower may borrow under this Section, repay, or to the extent permitted by Section 2.10 or Section 2.11, prepay Tranche B Loans and reborrow at any time prior to the Termination Date under this Section.\nSECTION 2.02. Method of Borrowing. (a) The Borrower shall give the Agent notice (a \"Notice of Borrowing\") not later than 11:30 A.M. (New York City time) on the date of each Base Rate Borrowing or Tranche B Borrowing, at least two Domestic Business Days before each CD Borrowing and at least three Euro-Dollar Business Days before each Euro-Dollar\nBorrowing, specifying:\n(i) the date of such Borrowing, which shall be a Domestic Business Day in the case of a Domestic Borrowing or a Euro-Dollar Business Day in the case of a Euro-Dollar Borrowing,\n(ii) the aggregate amount of such Borrowing,\n(iii) the Class of such Borrowing,\n(iv) in the case of a Tranche A Borrowing, whether the Loans comprising such Borrowing are to be CD Loans, Base Rate Loans or Euro-Dollar Loans, and\n(v) in the case of a Fixed Rate Borrowing, the duration of the Interest Period applicable thereto, subject to the provisions of the definition of Interest Period.\n(b) Upon receipt of a Notice of Borrowing, the Agent shall promptly notify each Bank of the contents thereof and of such Bank's ratable share of such Borrowing and such Notice of Borrowing shall not thereafter be revocable by the Borrower.\n(c) Not later than 1:30 P.M. (New York City time) on the date of each Borrowing, each Bank shall (except as provided in subsection (d) of this Section) make available its ratable share of such Borrowing, in Federal or other funds immediately available in New York City, to the Agent at its address referred to in Section 9.01. Unless the Agent determines that any applicable condition specified in Article III has not been satisfied, the Agent will make the funds so received from the Banks available to the Borrower at the Agent's aforesaid address.\n(d) If any Bank makes a new Loan hereunder on a day on which the Borrower is to repay all or any part of an outstanding Loan from such Bank, such Bank shall apply the proceeds of its new Loan to make such repayment and only an amount equal to the difference (if any) between the amount being borrowed and the amount being repaid shall be made available by such Bank to the Agent as provided in subsection (c) of this Section, or remitted by the Borrower to the Agent as provided in Section 2.12, as the case may be.\n(e) Unless the Agent shall have received notice from a Bank prior to the date of any Borrowing (or, in a case of a Tranche A Base Rate Borrowing or a Tranche B Borrowing, prior to noon (New York City time) on the date of such Borrowing) that such Bank will not make available to the Agent such Bank's share of such Borrowing, the Agent may assume that such Bank has made such share available to the Agent on the date of such Borrowing in accordance with subsections (c) and (d) of this Section 2.02 and the Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If and to the extent that such Bank shall not have so made such share available to the Agent, such Bank and the Borrower severally agree to repay to the Agent forthwith on demand such corresponding amount together with interest thereon, for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Agent, at (i) in the case of the Borrower, a rate per annum equal to the higher of the Federal Funds Rate and the interest rate applicable thereto pursuant to Section 2.05 and (ii) in the case of such Bank, the Federal Funds Rate. If such Bank shall repay to the Agent such corresponding amount, such amount so repaid shall constitute such Bank's Loan included in such Borrowing for purposes of this Agreement.\nSECTION 2.03. Notes. (a) The Loans of each Bank shall be\nevidenced by a single Note payable to the order of such Bank for the account of its Applicable Lending Office.\n(b) Each Bank may, by notice to the Borrower and the Agent, request that its Loans of a particular Class or type be evidenced by a separate Note in an amount equal to the aggregate unpaid principal amount of such Loans. Each such Note shall be in substantially the form of Exhibit A hereto with appropriate modifications to reflect the fact that it evidences solely Loans of the relevant class or type. Each reference in this Agreement to the \"Note\" of such Bank shall be deemed to refer to and include any or all of such Notes, as the context may require.\n(c) Upon receipt of each Bank's Note pursuant to Section 3.01(c), the Agent shall forward such Note to such Bank. Each Bank shall record the date, amount, type and maturity of each Loan made by it and the date and amount of each payment of principal made by the Borrower with respect thereto, and may, if such Bank so elects in connection with any transfer or enforcement of its Note, endorse on the schedule forming a part thereof appropriate notations to evidence the foregoing information with respect to each such Loan then outstanding; provided that the failure of any Bank to make any such recordation or endorsement shall not affect the obligations of the Borrower hereunder or under the Notes. Each Bank is hereby irrevocably authorized by the Borrower so to endorse its Note and to attach to and make a part of its Note a continuation of any such schedule as and when required.\nSECTION 2.04. Maturity of Loans. Each Loan included in any Borrowing shall mature, and the principal amount thereof shall be due and payable, on the last day of the Interest Period applicable to such Borrowing.\nSECTION 2.05. Interest Rates. (a) Each Tranche A Base Rate Loan shall bear interest on the outstanding principal amount thereof, for each day from the date such Loan is made until it becomes due, at a rate per annum equal to the sum of 1% plus the Base Rate for such day. Such interest shall be payable for each Interest Period on the last day thereof. Any overdue principal of or interest on any Tranche A Base Rate Loan shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the rate otherwise applicable to Tranche A Base Rate Loans for such day.\n(b) Each CD Loan shall bear interest on the outstanding principal amount thereof, for the Interest Period applicable thereto, at a rate per annum equal to the sum of the CD Margin plus the applicable Adjusted CD Rate; provided that if any CD Loan or any portion thereof shall, as a result of clause (2)(b) of the definition of Interest Period, have an Interest Period of less than 30 days, such portion shall bear interest during such Interest Period at the rate applicable to Base Rate Loans during such period. Such interest shall be payable for each Interest Period on the last day thereof and, if such Interest Period is longer than 90 days, at intervals of 90 days after the first day thereof. Any overdue principal of or interest on any CD Loan shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the higher of (i) the sum of the CD Margin plus the Adjusted CD Rate applicable to such Loan and (ii) the rate applicable to Base Rate Loans for such day.\n\"CD Margin\" means 2.375%.\nThe \"Adjusted CD Rate\" applicable to any Interest Period means a rate per annum determined pursuant to the following formula:\n[ CDBR ]* ACDR = [ ---------- ] + AR [ 1.00 - DRP ]\nACDR = Adjusted CD Rate CDBR = CD Base Rate DRP = Domestic Reserve Percentage AR = Assessment Rate\n__________ * The amount in brackets being rounded upward, if necessary, to the next higher 1\/100 of 1%\nThe \"CD Base Rate\" applicable to any Interest Period is the rate of interest determined by the Agent to be the average (rounded upward, if necessary, to the next higher 1\/100 of 1%) of the prevailing rates per annum bid at 10:00 A.M. (New York City time) (or as soon thereafter as practicable) on the first day of such Interest Period by two or more New York certificate of deposit dealers of recognized standing for the purchase at face value from each CD Reference Bank of its certificates of deposit in an amount comparable to the principal amount of the CD Loan of such CD Reference Bank to which such Interest Period applies and having a maturity comparable to such Interest Period.\n\"Domestic Reserve Percentage\" means for any day that percentage (expressed as a decimal) which is in effect on such day, as prescribed by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including without limitation any basic, supplemental or emergency reserves) for a member bank of the Federal Reserve System in New York City with deposits exceeding five billion dollars in respect of new non-personal time deposits in dollars in New York City having a maturity comparable to the related Interest Period and in an amount of $100,000 or more. The Adjusted CD Rate shall be adjusted automatically on and as of the effective date of any change in the Domestic Reserve Percentage.\n\"Assessment Rate\" means for any day the annual assessment rate in effect on such date which is payable by a member of the Bank Insurance Fund classified as adequately capitalized and within supervisory subgroup \"A\" (or a comparable successor assessment risk classification) within the meaning of 12 C.F.R. X 327.3(e) (or any successor provision) to the Federal Deposit Insurance Corporation (or any successor) for such Corporation's (or such successor's) insuring time deposits at offices of such institution in the United States. The Adjusted CD Rate shall be adjusted automatically on and as of the effective date of any change in the Assessment Rate.\n(c) Each Euro-Dollar Loan shall bear interest on the outstanding principal amount thereof, for the Interest Period applicable thereto, at a rate per annum equal to the sum of the Euro-Dollar Margin plus the applicable Adjusted London Interbank Offered Rate. Such interest shall be payable for each Interest Period on the last day thereof and, if such Interest Period is longer than three months, at intervals of three months after the first day thereof.\n\"Euro-Dollar Margin\" means 2.25%.\nThe \"Adjusted London Interbank Offered Rate\" applicable to any Interest Period means a rate per annum equal to the quotient obtained (rounded upward, if necessary, to the next higher 1\/100 of 1%) by dividing\n(i) the applicable London Interbank Offered Rate by (ii) 1.00 minus the Euro-Dollar Reserve Percentage.\nThe \"London Interbank Offered Rate\" applicable to any Interest Period means the average (rounded upward, if necessary, to the next higher 1\/16 of 1%) of the respective rates per annum at which deposits in dollars are offered to each of the Euro-Dollar Reference Banks in the London interbank market at approximately 11:00 A.M. (London time) two Euro-Dollar Business Days before the first day of such Interest Period in an amount approximately equal to the principal amount of the Euro-Dollar Loan of such Euro-Dollar Reference Bank to which such Interest Period is to apply and for a period of time comparable to such Interest Period.\n\"Euro-Dollar Reserve Percentage\" means for any day that percentage (expressed as a decimal) which is in effect on such day, as prescribed by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement for a member bank of the Federal Reserve System in New York City with deposits exceeding five billion dollars in respect of \"Eurocurrency liabilities\" (or in respect of any other category of liabilities which includes deposits by reference to which the interest rate on Euro-Dollar Loans is determined or any category of extensions of credit or other assets which includes loans by a non-United States office of any Bank to United States residents). The Adjusted London Interbank Offered Rate shall be adjusted automatically on and as of the effective date of any change in the Euro-Dollar Reserve Percentage.\n(d) Any overdue principal of or interest on any Euro-Dollar Loan shall bear interest, payable on demand, for each day from and including the date payment thereof was due to but excluding the date of actual payment, at a rate per annum equal to the sum of 2% plus the higher of (i) the sum of the Euro-Dollar Margin plus the Adjusted London Interbank Offered Rate applicable to such Loan and (ii) the Euro-Dollar Margin plus the quotient obtained (rounded upward, if necessary, to the next higher 1\/100 of 1%) by dividing (x) the average (rounded upward, if necessary, to the next higher 1\/16 of 1%) of the respective rates per annum at which one day (or, if such amount due remains unpaid more than three Euro-Dollar Business Days, then for such other period of time not longer than three months as the Agent may elect) deposits in dollars in an amount approximately equal to such overdue payment due to each of the Euro-Dollar Reference Banks are offered to such Euro-Dollar Reference Bank in the London interbank market for the applicable period determined as provided above by (y) 1.00 minus the Euro-Dollar Reserve Percentage (or, if the circumstances described in clause (a) or (b) of Section 8.01 shall exist, at a rate per annum equal to the sum of 2% plus the rate applicable to Base Rate Loans for such day).\n(e) Each Tranche B Loan shall bear interest on the outstanding principal amount thereof, for each day from the date such Loan is made until it becomes due, at a rate per annum equal to the sum of 2% plus the Base Rate for such day. Such interest shall be payable for each Interest Period on the last day thereof. Any overdue principal of or interest on any Loan shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the rate otherwise applicable to Tranche B Loans for such day.\n(f) The Agent shall determine each interest rate applicable to the Loans hereunder. The Agent shall give prompt notice to the Borrower and the Banks of each rate of interest so determined, and its determination thereof shall be conclusive in the absence of manifest error.\n(g) Each Reference Bank agrees to use its best efforts to furnish\nquotations to the Agent as contemplated hereby. If any Reference Bank does not furnish a timely quotation, the Agent shall determine the relevant interest rate on the basis of the quotation or quotations furnished by the remaining Reference Bank or Banks or, if none of such quotations is available on a timely basis, the provisions of Section 8.01 shall apply.\nSECTION 2.06. Commitment Fees. The Borrower shall pay to the Agent for the account of each Bank a commitment fee at the rate of 1\/2 of 1% per annum on the daily average unused portion of such Bank's Commitments. Such commitment fees shall accrue from and including the Effective Date to but excluding the Termination Date. Such commitment fees shall be payable on the last day of each fiscal quarter of the Borrower prior to the Termination Date and on the Termination Date.\nSECTION 2.07. Participation Fee. The Borrower shall pay to the Agent for the account of each Bank on the Effective Date (i) in the case of a Bank with Commitments aggregating $25,000,000 or more, a participation fee in an amount equal to .30% of such Bank's Commitments and (ii) in the case of a Bank with Commitments aggregating less than $25,000,000, a participation fee in an amount equal to .175% of such Bank's Commitments.\nSECTION 2.08. Agency Fee. The Borrower shall pay to the Agent as compensation for its services hereunder and under the Collateral Documents agency fees payable in the amounts and at the times heretofore agreed between the Borrower and the Agent. The Borrower shall also pay to the Agent for its own account on the Effective Date an arrangement fee in the amount previously agreed between the Borrower and the Agent.\nSECTION 2.09. Optional Termination or Reduction of Commitments. The Borrower may, upon at least three Domestic Business Days' notice to the Agent, terminate at any time, or proportionately permanently reduce from time to time by an aggregate amount of $5,000,000 or any larger multiple of $1,000,000, the unused portions of the Commitments. If the Commitments are terminated in their entirety, all accrued commitment fees shall be payable on the effective date of such termination.\nSECTION 2.10. Mandatory Termination or Reduction of Commitments. (a) The Commitments shall terminate on the Termination Date, and any Loans then outstanding (together with accrued interest thereon) shall be due and payable on such date.\n(b) The Commitments of all Banks shall be permanently, automatically and ratably reduced:\n(i) immediately upon receipt by the Borrower or any Subsidiary of the proceeds from the collection, sale or other disposition of any real property (other than real property used by the Borrower or a Consolidated Subsidiary in its construction business) owned by the Borrower or a Subsidiary by an amount equal to 50% of such proceeds net of all out-of-pocket costs, all applicable mortgage debt, fees, commissions and other expenses reasonably incurred in respect of such collection, sale or disposition and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof provided that no such reduction shall be required unless and until, and then only to the extent that, the aggregate amount of such net proceeds received by the Borrower and its Subsidiaries during (x) the period from the date hereof through December 31, 1994 or (y) any fiscal year thereafter exceeds $5,000,000;\n(ii) immediately upon receipt by the Borrower or a Subsidiary of\nproceeds from the settlement of any Construction Claim by an amount equal to 50% of such proceeds net of all out-of-pocket expenses reasonably incurred in respect of such collection and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof; provided that in the event that the Construction Claim filed by Tutor-Saliba-Perini JV against the California State Department of Highways for cost overruns associated with the Redwood Bypass in Humboldt and Del Norte Counties, California is settled at a time when the aggregate amount of the Commitments exceeds $110,000,000, 100% of the proceeds of the Borrower's or any Subsidiary's share of such settlement net of all out-of-pocket expenses reasonably incurred in respect of such collection and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof shall be applied to the extent required to permanently, automatically and ratably reduce the aggregate amount of the Commitments to $110,000,000, and 50% of the balance (if any) of such net proceeds shall be so applied; and\n(iii) by $15,000,000 upon the completion of an issuance by the Borrower of convertible preferred stock or other equity issue provided that in the event that the proceeds of such issuance net of all out- of-pocket expenses reasonably incurred in respect of such issuance and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof exceeds $30,000,000, the aggregate amount of the Commitments shall be reduced by an amount not less than the sum of $15,000,000 plus 50% of the excess over $30,000,000 of such proceeds.\n(c) On each day on which any Commitment is reduced pursuant to this Section, the Borrower shall repay such principal amount (together with accrued interest thereon) of each Bank's outstanding Loans of each Class, if any, as may be necessary so that after such repayment, the aggregate unpaid principal amount of such Bank's Loans of each Class, together with (in the case of the Tranche A Loans) such Bank's Percentage of the aggregate amount of Letter of Credit Liabilities, does not exceed the amount of such Bank's Commitment of such Class after giving effect to such reduction; provided that if this subsection (c) would otherwise require prepayment of any Fixed Rate Loan prior to the last day of the applicable Interest Period, such prepayment shall be deferred to such last day unless the Required Banks otherwise direct by notice to the Borrower. In the event that the aggregate amount of the Tranche A Commitments is reduced to an amount less than the aggregate amount of Letter of Credit Liabilities at such time in respect of all Letters of Credit, the Borrower hereby agrees that it shall forthwith, without any demand or taking of any other action by the Required Banks or the Agent, pay to the Agent an amount in immediately available funds equal to the difference to be held as security for the Letter of Credit Liabilities for the benefit of all Banks.\n(d) Any reduction of the Commitments described in clauses (a) and (b) above shall be applied first to reduce the Tranche B Commitments pro rata and if the Tranche B Commitments are reduced to zero, then to reduce the Tranche A Commitments pro rata.\nSECTION 2.11. Optional Prepayments. (a) The Borrower may, upon notice to the Agent not later than 11:30 A.M. (New York City time) on any Domestic Business Day, prepay on such Domestic Business Day any Base Rate Borrowing or any Tranche B Borrowing in whole at any time, or from time to time in part in amounts aggregating $1,000,000 or any larger multiple of $500,000, by paying the principal amount to be prepaid together with accrued interest thereon to the date of prepayment. Each such optional prepayment shall be applied to prepay ratably the Loans of the several Banks included in such Borrowing.\n(b) Except as provided in Sections 2.10(c) and 8.02, the Borrower may not prepay all or any portion of the principal amount of any Fixed Rate Loan prior to the maturity thereof.\n(c) Upon receipt of a notice of prepayment pursuant to this Section, the Agent shall promptly notify each Bank of the contents thereof and of such Bank's ratable share of such prepayment and such notice shall not thereafter be revocable by the Borrower.\nSECTION 2.12. General Provisions as to Payments. (a) The Borrower shall make each payment of principal of, and interest on, the Loans and of fees hereunder, not later than 1:30 P.M. (New York City time) on the date when due, in Federal or other funds immediately available in New York City, to the Agent at its address referred to in Section 9.01. The Agent will promptly distribute to each Bank its ratable share of each such payment received by the Agent for the account of the Banks. Whenever any payment of principal of, or interest on, the Domestic Loans or of fees shall be due on a day which is not a Domestic Business Day, the date for payment thereof shall be extended to the next succeeding Domestic Business Day. Whenever any payment of principal of, or interest on, the Euro- Dollar Loans shall be due on a day which is not a Euro-Dollar Business Day, the date for payment thereof shall be extended to the next succeeding Euro-Dollar Business Day unless such Euro-Dollar Business Day falls in another calendar month, in which case the date for payment thereof shall be the next preceding Euro-Dollar Business Day. If the date for any payment of principal is extended by operation of law or otherwise, interest thereon shall be payable for such extended time.\n(b) Unless the Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Banks hereunder that the Borrower will not make such payment in full, the Agent may assume that the Borrower has made such payment in full to the Agent on such date and the Agent may, in reliance upon such assumption, cause to be distributed to each Bank on such due date an amount equal to the amount then due such Bank. If and to the extent that the Borrower shall not have so made such payment, each Bank shall repay to the Agent forthwith on demand such amount distributed to such Bank together with interest thereon, for each day from the date such amount is distributed to such Bank until the date such Bank repays such amount to the Agent, at the Federal Funds Rate.\nSECTION 2.13. Funding Losses. If the Borrower makes any payment of principal with respect to any Fixed Rate Loan (pursuant to Section 2.10(c), Article VI or VIII or otherwise) on any day other than the last day of the Interest Period applicable thereto, or the last day of an applicable period fixed pursuant to Section 2.05(d), or if the Borrower fails to borrow any Fixed Rate Loans after notice has been given to any Bank in accordance with Section 2.02(b), the Borrower shall reimburse each Bank on demand for any resulting loss or expense incurred by it (or by any existing or prospective Participant in the related Loan), including (without limitation) any loss incurred in obtaining, liquidating or employing deposits from third parties, but excluding loss of margin for the period after any such payment or failure to borrow, provided that such Bank shall have delivered to the Borrower a certificate as to the amount of such loss or expense, which certificate shall be conclusive in the absence of manifest error.\nSECTION 2.14. Computation of Interest and Fees. Interest based on the Prime Rate shall be computed on the basis of a year of 365 days (or 366 days in a leap year) and paid for the actual number of days elapsed (including the first day but excluding the last day). All other interest and commitment fees shall be computed on the basis of a year of 360 days and paid for the actual number of days elapsed (including the first day but excluding the last day).\nSECTION 2.15. Maximum Interest Rate. (a) Nothing contained in this Agreement or the Notes shall require the Borrower to pay interest at a rate exceeding the maximum rate permitted by applicable law. Neither this Section nor Section 9.08 is intended to limit the rate of interest payable for the account of any Bank to the maximum rate permitted by the laws of the State of New York if a higher rate is permitted with respect to such Bank by supervening provisions of U.S. federal law.\n(b) If the amount of interest payable for the account of any Bank on any interest payment date in respect of the immediately preceding interest computation period, computed pursuant to Section 2.05, would exceed the maximum amount permitted by applicable law to be charged by such Bank, the amount of interest payable for its account on such interest payment date shall be automatically reduced to such maximum permissible amount.\n(c) If the amount of interest payable for the account of any Bank in respect of any interest computation period is reduced pursuant to clause (b) of this Section and the amount of interest payable for its account in respect of any subsequent interest computation period, computed pursuant to Section 2.05, would be less than the maximum amount permitted by applicable law to be charged by such Bank, then the amount of interest payable for its account in respect of such subsequent interest computation period shall be automatically increased to such maximum permissible amount; provided that at no time shall the aggregate amount by which interest paid for the account of any Bank has been increased pursuant to this clause (c) exceed the aggregate amount by which interest paid for its account has theretofore been reduced pursuant to clause (b) of this Section.\nSECTION 2.16. Letters of Credit. (a) Subject to the terms and conditions hereof, the LC Bank agrees to issue letters of credit hereunder from time to time before the Termination Date upon the request of the Borrower (such letters of credit issued, the \"Letters of Credit\"); provided that, immediately after each such Letter of Credit is issued, the aggregate amount of the Letter of Credit Liabilities for all Letters of Credit shall not exceed the Available LC Amount. Upon the date of issuance by the LC Bank of a Letter of Credit in accordance with this Section 2.16, the LC Bank shall be deemed, without further action by any party hereto, to have sold to each Bank, and each Bank shall be deemed, without further action by any party hereto, to have purchased from the LC Bank, a participation in such Letter of Credit and the related Letter of Credit Liabilities in proportion to its Percentage.\n(b) The Borrower shall give the LC Bank at least three Domestic Business Days' prior notice (effective upon receipt) specifying the date each Letter of Credit is to be issued, and describing the proposed terms of such Letter of Credit and the nature of the transactions proposed to be supported thereby. Upon receipt of such notice the LC Bank shall promptly notify the Agent, and the Agent shall promptly notify each Bank of the contents thereof and of the amount of such Bank's participation in such proposed Letter of Credit. The issuance by the LC Bank of any Letter of Credit shall, in addition to the conditions precedent set forth in Article III (the satisfaction of which the LC Bank shall have no duty to ascertain), be subject to the conditions precedent that such Letter of Credit shall be satisfactory to the LC Bank and that the Borrower shall have executed and delivered such other instruments and agreements relating to such Letter of Credit as the LC Bank shall have reasonably requested. Each Letter of Credit shall have an expiry date of not later than one year after its date of issue; provided that no Letter of Credit shall have a term extending beyond the Termination Date; and provided further that any such Letter of Credit may include an evergreen or renewal option, pursuant to which the expiry date of such Letter of Credit will be automatically\nextended unless notice of non-renewal is given by the LC Bank (provided that such Letter of Credit has an absolute expiry date not later than the Termination Date and provided further that the LC Bank shall deliver notice of non-renewal at the time such notice is required to be given (for any such Letter of Credit, the \"Notice Time\") unless requested not to by the Borrower, which request will be treated in the same manner as a request for issuance of a new Letter of Credit on the same terms (any such Letter of Credit, an \"Evergreen Letter of Credit\").\n(c) The Borrower shall pay to the Agent a letter of credit fee at a rate equal to (i) 1.00% per annum on the aggregate amount available for drawings under each Performance Letter of Credit issued from time to time and (ii) 2.25% per annum on the aggregate amount available for drawings under each Financial Letter of Credit issued from time to time, any such fee to be payable for the account of the Banks ratably in proportion to their Percentages. Such fee shall be payable in arrears on the last day of each fiscal quarter of the Borrower for so long as such Letter of Credit is outstanding and on the date of termination thereof. The Borrower shall pay to the LC Bank additional fees and expenses in the amounts and at the times as agreed between the Borrower and the LC Bank.\n(d) Upon receipt from the beneficiary of any Letter of Credit of any demand for payment or other drawing under such Letter of Credit, the LC Bank shall notify the Agent and the Agent shall promptly notify the Borrower and each other Bank as to the amount to be paid as a result of such demand or drawing and the respective payment date. The responsibility of the LC Bank to the Borrower and each Bank shall be only to determine that the documents (including each demand for payment or other drawing) delivered under each Letter of Credit issued by it in connection with such presentment shall be in conformity in all material respects with such Letter of Credit. The LC Bank shall endeavor to exercise the same care in the issuance and administration of the Letters of Credit as it does with respect to letters of credit in which no participations are granted, it being understood that in the absence of any gross negligence or willful misconduct by the LC Bank, each Bank severally agrees that it shall be unconditionally and irrevocably liable without regard to the occurrence of any Event of Default or any condition precedent whatsoever, pro rata to the extent of such Bank's Percentage, to reimburse the LC Bank on demand for the amount of each payment made by the LC Bank under each Letter of Credit issued by the LC Bank to the extent such amount is not reimbursed by the Borrower pursuant to clause (e) below together with interest on such amount for each day from the date of the LC Bank's demand for such payment (or, if such demand is made after 11:00 A.M. (New York City time) on such date, from the next succeeding Domestic Business Day) to the date of payment by such Bank of such amount at a rate of interest per annum equal to the Federal Funds Rate for such day.\n(e) The Borrower shall be irrevocably and unconditionally obligated forthwith to reimburse the LC Bank for any amounts paid by the LC Bank upon any drawing under any Letter of Credit, without presentment, demand, protest or other formalities of any kind; provided that neither the Borrower nor any Bank shall hereby be precluded from asserting any claim for direct (but not consequential) damages suffered by the Borrower or such Bank to the extent, but only to the extent, caused by (i) the willful misconduct or gross negligence of the LC Bank in determining whether a request presented under any Letter of Credit complied with the terms of such Letter of Credit or (ii) such Bank's failure to pay under any Letter of Credit after the presentation to it of a request strictly complying with the terms and conditions of the Letter of Credit. All such amounts paid by the LC Bank and remaining unpaid by the Borrower shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the rate applicable to Base Rate Loans for such day. The LC Bank will pay to each Bank ratably in accordance\nwith its Percentage all amounts received from the Borrower for application in payment, in whole or in part, of the Reimbursement Obligation in respect of any Letter of Credit, but only to the extent such Bank has made payment to the LC Bank in respect of such Letter of Credit pursuant to Section 2.16(d).\n(f) If after the date hereof, the adoption of any applicable law, rule or regulation, or any change in any applicable law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency shall impose, modify or deem applicable any tax, reserve, special deposit or similar requirement against or with respect to or measured by reference to Letters of Credit issued or to be issued hereunder or participations therein, and the result shall be to increase the cost to any Bank of issuing or maintaining any Letter of Credit or any participation therein, or reduce any amount receivable by any Bank hereunder in respect of any Letter of Credit (which increase in cost, or reduction in amount receivable, shall be the result of such Bank's reasonable allocation of the aggregate of such increases or reductions resulting from such event), then, upon demand by such Bank (which demand shall not be unreasonably delayed, provided that a demand within six months of the accrual of such increased cost or reduction in amount receivable will not be deemed to be unreasonably delayed), the Borrower agrees to pay to such Bank, from time to time as specified by such Bank, such additional amounts as shall be sufficient to compensate such Bank for such increased costs or reductions in amount incurred by such Bank. A certificate of such Bank submitted by such Bank to the Borrower shall be conclusive as to the amount thereof in the absence of manifest error.\n(g) The Borrower's obligations under this Section 2.16 shall be absolute and unconditional under any and all circumstances and irrespective of any setoff, counterclaim or defense to payment which the Borrower may have or have had against the LC Bank, any Bank or any beneficiary of a Letter of Credit. The Borrower further agrees with the LC Bank and the Banks that the LC Bank and the Banks shall not be responsible for, and the Borrower's Reimbursement Obligation in respect of any Letter of Credit shall not be affected by, among other things, the validity or genuineness of documents or of any endorsements thereon, even if such documents should in fact prove to be in any or all respects invalid, fraudulent or forged, or any dispute between or among the Borrower, any of its Subsidiaries, the beneficiary of any Letter of Credit or any financing institution or other party to whom any Letter of Credit may be transferred or any claims or defenses whatsoever of the Borrower or any of its Subsidiaries against the beneficiary of any Letter of Credit or any such transferee. The LC Bank shall not be liable for any error, omission, interruption or delay in transmission, dispatch or delivery of any message or advice, however transmitted, in connection with any Letter of Credit issued, extended or renewed by it. The Borrower agrees that any action taken or omitted by the LC Bank or any Bank under or in connection with each Letter of Credit and the related drafts and documents, if done in good faith and without gross negligence, shall be binding upon the Borrower and shall not put the LC Bank or any Bank under any liability to the Borrower.\n(h) To the extent not inconsistent with clause (g) above, the LC Bank shall be entitled to rely, and shall be fully protected in relying upon, any Letter of Credit, draft, writing, resolution, notice, consent, certificate, affidavit, letter, cablegram, telegram, telecopy, telex or teletype message, statement, order or other document believed by it to be genuine and correct and to have been signed, sent or made by the proper\nPerson or Persons and upon advice and statements of legal counsel, independent accountants and other experts selected by the LC Bank. The LC Bank shall be fully justified in failing or refusing to take any action under this Agreement unless it shall first have received such advice or concurrence of the Required Banks as it reasonably deems appropriate or it shall first be indemnified to its reasonable satisfaction by the Banks against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. Notwithstanding any other provision of this Section 2.16, the LC Bank shall in all cases be fully protected in acting, or in refraining from acting, under this Agreement in accordance with a request of the Required Banks, and such request and any action taken or failure to act pursuant thereto shall be binding upon the Banks and all future holders of participations in any Letters of Credit.\n(i) The Borrower hereby indemnifies and holds harmless each Bank and the Agent from and against any and all claims and damages, losses, liabilities, costs or expenses which such Bank or the Agent may incur (or which may be claimed against such Bank or the Agent by any Person whatsoever) by reason of or in connection with the execution and delivery or transfer of or payment or failure to pay under any Letter of Credit, including, without limitation, any claims, damages, losses, liabilities, costs or expenses which the LC Bank may incur by reason of or in connection with the failure of any other Bank to fulfill or comply with its obligations to the LC Bank hereunder (but nothing herein contained shall affect any rights the Borrower may have against such defaulting Bank); provided that the Borrower shall not be required to indemnify any Bank or the Agent for any claims, damages, losses, liabilities, costs or expenses to the extent, but only to the extent, caused by (i) the willful misconduct or gross negligence of the LC Bank in determining whether a request presented under any Letter of Credit complied with the terms of such Letter of Credit or (ii) the LC Bank's failure to pay under any Letter of Credit after the presentation to it of a request strictly complying with the terms and conditions of the Letter of Credit. Nothing in this Section 2.16(i) is intended to limit the obligations of the Borrower under any other provision of this Agreement.\n(j) Each Bank shall, ratably in accordance with its Percentage, indemnify the LC Bank, its affiliates and their respective directors, officers, agents and employees (to the extent not reimbursed by the Borrower) against any cost, expense (including reasonable counsel fees and disbursements), claim, demand, action, loss or liability (except such as result from such indemnitees' gross negligence or willful misconduct or the LC Bank's failure to pay under any Letter of Credit after the presentation to it of a request strictly complying with the terms and conditions of the Letter of Credit) that such indemnitees may suffer or incur in connection with this Section 2.16 or any action taken or omitted by such indemnitees hereunder.\n(k) In its capacity as a Bank the LC Bank shall have the same rights and obligations as any other Bank.\nSECTION 2.17. Termination of the Security Interest. Upon the completion of an issuance by the Borrower of convertible preferred stock or other equity instrument for proceeds (net of all out-of-pocket expenses reasonably incurred in respect of such issuance and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof) in excess of $25,000,000, so long as no Default is then continuing, the Borrower shall be entitled to the release of all Collateral from the Liens of the Collateral Documents in accordance with the provisions thereof, and the Collateral Documents shall thereupon cease to be Financing Documents.\nARTICLE III\nCONDITIONS\nSECTION 3.01. Effectiveness. This Agreement shall become effective on the date that each of the following conditions shall have been satisfied (or waived in accordance with Section 9.05):\n(a) receipt by the Agent of counterparts of this Agreement signed by each of the parties hereto (or, in the case of any party as to which an executed counterpart shall not have been received, receipt by the Agent in form satisfactory to it of telegraphic, facsimile, telex or other written confirmation from such party of execution of a counterpart hereof by such party);\n(b) receipt by the Agent of counterparts of the Subsidiary Guarantee Agreement, duly executed by each of the Obligors listed on the signature pages thereof;\n(c) receipt by the Agent of counterparts of the Borrower Security Agreement, the Borrower Pledge Agreement, the Subsidiary Security Agreement, the Deeds of Trust and all other documents and certificates to be delivered pursuant thereto on the Effective Date (including appropriately completed and duly executed Uniform Commercial Code financing statements required thereby) duly executed by each of the Obligors listed on the signature pages thereof;\n(d) receipt by the Agent of evidence satisfactory to the Agent that arrangements satisfactory to it shall have been made for recording the Deeds of Trust and filing the Uniform Commercial Code financing statements referred to in paragraph (c) above on or promptly after the Effective Date;\n(e) receipt by the Agent of all Pledged Instruments;\n(f) receipt by the Agent of copies of file search reports from the Uniform Commercial Code filing officer in each jurisdiction (i) in which any Mortgaged Facility is located or (ii) in which the chief executive office of the Borrower and each Subsidiary Guarantor is located, setting forth the results of Uniform Commercial Code file searches conducted in the name of the Borrower and each Subsidiary Guarantor, as the case may be;\n(g) receipt by the Agent of evidence satisfactory to the Agent of the insurance coverage required by Section 5.03;\n(h) with respect to each of the Mortgaged Facilities, receipt by the Agent of title reports with respect thereto issued by a title insurance company reasonably acceptable to the Agent and dated no more than 45 days prior to the Effective Date showing no Liens except Permitted Encumbrances with respect thereto;\n(i) receipt by the Agent of duly executed Notes for the account of each Bank dated on or before the Effective Date complying with the provisions of Section 2.03;\n(j) receipt by the Agent of (i) an opinion of the General Counsel of the Borrower and (ii) an opinion of Jacobs Persinger & Parker, New York counsel for the Borrower, substantially in the forms of Exhibits B-1 and B-2, respectively, and covering such additional matters relating to the transactions contemplated hereby as the Required Banks may reasonably request;\n(k) receipt by the Agent of (i) an opinion of Davis Polk & Wardwell, special New York counsel for the Agent, and (ii) an opinion of Meyer Hendricks Victor Osborn & Maledon, special Arizona counsel for the Agent, substantially in the forms of Exhibits C-1 and C-2, respectively, hereto and covering such additional matters relating to the transactions contemplated hereby as the Required Banks may reasonably request;\n(l) receipt by the Agent of evidence satisfactory to the Agent that the commitments under the Existing Credit Agreements have been terminated and that the principal and interest on all loans and accrued fees outstanding thereunder have been paid in full; and\n(m) receipt by the Agent of all documents it may reasonably request relating to the existence of the Obligors, the corporate authority for and the validity of the Financing Documents and any other matters relevant hereto, all in form and substance satisfactory to the Agent;\nprovided that this Agreement shall not become effective or be binding on any party hereto unless all of the foregoing conditions are satisfied not later than December 31, 1994. The Agent shall promptly notify the Borrower and the Banks of the Effective Date, and such notice shall be conclusive and binding on all parties hereto. The Borrower and each of the Banks which is a party to the Existing Credit Agreements, comprising the \"Required Banks\" as defined in the Existing Credit Agreements, hereby agree that (i) the commitments of the banks under the Existing Credit Agreements shall terminate simultaneously with the effectiveness of this Agreement without the notice required under Sections 2.09 of the Existing Credit Agreements and (ii) the Borrower may prepay any Borrowing as defined in the Existing Credit Agreements on the Effective Date hereof without prior notice. The Borrower covenants that all accrued and unpaid fees and any other amounts due and payable under the Existing Credit Agreements shall have been paid on or prior to the Effective Date. Upon the effectiveness of this Agreement, any letter of credit outstanding under the Primary Credit Agreement shall be deemed to be a Letter of Credit outstanding hereunder.\nSECTION 3.02. Credit Events. The obligation of any Bank to make a Loan on the occasion of any Borrowing and of the LC Bank to issue a Letter of Credit (or to permit the extension of an Evergreen Letter of Credit) on the occasion of a request therefor by the Borrower is subject to the satisfaction of the following conditions:\n(a) receipt (i) by the Agent of a Notice of Borrowing as required by Section 2.02, in the case of a Borrowing or (ii) by the LC Bank of notice as required by Section 2.16 , in the case of a Letter of\nCredit;\n(b) the fact that, after giving effect to such Credit Event, the Usage shall not exceed the aggregate amount of the Commitments and, in the case of a Tranche B Borrowing, the fact that the Tranche A Commitments shall be fully utilized;\n(c) the fact that, immediately after such Credit Event, no Default shall have occurred and be continuing;\n(d) the fact that the representations and warranties of each Obligor contained in each Financing Document to which it is a party (except, in the case of a Refunding Borrowing, the representation and warranty set forth in Section 4.04(c) hereof as to any material adverse change which has theretofore been disclosed in writing by the Borrower to the Banks) shall be true on and as of the date of such Borrowing.\nEach Borrowing shall be deemed to be a representation and warranty by the Borrower on the date of such Borrowing as to the facts specified in clauses (b), (c) and (d) of this Section.\nARTICLE IV\nREPRESENTATIONS AND WARRANTIES\nThe Borrower represents and warrants that:\nSECTION 4.01. Corporate Existence and Power. The Borrower is a corporation duly incorporated, validly existing and in good standing under the laws of Massachusetts, and has all corporate powers and all material governmental licenses, authorizations, consents and approvals required to carry on its business as now conducted.\nSECTION 4.02. Corporate and Governmental Authorization; No Contravention. The execution, delivery and performance by each Obligor of the Financing Documents to which it is a party are within its corporate powers, have been duly authorized by all necessary corporate action, require no action by or in respect of, or filing with, any governmental body, agency or official and do not contravene, or constitute a default under, any provision of applicable law or regulation or of the certificate of incorporation or by-laws of such Obligor or of any agreement, judgment, injunction, order, decree or other instrument binding upon such Obligor or any of its Subsidiaries or result in the creation or imposition of any Lien, except Liens created by the Collateral Documents, on any asset of such Obligor or any of its Subsidiaries.\nSECTION 4.03. Binding Effect; Liens of Collateral Documents. This Agreement constitutes a valid and binding agreement of the Borrower and the Notes, when executed and delivered in accordance with this Agreement, will constitute valid and binding obligations of the Borrower in each case enforceable in accordance with their respective terms. Each other Financing Document, when executed and delivered in accordance with this Agreement, will constitute a valid and binding agreement of each Obligor party thereto enforceable against each such Obligor in accordance with its terms. Subject to Section 2.17, the Collateral Documents create valid security interests in, and first mortgage Liens on, the Collateral purported to be covered thereby, which security interests and mortgage Liens are and will remain perfected security interests and duly recorded mortgage Liens, prior to all other Liens except Liens permitted by the Collateral Documents.\nSECTION 4.04. Financial Information.\n(a) The consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as of December 31, 1993 and the related consolidated statements of income, stockholders' equity and cash flows for the fiscal year then ended, reported on by Arthur Andersen & Co. and set forth in the Borrower's 1993 Form 10-K, a copy of which has been delivered to each of the Banks, fairly present, in conformity with generally accepted accounting principles, the consolidated financial position of the Borrower and its Consolidated Subsidiaries as of such date and their consolidated results of operations and cash flows for such fiscal year.\n(b) The unaudited consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as of September 30, 1994 and the related unaudited consolidated statements of income, stockholders' equity and cash flows for the nine months then ended, set forth in the Borrower's quarterly report for the fiscal quarter ended September 30, 1994 as filed with the Securities and Exchange Commission on Form 10-Q, a copy of which has been delivered to each of the Banks, fairly present, in conformity with generally accepted accounting principles applied on a basis consistent with the financial statements referred to in subsection (a) of this Section, the consolidated financial position of the Borrower and its Consolidated Subsidiaries as of such date and their consolidated results of operations and cash flows for such nine month period (subject to normal year-end adjustments).\n(c) Since September 30, 1994 there has been no material adverse change in the business, financial position, results of operations or prospects of the Borrower and its Consolidated Subsidiaries, considered as a whole.\nSECTION 4.05. Litigation. Except as disclosed in the Borrower's 1993 Form 10-K and the Form 10-Q referred to in Section 4.04(b) above, there is no action, suit or proceeding pending against, or to the knowledge of the Borrower threatened against or affecting, the Borrower or any of its Subsidiaries before any court or arbitrator or any governmental body, agency or official in which there is a reasonable possibility of an adverse decision which could materially adversely affect the business, consolidated financial position or consolidated results of operations of the Borrower and its Consolidated Subsidiaries or which in any manner draws into question the validity of any Financing Document.\nSECTION 4.06. Compliance with ERISA. Each member of the ERISA Group has fulfilled its obligations under the minimum funding standards of ERISA and the Internal Revenue Code with respect to each Plan and is in compliance in all material respects with the presently applicable provisions of ERISA and the Internal Revenue Code with respect to each Plan. No member of the ERISA Group has (i) sought a waiver of the minimum funding standard under Section 412 of the Internal Revenue Code in respect of any Plan, (ii) failed to make any contribution or payment to any Plan or Multiemployer Plan or in respect of any Benefit Arrangement, or made any amendment to any Plan or Benefit Arrangement, which has resulted or could result in the imposition of a Lien or the posting of a bond or other security under ERISA or the Internal Revenue Code or (iii) incurred any liability to the PBGC or any other Person under Title IV of ERISA other than a liability to the PBGC for premiums under Section 4007 of ERISA.\nSECTION 4.07. Environmental Matters. (a) In the ordinary course of its business, the Borrower conducts periodic reviews of the effect of Environmental Laws on the business, operations and properties of the Borrower and its Subsidiaries and compliance therewith. The Borrower and its Subsidiaries also attempt, whenever possible, to negotiate specific provisions in contracts for construction services that allocate to the\ncontracting governmental agency or private owner, the entire risk and responsibility for Hazardous Substances encountered during the course of construction. On the basis of such reviews and contract provisions and procedures, the Borrower has reasonably concluded that the costs and associated liabilities of compliance with Environmental Laws are unlikely to have a material adverse effect on the business, financial condition, results of operations or prospects of the Borrower and its Consolidated Subsidiaries, considered as a whole.\n(b) Without limiting the foregoing, as of the Effective Date:\n(i) no notice, notification, demand, request for information, citation, summons, complaint or order has been issued, no complaint has been filed, no penalty has been assessed and no investigation or review is pending or, to the knowledge of the Obligors, threatened by any governmental or other entity with respect to any (A) alleged violation by the Borrower or any of its Subsidiaries of any Environmental Law involving any Mortgaged Facility, (B) alleged failure by the Borrower or any of its Subsidiaries to have any environmental permit, certificate, license, approval, registration or authorization required in connection with the conduct of its business at any Mortgaged Facility, (C) Regulated Activity conducted at any Mortgaged Facility or (D) Release of Hazardous Substances at or in connection with any Mortgaged Facility;\n(ii) other than generation of Hazardous Substances in compliance with all applicable Environmental Laws, no Regulated Activity has occurred at or on any Mortgaged Facility;\n(iii) no polychlorinated biphenyls, radioactive material, urea formaldehyde, lead, asbestos, asbestos-containing material or underground storage tank (active or abandoned) is or has been present at any Mortgaged Facility;\n(iv) no Hazardous Substance has been Released (and no written notification of such Release has been filed) or is present (whether or not in a reportable or threshold planning quantity) at, on or under any Mortgaged Facility;\n(v) no Mortgaged Facility is listed or, to the knowledge of the Obligors, proposed for listing, on the National Priorities List promulgated pursuant to CERCLA, on CERCLIS (as defined in CERCLA) or on any similar federal, state or foreign list of sites requiring investigation or clean-up; and\n(vi) there are no Liens under Environmental Laws on any Mortgaged Facility, no government actions have been taken or are in process which could subject any Mortgaged Property to such Liens and neither the Borrower nor any of its Subsidiaries would be required to place any notice or restriction relating to Hazardous Substances in any deed to any Mortgaged Facility.\n(c) No environmental investigation, study, audit, test, review or other analysis has been conducted of which the Obligors have knowledge in relation to any Mortgaged Facility which has not been delivered to the Banks.\nSECTION 4.08. Taxes. United States Federal income tax returns of the Borrower and its Subsidiaries have been examined and closed through the fiscal year ended December 31, 1986. The Borrower and its Subsidiaries have filed all United States Federal income tax returns and all other material tax returns which are required to be filed by them and have paid all taxes due pursuant to such returns or pursuant to any\nassessment received by the Borrower or any Subsidiary. The charges, accruals and reserves on the books of the Borrower and its Subsidiaries in respect of taxes or other governmental charges are, in the opinion of the Borrower, adequate.\nSECTION 4.09. Subsidiaries. Each of the Borrower's corporate Subsidiaries is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation, and has all corporate powers and all material governmental licenses, authorizations, consents and approvals required to carry on its business as now conducted.\nSECTION 4.10. Not an Investment Company. The Borrower is not an \"investment company\" within the meaning of the Investment Company Act of 1940, as amended.\nSECTION 4.11. No Burdensome Restrictions. No contract, lease, agreement or other instrument to which the Borrower or any of its Subsidiaries is a party or by which any of its property is bound or affected, no charge, corporate restriction, judgment, decree or order and no provision of applicable law or governmental regulation has or is reasonably expected to materially and adversely affect the business, operations or financial condition of the Borrower and its Consolidated Subsidiaries, taken as a whole, or the ability of the Borrower to perform its obligations under this Agreement.\nSECTION 4.12. Full Disclosure. All information heretofore furnished by the Borrower to the Agent or any Bank for purposes of or in connection with this Agreement or any transaction contemplated hereby is, and all such information hereafter furnished by the Borrower to the Agent or any Bank will be, true and accurate in all material respects (or in the case of projections and similar information based on reasonable estimates) on the date as of which such information is stated or certified. The Borrower has disclosed to the Banks in writing any and all facts which materially and adversely affect or may reasonably be expected to materially and adversely affect (to the extent the Borrower can now reasonably foresee), the business, operations or financial condition of the Borrower and its Consolidated Subsidiaries, taken as a whole, or the ability of the Borrower to perform its obligations under this Agreement.\nSECTION 4.13. Ownership of Property; Liens. The Borrower and its Subsidiaries have good and marketable title to and are in lawful possession of, or have valid leasehold interests in, or have the right to use pursuant to valid and enforceable agreements or arrangements, all of their respective properties and other assets (real or personal, tangible, intangible or mixed), except where the failure to have or possess the same with respect to such properties or other assets could not, in the aggregate, have a material adverse effect on the business, financial condition, results of operations or prospects of the Borrower and its Consolidated Subsidiaries, considered as a whole. None of such properties or other assets is subject to any Lien except Permitted Liens.\nARTICLE V\nCOVENANTS\nThe Borrower agrees that, so long as any Bank has any Commitment hereunder or any amount payable under any Note remains unpaid or any Letter of Credit remains outstanding or any Reimbursement Obligation with respect thereto remains unpaid:\nSECTION 5.01. Information. The Borrower will deliver to each of\nthe Banks:\n(a) as soon as available and in any event within 90 days after the end of each fiscal year of the Borrower, consolidated and consolidating balance sheets of the Borrower and its Consolidated Subsidiaries as of the end of such fiscal year and the related consolidated and consolidating statements of income, stockholders' equity and cash flows for such fiscal year, setting forth in each case in comparative form the figures for the previous fiscal year, all reported on in a manner acceptable to the Securities and Exchange Commission by Arthur Andersen & Co. or other independent public accountants of nationally recognized standing;\n(b) as soon as available and in any event within 45 days after the end of each of the first three quarters of each fiscal year of the Borrower, a consolidated condensed balance sheet of the Borrower and its Consolidated Subsidiaries as of the end of such quarter and the related consolidated condensed statements of income and cash flows for such quarter and for the portion of the Borrower's fiscal year ended at the end of such quarter, setting forth in each case in comparative form the figures for the corresponding quarter and the corresponding portion of the Borrower's previous fiscal year, all certified (subject to normal year-end adjustments) as to fairness of presentation, generally accepted accounting principles and consistency by the chief financial officer or the chief accounting officer of the Borrower;\n(c) simultaneously with the delivery of each set of financial statements referred to in clauses (a) and (b) above, a certificate of the chief financial officer or the chief accounting officer of the Borrower (i) setting forth in reasonable detail the calculations required to establish whether the Borrower was in compliance with the requirements of Sections 5.07 to 5.10, inclusive, 5.12, 5.14 and 5.15 on the date of such financial statements and (ii) stating whether there exists on the date of such certificate any Default and, if any Default then exists, setting forth the details thereof and the action which the Borrower is taking or proposes to take with respect thereto;\n(d) simultaneously with the delivery of each set of financial statements referred to in clause (a) above, a statement of the firm of independent public accountants which reported on such statements (i) whether anything has come to their attention to cause them to believe that there existed on the date of such statements any Default and (ii) confirming the calculations set forth in the officer's certificate delivered simultaneously therewith pursuant to clause (c) above;\n(e) simultaneously with the delivery of each set of financial statements set forth above, a schedule, dated as of the date of such financial statements, listing each construction contract which provides for aggregate total payments in excess of $2,500,000 and with respect to which the Borrower or a Consolidated Subsidiary of the Borrower is a party or participates through a joint venture, and setting forth as of the date of such schedule for each such contract the Borrower's original estimate of revenue and profit, the Borrower's current estimate of revenue and profit, cumulative realized and estimated remaining revenue and profit, and the percentage of completion and anticipated completion date of each such contract, certified as to consistency, accuracy and reasonableness of estimates by the chief financial officer or the chief accounting officer of the Borrower;\n(f) forthwith upon the occurrence of any Default, a certificate of the chief financial officer or the chief accounting officer of the Borrower setting forth the details thereof and the action which the\nBorrower is taking or proposes to take with respect thereto;\n(g) promptly upon the mailing thereof to the shareholders of the Borrower generally, copies of all financial statements, reports and proxy statements so mailed;\n(h) promptly upon the filing thereof, copies of all registration statements (other than the exhibits thereto and any registration statements on Form S-8 or its equivalent) and annual, quarterly or monthly reports which the Borrower shall have filed with the Securities and Exchange Commission;\n(i) if and when any member of the ERISA Group (i) gives or is required to give notice to the PBGC of any \"reportable event\" (as defined in Section 4043 of ERISA) with respect to any Plan which might constitute grounds for a termination of such Plan under Title IV of ERISA, or knows that the plan administrator of any Plan has given or is required to give notice of any such reportable event, a copy of the notice of such reportable event given or required to be given to the PBGC; (ii) receives notice of complete or partial withdrawal liability under Title IV of ERISA or notice that any Multiemployer Plan is in reorganization, is insolvent or has been terminated, a copy of such notice; (iii) receives notice from the PBGC under Title IV of ERISA of an intent to terminate, impose liability (other than for premiums under Section 407 of ERISA) in respect of, or appoint a trustee to administer any Plan, a copy of such notice; (iv) applies for a waiver of the minimum funding standard under Section 412 of the Internal Revenue Code, a copy of such application; (v) gives notice of intent to terminate any Plan under Section 4041(c) of ERISA, a copy of such notice and other information filed with the PBGC; (vi) gives notice of withdrawal from any Plan pursuant to Section 4063 of ERISA, a copy of such notice; or (vii) fails to make any payment or contribution to any Plan or Multiemployer Plan or in respect of any Benefit Arrangement or makes any amendment to any Plan or Benefit Arrangement which has resulted or could result in the imposition of a Lien or the posting of a bond or other security, a certificate of the chief financial officer or the chief accounting officer of the Borrower setting forth details as to such occurrence and action, if any, which the Borrower or applicable member of the ERISA Group is required or proposes to take;\n(j) prompt notice of the receipt of any complaint, order, citation, notice or other written communication from any Person with respect to (i) the existence or alleged existence of a violation of any applicable Environmental Law at or on, or of any Environmental Liability arising with respect to, any Mortgaged Facility, (ii) any Release on any Mortgaged Facility or any part thereof in a quantity that is reportable under any applicable Environmental Law, and (iii) any pending or threatened proceeding for the termination, suspension or non-renewal of any permit required under any applicable Environmental Law with respect to any Mortgaged Facility; and\n(k) from time to time such additional information regarding the financial position or business of the Borrower and its Subsidiaries as the Agent, at the request of any Bank, may reasonably request.\nSECTION 5.02. Payment of Obligations. The Borrower will pay and discharge, and will cause each Subsidiary to pay and discharge, at or before maturity, all their respective material obligations and liabilities, including, without limitation, tax liabilities, except where the same may be contested in good faith by appropriate proceedings, and will maintain, and will cause each Subsidiary to maintain, in accordance with generally accepted accounting principles, appropriate reserves for the accrual of any of the same.\nSECTION 5.03. Maintenance of Property; Insurance. The Borrower will keep, and will cause each Subsidiary to keep, all property useful and necessary in its business in good working order and condition, ordinary wear and tear excepted; will maintain, and will cause each Subsidiary to maintain (either in the name of the Borrower or in such Subsidiary's own name) with financially sound and reputable insurance companies, insurance on all their property in at least such amounts and against at least such risks as are usually insured against in the same general area by companies of established repute engaged in the same or a similar business; and will furnish to the Banks, upon written request from the Agent, full information as to the insurance carried.\nSECTION 5.04. Conduct of Business and Maintenance of Existence. The Borrower will continue, and will cause each Subsidiary Guarantor to continue, to engage in business of the same general type as now conducted by the Borrower and its Subsidiaries, and will preserve, renew and keep in full force and effect, and will cause each Subsidiary Guarantor to preserve, renew and keep in full force and effect their respective corporate existence and their respective rights, privileges and franchises necessary or desirable in the normal conduct of business.\nSECTION 5.05. Compliance with Laws. The Borrower will comply, and cause each Subsidiary to comply, in all material respects with all applicable laws, ordinances, rules, regulations, and requirements of governmental authorities (including, without limitation, Environmental Laws and ERISA and the rules and regulations thereunder) except where the necessity of compliance therewith is contested in good faith by appropriate proceedings.\nSECTION 5.06. Inspection of Property, Books and Records. The Borrower will keep, and will cause each Subsidiary to keep, proper books of record and account in which full, true and correct entries in conformity with generally accepted accounting principles shall be made of all dealings and transactions in relation to its business and activities; and will permit, and will cause each Subsidiary to permit, representatives of any Bank at such Bank's expense (subject to Section 9.03(a)(ii)) to visit and inspect any of their respective properties, to examine and make abstracts from any of their respective books and records and to discuss their respective affairs, finances and accounts with their respective officers, employees and independent public accountants, all at such reasonable times and as often as may reasonably be desired.\nSECTION 5.07. Current Ratio. Consolidated Current Assets will at no time be less than 100% of Consolidated Current Liabilities.\nSECTION 5.08. Debt. (a) At the end of each fiscal quarter ending prior to September 30, 1996, Modified Parent Company Debt shall not exceed 75% of Consolidated Capital Base and at the end of each fiscal quarter ending on or after September 30, 1996, Modified Parent Company Debt shall not exceed 70% of Consolidated Capital Base.\n(b) The Borrower will not permit any Subsidiary to incur or suffer to exist any Debt other than (i) Debt of Perini Land and Development outstanding at September 30, 1994, as described in Schedule I, (ii) additional Debt of Perini Land and Development in an aggregate amount not exceeding $5,000,000, (iii) Debt of Perini International Corporation in an aggregate amount not exceeding $5,000,000, (iv) Debt of any Subsidiary Guarantor under the Subsidiary Guarantee Agreement and (v) any refinancing, extension, renewal or refunding of the Debt referred to in clauses (i) through (iv) above, provided that such Debt is not increased.\nSECTION 5.09. Minimum Consolidated Tangible Net Worth. Consolidated Tangible Net Worth of the Borrower will at no time be less\nthan the Minimum Compliance Level, determined as set forth below. The \"Minimum Compliance Level\" is an amount equal to the Base Compliance Amount subject to increase (but in no case subject to decrease) from time to time as follows: (i) at the end of each fiscal year commencing after December 31, 1993 for which Consolidated Net Income is a positive number, the Minimum Compliance Level shall be increased effective at the last day of such fiscal year by an amount equal to 50% of such Consolidated Net Income; and (ii) on the date of each issuance by the Borrower subsequent to December 31, 1993 of any capital stock or other equity interest, the Minimum Compliance Level shall be increased by an amount equal to 75% of the amount of the net proceeds received by the Borrower on account of such issuance. For purposes of this Section, \"Base Compliance Amount\" means (i) for any date prior to September 30, 1996, $110,000,000 or (ii) for any date on or after September 30, 1996, $135,000,000.\nSECTION 5.10. Interest Coverage. For each of (i) the fiscal quarter ending on December 31, 1994, (ii) the two consecutive fiscal quarters ending on March 31, 1995, (iii) the three consecutive fiscal quarters ending on June 30, 1995 or (iv) each period of four consecutive fiscal quarters ending on or after September 30, 1995 but on or before June 30, 1996, Consolidated Earnings Before Interest and Taxes shall not be less than 175% of Consolidated Interest Charges for each such period. Consolidated Earnings Before Interest and Taxes for each period of four consecutive fiscal quarters ending on or after September 30, 1996 shall not be less than 200% of Consolidated Interest Charges for such four fiscal quarters.\nSECTION 5.11. Negative Pledge. Neither the Borrower nor any Consolidated Subsidiary of the Borrower will create, assume or suffer to exist any Lien on any asset (including, without limitation, capital stock of Subsidiaries) now owned or hereafter acquired by it, except:\n(a) Liens existing on September 30, 1994 securing Debt outstanding on September 30, 1994 as described in Schedule II;\n(b) any Lien existing on any asset of any corporation at the time such corporation becomes a Consolidated Subsidiary of the Borrower and not created in contemplation of such event;\n(c) any Lien on any asset securing Debt incurred or assumed for the purpose of financing all or any part of the cost of acquiring such asset, provided that such Lien attaches to such asset concurrently with or within 90 days after the acquisition thereof and such Lien secures only such Debt;\n(d) any Lien on any asset of any corporation existing at the time such corporation is merged or consolidated with or into the Borrower or a Consolidated Subsidiary of the Borrower and not created in contemplation of such event;\n(e) any Lien existing on any asset prior to the acquisition thereof by the Borrower or a Consolidated Subsidiary of the Borrower and not created in contemplation of such acquisition;\n(f) any Lien arising out of the refinancing, extension, renewal or refunding of any Debt secured by any Lien permitted by any of the foregoing clauses of this Section, provided that such Debt is not increased and is not secured by any additional assets;\n(g) Liens incidental to conduct of its business or the ownership of its assets which (i) do not secure Debt and (ii) do not in the aggregate materially detract from the value of its assets or materially impair the use thereof in the operation of its business;\n(h) Permitted Encumbrances; and\n(i) Liens created by the Collateral Documents.\nSECTION 5.12. Consolidations, Mergers and Sales of Assets. (a) The Borrower will not (i) consolidate or merge with or into any other Person or sell, lease or otherwise transfer all or any substantial part of its assets to any other Person or (ii) permit any Material Subsidiary (other than a Subsidiary Guarantor) to consolidate or merge with or into, or transfer all or any substantial part of its assets to, any Person other than the Borrower or a Wholly-Owned Consolidated Subsidiary; provided that the Borrower or a Material Subsidiary other than Perini Land and Development may sell or otherwise transfer assets if Aggregate Asset Sale Proceeds after such sale less Aggregate Reinvested Proceeds does not at any time exceed $15,000,000. \"Aggregate Asset Sale Proceeds\" means the sum of the proceeds of each sale in a single transaction or series of related transactions by the Borrower or any Subsidiary, on or after the Effective Date, of fixed assets yielding proceeds in excess of 5% of the Consolidated Tangible Net Worth of the Borrower. \"Aggregate Reinvested Proceeds\" means the amount of Aggregate Asset Sale Proceeds used to purchase fixed assets for use in the same general business presently conducted by the Borrower or the Subsidiary that realized such proceeds, as the case may be, provided such proceeds are so used within 18 months of receipt thereof. The Borrower will not permit any Subsidiary Guarantor to consolidate or merge with or into, or transfer all or any substantial part of its assets to, any Person; provided that the foregoing shall not prohibit any Subsidiary Guarantor from selling, leasing or otherwise transferring assets in the ordinary course of its business.\n(b) The Borrower will not, and will not permit any of its Subsidiaries to, sell, lease or otherwise dispose of any item of Collateral unless (i) the Required Banks shall have given their prior written consent thereto and (ii) the consideration therefor is (x) at least equal to the fair market value of such asset (as determined in good faith by a financial officer of the Borrower or, if such value exceeds $15,000,000, by the board of directors of the Borrower or a duly constituted committee thereof) and (y) in the case of any agreement entered into on or after the Effective Date for the sale, lease or other disposition of such Collateral, shall consist of cash payable at closing.\nSECTION 5.13. Use of Proceeds. The proceeds of the Loans made under this Agreement will be used by the Borrower for general corporate purposes. None of such proceeds will be used, directly or indirectly, for the purpose, whether immediate, incidental or ultimate, of purchasing or carrying any \"margin stock\" within the meaning of Regulation U.\nSECTION 5.14. Restricted Payments. The aggregate amount of all dividends which constitute Restricted Payments declared and other Restricted Payments made during any period of four consecutive fiscal quarters will not exceed an amount equal to 50% of the excess, if any, of (x) Consolidated Net Income for such period over (y) the aggregate amount of preferred stock dividends not constituting Restricted Payments paid during such period. The Borrower will not declare any dividend payable more than 120 days after the date of declaration thereof.\nSECTION 5.15. Real Estate Investments. The Borrower will not, and will not permit any Consolidated Subsidiary to, make any Real Estate Investment if, after giving effect thereto, the cumulative amount of Net Real Estate Investments made (i) at any time during the period beginning January 1, 1994 and ending December 31, 1994 shall exceed $8,000,000 or (ii) during any fiscal year thereafter shall exceed $4,000,000 plus 25% of the amount, if any, by which the Net Real Estate Investments made during the preceding period were less than the applicable limitation specified\nabove for such period. For purposes of this Section, the cumulative amount of \"Net Real Estate Investments\" made during any period, as measured at any date during such period, is the aggregate amount of Real Estate Investments made by the Borrower and its Consolidated Subsidiaries from and including the first day of such period to and including such date, less the sum of all cash or cash equivalent payments received by the Borrower or one of its Consolidated Subsidiaries, as the case may be, in respect of Real Estate Investments from and including the first day of such period to and including such date.\nSECTION 5.16. Other Investments. Neither the Borrower nor any Consolidated Subsidiary will make or acquire any Investment in any Person other than:\n(a) Real Estate Investments permitted by Section 5.15;\n(b) Investments in Subsidiaries or joint ventures principally engaged in the construction business;\n(c) Temporary Cash Investments; and\n(d) any Investment not otherwise permitted by the foregoing clauses of this Section if, immediately after such Investment is made or acquired, the aggregate net book value of all Investments permitted by this clause (d) does not exceed 5% of Consolidated Tangible Net Worth;\nprovided that no Real Estate Investment may be made pursuant to clause (b), (c) or (d) above.\nSECTION 5.17. Further Assurances. (a) The Borrower will, and will cause each of its Subsidiaries to, at its sole cost and expense, do, execute, acknowledge and deliver all such further acts, deeds, conveyances, mortgages, assignments, notices of assignment, transfers and assurances as the Agent shall from time to time request, which may be necessary or desirable in the reasonable judgment of the Agent from time to time to assure, perfect, convey, assign, transfer and confirm unto the Agent the property and rights conveyed or assigned pursuant to the Collateral Documents, or which the Borrower or such Subsidiaries may be or may hereafter become bound to convey or assign to the Agent or which may facilitate the performance of the terms of the Collateral Documents or the filing, registering or recording of the Collateral Documents.\n(b) All costs and expenses in connection with the security interests and Liens created by the Collateral Documents, including reasonable legal fees and other reasonable costs and expenses in connection with the granting, perfecting and maintenance of such security interests and Liens, the preparation, execution, delivery, recordation or filing of documents and any other acts in connection with the grant of such security interests and Liens as the Agent may reasonably request, shall be paid by the Borrower promptly when due.\nARTICLE VI\nDEFAULTS\nSECTION 6.01. Events of Default. If one or more of the following events (\"Events of Default\") shall have occurred and be continuing:\n(a) the Borrower shall fail to pay when due any principal of any Loan, any Reimbursement Obligation, any fees or any other amount payable hereunder;\n(b) the Borrower shall fail to pay when due or within five Business Days thereof any interest on any Loan;\n(c) the Borrower shall fail to observe or perform any covenant contained in Sections 5.07 to 5.17, inclusive or in Section 3.01 of the Subsidiary Guarantee Agreement;\n(d) any Obligor shall fail to observe or perform any covenant or agreement contained in any Financing Document (other than those covered by clauses (a), (b) and (c) above) for 10 days after written notice thereof has been given to such Obligor by the Agent at the request of any Bank;\n(e) any representation, warranty, certification or statement made by any Obligor in any Financing Document or in any certificate, financial statement or other document delivered pursuant thereto shall prove to have been incorrect in any material respect when made (or deemed made);\n(f) the Borrower shall fail to make any payment in respect of any Debt (other than the Notes or Reimbursement Obligations) when due or within any applicable grace period;\n(g) any Subsidiary shall fail to make any payment in respect of any Debt the aggregate principal amount of which is $250,000 or more when due or within any applicable grace period;\n(h) any event or condition shall occur which results in the acceleration of the maturity of any Debt of the Borrower or any Subsidiary or enables (or, with the giving of notice or lapse of time or both, would enable) the holder of such Debt or any Person acting on such holder's behalf to accelerate the maturity thereof;\n(i) the Borrower or any Subsidiary shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due, or shall take any corporate action to authorize any of the foregoing;\n(j) an involuntary case or other proceeding shall be commenced against the Borrower or any Subsidiary seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of 60 days; or an order for relief shall be entered against the Borrower or any Subsidiary under the federal bankruptcy laws as now or hereafter in effect;\n(k) any member of the ERISA Group shall fail to pay when due an amount or amounts aggregating in excess of $5,000,000 which it shall have become liable to pay to the PBGC or any other Person under Title IV of ERISA; or notice of intent to terminate a Material Plan shall be filed under Title IV of ERISA by any member of the ERISA Group, any plan administrator or any combination of the foregoing; or the PBGC\nshall institute proceedings under Title IV of ERISA to terminate, to impose liability (other than for premiums under Section 4007 of ERISA) in respect of, or to cause a trustee to be appointed to administer any Material Plan; or a condition shall exist by reason of which the PBGC would be entitled to obtain a decree adjudicating that any Material Plan must be terminated; or there shall occur a complete or partial withdrawal from, or a default, within the meaning of Section 4219(c)(5) of ERISA, with respect to, one or more Multiemployer Plans which could cause one or more members of the ERISA Group to incur a current payment obligation in excess of $5,000,000;\n(l) a judgment or order for the payment of money in excess of $5,000,000 shall be rendered against the Borrower or any Subsidiary and such judgment or order shall continue unsatisfied, unstayed and unbonded for a period of 10 days;\n(m) any of the following: (i) any person or group or persons (within the meaning of Section 13 or 14 of the Securities Exchange Act of 1934, as amended) (other than the Exempt Group) shall have acquired beneficial ownership (within the meaning of Rule 13d-3 promulgated by the Securities and Exchange Commission under said Act) of 25% or more of the outstanding shares of common stock of the Borrower; (ii) fewer than two of the following people shall be members of the Board of Directors of the Borrower: David Perini, Joseph Perini and Bart Perini; or (iii) the Borrower shall cease to own 100% of the capital stock of any Subsidiary Guarantor; or\n(n) subject to Section 2.17, any Financing Document shall cease to be in full force and effect or shall be declared null and void, or the validity or enforceability thereof shall be contested by any Obligor, or the Agent on behalf of the Banks shall at any time fail to have a valid and perfected Lien on all of the Collateral purported to be subject to such Lien, subject to no prior or equal Lien except Liens permitted by the Collateral Documents, or any Obligor shall so assert in writing;\nthen, and in every such event, the Agent shall (i) if requested by Banks having more than 50% in aggregate amount of the Commitments, by notice to the Borrower terminate the Commitments and they shall thereupon terminate, and (ii) if requested by Banks holding Notes evidencing more than 50% in aggregate principal amount of the Loans, by notice to the Borrower declare the Notes (together with accrued interest thereon) to be, and the Notes shall thereupon become, immediately due and payable without presentment, demand, protest or other notice of any kind, all of which are hereby waived by the Obligors; provided that in the case of any of the Events of Default specified in clause (i) or (j) above with respect to any Obligor, without any notice to the Borrower or any other act by the Agent or the Banks, the Commitments shall thereupon terminate and the Notes (together with accrued interest thereon) shall become immediately due and payable without presentment, demand, protest or other notice of any kind, all of which are hereby waived by the Obligors.\nSECTION 6.02. Cash Cover. The Borrower hereby agrees, in addition to the provisions of Section 6.01 hereof, that upon the occurrence and during the continuance of any Event of Default, it shall, if requested by the Agent upon instructions from Banks having more than 50% in aggregate amount of the Commitments, pay (and, in the case of any of the Events of Default specified in clause (i) or (j) above with respect to any Obligor, forthwith, without any demand or the taking of any other action by the Agent or any Bank, it shall pay) to the Agent an amount in immediately available funds equal to the then aggregate Letter of Credit Liabilities for all Letters of Credit to be held as security therefor for the benefit of all Banks.\nSECTION 6.03. Notice of Default. The Agent shall give notice to the Borrower under Section 6.01(d) promptly upon being requested to do so by any Bank and shall thereupon notify all the Banks thereof.\nARTICLE VII\nTHE AGENT\nSECTION 7.01. Appointment and Authorization. Each Bank irrevocably appoints and authorizes the Agent to take such action as agent on its behalf and to exercise such powers under the Financing Documents as are delegated to the Agent by the terms thereof, together with all such powers as are reasonably incidental thereto.\nSECTION 7.02. Agent and Affiliates. Morgan Guaranty Trust Company of New York shall have the same rights and powers under the Financing Documents as any other Bank and may exercise or refrain from exercising the same as though it were not the Agent, and Morgan Guaranty Trust Company of New York and its affiliates may accept deposits from, lend money to, and generally engage in any kind of business with the Borrower or any Subsidiary or affiliate of the Borrower as if it were not the Agent hereunder.\nSECTION 7.03. Action by Agent. The obligations of the Agent under the Financing Documents are only those expressly set forth herein. Without limiting the generality of the foregoing, the Agent shall not be required to take any action with respect to any Default, except as expressly provided in Article VI.\nSECTION 7.04. Consultation with Experts. The Agent may consult with legal counsel (who may be counsel for an Obligor), independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken by it in good faith in accordance with the advice of such counsel, accountants or experts.\nSECTION 7.05. Liability of Agent. Neither the Agent nor any of its affiliates nor any of their respective directors, officers, agents or employees shall be liable for any action taken or not taken by it in connection herewith (i) with the consent or at the request of the Required Banks or (ii) in the absence of its own gross negligence or willful misconduct. Neither the Agent nor any of its affiliates nor any of their respective directors, officers, agents or employees shall be responsible for or have any duty to ascertain, inquire into or verify (i) any statement, warranty or representation made in connection with the Financing Documents or any borrowing hereunder; (ii) the performance or observance of any of the covenants or agreements of the Borrower; (iii) the satisfaction of any condition specified in Article III, except receipt of items required to be delivered to the Agent; or (iv) the validity, effectiveness or genuineness of any Financing Document or any other instrument or writing furnished in connection herewith. The Agent shall not incur any liability by acting in reliance upon any notice, consent, certificate, statement, or other writing (which may be a bank wire, telex or similar writing) believed by it to be genuine or to be signed by the proper party or parties.\nSECTION 7.06. Indemnification. Each Bank shall, ratably in accordance with its Commitment, indemnify the Agent, its affiliates and their respective directors, officers, agents and employees (to the extent not reimbursed by the Borrower) against any cost, expense (including reasonable counsel fees and disbursements), claim, demand, action, loss or liability (except such as result from such indemnitees' gross negligence or willful misconduct) that such indemnitees may suffer or incur in\nconnection with this Agreement or any action taken or omitted by such indemnitees hereunder.\nSECTION 7.07. Credit Decision. Each Bank acknowledges that it has, independently and without reliance upon the Agent or any other Bank, and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Bank also acknowledges that it will, independently and without reliance upon the Agent or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking any action under this Agreement.\nSECTION 7.08. Successor Agent. The Agent may resign at any time by giving notice thereof to the Banks and the Borrower. Upon any such resignation, the Required Banks shall have the right to appoint a successor Agent. If no successor Agent shall have been so appointed by the Required Banks, and shall have accepted such appointment, within 30 days after the retiring Agent gives notice of resignation, then the retiring Agent may, on behalf of the Banks, appoint a successor Agent, which shall be a commercial bank organized or licensed under the laws of the United States of America or of any State thereof and having a combined capital and surplus of at least $150,000,000. Upon the acceptance of its appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations hereunder. After any retiring Agent's resignation hereunder as Agent, the provisions of this Article shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Agent.\nSECTION 7.09. Collateral Documents. (a) As to any matters not expressly provided for in the Collateral Documents (including the timing and methods of realization upon the Collateral), the Agent shall act or refrain from acting in accordance with written instructions from the Required Banks or, in the absence of such instructions, in accordance with its discretion; provided that the Agent shall not be obligated to take any action if the Agent believes that such action is or may be contrary to any applicable law or might cause the Agent to incur any loss or liability for which it has not been indemnified to its satisfaction.\n(b) The Agent shall not be responsible for the existence, genuineness or value of any of the Collateral or for the validity, perfection, priority or enforceability of the security interests in any of the Collateral, whether impaired by operation of law or by reason of any action or omission to act on its part under the Collateral Documents. The Agent shall have no duty to ascertain or inquire as to the performance or observance of any of the terms of the Collateral Documents by any Obligor.\nARTICLE VIII\nCHANGE IN CIRCUMSTANCES\nSECTION 8.01. Basis for Determining Interest Rate Inadequate or Unfair. If on or prior to the first day of any Interest Period for any Fixed Rate Borrowing:\n(a) the Agent is advised by the Reference Banks that deposits in dollars (in the applicable amounts) are not being offered to the Reference Banks in the relevant market for such Interest Period, or\n(b) Banks having 50% or more of the aggregate amount of the Commitments advise the Agent that the Adjusted CD Rate or the Adjusted\nLondon Interbank Offered Rate, as the case may be, as determined by the Agent will not adequately and fairly reflect the cost to such Banks of funding their CD Loans or Euro-Dollar Loans, as the case may be, for such Interest Period,\nthe Agent shall forthwith give notice thereof to the Borrower and the Banks, whereupon until the Agent notifies the Borrower that the circumstances giving rise to such suspension no longer exist, the obligations of the Banks to make CD Loans or Euro-Dollar Loans, as the case may be, shall be suspended. Unless the Borrower notifies the Agent at least two Domestic Business Days before the date of any Fixed Rate Borrowing for which a Notice of Borrowing has previously been given that it elects not to borrow on such date, such Borrowing shall instead be made as a Base Rate Borrowing.\nSECTION 8.02. Illegality. If, after the date of this Agreement, the adoption of any applicable law, rule or regulation, or any change in any applicable law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Euro-Dollar Lending Office) with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency shall make it unlawful or impossible for any Bank (or its Euro-Dollar Lending Office) to make, maintain or fund its Euro-Dollar Loans and such Bank shall so notify the Agent, the Agent shall forthwith give notice thereof to the other Banks and the Borrower, whereupon until such Bank notifies the Borrower and the Agent that the circumstances giving rise to such suspension no longer exist, the obligation of such Bank to make Euro-Dollar Loans shall be suspended. Before giving any notice to the Agent pursuant to this Section, such Bank shall designate a different Euro-Dollar Lending Office if such designation will avoid the need for giving such notice and will not, in the judgment of such Bank, be otherwise disadvantageous to such Bank. If such Bank shall determine that it may not lawfully continue to maintain and fund any of its outstanding Euro-Dollar Loans to maturity and shall so specify in such notice, the Borrower shall immediately prepay in full the then outstanding principal amount of each such Euro-Dollar Loan, together with accrued interest thereon. Concurrently with prepaying each such Euro-Dollar Loan, the Borrower shall borrow a Base Rate Loan in an equal principal amount from such Bank (on which interest and principal shall be payable contemporaneously with the related Euro-Dollar Loans of the other Banks), and such Bank shall make such a Base Rate Loan.\nSECTION 8.03. Increased Cost and Reduced Return. (a) If after the date hereof, the adoption of any applicable law, rule or regulation, or any change in any applicable law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Applicable Lending Office) with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency:\n(i) shall subject any Bank (or its Applicable Lending Office) to any tax, duty or other charge with respect to its Fixed Rate Loans, its Note or its obligation to make Fixed Rate Loans, or shall change the basis of taxation of payments to any Bank (or its Applicable Lending Office) of the principal of or interest on its Fixed Rate Loans or any other amounts due under this Agreement in respect of its Fixed Rate Loans or its obligation to make Fixed Rate Loans (except for changes in the rate of tax on the overall net income of such Bank or its Applicable Lending Office imposed by the jurisdiction in which\nsuch Bank's principal executive office or Applicable Lending Office is located); or\n(ii) shall impose, modify or deem applicable any reserve (including, without limitation, any such requirement imposed by the Board of Governors of the Federal Reserve System, but excluding (A) with respect to any CD Loan any such requirement included in an applicable Domestic Reserve Percentage and (B) with respect to any Euro-Dollar Loan any such requirement included in an applicable Euro-Dollar Reserve Percentage), special deposit, insurance assessment (excluding, with respect to any CD Loan, any such requirement reflected in an applicable Assessment Rate) or similar requirement against assets of, deposits with or for the account of, or credit extended by, any Bank (or its Applicable Lending Office) or shall impose on any Bank (or its Applicable Lending Office) or on the United States market for certificates of deposit or the London interbank market any other condition affecting its Fixed Rate Loans, its Note or its obligation to make Fixed Rate Loans;\nand the result of any of the foregoing is to increase the cost to such Bank (or its Applicable Lending Office) of making or maintaining any Fixed Rate Loan, or to reduce the amount of any sum received or receivable by such Bank (or its Applicable Lending Office) under this Agreement or under its Note with respect thereto, by an amount deemed by such Bank to be material, then, within 15 days after demand by such Bank (with a copy to the Agent), the Borrower shall pay to such Bank such additional amount or amounts as will compensate such Bank for such increased cost or reduction.\n(b) If any Bank shall have determined that, after the date hereof, the adoption of any applicable law, rule or regulation regarding capital adequacy, or any change in any such law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on capital of such Bank (or its Parent) as a consequence of such Bank's obligations hereunder to a level below that which such Bank (or its Parent) could have achieved but for such adoption, change, request or directive (taking into consideration its policies with respect to capital adequacy) by an amount deemed by such Bank to be material, then from time to time, within 15 days after demand by such Bank (with a copy to the Agent), the Borrower shall pay to such Bank such additional amount or amounts as will compensate such Bank (or its Parent) for such reduction.\n(c) Each Bank will promptly notify the Borrower and the Agent of any event of which it has knowledge, occurring after the date hereof, which will entitle such Bank to compensation pursuant to this Section and will designate a different Applicable Lending Office if such designation will avoid the need for, or reduce the amount of, such compensation and will not, in the judgment of such Bank, be otherwise disadvantageous to such Bank. A certificate of any Bank claiming compensation under this Section and setting forth the additional amount or amounts to be paid to it hereunder shall be conclusive in the absence of manifest error. In determining such amount, such Bank may use any reasonable averaging and attribution methods.\nSECTION 8.04. Base Rate Loans Substituted for Affected Fixed Rate Loans. If (i) the obligation of any Bank to make Euro-Dollar Loans has been suspended pursuant to Section 8.02 or (ii) any Bank has demanded compensation under Section 8.03(a) and the Borrower shall, by at least\nfive Euro-Dollar Business Days' prior notice to such Bank through the Agent, have elected that the provisions of this Section shall apply to such Bank, then, unless and until such Bank notifies the Borrower that the circumstances giving rise to such suspension or demand for compensation no longer exist:\n(a) all Loans which would otherwise be made by such Bank as CD Loans or Euro-Dollar Loans, as the case may be, shall be made instead as Base Rate Loans (on which interest and principal shall be payable contemporaneously with the related Fixed Rate Loans of the other Banks), and\n(b) after each of its CD Loans or Euro-Dollar Loans, as the case may be, has been repaid, all payments of principal which would otherwise be applied to repay such Fixed Rate Loans shall be applied to repay its Base Rate Loans instead.\nARTICLE IX\nMISCELLANEOUS\nSECTION 9.01. Notices. All notices, requests and other communications to any party hereunder shall be in writing (including bank wire, telex, facsimile transmission or similar writing) and shall be given to such party: (x) in the case of the Borrower or the Agent, at its address or telex or facsimile number set forth on the signature pages hereof, (y) in the case of any Bank, at its address or telex or facsimile number set forth in its Administrative Questionnaire or (z) in the case of any party, such other address or telex or facsimile number as such party may hereafter specify for the purpose by notice to the Agent and the Borrower. Each such notice, request or other communication shall be effective (i) if given by telex, when such telex is transmitted to the telex number specified in this Section and the appropriate answerback is received, (ii) if given by facsimile transmission, when such facsimile is transmitted to the facsimile number specified in this Section and receipt of such facsimile is confirmed, either orally or in writing, by the party receiving such transmission, (iii) if given by certified mail, 72 hours after such communication is deposited in the mails with first class postage prepaid, addressed as aforesaid or (iv) if given by any other means, when delivered at the address specified in this Section; provided that notices to the Agent under Article II or Article VIII shall not be effective until received.\nSECTION 9.02. No Waivers. No failure or delay by the Agent or any Bank in exercising any right, power or privilege under any Financing Document shall operate as a waiver thereof nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies therein provided shall be cumulative and not exclusive of any rights or remedies provided by law.\nSECTION 9.03. Expenses; Documentary Taxes; Indemnification. (a) The Borrower shall pay (i) all out-of-pocket expenses of the Agent, including fees and disbursements of special counsel for the Agent, in connection with the preparation of the Financing Documents, any waiver or consent under any Financing Document, or any amendment of any Financing Document or any Default or alleged Default and (ii) if an Event of Default occurs, all out-of-pocket expenses incurred by the Agent and each Bank, including fees and disbursements of counsel (including allocated costs of internal counsel and disbursements of internal counsel), in connection with such Event of Default and collection, bankruptcy, insolvency and other enforcement proceedings resulting therefrom. The Borrower shall\nindemnify each Bank against any transfer taxes, documentary taxes, assessments or charges made by any governmental authority by reason of the execution and delivery of any Financing Document.\n(b) The Borrower agrees to indemnify the Agent and each Bank, their respective affiliates and the respective directors, officers, agents and employees of the foregoing (each an \"Indemnitee\") and hold each Indemnitee harmless from and against any and all liabilities, losses, damages, costs and expenses of any kind, including, without limitation, the reasonable fees and disbursements of counsel (including allocated costs of internal counsel and disbursements of internal counsel), which may be incurred by any Indemnitee in connection with any investigative, administrative or judicial proceeding (whether or not such Indemnitee shall be designated a party thereto) brought or threatened relating to or arising out of any Financing Document or any actual or proposed use of proceeds of Loans hereunder; provided that no Indemnitee shall have the right to be indemnified hereunder for such Indemnitee's own gross negligence or willful misconduct as determined by a court of competent jurisdiction.\n(c) The Borrower agrees to indemnify each Indemnitee and hold each Indemnitee harmless from and against any and all liabilities, losses, damages, costs and expenses of any kind (including without limitation reasonable expenses of investigation by engineers, environmental consultants and similar technical personnel and reasonable fees and disbursements of counsel including allocated costs of internal counsel and disbursements of internal counsel) of any Indemnitee arising out of, in respect of or in connection with any and all Environmental Liabilities. Without limiting the generality of the foregoing, the Borrower hereby waives all rights for contribution or any other rights of recovery with respect to liabilities, losses, damages, costs or expenses arising under or related to Environmental Laws that it might have by statute or otherwise against any Indemnitee.\nSECTION 9.04. Sharing of Setoffs. Each Bank agrees that if it shall, by exercising any right of setoff or counterclaim or otherwise, receive payment of a proportion of the aggregate amount due with respect to any Loan or Reimbursement Obligation owed to it which is greater than the proportion received by any other Bank in respect of the aggregate amount due with respect to any Loan or Reimbursement Obligation owed to such other Bank, the Bank receiving such proportionately greater payment shall purchase such participations in the Loans and Reimbursement Obligations owed to the other Banks, and such other adjustments shall be made, as may be required so that all such payments with respect to the Loans and Reimbursement Obligations owed to the Banks shall be shared by the Banks pro rata; provided that nothing in this Section shall impair the right of any Bank to exercise any right of setoff or counterclaim it may have and to apply the amount subject to such exercise to the payment of indebtedness of the Borrower other than its indebtedness hereunder. The Borrower agrees, to the fullest extent it may effectively do so under applicable law, that any holder of a participation in a Loan or Reimbursement Obligation, whether or not acquired pursuant to the foregoing arrangements, may exercise rights of setoff or counterclaim and other rights with respect to such participation as fully as if such holder of a participation were a direct creditor of the Borrower in the amount of such participation.\nSECTION 9.05. Amendments and Waivers. Any provision of this Agreement or the Notes may be amended or waived if, but only if, such amendment or waiver is in writing and is signed by the Borrower and the Required Banks (and, if the rights or duties of the Agent are affected thereby, by it); provided that no such amendment or waiver shall, unless signed by all the Banks, (i) increase or decrease the Commitment of any\nBank (except for a ratable decrease in the Commitments of all Banks) or subject any Bank to any additional obligation, (ii) reduce the principal of or rate of interest on any Loan or any fees hereunder, (iii) postpone the date fixed for any payment of principal of or interest on any Loan, any Reimbursement Obligation or any fees hereunder or for termination of any Commitment, (iv) amend or waive any of the provisions of Article VIII, (v) change the percentage of the Commitments or of the aggregate unpaid principal amount of the Notes, or the number of Banks, which shall be required for the Banks or any of them to take any action under this Section or any other provision of the Financing Documents or (vi) release any Subsidiary Guarantor from the Subsidiary Guarantee Agreement.\nSECTION 9.06. Successors and Assigns. (a) The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, except that the Borrower may not assign or otherwise transfer any of its rights under this Agreement without the prior written consent of all Banks.\n(b) Any Bank may at any time grant to one or more banks or other institutions (each a \"Participant\") participating interests in its Commitment or any or all of its Loans. In the event of any such grant by a Bank of a participating interest to a Participant, whether or not upon notice to the Borrower and the Agent, such Bank shall remain responsible for the performance of its obligations hereunder, and the Borrower and the Agent shall continue to deal solely and directly with such Bank in connection with such Bank's rights and obligations under this Agreement. Any agreement pursuant to which any Bank may grant such a participating interest shall provide that such Bank shall retain the sole right and responsibility to enforce the obligations of the Borrower hereunder including, without limitation, the right to approve any amendment, modification or waiver of any provision of this Agreement; provided that such participation agreement may provide that such Bank will not agree to any modification, amendment or waiver of this Agreement described in clause (i), (ii) or (iii) of Section 9.05 without the consent of the Participant. The Borrower agrees that each Participant shall, to the extent provided in its participation agreement, be entitled to the benefits of Article VIII with respect to its participating interest. An assignment or other transfer which is not permitted by subsection (c) or (d) below shall be given effect for purposes of this Agreement only to the extent of a participating interest granted in accordance with this subsection (b).\n(c) Any Bank may at any time assign to one or more banks or other institutions (each an \"Assignee\") all, or a proportionate part of all, of its rights and obligations under this Agreement and the Notes and such Assignee shall assume such rights and obligations, pursuant to an Assignment and Assumption Agreement in substantially the form of Exhibit I hereto executed by such Assignee and such transferor Bank, with (and subject to) the subscribed consent of the Borrower (which shall not be unreasonably withheld) and the Agent; provided that if an Assignee is an affiliate of such transferor Bank, no such consent shall be required. Upon execution and delivery of such instrument and payment by such Assignee to such transferor Bank of an amount equal to the purchase price agreed between such transferor Bank and such Assignee, such Assignee shall be a Bank party to this Agreement and shall have all the rights and obligations of a Bank with a Commitment as set forth in such instrument of assumption, and the transferor Bank shall be released from its obligations hereunder to a corresponding extent, and no further consent or action by any party shall be required. Upon the consummation of any assignment pursuant to this subsection (c), the transferor Bank, the Agent and the Borrower shall make appropriate arrangements so that, if required, a new Note is issued to the Assignee. In connection with any such assignment, the transferor Bank shall pay to the Agent an administrative fee for\nprocessing such assignment in the amount of $2,500.\n(d) Any Bank may at any time assign all or any portion of its rights under this Agreement and its Note to a Federal Reserve Bank. No such assignment shall release the transferor Bank from its obligations hereunder.\n(e) No Assignee, Participant or other transferee of any Bank's rights shall be entitled to receive any greater payment under Section 8.03 than such Bank would have been entitled to receive with respect to the rights transferred, unless such transfer is made with the Borrower's prior written consent or by reason of the provisions of Section 8.02 or 8.03 requiring such Bank to designate a different Applicable Lending Office under certain circumstances or at a time when the circumstances giving rise to such greater payment did not exist.\nSECTION 9.07. Collateral. Each of the Banks represents to the Agent and each of the other Banks that it in good faith is not relying upon any \"margin stock\" (as defined in Regulation U) as collateral in the extension or maintenance of the credit provided for in this Agreement.\nSECTION 9.08. Governing Law; Submission to Jurisdiction. This Agreement and each Note shall be construed in accordance with and governed by the law of the State of New York. The Borrower hereby submits to the nonexclusive jurisdiction of the United States District Court for the Southern District of New York and of any New York State court sitting in New York City for purposes of all legal proceedings arising out of or relating to this Agreement or the transactions contemplated hereby. The Borrower irrevocably waives, to the fullest extent permitted by law, any objection which it may now or hereafter have to the laying of the venue of any such proceeding brought in such a court and any claim that any such proceeding brought in such a court has been brought in an inconvenient forum.\nSECTION 9.09. Counterparts; Integration. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Agreement constitutes the entire agreement and understanding among the parties hereto and supersedes any and all prior agreements and understandings, oral or written, relating to the subject matter hereof.\nSECTION 9.10. WAIVER OF JURY TRIAL. EACH OF THE OBLIGORS, THE AGENT AND THE BANKS HEREBY IRREVOCABLY WAIVES ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY.\nIN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written.\nPERINI CORPORATION\nBy \/s\/ John H. Schwarz ---------------------------- Title: Exec. Vice President, Finance & Admin.\nBy \/s\/ Susan C. Mellace ---------------------------- Title: Vice President & Treasurer\n73 Mount Wayte Avenue Framingham, MA 01701 Facsimile number: (508) 628-2960\nCommitments\nTranche A: MORGAN GUARANTY TRUST COMPANY $22,704,000.00 OF NEW YORK Tranche B: $3,096,000.00\nBy \/s\/ Robert Bottamedi ---------------------------- Title: Vice President\nTranche A: SHAWMUT BANK, N.A. $22,704,000.00 Tranche B: $3,096,000.00\nBy \/s\/ Robert J. Lord ---------------------------- Title: Director\nTranche A: BANK OF AMERICA NATIONAL TRUST AND $16,016,000.00 SAVINGS ASSOCIATION Tranche B: $2,184,000.00\nBy \/s\/ Richard J. Cerf --------------------------------- Title: Vice President\nTranche A: FLEET BANK OF MASSACHUSETTS, N.A. $16,016,000.00 Tranche B: $2,184,000.00\nBy \/s\/ Jeffery Bauer ------------------------------- Title: Vice President\nTranche A: BAYBANK BOSTON, N.A., as Bank and $10,560,00.00 as LC Bank Tranche B: $1,440,00.00\nBy \/s\/ Timothy M. Laurion --------------------------------- Title: Vice President\nTranche A: COMERICA BANK $8,800,000.00 Tranche B: $1,200,000.00\nBy \/s\/ Jon A. Bird -------------------------------- Title: Vice President\nTranche A: HARRIS TRUST & SAVINGS BANK $8,800,000.00 Tranche B: $1,200,000.00\nBy \/s\/ David L. Sauerman ------------------------------ Title: Vice President\nTranche A: STATE STREET BANK AND TRUST COMPANY $4,400,000.00 Tranche B: $600,000.00\nBy \/s\/ Linda A. Moulton ------------------------------ Title: Vice President\n_________________ Total Commitments $125,000,000\nMORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Agent\nBy \/s\/ Robert Bottamedi --------------------------------- Title: Vice President\n60 Wall Street New York, New York 10260 Attn: Robert Bottamedi Telex number: 177615 MGT UT Facsimile number: (212) 648-5023\nEXHIBIT 22\nPERINI CORPORATION\nSUBSIDIARIES OF THE REGISTRANT\nPercentage of Interest or Place Voting Name of Organization Securities Owned\nPerini Corporation Massachusetts\nPerini Building Company, Inc. Arizona 100%\nPioneer Construction, Inc. West Virginia 100%\nPerland Environmental Delaware 100% Technologies, Inc.\nInternational Construction Delaware 100% Management Services, Inc.\nPercon Constructors, Inc. Delaware 100%\nPerini International Massachusetts 100% Corporation\nBow Leasing Company, Inc. New Hampshire 100%\nPerini Land & Development Massachusetts 100% Company\nParamount Development Massachusetts 100% Associates, Inc.\nI-10 Industrial Park Arizona General 80% Developers Partnership\nPerini Resorts, Inc. California 100%\nGlenco-Perini - HCV California 45% Partners Limited Partnership\nSquaw Creek Associates California 40% General Partnership\nPerland Realty Associates, Florida 100% Inc.\nRincon Center Associates California 46% Limited Partnership\nPerini Central Limited Arizona Limited 75% Partnership Partnership\nPerini Eagle Limited Arizona Limited 50% Partnership Partnership\nPerini\/138 Joint Venture Georgia General 49% Partnership\nPerini\/RSEA Partnership Georgia General 50% Partnership\nEXHIBIT 23\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the use of our reports, dated February 10, 1995, included in Perini Corporation's Annual Report on this Form 10-K for the year ended December 31, 1994, and into the Company's previously filed Registration Statements Nos. 2-82117, 33-24646, 33-46961, 33-53190, 33-53192, 33-60654, 33-70206 and 33-52967.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts March 22, 1995\nEXHIBIT 24\nPOWER OF ATTORNEY\nWe, the undersigned, Directors of Perini Corporation, hereby severally constitute David B. Perini, John H. Schwarz and Richard E. Burnham, and each of them singly, our true and lawful attorneys, with full power to them and to each of them to sign for us, and in our names in the capacities indicated below, any Annual Report on Form 10-K pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 to be filed with the Securities and Exchange Commission and any and all amendments to said Annual Report on Form 10-K, hereby ratifying and confirming our signatures as they may be signed by our said Attorneys to said Annual Report on Form 10-K and to any and all amendments thereto and generally to do all such things in our names and behalf and in our said capacities as will enable Perini Corporation to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission.\nWITNESS our hands and common seal on the date set forth below.\ns\/David B. Perini Director March 22, 1995 ---------------------- Date David B. Perini\ns\/Joseph R. Perini Director March 22, 1995 ---------------------- Date Joseph R. Perini\ns\/Richard J. Boushka Director March 22, 1995 ---------------------- Date Richard J. Boushka\ns\/Marshall M. Criser Director March 22, 1995 ---------------------- Date Marshall M. Criser\ns\/Thomas E. Dailey Director March 22, 1995 ---------------------- Date Thomas E. Dailey\ns\/Albert A. Dorman Director March 22, 1995 ---------------------- Date Albert A. Dorman\ns\/Arthur J. Fox, Jr. Director March 22, 1995 ---------------------- Date Arthur J. Fox, Jr.\ns\/Nancy Hawthorne Director March 22, 1995 ---------------------- Date Nancy Hawthorne\ns\/John J. McHale Director March 22, 1995 ---------------------- Date John J. McHale\ns\/Jane E. Newman Director March 22, 1995 ---------------------- Date Jane E. Newman\ns\/Bart W. Perini Director March 22, 1995 ---------------------- Date Bart W. Perini\nEXHIBIT 27\nFINANCIAL DATA SCHEDULE\nThis schedule contains summary financial information extracted from the Consolidated Balance Sheets as of December 31, 1994 and the Consolidated Statements of Operations for the twelve months ended December 31, 1994 and is qualified in its entirety by reference to such financial statements.\nMultiplier 1,000 Period Type 12 Months Fiscal Year End December 31, 1994 Period End December 31, 1994 Cash 7,841 Securities 0 Receivables 151,620 Allowances 0 Inventory 11,525 Current Assets 266,648 (F1) PP&E 42,588 Depreciation (29,082) Total Assets 482,500 (F2) Current Liabilities 236,700 Bonds 76,986 Common 4,985 Preferred Mandatory 100 Preferred 0\nOther SE 0 Total Liability and 482,500 (F3) Equity Sales 0 Total Revenues 1,012,045 CGS 0 Total Costs (960,248) Other Expenses (856) Loss Provision 0 Interest Expense (7,473) Income Pretax 483 (F4) Income Tax (180) Income Continuing 303 Discontinued 0 Extraordinary 0 Changes 0 Net Income 303 EPS Primary (.42) EPS Diluted 0\n(F1) Includes Equity in Construction Joint Ventures of $66,346, Unbilled Work of $20,209, and Other Short-Term Assets of $9,107, not currently reflected in this tag list.\n(F2) Includes investments in and advances to Real Estate Joint Ventures of $148,843, Land Held for Sale or Development of $43,295, and Other Long-Term Assets of $10,208 not currently reflected in this tag list.\n(F3) Includes Deferred Income Taxes and Other Liabilities of $33,488, Minority Interest of $3,297, Paid-In Surplus of $59,001, Retained Earnings of $81,772, ESOT Related Obligations of $(6,009), and Treasury Stock of $(7,820).\n(F4) Includes General, Administrative and Selling Expenses of $(42,985), not currently reflected on this tag list.","section_7":"","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Reports of Independent Public Accountants, Consolidated Financial Statements, and Supplementary Schedules, are set forth on the pages that follow in this Report and are hereby incorporated 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\nReference is made to the information to be set forth in the section entitled \"Election of Directors\" in the definitive proxy statement involving election of directors in connection with the Annual Meeting of Stockholders to 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 and Exchange Act of 1934, as amended.\nListed below are the names, offices held, ages and business experience of all executive officers of the Company.\nYear First Elected to Present Name, Offices Held and Age Office and Business Experience\nDavid B. Perini, Director, He has served as a Director, Chairman, President and Chief President, Chief Executive Officer Executive Officer - 57 and Acting Chairman since 1972. He became Chairman on March 17, 1978 and has worked for the Company since 1962 in various capacities. Prior to being elected President, he served as Vice President and General Counsel.\nRichard J. Rizzo, He has served in this capacity since Executive Vice President, January, 1994, which entails overall Building Construction - 51 responsibility for the Company's building construction operations. Prior thereto, he served as President of Perini Building Company (formerly known as Mardian Construction Co.) since 1985, and in various other operating capacities since 1977.\nJohn H. Schwarz, Executive He has served as Executive Vice Vice President, Finance and President, Finance and Administration Administration of the Company since August, 1994, and as Chief and Chief Executive Officer Executive Officer of Perini Land and of Perini Land and Development Company, which entails Development Company - 56 overall responsibility for the Company's real estate operations since April, 1992. Prior to that, he served as Vice President, Finance and Controls of Perini Land and Development Company. Previously, he served as Treasurer from August, 1984, and Director of Corporate Planning since May, 1982. He joined the Company in 1979 as Manager of Corporate Development.\nDonald E. Unbekant, Executive He has served in this capacity since Vice President, Civil and January, 1994, which entails overall Environmental Construction - responsibility for the Company's 63 civil and environmental construction operations. Prior thereto, he served in the Metropolitan New York Division of the Company as President since 1992, Vice President and General Manager since 1990 and Division Manager since 1984.\nThe Company's officers are elected on an annual basis at the Board of Directors Meeting immediately following the Shareholders Meeting in May, to hold such offices until the Board of Directors Meeting following the next Annual Meeting of Shareholders and until their respective successors have been duly appointed or until their tenure has been terminated by the Board of Directors, or otherwise.\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\nIn response to Items 11-13, reference is made to the information to be set forth in the section entitled \"Election of Directors\" in the 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\nPERINI CORPORATION AND SUBSIDIARIES\n(a)1. The following financial statements and supplementary financial information are filed as part of this report: Pages Financial Statements of the Registrant\nConsolidated Balance Sheets as of December 31, 1994 and 29 - 30\nConsolidated Statements of Operations for the three years 31 ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Stockholders' Equity for the 32 three years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the three years 33 - 34 ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements 35 - 48\nReport of Independent Public Accountants 49\n(a)2. The following financial statement schedules are filed as part of this report:\nPages\nReport of Independent Public Accountants on Schedules 50\nSchedule II -- Valuation and Qualifying Accounts and 51 Reserves\nAll other schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated Financial Statements or in the Notes thereto.\nSeparate condensed financial information of the Company has been omitted since restricted net assets of subsidiaries included in the consolidated financial statements and its equity in the undistributed earnings of 50% or less owned persons accounted for by the equity method do not, in the aggregate, exceed 25% of consolidated net assets.\n(a)3. Exhibits\nThe exhibits which are filed with this report or which are incorporated herein by reference are set forth in the Exhibit Index which appears on pages 52 and 53. The Company will furnish a copy of any exhibit not included herewith to any holder of the Company's common and preferred stock upon request.\n(b) During the quarter ended December 31, 1994, the Registrant made no filings on Form 8-K.\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, hereunto duly authorized.\nPERINI CORPORATION (Registrant)\nDated: March 22, 1995 David B. Perini Chairman, President 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 Company and in the capacities and on the dates indicated. Signature Title Date\n(i) Principal Executive Officer David B. Perini Chairman, President and Chief Executive Officer --------------------- March 22, 1995 David B. Perini\n(ii) Principal Financial Officer John H. Schwarz Executive Vice President, Finance & Administration ---------------------- March 22, 1995 John H. Schwarz\n(iii) Principal Accounting Officer Barry R. Blake Vice President and Controller ------------------------- March 22, 1995 Barry R. Blake (iv) Directors\nDavid B. Perini ) Joseph R. Perini ) By Richard J. Boushka ) Marshall M. Criser ) --------------------- Thomas E. Dailey ) David B. Perini Albert A. Dorman ) Arthur J. Fox, Jr. ) Attorney in Fact Nancy Hawthorne ) Dated: March 22, 1995 John J. McHale ) Jane E. Newman ) Bart W. Perini )\nConsolidated Balance Sheets December 31, 1994 and 1993\n(In thousands except per share data)\nAssets 1994 1993 CURRENT ASSETS: Cash, including cash equivalents of $3,518 and $ 7,841 $ 35,871 $20,354 (Note 1) Accounts and notes receivable, including retainage 151,620 123,009 of $63,344 and $45,084 Unbilled work (Note 1) 20,209 14,924 Construction joint ventures (Notes 1 and 2) 66,346 61,156 Real estate inventory, at the lower of cost or 11,525 11,666 market (Note 1)\nDeferred tax asset (Notes 1 and 5) 6,066 7,702 Other current assets 3,041 3,274 -------- -------- Total current assets $266,648 $257,602 -------- --------\nREAL ESTATE DEVELOPMENT INVESTMENTS: Land held for sale or development (including land development costs) at the lower of cost or market $ 43,295 $ 48,011 (Note 1) Investments in and advances to real estate joint ventures (Notes 1, 2 and 11) 148,843 138,095 Real estate properties used in operations, less accumulated depreciation of $3,698 and $3,638 6,254 12,678 Other 80 - -------- -------- Total real estate development investments $198,472 $198,784 -------- --------\nPROPERTY AND EQUIPMENT, at cost: Land $ 1,134 $ 1,451 Buildings and improvements 12,505 15,566 Construction equipment 16,397 16,440 Other equipment 12,552 11,625 -------- -------- $ 42,588 $ 45,082 Less - Accumulated depreciation (Note 1) 29,082 28,986 -------- -------- Total property and equipment, net $ 13,506 $ 16,096 -------- --------\nOTHER ASSETS: Other investments $ 2,174 2,188 Goodwill (Note 1) 1,700 1,708 -------- -------- Total other assets $ 3,874 $ 3,896 -------- --------\n$482,500 $476,378 ======== ========\nThe accompanying notes are an integral part of these financial statements.\nLiabilities and Stockholders' Equity\n1994 1993 CURRENT LIABILITIES: Current maturities of long-term debt (Note 4) $ 5,022 $ 7,617 Accounts payable, including retainage of $52,224 140,454 136,231 and $45,508 Deferred contract revenue (Note 1) 38,929 25,867 Accrued expenses 52,295 47,827 Accrued income taxes (Notes 1 and 5) - 3,183 --------- -------- Total current liabilities $236,700 $220,725 --------- --------\nDEFERRED INCOME TAXES AND OTHER LIABILITIES $ 33,488 $ 38,794 (Notes 1 and 5) -------- ---------\nLONG-TERM DEBT, less current maturities included above (Note 4): Real estate development $ 6,502 $ 11,382 Other 70,484 70,984 --------- --------- Total long-term debt $ 76,986 $ 82,366 --------- ---------\nMINORITY INTEREST (Note 1) $ 3,297 $ 3,350 --------- ---------\nCONTINGENCIES AND COMMITMENTS (Note 11)\nSTOCKHOLDERS' EQUITY (Notes 1, 7, 8, 9 and 10): Preferred stock, $1 par value - Authorized - 1,000,000 shares Issued and outstanding - 100,000 shares ($25,000 aggregate liquidation preference) $ 100 $ 100 Series A junior participating preferred stock, $1 par value - Authorized - 200,000 - - Issued - none Common stock, $1 par value - Authorized - 15,000,000 and 7,500,000 shares Issued - 4,985,160 shares 4,985 4,985 Paid-in surplus 59,001 59,875 Retained earnings 81,772 83,594 ESOT related obligations (6,009) (6,982) --------- --------- $139,849 $141,572\nLess - Common stock in treasury, at cost - 7,820 10,429 490,674 shares and 654,353 shares --------- ---------\nTotal stockholders' equity $132,029 $131,143 -------- ---------\n$482,500 $476,378 ======== ========\nConsolidated Statements of Operations For the years ended December 31, 1994, 1993 & 1992\n(In thousands, except per share data)\n1994 1993 1992\nREVENUES (Notes 2 and 13) $1,012,045 $1,100,116 $1,070,852 ----------- ----------- -----------\nCOSTS AND EXPENSES (Notes 2 and 10): Cost of operations $ 960,248 $1,047,330 $1,048,663 General, administrative and 42,985 44,212 41,328 selling expenses ----------- ----------- ----------- $1,003,233 $1,091,542 $1,089,991 ----------- ----------- -----------\nINCOME (LOSS) FROM OPERATIONS $ 8,812 $ 8,574 $ (19,139) (Note 13) ----------- ----------- -----------\nOther income (expense), net (856) 5,207 436 (Note 6) Interest expense, net of (7,473) (5,655) (7,651) capitalized amounts ----------- ----------- ----------- (Notes 1, 3 and 4)\nINCOME (LOSS) BEFORE INCOME TAXES $ 483 $ 8,126 $ (26,354)\n(Provision) credit for income (180) (4,961) 9,370 taxes (Notes 1 and 5) ----------- ----------- -----------\nNET INCOME (LOSS) $ 303 $ 3,165 $ (16,984) ========== ========== ===========\nEARNINGS (LOSS) PER COMMON SHARE $ (.42) $ .24 $ (4.69) (Note 1) =========== ========== ===========\nThe accompanying notes are an integral part of these financial statements.\n*Equivalent to $2.125 per depositary share (see Note 7).\nThe accompanying notes are an integral part of these financial statements.\nConsolidated Statements of Cash Flows For the years ended December 31, 1994, 1993 & 1992\n(In thousands)\n1994 1993 1992\nCash Flows from Operating Activities: Net income (loss) $ 303 $ 3,165 $(16,984)\nAdjustments to reconcile net income (loss) to net cash from operating activities - Depreciation and amortization 2,879 3,515 6,297\nNon-current deferred taxes and other (5,306) 11,239 (13,236) liabilities\nDistributions greater (less) than earnings of joint ventures 2,995 (2,821) 9,412 and affiliates Writedown of certain real estate - - 31,368 properties\nGain on sale of Monenco (Note 6) - - (1,976) Gain on sale of Majestic - (4,631) - (Notes 1 and 6)\nGain on sale of fixed assets (105) (299) (570)\nMinority interest, net (53) (78) 2,001 Cash provided from (used by) changes in components of working capital other than cash, notes payable and (14,119) (19,653) 35,819 current maturities of long-term debt\nReal estate development investments 11,451 10,908 6,253 other than joint ventures\nOther non-cash items, net (3,073) (2,922) (2,972) --------- --------- ---------\nNET CASH FROM OPERATING ACTIVITIES $ (5,028) $ (1,577) $ 55,412 --------- --------- ---------\nCash Flows from Investing Activities:\nProceeds from sale of property and $ 989 $ 1,344 $ 1,890 equipment Cash distributions of capital from unconsolidated joint ventures 13,112 4,977 3,413\nAcquisition of property and equipment (2,493) (4,387) (4,044)\nImprovements to land held for sale or (334) (4,227) (4,341) development Improvements to and acquisitions of real estate properties used in (140) (614) (6,310) operations\nCapital contributions to (20,199) (24,579) (8,425) unconsolidated joint ventures Advances to real estate joint (6,559) (16,031) (12,091) ventures, net\nProceeds from sale of Monenco shares - - 14,180\nProceeds from sale of Majestic, net - 4,377 - of subsidiary's cash Investments in other activities 14 - (3) --------- --------- ---------\nNET CASH USED BY INVESTING ACTIVITIES $(15,610) $(39,140) $(15,731) --------- --------- --------- Consolidated Statements of Cash Flows (Continued) For the years ended December 31, 1994, 1993 & 1992\n(In thousands)\nCash Flows from Financing Activities:\nProceeds from long-term debt $ 3,127 $ 8,014 $ 9,571 Repayment of long-term debt (10,129) (11,600) (17,590)\nCash dividends paid (2,125) (2,125) (2,125) Treasury stock issued 1,735 2,736 3,043 --------- --------- ---------\nNET CASH USED BY FINANCING ACTIVITIES $ (7,392) $ (2,975) $ (7,101) --------- --------- ---------\nEffect of Exchange Rate Changes on Cash $ - $ - $ (831) --------- --------- ---------\nNet Increase (Decrease) in Cash $(28,030) $(43,692) $ 31,749 Cash and Cash Equivalents at Beginning 35,871 79,563 47,814 of Year --------- --------- ---------\nCash and Cash Equivalents at End of $ 7,841 $ 35,871 79,563 Year ========= ========= =========\nSupplemental Disclosures of Cash Paid During the Year For:\nInterest, net of amounts capitalized $ 7,308 $ 5,947 $ 10,995 ========= ========= ========= Income tax payments (refunds) $ 1,176 $ 843 $ (2,603) ========= ========= ========\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 1993, 1992 & 1991\n[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n[a] Principles of Consolidation The consolidated financial statements include the accounts of Perini Corporation, its subsidiaries and certain majority-owned real estate joint ventures (the \"Company\"). All subsidiaries are wholly-owned except Majestic Contractors Limited (\"Majestic\"), which was approximately 74%- owned and Perland Environmental Technologies, Inc. (\"Perland\"), which was approximately 90%-owned until October 1994 when it became 100%-owned. All significant intercompany transactions and balances have been eliminated in consolidation. Non-consolidated joint venture interests are accounted for on the equity method with the Company's share of revenues and costs in these interests included in \"Revenues\" and \"Cost of Operations,\" respectively, in the accompanying consolidated statements of operations. All significant intercompany profits between the Company and its joint ventures have been eliminated in consolidation. Taxes are provided on joint venture results in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\".\nIn January 1993, the Company sold its 74%-ownership in Majestic, its Canadian pipeline construction subsidiary, for $31.7, million, which resulted in an after tax gain of approximately $1.0 million.\nEffective July 1, 1993, the Company acquired Gust K. Newberg Construction Co.'s (\"Newberg\") interest in certain construction projects and related equipment. The purchase price for the acquisition was (i) approximately $3 million in cash for the equipment paid by a third party leasing company, which in turn simultaneously entered into an operating lease agreement with the Company for the use of said equipment, (ii) the greater of $1 million or 25% of the aggregate pretax earnings during the period from April 1, 1993 through December 31, 1994, net of payments accruing to Newberg as described in (iii) below, and (iii) 50% of the aggregate of net profits earned from each project from April 1, 1993 through December 31, 1994 and, with regard to one project, through December 31, 1995. This acquisition has been accounted for as a purchase. If this acquisition had been consummated as of January 1, 1992, the 1992 and 1993 pro forma results would have been, respectively, Revenues of $1,164,444,000 and $1,134,264,000 and Net Income (Loss) of $(14,935,000) ($(4.18) per common share) and $3,724,000 ($.37 per common share).\n[b] Translation of Foreign Currencies The accounts of the former Canadian subsidiary were translated in accordance with Statement of Financial Accounting Standards (SFAS) No. 52, under which translation adjustments are accumulated directly as a separate\ncomponent of stockholders' equity. Gains and losses on foreign currency transactions are included in results of operations during the period in which they arise.\n[c] Method of Accounting for Contracts Profits from construction contracts and construction joint ventures are generally recognized by applying percentages of completion for each year to the total estimated profits for the respective contracts. The percentages of completion are determined by relating the actual cost of the work performed to date to the current estimated total cost of the respective contracts. When the estimate on a contract indicates a loss, the Company's policy is to record the entire loss. The cumulative effect of revisions in estimates of total cost or revenue during the course of the work is reflected in the accounting period in which the facts that caused the revision became known. An amount equal to the costs attributable to unapproved change orders and claims is included in the total estimated revenue when realization is probable. Profit from claims is recorded in the year such claims are resolved.\nIn accordance with normal practice in the construction industry, the Company includes in current assets and current liabilities amounts related to construction contracts realizable and payable over a period in excess of one year. Unbilled work represents the excess of contract costs and profits recognized to date on the percentage of completion accounting method over billings to date on certain contracts. Deferred contract revenue represents the excess of billings to date over the amount of contract costs and profits recognized to date on the percentage of completion accounting method on the remaining contracts.\n[d] Methods of Accounting for Real Estate Operations All real estate sales are recorded in accordance with SFAS No. 66. Gross profit is not recognized in full unless the collection of the sale price is reasonably assured and the Company is not obliged to perform significant activities after the sale. Unless both conditions exist, recognition of all or a part of gross profit is deferred.\nThe gross profit recognized on sales of real estate is determined by relating the estimated total land, land development and construction costs of each development area to the estimated total sales value of the property in the development. Real estate investments are stated at the lower of cost, which includes applicable interest and real estate taxes during the development and construction phases, or market. The market or net realizable value of a development is determined by estimating the sales value of the development in the ordinary course of business less the estimated costs of completion (to the stage of completion assumed in determining the selling price), holding and disposal. Estimated sales values are forecast based on comparable local sales (where applicable), trends as foreseen by knowledgeable local commercial real estate brokers or others active in the business and\/or project specific experience such as offers made directly to the Company relating to the property. If the net realizable value of a development is less than the cost of a development, a provision is made to reduce the carrying value of the development to net realizable value. A provision (or writedown to net realizable value) amounted to $31.4 million in 1992. At present, the Company believes its remaining real estate properties are carried at amounts at or below their net realizable values considering the expected timing of their disposal.Interest expense incurred by the Company and capitalized during the development or construction phase amounted to zero in 1994 and $.2 million per year in 1993 and 1992.\n[e] Depreciable Property and Equipment Land, buildings and improvements, construction and computer-related equipment and other equipment are recorded at cost. Depreciation is\nprovided primarily using accelerated methods for construction and computer-related equipment and the straight-line method for the remaining depreciable property.\n[f] Goodwill Goodwill represents the excess of the costs of subsidiaries acquired over the fair value of their net assets as of the dates of acquisition. These amounts are being amortized on a straight-line basis over 40 years.\n[g] Income Taxes The Company follows Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" (see Note 5).\nIt is the policy of the Company to accrue appropriate U.S. and foreign income taxes on earnings of foreign subsidiaries which are intended to be remitted to the Company.\n[h] Earnings (Loss) Per Common Share Computations of earnings (loss) per common share amounts are based on the weighted average number of common shares outstanding during the respective periods. During the three-year period ended December 31, 1994, earnings (loss) per common share reflect the effect of preferred dividends accrued during the year. Common stock equivalents related to additional shares of common stock issuable upon exercise of stock options (see Note 9) have not been included since their effect would be immaterial or antidilutive. Earnings (loss) per common share on a fully diluted basis are not presented because the effect of conversion of the Company's depositary convertible exchangeable preferred shares into common stock is antidilutive.\n[i] Cash and Cash Equivalents Cash equivalents include short-term, highly liquid investments with original maturities of three months or less.\n[j] Reclassifications Certain prior year amounts have been reclassified to be consistent with the current year classifications.\n[2] JOINT VENTURES\nThe Company, in the normal conduct of its business, has entered into certain partnership arrangements, referred to as \"joint ventures,\" for construction and real estate development projects. Each of the joint venture participants is usually committed to supply a predetermined percentage of capital, as required, and to share in a predetermined percentage of the income or loss of the project. Summary financial information (in thousands) for construction and real estate joint ventures accounted for on the equity method for the three years ended December 31, 1994 follows:\nCONSTRUCTION JOINT VENTURES\nFinancial position at December 31, 1994 1993 1992\nCurrent assets $232,025 $241,905 $216,568 Property and equipment, net 19,386 17,228 18,203 Current liabilities (132,326) (151,181) (155,026) --------- --------- --------- Net assets $119,085 $107,952 $ 79,745 ========= ========= =========\nOperations for the year ended December 31, 1994 1993 1992\nRevenue $544,546 $626,327 $487,758 Cost of operations 505,347 574,383 445,494 --------- -------- -------- Pretax income $ 39,199 $ 51,944 $ 42,264 ========= ========= =========\nCompany's share of joint ventures Revenue $241,784 $293,547 $254,265 Cost of operations 224,039 272,137 231,564 --------- -------- -------- Pretax income $ 17,745 $ 21,410 $ 22,701 ========= ========= =========\nEquity $ 66,346 $ 61,156 $ 29,654 ========= ========= =========\nREAL ESTATE JOINT VENTURES\nFinancial position at December 31, 1994 1993 1992\nProperty held for sale or $ 28,885 $ 35,855 $ 17,902 development Investment properties, net 177,258 191,606 243,477 Other assets 62,101 61,060 59,688 Long-term debt (77,968) (103,090) (151,538) Other liabilities* (277,184) (256,999) (229,865) --------- --------- --------- Net assets (liabilities) $(86,908) $(71,568) $(60,336) ========= ========= =========\nOperations for the year ended 1994 1993 1992 December 31,\nRevenue $ 58,326 $ 83,710 $ 64,776 --------- --------- -------- Cost of operations - Depreciation $ 7,245 $ 8,660 $ 9,469 Other 71,211 92,963 86,354 --------- --------- --------- $ 78,456 $101,623 $ 95,823 --------- --------- --------- Pretax income (loss) $(20,130) $(17,913) $(31,047) ========= ========= =========\nCompany's share of joint ventures Revenue $ 27,059 $ 43,590 $ 27,118 --------- --------- --------- Cost of operations - Depreciation $ 3,323 $ 4,033 $ 4,581 Other 26,682 40,716 36,105 --------- --------- --------- $ 30,005 $ 44,749 $ 40,686 --------- --------- --------- Pretax income (loss) $ (2,946) $ (1,159) $(13,568) ========= ========= =========\nEquity ** $(33,091) $(27,768) $(23,542) ========= ========= =========\n* Included in \"Other liabilities\" are advances from joint venture partners in the amount of $207.4 million in 1992, $236.8 million in 1993, and $259.3 million in 1994. Of the total advances from joint venture partners, $150.6 million in 1992, $165.9 million in 1993, and $181.9 million in 1994 represented advances from the Company.\n** When the Company's equity in a real estate joint venture is combined with advances by the Company to that joint venture, each joint venture has a positive investment balance at December 31, 1994.\n[3] NOTES PAYABLE TO BANKS\nDuring 1994 and 1993, the Company maintained unsecured short-term lines of credit totaling $18 million. In support of these credit lines, the Company paid fees approximating 1\/4 of 1% of the amount of the lines. All but $5 million of such lines were canceled as of December 12, 1994 upon the effective date of the expanded credit agreement referred to in Note 4 below. Information relative to the Company's short-term debt activity under such lines in 1994 and 1993 follows (in thousands):\n1994 1993 Borrowings during the year: Average $10,992 $ 8,451 Maximum $18,000 $18,000 At year-end $ - $ -\nWeighted average interest rates: During the year 7.4% 6.2% At year-end - -\n[4] LONG-TERM DEBT\nLong-term debt of the Company at December 31, 1994 and 1993 consists of the following (in thousands):\n1994 1993\nReal Estate Development:\nIndustrial revenue bonds, at 65% of prime, $ 1,310 $ 1,683 payable in semi-annual installments Mortgages on real estate, at rates ranging from prime plus 1 1\/2% to 10.82%, payable in 6,588 16,027 installments ------- ------- Total $ 7,898 $17,710 Less - current maturities 1,396 6,328 ------- ------- Net real estate development long-term debt $ 6,502 $11,382 ======= =======\nOther:\nRevolving credit loans at an average rate of $62,000 $60,000 8.6% in 1994 and 5.8% in 1993 ESOT Notes at 8.24%, payable in semi-annual 5,396 6,238 installments (Note 7) Industrial revenue bonds at various rates, 4,000 4,000 payable in installments to 2005\nTotal $74,110 $72,273 Less - current maturities 3,626 1,289 ------- ------- Net other long-term debt $70,484 $70,984 ======= =======\nPayments required under these obligations amount to approximately $5,022 in 1995, $1,945 in 1996, $63,999 in 1997, $4,841 in 1998, $2,201 in 1999 and $4,000 for the years 2000 and beyond.\nEffective December 12, 1994, the Company entered into a new revolving credit agreement with a group of major banks which provides for, among other things, the Company to borrow up to an aggregate of $125 million (aggregate limit under previous agreements was $85 million), with a $25 million maximum of such amount also being available for letters of credit. The Company may choose from three interest rate alternatives including a prime-based rate, as well as other interest rate options based on LIBOR (London inter-bank offered rate) or participating bank certificate of deposit rates. Borrowings and repayments may be made at any time through December 6, 1997, at which time all outstanding loans under the agreement must be paid or otherwise refinanced. The Company must pay a commitment fee of 1\/2 of 1% annually on the unused portion of the commitment.\nThe aggregate $125 million commitment is subject to permanent partial reductions based on certain events, as defined, such as proceeds from real estate sales over a defined annual minimum, certain claims and future equity offerings.\nThe revolving credit agreement, as well as certain other loan agreements, provides for, among other things, maintaining specified working capital and tangible net worth levels and, additionally, imposes limitations on indebtedness and future investment in real estate development projects.\n[5] INCOME TAXES\nThe Company accounts for income taxes in accordance with SFAS No. 109. This standard determines deferred income taxes based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities, given the provisions of enacted tax laws.\nThe (provision) credit for income taxes is comprised of the following (in thousands):\nFederal Foreign State Total Current $ - $ - $ (21) $ (21) Deferred (108) - (51) (159) -------- -------- -------- -------- $ (108) $ - $ (72) $ (180) ======== ======== ======== ========\nCurrent $(2,824) $ - $ (430) $(3,254) Deferred (1,808) - 101 (1,707) -------- -------- -------- -------- $(4,632) $ - $ (329) $(4,961) ======== ======== ======== ========\nCurrent $ - $(5,486) $ (325) $(5,811)\nDeferred 13,236 814 1,131 15,181 ------- -------- ------- -------- $13,236 $(4,672) $ 806 $ 9,370 ======= ======== ======= ========\nThe domestic and foreign components of income (loss) before income taxes are as follows (in thousands):\nU.S. Foreign Total\n1994 $ 483 $ - $ 483\n1993 $ 8,126 $ - $ 8,126\n1992 $(42,238) $15,884 $(26,354)\nThe table below reconciles the difference between the statutory federal income tax rate and the effective rate provided in the statements of operations.\n1994 1993 1992\nStatutory federal income 34% 34% (34)% tax rate State income taxes, net of 4 2 (1) federal tax benefit Sale of Canadian - 24 - subsidiary Goodwill and other (1) 1 (1) ---- ----- ---- 37% 61% (36)% ==== ===== =====\nThe following is a summary of the significant components of the Company's deferred tax assets and liabilities as of December 31, 1994 and 1993 (in thousands):\n1994 1993\nDeferred Deferred Deferred Deferred Tax Tax Tax Tax Assets Liabilities Assets Liabilities\nProvision for estimated $ 6,203 $ - $ 9,684 $ - losses Contract losses 887 - 2,841 - Joint ventures - - 8,088 - 6,996 construction Joint ventures - real - 25,668 - 18,078 estate Timing of expense 13,867 - 5,012 - recognition Capitalized carrying - 1,776 - 2,301 charges Net operating loss 5,960 - 916 - carryforwards Alternative minimum tax 2,300 - 3,567 - credit carryforwards General business tax 3,637 - 4,038 - credit carryforwards\nForeign tax credit 978 - 1,352 - carryforwards Other, net 685 - 422 - -------- -------- -------- -------- $34,517 $35,532 $27,832 $27,375 Valuation allowance for (1,846) - (2,251) - deferred tax assets -------- -------- -------- -------- Total $32,671 $35,532 $25,581 $27,375 ======== ======== ======== =========\nThe net of the above is deferred taxes in the amount of $2,861 in 1994 and $1,794 in 1993 which is classified in the respecitve Consolidated Balance Sheets as follows:\n1994 1993 Long-term deferred tax liabilities (included in $8,927 $9,496 \"Deferred Income Taxes and Other Liabilities\") Short-term Deferred Tax Asset 6,066 7,702 ------ ------ $2,861 $1,794 ====== ======\nThe valuation allowance for deferred tax assets is principally attributable to the net operating loss carryforwards of Perland Environmental Technologies, Inc. and foreign tax credit carryforwards resulting from the 1993 sale of the Company's Canadian subsidiary. Any portion of the valuation allowance attributable to these deferred tax assets for which benefits are subsequently recognized will be applied to reduce income tax expense.\nAt December 31, 1994, the Company has unused tax credits and net operating loss carryforwards for income tax reporting purposes which expire as follows (in thousands):\nUnused Investment Foreign Net Operating Loss Tax Credits Tax Credits Carryforwards\n1995-1998 $ 20 $ 978 $ - 1999-2004 3,617 - 823 2005-2009 - - 16,705 ------ ------- ------- $3,637 $ 978 $17,528 ====== ======= =======\nApproximately $2.7 million of the net operating loss carryforwards can only be used against the taxable income of the corporation in which the loss was recorded for tax and financial reporting purposes.\n[6] OTHER INCOME (EXPENSE), NET\nOther income (expense) items for the three years ended December 31, 1994 are as follows (in thousands):\n1994 1993 1992\nInterest and dividend income $ 205 $ 624 $ 1,783 Minority interest (Note 1) 24 167 (3,039)\nGain on sale of Majestic (Note 1) - 4,631 - Gain on sale of investment in Monenco - - 1,976 Bank fees (1,100) (584) (571) Miscellaneous income (expense), net 15 369 287 -------- ------- -------- $ (856) $5,207 $ 436 ======== ====== ======== [7] CAPITALIZATION\nIn July 1989, the Company sold 262,774 shares of its $1 par value common stock, previously held in treasury, to its Employee Stock Ownership Trust (\"ESOT\") for $9,000,000. The ESOT borrowed the funds via a placement of 8.24% Senior Unsecured Notes (\"Notes\") guaranteed by the Company. The Notes are payable in 20 equal semi-annual installments of principal and interest commencing in January 1990. The Company's annual contribution to the ESOT, plus any dividends accumulated on the Company's common stock held by the ESOT, will be used to repay the Notes. Since the Notes are guaranteed by the Company, they are included in \"Long-Term Debt\" with an offsetting reduction in \"Stockholders' Equity\" in the accompanying Consolidated Balance Sheets. The amount included in \"Long-Term Debt\" will be reduced and \"Stockholders' Equity\" reinstated as the Notes are paid by the ESOT.\nIn June 1987, net proceeds of approximately $23,631,000 were received from the sale of 1,000,000 depositary convertible exchangeable preferred shares (each depositary share representing ownership of 1\/10 of a share of $21.25 convertible exchangeable preferred stock, $1 par value) at a price of $25 per depositary share. Annual dividends are $2.125 per depositary share and are cumulative. Generally, the liquidation preference value is $25 per depositary share plus any accumulated and unpaid dividends. The preferred stock of the Company, as evidenced by ownership of depositary shares, is convertible at the option of the holder, at any time, into common stock of the Company at a conversion price of $37.75 per share of common stock. The preferred stock is redeemable at the option of the Company at any time after June 15, 1990, in whole or in part, at declining premiums until June 1997 and thereafter at $25 per share plus any unpaid dividends. The preferred stock is also exchangeable at the option of the Company, in whole but not in part, on any dividend payment date into 8 1\/2% convertible subordinated debentures due in 2012 at a rate equivalent to $25 principal amount of debentures for each depositary share.\n[8] SERIES A JUNIOR PARTICIPATING PREFERRED STOCK\nUnder the terms of the Company's Shareholder Rights Plan, as amended, the Board of Directors of the Company declared a distribution on September 23, 1988 of one preferred stock purchase right (a \"Right\") for each outstanding share of common stock. Under certain circumstances, each Right will entitle the holder thereof to purchase from the Company one one-hundredth of a share (a \"Unit\") of Series A Junior Participating Cumulative Preferred Stock, $1 par value (the \"Preferred Stock\"), at an exercise price of $100 per Unit, subject to adjustment. The Rights will not be exercisable or transferable apart from the common stock until the occurrence of certain events viewed to be an attempt by a person or group to gain control of the Company (a \"triggering event\"). The Rights will not have any voting rights or be entitled to dividends.\nUpon the occurrence of a triggering event, each Right will be entitled to that number of Units of Preferred Stock of the Company having a market value of two times the exercise price of the Right. If the Company is acquired in a merger or 50% or more of its assets or earning power is sold, each Right will be entitled to receive common stock of the acquiring company having a market value of two times the exercise price of the Right. Rights held by such a person or group causing a triggering event\nmay be null and void.\nThe Rights are redeemable at $.02 per Right by the Board of Directors at any time prior to the occurrence of a triggering event and will expire on September 23, 1998.\n[9] STOCK OPTIONS\nAt December 31, 1994 and 1993, 481,610 shares of the Company's authorized but unissued common stock were reserved for issuance to employees under its 1982 Stock Option Plan. Options are granted at fair market value on the date of grant and generally become exercisable in two equal annual installments on the second and third anniversary of the date of grant and expire eight years from the date of grant. The options for the 240,000 shares common stock granted in 1992 become exercisable on March 31, 2001 if the Company achieves a certain profit target in the year 2000; may become exercisable earlier if certain interim profit targets are achieved; and to the extent not exercised, expire 10 years from the date of grant. A summary of stock option activity related to the Company's stock option plan is as follows:\nNumber of Number of Option Price Shares Shares Per Share Exercisable\nOutstanding at 438,825 $11.06-$33.06 91,075 December 31, 1992 Granted - - Canceled (4,400) $11.06-$33.06 Outstanding at 434,425 $11.06-$33.06 143,000 December 31, 1993 Granted 20,000 $13.00 Canceled (32,900) $11.06-$33.06 Outstanding at 421,525 $11.06-$33.06 251,525 December 31, 1994\nWhen options are exercised, the proceeds are credited to stockholders' equity. In addition, the income tax savings attributable to nonqualified options exercised is credited to paid-in surplus.\n[10] EMPLOYEE BENEFIT PLANS\nThe Company and its U.S. subsidiaries have a defined benefit plan which covers its executive, professional, administrative and clerical employees, subject to certain specified service requirements. The plan is noncontributory and benefits are based on an employee's years of service and \"final average earnings\", as defined. The plan provides reduced benefits for early retirement and takes into account offsets for social security benefits. All employees are vested after 5 years of service. Net pension cost for 1994, 1993 and 1992 follows (in thousands):\n1994 1993 1992\nService cost - benefits earned during $1,178 $1,000 $ 896 the period Interest cost on projected benefit 2,936 2,862 2,314 obligation Return on plan assets: Actual 1,229 (4,002) (1,220) Deferred (3,839) 1,309 (1,043) Other - 19 19 ------- ------- -------\nNet pension cost $1,504 $1,188 $ 966 ======= ======= =======\nActuarial assumptions used: Discount rate 8 3\/4%* 7 1\/2%* 8 1\/2% Rate of increase in compensation 5 1\/2% 5 1\/2%* 6 1\/2% Long-term rate of return on assets 8% 8%* 9%\n*Rate was changed effective December 31, 1994 and resulted in a net decrease of $5.6 million in the projected benefit obligation referred to below.\n**Rates were changed effective December 31, 1993 and resulted in a net increase of $3.1 million in the projected benefit obligation referred to below.\nThe Company's plan has assets in excess of accumulated benefit obligation. Plan assets generally include equity and fixed income funds. The status of the Company's employee pension benefit plan is summarized below (in thousands):\nDecember 31, 1994 1993 Assets available for benefits: Funded plan assets at fair value $31,762 $32,795 Accrued pension expense 3,610 3,780 -------- -------- Total assets $35,372 $36,575 -------- --------\nActuarial present value of benefit obligations: Accumulated benefit obligations, $30,537 $32,463 including vested benefits of $30,179 and $31,837 Effect of future salary increases 4,546 6,468 -------- -------- Projected benefit obligations $35,083 $38,931 -------- --------\nAssets available more (less) than $ 289 $(2,356) projected benefits ======= ========\nConsisting of: Unamortized net liability existing at $ (36) $ (41) date of adopting SFAS No. 87 Unrecognized net loss (268) (2,260) Unrecognized prior service cost 593 (55) -------- -------- $ 289 $(2,356) ======== ========\nThe Company's policy is generally to fund currently the costs accrued under the pension plan and the Section 401(k) plan described below.\nThe Company also has noncontributory Section 401(k) and employee stock ownership plans (ESOP) which cover its executive, professional, administrative and clerical employees, subject to certain specified service requirements. Under the terms of the Section 401(k) plan, the\nprovision is based on a specified percentage of profits, subject to certain limitations. Contributions to the related employee stock ownership trust (ESOT) are determined by the Board of Directors and may be paid in cash or shares of Company common stock.\nThe Company also has an unfunded supplemental retirement plan for certain employees whose benefits under principal salaried retirement plans are reduced because of compensation limitations under federal tax laws. Pension expense for this plan was $.2 million in 1994 and $.1 million per year in 1993 and 1992. At December 31, 1994, the projected benefit obligation was $1.0 million. A corresponding accumulated benefit obligation of $.6 million has been recognized as a liability in the consolidated balance sheet and is equal to the amount of the vested benefits.\nIn addition, the Company has an incentive compensation plan for key employees which is generally based on achieving certain levels of profit within their respective business units.\nThe aggregate amounts provided under these employee benefit plans were $9.2 million in 1994, $8.5 million in 1993, and $10.8 million in 1992.\nThe Company also contributes to various multiemployer union retirement plans under collective bargaining agreements, which provide retirement benefits for substantially all of its union employees. The aggregate amounts provided in accordance with the requirements of these plans were $12.4 million in 1994, $5.2 million in 1993, and $11.2 million in 1992. The Multiemployer Pension Plan Amendments Act of 1980 defines certain employer obligations under multiemployer plans. Information regarding union retirement plans is not available from plan administrators to enable the Company to determine its share of unfunded vested liabilities.\n[11] Contingencies and Commitments\nIn connection with the Rincon Center real estate development joint venture, the Company's wholly-owned real estate subsidiary has guaranteed the payment of interest on both mortgage and bond financing covering a project with loans totaling $61 million; has issued a secured letter of credit to collateralize $3.7 million of these borrowings; has guaranteed amortization payments up to $9.1 million on these borrowings; and has guaranteed a master lease under a sale operating lease-back transaction. In calculating the potential obligation under the master lease guarantee, the Company has an agreement with its lenders which employs a 10% discount rate and no increases in future rental rates beyond current lease terms. Based on these assumptions, management believes its additional future obligation will not exceed $3.0 million. The Company has also guaranteed $5.0 million of the subsidiary's $9.1 million amortization guaranty and any obligation under the master lease during the next four years. As part of the sale operating lease-back transaction, the joint venture, in which the Company's real estate subsidiary is a 46% general partner, agreed to obtain a financial commitment on behalf of the lessor to replace at least $43 million of long-term financing by July 1, 1993. To satisfy this obligation, the partnership successfully extended existing financing to July 1, 1998. To complete the extension, the partnership had to advance funds to the lessor sufficient to reduce the financing from $46.5 million to $40.5 million. Subsequent payments through 1994 have further reduced the loan to $39.3 million. In addition, as part of the obligations of the extension, the partnership will have to further amortize the debt from its current level to $33 million through additional lease payments over the next four years. If by January 1, 1998, the joint venture has not received a further extension or new commitment for financing on the property for at least $33 million, the lessor will have the right under the lease to require the joint venture to purchase the property for approximately $18.8 million in excess of the then outstanding debt.\nIn 1993, the joint venture also extended $29 million of the $61 million financing then outstanding through October 1, 1998. This extension required a $.6 million up front paydown. Subsequent payments through 1994 further reduced the loan by $1.0 million. The joint venture is required to amortize up to $11.3 million more of the principal. Under certain conditions, that amortization could be as low as $8.5 million. Total lease payments and loan amortization obligations at Rincon Center through 1997 are as follows: $6.9 million in 1995, $7.5 million in 1996, and $7.3 million in 1997. It is expected that some but not all of these requirements will be generated by the project's operations. The Company's real estate subsidiary and, to a more limited extent, the Company, is obligated to fund any of the loan amortization and\/or lease payments at Rincon in the event sufficient funds are not generated by the property or contributed to by its partners. Based on current Company forecasts, it is expected the maximum exposure to service these commitments in each of the years through 1997 is as follows: $2.0 million in 1995, $2.4 million in 1996, and as much as $6.0 million in 1997 based on possible tenanting expenses during that year.\nIn a separate agreement related to this same property, the 20% co-general partner has indicated it does not currently have nor does it expect to have the financial resources to fund its share of capital calls. Therefore, the Company's wholly-owned real estate subsidiary agreed to lend this 20% co-general partner on an as-needed basis, its share of any capital calls which the partner cannot meet. In return, the Company's subsidiary receives a priority return from the partnership on those funds it advances for its partner and penalty fees in the form of rights to certain other distributions due the borrowing partner from the partnership. The severity of the penalty fees increases in each succeeding year for the next several years. The subsidiary advanced $.3 million in 1994 and $1.7 million in 1993 under this agreement.\nIn connection with a second real estate development joint venture known as the Resort at Squaw Creek, the Company's wholly-owned real estate subsidiary has guaranteed the payment of interest on mortgage financing with a total bank loan value currently estimated at $48 million; has guaranteed $10 million of loan principal; has posted a letter of credit for $1.0 million as its part of credit support required to extend the maturity of the $48 million loan to May 1995, which letter of credit is guaranteed by both the Company and its subsidiary; and has guaranteed leases which aggregate $1.5 million on a present value basis as discounted at 10%. The $48 million of bank financing on the project matures on May 1, 1995. Preliminary discussions have taken place with the Resort's lead bank and management anticipates extension or replacement of the loan. However, as with any real estate financing, there is no assurance that any extension or replacement financing will be available. In the event that were to happen, the property would be subject to foreclosure and possibly sale at a value below the Company's present investment basis. It is also possible an extension or new financing could require the joint venture to make additional amortization payments either on extension or over the life of such an extension, which could create additional financial requirements for the Company's wholly-owned real estate subsidiary.\nThe subsidiary also has an obligation through the year 2001 to cover approximately a $2 million per year preferred return at the Resort if the funds are not generated from hotel operations. Although results have shown improvement since the Resort opened in late 1990, it is not expected that hotel operations will contribute to the obligation during 1995. Although the results of the hotel's operations can be somewhat weather dependent, management believes that operations should contribute increasing amounts toward the coverage of the preferred return over the next two to three years and will, at some point during that period, fully cover it.\nIncluded in the loan agreements related to the above joint ventures, among other things, are provisions that, under certain circumstances, could limit the subsidiary's ability to transfer funds to the Company. In the opinion of management, these provisions should not affect the operations of the Company or the subsidiary.\nOn July 30, 1993, the U.S. District Court (D.C.), in a preliminary opinion, upheld terminations for default on two adjacent contracts for subway construction between Mergentime-Perini, under two joint ventures, and the Washington Metropolitan Area Transit Authority (\"WMATA\") and found the Mergentime Corporation, Perini Corporation and the Insurance Company of North America, the surety, jointly and severally liable to WMATA for damages in the amount of $16.5 million, consisting primarily of excess reprocurement costs to complete the projects. Many issues were left partially or completely unresolved by the opinion, including substantial joint venture claims against WMATA. Any such amounts awarded to the joint ventures could serve to offset the above damages awarded. The ultimate financial impact, if any, of this judgement is not yet determinable, and therefore, no impact is reflected in either the 1993 or 1994 financial statements.\nContingent liabilities also include liability of contractors for performance and completion of both company and joint venture construction contracts. In addition, the Company is a defendant in various lawsuits (some of which are for significant amounts). In the opinion of management, the resolution of these matters will not have a material effect on the accompanying financial statements.\n[12] UNAUDITED QUARTERLY FINANCIAL DATA\nThe following table sets forth unaudited quarterly financial data for the years ended December 31, 1994 and 1993 (in thousands, except per share amounts):\n1994 by Quarter\n1st 2nd 3rd 4th\nRevenues $174,391 $243,105 $304,776 $289,773\nNet income (loss) $ 792 $ (2,649) $ 984 $ 1,176\nEarnings (loss) per $ .06 $ (.73) $ .10 $ .15 common share\n1993 by Quarter\n1st 2nd 3rd 4th\nRevenues $258,043 $348,004 $274,795 $219,274\nNet income $ 745 $ 965 $ 679 $ 776\nEarnings per common share $ .05 $ .10 $ .04 $ .05\n[13] BUSINESS SEGMENTS AND FOREIGN OPERATIONS\nThe Company is currently engaged in the construction and real estate development businesses. The following tables set forth certain business and geographic segment information relating to the Company's operations for the three years ended December 31, 1994 (in thousands):\nBusiness Segments Revenues 1994 1993 1992\nConstruction $ 950,884 $1,030,341 $1,023,274 Real Estate 61,161 69,775 47,578 ----------- ----------- ----------- $1,012,045 $1,100,116 $1,070,852 =========== ========== ==========\nIncome (Loss) From Operations 1994 1993 1992\nConstruction $ 13,989 $ 15,164 $ 34,387 Real Estate 732 240 (47,206) Corporate (5,909) (6,830) (6,320) ----------- ----------- ----------- $ 8,812 $ 8,574 $ (19,139) =========== =========== ===========\nAssets 1994 1993 1992\nConstruction $ 262,850 $ 219,604 $ 214,089 Real Estate 209,635 218,715 204,713 Corporate* 10,015 38,059 51,894 ------------ ---------- ----------- $ 482,500 $ 476,378 $ 470,696 ============ =========== ===========\nCapital Expenditures 1994 1993 1992\nConstruction $ 2,491 $ 4,387 $ 4,042 Real Estate 10,274 23,590 29,131 ----------- ----------- ----------- $ 12,765 $ 27,977 $ 33,173 ========== =========== ===========\nDepreciation 1994 1993 1992\nConstruction $ 2,551 $ 2,552 $ 5,489 Real Estate** 328 963 808 ----------- ----------- ----------- $ 2,879 $ 3,515 $ 6,297 =========== =========== ===========\nGeographic Segments Revenues 1994 1993 1992\nUnited States $ 996,832 $1,064,380 $ 909,358 Canada - - 107,709 Other Foreign 15,213 35,736 53,785 ----------- ----------- ----------- $1,012,045 $1,100,116 $1,070,852 =========== =========== ===========\nIncome (Loss) From Operations 1994 1993 1992\nUnited States $ 17,275 $ 17,249 $ (28,994) Canada - - 12,812 Other Foreign (2,554) (1,845) 3,363 Corporate (5,909) (6,830) (6,320) ----------- ----------- ----------- $ 8,812 $ 8,574 $ (19,139) =========== =========== ===========\nAssets 1994 1993 1992\nUnited States $ 467,298 $ 433,488 $ 365,997\nCanada - - 46,089 Other Foreign 5,187 4,831 6,716 Corporate* 10,015 38,059 51,894 ----------- ----------- ----------- $ 482,500 $ 476,378 $ 470,696 =========== =========== ===========\n*In all years, corporate assets consist principally of cash, cash equivalents, marketable securities and other investments available for general corporate purposes.\n**Does not include approximately $3 to 4 million of depreciation that represents its share from real estate joint ventures. (See Note 2 to Notes to the Consolidated Financial Statements.)\nContracts with various federal, state, local and foreign governmental agencies represented approximately 56% of construction revenues in 1994, 54% in 1993 and 57% in 1992.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Perini Corporation:\nWe have audited the accompanying consolidated balance sheets of PERINI CORPORATION (a Massachusetts 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Perini 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.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts February 10, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo the Stockholders of Perini Corporation:\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 February 10, 1995. Our audits were made for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The supplemental schedules listed in the accompanying index are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state, in all material respects, the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts February 10, 1995\nSCHEDULE II PERINI CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS OF DOLLARS)\nAdditions Balance at Charged Charged to Deductions Balance Beginning to Costs Other from at End Description of Year & Expenses Accounts Reserves of Year\nYear Ended December 31, 1994 Reserve for $ 351 $ - $ - $ - $ 351 doubtful accounts ======= ======= ==== ====== =======\nReserve for $ 3,637 $ 328 $ - $ 267 (2) $ 3,698 depreciation on ======= ======= ==== ====== ======= real estate properties used in operations\nReserve for real $20,838 $ - $ - $9,367 (2) $11,471 estate ======= ======== ===== ====== ======= investments\nYear Ended December 31, 1993 Reserve for $ 351 $ - $ - $ - $ 351 doubtful accounts ======= ======= ===== ======= =======\nReserve for depreciation on real estate $ 3,181 $ 920 $ - $ 464 (2) $ 3,637 properties used ======= ======= ==== ====== ======= in operations\nReserve for real estate $29,968 $ - $ - $9,130 (2) $20,838 investments ======= ======= ===== ====== =======\nYear Ended December 31, 1992 Reserve for $ 742 $ - $ - $ 391 (1) $ 351 doubtful accounts ======= ======= ==== ====== =======\nReserve for depreciation on real estate $ 2,428 $ 974 $ - $ 221 (2) $ 3,181 properties used ======= ======= ==== ====== ======= in operations\nReserve for real estate $ 4,732 $31,368 $ - $6,132 (2) $29,968 investments ======= ======= ==== ====== ======\n(1) Represents write-off of uncollectible accounts and reversal of reserves no longer required.\n(2) Represents sales of real estate properties.\nEXHIBIT INDEX\nThe following designated exhibits are, as indicated below, either filed herewith or have heretofore been filed with the Securities and Exchange Commission under the Securities Act of 1933 or the Securities Act of 1934 and are referred to and incorporated herein by reference to such filings.\nExhibit 3. Articles of Incorporation and By-laws\n3.1 Restated Articles of Organization - As amended through July 7,\nFiled herewith\nIncorporated herein by reference:\n3.2 3.2By-laws - As amended through September 14, 1990 - Exhibit 3.2 to 1991 Form 10K, as filed.\nExhibit 4. Instruments Defining the Rights of Security Holders, Including Indentures\nIncorporated herein by reference:\n4.1 Certificate of Vote of Directors Establishing a Series of a Class of Stock determining the relative rights and preferences of the $21.25 Convertible Exchangeable Preferred Stock - Exhibit 4(a) to Amendment No. 1 to Form S-2 Registration Statement filed June 19, 1987; SEC Registration No. 33-14434.\n4.2 Form of Deposit Agreement, including form of Depositary Receipt - Exhibit 4(b) to Amendment No. 1 to Form S-2 Registration Statement filed June 19, 1987; SEC Registration No. 33-14434.\n4.3 Form of Indenture with respect to the 8 1\/2% Convertible Subordinated Debentures Due June 15, 2012, including form of Debenture - Exhibit 4(c) to Amendment No. 1 to Form S-2 Registration Statement filed June 19, 1987; SEC Registration No. 33-14434.\n4.4 Shareholder Rights Agreement and Certificate of Vote of Directors adopting a Shareholders Rights Plan providing for the issuance of a Series A Junior Participating Cumulative Preferred Stock purchase rights as a dividend to all shareholders of record on October 6, 1988, incorporated by reference from Current Report on Form 8-K filed on May 25, 1990.\nExhibit 10. Material Contracts\nIncorporated herein by reference:\n10.1 1982 Stock Option and Long Term Performance Incentive Plan - Registrant's Proxy Statement for Annual Meeting of Stockholders dated April 27, 1987.\n10.2 Perini Corporation Amended and Restated General Incentive Compensation Plan - Exhibit 10.2 to 1991 Form 10K, as filed.\n10.3 Perini Corporation Amended and Restated Construction Business Unit Incentive Compensation Plan - Exhibit 10.3 to 1991 Form 10K, as filed.\nEXHIBIT INDEX (Continued)\n10.4 $125 million Credit Agreement dated as of December 6, 1994 among Perini Corporation, the Banks listed herein, Morgan Guaranty Trust Company of New York, as Agent, and Shawmut Bank, N.A., Co-Agent.\nFiled herewith\nExhibit 22. Subsidiaries of Perini Corporation\nFiled herewith\nExhibit 23. Consent of Independent Public Accountants\nFiled herewith\nExhibit 24. Power of Attorney\nFiled herewith\nExhibit 27. Financial Data Schedule\nFiled Herewith\nEXHIBIT 3.1\nPERINI CORPORATION\nRESTATED ARTICLES OF ORGANIZATION (As Amended Through July 7, 1994)\n1. The name by which the corporation shall be known is:\nPERINI CORPORATION\n2. The purpose for which the corporation is formed are as follows:\nTo carry on a general contracting and construction business; to carry\non a general mining business; to carry on a general business with respect to oil, gas and other natural resources; to carry on a general real estate development and operations business; to carry on a general business of promoting, conducting or producing any one or more lawful athletic or amusement activities and exhibitions; to carry on a general business of manufacturing or otherwise producing, acquiring, preparing for market, buying and selling, dealing in and with and disposing of any and all kinds of construction, sporting and amusement equipment, materials and supplies and any and all products and by-products thereof, any and all ingredients, supplies and items in any stage of production, used or useful in combination with, in substitution for or otherwise in connection with or of which any one or more such products, by-products, ingredients, supplies or items form, or are suitable to form, a component part and all related machinery, appliances, apparatus and tools; to acquire, hold, use and dispose of property of whatever kind and wherever situated, and rights and interests therein, including going enterprises and the acquisition of interests in and obligations of other concerns (wherever and however organized) or of individuals, and while the owner thereof to exercise all the rights, powers and privileges of ownership in the same manner and to the same extent that an individual might; to discover, invent or acquire rights and interests in inventions, designs, patents, patent rights and licenses, trademarks, trade names, copyrights and trade secrets in any field, whether or not cognate to any other activity of the corporation and to hold, use, sell, license the use of or otherwise utilize, deal in or dispose of the same; to lend money, credit or security to, to guarantee or assume obligations of and to aid in any other manner other concerns (whatever and however organized) or individuals, any obligation of which or any interest in which is held by this corporation or in the affairs or prosperity of which this corporation has a lawful interest, and to do all acts and things designed to protect, improve or enhance the value of any such obligation or interest; to join with others in any enterprise conducive to the success of the corporation, in such manner and on such terms and conditions as may be agreed upon; and in general, whether as principal or as agent or contractor for others and in any manner, to do every act and thing and to carry on any and all businesses and activities in any way connected with any of the foregoing which may lawfully be done or carried on by business corporations wherever such one or more businesses or activities may be so done and to exercise all the powers conferred by the laws of The Commonwealth of Massachusetts upon business corporations, provided, however, that the corporation is not organized for any purpose which prevents the provisions of Chapter 156 B of the General Laws of said Commonwealth and acts in amendment thereof and in addition thereto, from being applicable to it.\n3. The total number of shares and the par value, if any, of each class of stock which the corporation is authorized to issue is as follows:\nWithout Par Value With Par Value\nNumber of Number of Class of Stock Shares Shares Par Value\nCommon None 15,000,000 $ 1.00 Preferred None 1,000,000 1.00\nSeries of Preferred Stock\n$ 21.25 Convertible Exchangeable Preferred Stock None 100,000 1.00\n$ Series A Junior Participating Cummulative None 200,000 1.00 Preferred Stock\nTwo classes of stock are authorized, Common Stock having a par value of $1.00 per share and Preferred Stock having a par value of $1.00 per share. Stock of any class or series authorized pursuant hereto may be issued from time to time by authority of the Board of Directors for such consideration as from time to time may be fixed by vote of the Board of Directors.\nI. The Preferred Stock may consist of one or more series. The Board of Directors may, from time to time, establish and designate the different series and the variations in the relative rights and preferences as between the different series as provided in Section II hereof, but in all other respects all shares of the Preferred Stock shall be identical. In the event that at any time the Board of Directors shall have established and designated one or more series of Preferred Stock consisting of a number of shares less than all of the authorized number of shares of Preferred Stock, the remaining authorized shares of Preferred Stock shall be deemed to be shares of an undesignated series of Preferred Stock until designated by the Board of Directors as being a part of a series previously established or a new series than being established by the Board of Directors.\nII. Subject to the provisions of this Description of Classes of Stock, the Board of Directors is authorized to establish one or more series of Preferred Stock and, to the extent now or hereafter permitted by the laws of the Commonwealth of Massachusetts to fix and determine the preferences, voting powers, qualifications and special or relative rights or privileges of each series including, but not limited to:\n(a) the number of shares to constitute such series and the distinctive designation thereof;\n(b) the dividend rate on the shares of such series and the preferences, if any, and the special and relative rights of such shares of such series as to dividend;\n(c) whether or not the shares of such series shall be redeemable, and, if redeemable, the price, terms and manner of redemption;\n(d) the preference, if any, and the special and relative rights of the shares of such series upon liquidation of the corporation;\n(e) whether or not the shares of such series shall be subject to the operation of a sinking or purchase fund and, if so, the terms and provisions of such fund;\n(f) whether or not the shares of such series shall be convertible into shares of any other class or of any other series of the same or any other class of stock of the corporation and, if so, the conversion price or ratio and other conversion rights;\n(g) the conditions under which the shares of such series shall have separate voting rights or no voting rights; and\n(h) such other designations, preferences and relative, participating, optional or other special rights and qualifications, limitations or restrictions of such series to the full extent now and hereafter permitted by the laws of the Commonwealth of Massachusetts.\nNotwithstanding the fixing of the number of shares constituting a particular series, the Board of Directors may at any time authorize the issuance of additional shares of the same series.\nIII. Holders of Preferred Stock shall be entitled to receive, when and as declared by the Board of Directors, but only out of funds legally available for the payment of dividends, cash dividends at the rates fixed by the Board of Directors for the respective series, payable on such dates in each year as the Board of Directors shall fix for the respective series as provided in Section II (hereinafter referred to as \"dividend dates\"). Until all accrued dividends on each series of Preferred Stock shall have been paid through the last preceding dividend date of each such series, no dividend or distribution shall be made to holders of Common Stock other than a dividend payable in Common Stock of the corporation. Dividends on shares on any cumulative series of Preferred Stock shall accumulate form and after the day on which such shares are issued, but arrearages in the payment thereof shall not bear interest. Nothing herein contained shall be deemed to limit the right of the corporation to purchase or otherwise acquire at any time any shares of its capital stock.\nFor purposes of this Description of Class of Stock, the amount of dividends \"accrued\" on any shares on any cumulative series of Preferred Stock as at any dividend date shall be deemed to be the amount of any unpaid dividends accumulated thereon to and including such dividend date, whether or not earned or declared. The amount of dividends \"accrued\" on any noncumulative series of Preferred Stock shall mean only those dividends declared by the Board of Directors, unless otherwise specified for such series by the Board of Directors pursuant to Section II.\nIV. Upon the voluntary or involuntary liquidation of the corporation, before any payment or distribution of the assets of the corporation shall be made to or set apart for any other class of stock, the holders of Preferred Stock shall be entitled to payment of the amount of the preference payable upon such liquidation of the corporation shall be insufficient to pay in full to the holders of the Preferred Stock the preferential amount aforesaid, then such assets, or the proceeds thereof, shall be distributed among the holders of each series of Preferred Stock ratably in accordance with the sums which would be payable on such distribution if all sums payable were discharged in full. The voluntary sale, conveyance, exchange or transfer of all or substantially all of the property and assets of the corporation, the merger or consolidation of the corporation into or with any other corporation, or the merger of any other corporation into it, shall not be deemed to be a liquidating of the corporation for the purpose of this Section IV.\nV. Any shares of Preferred Stock which shall at any time have been redeemed or which shall at any time have been surrendered for conversion or exchange or for cancellation, pursuant to any sinking or purchase fund provisions with respect to any series of Preferred Stock, shall be retired and shall thereafter have the status of authorized and unissued shares of Preferred Stock undesignated as to series.\nVI. The Common Stock shall have exclusive voting power except as required by law and except to the extent the Board of Directors shall, at the time any series of Preferred Stock is established, determine that the shares of such series shall vote (i) together as a single class with shares of Common Stock and\/or with shares of Preferred Stock (or one or more other series thereof) on all or certain matters presented to the stockholders and\/or upon the occurrence of any specified event or condition, and\/or (ii) exclusively on certain matters or, upon the occurrence of any specified event or condition, on all or certain matters. The Board of Directors, in establishing a series of Preferred Stock and fixing the voting rights thereof, may determine that the voting power of each share of such series may be greater or less than the voting power of each share of the Common Stock or of other series of Preferred Stock notwithstanding that the shares of such series of preferred Stock may vote as a single class with the shares of other series of Preferred Stock and\/or with the shares of Common Stock.\n4. If more than one class is authorized, a description of each of the different classes of stock with, if any, the preferences, voting powers, qualifications, special or relative rights or privileges as to each class thereof and any series now established:\nSee Article 3 above.\n5. The restrictions, if any, imposed by the articles of organization upon the transfer of shares of stock of any class are as follows:\nNone.\n6. Other lawful provisions for the conduct and regulation of the business and affairs of the corporation, of its voluntary dissolution, or for limiting, defining, or regulating the powers of the corporation, or of its directors or stockholders, or of any class of stockholders are as follows:\n6.1. The directors may make, amend or repeal the bylaws in whole or in part, except with respect to any provision thereof which by law or the by-laws requires action by the stockholders.\n6.2. Meetings of the stockholders may be held anywhere in the United States.\n6.3. Except as specifically authorized by statute, no stockholder shall have any right to examine any property or any books, accounts or other writings of the corporation if there is reasonable ground for belief that such examination will for any reason be adverse to the interest of the corporation, and a vote of the board of directors refusing permission to make such examination and setting forth that in the opinion of the board of directors such examination would be adverse to the interests of the corporation shall be prima facie evidence that such examination would be adverse to the interests of the corporation. Every such examination shall be subject to such reasonable regulations as the board of directors may establish in regard thereto.\n6.4. The board of directors may specify the manner in which the accounts of the corporation shall be kept and may determine what constitutes net earnings, profits and surplus, what amounts, if any, shall be reserved for any corporation purpose, and what amounts, if any, shall be declared as dividends. Unless the board of directors otherwise specifies, the excess of the consideration for any share of its capital stock with par value issued by it over such par value shall be paid in surplus. All surplus shall be available for any corporate purpose, including the payment of dividends.\n6.5 The corporation may purchase or otherwise acquire, hold, sell or otherwise dispose of shares of its own capital stock, and such purchase or holding shall not be deemed a reduction of its capital stock. The corporation may reduce its capital stock in any manner authorized by law. Such reduction may be effected by the cancellation and retirement of any shares to its capital stock held by it. Upon any reduction of capital or capital stock, no stockholder shall have any right to demand any distribution from the corporation, except as and to the extent that the stockholders shall so have provided at the time of authorizing such reduction.\n6.6. Each director and officer of the corporation shall, in the performance of his duties, be fully protected in relying in good faith upon the books of account of the corporation, reports made to the corporation by any of its officers of employees or by counsel, accountants, appraisers or other experts or consultants selected with reasonable care by the directors, or upon other records of the corporation.\n6.7. The directors shall have the power to fix from time to time their compensation.\n6.8. The corporation may enter into contracts and otherwise transact business as vendor, purchaser or otherwise with its directors, officers and stockholders and with corporations, joint stock companies, trusts, firms and associations in which they are or may be or become interested as directors, officers, shareholders, members, trustees, beneficiaries or otherwise as freely as though such adverse interest did not exist even though the vote, action or presence of such director, officer or stockholder may be necessary to obligate the corporation upon such contract or transactions; and no such contract or transaction shall be avoided and no such director, officer or stockholder shall be held liable to account to the corporation of to any creditor or stockholder of the corporation for any profit or benefit realized by him through any such contract or transaction by reasons of such adverse interest nor by reason of any fiduciary relationship of such director, officer or stockholder to the corporation arising out of such office or stock ownership; provided (in the case of directors and officers but not in the case of any stockholder who is not a director or not in the case of any stockholder who is not a director or officer of the corporation) the nature of the interest of such director of officer, though not necessarily the details or extend thereof, be known by or disclosed to the directors. Ownership or beneficial interest in a minority of the stock or securities of another corporation, joint stock company, trust, firm or association shall not be deemed to constitute an interest adverse to this corporation in such other corporation, joint stock company, trust, firm or association and need not be disclosed. A general notice that a director or officer of the corporation is interested in any corporation, joint stock company, trust, firm or association shall\nbe a sufficient disclosure as to such director or officer with respect to all contracts and transactions with that corporation, joint stock company, trust, firm of association. In any event the authorizing or ratifying vote of a majority of the capital stock of the corporation outstanding and entitled to vote passed at a meeting duly called and held for the purpose shall validate any such contract or transaction as against all stockholders of the corporation, whether of record or not at the time of such vote, and as against all creditors and other claimants, under the corporation, and no contract or transaction shall be avoided by reason of any provision of this paragraph which would be valid but for these provisions.\n6.9. The terms and conditions upon which a sale or exchange of all the property and assets, including the good will of the corporation, or any part thereof, is voted may include the payment thereof in whole or in part on shares, notes, bonds or other certificated of interest or indebtedness of any voluntary association, trust, joint stock company or corporation.\nSuch vote or a subsequent vote may in the event of or in contemplation of proceedings for the dissolution of the corporation also provide, subject to the rights of creditors and preferred stockholders, for the distribution pro rate among the stockholders of the corporation, of the proceed of any such sale or exchange, whether such proceeds be in cash or in securities as aforesaid (at values to be determined by the board of directors).\n6.10. No director of this corporation shall be personally liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director notwithstanding any provision of law imposing such liability; provided, however, that this Article shall not eliminate or limit any liability of a director (i) for any breach 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 of a knowing violation of law, (iii) under Sections 61 or 62 of the Massachusetts Business Corporation Law, or (iv) with respect to any transaction from which the director derived an improper personal benefit.\nNo amendment or repeal of this Article shall adversely affect the rights and protection afforded to a director of this corporation under this Article for acts or omissions occurring while this Article is in effect.\nEXHIBIT 10.4\n[CONFORMED COPY]\n$125,000,000\nCREDIT AGREEMENT\ndated as of\nDecember 6, 1994\namong\nPerini Corporation\nThe Banks Listed Herein\nMorgan Guaranty Trust Company of New York, as Agent\nShawmut Bank, N.A., Co-Agent\nPage ARTICLE I DEFINITIONS\nSECTION 1.01. Definitions. . . . . . . . . . . . . . . . . . . . 1 SECTION 1.02. Accounting Terms and Determinations. . . . . . . 17 SECTION 1.03. Types of Borrowings. . . . . . . . . . . . . . . 17\nARTICLE II THE CREDITS\nSECTION 2.01. The Loans. . . . . . . . . . . . . . . . . . . . 17 SECTION 2.02. Method of Borrowing. . . . . . . . . . . . . . . 18 SECTION 2.03. Notes. . . . . . . . . . . . . . . . . . . . . . 19 SECTION 2.04. Maturity of Loans. . . . . . . . . . . . . . . . 20 SECTION 2.05. Interest Rates. . . . . . . . . . . . . . . . . 21 SECTION 2.06. Commitment Fees. . . . . . . . . . . . . . . . . 24 SECTION 2.07. Participation Fee. . . . . . . . . . . . . . . . 24 SECTION 2.08. Agency Fee. . . . . . . . . . . . . . . . . . . . 25 SECTION 2.09. Optional Termination or Reduction of Commitments. . . . . . . . . . . . . . . . . . . . 25 SECTION 2.10. Mandatory Termination or Reduction of Commitments. . . . . . . . . . . . . . . . . . . . 25 SECTION 2.11. Optional Prepayments. . . . . . . . . . . . . . . 27 SECTION 2.12. General Provisions as to Payments. . . . . . . . 27 SECTION 2.13. Funding Losses. . . . . . . . . . . . . . . . . . 27 SECTION 2.14. Computation of Interest and Fees. . . . . . . . . 28 SECTION 2.15. Maximum Interest Rate. . . . . . . . . . . . . . 28 SECTION 2.16. Letters of Credit. . . . . . . . . . . . . . . . 29 SECTION 2.17. Termination of the Security Interest. . . . . . . 34\nARTICLE III CONDITIONS\nSECTION 3.01. Effectiveness. . . . . . . . . . . . . . . . . . 35 SECTION 3.02. Credit Events. . . . . . . . . . . . . . . . . . 37\nARTICLE IV REPRESENTATIONS AND WARRANTIES\nSECTION 4.01. Corporate Existence and Power. . . . . . . . . . 38 SECTION 4.02. Corporate and Governmental Authorization; No Contravention. . . . . . . . . . . . . . . . . . . 38 SECTION 4.03. Binding Effect; Liens of Collateral Documents. . . . . . . . . . . . . . . . . . . . . 38 SECTION 4.04. Financial Information. . . . . . . . . . . . . . 39 SECTION 4.05. Litigation. . . . . . . . . . . . . . . . . . . . 39 SECTION 4.06. Compliance with ERISA. . . . . . . . . . . . . . 40 SECTION 4.07. Environmental Matters. . . . . . . . . . . . . . 40 SECTION 4.08. Taxes. . . . . . . . . . . . . . . . . . . . . . 42 SECTION 4.09. Subsidiaries. . . . . . . . . . . . . . . . . . . 42 SECTION 4.10. Not an Investment Company. . . . . . . . . . . . 42 SECTION 4.11. No Burdensome Restrictions. . . . . . . . . . . . 42 SECTION 4.12. Full Disclosure. . . . . . . . . . . . . . . . . 42 SECTION 4.13. Ownership of Property; Liens. . . . . . . . . . . 43\nARTICLE V COVENANTS\nSECTION 5.01. Information. . . . . . . . . . . . . . . . . . . 43 SECTION 5.02. Payment of Obligations. . . . . . . . . . . . . . 46 SECTION 5.03. Maintenance of Property; Insurance. . . . . . . . 46 SECTION 5.04. Conduct of Business and Maintenance of Existence. 47 SECTION 5.05. Compliance with Laws. . . . . . . . . . . . . . . 47 SECTION 5.06. Inspection of Property, Books and Records. . . . 47 SECTION 5.07. Current Ratio. . . . . . . . . . . . . . . . . . 47 SECTION 5.08. Debt. . . . . . . . . . . . . . . . . . . . . . . 47 SECTION 5.09. Minimum Consolidated Tangible Net Worth. . . . . 48 SECTION 5.10. Interest Coverage. . . . . . . . . . . . . . . . 48 SECTION 5.11. Negative Pledge. . . . . . . . . . . . . . . . . 48 SECTION 5.12. Consolidations, Mergers and Sales of Assets. . . 49 SECTION 5.13. Use of Proceeds. . . . . . . . . . . . . . . . . 50 SECTION 5.14. Restricted Payments. . . . . . . . . . . . . . . 50 SECTION 5.15. Real Estate Investments. . . . . . . . . . . . . 51 SECTION 5.16. Other Investments. . . . . . . . . . . . . . . . 51 SECTION 5.17. Further Assurances. . . . . . . . . . . . . . . . 51\nARTICLE VI DEFAULTS\nSECTION 6.01. Events of Default. . . . . . . . . . . . . . . . 52 SECTION 6.02. Cash Cover. . . . . . . . . . . . . . . . . . . . 55\nARTICLE VII THE AGENT\nSECTION 7.01. Appointment and Authorization. . . . . . . . . . 56 SECTION 7.02. Agent and Affiliates. . . . . . . . . . . . . . . 56 SECTION 7.03. Action by Agent. . . . . . . . . . . . . . . . . 56 SECTION 7.04. Consultation with Experts. . . . . . . . . . . . 56 SECTION 7.05. Liability of Agent. . . . . . . . . . . . . . . . 56 SECTION 7.06. Indemnification. . . . . . . . . . . . . . . . . 57 SECTION 7.07. Credit Decision. . . . . . . . . . . . . . . . . 57 SECTION 7.08. Successor Agent. . . . . . . . . . . . . . . . . 57\nSECTION 7.09. Collateral Documents. . . . . . . . . . . . . . . 58\nARTICLE VIII CHANGE IN CIRCUMSTANCES\nSECTION 8.01. Basis for Determining Interest Rate Inadequate or Unfair. . . . . . . . . . . . . . . . 58 SECTION 8.02. Illegality. . . . . . . . . . . . . . . . . . . . 59 SECTION 8.03. Increased Cost and Reduced Return. . . . . . . . 59 SECTION 8.04. Base Rate Loans Substituted for Affected Fixed Rate Loans. . . . . . . . . . . . . . . . . . . . . 61\nARTICLE IX MISCELLANEOUS\nSECTION 9.01. Notices. . . . . . . . . . . . . . . . . . . . . 62 SECTION 9.02. No Waivers. . . . . . . . . . . . . . . . . . . . 62 SECTION 9.03. Expenses; Documentary Taxes; Indemnification. 63 SECTION 9.04. Sharing of Setoffs. . . . . . . . . . . . . . . . 64 SECTION 9.05. Amendments and Waivers. . . . . . . . . . . . . . 64 SECTION 9.06. Successors and Assigns. . . . . . . . . . . . . . 65 SECTION 9.07. Collateral. . . . . . . . . . . . . . . . . . . . 66 SECTION 9.08. Governing Law; Submission to Jurisdiction. . . . 66 SECTION 9.09. Counterparts; Integration. . . . . . . . . . . . 67 SECTION 9.10. WAIVER OF JURY TRIAL. . . . . . . . . . . . . . . 67\nCREDIT AGREEMENT\nAGREEMENT dated as of December 6, 1994 among PERINI CORPORATION, the BANKS listed on the signature pages hereof and MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Agent.\nARTICLE I\nDEFINITIONS\nSECTION 1.01. Definitions. The following terms, as used herein, have the following meanings:\n\"Adjusted CD Rate\" has the meaning set forth in Section 2.05(b).\n\"Adjusted London Interbank Offered Rate\" has the meaning set forth in Section 2.05(c).\n\"Administrative Questionnaire\" means, with respect to each Bank, the administrative questionnaire in the form submitted to such Bank by the Agent and submitted to the Agent (with a copy to the Borrower) duly completed by such Bank.\n\"Agent\" means Morgan Guaranty Trust Company of New York in its capacity as agent for the Banks under the Financing Documents, and its successors in such capacity.\n\"Applicable Lending Office\" means, with respect to any Bank, (i) in the case of its Domestic Loans, its Domestic Lending Office and (ii) in the case of its Euro-Dollar Loans, its Euro-Dollar Lending Office.\n\"Assessment Rate\" has the meaning set forth in Section 2.05(b).\n\"Assignee\" has the meaning set forth in Section 9.06(c).\n\"Available LC Amount\" means at any time an amount equal to the lesser of (x) $25,000,000 or (y) the excess, if any, of (i) the aggregate amount of the Tranche A Commitments over (ii) the aggregate outstanding principal amount of the Tranche A Loans.\n\"Bank\" means each bank listed on the signature pages hereof, each Assignee which becomes a Bank pursuant to Section 9.06(c), and their respective successors.\n\"Base Rate\" means, for any day, a rate per annum equal to the higher of (i) the Prime Rate for such day and (ii) the sum of 1\/2 of 1% plus the Federal Funds Rate for such day.\n\"Base Rate Loan\" means a Tranche A Loan to be made by a Bank as a Base Rate Loan pursuant to the Applicable Notice of Borrowing or Article VIII.\n\"Benefit Arrangement\" means at any time an employee benefit plan within the meaning of Section 3(3) of ERISA which is not a Plan or a Multiemployer Plan and which is maintained or otherwise contributed to by any member of the ERISA Group.\n\"Borrower\" means Perini Corporation, a Massachusetts corporation, and its successors.\n\"Borrower's 1993 Form 10-K\" means the Borrower's amended annual report on Form 10-KA for 1993, as filed with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934.\n\"Borrower Pledge Agreement\" means the Borrower Pledge Agreement in substantially the form of Exhibit E between the Borrower and the Agent as executed and delivered pursuant to Section 3.01(c) and as the same may be amended from time to time as permitted herein and in accordance with the terms thereof.\n\"Borrower Security Agreement\" means the Borrower Security Agreement in substantially the form of Exhibit D between the Borrower and the Agent, as executed and delivered pursuant to Section 3.01(c) and as the same may be amended from time to time as permitted herein and in accordance with the terms thereof.\n\"Borrowing\" has the meaning set forth in Section 1.03.\n\"CD Base Rate\" has the meaning set forth in Section 2.05(b).\n\"CD Loan\" means a Tranche A Loan to be made by a Bank as a CD Loan pursuant to the applicable Notice of Borrowing.\n\"CD Margin\" has the meaning set forth in Section 2.05(b).\n\"CD Reference Banks\" means Shawmut Bank, N.A., Fleet Bank of Massachusetts, N.A. and Morgan Guaranty Trust Company of New York.\n\"CERCLA\" means the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended from time to time, and any rules or regulations promulgated thereunder.\n\"Class\" refers to a determination whether a Loan is a Tranche A Loan or a Tranche B Loan (or whether a Borrowing is to be comprised of, or a Commitment relates to the making of, Tranche A Loans or Tranche B Loans).\n\"Collateral\" means all property, real and personal, tangible and intangible, with respect to which Liens are created or are purported to be created pursuant to the Collateral Documents.\n\"Collateral Documents\" means the Borrower Security Agreement, the Borrower Pledge Agreement, the Subsidiary Security Agreement, the Deeds of Trust and all other supplemental or additional security agreements, pledge agreements, mortgages or similar instruments delivered pursuant hereto or thereto.\n\"Commitment\" means a Tranche A Commitment or a Tranche B Commitment and \"Commitments\" means all or any combination of the foregoing, as the context may require.\n\"Consolidated Capital Base\" means, at any date, the Consolidated Tangible Net Worth of the Borrower at such date plus 75% of the principal amount of any Special Subordinated Debt outstanding at such date.\n\"Consolidated Current Assets\" means at any date the consolidated current assets of the Borrower and its Consolidated Subsidiaries excluding costs related to Claims, all determined as of such date. For purposes of this definition, \"Claims\" mean the amount (to the extent reflected in determining such consolidated current assets) of disputed or unapproved change orders in regards to scope and\/or price that, in Perini project management's opinion (and approved by Perini senior management), will not be resolved in the normal course of business (i.e. through the change order process and without resort to litigation or arbitration) and which have not been previously reflected in the consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as of September 30, 1994.\n\"Consolidated Current Liabilities\" means at any date the consolidated current liabilities of the Borrower and its Consolidated Subsidiaries, determined as of such date.\n\"Consolidated Earnings Before Interest and Taxes\" means for any period Consolidated Net Income for such period (x) less (i) the Borrower's equity share of income (or plus the Borrower's equity share of loss) of unconsolidated joint ventures for such period and (ii) capitalized real estate taxes for such period, to the extent not permitted to be capitalized in accordance with generally accepted accounting principles as in effect on the date hereof, and (y) plus (i) cash distributions of earnings from unconsolidated joint ventures for such period and (ii) the aggregate amount deducted in determining such Consolidated Net Income in respect of Consolidated Interest Charges and income taxes.\n\"Consolidated Interest Charges\" means for any period the aggregate interest expense of the Borrower and its Consolidated Subsidiaries for such period including, without limitation, (i) the portion of any obligation under capital leases allocable to interest expense in accordance with generally accepted accounting principles, (ii) the portion of any debt discount that shall be amortized in such period and (iii) any interest accrued during such period which is capitalized in accordance with generally accepted accounting principles, and without any reduction on account of interest income.\n\"Consolidated Net Income\" means for any period the consolidated net income (or loss) of the Borrower and its Consolidated Subsidiaries for such period.\n\"Consolidated Subsidiary\" of any Person means at any date any Subsidiary of such Person or other entity the accounts of which would be consolidated with those of such Person in its consolidated financial statements if such statements were prepared as of such date.\n\"Consolidated Tangible Net Worth\" of any Person means at any date the consolidated stockholders' equity of such Person and its Consolidated Subsidiaries less their consolidated Intangible Assets, all determined as of such date. For purposes of this definition \"Intangible Assets\" means the amount (to the extent reflected in determining such consolidated stockholders' equity) of (i) all write-ups (other than write-ups resulting from foreign currency translations and write-ups of assets of a going concern business made within twelve months after the acquisition of such business) subsequent to September 30, 1994 in the book value of any asset owned by the Borrower or a Consolidated Subsidiary and (ii) all unamortized debt discount and expense, capitalized real estate taxes (to the extent not permitted to be capitalized in accordance with generally accepted accounting principles as in effect on the date hereof), goodwill, patents, trademarks, service marks, trade names, copyrights, organization or developmental (other than real estate developmental) expenses and other intangible items.\n\"Construction Claim\" means a construction claim listed in Schedule IV.\n\"Credit Event\" means the making of a Loan or the issuance of a Letter of Credit or the extension of an Evergreen Letter of Credit.\n\"Debt\" of any Person means at any date, without duplication, (i) all obligations of such Person for borrowed money, (ii) all obligations of such Person evidenced by bonds, debentures, notes or other similar instruments, (iii) all obligations of such Person to pay the deferred purchase price of property or services, except trade accounts payable arising in the ordinary course of business, (iv) all obligations of such\nPerson as lessee which are capitalized in accordance with generally accepted accounting principles, (v) all Debt secured by a Lien on any asset of such Person, whether or not such Debt is otherwise an obligation of such Person, and (vi) all Debt of others Guaranteed by such Person; provided that advances to the Borrower or a Subsidiary by a joint venture out of the Borrower's or such Subsidiary's share of the undistributed earnings of such joint venture shall not constitute Debt.\n\"Deeds of Trust\" means the Deed of Trust, Assignment of Leases and Rents, Security Agreement and Financing Statement dated as of December 6, 1994 for each of the Mortgaged Facilities, each substantially in the form of Exhibits H-1 and H-2 hereto.\n\"Default\" means any condition or event which constitutes an Event of Default or which with the giving of notice or lapse of time or both would, unless cured or waived, become an Event of Default.\n\"Domestic Business Day\" means any day except a Saturday, Sunday or other day on which commercial banks in New York City or Massachusetts are authorized by law to close.\n\"Domestic Lending Office\" means, as to each Bank, its office located at its address set forth in its Administrative Questionnaire (or identified in its Administrative Questionnaire as its Domestic Lending Office) or such other office as such Bank may hereafter designate as its Domestic Lending Office by notice to the Borrower and the Agent; provided that any Bank may so designate separate Domestic Lending Offices for its Tranche A Base Rate Loans and Tranche B Loans, on the one hand, and its CD Loans, on the other hand, in which case all references herein to the Domestic Lending Office of such Bank shall be deemed to refer to either or both of such offices, as the context may require.\n\"Domestic Loans\" means CD Loans, Tranche A Base Rate Loans or Tranche B Loans.\n\"Domestic Reserve Percentage\" has the meaning set forth in Section 2.05(b).\n\"Effective Date\" means the date this Agreement becomes effective in accordance with Section 3.01.\n\"Environmental Laws\" means any and all federal state, local and foreign statutes, laws, judicial decisions, regulations, ordinances, rules, judgments, orders, decrees, plans, injunctions, permits, concessions, grants, franchises, licenses, agreements and other governmental restrictions relating to the environment, the effect of the environment on human health or to emissions, discharges or releases of pollutants, contaminants, Hazardous Substances or wastes into the environment including, without limitation, ambient air, surface water, ground water, or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, Hazardous Substances or wastes or the clean-up or other remediation thereof.\n\"Environmental Liabilities\" means any and all liabilities of or relating to the Borrower or any of its Subsidiaries (including any liabilities derived from an entity which is, in whole or in part, a predecessor of the Borrower or any of its Subsidiaries), whether vested or unvested, contingent or fixed, actual or potential, known or unknown, which arise under or relate to matters covered by Environmental Laws.\n\"ERISA\" means the Employee Retirement Income Security Act of 1974, as amended, or any successor statute.\n\"ERISA Group\" means the Borrower, any Subsidiary and all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which, together with the Borrower or any Subsidiary, are treated as a single employer under Section 414 of the Internal Revenue Code.\n\"Euro-Dollar Business Day\" means any Domestic Business Day on which commercial banks are open for international business (including dealings in dollar deposits) in London.\n\"Euro-Dollar Lending Office\" means, as to each Bank, its office, branch or affiliate located at its address set forth in its Administrative Questionnaire (or identified in its Administrative Questionnaire as its Euro-Dollar Lending Office) or such other office, branch or affiliate of such Bank as it may hereafter designate as its Euro-Dollar Lending Office by notice to the Borrower and the Agent.\n\"Euro-Dollar Loan\" means a Tranche A Loan to be made by a Bank as a Euro-Dollar Loan pursuant to the applicable Notice of Borrowing.\n\"Euro-Dollar Margin\" has the meaning set forth in Section 2.05(c).\n\"Euro-Dollar Reference Banks\" means the principal London offices of Bank of America National Trust and Savings Association and Morgan Guaranty Trust Company of New York.\n\"Euro-Dollar Reserve Percentage\" has the meaning set forth in Section 2.05(c).\n\"Event of Default\" has the meaning set forth in Section 6.01.\n\"Evergreen Letter of Credit\" has the meaning set forth in Section 2.16(b).\n\"Exempt Group\" means (i) any employee benefit plan of the Borrower or any Subsidiary, (ii) any entity or Person holding shares of common stock of Borrower organized, appointed or established by the Borrower or any Subsidiary for or pursuant to the terms of any such plan or (iii) The Perini Memorial Foundation, Inc., The Joseph Perini Memorial Foundation, or any of the various trusts established under the wills of Lewis R. Perini, Senior, Joseph R. Perini, Senior or Charles B. Perini, Senior.\n\"Existing Credit Agreements\" means the Primary Credit Agreement and the Credit Agreement dated as of March 9, 1994 among the Borrower, the banks listed therein and Morgan Guaranty Trust Company of New York, as agent for such banks, as amended to the Effective Date.\n\"Federal Funds Rate\" means, for any day, the rate per annum (rounded upward, if necessary, to the nearest 1\/100th of 1%) equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers on such day, as published by the Federal Reserve Bank of New York on the Domestic Business Day next succeeding such day, provided that (i) if such day is not a Domestic Business Day, the Federal Funds Rate for such day shall be such rate on such transactions on the next preceding Domestic Business Day as so published on the next succeeding Domestic Business Day, and (ii) if no such rate is so published on such next succeeding Domestic Business Day, the Federal Funds Rate for such day shall be the average rate quoted to Morgan Guaranty Trust Company of New York on such day on such transactions as determined by the Agent.\n\"Financial Letter of Credit\" means any Letter of Credit which constitutes a financial standby letter of credit within the meaning of Appendix A to Regulation H of the Board of Governors of the Federal Reserve System or other applicable capital adequacy guidelines promulgated by bank regulatory authorities (including without limitation workmen's compensation letters of credit).\n\"Financing Documents\" means this Agreement, the Subsidiary Guarantee Agreement, the Notes and the Collateral Documents.\n\"Fixed Rate Borrowing\" means a CD Borrowing or a Euro-Dollar Borrowing.\n\"Fixed Rate Loans\" means CD Loans or Euro-Dollar Loans or both.\n\"Guarantee\" by any Person means any obligation, contingent or otherwise, of such Person directly or indirectly guaranteeing any Debt of any other Person and, without limiting the generality of the foregoing, any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Debt (whether arising by virtue of partnership arrangements, by agreement to keep-well, to purchase assets, goods, securities or services, to take-or-pay, or to maintain financial statement conditions or otherwise) or (ii) entered into for the purpose of assuring in any other manner the holder of such Debt of the payment thereof or to protect such holder against loss in respect thereof (in whole or in part), provided that the term Guarantee shall not include endorsements for collection or deposit or bid and performance bonds and guarantees in the ordinary course of business. The term \"Guarantee\" used as a verb has a corresponding meaning.\n\"Hazardous Substances\" means any toxic, radioactive, caustic or otherwise hazardous substance, including petroleum, its derivatives, by-products and other hydrocarbons, or any substance having any constituent elements displaying any of the foregoing characteristics.\n\"Indemnitee\" has the meaning set forth in Section 9.03(b).\n\"Interest Period\" means: (1) with respect to each Euro-Dollar Borrowing, the period commencing on the date of such Borrowing and ending one, two, three or six months thereafter, as the Borrower may elect in the applicable Notice of Borrowing; provided that: (a) any Interest Period which would otherwise end on a day which is not a Euro-Dollar Business Day shall be extended to the next succeeding Euro-Dollar Business Day unless such Euro-Dollar Business Day falls in another calendar month, in which case such Interest Period shall end on the next preceding Euro-Dollar Business Day;\n(b) any Interest Period which begins on the last Euro-Dollar Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall, subject to clause (c) below, end on the last Euro-Dollar Business Day of a calendar month; and\n(c) any Interest Period which would otherwise end after the Termination Date shall end on the Termination Date;\n(2) with respect to each CD Borrowing, the period commencing on the date of such Borrowing and ending 30, 60 or 90 days thereafter, as the Borrower may elect in the applicable Notice of Borrowing; provided that:\n(a) any Interest Period (other than an Interest Period determined pursuant to clause (b) below) which would otherwise end on\na day which is not a Euro-Dollar Business Day shall be extended to the next succeeding Euro-Dollar Business Day; and\n(b) any Interest Period which would otherwise end after the Termination Date shall end on the Termination Date; and\n(3) with respect to each Tranche A Base Rate Borrowing or Tranche B Borrowing, the period commencing on the date of such Borrowing and ending 30 days thereafter; provided that:\n(a) any Interest Period (other than an Interest Period determined pursuant to clause (b) below) which would otherwise end on a day which is not a Euro-Dollar Business Day shall be extended to the next succeeding Euro-Dollar Business Day; and\n(b) any Interest Period which would otherwise end after the Termination Date shall end on the Termination Date.\n\"Internal Revenue Code\" means the Internal Revenue Code of 1986, as amended, or any successor statute.\n\"Investment\" means any investment in any Person, whether by means of share purchase, capital contribution, loan, Guarantee, time deposit or otherwise.\n\"LC Bank\" means BayBank Boston, N.A. or such other Bank as the Borrower may designate from time to time (with the consent of such other Bank).\n\"LC Exposure\" means, at any time and for any Bank, an amount equal to such Bank's Percentage of the aggregate amount of Letter of Credit Liabilities in respect of all Letters of Credit at such time.\n\"Letter of Credit\" has the meaning set forth in Section 2.16(a).\n\"Letter of Credit Liabilities\" means, at any time and in respect of any Letter of Credit, the sum, without duplication, of (i) the amount available for drawing under such Letter of Credit plus (ii) the aggregate unpaid amount of all Reimbursement Obligations in respect of previous drawings made under such Letter of Credit.\n\"Lien\" means, with respect to any asset, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind, or any other type of preferential arrangement that has the practical effect of creating a security interest, in respect of such asset. For the purposes of this Agreement, the Borrower or any Subsidiary shall be deemed to own subject to a Lien any asset which it has acquired or holds subject to the interest of a vendor or lessor under any conditional sale agreement, capital lease or other title retention agreement relating to such asset.\n\"Loan\" means a Domestic Loan or a Euro-Dollar Loan and \"Loans\" means Domestic Loans or Euro-Dollar Loans or both.\n\"Loan Commitment\" means for any Bank at any time an amount equal to the excess, if any, of such Bank's Commitment at such time over such Bank's LC Exposure at such time.\n\"London Interbank Offered Rate\" has the meaning set forth in Section 2.05(c).\n\"Material Plan\" means at any time a Plan or Plans having aggregate Unfunded Liabilities in excess of $10,000,000.\n\"Material Subsidiary\" means at any time a Subsidiary which as of such time meets the definition of a \"significant subsidiary\" contained as of the date hereof in Regulation S-X of the Securities and Exchange Commission.\n\"Modified Parent Company Debt\" means at any date the Debt of the Borrower (other than Debt payable to any Wholly-Owned Consolidated Subsidiary) determined on an unconsolidated basis as of such date, less 75% of the principal amount of any Special Subordinated Debt outstanding on such date.\n\"Mortgaged Facilities\" means the properties described on Schedule III.\n\"Multiemployer Plan\" means at any time an employee pension benefit plan within the meaning of Section 4001(a)(3) of ERISA to which any member of the ERISA Group is then making or accruing an obligation to make contributions or has within the preceding five plan years made contributions, including for these purposes any Person which ceased to be a member of the ERISA Group during such five year period.\n\"Notes\" means promissory notes of the Borrower, substantially in the form of Exhibit A hereto, evidencing the obligation of the Borrower to repay the Loans, and \"Note\" means any one of such promissory notes issued hereunder.\n\"Notice of Borrowing\" has the meaning set forth in Section 2.02.\n\"Notice Time\" has the meaning set forth in Section 2.16(b).\n\"Obligor\" means each of the Borrower and the Subsidiary Guarantors, and \"Obligors\" means all of the foregoing.\n\"Paramount Development Associates\" means Paramount Development Associates, a Massachusetts corporation.\n\"Parent\" means, with respect to any Bank, any Person controlling such Bank.\n\"Participant\" has the meaning set forth in Section 9.06(b).\n\"PBGC\" means the Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions under ERISA.\n\"Percentage\" means, with respect to each Bank, the percentage that such Bank's Tranche A Commitment constitutes of the aggregate amount of the Tranche A Commitments.\n\"Performance Letter of Credit\" means a Letter of Credit which constitutes a performance standby letter of credit within the meaning of Appendix A to Regulation H of the Board of Governors of the Federal Reserve system or other applicable capital adequacy guidelines promulgated by bank regulatory authorities.\n\"Perini Building Company\" means Perini Building Company, Inc., an Arizona corporation.\n\"Perini International\" means Perini International Corporation, a Massachusetts corporation.\n\"Perini Land and Development\" means Perini Land and Development Company, a Delaware corporation.\n\"Permitted Encumbrances\" means, with respect to any real property owned or leased by the Borrower or any of its Subsidiaries:\n(a) Liens for taxes, assessments or other governmental charges not yet due or which are being contested in good faith and by appropriate proceedings if adequate reserves with respect thereto are maintained on the books of the Borrower or such Subsidiary, as the case may be, in accordance with generally accepted accounting principles;\n(b) carriers', warehousemen's, mechanics', materialmens', repairmens' or other like Liens arising by operation of law in the ordinary course of business so long as (A) the underlying obligations are not overdue for a period of more than 60 days or (B) such Liens are being contested in good faith and by appropriate proceedings and adequate reserves with respect thereto are maintained on the books of the Borrower or such Subsidiary, as the case may be, in accordance with generally accepted accounting principles; and\n(c) other Liens or title defects (including matters which an accurate survey might disclose) which (x) do not secure Debt; (y) do not materially detract from the value of such real property or materially impair the use thereof by the Borrower or such Subsidiary in the operation of its business; and (z) are set forth in the title reports referred to in Section 3.01(h) hereof.\n\"Permitted Liens\" means the Liens permitted to exist under Section 5.11.\n\"Person\" means an individual, a corporation, a partnership, an association, a trust or any other entity or organization, including a government or political subdivision or an agency or instrumentality thereof.\n\"Plan\" means at any time an employee pension benefit plan (other than a Multiemployer Plan) which is covered by Title IV of ERISA or subject to the minimum funding standards under Section 412 of the Internal Revenue Code and either (i) is maintained, or contributed to, by any member of the ERISA Group for employees of any member of the ERISA Group or (ii) has at any time within the preceding five years been maintained, or contributed to, by any Person which was at such time a member of the ERISA Group for employees of any Person which was at such time a member of the ERISA Group.\n\"Pledged Instrument\" has the meaning set forth in Section 1 of the Borrower Pledge Agreement.\n\"Primary Credit Agreement\" means the Credit Agreement dated as of May 10, 1993 among the Borrower, the banks listed therein and Morgan Guaranty Trust Company of New York, as agent for such banks, as amended to the Effective Date.\n\"Prime Rate\" means the rate of interest publicly announced by Morgan Guaranty Trust Company of New York in New York City from time to time as its Prime Rate.\n\"Real Estate Investment\" means (i) the acquisition, construction or improvement of any real property, other than real property used by the Borrower or a Consolidated Subsidiary in the conduct of its construction business or (ii) any Investment in any Person (including Perini Land and Development or another Consolidated Subsidiary, but without duplication of any Real Estate Investment made by such Person with the proceeds of such Investment) engaged in real estate investment or development or whose\nprincipal assets consist of real property; provided that the Debt contemplated by Section 5.08(b)(ii) shall not constitute Real Estate Investments.\n\"R. E. Dailey & Co.\" means R. E. Dailey & Co., a Michigan corporation.\n\"Reference Banks\" means the CD Reference Banks or the Euro-Dollar Reference Banks, as the context may require, and \"Reference Bank\" means any one of such Reference Banks.\n\"Refunding Borrowing\" means a Borrowing which, after application of the proceeds thereof, results in no net increase in the outstanding principal amount of Loans made by any Bank.\n\"Regulated Activity\" means any generation, treatment, storage, recycling, transportation or Release of any Hazardous Substance.\n\"Regulation U\" means Regulation U of the Board of Governors of the Federal Reserve System, as in effect from time to time.\n\"Reimbursement Obligations\" means at any date the obligations of the Borrower then outstanding under Section 2.16 to reimburse any Bank for the amount paid by such Bank in respect of a drawing under a Letter of Credit.\n\"Release\" means any discharge, emission or release, including a Release as defined in CERCLA at 42 U.S.C. Section 9601(22). The term \"Released\" has a corresponding meaning.\n\"Required Banks\" means at any time Banks having at least 60% of the aggregate amount of the Commitments or, if the Commitments shall have been terminated, holding Notes evidencing at least 60% of the aggregate unpaid principal amount of the Loans.\n\"Restricted Payment\" means (i) any dividend or other distribution on any shares of the Borrower's capital stock (except dividends payable solely in shares of its capital stock) or (ii) any payment on account of the purchase, redemption, retirement or acquisition of (a) any shares of the Borrower's capital stock or (b) any option, warrant or other right to acquire shares of the Borrower's capital stock; provided that none of the following shall constitute Restricted Payments: (i) the declaration and payment of dividends on preferred stock of the Borrower in an aggregate amount with respect to any four consecutive fiscal quarters not exceeding $5,125,000, (ii) the exchange of Special Subordinated Debt for the Borrower's $21.25 Convertible Exchangeable Preferred Shares, (iii) the redemption, for an aggregate redemption price not exceeding $200,000, of the \"Rights\" issued pursuant to the Shareholder Rights Agreement dated as of September 23, 1988, as amended, between the Borrower and State Street Bank & Trust Company, as Rights Agent or (iv) cash payments in the ordinary course of business in full or partial settlement of employee stock options or similar incentive compensation arrangements.\n\"Special Subordinated Debt\" means the 8 1\/2% Convertible Subordinated Debentures due 2012 of the Borrower issuable in exchange for the Borrower's $21.25 Convertible Exchangeable Preferred Shares in accordance with the terms of the Certificate of Vote of Directors Establishing a Series of a Class of Stock fixing the relative rights and preferences of such Shares as originally filed with the Secretary of the Commonwealth of Massachusetts.\n\"Subsidiary\" of any Person means any corporation or other entity of which securities or other ownership interests having ordinary voting\npower 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\"Subsidiary Guarantor\" means each of Perini Building Company, Perini International, Perini Land and Development, R. E. Dailey & Co., Paramount Development Associates and each other Subsidiary of the Borrower which becomes a party to the Subsidiary Guarantee Agreement pursuant to Section 3.01 thereof, and their respective successors.\n\"Subsidiary Guarantee Agreement\" means the Subsidiary Guarantee Agreement in substantially the form of Exhibit F among the Borrower, the Subsidiary Guarantors party thereto and the Agent, as executed and delivered pursuant to Section 3.01(b) and as the same may be amended from time to time as permitted herein and in accordance with the terms thereof.\n\"Subsidiary Security Agreement\" means the Subsidiary Security Agreement in substantially the form of Exhibit G among the Borrower, the Subsidiary Guarantors party thereto and the Agent, as executed and delivered pursuant to Section 3.01(c) and as the same may be amended from time to time as permitted herein and in accordance with the terms thereof.\n\"Temporary Cash Investment\" means investment of cash balances in United States Government securities or other short-term money market investments.\n\"Termination Date\" means December 6, 1997 (or if such date is not a Euro-Dollar Business Day, the next preceding Euro-Dollar Business Day).\n\"Tranche A Commitment\" means, with respect to each Bank, the amount set forth opposite the name of such Bank on the signature pages hereof as its Tranche A Commitment, as such amount may be reduced from time to time pursuant to Section 2.09 and Section 2.10.\n\"Tranche A Loan\" means a Loan made by a Bank pursuant to Section 2.01(a).\n\"Tranche B Commitment\" means, with respect to each Bank, the amount set forth opposite the name of such Bank on the signature pages hereof as its Tranche B Commitment, as such amount may be reduced from time to time pursuant to Section 2.09 and Section 2.10.\n\"Tranche B Loan\" means a Loan made by a Bank pursuant to Section 2.01(b).\n\"Unfunded Liabilities\" means, with respect to any Plan at any time, the amount (if any) by which (i) the value of all benefit liabilities under such Plan, determined on a plan termination basis using the assumptions prescribed by the PBGC for purposes of Section 4044 of ERISA, exceeds (ii) the fair market value of all Plan assets allocable to such liabilities under Title IV of ERISA (excluding any accrued but unpaid contributions), all determined as of the then most recent valuation date for such Plan, but only to the extent that such excess represents a potential liability of a member of the ERISA Group to the PBGC or any other Person under Title IV of ERISA.\n\"Usage\" means, at any date, the sum of the aggregate outstanding principal amount of the Loans at such date plus the aggregate amount of Letter of Credit Liabilities at such date with respect to all Letters of Credit.\n\"Wholly-Owned Consolidated Subsidiary\" means any Consolidated\nSubsidiary of the Borrower all of the shares of capital stock or other ownership interests of which (except directors' qualifying shares) are at the time directly or indirectly owned by the Borrower.\nSECTION 1.02. Accounting Terms and Determinations. Unless otherwise specified herein, all accounting terms used herein shall be interpreted, all accounting determinations hereunder shall be made, and all financial statements required to be delivered hereunder shall be prepared in accordance with generally accepted accounting principles as in effect from time to time, applied on a basis consistent (except for changes concurred in by the Borrower's independent public accountants) with the most recent audited consolidated financial statements of the Borrower and its Consolidated Subsidiaries delivered to the Banks.\nSECTION 1.03. Types of Borrowings. The term \"Borrowing\" denotes the aggregation of Loans of one or more Banks to be made to the Borrower pursuant to Article II on a single date and for a single Interest Period. Borrowings are classified for purposes of this Agreement by reference to the Class of Loans comprising such Borrowing (e.g., a \"Tranche A Borrowing\" is a Borrowing comprised of Tranche A Loans) or by reference to the pricing of Loans comprising such Borrowing (e.g., a \"Euro-Dollar Borrowing\" is a Borrowing comprised of Euro-Dollar Loans).\nARTICLE II\nTHE CREDITS\nSECTION 2.01. The Loans.\n(a) Tranche A Loans. From time to time prior to the Termination Date, each Bank severally agrees, on the terms and conditions set forth in this Agreement, to lend to the Borrower from time to time amounts not to exceed in the aggregate at any one time outstanding the amount of its Tranche A Loan Commitment. Each Borrowing under this Section shall be in an aggregate principal amount of $1,000,000 or any larger multiple of $500,000 (except that any such Borrowing may be in the aggregate amount of the unused Tranche A Commitments) and shall be made from the several Banks ratably in proportion to their respective Tranche A Commitments. Within the foregoing limits, the Borrower may borrow under this Section, repay, or to the extent permitted by Section 2.10 or Section 2.11, prepay Tranche A Loans and reborrow at any time prior to the Termination Date under this Section.\n(b) Tranche B Loans. From time to time prior to the Termination Date each Bank severally agrees, on the terms and conditions set forth in this Agreement, to lend to the Borrower from time to time amounts not to exceed in the aggregate at any one time outstanding the amount of its Tranche B Commitment. Each Borrowing under this Section shall be in an aggregate principal amount of $1,000,000 or any larger multiple of $500,000 (except that any such Borrowing may be in the aggregate amount of the unused Tranche B Commitments) and shall be made from the several Banks ratably in proportion to their respective Commitments. Within the foregoing limits, the Borrower may borrow under this Section, repay, or to the extent permitted by Section 2.10 or Section 2.11, prepay Tranche B Loans and reborrow at any time prior to the Termination Date under this Section.\nSECTION 2.02. Method of Borrowing. (a) The Borrower shall give the Agent notice (a \"Notice of Borrowing\") not later than 11:30 A.M. (New York City time) on the date of each Base Rate Borrowing or Tranche B Borrowing, at least two Domestic Business Days before each CD Borrowing and at least three Euro-Dollar Business Days before each Euro-Dollar\nBorrowing, specifying:\n(i) the date of such Borrowing, which shall be a Domestic Business Day in the case of a Domestic Borrowing or a Euro-Dollar Business Day in the case of a Euro-Dollar Borrowing,\n(ii) the aggregate amount of such Borrowing,\n(iii) the Class of such Borrowing,\n(iv) in the case of a Tranche A Borrowing, whether the Loans comprising such Borrowing are to be CD Loans, Base Rate Loans or Euro-Dollar Loans, and\n(v) in the case of a Fixed Rate Borrowing, the duration of the Interest Period applicable thereto, subject to the provisions of the definition of Interest Period.\n(b) Upon receipt of a Notice of Borrowing, the Agent shall promptly notify each Bank of the contents thereof and of such Bank's ratable share of such Borrowing and such Notice of Borrowing shall not thereafter be revocable by the Borrower.\n(c) Not later than 1:30 P.M. (New York City time) on the date of each Borrowing, each Bank shall (except as provided in subsection (d) of this Section) make available its ratable share of such Borrowing, in Federal or other funds immediately available in New York City, to the Agent at its address referred to in Section 9.01. Unless the Agent determines that any applicable condition specified in Article III has not been satisfied, the Agent will make the funds so received from the Banks available to the Borrower at the Agent's aforesaid address.\n(d) If any Bank makes a new Loan hereunder on a day on which the Borrower is to repay all or any part of an outstanding Loan from such Bank, such Bank shall apply the proceeds of its new Loan to make such repayment and only an amount equal to the difference (if any) between the amount being borrowed and the amount being repaid shall be made available by such Bank to the Agent as provided in subsection (c) of this Section, or remitted by the Borrower to the Agent as provided in Section 2.12, as the case may be.\n(e) Unless the Agent shall have received notice from a Bank prior to the date of any Borrowing (or, in a case of a Tranche A Base Rate Borrowing or a Tranche B Borrowing, prior to noon (New York City time) on the date of such Borrowing) that such Bank will not make available to the Agent such Bank's share of such Borrowing, the Agent may assume that such Bank has made such share available to the Agent on the date of such Borrowing in accordance with subsections (c) and (d) of this Section 2.02 and the Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If and to the extent that such Bank shall not have so made such share available to the Agent, such Bank and the Borrower severally agree to repay to the Agent forthwith on demand such corresponding amount together with interest thereon, for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Agent, at (i) in the case of the Borrower, a rate per annum equal to the higher of the Federal Funds Rate and the interest rate applicable thereto pursuant to Section 2.05 and (ii) in the case of such Bank, the Federal Funds Rate. If such Bank shall repay to the Agent such corresponding amount, such amount so repaid shall constitute such Bank's Loan included in such Borrowing for purposes of this Agreement.\nSECTION 2.03. Notes. (a) The Loans of each Bank shall be\nevidenced by a single Note payable to the order of such Bank for the account of its Applicable Lending Office.\n(b) Each Bank may, by notice to the Borrower and the Agent, request that its Loans of a particular Class or type be evidenced by a separate Note in an amount equal to the aggregate unpaid principal amount of such Loans. Each such Note shall be in substantially the form of Exhibit A hereto with appropriate modifications to reflect the fact that it evidences solely Loans of the relevant class or type. Each reference in this Agreement to the \"Note\" of such Bank shall be deemed to refer to and include any or all of such Notes, as the context may require.\n(c) Upon receipt of each Bank's Note pursuant to Section 3.01(c), the Agent shall forward such Note to such Bank. Each Bank shall record the date, amount, type and maturity of each Loan made by it and the date and amount of each payment of principal made by the Borrower with respect thereto, and may, if such Bank so elects in connection with any transfer or enforcement of its Note, endorse on the schedule forming a part thereof appropriate notations to evidence the foregoing information with respect to each such Loan then outstanding; provided that the failure of any Bank to make any such recordation or endorsement shall not affect the obligations of the Borrower hereunder or under the Notes. Each Bank is hereby irrevocably authorized by the Borrower so to endorse its Note and to attach to and make a part of its Note a continuation of any such schedule as and when required.\nSECTION 2.04. Maturity of Loans. Each Loan included in any Borrowing shall mature, and the principal amount thereof shall be due and payable, on the last day of the Interest Period applicable to such Borrowing.\nSECTION 2.05. Interest Rates. (a) Each Tranche A Base Rate Loan shall bear interest on the outstanding principal amount thereof, for each day from the date such Loan is made until it becomes due, at a rate per annum equal to the sum of 1% plus the Base Rate for such day. Such interest shall be payable for each Interest Period on the last day thereof. Any overdue principal of or interest on any Tranche A Base Rate Loan shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the rate otherwise applicable to Tranche A Base Rate Loans for such day.\n(b) Each CD Loan shall bear interest on the outstanding principal amount thereof, for the Interest Period applicable thereto, at a rate per annum equal to the sum of the CD Margin plus the applicable Adjusted CD Rate; provided that if any CD Loan or any portion thereof shall, as a result of clause (2)(b) of the definition of Interest Period, have an Interest Period of less than 30 days, such portion shall bear interest during such Interest Period at the rate applicable to Base Rate Loans during such period. Such interest shall be payable for each Interest Period on the last day thereof and, if such Interest Period is longer than 90 days, at intervals of 90 days after the first day thereof. Any overdue principal of or interest on any CD Loan shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the higher of (i) the sum of the CD Margin plus the Adjusted CD Rate applicable to such Loan and (ii) the rate applicable to Base Rate Loans for such day.\n\"CD Margin\" means 2.375%.\nThe \"Adjusted CD Rate\" applicable to any Interest Period means a rate per annum determined pursuant to the following formula:\n[ CDBR ]* ACDR = [ ---------- ] + AR [ 1.00 - DRP ]\nACDR = Adjusted CD Rate CDBR = CD Base Rate DRP = Domestic Reserve Percentage AR = Assessment Rate\n__________ * The amount in brackets being rounded upward, if necessary, to the next higher 1\/100 of 1%\nThe \"CD Base Rate\" applicable to any Interest Period is the rate of interest determined by the Agent to be the average (rounded upward, if necessary, to the next higher 1\/100 of 1%) of the prevailing rates per annum bid at 10:00 A.M. (New York City time) (or as soon thereafter as practicable) on the first day of such Interest Period by two or more New York certificate of deposit dealers of recognized standing for the purchase at face value from each CD Reference Bank of its certificates of deposit in an amount comparable to the principal amount of the CD Loan of such CD Reference Bank to which such Interest Period applies and having a maturity comparable to such Interest Period.\n\"Domestic Reserve Percentage\" means for any day that percentage (expressed as a decimal) which is in effect on such day, as prescribed by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including without limitation any basic, supplemental or emergency reserves) for a member bank of the Federal Reserve System in New York City with deposits exceeding five billion dollars in respect of new non-personal time deposits in dollars in New York City having a maturity comparable to the related Interest Period and in an amount of $100,000 or more. The Adjusted CD Rate shall be adjusted automatically on and as of the effective date of any change in the Domestic Reserve Percentage.\n\"Assessment Rate\" means for any day the annual assessment rate in effect on such date which is payable by a member of the Bank Insurance Fund classified as adequately capitalized and within supervisory subgroup \"A\" (or a comparable successor assessment risk classification) within the meaning of 12 C.F.R. X 327.3(e) (or any successor provision) to the Federal Deposit Insurance Corporation (or any successor) for such Corporation's (or such successor's) insuring time deposits at offices of such institution in the United States. The Adjusted CD Rate shall be adjusted automatically on and as of the effective date of any change in the Assessment Rate.\n(c) Each Euro-Dollar Loan shall bear interest on the outstanding principal amount thereof, for the Interest Period applicable thereto, at a rate per annum equal to the sum of the Euro-Dollar Margin plus the applicable Adjusted London Interbank Offered Rate. Such interest shall be payable for each Interest Period on the last day thereof and, if such Interest Period is longer than three months, at intervals of three months after the first day thereof.\n\"Euro-Dollar Margin\" means 2.25%.\nThe \"Adjusted London Interbank Offered Rate\" applicable to any Interest Period means a rate per annum equal to the quotient obtained (rounded upward, if necessary, to the next higher 1\/100 of 1%) by dividing\n(i) the applicable London Interbank Offered Rate by (ii) 1.00 minus the Euro-Dollar Reserve Percentage.\nThe \"London Interbank Offered Rate\" applicable to any Interest Period means the average (rounded upward, if necessary, to the next higher 1\/16 of 1%) of the respective rates per annum at which deposits in dollars are offered to each of the Euro-Dollar Reference Banks in the London interbank market at approximately 11:00 A.M. (London time) two Euro-Dollar Business Days before the first day of such Interest Period in an amount approximately equal to the principal amount of the Euro-Dollar Loan of such Euro-Dollar Reference Bank to which such Interest Period is to apply and for a period of time comparable to such Interest Period.\n\"Euro-Dollar Reserve Percentage\" means for any day that percentage (expressed as a decimal) which is in effect on such day, as prescribed by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement for a member bank of the Federal Reserve System in New York City with deposits exceeding five billion dollars in respect of \"Eurocurrency liabilities\" (or in respect of any other category of liabilities which includes deposits by reference to which the interest rate on Euro-Dollar Loans is determined or any category of extensions of credit or other assets which includes loans by a non-United States office of any Bank to United States residents). The Adjusted London Interbank Offered Rate shall be adjusted automatically on and as of the effective date of any change in the Euro-Dollar Reserve Percentage.\n(d) Any overdue principal of or interest on any Euro-Dollar Loan shall bear interest, payable on demand, for each day from and including the date payment thereof was due to but excluding the date of actual payment, at a rate per annum equal to the sum of 2% plus the higher of (i) the sum of the Euro-Dollar Margin plus the Adjusted London Interbank Offered Rate applicable to such Loan and (ii) the Euro-Dollar Margin plus the quotient obtained (rounded upward, if necessary, to the next higher 1\/100 of 1%) by dividing (x) the average (rounded upward, if necessary, to the next higher 1\/16 of 1%) of the respective rates per annum at which one day (or, if such amount due remains unpaid more than three Euro-Dollar Business Days, then for such other period of time not longer than three months as the Agent may elect) deposits in dollars in an amount approximately equal to such overdue payment due to each of the Euro-Dollar Reference Banks are offered to such Euro-Dollar Reference Bank in the London interbank market for the applicable period determined as provided above by (y) 1.00 minus the Euro-Dollar Reserve Percentage (or, if the circumstances described in clause (a) or (b) of Section 8.01 shall exist, at a rate per annum equal to the sum of 2% plus the rate applicable to Base Rate Loans for such day).\n(e) Each Tranche B Loan shall bear interest on the outstanding principal amount thereof, for each day from the date such Loan is made until it becomes due, at a rate per annum equal to the sum of 2% plus the Base Rate for such day. Such interest shall be payable for each Interest Period on the last day thereof. Any overdue principal of or interest on any Loan shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the rate otherwise applicable to Tranche B Loans for such day.\n(f) The Agent shall determine each interest rate applicable to the Loans hereunder. The Agent shall give prompt notice to the Borrower and the Banks of each rate of interest so determined, and its determination thereof shall be conclusive in the absence of manifest error.\n(g) Each Reference Bank agrees to use its best efforts to furnish\nquotations to the Agent as contemplated hereby. If any Reference Bank does not furnish a timely quotation, the Agent shall determine the relevant interest rate on the basis of the quotation or quotations furnished by the remaining Reference Bank or Banks or, if none of such quotations is available on a timely basis, the provisions of Section 8.01 shall apply.\nSECTION 2.06. Commitment Fees. The Borrower shall pay to the Agent for the account of each Bank a commitment fee at the rate of 1\/2 of 1% per annum on the daily average unused portion of such Bank's Commitments. Such commitment fees shall accrue from and including the Effective Date to but excluding the Termination Date. Such commitment fees shall be payable on the last day of each fiscal quarter of the Borrower prior to the Termination Date and on the Termination Date.\nSECTION 2.07. Participation Fee. The Borrower shall pay to the Agent for the account of each Bank on the Effective Date (i) in the case of a Bank with Commitments aggregating $25,000,000 or more, a participation fee in an amount equal to .30% of such Bank's Commitments and (ii) in the case of a Bank with Commitments aggregating less than $25,000,000, a participation fee in an amount equal to .175% of such Bank's Commitments.\nSECTION 2.08. Agency Fee. The Borrower shall pay to the Agent as compensation for its services hereunder and under the Collateral Documents agency fees payable in the amounts and at the times heretofore agreed between the Borrower and the Agent. The Borrower shall also pay to the Agent for its own account on the Effective Date an arrangement fee in the amount previously agreed between the Borrower and the Agent.\nSECTION 2.09. Optional Termination or Reduction of Commitments. The Borrower may, upon at least three Domestic Business Days' notice to the Agent, terminate at any time, or proportionately permanently reduce from time to time by an aggregate amount of $5,000,000 or any larger multiple of $1,000,000, the unused portions of the Commitments. If the Commitments are terminated in their entirety, all accrued commitment fees shall be payable on the effective date of such termination.\nSECTION 2.10. Mandatory Termination or Reduction of Commitments. (a) The Commitments shall terminate on the Termination Date, and any Loans then outstanding (together with accrued interest thereon) shall be due and payable on such date.\n(b) The Commitments of all Banks shall be permanently, automatically and ratably reduced:\n(i) immediately upon receipt by the Borrower or any Subsidiary of the proceeds from the collection, sale or other disposition of any real property (other than real property used by the Borrower or a Consolidated Subsidiary in its construction business) owned by the Borrower or a Subsidiary by an amount equal to 50% of such proceeds net of all out-of-pocket costs, all applicable mortgage debt, fees, commissions and other expenses reasonably incurred in respect of such collection, sale or disposition and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof provided that no such reduction shall be required unless and until, and then only to the extent that, the aggregate amount of such net proceeds received by the Borrower and its Subsidiaries during (x) the period from the date hereof through December 31, 1994 or (y) any fiscal year thereafter exceeds $5,000,000;\n(ii) immediately upon receipt by the Borrower or a Subsidiary of\nproceeds from the settlement of any Construction Claim by an amount equal to 50% of such proceeds net of all out-of-pocket expenses reasonably incurred in respect of such collection and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof; provided that in the event that the Construction Claim filed by Tutor-Saliba-Perini JV against the California State Department of Highways for cost overruns associated with the Redwood Bypass in Humboldt and Del Norte Counties, California is settled at a time when the aggregate amount of the Commitments exceeds $110,000,000, 100% of the proceeds of the Borrower's or any Subsidiary's share of such settlement net of all out-of-pocket expenses reasonably incurred in respect of such collection and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof shall be applied to the extent required to permanently, automatically and ratably reduce the aggregate amount of the Commitments to $110,000,000, and 50% of the balance (if any) of such net proceeds shall be so applied; and\n(iii) by $15,000,000 upon the completion of an issuance by the Borrower of convertible preferred stock or other equity issue provided that in the event that the proceeds of such issuance net of all out- of-pocket expenses reasonably incurred in respect of such issuance and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof exceeds $30,000,000, the aggregate amount of the Commitments shall be reduced by an amount not less than the sum of $15,000,000 plus 50% of the excess over $30,000,000 of such proceeds.\n(c) On each day on which any Commitment is reduced pursuant to this Section, the Borrower shall repay such principal amount (together with accrued interest thereon) of each Bank's outstanding Loans of each Class, if any, as may be necessary so that after such repayment, the aggregate unpaid principal amount of such Bank's Loans of each Class, together with (in the case of the Tranche A Loans) such Bank's Percentage of the aggregate amount of Letter of Credit Liabilities, does not exceed the amount of such Bank's Commitment of such Class after giving effect to such reduction; provided that if this subsection (c) would otherwise require prepayment of any Fixed Rate Loan prior to the last day of the applicable Interest Period, such prepayment shall be deferred to such last day unless the Required Banks otherwise direct by notice to the Borrower. In the event that the aggregate amount of the Tranche A Commitments is reduced to an amount less than the aggregate amount of Letter of Credit Liabilities at such time in respect of all Letters of Credit, the Borrower hereby agrees that it shall forthwith, without any demand or taking of any other action by the Required Banks or the Agent, pay to the Agent an amount in immediately available funds equal to the difference to be held as security for the Letter of Credit Liabilities for the benefit of all Banks.\n(d) Any reduction of the Commitments described in clauses (a) and (b) above shall be applied first to reduce the Tranche B Commitments pro rata and if the Tranche B Commitments are reduced to zero, then to reduce the Tranche A Commitments pro rata.\nSECTION 2.11. Optional Prepayments. (a) The Borrower may, upon notice to the Agent not later than 11:30 A.M. (New York City time) on any Domestic Business Day, prepay on such Domestic Business Day any Base Rate Borrowing or any Tranche B Borrowing in whole at any time, or from time to time in part in amounts aggregating $1,000,000 or any larger multiple of $500,000, by paying the principal amount to be prepaid together with accrued interest thereon to the date of prepayment. Each such optional prepayment shall be applied to prepay ratably the Loans of the several Banks included in such Borrowing.\n(b) Except as provided in Sections 2.10(c) and 8.02, the Borrower may not prepay all or any portion of the principal amount of any Fixed Rate Loan prior to the maturity thereof.\n(c) Upon receipt of a notice of prepayment pursuant to this Section, the Agent shall promptly notify each Bank of the contents thereof and of such Bank's ratable share of such prepayment and such notice shall not thereafter be revocable by the Borrower.\nSECTION 2.12. General Provisions as to Payments. (a) The Borrower shall make each payment of principal of, and interest on, the Loans and of fees hereunder, not later than 1:30 P.M. (New York City time) on the date when due, in Federal or other funds immediately available in New York City, to the Agent at its address referred to in Section 9.01. The Agent will promptly distribute to each Bank its ratable share of each such payment received by the Agent for the account of the Banks. Whenever any payment of principal of, or interest on, the Domestic Loans or of fees shall be due on a day which is not a Domestic Business Day, the date for payment thereof shall be extended to the next succeeding Domestic Business Day. Whenever any payment of principal of, or interest on, the Euro- Dollar Loans shall be due on a day which is not a Euro-Dollar Business Day, the date for payment thereof shall be extended to the next succeeding Euro-Dollar Business Day unless such Euro-Dollar Business Day falls in another calendar month, in which case the date for payment thereof shall be the next preceding Euro-Dollar Business Day. If the date for any payment of principal is extended by operation of law or otherwise, interest thereon shall be payable for such extended time.\n(b) Unless the Agent shall have received notice from the Borrower prior to the date on which any payment is due to the Banks hereunder that the Borrower will not make such payment in full, the Agent may assume that the Borrower has made such payment in full to the Agent on such date and the Agent may, in reliance upon such assumption, cause to be distributed to each Bank on such due date an amount equal to the amount then due such Bank. If and to the extent that the Borrower shall not have so made such payment, each Bank shall repay to the Agent forthwith on demand such amount distributed to such Bank together with interest thereon, for each day from the date such amount is distributed to such Bank until the date such Bank repays such amount to the Agent, at the Federal Funds Rate.\nSECTION 2.13. Funding Losses. If the Borrower makes any payment of principal with respect to any Fixed Rate Loan (pursuant to Section 2.10(c), Article VI or VIII or otherwise) on any day other than the last day of the Interest Period applicable thereto, or the last day of an applicable period fixed pursuant to Section 2.05(d), or if the Borrower fails to borrow any Fixed Rate Loans after notice has been given to any Bank in accordance with Section 2.02(b), the Borrower shall reimburse each Bank on demand for any resulting loss or expense incurred by it (or by any existing or prospective Participant in the related Loan), including (without limitation) any loss incurred in obtaining, liquidating or employing deposits from third parties, but excluding loss of margin for the period after any such payment or failure to borrow, provided that such Bank shall have delivered to the Borrower a certificate as to the amount of such loss or expense, which certificate shall be conclusive in the absence of manifest error.\nSECTION 2.14. Computation of Interest and Fees. Interest based on the Prime Rate shall be computed on the basis of a year of 365 days (or 366 days in a leap year) and paid for the actual number of days elapsed (including the first day but excluding the last day). All other interest and commitment fees shall be computed on the basis of a year of 360 days and paid for the actual number of days elapsed (including the first day but excluding the last day).\nSECTION 2.15. Maximum Interest Rate. (a) Nothing contained in this Agreement or the Notes shall require the Borrower to pay interest at a rate exceeding the maximum rate permitted by applicable law. Neither this Section nor Section 9.08 is intended to limit the rate of interest payable for the account of any Bank to the maximum rate permitted by the laws of the State of New York if a higher rate is permitted with respect to such Bank by supervening provisions of U.S. federal law.\n(b) If the amount of interest payable for the account of any Bank on any interest payment date in respect of the immediately preceding interest computation period, computed pursuant to Section 2.05, would exceed the maximum amount permitted by applicable law to be charged by such Bank, the amount of interest payable for its account on such interest payment date shall be automatically reduced to such maximum permissible amount.\n(c) If the amount of interest payable for the account of any Bank in respect of any interest computation period is reduced pursuant to clause (b) of this Section and the amount of interest payable for its account in respect of any subsequent interest computation period, computed pursuant to Section 2.05, would be less than the maximum amount permitted by applicable law to be charged by such Bank, then the amount of interest payable for its account in respect of such subsequent interest computation period shall be automatically increased to such maximum permissible amount; provided that at no time shall the aggregate amount by which interest paid for the account of any Bank has been increased pursuant to this clause (c) exceed the aggregate amount by which interest paid for its account has theretofore been reduced pursuant to clause (b) of this Section.\nSECTION 2.16. Letters of Credit. (a) Subject to the terms and conditions hereof, the LC Bank agrees to issue letters of credit hereunder from time to time before the Termination Date upon the request of the Borrower (such letters of credit issued, the \"Letters of Credit\"); provided that, immediately after each such Letter of Credit is issued, the aggregate amount of the Letter of Credit Liabilities for all Letters of Credit shall not exceed the Available LC Amount. Upon the date of issuance by the LC Bank of a Letter of Credit in accordance with this Section 2.16, the LC Bank shall be deemed, without further action by any party hereto, to have sold to each Bank, and each Bank shall be deemed, without further action by any party hereto, to have purchased from the LC Bank, a participation in such Letter of Credit and the related Letter of Credit Liabilities in proportion to its Percentage.\n(b) The Borrower shall give the LC Bank at least three Domestic Business Days' prior notice (effective upon receipt) specifying the date each Letter of Credit is to be issued, and describing the proposed terms of such Letter of Credit and the nature of the transactions proposed to be supported thereby. Upon receipt of such notice the LC Bank shall promptly notify the Agent, and the Agent shall promptly notify each Bank of the contents thereof and of the amount of such Bank's participation in such proposed Letter of Credit. The issuance by the LC Bank of any Letter of Credit shall, in addition to the conditions precedent set forth in Article III (the satisfaction of which the LC Bank shall have no duty to ascertain), be subject to the conditions precedent that such Letter of Credit shall be satisfactory to the LC Bank and that the Borrower shall have executed and delivered such other instruments and agreements relating to such Letter of Credit as the LC Bank shall have reasonably requested. Each Letter of Credit shall have an expiry date of not later than one year after its date of issue; provided that no Letter of Credit shall have a term extending beyond the Termination Date; and provided further that any such Letter of Credit may include an evergreen or renewal option, pursuant to which the expiry date of such Letter of Credit will be automatically\nextended unless notice of non-renewal is given by the LC Bank (provided that such Letter of Credit has an absolute expiry date not later than the Termination Date and provided further that the LC Bank shall deliver notice of non-renewal at the time such notice is required to be given (for any such Letter of Credit, the \"Notice Time\") unless requested not to by the Borrower, which request will be treated in the same manner as a request for issuance of a new Letter of Credit on the same terms (any such Letter of Credit, an \"Evergreen Letter of Credit\").\n(c) The Borrower shall pay to the Agent a letter of credit fee at a rate equal to (i) 1.00% per annum on the aggregate amount available for drawings under each Performance Letter of Credit issued from time to time and (ii) 2.25% per annum on the aggregate amount available for drawings under each Financial Letter of Credit issued from time to time, any such fee to be payable for the account of the Banks ratably in proportion to their Percentages. Such fee shall be payable in arrears on the last day of each fiscal quarter of the Borrower for so long as such Letter of Credit is outstanding and on the date of termination thereof. The Borrower shall pay to the LC Bank additional fees and expenses in the amounts and at the times as agreed between the Borrower and the LC Bank.\n(d) Upon receipt from the beneficiary of any Letter of Credit of any demand for payment or other drawing under such Letter of Credit, the LC Bank shall notify the Agent and the Agent shall promptly notify the Borrower and each other Bank as to the amount to be paid as a result of such demand or drawing and the respective payment date. The responsibility of the LC Bank to the Borrower and each Bank shall be only to determine that the documents (including each demand for payment or other drawing) delivered under each Letter of Credit issued by it in connection with such presentment shall be in conformity in all material respects with such Letter of Credit. The LC Bank shall endeavor to exercise the same care in the issuance and administration of the Letters of Credit as it does with respect to letters of credit in which no participations are granted, it being understood that in the absence of any gross negligence or willful misconduct by the LC Bank, each Bank severally agrees that it shall be unconditionally and irrevocably liable without regard to the occurrence of any Event of Default or any condition precedent whatsoever, pro rata to the extent of such Bank's Percentage, to reimburse the LC Bank on demand for the amount of each payment made by the LC Bank under each Letter of Credit issued by the LC Bank to the extent such amount is not reimbursed by the Borrower pursuant to clause (e) below together with interest on such amount for each day from the date of the LC Bank's demand for such payment (or, if such demand is made after 11:00 A.M. (New York City time) on such date, from the next succeeding Domestic Business Day) to the date of payment by such Bank of such amount at a rate of interest per annum equal to the Federal Funds Rate for such day.\n(e) The Borrower shall be irrevocably and unconditionally obligated forthwith to reimburse the LC Bank for any amounts paid by the LC Bank upon any drawing under any Letter of Credit, without presentment, demand, protest or other formalities of any kind; provided that neither the Borrower nor any Bank shall hereby be precluded from asserting any claim for direct (but not consequential) damages suffered by the Borrower or such Bank to the extent, but only to the extent, caused by (i) the willful misconduct or gross negligence of the LC Bank in determining whether a request presented under any Letter of Credit complied with the terms of such Letter of Credit or (ii) such Bank's failure to pay under any Letter of Credit after the presentation to it of a request strictly complying with the terms and conditions of the Letter of Credit. All such amounts paid by the LC Bank and remaining unpaid by the Borrower shall bear interest, payable on demand, for each day until paid at a rate per annum equal to the sum of 2% plus the rate applicable to Base Rate Loans for such day. The LC Bank will pay to each Bank ratably in accordance\nwith its Percentage all amounts received from the Borrower for application in payment, in whole or in part, of the Reimbursement Obligation in respect of any Letter of Credit, but only to the extent such Bank has made payment to the LC Bank in respect of such Letter of Credit pursuant to Section 2.16(d).\n(f) If after the date hereof, the adoption of any applicable law, rule or regulation, or any change in any applicable law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency shall impose, modify or deem applicable any tax, reserve, special deposit or similar requirement against or with respect to or measured by reference to Letters of Credit issued or to be issued hereunder or participations therein, and the result shall be to increase the cost to any Bank of issuing or maintaining any Letter of Credit or any participation therein, or reduce any amount receivable by any Bank hereunder in respect of any Letter of Credit (which increase in cost, or reduction in amount receivable, shall be the result of such Bank's reasonable allocation of the aggregate of such increases or reductions resulting from such event), then, upon demand by such Bank (which demand shall not be unreasonably delayed, provided that a demand within six months of the accrual of such increased cost or reduction in amount receivable will not be deemed to be unreasonably delayed), the Borrower agrees to pay to such Bank, from time to time as specified by such Bank, such additional amounts as shall be sufficient to compensate such Bank for such increased costs or reductions in amount incurred by such Bank. A certificate of such Bank submitted by such Bank to the Borrower shall be conclusive as to the amount thereof in the absence of manifest error.\n(g) The Borrower's obligations under this Section 2.16 shall be absolute and unconditional under any and all circumstances and irrespective of any setoff, counterclaim or defense to payment which the Borrower may have or have had against the LC Bank, any Bank or any beneficiary of a Letter of Credit. The Borrower further agrees with the LC Bank and the Banks that the LC Bank and the Banks shall not be responsible for, and the Borrower's Reimbursement Obligation in respect of any Letter of Credit shall not be affected by, among other things, the validity or genuineness of documents or of any endorsements thereon, even if such documents should in fact prove to be in any or all respects invalid, fraudulent or forged, or any dispute between or among the Borrower, any of its Subsidiaries, the beneficiary of any Letter of Credit or any financing institution or other party to whom any Letter of Credit may be transferred or any claims or defenses whatsoever of the Borrower or any of its Subsidiaries against the beneficiary of any Letter of Credit or any such transferee. The LC Bank shall not be liable for any error, omission, interruption or delay in transmission, dispatch or delivery of any message or advice, however transmitted, in connection with any Letter of Credit issued, extended or renewed by it. The Borrower agrees that any action taken or omitted by the LC Bank or any Bank under or in connection with each Letter of Credit and the related drafts and documents, if done in good faith and without gross negligence, shall be binding upon the Borrower and shall not put the LC Bank or any Bank under any liability to the Borrower.\n(h) To the extent not inconsistent with clause (g) above, the LC Bank shall be entitled to rely, and shall be fully protected in relying upon, any Letter of Credit, draft, writing, resolution, notice, consent, certificate, affidavit, letter, cablegram, telegram, telecopy, telex or teletype message, statement, order or other document believed by it to be genuine and correct and to have been signed, sent or made by the proper\nPerson or Persons and upon advice and statements of legal counsel, independent accountants and other experts selected by the LC Bank. The LC Bank shall be fully justified in failing or refusing to take any action under this Agreement unless it shall first have received such advice or concurrence of the Required Banks as it reasonably deems appropriate or it shall first be indemnified to its reasonable satisfaction by the Banks against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. Notwithstanding any other provision of this Section 2.16, the LC Bank shall in all cases be fully protected in acting, or in refraining from acting, under this Agreement in accordance with a request of the Required Banks, and such request and any action taken or failure to act pursuant thereto shall be binding upon the Banks and all future holders of participations in any Letters of Credit.\n(i) The Borrower hereby indemnifies and holds harmless each Bank and the Agent from and against any and all claims and damages, losses, liabilities, costs or expenses which such Bank or the Agent may incur (or which may be claimed against such Bank or the Agent by any Person whatsoever) by reason of or in connection with the execution and delivery or transfer of or payment or failure to pay under any Letter of Credit, including, without limitation, any claims, damages, losses, liabilities, costs or expenses which the LC Bank may incur by reason of or in connection with the failure of any other Bank to fulfill or comply with its obligations to the LC Bank hereunder (but nothing herein contained shall affect any rights the Borrower may have against such defaulting Bank); provided that the Borrower shall not be required to indemnify any Bank or the Agent for any claims, damages, losses, liabilities, costs or expenses to the extent, but only to the extent, caused by (i) the willful misconduct or gross negligence of the LC Bank in determining whether a request presented under any Letter of Credit complied with the terms of such Letter of Credit or (ii) the LC Bank's failure to pay under any Letter of Credit after the presentation to it of a request strictly complying with the terms and conditions of the Letter of Credit. Nothing in this Section 2.16(i) is intended to limit the obligations of the Borrower under any other provision of this Agreement.\n(j) Each Bank shall, ratably in accordance with its Percentage, indemnify the LC Bank, its affiliates and their respective directors, officers, agents and employees (to the extent not reimbursed by the Borrower) against any cost, expense (including reasonable counsel fees and disbursements), claim, demand, action, loss or liability (except such as result from such indemnitees' gross negligence or willful misconduct or the LC Bank's failure to pay under any Letter of Credit after the presentation to it of a request strictly complying with the terms and conditions of the Letter of Credit) that such indemnitees may suffer or incur in connection with this Section 2.16 or any action taken or omitted by such indemnitees hereunder.\n(k) In its capacity as a Bank the LC Bank shall have the same rights and obligations as any other Bank.\nSECTION 2.17. Termination of the Security Interest. Upon the completion of an issuance by the Borrower of convertible preferred stock or other equity instrument for proceeds (net of all out-of-pocket expenses reasonably incurred in respect of such issuance and any taxes paid or payable (as estimated by a financial officer of the Borrower in good faith) in respect thereof) in excess of $25,000,000, so long as no Default is then continuing, the Borrower shall be entitled to the release of all Collateral from the Liens of the Collateral Documents in accordance with the provisions thereof, and the Collateral Documents shall thereupon cease to be Financing Documents.\nARTICLE III\nCONDITIONS\nSECTION 3.01. Effectiveness. This Agreement shall become effective on the date that each of the following conditions shall have been satisfied (or waived in accordance with Section 9.05):\n(a) receipt by the Agent of counterparts of this Agreement signed by each of the parties hereto (or, in the case of any party as to which an executed counterpart shall not have been received, receipt by the Agent in form satisfactory to it of telegraphic, facsimile, telex or other written confirmation from such party of execution of a counterpart hereof by such party);\n(b) receipt by the Agent of counterparts of the Subsidiary Guarantee Agreement, duly executed by each of the Obligors listed on the signature pages thereof;\n(c) receipt by the Agent of counterparts of the Borrower Security Agreement, the Borrower Pledge Agreement, the Subsidiary Security Agreement, the Deeds of Trust and all other documents and certificates to be delivered pursuant thereto on the Effective Date (including appropriately completed and duly executed Uniform Commercial Code financing statements required thereby) duly executed by each of the Obligors listed on the signature pages thereof;\n(d) receipt by the Agent of evidence satisfactory to the Agent that arrangements satisfactory to it shall have been made for recording the Deeds of Trust and filing the Uniform Commercial Code financing statements referred to in paragraph (c) above on or promptly after the Effective Date;\n(e) receipt by the Agent of all Pledged Instruments;\n(f) receipt by the Agent of copies of file search reports from the Uniform Commercial Code filing officer in each jurisdiction (i) in which any Mortgaged Facility is located or (ii) in which the chief executive office of the Borrower and each Subsidiary Guarantor is located, setting forth the results of Uniform Commercial Code file searches conducted in the name of the Borrower and each Subsidiary Guarantor, as the case may be;\n(g) receipt by the Agent of evidence satisfactory to the Agent of the insurance coverage required by Section 5.03;\n(h) with respect to each of the Mortgaged Facilities, receipt by the Agent of title reports with respect thereto issued by a title insurance company reasonably acceptable to the Agent and dated no more than 45 days prior to the Effective Date showing no Liens except Permitted Encumbrances with respect thereto;\n(i) receipt by the Agent of duly executed Notes for the account of each Bank dated on or before the Effective Date complying with the provisions of Section 2.03;\n(j) receipt by the Agent of (i) an opinion of the General Counsel of the Borrower and (ii) an opinion of Jacobs Persinger & Parker, New York counsel for the Borrower, substantially in the forms of Exhibits B-1 and B-2, respectively, and covering such additional matters relating to the transactions contemplated hereby as the Required Banks may reasonably request;\n(k) receipt by the Agent of (i) an opinion of Davis Polk & Wardwell, special New York counsel for the Agent, and (ii) an opinion of Meyer Hendricks Victor Osborn & Maledon, special Arizona counsel for the Agent, substantially in the forms of Exhibits C-1 and C-2, respectively, hereto and covering such additional matters relating to the transactions contemplated hereby as the Required Banks may reasonably request;\n(l) receipt by the Agent of evidence satisfactory to the Agent that the commitments under the Existing Credit Agreements have been terminated and that the principal and interest on all loans and accrued fees outstanding thereunder have been paid in full; and\n(m) receipt by the Agent of all documents it may reasonably request relating to the existence of the Obligors, the corporate authority for and the validity of the Financing Documents and any other matters relevant hereto, all in form and substance satisfactory to the Agent;\nprovided that this Agreement shall not become effective or be binding on any party hereto unless all of the foregoing conditions are satisfied not later than December 31, 1994. The Agent shall promptly notify the Borrower and the Banks of the Effective Date, and such notice shall be conclusive and binding on all parties hereto. The Borrower and each of the Banks which is a party to the Existing Credit Agreements, comprising the \"Required Banks\" as defined in the Existing Credit Agreements, hereby agree that (i) the commitments of the banks under the Existing Credit Agreements shall terminate simultaneously with the effectiveness of this Agreement without the notice required under Sections 2.09 of the Existing Credit Agreements and (ii) the Borrower may prepay any Borrowing as defined in the Existing Credit Agreements on the Effective Date hereof without prior notice. The Borrower covenants that all accrued and unpaid fees and any other amounts due and payable under the Existing Credit Agreements shall have been paid on or prior to the Effective Date. Upon the effectiveness of this Agreement, any letter of credit outstanding under the Primary Credit Agreement shall be deemed to be a Letter of Credit outstanding hereunder.\nSECTION 3.02. Credit Events. The obligation of any Bank to make a Loan on the occasion of any Borrowing and of the LC Bank to issue a Letter of Credit (or to permit the extension of an Evergreen Letter of Credit) on the occasion of a request therefor by the Borrower is subject to the satisfaction of the following conditions:\n(a) receipt (i) by the Agent of a Notice of Borrowing as required by Section 2.02, in the case of a Borrowing or (ii) by the LC Bank of notice as required by Section 2.16 , in the case of a Letter of\nCredit;\n(b) the fact that, after giving effect to such Credit Event, the Usage shall not exceed the aggregate amount of the Commitments and, in the case of a Tranche B Borrowing, the fact that the Tranche A Commitments shall be fully utilized;\n(c) the fact that, immediately after such Credit Event, no Default shall have occurred and be continuing;\n(d) the fact that the representations and warranties of each Obligor contained in each Financing Document to which it is a party (except, in the case of a Refunding Borrowing, the representation and warranty set forth in Section 4.04(c) hereof as to any material adverse change which has theretofore been disclosed in writing by the Borrower to the Banks) shall be true on and as of the date of such Borrowing.\nEach Borrowing shall be deemed to be a representation and warranty by the Borrower on the date of such Borrowing as to the facts specified in clauses (b), (c) and (d) of this Section.\nARTICLE IV\nREPRESENTATIONS AND WARRANTIES\nThe Borrower represents and warrants that:\nSECTION 4.01. Corporate Existence and Power. The Borrower is a corporation duly incorporated, validly existing and in good standing under the laws of Massachusetts, and has all corporate powers and all material governmental licenses, authorizations, consents and approvals required to carry on its business as now conducted.\nSECTION 4.02. Corporate and Governmental Authorization; No Contravention. The execution, delivery and performance by each Obligor of the Financing Documents to which it is a party are within its corporate powers, have been duly authorized by all necessary corporate action, require no action by or in respect of, or filing with, any governmental body, agency or official and do not contravene, or constitute a default under, any provision of applicable law or regulation or of the certificate of incorporation or by-laws of such Obligor or of any agreement, judgment, injunction, order, decree or other instrument binding upon such Obligor or any of its Subsidiaries or result in the creation or imposition of any Lien, except Liens created by the Collateral Documents, on any asset of such Obligor or any of its Subsidiaries.\nSECTION 4.03. Binding Effect; Liens of Collateral Documents. This Agreement constitutes a valid and binding agreement of the Borrower and the Notes, when executed and delivered in accordance with this Agreement, will constitute valid and binding obligations of the Borrower in each case enforceable in accordance with their respective terms. Each other Financing Document, when executed and delivered in accordance with this Agreement, will constitute a valid and binding agreement of each Obligor party thereto enforceable against each such Obligor in accordance with its terms. Subject to Section 2.17, the Collateral Documents create valid security interests in, and first mortgage Liens on, the Collateral purported to be covered thereby, which security interests and mortgage Liens are and will remain perfected security interests and duly recorded mortgage Liens, prior to all other Liens except Liens permitted by the Collateral Documents.\nSECTION 4.04. Financial Information.\n(a) The consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as of December 31, 1993 and the related consolidated statements of income, stockholders' equity and cash flows for the fiscal year then ended, reported on by Arthur Andersen & Co. and set forth in the Borrower's 1993 Form 10-K, a copy of which has been delivered to each of the Banks, fairly present, in conformity with generally accepted accounting principles, the consolidated financial position of the Borrower and its Consolidated Subsidiaries as of such date and their consolidated results of operations and cash flows for such fiscal year.\n(b) The unaudited consolidated balance sheet of the Borrower and its Consolidated Subsidiaries as of September 30, 1994 and the related unaudited consolidated statements of income, stockholders' equity and cash flows for the nine months then ended, set forth in the Borrower's quarterly report for the fiscal quarter ended September 30, 1994 as filed with the Securities and Exchange Commission on Form 10-Q, a copy of which has been delivered to each of the Banks, fairly present, in conformity with generally accepted accounting principles applied on a basis consistent with the financial statements referred to in subsection (a) of this Section, the consolidated financial position of the Borrower and its Consolidated Subsidiaries as of such date and their consolidated results of operations and cash flows for such nine month period (subject to normal year-end adjustments).\n(c) Since September 30, 1994 there has been no material adverse change in the business, financial position, results of operations or prospects of the Borrower and its Consolidated Subsidiaries, considered as a whole.\nSECTION 4.05. Litigation. Except as disclosed in the Borrower's 1993 Form 10-K and the Form 10-Q referred to in Section 4.04(b) above, there is no action, suit or proceeding pending against, or to the knowledge of the Borrower threatened against or affecting, the Borrower or any of its Subsidiaries before any court or arbitrator or any governmental body, agency or official in which there is a reasonable possibility of an adverse decision which could materially adversely affect the business, consolidated financial position or consolidated results of operations of the Borrower and its Consolidated Subsidiaries or which in any manner draws into question the validity of any Financing Document.\nSECTION 4.06. Compliance with ERISA. Each member of the ERISA Group has fulfilled its obligations under the minimum funding standards of ERISA and the Internal Revenue Code with respect to each Plan and is in compliance in all material respects with the presently applicable provisions of ERISA and the Internal Revenue Code with respect to each Plan. No member of the ERISA Group has (i) sought a waiver of the minimum funding standard under Section 412 of the Internal Revenue Code in respect of any Plan, (ii) failed to make any contribution or payment to any Plan or Multiemployer Plan or in respect of any Benefit Arrangement, or made any amendment to any Plan or Benefit Arrangement, which has resulted or could result in the imposition of a Lien or the posting of a bond or other security under ERISA or the Internal Revenue Code or (iii) incurred any liability to the PBGC or any other Person under Title IV of ERISA other than a liability to the PBGC for premiums under Section 4007 of ERISA.\nSECTION 4.07. Environmental Matters. (a) In the ordinary course of its business, the Borrower conducts periodic reviews of the effect of Environmental Laws on the business, operations and properties of the Borrower and its Subsidiaries and compliance therewith. The Borrower and its Subsidiaries also attempt, whenever possible, to negotiate specific provisions in contracts for construction services that allocate to the\ncontracting governmental agency or private owner, the entire risk and responsibility for Hazardous Substances encountered during the course of construction. On the basis of such reviews and contract provisions and procedures, the Borrower has reasonably concluded that the costs and associated liabilities of compliance with Environmental Laws are unlikely to have a material adverse effect on the business, financial condition, results of operations or prospects of the Borrower and its Consolidated Subsidiaries, considered as a whole.\n(b) Without limiting the foregoing, as of the Effective Date:\n(i) no notice, notification, demand, request for information, citation, summons, complaint or order has been issued, no complaint has been filed, no penalty has been assessed and no investigation or review is pending or, to the knowledge of the Obligors, threatened by any governmental or other entity with respect to any (A) alleged violation by the Borrower or any of its Subsidiaries of any Environmental Law involving any Mortgaged Facility, (B) alleged failure by the Borrower or any of its Subsidiaries to have any environmental permit, certificate, license, approval, registration or authorization required in connection with the conduct of its business at any Mortgaged Facility, (C) Regulated Activity conducted at any Mortgaged Facility or (D) Release of Hazardous Substances at or in connection with any Mortgaged Facility;\n(ii) other than generation of Hazardous Substances in compliance with all applicable Environmental Laws, no Regulated Activity has occurred at or on any Mortgaged Facility;\n(iii) no polychlorinated biphenyls, radioactive material, urea formaldehyde, lead, asbestos, asbestos-containing material or underground storage tank (active or abandoned) is or has been present at any Mortgaged Facility;\n(iv) no Hazardous Substance has been Released (and no written notification of such Release has been filed) or is present (whether or not in a reportable or threshold planning quantity) at, on or under any Mortgaged Facility;\n(v) no Mortgaged Facility is listed or, to the knowledge of the Obligors, proposed for listing, on the National Priorities List promulgated pursuant to CERCLA, on CERCLIS (as defined in CERCLA) or on any similar federal, state or foreign list of sites requiring investigation or clean-up; and\n(vi) there are no Liens under Environmental Laws on any Mortgaged Facility, no government actions have been taken or are in process which could subject any Mortgaged Property to such Liens and neither the Borrower nor any of its Subsidiaries would be required to place any notice or restriction relating to Hazardous Substances in any deed to any Mortgaged Facility.\n(c) No environmental investigation, study, audit, test, review or other analysis has been conducted of which the Obligors have knowledge in relation to any Mortgaged Facility which has not been delivered to the Banks.\nSECTION 4.08. Taxes. United States Federal income tax returns of the Borrower and its Subsidiaries have been examined and closed through the fiscal year ended December 31, 1986. The Borrower and its Subsidiaries have filed all United States Federal income tax returns and all other material tax returns which are required to be filed by them and have paid all taxes due pursuant to such returns or pursuant to any\nassessment received by the Borrower or any Subsidiary. The charges, accruals and reserves on the books of the Borrower and its Subsidiaries in respect of taxes or other governmental charges are, in the opinion of the Borrower, adequate.\nSECTION 4.09. Subsidiaries. Each of the Borrower's corporate Subsidiaries is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation, and has all corporate powers and all material governmental licenses, authorizations, consents and approvals required to carry on its business as now conducted.\nSECTION 4.10. Not an Investment Company. The Borrower is not an \"investment company\" within the meaning of the Investment Company Act of 1940, as amended.\nSECTION 4.11. No Burdensome Restrictions. No contract, lease, agreement or other instrument to which the Borrower or any of its Subsidiaries is a party or by which any of its property is bound or affected, no charge, corporate restriction, judgment, decree or order and no provision of applicable law or governmental regulation has or is reasonably expected to materially and adversely affect the business, operations or financial condition of the Borrower and its Consolidated Subsidiaries, taken as a whole, or the ability of the Borrower to perform its obligations under this Agreement.\nSECTION 4.12. Full Disclosure. All information heretofore furnished by the Borrower to the Agent or any Bank for purposes of or in connection with this Agreement or any transaction contemplated hereby is, and all such information hereafter furnished by the Borrower to the Agent or any Bank will be, true and accurate in all material respects (or in the case of projections and similar information based on reasonable estimates) on the date as of which such information is stated or certified. The Borrower has disclosed to the Banks in writing any and all facts which materially and adversely affect or may reasonably be expected to materially and adversely affect (to the extent the Borrower can now reasonably foresee), the business, operations or financial condition of the Borrower and its Consolidated Subsidiaries, taken as a whole, or the ability of the Borrower to perform its obligations under this Agreement.\nSECTION 4.13. Ownership of Property; Liens. The Borrower and its Subsidiaries have good and marketable title to and are in lawful possession of, or have valid leasehold interests in, or have the right to use pursuant to valid and enforceable agreements or arrangements, all of their respective properties and other assets (real or personal, tangible, intangible or mixed), except where the failure to have or possess the same with respect to such properties or other assets could not, in the aggregate, have a material adverse effect on the business, financial condition, results of operations or prospects of the Borrower and its Consolidated Subsidiaries, considered as a whole. None of such properties or other assets is subject to any Lien except Permitted Liens.\nARTICLE V\nCOVENANTS\nThe Borrower agrees that, so long as any Bank has any Commitment hereunder or any amount payable under any Note remains unpaid or any Letter of Credit remains outstanding or any Reimbursement Obligation with respect thereto remains unpaid:\nSECTION 5.01. Information. The Borrower will deliver to each of\nthe Banks:\n(a) as soon as available and in any event within 90 days after the end of each fiscal year of the Borrower, consolidated and consolidating balance sheets of the Borrower and its Consolidated Subsidiaries as of the end of such fiscal year and the related consolidated and consolidating statements of income, stockholders' equity and cash flows for such fiscal year, setting forth in each case in comparative form the figures for the previous fiscal year, all reported on in a manner acceptable to the Securities and Exchange Commission by Arthur Andersen & Co. or other independent public accountants of nationally recognized standing;\n(b) as soon as available and in any event within 45 days after the end of each of the first three quarters of each fiscal year of the Borrower, a consolidated condensed balance sheet of the Borrower and its Consolidated Subsidiaries as of the end of such quarter and the related consolidated condensed statements of income and cash flows for such quarter and for the portion of the Borrower's fiscal year ended at the end of such quarter, setting forth in each case in comparative form the figures for the corresponding quarter and the corresponding portion of the Borrower's previous fiscal year, all certified (subject to normal year-end adjustments) as to fairness of presentation, generally accepted accounting principles and consistency by the chief financial officer or the chief accounting officer of the Borrower;\n(c) simultaneously with the delivery of each set of financial statements referred to in clauses (a) and (b) above, a certificate of the chief financial officer or the chief accounting officer of the Borrower (i) setting forth in reasonable detail the calculations required to establish whether the Borrower was in compliance with the requirements of Sections 5.07 to 5.10, inclusive, 5.12, 5.14 and 5.15 on the date of such financial statements and (ii) stating whether there exists on the date of such certificate any Default and, if any Default then exists, setting forth the details thereof and the action which the Borrower is taking or proposes to take with respect thereto;\n(d) simultaneously with the delivery of each set of financial statements referred to in clause (a) above, a statement of the firm of independent public accountants which reported on such statements (i) whether anything has come to their attention to cause them to believe that there existed on the date of such statements any Default and (ii) confirming the calculations set forth in the officer's certificate delivered simultaneously therewith pursuant to clause (c) above;\n(e) simultaneously with the delivery of each set of financial statements set forth above, a schedule, dated as of the date of such financial statements, listing each construction contract which provides for aggregate total payments in excess of $2,500,000 and with respect to which the Borrower or a Consolidated Subsidiary of the Borrower is a party or participates through a joint venture, and setting forth as of the date of such schedule for each such contract the Borrower's original estimate of revenue and profit, the Borrower's current estimate of revenue and profit, cumulative realized and estimated remaining revenue and profit, and the percentage of completion and anticipated completion date of each such contract, certified as to consistency, accuracy and reasonableness of estimates by the chief financial officer or the chief accounting officer of the Borrower;\n(f) forthwith upon the occurrence of any Default, a certificate of the chief financial officer or the chief accounting officer of the Borrower setting forth the details thereof and the action which the\nBorrower is taking or proposes to take with respect thereto;\n(g) promptly upon the mailing thereof to the shareholders of the Borrower generally, copies of all financial statements, reports and proxy statements so mailed;\n(h) promptly upon the filing thereof, copies of all registration statements (other than the exhibits thereto and any registration statements on Form S-8 or its equivalent) and annual, quarterly or monthly reports which the Borrower shall have filed with the Securities and Exchange Commission;\n(i) if and when any member of the ERISA Group (i) gives or is required to give notice to the PBGC of any \"reportable event\" (as defined in Section 4043 of ERISA) with respect to any Plan which might constitute grounds for a termination of such Plan under Title IV of ERISA, or knows that the plan administrator of any Plan has given or is required to give notice of any such reportable event, a copy of the notice of such reportable event given or required to be given to the PBGC; (ii) receives notice of complete or partial withdrawal liability under Title IV of ERISA or notice that any Multiemployer Plan is in reorganization, is insolvent or has been terminated, a copy of such notice; (iii) receives notice from the PBGC under Title IV of ERISA of an intent to terminate, impose liability (other than for premiums under Section 407 of ERISA) in respect of, or appoint a trustee to administer any Plan, a copy of such notice; (iv) applies for a waiver of the minimum funding standard under Section 412 of the Internal Revenue Code, a copy of such application; (v) gives notice of intent to terminate any Plan under Section 4041(c) of ERISA, a copy of such notice and other information filed with the PBGC; (vi) gives notice of withdrawal from any Plan pursuant to Section 4063 of ERISA, a copy of such notice; or (vii) fails to make any payment or contribution to any Plan or Multiemployer Plan or in respect of any Benefit Arrangement or makes any amendment to any Plan or Benefit Arrangement which has resulted or could result in the imposition of a Lien or the posting of a bond or other security, a certificate of the chief financial officer or the chief accounting officer of the Borrower setting forth details as to such occurrence and action, if any, which the Borrower or applicable member of the ERISA Group is required or proposes to take;\n(j) prompt notice of the receipt of any complaint, order, citation, notice or other written communication from any Person with respect to (i) the existence or alleged existence of a violation of any applicable Environmental Law at or on, or of any Environmental Liability arising with respect to, any Mortgaged Facility, (ii) any Release on any Mortgaged Facility or any part thereof in a quantity that is reportable under any applicable Environmental Law, and (iii) any pending or threatened proceeding for the termination, suspension or non-renewal of any permit required under any applicable Environmental Law with respect to any Mortgaged Facility; and\n(k) from time to time such additional information regarding the financial position or business of the Borrower and its Subsidiaries as the Agent, at the request of any Bank, may reasonably request.\nSECTION 5.02. Payment of Obligations. The Borrower will pay and discharge, and will cause each Subsidiary to pay and discharge, at or before maturity, all their respective material obligations and liabilities, including, without limitation, tax liabilities, except where the same may be contested in good faith by appropriate proceedings, and will maintain, and will cause each Subsidiary to maintain, in accordance with generally accepted accounting principles, appropriate reserves for the accrual of any of the same.\nSECTION 5.03. Maintenance of Property; Insurance. The Borrower will keep, and will cause each Subsidiary to keep, all property useful and necessary in its business in good working order and condition, ordinary wear and tear excepted; will maintain, and will cause each Subsidiary to maintain (either in the name of the Borrower or in such Subsidiary's own name) with financially sound and reputable insurance companies, insurance on all their property in at least such amounts and against at least such risks as are usually insured against in the same general area by companies of established repute engaged in the same or a similar business; and will furnish to the Banks, upon written request from the Agent, full information as to the insurance carried.\nSECTION 5.04. Conduct of Business and Maintenance of Existence. The Borrower will continue, and will cause each Subsidiary Guarantor to continue, to engage in business of the same general type as now conducted by the Borrower and its Subsidiaries, and will preserve, renew and keep in full force and effect, and will cause each Subsidiary Guarantor to preserve, renew and keep in full force and effect their respective corporate existence and their respective rights, privileges and franchises necessary or desirable in the normal conduct of business.\nSECTION 5.05. Compliance with Laws. The Borrower will comply, and cause each Subsidiary to comply, in all material respects with all applicable laws, ordinances, rules, regulations, and requirements of governmental authorities (including, without limitation, Environmental Laws and ERISA and the rules and regulations thereunder) except where the necessity of compliance therewith is contested in good faith by appropriate proceedings.\nSECTION 5.06. Inspection of Property, Books and Records. The Borrower will keep, and will cause each Subsidiary to keep, proper books of record and account in which full, true and correct entries in conformity with generally accepted accounting principles shall be made of all dealings and transactions in relation to its business and activities; and will permit, and will cause each Subsidiary to permit, representatives of any Bank at such Bank's expense (subject to Section 9.03(a)(ii)) to visit and inspect any of their respective properties, to examine and make abstracts from any of their respective books and records and to discuss their respective affairs, finances and accounts with their respective officers, employees and independent public accountants, all at such reasonable times and as often as may reasonably be desired.\nSECTION 5.07. Current Ratio. Consolidated Current Assets will at no time be less than 100% of Consolidated Current Liabilities.\nSECTION 5.08. Debt. (a) At the end of each fiscal quarter ending prior to September 30, 1996, Modified Parent Company Debt shall not exceed 75% of Consolidated Capital Base and at the end of each fiscal quarter ending on or after September 30, 1996, Modified Parent Company Debt shall not exceed 70% of Consolidated Capital Base.\n(b) The Borrower will not permit any Subsidiary to incur or suffer to exist any Debt other than (i) Debt of Perini Land and Development outstanding at September 30, 1994, as described in Schedule I, (ii) additional Debt of Perini Land and Development in an aggregate amount not exceeding $5,000,000, (iii) Debt of Perini International Corporation in an aggregate amount not exceeding $5,000,000, (iv) Debt of any Subsidiary Guarantor under the Subsidiary Guarantee Agreement and (v) any refinancing, extension, renewal or refunding of the Debt referred to in clauses (i) through (iv) above, provided that such Debt is not increased.\nSECTION 5.09. Minimum Consolidated Tangible Net Worth. Consolidated Tangible Net Worth of the Borrower will at no time be less\nthan the Minimum Compliance Level, determined as set forth below. The \"Minimum Compliance Level\" is an amount equal to the Base Compliance Amount subject to increase (but in no case subject to decrease) from time to time as follows: (i) at the end of each fiscal year commencing after December 31, 1993 for which Consolidated Net Income is a positive number, the Minimum Compliance Level shall be increased effective at the last day of such fiscal year by an amount equal to 50% of such Consolidated Net Income; and (ii) on the date of each issuance by the Borrower subsequent to December 31, 1993 of any capital stock or other equity interest, the Minimum Compliance Level shall be increased by an amount equal to 75% of the amount of the net proceeds received by the Borrower on account of such issuance. For purposes of this Section, \"Base Compliance Amount\" means (i) for any date prior to September 30, 1996, $110,000,000 or (ii) for any date on or after September 30, 1996, $135,000,000.\nSECTION 5.10. Interest Coverage. For each of (i) the fiscal quarter ending on December 31, 1994, (ii) the two consecutive fiscal quarters ending on March 31, 1995, (iii) the three consecutive fiscal quarters ending on June 30, 1995 or (iv) each period of four consecutive fiscal quarters ending on or after September 30, 1995 but on or before June 30, 1996, Consolidated Earnings Before Interest and Taxes shall not be less than 175% of Consolidated Interest Charges for each such period. Consolidated Earnings Before Interest and Taxes for each period of four consecutive fiscal quarters ending on or after September 30, 1996 shall not be less than 200% of Consolidated Interest Charges for such four fiscal quarters.\nSECTION 5.11. Negative Pledge. Neither the Borrower nor any Consolidated Subsidiary of the Borrower will create, assume or suffer to exist any Lien on any asset (including, without limitation, capital stock of Subsidiaries) now owned or hereafter acquired by it, except:\n(a) Liens existing on September 30, 1994 securing Debt outstanding on September 30, 1994 as described in Schedule II;\n(b) any Lien existing on any asset of any corporation at the time such corporation becomes a Consolidated Subsidiary of the Borrower and not created in contemplation of such event;\n(c) any Lien on any asset securing Debt incurred or assumed for the purpose of financing all or any part of the cost of acquiring such asset, provided that such Lien attaches to such asset concurrently with or within 90 days after the acquisition thereof and such Lien secures only such Debt;\n(d) any Lien on any asset of any corporation existing at the time such corporation is merged or consolidated with or into the Borrower or a Consolidated Subsidiary of the Borrower and not created in contemplation of such event;\n(e) any Lien existing on any asset prior to the acquisition thereof by the Borrower or a Consolidated Subsidiary of the Borrower and not created in contemplation of such acquisition;\n(f) any Lien arising out of the refinancing, extension, renewal or refunding of any Debt secured by any Lien permitted by any of the foregoing clauses of this Section, provided that such Debt is not increased and is not secured by any additional assets;\n(g) Liens incidental to conduct of its business or the ownership of its assets which (i) do not secure Debt and (ii) do not in the aggregate materially detract from the value of its assets or materially impair the use thereof in the operation of its business;\n(h) Permitted Encumbrances; and\n(i) Liens created by the Collateral Documents.\nSECTION 5.12. Consolidations, Mergers and Sales of Assets. (a) The Borrower will not (i) consolidate or merge with or into any other Person or sell, lease or otherwise transfer all or any substantial part of its assets to any other Person or (ii) permit any Material Subsidiary (other than a Subsidiary Guarantor) to consolidate or merge with or into, or transfer all or any substantial part of its assets to, any Person other than the Borrower or a Wholly-Owned Consolidated Subsidiary; provided that the Borrower or a Material Subsidiary other than Perini Land and Development may sell or otherwise transfer assets if Aggregate Asset Sale Proceeds after such sale less Aggregate Reinvested Proceeds does not at any time exceed $15,000,000. \"Aggregate Asset Sale Proceeds\" means the sum of the proceeds of each sale in a single transaction or series of related transactions by the Borrower or any Subsidiary, on or after the Effective Date, of fixed assets yielding proceeds in excess of 5% of the Consolidated Tangible Net Worth of the Borrower. \"Aggregate Reinvested Proceeds\" means the amount of Aggregate Asset Sale Proceeds used to purchase fixed assets for use in the same general business presently conducted by the Borrower or the Subsidiary that realized such proceeds, as the case may be, provided such proceeds are so used within 18 months of receipt thereof. The Borrower will not permit any Subsidiary Guarantor to consolidate or merge with or into, or transfer all or any substantial part of its assets to, any Person; provided that the foregoing shall not prohibit any Subsidiary Guarantor from selling, leasing or otherwise transferring assets in the ordinary course of its business.\n(b) The Borrower will not, and will not permit any of its Subsidiaries to, sell, lease or otherwise dispose of any item of Collateral unless (i) the Required Banks shall have given their prior written consent thereto and (ii) the consideration therefor is (x) at least equal to the fair market value of such asset (as determined in good faith by a financial officer of the Borrower or, if such value exceeds $15,000,000, by the board of directors of the Borrower or a duly constituted committee thereof) and (y) in the case of any agreement entered into on or after the Effective Date for the sale, lease or other disposition of such Collateral, shall consist of cash payable at closing.\nSECTION 5.13. Use of Proceeds. The proceeds of the Loans made under this Agreement will be used by the Borrower for general corporate purposes. None of such proceeds will be used, directly or indirectly, for the purpose, whether immediate, incidental or ultimate, of purchasing or carrying any \"margin stock\" within the meaning of Regulation U.\nSECTION 5.14. Restricted Payments. The aggregate amount of all dividends which constitute Restricted Payments declared and other Restricted Payments made during any period of four consecutive fiscal quarters will not exceed an amount equal to 50% of the excess, if any, of (x) Consolidated Net Income for such period over (y) the aggregate amount of preferred stock dividends not constituting Restricted Payments paid during such period. The Borrower will not declare any dividend payable more than 120 days after the date of declaration thereof.\nSECTION 5.15. Real Estate Investments. The Borrower will not, and will not permit any Consolidated Subsidiary to, make any Real Estate Investment if, after giving effect thereto, the cumulative amount of Net Real Estate Investments made (i) at any time during the period beginning January 1, 1994 and ending December 31, 1994 shall exceed $8,000,000 or (ii) during any fiscal year thereafter shall exceed $4,000,000 plus 25% of the amount, if any, by which the Net Real Estate Investments made during the preceding period were less than the applicable limitation specified\nabove for such period. For purposes of this Section, the cumulative amount of \"Net Real Estate Investments\" made during any period, as measured at any date during such period, is the aggregate amount of Real Estate Investments made by the Borrower and its Consolidated Subsidiaries from and including the first day of such period to and including such date, less the sum of all cash or cash equivalent payments received by the Borrower or one of its Consolidated Subsidiaries, as the case may be, in respect of Real Estate Investments from and including the first day of such period to and including such date.\nSECTION 5.16. Other Investments. Neither the Borrower nor any Consolidated Subsidiary will make or acquire any Investment in any Person other than:\n(a) Real Estate Investments permitted by Section 5.15;\n(b) Investments in Subsidiaries or joint ventures principally engaged in the construction business;\n(c) Temporary Cash Investments; and\n(d) any Investment not otherwise permitted by the foregoing clauses of this Section if, immediately after such Investment is made or acquired, the aggregate net book value of all Investments permitted by this clause (d) does not exceed 5% of Consolidated Tangible Net Worth;\nprovided that no Real Estate Investment may be made pursuant to clause (b), (c) or (d) above.\nSECTION 5.17. Further Assurances. (a) The Borrower will, and will cause each of its Subsidiaries to, at its sole cost and expense, do, execute, acknowledge and deliver all such further acts, deeds, conveyances, mortgages, assignments, notices of assignment, transfers and assurances as the Agent shall from time to time request, which may be necessary or desirable in the reasonable judgment of the Agent from time to time to assure, perfect, convey, assign, transfer and confirm unto the Agent the property and rights conveyed or assigned pursuant to the Collateral Documents, or which the Borrower or such Subsidiaries may be or may hereafter become bound to convey or assign to the Agent or which may facilitate the performance of the terms of the Collateral Documents or the filing, registering or recording of the Collateral Documents.\n(b) All costs and expenses in connection with the security interests and Liens created by the Collateral Documents, including reasonable legal fees and other reasonable costs and expenses in connection with the granting, perfecting and maintenance of such security interests and Liens, the preparation, execution, delivery, recordation or filing of documents and any other acts in connection with the grant of such security interests and Liens as the Agent may reasonably request, shall be paid by the Borrower promptly when due.\nARTICLE VI\nDEFAULTS\nSECTION 6.01. Events of Default. If one or more of the following events (\"Events of Default\") shall have occurred and be continuing:\n(a) the Borrower shall fail to pay when due any principal of any Loan, any Reimbursement Obligation, any fees or any other amount payable hereunder;\n(b) the Borrower shall fail to pay when due or within five Business Days thereof any interest on any Loan;\n(c) the Borrower shall fail to observe or perform any covenant contained in Sections 5.07 to 5.17, inclusive or in Section 3.01 of the Subsidiary Guarantee Agreement;\n(d) any Obligor shall fail to observe or perform any covenant or agreement contained in any Financing Document (other than those covered by clauses (a), (b) and (c) above) for 10 days after written notice thereof has been given to such Obligor by the Agent at the request of any Bank;\n(e) any representation, warranty, certification or statement made by any Obligor in any Financing Document or in any certificate, financial statement or other document delivered pursuant thereto shall prove to have been incorrect in any material respect when made (or deemed made);\n(f) the Borrower shall fail to make any payment in respect of any Debt (other than the Notes or Reimbursement Obligations) when due or within any applicable grace period;\n(g) any Subsidiary shall fail to make any payment in respect of any Debt the aggregate principal amount of which is $250,000 or more when due or within any applicable grace period;\n(h) any event or condition shall occur which results in the acceleration of the maturity of any Debt of the Borrower or any Subsidiary or enables (or, with the giving of notice or lapse of time or both, would enable) the holder of such Debt or any Person acting on such holder's behalf to accelerate the maturity thereof;\n(i) the Borrower or any Subsidiary shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, or shall consent to any such relief or to the appointment of or taking possession by any such official in an involuntary case or other proceeding commenced against it, or shall make a general assignment for the benefit of creditors, or shall fail generally to pay its debts as they become due, or shall take any corporate action to authorize any of the foregoing;\n(j) an involuntary case or other proceeding shall be commenced against the Borrower or any Subsidiary seeking liquidation, reorganization or other relief with respect to it or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property, and such involuntary case or other proceeding shall remain undismissed and unstayed for a period of 60 days; or an order for relief shall be entered against the Borrower or any Subsidiary under the federal bankruptcy laws as now or hereafter in effect;\n(k) any member of the ERISA Group shall fail to pay when due an amount or amounts aggregating in excess of $5,000,000 which it shall have become liable to pay to the PBGC or any other Person under Title IV of ERISA; or notice of intent to terminate a Material Plan shall be filed under Title IV of ERISA by any member of the ERISA Group, any plan administrator or any combination of the foregoing; or the PBGC\nshall institute proceedings under Title IV of ERISA to terminate, to impose liability (other than for premiums under Section 4007 of ERISA) in respect of, or to cause a trustee to be appointed to administer any Material Plan; or a condition shall exist by reason of which the PBGC would be entitled to obtain a decree adjudicating that any Material Plan must be terminated; or there shall occur a complete or partial withdrawal from, or a default, within the meaning of Section 4219(c)(5) of ERISA, with respect to, one or more Multiemployer Plans which could cause one or more members of the ERISA Group to incur a current payment obligation in excess of $5,000,000;\n(l) a judgment or order for the payment of money in excess of $5,000,000 shall be rendered against the Borrower or any Subsidiary and such judgment or order shall continue unsatisfied, unstayed and unbonded for a period of 10 days;\n(m) any of the following: (i) any person or group or persons (within the meaning of Section 13 or 14 of the Securities Exchange Act of 1934, as amended) (other than the Exempt Group) shall have acquired beneficial ownership (within the meaning of Rule 13d-3 promulgated by the Securities and Exchange Commission under said Act) of 25% or more of the outstanding shares of common stock of the Borrower; (ii) fewer than two of the following people shall be members of the Board of Directors of the Borrower: David Perini, Joseph Perini and Bart Perini; or (iii) the Borrower shall cease to own 100% of the capital stock of any Subsidiary Guarantor; or\n(n) subject to Section 2.17, any Financing Document shall cease to be in full force and effect or shall be declared null and void, or the validity or enforceability thereof shall be contested by any Obligor, or the Agent on behalf of the Banks shall at any time fail to have a valid and perfected Lien on all of the Collateral purported to be subject to such Lien, subject to no prior or equal Lien except Liens permitted by the Collateral Documents, or any Obligor shall so assert in writing;\nthen, and in every such event, the Agent shall (i) if requested by Banks having more than 50% in aggregate amount of the Commitments, by notice to the Borrower terminate the Commitments and they shall thereupon terminate, and (ii) if requested by Banks holding Notes evidencing more than 50% in aggregate principal amount of the Loans, by notice to the Borrower declare the Notes (together with accrued interest thereon) to be, and the Notes shall thereupon become, immediately due and payable without presentment, demand, protest or other notice of any kind, all of which are hereby waived by the Obligors; provided that in the case of any of the Events of Default specified in clause (i) or (j) above with respect to any Obligor, without any notice to the Borrower or any other act by the Agent or the Banks, the Commitments shall thereupon terminate and the Notes (together with accrued interest thereon) shall become immediately due and payable without presentment, demand, protest or other notice of any kind, all of which are hereby waived by the Obligors.\nSECTION 6.02. Cash Cover. The Borrower hereby agrees, in addition to the provisions of Section 6.01 hereof, that upon the occurrence and during the continuance of any Event of Default, it shall, if requested by the Agent upon instructions from Banks having more than 50% in aggregate amount of the Commitments, pay (and, in the case of any of the Events of Default specified in clause (i) or (j) above with respect to any Obligor, forthwith, without any demand or the taking of any other action by the Agent or any Bank, it shall pay) to the Agent an amount in immediately available funds equal to the then aggregate Letter of Credit Liabilities for all Letters of Credit to be held as security therefor for the benefit of all Banks.\nSECTION 6.03. Notice of Default. The Agent shall give notice to the Borrower under Section 6.01(d) promptly upon being requested to do so by any Bank and shall thereupon notify all the Banks thereof.\nARTICLE VII\nTHE AGENT\nSECTION 7.01. Appointment and Authorization. Each Bank irrevocably appoints and authorizes the Agent to take such action as agent on its behalf and to exercise such powers under the Financing Documents as are delegated to the Agent by the terms thereof, together with all such powers as are reasonably incidental thereto.\nSECTION 7.02. Agent and Affiliates. Morgan Guaranty Trust Company of New York shall have the same rights and powers under the Financing Documents as any other Bank and may exercise or refrain from exercising the same as though it were not the Agent, and Morgan Guaranty Trust Company of New York and its affiliates may accept deposits from, lend money to, and generally engage in any kind of business with the Borrower or any Subsidiary or affiliate of the Borrower as if it were not the Agent hereunder.\nSECTION 7.03. Action by Agent. The obligations of the Agent under the Financing Documents are only those expressly set forth herein. Without limiting the generality of the foregoing, the Agent shall not be required to take any action with respect to any Default, except as expressly provided in Article VI.\nSECTION 7.04. Consultation with Experts. The Agent may consult with legal counsel (who may be counsel for an Obligor), independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken by it in good faith in accordance with the advice of such counsel, accountants or experts.\nSECTION 7.05. Liability of Agent. Neither the Agent nor any of its affiliates nor any of their respective directors, officers, agents or employees shall be liable for any action taken or not taken by it in connection herewith (i) with the consent or at the request of the Required Banks or (ii) in the absence of its own gross negligence or willful misconduct. Neither the Agent nor any of its affiliates nor any of their respective directors, officers, agents or employees shall be responsible for or have any duty to ascertain, inquire into or verify (i) any statement, warranty or representation made in connection with the Financing Documents or any borrowing hereunder; (ii) the performance or observance of any of the covenants or agreements of the Borrower; (iii) the satisfaction of any condition specified in Article III, except receipt of items required to be delivered to the Agent; or (iv) the validity, effectiveness or genuineness of any Financing Document or any other instrument or writing furnished in connection herewith. The Agent shall not incur any liability by acting in reliance upon any notice, consent, certificate, statement, or other writing (which may be a bank wire, telex or similar writing) believed by it to be genuine or to be signed by the proper party or parties.\nSECTION 7.06. Indemnification. Each Bank shall, ratably in accordance with its Commitment, indemnify the Agent, its affiliates and their respective directors, officers, agents and employees (to the extent not reimbursed by the Borrower) against any cost, expense (including reasonable counsel fees and disbursements), claim, demand, action, loss or liability (except such as result from such indemnitees' gross negligence or willful misconduct) that such indemnitees may suffer or incur in\nconnection with this Agreement or any action taken or omitted by such indemnitees hereunder.\nSECTION 7.07. Credit Decision. Each Bank acknowledges that it has, independently and without reliance upon the Agent or any other Bank, and based on such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Bank also acknowledges that it will, independently and without reliance upon the Agent or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking any action under this Agreement.\nSECTION 7.08. Successor Agent. The Agent may resign at any time by giving notice thereof to the Banks and the Borrower. Upon any such resignation, the Required Banks shall have the right to appoint a successor Agent. If no successor Agent shall have been so appointed by the Required Banks, and shall have accepted such appointment, within 30 days after the retiring Agent gives notice of resignation, then the retiring Agent may, on behalf of the Banks, appoint a successor Agent, which shall be a commercial bank organized or licensed under the laws of the United States of America or of any State thereof and having a combined capital and surplus of at least $150,000,000. Upon the acceptance of its appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations hereunder. After any retiring Agent's resignation hereunder as Agent, the provisions of this Article shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Agent.\nSECTION 7.09. Collateral Documents. (a) As to any matters not expressly provided for in the Collateral Documents (including the timing and methods of realization upon the Collateral), the Agent shall act or refrain from acting in accordance with written instructions from the Required Banks or, in the absence of such instructions, in accordance with its discretion; provided that the Agent shall not be obligated to take any action if the Agent believes that such action is or may be contrary to any applicable law or might cause the Agent to incur any loss or liability for which it has not been indemnified to its satisfaction.\n(b) The Agent shall not be responsible for the existence, genuineness or value of any of the Collateral or for the validity, perfection, priority or enforceability of the security interests in any of the Collateral, whether impaired by operation of law or by reason of any action or omission to act on its part under the Collateral Documents. The Agent shall have no duty to ascertain or inquire as to the performance or observance of any of the terms of the Collateral Documents by any Obligor.\nARTICLE VIII\nCHANGE IN CIRCUMSTANCES\nSECTION 8.01. Basis for Determining Interest Rate Inadequate or Unfair. If on or prior to the first day of any Interest Period for any Fixed Rate Borrowing:\n(a) the Agent is advised by the Reference Banks that deposits in dollars (in the applicable amounts) are not being offered to the Reference Banks in the relevant market for such Interest Period, or\n(b) Banks having 50% or more of the aggregate amount of the Commitments advise the Agent that the Adjusted CD Rate or the Adjusted\nLondon Interbank Offered Rate, as the case may be, as determined by the Agent will not adequately and fairly reflect the cost to such Banks of funding their CD Loans or Euro-Dollar Loans, as the case may be, for such Interest Period,\nthe Agent shall forthwith give notice thereof to the Borrower and the Banks, whereupon until the Agent notifies the Borrower that the circumstances giving rise to such suspension no longer exist, the obligations of the Banks to make CD Loans or Euro-Dollar Loans, as the case may be, shall be suspended. Unless the Borrower notifies the Agent at least two Domestic Business Days before the date of any Fixed Rate Borrowing for which a Notice of Borrowing has previously been given that it elects not to borrow on such date, such Borrowing shall instead be made as a Base Rate Borrowing.\nSECTION 8.02. Illegality. If, after the date of this Agreement, the adoption of any applicable law, rule or regulation, or any change in any applicable law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Euro-Dollar Lending Office) with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency shall make it unlawful or impossible for any Bank (or its Euro-Dollar Lending Office) to make, maintain or fund its Euro-Dollar Loans and such Bank shall so notify the Agent, the Agent shall forthwith give notice thereof to the other Banks and the Borrower, whereupon until such Bank notifies the Borrower and the Agent that the circumstances giving rise to such suspension no longer exist, the obligation of such Bank to make Euro-Dollar Loans shall be suspended. Before giving any notice to the Agent pursuant to this Section, such Bank shall designate a different Euro-Dollar Lending Office if such designation will avoid the need for giving such notice and will not, in the judgment of such Bank, be otherwise disadvantageous to such Bank. If such Bank shall determine that it may not lawfully continue to maintain and fund any of its outstanding Euro-Dollar Loans to maturity and shall so specify in such notice, the Borrower shall immediately prepay in full the then outstanding principal amount of each such Euro-Dollar Loan, together with accrued interest thereon. Concurrently with prepaying each such Euro-Dollar Loan, the Borrower shall borrow a Base Rate Loan in an equal principal amount from such Bank (on which interest and principal shall be payable contemporaneously with the related Euro-Dollar Loans of the other Banks), and such Bank shall make such a Base Rate Loan.\nSECTION 8.03. Increased Cost and Reduced Return. (a) If after the date hereof, the adoption of any applicable law, rule or regulation, or any change in any applicable law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Applicable Lending Office) with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency:\n(i) shall subject any Bank (or its Applicable Lending Office) to any tax, duty or other charge with respect to its Fixed Rate Loans, its Note or its obligation to make Fixed Rate Loans, or shall change the basis of taxation of payments to any Bank (or its Applicable Lending Office) of the principal of or interest on its Fixed Rate Loans or any other amounts due under this Agreement in respect of its Fixed Rate Loans or its obligation to make Fixed Rate Loans (except for changes in the rate of tax on the overall net income of such Bank or its Applicable Lending Office imposed by the jurisdiction in which\nsuch Bank's principal executive office or Applicable Lending Office is located); or\n(ii) shall impose, modify or deem applicable any reserve (including, without limitation, any such requirement imposed by the Board of Governors of the Federal Reserve System, but excluding (A) with respect to any CD Loan any such requirement included in an applicable Domestic Reserve Percentage and (B) with respect to any Euro-Dollar Loan any such requirement included in an applicable Euro-Dollar Reserve Percentage), special deposit, insurance assessment (excluding, with respect to any CD Loan, any such requirement reflected in an applicable Assessment Rate) or similar requirement against assets of, deposits with or for the account of, or credit extended by, any Bank (or its Applicable Lending Office) or shall impose on any Bank (or its Applicable Lending Office) or on the United States market for certificates of deposit or the London interbank market any other condition affecting its Fixed Rate Loans, its Note or its obligation to make Fixed Rate Loans;\nand the result of any of the foregoing is to increase the cost to such Bank (or its Applicable Lending Office) of making or maintaining any Fixed Rate Loan, or to reduce the amount of any sum received or receivable by such Bank (or its Applicable Lending Office) under this Agreement or under its Note with respect thereto, by an amount deemed by such Bank to be material, then, within 15 days after demand by such Bank (with a copy to the Agent), the Borrower shall pay to such Bank such additional amount or amounts as will compensate such Bank for such increased cost or reduction.\n(b) If any Bank shall have determined that, after the date hereof, the adoption of any applicable law, rule or regulation regarding capital adequacy, or any change in any such law, rule or regulation, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on capital of such Bank (or its Parent) as a consequence of such Bank's obligations hereunder to a level below that which such Bank (or its Parent) could have achieved but for such adoption, change, request or directive (taking into consideration its policies with respect to capital adequacy) by an amount deemed by such Bank to be material, then from time to time, within 15 days after demand by such Bank (with a copy to the Agent), the Borrower shall pay to such Bank such additional amount or amounts as will compensate such Bank (or its Parent) for such reduction.\n(c) Each Bank will promptly notify the Borrower and the Agent of any event of which it has knowledge, occurring after the date hereof, which will entitle such Bank to compensation pursuant to this Section and will designate a different Applicable Lending Office if such designation will avoid the need for, or reduce the amount of, such compensation and will not, in the judgment of such Bank, be otherwise disadvantageous to such Bank. A certificate of any Bank claiming compensation under this Section and setting forth the additional amount or amounts to be paid to it hereunder shall be conclusive in the absence of manifest error. In determining such amount, such Bank may use any reasonable averaging and attribution methods.\nSECTION 8.04. Base Rate Loans Substituted for Affected Fixed Rate Loans. If (i) the obligation of any Bank to make Euro-Dollar Loans has been suspended pursuant to Section 8.02 or (ii) any Bank has demanded compensation under Section 8.03(a) and the Borrower shall, by at least\nfive Euro-Dollar Business Days' prior notice to such Bank through the Agent, have elected that the provisions of this Section shall apply to such Bank, then, unless and until such Bank notifies the Borrower that the circumstances giving rise to such suspension or demand for compensation no longer exist:\n(a) all Loans which would otherwise be made by such Bank as CD Loans or Euro-Dollar Loans, as the case may be, shall be made instead as Base Rate Loans (on which interest and principal shall be payable contemporaneously with the related Fixed Rate Loans of the other Banks), and\n(b) after each of its CD Loans or Euro-Dollar Loans, as the case may be, has been repaid, all payments of principal which would otherwise be applied to repay such Fixed Rate Loans shall be applied to repay its Base Rate Loans instead.\nARTICLE IX\nMISCELLANEOUS\nSECTION 9.01. Notices. All notices, requests and other communications to any party hereunder shall be in writing (including bank wire, telex, facsimile transmission or similar writing) and shall be given to such party: (x) in the case of the Borrower or the Agent, at its address or telex or facsimile number set forth on the signature pages hereof, (y) in the case of any Bank, at its address or telex or facsimile number set forth in its Administrative Questionnaire or (z) in the case of any party, such other address or telex or facsimile number as such party may hereafter specify for the purpose by notice to the Agent and the Borrower. Each such notice, request or other communication shall be effective (i) if given by telex, when such telex is transmitted to the telex number specified in this Section and the appropriate answerback is received, (ii) if given by facsimile transmission, when such facsimile is transmitted to the facsimile number specified in this Section and receipt of such facsimile is confirmed, either orally or in writing, by the party receiving such transmission, (iii) if given by certified mail, 72 hours after such communication is deposited in the mails with first class postage prepaid, addressed as aforesaid or (iv) if given by any other means, when delivered at the address specified in this Section; provided that notices to the Agent under Article II or Article VIII shall not be effective until received.\nSECTION 9.02. No Waivers. No failure or delay by the Agent or any Bank in exercising any right, power or privilege under any Financing Document shall operate as a waiver thereof nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies therein provided shall be cumulative and not exclusive of any rights or remedies provided by law.\nSECTION 9.03. Expenses; Documentary Taxes; Indemnification. (a) The Borrower shall pay (i) all out-of-pocket expenses of the Agent, including fees and disbursements of special counsel for the Agent, in connection with the preparation of the Financing Documents, any waiver or consent under any Financing Document, or any amendment of any Financing Document or any Default or alleged Default and (ii) if an Event of Default occurs, all out-of-pocket expenses incurred by the Agent and each Bank, including fees and disbursements of counsel (including allocated costs of internal counsel and disbursements of internal counsel), in connection with such Event of Default and collection, bankruptcy, insolvency and other enforcement proceedings resulting therefrom. The Borrower shall\nindemnify each Bank against any transfer taxes, documentary taxes, assessments or charges made by any governmental authority by reason of the execution and delivery of any Financing Document.\n(b) The Borrower agrees to indemnify the Agent and each Bank, their respective affiliates and the respective directors, officers, agents and employees of the foregoing (each an \"Indemnitee\") and hold each Indemnitee harmless from and against any and all liabilities, losses, damages, costs and expenses of any kind, including, without limitation, the reasonable fees and disbursements of counsel (including allocated costs of internal counsel and disbursements of internal counsel), which may be incurred by any Indemnitee in connection with any investigative, administrative or judicial proceeding (whether or not such Indemnitee shall be designated a party thereto) brought or threatened relating to or arising out of any Financing Document or any actual or proposed use of proceeds of Loans hereunder; provided that no Indemnitee shall have the right to be indemnified hereunder for such Indemnitee's own gross negligence or willful misconduct as determined by a court of competent jurisdiction.\n(c) The Borrower agrees to indemnify each Indemnitee and hold each Indemnitee harmless from and against any and all liabilities, losses, damages, costs and expenses of any kind (including without limitation reasonable expenses of investigation by engineers, environmental consultants and similar technical personnel and reasonable fees and disbursements of counsel including allocated costs of internal counsel and disbursements of internal counsel) of any Indemnitee arising out of, in respect of or in connection with any and all Environmental Liabilities. Without limiting the generality of the foregoing, the Borrower hereby waives all rights for contribution or any other rights of recovery with respect to liabilities, losses, damages, costs or expenses arising under or related to Environmental Laws that it might have by statute or otherwise against any Indemnitee.\nSECTION 9.04. Sharing of Setoffs. Each Bank agrees that if it shall, by exercising any right of setoff or counterclaim or otherwise, receive payment of a proportion of the aggregate amount due with respect to any Loan or Reimbursement Obligation owed to it which is greater than the proportion received by any other Bank in respect of the aggregate amount due with respect to any Loan or Reimbursement Obligation owed to such other Bank, the Bank receiving such proportionately greater payment shall purchase such participations in the Loans and Reimbursement Obligations owed to the other Banks, and such other adjustments shall be made, as may be required so that all such payments with respect to the Loans and Reimbursement Obligations owed to the Banks shall be shared by the Banks pro rata; provided that nothing in this Section shall impair the right of any Bank to exercise any right of setoff or counterclaim it may have and to apply the amount subject to such exercise to the payment of indebtedness of the Borrower other than its indebtedness hereunder. The Borrower agrees, to the fullest extent it may effectively do so under applicable law, that any holder of a participation in a Loan or Reimbursement Obligation, whether or not acquired pursuant to the foregoing arrangements, may exercise rights of setoff or counterclaim and other rights with respect to such participation as fully as if such holder of a participation were a direct creditor of the Borrower in the amount of such participation.\nSECTION 9.05. Amendments and Waivers. Any provision of this Agreement or the Notes may be amended or waived if, but only if, such amendment or waiver is in writing and is signed by the Borrower and the Required Banks (and, if the rights or duties of the Agent are affected thereby, by it); provided that no such amendment or waiver shall, unless signed by all the Banks, (i) increase or decrease the Commitment of any\nBank (except for a ratable decrease in the Commitments of all Banks) or subject any Bank to any additional obligation, (ii) reduce the principal of or rate of interest on any Loan or any fees hereunder, (iii) postpone the date fixed for any payment of principal of or interest on any Loan, any Reimbursement Obligation or any fees hereunder or for termination of any Commitment, (iv) amend or waive any of the provisions of Article VIII, (v) change the percentage of the Commitments or of the aggregate unpaid principal amount of the Notes, or the number of Banks, which shall be required for the Banks or any of them to take any action under this Section or any other provision of the Financing Documents or (vi) release any Subsidiary Guarantor from the Subsidiary Guarantee Agreement.\nSECTION 9.06. Successors and Assigns. (a) The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, except that the Borrower may not assign or otherwise transfer any of its rights under this Agreement without the prior written consent of all Banks.\n(b) Any Bank may at any time grant to one or more banks or other institutions (each a \"Participant\") participating interests in its Commitment or any or all of its Loans. In the event of any such grant by a Bank of a participating interest to a Participant, whether or not upon notice to the Borrower and the Agent, such Bank shall remain responsible for the performance of its obligations hereunder, and the Borrower and the Agent shall continue to deal solely and directly with such Bank in connection with such Bank's rights and obligations under this Agreement. Any agreement pursuant to which any Bank may grant such a participating interest shall provide that such Bank shall retain the sole right and responsibility to enforce the obligations of the Borrower hereunder including, without limitation, the right to approve any amendment, modification or waiver of any provision of this Agreement; provided that such participation agreement may provide that such Bank will not agree to any modification, amendment or waiver of this Agreement described in clause (i), (ii) or (iii) of Section 9.05 without the consent of the Participant. The Borrower agrees that each Participant shall, to the extent provided in its participation agreement, be entitled to the benefits of Article VIII with respect to its participating interest. An assignment or other transfer which is not permitted by subsection (c) or (d) below shall be given effect for purposes of this Agreement only to the extent of a participating interest granted in accordance with this subsection (b).\n(c) Any Bank may at any time assign to one or more banks or other institutions (each an \"Assignee\") all, or a proportionate part of all, of its rights and obligations under this Agreement and the Notes and such Assignee shall assume such rights and obligations, pursuant to an Assignment and Assumption Agreement in substantially the form of Exhibit I hereto executed by such Assignee and such transferor Bank, with (and subject to) the subscribed consent of the Borrower (which shall not be unreasonably withheld) and the Agent; provided that if an Assignee is an affiliate of such transferor Bank, no such consent shall be required. Upon execution and delivery of such instrument and payment by such Assignee to such transferor Bank of an amount equal to the purchase price agreed between such transferor Bank and such Assignee, such Assignee shall be a Bank party to this Agreement and shall have all the rights and obligations of a Bank with a Commitment as set forth in such instrument of assumption, and the transferor Bank shall be released from its obligations hereunder to a corresponding extent, and no further consent or action by any party shall be required. Upon the consummation of any assignment pursuant to this subsection (c), the transferor Bank, the Agent and the Borrower shall make appropriate arrangements so that, if required, a new Note is issued to the Assignee. In connection with any such assignment, the transferor Bank shall pay to the Agent an administrative fee for\nprocessing such assignment in the amount of $2,500.\n(d) Any Bank may at any time assign all or any portion of its rights under this Agreement and its Note to a Federal Reserve Bank. No such assignment shall release the transferor Bank from its obligations hereunder.\n(e) No Assignee, Participant or other transferee of any Bank's rights shall be entitled to receive any greater payment under Section 8.03 than such Bank would have been entitled to receive with respect to the rights transferred, unless such transfer is made with the Borrower's prior written consent or by reason of the provisions of Section 8.02 or 8.03 requiring such Bank to designate a different Applicable Lending Office under certain circumstances or at a time when the circumstances giving rise to such greater payment did not exist.\nSECTION 9.07. Collateral. Each of the Banks represents to the Agent and each of the other Banks that it in good faith is not relying upon any \"margin stock\" (as defined in Regulation U) as collateral in the extension or maintenance of the credit provided for in this Agreement.\nSECTION 9.08. Governing Law; Submission to Jurisdiction. This Agreement and each Note shall be construed in accordance with and governed by the law of the State of New York. The Borrower hereby submits to the nonexclusive jurisdiction of the United States District Court for the Southern District of New York and of any New York State court sitting in New York City for purposes of all legal proceedings arising out of or relating to this Agreement or the transactions contemplated hereby. The Borrower irrevocably waives, to the fullest extent permitted by law, any objection which it may now or hereafter have to the laying of the venue of any such proceeding brought in such a court and any claim that any such proceeding brought in such a court has been brought in an inconvenient forum.\nSECTION 9.09. Counterparts; Integration. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Agreement constitutes the entire agreement and understanding among the parties hereto and supersedes any and all prior agreements and understandings, oral or written, relating to the subject matter hereof.\nSECTION 9.10. WAIVER OF JURY TRIAL. EACH OF THE OBLIGORS, THE AGENT AND THE BANKS HEREBY IRREVOCABLY WAIVES ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY.\nIN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written.\nPERINI CORPORATION\nBy \/s\/ John H. Schwarz ---------------------------- Title: Exec. Vice President, Finance & Admin.\nBy \/s\/ Susan C. Mellace ---------------------------- Title: Vice President & Treasurer\n73 Mount Wayte Avenue Framingham, MA 01701 Facsimile number: (508) 628-2960\nCommitments\nTranche A: MORGAN GUARANTY TRUST COMPANY $22,704,000.00 OF NEW YORK Tranche B: $3,096,000.00\nBy \/s\/ Robert Bottamedi ---------------------------- Title: Vice President\nTranche A: SHAWMUT BANK, N.A. $22,704,000.00 Tranche B: $3,096,000.00\nBy \/s\/ Robert J. Lord ---------------------------- Title: Director\nTranche A: BANK OF AMERICA NATIONAL TRUST AND $16,016,000.00 SAVINGS ASSOCIATION Tranche B: $2,184,000.00\nBy \/s\/ Richard J. Cerf --------------------------------- Title: Vice President\nTranche A: FLEET BANK OF MASSACHUSETTS, N.A. $16,016,000.00 Tranche B: $2,184,000.00\nBy \/s\/ Jeffery Bauer ------------------------------- Title: Vice President\nTranche A: BAYBANK BOSTON, N.A., as Bank and $10,560,00.00 as LC Bank Tranche B: $1,440,00.00\nBy \/s\/ Timothy M. Laurion --------------------------------- Title: Vice President\nTranche A: COMERICA BANK $8,800,000.00 Tranche B: $1,200,000.00\nBy \/s\/ Jon A. Bird -------------------------------- Title: Vice President\nTranche A: HARRIS TRUST & SAVINGS BANK $8,800,000.00 Tranche B: $1,200,000.00\nBy \/s\/ David L. Sauerman ------------------------------ Title: Vice President\nTranche A: STATE STREET BANK AND TRUST COMPANY $4,400,000.00 Tranche B: $600,000.00\nBy \/s\/ Linda A. Moulton ------------------------------ Title: Vice President\n_________________ Total Commitments $125,000,000\nMORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Agent\nBy \/s\/ Robert Bottamedi --------------------------------- Title: Vice President\n60 Wall Street New York, New York 10260 Attn: Robert Bottamedi Telex number: 177615 MGT UT Facsimile number: (212) 648-5023\nEXHIBIT 22\nPERINI CORPORATION\nSUBSIDIARIES OF THE REGISTRANT\nPercentage of Interest or Place Voting Name of Organization Securities Owned\nPerini Corporation Massachusetts\nPerini Building Company, Inc. Arizona 100%\nPioneer Construction, Inc. West Virginia 100%\nPerland Environmental Delaware 100% Technologies, Inc.\nInternational Construction Delaware 100% Management Services, Inc.\nPercon Constructors, Inc. Delaware 100%\nPerini International Massachusetts 100% Corporation\nBow Leasing Company, Inc. New Hampshire 100%\nPerini Land & Development Massachusetts 100% Company\nParamount Development Massachusetts 100% Associates, Inc.\nI-10 Industrial Park Arizona General 80% Developers Partnership\nPerini Resorts, Inc. California 100%\nGlenco-Perini - HCV California 45% Partners Limited Partnership\nSquaw Creek Associates California 40% General Partnership\nPerland Realty Associates, Florida 100% Inc.\nRincon Center Associates California 46% Limited Partnership\nPerini Central Limited Arizona Limited 75% Partnership Partnership\nPerini Eagle Limited Arizona Limited 50% Partnership Partnership\nPerini\/138 Joint Venture Georgia General 49% Partnership\nPerini\/RSEA Partnership Georgia General 50% Partnership\nEXHIBIT 23\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the use of our reports, dated February 10, 1995, included in Perini Corporation's Annual Report on this Form 10-K for the year ended December 31, 1994, and into the Company's previously filed Registration Statements Nos. 2-82117, 33-24646, 33-46961, 33-53190, 33-53192, 33-60654, 33-70206 and 33-52967.\nARTHUR ANDERSEN LLP\nBoston, Massachusetts March 22, 1995\nEXHIBIT 24\nPOWER OF ATTORNEY\nWe, the undersigned, Directors of Perini Corporation, hereby severally constitute David B. Perini, John H. Schwarz and Richard E. Burnham, and each of them singly, our true and lawful attorneys, with full power to them and to each of them to sign for us, and in our names in the capacities indicated below, any Annual Report on Form 10-K pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 to be filed with the Securities and Exchange Commission and any and all amendments to said Annual Report on Form 10-K, hereby ratifying and confirming our signatures as they may be signed by our said Attorneys to said Annual Report on Form 10-K and to any and all amendments thereto and generally to do all such things in our names and behalf and in our said capacities as will enable Perini Corporation to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission.\nWITNESS our hands and common seal on the date set forth below.\ns\/David B. Perini Director March 22, 1995 ---------------------- Date David B. Perini\ns\/Joseph R. Perini Director March 22, 1995 ---------------------- Date Joseph R. Perini\ns\/Richard J. Boushka Director March 22, 1995 ---------------------- Date Richard J. Boushka\ns\/Marshall M. Criser Director March 22, 1995 ---------------------- Date Marshall M. Criser\ns\/Thomas E. Dailey Director March 22, 1995 ---------------------- Date Thomas E. Dailey\ns\/Albert A. Dorman Director March 22, 1995 ---------------------- Date Albert A. Dorman\ns\/Arthur J. Fox, Jr. Director March 22, 1995 ---------------------- Date Arthur J. Fox, Jr.\ns\/Nancy Hawthorne Director March 22, 1995 ---------------------- Date Nancy Hawthorne\ns\/John J. McHale Director March 22, 1995 ---------------------- Date John J. McHale\ns\/Jane E. Newman Director March 22, 1995 ---------------------- Date Jane E. Newman\ns\/Bart W. Perini Director March 22, 1995 ---------------------- Date Bart W. Perini\nEXHIBIT 27\nFINANCIAL DATA SCHEDULE\nThis schedule contains summary financial information extracted from the Consolidated Balance Sheets as of December 31, 1994 and the Consolidated Statements of Operations for the twelve months ended December 31, 1994 and is qualified in its entirety by reference to such financial statements.\nMultiplier 1,000 Period Type 12 Months Fiscal Year End December 31, 1994 Period End December 31, 1994 Cash 7,841 Securities 0 Receivables 151,620 Allowances 0 Inventory 11,525 Current Assets 266,648 (F1) PP&E 42,588 Depreciation (29,082) Total Assets 482,500 (F2) Current Liabilities 236,700 Bonds 76,986 Common 4,985 Preferred Mandatory 100 Preferred 0\nOther SE 0 Total Liability and 482,500 (F3) Equity Sales 0 Total Revenues 1,012,045 CGS 0 Total Costs (960,248) Other Expenses (856) Loss Provision 0 Interest Expense (7,473) Income Pretax 483 (F4) Income Tax (180) Income Continuing 303 Discontinued 0 Extraordinary 0 Changes 0 Net Income 303 EPS Primary (.42) EPS Diluted 0\n(F1) Includes Equity in Construction Joint Ventures of $66,346, Unbilled Work of $20,209, and Other Short-Term Assets of $9,107, not currently reflected in this tag list.\n(F2) Includes investments in and advances to Real Estate Joint Ventures of $148,843, Land Held for Sale or Development of $43,295, and Other Long-Term Assets of $10,208 not currently reflected in this tag list.\n(F3) Includes Deferred Income Taxes and Other Liabilities of $33,488, Minority Interest of $3,297, Paid-In Surplus of $59,001, Retained Earnings of $81,772, ESOT Related Obligations of $(6,009), and Treasury Stock of $(7,820).\n(F4) Includes General, Administrative and Selling Expenses of $(42,985), not currently reflected on this tag list.","section_15":""}
{"filename":"54502_1994.txt","cik":"54502","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3: LEGAL PROCEEDINGS\nMystery Bridge Road Environmental Matters\nThe Company was named as one of four potentially responsible parties (\"PRPs\") at a U.S. Environmental Protection Agency (\"EPA\") Superfund site known as the Mystery Bridge Road\/U.S. Highway 20 site located\nnear Casper, Wyoming (the \"Brookhurst Subdivision\"). The EPA's remedy consists of two parts, \"Operating Unit One,\" which addresses the groundwater cleanup and \"Operating Unit Two,\" which addresses cleanup procedures for the soil and free-phase petroleum product. A Consent Decree between the Company, the EPA and another PRP was entered on October 2, 1991, in the Wyoming Federal District Court. Groundwater cleanup under Operating Units One and Two have been proceeding since 1990 and 1992, respectively, and is expected to proceed through 1996 at a total cost remaining estimated not to exceed $150,000. (United States of America v. Dow Chemical Company, Dowell Schlumberger, Inc., and K N Energy, Inc., Civil Action No. 91CV1042, United States District Court for the District of Wyoming; formerly reported as Administrative Orders for Removal Action on Consent, October 15, 1987, and Amendment to Administrative Order for Removal Order on Consent, October 10, 1989, Docket No. CERCLA VII-88-01, United States Environmental Protection Agency; Judicial Entry of Consent Decree, United States v. Dow Chemical Company, et al. (D. Wyo) USDC-WY-91CV1042B, Superfund Site Number 8T83, Natrona County, Wyoming; EPA Docket Number CERCLA-VIII.)\nOther Environmental Matters\nAn environmental audit performed by the Company revealed that a grease known as Rockwell 860 had been used as a valve sealant at several of the Company's locations in Nebraska and Colorado. Rockwell 860 is a solid clay-like material which does not easily spill into the environment, but contains approximately ten percent PCBs. The PCBs are contained within the pipeline and valves at the subject locations. PCBs are regulated under the Toxic Substances Control Act. On March 31, 1993, the Company filed suit against Rockwell International Corporation, manufacturer of the valve sealant, and two other related defendants, alleging that the defendants were responsible for the Company's environmental expenses and commercial losses resulting from any EPA or state required PCB cleanup or mitigation. The Company settled with Rockwell, et al. in March 1994 which resolved all disputes between the parties. (K N Energy, Inc. and Rocky Mountain Natural Gas Company v. Rockwell International Corp et al., United States District Court for the District of Colorado, Case No. 93-711.)\nDuring February 1994, the Company submitted its Phase I Report and PCBs Work Plan to EPA Region VII (covering Nebraska) and EPA Region VIII (covering Colorado). During March 1994, EPA Region VIII accepted both the Phase I Report and the PCBs Work Plan as administratively complete. EPA Region VIII also granted the Company permission to proceed with implementation of the PCBs management and remediation activities described in its Work Plan to address sites in Colorado. EPA Region VII has not yet formally responded. The Company currently estimates the total cost of remediation to be approximately $1.7 million, a substantial portion of which is recoverable under the Rockwell settlement. The unrecoverable amount will not have a material adverse impact on the Company's financial position or results of operations. The PCBs cleanup program is not expected to interrupt or diminish the Company's operational ability to gather or transport natural gas, and will occur over a period of years.\nCertain used pipe reclaimed at the Company's Holdrege, Nebraska pipeyard was wrapped with asphalt-saturated asbestos felt, which was commonly removed in accordance with Company practices. The removed wrap contains friable asbestos fibers above the regulatory standard. The Nebraska Department of Environmental Control, the agency having jurisdiction over this matter, was notified and approved the Company's remediation plan. Remediation was effectively completed in 1994 and the total cost is not expected to exceed $700,000. The asbestos cleanup program did not interrupt or diminish the Company's operational ability to gather or transport natural gas.\nIn the spring of 1994, the Kansas Department of Health and Environment (\"KDHE\") notified a number of pipeline companies operating in Kansas, including K N, that residual elemental mercury might be present in the soils adjacent to certain natural gas metering facilities. In July 1994, the Company initiated a mercury sampling program on its systems in central and western portions of Kansas, pursuant to a five year assessment program which has been approved by the KDHE and will require that 20 percent (135) of the 675 sites be tested each year. The sampling for the first year has been completed; however, no determination regarding remediation has been reached at this time. The Company currently cannot estimate the extent of the remediation nor the costs, although the Company believes all or a portion of such costs will be recoverable from insurance carriers. On December 27, 1994, the Company received notice from the KDHE that no active remediation will be required until completion of the five-year assessment program. Such costs are not expected to have any material adverse impact on the Company's financial position or results of operations. The mercury cleanup program is not expected to interrupt or diminish the Company's operational ability to gather or transport natural gas.\nIn May 1994, the Company discovered that use of a lubricating oil containing PCBs has caused contamination in certain equipment, soils and liquids at the Company's Scott City, Kansas, helium extraction facility. A Site Assessment Report has been submitted to the EPA for its review, and no response has yet been received. The Company's investigation of this situation is ongoing, and a workplan is being developed for EPA review. The Company estimates the total cost for remediation to be approximately $600,000, which is not expected to have a material adverse impact on the Company's financial position or results of operations. The PCBs cleanup program is not expected to interrupt or diminish the Company's operational ability at the helium facility.\nEffective April 1, 1992, the Company acquired substantially all of the assets and assumed substantially all of the liabilities of the Maple Gas Corporation (\"Maple\"). The assets consisted of 10 natural gas processing plants and approximately 1,100 miles of related gas gathering pipelines. The Maple assets contained certain environmental liabilities for which the Company obtained indemnifications from Maple and the Cabot Corporation (\"Cabot\"). The Company is unable to estimate its potential exposure, if any, for such liabilities at this time, but does not expect them to have any material adverse impact on the company's financial position or results of operation.\nIn November 1989, the Company acquired gathering and transmission assets from certain subsidiaries of Cabot. These assets contained certain environmental liabilities for which the Company obtained indemnities from Cabot pursuant to an Omnibus Acquisition Agreement. Issues have arisen concerning Cabot's indemnification obligations; however, in conjunction with the merger, the Company and Cabot entered into a standstill agreement pertaining to these and other matters. The Company believes it will be able to reach agreement with Cabot, and is unable to estimate its potential exposure for such liabilities at this time, but does not expect them to have a material adverse impact on the Company's financial position or results of operations.\nGrynberg v. K N,et al.\nOn October 9, 1992, Jack J. Grynberg filed suit in the United States District Court for the District of Colorado against the Company, Rocky Mountain Natural Gas Company and GASCO, Inc. (the \"K N Entities\") alleging that the K N Entities as well as K N Production Company and K N Gas Gathering, Inc., have violated Federal and state antitrust laws. In essence, Grynberg asserts that the companies have engaged in an illegal\nexercise of monopoly power, have illegally denied him economically feasible access to essential facilities to transport and distribute gas produced from fewer than 20 wells located in northwest Colorado, and have illegally attempted to monopolize or to enhance or maintain an existing monopoly. Grynberg also asserts certain causes of action relating to a gas purchase contract. No specific monetary damages have been claimed, although Grynberg has requested that any actual damages awarded be trebled. In addition, Grynberg has requested that the K N Entities be ordered to divest all interests in natural gas exploration, development and production properties, all interests in distribution and marketing operations, and all interests in natural gas storage facilities, separating these interests from the Company's natural gas gathering and transportation system in northwest Colorado. On August 13, 1993, the United States District Court, District of Colorado, stayed this proceeding pending exhaustion of appeals in a related state court action involving the same plaintiff. (Grynberg v. K N, et al., Civil Action No. 92-2000, United States District Court for the District of Colorado.)\nWesterman, et al. v. K N Energy, Inc.,et al.\nOn December 8, 1994, K N and its wholly owned subsidiary K N Gas Supply Services, Inc. were sued by gas producers in northeastern Colorado in District Court, Dallas County, Texas, under claims arising from two gas purchase contracts covering gas purchases from wells in the Niobrara Field, Colorado. The producers assert take-or-pay claims for contract years 1993 and 1994 in the amount of $1,157,000 plus interest, as well as actual and punitive damages in the amount of $156,000,000 for breaches of contractual and fiduciary duties arising out of a January 1977 Farmout Agreement between the producers and K N.\nOn December 21, 1994, the lawsuit was removed from Texas state court to the United States District Court for the Northern District of Texas (Dallas). (Westerman, et al. v. K N Energy, Inc. and K N Gas Supply Services, Inc., Civil Action No.:3:94-CV-2773-X, United States District Court for the Northern District of Texas, Dallas Division.)\nTake-or-Pay Matters\nCertain of the companies acquired from Cabot when the Company acquired the Westar System were parties to a number of lawsuits or were subject to asserted claims by natural gas purchase contracts containing take-or-pay provisions, which require the purchaser either to take a minimum amount of gas or to pay for such minimum quantities. All of these lawsuits and most claims have been resolved under terms which the Company considers favorable. Most gas suppliers of the Company have entered into excess gas purchase contracts with one of the Company's gas marketing subsidiaries. These excess gas purchases contracts are generally credited against take-or-pay gas volumes, which minimizes take-or-pay exposure.\nThe Basket Agreement between the Company and Cabot provides for an equal sharing of up to $40 million (any excess will be borne solely by Cabot) between the Company and Cabot of certain gas contract take-or-pay liabilities of the companies acquired from Cabot for periods prior to the closing date of the acquisition from Cabot and for certain other potential gas contract claims. (See \"Items 1 and 2: Business and Properties\"). The Company's maximum exposure under this arrangement is $20 million. The Company's estimated liability under the Basket Agreement is approximately $6.0 million, which was recorded in connection with the acquisition of the natural gas pipeline business from Cabot, and as such will not have a material adverse effect on the Company's financial position or results of operation. As of December 31, 1994, the Company had made net payments of approximately $12.4 million.\nThe Company is also involved in various disputes and litigation arising in the normal course of business including take-or-pay exposure not covered by the matters discussed above, including the Westerman litigation described in this Item 3. The Company believes that it has adequate defenses or insurance coverage relating to such litigation and that the outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on the Company's financial position or results of operations.\nThe Company believes it has meritorious defenses to all lawsuits and legal proceedings in which it is a defendant and will vigorously defend against them. Based on its evaluation of the above matters, and after consideration of reserves established, the Company believes that the resolution of such matters will not have a material adverse effect on the Company's financial position or results of operations.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nEXECUTIVE OFFICERS OF THE REGISTRANT\n(A) Identification and Business Experience of Executive Officers\nThese officers generally serve until March of each year.\n(B) Involvement in Certain Legal Proceedings\nNone.\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 for trading on the New York Stock Exchange under the symbol KNE. Dividends paid and the price range of the Company's common stock by quarters for the last two years, are provided below.\n* Pre-merger dividend rate reflects the effect of pooling of interests accounting. AOG did not pay a dividend on common stock.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nFIVE-YEAR REVIEW\nSelected Financial Data (In Thousands Except Per Share Amounts)\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCONSOLIDATED FINANCIAL RESULTS OF OPERATIONS\nIn the third quarter of 1994, the Company expensed $25.9 million of non-recurring costs related to the merger of AOG into K N and to the restructuring of the Company's retail natural gas services segment. These costs, primarily professional fees, severance-related expenses and the write-off of certain information systems costs, reduced 1994 net income by $19.3 million, or $0.69 per common share.\nExcluding the effect of the merger and restructuring costs, net income was $34.7 million, $30.9 million and $36.3 million for 1994, 1993 and 1992, respectively. After payment of preferred dividends, the respective earnings per common share were $1.21, $1.09 and $1.34.\nThe improvement in 1994 earnings over 1993 was attributable to rate increases in both retail and interstate system jurisdictions, increased deliveries to irrigation customers and expense reductions resulting from the merger. Net income in 1993 was reduced by a $4.5 million (pre-tax) write-down of an investment in a well servicing company. Operating results were adversely affected by mild fourth quarter 1994 weather (impacting systems throughput as well as margins on nonregulated gas sales) and lower 1994 prices for natural gas liquids (\"NGLs\").\nThe decline in 1993 earnings reflected the impact of unfavorable summer weather on gas sales to irrigation customers, a significant decline in prices for NGLs during the second half of 1993, and the investment write-down referred to previously. Incremental earnings from 1993 and 1992 acquisitions of natural gas gathering and processing facilities, favorable resolution of retail rate cases and insurance settlements related to environmental issues partially offset the unfavorable 1993 factors.\nRESULTS OF OPERATIONS\nOperating results by business segment, excluding the non-recurring merger and restructuring costs, and consolidated other income and (deductions) and income taxes are discussed below. The Company's retail natural gas services segment, which includes its Colorado and Wyoming intrastate operations, and the interstate transportation and storage services segment have been combined to provide meaningful comparisons. The interstate segment became a separate business unit effective with the implementation of Federal Energy Regulatory Commission (\"FERC\") Order No. 636 (\"Order 636\") on October 1, 1993. Segment operating revenues, gas purchases, operations and maintenance expenses, and volumetric data cited below are before intersegment eliminations (dollars in millions).\nThe decline in 1994 and 1993 gas sales revenues and volumes and gas purchases primarily reflects the implementation of Order 636, which became effective October 1, 1993. As a result, merchant services to wholesale customers were converted to transportation and storage services. Gas sales volumes to wholesale customers totaled 16.4 trillion Btus and 26.8 trillion Btus in 1993 and 1992, respectively. In addition to Order 636, effective January 1, 1994, the interstate segment's principal gas processing plant and substantially all of its gathering facilities were transferred to a nonjurisdictional subsidiary included in the gathering, processing and marketing services business segment. Accordingly, the above table reflects results of K N's rate-regulated businesses post-Order 636. The increase in 1993 transportation and storage revenues and volumes, compared to 1992, largely resulted from the Order 636-related change in service to wholesale customers. The full year's impact of Order 636 on 1994 transportation and storage revenues was offset by the effect of the transfer of gathering facilities. The decline in this segment's 1994 NGLs and other revenues, NGLs volumes, operations and maintenance expenses, and depreciation, depletion and amortization was primarily due to the transfer of properties. Operations and maintenance expenses were favorably impacted in the second half of 1994 due to merger savings.\nRate activity and weather have significantly influenced the operating results of this business segment. Favorable resolution of retail and interstate system rate cases generated additional annual revenues of $10.7 million during 1994. Retail rate activity in 1993 resulted in additional annual revenues of $4.9 million. The level of sales and transportation volumes delivered to irrigation customers depends on precipitation levels during the summer months. These volumes totaled 10.1 trillion Btus, 4.9 trillion Btus and 8.1 trillion Btus in 1994, 1993 and 1992, respectively. Retail sales volumes related to space heating were approximately the same in 1994 and 1992; however, 1993 sales volumes were approximately 4 trillion Btus higher, or 11 percent higher, than 1994 or 1992 due to colder weather.\nOperating results of this business segment, which include the merged AOG assets, were significantly impacted in 1994 by the transfer to this segment of certain properties from the interstate segment, as explained previously. In addition, 1994 revenues, expenses and operating income reflect the full year contribution of gathering and processing asset acquisitions in 1993 and 1992. In April 1992, the Company acquired 10 processing plants and related gathering systems. In October 1992, the Company assumed operations of the Douglas gathering and processing system. The Wattenberg gathering and transmission system was acquired in April 1993, and the Wind River joint-venture gathering facilities were acquired in June 1993.\nOperating results in 1994 and 1993 were adversely impacted by declining NGLs prices and lower margins on 1994 gas sales due, primarily, to unfavorable weather. The average NGLs price per gallon for 1994 was approximately $0.04 below 1993 prices; average prices for 1993 were $0.03 per gallon lower than 1992. Earnings from properties transferred from the interstate segment and expense reductions resulting from the merger more than offset the impact on segment operating income of lower 1994 NGLs prices and gas sales margins. The positive contributions of acquisitions (approximately $1.8 million of incremental operating income) to 1993 pre-tax earnings partially offset the effects of lower NGLs prices.\nSustained increases in revenues, expenses and production have resulted from acquisitions of gas and oil reserves and production in February 1994 and July 1992. In October 1994, the Company sold a 50 percent interest in the gas reserves and production acquired earlier in 1994. At December 31, 1994, net proved reserves were approximately 50 Bcf equivalent of natural gas.\nIncreases in interest expense resulted from the issuance of long-term debt to fund capital expenditures and acquisitions. The impact of higher amounts of long-term borrowings has been partially offset by the refunding of $65 million of higher coupon debt in 1993 and 1992. The Company realized a $1.5 million gain from the sale of a gathering system in the 1994 second quarter, which is included in \"Minority Interests and Other, Net\".\nThe 1994 effective tax rate reflects the non-deductibility of certain merger costs. Additionally, the one percent increase in the Federal tax rate, due to enactment of the Revenue Reconciliation Act of 1993, impacted the effective tax rate for both 1994 and 1993. Refer to Note 8 of Notes to Consolidated Financial Statements for a reconciliation of statutory rates to effective rates.\nLIQUIDITY AND CAPITAL RESOURCES\nThe primary sources of cash during 1994 were generated from operations, the issuance of long-term debt, the sale of contract demand receivables and short-term borrowings. Principal non-operating cash outflows included capital expenditures and acquisitions, redemptions of long-term debt and preferred stock, and payments of interest and dividends.\nCASH FLOWS FROM OPERATING ACTIVITIES\nExcluding the $41 million of proceeds from the sale of contract demand receivables and cash expenditures of $18.1 million related to the merger and restructuring, 1994 net cash flows from operations were $68.3 million, compared with $67.9 million and $51.0 million for 1993 and 1992, respectively. Net operating cash flows for 1994 and 1992 were adversely impacted by higher income tax payments, gas prepayments and litigation and environmental settlements.\nCAPITAL EXPENDITURES AND COMMITMENTS\nExcluding acquisitions, 1994 capital expenditures totaled $70.6 million compared with expenditures of $100.8 million in 1993 and $74.8 million in 1992. The higher level of spending in 1993 was due to implementation of Order 636 (measurement facilities and systems) and construction of new corporate office facilities.\nThe 1995 capital expenditures budget totals $73.9 million, excluding acquisitions. On February 16, 1995, the Company acquired natural gas transmission pipeline and storage assets in Texas for approximately $80\nmillion. The Company is negotiating the termination of certain pre-Order 636 gas purchase contracts with producers. This could result in significant expenditures in 1995.\nThe Company does not believe it has a material exposure related to take-or-pay matters. Generally, all amounts paid by the Company for take-or-pay are either fully recoupable under the terms of the gas purchase contracts, or are recoverable from offsetting gas purchase obligations under certain contractual arrangements. Take-or-pay obligations, including payments of above-market prices incurred with respect to the Company's retail distribution operations, are recoverable through purchased gas adjustment clauses in existing state or local regulations. At December 31, 1994, the cumulative amount of take-or-pay payments was $12.5 million.\nCAPITAL RESOURCES\nShort-term borrowings were $60.0 million and $47.0 million at year-end 1994 and 1993, respectively. The Company has credit agreements with 10 banks to either borrow or use as commercial paper support up to $225 million. Additionally, $125 million of debt securities are issuable under K N's 1993 shelf registration statement filed with the Securities and Exchange Commission. At December 31, 1994, the Company's long-term debt to capitalization ratio was 45 percent and the weighted-average cost of its long-term debt was 8.9 percent.\nFollowing the March 1994 announcement of the K N-AOG merger, Standard and Poor's and Fitch Investor Service placed the Company under credit watch. Subsequently, the two agencies affirmed their previous ratings and Moody's Investors Services upgraded the rating of the Company's debt securities from A3 to A2.\nThe Company expects that 1995 cash requirements for debt service, preferred stock redemptions, dividends and capital expenditures will be provided by internal cash flows, short-term borrowings and the issuance of common stock for dividend reinvestment and employee benefit plans. The issuance of long-term debt, if any, will be dependent on market conditions. The February 1995 acquisition of natural gas transmission pipeline and storage assets will be funded by short-term borrowings and an operating lease.\nREGULATION\nBeginning in 1993 and continuing into 1994, the Company has restructured to take advantage of the opportunities and comply with the requirements of Order 636. The competitive opportunities accompanying the unbundling of natural gas services under Order 636 are challenging the Company to become a more customer-responsive provider of natural gas services. In response to this challenge, the Company is repositioning its workforce to be a more dynamic, agile and accessible provider of services and products demanded by its customers.\nIn all of its regulatory jurisdictions, rates are currently determined on cost-based regulation. At the present time, the Company does not expect a significant change in the manner in which rates are set by regulators. Additionally, the impact of competition has not yet fully impacted the Company's businesses, and to date has generally resulted in conversion of services from the \"bundled\" merchant and transportation function to transportation services only. The gas cost component of the bundled service rate recovers only actual costs incurred.\nRISK MANAGEMENT\nTo minimize the risk of price changes in the natural gas and NGLs markets and interest rate fluctuations, the Company uses certain financial instruments for hedging purposes only. These instruments include energy futures traded on the New York Mercantile Exchange and over-the-counter markets, including fixed price and basis swaps, options, and interest rate swaps and caps.\nDuring 1994, K N's Board of Directors approved formal energy price risk management policies and procedures. These policies and procedures include the formation of a price risk management committee, and guidelines for authorizing the types of hedging instruments, contract limits, and approval levels. The policy also states that at no time will the Company enter into speculative trading.\nOUTLOOK\nMERGER\nThe merged Company operates along an axis of major gas supply basins stretching from the northern Rocky Mountain region through the Mid-Continent to south Texas. Access to six major, geographically diverse producing basins enables the Company to balance complementary peaking periods with a greater choice of supply alternatives. The Company's gas supply group is continually searching for opportunities to achieve lower gas supply costs, while seeking to take advantage of the Company's broader gas supply access. Additional future opportunities to provide broader gas supply access for the Company will come from its participation in the proposed TransColorado Pipeline Project and from the February 1995 acquisition of pipeline and storage assets. These assets are connected to currently existing assets in West Texas and provide expanded opportunities with new and existing customers.\nThe ongoing marketing efforts of the merged Company are expected to yield efficiencies in purchasing gas supplies, provide leverage in contracting for those supplies and improve utilization of the systems by increasing sales to customers in non-historical market areas. In addition, the Company plans to increase its emphasis on converting current spot market sales to longer-term premium markets and in developing incremental marketing, transportation, storage and other service opportunities, while retaining the current retail and on-system markets as a base load.\nAt year-end 1994, the Company had over 46 Bcf of working gas storage capacity in conventional and salt cavern storage fields near major pipeline interconnects in the Rocky Mountain, Mid-Continent and Permian Basin areas. An additional six Bcf of working gas storage capacity, strategically located near Houston, Texas, was acquired in the Company's February 1995 transaction. The combined deliverability from these storage fields is over 750 MMcf of gas per day. The key locations of these storage fields means that the merged Company will be able to provide a broader range of services to its customers, including physical gas movement between market centers, load balancing services and delivery reliability supported by storage.\nThe Company expects to realize greater leverage in the sales of NGLs in 1995 as a result of the merger and incremental throughput. The consolidated sales volumes of NGLs in 1994 were 385 million gallons.\nIncremental throughput volumes on the Company's Texas systems provide additional gas supply volumes that are transported through downstream pipelines and may be purchased and sold to incremental markets.\nContinued cost savings will result from consolidation of administrative and operational staff, space requirements and information systems and from eliminating certain outside legal, accounting and other services. Reduction in personnel in 1994 totaled 115 persons at an annual savings of $7.0 million. Cash costs related to the merger and restructuring were $18.1 million in 1994 and are expected to be $5.3 million in 1995.\nAt December 31, 1994, the Company had equity capital of approximately $401 million and a long-term debt to total capitalization ratio of approximately 45 percent, which provides significant financial flexibility to pursue continued growth opportunities. The performance of the combined Company is expected to increase cash flow from operations and provide for positive earnings momentum.\nLITIGATION\/ENVIRONMENTAL\nThe Company has been sued in Dallas County, Texas, by Westerman, et al., for breach of contractual and fiduciary duties, including take-or-pay claims, covering properties in Colorado. The Company denies the allegations. In a separate lawsuit filed in federal court in Colorado, the Company has sued the plaintiffs and others asserting that contractual provisions require payment of refunds for gas purchased at above-market prices and, prospectively, for a reduction in gas prices paid under the contracts to market levels. The actual damages claimed by Westerman, et al., total $1.5 million and the punitive damages claimed total $156 million. Although these substantial claims have been made, the Company believes it has a meritorious position in this matter, and does not expect this lawsuit to have a material adverse impact on the Company's results of operations or financial position.\nAs discussed in Note 6 of Notes to Consolidated Financial Statements, the Company has reported certain environmental liabilities assumed as a result of the July 13, 1994 merger. Included in these liabilities were certain environmental matters related to the Company's acquisition of various assets from the Cabot Corporation in 1989. While the Cabot Corporation agreed to indemnify the Company against certain of these liabilities, the Company may be responsible for certain costs associated with remediation in the future. The Company is presently unable to determine what, if any, dollar amount is associated with this contingency.\nThe Company's overall potential environmental cost exposure for 1995 is estimated to be approximately $1 million. A substantial part of the Company's 1995 environmental costs are either recoverable through insurance and indemnification provisions, or have been expensed as part of ongoing business.\nRefer to Note 6 of Notes to Consolidated Financial Statements for additional information on the Company's pending litigation and environmental matters. Company management believes it has established adequate reserves such that resolution of pending litigation and environmental matters will not have a material adverse impact on the Company's financial position or results of operations.\nSIGNIFICANT OPERATING VARIABLES\nNatural gas prices have continued on a steady downward trend during 1994 and early 1995. While the Company cannot know actual future prices of natural gas, continued unusually warm winter weather conditions nationwide could cause the downward trend to continue. The Company, however, is partially insulated from the severe impact of such a continuing downturn because of its diverse array of services offered, which span the natural gas value stream from wellhead to burnertip. Although the Company's earnings and success are not directly tied to natural gas price exposure, if the downturn continues over time and affects the industry to the degree the Company experiences significantly reduced gas flows throughout its pipeline systems, the Company's earnings could be negatively impacted.\nAs part of the processing business, NGLs are extracted from the raw natural gas stream and sold. The average prices for NGLs declined significantly during the second half of 1993 and showed some additional decline in 1994. Over the past six months, prices have been relatively stable. The Company expects a low likelihood of further material price declines in this market arena in the near future. For purposes of comparison, a one cent change in average NGLs prices impacts the Company's operating income by approximately $2.0 million.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo K N Energy, Inc.:\nWe have audited the accompanying consolidated balance sheets of K N Energy, Inc. (a Kansas corporation) and subsidiaries 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 financial position of K N Energy, 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 12 of Notes to Consolidated Financial Statements, the Company changed its method of accounting for postemployment benefits effective January 1, 1994, and its method of accounting for postretirement benefits other than pensions effective January 1, 1993.\n\/s\/ Arthur Andersen LLP\nDenver, Colorado February 16, 1995.\nCONSOLIDATED STATEMENTS OF INCOME K N ENERGY, INC. AND SUBSIDIARIES\nThe accompanying notes are an integral part of these statements.\nCONSOLIDATED BALANCE SHEETS K N ENERGY, INC. AND SUBSIDIARIES\nThe accompanying notes are an integral part of these balance sheets.\nCONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY K N ENERGY, INC. AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS K N ENERGY, INC. AND SUBSIDIARIES\nThe accompanying notes are an integral part of these statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) Principles of Consolidation\nThe consolidated financial statements include the accounts of K N Energy, Inc. (\"K N\") and its majority-owned subsidiaries (the \"Company\").\nInvestments in jointly-owned gas pipeline systems representing 20 to 50 percent ownership of such systems are accounted for under the equity method.\nAll material intercompany items and transactions have been eliminated.\n(B) Accounting for Regulatory Activities\nThe Company's regulated public utilities are accounted for in accordance with the provisions of Statement of Financial Accounting Standards No. 71, which prescribes the circumstances in which the application of generally accepted accounting principles is effected by the economic effect of regulation.\nRegulatory assets and liabilities represent probable future revenue or expense to the Company associated with certain charges and credits which will be recovered from or refunded to customers through the ratemaking process. The following regulatory assets and liabilities were reflected in the accompanying financial statements (in thousands):\nAs of December 31, 1994, $18.5 million of the Company's regulated assets and $7.7 million of the Company's regulated liabilities were being recovered from or refunded to customers through rates over periods ranging from 1 to 19 years.\n(C) Earnings Per Share\nPrimary earnings per share are computed based on the monthly weighted average number of common shares outstanding during the periods and the assumed exercise of dilutive common stock equivalents (stock options and warrants) using the treasury stock method.\nOn August 10, 1993, K N's Board of Directors declared a three-for-two common stock split. The number of common shares used in computing earnings per share and per share amounts in the accompanying financial statements have been restated to reflect the stock split and the tax-free exchange of 0.47 of a share of K N common stock for each outstanding share of American Oil and Gas Corporation (\"AOG\") common stock (see Note 2). The number of common shares used in computing earnings per share was 28,044,000 in 1994, 27,424,000 in 1993 and 24,828,000 in 1992.\n(D) Gas in Underground Storage\nK N's regulated interstate retail distribution business and Northern Gas Company account for gas in underground storage using the last-in, first-out (\"LIFO\") method. K N Gas Supply Services, Inc., K N Gas Marketing, Inc. and Anthem Energy Company, L.P., nonjurisdictional subsidiaries, value gas in underground storage at average cost. Rocky Mountain Natural Gas Company and Westar Transmission Company use the first-in, first-out (\"FIFO\") method.\nThe Company also maintains gas in its underground storage facilities on behalf of certain third parties. The Company receives a fee for its storage services but does not reflect the value of third party gas in the accompanying financial statements.\n(E) Prepaid Gas\nPrepaid gas represents payments made in lieu of taking delivery of (and purchasing) natural gas under the take-or-pay provisions of the Company's gas purchase contracts, net of any subsequent recoupments in kind from producers. Funds paid by the Company for take-or-pay are fully recoupable from future production, and are recorded as an asset (Prepaid Gas). When recoupment is made in kind in a subsequent contract year, natural gas purchase expense is recorded and the asset is reduced.\n(F) Property, Plant and Equipment\nProperty, plant and equipment is stated at cost, which for constructed plant includes indirect costs such as payroll taxes, fringe benefits, and administrative and general costs. Expenditures which increase capacities or extend useful lives are capitalized. Routine maintenance, repairs and renewal costs are expensed as incurred.\nThe cost of depreciable utility property, plant and equipment retired, plus the cost of removal less salvage, is deducted from accumulated depreciation with no effect on current period earnings. Gains or losses are recognized upon retirement of nonutility property, plant and equipment.\n(G) Exploration and Development Costs\nK N's gas and oil subsidiaries follow the \"successful efforts\" method of accounting. Under this method, acquisition costs, successful exploration costs and development costs are capitalized and unsuccessful exploration costs, lease rentals and evaluation costs are expensed.\n(H) Depreciation, Depletion and Amortization\nDepreciation is computed based on the straight-line method over the estimated useful life for most gas service property, plant and equipment. The unit-of-production method is used for computing depreciation, depletion and amortization for gas and oil properties.\n(I) Deferred Revenues\nIn conjunction with the Federal Energy Regulatory Commission (\"FERC\") Order No. 636 (\"Order 636\") restructuring activities, the Company negotiated new gas sales agreements with its former wholesale customers. As a result, the Company is now responsible for performance under, or to otherwise dispose of, certain pre-Order 636 gas purchase contracts. The gas sales agreements provide for such customers to pay fixed demand charges over the agreement term, and to purchase gas from a subsidiary of the Company at negotiated commodity rates. The demand portion of the gas sales agreements was recorded as deferred revenues in 1993. Commodity charges are recorded as deferred revenues as gas is delivered under these agreements. Gas purchase, gathering, transportation, and contract administration costs are recorded as a reduction to the related revenues. In addition, losses on sales of excess gas supplies to a marketing affiliate at market clearing rates are recorded in deferred revenues. Subsequent margins earned on these sales by the marketing affiliate are recognized as income when the gas is delivered. Company management believes that the revenues being collected and deferred under these agreements will be sufficient to offset future costs associated with the gas purchase contracts.\nIn January 1994, contract demand receivables with a face amount of $41 million were sold to a financial institution. No gain or loss was recorded on the sale.\n(J) Reclassification of Prior Year Amounts\nCertain prior year amounts have been reclassified to conform with the 1994 presentation.\n(K) Cash Flow Information\nThe Company considers all highly-liquid investments purchased with an original maturity of three months or less to be cash equivalents.\nChanges in Other Working Capital Items Summary, Supplemental Disclosures of Cash Flow Information and Supplemental Schedule of Noncash Investing and Financing Activities are as follows (in thousands):\nSUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES\nOn December 31, 1992, AOG acquired a partner's 25 percent interest in Red River Pipeline partnership (\"Red River\") by assuming that partner's share of Red River's liabilities. In January 1993, AOG acquired an additional 25 percent interest in Red River for cash and the assumption of liabilities. In April 1992, AOG acquired the assets of The Maple Gas Corporation (\"Maple\") for $5.5 million cash, a $5.5 million note payable and the assumption of certain of Maple's liabilities. In 1992, K N purchased all of the capital stock of two corporations, each of which owned gas distribution systems, for $5.2 million. The liabilities assumed in conjunction with these acquisitions are as follows (in thousands):\n2. MERGER\nOn July 13, 1994, pursuant to the Agreement of Merger dated March 24, 1994, AOG was merged into the Company. As a result of the merger, each outstanding share of common stock of AOG was converted into 0.47 of a share of common stock of K N and the right to receive in cash the value of any fractional share of K N. In connection with the merger, all the outstanding shares of AOG common stock were converted into approximately 12.2 million shares of K N stock, and the authorized number of shares of K N common stock was increased to 50 million shares. On July 13, 1994, the stockholders of K N approved the issuance of stock in connection with the merger, as well as certain other matters, and the shareholders of AOG approved the merger.\nThe merger was accounted for as a pooling of interests and, accordingly, the historical consolidated financial statements for periods prior to consummation of the merger have been restated as though the companies had been combined for all periods reported herein.\nThe following table provides a reconciliation of revenues and earnings reported by K N to the combined amounts presented (in thousands):\n* Represents revenues and earnings of AOG prior to the July 13, 1994 merger. ** Includes merger and restructuring costs totaling $19.3 million after taxes.\n3. MERGER AND RESTRUCTURING COSTS\nThe Company recorded merger and restructuring costs totaling $25.9 million in the third quarter of 1994. Total expected cash expenditures relating to these charges are $23.4 million, of which $5.3 million had not yet been paid as of December 31, 1994.\nMerger expenses include $12.4 million in investment bankers' and other professional fees, $7.7 million for severance and employee benefit costs for approximately 230 employees who have been or will be terminated through consolidation of administrative and operational staff, and $4.6 million in costs to eliminate duplicative space requirements and equipment, and to write-off the cost of information systems not required subsequent to the merger.\nCosts related to the formal restructuring plan of the Company's retail distribution operations total $1.2 million, representing severance and employee benefit costs for terminating approximately 90 retail distribution employees as a result of the restructuring and centralization of customer service functions. The restructuring is expected to be completed in the third quarter of 1995.\n4. ACQUISITIONS\n(A) Transmission and Storage Systems\nOn February 16, 1995, K N's gas transmission affiliate, AOG Gas Transmission Company, L.P., acquired natural gas transmission pipeline and storage assets in Texas.\nThe assets include two West Texas pipeline systems, comprised of 347 miles of pipeline and related facilities, which are currently connected to AOG's core pipeline system. In addition, surface facilities, lease rights and approximately 10.8 Bcf of natural gas in storage in a leased, Gulf Coast storage field will be acquired. AOG\nalso acquired the remaining 50 percent interest it did not previously own in a 90-mile joint venture pipeline near Midland, Texas.\nThe total price was $80.1 million, subject to closing adjustments. K N utilized an operating lease and short-term debt financing arrangements to fund the acquisition.\n(B) Natural Gas Processing Business\nEffective April 1, 1992, AOG acquired substantially all of the assets and assumed substantially all of the liabilities of Maple. The assets consisted of 10 natural gas processing plants and approximately 1,056 miles of related gas gathering pipelines. The purchase price was approximately $86 million, consisting of $5.5 million cash, a $5.5 million note payable and the assumption of substantially all of Maple's liabilities. The acquisition was accounted for as a purchase.\nThe results of operations of the acquired business are included in the accompanying financial statements from the date of the acquisition.\n(C) Gathering and Transmission System\nOn April 1, 1993, the Company completed the $48 million acquisition of the Wattenberg natural gas gathering and transmission system. The system has both regulated and nonregulated components. The regulated transmission segment, approximately $18 million of the acquisition, was financed with corporate funds, and the balance of the system was financed through an operating lease. The system gathers and transports gas from approximately 1,800 receipt points in northeastern Colorado.\n(D) Gas and Oil Reserve Acquisition\nOn February 1, 1994, the Company's gas and oil development subsidiaries, K N Production Company and GASCO, Inc., acquired gas reserves and production properties located near existing K N operations in western Colorado and in the Moxa Arch region of southwestern Wyoming for a total purchase price of approximately $30 million. The acquired properties have total net reserves of approximately 50 Bcf equivalent of natural gas. In October 1994, the Company sold a 50 percent undivided interest in substantially all the acquired properties to a third party with whom they will jointly develop the properties.\n5. REGULATORY MATTERS\n(A) Restructuring and Reorganization\nOn April 8, 1992, FERC issued Order 636 which requires a fundamental restructuring of interstate natural gas pipelines. K N implemented Order 636 restructured services on October 1, 1993. As a part of its action on K N's restructuring proposal, FERC approved implementation of K N's gas supply realignment (\"GSR\") crediting mechanism.\nK N requested FERC approval, as a result of Order 636, to transfer all of its interstate transmission and storage facilities to K N Interstate Gas Transmission Co. (\"KNI\"), a wholly-owned jurisdictional subsidiary of K N, and substantially all of its gathering and processing facilities to K N Gas Gathering, Inc. (\"KNGG\"), a nonjurisdictional wholly-owned subsidiary of K N. FERC approved the transfer of K N's interstate gas\ntransmission and storage facilities to KNI effective October 1, 1993. FERC authorized the transfer of certain gathering and processing facilities from KNI to KNGG effective January 1, 1994. KNI's only remaining gathering system was transferred to KNGG in early 1995. AOG's assets and facilities were not a part of this reorganization.\nOrder 636 required pipelines to unbundle sales and transportation services. KNI has complied with FERC's directive to mitigate its GSR costs caused by this restructuring. KNI's GSR process allows for the assignment of its above-market contracts. Under KNI's tariff, every shipper has a right to take assignment of these above-market contracts. Shippers may either take assignment of these above-market contracts or enter into a negotiated exit fee. This eliminated the need to make any GSR cost recovery filing with FERC.\nIn January 1995, as a result of a settlement reached with its customers, the Company filed an application with FERC to transfer certain storage assets held by KNI to a newly created nonjurisdictional subsidiary, K N Natural Gas, Inc. If this transfer is approved, KNI will own only the Huntsman, Nebraska storage facilities.\n(B) Rate Matters\nOn December 30, 1993, KNI made a rate filing with FERC requesting a $12.0 million annual increase in revenues. The new rates became effective July 1, 1994, subject to refund. KNI submitted a Stipulation and Agreement (\"S&A\") to FERC in November 1994. On January 20, 1995, FERC approved the S&A, which provides for an $8.7 million annual increase in revenues. As part of the settlement, test year depreciation expense was reduced $0.7 million as a result of lower depreciation rates on FERC jurisdictional facilities. Revenues collected above the settlement rates will be refunded to customers in early 1995.\nK N's retail natural gas services business segment received rate increases from a number of jurisdictions during 1994, 1993 and 1992, as summarized below:\n*Rocky Mountain Natural Gas Division of K N Energy, Inc.\nAdditionally, in connection with a 1990 Nebraska rate case, $1.6 million of previously deferred revenues were recorded as revenue in 1993.\n6. LEGAL MATTERS\nThe Company was named as one of four potentially responsible parties (\"PRPs\") at a U.S. Environmental Protection Agency (\"EPA\") Superfund site known as the Mystery Bridge Road\/U.S. Highway 20 site located near Casper, Wyoming (the \"Brookhurst Subdivision\"). The EPA's remedy consists of two parts, \"Operating Unit One,\" which addresses the groundwater cleanup, and \"Operating Unit Two,\" which addresses cleanup procedures for the soil and free-phase petroleum product. A Consent Decree between the Company, the EPA and another\nPRP was entered on October 2, 1991, in the Wyoming Federal District Court. Groundwater cleanup under Operating Unit One and Two have been proceeding since 1990 and 1992, respectively, and is expected to continue through 1996 at a total remaining estimated cost not to exceed $150,000.\nAn environmental audit performed by the Company revealed that a grease known as Rockwell 860 had been used as a valve sealant at several of the Company's locations in Nebraska and Colorado. Rockwell 860 is a solid clay-like material which does not easily spill into the environment, but contains approximately 10 percent polychlorinated biphenyls (\"PCBs\"). The PCBs are contained within the pipeline and valves at the subject locations. PCBs are regulated under the Toxic Substances Control Act. On March 31, 1993, the Company filed suit against Rockwell International Corporation, manufacturer of the valve sealant, and two other related defendants, alleging that the defendants were responsible for the Company's environmental expenses and commercial losses resulting from any EPA or state required PCBs cleanup or mitigation. The Company settled with Rockwell, et al. in March 1994 which resolved all disputes between the parties.\nDuring February 1994, the Company submitted its Phase I Report and PCBs Work Plan to EPA Region VII (covering Nebraska) and EPA Region VIII (covering Colorado). During March 1994, EPA Region VIII accepted both the Phase I Report and the PCBs Work Plan as administratively complete. EPA Region VIII also granted the Company permission to proceed with implementation of the PCBs management and remediation activities described in its Work Plan to address sites in Colorado. EPA Region VII has not yet formally responded. The Company currently estimates the total cost of remediation to be approximately $1.7 million, a substantial portion of which is recoverable under the Rockwell settlement. The unrecoverable amount will not have a material adverse impact on the Company's financial position or results of operations. The PCBs cleanup program is not expected to interrupt or diminish the Company's operational ability to gather or transport natural gas, and will occur over a period of years.\nCertain used pipe reclaimed at the Company's Holdrege, Nebraska, pipeyard was wrapped with asphalt-saturated asbestos felt, which was commonly removed in accordance with Company practices. The removed wrap contains friable asbestos fibers above the regulatory standard. The Nebraska Department of Environmental Control, the agency having jurisdiction over this matter, was notified and approved the Company's remediation plan. Remediation was effectively completed in 1994 and the total cost is not expected to exceed $700,000. The asbestos cleanup program did not interrupt or diminish the Company's operational ability to gather or transport natural gas.\nIn the spring of 1994, the Kansas Department of Health and Environment (\"KDHE\") notified a number of pipeline companies operating in Kansas, including K N, that residual elemental mercury might be present in the soils adjacent to certain natural gas metering facilities. In July 1994, the Company initiated a mercury sampling program on its systems in central and western portions of Kansas, pursuant to a five-year assessment program which has been approved by the KDHE and will require that 20 percent (135) of the 675 sites be tested each year. The sampling for the first year has been completed; however, no determination regarding remediation has been reached at this time. The Company currently cannot estimate the extent of the remediation nor the costs, although the Company believes all or a portion of such costs will be recoverable from insurance carriers. On December 27, 1994, the Company received notice from the KDHE that no active remediation will be required until completion of the five-year assessment program. Such costs are not expected to have any material adverse impact on the Company's financial position or results of operations. The mercury cleanup program is not expected to interrupt or diminish the Company's operational ability to gather or transport natural gas.\nIn May 1994, the Company discovered that use of a lubricating oil containing PCBs has caused contamination in certain equipment, soils and liquids at the Company's Scott City, Kansas, helium extraction facility. A Site Assessment Report has been submitted to the EPA for its review, and no response has yet been received. The Company's investigation of this situation is ongoing, and a workplan is being developed for EPA review. The Company estimates the total cost for remediation to be approximately $600,000, which is not expected to have a material adverse impact on the Company's financial position or results of operations. The PCBs cleanup program is not expected to interrupt or diminish the Company's operational ability at the helium facility.\nEffective April 1, 1992, the Company acquired substantially all of the assets and assumed substantially all of the liabilities of Maple. The assets consisted of 10 natural gas processing plants and approximately 1,056 miles of related gas gathering pipelines. The Maple assets contained certain environmental liabilities for which the Company obtained indemnifications from Maple and Cabot Corporation (\"Cabot\"). The Company is unable to estimate its potential exposure for such liabilities at this time, but does not expect them to have any material adverse impact on the Company's financial position or results of operations.\nIn November 1989, the Company acquired gathering and transmission assets from certain subsidiaries of Cabot. These assets contained certain environmental liabilities for which the Company obtained indemnities from Cabot pursuant to an Omnibus Acquisition Agreement. Issues have arisen concerning Cabot's indemnification obligations; however, in conjunction with the merger, the Company and Cabot entered into a standstill agreement pertaining to these and other matters. The Company believes it will be able to reach agreement with Cabot, and is unable to estimate its potential exposure for such liabilities at this time, but does not expect them to have a material adverse impact on the Company's financial position or results of operations.\nOn October 9, 1992, Jack J. Grynberg filed suit in the United States District Court for the District of Colorado against the Company, Rocky Mountain Natural Gas Company and GASCO, Inc. (the \"K N Entities\") alleging that the K N Entities as well as K N Production Company and K N Gas Gathering, Inc., have violated federal and state antitrust laws. In essence, Grynberg asserts that the companies have engaged in an illegal exercise of monopoly power, have illegally denied him economically feasible access to essential facilities to transport and distribute gas produced from fewer than 20 wells located in northwest Colorado, and illegally have attempted to monopolize or to enhance or maintain an existing monopoly. Grynberg also asserts certain causes of action relating to a gas purchase contract. No specific monetary damages have been claimed, although Grynberg has requested that any actual damages awarded be trebled. In addition, Grynberg has requested that the K N Entities be ordered to divest all interests in natural gas exploration, development and production properties, all interests in distribution and marketing operations, and all interests in natural gas storage facilities, separating these interests from the Company's natural gas gathering and transportation system in northwest Colorado. On August 13, 1993, the United States District Court, District of Colorado, stayed this proceeding pending exhaustion of appeals in a related state court action involving the same plaintiff.\nOn December 8, 1994, K N and its wholly-owned subsidiary K N Gas Supply Services, Inc. (\"KNGSS\") were sued by gas producers in northeastern Colorado in District Court, Dallas County, Texas under claims arising from two gas purchase contracts covering gas purchases from wells in the Niobrara Field, Colorado. The producers assert actual take-or-pay claims for contract years 1993 and 1994 in the amount of $1,157,000 plus interest, as well as punitive damages in the amount of $156,000,000 for alleged breaches of contractual and fiduciary duties arising out of a January 1977 Farmout Agreement between the producers and K N. On\nDecember 21, 1994, the lawsuit was removed from Texas state court to the United States District Court for the Northern District of Texas (Dallas). On January 12, 1995, K N and KNGSS filed a motion to dismiss for lack of personal jurisdiction or, if jurisdiction is found to exist, a motion to transfer the cause of action to federal court in Colorado. That motion is pending. Additional litigation was initiated on January 31, 1995, by KNGSS against the plaintiffs and others in federal court in Colorado. In this lawsuit, KNGSS asserts that contractual provisions require payment of refunds for gas purchased at above-market prices and, prospectively, for a reduction in gas prices paid under the contracts to market levels. The Company believes it has a meritorious position in these matters, and does not expect these lawsuits to have a material adverse effect on the Company's financial position or results of operations.\nThe Company believes it has meritorious defenses to all lawsuits and legal proceedings in which it is a defendant and will vigorously defend against them. Based on its evaluation of the above matters, and after consideration of reserves established, the Company believes that the resolution of such matters will not have a material adverse effect on the Company's financial position or results of operations.\n7. PROPERTY, PLANT AND EQUIPMENT\nInvestment in property, plant and equipment, at cost, and accumulated depreciation, depletion and amortization (\"Accumulated DD&A\"), detailed by business segment, are as follows (in thousands):\n8. INCOME TAXES\nDeferred income tax assets and liabilities are recognized based on enacted tax laws for all temporary differences between financial reporting and tax bases of assets and liabilities. Deferred tax assets are reduced by a valuation allowance for the amount of any tax benefit that is not expected to be realized. .\nComponents of the income tax provision applicable to federal and state income taxes are as follows (in thousands):\nThe difference between the statutory federal income tax rate and the Company's effective income tax rate is summarized as follows:\nThe Company has recorded deferred regulatory assets of $1.3 million and $2.0 million, and deferred regulatory liabilities of $5.2 million and $4.9 million at December 31, 1994 and 1993, respectively, which are expected to result in cost-of-service adjustments. These amounts reflect the \"gross of tax\" presentation required under Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes\". The deferred tax assets and liabilities and deferred regulatory assets and liabilities for rate-regulated entities computed according to SFAS 109 result from the following (in thousands):\nAs of December 31, 1994, the Company had for tax purposes: (i) estimated NOL carryforwards of $5.4 million and (ii) capital loss carryforwards of $1.0 million. The NOL carryforwards will expire in 2003 through 2008. The capital loss carryforwards, which are available to reduce future capital gains, expire in 1996. The Company also has AMT credits of approximately $15.4 million available to reduce its regular future tax liability in excess of the AMT otherwise due in any year.\n9. FINANCING\n(A) Notes Payable\nOn December 1, 1994, K N entered into a credit agreement with eight banks to borrow for general corporate purposes, including commercial paper support, up to a total of $200 million. Depending on the type of borrowing made under the credit agreement, borrowings may bear interest at or above prime, or at margins above certificate of deposit rates bid by New York certificate of deposit dealers, or at margins above rates offered by certain designated banks in the London Interbank market, or at money market rates quoted by the banks under the agreement. The term of borrowing may range from one day to no more than 360 days. Under the credit agreement, K N agrees to pay a facility fee based on the total commitment, at rates which vary based on the financial rating of K N's long-term debt. The credit agreement expires December 1, 1999. K N also has credit agreements with two banks to either borrow or use for commercial paper support up to a total of $25 million. Borrowings are made at rates negotiated on the borrowing date and for a term of not more than one year. Under these agreements, K N pays a commitment fee on the unused commitment. At December 31, 1994, no amounts were outstanding under these credit agreements. At December 31, 1993, $10 million was outstanding under credit agreement arrangements in effect at that time.\nCommercial paper issued by K N represents unsecured short-term notes with maturities not to exceed 270 days from the date of issue. During 1994, all commercial paper issued was redeemed within 50 days, with interest rates ranging from 3.12 percent to 6.30 percent. At December 31, 1994 and 1993, $60.0 million and $37.0 million of commercial paper, respectively, were outstanding at rates ranging from 5.87 percent to 6.30 percent and from 3.45 percent to 3.58 percent, respectively.\nThe weighted average interest rates on short-term borrowings outstanding were 6.09 percent and 3.45 percent as of December 31, 1994 and 1993, respectively.\n(B) Long-Term Debt\nMaturities of long-term debt for the five years ending December 31, 1999, are as follows (in thousands):\nIn October 1994, K N sold publicly $75 million of 30-year, 8.75% debentures at an all-in cost to the Company of 8.91 percent. This debt was issued from the Company's $200 million shelf registration statement which the Securities and Exchange Commission declared effective in November 1993. Proceeds from this financing were used to fund capital expenditures and to reduce short-term borrowing incurred in July 1994 to retire the Senior Revolving Credit and Term Note Facility of AOG.\nIn September 1993, K N sold $50 million of 6.5% debentures at an all-in cost to K N of 6.61 percent. Proceeds from the debt financing were used to redeem K N's 10 3\/4% sinking fund debentures and to fund capital expenditures.\nAs discussed more fully in Note 11, in 1993, AOG entered into two interest-rate swap agreements and, in 1994, the Company entered into four interest rate cap agreements covering $35 million of notional principal.\nAt December 31, 1994 and 1993, the carrying amount of the Company's long-term debt was $366.2 million and $362.1 million, respectively, and the estimated fair value was $355.2 million and $384.0 million, respectively. 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 maturation.\n10. PREFERRED STOCK\n(A) K N Class A $8.50 Preferred Stock\nThe remaining 5,000 shares of K N Class A $8.50 Preferred Stock subject to mandatory redemption were redeemed by the Company in 1994. In each of the years 1993 and 1992, the Company redeemed 10,000 shares subject to mandatory redemption.\n(B) K N Class B $8.30 Preferred Stock\nThe K N Class B $8.30 Preferred Stock is subject to mandatory redemption through a sinking fund (at $100 per share, plus accrued and unpaid dividends) of $571,400 annually in 1996 and 1997 and $572,000 in 1998. At the option of the Company, this stock is redeemable, in whole or in part, at $101.31 per share prior to January 2, 1996; such redemption price is reduced annually thereafter until January 2, 1998, when it becomes $100 per share. Also, at the option of the Company, 5,714 shares of this stock may be redeemed in each of the years 1995 through 1997, inclusive, at $100 per share. In each of the years 1994, 1993 and 1992, the Company redeemed 5,714 shares subject to mandatory redemption, and an additional 5,714 shares at $100 per share.\n(C) K N Class A $5.00 Preferred Stock\nThe K N Class A $5.00 Preferred Stock is redeemable, in whole or in part, at the option of the Company at any time on 30 days' notice at $105 per share plus accrued dividends. This series has no sinking fund requirements.\n(D) AOG 9% Cumulative Convertible Preferred Stock\nIn November 1992, AOG called all outstanding shares of its 9% cumulative convertible preferred stock for redemption. Prior to the redemption date, all holders elected to convert their shares into AOG's common stock. Effective January 20, 1993, AOG issued 2,429,265 of its common shares (equivalent to 1,141,755 shares of K N common stock) in connection with the conversion.\n(E) Rights of Preferred Shareholders\nAll outstanding series of preferred stock have voting rights.\nIf, for any class of preferred stock, the Company (i) is in arrears on dividends, (ii) has failed to pay or set aside any amounts required to be paid or set aside for all sinking funds, or (iii) is in default on any of its redemption obligations, then no dividends shall be paid or declared on any junior stock nor shall any junior stock be purchased or redeemed by the Company. Also, if dividends on any class of preferred stock are sufficiently in arrears, the holders of that stock may elect one-third of the Company's Board of Directors.\n(F) Fair Value\nAt December 31, 1994, the carrying amounts and the estimated fair value of the Company's outstanding preferred stock subject to mandatory redemption were $1.7 million and $1.6 million, respectively. The comparable amounts at December 31, 1993, were both $3.4 million. The fair value of the Company's preferred stock is estimated based on an evaluation made by an independent security analyst.\n11. RISK MANAGEMENT\nThe Company uses two types of risk management instruments - energy futures and interest rate swaps - which are discussed below. The Company is exposed to credit-related losses in the event of nonperformance by counterparties to these financial instruments, but does not expect any counterparties to fail to meet their obligations given their existing credit ratings.\nThe fair value of these risk management instruments reflects the estimated amounts that the Company would receive or pay to terminate the contracts at the reporting date, thereby taking into account the current unrealized gains or losses on open contracts. Market quotes are available for significantly all instruments used by the Company.\n(A) Energy Futures\nThe Company engages in energy futures trading activities to minimize its risk of price changes in the spot and fixed price natural gas, crude oil, and natural gas liquids markets. Energy futures trading activities include the use of crude oil and natural gas commodity contracts and options, fixed price swaps, and basis swaps and options. Pursuant to its Board of Directors' approved guidelines, the Company engages in these activities only as a hedging mechanism against pre-existing physical gas sale, purchase, system use, and storage contracts in order to protect profit margins, and does not engage in speculative trading. These energy futures, swaps, and options are recorded at fair value. Gains and losses on hedging positions are deferred and recognized as operating expenses in the period the underlying physical transactions take place. As the Company engages in no speculative trading activities, all 1994 transactions are recorded as hedges.\nAs of December 31, 1994, the Company had deferred $13.4 million, representing the difference between the current market value and the original physical contracts' value, associated with its hedging activities, of which $5.3 million relates to commodity contracts and $8.1 million relates to over-the-counter swaps and options. The deferrals will be offset by the corresponding underlying physical transactions and are reflected as deferred charges in the accompanying financial statements. At December 31, 1994, the Company held notional long volumetric positions of 69.4 Bcf of gas, of which 34.1 Bcf were held in gas commodity positions and 35.3 Bcf were held in over-the-counter swaps and options. Of the 69.4 Bcf notional total, associated physical transactions of 51.9 Bcf are expected to occur in 1995, 8.7 Bcf in 1996, and 8.8 Bcf in 1997 and beyond. A change of plus or minus 10 percent of the fair market prices of the above financial instruments would have the approximate effect of reducing or increasing the above deferrals by $13.4 million, which would be offset by corresponding increases or decreases in the value of the underlying physical transactions.\n(B) Interest Rate Swaps\nThe Company has entered into various interest rate swap and cap agreements for the purpose of managing interest rate exposure. Settlement amounts payable or receivable under these agreements are recorded as interest expense or income in the accounting period they are incurred.\nIn February 1993, AOG entered into a three-year interest rate swap agreement covering $25 million of notional principal whereby it pays LIBOR, which is reset every six months in arrears, in exchange for a fixed rate of 5.07 percent. This agreement terminates March 1996.\nIn September 1993, AOG entered into a second three-year interest rate swap agreement covering $10 million of notional principal at LIBOR rates, which are reset every 12 months in arrears, in exchange for a fixed rate of 5.27 percent. In August 1994, the counterparty to this second agreement exercised its rights to extend this agreement by one additional year, with the agreement now terminating in September 1997.\nIn 1994, the Company entered into four interest rate cap agreements which effectively cap the LIBOR rate to be paid by the Company under these swap agreements at 7.5 percent for the terms of the original swap agreements.\n12. EMPLOYEE BENEFITS\n(A) Retirement Plans\nThe Company has defined benefit pension plans covering substantially all full-time K N employees. The Merger Agreement provides that, beginning January 1, 1995, K N will provide to employees who were employed by AOG at the effective time of the merger and are currently with the Company, benefit plans, policies and programs that are no less favorable than those provided to K N's similarly situated employees. These plans provide pension benefits that are based on the employees' compensation during the period of employment. These plans are tax qualified subject to the minimum funding requirements of ERISA. The Company's funding policy is to contribute annually the recommended contribution using the actuarial cost method and assumptions used for determining annual funding requirements. Plan assets consist primarily of pooled fixed income, equity, bond and money market funds.\nNet pension cost includes the following components (in thousands):\nThe following table sets forth the plans' funded status and amounts recognized in the Company's financial statements at December 31, 1994 and 1993 (in thousands):\nThe rate of increase in future compensation and the expected long-term rate of return on assets were 4.5 and 8.5 percent, respectively, for 1994, 4.5 and 9.25 percent, respectively, for 1993 and 5.0 and 9.25 percent, respectively, for 1992. The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 8.25 percent for 1994 and 7.5 percent for the 1993 and 1992 periods.\nThe Company also contributes the lesser of 10 percent of K N's net income or 10 percent of normal K N employee compensation to the Employees Retirement Fund Trust Profit Sharing Plan (a defined contribution plan). Contributions by the Company were $2.3 million, $2.6 million and $2.1 million for 1994, 1993 and 1992, respectively.\n(B) Other Postretirement Employee Benefits\nThe Company has a defined benefit postretirement plan providing medical care benefits upon retirement for all eligible K N employees with at least five years of credited service as of January 1, 1993, and their eligible dependents. Retired K N employees are required to contribute monthly amounts which depend upon the retired employee's age, years of service upon retirement and date of retirement.\nThis plan also provides life insurance benefits upon retirement for all K N employees with at least 10 years of credited service who are age 55 or older when they retire. The Company pays for a portion of the life insurance benefit; K N employees may, at their option, increase the benefit by making contributions from age 55 until age 65 or retirement, whichever is earlier. In 1993, the Company began funding the future expected postretirement benefit costs under the plan by making payments to Voluntary Employee Benefit Association trusts. The Company's funding policy is to contribute amounts within the deductible limits imposed on Internal Revenue Code Sec. 501(c)(9) trusts. Plan assets consist primarily of pooled fixed income funds.\nEffective January 1, 1993, the Company prospectively adopted Statement of Financial Accounting Standards No. 106 (\"SFAS 106\") which requires the accrual of the expected costs of postretirement benefits other than pensions during the years that employees render service. The Accumulated Postretirement Benefit Obligation (\"APBO\") of the plan at January 1, 1993, was approximately $18.8 million. The Company has elected to amortize this transition obligation to expense over a 20-year period.\nNet postretirement benefit cost includes the following components (in thousands):\nPrior to 1993, the cost of providing medical care benefits to retired K N employees was recognized as expense as claims were paid, and the cost of life insurance benefits for retirees was not accrued. Instead, life insurance claims were paid from a trust fund resulting from termination of third-party coverage. The Company's net cost of medical care claims for retirees was approximately $1.2 million in 1992.\nThe following table sets forth the plan's funded status and the amounts recognized in the Company's financial statements as follows (in thousands):\nThe weighted average discount rate used in determining the actuarial present value of the APBO was 7.5 percent for both periods. The assumed health care cost trend rate was nine percent for 1994 and seven percent for 1995 and beyond. A one-percentage-point increase in the assumed health care cost trend rate 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 approximately $17,000 and would have increased the APBO as of December 31, 1994, by approximately $215,000.\nK N's interstate retail distribution business, in connection with rate filings described in Note 5(B) for Kansas, Nebraska and Wyoming, has received regulatory approval to include in the cost-of-service component of its rates the cost of postretirement benefits as measured by application of SFAS 106. In addition, KNI has received approval from FERC for similar regulatory treatment in connection with its rate filing, also described in Note 5(B). At December 31, 1994, no SFAS 106 costs were deferred as regulatory assets.\n(C) Other Postemployment Benefits\nIn November 1992, FASB issued SFAS 112, which 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 Company adopted SFAS 112 on January 1, 1994. Implementation of SFAS 112 had no material effect on the Company's financial position or results of operations. At December 31, 1994, $0.8 million of SFAS 112 costs were deferred as regulatory assets.\n13. COMMON STOCK OPTION AND PURCHASE PLANS\nK N has incentive stock option plans for key employees and nonqualified stock option plans for its nonemployee directors and employees. In 1994, the Company's shareholders approved an expanded stock-based awards plan for key employees which allows for the granting of both nonqualified and incentive options, restricted stock awards, stock appreciation rights and other stock-based awards. Outstanding stock options granted under\nan AOG stock plan have been converted to stock options for K N common stock using the exchange ratio of 0.47. Under all plans, except the 1994 plan and the AOG plan, options are granted at not less than 100 percent of the market value of the stock at the date of grant. Under the 1994 plan, options may be granted at less than 100 percent of the market value of the stock at the date of grant. Options granted under these plans vest immediately or up to five years and expire no later than 10 years after date of grant.\nDuring 1993, AOG issued to its chief executive officer 50,000 shares of restricted AOG common stock (23,500 shares of K N common stock) which vest 50 percent per year. AOG also sold 150,000 shares of AOG common stock (70,500 shares of K N common stock) to its president and chief operating officer for $0.04 per share of AOG common stock ($0.0851 per share of K N common stock). One-half of these shares was fully vested and nonforfeitable upon issuance, and the remainder became fully vested upon consummation of the merger described in Note 2. The market value of these AOG shares issued was approximately $2.3 million based on the average market price per share of AOG common stock on the date of issuance. The market value of the restricted shares was reflected as deferred compensation and is being amortized over the vesting period. The Company recorded compensation expense totaling $1.3 million and $1.2 million for 1994 and 1993, respectively, relating to restricted stock grants awarded under the plans.\nAt December 31, 1994, 114 employees, officers and directors of the Company held options under the plans. The changes in stock options outstanding during 1994, 1993 and 1992 are as follows, restated to reflect the three-for-two common stock split described in Note 1(C) and the merger described in Note 2:\nUnexercised options outstanding at December 31, 1994, expire at various dates between 1995 and 2004.\nEffective April 1, 1990, and for each succeeding year, K N established an Employee Stock Purchase Plan under which eligible employees may purchase K N's common stock through voluntary payroll deductions at a 15 percent discount from the market value of the common stock, as defined in the plan.\nUnder K N's Stock Option, Dividend Reinvestment, Employee Stock Purchase and Employee Benefit Plans, 4,853,498 shares were reserved for issuance at December 31, 1994.\n14. COMMON STOCK WARRANTS\nAt December 31, 1994, warrants to purchase 1,187,432 shares of the Company's common stock were outstanding. The warrants are exercisable at $17.55 per warrant and expire on September 30, 1999.\n15. COMMITMENTS AND CONTINGENT LIABILITIES\n(A) Leases\nOn February 16, 1995, AOG Gas Transmission Company, L.P. acquired natural gas transmission pipeline and storage assets in Texas. (See Note 4(A)). A portion of these assets has been funded through 10-year operating leases and payment amounts have been included in the future minimum commitments shown below.\nIn 1993, K N Front Range Gathering Company began to lease gas gathering equipment and facilities under a 10-year operating lease. In 1992, KNGG began to lease gas gathering facilities and processing equipment under a seven-year operating lease. These operating leases contain purchase options at the end of their lease terms. The Company also leases certain office space, properties and equipment under operating leases.\nPayments made under operating leases were $9.6 million in 1994, $8.3 million in 1993 and $5.1 million in 1992.\nFuture minimum commitments under major operating leases are as follows (in thousands):\n(B) Basket Agreement\nUnder terms of an agreement (the \"Basket Agreement\") entered into with Cabot Corporation (\"Cabot\"), the Company's largest stockholder, as part of AOG's acquisition of Cabot's natural gas pipeline business, AOG and Cabot equally share net payments made in settlement of certain liabilities related to operations of the acquired business prior to the acquisition date. During 1995, the Company expects to settle all significant matters covered by the Basket Agreement. The Company's estimated liability is approximately $6.0 million, which was recorded in connection with the acquisition of the natural gas pipeline business from Cabot. As of December 31, 1994, the Company had made net payments of approximately $12.4 million. The difference between net payments made by the Company and its estimated liability is reflected in current assets and consists of (i) the present value of Cabot's share of net payments and (ii) future recoveries from customers.\n(C) Capital Expenditure Budget\nThe consolidated capital expenditure budget for 1995 is approximately $73.9 million, excluding acquisitions.\n16. MAJOR CUSTOMER\nEnergas Company and affiliates comprised 11 percent of consolidated revenues in 1994 and 12 percent of consolidated revenues in both 1993 and 1992.\n17. BUSINESS SEGMENT INFORMATION\nThe Company is a natural gas energy products and services provider engaged in the following activities: (1) selling natural gas at retail (Retail Natural Gas Services), (2) interstate storing and transporting natural gas (Interstate Transportation and Storage Services), (3) gathering, processing, marketing, storing and transporting natural gas (Gathering, Processing and Marketing Services), and (4) developing and producing natural gas and crude oil (Gas and Oil Production).\nBUSINESS SEGMENT INFORMATION\n* Principally cash and investments\nQUARTERLY FINANCIAL INFORMATION (UNAUDITED) QUARTERLY OPERATING RESULTS FOR 1994 AND 1993\n(In Thousands Except Per Share Amounts)\n*Includes merger and restructuring costs totaling $19.3 million after taxes, or $0.69 per common share.\nITEM 9:","section_9":"ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no such matters during 1994.\nPART III\nITEM 10:","section_9A":"","section_9B":"","section_10":"ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(A) Identification of Directors\nFor information regarding the Directors, see pages 3-6 of the 1995 Proxy Statement.\n(B) Identification of Executive Officers\nSee Executive Officers of the Registrant under Part I.\n(C) Identification of Certain Significant Employees\nNone.\n(D) Family Relationships\nSee \"Relationship Between Certain Directors and the Company\" on page 8 of the 1995 Proxy Statement.\n(E) Business Experience\nSee Executive Officers of the Registrant under Part I.\n(F) Involvement in Certain Legal Proceedings\nSee Executive Officers of the Registrant under Part I.\n(G) Promoters and Control Persons\nNone.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION\nSee \"Executive Compensation\", \"Stock Options\", \"Pension Benefits\" and \"Director Compensation\" on pages 9-18 of the 1995 Proxy Statement.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee the following pages of the 1995 Proxy Statement: (i) Pages 3-6 relating to common stock owned by directors; (ii) pages 16-17, \"Executive Stock Ownership\"; and (iii) pages 19-20, \"Principal Shareholders\".\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(A) Transactions with Management and Others\nSee \"Certain Transactions\" on pages 7-8 of the 1995 Proxy Statement and \"Relationship Between Certain Directors and the Company\" on page 8 of the 1995 Proxy Statement.\n(B) Certain Business Relationships\nSee \"Relationship Between Certain Directors and the Company\" on page 8 of the 1995 Proxy Statement.\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) See the index for a listing and page numbers of financial statements and exhibits included herein or incorporated by reference.\nExecutive Compensation Plans and Arrangements\nForm of Key Employee Severance Agreement (Exhibit 10.2, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*\n1982 Stock Option Plan for Nonemployee Directors of the Company with Form of Grant Certificate (Exhibit 10.3, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*\n1982 Incentive Stock Option Plan for key employees of the Company (Exhibit 10.4, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*\n1986 Incentive Stock Option Plan for key employees of the Company (Exhibit 10.5, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*\n1988 Incentive Stock Option Plan for key employees of the Company (Exhibit 10.6, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*\nForm of Grant Certificate for Employee Stock Option Plans (Exhibit 10.7, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*\nDirectors' Deferred Compensation Plan Agreement (Exhibit 10.8, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*\n1987 Directors' Deferred Fee Plan and Form of Participation Agreement regarding the Plan (Exhibit 10.9, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*\n1992 Stock Option Plan for Nonemployee Directors of the Company with Form of Grant Certificate (Exhibit 4.1, File No. 33-46999)*\nK N Energy, Inc. 1994 Executive Incentive Plan (Exhibit 10(k) to the Annual Report on Form 10-K for the year ended December 31, 1993)*\nK N Energy, Inc. 1995 Executive Incentive Plan (attached hereto as Exhibit 10(l))**\nK N Energy, Inc. Nonqualified Deferred Compensation Plan (attached hereto as Exhibit 10(m)**\n(b) Reports on Form 8-K\nOn October 18, 1994, a Current Report on form 8-K was filed to report that on October 19, 1994, K N sold $75 million of its 8.75% Debentures due October 15, 2024, pursuant to an underwritten public offering.*\nOn January 11, 1995, a Current Report on Form 8-K was filed to report that on January 6, 1995, an affiliate of K N announced its proposed acquisition of certain gas gathering and gas storage assets located in Texas from affiliates of Meridian Oil Inc.*\nOn February 16, 1995, a Current Report on Form 8-K was filed to report that on February 16, 1995, an affiliate of K N closed its previously announced acquisition of certain gas gathering and gas storage assets located in Texas from affiliates of Meridian Oil Inc.*\n* Incorporated herein by reference. ** Included in SEC and NYSE copies only.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nK N ENERGY, INC. (Registrant)\nMarch 8, 1995 By \/s\/ E. Wayne Lundhagen ------------------------------- E. Wayne Lundhagen Vice President, Finance and Accounting\nPursuant to the requirements of the 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* Incorporated herein by reference. ** Included in SEC and NYSE copies only. *** Such report is being furnished for the information of the Securities and Exchange Commission only and is not to be deemed filed as a part of this annual report on Form 10-K **** Included in SEC copy only.","section_15":""}
{"filename":"706003_1994.txt","cik":"706003","year":"1994","section_1":"Item 1. Business\nGeneral Development of Business\nHutton\/GSH Commercial Properties 2 (the \"Registrant\" or the \"Partnership\") is a Virginia limited partnership organized pursuant to a Certificate and Agreement of Limited Partnership dated September 1, 1983, of which Real Estate Services VII, Inc. (\"RE Services\"), formerly Hutton Real Estate Services VII, Inc. (see Item 10. \"Certain Matters Involving Affiliates\"), and HS Advisors III, Ltd. (\"HS Advisors\") are the general partners (together, the \"General Partners\"). The Registrant is engaged in the business of acquiring, operating and holding for investment commercial properties, including office and light industrial buildings.\nCommencing June 3, 1983, the Registrant began offering through E.F. Hutton & Company Inc. up to a maximum of 100,000 units of limited partnership interests (the \"Units\") at $500 per Unit. The Units were registered under the Securities Act of 1933, as amended, under Registration Statement No. 2-79072, which Registration Statement was declared effective on June 3, 1983. The offering of Units was terminated on September 1, 1983. Upon the termination of the offering the Registrant had accepted subscriptions for 100,000 Units for an aggregate of $50,002,000, including the General Partners' capital contributions. As of November 30, 1994, all of the proceeds available for investment in real estate have been invested or committed for investment.\nSince the inception of operations, the Registrant has acquired and disposed of an interest as the general partner in the following limited partnerships: (i) 14800 Quorum Associates, Ltd., a Texas limited partnership formed to own and operate the Quorum I Office Building, and (ii) First Trade Center Office Associates, a Maryland limited partnership formed to own and operate Maryland Trade Center Building II. The Registrant had also acquired interests in the following joint ventures: (i) Two Financial Centre Associates Joint Venture, an Arkansas joint venture partnership formed to own and operate Two Financial Centre, (ii) Maitland Building C Joint Venture, a Florida joint venture partnership formed to own and operate Maitland Center Office Building C, and (iii) Gamma Building Associates Joint Venture, a California joint venture partnership formed to own and operate Swenson Business Park - Building C. For further descriptions of the properties see Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nDescription of Properties incorporated by reference to the section entitled Property Profiles & Leasing Update on pages 3 - 4 in the Partnership's Annual Report to Unitholders for the year ended November 30, 1994 filed as an exhibit under Item 14 and Note 5 \"Real Estate Investments\" of the Notes to the Consolidated Financial Statements.\nDiscussion on material leases at Properties incorporated by reference to Note 5 \"Real Estate Investments\" of the Notes to the Consolidated Financial Statements and the section entitled Property Profiles & Leasing Update on pages 3 - 4 of the Partnership's Annual Report to Unitholders for the year ended November 30, 1994 filed as an exhibit under Item 14.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNeither the Registrant nor any of the Properties is subject to 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 November 30, 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 Registrant's Limited Partnership Units and Related Unitholder Matters\nAs of November 30, 1994, the number of holders of Units was 3,768. No public trading market has developed for the Units, and it is not anticipated that such a market will develop in the future.\nCash distributions paid to the Limited Partners for the two years ended November 30, 1994 incorporated by reference to the section entitled Message to Investors on page 1 of the Partnership's Annual Report to Unitholders for the year ended November 30, 1994 filed as an exhibit under Item 14.\nItem 6.","section_6":"Item 6. Selected Financial Data\nIncorporated by reference to the section entitled Financial Highlights on page 5 of the Partnership's Annual Report to Unitholders for the year ended November 30, 1994 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 - ------------------------------- The Registrant had cash and cash equivalents at November 30, 1994 of $2,524,376 compared with $640,153 at November 30, 1993. The $1,884,223 increase is a result of the redemption of the short-term investment in the amount of $3,584,400 and net cash provided by operations in the amount of $1,982,994, partially offset by cash distributions totaling $3,434,343 and capital expenditures in the amount of $248,828. The Registrant also had a restricted cash balance of $160,341 at November 30, 1994 which is primarily made up of security deposits. The Registrant expects sufficient cash flow from operations to be generated to meet its current operating requirements.\nAt Two Financial Centre, a lease with a major tenant occupying 47,919 square feet and providing 19% of consolidated rental revenues is scheduled to vacate the property upon expiration of its lease in June 1995. Details of the tenant's scheduled vacancy and a discussion of material leases at all of the Partnership's properties are incorporated by reference to the section entitled Message to Investors and Property Profiles & Leasing Update contained in the Partnership's Annual Report to Unitholders for the year ended November 30, 1994 filed as an exhibit under Item 14.\nThe Registrant paid cash distributions to the Limited Partners of $34 per Unit for the year ended November 30, 1994, including a distribution of $4.25 per Unit for the fourth quarter, which was paid on January 25, 1995. Distributions represent a return of capital from the sale of Maryland Trade Center in 1989. A portion of the proceeds at the time of the sale were retained to fund any operating deficits, tenant improvements and leasing commissions required at the Partnership's remaining properties. At November 30, 1994, the remaining cash reserve balance from the sale of Maryland Trade Center is approximately $364,000. Future cash distributions will be funded from the remaining reserve balance and cash flow from operations. In order to fund leasing commissions and tenant improvements associated with the scheduled vacancy of a major tenant at Two Financial Centre, cash distributions will be reduced commencing with the first quarter of 1995. The General Partners anticipate reducing the quarterly distribution rate to an amount approximating cash flow generated by the Maitland and Swenson properties, approximately $3 per Unit. Details regarding the anticipated reduction in cash distributions is incorporated by reference to the section entitled Message to Investors contained in the Partnership's Annual Report to Unitholders for the year ended November 30, 1994 filed as an exhibit under Item 14.\nResults of Operations - --------------------- 1994 Versus 1993 - ---------------- Operations resulted in net income of $673,843 for the year ended November 30, 1994, compared to $396,332 in 1993. The increase in net income is primarily attributable to a 12% increase in rental revenues resulting from higher occupancy levels and rental rates at Maitland Center Office Building C and Two Financial Centre. Interest income totaled $116,399 for the year ended November 30, 1994, compared with $157,442 for the year ended November 30, 1993. The decrease is primarily due to a lower cash balance, reflecting the payment of a special distribution to Limited Partners, totaling $1.7 million on April 22, 1994.\nProperty operating expenses increased from $1,403,438 for the year ended November 30, 1993 to $1,427,276 in 1994 primarily as a result of an increase in insurance premiums for all properties. Depreciation and amortization expense totaled $1,369,956 for the year ended November 30, 1994, compared with $1,314,719 in 1993. The slight increase in 1994 reflects additional depreciation for building and tenant improvements completed at Maitland Center Office Building C and Two Financial Centre in 1994. General and administrative - - affiliates totaled $95,395 for the year ended November 30, 1994, compared with $110,126 in 1993. The decrease is due to a decrease in salary and overhead reimbursements. General and administrative - other totaled $93,703 for the year ended November 30, 1994, compared with $120,555 in 1993. The decrease is primarily due to a decrease in travel expenses, professional fees and printing and postage costs.\nAs of November 30, 1994, occupancy levels at each of the properties were as follows: Two Financial Centre - 100%; Maitland Center Office Building C - 95%; and Swenson Business Park, Building C - 100%.\n1993 Versus 1992 - ---------------- Operations resulted in net income of $396,332 for the year ended November 30, 1993, compared with net income of $89,855 in 1992. The increase in net income is primarily attributable to an increase in rental income in 1993.\nRental income increased 24% in 1993, as compared with 1992, primarily as a result of the lease execution with Asante Technologies, Inc. in September 1992 for 100% of Swenson Business Park Building C. The property had previously been vacant since July 1991. To a lesser extent, rental income increased in 1993 due to higher occupancy at the Registrant's other two properties. Interest income totalled $157,442 for the year ended November 30, 1993, compared with $261,640 for the year ended November 30, 1992. The decrease is largely the result of the Registrant's lower cash and cash equivalents balance and lower interest rates. The Registrant recognized other income of $21,187 for the period ended November 30, 1993, compared with $133,653 for the corresponding 1992 period. Other income was higher in 1992 primarily as a result of the sale of the Registrant's Arix stock. Information pertaining to the sale of Arix stock is incorporated by reference to Note 9 \"Arix Stock\" of the Registrant 's Annual Report to Unitholders for the year ended November 30, 1994 filed as an exhibit under Item 14.\nProperty operating expenses increased 8% in 1993. Property operating expenses were higher in 1993 primarily due to increased costs associated with higher occupancy at the Registrant's properties. Depreciation and amortization expense totaled $1,314,719 for the period ended November 30, 1993, compared with $1,247,967 for the corresponding period in 1992. The slight increase in 1993 reflects additional depreciation for building improvements at the Swenson property and the amortization of the Asante leasing commission, which was capitalized during the fourth quarter of 1992. General and administrative expenses totaled $230,681 for the year ended November 30, 1993, compared with $255,569 for the corresponding period in 1992. The decrease is largely due to the cessation of legal activity relating to the Arix default, reduced salary reimbursements, and lower printing and postage expenses.\nAs of November 30, 1993, lease levels at each of the properties were as follows: Two Financial Centre - 98%; Maitland Center Office Building C - 88%; and Swenson Business Park, Building C - 100%.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nSee list of Financial Statements and Financial Statement Schedules under Item 14 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 and directors. RE Services and HS Advisors, the co-General Partners of the Registrant, jointly manage and control the affairs of the Registrant.\nReal Estate Services VII, Inc. - ------------------------------ Real Estate Services VII, Inc., formerly known as Hutton Real Estate Services VII, Inc., is a Delaware corporation formed on August 2, 1982 and is an indirect wholly-owned subsidiary of Lehman Brothers Inc. (\"Lehman\"). The names and ages of, as well as the positions held by, the directors and executive officers of RE Services are set forth below. There are no family relationships between any officer or director and any other officer or director.\nCertain officers and directors of RE Services 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 bankruptcy petitions own real estate which has been adversely affected by the economic conditions in the markets in which that real estate is located and, consequently, the partnerships sought the protection of the bankruptcy laws to protect the partnership's assets from loss through foreclosure.\nName Age Office Rocco F. Andriola 36 Director, President, Chief Executive Officer Chief Operating Officer and Chief Financial Officer Michael Marron 31 Vice President Ken Zakin 47 Director William Caulfield 35 Vice President\nRocco F. Andriola, 36, 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. from Fordham University, a J.D. from New York University School of Law, and an LL.M in Corporate Law from New York University's Graduate School of Law.\nMichael Marron, 31, is a Vice President of Lehman Brothers and has been a member of the Diversified Asset Group since 1990. Prior to joining Lehman Brothers, Mr. Marron was associated with Peat Marwick Mitchell & Co. serving in both its audit and tax divisions from 1985 to 1989. Mr. Marron received a B.S. degree in accounting from the State University of New York at Albany in 1985 and is a Certified Public Accountant.\nKenneth L. Zakin, 47, is a Senior Vice President of Lehman Brothers and has held such title since November 1988. He is currently a senior manager in Lehman Brothers' Diversified Asset Group and was formerly group head of the Commercial Property Division of Shearson Lehman Brothers' Direct Investment Management Group responsible for the management and restructuring of limited partnerships owning commercial properties throughout the United States. From January 1985 through November 1988, Mr. Zakin was a Vice President of Shearson Lehman Brothers Inc. Mr. Zakin is a director of Lexington Corporate Properties, Inc. He is a member of the Bar of the State of New York and previously practiced as an attorney in New York City from 1973 to 1984 specializing in the financing, acquisition, disposition, and restructuring of real estate transactions. Mr. Zakin is currently an associate member of the Urban Land Institute and a member of the New York District Council Advisory Services Committee. He received a Juris Doctor degree from St. John's University School of Law in 1973 and a B.A. degree from Syracuse University in 1969.\nWilliam Caulfield, 35, is a Vice President of Lehman Brothers and is responsible for investment management of commercial real estate in the Diversified Asset Group. Prior to the Shearson\/Hutton merger in 1988, Mr. Caulfield was a Senior Analyst with E.F. Hutton since October 1986 in Hutton's Partnership Administration Group. Before joining Hutton, Mr. Caulfield was a Business Systems Analyst at Eaton Corp. from 1985 to 1986. Prior to Eaton, he was an Assistant Treasurer with National Westminster Bank USA. Mr. Caulfield holds a B.S. degree in Finance from St. John's University and an M.B.A. from Long Island University.\nHS Advisors - ----------- HS Advisors is a California limited partnership formed on August 11, 1982, the sole general partner of which is Hogan Stanton Investment, Inc. (\"HS Inc.\"), a wholly-owned subsidiary of GSH. The names and ages of, as well as the positions held by, the directors and executive officers of HS Inc. are as set forth below. There are no family relationships between or among any officer and any other officer or director.\nName Age Office Robert M. Stanton 55 Chairman of the Board, Principal Executive Officer Stewart H. Buckle, III 41 President Mark P. Mikuta 41 Treasurer, Secretary\nRobert M. Stanton is Chairman and Chief Executive Officer of Goodman Segar Hogan, Inc., a diversified commercial real estate company headquartered in Norfolk, Virginia. Mr. Stanton joined Goodman Segar Hogan in 1966, was named to the company's board of directors in 1972 and was named President and Chief Executive Officer in 1975. Early in 1990, he assumed the position of Chairman and CEO of the company, responsible for managing the brokerage, management and development divisions. Mr. Stanton currently serves as a Trustee of the Urban Land Institute (ULI) and chair of the Commercial and Retail Development Council. He is a past Trustee and State Director of the International Council of Shopping Centers (ICSC). He was chairman of the 1981 edition of The Dollars and Cents of Shopping Centers, published by ULI. He also served on the Board of Editors of the 1979 edition. Mr. Stanton co-authored The Valuation of Shopping Centers, published by the American Institute of Real Estate Appr aisers. Currently, he serves on the advisory board of Norfolk Southern Corporation and on the board of directors of Forward Hampton Roads, the Future of Hampton Roads and Greater Norfolk Corporation. He holds the Certified Property Manager (CPM) designation conferred by the Institute of Real Estate Management, as well as the Certified Shopping Center Manager (CSM) designation conferred by the International Council of Shopping Centers. Mr. Stanton also serves as Chairman of American Storage Properties and as Managing Partner of Bayville Holstein Associates. A graduate of Old Dominion University with a B.A. Degree in Banking and Finance, he served as Rector of the Board of Visitors. Active in civic affairs, Mr. Stanton was named First Citizen of Virginia Beach in 1976.\nStewart H. Buckle, III is President of Goodman Segar Hogan, Inc. He is responsible for the company's finance, asset management and acquisition divisions. Prior to his promotion to President, Mr. Buckle served as the company's Director of Acquisitions and Project Finance. Before joining Goodman Segar Hogan, Inc. in 1986, he was Project Manager for Essex Financial Group in 1985 and Vice President of Elizabeth River Terminals from 1983 to 1985. He had also held the position of Vice President of Lance J. Eller, Inc. and Senior Accountant at Price Waterhouse & Company. Mr. Buckle received his bachelor of science degree in accounting from Virginia Polytechnic Institute and State University in 1974 and his MBA from University of Colorado in 1977. He is a member of the Urban Land Institute and the International Council of Shopping Centers.\nMark P. Mikuta is Chief Financial Officer of Goodman Segar Hogan, Inc. and is Controller of Dominion Capital, Inc., a wholly-owned subsidiary of Dominion Resources. Mr. Mikuta joined Dominion Resources in 1987. Prior to joining Dominion Resources, he was an internal auditor with Virginia Commonwealth University in Richmond, Virginia from 1980 - 1987 and an accountant with Coopers & Lybrand from 1977 - 1980. Mr. Mikuta earned a bachelor of science degree in accounting from the University of Richmond in 1977. He is a Certified Public Accountant (CPA) and Certified Financial Planner (CFP) in the state of Virginia and a member of the American Institute of Certified Public Accountants.\nCertain Matters Involving Affiliates - ------------------------------------ On July 31, 1993 Shearson Lehman Brothers sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson Lehman Brothers Inc. changed its name to Lehman Brothers Inc. The transaction did not affect the ownership of the General Partners. However, the assets acquired by Smith Barney included the name \"Hutton.\" Consequently the Hutton Real Estate Services VII, Inc. general partner changed its name to Real Estate Services VII, Inc. to delete any reference to \"Hutton.\"\nOn August 1, 1993, GSH transferred all of its leasing, management and sales operations to Goodman Segar Hogan Hoffler, L.P., a Virginia limited partnership (\"GSHH\"). On that date, the leasing, management and sales operations of a portfolio of properties owned by the principals of Armada\/Hoffler (\"HK\") were also obtained by GSHH. The General Partner of GSHH is Goodman Segar Hogan Hofflerr, Inc., a Virginia corporation (\"GSHH Inc.\"), which has a 1% interest in GSHH. The stockholders of GSHH Inc. are GSH with a 62% interest and H.K. Associates, L.P., and affiliate of HK, with a 38% interest. The remaining interests in GSHH are limited partnership interests owned 50% by GSH and 49% by HK. The transaction did not affect the ownership of the General Partners.\nItem 11.","section_11":"Item 11. Executive Compensation\nNeither of the General Partners nor any of their directors and officers received any compensation from the Registrant. See Item 13 below with respect to a description of certain transactions of the General Partners and their affiliates with the Registrant.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nSecurity Ownership of Certain Beneficial Owners - ----------------------------------------------- As of November 30, 1994, no person was known by the Registrant to be the beneficial owner of more than 5% of the Units of the Registrant.\nChanges In Control - ------------------ The Registrant has been advised by representatives of HS Advisors that the following transactions occurred on October 19, 1992 resulting in an indirect change of control of HS Advisors and, therefore, of the Registrant. Capital stock of Stanton Associates, Inc., a Virginia Corporation (\"Stanton\"), which indirectly owns 100% of the capital stock of the sole general partner of HS Advisors, was acquired by Dominion Capital, Inc., a Virginia Corporation (\"Dominion Capital\"). The shares were acquired in connection with a restructuring of indebtedness owed by Stanton to Dominion Capital. On October 19, 1992, Dominion Capital acquired 51,993 shares of common stock of Stanton upon conversion of series A convertible preferred stock and, thereafter, acquired from Stanton an additional 387,418 shares of common stock of Stanton, resulting in Dominion Capital's owning approximately 83% of the outstanding common stock of Stanton. As a result of these transactions, Dominion Capital now has direct or indirect control of legal entities that own, in whole or in part, over 5 million square feet of commercial real estate, which is in addition to other real estate interests previously held by Dominion Capital. Since, as a result of these transactions, Dominion Capital has the indirect power to control HS Advisors, a change of control of Registrant is deemed to have occurred. The consideration received by Stanton for the issuance of 387,417 shares consisted of a covenant on the part of Dominion Capital not to sue on an aggregate of $7,473,567.44 owed to Dominion Capital by Stanton so long as certain conditions are met by Stanton. No borrowings were incurred in connection with the transactions.\nTo the knowledge of the Registrant, there are no arrangements or understandings between Dominion Capital and Stanton with respect to the selection of General Partners of the Registrant or other matters regarding the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nPursuant to the Certificate and Agreement of Limited Partnership of the Registrant, for the year ended November 30, 1994, $6,738 of the Registrant's net income was allocated to the General Partners ($4,782 to RE Services and $1,956 to HS Advisors). 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 75 through 78 of the Prospectus of Registrant dated June 3, 1983 (the \"Prospectus\"), contained in Amendment No. 2 to Registrant's Registration Statement No. 2-79072, under the section captioned \"Profits and Losses and Cash Distributions,\" which section is incorporated herein by reference thereto.\nThe Registrant may enter into one or more property management agreements with GSH pursuant to which GSH will provide certain property management services with respect to certain Properties owned by the Registrant or its joint ventures. For such services GSH will be entitled to receive a management fee as described under the section captioned \"Investment Objectives and Policies -- Management of Properties\" on page 36 of the Prospectus, which section is incorporated herein by reference thereto.\nPursuant to Section 12(g) of the Registrant's Certificate and Agreement of Limited Partnership, the General Partners and certain affiliates may be reimbursed by the Registrant for certain costs as described on page 16 of the Prospectus, which description is incorporated herein by reference thereto. TSSG provides partnership accounting and investor relations services for the Registrant. Prior to May 1993, these services were provided by an affiliate of one of the General Partners. The Registrant's transfer agent and certain tax reporting services are provided by Service Data Corporation. Disclosure relating to amounts paid to the General Partners or their affiliates during the past three years is incorporated by reference to Note 4 \"Transactions With the General Partners and Affiliates\" of Notes to Consolidated Financial Statements contained in the Partnership's Annual Report to Unitholders for the year ended November 30, 1994 filed as an exhibit under Item 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: Page Number (1) Financial Statements:\nReport of Independent Auditors (1)\nConsolidated Balance Sheets - At November 30, 1994 and 1993 (1)\nConsolidated Statements of Partners' Capital (Deficit) - For the years ended November 30, 1994, 1993 and 1992 (1)\nConsolidated Statements of Operations - For the years ended November 30, 1994, 1993 and 1992 (1)\nConsolidated Statements of Cash Flows - For the years ended November 30, 1994, 1993 and 1992 (1)\nNotes to Consolidated Financial Statements (1)\n(2) Financial Statement Schedules:\nSchedule III - Real Estate and Accumulated Depreciation\nNo other schedules are presented because either the information is not applicable or is included in the financial statements or notes thereto.\n(1) Incorporated by reference to the Partnership's Annual Report to Unitholders for the year ended November 30, 1994, which is filed as an exhibit under Item 14.\n(a)(3) See Exhibit Index contained herein.\n(4)(A) Certificate and Agreement of Limited Partnership (included as, and incorporated herein by reference to, Exhibit A to the Prospectus of Registrant dated June 3, 1983, contained in Amendment No. 2 to the Registration Statement, No. 2-79072, of Registrant filed June 1, 1983).\n(4)(B) Subscription Agreement and Signature Page (included as, and incorporated herein by reference to, Exhibit 3.1 to Amendment No. 1 to Registration Statement No. 2-79072 of Registrant filed May 25, 1983).\n(10)(A) Funding Commitment relating to Maitland Center Office Building C, and the exhibits thereto (included as, and incorporated herein by reference to, Exhibit (10)(A) to the Registrant's Annual Report on Form 10-K filed February 28, 1984).\n(10)(B) Agreement for Purchase and Sale relating to Quorum I Office Building, and the exhibits thereto (included as, and incorporated herein by reference to, Exhibit 28 to the Registrant's Current Report on Form 8-K filed on or about February 22, 1984).\n(10)(C) Agreements relating to Maryland Trade Center Building II (included as, and incorporated herein by reference to, Exhibit (10)(C) to the Registrant's Annual Report on Form 10-K filed February 28, 1985 (the \"1984 Annual Report\")).\n(10)(D) Funding Commitment relating to Swenson Business Park Building C (included as, and incorporated herein by reference to, Exhibit (10)(D) to the 1984 Annual Report).\n(10)(E) Agreements relating to Two Financial Centre Office Building (included as, and incorporated herein by reference to, Exhibit (10)(E) to the 1984 Annual Report).\n(13) Annual Report to the Unitholders for the year ended November 30, 1994.\n(23) Consent of Independent Auditors\n(28) Portions of Prospectus of Registrant dated June 3, 1983 (included as, and incorporated herein by reference to, Exhibit (28) to the Registrant's Annual Report on Form 10-K filed February 27, 1988).\n(b)(3) Reports on Form 8-K:\nNo reports on Form 8-K were filed in the fourth quarter of the 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.\nDated: February 27, 1995 HUTTON\/GSH COMMERCIAL PROPERTIES 2 BY: HS Advisors III, Ltd. General Partner\nBY: Hogan Stanton Investment, Inc. General Partner\nBY: \/s\/Robert M. Stanton Name: Robert M. Stanton Title: Chairman of the Board\nBY: Real Estate Services VII, Inc. General Partner\nBY: \/s\/Rocco F. Andriola Name: Rocco F. Andriola Title: Director, President, Chief Executive Officer, Chief Operating Officer 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 capabilities and on the dates indicated.\nREAL ESTATE SERVICES VII, INC. A General Partner\nDate: February 27, 1995 BY: \/s\/Rocco F. Andriola Rocco F. Andriola Director, President, Chief Executive Officer, Chief Operating Officer and Chief Financial Officer\nDate: February 27, 1995 BY: \/s\/Kenneth L. Zakin Kenneth L. Zakin Director\nDate: February 27, 1995 BY: \/s\/Michael T. Marron Michael T. Marron Vice President\nDate: February 27, 1995 BY: \/s\/William Caulfield William Caulfield 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.\nHS ADVISORS III, LTD. A General Partner\nDate: February 27, 1995 BY: \/s\/Robert M. Stanton Robert M. Stanton Chairman of the Board of Hogan Stanton Investment, Inc., as general partner of HS Advisors III, Ltd.\nDate: February 27, 1995 BY: \/s\/Stewart H. Buckle, III Stewart H. Buckle, III President, Asst. Treasurer, and Asst. Secretary of Hogan Stanton Investment, Inc., as general partner of HS Advisors III, Ltd.\nDate: February 27, 1995 BY: \/s\/Mark P. Mikuta Mark P. Mikuta Treasurer and Secretary - ------------ Schedule III - ------------ HUTTON\/GSH COMMERCIAL PROPERTIES 2\nSchedule III - Real Estate and Accumulated Depreciation\nNovember 30, 1994\nCost Capitalized Subsequent Initial Cost to Partnership To Acquisition --------------------------- ----------------\nBuildings and Buildings and Description Encumbrances(1) Land Improvements Improvements - ------------------- -------------- ---------- ------------- ------------- Commercial Property: Consolidated Ventures:\nTwo Financial Centre Little Rock, AR $7,993,146 $1,560,092 $9,583,430 $ 943,769\nMaitland Building C Orlando, FL -- 1,395,606 6,526,619 1,288,296\nSwenson C San Jose, CA -- 2,261,180 5,650,552 420,140 ---------- --------- ---------- --------- $7,993,146 $5,216,878 $21,760,601 $2,652,205 ========== ========= ========== =========\nGross Amount at Which Carried at Close of Period\nBuildings and Accumulated Description Land Improvements Total Depreciation - ------------------ --------- ----------- ---------- ------------ Commercial Property: Consolidated Ventures:\nTwo Financial Centre Little Rock, AR $1,560,092 $10,527,199 $12,087,291 $(4,476,056)\nMaitland Building C Orlando, FL 1,395,606 7,814,915 9,210,521 (3,216,063)\nSwenson C San Jose, CA 2,261,180 6,070,692 8,331,872 (2,212,894) --------- ---------- ---------- ---------- $5,216,878 $24,412,806 $29,629,684 $(9,905,013)(3) ========= ========== ========== ==========\nLife on which Depreciation in Latest Date of Date Income Statements Description Construction Acquired is Computed (4) - --------------- ------------ -------- ----------------- Commercial Property: Consolidated Ventures:\nTwo Financial Centre Little Rock, AR 1981 03\/29\/84 20 - 25 years\nMaitland Building C Orlando, FL 1984 09\/18\/84 20 - 25 years\nSwenson C San Jose, CA 1985 05\/06\/85 20 - 25 years\n(1) Property secures notes payable to the Partnership and is eliminated in consolidation. (2) For Federal income tax purposes, the aggregate cost of land, building and improvements is $30,523,646. (3) For Federal income tax purposes, the amount of accumulated depreciation is $15,454,337. (4) Improvements are depreciated over the terms of the respective leases, which range from one to twenty years.\nA reconciliation of the carrying amount of real estate and accumulated depreciation for the years ended November 30, 1994, 1993 and 1992:\nReal estate investments: 1994 1993 1992 ---------- ---------- ---------- Beginning of year $30,274,819 $29,629,169 $29,160,846 Additions 248,828 645,650 468,323 Less Retirements (893,963) -- -- ---------- ---------- ---------- End of year $29,629,684 $30,274,819 $29,629,169 ========== ========== ========== Accumulated Depreciation:\nBeginning of year $ 9,582,110 $ 8,392,182 $ 7,234,495 Depreciation expense 1,216,866 1,189,928 1,157,687 Less Retirements (893,963) -- -- ---------- ---------- ---------- End of year $ 9,905,013 $ 9,582,110 $ 8,392,182 ========== ========== ==========\n- ---------- Exhibit 13 - ---------- Hutton\/GSH Commercial Properties 2 - 1994 Annual Report\nHutton\/GSH Commercial Properties 2 is a limited partnership formed in 1983 to acquire, operate and hold for investment commercial real estate. The Partnership's investments currently consist of three commercial office buildings. Provided below is a comparison of lease levels at the properties as of November 30, 1994 and 1993.\nPercentage Leased Property Location 1994 1993\nSwenson Business Park - Building C San Jose, CA 100% 100% Two Financial Centre Little Rock, AR 100% 98% Maitland Center Office Building C Orlando, FL 95% 88%\nAdministrative Inquiries Performance Inquiries\/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 1 Message to Investors\n3 Property Profiles & Leasing Update\n5 Financial Highlights\n6 Consolidated Financial Statements\n9 Notes to Consolidated Financial Statements\n13 Report of Independent Auditors\n14 Net Asset Valuation\nMessage to Investors We are pleased to present the 1994 Annual Report for Hutton\/GSH Commercial Properties 2 (the \"Partnership\"). Partnership operations over the past few years have been characterized by relatively stable or improving performance at each of the Partnership's properties. Leasing progress at Two Financial Centre and Maitland Center Office Building C resulted in the properties being 100% and 95% leased, respectively, as of year-end 1994 and Swenson Business Park, Building C remains 100% leased. While we are pleased with this performance, 1995 is expected to be a particularly challenging year for the Partnership since the primary tenant at Two Financial Centre will vacate the building upon expiration of its lease in June 1995. Please refer to the Property Profiles and Leasing Update section of this report for additional information regarding the operating performance of each of the properties.\nCash Distributions The Partnership paid cash distributions to Limited Partners totaling $34 per Unit for the year ended November 30, 1994, including a fourth quarter cash distribution of $4.25 per Unit that was either credited to your brokerage account or sent directly to you on January 25, 1995. The total amount includes a special distribution of $17 per Unit, which was paid on April 22, 1994. All cash distributions made during the year, including the special distribution, represent a return of capital from the sale of the Maryland Trade Center property in 1989. As previously reported, a portion of the proceeds at the time of the sale were retained to fund any operating deficits, tenant improvements and leasing commissions required at the Partnership's remaining properties. Since inception, the Partnership has paid total cash distributions of $237.76 per original $500 Unit. Total cash distributions include return of capital payments in the amount of $179 per Unit which reduced the Unit size from $ 500 to $321.\n1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Total 1993 $4.25 $4.25 $4.25 $4.25 $17.00 1994 $4.25 $21.25(1) $4.25 $4.25 $34.00\n(1) Includes a special cash distribution of $17.00 per Unit paid on April 22, 1994.\nAs discussed in the Partnership's third quarter report, a major tenant occupying 47,919 square feet or approximately 42% of the leasable space at Two Financial Centre will vacate the premises upon the expiration of its lease on June 30, 1995. While we remain optimistic that the space can be ultimately re-leased, we are uncertain as to the timing of any new leases. In addition, it is unlikely that a single tenant can be secured for such a large amount of space and tenant improvement costs are likely to be higher as this large block of space is divided to accommodate smaller tenants. In anticipation of a decline in revenue and the expected leasing commissions and tenant improvement costs at this property, it is necessary to reduce Partnership cash distributions commencing with the first quarter distribution, payable in April. The General Partners anticipate that the quarterly distribution rate will be reduced to reflect the cash flow generated by the Maitland and Swenson properties. Additional information regarding this distribution will be included in the Partnership's first quarter report.\nMarket Overview The real estate industry, in general, continued its long recovery during 1994. The apartment complex and warehouse and distribution sectors exhibited the strongest performance, and certain types of commercial office space began to show signs of improvement. Specifically, the suburban office market has experienced declining vacancies and little new development. While the downtown office market continues to lag in the recovery, rental concessions have diminished, and rental rates have stabilized. As a result of these conditions, the national vacancy rate for commercial office space declined to approximately 17% as of the second quarter of 1994, down from approximately 19% as of the third quarter of 1993. The ongoing recovery of this market, however, is expected to be gradual, as technological advancements have made it easier and more efficient for traditional users of office space to work from home or satellite locations. As a result, a meaningful recovery in the value of office buildings is not anticipated in the immediate future.\nThe financing environment for commercial real estate also began to show signs of improvement during 1994. According to National Investor Survey, a CB Commercial publication, there are new sources of capital from commercial securitizations and mortgage conduits. Additionally, Emerging Trends in Real Estate indicated that traditional sources of capital such as pension funds, banks and, to a lesser degree, insurance companies are showing renewed interest in commercial real estate investment. It is important to note, however, that lenders are extremely selective in choosing their real estate investments, and there remains a gap between the supply and demand for funds, particularly with respect to the office sector. As a result, it is difficult for many potential buyers of commercial office space to obtain adequate financing, and sales opportunities remain limited.\nSummary While the consistently high occupancy rates at the Partnership's properties are encouraging, the Partnership faces significant challenges regarding the lease-up of the space scheduled to be vacated at Two Financial Center. It is anticipated that cash distributions will be maintained at a reduced rate until the majority of the vacant space is leased. Although the real estate market is gradually improving, a significant recovery in property values has yet to occur, and sales opportunities remain limited. The General Partners will continue to operate the Partnership's properties as effectively and efficiently as possible to ensure that they are well positioned for eventual sale. We will update you with respect to these efforts in future investor reports.\nVery truly yours,\nReal Estate Services VII, Inc. Hogan Stanton Investment, Inc. General Partner General Partner of HS Advisors III, Ltd.\n\/s\/ Rocco F. Andriola \/s\/Robert M. Stanton\nRocco F. Andriola Robert M. Stanton President Chairman\nFebruary 28, 1995 \t\nProperty Profiles & Leasing Update I. SWENSON BUSINESS PARK-BUILDING C San Jose, California\nSituated within a 65-acre business park which is located just north of central San Jose in California, Swenson Building C is a 90,145 square foot research and development facility providing an attractive location for many high technology companies due to its easy access to the San Jose Airport and Interstate 880.\nLeasing Update - Asante Technologies, Inc. (\"Asante\"), a designer of local area network products for Apple Computer's Macintosh line, leases 100% of the property pursuant to a five-year lease scheduled to expire in September 1997. The lease generated approximately 18% of the Partnership's consolidated revenues for 1994. Although Asante posted net income for its fiscal year ended September 30, 1994, the company incurred a loss during its last two quarters of fiscal 1994 and the first quarter of fiscal 1995. The company is currently seeking to expand and diversify its product line and remains current on its rental payments to the Partnership.\nMarket Update - While the entire Silicon Valley region continues to be adversely impacted by the downsizing of large corporations such as Hewlett Packard, the research and development (\"R&D\") market improved in 1994, as continued growth in the communications, software and biotechnology industries has offset declines in the defense, aerospace and electronics industries. As of the third quarter of 1994, the vacancy rate for the R&D sector in the Silicon Valley market declined to 10.8% from 12.9% a year earlier. San Jose benefitted from these improving conditions as demand for space increased. As a result, the vacancy rate in San Jose fell to 8.9% as of the third quarter of 1994, from 15.3% a year earlier. Despite this improvement, the area has not yet experienced any meaningful increase in rental rates and property values remain depressed.\nII. TWO FINANCIAL CENTRE Little Rock, Arkansas\nSituated in the Financial Centre Complex located in west Little Rock, Two Financial Centre is a 113,983 square foot, four-story brick office building. The property affords easy access to downtown Little Rock and the Little Rock Regional Airport, and is located near two interstate highways, I-630 and I-430. Several restaurants, hotels, hospitals and a country club are within the immediate vicinity.\nLeasing Update - As of November 30, 1994, the property was 100% occupied, compared to 98% a year earlier. Two leases were scheduled to expire in 1994. We are pleased to report that both tenants executed lease renewals during the year, including a tenant which expanded its space by 3,591 square feet. Additionally, a tenant which occupies 13,993 square feet or approximately 12% of the property's leasable space pursuant to a lease scheduled to expire January 30, 1995, executed a renewal at a slightly reduced rate.\nTwo of the property's leases generated rental income in excess of 10% of the Partnership's consolidated revenues for 1994. The first of these leases is with a tenant which occupies approximately 27,000 square feet or 24% of the property's leasable area pursuant to a ten-year lease scheduled to expire in July 1998. Rental income from this tenant for fiscal 1994 was approximately $443,323, or 13% of the Partnership's consolidated rental income.\nThe second lease is with a tenant occupying 47,919 square feet or approximately 42% of the property's leasable space pursuant to a lease scheduled to expire June 30, 1995. Rental income received from the tenant during fiscal 1994 was approximately $679,272, or 19% of the Partnership's consolidated rental income. The tenant intends to vacate the building upon expiration of its lease and move into a recently-completed build-to-suit corporate facility in west Little Rock. Although the General Partners have initiated an aggressive marketing campaign, it is unlikely that any single tenant can be found to re-lease the entire space. To date, our initiatives have generated interest in the space, however, there can be no assurance that new executed leases will result.\nMarket Update - The Little Rock office market improved somewhat in 1994 as a lack of new construction combined with an increase in demand for office space narrowed the gap between supply and demand. Although the overall vacancy rate for office property remained largely unchanged from 1993 at approximately 10%, average lease rental rates increased by approximately 3% during the year including the suburban submarket where the property is located. Vacancy rates in the suburban office market remained at approximately 7%, unchanged from 1993. Two Financial Centre's primary competitors include One Financial Centre, Three Financial Centre and First Little Rock Plaza. Occupancies at these properties as of the fourth quarter of 1994 were 93%, 90% and 97%, respectively. The property also competes with a nearby office park, Koger Executive Park, which had an average occupancy rate of 93% in the 1994 fourth quarter.\nIII. MAITLAND CENTER OFFICE BUILDING C Orlando, Florida\nMaitland Center Office Building C is a 98,096 square foot, three-story office building located in Maitland Center Office Park, a 230-acre development located in northwest metropolitan Orlando. The property features a brick and glass exterior.\nLeasing Update - The General Partners executed a new lease totaling 4,313 square feet, two lease renewals totaling 4,006 square feet, and three lease expansions totaling 4,320 square feet during 1994, resulting in an occupancy rate of 95% as of November 30, 1994, compared with 88% a year earlier. This leasing success is largely attributable to our ongoing aggressive marketing campaign along with improved leasing conditions in the Maitland Center office submarket.\nOne tenant, which leases 23,753 square feet of space pursuant to a lease originally scheduled to expire in January 1995, generated rental income in fiscal 1994 of approximately $309,000 or 8% of the Partnership's consolidated revenues. We are pleased to report that during the third quarter of 1994, this tenant executed a three-year lease renewal for 19,560 square feet.\nMarket Update - The Orlando office market improved in 1994 as the area benefitted from strong employment growth and a lack of new construction. As a result, the overall vacancy rate in Orlando declined to 13.1% as of December 31, 1994, the lowest level in seven years. The primary beneficiary of Orlando's improving conditions was the Maitland Center submarket, which is the largest submarket outside of downtown Orlando with approximately 3.6 million square feet of office space. Maitland Center boasted the lowest vacancy rate in the region at 6.7% in the fourth quarter of 1994, compared to 9.9% in 1993. With the increase in demand for office space, the use of rental concessions to attract prospective tenants has diminished. Rental rates, however, have not increased to any significant degree. Additionally, a substantial amount of space is expected to be added back to the Maitland Center submarket in 1995 as several large tenants move into newly-completed build-to-suit facilities.\nFinancial Highlights For the periods ended November 30, (dollars in thousands, except per Unit data)\n1994 1993 1992 1991 1990\nTotal Income $3,660 $3,345 $2,954 $3,242 $3,745 Net Income (Loss) 674 396 90 (283) 528 Total Assets 23,169 25,905 29,076 29,694 30,330 Net Cash From Operations 1,983 1,438 1,247 1,298 1,649 Net Income (Loss) per Limited Partnership Unit: 6.67 3.92 .89 (2.80) 5.22 Cash Distributions per Limited Partnership Unit: 34.00* 17.00* 30.00* -- --\n* Represent returns of capital associated with the sale of the Maryland Trade Center in 1989.\n1 The increase in Total Income, Net Income and Net Cash From Operations in 1994 is due to higher Rental Income. Rental Income increased 12% in 1994 primarily as a result of increased occupancy and rental rates at Maitland Center Office Building C and Two Financial Centre.\nConsolidated Balance Sheets November 30, 1994 and 1993\nAssets 1994 1993\nLand $ 5,216,878 $ 5,216,878 Buildings and improvements 24,412,806 25,057,941 ---------- ---------- 29,629,684 30,274,819 Less accumulated depreciation (9,905,013) (9,582,110) ---------- ---------- 19,724,671 20,692,709\nRestricted cash 160,341 186,259 Cash and cash equivalents 2,524,376 640,153 Short-term investment -- 3,584,400 --------- --------- 2,684,717 4,410,812\nRent and other receivables, net of allowance for doubtful accounts of $7,275 in 1994 and 1993 101,030 98,818 Prepaid expenses, net of accumulated amortization of $921,231 in 1994 and $768,141 in 1993 421,219 486,906 Deferred rent receivable 237,349 215,607 ---------- ---------- Total Assets $ 23,168,986 $ 25,904,852 ========== ==========\nLiabilities and Partners' Capital (Deficit)\nLiabilities: Accounts payable and accrued expenses $ 188,248 $ 161,318 Due to affiliates 71,670 78,502 Distribution payable 429,293 429,293 Security deposits payable 163,907 159,371 ---------- ---------- Total Liabilities 853,118 828,484\nPartners' Capital (Deficit): General Partners (203,413) (175,808) Limited Partners 22,519,281 25,252,176 ---------- ---------- Total Partners' Capital 22,315,868 25,076,368 ---------- ---------- Total Liabilities and Partners' Capital $ 23,168,986 $ 25,904,852 ========== ========== See accompanying notes to consolidated financial statements.\nConsolidated Statement of Partners' Capital (Deficit) For the years ended November 30, 1994, 1993 and 1992\nGeneral Limited Total Partners' Partners' Partners' Deficit Capital Capital ---------- ---------- ---------- Balance at November 30, 1991 $ (133,194) $29,470,851 $29,337,657 Net income 899 88,956 89,855 Distributions (30,100) (3,000,000) (3,030,100) ---------- ---------- ---------- Balance at November 30, 1992 (162,395) 26,559,807 26,397,412 Net income 3,963 392,369 396,332 Distributions (17,376) (1,700,000) (1,717,376) ---------- ---------- ---------- Balance at November 30, 1993 (175,808) 25,252,176 25,076,368 Net income 6,738 667,105 673,843 Distributions (34,343) (3,400,000) (3,434,343) ---------- ---------- ---------- Balance at November 30, 1994 $ (203,413) $22,519,281 $22,315,868 ========== ========== ========== See accompanying notes to the consolidated financial statements.\nConsolidated Statements of Operations For the years ended November 30, 1994, 1993 and 1992\nIncome 1994 1993 1992 - ---------- --------- --------- --------- Rent $3,538,864 $3,166,541 $2,558,379 Interest 116,399 157,442 261,640 Other 4,910 21,187 133,653 --------- --------- --------- Total Income 3,660,173 3,345,170 2,953,672\nExpenses - ---------- Property operating 1,427,276 1,403,438 1,298,528 Depreciation and amortization 1,369,956 1,314,719 1,247,967 General and administrative - affiliates 95,395 110,126 124,233 General and administrative - other 93,703 120,555 131,336 Bad debt expense -- -- 61,753 --------- --------- --------- Total Expenses 2,986,330 2,948,838 2,863,817 --------- --------- --------- Net Income $ 673,843 $ 396,332 $ 89,855 ========= ========= ========= Net Income Allocated:\nTo the General Partners $ 6,738 $ 3,963 $ 899 To the Limited Partners 667,105 392,369 88,956 --------- --------- --------- $ 673,843 $ 396,332 $ 89,855 ========= ========= ========= Per limited partnership unit (100,000 outstanding) $6.67 $3.92 $0.89 ========= ========= ========= See accompanying notes to the consolidated financial statements\nConsolidated Statements of Cash Flows For the years ended November 30, 1994, 1993 and 1992\nCash Flows from Operating Activities: 1994 1993 1992 --------- --------- --------- Net income $ 673,843 $ 396,332 $ 89,855 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,369,956 1,314,719 1,247,967 Increase (decrease) in cash arising from changes in operating assets and liabilities: Restricted cash 25,918 (19,503) (99,457) Rent and other receivables (2,212) (6,062) 111,853 Prepaid expenses (87,403) (170,796) (282,112) Deferred rent receivable (21,742) (70,197) 128,813 Accounts payable and accrued expenses 26,930 (8,776) (72,750) Due to affiliates (6,832) (14,042) 26,835 Security deposits payable 4,536 16,301 95,601 --------- --------- --------- Net cash provided by operating activities 1,982,994 1,437,976 1,246,605\nCash Flows from Investing Activities:\nAdditions to real estate assets (248,828) (645,650) (468,323) Short-term investment 3,584,400 2,535,594 409,392\nNet cash provided by (used for) --------- --------- --------- investing activities 3,335,572 1,889,944 (58,931)\nCash Flows from Financing Activities:\nDistributions (3,434,343) (3,560,608) (757,575) --------- --------- --------- Net cash used for financing activities (3,434,343) (3,560,608) (757,575)\nNet increase (decrease) in cash and --------- --------- --------- cash equivalents 1,884,223 (232,688) 430,099 Cash and cash equivalents at beginning of year 640,153 872,841 442,742 --------- --------- --------- Cash and cash equivalents at end of year $2,524,376 $ 640,153 $ 872,841 ========= ========= =========\nSupplemental Schedule of Non-Cash Investing Activity:\nWrite-off fully depreciated tenant improvements $ 893,963 $ -- $ -- ========= ========= ========= See accompanying notes to the consolidated financial statements.\nNotes to Consolidated Financial Statements November 30, 1994, 1993 and 1992\n1. Organization Hutton\/GSH Commercial Properties 2 (the \"Partnership\") was organized as a limited partnership under the laws of the Commonwealth of Virginia pursuant to a Certificate and Agreement of Limited Partnership dated and filed September 1, 1983 (the \"Partnership Agreement\"). The Partnership was formed for the purpose of making acquisitions in and operating certain types of commercial real estate. The General Partners of the Partnership are Real Estate Services VII, Inc., which is an affiliate of Lehman Brothers (see below), and HS Advisors, Ltd. (\"HS Advisors\"), which is an affiliate of Goodman Segar Hogan, Inc. (\"GSH\"). The Partnership will continue until December 31, 2010, unless terminated sooner in accordance with the terms of the Partnership Agreement.\nOn July 31, 1993, Shearson Lehman Brothers Inc. sold certain of its domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson Lehman Brothers Inc. changed its name to Lehman Brothers Inc. (\"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, Hutton Real Estate Services VII Inc., a general partner, changed its name to Real Estate Services VII Inc. (\"Real Estate Services\") to delete any reference to Hutton.\nOn August 1, 1993, GSH transferred all of its leasing, management and sales operations to Goodman Segar Hogan Hoffler, L.P., a Virginia limited partnership (\"GSHH\"). On that date, the leasing, management and sales operations of a portfolio of properties owned by the principals of Armada\/Hoffler (\"HK\") were also obtained by GSHH. The General Partner of GSHH is Goodman Segar Hogan Hoffler, Inc., a Virginia corporation (\"GSHH Inc.\"), which has a 1% interest in GSHH. The stockholders of GSHH Inc. are GSH with a 62% interest and H.K. Associates, L.P., an affiliate of HK, with a 38% interest. The remaining interests in GSHH are limited partnership interests owned 50% by GSH and 49% by HK. The transaction did not affect the ownership of the General Partners.\n2. Significant Accounting Policies\nConsolidation - The consolidated financial statements include the accounts of the Partnership and its ventures, Two Financial Centre Joint Venture, Swenson Building C Joint Venture and Maitland Building C, a wholly-owned property. Intercompany accounts and transactions between the Partnership and the ventures have been eliminated in consolidation.\nReal Estate Investments - Real estate investments, which consist of commercial office buildings, are recorded at cost less accumulated depreciation. Cost includes the initial purchase price of the property plus closing costs, acquisition and legal fees and capital improvements. Depreciation is computed using the straight-line method based on estimated useful lives of 20 to 25 years, except for tenant improvements, which are depreciated over the terms of the respective leases.\nLeases are accounted for as operating leases. Leasing commissions are amortized over the terms of the respective leases.\nDeferred rent receivable consists of rental income which is recognized on a straight-line basis over the terms of the respective leases but will not be received until later periods as a result of rent concessions.\nRestricted Cash - Restricted cash primarily represents cash held in connection with tenant security deposits.\nCash Equivalents - Cash equivalents consist of short-term highly liquid investments which have maturities of three months or less from the date of purchase.\nShort-term Investment - Short-term investment consists of a 30-day repurchase agreement collateralized by U.S. Treasury Notes. The investment was liquidated during 1994.\nIncome Taxes - No provision for income taxes has been made in the financial statements of the Partnership since such taxes are the responsibility of the individual partners, rather than of the Partnership.\nReclassifications - Certain balances in the 1993 and 1992 financial statements have been reclassified to conform to the 1994 presentation.\n3. The Partnership Agreement and Cash Distributions The Partnership Agreement provides that the net cash from operations, as defined, for each fiscal year will be distributed on a quarterly basis 99% to the limited partners and 1% to the general partners until each limited partner has received a 9% annual noncumulative return on his adjusted capital investment, as defined. The net cash from operations will then be distributed to the general partners until the general partners have received 10% of the aggregate net cash from operations distributed to all partners. Thereafter, net cash from operations will be distributed 90% to the limited partners and 10% to the general partners.\nNet proceeds from sales or refinancings shall 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 investment, as defined, and 10% cumulative annual return thereon, reduced by any net cash from operations actually distributed to such limited partner. The balance of net proceeds, if any, will then be distributed 85% to the limited partners and 15% to the general partners.\nUpon the dissolution and termination of the Partnership, the General Partners will be required to contribute to the Partnership an amount not to exceed 1% of the total capital contributions from all of the Partners of the Partnership less prior contributions of the General Partners. In no event shall the General Partners be obligated to contribute more than the negative balances in their respective capital accounts.\nThe Partnership paid cash distributions totalling $3,400,000 and $34,343 to the Limited and General Partners respectively, representing $34 per Limited Partnership Unit for the year ended November 30, 1994. An additional $429,293 has been accrued in 1994 for a distribution during the first quarter of 1995. The Partnership paid cash distributions totalling $3,525,000 and $35,608 to the Limited and General Partners respectively, representing $35.25 per Limited Partnership Unit for the year ended November 30, 1993. The cash distributions are funded from the Partnership's cash reserves and represent a return of capital from the sale of the Maryland Trade Center property in 1989. At November 30, 1994, the remaining reserve balance from the sale of the Maryland Trade Center property is approximately $364,000. Future cash distributions will be funded from the remaining reserve balance and cash flow from operations.\nThe timing and amount of future distributions will depend on several factors, including the adequacy of rental income being generated by current leases and Partnership cash flow.\nLosses and all depreciation and amortization for any fiscal year shall be allocated 99% to the limited partners and 1% to the general partners. Income before depreciation and amortization for any fiscal year and all gains from sales will be allocated in substantially the same manner as net cash from operations.\n4. Transactions with the General Partners and Affiliates The following is a summary of amounts paid or accrued to the General Partners during the years ended November 30, 1994, 1993, and 1992, respectively:\nUnpaid at November 30, Paid 1994 1994 1993 1992 ---------- ------- -------- -------- Reimbursement of: Administrative salaries and expenses $ 71,670 $ 96,920 $ 106,287 $ 114,004 -------- -------- -------- -------- $ 71,670 $ 96,920 $ 106,287 $ 114,004 ======== ======== ======== ========\nThe amounts listed on the previous page have been included in property operating and general and administrative expenses and were paid or accrued to the General Partners as follows:\nUnpaid at November 30, Paid 1994 1994 1993 1992 -------- -------- ------- -------- Real Estate Services VII $ 71,670 $ 69,116 $ 73,461 $ 81,994 HS Advisors -- 27,804 32,826 32,010 -------- -------- -------- -------- $ 71,670 $ 96,920 $ 106,287 $ 114,004 ======== ======== ======== ========\n5. Real Estate Investments Since inception, the Partnership has acquired five commercial office buildings through investments in joint ventures or limited partnerships with unaffiliated co-venturers, of which three remain:\nSquare Date Purchase Property Name Feet Location Acquired Price - -------------- ------- --------------- -------- ---------- Two Financial Centre 113,983 Little Rock, AR 3\/29\/84 $10,700,000 Maitland Building C 98,096 Orlando, FL 9\/18\/84 $ 8,770,000 Swenson Building C 90,145 San Jose, CA 5\/06\/85 $ 7,700,000\nThe joint venture agreements substantially provide that:\n(a) Net cash from operations will be distributed 100% to the Partnership until it has received an annual, noncumulative return on its capital contribution, as adjusted, ranging from 7% to 11%. Thereafter, any remaining cash from operations will be shared in a ratio relating to the various ownership interests of the Partnership. \t (b) Net proceeds from a sale or refinancing will be distributed 100% to the Partnership until it has received an annual, cumulative return ranging from 7% to 11% and an amount equal to 110% to 120% of its adjusted capital contribution. Any remaining balance will be shared in a ratio relating to the various ownership interests of the Partnership. \t (c) Taxable income of the joint ventures and limited partnerships will be allocated in substantially the same manner as net cash from operations. Taxable losses will generally be allocated to the Partnership in the same manner as net cash from operations for Swenson Building C. Taxable losses will generally be allocated 100% to the Partnership for Two Financial Centre.\nFor financial statement purposes, net income and net losses are allocated in the same manner as taxable income and taxable losses.\n6. Loan to Two Financial Centre Joint Venture The Two Financial Centre Joint Venture (\"TFC\") has provided a demand promissory note to the Partnership with a principal balance of $7,383,033 and which bears interest at 12% per annum, resulting in annual interest of $885,960. Monthly payments of interest only are due in arrears in the amount of $73,830. On September 17, 1993, TFC issued to the Partnership a new demand promissory note in the amount of $610,113 representing the unpaid accrued interest as of September 17, 1993 on the original principal balance of $7,383,033. The note bears interest at 8% per annum, resulting in annual interest of $48,809. Monthly interest of $4,067 is payable in arrears commencing October 17, 1993. As of November 30, 1994, accrued interest of $160,354 remains unpaid. Interest of $761,058, $1,165,821 and $674,870 has been paid by TFC to the Partnership during the fiscal years ended November 30, 1994, 1993 and 1992, respectively. All interest and principal activity and balances relating to the demand promissory notes are eliminated in consolidation for financial statement presentation purposes.\n7. Rental Income Under Operating Leases Future minimum rental income to be received on noncancellable operating leases as of November 30, 1994 is as follows:\n1995 $2,889,292 1996 2,331,729 1997 1,804,172 1998 796,664 1999 339,109 Thereafter 244,235 --------- $8,405,201\nLease terms range from one to ten years. The leases allow for increases in certain property operating expenses to be passed on to tenants.\nLeases to two tenants of TFC generated rental revenue in excess of 10% of the Partnership's consolidated rental revenues for the year ended November 30, 1994. The rental income derived from these leases for 1994 was $443,323 and $679,272, respectively, or 13% and 19% of the Partnership's 1994 consolidated rental income. As of November 30, 1994, both tenants are current in their rent payments. On June 30, 1995, the lease providing 19% of the Partnership's consolidated rental income is scheduled to expire. The tenant completed a build-to-suit corporate facility, which it will occupy subsequent to the expiration of its lease. As a result, the Partnership has initiated an aggressive marketing campaign to lease the vacated space.\nThe Partnership entered into a lease with Asante Technologies, Inc. (the \"Tenant\") pursuant to the terms of a lease agreement which became effective July 16, 1992. In accordance with the terms of the Lease Agreement, the Tenant was granted an allowance for Tenant Improvements in the amount of $315,508. The lease term is for five years. As a condition for approving the lease, the General Partners required the Tenant to pay a $100,000 security deposit. On September 14, 1992, the lease commenced and the Tenant occupied 100% of Swenson Building C. In addition to base rental payments, the Tenant shall pay as additional rent, real property taxes and insurance. Under the lease, the Partnership will record minimum annual rental revenue of $639,849. As of November 30, 1994, Asante has generated $638,847 or 18% of the Partnership's consolidated rental income and is current on its rent payments.\n8. Reconciliation of Net Income to Taxable Loss The net income reported in the financial statements for the year ended November 30, 1994 exceeded the taxable income reported to the partners by $249,093. The taxable loss reported to the partners for years ended November 30, 1993 and 1992 exceeded the net income reported in the financial statements by $449,370, and $272,656, respectively.\nThese differences are primarily due to the use of different methods of recording depreciation expense and rental income. The Partnership uses accelerated methods of depreciating real estate for tax purposes and the straight-line method for financial statement purposes. Rental income is recorded when received or receivable for tax purposes and on a straight-line basis for financial statement purposes.\n9. Swenson Building C - Arix Default In December 1991, Arix Corporation (\"Arix\"), the former tenant at Swenson Building C, filed for Chapter 11 bankruptcy protection from its creditors. Arix had occupied 100% of the Swenson property pursuant to a lease which expired on September 28, 1991. Pursuant to Arix's plan of reorganization, on April 14, 1992, the Partnership received 800,000 shares of Arix stock in lieu of $700,000 of rental payments which had been in default. A decrease in the market price of Arix's stock has resulted in the Partnership being unable to sell the stock for $700,000. As of December 12, 1992, the Partnership had sold all 800,000 shares of its Arix stock. The Partnership recognized proceeds of $12,212 and $98,760 net of brokerage commissions, respectively, included in other income for the years ended November 30, 1993 and 1992.\nREPORT OF INDEPENDENT AUDITORS The Partners Hutton\/GSH Commercial Properties 2 and Consolidated Ventures\nWe have audited the accompanying consolidated balance sheets of Hutton\/GSH Commercial Properties 2 and Consolidated Ventures as of November 30, 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 November 30, 1994. These financial statements and schedule are the responsibility of the Partnership 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 Hutton\/GSH Commercial Properties 2 and Consolidated Ventures at November 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 November 30, 1994, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nBoston, Massachusetts January 13, 1995\nComparison of Acquisition Costs to Appraised Value and Determination of Net Asset Value Per $321 Unit at November 30, 1994 (Unaudited)\nAcquisition Appraised Property Date of Acquisition Cost(1) Value(2) -------- --------- --------- Two Financial Centre (3) 03-29-84 $ 4,611,600 $ 1,006,854 Maitland Center Office Building C (4) 09-18-84 8,367,320 8,200,000 Swenson Business Park-Building C (5) 05-06-85 8,059,590 6,240,000\n$21,038,510 $15,446,854\nCash and cash equivalents 2,524,376 Interest and other receivables 101,030 Demand promissory notes receivable (6) 7,993,146 Prepaid expenses 71,903 ---------- 26,137,309 Less: Accounts payable and accrued expenses (188,248) Due to affiliates (71,670) Distribution payable (429,293) ---------- Partnership Net Asset Value (7) $25,448,098\nNet Asset Value Allocated: Limited Partners $25,193,617 General Partners 254,481 ---------- $25,448,098 ---------- Net Asset Value Per Unit (100,000 units outstanding) $251.94 ====== (1) Purchase price plus General Partners' acquisition fees.\n(2) This represents the Partnership's share of the November 30, 1994 Appraised Values which were determined by independent property appraisal firms. The Partnership's share of the November 30, 1994 Appraised Value takes into account the allocation provision of the joint venture agreements governing the distribution of sales proceeds for each of the properties.\n(3) The Acquisition Cost and the Partnership's share of the November 30, 1994 Appraised Value are net of the outstanding mortgage loan balance at the time of acquisition and the demand promissory note at November 30, 1994. The Acquisition Cost of $4,611,600 for Two Financial Centre is comprised of the acquisition fee paid to the General Partners and an amount required to fund the completion of tenant improvements and other capital items.\n(4) The Acquisition Cost of $8,367,320 for Maitland Center Office Building C is comprised of the acquisition fee paid to the General Partners and an amount required to fund the completion of tenant improvements and other capital items.\n(5) The Acquisition Cost of $8,059,590 for Swenson Business Park- Building C is comprised of the acquisition fee paid to the General Partners and an amount required to fund the completion of tenant improvements and other capital items.\n(6) The current principal balance of the demand promissory notes receivable from the Two Financial Centre Joint Venture is $7,993,146 as discussed in this report.\n(7) The Net Asset Value assumes a hypothetical sale at November 30, 1994 of all Partnership properties at their appraised values and the distribution of the proceeds of such sale, together with the Partnership's cash and the proceeds from temporary investments, to the Partners. Real estate brokerage commissions payable to the General Partners or others are not determinable at this time and have not been included in the determination. Since the Partnership would incur real estate brokerage commissions and other selling expenses in connection with the sale of its properties and other assets, cash available for distribution to the Partners would be less than the appraised Net Asset Value.\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. Because of the nature of the Partnership's properties and the existing market for such properties, there can be no assurance that the other properties reviewed by the appraiser are comparable. The appraised value does not reflect the actual costs which would be incurred in selling the property. 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 is likely to 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.\n- ---------- Exhibit 23 - ----------\nConsent of Independent Auditors\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of Hutton\/GSH Commercial Properties 2 of our report dated January 13, 1995, included in the 1994 Annual Report to Shareholders of Hutton\/GSH Commercial Properties 2 and Consolidated Ventures.\nOur audit also included the financial statement schedule of Hutton\/GSH Commercial Properties 2 and Consolidated Ventures listed in Item 14(a). This schedule is the responsibility of the Partnership's management. Our responsibility is to express an opinion based on our audits. 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 set forth therein.\nERNST & YOUNG LLP\nBoston, Massachusetts January 13, 1995","section_15":""}
{"filename":"812072_1994.txt","cik":"812072","year":"1994","section_1":"ITEM 1. BUSINESS\n(A) Background\nOn April 2, 1987, PLM Financial Services, Inc. (\"FSI\" or the \"General Partner\"), a wholly-owned subsidiary of PLM International, Inc. (\"PLM International\"), filed a Registration Statement on Form S-1 with the Securities and Exchange Commission with respect to a proposed offering of 7,500,000 limited partnership units (the \"Units\") in PLM Equipment Growth Fund II, a California limited partnership (the \"Partnership\", the \"Registrant\" or \"EGF II\"). The Partnership's offering became effective on June 5, 1987. FSI, as general partner, owns a 5% interest in the Partnership. The Partnership engages in the business of owning and leasing transportation equipment to be operated by and\/or leased to various shippers and transportation companies.\nThe Partnership was formed to engage in the business of owning and managing a diversified pool of used and new transportation-related equipment and certain other items of equipment. The Partnership's primary objectives are:\n(i) to acquire a diversified portfolio of long lived, low obsolescence, high residual value equipment with the net proceeds of the initial partnership offering, supplemented by debt financing if deemed appropriate by the General Partner. The General Partner intends to acquire the equipment at what it believes to be below inherent values and to place the equipment on lease or under other contractual arrangements with creditworthy lessees and operators of equipment;\n(ii) to generate sufficient net operating cash flow from lease operations to meet existing liquidity requirements and to generate cash distributions to the Limited Partners until such time as the General Partner commences the orderly liquidation of the Partnership assets or unless the Partnership is terminated earlier upon sale of all Partnership property or by certain other events;\n(iii) to selectively sell and purchase other equipment to add to the Partnership's initial equipment portfolio. The General Partner intends to sell equipment when it believes that, due to market conditions, market prices for equipment exceed inherent equipment values or expected future benefits from continued ownership of a particular asset will not equal or exceed other equipment investment opportunities. Proceeds from these sales, together with excess net cash flow from operations that remains after cash distributions have been made to the partners, will be used to acquire additional equipment throughout the intended seven year reinvestment phase of the Partnership;\n(iv) to preserve and protect the value of the portfolio through quality management, maintaining the portfolio's diversity and constantly monitoring equipment markets.\nThe offering of the Units of the Partnership closed on March 18, 1988. On November 20, 1990, the Units of the Partnership began trading on the American\nStock Exchange. Thereupon each Unitholder received a depositary receipt representing ownership of the number of Units owned by such Unitholder. As of December 31, 1994, there were 7,472,705 depositary units (\"Depositary Units\") outstanding (including 1,150 Depositary Units held in the Treasury). The General Partner contributed $100 for its 5% general partner interest in the Partnership.\nIt is anticipated that in the eleventh year of operations of the Partnership the General Partner will commence to liquidate the assets of the Partnership in an orderly fashion, unless the Partnership is terminated earlier upon sale of all Partnership property or by certain other events. Beginning after the Partnership's seventh year of operations which commences January 1, 1996, cash flow and surplus funds, if any, will not be reinvested and will be distributed to the partners.\nTable 1, below, lists the equipment and the cost of the equipment in the Partnership portfolio at December 31, 1994 (thousands of dollars):\nThe equipment is generally leased under operating leases with terms of one to six years. Some of the Partnership's marine containers and its 50% owned marine vessel are leased to operators of utilization-type leasing pools which include equipment owned by unaffiliated parties. In such instances, revenues received by the Partnership consist of a specified percentage of revenues generated by leasing the equipment to sub-lessees, after deducting certain direct operating expenses of the pooled equipment.\nAt December 31, 1994, 31% of the Partnership's trailer equipment operated in rental yards owned and maintained by PLM Rental, Inc., the short-term trailer rental subsidiary of PLM International. Revenues collected under short-term rental agreements with the rental yards' customers are distributed monthly to the owners of the related equipment. Direct expenses associated with the equipment, and an allocation of other direct expenses of the rental yard operations, are billed to the Partnership.\nThe lessees of the equipment include, but are not limited to: Carnival Airlines, Inc., DHL Airways, Inc., Trans Ocean Ltd., Union Pacific Railroad Company, Burlington Northern, and Cargill International. As of December 31, 1994, all of the equipment was either operating in short-term rental facilities, on lease, or under other contractual agreements except 266 containers and a tractor.\n(B) Management of Partnership Equipment\nThe Partnership has entered into an equipment management agreement with PLM Investment Management, Inc. (\"IMI\"), a wholly-owned subsidiary of FSI, for the management of the equipment. IMI agreed to perform all services necessary to manage the transportation equipment on behalf of the Partnership and to perform or contract for the performance of all obligations of the lessor under the Partnership's leases. In consideration for its services and pursuant to the Partnership Agreement, IMI is entitled to a monthly management fee (see Financial Statements, footnotes 1 and 2).\n(C) Competition\n(1) Operating Leases vs. Full Payout Leases\nGenerally, the equipment owned by the Partnership is primarily leased out on an operating lease basis wherein the rents owed during the initial noncancelable term of the lease are insufficient to recover the Partnership's purchase price of the equipment. The short-to mid-term nature of operating leases generally commands a higher rental rate than longer term, full payout leases and offers lessees relative flexibility in their equipment commitment. In addition, the rental obligation under the operating lease need not be capitalized on the lessee's balance sheet.\nThe Partnership encounters considerable competition from lessors utilizing full payout leases on new equipment, i.e., leases which have terms equal to the expected economic life of the equipment. Full payout leases are written for longer terms and for lower rates than the Partnership offers. While some lessees prefer the flexibility offered by a shorter term operating lease, other lessees prefer the rate advantages possible with a full payout lease. Competitors of the Partnership may write full payout leases at considerably lower rates, or larger\ncompetitors with a lower cost of capital may offer operating leases at lower rates, and as a result, the Partnership may be at a competitive disadvantage.\n(2) Manufacturers and Equipment Lessors\nThe Partnership also competes with equipment manufacturers who offer operating leases and full payout leases. Manufacturers may provide ancillary services which the Partnership cannot offer, such as specialized maintenance service (including possible substitution of equipment), training, warranty services, and trade-in privileges.\nThe Partnership competes with many equipment lessors, including ACF Industries, Inc. (Shippers Car Line Division), American Finance Group, General Electric Railcar Services Corporation, Greenbrier Leasing Company, Polaris Aircraft Leasing Corp., GPA Group Plc, and other limited partnerships which lease the same types of equipment.\n(D) Demand\nThe Partnership invests in transportation, transportation-related capital equipment, and in \"relocatable environments,\" examples of which include mobile offshore drilling units, storage units, and relocatable buildings. A general distinction can be drawn between equipment used for the transport of either materials and commodities or people. With the exception of aircraft leased to passenger air carriers, the Partnership's equipment is used primarily for the transport of materials. \"Relocatable environments\" refer to capital equipment constructed to be self-contained in function but transportable.\nThe following describe the markets for the Partnership's equipment:\n(1) Aircraft\nThe world air transport industry is poised for recovery from losses experienced during the first few years of the 1990s. The losses incurred by air carriers during the early 1990s were primarily attributable to the general worldwide recession. Over the last two years, the U.S. domestic economy has emerged from recession and is expected to continue to grow during 1995, although at a more moderate pace than the previous year. Analysts expect the economies of other regions of the world to follow the U.S. economic lead and stabilize or show gradual growth in 1995.\nMany air industry observers anticipate, however, that any recovery in the air transport industry will lag the current general economic rebound. The effects of fundamental restructuring by air carriers in recent years are just beginning to be manifested as improved performance. Substantial deliveries of new aircraft in the U.S. market are not expected before 1996 to 1997, when current orders for new aircraft mature and are subsequently filled. Demand for aircraft in Europe, Asia, and the Middle East, with the exception of the Indian subcontinent, is expected to remain weak. Carriers in these markets are still focusing on cost cutting and restructuring, and continue to experience a general decline in profitability.\nLatin American, Eastern European, and African markets are not expected to grow substantially due to political and economic instability in these regions.\nMost notably, the ongoing turmoil and uncertainty in the Mexican economy, the dominant participant in the Latin American market, will impede growth in demand for air transport capacity in this region.\nThe Partnership owns predominantly aircraft that are affected by the FAA regulatory requirements. However, the bulk of this equipment is on long-term leases in foreign markets and has been commanding lease rates higher than those available in the U.S. Those aircraft operating in the U.S. that are affected by the FAA regulatory requirements will either be moved into foreign markets, as applicable, or remain on lease in the U.S. maximizing what economic value is attainable until they must be retired from service.\n(2) Marine Containers\nIn the second-half of 1994, marine cargo container utilization rates firmed for the first time in a year and a half. This stabilization resulted from a further consolidation within the container leasing industry, pick-up in world-wide demand, and more moderate new equipment orders by the leasing and shipping communities.\nThe major event of the year was the consolidation of the second and third largest container lessors. This combination effectively created a counter-weight to the largest lessor's dominating position in the market with number one and number two now controlling 32% and 22% market shares, respectively. The leasing community generally considered this combination good for the industry as the high costs per TEU paid in this combination was expected to lead to rate stability and restrained purchase programs.\nSimultaneously, as the world's major economies rebounded from 1993 doldrums, increased demand in 1994 for containers reduced the 1993 year-end over-supply. Utilization rates improved in the second half of the year for both dry and refrigerated containers, although the positive effects have not yet materially affected per-diem rates. Industry forecasts are for a continued strengthening of the container markets in 1995, with per-diem rates rising somewhat after falling 8% - 12% over the last 24 months. The major on going effect of the 1993 and early 1994 container leasing market recession has been the greater attention placed on selling of older equipment into secondary markets. The Partnership owns predominately older containers, and will continue to be impacted by this industry trend of selling older equipment.\nThe manufacturing industry continues to migrate to lower cost and export- oriented areas. As happened with Japan in the mid-1980's, the strong currency and appreciating local wages decreased the formerly dominant Korean manufacturer's price competitiveness. As a result, Chinese production surged making China the dominant dry container export country in the world. Nevertheless, lessors and shipping lines reduced their overall production orders somewhat from 1993 levels as their focus became better utilization of existing fleet resources.\n(3) Railcars\nThe railroad industry produced strong financial results in 1994, following a similar year in 1993. The continuing strong results produced by the industry are attributable to the ongoing growth of the U.S. domestic economy, improved\noperational efficiency, and a stable rail fleet size.\nRailroad performance generally parallels that of the U.S. economy, which grew at an approximate 3.5% to 4% rate in 1994. Rail transport is the primary overland mover of bulk materials, and thus reflects the demand for goods and raw materials in the economy as a whole. Overall, 1994 car loadings increased by approximately 5% over 1993 levels, with particularly significant increases in the movement of chemicals, coal, lumber, and machinery.\nThe rail industry is also transforming itself to improve operational efficiency. This has been manifested in reduced turn-around times between loads and a reduction in unloaded miles traveled, both of which are necessary to maximize available rail capacity.\nFinally, the domestic supply of railcars available for service during the year has remained relatively stable. The excess of new railcar deliveries over older railcar retirements is expected to increase the entire fleet by less than 1%. To produce the total new car additions of approximately 51,000 per year, manufacturers are already operating at capacity. With no additional manufacturing capacity to radically increase the size of the fleet, and with continuing growth of the domestic economy leading to sustained demand for rail transport, 1995 railroad performance should continue to be strong.\n(4) Marine Vessels\nPLM International sponsored Partnerships own primarily small to medium-sized dry bulk vessels. Market conditions for these vessels in 1994 remained relatively unchanged from 1993. Vessel supply and demand conditions remained in relative equilibrium, underlying demand for transport of dry bulk materials remained substantially unchanged, and day rates remained relatively static.\nThe implementation and enforcement of COFR (Certificate of Financial Responsibility) provisions by the U.S. Coast Guard in 1995 appeared to contribute to the upturn in day and spot rates experienced by tanker vessels during the latter part of 1994. COFR requires petroleum product carrying ship owners and operators to provide evidence of sufficient financial resources to pay for any damages in the event of an oil spill or vessel accident while trading in U.S. waters. Generally, tanker vessel operators, anticipating the effects of COFR in 1995, accelerated delivery of petroleum products during the latter part of 1994, resulting in the increased demand and subsequent increases in day rates experienced in this market.\nThe General Partner operates many of the Partnerships' vessels in spot charters and pooled vessel operations. In contrast to longer term fixed-rate time and bareboat charters, spot charters and pooled operations provide the greatest flexibility to meet fluctuating demand conditions and achieve the highest average return for vessels subject to these types of operations during this time period. Despite the day rate upturn experienced in the tanker market during the latter part of 1994, supply and demand conditions for the majority of the Partnerships' vessels are expected to remain relatively stable. While a significant portion of the world's bulk and tanker fleets are nearing retirement age, new building in 1995 is expected to mitigate any fundamental change in the supply and demand equilibrium in the vessel markets.\n(5) Mobile Offshore Drilling Units\nWorldwide demand for offshore drilling services in 1994 was essentially equal to 1993; however, the geographic requirement for such services changed significantly from previous years. International demand for mobile offshore drilling units (\"rigs\") declined to a five-year low, while that for the U.S. Gulf of Mexico reached a four-year high. Strong natural gas demand in the United States and weak oil prices in late 1993 and early 1994 are the recognized causes of these market shifts. Composite worldwide rig utilization was approximately 79%, 3% lower than 1993.\nThe worldwide fleet shrank in 1994 as three rigs were retired while no rigs were added or ordered to be built. The most important trend in the market was the continued consolidation of the ranks of drilling contractors as two major mergers occurred in 1994. The mergers were of sufficient size to have the discernible effect of stabilizing prices for offshore drilling services in a year of low utilization.\nIncreasing oil prices seen in the latter half of 1994, and the need to replenish natural gas reserves in the Gulf of Mexico, are expected to strengthen the offshore drilling market in 1995. Additionally, industry projections show strong increases in the drilling requirements throughout the Middle East and Southeast Asia. Improvements in these markets, coupled with the stable demand in the Gulf of Mexico, should lead to higher rates for drilling services in the near future and, ultimately, higher residual values for rigs.\n(6) Trailers\nBoth the over-the-road and intermodal trucking industries produced strong financial results in 1994, continuing a series of improving financial results which began in 1991-1992. These results are attributable to the ongoing growth of the U.S. domestic economy, a focus in the trailer industry on cost efficiencies, and rate stability due to a shortage of trailers.\nOver-the-road and intermodal trailer performance generally parallels that of the U.S. domestic economy. Similar to railroads, trailer transport is a primary overland mover of bulk materials and finished goods and thus reflects demand for these products in current economic conditions. Overall increases in trailer results reflect the approximate 3.5% to 4% growth of the U.S. economy in 1994.\nWhile 1994 was a record year for new trailer production, the backlog of orders requires a delivery time of approximately nine (9) months for new units. To meet their immediate demand for transport resulting from shortages of new units, many trucking companies have turned to the short-term leasing market to add additional capacity. For short-term lessors, this has meant high levels of utilization and rate stability.\nThe General Partner continues to transfer trailers with expiring lease terms to the short-term trailer rental facilities operated by PLM Rental, Inc. The General Partner believes the strong performance of units in these rental facilities reflects the demand for short-term leases mentioned above and expects this trend to continue as long as the current shortage of trailers exists.\n(E) Government Regulations\nThe use, maintenance, and ownership of equipment is regulated by federal, state, local, and\/or foreign governmental authorities. Such regulations may impose restrictions and financial burdens on the Partnership's ownership and operation of equipment. Changes in government regulations, industry standards, or deregulation may also affect the ownership, operation, and resale of the equipment. Substantial portions of the Partnership's equipment portfolio are either registered or operated internationally. Such equipment may be subject to adverse political, government, or legal actions, including the risk of expropriation or loss arising from hostilities. Certain of the Partnership's equipment is subject to extensive safety and operating regulations which may require the removal from service or extensive modification of such equipment to meet these regulations at considerable cost to the Partnership. Such regulations include (but are not limited to):\n(1) the U.S. Oil Pollution Act of 1990 (which established liability for operators and owners of vessels, mobile offshore drilling units, etc. that create environmental pollution);\n(2) the U.S. Department of Transportation's Aircraft Capacity Act of 1990 (which limits or eliminates the operation of commercial aircraft in the U.S. that do not meet certain noise, aging, and corrosion criteria);\n(3) the Montreal Protocol on Substances That Deplete the Ozone Layer and the U.S. Clean Air Act Amendments of 1990 (which call for the control of and eventual replacement of substances that have been found to cause or contribute significantly to harmful effects on the stratospheric ozone layer and which are used extensively as refrigerants in refrigerated marine cargo containers, over-the-road trailers, etc.);\n(4) the U.S. Department of Transportation's Hazardous Materials Regulations (which regulate the classification of and packaging requirements for hazardous materials and which apply particularly to the Partnership's tank cars).\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership neither owns nor leases any properties other than the equipment it has purchased for leasing purposes. At December 31, 1994, the partnership owned a portfolio of transportation equipment as described in Part I, Table 1.\nThe Partnership maintains its principal office at One Market, Steuart Street Tower, Suite 900, San Francisco, California 94105-1301. All office facilities are provided by FSI without reimbursement by the Partnership.\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 Partnership's limited partners during the fourth quarter of its fiscal year ended December 31, 1994.\nPart II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE PARTNERSHIP'S EQUITY AND RELATED DEPOSITARY UNIT MATTERS\nThe Partnership's Depositary Units began trading (under the ticker symbol \"GFY\") on November 20, 1990, on the American Stock Exchange (\"AMEX\"). As of March 24, 1995, there were 7,454,505 Depositary Units outstanding (including 1,150 Depositary Units held in the Treasury). There are approximately 11,400 Depositary Unitholders of record as of the date of this report.\nPursuant to the terms of the Partnership Agreement, the General Partner is generally entitled to a 5% interest in the profits and losses and distributions of the Partnership. The General Partner also is entitled to a special allocation of any gains from sale of the Partnership's assets during the liquidation phase in an amount sufficient to eliminate any negative balance in the General Partner's capital account. The partnership has engaged in a plan to repurchase up to 250,000 Depository Units. In the twelve months ended December 31, 1994, the Partnership had purchased and canceled 20,200 Depository Units at a cost of $156,000. As of December 31, 1994, the Partnership had purchased and canceled a cumulative total of 26,900 Depositary units at a cost of $226,000. For January 1, 1995 to March 24, 1995, the Partnership repurchased 18,200 Depositary Units at a total cost of $0.1 million.\nTable 2, below, sets forth the high and low reported prices of the Partnership's Depositary Units for 1994 and 1993 as reported by the AMEX as well as cash distributions paid per Depositary Unit.\nTABLE 2\nReported Trade Cash Prices Distributions Paid Per Calendar Period High Low Depositary Unit\n1st Quarter $ 12.250 $ 10.125 $ 0.40 2nd Quarter $ 11.625 $ 10.125 $ 0.40 3rd Quarter $ 10.625 $ 9.375 $ 0.40 4th Quarter $ 9.875 $ 7.250 $ 0.40\n1st Quarter $ 13.375 $ 10.125 $ 0.40 2nd Quarter $ 11.500 $ 10.000 $ 0.40 3rd Quarter $ 11.375 $ 10.250 $ 0.40 4th Quarter $ 11.750 $ 10.250 $ 0.40\nThe Partnership has engaged in a plan to repurchase up to 250,000 of the outstanding Depositary Units. During the fourth quarter of 1994, the Partnership repurchased 20,200 Depositary Units at a total cost of $156,000. During the first quarter of 1993, the Partnership repurchased 6,700 Depositary Units at a total cost of $70,035.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nTable 3, below, lists selected financial data for the Partnership:\nTABLE 3\nFor the years ended December 31, 1994, 1993, 1992, 1991, and 1990 (thousands of dollars except per unit amounts)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIntroduction\nManagement's Discussion and Analysis of Financial Condition and Results of Operations relates to the Financial Statements of PLM Equipment Growth Fund II (the \"Partnership\"). The following discussion and analysis of operations focuses on the performance of the Partnership's equipment in various sectors of the transportation industry and its effect on the Partnership's overall financial condition.\nThe analysis is organized in the following manner:\n- Results of Operations - Year over Year Summary and Factors Affecting Performance - Financial Condition - Capital Resources, Liquidity, and Distributions - Outlook for the Future - Results of Operations - Year to Year Detail Comparison\n(A) Results of Operations\n(1) Year over Year Summary\nThe Partnership's operating income before depreciation, amortization, gain\/loss on sales, and loss on revaluation declined by approximately 22% in 1994 from 1993, primarily due to declining performance in the Partnership's vessel and container areas, the sale of certain equipment, and subsequent loss of income during the time required to redeploy those sales proceeds into additional equipment, and increases in overhead expenses. Re-leasing activity occurred in the Partnership's air, vessel, trailer, and rail portfolios, though the net contribution effect of such re-leases was small in comparison to the reduction in contribution resulting from the sale of equipment during the year. Similarly, the significant increase in the Partnership's rate rig income was due mainly to the purchase of a 55% interest in a rig in the third quarter 1993. Interest expense increased as the base rate of interest on the Partnership's floating rate debt rose, while management fees decreased as a function of decreased lease revenues.\n(2) Factors Affecting Performance\n(a) Re-leasing Activity and Repricing Exposure to Current Economic Conditions\nThe exposure of the Partnership's equipment portfolio to repricing risk occurs whenever the leases for the equipment expire or are otherwise terminated and the equipment must be remarketed. Major factors influencing the current market rate for transportation equipment include supply and demand for similar or comparable types or kinds of transport capacity, desirability of the equipment in the lease market, market conditions for the particular industry segment in which the equipment is to be leased, various regulations concerning the use of the equipment, and others. The Partnership experienced re-pricing exposure in 1994 primarily in its aircraft, vessel, container, and trailer portfolios.\n(i) Aircraft: The lease of one of the Partnership's aircraft was renegotiated in 1994. The lease was renewed in the second quarter for a term of three years at approximately 39% of its original rate. The impact of this rate reduction (approximately $0.48 million in 1994 versus 1993) was masked in a year over year comparison of aircraft performance by revenue generated in 1994 by aircraft that were off-lease for certain periods in 1993. For a more thorough discussion of market conditions and those factors impacting lease rates for aircraft, see the section in \"Demand\" on aircraft.\n(ii) Marine Vessels: In 1994, two of the Partnership's marine vessels were operated in the \"spot\" or \"voyage charter\" markets until their sale in the third quarter, while the Partnership's remaining vessel (owned 50% by the Partnership) transitioned from a \"bareboat\" charter into these markets in the first quarter. Spot or voyage charters are usually of short duration, and reflect the short-term demand and pricing trends in the vessel market, while \"bareboat\" charters are essentially fixed-rate net leases. While for periods of time in 1994, spot or voyage rates exceeded those in 1993, such rates were higher on average in 1993. However, the decline in the Partnership's vessel net contribution in 1994 versus 1993 resulted primarily from the sale of vessels in the fourth quarter of 1993, and third quarter of 1994, and less from repricing activity. Despite changing leases in 1994, revenues for the Partnership's remaining vessel were largely unchanged from the prior year, while net contribution declined due to increases in operating expenses as the vessel transitioned from a \"bareboat\" charter, where the lessee pays for all operating costs, into a pool where most costs are absorbed by the lessor. For a more thorough discussion of market conditions and those factors impacting rates for vessels, see the \"Demand\" section on marine vessels.\n(iii) Marine Containers: The majority of the Partnership's marine container portfolio is operated in utilization-based leasing pools and as such was highly exposed to repricing activity. Overall, container net contribution in 1994 declined 48% from 1993 levels. A substantial portion of a group of approximately 300 containers whose leases expired at the end of 1993 remained off-lease in 1994, resulting in a reduction in net contribution. Of the remaining containers owned by the Partnership at the beginning of the year, liquidations accounted for the majority of, and changes in market rates for the minority of, the difference in net income in 1994 versus 1993. For a more thorough discussion of market conditions and those factors impacting rates for containers, see the \"Demand\" section on marine containers.\nThe Partnership purchased 1,959 containers for approximately $2.2 million between the first and third quarters of 1994. The lessee of this equipment encountered financial difficulties in the fourth quarter. The Partnership established reserves against receivables invoiced for these units due to the General Partner's determination that ultimate collection of this revenue is uncertain. Additionally, the Partnership accrued legal and other costs necessary to repossess these units.\n(iv) Trailers: Similar to the Partnership's marine container portfolio, the majority of the trailer portfolio operates in short-term rental facilities or short-line railroad systems. The relatively short duration of most leases in these operations exposes the trailers to considerable re-leasing activity. While a year over year comparison of the Partnership's trailer portfolio shows a decline in net contribution, the impact of trailer sales and subsequent purchases\nhad far greater impact on performance than changing rates. For a more thorough discussion of market conditions and those factors impacting rates for trailers, see the \"Demand\" section on trailers.\n(v) Other Equipment: None of the leases of the Partnership's rigs expired in 1994. The decline in railcar performance year over year was largely due to the sale of railcars in 1993, while lease rates for those of the Partnership's railcars whose leases expired and were either renewed or re-leased in 1994 remained relatively stable. See \"Demand\" for a discussion of conditions in these equipment areas.\n(b) Reinvestment Risk\n(i) Reinvestment of Cash Flow and Surplus Funds: During the first seven years of operations, the Partnership intends to increase its equipment portfolio by investing surplus cash in additional equipment after fulfilling operating requirements and paying distributions to the partners. Subsequent to the end of the reinvestment period at December 31, 1995, the Partnership will continue to operate for an additional three years, then begin an orderly liquidation over an anticipated two year period.\nOther nonoperating funds for reinvestment are generated from the sale of equipment prior to the Partnership's planned liquidation phase, the receipt of funds realized from the payment of stipulated loss values on equipment lost or disposed of during the time it is subject to lease agreements, or the exercise of purchase options written into certain lease agreements. Equipment sales generally result from evaluations by the General Partner that continued ownership of certain equipment is either inadequate to meet Partnership performance goals, or that market conditions, market values, and other considerations indicate it is the appropriate time to sell certain equipment.\n(ii) Reinvestment Risk: Reinvestment risk occurs when 1) the Partnership cannot generate sufficient surplus cash after fulfillment of operating obligations and distributions to reinvest in additional equipment during the reinvestment phase of Partnership operations; 2) equipment is sold or liquidated for less than threshold amounts; 3) proceeds from sales, losses, or surplus cash available for reinvestment cannot be reinvested at threshold lease rates, or 4) proceeds from sales, losses, or surplus cash available for reinvestment cannot be deployed in a timely manner.\nFor the year ended December 31, 1994, the Partnership generated sufficient operating revenues to meet its operating obligations including interest expense. Cash distributions of $12.6 million included both funds generated from current period operations and cash available, but not distributed, in previous periods.\nDuring the year, the Partnership received proceeds of approximately $13.6 million from the liquidation or sale of containers, railcars, its 12.5% interest in a rig, trailers, and two marine vessels. The Partnership reinvested approximately $0.7 million in aircraft modifications and approximately $12.4 million (including fees) in the purchase of trailers and containers, predominantly in the third and fourth quarters of the year.\nThe Partnership began the year with approximately $14.2 million in cash and restricted cash, of which approximately $6.0 million was reserved by the General\nPartner for the purchase of up to approximately 3,600 containers. Production difficulties for these units, however, delayed the actual purchase until the end of the third quarter, and ultimately only 1,959 units were bought for approximately $2.3 million. As disclosed previously, the lessee of these units encountered financial difficulties in the fourth quarter, prompting the General Partner to establish reserves against receivables recorded for the units.\nAt the end of the first quarter, the Partnership sold trailers for approximately $1.5 million, representing approximately 59% of original cost. Near the end of the third quarter, the Partnership sold two marine vessels for approximately $7.4 million, which represented proceeds of approximately 32% of capitalized cost. While proceeds from sales and disposals were reinvested in trailers and containers during the course of the year, the net result of all sales, liquidations, and reinvestment has been a reduction in the cost basis of the Partnership's equipment portfolio of approximately $20.7 million. The General Partner will use approximately $8.0 million in remaining sales and disposal proceeds to prepay scheduled principal payments on the Partnership's outstanding permanent debt during the first two quarters of 1995.\n(c) Equipment Valuation\nThe General Partner prepares an evaluation of the carrying value of the Partnership's equipment portfolio at least annually, using, among other sources, independent third-party appraisals, values reported in trade publications, and comparative values from armslength transactions for similar equipment. Concurrently, the General Partner evaluates whether the current fair market value of equipment represents the effect of current market conditions or permanent impairment of value (e.g., technological obsolescence, etc.). Equipment whose carrying value is determined to be permanently impaired, without possibility of being leased at an acceptable rate, has its carrying value adjusted to its estimated net realizable value. The carrying value of two aircraft were reduced by approximately 0.9 million in 1994. The implicit impact of such reductions is anticipated future lower sales proceeds, and thus reduced reinvestment capability if its aircraft are sold during the reinvestment phase of Partnership operations.\nAs of December 31, 1994, the General Partner estimated the current fair market value of the Partnership's equipment portfolio to be approximately $70.8 million.\n(B) Financial Condition - Capital Resources, Liquidity, and Distributions\nThe General Partner purchased the Partnership's initial equipment portfolio with capital raised from its initial equity offering and permanent debt financing. No further capital contributions from original partners are permitted under the terms of the Partnership's Limited Partnership Agreement, while the Partnership's total outstanding indebtedness, currently $35.0 million, cannot be increased. The Partnership relies on operating cash flow to meet its operating obligations, make cash distributions to limited partners, and grow the Partnership's equipment portfolio with any remaining surplus cash available.\nFor the year ended December 31, 1994, the Partnership generated sufficient operating revenues to meet its operating obligations, but used undistributed available cash from prior periods of approximately $1.3 million to maintain the current level of distributions (total 1994 of $12.6 million) to the partners.\nDuring the year, the General Partner sold equipment for approximately $13.6 million while reinvesting approximately $13.1 million (including capital improvements and fees).\n(C) Outlook for the Future\nSeveral factors may affect the Partnership's operating performance in 1995 and beyond, including changes in the markets for the Partnership's equipment and changes in the regulatory environment in which that equipment operates.\n(1) Repricing and Reinvestment risk\nCertain of the Partnership's aircraft, vessel, railcars, and trailers will be re- marketed in 1995 as existing leases expire, exposing the Partnership to considerable repricing risk\/opportunity. Additionally, the General Partner has selected certain underperforming equipment, or equipment whose continued operation may become prohibitively expensive, for sale and subsequent re- deployment, and thus faces reinvestment risk. In either case, the General Partner intends to re-lease or sell equipment at prevailing market rates; however, the General Partner cannot predict these future rates with any certainty at this time and thus cannot accurately assess the effect of such activity on future Partnership performance.\n(2) Impact of Government Regulations on Future Operations\nThe General Partner operates the Partnership's equipment in accordance with current applicable regulations (see Item 1, Section E \"Government Regulations\"). However, the continuing implementation of new or modified regulations by some of the authorities mentioned previously, or others, may adversely affect the Partnership's ability to continue to own or operate equipment in its portfolio. Additionally, regulatory systems vary from country to country, which may increase the burden to the Partnership of meeting regulatory compliance for the same equipment operated between countries. Currently, the General Partner has observed rising insurance costs to operate certain vessels into U.S. ports resulting from implementation of the U.S. Oil Pollution Act of 1990. Ongoing changes in the regulatory environment, both in the U.S. and internationally, cannot be predicted with any accuracy, and preclude the General Partner from determining the impact of such changes on Partnership operations, purchases, or sale of equipment.\n(3) Additional Capital Resources and Distribution Levels\nThe Partnership's initial contributed capital was comprised of the proceeds from its initial offering, supplemented later by permanent debt in the amount of $35 million. The General Partner has not planned any expenditures, nor is it aware of any contingencies that would cause it to require any additional capital to that mentioned above.\nPursuant to the Limited Partnership Agreement, the Partnership will cease to reinvest in additional equipment beginning in its eighth year of operations which commences on January 1, 1996. The General Partner intends to continue its strategy of selectively redeploying equipment to achieve competitive returns. By the end of the reinvestment period, the General Partner intends to have assembled an equipment portfolio capable of achieving a level of operating cash\nflow for the remaining life of the Partnership sufficient to meet its obligations and sustain a predictable level of distributions to the partners.\nThe General Partner believes the current level of distributions to the partners can be maintained throughout 1995 using cash from operations, undistributed available cash from prior periods, and proceeds from sales or dispositions if necessary. Subsequent to this period, the General Partner will evaluate the level of distributions the Partnership can sustain over extended periods of time, and together with other considerations, may adjust the level of distributions accordingly. In the long term, the difficulty in predicting market conditions and the availability of suitable equipment acquisitions precludes the General Partner from accurately determining the impact of its redeployment strategy on liquidity or distribution levels.\nIn the first quarter of 1994, the General Partner completed the refinancing of a bank loan which was due to mature September 30, 1995. The new debt comprises notes payable of $35.0 million, and the corresponding loan agreements require the Partnership to maintain a minimum debt coverage ratio based on the fair market value of equipment, a minimum fixed charge coverage ratio, and limits the concentration of any one type of equipment in the Partnership's equipment portfolio. The refinanced debt begins to mature in March 1996. The General Partner intends to prepay the first two annual installments of principal due on the debt in the first two quarters of 1995. The maturities of the remaining principal installments on the debt coincide with the liquidation phase of the Partnership and will be repaid with proceeds from sales of equipment during that phase.\n(D) Results of Operations - Year to Year Detail Comparison\nComparison of the Partnership's Operating Results for the Years Ended December 31, 1994 and 1993\n(A) Revenues\nTotal revenues for the years ended December 31, 1994 and 1993, were $26.3 million and $36.9 million, respectively. The decrease in 1994 revenues was primarily attributable to lower lease revenue and reduced gains on disposition of Partnership marine vessels, a mobile offshore drilling unit, trailers and marine containers during 1994. The Partnership's ability to acquire or liquidate assets, secure leases, and re-lease those assets whose leases expire during the duration of the Partnership is subject to many factors and the Partnership's performance in 1994 is not necessarily indicative of future periods.\n(1) Lease revenue declined to $23.3 million in 1994 from $30.0 million in 1993. The following table lists lease revenue earned by equipment type (in thousands):\nFor the year ended December 31, 1994 1993 Marine vessels $ 5,294 $ 12,050 Rail equipment 4,823 5,336 Aircraft 4,935 5,051 Trailers and tractors 3,885 3,590 Mobile offshore drilling units 2,488 1,418 Marine containers 1,826 2,506 -------- -------- $ 23,251 $ 29,951 ======== ========\nSignificant revenue component changes resulted primarily from:\n(a) declines of $6.8 million in marine vessel revenue due to the sale of five on-lease marine vessels during the first and fourth quarters of 1993 and the third quarter of 1994;\n(b) declines of $0.7 million in marine container revenues primarily due to a group of marine containers which were on lease in 1993, but off-lease in 1994, offset, in part, by revenue earned on 1,959 marine containers purchased during 1994;\n(c) declines of $0.5 million in rail equipment revenues due to the sale of 639 railcars during 1993 and two railcars in 1994;\n(d) declines of $0.1 million in aircraft revenues due to the sale of an aircraft in the fourth quarter of 1993 and a significant rate reduction on a renewed lease for another aircraft;\n(e) increases of $1.1 million in mobile offshore drilling unit (\"rig\") revenues due to the acquisition and lease of a 55% interest in a rig during July of 1993;\n(f) increases of $0.3 million in trailer revenue due to the acquisition of 649 trailers during the third and fourth quarters of 1994.\n(2) Net gains on disposition of equipment during 1994 totaled $2.3 million from the sale or disposal of two marine vessels, two railcars, 267 trailers, and 423 marine containers and a 12% interest in a mobile offshore drilling unit. The equipment sold had an aggregate net book value of $13.5 million and accrued drydock reserves of $2.2 million and proceeds totaled $13.6 million. Net gains on disposition of equipment during 1993 totaled $6.7 million from the sale or disposal of three marine vessels, 639 railcars, one aircraft, 124 tractors and trailers, and 305 marine containers with an aggregate net book value of $16.0 million and accrued drydock reserves of $1.5 million for proceeds of $21.2 million (see Footnote 3 to the financial statements).\n(B) Expenses\nTotal expenses for the years ended December 31, 1994 and 1993, were $26.2 million and $31.3 million, respectively. The decrease in 1994 expenses was primarily attributable to decreased depreciation expense, marine equipment operating expenses, and repairs and maintenance, offset by increases in loss on revaluation of equipment and interest expense.\n(1) Direct Operating Expenses (defined as repairs and maintenance, insurance and marine equipment operating expenses) decreased to $8.2 million in 1994 from $12.3 million in 1993. This change resulted from:\n(a) declines of $2.1 million in marine equipment operating costs due to the sale of three marine vessels in 1993, and two in 1994. This decrease was offset by increased operating cost for three marine vessels (of which two were sold at the end of the third quarter of 1994) which operated under leases (voyage\ncharters and utilization based pooling arrangements) in which the Partnership paid costs not incurred when the vessels operated under time charter in the similar period one year eariler;\n(b) declines of $1.2 million in insurance expense which resulted primarily from the sale of three marine vessels in 1993, and a refund of $0.2 million from an insurance pool in which the Partnership's marine vessels participate, due to lower than expected insurance claims in the pool;\n(c) declines of $0.7 million in repairs and maintenance costs due to the sale of three marine vessels in 1993, and two marine vessels in the third quarter of 1994. These declines were offset by increases in trailer expenses resulting from the increased number of trailers coming off term leases which required refurbishment prior to transitioning to short-term rental facilities operated by an affiliate of the General Partner.\n(2) Indirect Operating Expenses (defined as depreciation and amortization expense, management fees, interest expense, general and administrative expenses and bad debt expense) decreased to $17.1 million in 1994 from $18.9 million in 1993. This change resulted from:\n(a) declines in depreciation expense of $2.4 million reflecting the Partnership's double-declining depreciation method and the effect of asset sales in 1993 and 1994, partially offset by the acquisition of the rig in July 1993;\n(b) declines of $0.4 million in management fees to affiliates, reflecting the lower levels of lease revenue in 1994 as compared to 1993;\n(c) declines in general and administrative expenses of $0.1 million from 1993 levels due to reduced professional services required by the Partnership and lower storage expenses for two aircraft (one sold in the fourth quarter of 1993) which were off-lease for most of 1993. These declines were offset, by a slight increase in legal and other expenses necessary to repossess containers from a lessee that encountered financial difficulties in the fourth quarter of 1994;\n(d) increases in interest expense of $0.8 million consisted of a $0.3 million write-off of unamortized loan origination costs due to the refinancing of the Partnership's debt and a $0.5 million increase due to a higher base rate of interest charged on the Partnership's floating rate debt during 1994;\n(e) increases of $0.2 million in bad debt expense due to the General Partner's evaluation of the collectability of trade receivables due from the trailer rental yard lessees, and a container lessee that encountered financial difficulties in the fourth quarter of 1994.\n(3) Loss on revaluation of equipment in 1994 results from the Partnership reducing the carrying value of two aircraft to their estimated net realizable values.\n(C) Net Income\nThe Partnership's net income of $67,000 for the year ended December 31, 1994,\ndecreased from a net income of $5.6 million for 1993. During 1994, the Partnership distributed $12.0 million to the Limited Partners, or $1.60 per Depositary Unit.\nComparison of the Partnership's Operating Results for the Years Ended December 31, 1993 and 1992\n(A) Revenues\nTotal revenues for the years ended December 31, 1993 and 1992, were $36.9 million and $34.5 million, respectively. The increase in 1993 revenues was primarily attributable to significant gains realized on disposition of Partnership marine vessels, rail equipment, and marine containers during 1993, compared to a small loss on equipment dispositions during 1992. The Partnership's ability to acquire or liquidate assets, secure leases, and re-lease those assets whose leases expire during the duration of the Partnership is subject to many factors and the Partnership's performance in 1993 is not necessarily indicative of future periods.\n(1) Lease revenue declined to $30.0 million in 1993 from $34.6 million in 1992. The following table lists lease revenues earned by equipment type (in thousands):\nFor the year ended December 31, 1993 1992 ---- ----\nMarine vessels $12,050 $15,254 Rail equipment 5,336 5,748 Aircraft 5,051 6,520 Trailers and tractors 3,590 3,405 Marine containers 2,506 3,193 Mobile offshore drilling units 1,418 455 ------- ------- $29,951 $34,575 ======= =======\nSignificant revenue component changes resulted primarily from:\n(a) a decline of $3.2 million in marine vessel revenues due to the sale of three on-lease marine vessels in the first and fourth quarters of 1993, and reductions in charter rates for two of the remaining marine vessels, partially offset by higher voyage rates in 1993 for other marine vessels;\n(b) declines of $1.5 million in aircraft revenues due to the early termination of an aircraft lease in November 1992, resulting in the aircraft being off-lease during a substantial part of 1993, and the sale of another aircraft during the fourth quarter of 1993;\n(c) declines of $0.7 million in container revenues primarily due to the sale or disposal of 305 marine containers during 1993;\n(d) declines of $0.4 million in rail equipment revenues primarily due to the sale of 639 railcars in 1993;\n(e) increase of $1.0 million in mobile offshore drilling unit revenues primarily due to the revenue attributable to the drilling rig purchased during the third quarter 1993 and to a full year's revenue on the mobile offshore drilling unit purchased in 1992;\n(f) increase of $0.2 million in trailer revenue due to more trailers operating in short-term rental facilities in 1993, as compared to 1992. Trailers operating in short-term rental facilities generate higher per day revenue than term lease trailers.\n(2) Net gains on disposition of equipment during 1993 totaled $6.7 million from the sale or disposal of three marine vessels, 639 railcars, one aircraft, 124 tractors and trailers, and 305 marine containers with an aggregate net book value of $16.0 million and accrued drydock reserves of $1.5 million for aggregate proceeds of $21.2 million. Net loss on disposition of equipment during 1992, totaled $0.3 million from the sale or disposal of 6 railcars, 224 marine containers, 53 trailers, and 8 tractors with an aggregate net book value of $1.1 million for aggregate proceeds of $0.8 million (see footnote 3 to the financial statements).\n(B) Expenses\nTotal expenses for the years ended December 31, 1993 and 1992, were $31.3 million and $45.0 million, respectively. The decrease in 1993 expenses was primarily attributable to decreased depreciation expense, interest expense, repairs and maintenance, marine equipment operating expenses, and loss on revaluation of equipment.\n(1) Direct Operating Expenses (defined as repairs and maintenance, insurance and marine equipment operating expenses) decreased to $12.3 million in 1993 from $15.4 million in 1992. This change resulted from:\n(a) decrease of $2.0 million in repairs in maintenance costs due primarily to a reduction in drydock expenses resulting from the sale of two marine vessels in the first quarter 1993, the completion of a retro-fit program for certain of the Partnership's boxcars during 1992 and a reduction in maintenance costs for the Partnership's coal cars sold in the first quarter 1993;\n(b) decrease of $1.1 million in marine equipment operating costs due to the sale of two marine vessels in the first quarter 1993, and one in the fourth quarter 1993;\n(c) decrease of $0.1 million in insurance expense due to the sales of Partnerhip equipment which was substantially offset by increasing insurance premiums. Market over-capacity during the mid to late 1980s led marine insurers to offer coverage terms and low deductibles at very low premiums. As a result, premium billing for this market segment was substantially less than losses. In response to the poor underwriting results of the late 80s, many insurers have withdrawn from the marine market causing a reduction in capacity. Those who remain are charging higher premiums with increased deductibles and more narrow coverage terms. The increases in the IMI managed fleet premiums over the past three years are consistent with overall marine market conditions. The\nPartnership pays certain insurance premiums directly to, among others, TEI, an affiliate of the General Partner (see Financial Statements Note 2).\n(2) Indirect Operating Expenses (defined as depreciation and amortization expense, management fees, interest expense, general and administrative expenses and bad debt expense) decreased to $18.9 million in 1993 from $22.7 million in 1992. This change resulted from:\n(a) decrease in depreciation and amortization expense of $3.3 million reflecting the Partnership's double-declining depreciation method and the sale of 2 marine vessels and 584 coal cars in the first quarter 1993, partially offset by depreciation expense incurred from the purchase of a mobile offshore drilling unit in July 1993;\n(b) decrease in interest expense of $0.5 million due to a decrease in the level of outstanding debt in 1993, compared to 1992, of $3.2 million and by a decline in the rate of interest charged on the Partnership's debt which was 4.56% at December 31, 1993, compared to 5.31% at December 31, 1992.\n(3) Loss on revaluation of equipment in 1993 results from the Partnership reducing the carrying value of 50 pulpwood flat cars to their estimated net realizable value. During 1992, the Partnership reduced the carrying value of one commercial aircraft, one commuter aircraft, one marine vessel, and 220 marine containers by $6.9 million to their estimated net realizable value.\n(C) Net Income\nThe Partnership's net income of $5.6 million for the year ended December 31, 1993, increased from a net loss of $10.5 million for 1992. During 1993, the Partnership distributed $12.0 million to the Limited Partners, or $1.60 per Depositary Unit.\nTrends\nRigs, marine containers, and marine vessels performed below historic norms in 1994. By year end, the markets had rebounded for marine containers and marine vessels; but, the rig market remained soft, due primarily to low oil and gas prices. These conditions have resulted in lower lease rates, attrition, and reduced values for these types of equipment, and have correspondingly significantly impacted partnership cash flow. The General Partner will closely monitor the effects of these factors on the Partnership's financial condition, and as stated previously, take appropriate actions regarding underperforming equipment.\nThe return of lease rates on certain types of equipment to their historical levels is dependent on a number of factors including improved international economic conditions, the absence of technological obsolescence, new government regulations, and increased industry-specific demand.\nThe Partnership intends to use excess cash flow, if any, after payment of expenses, loan principal, and cash distributions to acquire additional equipment during 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements for the Partnership are listed in the Index to Financial Statements and Financial Statement Schedules included in Item 14(a) of this Annual Report.\nTable 4, below, is a summary of the results of operations on a quarterly basis for the Partnership for the years ended December 31, 1994 and 1993 (in thousands of dollars except per unit amount):\nTABLE 4 Three months ended:\nMarch 31 June 30 Sept. 30 Dec. 31 -------- ------- -------- -------\nTotal revenues $ 6,863 $ 6,413 $ 6,283 $ 6,767\nNet gain (loss) on disposition of equipment 581 59 125 1,582\nLoss on revaluation of equipment -- -- -- (887) 1\nNet income (loss) $ 766 $ (816) $ 184 $ (67)\nNet income (loss) per Depositary Unit $ 0.08 $ (0.14) $ (0.03) $(0.03)2\nCash distributions $ 3,155 $ 3,155 $ 3,155 $ 3,155\nCash distributions per Depositary Unit $ 0.40 $ 0.40 $ 0.40 $ 0.40\nNumber of Depositary Units at end of quarter3 7,493 7,493 7,493 7,473\n-------- 1 At December 31, 1994, the Partnership reduced the carrying value of 2 aircraft. 2 After reduction of $963 ($0.13 per Depositary Unit) representing a special allocation to the General Partner (see Note 1 to the financial statements). 33 Includes 1,150 Depositary Units held in the Treasury.\nTABLE 4\nThree months ended:\nMarch 31 June 30 Sept. 30 Dec. 31 -------- ------- -------- -------\nTotal revenues $14,5891 $ 7,498 $ 7,448 $ 7,366\nNet gain (loss) on disposition of equipment 6,8481 (336) 38 154\nLoss on revaluation of equipment -- (161) -- --\nNet income (loss) $ 6,421 $ (284) $ (363) $ (178)\nNet income (loss) per Depositary Unit $ 0.81 $ (0.04) $ (0.06) $(0.11)2\nCash distributions $ 3,159 $ 3,156 $ 3,196 $ 3,154\nCash distributions per Depositary Unit $ 0.40 $ 0.40 $ 0.40 $ 0.40\nNumber of Depositary Units at end of quarter3 7,493 7,493 7,493 7,493\n-------- 1 The Partnership realized a net gain on disposition of equipment resulting primarily from the sale of 2 Marine Vessels and 584 railcars. 2 After reduction of $845 ($0.11 per Depositary Unit) representing a special allocation to the General Partner resulting from an amendment to the Partnership Agreement (see Note 1 to the financial statements). 33 Includes 1,150 Depositary Units held in the Treasury.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\n(This space intentionally left blank.)\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE PARTNERSHIP\nAs of the date of this Annual Report the directors and executive officers of PLM International (and key executive officers of its subsidiaries) are as follows:\nName Age Position\nJ. Alec Merriam 59 Director, Chairman of the Board, PLM International, Inc.; Director, PLM Financial Services, Inc.\nAllen V. Hirsch 41 Director, Vice Chairman of the Board, Executive Vice President of PLM International, Inc.; Director and President, PLM Financial Services Inc.; President, PLM Securities Corp., and PLM Transportation Equipment Corporation.\nWalter E. Hoadley 78 Director, PLM International, Inc.\nRobert L. Pagel 58 Director, Chairman of the Executive Committee, PLM International, Inc.; Director, PLM Financial Services, Inc.\nHarold R. Somerset 60 Director, PLM International, Inc.\nRobert N. Tidball 56 Director, President and Chief Executive Officer, PLM International, Inc.\nJ. Michael Allgood 46 Vice President and Chief Financial Officer, PLM International, Inc. and PLM Financial Services, Inc.\nStephen M. Bess 48 President, PLM Investment Management, Inc.; Vice President, PLM Financial Services, Inc.\nDavid J. Davis 38 Vice President and Corporate Controller, PLM International and PLM Financial Services, Inc.\nFrank Diodati 40 President, PLM Railcar Management Services Canada Limited\nDouglas P. Goodrich 48 Senior Vice President, PLM International; Senior Vice President PLM Transportation Equipment Corporation; President, PLM Railcar Management Services, Inc.\nDirk Langeveld 43 Senior Vice President, PLM Transportation Equipment Corporation\nSteven O. Layne 40 Vice President, PLM Transportation Equipment Corporation\nStephen Peary 46 Senior Vice President, General Counsel and Secretary, PLM International,Inc.; Vice President, General Counsel and Secretary, PLM Financial Services, Inc., PLM Investment Management, Inc., PLM Transportation Equipment Corporation; Vice President, PLM Securities Corp.\nThomas L. Wilmore 52 Vice President, PLM Transportation Equipment Corporation; Vice President, PLM Railcar Management Services Inc.\nJ. Alec Merriam was appointed Chairman of the Board of Directors of PLM International in September 1990, having served as a director since February 1988. In October 1988 he became a member of the Executive Committee of the Board of Directors of PLM International. From 1972 to 1988 Mr. Merriam was Executive Vice President and Chief Financial Officer of Crowley Maritime Corporation, a San Francisco area-based company engaged in maritime shipping and transportation services. Previously, he was Chairman of the Board and Treasurer of LOA Corporation of Omaha, Nebraska, and served in various financial positions with Northern Natural Gas Company, also of Omaha.\nAllen V. Hirsch became Vice Chairman of the Board and a Director of PLM International in April 1989. He is an Executive Vice President of PLM International and President of PLM Securities Corp. Mr. Hirsch became the President of PLM Financial Services, Inc. in January 1986 and President of PLM Investment Management, Inc. and PLM Transportation Equipment Corporation in August 1985, having served as a Vice President of PLM Financial Services, Inc. and Senior Vice President of PLM Transportation Equipment Corporation beginning in August 1984, and as a Vice President of PLM Transportation Equipment Corporation beginning in July 1982 and of PLM Securities Corp. from July 1982 to October 1, 1987. He joined PLM, Inc. in July 1981, as Assistant to the Chairman. Prior to joining PLM, Inc., Mr. Hirsch was a Research Associate at the Harvard Business School. From January 1977 through September 1978, Mr. Hirsch was a consultant with the Booz, Allen and Hamilton Transportation Consulting Division, leaving that employment to obtain his master's degree in business administration.\nDr. Hoadley joined PLM International's Board of Directors and its Executive Committee in September, 1989. He served as a Director of PLM, Inc. from November 1982 to June 1984 and PLM Companies, Inc. from October 1985 to February 1988. Dr. Hoadley has been a Senior Research Fellow at the Hoover Institute since 1981. He was Executive Vice President and Chief Economist for the Bank of America from 1968 to 1981 and Chairman of the Federal Reserve Bank of Philadelphia from 1962 to 1966. Dr. Hoadley has served as a Director of Transcisco Industries, Inc. since February 1988.\nRobert L. Pagel was appointed Chairman of the Executive Committee of the Board of Directors of PLM International in September 1990, having served as a director since February 1988. In October 1988 he became a member of the Executive Committee of the Board of Directors of PLM International. From June 1990 to April 1991 Mr. Pagel was President and Co-Chief Executive Officer of The Diana Corporation, a holding company traded on the New York Stock Exchange. He is the former President and Chief Executive Officer of FanFair Corporation which specializes in sports fan's gift shops. He previously served as President and Chief Executive Officer of Super Sky International, Inc., a publicly traded company, located in Mequon, Wisconsin, engaged in the manufacture of skylight systems. He was formerly Chairman and Chief Executive Officer of Blunt, Ellis & Loewi, Inc., a Milwaukee based investment firm. Mr. Pagel retired from Blunt, Ellis & Loewi in 1985 after a career spanning 20 years in all phases of the brokerage and financial industries. Mr. Pagel has also served on the Board of Governors of the Midwest Stock Exchange.\nHarold R. Somerset was elected to the Board of Directors of PLM International in July 1994. From February 1988 to December 1993, Mr. Somerset was President and Chief Executive Officer of California & Hawaiian Sugar Corporation (\"C&H\"), a recently acquired subsidiary of Alexander & Baldwin, Inc. Mr. Somerset joined C&H in 1984 as Executive Vice President and Chief Operating Officer, having served on its Board of Directors since 1978, a position in which he continues to serve. Between 1972 and 1984, Mr. Somerset served in various capacities with Alexander & Baldwin, Inc., a publicly-held land and agriculture company headquartered in Honolulu, Hawaii, including Executive Vice President - Agricultures, Vice President, General Counsel and Secretary. In addition to a law degree from Harvard Law School, Mr. Somerset also holds degrees in civil engineering from the Rensselaer Polytechnic Institute and in marine engineering from the U.S. Naval Academy. Mr. Somerset also serves on the Boards of Directors for various other companies and organizations, including Longs Drug Stores, Inc., a publicly-held company headquartered in Maryland.\nRobert N. Tidball was appointed President and Chief Executive Officer of PLM International in March, 1989. At the time of his appointment, he was Executive Vice President of PLM International. Mr. Tidball became a director of PLM International in April, 1989 and a member of the Executive Committee of the Board of Directors of PLM International in September 1990. Mr. Tidball was elected President of PLM Railcar Management Services, Inc. in January 1986. Mr. Tidball was Executive Vice President of Hunter Keith, Inc., a Minneapolis based investment banking firm, from March 1984 to January 1986. Prior to Hunter Keith, Inc., he was Vice President, a General Manager and a Director of North American Car Corporation, and a Director of the American Railcar Institute and the Railway Supply Association.\nJ. Michael Allgood was appointed Vice President and Chief Financial Officer of PLM International in October 1992. Between July 1991 and October 1992, Mr. Allgood was a consultant to various private and public sector companies and institutions specializing in financial operational systems development. In October 1987, Mr. Allgood co-founded Electra Aviation Limited and its holding company, Aviation Holdings Plc of London where he served as Chief Financial Officer until July 1991. Between June 1981 and October 1987, Mr. Allgood served as a First Vice President with American Express Bank, Ltd. In February 1978, Mr. Allgood founded and until June 1981, served as a director of Trade Projects International\/Philadelphia Overseas Finance Company, a joint venture with Philadelphia National Bank. From March 1975 to February 1978, Mr. Allgood served in various capacities with Citibank, N.A.\nStephen M. Bess was appointed President of PLM Investment Management, Inc. in August 1989, having served as Senior Vice President of PLM Investment Management, Inc. beginning in February 1984 and as Corporate Controller of PLM Financial Services, Inc. beginning in October 1983. Mr. Bess served as Corporate Controller of PLM, Inc., beginning in December 1982. Mr. Bess was Vice President-Controller of Trans Ocean Leasing Corporation, a container leasing company, from November 1978 to November 1982, and Group Finance Manager with the Field Operations Group of Memorex Corp., a manufacturer of computer peripheral equipment, from October 1975 to November 1978.\nDavid J. Davis was appointed Vice President and Controller of PLM International in January 1994. From March 1993 through January 1994, Mr. Davis was engaged as a consultant for various firms, including PLM. Prior to that Mr. Davis was Chief Financial Officer of LB Credit Corporation in San Francisco from July 1991 to March 1993. From April 1989 to May 1991, Mr. Davis was Vice President and Controller for ITEL Containers International Corporation which is located in San Francisco. Between May 1978 and April 1989, Mr. Davis held various positions with Transamerica Leasing Inc., in New York, including that of Assistant Controller for their rail leasing division.\nFrank Diodati was appointed President of PLM Railcar Management Services Canada Limited in 1986. Previously, Mr. Diodati was manager of Marketing and Sales for G.E. Railcar Services Canada Limited.\nDouglas P. Goodrich was appointed Senior Vice President of PLM International in March 1994. Mr. Goodrich also serves as Senior Vice President of PLM Transportation Equipment Corporation since July 1989, and as President of PLM Railcar Management Services, Inc. since September 1992 having been a Senior Vice President since June 1987. Mr. Goodrich was an Executive Vice President of G.I.C. Financial Services Corporation, a subsidiary of Guardian Industries Corp. of Chicago, Illinois from December 1980 to September 1985.\nDirk Langeveld was appointed Vice President of PLM Transportation Equipment Corporation's Marine Division in June 1990 and Senior Vice President in January 1991. Mr. Langeveld was Executive Vice President, Chief Operation Officer, and a Director of Marine Transport Lines from 1987 to 1990. From 1977 to 1987 Mr. Langeveld was employed by Stolt Tankers and Terminals Inc. in a variety of executive positions in the United States and the Far East.\nSteven O. Layne was appointed Vice President, PLM Transportation Equipment Corporation's Air Group in November 1992. Mr. Layne was its Vice President, Commuter and Corporate Aircraft beginning in July 1990. Prior to joining PLM, Mr. Layne was the Director, Commercial Marketing for Bromon Aircraft Corporation, a joint venture of General Electric Corporation and the Government Development Bank of Puerto Rico. Mr. Layne is a major in the United States Air Force Reserves and Senior Pilot with 13 years of accumulated service.\nStephen Peary became Vice President, Secretary, and General Counsel of PLM International in February 1988 and Senior Vice President in March 1994. Mr. Peary was Assistant General Counsel of PLM Financial Services, Inc. from August 1987 through January 1988. Previously, Mr. Peary was engaged in the private practice of law in San Francisco. Mr. Peary is a graduate of the University of Illinois,\nGeorgetown University Law Center, and Boston University (Masters of Taxation Program).\nThomas L. Wilmore was appointed Vice President - Rail, PLM Transportation Equipment Corporation, in March 1994 and has served as Vice President, Marketing for PLM Railcar Management Services, Inc. since May 1988. Prior to joining PLM, Mr. Wilmore was Assistant Vice President Regional Manager for MNC Leasing Corp. in Towson, Maryland from February 1987 to April 1988. From July 1985 to February 1987, he was President and Co-Owner of Guardian Industries Corp., Chicago, Illinois and between December 1980 and July 1985, Mr. Wilmore was an Executive Vice President for its subsidiary, G.I.C. Financial Services Corporation. Mr. Wilmore also served as Vice President of Sales for Gould Financial Services located in Rolling Meadows, Illinois from June 1978 to December 1980.\nThe directors of the General Partner are elected for a one-year term or until their successors are elected and qualified. There are no family relationships between any director or any executive officer of the General Partner.\n(This space intentionally left blank)\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no directors, officers or employees. The Partnership has no pension, profit-sharing, retirement, or similar benefit plan in effect as of December 31, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Security Ownership of Certain Beneficial Owners The General Partner is generally entitled to 5% interest in the profits and losses and distributions of the Partnership. At December 31, 1994, no investor was known by the General Partner to beneficially own more than 5% of the Depositary Units of the Partnership.\n(b) Security Ownership of Management Table 5, below, sets forth, as of the date of this report, the amount and the percent of the Partnership's outstanding Depositary Units beneficially owned by each director and executive officer and all directors and executive officers as a group of the General Partner and its affiliates:\nTABLE 5 Name Depositary Units Percent of Units\nJ. Alec Merriam 1,000 * Robert N. Tidball 400 * Allen V. Hirsch 749 *\nAll directors and officers as a group (3 people) 2,149 * -\n* Represents less than 1 percent of the Depositary Units outstanding.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n(a) Transactions with Management and Others\nDuring 1994, management fees to IMI were $1,150,000. The General Partner and its affiliates were reimbursed $732,000 for administrative and data processing services performed on behalf of the Partnership in 1994. The Partnership paid lease negotiation and equipment acquisition fees of $653,000 to PLM Transportation Equipment Corporation. The Partnership paid Transportation Equipment Indemnity Company Ltd. (\"TEI\"), a wholly owned, Bermuda-based subsidiary of PLM International, $299,000 for insurance coverages during 1994 which amounts were paid substantially to third party reinsurance underwriters or placed in risk pools managed by TEI on behalf of affiliated partnerships and PLM International which provide threshold coverages on marine vessel loss of hire and hull and machinery damage. All pooling arrangement funds are either paid out to cover applicable losses or refunded pro rata by TEI.\n(b) Certain Business Relationships\nNone.\n(c) Indebtedness of Management\nNone.\n(d) Transactions with Promoters\nNone.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements The financial statements listed in the accompanying Index to Financial Statements are filed as part of this Annual Report.\n(b) Reports on Form 8-K\nNone.\n(c) Exhibits\n4. Limited Partnership Agreement of Registrant. Incorporated by reference to the Partnership's Registration Statement on Form S- 1 (Reg. No. 33-13113) which became effective with the Securities and Exchange Commission on June 5, 1987.\n4.1 Amendment, dated November 18, 1991, to Limited Partnership Agreement of Partnership.\n10.1 Management Agreement between Registrant and PLM Investment Management, Inc. Incorporated by reference to the Partnership's Registration Statement on Form S-1 (Reg. No. 33-13113) which became effective with the Securities and Exchange Commission on June 5, 1987.\n10.2 $35,000,000 Note Agreement, dated as of March 1, 1994.\n25. Powers of Attorney.\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.\nThe Partnership has no directors or officers. The General Partner has signed on behalf of the Partnership by duly authorized officers.\nDate: March 24, 1995 PLM EQUIPMENT GROWTH FUND II Partnership\nBy: PLM Financial Services, Inc. General Partner\nBy: * Allen V. Hirsch President\nBy: J. Michael Allgood Vice President and Chief Financial Officer\n* Stephen Peary, by signing his name hereto, does sign this document on behalf of the persons indicated above pursuant to powers of attorney duly executed by such persons and filed with the Securities and Exchange Commission.\n\/s\/ Stephen Peary Stephen Peary Attorney-in-Fact\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following directors of the Partnership's General Partner on the dates indicated.\nName Capacity Date\n* Allen V. Hirsch Director - FSI March 24, 1995\n* J. Alec Merriam Director - FSI March 24, 1995\n* Robert L. Pagel Director - FSI March 24, 1995\n* Stephen Peary, by signing his name hereto does sign this document on behalf of the persons indicated above pursuant to powers of attorney duly executed by such persons and filed with the Securities and Exchange Commission.\n\/s\/ Stephen Peary Stephen Peary Attorney-in-Fact\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership)\n(Item 14(a))\nPage\nReport of Independent Auditors 37\nBalance sheets as of December 31, 1994 and 1993 38\nStatements of operations for the years ended December 31, 1994, 1993, and 1992 39\nStatements of changes in partners' capital for the years ended December 31, 1994, 1993, and 1992 40\nStatements of cash flows for the years ended December 31, 1994, 1993, and 1992 41\nNotes to financial statements 42-49\nAll other financial statement schedules have been omitted as the required information is not pertinent to the Registrant or is not material, or because the information required is included in the financial statements and notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nThe Partners PLM Equipment Growth Fund II:\nWe have audited the financial statements of PLM Equipment Growth Fund II as listed in the accompanying index to financial statements (Item 14 (a)) for the years ended December 31, 1994, 1993 and 1992. 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, the financial statements referred to above present fairly, in all material respects, the financial position of PLM Equipment Growth Fund II 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.\nSAN FRANCISCO, CALIFORNIA March 17, 1995\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership)\nBALANCE SHEETS\nDecember 31, (in thousands of dollars except unit amounts)\nSee accompanying notes to financial statements.\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership)\nSTATEMENTS OF OPERATIONS For the years ended December 31, (thousands of dollars except per unit amounts)\nSee accompanying notes to financial statements.\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership)\nSTATEMENTS OF CHANGES IN PARTNERS' CAPITAL For the years ended December 31, 1994, 1993, and (thousands of dollars)\nSee accompanying notes to financial statements.\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS For the years ended December 31, (thousands of dollars)\nSee accompanying notes to financial statements.\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership) NOTES TO FINANCIAL STATEMENTS December 31, 1994\n1. Basis of Presentation\nOrganization\nPLM Equipment Growth Fund II, a California limited partnership (the \"Partnership\") was formed on March 30, 1987. The Partnership engages in the business of owning and leasing primarily used transportation equipment. The Partnership commenced significant operations in June, 1987. PLM Financial Services, Inc. (\"FSI\") is the General Partner. FSI is a wholly-owned subsidiary of PLM International, Inc. (\"PLM International\").\nThe Partnership will terminate on December 31, 2006, unless terminated earlier upon sale of all equipment or by certain other events. At the conclusion of the Partnership's seventh year of operations on December 31, 1995, the General Partner will stop reinvesting excess cash and will start distributing these funds, if any, to the Partners. Beginning in the eleventh year, the General Partner intends to begin an orderly liquidation of the Partnership's assets.\nFSI manages the affairs of the Partnership. The net income (loss) and distributions of the Partnership are generally allocated 95% to the Limited Partners and 5% to the General Partner (see Net Income (Loss) and Distributions per Depositary Unit, below). The General Partner is entitled to an incentive fee equal to 7.5% of \"Surplus Distributions\", as defined in the Partnership Agreement, remaining after the Limited Partners have received a certain minimum rate of return.\nOperations\nThe equipment of the Partnership is managed under a continuing management agreement, by PLM Investment Management, Inc. (\"IMI\"), a wholly-owned subsidiary of FSI. IMI receives a monthly management fee from the Partnership for managing the equipment (see Note 2). FSI, in conjunction with its subsidiaries, syndicates investor programs, sells transportation equipment to investor programs and third parties, manages pools of transportation equipment under agreements with the investor programs, and is a general partner of other limited partnerships.\nAccounting for Leases\nThe Partnership's leasing operations generally consist of operating leases. Under the operating lease method of accounting, the leased asset is recorded at cost and depreciated over its estimated useful life. Rental payments are recorded as revenue over the lease term. Lease origination costs are capitalized and amortized over the term of the lease.\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership) NOTES TO FINANCIAL STATEMENTS December 31, 1994\n1. Basis of Presentation (continued)\nTranslation of Foreign Currency Transactions\nThe Partnership is a domestic partnership, however, a limited number of the Partnership's transactions are denominated in a foreign currency. The Partnership's asset and liability accounts denominated in a foreign currency were translated into U.S. dollars at the rates in effect at the balance sheet dates, and revenue and expense items were translated at average rates during the year. Gains or losses resulting from foreign currency transactions are included in the results of operations and are not material.\nDepreciation and Amortization\nDepreciation of equipment held for operating leases is computed on the 200% declining balance method taking a full month's depreciation in the month of acquisition, based upon estimated useful lives of 15 years for railcars and 12 years for all other types of equipment. The depreciation method changes to straight line when annual depreciation expense using the straight line method exceeds that calculated by the 200% declining balance method. Acquisition fees have been capitalized as part of the cost of the equipment. Major expenditures which are expected to extend the useful lives or reduce future operating expenses of equipment are capitalized. Lease negotiation fees are amortized over the initial equipment lease term. Debt issuance costs are amortized over the term of the loan for which they are paid.\nRevaluation of Equipment\nThe Partnership reviews the carrying value of its equipment at least annually in relation to expected market conditions for the purpose of assessing recoverability of the recorded amounts. If projected future lease revenue plus residual values are less than the carrying value of the equipment, a loss on revaluation is recorded.\nRepairs and Maintenance\nMaintenance costs are usually the obligation of the lessee. If they are not covered by the lessee they are charged against operations as incurred. To meet the maintenance obligations of certain aircraft airframes and engines, escrow accounts are prefunded by the lessees. Estimated costs associated with marine vessel drydockings, which are included in repairs and maintenance expense, are accrued and charged to income ratably over the period prior to such drydocking. The reserve accounts are included in the balance sheet as prepaid deposits and reserve for repairs.\nNet Income (Loss) and Distributions per Depositary Unit\nThe net income (loss) and distributions of the Partnership are generally allocated 95% to the Limited Partners and 5% to the General Partner. During\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership) NOTES TO FINANCIAL STATEMENTS December 31, 1994\n1. Basis of Presentation (continued)\nNet Income (Loss) and Distributions per Depositary Unit (continued)\n1994, the General Partner received a special allocation of income of $963,000 ($845,000 in 1993 and $1,495,000 in 1992). The Limited Partners' net income or loss and distributions are allocated among the Limited Partners based on the number of Depository Units owned by each Limited Partner. Cash distributions are recorded when paid. Cash distributions of $3,146,000, $3,155,000, and $3,158,000 ($0.40 per Depositary Unit) were declared on December 31, 1994, 1993, and 1992 and paid on February 15, 1995, 1994, and 1993 respectively, to the unitholders of record as of December 31, 1994, 1993, and 1992 respecetively. Cash distributions to investors in excess of net income are considered to represent a return of capital on a Generally Accepted Accounting Principles (GAAP) basis. Cash distributions to Limited Partners of $11,989,000, $7,562,000, and $16,502,000 in 1994, 1993, and 1992, respectively, were deemed to be a return of capital.\nCash and Cash Equivalents\nThe Partnership considers highly liquid investments that are readily convertible to known amounts of cash with original maturities of three months or less as cash equivalents. Lessee security deposits held by the Partnership are considered restricted cash.\nReclassifications\nCertain amounts in the 1993 and 1992 financial statements have been reclassified to conform with the 1994 presentation. Transportation equipment held for operating leases at December 31, 1994 and 1993, includes equipment previously reported as held for sale.\nRestricted Cash\nUnder the Partnership's new loan agreement (See Footnote 4 to the Financial Statements), at December 31, 1994, the Partnership is no longer required to deposit proceeds realized on the sale or disposal of equipment into a joint escrow account, to be held only for equipment acquisitions or debt paydown. At December 31, 1993, the Partnership was required to deposit proceeds realized on the sale or disposal of equipment into the joint escrow account, and the proceeds could only be used for the above-mentioned purposes.\n2. General Partner and Transactions with Affiliates\nFSI contributed $100 of the Partnership's initial capital. Under the equipment management agreement, IMI receives a monthly management fee equal to the greater of (i) 5% of Gross Revenues (as defined in the agreement)\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership) NOTES TO FINANCIAL STATEMENTS December 31, 1994\n2. General Partner and Transactions with Affiliates (continued)\nprior to the payment of any principal and interest incurred in connection with any indebtedness, or (ii) 1\/12 of 1\/2% of the net book value of the equipment portfolio subject to certain adjustments. Management fees were $1,150,000, $1,523,000, and $1,668,000, during 1994, 1993, and 1992, respectively. The Partnership reimbursed FSI and its affiliates $732,000, $736,000, and $562,000 for administrative and data processing services performed on behalf of the Partnership in 1994, 1993, and 1992, respectively. Debt placement fees are charged by the General Partner in an amount equal to 1% of the Partnership's borrowings less amounts paid to third parties in relation to the debt placement. No debt placement fees were paid or payable to FSI during 1994, 1993 and 1992.\nThe Partnership paid lease negotiation and equipment acquisition fees of $653,000, $691,000, and $220,000 in 1994, 1993, and 1992, respectively to PLM Transportation Equipment Corporation (\"TEC\"). TEC is a wholly owned subsidiary of FSI.\nThe Partnership paid $299,000, $1,082,000, and $1,089,000 in 1994, 1993 and 1992 respectively, to Transportation Equipment Indemnity Company Ltd. (\"TEI\") which provides insurance coverages for Partnership equipment and other insurance brokerage services to the Partnership. TEI is an affiliate of the General Partner. A substantial portion of these amounts was paid to third party reinsurance underwriters or placed in risk pools managed by TEI on behalf of affiliated partnerships and PLM International which provide threshold coverages on marine vessel loss of hire and hull and machinery damage. All pooling arrangement funds are either paid out to cover applicable losses or refunded pro rata by TEI.\nAt December 31, 1994, approximately 31% of the Partnership's trailer equipment had been transferred into rental yards operated by an affiliate of the General Partner. Revenues collected under short-term rental agreements with the rental yards' customers are distributed monthly to the owners of the related equipment. Direct expenses associated with the equipment and an allocation of other direct expenses of the rental yard operations are billed to the Partnership.\nThe Partnership owns certain equipment for lease in conjunction with affiliated partnerships. In 1994, this equipment included two commercial aircraft (each 50% owned), a bulk carrier marine vessel (50% owned) and one mobile offshore drilling unit (55% owned).\nThe balance due to affiliates at December 31, 1994, includes $236,000 due to FSI and its affiliates. The balance due to affiliates at December 31, 1993, includes $355,000 due to FSI and its affiliates.\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership) NOTES TO FINANCIAL STATEMENTS December 31, 1994\n3. Equipment\nEquipment held for operating leases is stated at cost. The components of equipment at December 31, 1994, and 1993, are as follows (in thousands):\n1994 1993 ---- ----\nEquipment held for operating leases:\nRail equipment $ 19,749 $ 19,800 Marine containers 17,939 17,889 Marine vessels 4,702 29,461 Aircraft 50,644 49,939 Trailers and tractors 23,092 16,049 Mobile offshore drilling unit 12,658 16,313 --------- --------- 128,784 149,451 Less accumulated depreciation (74,672) (83,035) --------- ---------\nNet equipment $ 54,112 $ 66,416 ========= =========\nRevenues are earned by placing the equipment under operating leases which are generally billed monthly or quarterly. Some of the Partnership's marine vessel and some of its marine containers are leased to operators of utilization-type leasing pools which include equipment owned by unaffiliated parties. In such instances revenues received by the Partnership consist of a specified percentage of revenues generated by leasing the equipment to sublessees, after deducting certain direct operating expenses of the pooled equipment. Rents for railcars are based on mileage travelled or a fixed rate; rents for all other equipment are based on fixed rates.\nAs of December 31, 1994, all equipment in the Partnership portfolio was either operating in short-term rental facilities or on lease, except 266 marine containers and one tractor. The aggregate carrying value of equipment off lease was $1,136,000 and $172,000 at December 31, 1994, and 1993, respectively.\nDuring 1994, the Partnership purchased 1,959 marine containers and 649 trailers at a cost of $11.9 million and paid acquisition and lease negotiation fees of $0.6 million to TEC. During 1993, the Partnership purchased 26 trailers and a 55% interest in a mobile offshore drilling unit at a cost of $12.3 million and paid acquisition and lease negotiation fees of $0.7 million to TEC (see Footnote 2 to the Financial Statements).\nDuring 1994, the Partnership sold or disposed of 423 marine containers, 267 trailers, two railcars, two marine vessels, and a 12% interest in a mobile\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership) NOTES TO FINANCIAL STATEMENTS December 31, 1994\n3. Equipment (continued)\noffshore drilling unit with an aggregate net book value of $13.5 million and accrued drydock reserves of $2.2 million for aggregate proceeds of $13.6 million. During 1993, the Partnership sold or disposed of one aircraft, three marine vessels, 124 tractors and trailers, 639 railcars, and 305 marine containers with an aggregate net book value of $16.0 million and accrued drydock reserves of $1.5 million for aggregate proceeds of $21.2 million.\nThe Partnership reduced the carrying value of two aircraft by $887,000 during 1994 and reduced the carrying value of 50 pulpwood railcars by $161,000 during 1993 to their estimated net realizable value.\nAll leases are being accounted for as operating leases. Future minimum rentals receivable under noncancelable leases at December 31, 1994, during each of the next five years are approximately $9,781,000 - 1995; $6,546,000 - 1996; $2,482,000 - 1997; $498,000 - 1998; and $195,000 - 1999. Contingent rentals based upon utilization were approximately $7,064,000 in 1994, $6,544,000 in 1993, and $8,738,000 in 1992.\nThe Partnership owned two marine vessels and an interest in one mobile offshore drilling unit, and currently owns an interest in another mobile offshore drilling unit, a marine vessel, marine containers, aircraft and rail equipment which are leased and operated internationally. Respective revenues and expenses (including depreciation and amortization) for these assets for the years ended December 31, 1994, 1993, and 1992, are as follows (in thousands):\n1994 1993 1992 ---- ---- ---- Revenues: Marine vessels $ 5,294 $11,956 $15,284 Marine containers 1,826 2,506 3,193 Aircraft 3,208 3,768 6,161 Rail equipment 1,800 1,742 1,672 Mobile offshore drilling units 2,488 1,418 455\nExpenses: Marine vessels $ 7,639 $13,671 $17,217 Marine containers 1,938 1,501 2,054 Aircraft 3,154 4,098 4,801 Rail equipment 811 847 1,554 Mobile offshore drilling units 2,473 1,560 523\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership) NOTES TO FINANCIAL STATEMENTS December 31, 1994\n3. Equipment (continued)\nThe net book value of these assets at December 31, 1994, and 1993, is as follows (in thousands):\n1994 1993 ---- ----\nMarine vessels $ 2,174 $13,295 Marine containers 7,533 7,220 Aircraft 9,144 15,027 Rail equipment 2,215 2,611 Mobile offshore drilling units 9,670 14,226\nThere were no lessees that accounted for 10% or more of total revenues for 1994 and 1993. Lessees accounting for 10% or more of total revenues in 1992 were Commodity Ocean Trading Company (21% in 1992), and Sinochem (12% in 1992).\n4. Notes Payable\nDebt borrowings of the Partnership are as follows:\n1994 1993 ---- ----\nNotes payable to insurance companies under a $35 million loan facility, bearing interest at LIBOR + 1.55% per annum (8.05% at December 31, 1994) payable quarterly in arrears. $35,000,000 $ --\nNotes payable to a bank under a $35 million loan facility, bearing interest at LIBOR + 1.25% per annum (4.56% at December 31, 1993) payable monthly, principal refinanced on March 31, 1994. -- 35,000,000 ----------- -----------\nTotal notes payable $35,000,000 $35,000,000 =========== ===========\nOn March 31, 1994, the Partnership completed a refinancing of its $35 million bank loan which was originally due on September 30, 1995.\nPLM EQUIPMENT GROWTH FUND II (A Limited Partnership) NOTES TO FINANCIAL STATEMENTS December 31, 1994\n4. Notes Payable (continued)\nThe new $35 million loan facility is unsecured and nonrecourse, limits additional borrowings, and specifies covenants related to collateral coverage, fixed charge coverage, ratios for market value, and composition of the equipment owned by the Partnership. The loan facility bears interest at LIBOR + 1.55% per annum (8.05% at December 31, 1994) and is payable quarterly in arrears. Principal is payable in annual installments of $4 million on March 31, 1996 and 1997, $9 million on March 31, 1998 and 1999, and a final payment of $9 million on March 31, 2000. The Partnership paid a facility fee of $236,000 to the lender in connection with this credit facility.\nThe General Partner believes that the book value of the Notes Payable approximates fair market value due to its variable interest rate.\nThe previous $35,000,000 loan facility was unsecured and nonrecourse, limited additional borrowings, and specified covenants related to tangible net worth, collateral coverage, and ratios for market value and composition of the equipment owned by the Partnership.\nThe previous loan facility required the Partnership to deposit proceeds realized on the sale or disposal of equipment into a joint escrow account, where the funds could only be used for the purchase of additional equipment, or reduce on a pro-rata basis the outstanding balance of the Partnership's debt. At December 31, 1993, $7.4 million of these proceeds were held by the Partnership as Restricted cash. Upon refinancing, the new lender lifted all restrictions on proceeds from the sale of assets. As of March 31, 1994, these funds are no longer considered restricted cash.\n5. Income Taxes\nThe Partnership is not subject to income taxes as any income or loss is included in the tax returns of the individual Partners. Accordingly, no provision for income taxes has been made in the financial statements of the Partnership.\nAs of December 31, 1994, there were temporary differences of approximately $9,803,000 between the financial statement carrying values of certain assets and liabilities and the income tax bases of such assets and liabilities, primarily due to the differences in depreciation methods and in the method of providing reserves for repairs.\n6. Subsequent Event\nCash distributions of $2,982,000 ($0.40 per Depositary Unit) were declared on March 16, 1995, and are to be paid on May 15, 1995, to the unitholders of record as of March 31, 1995. The Partnership repurchased 18,200 Depositary Units at a total cost of $0.1 million for the period January 1, 1995 to March 17, 1995.\nPLM EQUIPMENT GROWTH FUND II\nINDEX OF EXHIBITS\nExhibit Page\n4. Limited Partnership Agreement of Partnership *\n4.1 Amendment to Limited Partnership Agreement of Registrant *\n10.1 Management Agreement between Partnership and * PLM Investment Management, Inc.\n$35,000,000 Note Agreement, dated as of March 1, 1994. *\n25. Powers of Attorney 51-54\n*Incorporated by reference. See page 33 of this report.","section_15":""}
{"filename":"37941_1994.txt","cik":"37941","year":"1994","section_1":"ITEM 1. BUSINESS.\nThe Foothill Group, Inc. (\"Foothill Group\" or \"parent company\") is a specialized financial services company engaged in asset-based commercial lending through Foothill Capital Corporation (\"Foothill Capital\") and money management services through Foothill Group. Unless the context otherwise indicates, the \"Company\" refers to Foothill Group and its subsidiary.\nSince 1970, Foothill Capital has made revolving credit and term loans to companies which are generally unable to secure financing from traditional lending sources. The loans are generally secured by accounts receivable and inventory, machinery, equipment and other assets. At December 31, 1994, Foothill Capital had a total of $648,763,000 in loans outstanding. Foothill Capital generates revenues principally from interest income as well as loan commitment, appraisal, audit, monitoring fees and other related services. Foothill Capital's strategy is to provide innovative financing solutions to borrowers who have adequate collateral in the form of accounts receivable, inventory and other assets, but may not meet overall credit standards generally required by commercial banks. As part of its operating strategy, Foothill Capital, in conjunction with limited partnerships managed by Foothill Group, purchases loans at a discount to their principal amounts.\nAt December 31, 1994, loans in Foothill Capital's portfolio have principal amounts of up to $17,886,000. The average amount per borrower in Foothill Capital's portfolio was $2,595,000 and was either a revolving loan secured primarily by accounts receivable and inventory or a term loan secured by machinery, equipment or other assets. Revolving loans are normally provided for up to three year periods and are based on 50% to 80% of eligible accounts receivable and on 15% to 50% of the lower of cost or market value of eligible inventory. Term loans are frequently made in combination with revolving loans and are generally due within five years. Both revolving loans and term loans are made with full recourse to the borrower.\nFoothill Capital has historically purchased secured loans from other parties (\"purchased receivables\") consisting of non-public debt instruments including bank loans and private placements, public debt instruments including registered bonds, notes and debentures, and discounted receivables (bank debt purchased at a discount from its principal amount from the original lenders.) Foothill Capital's bank credit agreement limits the amount of its aggregate purchased receivables to $75,000,000. At December 31, 1994, purchased receivables totaled $33,056,000 and represented 4.7% of Foothill Capital's assets.\nIn 1988, Foothill Group established a money management business to capitalize on its experience in lending to and investing in debt securities of financially troubled borrowers. Foothill Group operates two limited partnerships for institutional investors (the \"Funds\") to invest in debt securities or claims of financially troubled companies. Many of the Funds' investments are in companies that may be involved in a restructuring or reorganization under the Federal Bankruptcy Code. Foothill Group acts as a general partner of such partnerships, which have aggregate capital commitments of $516,000,000. Foothill Group earns management fees from the Funds as well as incentive compensation based on distributed profits in excess of specified rates of return.\nEffective December 23, 1993, the parent company completed the spin-off of its Foothill Thrift and Loan subsidiary to Foothill Group shareholders. All previously reported financial results of Foothill Thrift and Loan, through the record date for the spin-off, are classified as discontinued operations. Revenues of Foothill Thrift and Loan totaled $21,658,000 and $23,131,000 for the years ended December 31, 1993 and 1992.\nMANAGEMENT OF CREDIT RISK\nThe Company endeavors to minimize credit losses by maintaining a diversity of borrowers and types of collateral, as well as by establishing credit policies and by maintaining close supervision of its loans and underlying collateral. Borrowers of Foothill Capital may be a higher credit risk than traditional unsecured borrowers of commercial banks. Foothill Capital attempts to offset this risk by collateralizing all loans. Foothill Capital's credit policies prohibit loans in excess of 15% of capital funds (consolidated net worth plus subordinated debt) to any one borrower. In practice, few of its loans approach such maximum. At December 31, 1994, Foothill Capital's largest loan was $17,886,000 (9.3% of capital funds). Foothill Capital\nalso manages its loan portfolio to avoid geographic and industry concentration risk. At December 31, 1994, 70% of its finance receivables were from borrowers outside the State of California, and borrowers from no other state represented more than 14% of its loan portfolio. In addition, it is Foothill Capital's policy to have no single industry other than wholesale trade (as defined by two digit SIC codes) account for greater than 10% of its loan portfolio.\nIn addition to originating loans for its own portfolio, Foothill Capital reduces its credit exposure by selling nonrecourse participations in loans to banks and other asset-based lenders. At December 31, 1994, Foothill Capital had sold $218,052,000 in nonrecourse loan participations.\nThe Company's credit investigation normally involves analysis of the underlying collateral securing the loan, review and analysis of the prospective borrower's financial statements and background, an analysis of cash flow ability of the prospective borrower to meet the Company's repayment requirements and review of credit and historical data with credit reporting agencies. In addition, the Company performs audits of information and operational data provided by revolving credit prospects.\nCOMPETITION\nIn its commercial finance activities, the Company competes with commercial finance companies throughout the nation as well as with banks and other financial institutions. Competition from banks comes primarily from their secured lending subsidiaries and divisions. Frequently, other finance companies are affiliated with large financial institutions and have greater financial resources and the ability to borrow at a lower cost of funds which enables them to charge lower rates to borrowers while maintaining adequate margins. These cost structures are available to banks and several other financial institutions with whom Foothill Capital competes. The Company believes, however, despite the generally higher interest rates it frequently charges, Foothill Capital's ability to respond quickly and to design specialized and non-traditional loan structures specific to its borrowers' needs, enables it to compete effectively in its markets.\nFoothill Group faces competition in its money management activities from asset and money managers, some of whom are affiliated with major investment or commercial banks and investment advisors whose investment strategies are substantially similar to those of the Funds.\nEMPLOYEES\nAs of December 31, 1994, the Company and its subsidiary employed 128 people.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company leases all of its offices. Information with respect to the Company's offices as of December 31, 1994 is as follows:\n- --------------- (1) Offices also used by the Registrant.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are several lawsuits and claims pending against the Company which management considers incident to normal operations, some of which seek substantial monetary damages. Management, after review, including consultation with counsel, believes that any ultimate liability which could arise from these lawsuits and claims 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.\nNot applicable.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThere is incorporated herein by reference the information from the section entitled \"Stock Information\" on page 41 of the Company's Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThere is incorporated herein by reference the information from the sections entitled \"Selected Consolidated Financial Data\" and \"Selected Financial Data For Foothill Capital Corporation\" on pages 17 and 18 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.\nThere is incorporated herein by reference the information from the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 19 to 25 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.\nThere is incorporated herein by reference the \"Consolidated Financial Statements\" of The Foothill Group, Inc. and its subsidiary, together with the Report of Ernst & Young, Independent Auditors, on pages 26 to 41 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 DISCLOSURE.\nNot applicable.\nWith the exception of the information incorporated in Items 1, 5, 6, 7 and 8, the Annual Report is not deemed filed as part of this report.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThere is incorporated herein by reference the information from the section entitled \"Election of Directors\" on pages 3 to 6 of the Company's definitive Proxy Statement, dated March 21, 1995, filed with the Securities and Exchange Commission. Reference is also made to the list of Executive Officers, which is provided below under the caption \"Executive Officers of the Registrant.\"\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following individuals are executive officers of the Registrant. Pertinent information relating to these individuals is set forth below. There are no family relationships between any of the officers. All of the Registrant's officers hold their respective offices at the pleasure of the Board of Directors, subject to the rights, if any, of an officer under any contract of employment.\nDON L. GEVIRTZ -- Chairman of the Board and Chief Executive Officer -- Age 67\nMr. Gevirtz has been Chairman of the Board and Chief Executive Officer since April 1972.\nJOHN F. NICKOLL -- President, Vice Chairman of the Board, Co-Chief Executive Officer and Chief Operating Officer -- Age 60\nMr. Nickoll has been President since April 1977. Since April 1972, he has been Vice Chairman of the Board and Chief Operating Officer. He has been Co-Chief Executive Officer since January 1985.\nDAVID C. HILTON -- Executive Vice President -- Age 47\nMr. Hilton was elected Executive Vice President in January 1990 and had served as Chief Financial Officer since November 1984, Senior Vice President since March 1983 and as Controller from April 1979 through October 1984. He was elected Executive Vice President of Foothill Capital in June 1985.\nPETER E. SCHWAB -- Executive Vice President -- Age 51\nMr. Schwab was elected Executive Vice President in January 1990 and had served as Senior Vice President since December 1984 and Senior Vice President of Foothill Capital since February 1983. He was elected President of Foothill Capital in August 1986.\nHENRY K. JORDAN -- Senior Vice President, Chief Financial Officer and Secretary -- Age 38\nMr. Jordan was elected Senior Vice President in January 1994 and has served as Chief Financial Officer and Secretary since February 1990. He had served as Vice President and Controller since November 1984. He was elected Senior Vice President of Foothill Capital in September 1986.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThere is incorporated herein by reference the information from the section entitled \"Executive Compensation\" on pages 6 to 13 of the Company's definitive Proxy Statement, dated March 21, 1995, filed with the Securities and Exchange Commission.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThere is incorporated herein by reference the information from the section entitled \"Voting Securities\" on pages 1 to 3 and \"Election of Directors\" on pages 3 to 6 of the Company's definitive Proxy Statement, dated March 21, 1995, filed with the Securities and Exchange Commission.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThere is incorporated herein by reference the information from the section entitled \"Transactions with Management and Others\" on pages 15 to 16 of the Company's definitive Proxy Statement, dated March 21, 1995, 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) 1 and 2. Financial Statements and Financial Statement Schedules\nThe financial statements and schedules listed in the accompanying Index to Financial Statements and Financial Statement Schedules are filed as part of this Form 10-K.\n3. List of Exhibits\nThe exhibits listed on the accompanying Index to Exhibits are filed as part of this Form 10-K. In addition, following is a list of each executive compensation plan and arrangement required to be filed as an exhibit.\n(b) Reports on Form 8-K\nDuring the quarter ended December 31, 1994 and through the date of this filing, the following reports on Form 8-K were filed:\n(c) Exhibits\nThe exhibits listed on the accompanying Index to Exhibits are filed as part of this Form 10-K.\nTHE FOOTHILL GROUP, INC.\nAND FINANCIAL STATEMENT SCHEDULES\n(ITEM 14(A))\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 and related notes in the Annual Report to Stockholders for the year ended December 31, 1994.\nTHE FOOTHILL GROUP, INC. (PARENT COMPANY)\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (UNCONSOLIDATED)\nCONDENSED BALANCE SHEETS (UNCONSOLIDATED)\nDECEMBER 31, 1994 AND 1993\nASSETS\nSee accompanying notes.\nTHE FOOTHILL GROUP, INC. (PARENT COMPANY)\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (UNCONSOLIDATED) (CONTINUED)\nCONDENSED STATEMENTS OF INCOME (UNCONSOLIDATED) YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee accompanying notes.\nTHE FOOTHILL GROUP, INC. (PARENT COMPANY)\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (UNCONSOLIDATED) (CONTINUED)\nCONDENSED STATEMENTS OF CASH FLOWS (UNCONSOLIDATED)\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee accompanying notes.\nTHE FOOTHILL GROUP, INC.\nNOTES TO CONDENSED FINANCIAL STATEMENTS (UNCONSOLIDATED)\nNOTE 1 -- SUMMARY OF ACCOUNTING POLICIES\nFor financial reporting purposes, Foothill Capital's provision for income taxes is determined on a separate company basis. Foothill Capital's tax benefits are not limited by the consolidated group's ability to utilize these tax benefits. The difference between the provision of Foothill Capital and the consolidated provision is accounted for by the parent company.\nThe presentation of certain prior year amounts has been conformed to the 1994 presentation.\nAll previously reported financial results of Foothill Thrift and Loan are classified as discontinued operations.\nFor information concerning other significant accounting policies followed, restrictions on investments in subsidiaries and extraordinary items, reference is made to Notes to Consolidated Financial Statements in the Annual Report to Stockholders for the year ended December 31, 1994.\nNOTE 2 -- INDEBTEDNESS\nSee Notes 4 and 5 of Notes to Consolidated Financial Statements in the Annual Report to Stockholders for the year ended December 31, 1994.\nNOTE 3 -- CONTINGENCIES\nSee Note 10 of Notes to Consolidated Financial Statements in the Annual Report to Stockholders for 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.\nTHE FOOTHILL GROUP, INC.\nBy: \/s\/ DON L. GEVIRTZ ------------------------------------ Don L. Gevirtz Chief Executive Officer\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:\nTHE FOOTHILL GROUP, INC.\nINDEX TO EXHIBITS\n(ITEM 14(C))\n- ---------------\n(1) Filed herewith.\n(2) Except for the portions thereof which are expressly incorporated by reference into this Form 10-K, such Annual Report to Stockholders is not deemed filed as part of this report.\n(3) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1987.\n(4) Incorporated herein by reference from Registrant's Annual Report on Form 10-K for its year ended December 31, 1986.\n(5) Incorporated herein by reference from Exhibit A of Registrant's 1988 proxy statement dated March 21, 1988.\n(6) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988.\n(7) Incorporated herein by reference from Registrant's Annual Report on Form 10-K for its year ended December 31, 1988.\n(8) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1989.\n(9) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990.\n(10) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1990.\n(11) Incorporated herein by reference from Appendix A of Registrant's 1990 proxy statement dated March 8, 1990.\n(12) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991.\n(13) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991.\n(14) Incorporated herein by reference from Registrant's Annual Report on Form 10-K for its year ended December 31, 1990.\n(15) Incorporated herein by reference from Registrant's Annual Report on Form 10-K for its year ended December 31, 1989.\n(16) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992.\n(17) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n(18) Incorporated herein by reference from Registrant's Annual Report on Form 10-K for its year ended December 31, 1991.\n(19) Incorporated herein by reference from Exhibit 10.34 to Registrant's Amendment No. 2 to Form S-2 Registration Statement No. 33-46673.\n(20) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n(21) Incorporated herein by reference from Registrant's Annual Report on Form 10-K for its year ended December 31, 1992.\n(22) Incorporated herein by reference from Registrant's Annual Report on Form 10-K for its year ended December 31, 1993.\n(23) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994.\n(24) Incorporated herein by reference from Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.","section_15":""}
{"filename":"64908_1994.txt","cik":"64908","year":"1994","section_1":"ITEM 1. BUSINESS General\nMercantile Bankshares Corporation (\"Mercshares\") was incorporated under the laws of Maryland on May 27, 1969. Mercshares is a bank holding company registered under the Bank Holding Company Act of 1956 and, as of December 31, 1994, owned substantially all of the outstanding shares of capital stock of twenty banks (the \"Affiliated Banks\"): The Annapolis Banking and Trust Company (\"Annapolis\"), Baltimore Trust Company (\"Baltimore Trust\"), Bank of Southern Maryland (\"Southern\"), Calvert Bank and Trust Company (\"Calvert\"), The Chestertown Bank of Maryland (\"Chestertown\"), The Citizens National Bank (\"Citizens\"), County Banking & Trust Company (\"County\"), The Eastville Bank (\"Eastville\"), Farmers & Merchants Bank - Eastern Shore (\"Farmers & Merchants\"), The Fidelity Bank (\"Fidelity\"), The First National Bank of St. Mary's (\"First National\"), The Forest Hill State Bank (\"Forest Hill\"), Fredericktown Bank & Trust Company (\"Fredericktown\"), Mercantile-Safe Deposit and Trust Company (\"Merc-Safe\"), The National Bank of Fredericksburg (\"Fredericksburg\"), Peninsula Bank (\"Peninsula\"), The Peoples Bank of Maryland (\"Peoples\"), Potomac Valley Bank (\"Potomac\"), St. Michaels Bank (\"St. Michaels\") and Westminster Bank and Trust Company of Carroll County (\"Westminster\"). Mercshares also owns all of the outstanding shares of Mercantile Mortgage Corporation, a mortgage banking company, MBC Agency, Inc., an insurance agency and MBC Realty, Inc., which owns and operates various properties used by Merc-Safe. Merc-Safe owns all of the outstanding shares of Mercantile Pennsylvania Corporation which makes extensions of credit in Pennsylvania. MBC Agency, Inc., owns all of the outstanding shares of Mercantile Life Insurance Company, which is in the business of reinsuring credit insurance made available through the Affiliated Banks. Mercantile Mortgage Corporation owns all of the outstanding shares of Benchmark Appraisal\nGroup, Inc. which appraises real property in connection with loans made by Mercantile Mortgage Corporation, certain of the Affiliated Banks, and others. The Affiliated Banks, Mercantile Mortgage Corporation, MBC Agency, Inc., Mercantile Life Insurance Company, MBC Realty, Inc., Mercantile Pennsylvania Corporation and Benchmark Appraisal Group, Inc. are herein referred to as \"Affiliates.\" For information on the location and number of offices of the Affiliated Banks and Mercantile Mortgage Corporation, at December 31, 1994, see pages 42 to 47 of Registrant's Annual Report to Stockholders for the year ended December 31, 1994, which information is incorporated by reference herein. On December 15, 1994, Mercshares and The Sparks Bank (\"Sparks Bank\"), Sparks, Maryland, reached an agreement under which Mercshares proposes to acquire all of the outstanding 771,241 shares of Sparks Bank in a statutory share exchange transaction. The maximum number of shares of Mercshares common stock issuable will be 1,804,700. The affiliation is subject to approval by the Virginia State Corporation Commission, Bureau of Financial Institutions, the Maryland Bank Commissioner, the Federal Reserve Board and by the holders of two- thirds of the outstanding shares of voting stock of Sparks Bank. As of December 31, 1994, Sparks Bank had total assets of $191,028,000 (about 3% of the combined assets of Mercshares and its Affiliates), deposits of $163,520,000, loans (net of unearned income) of $128,785,000 and stockholders equity of $19,769,000. For the year ended December 31, 1994, Sparks Bank had net income of $2,397,000. Sparks Bank was incorporated in 1916 and has five offices located in Baltimore County, Maryland. Mercshares periodically reviews and considers possible acquisitions of banks and corporations performing related activities and discusses such possible acquisitions with managements of the subject companies, and such acquisitions may be made from time to time. Such acquisitions are normally subject to regulatory approval.\nOperations The Affiliated Banks are engaged in a general commercial and retail banking business with normal banking services, including acceptance of demand, savings and time deposits and the making of various types of loans. Merc-Safe offers a full range of personal trust services, investment management services and (for corporate and institutional customers) investment advisory, financial and pension and profit sharing services. As of December 31, 1994, assets under the investment supervision of Merc-Safe's trust division had an estimated value of $9.3 billion, assets held in its personal and corporate custody accounts had an estimated value of $13.8 billion and assets held in escrow accounts had an estimated value of $0.4 billion. Mercantile Mortgage Corporation, through offices in Maryland and Delaware, arranges for and services various types of mortgage loans as principal and as agent primarily for non-affiliated institutional investors and also for the Affiliated Banks. Benchmark Appraisal Group, Inc., which is owned by Mercantile Mortgage Corporation, appraises real property in connection with loans made by Mercantile Mortgage Corporation, certain of the Affiliated Banks, and others. Mercantile Pennsylvania Corporation makes various commercial extensions of credit in Pennsylvania. MBC Agency, Inc., provides, under group policies, credit life insurance in connection with extensions of credit by Affiliated Banks. Mercantile Life Insurance Company, which is owned by MBC Agency, Inc., reinsures the insurance provided by that Company.\nStatistical Information\nThe statistical information required in this Item 1 is incorporated by reference to the information appearing in Registrant's Annual Report to Stockholders for the year ended December 31, 1994, as follows:\nDisclosure Required by Guide 3 Reference to 1994 Annual Report\n(I) Distribution of Assets, Liabilities and Stockholder Equity; Interest Rates and Interest Differential . . .Analysis of Interest Rates and Interest Differentials (pages 6-7) . . .Rate\/Volume Analysis (page 8) . . .Non-performing Assets (pages 16-17)\n(II) Investment Portfolio . . .Bond Investment Portfolio (page 11)\n(III) Loan Portfolio . . .Year-End Loan Data (page 40) . . .Loan Maturity Schedule (page 13) . . .Asset\/Liability Management (pages 12-14) . . .Non-performing Assets (pages 16-17)\n(IV) Summary of Loan Loss Experience . . .Allowance for Loan Losses (page 14) and Credit Risk Analysis (pages 13, 15) . . .Allocation of Allowance for Loan Losses (page 15)\n(V) Deposits . . .Analysis of Interest Rates and Interest Differentials (pages 6-7) . . .Notes to Financial Statements, Note 5 - Deposits (page 28)\n(VI) Return on Equity and Assets . . .Return on Equity and Assets (page 39)\n(VII) Short-Term Borrowings . . .Notes to Financial Statements, Note 6 (page 28)\nEmployees\nAt December 31, 1994, Mercshares and its Affiliates had approximately 789 officers and 2,056 other employees. Competition The banking business, in all of its phases, is highly competitive. Within their service areas, the Affiliated Banks compete with commercial banks (including local banks and branches or affiliates of other larger banks), savings and loan associations and credit unions for loans and deposits, and with insurance companies and other financial institutions for various types of loans. These Banks also face competition for commercial and retail banking business from banks and financial institutions located outside their service areas. Maryland law currently provides that companies based in Alabama, Arkansas, Delaware, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina, Pennsylvania, South Carolina, Tennessee, Virginia, West Virginia and the District of Columbia are permitted to own Maryland banks or bank holding companies, so long as their states have reciprocal statutes. However, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"1994 Interstate Act\"), which became law September 29, 1994, provides, among other things that, over time, bank holding companies that are adequately capitalized and managed will be permitted to acquire banks in any state, preempting essentially all state laws prohibiting interstate bank acquisitions and mergers, subject to certain state \"opt out\" rights with respect to interstate mergers. As a result of this and other provisions of the Interstate Act, competition may increase. While Mercshares is the second largest bank holding company headquartered in Maryland, it is the largest independent bank holding company in the state. Its largest subsidiary, Merc-Safe, is the sixth largest commercial bank in Maryland. Mercshares also competes with Maryland-based bank subsidiaries of the\nfirst, fourth, sixth, ninth and twenty-fifth largest bank holding companies in the United States as well as banking subsidiaries of other non-Maryland bank holding companies. Measured in terms of assets under investment supervision, Merc-Safe believes it is one of the largest trust institutions in southeastern United States. Merc-Safe competes for various classes of fiduciary and investment advisory business with other banks and trust companies, insurance companies, investment counseling firms, mutual funds and others. Mercantile Mortgage Corporation, Benchmark and Mercantile Pennsylvania Corporation are relatively small competitors in their areas of activity. MBC Agency, Inc., is limited to providing credit life, health and accident insurance in connection with credit extended by the Affiliated Banks.\nSupervision and Regulation Mercshares Mercshares, as a registered bank holding company, is subject to regulation and examination by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956 (the \"Act\") and is required to file with the Board of Governors quarterly and annual reports and such additional information as the Board of Governors may require pursuant to the Act. With certain exceptions, Mercshares is prohibited from acquiring direct or indirect ownership or control of more than 5% of any class of the voting shares of any company which is not a bank or bank holding company and from engaging in any business other than that of banking or of managing or controlling banks or of furnishing services to, or performing services for, its Affiliated Banks. The Act and Regulations promulgated under the Act require prior approval of the Board of Governors of the Federal Reserve System of the acquisition by Mercshares of more than 5% of any class of the voting shares of any additional bank. With certain exceptions relating to troubled banks receiving assistance from the Federal Deposit Insurance Corporation, it also prohibits, until September 29, 1995, the acquisition by Mercshares of a bank located outside the State of Maryland unless statutory laws of the state in which such bank is located specifically authorize such acquisition. Maryland has enacted regional reciprocal banking legislation that creates a vehicle for acquisitions across state lines with respect to certain designated states. Further, under Section 106 of the 1970 Amendments to the Bank Holding Company Act and the Board's Regulations, bank subsidiaries of bank holding companies are prohibited from engaging in certain tie-in arrangements with bank\nholding companies and their non-bank subsidiaries in connection with any extension of credit or provision of any property or services. The Act, generally, restricts activities of all bank holding companies and their subsidiaries to banking, and the business of managing and controlling banks, and to other activities which are determined by the Board of Governors of the Federal Reserve System to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Mercshares is also subject to certain restrictions with respect to engaging in the securities business. It is Federal Reserve Policy that a bank holding company should serve as a source of financial strength for and commit resources to support each of its subsidiary banks even in circumstances in which it might not do so (or may not legally be required or financially able to do so) absent such a policy. Changes in control of Mercshares and its Affiliated Banks are regulated under the Bank Holding Company Act of 1956, the Change in Bank Control Act of 1978 and various state laws.\nAffiliated Banks All Affiliated Banks, with the exception of Citizens, Baltimore Trust, Eastville, Farmers & Merchants, First National and Fredericksburg are Maryland banks, subject to the banking laws of Maryland and to regulation by the Bank Commissioner of Maryland, who is required by statute to make at least one examination in each calendar year. Their deposits are insured by, and they are subject to certain provisions of Federal law and regulations and examination by, the Federal Deposit Insurance Corporation. In addition, Annapolis, Forest Hill and St. Michaels are members of the Federal Reserve System, and are thereby subject to regulation by the Board of Governors of that System.\nCitizens, First National and Fredericksburg are national banks subject to regulation and regular examination by the Comptroller of the Currency in addition to regulation and examination by the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation which insures their deposits. Eastville and Farmers & Merchants are Virginia banks, subject to the banking laws of Virginia and to regulation by its State Corporation Commission, which is required by statute to make at least two examinations in every three year period. Their deposits are insured by, and they are subject to certain provisions of Federal law and regulation and examination by, the Federal Deposit Insurance Corporation. Baltimore Trust is a Delaware bank, subject to the banking laws of Delaware and to regulation by the Delaware State Bank Commissioner, who is required by statute to make periodic examinations. Its deposits are insured by, and it is subject to certain provisions of Federal law and regulation and examination by the Federal Deposit Insurance Corporation. Mercshares and its Affiliates are subject to the provisions of Section 23A of the Federal Reserve Act which limit the amount of loans or extensions of credit to, and investments in, Mercshares and its nonbanking Affiliates by the Affiliated Banks, and Section 23B of the Federal Reserve Act which requires that transactions between the Affiliated Banks and Mercshares and its nonbanking Affiliates be on terms and under circumstances that are substantially the same as with non-affiliates. Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, there are circumstances under which Affiliated Banks could be responsible to the Federal Deposit Insurance Corporation for losses incurred by it with respect to other Affiliated Banks.\nOther Affiliates As affiliates of Mercshares, the nonbanking Affiliates are subject to examination by the Board of Governors of the Federal Reserve System and, as affiliates of the Affiliated Banks, they are subject to examination by the Federal Deposit Insurance Corporation and the Bank Commissioner of Maryland. In addition, MBC Agency, Inc. and Mercantile Life Insurance Company are subject to licensing and regulation by state insurance authorities. Recent Banking Legislation The 1994 Interstate Act (the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994), enacted into law September 29, 1994, made a number of major changes that will have a significant effect on competition among, and the operations of, banks. Although there are numerous provisions, the principal elements include those summarized below. Commencing September 29, 1995, bank holding companies that are adequately capitalized and managed will be permitted to acquire banks in any state, essentially preempting state laws prohibiting interstate bank acquisitions. Commencing June 1, 1997, adequately capitalized and managed banks will be able to engage in interstate branching by merging banks in different states. States may elect not to permit such branching by adopting specific legislation before June 1, 1997 in which case out-of-state banks generally will not be able to branch into such states, and banks headquartered in such states generally will not be permitted to branch into other states. In addition, states may elect to permit such branching earlier by adopting specific legislation to that effect prior to June 1, 1997, which must be applicable to all out-of-state banks and permit interstate merger transactions with all out-of-state banks. States may also elect, by legislation, to permit acquisitions of existing branches of banks by out-of-state banks without the acquisition of the entire bank. With respect to both interstate acquisitions and branching through mergers, states may require that banks to be acquired have been in existence for a period\nof time (not more than five years), may limit, on a non-discriminatory basis, the percent of deposits within a state that may be held by a bank, or bank holding company, and may adopt, on a non-discriminatory basis, laws relating to the operations of a bank within the state. The Federal Reserve Board may not permit an acquisition, and the responsible federal agency may not permit a merger, that would result in the acquiring institution controlling more than 10% of total insured deposits in the U. S., or 30% of a state's insured deposits (other than in connection with an initial entry into a state or with an interstate merger involving affiliated banks), although this 30% limit may be increased or decreased by a state on a non-discriminatory basis. The pertinent federal agencies must take into account the acquiring institution's record under the Community Reinvestment Act and any applicable state community reinvestment laws. States may impose filing requirements and may continue to regulate intrastate branching in a non-discriminatory way, examine banks and branches operated in that state, impose non-discriminatory notification and reporting requirements, adopt laws relating to community reinvestment, consumer protection and fair lending, and exercise taxing authority. The appropriate federal banking agency may permit an adequately capitalized and managed bank to open and operate an interstate branch de novo in any state that has a law expressly permitting all out-of-state banks to open and operate such a branch, provided the bank complies with state filing and community reinvestment requirements. Commencing September 29, 1995, subsidiaries of the same bank holding company may act as agents for one another in receiving deposits, closing and servicing loans and accepting loan payments without being deemed branches, but the new authority does not extend to originating or approving loans or opening deposit accounts. Generally, foreign banks will be allowed to engage in interstate banking in the same way as domestic banks without establishing U. S. banks subsidiaries. There are many other provisions of the 1994 Interstate Act, such as prohibitions against interstate branches being operated primarily to produce\ndeposits, requiring hearings on closing of certain branches, and requiring separate evaluations and ratings of a bank's Community Reinvestment Act performance in each state in which it operates, and separate evaluations for each metropolitan area and for the remaining non-metropolitan area in which the bank maintains a branch. Although the 1994 Interstate Act, and regulations implementing its provisions, become effective over a multi-year period so that the ultimate impact cannot now be predicted, it is clear that it will have a substantial impact on the manner in which the banking business in the United States is conducted. In addition, the Riegle Community Development and Regulatory Improvement Act of 1994, which contains a number of provisions affecting the operations of financial institutions, became law September 23, 1994. Among these provisions are those that, (1) establish a Community Development Financial Institutions Fund to promote economic revitalization and development in communities considered to be financially underserved, through investment in Community Development Financial Institutions, (2) add additional protections to individuals entering into reverse mortgage transactions and \"high cost\" mortgage transactions, (3) remove certain existing impediments to the securitization of small business loans and leases in an effort to improve access to capital by small businesses, (4) reduce or simplify administrative requirements, previously imposed by regulations, of financial institutions to the extent consistent with safe and sound banking practices, (5) reduce and revise reporting requirements relating to money laundering and, (6) improve compliance with the National Flood Insurance Program by lenders and secondary market purchasers in order to increase participation nationally by individuals with mortgaged homes or businesses in special flood hazard areas who have not purchased or maintained flood insurance coverage. Proposed regulations designed to implement certain provisions of this law have been issued. The various provisions of this Act should facilitate the operations of banks but their overall impact cannot be predicted.\nEffects of Monetary Policy All commercial banking operations are affected by the Federal Reserve System's conduct of monetary policy and its policies change from time to time based on changing circumstances. A function of the Federal Reserve System is to regulate the national supply of bank credit in order to achieve economic results deemed appropriate by its Board of Governors, including efforts to combat unemployment, recession or inflationary pressures. Among the instruments of monetary policy used to implement these objectives are open market operations in U.S. Government securities, changes in the discount rate charged on bank borrowings and changes in reserve requirements against bank deposits. These means are used in varying combinations to influence overall growth of bank loans, investments and deposits, and they also affect interest rates charged on loans or paid on deposits. In recent years, Federal legislation has changed some of the restrictions under which banks and other financial institutions have operated historically. The monetary policies of bank regulatory and other authorities have affected the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national economy, in the money markets, and in the relationships of international currencies, as well as the effect of legislation and of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand, or the business and earnings of the Affiliated Banks.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The main offices of Merc-Safe and Mercshares are located in a 21-story building at Hopkins Plaza in Baltimore owned by MBC Realty, Inc., a wholly owned subsidiary of Mercshares. At December 31, 1994, approximately 134,000 square feet were occupied by Merc-Safe and Mercshares. At December 31, 1994, Merc-Safe also occupied approximately 132,000 square feet of leased space in a building located in Linthicum, Maryland, in which its operations and certain other departments are located. This building is also owned by MBC Realty, Inc. Of the 17 banking and bank-related offices occupied by Merc-Safe, 6 are owned in fee, 4 are owned subject to ground leases and 7 are leased with aggregate annual rentals of approximately $733,000, not including rentals for the main office and adjacent premises owned by MBC Realty, Inc. Merc-Safe is the owner of an office building in Towson, Maryland, which houses Merc-Safe's branch administrative offices and one of its Baltimore County banking offices. Of the 138 banking offices of the other Affiliated Banks, 77 are owned in fee, 8 are owned subject to ground leases and 53 are leased, with aggregate annual rentals of approximately $3,044,000 as of December 31, 1994.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS There was no matter which is required to be disclosed in this Item 3 pursuant to the instructions contained in the form for this report.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders which is required to be disclosed pursuant to the instructions contained in the form for this report.\nSPECIAL ITEM: EXECUTIVE OFFICERS OF THE REGISTRANT The Executive Officers of Registrant are:\nName Position Age\nH. Furlong Baldwin Chairman of the Board and Chief Executive Officer 63 Douglas W. Dodge Vice Chairman of the Board 62 Edward K. Dunn, Jr. President and Director 59 Kenneth A. Bourne, Jr. Executive Vice President and Treasurer 52 Hugh W. Mohler Executive Vice President 49 Jay M. Wilson Executive Vice President 48 Brian B. Topping Vice President 60 John A. O'Connor, Jr. Senior Vice President and Secretary 63 Robert W. Johnson Senior Vice President 52 O. James Talbott, II Senior Vice President 51\nNo family relationships, as defined by the Rules and Regulations of the Securities and Exchange Commission, exist among any of the Executive Officers. All officers are elected annually by the Board of Directors and hold office at the pleasure of the Board. Mr. Baldwin has been Chairman of the Board of Mercshares since 1984, and has been its Chief Executive Officer since 1976. He has been Chairman of the Board and Chief Executive Officer of Merc-Safe since 1976. Mr. Dodge has been Vice Chairman of the Board of Mercshares since 1984 and President of Merc-Safe since 1983. Mr. Dunn has been President of Mercshares and a Vice Chairman of the Board of Merc-Safe since 1991. He was Chairman of the Executive Committee of Mercshares and of Merc-Safe from 1988 to 1991. Mr. Bourne has been Executive Vice President of Mercshares since 1989 and was elected Treasurer in February, 1994. He was a Senior Vice President of Merc- Safe from 1981 until March, 1994 when he was elected an Executive Vice President. Mr. Mohler was elected an Executive Vice President of Mercshares in March, 1994. He was a Senior Vice President of Merc-Safe from March, 1994 until September, 1994 when he was elected an Executive Vice President. He was President and Chief Executive Officer of Peninsula from 1978 until February, 1994.\nMr. Wilson was elected an Executive Vice President of Mercshares and Merc-Safe in September, 1994. He was a consultant to U. S. Can Corporation from January, 1994 until September, 1994 and President and Chief Executive Officer of Steeltin Can Corporation from 1978 until January, 1994. Mr. Wilson served as a Director of Mercshares and Merc-Safe from 1989 until September, 1994. Mr. Topping has been Vice President of Mercshares since 1988. He has served as a Vice Chairman of the Board of Merc-Safe since 1984. Mr. O'Connor has been Secretary of Mercshares and Merc-Safe since 1971. He was Vice President of Merc-Safe from 1971 to 1978 when be became Senior Vice President. He was a Vice President of Mercshares from 1986 until 1989 when he became a Senior Vice President. He has been General Counsel for Mercshares and Merc-Safe since 1970. Mr. Johnson has been Senior Vice President of Mercshares since 1989. He has been a Vice President of Merc-Safe since 1982. Mr. Talbott has been a Senior Vice President of Mercshares since 1989. He has been a Vice President of Merc-Safe since 1977.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required by this Item 5 is incorporated by reference to the information appearing under the captions \"Dividends\" on page 18 and \"Recent Common Stock Prices\" on page 19 of the Registrant's Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this Item 6 is incorporated by reference to the information appearing under the caption \"Five Year Selected Financial Data\" on page 40 of the Registrant'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 OPERATION\nThe information required by this Item 7 is incorporated by reference to the information appearing under the caption \"Management's Discussion\" on pages 4 to 19 of the Registrant'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 The information required by this Item 8 and the auditor's report thereon are incorporated by reference to pages 19 to 37 of the Registrant'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 DISCLOSURE\nThere was no matter which is required to be disclosed in this Item 9 pursuant to the instructions contained in the form for this report.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item 10 with respect to the Executive Officers of Registrant appears in Part I of this Report. The remaining information required by this Item 10 is incorporated by reference to the definitive proxy statement of Registrant filed with the Securities and Exchange Commission under Regulation 14A.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is incorporated by reference to the definitive proxy statement of Registrant filed with the Securities and Exchange Commission under Regulation 14A.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item 12 is incorporated by reference to the definitive proxy statement of Registrant filed with the Securities and Exchange Commission under Regulation 14A.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item 13, is incorporated by reference to the definitive proxy statement of Registrant filed with the Securities and Exchange Commission under Regulation 14A.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report, except as indicated. (1) (2) The financial statements and schedules filed herewith or incorporated by reference are listed in the accompanying Index to Financial Statements. (3) Exhibits filed herewith or incorporated by reference herein are set forth in the following table prepared in accordance with Item 601 of Regulation S-K. Exhibit Table (3) Charter and by-laws A. Charter of the Registrant (Exhibits 3-A(1) through 3-A(5) listed below are incorporated by reference to Exhibits 3- A(1) through 3-A(5) to Form S-1 of the Registrant, No. 2- 39545, Exhibit 3-A(6) listed below is incorporated by reference to Exhibit 3-A(6) of Form S-1 of the Registrant, No. 2-41379, Exhibit 3-A(7) listed below is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended 1993, Exhibit 3-A(7), Commission File No. 0-5127, Exhibit 3-A(8) listed below is incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended 1993, Exhibit 3-A(8), Commission File No. 0-5127, Exhibit 3-A(9) listed below is incorporated by reference to Exhibit B attached to Exhibit 4-A of Form 8-K of Registrant filed September 27, 1989, Commission File No. 0-5127, Exhibit 3-A(10) listed below is incorporated by reference to Exhibit B attached to Exhibit 4-A of Form 8-K of the Registrant filed January 9, 1990, Commission File No. 0-5127, and Exhibit 3-A(11) listed below is incorporated by reference to Exhibit 3-A(11) of the Annual Report on Form 10-K for the year ended\nDecember 31, 1990, Commission File No. 0-5127). (1) Articles of Incorporation effective May 27, 1969. (2) Articles of Amendment effective June 6, 1969. (3) Articles Supplementary effective August 28, 1970. (4) Articles of Amendment effective December 14, 1970. (5) Articles Supplementary effective May 10, 1971. (6) Articles Supplementary effective July 30, 1971. (7) Articles of Amendment effective May 8, 1986. (8) Articles of Amendment effective April 27, 1988. (9) Articles Supplementary effective September 13, 1989. (10) Articles Supplementary effective January 3, 1990. (11) Articles of Amendment effective April 26, 1990.\nB. By-Laws of the Registrant, as amended to date (filed herewith). (4) Instruments defining the rights of security holders, including indentures, Charter and by-laws: See Item 14(a)(3) above. A. Rights Agreement dated as of September 12, 1989 between Registrant and the Rights Agent, including Form of Rights Certificate and Articles Supplementary (Incorporated by reference to Form 8-K of the Registrant filed September 27, 1989, Exhibit 4-A, Commission File No. 0-5127). B. First Amendment, dated as of December 31, 1989, to Rights Agreement dated as of September 12, 1989 between Registrant and the Rights Agent, including amended Form of Rights Certificate and amended Form of Articles Supplementary (Incorporated by reference to Form 8-K of the Registrant filed January 9, 1990, Exhibit 4-A, Commission File No. 0-5127). C. Second Amendment, dated as of September 30, 1993, to Rights Agreement dated as of September 12, 1989 between Registrant and the Rights Agent, including amended Form of Rights Certificate (Incorporated by reference to Form 8-K of the Registrant filed September 30, 1993, Exhibit 4-A, Commission File No. 0-5127). D. Amendment No. 1 to Registrant's Registration Statement on Form 8-B, amending description of securities previously filed (Incorporated by reference to Form 8 filed December 20, 1991, Commission File No. 0-5127).\n(10) Material contracts - Each material contract listed herein is filed as a management contract or compensatory plan or arrangement, with the exception of Exhibits 10 B and 10 I. A. Mercantile Bankshares Corporation and Affiliates Annual Incentive Compensation Plan, as amended through March 14, 1995 (filed herewith). B. Dividend Reinvestment and Stock Purchase Plan of Mercantile Bankshares Corporation (Incorporated by reference to the Plan text included in the Form S-3 Registration No. 33- 44376.) C. Executive Employment Agreement dated March 24, 1982, between Mercantile Bankshares Corporation, Mercantile-Safe Deposit and Trust Company and H. Furlong Baldwin, as amended by Agreements dated March 13, 1984 and December 13, 1988 (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, Exhibit 10 D, Commission File No. 0-5127). D. Deferred Compensation Agreement, including supplemental pension and thrift plan arrangements, dated September 30, 1982, between Mercantile-Safe Deposit and Trust Company and H. Furlong Baldwin, as amended by Agreements dated as of October 24, 1983, March 13, 1984, January 1, 1987, December 8, 1987 and January 1, 1989 (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, Exhibit 10 E, Commission File No. 0-5127). E. Deferred Compensation Agreement, including supplemental pension and thrift plan arrangements, dated September 30, 1982, between Mercantile-Safe Deposit and Trust Company and Douglas W. Dodge, as amended by Agreements dated as of October 24, 1983, March 13, 1984, January 1, 1987, December 8, 1987 and January 1, 1989 (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, Exhibit 10 F,\nCommission File No. 0-5127). F. Mercantile Bankshares Corporation and Participating Affiliates Unfunded Deferred Compensation Plan for Directors, as amended through January 1, 1984 (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, Exhibit 10 G, Commission File No. 0-5127). G. Executive Employment Agreement dated March 13, 1984, between Mercantile Bankshares Corporation, Mercantile-Safe Deposit and Trust Company and Douglas W. Dodge, as amended by Agreement dated December 13, 1988 (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, Exhibit 10 I, Commission File No. 0-5127). H. Mercantile Bankshares Corporation 1985 Executive Stock Appreciation Rights Plan dated December 10, 1985 (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, Exhibit 10 K, Commission File No. 0-5127). I. Mercantile Bankshares Corporation Employee Stock Purchase Dividend Reinvestment Plan dated February 13, 1995 (filed herewith). J. Mercantile Bankshares Corporation 1985 Stock Option Plan, as amended, (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992, Exhibit 10 J, Commission File No. 0-5127). K. Deferred Compensation Agreement, including supplemental pension and thrift plan arrangements, dated September 30, 1982 between Mercantile-Safe Deposit and Trust Company and Brian B. Topping, as amended by Agreements dated as of October 24, 1983, March 13, 1984, January 1, 1987, December 8, 1987, and January 1, 1989 (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, Exhibit\n10 N, Commission File No. 0-5127). L. Executive Employment Agreement dated March 13, 1984 between Mercantile Bankshares Corporation, Mercantile-Safe Deposit and Trust Company and Brian B. Topping as restated September 13, 1988 and amended December 13, 1988 (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, Exhibit 10 L, Commission File No. 0-5127). M. Executive Employment Agreement dated December 13, 1988 between Mercantile Bankshares Corporation, Mercantile-Safe Deposit and Trust Company and Edward K. Dunn, Jr. (Incorporated by reference to Registrant's Annual Report on Form 10-K for year ended December 31, 1993, Exhibit 10 M, Commission File No. 0-5127). N. Executive Severance Agreements dated as of December 31, 1989 between Mercantile Bankshares Corporation and Mercantile-Safe Deposit and Trust Company, and each of H. Furlong Baldwin, Douglas W. Dodge, Edward K. Dunn, Jr., Brian B. Topping, and John A. O'Connor, Jr. (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, Exhibit 10 Q, Commission File No. 0-5127). O. Mercantile Bankshares Corporation Omnibus Stock Plan (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, Exhibit 10 O, Commission File No. 0-5127). P. Supplemental Pension Agreement dated January 10, 1992 between Mercantile Bankshares Corporation, Mercantile-Safe Deposit and Trust Company and Edward K. Dunn, Jr. (Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, Exhibit 10 P, Commission File No. 0-5127). Q. Supplemental Pension Agreement, dated February 10, 1995,\nbetween Mercantile Bankshares Corporation and Mercantile- Safe Deposit and Trust Company, Peninsula Bank and Hugh W. Mohler (filed herewith). R. Mercantile Bankshares Corporation and Participating Affiliates Supplemental Cash Balance Executive Retirement Plan, dated April 27, 1994, effective January 1, 1994 (filed herewith). S. Mercantile Bankshares Corporation and Participating Affiliates Supplemental 401(k) Executive Retirement Plan, dated December 13, 1994, effective January 1, 1995 (filed herewith). (13) Annual Report to security holders for the year ended December 31, 1994 (filed herewith). (22) Subsidiaries of the Registrant\nInformation as to subsidiaries of the Registrant (filed herewith)\n(24) Consent\nConsent of Certified Public Accountants (filed herewith)\n(25) Power of Attorney\nPower of Attorney dated March 14, 1995 (filed herewith)\n(b) No reports on Form 8-K were filed during the last quarter of the period covered by this Report.\nThe Report of Independent Certified Public Accountants as pertaining to the Consolidated Financial Statements of Mercantile Bankshares Corporation and Affiliates and related notes is incorporated by reference to page 19 of the Registrant's Annual Report to Stockholders for the year ended December 31, 1994.\nConsolidated Financial Statements and related notes are incorporated by reference to the Registrant's Annual Report to Stockholders for the year ended December 31, 1994, and may be found on the pages of said Report as indicated in parentheses:\nConsolidated Balance Sheets, December 31, 1994 and 1993 (page 20) Statement of Consolidated Income for the years ended December 31, 1994, 1993 and 1992 (page 21) Statement of Consolidated Cash Flows for the years ended December 31, 1994, 1993 and 1992 (pages 22 and 23) Statement of Changes in Consolidated Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992 (page 24) Notes to Consolidated Financial Statements (pages 25 to 37)\nSupplementary Data:\nQuarterly Results of Operations are incorporated by reference to the information appearing under the caption \"Quarterly Results of Operations\" on page 34 of the Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1994.\nFinancial Statement Schedules are omitted because of the absence of the conditions under which they are required or because the information called for is included in the Consolidated Financial Statements or notes thereto.\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. MERCANTILE BANKSHARES CORPORATION By: \/S\/ H. Furlong Baldwin March 28, 1995 H. Furlong Baldwin, Chairman of the Board and Chief Executive Officer\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: Principal Executive Officer\n\/S\/ H. Furlong Baldwin March 28, 1995 H. Furlong Baldwin, Chairman of the Board and Chief Executive Officer\nPrincipal Financial Officer\n\/S\/ Kenneth A. Bourne, Jr. March 28, 1995 Kenneth A. Bourne, Jr. Executive Vice President and Treasurer\nPrincipal Accounting Officer\n\/S\/ Jerry F. Graham March 28, 1995 Jerry F. Graham Vice President and Controller\nA majority of the Board of Directors: Douglas W. Dodge, Robert D. Kunisch, Christian H. Poindexter, William C. Richardson, Morris W. Offit, Brian B. Topping, George L. Bunting, Jr., Donald J. Shepard, James A. Block, Calman J. Zamoiski, Jr., Bishop L. Robinson, Thomas M. Bancroft, Jr., B. Larry Jenkins, Richard O. Berndt, William J. McCarthy.\nBy: \/S\/ H. Furlong Baldwin March 28, 1995 H. Furlong Baldwin For Himself and as Attorney-in-Fact","section_15":""}
{"filename":"718077_1994.txt","cik":"718077","year":"1994","section_1":"Item 1. Business\nPeoples First Corporation (the \"Company\") is a multi-bank and unitary savings and loan holding company registered with the Board of Governors of the Federal Reserve System (\"Federal Reserve Board\") pursuant to Section 5(a) of the Bank Holding Company Act of 1956, as amended. In recent years, the Company has been on of the ten largest independent financial institutions headquartered in Kentucky. The Company conducts a complete range of commercial and personal banking activities in Western Kentucky through three wholly owned subsidiaries: The Peoples First National Bank & Trust Company of Paducah in McCracken, Marshall, Ballard, Livingston and Calloway Counties; First Kentucky Federal Savings Bank of Central City in Muhlenberg, Ohio, McLean and Butler Counties; and Liberty Bank & Trust of Mayfield in Graves County (together, the \"Banks\"). Peoples First Corporation's principal executive offices are located at 100 South Fourth Street, Paducah, Kentucky 42002-2200.\nThe Company is a Kentucky Corporation incorporated on March 1, 1983. The Company became a bank holding company when it acquired Peoples First National Bank & Trust Company (\"Peoples Bank\") in 1983. The Company acquired (and subsequently merged into Peoples Bank during 1994) First Liberty Bank in 1985, First National Bank of LaCenter in 1987 Salem Bank, Inc. in 1989 and Bank of Murray in 1992.\nDuring 1994, the Company consummated the acquisition of Libsab Bancorp, Inc. (Libsab) and Liberty Bank and Trust, a wholly-owned subsidiary of Libsab. The Company acquired all of the outstanding shares of Libsab in exchange for 1,077,853 shares of Peoples First Corporation common stock. Libsab's three locations are part of the market area served by the Company's other subsidiary banks. Also during 1994, the Company consummated the acquisition of First Kentucky Bancorp, Inc. and First Kentucky Federal Savings Bank (First Kentucky FSB), a wholly-owned subsidiary of First Kentucky. The Company acquired all of the outstanding shares of First Kentucky Bancorp, Inc. in exchange for 929,794 shares of Peoples First Corporation common stock. First Kentucky FSB's six locations are immediately east of the market area served by the Company's other subsidiary banks.\nDividends from the banks are the principal source of cash income for the Company. Legal limitations are imposed on the amount of dividends that may be paid by the individual banks. Although the Company may engage in other activities, subject to rules and regulations of the Federal Reserve Board and Kentucky Department of Financial Institutions, it is currently expected that the banks will remain the principal source of operating revenues.\nPeoples Bank, organized in 1926, provides a full range of banking services to the Western Kentucky region through its main office in Paducah, Kentucky and twelve full service branch offices, three limited service branch offices and one business operations office. Commercial lending services provided to medium-size and small businesses, real estate mortgage lending and individual consumer lending services are the primary sources of operating revenues. Peoples Bank had total deposits of $726.6 million at December 31, 1994 and is the first or\nsecond largest commercial banking operation in each of the five counties it operates. At December 31, 1994, Peoples Bank had 395 full-time equivalent employees.\nFirst Kentucky FSB, organized in 1934, provides a broad array of banking services to the Western Kentucky region through its main office in Central City, Kentucky and five branch offices. Residential real estate mortgage lending is the primary source of operating income. First Kentucky FSB had total deposits of $151.7 million at December 31, 1994 and is largest financial institution headquartered in their immediate West-Central Kentucky market area. At December 31, 1994, First Kentucky FSB had 64 full-time employees.\nLiberty Bank, organized in 1956, provides a full range of banking services to the Graves County Kentucky area through its main office in Mayfield, Kentucky and two branch offices. Residential real estate mortgage lending as well as other customary banking services are the primary sources of operating income. Liberty Bank had total deposits of $120.9 million at December 31, 1994 and is largest financial institution headquartered in Graves County Kentucky. At December 31, 1994, Liberty Bank had 70 full-time employees.\nManagement considers employee relations to be good with all of the bank employees, none of which are covered by a collective bargining agreement.\nCompetition\nThe Banks actively compete on local and regional levels with other commercial banks and financial institutions for all types of deposits, loans, trust accounts and the provision of financial and other services. With respect to certain banking services, the Banks compete with insurance companies, savings and loan associations, credit unions and other financial institutions. Many of the Banks' competitors are not commercial banks or savings and loan associations. For example, the Banks compete for funds with money market mutual funds, brokerage houses, and governmental and private issuers of money market instruments. The Banks also compete for loans with other financial institutions and private concerns providing financial services. These include finance companies, credit unions, certain governmental agencies and merchants who extend their own credit selling to consumers and other customers. Many of the banks, financial institutions and other interests with which the Banks compete have capital resources substantially in excess of the capital and resources of the Banks.\nSupervision and Regulation\nThe Registrant is a bank holding company within the meaning of the Bank Holding Company Act. As such, it is registered with the Federal Reserve Board (FRB) and files reports with and is subject to examination by that body.\nPeoples Bank, chartered under the National Bank Act, is subject to the supervi- sion of and is regularly examined by the Comptroller of the Currency of the United States. By law, Peoples Bank is a member of the Federal Reserve System and insured members of the Federal Deposit Insurance Corporation (FDIC). As such, they are subject to regulation by these federal agencies.\nLiberty Bank, chartered under the Commonwealth of Kentucky, is subject to the supervision of and is regularly examined by the Kentucky Department of Financial Institutions. They are insured members of the FDIC, and, as such, are subject to regulation and examined by that federal agency.\nFirst Kentucky FSB, as a federally chartered savings association, is subject to the supervision of and is regularly examined by Office of Thrift Supervision. They are subject to certain reserve requirements of the FRB and are insured members of the Savings Association Insurance Fund of the FDIC, and, as such, are subject to regulation and examined by these federal agencies.\nGovernmental Monetary Policies and Economic Growth\nThe continuing volatile conditions in the national economy and in the money markets, together with the effects of actions by monetary and fiscal authorities in recent years, make it exceedingly difficult to predict with any reasonable accuracy the possible future changes in interest rates and their effect on deposit levels, loan demand and the business and earnings of the Registrant and its subsidiaries.\nStatistical Disclosures\nI. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential\nA. AVERAGE BALANCE SHEETS For the Year Ended December 31, (in thousands) 1994 1993 1992 _______________________________________________________________________________\nINTEREST-EARNING ASSETS Short-term investments $3,831 $10,579 $18,509 Taxable debt securities 278,165 313,315 297,266 Non-taxable debt securities 69,731 71,001 60,642 Loans (1) 755,314 660,345 568,477 --------- --------- --------- 1,107,041 1,055,240 944,894 NONINTEREST-EARNING ASSETS Cash and due from banks 34,878 33,974 30,799 Allowance for loan losses (11,524) (9,827) (7,693) Other assets 47,877 47,088 40,107 --------- --------- --------- $1,178,272 $1,126,475 $1,008,107 ========= ========= =========\nINTEREST-BEARING LIABILITIES Transaction accounts $235,918 $228,146 $197,566 Saving deposits 106,891 105,191 83,008 Time deposits 567,438 555,689 535,314 Short-term borrowings 51,454 31,761 24,174 Long-term borrowings 13,679 17,956 9,524 Other liabilities 1,201 944 776 --------- --------- --------- 976,581 939,687 850,362\nNONINTEREST-BEARING LIABILITIES Demand deposits 85,307 78,178 63,523 Other liabilities 8,391 9,471 11,278\nSTOCKHOLDERS' EQUITY 107,993 99,139 82,944 --------- --------- --------- $1,178,272 $1,126,475 $1,008,107 ========= ========= =========\n(1) Nonperforming loans are included in average loans\nB. ANALYSIS OF NET INTEREST EARNINGS For the Year Ended December 31, (in thousands) 1994 1993 1992 _______________________________________________________________________________\nINTEREST INCOME Short-term investments $169 $335 $781 Taxable securities 17,017 19,652 21,484 Non-taxable securities (TE) (2) 6,302 6,487 5,692 Loans 62,929 56,592 53,887 ------ ------ ------ 86,417 83,066 81,844\nINTEREST EXPENSE Transaction accounts 6,970 5,854 5,834 Saving deposits 3,194 3,980 4,412 Time deposits 25,547 25,926 30,888 Short-term borrowings 2,168 1,026 946 Long-term borrowings 900 1,151 668 Other liabilities 76 60 20 ------ ------ ------ 38,855 37,997 42,768 ------ ------ ------ NET INTEREST INCOME (TE) (2) 47,562 45,069 39,076 TE Basis Adjustment (2,080) (2,161) (1,878) ------ ------ ------ NET INTEREST EARNINGS $45,482 $42,908 $37,198 ====== ====== ======\n(2) Tax equivalent (TE) interest income is based upon a Federal income tax rate of 35%.\nB. AVERAGE YIELDS AND RATES PAID For the Year Ended December 31, 1994 1993 1992 _______________________________________________________________________________\nAVERAGE YIELDS FOR INTEREST-EARNING ASSETS Short-term investments 4.41% 3.17% 4.22% Taxable securities 6.12% 6.27% 7.23% Non-taxable securities (TE) (2) 9.04% 9.14% 9.39% Loans (1) 8.33% 8.57% 9.48% All interest-earning assets 7.81% 7.87% 8.66%\nAVERAGE RATES FOR INTEREST-BEARING LIABILITIES Transaction accounts 2.95% 2.57% 2.95% Saving deposits 2.99% 3.78% 5.32% Time deposits 4.50% 4.67% 5.77% Short-term borrowings 4.21% 3.23% 3.91% Long-term borrowings 6.58% 6.41% 7.01% Other liabilities 6.33% 6.36% 2.58% All interest-bearing liabilities 3.98% 4.04% 5.03% ---- ---- ---- NET INTEREST-RATE SPREAD (TE) (2) 3.83% 3.83% 3.63% ==== ==== ====\nNET YIELD ON INTEREST-EARNING ASSETS 4.30% 4.27% 4.14% ==== ==== ====\n(1) Nonperforming loans are included in average loans (2) Tax equivalent (TE) interest income is based upon a Federal income tax rate of 35%.\nC. FOR THE LAST TWO FISCAL YEARS\nCHANGES ATTRIBUTABLE TO VOLUME AND RATE Change Due to Due to (in thousands) 1994\/1993 Volume Rate (3) _______________________________________________________________________________\nINTEREST INCOME Short-term investments ($166) ($214) $48 Taxable securities (2,635) (2,205) (430) Non-taxable securities (TE) (2) (185) (116) (69) Loans (1) 6,337 8,139 (1,802) ------ 3,351 4,078 (727) INTEREST EXPENSE Transaction accounts 1,116 199 917 Saving deposits (786) 64 (850) Time deposits (379) 548 (927) Short-term borrowings 1,142 636 506 Long-term borrowings (251) (274) 23 Other liabilities 16 16 (0) ------ 858 1,492 (634) ------ ------ ------ NET INTEREST INCOME (TE) (2) $2,493 $2,586 ($93) ====== ====== ======\n(1) Nonperforming loans are included in average loans. (2) Tax equivalent (TE) net interest income is based upon a Federal income tax rate of 35%. (3) Changes due to both rate and volume are included in due to rate.\nCHANGES ATTRIBUTABLE TO VOLUME AND RATE Change Due to Due to (in thousands) 1993\/1992 Volume Rate (3) _______________________________________________________________________________\nINTEREST INCOME Short-term investments ($446) ($335) ($111) Taxable securities (1,832) 1,160 (2,992) Non-taxable securities (TE) (2) 795 972 (177) Loans (1) 2,705 8,708 (6,003) ------ 1,222 9,558 (8,336)\nINTEREST EXPENSE Transaction accounts 20 903 (883) Saving deposits (432) 1,179 (1,611) Time deposits (4,962) 1,176 (6,138) Short-term borrowings 80 297 (217) Long-term borrowings 483 591 (108) Other liabilities 40 4 36 ------ (4,771) 4,493 (9,264) ------ ------ ------ NET INTEREST INCOME (TE) (2) $5,993 $5,065 $928 ====== ====== ======\n(1) Nonperforming loans are included in average loans. (2) Tax equivalent (TE) net interest income is based upon a Federal income tax rate of 35%. (3) Changes due to both rate and volume are included in due to rate.\nII. Debt Security Portfolios\nA. Footnote 4 to the Consolidated Financial Statements included herein on page 41 presents the book value as of the end of 1994 and 1993 of debt securities by type of security.\nB. Footnote 4 to the Consolidated Financial Statements included herein on page 42 presents the amortized cost, estimated market value and the weighted average yield of debt securities at December 31, 1994, by contractual maturity range.\nC. As of December 31, 1994, the Company owned no securities (other than U. S. Government and U. S. Government agencies and corporations) issued by one issuer for which the book value exceeded ten percent of stockholders' equity.\nIII. Loan Portfolio\nA. The table of Types of Loans in Management's Discussion and Analysis of Financial Condition and Results of Operations (MDA) included herein on page 20 presents the amount of all loans in various categories as of the end of 1994 and 1993.\nB. The following table presents the maturities in the loan portfolio, excluding commercial paper, real estate mortgage, installment, consumer revolving credit and other loans at December 31, 1994:\nLoan Portfolio Maturities 1 year 1 to 5 Over December 31, 1994 or less years 5 years Total _______________________________________________________________________________ (in thousands)\nCommercial, financial and agricultural $58,251 $24,607 $29,071 $111,929 Real estate construction 17,529 556 1,336 19,421 ------- ------- ------- ------- $75,780 $25,163 $30,407 $131,350 ======= ======= ======= =======\nThe amounts of these loans due after one year which have predetermined rates and adjustable rates are $4.8 million and $50.8 million, respectively.\nC. Risk Elements\n1. The table of Nonperforming Assets in MDA included herein on page 22 states the amount of nonaccrual, past due and restructured loans. The following table states the gross interest income that would have been recorded for the years ended December 31, 1990 through 1994, if the nonaccrual and renegotiated loans had been current in accordance with their original terms, and the amount of interest income that was included in net income for each year:\n2. Potential Problem Loans\nInternal credit review procedures are designed to alert management of possible credit problems which would create serious doubts as to the future ability of borrowers to comply with loan repayment terms. At December 31, 1994, loans with a total principal balance of $14.8 million had been identified that may become nonperforming in the future, compared to $22.4 million at December 31, 1993. Potential problem loans are not included in nonperforming assets since the borrowers currently meet all applicable loan agreement terms. The identified potential problem loan totals consist of many different loans and are generally loans for which the collateral appears to be sufficient but that have potential financial weakness evidenced by internal credit review's analysis of historical financial information. At December 31, 1994, a total of $5.2 million of potential problem loans were to three borrowers.\n3. Foreign Outstandings\nThere were no foreign outstandings at anytime during the last three years.\n4. Loan Concentrations\nAs of December 31, 1994, there was no concentration of loans exceeding 10% of total loans which are not otherwise disclosed in the Types of Loans table pursuant to III. A. There were no amounts loaned in excess of 10% of total loans to a multiple of borrowers engaged in similar activities which would cause them to be similarly impacted by economic or other conditions. Most loans are originated in the immediate market area of the Banks.\nD. Other Interest Bearing Assets\nThe Company has no other interest earning assets that would be required to be disclosed under Item III. C.1. or 2. if such assets were loans.\nIV. SUMMARY OF LOAN LOSS EXPERIENCE\nA. The following table presents an analysis of loss experience and the allow- ance for loan losses for the years ended December 31, 1994, 1993, 1992, 1991 and 1990:\nB. The following tables present a breakdown of the allowance for loan losses at December 31, 1994, 1993, 1992, 1991 and 1990:\nV. DEPOSITS\nA.B. Average Balances and Rates Paid by Deposit\nThe Average Balance Sheets table and Average Yields and Rates Paid table in- cluded herein on pages 6 and 8 present the average amount of and the average rate paid for the years ended December 31, 1994, 1993 and 1992.\nC. Foreign Deposits\nThe Company had no foreign deposits during the past three years.\nD.E. Maturity Distribution of Time Deposits of $100,000 or More\nThe following table states the amount of time certificates of deposit at December 31, 1994, of $100,000 or more by maturity:\nMaturity of $100,000 Time Deposits December 31, 1994 _______________________________________________________________________________ (in thousands)\nMaturing 3 months or less $27,032 Maturing over 3 months through 6 months 14,991 Maturing over 6 months through 12 months 38,113 Maturing over 12 months 3,461 ------ $83,597 ======\nFor the Year Ended December 31, VI. RETURN ON EQUITY AND ASSETS 1994 1993 1992 _______________________________________________________________________________\n1. Return on average assets 1.11% 1.14% 1.04% 2. Return on average equity 12.15% 12.92% 12.67% 3. Dividend payout ratio 28.85% 26.32% 26.47% 4. Equity to assets ratio 9.17% 8.80% 8.23%\nVII. SHORT-TERM BORROWINGS\nA. Footnote 7 to the Consolidated Financial Statements included herein on page 46 presents for each category of short-term borrowings, the amounts outstanding at the end of the reported periods, the weighted average interest rate, the maiximum amount of borrowings in each catergory at any month-end and the approximate weighted interest rate.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's investments in premises and equipment are comprised of properties owned and leased by the Banks. Peoples Bank owns the building housing its main offices, which contains 17,325 square feet of space and is located at 401 Kentucky Avenue. Peoples Bank also owns its Service Center, located at 100 South Fourth Street, which contains 50,000 square feet of space and houses the Company's executive offices. Of the twenty-four other banking offices of the Banks, twenty-one are owned and three are leased by their respective Banks.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS - None\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 STOCK AND RELATED SHAREHOLDER MATTERS\nMarket Information, Dividends The registrant's only class of common stock is traded on the National Associa- tion of Securities Dealers Automated Quotation System National Market System. Peoples First Corporation's common stock symbol is \"PFKY\". The high and low stock prices and the quarterly dividends declared on the Company's common stock for each quarter of 1994 and 1993 are as follows:\nHigh and Low Stock Prices First Second Third Fourth Dividends Declared quarter quarter quarter quarter _______________________________________________________________________________\nHigh 1994 $28.50 $25.50 $24.50 $21.75 Low 1994 23.50 22.00 21.00 16.25 Dividends declared 0.105 0.105 0.120 0.120\nHigh 1993 $16.50 $16.88 $20.00 $25.50 Low 1993 16.00 16.00 16.63 19.25 Dividends declared 0.095 0.095 0.105 0.105\nHolders The approximate number of holders of registrant's only class of common stock as of February 16, 1995, was 2,418.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nShares outstanding and per share amounts have been adjusted for a two-for-one stock split on January 4, 1994.\nAs more fully explained in Footnote 2. to the consolidated financial statements, additional banking organizations were acquired in 1994 and 1992.\nEarnings of First Kentucky Federal Savings Bank are excluded from the net income per common share calculation prior to June 18, 1991, the date of their initial public offering of common stock.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe purpose of this discussion and analysis is to provide annual report readers with information relevant to understanding and assessing the financial condition and results of operations of Peoples First Corporation (Company). Headquartered in Paducah, Kentucky, the Company is a multi-bank and unitary savings and loan holding company registered with the Federal Reserve Board. The Company's market area is primarily western Kentucky and the contiguous interstate area. This discussion should be read in conjunction with the consolidated financial state- ments and accompanying notes.\nThe following table provides certain information regarding the Company's three banking subsidiaries as of December 31, 1994:\nYear Subsidiary acquired Assets Loans Deposits _______________________________________________________________________________ (in thousands)\nPeoples First National Bank 1983 $890,430 $634,498 $726,582 Liberty Bank & Trust 1994 143,479 81,585 120,895 First Kentucky Federal Savings Bank 1994 173,556 89,863 151,722\nThe above amounts do not total to consolidated amounts due to eliminating entries and parent company amounts.\nEARNING ASSETS Average earning assets of the Company for 1994, increased 4.9%, or $51.8 million to $1,107.0 million from $1,055.2 million for 1993. This compares to growth of earning assets, excluding the purchase of three branch bank locations in 1992, of 3.4% and 5.9%, respectively, for 1993 and 1992, over respective previous years. Strong loan growth during the last three years has been partially funded with reductions in debt securities, the other significant earning asset category. The Company maintains a consistently favorable ratio of average earning assets to average total assets. The ratio was 94.0% for 1994, compared to 93.7% and 93.5% for 1993 and 1992, respectively.\nLoans are the Company's primary earning asset. Management has focused on in- creasing residential real estate and consumer lending activities and loan demand has been strong. Loans, net of unearned income, increased $101.9 million during 1994, compared to $78.8 million and $26.7 million increases during 1993 and 1992 over respective prior years excluding the initial effect of the 1992 purchase of three branch bank locations. Internal average loan growth for 1994 was 14.4%, up from an 8.6% increase in average loans for 1993 from 1992, and compared to a 3.9% increase in average loans for 1992 from 1991. Average loans for 1994 were 68.2% of total average earning assets, compared to 62.6% and 60.1% during 1993 and 1992, respectively. Prior to 1993, loans had been a decreasing portion of earning assets. Management attributes the reversal of the declining loan composition trend to their focus on improving the earning asset\ncomposition, strong loan demand and a slowed growth of deposits. The potential mix of earning assets will be significantly impacted by the acquisition of additional financial institutions and future loan demand levels.\nThe Company primarily directs lending activities to its regional market from which deposits are drawn. Management has focused on secured lending and the growth of real estate mortgage and consumer loans during the last three years.\nA portion of the proceeds from the sale and maturity of debt securities and the principal collected on mortgage-backed securities was used to fund high loan demand. Debt securities decreased $43.7 million during 1994 and $20.8 million during 1993. The Company maintains a portfolio of debt securities held for sale as a partial source of available funding for loan growth.\nFUNDING Average deposits, which management relies on as a stable source of funding, of the Company for 1994 increased 2.9%, or $28.4 million to $995.6 million from $967.2 million for 1993. Internal growth from local area deposits was 1.5% for 1994 compared to average local deposit growth of 1.1% and 3.6% for 1993 and 1992, over respective previous year periods. Highly competitive local markets for deposits exist and low interest rates do not benefit internal funding efforts. During recent periods of low core deposit growth, management has partially relied on brokered deposits, Federal funds purchased and other short-term borrowings to fund loan growth. Brokered deposits amounted to $21.4 million, $19.2 million and $0.0 million at December 31, 1994, 1993 and 1992, respectively. Average Federal funds purchased were $21.2 million for 1994, up from $11.0 million for 1993 and $0.3 million for 1992. Average short-term borrowings were $51.5 million for 1994, up from $31.8 million for 1993 and $24.3 million for 1992.\nManagement anticipates an increasing need to rely on more volatile purchased liabilities. The Company's subsidiaries have obtained various short-term and long-term advances from the Federal Home Loan Bank (FHLB) under Blanket\nAgreements for Advances and Security Agreements (Agreements). The Agreements entitle the banks to borrow additional funds from the FHLB to fund mortgage loan programs and satisfy other funding needs.\nNONPERFORMING ASSETS AND RISK ELEMENTS The level of nonperforming assets at December 31, 1994 has improved since December 31, 1993. Diversification within the loan portfolio is an important means of reducing inherent lending risks. At December 31, 1994, the Company had no concentrations of ten percent or more of total loans in any single industry nor any geographical area outside of the Paducah, Kentucky, western Kentucky region, the immediate market area of the subsidiary banks.\nThe Company discontinues the accrual of interest on loans which become ninety days past due as to principal or interest, unless the loans are adequately secured and in the process of collection. Other real estate owned is carried at the lower of cost or fair value. A loan is classified as a renegotiated loan when the interest rate is materially reduced or the term is extended beyond the original maturity date because of the inability of the borrower to service the debt under the original terms.\nManagement continues to exert efforts to monitor and minimize nonperforming assets and to maintain aggressive charge-off practices, even though the nonperforming totals are significantly lower than peer bank holding company ratios. Significant focus on underwriting standards is maintained by management and the subsidiary bank boards.\nInternal credit review procedures are designed to alert management of possible credit problems which would create serious doubts as to the future ability of borrowers to comply with loan repayment terms. At December 31, 1994, loans with a total principal balance of $14.8 million have been identified that may become nonperforming in the future, compared to $22.4 million at December 31, 1993. Performance of borrowers has previously been aided by lower interest carrying costs. Potential problem loans are not included in nonperforming assets since the borrowers currently meet all applicable loan agreement terms.\nNonperforming assets at December 31, 1994 were 0.60% of total loans and other real estate, down from 0.86% at December 31, 1993. A small number of loans and one tract of undeveloped land in Nashville, Tennessee, represent most of the nonperforming balance for the last three years.\nCAPITAL RESOURCES AND DIVIDENDS The current economic and regulatory environment places increased emphasis on capital strength. Stockholders' equity was 9.1% of assets at December 31, 1994, a decrease of 0.1% from December 31, 1993. Stockholders' equity increased $3.9 million, or 3.7%, during 1994, and increased $12.7 million, or 13.6%, during 1993. The earnings retention rate has been decreased by the board of directors and was 71.2% for 1994 and 73.7% for 1993. Proceeds from the sale of common stock through shareholder and employee plans amounted to $1.0 million in 1994 and $1.2 million in 1993. Unrealized gain or loss on securities held for sale, net of applicable income taxes, are recorded directly to stockholders' equity. For 1994 stockholders' equity was reduced by $6.5 million and for 1993 was increased by $1.9 million to record the change in the fair value of securities held for sale during the year.\nThe quarterly dividend was raised to $0.105 per share in the third quarter of 1993 and to $0.120 per share in the third quarter of 1994. Similar, if not greater, increases are expected for the next few years. The board of directors develops and reviews the capital goals of the consolidated entity and each of the subsidiary banks. The Company's dividend policy is designed to retain sufficient amounts for healthy financial ratios, considering future planned asset growth and other prudent financial management principles. Subsidiary bank dividends are the principal source of funds for the Company's payment of dividends to its stockholders. At December 31, 1994, approximately $19.2 million in retained earnings of subsidiary banks was available for dividend payments to the Company without regulatory approval or without reducing capital of the respective banks below minimum standards.\nBank regulatory agencies' minimum capital guidelines assign relative measures of credit risk to balance sheet assets and off-balance sheet exposures. Based upon\nthe nature and makeup of their current businesses and growth expectations, management expects all of the reporting entities' capital ratios to continue to exceed regulatory minimums. At December 31, 1994 and 1993, the Company and the subsidiary banks' capital ratios were as follows:\nRESULTS OF OPERATIONS Net income in 1994 reached a record level, increasing 2.5% and totaling $13.1 million, compared to an increase of 21.9% in 1993 when net income totaled $12.8 million. Net income per common share and common share equivalent for the year ended December 31, 1994 increased 2.6% to $1.56, from $1.52 for the year ended December 31, 1993, compared to $1.36 for the year ended December 31, 1992. Net income per common share and common share equivalent for the fourth quarter of 1994 increased 10.8% to $0.41 from $0.37 for the fourth quarter of 1993, principally due to a greater volume of earning assets and decreased provision for loan losses.\nReturn on average stockholders' equity for the years ended December 31, 1994, 1993 and 1992 was 12.15%, 12.92% and 12.67%, respectively. Return on average assets for the year ended 1994, 1993 and 1992 was 1.11%, 1.14% and 1.04%, respectively. Earnings performance for 1994 was negatively impacted by costs of approximately $0.07 per share related to two acquisitions completed during the year.\nNET INTEREST INCOME The amount by which interest earned on assets exceeds the interest paid on sup- porting funds, constitutes the primary source of income for the Company. For the year ended December 31, 1994, net interest income (TE) increased 5.5%, or $2.5 million to $47.6 million compared to $45.1 million for 1993. The 1994 increase is substantially all attributable to growth of average earning assets as the interest margin increased only three basis points. Average earning asset growth accounted for all but approximately 15% of the increased net interest income for the year ended December 31, 1993 over 1992. Net interest income on a tax-equivalent basis as a percent of average earning assets has improved slightly and was 4.30%, 4.27% and 4.14% for the years ended December 31, 1994, 1993 and 1992, respectively. Margins in 1993 and 1992, to a greater degree than 1994, were unfavorably affected by the purchase accounting recognition of interest income on certain debt securities at market yields. Net interest income margins continue to benefit from a favorable mix of earning assets and a funding sources.\nAlthough the subsidiary banks generally maintain a relatively balanced position between volumes of rate-repricing assets and liabilities to guard against adverse effects to net interest income from possible fluctuations in interest rates, net interest income was unfavorably affected in 1994 by interest rate caps on a significant portion of residential mortgage loans originated with low rates that have repriced less quickly than the average liability funding rate during the recent rapidly increasing interest-rate environment. Low levels of nonperforming loans favorably contributed to margins each period.\nPROVISION FOR LOAN LOSSES A significant factor in the Company's past and future operating results is the level of the provision for loan losses. Management desires to provide assurance through sufficient provision for loan losses that future earnings will be less susceptible to changing economic cycles. The provision for loan losses amounted to $1.7 million for 1994, a decrease of $0.8 million or 32.0% compared to $2.5 million in 1993, which was a decrease of $0.7 million or 21.9% compared to $3.2 million in 1992. The declines in the 1994 and 1993 provisions for loan losses were influenced by significant declines in net charge-offs and modest declines in nonperforming assets. The provision for loan losses as a percentage of average loans was 0.23% for the year ended December 31, 1994, down from 0.38% and 0.57% for the years ended December 31, 1993 and 1992, respectively. Levels of providing for loan losses reflect, among other things, management's evalua- tion of potential problem loans, which are currently at lower levels than in much of the past five years.\nNet chargeoffs as a percentage of average loans were 0.03% for 1994, down from 0.07% for 1993, periods of unusually low net chargeoffs, and 0.45% for 1992. Net chargeoffs as a percent of average loans were 0.23% for the five-year period ended December 31, 1994. The allowance for loan losses was 1.51% of outstanding loans at December 31, 1994, compared 1.52% of outstanding loans at December 31, 1993. The December 31, 1994 allowance is 252% compared to 176% at December 31, 1993, of nonperforming assets and is maintained at a level which management considers adequate to absorb estimated potential losses in the loan portfolio, after reviewing the individual loans and in relation to risk elements in the portfolios and giving consideration to the prevailing economy and anticipated changes.\nNONINTEREST INCOME Noninterest income amounted to $7.2 million in 1994, an 8.2% increase from $6.6 million in 1993. Excluding net securities gains, the increase was 10.9%. Service charges on deposit accounts, the largest component of noninterest income, increased 11.2% in 1994 over 1993. During the past two years, some of the subsidiary banks adjusted fee schedules to recapture higher operating costs and to provide more uniform pricing among the affiliated banks.\nNet gains of $62,309 were recognized in 1994 on $11.9 million of debt securities held for sale and net gains of $230,642 were recognized on $21.9 million of debt securities sold during 1993. Debt securities, primarily mortgage-backed securities, were sold to reduce, to the extent possible, the Company's interest rate sensitivity on assets in response to changing interest rates and prepayment risks as a part of the Company's asset\/liability strategies.\nTrust department fees for the last three years, without the effects of the additional locations purchased in 1992, have been relatively the same. There has been little growth in average assets managed. Trust fees, which are recognized on a cash basis, are usually greater in the fourth quarter than other quarters of the year because of billing cycles. The 48.2% increase in insurance commissions for 1994 over 1993 is attributable to greater opportunities resulting from the significant increase in consumer loans as well as better penetration of this product to customers. As expected, fee income from secondary-market mortgage loan services during 1994 was lower than 1993 due to the unusually large amount of home refinancing in 1993. The Company made available two new financial services during 1994 to bank customers. Fees from newly available investment brokerage services and property and casualty insurance products, which will be higher in 1995, were not significant in 1994. The relative improvement in fee income is slightly more than the growth in net interest income. Management expects this trend to continue into 1995. Noninterest income excluding securities gains was 13.9% of total net interest income plus noninterest income for 1994, compared to 13.0% for both 1993 and 1992.\nNONINTEREST EXPENSE The ratio of noninterest expense as a percent of average assets has been steadily rising, and was 2.74% for 1994, 2.61% for 1993 and 2.57% for 1992. It is requiring more noninterest expense (overhead) to produce total net interest income plus noninterest income exclusive of net securities gains (revenue). The ratio of overhead to revenue was 61.5% for 1994, compared to 59.6% for 1993 and 60.5% for 1992. Since internal asset growth has slowed, management continues to focus on controlling the rate of increase of noninterest expense by reconfigur- ing certain functions to gain more employee productivity and consolidating some operational tasks of the various banks. Based upon an analysis of operations, the Company consolidated five of the previously separate corporate subsidiaries into one bank during the fourth quarter of 1994 to allow the personnel at all locations to better focus on consistent quality customer service, increasing the volume of business and to reduce a small amount of redundant costs.\nThe ratio of personnel expense has been relatively constant as a percentage of average total assets and was 1.26% for 1994, compared to 1.24% and 1.20%, re- spectively, for 1993 and 1992. The Company has made investments in facilities and equipment of approximately $5 million during the last three years as tech- nology has advanced and the need to leverage personnel costs has intensified. Occupancy expense increased an average of 5.5% per year for 1994 and 1993. One new branch was opened during 1994 and investments in two new branches are expected for 1995. The 1993 increase in occupancy expense was related to the additional bank locations purchased in 1992. Equipment expense increased an average of 19.2% per year for 1994 and 1993 due to depreciation and maintenance of new equipment. Depreciation is computed using the straight-line method over the estimated useful lives of the assets which range from two to ten years for equipment. Much of the recent years' equipment purchases are electronic and technology sensitive items which the Company depreciates over five year or less periods.\nIncreased data processing expense is attributable to a greater volume of activ- ity, the outsourcing of a portion of some functions in 1993, one-time system conversion costs and the additional bank locations purchased in 1992. More than one-half of 1994 and 1993's average annual increase of 14.4% is due to nonrecur- ring conversion costs and to the additional bank locations. The Company's bank subsidiaries are required to pay deposit insurance assessments to the FDIC, to maintain significant noninterest-bearing balances with the Federal Reserve, and to pay fees to regulatory agencies for periodic examinations by the agencies. Assessments for deposit insurance were $2.2 million, $2.1 million and $2.0 million, respectively, in 1994, 1993 and 1992. Beginning in 1993, the assess- ments were based not only on deposits but also on the risk characteristics of the individual financial institutions. All of the Company's subsidiaries received the lowest deposit assessment rate from the FDIC. Recent governmental discussions have included indications that future FDIC assessment rates could be significantly lower than the Company's current 0.23% of applicable deposits rate.\nBankshare taxes imposed by the State of Kentucky have been increasing and are expected to continue to increase in future years. Kentucky has raised the assessment level and is attempting to significantly increase this taxation, which is based upon net income and capital of the subsidiaries.\nDuring 1994, the Company completed two pooling-of-interest acquisitions. Included in other noninterest expense for 1994 and 1993 was approximately $561,000 and $145,000, respectively, of professional fees related to these acquisitions.\nINCOME TAXES Approximately one-half of the increase in income tax expense for the year ended December 31, 1994 from the prior year, is attributable to higher operating earnings and one-half is attributable to a higher effective tax rate. Most of the 1993 increase from 1992 was due to higher operating earnings. The effective tax rate has increased, and was 29.4% for the year ended December 31, 1994, compared to 27.3% for 1993 and 27.9% for 1992. Nondeductible organizational costs associated with two acquisitions was the main cause of the 1994 increase in the effective tax rate. Also contributing to higher effective tax rates is a lessening of the portion of pretax income that is derived from nontaxable sources. The Company manages the effective tax rate to some degree, based upon changing tax laws, particularly alternative minimum tax provisions, the availability and price of nontaxable debt securities and other portfolio considerations.\nLIQUIDITY AND INTEREST-RATE SENSITIVITY The Company's objective of liquidity management is to ensure the ability to access funding which enables each bank to efficiently satisfy the cash flow requirements of depositors and borrowers. Asset\/Liability management (ALM) involves the funding and investment strategies necessary to maintain an appropriate balance between interest sensitive assets and liabilities as well as to assure adequate liquidity. The Company's ALM committee monitors funds available from a number of sources to meet its objectives. The primary source\nof liquidity for the banks, in addition to loan repayments, is their debt securities portfolios. Debt securities classified as held for sale are those that the Company intends to use as part of its asset\/liability management and that may be sold prior to maturity in response to changes in interest rates, resultant prepayment risks and other factors. The Company's access to the retail deposit market through individual banks locations in ten different counties has been a reliable source of funds. Additional funds for liquidity are available by borrowing Federal funds from correspondent banks, Federal Home Loan Bank borrowings and brokered deposits. Various types of analyses are performed to ensure adequate liquidity, and to evaluate the desirability of the relative interest rate sensitivity of assets and liabilities.\nAs is typical for most financial institutions, the Company's cash flows provided by financing activities generally greatly exceed cash flows from operations and are used to fund investing activities. Area deposit growth is no longer the principal source of cash flows provided by financing activities. During 1994 and 1993, due to strong loan demand coupled with a low interest-rate environment, which hinders area deposit growth, financing activities funding was derived from increased levels of brokered deposits, Federal funds purchased and other short-term borrowings. Debt securities held for sale totaling $11.9 million and $21.9 million in 1994 and 1993, respectively, were sold to adjust repricing characteristics as determined to be desirable by the ALM Committee. Management considers current liquidity positions of the subsidiary banks to be adequate to meet depositor and borrower needs.\nBecause banks must assume interest rate risks as part of their normal opera- tions, the Company actively manages its interest rate sensitivity as well as liquidity positions. Both interest rate sensitivity and liquidity are affected by maturing assets and sources of funds; however, management must also consider those assets and liabilities with interest rates which are subject to change prior to maturity. The primary objective of the ALM Committee is to optimize earnings results, while controlling interest rate risks within internal policy constraints. The subsidiary banks and the Company collectively measure their level of earnings exposure to future interest rate movements. Currently, the Company does not employ interest rate swaps, financial futures or options to affect interest rate risks. The Company expects a greater amount of assets will reprice than liabilities in the first six months of 1995. This position is subject to change in response to the dynamics of the Company's balance sheet and general market conditions. Rising interest rates are likely to increase net interest income in a positive gap position (greater amount of repricing assets than liabilities) and falling rates would likely decrease net interest income.\nINDUSTRY DEVELOPMENTS On September 29, 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Branching Act\") was enacted. Under the Branching Act, beginning September 29, 1995, adequately capitalized and adequately managed bank holding companies will be allowed to acquire banks across state line, without regard to whether the transaction is prohibited by state law; however, they will be required to maintain the acquired institutions as separately chartered institutions. Any state law relating to the minimum age of target banks (not to exceed five years) will be preserved. Under the Branching Act,\nthe Federal Reserve Board will not be permitted to approve any acquisition if, after the acquisition, the bank holding company would control more than 10% of the deposits of insured depository institutions nationwide or 30% or more of the deposits in the state where the target bank is located. The Federal Reserve Board could approve an acquisition, notwithstandig the 30% limit, if the state waives the limit either by statute, regulation or order of the appropriate state official.\nIn addition, under the Branching Act beginning on June 1, 1997, banks will be permitted to merge with one another across state lines and thereby create a main bank with branches in separate states. After establishing branches in a state through an interstate merger transaction, the bank could establish and acquire additional branches at any location in the state where any bank involved in the merger could have estabished or acquired branches under applicable Federal or state law.\nUnder the Branching Act, states may adopt legislation permitting interstate mergers before June 1, 1997. In contrast, states may adopt legislation before June 1, 1997, subject to certain conditions, opting-out of interstate branching. If a state opts-out of interstate branching, no out-of-state bank may establish a branch in that state through an acquisition or de novo, and a bank whose home state opts-out may not participate in an interstate merger transaction.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndependent Auditors' Report _______________________________________________________________________________\nThe Board of Directors and Stockholders Peoples First Corporation\nWe have audited the accompanying consolidated balance sheets of Peoples First Corporation 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 consolidated financial statements 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 financial position of Peoples First 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.\n\/s\/ KPMG Peat Marwick LLP\nSt. Louis, Missouri January 27, 1995\nDecember 31, December 31, CONSOLIDATED BALANCE SHEETS 1994 1993 _______________________________________________________________________________ (in thousands)\nASSETS Cash and due from banks $39,333 $42,591 Short-term investments 0 3,100 Debt securities held for sale 121,172 118,820 Debt securities held for investment 203,844 249,838 Loans 805,947 704,037 Allowance for loan losses (12,188) (10,715) --------- --------- Loans, net 793,759 693,322 Excess of cost over net assets of purchased subsidiaries 10,077 10,907 Premises and equipment 16,980 16,698 Other assets 25,391 21,230 --------- --------- $1,210,556 $1,156,506 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Demand deposits $87,985 $86,250 Interest-bearing transaction accounts 243,910 238,760 Savings deposits 98,571 107,058 Time deposits 568,117 560,828 --------- --------- 998,583 992,896 Federal funds purchased 41,500 12,600 Other short-term borrowings 43,067 19,902 Long-term borrowings 9,536 16,555 Other liabilities 7,607 8,182 --------- --------- Total liabilities 1,100,293 1,050,135\nStockholders' Equity Common stock 6,422 6,381 Surplus 34,859 33,862 Retained earnings 73,739 64,416 Unrealized net gain (loss) on securities held for sale (4,624) 1,870 Debt on ESOP shares (133) (158) --------- --------- 110,263 106,371 --------- --------- $1,210,556 $1,156,506 ========= =========\nFair value of debt securities held for investment $200,092 $259,760 Common shares issued and outstanding 8,220 8,168\nSee accompanying notes to consolidated financial statements. 30\nYear Ended December 31, CONSOLIDATED STATEMENTS OF INCOME 1994 1993 1992 _______________________________________________________________________________ (in thousands except per share data)\nINTEREST INCOME Interest on short-term investments $169 $336 $781 Taxable interest on securities 17,017 19,664 21,528 Nontaxable interest on securities 4,305 4,413 3,881 Interest and fees on loans 62,846 56,492 53,776 ------ ------ ------ 84,337 80,905 79,966 INTEREST EXPENSE Interest on deposits 35,710 35,761 41,160 Other interest expense 3,145 2,236 1,608 ------ ------ ------ 38,855 37,997 42,768 ------ ------ ------ Net Interest Income 45,482 42,908 37,198 Provision for Loan Losses 1,723 2,541 3,246 ------ ------ ------ Net Interest Income after Provision for Loan Losses 43,759 40,367 33,952\nNoninterest Income 7,168 6,623 6,569 Noninterest Expense 32,337 29,373 25,942 ------ ------ ------ Income Before Income Tax Expense 18,590 17,617 14,579 Income Tax Expense 5,465 4,807 4,074 ------ ------ ------ NET INCOME $13,125 $12,810 $10,505 ====== ====== ======\nNet Income per Common Share and Common Share Equivalent $1.56 $1.52 $1.36\nCash Dividend per Common Share 0.45 0.40 0.36\nSee accompanying notes to consolidated financial statements. 31\nSee accompanying notes to consolidated financial statements. 32\nSee accompanying notes to consolidated financial statements. 33\nSee accompanying notes to consolidated financial statements. 34\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Peoples First Corporation (Company) through its subsidiaries, Peoples First National Bank and Trust Company, First Kentucky Federal Savings Bank and Liberty Bank and Trust, provides a full range of banking services to individual and corporate customers in the western Kentucky and contiguous interstate area. The Company and the subsidiary banks are subject to the regulations of various Federal and state agencies and undergo periodic examination by regulators.\nThe accounting policies and reporting practices of the Company are based upon generally accepted accounting principles and conform to predominant practices within the banking industry. In preparing financial statements, management is required to make assumptions and estimates which affect the Company's reported amounts of assets and liabilities and the results of operations. The more significant policies are summarized below.\nBASIS OF PRESENTATION The consolidated financial statements include the accounts of the parent company and its subsidiaries. All significant intercompany balances and transactions have been eliminated. Prior period financial statements are also restated to include the accounts of companies which are acquired and accounted for as pooling of interests. Results of operations of companies which are acquired and subject to purchase accounting are included from the dates of acquisition. In accordance with the purchase method of accounting, the assets and liabilities of purchased companies are stated at fair values, less accumulated amortization and depreciation since the date of acquisition. The excess of cost over fair value of the net assets acquired is being amortized on the straight-line method over a fifteen-year period.\nSECURITIES HELD FOR SALE AND INVESTMENT At acquisition, securities are classified into one of three categories: trading, held for sale or investment. Transfers of debt securities between categories are recorded at fair value at the date of transfer. Unrealized gains or losses associated with transfers of debt securities from the investment to the held for sale category are recorded and maintained as a separate component of stock- holders' equity. The unrealized gains or losses included as a separate component of stockholders' equity for debt securities transferred to the investment from the held for sale category are maintained and amortized into earnings over the remaining life of the debt securities as an adjustment to yield in a manner consistent with the amortization or accretion of premiums or discounts on the associated securities.\nTrading securities are bought and held principally with the intention of selling them in the near term. The Company currently has no trading securities. Securities that are being held for indefinite periods of time, including secur- ities that management intends to use as a part of its asset\/liability strategy, or that may be sold in response to changes in interest rates, changes in prepay- ment risk, to meet liquidity needs, the need to increase regulatory capital or other similar factors, are classified as securities held for sale and are stated at fair value. Fair value is based on market prices quoted in financial publi- cations or other independent sources. Net unrealized gains or losses are excluded from earnings and reported, net of applicable income taxes, as a\nseparate component of stockholders' equity until realized. Securities for which the Company has the ability and positive intent to hold until maturity are classified as investment securities and are carried at cost, adjusted for amortization of premiums and accretion of discounts, which are recognized as adjustments to interest income on the level-yield method.\nRealized gains or losses on securities held for sale or investment are accounted for using the specific security. Mortgage-backed securities represent a significant portion of the security portfolios. Amortization of premiums and accretion of discounts on mortgage-backed securities are analyzed in relation to the corresponding prepayment rates, both historical and estimated, using a method which approximates the level-yield method.\nDuring October 1994, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 119, \"Disclosures about Derivative Financial Instruments and Fair Value of Financial Instruments\" (FAS 119). FAS 119, which is effective for 1994 financial statements, requires disclosure about amounts, nature, and terms of derivative financial instruments. The Company does not hold any derivative financial instruments contemplated by FAS 119. The Company does not issue any derivative financial instruments as defined by FAS 119, except for commitments for traditional banking products such as fixed rate loan commitments, variable rate loans with lagging interest rate adjustments or interest rate caps or floors. The average value of these instruments during the past three years was small, except for variable rate loans which normally reprice in conjunction with repricing funding with the net effect recorded in net interest income.\nLOANS RECEIVABLE Loans receivable held for investment are carried at cost, as the Company has the ability and it is management's intention to hold them to maturity. Interest on commercial and real estate mortgage loans is accrued if deemed collectible and credited to income based upon the principal amount outstanding. Consumer installment loans are generally made on a discount basis. The unearned discount attributable to these loans is credited to income using a method which approxi- mates the level yield method. Mortgage loans originated principally under programs with the Government National Mortgage Association (GNMA) or the Federal National Mortgage Association (FNMA) and held for sale are carried at the lower of cost or market value.\nThe Company evaluates the collectibility of both contractual interest and contractual principal of all receivables when assessing the need for a loss accrual. When in the opinion of management the collection of interest on a loan is unlikely or when either principal or interest is past due over 90 days, that loan is generally placed on nonaccrual status and interest is not recognized unless received in cash. When a loan is placed in nonaccrual status, accrued interest for the current period is reversed and charged against earnings and accrued interest from prior periods is charged against the allowance for loan losses. A loan remains on nonaccrual status until the loan is current as to payment of both principal and interest and\/or the borrower demonstrates the ability to pay and remain current. Interest payments received on nonaccrual loans are applied to principal if there is any doubt as to the collectibility of total principal, otherwise these payments are recorded as interest income.\nALLOWANCE FOR LOAN LOSSES The allowance is increased by provisions for loan losses charged to operations and is maintained at a level adequate to absorb estimated credit losses associated with the loan portfolio, including binding commitments to lend and off-balance sheet credit instruments. At the end of each quarter, or more frequently if warranted, management uses a systematic, documented approach in determining the appropriate level of the allowance for loan losses. Management's approach provides for general and specific allowances and is based upon current economic conditions, past losses, collection experience, risk characteristics of the loan portfolio, assessment of collateral values and such other factors which in management's judgement deserve current recognition in estimating potential loan losses.\nDuring May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (FAS 114), and during October 1994, issued Statement of Financial Accounting Standards No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\" (FAS 118). These financial accounting standards are effective for fiscal years beginning after December 15, 1994. FAS 114, as amended by FAS 118 requires that impaired loans subject to the statements be measured at 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. Management believes there will be no financial impact of the adoption of FAS 114 and FAS 118 in the first quarter of 1995.\nPREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation and amortization. The provision for depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Esti- mated useful lives on buildings range from ten to thirty years and two to ten years on equipment. Leasehold improvements are amortized over the term of the related leases. Expenditures for major renewals and betterments of premises and equipment are capitalized and those for maintenance and repairs are expensed as incurred.\nOTHER REAL ESTATE Real estate acquired through foreclosure or deed in lieu of foreclosure is in- cluded in other assets, and is recorded at the lower of cost or the property's fair value at the time of foreclosure less estimated disposal costs, if any. The excess of cost over fair value of other real estate at the date of acquisition is charged to the allowance for loan losses. Subsequent reductions in carrying value to reflect current fair value and any other period costs are charged to expense as incurred.\nINCOME TAXES Income tax expense is reported as the total of current income taxes payable and the net change in deferred income taxes payable provided for temporary differences. Deferred income taxes reflect the net tax effects of temporary differences between the carrying values of assets and liabilities for financial\nreporting purposes and the values used for income tax purposes. Deferred income taxes are recorded at the statutory Federal rates in effect at the time that the temporary differences are expected to reverse. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based upon management's judgment of available evidence, are not expected to be realized. The significant components of deferred tax assets and liabilities are principally related to unrealized net gain or loss on securities, provisions for loan losses, amortization of premiums on debt securities, depreciation and deferred compensation. The Company files a consolidated Federal income tax return which includes all of its subsidiaries. Income tax expense is allocated among the parent company and its subsidiaries as if each had filed a separate tax return.\nNET INCOME PER COMMON SHARE AND COMMON SHARE EQUIVALENT Net income per common share and common share equivalent is determined by divid- ing net income by the weighted average number of common shares actually out- standing and common stock equivalents pertaining to common stock options. The average number of shares outstanding including common stock equivalents for 1994, 1993 and 1992 were 8,437,240, 8,454,583 and 7,803,457, respectively. Common stock equivalents have no material dilutive effect.\nCASH AND CASH EQUIVALENTS For purposes of the consolidated statements of cash flows, the Company considers all cash and due from banks to be cash equivalents.\nRECLASSIFICATIONS Certain amounts in the 1993 and 1992 consolidated financial statements have been reclassified to conform with the 1994 presentation.\n2. BUSINESS COMBINATIONS During the three year period ended December 31, 1994, the Company was a party to three business combinations.\nOn October 7, 1994, the Company consummated the acquisition of Libsab Bancorp, Inc. (Libsab) and Liberty Bank and Trust, a wholly-owned subsidiary of Libsab. The Company acquired all of the outstanding shares of Libsab in exchange for 1,077,853 shares of Peoples First Corporation common stock. Libsab's three locations are part of the market area served by the Company's other subsidiary banks. At December 31, 1994, Libsab had total assets of approximately $143.5 million.\nOn March 10, 1994, the Company consummated the acquisition of First Kentucky Bancorp, Inc. (First Kentucky) and First Kentucky Federal Savings Bank, a wholly-owned subsidiary of First Kentucky. The Company acquired all of the outstanding shares of First Kentucky in exchange for 929,794 shares of Peoples First Corporation common stock. First Kentucky's six locations are immediately east of the market area served by the Company's other subsidiary banks. The preacquisition year end for First Kentucky was September 30. The Consolidated Financial Statements for December 31, 1993 and 1992 include the accounts of First Kentucky for the twelve months ended the previous September 30, for the respective years. For the year ended December 31, 1994, consolidated retained earnings were increased $334,814 due to the change in First Kentucky's year end\nto December 31. For the three months ended December 31, 1993, First Kentucky had revenues of $3.0 million, expenses of $2.7 million and net income of $334,814. At December 31, 1994, First Kentucky had total assets of approxi- mately $173.6 million.\nThe two aforementioned acquisitions have been accounted for as pooling of interests, and accordingly, the accompanying consolidated financial statements have been restated.\nThe following table shows the results of operations of the previously separate entities for the periods prior to combination: First Results of Operations Company Libsab Kentucky Combined _______________________________________________________________________________ (in thousands)\n1993 Total revenue $37,586 $5,911 $6,034 $49,531 Net income 9,534 1,520 1,756 12,810 1992 Total revenue 32,291 5,826 5,650 43,767 Net income 7,569 1,643 1,293 10,505\nMerger expenses of approximately $561,000 and $145,000 related to the above acquisitions were charged to expense during 1994 and 1993, respectively. The after-tax impact of these expenses on earnings per share was $0.07 and $0.02 for 1994 and 1993, respectively.\nOn May 4, 1992, the Company consummated the acquisition of an additional banking organization, Bank of Murray. The purchase price of approximately $42.4 million consisted of 1,217,246 shares of the Company's common stock, $10.0 million of subordinated two-year notes with an interest rate of 7.25% and $14.1 million in cash. The transaction was accounted for using the purchase method of accounting. The results of operations of Bank of Murray are included in the accompanying consolidated financial statements subsequent to the acquisition date and the excess of cost over fair value of the net assets acquired, $11.9 million, is being amortized over fifteen years on a straight-line basis. At December 31, 1991, Bank of Murray had total assets of approximately $229.7 million. During 1994, Bank of Murray was merged into Peoples First National Bank and Trust Company. The following table presents unaudited pro forma results of operations for the year ended December 31, 1992 assuming the purchase of Bank of Murray had taken place on January 1, 1992:\nPro Forma Statement of Income (unaudited) Year Ended December 31, 1992 __________________________________________________________________ (in thousands, except per share data)\nInterest income $85,457 Interest expense 46,247 ------ Net interest income 39,210 Provision for loan losses 3,719 ------ Net interest income after provision for loan losses 35,491 Noninterest income 6,767 Noninterest expense 28,232 ------ Income before income tax expense 14,026 Income tax expense 3,962 ------ Net income $10,064 ====== Net income per common share and common share equivalent $1.26\nThe pro forma information is not necessarily indicative of the actual results of operations which would have occurred had the acquisition of Bank of Murray been consummated as of January 1, 1992, nor is it necessarily indicative of future operating results.\n3. CASH AND DUE FROM BANKS The Company's bank subsidiaries are required to maintain certain reserve balances in accordance with Federal Reserve Board requirements. The reserve balances maintained in accordance with such requirements as of December 31, 1994 and 1993 were $8.2 million and $7.9 million, respectively.\n4. DEBT SECURITIES HELD FOR SALE AND DEBT SECURITIES HELD FOR INVESTMENT The amortized cost and fair value of debt securities held for sale as of December 31, 1994 and 1993 are summarized as follows:\nDebt Securities Gross Gross Held For Sale Amortized unrealized unrealized Fair December 31, 1994 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $58,813 $0 ($3,321) $55,492 Mortgage-backed securities 69,304 39 (3,663) 65,680 ------- ------- ------- ------- $128,117 $39 ($6,984) $121,172 ======= ======= ======= =======\nDebt Securities Gross Gross Held For Sale Amortized unrealized unrealized Fair December 31, 1993 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $32,915 $1,801 ($1) $34,715 Mortgage-backed securities 81,404 1,193 (220) 82,377 Other 1,669 59 0 1,728 ------- ------- ------- ------- $115,988 $3,053 ($221) $118,820 ======= ======= ======= =======\nThe amortized cost and fair value of debt securities held for investment as of December 31, 1994 and 1993 are summarized as follows:\nDebt Securities Gross Gross Held for Investment Amortized unrealized unrealized Fair December 31, 1994 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $45,709 $3 ($539) $45,173 Mortgage-backed securities 87,803 33 (3,480) 84,356 State and political subdivisions 67,333 1,579 (1,329) 67,583 Other 2,999 3 (22) 2,980 ------- ------- ------- ------- $203,844 $1,618 ($5,370) $200,092 ======= ======= ======= =======\nDebt Securities Gross Gross Held for Investment Amortized unrealized unrealized Fair December 31, 1993 cost gains losses value _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies $74,929 $1,908 ($1) $76,836 Mortgage-backed securities 97,082 2,148 (62) 99,168 State and political subdivisions 73,771 5,858 (31) 79,598 Other 4,056 102 0 4,158 ------- ------- ------- ------- $249,838 $10,016 ($94) $259,760 ======= ======= ======= =======\nProceeds from sales of debt securities during 1994, 1993 and 1992 were $11,885,303, $21,897,188 and $47,545,840, respectively. Gross gains of $62,309, $252,056 and $1,041,127 were realized on those sales during 1994, 1993 and 1992, respectively, and gross losses of $0, $21,414 and $48,475 were realized on those sales during 1994, 1993 and 1992, respectively.\nThe amortized cost, estimated fair value and the weighted average yield of securities held for sale and investment at December 31, 1994, by contractual maturity, are shown below. Actual maturities will differ from the depicted maturities because of the borrowers' right to call or prepay obligations with or without prepayment penalties. Contractual maturities are not meaningful for mortgage-backed securities, which are particularly exposed to prepayments. Management evaluates, on an on-going basis, the potential maturities for asset\/liability purposes. Yields on tax-exempt obligations have not been computed on a tax-equivalent basis.\nSecurities Held for Sale Portfolio Weighted Maturity Distribution Amortized Fair average December 31, 1994 cost value yield _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies 1 year or less $2,017 $2,003 5.61% Over 1 through 5 years 42,877 40,600 5.65 Over 5 through 10 years 12,919 11,944 6.84 Over 10 years 1,000 945 7.65 Mortgage-backed securities 69,304 65,680 6.33 ------- ------- $128,117 $121,172 6.15% ======= =======\nSecurities Held for Investment Portfolio Weighted Maturity Distribution Amortized Fair average December 31, 1994 cost value yield _______________________________________________________________________________ (in thousands)\nU.S. treasury and agencies 1 year or less $22,517 $22,452 7.13% Over 1 through 5 years 23,193 22,722 6.36 Over 5 through 10 years -- -- -- Over 10 years -- -- -- Mortgage-backed securities 87,803 84,356 6.54 State and political sudivisions 1 year or less 4,257 4,293 6.40 Over 1 through 5 years 17,733 18,171 6.35 Over 5 through 10 years 25,059 25,787 6.49 Over 10 years 20,283 19,331 5.88 Other 1 year or less 2,499 2,477 5.56 Over 1 through 5 years 465 468 8.49 Over 5 through 10 years 35 35 7.50 Over 10 years -- -- -- ------- ------- $203,844 $200,092 6.48% ======= =======\nAt December 31, 1994 and 1993, debt securities with carrying values of approxi- mately $135.4 million and $110.6 million respectively, were pledged to secure repurchase agreements, public and trust deposits and for other purposes as required by law.\n5. LOANS The Company's lending activities are concentrated primarily in the contiguous interstate area of western Kentucky, southern Illinois, northwestern Tennessee and southeastern Missouri. The loan portfolio is well diversified and consists of business loans extending across many industry types, as well as loans to individuals. As of December 31, 1994 and 1993, total loans to any group of customers engaged in similar activities and having similar economic character- istics, as defined by standard industrial classifications, did not exceed 10% of total loans, although the geographical concentration is a necessary factor for regional banks.\nMajor classification of loans are as follows:\nDecember 31, 1994 1993 _______________________________________________________________________________ (in thousands)\nCommercial, financial and agricultural $111,929 $118,906 Real estate Construction 19,421 12,255 Residential mortgage 318,551 269,265 Commercial mortgage 139,629 127,666 Consumer, net of unearned income of $11,340 and $11,026 at December 31, 1994 and 1993 214,309 173,191 Loans held for sale 156 504 Other 1,952 2,250 ------- ------- $805,947 $704,037 ======= =======\nThe 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 counterparty. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, income producing commercial properties, real estate mortgages and other property owned by the borrowers.\nNonaccrual and renegotiated loans totaled $3.3 million and $3.8 million at December 31, 1994 and 1993, respectively.\nAllowance for Loan Losses Year Ended December 31, 1994 1993 1992 _______________________________________________________________________________ (in thousands)\nBalance at beginning of year $10,715 $8,606 $6,420 Balance of purchased subsidiary bank at acquisition -- -- 1,485 Provision charged to expense 1,723 2,541 3,246 Loans charged off (686) (1,044) (2,907) Recoveries of loans previously charged off 436 612 362 ------ ------ ------ Net loans charged off (250) (432) (2,545) ------ ------ ------ Balance at end of year $12,188 $10,715 $8,606 ====== ====== ======\nCertain officers and directors of Peoples First Corporation and its subsidiaries and certain corporations and individuals related to them 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\ntime for comparable transactions with other customers and did not involve more than the normal risk of collectibility. The activity of these loans is summarized below:\nLoans to Officers and Directors Year Ended December 31, 1994 1993 _______________________________________________________________________________ (in thousands)\nBalance at beginning of year $20,663 $15,849 Additions 4,230 6,050 Repayments (1,087) (1,236) Changes in officer and director status (11,981) -- ------ ------ Balance at end of year $11,825 $20,663 ====== ======\n6. PREMISES AND EQUIPMENT A summary of premises and equipment is as follows:\nDecember 31, 1994 1993 _______________________________________________________________________________ (in thousands)\nLand $2,264 $2,195 Buildings 17,502 17,209 Equipment 11,157 9,719 Leasehold improvements 1,084 957 Construction in progress 156 296 ------ ------ 32,163 30,376 Accumulated depreciation (15,183) (13,678) ------ ------ $16,980 $16,698 ====== ======\nThe amount of depreciation and amortization related to premises and equipment that was charged to operating expenses in 1994, 1993 and 1992 was $1,650,659, $1,426,263 and $1,192,999, respectively.\n7. SHORT-TERM BORROWINGS Federal funds purchased and repurchase agreements generally represent borrowings with overnight maturities as do certain short-term advances from the Federal Home Loan Bank (FHLB) of Cincinnati. Information pertaining to the subsidiary banks' short-term borrowings is summarized below:\nShort-term Borrowings 1994 1993 1992 _______________________________________________________________________________ (in thousands)\nFederal funds purchased Average balance $21,171 $10,980 $331 Year end balance 41,500 12,600 0 Highest month-end balance 41,500 23,700 2,500 Average interest rate 4.63% 3.23% 3.87% Year end interest rate 6.12% 3.30% -- Repurchase agreements Average balance 22,702 20,781 23,843 Year end balance 21,567 19,902 19,606 Highest month-end balance 24,090 22,883 28,909 Average interest rate 3.50% 3.23% 3.92% Year end interest rate 4.08% 3.27% 3.27% Short-term FHLB advances Average balance 7,581 0 0 Year end balance 21,500 0 0 Highest month-end balance 21,500 0 0 Average interest rate 5.18% -- -- Year end interest rate 6.16% -- --\nAt December 31, 1994, the subsidiary banks had total lines-of-credit for Federal funds purchased of $60.0 million for funding from unaffiliated banks, of which $18.5 million was undrawn and available.\n8. LONG-TERM BORROWINGS Information pertaining to long-term borrowings is summarized below:\nDecember 31, 1994 1993 __________________________________________________________________ (in thousands)\nParent Company Bank loan for subsidiary acquisition $1,530 $4,577 Subordinated notes 0 5,012 Subsidiaries Federal Home Loan Bank advances 7,873 6,808 Employee Stock Ownership Plan debt 133 158 ------ ------ $9,536 $16,555 ====== ======\nIn May 1993, the Company obtained a $10,200,000 loan commitment from a regional bank, which was used to retire short-term notes and other bank debt originally used in the acquisition of a subsidiary bank. Interest is payable quarterly at the lender's prime rate which can be adjusted daily (8.50% at December 31, 1994 and 6.00% at December 31, 1993). The note provides for quarterly principal payments of $261,604 and a final maturity in May 2004. The note agreement contains various financial covenants pertaining to levels of net worth and indebtedness. The Company was in compliance with all such covenants at December 31, 1994.\nThe Company issued unsecured, subordinated, two-year notes on May 4, 1992 in connection with an acquisition of a subsidiary bank. The notes provided for quarterly interest payments at the annual rate of 7.25%.\nThe banking subsidiaries obtain various short-term and long-term advances from the FHLB under Blanket Agreements for Advances and Security Agreements (Agreements). The Agreements entitle the banks to borrow funds from the FHLB to fund mortgage loan programs and satisfy other funding needs. Of the long-term advances at December 31, 1994, none were at variable interest rates and $7.9 million were at fixed interest rates ranging from 5.55% to 8.10%. FHLB advances are collateralized by the subsidiary banks' FHLB stock they are required to own and certain single-family first mortgage loans in the approximate amount of $231.4 million at December 31, 1994. As members of the FHLB system, the Company's subsidiary banks must hold a minimum of FHLB stock equal to one percent of home mortgage related assets. Additional FHLB stock ownership is required as the level of advances increase. The subsidiary banks are in compliance with the FHLB stock ownership requirements with a total required investment of $5.2 million at December 31, 1994. The long-term advances provide for scheduled monthly payments but may be prepaid at the option of the subsidiary banks with the payment of a premium.\nOne of the Company's subsidiaries is obligated to pay, through annual contri- butions and dividends to their Employee Stock Ownership Plan, a note payable to a regional financial institution. An original amount of $253,570 was borrowed in May, 1991. The loan is secured by the pledge of certain shares of the subsidiary stock. Interest is payable quarterly at the lender's prime rate less 0.50% which can be adjusted daily (9.50% at December 31, 1994 and 7.00% at December 31, 1993). The note provides for annual principal payments of $25,357 and a final maturity in May, 2001.\nAnnual minimum principal repayment requirements for long-term borrowings for the years 1995 through 1999 are $1,432,693, $874,882, $414,356, $439,319 and $460,912, respectively.\n9. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those 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. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These off-balance-sheet financial instruments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the financial instruments may expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. Commitments to extend credit and standby letters of credit are subject to the same underwriting and collater- alizing standards as on-balance-sheet items.\nContractual commitments to extend credit and standby letters of credit at December 31, 1994 and 1993 are summarized as follows:\nFinancial Instruments with Off-Balance-Sheet Risk December 31, 1994 1993 _______________________________________________________________________________ (in thousands)\nContractual commitments to extend credit $101,132 $83,581 Standby letters of credit 4,183 3,607\nFixed-rate loan commitments, as defined in FAS 119, are considered derivative financial instruments. Of the total commitments to extend credit at December 31, 1994, none represent fixed-rate loan commitments.\n10. EMPLOYEE BENEFITS The Company maintains two noncontributory Employee Stock Ownership Plans (ESOP) and an employer matching 401(k) Plan. The plans cover substantially all of the Company's employees.\nEmployer contributions to the ESOPs are determined annually by the Company's board of directors and were $201,696, $208,983 and $188,102 for the years ended 1994, 1993 and 1992, respectively. The ESOP's investments include 255,191 and 268,080 shares of the Company's common stock at December 31, 1994 and 1993, respectively.\nDuring November 1993, the American Institute of Certified Public Accountants issued Statement of Position 93-6, \"Employers' Accounting for Employee Stock Ownership Plans\" (SOP 93-6), which is effective for fiscal years beginning after December 15, 1993. SOP 93-6 replaced previous accounting guidance and provided changes for certain leveraged employee stock ownership plan. There was no impact of SOP 93-6 on the Company's financial condition or results of operations.\nUnder the 401(k) Plan, participants may voluntarily contribute a percentage of their salary through payroll deductions. The Company is currently committed to make contributions to the 401(k) Plan annually in an amount equal to 100% of the first 3% contribution of each participant's base salary. For the years ended December 31, 1994, 1993 and 1992, the Company's required matching contribution amounted to $225,583, $184,472 and $148,665, respectively. Employees have four investment options in which their contributions may be invested.\nThe terms of the acquisitions, as described in Note 2., provided for the termi- nation of the defined benefit retirement plans of Liberty Bank & Trust (Liberty), First Kentucky Federal Savings Bank (First Federal) and Bank of Murray as soon as reasonably practicable. Liberty's and First Federal's defined benefit retirement plans will be terminated. Liberty's employees will become eligible to participate in the Company's ESOP and 401(k) plans during 1995. First Federal's employees remain covered by a previously existing ESOP and became eligible to participate in the Company's 401(k) plan during 1994. The respective fair value of defined benefit retirement plan assets will be distributed to Liberty's and First Federal's employees as soon as Internal Revenue and Department of Labor requirements are met. The plan terminations should have no material financial effect on the Company. Bank of Murray's defined benefit plan was terminated and their employees became eligible to participate in the Company's ESOP and 401(k) plans during 1992. The fair value of Bank of Murray's defined benefit plan assets, which were distributed to plan participants in 1993, exceeded the actuarial present value of all accrued benefits. The plan termination had no financial effect on the Company.\nPost retirement benefits other than pensions are not provided for the Company's employees. Eligible retired employees may for a period of time maintain certain health care benefits through policies of the Company at the employee's expense. There was no cost for employee benefits for retired employees in 1994, 1993 and 1992.\n11. STOCKHOLDERS' EQUITY\nAUTHORIZED CAPITAL STOCK The Company has six million authorized shares of no par preferred stock and thirty million authorized shares of no par, $0.7812 stated value common stock.\nSHARE PURCHASE RIGHTS PLAN In January of 1995, the Board of Directors of the Company adopted a Share Purchase Rights Plan and distributed a dividend of one Preferred Share Purchase Right (Right) for each outstanding common share of the Company and for each common share issued thereafter. The Rights are generally designed to deter coercive takeover tactics and to encourage all persons interested in acquiring control of the Company to deal with each shareholder on a fair and equal basis. Each Right trades in tandem with its respective share of common stock until the occurrence of certain events, in which case it would separate from the common stock and entitle the registered holder, subject to the terms of the Rights Agreement, to purchase certain equity securities at a price below their market value. The Company has not issued any of the authorized no par preferred stock.\nDIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN In 1987, the Board of Directors of the Company adopted the Peoples First Corporation Share Owner Dividend Reinvestment and Stock Purchase Plan (DRIP), and amended the Plan during 1994. The DRIP provides for the issuance of 1,040,000 shares of authorized but previously unissued common stock. On certain investment dates, shares may be purchased with all or a portion of reinvested dividends or with optional cash payments not to exceed $3,000. The price of shares purchased pursuant to the DRIP is the average market price reported by NASDAQ for the last five trading days of the month preceding the dividend\npayment month. At December 31, 1994 and 1993, 779,705 shares and 820,322 shares, were reserved for issuance under the DRIP. Shares issued under the DRIP totaled 40,617, 33,912 and 32,268 shares in 1994, 1993 and 1992, respectively.\nSTOCK OPTION PLAN The Peoples First Corporation 1986 Stock Option Plan (Option Plan), as amended in 1994, authorizes the granting to key employees of the Company incentive stock options and nonqualified stock options to purchase common stock of the Company at market value at the time the options are granted. Shares sold under the Option Plan may be either unissued authorized shares or shares reacquired by the Company. Options granted are exercisable, subject to vesting and other requirements, at varying times from the first through the tenth year after the grant date. Optionees may exercise their options with cash or with shares of the Company's common stock. Outstanding stock options are considered common stock equivalents in the computation of earnings per share.\nRETAINED EARNINGS RESTRICTION In connection with the Company's savings bank subsidiary conversion from mutual to stock form of ownership during 1991, the subsidiary restricted the amount of retained earnings at that date by establishing a liquidation account equal to $6,750,000 for the purpose of granting to eligible depositors a priority in the event of future liquidation. Only in such an event, an eligible depositor who continues to maintain an account will be entitled to receive a distribution from the liquidation account. The total amount of the liquidation account decreases in an amount proportionately corresponding to decreases in the deposit account balances of the eligible account holders.\nDIVIDEND LIMITATIONS Payment of dividends by the subsidiary banks, which is the principal source of funds for payment of dividends by the Company to its shareholders, are subject to various national and\/or state regulatory restrictions. At December 31, 1994, total retained earnings of the Company's direct subsidiaries was approxi- mately $65.2 million, of which $19.2 million was available for payment of dividends without approval by the applicable regulatory authority.\nCAPITAL RESTRICTIONS Banking regulations require minimum ratios of capital to total \"risk weighted\" assets. The Company and its subsidiaries are required to have minimum Tier I and total capital ratios of 4.00% and 8.00%, respectively. At December 31, 1994 and 1993, the Company and its subsidiaries actual capital ratios exceeded minimum requirements.\n12. INCOME TAXES The current and deferred portions of income tax expense were as follows:\nYear Ended December 31, 1994 1993 1992 _______________________________________________________________________________ (in thousands)\nCurrent taxes $6,397 $6,119 $5,002 Deferred taxes (932) (1,312) (928) ----- ----- ----- Income tax expense $5,465 $4,807 $4,074 ===== ===== =====\nThe Company adopted Statement of Financial Accounting Standards No. 109 as of January 1, 1992, changing the method of computing deferred taxes on a prospec- tive basis. No cumulative adjustment was required for the adoption of this statement.\nThe following is a reconciliation between the amount of income tax expense and the amount of tax computed by applying the statutory Federal income tax rates:\nYear Ended December 31, 1994 1993 1992 _______________________________________________________________________________ (in thousands)\nTax computed at statutory rates $6,407 $6,020 $4,958 Increase (decrease) in taxes resulting from: Tax-exempt income (1,413) (1,562) (1,322) Goodwill amortization 290 290 192 Other, net 181 59 246 ----- ----- ----- Income tax expense $5,465 $4,807 $4,074 ===== ===== =====\nEnacted in September, 1993, the Revenue Reconciliation Act of 1993 was a change in the tax laws that raised the Company's top income tax rate. Adjustment to the deferred tax asset required by this rate change was insignificant. Not all temporary differences are accounted for through income tax expense on the consolidated statements of income. The tax effects of temporary differences, that give rise to significant elements of the deferred tax assets and deferred tax liabilities are as follows:\nDecember 31, 1994 1993 _______________________________________________________________________________ (in thousands)\nDeferred tax assets: Allowance for loan losses ($3,824) ($2,963) Deferred compensation (424) (347) Other real estate owned (171) (107) Unrealized security gain (loss) (1,650) -- Other (105) (297) ----- ----- (6,174) (3,714) Deferred tax liabilities: Premiums on securities 18 196 Discounts on securities 35 25 Unrealized security gain -- 965 Accrued interest income 93 98 Premises and equipment 1,314 1,365 Other 299 197 ----- ----- 1,759 2,846 ----- ----- Net deferred tax assets ($4,415) ($868) ===== =====\nDeferred tax assets have not been reduced by a valuation allowance. Based on the weight of available evidence, management believes it is more likely than not all of the deferred tax assets will be realized. Neither current or deferred taxes have been provided for approximately $2.6 million of income at December 31, 1994 and 1993 which represents allocations for bad debt deductions for tax purposes only. If the amounts that qualify for Federal income tax purposes are later used for purposes other than bad debt losses, including distributions in liquidation, such distributions will be subject to Federal income tax at the then current corporate rate.\n13. SUPPLEMENTAL INCOME STATEMENT INFORMATION Details of noninterest income and noninterest expense are as follows:\nYear Ended December 31, 1994 1993 1992 _______________________________________________________________________________ (in thousands)\nNoninterest Income Service charges on deposits $3,680 $3,308 $2,881 Net securities gains 62 230 993 Trust department fees 1,181 1,199 1,091 Insurance commissions 470 317 291 Other income 1,775 1,569 1,313 ----- ----- ----- $7,168 $6,623 $6,569 ===== ===== =====\nYear Ended December 31, 1994 1993 1992 _______________________________________________________________________________ (in thousands)\nNoninterest Expense Salaries $12,370 $11,591 $9,984 Employee benefits 2,450 2,348 2,149 Occupancy expense 1,677 1,579 1,508 Equipment expense 1,665 1,433 1,173 FDIC insurance expense 2,250 2,135 1,962 Data processing expense 2,140 1,890 1,637 Bankshare taxes 1,365 1,253 1,003 Goodwill amortization 830 830 565 Other expense 7,590 6,314 5,961 ------ ------ ------ $32,337 $29,373 $25,942 ====== ====== ======\n14. PARENT COMPANY FINANCIAL INFORMATION Following are condensed balance sheets of Peoples First Corporation (parent company only) as of December 31, 1994 and 1993, and the related condensed statements of income and cash flows for the years ended 1994, 1993 and 1992:\nCondensed Balance Sheets December 31, 1994 1993 __________________________________________________________________ (in thousands)\nASSETS Cash in subsidiary bank $492 $956 Investment in subsidiaries 111,302 114,561 Cost in excess of net assets acquired 0 202 Other assets 276 558 ------- ------- $112,070 $116,277 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Notes payable $1,530 $9,589 Other liabilities 277 317 ------- ------- Total liabilities 1,807 9,906\nStockholders' equity Common stock 6,422 6,381 Surplus 34,859 33,862 Retained earnings 73,739 64,416 Unrealized net gain (loss) on securities held for sale (4,624) 1,870 Debt on ESOP shares (133) (158) ------- ------- 110,263 106,371 ------- ------- $112,070 $116,277 ======= =======\nCommon shares issued and outstanding 8,220 8,168\nCondensed Statements of Income Year Ended December 31, 1994 1993 1992 _______________________________________________________________________________ (in thousands)\nINCOME Dividends from subsidiaries $10,878 $5,752 $3,520 Other income 11 7 84 ------ ------ ------ 10,889 5,759 3,604 EXPENSE Salaries and employee benefits 0 0 127 Interest expense 385 745 578 Legal and accounting fees 571 335 140 Other expense 654 450 596 ------ ------ ------ 1,610 1,530 1,441 ------ ------ ------ Income before income taxes and equity in undistributed income from subsidiaries 9,279 4,229 2,163 Income tax benefit 385 434 429 Income before equity in ------ ------ ------ undistributed income of subsidiaries 9,664 4,663 2,592 Equity in undistributed income of subsidiaries 3,461 8,147 7,913 ------ ------ ------ NET INCOME $13,125 $12,810 $10,505 ====== ====== ======\nCondensed Statement of Cash Flows Year Ended December 31, 1994 1993 1992 _______________________________________________________________________________ (in thousands)\nOPERATING ACTIVITIES Net income $13,125 $12,810 $10,505 Adjustments to reconcile net income to net cash provided by operating activities Equity in undistributed income of subsidiaries (3,461) (8,147) (7,913) Amortization and other, net 134 (16) (150) Net cash provided by ------ ------ ----- operating activities 9,798 4,647 2,442\nINVESTING ACTIVITIES Cash paid for acquisition of subsidiary, net of dividend received -- -- (3,914) ------ ------ --------- Net cash used by investing activities -- -- (3,914)\nFINANCING ACTIVITIES Proceeds from notes payable 3,800 6,200 2,700 Repayments of notes payable (11,859) (8,712) (623) Issuance of common stock 495 299 386 Cash dividends paid (2,698) (2,012) (1,633) Net cash provided (used) ------ ------ ----- by financing activities (10,262) (4,225) 830\nNet Increase (Decrease) in Cash (464) 422 (642) and Cash Equivalents Cash and Cash Equivalents at Beginning of Year 956 534 1,176 ------ ------ ----- Cash and Cash Equivalents at End of Year $492 $956 $534 ====== ====== =====\nSUPPLEMENTAL DISCLOSURES Cash paid for interest expense $405 $716 $551 Cash received for income taxes (711) (365) (338)\nNONCASH INVESTING AND FINANCING ACTIVITIES Dividends reinvested 542 438 347 Notes payable issued in purchase acquisition of subsidiary -- -- 10,025 Common stock issued in purchase acquisition of subsidiary -- -- 18,258\n15. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS To value financial instruments for both on and off-balance sheet assets and liabilities where it is practicable to estimate that value, quoted market prices are utilized by the Company where readily available. If quoted market prices are not available, fair values are based on estimates using present value and other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The calculated fair value estimates, therefore, cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented are not intended to represent the underlying value of the Company.\nThe following methods and assumptions were used in estimating the fair value for financial instruments.\nCASH, DUE FROM BANKS, ACCRUED INTEREST RECEIVABLE, FEDERAL FUNDS SOLD, FEDERAL FUNDS PURCHASED, ACCRUED INTEREST PAYABLE AND SHORT-TERM BORROWINGS The carrying amount reported for cash, due from banks, accrued interest receiv- able, Federal funds sold, Federal funds purchased, accrued interest payable and short-term borrowings approximates the fair value for those assets and liabilities.\nDEBT AND EQUITY SECURITIES For securities held both for sale and investment, fair values are based on quoted market prices or dealer quotes, if available. If a quoted market price is not available, fair value is estimated using quoted prices for similar securities.\nLOANS RECEIVABLE Loan balances were assigned fair values based on a discounted cash flow analysis. The discount rate is based on the treasury yield curve, with rate adjustments for credit risk, liquidity, servicing costs and the prepayment uncertainty.\nDEPOSIT LIABILITIES The fair value for demand deposits, any interest bearing deposit with no fixed maturity date or short-term repurchase agreement liabilities is considered to be equal to the amount payable on demand or maturity date at the reporting date. Time deposits are assigned fair values based on a discounted cash flow analysis using discount rates which approximate interest rates currently being offered on liabilities with comparable maturities.\nLONG-TERM BORROWINGS Long-term debt is fair valued using discounted cash flow analysis with a discount rate based on current incremental borrowing rates for similar types of arrangements.\nUNRECOGNIZED FINANCIAL INSTRUMENTS No fair value of loan commitments is presented since the Company does not generally collect fees for loan commitments. The fair value of guarantees and letters of credit is based on equivalent fees that would be charged for similar agreements and is less than $10,000 for 1994 and 1993.\nThe book values and estimated fair values for financial instruments as of December 31, 1994 and 1993 are reflected below.\nFinancial Instruments December 31, 1994 Book value Fair value _______________________________________________________________________________ (in thousands)\nFinancial Assets Cash and due from banks $39,333 $39,333 Debt securities held for sale 121,172 121,172 Debt securities held for investment 203,844 200,092 Loans, net 793,759 777,877 Equity securities 8,472 8,571 Accrued interest receivable 8,627 8,627\nFinancial Liabilities Deposits 998,583 996,989 Federal funds purchased 41,500 41,500 Other short-term borrowings 43,067 43,067 Long-term borrowings 9,536 9,536 Accrued interest payable 4,454 4,454\nFinancial Instruments December 31, 1993 Book value Fair value _______________________________________________________________________________ (in thousands)\nFinancial Assets Cash and due from banks $42,591 $42,591 Federal funds sold 3,100 3,100 Debt securities held for sale 118,820 118,820 Debt securities held for investment 249,838 259,760 Loans, net 693,322 706,862 Equity securities 6,709 6,826 Accrued interest receivable 8,507 8,507\nFinancial Liabilities Deposits 992,896 999,624 Federal funds purchased 12,600 12,600 Other short-term borrowings 19,902 19,902 Long-term borrowings 16,555 16,579 Accrued interest payable 4,049 4,049\nIMPACT OF INFLATION AND CHANGING PRICES Inflation has a minor effect on banking concerns since most of the assets and liabilities are monetary in nature. Monetary assets are those which can be readily converted into a fixed number of dollars. Management believes that the effect of inflation on nonmonetary assets such as bank premises and equipment is not material to the Company as a whole.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nDuring the years ended December 31, 1994, 1993 and 1992 and in the subsequent interim period, there has been no change in, or disagreements on accounting matters with, the Company's independent auditors.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND OFFICERS OF THE REGISTRANT\nInformation with respect to all directors and all persons nominated to become directors of the registrant appearing in the table and footnotes on pages 3 through 6 and the first narrative paragraph on page 8 of Peoples First Corporation's definitive proxy statement, filed with the Securities and Exchange Commission on March 10, 1995, is incorporated herein by reference.\nThe following table provides information as of December 31, 1994, with respect to the executive officers of the registrant:\nShares of common stock Executive Officers Officer beneficially Name and age Principal positions since owned _______________________________________________________________________________\nAubrey W. Lippert, Chairman of the Board, 1983 173,976(1) age 54 President and Chief Executive of the registrant; Chairman of the Board and Chief Executive Officer, Peoples Bank\nSteve Kight, Vice President of the regis- 1983 97,568(2) age 43 trant; formerly Director, President and Chief Operating Officer of Peoples Bank\nAllan B. Kleet, Chief Financial Officer, 1986 54,580(3) age 46 Treasurer and Director of the registrant\nGeorge Shaw, Director, President and Chief 1993 2,200(4) age 49 Operating Officer of Peoples Bank; formerly President and Chief Executive Officer of Bowling Green Bank & Trust Company (1982-05\/93)\n(1) Represents 2.1% of the class of stock. Includes 98,300 shares subject to currently exercisable stock options and 20,054 shares held in Mr. Lippert's ESOP account for which he has voting but no dispositive power.\n(2) Represents 1.4% of the class of stock. Includes 15,248 shares held jointly by Mr. Kight and his wife, 76,280 shares subject to currently exercisable stock options and 6,040 shares held in Mr. Kight's ESOP account for which he has voting but no dispositive power.\n(3) Represents less than 1.0% of the class of stock. Includes 637 shares held individually by Mr. Kleet's wife, 49,800 shares subject to currently exercisable stock options and 2,776 shares held in Mr. Kleet's ESOP account for which he has voting but no dispositive power.\n(4) Represents less than 1.0% of the class of stock. Includes 2,000 shares subject to currently exercisable stock options\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information concerning compensation appearing on pages 8 through 12 of Peoples First Corporation's definitive proxy statement, filed with the Securities and Exchange Commission on March 10, 1995, is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to any person who is known to the registrant to be the beneficial owner of more than five percent of any class of the registrant's voting securities appearing in the tables and footnotes on page 2 and pages 3 through 6 of Peoples First Corporation's definitive proxy statement, filed with the Securities and Exchange Commission on March 10, 1995, is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information in the second narrative paragraph on page 8 of Peoples First Corporation's definitive proxy statement, filed with the Securities and Exchange Commission on March 10, 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 are incorporated herein by reference, and listed in Item 8 hereof.\n(2) Financial Statement Schedules - None\n(3) List of Exhibits filed with original:\n(3.1) Amended and Restated Articles of Incorporation of Peoples First Corporation.\n(3.2) Bylaws and Amendments of Peoples First Corporation are incorporated herein by reference to Exhibit 3(b) to the Registrant's Form 10-K for the year ended December 31, 1992.\n(4) May, 1992 indenture, from Peoples First Corporation to The Paducah Bank & Trust Company, relating to the 7.25% Subord- inated Short-Term Notes due 1994, is incorporated herein by reference to Exhibit 4.1 of Form S-4, registration No. 33-44235 as filed with the Securities and Exchange Commis- sion on January 8, 1992.\n(10.1)Peoples First Corporation 1986 Stock Option Plan is incorporated herein by reference to Exhibit 10 to Form 10-Q\/A for the quarter ended March 31, 1994.\n(10.3)Consulting agreement between Bank of Murray and Mr. Joe Dick is herein incorporated by reference to Exhibit 10.1 of Form S-4, registration #33-44235 as filed with the Securities and Exchange Commission on January 8, 1992.\n(10.2)Employment agreement between First Kentucky Federal Savings Bank and Dennis W. Kirtley is herein incorporated by reference to Exhibit 10.1 of Form S-4, registration #33-51741 as filed with the Securities and Exchange Commission on December 29, 1993.\n(21) Subsidiaries of Registrant.\n(23) Consent of KPMG Peat Marwick LLP, independent public accountants.\n(27) Financial Data Schedules.\n(99) Undertakings.\n(b) Reports on Form 8-K\nPeoples First Corporation filed a current report on Form 8-K dated January 18, 1995 on January 18, 1995 to report the Board of Director's declaration of a dividend of one Junior Participating Preferred Stock Purchase Right on each outstand- ing share of the Registrant's common stock.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPEOPLES FIRST CORPORATION\nDate: 03\/23\/95 \/s\/ Aubrey W. Lippert Aubrey W. Lippert President and Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant, in the capacities and on the dated indicated.\nSignature Title Date _____________________ ______________________ ________\n\/s\/ Aubrey W. Lippert President and Chairman 03\/23\/95 Aubrey W. Lippert of the Board\n\/s\/ Allan B. Kleet Chief Financial Officer 03\/23\/95 Allan B. Kleet\n\/s\/ William R. Dibert Director 03\/23\/95 William R. Dibert\n\/s\/ Joe Dick Director 03\/23\/95 Joe Dick\n\/s\/ Richard E. Fairhurst, Jr. Director 03\/23\/95 Richard E. Fairhurst, Jr.\n\/s\/ William Rowland Hancock Director 03\/23\/95 William Rowland Hancock\n\/s\/ Dennis W. Kirtley Director 03\/23\/95 Dennis W. Kirtley\n\/s\/ Jerry L. Page Director 03\/23\/95 Jerry L. Page\n\/s\/ Rufus E. Pugh Director 03\/23\/95 Rufus E. Pugh\n\/s\/ Victor F. Speck, Jr. Director 03\/23\/95 Victor F. Speck, Jr.\nINDEX TO EXHIBITS Page _______________________________________________________________________________\n(3.1) Amended and Restated Articles of Incorporation of Peoples First Corporation 65\n(21) Subsidiaries of Registrant 76\n(23) Consent of KPMG Peat Marwick LLP, independent public accountants 77\n(27) Financial Data Schedules 78\n(99) Undertakings 80","section_15":""}
{"filename":"11454_1994.txt","cik":"11454","year":"1994","section_1":"ITEM 1. BUSINESS\nA. General Development of Business -------------------------------\nBergen Brunswig Corporation, a New Jersey corporation formed in 1956, and its subsidiaries (collectively, the \"Company\"), are a diversified drug and health care distribution organization and, as such, one of the nation's largest distributors of products sold by pharmacies.\nOn February 9, 1994, the Board adopted a Shareowner Rights Plan pursuant to which a dividend of one Preferred Share Purchase Right (the \"Rights\") was declared for each share of Common Stock outstanding at the close of business on February 18, 1994 as well as for each share of Common Stock issued between such record date and the Distribution Date (as defined in the Shareowner Rights Plan). The Shareowner Rights Plan is more fully described in Item 5 of this Annual Report.\nOn February 24, 1994, in accordance with the provisions of the Recapitalization Plan approved by the Company's shareowners on January 31, 1989, all of the 100,492 then outstanding shares of the Company's Class B Stock were automatically converted into shares of the Company's Class A Common Stock at the stated conversion rate of 9.5285 shares of Class A Common Stock for each share of Class B Common Stock. All Class B Common Stock was subsequently cancelled.\nEffective October 1, 1993, the Company changed its fiscal year from a twelve-month period ending August 31 to a twelve-month period ending September 30. This change in fiscal year is more fully described in Note 1 of Notes to Consolidated Financial Statements appearing in Part II, Item 8, \"Financial Statements and Supplementary Data,\" of this Annual Report.\nEffective September 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). The effect of initially adopting SFAS 109 was accounted for as a cumulative effect of an accounting change of $8.7 million, or $0.24 per share, recorded in September 1993. The adoption of this Statement is more fully described in Note 7 of Notes to Consolidated Financial Statements appearing in Part II, Item 8, \"Financial Statements and Supplementary Data,\" of this Annual Report.\nOn September 15, 1992, the Company entered into a credit agreement (the \"Credit Agreement\") with a group of banks providing the Company with a three-year $300 million unsecured revolving line of credit for payment in connection with the acquisition of Durr-Fillauer Medical, Inc. and subsidiaries (\"Durr\") and to be used for general working capital purposes of the Company. On\nI - 1\nOctober 7, 1994, the Credit Agreement, was amended to, among other things, increase the maximum borrowing to $350 million and to extend the maturity date to September 15, 1997. Borrowings outstanding under the Credit Agreement were $40 million at September 30, 1994. The maximum outstanding borrowing under the Credit Agreement for the year ended September 30, 1994 was $270 million.\nOn April 29, 1994, the Company completed the acquisition of Southeastern Hospital Supply Corporation (\"Southeastern\"), a privately held medical supply distributor located in Fayetteville, North Carolina, for 747,422 shares, previously held as Treasury shares, of the Company's Class A Common Stock valued at approximately $12.6 million and the assumption of approximately $6.7 million of debt by the Company, which was paid by the Company on the acquisition date. The Southeastern acquisition is more fully described in Note 4 of Notes to Consolidated Financial Statements appearing in Part II, Item 8, \"Financial Statements and Supplementary Data\" of this Annual Report.\nOn August 31, 1994, the Company completed the acquisition of certain net assets of Professional Medical Supply Co., a privately held medical-surgical supply distributor located in Denver, Colorado, for approximately $2.4 million in cash.\nOn November 17, 1994, the Company announced that it had signed a definitive merger agreement to acquire Biddle & Crowther Company, a privately-held medical-surgical supply distributor headquartered in Seattle, Washington, in exchange for the Company's Class A Common Stock valued at approximately $13.0 million. The Company estimates a closing in early January 1995.\nDuring the fourth quarter of fiscal 1993, the Company approved a restructuring plan which consists of an accelerated consolidation of pharmaceutical distribution facilities into larger, more efficient regional distribution centers, the merging of duplicate operating systems, the reduction of administrative support in areas not affecting valued services to customers and the discontinuance of services and programs that do not meet the Company's strategic and economic return objectives. The estimated pre-tax cost of the restructuring plan is $33.0 million. The restructuring charge represents the costs associated with restructure, primarily abandonment and severance. For those activities or assets where the disposal is expected to result in a gain, no gain will be recognized until realized. During fiscal 1994, the Company incurred costs of approximately $13.1 million related to the restructuring plan.\nDuring the quarter ended March 31, 1994, the Company recorded a pre-tax charge of $1.4 million ($0.8 million after tax) for the uninsured\nI - 2\nportion of an earthquake loss sustained by the Company's Valencia, California Regional Distribution Center on January 17, 1994.\nIn November 1993, the Company announced that it had applied for a listing of its Class A Common Stock and various debt securities on the New York Stock Exchange(\"NYSE\"). Trading on the NYSE began on December 16, 1993 with the same trading symbol, BBC.\nB. Narrative Description of Business ---------------------------------\nBergen Brunswig Drug Company (the \"Drug Company\") is one of the largest national distributors of products sold by institutional (hospital) and retail pharmacies. The Drug Company distributes from 33 locations in 23 states a full line of products, including pharmaceuticals, proprietary medicines, cosmetics, toiletries, personal health products, sundries, and home healthcare supplies and equipment. These products are sold to a large number of hospital pharmacies, managed care facilities, health maintenance organizations (\"HMO's\"), independent retail pharmacies, pharmacy chains, supermarkets, food-drug combination stores and other retailers located in over 44 states, Guam and Mexico. During fiscal 1994, no single customer or affiliated group of customers of the Drug Company accounted for more than 10% of its net sales and other revenues. However, purchasing groups are expected to represent increasing percentages of total sales in the future. The Drug Company is required to carry significant amounts of inventory to meet the rapid delivery requirements of its customers.\nThe Drug Company has been an innovator in the development and utilization of computer-based retailer order entry systems and of electronic data interchange (\"EDI\") systems including computer-to-computer ordering systems with suppliers. During fiscal 1994, substantially all of Bergen Brunswig Drug Company's orders received from customers were received via electronic order entry systems. These systems, combined with daily delivery, improve customers' cash and inventory management and profitability by freeing them from the burden of maintaining large inventories. Although these systems require capital expenditures by the Company, benefits from these systems to the Drug Company are expected to be realized through increased productivity. The Drug Company is expanding its electronic interface with its suppliers and now electronically processes a substantial portion of its purchase orders, invoices and payments. The Drug Company has opened seven regional distribution centers (\"RDCs\") since fiscal 1986, replacing 18 older, less efficient facilities. These facilities will service 45% of the Drug Company sales volume in 1995. The newest RDC was opened in November 1994 in Richmond, Virginia, and, similar to the Corona and Valencia, California facilities, exceeds 200,000 square feet and utilizes a highly automated order-picking system. The Richmond RDC has the ability to automatically pick 90% of its orders.\nI - 3\nIn July 1994, the Company introduced AccuSourceTM, a multimedia communication, product information, and electronic ordering system for pharmacies. AccuSource was developed jointly by the Drug Company and Apple Computer and is the first link of its kind between supplier, wholesaler and retailer in the pharmaceutical distribution process. AccuSource simplifies the ordering process and gives retailers detailed information on thousands of products, services and special purchase opportunities as well as prescription substitution alternatives and Medicaid coverage information. AccuSource's on-line feature provides retailers with a convenient method for ensuring product availability by giving immediate information on quantity levels at their Drug Company distribution center.\nThe Drug Company also provides a wide variety of promotional, advertising, merchandising, and marketing assistance to independent community pharmacies. For example, the Good Neighbor PharmacyTM program utilizes circular and media advertising to strengthen the consumer image of the independent pharmacy without sacrificing its local individuality. Other programs for the independent community pharmacy include in-store merchandising programs, private label products, shelf management systems, pharmacy computers and a fully integrated point-of-sale system marketed under the Drug Company's trademark of OmniPhaseTM.\nHospital and other institutional accounts are offered a wide variety of inventory management and information services by the Drug Company to better manage inventory investment and contain costs. Accu NetR allows customers to customize their own reports and use it to complement the on-line real-time PRIMELINESM order entry system which was introduced in December 1989.\nDurr Medical Corporation, Southeastern and Professional Medical Supply Co., collectively \"Medical\", wholly-owned subsidiaries of the Company, distribute a variety of medical and surgical products to individual hospitals and alternate site health providers through 20 distribution centers located in 15 states in the southeastern, southwestern and northwestern regions of the United States.\nMedical serves hospital customers and alternate site customers in 39 states. Alternate site customers include outpatient clinics, nursing homes, surgery centers, dialysis and oncology centers, emergency centers, laboratories and veterinary clinics. Medical's distribution centers range between 14,000 and 70,000 square feet and average 30,000 square feet. Medical employs approximately 850 people.\nI - 4\n1. Competition\nThe Drug Company, which is the second largest national pharmaceutical distributor measured by sales, faces intense competition from other national pharmaceutical distributors, as well as regional and local full-line and short-line distributors, direct selling manufacturers, rack jobbers and specialty distributors. The principal competitive factors of the Drug Company's business are service and price.\n2. Employees\nAs of November 30, 1994, the Company employed approximately 4,250 people, including Medical. The Company considers its relationship with its employees and the unions representing certain of its employees to be satisfactory.\n3. Other\nWhile the Company's operations may show quarterly fluctuations, the Company does not consider its business to be seasonal in nature on a consolidated basis.\nAlthough the Company's computer service operations expend time and effort on the development and marketing of computer programs relating to the services for its subsidiaries, which are described in part elsewhere herein, the Company has not, during the past three fiscal years, expended any material amounts on research and development.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nBecause of the nature of the Company's business, office and warehousing facilities are operated in widely dispersed locations in the United States. Some of the facilities are owned by the Company, but most are leased on a long-term basis. The Company considers its operating properties to be in satisfactory condition and well utilized with adequate capacity for growth. In connection with a restructuring plan, which is being implemented over an approximate 18-month period, certain facilities are being consolidated and others are being automated to serve a larger geographic area.\nFor certain financial information regarding the Company's warehouse and office leases, see Note 6 of Notes to Consolidated Financial Statements appearing in Part II, Item 8, \"Financial Statements and Supplementary Data,\" of this Annual Report.\nI - 5\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn November 2, 1988, Aline K. Hayle instituted legal proceedings (\"Hayle Complaint\") in the Orange County Superior Court (State of California), which was consolidated with related proceedings instituted on November 14, 1988 in the same court by Martin Bergstein. The Hayle Complaint names the Company as a nominal defendant, and further names as defendants certain officers who are also directors of the Company as well as seven independent Company directors. This complaint seeks damages and other relief with respect to actions allegedly taken by the defendants in connection with the Company's recapitalization plan, said plan having been approved by the Company's shareowners in January 1989. On March 16, 1994, the Court gave its preliminary approval for the settlement of this matter and approved the form of notice to be sent to all shareowners. On September 7, 1994, an Order and Final Judgment was signed approving the settlement of the class and derivative litigation. Under the order, the Company became obligated to pay the plaintiff's attorneys the sum of $446,000 for fees, expenses and interest, and Robert E. Martini and the Estate of Emil P. Martini, Jr. each agreed to transfer to the Company 15,000 shares of the Company's Class A Common Stock. The Estate of Emil P. Martini, Jr. was also given the option, in lieu of the transfer of 15,000 shares of Class A Common Stock, to pay the Company in cash the sum of $294,000.\nOn July 7, 1992, two putative class action complaints were filed in the Delaware Court of Chancery against Durr and its directors: Steiner v, Adair, et al., C.A. No. 12634 and Goldwurm v. Adair, et al., C.A. No. 12635. These actions were consolidated on July 15, 1992. On July 17, 1992, another putative class action complaint was filed in the Delaware Court of Chancery against Durr and its directors: Trief v. Adair, et al., C.A. No. 12648. This action was consolidated with C.A. Nos. 12634 and 12635 on August 7, 1992. The named plaintiffs in the three complaints (the \"Class Action Complaints\") allegedly owned an undisclosed number of shares of Durr common stock. The plaintiffs sought certification of a class consisting of all public stockholders of Durr who held Durr stock at the time of the filing of the Class Action Complaints and who were not affiliated with any of the defendants. The Class Action Complaints alleged, among other things, that Durr's directors breached their fiduciary duties in entering into a June 2, 1992, Agreement and Plan of Reorganization which contemplated the merger of Durr's wholesale drug business with Cardinal Distribution, Inc. (\"Cardinal\") and the spin-off of Durr's remaining businesses into a newly formed entity (the \"Cardinal Acquisition\"). The Class Action Complaints sought a variety of relief, including: an injunction requiring the Durr directors to consider competing offers, damages, attorneys fees and costs.\nIn connection with the acquisition of Durr, and for the purpose of settling the expressed concern of the Attorneys General of the States of\nI - 6\nAlabama, Florida and Louisiana (collectively, the \"Attorneys General\") over the alleged potential lessening of competition in the wholesale distribution of pharmaceutical products, the Company and Durr entered into an agreement dated September 18, 1992, with the Attorneys General wherein the Company agreed that (1) subject to certain exceptions, no existing customer of either the Company or Durr in Alabama, Florida and Louisiana (the \"Customers\") will suffer a diminution of service levels until April 30, 1997, (2) except for price increases resulting from taxes, fees or governmental charges, neither the Company nor Durr will increase the markup percentage for the Customers in Alabama, Florida and Louisiana for a period of two years and from September 1994 through April 1997 will not increase such percentage in excess of the percentage increase in the Consumer Price Index; (3) Durr will maintain its distribution facilities in Montgomery and Mobile, Alabama; Lakeland, Florida; and Shreveport, Louisiana for a period of at least two years; (4) Durr will maintain and enhance its Accu NetR system for a period of at least two years; and (5) the Company will reimburse the States of Alabama, Florida and Louisiana for their legal fees, costs and expenses incurred in the investigation of the acquisition of Durr by the Company.\nDrug Barn, Inc. (\"Drug Barn\"), a former retail pharmacy chain in the San Francisco Bay Area, currently with two operating stores, owed the Company approximately $6.2 million in principal obligations as of October 31, 1994, of which approximately $1.2 million represents trade receivables and $5.0 million represents a note which matured on March 25, 1993 and has not been paid to date. The Company has a security interest in virtually all of Drug Barn's assets, as well as personal guaranties, which collaterize the note and trade receivables.\nIn May 1992, Drug Barn requested additional financing which the Company denied to extend. In December 1992, Drug Barn commenced an action against the Company in the Santa Clara Superior Court (State of California) alleging breach of contract, misrepresentation and violations of certain California antitrust and unfair practices laws. Drug Barn seeks a variety of damage claims including compensatory, treble and punitive damages, an injunction against collection on the note, and declaratory judgment as to Drug Barn's rights under the alleged oral joint venture agreement with the Company.\nOn April 20, 1993, the Company filed a complaint in the Orange County Superior Court (State of California), Case No. 709136 against Drug Barn and Milton Sloban and Barbara Sloban, as guarantors on the defaulted note and open trade receivables, alleging breach of contract and guaranty, and requesting judicial foreclosure of and the possession of collateral.\nDrug Barn commenced a Chapter 11 case in U.S. Bankruptcy Court for the Northern District of California, Case No. 93-3-3437 TC, by filing a voluntary\nI - 7\npetition for relief under Chapter 11 of the United States Code on July 29, 1993 and remains in possession pursuant to 11 U.S.C. Section 1107. The effect of this filing is that the Company's action against Drug Barn has been automatically stayed.\nIn April 1994, this matter was transferred to the San Francisco County Superior Court with the California state actions referenced in the next paragraph and the trial date was vacated.\nBetween August 3, 1993 and February 14, 1994, the Company, along with various other pharmaceutical industry-related companies, was named as a defendant in eight separate state antitrust actions in three courts in California. These lawsuits are more fully detailed in \"Item 3 - Legal Proceedings\" of Part I of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 as filed with the Securities and Exchange Commission and is incorporated herein by reference. In April 1994, these California state actions were all coordinated as Pharmaceutical Cases I, II and III, and assigned to a single judge in San Francisco Superior Court. On August 22, 1994, a Consolidated Amended Complaint (\"California Complaint\"), which supersedes and amends the eight prior complaints, was filed in these actions.\nThe California Complaint alleges that the Company and 35 other pharmaceutical industry-related companies violated California's Cartwright Act, Unfair Practices Act, and the Business and Professions Code unfair competition statute. The California Complaint alleges that defendants jointly and separately engaged in secret rebating, price fixing and price discrimination between plaintiffs and plaintiffs' alleged competitors who sell pharmaceuticals to patients or retail customers. Plaintiffs seek, on behalf of themselves and a class of similarly situated California pharmacies, injunctive relief and treble damages in an amount to be determined at trial. The judge recently struck the class allegations from the Unfair Practices Act claims.\nBetween August 12, 1993 and November 29, 1993, the Company was also named in 11 separate Federal antitrust actions. All 11 actions were consolidated into one multidistrict action in the Northern District of Illinois entitled, In Re Brand-Name Prescription Drugs Antitrust Litigation, No. 94 C. 897 (MDL 997). On March 7, 1994, plaintiffs in these 11 actions filed a consolidated amended class action complaint (\"Federal Complaint\") which amended and superseded all previously Federal complaints against the Company. The Federal Complaint names the Company and 30 other pharmaceutical industry-related companies. The Federal Complaint alleges, on behalf of a nationwide class of retail pharmacies, that the Company conspired with other wholesalers and manufacturers to discriminatorily fix prices in violation of Section 1 of the\nI - 8\nSherman Act. The Federal Complaint seeks injunctive relief and treble damages. On November 15, 1994, the federal court certified the class defined in the Federal Complaint for the time period October 15, 1989 to the present. These lawsuits are more fully detailed in \"Item 3 - Legal Proceedings\" of Part I of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994 as filed with the Securities and Exchange Commission and is incorporated herein by reference.\nOn April 29, 1994, Durr Drug Company (a subsidiary of the Company) was named as a defendant, along with 17 other parties, in a class action in the Circuit Court of Bullock County, Alabama entitled Main Drug Company v. The UpJohn Company, et al., No. CV-94-37. This case was voluntarily dismissed on October 31, 1994. On May 2, 1994, the Company and Durr Drug Company were named as defendants, along with 25 other pharmaceutical related-industry companies, in a state antitrust class action in the Circuit Court of Greene County, Alabama entitled Durrett v. UpJohn Company, et al., No. 94-029 (\"Alabama Complaint\"). The Alabama Complaint alleges on behalf of a class of Alabama retail pharmacies and a class of Alabama consumers that the defendants conspired to discriminatorily fix prices to plaintiffs at artificially high levels. The Alabama Complaint seeks injunctive relief and treble damages.\nOn October 21, 1994, the Company entered into a sharing agreement with five other wholesalers and 26 pharmaceutical manufacturers. Among other things, the agreement provides that: (a) if a judgment is entered into against both the manufacturer and wholesaler defendants, the total exposure for joint and several liability of the Company is limited to $1,000,000; (b) if a settlement is entered into by, between, and among the manufacturer and wholesaler defendants, the Company has no monetary exposure for such settlement amount; (c) the six wholesaler defendants will be reimbursed by the 26 pharmaceutical defendants for related legal fees and expenses up to $9,000,000 total (of which the Company will receive a proportionate share) and (d) the Company is to release certain claims which it might have had against the manufacturer defendants for the claims presented by the plaintiffs in these cases. The agreement covers the Federal court litigation as well as the cases which have been filed in various state courts. In December 1994, plaintiffs in the Federal action have moved to set aside the agreement. The Company believes the agreement is enforceable and intends to vigorously oppose this motion. After discussions with counsel, management of the Company believes that the allegations of liability set forth in these lawsuits are without merit as to the wholesaler defendants and that any attendant liability of the Company, although unlikely, would not have a material adverse effect on the Company's financial condition.\nI - 9\nThe Company is involved in various additional items of litigation. Although the amount of liability at September 30, 1994 with respect to these items of litigation cannot be ascertained, in the opinion of management, any resulting future liability will not 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\nNo matter was submitted to a vote of shareowners during the three months ended September 30, 1994.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nIdentification of Executive Officers.\nThe executive officers of the Company are elected by and serve at the pleasure of the Board of Directors. Each executive officer holds office until the next annual election of officers held in December or January of each year. The current executive officers of the Company, and their respective principal occupations and employment during the last five years ended September 30, 1994, are listed alphabetically as follows:\nJohn Calasibetta, 89, Senior Vice President since 1974. Mr. Calasibetta is also a member of the Board of Directors.\nNeil F. Dimick, 45, Executive Vice President (since April 1992), Chief Financial Officer (since 1991); formerly Vice President, Finance (1991-1992); formerly Partner, Deloitte & Touche LLP (1984-1991), the Company's independent auditors.\nPhillip R. Engle, 54, Executive Vice President, Supplier Relations and Operations (since February 1994); formerly President, Drug Operations (1992-1994), President, Bergen Brunswig Drug Company (1985-1994); formerly Vice President, Pharmaceutical Distribution (1986-1992).\nRobert E. Martini, 62, Chairman of the Board (since April 1992) and Chief Executive Officer (since 1990); formerly President (1981-1992). Mr. Martini is also a member of the Board of Directors.\nJohn P. Naughton, 56, Vice President and Controller of Bergen Brunswig Drug Company since 1981.\nI - 10\nMilan A. Sawdei, 48, Secretary (since July 1992); Executive Vice President (since April 1992), Chief Legal Officer (since 1989); formerly Vice President and Assistant Secretary (1989-1992); formerly Director, Legal Affairs\/Senior Counsel (1987-1989).\nEric J. Schmitt, 44, Vice President, Finance and Treasurer (since February 1994); Vice President, Financial Planning (1989-1994).\nDenny W. Steele, 51, Executive Vice President, Chief Information Officer (since April 1992); formerly Vice President, Corporate Information Resources (1990-1992); formerly Group Director, Corporate Information Resources (1989-1990).\nDwight A. Steffensen, 51, President (since April 1992) and Chief Operating Officer (since 1990); formerly Executive Vice President (1985-1992). Mr. Steffensen is also a member of the Board of Directors.\nI - 11\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nFor certain information regarding shares of the Company's Class A Common Stock, including cash dividends per share, market prices per share, stock market information and number of shareowners, and cash dividend information for shares of Class B Common Stock, see \"Selected Quarterly Results (unaudited)\" as set forth in Part II, Item 8, \"Financial Statements and Supplementary Data,\" of this Annual Report. Shares of the Company's Class B Common Stock were not publicly traded but were convertible into shares of the Company's Class A Common Stock at a conversion rate of 9.5285 shares of Class A Common Stock for each share of Class B Common Stock.\nOn February 24, 1994, in accordance with the provisions of the Recapitalization Plan approved by the Company's shareowners on January 31, 1989, all of the 100,492 then outstanding shares of the Company's Class B Common Stock were automatically converted into shares of the Company's Class A Common Stock at the stated conversion rate of 9.5285 shares of Class A Common Stock for each share of Class B Common Stock. All Class B Common Stock was subsequently cancelled.\nOn February 9, 1994, the Board adopted a Shareowner Rights Plan pursuant to which a dividend of one Preferred Share Purchase Right (the \"Rights\") was declared for each share of Common Stock outstanding at the close of business on February 18, 1994 as well as for each share of Common Stock issued between such record date and the Distribution Date (as defined below). The Rights, unless earlier redeemed, will expire on February 18, 2004. Prior to such expiration date, the Rights are redeemable by the Company for $0.01 per Right at any time prior to 10 days after the Stock Acquisition Date (as defined below). The Rights are not exercisable until 10 days after the first date (the \"Stock Acquisition Date\") of public announcement by the Company or an Acquiring Person (as defined below) that a person or group has become the beneficial owner of 15% or more of the Common Stock without the prior approval of the Company's Board of Directors (an \"Acquiring Person\") or (unless the Board postpones the Distribution Date) 10 days after any person or group announces a tender offer as a result of which, if consummated, there would be an Acquiring Person (a \"Distribution Date\"). Upon a Distribution Date, the Rights would separate from the underlying Common Stock and entitle all holders (except for any Acquiring Person and its associates, affiliates and transferees) to purchase, for an initial exercise price (subject to possible future adjustment) of $80.00 (the \"Exercise Price\"), either 1\/100th of a share of a new series of the Company's Series A Junior Preferred Stock or, if the Distribution Date occurs as a result\nII - 1\nof the occurrence of a Stock Acquisition Date, Common Stock having twice the aggregate market value of the Exercise Price. All holders of Rights, other than the Acquiring Person and its affiliates, associates and transferees, would also be entitled to purchase Common Stock having twice the aggregate market value of the Exercise Price if the Company was the surviving corporation in a merger with an Acquiring Person and its Common Stock was not changed, an Acquiring Person engaged in one or more \"self-dealing\" transactions or, during such time as there was an Acquiring Person, an event occurred which increased such Acquiring Person's ownership interest by more than 1%.\nIf, at any time after there was an Acquiring Person, the Company was acquired in a business combination in which it was not the surviving corporation or 50% or more of its assets or earning power was transferred, all holders of Rights, other than any Acquiring Person and its affiliates, associates and transferees, would be entitled to purchase, for the Exercise Price, Common Stock of the acquiring company having twice the aggregate market value of the Exercise Price.\nII - 2\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations 1994 Compared with 1993.\nNet sales and other revenues from continuing operations in fiscal 1994 were 10% higher than 1993 while operating earnings and pre-tax earnings from continuing operations showed increases of 63% and 103%, respectively. Major influences which impacted operating and pre-tax earnings from continuing operations for 1994 were a charge of $1.4 million for the uninsured portion of an earthquake loss incurred in the second quarter of fiscal 1994, and a gain recognized from the sale of investment securities of $5.1 million in the third and fourth quarters of fiscal 1994. See Note 12 of Notes to Consolidated Financial Statements. Major influences which impacted operating earnings and pre-tax earnings from continuing operations for 1993 were the unusual provisions totaling $35.5 million for the restructuring plan announced in September 1993 and the costs associated with the termination of the bid for Office Commercial Pharmaceutique recorded in the fourth quarter of fiscal 1993.\nOf the 10% increase in net sales and other revenues, approximately 1% in the aggregate is attributable to the acquisitions of Southeastern Hospital Supply Corporation (\"Southeastern\") in April 1994, Dr. T.C. Smith Company (\"T.C. Smith\") in November 1992 and Healthcare Distributors of Indiana, Inc. (\"HDI\") in January 1993. Approximately 9% of the net sales and other revenues increase reflects internal growth within the Company's existing pharmaceutical distribution business.\nPrimary and fully diluted earnings per share from continuing operations both increased 92% compared to 1993. The average number of common and common equivalent shares outstanding increased 1% and decreased 7% for primary and fully diluted earnings per share computations, respectively. The uninsured earthquake-related charge and investment gain for 1994 referred to above were equivalent to $0.06 per fully diluted share from continuing operations. The unusual charge and costs referred to above for 1993 were equivalent to $0.59 per fully diluted share from continuing operations. See Note 12 of Notes to Consolidated Financial Statements. The decrease in the average number of common and common equivalent shares used for computing fully diluted earnings per share in 1994 was primarily due to the redemption of the Company's Liquid Yield OptionTM Notes (\"LYONs\") in February 1993.\nCost of sales increased 10% compared to 1993 due mainly to the Company's increased sales levels. The overall gross margin as a percentage of net sales and other revenues decreased due to continued price competition and reduced opportunities for investment buying. In the pharmaceutical distribution\nII - 4\nindustry, it has been customary to pass on to customers price increases from manufacturers. Investment buying enables distributors such as the Company to benefit from anticipated price increases. The rate or frequency of future price increases by manufacturers, or lack thereof, does influence the profitability of the Company. The effect of reduction in price increases in the comparison of fiscal 1994 to fiscal 1993 was partially offset by the use of the LIFO method of accounting for inventory costs.\nManagement of the Company anticipates further downward pressure on gross margins in the Company's pharmaceutical distribution business during fiscal year 1995 because of continued price competition influenced by large buying groups, reduced opportunities for investment buying and continuing political pressures on the health care industry. The Company expects that these pressures on margins may be offset to some extent by continued reductions in distribution, selling, general and administrative expenses as a percentage of net sales and other revenues through improved operating efficiencies.\nDistribution, selling, general and administrative expenses, including the earthquake-related charge in 1994 and the unusual charges in 1993, decreased 9% over 1993, while net sales and other revenues increased 10% over the prior year. These expenses decreased as a percentage of net sales and other revenues from 5.3% in fiscal 1993 to 4.4% in fiscal 1994. The decrease in the current year reflects operating efficiencies achieved from the positive effects of the Company's restructuring plan adopted for its pharmaceutical distribution business in the fourth quarter of fiscal 1993 and the continuing consolidation of distribution divisions into larger regional distribution centers.\nNet interest expense, excluding the aforementioned unusual investment gain, increased from $22.7 million in 1993 to $23.0 million in 1994, primarily due to a lower cash investment base in 1994, partially offset by decreased interest on borrowings under the Credit Agreement.\nThe extraordinary after-tax loss for fiscal 1993 of $2.6 million (net of the related income tax benefit of $1.8 million) was recorded in connection with the redemption of the LYONs due 2004 as reported in Note 2 of Notes to Consolidated Financial Statements.\nThe effective tax rate for 1994 increased to 42.80% from 40.72% in 1993 reflecting, primarily, higher non-deductible goodwill amortization and lower non-taxable investment income in fiscal 1994.\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,\" which will require the Company to classify its\nII - 5\ninvestments in debt securities into three categories and to account for them as follows: (1) debt securities that the Company has the intent and ability to hold to maturity will be classified as \"held-to-maturity securities\" and reported at amortized cost; (2) debt securities that are bought and held principally for the purpose of selling them in the near term will be classified as \"trading securities\" and reported at fair value, with unrealized gains and losses included in earnings; and (3) debt securities not classified as held-to-maturity securities or trading securities will be classified as \"available for sale securities\" and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareowners' equity. This Statement became effective for the Company on October 1, 1994. It is expected that implementation will not result in any material change in the Company's consolidated financial position or results of operations.\nInflation, while not as significant as in previous years, is a factor and the Company is continually seeking ways to manage its impact. The Company uses the LIFO method of accounting for inventory which reduces the effects of inflation by reporting the cost of products sold at approximate current cost. Management of the Company has successfully limited the impact of inflation on operating expense by improving productivity and increasing sales volume.\nResults of Operations 1993 Compared with 1992.\nNet sales and other revenues from continuing operations in fiscal 1993 were 35% higher than 1992 while operating earnings and pre-tax earnings from continuing operations showed decreases of 21% and 42%, respectively. Major influences which impacted operating earnings and pre-tax earnings from continuing operations for 1993 were the unusual provisions totaling $35.5 million for the restructuring plan announced in September 1993 and the costs associated with the termination of the bid for Office Commercial Pharmaceutique recorded in the fourth quarter of fiscal 1993.\nOf the 35% increase in net sales and other revenues, approximately 22% is attributable to the acquisition of Durr-Fillauer Medical, Inc. (\"Durr\") in September 1992 and approximately 6% in the aggregate is attributable to the acquisition of substantially all of the pharmaceutical distribution business of Owens & Minor, Inc., in February 1992 and the acquisitions of T.C. Smith and HDI in November 1992 and January 1993, respectively. Approximately 7% of the net sales and other revenues increase reflects internal growth within the Company's existing pharmaceutical distribution business.\nPrimary and fully diluted earnings per share from continuing operations decreased 44% and 42%, respectively, compared to 1992 on decreases of\nII - 6\n4% and 12%, respectively, in the average number of common and common equivalent shares outstanding. The unusual charge and costs referred to above were equivalent to $0.59 per fully diluted share from continuing operations. See Note 12 of Notes to Consolidated Financial Statements. The decrease in the average number of common and common equivalent shares used for computing fully diluted earnings per share in 1993 was primarily due to the redemption of the Company's LYONs in February 1993.\nA major influence which impacted operating earnings and pre-tax earnings from continuing operations for 1992 was a provision of $8.0 million for probable losses recorded in the first quarter of fiscal 1992 in connection with credit extended to certain customers. This charge was equivalent to $0.11 per fully diluted share from continuing operations.\nCost of sales increased 35% compared to 1992 due mainly to the Company's increased sales levels. The overall gross margin as a percentage of net sales and other revenues increased as a result of including the higher margins of Durr's medical supply business, partially offset by a decline in the Company's pharmaceutical distribution's gross margins. The decline in the Company's pharmaceutical distribution's gross margins was due to accelerated price competition and reduced opportunities for investment buying. In the pharmaceutical distribution industry, it has been customary to pass on to customers price increases from manufacturers. Investment buying enables distributors such as the Company to benefit from anticipated price increases. The rate or frequency of future price increases by manufacturers, or the lack thereof, does influence the profitability of the Company. The effect of reduction in price increases in the comparison of fiscal 1993 to fiscal 1992 was partially offset by the use of the LIFO method of accounting for inventory costs.\nDistribution, selling, general and administrative expenses including the restructuring charge increased 59% over 1992 while net sales and other revenues increased 35% over the prior year. These expenses increased as a percentage of net sales and other revenues from 4.5% in 1992 to 5.3% in 1993. Had the Company not recorded the above-mentioned $35.5 million pre-tax provisions in the fourth quarter of fiscal 1993, distribution, selling, general and administrative expenses during the current year would have been 4.8% of net sales and other revenues. Had the Company not recorded the above-mentioned $8.0 million pre-tax bad debt provision in the first quarter of fiscal 1992, distribution, selling, general and administrative expenses during the prior year would have been 4.4% of net sales and other revenues. The comparable figure of 4.8% in fiscal 1993 reflects a higher rate of distribution, selling, general and administrative expenses associated with Durr's medical supply business and $6.9 million of expenses attributable to the amortization of goodwill resulting from\nII - 7\nthe Company's acquisition of Durr, partially offset by improvements in operating efficiencies.\nNet interest expense increased from $6.9 million in 1992 to $22.7 million in 1993, primarily due to interest on borrowings under the Credit Agreement as well as a lower cash investment base and lower short-term investment rates in 1993.\nEarnings from discontinued operations after taxes on income were $3.9 million in fiscal 1992 and relate to the discontinuance of Commtron Corporation (\"Commtron\"), the Company's former Home Entertainment business segment, as reported in Note 10 of Notes to Consolidated Financial Statements. The gain on disposition of Commtron of $4.0 million was recorded in the fourth quarter of fiscal 1992.\nThe extraordinary after-tax loss for fiscal 1993 of $2.6 million (net of the related income tax benefit of $1.8 million) was recorded in connection with the redemption of the LYONs due 2004 as reported in Note 2 of Notes to Consolidated Financial Statements.\nThe effective tax rate for 1993 increased to 40.72% from 36.49% in 1992 reflecting, primarily, higher non-deductible goodwill amortization and lower non-taxable investment income in fiscal 1993.\nDuring fiscal 1993, the Company adopted Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" which requires disclosure of fair value of financial instruments recognized or not recognized in the balance sheet. See Note 13 of Notes to Consolidated Financial Statements.\nFinancial Condition.\nAt September 30, 1994, capitalization consisted of 41% debt and 59% shareowners' equity, the same as at August 31, 1993. On October 7, 1994, the Credit Agreement was amended to, among other things, increase the maximum borrowing to $350 million and to extend the maturity date to September 15, 1997. Borrowings outstanding under the Credit Agreement were $40.0 million at September 30, 1994. There were no borrowings outstanding under the Credit Agreement at August 31, 1993. Cash and cash equivalents of $5.3 million at September 30, 1994 decreased from $55.0 million at August 31, 1993.\nOn April 29, 1994, the Company acquired Southeastern, a medical supply distributor. The transaction included issuance of 747,422 shares, previously held as Treasury shares, of the Company's Class A Common Stock and the\nII - 8\nassumption of certain liabilities. See Note 4 of Notes to Consolidated Financial Statements.\nEffective September 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). This Statement changed the Company's method of accounting for income taxes from the deferred method to an asset and liability method. The effect of initially adopting SFAS 109 was accounted for as a cumulative effect of an accounting change of $8.7 million, or $0.24 per share, recorded in September 1993. See Notes 1 and 7 of Notes to Consolidated Financial Statements.\nOn September 1, 1993, the Company also adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\") which requires the cost of postretirement benefits other than pensions to be recognized on an accrual basis as employees perform services to earn such benefits. The Company had previously expensed postretirement benefits as paid. The estimated transition obligation of the Company, which is the accumulated postretirement benefit obligation at the date of adoption, amounted to approximately $2.1 million. This obligation is being recognized over 20 years. The impact of the Company's adoption of SFAS 106 is to increase each future year's annual benefits expense (assuming amortization of the transition obligation over 20 years) by $275,000.\nDuring 1994, the Company incurred costs of approximately $13.1 million related to the restructuring plan announced in September 1993.\nCapital expenditures for 1994 were $24.9 million and related principally to the expansion of the Company into new locations, the expansion of existing locations, the acquisition of automated warehouse equipment and additional investments in data processing equipment. Capital expenditures for 1995 are estimated to be approximately $27 million and will include additional investments in data processing and automated warehouse equipment as well as investments related to the consolidation and relocation of existing locations.\nOn February 24, 1994, in accordance with the provisions of the Recapitalization Plan approved by the Company's shareowners on January 31, 1989, all of the 100,492 then outstanding shares of the Company's Class B Stock were automatically converted into shares of the Company's Class A Common Stock at the stated conversion rate of 9.5285 shares of Class A Common Stock for each share of Class B Common Stock.\nDividends on Class A and Class B Common Stock amounted to $17.0 million in 1994 compared to $14.5 million in 1993, and $14.9 million in 1992, reflecting, primarily, a 20% increase in the quarterly dividend rate on both the\nII - 9\nClass A and Class B Common Stock during the second quarter of fiscal 1994. While the Company has no policy with regard to the payment of dividends, during the three-year period ended September 30, 1994, dividends have averaged 34% of earnings from continuing operations.\nThe Company's working capital increased from $186.1 million at August 31, 1993 to $254.3 million at September 30, 1994 and represented 13% of total assets at September 30, 1994. The Company's current ratio was 1.21 at September 30, 1994, compared to 1.18 at August 31, 1993. Trade receivables outstanding were 19 days for both 1994 and 1993. The inventory turnover rate on a FIFO basis was 6.9 times for 1994 and 7.5 times for 1993.\nThe Company believes that internally generated funds, funds available under the existing Credit Agreement and funds available under the existing shelf registration will be sufficient to meet anticipated cash and capital needs.\nII - 10\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended September 30, 1994, August 31, 1993 and 1992\n1. Summary of Significant Accounting Policies\nThe consolidated financial statements include the accounts of Bergen Brunswig Corporation and its subsidiaries (the \"Company\"), after elimination of the effect of intercompany transactions and balances.\nThe Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Other investments include primarily debt instruments, primarily variable rate demand notes having maturities of more than one year, and are stated at cost plus accrued interest.\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,\" which will require the Company to classify its investments in debt securities into three categories and to account for them as follows: (1) debt securities that the Company has the intent and ability to hold to maturity will be classified as \"held-to-maturity securities\" and reported at amortized cost; (2) debt securities that are bought and held principally for the purpose of selling them in the near term will be classified as \"trading securities\" and reported at fair value, with unrealized gains and losses included in earnings; and (3) debt securities not classified as held-to-maturity securities or trading securities will 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 shareowners' equity. This Statement became effective for the Company on October 1, 1994. It is expected that implementation will not result in any material change in the Company's consolidated financial position or results of operations.\nInventories are valued at the lower of cost or market, determined on the last-in, first-out (LIFO) method. If the Company had used the first-in, first-out (FIFO) method of inventory valuation, which approximates current replacement cost, inventories would have been higher than reported at September 30, 1994, by $150,361,000 and at August 31, 1993, by $151,504,000.\nDepreciation and amortization of property are computed principally on a straight-line basis over estimated useful lives. Generally, the estimated useful lives are 15 to 40 years for buildings and leasehold improvements, and 3 to 10 years for equipment and fixtures.\nThe excess of cost over net assets of acquired companies (net of amortization of $29,002,000 at September 30, 1994; $19,547,000 at August 31,\nII - 16\n1993) is amortized on a straight-line basis principally over 40 years. Customer lists, included in deferred charges and other assets, ($12,254,000 at September 30, 1994 , net of accumulated amortization of $13,977,000; $14,149,000 at August 31, 1993, net of accumulated amortization of $12,082,000) are amortized on a straight-line basis over 15 years.\nNoncurrent receivables include notes receivable from employees and officers due at the Company's discretion in the amount of $3,840,000 and $3,471,000 at September 30, 1994 and August 31, 1993, respectively.\nNet sales and other revenues of the Company include service fees of $4.4 million, $2.9 million and $2.6 million for the years ended September 30, 1994, August 31, 1993 and 1992, respectively, related to bulk shipments of pharmaceuticals.\nEffective October 1, 1993, the Company changed its fiscal year from a twelve-month period ending August 31 to a twelve-month period ending September 30. The Statements of Consolidated Earnings and Retained Earnings and Cash Flows are presented for the twelve months ended September 30, 1994, exclusive of September 1993 results, and for the twelve-month periods ended August 31, 1993 and 1992.\nThe Statement of Consolidated Earnings for the month of September 1993 is as follows:\nII - 17\nDuring the month of September 1993, net cash and cash equivalents of $27.1 million and $6.2 million was provided by operations and financing activities, respectively, and net cash and cash equivalents of $2.5 million was used for investing activities. The resulting $30.8 million net increase in cash and cash equivalents during the period increased the $55.0 million of cash and cash equivalents at September 1, 1993 to $85.8 million at September 30, 1993.\nCertain reclassifications have been made in the consolidated financial statements and notes to conform to fiscal 1994 presentations.\n2. Borrowing Arrangements\nOn September 15, 1992, the Company entered into a credit agreement (the \"Credit Agreement\") with a group of banks providing the Company with a three-year $300 million unsecured revolving line of credit to be used to fund the fiscal 1993 acquisition of Durr-Fillauer Medical, Inc. and subsidiaries (\"Durr\") and to be used for general working capital purposes of the Company. On October 7, 1994, the Credit Agreement was amended to, among other things, increase the maximum borrowing to $350 million and to extend the maturity date to September 15, 1997. Borrowings outstanding under the Credit Agreement were $40.0 million at September 30, 1994. The maximum outstanding borrowings under the Credit Agreement for the year ended September 30, 1994 were $270.0 million.\nOn January 14, 1993, the Company publicly sold $100 million aggregate principal amount of 5 5\/8% Senior Notes due January 15, 1996 and $150 million aggregate principal amount of 7 3\/8% Senior Notes due January 15, 2003, collectively the \"Senior Notes.\" The Senior Notes were issued pursuant to the $400 million shelf registration filed by the Company in December 1992. Interest on the Senior Notes is payable semi-annually on January 15 and July 15 of each year, beginning July 15, 1993. The Senior Notes are not redeemable prior to maturity and are not entitled to any sinking fund. The carrying value of the Senior Notes represents gross proceeds plus amortization of the original issue discount ratably over the life of each issue.\nIn connection with the acquisition of Durr, the Company assumed $69.0 million of Durr's 7% Convertible Subordinated Debentures due March 1, 2006 (the \"7% Debentures\"). The acquisition of Durr by the Company resulted in each holder receiving the right, at such holder's option, to require Durr to redeem, on November 23, 1992, all or any portion of such holder's 7% Debentures for cash equal to the principal amount plus accrued interest to that date. As a result, the Company redeemed $45.6 million aggregate principal amount on November 23,\nII - 18\n1992. Since that date an additional $2.5 million aggregate principal amount has been redeemed. The remaining outstanding 7% Debentures receive interest on March 1 and September 1 of each year.\nOn February 10, 1993, the Company redeemed for cash $471,429,000 of the outstanding principal amount of its Liquid Yield OptionTM Notes (\"LYONs\") due 2004 at a redemption price of $458.08 per $1,000 principal amount at maturity (representing the issue price plus accrued original issue discount to February 10, 1993). The balance of $71,000 principal amount was converted into 1,169 shares of the Company's Class A Common Stock. The redemption resulted in an extraordinary after-tax loss of $2.6 million, net of related income tax benefit of $1.8 million.\nIn July 1986, the Company issued $43.0 million of 6 7\/8% Exchangeable Subordinated Debentures due July 2011 (the \"Debentures\") and during March 1990, $32.1 million principal amount of the Debentures was tendered and purchased pursuant to an offer from the Company. Since that date an additional $0.3 million aggregate principal amount has been redeemed. See Note 10 for the effect of the fiscal 1992 disposition of Commtron Corporation (\"Commtron\") on the Debentures.\nScheduled future principal payments of long-term obligations, excluding deferred income taxes, for the next five years are $1,307,000 in 1995, $101,006,000 in 1996, $40,933,000 in 1997, $933,000 in 1998 and $909,000 in 1999.\n3. Capital Stock, Paid-in Capital and Stock Options\nThe authorized capital stock of the Company consists of 100,000,000 shares of Class A Common, par value $1.50 per share (the \"Common Stock\") and 3,000,000 shares of Preferred Stock without nominal or par value (the \"Preferred Stock\").\nThe Board of Directors (the \"Board\") is authorized to divide the Preferred Stock into one or more series, to determine the relative rights, preferences and limitations of the shares of any class or of any such series. In addition, the Board may give the Preferred Stock (or any series), special, limited, multiple or no voting rights.\nSubject to the preferences and other rights of the Preferred Stock, the Common Stock may receive stock or cash dividends as declared by the Board and each share of Common Stock is entitled to one vote per share at every meeting of shareowners. In the event of any liquidation, dissolution or winding up of the affairs of the Company, after payment to the owners of the Preferred Stock of the full amounts to which they have a liquidation preference, the owners of Common Stock shall be entitled to receive a distribution of all assets then remaining.\nII - 19\nNo owner of stock of any class of the Company shall have any preemptive right to purchase or subscribe for, or to receive rights or warrants to purchase or subscribe for, any shares of the Company, whenever authorized, which the Company may issue or sell or any obligations which the Company may issue or sell that shall be convertible into or exchanged for any shares of any class of stock of the Company.\nThe Company shall not be obligated to issue any fractional shares of Common Stock and if any interest in a fractional share would otherwise be deliverable, the Company shall make adjustment for that fractional share interest by payment of an amount in cash equal to the same fraction of the market value of a full share of Common Stock.\nOn February 9, 1994, the Board adopted a Shareowner Rights Plan which provided that a dividend of one Preferred Share Purchase Right (the \"Rights\") was declared for each share of Common Stock outstanding at the close of business on February 18, 1994. The Rights are generally not exercisable until 10 days after a person or group acquires 15% of the Common Stock or announces a tender offer which could result in a person or group owning 15% or more of the Common Stock (an \"Acquisition\"). Each Right, should it become exercisable, will entitle the owner to buy 1\/100th of a share of a new series of the Company's Series A Junior Preferred Stock at an exercise price of $80.00.\nIn the event of an Acquisition without the approval of the Board, each Right will entitle the owner, other than an acquiror, to buy at the Rights' then current exercise price a number of shares of Common Stock with a market value equal to twice the exercise price. In addition, if at the time when there was a 15% shareowner, the Company were to be acquired by merger, shareowners with unexercised Rights could purchase common stock of the acquiror with a value of twice the exercise price of the Rights. The Board may redeem the Rights for $0.01 per Right at any time prior to an Acquisition. Unless earlier redeemed, the Rights will expire on February 18, 2004.\nIn addition to the Shareowner Rights Plan, the staggered election of the Board of Directors, the possible impact of the anti-trust laws and the New Jersey Shareholders Protection Act (\"NJSPA\") may deter a hostile takeover of the Company.\nThe NJSPA could discourage a hostile takeover of the Company because it could significantly delay the ability of a person who acquires control of the Company to consummate a merger with the Company. The NJSPA provides that no \"Resident Domestic Corporation\" shall engage in any \"Business Combination\" with any \"Interested Stockholder\" of such corporation for a period of five years following that \"Interested Stockholder's\" \"Stock Acquisition Date\" unless that\nII - 20\n\"Business Combination\" is approved by the Board of Directors of the \"Resident Domestic Corporation\" prior to that \"Interested Stockholder's\" \"Stock Acquisition Date.\"\nThe NJSPA defines a \"Resident Domestic Corporation\" as a corporation incorporated in, and having its principal executive offices or significant business operations located in, the State of New Jersey. The Company believes that it is a Resident Domestic Corporation because it has significant business operations located in New Jersey. A \"Business Combination\" includes (i) a merger of a Resident Domestic Corporation with an Interested Stockholder or any corporation which is an affiliate of such Interested Stockholder; (ii) any sale, lease, exchange, mortgage, pledge, transfer or other disposition of 10% or more of the assets of a Resident Domestic Corporation to or with an Interested Stockholder or any affiliate thereof; and (iii) other specified extraordinary transactions between a Resident Domestic Corporation and an Interested Stockholder or any affiliate thereof. \"Interested Stockholder\" is defined, in pertinent part, as any person that is the beneficial owner, directly or indirectly, of 10% or more of the voting power of the outstanding voting stock of a Resident Domestic Corporation. \"Stock Acquisition Date\" is defined as the date that a person becomes an Interested Stockholder.\nThe Securities and Exchange Commission (the \"Commission\") has argued that statutes similar to the NJSPA are invalid. The United States Court of Appeals for the Seventh Circuit has upheld a Wisconsin statute which is similar to the NJSPA. The Company has not solicited or received any legal opinion as to the validity of the NJSPA.\nThe NJSPA imposes additional restrictions on the ability of an Interested Stockholder to consummate a Business Combination with a Resident Domestic Corporation even after the five year period has expired. The NJSPA requires the affirmative vote of the holders of two-thirds of the shares not beneficially owned by an Interested Stockholder to approve a Business Combination with the Interested Stockholder unless (i) the Business Combination is approved by the Company's Board of Directors prior to the Interested Stockholder's Stock Acquisition Date or (ii) a \"fair price\" consideration, determined pursuant to criteria specified in the NJSPA, is paid to holders of shares and certain other specified conditions are met.\nUnder the New Jersey Business Corporation Act (\"NJBCA\"), a merger would generally require the approval of the Board of Directors of the Company and the affirmative vote of a majority of the votes cast by the holders of capital stock of the Company entitled to vote on the merger assuming the presence of a quorum which would be a majority of all shares entitled to vote. Any merger would have to comply with the applicable procedural and substantive requirements of the NJBCA, including the NJSPA and any duties to other shareholders imposed upon a\nII - 21\ncontrolling or, if applicable, majority shareholder.\nAny merger would also have to comply with any applicable federal law. In particular, an Interested Stockholder may be required to comply with Rule 13e-3 promulgated by the Commission under the Exchange Act. Rule 13e-3 requires, among other things, that certain financial information concerning the Company and certain information relating to the fairness of such merger or other similar business combination and the consideration offered to minority shareholders be filed with the Commission and distributed to minority shareholders prior to the consummation of any such transaction.\nOn February 24, 1994 (the \"Conversion Date\"), in accordance with the provisions of the Recapitalization Plan approved by the Company's shareowners on January 31, 1989, all of the 100,492 then outstanding shares of the Company's Class B Stock were automatically converted into shares of the Company's Class A Common Stock at the stated conversion rate of 9.5285 shares of Class A Common Stock for each share of Class B Common Stock. All Class B Common Stock was subsequently cancelled.\nDuring fiscal years 1991 and 1992, the Board of Directors authorized total expenditures of $200,000,000 to purchase shares of the Company's capital stock on the open market. During fiscal year 1992, 5,252,625 shares of Class A Common Stock were purchased for Treasury at a cost of approximately $106.9 million. The Company has discontinued the stock repurchase program.\nChanges in Class A and Class B Common Stock, Paid-in capital and Treasury shares for the years ended September 30, 1994, August 31, 1993 and 1992 were as follows:\nII - 22\nThe Company has a 1983 stock option plan which authorizes the granting of options to key employees to purchase, within a period of ten years from date of grant, up to 1,345,830 shares of Class A Common Stock at prices per share not less than the fair market value on the dates the options are granted. At September 30, 1994, there were 29,839 shares available for grant under the 1983 plan.\nThe Company has a 1989 stock incentive plan which authorizes the granting of options to key employees, non-employee directors and certain other recipients to purchase, within a period of ten years from date of grant, up to 1,875,000 shares, of which 187,500 may be utilized for grants to non-employee directors, of Class A Common Stock at prices per share as may be set by the Company's Compensation\/Stock Option Committee (except for non-employee director options which may not be less than the fair market value on the date the options are granted). At September 30, 1994, there were 883,061 shares available for grant under the 1989 plan.\nStock appreciation rights may be offered to some or all of the employees, but not non-employee directors, who hold or receive options granted under the stock option plans. The stock appreciation rights entitle the optionee, in lieu of exercising stock options, and without payment to the Company, to receive an amount representing the value in shares of the stock appreciation rights. Such value is related to the increase in market value of the Company's Class A Common Stock and may be paid in shares of Class A Common Stock or up to 50% in cash. Stock appreciation rights become exercisable and expire on the same dates as the related options. No stock appreciation rights were outstanding as of September 30, 1994, August 31, 1993 or 1992.\nChanges in the number of shares represented by outstanding options during the years ended September 30, 1994, August 31, 1993 and 1992 are summarized as follows:\nAt September 30, 1994, options for 454,123 shares were exercisable. The remaining options become exercisable in the following fiscal years: 1995, 198,574 shares; 1996, 209,171 shares; 1997, 216,171 shares; 1998, 143,850 shares.\nII - 23\nAt September 30, 1994, an aggregate of 2,759,789 shares of Class A Common Stock was reserved for the exercise of stock options and for issuance under the elective retirement savings plan (see Note 8).\n4. Acquisitions\nOn April 29, 1994, the Company completed the acquisition of Southeastern Hospital Supply Corporation (\"Southeastern\"), a privately held medical supply distributor located in Fayetteville, North Carolina, for 747,422 shares, previously held as Treasury shares, of the Company's Class A Common Stock valued at approximately $12.6 million, incurred expenses of $0.4 million and assumed approximately $6.7 million of debt, which was paid by the Company on the acquisition date. The Company recorded an excess of cost over net assets acquired of approximately $5.4 million in the transaction.\nOn August 31, 1994, the Company completed the acquisition of certain net assets of Professional Medical Supply Co., a privately held medical supply distributor located in Denver, Colorado, for approximately $2.4 million in cash including excess of cost over net assets acquired and other intangible assets of $1.9 million.\nOn September 18, 1992, the Company completed its $33 per share cash tender offer for the outstanding shares of common stock of Durr. The total cost of the acquisition was approximately $395.3 million in cash plus expenses of $16.7 million and the assumption of long-term debt of approximately $72.1 million. The acquisition, which has been accounted for as a purchase, was financed from borrowings under the Credit Agreement (as described in Note 2) and from funds generated internally. Durr is a distributor of pharmaceuticals and medical supplies based in Montgomery, Alabama.\nAn excess of cost over net assets acquired of approximately $279.1 million was recorded based upon the fair value of assets acquired and liabilities assumed in the transaction. The operating results of Durr have been included in the Statements of Consolidated Earnings and Retained Earnings from the date of the acquisition.\nII - 24\nIf the acquisition of Durr had occurred as of the beginning of the year ended August 31, 1992, the Company's unaudited pro forma net sales and other revenues, earnings from continuing operations before taxes on income, earnings from continuing operations, net earnings and earnings per common and common equivalent share from continuing operations, primary and fully diluted, would have been as follows:\nThe pro forma operating results above include Durr's results of operations for fiscal 1992 with increased depreciation and amortization of property, plant and equipment and excess of cost over net assets acquired along with other relevant adjustments to reflect fair value of the acquired assets, and pro forma interest expense on the assumed acquisition borrowings.\nThe results of operations reflected in the pro forma information above are not necessarily indicative of the results which would have been reported if the Durr acquisition had been effected at the beginning of fiscal 1992.\nOn March 16, 1993, the Company sold Durr-Fillauer Orthopedic, Inc., an indirect wholly-owned subsidiary of Durr, and a manufacturer and distributor of orthotic and prosthetic devices, for approximately $9.0 million in cash.\nOn November 18, 1992, the Company completed the acquisition of the stock of Dr. T. C. Smith Company, a privately-held pharmaceutical distributor, located in Asheville and Raleigh, North Carolina, for approximately $8.2 million in cash plus expenses of $1.3 million and the assumption of approximately $9.7 million of bank debt which was paid by the Company on the acquisition date. The Company recorded an excess of cost over net assets acquired of approximately $1.5 million in the transaction.\nOn January 29, 1993, the Company completed the acquisition of substantially all of the assets of Healthcare Distributors of Indiana, Inc.(\"HDI\"), a privately-held pharmaceutical distributor located in South Bend, Indiana, for 433,957 shares, net of 37,608 shares subsequently reacquired, of the Company's Class A Common Stock valued at approximately $8.7 million, incurred expenses of $0.9 million and assumed approximately $7.3 million of debt which was paid by\nII - 25\nthe Company on the acquisition date. The Company recorded an excess of cost over net assets acquired of approximately $2.9 million in the transaction.\nOn February 28, 1992, the Company acquired substantially all of the net assets and business of the pharmaceutical distribution segment of Owens & Minor, Inc. for approximately $51.8 million in cash, including excess of cost over net assets acquired and other intangible assets of $9.9 million.\nThe inclusion of each of the preceding acquisitions would not materially affect the foregoing pro forma amounts.\n5. Earnings per Common and Common Equivalent Share\nEarnings per common and common equivalent share are based on the weighted average number of shares of Class A Common Stock outstanding during each year, the assumed conversion of the weighted average number of shares of Class B Common Stock outstanding during each year through the Conversion Date (see Note 3) and the assumed exercise of dilutive employees' stock options (less the number of Treasury shares assumed to be purchased from the proceeds using the average market price or, for fully diluted earnings per share, the greater of the average market price or year-end market price of the Company's Class A Common Stock). Primary earnings per share are based upon 36,841,690 shares in 1994, 36,313,436 shares in 1993 and 37,644,849 shares in 1992. Fully diluted earnings per share are based upon 36,848,580 shares in 1994 and 45,416,860 shares in 1992 and assume conversion of the LYONs in 1992. In 1993, the computation of fully diluted earnings per share was anti-dilutive.\n6. Leases\nThe Company conducts certain of its operations from leased warehouse and office facilities and uses certain data processing, transportation, and other equipment under lease agreements expiring at various dates during the next 14 years, excluding renewal options. Future minimum rental commitments at September 30, 1994, under operating leases having noncancelable lease terms in excess of one year, aggregated $56,571,000, with rental payments during the five succeeding years of $14,148,000, $10,640,000, $9,123,000, $6,993,000 and $5,549,000, respectively. Future minimum rentals to be received under noncancelable subleases at September 30, 1994 totaled $15,000. Net rental expense for the years ended September 30, 1994, August 31, 1993 and 1992, was $15,871,000, $15,978,000 and $13,988,000, respectively, after deducting sublease income of $187,000, $675,000 and $967,000, respectively.\nII - 26\n7. Taxes on Income\nEffective September 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). The effect of initially adopting SFAS 109 was accounted for as a cumulative effect of an accounting change of $8.7 million, or $0.24 per share, recorded in September 1993.\nThis Statement changed the Company's method of accounting for income taxes from the deferred method to an asset and liability method. Under the deferred method, annual income tax expense is matched with pre-tax accounting income by providing deferred taxes at current rates for timing differences between the determination of net income for financial reporting and tax purposes. Under the asset and liability method, deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities at tax rates expected to be in effect when such assets or liabilities are realized or settled.\nTotal Federal and State taxes on income for the years ended September 30, 1994, August 31, 1993 and 1992 are summarized as follows:\nII - 27\nDiscontinued operations include Federal and State taxes on income for both the net results of operations and the gain on disposition of Commtron.\nDeferred taxes result from temporary differences in the recognition of revenues and expenses for tax and financial reporting purposes. The sources of these temporary differences and the tax effects from continuing operations are as follows:\nThe principal sources of timing differences from discontinued operations are accelerated depreciation, inventory transactions and receivables transactions.\nTaxes on income from continuing operations vary from the statutory Federal income tax rate applied to earnings from continuing operations before taxes on income as the result of the following:\nII - 28\nThe tax effects of significant items comprising the Company's net deferred tax liability as of September 30, 1994 are as follows (dollars in thousands):\nIn the opinion of management of the Company, no valuation reserve related to recorded deferred tax assets is deemed necessary.\n8. Retirement and Savings Plans\nThe Company provides for retirement benefits through an elective retirement savings plan and supplemental retirement plans.\nThe Company has an elective retirement savings plan generally available to all employees with six months of service. Under the terms of the plan, the Company guarantees a contribution of $0.50 for each $1.00 invested by the participant up to the participant's investment of 6% of salary, subject to plan and regulatory limitations. The Company may also make additional cash or stock contributions to the plan at its discretion. The Company's contributions are vested to participants over five years. The Company made contributions of $4,146,000, $4,219,000 and $2,760,000 to the plan in 1994, 1993 and 1992, respectively.\nThe Company terminated its defined benefit contributory retirement plan on December 31, 1991. The Company's general funding policy with respect to the defined benefit contributory retirement plan was to contribute amounts which were sufficient to satisfy legal funding requirements and were deductible for Federal income tax purposes. No contributions were made in 1992. Upon termination of the plan, all participants became fully vested and received their\nII - 29\nbenefits through the purchase of annuity contracts or by cash distribution.\nThe supplemental retirement plans provide benefits for certain officers and key employees. Effective January 1991, the Company approved a new Supplemental Executive Retirement Plan (\"SERP\") for officers and key employees. SERP is a \"target\" benefit plan, with the annual lifetime benefit based upon a percentage of salary during the final five years of pay at age 62, offset by several other sources of income including benefits payable under a prior supplemental retirement plan.\nThe components of net periodic pension cost for the supplemental retirement plans for 1994 and the defined benefit contributory and supplemental retirement plans for 1993 and 1992 are as follows:\nAssumptions used to develop the net periodic pension cost for the defined benefit contributory and supplemental retirement plans were:\nII - 30\nThe funded status of the supplemental retirement plans as of September 30, 1994 and August 31, 1993 is as follows:\nAt September 30, 1994, the Company owns life insurance in the aggregate amount of $43 million covering substantially all the participants in a supplemental retirement plan. The Company intends to keep this life insurance in force until the demise of the participants.\nContributions are also made to multi-employer defined benefit plans administered by labor unions for certain union employees. Amounts charged to pension expense and contributed to these plans were $297,000, $284,000 and $331,000, in 1994, 1993 and 1992, respectively.\nOn September 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\") which requires the cost of postretirement benefits other than pensions to be recognized on an accrual basis as employees perform services to earn such benefits. The Company had previously expensed postretirement benefits as paid. The estimated transition obligation of the Company, which is the accumulated postretirement benefit obligation at the date of adoption, amounted to approximately $2.1 million. This obligation is being recognized over 20 years. The impact of the Company's adoption of SFAS 106 was to increase each future year's annual benefits expense (assuming amortization of the transition obligation over 20 years) by $275,000.\nII - 31\n9. Supplemental Cash Flow Disclosures\nOn April 29, 1994, the Company completed the acquisition of Southeastern Hospital Supply Corporation (\"Southeastern\"), a privately held medical supply distributor located in Fayetteville, North Carolina, for 747,422 shares, previously held as Treasury shares, of the Company's Class A Common Stock valued at approximately $12.6 million, incurred expenses of $0.4 million and assumed approximately $6.7 million of debt, which was paid by the Company on the acquisition date. The Company recorded an excess of cost over net assets acquired of approximately $5.4 million in the transaction.\nOn August 31, 1994, the Company completed the acquisition of certain net assets of Professional Medical Supply Co., a privately held medical supply distributor located in Denver, Colorado, for approximately $2.4 million in cash, including excess of cost over net assets acquired, and other intangible assets of $1.9 million.\nDuring fiscal 1993, the Company paid approximately $412.0 million in cash, acquired assets at fair value of approximately $370.9 million and assumed liabilities of approximately $238.0 million in connection with the Durr acquisition. Also during fiscal 1993, the Company paid approximately $8.2 million in cash plus expenses of $1.3 million, acquired assets at fair value of approximately $32.4 million and assumed liabilities of approximately $24.4 million in connection with the acquisition of the Dr. T.C. Smith Company. Additionally, during fiscal 1993, the Company issued 433,957 shares, net of 37,608 shares subsequently reacquired, of the Company's Class A Common Stock valued at approximately $8.7 million, incurred expenses of $0.9 million, acquired assets at fair value of approximately $30.1 million and assumed liabilities of approximately $23.1 million in connection with the acquisition of HDI.\nDuring the fourth quarter of fiscal 1993, the Company approved a restructuring plan which resulted in a charge of $33.0 million to earnings from continuing operations before taxes on income(see Note 12). In the second quarter of fiscal 1993, the Company redeemed for cash the outstanding LYONs, which resulted in an extraordinary after-tax loss of $2.6 million, net of related income tax benefit of $1.8 million (see Note 2).\nII - 32\nIn fiscal 1992, the Company transferred assets totaling $145.5 million, excluding intercompany advances, and liabilities of $142.9 million in connection with the sale of Commtron (see Note 10).\n10. Discontinued Operations\nOn June 19, 1992, the Company sold its 81%-owned subsidiary, Commtron, to Ingram Industries, Inc. (\"Ingram\"). On that date, the Company received aggregate consideration of $7.75 per share for each of the 3,246,000 shares of Commtron Class A Common Stock and 5,000,000 shares of Class B Common Stock owned by the Company. Of the approximate $63.9 million of aggregate consideration received by the Company, approximately $58.2 million was paid outright to the Company with respect to shares of Commtron's outstanding Common Stock owned by the Company free of escrow, and approximately $5.7 million was paid in escrow with respect to 732,863 shares of Commtron Class A Common Stock registered in the name of the Company but held in escrow for issuance in exchange for the Company's Debentures (see Note 2). As a result of the sale, each $1,000 principal amount of Debentures which, prior to the sale, was exchangeable for 67.20 shares of Commtron Class A Common Stock, is now exchangeable for approximately $520.83 cash, less applicable taxes, plus interest accrued on the net amount (\"Escrow Amount Per Debenture\"). Unless exchanged for the Escrow Amount Per Debenture, or otherwise acquired or redeemed by the Company, each Debenture will remain an outstanding obligation of the Company until maturity. On the closing date, the Company also repaid net advances made to the Company by Commtron of approximately $68.6 million. The Company recorded an after-tax gain of $4.0 million on the transaction.\nThe net results of operations of Commtron have been reclassified and shown separately for the year ended August 31, 1992 in the Statements of Consolidated Earnings and Retained Earnings as earnings from discontinued operations and, accordingly, have been omitted from the various categories as follows:\nII - 33\n11. Contingencies\nThe Company received proceeds of $14,831,000 and $4,097,000 in 1994 and 1993, respectively, from receivables sold with recourse by the Company to financial institutions and is contingently liable as guarantor of $29,439,000 and $36,068,000 at September 30, 1994 and August 31, 1993 of such receivables.\nIn December 1992, a customer of the Company commenced a legal action against the Company in the Superior Court of the State of California alleging breach of contract, misrepresentation and violations of certain California antitrust and unfair practices laws. This customer seeks a variety of damage claims in substantial amounts including compensatory, treble and punitive damages, an injunction against collection on a note, and declaratory judgement as to the customer's rights under an alleged oral joint venture agreement with the Company. As of October 31, 1994, this customer owed the Company approximately $6.2 million, of which approximately $1.2 million represents trade receivables and $5.0 million represents a loan.\nOn July 29, 1993, this customer filed a voluntary petition for relief under Chapter 11 of the United States Code and the complaint filed by the Company against the customer has been stayed. An additional action brought by the Company against two individuals as guarantors of the customer's obligations has been transferred to the Superior Court in San Francisco County, with the California State antitrust actions referenced in the next paragraph.\nIn addition, the Company has been named as a defendant along with several pharmaceutical industry-related companies in several State antitrust actions in California and Alabama and a Federal multidistrict antitrust action. The California State action purports to be a coordinated class action under California's Cartwright Act, Unfair Practices Act and Business and Professions Code. (The State court judge recently struck the class allegations from the Unfair Practices Act claims). The Alabama State complaint purports to be a class action under Alabama antitrust law. The Federal class action complaint alleges that the Company and numerous manufacturers and other wholesalers violated the Sherman Act. Plaintiffs seek injunctive relief and treble damages in an amount to be determined at trial.\nOn October 21, 1994, the Company entered into a sharing agreement with five other wholesalers and 26 pharmaceutical manufacturers. Among other things, the agreement provides that: (a) if a judgement is entered into against both the manufacturer and wholesaler defendants, the total exposure for joint and several liability of the Company is limited to $1,000,000; (b) if a settlement is entered into by, between, and among the manufacturer and wholesaler defendants, the Company has no monetary exposure for such settlement amount; (c) the six\nII - 34\nwholesaler defendants will be reimbursed by the 26 pharmaceutical defendants for related legal fees and expenses up to $9,000,000 total (of which the Company will receive a proportionate share) and (d) the Company is to release certain claims which it might have had against the manufacturer defendants for the claims presented by the plaintiffs in these cases. The agreement covers the Federal court litigation as well as the cases which have been filed in the various State courts. After discussions with counsel, management of the Company believes that the allegations of liability set forth in these lawsuits are without merit as to the wholesaler defendants and that any attendant liability of the Company, although unlikely, would not have a material adverse effect on the Company's financial condition.\nOn November 2, 1988 and November 14, 1988, two class action and derivative suits were filed naming the Company and certain Directors and Officers as defendants and seeking damages and relief as a result of the Recapitalization Plan approved by the shareowners at the January 31, 1989 Annual Meeting. On April 5, 1989, the two actions were consolidated. On September 7, 1994, an Order and Final Judgement was signed approving the settlement of the class and derivative litigation. Under the order, the Company became obligated to pay the plaintiff's attorneys the sum of $446,000 for fees, expenses and interest and Mr. Robert E. Martini and the Estate of Emil P. Martini, Jr. each agreed to transfer to the Company 15,000 shares of the Company's Class A Common Stock. The Estate of Emil P. Martini, Jr. was also given the option, in lieu of the transfer of 15,000 shares of Class A Common Stock, to pay the Company in cash the sum of $294,000.\nThe Company is involved in various additional items of litigation. Although the amount of liability at September 30, 1994 with respect to these items of litigation cannot be ascertained, in the opinion of management, any resulting future liability will not have a material adverse effect on its financial position or results of operations.\n12. Restructuring and Other Unusual Items\nDuring the fourth quarter of fiscal 1993, the Company approved a restructuring plan which consists of an accelerated consolidation of pharmaceutical distribution facilities into larger, more efficient regional distribution centers, the merging of duplicate operating systems, the reduction of administrative support in areas not affecting valued services to customers, and the discontinuance of services and programs that do not meet the Company's strategic and economic return objectives. The estimated pre-tax cost of the restructuring plan is $33.0 million. The restructuring charge represents the costs associated with restructure, primarily abandonment and severance. For\nII - 35\nthose activities or assets where the disposal is expected to result in a gain, no gain will be recognized until realized. During fiscal 1994, the Company incurred costs of approximately $13.1 million related to the restructuring plan.\nDuring fiscal 1994, the Company recognized a gain from the sale of investment securities of $5.1 million before income taxes of $2.2 million.\nDuring the second quarter of fiscal 1994, the Company recorded a pre-tax charge of $1.4 million ($0.8 million after tax) for the uninsured portion of an earthquake loss sustained by the Company's Valencia, California Regional Distribution Center on January 17, 1994.\nOn June 18, 1993, the Company announced that a joint bid which the Company had made in April 1993 with the French company, Cooperation Pharmaceutique Francaise, to acquire the largest French pharmaceutical distribution company, Office Commercial Pharmaceutique, had been withdrawn. Accordingly, expenses of $2.5 million, before income tax benefit of $1.0 million associated with the transaction, were recorded in the fourth quarter of fiscal 1993.\n13. Disclosures About Fair Value of Financial Instruments\nThe recorded amounts of the Company's cash and cash equivalents, the Debentures and the 7% Debentures at September 30, 1994, approximate fair value. The fair values of the Company's other investments and the Senior Notes are estimated as follows, based on the market prices of these instruments at September 30, 1994:\nII - 36\nINDEPENDENT AUDITORS' REPORT\nTo the Directors and Shareowners of Bergen Brunswig Corporation:\nWe have audited the accompanying consolidated balance sheets of Bergen Brunswig Corporation and subsidiaries as of September 30, 1994 and August 31, 1993, and the related statements of consolidated earnings and retained earnings and cash flows for the year ended September 30, 1994 and the years ended August 31, 1993 and 1992. Our audits also included the financial statement schedule listed in the index at Item 14(a)(2). 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 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 Bergen Brunswig Corporation and subsidiaries at September 30, 1994 and August 31, 1993, and the results of their operations and their cash flows for the year ended September 30, 1994 and the years ended August 31, 1993 and 1992, 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, present fairly in all material respects the information set forth therein.\nAs discussed in Note 7 of Notes to Consolidated Financial Statements, the Company changed its method of accounting for income taxes in September 1993.\n\/s\/ Deloitte & Touche LLP - ---------------------------------- Costa Mesa, California October 31, 1994\nII - 37\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nII - 38\nPART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIdentification of Directors.\nInformation required by this item is set forth under the caption \"Election of Directors\" on pages 2 through 5 of the registrant's definitive proxy statement dated December 22, 1994 for its January 26, 1995 Annual Meeting of Shareowners, as filed with the Securities and Exchange Commission, and is incorporated herein by reference.\nIdentification of Executive Officers.\nInformation required by this item is contained in Item 4A captioned \"Executive Officers of Registrant\" and is included in Part I of this Annual Report.\nITEM 11. EXECUTIVE COMPENSATION\nInformation required by this item is set forth under the captions \"Directors Compensation,\" \"Compensation of Executive Officers,\" \"Employment and Severance Agreements,\" \"Stock Option Grants and Exercises,\" \"Retirement Benefits,\" \"Report of the Compensation \/ Stock Option Committee,\" \"Compensation \/ Stock Option Committee Interlocks and Insider Participation,\" \"Performance Graphs\" and \"Certain Transactions\" on pages 6 and 7 and pages 9 through 19, respectively, of the registrant's definitive proxy statement dated December 22, 1994 for its January 26, 1995 Annual Meeting of Shareowners, as filed with the Securities and Exchange Commission, and is incorporated herein by reference.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by this item is set forth under the caption \"Beneficial Ownership of Securities\" on pages 7 through 9 of the registrant's definitive proxy statement dated December 22, 1994 for its January 26, 1995 Annual Meeting of Shareowners, as filed with the Securities and Exchange Commission, and is incorporated herein by reference.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by this item is set forth as to certain transactions with management and others under the caption \"Director Compensation\" and as to management indebtedness under the caption \"Certain Transactions,\" and certain arrangements with respect to the indemnification of Directors and Officers under the caption \"Indemnification of Directors and Officers\" on pages 6 and 7, 18 and 19, and 26, respectively, of the registrant's definitive proxy statement dated December 22, 1994 for its January 26, 1995 Annual Meeting of Shareowners, as filed with the Securities and Exchange Commission, and is incorporated herein by reference.\nIII - 1\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nPage No. -------- (a) Documents filed as part of this report:\n1. Financial Statements\nThe following Consolidated Financial Statements of Bergen Brunswig Corporation and Subsidiaries are included in Part II, Item 8:","section_7A":"","section_8":"Item 8:\nStatements of Consolidated Earnings and Retained Earnings for the Years Ended September 30, 1994 and August 31, 1993 and 1992 Consolidated Balance Sheets, September 30, 1994 and August 31, 1993 Statements of Consolidated Cash Flows for the Years Ended September 30, 1994 and August 31, 1993 and 1992 Notes to Consolidated Financial Statements Independent Auditors' Report\n2. Financial Statement Schedule\nSchedule:\nII Amounts Receivable from Employees IV - 10\nFinancial statements and schedules not listed are omitted because of the absence of the conditions under which they are required or because all material information is included in the consolidated financial statements or notes thereto.\nIV - 1\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 (Continued)\n3. Exhibits -------- 3(a) The By-Laws as amended and restated and dated December 16, 1994.\n3(b) Amendment to By-Laws dated December 16, 1994.\n*3(c) The Restated Certificate of Incorporation dated March 26, 1969, as amended, and the following Amendments thereto dated:\nFebruary 14, 1994 September 5, 1991 December 14, 1989 October 11, 1989 April 10, 1989 February 24, 1989 July 9, 1987 March 15, 1985 January 6, 1982 September 14, 1973 August 28, 1972 December 16, 1970 December 17, 1969\nare set forth as Exhibit 3(c) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1991, except for the Amendment dated February 14, 1994 which is set forth as Exhibit A of Exhibit 1 to the Company's Registration Statement on Form 8-A dated February 14, 1994.\n*4(a) The Senior Indenture for $400,000,000 of Debt Securities dated as of December 1, 1992 between the Company and Chemical Trust Company of California as Trustee is set forth as Exhibit 4.1 to the Company's Registration Statement on Form S-3 dated December 1, 1992 (file no. 33-55136).\nThe Company agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each instrument with respect to other issues of long-term debt of the Company, the authorized principal amount of which does not exceed 10% of the total assets of the Company on a consolidated basis.\nIV - 2\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (Continued)\n3. Exhibits (Continued) -------- *4(b) Rights Agreement, dated as of February 8, 1994, between Bergen Brunswig Corporation and Chemical Trust Company of California, as Rights Agent, including all exhibits thereto, is incorporated herein by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A dated February 14, 1994.\n*10(a) Agreement among Emil P. Martini, Jr., Robert E. Martini and Bergen Brunswig Corporation, (the \"Martini Agreement\") dated February 24, 1989 is set forth as Exhibit 28.2 in the Company's Current Report on Form 8-K dated February 24, 1989.\n*10(b) Amendment to Martini Agreement dated April 18, 1991 is set forth as Exhibit 2(b) in the Company's Quarterly Report on Form 10-Q for the quarter ended May 31, 1991.\n*10(c) Agreement by Emil P. Martini, Jr. and Plan of Recapitalization dated August 10, 1988 are set forth as Exhibit 10(b) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988.\n*10(d) Agreement by Robert E. Martini and Plan of Recapitalization dated August 10, 1988 are set forth as Exhibit 10(c) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988.\n*10(e) Agreement by Emil P. Martini, Jr. dated December 13, 1988 is set forth as Exhibit 10(h) in Form 8, Amendment No. 1 to Item 14 of the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988.\n*10(f) Agreement by Robert E. Martini dated December 13, 1988 is set forth as Exhibit 10(i) in Form 8, Amendment No. 1 to Item 14 of the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988.\n**10(g) Bergen Brunswig Corporation Deferred Compensation Plan.\nIV - 3\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (Continued)\n3. Exhibits (Continued) -------- **10(h) Director Indemnification Agreement and Amendment to Director Indemnification Agreement.\n*10(i) Bergen Brunswig Corporation Bonus Plan as adopted September 1, 1977, amended October 19, 1990, is set forth as Exhibit 10(i) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1991.\n**10(j) Bergen Brunswig Corporation Stock Option Plans, other than the 1989 Stock Incentive Plan.\n*10(k) 1989 Stock Incentive Plan of Bergen Brunswig Corporation is set forth as Exhibit 10(j) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1989.\n*10(l) Executive Loan Program is set forth as Exhibit 10(k) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1990.\n*10(m) Non-Solicitation Agreement dated as of September 4, 1992 among W.A. Williamson, Jr., Durr-Fillauer Medical, Inc. and Bergen Brunswig Corporation is set forth as Exhibit (c)(2) to Amendment No. 16 to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement pursuant to Section 14(d)(1) of the Securities and Exchange Act of 1934.\n*10(n) Non-Solicitation Agreement dated as of September 4, 1992 among Charles E. Adair, Durr-Fillauer Medical, Inc. and Bergen Brunswig Corporation is set forth as Exhibit (c)(3) to Amendment No. 16 to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement pursuant to Section 14(d)(1) of the Securities and Exchange Act of 1934.\nIV - 4\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (Continued)\n3. Exhibits (Continued) -------- *10(o) Non-Solicitation Agreement dated as of September 4, 1992 among Winfield Cotton, Durr-Fillauer Medical, Inc. and Bergen Brunswig Corporation is set forth as Exhibit (c)(4) to Amendment No. 16 to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement pursuant to Section 14(d)(1) of the Securities Exchange Act of 1934.\n*10(p) Agreement dated as of September 18, 1992 by and among Bergen Brunswig Corporation, Durr-Fillauer Medical, Inc. and the Attorneys General of the States of Alabama, Florida and Louisiana is set forth as Exhibit 10(p) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1992.\n10(q) Employment Agreement and Schedule.\n10(r) Severance Agreement and Schedule.\n11 Computation of primary earnings per share and computation of earnings per share assuming full dilution for the five years ended September 30, 1994, August 31, 1993, 1992, 1991 and 1990.\n21 List of subsidiaries of Bergen Brunswig Corporation.\n23 Independent Auditors' Consent.\n24 Power of Attorney is set forth on the Signature pages in Part IV of this Annual Report.\n27 Financial Data Schedule for the year ended September 30, 1994.\n*99(a) Split Dollar Life Insurance Plan with Emil P. Martini, Jr. and Robert E. Martini.\n*99(b) Capital Accumulation Plan and Amendment No. 1 thereto.\nExhibits 99(a) and (b) above are set forth as Exhibits 19(a) and (b) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1989.\nIV - 5\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (Continued)\n3. Exhibits (Continued) -------- *99(c) Credit Agreement dated as of September 15, 1992 by and among Bergen Brunswig Drug Company, Bergen Brunswig Corporation and Continental Bank N.A. (the \"Credit Agreement\") is set forth as Exhibit (b)(4) to the Final Amendment to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement pursuant to Section 14(d)(1) of the Securities Exchange Act of 1934.\n*99(d) First Amendment to Credit Agreement dated December 23, 1992 is set forth as Exhibit 28(b) in the Company's Quarterly Report on Form 10-Q for the quarter ended February 28, 1993.\n*99(e) Second Amendment to Credit Agreement dated May 18, 1993 is set forth as Exhibit 28(c) in the Company's Quarterly Report on Form 10-Q for the quarter ended May 31, 1993.\n*99(f) Third Amendment to Credit Agreement dated August 27, 1993 is set forth as Exhibit 99(f) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1993.\n*99(g) Fourth Amendment to Credit Agreement dated as of September 1, 1993 is set forth as Exhibit 99(e) in the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1993.\n99(h) Amended and Restated Credit Agreement dated as of September 30, 1994 among Bergen Brunswig Drug Company, Bergen Brunswig Corporation and Bank of America National Trust and Savings Association.\n*99(i) Item 1 - Legal Proceedings of Part II of the Company's Quarterly Report on Form 10-Q for the quarter ended May 31, 1989 and Item 3 - Legal Proceedings of Part I of the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988 as filed with the Securities and Exchange Commission, are incorporated herein by reference in Part I, Item 3 of this Annual Report.\nIV - 6\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (Continued)\n3. Exhibits (Continued) --------\n*99(j) Agreement and Plan of Merger dated as of September 4, 1992 by and among Bergen Brunswig Corporation, BBC Acquisition Corp. and Durr-Fillauer Medical, Inc. is set forth as Exhibit (c)(1) to Amendment No. 16 to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement Pursuant to Section 14(d)(1) of the Securities and Exchange Act of 1934.\n* Document has heretofore been filed with the Securities and Exchange Commission and is incorporated herein by reference and made a part hereof.\n** Incorporated herein by reference to the exhibits filed as part of the Company's Registration Statement on Form S-3 (Registration No. 33-5530) and Amendment Nos. 1 and 2 thereto relating to an offering of $43,000,000 principal amount of 6-7\/8% Exchangeable Subordinated Debentures due 2011, filed with the Securities and Exchange Commission on May 8, July 1, and July 8, 1986, respectively.\n(b) Reports on Form 8-K:\nThere were no reports filed on Form 8-K during the three months ended September 30, 1994.\nIV - 7\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBERGEN BRUNSWIG CORPORATION December 21, 1994 By \/s\/ Robert E. Martini -------------------------------------- Robert E. Martini Chairman of the Board and Chief Executive Officer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS that each person whose signature appears below, hereby constitutes and appoints Robert E. Martini, Dwight A. Steffensen and Milan A. Sawdei and each of them singly, 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 or all amendments (including pre-effective amendments and post-effective 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 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 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 - --------- ----- ----\n\/s\/ Robert E. Martini Chairman of the Board December 21, 1994 - ------------------------- and Chief Executive Robert E. Martini Officer and Director (Principal Executive Officer)\n\/s\/ Dwight A. Steffensen President and Chief December 21, 1994 - ------------------------- Operating Officer Dwight A. Steffensen and Director\n\/s\/ Neil F. Dimick Executive Vice President, December 21, 1994 - ------------------------- Chief Financial Officer Neil F. Dimick (Principal Financial Officer and Principal Accounting Officer)\nIV - 8\nSIGNATURE TITLE DATE - --------- ----- ----\n\/s\/ John Calasibetta Senior Vice President December 21, 1994 - ----------------------------- and Director John Calasibetta\n\/s\/ Jose E. Blanco, Sr. Director December 21, 1994 - ----------------------------- Jose E. Blanco, Sr.\n\/s\/ Rodney H. Brady Director December 21, 1994 - ----------------------------- Rodney H. Brady\n\/s\/ Charles C. Edwards, M.D. Director December 21, 1994 - ----------------------------- Charles C. Edwards, M.D.\n\/s\/ Charles J. Lee Director December 21, 1994 - ----------------------------- Charles J. Lee\n\/s\/ George R. Liddle Director December 21, 1994 - ----------------------------- George R. Liddle\n\/s\/ James R. Mellor Director December 21, 1994 - ----------------------------- James R. Mellor\n\/s\/ George E. Reinhardt, Jr. Director December 21, 1994 - ----------------------------- George E. Reinhardt, Jr.\n\/s\/ Francis G. Rodgers Director December 21, 1994 - ----------------------------- Francis G. Rodgers\nIV - 9\nIV - 10\nINDEX TO EXHIBITS\nEXHIBIT NO. PAGE NO. - ----------- --------\n3(a) The By-Laws as amended and restated and dated 70 December 16, 1994.\n3(b) Amendment to By-Laws dated December 16, 1994. 98\n*3(c) The Restated Certificate of Incorporation dated March 26, 1969, as amended, and the following Amendments thereto dated:\nFebruary 14, 1994 September 5, 1991 December 14, 1989 October 11, 1989 April 10, 1989 February 24, 1989 July 9, 1987 March 15, 1985 January 6, 1982 September 14, 1973 August 28, 1972 December 16, 1970 December 17, 1969\nare set forth as Exhibit 3(c) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1991, except for the Amendment dated February 14, 1994 which is set forth as Exhibit A of Exhibit 1 to the Company's Registration Statement on Form 8-A dated February 14, 1994.\n*4(a) The Senior Indenture for $400,000,000 of Debt Securities dated as of December 1, 1992 between the Company and Chemical Trust Company of California as Trustee is set forth as Exhibit 4.1 to the Company's Registration Statement on Form S-3 dated December 1, 1992 (file no. 33-55136).\nThe Company agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each instrument with respect to other issues of long-term debt of the Company, the authorized principal amount of which does not exceed 10% of the total assets of the Company on a consolidated basis.\nINDEX TO EXHIBITS (CONTINUED)\nEXHIBIT NO. PAGE NO. - ----------- --------\n*4(b) Rights Agreement, dated as of February 8, 1994, between Bergen Brunswig Corporation and Chemical Trust Company of California, as Rights Agent, including all exhibits thereto, is incorporated herein by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A dated February 14, 1994.\n*10(a) Agreement among Emil P. Martini, Jr., Robert E. Martini and Bergen Brunswig Corporation, (the \"Martini Agreement\") dated February 24, 1989 is set forth as Exhibit 28.2 in the Company's Current Report on Form 8-K dated February 24, 1989.\n*10(b) Amendment to Martini Agreement dated April 18, 1991 is set forth as Exhibit 2(b) in the Company's Quarterly Report on Form 10-Q for the quarter ended May 31, 1991.\n*10(c) Agreement by Emil P. Martini, Jr. and Plan of Recapitalization dated August 10, 1988 are set forth as Exhibit 10(b) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988.\n*10(d) Agreement by Robert E. Martini and Plan of Recapitalization dated August 10, 1988 are set forth as Exhibit 10(c) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988.\n*10(e) Agreement by Emil P. Martini, Jr. dated December 13, 1988 is set forth as Exhibit 10(h) in Form 8, Amendment No. 1 to Item 14 of the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988.\n*10(f) Agreement by Robert E. Martini dated December 13, 1988 is set forth as Exhibit 10(i) in Form 8, Amendment No. 1 to Item 14 of the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988.\n**10(g) Bergen Brunswig Corporation Deferred Compensation Plan.\n**10(h) Director Indemnification Agreement and Amendment to Director Indemnification Agreement.\nINDEX TO EXHIBITS (CONTINUED)\nEXHIBIT NO. PAGE NO. - ----------- --------\n*10(i) Bergen Brunswig Corporation Bonus Plan as adopted September 1, 1977, amended October 19, 1990, is set forth as Exhibit 10(i) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1991.\n**10(j) Bergen Brunswig Corporation Stock Option Plans, other than the 1989 Stock Incentive Plan.\n*10(k) 1989 Stock Incentive Plan of Bergen Brunswig Corporation is set forth as Exhibit 10(j) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1989.\n*10(l) Executive Loan Program is set forth as Exhibit 10(k) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1990.\n*10(m) Non-Solicitation Agreement dated as of September 4, 1992 among W.A. Williamson, Jr., Durr-Fillauer Medical, Inc. and Bergen Brunswig Corporation is set forth as Exhibit (c)(2) to Amendment No. 16 to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement pursuant to Section 14(d)(1) of the Securities and Exchange Act of 1934.\n*10(n) Non-Solicitation Agreement dated as of September 4, 1992 among Charles E. Adair, Durr-Fillauer Medical, Inc. and Bergen Brunswig Corporation is set forth as Exhibit (c)(3) to Amendment No. 16 to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement pursuant to Section 14(d)(1) of the Securities and Exchange Act of 1934.\n*10(o) Non-Solicitation Agreement dated as of September 4, 1992 among Winfield Cotton, Durr-Fillauer Medical, Inc. and Bergen Brunswig Corporation is set forth as Exhibit (c)(4) to Amendment No. 16 to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement pursuant to Section 14(d)(1) of the Securities Exchange Act of 1934.\nINDEX TO EXHIBITS (CONTINUED)\nEXHIBIT NO. PAGE NO. - ----------- --------\n*10(p) Agreement dated as of September 18, 1992 by and among Bergen Brunswig Corporation, Durr-Fillauer Medical, Inc. and the Attorneys General of the States of Alabama, Florida and Louisiana is set forth as Exhibit 10(p) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1992.\n10(q) Employment Agreement and Schedule. 101\n10(r) Severance Agreement and Schedule. 114\n11 Computation of primary earnings per share and 124 computation of earnings per share assuming full dilution for the five years ended September 30, 1994, August 31, 1993, 1992, 1991 and 1990.\n21 List of subsidiaries of Bergen Brunswig 126 Corporation.\n23 Independent Auditors' Consent. 127\n24 Power of Attorney is set forth on the Signature pages in Part IV of this Annual Report.\n27 Financial Data Schedule for the year ended September 30, 128 1994.\n*99(a) Split Dollar Life Insurance Plan with Emil P. Martini, Jr. and Robert E. Martini.\n*99(b) Capital Accumulation Plan and Amendment No. 1 thereto.\nExhibits 99(a) and (b) above are set forth as Exhibits 19(a) and (b) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1989.\n*99(c) Credit Agreement dated as of September 15, 1992 by and among Bergen Brunswig Drug Company, Bergen Brunswig Corporation and Continental Bank N.A. (the \"Credit Agreement\") is set forth as Exhibit (b)(4) to the Final Amendment to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement pursuant to Section 14(d)(1) of the Securities Exchange Act of 1934.\nINDEX TO EXHIBITS (CONTINUED)\nEXHIBIT NO. PAGE NO. - ----------- --------\n*99(d) First Amendment to Credit Agreement dated December 23, 1992 is set forth as Exhibit 28(b) in the Company's Quarterly Report on Form 10-Q for the quarter ended February 28, 1993.\n*99(e) Second Amendment to Credit Agreement dated May 18, 1993 is set forth as Exhibit 28(c) in the Company's Quarterly Report on Form 10-Q for the quarter ended May 31, 1993.\n*99(f) Third Amendment to Credit Agreement dated August 27, 1993 is set forth as Exhibits 99(f) in the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1993.\n*99(g) Fourth Amendment to Credit Agreement dated as of September 1, 1993 is set forth as Exhibit 99(e) in the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1993.\n99(h) Amended and Restated Credit Agreement dated as 129 of September 30, 1994 among Bergen Brunswig Drug Company, Bergen Brunswig Corporation and Bank of America National Trust and Savings Association.\n*99(i) Item 1 - Legal Proceedings of Part II of the Company's Quarterly Report on Form 10-Q for the quarter ended May 31, 1989 and Item 3 - Legal Proceedings of Part I of the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1988 as filed with the Securities and Exchange Commission, are incorporated herein by reference in Part I, Item 3 of this Annual Report.\n*99(j) Agreement and Plan of Merger dated as of September 4, 1992 by and among Bergen Brunswig Corporation, BBC Acquisition Corp. and Durr-Fillauer Medical, Inc. is set forth as Exhibit (c)(1) to Amendment No. 16 to Bergen Brunswig Corporation's and BBC Acquisition Corp.'s Tender Offer Statement Pursuant to Section 14(d)(1) of the Securities and Exchange Act of 1934.\nINDEX TO EXHIBITS (CONTINUED)\nEXHIBIT NO. PAGE NO. - ----------- --------\n* Document has heretofore been filed with the Securities and Exchange Commission and is incorporated herein by reference and made a part hereof.\n** Incorporated herein by reference to the exhibits filed as part of the Company's Registration Statement on Form S-3 (Registration No. 33-5530) and Amendment Nos. 1 and 2 thereto relating to an offering of $43,000,000 principal amount of 6-7\/8% Exchangeable Subordinated Debentures due 2011, filed with the Securities and Exchange Commission on May 8, July 1, and July 8, 1986, respectively.","section_15":""}
{"filename":"831259_1994.txt","cik":"831259","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings. -------------------------- Although FCX may be from time to time involved in various legal proceedings of a character normally incident to the ordinary course of its business, the management of FCX believes that potential liability in any such pending or threatened proceedings would not have a material adverse effect on the financial condition or results of operations of FCX. FCX, through FTX, maintains liability insurance to cover some, but not all, potential liabilities normally incident to the ordinary course of its business as well as other insurance coverages customary in its business, with such coverage limits as management deems prudent.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. ------------------------------------------------------------ Not applicable.\nExecutive Officers of the Registrant. ------------------------------------ In addition to the elected executive officers of FCX (the \"Elected FCX Executive Officers\"), one officer of PT-FI is deemed by FCX to be an executive officer of FCX (the \"Designated FCX Executive Officer\") for purposes of the federal securities laws. Listed below are the names and ages, as of March 15, 1995, of each of the Elected FCX Executive Officers and the Designated FCX Executive Officer, together with the principal positions and offices with FCX, FTX, and PT-FI held by each. All officers of FCX, FTX, and PT-FI are elected or appointed for one year terms, subject to death, resignation or removal.\nName Age Position or Office ---- --- -------------------\nRichard C. Adkerson 48 Senior Vice President of FCX. Senior Vice President of FTX. Commissioner of PT-FI.\nJohn G. Amato 51 General Counsel of FCX. General Counsel of FTX. Commissioner of PT-FI.\nRichard H. Block 44 Senior Vice President of FCX. Senior Vice President of FTX.\nThomas J. Egan 50 Senior Vice President of FCX. Senior Vice President of FTX.\nCharles W. Goodyear 37 Senior Vice President of FCX. Senior Vice President of FTX. Commissioner of PT-FI.\nHoediatmo Hoed*** 55 President Director of PT-FI.\nW. Russell King 45 Senior Vice President of FCX. Senior Vice President of FTX.\nRene L. Latiolais 52 Director and Vice Chairman of the Board of FCX. Director, President, and Chief Operating Officer of FTX. Commissioner of PT-FI.\nGeorge A. Mealey 61 Director, President, and Chief Executive Officer of FCX. Executive Vice President of FTX. Director and Executive Vice President of PT-FI.\nJames R. Moffett 56 Director and Chairman of the Board of FCX. Director, Chairman of the Board, and Chief Executive Officer of FTX. President Commissioner of PT-FI.\nThe individuals listed above have served FCX, FTX, or PT-FI in various executive capacities for at least the last five years.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related ----------------------------------------------------------------- Stockholder Matters. ------------------- The information set forth under the caption \"FCX Class A Common Shares\" and \"Class A Common Share Dividends\", on the inside back cover of FCX's 1994 Annual Report to stockholders, is incorporated herein by reference. As of March 10, 1995, there were 19,844 record holders of FCX's Class A common stock.\n----------------- ***This individual is a Designated FCX Executive Officer and not an Elected FCX Executive Officer. He is deemed by FCX to be a Designated FCX Executive Officer solely for purposes of the federal securities laws in view of his position and responsibilities as an officer of PT-FI; he holds no actual position as an officer of FCX.\nItem 6.","section_6":"Item 6. Selected Financial Data. -------------------------------- The information set forth under the caption \"Selected Financial and Operating Data\", on page 16 of FCX's 1994 Annual Report to stockholders, is incorporated herein by reference.\nFCX's ratio of earnings to fixed charges for each of the years 1990 through 1994, inclusive, was 9.2x, 4.5x, 6.5x, 3.6x and 7.5x respectively. For this calculation, earnings consist of income from continuing operations before income taxes, minority interest and fixed charges. Fixed charges include interest and that portion of rent deemed representative of interest.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and ------------------------------------------------------------------------------- Results of Operations. --------------------- The information set forth under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", on pages 11 through 14 and 17 through 20, of FCX's 1994 Annual Report to stockholders, is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. ---------------------------------------------------- The financial statements of FCX, the notes thereto and the report thereon of Arthur Andersen LLP, appearing on pages 21 through 34, inclusive, and the report of management on page 15 of FCX's 1994 Annual Report to stockholders, are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting ---------------------------------------------------------------------------- and Financial Disclosure. ------------------------ Not applicable.\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 set forth under the captions \"Voting Procedure\" and \"Election of Directors\", beginning on pages 1 and 4, respectively, of the Proxy Statement dated March 23, 1995, submitted to the stockholders of FCX in connection with its 1995 Annual Meeting to be held on May 4, 1995, 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)(1), (a)(2), and (d). Financial Statements. See Index to Financial Statements appearing on page hereof.\n(a)(3) and (c). Exhibits. See Exhibit Index beginning on page E-1 hereof.\n(b). Reports on Form 8-K. No reports on Form 8-K were filed by the registrant during the fourth quarter of 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, on March 23, 1995.\nFREEPORT-McMoRan COPPER & GOLD INC.\nBY: \/s\/ James R. Moffett -------------------------------- James R. Moffett 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 on March 23, 1995.\n\/s\/ James R. Moffett Chairman of the Board ---------------------- Director James R. Moffett\nGeorge A. Mealey* President, Chief Executive Officer and Director (Principal Executive Officer)\nRichard C. Adkerson* Senior Vice President and Chief Financial Officer (Principal Financial Officer)\nJohn T. Eads* Controller - Financial Reporting (Principal Accounting Officer)\nLeland O. Erdahl* Director\nRonald Grossman* Director\nRene L. Latiolais* Director\nWolfgang F. Siegel* Director\nElwin E. Smith* Director\nEiji Umene* Director\n*By: \/s\/ James R. Moffett -------------------------- James R. Moffett Attorney-in-Fact\n------------------------------\nThe financial statements of FCX, the notes thereto, and the report thereon of Arthur Andersen LLP appearing on pages 21 through 34, inclusive, of FCX's 1994 Annual Report to stockholders are incorporated by reference.\nThe financial statement schedules listed below should be read in conjunction with such financial statements contained in FCX's 1994 Annual Report to stockholders.\nPage ---- Report of Independent Public Accountants........................F-1 III-Condensed Financial Information of Registrant...............F-2\nSchedules other than those schedules listed above have been omitted since they are either not required or not applicable or the required information is included in the financial statements or notes thereof.\n* * *\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nWe have audited, in accordance with generally accepted auditing standards, the financial statements as of December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994 included in Freeport-McMoRan Copper & Gold Inc.'s annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 24, 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\nNew Orleans, Louisiana, January 24, 1995\nFREEPORT-McMoRan COPPER & GOLD INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nBalance Sheets\nDecember 31, ------------------------ 1994 1993 ---------- ---------- (In Thousands)\nAssets Cash and short-term investments $ 171 $ 427 Interest receivable 12,676 7,582 Receivable from Government of Indonesia - 2,247 Notes receivable from PT-FI 1,338,611 1,064,888 Investment in PT-FI 195,258 145,959 Investment in PTII 76,081 75,601 Investment in RTM 81,386 43,254 Other assets 14,988 2,011 ---------- ---------- Total assets $1,719,171 $1,341,969 ========== ========== Liabilities and Stockholders' Equity Accounts payable and accrued liabilities $ 27,270 $ 32,468 Long-term debt 190,000 102,039 Amount due to FTX 800 12,270 RTM stock subscription payable - 12,644 Other liabilities and deferred credits 6,119 2,001 Mandatory redeemable preferred stock 500,007 232,620 Stockholders' equity 994,975 947,927 ---------- ---------- Total liabilities and stockholders' equity $1,719,171 $1,341,969 ========== ==========\nStatements of Income Years Ended December 31, -------------------------------- 1994 1993 1992 -------- -------- -------- (In Thousands) Income from investment in PT-FI and PTII, net of PT-FI tax provision $111,822 $ 53,861 $128,220 Net loss from investment in RTM (6,309) (15,666) - Elimination of intercompany profit 3,005 (6,610) - General and administrative expenses (7,253) (5,207) (4,802) Depreciation and amortization (3,711) (2,397) (200) Interest expense (10,259) (8,017) (16,518) Interest income on PT-FI notes receivable: Zero coupon exchangeable notes 352 19,175 18,326 Promissory notes 21,094 9,292 11,097 8.235% convertible 14,033 14,036 - Step-up perpetual convertible 26,256 12,785 - Gold and silver production payment loans 20,222 4,055 - Other income (expense), net (7,424) (406) 5,561 Provision for income taxes (31,587) (24,085) (11,791) -------- -------- -------- Net income 130,241 50,816 129,893 Preferred dividends (51,838) (28,954) (7,025) -------- -------- -------- $ 78,403 $ 21,862 $122,868 ======== ======== ========\nFREEPORT-McMoRan COPPER & GOLD INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) Statements of Cash Flow Years Ended December 31, ----------------------------- 1994 1993 1992 -------- -------- -------- (In Thousands) Cash flow from operating activities: Net income $130,241 $ 50,816 $129,893 Adjustments to reconcile net income to net cash provided by operating activities: Income from investment in PT-FI and PTII (111,822) (53,861) (128,220) Net loss from investment in RTM 6,309 15,666 - Elimination of intercompany profit (3,005) 6,610 - Dividends received from PT-FI and PTII 147,465 132,048 78,214 Accretion of note receivable from PT-FI, net - (9,104) (1,808) Depreciation and amortization 3,711 2,397 200 (Increase) decrease in accounts receivable (24,240) - 20,000 Increase (decrease) in accounts payable (4,648) (646) 597 Other 1,654 (5,959) (1,854) -------- -------- -------- Net cash provided by operating activities 145,665 137,967 97,022 -------- -------- -------- Cash flow from investing activities: Received from Government of Indonesia 2,247 6,288 3,911 Investment in RTM (36,365) (43,642) - Investment in PTII (8) - (211,892) Investment in Freeport Hasa Inc. - - (1) -------- -------- -------- Net cash used in investing activities (34,126) (37,354) (207,982) -------- -------- -------- Cash flow from financing activities: Cash dividends paid: Class A common stock (38,316) (33,298) (26,088) Class B common stock (85,187) (85,277) (85,277) Special preference stock (15,708) (15,708) (4,407) Step-Up preferred stock (17,500) (5,590) - Mandatory redeemable preferred stock (13,614) (1,683) - Proceeds from sale of: Class A common stock - - 174,142 Preferred and preference stock 252,985 561,090 217,867 PT-FI common shares - - 212,484 9 3\/4% senior notes 116,276 - - Proceeds from equipment loan 70,000 - - Proceeds from FTX 88,280 20,650 - Repayment to FTX (99,750) (8,380) - Loans to PT-FI (369,261) (706,750) (212,484) -------- -------- -------- Net cash provided by (used) in financing activities (111,795) (274,946) 276,237 -------- -------- -------- Net increase (decrease) in cash and short- term investments (256) (174,333) 165,277 Cash and short-term investments at beginning of year 427 174,760 9,483 -------- -------- -------- Cash and short-term investments at end of year $ 171 $ 427 $174,760 ======== ======== ======== Interest paid $ 7,788 $ 213 $ - ======== ======== ======== Taxes paid $ 29,871 $ 22,723 $ 11,762 ======== ======== ========\nFREEPORT-McMoRan COPPER & GOLD INC. SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)\na. The footnotes contained in FCX's 1994 Annual Report to stockholders are an integral part of these statements.\nFreeport-McMoRan Copper & Gold Inc.\nEXHIBIT INDEX --------------- Sequentially Exhibit Numbered Number Page -------- ----\n3.1 Composite copy of the Certificate of Incorporation of FCX.\n3.2 By-Laws of FCX, as amended. Incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K of FCX for the fiscal year ended December 31, 1992 (the \"FCX 1992 Form 10-K\").\n4.1 Certificate of Designations of the 7% Convertible Exchangeable Special Preference Stock (the \"Special Preference Stock\") of FCX. Incorporated by reference to Exhibit 5 to the Form 8 Amendment No. 1 dated July 16, 1992 (the \"Form 8 Amendment\") to the Application for Registration on Form 8-A of FCX dated July 2, 1992.\n4.2 Deposit Agreement dated as of July 21, 1992 among FCX, Mellon Securities Trust Company, as Depositary, and holders of depositary receipts (\"Depositary Receipts\") evidencing certain Depositary Shares, each of which, in turn, represents 2-16\/17 shares of Special Preference Stock. Incorporated by reference to Exhibit 2 to the Form 8 Amendment.\n4.3 Form of Depositary Receipt. Incorporated by reference to Exhibit 1 to the Form 8 Amendment.\n4.4 Certificate of Designations of the Step-Up Convertible Preferred Stock of FCX. Incorporated by reference to Exhibit 4.4 to the Annual Report on Form 10-K of FCX for the fiscal year ended December 31, 1993 (the \"FCX 1993 Form 10-K\").\n4.5 Deposit Agreement dated as of July 1, 1993 among FCX, Mellon Securities Trust Company, as Depositary, and holders of depositary receipts (\"Step- Up Depositary Receipts\") evidencing certain Depositary Shares, each of which, in turn, represents 0.05 shares of Step-Up Convertible Preferred Stock. Incorporated by reference to Exhibit 4.5 to the FCX 1993 Form 10-K.\n4.6 Form of Step-Up Depositary Receipt. Incorporated by reference to Exhibit 4.6 to the FCX 1993 Form 10-K.\n4.7 Certificate of Designations of the Gold-Denominated Preferred Stock of FCX. Incorporated by reference to Exhibit 4.7 to the FCX 1993 Form 10-K.\n4.8 Deposit Agreement dated as of August 12, 1993 among FCX, Mellon Securities Trust Company, as Depositary, and holders of depositary receipts (\"Gold- Denominated Depositary Receipts\") evidencing certain Depositary shares, each of which, in turn, represents 0.05 shares of Gold-Denominated Preferred Stock. Incorporated by reference to Exhibit 4.8 to the FCX 1993 Form 10-K.\n4.9 Form of Gold-Denominated Depositary Receipt. Incorporated by reference to Exhibit 4.9 to the FCX 1993 Form 10-K.\n4.10 Certificate of Designations of the Gold-Denominated Preferred Stock, Series II (the \"Gold-Denominated Preferred Stock II\") of FCX. Incorporated by reference to Exhibit 4.1 to the Quarterly Report on Form 10-Q of FCX for the quarter ended March 31, 1994 (the \"FCX 1994 First Quarter Form 10-Q\").\n4.11 Deposit Agreement dated as of January 15, 1994, among FCX, Mellon Securities Trust Company, as Depositary, and holders of depositary receipts (\"Gold- Denominated II Depositary Receipts\") evidencing certain Depositary shares, each of which, in turn, represents 0.05 shares of Gold-Denominated Preferred Stock II. Incorporated by reference to Exhibit 4.2 to the FCX 1994 First Quarter Form 10-Q.\n4.12 Form of Gold-Denominated II Depositary Receipt. Incorporated by reference to Exhibit 4.3 to the FCX 1994 First Quarter Form 10-Q.\n4.13 Certificate of Designations of the Silver-Denominated Preferred Stock of FCX.\n4.14 Deposit Agreement dated as of July 25, 1994 among FCX, Mellon Securities Trust Company, as Depositary, and holders of depositary receipts (\"Silver-Denominated Depositary Receipts\") evidencing certain Depositary shares, each of which, in turn, initially represents 0.025 shares of Silver-Denominated Preferred Stock. Incorporated by reference to Exhibit 4.2 to the July 15, 1994 Form 8-A.\n4.15 Form of Silver-Denominated Depositary Receipt. Incorporated by reference to Exhibit 4.1 to the July 15, 1994, Form 8-A.\n4.16 Credit Agreement dated as of June 1, 1993 (the \"PT-FI Credit Agreement\") among PT-FI, the several banks which are parties thereto (the \"PT-FI Banks\"), Morgan Guaranty Trust Company of New York, as PT-FI Trustee (the \"PT-FI Trustee\"), and Chemical Bank, as agent (the \"PT-FI Bank Agent\"). Incorporated by reference to Exhibit 4.10 to the FCX 1993 Form 10-K.\n4.17 First Amendment dated as of February 2, 1994 to the PT-FI Credit Agreement among PT-FI, the PT-FI Banks, the PT- FI Trustee and the PT-FI Bank Agent. Incorporated by reference to Exhibit 4.11 to the FCX 1993 Form 10-K.\n4.18 Second Amendment dated as of March 1, 1994 to the PT-FI Credit Agreement among PT-FI, the PT-FI Banks, the PT- FI Trustee and the PT-FI Bank Agent. Incorporated by reference to Exhibit 4.12 to the FCX 1993 Form 10-K.\n4.19 Third Consent and Waiver dated as of October 18, 1994 to the PT-FI Credit Agreement among PT-FI, the PT-FI Banks, the PT-FI Trustee and the PT-FI Bank Agent.\n4.20 Fourth Amendment, Consent and Limited Waiver dated as of November 23, 1994 to the PT-FI Credit Agreement among PT-FI, the PT-FI Banks, the PT-FI Trustee and the PT-FI Bank Agent.\n4.21 Term Loan and Working Capital Agreement dated as of November 4, 1994 (the \"RTML Term Loan\") among Rio Tinto Metal, S.A. (\"RTML\"), the Lenders and Barclays Bank PLC as Agent (the \"Agent\").\n4.22 Amendment No. 1 dated as of March 7, 1995 to the RTML Term Loan among RTML, the Lenders and the Agent.\n4.23 Agreement dated as of May 1, 1988 between Freeport Minerals Company and FCX assigning certain stockholder rights and obligations. Incorporated by reference to Exhibit 10.13 to Registration No. 33-20807.\n10.1 Design, Engineering and Related Services Contract dated as of September 15, 1992 between PT-FI and Fluor Daniel Engineers & Constructors, Ltd. Incorporated by reference to Exhibit 10.1 to the FCX 1992 Form 10- K.\n10.2 Site Services Contract dated as of September 15, 1992 between PT-FI and Fluor Daniel Eastern, Inc. Incorporated by reference to Exhibit 10.2 to the FCX 1992 Form 10-K.\n10.3 Contract of Work dated December 30, 1991 between The Government of the Republic of Indonesia and PT-FI. Incorporated by reference to Exhibit 10.20 to the FCX 1991 Form 10-K.\n10.4 Management Services Agreement dated as of May 1, 1988 among FCX, FII and FTX. Incorporated by reference to Exhibit 10.01 to Registration No. 33-20807.\n10.5 Concentrate Sales Agreement dated as of December 30, 1990 between FII and Dowa Mining Co., Ltd., Furukawa Co., Ltd., Mitsubishi Materials Corporation, Mitsui Mining & Smelting Co., Ltd., Nittetsu Mining Co., Ltd., Nippon Mining Co., Ltd. and Sumitomo Metal Mining Co., Ltd. (Confidential information omitted and filed separately with the Securities and Exchange Commission.) Incorporated by reference to Exhibit 10.3 to the Annual Report on Form 10-K of FCX for the fiscal year ended December 31, 1990.\n12.1 FCX Computation of Ratio of Earnings to Fixed Charges.\n13.1 Those portions of the 1994 Annual Report to stockholders of FCX which are incorporated herein by reference.\n21.1 Subsidiaries of FCX.\n23.1 Consent of Arthur Andersen LLP dated March 23, 1995.\n24.1 Certified resolution of the Board of Directors of FCX authorizing this report to be signed on behalf of any officer or director pursuant to a Power of Attorney.\n24.2 Powers of Attorney pursuant to which this report has been signed on behalf of certain officers and directors of FCX.\n27.1 FCX Financial Data Schedule.","section_15":""}
{"filename":"790129_1994.txt","cik":"790129","year":"1994","section_1":"ITEM 1. BUSINESS.\nOrganization\nGlenborough Partners, A California Limited Partnership (\"Partners\"), successor to Glenborough Limited, A California Limited Partnership pursuant to section 15d-5 of the Securities Exchange Act of 1934, was originally formed in 1986 generally to acquire, own, operate, develop and lease commercial and residential real estate. To facilitate compliance with certain recording and filing requirements, a second limited partnership, GOCO Realty Fund I, a California Limited Partnership formerly known as Glenborough Operating Co. Ltd., A California Limited Partnership (\"GOCO\"), was formed in April 1986 to hold and operate all real and personal property then or thereafter owned by the Partnership (the \"Partnership Property\"). Partners and GOCO operated as an economic unit and unless specifically designated otherwise, were referred to collectively as the \"Partnership\". The present general partners of both Partners and GOCO are Glenborough Realty Corporation, a California corporation, and Robert Batinovich (collectively \"Glenborough\" or \"General Partner\"). Glenborough Realty Corporation is the managing general partner of the Partnership (the \"Managing General Partner\"). Glenborough Partners is the sole limited partner of GOCO.\nIn June 1986, the Partnership acquired (the \"Roll Up\") 66 real estate projects (the \"Original Projects\"), subject to non-recourse institutional debt secured by the Original Projects and certain assets, subject to certain liabilities, most of which were related to the operation of the Original Projects (\"Net Other Assets\"). The Original Projects and the Net Other Assets (collectively, the \"Original Assets\") were acquired by the Partnership from 21 limited partnerships and one individual (collectively, the \"Predecessor Owners\"). The Partnership acquired the Original Assets in exchange for 4,948,891 limited partnership units (the \"Exchange Transaction\").\nTo facilitate the Partnership's holding and transfer of real property as set forth under the plan of reorganization discussed below, two partnerships were created in February 1994: (i) GPA West, L.P.; and (ii) GPA Industrial, L.P. Subsequently, a third partnership was created in 1994, GPA Bond, L.P., to hold a property purchased on December 29, 1994.\nAll three partnerships are subsidiaries of GOCO Realty Fund I and as such, the financial statements are consolidated with Glenborough Partners. The general partners of each of these partnerships are Glenborough Realty Corporation and Robert Batinovich while the sole limited partner of each is GOCO Realty Fund I.\nChapter 11 - Reorganization\nOn May 21, 1992, GOCO Realty Fund I, the partnership holding and operating the Partnership's real property, filed a petition in the\nPage 2 of 54\nUnited States Bankruptcy Court for the Northern District of California (\"the Bankruptcy Court\") for reorganization under Chapter 11 of the Federal Bankruptcy Code. The Partnership filed a plan of reorganization with the Bankruptcy Court which became effective January 24, 1994 (see Note 10 of the Notes to Consolidated Financial Statements).\nThe following is a brief description of the principal points of the reorganization plan:\n1. The claims of all creditors were satisfied in full.\n2. Transfer to Brazos Asset Management, Inc. or its affiliates (\"Brazos\"), successor to New West Federal which succeeded American Savings and Loan, (\"American\"), the original lender, (see Note 3 of the Notes to the Consolidated Financial Statements) of the Partnership's interest in the restricted cash and Griffin note receivable from Griffin Investments (Griffin\"), successor to Mariani Financial Company (\"MFCo\"), the original contributor of 15 properties to the Partnership in the Roll-Up (see Note 4 of the Notes to the Consolidated Financial Statements).\n3. Twelve properties have been transferred into two separate rollouts, four to Griffin Investments (Phase II Rollout), and eight to a Griffin affiliate (Phase III Rollout), in redemption of all of Griffin's (and its affiliates') 448,894 units in Glenborough Partners (which is successor to Glenborough Limited). These redemptions reduced Glenborough Partners' outstanding equity securities from 3,410,747 limited partner units to 2,961,853 limited partner units. Those entities were given options to pay off Brazos' lien on those properties, at negotiated prices, or transfer them to Brazos.\n4. GOCO's obligation to deliver the property known as Burlingame Plaza to Robert Fraser was satisfied through the payment by GOCO Realty Fund I of $750,000 toward the price charged by Brazos for release of Burlingame Plaza, which was then delivered to Mr. Fraser free and clear following his payment of $150,000 owed by him to GOCO. GOCO paid this amount over to Brazos against the balance of the release price.\n5. The claims of Brazos were satisfied through a multipart transaction including the following:\na. Brazos unconditionally released its lien on two properties; (i) a 50,000-foot industrial facility in Auburn, California, which was leased to Coherent, Inc. - the release of this lien occurred on February 4, 1994, as part of a sale of the property to the tenant; and (ii) a vacant 95,500 square foot industrial\/office facility in the Stanford Business Park in Palo Alto, California.\nb. GOCO paid Brazos the sum of $500,000, from the Coherent Auburn sale, discussed below, in return for which Brazos released its lien on the property known as Rosemead\nPage 3 of 54\nSprings Business Park in El Monte, California - this transaction occurred on February 4, 1994.\nc. GOCO had an option (exercisable at any time prior to April 30, 1994) to obtain a release of the Brazos lien as to any of the remaining properties (the \"Option Properties\") subject to Brazos' lien by paying a negotiated release price to Brazos. The Partnership exercised its option on eight properties as discussed in paragraph 4, 5.a and 5.b above and 6. below. The remaining options were not exercised and those properties were transferred to Brazos in satisfaction of the remaining balance of Brazos claims in May 1994.\n6. GOCO closed the sale of the Coherent Auburn facility to the tenant for $3,650,000 on February 4, 1994, and applied a portion of the net proceeds from the sale toward the payment of the release price for the Rosemead Springs property referred to in paragraph 5.b., above. Most of the remaining proceeds were applied toward the partial paydown of Brazos' discounted lien release price for four of the Option Properties referred to in paragraph 5.c., above. The balance of the funds required for the payment of those release prices were financed through a $12 million loan obtained by GPA Industrial, L.P. from Heller Financial, Inc. Such financing was applied to the release of the liens on the two properties known as the J.I. Case buildings and the two properties known as the Navistar buildings. The total release price for these properties and the Rosemead property was $14,500,000.\n7. Included in the above transactions, was $962,000 in net transaction fees payable to a general partner which was paid in August 1994.\nMaterial Disposition of Properties\nMFCo. Phase I Rollout - Effective January 1, 1987, the Partnership transferred to MFCo., under an installment land contract, equitable title to nine of the 15 properties originally contributed by MFCo. and its affiliates to the Partnership in the Exchange Transaction. These properties had an original exchange value of $73,852,000. In consideration for the properties and related net assets and liabilities, David W. Mariani and MFCo. transferred back 1,110,863 units of partnership interest in Limited and gave Limited a note in the original principal amount of $53,172,000, which included undrawn reserves of $1,960,000. This amount approximated the prorata share of refinanced New West Federal Debt (now known as the \"Brazos Debt\")(see Note 3 - Notes Payable) attributable to the MFCo. Rollout properties. This note has an original maturity date of June 30, 1996.\nThe difference between the promissory note received from MFCo. and the book value of the assets transferred\/rolled out was recorded on the Partnership's books as deferred gain. MFCo. Rollout price adjustments affecting deferred gain have been made subsequent to the Rollout, due to a provision in the original Master Lease on one\nPage 4 of 54\nof the properties rolled-out. The note receivable was discounted to yield the same effective interest rate as the Brazos Debt, 7.44%. No accounting recognition has been given to the surrender of Partnership Units.\nThis transaction substantially reduced MFCo.'s interest in the Partnership from approximately 31% to approximately 11%. In addition, David W. Mariani withdrew as a general partner of both Glenborough Limited and GOCO and also resigned as an officer and director of Glenborough Realty Corporation, the managing general partner of Glenborough Limited and GOCO, effective July 9, 1987.\nIn January 1988, MFCo. assigned to Griffin Investments, a California limited partnership, its interest in the installment sale land contract. Interest only payments (originally five percent increasing over time to ten percent) are due monthly. Effective July 1, 1991, the Partnership agreed to forbear from collecting from Griffin Investments the increased interest payments which would otherwise have taken effect on that date, in the approximate amount of $77,000 per month.\nAt December 31, 1993, the Partnership remained primarily liable for the full amount of the Brazos Debt and the MFCo. Rollout properties remained collateral for that debt. Griffin Investments had the right to partially reinstate its prorata share of the Brazos Debt in the event of a default by the Partnership. The Partnership also had the right to transfer title of the properties to Griffin Investments. On January 24, 1994, pursuant to the plan of reorganization discussed above, the claims of Brazos were satisfied through a multipart transaction which included a transfer by the Partnership to Brazos of the Griffin note receivable.\nBusiness Plan\nIn general, the Partnership's intentions were to acquire and hold properties for the long term, with the objective of providing a strong, growing, diversified portfolio that can generate predictable cash distributions.\nThe business of the Partnership consists primarily of owning and operating as a continuing business, the current projects (\"Partnership Properties\" or \"Properties\") and mortgages (the \"Partnership Assets\"). Information regarding the Partnership Properties is incorporated herein by reference to Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nAs discussed above under Chapter 11 - Reorganization, the Partnership exercised its option to obtain a release of the Brazos lien on eight properties. The options on the remaining properties were not exercised and those properties were transferred to Brazos in satisfaction of the remaining balance of Brazos' claims in May 1994.\nAs of December 31, 1994, the Partnership has a total of 6 projects. There are 170,000 rentable square feet of multi-tenant office space located in suburban areas of Los Angeles and Detroit with aggregate occupancy of 34%. Industrial\/warehouse facilities, totaling 1.2 million rentable square feet are located in Memphis, Chicago, Kansas City, and Baltimore. The industrial\/warehouse space is 100% leased. The overall property occupancy is 92%.\nIn the opinion of management, the insurance coverage on each of the real estate projects has been and continues to be adequate.\nThere are four leases which occupied ten percent or more of the total net rentable square footage available at year end. See \"Material Leases\" below for the lease and option provisions for these leases. On a cumulative basis, these light industrial warehouse projects produced gross revenue of $2,101,000 for the last fiscal year equal to approximately 34% of the aggregate gross revenues of the Partnership.\nInformation regarding encumbrances on Partnership Projects is incorporated herein by reference to Item 8, Note 3 - Notes Payable in the Notes to Consolidated Financial Statements.\nThe following table sets forth information regarding the Partnership Projects which were owned as of December 31, 1994, grouped by type of project, including project name, location, general physical characteristics, and total amount of leasable square feet.\nPage 7 of 54\nPage 8 of 54\nMaterial Leases\nThe following is a description of leases containing an option to purchase the project. Currently, the Partnership is not a party to any leases with any General Partner of the Partnership, or officers, directors or affiliates of a General Partner of the Partnership.\nJ. I. Case Company Building, Kansas City, KS - J. I. Case Company occupies 100% of the leasable space under a lease assigned by Navistar International Corporation that commenced in 1984 and expires on February 29, 2004, with an option to extend for two five-year terms. Gross base rent annualized is currently $360,000. The lessee did not exercise its option to purchase the property on March 1, 1993. On March 1, 1997, the Lessee has another option to purchase the property for the greater of fair market value of the property at the time of exercise or $2,061,000.\nJ. I. Case Company Building, Memphis, TN - J. I. Case Company leases but does not occupy 100% of the leasable space under a lease assigned by Navistar International Corporation that commenced in 1984 and expires on February 29, 2004, with an option to extend for two five-year terms. Gross base rent annualized is currently $316,000. The lessee did not exercise its option to purchase the property on March 1, 1993. On March 1, 1997, the Lessee has another option to purchase the property for the greater of fair market value of the property at the time of exercise or $1,664,000.\nNavistar International Corporation Building, Baltimore, MD -Navistar International Corporation occupies 100% of the leasable space under a lease that commenced in 1984 and expires on February 29, 2004, with an option to extend for two five-year terms. The rental amounts payable under the lease were modified in 1989 and 1990 in consideration of waiver by the tenant of purchase options exercisable in those years. Gross annual rent, triple net, is $422,000. The lessee did not exercise its option to purchase the property on March 1, 1993, but has an option to purchase the property every three years thereafter, at a price equal to fair market value, but not less than $3,700,000 and not more than $4,200,000, a figure determined in accordance with a formula specified in the 1990 modification. This figure may change in future years based on the formula specified in the modification.\nNavistar International Corporation Building, West Chicago, IL -Navistar International Corporation occupies 100% of the leasable space under a lease that commenced in 1984 and expires on February 29, 2004, with an option to extend for two five-year terms. The rental amounts payable under the lease were modified in 1989 and 1990 in consideration of waiver by the tenant of purchase options exercisable in those years. Gross annual rent, triple net, is $1,003,000. The lessee did not exercise its option to purchase the property on March 1, 1993, but has an option to purchase the property every three years thereafter, at a price equal to fair market value, but not less than $8,195,000 and not more than $9,952,000, a figure determined in accordance with a formula\nPage 9 of 54\nspecified in the 1990 modification. This figure may change in future years based on the formula specified in the modification.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn May 21, 1992, New West Federal Savings and Loan Association filed a judicial foreclosure action in Superior Court in Orange County. Also on May 21, the Partnership (i) filed a civil action against New West Federal in Superior Court in San Mateo County, seeking in excess of $30 million in damages for a variety of claims, including misrepresentation and breach of contract, and (ii) filed a petition in the United States Bankruptcy Court (\"the Court\") for the Northern District of California for reorganization under Chapter 11 of the Federal Bankruptcy Code. On January 13, 1994, the Court entered an order confirming a plan of reorganization (the \"Plan\") (see Item 8 - Note 10). The Plan became effective on January 24, 1994.\nPursuant to the Plan, the lawsuits were dropped in 1994 after all the terms of the Plan were met.\nITEM 4.","section_4":"ITEM 4. RESULTS OF VOTES OF SECURITY HOLDERS.\nDuring the fourth quarter of fiscal year 1994, no matters were 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 EQUITY AND RELATED SECURITY HOLDER MATTERS.\nMarket Information\nThere is no public market for units of limited partnership interest in the Partnership (the \"Units\") and it is not expected that any will develop. The Units have limited transferability. Restrictions on transfer may be imposed under certain state securities laws. Consequently, holders of Units may not be able to liquidate their investments and the Units may not be readily acceptable as collateral.\nHolders\nAs of December 31, 1994, 414 holders of record held 2,961,853 Limited Partnership Units.\nCash Distributions\nThe Partnership began paying quarterly cash distributions on April 30, 1987, at a quarterly rate of $0.375 per Limited Partnership Unit and continued paying the same quarterly cash distribution through the fourth quarter 1988 distribution on January 31, 1989. In 1989, the Partnership lowered its quarterly cash distribution rate to $0.25 per Unit for the first quarter distribution and to $0.1875 per Unit beginning with the second quarter 1989\nPage 10 of 54\ndistribution. Distributions were suspended as of the second quarter of 1990. It is not known when they will be resumed.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe selected financial data should be read in conjunction with the financial statements and related notes contained elsewhere in this report. This selected financial data is not covered by the reports of the independent public accountants.\nPage 11 of 54\nNOTES TO SELECTED FINANCIAL DATA\n1. The Partnership recognized extraordinary items from the Chapter 11 bankruptcy reorganization, early extinguishment of debt, and related costs.\n2. The Partnership suspended distributions in the second quarter of 1990.\n3. In 1990 and 1991, the per unit data is based on 98.01% of the subject divided by 3,442,110 total limited partner units outstanding. In 1992 and 1993, with a limited partner reassigning 27,271 units back to Glenborough Limited (a predecessor to Glenborough Partners) at the close of business December 31, 1991, the per unit data is based on 98.01% of the subject divided by 3,414,839 limited partner units outstanding. In 1994, after the redemption of a total of 449,894 units as part of the reorganization plan (see Note 10 of the Notes to the Consolidated Financial Statements), the per unit data is based on 97.73% of the subject divided by 3,146,492 weighted average limited partner units.\n4. Real Estate Investment additions at cost, were $2,767,000, $595,000, $980,000, $633,000 and $440,000 for the years ended\nPage 12 of 54\nDecember 31, 1990, 1991, 1992, 1993 and 1994 respectively. Net Real Estate Investment deletions due to sales were $9,842,000 and $6,182,000 for the years ended December 31, 1990 and 1994, respectively. In 1994, the Partnership transferred back to the lender, Brazos Asset Management Inc., net real estate investments of $106,049,000 in satisfaction of the remaining balance of Brazos' claims (see Legal Proceedings and Item 1. Chapter 11 - Reorganization).\nThe comparability of the Consolidated Financial Data reflected in the above table has been affected by the reduction of total assets and related debt resulting from the bankruptcy reorganization and early extinguishment of debt in 1994 and by the Statement of Position 90-7 - Financial Reporting by Entities in Reorganization Under the Bankruptcy Code (\"SOP 90-7\") in 1993 and 1992. Interest on secured claims accrues only to the extent that the value of the underlying collateral exceeds the principal amount of the secured claim. Therefore, interest is accrued only through May 21, 1992.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nIntroduction\nThe predecessor partnership commenced operations as of June 30, 1986, following its acquisition of 66 real estate projects subject to non-recourse institutional debt secured by the projects and certain other assets, subject to certain liabilities, most of which related to the operation of the projects. The predecessor partnership acquired the projects and other assets in exchange for the Units, in an Exchange Transaction involving 21 limited partnerships and one individual property owner. At the end of 1993, there was a technical termination of the predecessor partnership and Glenborough Partners commenced as successor to Glenborough Limited (collectively, \"the Partnership\").\nThe following discussion addresses the Partnership's financial condition at December 31, 1994 and its results of operations for the years ended December 31, 1994, 1993 and 1992. This information should be read in conjunction with the Consolidated Financial Statements, notes thereto and other information contained elsewhere in this report.\nLIQUIDITY AND CAPITAL RESOURCES\nOn May 21, 1992, New West Federal Savings and Loan Association (\"New West\") filed a judicial foreclosure action in Superior Court in Orange County. Also on May 21, the Partnership (i) filed a civil action against New West in Superior Court in San Mateo County, seeking in excess of $30 million in damages for a variety of claims, including misrepresentation and breach of contract, and (ii) filed a petition in the United States Bankruptcy Court for the Northern District of California for reorganization under Chapter 11 of the Federal Bankruptcy Code (see Results of Operations below). The Bankruptcy Court approved the Partnership as debtor in possession, the continuation of Glenborough as manager of the\nPage 13 of 54\nPartnership's assets, and an agreement between the Partnership and New West relating to the use of cash collateral, as well as ruling on a variety of other miscellaneous issues. On December 23, 1992, the Partnership and New West agreed on the terms of a litigation moratorium under which virtually all activity in the civil actions and in the Bankruptcy Court (other than routine matters relating to day-to-day operations) were suspended while the parties attempted to negotiate a settlement.\nAs a result of the Chapter 11 filing, a cash collateral agreement was implemented between the Partnership and New West, whereby the Partnership was required to pay to New West monthly, all but $50,000 of the funds remaining in the operating cash accounts as of the last day of the previous month. In accordance with SOP 90-7, such payments have been recognized as interest expense. Net cash paid to New West, Brazos (discussed below) or its agent for interest pursuant to the cash collateral agreement was $2,216,000 and $12,219,000 in 1994 and 1993, respectively.\nOn November 19, 1993, GOCO and Brazos executed a settlement agreement, which was incorporated into a Second Amended Plan of Reorganization (incorporated by reference to Exhibit 2.1 to the Partnership's Current Report on Form 8-K dated January 24, 1994) (\"Amended Plan\") for GOCO, which was confirmed by the court on January 13, 1994, without opposition from any party, and became effective on January 24, 1994.\nThe Amended Plan and settlement had five principal components. First, Brazos unconditionally released its lien on two properties: (i) a 50,000-foot industrial facility leased to Coherent, Inc. in Auburn, California, which was sold to the tenant as described more fully below; and (ii) a vacant 95,500 square foot industrial\/office facility in the Stanford Business Park in Palo Alto, California, which was sold to Coherent in December 1994 as described more fully below. Second, GOCO acquired Rosemead for $500,000. Third, GOCO had an option (exercisable at any time prior to April 30, 1994) to obtain a release of the Brazos lien as to any remaining properties subject to Brazos's lien by paying a negotiated release price to Brazos. The Partnership exercised its option on a few properties as discussed below. Fourth, by April 30, 1994, GOCO was to have transferred to Brazos, in satisfaction of the balance of Brazos's claims, any property as to which GOCO had not exercised the option described above. This transaction actually closed on May 6, 1994. Fifth, certain properties were transferred by GOCO to Griffin (see Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nPage ---- Report of Independent Public Accountants....................................20\nFinancial Statements:\nConsolidated Balance Sheets - December 3l, l994 and l993 ........................................................21\nConsolidated Statements of Operations for the years ended December 3l, l994, l993 and l992.........................................................23\nConsolidated Statements of Partners' Equity (Deficit) for the years ended December 3l, l994, l993 and l992....................................................25\nConsolidated Statements of Cash Flows for the years ended December 3l, l994, l993 and l992...........................26\nNotes to the Consolidated Financial Statements........................28\nFinancial Statement Schedule:\nSchedule III - Consolidated Real Estate Investments and Related Accumulated Depreciation and Amortization at December 31, 1994.....................................................46\nOther schedules are omitted either because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.\nPage 19 of 54\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of GLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP:\nWe have audited the accompanying consolidated balance sheets of GLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP (formerly known as GLENBOROUGH LIMITED, A CALIFORNIA LIMITED PARTNERSHIP), as of December 3l, l994 and l993, and the related consolidated statements of operations, partners' equity (deficit), and cash flows for each of the three years in the period ended December 3l, l994. These consolidated financial statements and the schedule referred to below are the responsibility of the Partnership'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 GLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP, as of December 3l, l994, and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 3l, l994, in conformity with generally accepted accounting principles.\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 and schedules 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. The 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 ANDERSON LLP\nSan Francisco, California, February 10, 1995\nGLENBOROUGH PARTNERS A CALIFORNIA LIMITED PARTNERSHIP\nConsolidated Balance Sheets (in thousands, except units outstanding)\nDecember 31, 1994 and 1993\n1994 1993 ------- -------- Assets\nReal estate investments, at cost: Land $ 2,045 $ 28,620 Building and improvements 16,076 137,956 ------- -------- 18,121 166,576 Less: Accumulated depreciation (2,901) (42,875) ------- -------- Net real estate investments 15,220 123,701\nReal estate held for sale - net 4,558 -\nOther Assets: Cash and cash equivalents 2,604 1,506 Restricted cash - 8,247 Receivables, net of allowance for doubtful receivables of $117 at December 31, 1993 (including $70 from a related party at December 31, 1993) 15 2,276 Deferred loan fees, net of accumulated amortization of $44 and $8,856 at December 31, 1994 and 1993, respectively 352 2,933 Deferred leasing commissions, net of accumulated amortization of $161 and $2,278 at December 31, 1994 and 1993, respectively 10 721 Griffin notes receivable, net (including premium of $4,092 at December 31, 1993) - 44,830 Other notes receivable - 121 Prepaid incentive and transaction fees (paid to related party) - 623 Prepaid expenses 69 - Deposits 199 275 Other assets 158 49 ------- -------\nTotal assets $23,185 $185,282 ======= ========\n(continued)\nThe accompanying notes are an integral part of these consolidated statements.\nPage 21 of 54\nGLENBOROUGH PARTNERS A CALIFORNIA LIMITED PARTNERSHIP\nConsolidated Balance Sheets - continued (in thousands, except units outstanding)\nDecember 31, 1994 and 1993\n1994 1993 ------- --------\nLiabilities and Partners' Equity (Deficit)\nPrepetition liabilities: Notes payable, including premium of $38,641 at December 31, 1993 (including $90 to a related party at December 31, 1993) $ - $273,762 Accrued interest - 21,237 Accounts payable - 563 Deposits and other liabilities - 726 ------- --------\nTotal prepetition liabilities - 296,288 ------- --------\nPostpetition liabilities: Notes payable 17,160 381 Accounts payable 85 - Accrued expenses 496 239 Advances from related parties 60 - Lease obligation - 167 Deposits and other liabilities 95 475 ------- --------\nTotal postpetition liabilities 17,896 1,262 ------- --------\nPartners' equity (deficit) General partner 435 (2,234) Limited partners, 2,961,853 and 3,414,839 units outstanding at December 31, 1994 and 1993, respectively 4,854 (110,034) ------- --------\nTotal partners' equity (deficit) 5,289 (112,268) ------- --------\nTotal liabilities and partners' equity (deficit) $23,185 $185,282 ======= ========\nThe accompanying notes are an integral part of these consolidated statements.\nPage 22 of 54\n(continued)\nPage 23 of 54\nGLENBOROUGH PARTNERS A CALIFORNIA LIMITED PARTNERSHIP\nConsolidated Statements of Operations - continued (in thousands, except per unit amounts)\nFor the years ended December 31, 1994, 1993 and 1992\nLoss before extraordinary items per Limited Partnership Unit ............................. $ (.74) $ (1.81) $ (1.77)\nExtraordinary items per Limited Partnership Unit ......................................... $ 37.26 (0.01) (0.01) ------ ------ ------\nNet income (loss) per Limited Partnership Unit ......................................... $ 36.52 $ (1.82) $ (1.78) ====== ====== ======\nDistributions per Limited Partnership Unit ....... $ -- $ -- $ -- ====== ====== ======\nThe accompanying notes are an integral part of these consolidated statements.\nPage 24 of 54\nGLENBOROUGH PARTNERS A CALIFORNIA LIMITED PARTNERSHIP\nConsolidated Statements of Partners' Equity (Deficit) (in thousands)\nFor the years ended December 31, 1994, 1993 and 1992\nTotal Partners' General Limited Capital Partner Partners (Deficit) ------- -------- ---------\nConsolidated balance, December 31, 1991 . $ (1,983) $ (97,710) $ (99,693)\nNet loss .............................. (124) (6,093) (6,217) --------- --------- ---------\nConsolidated balance, December 31, 1992 . (2,107) (103,803) (105,910)\nNet loss .............................. (127) (6,231) (6,358) --------- --------- ---------\nConsolidated balance, December 31, 1993 . (2,234) (110,034) (112,268)\nNet income ............................ 2,669 114,888 117,557 --------- --------- ---------\nConsolidated balance, December 31, 1994 . $ 435 $ 4,854 $ 5,289 ========= ========= =========\nThe accompanying notes are an integral part of these consolidated statements.\nPage 25 of 54\n(continued)\nPage 26 of 54\nPage 27 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nNote. 1. SUMMARY OF ORGANIZATION\nGlenborough Partners, A California Limited Partnership (\"Partners\"), successor to Glenborough Limited, A California Limited Partnership pursuant to section 15d-5 of the Securities Exchange Act of 1934 was originally formed in 1986 generally to acquire 66 real estate projects from their predecessor owners in exchange for Partnership units (\"the Exchange Transaction\"). Debt secured by the properties was restructured and consolidated into one loan at that time. The properties were managed and other services were performed by affiliates of the general partners.\nTo facilitate compliance with certain recording and filing requirements, a second limited partnership, GOCO Realty Fund I, a California Limited Partnership formerly known as Glenborough Operating Co. Ltd., A California Limited Partnership (\"GOCO\"), was formed in April 1986 to hold and operate all real and personal property then or thereafter owned by the Partnership (the \"Partnership Property\"). Partners and GOCO operated as an economic unit and unless specifically designated otherwise, were referred to collectively as the \"Partnership\". The present general partners of both Partners and GOCO are Glenborough Realty Corporation, a California corporation (\"Realty\"), and Robert Batinovich (collectively \"Glenborough\" or \"General Partner\"). Glenborough Realty Corporation is the managing general partner of the Partnership (the \"Managing General Partner\"). Glenborough Partners is the sole limited partner of GOCO.\nOn May 21, 1992, GOCO Realty Fund I, the partnership holding and operating the Partnership's real property (including its related debt), filed a petition in the United States Bankruptcy Court for the Northern District of California for reorganization under Chapter 11 of the Federal Bankruptcy Code. On January 13, 1994, a plan of reorganization was filed with the Bankruptcy court which became effective January 24, 1994 (see Note 10).\nTo facilitate the Partnership's holding and transfer of real property as set forth under the plan of reorganization, two partnerships were created in February 1994: (i) GPA West, L.P. (\"West\"), and (ii) GPA Industrial L.P. (\"Industrial\"). West and Industrial are subsidiaries of GOCO Realty Fund I and as such, the financial statements have been consolidated with Glenborough Partners. The general partners of West and Industrial are Glenborough Realty Corporation and Robert Batinovich while the sole limited partner of each of the two partnerships is GOCO Realty Fund I.\nA third subsidiary partnership, GPA Bond L.P., was created in 1994 to hold and operate a property purchased on December 29, 1994.\nPage 28 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nAllocation of Net Income\/Loss and Equity (Deficit). The limited partners and assignees have a 99% share and the general partners have an aggregate 1% share in the net income\/loss and partners' equity (deficit) of Partners. Partners was allocated 99% of the net income\/loss and partners' equity (deficit) of GOCO and its subsidiaries and the general partners were allocated an aggregate l% of the net income\/loss of GOCO. The 1% general partner interest in both Partners and GOCO for net income\/loss and partners' equity (deficit) was equal to a 1.99% interest on a combined basis; while the 99% limited partner interest in each of Partners and GOCO and its subsidiaries is equal to a 98.0l% interest on a combined basis.\nAfter the redemption of units as part of the reorganization plan discussed in Note 10, the general partners hold a 2.27% and share of the partnership's net income or loss and distributions. The limited partners currently hold a 97.73% share of the partnership's net income or loss and distributions.\nNote 2. SIGNIFICANT ACCOUNTING POLICIES\nConsolidation. The accompanying consolidated financial statements include the accounts of Partners and GOCO and its subsidiaries. All significant intercompany transactions have been eliminated.\nReal Estate Investments. Land, buildings and improvements are stated at the lower of cost or net realizable value on a property by property basis.\nThe depreciation of building and improvements is calculated on a straight line basis over their estimated useful lives of 35 years for residential properties to 50 years for commercial properties and over an average lease term of five years for tenant improvements (see Financial Statement Schedule III).\nCash and Cash Equivalents. The Partnership considers short-term investments, including certificates of deposit, with a maturity of three months or less to be cash equivalents.\nRestricted Cash. Proceeds from prior period sales were placed into certificates of deposit, which were pledged as cash collateral for the debt owed to Brazos Asset Management, Inc. (the \"Brazos Debt\"), formerly known as New West Federal Debt or the American Consolidated Debt (see Note 3 - Notes Payable).\nAll of these certificates of deposit were released to Brazos as part of the plan of reorganization (see Note 10).\nLoan Fees and Leasing Commissions. Loan fees are costs associated with obtaining financing and include refinancing and certain\nPage 29 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\ntransaction fees. Loan fees are capitalized and amortized over the original term of the related loan. Leasing commissions are capitalized and amortized over the term of the leases to which they relate.\nAccrued Interest. Pursuant to Part B of the 1987 refinanced New West Federal Debt, interest expense of $639,375 per month was accrued through May 21, 1992, the date of the Chapter 11 filing. Subsequent to that date and through the completion of the reorganization on January 24, 1994, the Partnership recognized interest expense only to the extent paid in accordance with the requirements of Statement of Position 90-7 - Financial Reporting by Entities in Reorganization Under the Bankruptcy Code (\"SOP 90-7\").\nInterest Paid. As a result of the Chapter 11 filing, a cash collateral agreement was implemented between the Partnership and Brazos Asset Management Inc., (\"Brazos\", successor to New West Federal), whereby the Partnership was required to pay monthly, to Brazos all but $50,000 of the funds remaining in the operating cash accounts as of the last day of the previous month. Such payments have been applied as interest expense. Total cash paid for interest, for all notes, during 1994, 1993 and 1992 was $3,070,000, $12,219,000 and $13,256,000, respectively.\nRental Income. Certain commercial lease agreements provide for significant amounts of free rent to tenants. In such cases, revenue is recognized at a constant rate over the term of the lease.\nNet Income (Loss) Per Limited Partner Unit. For financial reporting purposes, 4,899,488 units were issued to limited partners upon the consummation of the Exchange Transaction. After considering the MFCo. and Fraser Rollouts (see Note 4 - Property Sales), the units outstanding were adjusted to 3,442,ll0 for December 3l, l990 and 1991. At the close of business on December 31, 1991, a limited partner reassigned 27,271 units back to Glenborough Limited, resulting in 3,414,839 units outstanding at December 31, 1992 and 1993. The net loss per limited partner unit for December 31, 1993 and prior is derived by dividing 98.0l% of the net loss by the number of units outstanding to the limited partners.\nFor financial reporting purposes, after the redemption of units as a result of the plan of reorganization discussed in Note 10, 3,146,492 weighted average units were outstanding to limited partners for the year ended December 31, 1994. Net income (loss) per unit in 1994 is derived by dividing 97.73% of the net income (loss) by the weighted average number of units outstanding to the limited partners.\nPage 30 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nNote 3. NOTES PAYABLE\nHistorical Indebtedness\n1987 Debt Refinancing. In l987, agreements were signed between American and the Partnership which provided for, among other items, the consolidation of various American notes into one amended consolidated note (the \"Brazos Debt\") and the transfer of 541 homes back to American for debt relief of approximately $35 million.\nThe new note which became effective March 1, l987, was divided into two parts, Part A and Part B. Part A provided for principal only payments at various scheduled amounts through March l, l99l, and interest only payments thereafter to maturity at June 30, l996. Interest was a stated dollar amount from February 28, l99l through March l, l993 regardless of the principal balance. From March l, l993 through the maturity date of June 30, l996, the monthly interest rate floated at the Federal Home Loan Board 11th District Cost of Funds plus 250 basis points. Part B was a $45 million note which bore simple non-compounding interest at l7.05% per annum, payable monthly in arrears. Monthly interest was forgiven through February l990 on this part.\nWith the Partnership filing for reorganization under Chapter 11 of the Federal Bankruptcy Code on May 21, 1992 and pursuant to the SOP 90-7, interest ceased to be accrued as of May 21, 1992.\nThe homes sold to American, for debt relief of approximately $35 million, had a net book value of approximately $l6 million. Because the Partnership originally purchased these homes from American, no gain was recognized on this transaction. The difference between net book value and appraised value was transferred to the carrying amount of the Brazos Debt. The revised net book value of the Brazos Debt was compared to cash payments required under the amended note resulting in a constant effective interest rate of 7.44%. The discount\/premium on the debt is amortized\/accreted to yield this rate over the life of the note. This amortization schedule assumed that the properties, except for one which was contemplated to be sold at the date of refinancing, were to be held for the full term of the note.\nChapter 11 - Bankruptcy Reorganization - In 1991 and 1992, the Resolution Trust Corporation disapproved the terms of two separate proposed revisions of the terms of the Brazos Debt that had been negotiated by management and New West Federal. As a result, a forbearance agreement suspending the implementation of required debt service increases expired under the then existing debt terms. Without a modification or forbearance, the Partnership was unable to meet its May 1, 1992 debt service payment to New West Federal.\nPage 31 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nOn May 21, 1992, New West filed a judicial foreclosure action in the Superior Court of Orange County. Also on May 21, 1992, the Partnership (i) filed a civil action against New West Federal in the Superior Court of San Mateo County, seeking in excess of $30 million in damages for a variety of claims, including misrepresentation and breach of contract, and (ii) filed a petition in the United States Bankruptcy Court for the Northern District of California for reorganization under Chapter 11 of the Federal Bankruptcy Code. Since the filing of those actions, the Partnership endeavored to bring about settlement discussions with Brazos.\nOn January 13, 1994, the United States Bankruptcy Court for the Northern District of California confirmed a plan of reorganization which became effective on January 24, 1994. (See Note 10 for discussion the reorganization plan).\nCurrent Indebtedness\nThe two subsidiaries of GOCO Realty Fund I, GPA West, L.P. and GPA Industrial, L.P. obtained the Rosemead Springs and J.I. Case\/Navistar properties in February 1994 and May 1994, respectively, as described in the plan of reorganization through the payment to Brazos of the negotiated release prices for each of the properties. This required GPA West, L.P. and GPA Industrial, L.P. to secure financing.\nGPA West, L.P. incurred indebtedness of $2,500,000 to Mid-Peninsula Bank, secured by Rosemead Springs. The interest rate on this promissory note payable is two (2) percentage points per annum over the Mid-Peninsula Bank Base Rate. Regular interest payments are due monthly until the May 1995 maturity, at which time the entire principal balance and accrued interest are due.\nGPA Industrial, L.P. incurred indebtedness of $12,000,000 to Heller Financial, Inc. (\"Heller\") secured by the four J.I. Case\/Navistar properties. The interest rate on this promissory note payable is five (5) percentage points per annum over the three month London Interbank Offered Rate (\"Libor\") and is reset the first business day of each month. Monthly $25,000 principal plus interest payments are due during the first two years of the loan. In the third fiscal year of the loan monthly payments increase to $33,333 principal plus interest. Finally, beginning with the fourth fiscal year of the loan until the May 2004 maturity, monthly payments will increase to $41,667 principal plus interest.\nIn August 1994, Glenborough Partners borrowed $1,412,000 from an unaffiliated lender to pay off professional fees and the general partner transaction fees on the reorganization discussed in Note\nPage 32 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\n10. This loan was repaid on December 23, 1994, with the proceeds from the sale of the Palo Alto property (see Note 4).\nOn December 29, 1994, GPA Bond, L.P. purchased the Bond Street Building from Heller. Heller financed $2,835,000 towards this transaction at the rate of three hundred fifty (350) basis points plus the Base Rate (which is defined as the three month Libor rate). Monthly interest only payments commenced February 1, 1995 and will continue until the maturity date of December 31, 1999. Principal payments are required on a quarterly basis commencing April 15, 1995 at an amount of excess cash flow, which is defined as net cash flow less: (i) current payments due on the loan; and (ii) a ten percent (10%) per annum return on equity to the borrower.\nSubject to the effect of the reorganization plan, the Partnership had the following notes payable including premium outstanding at December 31 (in thousands):\n1994 1993 --------- --------- Brazos Debt: Principal ............................. -- $ 235,032 Premium ............................... -- 38,641 --------- --------- Total ................................. -- 273,673\nOther notes payable: GPA Industrial - Heller ............... $ 11,825 -- GPA West - Mid Peninsula .............. 2,500 -- GPA Bond - Heller ..................... 2,835 -- Miscellaneous ......................... -- 470 --------- --------- Total ................................. 17,160 470 --------- ---------\nTOTAL .......................................... $ 17,160 $ 274,143 ========= =========\nPrincipal repayments scheduled on all notes outstanding at December 31, 1994 assuming current interest rates are as follows (in thousands):\n1995 $ 2,800 1996 358 1997 458 1998 500 1999 3,335 Thereafter 9,709 ------- TOTAL $ 17,160 =======\nPage 33 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nNote 4. PROPERTY SALES\nMFCo. Rollout. Effective January 1, 1987, the Partnership transferred to MFCo., under an installment land contract, equitable title to nine of the 15 properties originally contributed by MFCo. and its affiliates to the Partnership in the Exchange Transaction. These properties had an original exchange value of $73,852,000. In consideration for the properties and related net assets and liabilities, David W. Mariani and MFCo. transferred back 1,110,863 units of partnership interest in Limited and gave the Partnership a note in the original principal amount of $53,172,000, which included undrawn reserves of $1,960,000. This amount approximated the prorata share of refinanced Brazos Debt (see Note 3 - - Notes Payable) attributable to the MFCo. Rollout properties and had an original maturity date of June 30, 1996.\nThe difference between the promissory note received from MFCo. and the book value of the assets transferred was recorded on the Partnership's books as deferred gain, an offset to the note receivable. An additional adjustment affecting the promissory note was made subsequent to the Rollout, due to a provision in the original master lease on one of the properties rolled-out. The note receivable was discounted to yield the same effective interest rate as the Brazos Debt, 7.44% (see Note 5). No accounting recognition had been given to the surrender of Partnership Units. At December 31, 1993, the net Griffin note receivable was $44,830,000.\nIn early 1994, pursuant to the plan of reorganization, the Partnership transferred to Brazos its interest and rights to this Griffin note receivable.\nThe following are combined statements of property revenues and expenses for the MFCo. Rollout properties for 1993 and l992, when the Griffin note was in effect (in thousands):\n1993 1992 ------ ------- Rental Revenue ............................. $ 5,334 $ 5,212 Other Revenue .............................. 390 450 ------- ------- Total Revenue ........................ $ 5,724 5,662 ------- -------\nDepreciation ............................... (1,060) (1,088) Interest Expense ........................... (2,885) (4,652)\nProperty Taxes ............................. (748) (599) Other Operating Costs ...................... (1,016) (1,203) ------- ------- Total Expense ........................ (5,709) (7,542) ------- ------- Net Income (Loss) .................... $ 15 $(1,880) ======= =======\nPage 34 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nCoherent Auburn & Coherent Palo Alto - On February 4, 1994, the Partnership sold the Coherent Auburn facility to the tenant for $3,650,000. After paying approximately $93,000 for other fees, $500,000 for Brazos' release of the Rosemead Springs Business Park, and $750,000 for Brazos' release of Burlingame Plaza, the Partnership applied most of the remaining proceeds towards Brazos' lien release price for four properties known as the J.I. Case and Navistar buildings. The gain on sale was approximately $1,503,000.\nOn December 22, 1994, the Partnership sold the property formerly known as Coherent Palo Alto for $4,300,000. After paying approximately $87,000 for other fees, the Partnership received gross proceeds of $4,213,000. The Partnership then paid off a note payable for $1,358,000 on December 23, 1994. The remaining balance was added to working capital reserves.\nNote 5. NOTES RECEIVABLE\nNotes receivable generally result from the disposition of rental properties. At December 31, 1993, the Partnership had two notes which bore interest at 8.75% and 11% per annum. Notes arising from sales are typically secured by deeds of trust or letters of credit, while the note resulting from the MFCo. Rollout, net of deferred gain, was secured by an Installment Sale Land Contract, Security Agreement and Assignment of Rents. As discussed in Note 4, premium on the Griffin Note Receivable was accreted and amortized based on the 7.44% internal rate of return on the Brazos Debt (see Note 3).\nPage 35 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nThe following table lists the notes receivable outstanding as of December 31, 1993 (in thousands):\nBuilding\/Maker Maturity Date Interest 1993 - -------------- -------- ------- MFCo. 5% - 10% Principal $ 53,057 Rolled-Out Premium 4,092 Properties\/ Deferred Gain (12,319) ------- Griffin Investments\/ Total Griffin 6-30-96 Notes Receivable $ 44,830 =======\nBurlingame Prime plus Principal $ 121 Plaza\/ 2% (plus 5% Robert Fraser\/ while in 6-30-96 default) -------- Total Other Notes Receivable $ 121 =======\nPrior to May 21, 1992, the Partnership recognized interest income on the Griffin note receivable at an effective rate of 7.44% as discussed previously. Subsequent to that date, the Partnership only recognized interest income to the extent cash was received from Griffin and ceased to accrue interest receivable in accordance to SOP 90-7.\nBecause the properties underlying these notes in part secure the Brazos Debt, the notes were included as part of the plan of reorganization that was confirmed by the Bankruptcy Court on January 13, 1994 (see Note 10). Under the plan of reorganization, the Griffin note was transferred to Brazos and the Fraser note was paid in the first quarter of 1994.\nNote 6. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions are used to estimate the fair value of each class of instruments for which it is practical to estimate that value:\na) Cash and cash equivalents - For those short term instruments the carrying amount is a reasonable estimate of fair value.\nb) Restricted cash - For those short term instruments the carrying amount is a reasonable estimate of fair value.\nc) Other notes receivable - For these instruments, the\nPage 36 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\ncarrying amount is a reasonable estimate of the fair value given prevailing interest rates and terms of similar instruments.\nd) Griffin notes receivable and Brazos notes payable - These notes are interdependent and given the pending reorganization (Note 10), it is not practical or possible to estimate the fair value of either instrument.\ne) Heller and Mid Peninsula notes payable - The carrying amount is a reasonable estimate of the fair value given prevailing interest rates and terms of similar instruments.\nNote 7. TENANT LEASES\nFuture minimum lease receivables under noncancellable operating leases on currently owned properties as of December 3l, l994 are as follows (in thousands):\n1995 $ 2,960 1996 2,778 1997 2,575 1998 2,539 1999 2,444 Thereafter 9,277 ------- TOTAL $ 22,573 =======\nTwo tenants have options to purchase certain properties. One tenant, J.I. Case did not exercise its option to purchase the Kansas City and Memphis properties on March 1, 1993, but has an option to purchase the property every three years thereafter, at a price equal to fair market value, but not less than $2,061,000 (Kansas City) and $1,664,000 (Memphis). The other tenant, Navistar did not exercise its option to purchase the Baltimore and West Chicago properties on March 1, 1993, but has an option to purchase the property every three years thereafter, at a price equal to fair market value, but not less than $8,195,000 (Chicago) and $3,700,000 (Baltimore), and not more than $9,952,000 (Chicago) and $4,200,000 (Baltimore). These figures are determined in accordance with a formula specified in a 1990 modification of the lease. These figures may change in future years based on the formula specified in the modification.\nNote 8. RELATED PARTY TRANSACTIONS\nBackground\nAs discussed in Note 1 - Summary of Organization, the general partners of Partners and GOCO and its subsidiaries are Realty and\nPage 37 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nRobert Batinovich. Realty is the managing general partner of the Partnership and has the exclusive management and control of the business of the Partnership.\nIndemnification of General Partners\nIn September 1992, Sleepy Hollow Associates, holder of the second deed of trust on the Sleepy Hollow property (a property transferred to Brazos in 1994 pursuant to the reorganization plan), made a demand upon Robert Batinovich, a co-general partner of the Partnership, for payment under his guarantee of GOCO Realty Fund I's promissory note to Sleepy Hollow Associates. Mr. Batinovich negotiated a discount from $90,000 to $70,000 and purchased the note from Sleepy Hollow Associates and paid Sleepy Hollow Associates the discounted amount.\nPursuant to the Indemnification Provision of the Limited Partnership Agreement, the Partnership reimbursed Mr. Batinovich for the $70,000. However, on December 31, 1993, the Partnership had not relieved the original note of $90,000 because it is a prepetition liability and as such, payment had not yet been approved by the Bankruptcy Court. As a result, the $70,000 reimbursement was recorded as receivable from Mr. Batinovich.\nFees to Affiliates\nPrior to May 21, 1992, Realty and its affiliates received expense reimbursements, fees, and other compensation for services provided to the Partnership pursuant to the Limited Partnership Agreement as follows:\nTransaction Fee - 2% of qualifying transaction price Property Management Fees - 3 to 5% of gross property receipts Incentive Fee - .5% of the fair value of assets to the extent earnings exceed $1.50 per unit General and Administrative Expenses - actual costs reimbursable\nPage 38 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nAfter May 21, 1992, by order of New West Federal and the Bankruptcy Court, Realty and its affiliates received expense reimbursements, fees, and other compensation for services provided to the Partnership pursuant to the Limited Partnership, Cash Collateral and Property Management Agreements (incorporated by reference to Exhibit 10.39 to the Partnership's Annual Report on Form 10-K dated December 31, 1992 - No. 33-3657). The items amended were as follows:\nProperty Management Fees - 2 to 5% of gross property receipts or a minimum of $49,300 per month Leasing Fees - 7% of total first year rent, declining to 2% of rent for the 11th year and beyond\nAfter obtaining selected properties through the payment of Brazos' lien release prices, new subsidiary partnership were created. Pursuant to the Limited Partnership Agreements (incorporated by reference to Exhibits 10.40 through 10.43 to the Partnership's Annual Report on Form 10-K dated December 31, 1994 - No. 33-3657), Realty and its affiliates are entitled to receive expense reimbursements, fees, and other compensation for services provided to the Partnership as follows:\nProperty management fees - 3 to 5% (10% for single-family residences) of gross receipts collected Incentive fee - .5% of the fair value of assets to the extent earnings exceed $1.50 per unit Transaction fee - 2% of qualifying transaction price Refinancing fee - 1% of qualifying net loan refinancing proceeds\nFees and allocated expenses paid by the Partnership to affiliates for the years ended December 31, 1994, 1993 and 1992 are as follows (in thousands):\n1994 1993 1992 ------ ------ -----\nProperty Management Fees ............. $ 239 $ 736 $ 831 Reimbursed General and Administrative Expenses ............. 571 1,148 1,163 ------- ------- -------\nTotal Management Fees and Reimbursed General and Administrative Expenses ............. $ 810 $ 1,884 $ 1,994 ======= ======= =======\nLeasing fees ......................... $ 50 $ 84 $ 267 ======= ======= =======\nIn 1992, Glenborough was reimbursed $762,000 for salaries and benefits of on-site management, maintenance and landscape employees and $219,000 for miscellaneous reimbursements. During 1992, with Glenborough under no obligation to immediately reimburse the\nPage 39 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nPartnership for the balance in prepaid incentive fees, the Partnership began amortizing monthly overhead reimbursements from prepaid incentive and transaction fees in lieu of actual payments.\nIn 1993, Glenborough was reimbursed $751,000 for salaries and benefits of on-site management, maintenance and landscape employees and $156,000 for miscellaneous reimbursements. During 1993, the Partnership continued to amortize monthly overhead reimbursements from prepaid incentive fees. The Partnership amortized 56% of the total monthly overhead reimbursements from prepaid incentive and transaction fees in lieu of actual payments.\nIn 1994, Glenborough was reimbursed $206,000 for salaries and benefits of on-site management, maintenance and landscaping employees and $19,000 for miscellaneous reimbursements. During a portion of 1994, the Partnership continued to amortize monthly overhead reimbursements from prepaid incentive fees. The Partnership amortized 61% of the total overhead reimbursements from prepaid incentive and transaction fees in lieu of actual payments.\nLoss on investment in real estate\nThrough the May 1994 escrow related to the Partnership's obtaining free and clear title from Brazos on the properties known as the J.I.Case and Navistar buildings, the Partnership made a $1,000,000 principal paydown on a note payable for an affiliated partnership. Financing for the J.I.Case and Navistar buildings was extremely difficult to find in the current market, so as an inducement for the lender to finance this release price purchase, the Partnership paid down a portion of an affiliate's note payable in good faith. In December 1994, the Partnership and the affiliated partnership, UCT Associates, A California Limited Partnership (\"UCT\") agreed that the $1,000,000 paid by the Partnership on behalf of UCT was an investment in UCT. Coupled with that, Robert Batinovich contributed his limited partner interest in the profits and losses of UCT. This gave the Partnership a 45% non-voting limited partner interest, a 99% allocation of future income and losses, and an economic interest in any future upside of this property, without exposure to any loss. This was made possible after Glenborough waived a portion of its potential transaction fees on the disposition of properties in 1994.\nAt December 31, 1994, the General Partner believes that there is no real equity in UCT, therefore the $1,000,000 invested in UCT was recognized as a loss on investment in real estate.\nPage 40 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nNote 9. OPTION PLAN\nThe Partnership's Option Plan provides for the grant of nonstatutory options to purchase units to the General Partners and the officers, directors, employees and certain consultants of the Managing General Partner, the property manager and its affiliates. Individuals who render services to Realty, Glenborough or its affiliates as an independent contractor may be considered an \"employee\" for purposes of the Option Plan, provided services are rendered on a continuing basis. In general, options exercisable on the date of termination of employment may remain exercisable for up to one year following termination.\nAt December 31, 1993, options to purchase 14,890 units at an exercised price of $20 were outstanding to former employees and 269,728 units at an exercise price of $6.50 per unit were outstanding to 14 persons including 9 officers, directors or affiliates of the managing general partner. At December 31, 1994, options to purchase 14,890 units at an exercise price of $20 and 2,000 units at an exercise price of $6.50 per unit were outstanding to former employees and 267,728 units at an exercise price of $6.50 per unit were outstanding to 13 persons including 9 officers, directors or affiliates of the managing general partner. No options had been exercised as of December 31, 1994.\nNote 10. CHAPTER 11 - PLAN OF REORGANIZATION AND RELATED PRO FORMA BALANCE SHEET (UNAUDITED)\nOn May 21, 1992, GOCO Realty Fund I, the partnership holding and operating the Partnership's real property (including its related Brazos Debt), filed a petition in the United States Bankruptcy Court for the Northern District of California for reorganization under Chapter 11 of the Federal Bankruptcy Code.\nOn January 13, 1994, GOCO Realty Fund I entered a plan of reorganization in the United States Bankruptcy Court (the \"Court\") for the Northern District of California. The plan was confirmed by the Court and the plan became effective January 24, 1994.\nThe following is a brief description of the principal points of the plan of reorganization.\n1. The claims of all creditors were satisfied in full.\n2. Transfer to Brazos of the Partnership's interest in the restricted cash and Griffin note receivable.\nPage 41 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\n3. Twelve properties have been transferred into two separate rollouts, four to Griffin Investments (Phase II Rollout), and eight to a Griffin affiliate (Phase III Rollout), in redemption of all of Griffin's (and its affiliates') 448,894 units in Glenborough Partners. These redemptions reduced Glenborough Partners' outstanding equity securities from 3,410,747 limited partner units to 2,961,853 limited partner units. Those entities were given options to pay off Brazos' lien on those properties, at negotiated prices, or transfer them to Brazos. The options on both the Phase II and the Phase III Properties were not exercised, and the properties were transferred to Brazos.\n4. GOCO's obligation to deliver the property known as Burlingame Plaza to Robert Fraser was satisfied through the payment by GOCO Realty Fund I of $750,000 toward the price charged by Brazos for release of Burlingame Plaza, which was then delivered to Mr. Fraser free and clear following his payment of $150,000 owed by him to GOCO. GOCO paid this amount over to Brazos against the balance of the release price.\n5. The claims of Brazos were satisfied through a multipart transaction including the following:\na. Brazos unconditionally released its lien on two properties; (i) a 50,000-foot industrial facility in Auburn, California, which was leased to Coherent, Inc. -the release of this lien occurred on February 4, 1994, as part of a sale of the property to the tenant ; and (ii) a vacant 95,500 square foot industrial\/office facility in the Stanford Business Park in Palo Alto, California.\nb. GOCO paid Brazos the sum of $500,000, from the Coherent Auburn sale, discussed below, in return for which Brazos released its lien on the property known as Rosemead Springs Business Park in El Monte, California - this transaction occurred on February 4, 1994.\nc. GOCO had an option (exercisable at any time prior to April 30, 1994) to obtain a release of the Brazos lien as to any of the remaining properties subject to Brazos' lien (the \"Option Properties\") by paying a negotiated release price to Brazos. The Partnership exercised its option on eight properties as discussed in paragraph 4, 5.a and 5.b above and 6. below. The remaining options were not exercised and those properties were transferred to Brazos in satisfaction of the remaining balance of Brazos claims in May 1994.\nPage 42 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\n6. GOCO closed the sale of the Coherent Auburn facility to the tenant for $3,650,000 on February 4, 1994, and applied a portion of the net proceeds from the sale toward the payment of the release price for the Rosemead Springs property referred to in paragraph 5.b., above. Most of the remaining proceeds were applied toward the partial paydown of Brazos' discounted lien release price for four of the Option Properties referred to in paragraph 5.c., above. The balance of the funds required for the payment of those release prices were financed through a $12 million loan obtained by GPA Industrial, L.P. from Heller Financial, Inc. Such financing was applied to the release of the liens on the two properties known as the J.I. Case buildings and the two properties known as the Navistar buildings. The total release price for these properties and the Rosemead property was $14,500,000.\n7. Included in the above transactions, was $962,000 in net transaction fees payable to a general partner which was paid in August 1994.\nThe impact of the reorganization is a $119,954,000 extraordinary gain from bankruptcy reorganization and early extinguishment of debt. The consolidated financial statements include adjustments that arose from the reorganization plan.\nThe ultimate result is (i) GPA West obtaining Coherent Palo Alto free and clear, which was subsequently sold on December 22, 1994 (see Note 4); (ii) GPA West obtaining Rosemead Springs, financed through debt of $2,500,000; and (iii) GPA Industrial obtaining the J.I. Case and Navistar buildings financed through debt of $12,000,000.\nNote 11. INCOME TAXES\nFederal and state income tax laws provide that the income or loss of the Partnership is reportable by the Partners in their individual tax returns. Accordingly, no provisions for such taxes have been made in the accompanying financial statements. The Partnership reports certain transactions differently for tax and financial reporting purposes.\nThe Partnership's tax returns, its qualification as a partnership for Federal income tax purposes, and the amount of taxable income or loss are subject to examination by the Federal and State taxing authorities. If such examinations result in changes to the Partnership's taxable income or loss, the tax liability of the partners could change accordingly.\nPage 43 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nFor Federal income tax reporting, (a) revenues and expenses are recognized on an accrual basis, i.e. lease income is recognized under the terms of the lease contract, (b) fees paid for services related to seeking and evaluating potential real estate investments are deducted if and when the plans of acquisition are subsequently abandoned, (c) depreciation is provided for under accelerated and modified accelerated cost recovery methods, (d) certain organizational costs classified as syndication costs for tax purposes are not deductible, and (e) bad debts are deducted and written off when deemed uncollectible.\nThe following is a reconciliation for the years ended December 31, 1994, 1993 and 1992, of the net income (loss) for financial reporting purposes to the taxable income (loss) determined in accordance with accounting practices used in preparation of Federal income tax returns.\n1994 1993 1992 ------ ------ ----- (in thousands) Net income (loss) per financial statements ................ $ 117,557 $ (6,358) $ (6,217) Adjustments: Depreciation ................ 1,132 (1,838) (1,326) Interest and Original Issue Discount ............ 70 529 935 Loan Fee Amortization ....... (2,626) (51) (51) Prepaid Income .............. (339) 42 (236) Free Rent Revenue ........... -- (30) 474 Gain on disposition of real estate ................ (95,188) -- -- Loss on investment in real estate ................ 1,000 -- -- Other ....................... (74) 166 13 ---------- ---------- ---------- Partners' income (loss) for Federal income tax purposes ............................ $ 21,532 $ (7,540) $ (6,408) ========== ========== ==========\nPage 44 of 54\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nNotes to the Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992\nThe following is a reconciliation as of December 31, 1994 and 1993 of partners' equity (deficit) for financial reporting purposes to partners' equity (deficit) for Federal income tax purposes.\n1994 1993 ----- ------ (in thousands)\nPartners' equity (deficit) per financial statements ........................ $ 5,289 $(112,268) Adjustments: Real Estate Investments ............. (14,500) 85,586 Depreciation ........................ 5,454 (42,875) Loan Fees Net of Amortization ...................... 148 73 Unearned Revenue .................... -- 339 Free Rent ........................... -- (328) Bad Debt ............................ -- 117 Unit Redemptions .................... (35,501) (274) Other ............................... 262 212 --------- --------- Partners' equity (deficit) for Federal income tax purposes ................. $ (38,848) $ (69,418) ========= =========\n12. SUBSEQUENT EVENT\nIn March 1995, GPA West purchased a $1,908,000 note receivable from California Federal Bank, secured by a first deed of trust on a property owned by an affiliate. This transaction was funded from the proceeds of the Palo Alto property sale discussed in Note 4. The note currently bears interest at 7.958% until an anticipated loan modification is ratified in the second quarter of 1995.\nPage 45 of 54\nColumn A Column F Column G Column H Column I - ---------- ---------- ---------- ---------- ---------\nLife on which Depreciation in the latest Accumulated Date of Date Income Statement Properties Depreciation Construction Acquired Is Computed - ---------- ------------ ------------ --------- ----------------\nNavistar & J.I. Case\/ Various Midwest\/ East Cities 2,901 1950-1977 3\/01\/84 50 yrs\nRosemead Springs Business Center, El Monte, CA (1) - 1980 7\/15\/83 50 yrs\nBond Street Building, Farmington Hills, MI - - 12\/28\/94 - ------- $ 2,901 ======\nNote (1): Rosemead Springs has been reclassified as real estate held for sale in 1994.\nSee accompanying reconciliations.\nPage 46 of 54\nRECONCILIATION OF REAL ESTATE COST FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (in thousands)\nNote to Real Estate and Accumulated Depreciation Table.\n(A) In addition to these encumbrances at December 31, 1993, the properties are collateral for the Brazos Debt in the aggregate amount of $235,032,000, plus accrued interest of $21,237,000.\n1994 1993 1992 ------ ------ -----\nBalance, Beginning of Period ........ $ 166,576 $ 165,943 $ 164,963\nReal estate addition ................ 3,153 -- -- Improvements ........................ 440 633 980 Disposition of real estate .......... (144,814) -- -- Real estate held for sale ........... (7,234) -- -- --------- --------- --------- Balance, End of Period .............. $ 18,121 $ 166,576 $ 165,943 ========= ========= =========\nRECONCILIATION OF ACCUMULATED DEPRECIATION FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (in thousands)\n1994 1993 1992 ------ ------ -------\nBalance, Beginning of Period ........ $ 42,875 $ 38,548 $ 33,727\nDepreciation Expense ................ 1,467 4,327 4,821\nDisposition of real estate .......... (38,765) -- --\nReal estate held for sale ........... (2,676) -- -- -------- -------- --------\nBalance, End of Period .............. $ 2,901 $ 42,875 $ 38,548 ======== ======== ========\nThe aggregate cost basis of real estate owned at December 31, 1994, for Federal income tax purposes was approximately $ 9,908,000.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPage 47 of 54\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nGENERAL PARTNERS\nThe Partnership has no directors or executive officers. The general partners of the Partnership are Glenborough Realty Corporation (the \"Managing General Partner\") and Robert Batinovich. For informational purposes, the following are the names and additional information relating to each of the controlling persons, directors and executive officers of the Managing General Partner as of March 1, 1995:\nName Age Position - ---- --- -------- Robert Batinovich 58 President and Chairman of the Board\nAndrew Batinovich 36 Senior Vice President, Chief Financial Officer and Director\nSandra L. Boyle 46 Vice President\nBarbara L. Evans 54 Vice President, Secretary and Corporate Counsel\nEugene F. Daly 51 Director\nWallace A. Krone Jr. 63 Director\nLaurence N. Walker 62 Director\nJ. Sydney Whalen 60 Director\nThe following is a brief description of the background and experience of Robert Batinovich and each of the officers and directors of Glenborough Realty Corporation.\nRobert Batinovich has been the President and a Director of Glenborough Corporation since its inception in l978 and of Glenborough Realty Corporation since its inception in l985. He has been the Chief Financial Officer (\"CFO\") of Glenborough Corporation since April l986 and the CFO of Glenborough Realty Corporation from April l986 through April l988. He was a member of the California Public Utilities Commission from l975 to January l979 and served as its Chairman from January l977 to January l979. He has extensive real estate investment experience. Mr. Batinovich's business background includes managing and owning manufacturing, vending and service companies and a national bank.\nPage 48 of 54\nAndrew Batinovich has been Senior Vice President and Chief Financial Officer of Glenborough Realty Corporation since April l988. He was Vice President-Property Management of Glenborough Realty Corporation from April l986 to April l988. He also is Senior Vice President in charge of property management and partnership accounting for Glenborough Corporation. Prior to joining Glenborough Corporation in June l983, he was employed at Security Pacific National Bank in its international and corporate banking groups specializing in real estate lending. He is the son of Robert Batinovich.\nSandra L. Boyle has been Vice President of Glenborough Realty Corporation since February 1991. She first joined Glenborough Corporation in 1984 and is responsible for property management, including maintenance, capital and tenant improvements, rent collection, budgeting and supervision of regional offices. Prior to joining Glenborough Corporation, she was a residential real estate marketing representative for Great Western Realtors.\nBarbara L. Evans has been Secretary of Glenborough Realty Corporation since April 1986 and Vice President since February 1991. She joined Glenborough Corporation in l985 and serves as Counsel and Secretary. She was admitted as an attorney in the State of California in l983. Prior to attending law school and on a part-time basis during law school, Ms. Evans was a co-owner of TES Associates, a property management and real estate investment advisor.\nEugene F. Daly was elected a Director of Glenborough Realty Corporation in August 1989. He is President of Daly International Financial and Insurance Services. Mr. Daly is a Registered Principal with the National Association of Securities Dealers (NASD) and his firm Daly International Financial and Insurance Services is a Registered Investment Advisor with the Securities and Exchange Commission.\nWallace A. Krone, Jr. was elected a Director of Glenborough Realty Corporation in August 1989. He has been associated with Glenborough for approximately 15 years as an investor in Glenborough sponsored partnerships. For the past twenty-seven years, he has been self-employed owning various restaurants in the San Francisco Bay Area. Currently Mr. Krone owns a number of Burger King restaurants in the same area. Laurence N. Walker was a Director of Glenborough Corporation from October l984 to November l985 and served as Treasurer from January l985 to November l985. He has been a Director of Glenborough Realty Corporation since its inception in l985. He is an attorney specializing in real estate law.\nJ. Sydney Whalen was elected a Director of Glenborough Realty Corporation in April l988. He is a Canadian Chartered Accountant and since l983 has been president of Whalen & Associates, a management consulting firm specializing in executive management and chief financial officer services to companies experiencing operating or financial difficulties. In 1993, Mr. Whalen was a co-\nPage 49 of 54\nfounder and became President of Round Hill Securities, Inc., a securities broker\/dealer. From l975 to l982, he was Vice President-Finance and Administration of Raymond Kaiser Engineers, Inc.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nCompensation and Fees\nIn accordance with the Partnership Agreement for GOCO, the Managing General Partner receives expense reimbursements and fees for services provided to the Partnership. Information regarding these fees and reimbursements is incorporated herein by reference to Note 8 of the Notes to Consolidated Financial Statements under the heading \"Fees to Affiliates\" and Note 1 of the Notes to Consolidated Financial Statements under the heading \"Participation in Net Income and Net Loss\".\nThe Partnership has no employees and pays no salary or other cash compensation, directly to any person other than the fees and expense reimbursements described above. All officers of the Managing General Partner currently are officers of Glenborough Corporation and receive a salary and other benefits from Glenborough Corporation as compensation for Partnership activities as well as other activities of Glenborough Corporation not related to the Partnership.\nOption Plan\nAt December 31, 1993, options to purchase 14,890 units at an exercised price of $20 were outstanding to former employees and 269,728 units at an exercise price of $6.50 per unit were outstanding to 14 persons including 9 officers, directors or affiliates of the managing general partner. At December 31, 1994, options to purchase 14,890 units at an exercise price of $20 and 2,000 units at an exercise price of $6.50 per unit were outstanding to former employees and 267,728 units at an exercise price of $6.50 per unit were outstanding to 13 persons including 9 officers, directors or affiliates of the managing general partner. No options had been exercised as of December 31, 1994.\nOptions Issued to Officers and Directors Number of Name Office Units - ---- ------ --------- Robert Batinovich Chairman of the Board\/President 38,500 Andrew Batinovich Senior Vice President\/ Chief Financial Officer\/Director 38,500 Sandra L. Boyle Vice President 16,000 Barbara L. Evans Vice President\/Secretary 16,000 Eugene F. Daly Director 17,000 Wallace A. Krone, Jr. Director 17,000 Laurence N. Walker Director 25,000 J. Sydney Whalen Director 17,000 -------- Total 185,000 ========\nPage 50 of 54\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe following table sets forth certain information regarding the Units owned on December 3l, l994 by (a) each Unitholder known to the Partnership to own beneficially more than 5% of the outstanding Units; (b) each Unitholder under common control of an officer, director, or 5% Unitholder; (c) each individual general partner of the Partnership and each director of the managing general partner; and (d) all executive officers and directors of the managing general partners as a group.\nName of Beneficial Units Exercisable Percent Owner (Notes 1 and 2) Owned Options Owned (3) - --------------------- ----- ------- ---------\nRobert Batinovich (Note 4) ............................... 542,868 38,500 18.20%\nRobert Batinovich, General Partner ........................ 34,577 -0- 1.08%\nGlenborough Corporation ................ 116,945 10,728 4.00%\nAndrew Batinovich ...................... 24,248 38,500 1.96%\nEugene F. Daly ......................... 12,640 17,000 0.93% 577 Airport Boulevard, #200 Burlingame, CA 94010\nWallace A. Krone, Jr ................... 52,026 17,000 2.16% 393 Vintage Park Drive, #120 Foster City, CA 94404\nLaurence N. Walker (Note 5) ............ 27,102 25,000 1.63% 2922 Forest Avenue Berkeley, CA 94507\nJ. Sydney Whalen ....................... -0- 17,000 0.53% 3201 Danville Boulevard, #100 Alamo, CA 94507\nAll Executive Officers and ............. 696,289 185,000 27.60% Directors as a Group (8 persons) (Notes 4 and 5)\nNotes:\n(1) Unless otherwise indicated, the addresses of the above beneficial owners are the same as that of the registrant.\n(2) The persons named on the table have sole voting and investment power with respect to all interests beneficially owned by them, subject to community property laws where applicable and the information contained in the footnotes to the table. The table assumes the exercise of outstanding options held by eight officers\nPage 51 of 54\nand directors and one former director to acquire an aggregate of 193,272 Units, which are presently exercisable.\n(3) Percent owned is calculated by dividing the sum of the Unitholder's Units and exercisable options by the sum of all outstanding Units and exercisable options.\n(4) Excludes Units held by Glenborough Corporation, of which Mr. Batinovich is an officer and director, and which is owned in majority by Mr. Batinovich. Excludes Mr. Batinovich's 1.15% General Partner interest in the Partnership. Excludes 14,817 Units that Mr. Batinovich may vote pursuant to powers of attorney or as Trustee from one Unitholder, as to which Mr. Batinovich disclaims beneficial ownership. Excludes the 0.1% General Partner interest and 1,108 Limited Partnership Units owned by Glenborough Realty Corporation, of which Mr. Batinovich is majority owner. Excludes 5,198 Units owned by the Robert and Garnet Anne Batinovich l982 Irrevocable Inter Vivos Trust for the benefit of Angela Batinovich, as to which Robert Batinovich disclaims beneficial ownership.\n(5) Excludes 303,979 Units that Mr. Walker may vote pursuant to a power of attorney or as Trustee, as to which Mr. Walker disclaims beneficial ownership. Excludes 145,907 Units owned by BOS Associates, of which Mr. Walker is the general partner.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nFees and Reimbursable Expenses - During l994 and in accordance with the prior and current Limited Partnership Agreements (incorporated by reference to Exhibits 10.40 thru 10.43 to the Partnership's annual report on Form 10-K dated December 31, 1994, No. 33-3657), the Managing General Partner received management fees and reimbursed expenses (see Item 8., Note 8 - Related Party Transactions).\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) (l) Financial Statements and (2) Financial Statement Schedules\nSee Item 8 of this Form 10-K for the Financial Statements of the Partnership, Notes thereto, Report of Independent Certified Public Accountants, and Supplemental Schedules. A Table of Contents to Financial Statements and Supplemental Schedules is included in Item 8 and incorporated herein by reference.\nPage 52 of 54\n(3) Exhibits Page Number or Exhibit Incorporation Number Description By Reference to - ------------------------------------------------------------------------------- 10.39 Cash Collateral and Property Exhibit 10.39 to Management Agreement dated the Annual Report July 1, 1992 and amended on Form 10-K October 23, 1992 by and among No. 33-3657 for the New West Federal Savings and year ended Loan Association, GOCO Realty December 31, 1992. Fund I and Glenborough Corporation.\n10.40 Limited Partnership Agreement of Glenborough Partners, A California Limited Partnership\n10.41 Limited Partnership Agreement of GPA West L.P.\n10.42 Limited Partnership Agreement of GPA Industrial L.P.\n10.43 Limited Partnership Agreement of GPA Bond L.P.\n27 Financial Data Schedule\n(b) Reports on Form 8-K\nNo reports on Form 8-K were required to be filed in the period subsequent to September 30, l994.\nPage 53 of 54\nSIGNATURES\nPursuant to the requirements of Section l3 or l5(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.\nGLENBOROUGH PARTNERS, A CALIFORNIA LIMITED PARTNERSHIP\nBy: \/s\/ Robert Batinovich By: Glenborough Realty Corporation, ------------------------- a California corporation, Robert Batinovich the Managing General Partner General Partner\nDate: 3\/30\/95 By: \/s\/ Robert Batinovich --------------- ------------------------------- Robert Batinovich President and Chairman of the Board\nDate: 3\/30\/95 -------------------------\nBy: \/s\/ Andrew Batinovich ------------------------------ Andrew Batinovich Senior Vice President, Chief Financial Officer and Director\nDate: 3\/30\/95 -------------------------\nBy: \/s\/ Laurence N. Walker ------------------------------ Laurence N. Walker Director\nDate: 3\/30\/95 -------------------------\nBy: \/s\/ J. Sydney Whalen ----------------------------- J. Sydney Whalen Director\nDate: 3\/30\/95 -------------------------\n(A Majority of the Board of Directors of the General Partner)\nPage 54 of 54","section_15":""}
{"filename":"65901_1994.txt","cik":"65901","year":"1994","section_1":"Item 1. BUSINESS.\n(a) Mid-Plains Telephone, Inc., (Mid-Plains), which was incorporated in 1901, is a public utility providing telecommunications services primarily in Middleton, Cross Plains and the west side of Madison, Wisconsin.\nMid-Plains has a wholly-owned subsidiary, Mid-Plains Communications Systems, Inc., (MPCS), which, in southern Wisconsin and northern Illinois, markets and installs deregulated communications systems and provides maintenance services related to their continued use. In October, 1994 MPCS began providing long distance service.\nThere was no material change in the nature of the business conducted by the Company during 1994.\nInformation regarding the recent development of the Company's business in the number of access lines is shown below:\n(b) Mid-Plains operates in two industry segments: telecommunica- tions services (telephone utility) and sales and service of communications systems (non-telephone utility). The financial information regarding Mid-Plains' industry segments is provided in the Company's Annual Report to Shareholders, page 21 (Footnote 9) for the year ended December 31, 1994, incorporated herein and filed as Exhibit 13.\n(c) Mid-Plains' principal line of business is providing telecommunications services. Operating revenues fall into four major classes: local network revenues, network access and long distance services, system sales and services, and other (billing and collection, directory, other nonregulated and miscellaneous).\nRevenues from each of these classes over the last three years are as follows:\nThe business of Mid-Plains is not seasonal to any significant extent.\nMid-Plains telephone utility operations are subject to regulation by the Public Service Commission of Wisconsin (PSCW). Mid-Plains provides local exchange network service to customers within its 115.8 square mile service area located in Dane County, Wisconsin. The customers have local extended area services (EAS) and access to the nationwide direct dial toll service network. Although the Company's customers have access to the nationwide direct toll network, the Company does not have toll operators. The operator service is provided primarily through Ameritech.\nDuring 1993, the Wisconsin Legislature changed the definition of small telecommunications utilities to include utilities with less than 50,000 access lines. This change reduces regulation for Mid-Plains, allowing greater flexibility in regulatory matters. Legislation is pending which will make this change permanent.\nIn 1994, the Wisconsin Legislature enacted the Telecommunications Act of 1993. This legislation results in open competition for Ameritech and GTE and further relaxes regulation for other telecommunications utilities in Wisconsin.\nThe Telecommunications industry continues to undergo various regulatory, competitive and technological changes. Wisconsin regulation of local exchange carriers (LEC's) is moving from traditional cost-based rate-of-return regulation to incentive-based alternative regulation. Coincident with this is the encouragement of\nlocal exchange competition and the emergence of companies providing competitive access and other services that will compete with LEC's. In addition, local service competition will be enhanced by the convergence of telecommunications, cable, wireless, video, computer and other technologies. While these changes may eventually cause regulatory risks and adverse revenue and earnings pressures on Mid- Plains, competition should also bring more creative uses for the market and new opportunities.\nInformation regarding the Company's major customers is provided in Mid-Plains' Annual Report to Shareholders, page 17 (Footnote 1) for the year ended December 31, 1994, incorporated herein and filed as Exhibit 13.\nThe Company encounters substantial competition from other companies in the sale and servicing of communication systems and in the sale and provision of long distance service.\nOrder backlog is not a significant consideration in the Company's business, and the Company has no contracts or subcontracts which may be subject to renegotiation of profits or termination at the election of the Federal government.\nInformation regarding this Company's working capital practice is provided in Mid-Plains Annual Report to Shareholders, page 11, for the year ended December 31, 1994, incorporated herein and filed as Exhibit 13.\nThe number of employees on the Company's payroll as of December 31, 1994, was 153.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.\nThe Company owns telecommunications property including: general support assets (18%), central office assets (33%), cable wire facilities assets (47%), and other assets (2%), all as necessary to provide services in its serving area. Between January 1, 1992 and December 31, 1994, the Company made property additions in the amount of $10.3 million and retirements of $1.7 million. Virtually all of this property is subject to liens securing long-term debt. In the opinion of management, the Company's telecommunications plant is substantially in good repair and suitably equipped.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nThere are no material pending legal actions, either for or against the Company.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThere were none in the fourth quarter.\nEXECUTIVE OFFICERS OF THE REGISTRANT.\nThe following table sets forth the names and ages of all executive officers of Mid-Plains and all positions and offices within the Company presently held by such executive officers. Executive officers are elected annually for one year and hold office until their successors are elected. None of the executive officers of Mid- Plains has any family relationship with any other executive officer or director of the Company.\nDean W. Voeks has served as President and Director of Mid-Plains since January, 1991. He has been an officer of Mid-Plains since 1987. He has been President and a Director of Mid-Plains Communications System, Mid-Plains subsidiary, since 1991.\nHoward G. Hopeman has served as Vice-President and Chief Financial Officer since 1989. He has been a Director and Secretary & Treasurer of Mid-Plains Communications Systems, Mid-Plains' subsidiary, since 1994.\nRick J. Mason joined Mid-Plains in September, 1992 as Vice-President Operations. Previously he was employed by TDS Telcom from 1981 to 1992 and held various managerial positions.\nDaniel J. Stein has served as Executive Vice-President and General Manager of the subsidiary, Mid-Plains Communications Systems, Inc., for the past eight years. He became a Director of the subsidiary in 1987.\nFredrick E. Urben is Vice-President Administration & Human Relations, and Secretary & Treasurer. He has been an officer of Mid-Plains since 1972 and a Director since 1977.\nPART II.\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nReference is made to Mid-Plains' Annual Report To Shareholders, page opposite page 1, and page 17 (Footnote 2) and page opposite page 24, for the year ended December 31, 1994, incorporated herein and filed as Exhibit 13.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA.\nReference is made to Mid-Plains' Annual Report To Shareholders, page opposite page 1, for the year ended December 31, 1994, incorporated herein and filed as Exhibit 13.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nReference is made to Mid-Plains' Annual Report To Shareholders, pages 10-11, for the year ended December 31, 1994, incorporated herein and filed as Exhibit 13.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nReference is made to the Company's Annual Report To Shareholders, pages 12-22, for the year ended December 31, 1994, incorporated herein and filed as Exhibit 13.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPart III.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information required as to the Directors of the Registrant is incorporated by reference and is contained in Mid-Plains' definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed not later than 120 days after the end of the fiscal year covered by this report. Information as to the Executive Officers of the Registrant appears in Part I of this Form 10K Annual Report as an unnumbered item under the caption \"Executive Officers of the Registrant\".\nThe information as to the delinquent filers pursuant to Item 405 of Regulation S-K is incorporated by reference and is contained in Mid- Plains' definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed 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 by this item is incorporated by reference and is contained in Mid-Plains' definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed 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.\n(a) Security ownership of certain beneficial owners. Pursuant to restrictions in Mid-Plains' By-Laws, no person, including any \"group\" as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, may be, nor is any person in fact the beneficial owner of more than five percent of any class of the Company's voting securities.\n(b) Security ownership of certain beneficial owners. The information required by this item is incorporated by reference and is contained in Mid-Plains' definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed not later than 120 days after the end of the fiscal year covered by this report.\n(c) Changes in control. Mid-Plains does not know of any arrangements, including the pledge by any person, of the Company's securities, the operation of which may at a subsequent date result in a change of control of the Company.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by this item is incorporated by reference and is contained in Mid-Plains' definitive proxy statement for its 1995 Annual Meeting of Shareholders filed or to be filed 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) 1. FINANCIAL STATEMENTS. Reference is made to the Registrant's Annual Report To Shareholders, pages 12-22, for the year ended December 31, 1994, incorporated herein and filed as Exhibit 13.\nConsolidated Balance Sheets at December 31, 1994 and 1993.\nConsolidated Statements for each of the three years ended December 31, 1994 --\nStatements of Income Statements of Shareholders' Equity Statements of Cash Flows\nNotes to Consolidated Financial Statements.\nReport of Independent Public Accountants\nResponsibility For Financial Statements\n2. FINANCIAL STATEMENTS SCHEDULES.\nAll schedules are omitted because of the absence of conditions under which they are required.\nSeparate financial statements and supplemental schedules of Mid-Plains are omitted since Mid-Plains is primarily an operating company and its subsidiary, included in the consolidated financial statements being filed, does not have a minority equity interest or indebtedness to any person other than Mid-Plains in an amount which exceeds five percent of the total assets as shown by the consolidated financial statements filed herein.\n3. EXHIBITS. Exhibits filed (or to be filed) as a part of this Form 10-K Annual Report are as follows:\nEXHIBITS INCORPORATED BY REFERENCE\nCompilation of Articles of Incorporation current in effect as of December 31, 1990 (See Exhibit 6, Form 10-K for the fiscal year ending December 31, 1990).\nBy-laws of the Company in effect as of December 30, 1990 (See Exhibit 7, Form 10-K for the fiscal year ending December 31, 1990).\nJanuary 16, 1992 Amendment to Bylaws (See Exhibit 5, Form 10-K for the fiscal year ended December 31, 1991).\nThird Supplemental Indenture, Mid-Plains Telephone, Inc., to M&I First National Bank, West Bend, Wisconsin, Successor Trustee, dated as of July 1, 1990 (See Exhibit 8, Form 10-K for the fiscal year ending December 31, 1990).\n(b) REPORTS ON FORM 8-K. There were no reports on Form 8-K filed with the Securities and Exchange Commission during the fourth 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 Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMID-PLAINS TELEPHONE, INC. (Registrant)\nDate: March 30, 1995 By \/s\/Dean W. Voeks Dean W. Voeks, 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 Company and in the capacities and on the dates indicated.\n\/s\/Dean W. Voeks President and Director March 30, 1995 Dean W. Voeks (Principal Executive Officer)\n\/s\/Howard G. Hopeman Vice-President and March 30, 1995 Howard G. Hopeman Chief Financial Officer (Principal Financial and Accounting Officer)\n\/s\/Fredrick E. Urben Vice-President, March 30, 1995 Fredrick E. Urben Administration & Human Relations, Secretary & Treasurer and Director\n\/s\/Charles Maulbetsch Director March 30, 1995 Charles Maulbetsch\n\/s\/S. C. Ehlers Director March 30, 1995 S. C. Ehlers\nThe above signatures include a majority of the signatures of the Board of Directors.","section_15":""}
{"filename":"17797_1994.txt","cik":"17797","year":"1994","section_1":"ITEM 1. BUSINESS _________________\nGENERAL _______\n1. COMPANY. Carolina Power & Light Company (Company) is a public service corporation formed under the laws of North Carolina in 1926, and is engaged in the generation, transmission, distribution and sale of electricity in portions of North Carolina and South Carolina. The Company had 7,812 employees at December 31, 1994. The principal executive offices of the Company are located at 411 Fayetteville Street, Raleigh, North Carolina 27601, telephone number: 919-546-6111.\n2. SERVICE.\na. The territory served, an area of approximately 30,000 square miles, includes a substantial portion of the coastal plain in North Carolina extending to the Atlantic coast between the Pamlico River and the South Carolina border, the lower Piedmont section in North Carolina, an area in northeastern South Carolina, and an area in western North Carolina in and around the City of Asheville. The estimated total population of the territory served is approximately 3.5 million.\nb. The Company provides electricity at retail in 219 communities, each having an estimated population of 500 or more, and at wholesale to one joint municipal power agency, 4 municipalities and 2 electric membership corporations (North Carolina Electric Membership Corporation, which has 17 members, and French Broad Electric Membership Corporation). At December 31, 1994, the Company was furnishing electric service to approximately 1,057,000 customers.\n3. SALES. During 1994, 31.8% of operating revenues was derived from residential sales, 20.7% from commercial sales, 25.8% from industrial sales, 17.4% from resale sales and 4.3% from other sources. Of such operating revenues, approximately 85% was derived from North Carolina and approximately 15% from South Carolina. For the twelve months ended December 31, 1994, average revenues per kilowatt-hour (kWh) sold to residential, commercial and industrial customers were 8.22 cents, 6.85 cents and 5.29 cents, respectively. Sales to residential customers for the past five years are listed below.\nAverage Average Annual Annual Revenue Year kWh Use Bill per kWh ____ _______ ______ _______\n1990 11,957 $ 995.01 8.32 cents 1991 12,472 1,040.70 8.34 1992 12,396 1,029.82 8.31 1993 13,167 1,090.16 8.28 1994 12,559 1,032.00 8.22\n4. PEAK DEMAND.\na. A 60-minute system peak demand record of 10,144 megawatts (MW) was reached on January, 19, 1994. At the time of this peak demand, the Company's capacity margin based on installed capacity (less unavailable capacity) and scheduled firm purchases and sales was approximately (0.22%).\nb. Total system peak demand for 1992 increased by 3.1%, for 1993 increased by 3.8%, and for 1994 increased by 5.8%, as compared with the preceding year. The Company currently projects a 2.1% average annual growth in system peak demand over the next ten years. The year-to-year change in actual peak demand is influenced by the specific weather conditions during those years and may not exhibit a consistent pattern. Total system load factors, expressed as the ratio of the average load supplied to the peak load demand, for the years 1992-1994 were 57.4%, 59.0% and 56.0%, respectively. The Company forecasts capacity margins of 13.6% over anticipated system peak load for both 1995 and 1996. This forecast assumes normal weather conditions in each year consistent with long-term experience, and is based upon the rated Maximum Dependable Capacity of generating units in commercial operation and scheduled firm purchases of power. See ITEM 1, \"Generating Capability\" and \"Interconnections With Other Systems.\" However, some of the generating units included in arriving at these capacity margins may be unavailable as a result of scheduled outages, environmental modifications or unplanned outages. See ITEM 1, \"Environmental Matters\" and \"Nuclear Matters.\" The data contained in this paragraph includes North Carolina Eastern Municipal Power Agency's (Power Agency) load requirements and capability from its ownership interests in certain of the Company's generating facilities. See ITEM 1, \"Generating Capability,\" paragraph 1.\nGENERATING CAPABILITY _____________________\n1. FACILITIES. The Company has a total system installed generating capability of 9,613 MW, with generating capacity provided primarily from the installed generating facilities listed in the table below. The remainder of the Company's generating capacity is composed of 53 coal, hydro and combustion turbine units ranging in size from a 2.5 MW hydro unit to a 78 MW coal-fired unit. Pursuant to certain agreements with Power Agency, which is comprised of former North Carolina municipal wholesale customers of the Company and Virginia Electric and Power Company (Virginia Power), Power Agency has acquired undivided ownership interests of 18.33% in Brunswick Unit Nos. 1 and 2, 12.94% in Roxboro Unit No. 4 and 16.17% in Harris Unit No. 1 and Mayo Unit No. 1 (collectively, the Joint Facilities). Of the total system installed generating capability of 9,613 MW (including Power Agency's share), 55% is coal, 32% is nuclear, 2% is hydro and 11% is fired by other fuels including No. 2 oil, natural gas and propane.\nMAJOR INSTALLED GENERATING FACILITIES _____________________________________ Year Maximum Plant Unit Commercial Primary Dependable Location No. Operation Fuel Capacity ________ ____ __________ _______ __________\nAsheville 1 1964 Coal 198 MW (Skyland, N.C.) 2 1971 Coal 194 MW\nCape Fear 5 1956 Coal 143 MW (Moncure, N.C.) 6 1958 Coal 173 MW\nH. F. Lee 1 1952 Coal 79 MW (Goldsboro, N.C.) 2 1951 Coal 76 MW 3 1962 Coal 252 MW\nH. B. Robinson 1 1960 Coal 174 MW (Hartsville, S.C.) 2 1971 Nuclear 683 MW\nRoxboro 1 1966 Coal 385 MW (Roxboro, N.C.) 2 1968 Coal 670 MW 3 1973 Coal 707 MW 4 1980 Coal 700 MW*\nL. V. Sutton 1 1954 Coal 97 MW (Wilmington, N.C.) 2 1955 Coal 106 MW 3 1972 Coal 410 MW\nBrunswick 1 1977 Nuclear 767 MW* (Southport, N.C.) 2 1975 Nuclear 754 MW*\nMayo 1 1983 Coal 745 MW* (Roxboro, N.C.)\nHarris 1 1987 Nuclear 860 MW* (New Hill, N.C.)\n*Facilities are jointly owned by the Company and Power Agency, and the capacity shown includes Power Agency's share.\n2. MAINTENANCE OF PROPERTIES. The Company maintains all of its properties in good operating condition in accordance with sound management practices. The average life expectancy for ratemaking and accounting purposes of the Company's generating facilities (excluding combustion turbine units and hydro units) is approximately 40 years from the date of commercial operation.\n3. GENERATION ADDITIONS SCHEDULE. The Company's energy and load forecasts were revised in December 1994. Over the next ten years, system sales growth is forecasted to average 2.1% per year and annual growth in system peak demand is projected to average 2.1%. The Company's generation additions schedule, which is updated annually, reflects no additions until 1997, when three new combustion turbine generating units are currently scheduled to commence commercial operation. These units, having a total generating capacity of approximately 225 MW, will be located at the Company's Darlington County Electric Plant near Hartsville, South Carolina and are expected to cost an aggregate of approximately $72 million. The generation additions schedule also includes generation additions of up to 1,200 MW in combustion turbine generating units to be added adjacent to the Company's Lee Steam Electric Plant in Wayne County, North Carolina. In December 1994, the Company filed preliminary plans with the North Carolina Utilities Commission (NCUC) and the North Carolina Division of Environmental Management to construct the ten new combustion turbine generating units at the Wayne County site. The units are nominally rated at 100-200 MW each and would represent a capital investment of approximately $300 million. The units would primarily be used during periods of summer and winter peak demands. The schedule, which is subject to change, calls for construction to begin in 1996, with the units beginning commercial service between 1998 and 2000. In addition to this proposed project, the generation addition schedule provides for the addition of 1,400 MW in combustion turbine capacity, and 900 MW combined cycle capacity at undesignated sites over the period 2000 to 2007, and a 500 MW baseload coal unit in 2008 at an undesignated site.\n4. RELICENSING OF HYDROELECTRIC PLANT. In 1973, the Company filed an application with the Federal Power Commission, now the Federal Energy Regulatory Commission (FERC), for a new long-term license for its 105 MW Walters Hydroelectric Plant (Project No. 432- 004). North Carolina Electric Membership Corporation (NCEMC), doing business as Carolina Electric Cooperatives, filed a competing application in August 1974 (Project No. 2748-000). On September 17, 1993, the Company and NCEMC filed a settlement agreement (Settlement Agreement) with the FERC for approval. Another settlement agreement regarding various environmental issues was filed with the FERC for approval on February 16, 1994. Through a series of orders, the FERC approved final settlement of this proceeding, and on November 4, 1994, issued the Company a forty year license to operate its Walters Hydroelectric Plant. The license contains numerous conditions for the ongoing operation of the plant, including recreational enhancements, environmental monitoring and funding, and cultural resource management. Issuance of the license for the Walters Plant by the FERC and the Company's acceptance of the license terms conclude this licensing proceeding.\nINTERCONNECTIONS WITH OTHER SYSTEMS ___________________________________\n1. INTERCONNECTIONS. The Company's facilities in Asheville and vicinity are integrated into the total system through the facilities of Duke via interconnection agreements that permit transfer of power to and from the Asheville area. The Company also has major interconnections with the Tennessee Valley Authority (TVA), Appalachian Power Company (APCO), Virginia Power, South Carolina Electric and Gas Company (SCE&G), South Carolina Public Service Authority (SCPSA) and Yadkin, Inc. (Yadkin). Major interconnections include 115 kV and 230 kV ties with SCE&G and SCPSA; 115 kV, 230 kV and 500 kV ties with Duke and Virginia Power; a 115 kV tie with Yadkin; a 161 kV tie with TVA; and three 138 kV ties and one 230 kV tie with APCO. See paragraph 3.b. below.\n2. INTERCHANGE AGREEMENTS.\na. The Company has interchange agreements with APCO, Duke, SCE&G, SCPSA, TVA, Virginia Power and Yadkin which provide for the purchase and sale of power for hourly, daily, weekly, monthly or longer periods. Purchases and sales under these agreements may be made due to changes in the in-service dates of new generating units, outages at existing units, economic considerations or for other reasons.\nb. The Virginia-Carolinas Subregion of the Southeastern Electric Reliability Council is made up of the Company, Duke, Nantahala Power & Light Company, SCE&G, SCPSA and Virginia Power, plus the Southeastern Power Administration and Yadkin. Electric service reliability is promoted by contractual arrangements among the members of electric reliability organizations at the area, regional and national levels, including the Southeastern Electric Reliability Council and the North American Electric Reliability Council.\n3. PURCHASE POWER CONTRACTS.\na. In March 1987, the Company entered into a purchase power contract with Duke, whereby Duke would provide 400 MW of firm capacity to the Company's system over the period January 1, 1992, through December 31, 1997. The contract was filed with the FERC in December 1988 (Docket No. ER89-106). NCEMC, Power Agency, Nucor Steel, the South Carolina Consumer Advocate and others moved to intervene in the proceeding, objecting to various aspects of the contract. A hearing was held in January 1990. Pursuant to an amendment of the contract, commencement of the purchase of power by the Company was delayed until July 1993 and termination was extended through June 1999. This amendment was filed with the FERC and accepted for filing, subject to refund, pursuant to an Order dated January 21, 1992. A settlement agreement resolving issues related to the purchase power contract and other matters between the Company and NCEMC was filed with the FERC for approval on September 17, 1993. See ITEM 1, \"Generating Capability,\" paragraph 4. Pending the FERC's approval of the settlement, the Company began purchasing 400 MW of generating capacity from Duke in July 1993. The estimated minimum annual payment for power under the six-year agreement is $43 million, which represents capital-related capacity costs. Purchases under this agreement, including transmission use charges, totaled $62.9 million in 1994. On January 20, 1995, the FERC issued an order approving a final settlement agreement in this docket, thereby accepting the purchase power contract and making it no longer subject to refund.\nb. The Company has entered into an agreement, which has been approved by the FERC, with APCO and Indiana Michigan Power Company (Indiana Michigan), operating subsidiaries of American Electric Power Company, to upgrade a transmission interconnection with APCO in the Company's western service area, establish a new interconnection in the Company's eastern service area, and purchase 250 MW of generating capacity from Indiana Michigan's Rockport Unit No. 2 through 2010. The estimated minimum annual payment for power purchased under the terms of the agreement is approximately $30 million, which represents capital-related capacity costs. Other costs associated with the agreement include demand-related production expenses, fuel, energy-related operation and maintenance expenses and transmission use charges. Purchases under this agreement, including transmission use charges, totaled $61.9 million in 1994.\n4. FAYETTEVILLE. The Company has an agreement with the City of Fayetteville's Public Works Commission (City) to exchange capacity and energy. The City has a 70 MW heat recovery unit and eight 27.5 MW dual fuel (gas or oil) fired combustion turbine units. The heat recovery unit and five of the combustion turbine units are being used by the City to satisfy energy requirements during periods of peak demand. The agreement makes provisions for the purchase and sale of capacity and\/or energy for economic and reliability reasons to the mutual benefit of both parties. On March 10, 1994, the City and the Company entered into a new ten-year agreement under which the Company will continue to be the City's wholesale supplier of electricity. See ITEM 1, \"Wholesale Rate Matters,\" paragraph 3.c. for further discussion of the new agreement.\n5. POWER AGENCY. The Company is obligated to purchase a percentage of Power Agency's ownership capacity of and energy from the Mayo Plant and the Harris Plant through 1997 and 2007, respectively. The estimated minimum annual payments for these purchases, which reflect capital-related capacity costs, total approximately $27 million. Other costs of such purchases are primarily demand-related production expenses, fuel and energy-related operation and maintenance expenses. Purchases under the agreement with Power Agency totaled $60.4 million in 1994.\nCOMPETITION AND FRANCHISES __________________________\n1. COMPETITION.\na. Generally, in municipalities and other areas where the Company provides retail electric service, no other utility directly renders such service. In recent years, however, customers interested in building their own generation facilities, competition from unregulated energy suppliers and changing government regulations have fostered the development of alternative sources of electricity for certain of the Company's wholesale and industrial customers. The Public Utility Regulatory Policies Act (PURPA) has facilitated the entry of non-utility companies into the wholesale electric generation business. Under PURPA, non-utility companies are allowed to construct \"qualifying facilities\" for the production of electricity in connection with industrial steam supplies and, under certain circumstances, to compel a utility to purchase the electricity generated at prices reflecting the utility's avoided cost as set by state regulatory bodies. Over the near term, the purchase of power from qualifying facilities has increased the Company's total cost of generation.\nb. In 1992, the National Energy Policy Act (Energy Act) changed certain underlying federal policies governing wholesale generation and the sale of electric power. In effect, the Energy Act partially deregulated the wholesale electric utility industry at the generation level by allowing non-utility generators to build and own generating plants for both cogeneration and sales to utilities. Provisions of the Energy Act that most affected the utility industry were the establishment of exempt wholesale generators, and the authority given the FERC to permit wholesale transfer, or wheeling, of power over the transmission lines of other utilities. The Company is unable to predict the ultimate impact the Energy Act will have on its operations. When fully implemented, the Energy Act could impact the Company's load forecasts and plans for power supply to the extent additional generation is facilitated by the Energy Act, current wholesale customers elect to purchase from other suppliers, or new opportunities are created for the Company to expand its wholesale load. Although the Energy Act prohibits the FERC from ordering retail wheeling--transmitting power on behalf of another producer to an individual retail customer--some states are considering changing their laws or regulations to allow retail electric customers to buy power from suppliers other than the local utility. The Company believes changes in existing laws in both North Carolina and South Carolina would be required to permit retail wheeling in the Company's retail jurisdictions. The South Carolina Public Service Commission (SCPSC) has ruled that it would be a violation of its past practice and of South Carolina's territorial assignment statute to require utilities to engage in retail wheeling. On February 8, 1995, the Carolina Utility Consumers Association, Inc., a group of industrial customers doing business in North Carolina, filed a petition with the NCUC requesting that the NCUC hold a generic hearing to examine whether retail wheeling would be in the public interest, how it could be implemented in North Carolina and whether it could be implemented without changing state law. The NCUC has issued an order inviting interested parties to comment on the petition. The Company cannot predict the outcome of this matter.\nThe possible migration of some of the Company's load due to increased competition in the electric industry has created greater planning uncertainty and risks for the Company. The Company has been addressing these risks by securing long-term contracts with its customers, which allow the Company flexibility in managing its load and efficiently planning its future resource requirements. In this regard, in 1993 and 1994 the Company signed long-term agreements with almost all of the Company's wholesale customers, representing approximately 15% of the Company's operating revenues. In the industrial sector, the Company is working to meet the energy needs of its customers. In 1994, the Company reached an agreement with its largest industrial customer that ensures the Company will serve that customer through 2001. Other elements of the Company's strategy for responding to the changing market for electricity include promoting economic development, implementing new market strategies, increasing the focus on managing and reducing costs, and consequently, avoiding future rate increases.\nc. In April 1994, the North Carolina Public Staff (Public Staff), which represents the using and consuming public in matters before the NCUC, filed a petition with the NCUC proposing interim guidelines to apply to requests for self-generation deferral rates. By order issued May 13, 1994, the NCUC established a docket (Docket No. E-100, Sub 73) to consider the proposed self-generation deferral rates guidelines, and dispersed energy facilities and economic development rates. Initial comments were filed by the Company and other interested parties on June 13, 1994, and reply comments were filed on June 27, 1994. In response to the parties' comments, on July 1, 1994, the Public Staff filed modifications to the proposed self-generation deferral rate guidelines. By order issued July 21, 1994, the NCUC, with limited exceptions, approved and adopted the modified self-generation deferral rate guidelines proposed by the Public Staff. The guidelines allow the Company to adjust rates to retain certain loads for which self-generation is feasible. In this order, the NCUC also requested that additional comments regarding economic development rates be filed by October 21, 1994, and stated that the issue of dispersed energy facilities would be addressed on a case by case basis. On November 28, 1994, the NCUC issued an order adopting interim guidelines for economic development rates. These guidelines allow the Company to adjust its rates to attract new industrial load that would not have been served in the absence of such rates, provided certain criteria are satisfied. The NCUC will review the economic development rate guidelines after one year.\nd. On September 17, 1993, the Company and NCEMC filed with the FERC a Power Coordination Agreement (PCA) and an Interchange Agreement (IA), both dated August 27, 1993. The PCA and IA, which were both filed in connection with the Walters Hydroelectric Plant relicensing proceeding (Project Nos. 432-004 and 2748-000), set forth explicitly the future relationship between the Company and NCEMC, and establish a framework under which they will operate. See ITEM 1, \"Generating Capability,\" paragraph 4 for further discussion of the Walters relicensing proceeding. The FERC granted final approval of the PCA and the IA in June 1994. The PCA provides NCEMC the option to gradually assume responsibility for a portion of its load, subject to agreed upon limits, thereby enabling the Company to further enhance its planning for generation and transmission property. Additionally, the Company will sell electricity and provide necessary transmission and coordinating services to NCEMC subject to rates that will benefit the Company and its customers. The PCA allows NCEMC to assume responsibility for up to 200 MW of its load from the Company's system between January 1, 1996 and December 31, 2000. On and after January 1, 1996, the Company expects to continue to supply not less than 1000 MW of electricity to NCEMC until at least December 31, 2000. NCEMC's board of directors has voted to award a power-supply contract for 200 MW to another supplier beginning on January 1, 1996. If approved by the FERC, the contract will displace 200 MW of baseload capacity that NCEMC currently purchases from the Company. Load reductions beyond the year 2000 are subject to specific limits and require five years' advance notice. On November 4, 1994, NCEMC issued two requests for proposals (RFP) to provide up to 225 MW per year (for a minimum of ten years) of baseload power NCEMC would otherwise purchase from the Company beginning in 2001, 2002 and 2003. On March 3, 1995, the Company submitted a bid in response to each RFP to compete for this load. The Company cannot predict the outcome of these matters.\ne. By order issued September 30, 1994, the SCPSC established a docket for a generic proceeding to consider the effect of electric and natural gas demand side management programs on competition between the two types of utilities. The order states that the outcome of such a proceeding will not apply to the 1995 integrated resource plans that electric utilities file with the SCPSC. The filing of testimony and scheduling of hearings in the SCPSC proceeding have been indefinitely postponed. The NCUC established a docket for a similar generic proceeding (Docket No. E-100, Sub 71) by order dated February 24, 1994. The NCUC's hearings on this matter concluded on December 20, 1994, but the NCUC has not issued an order in that proceeding. The Company cannot predict the outcome of these matters.\n2. FRANCHISES. The Company is a regulated public utility and holds franchises to the extent necessary to operate in the municipalities and other areas it serves.\nCONSTRUCTION PROGRAM ____________________\n1. CAPITAL REQUIREMENTS. During 1994 the Company expended approximately $386 million for capital requirements. The Company revised its capital program in 1994 as part of its annual business planning process. Capital requirements, including anticipated construction expenditures for plant modifications, for the years 1995 through 1997 are set forth below. These estimates include Clean Air Act compliance expenditures of approximately $117 million, and generating facility addition expenditures of approximately $287 million. See ITEM 1, \"Environmental Matters,\" paragraph 2 for further discussion of the impact of the Clean Air Act on the Company.\nEstimated Capital Requirements ______________________________ (In millions)\n1995 1996 1997 TOTAL ____ ____ ____ _____\nConstruction Expenditures $358 $445 $527 $1,330 Nuclear Fuel Expenditures 99 77 71 247 AFUDC (19) (25) (34) (78) ____ ____ ____ ______ Net expenditures (a) 438 497 564 1,499 Long-Term Debt Maturities 275 105 100 480 ____ ____ ____ ______ TOTAL $713 $602 $664 $1,979 ==== ==== ==== ======\n(a) Reflects reductions of approximately $29 million, $28 million and $21 million for 1995, 1996 and 1997, respectively, in net capital requirements resulting from Power Agency's projected payment of its ownership share of capital expenditures related to the Joint Facilities.\nFINANCING PROGRAM _________________\n1. CAPITAL REQUIREMENTS. External funding requirements, which do not include early redemptions of long-term debt or redemptions of preferred stock, are expected to approximate $417 million in 1995 and $120 million in 1997. These funds will be required for construction, long-term debt maturities and general corporate purposes, including the repayment of short-term debt. Based on the Company's most recent estimate of capital requirements, the Company does not expect to have external funding requirements in 1996. The Company may from time to time sell additional securities beyond the amount needed to meet capital requirements to allow for the early redemption of outstanding issues of long-term debt, the redemption of preferred stock, the reduction of short-term debt or for other corporate purposes. The amounts and timing of the sales of securities will depend upon market conditions and the specific needs of the Company. See ITEM 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" for further analysis and discussion of the Company's financing plans and capital resources and liquidity.\n2. SEC FILINGS.\na. The Company has on file with the Securities and Exchange Commission (SEC) a shelf registration statement (File No. 33-57835), enabling the Company to issue an aggregate of $450 million principal amount of First Mortgage Bonds, and an additional $250 million combined aggregate principal amount of First Mortgage Bonds and\/or unsecured debt securities of the Company.\nb. The Company has on file with the SEC a shelf registration statement (File No. 33-5134) enabling the Company to issue up to $180 million of Serial Preferred Stock.\n3. FINANCINGS. External financings during 1994 and early 1995 included:\n- The issuance on January 19, 1994, of $150 million principal amount of First Mortgage Bonds, 5 7\/8% Series due January 15, 2004, for net proceeds of approximately $148 million. The proceeds from the issuance were used to reduce the outstanding balance of commercial paper and other short-term debt, to redeem outstanding long-term debt and for other general corporate purposes.\n- The issuance on May 12, 1994, of $72.6 million principal amount of First Mortgage Bonds, Pollution Control Series L, Wake County Pollution Control Revenue Refunding Bonds (Carolina Power & Light Company Project) Series 1994A due May 1, 2024 and $50 million principal amount of First Mortgage Bonds, Pollution Control Series M, Wake County Pollution Control Revenue Refunding Bonds (Carolina Power & Light Company Project) Series 1994B due May 1, 2024, for a total net proceeds of $122.6 million. The proceeds from the issuances were used for the redemption on June 15, 1994 of $122.6 million First Mortgage Bonds, Pollution Control Series G, Wake County Pollution Control Revenue Bonds (Carolina Power & Light Company) Series 1984A due June 15, 2014, at 100% of the principal amount of such bonds plus accrued interest to the date of redemption.\n- The remarketing on July 1, 1994, of First Mortgage Bonds, Pollution Control Series J, New Hanover County Pollution Control Revenue Bonds (Carolina Power & Light Company Project) Series 1984 due June 15, 2014 and First Mortgage Bonds, Pollution Control Series K, Chatham County Pollution Control Revenue Bonds (Carolina Power & Light Company Project) Series 1984 due June 15, 2014, at a fixed rate of 6.30% to June 15, 2014.\n- The issuance on December 28, 1994, of $50 million principal amount of First Mortgage Bonds, Secured Medium-Term Notes, 7.9% Series C, due December 27, 1996 for net proceeds of $49.8 million. The proceeds from the issuance were used to reduce the outstanding balance of commercial paper and other short-term debt, to redeem outstanding long-term debt and for other general corporate purposes.\n- The issuance on January 24, 1995, of $60 million principal amount of First Mortgage Bonds, Secured Medium-Term Notes, 7.75% Series C, due January 24, 1997 for net proceeds of $59.7 million. The proceeds were used to reduce the outstanding balance of commercial paper and other short-term debt and for other general corporate purposes.\n4. REDEMPTIONS\/RETIREMENTS. Redemptions and retirements during 1994 and early 1995 included:\n- The redemption on March 24, 1994, of $17.5 million principal amount of First Mortgage Bonds, 8 1\/2% Series due October 1, 2007, at 100.25% of the principal amount of such bonds plus accrued interest to the date of redemption.\n- The partial redemption on March 24, 1994, of $77.4 million principal amount of First Mortgage Bonds, 8 1\/8% Series, due November 1, 2003, at 100.61% of the principal amount of such bonds plus accrued interest to the date of redemption.\n- The retirement on April 15, 1994, of $50 million principal amount of First Mortgage Bonds, 5.85% Secured Medium-Term Notes, Series B, which matured on that date.\n- The redemption on June 15, 1994, of $122.6 million principal amount of First Mortgage Bonds, Pollution Control Series G, Wake County Pollution Control Revenue Bonds (Carolina Power & Light Company Project) Series 1984A due June 15, 2014, at 100% of the principal amount of such bonds plus accrued interest to the date of redemption.\n- The retirement on January 1, 1995, of $125 million principal amount of First Mortgage Bonds, 5.20% Series, which matured on that date.\n5. CREDIT FACILITIES. The Company's credit facilities presently total $307.9 million, consisting of long-term agreements totaling $207.9 million and a $100 million short-term agreement.\nRETAIL RATE MATTERS ___________________\n1. GENERAL. The Company is subject to regulation in North Carolina by the NCUC and in South Carolina by the SCPSC with respect to, among other things, rates for electric energy sold at retail, retail service territory and issuances of securities.\n2. CURRENT RETAIL RATES. The rates of return granted to the Company in its most recent general rate cases are as follows:\n1988 North Carolina Utilities Commission Order (test year ended March 31, 1987) _______________________________________________________________________________ Capital Weighted Weighted Capital Structure Ratio Cost Rate Cost _________________ _______ _________ ________\nLong-Term Debt 48.57% 8.62% 4.19% Preferred Stock 7.43 8.75 .65 Common Equity 44.00 12.75 5.61 _____ Rate of Return 10.45% ===== 1988 South Carolina Public Service Commission Order (test year ended September 30, 1987) _________________________________________________________________________\nCapital Weighted Weighted Capital Structure Ratio Cost Rate Cost _________________ _______ _________ ________\nLong-Term Debt 47.82% 8.62% 4.12% Preferred Stock 7.46 8.75 .65 Common Equity 44.72 12.75 5.71 _____ Rate of Return 10.48% =====\n3. INTEGRATED RESOURCE PLANNING. Integrated Resource Planning is a process that systematically compares all reasonably available resources, both demand-side and supply-side, in order to develop that mix of resources that allows a utility to meet customer demand in a cost effective manner, giving due regard to system reliability and safety. The Company is required to file its Integrated Resource Plan (IRP) with the NCUC and the SCPSC once every three years. The Company regularly reviews its IRP in light of changing conditions and evaluates the impact these changes have on its resource plans, including purchases and other resource options. The next IRP is scheduled to be filed with the NCUC on or before April 28, 1995, and with the SCPSC on or before June 30, 1995.\n4. DEMAND SIDE MANAGEMENT. The Company's Demand Side Management (DSM) programs are an integral part of its IRP. The Company offers a variety of conservation, load management, and strategic sales programs to its residential, commercial and industrial customers. The objectives of the DSM programs are to improve system operating efficiencies, meet customer needs in a growing service area, defer the need for future generating units and delay the need for future rate increases. Currently, the Company offers time-of-use rates to all its retail customers, low interest loans to its residential customers for the installation of additional insulation and high efficiency heat pumps in existing homes, financial incentives and an energy conservation discount for all-electric homes that meet enhanced thermal integrity and appliance efficiency standards, financial incentives for Company control of residential water heaters and air conditioners in most of the major metropolitan areas served by the Company, incentives for the curtailment of large industrial loads, and energy audits for large commercial and industrial customers, as well as many other programs. Additional programs are in various stages of investigation and development. The Company currently has no deferred costs related to DSM programs.\n5. FUEL COST RECOVERY. In the North Carolina retail jurisdiction, the NCUC establishes base fuel costs in general rate cases and holds hearings annually to determine whether a rider should be added to base fuel rates to reflect increases or decreases in the cost of fuel and the fuel cost component of purchased power as well as changes in the fuel cost component of sales to other utilities. The NCUC considers the changes in the Company's cost of fuel during a historic test period ending March 31 of each year and corrects any past over- or under-recovery. The Company's 1995 North Carolina fuel case hearing is scheduled to begin on August 1, 1995. The Company cannot predict the outcome of this matter.\nIn the South Carolina retail jurisdiction, fuel rates are set by the SCPSC based on projected costs for a future six-month test period. At the semi-annual hearings, any past over- or under- recovery of fuel costs is taken into account in establishing the new projected rate for the subsequent six-month billing period. The Company's spring 1995 South Carolina fuel case was held on March 15, 1995 (Docket No. 95-001-E). On March 21, 1995, the SCPSC approved a fuel factor of 1.34 cents\/kWh for the six month period April 1 through September 30, 1995.\n6. AVOIDED COST PROCEEDINGS. The NCUC has opened Docket No. E-100, Sub. 75 for its biennial proceeding to establish the avoided cost rates for all electric utilities in North Carolina. Avoided cost rates are intended to reflect the costs that utilities are able to \"avoid\" by purchasing power from qualifying facilities. The Company has proposed to lower its avoided cost rates. The hearings in this docket concluded on March 9, 1995, but the NCUC has not issued an order in this proceeding. The Company cannot predict the outcome of this matter.\n7. IMPACT OF ENERGY ACT. Section 111 of the Energy Act requires all state commissions to consider whether the adoption of certain standards would further the purposes of the PURPA. These standards relate to the use of integrated resource planning by electric utilities, investments in conservation and demand side management, and energy efficiency investments in power generation and supply. Both the NCUC and the SCPSC have opened dockets to consider these standards. With regard to the NCUC proceeding, direct testimony was filed by the Company on February 8, 1994. A hearing was held on March 8, 1994, but the NCUC has not yet issued its ruling. The Company cannot predict the outcome of this matter. With regard to the SCPSC proceeding, the Company filed initial written comments on March 1, 1994, and reply comments were due on April 15, 1994. By order dated June 22, 1994, the SCPSC approved a stipulation entered into by the Company and the other parties to the proceeding. In that stipulation, the parties agreed that standards similar to those of Section 111 of the Energy Act have already been implemented to the degree necessary, and therefore, the specific standards of Section 111 do not need to be adopted by the SCPSC in order to implement the purposes of PURPA.\n8. MISCELLANEOUS. There are two additional dockets pending in the NCUC. The first docket (Docket No. M-100, Sub 124) involves the proper interpretation of North Carolina General Statute Section 62-140(c) which controls the offer or payment of consideration by a public utility to secure the installation or adoption of the use of the utility's services. This docket will be decided based upon the written comments of the parties. The second docket (Docket No. E- 100, Sub 71) explores the issue of what factors the NCUC should consider when evaluating the reasonableness of proposed DSM programs. Hearings in the second docket have been completed, but the NCUC has not yet issued an order in the proceeding. The Company cannot predict the outcome of these matters.\nWHOLESALE RATE MATTERS ______________________\nThe Company is subject to regulation by the FERC with respect to rates for transmission and sale of electric energy at wholesale, the interconnection of facilities in interstate commerce (other than interconnections for use in the event of certain emergency situations), the licensing and operation of hydroelectric projects and, to the extent the FERC determines, accounting policies and practices. The Company and its wholesale customers last agreed to a general increase in wholesale rates in 1988. At the present time, the Company has no wholesale rate matters pending at the FERC.\nENVIRONMENTAL MATTERS _____________________\n1. GENERAL. In the areas of air quality, water quality, control of toxic substances and hazardous and solid wastes and other environmental matters, the Company is subject to regulation by various federal, state and local authorities. The Company considers itself to be in substantial compliance with those environmental regulations currently applicable to its business and operations and believes it has all necessary permits to conduct such operations. Except as noted below in paragraph 2, the Company does not currently anticipate that its potential capital expenditures for environmental pollution control purposes will be material. Environmental laws and regulations, however, are constantly evolving and the character, scope and ultimate costs for compliance with such evolving laws and regulations cannot now be accurately estimated. Costs associated with compliance with pollution control laws and regulations at the Company's existing facilities, which are expected to be incurred from 1995 through 1997, are included in the estimates of capital requirements under ITEM 1, \"Construction Program.\"\n2. CLEAN AIR LEGISLATION. The 1990 amendments to the Clean Air Act (Act) require substantial reductions in sulfur dioxide and nitrogen oxides emissions from fossil-fueled electric generating plants. The Company was not required to take action to comply with the Act's Phase I requirements, which had to be met by January 1, 1995. Phase II of the Act, which contains more stringent provisions, will become effective January 1, 2000. To reduce sulfur dioxide emissions, as required by Phase II, the Company will modify equipment to allow certain of the Company's plants to burn lower sulfur coal, and is planning for the installation of scrubbers. Installation of additional equipment will also be necessary to reduce nitrogen oxides emissions. The Company anticipates that it will be able to delay the installation and operation of scrubbers until 2007 by utilizing lower sulfur coal and sulfur dioxide emission allowances. The Company purchased emission allowances under the Environmental Protection Agency's (EPA) emission allowance trading program in 1993 and 1994. Each sulfur dioxide emission allowance will allow a utility to emit one ton of sulfur dioxide. The Company estimates that the total capital cost to comply with Phase II of the Act will approximate $273 million during the period 1995 through 1999 and an additional $272 million during the period 2000 through 2007. These estimates, for installation or modification of equipment, are in nominal dollars (undiscounted future amounts expected to be expended). The required modifications and additions are expected to increase operating and maintenance costs by a total of $18 million for the period 1995 through 1999, $35 million for the period 2000 through 2006 and by $24 million annually beginning in 2007. Additionally, fuel costs are expected to increase by a total of approximately $277 million for the period 2000 through 2006, and by approximately $62 million annually beginning in 2007. The Company expects these increased fuel costs to be recoverable through applicable fuel adjustment statutes. Actual plans for compliance with the Act's requirements have not been finalized and the amount required for capital expenditures and for increased operating, maintenance and fuel expenditures cannot be determined with certainty at this time. The financial impact of additional expenditures will be dependent on future ratemaking treatment. The NCUC and the SCPSC are currently allowing the Company to accrue carrying charges on its investment in emission allowances. A plan for compliance with Phase II of the Act must be submitted to the EPA by January 1, 1996. The Company cannot predict the outcome of this matter.\n3. SUPERFUND. The provisions of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (CERCLA), authorize the EPA and, indirectly, the states, to require generators and certain transporters of certain hazardous substances released from or at a site, and the owners and operators of such site, to clean up the site or reimburse the costs therefor. This statute has been interpreted to impose joint and several liability on responsible parties. There are presently several sites with respect to which the Company has been notified by the EPA or the State of North Carolina of its potential liability, as described below in greater detail.\na. On December 2, 1986, the EPA notified the Company of its potential liability pursuant to CERCLA for the investigation and cleanup activities associated with the Maxey Flats Nuclear Disposal Site in Fleming County, Kentucky. The EPA indicated that the site was operated from 1963 to 1977 under the management of Nuclear Engineering Company (now U. S. Ecology). The EPA estimated that the Company sent 304,459 cubic feet of waste to the disposal site. In response to the EPA's notice, the Company and several other potentially responsible parties (PRPs) formed a steering committee (the Maxey Flats Steering Committee) to undertake a remedial investigation\/feasibility study pursuant to CERCLA. As a result of this study, the EPA has selected a remedial action which is currently estimated to have a present value cost of between $57 million and $78 million. Subsequent analysis of waste volume sent to the site performed by the Maxey Flats Steering Committee established that the Company contributed only approximately 1% of the total waste volume. It is expected that the Company's share of remediation costs will be based on the ratio of the Company's waste volume to that of other participating PRPs. The Company is currently ranked twenty-fourth on the waste-in list. On June 30, 1992, the EPA sent the Company, along with a number of other companies, agencies and organizations, a notice demanding reimbursement of response costs of approximately $5.8 million that have been incurred at the site and seeking to initiate formal negotiations regarding performance of the remedial design and remedial action for the site. On July 20, 1992, the Company responded that it would negotiate these matters through the Maxey Flats Steering Committee. In December 1992, the EPA rejected the offer the Maxey Flats Steering Committee filed regarding the performance of the remedial design and remedial action for this site. The Maxey Flats Steering Committee submitted amended offers to the EPA in 1993. The EPA has engaged in settlement negotiations with the Maxey Flats Steering Committee, the Commonwealth of Kentucky, which owns the site, and the federal agencies in an effort to reach global settlement. It appears that the Steering Committee and eleven federal agencies will perform the Initial Remediation Phase and the Commonwealth of Kentucky will perform the Balance of Remediation Phase pursuant to a Consent Decree with EPA. Although the Company cannot predict the outcome of this matter, it does not anticipate that costs associated with this site will be material to the results of operations of the Company.\nb. On December 2, 1986, the EPA notified the Company that it is a PRP with respect to the disposal, treatment or transportation for disposal or treatment of polychlorinated biphenyls (PCBs) at the Martha C. Rose Chemicals, Inc. (Rose) facility located in Holden, Missouri. Roughly 190,000 pounds of PCB wastes (approximately 0.8% of the total waste volume) are alleged to have been sent to the site by the Company. By volume, the Company ranks twenty-third on the waste-in list. Site stabilization was completed by Clean Sites, Inc., the third party hired to negotiate a cleanup between the waste generators and the EPA. By letter dated November 12, 1993, the EPA approved the final remediation design for the Rose site. Final site remediation began in May 1994, and is scheduled to be completed in early 1995. Final grading, seeding and demobilization is scheduled to be conducted in March 1995. It is currently estimated that cleanup will cost approximately $23.7 million. There is currently over 90% participation by the PRPs in the site cleanup. The Company has contributed approximately $293,000 to the waste generators' group and does not expect that it will be required to contribute additional funds to complete remediation of this site. Although the Company cannot predict the outcome of this matter, it does not anticipate that future costs associated with this site, if any, would be material to the results of operations of the Company.\nc. In May 1989, the EPA notified the Company that it is a PRP with respect to the disposal of PCB transformers allegedly sent through Saline County Salvage to the Elliot's Auto Parts site in Benton, Arkansas. In its responses to the EPA, the Company stated its belief that no Company electrical equipment went to the site. Additionally, the Company declined to enter into an Administrative Order of Consent. In December 1992, the Elliot's Auto Parts PRP Committee (a group of PRPs with respect to the Elliot's site), requested that the Company pay a share of the estimated $2.65 million cost of cleaning up the site, and threatened to initiate litigation should the Company not contribute to the cleanup cost. The Company responded that it would be willing to participate in cleanup activities at the site if documentation was produced showing that the Company contributed any hazardous substances to the site. On January 21, 1993, the Elliot's Auto Parts PRP Committee produced documents alleging that the Company contributed hazardous substances to the site. Although the documentation provided does not clearly establish that the Company disposed of transformers at the Elliot's site, the Company negotiated with the Elliot's Auto Parts PRP Committee to avoid protracted litigation. The Elliot's Auto Parts PRP Committee has completed remedial activities at the site at a cost of approximately $2.7 million and will soon submit a final report to the EPA. Once the Elliot's Auto Parts PRP Committee receives final approval from the EPA for its final report, the Company, based on its negotiations with the Elliot's Auto Parts PRP Committee, has agreed to (i) pay $90,000 to the Elliot's Auto Parts PRP Committee towards the $2.7 million previously expended to remediate the site; (ii) pay 3.4% toward any future expense incurred in connection with the site; and (iii) execute an Administrative Order on Consent with the EPA. Although the Company cannot predict the outcome of this matter, it does not anticipate that future costs associated with this site, if any, would be material to the results of operations of the Company.\nd. By letter dated May 21, 1991, the EPA notified the Company that it is a PRP with respect to the disposal of hazardous substances at the Benton Salvage site in Benton, Arkansas. The Company has been unable to identify any records of shipments by the Company to that site. Until any such documentation can be produced, the Company does not intend to participate in cleanup activities at the site. The Company cannot predict the outcome of this matter.\ne. On April 15, 1991, the North Carolina Department of Environment, Health, and Natural Resources (DEHNR) notified the Company that it is a PRP with respect to the disposal of hazardous waste at the Seaboard Chemical Corporation (Seaboard) site in Jamestown, North Carolina. DEHNR has indicated that it is offering PRPs the opportunity to perform voluntary site cleanup. Seaboard records indicate that there are over 1,300 PRPs for the site and that the Company's contribution to waste disposal is less than 1% of the total waste disposed. On May 29, 1992, the Company entered into an Administrative Order on Consent with DEHNR, Division of Solid Waste Management, to undertake and perform a Work Plan for Surface Removal (Removal Work Plan). The Company estimates that to date its costs associated with completion of the Removal Work Plan total approximately $12,000. On July 28, 1993, DEHNR determined that the Removal Work Plan had been substantially completed. DEHNR further recommended that the Seaboard Group (a group of PRPs with respect to the Seaboard site) undertake additional remedial activities at the Seaboard site. The Company recently joined the Seaboard Group II (a group of PRPs formed to conduct additional work at the Seaboard site). Cost estimates for the additional work are not available. Although the Company cannot predict the outcome of this matter, it does not anticipate that costs associated with this site would be material to the results of operations of the Company.\nf. On January 9, 1992, the EPA sent notice to the Company, along with a number of other companies and persons, stating that the Company is a PRP with respect to the additional remediation of hazardous wastes at the Macon-Dockery site located near Cordova, North Carolina. The Company made arrangements in the past for the transportation and sale of waste and residual oil to C&M Oil Distributors, a company that operated an oil reprocessing facility at the Macon-Dockery site for a period of several months. However, the information available to the Company indicates that no hazardous wastes from Company facilities were sent to the site. Previously, in 1987, the EPA sent notice to the Company that the EPA believed the Company was a PRP with respect to costs incurred by the EPA for initial site cleanup of the Macon-Dockery site. The Company was also a third-party defendant in a lawsuit brought in federal district court to recover the cleanup costs incurred by the EPA. That lawsuit was subsequently settled.\nOn April 13, 1994, Crown Cork & Seal Company, Inc. and Clark Equipment Co. filed a motion to add the Company as a defendant in an ongoing lawsuit concerning the Macon-Dockery site, which was filed in the United States District Court for the Middle District of North Carolina in Greensboro, North Carolina (Civil Action No. 3:92CV00744) on December 4, 1992. The lawsuit seeks to recover costs incurred in undertaking the Remedial Investigation Feasibility Study and the Remedial Design for the Macon-Dockery site. On July 6, 1994, the United States District Court for the Middle District of North Carolina granted the motion Crown Cork & Seal Company and Clark Equipment Co. filed seeking to name the Company as a defendant in the lawsuit. On September 30, 1994, the Company filed an Answer denying any liability to Crown Cork & Seal Company and Clark Equipment Co. Although the Company cannot predict the outcome of this matter, it does not anticipate that costs associated with this site would be material to the results of operations of the Company.\ng. Various organic materials associated with the production of manufactured gas, generally referred to as coal tar, are regulated under various federal and state laws, and a liability may exist for their remediation. The production of manufactured gas was commonplace from the late 1800s until the 1950s. The Company has learned of the existence of several manufactured gas plant (MGP) sites to which the Company and certain entities which were later merged into the Company may have had some connection. In this regard, the Company, along with other entities alleged to be former owners and operators of MGP sites in North Carolina, is participating in a cooperative effort with the North Carolina Department of Environment, Health and Natural Resources, Division of Solid Waste Management (DSWM) to establish a uniform framework for addressing those sites. It is anticipated that the investigation and remediation of specific MGP sites will be addressed pursuant to one or more Administrative Orders on Consent between DSWM and individual PRPs. To date, the Company has not entered into any such orders.\nThe Company has recently been approached by another North Carolina public utility concerning a possible cost-sharing arrangement with respect to the investigation and, if necessary, remediation of four MGP sites. The Company is currently engaged in discussions with the other utility regarding this matter. Based on current cost estimates provided by that utility, the Company does not believe its portion of costs associated with the investigation and remediation of these sites, if any, would be material to the results of operations of the Company.\nIn addition, the Company and a current owner of property that was the site of one MGP owned by Tide Water Power Company (Tide Water Power), which merged into the Company in 1952, have entered into an agreement to share the cost of investigation and remediation of this site. The Company has also been approached by a North Carolina municipality that is the current owner of another MGP site that was formerly owned by Tide Water Power. The Company is engaged in discussions with that municipality concerning a possible cost- sharing arrangement with respect to the investigation and, if necessary, the remediation of that site. Due to the uncertainty concerning potential environmental harm and the full extent to which remedial action will be required at the two sites formerly owned by Tide Water Power, the total cost of investigating and remediating these sites is not determinable at this time.\nThe Company is continuing its investigation regarding the identities of parties connected to individual MGP sites, the relative relationships of the Company and other parties to those sites, and the degree, if any, to which the Company should undertake shared voluntary efforts with others at individual sites. Except as noted above, due to the lack of information with respect to the operation of MGP sites and the uncertainty concerning questions of liability and potential environmental harm, the extent and cost of required remedial action, if any, and the extent to which liability may be asserted against the Company or against others are not currently determinable. The Company cannot predict the outcome of these matters or the extent to which other former MGP sites may become the subject of inquiry.\n4. OTHER ENVIRONMENTAL MATTERS. On April 21, 1989, the North Carolina Division of Environmental Management (DEM) requested that the Company install a groundwater compliance monitoring system at the Company's Wilmington Oil Terminal located in New Hanover County, North Carolina. The request was prompted by the discovery of petroleum contamination beneath a neighboring oil transportation facility. DEM requested the installation of the monitoring system in order to determine if groundwater quality standards have been violated at the Wilmington Oil Terminal and if any such violations have contributed to the contamination underneath the neighboring facility. During the second half of 1989, six groundwater monitoring wells were installed and samples were collected and analyzed for the presence of petroleum hydrocarbons. Samples from one of the six wells indicated gasoline contamination and samples from a second well indicated No. 2 fuel oil contamination. The Company provided information on these monitoring wells to the DEM and in February 1993, DEM granted the Company permission to install a remediation system to collect and treat contaminated groundwater. This system conveys the groundwater to the neighboring facility for co-treatment of the contaminated water. In November 1994, the Company was asked by DEM to expand its assessment to determine whether the No. 2 fuel oil spill had migrated off-site. Off-site contamination was confirmed; however, it is not clear that the Company is responsible for such off-site contamination. The Company will discuss this matter with DEM. Although the Company cannot predict the outcome of this matter, it believes that any remediation expense would not exceed $100,000 annually.\n5. ENVIRONMENTAL ACCRUAL. In 1994, the Company accrued a liability for the estimated costs associated with investigation and remediation activities for certain MGP sites and for sites other than MGP sites. This accrual was not material to the results of operations of the Company.\nNUCLEAR MATTERS _______________\n1. GENERAL. Under the Atomic Energy Act of 1954 and the Energy Reorganization Act of 1974, as amended, operation of nuclear plants is intensively regulated by the NRC, which has broad power to impose nuclear safety and security requirements. In the event of non-compliance, the NRC has the authority to impose fines, set license conditions, or shut down a nuclear unit, or some combination of these, depending upon its assessment of the severity of the situation, until compliance is achieved. The electric utility industry in general has experienced challenges in a number of areas relating to the operation of nuclear plants, including substantially increased capital outlays for modifications; the effects of inflation upon the cost of operations; increased costs related to compliance with changing regulatory requirements; renewed emphasis on achieving excellence in all phases of operations; unscheduled outages; outage durations; and uncertainties regarding storage facilities for spent nuclear fuel. See paragraph 7.b. below. The Company experiences these challenges to varying degrees. Capital expenditures for modifications at the Company's nuclear units, excluding Power Agency's ownership interests, during 1995, 1996 and 1997 are expected to total approximately $72 million, $58 million and $34 million, respectively (including AFUDC).\n2. SPENT FUEL AND OTHER HIGH-LEVEL RADIOACTIVE WASTE. The Nuclear Waste Policy Act of 1982 (Nuclear Waste Act) provides the framework for development by the federal government of interim storage and permanent disposal facilities for high-level radioactive waste materials. The Nuclear Waste Act promotes increased usage of interim storage of spent nuclear fuel at existing nuclear plants. The Company will continue to maximize the usage of spent fuel storage capability within its own facilities for as long as feasible. Pursuant to the Nuclear Waste Act, the Company, through a joint agreement with the U. S. Department of Energy (DOE) and the Electric Power Research Institute, has built a demonstration facility at the Robinson Plant that allows for the dry storage of 56 spent nuclear fuel assemblies. As of December 31, 1994, sufficient on-site spent nuclear fuel storage capability is available for the full-core discharge of Brunswick Unit No. 1 through 1995, Brunswick Unit No. 2 through 1996, and Robinson Unit No. 2 through 1998, assuming normal operating and refueling schedules. The Harris Plant spent fuel storage facilities, with certain modifications together with the spent fuel storage facilities at the Brunswick and Robinson Units, are sufficient to provide storage space for spent fuel generated on the Company's system through the expiration of the current operating licenses for all of the Company's nuclear generating units. Subsequent to the expiration of the licenses, dry storage may be necessary in conjunction with the decommissioning of the units. The Company is maintaining full-core discharge capability for the Brunswick Units and Robinson Unit No. 2 by transferring spent nuclear fuel by rail to the Harris Plant. As a contingency to the shipment by rail of spent nuclear fuel, on April 27, 1989, the Company filed an application with the NRC for the issuance of a license to construct and operate an independent spent fuel storage facility for the dry storage of spent nuclear fuel at the Brunswick Plant. Due to the success of the Company's shipping efforts to date, however, the Company has requested that the NRC suspend review of the Company's license application pending notification by the Company of its desire to continue the application process. The Company cannot predict the outcome of this matter.\nAs required by the Nuclear Waste Act, the Company entered into a contract with the DOE under which the DOE agreed to dispose of the Company's spent nuclear fuel. The contract includes a provision requiring the Company to pay the DOE for disposal costs. Disposal costs of fuel burned are based upon actual nuclear generation and are paid on a quarterly basis. Effective January 31, 1992, the DOE revised the method for calculating the nuclear waste disposal cost, which reduced the Company's quarterly payment. Overpayments, with interest, were refunded in the form of credits over the period 1992 through 1994. Disposal costs, excluding waste disposal credits, are approximately $20 million annually based on the expected level of operations and the present disposal fee per kWh of nuclear generation, and are currently recovered through the Company's fuel adjustment clauses. See ITEM 1, \"Retail Rate Matters,\" paragraph 5. Disposal fees may be reviewed annually by the DOE and adjusted, if necessary. The Company cannot predict at this time whether the DOE will be able to perform its contract and provide interim storage or permanent disposal repositories for spent fuel and\/or high-level radioactive waste materials on a timely basis.\n3. LOW-LEVEL RADIOACTIVE WASTE. Disposal costs for low- level radioactive waste that results from normal operation of nuclear units have increased significantly in recent years and are expected to continue to rise. Pursuant to the Low-Level Radioactive Waste Policy Act of 1980, as amended in 1985, each state is responsible for disposal of low-level waste generated in that state. States that do not have existing sites may join in regional compacts. The States of North Carolina and South Carolina are participants in the Southeast regional compact and, currently, dispose of waste at an existing disposal site in South Carolina along with other members of the compact. The North Carolina Low- Level Radioactive Waste Management Authority, which is responsible for siting and operating a new low-level radioactive waste disposal facility for the Southeast regional compact, recently selected a preferred site in Wake County, North Carolina. Although the Company does not control the future availability of low-level waste disposal facilities, the cost of waste disposal or the development process, it is actively supporting the development of new facilities and is committed to a timely and cost-effective solution to low-level waste disposal. When shipments to the existing regional compact site cease on December 31, 1995, present projections indicate that existing on-site storage facilities at the Company's nuclear plants are sufficient to provide approximately one year of storage capacity. The Company cannot predict the outcome of this matter.\n4. DECOMMISSIONING.\na. Pursuant to a NRC rule, licensees of nuclear facilities are required to submit decommissioning funding plans to the NRC for approval to provide reasonable assurance that the licensee will have the financial ability to implement its decommissioning plan for each facility. The rule requires licensees to do one of the following: prepay at least a NRC-prescribed minimum amount immediately; set up an external sinking fund for accumulation of at least that minimum amount over the operating life of the facility; or provide a surety to guarantee financial performance in the event of the licensee's financial inability to perform actual decommissioning. On July 26, 1990, the Company submitted its decommissioning funding plans to the NRC. In this regard, the Company entered into a Master Decommissioning Trust Agreement dated July 19, 1990 (Trust), with Wachovia Bank of North Carolina, N.A., as Trustee, as a vehicle to achieve such decommissioning funding. In June 1991, the Company began depositing a portion of decommissioning expense into the Trust.\nWith regard to the Company's recovery through rates of nuclear decommissioning costs, in the Company's retail jurisdictions, provisions for nuclear decommissioning costs were approved by the NCUC and the SCPSC in the Company's 1988 general rate cases, and were based on site-specific estimates that included the costs for removal of all radioactive and other structures at the site. In the wholesale jurisdiction, the provisions for nuclear decommissioning costs are based on amounts agreed upon in applicable rate settlements. Decommissioning cost provisions, which are included in depreciation and amortization, were $29.5 million in 1994, $34.0 million in 1993 and $27.1 million in 1992. Accumulated decommissioning costs, which are included in accumulated depreciation, were $252.7 million at December 31, 1994, and $221.6 million at December 31, 1993, and include amounts retained internally and amounts funded in the Trust. The balance of the Trust, which is included in miscellaneous other property and investments, was $67.6 million at December 31, 1994, and $44.5 million at December 31, 1993. Trust earnings, which increase the trust balance with a corresponding increase in accumulated decommissioning, were $1.5 million in 1994, $1.2 million in 1993 and $.8 million in 1992. Based on the site-specific estimates discussed below and using an assumed after-tax earnings rate of 8.5% and an assumed cost escalation rate of 4%, current levels of rate recovery for nuclear decommissioning costs are adequate to provide for decommissioning of the Company's nuclear facilities.\nb. The Company's most recent site-specific estimates of decommissioning costs were developed in 1993 using 1993 cost factors, and are based on prompt dismantlement decommissioning, which reflects the cost of removal of all radioactive and other structures currently at the site, with such removal occurring shortly after operating license expiration. See paragraph 5 below for expiration dates of operating licenses. These estimates, in 1993 dollars, are as follows: $257.7 million for Robinson Unit No. 2; $235.4 million for Brunswick Unit No. 1; $221.4 million for Brunswick Unit No. 2; and $284.3 million for the Harris Plant. These estimates are subject to change based on a variety of factors, including, but not limited to, cost escalation, changes in technology applicable to nuclear decommissioning, and changes in federal, state or local regulations. The cost estimates exclude the portion attributable to Power Agency, which holds an undivided ownership interest in certain of the Company's generating facilities. To the extent of its ownership interests, Power Agency is responsible for satisfying the NRC's financial assurance requirements for decommissioning costs. See ITEM 1, \"Generating Capabilities,\" paragraph 1.\nc. The Financial Accounting Standards Board has added a project to its agenda regarding the electric utility industry's current accounting practices related to decommissioning costs. Any changes to these practices could affect such items as: 1) when the decommissioning obligation is recognized, 2) where balances of accumulated decommissioning costs are recorded, 3) where income earned on external decommissioning trust balances is recorded and 4) the levels of annual decommissioning cost provisions. The Financial Accounting Standards Board is in the early stages of this project, and consequently, it is uncertain what impacts, if any, this project may have on the Company's accounting for decommissioning costs.\n5. OPERATING LICENSES. Facility Operating Licenses, issued by the NRC, may be amended by the NRC to extend the expiration dates of an operating license of a nuclear facility to allow for up to 40 years of commercial operation. The current expiration dates for the Company's nuclear facilities allow for the entire 40 years of commercial operation and are set forth in the following table.\nFacility Operating License Facility Expiration Date ________ ___________________________\nRobinson Unit No. 2 July 31, 2010 Brunswick Unit No. 1 September 8, 2016 Brunswick Unit No. 2 December 27, 2014 Harris Plant October 24, 2026\n6. DESIGN BASIS RECONSTITUTION EFFORTS. The Company has been in the process of reviewing the design basis documentation for Robinson Unit No. 2 since 1988 and for the Brunswick Plant since 1990. Significantly more design detail has been required by the NRC for recently constructed plants than was needed when Robinson Unit No. 2 and the Brunswick Plant were built. In order to operate effectively in the current regulatory environment, the Company must be able to provide documentary evidence of compliance with regulations and design documents. The design basis reconstitution effort involves research, compilation and verification of documents that set forth the key design requirements of the various safety systems. The Company's review of the design basis documentation for Robinson Unit No. 2 was completed in 1993, and the Brunswick Plant effort was completed in 1994. This documentation will remain at the plants and will be provided to the NRC upon request.\n7. OTHER NUCLEAR MATTERS.\na. In 1991, the NRC issued a final rule on nuclear plant maintenance that will become effective on July 10, 1996. In general terms, the new maintenance rule prescribes the establishment of performance criteria for each safety system based on the significance of that system. The rule also requires monitoring of safety system performance against the established acceptance criteria, and provides that remedial action be taken when performance falls below the established criteria. The Company has been working closely with the Nuclear Energy Institute (formerly the Nuclear Management and Resources Council) and with other utilities to develop its compliance approach and to minimize the financial and operational impacts of the new rule. The Company anticipates its compliance will be on schedule and is evaluating the magnitude of the financial and operational impacts of this new rule. The Company cannot predict the outcome of this matter.\nb. On November 23, 1988, the NRC requested in Generic Letter 88-20 that utilities perform Individual Plant Examinations (IPEs) to determine potential vulnerabilities to severe accidents beyond the design basis accidents for which the plants are designed. These are considered to be very low probability events. The Company submitted the results of the first phase (for internally initiated events) in August 1992 for the Brunswick and Robinson Plants. Based on those results, potential enhancements for the Robinson Plant were evaluated and several enhancements were made to the Robinson Plant. These changes had insignificant financial and operational impacts. For the Brunswick Plant, no modifications were required to meet the guidelines of the IPE. On August 20, 1993, the Company submitted the results of the Harris Plant IPE. While some Harris Plant procedural changes were made due to the IPE results, the IPE did not reveal any significant financial or operational impacts or identify any need for plant modifications. The Company cannot predict at this time the exact magnitude of the financial and operational impact of the second phase of the IPE (for externally initiated events), which will be completed for all three plants and submitted to the NRC in 1995.\nc. In July 1993, cracks were discovered in the Brunswick Unit No. 1 reactor vessel shroud during inspections made as part of refueling activities performed during the Brunswick Plant outage that began in April 1992. The Company conducted intensive ultrasonic testing and physical sampling inspections of the cracks. The results of this investigation provided data used to develop new stiffening braces to ensure that the shroud will continue to perform its design function. Shroud modifications were completed in late December 1993. The Company commenced startup of Unit No. 1 on February 1, 1994, and Unit No. 1 was returned to normal operation on February 23, 1994, after successfully completing extensive startup testing. In July 1993, the Company also determined that the Brunswick Unit No. 2 shroud had minor crack indications which did not compromise the safety or operation of the Unit. Shroud modifications, similar to those performed on Unit No. 1, were successfully completed on Unit No. 2 during the spring 1994 refueling outage, and Unit No. 2 resumed generating electricity on June 30, 1994. Costs associated with the shroud modifications were not material to the results of operations of the Company.\nOn October 14, 1993, two private organizations, the National Whistleblower Center and the Coastal Alliance for a Safe Environment, and an individual filed a petition with the NRC under 10 C.F.R. Section 2.206 alleging that the Company was aware of the shroud cracks as early as 1984 and engaged in criminal activities to conceal its knowledge of the cracks. The petitioners requested that the NRC require the Company to state whether it knew about the cracks in 1984 and determine whether the Company has engaged in criminal wrongdoing. The petitioners failed to provide the NRC or the Company with any evidence substantiating their claims. Additionally, the Company conducted an internal technical review of this matter which did not reveal any evidence that substantiates the petitioners' claims. The results of this technical review were submitted to the NRC in November 1993. On October 19, 1994, the Director of the NRC's Office of Nuclear Reactor Regulation issued a decision which granted the petitioners' request for an NRC investigation, but concluded that no substantial health and safety issue remains that would warrant institution of further proceedings. The NRC Commissioners declined to review the decision. Thus, the decision became the NRC's final action on November 14, 1994. The petitioners did not file an appeal with the United States Court of Appeals by the February 13, 1995 deadline.\nd. On November 17, 1993, during startup from a scheduled refueling outage at the Company's H. B. Robinson Plant Unit No. 2, the Company discovered problems with the fuel supplier's fabrication of certain fuel assemblies which had been loaded during the outage. A problem relating to the calibration of the power level instrumentation was also identified. The Company elected to interrupt and delay the startup process pending analysis and correction of the problems, and notified the NRC of its decision. The NRC issued a Confirmatory Action letter, dated November 19, 1993, in which it confirmed, among other things, that the Company would conduct detailed root cause analyses of the fuel assembly and power level instrumentation issues and would take appropriate corrective actions. On November 20, 1993, a NRC Augmented Inspection Team (AIT) began its investigation of the fuel assembly and power level instrumentation issues. In investigating the fuel assembly issue, the AIT visited both the Robinson Plant and the fuel supplier's facilities. Results of the AIT's investigation were initially released in a public meeting on December 6, 1993 and the AIT's report was issued on January 5, 1994. In early February 1994, the Company satisfied the conditions of the NRC's November 19, 1993 Confirmatory Action letter, and returned Robinson Unit No. 2 to service on March 21, 1994 under a power ascension plan. An enforcement conference was conducted on March 14, 1994 for the purpose of discussing apparent violations identified in the AIT's report in the areas of management control of refueling and restart activities. On May 9, 1994, the NRC issued a Severity Level IV Notice of Violation (the next to the lowest severity level) concluding that this situation involved noncompliance with certain NRC requirements. The NRC did not propose a civil penalty in connection with this matter. In a letter to the NRC dated June 8, 1994, the Company acknowledged that the violations had occurred, clarified the events surrounding the occurrences, and described the corrective actions that had been taken to address the situation.\nIn a separate action, on March 14, 1994, the NRC issued a Notice of Violation and Proposed Imposition of Civil Penalty in the amount of $37,500 relating to the degradation of both Robinson Unit No. 2 emergency diesel generators and failure to correct conditions which affected operation of one of the diesel generators in mid-November 1993. The base civil penalty for this type of violation is $50,000, but the proposed penalty was reduced to $37,500 due to the Company's comprehensive performance in analyzing the root cause of the diesel generator problem. On April 13, 1994, the Company submitted a written response to the Notice of Violation and Proposed Imposition of Civil Penalty that the NRC issued in connection with the degradation of the Robinson Unit No. 2 diesel generators, and paid the assessed $37,500 civil penalty.\nOn February 8, 1994 the NRC issued its Systematic Assessment of Licensee Performance report for Robinson Unit No. 2 for the period June 1992 through December 1993. While the NRC noted that overall performance of Robinson Unit No. 2 was reasonably good, it indicated that performance had declined in several areas, primarily due to the matters discussed above. The NRC rated Robinson Unit No. 2's performance as \"good\" in operations, engineering and plant support and \"acceptable\" in maintenance.\nThe Company received a letter, dated May 6, 1994, from the NRC regarding an apparent violation of NRC requirements related to inattention to licensed duties which was identified at the Company's H. B. Robinson Plant. An enforcement conference between the Company and the NRC was held on May 16, 1994, to discuss this matter. On May 30, 1994, the NRC issued a Severity Level IV Notice of Violation to the Company in connection with this matter, but did not propose a civil penalty. In a letter to the NRC dated June 29, 1994, the Company acknowledged that the violation had occurred and described the corrective actions that had been taken to address the occurrence.\nThe NRC report regarding inspections conducted at the Robinson Plant during the period May 22 through June 24, 1994, identified certain activities, which occurred in January 1994 that might have violated certain NRC requirements. The activities related to the failure to take adequate corrective action on issues identified by a contractor, inadequate testing of ventilation equipment, and inadequate corrective actions on a design concern involving an isolation valve. An enforcement conference between the Company and the NRC was held on July 26, 1994 to determine whether a violation had occurred and if so, to assess the significance of the violation. By letter dated August 30, 1994, the NRC issued a Notice of Violation and Imposition of Civil Penalty in the amount of $75,000 involving the Company's testing of ventilation equipment at its H.B. Robinson Plant. The Notice also indicated that activities related to the adequacy of corrective action on issues identified by a contractor and the adequacy of corrective actions on a design concern involving an isolation valve constituted violations of NRC requirements; however, no civil penalty was assessed in connection with those violations. By letter dated September 29, 1994, the Company responded to the Notice of Violation and paid the assessed penalty.\nIn November 1994, the NRC proposed a $100,000 civil penalty for noncompliance with NRC requirements at the Robinson Plant. During a plant cooldown on February 26, 1994, the plant exceeded a technical specification limit. At one point during the process of the plant shutdown, the reactor's pressurizer was allowed to cool down at a rate that is higher than the specified maximum rate. After extensive analysis, the Company determined that the structural integrity of the pressurizer had not been negatively affected and neither had the useful life of any reactor component. The Company has implemented additional administrative controls to monitor the pressurizer throughout the cooldown process, and has conducted additional training to ensure proper monitoring. The NRC concurs with the corrective actions being taken by the Company. The Company paid the assessed penalty on December 22, 1994.\ne. The Company is insured against public liability for a nuclear incident up to $8.9 billion per occurrence, which is the maximum limit on public liability claims pursuant to the Price- Anderson Act. The $8.9 billion coverage includes $200 million primary coverage and $8.7 billion secondary financial protection through assessments on nuclear reactor owners. In the event that public liability claims from an insured nuclear incident exceed $200 million, the Company would be subject to a pro rata assessment, for each reactor it owns, of up to $75.5 million, plus a 5% surcharge, for each incident. Payment of such assessment would be made over time as necessary to limit the payment in any one year to no more than $10 million per reactor owned. Power Agency would be responsible for its ownership share of the assessment on jointly- owned units.\nFUEL ____\n1. SOURCES OF GENERATION. Total system generation (including Power Agency's share) by primary energy source, along with purchased power, for the years 1991 through 1995 is set forth below:\n1991 1992 1993 1994 1995 ____ ____ ____ ____ ____ (estimated)\nFossil 47% 56% 54% 43% 46% Nuclear 41 27 31 42 41 Purchased Power 10 15 13 13 11 Hydro 2 2 2 2 2\n2. COAL. The Company has intermediate and long-term agreements from which it expects to receive approximately 86% of its coal burn requirements in 1995. During 1993 and 1994, the Company obtained approximately 73% (7,198,000 tons), and 93% (8,120,220 tons), respectively, of its coal burn requirements from intermediate and long-term agreements. Over the next ten years, the Company expects to receive approximately 75% of its coal burn requirements from intermediate and long-term agreements. Existing agreements have expiration dates ranging from 1996 to 2006. During 1994, the Company maintained from 40 to 92 days' supply of coal, based on anticipated burn rate. All of the coal that the Company is currently purchasing under intermediate and long-term agreements is considered to be low sulfur coal by industry standards. Recent amendments to the Clean Air Act may result in increases in the price of low sulfur coal which continue beyond the effective date of the second phase of the Act. See ITEM 1, \"Environmental Matters,\" paragraph 2. The Company purchased approximately 2,650,000 tons of coal in the spot market during 1993 and 1,690,000 tons in 1994. The Company's contract coal purchase prices during 1994 ranged from approximately $23.19 to $40.63 per ton (F.O.B. mine adjusted to 12,000 Btu\/lb.). The average cost (including transportation costs) to the Company of coal delivered for the past five years is as follows:\nYear $\/Ton Cents\/Million BTU ____ _____ _________________\n1990 45.88 183 1991 47.40 190 1992 43.25 174 1993 43.10 172 1994 43.36 174\n3. OIL. The Company uses No. 2 oil primarily for its combustion turbine units, which are used for emergency backup and peaking purposes, and for boiler start-up and flame stabilization. The Company burned approximately 9.1 million and 12.6 million gallons of No. 2 oil during 1993 and 1994, respectively. The Company has a No. 2 oil supply contract for its normal requirements. In the event base-load capacity is unavailable during periods of high demand, the Company may increase the use of its combustion turbine units, thereby increasing No. 2 oil consumption. The Company intends to meet any additional requirements for No. 2 oil through additional contract purchases or purchases in the spot market. There can be no assurance that adequate supplies of No. 2 oil will be available to meet the Company's requirements. To reduce the Company's vulnerability to dislocations in the oil market, seven combustion turbine units with a total generating capacity of 364 MW have been converted to burn either propane or No. 2 oil. In addition, twelve combustion turbine units with a total generating capacity of 425 MW can burn natural gas when available. Over the last five years, No. 2 oil, natural gas and propane accounted for 1.8% of the Company's total burned fuel cost. In 1994, No. 2 oil, natural gas and propane accounted for 1.9% of the Company's total burned fuel cost. The availability and cost of fuel oil could be adversely affected by energy legislation enacted by Congress, disruption of oil or gas supplies, labor unrest and the production, pricing and embargo policies of foreign countries.\n4. NUCLEAR. The nuclear fuel cycle requires the mining and milling of uranium ore to provide uranium oxide concentrate (U3O8), the conversion of U3O8 to uranium hexafluoride (UF6), the enrichment of the UF6 and the fabrication of the enriched uranium into fuel assemblies. Existing contracts are expected to supply the necessary nuclear fuel to operate Robinson Unit No. 2 through 1995, Brunswick Unit No. 1 through 1995, Brunswick Unit No. 2 through 1995, and the Harris Plant through 1996. The Company currently has contracts for the ongoing procurement of raw materials and services for its nuclear units through the years shown below:\nRaw Materials And Services ___________________________________________________ Unit Uranium Conversion Enrichment Fabrication ____ _______ __________ __________ ___________\nRobinson No. 2 1995 1995 2000 2000 Brunswick No. 1 1995 1995 2000 1998 Brunswick No. 2 1995 1995 2000 1998 Harris Plant 1996 1995 2000 1999\nThe Company expects to meet its U3O8 requirements through the years shown above from inventory on hand and amounts received under contract. Although the Company cannot predict the future availability of uranium and nuclear fuel services, the Company does not currently expect to have difficulty obtaining U3O8 and the services necessary for its conversion, enrichment and fabrication into nuclear fuel for years later than those shown above. For a discussion of the Company's plans with respect to spent fuel storage, see ITEM 1, \"Nuclear Matters,\" paragraph 2.\n5. DOE ENRICHMENT FACILITIES DECONTAMINATION AND DECOMMISSIONING FUND. Under Title XI of the Energy Policy Act of 1992, Public Law 102-486, Congress established a decontamination and decommissioning fund for the DOE's gaseous diffusion enrichment plants. Contributions to this fund will be made by U.S. domestic utilities who have purchased enrichment services from DOE since it began sales to non-Department of Defense customers. Each utility's share of the contributions will be based on that utility's past purchases of services as a percentage of all purchases of services by U.S. utilities, with total annual contributions capped at $150 million per year, indexed to inflation, and an overall cap of $2.25 billion over 15 years, also indexed to inflation. At December 31, 1994, the Company had recorded a liability of $67.4 million representing its estimated share of the contributions and is recovering this expense as a component of fuel cost.\n6. PURCHASED POWER. In 1994 the Company purchased 6,710,346 MWh or approximately 13% of its energy requirements and had available 2,840 MW of firm purchased capacity under contract at the time of peak load. The Company may acquire purchased power capacity in the future to accommodate a portion of its system load needs.\nOTHER MATTERS _____________\n1. SAFETY INSPECTION REPORTS. On April 3, 1990, the FERC sent a letter to the Company providing comments on its review of the Company's Fifth (1987) Independent Consultant's Safety Inspection Report (required every five years under FERC Regulation 18 CFR Part 12) for the Walters Hydroelectric Project and requesting the Company to undertake certain supplemental analyses and investigations regarding the stability of the dam under extreme and improbable loading conditions. Similar letters were sent by the FERC on May 30, 1990, with respect to the Company's Blewett and Tillery Hydroelectric Plants. With the independent consultant, the Company has begun addressing the issues raised by the FERC and is working with the FERC to complete investigations and analyses with respect to each of these matters. On November 30, 1994, the Company submitted the independent consultant's report to the FERC regarding the stability of the dam at the Walters Project. The independent consultant concluded that the Walters dam has adequate structural stability and reserve capacity to resist both usual and unusual loading conditions without failure and that structural remediation is neither warranted nor recommended. While the Company does not believe that there are any stability concerns that would be cause for any imminent safety concerns, the FERC's review and analysis of the consultant's report are pending. The consultant's final reports regarding the Blewett and Tillery Hydroelectric Plants are not yet completed. Depending on the outcome of these matters, the Company could be required to undertake efforts to enhance the stability of the dams. The cost and need for such efforts have not been determined. The Company cannot predict the outcome of these matters.\n2. MARSHALL HYDROELECTRIC PROJECT. On November 21, 1991, the FERC notified the Company that the 5 MW Marshall Hydroelectric Project is no longer exempt from 18 CFR Part 12, Subparts C and D, dam safety regulations and that the plant's regulatory jurisdiction was being transferred from the NCUC to the FERC. This change resulted from updated dambreak flood studies which identified the potential impact on new downstream development, thus indicating the need to reclassify the project from a \"low\" to a \"high\" hazard classification. In accordance with the change in regulatory jurisdiction, the Company developed an emergency action plan which meets FERC regulations and guidelines and engaged its independent consultant to perform a safety inspection. On April 6, 1992, the consultant's safety inspection report was submitted to the FERC for approval. Depending on the outcome of FERC's review of the safety inspection report, the Company could be required to undertake efforts to enhance the stability of the Marshall dam and\/or powerhouse. The cost and need for such efforts have not been determined. The Company cannot predict the outcome of this matter.\n3. STONE CONTAINER DISPUTE. On April 20, 1994, the Company filed a Complaint with the FERC (Docket No. EL-94-62-000 and QF85- 102-005) and in the United States District Court for the Eastern District of North Carolina in Raleigh, North Carolina (Civil Action No. 5:94-CV-285-DI) claiming that the rate the Company pays for power it purchases from Stone Container Corporation (Stone Container) is invalid. The Company entered into a twenty-year purchase power agreement with Stone Container in 1984, and in 1987 began receiving power from a cogeneration facility operated by Stone Container in Florence, South Carolina. It is the Company's position that when Stone Container elected to sell the facility's gross output under a \"buy all\/sell all\" option in 1991, the facility lost its status as a \"qualified facility\" under PURPA and became a public utility. As a result, the contract rate the Company pays for power purchased from the facility is no longer valid, and a just and reasonable rate should be established by the FERC under the Federal Power Act. The Company will continue to purchase electricity from Stone Container at the current contract rate pending the outcome of this litigation. The Company cannot predict the outcome of this matter.\n4. TAX REFUND DISPUTE. On April 28, 1994, the Company filed a Complaint against the U.S. Government in the United States District Court for the Eastern District of North Carolina in Raleigh, North Carolina (Civil Action No. 5:94-CV-313-BR3) seeking a refund of approximately $188 million representing tax and interest related to depreciation deductions the Internal Revenue Service (IRS) previously disallowed for the years 1986 and 1987 on the Company's Harris Plant. The Company maintains that under applicable laws and regulations the Harris Plant was ready and available for operation in 1986. The IRS has previously denied some of the depreciation deductions on the Company's tax returns for the years in question on the ground that in its view the plant was not placed in service until 1987. The Company cannot predict the outcome of this matter.\n5. WOLF CREEK COAL DISPUTE. On November 4, 1994, the Company filed a complaint against SMC Mining Company, Wolf Creek Collieries Company and Kermit Coal Company (collectively, the Sellers) in the United States District Court for the Eastern District of North Carolina in Raleigh, North Carolina (Civil Action No. 5:94-CV-846-BO(2)). The Sellers are all companies owned by Ziegler Coal Holding Company (Ziegler). Under the terms of a 1971 contract, as amended, the Sellers are to supply the Company with coal having certain qualities and characteristics from the Wolf Creek mine (Wolf Creek) in Kentucky. The contract provides that the Company has the right to refuse to accept further deliveries from the Sellers if the coal they ship fails to meet the specification for sulfur content for two consecutive months. During the months of August and September 1994, the Sellers shipped to the Company Wolf Creek coal that did not meet the sulfur specifications provided in the contract. As a result of the Sellers' shipment of non-complying coal, on November 4, 1994, the Company exercised its right to suspend future shipments of coal from Wolf Creek until the Sellers can give the Company reasonable assurance that future shipments will meet the contract's specifications. The Complaint asks the court to determine whether the dispute is subject to arbitration and that the Company's suspension of future shipments from the Sellers was legal. On November 4, 1994, the Sellers filed a Complaint against the Company in the Circuit Court of Martin County, Kentucky (Civil Action No. 94-CZ-00212), asking the court to restrain the Company from refusing to accept future shipments of coal under the 1971 contract. On November 4, 1994, the court issued an ex parte temporary restraining order (TRO) which prevents the Company, for the time being, from refusing contract coal deliveries from Wolf Creek. The Company removed the Kentucky state court action to the United States District Court for the Eastern District of Kentucky. On November 9, 1994 the Company filed in the Kentucky federal court a response to the state court's TRO. The response sought to dissolve the TRO, which would allow the Company to refuse coal shipments from Wolf Creek until the dispute is settled. In its response, the Company also moved for transfer of the case to the United States District Court for the Eastern District of North Carolina, which was subsequently granted. On December 1, 1994, a federal District Court judge in Raleigh signed a consent order establishing a three member panel to arbitrate the dispute. The consent order provides that in the interim, Ziegler will ship only coal that complies with the quality specifications as the Company interprets the contract. The Company will receive a price adjustment on the coal purchases if its view of the contract is upheld. The arbitration, currently scheduled to begin in late March 1995 and conclude by the end of April 1995, will resolve the issues of suspension and compliance with contractual quality standards. The arbitration will also address other issues raised by the Company, including two requests for adequate assurance of performance under N.C. Gen. Stat. Section 25-2-609. The Company requested in October 1994 that Sellers provide assurance that they were (1) not sending the Company coal from sources (or mines) outside those specified in the contract and (2) that it had adequate reserves to meet its supply obligations under the contract. Whatever the outcome of this dispute, the Company anticipates no problems in ensuring sufficient coal supplies for its plants. The Company cannot predict the outcome of this matter.\n6. CARONET, INC. On November 29, 1994, the Company established a wholly-owned subsidiary, CaroNet, Inc., and the subsidiary joined a regional partnership led by BellSouth Personal Communications, Inc. (BellSouth). On March 14, 1995 BellSouth won its bid for a Federal Communications Commission (FCC) license for the partnership to operate a Personal Communications Services (PCS) system covering most of North Carolina and South Carolina, as well as a small portion of Georgia. PCS, a wireless communications technology, is expected to provide high-quality mobile communications. Wireless technology could also support automated meter reading, automated service connection and disconnection, and control and monitoring of certain aspects of the Company's electric transmission and distribution systems. BellSouth will transfer the PCS license to the partnership. BellSouth will be general partner and handle day-to-day management of the business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES _______ __________\nIn addition to the major generating facilities listed in ITEM ____ 1, \"Generating Capability,\" the Company also operates the following plants:\nPlant Location _____ ________\n1. Walters North Carolina 2. Marshall North Carolina 3. Tillery North Carolina 4. Blewett North Carolina 5. Darlington South Carolina 6. Weatherspoon North Carolina 7. Morehead City North Carolina\nThe Company's sixteen power plants represent a flexible mix of fossil, nuclear and hydroelectric resources, with a total generating capacity of 9,613 MW. The Company's strategic geographic location facilitates purchases and sales of power with many other electric utilities, allowing the Company to serve its customers more economically and reliably. Major industries in the Company's service area include textiles, chemicals, metals, paper, automotive components and electronic machinery and equipment.\nAt December 31, 1994, the Company had 5,822 pole miles of transmission lines including 292 miles of 500 kV and 2,790 miles of 230 kV lines, and distribution lines of approximately 39,907 pole miles of overhead lines and approximately 7,557 miles of underground lines. Distribution and transmission substations in service had a transformer capacity of approximately 35,250 kVA in 2,270 transformers. Distribution line transformers numbered 391,474 with an aggregate 15,744,200 kVA capacity.\nPower Agency has acquired undivided ownership interests of 18.33% in Brunswick Unit Nos. 1 and 2, 12.94% in Roxboro Unit No. 4 and 16.17% in Harris Unit No. 1 and Mayo Unit No. 1. Otherwise, the Company has good and marketable title, subject to the lien of its Mortgage and Deed of Trust, with minor exceptions, restrictions and reservations in conveyances and defects, which are of the nature ordinarily found in properties of similar character and magnitude, to its principal plants and important units, except certain right- of-way easements over private property on which transmission and distribution lines are located.\nThe Company believes that its generating facilities are suitable, adequate, well-maintained and in good operating condition.\nPlant Accounts (including nuclear fuel) - _______________________________________\nDuring the period January 1, 1990 through December 31, 1994, there was added to the Company's utility plant accounts $1,779,168,000, there was retired $476,328,000 of property and there were transfers to other accounts and adjustments for a net decrease of $319,690,000 resulting in net additions during the period of $983,149,000 or an increase of approximately 11.23%.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS _______ _________________\nLegal and regulatory proceedings are included in the discussion of the Company's business in ITEM 1 and incorporated by reference herein.\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 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT ____________________________________\nName Age Recent Business Experience ____ ___ __________________________\nSherwood H. Smith, Jr. 60 CHAIRMAN AND CHIEF EXECUTIVE OFFICER, September 1992 to present; Chairman\/ President and Chief Executive Officer, May 1980 to September 1992. Member of the Board of Directors of the Company since 1971.\nWilliam Cavanaugh III 56 PRESIDENT AND CHIEF OPERATING OFFICER, September 1992 to present; Group President - Energy Supply, Entergy Corporation, July, 1992; Chairman, Chief Executive Officer and Director, System Energy Resources, Inc., April 1992; Chairman and Chief Executive Officer, Entergy Operations, Inc., April 1992; Senior Vice President, System Executive - Nuclear, Entergy Corporation and Entergy Services, Inc., 1987-August 1992; Executive Vice President and Chief Nuclear Officer, Arkansas Power & Light Company and Louisiana Power & Light Company, January 1990-August 1992; President and Chief Executive Officer, System Energy Resources, Inc., 1986- August 1992; President and Chief Executive Officer, Entergy Operations, Inc., June 1990-April 1992. Member of Board of Directors of Arkansas Power & Light Company and Louisiana Power & Light Company, January 1990-August 1992; Member of Board of Directors of System Fuels, Inc., 1992-August 1992; Member of Board of Directors of System Energy Resources, Inc., 1986-August 1992; Member of Board of Directors of Entergy Operations, Inc., 1990-August 1992; Member of Board of Directors of Entergy Services, Inc., 1987-August 1992. Before joining the Company, Mr. Cavanaugh held various senior management and executive positions during a 23-year career with Entergy Corporation, an electric utility holding company with operations in Arkansas, Louisiana and Mississippi. Member of the Board of Directors of the Company since 1993.\nCharles D. Barham, Jr. 64 EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER - Finance and Administration, November 1990 to present; Senior Vice President - Legal, Planning and Regulatory Group, July 1987; Senior Vice President and General Counsel - Legal and Regulatory Group, May 1982. Member of the Board of Directors of the Company since 1990.\nLynn E. Eury 58 EXECUTIVE VICE PRESIDENT - Power Supply, April 1989 to July 1994 (retired); Senior Vice President - Operations Support, June 1986; Senior Vice President - Fossil Generation and Power Transmission Group, August 1983.\nWilliam S. Orser 50 EXECUTIVE VICE PRESIDENT - Nuclear Generation, April 1993 to present; Executive Vice President - Nuclear Generation, Detroit Edison Company, 1992-April 1993; Senior Vice President - Nuclear Generation, Detroit Edison Company, 1990-1992; Vice President - Nuclear Operations, Detroit Edison Company, 1987-1990. Prior to 1987, Mr. Orser held various other positions with Detroit Edison, and with Portland General Electric Company, Southern California Edison, and the U. S. Navy.\nJames M. Davis, Jr. 58 SENIOR VICE PRESIDENT, Group Executive - Power Operations, June 1986 to present; Senior Vice President - Operations Support Group, August 1983.\nNorris L. Edge 63 SENIOR VICE PRESIDENT, Group Executive - Customer and Operating Services, May 1990 to present; Vice President - Rates and Energy Services, September 1989; Vice President - Rates and Service Practices, December 1980.\nCecil L. Goodnight 52 SENIOR VICE PRESIDENT, Human Resources and Support Services, March 1995- present; Vice President - Human Resources (formerly Employee Relations Department), May 1983 to March 1995.\nGlenn E. Harder 43 SENIOR VICE PRESIDENT, Group Executive - Financial Services, October 1994 to present; Vice President - Financial Strategies and Treasurer, Entergy Corporation, September 1991 to October 1994; Vice President -Administrative Services & Regulatory Affairs, Entergy Operations, Inc., May 1991 to August 1991; Vice President, Accounting and Treasurer, System Energy Resources, Inc., October 1986 to May 1991. Before joining the Company, Mr. Harder held various senior management and executive positions with Entergy Corporation, an electric utility holding company with operations in Arkansas, Louisiana and Mississippi, and related entities.\nRichard E. Jones 57 SENIOR VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY, Group Executive - Legal, Rates, Communications, Community Relations and Public Affairs, January 1993 to present; Group Executive - Legal and Regulatory Services, November 1990 to January 1993; Vice President, General Counsel and Secretary, November 1989; Vice President and General Counsel, July 1987; Vice President, Senior Counsel and Manager - Legal Department, May 1982.\nPaul S. Bradshaw 57 VICE PRESIDENT AND CONTROLLER, March 1980 to present.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS _______ _____________________________________________________\nThe Company's Common Stock is listed on the New York and Pacific Stock Exchanges. The high and low sales prices per share, as reported as composite transactions in The Wall Street Journal, _______________________ and dividends paid are as follows:\n1993 High Low Dividends Paid ____ ____ ___ ______________\nFirst Quarter $ 32 7\/8 $ 27 1\/16 $ .410 Second Quarter 34 31 1\/4 .410 Third Quarter 34 1\/2 32 1\/8 .410 Fourth Quarter 33 3\/8 28 1\/8 .410\n1994 High Low Dividends Paid ____ ____ ___ ______________\nFirst Quarter $ 29 3\/4 $ 25 5\/8 $ .425 Second Quarter 26 5\/8 22 7\/8 .425 Third Quarter 27 22 3\/4 .425 Fourth Quarter 27 3\/4 25 1\/4 .425\nThe December 31 closing price of the Company's Common Stock was $30 1\/8 in 1993 and $26 5\/8 in 1994.\nAs of February 28, 1995, the Company had 69,748 holders of record of Common Stock.\nOn July 13, 1994, the Board of Directors of the Company (Board) authorized the Executive Committee of the Board to repurchase up to 10 million shares of the Company's Common Stock on the open market. Under this stock repurchase program, the Company had purchased approximately 4.4 million shares through December 31, 1994.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS _______ _________________________________________________\nRESULTS OF OPERATIONS _____________________\nRevenues ________\nUnusually mild weather in 1994 contributed significantly to a decrease in revenues as compared to 1993. This weather-related decrease totaled $86 million. Additionally, in 1994 the Company completed recovery of the portion of abandoned plant costs collected under a special rider resulting from the 1990 North Carolina Utilities Commission (NCUC) Order on Remand. This reduced 1994 revenues by $28 million, but did not significantly impact net income due to a corresponding decrease in amortization expense. Partially offsetting these decreases was an increase in revenue of $101 million due to customer growth and changes in customer usage patterns.\nThe increase in revenues in 1993 is primarily the result of an increase in energy sales of 6.2%. The effects of weather did not significantly impact revenues from 1992 to 1993. Revenues did not increase from 1992 to 1993 proportionately with energy sales due to a decline in the fuel factors included in rates and due to lower demand-related charges for certain customer classes.\nOperating Expenses __________________\nFuel for generation decreased in 1994 primarily due to a change in the generation mix. Nuclear generation, as a percentage of total generation, increased to 46%, from 34%, and higher-cost fossil generation decreased to 52%, from 64%, due to greater availability of the Company's nuclear generating facilities. In 1993, an 8% increase in total generation, offset somewhat by a decrease in the cost of fossil fuel and by increased use of nuclear generation, resulted in a slight increase in fuel for generation.\nDeferred fuel reflects fuel costs or recoveries that are deferred through fuel clauses required by the Company's regulators. These clauses allow the Company to recover fuel costs and fuel-related purchased power costs through the fuel component of customer rates. Any difference between actual costs incurred and the fuel component collected in customer billings is reflected in operating expenses as deferred fuel. As a result, except for fuel settlements such as those discussed below, net income is not impacted significantly by fluctuations in fuel costs.\nIn 1994, the Company reached settlement agreements with regulators in the North Carolina and South Carolina retail jurisdictions and agreed to forgo recovery of $8 million of deferred fuel costs. In 1993, the Company agreed to forgo recovery of $41.1 million of deferred fuel costs related to the Brunswick Plant's extended outage in 1992 and 1993. The net effect of these agreements resulted in a decrease of $33.1 million in deferred fuel cost from 1993 to 1994. Excluding the effect of these settlements, deferred fuel costs increased from 1993 to 1994 due to lower fuel costs associated with increased nuclear generation and due to the recovery of prior fuel costs as allowed by the North Carolina fuel adjustment statute. From 1992 to 1993, excluding the effect of the 1993 settlements, deferred fuel costs increased due to lower fuel costs.\nThe increase in purchased power from 1992 to 1994 is primarily attributable to an agreement under which the Company began purchasing 400 megawatts of generating capacity from Duke Power Company in July 1993. Purchases under this agreement accounted for an increase in purchased power of $26 million in 1994 and $37 million in 1993. In addition, purchases from North Carolina Eastern Municipal Power Agency (Power Agency) increased $8 million in 1994 and $14 million in 1993, primarily due to the increased buyback provisions of the Company's 1993 agreement with Power Agency (see Other Business). A substantial portion of the increase in purchased power is capacity cost and, therefore, not recoverable through the Company's fuel clauses.\nThe increase in other operating expenses from 1993 to 1994 is due to increases in various cost categories such as benefits, salaries and demand-side management programs. Partially offsetting these increases was a 1994 adjustment of $23 million to reduce the Company's nuclear insurance reserves. Other operating expenses increased from 1992 to 1993 due to 1) the Brunswick Plant outage in 1992 and 1993, 2) the recognition of increased expense for postretirement benefits other than pensions due to new accounting requirements and 3) 1992 adjustments that were made to certain accrual and asset balances as a result of more current information at that time. Excluding the effect of the 1994 insurance reserve adjustment, the Company's business plan for the period through 1997 does not project an increase in other operating expenses.\nMaintenance expense decreased from 1992 to 1994 primarily due to a decrease in costs associated with the Brunswick Plant's outage in 1992 and 1993. Additionally, maintenance expense decreased in 1993 due to the capitalization of costs associated with plant modifications as compared to the prior year.\nThe decrease in depreciation and amortization from 1993 to 1994 is primarily attributable to the completion of the amortization of abandoned plant costs for Harris Unit No. 2 and of costs associated with the 1990 NCUC Order on Remand; these decreases in amortization totaled $25 million. In 1993, the Company began amortizing costs associated with two significant software projects, which contributed to a portion of the increase in depreciation and amortization from 1992 to 1993.\nThe fluctuation in Harris Plant deferred costs from 1992 to 1993 is primarily due to an adjustment made in 1992 in order to better match these costs with the associated revenue recovery. This adjustment decreased 1992 operating expenses by $13.4 million, net of tax. Contributing to the increase in 1993 were adjustments related to the settlement between North Carolina Electric Membership Corporation (NCEMC) and the Company (see Other Business).\nOther Income ____________\nThe fluctuation in Harris Plant carrying costs from 1992 to 1994 is primarily related to the Company's settlement with NCEMC, which was recorded in 1993 and increased carrying costs in that year.\nThe Harris Plant disallowance - Power Agency line item reflects a write-off recorded as a result of the 1993 settlement with Power Agency (see Other Business).\nBeginning in 1994, the Company is no longer recording interest income related to the Company's qualified employee stock ownership plan (ESOP) loan (see New Accounting Standard). Interest income also decreased in 1994 due to the Company's 1993 settlement with Westinghouse Electric Corporation (Westinghouse), which increased interest income in 1993 (see Other Business). Partially offsetting these decreases was an increase for interest income related to certain IRS audit issues. The increase in interest income from 1992 to 1993 is primarily due to the Westinghouse settlement.\nOther income, net, decreased in 1994 primarily due to a change in accounting for ESOPs.\nInterest Charges ________________\nInterest charges on long-term debt decreased from 1992 to 1994 due to long-term debt refinancings that allowed the Company to take advantage of lower interest rates. In addition, for 1993 as compared to 1992, interest rates on the Company's variable rate debt were lower.\nLIQUIDITY AND CAPITAL RESOURCES _______________________________\nCapital Requirements ____________________\nEstimated capital requirements for the period 1995 through 1997 primarily reflect construction expenditures that will be made to add generating facilities, to upgrade existing generating facilities and to add transmission and distribution facilities to meet customer growth. The Company's capital requirements for those years are reflected below (in millions).\n1995 1996 1997 ____ ____ ____\nConstruction expenditures $358 $445 $527 Nuclear fuel expenditures 99 77 71 AFUDC (19) (25) (34) Mandatory redemptions of long-term debt 275 105 100 ____ ____ ____ Total $713 $602 $664 ==== ==== ====\nThe table above includes Clean Air Act requirement expenditures of approximately $117 million and generating facility addition expenditures of approximately $287 million for the period 1995 through 1997. The generating facility addition expenditures will primarily be used to construct new combustion turbine units, which are intended for use during periods of high demand. The units are scheduled to be placed in service in 1997 through 2000.\nThe 1990 amendments to the Clean Air Act (Act) require substantial reductions in sulfur dioxide and nitrogen oxides emissions from fossil-fueled electric generating plants. The Company was not required to take action to comply with the Act's Phase I requirements, which had to be met by January 1, 1995. Phase II of the Act, which contains more stringent provisions, will become effective January 1, 2000. To reduce sulfur dioxide emissions as required by Phase II, the Company will modify equipment to allow certain of its plants to burn lower-sulfur coal, and the Company is planning for the installation of scrubbers. Installation of additional equipment will also be necessary to reduce nitrogen oxides emissions. The Company anticipates that it will be able to delay the installation and operation of scrubbers until 2007 by utilizing lower-sulfur coal and sulfur dioxide emission allowances. Each sulfur dioxide emission allowance issued by the Environmental Protection Agency (EPA) will allow a utility to emit one ton of sulfur dioxide. The Company has purchased emission allowances under the EPA's emission allowance trading program.\nThe Company estimates that the total capital cost to comply with Phase II of the Act will approximate $273 million during the period 1995 through 1999 and an additional $272 million during the period 2000 through 2007. These estimates, for installation or modification of equipment, are in nominal dollars (undiscounted future amounts expected to be expended). The required modifications and additions are expected to increase operating and maintenance costs by a total of $18 million for the period 1995 through 1999, $35 million for the period 2000 through 2006 and by $24 million annually beginning in 2007. Additionally, fuel costs are expected to increase by a total of approximately $277 million for the period 2000 through 2006 and by approximately $62 million annually beginning in 2007. The Company expects these increased fuel costs to be recoverable through the Company's fuel clauses. Actual plans for compliance with the Act's requirements have not been finalized and the amount required for capital expenditures and for increased operating, maintenance and fuel expenditures cannot be determined with certainty at this time. The NCUC and the South Carolina Public Service Commission (SCPSC) are allowing the Company to accrue carrying charges on its investment in emission allowances.\nThe Company has two long-term agreements for the purchase of power from other utilities. The first agreement provides for the purchase of 250 megawatts of capacity from Indiana Michigan Power Company's Rockport Unit No.2. The estimated minimum annual payment for these power purchases is approximately $30 million, which represents capital-related capacity costs. Other costs include demand-related production expenses, fuel and energy-related operation and maintenance expenses. In 1994, purchases under this agreement totaled $61.9 million, including transmission use charges. The agreement expires in 2009. The second agreement is with Duke Power Company for the purchase of 400 megawatts of firm capacity through mid-1999. The estimated minimum annual payment for these power purchases is approximately $43 million, which represents capital-related capacity costs. Other costs include fuel and energy-related operation and maintenance expenses. Purchases under this agreement, including transmission use charges, totaled $62.9 million in 1994. The agreement with Duke Power Company was recently approved by the Federal Energy Regulatory Commission (FERC).\nIn addition, the Company is obligated to purchase a percentage of Power Agency's ownership capacity of and energy from the Mayo Plant and the Harris Plant through 1997 and 2007, respectively. The estimated minimum annual payments for these purchases, which reflect capital-related capacity costs, total approximately $27 million. Other costs of such purchases are primarily demand-related production expenses, fuel and energy-related operation and maintenance expenses. Purchases under the agreement with Power Agency totaled $60.4 million in 1994.\nCash Flow and Financing _______________________\nNet cash used in investing activities primarily consists of capital expenditures, which include replacement or expansion of existing facilities and construction to comply with pollution control laws and regulations. Capital expenditures in 1994 were lower than in 1993 primarily due to work performed at the Brunswick Plant in 1993.\nDuring 1994, the Company issued $322.6 million in long-term debt. The proceeds of these issuances were primarily used to redeem or retire $267.4 million of long-term debt. External funding requirements, which do not include early redemptions of long-term debt or redemptions of preferred stock, are expected to approximate $417 million in 1995 and $120 million in 1997. These funds will be required for construction, mandatory redemptions of long-term debt and general corporate purposes, including the repayment of short-term debt. The Company does not expect to have external funding requirements in 1996.\nIn 1994, the Board of Directors of the Company authorized the Executive Committee of the Board to repurchase up to 10 million shares of the Company's common stock on the open market. Under this stock repurchase program, the Company has purchased approximately 4.4 million shares through December 31, 1994.\nThe Company has on file with the Securities and Exchange Commission (SEC) a shelf registration statement enabling the Company to issue an aggregate of $450 million principal amount of first mortgage bonds, and an additional $250 million combined aggregate principal amount of first mortgage bonds and\/or unsecured debt securities of the Company.\nThe Company's ability to issue first mortgage bonds and preferred stock is subject to earnings and other tests as stated in certain provisions of its mortgage, as supplemented, and charter. The Company has the ability to issue an additional $3.4 billion in first mortgage bonds and an additional 14 million shares of preferred stock at an assumed price of $100 per share and a $8.63 annual dividend rate. The Company also has ten million authorized preference stock shares available for issuance that are not subject to an earnings test.\nThe Company's access to outside capital depends on its ability to maintain its credit ratings. The Company's first mortgage bonds are currently rated A2 by Moody's Investors Service, A by Standard & Poors and A+ by Duff & Phelps. In order to provide flexibility in the timing and amounts of long-term financing, the Company uses short-term financing in the form of commercial paper backed by revolving credit agreements. These revolving credit agreements total $307.9 million. The Company had $68.1 million of commercial paper outstanding at December 31, 1994, which Standard & Poors and Moody's Investors Service have rated A-1 and P-1, respectively.\nThe amount and timing of future sales of Company securities will depend upon market conditions and the specific needs of the Company. The Company may from time to time sell securities beyond the amount needed to meet capital requirements in order to allow for the early redemption of outstanding issues of long-term debt, the redemption of preferred stock, the reduction of short-term debt or for other corporate purposes.\nOTHER MATTERS _____________\nEnvironmental _____________\nThe Company is subject to federal, state and local regulations addressing air and water quality, hazardous and solid waste management and other environmental matters.\nVarious organic materials associated with the production of manufactured gas, generally referred to as coal tar, are regulated under various federal and state laws, and a liability may exist for their remediation. There are several manufactured gas plant (MGP) sites to which the Company and certain entities that were later merged into the Company may have had some connection. In this regard, the Company, along with other entities alleged to be former owners and operators of MGP sites in North Carolina, is participating in a cooperative effort with the North Carolina Department of Environment, Health and Natural Resources, Division of Solid Waste Management (DSWM) to establish a uniform framework for addressing those sites. It is anticipated that the investigation and remediation of specific MGP sites will be addressed pursuant to one or more Administrative Orders on Consent between DSWM and individual potentially responsible parties. To date, the Company has not entered into any such orders.\nThe Company has recently been approached by another North Carolina public utility concerning a possible cost-sharing arrangement with respect to the investigation and, if necessary, the remediation of four MGP sites. The Company is currently engaged in discussions with the other utility regarding this matter.\nIn addition, a current owner of property that was the site of one MGP owned by Tide Water Power Company (Tide Water Power), which merged into the Company in 1952, and the Company have entered into an agreement to share the cost of investigation and, if necessary, remediation of this site. The Company has also been approached by a North Carolina municipality that is the current owner of another MGP site that was formerly owned by Tide Water Power. The Company is engaged in discussions with that municipality concerning a possible cost-sharing arrangement with respect to the investigation and, if necessary, the remediation of that site.\nThe Company is continuing its investigation regarding the identities of parties connected to several additional MGP sites, the relative relationships of the Company and other parties to those sites and the degree, if any, to which the Company should undertake shared voluntary efforts with others at individual sites.\nThe Company has been notified by regulators of its involvement or potential involvement in several sites, other than MGP sites, that require remedial action. Although the Company cannot predict the outcome of these matters, it does not anticipate significant costs associated with these sites.\nIn 1994, the Company accrued a liability for the estimated costs associated with investigation and remediation activities for certain MGP sites and for sites other than MGP sites. This accrual was not material to the results of operations of the Company. Due to the lack of information with respect to the operation of MGP sites for which a liability has not been accrued and due to the uncertainty concerning questions of liability and potential environmental harm, the extent and cost of required remedial action, if any, are not currently determinable. The Company cannot predict the outcome of these matters or the extent to which other MGP sites may become the subject of inquiry.\nNuclear _______\nIn the Company's retail jurisdictions, provisions for nuclear decommissioning costs were approved by the NCUC and the SCPSC in the Company's 1988 general rate cases and were based on site-specific estimates that included the costs for removal of all radioactive and other structures at the site. In the wholesale jurisdiction, the provisions for nuclear decommissioning costs are based on amounts agreed upon in applicable rate settlements. Based on the site-specific estimates discussed below, and using an assumed after-tax earnings rate of 8.5% and an assumed cost escalation rate of 4%, current levels of rate recovery for nuclear decommissioning costs are adequate to provide for decommissioning of the Company's nuclear facilities.\nThe Company's most recent site-specific estimates of decommissioning costs were developed in 1993, using 1993 cost factors, and are based on prompt dismantlement decommissioning, which reflects the cost of removal of all radioactive and other structures currently at the site, with such removal occurring shortly after operating license expiration. These estimates, in 1993 dollars, are $257.7 million for Robinson Unit No. 2, $235.4 million for Brunswick Unit No. 1, $221.4 million for Brunswick Unit No. 2 and $284.3 million for the Harris Plant. The estimates are subject to change based on a variety of factors including, but not limited to, cost escalation, changes in technology applicable to nuclear decommissioning, and changes in federal, state or local regulations. The cost estimates exclude the portion attributable to Power Agency, which holds an undivided ownership interest in certain of the Company's generating facilities. Operating licenses for the Company's nuclear units expire in the year 2010 for Robinson Unit No. 2, 2016 for Brunswick Unit No. 1, 2014 for Brunswick Unit No. 2 and 2026 for the Harris Plant.\nThe Financial Accounting Standards Board has added a project to its agenda regarding the electric utility industry's current accounting practices related to decommissioning costs. Any changes to these practices could affect such items as: 1) when the decommissioning obligation is recognized, 2) where balances of accumulated decommissioning costs are recorded, 3) where income earned on external decommissioning trust balances is recorded and 4) the levels of annual decommissioning cost provisions. The Financial Accounting Standards Board is in the early stages of this project, and consequently, it is uncertain what impacts, if any, this project may have on the Company's accounting for decommissioning costs.\nAs required under the Nuclear Waste Policy Act of 1982, the Company entered into a contract with the U.S. Department of Energy (DOE) under which the DOE agreed to dispose of the Company's spent nuclear fuel. The Company cannot predict whether the DOE will be able to perform its contractual obligations and provide interim storage or permanent disposal repositories for spent nuclear fuel and\/or high-level radioactive waste materials on a timely basis.\nWith certain modifications, the Company's spent fuel storage facilities are sufficient to provide storage space for spent fuel generated on the Company's system through the expiration of the current operating licenses for all of the Company's nuclear generating units. Subsequent to the expiration of the licenses, dry storage may be necessary.\nNew Accounting Standard _______________________\nIn 1994, the Company implemented Statement of Position (SOP) 93-6, \"Employers' Accounting for Employee Stock Ownership Plans,\" on a prospective basis. This SOP required the following changes in accounting for the Company's ESOP: 1) ESOP shares that have not been committed to be released to participants' accounts are no longer considered outstanding for the determination of earnings per common share; 2) dividends on unallocated ESOP shares are no longer recognized for financial statement purposes; 3) interest income related to the qualified ESOP loan is no longer recognized; 4) the difference between the acquisition and allocation prices of ESOP shares, which was previously recorded as other income, net, is now recorded directly to common stock; and 5) all tax benefits of ESOP dividends are now recorded to non-operating income tax expense, whereas in 1993, a portion of the tax benefits was recorded directly to retained earnings. In 1992, prior to the implementation of Statement of Financial Accounting Standards No. 109, all tax benefits of ESOP dividends were recorded to retained earnings and were included in the determination of earnings per common share. In addition, pursuant to SOP 93-6, ESOP loan transactions between the Company and the Stock Purchase Savings Plan Trustee are no longer reflected in the Statement of Cash Flows. The implementation of SOP 93-6 resulted in an increase in earnings per common share of approximately $.04 for 1994.\nOther Business ______________\nIn 1993, the Company and Westinghouse reached an agreement that settled all issues related to the Harris and Robinson Plants' steam generators, as well as certain issues related to Harris Unit Nos. 2, 3 and 4 cancellation costs. The effect of the agreement on the Company's results of operations, approximately $17.3 million, net of tax, increased the Company's 1993 earnings by $.11 per common share. In 1993, the Company and Power Agency entered into an agreement to restructure portions of their contracts covering power supplies and interests in several jointly-owned generating units. Under terms of this agreement, the Company increased the amount of capacity and energy purchased from Power Agency's ownership interest in the Harris Plant. Also, the buyback period was extended six years through 2007. In addition, pursuant to the agreement, a portion of the Company's Harris Plant cost will not be recoverable through sales of supplemental power to Power Agency. As a result, the Company recorded a write-off in 1993 of approximately $14.7 million, net of tax, or $.09 per common share. The agreement has been approved by the FERC.\nAs part of its 1993 agreement with the Company, Power Agency will delay the commercial operation date of a combustion turbine electric generating project from 1995 until 1998. The project could displace up to approximately 180 megawatts of capacity that Power Agency currently purchases from the Company. In 1994, the FERC approved an agreement that resolved issues between Power Agency and the Company with respect to the turbine generating project.\nIn 1994, the FERC approved the Company's license application to continue operating the Company's 105-megawatt Walters Hydroelectric Plant for the next 40 years. In conjunction with the Walters' relicensing proceeding, the FERC also approved a 30-year Power Coordination Agreement (PCA) between the Company and NCEMC. The agreement assures that the Company will continue to be NCEMC's primary source of electricity for the next several years. The PCA allows NCEMC to assume responsibility for up to 200 megawatts of its load beginning in 1996. NCEMC has given notice that it will purchase 200 megawatts from another supplier beginning January 1996. From January 1996 through 2000, the Company will continue to supply at least 1,000 megawatts of electricity. Load reductions beyond the year 2000 are subject to specific limits and require five years advance notice.\nIn 1993, the Company and NCEMC entered into a settlement agreement that provided for the continuation of existing wholesale rate levels and resolved a wholesale fuel clause billing issue through June 30, 1993. The impact of the settlement totaled approximately $8 million, net of tax, and decreased the Company's 1993 earnings by $.05 per common share.\nIn 1994, the Company established a wholly-owned subsidiary, CaroNet, Inc., and the subsidiary joined a regional partnership led by BellSouth Personal Communications, Inc. (BellSouth). In March 1995, BellSouth won its bid for a Federal Communications Commission license for the partnership to operate a personal communications services (PCS) system covering most of North Carolina and South Carolina and a small portion of Georgia. PCS, a wireless communications technology, is expected to provide high-quality mobile communications. Wireless technology could also support automated meter reading, automated service connection and disconnection, and control and monitoring of certain aspects of the Company's electric transmission and distribution systems. BellSouth will transfer the PCS license to the partnership. BellSouth will be general partner and handle day-to-day management of the business.\nCompetition ___________\nIn 1992, the National Energy Policy Act (Energy Act) changed certain underlying federal policies governing wholesale generation and the sale of electric power. In effect, the Energy Act partially deregulated the wholesale electric utility industry at the generation level by allowing non-utility generators to build and own generating plants for both cogeneration and sales to utilities. Provisions of the Energy Act that most affected the utility industry were the establishment of exempt wholesale generators, and the authority given the FERC to permit wholesale transfer, or wheeling, of power over the transmission lines of other utilities. The Company is unable to predict the ultimate impact the Energy Act will have on its operations. When fully implemented, the Energy Act could impact the Company's load forecasts and plans for power supply to the extent additional generation is facilitated by the Energy Act, current wholesale customers elect to purchase from other suppliers or new opportunities are created for the Company to expand its wholesale load. Although the Energy Act prohibits the FERC from ordering retail wheeling--transmitting power on behalf of another producer to an individual retail customer--some states are considering changing their laws or regulations to allow retail electric customers to buy power from suppliers other than the local utility. The Company believes changes in existing laws in both North Carolina and South Carolina would be required to permit retail wheeling in the Company's retail jurisdictions. The South Carolina Public Service Commission (SCPSC) has ruled that it would be a violation of its past practice and of South Carolina's territorial assignment statute to require utilities to engage in retail wheeling. On February 8, 1995, the Carolina Utility Consumers Association, Inc., a group of industrial customers doing business in North Carolina, filed a petition with the NCUC requesting that the NCUC hold a generic hearing to examine whether retail wheeling would be in the public interest, how it could be implemented in North Carolina and whether it could be implemented without changing state law. The NCUC has issued an order inviting interested parties to comment on the petition. The Company cannot predict the outcome of this matter.\nThe possible migration of some of the Company's load due to increased competition in the electric industry has created greater planning uncertainty and risks for the Company. The Company has been addressing these risks by securing long-term contracts with its customers, which allow the Company flexibility in managing its load and efficiently planning its future resource requirements. In this regard, in 1993 and 1994, the Company signed long-term agreements with almost all of the Company's wholesale customers, representing approximately 15% of the Company's operating revenues. In the industrial sector, the Company is working to meet the energy needs of its customers. In 1994, the Company reached an agreement with its largest industrial customer, which ensures the Company will serve this customer through 2001. Other elements of the Company's strategy to respond to the changing market for electricity include promoting economic development, implementing new marketing strategies, improving customer satisfaction, increasing the focus on managing and reducing costs and, consequently, avoiding future rate increases.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA _______ ___________________________________________\nThe following financial statements, supplementary data and financial statement schedules are included herein:\nPage(s)\nIndependent Auditors' Report 45-46\nFinancial Statements:\nStatements of Income for the Years Ended December 31, 1994, 1993 and 1992 47 Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 48 Balance Sheets as of December 31, 1994 and 1993 49-50 Schedules of Capitalization as of December 31, 1994 and 1993 51 Statements of Retained Earnings for the Years Ended December 31, 1994, 1993 and 1992 52 Quarterly Financial Data 52 Notes to Financial Statements 53-64\nFinancial Statement Schedules for the Years Ended December 31, 1994, 1993 and 1992:\nVIII - Reserves 65-67\nAll other schedules have been omitted as not applicable or not required or because the information required to be shown is included in the Financial Statements or the accompanying Notes to Financial Statements.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Carolina Power & Light Company:\nWe have audited the accompanying balance sheets and schedules of capitalization of Carolina Power & Light 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. Our audits also included the financial statement schedules listed in the Index 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 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. 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.\nWe have also previously audited, in accordance with generally accepted auditing standards, the balance sheets and schedules of capitalization as of December 31, 1992, 1991, and 1990, and the related statements of income, retained earnings and cash flows for the years ended December 31, 1991 and 1990 (none of which are presented herein); and we expressed unqualified opinions on those financial statements. In our opinion, the information set forth in the selected financial data for each of the five years in the period ended December 31, 1994, appearing at Item 6, is fairly presented in all material respects in relation to the financial statements from which it has been derived.\nAs discussed in Note 8 to the financial statements, in 1993 the Company changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109.\n\/s\/ DELOITTE & TOUCHE LLP Raleigh, North Carolina February 13, 1995\nNotes to Financial Statements\n1. Summary of Significant Accounting Policies\nA. System of Accounts\nThe accounting records of the Company are maintained in accordance with uniform systems of accounts prescribed by the Federal Energy Regulatory Commission (FERC), the North Carolina Utilities Commission (NCUC) and the South Carolina Public Service Commission (SCPSC). Certain amounts for 1993 and 1992 have been reclassified to conform to the 1994 presentation.\nB. Electric Utility Plant\nThe cost of additions, including betterments and replacements of units of property, is charged to electric utility plant. Maintenance and repairs of property, and replacements and renewals of items determined to be less than units of property, are charged to maintenance expense. The cost of units of property replaced, renewed or retired, plus removal or disposal costs, less salvage, is charged to accumulated depreciation. Generally, electric utility plant other than nuclear fuel is subject to the lien of the Company's mortgage. The balances of electric utility plant in service at December 31 are listed below (in millions).\n1994 1993\nProduction plant $ 5,911.2 $ 5,713.9 Transmission plant 879.6 873.4 Distribution plant 1,929.5 1,825.2 General plant and other 470.6 377.0 --------- --------- Electric utility plant in service $ 9,190.9 $ 8,789.5 ========= =========\nAs prescribed in regulatory uniform systems of accounts, an allowance for the cost of borrowed and equity funds (AFUDC) used to finance electric utility plant construction is charged to the cost of plant. Regulatory authorities consider AFUDC an appropriate charge for inclusion in the Company's utility rates to customers over the service life of the property. The equity funds portion of AFUDC is credited to other income, the borrowed funds portion is credited to interest charges and, in 1992, a deferred income tax provision was reflected as a reduction in the borrowed funds portion. Due to the 1993 implementation of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" AFUDC-borrowed funds is no longer recorded on a net-of-tax basis (see Note 8). The composite AFUDC rate was 8.4% in 1994 and 8.8% in 1993, and the composite, net-of-tax AFUDC rate was 7.3% in 1992. Pursuant to the provisions of SFAS No. 109, the deferred income tax related to AFUDC in undepreciated plant in service as of January 1, 1993, was recorded to a deferred income tax liability with an offsetting adjustment to a regulatory asset.\nC. Depreciation and Amortization\nFor financial reporting purposes, depreciation of utility plant other than nuclear fuel is computed on the straight-line method based on the estimated remaining useful life of the property, adjusted for estimated net salvage. Depreciation provisions, including decommissioning costs (see Note 1D), as a percent of average depreciable property other than nuclear fuel, were approximately 3.8% in 1994 and 1993, and 3.7% in 1992. Depreciation expense totaled $335.1 million for 1994, $325.4 million for 1993 and $306.0 million for 1992. Depreciation and amortization expense also includes amortization of plant abandonment costs (see Note 7).\nAmortization of nuclear fuel costs, including disposal costs associated with obligations to the U.S. Department of Energy (DOE), is computed primarily on the unit-of-production method and charged to fuel for generation. Costs related to obligations to the DOE for the decommissioning and decontamination of enrichment facilities are also charged to fuel for generation. The disposal and the decommissioning and decontamination costs are components of fuel costs for the purpose of deferred fuel accounting (see Note 1F).\nD. Nuclear Decommissioning\nIn the Company's retail jurisdictions, provisions for nuclear decommissioning costs are approved by the NCUC and the SCPSC and are based on site-specific estimates that included the costs for removal of all radioactive and other structures at the site. In the wholesale jurisdiction, the provisions for nuclear decommissioning costs are based on amounts agreed upon in applicable rate settlements. Decommissioning cost provisions, which are included in depreciation and amortization, were $29.5 million in 1994, $34.0 million in 1993 and $27.1 million in 1992.\nAccumulated decommissioning costs, which are included in accumulated depreciation, were $252.7 million at December 31, 1994, and $221.6 million at December 31, 1993, and include amounts retained internally and amounts funded in an external decommissioning trust. The balance of the external decommissioning trust, which is included in miscellaneous other property and investments, was $67.6 million at December 31, 1994, and $44.5 million at December 31, 1993. Trust earnings, which increase the trust balance with a corresponding increase in accumulated decommissioning, were $1.5 million in 1994, $1.2 million in 1993 and $.8 million in 1992. Based on the site-specific estimates discussed below, and using an assumed after-tax earnings rate of 8.5% and an assumed cost escalation rate of 4%, current levels of rate recovery for nuclear decommissioning costs are adequate to provide for decommissioning of the Company's nuclear facilities.\nThe Company's most recent site-specific estimates of decommissioning costs were developed in 1993, using 1993 cost factors, and are based on prompt dismantlement decommissioning, which reflects the cost of removal of all radioactive and other structures currently at the site, with such removal occurring shortly after operating license expiration. These estimates, in 1993 dollars, are $257.7 million for Robinson Unit No. 2, $235.4 million for Brunswick Unit No. 1, $221.4 million for Brunswick Unit No. 2 and $284.3 million for the Harris Plant. The estimates are subject to change based on a variety of factors including, but not limited to, cost escalation, changes in technology applicable to nuclear decommissioning, and changes in federal, state or local regulations. The cost estimates exclude the portion attributable to North Carolina Eastern Municipal Power Agency (Power Agency), which holds an undivided ownership interest in certain of the Company's generating facilities. Operating licenses for the Company's nuclear units expire in the year 2010 for Robinson Unit No. 2, 2016 for Brunswick Unit No. 1, 2014 for Brunswick Unit No. 2 and 2026 for the Harris Plant.\nThe Financial Accounting Standards Board has added a project to its agenda regarding the electric utility industry's current accounting practices related to decommissioning costs. Any changes to these practices could affect such items as: 1) when the decommissioning obligation is recognized, 2) where balances of accumulated decommissioning costs are recorded, 3) where income earned on external decommissioning trust balances is recorded and 4) the levels of annual decommissioning cost provisions. The Financial Accounting Standards Board is in the early stages of this project, and consequently, it is uncertain what impacts, if any, this project may have on the Company's accounting for decommissioning costs.\nE. Regulatory Assets and Liabilities\nAs a regulated entity, the Company is subject to the provisions of SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" Accordingly, the Company records certain assets and liabilities that result from the effects of the ratemaking process, which would not be recorded under generally accepted accounting principles for non-regulated entities. At December 31, 1994, the balances of the Company's regulatory assets were as follows: 1) $384.4 million for income taxes recoverable through future rates, 2) $127.8 million for Harris Plant deferred costs, 3) $71.1 million for abandonment costs, 4) $55 million for loss on reacquired debt, which is included in unamortized debt expense and 5) $66 million for deferred DOE enrichment facilities-related cost, which is included in other assets and deferred debits. At December 31, 1994, the Company had a regulatory liability of $28.3 million related to deferred fuel.\nF. Other Policies\nCustomers' meters are read and bills are rendered on a cycle basis. Revenues are recorded as services are rendered.\nDeferred fuel reflects fuel costs or recoveries that are deferred through fuel clauses established by the Company's regulators. These clauses allow the Company to recover fuel costs and the fuel component of purchased power costs through the fuel component of customer rates. Any difference between actual costs incurred and the fuel component collected in customer billings is reflected in operating expenses as deferred fuel. Customer rates are adjusted periodically to incorporate the approved deferrals. In 1993, the Company reached settlement agreements with regulators in the North Carolina and South Carolina retail jurisdictions and agreed to forgo recovery of a total of $41.1 million of deferred fuel expenses.\nOther property and investments are stated principally at cost. The Company maintains an allowance for doubtful accounts receivable, which totaled $2.5 million at December 31, 1994, and $2.3 million at December 31, 1993. Fuel inventory and inventory of materials and supplies are carried on a first-in, first-out or average cost basis. Long-term debt premiums, discounts and issuance expenses are amortized over the life of the related debt using the straight-line method. Any expenses or call premiums associated with the reacquisition of debt obligations are amortized over the remaining life of the original debt using the straight-line method. For purposes of the Statements of Cash Flows, the Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.\n2. Employee Stock Ownership Plan\nThe Company sponsors a Stock Purchase-Savings Plan (SPSP) for which all full-time employees and certain part-time employees are eligible. The SPSP, which has company match and incentive goal features, encourages systematic savings by employees and provides a method of acquiring Company common stock and other diverse investments. The SPSP, as amended in 1989, is an employee stock ownership plan (ESOP) that can enter into acquisition loans for the purpose of acquiring Company common stock to satisfy SPSP common share needs. Qualification as an ESOP did not change the level of benefits received by employees under the SPSP. Common stock acquired with the proceeds of an ESOP loan is held by the SPSP Trustee in a suspense account and is released from the suspense account and made available for allocation to participants as the ESOP loan is repaid, as specified by provisions of the Internal Revenue Code. Such allocations are used to partially meet common stock needs related to participant contributions, Company matching and incentive contributions and\/or reinvested dividends. Dividends paid on ESOP suspense shares and on ESOP shares allocated to participants, as well as certain Company contributions, are used to repay ESOP acquisition loans, and such dividends are deductible for income tax purposes.\nThere were 9,315,789 ESOP suspense shares at December 31, 1994, with a fair value of $248 million. ESOP shares allocated to plan participants totaled 13,891,199 at December 31, 1994. The Company has a long-term note receivable from the SPSP Trustee related to the purchase of common stock from the Company in 1989. The balance of the Company's note receivable from the SPSP Trustee, $204 million at December 31, 1994, is recorded as unearned ESOP common stock and reduces common stock equity.\nIn 1994, the Company implemented Statement of Position (SOP) 93-6, \"Employers' Accounting for Employee Stock Ownership Plans,\" on a prospective basis. This SOP required the following changes in accounting for the Company's ESOP: 1) ESOP shares that have not been committed to be released to participants' accounts are no longer considered outstanding for the determination of earnings per common share; 2) dividends on unallocated ESOP shares are no longer recognized for financial statement purposes; 3) interest income related to the qualified ESOP loan is no longer recognized; 4) the difference between the acquisition and allocation prices of ESOP shares, which was previously recorded as other income, net, is now recorded directly to common stock; and 5) all tax benefits of ESOP dividends are now recorded to non-operating income tax expense, whereas in 1993, a portion of the tax benefits was recorded directly to retained earnings. In 1992, prior to the implementation of SFAS No. 109, all tax benefits of ESOP dividends were recorded to retained earnings and were included in the determination of earnings per common share. In addition, pursuant to SOP 93-6, ESOP loan transactions between the Company and the SPSP Trustee are no longer reflected in the Statement of Cash Flows. The implementation of SOP 93-6 resulted in an increase in earnings per common share of approximately $.04 for 1994.\n3. Capitalization\nIn 1994, the Board of Directors of the Company authorized the Executive Committee of the Board to repurchase up to 10 million shares of the Company's common stock on the open market. Under this stock repurchase program, the Company has purchased approximately 4.4 million shares through December 31, 1994.\nIn 1993, the Company's common stock was split and one additional share was issued for each common share outstanding. Prior year financial information was restated to reflect the two-for-one stock split.\nAt December 31, 1994, the Company had 14,767,052 shares of authorized but unissued common stock reserved and available for issuance to satisfy the requirements of the Company's stock plans. The Company intends, however, to meet the requirements of these stock plans with issued and outstanding shares presently held by the Trustee of the SPSP or with open market purchases of common stock shares, as appropriate.\nThe Company's mortgage, as supplemented, and charter contain provisions limiting the use of retained earnings for the payment of dividends under certain circumstances. At December 31, 1994, there were no significant restrictions on the use of retained earnings.\nAt December 31, 1994, long-term debt maturities for the years 1995 through 1999 were $275.1 million, $105 million, $40 million, $205 million and $50 million, respectively.\nPerson County Pollution Control Revenue Refunding Bonds - Series 1992A totaling $56 million have interest rates that must be negotiated on a weekly basis. At the time of interest rate renegotiation, holders of these bonds may require the Company to repurchase their bonds. These bonds are classified as long-term debt in the Balance Sheets, consistent with the Company's intention to maintain the debt as long-term and to the extent this intention is supported by the Company's long-term revolving credit agreements.\n4. Short-Term Debt and Revolving Credit Facilities\nAt December 31, 1994 and 1993, the Company's short-term debt balances were $68.1 million and $76 million, respectively. The weighted-average interest rates of these borrowings were 6.18% at December 31, 1994, and 3.65% at December 31, 1993. At December 31, 1994, the Company's unused and readily available revolving credit facilities totaled $307.9 million, consisting of long-term agreements totaling $207.9 million and a $100 million short-term agreement.\n5. Fair Value of Financial Instruments\nThe carrying amounts of cash, cash equivalents and notes payable approximate fair value because of the short maturities of these instruments. The carrying amount of the Company's long-term debt was $2.86 billion at December 31, 1994, and $2.80 billion at December 31, 1993. The estimated fair value of this debt, which was obtained from an independent pricing service, was $2.70 billion at December 31, 1994, and $2.88 billion at December 31, 1993. There are inherent limitations in any estimation technique, and these estimates are not necessarily indicative of the amount the Company could realize in current transactions.\n6. Postretirement Benefit Plans\nThe Company has a noncontributory defined benefit retirement (pension) plan for all full-time employees and funds the pension plan in amounts that comply with contribution limits imposed by law. Pension plan benefits reflect an employee's compensation, years of service and age at retirement.\nThe components of net periodic pension cost are (in thousands):\n1994 1993 1992\nActual return on plan assets $ 4,897 $(43,604) $(26,882) Variance from expected return, deferred (47,219) 4,490 (9,743) ------- -------- ------- Expected return on plan assets (42,322) (39,114) (36,625) Service cost 19,686 16,776 21,368 Interest cost on projected benefit obligation 35,108 31,928 31,141 Net amortization 831 (2,390) 758 ------- ------- ------ Net periodic pension cost $ 13,303 $ 7,200 $ 16,642 ======= ====== =======\nReconciliations of the funded status of the pension plan at December 31 are (in thousands): 1994 1993\nActuarial present value of benefits for services rendered to date: Accumulated benefits based on salaries to date, including vested benefits of $287.7 million for 1994 and $293.6 million for 1993 $ 330,361 $ 339,301 Additional benefits based on estimated future salary levels 103,766 112,497 -------- -------- Projected benefit obligation 434,127 451,798 Fair market value of plan assets, invested primarily in equity and fixed-income securities 506,605 515,428 -------- -------- Funded status 72,478 63,630 Unrecognized prior service costs 9,471 12,620 Unrecognized actuarial gain (124,447) (119,352) Unrecognized transition obligation, being amortized over 18.5 years beginning January 1, 1987 1,110 1,216 -------- -------- Accrued pension costs recognized in the Balance Sheets $ (41,388) $ (41,886) ======== ========\nThe assumptions used to measure the projected benefit obligation are:\n1994 1993\nWeighted-average discount rate 8.5% 7.5% Assumed rate of increase in future compensation 4.2% 4.2%\nThe expected long-term rate of return on pension plan assets used in determining the net periodic pension cost was 9% in each of the years 1994, 1993 and 1992.\nIn addition to pension benefits, the Company provides contributory postretirement benefits, including certain health care and life insurance benefits, for substantially all retired employees. In 1993, the Company implemented SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS No. 106 requires the recognition of the costs associated with these other postretirement benefits (OPEB) on an accrual basis. Previously, the cost of OPEB was generally recognized as claims were incurred and premiums were paid and totaled $2.7 million in 1992.\nThe components of net periodic OPEB cost are (in thousands):\n1994 1993\nActual return on plan assets $ 42 $ (497) Variance from expected return, deferred (682) 9 ------- ------- Expected return on plan assets (640) (488) Service cost 8,039 6,797 Interest cost on accumulated benefit obligation 9,463 9,662 Net amortization 5,966 5,966 ------- ------- Net periodic OPEB cost $ 22,828 $ 21,937 ======= =======\nReconciliations of the funded status of the OPEB plans at December 31 are (in thousands): 1994 1993\nActuarial present value of benefits for services rendered to date: Current retirees $ 55,799 $ 62,727 Active employees eligible to retire 11,933 14,800 The assumptions used to measure the accumulated postretirement benefit obligation are: Active employees not eligible to retire 63,164 62,225 ------- ------- Accumulated postretirement benefit obligation 130,896 139,752 Fair market value of plan assets, invested primarily in equity and fixed-income securities 12,142 7,584 ------- ------- Funded status (118,754) (132,168) Unrecognized actuarial (gain) loss (15,125) 6,288 Unrecognized transition obligation, being amortized over 20 years beginning January 1, 1993 107,379 113,345 ------- ------- Accrued OPEB costs recognized in the Balance Sheets $(26,500) $(12,535) ======= =======\nThe assumptions used to measure the accumulated postretirement benefit obligation are:\n1994 1993\nWeighted-average discount rate 8.5% 7.5% Initial medical cost trend rate for pre-medicare benefits 9.6% 10.7% Initial medical cost trend rate for post-medicare benefits 8.7% 9.5% Ultimate medical cost trend rate 6.0% 5.0% Year ultimate medical cost trend rate is achieved 2005 2005\nThe expected long-term rate of return on plan assets used in determining the net periodic OPEB cost was 9% in 1994 and 1993. Assuming a one percent increase in the medical cost trend rates, the aggregate of the service and interest cost components of the net periodic OPEB cost for 1994 would increase by $2.5 million, and the accumulated postretirement benefit obligation at December 31, 1994, would increase by $15.1 million. In general, OPEB costs are paid as claims are incurred and premiums are paid; however, the Company is partially funding retiree health care benefits in a trust created pursuant to Section 401(h) of the Internal Revenue Code.\n7. Plant-Related Deferred Costs\nThe Company abandoned efforts to complete Harris Unit Nos. 3 and 4 in December 1981, Harris Unit No. 2 in December 1983 and Mayo Unit No. 2 in March 1987. The NCUC and SCPSC each allowed the Company to recover the cost of these abandoned units over a ten-year period without a return on the unamortized balances. The amortization of Harris Unit Nos. 3 and 4 costs was completed in 1992, and of Harris Unit No. 2 costs in 1994. In 1988 rate orders and a 1990 NCUC Order on Remand, the Company was ordered to remove from rate base and treat as abandoned plant certain costs related to the Harris Plant. Amortization related to abandoned plant costs associated with the 1990 NCUC Order on Remand was completed in 1994. Abandoned plant amortization related to the 1988 rate orders will be completed in 1998 for the North Carolina retail and the wholesale jurisdictions and in 2027 for the South Carolina retail jurisdiction.\nAmortization of plant abandonment costs is included in depreciation and amortization expense and totaled $60.5 million in 1994, $100.7 million in 1993 and $92.5 million in 1992. Prior to the 1993 implementation of SFAS No. 109, this amortization was reported net of certain deferred taxes (see Note 8). The unamortized balances of plant abandonment costs are reported at the present value of future recoveries of these costs. The associated accretion of present value was $6.6 million in 1994, $13.2 million in 1993 and $18.2 million in 1992 and is reported in other income, net.\nIn 1988, the Company began recovering certain Harris Plant deferred costs over ten years from the date of deferral, with carrying costs accruing on the unamortized balance. Excluding deferred purchased capacity costs (see Note 10A), the unamortized balance of Harris Plant deferred costs was $60.8 million at December 31, 1994, and $81.4 million at December 31, 1993.\n8. Income Taxes\nIncome taxes are allocated between operating income and other income based on the source of the income that generated the tax. Investment tax credits related to operating income are amortized over the service life of the related property.\nIn 1993, the Company implemented SFAS No. 109 on a prospective basis. SFAS No. 109 required the Company to establish additional deferred tax assets and liabilities for certain temporary differences and to adjust deferred tax accounts for changes in income tax rates. It also prohibited net-of-tax accounting for income statement and balance sheet items. Substantially all of the adjustments required by SFAS No. 109 were recorded to deferred income tax balance sheet accounts, with offsetting adjustments to certain assets and liabilities. As a result, the cumulative effect on net income was not material. Prior to the implementation of SFAS No. 109, the Company recorded the following income statement items on a net-of-tax basis: Harris Plant deferred costs, Harris Plant carrying costs and allowance for borrowed funds used during construction. See Note 2 for the impact of SFAS No. 109 on the treatment of tax benefits of ESOP dividends. Prior period financial statement amounts were not restated for SFAS No. 109.\nNet accumulated deferred income tax liabilities at December 31 are (in thousands):\n1994 1993 Accelerated depreciation and property cost differences $ 1,504,187 $ 1,449,796 Deferred costs, net 144,751 168,311 Miscellaneous other temporary differences, net (7,173) (12,443) ---------- ---------- Net accumulated deferred income tax liability $ 1,641,765 $ 1,605,664 ========== ==========\nTotal deferred income tax liabilities were $1.9 billion at December 31, 1994, and 1993. Total deferred income tax assets were $297 million at December 31, 1994, and $261 million at December 31, 1993.\nThe provisions for income tax expense are comprised of (in thousands):\n1994 1993 1992 Included in Operating Expenses Income tax expense (credit) Current - federal $ 143,461 $ 108,935 $ 93,319 state 39,185 29,687 37,616 Deferred - federal 23,926 50,719 81,134 state 3,500 11,588 6,342 Investment tax credit adjustments (11,537) (11,612) (11,083) -------- -------- -------- Subtotal 198,535 189,317 207,328 -------- -------- -------- Harris Plant deferred costs Deferred - federal - - 2,523 state - - 597 Investment tax credit adjustments (297) 218 (182) -------- -------- -------- Subtotal (297) 218 2,938 -------- -------- -------- Total included in operating expenses 198,238 189,535 210,266 -------- -------- -------- Included in Other Income Income tax expense (credit) Current - federal (15,732) (6,168) (5,857) state (3,507) (1,291) (1,268) Deferred - federal 8,065 7,483 11,024 state 1,749 1,562 1,986 Investment tax credit adjustments - (1,194) - -------- -------- -------- Subtotal (9,425) 392 5,885 -------- -------- -------- Harris Plant carrying costs Deferred - federal - - 1,612 state - - 357 -------- -------- -------- Subtotal - - 1,969 -------- -------- -------- Other income, net Deferred - federal - - 47 state - - 11 -------- -------- -------- Subtotal - - 58 -------- -------- -------- Total included in other income (9,425) 392 7,912 -------- -------- -------- Included in Interest Charges Allowance for borrowed funds used during construction Deferred - federal - - 1,678 state - - 382 -------- -------- -------- Total included in interest charges - - 2,060 -------- -------- -------- Total income tax expense $ 188,813 $ 189,927 $ 220,238 ======== ======== ========\nA reconciliation of the Company's effective income tax rate to the statutory federal income tax rate follows.\n1994 1993 1992\nEffective income tax rate 37.6% 35.4% 36.7% State income taxes, net of federal income tax benefit (5.5) (5.1) (5.1) Investment tax credit amortization 2.4 2.3 1.9 Other differences, net 0.5 2.4 0.5 ---- ---- ---- Statutory federal income tax rate 35.0% 35.0% 34.0% ==== ==== ====\n9. Joint Ownership of Generating Facilities\nPower Agency, which includes a majority of the Company's previous municipal wholesale customers, holds undivided ownership interests in certain generating facilities of the Company. The Company and Power Agency are entitled to shares of the generating capability and output of each unit equal to their respective ownership interests. Each also pays its ownership share of additional construction costs, fuel inventory purchases and operating expenses. The Company's share of expenses for the jointly-owned units is included in the appropriate expense category in the Statements of Income. Power Agency's payment obligation with respect to abandonment costs for Mayo Unit No. 2 is 12.94% of such costs.\nThe Company's share of the jointly-owned generating facilities is listed below with related information as of December 31, 1994 (dollars in millions).\nFacility Megawatt Company Plant Accumulated Under Capability Ownership Investment Depreciation Construction Interest\nMayo Plant 745 83.83% $ 432.3 $ 146.9 $ 1.3 Harris Plant 860 83.83% $ 2,994.3 $ 661.0 $ 7.7 Brunswick Plant 1,521 81.67% $ 1,315.0 $ 708.9 $ 59.8 Roxboro Unit No.4 700 87.06% $ 219.2 $ 86.7 $ 4.9\nIn the table above, plant investment and accumulated depreciation, which includes accumulated decommissioning, are not reduced by the regulatory disallowances related to the Harris Plant.\n10. Commitments and Contingencies\nA. Purchased Power\nThe Company is obligated to purchase a percentage of Power Agency's ownership capacity and energy from the Mayo and Harris Plants. For Mayo, the percentage purchased declines ratably over a 15-year period that ends in 1997. In 1993, the Company and Power Agency entered into an agreement to restructure portions of their contracts covering power supplies and interests in jointly-owned units. Pursuant to the agreement, a portion of the Company's Harris Plant cost will not be recoverable through sales of supplemental power to Power Agency. As a result, the Company recorded a write-off in 1993 of $20.6 million, or $14.7 million, net of tax. Under the terms of the 1993 agreement, the Company also increased the amount of capacity and energy purchased from Power Agency's ownership interest in the Harris Plant, and the buyback period was extended six years through 2007. The estimated minimum annual payments for these purchases, which reflect capital-related capacity costs, total approximately $27 million. Other costs of such purchases are primarily demand-related production expenses, fuel and energy-related operation and maintenance expenses. Contractual purchases from the Mayo and Harris Plants totaled $60.4 million for 1994, $52.6 million for 1993 and $39.8 million for 1992. In 1987, the NCUC ordered the Company to reflect the recovery of the capacity portion of these costs on a levelized basis over the original 15-year buyback period, thereby deferring for future recovery the difference between such costs and amounts collected through rates. In 1988, the SCPSC ordered similar treatment, but with a ten-year levelization period. At December 31, 1994 and 1993, the Company had deferred purchased capacity costs, including carrying costs accrued on the deferred balances, of $70.9 million and $67.1 million, respectively. Increased purchases resulting from the 1993 agreement with Power Agency, which were approximately $21 million on an annual basis for 1994 and 1993, are not being deferred for future recovery.\nThe Company purchases 250 megawatts of generating capacity from Indiana Michigan Power Company's Rockport Unit No. 2. The estimated minimum annual payment for power is approximately $30 million, which represents capital-related capacity costs. Other power costs include demand-related production expenses, fuel and energy-related operation and maintenance expenses. Purchases, including transmission use charges, totaled $61.9 million, $60.2 million and $62.9 million for 1994, 1993 and 1992, respectively. The agreement expires on December 31, 2009.\nIn mid-1993, the Company began purchasing 400 megawatts of generating capacity from Duke Power Company. The estimated minimum annual payment for power under the six-year agreement is $43 million, which represents capital-related capacity costs. Other power costs associated with the agreement include fuel and energy-related operation and maintenance expenses. Purchases, including transmission use charges, totaled $62.9 million for 1994 and $37.1 million for 1993. The agreement was recently approved by FERC.\nB. Insurance\nThe Company is a member of Nuclear Mutual Limited (NML), which provides primary insurance coverage against property damage to members' nuclear generating facilities. The Company is insured thereunder for $500 million for each of its nuclear generating facilities. For the current policy period, the Company is subject to maximum retrospective premium assessments of approximately $22.7 million in the event that losses at insured facilities exceed premiums, reserves, reinsurance and other NML resources, which are at present more than $741 million.\nThe Company is also a member of Nuclear Electric Insurance Limited (NEIL), which provides insurance coverage against incremental costs of replacement power resulting from prolonged accidental outages of members' nuclear generating units. The Company is insured thereunder for the first 52 weeks (starting 21 weeks after the outage begins) in weekly amounts of $1.9 million at Brunswick Unit No. 1, $1.9 million at Brunswick Unit No. 2, $2.4 million at the Harris Plant and $1.7 million at Robinson Unit No. 2. The Company is insured for the next 104 weeks for 80% of the above amounts. NEIL also provides decontamination, decommissioning and excess property insurance for nuclear generating facilities. The Company is insured under this coverage for $1.4 billion at each of its nuclear generating facilities. This is in addition to the $500 million coverage provided by NML. For the current policy period, the Company is subject to retrospective premium assessments of up to approximately $10.1 million with respect to the incremental replacement power costs coverage and $43.3 million with respect to the decontamination, decommissioning and excess property coverage in the event covered expenses at insured facilities exceed premiums, reserves, reinsurance and other NEIL resources. These resources are at present more than $2.1 billion. Pursuant to regulations of the Nuclear Regulatory Commission, the Company's property damage insurance policies provide that all proceeds from such insurance be applied, first, to place a plant in safe and stable condition after an accident and, second, to decontaminate it before any proceeds can be used for plant repair or restoration. The Company is responsible to the extent losses may exceed limits of the coverage described above. Power Agency would be responsible for its ownership share of such losses and for certain retrospective premium assessments on jointly-owned units.\nThe Company is insured against public liability for a nuclear incident up to $8.9 billion per occurrence, which is the maximum limit on public liability claims pursuant to the Price-Anderson Act. In the event that public liability claims from an insured nuclear incident exceed $200 million, the Company would be subject to a pro rata assessment of up to $75.5 million, plus a 5% surcharge, for each reactor owned for each incident. Payment of such assessment would be made over time as necessary to limit the payment in any one year to no more than $10 million per reactor owned. Power Agency would be responsible for its ownership share of the assessment on jointly-owned units.\nC. Claims and Uncertainties\n(1) The Company is subject to federal, state and local regulations addressing air and water quality, hazardous and solid waste management and other environmental matters.\nVarious organic materials associated with the production of manufactured gas, generally referred to as coal tar, are regulated under various federal and state laws, and a liability may exist for their remediation. There are several manufactured gas plant (MGP) sites to which the Company and certain entities that were later merged into the Company may have had some connection. In this regard, the Company, along with other entities alleged to be former owners and operators of MGP sites in North Carolina, is participating in a cooperative effort with the North Carolina Department of Environment, Health and Natural Resources, Division of Solid Waste Management (DSWM) to establish a uniform framework for addressing those sites. It is anticipated that the investigation and remediation of specific MGP sites will be addressed pursuant to one or more Administrative Orders on Consent between DSWM and individual potentially responsible parties. To date, the Company has not entered into any such orders.\nThe Company has recently been approached by another North Carolina public utility concerning a possible cost-sharing arrangement with respect to the investigation and, if necessary, the remediation of four MGP sites. The Company is currently engaged in discussions with the other utility regarding this matter.\nIn addition, a current owner of property that was the site of one MGP owned by Tide Water Power Company (Tide Water Power), which merged into the Company in 1952, and the Company have entered into an agreement to share the cost of investigation and, if necessary, remediation of this site. The Company has also been approached by a North Carolina municipality that is the current owner of another MGP site that was formerly owned by Tide Water Power. The Company is engaged in discussions with that municipality concerning a possible cost-sharing arrangement with respect to the investigation and, if necessary, the remediation of that site.\nThe Company is continuing its investigation regarding the identities of parties connected to several additional MGP sites, the relative relationships of the Company and other parties to those sites and the degree, if any, to which the Company should undertake shared voluntary efforts with others at individual sites.\nThe Company has been notified by regulators of its involvement or potential involvement in several sites, other than MGP sites, that require remedial action. Although the Company cannot predict the outcome of these matters, it does not anticipate significant costs associated with these sites.\nIn 1994, the Company accrued a liability for the estimated costs associated with investigation and remediation activities for certain MGP sites and for sites other than MGP sites. This accrual was not material to the results of operations of the Company. Due to the lack of information with respect to the operation of MGP sites for which a liability has not been accrued and due to the uncertainty concerning questions of liability and potential environmental harm, the extent and cost of required remedial action, if any, are not currently determinable. The Company cannot predict the outcome of these matters or the extent to which other MGP sites may become the subject of inquiry.\n(2) As required under the Nuclear Waste Policy Act of 1982, the Company entered into a contract with the DOE under which the DOE agreed to dispose of the Company's spent nuclear fuel. The Company cannot predict whether the DOE will be able to perform its contractual obligations and provide interim storage or permanent disposal repositories for spent nuclear fuel and\/or high-level radioactive waste materials on a timely basis.\nWith certain modifications, the Company's spent fuel storage facilities are sufficient to provide storage space for spent fuel generated on the Company's system through the expiration of the current operating licenses for all of the Company's nuclear generating units. Subsequent to the expiration of the licenses, dry storage may be necessary.\nIn the opinion of management, liabilities, if any, arising under other pending claims would not have a material effect on the financial position, results of operations or cash flows of the Company.\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 ________ __________________________________________________\na) Information on the Company's directors is set forth in the Company's 1995 definitive proxy statement dated March 31, 1995, and incorporated by reference herein.\nb) Information on the Company's executive officers is set forth in Part I and incorporated by reference herein.\nITEM 11. EXECUTIVE COMPENSATION ________ ______________________\nInformation on executive compensation is set forth in the Company's 1995 definitive proxy statement dated March 31, 1995, and incorporated by reference herein.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT _______ _______________________________________________\na) The Company knows of no person who is a beneficial owner of more than five (5%) percent of any class of the Company's voting securities except for Wachovia Bank of North Carolina, N.A., Post Office Box 3099, Winston-Salem, North Carolina 27102 which as of December 31, 1994, owned 25,027,393 shares of Common Stock (15.9% of Class) as Trustee of the Company's Stock Purchase-Savings Plan.\nb) Information on security ownership of the Company's management is set forth in the Company's 1995 definitive proxy statement dated March 31, 1995, and incorporated by reference herein.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS _______ ______________________________________________\nInformation on certain relationships and transactions is set forth in the Company's 1995 definitive proxy statement dated March 31, 1995, and incorporated by reference herein.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. ________ ________________________________________________________\na) 1. Financial Statements Filed:\nSee ITEM 8 - Financial Statements and Supplementary Data. ______\n2. Financial Statement Schedules Filed:\nSee ITEM 8 - Financial Statements and Supplementary Data. ______\n3. Exhibits Filed: ______________\nExhibit No. *3a(1) Restated Charter of Carolina Power & Light Company, dated May 22, 1980 (filed as Exhibit 2(a)(1), File No. 2-64193).\nExhibit No. *3a(2) Amendment, dated May 10, 1989, to Restated Charter of the Company (filed as Exhibit 3(b), File No. 33-33431).\nExhibit No. *3a(3) Amendment, dated May 27, 1992 to Restated Charter of the Company (filed as Exhibit 4(b)(2), File No. 33-55060).\nExhibit No. *3a(4) By-laws of the Company as amended December 12, 1990 (filed as Exhibit 3(c), File No. 33-38298).\nExhibit No. *4a(1) Resolution of Board of Directors, dated December 8, 1954, authorizing the issuance of, and establishing the series designation, dividend rate and redemption prices for the Company's Serial Preferred Stock, $4.20 Series (filed as Exhibit 3(c), File No. 33- 25560).\nExhibit No. *4a(2) Resolution of Board of Directors, dated January 17, 1967, authorizing the issuance of, and establishing the series designation, dividend rate and redemption prices for the Company's Serial Preferred Stock, $5.44 Series (filed as Exhibit 3(d), File No. 33- 25560).\nExhibit No. *4a(3) Statement of Classification of Shares dated January 13, 1971, relating to the authorization of, and establishing the series designation, dividend rate and redemption prices for the Company's Serial Preferred Stock, $7.95 Series (filed as Exhibit 3(f), File No. 33- 25560).\nExhibit No. *4a(4) Statement of Classification of Shares dated September 7, 1972, relating to the authorization of, and establishing the series designation, dividend rate and redemption prices for the Company's Serial Preferred Stock, $7.72 Series (filed as Exhibit 3(g), File No. 33- 25560).\nExhibit No. *4b Mortgage and Deed of Trust dated as of May 1, 1940 between the Company and The Bank of New York (formerly, Irving Trust Company) and Frederick G. Herbst (W.T. Cunningham, Successor), Trustees and the First through Fifth Supplemental Indentures thereto (Exhibit 2(b), File No. 2-64189); and the Sixth through Sixty-third Supplemental Indentures (Exhibit 2(b)-5, File No. 2-16210; Exhibit 2(b)-6, File No. 2-16210; Exhibit 4(b)-8, File No. 2-19118; Exhibit 4(b)-2, File No. 2-22439; Exhibit 4(b)-2, File No. 2-24624; Exhibit 2(c), File No. 2-27297; Exhibit 2(c), File No. 2-30172; Exhibit 2(c), File No. 2-35694; Exhibit 2(c), File No. 2-37505; Exhibit 2(c), File No. 2-39002; Exhibit 2(c), File No. 2-41738; Exhibit 2(c), File No. 2-43439; Exhibit 2(c), File No. 2-47751; Exhibit 2(c), File No. 2-49347; Exhibit 2(c), File No. 2-53113; Exhibit 2(d), File No. 2-53113; Exhibit 2(c), File No. 2-59511; Exhibit 2(c), File No. 2-61611; Exhibit 2(d), File No. 2- 64189; Exhibit 2(c), File No. 2-65514; Exhibits 2(c) and 2(d), File No. 2-66851; Exhibits 4(b)-1, 4(b)-2, and 4(b)-3, File No. 2-81299; Exhibits 4(c)-1 through 4(c)-8, File No. 2-95505; Exhibits 4(b) through 4(h), File No. 33-25560; Exhibits 4(b) and 4(c), File No. 33-33431; Exhibits 4(b) and 4(c), File No. 33-38298; Exhibits 4(h) and 4(i), File No. 33- 42869; Exhibits 4(e)-(g), File No. 33- 48607; Exhibits 4(e) and 4(f), File No 33-55060; Exhibits 4(e) and 4(f), File No. 33-60014; Exhibits 4(a) and 4(b), File No. 33-38349; Exhibit 4(e), File No. 33-50597; and Exhibit 4(e) and 4(f), File No. 33-57835.\nExhibit No. *10a(1) Purchase, Construction and Ownership Agreement dated July 30, 1981 between Carolina Power & Light Company and North Carolina Municipal Power Agency Number 3 and Exhibits, together with resolution dated December 16, 1981 changing name to North Carolina Eastern Municipal Power Agency, amending letter dated February 18, 1982, and amendment dated February 24, 1982 (filed as Exhibit 10(a), File No. 33-25560).\nExhibit No. *10a(2) Operating and Fuel Agreement dated July 30, 1981 between Carolina Power & Light Company and North Carolina Municipal Power Agency Number 3 and Exhibits, together with resolution dated December 16, 1981 changing name to North Carolina Eastern Municipal Power Agency, amending letters dated August 21, 1981 and December 15, 1981, and amendment dated February 24, 1982 (filed as Exhibit 10(b), File No. 33- 25560).\nExhibit No. *10a(3) Power Coordination Agreement dated July 30, 1981 between Carolina Power & Light Company and North Carolina Municipal Power Agency Number 3 and Exhibits, together with resolution dated December 16, 1981 changing name to North Carolina Eastern Municipal Power Agency and amending letter dated January 29, 1982 (filed as Exhibit 10(c), File No. 33-25560).\nExhibit No. *10a(4) Amendment dated December 16, 1982 to Purchase, Construction and Ownership Agreement dated July 30, 1981 between Carolina Power & Light Company and North Carolina Eastern Municipal Power Agency (filed as Exhibit 10(d), File No. 33-25560).\nExhibit No. *10a(5) Agreement Regarding New Resources and Interim Capacity between Carolina Power & Light Company and North Carolina Eastern Municipal Power Agency dated October 13, 1987 (filed as Exhibit 10(e), File No. 33-25560).\nExhibit No. *10a(6) Power Coordination Agreement - 1987A between North Carolina Eastern Municipal Power Agency and Carolina Power & Light Company for Contract Power From New Resources Period 1987- 1993 dated October 13, 1987 (filed as Exhibit 10(f), File No. 33-25560).\n+ Exhibit No. *10c(1) Directors Deferred Compensation Plan effective January 1, 1982 as amended (filed as Exhibit 10(g), File No. 33-25560).\n+ Exhibit No. *10c(2) Supplemental Executive Retirement Plan effective January 1, 1984 (filed as Exhibit 10(h), File No. 33-25560).\n+ Exhibit No. *10c(3) Retirement Plan for Outside Directors (filed as Exhibit 10(i), File No. 33- 25560).\n+ Exhibit No. *10c(4) Executive Deferred Compensation Plan effective May 1, 1982 as amended (filed as Exhibit 10(j), File No. 33-25560).\n+ Exhibit No. *10c(5) Key Management Deferred Compensation Plan (filed as Exhibit 10(k), File No. 33-25560).\n+ Exhibit No. *10c(6) Resolutions of the Board of Directors, dated March 15, 1989, amending the Key Management Deferred Compensation Plan (filed as Exhibit 10(a), File No. 33- 48607).\n+ Exhibit No. *10c(7) Resolutions of the Board of Directors dated May 8, 1991, amending the Directors Deferred Compensation Plan (filed as Exhibit 10(b), File No. 33- 48607).\n+ Exhibit No. *10c(8) Resolutions of the Board of Directors dated May 8, 1991, amending the Executive Deferred Compensation Plan (filed as Exhibit 10(c), File No. 33- 48607).\nExhibit No. 12 Computation of Ratio of Earnings to Fixed Charges and Preferred Dividends Combined and Ratio of Earnings to Fixed Charges.\nExhibit No. 23(a) Consent of Deloitte & Touche LLP.\nExhibit No. 23(b) Consent of Richard E. Jones.\n____________\n*Incorporated herein by reference as indicated. +Management contract or compensation plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14(c) of Form 10-K.\nb) Reports on Form 8-K filed during or with respect to the last quarter of 1994 and the portion of the first quarter of 1995 prior to the filing of this 10-K:\nDate of Report Item Reported ______________ _____________\nJanuary 23, 1995 Item 7. Financial Statements, Pro Forma Financial Information and Exhibits\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 24th day of March, 1995.\nCAROLINA POWER & LIGHT COMPANY ______________________________ (Registrant)\nBy \/s\/ Paul S. Bradshaw Vice President 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 date indicated.\nSignature Title Date _________ _____ ____\n\/s\/ Sherwood H. Smith, Jr. Principal Executive (Chairman and Chief Executive Officer) Officer and Director\n\/s\/ Charles D. Barham, Jr. Principal Financial (Executive Vice President Officer and Director and Chief Financial Officer)\n\/s\/ Paul S. Bradshaw Principal Accounting (Vice President and Controller) Officer\n\/s\/ Edwin B. Borden Director March 24, 1995\n\/s\/ Felton J. Capel Director\n\/s\/ William Cavanaugh III Director (President and Chief Operating Officer)\n\/s\/ George H. V. Cecil Director\n\/s\/ Charles W. Coker Director\n\/s\/ William E. Graham, Jr. Director\n\/s\/ Gordon C. Hurlbert Director\n\/s\/ J. R. Bryan Jackson Director\n\/s\/ Robert L. Jones Director\n\/s\/ Estell C. Lee Director\n\/s\/ J. Tylee Wilson Director","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS _______ _________________________________________________\nRESULTS OF OPERATIONS _____________________\nRevenues ________\nUnusually mild weather in 1994 contributed significantly to a decrease in revenues as compared to 1993. This weather-related decrease totaled $86 million. Additionally, in 1994 the Company completed recovery of the portion of abandoned plant costs collected under a special rider resulting from the 1990 North Carolina Utilities Commission (NCUC) Order on Remand. This reduced 1994 revenues by $28 million, but did not significantly impact net income due to a corresponding decrease in amortization expense. Partially offsetting these decreases was an increase in revenue of $101 million due to customer growth and changes in customer usage patterns.\nThe increase in revenues in 1993 is primarily the result of an increase in energy sales of 6.2%. The effects of weather did not significantly impact revenues from 1992 to 1993. Revenues did not increase from 1992 to 1993 proportionately with energy sales due to a decline in the fuel factors included in rates and due to lower demand-related charges for certain customer classes.\nOperating Expenses __________________\nFuel for generation decreased in 1994 primarily due to a change in the generation mix. Nuclear generation, as a percentage of total generation, increased to 46%, from 34%, and higher-cost fossil generation decreased to 52%, from 64%, due to greater availability of the Company's nuclear generating facilities. In 1993, an 8% increase in total generation, offset somewhat by a decrease in the cost of fossil fuel and by increased use of nuclear generation, resulted in a slight increase in fuel for generation.\nDeferred fuel reflects fuel costs or recoveries that are deferred through fuel clauses required by the Company's regulators. These clauses allow the Company to recover fuel costs and fuel-related purchased power costs through the fuel component of customer rates. Any difference between actual costs incurred and the fuel component collected in customer billings is reflected in operating expenses as deferred fuel. As a result, except for fuel settlements such as those discussed below, net income is not impacted significantly by fluctuations in fuel costs.\nIn 1994, the Company reached settlement agreements with regulators in the North Carolina and South Carolina retail jurisdictions and agreed to forgo recovery of $8 million of deferred fuel costs. In 1993, the Company agreed to forgo recovery of $41.1 million of deferred fuel costs related to the Brunswick Plant's extended outage in 1992 and 1993. The net effect of these agreements resulted in a decrease of $33.1 million in deferred fuel cost from 1993 to 1994. Excluding the effect of these settlements, deferred fuel costs increased from 1993 to 1994 due to lower fuel costs associated with increased nuclear generation and due to the recovery of prior fuel costs as allowed by the North Carolina fuel adjustment statute. From 1992 to 1993, excluding the effect of the 1993 settlements, deferred fuel costs increased due to lower fuel costs.\nThe increase in purchased power from 1992 to 1994 is primarily attributable to an agreement under which the Company began purchasing 400 megawatts of generating capacity from Duke Power Company in July 1993. Purchases under this agreement accounted for an increase in purchased power of $26 million in 1994 and $37 million in 1993. In addition, purchases from North Carolina Eastern Municipal Power Agency (Power Agency) increased $8 million in 1994 and $14 million in 1993, primarily due to the increased buyback provisions of the Company's 1993 agreement with Power Agency (see Other Business). A substantial portion of the increase in purchased power is capacity cost and, therefore, not recoverable through the Company's fuel clauses.\nThe increase in other operating expenses from 1993 to 1994 is due to increases in various cost categories such as benefits, salaries and demand-side management programs. Partially offsetting these increases was a 1994 adjustment of $23 million to reduce the Company's nuclear insurance reserves. Other operating expenses increased from 1992 to 1993 due to 1) the Brunswick Plant outage in 1992 and 1993, 2) the recognition of increased expense for postretirement benefits other than pensions due to new accounting requirements and 3) 1992 adjustments that were made to certain accrual and asset balances as a result of more current information at that time. Excluding the effect of the 1994 insurance reserve adjustment, the Company's business plan for the period through 1997 does not project an increase in other operating expenses.\nMaintenance expense decreased from 1992 to 1994 primarily due to a decrease in costs associated with the Brunswick Plant's outage in 1992 and 1993. Additionally, maintenance expense decreased in 1993 due to the capitalization of costs associated with plant modifications as compared to the prior year.\nThe decrease in depreciation and amortization from 1993 to 1994 is primarily attributable to the completion of the amortization of abandoned plant costs for Harris Unit No. 2 and of costs associated with the 1990 NCUC Order on Remand; these decreases in amortization totaled $25 million. In 1993, the Company began amortizing costs associated with two significant software projects, which contributed to a portion of the increase in depreciation and amortization from 1992 to 1993.\nThe fluctuation in Harris Plant deferred costs from 1992 to 1993 is primarily due to an adjustment made in 1992 in order to better match these costs with the associated revenue recovery. This adjustment decreased 1992 operating expenses by $13.4 million, net of tax. Contributing to the increase in 1993 were adjustments related to the settlement between North Carolina Electric Membership Corporation (NCEMC) and the Company (see Other Business).\nOther Income ____________\nThe fluctuation in Harris Plant carrying costs from 1992 to 1994 is primarily related to the Company's settlement with NCEMC, which was recorded in 1993 and increased carrying costs in that year.\nThe Harris Plant disallowance - Power Agency line item reflects a write-off recorded as a result of the 1993 settlement with Power Agency (see Other Business).\nBeginning in 1994, the Company is no longer recording interest income related to the Company's qualified employee stock ownership plan (ESOP) loan (see New Accounting Standard). Interest income also decreased in 1994 due to the Company's 1993 settlement with Westinghouse Electric Corporation (Westinghouse), which increased interest income in 1993 (see Other Business). Partially offsetting these decreases was an increase for interest income related to certain IRS audit issues. The increase in interest income from 1992 to 1993 is primarily due to the Westinghouse settlement.\nOther income, net, decreased in 1994 primarily due to a change in accounting for ESOPs.\nInterest Charges ________________\nInterest charges on long-term debt decreased from 1992 to 1994 due to long-term debt refinancings that allowed the Company to take advantage of lower interest rates. In addition, for 1993 as compared to 1992, interest rates on the Company's variable rate debt were lower.\nLIQUIDITY AND CAPITAL RESOURCES _______________________________\nCapital Requirements ____________________\nEstimated capital requirements for the period 1995 through 1997 primarily reflect construction expenditures that will be made to add generating facilities, to upgrade existing generating facilities and to add transmission and distribution facilities to meet customer growth. The Company's capital requirements for those years are reflected below (in millions).\n1995 1996 1997 ____ ____ ____\nConstruction expenditures $358 $445 $527 Nuclear fuel expenditures 99 77 71 AFUDC (19) (25) (34) Mandatory redemptions of long-term debt 275 105 100 ____ ____ ____ Total $713 $602 $664 ==== ==== ====\nThe table above includes Clean Air Act requirement expenditures of approximately $117 million and generating facility addition expenditures of approximately $287 million for the period 1995 through 1997. The generating facility addition expenditures will primarily be used to construct new combustion turbine units, which are intended for use during periods of high demand. The units are scheduled to be placed in service in 1997 through 2000.\nThe 1990 amendments to the Clean Air Act (Act) require substantial reductions in sulfur dioxide and nitrogen oxides emissions from fossil-fueled electric generating plants. The Company was not required to take action to comply with the Act's Phase I requirements, which had to be met by January 1, 1995. Phase II of the Act, which contains more stringent provisions, will become effective January 1, 2000. To reduce sulfur dioxide emissions as required by Phase II, the Company will modify equipment to allow certain of its plants to burn lower-sulfur coal, and the Company is planning for the installation of scrubbers. Installation of additional equipment will also be necessary to reduce nitrogen oxides emissions. The Company anticipates that it will be able to delay the installation and operation of scrubbers until 2007 by utilizing lower-sulfur coal and sulfur dioxide emission allowances. Each sulfur dioxide emission allowance issued by the Environmental Protection Agency (EPA) will allow a utility to emit one ton of sulfur dioxide. The Company has purchased emission allowances under the EPA's emission allowance trading program.\nThe Company estimates that the total capital cost to comply with Phase II of the Act will approximate $273 million during the period 1995 through 1999 and an additional $272 million during the period 2000 through 2007. These estimates, for installation or modification of equipment, are in nominal dollars (undiscounted future amounts expected to be expended). The required modifications and additions are expected to increase operating and maintenance costs by a total of $18 million for the period 1995 through 1999, $35 million for the period 2000 through 2006 and by $24 million annually beginning in 2007. Additionally, fuel costs are expected to increase by a total of approximately $277 million for the period 2000 through 2006 and by approximately $62 million annually beginning in 2007. The Company expects these increased fuel costs to be recoverable through the Company's fuel clauses. Actual plans for compliance with the Act's requirements have not been finalized and the amount required for capital expenditures and for increased operating, maintenance and fuel expenditures cannot be determined with certainty at this time. The NCUC and the South Carolina Public Service Commission (SCPSC) are allowing the Company to accrue carrying charges on its investment in emission allowances.\nThe Company has two long-term agreements for the purchase of power from other utilities. The first agreement provides for the purchase of 250 megawatts of capacity from Indiana Michigan Power Company's Rockport Unit No.2. The estimated minimum annual payment for these power purchases is approximately $30 million, which represents capital-related capacity costs. Other costs include demand-related production expenses, fuel and energy-related operation and maintenance expenses. In 1994, purchases under this agreement totaled $61.9 million, including transmission use charges. The agreement expires in 2009. The second agreement is with Duke Power Company for the purchase of 400 megawatts of firm capacity through mid-1999. The estimated minimum annual payment for these power purchases is approximately $43 million, which represents capital-related capacity costs. Other costs include fuel and energy-related operation and maintenance expenses. Purchases under this agreement, including transmission use charges, totaled $62.9 million in 1994. The agreement with Duke Power Company was recently approved by the Federal Energy Regulatory Commission (FERC).\nIn addition, the Company is obligated to purchase a percentage of Power Agency's ownership capacity of and energy from the Mayo Plant and the Harris Plant through 1997 and 2007, respectively. The estimated minimum annual payments for these purchases, which reflect capital-related capacity costs, total approximately $27 million. Other costs of such purchases are primarily demand-related production expenses, fuel and energy-related operation and maintenance expenses. Purchases under the agreement with Power Agency totaled $60.4 million in 1994.\nCash Flow and Financing _______________________\nNet cash used in investing activities primarily consists of capital expenditures, which include replacement or expansion of existing facilities and construction to comply with pollution control laws and regulations. Capital expenditures in 1994 were lower than in 1993 primarily due to work performed at the Brunswick Plant in 1993.\nDuring 1994, the Company issued $322.6 million in long-term debt. The proceeds of these issuances were primarily used to redeem or retire $267.4 million of long-term debt. External funding requirements, which do not include early redemptions of long-term debt or redemptions of preferred stock, are expected to approximate $417 million in 1995 and $120 million in 1997. These funds will be required for construction, mandatory redemptions of long-term debt and general corporate purposes, including the repayment of short-term debt. The Company does not expect to have external funding requirements in 1996.\nIn 1994, the Board of Directors of the Company authorized the Executive Committee of the Board to repurchase up to 10 million shares of the Company's common stock on the open market. Under this stock repurchase program, the Company has purchased approximately 4.4 million shares through December 31, 1994.\nThe Company has on file with the Securities and Exchange Commission (SEC) a shelf registration statement enabling the Company to issue an aggregate of $450 million principal amount of first mortgage bonds, and an additional $250 million combined aggregate principal amount of first mortgage bonds and\/or unsecured debt securities of the Company.\nThe Company's ability to issue first mortgage bonds and preferred stock is subject to earnings and other tests as stated in certain provisions of its mortgage, as supplemented, and charter. The Company has the ability to issue an additional $3.4 billion in first mortgage bonds and an additional 14 million shares of preferred stock at an assumed price of $100 per share and a $8.63 annual dividend rate. The Company also has ten million authorized preference stock shares available for issuance that are not subject to an earnings test.\nThe Company's access to outside capital depends on its ability to maintain its credit ratings. The Company's first mortgage bonds are currently rated A2 by Moody's Investors Service, A by Standard & Poors and A+ by Duff & Phelps. In order to provide flexibility in the timing and amounts of long-term financing, the Company uses short-term financing in the form of commercial paper backed by revolving credit agreements. These revolving credit agreements total $307.9 million. The Company had $68.1 million of commercial paper outstanding at December 31, 1994, which Standard & Poors and Moody's Investors Service have rated A-1 and P-1, respectively.\nThe amount and timing of future sales of Company securities will depend upon market conditions and the specific needs of the Company. The Company may from time to time sell securities beyond the amount needed to meet capital requirements in order to allow for the early redemption of outstanding issues of long-term debt, the redemption of preferred stock, the reduction of short-term debt or for other corporate purposes.\nOTHER MATTERS _____________\nEnvironmental _____________\nThe Company is subject to federal, state and local regulations addressing air and water quality, hazardous and solid waste management and other environmental matters.\nVarious organic materials associated with the production of manufactured gas, generally referred to as coal tar, are regulated under various federal and state laws, and a liability may exist for their remediation. There are several manufactured gas plant (MGP) sites to which the Company and certain entities that were later merged into the Company may have had some connection. In this regard, the Company, along with other entities alleged to be former owners and operators of MGP sites in North Carolina, is participating in a cooperative effort with the North Carolina Department of Environment, Health and Natural Resources, Division of Solid Waste Management (DSWM) to establish a uniform framework for addressing those sites. It is anticipated that the investigation and remediation of specific MGP sites will be addressed pursuant to one or more Administrative Orders on Consent between DSWM and individual potentially responsible parties. To date, the Company has not entered into any such orders.\nThe Company has recently been approached by another North Carolina public utility concerning a possible cost-sharing arrangement with respect to the investigation and, if necessary, the remediation of four MGP sites. The Company is currently engaged in discussions with the other utility regarding this matter.\nIn addition, a current owner of property that was the site of one MGP owned by Tide Water Power Company (Tide Water Power), which merged into the Company in 1952, and the Company have entered into an agreement to share the cost of investigation and, if necessary, remediation of this site. The Company has also been approached by a North Carolina municipality that is the current owner of another MGP site that was formerly owned by Tide Water Power. The Company is engaged in discussions with that municipality concerning a possible cost-sharing arrangement with respect to the investigation and, if necessary, the remediation of that site.\nThe Company is continuing its investigation regarding the identities of parties connected to several additional MGP sites, the relative relationships of the Company and other parties to those sites and the degree, if any, to which the Company should undertake shared voluntary efforts with others at individual sites.\nThe Company has been notified by regulators of its involvement or potential involvement in several sites, other than MGP sites, that require remedial action. Although the Company cannot predict the outcome of these matters, it does not anticipate significant costs associated with these sites.\nIn 1994, the Company accrued a liability for the estimated costs associated with investigation and remediation activities for certain MGP sites and for sites other than MGP sites. This accrual was not material to the results of operations of the Company. Due to the lack of information with respect to the operation of MGP sites for which a liability has not been accrued and due to the uncertainty concerning questions of liability and potential environmental harm, the extent and cost of required remedial action, if any, are not currently determinable. The Company cannot predict the outcome of these matters or the extent to which other MGP sites may become the subject of inquiry.\nNuclear _______\nIn the Company's retail jurisdictions, provisions for nuclear decommissioning costs were approved by the NCUC and the SCPSC in the Company's 1988 general rate cases and were based on site-specific estimates that included the costs for removal of all radioactive and other structures at the site. In the wholesale jurisdiction, the provisions for nuclear decommissioning costs are based on amounts agreed upon in applicable rate settlements. Based on the site-specific estimates discussed below, and using an assumed after-tax earnings rate of 8.5% and an assumed cost escalation rate of 4%, current levels of rate recovery for nuclear decommissioning costs are adequate to provide for decommissioning of the Company's nuclear facilities.\nThe Company's most recent site-specific estimates of decommissioning costs were developed in 1993, using 1993 cost factors, and are based on prompt dismantlement decommissioning, which reflects the cost of removal of all radioactive and other structures currently at the site, with such removal occurring shortly after operating license expiration. These estimates, in 1993 dollars, are $257.7 million for Robinson Unit No. 2, $235.4 million for Brunswick Unit No. 1, $221.4 million for Brunswick Unit No. 2 and $284.3 million for the Harris Plant. The estimates are subject to change based on a variety of factors including, but not limited to, cost escalation, changes in technology applicable to nuclear decommissioning, and changes in federal, state or local regulations. The cost estimates exclude the portion attributable to Power Agency, which holds an undivided ownership interest in certain of the Company's generating facilities. Operating licenses for the Company's nuclear units expire in the year 2010 for Robinson Unit No. 2, 2016 for Brunswick Unit No. 1, 2014 for Brunswick Unit No. 2 and 2026 for the Harris Plant.\nThe Financial Accounting Standards Board has added a project to its agenda regarding the electric utility industry's current accounting practices related to decommissioning costs. Any changes to these practices could affect such items as: 1) when the decommissioning obligation is recognized, 2) where balances of accumulated decommissioning costs are recorded, 3) where income earned on external decommissioning trust balances is recorded and 4) the levels of annual decommissioning cost provisions. The Financial Accounting Standards Board is in the early stages of this project, and consequently, it is uncertain what impacts, if any, this project may have on the Company's accounting for decommissioning costs.\nAs required under the Nuclear Waste Policy Act of 1982, the Company entered into a contract with the U.S. Department of Energy (DOE) under which the DOE agreed to dispose of the Company's spent nuclear fuel. The Company cannot predict whether the DOE will be able to perform its contractual obligations and provide interim storage or permanent disposal repositories for spent nuclear fuel and\/or high-level radioactive waste materials on a timely basis.\nWith certain modifications, the Company's spent fuel storage facilities are sufficient to provide storage space for spent fuel generated on the Company's system through the expiration of the current operating licenses for all of the Company's nuclear generating units. Subsequent to the expiration of the licenses, dry storage may be necessary.\nNew Accounting Standard _______________________\nIn 1994, the Company implemented Statement of Position (SOP) 93-6, \"Employers' Accounting for Employee Stock Ownership Plans,\" on a prospective basis. This SOP required the following changes in accounting for the Company's ESOP: 1) ESOP shares that have not been committed to be released to participants' accounts are no longer considered outstanding for the determination of earnings per common share; 2) dividends on unallocated ESOP shares are no longer recognized for financial statement purposes; 3) interest income related to the qualified ESOP loan is no longer recognized; 4) the difference between the acquisition and allocation prices of ESOP shares, which was previously recorded as other income, net, is now recorded directly to common stock; and 5) all tax benefits of ESOP dividends are now recorded to non-operating income tax expense, whereas in 1993, a portion of the tax benefits was recorded directly to retained earnings. In 1992, prior to the implementation of Statement of Financial Accounting Standards No. 109, all tax benefits of ESOP dividends were recorded to retained earnings and were included in the determination of earnings per common share. In addition, pursuant to SOP 93-6, ESOP loan transactions between the Company and the Stock Purchase Savings Plan Trustee are no longer reflected in the Statement of Cash Flows. The implementation of SOP 93-6 resulted in an increase in earnings per common share of approximately $.04 for 1994.\nOther Business ______________\nIn 1993, the Company and Westinghouse reached an agreement that settled all issues related to the Harris and Robinson Plants' steam generators, as well as certain issues related to Harris Unit Nos. 2, 3 and 4 cancellation costs. The effect of the agreement on the Company's results of operations, approximately $17.3 million, net of tax, increased the Company's 1993 earnings by $.11 per common share. In 1993, the Company and Power Agency entered into an agreement to restructure portions of their contracts covering power supplies and interests in several jointly-owned generating units. Under terms of this agreement, the Company increased the amount of capacity and energy purchased from Power Agency's ownership interest in the Harris Plant. Also, the buyback period was extended six years through 2007. In addition, pursuant to the agreement, a portion of the Company's Harris Plant cost will not be recoverable through sales of supplemental power to Power Agency. As a result, the Company recorded a write-off in 1993 of approximately $14.7 million, net of tax, or $.09 per common share. The agreement has been approved by the FERC.\nAs part of its 1993 agreement with the Company, Power Agency will delay the commercial operation date of a combustion turbine electric generating project from 1995 until 1998. The project could displace up to approximately 180 megawatts of capacity that Power Agency currently purchases from the Company. In 1994, the FERC approved an agreement that resolved issues between Power Agency and the Company with respect to the turbine generating project.\nIn 1994, the FERC approved the Company's license application to continue operating the Company's 105-megawatt Walters Hydroelectric Plant for the next 40 years. In conjunction with the Walters' relicensing proceeding, the FERC also approved a 30-year Power Coordination Agreement (PCA) between the Company and NCEMC. The agreement assures that the Company will continue to be NCEMC's primary source of electricity for the next several years. The PCA allows NCEMC to assume responsibility for up to 200 megawatts of its load beginning in 1996. NCEMC has given notice that it will purchase 200 megawatts from another supplier beginning January 1996. From January 1996 through 2000, the Company will continue to supply at least 1,000 megawatts of electricity. Load reductions beyond the year 2000 are subject to specific limits and require five years advance notice.\nIn 1993, the Company and NCEMC entered into a settlement agreement that provided for the continuation of existing wholesale rate levels and resolved a wholesale fuel clause billing issue through June 30, 1993. The impact of the settlement totaled approximately $8 million, net of tax, and decreased the Company's 1993 earnings by $.05 per common share.\nIn 1994, the Company established a wholly-owned subsidiary, CaroNet, Inc., and the subsidiary joined a regional partnership led by BellSouth Personal Communications, Inc. (BellSouth). In March 1995, BellSouth won its bid for a Federal Communications Commission license for the partnership to operate a personal communications services (PCS) system covering most of North Carolina and South Carolina and a small portion of Georgia. PCS, a wireless communications technology, is expected to provide high-quality mobile communications. Wireless technology could also support automated meter reading, automated service connection and disconnection, and control and monitoring of certain aspects of the Company's electric transmission and distribution systems. BellSouth will transfer the PCS license to the partnership. BellSouth will be general partner and handle day-to-day management of the business.\nCompetition ___________\nIn 1992, the National Energy Policy Act (Energy Act) changed certain underlying federal policies governing wholesale generation and the sale of electric power. In effect, the Energy Act partially deregulated the wholesale electric utility industry at the generation level by allowing non-utility generators to build and own generating plants for both cogeneration and sales to utilities. Provisions of the Energy Act that most affected the utility industry were the establishment of exempt wholesale generators, and the authority given the FERC to permit wholesale transfer, or wheeling, of power over the transmission lines of other utilities. The Company is unable to predict the ultimate impact the Energy Act will have on its operations. When fully implemented, the Energy Act could impact the Company's load forecasts and plans for power supply to the extent additional generation is facilitated by the Energy Act, current wholesale customers elect to purchase from other suppliers or new opportunities are created for the Company to expand its wholesale load. Although the Energy Act prohibits the FERC from ordering retail wheeling--transmitting power on behalf of another producer to an individual retail customer--some states are considering changing their laws or regulations to allow retail electric customers to buy power from suppliers other than the local utility. The Company believes changes in existing laws in both North Carolina and South Carolina would be required to permit retail wheeling in the Company's retail jurisdictions. The South Carolina Public Service Commission (SCPSC) has ruled that it would be a violation of its past practice and of South Carolina's territorial assignment statute to require utilities to engage in retail wheeling. On February 8, 1995, the Carolina Utility Consumers Association, Inc., a group of industrial customers doing business in North Carolina, filed a petition with the NCUC requesting that the NCUC hold a generic hearing to examine whether retail wheeling would be in the public interest, how it could be implemented in North Carolina and whether it could be implemented without changing state law. The NCUC has issued an order inviting interested parties to comment on the petition. The Company cannot predict the outcome of this matter.\nThe possible migration of some of the Company's load due to increased competition in the electric industry has created greater planning uncertainty and risks for the Company. The Company has been addressing these risks by securing long-term contracts with its customers, which allow the Company flexibility in managing its load and efficiently planning its future resource requirements. In this regard, in 1993 and 1994, the Company signed long-term agreements with almost all of the Company's wholesale customers, representing approximately 15% of the Company's operating revenues. In the industrial sector, the Company is working to meet the energy needs of its customers. In 1994, the Company reached an agreement with its largest industrial customer, which ensures the Company will serve this customer through 2001. Other elements of the Company's strategy to respond to the changing market for electricity include promoting economic development, implementing new marketing strategies, improving customer satisfaction, increasing the focus on managing and reducing costs and, consequently, avoiding future rate increases.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA _______ ___________________________________________\nThe following financial statements, supplementary data and financial statement schedules are included herein:\nPage(s)\nIndependent Auditors' Report 45-46\nFinancial Statements:\nStatements of Income for the Years Ended December 31, 1994, 1993 and 1992 47 Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 48 Balance Sheets as of December 31, 1994 and 1993 49-50 Schedules of Capitalization as of December 31, 1994 and 1993 51 Statements of Retained Earnings for the Years Ended December 31, 1994, 1993 and 1992 52 Quarterly Financial Data 52 Notes to Financial Statements 53-64\nFinancial Statement Schedules for the Years Ended December 31, 1994, 1993 and 1992:\nVIII - Reserves 65-67\nAll other schedules have been omitted as not applicable or not required or because the information required to be shown is included in the Financial Statements or the accompanying Notes to Financial Statements.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Carolina Power & Light Company:\nWe have audited the accompanying balance sheets and schedules of capitalization of Carolina Power & Light 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. Our audits also included the financial statement schedules listed in the Index 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 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. 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.\nWe have also previously audited, in accordance with generally accepted auditing standards, the balance sheets and schedules of capitalization as of December 31, 1992, 1991, and 1990, and the related statements of income, retained earnings and cash flows for the years ended December 31, 1991 and 1990 (none of which are presented herein); and we expressed unqualified opinions on those financial statements. In our opinion, the information set forth in the selected financial data for each of the five years in the period ended December 31, 1994, appearing at Item 6, is fairly presented in all material respects in relation to the financial statements from which it has been derived.\nAs discussed in Note 8 to the financial statements, in 1993 the Company changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109.\n\/s\/ DELOITTE & TOUCHE LLP Raleigh, North Carolina February 13, 1995\nNotes to Financial Statements\n1. Summary of Significant Accounting Policies\nA. System of Accounts\nThe accounting records of the Company are maintained in accordance with uniform systems of accounts prescribed by the Federal Energy Regulatory Commission (FERC), the North Carolina Utilities Commission (NCUC) and the South Carolina Public Service Commission (SCPSC). Certain amounts for 1993 and 1992 have been reclassified to conform to the 1994 presentation.\nB. Electric Utility Plant\nThe cost of additions, including betterments and replacements of units of property, is charged to electric utility plant. Maintenance and repairs of property, and replacements and renewals of items determined to be less than units of property, are charged to maintenance expense. The cost of units of property replaced, renewed or retired, plus removal or disposal costs, less salvage, is charged to accumulated depreciation. Generally, electric utility plant other than nuclear fuel is subject to the lien of the Company's mortgage. The balances of electric utility plant in service at December 31 are listed below (in millions).\n1994 1993\nProduction plant $ 5,911.2 $ 5,713.9 Transmission plant 879.6 873.4 Distribution plant 1,929.5 1,825.2 General plant and other 470.6 377.0 --------- --------- Electric utility plant in service $ 9,190.9 $ 8,789.5 ========= =========\nAs prescribed in regulatory uniform systems of accounts, an allowance for the cost of borrowed and equity funds (AFUDC) used to finance electric utility plant construction is charged to the cost of plant. Regulatory authorities consider AFUDC an appropriate charge for inclusion in the Company's utility rates to customers over the service life of the property. The equity funds portion of AFUDC is credited to other income, the borrowed funds portion is credited to interest charges and, in 1992, a deferred income tax provision was reflected as a reduction in the borrowed funds portion. Due to the 1993 implementation of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" AFUDC-borrowed funds is no longer recorded on a net-of-tax basis (see Note 8). The composite AFUDC rate was 8.4% in 1994 and 8.8% in 1993, and the composite, net-of-tax AFUDC rate was 7.3% in 1992. Pursuant to the provisions of SFAS No. 109, the deferred income tax related to AFUDC in undepreciated plant in service as of January 1, 1993, was recorded to a deferred income tax liability with an offsetting adjustment to a regulatory asset.\nC. Depreciation and Amortization\nFor financial reporting purposes, depreciation of utility plant other than nuclear fuel is computed on the straight-line method based on the estimated remaining useful life of the property, adjusted for estimated net salvage. Depreciation provisions, including decommissioning costs (see Note 1D), as a percent of average depreciable property other than nuclear fuel, were approximately 3.8% in 1994 and 1993, and 3.7% in 1992. Depreciation expense totaled $335.1 million for 1994, $325.4 million for 1993 and $306.0 million for 1992. Depreciation and amortization expense also includes amortization of plant abandonment costs (see Note 7).\nAmortization of nuclear fuel costs, including disposal costs associated with obligations to the U.S. Department of Energy (DOE), is computed primarily on the unit-of-production method and charged to fuel for generation. Costs related to obligations to the DOE for the decommissioning and decontamination of enrichment facilities are also charged to fuel for generation. The disposal and the decommissioning and decontamination costs are components of fuel costs for the purpose of deferred fuel accounting (see Note 1F).\nD. Nuclear Decommissioning\nIn the Company's retail jurisdictions, provisions for nuclear decommissioning costs are approved by the NCUC and the SCPSC and are based on site-specific estimates that included the costs for removal of all radioactive and other structures at the site. In the wholesale jurisdiction, the provisions for nuclear decommissioning costs are based on amounts agreed upon in applicable rate settlements. Decommissioning cost provisions, which are included in depreciation and amortization, were $29.5 million in 1994, $34.0 million in 1993 and $27.1 million in 1992.\nAccumulated decommissioning costs, which are included in accumulated depreciation, were $252.7 million at December 31, 1994, and $221.6 million at December 31, 1993, and include amounts retained internally and amounts funded in an external decommissioning trust. The balance of the external decommissioning trust, which is included in miscellaneous other property and investments, was $67.6 million at December 31, 1994, and $44.5 million at December 31, 1993. Trust earnings, which increase the trust balance with a corresponding increase in accumulated decommissioning, were $1.5 million in 1994, $1.2 million in 1993 and $.8 million in 1992. Based on the site-specific estimates discussed below, and using an assumed after-tax earnings rate of 8.5% and an assumed cost escalation rate of 4%, current levels of rate recovery for nuclear decommissioning costs are adequate to provide for decommissioning of the Company's nuclear facilities.\nThe Company's most recent site-specific estimates of decommissioning costs were developed in 1993, using 1993 cost factors, and are based on prompt dismantlement decommissioning, which reflects the cost of removal of all radioactive and other structures currently at the site, with such removal occurring shortly after operating license expiration. These estimates, in 1993 dollars, are $257.7 million for Robinson Unit No. 2, $235.4 million for Brunswick Unit No. 1, $221.4 million for Brunswick Unit No. 2 and $284.3 million for the Harris Plant. The estimates are subject to change based on a variety of factors including, but not limited to, cost escalation, changes in technology applicable to nuclear decommissioning, and changes in federal, state or local regulations. The cost estimates exclude the portion attributable to North Carolina Eastern Municipal Power Agency (Power Agency), which holds an undivided ownership interest in certain of the Company's generating facilities. Operating licenses for the Company's nuclear units expire in the year 2010 for Robinson Unit No. 2, 2016 for Brunswick Unit No. 1, 2014 for Brunswick Unit No. 2 and 2026 for the Harris Plant.\nThe Financial Accounting Standards Board has added a project to its agenda regarding the electric utility industry's current accounting practices related to decommissioning costs. Any changes to these practices could affect such items as: 1) when the decommissioning obligation is recognized, 2) where balances of accumulated decommissioning costs are recorded, 3) where income earned on external decommissioning trust balances is recorded and 4) the levels of annual decommissioning cost provisions. The Financial Accounting Standards Board is in the early stages of this project, and consequently, it is uncertain what impacts, if any, this project may have on the Company's accounting for decommissioning costs.\nE. Regulatory Assets and Liabilities\nAs a regulated entity, the Company is subject to the provisions of SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" Accordingly, the Company records certain assets and liabilities that result from the effects of the ratemaking process, which would not be recorded under generally accepted accounting principles for non-regulated entities. At December 31, 1994, the balances of the Company's regulatory assets were as follows: 1) $384.4 million for income taxes recoverable through future rates, 2) $127.8 million for Harris Plant deferred costs, 3) $71.1 million for abandonment costs, 4) $55 million for loss on reacquired debt, which is included in unamortized debt expense and 5) $66 million for deferred DOE enrichment facilities-related cost, which is included in other assets and deferred debits. At December 31, 1994, the Company had a regulatory liability of $28.3 million related to deferred fuel.\nF. Other Policies\nCustomers' meters are read and bills are rendered on a cycle basis. Revenues are recorded as services are rendered.\nDeferred fuel reflects fuel costs or recoveries that are deferred through fuel clauses established by the Company's regulators. These clauses allow the Company to recover fuel costs and the fuel component of purchased power costs through the fuel component of customer rates. Any difference between actual costs incurred and the fuel component collected in customer billings is reflected in operating expenses as deferred fuel. Customer rates are adjusted periodically to incorporate the approved deferrals. In 1993, the Company reached settlement agreements with regulators in the North Carolina and South Carolina retail jurisdictions and agreed to forgo recovery of a total of $41.1 million of deferred fuel expenses.\nOther property and investments are stated principally at cost. The Company maintains an allowance for doubtful accounts receivable, which totaled $2.5 million at December 31, 1994, and $2.3 million at December 31, 1993. Fuel inventory and inventory of materials and supplies are carried on a first-in, first-out or average cost basis. Long-term debt premiums, discounts and issuance expenses are amortized over the life of the related debt using the straight-line method. Any expenses or call premiums associated with the reacquisition of debt obligations are amortized over the remaining life of the original debt using the straight-line method. For purposes of the Statements of Cash Flows, the Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.\n2. Employee Stock Ownership Plan\nThe Company sponsors a Stock Purchase-Savings Plan (SPSP) for which all full-time employees and certain part-time employees are eligible. The SPSP, which has company match and incentive goal features, encourages systematic savings by employees and provides a method of acquiring Company common stock and other diverse investments. The SPSP, as amended in 1989, is an employee stock ownership plan (ESOP) that can enter into acquisition loans for the purpose of acquiring Company common stock to satisfy SPSP common share needs. Qualification as an ESOP did not change the level of benefits received by employees under the SPSP. Common stock acquired with the proceeds of an ESOP loan is held by the SPSP Trustee in a suspense account and is released from the suspense account and made available for allocation to participants as the ESOP loan is repaid, as specified by provisions of the Internal Revenue Code. Such allocations are used to partially meet common stock needs related to participant contributions, Company matching and incentive contributions and\/or reinvested dividends. Dividends paid on ESOP suspense shares and on ESOP shares allocated to participants, as well as certain Company contributions, are used to repay ESOP acquisition loans, and such dividends are deductible for income tax purposes.\nThere were 9,315,789 ESOP suspense shares at December 31, 1994, with a fair value of $248 million. ESOP shares allocated to plan participants totaled 13,891,199 at December 31, 1994. The Company has a long-term note receivable from the SPSP Trustee related to the purchase of common stock from the Company in 1989. The balance of the Company's note receivable from the SPSP Trustee, $204 million at December 31, 1994, is recorded as unearned ESOP common stock and reduces common stock equity.\nIn 1994, the Company implemented Statement of Position (SOP) 93-6, \"Employers' Accounting for Employee Stock Ownership Plans,\" on a prospective basis. This SOP required the following changes in accounting for the Company's ESOP: 1) ESOP shares that have not been committed to be released to participants' accounts are no longer considered outstanding for the determination of earnings per common share; 2) dividends on unallocated ESOP shares are no longer recognized for financial statement purposes; 3) interest income related to the qualified ESOP loan is no longer recognized; 4) the difference between the acquisition and allocation prices of ESOP shares, which was previously recorded as other income, net, is now recorded directly to common stock; and 5) all tax benefits of ESOP dividends are now recorded to non-operating income tax expense, whereas in 1993, a portion of the tax benefits was recorded directly to retained earnings. In 1992, prior to the implementation of SFAS No. 109, all tax benefits of ESOP dividends were recorded to retained earnings and were included in the determination of earnings per common share. In addition, pursuant to SOP 93-6, ESOP loan transactions between the Company and the SPSP Trustee are no longer reflected in the Statement of Cash Flows. The implementation of SOP 93-6 resulted in an increase in earnings per common share of approximately $.04 for 1994.\n3. Capitalization\nIn 1994, the Board of Directors of the Company authorized the Executive Committee of the Board to repurchase up to 10 million shares of the Company's common stock on the open market. Under this stock repurchase program, the Company has purchased approximately 4.4 million shares through December 31, 1994.\nIn 1993, the Company's common stock was split and one additional share was issued for each common share outstanding. Prior year financial information was restated to reflect the two-for-one stock split.\nAt December 31, 1994, the Company had 14,767,052 shares of authorized but unissued common stock reserved and available for issuance to satisfy the requirements of the Company's stock plans. The Company intends, however, to meet the requirements of these stock plans with issued and outstanding shares presently held by the Trustee of the SPSP or with open market purchases of common stock shares, as appropriate.\nThe Company's mortgage, as supplemented, and charter contain provisions limiting the use of retained earnings for the payment of dividends under certain circumstances. At December 31, 1994, there were no significant restrictions on the use of retained earnings.\nAt December 31, 1994, long-term debt maturities for the years 1995 through 1999 were $275.1 million, $105 million, $40 million, $205 million and $50 million, respectively.\nPerson County Pollution Control Revenue Refunding Bonds - Series 1992A totaling $56 million have interest rates that must be negotiated on a weekly basis. At the time of interest rate renegotiation, holders of these bonds may require the Company to repurchase their bonds. These bonds are classified as long-term debt in the Balance Sheets, consistent with the Company's intention to maintain the debt as long-term and to the extent this intention is supported by the Company's long-term revolving credit agreements.\n4. Short-Term Debt and Revolving Credit Facilities\nAt December 31, 1994 and 1993, the Company's short-term debt balances were $68.1 million and $76 million, respectively. The weighted-average interest rates of these borrowings were 6.18% at December 31, 1994, and 3.65% at December 31, 1993. At December 31, 1994, the Company's unused and readily available revolving credit facilities totaled $307.9 million, consisting of long-term agreements totaling $207.9 million and a $100 million short-term agreement.\n5. Fair Value of Financial Instruments\nThe carrying amounts of cash, cash equivalents and notes payable approximate fair value because of the short maturities of these instruments. The carrying amount of the Company's long-term debt was $2.86 billion at December 31, 1994, and $2.80 billion at December 31, 1993. The estimated fair value of this debt, which was obtained from an independent pricing service, was $2.70 billion at December 31, 1994, and $2.88 billion at December 31, 1993. There are inherent limitations in any estimation technique, and these estimates are not necessarily indicative of the amount the Company could realize in current transactions.\n6. Postretirement Benefit Plans\nThe Company has a noncontributory defined benefit retirement (pension) plan for all full-time employees and funds the pension plan in amounts that comply with contribution limits imposed by law. Pension plan benefits reflect an employee's compensation, years of service and age at retirement.\nThe components of net periodic pension cost are (in thousands):\n1994 1993 1992\nActual return on plan assets $ 4,897 $(43,604) $(26,882) Variance from expected return, deferred (47,219) 4,490 (9,743) ------- -------- ------- Expected return on plan assets (42,322) (39,114) (36,625) Service cost 19,686 16,776 21,368 Interest cost on projected benefit obligation 35,108 31,928 31,141 Net amortization 831 (2,390) 758 ------- ------- ------ Net periodic pension cost $ 13,303 $ 7,200 $ 16,642 ======= ====== =======\nReconciliations of the funded status of the pension plan at December 31 are (in thousands): 1994 1993\nActuarial present value of benefits for services rendered to date: Accumulated benefits based on salaries to date, including vested benefits of $287.7 million for 1994 and $293.6 million for 1993 $ 330,361 $ 339,301 Additional benefits based on estimated future salary levels 103,766 112,497 -------- -------- Projected benefit obligation 434,127 451,798 Fair market value of plan assets, invested primarily in equity and fixed-income securities 506,605 515,428 -------- -------- Funded status 72,478 63,630 Unrecognized prior service costs 9,471 12,620 Unrecognized actuarial gain (124,447) (119,352) Unrecognized transition obligation, being amortized over 18.5 years beginning January 1, 1987 1,110 1,216 -------- -------- Accrued pension costs recognized in the Balance Sheets $ (41,388) $ (41,886) ======== ========\nThe assumptions used to measure the projected benefit obligation are:\n1994 1993\nWeighted-average discount rate 8.5% 7.5% Assumed rate of increase in future compensation 4.2% 4.2%\nThe expected long-term rate of return on pension plan assets used in determining the net periodic pension cost was 9% in each of the years 1994, 1993 and 1992.\nIn addition to pension benefits, the Company provides contributory postretirement benefits, including certain health care and life insurance benefits, for substantially all retired employees. In 1993, the Company implemented SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS No. 106 requires the recognition of the costs associated with these other postretirement benefits (OPEB) on an accrual basis. Previously, the cost of OPEB was generally recognized as claims were incurred and premiums were paid and totaled $2.7 million in 1992.\nThe components of net periodic OPEB cost are (in thousands):\n1994 1993\nActual return on plan assets $ 42 $ (497) Variance from expected return, deferred (682) 9 ------- ------- Expected return on plan assets (640) (488) Service cost 8,039 6,797 Interest cost on accumulated benefit obligation 9,463 9,662 Net amortization 5,966 5,966 ------- ------- Net periodic OPEB cost $ 22,828 $ 21,937 ======= =======\nReconciliations of the funded status of the OPEB plans at December 31 are (in thousands): 1994 1993\nActuarial present value of benefits for services rendered to date: Current retirees $ 55,799 $ 62,727 Active employees eligible to retire 11,933 14,800 The assumptions used to measure the accumulated postretirement benefit obligation are: Active employees not eligible to retire 63,164 62,225 ------- ------- Accumulated postretirement benefit obligation 130,896 139,752 Fair market value of plan assets, invested primarily in equity and fixed-income securities 12,142 7,584 ------- ------- Funded status (118,754) (132,168) Unrecognized actuarial (gain) loss (15,125) 6,288 Unrecognized transition obligation, being amortized over 20 years beginning January 1, 1993 107,379 113,345 ------- ------- Accrued OPEB costs recognized in the Balance Sheets $(26,500) $(12,535) ======= =======\nThe assumptions used to measure the accumulated postretirement benefit obligation are:\n1994 1993\nWeighted-average discount rate 8.5% 7.5% Initial medical cost trend rate for pre-medicare benefits 9.6% 10.7% Initial medical cost trend rate for post-medicare benefits 8.7% 9.5% Ultimate medical cost trend rate 6.0% 5.0% Year ultimate medical cost trend rate is achieved 2005 2005\nThe expected long-term rate of return on plan assets used in determining the net periodic OPEB cost was 9% in 1994 and 1993. Assuming a one percent increase in the medical cost trend rates, the aggregate of the service and interest cost components of the net periodic OPEB cost for 1994 would increase by $2.5 million, and the accumulated postretirement benefit obligation at December 31, 1994, would increase by $15.1 million. In general, OPEB costs are paid as claims are incurred and premiums are paid; however, the Company is partially funding retiree health care benefits in a trust created pursuant to Section 401(h) of the Internal Revenue Code.\n7. Plant-Related Deferred Costs\nThe Company abandoned efforts to complete Harris Unit Nos. 3 and 4 in December 1981, Harris Unit No. 2 in December 1983 and Mayo Unit No. 2 in March 1987. The NCUC and SCPSC each allowed the Company to recover the cost of these abandoned units over a ten-year period without a return on the unamortized balances. The amortization of Harris Unit Nos. 3 and 4 costs was completed in 1992, and of Harris Unit No. 2 costs in 1994. In 1988 rate orders and a 1990 NCUC Order on Remand, the Company was ordered to remove from rate base and treat as abandoned plant certain costs related to the Harris Plant. Amortization related to abandoned plant costs associated with the 1990 NCUC Order on Remand was completed in 1994. Abandoned plant amortization related to the 1988 rate orders will be completed in 1998 for the North Carolina retail and the wholesale jurisdictions and in 2027 for the South Carolina retail jurisdiction.\nAmortization of plant abandonment costs is included in depreciation and amortization expense and totaled $60.5 million in 1994, $100.7 million in 1993 and $92.5 million in 1992. Prior to the 1993 implementation of SFAS No. 109, this amortization was reported net of certain deferred taxes (see Note 8). The unamortized balances of plant abandonment costs are reported at the present value of future recoveries of these costs. The associated accretion of present value was $6.6 million in 1994, $13.2 million in 1993 and $18.2 million in 1992 and is reported in other income, net.\nIn 1988, the Company began recovering certain Harris Plant deferred costs over ten years from the date of deferral, with carrying costs accruing on the unamortized balance. Excluding deferred purchased capacity costs (see Note 10A), the unamortized balance of Harris Plant deferred costs was $60.8 million at December 31, 1994, and $81.4 million at December 31, 1993.\n8. Income Taxes\nIncome taxes are allocated between operating income and other income based on the source of the income that generated the tax. Investment tax credits related to operating income are amortized over the service life of the related property.\nIn 1993, the Company implemented SFAS No. 109 on a prospective basis. SFAS No. 109 required the Company to establish additional deferred tax assets and liabilities for certain temporary differences and to adjust deferred tax accounts for changes in income tax rates. It also prohibited net-of-tax accounting for income statement and balance sheet items. Substantially all of the adjustments required by SFAS No. 109 were recorded to deferred income tax balance sheet accounts, with offsetting adjustments to certain assets and liabilities. As a result, the cumulative effect on net income was not material. Prior to the implementation of SFAS No. 109, the Company recorded the following income statement items on a net-of-tax basis: Harris Plant deferred costs, Harris Plant carrying costs and allowance for borrowed funds used during construction. See Note 2 for the impact of SFAS No. 109 on the treatment of tax benefits of ESOP dividends. Prior period financial statement amounts were not restated for SFAS No. 109.\nNet accumulated deferred income tax liabilities at December 31 are (in thousands):\n1994 1993 Accelerated depreciation and property cost differences $ 1,504,187 $ 1,449,796 Deferred costs, net 144,751 168,311 Miscellaneous other temporary differences, net (7,173) (12,443) ---------- ---------- Net accumulated deferred income tax liability $ 1,641,765 $ 1,605,664 ========== ==========\nTotal deferred income tax liabilities were $1.9 billion at December 31, 1994, and 1993. Total deferred income tax assets were $297 million at December 31, 1994, and $261 million at December 31, 1993.\nThe provisions for income tax expense are comprised of (in thousands):\n1994 1993 1992 Included in Operating Expenses Income tax expense (credit) Current - federal $ 143,461 $ 108,935 $ 93,319 state 39,185 29,687 37,616 Deferred - federal 23,926 50,719 81,134 state 3,500 11,588 6,342 Investment tax credit adjustments (11,537) (11,612) (11,083) -------- -------- -------- Subtotal 198,535 189,317 207,328 -------- -------- -------- Harris Plant deferred costs Deferred - federal - - 2,523 state - - 597 Investment tax credit adjustments (297) 218 (182) -------- -------- -------- Subtotal (297) 218 2,938 -------- -------- -------- Total included in operating expenses 198,238 189,535 210,266 -------- -------- -------- Included in Other Income Income tax expense (credit) Current - federal (15,732) (6,168) (5,857) state (3,507) (1,291) (1,268) Deferred - federal 8,065 7,483 11,024 state 1,749 1,562 1,986 Investment tax credit adjustments - (1,194) - -------- -------- -------- Subtotal (9,425) 392 5,885 -------- -------- -------- Harris Plant carrying costs Deferred - federal - - 1,612 state - - 357 -------- -------- -------- Subtotal - - 1,969 -------- -------- -------- Other income, net Deferred - federal - - 47 state - - 11 -------- -------- -------- Subtotal - - 58 -------- -------- -------- Total included in other income (9,425) 392 7,912 -------- -------- -------- Included in Interest Charges Allowance for borrowed funds used during construction Deferred - federal - - 1,678 state - - 382 -------- -------- -------- Total included in interest charges - - 2,060 -------- -------- -------- Total income tax expense $ 188,813 $ 189,927 $ 220,238 ======== ======== ========\nA reconciliation of the Company's effective income tax rate to the statutory federal income tax rate follows.\n1994 1993 1992\nEffective income tax rate 37.6% 35.4% 36.7% State income taxes, net of federal income tax benefit (5.5) (5.1) (5.1) Investment tax credit amortization 2.4 2.3 1.9 Other differences, net 0.5 2.4 0.5 ---- ---- ---- Statutory federal income tax rate 35.0% 35.0% 34.0% ==== ==== ====\n9. Joint Ownership of Generating Facilities\nPower Agency, which includes a majority of the Company's previous municipal wholesale customers, holds undivided ownership interests in certain generating facilities of the Company. The Company and Power Agency are entitled to shares of the generating capability and output of each unit equal to their respective ownership interests. Each also pays its ownership share of additional construction costs, fuel inventory purchases and operating expenses. The Company's share of expenses for the jointly-owned units is included in the appropriate expense category in the Statements of Income. Power Agency's payment obligation with respect to abandonment costs for Mayo Unit No. 2 is 12.94% of such costs.\nThe Company's share of the jointly-owned generating facilities is listed below with related information as of December 31, 1994 (dollars in millions).\nFacility Megawatt Company Plant Accumulated Under Capability Ownership Investment Depreciation Construction Interest\nMayo Plant 745 83.83% $ 432.3 $ 146.9 $ 1.3 Harris Plant 860 83.83% $ 2,994.3 $ 661.0 $ 7.7 Brunswick Plant 1,521 81.67% $ 1,315.0 $ 708.9 $ 59.8 Roxboro Unit No.4 700 87.06% $ 219.2 $ 86.7 $ 4.9\nIn the table above, plant investment and accumulated depreciation, which includes accumulated decommissioning, are not reduced by the regulatory disallowances related to the Harris Plant.\n10. Commitments and Contingencies\nA. Purchased Power\nThe Company is obligated to purchase a percentage of Power Agency's ownership capacity and energy from the Mayo and Harris Plants. For Mayo, the percentage purchased declines ratably over a 15-year period that ends in 1997. In 1993, the Company and Power Agency entered into an agreement to restructure portions of their contracts covering power supplies and interests in jointly-owned units. Pursuant to the agreement, a portion of the Company's Harris Plant cost will not be recoverable through sales of supplemental power to Power Agency. As a result, the Company recorded a write-off in 1993 of $20.6 million, or $14.7 million, net of tax. Under the terms of the 1993 agreement, the Company also increased the amount of capacity and energy purchased from Power Agency's ownership interest in the Harris Plant, and the buyback period was extended six years through 2007. The estimated minimum annual payments for these purchases, which reflect capital-related capacity costs, total approximately $27 million. Other costs of such purchases are primarily demand-related production expenses, fuel and energy-related operation and maintenance expenses. Contractual purchases from the Mayo and Harris Plants totaled $60.4 million for 1994, $52.6 million for 1993 and $39.8 million for 1992. In 1987, the NCUC ordered the Company to reflect the recovery of the capacity portion of these costs on a levelized basis over the original 15-year buyback period, thereby deferring for future recovery the difference between such costs and amounts collected through rates. In 1988, the SCPSC ordered similar treatment, but with a ten-year levelization period. At December 31, 1994 and 1993, the Company had deferred purchased capacity costs, including carrying costs accrued on the deferred balances, of $70.9 million and $67.1 million, respectively. Increased purchases resulting from the 1993 agreement with Power Agency, which were approximately $21 million on an annual basis for 1994 and 1993, are not being deferred for future recovery.\nThe Company purchases 250 megawatts of generating capacity from Indiana Michigan Power Company's Rockport Unit No. 2. The estimated minimum annual payment for power is approximately $30 million, which represents capital-related capacity costs. Other power costs include demand-related production expenses, fuel and energy-related operation and maintenance expenses. Purchases, including transmission use charges, totaled $61.9 million, $60.2 million and $62.9 million for 1994, 1993 and 1992, respectively. The agreement expires on December 31, 2009.\nIn mid-1993, the Company began purchasing 400 megawatts of generating capacity from Duke Power Company. The estimated minimum annual payment for power under the six-year agreement is $43 million, which represents capital-related capacity costs. Other power costs associated with the agreement include fuel and energy-related operation and maintenance expenses. Purchases, including transmission use charges, totaled $62.9 million for 1994 and $37.1 million for 1993. The agreement was recently approved by FERC.\nB. Insurance\nThe Company is a member of Nuclear Mutual Limited (NML), which provides primary insurance coverage against property damage to members' nuclear generating facilities. The Company is insured thereunder for $500 million for each of its nuclear generating facilities. For the current policy period, the Company is subject to maximum retrospective premium assessments of approximately $22.7 million in the event that losses at insured facilities exceed premiums, reserves, reinsurance and other NML resources, which are at present more than $741 million.\nThe Company is also a member of Nuclear Electric Insurance Limited (NEIL), which provides insurance coverage against incremental costs of replacement power resulting from prolonged accidental outages of members' nuclear generating units. The Company is insured thereunder for the first 52 weeks (starting 21 weeks after the outage begins) in weekly amounts of $1.9 million at Brunswick Unit No. 1, $1.9 million at Brunswick Unit No. 2, $2.4 million at the Harris Plant and $1.7 million at Robinson Unit No. 2. The Company is insured for the next 104 weeks for 80% of the above amounts. NEIL also provides decontamination, decommissioning and excess property insurance for nuclear generating facilities. The Company is insured under this coverage for $1.4 billion at each of its nuclear generating facilities. This is in addition to the $500 million coverage provided by NML. For the current policy period, the Company is subject to retrospective premium assessments of up to approximately $10.1 million with respect to the incremental replacement power costs coverage and $43.3 million with respect to the decontamination, decommissioning and excess property coverage in the event covered expenses at insured facilities exceed premiums, reserves, reinsurance and other NEIL resources. These resources are at present more than $2.1 billion. Pursuant to regulations of the Nuclear Regulatory Commission, the Company's property damage insurance policies provide that all proceeds from such insurance be applied, first, to place a plant in safe and stable condition after an accident and, second, to decontaminate it before any proceeds can be used for plant repair or restoration. The Company is responsible to the extent losses may exceed limits of the coverage described above. Power Agency would be responsible for its ownership share of such losses and for certain retrospective premium assessments on jointly-owned units.\nThe Company is insured against public liability for a nuclear incident up to $8.9 billion per occurrence, which is the maximum limit on public liability claims pursuant to the Price-Anderson Act. In the event that public liability claims from an insured nuclear incident exceed $200 million, the Company would be subject to a pro rata assessment of up to $75.5 million, plus a 5% surcharge, for each reactor owned for each incident. Payment of such assessment would be made over time as necessary to limit the payment in any one year to no more than $10 million per reactor owned. Power Agency would be responsible for its ownership share of the assessment on jointly-owned units.\nC. Claims and Uncertainties\n(1) The Company is subject to federal, state and local regulations addressing air and water quality, hazardous and solid waste management and other environmental matters.\nVarious organic materials associated with the production of manufactured gas, generally referred to as coal tar, are regulated under various federal and state laws, and a liability may exist for their remediation. There are several manufactured gas plant (MGP) sites to which the Company and certain entities that were later merged into the Company may have had some connection. In this regard, the Company, along with other entities alleged to be former owners and operators of MGP sites in North Carolina, is participating in a cooperative effort with the North Carolina Department of Environment, Health and Natural Resources, Division of Solid Waste Management (DSWM) to establish a uniform framework for addressing those sites. It is anticipated that the investigation and remediation of specific MGP sites will be addressed pursuant to one or more Administrative Orders on Consent between DSWM and individual potentially responsible parties. To date, the Company has not entered into any such orders.\nThe Company has recently been approached by another North Carolina public utility concerning a possible cost-sharing arrangement with respect to the investigation and, if necessary, the remediation of four MGP sites. The Company is currently engaged in discussions with the other utility regarding this matter.\nIn addition, a current owner of property that was the site of one MGP owned by Tide Water Power Company (Tide Water Power), which merged into the Company in 1952, and the Company have entered into an agreement to share the cost of investigation and, if necessary, remediation of this site. The Company has also been approached by a North Carolina municipality that is the current owner of another MGP site that was formerly owned by Tide Water Power. The Company is engaged in discussions with that municipality concerning a possible cost-sharing arrangement with respect to the investigation and, if necessary, the remediation of that site.\nThe Company is continuing its investigation regarding the identities of parties connected to several additional MGP sites, the relative relationships of the Company and other parties to those sites and the degree, if any, to which the Company should undertake shared voluntary efforts with others at individual sites.\nThe Company has been notified by regulators of its involvement or potential involvement in several sites, other than MGP sites, that require remedial action. Although the Company cannot predict the outcome of these matters, it does not anticipate significant costs associated with these sites.\nIn 1994, the Company accrued a liability for the estimated costs associated with investigation and remediation activities for certain MGP sites and for sites other than MGP sites. This accrual was not material to the results of operations of the Company. Due to the lack of information with respect to the operation of MGP sites for which a liability has not been accrued and due to the uncertainty concerning questions of liability and potential environmental harm, the extent and cost of required remedial action, if any, are not currently determinable. The Company cannot predict the outcome of these matters or the extent to which other MGP sites may become the subject of inquiry.\n(2) As required under the Nuclear Waste Policy Act of 1982, the Company entered into a contract with the DOE under which the DOE agreed to dispose of the Company's spent nuclear fuel. The Company cannot predict whether the DOE will be able to perform its contractual obligations and provide interim storage or permanent disposal repositories for spent nuclear fuel and\/or high-level radioactive waste materials on a timely basis.\nWith certain modifications, the Company's spent fuel storage facilities are sufficient to provide storage space for spent fuel generated on the Company's system through the expiration of the current operating licenses for all of the Company's nuclear generating units. Subsequent to the expiration of the licenses, dry storage may be necessary.\nIn the opinion of management, liabilities, if any, arising under other pending claims would not have a material effect on the financial position, results of operations or cash flows of the Company.\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) Information on the Company's directors is set forth in the Company's 1995 definitive proxy statement dated March 31, 1995, and incorporated by reference herein.\nb) Information on the Company's executive officers is set forth in Part I and incorporated by reference herein.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ________ ______________________\nInformation on executive compensation is set forth in the Company's 1995 definitive proxy statement dated March 31, 1995, and incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT _______ _______________________________________________\na) The Company knows of no person who is a beneficial owner of more than five (5%) percent of any class of the Company's voting securities except for Wachovia Bank of North Carolina, N.A., Post Office Box 3099, Winston-Salem, North Carolina 27102 which as of December 31, 1994, owned 25,027,393 shares of Common Stock (15.9% of Class) as Trustee of the Company's Stock Purchase-Savings Plan.\nb) Information on security ownership of the Company's management is set forth in the Company's 1995 definitive proxy statement dated March 31, 1995, and incorporated by reference herein.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS _______ ______________________________________________\nInformation on certain relationships and transactions is set forth in the Company's 1995 definitive proxy statement dated March 31, 1995, and incorporated by reference herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. ________ ________________________________________________________\na) 1. Financial Statements Filed:\nSee ITEM 8 - Financial Statements and Supplementary Data. ______\n2. Financial Statement Schedules Filed:\nSee ITEM 8 - Financial Statements and Supplementary Data. ______\n3. Exhibits Filed: ______________\nExhibit No. *3a(1) Restated Charter of Carolina Power & Light Company, dated May 22, 1980 (filed as Exhibit 2(a)(1), File No. 2-64193).\nExhibit No. *3a(2) Amendment, dated May 10, 1989, to Restated Charter of the Company (filed as Exhibit 3(b), File No. 33-33431).\nExhibit No. *3a(3) Amendment, dated May 27, 1992 to Restated Charter of the Company (filed as Exhibit 4(b)(2), File No. 33-55060).\nExhibit No. *3a(4) By-laws of the Company as amended December 12, 1990 (filed as Exhibit 3(c), File No. 33-38298).\nExhibit No. *4a(1) Resolution of Board of Directors, dated December 8, 1954, authorizing the issuance of, and establishing the series designation, dividend rate and redemption prices for the Company's Serial Preferred Stock, $4.20 Series (filed as Exhibit 3(c), File No. 33- 25560).\nExhibit No. *4a(2) Resolution of Board of Directors, dated January 17, 1967, authorizing the issuance of, and establishing the series designation, dividend rate and redemption prices for the Company's Serial Preferred Stock, $5.44 Series (filed as Exhibit 3(d), File No. 33- 25560).\nExhibit No. *4a(3) Statement of Classification of Shares dated January 13, 1971, relating to the authorization of, and establishing the series designation, dividend rate and redemption prices for the Company's Serial Preferred Stock, $7.95 Series (filed as Exhibit 3(f), File No. 33- 25560).\nExhibit No. *4a(4) Statement of Classification of Shares dated September 7, 1972, relating to the authorization of, and establishing the series designation, dividend rate and redemption prices for the Company's Serial Preferred Stock, $7.72 Series (filed as Exhibit 3(g), File No. 33- 25560).\nExhibit No. *4b Mortgage and Deed of Trust dated as of May 1, 1940 between the Company and The Bank of New York (formerly, Irving Trust Company) and Frederick G. Herbst (W.T. Cunningham, Successor), Trustees and the First through Fifth Supplemental Indentures thereto (Exhibit 2(b), File No. 2-64189); and the Sixth through Sixty-third Supplemental Indentures (Exhibit 2(b)-5, File No. 2-16210; Exhibit 2(b)-6, File No. 2-16210; Exhibit 4(b)-8, File No. 2-19118; Exhibit 4(b)-2, File No. 2-22439; Exhibit 4(b)-2, File No. 2-24624; Exhibit 2(c), File No. 2-27297; Exhibit 2(c), File No. 2-30172; Exhibit 2(c), File No. 2-35694; Exhibit 2(c), File No. 2-37505; Exhibit 2(c), File No. 2-39002; Exhibit 2(c), File No. 2-41738; Exhibit 2(c), File No. 2-43439; Exhibit 2(c), File No. 2-47751; Exhibit 2(c), File No. 2-49347; Exhibit 2(c), File No. 2-53113; Exhibit 2(d), File No. 2-53113; Exhibit 2(c), File No. 2-59511; Exhibit 2(c), File No. 2-61611; Exhibit 2(d), File No. 2- 64189; Exhibit 2(c), File No. 2-65514; Exhibits 2(c) and 2(d), File No. 2-66851; Exhibits 4(b)-1, 4(b)-2, and 4(b)-3, File No. 2-81299; Exhibits 4(c)-1 through 4(c)-8, File No. 2-95505; Exhibits 4(b) through 4(h), File No. 33-25560; Exhibits 4(b) and 4(c), File No. 33-33431; Exhibits 4(b) and 4(c), File No. 33-38298; Exhibits 4(h) and 4(i), File No. 33- 42869; Exhibits 4(e)-(g), File No. 33- 48607; Exhibits 4(e) and 4(f), File No 33-55060; Exhibits 4(e) and 4(f), File No. 33-60014; Exhibits 4(a) and 4(b), File No. 33-38349; Exhibit 4(e), File No. 33-50597; and Exhibit 4(e) and 4(f), File No. 33-57835.\nExhibit No. *10a(1) Purchase, Construction and Ownership Agreement dated July 30, 1981 between Carolina Power & Light Company and North Carolina Municipal Power Agency Number 3 and Exhibits, together with resolution dated December 16, 1981 changing name to North Carolina Eastern Municipal Power Agency, amending letter dated February 18, 1982, and amendment dated February 24, 1982 (filed as Exhibit 10(a), File No. 33-25560).\nExhibit No. *10a(2) Operating and Fuel Agreement dated July 30, 1981 between Carolina Power & Light Company and North Carolina Municipal Power Agency Number 3 and Exhibits, together with resolution dated December 16, 1981 changing name to North Carolina Eastern Municipal Power Agency, amending letters dated August 21, 1981 and December 15, 1981, and amendment dated February 24, 1982 (filed as Exhibit 10(b), File No. 33- 25560).\nExhibit No. *10a(3) Power Coordination Agreement dated July 30, 1981 between Carolina Power & Light Company and North Carolina Municipal Power Agency Number 3 and Exhibits, together with resolution dated December 16, 1981 changing name to North Carolina Eastern Municipal Power Agency and amending letter dated January 29, 1982 (filed as Exhibit 10(c), File No. 33-25560).\nExhibit No. *10a(4) Amendment dated December 16, 1982 to Purchase, Construction and Ownership Agreement dated July 30, 1981 between Carolina Power & Light Company and North Carolina Eastern Municipal Power Agency (filed as Exhibit 10(d), File No. 33-25560).\nExhibit No. *10a(5) Agreement Regarding New Resources and Interim Capacity between Carolina Power & Light Company and North Carolina Eastern Municipal Power Agency dated October 13, 1987 (filed as Exhibit 10(e), File No. 33-25560).\nExhibit No. *10a(6) Power Coordination Agreement - 1987A between North Carolina Eastern Municipal Power Agency and Carolina Power & Light Company for Contract Power From New Resources Period 1987- 1993 dated October 13, 1987 (filed as Exhibit 10(f), File No. 33-25560).\n+ Exhibit No. *10c(1) Directors Deferred Compensation Plan effective January 1, 1982 as amended (filed as Exhibit 10(g), File No. 33-25560).\n+ Exhibit No. *10c(2) Supplemental Executive Retirement Plan effective January 1, 1984 (filed as Exhibit 10(h), File No. 33-25560).\n+ Exhibit No. *10c(3) Retirement Plan for Outside Directors (filed as Exhibit 10(i), File No. 33- 25560).\n+ Exhibit No. *10c(4) Executive Deferred Compensation Plan effective May 1, 1982 as amended (filed as Exhibit 10(j), File No. 33-25560).\n+ Exhibit No. *10c(5) Key Management Deferred Compensation Plan (filed as Exhibit 10(k), File No. 33-25560).\n+ Exhibit No. *10c(6) Resolutions of the Board of Directors, dated March 15, 1989, amending the Key Management Deferred Compensation Plan (filed as Exhibit 10(a), File No. 33- 48607).\n+ Exhibit No. *10c(7) Resolutions of the Board of Directors dated May 8, 1991, amending the Directors Deferred Compensation Plan (filed as Exhibit 10(b), File No. 33- 48607).\n+ Exhibit No. *10c(8) Resolutions of the Board of Directors dated May 8, 1991, amending the Executive Deferred Compensation Plan (filed as Exhibit 10(c), File No. 33- 48607).\nExhibit No. 12 Computation of Ratio of Earnings to Fixed Charges and Preferred Dividends Combined and Ratio of Earnings to Fixed Charges.\nExhibit No. 23(a) Consent of Deloitte & Touche LLP.\nExhibit No. 23(b) Consent of Richard E. Jones.\n____________\n*Incorporated herein by reference as indicated. +Management contract or compensation plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14(c) of Form 10-K.\nb) Reports on Form 8-K filed during or with respect to the last quarter of 1994 and the portion of the first quarter of 1995 prior to the filing of this 10-K:\nDate of Report Item Reported ______________ _____________\nJanuary 23, 1995 Item 7. Financial Statements, Pro Forma Financial Information and Exhibits\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 24th day of March, 1995.\nCAROLINA POWER & LIGHT COMPANY ______________________________ (Registrant)\nBy \/s\/ Paul S. Bradshaw Vice President 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 date indicated.\nSignature Title Date _________ _____ ____\n\/s\/ Sherwood H. Smith, Jr. Principal Executive (Chairman and Chief Executive Officer) Officer and Director\n\/s\/ Charles D. Barham, Jr. Principal Financial (Executive Vice President Officer and Director and Chief Financial Officer)\n\/s\/ Paul S. Bradshaw Principal Accounting (Vice President and Controller) Officer\n\/s\/ Edwin B. Borden Director March 24, 1995\n\/s\/ Felton J. Capel Director\n\/s\/ William Cavanaugh III Director (President and Chief Operating Officer)\n\/s\/ George H. V. Cecil Director\n\/s\/ Charles W. Coker Director\n\/s\/ William E. Graham, Jr. Director\n\/s\/ Gordon C. Hurlbert Director\n\/s\/ J. R. Bryan Jackson Director\n\/s\/ Robert L. Jones Director\n\/s\/ Estell C. Lee Director\n\/s\/ J. Tylee Wilson Director","section_15":""}
{"filename":"788964_1994.txt","cik":"788964","year":"1994","section_1":"ITEM 1. BUSINESS -------------------------------------------------------------------------------- OVERVIEW --------------------------------------------------------------------------------\nOHM Corporation (the \"Company\") is one of the largest providers, on the basis of revenues, of technology-based, on-site hazardous waste remediation services in the United States. The Company and its predecessors have been in the environmental services business since 1969. Over time the Company developed emergency response cleanup and planned remediation capabilities. The Company has successfully completed over 19,000 projects involving contaminated groundwater, soil and facilities.\nThe Company provides a wide range of environmental services, primarily to large chemical, petroleum, transportation and industrial companies, and to government agencies. The Company has worked for most of the Fortune 100 industrial companies, the Environmental Protection Agency (the \"EPA\"), the Department of Defense (the \"DOD\") (including the U.S. Army Corp of Engineers (\"USACE\") and the U.S. Departments of the Air Force and Navy), the Department of Energy (\"DOE\") and a number of state and local governments. The Company specializes in applying a full spectrum of on-site technologies, including biological, chemical, physical, soil vapor extraction and thermal technologies, to remediate hazardous and industrial wastes on both a planned and an emergency response basis. In 1994, planned services represented approximately 95% of net revenues and emergency response services represented approximately 5% of net revenues. Although the Company primarily performs technology-based, on-site remediation services, it also offers a broad range of other services, including site assessment, engineering, remedial design and analytical testing. Service is provided through 29 regional offices, one fixed laboratory at its headquarters in Findlay, Ohio, nine mobile laboratories, and more than 3,000 pieces of mobile treatment and related field equipment.\nIn response to what the Company perceived as increased opportunities in the field of on-site hazardous waste remediation services, since 1990 the Company has substantially completed a program to divest itself of or reduce its ownership in its nonremediation businesses in order to focus on its core remediation business. In 1991, the Company sold its three commercial testing laboratories in September 1991 for $12.9 million and completed the write-off of its investment in Concord Resources Group, Inc., a joint venture with Consolidated Rail Corporation which owned and operated fixed-base hazardous waste facilities. In 1993 the Company sold its fixed-base hazardous waste treatment and storage facility for $14.6 million and the Company's investment in NSC Corporation (\"NSC\") was reduced from 70% to 40% as a result of NSC's purchase of the asbestos abatement division of The Brand Companies, Inc. (\"Brand\") in exchange for NSC's industrial cleaning and maintenance business and the issuance of 4,010,000 shares of NSC's common stock.\nAs previously announced, the Company has entered into an Agreement and Plan of Reorganization dated December 5, 1994 with Rust International Inc. and certain of its subsidiaries (\"Rust\") pursuant to which the hazardous and nuclear waste remediation businesses of Rust will be merged with and into the Company's subsidiary, OHM Remediation Services Corp. in exchange for the issuance to Rust of 10,368,000 shares of the Company's Common Stock. The transaction is subject to the approval of the Company's shareholders which will be considered at the Company's Annual Meeting of Shareholders to be held May 11, 1995.\nOHM'S ENVIRONMENTAL REMEDIATION SERVICES\nThe Company assists its clients by providing comprehensive on-site treatment of toxic materials and hazardous wastes. By applying a broad range of biological, chemical, physical, soil vapor extraction and thermal treatment technologies, the Company performs on-site treatment and remediation services for the control, detoxification, decontamination, and volume reduction of hazardous and toxic material. Accordingly, the Company has designed a wide range of modular mobile treatment equipment, which can be used on-site, either independently or in a system, for removing, detoxifying, reducing the volume of, or stabilizing contaminants. This equipment includes thermal destruction units, dewatering presses, filters, separators, ion exchangers, stripping\nsystems and mobile process equipment which apply various physical, chemical and biological technologies to remediate contaminants. Since 1970, the Company has completed over 16,000 projects throughout the United States, cleaning up hazardous wastes, removing toxic chemicals from groundwater, and cleaning facilities of contaminants. Since the disposition by the Company in early 1993 of its interest in OHM Resource Recovery Corp., the operator of a hazardous waste treatment and disposal facility, the Company does not own or operate any hazardous waste disposal sites or other off-site waste treatment or disposal facilities. The Company generally coordinates through licensed subcontractors the transportation and disposal of any hazardous waste which is not remediated on site.\nThe Company endeavors to offer clients an increasingly broad array of on-site treatment services, either on a planned or emergency basis, from its 29 regional offices located throughout the country. On-site environmental remediation services provided by the Company include:\n. Treatment, stabilization or removal of contaminants;\n. Decontamination of industrial facilities;\n. Assessment, characterization and treatment of contaminated soil and\/or groundwater;\n. Surface impoundment restoration, including volume reduction, stabilization and closure of contaminated lagoons;\n. Management of underground and aboveground storage tanks;\n. Design, engineering, fabrication, installation and operation of on-site treatment equipment; and\n. Emergency response to virtually any kind of industrial or transportation-related accident involving hazardous waste or materials.\nThe Company undertakes these projects on both a planned basis, which is scheduled in advance, and an emergency basis, which is performed in direct response to spills, fires and industrial accidents. The Company places its emphasis upon planned work because of its more predictable resource requirements, and because of its larger potential market. In 1994, planned projects accounted for 95% of the Company's net revenues.\nThe Company believes that professional project management and cost accounting systems are key factors in ensuring that projects are accurately and successfully completed on time and within prescribed cost estimates. The Company's project management structure combines the various functional areas performing work at the project, including technical, engineering, administrative and accounting specialists, into a coordinated team, reporting directly to the project manager. The project manager's responsibility for scheduling and project completion allows technical and operations specialists to operate efficiently with fewer distractions.\nThe Company also believes that professional project management is a critical element in limiting the significant risks and potential liabilities involved in environmental remediation projects due to the presence of hazardous and toxic substances. The Company has adopted a number of risk management policies and practices including special employee training and health monitoring programs. The Company's health and safety staff establish a safety plan for each project prior to the initiation of work, monitor compliance with the plan and administer the Company's medical monitoring program to staff involved. The Company believes that it has an excellent overall health and safety record.\nTREATMENT TECHNOLOGIES\nDesigning, developing and implementing solutions to environmental hazards requires an interdisciplinary approach combining practical field experience with remediation processes and technical skills in fields such as chemistry, microbiology, hydrogeology, fluid mechanics, thermodynamics, and geotechnical, biochemical and\nprocess engineering. The Company employs scientific and engineering professionals in the environmental services field who enhance the Company's ability to effectively participate in larger, more technically complex remediation projects.\nThe Company has significant experience in the commercialization and practical field application of new and existing technologies for the treatment of hazardous wastes, with emphasis on the further development and application of existing technologies. To provide direct support for its efforts to place innovative technology in the field, in 1973, the Company built its own equipment fabrication facility; in 1978, the Company built a laboratory dedicated to developing commercial applications of biological treatment of hazardous wastes; and in 1993, built a treatability laboratory to support testing and enhancement of a broad range of innovative technology applications. In 1986, the Company formally organized its technology application efforts through the creation of its Technology Assessment and Commercialization (\"TAC\") group. The TAC group studies emerging technologies in the laboratory and, through pilot scale studies, provides scientific and engineering support for full-scale commercial remediation. The Company also provides technology development services under contract to its clients.\nThe following represent the principal technologies used by the Company for remediation projects:\n. BIOLOGICAL REMEDIATION: The Company's biological treatability laboratory designs and tests bioremediation techniques for treating hazardous waste. Biological treatment technologies generally utilize enhanced microbiological activity to decompose and detoxify contaminants, often using a site's natural flora to remediate a problem. The Company's biological laboratories can \"feed\" the microorganisms that destroy the pollutant so that they grow at a faster rate than would occur in nature. The Company has developed considerable expertise in transferring innovative bioremediation techniques from the laboratory to the field, having performed more than 40 full-scale bioremediation projects since 1976, and is considered one of the country's most experienced providers of this emerging technology. The Company utilizes the following biological treatment technologies:\nAnaerobic Digestion Vessel -- degradation of organic contaminants in the absence of air.\nTrickling Filters -- secondary treatment on large-scale treatment applications to enhance the oxygenation process.\nActivated Sludge Reactor -- treatment utilizing holding tanks to enhance biological degradation.\nSubmerged Fixed Reactor Vessel -- combines a trickling filter and an activated sludge reactor for more efficient degradation of contaminants.\nAeration Lagoons -- secondary or tertiary treatment to remove carbon, nitrogen or phosphorous.\n. CHEMICAL TREATMENT: The Company's mobile chemical treatment equipment utilizes the following technologies:\nCarbon Adsorption -- passage of a liquid or vapor discharge stream through a bed of activated carbon which adsorbs certain contaminants.\nOxidation\/Reduction -- conversion of complex components of the wastestream into simpler, less toxic materials through addition of oxidizing or reducing agents such as ozone, hydrogen peroxide and sodium bisulfate.\nClarification\/Flocculation -- addition of chemicals which bond with dissolved metals to form insoluble products which separate through settling techniques.\nIon-Exchange -- ion-exchange resins used for the selective removal of heavy metals and hazardous ions.\nUltra-Violet Treatment -- use of ultra-violet light to kill pathogens and weaken strong bonds associated with some organic chemicals.\n. PHYSICAL TREATMENT: The Company's physical treatment technologies generally involve removal of contaminants through osmosis, settlement or filtration. The Company's mobile physical treatment equipment utilizes the following technologies:\nHeated Volatile Stripping -- removal of contaminants with low boiling points by passage of air under pressure through the wastestream.\nFume Scrubbing -- passage of a vaporized stream through an aerosol spray to remove contaminant particles from the vapor stream.\nImmiscible Fraction Separation -- removal of a component of a wastestream which is immiscible in water through settling techniques.\nMixed Media Filtration -- removal of suspended particles by passage through selected filter media.\n. SOIL VAPOR EXTRACTION AND SOIL FLUSHING: The Company has applied several innovative technologies, known generally as soil vapor extraction and soil flushing, based on a patent granted in 1984 for a portable method of soil decontamination above or below the groundwater table. The technologies generally involve the use of a system of pressurized injection and vacuum extraction wells to induce a pressure gradient and a fluid flow to extract contaminants and treat them in-situ or in an aboveground system. The technologies can be used to remove contaminants in soils and groundwater, in-situ or ex-situ, and can be combined with bioremediation to treat mixtures of volatile and non-volatile contaminants.\n. THERMAL TREATMENT: The Company's thermal treatment technologies include infrared incineration, rotary kiln technology and thermal desorption. Infrared incineration uses electric powered resistance heaters as a source of radiant heat for removal and destruction of hazardous organic contaminants. Rotary kiln incineration is the traditional incineration process for destroying organic hazardous waste constituents in a refractory lined rotating kiln. Thermal desorption is a thermal treatment technology which uses heat to remove volatile compounds from a waste without oxidation of the compounds. The Company has established a thermal treatment engineering group to assess, develop and commercialize thermal technologies for on-site remediation. The Company provides incineration services through three thermal destruction units which can be moved directly onto a project site involving PCBs or other toxic organics. The Company has successfully completed five large-scale, on-site incineration projects with its mobile infrared unit. The Company has constructed a 30 tons per hour state-of-the-art mobile treatment system that is being used for its Baird & McGuire Superfund site remediation project.\nFOCUS ON LARGER PROJECTS AND GOVERNMENT CONTRACTS\nRecently, the Company has pursued larger projects as a method to achieve a more predictable revenue stream, more consistent utilization of equipment and personnel, and greater leverage of sales and marketing costs. Historically, the Company relied most heavily on private sector remediation projects in the Northeast and Midwest that typically involved planned cleanups of sites that were contaminated in the normal course of manufacturing activity and emergency cleanups of oil or chemical spills. Contract values typically were less than $1 million in size and less than one year in duration. While this type of remediation activity still comprises a majority of the work performed by the Company, it now aggressively targets more complex, multi-million dollar, multi- year private sector and government site-specific and term contracts. As a result of its shift in project focus,\nsince the beginning of 1991 the Company has been awarded a number of large, site-specific contracts which, in some cases, may require several years to complete. Larger site-specific projects may offer the Company the opportunity to realize margins higher than on other types of contracts, but also impose heightened risks of loss in the event that actual costs are higher than those estimated at the time of bid due to unanticipated problems, inefficient project management, or disputes over the terms and specifications of the contracted performance.\nSince the beginning of 1991, the Company has been awarded 18 government term contracts with potential values ranging from $10 million to $250 million and terms ranging from three to ten years. Such government term contracts typically are performed by completing remediation work under delivery orders, issued by the contracting government entity, for a large number of small- to medium-sized projects throughout the geographic area covered by the contract. Such government term contracts do not represent commitments with respect to the amount, if any, that will actually be expended pursuant to such contracts, may generally be cancelled, delayed or modified at the sole option of the government, and are subject to annual funding limitations and public sector budget constraints. Accordingly, such government contracts represent the potential dollar value that may be expended under such contracts, but there is no assurance that such amounts, if any, will be actually spent on any projects, or of the timing thereof.\nFor the fiscal year ended December 31, 1994, 64.5% of the Company's gross revenues were derived from federal, state and local government contracts. The Company expects that the percentage of its revenues attributable to such government clients may continue to grow and represent a greater portion of its revenues. In addition to its dependence on government contracts, the Company also faces the risks associated with such contracting, which could include substantial civil and criminal fines and penalties. As a result of its government contracting business, the Company is, has been and may in the future be subject to audits and investigations by government agencies. In addition to potential damage to the Company's business reputation, the failure by the Company to comply with the terms of any of its government contracts could also result in the Company's suspension or debarment from future government contracts for a significant period of time. The fines and penalties which could result from noncompliance with appropriate standards and regulations, or the Company's suspension or debarment, 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 \"Item 3, Legal Proceedings.\"\nENVIRONMENTAL CONTRACTOR RISKS\nAlthough the Company believes that it generally benefits from increased environmental regulations, and from enforcement of those regulations, increased regulation and enforcement also create significant risks for the Company. The assessment, remediation, analysis, handling and management of hazardous substances necessarily involve significant risks, including the possibility of damages or injuries caused by the escape of hazardous materials into the environment, and the possibility of fines, penalties or other regulatory action. These risks include potentially large civil and criminal liabilities for violations of environmental laws and regulations, and liabilities to customers and to third parties for damages arising from performing services for clients, which could have a material adverse effect on the Company.\nPotential Liabilities Arising Out of Environmental Laws and Regulations. All 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 EPA, the Occupational Safety and Health Administration (\"OSHA\"), and, on limited occasions, the Nuclear Regulatory Commission, as well as applicable state and local regulatory agencies. (For a description of certain applicable laws and regulations, see \"Business--Regulation.\")\nPotential Liabilities Involving Clients and Third Parties. In performing services for its clients, 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\nwarranties). The damages available to a client, should it prevail in its claims, are potentially large and could include consequential damages.\nEnvironmental contractors, in connection with work performed for clients, also potentially face liabilities to third parties from various claims including claims for property damage or personal injury stemming from a release of hazardous 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 such services involved \"abnormally dangerous activities.\"\nClients frequently attempt to shift various of the liabilities 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 environmental fines and penalties. The Company has adopted risk management policies designed to address these problems, but cannot assure their adequacy. In addition, the Company generally coordinates through subcontractors the transportation of any hazardous waste which is not remediated on-site to a licensed hazardous waste disposal or incineration facility.\nRecently, the EPA has constricted significantly the circumstances under which it will indemnify its contractors against liabilities incurred in connection with CERCLA projects.\nDEPENDENCE ON ENVIRONMENTAL REGULATION\nMuch of the Company's business is generated either directly or indirectly as a result of federal and state laws, regulations and programs related to environmental issues. Accordingly, a reduction in the number or scope of these laws and regulations, or changes in government policies regarding the funding, implementation or enforcement of such laws, regulations and programs, could have a material adverse effect on the Company's business. See \"Business -- Regulation.\"\nMARKETS AND CUSTOMERS --------------------------------------------------------------------------------\nThe Company provides its services to a broad base of clients in both the private and government sectors. Its private sector clients include large chemical, petroleum, manufacturing, transportation, real estate, electronics, automotive, aerospace and other industrial companies, as well as engineering and consulting firms. The Company has worked for a majority of the Fortune 100 industrial companies. Historically, the majority of the Company's private sector revenues were derived from projects with values typically less than $1 million in size and less than one year in duration. Net revenues from industrial clients for 1994 were $78.3 million and constituted 35.5% of the Company's net revenues.\nIn the government sector, the market for the Company's services primarily consists of federal government agencies. The Company has been a prime contractor to the EPA since 1984 under Emergency Response Cleanup Services (\"ERCS\") contracts administered under the Superfund Removal Program. In addition, through site specific and term contracts, the Company provides its services to the DOD, including USACE, the U.S. Departments of the Navy, Air Force and Army, at DOE facilities and to state and local governments. Net revenues from government agencies in 1994 aggregated $142 million and accounted for 64.5% of net revenues, of which the USACE and the Department of the Navy accounted for approximately $56 million and 25.4% and $32.8 million and 14.9% of net revenues, respectively.\nAt December 31, 1994, the Company had 259 Environmental Service Agreements in place with commercial customers and 14 with government customers. Under these agreements, which generally have terms of one to five years, the Company agrees to provide its services to customers upon request at stipulated prices.\nSEASONALITY AND FLUCTUATION IN QUARTERLY RESULTS --------------------------------------------------------------------------------\nQuarterly results are subject to fluctuation due to a number of factors. The timing of the Company's revenues is dependent on its backlog, contract awards and the performance requirements of each contract. The Company's revenues are also affected by the timing of its clients' planned remediation activities which generally increase during the third and fourth quarters. Because of this change in demand, the Company's quarterly revenues can fluctuate, and revenues for the first and second quarters of each year have historically been lower than for the third and fourth quarters. Accordingly, results for any one quarter should not be considered indicative of results to be expected for any other quarter or for a full fiscal year.\nCOMPETITION --------------------------------------------------------------------------------\nThe environmental services industry is highly competitive with numerous companies of various size, geographic presence and capabilities participating. The Company believes that it has approximately a dozen principal competitors in the environmental remediation sector of the environmental services industry and numerous smaller competitors. The Company believes that the principal competitive factors in its business are operational experience, technical proficiency, breadth of services offered, local presence and price. In certain aspects of the Company's environmental remediation business, substantial capital investment is required for equipment. Certain of the Company's competitors have greater financial resources, which could allow for greater investment in equipment and provide better access to bonding and insurance markets to provide the financial assurance instruments which are often required by clients. Additionally, the relatively recent entry of several aerospace and defense contractors, as well as large construction and engineering firms, into the environmental services industry has increased the level of competition. The Company believes that the demand for environmental services is still developing and expanding and, as a result, many small and large firms will continue to be attracted to the industry.\nINSURANCE --------------------------------------------------------------------------------\nThe Company's insurance program in effect from November 1, 1994 through October 31, 1995 includes primary commercial general liability coverage in the amount of $1,000,000 per occurrence\/$2,000,000 aggregate, primary automobile liability coverage in the amount of $1,000,000 combined single limit, workers' compensation liability to statutory limits and employer's liability insurance of $1,000,000. The Company's primary insurance is in a deductible program with self-insured retentions equal to the limit of liability and up to $500,000 per occurrence and $500,000 for the Company's workers' compensation and employer's liability insurance coverage in most states. With respect to certain other states, the Company's workers' compensation and the Company's captive insurance subsidiary (the \"Captive\") reinsures such policies and indemnifies the insurance carrier against all losses and costs of defense up to a self insured retention of $500,000 per occurrence. With respect to the Company's primary insurance coverages in effect prior to November 1, 1994, such coverages were also provided under a reinsurance arrangement pursuant to which the Captive reinsured the limits of each such policy (except for the worker's compensation policy with a self-insured retention of $500,000 per occurrence.) The Company supports the indemnity commitment of the Captive with letters of credit provided under the Company's Revolving Credit Facility. The Company has caused to be issued $7,030,000 in letters of credit to support the Captive's existing or anticipated obligations to indemnify the insurance carrier, which amount is adjusted from time to time. From a risk management perspective, the deductible amounts under the Company's primary insurance policies and all policies reinsured by the Captive are, in effect, a self-insurance layer. Additionally, the Company has $40,000,000 of excess liability policies insuring claims in excess of the primary insurance coverages described above. The Company also has other insurance policies with various self-insured retentions, including property coverage in the amount of $121,000,000, consultants' environmental liability coverage in the amount of $30,000,000 per claim and in the aggregate, and environmental impairment liability coverage in the amount of $5,000,000 with respect to the Company's fixed base laboratory facility.\nAlthough the Company believes its insurance program to be appropriate for the management of its risks, 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 deductible programs and self-insurance through the Captive, thus exposing the Company to additional liabilities.\nEMPLOYEES --------------------------------------------------------------------------------\nThe Company had approximately 2,168 employees at December 31, 1994. The Company is not party to collective bargaining agreements. The Company considers relations with its employees to be satisfactory.\nPATENTS --------------------------------------------------------------------------------\nThe Company currently owns two patents covering certain design features of equipment employed in its on-site remediation business. The first relates to a filtration system developed and used by the Company to remove pollutants from flowing creeks and streams and the second, known as a Portable Method for Decontaminating Earth, relates to a decontamination system used by the Company to remove contaminants from the soil through a process, commonly known as soil vapor extraction. Although the Company considers its patents to be important, they are not a material factor in its business.\nREGULATION --------------------------------------------------------------------------------\nThe environmental services business, including the remediation services segment of the industry, has benefited enormously from extensive federal and state regulation of environmental matters. On the other hand, the Company's environmental services are also subject to extensive federal and state legislation as well as regulation by the EPA, the Occupational Safety and Health Administration and applicable state and local regulatory agencies. All facets of the Company's business are conducted in the context of a rapidly developing and changing statutory and regulatory framework and an aggressive enforcement and regulatory posture. The full impact of these laws and regulations, and the enforcement thereof, on the Company's business is difficult to predict, principally due to the complexity of the relatively new legislation, new and changing regulations, and the impact of political and economic pressures. The assessment, remediation, analysis, handling and management of hazardous substances necessarily involve significant risks, including the possibility of damages or injuries caused by the escape of hazardous materials into the environment, and the possibility of fines, penalties or other regulatory action.\nThe Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\") addresses cleanup of sites at which there has been a release or threatened release of hazardous substances into the environment. CERCLA assigns liability for costs of cleanup of such sites and for 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 disposed of; to any person who by agreement or otherwise arranged for disposal or treatment, or arranged with a transporter for transport for disposal or treatment of hazardous substances owned or possessed by such person for disposal or treatment by others; and to any person who accepted hazardous substances for transport to disposal or treatment facilities or sites selected by such persons from which there is a release or threatened release of hazardous substances. CERCLA authorizes the federal government both to clean up these sites itself and to order persons responsible for the situation to do so. In addition, under the authority of Superfund and its implementing regulations, detailed requirements apply to the manner and degree of remediation of facilities and sites where hazardous substances have been or are threatened to be released into the environment. 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 may seek reimbursement from the \"potentially responsible parties.\" CERCLA imposes strict, joint and several retroactive liability upon such parties. Increasingly, there are efforts to expand the reach of CERCLA to make environmental contractors responsible for cleanup costs by claiming that environmental contractors are owners or operators of hazardous waste facilities or that they arranged for treatment, transportation or disposal of\nhazardous 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. Although CERCLA's taxing authority expires December 31, 1995, EPA and congressional analysts concur that a sufficient surplus of unspent appropriated funds exist to run the program through mid-1997. The Company believes Superfund reauthorization hearings will begin this year and anticipates its reauthorization in 1995 or 1996.\nThe Resource Conservation and Recovery Act of 1976, as amended in 1984 (\"RCRA\"), is the principal federal statute governing hazardous waste generation, treatment, storage and disposal. RCRA, or EPA-approved state programs at least as stringent, govern waste handling activities involving wastes classified as \"hazardous.\" Under RCRA, liability and stringent operating requirements are imposed on a person who is either a \"generator\" or \"transporter\" of hazardous wastes, or an \"owner\" or \"operator\" of a hazardous waste treatment, storage or disposal facility. The EPA has issued regulations under RCRA for hazardous waste generators, transporters and owners and operators of hazardous waste treatment, storage or disposal facilities. These regulations impose detailed operating, inspection, training, emergency preparedness and response standards, and requirements for closure, continuing financial responsibility, manifesting, recordkeeping and reporting. The Company's clients remain responsible by law for the generation or transportation of hazardous wastes or ownership or operation of hazardous waste treatment, storage or disposal facilities. Although the Company does not believe its conduct in performing environmental remediation services would cause it to be considered liable as an owner or operator of a hazardous waste treatment, storage or disposal facility, or a generator or transporter of hazardous wastes under RCRA, RCRA and similar state statutes regulate the Company's practices for the treatment, transportation and other handling of hazardous materials, and substantial fines and penalties may be imposed for any violation of such statutes and the regulations thereunder.\nThe 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 statutes, regulations and policies to cover more detailed aspects of hazardous materials management.\nThe Company, through its on-site treatment capabilities and the use of subcontractors, attempts to minimize its transportation of hazardous substances and wastes. However, there are occasions, especially in connection with its emergency response activities, when the Company does transport hazardous substances and waste. Such transportation activities are closely regulated by the United States Department of Transportation, the Interstate Commerce Commission, and transportation regulatory bodies in each state. The applicable regulations include licensing requirements, truck safety requirements, weight limitations and, in some areas, rate limitations and operating conditions.\nBACKLOG AND POTENTIAL VALUE OF TERM CONTRACTS --------------------------------------------------------------------------------\nThe following table lists at the dates indicated (i) the Company's backlog, defined as the unearned portion of the Company's existing contracts and unfilled orders, and (ii) the Company's term contracts, defined as the potential value of government term contracts (in thousands):\nBacklog. In accordance with industry practice, substantially all of the Company's contracts in backlog may be terminated at the convenience of the client. In addition, the amount of the Company's backlog is subject to changes in the scope of services to be provided under any given contract. The Company has not historically\nexperienced any material contract terminations and generally experiences favorable changes in contract scope. The Company estimates that approximately 65% of the backlog at December 31, 1994 will be realized within the next year.\nTerm Contracts. The significant increase in the potential value of term contracts since 1992 has resulted from the award of 18 government contracts ranging in size from $10,000,000 to $250,000,000 and with terms ranging from three to ten years. The majority of dollars awarded came from the U.S. Departments of the Navy, Air Force and Army. Such government term contracts typically are performed by completing remediation work under delivery orders, issued by the contracting government entity, for a large number of small- to medium-sized projects throughout the geographic area covered by the contract. The Company's government term contracts generally may be cancelled, delayed or modified at the sole option of the government, and typically are subject to annual funding limitations and public sector budget constraints. Accordingly, such government contracts represent the potential dollar value that may be expended under such contracts, but there is no assurance that such amounts, if any, will be actually spent on any projects, or of the timing thereof.\nEQUITY INVESTMENT --------------------------------------------------------------------------------\nNSC Corporation (\"NSC\"). NSC is the leading provider of asbestos abatement services to a broad range of commercial and industrial clients and government agencies throughout the United States. NSC provides services to abate, primarily through removal, the hazards associated with asbestos insulation and materials containing asbestos in large commercial and public buildings, and in connection with large industrial facility decontamination and decommissioning projects. In May 1993, the Company's investment in NSC was reduced from 70% to 40% as a result of NSC's purchase of the asbestos abatement division of Brand in exchange for its industrial cleaning and maintenance business and the issuance of 4,010,000 shares of NSC common stock. As a part of this acquisition, NSC repaid all of its intercompany indebtedness to the Company, which amounted to $12.9 million, and replaced the letters of credit extended on behalf of NSC by the Company through its revolving credit agreement. The Company now owns 40% of NSC and accounts for NSC on the equity method. Rust International, Inc., a subsidiary of Waste Management, Inc., owns another 40% of NSC, and the remaining 20% is publicly held.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES --------------------------------------------------------------------------------\nThe Company currently owns property in four states and leases property in 19 states and the District of Columbia. The property owned by the Company includes approximately 26 acres in Findlay, Ohio, upon which are located the Company's 31,200 square foot corporate headquarters, a 39,600 square foot laboratory and technical facility, a 20,000 square foot support services facility, as well as its fabrication, maintenance and remediation service center facilities. The Company also owns remediation service centers in Covington, Georgia (approximately ten acres of land and an 8,200 square foot building), Clermont, Florida (approximately five acres of land and a 6,500 square foot building) and Baton Rouge, Louisiana (approximately ten acres of land and a 52,500 square foot building).\nThe Company operates other offices and remediation service centers in the following states: California, Colorado, the District of Columbia, Florida, Hawaii, Illinois, Iowa, Georgia, Massachusetts, Minnesota, Missouri, New Jersey, New York, Ohio, Pennsylvania, Tennessee, Texas, Virginia and Washington. All of these offices and service center facilities are leased. Under these leases, the Company is required to pay base rentals, real estate taxes, utilities and other operating expenses. Annual rental payments for the remediation service centers and office properties are approximately $2,600,000.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS --------------------------------------------------------------------------------\nIn October 1993, the Company was retained by Citgo Petroleum Corporation (\"Citgo\") for the removal of surface impoundment sludge at its Lake Charles, Louisiana refinery. Based on information provided to the Company by Citgo, the Company bid and was awarded a contract for approximately $28,600,000. During April 1994, the Company submitted to Citgo a request for a substantial equitable adjustment to the contract as a result\nof deficient project specifications provided by Citgo as well as other unplanned events controlled by Citgo. On April 29, 1994, Citgo filed a declaratory judgment action in the United States District Court for the Western District of Louisiana requesting a declaratory judgment that the Company is not entitled to additional compensation and requesting an order for specific performance requiring the Company to perform the contract. The financial statements of the Company as of December 31, 1994 reflect a claim receivable and other accounts receivable relating to performance of the Citgo project aggregating approximately $28,210,000. The Company's answer to the declaratory judgment action was filed on July 29, 1994, together with counterclaims against Citgo for negligent misrepresentation, breach of contract and quantum meruit seeking damages in excess of $35,000,000. Subsequent to filing of the Company's answer and counterclaim, Citgo amended its complaint seeking damages under the contract, which the Company believes approximates the amount of disputed accounts receivable that Citgo is currently withholding. In December 1994 Citgo filed a motion to allow it to file, and in January 1995 Citgo filed, a third party complaint against Occidental Oil and Gas Corporation and OXY USA, Inc. asserting various claims relating to their prior involvement with the Citgo site and its contract specifications.\nThe Company was named in April 1994 as one of 33 third party defendants in a case titled United States of America v. American Cyanamid Company, Inc., et al., pending in the United States District Court for the Southern District of Virginia. This litigation arises out of Superfund cost recovery claims made against several potentially responsible parties (\"PRPs\") by the EPA for amounts in excess of $24,000,000 for response costs arising out of releases and threatened releases of hazardous wastes at the Fike Chemical, Inc. Superfund site (the \"Site\") in Nitro, West Virginia. The Company was retained as a response action contractor for the Site under contracts with the EPA and USACE. The third party complaint alleges that the Company was an operator of the Site during the remediation and that the Company caused releases or threatened releases of hazardous substances at the Site as a result of its negligent conduct, grossly negligent conduct or intentional misconduct. The third party complaint seeks damages and contribution from the Company and the other third party defendants. The Company has submitted claims for indemnification related to this lawsuit under its contract with the USACE and the EPA and has notified its contractors pollution liability insurance carrier. The Company believes the lawsuit is without merit, intends to vigorously defend against it and does not believe that it will have a material adverse effect on the results of future operations and financial condition of the Company. In May 1994 the Company learned a criminal and civil investigation has been commenced by the government relating to the Company's billings to the EPA and USACE for its work at the Site. The Company believes the investigation followed certain allegations made by the PRPs in defense of the main cost recovery action. The Company is cooperating fully with the investigation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------------------------------------\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------------------------------------\nThe executive officers of the Company are listed below:\n------------------------------------------------------------------------------\nJames L. Kirk - Chairman of the Board, President and Chief Executive Officer. Mr. Kirk was elected President and Chief Executive Officer of the Company in July 1986, and was elected Chairman of the Board in January 1987. Mr. Kirk was elected Chairman of the Board and Chief Executive Officer of OHM Remediation Services Corp. (\"OHM\"), a wholly owned subsidiary of the Company, in April 1985. Mr. Kirk is a founder of OHM and has served in various capacities as an officer and director of OHM. Mr. Kirk also serves as a director of NSC.\nJoseph R. Kirk - Executive Vice President and Director. Mr. Kirk assumed his current position in July 1986 and previously served as Vice Chairman of OHM. He is a founder of OHM and has served in various capacities as an officer and director of OHM.\nPamela K.M. Beall - Vice President, Treasurer and Assistant Secretary. Ms. Beall assumed her current position in July 1986 and became Treasurer and Assistant Secretary of OHM in September 1985, having joined OHM in June 1985 as Director of Finance. Prior to joining OHM, Ms. Beall was General Manager, Treasury Services for USX Corporation and previous to that with Marathon Oil Company.\nRobert J. Blackwell - Vice President, Marketing and Strategic Planning. Mr. Blackwell joined the Company in July 1993. Prior to joining the Company, Mr. Blackwell was Vice President for Federal Marketing and Legislative Affairs, from January 1993 to July 1993, and Director of Marketing and Federal Relations, from January 1989 to December 1992 of Ebasco Services Incorporated.\nDaniel P. Buettin - Vice President, Finance and Chief Financial Officer. Mr. Buettin joined the Company as Controller in January 1987 and served as Vice President, Midwest Region from April 1992 until he assumed his current position in November 1994. Prior to joining the Company, Mr. Buettin was a Senior Manager with Arthur Andersen & Co.\nFred H. Halvorsen - Vice President, Health and Safety. Dr. Halvorsen joined OHM in July 1984 as Director of Health and Safety and assumed his current position in May 1987.\nKris E. Hansel - Vice President and Controller. Mr. Hansel joined the Company as General Accounting Manager in November 1988, became Assistant Controller in October 1991 and assumed his current position in April 1992. Prior to joining the Company, Mr. Hansel was General Accounting Manager of WearEver-ProctorSilex, Inc.\nFrank A. McBride - Vice President. Mr. McBride joined the Company in May 1987. Prior to joining the Company, Mr. McBride was Vice President, Product Management for US Sprint Telephone Company. Mr. McBride also serves as a director of NSC.\nPhillip V. Petrocelli - Vice President, Western Operations. Mr. Petrocelli joined the Company in August 1993. Prior to joining the Company, Mr. Petrocelli was Regional Director and previous to that was Acting Vice President - Analytical Labs, with IT Corporation.\nMichael A. Szomjassy - Vice President, Eastern Operations. Mr. Szomjassy joined the Company in November 1989, as Vice President, Southeast Region of OHM and assumed his current position with the Company in May 1993. Prior to joining OHM, Mr. Szomjassy was Regional Manager, Remediation Services of Ebasco Services, Inc.\nRandall M. Walters - Vice President, General Counsel and Secretary. Mr. Walters joined the Company in January 1987. Prior to joining the Company, Mr. Walters was associated with the law firm of Jones, Day, Reavis & Pogue from December 1984 to January 1987 and was previously associated with the law firm of Vinson & Elkins, Houston, Texas. Mr. Walters also serves as a director of NSC.\nPART II --------------------------------------------------------------------------------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS --------------------------------------------------------------------------------\nThe information required by this item is set forth on page 44 of the Company's Annual Report to Shareholders for the year ended December 31, 1994 and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA --------------------------------------------------------------------------------\nThe information required by this item is set forth on pages 17 and 18 of the Company's Annual Report to Shareholders for the year ended December 31, 1994 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 set forth on pages 19 through 26 of the Company's Annual Report to Shareholders for the year ended December 31, 1994 and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA --------------------------------------------------------------------------------\nThe Report of Independent Auditors and Consolidated Financial Statements set forth on pages 27 through 45 of the Company's Annual Report to Shareholders for the year ended December 31, 1994 is incorporated herein by reference. The Quarterly Results of Operations set forth on page 44 of the Company's 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 DISCLOSURES --------------------------------------------------------------------------------\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, in addition to that set forth above in Part I under the caption \"Executive Officers of the Registrant,\" is set forth in the section entitled \"Election of Directors\" contained on pages 63 and 64 of the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission (the \"Proxy Statement\") in connection with the Company's 1995 Annual Meeting of Shareholders, and said information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION --------------------------------------------------------------------------------\nRemuneration of directors and officers and information related thereto is included on pages 67 through 71 of the Proxy Statement under the caption \"Executive Compensation and Other Information,\" and said information is incorporated herein by reference except for information included under the subcaptions \"Board Compensation and Stock Option Committee Report\" and \"Performance Graph.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------------------------\nSecurity ownership of management and certain beneficial owners and information related thereto is included on pages 65 and 66 of the Proxy Statement under the caption \"Voting Securities and Principal Holders Thereof,\" and said information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS --------------------------------------------------------------------------------\nTransactions with management and related parties and information related thereto is included on page 72 of the Proxy Statement under the caption \"Certain Relationships and Related Transactions,\" and said information is incorporated herein by reference.\nPART IV -------------------------------------------------------------------------------- ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K --------------------------------------------------------------------------------\n(a)(1) The following consolidated financial statements of the Company and its subsidiaries, included in the Registrant's 1994 Annual Report to Shareholders, have been incorporated herein by reference pursuant to Item 8:\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 Changes in 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\nReport of Independent Auditors\n(a)(2) The following consolidated financial statement information and schedule of the Company and its subsidiaries are included in this Annual Report on Form 10-K:\nSchedule II Valuation and Qualifying Accounts -- For the Years Ended December 31, 1994, 1993 and 1992\n(a)(3) Exhibits\nThe following Exhibits are included in this Annual Report on Form 10-K:\n__________________________\n* Indicates a management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c) of Form 10- K.\n---------------------------\n* Indicates a management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c) of Form 10- K.\n(d) The following consolidated financial statements of NSC Corporation and its subsidiaries, which are consolidated under the equity method of accounting in the Company's financial statements, are included in this Annual Report on Form 10-K pursuant to the requirements of Rule 3-09 of Regulation S-X:\nConsolidated Balance Sheets -December 31, 1994 and 1993\nConsolidated Statements of Operations -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\nReport of Independent Auditors\nFinancial Statement Information and Schedules\nSchedule II Valuation and Qualifying Accounts -Years Ended December 31, 1994, 1993 and 1992\nNote: None of the Exhibits listed in this foregoing index is included with this Annual Report on Form 10-K. A copy of these Exhibits may be obtained without charge by writing to Pamela K.M. Beall, Vice President, Treasurer and Assistant Secretary, OHM Corporation, 16406 U.S. Route 224 East, P.O. Box 551, Findlay, Ohio 45839-0551.\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.\nOHM CORPORATION\nBy * JAMES L. KIRK ------------------------------------- James L. Kirk-Chairman of the Board, President and Chief Executive Officer 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 March 30, 1995.\n* JAMES L. KIRK ----------------------------------------------------------------------------- James L. Kirk-Chairman of the Board, President and Chief Executive Officer\n* DANIEL P. BUETTIN ----------------------------------------------------------------------------- Daniel P. Buettin-Vice President, Finance and Chief Financial Officer (Principal Financial Officer)\n* KRIS E. HANSEL ----------------------------------------------------------------------------- Kris E. Hansel-Vice President and Controller (Principal Accounting Officer)\n* IVAN W. GORR ----------------------------------------------------------------------------- Ivan W. Gorr-Director\n* CHARLES D. HOLLISTER ----------------------------------------------------------------------------- Charles D. Hollister-Director\n* JOSEPH R. KIRK ----------------------------------------------------------------------------- Joseph R. Kirk-Director\n* RICHARD W. POGUE ----------------------------------------------------------------------------- Richard W. Pogue-Director\n* CHARLES W. SCHMIDT ----------------------------------------------------------------------------- Charles W. Schmidt-Director\n* The undersigned, by signing his name hereto does sign and execute this report pursuant to Powers of Attorney executed on behalf of the above-named directors and contemporaneously herewith filed with the Securities and Exchange Commission.\n\/s\/ RANDALL M. WALTERS March 30, 1995 ------------------------------------ Randall M. Walters, Attorney-in-Fact\nOHM CORPORATION\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(In Thousands)\n(1) Uncollectible accounts charged against the valuation reserve.","section_15":""}
{"filename":"812563_1994.txt","cik":"812563","year":"1994","section_1":"Item 1. BUSINESS\nGeneral\nIDS Life Account RE (the Account) was established by a resolution of the Board of Directors of IDS Life Insurance Company (IDS Life) as a separate asset account, pursuant to Minnesota law. The Account was formed to make real estate related investments in connection with the sale of individual deferred variable annuity contracts (Contracts) offered by IDS Life. The Account commenced operations on August 7, 1987 when the annuity contracts were first offered for sale to the public. The Account holds assets that are segregated from all of IDS Life's other assets and are not chargeable with liabilities arising out of any other business of IDS Life.\nThe Account is not registered as an investment management company under the Investment Company Act of 1940. The Account is under the control and management of the Board of Directors of IDS Life and its officers. The owners of the Contracts have no voting rights with respect to the Account.\nIDS Life does not guarantee the investment performance of the Account and is not responsible for the liabilities of the Account. However, IDS Life is responsible for the fulfillment of the terms of each Contract, including payment of death benefits and the guarantees of the minimum annuity purchase rates contained in the Contracts.\nInvestment Objective\nThe investment objectives of the Account are to provide for payment of retirement income under the Contracts by seeking to: (i) preserve and protect the Account's assets in real (i.e., inflation- adjusted) terms; (ii) provide for compounding of income through reinvestment of cash flow from investments; and (iii) provide for increases in income through capital appreciation of real property investments and, to the extent available, through participation in the capital appreciation, gross revenues or income of the real properties subject to mortgage loans or land sale-leasebacks. There is no guarantee that the investment objectives of the Account will be attained. The assets of the Account will be invested primarily in real estate related investments in accordance with the diversification requirements regarding variable annuities contained in Section 817(h) of the Internal Revenue Code (the \"Code\").\nPreviously, the Account had been seeking an asset mix of approximately 65 to 70 percent in real property investments and 15 to 25 percent in mortgage loans and land sale-leaseback investments. The Account is currently seeking to have approximately 50 to 70 percent of the Account's assets invested in income-producing real property investments such as office buildings, shopping centers, apartment complexes and other real properties, and that approximately 15 to 40 percent of the Account's assets will be invested in mortgage loans and land sale-leaseback investments, which may include participation in theappreciation or the gross revenues or income of the real properties that are subject to the mortgage loans or land sale-leaseback investments. The remaining portion of the Account's assets generally will be invested in short-term debt instruments and intermediate term bonds with maturities of up to five years. However, IDS Life will have the discretion to alter such percentages in accordance with changing market conditions or under certain other circumstances if it deems it advisable given the Account's investment objectives and portfolio or the liquidity considerations of the Account. IDS Life expects to diversify the Account's investments consistent with the U.S. Treasury regulations regarding diversification for variable annuities. Other than meeting the diversification requirements of Section 817(h) of the Code, there are no limits on the percentage of Account assets that may be invested in one property.\nCompetition\nAs of December 31, 1994, IDS Life was aware of 3 other real estate variable annuity products that have been registered with the Securities and Exchange Commission and that are being offered for sale by competitors. These products differ from IDS Life Account RE in various features although their structure and investment objectives are similar. In addition, the Account competes against other real estate investment funds and registered investment companies including limited partnerships, real estate investment trusts, unit investment trusts, pension and profit sharing trusts, corporations, etc., all of which may or may not be offered for sale by commercial and investment banks, realty corporations, insurance companies, savings and loan associations, diversified financial service companies, and other financial service intermediaries.\nThe Account will be competing for real property investments, mortgage loans and land sale-leasebacks with numerous other entities, as well as with individuals, corporations, real estate investment trusts, real estate partnerships and other entities engaged in real estate investment activities, including certain affiliates of the JMB Annuity Advisers (the Investment Adviser) and IDS Life. The real properties that are the subject of the Account's real estate related investments are in competition with other real properties (including those in which the Investment Adviser, IDS Life or their affiliates may have an interest) in the areas in which they are located, particularly with respect to obtaining new tenants and the retention of existing tenants. Such competition is based upon, among other things, effective rents charged, services to tenants and the facilities available.\nEmployees\nIDS Life Account RE does not directly employ any persons. The business of the Account is under the control and management of IDS Life's Board of Directors, its principal officers, and its investment committee to the Account. The Investment Adviser, an affiliate of JMB Realty Corporation, provides investment selection, management, disposition, and consulting services with respect to the real estate related investments of the Account pursuant to an investment advisory agreement. Item 2.","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material current or pending legal proceedings to which the Registrant is a party, or to which the Registrant's assets are subject.\nItem 4.","section_4":"Item 4. SUBMISSIONS OF MATTERS TO VOTE OF SECURITY HOLDERS\nNot applicable. PART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDERS MATTERS\nThe Contracts are offered for sale through the registered representatives of IDS Life. There is no established public trading market for the Contracts. In addition, the Contracts are not bid for, but are sold at the Account's current accumulation unit value. A contract owner may elect to surrender all or part of the Contract while the Contract is in force prior to the earlier of the retirement date or the death of the first to die of the annuitant or owner. A description of surrenders, withdrawals and transfers is hereby incorporated herein by reference to pages 62 to 64 under the heading \"Contract Surrender\" and 67 to 68 under the headings \"Suspension and Delay of Payments\" and \"Transfer of Ownership\" in the Registrant's prospectus included in Form S-1 (as amended), File Number 33-13375, filed March 31, 1995, which pages are filed herewith as Exhibit 99.1 to this report. For the year ended December 31, 1994, the high and low accumulation unit values were $1.10 and $1.05 per unit, respectively. The number of contract owners at December 31, 1994 was 3,039.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nIDS LIFE ACCOUNT RE of IDS LIFE INSURANCE COMPANY\nDecember 31, 1994\nNOTES TO FINANCIAL STATEMENTS\n1. Organization\nIDS Life Account RE (the Account) is a segregated asset account of IDS Life Insurance Company (IDS Life) under Minnesota law. A registration statement under the Securities Act of 1933 relative to the deferred variable annuity contracts (the Contracts) issued by the Account became effective on August 6, 1987. The assets of the Account are held for the exclusive benefit of contract owners and are not chargeable with liabilities arising out of any other business conducted by IDS Life.\n2. Summary of Significant Accounting Policies\nThe accompanying financial statements have been prepared on the accrual basis of accounting. Significant accounting policies followed by the Account are summarized below.\nInvestments in Securities Investments in short-term securities maturing more than 60 days from the valuation date are valued at the market price or approximate fair value based on current interest rates; those maturing in 60 days or less are valued at amortized cost. The Account also may invest in intermediate-term bonds with maturities of up to five years which are valued at fair value as determined by reference to market quotations, market indices, matrices and data from independent brokers.\nSecurity transactions are accounted for on the date securities are purchased or sold. Interest income, including amortization of premium and discount, is accrued daily.\nConsolidation and Unconsolidated Joint Ventures The Account's policy is to consolidate the underlying assets, liabilities and operations of property investments where 50 percent or greater ownership position is maintained. Investments in unconsolidated joint ventures with less than 50 percent ownership interest are accounted for on the equity method of accounting.\nInvestments in Real Property, Mortgage Loans and Land\/Sale-Leasebacks The Account initially values real estate related investments at their cost (including acquisition or mortgage placement fees and other acquisition or placement expenses) unless circumstances otherwise indicate that a different value should be used. Subsequently, the value of these investments will be periodically determined by JMB Annuity Advisers (the Investment Adviser). Procedures utilized to determine the estimated value include the following: (i) at the time of purchase and once every two years thereafter, each real property investment and each real property underlying a participating mortgage loan or land sale-leaseback investment will be appraised by an independent appraiser or an existing appraisal will be updated, (ii) various assumptions including, but not limited to, occupancy and rental rates, expense levels, net operating income, average capital costs and capitalization rates upon sale will be used in determining the discounted present value of an investment's estimated cash flow and its estimated sale proceeds or its asset value under a direct capitalization methodology, and (iii) for fixed interest rate mortgage loans and fixed rental rate land sale-leaseback investments, estimated values will be determined by comparison to current interest rates on U.S. Treasury debt as adjusted for a risk differential of the Account's investments. The relative weight to be given to a particular methodology or other relevant factors in determining the estimated asset value of a particular real property will depend upon an assessment of the existing and anticipated market conditions and property specific factors relevant to such real property. There is no assurance that the assumptions, estimates and methodologies used in valuing the Account's real estate related investments will in fact prove accurate or that such values would in fact be realized. In addition, any expenses that may be borne by the Account in connection with the disposition of a real estate related investment are not deducted in determining its estimated value.\nBecause the Account values its real property investments at estimated fair values, no provision for depreciation expense is recorded.\nEach day the Account will record estimated income and expenses attributable to real estate related assets. Periodically, adjustments to reflect the difference between estimates and actual income and expenses will be made.\nFederal Income Taxes IDS Life is taxed as a life insurance company. The Account is treated as part of IDS Life for federal income tax purposes. Under existing federal income tax law, no income taxes are payable with respect to any income of the Account.\n3. Fees and Expenses\nThe Account pays a mortality and expense risk fee to IDS Life which is accrued daily and is equal, on an annual basis, to 1.00 percent of the average daily asset value, as defined, of the Account. The mortality risk is IDS Life's guarantee to make retirement payments according to the terms of the Contract, no matter how long annuitants live. The expense risk portion of the fee is paid to IDS Life for its guarantee that the various fees paid by the Account to IDS Life will not be increased in the future. For the years ended December 31, 1994, 1993 and 1992, the Account paid IDS Life a mortality and expense risk fee of $502,607, $549,250 and $649,173, respectively. The Account also pays IDS Life an asset management fee equal, on an annual basis, to 1.25 percent of the average daily asset value, as defined, of the Account. A portion of this fee, equal to 0.95 percent of the average daily asset value, is paid by IDS Life to the Investment Adviser. The total fee may be adjusted upward to a maximum of 1.50 percent depending upon the performance of the Account's real property investments as measured against the FRC Property Index. The performance-related portion of the fee is calculated and recorded on an annual basis when the FRC Property Index is released each year for the preceding calendar year. The performance fee paid by the Account in 1994 for 1993 was $137,299. The performance fee paid by the Account in 1993 for 1992 was $87,287. The performance fee paid by the Account in 1992 for 1991 was $177,202. Any performance fee adjustment will be paid to the Investment Adviser. For the years ended December 31, 1994, 1993 and 1992, the Account paid total asset management fees of $765,557, $773,849 and $988,698, respectively.\nIDS Life will receive from the Account an acquisition and mortgage placement fee equal to 3.75 percent of the total cash to be paid or advanced by the Account (net of any borrowings in the case of real property investments) in connection with each real property investment, mortgage loan or land sale-leaseback investment made by the Account. A portion of this fee, equal to 3.50 percent, will be paid to the Investment Adviser in consideration for its services in connection with the acquisition or placement of real estate related investments of the Account. No acquisition and mortgage placement fees were paid in 1994, 1993 and 1992.\nThe Account will pay for all operational expenses incurred on behalf of the Account. For the years ended December 31, 1994, 1993 and 1992, IDS Life was reimbursed $51,223, $83,122 and $65,290, respectively, for personnel related expenses incurred in the administration of the Account.\n4. Investments in Unconsolidated Joint Venture Partnerships and Participation in Mortgage Loan\nJoint Venture Partnership - N\/S Associates\nIDS Life, on behalf of the Account, entered into a joint venture partnership called N\/S Associates, which on April 4, 1988 acquired interests in two enclosed super regional shopping malls that are described below.\nThe terms of N\/S Associates partnership agreement provide that its annual net cash flows and net sales or refinancing proceeds generally will be distributed among all of the partners in accordance with their respective percentage ownership interests in N\/S Associates.\nThe Account contributed approximately $12,008,000 to N\/S Associates as its capital contribution. The percentage interest of the Account in N\/S Associates is 5.92 percent. In connection with the purchase of the shopping malls, the Account paid to IDS Life and the Investment Adviser their respective portions of the acquisition fee amounting to approximately $450,000.\nSummary of Real Estate Investments Made Through N\/S Associates\nMilwaukee, Wisconsin - Northridge Mall\nThe Account, through N\/S Associates, owns an interest in an existing enclosed super regional shopping center in Milwaukee, Wisconsin, known as Northridge Mall. The mall shops and four adjacent department stores comprising the shopping center contain approximately 1,053,000 square feet of gross leasable area, of which N\/S Associates owns approximately 399,000 square feet of mall shops (approximately 388,000 square feet ) and storage space (approximately 11,000 square feet). The remaining 654,000 square feet of gross leasable area are occupied by four department stores, three of which own their own stores and a portion of the parking area. The fourth department store leases its space from an unaffiliated third party.\nN\/S Associates acquired its interest in the shopping center in April 1988 for a purchase price of approximately $108,107,000, of which $89,653,000 was paid in cash at closing, subject to the existing mortgage loans with a then outstanding aggregate balance of approximately $18,454,000. The property was encumbered by two mortgage loans with outstanding principal balances at December 31,1994 of approximately $15,058,000 and $365,000, respectively. In addition to the purchase price, a reserve of $8,900,000 was established, all of which has been used to pay for certain capital improvements made at the shopping center. In February 1995, the two mortgage loans secured by the property were repaid with a portion of the proceeds from the refinancing of the Southridge Mall mortgage loan.\nThe shopping center is being managed by an affiliate of the Investment Adviser under a management agreement. The affiliate of the Investment Adviser receives an annual fee equal to 3.75 percent of the gross receipts of the property plus reimbursement of certain direct expenses in connection with the property management.\nGreendale, Wisconsin - Southridge Mall\nThe Account, through N\/S Associates, owns an interest in an existing enclosed super regional shopping center in Greendale, Wisconsin, known as Southridge Mall. The mall shops and five adjacent department stores comprising the shopping center contain approximately 1,297,000 square feet of gross leasable area, of which N\/S Associates owns approximately 437,000 square feet, including the space leased to one of the department stores. The remaining 860,000 square feet of gross leasable area are occupied by four other department stores, three of which own their own stores and a portion of the parking area. The fourth department store leases its space from an unaffiliated third party. N\/S Associates acquired its interest in the shopping center for a purchase price of approximately $115,401,000, of which $96,865,000 was paid in cash at closing. The property was encumbered by a first mortgage loan with an outstanding principal balance at December 31, 1994 of approximately $15,506,000. In addition to the purchase price, a reserve of approximately $7,250,000 was established for capital improvements, all of which has been spent as of December 31, 1994. In February 1995, the mortgage loan secured by the property was repaid with a portion of the proceeds from a new mortgage loan in the principal amount of $35,000,000. The new mortgage loan has a term of seven years, bears interest at 8.35 percent per annum and requires monthly payments of interest only prior to maturity. Proceeds from the new mortgage loan were also used to repay the two mortgage loans secured by Northridge Mall. The remaining net proceeds from the new loan are expected to be used to pay approximately $2,900,000 of tenant improvement and other capital costs expected to be incurred for Northridge and Southridge Malls.\nThe shopping center is being managed by an affiliate of the Investment Adviser under a management agreement. The affiliate of the Investment Adviser will receive an annual fee equal to 3.75 percent of the gross receipts of the property plus reimbursement of certain direct expenses in connection with the property management.\nJoint Venture Partnership - Monmouth Associates\nIDS Life, on behalf of the Account, entered into a joint venture partnership called Monmouth Associates, which on October 27, 1988 (i) acquired certain land underlying a super regional shopping center in Eatontown, New Jersey known as Monmouth Mall, (ii) leased the land to the owner of the shopping center pursuant to a long-term ground lease, and (iii) executed a first leasehold mortgage loan to the owner of the shopping center secured by the leasehold real estate and the improvements thereon as more fully described below. The owner of the shopping center (the Borrower\/Lessee) is a partnership whose partners are not affiliated with Monmouth Associates.\nThe terms of Monmouth Associates' partnership agreement provide that its annual net cash flows and net sales or refinancing proceeds generally will be distributed among all of the partners in accordance with their respective percentage interests in Monmouth Associates. The Account contributed approximately $10,000,000 to Monmouth Associates as its initial capital contribution. The Account expects to make additional capital contributions of approximately $685,000. The percentage interest of the Account in Monmouth Associates is 6.97 percent. In connection with the investment, the Account paid to IDS Life and the Investment Adviser their respective portions of the acquisition and mortgage placement fee amounting to approximately $375,000. Summary of Real Estate Investment Made Through Monmouth Associates\nEatontown, New Jersey - Monmouth Mall\nThe Account, through Monmouth Associates, acquired an interest in the land underlying a shopping center in Eatontown, New Jersey known as Monmouth Mall. The mall is located on approximately 90 acres of land, of which Monmouth Associates owns approximately 88.5 acres, subject to the rights of one of the department store tenants to acquire the land underlying its store and the improvements thereon for nominal consideration. The remaining acres are owned by 2 department stores. Monmouth Associates acquired its interest in the land for a purchase price of approximately $13,500,000.\nMonmouth Associates entered into an agreement whereby the land underlying the mall is leased back to the Borrower\/Lessee under a long-term ground lease. The long-term ground lease, which has a term of 75 years, provides for monthly base rent aggregating $780,000 per annum for the first two lease years, $1,040,000 per annum for the third lease year, and $650,000 per annum for each lease year thereafter. The long-term ground lease also provides for contingent rent, payable quarterly out of the excess, if any, of substantially all of the gross receipts from the shopping center received by the Borrower\/Lessee over certain base amounts, equal to the sum of (x) a specified annual amount (commencing in the fourth lease year at $390,000 per annum and increasing in the sixth lease year to $520,000 per annum), increased until paid at the \"applicable rate\" of interest payable under the first leasehold mortgage loan described below (such amount as so increased herein called the \"rent shortfall amount\"), plus (y) 15 percent of the balance of such excess gross receipts remaining after deducting the aggregate amount paid at such time of the rent shortfall amount under the long-term ground lease and the \"interest shortfall amount\" under the first leasehold mortgage loan as described below.\nIn addition, Monmouth Associates made a first leasehold participating mortgage loan in the original principal amount of $128,920,000 to the Borrower\/Lessee which is secured by the leasehold real estate and the improvements thereon. The current loan amount is $127,670,000. The loan has a term of 15 years, which may be extended from time to time at the option of Monmouth Associates for up to an additional 20 years. The loan provides for monthly payments of base interest at a base rate of approximately 5.98 percent per annum for the first two loan years, approximately 7.97 percent per annum for the third loan year and approximately 5.00 percent per annum for each loan year thereafter. The first leasehold mortgage also provides for quarterly payments of contingent interest, payable out of the excess, if any, of substantially all of the gross receipts from the shopping center received by the Borrower\/Lessee over certain base amounts, equal to the sum of (x) the difference between the amount of interest payable on the loan at the \"applicable rate\" and that payable at the base rate described above, increased until paid at the applicable rate (such amount as so increased herein called the \"interest shortfall amount\"), plus (y) 45 percent of the balance of such excess gross receipts remaining after deducting the aggregate amount paid at such time of the rent shortfall amount under the ground lease and the interest shortfall amount under the first leasehold mortgage loan. The \"applicable rate\" under the loan is 5.98 percent per annum for the first two loan years, 7.97 percent per annum for the next three loan years and 8.97 percent per annum for each loan year thereafter. In addition, upon a joint sale or refinancing of the land and improvements or at maturity of the leasehold mortgage loan, Monmouth Associates is entitled to receive certain participations in the proceeds from such sale or refinancing after payment of its investment in the land and\/or repayment of the principal amount of the leasehold mortgage loan. In April 1992, Monmouth Associates discontinued the accrual of contingent interest on the leasehold mortgage loan as a result of uncertainty as to the collectibility of such contingent interest in light of the previous decrease in the estimated value of Monmouth Mall. In addition, no contingent rent was accrued under the ground lease for 1994, 1993 or 1992.\nMonmouth Associates is obligated to make certain additional loans to the Borrower\/Lessee under certain circumstances to finance the cost of 60 percent of tenant improvements or other ordinary capital expenditures. In addition, in May 1994, Monmouth Associates made a loan to finance the cost of a renovation of the shopping center, which commenced during the third quarter of 1994. The renovation consists of, among other things, the elimination of certain outparcels, the addition of a food court and cinema, and the re-merchandising of approximately 300,000 square feet of gross leasable area. The renovation loan from Monmouth Associates bears interest at a fixed interest rate of 10.5 percent per annum. In addition, Monmouth Associates' participation in certain levels of sale or refinancing proceeds from the property will be increased until Monmouth Associates has received aggregate payments equal to an internal rate of return of 11 percent per annum on its investments in the land and\/or the first leasehold mortgage loan. The maximum amount of the renovation loan is $29,100,000, and the cost of the renovation is currently estimated to be $28,500,000. Monmouth Associates is funding the renovation loan out of its cash reserves, cash flow and additional capital contributions made pro rata based upon the respective interests of the joint venture partners in Monmouth Associates. The renovation loan requires monthly payments of interest only until maturity when the entire principal amount and any accrued and unpaid interest will be due. The renovation loan will mature contemporaneously with the first leasehold mortgage loan in October 2003, subject to acceleration or extension of the loan by Monmouth Associates under certain circumstances. Joint Venture - 1225 Connecticut Avenue, N.W.\nWashington, D.C. - 1225 Connecticut Avenue, N.W.\nIn May 1990, IDS Life, on behalf of the Account, acquired an interest in a newly formed Delaware corporation, 1225 Investment Corporation (the Corporation) owned jointly with certain other persons described below. The Corporation acquired an office building located in Washington, D.C. known as 1225 Connecticut Avenue, N.W. (1225 Connecticut).\nThe office building, which was completed in 1968, is an eight-story reinforced concrete frame building containing 184,432 square feet of rentable office space, 18,498 square feet of rentable retail space, 6,416 square feet of below grade storage space and 100,024 square feet of subsurface parking space for over 300 automobiles.\nThe Corporation has elected to qualify as a real estate investment trust (REIT) pursuant to sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the Code). For each taxable year that the Corporation qualifies as a REIT, the Corporation in general will not be subject to federal corporate income tax or the District of Columbia corporate franchise tax on its regular taxable income and will not be taxed on long-term capital gain income to the extent its income is distributed as dividends. If the Corporation were to fail to qualify as a REIT, it would be taxed at rates applicable to a corporation on its taxable income, whether or not distributed.\nThe Account owns approximately 16.3 percent of the outstanding shares of common stock of the Corporation. Certain of the outstanding shares of common stock of the Corporation not owned by the Account are owned by an affiliate of the Investment Adviser.\nThe Corporation purchased 1225 Connecticut from the seller for a purchase price of approximately $54,125,000 (net of prorations and miscellaneous closing costs), consisting of $51,425,000 paid in cash and assumption of approximately $2,700,000 of mortgage indebtedness then encumbering the property. The Corporation paid approximately $2,130,000 for real estate brokerage commissions to an independent third party and certain closing costs. The Account contributed $9,000,000 for its interest in the Corporation. The Account has also paid acquisition fees amounting to $337,500.\nAt December 31, 1993, the outstanding balance of the mortgage loan encumbering the property was approximately $1,695,000. The mortgage loan bore interest at a rate of 6.50 percent per annum and required monthly payments of principal and interest aggregating approximately $426,300 per annum. In January 1994, the Corporation refinanced its mortgage loan with a first mortgage loan in the principal amount of $7,000,000 bearing interest 6.98 percent per annum. The new loan requires monthly payments of interest only aggregating $488,600 per annum until maturity in February 2001 when the principal amount together with accrued interest will be due and payable. Under certain circumstances, the principal amount of the loan may be prepaid in whole (but not in part), subject to a prepayment premium. Pursuant to the deed of trust securing the mortgage loan, the Corporation is prohibited from modifying Ernst & Young's primary lease or from entering into certain other tenant leases without the lender's consent. Prior to selling the property or encumbering the property with any additional debt, the Corporation must obtain the consent of the lender, which may be arbitrarily withheld. However, subject to certain restrictions, the Corporation has a one-time right to transfer title to the property together with an assumption of the mortgage loan.\nThe property is being managed under an agreement pursuant to which the manager is obligated to manage 1225 Connecticut, collect all of the receipts from operations and, to the extent available from such receipts, pay all of the expenses of 1225 Connecticut. The manager is paid a fee equal to 2.5 percent of the gross revenues of 1225 Connecticut, plus reimbursement for certain direct expenses of the manager. The property had previously been managed by JMB Properties Company, an affiliate of the Investment Adviser. In December 1994, JMB Properties Company sold substantially all of its assets to an unaffiliated third party, and certain management personnel of JMB Properties Company became management personnel of the third party. As a result of the sale, the successor to JMB Properties Company's assets now acts as property manager of the 1225 Connecticut office building on the same terms that existed prior to the sale.\nPursuant to a lease currently in effect, an unaffiliated third party leases and operates the entire parking garage (subject to certain parking rights provided for tenants of the property) until November 1997. The lease provides for a fixed rent payment of $485,000 a year (which reflects an increase at the end of 1993 from $430,000 a year), provides that the lessee shall pay the operating expenses of the parking garage and does not provide such lessee with an option to extend the term of the lease. Unconsolidated Joint Ventures - Summary Information\nSummary information for the Account of its investments in Unconsolidated Joint Ventures for the years ended December 31, 1994 and 1993 is as follows:\nParticipation in Mortgage Loan - Riverpoint Associates\nChicago, Illinois - Riverpoint Center\nIn August 1989, IDS Life, on behalf of the Account, participated in the initial funding of a non-recourse participation first mortgage loan in the principal amount of $26,000,000. The Account's share of the initial funding was $2,666,660 or 10.26 percent of this loan. The remaining portion of the loan is funded by affiliates of the Investment Adviser (herein, the Account and said affiliates are collectively called the Lenders). The Loan is secured by a first mortgage on a shopping center known as Riverpoint Center in Chicago, Illinois. The shopping center is owned by a partnership (the Borrower) whose general partners are not affiliated with any of the Lenders. In connection with the loan, the Account paid to the Investment Adviser a mortgage placement fee amounting to approximately $108,000, less $37,500 in loan origination fees paid to the Investment Adviser by the Borrower, for a net fee paid of approximately $70,500 paid by the Account.\nAdditional amounts aggregating approximately $2,040,000 (of which the Account's share was approximately $209,000) have been funded since the Initial Funding. The Borrower did not qualify for any additional fundings above the $28,040,000 which has been funded to date, and no additional fundings will be made by the Lenders.\nThe ten-year loan requires periodic payments of interest only and bears basic interest at the rate of 8.84 percent per annum in the first loan year, 8.75 percent per annum during the second loan year, increasing 0.50 percent per annum in the fourth and 0.25 percent per annum in the seventh loan year to a maximum rate of 9.50 percent per annum, payable monthly in advance. The loan also provides for additional annual simple accrual of interest at the rate of 2.00 percent per annum payable upon prepayment or maturity. For financial reporting purposes, commencing in August of 1991, the Account suspended recognition of income related to the simple accrual interest receivable (deferred until maturity).The loan also provides for additional interest in an amount equal to a percentage of annual gross income from the underlying property (exclusive of tenant reimbursement of expenses) in excess of a base amount and, on sale or repayment of the loan, an amount equal to a percentage of the subsequent increase in the value of the underlying property in excess of a specified amount. Such amounts of additional interest payments made by the Borrower will be used to offset, on a dollar-for-dollar basis, the amount of accrued interest payable. The loan is generally non-recourse to the borrower and its partners.\nThe shopping center, completed in 1989, is located on approximately 17 acres and consists of approximately 200,800 square feet of gross leasable area.\n5. Investments in Wholly-owned Real Estate Property\nFairfax County, Virginia - West Springfield Terrace Apartments\nIn August 1989, IDS Life, on behalf of the Account, acquired a 244-unit garden apartment complex known as West Springfield Terrace Apartments, which is located in Fairfax County, Virginia.\nThe apartment complex, which was completed in 1978, consists of 17 separate three and four-story buildings of wood frame with brick veneer construction containing 52 one-bedroom units, 22 one-bedroom and den units, 118 two-bedroom units, 22 two-bedroom and den units, and 30 three-bedroom units. The complex contains a swimming pool, tennis court, clubhouse and approximately 380 parking spaces.\nThe Account paid $15,222,278 for the apartment complex in cash at closing, excluding closing costs and prorations. In connection with the acquisition of the property, the Account paid a prepayment charge at closing of $92,221 to the lender that held the mortgage loan on the property. The Account also paid to IDS Life and the Investment Adviser their respective portions of the acquisition fee amounting to $274,834. At the time of the acquisition it was anticipated that an additional amount of approximately $1,450,000 would be used by the Account to pay the cost of upgrading kitchens and bathrooms and certain other upgrades and capital improvements at the complex. The renovation project was subsequently increased to include replacing certain carpets in units as they were renovated and to increase the number of units that received certain upgrades. The renovation project was completed during 1992 at an aggregate cost of approximately $1,900,000. To date the Account has paid IDS Life and the Investment Adviser their respective portions of the acquisition fee amounting to $18,000 in connection with the renovation project. In November 1989, the Account obtained a loan from an institutional lender in the principal amount of $8,000,000 secured by a first mortgage on the property. At December 31, 1994, the current balance of the mortgage loan encumbering the property was approximately $7,852,000. The loan has a term of seven years and bears interest at a rate of 9.50 percent per annum. The loan required monthly payments of interest only during the first three loan years and thereafter is amortizable over a 27-year schedule through monthly payments of principal and interest aggregating $824,400 per annum until November 1996, when the remaining principal balance and any accrued and unpaid interest of approximately $7,704,000 is due and payable.\nThe apartment complex is being managed for a fee equal to 5.00 percent of the gross revenues from the property, plus reimbursement of certain direct expenses of the manager. The property had previously been managed by JMB Properties Company, an affiliate of the Investment Adviser, but since December 1994 has been managed on the same terms by an unaffiliated third party that purchased substantially all of JMB Properties Company's assets, as discussed in Note 4 in connection with the 1225 Connecticut office building.\n6. Line of Credit with IDS Life\nIn March 1994, the Account obtained a short-term revolving line of credit for up to $10 million from IDS Life to pay for contract surrenders and other obligations under the Contracts. The line of credit is for a one-year term and is automatically renewed at each anniversary for an additional one-year term subject to termination by one party giving 30 days' prior written notice of termination to the other party. Borrowings under the line of credit must be made in increments (or multiples) of $100,000. Outstanding borrowings under the line of credit bear interest at a floating rate equal to the 30-day London Interbank Offered Rate (LIBOR), adjusted on a monthly basis. The line of credit requires monthly payments of interest only until the earlier of maturity or termination of the line of credit, when the entire outstanding principal plus any accrued and unpaid interest on the line of credit will be due and payable. Outstanding principal may be repaid in whole or in part in increments (or multiples) of $100,000, together with any accrued and unpaid interest thereon, at any time without premium or penalty. Borrowings under the line of credit are generally unsecured, although IDS Life has a right of set off for outstanding borrowings against any deposits or credits of the Account held by IDS Life. At December 31, 1994, $2,100,000 was outstanding on the line of credit at a rate of 6.125% per annum.\nSchedule III\nIDS LIFE ACCOUNT RE of IDS LIFE INSURANCE COMPANY\nParticipation in Mortgage Loan on Real Estate and Interest Earned on Participation in Mortgage\nDecember 31, 1994\nIndependent Auditors' Report\nThe Board of Directors of IDS Life Insurance Company and Contract Owners of IDS Life Account RE:\nWe have audited the combined financial statements of N\/S Associates, Monmouth Associates and 1225 Investment Corporation, unconsolidated joint ventures of IDS Life Account RE (Note 1), as listed in the accompanying index. In connection with our audits of the combined financial statements, we also have audited the combined financial statement schedules as listed in the accompanying index. These combined financial statements and combined financial statement schedules are the responsibility of the Investment Adviser. Our responsibility is to express an opinion on these combined financial statements and combined 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 combined financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the combined financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Investment Adviser, as well as evaluating the overall combined 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 combined financial position of N\/S Associates, Monmouth Associates and 1225 Investment Corporation, at December 31, 1994 and 1993 and the results of their combined operations and combined 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 combined financial statement schedules, when considered in relation to the basic combined financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.\nAs discussed in Note 1, the combined financial statements include assets and liabilities stated at market values which have been estimated by the Investment Adviser. Such market value estimates involve subjective judgments and the actual market values can only be determined by negotiation between independent third parties.\nKPMG PEAT MARWICK LLP\nChicago, Illinois March 15, 1995 IDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nCombined Balance Sheets\nDecember 31, 1994 and 1993\nAssets\nIDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nNotes to Combined Financial Statements\nYears ended December 31, 1994, 1993, and 1992\n(1) Organization and 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. The combined financial statements include the accounts of the unconsolidated joint ventures in which IDS Life Account RE of IDS Life Insurance Company owns an equity interest. The unconsolidated joint ventures are N\/S Associates, Monmouth Associates and 1225 Investment Corporation.\nThe accompanying combined financial statements have been prepared on the accrual basis of accounting.\nThe ventures have implemented Statement of Accounting Standards No. 95 \"Statement of Cash Flows\" which classifies receipts and payments according to whether they stem from operating, investing or financing activities. The ventures record amounts held in U.S. Government obligations at cost, which approximates market. For the purposes of these statements, the ventures' policy is to consider all such amounts held with original maturities of three months or less ($5,989,000 and $3,774,000 at December 31, 1994 and 1993, respectively) as cash equivalents with any remaining amounts reflected as short-term investments. Short-term investments (generally with original maturities of one year or less) are being held to maturity and are held at amortized cost which approximates market.\nInvestments in real estate are stated at estimated fair value. A description of the valuation process is contained in Note 2 of Notes to Financial Statements of the Account. Such note is incorporated herein by reference.\nNo provision for State or Federal income taxes has been made for N\/S Associates or Monmouth Associates as the liability for such taxes, if any, is expected to be that of the venture partners rather than the venture. 1225 Investment Corporation has elected and qualifies to be treated as a real estate investment trust for Federal income tax purposes. The Corporation had no Federal income tax liabilities for taxable years ended December 31, 1994, 1993 and 1992.\nMaintenance and repair expenses are charged to operations as incurred. Significant costs of physical improvements are capitalized as part of investments in real estate.\nFixed rental income is recorded when the obligation for the payment of rent is incurred according to the terms of the lease agreements. IDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nNotes to Combined Financial Statements - (Continued)\nStatement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments\", requires entities with total assets exceeding $150 million at December 31, 1994 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 ventures believe the carrying amount of its 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 ventures' other instruments. Based upon estimates of current market rates for debt with similar terms, the ventures discounted the scheduled loan payments to maturity. Based upon this calculation, the ventures believe that the carrying value of the mortgage notes payable approximate market value.\nCertain reclassifications have been made to the 1993 and 1992 financial statements to conform with the 1994 presentation.\n(2) Venture Agreements\nA description of the venture agreements are contained in Note 4 of Notes to Financial Statements of the Account for the year ended December 31, 1994. Such note is incorporated herein by reference.\n(3) Mortgage Notes Payable\nMortgage notes payable consist of the following at December 31, 1994 and 1993:\n1994 1993 9.125% mortgage note due January 1, 2008 secured by Northridge Mall; payable in monthly installments of principal and interest of $165,000, reference is made to Note 6 (a) $15,058,000 15,631,000\n10% mortgage note due October 1, 2012, secured by Northridge Mall; payable in monthly installments of principal and interest of $4,000, reference is made to Note 6 (a) 365,000 371,000\n8.42% mortgage note due October 1, 2001, secured by Southridge Mall; payable in monthly installments of principal and interest of $158,000, reference is made to Note 6 (a) 15,506,000 16,075,000\n6.5% mortgage note, due March 1, 1998, secured by 1225 Connecticut Avenue; payable in monthly installments of $35,000 (including interest); in January 1994 the principal balance was refinanced -- 1,695,000\n6.98% mortgage note, due February 1, 2001, secured by 1225 Connecticut Avenue; interest only, payable monthly 7,000,000 --\nTotal mortgage notes payable $37,929,000 33,772,000 \/TABLE\nIDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nNotes to Combined Financial Statements - (Continued)\nFive year maturities of mortgage notes payable are as follows:\n1995 $1,254,000 1996 1,369,000 1997 1,494,000 1998 1,631,000 1999 1,780,000\n(4) Leases - As Property Lessor\nThe venture has determined that all leases relating to the two retail properties and the office building are properly classified as operating leases; therefore, rental income is reported when earned. Leases with tenants range in term from one to thirty-two years and provide for fixed minimum rent and partial to full reimbursement of operating costs. In addition, substantially all retail leases provide for additional rent based upon percentage of tenants' sale volumes over certain specified amounts.\nMinimum lease payments to be received in the future under the above operating lease agreements, are as follows:\n1995 $20,046,882 1996 19,281,728 1997 17,960,772 1998 16,005,720 1999 14,154,051 Thereafter 61,845,875\n149,295,028\nContingent rent (based on sales by property tenants) from the retail investments included in rental income is $1,010,000, $1,000,000 and $2,224,000 in 1994, 1993 and 1992, respectively.\nMonmouth Associates entered into an agreement whereby the land underlying the Monmouth shopping center is leased under a long-term ground lease. The long-term ground lease, which has a term of 75 years, provides for monthly base rent aggregating $780,000 per annum for the first two lease years, $1,040,000 per annum for the third lease year, and $650,000 per annum for each lease year thereafter.\n(5) Related Party Transactions\nNS Associates has entered into a management agreement with JMB Retail Properties Company, (the \"Retail Manager\"). The Retail Manager is entitled to receive a fee of 3.75% of gross receipts from the operations of the Malls. Management fees earned by the Retail IDS LIFE ACCOUNT RE OF IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nNotes to Combined Financial Statements - (Continued)\nManager are included in property operating expenses and aggregated approximately $1,266,000 and $1,186,000 for the periods ended December 31, 1994 and 1993, respectively.\n1225 Investment Corporation had entered into a management agreement with JMB Properties Company. During December 1994, JMB Properties Company assigned the management agreement to Heitman Washington D.C. Properties, Ltd. (\"Office Manager\"). The Office Manager is entitled to receive a fee of 2.5% of gross receipts from the operations of the Property. Management fees earned by the Office Manager are included in property operating expenses and aggregated approximately $196,000 and $176,000 for the years ended December 31, 1994 and 1993, respectively.\n(6) Subsequent Events\n(a) NS Associates\nOn February 1, 1995, NS Associates refinanced the existing mortgage note on Southridge Mall. The new mortgage note is in the amount of $35,000,000 and was used to retire the existing mortgage notes at Southridge and Northridge Malls. The new mortgage note secured by Southridge Mall bears interest at 8.35% per annum and provides for interest only payments until maturity in 2002.\nOn February 28, 1995, the Trustees authorized and paid a cash distribution to the partners aggregating $4,000,000. Each partner received its proportionate share based on its respective ownership percentage.\n(b) 1225 Investment Corporation\nIn February 1995, 1225 Investment Corporation paid a dividend of $1,125,000 ($20 per share) to the shareholders of record as of December 31, 1994. Schedule III\nIDS LIFE ACCOUNT RE of IDS LIFE INSURANCE COMPANY Monmouth Associates Unconsolidated Joint Venture of IDS Life Account RE Participation in Mortgage Loan on Real Estate and Interest Earned on Participation in Mortgage\nDecember 31, 1994\nPart 1 - Participation in Mortgage Part 2 - Interest Earned on Loan on Real Estate at Close of Year on Participation in Mortgage\nLiens on Shopping Center: Principal unpaid Amount of Interest due Monmouth Mall Carrying at close mortgage being & accrued at Interest Eatontown, New Jersey Amount (A) of period foreclosed end of period Income Earned\n1994 $ 119,154,000 $ 141,056,000 $ -- $ 3,960,000 $ 7,641,000\n1993 $ 119,650,000 $ 132,338,000 $ -- $ 3,437,000 $ 7,166,000\n1992 $ 119,650,000 $ 130,688,000 $ -- $ 3,028,000 $ 7,964,000\n(A) - Reconciliation of the carrying value of the participation in the mortgage loan:\n1994 1993 1992\nBalance at the beginning of year........... $ 119,650,000 $ 119,650,000 $ 118,000,000\nChanges during year: Additional fundings...................... 9,318,000 -- 1,650,000 Unrealized depreciation.................. (9,814,000) -- --\nBalance at end of year..................... $ 119,154,000 $ 119,650,000 $ 119,650,000\nSchedule IV IDS LIFE ACCOUNT RE of IDS LIFE INSURANCE COMPANY N\/S Associates, Monmouth Associates and 1225 Investment Corporation Unconsolidated Joint Ventures of IDS Life Account RE\nCombined Real Estate Owned and Rental Income\nDecember 31, 1994\nPart 1 - Real Estate Owned at End of Year (C) Amount at Cost of Unrealized which carried Amount of improvements, Appreciation at close of encumbrances Initial Cost etc. (Depreciation) period (A)(B) Retail properties: Northridge Mall, Milwaukee, WI $ 15,423,000 $108,107,000 $ 13,618,000 $(56,725,000) $ 65,000,000 Southridge Mall, Greendale, WI $ 15,506,000 $115,401,000 $ 14,351,000 $ (6,252,000) $123,500,000 Office Building: 1225 Connecticut Ave., Washington, D.C. $ 7,000,000 $ 54,775,000 $ 6,298,000 $ (8,073,000) $ 53,000,000 Ground Lease: Monmouth Mall, Eatontown, NJ $ -- $ 13,000,000 $ -- $ -- $ 13,000,000 $ 37,929,000 $291,283,000 $ 34,267,000 $(71,050,000) $254,500,000\nPart 2 - Rental Income\nRents due and accrued at end of period Retail Properties: Northridge Mall, Milwaukee, WI $ 403,000 Southridge Mall, Greendale, WI $ 1,682,000 Office Building: 1225 Connecticut Ave., Washington, D.C. $ 51,000 Ground Lease: Monmouth Mall, Eatontown, NJ $ -- $ 2,136,000\n(A) The aggregate cost of real estate owned at December 31, 1994 for Federal Income tax purposes was approximately $325,380,000.\n(B) Reconciliation of real estate owned:\n1994 1993 1992\nBalance at the beginning of period.......... $272,660,000 $279,726,000 $313,990,000\nAdditions (deductions), including unrealized depreciation................... (18,160,000) (7,066,000) (34,264,000)\nBalance at end of year...................... $254,500,000 $272,660,000 $279,726,000\n(C) - Reconciliation for depreciation is not applicable as real estate owned is stated at estimated market value. \/TABLE Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Account has no directors or officers. The directors and principal executive officers of IDS Life Insurance Company are listed below.\nLouis C. Fornetti, 45: Director, IDS Life, since March 1994; Senior Vice President and Director, American Express Financial Corporation (AEFC), since February 1985.\nDavid R. Hubers, 52: Director, IDS Life, since September 1989; President and Chief Executive Officer, AEFC, since August 1993, and Director since January 1984. Senior Vice President, Finance and Chief Financial Officer, AEFC, from January 1984 to August 1993.\nRichard W. Kling, 54: Director, IDS Life, since February 1984; President, IDS Life, since March 1994; Executive Vice President, Marketing and Products, from January 1988 to March 1994. Senior Vice President, AEFC, since May 1994. Director of IDS Life Series Fund, Inc. and manager of IDS Life Variable Annuity Funds A & B.\nPaul F. Kolkman, 48: Director, IDS Life, since May 1984; Executive Vice President, IDS Life, since March 1994; Vice President, Finance, IDS Life from May 1984 to March 1994; Vice President, AEFC, since January 1987.\nPeter A. Lefferts, 53: Director and Executive Vice President, Marketing since March 1994; Senior Vice President and Director, AEFC, since February 1986.\nJanis E. Miller, 43: Director and Executive Vice President, Variable Assets since March 1994; Vice President, AEFC, since June 1990; Director, Mutual Funds Product Development and Marketing, AEFC, from May 1987 to May 1990. Director of IDS Life Series Fund, Inc. and manager of IDS Life Variable Annuity Funds A and B.\nJames A. Mitchell, 53: Chairman of the Board since March 1994; Chief Executive Officer since November 1986; President from July 1984 to March 1994; Executive Vice President, AEFC, since March 1994; Director, AEFC, since July 1984; Senior Vice President, AEFC, from July 1984 to March 1994.\nBarry J. Murphy, 44: Director and Executive Vice President, Client Service since March 1994; Senior Vice President, Operations, Travel Related Services (TRS) a subsidiary of American Express Company, since July 1992; Vice President, TRS, from November 1989 to July 1992; Chief Operating Officer, TRS, from March 1988 to November 1989. Stuart A. Sedlacek, 37: Director and Executive Vice President, Assured Assets since March 1994; Vice President, AEFC, since September 1988.\nMelinda S. Urion, 41: Director and Controller, IDS Life, since September 1991; Executive Vice President since March 1994; Vice President and Treasurer from September 1991 to March 1994; Corporate Controller, AEFC, since April 1994; Vice President, AEFC, since September 1991; Chief Accounting Officer, AEFC, from July 1988 to September 1991.\nMorris Goodwin Jr., 43: Vice President and Treasurer since March 1994; Vice President and Corporate Treasurer, AEFC, since July 1989; Chief Financial Officer and Treasurer, American Express Trust Company, from January 1988 to July 1989.\nWilliam A. Stoltzmann, 46: Vice President, General Counsel and Secretary since 1985.\nThe directors, executive officers and certain other offices of JMB Realty Corporation (JMB), the managing partner of the Investment Adviser, are listed below. Many of such persons are also officers and\/or directors of numerous affiliated companies of JMB and\/or partners of certain partnerships (herein collectively referred to as the Associate Partnerships) which are partners, directly or indirectly, in publicly offered real estate limited partnerships sponsored by JMB.\nJudd D. Malkin, 57, Chairman and Director of JMB, is a director of Urban Shopping Centers, Inc., an affiliate of JMB engaged in the business of owning, managing and developing shopping centers, an officer and\/or director of various other JMB affiliates and a partner of the Associate Partnerships. Until December 1994, he was also a Trustee of JMB Group Trust I, JMB Group Trust II, JMB Group Trust III, JMB Group Trust IV and JMB Group Trust V, which until that time had been advised by an affiliate of the Investment Adviser. Mr. Malkin has been associated with JMB since October 1969. Mr. Malkin also is a Director of Catellus Development Corporation, a major diversified real estate development company. He is a Certified Public Accountant.\nNeil G. Bluhm, 57, President and Director of JMB, is a director of Urban Shopping Centers, Inc., an affiliate of JMB engaged in the business of owning, managing and developing shopping centers, an officer and\/or director of various other JMB affiliates and a partner of the Associate Partnerships. Until December 1994, he was also a Trustee of JMB Group Trust I, JMB Group Trust II, JMB Group Trust III, JMB Group Trust IV and JMB Group Trust V, which until that time has been advised by an affiliate of the Investment Adviser. Mr. Bluhm has been associated with JMB since August 1970. He is a member of the Bar of the State of Illinois and is a Certified Public Accountant.\nBurton E. Glazov, 56, Director of JMB, was until December 1990 also Executive Vice President of JMB. Mr. Glazov has been associated with JMB since June 1971. He is member of the Bar of the State of Illinois and is a Certified Public Accountant. Stuart C. Nathan, 53, Executive Vice President and Director of JMB, is an officer and\/or director of various JMB affiliates and a partner of the Associate Partnerships. Mr. Nathan has been associated with JMB since July 1972. He is also a director of Sportmart Inc., a retailer of sporting goods. He is member of the Bar of the State of Illinois.\nJohn G. Schreiber, 48, Director of JMB, is also a director of Urban Shopping Centers, Inc., an affiliate of JMB engaged in the business of owning, managing and developing shopping centers, and was, until December 1990, Executive Vice President of JMB. Mr. Schreiber has been associated with JMB since December 1970. 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. Mr. Schreiber also serves 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 master's degree in business administration from the Harvard University Graduate School of Business.\nA. Lee Sacks, 61, Director of JMB, is President and Director of JMB Insurance Agency, Inc. and a partner of various Associate Partnerships. Mr. Sacks has been associated with JMB since December 1972.\nH. Rigel Barber, 46, Chief Executive Officer and Executive Vice President of JMB, is an officer of various JMB affiliates and a partner of various Associate Partnerships. Mr. Barber has been associated with JMB since March 1982. He holds a law degree from the Northwestern University Law School and is a member of the Bar of the State of Illinois.\nIra J. Schulman, 43, Executive Vice President of JMB, is an officer of various JMB affiliates and a partner of various Associate Partnerships. Mr. Schulman has been associated with JMB since February 1983. He holds a master's degree in business administration from the University of Pittsburgh.\nGary Nickele, 42, Executive Vice President and General Counsel of JMB, is an officer and\/or director of various JMB affiliates and a partner of various Associate Partnerships. Mr. Nickele has been associated with JMB since February 1984. He holds a law degree from the University of Michigan Law School and is a member of the Bar of the State of Illinois.\nJeffrey R. Rosenthal, 44, Chief Financial Officer and Managing Director -- Corporate of JMB, is an officer of various JMB affiliates and a partner of various Associate Partnerships. Mr. Rosenthal has been associated with JMB since December 1987. He is a Certified Public Accountant.\nGlenn E. Emig, age 47, Executive Vice President and Chief Operating Officer of JMB, is an officer of various JMB affiliates and a partner of various Associate Partnerships. Mr. Emig has been associated with JMB since December 1979. He holds a master's degree in business administration from the Harvard University Graduate School of Business.\nDouglas Cameron, age 45, Executive Vice President of JMB, is an officer of various JMB affiliates and a partner of various Associate Partnerships. Mr. Cameron has been associated with JMB since April 1977. He holds a master's degree in business administration from the University of Southern California.\nItem 11. EXECUTIVE COMPENSATION\nNot applicable.\nItem 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIDS Life purchased the initial 200,000 units of the Account at $1.00 per unit. Such units held by IDS Life were redeemed in April 1990 at the then current accumulation unit value.\nItem 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Account incurred asset management fees for the year ended December 31, 1994 of $765,557 of which $614,775 was paid to the Investment Adviser and the remainder to IDS Life. Asset management fees incurred for the year ended December 31, 1993 was $773,849, of which $609,074 was paid to the Investment Adviser and the remainder to IDS Life.\nFor the years ended December 31, 1994 and 1993, IDS Life was paid or reimbursed $502,607 and $549,250, respectively, for mortality and expense risk fee and $51,225 and $83,122, respectively, for personnel related expenses incurred in the administration of the Account.\nItem 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A.1) See Item 8","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":"354827_1994.txt","cik":"354827","year":"1994","section_1":"Item 1. Business\nGENERAL\n\tThe Company designs, manufactures, markets, and services computerized instruments and control systems that measure thickness and coating weight, and control the manufacturing process in primary products produced by the metals, plastics, and paper industries throughout the world. The Company's instruments enable producers of flat and rolled metal, plastics, rubber, paper, board, textiles, and particle board to fabricate goods with close tolerances and without variations in quality that impair the usefulness of products and waste raw materials. Instrument systems of the type manufactured by the Company are typically installed as part of the production line in industrial plants producing continuously-made extruded or rolled products, such as steel plate, tin plate, galvanized sheets, copper, aluminum sheets, and plastics produced in calenders. These instruments provide continuous quality control capabilities that enable prompt adjustments to be made in the manufacturing process, thereby permitting goods to be produced within closer tolerances and with greater assurance of meeting specifications. Savings of raw materials that result from manufacturing to closer tolerances can be substantial. Moreover, the statistical record of the measurements printed by the instrument increasingly is being required not only by the producer of such products, but also by their users.\n\tAs part of the efforts to expand the line of products offered and to increase the customer base, the Company's strategy in the mid 1980's was to acquire other firms in the same general business. The Company typically sought to acquire suitable businesses with compatible technological and commercial strengths, and which experienced financial difficulties as a result of management deficiencies. Such acquisitions enabled the Company to enter new industry markets at a substantially lower cost than through new entry, that is, without such acquisitions. Recently, the Company has sought to expand by establishing a service and sales presence in major steel producing areas around the world. The Company believes that the creation of this local representation network will enable it to both better defend its customer base in established markets and to more readily penetrate new geographic markets.\n\tThe Company has had sales, service and manufacturing facilities in the U.K. since 1982. The Company has had sales and service operations in Germany since 1987. The Company's sales and service operations in the remainder of Europe are directed by DMC U.K.\n\tIn 1994 the Company established DMC Foreign Sales Corporation in St. Thomas, U.S. Virgin Islands. This wholly owned subsidiary represents the Company in certain export transactions.\nPRODUCTS\n\tThe equipment made by the Company covers a range of activities extending from strictly measurement and display of data to control of a process. A growing share of the Company's sales is in process control. Process control enables the thickness of the rolled product, or applied coating, to be altered automatically to preset targets as a result of the measurements taken by the Company's instruments. The Company's products can be used with practically all materials made in flat form on a continuous basis. The Company also makes pinhole detectors and some laboratory versions of its on-line instruments.\n\ta. Non-contact thickness gauges for production lines. The Company presently makes two types of thickness gauges that measure either the total thickness of a flat rolled product or the thickness of a coating applied to a flat rolled product. These two types are distinguished by the method used by the sensor making the measurements. These measuring systems typically range in price from $30,000 to $750,000, with an average selling price of approximately $175,000. In 1994 these items represented 66% of total sales.\n\tTotal Thickness Gauges. These gauges, also known as transmission gauges, provide measurement of total thickness or weight per unit area of metals, plastics, rubber, paper, board, textiles and carpet. The gauges consist of two main parts, the sensor and the electronic processor. The Company's thickness gauges operate without touching the material being measured and measure thickness from 10 microns (0.0004 inches) up to 100 millimeters (4 inches), with an accuracy of a fraction of one percent.\n\tTransmission gauges operate by directing a beam of radiation through the material being measured. The radiation beam is produced either by a radioisotope (cesium, curium, krypton, promethium, strontium, americium, or cobalt) with fixed emission energy or by an x-ray tube with variable emission energy. In either case, the gauge measures the intensities of the radiation beam before and after passing through the material being gauged. A micro-computer analyzes the detected radiation, calculates the thickness of the material, and provides an instantaneous visual or printed readout of the measurement.\n\tCoating weight gauges. These non-contact gauges measure organic or metallic coatings on metals using either a fluorescence or a backscatter principle.\n\tFor example, fluorescence gauges are used to measure the thickness of zinc, tin, or chromium coatings on steel. Fluorescence gauges direct a radiation beam at a given sample. Each of the elements encountered by such a beam emits radiation at a characteristic energy level -- a phenomenon known as x-ray fluorescence.\n\tBackscatter gauges use the reflection of a beam of radiation by an underlying material (for example, steel) to measure the thickness of a coating (for example, paint).\n\tThe Company's thickness gauges and coating weight gauges are offered for hot or cold measurements, high speed production lines, and varying material sizes and thicknesses. They are equipped with different radiation sources depending on the thickness and type of material being gauged. Computer capacity and performance vary among the Company's models. The Company often specially modifies its standard thickness gauges to meet particular specifications and performance requirements of customers. The Company's closed loop control systems are typically based on the use of one or several gauges to control the thickness or coating thickness of materials.\n\tb. Pinhole detectors. The Company's line of pinhole detectors is designed to locate minute holes in sheet materials, such as tin plate, tin-free steel, galvanized steel, copper, brass, aluminum and opaque plastic. These detectors are installed on the production line and, without interrupting the manufacturing process, identify and locate pinholes and other through-the-strip flaws as minute as 2.5 microns (0.0001 inches). In 1994 this line generated less than 2% of total sales.\n\tA pinhole detector operates by projecting a beam from an ultraviolet light source located above the strip of material through flaws in the material. An ultraviolet filter collects the beam passing through a flaw and removes most visible light. Photomultiplier tubes transform the light passing through the filter into an electrical signal that is processed to produce a \"pinhole\" signal. Interconnected digital computer equipment identifies, in visual or printed readout form, the position and number of flaws in the material. The computer may be integrated with various control units that cut or reject defective material.\n\tThe Company's pinhole detectors offer various performance and sensitivity options which may be selected by a customer depending upon the intended use of the instrument. The Company's pinhole detectors typically range in price from $25,000 to $75,000.\n\tc. Laboratory gauges. The Company makes two measuring systems that are used in laboratories and production facilities, but are not directly mounted on production lines - the Basis Weight and Caliper Profiler, and the Laboratory Coating Weight Gauge. In 1994 this line generated less than 1% of total sales.\n\tBasis Weight and Caliper Profilers. This instrument provides fast and accurate measurement of samples of paper, paperboard, plastic, and non-woven fabrics. Such samples are fed into the unit for measurement and then are used to test the accuracy of the instruments used in the production process.\n\tLaboratory Coating Weight Gauges. This instrument is used in a laboratory to monitor the thickness or coating weight of zinc or tin on steel. The instrument inspects samples and records measurements of the material.\n\td. New Products. The Company has recently completed development of a new measuring process whereby the entire width of the surface is measured instantaneously. (The Company's traditional measurement systems measure only one spot at any one time.) This system, which uses the trade name \"MIP\" -- Measurement of Instantaneous Profile -- was jointly developed under an exclusive license agreement with IRSID, the French national steel research institute. These gauges are particularly useful for sensitive measurements at the edge of a steel strip. In 1994 the Company received two orders for MIP systems and expects to ship both systems during the first half of 1995. The order value of each system ranges from $600,000 to $900,000.\n\te. Spare Parts. The Company sells spare parts for all of the measurement systems it manufactures. Spare parts sales typically bear higher gross profit margins than do system sales. Customers generally procure a minimum complement of spare parts, either at the time of the initial purchase of a gauging system, or at the end of the warranty period -- generally one year after delivery and start up. Additional spare parts orders are received as the measurement system ages. In 1994 spare parts sales accounted for 21% of total sales.\nSERVICE\n\tThe Company's instruments are usually covered by a one year warranty against defects in workmanship or components. The Company maintains worldwide product liability insurance. No product liability claims have ever been brought against the Company. Warranty services, in addition to services performed on a fee basis such as commissioning of new equipment, training of equipment operators, and post-warranty maintenance and repairs, are handled by personnel based either at the Company's facilities in Gaithersburg, Michelstadt (Germany) or Northfleet (United Kingdom), or at field offices currently located in Chicago, Kaoshiung (Taiwan), Liege (Belgium), Pittsburgh, Pusan (South Korea), and Gloucester (U.K.). The Company has also contracted with independent organizations to provide service in Australia, India, Italy, Japan and the Republic of South Africa and has a joint venture agreement with Anshan Steel to provide service in China.\nRAW MATERIALS\n\tThe Company's products require a wide variety of components and materials. The Company uses multiple vendors to supply its components and materials. The Company believes that the sources and availability of its components and materials are adequate.\nGOVERNMENT REGULATIONS AND LICENSES\n\tThe use of radioisotopes in equipment manufactured by the Company is licensed by the State of Maryland, Department of Health and Mental Hygiene, Division of Radiological Health. In the United Kingdom, the use of radioisotopes in manufacturing is licensed by the Department of the Environment and is under the control of the Health and Safety Executive. In Germany, the use of radioisotopes is licensed by the Factory Inspectorate under the control of the Staatliches Gewerbeaufsichtsamt, Wiesbaden. The Company does not believe that there are any risks attendant to the manufacture or use of the Company's equipment using radioisotopes and, accordingly, does not maintain supplemental liability insurance against such risks.\nPATENTS AND MANUFACTURING LICENSES\n\tThe Company is the assignee of six patents which expire between 1998 and 2009. The Company has applied for patents on four other measuring system inventions and expects these patents to be issued by 1996. The Company has entered into a joint development and license agreement with IRSID, the French national steel research institute, to develop an instantaneous profile measurement system. The license agreement, which expires in 2001, grants the Company exclusive, worldwide marketing rights.\nSALES AND MARKETING\n\tThe Company's market is divided in two categories, direct users and prime contractors, that is, mill manufacturers who subcontract the gauge part of their orders. Sales to direct users have, in 1994, been made to Inland Steel, Bethlehem Steel, Usinor, British Steel, Kawasaki Steel, Nippon Steel, Wuhan Iron and Steel, Posco, and Yieh United, among others. 1994 sales to prime contractors in the construction of mills and plants include General Electric, Mitsubishi, MDS, SMS, Jeumont-Schneider, Davy McKee and Hitachi, among others.\n\tThe Company maintains sales offices in Maryland, Illinois, Pennsylvania, Northfleet (U.K.), Michelstadt (Germany), Liege (Belgium), Beijing (PRC) and Paris (France). The Company employs eight full-time salespeople to service major domestic and foreign accounts. In addition, the Company has agency arrangements with technical sales representatives in Australia, Brazil, Canada, India, Italy, Japan, South Korea, the Philippines, Mexico, South Africa, Germany, Spain, Sweden, the Netherlands, Taiwan, Thailand, Turkey and Venezuela.\n\tExcluding intercompany transactions, export sales from the U.S. were $12,004,000, $10,564,00 and $10,376,000 in 1994, 1993 and 1992, respectively. Export sales from DMC (U.K.) Ltd. were $3,444,000, $2,100,000 and $2,890,000 in 1994, 1993 and 1992, respectively.\n\tExcluding intercompany transactions, shipments of new measurement systems to the Company's major markets over the last three years were:\n\t The Americas Asia Europe\/Africa 1994 $6,295,000 $5,497,000 $4,825,000 1993 4,817,000 5,210,000 2,765,000 1992 3,018,000 2,367,000 6,844,000 \t \tThe Company does not believe it is dependent upon any single customer on a continuing basis, although in any one year, one customer may account for a material portion of the Company's sales. During 1994, 1993, and 1992, no single customer accounted for 10% or more of sales.\n\tThe Company's business is not seasonal in nature, but is directly affected by changes in capital expenditures by industry. Backlog of orders believed to be firm as of December 31, 1994, 1993, and 1992 was approximately $14,406,000, $11,675,000 and $9,826,000, respectively. Most orders on backlog are expected to be shipped within one year.\n\tThe Company does not typically offer extended payment terms to customers. Long collection times occur occasionally due to slowness of payment by some foreign customers, retainages or receivables not due until the occurrence of certain events such as the commissioning of equipment or the expiration of the warranty period, and some customers' habit (contrary to the purchase order contract) of delaying payment of invoices until the equipment is proven to work to their satisfaction.\nCOMPETITION\n\tThe company's major market has been sales to the metals industries and especially to the steel industry. The Company knows of no competitor that sells more thickness measurement equipment to the steel industry than it sells. In general, the industrial measurement and control instruments industry is highly price competitive. The Company faces vigorous competition for sales of all products from a number of firms, many of which are larger and have substantially greater financial resources than the Company. They include Thermo Instrument Systems (formerly FAG), Measurex, Accuray, Toshiba, Loral Control Systems, IMS and Yokogawa.\n\tIn the opinion of the Company, its ability to obtain business is based on its technical competence in the design, manufacture and performance of its products, product quality, and in its ability to quickly service its instruments in both domestic and foreign markets. The Company's world-wide network of service centers allows it to have a service representative at most customer's sites within 24 hours and at all sites within 48 hours; this is particularly important in making direct sales to the end users of the Company's products.\nDevelopment and Engineering\n\tThe Company's technical competence is an important factor in marketing. Most of the Company's development efforts are directed toward product design, performance enhancements and standardization of products. The Company is engaged in a continuing program to develop the hardware and software necessary to further the use of computer techniques in its products.\nEMPLOYEES\n\tAt December 31, 1994, the Company employed 226 full-time employees, 204 of which were based in the U.S., 16 in the U.K., 3 in France, 2 in Germany and 1 in China. There are no collective bargaining agreements with any of the Company's employees. The Company considers its relations with its employees to be good.\n\t\t\t Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\n\tThe Company leases 45,065 square feet of space in a modern industrial park in Gaithersburg, Maryland, a suburb of Washington, D.C. The Company's lease, with options, extends until November 2002. The Company's offices occupy 9,600 square feet, and the remaining 35,465 square feet are dedicated to manufacturing activities. This facility includes testing and research laboratories, a complete machine shop, welding and paint rooms, and assembly and general test areas. Raw materials and work-in-process inventory are also stored at this facility as well as at two smaller, off-site facilities. The Company believes that currently leased space is adequate for business operations for the foreseeable future. Monthly rent under these leases amounts to $48,900.\n\tThe Company's wholly-owned U.K. subsidiary owns a building and land in Northfleet, Kent. Of the building's 13,500 square feet, offices occupy 5,000 square feet, and 8,500 square feet are dedicated to manufacturing and engineering activities. Raw materials and work-in-process are also stored at this facility. On March 1, 1988, a 1,500 square foot storage facility was leased, at a monthly rental of $1,068. This lease extends until April 1995.\n\tThe Company's wholly-owned German subsidiary has office space in Michelstadt that is subleased, on a month to month basis, from the Company's German agent as part of the agency agreement. Spare parts are also stored in the Michelstadt facility. The Company believes that for the foreseeable future, this facility is adequate for business operations.\n\tThe Company's China division leases a small office in Beijing under a lease expiring in 1995 at $1,400 per month.\n\t\t\tItem 3.","section_3":"Item 3. Legal Proceedings\n\tThe Company has no material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\n\tNot applicable.\n\t\t\t\t PART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and \t\t\t Related Stockholder Matters\n\tThe following is a summary of the trading range of the Company's common stock. Since May 5, 1987, the Company's common stock has been traded on the NASDAQ National Market System. The following table sets forth the high and low quotations for the periods indicated. These prices reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.\n\t Quarter Low High \t\t \t 1st 1992 1 3 7\/8 \t 2nd 1992 2 7\/8 4 1\/2 \t 3rd 1992 3 3\/8 5 1\/4 \t 4th 1992 4 5 3\/4\n\t 1st 1993 4 3\/4 7 1\/2 \t 2nd 1993 5 3\/4 7 3\/4 \t 3rd 1993 4 1\/4 6 1\/4 \t 4th 1993 3 1\/4 5 3\/4\n\t 1st 1994 3 3\/8 4 3\/4 \t 2nd 1994 3 1\/2 4 5\/8 \t 3rd 1994 3 3\/4 6 1\/2 \t 4th 1994 4 3\/4 7 3\/8\n\t 1st 1995 (to 2\/28) 4 3\/4 6 3\/4\n\tAs of December 31, 1994, there were 232 holders of record of the Company's common stock. The Company believes that there are approximately an additional 700 shareholders whose holdings are maintained in street name.\n\tNo cash dividends were paid during 1994, 1993 or 1992. Payment of future cash dividends will be dependent upon the income and financial condition of the Company, lending covenants then in effect, and other factors which the Board of Directors may deem appropriate. The Company's current loan agreements prohibit the payment of cash dividends without the lender's consent.\n\t\t Item 6.","section_6":"Item 6. Selected Financial Data\n\tThe following table summarizes selected consolidated financial data and is qualified in its entirety by the more detailed consolidated financial statements, related notes thereto, and other statistical information contained elsewhere herein. The information has been derived from the Company's audited consolidated financial statements.\n\t\tItem 7.","section_7":"Item 7. Management's Discussion and Analysis of \t\t Financial Condition and Results of Operations\nCOMPARISON OF 1994 TO 1993\n\tSales for 1994 were $24,206,165, a 19.8% increase over the prior year amount of $20,211,006. Worldwide system sales increased by approximately $3,800,000 (29.7%) to $16,617,000 while sales of spare parts increased approximately $400,000 (8.6%) to $5,052,000. Worldwide backlog at year end 1994 was $14,406,000, a 23.4% increase over the prior year.\n\tNew orders received during 1994 amounted to $21,652,000, an increase of 27.8% over 1993 bookings. In actual dollar terms, orders from North America were up 138%, to $8,860,000, in 1994 as compared to 1993:\nOrders Received by Location of End User 1994 1993 1992\n\t\tAsia 32% 46% 32% \t\tNorth America 40 22 32 \t\tEurope 23 16 32 \t\tOther 5 16 4 \t\t\t \t\t\t Total 100% 100% 100% \t \tGross profit margins declined from 25.2% in 1993 to 24.8% in 1994. The large increase in new system sales carrying lower margins combined with the relatively smaller increase in spare parts sales carrying higher margins accounted for this decline in overall margins. Selling, general and administrative expenses increased only $159,000 in 1994 compared to 1993 and decreased from 21.8% in 1993 to 18.8% in 1994 reflecting the Company's ability to contain increases in these largely fixed expenses. \t \tInterest expense, while essentially constant in actual terms, declined as a percent of sales from 2.0% in 1993 to 1.7% in 1994. The Company recorded losses on foreign exchange transactions of $78,794 in 1993 and $19,439 in 1994.\n\tThe Company's effective tax rate in 1994 was 19.1% as compared to 41.4% in 1993. The reduction resulted from better utilization of net operating loss (NOL) carryforwards in the Company's foreign subsidiaries.\n\tThe Company was not impacted by SFAS No. 106 (\"Employers' Accounting for Postretirement Benefits Other Than Pensions\") as the Company does not have a liability for such benefits. In addition, the Company was not impacted by SFAS No. 112 (\"Employers' Accounting for Postemployment Benefits\") since the Company does not offer benefits of this type to its employees.\nCOMPARISON OF 1993 TO 1992\n\tDuring 1993 the Company's gross profit margins were adversely affected by a change in sales mix and by extremely aggressive price competition as compared to 1992. The proportion of spare parts sales in 1993 declined to 22.8% of total sales from 25.0% in 1992. Since gross profit on spares is approximately double the gross profit on system sales, this decline resulted in a $200,000 reduction in gross profit contribution. The Company believes, however, that future spare parts sales will increase over time as a percentage of total sales as the installed base of measuring systems grows.\n\tAdditionally, aggressive pricing by the Company's major North American and European competitors resulted in a 2% decline in average selling prices for new systems. This negatively impacted gross profits by $200,000.\n\tSales for 1993 were $20,211,006, a 1.4% increase over the prior year amount of $19,937,493. Worldwide system sales increased by approximately $600,000 (4.6%) to $12,797,000 while sales of spare parts declined approximately $400,000 (7.5%) to $4,610,000. Worldwide backlog at year end 1993 was $11,675,000, an 18.8% increase over the prior year. A surge of new orders during the fourth quarter resulted in year end work in process inventory increasing by $1,300,000 over 1992's ending amount.\n\tNew orders received during 1993 amounted to $16,943,000, an increase of 1.8% over 1992 bookings. \t \tGross profit margins declined from 27.6% in 1992 to 25.2% in 1993 due to the aforementioned changes in sales mix and competitive pricing pressures. Selling, general and administrative expenses, as a percent of total sales, increased from 21.1% in 1992 to 21.8% in 1993. This increase was primarily attributable to higher foreign agent commission expenses which resulted from a relatively higher proportion of foreign sales.\n\tInterest expense declined by more than $200,000 to 2.0% of sales in 1993 as compared to 3.1% in 1992. This was primarily a result of the FDIC debt restructuring which was consummated as of September 30, 1992.\n\tThe Company recorded losses on foreign exchange transactions of $78,794 in 1993 and $41,366 in 1992. The losses were attributed to the strengthening of the U.S. Dollar versus major European currencies. In June 1993, the Company obtained a foreign exchange facility with which to hedge these transactions but was unable to fully utilize the facility in 1993 due to the uncertainty of the timing of its foreign denominated collections.\n\tThe Company's effective tax rate in 1993 was 41.4% as compared to 17.9% in 1992. This difference is primarily due to large net operating loss (NOL) carryforwards that significantly reduced the effective tax rate in 1992.\nCOMPARISON OF 1992 TO 1991\n\tSales for 1992 declined by 1.0% to $19,937,493 as compared to $20,142,764 in the prior year. The fall off in sales was primarily attributable to the weakness of the British economy and its resulting impact on the Company's subsidiary located in the United Kingdom. This decrease was only partially offset by increases in sales in France and Germany; sales in the United States decreased less than 0.1%. World-wide bookings of major systems for 1992 amounted to $16,664,000 -- a 37% increase over prior year. Year end back log was $9,826,000 -- a 15% increase over prior year. This also resulted in the level of advance payments increasing from $580,607 at the end of 1991 to $933,072 at the end of 1992. The allowance for doubtful accounts was $187,000 in 1992 compared to $443,000 in 1991, a decline of $256,000 which is principally the result of accounts from prior years being written off. The current reserve is adequate given the composition of accounts receivable at the end of the year.\n\tGross margin increased to $5,503,283 or 27.6% of sales in 1992 versus $5,230,723 or 26.0% of sales in 1991. The Company was able to continue to improve margins as a result of better manufacturing cost controls and because technical maturity in its products resulted in lower engineering costs.\n\tSelling, general and administrative costs were relatively unchanged and amounted to $4,217,244 or 21.2% of sales in 1992 as compared to $4,239,529 or 21.0% of sales in 1991.\n\tInterest expense declined to $614,281 or 3.1% of sales from $885,998 or 4.4% of sales in 1991. This reflects a decrease in total borrowings and the favorable restructuring of the Company's FDIC debt which is more fully discussed in the Liquidity and Capital Resources section.\n\tThe Company recorded losses on foreign exchange transactions of $41,366 in 1992 and $63,044 in 1991. The losses were attributed to the strengthening of the U.S. Dollar versus major European currencies. The Company did not have a foreign exchange facility with which to hedge these transactions during 1992.\n\tThe Company's effective tax rate in 1992 was 17.9% as compared to 36.4% in 1991.\n\tDuring 1992 the Company successfully restructured its FDIC debt and, as a result, was able to substantially reschedule its debt obligations (See Liquidity and Capital Resources discussion).\nLIQUIDITY AND CAPITAL RESOURCES\n\tDuring 1992, 1993 and 1994, the Company's primary sources of liquidity were cash flow from operations and short-term borrowings. On September 29, 1994, the Company completed a refinancing of its long term debt which resulted in an extraordinary gain of $4,012,180. The new long term financing allowed the Company to fully repay an existing obligation in the amount of $2,821,845, plus accrued interest, to the Federal Deposit Insurance Corporation as receiver of the National Bank of Washington (\"FDIC\"). This payment completed and terminated the Company's obligations under the Loan Modification Agreement between the Company and the FDIC dated as of September 30, 1992 (\"Agreement\"). That Agreement had provided for the division of the Company's debt to FDIC into a term loan and a contingent liability (which was recorded on the Company's Balance Sheet as a Non Interest Bearing Long Term Obligation). As a result of the refinancing, the term loan was paid in full and the contingent liability was terminated.\n\tAdditionally, the Company issued to the FDIC a new Convertible Subordinated Debenture due in 1999 (\"Debenture\") in the principal amount of $240,000 in exchange for the Warrant (\"Warrant\") for 120,000 shares of DMC common stock which was previously issued to the FDIC as part of the Agreement. The Debenture bears no interest and may be converted into 120,000 shares of DMC common stock at any time between October 1, 1996 and September 30, 1999 at an exercise price of $2.00 per share. If FDIC chooses to convert the Debenture, the Company has the right to redeem the Debenture for 65% of the market value of the underlying common stock at the time of conversion.\n\tAlso, the FDIC has released all security interests it previously held on DMC's inventory and fixed assets. Those assets have now been pledged to the Company's bank as collateral for the Company's bank loans.\n\tThe new banking facility, which is in addition to the Company's existing bank facilities, totalled $2,600,000 as of December 31, 1994, is repayable in quarterly installments over a five year period beginning on September 30, 1994 and ending June 30, 1999 and carries an interest rate of prime plus 1.5%. The bank loan agreement contains other terms and covenants typical of term loans of this type. The Company does not believe that these conditions will impair its ability to operate or expand its business.\n\tIn August 1992, the Company also restructured the long term debt of its British subsidiary by converting a mortgage note bearing an interest rate of 14% with a three year maturity to a ten year note bearing an interest rate of 9.75% which is reset annually to LIBOR plus 4.0%. As of December 31, 1994, the balance of this mortgage was $386,052.\n\tIn June 1992, the holders of the Company's $625,000 convertible subordinated debentures agreed to extend the principal redemption date for five years to September 30, 1997. The interest rate and conversion price remained unchanged at 12% per annum and $2.50 per common share, respectively. During 1994, 1993 and 1992, one of the bondholders converted $80,000, $90,000 and $30,000, respectively, worth of its debentures into 32,000, 36,000 and 12,000 shares, respectively, of common stock.\n\tIn August 1994, the Company renewed a $2,000,000 banking facility from Chase Manhattan Bank of Maryland. This facility comprises a $1,000,000 working capital line, a $500,000 stand-by letter of credit line and a $500,000 foreign currency trading line. The facility is secured by the inventory, fixed assets and accounts receivable of the domestic operation and bears interest at the rate of prime plus 0.75%. At December 31, 1994, borrowings against the working capital line were $603,223. The facility expires in July 1995.\n\tThe Company's U.K. and German subsidiaries also have working capital facilities of which $532,000 was unused at the end of 1994.\n\tThe Company has no material commitments for capital expenditures.\nINFLATION\n\tFor the past three years, inflation has not had a material effect on the Company's business.\n\t\t Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data \t\t\t\t INDEPENDENT AUDITOR'S REPORT \t\t\t\t To the Board of Directors and Stockholders of \tData Measurement Corporation \tGaithersburg, Maryland\nWe have audited the accompanying consolidated balance sheets of Data Measurement 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)(2). These financial statements and 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. We did not audit the financial statements of DMC (U.K.) Limited (a consolidated subsidiary), which statements reflect total assets constituting 20% and 18% of consolidated total assets as of December 31, 1994, and 1993, respectively, and total revenues constituting 19%, 11% and 14% of consolidated total revenues for the years ended December 31, 1994, 1993, and 1992, respectively. Such financial statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for DMC (U.K.) Limited, is based solely on the report of such other auditors.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the overall financial statment 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, such consolidated financial statements present fairly, in all material respects, the financial position of Data Measurement 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, based on our audits and (as to the amounts included for DMC (U.K. Limited) the report of other auditors, 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.\n\/s\/ Deloitte & Touche LLP Washington, D.C. March 1, 1995\nINDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors of \tDMC (UK) Limited\nWe have audited the accompanying Balance Sheets of DMC (UK) Limited as of December 31, 1994 and 1993, and the related statements of Profit and Loss Account and Cash Flow Statements for each of the three years in the period ended December 31, 1994. These financial statments are the responsibility of the Company's management. Our resposibility is to express an opinion on these financial statments 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 also includes 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 the above present fairly, in all material respects, the financial position of DMC (UK) Limited as of December 31, 1994 and 1993, and the results of its Profit and Loss Account and Cash Flow Statements for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\n\/s\/ SINCLAIRS LONDON, U.K. 1 March 1995\n\t\t\t DATA MEASUREMENT CORPORATION \t\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS \t\t Years Ended December 31, 1994, 1993 and 1992\nNOTE 1. Summary of Significant Accounting Policies\nConsolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries, DMC (U.K.) Limited, DMC Mess- & Regeltechnik GmbH, DMC France, S.A.R.L., DMC Foreign Sales Corporation and Industrial Gauging Disc, Inc., a former interest charge domestic international sales corporation (\"DISC\"). All intercompany transactions have been eliminated.\nRevenue Recognition\nThe Company manufactures gauging systems, pinhole detectors, and other industrial instruments pursuant to specific contract orders. Revenues related to the production of these items are recognized either using the percentage of completion method or upon completion and shipment of units to customers, depending on the magnitude and duration of the contract. Revenues related to the installation and service of equipment at customers' locations are recognized when the installation or service work is performed.\nForeign Currency Translation\nGains or losses resulting from translating foreign currency financial statements are accumulated in a separate component of stockholders' equity. Gains or losses resulting from foreign exchange transactions (transactions denominated in a currency other than the entity's local currency) are included in determining net income.\nInventories\nMaterial and parts inventory is stated at the lower of cost (first-in, first-out basis) or market. Work-in-process inventory represents accumulated labor, material, and overhead costs related to specific uncompleted contracts. Provisions are made to reduce accumulated costs on uncompleted contracts to net realizable value when losses are anticipated.\nDepreciation\nDepreciation is computed on the straight-line method using the following estimated useful lives: \tBuilding. . . . . . . . . . . . . . . . 50 years \tMachinery and equipment . . . . . . . . 3-7 years \tDemonstration equipment . . . . . . . . 3-10 years \tOffice furniture. . . . . . . . . . . . 5-7 years \tLeasehold improvements. . . . . . . . . 5-7 years\nAmortization\nPatents and licenses are amortized on a straight-line basis over five-year periods. Goodwill is amortized over a forty-year period.\nIncome Taxes\nThe Company provides for federal and state income taxes at the statutory rates in effect on taxable income. Deferred income taxes result primarily from the temporary differences in recognizing depreciation, vacation pay and reserves.\nIncome taxes have not been provided for the undistributed earnings of the Company's subsidiary, DMC (U.K.) Ltd., because the Company intends to continue these operations and reinvest the undistributed earnings indefinitely. Undistributed earnings of the subsidiary amounted to $2,122,355 at December 31, 1994.\nNet Income Per Share\nPrimary net income per share is based on the weighted average number of common shares outstanding including common stock equivalents from dilutive stock options and warrants. Common equivalent shares were computed using the treasury stock method. The Company's convertible subordinated debentures (see Note 2) are not common stock equivalents. Shares used in the primary net income per share calculation were 1,371,622, 1,285,768 and 1,246,357 in 1994, 1993, and 1992, respectively. Fully diluted net income per share assumes the conversion of the convertible subordinated debentures. Shares used in the fully diluted net income per share computation were 1,558,022, 1,505,768 and 1,509,906 in 1994, 1993, and 1992, respectively.\nCash, Cash Equivalents and Restricted Cash\nFor purposes of the statements of cash flows, the Company considers all temporary investments with an original maturity of three months or less to be cash equivalents. Included in cash at December 31, 1994 and 1993, is restricted cash in the amount of $102,000 and $34,000, respectively. These amounts collateralize performance bonds established by the Company.\nShort-Term Investments\nThe Company considers temporary investments with a maturity exceeding three months but less than one year to be short-term investments.\nRetainages and Unbilled Receivables\nThe Company expects to realize substantially all retainages and unbilled receivables within one year.\nReclassifications\nCertain reclassifications have been made to the 1993 consolidated financial statements to conform with the 1994 presentation.\nEstimated future maturities on long-term debt at December 31, 1994, were as follows:\n\t\t1995 $ 570,000 \t\t1996 666,000 \t\t1997 1,088,000 \t\t1998 642,000 \t\t1999 1,005,000 \t\t2000 and thereafter 167,532 \t\t\t\t\t\t ---------- \t\t\t\t\t\t $4,138,532 \t\t\t\t\t\t ==========\nDuring 1990, the Company negotiated with its principal lender, National Bank of Washington, for increases to the Company's line of credit. The Company expected that such a credit facility could be put in place. However, in August 1990, the Federal Deposit Insurance Corporation (FDIC) seized the National Bank of Washington and effectively closed out all lending activities.\nThe Company restructured its debt obligation with the FDIC effective September 30, 1992. The restructuring modified the debt by converting the principal and accrued interest obligation from a demand note to a $3,000,000 term note at 9.0% interest with quarterly repayments equal to 65% of the after-tax free cash flow generated by the domestic operations of the Company for five years. As part of the restructuring, the FDIC released the lien it held on the Company's domestic accounts receivable but has maintained its lien on the domestic inventory and fixed assets until the $3,000,000 obligation was repaid. In addition, the Company granted the FDIC warrants, exercisable from April 1, 1997 through September 30, 1997, to purchase 120,000 common shares at $5.00 per share.\nOn September 29, 1994, the Company completed a refinancing of its long term debt with the FDIC. The new long term financing allowed the Company to fully repay its existing obligation in the amount of $2,821,845, plus accrued interest. This payment completed and terminated the Company's obligations under the Loan Modification Agreement between the Company and the FDIC dated as of September 30, 1992. The debt forgiveness resulted in an extraordinary gain of $4,012,180. Since the gain had been previously recognized by the Company for tax purposes and since a valuation allowance had been recorded against the deferred tax asset, it has no current income tax effect.\nAdditionally, the Company issued to the FDIC a new Convertible Subordinated Debenture due in 1999 (\"Debenture\") in the principal amount of $240,000 in exchange for the Warrant (\"Warrant\") for 120,000 shares of DMC common stock which was previously issued to the FDIC as part of the Agreement. The Debenture bears no interest and may be converted into 120,000 shares of DMC common stock at any time between October 1, 1996 and September 30, 1999 at an exercise price of $2.00 per share. If the FDIC chooses to convert the Debenture, the Company has the right to redeem the Debenture for 65% of the market value of the underlying common stock at the time of conversion. The Company has determined that the fair market value of the debenture, under these conversion terms, is $663,000. That amount has been recorded in the accompanying consolidated balance sheet at December 31, 1994.\nThe new banking facility, which is in addition to the Company's existing bank facilities, totalled $2,600,000 as of December 31, 1994, is repayable in quarterly installments over a five year period beginning on September 30, 1994 and ending June 30, 1999 and carries an interest rate of prime plus 1.5%.\nDuring 1990, the Board of Directors authorized the Company to sell $625,000 of convertible subordinated debentures to certain key investors and directors of the Company. These debentures bear interest at 12%, were originally due September 30, 1992, and were extended to September 30, 1997, under the same terms, on June 30, 1992. The debentures are convertible to shares of the Company's common stock at the conversion price of $2.50 per share, for a maximum total conversion of 250,000 shares, of which 32,000 and 36,000 shares, respectively, were converted in 1994 and 1993. The Company has the right to call the debentures, subject to certain call premiums, beginning October 1, 1994; the Company has not called any debentures. The debentures are subordinate to all of the Company's current and future borrowing from banks, insurance companies, or other financial institutions regularly engaged in the business of lending of money.\nIn August 1992, the Company restructured the long-term debt of its British subsidiary by converting a mortgage note bearing an interest rate of 14% with a three year maturity to a ten year mortgage note currently bearing an interest rate of 9.750%. The interest rate is reset annually to LIBOR plus 4.0%.\nIn August 1994, the Company renewed its $2,000,000 banking facility from Chase Manhattan Bank of Maryland. This facility comprises a $1,000,000 working capital line, a $500,000 stand by letter of credit line and a $500,000 foreign currency trading line. The facility is secured by the assets of the domestic operations and bears interest at the rate of prime plus 0.75%. The facility expires on July 31, 1995. At December 31, 1994 and 1993, borrowings against the working capital line were $603,223 at 9.25% and $263,649 at 6.75%, respectively.\nThe Company's wholly-owned United Kingdom subsidiary, DMC (U.K.) Ltd., has a line of credit that provides for borrowing up to 280,000(pounds) ($438,000 at December 31, 1994). Under this line, borrowings denominated in pounds sterling bear interest at 3.5% over the U.K. base rate. The facility expires in June 1995. At December 31, 1994 and 1993, total borrowings under this line amounted to $102,883 at 9.75% and $223,748 at 9.0%, respectively. These borrowings are secured by substantially all of DMC (U.K.) Ltd.'s assets.\nThe Company's wholly-owned German subsidiary, DMC Mess- & Regeltechnik GmbH, has a line of credit of $197,000. Borrowings under this line bear interest at 10.5%, and are secured by substantially all of this subsidiary's assets. There were no borrowings against this line at December 31, 1994 and 1993, respectively.\nNOTE 3. Income Taxes\nThe provision (benefit) for income taxes is composed of the following:\n\t\t\t 1994 1993 1992\nCurrent: \tFederal . . . . . $136,000 $ (55,228) $ 195,896 \tState . . . . . . 21,327 3,164 43,395 \tForeign . . . . . 122,453 50,299 23,798 \t\t\t --------- ---------- ---------- \t\t\t 280,080 (1,765) 263,089 \t\t\t --------- ---------- ----------\nDeferred: \tFederal . . . . . (75,928) 88,760 (119,361) \tState . . . . . . (10,273) 348 (26,441) \tForeign . . . . . -- -- (4,384) \t\t\t --------- ---------- ---------- \t\t\t (86,201) 89,108 (150,186) \t\t\t --------- ---------- ---------- \t\t\t $193,879 $ 87,343 $ 112,903 \t\t\t ========= ========== ==========\n\tThe provision (benefit) for income taxes differs from that computed by applying the statutory federal income tax rate to income (loss) before income taxes due to the following:\n\t\t\t\t\t1994 1993 1992\nStatutory rate. . . . . . . . . . 34.0% 34.0% 34.0% Effect of tax loss carry forward. -- -- (106.1) Difference in effective rates on earnings of foreign subsidiaries (0.8) 1.5 4.4 State income taxes (benefit), net of federal income tax benefit. . 2.4 4.6 1.8 Debt restructuring. . . . . . . . -- -- 94.2 Valuation allowance adjustment. . -- -- (17.2) Other . . . . . . . . . . . . . . -- 1.3 6.8 Reversal of previously provided income tax. . . . . . . . . . . . (16.5) -- -- \t\t\t\t ------ ------ ------- \t\t\t\t 19.1% 41.4% 17.9% \t\t\t\t ====== ====== ======= \t\t\t\t The approximate tax effect of each type of temporary difference and carryforward that gave rise to the Company's deferred tax assets (liabilities), as of December 31, 1994 and 1993, are as follows:\n\t\t\t\t 1994 1993 \t\t\t\t Accelerated depreciation $ (33,000) $ (36,000) Bad debt reserves 21,000 46,000 Rent expense 5,000 4,000 Vacation expense 163,000 141,000 Commission Expense 55,000 -- Warranty Expense 42,000 -- Inventory reserves (8,000) -- Debt restructuring -- 1,898,000 Interest Expense OID (4,000) -- DISC distributions (39,000) (61,000) Tax credit carryforward -- 65,000 Other (80,000) (123,000) Less: valuation allowance -- (1,898,000) \t\t\t\t ------------- ------------ \t\t\t\t $ 122,000 $ 36,000 \t\t\t\t ============= ============\n\t \tAs a result of the debt restructuring and resulting extraordinary gain in 1994, the Company reversed the valuation allowance of $1,898,000 recorded at December 31, 1992, and therefore, the extraordinary gain had no income tax effect.\nNOTE 4. Employee Benefit Plans\n\tThe Company and DMC (U.K.) Ltd. maintain separate defined contribution employee benefit plans. U.S. and U.K. employees over the age of 21 and with more than 1 year of experience with the Company are eligible to participate. Eligible employees can defer a portion of their total compensation through contributions, a portion of which is matched by the Company. Participant contributions are immediately 100% vested, while Company contributions vest over four years.\n\tExpense related to these employee benefit plans was $96,236 for 1994, $73,844 for 1993, and $59,705 for 1992.\nNOTE 5. Commitments\n\tThe Company is obligated under various operating and capital lease agreements, primarily for office space, a manufacturing facility, and office equipment through 1998. The Company entered into a lease for office and manufacturing space in the United States during 1987 which, with options, extends until November 2002 and contains an escalation clause related to increases in the Consumer Price Index.\n\tThe following is a schedule by years of future minimum rental payments required under operating and capital leases that have initial or remaining noncancellable lease terms in excess of one year as of December 31, 1994: \t\t\t\t\t\t\t \t\t1995 $ 633,378 \t\t1996 577,614 \t\t1997 534,907 \t\t1998 52,117 \t\t1999 and thereafter 28,800 \t\t\t\t\t\t\t ---------- \t\t\t\t\t\t\t $1,826,816 \t\t\t\t\t\t\t ==========\n\tRental expense was $595,167 in 1994, $558,000 in 1993, and $516,000 in 1992.\nNOTE 6. Stockholders' Equity\nOptions \t \tThe Company adopted an Incentive Stock Option Plan (\"ISO Plan\") in 1985, and established a non-qualified stock option policy (\"Warrant Plan\") in 1984. In 1988, the Company adopted the 1988 Stock Option Plan (\"1988 Plan\"). In 1992, the Company adopted the 1991 Stock Option Plan (\"1991 Plan\") which was intended to supersede and replace the shares granted under the previous plans. As such, no grants were made under the old plans after the Shareholders approved the 1991 Plan on June 6, 1992. During 1992, employees holding option grants under the old plans were given a one time opportunity to transfer their options to the 1991 Plan at a conversion price of the higher of the original conversion price or $3.75. Consequently, 116,379 options were transferred to the 1991 Plan. In 1992, the Company also adopted the Outside Directors Stock Option Plan (\"Directors Plan\").\n\tThe ISO Plan is administered by a Committee appointed by the Board of Directors, which determines the officers and key employees to be granted options on shares of the Company's common stock, at prices no lower than the fair market value on the date of grant. As of December 31, 1994, there were options outstanding to purchase 20,000 shares of common stock, with expiration dates through December 31, 1997. At December 31, 1994, there were no shares available for future grants of options under the ISO Plan.\n\tThe following table summarizes the activity under the ISO Plan:\n\t\t\t\t\t Shares Option Price Range \t Options outstanding at \tJanuary 1, 1992 . . . . . . 93,965 $2.50 - $8.00\nTransferred to 1991 Plan. . . . . . 59,499 $5.00 - $8.00 Granted . . . . . . . . . . . . . . --\nCanceled or terminated. . . . . . . 3,533 $6.00 - $7.87 Exercised . . . . . . . . . . . . . -- \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1992 . . . . . 30,933 $2.50 - $7.87\nGranted . . . . . . . . . . . . . . -- --\nCanceled or terminated. . . . . . . 533 $7.87 - $7.87 Exercised . . . . . . . . . . . . . 10,400 $2.50 - $2.50 \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1993 . . . . . 20,000 $2.50 - $2.50\nGranted . . . . . . . . . . . . . . -- --\nCanceled or terminated. . . . . . . -- -- Exercised . . . . . . . . . . . . . -- -- \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1994 . . . . . 20,000 $2.50 - $2.50 \t\t\t\t\t======= ============= Options exercisable at \tDecember 31, 1994 . . . . . 20,000 $2.50 - $2.50 \t\t\t\t\t======= =============\n\t \tThe Warrant Plan is administered by the Board of Directors, which determines those individuals to be granted options on shares of the Company's common stock, at prices no lower than the fair market value on the date of grant. As of December 31, 1994, there were options outstanding to purchase 15,500 shares of common stock, with an expiration date of December 31, 1997. At December 31, 1994 there were no shares available for future grants of options under the Warrant Plan.\nThe following table summarizes the activity under the Warrant Plan:\n\t\t\t\t\t Shares Option Price Range Options outstanding at \tJanuary 1, 1992 . . . . . . 76,680 $2.50 - $12.00\nTransferred to 1991 Plan. . . . . . 37,080 $2.50 - $ 8.00 Granted . . . . . . . . . . . . . . 520 $2.50 - $ 2.50 Canceled or terminated. . . . . . . 400 $6.00 - $12.00 Exercised . . . . . . . . . . . . . -- \t\t\t\t\t------- -------------- Options outstanding at \tDecember 31, 1992 . . . . . 39,720 $2.50 - $12.00\nGranted . . . . . . . . . . . . . . -- Canceled or terminated. . . . . . . 720 $7.85 - $12.00 Exercised . . . . . . . . . . . . . 23,500 $2.50 - $ 2.50 \t\t\t\t\t------- -------------- Options outstanding at December 31, 1993 . . . . . . . . . 15,500 $2.50 - $ 6.00\nGranted . . . . . . . . . . . . . . -- Canceled or terminated. . . . . . . -- -- Exercised . . . . . . . . . . . . . -- -- \t\t\t\t\t------- -------------- Options outstanding at \tDecember 31, 1994 . . . . . 15,500 $2.50 - $ 6.00 \t\t\t\t\t======= ============== \t\t\t\t\t\t\t Options exercisable at \tDecember 31, 1994 . . . . . 15,500 $2.50 - $ 6.00 \t\t\t\t\t ====== ==============\n\tThe Company adopted the 1988 Stock Option Plan in September 1988. Of the 80,000 shares of common stock issuable under the 1988 Plan, there were options under the plan outstanding to purchase 5,000 shares at December 31, 1994. Options to purchase common stock granted under the 1988 Plan are not intended to qualify as \"incentive stock options\" within the meaning of Section 422A of the Internal Revenue Code. As of December 31, 1994, there were no shares available for future grants of options under the 1988 Plan.\nThe following table summarizes the activity under the 1988 Option Plan: \t\t\t\t\t Shares Option Price Range Options outstanding at \tJanuary 1, 1992 . . . . . . 28,300 $2.50 - $8.75\nTransferred to 1991 Plan. . . . . . 19,800 $2.50 - $8.75 Granted . . . . . . . . . . . . . . 1,500 $2.50 - $2.50 Canceled or terminated. . . . . . . -- Exercised . . . . . . . . . . . . . -- \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1992 . . . . . 10,000 $2.50 - $2.50\nGranted . . . . . . . . . . . . . . -- Canceled or terminated. . . . . . . 1,667 $2.50 - $2.50 Exercised . . . . . . . . . . . . . 3,333 $2.50 - $2.50 \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1993 . . . . . 5,000 $2.50 - $2.50\nGranted . . . . . . . . . . . . . . -- Canceled or terminated. . . . . . . -- -- Exercised . . . . . . . . . . . . . -- -- \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1994 . . . . . 5,000 $2.50 - $2.50 \t\t\t\t\t======= ============= Options exercisable at \tDecember 31, 1994 . . . . . 5,000 $2.50 - $2.50 \t\t\t\t\t======= =============\n\tAt the 1992 Annual Meeting, the Shareholders approved the 1991 Stock Option Plan and authorized 250,000 shares to replace shares issued under the old plans. The 1991 Plan is administered by the Board of Directors, which determines those individuals to be granted options on shares of the Company's common stock, at prices no lower than the fair market value on the date of grant. As of December 31, 1994, there were options outstanding to purchase 146,626 shares of common stock, with an expiration date of December 31, 1997. At December 31, 1994 there were 102,874 shares available for future grants of options under the 1991 Plan.\nThe following table summarizes the activity under the 1991 Option Plan: \t\t\t\t\t Shares Option Price Range\nOptions outstanding at \tJanuary 1, 1992 . . . . . . --\nTransferred from old plans. . . . . 116,379 $3.75 - $8.75 Granted . . . . . . . . . . . . . . 8,000 $5.00 - $5.00 Canceled or terminated. . . . . . . -- Exercised . . . . . . . . . . . . . -- \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1992 . . . . . 124,379 $3.75 - $8.75 \t\t\t\t\t\t Granted . . . . . . . . . . . . . . 21,000 $6.75 - $6.75 Canceled or terminated. . . . . . . 26,253 $5.00 - $8.75 Exercised . . . . . . . . . . . . . -- \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1993 . . . . . 119,126 $3.75 - $8.75 \t\t\t\t Granted . . . . . . . . . . . . . . 28,000 $3.50 - $5.37 Canceled or terminated. . . . . . . -- -- Exercised . . . . . . . . . . . . . 500 $4.00 $4.00 \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1994 . . . . . 146,626 $3.50 - $8.75 \t\t\t\t\t======= ============= Options exercisable at \tDecember 31, 1994 . . . . . 121,287 $3.50 - $8.75 \t\t\t\t\t======= =============\nAt the 1992 Annual Meeting, the Shareholders approved the Outside Directors Stock Option Plan and authorized 50,000 shares for granting to non-employee directors of the Company. The Directors Plan provides that, upon joining the Board, each outside director is awarded 5,000 shares at a price equal to the higher of $2.50 or the fair market value on the date of grant. As of December 31, 1994, there were options outstanding to purchase 28,750 shares of common stock, with an expiration date of December 31, 1997. At December 31, 1994, there were 18,750 shares available for future grants of options under the Directors Plan.\n\tThe following table summarizes the activity under the Directors Plan: \t\t\t\t\t Shares Option Price Range\nOptions outstanding at \tJanuary 1, 1992 . . . . . . --\nGranted . . . . . . . . . . . . . . 25,000 $2.50 - $2.50 Canceled or terminated. . . . . . . -- Exercised . . . . . . . . . . . . . -- \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1992 . . . . . 25,000 $2.50 - $2.50\nGranted . . . . . . . . . . . . . . 5,000 $6.00 - $6.00 Canceled or terminated. . . . . . . 3,750 $2.50 - $2.50 Exercised . . . . . . . . . . . . . 2,500 $2.50 - $2.50 \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1993 . . . . . 23,750 $2.50 - $6.00\nGranted . . . . . . . . . . . . . . 5,000 $4.00 - $4.00 Canceled or terminated. . . . . . . -- -- Exercised . . . . . . . . . . . . . -- -- \t\t\t\t\t------- ------------- Options outstanding at \tDecember 31, 1994 . . . . . 28,750 $2.50 - $6.00 \t\t\t\t\t======= ============= Options exercisable at \tDecember 31, 1994 . . . . . 17,500 $2.50 - $6.00 \t\t\t\t\t======= =============\nNOTE 7. Business Segment Information\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Registration Statements No. 33-50982 and 33-54028 of Data Measurement Corporation on Forms S-8 and S-3, respectively, of our report dated March 1, 1995, appearing in this Annual Report on Form 10-K of Data Measurement Corporation for the year ended December 31, 1994.\n\/s\/ Deloitte & Touche LLP Washington, D.C. March 15, 1995\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Registration Statements No. 33-50982 and 33-54028 of Data Measurement Corporation on Forms S-8 and S-3, respectively, of our report dated March 1, 1995, appearing in this Annual Report on Form 10-K of Data Measurement Corporation for the year ended December 31, 1994.\n\/s\/ SINCLAIRS LONDON, U.K. 15 March 1995\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 DATA MEASUREMENT CORPORATION \t\t\t\t (Registrant)\nDate: By:\/s\/ Dominique Gignoux March 16, 1995 Dominique Gignoux \t\t\t\t\t\t Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ James F. Collins James F. Collins Director March 16, 1994\n\/s\/ Dominique Gignoux Dominique Gignoux Chairman of the Board of Directors, President (Principal Executive Officer) March 16, 1994\n\/s\/ Marshal Greenblatt Marshal Greenblatt Director March 16, 1994\n\/s\/ Gregory A. Harrison Gregory A. Harrison Director March 16, 1994\n\/s\/ Ira A. Hunt, Jr. Ira A. Hunt, Jr. Director March 16, 1994\n\/s\/ Frederick S. Rolandi Frederick S. Rolandi Vice President, Chief Financial Officer and Director March 16, 1994\n\/s\/ John D. Sanders John D. Sanders Director March 16, 1994\n\/s\/ Bonnie K. Wachtel Bonnie K. Wachtel Director March 16, 1994","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"278352_1994.txt","cik":"278352","year":"1994","section_1":"Item 1. Business\nThe Company\nSymbol Technologies, Inc. (\"Symbol\" and, together with its subsidiaries, the \"Company\"), a Delaware corporation, is the successor by merger in 1987 to Symbol Technologies, Inc., a New York corporation which was organized in 1973 and is the largest manufacturer of bar code-based data capture systems. The Company is the only corporation in its industry with in-house technology for the design and manufacture of bar code scanning products, portable data collection systems and radio frequency (RF) data communications products. Linear bar codes consist of a series of lines or bars printed on a contrasting background. By varying the width of the bars and spaces between the bars, the bar code is encoded with information to identify an item, which enables the system to provide the user with relevant data about that item (for example, its location, cost, selling price and manufacturer). The Company is engaged in one industry segment - the design, manufacture and marketing of bar code reading equipment, portable data collection systems and radio frequency data communications products which are used as strategic building blocks in data collection systems in retail, parcel delivery and postal service, warehousing and distribution, factory automation and many other applications.\nCompany Products and Services\nGeneral\nThe Company develops, manufactures, sells and services (i) portable bar code scanning products that employ laser technology to read data encoded in bar code symbols, and (ii) a family of portable data collection systems. The Company's bar code scanning equipment is compatible with a wide variety of data collection systems, including computers, electronic cash registers and portable data collection devices. Bar code scanners are used to enhance accurate data entry and productivity in retail, parcel delivery and postal service, warehousing and distribution, factory automation and many other applications.\nThe Company's portable data collection systems consist of portable data collection devices, peripheral devices, software and programming tools, and are designed to provide solutions to specific customer needs in data collection. They are used to collect data at remote locations and to transmit information between these locations and the user's central data processing facility. Data can be entered by a device which reads bar codes\nor may be keyed into memory on a numeric or alpha-numeric keyboard. Data can be transmitted and received through direct connection, regular telephone lines with acoustic couplers and modems or by radio waves. A majority of the Company's portable data collection devices include an integrated bar code reader.\nBar Code Scanning Products\nSales of the Company's bar code scanning products have accounted for approximately 40%, 45% and 50%, respectively, of the Company's revenues for the years ended December 31, 1994, 1993 and 1992.\nThe Company's bar code scanning products consists of devices designed to scan and decode bar code symbols and transmit data. The Company manufactures various models of its bar code reading systems, each of which consists of a laser scanner and interface controller. In some models, the interface controller is integrated into the handle of the scanner. The laser scanner reads the symbol and transmits a digitized signal to the interface controller. The interface controller contains a microprocessor which decodes the information received and interfaces with the user's computer.\nThe Company sells several different hand-held laser based scanners, the most important of which are the LS 2000 and LS 3000. The LS 2000 Series is a trigger-operated, visible laser diode-based scanner with the capability to handle contact as well as non-contact scanning applications out to the limit of visibility of the scanning beam. It was first introduced in 1989. Its single board design significantly reduces the cost of the LS 2000, making it one of the lowest cost scanners produced by the Company. The LS 2000 Series is primarily sold to point- of-sale customers and for use in conjunction with portable data collection devices.\nThe LS 3000 Series introduced in 1993, consists of trigger-operated, visible laser diode-based scanners used to read all common linear bar code symbologies and densities up to a distance of 20 feet. The LS 3000 Series is particularly well- suited for industrial and military applications because of its rugged housing. These devices consume less than one watt of power during scanning. Specialty versions of the LS 3000 include long range scanners (3000 LR, ALR and XLR) and low contrast reading capability scanners (3000 HV and VHD) both using \"spot and scan\" two position triggers for ease of aiming and visibility.\nIn 1993, the Company introduced the first cableless hand-held scanner, the LS 3070. The LS 3070 transmits data via\nnarrow band RF with a range of up to 50 feet from its base station. The scanner is particularly useful in environments where tethered scanning is inadequate.\nIn 1992, the Company introduced the LT 1700 LaserTouch(R), a family of visible laser-based bar code scanners that combines the performance and accuracy of laser-based bar code technology with scanning for applications where near contact scanning and touch ergonomics are sufficient. These applications typically include low volume scanning environments including certain types of retail point-of-sale as well as work station and portable terminal data entry. The LT 1700 competes with charge coupled device (\"CCD\") bar code readers in environments where the benefits of extended depth of field and range are not required and cost is an important factor.\nIn 1992, the Company introduced the PDF 1000, the first hand-held laser scanner designed to read PDF 417, a high- density, high-capacity portable data file storing approximately one kilobyte of data in a machine-readable code. PDF 417 is a two-dimensional checkerboard-like bar code symbology which incorporates error detection and correction capability and has one hundred times the information capacity of a traditional linear bar code. Unlike linear bar codes, PDF 417 can contain an entire data record reducing or eliminating the need for an external system of linked data storage. PDF 417 may be read by either a laser-based bar code reader or a one- or two-dimensional CCD bar code reader. Most other two-dimensional bar codes can only be read by a CCD bar code reader.\nThe PDF 1000 decodes PDF 417 with subsecond performance. Unlike the Company's traditional hand-held laser scanners which trace a single laser line across a linear bar code, the PDF 1000 scans in a rastering pattern, its laser beam zigzagging across and down the PDF 417 symbol. The PDF 1000 is also capable of reading traditional linear bar codes. To date, sales of the PDF 1000 have not been material.\nIn addition to its hand-held scanners, the Company also offers several families of \"hands-free\" scanners. Unlike the Company's hand-held scanners, these scanners are usually triggered by an object sensor to enable use in situations where use of both hands is required.\nIn 1991, the Company introduced the LS 5000, a miniaturized slot scanner, primarily sold to mass merchants, drug stores, convenience stores and smaller grocery chains. The Company believes that the LS 5000 was the first slot scanner based upon visible laser diode scanning technology.\nIn 1990, the Company began marketing bar code laser scanner modules or scan engines which are integrated by unaffiliated third parties into their portable computing devices. An example of this type of product is the Delivery Information Acquisition Device (DIAD) used by United Parcel Services (\"UPS\") so that UPS can rapidly and accurately collect data from bar coded packages, consignee signatures and other delivery information.\nIn 1992, the Company introduced the SE 1000 scan engine. The SE 1000, which measures approximately one cubic inch and weighs about 1 ounce, enables third-party manufacturers to integrate high performance laser scanning into a variety of devices including hand-held computers, medical instruments, diagnostic equipment, lottery terminals, vending machines and robotics. With a working range of 2 to 20 inches, the SE 1000 operates at supply voltages as low as three volts, making it ideal for integration into portable and battery-powered devices. A version of SE 1000 is available with an integrated decoder and RS 232 interface.\nSince 1988, the Company has been selling a series of scan modules consisting of solid state laser diode-based laser scanners. Its latest version, the LS 1220 was introduced in 1994 and will be commercially available in the first quarter of 1995. These compact, non-contact scanners can be integrated internally with the user's own equipment or used independently as fixed-mount scanners on conveyor lines or robotic arms.\nIn 1989, the Company introduced a series of stand- mounted laser scanners under the ScanLamp brand name. One version, the SL 6700 is a single line scanner. In 1994, the Company introduced the LS 9100, a laser-diode based projection scanner. The LS 9100 generates a large omnidirectional pattern of twenty interlocking laser lines that can read bar codes at various angles for high productivity scanning.\nIn 1992, the Company introduced \"Gladiator\", an innovative arm-mounted bar code-based data transaction system that allows portable hands-free bar code scanning, data collection and RF data communications. The Symbol Application Productivity System (APS) 3395 is a wearable computer system for users who rely on the efficiency and accuracy of bar code scanning but require the use of both hands to perform job functions. The APS 3395 system combines three elements: the Symbol HF 2000, a laser scanner about the size of a computer mouse that is mounted to the back of the hand; the Symbol AP 3390, a forearm-mounted keyboard\/display module; and a waist- mounted 16-bit, DOS-based portable terminal.\nThe Company also produces a series of low cost, interface controllers. These devices permit the Company's scanner products to easily interface with a wide range of standardized terminals, personal computers, point-of-sale terminals, portable terminals and dedicated computing hardware.\nProduct list prices for the Company's bar code scanning equipment range between $140 to $2,800 depending on product configuration. The Company offers discounts off list price for quantity orders and sales are frequently made at prices below list price.\nPortable Data Collection Systems\nThe Company's portable data collection systems consist of portable collection devices (or terminals), peripheral devices, software and programming tools. These systems collect data at remote locations and transmit information between these locations and the user's central data processing facility and are designed to provide data collection solutions for a variety of applications. A majority of the Company's portable data collection devices also include an integated bar code reader. These systems accounted for approximately 50% of the Company's total revenues for the year ended December 31, 1994 and approximately 40% of the Company's total revenues for the years ended December 31, 1993 and 1992.\nPortable Collection Devices. The Company's portable data collection terminals are microprocessor-based, lightweight and battery-operated hand-held computers. Data may be captured by a device which reads bar codes or may be keyed into memory via an integrated keyboard. The data collected by the terminal can then be transmitted from the terminal to the host computer by direct connection through regular telephone lines with acoustic couplers and modems (batch file transfer mode). Data may also be transmitted instantly as it is collected by radio waves (real- time transaction processing). Information from the Company's terminals may be communicated to a stand-alone receiver or computer which formats the data for input into a host computer, or directly into a host computer by communications controllers supplied by the Company. Depending on the model, the Company's terminals may have up to 4.2 megabytes of Random Access Memory (RAM) for data storage, multiple input and output capabilities for the connection of printers, bar code readers and communications devices. In addition, based upon customer specifications, the terminals may also have built-in bar code readers and various built-in communications devices for transmission and receipt of data.\nIn 1990 the Company introduced the next-generation Spectrum One(R) cellular radio frequency network for wireless data transactions. Installation of the network at various customer sites began in 1991 and the network is now installed in several thousand sites. Based on spread spectrum RF technology, Spectrum One provides real-time wireless data communications with a host computer for hundreds of portable and fixed-station computer terminals and radio-integrated scanners. Unlike traditional RF- based networks, spread spectrum installation requires no individual site license from the FCC.\nThe Spectrum One system works in tandem with the LRT 3800 laser radio terminal, also introduced in 1990, as well as other products. The LRT 3800 incorporates in a single, hand-held unit, high-performance laser bar code scanning, a 16-bit DOS- based portable computer and a radio modem for communication via the Spectrum One network. Based on visible laser diode scanning technology, the battery-operated LRT 3800 is compact and ergonomically designed and provides up to 1.2 megabytes of memory capacity.\nThe LDT 3805, also introduced in 1990, is identical to the LRT 3800 in physical appearance. Its scanning and computing functions are similar but it has no RF communication capability. It is optimized for collecting and storing data, later to be downloaded to a host computer.\nBoth the LRT and LDT have the capability for data entry via bar code scanning or by using the full-function keypad. The pair are ideal for scan-intensive applications such as receiving, shipping, inventory control, order and shelf-price verification as well as other applications in both retail and warehousing.\nIn 1989, the Company introduced the Portable Radio Terminal (PRT), a narrow band radio frequency version of the PDT product line. In 1990, the Company introduced another narrow band RF terminal (RFT), with an improved (more robust) frequency synthesized radio designed for use in warehousing and other similar environments.\nThe Company's Network Systems Organization, situated in San Jose, California is responsible for design engineering, pilot installation, systems integration and support for both the Company and third-party RF-based data communications systems. The focus of the group is the design of wireless bar code data transaction systems based on the Company's Spectrum One network and the integration of those high-performance networks into customer's data networks and enterprise-wide information systems.\nThe PDT (Portable Data Terminal) family of general purpose data collection terminals features advanced technology including Very Large Scale Integrated (VLSI) circuits, which incorporate many standardized integrated circuits into one computer chip allowing for size and cost reductions. Also, the PDT family employs surface mounted component technology for reduced size and increased performance and dependability, as well as an industry standard 8- and 16-bit microprocessors. The PDT family includes a series of hand-held terminals which are available with different features and at varying costs depending on customer requirements and preferences. The PDT terminals feature up to sixteen lines of liquid crystal display, slim lightweight design, multiple input and output ports and up to one megabyte of internal memory. PDT terminals have various keyboard configurations, including a user configurable keyboard. The PDT family was originally introduced in 1985.\nIn 1990, the Company introduced the PDT 3300, a 16-bit DOS-compatible batch terminal. The PDT 3300 provides expanded program capacity and keyboard and display flexibility coupled with an environmentally sealed unit for use in harsh environments. The PDT 3300 is the Company's largest selling, non-integrated batch terminal. In 1992, the Company developed versions of the PDT 3300 which also incorporate the Company's Spectrum One network.\nThe PDT 3100 terminal, a 16-bit DOS-compatible terminal, was introduced in 1993. Versions of the PDT 3100 also incorporate the Company's SE 1000 scan engine and feature a unique swivel-head scanner design which adjusts instantly for right- or left-hand scanning operation. In 1994, the Company introduced versions of the PDT 3100 incorporating the Company's Spectrum One data communications network and direct or accoustic modems for telephone line communications.\nIn 1993, the Company announced the co-development with Albert Heijn of The Netherlands, Europe's largest grocery market chain, and TNO Product Centre, a leading Dutch engineering design firm, of a shoppers portable self checkout system. The system uses an integrated laser scanner terminal, the LST 3803, which has a limited keyboard and display so that shoppers can scan and tabulate purchases as they shop. The self checkout system is currently operational in a pilot program being conducted at an Albert Heijn supermarket located in Geldermalsen, The Netherlands. Although Albert Heijn is very pleased with the results of the pilot and other food and non-food retailers have expressed an interest in the self checkout concept, due to both the limited trial and innovative nature of the concept, there can be no assurance that self checkout will become a commercially\nviable concept or that it will be implemented on a wide scale either internationally or domestically.\nFor certain applications in which small size, lower- cost and one piece integrated bar code readers and terminals are required, the Company's Datawand product line offers an attractive alternative to the PDT family. Datawand terminals were first introduced in 1985. The Company's principal Datawand product, the Datawand IIB, is a self-contained optical wand bar code reader terminal which is only 7-1\/4 inches long and one inch in diameter and weighs slightly more than two ounces. The Datawand IIB is designed to read several standard bar codes and has a CMOS RAM memory configuration, which can accommodate 32 kilobytes of storage, and a time clock which can automatically record the time entry of each bar code read. The Datawand IIB is a unique portable terminal due to its small size and weight, but it has no display, fewer features and a limited memory compared to the PDT terminals. Principal applications for the Datawand IIB are parcel tracking, file tracking, market surveys and inventory control. In 1989, the Company introduced a new optical wand bar code reader, the Datawand III, which contains 32 kilobytes of memory and a 16 character single line display. Although the Datawand scanners require contact with the bar code and human motion to accomplish the reading, they offer cost- effective solutions to certain applications.\nIn 1989, the Company introduced the Scanning Data Terminal (SDT). The SDT is an 8-bit, ergonomically designed, wand-integrated, full capability portable terminal. It has an alpha-numeric keyboard and a self-contained contact wand bar code reader.\nIn January 1994, the Company introduced a portable pen terminal, the PPT 4100, which integrates several key technologies for improving information management. The 20-ounce unit is a PC- compatible hand-held terminal that incorporates pen and touch input on a 5.5\" x 3.0\" screen; a graphical user interface; an SE 1000 scan engine; and a PCMCIA Spectrum One radio card. The PPT 4100 is intended for use in information-intensive applications in retail and other environments where managers will benefit by accessing remote databases to make real-time inventory and purchasing decisions to significantly enhance customer service and improve productivity.\nProduct list prices for the Company's portable data collection equipment range between $400 to $4,400 depending on product configuration. The Company offers discounts off list price for quantity orders and sales are frequently made at prices below list price.\nSoftware and Programming Tools. The Company's portable terminal products utilize software which consists of a number of specialized applications and communications software programs, along with a series of program compilers and generators which run on both IBM and IBM compatible personal computers and DEC VAX or Micro VAX computers. The compilers and generators allow the Company's programmers, VARs (\"Value Added Resellers\") and end- user customers to generate applications software to meet specific customer requirements. Through communications software, information collected by hand-held terminals can be transmitted to, and data can be received from, most commonly used computer systems. The Company's PDT terminal architecture is designed to allow customers to utilize advances in PDT terminals while preserving the customer's ability to use existing software.\nThe Company has developed program generators for use by customers and VARs which are designed to allow them to rapidly develop and debug programs for use in the Company's PDT terminals. Using these generators, customers can create their own programs on IBM and IBM-compatible personal computers and DEC VAX and Micro VAX computers. These programs can be down loaded directly from the computer to the Company's terminals or by the creation of Custom Application Modules (CAMs) which can be inserted in the PDT. Powergen, one of the Company's program generators, allows the Company's customers to develop simple application programs for the PDT family of terminals.\nThe Company has also developed several communication protocols designed to facilitate transmission and reception of data between terminals and stand-alone receivers or host computers. The Company has entered into alliances with independent suppliers of software who assist the Company in the development of software.\nCustomer Support\nThe Company has a customer support organization which repairs and maintains the Company's products.\nThe Company's domestic customer support operations include locations in Arkansas, California, Georgia, Illinois, Kentucky, Michigan, Minnesota, New Jersey, New York, Texas and Virginia. The Company also has foreign customer support offices in Australia, Austria, Belgium, Canada, France, Germany, Italy, Norway, Singapore, Spain and the United Kingdom. In Japan, customer support is provided by Olympus Symbol, Inc. These centers enhance the Company's ability to respond to its customers' requirements for fast, efficient service.\nThe Company currently offers a variety of service arrangements to meet customer needs. The Company's On-Site service provides for maintenance and repairs at any customer location. Central Service provides for the performance of maintenance and repairs at selected, centralized customer sites. Depot Service includes maintenance and repairs at the Company's field service offices. The Self-Service contracts generally have a term of from one to five years. In addition, the Company offers Time-And-Materials service on a non-contract, as-needed basis.\nThe Company undertakes to correct defects in materials and workmanship for a period of time after delivery of its products. The period of time covered by these warranties varies depending on the product involved as well as contractual arrangements but is generally from three to twelve months.\nMaintenance and support revenues contributed less than 10% of the Company's total revenues for the years ended December 31, 1994, 1993 and 1992.\nSales and Marketing\nThe Company presently markets its products domestically and internationally through a variety of distribution channels, including a direct sales force, original equipment manufacturers, VARs and sales representatives and distributors. VARs distribute the Company's products to customers while also selling to those customers other products or services not provided by the Company. The Company's sales organization includes domestic sales offices located throughout the United States and foreign sales offices in Australia, Austria, Belgium, Canada, France, Germany, Italy, Norway, Spain and the United Kingdom. The Company is currently represented by Olympus Symbol, Inc. in Asia and Japan although the Company anticipates that in 1995 it will transfer its Asian operations (other than Japan) to Singapore.\nThe Company currently has contractual relationships and strategic alliances with unaffiliated partners. Through these relationships, the Company is able to broaden its distribution network and participate in industries other than those serviced by the Company's direct sales force and distributors.\nWhile the Company does monitor backlog, it does not consider it to be a reliable predictor of financial performance for periods other than the then current quarter because customers generally order products for delivery within 45 days. Accordingly, shipments made during any particular quarter generally represent orders received either during that quarter or shortly before the beginning of that quarter. Shipments for orders received in a fiscal quarter are generally from products manufactured in that quarter. The Company maintains significant levels of raw materials to facilitate meeting delivery\nrequirements of its customers. However, there can be no assurance that during any given quarter, the Company has or can procure the appropriate mix of raw materials in order to accommodate any given order. In light of the levels of current and anticipated backlog, the Company's financial performance in any quarter is dependent to a significant degree upon obtaining orders in that quarter which can be manufactured and delivered to its customers in that quarter. Thus, financial performance for any given quarter cannot be known or fully assessed until near the end of that quarter.\nSince a substantial portion of the Company's sales of scanner products are to retail organizations which tend not to purchase equipment such as the Company's scanner products during the Christmas selling season, the Company's business has, from time to time, been seasonal in the fourth quarter. The Company believes there may again be reduced demand for its scanner products in the fourth quarter of the current fiscal year. The Company attempts to offset the reduced demand of the retail industry by selling its products to other market segments, although there is no assurance that this effort will be successful. The Company, pursuant to contract or invoice, normally extends 30 day payment terms to its customers. Actual payment terms vary from time to time but generally do not exceed 90 days.\nThe following table sets forth certain information as to international sales of the Company:\nYear Ended December 31, Area 1994 1993 1992\nWestern Europe $141,090 $98,188 $106,794\nOther $ 25,999 14,344 14,719\nForeign sales of the Company are subject to the normal risks of foreign operations, such as protective tariffs, export\/import controls and transportation delays and interruptions. The majority of the Company's equipment sales in Western Europe and Asia are generally billed in foreign currencies and are subject to currency exchange fluctuations. Since the Company's products are principally manufactured in the United States, sales and results of operations could be affected by fluctuations in the U.S. dollar. Changes in the relative value of the U.S. dollar in terms of foreign currencies in the past have had an impact on the Company's sales and margins. The Company undertakes hedging activities to the extent of known cash\nflow in an attempt to minimize the impact of foreign currency fluctuations.\nIn 1991, the Company entered into a comprehensive technology agreement with respect to bar code data capture products and the formation of a joint venture with Olympus Optical Co., Ltd. of Tokyo, Japan (\"Olympus\"). The parties have entered into a new agreement, which they anticipate will close by the end of the first quarter of 1995 which will restructure the arrangement. Under the new arrangement, Olympus will repurchase the Company's approximate fifty percent ownership interest in the joint venture company, Olympus Symbol, Inc. Olympus will then generally be the Company's sole distributor of its bar code data capture products in Japan. The Company will generally be Olympus' sole distributor of its bar code data capture products throughout the world, except Japan. From time to time on a negotiated basis, Olympus and the Company will engage in joint development of bar code data capture products.\nManufacturing\nThe Company manufactures its principal products at its Bohemia, New York facilities.\nWhile components and supplies are generally available from a variety of sources, the Company presently depends on a limited number of suppliers for several components of its equipment, certain subassemblies and certain of its products such as its printers. Certain of the Company's products are manufactured in Japan. The manufacture of these items is subject to risks common to all foreign manufacturing activities such as governmental regulation, currency fluctuations, transportation delays and interruptions, political and economic disruptions and the risk of imposition of tariffs or other trade barriers. Due to the general availability of components and supplies, the Company does not believe that the loss of any supplier or subassembly manufacturer would have a material adverse effect on its business. The Company has in the past, and may in the future, encounter shortages of supplies and delays in deliveries of necessary components. In the past, delays in delivery of components has not had a material adverse effect on shipments of the Company's products.\nResearch and Product Development\nThe Company believes that its future growth depends, in large part, upon its ability to continue to apply its technology to develop new products, improve existing products and expand market applications for its products. The Company's research and development projects include, among others: improvements to the\nreliability, quality and readability of its laser scanners at increased working distances and higher density codes (including, but not limited to, two-dimensional codes); improvements in and expansion of its series of interface controllers; continued development of its solid state laser diode scanners; improvements to packaging and miniaturization technology for bar code data capture products, portable data collection devices and integrated bar coded data capture products; development of high performance digital data radios, high-speed radio frequency data communications networks and telecommunications protocols and products; and the addition of application software to provide a complete line of high performance interface hardware. There can be no assurance that the Company's research and development activities will lead to the successful introduction of new or improved products or that the Company will not encounter delays or problems in connection therewith. Furthermore, customers may defer purchases of existing products in anticipation of new or improved versions of those products. Although the Company contemplates the introduction of new products in 1995, the majority are scheduled for introduction in the second half of the year. Moreover, there can be no assurance that there will not be delays in commencing volume production of such products or that such products will ultimately be commercially successful.\nThe Company uses both its own associates and from time to time unaffiliated consultants in its product engineering and research and development programs. Dr. Jerome Swartz, Chairman of the Board of Directors and Chief Executive Officer of the Company, leads the Company's research, patent and new product development programs. From time-to-time the Company has participated with and\/or partially funded research projects in conjunction with a number of universities including the State University of New York at Stony Brook, Polytechnic University of New York and Tel Aviv University in Israel.\nThe Company expended (including overhead charges) approximately $16,678,000, $16,258,000 and $ 13,581,000 for research and development during the years ended December 31, 1994, 1993 and 1992, respectively.\nCompetition\nThe business in which the Company is engaged is highly competitive. To the Company's knowledge, many firms are engaged in the manufacture and marketing of portable data collection systems and bar code reading equipment utilizing laser technology. In addition, the Company's bar code reading equipment also competes with devices which utilize technologies other than laser scanners such as CCDs and optical wands. Furthermore, numerous companies, including present manufacturers\nof scanners, lasers, optical instruments, microprocessors, notebook computers, PDAs and data radios have the technical potential to compete with the Company. Many of these firms have far greater financial, marketing and technical resources than the Company. The Company competes principally on the basis of performance and the quality of its products and services.\nThe Company believes that its principal competitors in the bar code scanning equipment market are AT&T Global Information Systems (formerly NCR Corporation), INTERMEC Corporation, Matsushita Electric Corporation, Metrologic Instruments, Inc., NipponDenso Co., Ltd., Opticon, Inc., PSC, Inc. (formerly Photographic Sciences Corporation), Spectra Physics, Inc. and Welch Allyn, Inc. and that its principal competitors in the portable data collection systems market are Fujitsu, Ltd., Hand Held Products, Inc., INTERMEC Corporation, LXE Inc., Norand Corporation, Mars Electronics and Telxon Corporation. Some of the Company's competitors in the portable data collection systems market also participate in the field service market.\nPatent and Trademark Matters\nThe Company files domestic and foreign patent applications to support its technology position and new product development. The Company owns over 160 U.S. Letters Patents covering various aspects of the technology used in the Company's principal products and has entered into cross-license agreements with other companies in the laser scanning business. Key patents covering basic hand-held laser scanning technology begin to expire in 2000 and key patents covering scanner integrated terminals begin to expire in 2005. In addition, the Company owns numerous foreign companion patents. The Company has also filed additional patent applications in the U.S. Patent and Trademark Office as well as in foreign patent offices. The Company will continue to file patents, both U.S. and foreign, to cover its most recent research developments in the scanning, data collection and RF data communications fields. The Company believes that its patent portfolio does provide some competitive advantage in that such patents tend to limit the number of unlicensed competitors and permit the Company to manufacture products which may have features which provide better performance and\/or lower cost. Although management believes that its patents provide some competitive advantage, the Company depends more for its success upon its proprietary know-how, innovative skills, technical competence and marketing abilities. In addition, because of rapidly changing technology, the Company's present intention is not to rely primarily on patents or other intellectual property rights to protect or establish its market position. Instead, the Company has established an active program\nto protect its investment in technology by enforcing and licensing certain of its intellectual property rights. The Company has entered into royalty-bearing license agreements with, among others, Hand Held Products, Inc., INTERMEC Corporation, LXE Inc., Norand Corporation, Olympus Optical Co., Ltd, Opticon Sensors Europe, B.V., PSC, Inc., Spectra Physics, Inc. and Telxon Corporation.\nFrom time to time, at the behest of the Company or a third party, one or more of the Company's patents has been subject to a reexamination proceeding by the United States Patent and Trademark Office, including patents that the Company has licensed to other parties. As a result of such a proceeding, it is possible that a patent may be clarified, limited, amended, or even become unenforceable. The Company is currently participating in such a reexamination proceeding. The Company does not believe that such reexamination proceeding will have a material adverse effect on its patent portfolio.\nAlthough there are currently no pending actions, the Company has in the past initiated several actions, both U.S. and foreign, relating to patent infringement.\nIn 1990, Spectra Physics, Inc., (\"Spectra\") brought suit against the Company in the United States District Court in Eugene, Oregon seeking declaratory judgment that a hand held laser scanner manufactured by Spectra did not infringe the Company's patents. Spectra further contended that the Company had violated certain state and federal antitrust laws and that the Company was liable for unfair competition and for tortious interference with prospective contractual relations. The Company counterclaimed that Spectra's products infringed certain of its patents. The Company believes that Spectra's antitrust and unfair competition claims are without merit.\nIn January 1995, the parties entered into a definitive settlement agreement which settled the litigation. Pursuant to this agreement, all claims and counterclaims asserted in the litigation have been dismissed and the Company has affirmed, clarified and expanded its license with Spectra and confirmed that Spectra is entitled to sell its SP 300 and SP 400 product lines without any liability for patent infringement of the Company's patents. Spectra also entered into a consent judgement acknowledging the validity and enforceability of the Company's U.S. Patent Nos. 4,816,660 and 5,247,162, under which it is now licensed. Under the new agreement, Spectra Physics will pay the Company an increased royalty for certain products.\nThe Company has also obtained certain domestic and international trademark registrations for its products and maintains certain details about its processes, products and strategies as trade secrets.\nThe Company regards its software as proprietary and attempts to protect it with copyrights, trade secret law and international nondisclosure safeguards, as well as restrictions on disclosure and transferability that are incorporated into its software license agreements. The Company licenses its software products to customers rather than transferring title. Despite these restrictions, it may be possible for competitors or users to copy aspects of the Company's products or to obtain information which the Company regards as trade secrets. Computer software generally has not been patented and existing copyright laws afford only limited practical protection. In addition, the laws of foreign countries generally do not protect the Company's proprietary rights in its products to the same extent as do the laws of the United States.\nGovernment Regulations\nThe use of lasers and radio emissions are subject to regulation in the United States and in other countries in which the Company does business. In the United States, various Federal agencies, including the Center for Devices and Radiological Health of the Food and Drug Administration, the Federal Communications Commission, the Occupational Safety and Health Administration and various State agencies, have promulgated regulations which concern the use of lasers and\/or radio\/electromagnetic emissions standards. Member countries of the European community have enacted or are in the process of adopting standards concerning electrical and laser safety and electromagentic compatability and emissions standards.\nThe Company believes that all of its products are in material compliance with current standards and regulations; however, regulatory changes may require modifications to certain of the Company's products in order for the Company to continue to be able to manufacture and market these products. There can be no assurances that more stringent regulations in these or other areas will not be issued in the future with an adverse effect on the business of the Company. In addition, sales of the Company's products could be adversely affected if similar or more stringent safety standards are adopted by potential customers such as electronic cash register manufacturers.\nThe Company's RF terminals include various models all of which intentionally transmit radio signals as part of their normal operation. The Company's LRT 3800 laser radio terminal and certain versions of its portable terminals and its Spectrum One cellular frequency network utilize spread spectrum radio technology. The Company has obtained certification from the FCC for its products which utilize this radio technology. Such certification is valid for the life of the product unless and until the circuitry of the product is altered in material respects, in which case a new certification may be required. Users of these products in the United States do not require any\nlicense from the FCC to use or operate the product. Certain of the Company's products transmit narrow band radio signals as part of their normal operation. The Company has obtained certification from the FCC for its narrow band radio products. However, these models must not only be accepted by the FCC prior to marketing but users of these devices must themselves also obtain a site license from the FCC to operate them.\nAssociates\nAt December 31, 1994, the Company had 2,387 full-time associates. Of these, approximately 2,045 were employed domestically. The Company also employs temporary production personnel. None of the Company's associates are represented by a labor union. The Company considers its relationship with its associates to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following table states the location, primary use and approximate size of all principal plants and facilities of the Company and its subsidiaries and the duration of the Company's tenancy with respect to each facility.\nLocation Principal Use Size Tenancy\/Ownership\n116 Wilbur Place Corporate headquarters 92,000 square Owned (subject to Bohemia, NY feet mortgage)\n110 Wilbur Place Research and develop- 30,000 square Owned (subject to Bohemia, NY ment and engineering feet mortgage)\n12 & 13 Oaklands Park International head- 21,700 square Owned Fishponds Road quarters, marketing feet Wokingham, Berkshire and administration England and U.K. headquarters\n110 Orville Drive Manufacturing 110,000 square Leased: expires Bohemia, NY feet April 6, 1998\n1101 Lakeland Avenue Warehousing and 90,400 square Leased: expires Bohemia, NY administration feet April 6, 1998\n2145 Hamilton Ave. Network Systems, 51,500 square Leased: expires San Jose, CA Engineering, Marketing feet March 31, 1999 Customer Service\n340 Fischer Avenue Service and Sales 31,200 square Leased: expires Costa Mesa, CA feet May 31, 2001\n50 Orville Drive Marketing and 28,000 square Leased: expires Bohemia, NY administration feet December 31,\n80 13th Avenue Warehousing 25,800 square Leased: expires Ronkonkoma, NY feet June 30, 1995\n180 Orville Drive Warehousing and 11,300 square Leased: expires Bohemia, NY facilities management feet May 31, 1997\n120 Wilbur Place Sales 7,700 square Leased: expires Bohemia, NY feet June 30, 1995\nIn addition to these principal locations, the Company and its subsidiaries also lease other offices throughout the\nworld, ranging in size from approximately 150 to 14,000 square feet. The Company also owns a 77,000 square foot facility in Costa Mesa, California and 2.82 acres of adjacent land. The Company has entered into a contract for the sale of these properties for a price of $4,500,000 (in cash and notes) to the party that currently leases the facility. The lease expires in June 1995 and the Company anticipates that the sale will be completed in June 1995 upon expiration of the lease.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn March 1993, plaintiffs filed the first Consolidated Amended Class Action Complaint in the action entitled In re. Symbol Technologies Class Action Litigation (\"First Complaint\") in the Eastern District of New York which essentially asserted the same alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder as had been contained in the six separate purported class action suits previously filed, and alleged a class period of March 17, 1992 through September 14, 1992. Defendants moved to dismiss the First Complaint for failure to state a cause of action and for failure to allege fraud with particularity. On September 14, 1993, the Court granted defendants' motion and dismissed the First Complaint. However, the Court granted plaintiffs leave to file a new complaint within 30 days. On October 14, 1993, a Second Consolidated Amended Class Action Complaint (\"Second Complaint\") was served. It alleges essentially similar violations as had the prior complaints but alleges a class period from June 8, 1992 to September 14, 1992. Defendants moved to dismiss the Second Complaint and such motion is currently pending before the Court. Argument on the motion was heard on February 10, 1995 and the parties are awaiting a decision from the Court. The Company believes that the litigation is without merit and intends to defend the action vigorously.\nSee also Patent and Trademark Matters for a discussion of other litigation involving the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable\nItem 4A. Executive Officers of the Registrant\nThe following table sets forth the names, ages and all positions and offices held by the Company's executive officers:\nJerome Swartz .......... 54 Chairman of the Board of Directors, Chief Executive Officer and Director\nJan Lindelow ........... 49 President, Chief Operating Officer and Director\nFrederic P. Heiman...... 55 Executive Vice President, Chief Technology Officer, General Manager-Network Systems Organization and Director\nThomas G. Amato......... 49 Senior Vice President-Finance and Chief Financial Officer\nRichard Bravman......... 40 Senior Vice President-Business Development\nBrian T. Burke.......... 48 Vice President, Controller and Chief Accounting Officer\nAllen C. Creveling...... 53 Senior Vice President-Human Resources\nLeonard H. Goldner...... 47 Senior Vice President, General Counsel and Secretary\nRoger Kiel.............. 58 Senior Vice President, General Manager-Scanners and Integrated Terminals\nJack Lieberman.......... 58 Senior Vice President-Operations\nTomo Razmilovic......... 52 Senior Vice President-Worldwide Sales and Services and Managing Director-International Operations\nDr. Swartz co-founded and has been employed by the Company from its inception in 1973. He has been the Chairman of the Board of Directors and Chief Executive Officer of the Company for more than the past five years. Dr. Swartz was an industry consultant for 12 years in the areas of optical and electronic systems and instrumentation and has a total of some 120 technical\npapers and issued U.S. patents to his credit, including the Company's basic patents in hand-held laser scanning. He is also a trustee of the Polytechnic University of New York and an adjunct full professor of Electrical Engineering at the State University of New York at Stony Brook.\nMr. Lindelow joined the Company in June 1994. Previously, he was employed by Asea Brown Boveri LTD, a Swiss multinational conglomerate, from May 1989 until June 1994. From January 1992 until leaving ABB, Mr. Lindelow served as President of its U.S. Industrial and Diversified Business Segment with responsibility for 15 companies having combined revenue in excess of $2 Billion and from May 1989 until December 1991, as chairman and CEO of ABB Power T&D Company Inc. Prior to that time, he was employed for more than 18 years by Sperry Univac Corporation (now Unisys Corporation) in various technical and senior management positions.\nDr. Heiman joined the Company in July 1986. He had previously been employed by Intel Corporation, a manufacturer of semiconductor components, from May 1983 until July 1986, in a number of positions, the most recent of which was as its Director of Corporate Planning. Dr. Heiman is the inventor or co-inventor of 20 issued U.S. patents, including the first MOS integrated circuit chip, which became the basis of much of the modern revolution in computer and electronics communications and the first silicon storage tube used in display and scanning applications.\nMr. Amato joined the Company in October 1990. Prior to joining the Company he was Senior Vice President of Finance and Administration and Chief Financial Officer for Amcast Industrial Corp., a manufacturer of metal components, from 1985 to 1990.\nMr. Bravman has been employed by the Company for more than the past fifteen years in various management positions.\nMr. Burke joined the Company in 1987. From October 1984 to October 1987, he was President, Chief Executive Officer and director of Super Web Press Service Corporation, a manufacturer of printing presses. From August 1976 to October 1984, Mr. Burke served as Vice President - Finance and Operations of the Linotype Division of Allied Signal Corporation, a manufacturer of photo composition equipment.\nMr. Creveling joined the Company in February 1989. From January 1988 to January 1989, he was Chief Financial Officer at Keystone Camera Corp. From 1971 to 1987, he was employed by Mars Electronics, a division of M&M\/Mars, where he held the position of Vice President Finance.\nMr. Goldner joined the Company in September 1990. From September 1979 until August 1990, he was a partner of the New York law firm of Shereff, Friedman, Hoffman & Goodman, which firm was securities counsel to the Company.\nDr. Kiel joined the Company in October 1990. From June 1989 to September 1990, he was president and Chief Executive Officer of AccuPrint, Inc., a manufacturer of laser printers. Prior to that, he served from March 1988 to June 1989 as Executive Vice President and Chief Operating Officer of Color Systems Technology, Inc., an electronic converter of black and white film to color film. Dr. Kiel held the position of Vice President and General Manager of the Printing Systems division of Xerox Corporation from November 1965 to February 1987.\nMr. Lieberman joined the Company in May 1990. From September 1987 to May 1990, he was Vice President and General Manager of the Electronics Products Group of Analogic Corp. From September 1986 to September 1987, he served as President and Chief Executive Officer of Digital Pathways, a computer security company. From 1964 to 1986, he was employed as General Manager of the Santa Clara Instruments Division of Hewlett Packard Corporation.\nMr. Razmilovic joined the Company in November 1989. From January 1989 to August 1989, he was President and Chief Executive Officer of Cominvest Group, a Swedish multinational high technology company. From August 1985 to December 1988, he was President of ICL Europe, a major European computer manufacturer and he also led its industry marketing and software development divisions.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Security Holder Matters\nThe Company's Common Stock is listed on the New York Stock Exchange. The following table sets forth, for each quarter period of the last two years, the high and low sales prices as reported by the New York Stock Exchange.\nYear Ending: High Low\nDecember 31, 1993 First Quarter 15 7\/8 11 1\/2 Second Quarter 15 1\/8 12 1\/8 Third Quarter 14 11 1\/4 Fourth Quarter 19 3\/4 13 1\/8\nDecember 31, 1994 First Quarter 20 3\/4 15 5\/8 Second Quarter 27 7\/8 18 1\/2 Third Quarter 31 1\/4 25 Fourth Quarter 34 3\/8 27 5\/8\nAs of January 27, 1995 there were 1,456 holders of record of the Company's Common Stock.\nHistorically, changes in the Company's results of operations or projected results of operations have resulted in significant changes in the market price of the Company's Common Stock. As a result, the market price of the Company's Common Stock has been highly volatile.\nShareholders should be aware that while the Company does, from time to time, communicate with securities analysts, it is against the Company's policy to disclose to such analysts any material non-public information or other confidential commercial information. Accordingly, shareholders should not assume that the Company agrees with any report issued by any analyst. Furthermore, the Company has a policy against issuing financial forecasts or projections or confirming the accuracy of forecasts or projections issued by others. Accordingly, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not the responsibility of the Company and have been prepared by each analyst based on his own judgment and research.\nTo date, the Company has not paid any cash dividends to its shareholders. The Company's ability to pay cash dividends is limited by certain of the Company's loan agreements. The most\nrestrictive of which would generally limit dividends payable in any year to an amount not greater than 50% of the Company's net income. Any future declaration of cash dividends will depend upon the Company's earnings and financial condition, capital requirements and other relevant factors. The Company does not intend to propose the declaration of any cash dividends in the foreseeable future but intends to retain its earnings for use in its business.\nItem 6.","section_6":"Item 6. Selected Financial Data (in thousands, except per share data)\nYear Ended December 31, Operating Results: 1994 1993 1992(1) 1991 1990\nNet Revenue $465,306 $359,980 $344,940 $319,376 $231,496 Earnings (Loss) Before Cumulative Effect of Accounting Change $34,984 $12,445 ($15,506) $22,768 $7,576 Net Earnings (Loss) $34,984 $12,445 ($16,250) $22,768 $7,576\nEarnings (Loss) Per Share: Primary Earnings (Loss) Before Cumulative Effect of Accounting Change $1.34 $0.50 ($0.65) $0.91 $0.33 Net Earnings (Loss) $1.34 $0.50 ($0.68) $0.91 $0.33\nFully-diluted Earnings (Loss) Before Cumulative Effect of Accounting Change $1.33 $0.50 ($0.65) $0.90 $0.33 Net Earnings (Loss) $1.33 $0.50 ($0.68) $0.90 $0.33\nFinancial Position:\nTotal Assets $474,213 $419,615 $378,666 $354,357 $315,131 Working Capital $191,823 $141,739 $88,623 $122,812 $99,138 Long-Term Debt, less Current Maturities $59,884 $62,077 $14,582 $21,675 $24,803 Stockholders' Equity $316,167 $258,746 $244,961 $262,791 $226,239\nWeighted Average Number of Common Shares Outstanding: Primary 26,162 24,661 24,028 25,013 22,949 Fully-diluted 26,392 25,072 24,028 25,295 23,216\n(1) Includes cumulative effect of a change in accounting for income taxes of $744,000 or ($0.03) per share and a pre-tax charge of $40,933,000 related to a workforce reduction and the consolidation and restructuring of the Company's operations as described in the Notes to the Consolidated Financial Statements.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\nThe following table sets forth for the years indicated (i) certain revenue and expense items expressed as a percentage of net revenues and (ii) the percentage increase or decrease of such items as compared to the corresponding prior year.\nYear to Year Changes Year Ending December 31,\nPercentage of Revenue 1994 1993 Year Ending December 31, vs. vs. 1994 1993 1992 1993 1992 (1) Net Revenue 100.0% 100.0% 100.0% 29.3% 4.4%\nCost of Revenue 50.1 51.6 50.3 25.5 6.9\nAmortization of Software Development Costs 2.1 1.9 1.3 46.5 54.6\nGross Profit 47.8 46.5 48.4 32.8 0.4\nOperating Expenses: Engineering 7.9 9.7 9.1 5.4 11.1 Selling, General and Administrative 25.7 29.5 32.2 12.5 (4.4) Amortization of Excess of Cost Over Fair Value of Net Assets Acquired 0.6 0.8 0.8 (0.7) 3.6 Restructuring Costs - - 11.9 - (100.0) 34.2 40.0 54.0 10.6 (22.7)\nEarnings (Loss) from Operations 13.6 6.5 (5.6) 168.4 -\nNet Other Expense - - (0.4) - (100.0)\nNet Interest Expense (1.1) (1.1) (0.5) 20.2 158.7\nEarnings (Loss) Before Income Taxes and Cumulative Effect of Accounting Change 12.5 5.4 (6.5) 199.9 -\nProvision (Benefit) for Income Taxes 5.0 1.9 (2.0) 233.2 200.0\nEarnings (Loss) before cumulative effect of accounting change 7.5 3.5 (4.5) 181.1 -\nCumulative effect of accounting change - - 0.2 - (100.0)\nNet Earnings (Loss) 7.5% 3.5% (4.7)% 181.1% -%\n(1) Year to year changes in earnings are not applicable due to the loss incurred for the year ended December 31, 1992 For the year ended December 31, 1994\nNet revenue of $465,306,000 for the year ended December 31, 1994, increased 29.3 percent over 1993. The increase in net revenue resulted primarily from the strong performance of new scanner and terminal products introduced during the last two years and improved economic conditions which accelerated capital spending for the Company's productivity-enhancing hardware and systems. The increases were evident in both scanner and terminal sales. Foreign exchange fluctuations did not have a material impact on net revenue for the year ended December 31, 1994.\nGeographically, North America revenue increased 20.5 percent over the prior year. International revenue increased 48.5 percent over the prior year. North America and International revenue continue to represent approximately two-thirds and one-third of net revenue, respectively.\nCost of revenue (as a percentage of net revenue) of 50.1 percent for the year ended December 31, 1994, decreased from 51.6 percent in 1993. This improvement resulted primarily from a lower cost structure as a result of the execution of the consolidation and restructuring program adopted by the Company in December 1992 offset, in part, by a change in the mix of the Company's products sold to a higher percentage of lower margin terminal products. The Company believes it has derived substantially all of the cost reductions obtainable from the implementation of the program.\nAmortization of software development costs increased to $9,963,000 for the year ended December 31, 1994, from $6,799,000 in 1993, due to new product releases.\nEngineering costs increased to $36,682,000 for the year ended December 31, 1994, from $34,788,000 in 1993. While engineering expenses increased 5.4 percent for the year ended December 31, 1994, from the prior year, as a percentage of revenue such expenses were reduced to 7.9 percent for the year ended December 31, 1994, from 9.7 percent for the prior year due to the 29.3 percent increase in revenue. The increase in absolute dollars reflects expenses incurred in connection with the continuing research and development of new products and the improvement of existing products.\nSelling, general and administrative expenses increased to $119,733,000 for the year ended December 31, 1994, from $106,412,000 in 1993. While in absolute dollars selling, general and administrative expenses increased 12.5 percent for the year ended December 31, 1994, from the prior year, as a percentage of revenue such expenses were reduced to 25.7 percent for the year ended December 31, 1994, from 29.5 percent in 1993. Expenses, which increased to support a higher revenue base, were offset, in part, by cost savings realized as a result of the Company's consolidation and restructuring program.\nNet interest expense increased to $4,960,000 for the year ended December 31, 1994, from $4,126,000 in 1993 due primarily to a full year's interest incurred on the Company's Senior Notes, which were issued in March 1993 described in Note 8 of Notes to Consolidated Financial Statements.\nThe effective tax rate for 1994 increased to 40.0 percent from 36.0 percent in 1993. The effective rate for 1993 reflects the retroactive reinstatement, during the third quarter of 1993, of U.S. Federal research and development tax credits earned since July 1, 1992.\nAt December 31, 1994, the Company had net deferred tax assets of approximately $13,610,000, consisting of current deferred tax assets of $23,300,000 and long-term deferred tax liabilities of $9,690,000. The current deferred tax assets reflect a valuation allowance of approximately $814,000 relating to New York State investment tax credit carryforwards which may be recaptured or may expire unutilized due to the limited ten-year carryover period. No other valuation allowance is necessary due to the Company's history of profitability and anticipated future profitability.\nFor the year ended December 31, 1993\nNet revenue of $359,980,000 for the year ended December 31, 1993, increased 4.4 percent over 1992. The increase in net revenue, notwithstanding a 4.3 percent decrease due to unfavorable foreign exchange fluctuations, resulted primarily from a significant rise in worldwide terminal sales principally related to scanner-integrated terminals. While worldwide scanner sales increased during the second half of 1993 compared with the prior year, for the year ended December 31, 1993, they remained relatively stable compared with 1992.\nGeographically, North America revenue increased 10.8 percent over the prior year. International revenue declined 7.4 percent due to the unfavorable exchange rate fluctuations described above. North America and International revenue represent approximately two thirds and one third of net revenue, respectively.\nCost of revenue (as a percentage of net revenue) of 51.6 percent for the year ended December 31, 1993, increased from 50.3 percent in 1992. This increase resulted primarily from a combination of the impact on revenue of unfavorable fluctuations in foreign exchange rates discussed above and a change in the mix of the Company's products sold to a higher percentage of lower margin terminal products. The increase was offset, in part, by reduced manufacturing costs related to the consolidation and restructuring program adopted by the Company in 1992.\nAmortization of software development costs increased to $6,799,000 for the year ended December 31, 1993, from $4,398,000 in 1992 due to new product releases.\nEngineering costs increased to $34,788,000 for the year ended December 31, 1993, from $31,326,000 in 1992. The increase reflects expenses incurred in connection with the continuing research and development of new products and the improvement of existing products.\nSelling, general and administrative expenses decreased to $106,412,000 for the year ended December 31, 1993, from $111,362,000 in 1992. As a percentage of revenue, such expenses were reduced to 29.5 percent for the year ended December 31, 1993, from 32.2 percent in 1992. The decrease primarily reflects cost reductions realized as a result of the consolidation and restructuring program and the workforce reduction program adopted by the Company in 1992 and to lower International expenses due to a strengthened U.S. dollar.\nNet interest expense increased to $4,126,000 for the year ended December 31, 1993, from $1,595,000 in 1992, due to the issuance of Senior Notes in March 1993 described in Note 8 of Notes to Consolidated Financial Statements.\nThe effective tax rate for 1993 increased to 36.0 percent from 31.1 percent in 1992. The increase primarily resulted from the effect during 1992 of certain non-recurring permanent differences between financial accounting income and taxable income, as well as the effect of changes in the amount of other permanent differences. The effective rate for 1993 reflects the benefit for the Federal research and development credit earned since July 1, 1992, as the credit was retroactively reinstated during the third quarter of 1993.\nAt December 31, 1993, the Company had net deferred tax assets of approximately $21,930,000, consisting of current deferred tax assets of $29,166,000 and long-term deferred tax liabilities of $7,236,000. The current deferred tax assets reflect a valuation allowance of approximately $663,000 relating to New York State investment tax credit carryforwards which may be recaptured or may expire unutilized due to the limited ten- year carryover period. No other valuation allowance is necessary due to the Company's history of profitability and anticipated future profitability.\nLiquidity and Capital Resources\nThe Company utilizes a number of measures of liquidity including the following:\nYear Ended December 31, 1994 1993 1992 Working Capital (in thousands) $191,823 $141,739 $ 88,623\nCurrent Ratio (Current Assets to Current Liabilities) 3.6:1 2.8:1 1.9:1\nLong-Term Debt to Capital 15.9% 19.3% 5.6% (Long-term debt to long- term debt plus equity)\nCurrent assets at December 31, 1994, increased $45,852,000 from December 31, 1993, principally due to an increase in cash as a result of cash generated both from operating activities and financing activities, in accounts receivable due to higher operating levels, and in inventories to support increased demand.\nCurrent liabilities at December 31, 1994, decreased $4,232,000 from December 31, 1993, primarily due to incurred restructuring costs and a decrease in income taxes payable, offset, in part, by an increase in accounts payable and accrued expenses, deferred revenues and the reclassification of the first annual installment due under the Company's 7.76% Series A Senior Notes.\nThe aforementioned activity resulted in a working capital increase of $50,084,000 for the fiscal year ended December 31, 1994. As a result, the Company's current ratio at December 31, 1994, increased to 3.6:1 from 2.8:1 at December 31, 1993.\nWorking capital increased to $141,739,000 for the fiscal year ended December 31, 1993, primarily due to an increase in inventories due to higher demand, increased accounts receivable due to higher sales levels, increased prepaid expenses, and incurred restructuring costs.\nThe Company had a positive cash flow from operations (excluding restructuring costs) during 1994 and generated an increase of $23,890,000 in cash and temporary investments during 1994, primarily as a result of net earnings and equity proceeds of stock option exercises and the corresponding tax benefits. The Company used cash in operations during 1993 for incurred restructuring costs and to increase inventories due to a higher demand and to facilitate product availability to customers during the consolidation of the Company's manufacturing operations. Such activities were financed principally through the issuance of Senior Notes. The Company generated overall positive cash flow for the year ended December 31, 1993.\nProperty, plant and equipment expenditures for the year ended December 31, 1994, totalled $24,790,000 compared to $18,084,000 for the year ended December 31, 1993. Such expenditures were financed by existing cash and temporary investments and from a $3,000,000 seven- year loan from an agency of the State of New York. The loan, which bears interest at 1.0 percent (payable monthly) is to be repaid in one installment in 2001. The Company has an agreement to acquire a forty- acre parcel of land in Suffolk County, New York for $5,000,000. The Company does not intend to commence construction of a corporate headquarters and manufacturing facility on this site before the end of 1995. The Company does not have any other material commitments for capital expenditures.\nAt December 31, 1994, the Company had $59,884,000 in long-term debt outstanding, excluding current maturities. In March 1993 the Company issued $25,000,000 of its 7.76 percent Series A Senior Notes due February 15, 2003, and $25,000,000 of its 7.76 percent Series B Senior Notes due February 15, 2003, to four insurance companies for working capital and general corporate purposes. The Series A Senior Notes will be repaid in equal annual installments beginning in February 1995. The Series B Senior Notes will be repaid in equal annual installments beginning in February 1997. The Senior Notes represent $47,222,000 of the total balance outstanding at December 31, 1994. The remaining $12,662,000 is primarily related to the Industrial Development Bond financing completed in October 1989 and a loan from an agency of the State of New York previously described.\nThe long-term debt to capital percentage at December 31, 1994 decreased to 15.9 percent from 19.3 percent at December 31, 1993, primarily due to increased equity from the results of operations, the proceeds of stock option exercises and the corresponding tax benefits and the decrease in long-term debt due to reclassification to current maturities of long- term debt.\nThe Company has loan agreements with three banks pursuant to which the banks have agreed to provide lines of credit totalling $30,000,000. As of December 31, 1994, the Company had no outstanding borrowings under these lines. These agreements expire between June 30, 1995, and December 31, 1995.\nThe Company believes that it has adequate liquidity to meet its current and anticipated needs from the results of its operations, working capital and existing credit facilities.\nIn the opinion of management, inflation has not had a material effect on the operations of the Company.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following documents are filed on the pages listed below, as part of Part II, Item 8 of this report.\nDocument Page\n1. Financial Statements and Accountants' Report:\nIndependent Auditors' Report\nConsolidated Financial Statements:\nBalance Sheets as of December 31, 1994 and 1993\nStatements of Operations for the Years Ended December 31, 1994, 1993 and 1992\nStatements of Stockholders' 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 Consolidated Financial Statements Notes 1-14 through\n2. Financial Statement Schedules:\nSchedule VIII S-1\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\n(a) Identification of Directors: The section entitled \"Nominees for Election\" contained in the Proxy Statement is hereby incorporated by reference.\n(b) Identification of Executive Officers: See PART I of this Form 10-K.\n(c) Section 16(a) Reporting Delinquencies: The section entitled \"Compliance with Section 16(a) of the Securities Exchange Act\" contained in the Proxy Statement is hereby incorporated by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe section entitled \"Management Remuneration and Transactions\" contained in the Proxy Statement is hereby incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe sections entitled \"Principal Shareholders\" and \"Security Ownership of Management\" contained in the Proxy Statement are hereby incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe section entitled \"Management Remuneration and Transactions\" contained in the 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. FINANCIAL STATEMENTS:\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\n2. FINANCIAL STATEMENT SCHEDULES\nIncluded in Part IV of this report:\nSchedules:\nVIII Valuation and Qualifying Accounts\nOther schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the consolidated financial statements or notes thereto.\nIndividual financial statements of the Company are omitted as the Company is primarily an operating company and the subsidiaries included in the consolidated financial statements filed are substantially wholly-owned and are not indebted to any person other than the parent in amounts which exceed 5% of total consolidated assets at the date of the latest balance sheet filed, excepting indebtedness incurred in the ordinary course of business which is not overdue and which matures within one year from the date of its creation, whether evidenced by securities or not, and indebtedness which is collateralized by the parent by guarantee, pledge, assignment or otherwise.\n3.Exhibits\nExhibit\n3.1 Certificate of Incorporation of Symbol Technologies, Inc. (Incorporated by reference to Exhibit 3.1 to the Form 8-B Registration No. 0-9028, filed with the Commission on November 23, 1987 (the \"Form 8-B\").)\n3.2 By-laws of the Company as currently in effect. (Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (the \"December 1988 Form l0-K\").)\n4.1 Form of Certificate for Shares of the Common Stock of the Company. (Incorporated by reference to Exhibit 4.1 of the Form 8-B.)\n10.1 1991 Employee Stock Option Plan. (Incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (the \"1991 Form 10-K\").)\n10.2 1990 Non-Executive Stock Option Plan as amended. (Incorporated by reference to Exhibit 4.1 to Registration Statement No. 33-78622 on Form S-8.)\n10.3 1987 Consultant Stock Option Plan, as amended. (Incorporated by reference to Exhibit 10.3 of the 1991 Form 10-K.)\n10.4 Employment Agreement by and between the Company and Jerome Swartz, dated as of July 1, 1990. (Incorporated by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (the \"1990 Form 10-K\").)\n10.5 Employment Agreement by and between the Company and Frederic P. Heiman, dated as of July 1, 1990. (Incorporated by reference to Exhibit 10.8 of the 1990 Form 10-K.)\n10.6 Employment Agreement by and between the Company and Tomo Razmilovic, dated as of June 1, 1993 and an Employment Agreement by and between Symbol Technologies Limited and Tomo Razmilovic, dated as of June 1, 1993. (Incorporated by reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.7 Employment Agreement by and between the Company and Jan Lindelow, dated as of June 12, 1994.\n10.8 Employment Agreement by and between the Company and Raymond Martino, dated as of June 12, 1994.\n10.9 Form of 1997 Stock Purchase Warrant issued to directors. (Incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1988.)\n10.10 Form of 2000 Stock Purchase Warrant issued to directors. (Incorporated by reference to Exhibit 10.11 to the 1991 Form 10-K.)\n10.11 1994 Directors Stock Option Plan. (Incorporated by reference to Exhibit 4.1 to Registration Statement No. 33-78678 on Form S-8.)\n10.12 Summary of Profit Sharing Bonus Plan. (Incorporated by reference to Exhibit 10.22 to the December 1988 Form 10-K.)\n10.13 Executive Retirement Plan, as amended. (Incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (the \"1989 Form 10-K\").)\n10.14 Lease Agreement and Amended and Restated Lease Agreement dated as of October 1, 1989 between Suffolk County Industrial Development Agency and Symbol Technologies, Inc. (Incorporated by reference to Exhibit 10.15 to the 1989 Form 10-K.)\n10.15 Form of Note Agreements dated as of February 15, 1993 relating to the Company's 7.76% Series A and Series B Senior Notes due February 15, 2003 (Incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.)\n21. Subsidiaries. 23. Consent of Deloitte & Touche\n(b) Reports on Form 8-K\nNot Applicable\n27. Financial Data Schedule - For electronic filing purposes only.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSYMBOL TECHNOLOGIES, INC. (Registrant)\nBy: s\/Jerome Swartz Jerome Swartz Chairman of the Board\nDated: March 3, 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\ns\/Jerome Swartz Chairman of the March 3, 1995 Jerome Swartz Board and Director (Principal Executive Officer)\ns\/Jan Lindelow Director Jan Lindelow March 3, 1995\ns\/Raymond R. Martino Director March 3, 1995 Raymond R. Martino\ns\/Harvey P. Mallement Director March 3, 1995 Harvey P. Mallement\ns\/Frederic P. Heiman Director March 3, 1995 Frederic P. Heiman\ns\/Saul P. Steinberg Director March 3, 1995 Saul P. Steinberg\ns\/Lowell C. Freiberg Director March 3, 1995 Lowell C. Freiberg\ns\/George Bugliarello Director March 3, 1995 George Bugliarello\ns\/Charles Wang Director March 3, 1995 Charles Wang\ns\/Thomas G. Amato Senior Vice President- March 3, 1995 Thomas G. Amato Finance (Chief Financial Officer)\ns\/Brian T. Burke Vice President and March 3, 1995 Brian T. Burke Controller (Chief Accounting Officer)\nSYMBOL TECHNOLOGIES, INC.\nAND SUBSIDIARIES\n------\nCONSOLIDATED FINANCIAL STATEMENTS\nCOMPRISING ITEM 8 AND SCHEDULE LISTED IN THE\nINDEX AT ITEM 14(a)2 OF ANNUAL REPORT ON FORM 10-K\nTO SECURITIES AND EXCHANGE COMMISSION FOR THE\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSYMBOL TECHNOLOGIES, INC. AND SUBSIDIARIES\nCONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nI N D E X\nPAGE\nIndependent auditors' report\nConsolidated financial statements:\nBalance sheets\nStatements of operations\nStatements of stockholders' equity\nStatements of cash flows\nNotes to consolidated financial statements (1-14) through\nAdditional financial information pursuant to the requirements of Form 10-K:\nSchedule:\nVIII - Valuation and qualifying accounts S-1\nSchedules not listed above have been omitted because they are either not applicable or the required information has been given elsewhere in the consolidated financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Symbol Technologies, Inc. Bohemia, New York\nWe have audited the accompanying consolidated balance sheets of Symbol Technologies, Inc. and subsidiaries as of December 31, l994 and l993, 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)2. 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 present fairly, in all material respects, the financial position of Symbol Technologies, 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.\nAs discussed in Note 9 to the consolidated financial statements, in 1992 the Company changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109.\n\/s\/ DELOITTE & TOUCHE LLP\nJericho, New York February 9, l995\nSYMBOL TECHNOLOGIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n(All amounts in thousands, except stock par value)\nDecember 31, December 31, ASSETS 1994 1993\nCURRENT ASSETS: Cash, including temporary investments of $27,874 and $1,326, respectively $ 31,389 $ 7,499 Accounts receivable, less allowance for doubtful accounts of $7,269 and $5,112, respectively 96,827 90,106 Inventories, net 101,038 82,885 Deferred income taxes 23,300 29,166 Prepaid expenses and other current assets 13,568 10,614\nTOTAL CURRENT ASSETS 266,122 220,270\nPROPERTY, PLANT AND EQUIPMENT, net 71,705 63,200 INTANGIBLE ASSETS, net 98,788 99,887 SOFTWARE DEVELOPMENT COSTS, net 18,558 17,276 OTHER ASSETS 19,040 18,982\n$474,213 $419,615\nLIABILITIES AND STOCKHOLDERS' EQUITY\nCURRENT LIABILITIES: Accounts payable and accrued expenses $ 60,635 $ 56,642 Current portion of long-term debt 5,285 2,586 Income taxes payable 1,382 3,283 Deferred revenue 6,840 5,477 Accrued restructuring costs 157 10,543\nTOTAL CURRENT LIABILITIES 74,299 78,531\nLONG-TERM DEBT, less current maturities 59,884 62,077\nDEFERRED REVENUE 3,639 2,981\nOTHER LIABILITIES 20,224 17,280\nCOMMITMENTS AND CONTINGENCIES\nSTOCKHOLDERS' EQUITY Preferred stock, par value $1.00; authorized 10,000 shares; none issued or outstanding - - Common stock, par value $.01; authorized 40,000 shares; issued 26,719 shares and 24,716 shares, respectively 267 247 Additional paid-in capital 234,798 201,885 Cumulative translation adjustments (8,187) (5,317) Retained earnings 109,589 74,605 336,467 271,420 Less: Treasury stock at cost, 998 shares and 717 shares, respectively (20,300) (12,674) 316,167 258,746\n$474,213 $419,615\nSee notes to consolidated financial statements\nSYMBOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (All amounts in thousands, except per share data)\nYear ended December 31, 1994 1993 1992\nNET REVENUE $465,306 $359,980 $344,940 COST OF REVENUE 232,889 185,617 173,567 AMORTIZATION OF SOFTWARE DEVELOPMENT COSTS 9,963 6,799 4,398\nGROSS PROFIT 222,454 167,564 166,975\nOPERATING EXPENSES: Engineering 36,682 34,788 31,326 Selling, general and administrative 119,733 106,412 111,362 Amortization of excess of cost over fair value of net assets acquired 2,773 2,793 2,697 Restructuring costs - - 40,933 159,188 143,993 186,318\nEARNINGS (LOSS) FROM OPERATIONS 63,266 23,571 (19,343)\nOTHER (EXPENSE)\/INCOME: Other income - - 3,200 Other expense - - (4,768) Interest income 352 537 472 Interest expense (5,312) (4,663) (2,067)\n(4,960) (4,126) (3,163)\nEARNINGS (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE 58,306 19,445 (22,506)\nPROVISION (BENEFIT) FOR INCOME TAXES 23,322 7,000 (7,000)\nEARNINGS (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 34,984 12,445 (15,506)\nCUMULATIVE EFFECT OF ACCOUNTING CHANGE - - 744 NET EARNINGS (LOSS) $ 34,984 $ 12,445 ($ 16,250)\nEARNINGS (LOSS) PER SHARE: On Earnings (Loss) before Cumulative Effect of Accounting Change: Primary $1.34 $0.50 ($0.65) Fully-diluted $1.33 $0.50 ($0.65)\nOn Cumulative Effect of Accounting Change: Primary $ - $ - ($0.03) Fully-diluted $ - $ - ($0.03)\nOn Net Earnings (Loss): Primary $1.34 $0.50 ($0.68) Fully-diluted $1.33 $0.50 ($0.68)\nWEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Primary 26,162 24,661 24,028 Fully-diluted 26,392 25,072 24,028\nSee notes to consolidated financial statements\nSee notes to consolidated financial statements\nSYMBOL TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\n(All amounts in thousands)\nYear ended December 31, 1994 1993 1992\nCash flows from operating activities: Net earnings (loss) $34,984 $ 12,445 ($16,250) Adjustments to reconcile net earnings (loss) to net cash from operating activities: Cumulative effect of accounting change - - 744 Depreciation and amortization of property, plant and equipment 15,263 12,671 15,240 Other amortization 13,756 13,576 10,040 Provision for losses on accounts receivable 2,336 1,823 2,119 Deferred income taxes 5,854 1,906 (18,560) Changes in assets and liabilities, net of effects from acquisitions: Accounts receivable (10,614) (13,610) (16,829) Inventories (18,914) (22,195) 2,365 Prepaid expenses and other current assets (2,954) (3,530) 2,837 Software development cost (11,245) (5,590) (9,058) Intangible assets (2,289) (1,862) (4,938) Other assets (463) (6,458) (7,321) Accounts payable and accrued expenses 3,389 18,104 1,604 Income taxes payable (1,901) (3,016) 3,849 Accrued restructuring costs (10,386) (23,985) 34,528 Other liabilities and deferred revenue 4,977 (3,671) 2,774\nNet cash provided by (used in) operating activites 21,793 (23,392) 3,144\nCash flows from investing activities: Expenditures for property, plant and equipment (24,790) (18,084) (14,974) Other investing activities, net 720 186 170\nNet cash used in investing activities (24,070) (17,898) (14,804)\nCash flows from financing activities: Proceeds from issuance of notes payable 3,000 50,000 7,500 Principal repayments of notes payable and long-term debt (2,494) (10,065) (6,860) Exercise of stock options and warrants 32,933 4,266 5,088 Purchase of treasury shares (7,626) (1,881) (3,461)\nNet cash provided by financing activities 25,813 42,320 2,267\nEffects of exchange rate changes on cash 354 (398) (1,043) Net increase (decrease) in cash and temporary investments 23,890 632 (10,436)\nCash and temporary investments, beginning of year 7,499 6,867 17,303\nCash and temporary investments, end of year $ 31,389 $ 7,499 $ 6,867\nSupplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 5,177 $ 5,172 $ 1,983 Income taxes $ 7,513 $ 4,714 $ 2,711\nSee notes to consolidated financial statements\nSYMBOL TECHNOLOGIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\na. Principles of Consolidation\nThe consolidated financial statements include the accounts of Symbol Technologies, Inc. and its subsidiaries (the \"Company\"), substantially all of which are wholly-owned. Significant intercompany transactions and balances have been eliminated in consolidation.\nb. Temporary Investments\nTemporary investments include highly liquid investments with original maturities of three months or less and consist of money market funds and time deposits at December 31, 1994, and 1993. Temporary investments are stated at cost, which approximates market value. These investments are not subject to significant market risk.\nc. Inventories\nInventories are stated at the lower of cost (determined on a first-in, first-out basis) or market.\nd. Property, Plant and Equipment\nProperty, plant and equipment is recorded at cost. Depreciation and amortization is provided on a straight-line basis over the following estimated useful lives:\nBuildings and improvements 15 to 40 years Machinery and equipment 2 to 5 years Furniture, fixtures and office equipment 5 to 10 years Leasehold improvements (limited to terms of the leases) 2 to 10 years\ne. Intangible Assets\nThe excess of cost over fair value of net assets acquired is generally being amortized on the straight-line method over 40 years.\nPatents and trademarks, including costs incurred in connection with the protection of patents, are amortized over their estimated useful lives, not exceeding 17 years, using the straight-line method.\nf. Software Development Costs\nThe Company capitalizes costs incurred for internally developed product software where economic and technological feasibility has been established and for qualifying purchased product software. Capitalized software costs are amortized on a straight-line basis over the estimated useful product lives (normally three years).\ng. Research and Development Expenses\nThe Company expenses all research and development costs as incurred. The Company incurred research and development expenses of approximately $16,678,000, $16,258,000, and $13,581,000, for the years ended December 31, 1994, 1993 and 1992, respectively, which are classified in engineering expenses.\nh. Revenue Recognition\nRevenue for sales of the Company's products is recognized upon shipment. In conjunction with these sales, field service maintenance agreements are sold for certain products. When such revenue is recorded prior to providing repair and maintenance service, it is deferred and recognized over the term of the related agreements.\ni. Income Taxes\nIn 1992, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" (\"SFAS 109\") which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the Company's financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial accounting and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.\nInvestment, research and development and other tax credits are accounted for by the flow-through method.\nThe cumulative amount of undistributed earnings of foreign subsidiaries at December 31,l994 approximates $9,322,000. The Company does not provide deferred taxes on undistributed earnings of foreign subsidiaries since the Company anticipates no significant incremental U.S. income taxes on the repatriation of these earnings as tax rates in foreign jurisdictions generally approximate or exceed the U.S. Federal rate.\nj. Earnings Per Share\nPrimary and fully-diluted earnings per share are based on the weighted average number of shares of common stock and common stock equivalents (options and warrants) outstanding during the period, computed in accordance with the treasury stock method. In 1992, weighted average common stock equivalents were excluded from the loss per share calculation as their inclusion would have been anti-dilutive.\nk. Foreign Currency Translation and Transactions\nAssets and liabilities of foreign subsidiaries are translated at year-end exchange rates. Results of operations are translated using the average exchange rates prevailing throughout the year. Gains and losses from foreign currency transactions are included in net earnings for the year and are not material. Exchange rate changes arising from translation are included in the cumulative translation adjustments component ofstockholders' equity.\nThe Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. The Company enters into foreign currency forward exchange contracts to hedge a portion of its intercompany accounts receivable transactions. The effect of this practice is to minimize the impact of foreign exchange rate movements on the Company's operating results. The Company's hedging activities do not subject the Company to exchange rate risk because gains and losses on these contracts offset losses and gains on the related intercompany receivables being hedged.\nAs of December 31, 1994, the Company had no material forward exchange contracts outstanding. The forward exchange contracts generally have maturities that do not exceed 12 months and require the Company to exchange foreign currencies for U.S. dollars at maturity, at rates agreed to at inception of the contracts.\n2. INVENTORIES December 31, December 31, l994 1993 (in thousands)\nRaw materials $ 46,442 $ 48,463 Work-in-process 8,485 4,887 Finished goods 46,111 29,535 $101,038 $ 82,885\n3. PROPERTY, PLANT AND EQUIPMENT\nDecember 31, December 31, l994 1993 (in thousands)\nLand $ 4,999 $ 4,869 Buildings and improvements 13,635 12,781 Machinery and equipment 62,830 57,883 Furniture, fixtures and office equipment 34,640 30,089 Leasehold improvements 9,092 5,572 Assets held for sale 4,723 4,723 129,919 115,917 Less: Accumulated depreciation and amortization 58,214 52,717\n$ 71,705 $ 63,200\nAssets held for sale, stated at the lower of cost or estimated realizable value, include land and a building in Costa Mesa, California, that will be sold as a result of the consolidation and restructuring discussed in Note 7. The Company has entered into a contract for the sale of these properties to the party that currently leases the facility. The lease expires in June 1995 and the Company anticipates that the sale will be completed in June 1995, upon expiration of the lease.\n4. INTANGIBLE ASSETS\nDecember 31, December 31, l994 1993 (in thousands)\nExcess of cost over fair value of net assets acquired $102,695 $102,695 Patents, trademarks and purchased technologies 18,666 16,264 Executive retirement plan unrecognized prior service costs 1,173 1,286 122,534 120,245\nLess: Accumulated amortization 23,746 20,358\n$ 98,788 $ 99,887\n5. SOFTWARE DEVELOPMENT COSTS\nYear Ended December 31,\nl994 1993 1992 (in thousands)\nBeginning of year $17,276 $18,485 $13,825 Amounts capitalized 11,245 5,590 9,058 28,521 24,075 22,883\nLess: Amortization 9,963 6,799 4,398 End of year $18,558 $17,276 $18,485\n6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\nDecember 31, December 31, l994 1993 (in thousands)\nAccounts payable $24,192 $29,261 Accrued payroll, bonuses, fringe benefits and payroll taxes 21,208 13,286 Other accrued expenses 15,235 14,095 $60,635 $56,642\n7. RESTRUCTURING COSTS\nIn December 1992 the Company announced a program to restructure its operations by consolidating engineering and manufacturing operations and streamlining the sales, marketing and finance and administrative departments along functional lines. A pre-tax charge of $34,933,000 was accrued to cover costs of the program including associate severance and related costs, lease terminations, transfer of manufacturing and engineering operations and losses on asset dispositions.\nIn August 1992 the Company implemented a workforce reduction designed to reduce costs and improve operating efficiencies. Pre-tax costs of $6,000,000, principally for associate severance and other related costs, were recorded in connection with this program.\n8. LONG-TERM DEBT December 31, December 31, 1994 1993 (in thousands)\nSenior Notes (a) $50,000 $50,000 Industrial Development Bonds (b) 11,844 14,213 State Loan (c) 3,000 - Other 325 450 65,169 64,663\nLess: Current maturities 5,285 2,586 $59,884 $62,077\n(a) In March 1993 the Company issued $25,000,000 of its 7.76 percent Series A Senior Notes due February 15, 2003, and $25,000,000 of its 7.76 percent Series B Senior Notes due February 15, 2003, to four insurance companies. The Series A Senior Notes will be repaid in equal annual installments beginning in February 1995. The Series B Senior Notes will be repaid in equal annual installments beginning in February 1997. Interest is payable quarterly for these Notes. The financing agreements contain certain covenants regarding the maintenance of a minimum level of tangible net worth, as well as certain financial ratios, as defined, and certain restrictions including limitations on indebtedness.\n(b) Borrowings under the Industrial Development Bond financings accrue interest at the rate of 8.95 percent, payable quarterly, and the loan is being repaid in equal annual installments of $2,368,000 which began in October 1992. The Company's principal New York facilities are pledged as collateral for this debt. The financing agreements contain certain covenants regarding the maintenance of a minimum level of tangible net worth and working capital, as well as certain financial ratios, as defined, and limitations on investments, dividends and indebtedness.\n(c) In 1994, the Company received a $3,000,000 loan from an agency of New York State. The loan bears interest at 1.0 percent, payable monthly, and the principal is to be repaid in one installment in 2001. The interest rate is subject to a covenant requiring a minimum level of full time permanent employees.\nBased on the borrowing rates currently available to the Company for bank loans with similar terms, the fair value of Senior Notes and Industrial Development Bonds approximates the carrying value. The fair value of the State Loan as of December31, 1994, is approximately $1,700,000.\nLong-term debt maturities are:\nYear ending December 31, (in thousands)\n1995 $ 5,285 1996 5,197 1997 8,773 1998 8,763 1999 8,721 Thereafter 28,430 $65,169\n9. INCOME TAXES\nThe provision\/(benefit) for income taxes consists of:\nYear Ended December 31,\n1994 1993 1992 (in thousands) Current: Federal $11,067 $ 3,270 $ 4,036 State and local 3,168 1,177 1,091 Foreign 3,233 647 2,386 17,468 5,094 7,513\nDeferred: Federal 4,714 1,481 (11,648) State and local 1,246 233 (2,589) Foreign (106) 192 (276) 5,854 1,906 (14,513) Total Provision\/(Benefit) for Income Taxes $23,322 $ 7,000 ($ 7,000)\nAs described in Note 1, the Company adopted SFAS 109 during 1992. This accounting change resulted in a restatement of the Company's deferred tax accounts as of January 1, 1992, which resulted in a charge of $744,000 ($0.03 per share) which is reflected as a cumulative effect of accounting change in the Company's consolidated statement of operations. Additionally, the adoption of SFAS 109 resulted in an increase in the income tax benefit recognized during 1992 and, therefore, a decrease in the loss before cumulative effect of accounting change of $9,110,000 ($0.38 per share).\nA reconciliation between the statutory U.S. Federal income tax rate and the Company's effective tax rate is: Year Ended December 31, 1994 1993 1992\nStatutory U.S. Federal rate 35.0% 34.0% (34.0)% State taxes, net of Federal tax effect 4.9 4.8 (4.0) Tax credits (4.6) (7.3) - Tax-exempt interest income - - (0.3) Amortization of excess of cost over fair value of net assets acquired 1.5 4.9 4.1 Exempt income of foreign sales corporation (1.1) (2.3) - Income of foreign subsi- diaries taxed at higher tax rates 1.1 1.8 1.9 Losses of foreign subsi- diaries for which no benefit is recognized - - 1.5 Release of excess reserves for contingencies - - (4.8) Settlement of lawsuits - - 1.2 Other, net 3.2 0.1 3.3\n40.0% 36.0% (31.1)%\nAt December 31, 1994, 1993 and 1992, other liabilities include deferred income taxes of $9,690,000, $7,236,000 and $6,893,000, respectively. The deferred tax assets and liabilities at December 31, 1994, 1993 and 1992, respectively, are comprised of:\nYear Ended December 31, 1994 1993 1992\nDeferred Tax Deferred Tax Deferred Tax Assets\/(Liabilities) Assets\/(Liabilities) Assets\/(Liabilities) (in thousands)\nReceivables $ 4,977 $ 3,405 $ 3,043 Inventory 6,249 11,677 8,094 Net investment in sales-type leases (2,245) (1,722) (817) Accrued compensation and associate benefits 3,739 3,307 2,153 Other accrued liabilities 3,382 3,037 2,469 Accrued restructuring costs 61 4,338 13,807 Deferred revenue - current 2,296 1,902 1,324 Deferred revenue - long term 1,511 1,204 379 Deferred patent and product development costs (10,427) (9,809) (9,854) Property, plant and equipment (1,492) (1,851) (1,664) Investments 1,338 1,181 390\nCumulative translation adjustments 945 3,411 2,731 Tax credit carryforwards 3,410 2,163 2,071 Other, net 680 350 1,106 14,424 22,593 25,232 Less: Valuation allowance 814 663 560\nNet Deferred Taxes $13,610 $21,930 $24,672\nThe valuation allowance increased by $151,000 during 1994 and by $103,000 during 1993. The valuation allowance decreased $45,000 in 1992. The valuation allowance relates to state investment tax credit carryforwards which are likely to be subject to recapture and which are likely to expire unutilized. No other valuation allowances for deferred tax assets are necessary due to the Company's history of profitability and anticipated future profitability.\n10. COMMITMENTS AND CONTINGENCIES\na. Lease Agreements\nFuture minimum annual rental payments required under noncancellable operating leases are: Year ending December 31, (in thousands)\n1995 $ 4,904 1996 3,993 1997 3,446 1998 2,432 1999 1,386 Thereafter 1,249 $17,410\nRent expense under substantially all operating leases was $5,673,000, $5,465,000, and $4,734,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nb. Credit Facilities\nThe Company has loan agreements with three banks pursuant to which the banks have agreed to provide lines of credit totalling $30,000,000. As of December 31, 1994, and 1993, the Company had no outstanding borrowings under these lines. Such borrowings would bear interest at the respective bank's cost of funds rate, which approximated 6% at December 31, 1994. These agreements expire between June 30, 1995, and December 31, 1995.\nc. Capital Expenditures\nThe Company has an agreement to acquire a forty acre parcel of land in Suffolk County, New York for $5,000,000. The Company does not intend to commence construction of a corporate headquarters and manufacturing facility on this site before the end of 1995.\nd. Employment Contracts\nThe Company has executed employment contracts with certain senior executives that vary in length for which the Company has a minimum commitment aggregating approximately $3,625,000 at December 31, 1994.\ne. Legal Matters\nThe Company is currently involved in matters of litigation arising from the normal course of business. Management is of the opinion that such litigation will have no material adverse effect on the Company's consolidated financial position or results of operations.\nIn March 1993, the Company and certain of its officers received a purported first Consolidated Amended Class Action Complaint in the action entitled In re. Symbol Technologies Class Action Litigation (\"First Complaint\") in the Eastern District of New York which essentially asserted the same alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder as had been contained in six separate purported class action suits previously filed, and alleged a class period of March 17, 1992, through September 14, 1992. Defendants moved to dismiss the First Complaint for failure to state a cause of action and for failure to allege fraud with particularity. On September 14, 1993, the Court granted defendants' motion and dismissed the First Complaint. However, the Court granted plaintiffs leave to file a new complaint within 30 days. On October 14, 1993, a Second Consolidated Amended Class Action Complaint (\"Second Complaint\") was served. It alleges essentially similar violations as had the prior complaints but alleges a class period from June 8, 1992, to September 14, 1992. Defendants moved to dismiss the Second Complaint and such motion is currently pending before the Court. The Company believes that the litigation is without merit and intends to defend it vigorously.\nDuring 1989 and 1990, the Company, its directors and certain of its officers were named as defendants in shareholder class action and derivative lawsuits inconnection with complaints principally alleging violations of federal securities laws and misrepresentations regarding the Company's August 1989 sale of Common Stock and statements made to the investing public. On March 3, 1992, the Company agreed to settle the lawsuits. A settlement fund of $11,500,000, which was comprised of $7,250,000 of cash and six-year warrants valued at $4,250,000, had to be created to settle the litigation. The $7,250,000 cash portion of the settlement has been provided by an unaffiliated insurance company. In January 1994, the Company exercised its option of paying $4,250,000 in cash in lieu of issuing the warrants. This liability was included in accounts payable and accrued expenses at December 31, 1993.\n11. STOCKHOLDERS' EQUITY\na. Stock Option Plans\nThere are a total of 4,828,000 shares of Common Stock reserved for issuance under the Company's stock option plans at December 31, 1994.\nA summary of changes in the stock option plans is:\nShares Under Option Number of Option Price Shares per Share (in thousands)\nShares under option at December 31, 1992 4,611\nGranted $12.00 to $18.25 1,287 Exercised $ 5.50 to $14.88 (376) Cancelled $ 7.63 to $23.75 (356)\nShares under option at December 31, 1993 5,166\nGranted $ 9.00 to $29.88 626 Exercised $ 5.50 to $23.75 (1,993) Cancelled $ 8.00 to $23.75 (219)\nShares under option at December 31, 1994 3,580\nShares exercisable at December 31, 1994 $ 5.50 to $23.75 1,419\nAt December 31, l994, an aggregate of 1,248,000 shares remain available for grant under the stock option plans (1,000,000 of which are subject to shareholder approval in May 1995). The tax benefits arising from stock option exercises during the years ended December 31, 1994, 1993 and 1992, in the amount of $14,066,000, $1,062,000 and $1,460,000, respectively, were recorded in stockholders' equity as additional paid-in capital.\nb. Treasury Stock\nTreasury stock is comprised of 596,000 shares of Common Stock purchased for a total of $14,958,000 from certain officers related to the exercise of stock options and 402,000 shares purchased in open market transactions at a total of $5,342,000 pursuant to the stock repurchase program authorized by the Board of Directors on May4, 1992.\nc. Stock Purchase Warrants\nThe following table indicates the number of common shares issuable upon exercise and exercise price per share of all outstanding Directors' warrants as of December 31,1994:\nExercisable Number of Shares Exercise Price Shares Vested to Issuable Upon Exercise per Share at December 31, 1994\n1997 35,000 $11.00 35,000 2000 39,000 $ 8.13 to $15.50 39,000 2004 20,000 $25.25 to $27.75 - 94,000 74,000\n12. ASSOCIATE BENEFIT PLANS\na. Profit Sharing Retirement Plan\nThe Company maintains a 401(k) profit sharing retirement plan for all U.S. associates meeting certain service requirements. The Company contributes monthly 50% of associates' contributions up to a maximum of 6% of annual compensation. Plan expense for the years ended December 31, 1994, 1993 and 1992 was $2,559,000, $2,336,000 and $2,358,000, respectively.\nb. Health Benefits\nThe Company pays substantially all costs incurred in connection with providing associate health benefits through a program administered by an insurance company. Such costs amounted to $8,536,000, $10,275,000 and $8,905,000, for the years ended December 31, 1994, 1993 and 1992, repectively.\nc. Executive Retirement Plan\nThe Company maintains an Executive Retirement Plan (the \"Plan\") in which certain highly compensated associates are eligible to participate. Participants are selected by a committee of the Board of Directors. Benefits vest after five years of service and are based on a percentage of average compensation for the three years immediately preceding termination of the participant's full-time employment. As of December 31, 1994, 12 officers were participants in the Plan. The Company's obligations under the Plan are not funded apart from the Company's general assets. The Company's funding policy is to set aside assets for the Plan based on the annual net periodic pension expense. The funded assets are classified in other assets.\nPlan costs are:\nYear Ended December 31, 1994 1993 1992 (in thousands)\nService cost - benefits earned during the period $ 543 $ 513 $ 708 Interest cost on projected benefit obligation 624 488 530 Amortization of unfunded prior service costs and unrecognized loss 130 150 303\nNet periodic pension expense $1,297 $1,151 $1,541\nThe Plan's funded status is as follows:\nDecember 31, December 31, 1994 1993 (in thousands)\nAccumulated benefit obligation $5,496 $5,007\nProjected benefit obligation ($7,830) ($7,003) Unrecognized net loss 963 1,120 Unrecognized prior service costs 1,173 1,286 Accrued pension costs ($5,694) ($4,597)\nThe Plan had $4,906,000 and $4,578,000 of vested benefit obligations at December 31, 1994, and 1993, respectively. The projected benefit obligation at December 31, 1994, 1993 and 1992 was determined using an assumed weighted average discount rate of 8.0 percent, 7.0 percent and 7.0 percent, respectively, and an assumed increase in the long-term rate of compensation of 5.0 percent, 5.0 percent and 5.0 percent,respectively.\n13. OPERATIONS BY GEOGRAPHIC AREA\nThe Company is engaged in one industry, specifically, the design, manufacture and marketing of bar code reading equipment, portable data collection systems and radio frequency data communications products. Operations in this business segment are summarized below by geographic area. The Company's operations in Western Europe generally consist of selling and performing field service maintenance on products designed and manufactured primarily in the United States.\nNorth Western America Europe Other Eliminations Consolidated (in thousands) Year ended December 31, l994:\nSales to unaffiliated customers $298,217 $141,090 $25,999 $ - $465,306 Transfers between geographic areas 97,981 - - (97,981) -\nTotal net revenue $396,198 $141,090 $25,999 ($97,981) $465,306\nEarnings before provision for income taxes $ 46,502 $ 4,783 $ 836 $ 6,185 $ 58,306\nIdentifiable assets $296,530 $ 62,839 $ 3,217 $ - $362,586\nCorporate assets 111,627\nTotal assets $474,213\nYear ended December 31, 1993:\nSales to unaffiliated customers $247,448 $ 98,188 $14,344 $ - $359,980 Transfers between geographic areas 56,244 - - (56,244) -\nTotal net revenue $303,692 $ 98,188 $14,344 ($56,244) $359,980\nEarnings before provision for income taxes $ 18,152 $ 1,062 $ 180 $ 51 $ 19,445 identifiable assets $274,032 $ 50,919 $ 1,738 $ - $326,689\nCorporate assets 92,926\nTotal assets $419,615\nYear ended December 31, 1992:\nSales to unaffiliated customers $223,427 $106,794 $14,719 $ - $344,940 Transfers between geographic areas 66,692 - - (66,692) -\nTotal net revenue $290,119 $106,794 $14,719 ($66,692) $344,940\n(Loss) Earnings before benefit for income taxes $(15,406) $ 4,141 $ (652) ($10,589) ($22,506)\nIdentifiable assets $232,868 $ 49,792 $ 1,449 $ - $284,109\nCorporate assets 94,557\nTotal assets $378,666\nIn determining earnings before provision for income taxes for each geographic area, sales and purchases between areas have been accounted for on the basis of internal transfer prices set by the Company. Certain U.S. operating expenses are allocated between geographic areas based upon the percentage of geographic area revenue to total revenue. This allocation has the effect of reducing reported European and other operating profit.\nIdentifiable assets are those tangible and intangible assets used in operations in each geographic area. Corporate assets are principally temporary investments and the excess of cost over fair value of net assets acquired.\nThe Company's export sales, primarily to Europe, approximated $167,089,000, $112,532,000 and $121,513,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nThe Company has customers in the retail industry which accounted for approximately $38,895,000 in accounts receivable at December 31, 1994. The carrying amounts of accounts receivable approximate fair value because of the short maturity of these instruments.\n14. SELECTED QUARTERLY FINANCIAL DATA (unaudited)\nThe following tables set forth unaudited quarterly financial information for the years ended December 31, 1994 and 1993:\nQuarter Ended March 31 June 30 September 30 December 31 (in thousands, except per share amounts)\nYear Ended December 31, 1994:\nNet revenue $103,668 $113,423 $124,433 $123,782 Gross profit 49,465 54,168 59,575 59,246 Net earnings 6,656 8,397 10,295 9,636 Primary and Fully- diluted earnings per share: $0.26 $0.32 $0.39 $0.36\nYear Ended December 31, 1993:\nNet revenue $83,719 $89,936 $92,378 $93,947 Gross profit 38,185 41,523 43,133 44,723 Net earnings 727 2,249 4,625 4,844 Primary and Fully- diluted earnings per share: $0.03 $0.09 $0.19 $0.19\nThe Company accounts for interim inventories using the gross profit method. The results of operations in the quarters ended December 31, 1994, and 1993 reflect adjustment of gross profit estimates based upon the actual physical inventory valuation.\nThe quarterly earnings per share information is computed separately for each period. Therefore, the sum of such quarterly per share amounts may differ from the total for the year.\nSCHEDULE VIII\nSYMBOL TECHNOLOGIES, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(All amounts in thousands)\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E Additions (1) (2) Balance at Charged to Charged Balance beginning cost and to other at end Description of year expenses accounts Deductions of year\nAllowance for doubtful accounts:\nDecember 31, l994 $5,112 $2,336 $ - $ 179 (a) $7,269\nDecember 31, 1993 $4,893 $1,823 $ - $1,604 (a) $5,112\nDecember 31, 1992 $4,181 $2,119 $ - $1,407 (a) $4,893\n(a) Uncollectible accounts written off.\nS-1\nSECURITIES AND EXCHANGE COMMISSION\nWASHINGTON, D.C. 20549\n__________________________________\nANNUAL REPORT\nON\nFORM 10-K\nFOR FISCAL YEAR ENDED\nDECEMBER 31, 1994\n_________________________________\nSYMBOL TECHNOLOGIES, INC.\nEXHIBITS\n3. Exhibits\nExhibit\n3.1 Certificate of Incorporation of Symbol Technologies, Inc. (Incorporated by reference to Exhibit 3.1 to the Form 8-B Registration No. 0-9028, filed with the Commission on November 23, 1987 (the \"Form 8-B\").)\n3.2 By-laws of the Company as currently in effect. (Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 (the \"December 1988 Form l0-K\").)\n4.1 Form of Certificate for Shares of the Common Stock of the Company. (Incorporated by reference to Exhibit 4.1 of the Form 8-B.)\n10.1 1991 Employee Stock Option Plan. (Incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (the \"1991 Form 10-K\").)\n10.2 1990 Non-Executive Stock Option Plan as amended. (Incorporated by reference to Exhibit 4.1 to Registration Statement No. 33-78622 on Form S-8.)\n10.3 1987 Consultant Stock Option Plan, as amended. (Incorporated by reference to Exhibit 10.3 of the 1991 Form 10-K.)\n10.4 Employment Agreement by and between the Company and Jerome Swartz, dated as of July 1, 1990. (Incorporated by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (the \"1990 Form 10-K\").)\n10.5 Employment Agreement by and between the Company and Frederic P. Heiman, dated as of July 1, 1990. (Incorporated by reference to Exhibit 10.8 of the 1990 Form 10-K.)\n10.6 Employment Agreement by and between the Company and Tomo Razmilovic, dated as of June 1, 1993 and an Employment Agreement by and between Symbol Technologies Limited and Tomo Razmilovic, dated as of June 1, 1993. (Incorporated by reference to Exhibit 10.7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.)\n10.7 Employment Agreement by and between the Company and Jan Lindelow, dated as of June 12, 1994.\n10.8 Employment Agreement by and between the Company and Raymond Martino, dated as of June 12, 1994.\n10.9 Form of 1997 Stock Purchase Warrant issued to directors. (Incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1988.)\n10.10 Form of 2000 Stock Purchase Warrant issued to directors. (Incorporated by reference to Exhibit 10.11 to the 1991 Form 10-K.)\n10.11 1994 Directors Stock Option Plan. (Incorporated by reference to Exhibit 4.1 to Registration Statement No. 33-78678 on Form S-8.)\n10.12 Summary of Profit Sharing Bonus Plan. (Incorporated by reference to Exhibit 10.22 to the December 1988 Form 10-K.)\n10.13 Executive Retirement Plan, as amended. (Incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989 (the \"1989 Form 10-K\").)\n10.14 Lease Agreement and Amended and Restated Lease Agreement dated as of October 1, 1989 between Suffolk County Industrial Development Agency and Symbol Technologies, Inc. (Incorporated by reference to Exhibit 10.15 to the 1989 Form 10-K.)\n10.15 Form of Note Agreements dated as of February 15, 1993 relating to the Company's 7.76% Series A and Series B Senior Notes due February 15, 2003 (Incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.)\n21. Subsidiaries.\n23. Consent of Deloitte & Touche\n(b) Reports on Form 8-K\nNot Applicable\n27. Financial Data Schedule - For electronic filing purposes only.\nEXHIBIT 10.7\nEMPLOYMENT AGREEMENT\nEMPLOYMENT AGREEMENT (the \"Agreement\") made as of the 12th day of June, 1994 by and between SYMBOL TECHNOLOGIES, INC., a Delaware corporation (the \"Corporation\"), and JAN LINDELOW, (the \"Executive\").\nW I T N E S S E T H\nWHEREAS, the Corporation desires to employ the Executive and the Executive desires to be employed by the Corporation in the manner and on the terms and conditions hereinafter set forth.\nNOW, THEREFORE, in consideration of the premises and of the mutual and dependent agreements and covenants herein set forth, the parties hereto agree as follows:\n1. EMPLOYMENT\nThe Corporation hereby agrees to employ the Executive as its President and Chief Operating Officer (\"Employment\"), and the Executive hereby agrees to accept such Employment and to render services to the Corporation and its subsidiaries, divisions and affiliates for the period and on the terms and conditions set forth in this Agreement. The Corporation hereby agrees to use its best efforts, undertaken in good faith, to ensure that the Executive shall be elected a director by the Board of Directors of the Corporation at its next meeting (and in no event later than June 20, 1994) and nominated by the Board of Directors for reelection by the shareholders of the Corporation at the next annual meeting of shareholders and that he shall remain a director of the Corporation during the period of his Employment under this Agreement; provided, however, that, except as otherwise provided in subsection 12(b)(3) in the event that the Executive is not elected at any time during his Employment under this Agreement, such fact in and of itself shall not serve to accelerate, decrease, increase or otherwise enlarge the benefits to which the Executive shall be entitled under this Agreement.\n2. TERM\nThe Executive's Employment under this Agreement shall be for a term of five (5) years, commencing as of July 1, 1994 and ending on June 30, 1999; provided, however, that the term of the Executive's actual Employment hereunder shall at all times be subject to earlier termination in accordance with the provisions of section 12 hereof.\n3. DUTIES\n(a) So long as the Executive's Employment under this Agreement shall continue, the Executive shall, subject to periods of illness, vacation and other excused absences, devote his entire business time, attention, and energies to the affairs of the Corporation and its subsidiaries, divisions and affiliates, use his best efforts to promote its and their best interests and perform such executive duties as may be assigned to him by the Chief Executive Officer of the Corporation; provided, however, that such executive duties shall be consistent with the position of President and Chief Operating Officer of the Corporation as such duties exist as of the date hereof.\n(b) So long as the Executive's Employment under this Agreement shall continue, the Executive shall, if elected or appointed, serve as an executive officer and\/or director of the Corporation and of any subsidiary, division or affiliate of the Corporation and shall hold, without any compensation other than that provided for in this Agreement, the offices in the Corporation and in any such subsidiary, division or affiliate to which he may, at any time or from time to time, be elected or appointed. 4. COMPENSATION\n(a) The Corporation hereby agrees to pay to the Executive, and the Executive hereby agrees to accept, as compensation for services rendered under this Agreement, a base salary at the rate of four hundred thirty-seven thousand five hundred Dollars ($437,500) per annum for the period ending December 31, 1995 payable at such intervals as the Corporation customarily pays the salaries of its executive officers. Effective January 1, 1996 and each January 1st thereafter, the Executive and the Corporation shall negotiate, in good faith, with respect to increasing said base salary for an additional one year period in an amount mutually satisfactory to the Corporation and the Executive.\n(b) In addition to the base salary provided for in subsection 4(a) above, the Executive shall participate in the Corporation's profit sharing bonus plan and thereby be entitled to receive an annual bonus for each fiscal year during the term of this Agreement in the amounts determined pursuant to such plan. The target amount of the Executive's bonus under said plan shall be 100% of his base salary actually earned in each fiscal year. The target bonus for 1994 shall be guaranteed by the Corporation which guaranteed amount shall be paid to the Executive upon commencement of his employment with the Corporation. Fifty percent of the target bonus for 1995 shall be guaranteed by the Corporation. Payment of the bonus provided herein (other than 1994's guaranteed portion) shall be paid to the Executive no later than ninety (90) days after the completion of each fiscal year.\n(c) During the term of this Agreement, the Executive shall participate in the Corporation's Executive Retirement Plan. The Executive acknowledges that he has previously been provided with a copy of said plan.\n(d) In addition to the foregoing, it is hereby agreed that the Corporation shall, at its sole expense, provide and the Executive shall be entitled to receive, during his Employment hereunder, the employee fringe benefits provided by the Corporation, from time to time, to its executive officers, including, but not limited to, benefits relating to life, medical and disability insurance, vacation time, and participation in the Corporation's Section 401(k) Plan; provided, however, that as used in this Agreement, the term employee fringe benefits' shall not include any salary or other bonus plan, except as set forth in this Agreement.\n(e) As a bonus for entering into this Agreement and to compensate the Executive for a portion of the compensation he will be forfeiting from his prior employer, the Corporation will pay the Executive $111,750 within ten (10) days after the date he first commences Employment with the Corporation and $111,750 payable on the earlier of (i) the date of the termination of his Employment or (ii) March 1, 1995.\n5. AUTOMOBILE\nDuring the period of the Executive's Employment under this Agreement, the Corporation shall either (i) make available to the Executive the use of an automobile, with a lease allotment of up to $1,000 per month as well as gasoline, maintenance and insurance expenses associated with such automobile or (ii) reimburse the Executive for comparable automobile expenses if the Executive chooses to lease his own automobile.\n6. EXPENSES; OPTIONS\n(a) The Corporation shall pay or reimburse the Executive for all reasonable travel and other expenses incurred or paid by him in connection with the performance of his duties under this Agreement, upon presentation to the Corporation of expense statements or vouchers and such other supporting documentation as it may, from time to time, reasonably require; provided, however, that the maximum amount available for such expenses may, at any time or from time to time, be fixed in advance for executive officers by the Board of Directors of the Corporation.\n(b)(1) The Corporation agrees, as promptly as practicable to cause the award to the Executive by the Compensation\/Stock Option Committee of the Board of Directors of the Corporation, subject to shareholder approval as required, of stock options to purchase 250,000 shares of the Corporation's Common Stock (50,000 of which shall be a bonus for entering into this Agreement). All of the above options shall be at an exercise price equal to the closing price of the Corporation's Common Stock on the later of (i) date of the award thereof, or (ii) the date the Executive first commences employment (including part-time) with the Corporation. These options shall have a term of ten years; 25% of these options shall vest July 1, 1996 and 25% of these options shall vest on each of the next three consecutive anniversary dates of that date. The Executive acknowledges that he has been provided with a summary of the provisions of the Corporation's stock option plan.\n(2) In the event that for any reason the options or any portion thereof to be granted pursuant to subsection 6(b)(1) are not issued or the stockholders of the Corporation do not approve at the next annual meeting of stockholders an amendment to the stock option plan increasing the number of stock options available for grant to an amount sufficient to cover the total options granted pursuant to this Agreement, unless the Corporation and the Executive enter into an arrangement satisfactory to the Executive which provides him with economic benefits comparable to those he would have obtained from the options provided herein, then the Executive will be deemed to have been granted stock appreciation rights equal to the number of stock options not approved by the stockholders or not issued. The Executive shall be entitled to payment by the Corporation of an amount equal to the difference between the closing price of the Corporation's Common Stock at the time of exercise less the closing price of the Corporation's Common Stock provided in subsection 6(b)(1) above multiplied by the number of stock appreciation rights granted. All vesting and rights to exercise stock appreciation rights granted pursuant to this subsection shall conform to the vesting and exercise rights of stock options that would have been granted pursuant to subsection 6(b)(1) above.\n(3) Furthermore, in December 1995 and on a biennial basis thereafter the Executive shall be eligible to be awarded additional options subject to satisfactory job performance. All such options shall be at an exercise price equal to the closing price of the Corporation's Common Stock on the date of award and shall otherwise contain terms and conditions similar to those options referred to in subsection 6(b)(1) hereof.\n(c) All outstanding options to purchase shares of Common Stock of the Corporation awarded to the Executive during the term of this Agreement shall vest regardless of any conditions precedent to the vesting of such options (such as the passage of time) if and when there is a change in control of the Corporation as hereafter defined. As used in this Agreement, a change in control of the Corporation shall mean a change in control of a nature that would be required to be reported in response to Item 1 of Form 8-K promulgated under the Securities Exchange Act of 1934, as amended, (the \"Exchange Act\"); provided, that, without limitation, such a change in control shall be deemed to have occurred if (i) any \"person\" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), other than the Corporation or any \"person\" who on the date hereof is a director or officer of the Corporation, is or becomes the \"beneficial owner\", (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing 25% or more of the combined voting power of the Corporation's then outstanding securities and the Corporation's Board of Directors, after having been advised that such ownership level has been reached, does not, within fifteen (15) business days, adopt a resolution approving the acquisition of that level of securities ownership by such person; or (ii) during any period of two consecutive years during the term of this Agreement, individuals who at the beginning of such period constitute the Board of Directors cease for any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two- thirds of the directors then in office who were directors at the beginning of the period.\n(d) Notwithstanding the then-current state of the Corporation's By-Laws, the Executive shall be entitled at all times to the benefit of the maximum indemnification and advancement of expenses available from time to time under the laws of the State of Delaware.\n(e) The Corporation and\/or any of its subsidiaries, divisions or affiliates may, from time to time, apply for and obtain, for its or their benefit and at its or their sole expense, key man life, health, accident, disability, or other insurance upon the Executive, in any amounts that it or they may deem necessary or desirable to protect its or their respective interests, and the Executive agrees to cooperate with and assist the Corporation or such subsidiary, division or affiliate in obtaining any and all such insurance by submitting to all reasonable medical examinations, if any, and by filling out, executing, and delivering any and all such applications and other instrument as may reasonably be necessary.\n(f) The Corporation shall also reimburse the Executive for the cost, in an amount not to exceed $10,000 per annum, of term life insurance which the Executive may obtain, which insurance shall be for the sole benefit of the Executive and\/or his designated beneficiaries.\n(g) The Corporation agrees to pay or reimburse the Executive for the reasonable expenses incurred by him in connection with his relocation, prior to July 1, 1995, to the Long Island area in accordance with the Corporation's existing policy with respect to relocation of executive employees provided, however, that the Executive shall be entitled to be reimbursed for additional temporary housing expenses for a period of up to one year. In the event the Executive voluntarily terminates his employment during the first year of his Employment, the Executive shall reimburse the Corporation for any and all relocation expenses paid or reimbursed pursuant to this subsection.\n7. INVENTIONS\n(a) The Executive agrees to and hereby does assign to the Corporation or any subsidiary, affiliate or division of the Corporation designated by the Corporation, all his right, title and interest throughout the world in and to all ideas, methods, developments, products, inventions, processes, improvements, modifications, techniques, designs and\/or concepts relating directly or indirectly to the business of the Corporation, its subsidiaries, affiliates or divisions, whether patentable or unpatentable, which the Executive may conceive and\/or develop during his employment by the Corporation (whether pursuant to this Agreement or otherwise) or which the Executive may conceive and\/or develop during a twenty-four (24) month period following the termination of his employment if such concept and\/or development during such twenty-four (24) month period is a direct result of the Executive's activities while employed by the Corporation, whether or not conceived and\/or developed at the request of the Corporation or any subsidiary, affiliate or division (the \"Inventions\"); provided, however, that if the Corporation or such subsidiary, affiliate or division determine that it will not use any such Invention or that it will license or transfer any such Invention to an unaffiliated third party, then it will negotiate in good faith with the Executive, if the Executive so requests, with respect to a transfer or license of such Invention to the Executive.\n(b) The Executive further agrees to promptly communicate and disclose to the Corporation any and all such Inventions as well as any other knowledge or information which he may possess or obtain relating to any such Inventions.\n(c) In furtherance of the foregoing, the Executive agrees that at the request of the Corporation, and at its expense, he will make or cooperate in making of applications for letters patent of the United States or elsewhere and will execute such other agreements, documents or instruments which the Corporation may reasonably consider necessary to transfer to and vest in the Corporation or any subsidiary, affiliate or division, all right, title and interest in any such Inventions, and all applications for any letters patent issued in respect of any of the foregoing.\n(d) The Executive shall assist, upon request, in locating writings and other physical evidence of the making of the Inventions and provide unrecorded information relating to them and give testimony in any proceeding in which any of the Inventions or any application or patent directed thereto may be involved, provided that reasonable compensation shall be paid the Executive for such services and the Executive shall be reimbursed for any expenses incurred by him in connection therewith, except that during such period of time as the Executive is employed by the Corporation, the Corporation shall not be obligated to compensate the Executive at a higher rate for the giving of testimony than the rate established by law for the compensation of witnesses in the court or tribunal where the testimony is given or in the district where the testimony is taken. The Corporation shall give the Executive reasonable notice should it require such services, and, to the extent reasonably feasible, the Corporation shall use its best efforts to request such assistance at times and places as will least interfere with any other employment of the Executive.\n(e) At the expense of the Corporation, the Executive shall assign to the Corporation all his interest in copyrightable material which he produces, composes, or writes, individually or in collaboration with others, which arises out of work performed by him on behalf of the Corporation, and shall sign all papers and do all other acts necessary to assist the Corporation to obtain copyrights on such material in any and all jurisdictions.\n8. CONFIDENTIAL INFORMATION\nThe Executive hereby acknowledges that, in the course of his employment by the Corporation, he will have access to secret and confidential information which relates to or affects all aspects of the business and affairs of the Corporation and its subsidiaries, affiliates and divisions, and which are not available to the general public (\"Confidential Information\"). Without limiting the generality of the foregoing, Confidential Information shall include information relating to inventions (including, without limitation, Inventions), developments, specifications, technical and engineering data, information concerning the filing or pendency of patent applications, business ideas, trade secrets, products under development, production methods and processes, sources of supply, marketing plans, and the names of customers or prospective customers or of persons who have or shall have traded or dealt with the Corporation. Accordingly, the Executive agrees that he will not, at any time, without the express written consent of the Corporation, directly or indirectly, disclose or furnish, or negligently permit to be disclosed or furnished, any Confidential Information to any person, firm, corporation or other entity except in performance of his duties hereunder.\n9. CONFIDENTIAL MATERIALS\nThe Executive hereby acknowledges and agrees that any and all models, prototypes, notes, memoranda, notebooks, drawings, records, plans, documents or other material in physical form which contain or embody Confidential Information and\/or information relating to Inventions and\/or information relating to the business and affairs of the Corporation, its subsidiaries, affiliates and divisions and\/or the substance thereof, whether created or prepared by the Executive or by others (\"Confidential Materials\"), which are in the Executive's possession or under his control, are the sole property of the Corporation. Accordingly, the Executive hereby agrees that, upon the termination of his employment with the Corporation, whether pursuant to this Agreement or otherwise, or at the Corporation's earlier request, the Executive shall return to the Corporation all Confidential Materials and all copies thereof in his possession or under his control and shall not retain any copies of Confidential Materials.\n10. NON-COMPETITION\n(a) The Executive agrees that he shall not, so long as he shall be employed by the Corporation in any capacity (whether pursuant to this Agreement or otherwise), without the express written consent of the Corporation, directly or indirectly, own, manage, operate, control or participate in the ownership, management, operation or control or be employed by or connected in any manner with, any business which is or may be in competition, directly or indirectly, with the business of the Corporation or any subsidiary, affiliate or division of the Corporation.\n(b) The Executive agrees that for a period of twelve (12) months, commencing on the effective date of the termination of his employment, whether such termination is pursuant to the terms of this Agreement or otherwise, he shall not, without the express written consent of the Corporation, directly or indirectly, own, manage, operate control or participate in the ownership, management, operation or control, or be employed by or connected in any manner with, any business, firm or corporation which is engaged in any business activity competitive with the business of the Corporation and its subsidiaries, affiliates and divisions as such business is conducted during the period of his employment by the Corporation (whether pursuant to this Agreement or otherwise) and at the termination thereof.\n(c) The Executive agrees that for a period of twelve (12) months, commencing twelve (12) months after the effective date of the termination of his employment, whether such termination is pursuant to the terms of this Agreement or otherwise, he shall not, without the express written consent of the Corporation, directly or indirectly, own, manage, operate, control or participate in the ownership, management, operation or control, or be employed by or connected in any manner with any business, firm or corporation which is listed as a competitor of the Corporation in the Corporation's latest Annual Report on Form 10-K filed with the Securities and Exchange Commission prior to the date of termination of his employment.\n(d) Anything to the contrary herein notwithstanding, the provisions of this section shall not be deemed violated by the purchase and\/or ownership by the Executive of shares of any class of equity securities (or options, warrants or rights to acquire such securities, or any securities convertible into such securities) representing (together with any securities which would be acquired upon the exercise of any such options, warrants or rights or upon the conversion of any other security convertible into such securities) the lesser of (i) 1% or less of the outstanding shares of any such class of equity securities of any issuer whose securities are listed on a national securities exchange or traded on NASDAQ, the National Quotation Bureau Incorporated or any similar organization or (ii) securities having a market value of less than $100,000 at the time of purchase; provided, however, that the Executive shall not be otherwise connected with or active in the business of the issuers described in this subsection 10(d).\n11. REMEDY FOR BREACH\nThe Executive hereby acknowledges that in the event of any breach or threatened breach by him of any of the provisions of sections 7, 8, 9 or 10 of this Agreement, the Corporation would have no adequate remedy at law and could suffer substantial and irreparable damage. Accordingly, the Executive hereby agrees that, in such event, the Corporation shall be entitled, without the necessity of proving damages, and notwithstanding any election by the Corporation to claim damages, to obtain a temporary and\/or permanent injunction to restrain any such breach or threatened breach or to obtain specific performance of any of such provisions, all without prejudice to any and all other remedies which the Corporation may have at law or in equity.\n12. TERMINATION\n(a) This Agreement and the Employment of the Executive by the Corporation shall terminate upon the earliest of the dates specified below:\n(i) the close of business on the date as of which the term of the Executive's Employment hereunder has terminated as provided in section 2 hereof; provided, however, that such term is not extended by any other agreement between the Executive and the Corporation; or\n(ii) the close of business on the date of death of the Executive; or\n(iii) the close of business on the effective date of the voluntary termination by the Executive of his Employment with the Corporation other than for Good Reason as hereafter defined; or\n(iv) the close of business on the effective date of voluntary termination by the Executive of his Employment with the Corporation for Good Reason; or (v) the close of business on the fourteenth (14th) day following the date on which the Corporation provides the Executive with written notice of its intention to terminate the Employment of the Executive for \"cause\" (as defined in subsection 12(b)(1) below), which notice shall set forth the basis for such termination; provided, however, within the first seven (7) days of this period the Chief Executive Officer of the Corporation shall meet with the Executive and discuss in detail the reasons for the Executive's termination and permit the Executive (if possible) to cure the refusal to perform, gross negligence or willful misconduct asserted as the occurrence of such cause or, at the Executive's request, permit him to resign without the Corporation's making any public disclosure of the basis of the Corporation's action (provided, however, that for purposes of this Agreement any such resignation shall still be deemed to be a termination for \"cause\" (as provided herein)), provided, further the Corporation shall not purport to terminate the Executive's Employment for \"cause\" unless there exists clear and convincing evidence of the existence of such \"cause\" pursuant to the criteria set forth in subsection 12(b)(1) below; or\n(vi) the close of business on the thirtieth (30th) day following the date on which the Chief Executive Officer provides the Executive with written notice of his intention to terminate the Employment of the Executive for \"inadequate performance\" (as defined in subsection 12(b)(2) below) which notice shall specify the basis of the Executive's inadequate performance, provided, however, (a) within the first fifteen (15) days of this period, the Chief Executive Officer and the entire Board of Directors shall meet with the Executive and discuss in detail the reasons for the Executive's termination and permit the Executive (if possible) to cure such inadequate performance or, at the Executive's request, permit him to resign without the Corporation's making any public disclosure of the basis of the Corporation's action (provided, however, that for purposes of the Agreement any such resignation shall still be deemed to be a termination for inadequate performance as provided herein) and (b) the Board of Directors shall, by a unanimous vote (not including the Executive if he is then a member of the Board), ratify the decision of the Chief Executive Officer and in addition determine that such termination is being made in good faith and that there is a reasonable basis for the Chief Executive Officer's decision; or\n(vii) the close of business on the last day of the month within which the Board of Directors of the Corporation elects to terminate the Executive's Employment following and as a result of the inability of the Executive, by reason of physical or mental disability, for six (6) months within any twelve (12) month period during the term of this Agreement, to render services of the character contemplated by this Agreement.\n(b)(1) For purposes of this Agreement, the term \"cause\" shall mean a reasonable determination made in good faith by vote of a majority of the members of the Board of Directors of the Corporation then holding office (other than the Executive if he shall then be a director) that one of the following conditions exists or one of the following events has occurred;\n(i) conviction of the Executive for a felony offense; or\n(ii) the refusal by the Executive to perform such service as may reasonably be delegated or assigned to him, consistent with his position, by the Chief Executive Officer of the Corporation; willful misconduct or gross negligence on his part in connection with the performance of such duties.\n(2) For purposes of this Agreement, the term inadequate performance shall mean a determination by the Chief Executive Officer, made in good faith, that the Executive's performance has not met the reasonable expectations of the Chief Executive Officer and the Board of Directors and that his continued Employment is not in the best interests of the Corporation.\n(3) For purposes of this Agreement, the Executive shall have \"Good Reason\" to terminate his Employment if any duties are assigned to the Executive that are inconsistent with his position, duties and responsibilities as President of the Corporation or his duties as set forth in section 3 hereof are materially changed without his written consent or he is not elected or reelected to the Board of Directors, provided, however, that he shall give the Corporation written notice of his intention to so terminate his Employment and the reasons therefore and the Executive and the Chief Executive Officer shall meet to discuss the reasons for the Executive's termination within fifteen (15) days of the notice and permit the Corporation (if possible) to remedy the situation. (c)(1) In the event of the termination of the Executive's Employment for cause pursuant to subsection 12(a)(v) or voluntarily by the Executive pursuant to subsection 12(a)(iii), then the sole compensation required to be paid by the Corporation to the Executive shall consist of his accrued but as then unpaid base salary. In addition, he shall be eligible to exercise any then vested options held by him up to and including the date of the termination of his Employment.\n(2) In the event of the termination of the Executive's Employment pursuant to subsection 12(a)(i) (due to a failure to extend the terms of the Executive's Employment), 12(a)(ii) (due to the death of the Executive) or 12(a)(vii) (due to the disability of the Executive), then the Executive shall be paid at the time of such termination an amount equal to the bonus (twice the bonus if the termination occurs prior to December 31, 1995) (as provided in subsection 4(b)) earned by him during the last completed fiscal year immediately preceding any such termination and shall continue to pay him for the next twelve (12) months, his then annual base salary. The Corporation shall also, to the extent that the Executive's continued participation is possible under the general terms and provisions of such plans and programs continue to provide the Executive, at the Corporation's sole expense, for one year after termination of his Employment, with all of the employee fringe benefits referred to in subsection 4(d) that he was entitled to receive immediately prior to the termination of his Employment including but not limited to life, health and disability insurance as well as the use of the automobile referred to in section 5, provided, however, he will not be credited for this period with an additional year of service under the Executive Retirement Plan referred to in subsection 4(c). The Executive shall not be required to mitigate any of the payments provided in this subsection 12(c)(2). In addition, in the event of the Executive's death or disability, the Executive shall be eligible to exercise any then vested options held by him in accordance with the Corporation's stock option plan. In the event the term of the Executive's Employment is not extended after the expiration of the initial term provided in section 2, then all outstanding options awarded to the Executive shall immediately vest regardless of any condition precedent to the vesting of such options (such as the passage of time) and the Executive shall be eligible to exercise such options up to and including the date of the termination of his Employment.\n(3)(i) In the event of the termination of the Executive's Employment for \"inadequate performance\" pursuant to subsection 12(a)(vi), then the Executive shall be paid at the time of such termination an amount equal to the bonus (twice the bonus if the termination occurs prior to December 31, 1995) (as provided in subsection 4(b)) earned by him during the last completed fiscal year immediately preceding any such termination and shall continue to pay him for the next twenty-four (24) months, his then annual base salary. The Executive shall also be paid a second bonus, in the amount he would have received had his Employment continued for an additional year and which he would have then earned pursuant to subsection 4(b) The Corporation shall also, to the extent that the Executive's continued participation is possible under the general terms and provisions of such plans and programs, continue to provide the Executive, at the Corporation's sole expense, for two years after the termination of his Employment, with all of the employee fringe benefits referred to in subsection 4(d) that he was entitled to receive immediately prior to the termination of his Employment including but not limited to life, health, and disability insurance as well as the use of the automobile referred to in section 5, provided, however, he will not be credited for this period with an additional year of service under the Executive Retirement Plan referred to in subsection 4(c). The Executive shall be required to mitigate the second bonus payment as well as any compensation which is payable to him in the second twelve (12) month period by seeking other comparable employment.\n(ii) In the event of the termination of the Executive's Employment after July 1, 1995 but prior to June 30, 1996 by the Corporation for inadequate performance, 50,000 of the options awarded to the Executive pursuant to subsection 6(b)(1) hereof shall vest seven (7) days prior to the date of the termination of his Employment. During such period, all other options which have not vested as of the date of the termination of his Employment shall be cancelled and shall be null and void. In the event of termination by the Corporation for inadequate performance subsequent to June 30, 1996, the Executive shall be eligible to exercise any of the vested options held by him up to and including the date of termination of his Employment.\n(iii) In the event of the termination of the Executive's Employment after July 1, 1995 but prior to June 30, 1996 by the Corporation for inadequate performance, and only to the extent that the Executive exercises any of the options referred to in subsection 12(c)(3)(ii), the Executive shall repay to the Corporation all or a portion of $111,750 equal to the number of options exercised multiplied by the amount by which the closing price of the Corporation's Common Stock on the date he exercises such options exceeds the exercise price thereof. The Executive may retain any and all profits derived from such options in excess of $111,750.\n(4)(i) In the event of the termination of the Executive's Employment voluntarily for Good Reason pursuant to subsection 12(a)(iv) or by the Corporation in breach of its obligations hereunder (it being understood that a purported termination pursuant to subsection 12(a)(v) or (vi) hereof which is disputed and finally determined not to have been proper shall be a termination by the Corporation in breach of its obligations hereunder) then the Executive shall be paid at the time of such termination an amount equal to the bonus (twice the bonus if the termination occurs prior to December 31, 1995) (as provided in subsection 4(b)) earned by him during the last completed fiscal year immediately preceding any such termination and shall continue to pay him for the next twelve (12) months, his then annual salary. The Executive shall not be required to mitigate these payments by seeking other comparable employment.\n(ii) in lieu of any further salary and bonus compensation payments to the Executive for periods subsequent to the first year following termination of his Employment, the Corporation shall pay as liquidated damages to the Executive his annual base salary, payable at such times as the Corporation customarily pays the salaries of its executive officers for the remainder of the term of Employment originally provided hereby, plus amounts equal to the bonus paid or payable each year for the remainder (except to the extent such bonus shall have been paid as provided in subsection 4(i) above) of the original term of the Employment hereunder at the times set forth in subsection 4(b) hereof; and\n(iii) the Corporation shall also pay all other damages to which the Executive may be entitled to, including damages for any and all loss of employee fringe benefits to the Executive under the Corporation's employee benefit plans which the Executive would have received had the Executive's Employment continued for the full term provided in section 2 hereof (including specifically, but without limitation, the benefits which the Executive would have been entitled to receive pursuant to any of the Corporation's pension plans including, but not limited to, the Executive Retirement Plan had his Employment continued for the full term provided in section 2 hereof at the rate of compensation specified herein), and including all reasonable legal fees and expenses incurred by him as a result of such termination and in enforcing his rights hereunder; the parties hereby agreeing that in lieu of paying damages for the loss of employee fringe benefits the Corporation may continue to provide such benefits or their equivalent for the remainder of the term hereof; and\n(iv) the Executive shall be required to mitigate the amount of any payment or other benefit provided in subsection 12(c)(4)(ii) and (iii) by seeking other comparable employment except for the benefits under the Executive Retirement Plan if the Executive's Employment is terminated after January 1, 1997; and\n(v) in the event of the termination of the Executive's Employment voluntarily for Good Reason pursuant to subsection 12(a)(iv) or by the Corporation in breach of its obligations hereunder then all outstanding options awarded to the Executive shall immediately vest regardless of any conditions precedent to the vesting of such options (such as the passage of time) and the Executive shall be eligible to exercise any vested options held by him for the longer of one year from such termination or through the end of the initial term provided in section 2.\n13. NO CONFLICTING AGREEMENTS\nIn order to induce the Corporation to enter into this Agreement and to employ the Executive on the terms and conditions set forth herein, the Executive hereby represents and warrants that he is not a party to or bound by any agreement, arrangement or understanding, written or otherwise, which prohibits or in any manner restricts his ability to enter into and fulfill his obligations under this Agreement, to be employed by and serve as an executive of the Corporation.\n14. MISCELLANEOUS\n(a) This Agreement shall become effective as of the date hereof and, from and after that time, shall extend to and be binding upon the Executive, his personal representative or representatives and testate or intestate distributees, and upon the Corporation, its successors and assigns; and the term Corporation, as used herein, shall include successors and assigns.\n(b) Nothing contained in this Agreement shall be deemed to involve the creation by the Corporation of a trust for the benefit of, or the establishment by the Corporation of any other form of fiduciary relationship with the Executive, his beneficiaries or any of their respective legal representatives or distributees. To the extent that any person shall acquire the right to receive any payments from the Corporation hereunder, such right shall be no greater than the right of any unsecured general creditor of the Corporation.\n(c) Any notice required or permitted by this Agreement shall be given by registered or certified mail, return receipt requested, addressed to the Corporation at its then principal office or to the Executive at his residence address, or to either party at such other address or addresses as it or he may from time to time specify for the purpose in a notice similarly given to the other party.\n(d) This Agreement shall be construed and enforced in accordance with the laws of the State of New York. Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by binding arbitration in Suffolk County of the State of New York and shall proceed under the rules then prevailing of the American Arbitration Association (AAA). The dispute shall be referred to a single arbitrator if such arbitration is mutually agreeable to the parties within twenty (20) days of the demand for arbitration, otherwise to a single arbitrator appointed by the AAA upon application by either party. Any award determined by an arbitrator must be in accordance with the terms of this Agreement and shall be final and binding upon the parties. Judgment upon any award made in such arbitration may be entered and enforced in any court of competent jurisdiction. The Corporation and the Executive waive any right of appeal with respect to any judgment entered on an arbitrator's award in any court having jurisdiction. In the event that it is necessary for any party hereto incur legal expenses in defending its or his rights hereunder, the losing party shall reimburse the winning party for all reasonable legal fees and expenses incurred by him or it as a result thereof.\n(e) Except as stated otherwise herein, this instrument contains the entire agreement of the parties relating to the subject matter hereof, and there are no agreements, representations or warranties not herein set forth. No modification of this Agreement shall be valid unless in writing and signed by the Corporation and the Executive. A waiver of the breach of any term or condition of this Agreement shall not be deemed to constitute a waiver of any subsequent breach of the same or any other term or condition.\n(f) If any provision of this Agreement shall be held invalid, such invalidity shall not affect any other provisions of this Agreement not held so invalid, and all other such provisions shall remain in full force and effect to the full extent consistent with the law.\nIN WITNESS WHEREOF, the parties hereto have duly executed and delivered this Agreement as of the day and year first above written.\nSYMBOL TECHNOLOGIES, INC.\nBy: s\/Jerome Swartz EXECUTIVE ATTEST:\ns\/Leonard H. Goldner s\/Jan Lindelow JAN LINDELOW\nEXHIBIT 10.8\nEMPLOYMENT AGREEMENT\nEMPLOYMENT AGREEMENT (the \"Agreement\") made as of the 12th day of June, 1994 by and between SYMBOL TECHNOLOGIES, INC., a Delaware corporation (the \"Corporation\"), and RAYMOND R. MARTINO (the \"Executive\").\nW I T N E S S E T H:\nWHEREAS, the Executive and the Corporation are parties to an Employment Agreement, dated as of July 1, 1990, (the \"Prior Employment Agreement\"), setting forth the terms and conditions of the Executive's employment by the Corporation; and\nWHEREAS, the Executive has expressed a desire to retire and end his Prior Employment Agreement; and\nWHEREAS, the Corporation desires to continue to employ the Executive until such time as it hires an individual to replace the Executive, and to have the Executive assist the Corporation and his replacement until such replacement completes his\/her transition period and becomes acclimated to the Corporation and, further, desires to continue to employ the Executive thereafter; and\nWHEREAS, the Executive desires to continue to be employed by the Corporation in the manner and on the terms and conditions hereinafter set forth.\nNOW, THEREFORE, in consideration of the premises and of the mutual and dependent agreements and covenants herein set forth, the parties hereto agree as follows: 1. Prior Employment Agreement The Executive and the Corporation agree that the Prior Employment Agreement will terminate upon the execution of this Agreement. 2. Employment The Corporation hereby agrees to employ the Executive as its President and Chief Operating Officer, and the Executive hereby agrees to render services to the Corporation and its subsidiaries, divisions and affiliates for the period and on the terms and conditions set forth in this Agreement. However, after the Corporation hires a new President and Chief Operating Officer, the Executive shall assume a new position in an executive capacity, with his job title to be agreed upon by the Executive and Chairman of the Board. For the balance of the contractual term, the Executive shall render such services as may be required of the Executive by the Chairman of the Board from time to time as set forth in Section 4 of this Agreement. 3. Term The Executive's employment under this Agreement shall be as follows: from the date of the execution of this Agreement through and including December 31, 1994, the Executive shall remain as a full-time employee of the Corporation. However, following the commencement of employment by the Executive's replacement, the Executive shall begin the transition to part-time employee status, as soon thereafter as practicable. The Corporation anticipates this transition being completed by September 30, 1994, but in no event later than December 31, 1994. Thereafter (i.e., commencing January 1, 1995), the Executive shall remain as a part-time employee for a five year term, unless this Agreement is terminated earlier pursuant to the provisions of Section 13 hereof. The Executive shall be compensated for his services as a part-time employee pursuant to Section 5 of this Agreement. 4. Duties a. So long as the Executive's employment under this Agreement shall continue on a full-time basis, pursuant to Section three (3) above, the Executive shall, subject to periods of illness, vacation and other excused absences, devote his entire business time, attention, and energies to the affairs of the Corporation and its subsidiaries, divisions and affiliates, use his best efforts to promote its and their best interests and perform such executive duties as may be assigned to him by the Chief Executive Officer of the Corporation; provided, however, that such executive duties shall be consistent with and shall generally be of the nature of the services ordinarily and customarily performed by the Executive prior to the date hereof. (1) In accordance with the provisions of Section three (3) of this Agreement, when the Executive assumes his new position, the Executive shall be responsible for performing those executive-level duties and responsibilities that may be assigned to him from time to time. Such duties shall include, but not be limited to, serving as advisor to the Chairman; assisting in key sales, marketing activities, strategic alliances and licensing arrangements; consultation with respect to patent strategy, etc. b. So long as the Executive's employment under this Agreement shall continue pursuant to Section 3 above, the Executive shall, if elected or appointed, serve as an executive officer and\/or director of the Corporation and of any subsidiary, division or affiliate of the Corporation and shall hold, without any compensation other than that provided for in this Agreement, the executive offices in the Corporation and in any such subsidiary, division or affiliate to which he may, at any time or from time to time, be elected or appointed. If the Executive is elected or appointed to serve on the Corporation's Board of Directors during the term hereof, the Executive shall not be entitled to receive any fees (other than reimbursement of covered expenses) that are provided by the Corporation to its outside Directors, as it is contemplated that the compensation provided to Executive, pursuant to Section 5 hereof, is designed to compensate Executive for all services he may render to the Corporation. 5. Compensation a.(i) The Corporation hereby agrees to pay to the Executive, and the Executive hereby agrees to accept, as compensation for services rendered under this Agreement, a base salary at the rate of four hundred thirty-seven thousand five hundred dollars ($437,500) per annum for the period from January 1, 1994 through and including December 31, 1994, payable at such intervals as the Corporation customarily pays the salaries of its executive officers. (ii) During the period commencing January 1, 1995 through December 31, 1999, the Executive shall be paid a salary of $150,000 per annum, for all services rendered by him to the Corporation. Such salary shall be payable at such intervals as the Corporation pays the salaries of its executive officers. b. In addition to the base salary provided for in subsection 5(a)(i) above, the Executive shall participate in the Corporation's profit sharing plan and thereby be entitled to receive an annual bonus for fiscal year 1994. The Executive's annual target bonus amount for the fiscal year ending December 31, 1994 shall be 100% of Executive's base salary. Payment of the bonus provided herein shall be paid to the Executive no later than 90 days after the completion of the fiscal year. The Executive shall not participate in this Plan after December 31, 1994. c. Through December 31, 1994, the Executive shall continue to participate in the Corporation's Executive Retirement Plan. Thereafter, he will not be eligible to participate in the Plan. The Corporation also agrees to provide the Executive with a discounted lump sum equal to his retirement benefit payable under this Plan no later than April 1, 1995. d. In addition to the foregoing, it is hereby agreed that the Corporation shall, at its sole expense, provide and the Executive shall be entitled to receive, during calendar year 1994, the employee fringe benefits provided by the Corporation, from time to time, to its executive officers, but in no event less favorable to the Executive than benefits provided to him by the Corporation as of the date of this Agreement, including, but not limited to, benefits relating to life, medical and disability insurance, vaca- tion time, and participation in the Corporation's existing Section 401(k) Plan; provided, however, that as used in this Agreement, the term \"employee fringe benefits\" shall not include any salary or other bonus plan, except as set forth in this Agreement. e. In addition to the foregoing, it is hereby agreed that commencing January 1, 1995 and continuing for the balance of this Agreement the Corporation shall provide and Executive shall be entitled to receive employee fringe benefits provided by the Corporation, from time to time to its executive officers, at its sole expense, but in no event less favorable to the Executive than the benefits provided to him by the Corporation as of the date of this Agreement relating to life and disability insurance. In addition, the Executive shall be eligible to participate in the Corporation's group health insurance plan and 401(k) plan; provided, however, that in the event the Executive is not entitled to remain a member of the Corporation's group health insurance plan, then commencing on the date the Executive is no longer entitled to remain a member and continuing for eighteen (18) months thereafter, the Corporation shall pay the Executive's group health insurance premiums to enable the Executive to remain a member of the Corporation's group health insurance plan. This period shall constitute the Executive's COBRA continuation period as required by applicable federal law. 6. Automobile During the term of this Agreement, the Corporation shall make available to the Executive the use of an automobile, with a lease allotment of up to $1,250 per month as well as in 1994, gasoline, maintenance and insurance expenses associated with such automobile. 7. Expenses; Options a. The Corporation shall pay or reimburse the Executive for all reasonable travel and other expenses incurred or paid by him in connection with the performance of his employment duties under this Agreement, upon presentation to the Corporation of expense statements or vouchers and such other supporting documentation as it may, from time to time, reasonably require; provided however that the maximum amount available for such expenses may, at any time or from time to time, be fixed in advance by the Board of Directors of the Corporation. b. All outstanding options to purchase shares of Common Stock of the Corporation now held by the Executive or hereafter awarded to the Executive during the term of this Agreement shall vest regardless of any conditions precedent to the vesting of such options (such as the passage of time) if and when there is a \"change in control of the Corporation\" as hereafter defined. As used in this Agreement, a \"change in control of the Corporation\" shall mean a change in control of a nature that would be required to be reported in response to Item 1 of Form 8-K promulgated under the Securities Exchange Act of 1934, as amended, (the \"Exchange Act\"); provided, that, without limitation, such a change in control shall be deemed to have occurred if (i) any \"person\" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), other than the Corporation or any \"person\" who on the date hereof is a director or officer of the Company, is or becomes the \"beneficial owner\", (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing 25% or more of the combined voting power of the Company's then outstanding securities and the Corporation's Board of Directors, after having been advised that such ownership level has been reached, does not, within fifteen (15) business days, adopt a resolution approving the acquisition of that level of securities ownership by such person; or (ii) during any period of two consecutive years during the term of this Agreement, individuals who at the beginning of such period constitute the Board of Directors cease for any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two-thirds of the directors then in office who were directors at the beginning of the period. c. Notwithstanding the then-current state of the Corporation's By-Laws, the Executive shall be entitled at all times to the benefit of the maximum indemnification and advancement of expenses available from time to time under the laws of the State of Delaware. d. The Corporation and\/or any of its subsidiaries, divisions or affiliates may, from time to time, apply for and obtain, for its or their benefit and at its or their sole expense, key man life, health, accident, disability, or other insurance upon the Executive, in any amounts that it or they may deem necessary or desirable to protect its or their respective interests, and the Executive agrees to cooperate with and assist the Corporation or such subsidiary, division or affiliate in obtaining any and all such insurance by submitting to all reasonable medical examina- tions, if any, and by filling out, executing, and delivering any and all such applications and other instrument as may reasonably be necessary. e. Any time after July 1, 1994, but prior to December 31, 1994, the Corporation agrees to purchase the Executive's primary residence located in St. James, New York, at the residence's then fair market value (FMV). This home-sale purchase provision will occur during this period at any time at the Executive's request. The FMV shall be determined in accordance with the appraisal formula: the Corporation shall arrange to have the Executive's home appraised by two professional real estate appraisers. The Corporation shall then average the two appraisals to arrive at the home-sale purchase price. If the two appraisals differ by more than five percent, the Corporation shall order a third appraisal, and the purchase price shall then become the average of the closest two of the three appraisals. The FMV purchase price shall be paid to the Executive within thirty (30) days of the completion of the appraisal process. 8. Inventions a. The Executive agrees to and hereby does assign to the Corporation or any subsidiary, affiliate or division of the corporation designated by the Corporation, all his right, title and interest throughout the world in and to all ideas, methods, developments, products, inventions, processes, improvements, modifications, techniques, designs and\/or concepts relating directly or indirectly to the business of the Corporation, its subsidiaries, affiliates or divisions, whether patentable or unpatentable, which the Executive may conceive and\/or develop during his employment by the Corporation (whether pursuant to this Agreement or otherwise) or which the Executive may conceive and\/or develop during a period of thirty (30) months following the termination of his employment (whether pursuant to this Agreement or otherwise) if such conception and\/or development during such thirty (30) month period is a direct result of the Executive's activities while employed by the Corporation, whether or not conceived and\/or developed at the request of the Corporation or any subsidiary, affiliate or division (the \"Inventions\"); provided, however, that if the Corporation or such subsidiary, affiliate or division determine that it will not use any such Invention or that it will license or transfer any such Invention to an unaffiliated third party, then it will negotiate in good faith with the Executive, if the Executive so requests, with respect to a transfer or license of such Invention to the Executive. b. The Executive further agrees to promptly communicate and disclose to the Corporation any and all such Inventions as well as any other knowledge or information which he may possess or obtain relating to any such Inventions. c. In furtherance of the foregoing, the Executive agrees that at the request of the Corporation, and at its expense, he will make or cooperate in the making of applications for letters patent of the United States or elsewhere and will execute such other agreements, documents or instruments which the Corporation may reasonably consider necessary to transfer to and vest in the Corporation or any subsidiary, affiliate or division, all right, title and interest in any such Inventions, and all applications for any letters patent issued in respect of any of the foregoing. d. The Executive shall assist, upon request, in locating writings and other physical evidence of the making of the Inventions and provide unrecorded information relating to them and give testimony in any proceeding in which any of the Inventions or any application or patent directed thereto may be involved, provided that reasonable compensation shall be paid the Executive for such services and the Executive shall be reimbursed for any expenses incurred by him in connection therewith, except that during such period of time as the Executive is employed by the Corporation, the Corporation shall not be obligated to compensate the Executive at a higher rate for the giving of testimony than the rate established by law for the compensation of witnesses in the court or tribunal where the testimony is given or in the district where the testimony is taken. The Corporation shall give the Executive reasonable notice should it require such services, and, to the extent reasonably feasible, the Corporation shall use its best efforts to request such assistance at times and places as will least interfere with any other employment of the Executive. e. At the expense of the Corporation, the Executive shall assign to the Corporation all his interest in copyrightable material which he produces, composes, or write, individually or in collaboration with others, which arises out of work performed by him on behalf of the Corporation, and shall sign all papers and do all other acts necessary to assist the Corporation to obtain copyrights on such material in any and all jurisdictions. 9. Confidential Information The Executive hereby acknowledges that, in the course of his employment by the corporation he has had and will have access to secret and confidential information which relates to or affects all aspects of the business and affairs of the Corporation and its subsidiaries, affiliates and divisions, and which are not available to the general public (\"Confidential Information\"). Without limiting the generality of the foregoing, Confidential Information shall include information relating to inventions (including, without limitation, Inventions), developments, specifications, technical and engineering data, information concerning the filing or pendency of patent applications, business ideas, trade secrets, products under development, production methods and processes, sources of supply, marketing plans, and the names of customers or prospective customers or of persons who have or shall have traded or dealt with the Corporation. Accordingly, the Executive agrees that he will not, at any time, without the express written consent of the Corporation, directly or indirectly, disclose or furnish, or negligently permit to be disclosed or furnished, any Confidential Information to any person, firm, corporation or other entity except in performance of his duties hereunder. 10. Confidential Materials The Executive hereby acknowledges and agrees that any and all models, prototypes, notes, memoranda, notebooks, drawings, records, plans, documents or other material in physical form which contain or embody Confidential Information and\/or information relating to Inventions and\/or information relating to the business and affairs of the Corporation, its subsidiaries, affiliates and divisions and\/or the substance thereof, whether created or prepared by the Executive or by others (Confidential Materials), which are in the Executive's possession or under his control, are the sole property of the Corporation. Accordingly, the Executive hereby agrees that, upon the termination of his employment with the Corporation, whether pursuant to this Agreement or otherwise, or at the Corporation's earlier request, the Executive shall return to the Corporation all Confidential Materials and all copies thereof in his possession or under his control and shall not retain any copies of Confidential Materials. 11. Non-competition a. The Executive agrees that he shall not, so long as he shall be employed by the Corporation in any capacity (whether pursuant to this Agreement or otherwise), without the express written consent of the Corporation, directly or indirectly, own, manage, operate, control or participate in the ownership, management, operation or control or be employed by or connected in any manner including as a consultant, with any business which is or may be in competition, directly or indirectly, with the business of the Corporation or any subsidiary, affiliate or division of the Corporation. b. The Executive agrees that for a period of thirty (30) months, commencing on the effective date of the termination of his employment, whether such termination is pursuant to the terms of this Agreement or otherwise, he shall not, without the express written consent of the Corporation, directly or indirectly, own, manage, operate, control, or participate in the ownership, management, operation or control, or be employed by or connected in any manner including as a consultant, with any business, firm or corporation which is engaged in any business activity competitive with the business of the Corporation and its subsidiaries, affiliates and divisions as such business is conducted during the period of his employment by the Corporation (whether pursuant to this Agreement or otherwise and at the termination thereof). c. Anything to the contrary herein notwithstanding, the provisions of this section shall not be deemed violated by the purchase and\/or ownership by the Executive of shares of any class of equity securities (or options, warrants or rights to acquire such securities, or any securities convertible into such securities) representing (together with any securities which would be acquired upon the exercise of any such options, warrants or rights or upon the conversion of any other security convertible into such securities) 2% or less of the outstanding shares of any such class of equity securities of any issuer whose securities are listed on a national securities exchange or traded on NASDAQ, the National Quotation Bureau Incorporated or any similar organization; provided, however, that the Executive shall not be otherwise connected with or active in the business of the issuers described in this subsection 11(c). 12. Remedy for Breach The Executive hereby acknowledges that in the event of any breach or threatened breach by him of any of the provisions of sections 8, 9, 10 or 11 of this Agreement, the Corporation would have no adequate remedy at law and could suffer substantial and irreparable damage. Accordingly, the executive hereby agrees that, in such event, the Corporation shall be entitled, without the necessity of proving damages, and notwithstanding any election by the Corporation to claim damages, to obtain a temporary and\/or permanent injunction to restrain any such breach or threatened breach or to obtain specific performance of any of such provisions, all without prejudice to any and all other remedies which the Corporation may have at law or in equity. 13. Termination a. This Agreement and the employment of the Executive by the Corporation shall terminate upon the earliest of the dates specified below: (1) the close of business on the date as of which the term of the Executive's employment hereunder has terminated as provided in section 3 hereof; provided, however, that such term is not extended by any other agreement between the Executive and the Corporation; or (2) the close of business on the date of death of the Executive; or (3) the close of business on the effective date of the voluntary termination by the Executive of his employment with the Corporation; or (4) the close of business on the day following the date on which the Corporation shall have given to the Executive written notice of the election of its Board of Directors to terminate his employment for \"cause\" (as defined in subsection (b) of this section 13). b. For purposes of this Agreement, the term \"cause\" shall mean a determination by vote of a majority of the members of the Board of Directors of the Corporation then holding office (other than the Executive if he shall then be a director) that one of the following conditions exists or one of the following events has occurred; (1) conviction of the Executive for a felony offense; or (2) the refusal by the Executive to perform such service as may reasonably be delegated or assigned to him, consistent with his position, by the Chief Executive Officer of the Corporation; continued neglect by the Executive of his duties hereunder; or willful misconduct or gross negligence on his part in connection with the performance of such duties. 14. No Conflicting Agreements In order to induce the Corporation to enter into this Agreement and to employ the Executive on the terms and conditions set forth herein, the Executive hereby represents and warrants that he is not a party to or bound by any agreement, arrangement or understanding, written or otherwise, which prohibits or in any manner restricts his ability to enter into and fulfill his obligations under this Agreement, to be employed by and serve as an executive of the Corporation. This Agreement supersedes the Prior Employment Agreement in all respects. 15. Miscellaneous a. This Agreement shall become effective as of the date hereof and, from and after that time, shall extend to and be binding upon the Executive, his personal representative or representatives and testate or intestate distributees, and upon the Corporation, its successors and assigns; and the term \"Corporation\", as used herein, shall include successors and assigns. b. Nothing contained in this Agreement shall be deemed to involve the creation by the Corporation of a trust for the benefit of, or the establishment by the Corporation of any other form of fiduciary relationship with the Executive, his beneficiaries or any of their respective legal representatives or distributees. To the extent that any person shall acquire the right to receive any payments from the Corporation hereunder, such right shall be no greater than the right of any unsecured general creditor of the Corporation. c. Any notice required or permitted by this Agreement shall be given by registered or certified mail, return receipt requested, addressed to the Corporation at its then principal office or to the Executive at his residence address, or to either party at such other address or addresses as it or he may from time to time specify for the purpose in a notice similarly given to the other party. d. This Agreement shall be construed and enforced in accordance with the laws of the State of New York. In this connection, Executive hereby consents to the jurisdiction of the courts of the State of New York to resolve any disputes arising out of the interpretation or administration of this Agreement. e. This instrument contains the entire agreement of the parties relating to the subject matter hereof, and there are no agreements, representations or warranties not herein set forth. No modification of this Agreement shall be valid unless in writing and signed by the Corporation and the Executive. A waiver of the breach of any term or condition of this Agreement shall not be deemed to constitute a waiver or any subsequent breach of the same or any other term or condition. f. If any provision of this Agreement shall be held invalid, such invalidity shall not affect any other provisions of this Agreement not held so invalid, and all other such provisions shall remain in full force and effect to the full extent consistent with the law. IN WITNESS WHEREOF, the parties hereto have duly executed and delivered this Agreement as of the day and year first above written. SYMBOL TECHNOLOGIES, INC.\nBy: s\/Raymond R. Martino\nBy: s\/Jerome Swartz\nEXHIBIT 21.\nSYMBOL TECHNOLOGIES, INC.\n100% Owned by Symbol Technologies, Inc.\nSymbol Technologies International, Inc. 116 Wilbur Place Bohemia, NY 11716 State of Incorporation: Delaware\nSymboLease, Inc. 116 Wilbur Place Bohemia, NY 11716 State of Incorporation: Delaware\nSymboLease Canada, Inc. 2540 Matheson Boulevard East Mississauga, Ontario, Canada L4W 4Z2 State of Incorporation: Delaware\nTrue Data Corporation 116 Wilbur Place Bohemia, NY 11716 State of Incorporation: Delaware\nSymbol Technologies Texas, Inc. 116 Wilbur Place Bohemia, NY 11716 State of Incorporation: Texas\nSymbol Technologies Asia, Inc. 116 Wilbur Place Bohemia, NY 11716 State of Incorporation: Delaware\nSymbol Technologies International, Inc. 116 Wilbur Place Bohemia, NY 11716 State of Incorporation: New York\n100% Owned Subsidiaries of Symbol Technologies International, Inc. (Delaware)\nSymbol Australia Pty. Ltd. 432 St. Kilda Road Melbourne, Victoria 3004 Australia Country of Incorporation: Australia\nSymbol Technologies GmbH 2 Haus - 5 Stock Prinz-Eugenstrasse 70 1040 Wein Austria Country of Incorporation: Austria\nSymbol Technologies Canada, Inc. 2540 Matheson Blvd. East Mississauga, Ontario, Canada L4W 4Z2 Country of Incorporation: Canada\nSymbol Technologies S.A. Centre d'Affaire d'Anthony 3 Rue du la Renaissance 92184 Antony Cedex, France Country of Incorporation: France\nSymbol Technologies GmbH Waldstrasse 68 6057 Dietzenbach Germany Country of Incorporation: Germany\nSymbol Technologies, S.R.L. Via Cristoforo Colombo, 49 20090 Trezzano S\/L Naviglio, Milan, Italia Country of Incorporation: Italy\nSymbol Technologies, S.A.* Calle Princesa 32 Edificion Piovera Azul 28042 Madrid Spain Country of Incorporation: Spain\nSymbol Technologies Limited 12 Oaklands Park Fishponds Road Wokingham Berkshire, England RG11 2FD Country of Incorporation: United Kingdom\n* Majority owned by Symbol Technologies International, Inc.\nEXHIBIT 23\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Registration Statements No. 2-81405, No. 2-94868, No. 2-94876, No. 33-3771, No. 33-13009, No. 33-18748, No. 33-25509, No. 33-25484, No. 33- 25567, No. 33-25510, No. 33-35821, No. 33-43580, No. 33-48025, No. 35-48026, No. 33-78622 and No. 33-78678 on Form S-8 and No. 33-18745, No. 33-25432, No. 33-43581, No. 33-43584 and No. 33- 45016 on Form S-3 of Symbol Technologies, Inc. of our report dated February 9, 1995, appering in this Annual Report on Form 10-K of Symbol Technologies, Inc. for the year ended December 31, 1994.\ns\/Deloitte & Touche LLP Jericho, New York March 6, 1995","section_15":""}
{"filename":"716823_1994.txt","cik":"716823","year":"1994","section_1":"ITEM 1. BUSINESS Cincinnati Milacron Inc. was incorporated in Delaware in 1983 as the successor to a business established in 1884. Its principal executive offices are located in Cincinnati, Ohio. Except where the context otherwise requires, the terms \"company\" and \"Cincinnati Milacron\" herein mean Cincinnati Milacron Inc. and its consolidated subsidiaries.\nCincinnati Milacron is one of the world's leading manufacturers of plastics machinery, machine tools and industrial products for metalworking, as well as related computer controls and software for factory automation.\nThe company sells products and provides services to industrial customers throughout the world. The company has a long-standing reputation for quality and technological leadership. Virtually all of its plastics machinery products and machine tools are computer-controlled and many include advanced applications software.\nIn recent years, the company has undertaken a major program, called \"Wolfpack\", for product development, process improvement and modernization. The objectives of Wolfpack are to design and produce new products at world-competitive levels of quality, performance, efficiency and cost. The key principles of the Wolfpack philosophy are teamwork, a \"market-driven\" approach, \"simultaneous engineering\", reduction and standardization of parts, design for manufacturability and integrated, just-in-time manufacturing. Wolfpack teams develop marketable products faster than conventional teams with improved quality, features and cost and quality performance ratios. Compared to the products they replace, Wolfpack-products typically have achieved a 30 to 50 percent reduction in each of the following areas: product development cycles, number of total parts, manufacturing lead time, installation time and overall cost. In 1993, Wolfpack designed products accounted for substantially all of the company's plastics machinery sales and approximately one-half of the company's machinery portion of its machine tool segment sales.\nEarly in 1993, the company acquired GTE Valenite Corporation (\"Valenite\"), which the company believes is the second largest U.S. and third largest worldwide producer of metalcutting systems. The acquisition of Valenite was part of the company's strategic objective to expand its industrial products segment and thereby balance revenues among its three business segments of plastics machinery, machine tools and industrial products. Later in 1993, the company acquired Ferromatik, a German manufacturer of plastic injection molding machines. The company expects the acquisition to expand its plastics processing technology and product line offering and help the company achieve its objective of establishing a plastics machinery manufacturing and distribution base in Germany to serve Europe and other markets. With this acquisition, plastics machinery is now the company's largest segment.\nOn February 10, 1994, the company announced a major consolidation of its U.S. machine tool operations to Cincinnati and recorded in the fourth quarter of 1993 a $47.1 million nonrecurring charge to cover the costs of the plan. Production at the company's two machine tool facilities in South Carolina will be phased out and the plants closed by year end 1994. The company will transfer most of the modern machines and systems in South Carolina now used to manufacture horizontal machining centers and turning centers to its Cincinnati facilities. The incremental cash required in 1994, before considering any proceeds from the disposition of assets, will be approximately $18 million. The consolidation, once fully implemented, is expected to result in annual cost savings of approximately $16 million. The consolidation addresses excess manufacturing capacity created by two factors: the company's successful Wolfpack program, which has significantly reduced the hours and floorspace required to manufacture and assemble machine tool products; and the unusually steep recession in the aerospace industry, which has dramatically lowered demand for the company's advanced machine tool systems.\nOn February 4, 1994, the company sold its Sano blown and cast film systems business which incurred an operating loss of approximately $26.3 million in 1993, which included charges totaling $22.8 million for the disposition of this subsidiary.\nSTRATEGY AND PRODUCT DEVELOPMENT\nThe company's objectives are: to develop and produce machines and systems for world markets that incorporate leading-edge technology and offer its customers competitive advantages; to increase its manufacturing efficiencies to meet international competition; and to improve its responsiveness to changing world markets by decentralizing responsibility for manufacturing, marketing and product development.\nIn 1993, the company made progress in the achievement of its overall objectives. The company's strategic acquisitions of Valenite and Ferromatik enhanced its technological base, diversified its product line and expanded its worldwide sales and distribution network. In addition, by balancing revenues among its three business segments, the company believes that it is in a better position to take advantage of opportunities in each market even while demand in a single segment may be weak.\nIn recent years, the company also has undertaken a major program for product development, process improvement and modernization. This program is named \"Wolfpack\" because of its emphasis on teamwork and fierce competitiveness. The objectives of Wolfpack are to design and produce new products at world-competitive levels of quality, performance, efficiency and cost. Wolfpack teams consist of members not only from design engineering but also from sales, marketing, manufacturing, engineering, quality control, purchasing and assembly, and often include suppliers and customers. In addition to teamwork, other key principles of the Wolfpack philosophy are: a \"market-driven\" approach, \"simultaneous engineering\", reduction and standardization of parts, design for manufacturability and integrated, just-in-time manufacturing. Wolfpack teams develop marketable products faster than conventional teams with improved quality, features and cost and quality performance ratios. Compared to the products they replace, Wolfpack-developed products typically have achieved a 30 to 50 percent reduction in each of the following areas: product development cycles, number of total parts, manufacturing lead time, installation time and overall cost.\nIn 1985, the company began applying Wolfpack principles to the development of its Vista line of plastics injection molding machines, and the line has since become the market leader in the United States. Today, most of the company's plastics processing machinery lines have been developed through the Wolfpack approach. In 1989, the company formally adopted the Wolfpack approach to product development and introduced its first Wolfpack machine tool, the Sabre vertical machining center, which was well received. Subsequently, several other Sabre machines were added to the family, all of which have met with good market acceptance. In 1992, key Wolfpack machine tool introductions included the Maxim line of horizontal machining centers and the Avenger turning center series, again with encouraging customer reaction. Late in 1993, the company introduced the Arrow and Lancer lines of vertical machining centers which have resulted in encouraging sales levels. Additional Wolfpack-developed machine tool introductions are planned for 1994.\nIn many cases, Wolfpack designs represent new products for new applications or markets. In other cases, they replace older product lines and the company coordinates the phase-out of the older lines with the phase-in of the Wolfpack-developed product lines. This approach is designed to minimize inventory obsolescence while providing an opportunity for increased revenue as the new products achieve market acceptance. From 1991 through 1993, the Wolfpack program resulted in 27 new product introductions.\nThe company also conducts an ongoing research and product development effort for all product lines, designed to create new products to maintain or enhance its competitive market positions. During the last three years, the company has maintained its expenditures for research and development at an average of approximately 4% of sales.\nIn 1993, the company initiated Total Quality Leadership (\"TQL\"), a company-wide commitment to promote higher levels of teamwork, innovation and employee empowerment. TQL is a people-oriented philosophy that seeks commitment from all employees, representatives and suppliers to focus on total customer satisfaction. TQL is a long-term strategy intended to promote continuous process and quality improvement.\nThe company continually explores acquisition, divestiture and consolidation opportunities when it believes such actions could expand markets, enhance product synergies or improve earnings potential for the long-term. In addition to the Valenite and Ferromatik acquisitions, in the past three years the company has sold certain businesses and consolidated certain manufacturing operations. In early 1994, the company announced a major consolidation of its U.S. machine tool operations.\nSEGMENT INFORMATION\nThe company has three business segments: plastics machinery, machine tools and industrial products. Financial data for the past three years for these segments are shown in the tables below.\nFiscal Year (a) ------------------------------ (In millions) 1993 1992 1991 -------- ------ ------ SALES Plastics machinery. . . . . . . . $ 357.2 $301.4 $267.6 Machine tools . . . . . . . . . . 355.0 379.7 383.7 Industrial products (b) . . . . . 317.2 108.1 102.7 -------- ------ ------ Total sales . . . . . . . . . . $1,029.4 $789.2 $754.0 ======== ====== ====== BACKLOG OF UNFILLED ORDERS Plastics machinery. . . . . . . . $ 85.5 $ 56.1 $ 53.3 Machine tools . . . . . . . . . . 123.9 188.8 219.7 Industrial products (b) . . . . . 36.6 4.7 4.3 -------- ------ ------ Total backlog . . . . . . . . . $ 246.0 $249.6 $277.3 ======== ====== ======\n_______________________________________________________________________________\n(a) 1992 includes 53 weeks compared to 52 weeks included in 1993 and 1991.\n(b) The 1993 increases in the industrial products segment are largely attributable to the inclusion of Valenite as of February 1, 1993. ___________________________________________________________________________\nFiscal Year (a) ------------------------------ (In millions) 1993 1992 1991 ------ ------ ------ OPERATING EARNINGS (LOSS) Plastics machinery (c). . . . . . $ 26.6 $ 22.8 $ 14.6 Machine tools . . . . . . . . . . 3.9 8.9 (6.6) Industrial products (b) . . . . . 27.1 17.7 18.3 Consolidation charge and closing and relocation charge (d). . . . . . . . . . . (47.1) - (75.1) Disposition of subsidiary (e) . . (22.8) - - Unallocated corporate expenses (f). . . . . . . . . . (11.5) (6.2) (9.5) ------ ------ ------ Operating earnings (loss) . . . . (23.8) 43.2 (58.3) Interest - net. . . . . . . . . . (13.4) (16.2) (15.1) ------ ------ ------ Earnings (loss) from continuing operations before income taxes, extraordinary items and cumulative effect of changes in methods of accounting. . . . $(37.2) $ 27.0 $(73.4) ====== ====== ======\nIDENTIFIABLE ASSETS Plastics machinery. . . . . . . . $289.0 $219.9 $202.9 Machine tools . . . . . . . . . . 243.1 282.8 310.9 Industrial products (b) . . . . . 174.4 56.8 63.7 Unallocated corporate assets (g). 23.1 19.4 20.9 ------ ------ ------ Total assets. . . . . . . . . . $729.6 $578.9 $598.4 ====== ====== ======\nCAPITAL EXPENDITURES Plastics machinery. . . . . . . . $ 4.2 $ 6.2 $ 6.5 Machine tools . . . . . . . . . . 8.8 7.1 7.5 Industrial products (b) . . . . . 10.4 4.3 1.5 ------ ------ ------ Total capital expenditures. . . $ 23.4 $ 17.6 $ 15.5 ====== ====== ======\nDEPRECIATION 3 Plastics machinery. . . . . . . . $ 6.2 $ 7.7 $ 7.0 Machine tools . . . . . . . . . . 9.4 10.6 14.2 Industrial products (b) . . . . . 10.5 2.6 2.8 ------ ------ ------ Total depreciation. . . . . . . $ 26.1 $ 20.9 $ 24.0 ====== ====== ====== __________________________________________________________________________\n(a) 1992 includes 53 weeks compared to 52 weeks included in 1993 and 1991.\n(b) The 1993 increases in the industrial products segment are largely attributable to the inclusion of Valenite as of February 1, 1993.\n(c) The 1993 amount includes a $2.5 million gain on sale of surplus land.\n(d) These amounts relate to the machine tools segment.\n(e) This amount relates to the plastics machinery segment.\n(f) Includes corporate research and development and certain administrative expenses. The 1993 amount includes amortization of financing costs and costs related to the sale of receivables totaling $3.0 million.\n(g) Includes cash and cash equivalents and the assets of the company's insurance and utility subsidiaries.\nThe following table summarizes the company's United States and foreign operations which are located principally in Western Europe:\n(In millions) 1993 1992 1991 ------ ------ ------ GEOGRAPHIC INFORMATION U.S. operations Sales . . . . . . . . . . . . . . . $831.9 $654.1 $613.0 Operating earnings. . . . . . . . . 49.6 47.9 23.3 Consolidation charge and closing and relocation charge . . . . . . (47.1) - (75.1) Disposition of subsidiary . . . . . (22.8) - - Identifiable assets . . . . . . . . 420.6 410.8 413.9 Liabilities . . . . . . . . . . . . 469.9 403.3 404.7 Capital expenditures. . . . . . . . 21.3 13.9 11.8 Depreciation. . . . . . . . . . . . 19.1 16.3 19.3\nForeign operations Sales . . . . . . . . . . . . . . . 197.5 135.1 141.0 Operating earnings. . . . . . . . . 8.0 1.5 3.0 Identifiable assets . . . . . . . . 285.9 148.7 163.6 Liabilities . . . . . . . . . . . . 135.6 41.2 64.7 Capital expenditures. . . . . . . . 2.1 3.7 3.7 Depreciation. . . . . . . . . . . . 7.0 4.6 4.7\nSales of U.S. operations include export sales of $118.7 million in 1993, $111.7 million in 1992, and $98.6 million in 1991.\nTotal sales of the company's U.S. and foreign operations outside the U.S. were $298.4 million, $242.6 million, and $236.0 million in 1993, 1992 and 1991, respectively.\nPLASTICS MACHINERY\nThe company is the largest U.S. producer of plastics machinery. In 1993, the company's plastics machinery segment sales were $357 million, of which approximately 70% were to customers in the U.S. The company believes it offers more varieties of machinery to process plastic than any other U.S. company.\nThe company produces equipment for most of the major plastics processing technologies, including a full range of injection molding machines and systems for extrusion and blow molding. In February 1994, the company sold Sano. The company also sells a line of imported electric injection molding machines and a number of types of auxiliary equipment, which are manufactured by others to the company's specifications.\nThe company designs and builds its own electronic controls and develops the necessary software for virtually all of its plastics machinery lines. The company believes that its advanced controls and software for plastics manufacturing equipment are key selling features that have helped increase its market share.\nPLASTICS MACHINERY INDUSTRY\nThe market for plastics machinery has grown steadily over the past four decades, as plastics have continued to replace traditional materials such as metal, wood, glass and paper in an increasing number of manufactured products, particularly in the transportation, construction, packaging and medical industries. Advancements in both the development of materials, which make plastic products more functional, and the capabilities of plastics processing equipment have been major contributors to the steady growth in the plastics machinery market. In addition, consumer demand for safer, more convenient and recyclable products has increased the general demand for plastic products. Like other capital goods markets, the plastics machinery market is subject to economic cycles, but to a lesser degree than the machine tool market. In particular, the market for injection molding machines is driven by the consumer economy and the automotive industry. Beginning in 1989, the plastic machinery industry began to experience a slowdown in orders from these sectors and the slowdown continued through 1991 and into the first half of 1992. Plastics machinery orders improved in the second half of 1992 and continued to be strong through 1993.\nCustom molders, which produce a wide variety of components for many industries, are the single largest group of plastics machinery buyers. Other customer categories include the automotive industry, the packaging industry, the construction industry, manufacturers of housewares and appliances and producers of medical supplies. Among the factors that affect the plastics machinery market are the health of the consumer economy, residential and commercial construction and automotive production. Because of intense competition from international plastics machinery producers, currency exchange rates also have a significant impact. Fluctuations in oil and natural gas supplies and prices may affect the businesses of the customers for plastics machinery and, in turn, the market for this equipment.\nEnvironmental concerns about plastics may have the potential to slow the growth of the plastics machinery market. However, some plastics raw materials suppliers, machinery makers and processors are developing biodegradable products and methods of recycling to address environmental issues. The company believes that environmental concerns have not had any discernible negative effect on the market to date. Nevertheless, the company, through its membership in The Society of Plastics Industry (an industry trade association), is participating in a joint initiative with \"The Partnership for Plastics Progress\", which has brought together leading companies within the plastics industry to address the role of plastics in the environment.\nTHE COMPANY'S PLASTICS MACHINERY SEGMENT\nThe company's plastics machinery segment consists of three major businesses: injection molding machines, extrusion systems and blow molding systems. In 1993, sales of injection molding machines constituted over one-half of the sales of the company's plastics machinery segment.\nINJECTION MOLDING\nThe company is the largest U.S. producer of injection molding machines. Injection molding is the most common and versatile method of processing plastic. The company manufactures many types of injection molding machines, all of which were developed using Wolfpack principles. Product standardization (which facilitates part commonality), the modernization of the company's manufacturing facilities and methods as well as increased volumes have enabled the company to achieve significant economies of scale for the production of injection molding machines. The company believes these factors have enabled it to become the lowest cost U.S. producer of these machines. Additionally, the company believes its success in injection molding machines has been due in large part to the development and marketing of its Vista line, which the company continues to expand. In 1991, the company entered the market for very small hydraulic injection molding machines with its Wolfpack-developed Sentry Line, which has been well received in the marketplace. In 1992 and 1993, the company introduced two new Vista models known as the Revenge and the Patriot.\nAdditionally, in 1993 the company began shipping the largest hydraulic injection molding machine it has ever built, the Wolfpack-designed VL4000, which is used for large interior and exterior automotive parts.\nSales of injection molding machines began to weaken in May 1989 and remained depressed through 1991. Sales remained soft in the first half of 1992, but became particularly strong in the second half of 1992 and through 1993. As a result, the company's injection molding machine business had a record sales-year in 1992, and the company surpassed that record in 1993.\nOn November 8, 1993, the company acquired Ferromatik, one of Europe's leading producers of injection molding machines. Ferromatik is recognized for its high-end technology including multi-color machines, multi-component systems and other specialty applications. The company expects the Ferromatik acquisition to expand its technology base and product line and help it achieve its objective of establishing a manufacturing and distribution base in Germany to serve Europe and other markets. The acquisition included the Ferromatik lines of hydraulic and electric injection molding machines and a modern manufacturing facility in Malterdingen, Germany, as well as Ferromatik's worldwide marketing, sales and service network. The company believes Ferromatik provides a complementary fit with its existing injection molding machine business. The purchase price, including assumed debt of approximately $6 million, was approximately $56 million. The amount of the purchase price paid was based upon estimates of the amount of assets and liabilities of Ferromatik, a subject to adjustment as set forth in the purchase agreement. The company financed the purchase by drawing upon its revolving credit facility of $130 million and the company's existing European lines of credit.\nThe company has commenced a restructuring of Ferromatik intended to (1) derive benefits of synergies between Ferromatik and other company operations and (2) improve Ferromatik operations through implementation of manufacturing techniques and methods currently being used in the company's U.S. plastics machinery operations. The company believes that restructuring opportunities are available in both marketing and manufacturing.\nThe company intends to conduct its plastics machinery European marketing activities through Ferromatik's existing network and thus to eliminate expenses previously incurred by the company's European marketing operation in Offenbach, Germany. The company will sell several of its successful plastics machinery lines to European customers through Ferromatik's sales and distribution network.\nTo improve manufacturing efficiency, in addition to the head count reductions made at Ferromatik prior to the acquisition, the company intends to further reduce head count in 1994. The company believes such personnel reductions will not adversely affect current production capacity at Ferromatik. The company intends to implement numerous advanced manufacturing technologies in the Malterdingen facility, including cellular manufacturing, which have been successful in the company's main U.S. facility for injection molding machine production in Ohio.\nEXTRUSION SYSTEMS\nExtrusion systems business consists of systems comprised of multiple units which are tooled to make a specific product in quantity. Such systems take longer to manufacture than do injection molding machines. Extrusion systems include twin-screw extruders and single-screw extruders. The company believes it has a strong competitive position in each of these lines. Twin-screw extruders are used to produce continuous-flow products such as pipe, residential siding, sheet lines and window frames, hence the business is closely tied to housing market cycles. Single-screw extruders are used in a variety of applications and systems such as blow molding, blown-film and cast-film systems, pipe and profiles. In February 1994, the company sold its Sano blown and cast film systems business. The company recorded nonrecurring charges totaling $22.8 million in 1993 on the disposition of this subsidiary.\nBLOW MOLDING SYSTEMS\nThe company's blow molding systems business consists of reheat and extrusion blow molding systems. Reheat blow molding systems are used to produce strong, lightweight containers that resist oxygen migration to hold perishable liquids, such as soft drinks, toiletries, and household products. Extrusion blow molding systems are used to make a wide variety of products ranging from bottles, jars, vials and other containers, to industrial parts and toys. In 1991, the company introduced a Wolfpack-developed line of accumulator-head blow molding machines, known as Eclipse. Additionally, in 1993, the company expanded its Eclipse line by introducing three models of large extrusion and blow molding machines.\nSPECIALTY EQUIPMENT\nThe company sells a variety of specialty equipment used in the processing of plastics products including peripheral auxiliary equipment such as material management systems, heat exchangers and product handling systems which are manufactured by third parties to the company's specifications. The company also rebuilds and retrofits many types of plastics processing equipment sold by the company or others, refitting them with new company-produced controls and software.\nSALES, MARKETING AND CUSTOMER SERVICE\nThe company maintains a large direct sales force in the United States for its plastics machinery segment, which it supplements with independent agents. Internationally, the company uses both a direct sales force and independent agents. In the U.S., the plastics machinery business uses the company's regional technical centers in Allentown, Pennsylvania; Arlington, Texas; Charlotte, North Carolina; Chicago, Illinois; Detroit, Michigan; and Los Angeles, California to demonstrate and market its products, and provide customer support and training. Through its Austrian subsidiary and Ferromatik, the company has an extensive sales, marketing, service and distribution system throughout Europe.\nCOMPETITION\nThe markets for plastics machinery in the United States and worldwide are highly competitive and are made up of a number of U.S., European and Asian competitors. The company believes it has a significant share of the U.S. market for the type of products it produces. The company's competitors vary in size and resources; some are larger than the company, many are smaller, and only a few compete in more than one product category. Principal competitive factors in the plastics machinery industry are: product features, technology, quality, performance, reliability, speed of delivery, price and customer service. The Wolfpack program is designed to enhance the company's competitive position with respect to each of these competitive factors.\nMACHINE TOOLS - -------------\nThe company is a leading U.S. producer of machine tools. A machine tool is a power-driven machine, not hand-held, that is used to cut, form or shape metal. Machine tools are typically installed as capital equipment in metalworking industries. In 1993, the company's machine tool segment sales were $355 million, of which approximately 75% were to customers in the U.S.\nMACHINE TOOL INDUSTRY The primary customers for machine tools are the automotive and aerospace industries; machine shops; producers of farm, construction, off-road and power generation equipment; manufacturers of bearings; the die and mold industry; and a variety of other metalworking manufacturers. The machine tool industry has historically been cyclical with relatively long lead times between orders and shipments. Machine tool sales are affected by capital spending levels, interest rates, tax and depreciation policies, international competition, currency exchange rates and general economic conditions.\nU.S. machine tool producers benefitted to a degree in the late 1980s when the U.S. manufacturing sector continued efforts to improve productivity and quality and to lower costs in order to compete in world markets. At that time, the dollar also weakened relative to other currencies. A growing market then developed for automated flexible manufacturing cells, which are machine tools linked together using computers, software and materials-handling equipment to automate and integrate all manufacturing functions, allowing for lightly-manned or unattended operation. In 1989, however, the U.S. market softened, primarily as a result of cutbacks in capital spending by the automotive industry. This softness in automotive industry capital spending continued through 1991 and 1992. Also in 1992, machine tool orders in the aerospace industry declined due primarily to difficulties in the commercial airline industry. In 1993, U.S. automotive capital spending began to pick up for certain types of machine tools-mostly transfer line and fixed station equipment, which the company does not manufacture. Demand for machine tools from the aerospace industry, however, continued to worsen. Since early 1991 the machine tool markets in Europe and Japan have been severely depressed.\nTHE COMPANY'S MACHINE TOOL SEGMENT\nThe company's machine tool segment is comprised of three focused businesses: standard machine tool products, advanced machine tool systems and electronic systems. The company's standard machine tool products business manufactures horizontal machining centers, vertical machining centers and turning centers for a variety of industries engaged in basic metalworking operations, including machine shops. The products of the company's advanced machine tool systems business include large, multi-axis metalcutting and composites processing systems for the aerospace industry; large, multi-axis machines for manufacturers of farm, construction, off-road and power generation equipment and for the die and mold industry; applied production turning centers and centerless grinding machines for the automotive industry and for bearings manufacturers; and automated flexible manufacturing cells for the metalworking industry. The company's electronic systems business designs and manufactures computer controls and develops proprietary software for the company's machine tools, plastics machinery and automated flexible manufacturing cells.\nSTANDARD MACHINE TOOL PRODUCTS HORIZONTAL AND VERTICAL MACHINING CENTERS\nThe company designs, builds and sells general-purpose CNC horizontal and vertical machining centers for basic metalworking operations to a number of industries. These machines produce prismatic or box-like parts and are capable of performing a variety of operations such as milling, drilling, boring, tapping, reaming and routing. Since 1991, the company has introduced a number of new Wolfpack machines, including four models of the Sabre line of vertical machining centers and, in 1992, the Maxim series of horizontal machining centers, and in 1993 the Arrow and Lancer lines of vertical machining centers.\nTURNING CENTERS\nStandard turning centers are designed for ease of use by a broad variety of customers that do not require custom-designed features. As part of its ongoing Wolfpack program, the company has introduced a variety of new turning centers, including the Talon entry-level series in 1991, and the more sophisticated Avenger series in 1992. In 1993 the company expanded its Avenger series which now includes eight models.\nAUTOMATED FLEXIBLE MANUFACTURING CELLS\nAutomated flexible manufacturing cells consist of one or more processing machines (usually standard machine tools), ancillary equipment for parts and tools handling and computer hardware and software to automate and integrate all necessary functions, allowing for lightly-manned or unattended operation. These systems are used widely throughout the metalworking industry and generally feature a number of computer-driven functions, such as work and tool scheduling and quality control. Automated flexible manufacturing cells are a major focus of a number of U.S. companies seeking to update plant and equipment to enhance their productivity and international competitiveness. The company believes that its Wolfpack-developed cell control hardware and software have enabled it to obtain a leadership position in the U.S. automated flexible manufacturing cells market.\nADVANCED MACHINE TOOL SYSTEMS\nMETALCUTTING AND COMPOSITES PROCESSING SYSTEMS FOR AEROSPACE\nThe company believes it is one of the world's leading producers of large five-axis machining centers and profilers used to machine intricately contoured surfaces, often out of aluminum, titanium and other high-strength alloys, for the aerospace industry. The company is also a world leader in the development of new machines and systems to automate the manufacture of components made of advanced composite materials, such as carbon or graphite fibers in combination with epoxy. These systems are used by the aerospace industry to manufacture jet engine parts and structural components, primarily for commercial aircraft.\nLARGE MACHINE TOOLS\nThe company makes large, often highly customized, metalcutting machines and systems for the manufacturers of heavy machinery such as farm and construction implements and machinery, off-road vehicles and power generation equipment. The company's large machine tools business also includes the product lines acquired by the company from The Pratt & Whitney Company, Inc. early in 1991. These product lines, which include die sinkers, blade mills and heavy-duty bridge mills, expand and supplement the company's offering of products to jet engine and power generation equipment makers and to the die and mold industry.\nAPPLIED PRODUCTION TURNING CENTERS AND CENTERLESS GRINDING MACHINES\nThe company also specializes in manufacturing applied production turning centers and centerless grinding machines designed to meet exacting specifications for the automotive industry. Turning centers, also called CNC lathes, shape cylindrical parts, which are rotated at high speed against a stationary tool. The company's applied production turning centers are used by the automotive industry in a number of applications, including aluminum-alloy wheel turning. Grinding machines are used to bring a part surface to a more precise definition or finish. There are many different kinds of grinding processes. In 1991, the company announced its intention to focus on centerless grinding machines, which grind external diameters of cylindrical parts primarily for the automotive industry and for bearings manufacturers. The company has a long-standing leadership position in the domestic centerless grinding machine business. In 1993, this business experienced an increase in new orders from the automotive industry.\nELECTRONIC SYSTEMS\nThe company designs and manufactures computer controls and develops proprietary software for its machine tools, plastics machinery and automated flexible manufacturing cells. Computer controls and software are often important selling features for individual machines, and the controls and software enable machines to be linked together to form automated cells and manufacturing systems. Most of the controls for the company's machine tools and plastics machinery are manufactured by the company, providing significant product differentiation from competing products. The company's electronic systems business also offers a variety of retrofitting services to automate or upgrade existing machine tools, including those manufactured by other companies. During 1992, the company upgraded two of its major families of computer numerical controls, the Acramatic 950 and the Acramatic 850SX, with enhanced software and programming capabilities.\nSALES, MARKETING AND CUSTOMER SERVICE\nThe company markets machine tools in North America through a comprehensive network of independent distributors assisted by the company's direct sales force. The expanded use of distributors is a significant aspect of the company's strategy aimed at placing more sales representatives in the field to reach additional markets. Through these distributors, the company currently has approximately 300 salespeople representing its machine tools in North America, which is approximately three times more salespeople than it had four years ago. The company has begun emphasizing distribution in Europe by upgrading its distributor network. A strong distribution network is one of the cornerstones in the company's plan to improve its position in the global market for standard machine tools.\nThe company believes that extensive applications work, field service engineering and customer support are important for all its products, especially for grinding machines, aerospace and special machines and automated flexible manufacturing cells. In addition to its marketing and service headquarters in Cincinnati, the company maintains regional technical centers in Allentown, Pennsylvania; Chicago, Illinois; Detroit, Michigan; Los Angeles, California; and Toronto, Ontario; as well as in Birmingham, England; and Offenbach, Germany. These facilities provide customers with demonstrations, engineering services and training for most major product lines.\nCOMPETITION\nThe worldwide machine tool industry is made up of a number of competitors, none of which has a dominant market share despite the considerable consolidation that has occurred in the industry over the past decade. The markets for the company's machine tool segment products are highly competitive in the United States and internationally, with strong competition from U.S., European and Asian companies in all markets. The company's competitors vary in size and resources; some are larger than the company, many are smaller, and only a few compete in more than one product category.\nPrincipal competitive factors for products in the machine tool business are product features (including controls and software), quality, performance, reliability, technology, speed of delivery, price and customer service. The Wolfpack program is designed to enhance the company's competitive position with respect to each of these competitive factors. In certain aerospace and grinding machine lines, the company has significant market positions and relatively few competitors. However, in the case of standard machine tool products and automated flexible manufacturing cells, there are many competitors and no one company has market dominance.\nINDUSTRIAL PRODUCTS - -------------------\nTHE COMPANY'S INDUSTRIAL PRODUCTS SEGMENT\nThe company is a leading producer of three basic types of industrial products: metalcutting tools, metalworking fluids and precision grinding wheels. In 1993, sales of the company's industrial products segment, including Valenite's sales for 11 months, were $317 million, of which approximately 70% were to customers in the U.S. Most of the company's industrial products are consumable, which means they are depleted during the process for which they are used, offering the company a continuous opportunity to sell replacement products to its customers. The company believes that its industrial products business complements its plastics machinery and machine tool businesses, as the industrial products business requires relatively small investment in equipment and working capital and is exposed to less pronounced business cycles.\nVALENITE\nIn 1993, Valenite's sales were $209 million, of which approximately 65% were to customers in the U.S. The company believes Valenite is the second largest producer of metalcutting tool systems in the U.S. and the third largest worldwide. Valenite manufactures over 20,000 products, including an extensive line of cutting tool inserts in a wide variety of materials and geometries for turning, boring, milling and drilling; standard and special steel insert holders; and monitoring, gauging and control devices. Valenite has strong market positions in carbide die and wear products for metalforming and in products requiring the wear and corrosion resistant properties of tungsten carbide.\nMETALWORKING FLUIDS\nMetalworking fluids are used as lubricants and coolants in a wide variety of metalcutting and metalforming operations. Major customers are producers of precision metal components for many industries, including manufacturers of automotive power trains, aerospace engines and bearings as well as general metalworking shops. The company is a full-line supplier, offering water-based fluids (synthetics), water-based oil-bearing fluids (semi-synthetics) and oil-based fluids. Over the last three years, the company expanded its lines of soluble oils, base oils and synthetic fluids. In 1993 the company developed a brand of fluid called Valcool designed specifically to work with Valenite metal cutting tools that is being marketed through Valenite's distribution channels.\nGRINDING WHEELS\nGrinding wheels are used by manufacturers in the metalworking industry. Major customers are producers of precision metal components for many industries, including manufacturers of automotive power trains, aerospace engines and bearings as well as general metalworking machine shops. The company designs and manufactures a wide variety of precision abrasive grinding wheels, including resin-bonded, vitrified, diamond and synthetic types. Recently, the company introduced two Wolfpack-developed products: CMSA II, a second generation line of ceramic abrasive grinding wheels, and VIDA, a new line of diamond wheels for nonferrous metals.\nThe company believes, based on tests in its own laboratories and in customer plants, that the company's proprietary formulae and modern production equipment and techniques for the manufacture of precision grinding wheels give it advantages in terms of product quality, lower production costs and faster deliveries. The company achieves lower production costs, in part, by finishing its wheels on computer numerically controlled machines designed and built by the company's machine tool business.\nSALES, MARKETING AND CUSTOMER SERVICE\nThe company sells its fluids and wheels primarily through a growing network of independent industrial distributors, as well as through a direct sales force. The company's metalworking fluids and grinding wheels businesses offer customer demonstrations, service, training, and applications engineering at most of the company's regional technical centers in the U.S. and Europe. Valenite maintains its own worldwide, direct sales and service force of some 350 technically trained engineers of whom 200 are located in the United States. The direct sales and service force is complemented by selected independent industrial distributors.\nCOMPETITION\nThe company's main global competitors in its metalworking fluids business are large petrochemical companies and smaller companies specializing in similar fluids. There are a small number of large competitors in the U.S. grinding wheel market, one of which is significantly larger than the company. The company has limited sales of grinding wheels outside the U.S.\nThe company believes that Valenite has the second largest metalcutting tool systems business in the U.S. In international markets Valenite faces competition from several competitors, two of which have larger market shares.\nPATENTS - -------\nThe company holds a number of patents, none of which is material to any business segment.\nEMPLOYEES - ---------\nDuring 1993, the company employed an average of 7,885 people, of whom 1,617 were employed outside the United States. As of year-end 1993, the company employed 8,427 people.\nBACKLOG - ------- The backlog of unfilled orders was $246.0 million at the end of 1993 and $249.6 million at the end of 1992. The backlog at year-end is believed firm and, in general, is expected to be delivered in 1994 and early 1995.\nITEM 1. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following information is included in accordance with the provisions for Part III, Item 10:\nPositions Held During Name and Age Position Last Five Years ------------ -------- ---------------------\nDaniel J. Meyer Chairman and Chief Elected Chairman and Chief (57) Executive Officer, Executive Officer in Director November, 1991. Prior thereto was Chairman, President and Chief Executive Officer from January, 1991, President and Chief Executive Officer from 1990, President and Chief Operating Officer from 1987. Has served as Director since 1985. Also, is a member of the Nominating and Executive Committees.\nRaymond E. Ross President and Chief Elected President and Chief (57) Operating Officer, Operating Officer in Director November, 1991. Prior thereto was Executive Vice President - Operations from February, 1991, Senior Vice President - Industrial Systems from 1989 and Vice President - U.S. Plastics Machinery from 1987. Has served as Director since 1991.\nDavid E. Noffsinger(a) Senior Vice President- Elected Senior Vice (59) Plastics Machinery President - Plastics Machinery in 1989. Prior thereto was Group Vice President - Plastics Machinery from 1985.\nD. Michael Clabaugh Group Vice President- Elected Group Vice (51) Machine Tools President - Machine Tools in 1993. Prior thereto was Vice President - Advanced Systems from 1990, Vice President - Marketing, Industrial Systems from 1989 and Vice President - Machine Tool Marketing from 1988.\nHarold J. Faig Group Vice President- Elected Group Vice (45) Plastics Machinery President - Plastics Machinery in February, 1994. Prior thereto was Vice President - Injection Molding from 1990 and Manager - Injection Molding from 1988.\nAlan L. Shaffer Group Vice President- Elected Group Vice (43) Industrial Products President - Industrial Products in 1989. Prior thereto was Group Vice President in charge of certain industrial specialty products from 1986.\nRonald D. Brown Vice President- Elected Vice President - (40) Finance and Finance and Chief Financial Chief Financial Officer in 1993. Prior Officer thereto was Treasurer and Assistant Secretary from 1989 and Assistant Treasurer from 1988.\nChristopher C. Cole(b) Vice President- Elected Vice President - (38) Machine Tool Machine Tool Products in Products 1993. Prior thereto was Vice President- Strategy and Business Development from 1991, Group Vice President- Machine Tool Products from 1990, Group Vice President Industrial Systems Operations from 1989, Group Vice President - Machine Tools from 1988.\nRichard L. Kegg Vice President - Elected Vice President - (58) Technology and Technology and Manufacturing Manufacturing Development in 1993. Prior Development thereto was Director, Corporate Research and Manufacturing Development from 1990 and Director of Engineering, Aerospace and Specials Division from 1988.\nTheodore Mauser Vice President- Elected Vice President - (54) Human Resources Human Resources in 1984.\nWayne F. Taylor Vice President- Elected Vice President - (50) General Counsel and General Counsel and Secretary Secretary in 1990. Prior thereto was Secretary and Corporate Counsel from 1988.\nRobert P. Lienesch Controller Elected Controller in 1989. (48) Prior thereto was Assistant Corporate Controller from 1988.\nKenneth W. Mueller Treasurer and Elected Treasurer and (60) Assistant Secretary Assistant Secretary in 1993. Prior thereto was Acting Director of Standard Machine Tools from 1992, Machine Tool Group Controller from 1989, and Division Manager for certain industrial and specialty products from 1988.\nNote: Parenthetical figure below name of individual indicates age at most recent birthday prior to January 1, 1994.\nThere are no family relationships among the executive officers of the Registrant.\nOfficers of the company are elected each year by the Board of Directors.\n(a) In February, 1994, Mr. Noffsinger announced his intention to retire in April, 1994. (b) In March, 1994, Mr. Cole announced his intention to leave the company at the end of that month.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe company has thirty four principal manufacturing plants in operation with a combined floor space of approximately 5.0 million square feet as listed below:\nLocation No. of Plants Principal Product Line Manufactured - -------- ------------- ----------------------------------- Cincinnati, Ohio 5 Standard machine tool products and advanced machine tool systems\nCincinnati, Ohio 1 Extrusion systems\nCincinnati, Ohio 1 Metalworking fluids and precision grinding wheels\nSouth Lebanon, Ohio 1 Electronic controls and industrial software\nBatavia, Ohio 1 (A) Injection and blow molding machines\nMt. Orab, Ohio 1 (A) Plastics machinery parts Fountain Inn, South Carolina 1 (C) Standard horizontal machining centers and standard turning centers\nGreenwood, South Carolina 1 (A)(C) Standard turning centers\nCarlisle, Pennsylvania 1 Precision grinding wheels Birmingham, England 1 Standard vertical machining centers\nVlaardingen, The Netherlands 1 Metalworking fluids\nVienna, Austria 1 Extrusion systems\nNogales, Mexico 1 (B) Precision grinding wheels\nMalterdingen, Germany 1 Injection molding machines\nDetroit, Michigan (metro area) 6 (B) Carbide inserts, special steel products and gauging systems, ceramic inserts and cerment inserts\nWest Branch, Michigan 2 Powder production, die and wear\nWestminister and Seneca, South Carolina 4 Carbide and diamond inserts\nGainsville, Texas 1 Turning tools, milling cutters and boring bars\nAndrezieux, France 1 Carbide inserts\nSinsheim, Germany 1 Special steel tooling products\nTokyo, Japan 1 Carbide inserts and steel tools\n(A) The plant in Batavia, Ohio operates under a long-term lease, which was financed by the sale of Clermont County Industrial Development Revenue Bonds. The plant in Mt. Orab, Ohio operates under a long-term lease, which was financed by the sale of State of Ohio Industrial Development Revenue Bonds. The plant in Greenwood, South Carolina operates under a long-term lease, which was financed by the sale of Greenwood County, South Carolina Industrial Revenue Bonds. At the expiration of the long-term leases, the company will acquire title to the leased properties at a nominal cost.\n(B) The Nogales, Mexico plant and three plants in the Detroit, Michigan (metro area) are leased from unrelated third parties.\n(C) In February, 1994, the company announced its intention to close these facilities and transfer the manufacturing operations to Cincinnati, Ohio.\nIn addition to the above facilities, the company has nine marketing bases, called \"regional technical centers.\" These centers are located in Allentown, Pennsylvania; Arlington, Texas; Charlotte, North Carolina; Chicago, Illinois; Detroit, Michigan; Los Angeles, California; Toronto, Canada; Birmingham, England; and Offenbach, Germany and provide customers with demonstrations, engineering services and training for most major product lines.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the opinion of management and counsel, there are 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 the subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS\nThere were no matters submitted to a vote of stockholders during the fourth quarter of 1993.\nPART II ----------\nITEM. 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe company's common shares are listed on the New York Stock Exchange. Such shares are also traded on the Cincinnati Stock Exchange, Boston Stock Exchange, Pacific Stock Exchange, Philadelphia Stock Exchange and Midwest Stock Exchange, with options traded on the Philadelphia Stock Exchange. As of February 25, 1994, there were approximately 6,900 holders of record of the company's common shares. The company's preferred shares are not actively traded.\nThe table below shows the price range of the common shares for 1992 and 1993, as reported by the New York Stock Exchange. Cash dividends of $.09 per common share and $1.00 per preferred share were paid in each quarter of 1992 and 1993.\nCommon Stock Price Range\n-------------------- Fiscal 1992, quarter ended High Low ------ ------ March 21 ........................... $17.50 $10.88 June 13 ............................ 18.25 13.88 October 3 .......................... 15.50 12.25 January 2 .......................... 17.63 13.38\nFiscal 1993, quarter ended March 27 ........................... $22.25 $16.25 June 19 ............................ 29.63 19.50 October 9 .......................... 26.00 20.75 January 1 .......................... 24.75 19.25\n_____________________________________________________________________________\n(a) Includes a charge of $14.9 million (with no current tax effect), or $.54 per share, related to the revaluation for sale of the company's coordinate measurement and inspection machine business, LK Tool.\n(b) Includes a provision for loss on the sale of the discontinued industrial robot business of $1.7 million (with no current tax effect), or $.06 per share.\n(c) Includes a provision for loss on the sale of the discontinued laser machine operations of $4.5 million, or $.18 per share. _____________________________________________________________________________\n(Dollars in millions, except per-share amounts)\n_____________________________________________________________________________\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThe company's financial results for the last three years, presented on page 27, are discussed below. The company operates in three principal business segments: plastics machinery, machine tools and industrial products. Financial information for each of these segments is presented on pages 5 and 6.\n1993 COMPARED TO 1992 - ---------------------\nSALES\nSales in 1993 were $1,029 million, which represented a $240 million increase over 1992. This increase was primarily attributable to the $209 million increase in sales of industrial products which resulted from the acquisition of Valenite in February, 1993. The plastics machinery sales increase totaled $56 million, or 19%, which resulted primarily from increased domestic sales of injection molding machines and the acquisition of Ferromatik in November, 1993. Machine tool sales declined by $25 million, or 7%, due to the decline in sales of advanced machine tools for the aerospace market.\nSales of all segments to foreign markets totaled $298 million, compared to $243 million in 1992. Export shipments increased by $7 million due to the acquisition of Valenite which more than offset reductions in exports of injection molding machines and advanced machine tools to Europe.\nNEW ORDERS AND BACKLOG\nNew orders for 1993 were $970 million, which represented a $208 million increase over 1992. The increase was caused by a $60 million, or 20%, improvement in plastics machinery orders and by orders totaling $209 million for Valenite. Machine tool orders declined by $61 million, or 17%. This decline was caused principally by (i) a large order (over $25 million) that was received in the third quarter of 1992 that was not repeated in 1993, (ii) reduced demand from customers in the aerospace industry and (iii) the discontinuation of certain less profitable product lines. Export orders approximated $100 million in 1993 and 1992; in 1993, export orders for industrial products increased due to the Valenite acquisition while export orders for plastics machinery and machine tools declined.\nAt January 1, 1994, the backlog of unfilled orders was $246 million, down from $250 million a year ago, reflecting reduced orders for aerospace equipment which was partially offset by the acquisitions of Valenite and Ferromatik and the increased backlog of orders for other plastics machinery products.\nMARGINS, COSTS AND EXPENSES\nManufacturing margins increased from 22.4% in 1992 to 23.1% in 1993. Margins for plastics machinery continued to be held back due to competitive pricing pressures in the U.S. and Europe. Margins for machine tools declined primarily due to the severe reduction in shipments of advanced machine tools to aerospace customers that resulted in significant excess capacity costs late in 1993. Margins for industrial products, excluding Valenite, declined in 1993 due in part to reduced volume of European cutting fluids. The Valenite acquisition contributed to the overall increase in manufacturing margins in 1993.\nSelling and administrative expense for 1993 increased over 1992 due to increased sales. Excluding the effects of the Valenite acquisition, selling expense remained constant at approximately 14% of sales. Administrative expense increased primarily due to the Valenite acquisition.\nInterest expense, net of interest income, for 1993 decreased by $2.8 million compared with 1992. This reduction resulted primarily from the redemption of $60 million of the company's 12% Sinking Fund Debentures due 2010.\nCONSOLIDATION CHARGE\nA nonrecurring charge of $47.1 million was recorded in 1993 for the consolidation of U.S. machine tool manufacturing into facilities in Cincinnati. Production at the company's two machine tool facilities in Fountain Inn and Greenwood, South Carolina are being phased out and the plants are expected to be closed by year-end 1994. The consolidation will reduce the machine tool group's employment by a net 235 people. The charge includes amounts for severance, relocation of production and the sale of the two South Carolina facilities.\nThe consolidation addresses excess manufacturing capacity created by two factors: the company's successful Wolfpack program, which has significantly reduced the hours and floorspace required to manufacture and assemble machine tool products; and the unusually steep recession in the aerospace industry, which has dramatically lowered demand for the company's advanced machine tool systems.\nThe consolidation is expected to result in an incremental cash requirement for 1994, before considering any proceeds from the disposition of assets, of approximately $18 million which will be funded by operations and bank borrowings. The consolidation, once fully implemented, is expected to result in annual cost savings of approximately $16 million.\nDISPOSITION OF SUBSIDIARY\nA nonrecurring charge of $22.8 million was recorded in 1993 to revalue the company's Sano subsidiary in anticipation of its sale. The decision to sell Sano was due in part to continuing operating losses. In addition, the Sano business does not serve a major global market with good long-term growth and profit potential and as a result, does not meet the company's criteria for a core business. The business was sold in February, 1994 and the transaction is not expected to affect the company's 1994 financial results.\nINCOME TAXES AND EXTRAORDINARY TAX BENEFIT\nThe provision for income taxes in 1993 consists of domestic state and local taxes and certain foreign taxes. Current tax benefits were not offset against the domestic loss that was caused by the nonrecurring charges described above, in accordance with new income tax accounting rules adopted in 1993. In addition, current tax benefits could not be recognized for losses in certain foreign jurisdictions. At the end of 1993, for U.S. Federal tax reporting purposes, the company has a U.S. net operating loss carryforward of approximately $19 million which expires in 2008.\nThe provision for income taxes in 1992 of approximately 40% includes the Federal statutory rate as well as the effect of state and local and foreign income taxes.\nThe extraordinary tax benefit in 1992 resulted from the utilization of a portion of the company's net operating loss carryforward.\nEARNINGS\nFor 1993, before extraordinary items and cumulative effect of changes in methods of accounting, the company reported a loss of $45.4 million, or $1.41 per share, compared with a profit of $16.1 million, or $.58 per share, for 1992. The reduction in earnings from 1992 to 1993 was caused by the nonrecurring charges described above that totaled $69.9 million.\nThe net loss for 1993 includes the effect of an extraordinary charge of $4.4 million, or $.14 per share, related to the early extinguishment of $60 million of 12% Sinking Fund Debentures due 2010.\nThe net loss for 1993 also includes the effect of adopting two new accounting standards resulting in charges to earnings totaling $52.1 million, or $1.61 per share. The first new standard, SFAS No. 109, significantly changes existing methods of accounting for income taxes and resulted in a charge of $4.2 million, or $.13 per share. The second standard, SFAS No. 106, requires that certain postretirement benefits, such as health care, be accounted for on the accrual method. The adoption of this standard resulted in a charge of $47.9 million, or $1.48 per share, to record the accrued liability for retiree health care benefits. Because of limitations on the recognition of deferred tax assets under SFAS No. 109, no income tax benefit could be recorded in connection with the adoption of SFAS No. 106. Except for the cumulative effect, the new rules regarding postretirement medical benefits did not significantly affect the company's earnings for 1993, while the new rules regarding income taxes precluded the recognition of tax benefits with respect to domestic and certain foreign operating losses.\nAs discussed above, the company recorded an extraordinary tax benefit from the utilization of loss carryforwards of $5.4 million, or $.19 per share, for 1992.\nAfter the nonrecurring charges, extraordinary items and cumulative effect of changes in methods of accounting, the company had a net loss of $101.9 million, or $3.16 per share, for 1993, compared with net earnings of $21.5 million, or $.77 per share, for 1992. The reduction in net earnings from 1992 to 1993 was caused by the nonrecurring charges, the extraordinary item and the cumulative effect of changes in methods of accounting that totaled $126.4 million.\n1992 COMPARED TO 1991 - ---------------------\nSALES\nSales in 1992 were $789 million, which represented a 5% increase from $754 million in 1991. The increase was caused by a 13% increase in plastics machinery sales and a 5% increase in sales of industrial products. The plastics machinery increase was due in large part to increased sales of injection molding machines in the U.S. and Europe. Increased sales of industrial products resulted from higher sales of grinding wheels in the U.S. and cutting fluids in Europe. Sales of machine tools declined approximately 1%. The decrease is attributable to the phase-out of certain less profitable turning center and grinding machine product lines, which were formerly manufactured at the company's plants in Wilmington, Ohio, and Worcester, Massachusetts, respectively, which have been closed. The cost to close these plants, along with the cost to relocate certain product lines to more modern facilities, was included in the $75 million closing and relocation charge recorded in the third quarter of 1991.\nSales of all segments to foreign markets totaled $243 million in 1992 compared to $236 million in 1991. Export shipments increased by $13 million, but sales by the company's European subsidiaries to non-U.S. markets declined by $6 million due to the continuing recession in the European capital goods market. NEW ORDERS AND BACKLOG\nNew orders in 1992 were $762 million compared to $770 million in 1991. Orders for machine tools declined by $46 million due to reductions in orders for advanced machine tool systems from the aerospace industry due to difficulties in the commercial airline industry. Such aerospace orders remained soft in 1993. Orders for plastics machinery increased by 12%, largely due to increased orders for injection molding machines. Industrial products orders improved by 5%. The backlog of unfilled orders decreased from $277 million in 1991 to $250 million in 1992 due to an unusually high level of aerospace sales in the 1992 fourth quarter, which were not replaced with new orders.\nMARGINS, COSTS AND EXPENSES\nThe company's manufacturing margin in 1992 was 22.4% compared to 20.0% in 1991. Margins improved for all business segments compared to 1991. Most significantly, plastics machinery margins improved due to higher volume while machine tool margins improved due to the aforementioned plant closing and phase-out of less profitable product lines. Machine tool margins were held back in 1992 due to continued price discounting in several soft metalworking markets and by cost overruns on certain large aerospace systems.\nSelling and administrative expense increased from $132 million in 1991 to $134 million in 1992. The increase resulted from increased selling expense associated with the higher sales volume. Selling expense approximated 14% of sales in both years. Administrative expense declined due to cost containment initiatives.\nINCOME TAXES AND EXTRAORDINARY TAX BENEFIT\nThe company's effective tax rate of 40% in 1992 exceeded the Federal statutory rate due principally to domestic state and local income taxes and the effect of foreign operating losses for which tax benefits were not currently available. The provision for income taxes in 1991 consisted of domestic state and local and foreign income taxes, as well as a $4 million tax on a planned withdrawal of surplus assets from the company's British pension fund that was completed in 1992. Because the company entered 1991 with a U.S. net operating loss carryforward, domestic Federal income tax benefits could not be recognized with respect to the losses incurred in that year.\nThe extraordinary tax benefit recognized in 1992 results from the utilization of a portion of the company's U.S. net operating loss carryforward for financial reporting purposes that arose principally from the 1991 closing and relocation charge.\nEARNINGS\nIn 1992, the company earned $16.1 million, or $.58 per share, from continuing operations before extraordinary item, compared with a loss of $83.1 million, or $3.04 per share, in 1991. The 1991 figures were adversely affected by a $75.1 million closing and relocation charge and the $4.0 million tax provision for the anticipated withdrawal from the company's British pension plan.\nIn 1991, the company announced its intention to sell LK Tool, its coordinate measurement and inspection machine business, due in part to continuing operating losses. The losses from discontinued operations of $17.1 million, or $.63 per share, for 1991, included a $14.9 million nonrecurring charge to revalue for sale the company's investment in LK Tool. The subsidiary was sold in 1993.\nNet earnings were $21.5 million, or $.77 per share, in 1992, compared with a $100.2 million net loss, or $3.67 per share, in 1991. The 1991 losses were caused principally by the aforementioned nonrecurring charges totaling $94.0 million.\nLIQUIDITY AND SOURCES OF CAPITAL\nAt January 1, 1994, the company had cash and cash equivalents of $19 million, an increase of $4 million during the year. In 1993, operating activities provided $22 million of cash. During 1993, the company sold interests in certain accounts receivable resulting in cash proceeds of approximately $61 million. At year-end 1992 the company had sold $13 million of domestic accounts receivable under a separate agreement that was terminated early in 1993. The net cash proceeds from these transactions of $48 million are included in cash provided by operating activities.\nApproximately $50 million of the $61 million proceeds in 1993 resulted from the sale of accounts receivable under a three year receivables purchase agreement with an independent issuer of receivables-backed commercial paper, pursuant to which the company agreed to sell on an ongoing basis an undivided percentage ownership interest in designated pools of accounts receivable. The remaining $11 million of such proceeds resulted from the sale of an undivided percentage ownership interest in certain accounts receivable originated by Valenite in a separate transaction that is expected to be incorporated into the three year receivables agreement referred to above.\nExpenditures for new property, plant and equipment for 1993 were $23.4 million, as compared to $17.6 million for 1992. Capital expenditures for 1994 are expected to be approximately $40 million. Proceeds from the disposal of property, plant and equipment for 1993 were $22.2 million, compared to $11.1 million in 1992, and included amounts related to the sale of surplus assets (including surplus land in 1993) and the sale and operating leaseback of certain manufacturing equipment.\nDuring 1993, the company issued 5.175 million shares of common stock, resulting in net proceeds of $101 million, which were used principally to redeem $60 million of 12% debentures (plus a cash call premium of $4.7 million) and to repay borrowings under revolving lines of credit and other bank debt.\nIn the fourth quarter of 1993, the company acquired Ferromatik for approximately $56 million, which was financed by assuming $6 million of debt and utilizing $50 million of borrowings under bank lines of credit.\nIn addition, in 1993 the company recorded several large non-cash items: a $47.1 million consolidation charge, a $22.8 million charge for disposition of a subsidiary and a $52.1 million charge for cumulative effects of changes in methods of accounting. As a result of these and other factors, including financing for the acquisitions, in 1993, the company's working capital decreased by $78 million, the current ratio declined to 1.3 and the ratio of total debt to total capital increased to 60%.\nAt January 1, 1994, the company had lines of credit of approximately $138 million with various U.S. and foreign banks. Additional borrowing capacity available under committed lines of credit totaled approximately $40 million at January 1, 1994.\nSUBSEQUENT EVENT\nOn March 17, 1994 the company completed a private financing involving the placement of $115 million of 8-3\/8% notes due 2004. The proceeds will be used to redeem $60 million of the company's outstanding 8-3\/8% notes due 1997 and to repay borrowings under bank lines of credit.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nBeginning on page 27 and continuing through page 41 are the consolidated financial statements with applicable notes and the related Report of Independent Auditors, and the supplementary financial information specified by Item 302 of Regulation S-K.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nCONSOLIDATED STATEMENT OF EARNINGS CINCINNATI MILACRON INC. AND SUBSIDIARIES Fiscal year ends on Saturday closest to December 31.\nSee notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEET CINCINNATI MILACRON INC. AND SUBSIDIARIES Fiscal year ends on Saturday closest to December 31.\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY CINCINNATI MILACRON INC. AND SUBSIDIARIES Fiscal year ends on Saturday closest to December 31.\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS CINCINNATI MILACRON INC. AND SUBSIDIARIES Fiscal year ends on Saturday closest to December 31.\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFISCAL YEAR END\nThe company's year ends on the Saturday closest to December 31 of each year. Fiscal year ends are as follows:\n1993: January 1, 1994 1992: January 2, 1993 1991: December 28, 1991\nCONSOLIDATION\nThe consolidated financial statements include the accounts of the company and its subsidiaries. All significant intercompany transactions are eliminated.\nFOREIGN CURRENCY TRANSLATION\nAssets and liabilities of the company's foreign operations are translated into U.S. dollars at period-end exchange rates, and income and expense accounts are translated at weighted-average exchange rates for the period. Net exchange gains or losses resulting from such translation are excluded from net earnings (loss) and accumulated in a separate component of shareholders' equity. Gains and losses from foreign currency transactions are included in other expense - net in the Consolidated Statement of Earnings. Gains and losses on foreign exchange forward contracts are recognized as part of the specific transaction hedged.\nCASH AND CASH EQUIVALENTS\nThe company considers all highly liquid investments with a maturity of three months or less to be cash equivalents.\nINVENTORY VALUATION\nInventories are stated at the lower of cost or market. The principal methods of determining costs are last-in, first-out (LIFO) for U.S. inventories and average or standard cost, which approximates first-in, first-out (FIFO), for other inventories.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment, including capital leases, are stated at cost. Equipment leased to customers is accounted for under the operating lease method. For financial reporting purposes, depreciation is generally determined on the straight-line method using estimated useful lives of plant and equipment.\nINCOME TAXES\nThe company provides deferred taxes for cumulative temporary differences between the financial reporting basis and income tax basis of its assets and liabilities. Provisions are made for any additional taxes payable on anticipated distributions from subsidiaries.\nEARNINGS PER SHARE\nEarnings per common share are based on the weighted-average number of common shares and common share equivalents outstanding.\nRETIREMENT BENEFIT PLANS\nThe company maintains various pension plans covering substantially all employees. Pension benefits are based primarily on length of service and highest consecutive average five-year compensation. The company's policy is to fund the plans in accordance with applicable laws and regulations.\nCUMULATIVE EFFECT OF CHANGES IN METHODS OF ACCOUNTING\nEffective January 3, 1993, the company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". This standard requires the use of the liability method, under which deferred income tax assets and liabilities related to cumulative differences between an entity's financial reporting and tax basis balance sheets are recognized using expected future tax rates. Previously, the company had used the deferred method, under which deferred income tax assets and liabilities were based on historical differences between financial reporting income and taxable income and recognized using historical income tax rates. Financial results for prior years have not been restated in connection with the adoption of this standard.\nThe company's domestic operations also adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", effective January 3, 1993. This standard requires that the expected cost of postretirement benefits other than pensions, such as health care benefits, that are provided to retirees be recognized on the accrual method during the years that employees render service. The company provides health care benefits to U.S. retirees and previously recognized the related cost as the benefits were paid. The standard does not permit the restatement of the financial results of prior years. Certain of the company's foreign operations also provide postretirement health care benefits to their employees. The company expects to adopt the standard for these operations in 1995.\nThe company has recorded the cumulative effect (to January 2, 1993) of adopting these standards as a charge to earnings in the first quarter of 1993, as follows:\nCUMULATIVE EFFECT OF CHANGES IN METHODS OF ACCOUNTING\nCharge to Earnings Per common (In millions) share ------------ ------- Income taxes $ (4.2) $ (.13) Retiree health care benefits (with no current tax effect) (47.9) (1.48) ------ ------ $(52.1) $(1.61) ====== ======\nThe new standard for accounting for income taxes imposes significant limitations on the recognition and valuation of deferred tax assets related to future tax deductions previously recognized for financial reporting purposes and to net operating loss carryforwards. Because of these limitations, and because the company entered 1993 with a U.S. net operating loss carryforward of approximately $36 million, no income tax benefit could be recognized on a net basis for the cumulative effect of adopting the new accounting rules for postretirement health care benefits.\nCONSOLIDATION CHARGE\nIn the fourth quarter of 1993, the company recorded a nonrecurring charge of $47.1 million (with no current tax effect) for the consolidation of all U.S. machine tool manufacturing into its facilities in Cincinnati. Production at the company's two machine tool facilities in South Carolina, Fountain Inn and Greenwood, will be phased out during 1994. The consolidation is intended to eliminate excess capacity that resulted from the introduction of \"Wolfpack\" designed products that require less hours and manufacturing floor space and from reduced demand from customers in the aerospace industry. The charge includes amounts for severance, relocation of production, and the sale of the two South Carolina facilities.\nDISPOSITION OF SUBSIDIARY\nIn November, 1993, the company announced its decision to sell its Sano business. Accordingly, the company recorded charges in the third and fourth quarters of 1993 totaling $22.8 million (with no current tax effect) to adjust its investment in Sano to net realizable value. The decision to sell Sano was due in part to its continuing operating losses. In addition, the Sano business does not serve a major global market with good long-term growth and profit potential and as a result, does not meet the company's criteria for a core business. The business was sold in February, 1994 and the completion of the transaction is not expected to affect the company's 1994 financial results.\nCLOSING AND RELOCATION CHARGE\nIn the third quarter of 1991, the company recorded a nonrecurring charge aggregating $90.0 million (with no current tax effect) to address problems in loss operations. Of the total charge, $75.1 million related to the relocation of centerless grinding machine and turning center manufacturing operations, the sale or other disposal of the company's remaining grinding machine assets and product lines, and the closing of the company's turning center factory in Wilmington, Ohio.\nAn additional $14.9 million, which is included in discontinued operations in the Consolidated Statement of Earnings, related to the revaluation for sale of the company's coordinate measurement and inspection machine business, LK Tool.\nDISCONTINUED OPERATIONS\nIn 1991, the company announced its intention to sell its coordinate measurement and inspection machine business, LK Tool, and recorded a provision for the anticipated loss on the sale of $14.9 million. During the third quarter of 1993, the company completed the sale of LK Tool for $5.0 million in cash. The completion of the transaction did not affect the company's financial results for 1993.\nACQUISITIONS\nOn February 1, 1993, the company completed the acquisition of GTE Valenite Corporation (Valenite) for $66 million in cash and $11 million of assumed debt. Valenite is a leading producer of consumable industrial metalcutting products. The acquisition, which is being accounted for under the purchase method, was financed principally through the sale of $50 million of accounts receivable and borrowings under a then new $85 million committed revolving credit facility.\nOn November 8, 1993, the company completed the acquisition of Ferromatik, the plastics injection molding machine business of Kloeckner-Werke AG, for DM 82.8 million (approximately $50 million) in cash and DM 10.6 million (approximately $6 million) in assumed debt. A portion of the cash purchase price is expected to be refunded in a post-closing adjustment. The acquisition, which is being accounted for under the purchase method, was financed primarily through borrowings under the company's existing lines of credit, including its committed revolving credit facility, which was amended to increase the lines of credit available thereunder. Ferromatik, which is headquartered in Germany, is one of the world's leading producers of injection molding machines and is recognized for high-end technology and other specialty applications.\nThe aggregate acquisition cost of the company's investments in Valenite and Ferromatik, including professional fees and other costs related thereto and after giving effect to the anticipated refund of a portion of cash paid for Ferromatik, is expected to be approximately $114.7 million. The following table presents the allocation of the aggregate acquisition cost to the assets acquired and liabilities assumed. The amounts included therein with respect to Ferromatik are preliminary and are subject to revision once appraisals, actuarial reviews and other studies of fair value are completed. Goodwill arising from the Valenite acquisition, which is included in other noncurrent assets in the following table, totaled $8.7 million. No goodwill is expected to result from the Ferromatik acquisition.\nALLOCATION OF ACQUISITION COST\n(In millions)\nCash and cash equivalents $ 2.2 Accounts receivable 54.5 Inventories 77.1 Other current assets 15.5 Property, plant and equipment 89.5 Other noncurrent assets 25.1 ------ Total assets 263.9\nAmounts payable to banks and long-term debt due within one year 11.9 Other current liabilities 107.3 Long-term accrued liabilities 25.1 Long-term debt and lease obligations 4.9 ------ Total liabilities 149.2 ------ Total acquisition cost $114.7 ======\nAs presented above, other current liabilities includes a reserve of $44.0 million for the restructuring of Valenite for future profitability. The restructuring plan includes the consolidation of production through the closing of eleven production facilities, the downsizing of two production facilities and a net employee reduction in excess of 500. The total cost of the restructuring is estimated to be $53.7 million ($25.8 million in cash) and includes amounts for severance, relocation and losses on the sale of surplus inventory, machinery and equipment and production facilities. The restructuring, which began March 2, 1993, will be completed in 1994.\nOther current liabilities also includes a reserve of $8.7 million for the restructuring of Ferromatik during 1994. Due to general economic conditions in Europe, the operations of Ferromatik's manufacturing plant were restructured during 1993 and 1992 to improve efficiency and reduce personnel levels. The company and Ferromatik have identified additional restructuring actions, including further personnel reductions, that are expected to improve Ferromatik's profitability in the future. These actions, which are intended to complement the actions already taken prior to the acquisition, will be substantially completed during 1994.\nUnaudited pro forma sales and earnings information for 1993 and 1992 prepared under the assumption that the acquisitions had been completed at the beginning of 1992 is as follows:\nPRO FORMA INFORMATION\n(In millions, except per-share amounts) 1993 1992 ---- ---- Sales $1,128.4 $1,187.5 ======== ========\nEarnings (loss) before extraordinary items and cumulative effect of changes in methods of accounting $ (48.2) $ 19.3 Extraordinary items Loss on early extinguishment of debt (4.4) - Tax benefit from loss carryforward - 4.0 Cumulative effect of changes in methods of accounting (52.1) - -------- --------\nNet earnings (loss) $(104.7) $ 23.3 ======= ========\nEarnings (loss) per common share Earnings (loss) before extraordinary items and cumulative effect of changes in methods of accounting $ (1.50) $ .69 Extraordinary items Loss on early extinguishment of debt (.14) - Tax benefit from loss carryforward - .15 Cumulative effect of changes in methods of accounting (1.61) - ------- -------- Net earnings (loss) $ (3.25) $ .84 ======= ========\nBased on a comprehensive analysis, the company and Valenite had originally estimated that the annual improvement in pretax earnings that would result from the completion of the restructuring plan would be approximately $15.6 million. The pro forma amounts presented above include favorable adjustments based on the original estimate. However, it is expected that the annual savings will exceed the original estimate on an ongoing basis by as much as 20%.\nDuring its fiscal year ended September 30, 1993, Ferromatik incurred significant operating losses due principally to general economic conditions in Europe and its inability to adjust personnel levels to reduced customer demand. The company and Ferromatik estimate that the minimum annual pretax earnings improvement that will result from the restructuring actions taken prior to the acquisition and those that will occur subsequent thereto will be no less than $4.2 million. Accordingly, the pro forma amounts presented above include favorable adjustments based on this estimate, which is based principally on reductions in personnel levels that have occurred since the acquisition and that are expected to occur in 1994. The actual savings from the completion of the restructuring plan are expected to be higher than $4.2 million.\nIn 1991, the company completed the acquisition of the assets and business of SL Abrasives, Inc., a manufacturer of resin-bonded grinding wheels. This transaction, which has been accounted for using the purchase method, did not significantly affect the company's financial position at December 28, 1991, or its results of operations for the year then ended.\nRESEARCH AND DEVELOPMENT\nCharges to operations for research and development activities are summarized below. The amounts include expenses related to the company's Wolfpack product development and process improvement program.\nRESEARCH AND DEVELOPMENT\n(In millions) 1993 1992 1991 ---- ---- ----\nResearch and development $41.9 $34.1 $35.8 Percent of sales 4.1% 4.3% 4.7%\nRETIREMENT BENEFIT PLANS\nSummarized in the following tables are the company's pension cost (income) and funded status of its major pension plans.\nPENSION COST (INCOME)\n(In millions) 1993 1992 1991 ---- ---- ----\nService cost (benefits earned during the period) $ 6.3 $ 6.3 $ 6.4 Interest cost on projected benefit obligation 31.5 29.0 29.6 Actual return on plan assets (54.8) (24.0) (65.1) Net amortization and deferral 14.3 (18.7) 26.0 ----- ----- -----\nPension cost (income) $(2.7) $(7.4) $(3.1) ===== ===== =====\nFUNDED STATUS OF PENSION PLANS AT YEAR-END\n(In millions) 1993 1992 ---- ---- Vested benefit obligation $(340.2) $(263.8) ======= =======\nAccumulated benefit obligation $(353.7) $(269.8) ======= =======\nPlan assets at fair value, primarily listed stocks and debt securities, including company stock of $14.0 in 1993 and $10.6 in 1992 $ 396.9 $ 370.8 Projected benefit obligation (416.9) (332.3) ------- -------\nExcess (deficiency) of plan assets in relation to projected benefit obligation (20.0) 38.5 Unrecognized net (gain ) loss 46.8 (6.5) Unrecognized net transition asset (30.2) (35.8) ------- -------\nAccrued pension liability $ (3.4) $ (3.8) ======= =======\nAt January 1, 1994, the projected benefit obligation of the company's domestic plan exceeded its assets by $37.9 million, while the assets of the plan for United Kingdom employees exceeded the projected benefit obligation by $17.9 million. Because of the current funded status of the plans, no contributions were required or made in 1993, 1992 and 1991. For 1993 and 1992, the assumed discount rates used in determining the projected benefit obligation were 7 1\/2 % and 9%, respectively. The assumed rate of increase in renumeration was 4 1\/2 % for 1993 and 6% for 1992. The weighted-average expected long-term rate of return on plan assets used to determine pension income was 9 1\/2 % in all years presented.\nIn addition to pension benefits, the company also provides varying levels of postretirement health care benefits to most U.S. employees who retire from active service after having attained age 55 and ten years of service. The plan is contributory in nature. Prior to 1993, retiree contributions were based on varying percentages of the average per-contract cost of benefits, with the company funding any excess over these amounts. However, the plan was amended in 1992 to freeze the dollar amount of the company's contributions in future years for employees retiring after 1980 based on specified percentages of the 1993 per-contract cost.\nEffective January 3, 1993, the company's domestic operations adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The change did not significantly affect earnings before extraordinary items and cumulative effect of changes in methods of accounting for 1993.\nThe following table presents the components of the company's liability for future retiree health care benefits.\nACCRUED POSTRETIREMENT HEALTH CARE BENEFITS\n(In millions) 1993 1992 ---- ---- Accumulated postretirement benefit obligation Retirees $(42.6) $(40.5) Fully eligible active participants (7.4) (4.1) Other active participants (8.1) (4.5) ------ ------ (58.1) (49.1) Unrecognized net loss 9.8 - ------ ------ (48.3) (49.1) Unrecognized transition obligation - 47.9 ------ ------ $(48.3) $ (1.2) ====== ======\nAt year-end 1993, $1.4 million of the total liability for postretirement health care benefits is included in current liabilities in the Consolidated Balance Sheet.\nThe retiree health care costs for 1993 were $4.5 million, of which service cost and interest cost were $.3 million and $4.2 million, respectively.\nPrior to 1993, the company recognized the cost of health care benefits paid to U.S. retirees as incurred. Such costs totaled $5.8 million and $5.1 million in 1992 and 1991, respectively.\nThe discount rates used in calculating the accumulated postretirement benefit obligation were 7% for 1993 and 8 1\/2 % for 1992. For 1994, the assumed rate of increase in health care costs used to calculate the accumulated postretirement benefit obligation is 10.6%. This rate is assumed to decrease to varying degrees annually to 5.0% for years 2005 and thereafter. Because of the effect of the 1992 plan changes that froze the dollar amount of the company's contributions for future years, a one percent change in each year in relation to the above assumptions would not significantly change the accumulated postretirement benefit obligation or the total cost of the plan.\nCertain foreign operations of the company also provide postretirement health care benefits to their employees. The company expects to adopt Statement of Financial Accounting Standards No. 106 for these operations in 1995.\nStatement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\", was issued in late 1992 and requires that certain benefits provided by an employer to former or inactive employees be accounted for on the accrual method beginning no later than 1994. The effect of adopting the new standard on the company's operating results and financial position is not material.\nINCOME TAXES\nEffective January 3, 1993, the company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". The standard requires the use of the liability method to recognize deferred income tax assets and liabilities using expected future tax rates. The tax effects of temporary differences that give rise to the recorded deferred tax assets and deferred tax liabilities at year-end 1993 are presented in the following table.\nCOMPONENTS OF DEFERRED TAX ASSETS AND LIABILITIES\n(In millions) 1993 ---- Deferred tax assets Net operating loss and various tax credit carryforwards $ 40.8 Accrued postretirement health care benefits 16.9 Consolidation, restructuring and other reserves 34.8 Inventories, principally due to obsolescence reserves and additional costs inventoried for tax purposes pursuant to the Tax Reform Act of 1986 5.6 Accrued pension costs 5.3 Accrued warranty costs 2.2 Accrued employee benefits other than pensions and retiree health care benefits 3.2 Accounts receivable, principally due to allowances for doubtful accounts 1.3 Foreign investments 9.2 Other 13.1 ------\nTotal deferred tax assets 132.4 Less valuation allowance (95.7) -----\nNet deferred tax assets $ 36.7 ====== Deferred tax liabilities Property, plant and equipment, principally due to differences in depreciation methods $ 26.1 Undistributed earnings of foreign subsidiaries 3.9 Pension assets 2.9 Other 4.2 ------ Total deferred tax liabilities $ 37.1 ====== Net deferred tax liability $ (.4) ======\nSummarized in the following tables are the company's earnings (loss) from continuing operations before income taxes, extraordinary items and cumulative effect of changes in methods of accounting, its provision for income taxes, and a reconcilement of the U.S. statutory rate to the tax provision rate.\nEARNINGS (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, EXTRAORDINARY ITEMS AND CUMULATIVE EFFECT OF CHANGES IN METHODS OF ACCOUNTING\n(In millions) 1993 1992 1991 ---- ---- ----\nUnited States $(41.5) $28.0 $(73.8) Foreign 4.3 (1.0) .4 ------ ----- ------ $(37.2) $27.0 $(73.4) ====== ===== ====== PROVISION FOR INCOME TAXES\nLiability Method Deferred Method (In millions) 1993 1992 1991 -------- -------- -----\nCurrent provision United States $ - $ - $ - State and local 2.4 1.7 2.3 Foreign 4.3 2.3 4.1 ---- ----- ---- 6.7 4.0 6.4 ---- ----- ---- Deferred provision United States - .6 .4 Foreign 1.5 .9 2.9 ---- ----- ---- 1.5 1.5 3.3 ---- ----- ---- Provision recognized as extraordinary benefit - 5.4 - ---- ----- ----\n$8.2 $10.9 $9.7 ==== ===== ====\nIn 1991, the current provision for foreign income taxes included $4.0 million related to a planned withdrawal from the company's United Kingdom pension fund that was completed in 1992.\nCOMPONENTS OF THE PROVISION FOR DEFERRED INCOME TAXES Liability Method Deferred Method (In millions) 1993 1992 1991 -------- ---- ----\nTax effects of consolidation, restructuring and other reserves $ (9.2) $1.2 $3.3 Change in deferred revenue (16.3) - - Depreciation 1.3 - - Change in valuation allowance 25.5 - - Reversal of prior year's deferred taxes related to operating loss carryforward - (.2) - Other .2 .5 - ------ ----- ---- $ 1.5 $1.5 $3.3 ====== ==== ====\nRECONCILEMENT OF THE U.S. STATUTORY RATE TO THE TAX PROVISION RATE\nLiability Method Deferred Method (In percent) 1993 1992 1991 --------- ---- ----\nU.S. statutory tax rate (35.0)% 34.0% (34.0)% Increase (decrease) resulting from Losses without current tax benefits 56.1 5.1 38.2 Effect of operations outside the U.S. (5.5) (2.7) 5.3 State and local taxes, net of federal benefit 6.5 4.2 2.1 Other (.1) (.2) 1.6 ----- ---- ----- 22.0% 40.4% 13.2% ===== ==== =====\nIn 1992, in accordance with accounting rules then in effect, the company recognized an extraordinary tax benefit of $5.4 million, or $.19 per share, from the realization of its U.S. net operating loss carryforward that originated principally from the 1991 closing and relocation charge and a pretax special charge of $32.8 million recorded in 1990 for product discontinuance and the reorganization of grinding machine and certain other machine tool manufacturing operations.\nFor U.S. tax reporting purposes, at year-end 1993 the company had a net operating loss carryforward of approximately $19 million which expires in 2008.\nUndistributed earnings of foreign subsidiaries which are intended to be indefinitely reinvested aggregated $30 million at the end of 1993.\nIncome taxes of $16.1 million, $5.0 million and $4.9 million were paid in 1993, 1992 and 1991, respectively.\nRECEIVABLES\nThe components of notes and accounts receivable less allowances are shown in the following table.\nNOTES AND ACCOUNTS RECEIVABLE LESS ALLOWANCES\n(In millions) 1993 1992 ---- ----\nNotes receivable $ 6.0 $ 8.8 Accounts receivable 190.2 174.1 ------ ------ 196.2 182.9 Less allowances for doubtful accounts 7.9 5.9 ------ ------ $188.3 $177.0 ====== ======\nNotes receivable include amounts not due within one year of $.7 million and $2.2 million in 1993 and 1992, respectively.\nThe acquisition of Valenite was financed in part through the sale of $50.0 million of the company's domestic accounts receivable. The sale transaction, which resulted in costs of $2.2 million in 1993, occurred under a three year receivables purchase agreement with an independent issuer of receivables-backed commercial paper, pursuant to which the company agreed to sell on an ongoing basis and without recourse, an undivided percentage ownership interest in designated pools of accounts receivable. In order to maintain the balance in the designated pools of accounts receivable sold, the company is obligated to sell undivided percentage interests in new receivables as existing receivables are collected. At January 1, 1994, the undivided interest in the company's gross accounts receivable that had been sold to the purchaser aggregated $50.0 million. The company also sold an additional $11.4 million of accounts receivable in the fourth quarter of 1993 under a separate receivables purchase agreement. Costs related to both sales are included in other expense - net in the Consolidated Statement of Earnings. The proceeds are reported as providing operating cash flow in the Consolidated Statement of Cash Flows for 1993.\nINVENTORIES\nInventories amounting to $134.8 million for 1993 and $156.3 million for 1992 are stated at LIFO cost. Such inventories if stated at FIFO cost would be greater by approximately $57.4 million in 1993 and $54.2 million in 1992.\nPROPERTY, PLANT AND EQUIPMENT\nThe components of property, plant and equipment are shown in the following table.\nPROPERTY, PLANT AND EQUIPMENT - NET\n(In millions) 1993 1992 ---- ----\nLand $ 5.7 $ 5.1 Buildings 108.5 108.9 Machinery and equipment 317.1 269.1 ------ ------ 431.3 383.1 Less accumulated amortization and allowances for depreciation 247.3 262.0 ------ ------ $184.0 $121.1 ====== ======\nLIABILITIES\nThe components of accrued and other current liabilities and long-term accrued liabilities are shown in the following tables.\nACCRUED AND OTHER CURRENT LIABILITIES (In millions) 1993 1992 ---- ----\nAccrued salaries, wages and other compensation $ 21.5 $16.3 Consolidation reserve 38.7 - Restructuring reserves 17.1 - Other accrued expenses 92.9 82.7 ------ ----- $170.2 $99.0 ====== =====\nLONG-TERM ACCRUED LIABILITIES (In millions) 1993 1992 ---- ----\nAccrued pension and other compensation $ 24.1 $19.1 Accrued postretirement health care benefits 46.9 - Accrued and deferred taxes 30.5 8.0 Other 27.1 25.9 ------ ----- $128.6 $53.0 ====== =====\nLONG-TERM DEBT AND LEASE OBLIGATIONS\nLong-term debt and lease obligations are shown in the following table.\nLONG-TERM DEBT AND LEASE OBLIGATIONS\n(In millions) 1993 1992 ----- ----\nLong-term debt 8 3\/8 % Senior Notes due 1997 $ 60.0 $ 60.0 12% Sinking Fund Debentures due 2010 10.8 70.8 Industrial Development Revenue Bonds due 2008 10.0 10.0 Revolving credit facility 10.0 - Other 8.8 2.5 ------ ------ 99.6 143.3\nCapital lease obligations 6 3\/4 % Bonds due 2004 7.6 7.6 6 3\/8 % Bonds due 1994 - 1997 3.4 4.2 6 1\/2 % Bonds due 1994 .4 .7 ------ ------ 11.4 12.5 ------ ------ 111.0 155.8 ------ ------ Current maturities (3.4) (1.4) ------ ------- $107.6 $154.4 ====== ======\nThe carrying amount of the company's long-term debt approximates fair value, which is determined using discounted cash flow analysis based on the company's incremental borrowing rate for similar types of financing arrangements.\nThe 8 3\/8 % Senior Notes due 1997 are redeemable at par beginning in 1994 at the company's option. The 12% Sinking Fund Debentures due 2010 have annual sinking fund installments commencing in 1996. The debentures are redeemable at any time at the company's option subject to possible premiums and other restrictions.\nThe Industrial Development Revenue Bonds due 2008 are tax-exempt variable-rate bonds. The interest rate is established weekly and averaged 2.4% in 1993. The bonds are supported by a bank letter of credit, which requires a fee of 1 1\/4 % per annum on the amount outstanding.\nCertain of the above long-term debt obligations contain various restrictions and financial covenants relating principally to additional secured indebtedness.\nAt January 1, 1994, $10.0 million of borrowings under the company's revolving credit facility are included in long-term debt based on the expectation that such amount will remain outstanding for more than one year.\nInterest paid was $19.0 million in 1993, $18.9 million in 1992 and $19.2 million in 1991.\nMaturities of long-term debt for the five years after 1993 are: 1994: $ 2.4 million 1995: 2.0 million 1996: 2.0 million 1997: 67.2 million 1998: 5.4 million\nThe capitalized lease assets are included in property, plant and equipment. Amortization of leased properties is included in depreciation and interest on lease obligations is included in interest expense.\nFuture minimum payments for principal and interest on capitalized leases during the next five years and in the aggregate thereafter are: 1994: $ 1.9 million 1995: 1.5 million 1996: 1.5 million 1997: 1.5 million 1998: .5 million After 1998: 10.7 million\nThe company also leases certain equipment under operating leases, some of which include varying renewal and purchase options. Future minimum rental payments applicable to noncancelable operating leases during the next five years and in the aggregate thereafter are: 1994: $14.6 million 1995: 12.0 million 1996: 8.6 million 1997: 5.5 million 1998: 4.2 million After 1998: 8.6 million\nRent expense was $14.7 million and $9.6 million in 1993 and 1992, respectively, and was not material in 1991.\nLINES OF CREDIT\nAt the end of 1993, the company had formal and informal lines of credit with various domestic and foreign banks of $276.1 million, including a revolving credit facility and other committed lines totaling $137.5 million. These credit facilities support letters of credit and leases in addition to providing borrowings under varying terms. Additional borrowing capacity available under all lines of credit totaled approximately $40 million at January 1, 1994.\nIn January, 1993, in connection with the acquisition of Valenite, the company replaced its previous $55.0 million revolving credit agreement with a new $85.0 million committed revolving credit facility. In connection with the acquisition of Ferromatik, the facility was amended to increase the lines of credit available thereunder to $130.0 million. The facility allows borrowings through July, 1995 and requires a facility fee of 1\/2 % per annum on the total $130.0 million revolving loan commitment.\nThe revolving credit facility requires compliance with certain financial loan covenants related to tangible net worth, interest and fixed charge coverages and debt leverage. The company has remained in compliance with these covenants since the inception of this facility.\nSHAREHOLDERS' EQUITY\nOn April 15, 1993, the company completed the issuance of an additional 5.175 million common shares through a public offering, resulting in net proceeds (after deducting issuance costs) of $100.6 million. The proceeds of the offering were used to redeem $60.0 million of the company's 12% Sinking Fund Debentures due 2010 and to repay borrowings under revolving lines of credit and other bank debt. The redemption of the 12% Sinking Fund Debentures due 2010 effective May 17, 1993 resulted in a pretax extraordinary loss on early extinguishment of debt of $5.2 million ($4.4 million after tax) in the second quarter. The pretax extraordinary loss included a cash call premium of $4.7 million and the write-off of deferred financing fees of $.5 million.\nSHAREHOLDERS' EQUITY - PREFERRED AND COMMON SHARES\n(Dollars in millions, except per-share amounts) 1993 1992 ---- ----\n4% Cumulative Preferred shares authorized, issued and outstanding, 60,000 shares at $100 par value, redeemable at $105 a share $ 6.0 $ 6.0 Common shares, $1 par value authorized 50,000,000 shares, issued and outstanding, 1993: 33,531,723 shares, 1992: 27,505,772 33.5 27.5\nThe company has authorized ten million serial preference shares with $1 par value. None of these shares has been issued.\nHolders of company common stock have one vote per share until they have held their shares for at least 36 consecutive months, after which they are entitled to ten votes per share.\nCONTINGENCIES\nThe Internal Revenue Service has conducted examinations of the company's federal income tax returns for the years 1981 through 1986 and had proposed various adjustments to increase taxable income. During 1993, all issues for these years were resolved with no significant effect on the company's consolidated financial position or results of operations.\nVarious lawsuits arising during the normal course of business are pending against the company and its consolidated subsidiaries. In the opinion of management, the ultimate liability, if any, resulting from these matters will have no significant effect on the company's consolidated financial position or results of operations.\nFOREIGN EXCHANGE CONTRACTS\nThe company enters into foreign exchange contracts to hedge foreign currency transactions on a continuing basis for periods commensurate with its known or expected exposures. The purpose of this practice is to minimize the effect of foreign currency exchange rate fluctuations on the company's operating results. The company does not engage in speculation.\nAt January 1, 1994, the company had outstanding foreign exchange contracts totaling $45.3 million, which generally mature in periods of six months or less. These contracts require the company and its subsidiaries to exchange currencies at the maturity dates at exchange rates agreed upon at inception.\nLONG-TERM INCENTIVE PLANS\nThe 1991 Long-Term Incentive Plan (\"1991 Plan\"), which expired December 31, 1993, permitted the company to grant its common shares in the form of non-qualified stock options, incentive stock options, stock appreciation rights (SARs), restricted stock and performance awards. A summary of amounts issued under the 1991 Plan and prior plans is presented in the tables. The 1994 Long-Term Incentive Plan (\"1994 Plan\") was approved by the company's Board of Directors on February 10, 1994 and, subject to shareholder approval, will provide for issuance of the same types of grants as were permitted by the 1991 Plan with the exception of SARs, which may no longer be granted.\nSTOCK OPTIONS, RESTRICTED STOCK AWARDS AND SARS\nPrice Shares(a) SARs Range -------- ---- -----\nOutstanding at year-end 1990 1,222,537 530,322 $9 - 29 Activity during 1991 - Granted 837,607 110,750 9 - 13 - Exercised (68,357) - 9 - 10 - Canceled (139,759) (125,310) 13 - 29 --------- -------- Outstanding at year-end 1991 1,852,028 515,762 9 - 29 Activity during 1992 - Granted 462,920 - 15 - 16 - Exercised (91,628) - 9 - 25 - Canceled (148,167) - 9 - 25 - SARs Canceled 515,762 (515,762) 9 - 28 --------- --------\nOutstanding at year-end 1992 2,590,915 - 9 - 29 Activity during 1993 - Granted 118,025 - 17 - 24 - Exercised (854,918) - 9 - 25 - Canceled (136,947) - 13 - 29 --------- ---------\nOutstanding at year-end 1993 1,717,075 - $9 - 28 ========= =========\nEXERCISABLE STOCK OPTIONS AND SARS AT YEAR-END\nStock Options(a) SARs ---------- -------\n1991 955,838 276,286 1992 1,748,565 - 1993 1,474,262 -\n(a) Excludes stock options granted in tandem with SARs.\nThe non-qualified stock options and incentive stock options are issued at market and, under the terms of the 1991 Plan, may be granted in tandem with SARs. However, during 1992, all previously granted SARs were canceled with the consent of the holders. Stock options become excercisable under varying terms and expire in ten years. Shares of restricted stock are subject to three-year restrictions against selling, encumbering or otherwise disposing of these Shares. Performance awards may be earned based on achievement of predetermined return-on-capital targets over specified periods.\nThe maximum number of shares available for grant under the 1991 Plan was 1,650,000, of which 262,100 were available for grant at year-end 1992. Additional shares may no longer be granted under the 1991 Plan. The maximum number of shares that may be granted under the 1994 Plan is expected to be 2,000,000.\nGEOGRAPHIC INFORMATION\nThe following table summarizes the company's U.S. and foreign operations which are located principally in Western Europe.\nSales of U.S. operations include export sales of $118.7 million in 1993, $111.7 million in 1992 and $98.6 million in 1991.\nTotal sales of the company's U.S. and foreign operations to unaffiliated customers outside the U.S. were $298.4 million, $242.6 million and $236.0 million, in 1993, 1992 and 1991, respectively.\nU.S. AND FOREIGN OPERATIONS\n(In millions) 1993 1992 1991 ---- ---- ---- U.S. operations Sales $831.9 $654.1 $613.0 Operating earnings 49.6 47.9 23.3 Consolidation charge and closing and relocation charge (47.1) - (75.1) Disposition of subsidiary (22.8) - - Identifiable assets 420.6 410.8 413.9 Liabilities 469.9 403.3 404.7 Capital expenditures 21.3 13.9 11.8 Depreciation 19.1 16.3 19.3\nForeign operations Sales 197.5 135.1 141.0 Operating earnings 8.0 1.5 3.0 Identifiable assets 285.9 148.7 163.6 Liabilities 135.6 41.2 64.7 Capital expenditures 2.1 3.7 3.7 Depreciation 7.0 4.6 4.7\nSEGMENT INFORMATION\nCincinnati Milacron is one of the world's leading manufacturers of plastics machinery, machine tools, computer controls and software for factory automation. In addition, the company is a leading producer of precision grinding wheels, metalworking fluids and metalcutting tools.\nFinancial data for the past three years for the company's business segments are shown in the following tables. SALES BY SEGMENT\n(In millions) 1993 1992 1991 ---- ---- ----\nPlastics machinery $357.2 $301.4 $267.6 Machine tools 355.0 379.7 383.7 Industrial products (a) 317.2 108.1 102.7 -------- ------ ------ $1,029.4 $789.2 $754.0 ======== ====== ======\nOPERATING INFORMATION BY SEGMENT\n(In millions) 1993 1992 1991 ---- ---- ---- Operating earnings (loss) Plastics machinery (b) $ 26.6 $22.8 $14.6 Machine tools 3.9 8.9 (6.6) Industrial products (a) 27.1 17.7 18.3 Consolidation charge and closing and relocation charge (c) (47.1) - (75.1) Disposition of subsidiary (d) (22.8) - - Unallocated corporate expenses (e) (11.5) (6.2) (9.5) ------ ----- ----- Operating earnings (loss) (23.8) 43.2 (58.3) Interest expense-net (13.4) (16.2) (15.1) ------ ----- ----- Earnings (loss) from continuing operations before income taxes, extraordinary items and cumulative effect of changes in methods of accounting $(37.2) $27.0 $(73.4) ====== ===== ======\nIdentifiable assets Plastics machinery $289.0 $219.9 $202.9 Machine tools 243.1 282.8 310.9 Industrial products (a) 174.4 56.8 63.7 Unallocated corporate assets (f) 23.1 19.4 20.9 ------ ------ ------ Total assets $729.6 $578.9 $598.4 ====== ====== ======\nCapital expenditures Plastics machinery $ 4.2 $ 6.2 $ 6.5 Machine tools 8.8 7.1 7.5 Industrial products (a) 10.4 4.3 1.5 ------ ------ ------ Total capital expenditures $ 23.4 $ 17.6 $ 15.5 ====== ====== ====== Depreciation Plastics machinery $ 6.2 $ 7.7 $ 7.0 Machine tools 9.4 10.6 14.2 Industrial products (a) 10.5 2.6 2.8 ------ ------ ------ Total depreciation $ 26.1 $ 20.9 $ 24.0 ====== ====== ======\n(a) The 1993 increases in the industrial products segment are largely attributable to the inclusion of Valenite as of February 1, 1993. (b) The 1993 amount includes a $2.5 million gain on sale of surplus land. (c) These amounts relate to the machine tool segment. (d) This amount relates to the plastics machinery segment. (e) Includes corporate research and development and certain administrative expenses. The 1993 amount includes amortization of financing costs and costs related to the sale of receivables totaling $3.0 million. (f) Includes cash and cash equivalents and the assets of the company's insurance and utility subsidiaries.\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Cincinnati Milacron Inc.\nWe have audited the accompanying Consolidated Balance Sheet of Cincinnati Milacron Inc. and subsidiaries as of January 1, 1994 and January 2, 1993, and the related Consolidated Statements of Earnings, Changes in Shareholders' Equity, and Cash Flows for each of the three years in the period ended January 1, 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 consolidated financial position of Cincinnati Milacron Inc. and subsidiaries at January 1, 1994 and January 2, 1993, and the consolidated results of their operations and their 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.\nAs discussed in the Note to Consolidated Financial Statements, Cumulative Effect of Changes in Methods of Accounting, in 1993 the company changed its method of accounting for postretirement benefits other than pensions and its method of accounting for income taxes.\n\/s\/ ERNST & YOUNG\nCincinnati, Ohio February 28, 1994\nSUPPLEMENTARY FINANCIAL INFORMATION\nOPERATING RESULTS BY QUARTER (Unaudited)\n(a) The fiscal year consists of thirteen four-week periods in 1993 and twelve four-week periods and one five week period in 1992. The first and second quarters consist of twelve weeks each, and the third quarter, sixteen weeks. The fourth quarter of 1993 consists of twelve weeks and the fourth quarter of 1992 consists of thirteen weeks.\n(b) The fourth quarter includes a charge of $47.1 million (with no current tax effect) for the consolidation of domestic machine tool manufacturing operations. Earnings were also reduced by charges of $18.1 million in the third quarter and $4.7 million in the fourth quarter (with no current tax effect) for the disposition of the company's Sano business.\n(c) Because the quarter per-share amounts are based on the weighted-average shares outstanding in each period, their sum does not equal the annual calculation.\nPART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by Item 10 is (i) incorporated herein by reference to the \"Election of Directors\" section of the company's proxy statement dated March 25, 1994 and (ii) included in Part I on pages 16 through 17 of this Form 10-K.\nITEM 11. EXECUTIVE COMPENSATION\nThe \"Executive Compensation\" section of the company's proxy statement dated March 25, 1994 is incorporated herein by reference.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe \"Principal Holders of Voting Securities\" section of the company's proxy statement dated March 25, 1994 is incorporated herein by reference.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe paragraph captioned \"Stock Option Loan Programs\" of the company's proxy statement dated March 25, 1994 is incorporated herein by reference.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nITEM 14(A)(1)&(2)-- LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Cincinnati Milacron Inc. and subsidiaries are included in Item 8:\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 (a)(3) - LIST OF EXHIBITS\n(3) Articles of Incorporation and By-Laws\n3.1 Restated Certificate of Incorporation filed with the Secretary of State of the State of Delaware on June 16, 1983 - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 28, 1985, as amended by Amendment No. 1 thereto on Form 8 dated June 30, 1986, and Amendment No. 2 thereto on Form 8 dated July 17, 1986 (File No. 1-8485)\n3.2 Certificate of Amendment of the Restated Certificate ofIncorporation dated April 22, 1986, and filed with the Secretary of State of the State of Delaware on April 22, 1986 - Incorporated herein by reference to the company's Form 10-Q for the quarter ended March 22, 1986 (File No. 1-8485)\n3.3 Certificate of Amendment of the Restated Certificate of Incorporation dated June 11, 1987, and filed with the Secretary of State of the State of Delaware on June 15, 1987 - Incorporated herein by reference to the company's Form 10-Q for the quarter ended March 28, 1987 (File No. 1-8485)\n3.4 By-laws, as amended - Incorporated herein by reference to the company's Registration Statement on Form S-8 (Registration No. 33-33623)\n(4) Instruments Defining the Rights of Security Holders, Including Indentures:\n4.1 12% Sinking Fund Debentures due July 15, 2010 - Incorporated herein by reference to the company's Registration Statement on Form S-3 (Registration No. 2-98653)\n4.2 8-3\/8% Notes due 1997 - Incorporated herein by reference to the company's Form 8-K dated February 25, 1987 (File No. 1-8485)\n4.3 Cincinnati Milacron Inc. hereby agrees to furnish to the Securities and Exchange Commission, upon its request, the instruments with respect to long-term debt for securities authorized thereunder which do not exceed 10% of the registrant's total consolidated assets\n(9) Voting Trust Agreement- not applicable\n(10) Material Contracts:\n10.1 Cincinnati Milacron 1984 Long-Term Incentive Plan - Incorporated herein by reference to the company's Registration Statement on Form S-8 (Registration No. 2-89499)\n10.2 Cincinnati Milacron 1987 Long-Term Incentive Plan - Incorporated herein by reference to the company's Proxy Statement dated March 27, 1987\n10.3 Cincinnati Milacron 1991 Long-Term Incentive Plan - Incorporated herein by reference to the company's Form 10-Q for the quarter ended June 15, 1991\n10.4 Cincinnati Milacron Inc. Short-Term Management Incentive Program - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended January 3, 1987 10.5 Cincinnati Milacron Inc. Supplemental Pension Plan - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 31, 1988\n10.6 Cincinnati Milacron Inc. Supplemental Retirement Plan #2 - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 31, 1988\n10.7 Cincinnati Milacron Retirement Savings Plan - Incorporated herein by reference to the company's Registration Statement on Form S-8 (Registration No. 33-33623)\n10.8 Cincinnati Milacron Inc. Plan for the Deferral of Directors' Compensation - Incorporated herein by reference to the company's Form 10-Q for the quarter ended June 15, 1991\n10.9 Underwriting Agreement between Cincinnati Milacron Inc. and the First Boston Corporation - Incorporated herein by reference to the company's Registration Statement on Form S-3 (Registration No. 33-35097)\n10.10 Cincinnati Milacron Inc. 1988 Restricted Stock Plan for Non-Employee Directors - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 29, 1990\n10.11 Cincinnati Milacron Inc. Retirement Plan for Non-Employee Directors - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 29, 1990\n10.12 Cincinnati Milacron Inc. 1991 Restricted Stock Plan for Non-Employee Directors - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 29, 1990\n10.13 Valenite Stock Purchase Agreement between GTE Corporation and Cincinna Milacron, Inc. - Incorporated herein by reference to the company's Form 8-K dated February 1, 1993.\n10.14 Purchase Agreement between Kloeckner Ferromatik Desma GmbH, Kloeckner Werke Aktiengesellschaft and Cincinnati Milacron Inc. - Incorporated herein by reference to the company's Form 8-K dated November 8, 1993.\n10.15 Cincinnati Milacron Supplemental Executive Retirement Plan - Filed herewith\n10.16 Amended and Restated Revolving Credit Agreement dated as of January 28, 1993, and amended and restated as of July 20, 1993 - Incorporated herein by reference to the company's Form 10-Q for the quarter ended October 9, 1993.\n10.17 Amendment Number One, dated as of October 26, 1993, to the Amended and Restated Revolving Credit Agreement dated as of January 28, 1993, and amended and restated as of July 20, 1993, among Cincinnati Milacron Inc., the Lenders listed therein and Bankers Trust Company, as Agent - Incorporated herein by reference to the company's Form 8-K dated November 8, 1993.\n10.18 Amendment Number Two, dated as of December 31, 1993, to the Amended and Restated Revolving Credit Agreement dated as of January 28, 1993, as amended and restated as of October 26, 1993, among Cincinnati Milacron Inc., the Lenders listed therein and Bankers Trust Company, as Agent - Filed herewith\n(11) Statement Regarding Computation of Per-Share Earnings\n(12) Statement Regarding Computation of Ratios- not applicable\n(18) Letter Regarding Change in Accounting Principles- not applicable\n(21) Subsidiaries of the Registrant\n(22) Published Report Regarding Matters Submitted to Vote of Security Holders - Incorporated by reference to the company's Proxy Statement dated March 25, 1994.\n(23) Consent of Independent Auditors\n(24) Power of Attorney- not applicable\n(27) Financial Data Schedule - not applicable\n(28) Information from Reports Furnished to State Insurance Regulatory Authorities- not applicable\n(99) Additional Exhibits- not applicable\nITEM 14(B)-- REPORTS ON FORM 8-K\nOne report on Form 8-K was filed during the fourth quarter of 1993.\n(i) November 8, 1993 - The company reported the closing of the purchase of the Ferromatik business of Kloeckner Ferromatik Desma GmbH\nITEM 14(C)&(D)-- EXHIBITS AND FINANCIAL STATEMENT SCHEDULES\nThe responses to these portions of Item 14 are 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.\nCINCINNATI MILACRON INC.\nBY: \/s\/ Daniel J. Meyer ---------------------------------------------- Daniel J. Meyer; Chairman and Chief Executive Officer, Director (Chief Executive Officer)\nBY: \/s\/ Raymond E. Ross ----------------------------------------------- Raymond E. Ross; President and Chief Operating Officer, Director (Chief Operating Officer)\nBY: \/s\/ Ronald D. Brown ----------------------------------------------- Ronald D. Brown; Vice President- Finance (Chief Financial Officer)\nBY: \/s\/ Robert P. Lienesch ----------------------------------------------- Robert P. Lienesch; Controller (Chief Accounting Officer)\nDate: March 25, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ Neil A. Armstrong \/s\/ Darryl F. Allen - ------------------------------------ ---------------------------------- Neil A. Armstrong; March 25, 1994 Darryl F. Allen; March 25, 1994 (Director) (Director)\n\/s\/ Harry A. Hammerly \/s\/ James A. D. Geier - ----------------------------------- ---------------------------------- Harry A. Hammerly; March 25, 1994 James A. D. Geier; March 25, 1994 (Director) (Director)\nITEM 14(C) AND (D)-- INDEX TO CERTAIN EXHIBITS AND FINANCIAL STATEMENT SCHEDULES Page No. -------- Exhibit 11 Computation of Per-Share Earnings 49\nExhibit 21 Subsidiaries of the Registrant 50\nExhibit 23 Consent of Independent Auditors 51\nSchedule II Amounts Receivable From Related Parties and Underwriters, Promoters and Employees Other Than Related Parties 52\nSchedule V Property, Plant and Equipment 53\nSchedule VI Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment 54\nSchedule VIII Valuation and Qualifying Accounts and Reserves 55\nSchedule IX Short-Term Borrowings 56\nSchedule X Supplementary Income Statement Information 57\n(a) Represents borrowings under the company's Key Employee Stock Option Loan Program, which bear interest at 6%.\nCINCINNATI MILACRON INC. AND SUBSIDIARIES\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT\nYears Ended 1993, 1992 and 1991\n(In Thousands)\n(a) Consists principally of foreign currency translation adjustments and in 1993 includes amounts related to the revaluation for sale of certain Valenite assets.\n(b) Assets acquired through the purchase of Valenite Inc. in February, 1993 and Ferromatik Milacron Maschinenbau GmbH in November, 1993.\n(c) Assets acquired through the purchase of the assets and business of SL Abrasives, Inc. in January, 1991.\nNote: Depreciation has been computed principally in accordance with the following general range of useful lives: buildings (20 to 45 years), building equipment (5 to 30 years), automobiles and trucks (3 to 7 years), and other machinery and equipment (2 to 20 years).\nCINCINNATI MILACRON INC. AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nYears Ended 1993, 1992 and 1991\n(In Thousands)\n(a) Consists principally of foreign currency translation adjustments and in 1993 includes amounts related to the revaluation for sale of certain Valenite assets.\n(b) Relates to 1993 consolidation charge and 1991 closing and relocation charge.\nCINCINNATI MILACRON INC. AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nYears Ended 1993, 1992 and 1991\n(In Thousands)\n(a) Represents amounts charged against the reserves during the year. (b) Represents foreign currency translation adjustments in all years and in 1993 includes reserves of subsidiaries sold during the year. (c) Consists of reserves of subsidiaries purchased during the year. (d) Includes $1,500 in long-term accrued liabilities. (e) Includes $4,670 in long-term accrued liabilities. (f) Includes $8,900 in long-term accrued liabilities.\nSCHEDULE IX - SHORT-TERM BORROWINGS\nYears Ended 1993, 1992 and 1991\n(In Thousands)\n(a) These balances represent borrowings under formal lines of credit. These arrangements provide for borrowings at prevailing market rates.\nCINCINNATI MILACRON INC. AND SUBSIDIARIES\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nYears Ended 1993, 1992 and 1991\n(In Thousands) COL. A COL. B - ------------------------------------------------------------------------------- Item Charged to Costs and Expenses\n- -------------------------------------------------------------------------------\n1993 1992 1991 ------- ------- -------\nMaintenance and repairs $14,752 $11,430 $12,828 ======= ======= =======\nTaxes, other than payroll and income taxes $ 9,879 $10,145 $ 8,196 ======= ======= =======\nAdvertising $ 9,908 $ 9,573 $ 7,462 ======= ======= =======\nNote: Amounts for royalties and amortization of intangible assets are not presented, as such amounts are less than 1% of total sales.","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThe company's financial results for the last three years, presented on page 27, are discussed below. The company operates in three principal business segments: plastics machinery, machine tools and industrial products. Financial information for each of these segments is presented on pages 5 and 6.\n1993 COMPARED TO 1992 - ---------------------\nSALES\nSales in 1993 were $1,029 million, which represented a $240 million increase over 1992. This increase was primarily attributable to the $209 million increase in sales of industrial products which resulted from the acquisition of Valenite in February, 1993. The plastics machinery sales increase totaled $56 million, or 19%, which resulted primarily from increased domestic sales of injection molding machines and the acquisition of Ferromatik in November, 1993. Machine tool sales declined by $25 million, or 7%, due to the decline in sales of advanced machine tools for the aerospace market.\nSales of all segments to foreign markets totaled $298 million, compared to $243 million in 1992. Export shipments increased by $7 million due to the acquisition of Valenite which more than offset reductions in exports of injection molding machines and advanced machine tools to Europe.\nNEW ORDERS AND BACKLOG\nNew orders for 1993 were $970 million, which represented a $208 million increase over 1992. The increase was caused by a $60 million, or 20%, improvement in plastics machinery orders and by orders totaling $209 million for Valenite. Machine tool orders declined by $61 million, or 17%. This decline was caused principally by (i) a large order (over $25 million) that was received in the third quarter of 1992 that was not repeated in 1993, (ii) reduced demand from customers in the aerospace industry and (iii) the discontinuation of certain less profitable product lines. Export orders approximated $100 million in 1993 and 1992; in 1993, export orders for industrial products increased due to the Valenite acquisition while export orders for plastics machinery and machine tools declined.\nAt January 1, 1994, the backlog of unfilled orders was $246 million, down from $250 million a year ago, reflecting reduced orders for aerospace equipment which was partially offset by the acquisitions of Valenite and Ferromatik and the increased backlog of orders for other plastics machinery products.\nMARGINS, COSTS AND EXPENSES\nManufacturing margins increased from 22.4% in 1992 to 23.1% in 1993. Margins for plastics machinery continued to be held back due to competitive pricing pressures in the U.S. and Europe. Margins for machine tools declined primarily due to the severe reduction in shipments of advanced machine tools to aerospace customers that resulted in significant excess capacity costs late in 1993. Margins for industrial products, excluding Valenite, declined in 1993 due in part to reduced volume of European cutting fluids. The Valenite acquisition contributed to the overall increase in manufacturing margins in 1993.\nSelling and administrative expense for 1993 increased over 1992 due to increased sales. Excluding the effects of the Valenite acquisition, selling expense remained constant at approximately 14% of sales. Administrative expense increased primarily due to the Valenite acquisition.\nInterest expense, net of interest income, for 1993 decreased by $2.8 million compared with 1992. This reduction resulted primarily from the redemption of $60 million of the company's 12% Sinking Fund Debentures due 2010.\nCONSOLIDATION CHARGE\nA nonrecurring charge of $47.1 million was recorded in 1993 for the consolidation of U.S. machine tool manufacturing into facilities in Cincinnati. Production at the company's two machine tool facilities in Fountain Inn and Greenwood, South Carolina are being phased out and the plants are expected to be closed by year-end 1994. The consolidation will reduce the machine tool group's employment by a net 235 people. The charge includes amounts for severance, relocation of production and the sale of the two South Carolina facilities.\nThe consolidation addresses excess manufacturing capacity created by two factors: the company's successful Wolfpack program, which has significantly reduced the hours and floorspace required to manufacture and assemble machine tool products; and the unusually steep recession in the aerospace industry, which has dramatically lowered demand for the company's advanced machine tool systems.\nThe consolidation is expected to result in an incremental cash requirement for 1994, before considering any proceeds from the disposition of assets, of approximately $18 million which will be funded by operations and bank borrowings. The consolidation, once fully implemented, is expected to result in annual cost savings of approximately $16 million.\nDISPOSITION OF SUBSIDIARY\nA nonrecurring charge of $22.8 million was recorded in 1993 to revalue the company's Sano subsidiary in anticipation of its sale. The decision to sell Sano was due in part to continuing operating losses. In addition, the Sano business does not serve a major global market with good long-term growth and profit potential and as a result, does not meet the company's criteria for a core business. The business was sold in February, 1994 and the transaction is not expected to affect the company's 1994 financial results.\nINCOME TAXES AND EXTRAORDINARY TAX BENEFIT\nThe provision for income taxes in 1993 consists of domestic state and local taxes and certain foreign taxes. Current tax benefits were not offset against the domestic loss that was caused by the nonrecurring charges described above, in accordance with new income tax accounting rules adopted in 1993. In addition, current tax benefits could not be recognized for losses in certain foreign jurisdictions. At the end of 1993, for U.S. Federal tax reporting purposes, the company has a U.S. net operating loss carryforward of approximately $19 million which expires in 2008.\nThe provision for income taxes in 1992 of approximately 40% includes the Federal statutory rate as well as the effect of state and local and foreign income taxes.\nThe extraordinary tax benefit in 1992 resulted from the utilization of a portion of the company's net operating loss carryforward.\nEARNINGS\nFor 1993, before extraordinary items and cumulative effect of changes in methods of accounting, the company reported a loss of $45.4 million, or $1.41 per share, compared with a profit of $16.1 million, or $.58 per share, for 1992. The reduction in earnings from 1992 to 1993 was caused by the nonrecurring charges described above that totaled $69.9 million.\nThe net loss for 1993 includes the effect of an extraordinary charge of $4.4 million, or $.14 per share, related to the early extinguishment of $60 million of 12% Sinking Fund Debentures due 2010.\nThe net loss for 1993 also includes the effect of adopting two new accounting standards resulting in charges to earnings totaling $52.1 million, or $1.61 per share. The first new standard, SFAS No. 109, significantly changes existing methods of accounting for income taxes and resulted in a charge of $4.2 million, or $.13 per share. The second standard, SFAS No. 106, requires that certain postretirement benefits, such as health care, be accounted for on the accrual method. The adoption of this standard resulted in a charge of $47.9 million, or $1.48 per share, to record the accrued liability for retiree health care benefits. Because of limitations on the recognition of deferred tax assets under SFAS No. 109, no income tax benefit could be recorded in connection with the adoption of SFAS No. 106. Except for the cumulative effect, the new rules regarding postretirement medical benefits did not significantly affect the company's earnings for 1993, while the new rules regarding income taxes precluded the recognition of tax benefits with respect to domestic and certain foreign operating losses.\nAs discussed above, the company recorded an extraordinary tax benefit from the utilization of loss carryforwards of $5.4 million, or $.19 per share, for 1992.\nAfter the nonrecurring charges, extraordinary items and cumulative effect of changes in methods of accounting, the company had a net loss of $101.9 million, or $3.16 per share, for 1993, compared with net earnings of $21.5 million, or $.77 per share, for 1992. The reduction in net earnings from 1992 to 1993 was caused by the nonrecurring charges, the extraordinary item and the cumulative effect of changes in methods of accounting that totaled $126.4 million.\n1992 COMPARED TO 1991 - ---------------------\nSALES\nSales in 1992 were $789 million, which represented a 5% increase from $754 million in 1991. The increase was caused by a 13% increase in plastics machinery sales and a 5% increase in sales of industrial products. The plastics machinery increase was due in large part to increased sales of injection molding machines in the U.S. and Europe. Increased sales of industrial products resulted from higher sales of grinding wheels in the U.S. and cutting fluids in Europe. Sales of machine tools declined approximately 1%. The decrease is attributable to the phase-out of certain less profitable turning center and grinding machine product lines, which were formerly manufactured at the company's plants in Wilmington, Ohio, and Worcester, Massachusetts, respectively, which have been closed. The cost to close these plants, along with the cost to relocate certain product lines to more modern facilities, was included in the $75 million closing and relocation charge recorded in the third quarter of 1991.\nSales of all segments to foreign markets totaled $243 million in 1992 compared to $236 million in 1991. Export shipments increased by $13 million, but sales by the company's European subsidiaries to non-U.S. markets declined by $6 million due to the continuing recession in the European capital goods market. NEW ORDERS AND BACKLOG\nNew orders in 1992 were $762 million compared to $770 million in 1991. Orders for machine tools declined by $46 million due to reductions in orders for advanced machine tool systems from the aerospace industry due to difficulties in the commercial airline industry. Such aerospace orders remained soft in 1993. Orders for plastics machinery increased by 12%, largely due to increased orders for injection molding machines. Industrial products orders improved by 5%. The backlog of unfilled orders decreased from $277 million in 1991 to $250 million in 1992 due to an unusually high level of aerospace sales in the 1992 fourth quarter, which were not replaced with new orders.\nMARGINS, COSTS AND EXPENSES\nThe company's manufacturing margin in 1992 was 22.4% compared to 20.0% in 1991. Margins improved for all business segments compared to 1991. Most significantly, plastics machinery margins improved due to higher volume while machine tool margins improved due to the aforementioned plant closing and phase-out of less profitable product lines. Machine tool margins were held back in 1992 due to continued price discounting in several soft metalworking markets and by cost overruns on certain large aerospace systems.\nSelling and administrative expense increased from $132 million in 1991 to $134 million in 1992. The increase resulted from increased selling expense associated with the higher sales volume. Selling expense approximated 14% of sales in both years. Administrative expense declined due to cost containment initiatives.\nINCOME TAXES AND EXTRAORDINARY TAX BENEFIT\nThe company's effective tax rate of 40% in 1992 exceeded the Federal statutory rate due principally to domestic state and local income taxes and the effect of foreign operating losses for which tax benefits were not currently available. The provision for income taxes in 1991 consisted of domestic state and local and foreign income taxes, as well as a $4 million tax on a planned withdrawal of surplus assets from the company's British pension fund that was completed in 1992. Because the company entered 1991 with a U.S. net operating loss carryforward, domestic Federal income tax benefits could not be recognized with respect to the losses incurred in that year.\nThe extraordinary tax benefit recognized in 1992 results from the utilization of a portion of the company's U.S. net operating loss carryforward for financial reporting purposes that arose principally from the 1991 closing and relocation charge.\nEARNINGS\nIn 1992, the company earned $16.1 million, or $.58 per share, from continuing operations before extraordinary item, compared with a loss of $83.1 million, or $3.04 per share, in 1991. The 1991 figures were adversely affected by a $75.1 million closing and relocation charge and the $4.0 million tax provision for the anticipated withdrawal from the company's British pension plan.\nIn 1991, the company announced its intention to sell LK Tool, its coordinate measurement and inspection machine business, due in part to continuing operating losses. The losses from discontinued operations of $17.1 million, or $.63 per share, for 1991, included a $14.9 million nonrecurring charge to revalue for sale the company's investment in LK Tool. The subsidiary was sold in 1993.\nNet earnings were $21.5 million, or $.77 per share, in 1992, compared with a $100.2 million net loss, or $3.67 per share, in 1991. The 1991 losses were caused principally by the aforementioned nonrecurring charges totaling $94.0 million.\nLIQUIDITY AND SOURCES OF CAPITAL\nAt January 1, 1994, the company had cash and cash equivalents of $19 million, an increase of $4 million during the year. In 1993, operating activities provided $22 million of cash. During 1993, the company sold interests in certain accounts receivable resulting in cash proceeds of approximately $61 million. At year-end 1992 the company had sold $13 million of domestic accounts receivable under a separate agreement that was terminated early in 1993. The net cash proceeds from these transactions of $48 million are included in cash provided by operating activities.\nApproximately $50 million of the $61 million proceeds in 1993 resulted from the sale of accounts receivable under a three year receivables purchase agreement with an independent issuer of receivables-backed commercial paper, pursuant to which the company agreed to sell on an ongoing basis an undivided percentage ownership interest in designated pools of accounts receivable. The remaining $11 million of such proceeds resulted from the sale of an undivided percentage ownership interest in certain accounts receivable originated by Valenite in a separate transaction that is expected to be incorporated into the three year receivables agreement referred to above.\nExpenditures for new property, plant and equipment for 1993 were $23.4 million, as compared to $17.6 million for 1992. Capital expenditures for 1994 are expected to be approximately $40 million. Proceeds from the disposal of property, plant and equipment for 1993 were $22.2 million, compared to $11.1 million in 1992, and included amounts related to the sale of surplus assets (including surplus land in 1993) and the sale and operating leaseback of certain manufacturing equipment.\nDuring 1993, the company issued 5.175 million shares of common stock, resulting in net proceeds of $101 million, which were used principally to redeem $60 million of 12% debentures (plus a cash call premium of $4.7 million) and to repay borrowings under revolving lines of credit and other bank debt.\nIn the fourth quarter of 1993, the company acquired Ferromatik for approximately $56 million, which was financed by assuming $6 million of debt and utilizing $50 million of borrowings under bank lines of credit.\nIn addition, in 1993 the company recorded several large non-cash items: a $47.1 million consolidation charge, a $22.8 million charge for disposition of a subsidiary and a $52.1 million charge for cumulative effects of changes in methods of accounting. As a result of these and other factors, including financing for the acquisitions, in 1993, the company's working capital decreased by $78 million, the current ratio declined to 1.3 and the ratio of total debt to total capital increased to 60%.\nAt January 1, 1994, the company had lines of credit of approximately $138 million with various U.S. and foreign banks. Additional borrowing capacity available under committed lines of credit totaled approximately $40 million at January 1, 1994.\nSUBSEQUENT EVENT\nOn March 17, 1994 the company completed a private financing involving the placement of $115 million of 8-3\/8% notes due 2004. The proceeds will be used to redeem $60 million of the company's outstanding 8-3\/8% notes due 1997 and to repay borrowings under bank lines of credit.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nBeginning on page 27 and continuing through page 41 are the consolidated financial statements with applicable notes and the related Report of Independent Auditors, and the supplementary financial information specified by Item 302 of Regulation S-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nCONSOLIDATED STATEMENT OF EARNINGS CINCINNATI MILACRON INC. AND SUBSIDIARIES Fiscal year ends on Saturday closest to December 31.\nSee notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEET CINCINNATI MILACRON INC. AND SUBSIDIARIES Fiscal year ends on Saturday closest to December 31.\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY CINCINNATI MILACRON INC. AND SUBSIDIARIES Fiscal year ends on Saturday closest to December 31.\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS CINCINNATI MILACRON INC. AND SUBSIDIARIES Fiscal year ends on Saturday closest to December 31.\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFISCAL YEAR END\nThe company's year ends on the Saturday closest to December 31 of each year. Fiscal year ends are as follows:\n1993: January 1, 1994 1992: January 2, 1993 1991: December 28, 1991\nCONSOLIDATION\nThe consolidated financial statements include the accounts of the company and its subsidiaries. All significant intercompany transactions are eliminated.\nFOREIGN CURRENCY TRANSLATION\nAssets and liabilities of the company's foreign operations are translated into U.S. dollars at period-end exchange rates, and income and expense accounts are translated at weighted-average exchange rates for the period. Net exchange gains or losses resulting from such translation are excluded from net earnings (loss) and accumulated in a separate component of shareholders' equity. Gains and losses from foreign currency transactions are included in other expense - net in the Consolidated Statement of Earnings. Gains and losses on foreign exchange forward contracts are recognized as part of the specific transaction hedged.\nCASH AND CASH EQUIVALENTS\nThe company considers all highly liquid investments with a maturity of three months or less to be cash equivalents.\nINVENTORY VALUATION\nInventories are stated at the lower of cost or market. The principal methods of determining costs are last-in, first-out (LIFO) for U.S. inventories and average or standard cost, which approximates first-in, first-out (FIFO), for other inventories.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment, including capital leases, are stated at cost. Equipment leased to customers is accounted for under the operating lease method. For financial reporting purposes, depreciation is generally determined on the straight-line method using estimated useful lives of plant and equipment.\nINCOME TAXES\nThe company provides deferred taxes for cumulative temporary differences between the financial reporting basis and income tax basis of its assets and liabilities. Provisions are made for any additional taxes payable on anticipated distributions from subsidiaries.\nEARNINGS PER SHARE\nEarnings per common share are based on the weighted-average number of common shares and common share equivalents outstanding.\nRETIREMENT BENEFIT PLANS\nThe company maintains various pension plans covering substantially all employees. Pension benefits are based primarily on length of service and highest consecutive average five-year compensation. The company's policy is to fund the plans in accordance with applicable laws and regulations.\nCUMULATIVE EFFECT OF CHANGES IN METHODS OF ACCOUNTING\nEffective January 3, 1993, the company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". This standard requires the use of the liability method, under which deferred income tax assets and liabilities related to cumulative differences between an entity's financial reporting and tax basis balance sheets are recognized using expected future tax rates. Previously, the company had used the deferred method, under which deferred income tax assets and liabilities were based on historical differences between financial reporting income and taxable income and recognized using historical income tax rates. Financial results for prior years have not been restated in connection with the adoption of this standard.\nThe company's domestic operations also adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", effective January 3, 1993. This standard requires that the expected cost of postretirement benefits other than pensions, such as health care benefits, that are provided to retirees be recognized on the accrual method during the years that employees render service. The company provides health care benefits to U.S. retirees and previously recognized the related cost as the benefits were paid. The standard does not permit the restatement of the financial results of prior years. Certain of the company's foreign operations also provide postretirement health care benefits to their employees. The company expects to adopt the standard for these operations in 1995.\nThe company has recorded the cumulative effect (to January 2, 1993) of adopting these standards as a charge to earnings in the first quarter of 1993, as follows:\nCUMULATIVE EFFECT OF CHANGES IN METHODS OF ACCOUNTING\nCharge to Earnings Per common (In millions) share ------------ ------- Income taxes $ (4.2) $ (.13) Retiree health care benefits (with no current tax effect) (47.9) (1.48) ------ ------ $(52.1) $(1.61) ====== ======\nThe new standard for accounting for income taxes imposes significant limitations on the recognition and valuation of deferred tax assets related to future tax deductions previously recognized for financial reporting purposes and to net operating loss carryforwards. Because of these limitations, and because the company entered 1993 with a U.S. net operating loss carryforward of approximately $36 million, no income tax benefit could be recognized on a net basis for the cumulative effect of adopting the new accounting rules for postretirement health care benefits.\nCONSOLIDATION CHARGE\nIn the fourth quarter of 1993, the company recorded a nonrecurring charge of $47.1 million (with no current tax effect) for the consolidation of all U.S. machine tool manufacturing into its facilities in Cincinnati. Production at the company's two machine tool facilities in South Carolina, Fountain Inn and Greenwood, will be phased out during 1994. The consolidation is intended to eliminate excess capacity that resulted from the introduction of \"Wolfpack\" designed products that require less hours and manufacturing floor space and from reduced demand from customers in the aerospace industry. The charge includes amounts for severance, relocation of production, and the sale of the two South Carolina facilities.\nDISPOSITION OF SUBSIDIARY\nIn November, 1993, the company announced its decision to sell its Sano business. Accordingly, the company recorded charges in the third and fourth quarters of 1993 totaling $22.8 million (with no current tax effect) to adjust its investment in Sano to net realizable value. The decision to sell Sano was due in part to its continuing operating losses. In addition, the Sano business does not serve a major global market with good long-term growth and profit potential and as a result, does not meet the company's criteria for a core business. The business was sold in February, 1994 and the completion of the transaction is not expected to affect the company's 1994 financial results.\nCLOSING AND RELOCATION CHARGE\nIn the third quarter of 1991, the company recorded a nonrecurring charge aggregating $90.0 million (with no current tax effect) to address problems in loss operations. Of the total charge, $75.1 million related to the relocation of centerless grinding machine and turning center manufacturing operations, the sale or other disposal of the company's remaining grinding machine assets and product lines, and the closing of the company's turning center factory in Wilmington, Ohio.\nAn additional $14.9 million, which is included in discontinued operations in the Consolidated Statement of Earnings, related to the revaluation for sale of the company's coordinate measurement and inspection machine business, LK Tool.\nDISCONTINUED OPERATIONS\nIn 1991, the company announced its intention to sell its coordinate measurement and inspection machine business, LK Tool, and recorded a provision for the anticipated loss on the sale of $14.9 million. During the third quarter of 1993, the company completed the sale of LK Tool for $5.0 million in cash. The completion of the transaction did not affect the company's financial results for 1993.\nACQUISITIONS\nOn February 1, 1993, the company completed the acquisition of GTE Valenite Corporation (Valenite) for $66 million in cash and $11 million of assumed debt. Valenite is a leading producer of consumable industrial metalcutting products. The acquisition, which is being accounted for under the purchase method, was financed principally through the sale of $50 million of accounts receivable and borrowings under a then new $85 million committed revolving credit facility.\nOn November 8, 1993, the company completed the acquisition of Ferromatik, the plastics injection molding machine business of Kloeckner-Werke AG, for DM 82.8 million (approximately $50 million) in cash and DM 10.6 million (approximately $6 million) in assumed debt. A portion of the cash purchase price is expected to be refunded in a post-closing adjustment. The acquisition, which is being accounted for under the purchase method, was financed primarily through borrowings under the company's existing lines of credit, including its committed revolving credit facility, which was amended to increase the lines of credit available thereunder. Ferromatik, which is headquartered in Germany, is one of the world's leading producers of injection molding machines and is recognized for high-end technology and other specialty applications.\nThe aggregate acquisition cost of the company's investments in Valenite and Ferromatik, including professional fees and other costs related thereto and after giving effect to the anticipated refund of a portion of cash paid for Ferromatik, is expected to be approximately $114.7 million. The following table presents the allocation of the aggregate acquisition cost to the assets acquired and liabilities assumed. The amounts included therein with respect to Ferromatik are preliminary and are subject to revision once appraisals, actuarial reviews and other studies of fair value are completed. Goodwill arising from the Valenite acquisition, which is included in other noncurrent assets in the following table, totaled $8.7 million. No goodwill is expected to result from the Ferromatik acquisition.\nALLOCATION OF ACQUISITION COST\n(In millions)\nCash and cash equivalents $ 2.2 Accounts receivable 54.5 Inventories 77.1 Other current assets 15.5 Property, plant and equipment 89.5 Other noncurrent assets 25.1 ------ Total assets 263.9\nAmounts payable to banks and long-term debt due within one year 11.9 Other current liabilities 107.3 Long-term accrued liabilities 25.1 Long-term debt and lease obligations 4.9 ------ Total liabilities 149.2 ------ Total acquisition cost $114.7 ======\nAs presented above, other current liabilities includes a reserve of $44.0 million for the restructuring of Valenite for future profitability. The restructuring plan includes the consolidation of production through the closing of eleven production facilities, the downsizing of two production facilities and a net employee reduction in excess of 500. The total cost of the restructuring is estimated to be $53.7 million ($25.8 million in cash) and includes amounts for severance, relocation and losses on the sale of surplus inventory, machinery and equipment and production facilities. The restructuring, which began March 2, 1993, will be completed in 1994.\nOther current liabilities also includes a reserve of $8.7 million for the restructuring of Ferromatik during 1994. Due to general economic conditions in Europe, the operations of Ferromatik's manufacturing plant were restructured during 1993 and 1992 to improve efficiency and reduce personnel levels. The company and Ferromatik have identified additional restructuring actions, including further personnel reductions, that are expected to improve Ferromatik's profitability in the future. These actions, which are intended to complement the actions already taken prior to the acquisition, will be substantially completed during 1994.\nUnaudited pro forma sales and earnings information for 1993 and 1992 prepared under the assumption that the acquisitions had been completed at the beginning of 1992 is as follows:\nPRO FORMA INFORMATION\n(In millions, except per-share amounts) 1993 1992 ---- ---- Sales $1,128.4 $1,187.5 ======== ========\nEarnings (loss) before extraordinary items and cumulative effect of changes in methods of accounting $ (48.2) $ 19.3 Extraordinary items Loss on early extinguishment of debt (4.4) - Tax benefit from loss carryforward - 4.0 Cumulative effect of changes in methods of accounting (52.1) - -------- --------\nNet earnings (loss) $(104.7) $ 23.3 ======= ========\nEarnings (loss) per common share Earnings (loss) before extraordinary items and cumulative effect of changes in methods of accounting $ (1.50) $ .69 Extraordinary items Loss on early extinguishment of debt (.14) - Tax benefit from loss carryforward - .15 Cumulative effect of changes in methods of accounting (1.61) - ------- -------- Net earnings (loss) $ (3.25) $ .84 ======= ========\nBased on a comprehensive analysis, the company and Valenite had originally estimated that the annual improvement in pretax earnings that would result from the completion of the restructuring plan would be approximately $15.6 million. The pro forma amounts presented above include favorable adjustments based on the original estimate. However, it is expected that the annual savings will exceed the original estimate on an ongoing basis by as much as 20%.\nDuring its fiscal year ended September 30, 1993, Ferromatik incurred significant operating losses due principally to general economic conditions in Europe and its inability to adjust personnel levels to reduced customer demand. The company and Ferromatik estimate that the minimum annual pretax earnings improvement that will result from the restructuring actions taken prior to the acquisition and those that will occur subsequent thereto will be no less than $4.2 million. Accordingly, the pro forma amounts presented above include favorable adjustments based on this estimate, which is based principally on reductions in personnel levels that have occurred since the acquisition and that are expected to occur in 1994. The actual savings from the completion of the restructuring plan are expected to be higher than $4.2 million.\nIn 1991, the company completed the acquisition of the assets and business of SL Abrasives, Inc., a manufacturer of resin-bonded grinding wheels. This transaction, which has been accounted for using the purchase method, did not significantly affect the company's financial position at December 28, 1991, or its results of operations for the year then ended.\nRESEARCH AND DEVELOPMENT\nCharges to operations for research and development activities are summarized below. The amounts include expenses related to the company's Wolfpack product development and process improvement program.\nRESEARCH AND DEVELOPMENT\n(In millions) 1993 1992 1991 ---- ---- ----\nResearch and development $41.9 $34.1 $35.8 Percent of sales 4.1% 4.3% 4.7%\nRETIREMENT BENEFIT PLANS\nSummarized in the following tables are the company's pension cost (income) and funded status of its major pension plans.\nPENSION COST (INCOME)\n(In millions) 1993 1992 1991 ---- ---- ----\nService cost (benefits earned during the period) $ 6.3 $ 6.3 $ 6.4 Interest cost on projected benefit obligation 31.5 29.0 29.6 Actual return on plan assets (54.8) (24.0) (65.1) Net amortization and deferral 14.3 (18.7) 26.0 ----- ----- -----\nPension cost (income) $(2.7) $(7.4) $(3.1) ===== ===== =====\nFUNDED STATUS OF PENSION PLANS AT YEAR-END\n(In millions) 1993 1992 ---- ---- Vested benefit obligation $(340.2) $(263.8) ======= =======\nAccumulated benefit obligation $(353.7) $(269.8) ======= =======\nPlan assets at fair value, primarily listed stocks and debt securities, including company stock of $14.0 in 1993 and $10.6 in 1992 $ 396.9 $ 370.8 Projected benefit obligation (416.9) (332.3) ------- -------\nExcess (deficiency) of plan assets in relation to projected benefit obligation (20.0) 38.5 Unrecognized net (gain ) loss 46.8 (6.5) Unrecognized net transition asset (30.2) (35.8) ------- -------\nAccrued pension liability $ (3.4) $ (3.8) ======= =======\nAt January 1, 1994, the projected benefit obligation of the company's domestic plan exceeded its assets by $37.9 million, while the assets of the plan for United Kingdom employees exceeded the projected benefit obligation by $17.9 million. Because of the current funded status of the plans, no contributions were required or made in 1993, 1992 and 1991. For 1993 and 1992, the assumed discount rates used in determining the projected benefit obligation were 7 1\/2 % and 9%, respectively. The assumed rate of increase in renumeration was 4 1\/2 % for 1993 and 6% for 1992. The weighted-average expected long-term rate of return on plan assets used to determine pension income was 9 1\/2 % in all years presented.\nIn addition to pension benefits, the company also provides varying levels of postretirement health care benefits to most U.S. employees who retire from active service after having attained age 55 and ten years of service. The plan is contributory in nature. Prior to 1993, retiree contributions were based on varying percentages of the average per-contract cost of benefits, with the company funding any excess over these amounts. However, the plan was amended in 1992 to freeze the dollar amount of the company's contributions in future years for employees retiring after 1980 based on specified percentages of the 1993 per-contract cost.\nEffective January 3, 1993, the company's domestic operations adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The change did not significantly affect earnings before extraordinary items and cumulative effect of changes in methods of accounting for 1993.\nThe following table presents the components of the company's liability for future retiree health care benefits.\nACCRUED POSTRETIREMENT HEALTH CARE BENEFITS\n(In millions) 1993 1992 ---- ---- Accumulated postretirement benefit obligation Retirees $(42.6) $(40.5) Fully eligible active participants (7.4) (4.1) Other active participants (8.1) (4.5) ------ ------ (58.1) (49.1) Unrecognized net loss 9.8 - ------ ------ (48.3) (49.1) Unrecognized transition obligation - 47.9 ------ ------ $(48.3) $ (1.2) ====== ======\nAt year-end 1993, $1.4 million of the total liability for postretirement health care benefits is included in current liabilities in the Consolidated Balance Sheet.\nThe retiree health care costs for 1993 were $4.5 million, of which service cost and interest cost were $.3 million and $4.2 million, respectively.\nPrior to 1993, the company recognized the cost of health care benefits paid to U.S. retirees as incurred. Such costs totaled $5.8 million and $5.1 million in 1992 and 1991, respectively.\nThe discount rates used in calculating the accumulated postretirement benefit obligation were 7% for 1993 and 8 1\/2 % for 1992. For 1994, the assumed rate of increase in health care costs used to calculate the accumulated postretirement benefit obligation is 10.6%. This rate is assumed to decrease to varying degrees annually to 5.0% for years 2005 and thereafter. Because of the effect of the 1992 plan changes that froze the dollar amount of the company's contributions for future years, a one percent change in each year in relation to the above assumptions would not significantly change the accumulated postretirement benefit obligation or the total cost of the plan.\nCertain foreign operations of the company also provide postretirement health care benefits to their employees. The company expects to adopt Statement of Financial Accounting Standards No. 106 for these operations in 1995.\nStatement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\", was issued in late 1992 and requires that certain benefits provided by an employer to former or inactive employees be accounted for on the accrual method beginning no later than 1994. The effect of adopting the new standard on the company's operating results and financial position is not material.\nINCOME TAXES\nEffective January 3, 1993, the company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". The standard requires the use of the liability method to recognize deferred income tax assets and liabilities using expected future tax rates. The tax effects of temporary differences that give rise to the recorded deferred tax assets and deferred tax liabilities at year-end 1993 are presented in the following table.\nCOMPONENTS OF DEFERRED TAX ASSETS AND LIABILITIES\n(In millions) 1993 ---- Deferred tax assets Net operating loss and various tax credit carryforwards $ 40.8 Accrued postretirement health care benefits 16.9 Consolidation, restructuring and other reserves 34.8 Inventories, principally due to obsolescence reserves and additional costs inventoried for tax purposes pursuant to the Tax Reform Act of 1986 5.6 Accrued pension costs 5.3 Accrued warranty costs 2.2 Accrued employee benefits other than pensions and retiree health care benefits 3.2 Accounts receivable, principally due to allowances for doubtful accounts 1.3 Foreign investments 9.2 Other 13.1 ------\nTotal deferred tax assets 132.4 Less valuation allowance (95.7) -----\nNet deferred tax assets $ 36.7 ====== Deferred tax liabilities Property, plant and equipment, principally due to differences in depreciation methods $ 26.1 Undistributed earnings of foreign subsidiaries 3.9 Pension assets 2.9 Other 4.2 ------ Total deferred tax liabilities $ 37.1 ====== Net deferred tax liability $ (.4) ======\nSummarized in the following tables are the company's earnings (loss) from continuing operations before income taxes, extraordinary items and cumulative effect of changes in methods of accounting, its provision for income taxes, and a reconcilement of the U.S. statutory rate to the tax provision rate.\nEARNINGS (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, EXTRAORDINARY ITEMS AND CUMULATIVE EFFECT OF CHANGES IN METHODS OF ACCOUNTING\n(In millions) 1993 1992 1991 ---- ---- ----\nUnited States $(41.5) $28.0 $(73.8) Foreign 4.3 (1.0) .4 ------ ----- ------ $(37.2) $27.0 $(73.4) ====== ===== ====== PROVISION FOR INCOME TAXES\nLiability Method Deferred Method (In millions) 1993 1992 1991 -------- -------- -----\nCurrent provision United States $ - $ - $ - State and local 2.4 1.7 2.3 Foreign 4.3 2.3 4.1 ---- ----- ---- 6.7 4.0 6.4 ---- ----- ---- Deferred provision United States - .6 .4 Foreign 1.5 .9 2.9 ---- ----- ---- 1.5 1.5 3.3 ---- ----- ---- Provision recognized as extraordinary benefit - 5.4 - ---- ----- ----\n$8.2 $10.9 $9.7 ==== ===== ====\nIn 1991, the current provision for foreign income taxes included $4.0 million related to a planned withdrawal from the company's United Kingdom pension fund that was completed in 1992.\nCOMPONENTS OF THE PROVISION FOR DEFERRED INCOME TAXES Liability Method Deferred Method (In millions) 1993 1992 1991 -------- ---- ----\nTax effects of consolidation, restructuring and other reserves $ (9.2) $1.2 $3.3 Change in deferred revenue (16.3) - - Depreciation 1.3 - - Change in valuation allowance 25.5 - - Reversal of prior year's deferred taxes related to operating loss carryforward - (.2) - Other .2 .5 - ------ ----- ---- $ 1.5 $1.5 $3.3 ====== ==== ====\nRECONCILEMENT OF THE U.S. STATUTORY RATE TO THE TAX PROVISION RATE\nLiability Method Deferred Method (In percent) 1993 1992 1991 --------- ---- ----\nU.S. statutory tax rate (35.0)% 34.0% (34.0)% Increase (decrease) resulting from Losses without current tax benefits 56.1 5.1 38.2 Effect of operations outside the U.S. (5.5) (2.7) 5.3 State and local taxes, net of federal benefit 6.5 4.2 2.1 Other (.1) (.2) 1.6 ----- ---- ----- 22.0% 40.4% 13.2% ===== ==== =====\nIn 1992, in accordance with accounting rules then in effect, the company recognized an extraordinary tax benefit of $5.4 million, or $.19 per share, from the realization of its U.S. net operating loss carryforward that originated principally from the 1991 closing and relocation charge and a pretax special charge of $32.8 million recorded in 1990 for product discontinuance and the reorganization of grinding machine and certain other machine tool manufacturing operations.\nFor U.S. tax reporting purposes, at year-end 1993 the company had a net operating loss carryforward of approximately $19 million which expires in 2008.\nUndistributed earnings of foreign subsidiaries which are intended to be indefinitely reinvested aggregated $30 million at the end of 1993.\nIncome taxes of $16.1 million, $5.0 million and $4.9 million were paid in 1993, 1992 and 1991, respectively.\nRECEIVABLES\nThe components of notes and accounts receivable less allowances are shown in the following table.\nNOTES AND ACCOUNTS RECEIVABLE LESS ALLOWANCES\n(In millions) 1993 1992 ---- ----\nNotes receivable $ 6.0 $ 8.8 Accounts receivable 190.2 174.1 ------ ------ 196.2 182.9 Less allowances for doubtful accounts 7.9 5.9 ------ ------ $188.3 $177.0 ====== ======\nNotes receivable include amounts not due within one year of $.7 million and $2.2 million in 1993 and 1992, respectively.\nThe acquisition of Valenite was financed in part through the sale of $50.0 million of the company's domestic accounts receivable. The sale transaction, which resulted in costs of $2.2 million in 1993, occurred under a three year receivables purchase agreement with an independent issuer of receivables-backed commercial paper, pursuant to which the company agreed to sell on an ongoing basis and without recourse, an undivided percentage ownership interest in designated pools of accounts receivable. In order to maintain the balance in the designated pools of accounts receivable sold, the company is obligated to sell undivided percentage interests in new receivables as existing receivables are collected. At January 1, 1994, the undivided interest in the company's gross accounts receivable that had been sold to the purchaser aggregated $50.0 million. The company also sold an additional $11.4 million of accounts receivable in the fourth quarter of 1993 under a separate receivables purchase agreement. Costs related to both sales are included in other expense - net in the Consolidated Statement of Earnings. The proceeds are reported as providing operating cash flow in the Consolidated Statement of Cash Flows for 1993.\nINVENTORIES\nInventories amounting to $134.8 million for 1993 and $156.3 million for 1992 are stated at LIFO cost. Such inventories if stated at FIFO cost would be greater by approximately $57.4 million in 1993 and $54.2 million in 1992.\nPROPERTY, PLANT AND EQUIPMENT\nThe components of property, plant and equipment are shown in the following table.\nPROPERTY, PLANT AND EQUIPMENT - NET\n(In millions) 1993 1992 ---- ----\nLand $ 5.7 $ 5.1 Buildings 108.5 108.9 Machinery and equipment 317.1 269.1 ------ ------ 431.3 383.1 Less accumulated amortization and allowances for depreciation 247.3 262.0 ------ ------ $184.0 $121.1 ====== ======\nLIABILITIES\nThe components of accrued and other current liabilities and long-term accrued liabilities are shown in the following tables.\nACCRUED AND OTHER CURRENT LIABILITIES (In millions) 1993 1992 ---- ----\nAccrued salaries, wages and other compensation $ 21.5 $16.3 Consolidation reserve 38.7 - Restructuring reserves 17.1 - Other accrued expenses 92.9 82.7 ------ ----- $170.2 $99.0 ====== =====\nLONG-TERM ACCRUED LIABILITIES (In millions) 1993 1992 ---- ----\nAccrued pension and other compensation $ 24.1 $19.1 Accrued postretirement health care benefits 46.9 - Accrued and deferred taxes 30.5 8.0 Other 27.1 25.9 ------ ----- $128.6 $53.0 ====== =====\nLONG-TERM DEBT AND LEASE OBLIGATIONS\nLong-term debt and lease obligations are shown in the following table.\nLONG-TERM DEBT AND LEASE OBLIGATIONS\n(In millions) 1993 1992 ----- ----\nLong-term debt 8 3\/8 % Senior Notes due 1997 $ 60.0 $ 60.0 12% Sinking Fund Debentures due 2010 10.8 70.8 Industrial Development Revenue Bonds due 2008 10.0 10.0 Revolving credit facility 10.0 - Other 8.8 2.5 ------ ------ 99.6 143.3\nCapital lease obligations 6 3\/4 % Bonds due 2004 7.6 7.6 6 3\/8 % Bonds due 1994 - 1997 3.4 4.2 6 1\/2 % Bonds due 1994 .4 .7 ------ ------ 11.4 12.5 ------ ------ 111.0 155.8 ------ ------ Current maturities (3.4) (1.4) ------ ------- $107.6 $154.4 ====== ======\nThe carrying amount of the company's long-term debt approximates fair value, which is determined using discounted cash flow analysis based on the company's incremental borrowing rate for similar types of financing arrangements.\nThe 8 3\/8 % Senior Notes due 1997 are redeemable at par beginning in 1994 at the company's option. The 12% Sinking Fund Debentures due 2010 have annual sinking fund installments commencing in 1996. The debentures are redeemable at any time at the company's option subject to possible premiums and other restrictions.\nThe Industrial Development Revenue Bonds due 2008 are tax-exempt variable-rate bonds. The interest rate is established weekly and averaged 2.4% in 1993. The bonds are supported by a bank letter of credit, which requires a fee of 1 1\/4 % per annum on the amount outstanding.\nCertain of the above long-term debt obligations contain various restrictions and financial covenants relating principally to additional secured indebtedness.\nAt January 1, 1994, $10.0 million of borrowings under the company's revolving credit facility are included in long-term debt based on the expectation that such amount will remain outstanding for more than one year.\nInterest paid was $19.0 million in 1993, $18.9 million in 1992 and $19.2 million in 1991.\nMaturities of long-term debt for the five years after 1993 are: 1994: $ 2.4 million 1995: 2.0 million 1996: 2.0 million 1997: 67.2 million 1998: 5.4 million\nThe capitalized lease assets are included in property, plant and equipment. Amortization of leased properties is included in depreciation and interest on lease obligations is included in interest expense.\nFuture minimum payments for principal and interest on capitalized leases during the next five years and in the aggregate thereafter are: 1994: $ 1.9 million 1995: 1.5 million 1996: 1.5 million 1997: 1.5 million 1998: .5 million After 1998: 10.7 million\nThe company also leases certain equipment under operating leases, some of which include varying renewal and purchase options. Future minimum rental payments applicable to noncancelable operating leases during the next five years and in the aggregate thereafter are: 1994: $14.6 million 1995: 12.0 million 1996: 8.6 million 1997: 5.5 million 1998: 4.2 million After 1998: 8.6 million\nRent expense was $14.7 million and $9.6 million in 1993 and 1992, respectively, and was not material in 1991.\nLINES OF CREDIT\nAt the end of 1993, the company had formal and informal lines of credit with various domestic and foreign banks of $276.1 million, including a revolving credit facility and other committed lines totaling $137.5 million. These credit facilities support letters of credit and leases in addition to providing borrowings under varying terms. Additional borrowing capacity available under all lines of credit totaled approximately $40 million at January 1, 1994.\nIn January, 1993, in connection with the acquisition of Valenite, the company replaced its previous $55.0 million revolving credit agreement with a new $85.0 million committed revolving credit facility. In connection with the acquisition of Ferromatik, the facility was amended to increase the lines of credit available thereunder to $130.0 million. The facility allows borrowings through July, 1995 and requires a facility fee of 1\/2 % per annum on the total $130.0 million revolving loan commitment.\nThe revolving credit facility requires compliance with certain financial loan covenants related to tangible net worth, interest and fixed charge coverages and debt leverage. The company has remained in compliance with these covenants since the inception of this facility.\nSHAREHOLDERS' EQUITY\nOn April 15, 1993, the company completed the issuance of an additional 5.175 million common shares through a public offering, resulting in net proceeds (after deducting issuance costs) of $100.6 million. The proceeds of the offering were used to redeem $60.0 million of the company's 12% Sinking Fund Debentures due 2010 and to repay borrowings under revolving lines of credit and other bank debt. The redemption of the 12% Sinking Fund Debentures due 2010 effective May 17, 1993 resulted in a pretax extraordinary loss on early extinguishment of debt of $5.2 million ($4.4 million after tax) in the second quarter. The pretax extraordinary loss included a cash call premium of $4.7 million and the write-off of deferred financing fees of $.5 million.\nSHAREHOLDERS' EQUITY - PREFERRED AND COMMON SHARES\n(Dollars in millions, except per-share amounts) 1993 1992 ---- ----\n4% Cumulative Preferred shares authorized, issued and outstanding, 60,000 shares at $100 par value, redeemable at $105 a share $ 6.0 $ 6.0 Common shares, $1 par value authorized 50,000,000 shares, issued and outstanding, 1993: 33,531,723 shares, 1992: 27,505,772 33.5 27.5\nThe company has authorized ten million serial preference shares with $1 par value. None of these shares has been issued.\nHolders of company common stock have one vote per share until they have held their shares for at least 36 consecutive months, after which they are entitled to ten votes per share.\nCONTINGENCIES\nThe Internal Revenue Service has conducted examinations of the company's federal income tax returns for the years 1981 through 1986 and had proposed various adjustments to increase taxable income. During 1993, all issues for these years were resolved with no significant effect on the company's consolidated financial position or results of operations.\nVarious lawsuits arising during the normal course of business are pending against the company and its consolidated subsidiaries. In the opinion of management, the ultimate liability, if any, resulting from these matters will have no significant effect on the company's consolidated financial position or results of operations.\nFOREIGN EXCHANGE CONTRACTS\nThe company enters into foreign exchange contracts to hedge foreign currency transactions on a continuing basis for periods commensurate with its known or expected exposures. The purpose of this practice is to minimize the effect of foreign currency exchange rate fluctuations on the company's operating results. The company does not engage in speculation.\nAt January 1, 1994, the company had outstanding foreign exchange contracts totaling $45.3 million, which generally mature in periods of six months or less. These contracts require the company and its subsidiaries to exchange currencies at the maturity dates at exchange rates agreed upon at inception.\nLONG-TERM INCENTIVE PLANS\nThe 1991 Long-Term Incentive Plan (\"1991 Plan\"), which expired December 31, 1993, permitted the company to grant its common shares in the form of non-qualified stock options, incentive stock options, stock appreciation rights (SARs), restricted stock and performance awards. A summary of amounts issued under the 1991 Plan and prior plans is presented in the tables. The 1994 Long-Term Incentive Plan (\"1994 Plan\") was approved by the company's Board of Directors on February 10, 1994 and, subject to shareholder approval, will provide for issuance of the same types of grants as were permitted by the 1991 Plan with the exception of SARs, which may no longer be granted.\nSTOCK OPTIONS, RESTRICTED STOCK AWARDS AND SARS\nPrice Shares(a) SARs Range -------- ---- -----\nOutstanding at year-end 1990 1,222,537 530,322 $9 - 29 Activity during 1991 - Granted 837,607 110,750 9 - 13 - Exercised (68,357) - 9 - 10 - Canceled (139,759) (125,310) 13 - 29 --------- -------- Outstanding at year-end 1991 1,852,028 515,762 9 - 29 Activity during 1992 - Granted 462,920 - 15 - 16 - Exercised (91,628) - 9 - 25 - Canceled (148,167) - 9 - 25 - SARs Canceled 515,762 (515,762) 9 - 28 --------- --------\nOutstanding at year-end 1992 2,590,915 - 9 - 29 Activity during 1993 - Granted 118,025 - 17 - 24 - Exercised (854,918) - 9 - 25 - Canceled (136,947) - 13 - 29 --------- ---------\nOutstanding at year-end 1993 1,717,075 - $9 - 28 ========= =========\nEXERCISABLE STOCK OPTIONS AND SARS AT YEAR-END\nStock Options(a) SARs ---------- -------\n1991 955,838 276,286 1992 1,748,565 - 1993 1,474,262 -\n(a) Excludes stock options granted in tandem with SARs.\nThe non-qualified stock options and incentive stock options are issued at market and, under the terms of the 1991 Plan, may be granted in tandem with SARs. However, during 1992, all previously granted SARs were canceled with the consent of the holders. Stock options become excercisable under varying terms and expire in ten years. Shares of restricted stock are subject to three-year restrictions against selling, encumbering or otherwise disposing of these Shares. Performance awards may be earned based on achievement of predetermined return-on-capital targets over specified periods.\nThe maximum number of shares available for grant under the 1991 Plan was 1,650,000, of which 262,100 were available for grant at year-end 1992. Additional shares may no longer be granted under the 1991 Plan. The maximum number of shares that may be granted under the 1994 Plan is expected to be 2,000,000.\nGEOGRAPHIC INFORMATION\nThe following table summarizes the company's U.S. and foreign operations which are located principally in Western Europe.\nSales of U.S. operations include export sales of $118.7 million in 1993, $111.7 million in 1992 and $98.6 million in 1991.\nTotal sales of the company's U.S. and foreign operations to unaffiliated customers outside the U.S. were $298.4 million, $242.6 million and $236.0 million, in 1993, 1992 and 1991, respectively.\nU.S. AND FOREIGN OPERATIONS\n(In millions) 1993 1992 1991 ---- ---- ---- U.S. operations Sales $831.9 $654.1 $613.0 Operating earnings 49.6 47.9 23.3 Consolidation charge and closing and relocation charge (47.1) - (75.1) Disposition of subsidiary (22.8) - - Identifiable assets 420.6 410.8 413.9 Liabilities 469.9 403.3 404.7 Capital expenditures 21.3 13.9 11.8 Depreciation 19.1 16.3 19.3\nForeign operations Sales 197.5 135.1 141.0 Operating earnings 8.0 1.5 3.0 Identifiable assets 285.9 148.7 163.6 Liabilities 135.6 41.2 64.7 Capital expenditures 2.1 3.7 3.7 Depreciation 7.0 4.6 4.7\nSEGMENT INFORMATION\nCincinnati Milacron is one of the world's leading manufacturers of plastics machinery, machine tools, computer controls and software for factory automation. In addition, the company is a leading producer of precision grinding wheels, metalworking fluids and metalcutting tools.\nFinancial data for the past three years for the company's business segments are shown in the following tables. SALES BY SEGMENT\n(In millions) 1993 1992 1991 ---- ---- ----\nPlastics machinery $357.2 $301.4 $267.6 Machine tools 355.0 379.7 383.7 Industrial products (a) 317.2 108.1 102.7 -------- ------ ------ $1,029.4 $789.2 $754.0 ======== ====== ======\nOPERATING INFORMATION BY SEGMENT\n(In millions) 1993 1992 1991 ---- ---- ---- Operating earnings (loss) Plastics machinery (b) $ 26.6 $22.8 $14.6 Machine tools 3.9 8.9 (6.6) Industrial products (a) 27.1 17.7 18.3 Consolidation charge and closing and relocation charge (c) (47.1) - (75.1) Disposition of subsidiary (d) (22.8) - - Unallocated corporate expenses (e) (11.5) (6.2) (9.5) ------ ----- ----- Operating earnings (loss) (23.8) 43.2 (58.3) Interest expense-net (13.4) (16.2) (15.1) ------ ----- ----- Earnings (loss) from continuing operations before income taxes, extraordinary items and cumulative effect of changes in methods of accounting $(37.2) $27.0 $(73.4) ====== ===== ======\nIdentifiable assets Plastics machinery $289.0 $219.9 $202.9 Machine tools 243.1 282.8 310.9 Industrial products (a) 174.4 56.8 63.7 Unallocated corporate assets (f) 23.1 19.4 20.9 ------ ------ ------ Total assets $729.6 $578.9 $598.4 ====== ====== ======\nCapital expenditures Plastics machinery $ 4.2 $ 6.2 $ 6.5 Machine tools 8.8 7.1 7.5 Industrial products (a) 10.4 4.3 1.5 ------ ------ ------ Total capital expenditures $ 23.4 $ 17.6 $ 15.5 ====== ====== ====== Depreciation Plastics machinery $ 6.2 $ 7.7 $ 7.0 Machine tools 9.4 10.6 14.2 Industrial products (a) 10.5 2.6 2.8 ------ ------ ------ Total depreciation $ 26.1 $ 20.9 $ 24.0 ====== ====== ======\n(a) The 1993 increases in the industrial products segment are largely attributable to the inclusion of Valenite as of February 1, 1993. (b) The 1993 amount includes a $2.5 million gain on sale of surplus land. (c) These amounts relate to the machine tool segment. (d) This amount relates to the plastics machinery segment. (e) Includes corporate research and development and certain administrative expenses. The 1993 amount includes amortization of financing costs and costs related to the sale of receivables totaling $3.0 million. (f) Includes cash and cash equivalents and the assets of the company's insurance and utility subsidiaries.\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Cincinnati Milacron Inc.\nWe have audited the accompanying Consolidated Balance Sheet of Cincinnati Milacron Inc. and subsidiaries as of January 1, 1994 and January 2, 1993, and the related Consolidated Statements of Earnings, Changes in Shareholders' Equity, and Cash Flows for each of the three years in the period ended January 1, 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 consolidated financial position of Cincinnati Milacron Inc. and subsidiaries at January 1, 1994 and January 2, 1993, and the consolidated results of their operations and their 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.\nAs discussed in the Note to Consolidated Financial Statements, Cumulative Effect of Changes in Methods of Accounting, in 1993 the company changed its method of accounting for postretirement benefits other than pensions and its method of accounting for income taxes.\n\/s\/ ERNST & YOUNG\nCincinnati, Ohio February 28, 1994\nSUPPLEMENTARY FINANCIAL INFORMATION\nOPERATING RESULTS BY QUARTER (Unaudited)\n(a) The fiscal year consists of thirteen four-week periods in 1993 and twelve four-week periods and one five week period in 1992. The first and second quarters consist of twelve weeks each, and the third quarter, sixteen weeks. The fourth quarter of 1993 consists of twelve weeks and the fourth quarter of 1992 consists of thirteen weeks.\n(b) The fourth quarter includes a charge of $47.1 million (with no current tax effect) for the consolidation of domestic machine tool manufacturing operations. Earnings were also reduced by charges of $18.1 million in the third quarter and $4.7 million in the fourth quarter (with no current tax effect) for the disposition of the company's Sano business.\n(c) Because the quarter per-share amounts are based on the weighted-average shares outstanding in each period, their sum does not equal the annual calculation.\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 is (i) incorporated herein by reference to the \"Election of Directors\" section of the company's proxy statement dated March 25, 1994 and (ii) included in Part I on pages 16 through 17 of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe \"Executive Compensation\" section of the company's proxy statement dated March 25, 1994 is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe \"Principal Holders of Voting Securities\" section of the company's proxy statement dated March 25, 1994 is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe paragraph captioned \"Stock Option Loan Programs\" of the company's proxy statement dated March 25, 1994 is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nITEM 14(A)(1)&(2)-- LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Cincinnati Milacron Inc. and subsidiaries are included in Item 8:\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 (a)(3) - LIST OF EXHIBITS\n(3) Articles of Incorporation and By-Laws\n3.1 Restated Certificate of Incorporation filed with the Secretary of State of the State of Delaware on June 16, 1983 - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 28, 1985, as amended by Amendment No. 1 thereto on Form 8 dated June 30, 1986, and Amendment No. 2 thereto on Form 8 dated July 17, 1986 (File No. 1-8485)\n3.2 Certificate of Amendment of the Restated Certificate ofIncorporation dated April 22, 1986, and filed with the Secretary of State of the State of Delaware on April 22, 1986 - Incorporated herein by reference to the company's Form 10-Q for the quarter ended March 22, 1986 (File No. 1-8485)\n3.3 Certificate of Amendment of the Restated Certificate of Incorporation dated June 11, 1987, and filed with the Secretary of State of the State of Delaware on June 15, 1987 - Incorporated herein by reference to the company's Form 10-Q for the quarter ended March 28, 1987 (File No. 1-8485)\n3.4 By-laws, as amended - Incorporated herein by reference to the company's Registration Statement on Form S-8 (Registration No. 33-33623)\n(4) Instruments Defining the Rights of Security Holders, Including Indentures:\n4.1 12% Sinking Fund Debentures due July 15, 2010 - Incorporated herein by reference to the company's Registration Statement on Form S-3 (Registration No. 2-98653)\n4.2 8-3\/8% Notes due 1997 - Incorporated herein by reference to the company's Form 8-K dated February 25, 1987 (File No. 1-8485)\n4.3 Cincinnati Milacron Inc. hereby agrees to furnish to the Securities and Exchange Commission, upon its request, the instruments with respect to long-term debt for securities authorized thereunder which do not exceed 10% of the registrant's total consolidated assets\n(9) Voting Trust Agreement- not applicable\n(10) Material Contracts:\n10.1 Cincinnati Milacron 1984 Long-Term Incentive Plan - Incorporated herein by reference to the company's Registration Statement on Form S-8 (Registration No. 2-89499)\n10.2 Cincinnati Milacron 1987 Long-Term Incentive Plan - Incorporated herein by reference to the company's Proxy Statement dated March 27, 1987\n10.3 Cincinnati Milacron 1991 Long-Term Incentive Plan - Incorporated herein by reference to the company's Form 10-Q for the quarter ended June 15, 1991\n10.4 Cincinnati Milacron Inc. Short-Term Management Incentive Program - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended January 3, 1987 10.5 Cincinnati Milacron Inc. Supplemental Pension Plan - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 31, 1988\n10.6 Cincinnati Milacron Inc. Supplemental Retirement Plan #2 - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 31, 1988\n10.7 Cincinnati Milacron Retirement Savings Plan - Incorporated herein by reference to the company's Registration Statement on Form S-8 (Registration No. 33-33623)\n10.8 Cincinnati Milacron Inc. Plan for the Deferral of Directors' Compensation - Incorporated herein by reference to the company's Form 10-Q for the quarter ended June 15, 1991\n10.9 Underwriting Agreement between Cincinnati Milacron Inc. and the First Boston Corporation - Incorporated herein by reference to the company's Registration Statement on Form S-3 (Registration No. 33-35097)\n10.10 Cincinnati Milacron Inc. 1988 Restricted Stock Plan for Non-Employee Directors - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 29, 1990\n10.11 Cincinnati Milacron Inc. Retirement Plan for Non-Employee Directors - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 29, 1990\n10.12 Cincinnati Milacron Inc. 1991 Restricted Stock Plan for Non-Employee Directors - Incorporated herein by reference to the company's Form 10-K for the fiscal year ended December 29, 1990\n10.13 Valenite Stock Purchase Agreement between GTE Corporation and Cincinna Milacron, Inc. - Incorporated herein by reference to the company's Form 8-K dated February 1, 1993.\n10.14 Purchase Agreement between Kloeckner Ferromatik Desma GmbH, Kloeckner Werke Aktiengesellschaft and Cincinnati Milacron Inc. - Incorporated herein by reference to the company's Form 8-K dated November 8, 1993.\n10.15 Cincinnati Milacron Supplemental Executive Retirement Plan - Filed herewith\n10.16 Amended and Restated Revolving Credit Agreement dated as of January 28, 1993, and amended and restated as of July 20, 1993 - Incorporated herein by reference to the company's Form 10-Q for the quarter ended October 9, 1993.\n10.17 Amendment Number One, dated as of October 26, 1993, to the Amended and Restated Revolving Credit Agreement dated as of January 28, 1993, and amended and restated as of July 20, 1993, among Cincinnati Milacron Inc., the Lenders listed therein and Bankers Trust Company, as Agent - Incorporated herein by reference to the company's Form 8-K dated November 8, 1993.\n10.18 Amendment Number Two, dated as of December 31, 1993, to the Amended and Restated Revolving Credit Agreement dated as of January 28, 1993, as amended and restated as of October 26, 1993, among Cincinnati Milacron Inc., the Lenders listed therein and Bankers Trust Company, as Agent - Filed herewith\n(11) Statement Regarding Computation of Per-Share Earnings\n(12) Statement Regarding Computation of Ratios- not applicable\n(18) Letter Regarding Change in Accounting Principles- not applicable\n(21) Subsidiaries of the Registrant\n(22) Published Report Regarding Matters Submitted to Vote of Security Holders - Incorporated by reference to the company's Proxy Statement dated March 25, 1994.\n(23) Consent of Independent Auditors\n(24) Power of Attorney- not applicable\n(27) Financial Data Schedule - not applicable\n(28) Information from Reports Furnished to State Insurance Regulatory Authorities- not applicable\n(99) Additional Exhibits- not applicable\nITEM 14(B)-- REPORTS ON FORM 8-K\nOne report on Form 8-K was filed during the fourth quarter of 1993.\n(i) November 8, 1993 - The company reported the closing of the purchase of the Ferromatik business of Kloeckner Ferromatik Desma GmbH\nITEM 14(C)&(D)-- EXHIBITS AND FINANCIAL STATEMENT SCHEDULES\nThe responses to these portions of Item 14 are 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.\nCINCINNATI MILACRON INC.\nBY: \/s\/ Daniel J. Meyer ---------------------------------------------- Daniel J. Meyer; Chairman and Chief Executive Officer, Director (Chief Executive Officer)\nBY: \/s\/ Raymond E. Ross ----------------------------------------------- Raymond E. Ross; President and Chief Operating Officer, Director (Chief Operating Officer)\nBY: \/s\/ Ronald D. Brown ----------------------------------------------- Ronald D. Brown; Vice President- Finance (Chief Financial Officer)\nBY: \/s\/ Robert P. Lienesch ----------------------------------------------- Robert P. Lienesch; Controller (Chief Accounting Officer)\nDate: March 25, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\n\/s\/ Neil A. Armstrong \/s\/ Darryl F. Allen - ------------------------------------ ---------------------------------- Neil A. Armstrong; March 25, 1994 Darryl F. Allen; March 25, 1994 (Director) (Director)\n\/s\/ Harry A. Hammerly \/s\/ James A. D. Geier - ----------------------------------- ---------------------------------- Harry A. Hammerly; March 25, 1994 James A. D. Geier; March 25, 1994 (Director) (Director)\nITEM 14(C) AND (D)-- INDEX TO CERTAIN EXHIBITS AND FINANCIAL STATEMENT SCHEDULES Page No. -------- Exhibit 11 Computation of Per-Share Earnings 49\nExhibit 21 Subsidiaries of the Registrant 50\nExhibit 23 Consent of Independent Auditors 51\nSchedule II Amounts Receivable From Related Parties and Underwriters, Promoters and Employees Other Than Related Parties 52\nSchedule V Property, Plant and Equipment 53\nSchedule VI Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment 54\nSchedule VIII Valuation and Qualifying Accounts and Reserves 55\nSchedule IX Short-Term Borrowings 56\nSchedule X Supplementary Income Statement Information 57\n(a) Represents borrowings under the company's Key Employee Stock Option Loan Program, which bear interest at 6%.\nCINCINNATI MILACRON INC. AND SUBSIDIARIES\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT\nYears Ended 1993, 1992 and 1991\n(In Thousands)\n(a) Consists principally of foreign currency translation adjustments and in 1993 includes amounts related to the revaluation for sale of certain Valenite assets.\n(b) Assets acquired through the purchase of Valenite Inc. in February, 1993 and Ferromatik Milacron Maschinenbau GmbH in November, 1993.\n(c) Assets acquired through the purchase of the assets and business of SL Abrasives, Inc. in January, 1991.\nNote: Depreciation has been computed principally in accordance with the following general range of useful lives: buildings (20 to 45 years), building equipment (5 to 30 years), automobiles and trucks (3 to 7 years), and other machinery and equipment (2 to 20 years).\nCINCINNATI MILACRON INC. AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nYears Ended 1993, 1992 and 1991\n(In Thousands)\n(a) Consists principally of foreign currency translation adjustments and in 1993 includes amounts related to the revaluation for sale of certain Valenite assets.\n(b) Relates to 1993 consolidation charge and 1991 closing and relocation charge.\nCINCINNATI MILACRON INC. AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nYears Ended 1993, 1992 and 1991\n(In Thousands)\n(a) Represents amounts charged against the reserves during the year. (b) Represents foreign currency translation adjustments in all years and in 1993 includes reserves of subsidiaries sold during the year. (c) Consists of reserves of subsidiaries purchased during the year. (d) Includes $1,500 in long-term accrued liabilities. (e) Includes $4,670 in long-term accrued liabilities. (f) Includes $8,900 in long-term accrued liabilities.\nSCHEDULE IX - SHORT-TERM BORROWINGS\nYears Ended 1993, 1992 and 1991\n(In Thousands)\n(a) These balances represent borrowings under formal lines of credit. These arrangements provide for borrowings at prevailing market rates.\nCINCINNATI MILACRON INC. AND SUBSIDIARIES\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nYears Ended 1993, 1992 and 1991\n(In Thousands) COL. A COL. B - ------------------------------------------------------------------------------- Item Charged to Costs and Expenses\n- -------------------------------------------------------------------------------\n1993 1992 1991 ------- ------- -------\nMaintenance and repairs $14,752 $11,430 $12,828 ======= ======= =======\nTaxes, other than payroll and income taxes $ 9,879 $10,145 $ 8,196 ======= ======= =======\nAdvertising $ 9,908 $ 9,573 $ 7,462 ======= ======= =======\nNote: Amounts for royalties and amortization of intangible assets are not presented, as such amounts are less than 1% of total sales.","section_15":""}
{"filename":"28823_1994.txt","cik":"28823","year":"1994","section_1":"ITEM 1. BUSINESS. - ------- ---------\n(a) General Development - -----------------------\nThe Registrant was incorporated under the laws of the State of Ohio in August, 1876, succeeding a proprietorship established in 1859 and is engaged primarily in the sale, manufacture, installation and service of automated self-service transaction systems, security products and software.\nDuring 1994, no significant changes occurred in the manner of conducting the Registrant's business.\n(b) Financial Information about Industry Segments - -------------------------------------------------\nThe Registrant operates predominantly in one industry segment: financial systems and equipment. This segment accounts for more than 90% of the consolidated net sales, operating profit and identifiable assets.\n(c) Description of Business - ---------------------------\nThe Registrant develops, manufactures, sells and services automated teller machines (ATMs), electronic and physical security systems, various products used to equip bank facilities, software and systems for global financial and commercial markets. Sales of systems and equipment are made directly to customers by the Registrant's sales personnel and by manufacturer's representatives and distributors. The sales\/support organization works closely with customers and their consultants to analyze and fulfill the customers' needs. Products are sold under contract for future delivery at agreed upon prices. In 1994, 1993, and 1992 the Registrant's sales and services of financial systems and equipment accounted for more than 90% of consolidated net sales.\nThe principal raw materials used by the Registrant are steel, copper, brass, lumber and plastics which are purchased from various major suppliers. Electronic parts and components are also procured from various suppliers. These materials and components are generally available in quantity at this time.\nNo customer of the Registrant accounted for more than 10% of consolidated net sales in 1994, and no material part of the business is dependent upon a single customer or a few customers, the loss of any one or more of whom would have a material adverse effect on the business of the Registrant.\nBacklog as of December 31, 1994 was $152,511,000 a 5% decrease from December 31, 1993 backlog of $161,303,000. The Registrant believes, however, that with varying customer lead time requirements and other industry factors, order backlog information is not, by itself, a meaningful indicator of future revenue streams. There are numerous factors which influence the amount and timing of revenue in future periods.\nITEM 1. BUSINESS. - (continued) - ------- ---------\nAll phases of the Registrant's business are highly competitive; some products being in competition directly with similar products and others competing with alternative products having similar uses or producing similar results. Registrant believes, based upon outside independent industry surveys, that it is the leading manufacturer of automated teller machines in the United States and is also a market leader internationally. In the area of automated transaction systems, the Registrant competes primarily with AT&T Global Information Systems (formerly NCR Corporation) and Fujitsu - ICL Systems, Inc. In serving the security products market for the financial services industry, the Registrant meets numerous large competitors in the security equipment and systems field. Of these, some compete in only one or two product lines, while others sell a broader spectrum of products competing with the Registrant. However, the unavailability of comparative sales information and the large variety of individual products makes it impossible to give reasonable estimates of the Registrant's competitive ranking in or share of the market in its security product fields of activity. Many smaller manufacturers of safes, surveillance cameras, alarm systems and remote drive-up equipment are found in the market.\nThe Registrant charged to expense approximately $34.5 million in 1994, $25.5 million in 1993 and $24.5 million in 1992 for research and development costs.\nCompliance by the Registrant with federal, state and local environmental protection laws during 1994 had no material effect upon capital expenditures, earnings or the competitive position of the Registrant and its subsidiaries.\nThe total number of persons employed by the Registrant at December 31, 1994 was 4,731 compared to 4,202 at the end of the preceding year.\n(d) Financial Information about Foreign and Domestic - ---------------------------------------------------- Operations and Export Sales ---------------------------\nSales to customers in foreign countries approximated 19.8%, 17.6% and 18.2% of consolidated net sales for 1994, 1993 and 1992, respectively.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. - ------- -----------\nThe Registrant's corporate offices are located in Canton, Ohio. It owns facilities (approximately 1.6 million square feet) in Canton, Uniontown and Newark, Ohio; Lynchburg, Virginia; Sumter, South Carolina; and leases facilities (approximately .3 million square feet) in Akron, Canton, Canal Fulton, Massillon, Newark and Seville, Ohio; Mexico City, Mexico; and Shanghai, China. These facilities house manufacturing, production, associated engineering, warehousing, testing, administration and development and distribution for all product lines. The Registrant believes these facilities are both suitable and adequate for existing operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. - ------- ------------------\nAt December 31, 1994, the Registrant was a party to several lawsuits that were incurred in the normal course of business, none of which individually or in the aggregate is considered material in relation to the Registrant's financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - ------- ----------------------------------------------------\nNo matters were submitted to a vote of security holders during the fourth quarter of 1994.\nITEM 4a. EXECUTIVE OFFICERS OF THE REGISTRANT. - -------- -------------------------------------\nRefer to pages 6 through 9.\nThere is no family relationship, either by blood, marriage or adoption, between any of the executive officers of the Registrant.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND - ------- --------------------------------------------- RELATED STOCKHOLDER MATTERS. ----------------------------\nOn February 1, 1994 the Board of Directors of the Registrant declared a three-for-two stock split which was effected in the form of a stock dividend, distributed on February 22, 1994 to shareholders of record on February 10, 1994. Accordingly, all numbers of Common Shares, except authorized shares and treasury shares, and all per share data have been restated to reflect this stock split in addition to the three-for-two stock split declared on January 27, 1993, distributed on February 26, 1993, to shareholders of record on February 10, 1993.\nThe Common Shares of the Registrant are listed on the New York Stock Exchange with a symbol of DBD. The price ranges of Common Shares for the Registrant are as follows:\nThere were approximately 3,400 registered shareholders of record at December 31, 1994.\nOn the basis of amounts paid and declared the annualized quarterly dividends per share were $0.88 in 1994, $0.80 in 1993 and $0.75 in 1992.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. - ------- ------------------------\nNET SALES Consolidated net sales for 1994 totaled $760,171, which represented growth of $136,894 or 22.0 percent from 1993, and $216,319 or 39.8 percent from 1992. This was the Registrant's fifth consecutive year of record sales.\nProduct sales of $479,314 grew $111,929 or 30.5 percent from 1993 and $181,275 or 60.8 percent from 1992. The Registrant continued to experience strong growth in domestic sales of ATMs, and also realized increases in domestic sales from all other major product lines during 1994. Total domestic product revenue was up 30.5 percent from 1993. Sales of products outside the U.S. increased 30.4 percent from 1993. The planned decline in fees received by InterBold for the sale of ATMs manufactured by IBM reduced the sales growth of Registrant's products abroad.\nService net sales of $280,857 increased $24,965 or 9.8 percent from 1993 and were up $35,044 or 14.3 percent from 1992. The major factors contributing to the service revenue gain in 1994 were the continuing growth of the installed base of equipment resulting from new product installations, growth of new service offerings such as first-line maintenance and the acquisition of Mexico's largest ATM service business.\nTotal product backlog of unfilled orders was $152,511 at December 31, 1994, compared to $161,303 at the end of 1993 and $106,122 at the end of 1992. In response to customer requirements for shorter manufacturing lead times, the Registrant has committed to reducing its production cycle time. The Registrant believes that due to varying customer lead time requirements and other industry factors, order backlog information is not, by itself, a meaningful indicator of future revenue streams. There are numerous factors which influence the amount and timing of revenue in future periods.\nCOST OF SALES AND EXPENSES Consolidated cost of sales for 1994 was $504,489, compared to $413,239 in 1993 and $358,031 in 1992.\nGross profits on product sales increased $33,180 and $55,019 from 1993 and 1992, respectively, to a level of $167,524 in 1994. Product gross margins in 1994 were 35.0 percent of product sales, compared to 36.6 percent in 1993 and 37.7 percent in 1992.\nThe anticipated reduction in license fees received from IBM by InterBold reduced gross margin percentages. This trend has continued as these fees have become a smaller percentage of total ATM sales as a result of continuing international market acceptance of the InterBold i and ix Series ATMs. The Registrant believes the planned phase-out of the fees will have minimal effect on product gross margin percentages going forward. Excluding the effect of the fees, product gross margins continued to improve in 1994.\nService gross profits of $88,158 in 1994 increased from $75,694 in 1993 and $73,316 in 1992. Service gross margins as a percentage of service sales also improved to 31.4 percent from 29.6 percent in 1993 and 29.8 percent in 1992. Even with the establishment of money-back guarantees for service performance, cost controls and improved reliability of products enabled service profitability to improve. The performance of Diebold Mexico's service business which was acquired at the beginning of 1994 also contributed favorably to service gross margins.\nSupporting the Registrant's volume growth and market expansion, operating expenses increased $23,960 or 17.0 percent from 1993 and were $32,888 or 24.9 percent above 1992. Total operating expenses of $164,908 in 1994 improved to 21.7 percent of net sales, from 22.6 percent in 1993 and 24.3 percent in 1992.\nOperating profit of $90,774 in 1994 represented an increase of $21,684 or 31.4 percent from 1993 and $36,973 or 68.7 percent from 1992. Operating profit again grew faster than net sales as manufacturing cost reductions and expense controls allowed the operating profit margin to widen from 11.1 percent and 9.9 percent in 1993 and 1992, respectively, to 11.9 percent in 1994.\nOTHER INCOME, NET AND MINORITY INTEREST Other income, net decreased $512 or 9.0 percent from 1993 but was $1,633 or 46.4 percent above 1992. Investment income increased slightly in 1994 due to rising interest rates and return on investment in lease receivables. The increase in investment income was offset, however, by increases in certain expenses related to Registrant-owned insurance contracts and amortization related to the purchase of certain assets.\nMinority interest of $1,948 decreased from $4,239 in 1993 and consisted primarily of income or losses allocated to the minority ownership of InterBold and Diebold Financial Equipment Company, Ltd. (China). Minority interests for both companies are calculated as a percentage of profits of the joint ventures based on formulas defined in the partnership agreements.\nINCOME Income before taxes and cumulative effect of change\nin accounting principles amounted to $93,978 in 1994. This was an increase of $23,463 or 33.3 percent from 1993 and $39,142 or 71.4 percent from 1992. Income before taxes and cumulative effect of change in accounting principles also improved as a percentage of sales, representing 12.4 percent in 1994 compared to 11.3 percent in 1993 and 10.1 percent in 1992.\nThe effective tax rate was 32.4 percent in 1994, compared to 31.4 percent in 1993 and 25.0 percent in 1992. The primary reason for the higher tax rate in 1994 was a reduction in tax-exempt interest as a percentage of pretax income. The 1992 rate was favorably affected by the settlement of a tax case involving accounting for rotatable spare parts. Details of the reconciliation between the U.S. statutory rate and the effective tax rate are included in Note 12 of the 1994 Consolidated Financial Statements.\nIncome before cumulative effect of change in accounting principles increased to $63,511 or 8.4 percent of consolidated net sales, compared to income of $48,374 or 7.8 percent of net sales in 1993 and $41,137 or 7.6 percent of net sales in 1992.\nMANAGEMENT'S ANALYSIS OF FINANCIAL CONDITION The Registrant continued to enhance its financial position during 1994. Total assets increased $52,864 or 8.7 percent to a 1994 year-end level of $661,883. Asset turnover (excluding cash, cash equivalents and short-term and long-term investment securities) increased to 1.89 in 1994 from 1.78 in 1993.\nTotal current assets at December 31, 1994, of $326,089 represented an increase of $14,589 or 4.7 percent from the prior year-end. The increase in trade receivables and inventories comprises the majority of this increase and is a result of higher sales volumes and expansion of international operations in 1994. Trade receivables increased $23,851 or 18.5 percent to a December 31, 1994, level of $153,107. However, as a percentage of consolidated net sales, trade receivables continued to decline from 22.2 percent and 20.7 percent in 1992 and 1993, respectively, to a 1994 level of 20.1 percent. Inventories at year-end 1994 totaled $85,543 which represented an increase of $10,560 or 14.1 percent from 1993.\nLong-term securities and other investments declined by $25,532 or 14.1 percent to a December 31, 1994, level of $155,800 largely due to maturities of tax- exempt municipal bonds, which were reinvested into certain other assets. The Registrant anticipates being able to meet both short- and long-term operational funding requirements without liquidating individual securities prior to maturity by varying the length and timing of maturities within the portfolio. However, since most of these securities are marketable, they could readily be converted into cash and cash equivalents if needed. The Registrant adopted the provisions of the Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective January 1, 1994.\nTotal property, plant and equipment, net of accumulated depreciation, was $64,713 at the end of 1994, which results in an increase of $4,053 or 6.7 percent over prior year-end. Capital expenditures were $22,641 in 1994 compared with $18,343 in 1993. This increase resulted primarily from the need to meet higher manufacturing capacity requirements, capital investments in new foreign operations and expansion of facilities for research, development and administration. Other assets increased as a result of increases in net lease receivables and certain assets acquired in relation to new businesses.\nTotal current liabilities at December 31, 1994, were $155,464, representing an increase of $16,893 or 12.2 percent from the prior year-end. The primary reason for the increase in current liabilities was an increase in accounts payable of $16,370 or 36.7 percent to a level of $60,962, reflecting increased purchasing activity to support higher sales volumes. The Registrant's current ratio was 2.1 at the end of 1994, compared to 2.3 at the end of 1993.\nAt December 31, 1994, the Registrant had lines of credit totaling $40,000, all unrestricted as to use. Due to the strong liquidity position, the Registrant continued its practice of having no long-term debt. The Registrant's financial position provides it with sufficient resources to meet projected future capital expenditures, dividend and working capital requirements. However, if the need arises, the Registrant's financial position should ensure the availability of adequate additional financial resources.\nMinority interests of $15,028 represented the minority interest in InterBold owned by IBM and the minority interests in Diebold Financial Equipment Company, Ltd. (China) owned by the Shanghai FarEast Aero-Technology Import and Export Corporation and the Industrial and Commercial Bank of China, Shanghai Pudong Branch. Shareholders' equity increased $32,172 or 7.5 percent to $459,219 at December 31, 1994. Included within shareholders' equity are a translation adjustment related to the year-end revaluation of foreign net assets and the effects of adopting Statement of Financial Accounting Standards No. 115. Shareholders' equity per share was $15.08 at the end of 1994 compared to $14.11 in 1993. The Common Shares of the Registrant are\nlisted on the New York Stock Exchange with a symbol of DBD. There were approximately 3,400 shareholders of record as of December 31, 1994.\nThe Board of Directors declared a first-quarter 1995 cash dividend of $0.24 per share. This amount, which represents a 9.0 percent increase from the prior year's quarterly dividend rate, will be paid on March 10, 1995, to shareholders of record on February 17, 1995. Comparative quarterly cash dividends paid in 1994 and 1993 were $0.22 and $0.20, respectively.\nMANAGEMENT'S ANALYSIS OF CASH FLOWS During 1994, the Registrant generated $41,333 in cash from operating activities, compared to $94,577 in 1993 and $86,485 in 1992. In addition to net income of $63,511, adjusted for depreciation, amortization and other charges of $31,014, increases in accounts payables of $16,370 also aided cash provided by operations. Cash in operations was utilized to fund long-term lease receivables and increases in inventory levels and trade receivables as a result of additional sales volumes and formation of international operations. Expressed as a percentage of total assets employed, the Registrant's cash yield from operations was 6.2 percent in 1994 and 15.5 percent in 1993 and 1992. Cash generated from operating activities in 1994 was used to reinvest $40,615, net, in assets of the Registrant, compared with $63,303 in 1993 and $58,838 in 1992. The Registrant returned $26,682 to shareholders in the form of cash dividends paid during 1994, which was a 10.3 percent increase from 1993 and an 18.8 percent increase from 1992.\nOTHER BUSINESS INFORMATION In January 1994, the Registrant purchased 100 percent of the ATM distribution and certain related businesses of Hidromex, S.A. de C.V., to form Diebold Mexico, S.A. de C.V. This new subsidiary is responsible for the distribution and service of ATMs and certain other products in the Mexican market. In January 1994, the Registrant also acquired a 50 percent interest in OLTP ATM Systems, C.A. which distributes, installs and services ATMs and certain other products in Venezuela. Both of these actions were part of a continuing strategy to strengthen the Registrant's international competitiveness by actively seeking acquisitions, joint ventures and strategic alliances throughout the world. As operations are established in foreign locations, the Registrant recognizes that an increasing number of business transactions will involve foreign currencies. To minimize foreign currency exchange risk, the Registrant denominates transactions in U.S. dollars whenever feasible. However, when that is not possible, the Registrant utilizes a strategy of matching monetary assets and liabilities in each currency to the extent practicable.\nThe Registrant also has a continuing strategy to leverage its technological expertise into new product applications and new markets for its products. At December 31, 1994, the Registrant owned 100 percent of MedSelect Systems, Inc., which was originally formed as a joint venture with Daily-Med, Inc. in 1993. MedSelect Systems, now a division of the Company, develops, manufactures and distributes medical supply, medication control and dispensing systems.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDIEBOLD, INCORPORATED AND SUBSIDIARIES (Dollars in thousands except per share amounts)\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Registrant and its subsidiaries. All significant inter-company accounts and transactions have been eliminated.\nSTATEMENTS OF CASH FLOWS\nFor the purposes of the Consolidated Statements of Cash Flows, the Registrant considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Cash paid during 1994, 1993 and 1992 for income taxes amounted to $37,488, $30,134 and $16,898, respectively.\nFOREIGN OPERATIONS\nThe Registrant translates the assets and liabilities of its foreign subsidiaries at the exchange rates in effect at year-end and the results of operations at the average rate throughout the year. The translation adjustments are recorded directly as a separate component of shareholders' equity, while transaction gains (losses) are included in net income. The Registrant does not have any investment-type transactions or any unperformed forward exchange contracts.\nSales to customers in foreign countries approximated 19.8 percent, 17.6 percent and 18.2 percent of net sales in 1994, 1993 and 1992, respectively. The investment used to generate this sales volume is considered immaterial by management.\nTRADE RECEIVABLES AND SALES\nRevenue, after provision for installation, is generally recognized based on the terms of the contracts which, for product sales, is usually when material to be installed for customer orders is shipped from the plants.\nThe equipment that is sold is usually shipped and installed within one year. Installation that extends beyond one year is ordinarily attributable to causes not under the control of the Registrant.\nThe concentration of credit risk in the Registrant's trade receivables with respect to the banking and financial services industries is substantially mitigated by the Registrant's credit evaluation process, reasonably short collection terms and the geographical dispersion of sales transactions from a large number of individual customers. The Registrant maintains allowances for potential credit losses, and such losses have been minimal and within management's expectations.\nINVENTORIES\nInventories are valued principally at the lower of cost or market applied on a first-in, first-out basis. Cost is determined on the basis of actual cost.\nSECURITIES AND OTHER INVESTMENTS\nEffective January 1, 1994, the Registrant adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires that investments in debt and marketable equity securities be designated as held-to-maturity, trading or available-for-sale.\nHeld-to-maturity securities are stated at cost and no adjustment is made in the financial statements for unrealized holding gains and losses.\nTrading securities are stated at fair value and unrealized holding gains and losses are included in income.\nSecurities that are not classified as held-to-maturity or trading are classified as available-for-sale and are carried at fair value with the unrealized holding gains and losses, net of tax, reported as a separate component of shareholders' equity.\nThere is no cumulative effect resulting from the adoption of Statement 115.\nPrior to 1994, the Registrant followed Statement of Financial Accounting Standards No. 12, \"Accounting for Certain Marketable Securities.\"\nDEPRECIATION AND AMORTIZATION\nDepreciation of property, plant and equipment is computed using the straight-line method for financial statement purposes. Accelerated methods of depreciation are used for federal income tax purposes. Amortization of leasehold improvements is based upon the shorter of original terms of the lease or life of the improvement.\nRESEARCH AND DEVELOPMENT\nTotal research and development costs charged to expense were $34,476, $25,493 and $24,452 in 1994, 1993 and 1992, respectively.\nOTHER ASSETS\nPurchased contracts, deferred charges and certain other assets are stated at cost and are amortized ratably over a period of three to 25 years.\nDEFERRED INCOME\nDeferred income is recognized for customer billings in advance of the period in which the service will be performed and is recognized in income on a straight-line basis over the contract period.\nTAXES ON INCOME\nEffective January 1, 1992, the Registrant adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" There was no cumulative effect on the consolidated income statement resulting from the adoption of Statement 109.\nRECLASSIFICATIONS\nThe Registrant has reclassified the presentation of certain prior-year information to conform with the current presentation format.\nNOTE 2: RELATED PARTY TRANSACTIONS\nINTERBOLD JOINT VENTURE\nThe consolidated financial statements include the accounts of InterBold, a joint venture between the Registrant and IBM, of which the Registrant owns 70 percent. The joint venture provides ATMs and other financial self-service systems worldwide. IBM's ownership interest in InterBold is reflected in \"minority interest\" on the Registrant's Consolidated Balance Sheets. Net profits of InterBold are allocated based upon a formula as specified in the partnership agreement.\nInterBold provides ATM and other financial self-service systems marketing and sales support for IBM's international sales and marketing organization, and the Registrant's U.S. sales and marketing organization, both of which sell and distribute InterBold products.\nAll research, development and engineering activities for the Registrant for self-service financial systems are the responsibility of the joint venture.\nNOTE 3: FINANCIAL INSTRUMENTS\nEffective January 1, 1994, the Registrant adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires certain investments in marketable debt and equity securities to be classified as either trading, held-to-maturity or available-for-sale. At December 31, 1993, the Registrant's investment portfolio was stated at the lower of cost or market. At December 31, 1994, the investment portfolio was classified as available-for-sale due to the potential needs for liquidity to fund future acquisitions, joint ventures and strategic alliances throughout the world as part of a continuing strategy to strengthen the Registrant's international competitiveness. At December 31, 1994, the marketable debt and equity securities are stated at fair value and net unrealized holding losses of $1,649, net of tax, are included as a separate component of shareholders' equity until realized. The fair value of securities and other investments is estimated based on quoted market prices.\nThe Registrant's financial instruments, excluding insurance contracts at December 31, are summarized as follows:\nNOTE 6: OTHER ASSETS\nIncluded in other assets are net lease receivables and prepaid pension costs which are the excess of plan contributions over net periodic pension costs. Also, included in other assets were certain assets acquired in relation to new businesses.\nNOTE 7: SHORT-TERM FINANCING\nAt December 31, 1994, bank credit lines approximated $40,000 with various banks for short-term financing. There were no short-term borrowings under these agreements at any time during 1994 and 1993.\nThe Registrant has informal understandings with certain of the banks to maintain compensating balances which are not legally restricted as to withdrawal. The lines of credit can be withdrawn at each bank's option.\nNOTE 8: SHAREHOLDERS' EQUITY\nOn February 1, 1994, the Board of Directors declared a three-for-two stock split effected in the form of a stock dividend, distributed on February 22, 1994, to shareholders of record on February 10, 1994. Accordingly, all numbers of Common Shares, except authorized shares and treasury shares, and all per share data have been restated to reflect this stock split in addition to the three-for-two stock split declared on January 27, 1993, distributed on February 26, 1993, to shareholders of record on February 10, 1993. On the basis of amounts declared and paid, the annualized quarterly dividends per share were $0.88 in 1994, $0.80 in 1993 and $0.75 in 1992. Under the 1991 Equity and Performance Incentive Plan (1991 Plan), Common Shares are available for grant of options at a price not less than 85 percent of the fair market value of the Common Shares on the date of grant. Options are exercisable in cumulative annual installments over five years, beginning one year from the date of grant. The number of Common Shares that may be issued or delivered pursuant to the 1991 Plan is 1,451,250, of which 1,170,901 shares were available for issuance at December 31, 1994. The 1991 Plan will expire on April 2, 2002. The 1991 Plan replaced the Amended and Extended 1972 Stock Option Plan (1972 Plan), which expired by its terms on April 2, 1992. Awards already outstanding under the 1972 Plan are unaffected by the adoption of the 1991 Plan.\nAt December 31, 1994, there were 82,506 and 79,057 shares subject to options issued under the 1991 Plan and the 1972 Plan, respectively, that were exercisable. The 1991 Plan also provides for the issuance of restricted shares without cost to certain employee associates. Outstanding awards granted at December 31, 1994, for both plans totaled 162,000 restricted shares. The shares are subject to forfeiture under certain circumstances. Unearned compensation representing the fair market value of the shares at the date of grant will be charged to income over the three-to-five-year vesting period. The 1991 Plan also provides for the issuance of Common Shares based on certain management objectives achieved within a specified performance period of at least one year as determined by the Board of Directors. The management objectives set in 1994 are based on a three-year performance period ending December 31, 1996. The management objectives for the period ended December 31, 1994, were set in April 1992. The objectives were exceeded and shares were issued in 1995. In February 1989, the Board of Directors declared a dividend distribution of one right for each outstanding Common Share of the Registrant. Pursuant to the Rights Agreement covering the Shareholder Rights Plan, each right entitles the registered holder to purchase one one-hundredth of a share of Cumulative Redeemable Serial Preferred Shares, without par value, at a price of $130. The rights become exercisable 20 days after a person or group acquires 20 percent or more of the Registrant's shares. At that time, rights certificates would be issued and could be traded independently from the Registrant's shares. If the Registrant is involved in certain mergers or other business combination transactions at any time after the rights become exercisable, then the rights will be modified so as to entitle the holder to buy a number of an acquiring company's shares having a market value of twice the exercise price of each right. In addition, if a holder of 20 percent or more acquires the Registrant by means of a reverse merger in which the Registrant and its shares survive, or engages in certain other self-dealing transactions with the Registrant, each right not owned by the acquirer will become exercisable for a number of Common Shares of the Registrant with a market value of two times the exercise price of the right. The rights are redeemable for $0.01 per right at any time before 20 percent or more of the Registrant's shares have been acquired, and will expire on February 10, 1999, unless redeemed earlier by the Registrant. As a result of the stock split effected on February 22, 1994, each Common Share is currently accompanied by four-ninths of a right.\nNOTE 9: INCOME PER SHARE\nThe income per share computations are based upon the weighted average number of Common Shares outstanding during each year. The inclusion in the computation of incremental shares applicable to outstanding stock options and performance shares would have no material effect.\nNOTE 10: PENSION PLANS AND POSTRETIREMENT BENEFITS\nThe Registrant has several pension plans covering substantially all employee associates. Plans covering salaried employee associates provide pension benefits that are based on the employee associate's compensation during the 10 years before retirement. The Registrant's funding policy for those plans is to contribute annually at an actuarially determined rate. Plans covering hourly employee associates and union members generally provide benefits of stated amounts for each year of service. The Registrant's funding policy for those plans is to make at least the minimum annual contributions required by applicable regulations. Approximately 90 percent of the plan assets at December 31, 1994, were invested in listed stocks and investment grade bonds.\nMinimum liabilities have been recorded in 1994, 1993 and 1992 for the plans whose total accumulated benefit obligation exceeded the fair value of the plan's assets. The Registrant offers an employee associate 401(k) Savings Plan (Savings Plan) to encourage eligible employee associates to save on a regular basis, by payroll deductions, and to provide them with an opportunity to become shareholders of the Registrant. Under the Savings Plan in 1994, the Registrant matched 80 percent of a participating employee associate's first 4 percent of earnings and 40 percent of a participating employee associate's second 4 percent of earnings.\nIn addition to providing pension benefits, the Registrant provides certain healthcare and life insurance benefits for retired employee associates. Eligible employee associates may be entitled to these benefits based upon years of service with the Registrant, age at retirement and collective bargaining agreements.\nEffective January 1, 1992, the Registrant adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" Under Statement 106, the Registrant records such postretirement benefit costs during the periods in which employee associates provide services for such benefits. The Registrant elected immediate recognition of the transition charge associated with adopting Statement 106 by recording a one-time charge of $17,932, net of $10,990 in income taxes, as a cumulative effect of change in accounting principle.\nThe transition obligation represented accumulated postretirement benefits associated with service rendered prior to January 1, 1992, by eligible current and former employee associates. Presently, the Registrant has made no commitments to increase these benefits for existing retirees or for employee associates who may become eligible for these benefits in the future. Currently there are no plan assets and the Registrant funds the benefits as the claims are paid.\nThe effect of a one percentage point annual increase in the assumed healthcare cost trend rate would increase the service and interest cost components of the healthcare benefits from $1,783 to $1,942, an 8.9 percent increase.\nMeasurement of the accumulated postretirement benefit obligation at December 31, was based on a discount rate of 7.25 percent in 1994 and 1993.\nUnder the provisions of Statement 106, the postretirement benefit obligation was determined by application of the terms of medical and life insurance plans together with relevant actuarial assumptions and healthcare cost trend rates projected at annual rates declining from 13.2 percent in 1994 to 5.3 percent through the year 2026. The effect of a one percentage point annual increase in these assumed healthcare cost trend rates would increase the healthcare accumulated postretirement benefit obligation from $25,121 to $27,426, a 9.2 percent increase.\nRental expense for 1994, 1993 and 1992 under all lease agreements amounted to approximately $18,100, $16,500 and $15,900, respectively.\nDeferred tax assets amounted to $46,308 and $37,706 and deferred tax liabilities amounted to $16,694 and $21,775 at December 31, 1994, and 1993, respectively. No valuation allowance was required for the deferred tax assets.\nIn 1990, the Registrant filed petitions with the United States Tax Court to protest the Internal Revenue Service's (IRS) proposed deficiencies for the years 1978 through 1982. The IRS disagreed with the Registrant's position that rotatable spare parts (used in the servicing of customer equipment) were fixed assets subject to depreciation and eligible for the Investment Tax Credit (ITC). It is the IRS's position that rotatable spare parts are not entitled to depreciation or ITC and should be accounted for as inventory, for tax purposes, and deducted only when sold or abandoned.\nOn December 11, 1992, the United States Tax Court entered its decision based on a resolution agreed upon by the IRS and the Registrant regarding the petitions the Registrant had filed to contest the proposed deficiencies for the years 1978 through 1982. In addition, on January 11, 1993, the Registrant and the IRS signed a closing agreement under Section 7121 of the Internal Revenue Code. This agreement applies to the years 1983 through 1990.\nAs a result of the Tax Court decision and the settlement reached with the IRS, the Registrant will account for its rotatable spare parts as inventory for tax purposes. Under this method of accounting, for tax purposes the value of the rotatable spare parts used to service customer equipment will be deducted as sold or abandoned.\nThe amounts the Registrant had reserved for the\nyears in question exceeded the total tax and related accrued interest payable to the IRS for the years noted above. The resolution of this tax case did not have a material impact upon the financial position of the Registrant.\nNOTE 13: COMMITMENTS AND CONTINGENCIES\nAt December 31, 1994, the Registrant was a party to several lawsuits that were incurred in the normal course of business, none of which individually or in the aggregate is considered material in relation to the Registrant's financial position or results of operations.\nNOTE 14: SEGMENT INFORMATION\nThe Registrant operates predominantly in one industry segment, financial systems and equipment. This industry segment accounts for more than 90 percent of the consolidated revenues, operating profit and identifiable assets.\nNOTE 15: QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nSee \"Comparison of Selected Quarterly Financial Data (Unaudited)\" on page 28 of this Annual Report on Form 10-K.\nREPORT OF MANAGEMENT\nThe management of Registrant is responsible for the contents of the consolidated financial statements, which are prepared in conformity with generally accepted accounting principles. The consolidated financial statements necessarily include amounts based on judgments and estimates. Financial information elsewhere in the Form 10-K is consistent with that in the consolidated financial statements. The Registrant maintains a comprehensive accounting system which includes controls designed to provide reasonable assurance as to the integrity and reliability of the financial records and the protection of assets. An internal audit staff is employed to regularly test and evaluate both internal accounting controls and operating procedures, including compliance with the Registrant's statement of policy regarding ethical and lawful conduct. The role of KPMG Peat Marwick LLP, the independent auditors, is to provide an objective review of the consolidated financial statements and the underlying transactions in accordance with generally accepted auditing standards. The report of KPMG Peat Marwick LLP accompanies the consolidated financial statements. The Audit Committee of the Board of Directors, composed of directors who are not members of management, meets regularly and separately with management, the independent auditors and the internal auditors to ensure that their respective responsibilities are properly discharged. KPMG Peat Marwick LLP and the Director of Internal Audit have full and free access to the Audit Committee.\nGerald F. Morris Executive Vice President and Chief Financial Officer\nITEM 9.","section_7":"","section_7A":"","section_8":"","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING - ------- ----------------------------------------------------------- AND FINANCIAL DISCLOSURE. -------------------------\nThere have been no changes in accountants or disagreements with accountants on accounting and financial disclosures.\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - -------- ---------------------------------------------------\nInformation with respect to directors of the Registrant is included on pages 3 through 9 of the Registrant's proxy statement for the 1995 Annual Meeting of Shareholders (\"1995 Annual Meeting\") and is incorporated herein by reference. Refer to pages 6 through 9 of this Form 10-K for information with respect to executive officers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. - -------- -----------------------\nInformation with respect to executive compensation is included on pages 9 through 20 of the Registrant's proxy statement for the 1995 Annual Meeting and is incorporated herein by reference.\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 included on pages 1 through 7 of the Registrant's proxy statement for the 1995 Annual Meeting and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - -------- -----------------------------------------------\nThe information with respect to certain relationships and related transactions set forth under the caption \"Compensation Committee Interlocks and Insider Participation\" on page 9 of the Registrant's proxy statement for the 1995 Annual Meeting 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 a part of this report.\n1. The following additional information for the years 1994, 1993 and 1992 is submitted herewith:\nIndependent Auditors' Report on Financial Statements and Financial Statement Schedule\nSCHEDULE VIII. Valuation and Qualifying Accounts\nAll other schedules are omitted, as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K. - -------- --------------------------------------------------------------- (continued)\n2. Exhibits\n3.1 (i) Amended and Restated Articles of Incorporation of Diebold, Incorporated.\n3.1 (ii) Code of Regulations -- incorporated by reference to Exhibit 4(c) to Registrant's Post-Effective Amendment No. 1 to Form S-8 Registration Statement No. 33-32960.\n3.2 Certificate of Amendment by Shareholders to Amended Articles of Incorporation of Diebold, Incorporated -- incorporated by reference to Exhibit 3.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n4. Rights Agreement dated as of February 10, 1989 between Diebold, Incorporated and Ameritrust Company National Association -- incorporated by reference to Exhibit 2.1 to Registrant's Registration Statement on Form 8-A dated February 10, 1989.\n* 10.1 Form of Employment Agreement as amended and restated as of September 13, 1990 -- incorporated by reference to Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n* 10.2 Schedule of Certain Officers who are Parties to Employment Agreements in the form of Exhibit 10.1. -- incorporated by reference to Exhibit 10.2 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n* 10.3 Supplemental Pension Agreement with Raymond Koontz.\n* 10.4 Supplemental Retirement Benefit Agreement with Robert W. Mahoney.\n* 10.5 Supplemental Employee Retirement Plan (as amended January 1, 1994).\n10.6 Amended and Restated Partnership Agreement dated as of September 12, 1990 -- incorporated by reference to Exhibit 10 to Registrant's Form 8-K dated September 26, 1990.\n* 10.7 1985 Deferred Compensation Plan for Directors of Diebold, Incorporated -- incorporated by reference to Exhibit 10.7 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n* 10.8 1991 Equity and Performance Incentive Plan -- incorporated by reference to Exhibit 4(a) to Registrant's Form S-8 Registration Statement No. 33-39988.\n* Reflects management contract or other compensatory arrangement required to be filed as an exhibit pursuant to Item 14(c) of this report.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K. - -------- --------------------------------------------------------------- (continued)\n* 10.9 Long-Term Executive Incentive Plan -- incorporated by reference to Exhibit 10.9 of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n* 10.10 1992 Deferred Incentive Compensation Plan (as amended and restated as of July 1, 1993) -- incorporated by reference to Exhibit 10.10 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n* 10.11 Annual Incentive Plan -- incorporated by reference to Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n* 10.12 Employment Agreement with Robert P. Barone -- incorporated by reference to Exhibit 10.12 to Registrant's Form 10-Q for the quarter ended September 30, 1994.\n21. Subsidiaries of the Registrant.\n23. Consent of Independent Auditors.\n24. Power of Attorney.\n27. Financial Data Schedule.\n* Reflects management contract or other compensatory arrangement required to be filed as an exhibit pursuant to Item 14(c) of this report.\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.\nDIEBOLD, INCORPORATED\nMarch 9, 1995 By: \/s\/Robert W. Mahoney - ------------- ----------------------- Date Robert W. Mahoney 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.\nINDEPENDENT AUDITORS' REPORT ON ------------------------------- FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE -----------------------------------------------------\nThe Board of Directors Diebold, Incorporated\nWe have audited the accompanying consolidated balance sheets of Diebold, 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 years in the three-year period ended December 31, 1994. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in Item 14 (a)(1) of Form 10-K of Diebold, Incorporated for each of the years in the three-year period ended December 31, 1994. These consolidated financial statements and financial statement schedule are the responsibility of the Registrant'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 Diebold, Incorporated 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.\nAs discussed in Notes 1 and 10 to the consolidated financial statements, the Registrant adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" and Statement of Financial Accounting Standards No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions,\" in 1992.\n\/s\/KPMG Peat Marwick LLP\nKPMG PEAT MARWICK LLP Cleveland, Ohio January 18, 1995","section_15":""}
{"filename":"357019_1994.txt","cik":"357019","year":"1994","section_1":"Item 1. Business ---------------------\nThe principal business of GATX Capital Corporation and subsidiaries (the \"Company\") is to provide and arrange equipment leases and other loan financing. The Company also manages a portfolio of leased equipment for its own account and the account of others. GATX Capital Corporation is a wholly- owned subsidiary of GATX Corporation.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ----------------------\nThe Company leases all of its office space and owns no materially important physical properties other than those related directly to its investment portfolio. The Company's principal offices are rented under a twelve year lease expiring in 2003.\nItem 3.","section_3":"Item 3. Legal Proceedings ---------------------------------\nThere are no legal proceedings pending to which the Company is a party, other than routine litigation in the normal course of business of the Company. The Company believes that the outcome of any lawsuit or claim which is pending or threatened will not have a material adverse effect on its financial condition or operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders -------------------------------------------------------------------------\nOmitted under provisions of the reduced disclosure format.\n\t\t\t\t PART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder ----------------------------------------------------------------------------- Matters --------\nNot applicable. All common stock of the Registrant is held by GATX Corporation. Information regarding dividends is shown on the consolidated statements of income and reinvested earnings included in Item 8.\nItem 6.","section_6":"Item 6. Selected Financial Data ---------------------------------------\nOmitted under provisions of the reduced disclosure format.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and ----------------------------------------------------------------------------- Results of Operations ---------------------\nIncorporate herein by reference to the Annual Report, pages 19, 21, 22 and 25, included as Exhibit 13 of this document.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -----------------------------------------------------\nThe following consolidated financial statements of GATX Capital Corporation, included in the 1994 Annual Report (Exhibit 13), are incorporated herein by reference (page references are to the Annual Report):\nConsolidated Statements of Income and Reinvested Earnings \tYears Ended December 31, 1994, 1993 and 1992 Page 20\nConsolidated Balance Sheets \tAs of December 31, 1994 and 1993 Page 23\nConsolidated Statements of Cash Flows \tYears Ended December 31, 1994, 1993 and 1992 Page 24\nNotes to Consolidated Financial Statements Pages 26-33\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and ----------------------------------------------------------------------------- Financial Disclosure ---------------------\nNone.\n\t\t\t\t PART III\nItem 10(a). Directors of the Registrant ----------------------------------------------\nName Office Held Since Age ------- -------------- -------- ------- James J. Glasser Chairman of the Board 1971 60 Joseph C. Lane President and Director 1994 41 Alan C. Coe Executive Vice President \t\t\tand Director 1994 43 Jesse V. Crews Executive Vice President \t\t \tand Director 1994 42 David M. Edwards Director 1990 43 Frederick L. Hatton Executive Vice President \t\t \tand Director 1984 52 Ronald H. Zech Director 1984 51\nItem 10(b). Executive Officers of the Registrant\nName Office Held Since Age ------- -------------- -------- ------- Joseph C. Lane President, Director, and \t\t\t Chief Executive Officer 1994 41 \t\t\t\t Frederick L. Hatton Executive Vice President \t\t\t and Director 1984 52 Alan C. Coe Executive Vice President \t\t\t and Director 1994 43 Jesse V. Crews Executive Vice President \t\t\t and Director 1994 42 Michael E. Cromar Vice President and Chief \t\t\t Financial Officer 1994 47 Cal C. Harling Senior Vice President 1994 46 Robert J. Sammis Senior Vice President 1993 48 Thomas C. Nord Vice President, General Counsel, \t\t\t and Secretary 1980 54 George R. Prince Vice President and Treasurer 1983 50 Curt F. Glenn Principal Accounting Officer, 1992 40 \t\t\tVice President and Controller Valerie C. Williams Vice President - Human Resources 1989 50\nJOSEPH C. LANE, President, Director and Chief Executive Officer since 1994. Mr. Lane joined the Company in 1979 as a Financial Analyst and has served as District Manager, Regional Manager, Vice President, Senior Vice President and Executive Vice President. Mr. Lane was formerly Vice President - Corporate Finance for Rotan Mosle Investment Bankers (two years) and a member of the Yale University Development Faculty (three years). Mr. Lane currently serves as a Director of the Equipment Leasing Association Board. He received a BA from Yale University in 1975.\nFREDERICK L. HATTON, Executive Vice President and Director since 1984. Mr. Hatton joined the Company in 1983 as Senior Vice President and President of GATX Air. He is currently responsible for GATX Airlog. Prior to 1983, he served as Vice President-Marketing for two years, and Executive Vice President for four years with International Air Service Company (IASCO). Prior to IASCO, Mr. Hatton served in a number of managerial capacities for Flying Tiger Lines. He received a BS from Yale University in 1964, an MS in aerospace management from the University of Southern California in 1971, and an MBA from the Wharton School in 1972. Mr. Hatton served as a U.S. Marine Corps fighter pilot from 1964 to 1970 including a tour in Vietnam.\nALAN C. COE, Executive Vice President and Director since 1994. Mr. Coe joined the Company in 1977 as a Financial Analyst and has held a variety of positions both domestically and internationally. Prior to 1977, Mr. Coe served as an officer in the United States Air Force (four years) and as Vice President - Corporate Finance - with Rotan Mosle in Houston, Texas (three years). Mr. Coe received a BA from Southern Methodist University in 1973 and his MBA from Golden Gate University in 1976.\nJESSE V. CREWS, Executive Vice President and Director since 1994. Mr. Crews joined the Company in 1977 as a Financial Analyst and had a variety of positions, including Regional Manager of the Singapore (two years) and New Orleans\/Houston (five years) offices before returning to San Francisco in 1985. He has been broadly responsible for the development of new business investment opportunities for the Company's own portfolio since 1986 and as head of the Corporate Finance Group from 1990 to 1994. Mr. Crews received a BA from Yale and an MBA from the University of Virginia.\nMICHAEL E. CROMAR, Vice President and Chief Financial Officer since October 1994. Prior to joining GATX, Mr. Cromar was Vice President, Treasurer and Chief Financial Officer at The Harper Group, Inc., a San Francisco based international logistics services company (two years). Previously, he served S.A. Louis-Dreyfus & Cie., principally as Senior Vice President, Finance and Information, for Gearbulk Ltd. an industrial bulk shipping joint venture in Bergen, Norway (four years). From 1982 to 1988 (five years) he was corporate controller and a director of information technology for American President Companies, Ltd. From 1975, he held a variety of financial management positions with Natomas Co., an energy resources company. Mr. Cromar began his career with Touche Ross & Co. where he was a Certified Public Accountant. He received a BS degree in Business Administration in 1972 from the University of Utah and was an infantry officer in the U.S. Army, including service in Vietnam.\nCAL C. HARLING, Senior Vice President since 1994. Mr Harling joined the Company in 1987 as Vice President, Technology Financing. Prior to 1987 Mr. Harling was an independent consultant for two years. Mr. Harling worked for Decimus Corporation, a subsidiary of BankAmerica Corporation, for ten years starting in 1975. While at Decimus Mr. Harling held various positions including Vice President of Vendor Operating Leasing, Vice President of Portfolio Management, and other management positions in systems development. Mr. Harling received a BS from California State University, Sacramento in 1973.\nROBERT J. SAMMIS, Senior Vice President - Corporate Development since 1993. Mr. Sammis joined the Company in 1975 as Associate Counsel. He has served as a Senior Vice President in charge of Equipment Management and as Managing Director, International. Mr. Sammis is a Fulbright scholar and, in that capacity, taught law at the University of Los Andes, Bogota, Columbia. Prior to joining the Company, he was with Pillsbury, Madison & Sutro as Associate Counsel. Mr. Sammis received a BA from the University of California and a JD from the University of Michigan.\nTHOMAS C. NORD, Vice President and General Counsel since 1980. Mr. Nord joined the Company as Associate Counsel in 1977 and became Assistant General Counsel in 1978. Prior to 1977, Mr. Nord served as Counsel for Charter New York Leasing, an affiliate of Irving Trust Company (three years), and as an Associate in the New York law firm of Seward and Kissel (five years). Mr. Nord received a BA from Northwestern University in 1962 and a JD from the University of North Carolina in 1969.\nGEORGE R. PRINCE, Vice President and Treasurer since 1983. Mr. Prince joined the Company in 1981 as Assistant Vice President - Corporate Development. In 1983, he was promoted to Vice President and Treasurer. Prior to 1981, Mr. Prince was Vice President for Continental Bank. Mr. Prince received his BS in 1966 from Cornell University and MBA in 1968 from Michigan State.\nCURT F. GLENN, Principal Accounting Officer, Vice President and Controller since 1992. Mr. Glenn joined the company in 1980 as Assistant Tax Manager, was appointed Tax Manager in 1985 and elected Vice President in 1989. Prior to joining the Company, Mr. Glenn was a Senior Tax Analyst at GATX Corporation (two years) and a Senior Tax Accountant with Trans Union Corporation (four years). Mr. Glenn received a B.S. in Accounting from DePaul University in 1977. Mr. Glenn is currently Chairman of the Federal Tax Committee of the Equipment Leasing Association of America.\nVALERIE C. WILLIAMS, Vice President - Human Resources since 1989. Prior to joining GATX, Ms. Williams was President of VC Williams & Associates, a human resources consulting firm; was Director, Corporate Compensation and Incentives at Carson Pirie Scott & Co. and Consultant, Compensation with A.S. Hansen, Inc. Ms. Williams received her MBA from Lake Forest College in 1980.\nItems 11, 12 & 13 ----------------------\nOmitted under provisions of the reduced disclosure format.\n\t\t\t\t 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 --------------------------------------------------------------------------- (a) 1. Financial statements\nThe following consolidated financial statements of GATX Capital Corporation included in the Annual Report for the year ended December 31, 1994, are incorporated by reference in Item 8.\nConsolidated Balance Sheets As of December 31, 1994 and 1993 Consolidated Statements of Income and Reinvested Earnings 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\n2. Financial statement schedules\nAll financial statement schedules have been omitted because they are not applicable or because required information is provided in the financial statements, including the notes thereto, which are incorporated by reference in Item 8.\nItem 14.(a) (continued) --------------------------- 3. Exhibits Required by Item 601 of Regulation S-K\nExhibit Number ----------- 3(a) Restated Certificate of Incorporation of the Company.(1) 3(b) By-laws of the Company.(2) 4(d) Term Loan Agreement between the Company and a Bank dated as of \t December 26, 1990.(3) 10(a) Office Leases, Four Embarcadero Center, dated October 1, 1990 and \t June 1, 1991, between the Company and Four Embarcadero Center \t Venture.(3) 10(b) Tax Operating Agreement dated January 1, 1983 between GATX \t Corporation and GATX Leasing Corporation.(4) 10(c) Preferred Stock and Tax Assumption program and Issuance of Common \t Stock.(5) 10(d) Preferred Stock Redemption Agreement.(6) 10(e) Credit Agreement among the Company, the Subsidiaries listed in \t Schedule II thereto, the Banks listed on the signature pages \t thereto, and Chase Manhattan Bank, as agent for the Banks, \t dated December 14, 1992.(7) 10(f) Credit Agreement among the Company, its two subsidiaries \t\toperating in Canada, and the Bank of Montreal, dated December \t\t14, 1992.(7) 10(g) Second Amendment, dated June 14, 1994, to Credit Agreement referred \t\tto in 10(f).(8) 10(h) Third Amendment, dated December 1, 1994, to Credit Agreement \t\treferred to in 10(f).(8) 10(i) Amendment No. 1, dated December 1, 1994, to Credit Agreement \t\t referred to in 10(e).(8) 10(j) First Amendment, dated June 20, 1993, to Credit Agreement referred to in 10(f).(8) 12 Computation of Ratio of Earnings to Fixed Charges.(8) 13 Annual Report to Shareholder, pages 19-34.(8) 23 Consent of Independent Auditors.(8) 27 Financial Data Schedule.(8) 99 Listing of Medium Term Notes.(8)\nThe Registrant agrees to furnish to the Commission upon request a copy of each instrument with respect to issues of long-term debt of the Registrant the authorized principal amount of which does not exceed 10% of the total assets of Registrant.\n(1) Incorporated by reference to Form 10-K filed with the Commission on \t March 30, 1990. (2) Incorporated by reference to Registration Statement on Form S-1, as \t amended, (file number 2-75467) filed with the Commission on \t December 23, 1981, page II-4. (3) Incorporated by reference to Form 10-K filed with the Commission on \t March 30, 1991. (4) Incorporated by reference to Form 10-K filed with the Commission on \t March 28, 1983. (5) Incorporated by reference to Form 10-K filed with the Commission on \t March 24, 1986. (6) Included in the Restated Certificate of Incorporation incorporated by \t reference herein. (7) Incorporated by reference to Form 10-K filed with the Commission on \t March 31, 1993. (8) Submitted to the Securities and Exchange Commission with the \t electronic filing of this document.\nItem 14(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.\nReport of Independent Auditors\nBoard of Directors GATX Capital Corporation\nWe have audited the consolidated financial statements of GATX Capital Corporation (a wholly owned subsidiary of GATX Corporation) and subsidiaries listed in the accompanying index to financial statements (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 financial statements listed in the accompanying index to financial statements Item 14(a)) present fairly, in all material respects, the consolidated financial position of GATX 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.\nIn 1992, the Company changed its method of accounting for income taxes and postretirement benefits other than pensions effective January 1, 1992.\n\t\t\t\t\t\t\t\t\t\t\t\t\t ERNST & YOUNG LLP\nSan Francisco, California January 24, 1995\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\t\t\t\t\t\t\t GATX CAPITAL CORPORATION \t\t\t\t\t\t\t\t\t\t\t\t\t (Registrant)\n\t\t\t\t\t\t\t\t\t\t\t\t By \/s\/ Joseph C. Lane \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 Joseph C. Lane President, Director, and Chief Executive Officer\n\t\t\t\t\t\t\t\t\t\t\t\t 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 date indicated.\nBy \/s\/ Joseph C. Lane By \/s\/ Michael E. Cromar ---------------------- --------------------------- Joseph C. Lane Michael E. Cromar President, Director, and Vice President and Chief Executive Officer Chief Financial Officer\nDated: March 27, 1995 Dated: March 27, 1995\nBy \/s\/ Curt F. Glenn By \/s\/ David M. Edwards ---------------- --------------------------- Curt F. Glenn David M. Edwards Principal Accounting Officer and Director Vice President & Controller\n\tDated: March 27, 1995 Dated: March 27, 1995\nBy \/s\/ Jesse V. Crews By \/s\/ Alan C. Coe ----------------------- --------------------- Jesse V. Crews Alan C. Coe Executive Vice President Executive Vice President and Director and Director\n\tDated: March 27, 1995 Dated: March 27, 1995","section_15":""}
{"filename":"51467_1994.txt","cik":"51467","year":"1994","section_1":"ITEM 1. BUSINESS\nRECENT EVENT\nOn August 23, 1994, the Company announced that it had entered into a definitive merger agreement (the \"Merger Agreement) to be acquired at a cash purchase price of $9.00 per share (the \"Merger Consideration\") by a new company formed by institutional investors led by 399 Ventures, Inc. Stockholders in the acquiror will include members of senior management of the Company. Completion of the transaction, which will be effected by a statutory merger, is subject to receipt of financing as well as customary closing conditions. At the time the Merger Agreement was signed, the acquiror delivered to the Company a letter that it had obtained from Bear, Stearns & Co., Inc. (\"Bear Stearns\") indicating that, based on then-current market conditions and subject to a number of material financial conditions, Bear Stearns was highly confident of its ability to place debt securities constituting a substantial portion of the proposed financing. Approval of the merger requires a two-thirds vote of the Company's stockholders.\nOn November 16, 1994, the Company announced that it had agreed to extend until January 31, 1995 the termination date of the Merger Agreement in order to allow the acquiror more time to arrange financing for the transaction. The Company announced that it had been advised by the acquiror that the acquiror had received advice from Bear Stearns regarding the deterioration of conditions in the high-yield financing market and that, as a result, the acquiror did not believe that the financing necessary to consummate the proposed merger will be available on the terms contemplated at the time of the original Merger Agreement. As a result, the acquiror has advised the Company that it is pursuing alternative financing structures to complete the transaction. Under the Merger Agreement, the acquiror is obligated to use its best efforts to obtain financing on terms contemplated at the time of the original Merger Agreement that would permit it to consummate the merger for the Merger Consideration. There can be no assurance that the financing can be obtained on such terms and, therefore, that the merger can be completed.\nThe amended Merger Agreement entitles either party to terminate the agreement if the merger does not occur on or before January 31, 1995, provided that the party electing to terminate is not in material breach of the Merger Agreement. If the Merger Agreement is terminated, the Company will not be obligated to pay any fees of the acquiror under the Merger Agreement other than to reimburse the acquiror's expenses up to a maximum of $1.5 million under certain circumstances, including termination of the agreement to accept an offer from a third party. The Company may furnish information to and negotiate with parties making unsolicited inquiries, accept an offer received from a third party, and terminate the amended Merger Agreement.\nOVERVIEW\nThe Company operates and franchises family-oriented, full-service, casual dining restaurants in 23 states in the Northeast, Mid- Atlantic and Midwest regions of the United States and franchises one restaurant in Canada. Ground Round restaurants offer a broad selection of high quality, moderately-priced menu items, including a choice of appetizers, entree salads, specialty sandwiches, the one-half pound THE GROUND ROUNDER(R) hamburger and entrees featuring seafood, baby back ribs, steak, chicken and pasta, as well as full liquor service. A specialty section of the menu, \"Just for Kids,\" offers pizza, hot\ndogs and grilled cheese sandwiches at reduced prices. On Tuesdays or Thursdays, KIDS PAY WHAT THEY WEIGH(R) at JUST A PENNY A POUND(R) for any item selected from the children's section of the menu. As of October 2, 1994, the end of the Company's most recent fiscal year, there were 205 restaurants system-wide, 164 of which were Company-operated and 41 of which were operated by franchisees.\nSTRATEGY\nThe Company's objective is to become the premier family-oriented, full service, casual dining restaurant in the industry. The key elements of the Company's strategy include the following:\n- - -- emphasizing a \"no compromise\" dining experience by creating an atmosphere WHERE KIDS CAN RELAX...AND GROWN-UPS CAN HAVE FUN(R);\n- - -- offering customers an excellent price-to-value alternative to other casual dining restaurants;\n- - -- revitalizing the menu to offer items that are more appealing to the Company's target customers;\n- - -- implementing a new compensation plan designed to motivate each restaurant general manager by tying financial rewards to the operating profits of the manager's restaurant;\n- - -- remodeling older restaurants to improve their exterior and interior appearance to provide continuity throughout the Ground Round system;\n- - -- selling or closing certain restaurants for which renovation is not economically justifiable; and\n- - -- accelerating the rate at which the company opens new restaurants.\nNo Compromise Dining. The Company seeks to create an atmosphere WHERE KIDS CAN RELAX...AND GROWN-UPS CAN HAVE FUN(R). Each restaurant typically has two distinct dining areas, a main dining room for families with children and a smaller dining and bar area for adults. In the main dining room, children can enjoy a special selection of kids' meals while watching cartoons, coloring in books, playing games or being entertained by periodic visits from BINGO THE CLOWN(R). Adults dining without children or families seeking a more mature ambiance can enjoy light snacks and complete meals in the second dining area. By offering two distinct dining atmospheres, the Ground Round restaurants cater to a large customer base, which the Company believes has contributed to the resiliency of the Ground Round concept over the past 25 years.\nExcellent Price-to-Value Relationship. The Company believes it offers its customers an excellent price-to-value alternative to other casual dining restaurants. By offering sandwiches and entrees that range in price from $3.79 to $12.95 and a children's menu with lower prices, the Company targets both families and adults dining without children seeking a value oriented full-service, casual dining experience. In fiscal 1994, the average guest check in Company-operated restaurants was approximately $8.29 (including alcoholic beverages). Alcoholic beverages have accounted for approximately 22% of restaurant sales during the last three fiscal years.\nRevitalized Menu. The Company continues to refine its menu by developing new products, which are perceived to be of higher quality and which reflect changes in guest preferences. Examples include chicken quesadillas, sauteed dishes, such as tomato and basil pasta and chicken alfredo, sizzling fajitas, a 12-ounce, center-cut sirloin steak and cajun swordfish. Several unique desserts, such as CINNAMON DIPPERS(R), CHAOS(R) pie and peanut butter pie, have also been added. Additionally, the Company is reducing the number of menu items to enhance restaurant performance by simplifying execution.\nMotivated General Managers. The Company believes that by sharing the restaurant's operating profits with its managers, the Company will foster a feeling of ownership in its managers and encourage entrepreneurship. The Company recently began implementing its Managing General Partner program, which allows each selected general manager to share in the success of the manager's restaurant. A participating general manager will receive 2.5% of the monthly operating profit and 15% of the increase in the quarterly operating profits of the manager's restaurant. Additionally, each participating general manager will receive a bonus of 10% of the total profit of the restaurant in the managers's fifth year in the program. The Company expects that within the next several years, all restaurant general managers will participate in the Managing General Partner program. Currently, each restaurant manager not participating in the Managing General Partner program receives incentive compensation based upon the operating profits of the manager's restaurant. By providing its general managers with a significant participation in the operating profits of their restaurants, the Company believes that it will attract and retain highly motivated managers.\nRemodeling Program. The Company currently is in the process of remodeling older restaurants to provide continuity throughout the entire Ground Round system and preserve the integrity of the Ground Round concept. In 1992 and 1993 the Company remodeled 29 restaurants at an average cost of approximately $275,000 per restaurant. In fiscal 1994, the Company remodeled 49 restaurants at an average cost of approximately $147,000 per restaurant. The Company has an additional nine restaurants undergoing remodeling. By the end of fiscal 1995, the Company plans to remodel substantially all remaining restaurants which are economically justifiable to remodel, through which the Company can achieve an adequate return through increased sales.\nDivestiture Program. During fiscal 1994, the Company determined that it would sell or close locations for which remodeling was not economically justifiable. During fiscal 1994, the Company closed four locations and sold seven Company-operated restaurants generating cash proceeds of approximately $4.4 million and has agreed to sell, subject to the fulfillment of certain closing conditions, six Company-operated restaurants, which in the aggregate will generate additional cash proceeds of approximately $3.6 million. The Company intends to sell or close an additional 27 restaurants by the end of the second quarter of fiscal year 1996. The disposal of some or all of these resturants is not expected to have a material effect on the Company's operating profit. In addition to the cash proceeds expected by the Company from the sales of the remaining targeted restaurants, the Company should also realize significant economic benefits through improved utilization of assets and decreased management-supervision time.\nExpansion Program. Management recently accelerated its expansion program by opening five newly-constructed, Company-operated restaurants during fiscal 1992 and eight newly-constructed, Company-operated restaurants during fiscal 1993. The Company-operated restaurants that were opened in fiscal 1992 recorded average sales of approximately $1.9 million in fiscal 1993 (a 53-week year), compared to $1.4 million average sales recorded by comparable Company-operated restaurants in fiscal 1993. The eight Company- operated restaurants opened during the fourth quarter of fiscal 1993 recorded average annualized sales of approximately $1.8 million for fiscal 1994. The Company opened nine Company-\noperated restaurants in fiscal 1994 and anticipates opening 10 to 20 Company- operated restaurants in fiscal 1995.\nTHE RESTAURANTS\nThe Company's restaurants are divided into 20 geographic regions, managed by an Executive Vice President, a Senior Vice President and a Director of Operations. Each region has a Regional Director who typically oversees between five and 16 Company-operated restaurants and one to five franchise restaurants. The day-to-day operation of each restaurant, including personnel management, food procurement, inventory control, guest relations and local marketing, is the responsibility of a general manager who reports to the appropriate Regional Director.\nGround Round restaurants are located primarily in the Northeast, Mid-Atlantic and Midwest regions of the United States. Most restaurants are in free-standing buildings along commercial roadways with high traffic counts. Many of the restaurants are located near a retail shopping area or in major shopping malls.\nGround Round restaurants average approximately 5,600 square feet and 210 seats. The family dining room averages approximately 2,800 square feet in size and has approximately 140 seats. The adult dining room, which includes a bar and lounge, generally averages 1,400 square feet with 70 seats. The Company has developed a restaurant facility prototype for its new restaurants and is remodeling its existing restaurants to make their physical appearance consistent with this prototype. The exterior of the new and remodeled restaurants features a green and yellow striped backlit awning, new illuminated signage and attractive landscaping. The design of Ground Round restaurants is flexible and can be adapted to local architectural styles and varying floor plans. The Company is, therefore, able to convert existing buildings to the Ground Round concept.\nThe Company estimates that the investment required to open a typical Company-operated restaurant (excluding occupancy costs, such as rent and taxes) currently ranges from approximately $900,000 to $1.3 million, assuming the Company does not purchase the land. The Company currently anticipates that it will lease the land and buildings for substantially all new Company-operated restaurants. Costs for construction of leasehold improvements vary based upon such factors as size, location, condition and type of property. The cost of furniture, fixtures and equipment, initial inventory and supplies and other pre-opening expenses, including liquor licenses, are included in the range set forth above and are incurred whether a restaurant is leased or owned. The Company does not have any exclusive arrangements with contractors or designers.\nThe Company believes that location is a key factor in a restaurant's ability to operate profitably. The Company studies area demographics, such as household size, density of population and average household income, and site characteristics, such as traffic volume, visibility, accessibility, parking availability, proximity to a major shopping center and proximity to other restaurants. Based on analysis of its most profitable restaurants, the Company seeks sites in areas that have populations in excess of 50,000 persons within a three-mile radius and an average household incomes of approximately $35,000.\nThe Company intends to locate its new restaurants primarily within or near markets in which existing Ground Round restaurants are concentrated to benefit from marketing and operating efficiencies. Of the new restaurants opened in fiscal 1994, three are in Maryland, two are in Massachusetts, two are in Ohio, and there is one in each of Minnesota and Pennsylvania. The two new franchised restaurants opened in fiscal 1994 are in North Dakota and Pennsylvania.\nThe Company periodically evaluates the prospects of existing Company-operated restaurants and will, from time to time, sell or close individual restaurants. See \" --Strategy--Divestiture Program\" above. Similarly, franchised restaurants have closed in the past and may close in the future. During fiscal 1994, eleven Company-operated and five franchised restaurants were closed. Four franchised restaurants were terminated for cause. Four of the five franchised restaurants that ceased operating during fiscal 1994 were in the bottom 30% in annualized sales among all franchised restaurants.\nRESTAURANT OPERATIONS\nHours of Operation. All Ground Round restaurants are open seven days a week, for lunch and dinner, with typical operating hours of 11:30 a.m. to midnight. In most locations, dinner accounts for approximately 60% of sales, with lunch and late night dining accounting for the remaining 40% of sales. Ground Round restaurants are operated in accordance with the Company's uniform operating standards and specifications, which are applied on a system-wide basis. These standards and specifications relate, among other things, to the quality, preparation and selection of menu items, furnishing and equipment, maintenance and cleanliness of restaurant premises and employee service and attire. The Company stresses efficient, courteous and responsive service.\nPurchasing. The Company's purchasing department coordinates purchases of most food products and most non-alcoholic beverages used in both Company-operated and franchised restaurants. The nature of the Company's standing purchase order arrangements with its suppliers enables it to anticipate and better control its food costs. The Company purchases beef (other than ground beef), chicken and fish under forward purchase contracts generally having a term of one year, which are designed to assure the availability of specific products at a constant price throughout the year. The Company has a coordinated purchasing system, which offers the same prices to both Company-operated and franchised restaurants. All franchisees are required to purchase food, equipment and smallwares from suppliers approved by the Company. This enables the Company to assure that the items sold in all Ground Round restaurants meet the Company's standards and specifications for uniform quality. Although not required to do so, virtually all franchisees purchase through the Company's purchasing department to capitalize on the strength of the Company's purchasing power. Beer, alcoholic beverages, produce and certain dairy products are purchased by restaurant general managers on a local basis.\nTraining. The Company emphasizes the training of both new and existing employees. Training is an integral part of both Company- operated and franchised new restaurant openings. A specialized training team works on-site to implement an extensive training program for each hourly employee in a new restaurant prior to and for several weeks after its opening. In addition, the Company has implemented a system-wide training program to achieve standardization of food preparation and operational procedures and efficient, courteous and responsive service.\nAll managers also are required to complete successfully an eight-to-ten week course in basic skills and management training. A written test and skill demonstration to a supervisor are required to complete the course. In addition, the Company requires that its hourly restaurant employees undergo training relevant to their positions and be certified by a supervisor, based upon a demonstration of the skills necessary for the position and a written test.\nAs part of its Managing General Partner program, the Company has developed a comprehensive training course which all participating restaurant managers are required to complete successfully. The course includes a workshop on leadership training and covers virtually all aspects of restaurant operations, such as techniques to increase sales, local restaurant marketing, management information systems,\nunderstanding the law as a means of risk management, facilities management, food and beverage purchasing and managing employees.\nRestaurant Reporting. During fiscal 1993, the Company completed installation of a point of sale system in its restaurants. Through this system, the Company collects sales information and cash balances on a daily basis from each restaurant. The Company also receives payroll and other operating information on a weekly basis from its restaurants. The point of sale system also provides real-time information to restaurant managers which allows them to track sales by menu item, prepare daily cost and sales reports and prepare weekly and monthly profit and loss statements. The Company's goal is to use the information generated by the point of sale system to facilitate planning activities at both the corporate and restaurant levels. In addition, the time required to assemble and report restaurant information should be decreased, allowing the restaurant manager to focus on other aspects of operations.\nMarketing. Historically, the Company's marketing strategy was to use media-based advertising focused on discounts. In 1993, the Company shifted its strategy to focus on building long-term consumer loyalty, which the Company believes can best be accomplished by providing customers with superior service and value. Accordingly, the Company is focusing on enhancing its image through the remodeling of existing restaurants, increasing training at the restaurant level and improving menus. The Company now principally employs in-store, point of purchase materials such as banners, posters and buttons, as marketing tools. The Company also is using radio advertising that is image- and product-oriented.\nRestaurant managers are encouraged to create and implement marketing strategies on a local level to build sales and generate guest traffic and to become involved in community programs in order to strengthen a restaurant's ties to its community. These community programs include activities with area schools and youth organizations and participation in local events.\nFRANCHISING\nAs of October 2, 1994, the Company had 41 franchised restaurants, the majority of which were located in the same geographic regions as, or in close proximity to, Company-operated restaurants. During fiscal 1994, the average annual comparable sales by the Company's franchised restaurants were $1.8 million. The Company's franchise program enables the Company to enhance its brand-name recognition and derive additional revenue without substantial investment.\nIn fiscal 1994, two new franchised restaurants were opened, and five restaurants were closed. Four of the five franchised restaurants were terminated for cause. Four of the five franchised restaurants that ceased operating during fiscal 1994 were in the bottom 30% in annualized sales among all franchised restaurants. The Company expects four additional franchise restaurants to open in fiscal 1995.\nFranchisees undergo a selection process supervised by the Director of Development and requiring final approval by senior management. The Company seeks franchisees with significant experience in the restaurant business who have demonstrated financial and management capabilities to develop and operate a franchised restaurant.\nThe Company assists franchisees with both the development and ongoing operation of their restaurants. The Company provides assistance with site selection, approves all franchise sites and provides franchisees with prototype plans and specifications for construction of their restaurants. The Company's training and new restaurant opening teams provide on-site instruction to franchised restaurant employees. The Company's support continues with periodic training programs, the provision of manuals and updates\nrelating to product specifications and quality control procedures, advertising and marketing materials and assistance with particular advertising and marketing needs.\nSupervision of franchisees is the primary responsibility of the Director of Franchise Operations and the respective Regional Directors. The Company provides the franchisees with ongoing support and assistance in the operations of their restaurants and makes periodic visits to consult with franchisees and assure that franchisees are complying with the terms of the franchise agreement. In addition, from time to time, the Company performs audits to verify the proper calculation of royalty payments from franchisees.\nAll franchised restaurants are required, pursuant to their respective franchise agreements, to serve Ground Round menu items. In addition, all franchisees are required to purchase food, equipment and smallwares from suppliers approved by the Company. This enables the Company to assure that the items sold in all Ground Round restaurants meet the Company's standards and specifications for uniform quality. Although not required to do so, virtually all franchisees purchase through the Company's purchasing department to capitalize on the strength of the Company's purchasing power.\nThe current Ground Round franchise agreement has an initial term of 20 years. Among other obligations, the agreements require franchisees to pay an initial franchise fee of $40,000 for the first restaurant and $35,000 for subsequent restaurants and a continuing royalty of 3% of monthly gross sales. The current franchise agreement also requires franchisees to spend 2% of monthly gross sales on advertising, 1 1\/2% of which must be spent locally and 1\/2% of which is paid to the Company for creative and promotional development. The franchise agreements related to ten of the 41 franchised restaurants will expire in the next five years but give the franchisees the right to renew their agreements for a 20-year term, subject to certain conditions. There currently are no territorial exclusivity provisions that limit the Company's ability to expand in any market. The Company, however, currently is engaged in discussions with an existing franchisee regarding the granting of exclusive territorial development rights in a market in which there are no Ground Round restaurants.\nEMPLOYEES\nAs of October 2, 1994, the Company had approximately 9,400 employees, approximately 5,600 of whom were part-time employees. Approximately 8,700 of these employees were employed in non-management restaurant positions, 600 were involved in restaurant management or training programs and 75 were corporate employees. The typical restaurant has approximately 60 employees. Company employees are not unionized, and the Company considers its employee relations to be good.\nCOMPETITION\nThe restaurant business generally, and the full-service, casual dining segment in particular, is highly competitive. While management believes that Ground Round's \"no compromise\" dining concept distinguishes its restaurants from other casual dining restaurants, there can be no assurance that other chains will not adopt a concept similar to that of Ground Round or that the concept will not lose its appeal. Competitors of Ground Round include restaurants operated by large national and regional chains having substantially greater financial and marketing resources and name recognition than Ground Round, as well as numerous local independent restaurants. The Company and its franchisees also encounter substantial competition in their efforts to obtain suitable locations for new restaurants.\nHEALTH CARE AND MINIMUM WAGE LAWS\nThe Clinton Administration and various members of Congress have proposed legislation to overhaul the nation's health care system. Because the outcome of any health care reform legislation is uncertain, the Company is unable to determine the likely impact of health care reform initiatives on its operations.\nA significant number of the Company's food service personnel are paid at rates based on applicable federal and state minimum wages. During the 1992 presidential election campaign, then-candidate Clinton pledged to seek an increase in the minimum wage, coupled with a proposal to index future increases. It is not possible at this time to predict the likelihood that an increase in the minimum wage will be enacted or, if enacted, its impact on the Company's profitability.\nGOVERNMENTAL REGULATION\nThe Company is subject to various federal, state and local laws affecting its employees and guests, its owned and leased properties and the operations of its restaurants. The Company restaurants are subject to licensing and\/or regulations by various fire, health, sanitation and safety agencies in the applicable state and\/or municipality. In particular, the Company has adopted extensive procedures designed to meet the requirements of applicable food handling and sanitation laws and regulations. The Company has not experienced any material problems resulting from its sanitation and food handling procedures.\nGround Round restaurants are subject to state and local licensing and regulations with respect to the sale and service of alcoholic beverages. Typically, licenses must be renewed annually and may be revoked or suspended for cause. Alcoholic beverage control regulations relate to numerous aspects of the daily operations of the Company's restaurants, including minimum age of patrons and employees, hours of operation, advertising, wholesale purchasing, inventory control and the handling, storage and dispensing of alcoholic beverages. The Company has not encountered material problems relating to alcoholic beverage licenses to date, but the failure of a restaurant to obtain or retain a liquor license would adversely affect the restaurant's operations.\nIn certain states, the Company is subject to \"dram shop\" statutes, which generally give a person injured by an intoxicated person the right to recover damages from the establishment that wrongfully served alcoholic beverages to the intoxicated person. The Company carries liquor liability coverage as part of its existing comprehensive general liability insurance. The Company currently is a defendant in several \"dram shop\" suits. Management does not believe that an adverse result in any of these cases will have a materially adverse effect on the Company's financial condition or results of operations.\nThe Company is subject to federal and state fair labor standards, statutes and regulations that govern such matters as minimum wages, overtime, tip credits, child labor and other working conditions. A significant number of Ground Round food service personnel are paid at rates based on applicable federal and state minimum wages.\nThe Company's restaurants are subject to the provisions of the Americans with Disabilities Act (\"ADA\"), which requires that private entities operating places of public accommodation, including restaurants, take steps to ensure that disabled employees and customers are not denied access and are not segregated. Under ADA, however, the Company is not required to make any accommodation that would result in an \"undue burden\" on the Company.\nManagement is not aware of any federal or state environmental regulations that have had a material effect\non the Company's operations to date. However, more stringent requirements of local governmental bodies with respect to waste disposal, zoning, construction and land use may increase both the cost and the time required for construction of new restaurants and the cost of operating restaurants.\nThe Company is subject to federal and state laws, rules and regulations governing the offer and sale of franchises. Most states have enacted laws that require detailed disclosure in the offer and sale of franchises and\/or the registration of the franchisor with state administrative agencies. The Company also is subject to Federal Trade Commission regulations relating to disclosure requirements in the sale of franchises. Certain states have enacted, and others may enact, legislation governing certain aspects of the franchise relationship and limiting the ability of the franchisor to terminate or refuse to renew a franchise. The law applicable to franchise sales and relationships is rapidly evolving, and the Company is unable to predict the effect on its franchising program of additional requirements or restrictions that may be enacted or promulgated or of court decisions that may be adverse to franchisors. Such decisions and regulations often have limited the ability of franchisors to enforce certain provisions of franchise agreements and alter or terminate franchise agreements. The scope of the Company's business, and the complexity of franchise regulation, may create regulatory compliance problems from time to time. The Company does not believe that such problems would be material to the operation of its business.\nTRADEMARKS\nThe Company has registered the name THE GROUND ROUND and its logo with the United States Patent and Trademark Office. In addition, the Company has other registered trademarks, including WHERE KIDS CAN RELAX AND GROWN-UPS CAN HAVE FUN; THE GROUND ROUNDER; BINGO THE CLOWN; KIDS PAY WHAT THEY WEIGH; JUST A PENNY A POUND; KIDS PAY BY DEGREE!; IT'S A GREAT DEAL OF FUN!; FAMILY COUNTS; CINNAMON DIPPERS' and SLIDER sundae. The Company believes that these trademarks are valuable to the operation of its restaurants and marketing strategy.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of October 2, 1994, the Company operated 164 of the 205 Ground Round restaurants. At 29 locations, both the real estate and structure are owned by the Company in fee. At 117 locations, both the real estate and structure are leased. At the remaining 18 locations, the land is leased and the structure is owned. Lease terms run from 10 to 30 years, with most of the leases providing for an option to renew for at lease one additional term of five years. Within the next five years, 83 of the Company's leases will be up for renewal. Under most leases, rent is calculated as a percentage of gross revenues, subject to a minimum annual rent. Generally, the leases are net leases which require the Company to pay the cost of insurance, taxes and maintenance on the leased property. The Company owned properties and certain leased properties are subject to security interests.\nThe Company's headquarters are located in a modern office park in Braintree, Massachusetts, where the Company leases approximately 22,000 square feet. The lease expires in 1996 and has a five-year renewal option. The Company believes this space is adequate for its present and projected needs for at least the next five years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is subject to various claims and legal actions that arise in the ordinary course of business, including claims and actions brought pursuant to \"dram shop\" statutes and under federal and state employment laws prohibiting employment discrimination.\nThe Company has been named in a number of separate claims brought by former employees alleging that the Company engaged in discriminatory practices based on age, race, sex or disability. Plaintiffs maintaining claims of employment discrimination, such as those being brought against the Company, generally are entitled to have their claims tried by a jury and such claims may result in punitive damage awards. Most of the proceedings against the Company are still in the discovery phase. Management believes that the discrimination claims against the Company are without merit and the Company is actively defending the claims.\nOn August 24, 1994, a suit was filed in the Massachusetts Superior Court, Suffolk County in which the Company and each member of its Board of Directors were named as defendants. That suit is styled Perry v. O'Donnell, et al., Civil Action No. 94-4648 G. The suit, which has been brought by a purported\nshareholder seeking to be certified as a representative of a class of shareholders, alleges in substance that the members of the Board of Directors acted in breach of their fiduciary duty to the Company's shareholders by (i) failing to take appropriate steps to maximize the value to be received by the Company shareholders upon the sale of the Company, (ii) authorizing the Company to enter into the Merger Agreement with an entity in which certain members of the Company's senior management, including Mr. O'Donnell, will have ownership interest and (iii) agreeing to recommend a transaction in which the Merger Consideration is unfair and grossly inadequate. The relief requested by the plaintiff includes that the proposed Merger be enjoined or, if completed, rescinded, or that damages be awarded. On September 13, 1994, a similar suit, Weinstein v. Ground Round Restaurants, Inc., Civil Action No. 94- 4714 G, was brought by another purported shareholder. That suit, also brought in the Massachusetts Superior Court, Suffolk County, made the same allegations and demanded the same relief as were made and demanded in Perry. The Company and its directors currently are preparing their responses to both complaints. The Company and the Board of Directors believe that such allegations completely are without merit, and they intend vigorously to defend against them.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable\nPART II\nThe Company has not paid a cash dividend on the Common Stock since its public offering in September 1991. The Company intends to retain future earnings for use in the operation and expansion of its restaurants and, accordingly, does not intend to pay cash dividends in the foreseeable future. In addition, the terms of the Company's current credit agreement effectively prohibit the Company from declaring or paying cash dividends while borrowings are outstanding pursuant to this agreement.\nAs of November 30, 1994, the number of holders of record of shares of the Company's Common Stock was 866.\nITEM 7.","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe following discussion and analysis examines the Company's operations which comprise the Ground Round restaurant chain. As of October 2, 1994, the Company operated 164 and franchised 41 family-oriented, full service, casual dining restaurants.\nFor purposes of this discussion and analysis, the 52 week year ended October 2, 1994, the 53 week year ended October 3, 1993 and the 52 week year ended September 27, 1992, are referred to as 1994, 1993, and 1992, respectively.\nRESTAURANT REVENUE. Restaurant revenue totalled $242.0, $230.0 and $224.0 million for 1994, 1993 and 1992, respectively. Restaurant revenue is comprised of comparable restaurant revenue (revenue from restaurants open during all of both fiscal years) and non-comparable restaurant revenue.\nComparable restaurant revenue, comprised of revenue from restaurants open during all of 1994 and 1993, increased in 1994 by .7% to $213.6 million for the comparable 52 week period. Management believes the increase is principally attributable to improvement in operations, the continued impact of the Company's renovation program and image- and product-based advertising. Comparable restaurant revenue in 1993 decreased 2.1% for the comparable 52-week period. In 1993, management de-emphasized advertised discounting, which contributed to lower guest count levels and lower revenue but resulted in significant savings in discounting and advertising.\nThe average guest check was approximately $8.29, $7.95 and $7.35 in 1994, 1993 and 1992, respectively. These increases primarily reflected an evolving menu mix with higher priced menu items, as well as the de-emphasized discounting in 1994 and 1993. For example, 1992 included 66 additional days of JUST A PENNY A POUND(R) and KIDS PAY BY DEGREE!(R) promotions which were not duplicated in 1993 or 1994. An insignificant portion of the increase in the average guest check is attributed to price increases on existing menu items. Sales of alcoholic beverages (excluding soda) were approximately 22% of revenue in each of these three years.\nNon-comparable restaurant revenue, consisting of those restaurants not in operation during all of both comparable years, increased to $28.2 million in 1994 from $13.8 million in 1993 and $9.7 million in 1992. The increase in 1994 was attributable to the full year operation of nine new restaurants added in 1993, as well as nine new restaurants added in 1994. These increases were partially offset by the sale or closing of eleven locations in 1994. In 1993, the increase in non-comparable restaurant revenue was attributable to the full year operation of seven new restaurants added in 1992, as well as nine new restaurants added in 1993. These increases were partially offset by the closing of three locations in 1993.\nFRANCHISE REVENUE. The Company's franchise base consisted of 41 franchised restaurants in 1994 and 44 franchised restaurants in 1993 and 1992. In 1994 two new franchised restaurants were added, while five franchised restaurants were closed. Five new franchised restaurants were added during 1993, four of which were opened by new franchisees, while one franchise agreement was not renewed, three franchised restaurants were closed and another was acquired by the Company. Revenue from franchised restaurants (consisting of royalties and franchise fees) were $2.2 million, $2.5 million and $2.4 million in 1994, 1993 and 1992, respectively. In 1993 and 1992, $.2 million and $.5 million, respectively, which had been reserved in prior periods, was received and recognized as royalty revenue.\nCOST OF PRODUCTS SOLD. Cost of products sold consists of both food and beverage costs and restaurant operating expenses. Food and beverage costs totalled 31.8%, 31.9% and 31.3% of Company-operated restaurant revenue in 1994, 1993 and 1992, respectively. Restaurant operating expenses were 52.1%, 52.3% and 52.5% of Company-operated restaurant revenue, respectively, in 1994, 1993 and 1992.\nFood and beverage costs as a percentage of Company-operated restaurant revenue decreased .1% from 1993 to 1994 as compared to the increase of .6% from 1992 to 1993. The decrease in food and beverage costs in 1994 was attributable to lower product costs and management's increased efforts to control food costs and reduce waste. These activities resulted in a decrease of .5% of food costs, offset by an increase of 1.1% of beverage costs largely due to the increased cost of beer. Food and beverage costs in 1993 were adversely affected by higher produce costs due to winter flooding in Arizona, late planting in California and higher beef prices.\nRestaurant operating expenses in 1994 decreased by .2% of Company-operated restaurant revenue from 1993, principally due to decreases in labor costs as a result of a change in the Company's policy on accrued vacation for hourly employees, partially offset by increases in bonuses earned by restaurant management based on increased profits. Other costs have remained at relatively constant levels as compared with the prior year. In 1993, restaurant operating expenses decreased by .2% of Company-operated restaurant revenue from 1992, principally due to decreases in labor costs and reductions in discounts, partially offset by increases in rental expense.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses were 6.3%, 6.8% and 7.2% of total revenue in 1994, 1993 and 1992, respectively. Selling expenses, comprised of advertising and point of purchase materials, development and production costs, were .5%, .7% and 1.5% of total revenue for 1994, 1993 and 1992, respectively. Selling expenses decreased in 1994 by .2% of total revenue from 1993, primarily due to an additional credit of $.4 million from Coca-Cola(TM) based on product usage. Management's strategic decision to de-emphasize media advertising used in connection with discounting programs was primarily responsible for reducing selling costs by .8% of revenue in 1993.\nGeneral and administrative costs, comprised of restaurant manager training, regional overhead, and corporate administrative costs, were 5.8%, 6.1% and 5.7% of total revenue in 1994, 1993 and 1992, respectively. General and administrative costs decreased in 1994 from 1993 largely due to the termination of the executive retirement plan which resulted in a credit of $.3 million. All other general and administrative costs in 1994 remained constant as a percentage of total revenue as compared to 1993. In 1993, general and administrative cost increases reflect the impact of increased training and recruitment expenses associated primarily with the hiring of new restaurant and regional management personnel.\nDEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses were 5.5%, 4.8% and 4.4% of total revenue in 1994, 1993 and 1992, respectively. The increase in depreciation and amortization from 4.8% of total revenue in 1993 to 5.5% of total revenue in 1994 resulted from nine new restaurants added in 1994, nine new restaurants added in 1993 and the remodeling of seventy-eight restaurants since 1992. In 1993, depreciation and amortization increased to 4.8% from 4.4% in 1992 due to new restaurant development and the remodeling of twenty-nine restaurants.\nOTHER (INCOME) AND EXPENSE. During 1994, the Company completed a sale of one location for approximately $2.0 million and realized a pretax gain of approximately $1.5 million. This gain was partially offset by the write-off of $.6 million in expenses associated with a proposed public offering of convertible subordinated debentures which the Company withdrew due to market conditions.\nIn August 1994, the Company entered into the Merger Agreement pursuant to which it agreed to be acquired for cash. Completion of the proposed acquisition is subject to, among other things, the approval\nof the holders of two-thirds of the Company's stock and the acquiror's receipt of financing. In November 1994, the acquiror advised the Company that the acquiror did not believe the financing necessary to consummate the proposed acquisition will be available on the terms contemplated at the time the parties entered into the Merger Agreement. Although the acquiror is obligated to use its best efforts to obtain financing on terms contemplated at the time of the Merger Agreement that would permit it to consummate the Merger for the Merger Consideration, there can be no assurance that the financing can be obtained on such terms and, therefore, that the acquisition can be completed. To date, the Company has incurred $.4 million of expense in connection with the proposed acquisition. If the transaction is not completed, those expenses will be recognized in fiscal 1995.\nINTEREST EXPENSE. Interest expenses were 1.7%, 1.7% and 2.0% of total revenue in 1994, 1993 and 1992, respectively. Interest expense in 1994 remained constant as a percentage of total revenue as compared to 1993. The decrease in interest expense from 1992 to 1993 was primarily a result of lower average interest rates, which more than offset interest expense incurred under interest rate swap agreements (see \"Liquidity and Capital Resources\" below) of approximately $.8 million and $.9 million in 1993 and 1992, respectively. At November 30, 1994, the average interest rate under the Company's credit facilities (described below) was 7.3% as compared to an average interest rate of 6.5% for 1994. The increase in the applicable interest rate reflects the rising interest rate environment in the United States during the second half of calendar 1994.\nINCOME TAXES. The Company's effective income tax rates were 32%, 32% and 38% in 1994, 1993 and 1992, respectively. The reduction in the 1993 effective tax rate was primarily the result of lower state taxes and the generation of targeted jobs tax credits. The full utilization of a net operating loss carryforward also affected the 1992 income tax rate.\nNET INCOME. As a result of the above, the Company reported income from continuing operations of $6.2 million in 1994, $5.3 million in 1993 and $4.6 million in 1992, representing 2.6%, 2.3% and 2.1% of total revenue, respectively. Net income from continuing operations was $.56, $.48 and $.42 per share for 1994, 1993 and 1992, respectively.\nLIQUIDITY AND CAPITAL RESOURCES.\nA significant amount of the Company's restaurant sales are for cash, with the remainder made with credit cards that are generally realized in cash within a few days. Because the Company does not have significant accounts receivable or inventories and pays its expenses within normal terms, the Company operates with working capital deficits as is typical in the restaurant industry. The Company had working capital deficits of $15.3 million and $12.6 million as of October 2, 1994 and October 3, 1993, respectively.\nNet cash provided by operating activities totalled $22.4 million in 1994, and $15.5 million in 1993. The company incurred capital expenditures totalling $24.1 million and $25.1 million in 1994 and 1993, respectively, primarily for restaurant capital maintenance, remodeling and new restaurant construction. Cash flow from operations plus proceeds from sales of locations funded 1994 capital expenditures and provided for the repayment of approximately $1.0 million in long-term borrowings. On October 2, 1994 and October 3, 1993, the Company's borrowings under its credit facilities were approximately $53.0 million and $53.0 million, respectively. On October 8, 1993 the credit facilities were amended to a $70 million commitment, with the aggregate balance of $53.7 million of the combined facility balances on that date converted to term debt. The balance of $16.3 million is a revolving facility to fund operations\nand new store development and converts to term debt on October 8, 1995. Principal payments under the credit facilities begin in October 1995 and are scheduled through July 2000.\nThe credit facility obligates the Company to hedge its interest rate risk on approximately 50% of its total term borrowings. In fiscal 1992 and 1993, the Company effected such a hedge by entering into interest rate swap agreements under which it agreed to exchange LIBOR-based interest payments for fixed-rate payments (see \"Results of Operations-Interest Expense\" above). In fiscal 1994, the Company hedged its interest rate risk by entering interest cap agreements under which the maximum base interest rate of its LIBOR-based payments would be 7.0%. The interest rate cap agreements had no effect on the Company's interest expense in fiscal 1994.\nThe credit facilities contain certain restrictions on the conduct of the Company's business including a prohibition on the payment of dividends. In addition, the Company is required to comply with certain financial covenants relating to maintenance of net worth, interest coverage, fixed charges coverage, the ratio of funded debt to free operating cash flow and capital expenditures (other than the separate limitations for capital expenditures for new restaurants). The revolving line of credit requires the satisfaction of certain criteria prior to entering into a commitment to open a new restaurant. These criteria relate to projected capital investment and first year sales, margins and profits as well as to location. The credit facilities also currently restrict the Company from entering into commitments to open more than 18 new restaurants in any fiscal year, entering into a new commitment if ten or more restaurants for which commitments are outstanding remain unopened or entering into a new restaurant commitment if total new restaurant commitments exceed $15 million at any one time. In addition, new restaurants must meet certain operating tests.\nThe Company expects to incur approximately $25 million in capital expenditures during the 1995 fiscal year. Management believes that existing cash, cash flow from operations, and available borrowings under the credit facilities will be sufficient to meet operating needs, fund anticipated capital expenditures and service debt requirements during fiscal 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required under this item is 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\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nDIRECTORS OF REGISTRANT\nThe information called for by this Item with respect to directors will be contained in either (i) the Company's Proxy Statement, if the Company files the proxy statement within 120 days after the end of the Company's fiscal year ended October 2, 1994 or (ii) an amendment to this Annual Report filed on Form 10.\nMichael P. O'Donnell has served as the Chairman of the Board, President and Chief Executive Officer of the Company since September 1991 and President and Chief Executive Officer of the Ground Round since January 1990. He was Senior Vice President (Southern Division) of TGI Friday's Inc., a restaurant chain, from December 1986 through December 1989.\nPeter J. Beaudrault has served as Executive Vice President of the Company since June 1994 and was Senior Vice President of Division Operations of the Company from September 1993 to May 1994. He\nwas Divisional Vice President of the Company and Ground Round since September 1992. He was Regional Manager of TGI Friday's Inc. from July 1989 through September 1992. He was Director of Operations for Hard Rock Cafes, Inc. from November 1987 through July 1989.\nMichael R. Jorgensen has served as Vice President, Chief Financial Officer and Treasurer of the Company since June 1993 and was appointed Senior Vice President in September 1993. He was Vice President, Finance - Middle East of Alghanim Industries, the largest consumer products distributor in Kuwait, from March 1992 to April 1993. Prior to that, Mr. Jorgensen was Vice President and Chief Financial Officer of the Company (then known as International Proteins) from May 1988 to September 1991.\nWilliam C. Schoener has served as Senior Vice President of Division Operations since September 1993. He was Divisional Vice President of the Company since September 1991 and January 1989, respectively. He was a Director of Operations of Ground Round from June 1986 through December 1988.\nWarren C. Hutchins has served as Vice President, Purchasing and Distribution of the Company since September 1991 and August 1986, respectively. He was Secretary of Ground Round from March 1990 through February 1991.\nHolly J. Young has served as Vice President of Marketing since May of 1994, and served as Director of Marketing when she joined the Company in March of 1994 to April 1994. She was Senior Vice President of Marketing of Chi-Chi's Restaurants, Inc. from January 1993 through January 1994, and Vice President of Marketing for Grisanti's Inc. from April 1992 to December 1992. From June 1989 to March 1991, she was Senior Vice President of Marketing for Metromedia Steakhouses, Inc. She was Vice President of Marketing for TGI Friday's Inc. from 1987 to 1989.\nRobin L. Moroz was appointed General Counsel and Secretary in December 1994. She was hired by the Company in August 1989 and since October 1991 has served as Assistant General Counsel.\nElizabeth Brennan Baker has served as Vice President of Organizational Development since July of 1994. She was Vice-President of Human Resources from January 1993 through June of 1994. She was Vice President - Personnel and Training of the Company since September 1991 and March 1990, respectively. She was Vice President - Training and Development of Ground Round from November 1988 through February 1990, Director of Training and Development of Ground Round from August 1985 through October 1988.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information called for by this Item with respect to directors will be contained in either (i) the Company's Proxy Statement, if the Company files the proxy statement within 120 days after the end of the Company's fiscal year ended October 2, 1994 or (ii) an amendment to this Annual Report filed on Form 10.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information called for by this Item with respect to directors will be contained in either (i) the Company's Proxy Statement, if the Company files the proxy statement within 120 days after the end of the Company's fiscal year ended October 2, 1994 or (ii) an amendment to this Annual Report filed on Form 10.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for by this Item with respect to directors will be contained in either (i) the Company's Proxy Statement, if the Company files the proxy statement within 120 days after the end of the Company's fiscal year ended October 2, 1994 or (ii) an amendment to this Annual Report filed on Form 10.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(A) FINANCIAL STATEMENTS\nReport of Ernst & Young LLP, Independent Auditors.\nConsolidated Balance Sheets - October 2, 1994 and October 3, 1993.\nConsolidated Statements of Income - Years Ended October 2, 1994 and October 3, 1993 and September 27, 1992.\nConsolidated Statements of Stockholders' Equity - Years Ended October 2, 1994 and October 3, 1993, and September 27, 1992.\nConsolidated Statements of Cash Flows -Years Ended October 2, 1994 and October 3, 1993, and September 27, 1992.\nNotes to Consolidated Financial Statements - Years Ended October 2, 1994 and October 3, 1993, and September 27, 1992.\nFINANCIAL STATEMENT SCHEDULES\nSchedule II - Amounts Receivable from 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 Information\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) EXHIBITS\nExhibits filed as part of this Report are listed in the EXHIBIT INDEX appearing on Pages 26 and 27 of this Report.\nSIGNATURES\nPursuant to the requirement 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 14th day of December, 1994.\nGROUND ROUND RESTAURANTS, INC. (Registrant)\nBy: \/s\/ Michael R. Jorgensen ------------------------ Michael R. Jorgensen Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareholders and Board of Directors Ground Round Restaurants, Inc.\nWe have audited the accompanying consolidated balance sheets of Ground Round Restaurants, Inc. as of October 2, 1994 and October 3, 1993, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended October 2, 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 Ground Round Restaurants, Inc. at October 2, 1994 and October 3, 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended October 2, 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 November 1, 1994 except for Note L, as to which the date is November 16, 1994\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements\nSee notes to consolidated financial statements.\nGROUND ROUND RESTAURANTS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the years ended October 2, 1994 and October 3, 1993 and September 27, 1992\nA. SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION: The consolidated financial statements include the accounts of Ground Round Restaurants, Inc. (the Company), and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company operates and franchises family-oriented, full-service restaurants primarily in the Northeast, Mid-Atlantic and Midwest United States.\nThe fiscal year of the Company is the 52 or 53 week period ending on the Sunday closest to September 30th. For purposes of these notes to the consolidated financial statements, the 52 week fiscal year ended October 2, 1994, the 53 week fiscal year ended October 3, 1993, and the 52 week fiscal year ended September 27, 1992, are referred to as 1994, 1993, and 1992, respectively.\nCertain items in prior years in specific captions of the accompanying consolidated financial statements and notes to the consolidated financial statements have been reclassified for comparative purposes.\nCASH EQUIVALENTS: Cash equivalents consist of highly liquid investments with maturities of three months or less when purchased, and are carried at cost which approximates fair value.\nINVENTORIES: Inventories are stated at the lower of cost or market, as determined by the first-in, first-out (FIFO) cost method.\nPROPERTY AND EQUIPMENT: Property and equipment are recorded at cost. Depreciation and amortization, including amortization of assets recorded under capital leases, are computed principally by the straight-line method, based on estimated useful lives. Useful lives range from 33 years for buildings, 10 years for machinery and equipment and the shorter of the lease term or estimated useful life for leasehold improvements.\nDEFERRED DEBT COSTS: Deferred debt costs, included in other assets, are costs associated with the issuance of long-term debt and are amortized over the terms of the related instruments.\nDEFERRED PRE-OPENING COSTS: Pre-opening costs consist of incremental amounts directly associated with opening a new restaurant. These costs, which principally include initial purchases of expendables and expenses of the restaurant staff, hired to operate the restaurant upon opening, for the training period before the restaurant opens, are capitalized and amortized over the twelve month period following the restaurant opening. Prior to 1994, the Company amortized the costs over the 24 month period following the restaurant opening. The change did not have a material effect on the Company's results of operations.\nINTANGIBLE ASSETS: Intangible assets included in other assets consist of the excess of the cost of acquired companies over the values assigned to net tangible assets and primarily represent fair values assigned to trade names, goodwill, liquor licenses and franchises. These intangibles are being amortized by the straight-line method over lives ranging between 15 and 40 years.\nACCRUED INSURANCE CLAIMS: The Company maintains insurance coverage for workers' compensation risks under contractual arrangements which retroactively adjust premiums for claims paid subject to specified limitations. In addition, the Company is self insured up to certain limits for risks associated with the health care plan provided for its employees. Expenses associated with such risks are accrued based upon the estimated amounts required to cover incurred incidents. The Company does not provide health or other benefits to retirees.\nINCOME TAXES: On September 28, 1992 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. In fiscal 1992, the Company provided for income taxes following the provisions of SFAS No. 96. The cumulative effect of this accounting change on the provision for income taxes in 1993 was not significant.\nOTHER LONG-TERM LIABILITIES: Other long-term liabilities comprise various reserves including reserves for casualty insurance coverage and restaurant closings.\nFRANCHISE REVENUE: Initial franchise fees of $40,000 new franchises are recognized as revenue when substantially all commitments and obligations have been fulfilled, which is generally when the restaurant opens. The terms of franchise agreements are generally twenty years and provide for a continuing franchise royalty fees equal to 3% of monthly gross sales. The franchise agreements also provide that franchisees are required to pay up to 2% of monthly gross sales for advertising. Franchise and royalty fees included in revenues aggregated $2,192,000, $2,539,000 and $2,418,000 for 1994, 1993 and 1992, respectively.\nOther assets were net of allowances for doubtful accounts of $307,000 and $352,000 at October 2, 1994 and October 3, 1993, respectively.\nPrepaid expenses and other current assets of $2,249,000 at October 2, 1994 and $6,413,000 at October 3, 1993 included prepaid casualty insurance costs of $1,510,000 and $5,656,000, respectively.\nThe Company had an amended credit agreement dated April 26, 1992 with a syndicate of banks consisting of (a) a term facility in the original amount of $44,000,000 expiring on October 15, 1997, (b) a growth facility in an amount up to $25,000,000 and (c) a working capital facility in an amount of up to $10,000,000. Interest on each of these facilities was, at the option of the Company, payable at a spread over the prime rate or Eurodollar rate. The spread, in each case, was subject to adjustment based on the Company's ratio of free operating cash flow to debt.\nOn October 8, 1993 the Company and a majority of its lenders along with certain new banks, amended the agreement dated April 26, 1992. The Amended and Restated Credit Agreement (\"Amended Agreement\") provides the Company with $70,000,000 that is comprised of the following: Tranche A Term borrowings of $37,953,000, at prime plus .5% to .875% or LIBOR plus 1.125% to 1.625%, depending on the funded debt to free operating cash flow ratio, with payments commencing on October 8, 1995 (the \"Conversion Date\") and payable through January 1999; Tranche A Revolving facility of up to $16,348,000 ($2,100,000 outstanding at October 2, 1994, none outstanding at October 3, 1993), at prime plus .5% to .875% or LIBOR plus 1.125% to 1.625%, depending on the funded debt to free operating cash flow ratio, which converts to term on the Conversion Date and is then payable through January 1999; and Tranche B Term borrowings of $15,000,000 at prime plus .875% or LIBOR plus 2.25% with payments commencing in April 1999 and a final maturity of July 2000. The interest rates under the Amended Agreement at October 2, 1994 on Tranche A Term, Tranche A Revolving, and Tranche B Term were 6.06%, 7.75% and 6.94%, respectively.\nThe Amended Agreement also contains certain financial covenants, including maintenance of minimum interest and fixed charge coverage ratios, cash flow ratios, minimum levels of net worth and maximum leverage ratios. Provisions of the Amended Agreement restricting the payment of dividends would prevent the Company from paying dividends during the term of the Amended Agreement.\nInterest expense for 1994, 1993 and 1992 as presented has been reduced by interest income of $171,000, $248,000 and $379,000, respectively. Principal payments may be accelerated due to additional payments based upon excess cash flow from operations, the sale of certain assets and the offering proceeds from the sale of stock of the Company. Pursuant to the Amended Agreement, certain commitment and facility fees are payable based upon the borrowing levels.\nDuring 1994, the Company entered into two interest rate cap agreements in the aggregate of $15,000,000 expiring during fiscal 1995. The fixed interest rates on these contracts at October 2, 1994 ranged from 5.5% to 7%. During 1993, the Company had outstanding a $10,000,000 interest rate swap agreement which expired in fiscal 1994, and a $15,000,000 interest cap agreement expiring in fiscal year 1995 to exchange LIBOR based interest payments for fixed rate payments. The fixed rate interest rates on these contracts at October 3, 1993 were 8.725% and 7% on the swap and cap agreements, respectively. The interest rate differential is recognized over the lives of the agreements as an adjustment to interest expense. The amount included in the financial statements for outstanding debt and the related swap agreements approximates fair value.\nThe Company occupies certain of its real estate under long-term leases, substantially all of which contain renewal options. Most of these leases provide for a percentage rental based on sales and, in most cases, require a minimum annual rental.\nThe above amounts represent the present value of future minimum lease payments at the inception of the leases, excluding that portion of the lease payments representing estimated insurance and tax cost. Leases capitalized also exclude that portion of the minimum lease payments attributable to land. Lease amortization is included in depreciation expense.\nMinimum obligations for noncancelable operating leases have been reduced by minimum noncancellable operating sublease rentals of $397,000.\nRent expense under operating leases for continuing operations was $8,280,000, $7,623,000 and $7,087,000 for 1994, 1993 and 1992, respectively. Rent expense includes contingent rental expense for capital and operating leases of $2,373,000, $2,424,000 and $2,532,000 for 1994, 1993 and 1992, respectively.\nE. STOCKHOLDERS' EQUITY\nThe 1992 Equity Incentive Plan, approved by the shareholders of the Company, authorizes the granting of various options and rights to purchase 350,000 shares of common stock of the Company. Incentive stock options cannot be issued at less than fair market value whereas the exercise price of nonqualified stock options is specified by the Compensation Committee. Furthermore, the number of shares available for grant is reduced by shares that are issued or are issuable under the 1987 and 1982 stock option plans.\nAs of October 2, 1994, options to purchase 628,000 shares of Common Stock were exercisable, options to purchase 195,000 shares of Common Stock were available for future grants and 823,000 shares of Common Stock were reserved for issuance. In December of 1991 the exercise price of previously issued options to purchase 113,000 shares of Common Stock were adjusted downward to reflect the distribution of the Company's non-restaurant operations in September 1991.\nOn February 2, 1993 the Compensation Committee of the Board of Directors authorized 30,000 shares of restricted stock to be offered to Michael P. O'Donnell, Chairman of the Board, President, and Chief Executive Officer. These shares, valued at $274,000 at issuance, are subject to forfeiture and transfer restrictions over the three years following issuance. At the completion of each year of service subsequent to the issuance date, forfeiture restrictions are released on 10,000 shares. An aggregate amount of $178,000 has been recorded as compensation expense through fiscal 1994.\nA valuation allowance has been provided for those deferred tax assets for which management believes it is more likely than not that the tax benefit will not be realized. As of October 2, 1994 the Company had approximately $1,231,000 of alternative minimum tax credit carryforwards for federal tax purposes, approximately $298,000 of targeted jobs tax credits, approximately $640,000 of FICA tax credits, and $17,000 of foreign tax credits which expire on various dates through 2009. The Company also had a 1991 net operating loss carryforward of $1,710,000 at the end of 1991 that was utilized in 1992.\nG. RETIREMENT BENEFITS\nThe Company sponsors a qualified defined contribution pension plan which covers substantially all full-time eligible employees. Employees may contribute up to 10% of earnings on an after tax basis which are matched by the Company based upon years of participation in the plan up to a maximum of 3%. Defined contribution expense for the Company was $221,000, $240,000 and $260,000 for 1994, 1993 and 1992, respectively.\nThe Company also sponsors a non-qualified deferred compensation plan for key management employees. An employee can defer up to 10% of eligible compensation which will be matched by the Company up to 3%. The Company may also make discretionary matching contributions between 25% and 100% of each employee's deferred compensation between 3% and 10%. In addition, a rate of return, determined in advance by the Company, will be credited each year to the employee's account. The funds are invested at the discretion of the company. Deferred compensation expense for the Company was $112,000, $97,000 and $95,000 for 1994, 1993 and 1992, respectively. Except as set forth above, the Company has no liability for health or other benefits to retirees.\nH. COST OF PRODUCTS SOLD\nI. OTHER INCOME\nDuring 1994, the Company completed a sale of one location for approximately $2.0 million and realized a pretax gain of approximately $1.5 million. This gain was partially offset by the write-off of $.6 million in expenses associated with a proposed public offering of convertible subordinated debentures which the Company withdrew due to market conditions.\nK. LITIGATION\nThe Company has been named in a number of separate claims brought by former employees alleging that the Company engaged in discriminatory practices based on age, race, sex or disability. Plaintiffs maintaining claims of employment discrimination, such as those being brought against the Company, generally are entitled to have their claims tried by a jury and such claims may result in punitive damage awards. Most of the proceedings against the Company are still in the discovery phase. Management believes that the discrimination claims against the Company are without merit and the Company is actively defending the claims.\nL. SUBSEQUENT EVENT\nOn August 23, 1994 the Company announced that it had entered into a definitive merger agreement with a private investor group to include 399 Ventures, Inc., certain key members of management and various financial institutions. The merger agreement is subject to receipt of financing and shareholder approval, and provides that the Company's shareholders will receive $9 in cash for each share of common stock. In connection with the merger, the Company plans to repay all amounts outstanding under its Amended Agreement as described in Note D. On November 16, 1994, the Company announced that it had agreed to extend until January 31, 1995 the termination date of the Merger Agreement in order to allow the acquiror more time to arrange financing for the transaction. The Company anticipates holding a special meeting of shareholders to consider and act on a proposal to approve and adopt the merger in the second quarter of fiscal 1995. Management does not expect that the resolution of these matters will have a material adverse effect on the consolidated financial position of the Company.\nDepreciation and amortization of intangible assets, restaurant development costs and similar deferrals and royalties are not scheduled above since each of these items does not exceed one percent of total revenues.","section_15":""}
{"filename":"793983_1994.txt","cik":"793983","year":"1994","section_1":"ITEM 1. BUSINESS\nBernard Chaus, Inc., a New York corporation organized in 1975, together with its subsidiaries, designs, arranges for the manufacture of and markets an extensive range of women's clothing, principally under the CHAUS and CHAUS SPORT trademarks. (Hereinafter, Bernard Chaus, Inc. and its subsidiaries are referred to as the \"Company\".) The Company provides apparel appropriate in a business environment as well as apparel suitable for leisure and active wear. The Company's clothing embodies \"updated\" styling, which combines contemporary fashion influences with traditional or classic design, and is sold within the \"moderate\" price category. The Company offers an extensive selection of styles, colors, fabrics and size categories and directs its product mix toward well-received styles. The Company believes that the increasing number of career women contributed in prior years to the Company's growth and to the growth of the market for updated women's apparel in general. In recent years the Company has begun to tailor styles and size categories to a somewhat older and more conservative customer because the female population over thirty-five years of age is increasing faster than that under thirty-five as a result of the aging of the post-war or \"baby boom\" generation.\nIn September of 1994, the Company announced a restructuring plan which entailed several initiatives designed to reduce expenses and improve and control inventory position. These included overhead reductions, centralization of certain functions, consolidation and closing of office space and closing of selected retail outlets. Additionally the Company announced the hiring of Andrew Grossman, former President of Jones Apparel Group, as its new Chief Executive Officer.\nTo further strengthen the Company's operations, Josephine Chaus, Chief Executive Officer and Chairwoman, has provided additional financial support to the Company of $14.4 million. Half of the sum is in the form of an increased letter of credit to provide additional working capital. The remaining half represents proceeds from a cash infusion (See Financial Condition, Liquidity And Capital Resources) that will be used for costs and associated expenses related to the signing of the new Chief Executive Officer.\nPRODUCTS\nThe Company's four principal product lines are: a broad selection of related separates, referred to in the apparel industry as career casual sportswear (marketed under the CHAUS, CHAUS WOMAN and CHAUS PETITE labels); blouses (marketed under the JOSEPHINE label); dresses (marketed under the CHAUS DRESSES, CHAUS WOMAN DRESSES and CHAUS PETITE DRESSES labels); and weekend casual sportswear (marketed under the CHAUS SPORT and CHAUS JEANSWEAR labels). The Company produces collections of each of these product lines for each of its six principal selling seasons: Spring I, Spring II, Summer, Fall I, Fall II and Holiday. Spring and Fall have been traditionally the Company's major selling seasons.\nCareer Casual Sportswear. The Company markets an extensive line of career casual sportswear under the CHAUS label for misses sizes, the CHAUS WOMAN label for larger sizes and the CHAUS PETITE label for smaller sizes.\nI-1\nThese labels accounted for approximately 26%, 11% and 6%, respectively, of the Company's net sales in fiscal 1994. Although the Company adjusts its product mix to meet anticipated consumer demand, each sportswear collection typically includes a broad selection of blouses, jackets, sweaters, pants and skirts, as well as more casual apparel such as knit tops, shirts, shorts and jumpsuits. Substantially all items in these collections are sold as \"separates\" rather than as ensembles such as suits. However, the collections are harmonized as to styles, color schemes and fabrics to enable a consumer to assemble outfits consisting of separate styles which are designed to be worn together.\nBlouses. Under the JOSEPHINE label, the Company offers women's blouses primarily appropriate in a business environment which are intended to appeal to the more value-conscious consumer. On January 1, 1993, this operation was consolidated into the Chaus Division to save costs and refocus the product.\nDresses. The Company offers its line of moderately-priced dresses under the CHAUS DRESSES, CHAUS WOMAN DRESSES and CHAUS PETITE DRESSES labels. Dresses accounted for approximately 12% of fiscal 1994 net sales.\nWeekend Casual Sportswear. The CHAUS SPORT and CHAUS JEANSWEAR labels, consisting of casual jackets, sweaters, pants and skirts, knit tops, shirts, shorts, and denim wearing apparel accounted for approximately 29% of fiscal 1994 net sales.\nThe Company from time to time produces and makes available to certain of its customers on a special order basis a limited number of styles of its products.\nThe Company's products and certain of the fabrics from which they are made are designed by a 29-person in-house staff of fashion designers. Josephine Chaus, who is instrumental in the design function, and the design staff meets from time to time with representatives of the Company's sales, merchandising and production staffs to review the status of each collection and to discuss adjustments in line composition, fabric and color selection, garment construction and product mix. While the Company believes that it has a highly professional design staff, there can be no assurance that its present level of sales could be maintained if Josephine Chaus's personal design and supervisory skills were no longer available to the Company.\nSALES AND MARKETING\nDuring fiscal 1994, the Company's products were sold to over 340 trade customers, principally major multi-unit department stores and retail outlets throughout the United States. The Company's products are often displayed together with moderately-priced, updated apparel produced by competing manufacturers, including, in department stores, such stores' own private label merchandise.\nDuring fiscal 1994, approximately 74% of the Company's gross sales were made to the Company's ten largest customers and approximately 87% of gross sales were made to its 100 largest customers. Certain of these customers\nI-2\nare under common ownership. For example, ten different multi-unit department store customers owned by The May Department Stores Company accounted for approximately 17% of gross sales and six different multi- unit department store customers owned by Dillards Department Stores accounted for approximately 17% and six different multi-unit department store customers owned by Federated Department Stores accounted for approximately 9% of the Company's gross sales in fiscal 1994. Assuming the Federated\/Macy's merger had occurred for fiscal 1994, sales to department stores owned by the combined entity would have approximated 12%. Although the Company believes multi-unit department store customers make their own decisions regarding purchases of the Company's products, these decisions are affected generally by policies and guidelines adopted by their parent companies. The Company believes that there is a trend among such customers toward more centralized buying decisions. The Company expects that its 100 largest customers will continue to account for the overwhelming majority of its sales. In addition, during fiscal 1994 the Company generated approximately $9,000,000 in foreign sales.\nThe Company's selling operation is highly centralized. Sales are made by the Company's employees primarily through the Company's New York City showrooms. The Company does not employ outside sales representatives or operate regional sales offices, but it does occasionally participate in regional merchandise marts. This sales structure enables management to control the Company's selling operation more effectively, limit travel expenses, as well as to deal directly with, and be readily accessible to, major customers. The Company assists its customers in allocating their purchasing budgets among the items in the various product lines to enable consumers to view the full range of the Company's offerings in each collection. During the course of the retail selling seasons, the Company monitors its customers' retail sales in order to assess directly, consumer response to its products.\nAt June 30, 1994, the Company had 35 retail outlet stores as compared to 32 stores at June 30, 1993. The retail outlet stores operation is now located throughout the country from New York to California. These outlet stores are operated in traditional factory outlet centers in locations intended not to conflict with the Company's major retail department store customers. As part of the Company's restructuring, one store was closed in fiscal 1994 and four stores will be closed in fiscal 1995.\nThe Company maintains a limited cooperative advertising program under which it reimburses, in certain circumstances, a portion of a customer's advertising expenditures to promote the Company's products. Except for this cooperative advertising program, the Company has not engaged in any direct advertising to the public. The Company's cooperative advertising expenditures were approximately $1,649,000 in fiscal 1994.\nMANUFACTURING\nThe Company does not own any manufacturing facilities. The Company obtained substantially all (approximately 85%) of its products directly from over 260 independent suppliers located primarily in South Korea, Hong Kong, Taiwan, the Philippines, China, Indonesia and elsewhere in the Far East. Approximately 15% of the Company's products were manufactured in Israel, India and the Caribbean Basin. No contractual obligations exist between the Company and its manufacturers except on an order-by-order\nI-3\nbasis. During fiscal 1994, the Company purchased approximately 47% of its finished goods from its ten largest manufacturers, including approximately 10% of its finished goods from its largest manufacturer, which is located in the Philippines and Sri Lanka. Contracting with foreign manufacturers enables the Company to take advantage of prevailing lower labor rates, to use a skilled labor force to produce high quality products and to have more flexibility to provide raw materials (piece goods) to the manufacturer.\nNormally, each manufacturer agrees to produce finished garments on the basis of purchase orders from the Company, supported by a letter of credit naming the manufacturer as beneficiary to secure payment for the finished garments. The manufacturer generally purchases all necessary fabrics and raw materials from suppliers from which such fabrics and raw materials have been previously ordered by the Company. The Company itself will occasionally purchase fabrics and other raw materials.\nThe Company's technical production support staff located in New York City produces patterns, prepares production samples from the patterns for modification and approval by the Company's design staff, and marks and grades the patterns in anticipation of production. While the factories have the capability to perform these services, the Company believes that its personnel can best express its design concepts and efficiently supervise production to better ensure that a quality product is produced. Once production fabric is shipped to them, the manufacturers produce finished garments in accordance with the production samples and obtain necessary quota allocations and other requisite customs clearances. Branch offices of the Company's subsidiaries in Korea, Hong Kong, and Taiwan and the Company's employees based in Italy and India, monitor production at each manufacturing facility to control quality, compliance with the Company's specifications and timely delivery of finished garments, and arrange for the shipment of finished products to the Company's New Jersey distribution center.\nThe Company believes that the number and geographical diversity of its manufacturing sources minimize the risk of adverse consequences that would result from termination of its relationship with any of its larger manufacturers. The Company also believes that it would have the ability to develop, over a reasonable period of time, adequate alternate manufacturing sources should any of its existing arrangements terminate. However, should any substantial number of such manufacturers become unable or unwilling to continue to produce apparel for the Company or to meet their delivery schedules, or if the Company's present relationships with such manufacturers were otherwise materially adversely affected, there can be no assurance that the Company would find alternate manufacturers of finished goods on satisfactory terms to permit the Company to meet its commitments to its customers on a timely basis. In such event, the Company's operations could be materially disrupted, especially over the short-term. The Company believes that relationships with its major manufacturers are satisfactory.\nThe Company uses a broad range of fabrics in the production of its clothing, which is primarily made from synthetic fibers (including polyester and acrylic), as well as from natural fibers (including cotton and wool) and blends of natural and synthetic fibers. The Company does not have any formal, long-term arrangements with any fabric or other raw\nI-4\nmaterial supplier. During fiscal 1994, virtually all of the fabrics used in the Company's products were ordered from the Company's five largest suppliers, which are located in Japan, Taiwan and Korea. The Company selects the fabrics to be purchased, which are generally produced for it in accordance with its own specifications. To date, the Company has not experienced any significant difficulty in obtaining fabrics or other raw materials and considers its sources of supply to be adequate.\nThe Company operates under substantial time constraints in producing each of its collections. Orders from the Company's customers generally precede the related shipping period by up to five months. However, proposed production budgets are prepared substantially in advance of the Company's initial commitments for each collection. In order to make timely delivery of merchandise which reflects current style trends and tastes, the Company attempts to schedule a substantial portion of its fabric and manufacturing commitments relatively late in a production cycle. In order to secure adequate amounts of quality raw materials, especially greige (i.e., \"undyed\") goods, the Company must make substantial advance commitments to suppliers of such goods, often as much as seven months prior to the receipt of firm orders from customers for the related merchandise. Many of these early commitments are made subject to changes in colors, assortments and\/or delivery dates.\nThe Company's arrangement with its manufacturers and suppliers are subject to the risks attendant to doing business abroad, including the availability of quota and other requisite customs clearances, the imposition of export duties, political and social instability, currency revaluations and restrictions on the transfer of funds. Bilateral agreements between exporting countries, including those from which the Company imports substantially all of its products, and the United States imposition of quotas limits the amount of certain categories of merchandise, including substantially all categories of merchandise manufactured by the Company, that may be imported into the United States. Furthermore, the majority of such agreements contain \"consultation clauses\" which allow the United States to impose at any time restraints on the importation of categories of merchandise which, under the terms of the agreements, are not subject to specified limits. The bilateral agreements through which quotas are imposed have been negotiated under the framework established by the Arrangement Regarding International Trade in Textiles, known as the Multifiber Arrangement.\nThe United States and the countries in which the Company's products are manufactured may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adversely adjust presently prevailing quotas, duty or tariff levels, with the result that the Company's operations and its ability to continue to import products at current or increased levels could be adversely affected. The Company cannot now predict the likelihood or frequency of any such events occurring.\nThe Company monitors duty, tariff and quota-related developments, and seeks continually to minimize its potential exposure to quota-related risks through, among other measures, geographical diversification of its manufacturing sources, allocation of production of merchandise categories where more quota is available and shifts of production among countries and manufacturers. The expansion in the past few years of the Company's varied manufacturing sources and the variety of countries in which it has\nI-5\nmanufacturing arrangements, although not the result of specific import restrictions, have had the result of reducing the adverse effect of any increase in such restrictions.\nSubstantially all of the Company's products are subject to United States customs duties. In the ordinary course of business, the Company, from time to time, is subject to claims by the United States Customs Service (\"Customs\") for duties and other charges and is entitled to refunds from Customs due to overpayment of duties by the Company and may be required to pay penalties with respect to underpayment of duties. The Company conducted an internal review, on its own initiative, with respect to the declared price of certain of its imported finished goods to determine whether such price had been understated because of a failure to include the cost of raw materials provided by the Company to certain of its manufacturers, as well as the cost of shipping such raw materials by air freight to such manufacturers. During fiscal 1987, the Company made a voluntary tender to Customs of duties and other charges believed to be due with regard to such finished goods and as a result, in accordance with routine administrative procedure in voluntary disclosure and tender situations, Customs initiated an audit to verify the accuracy of the Company's submission and records. At the conclusion of the audit, Customs officials informally advised the Company that further duties in the amount of approximately $700,000 plus penalties and interest may be assessed against the Company. The Company believes that these additional duties relate principally to items of U.S. origin which are not dutiable and intends to vigorously contest any claims that may be made by Customs. The Company and Customs have been reviewing the $700,000 duty amount which has now been substantially reduced; penalties and interest, however, may still be imposed. In addition to the original 1987 tender of $161,000, the Company tendered $500,000 to U.S. Customs in December 1991 as an offer-in- compromise in order to settle this matter. The offer is pending at U.S. Customs headquarters and the Company is awaiting a decision.\nAlmost all finished goods are shipped to the Company's New Jersey distribution center for final inspection, assembly into collections, allocation and shipment to customers.\nBACKLOG\nAt September 20, 1994, the Company's order book reflected unfilled customer orders for approximately $62.6 million of merchandise (compared to a backlog of $44.2 million at September 20, 1993), all of which is scheduled for delivery during fiscal 1995. The Company does not believe that cancellations, rejections or returns will materially reduce the amount of sales realized from such backlog. Order book data at any date are materially affected by the timing of the initial showing of collections to the trade, as well as by the timing of recording of orders and of shipments. Accordingly, order book data do not provide meaningful period to period comparisons as of specific dates, and comparisons of backlog information with such information as of specific dates for prior periods is not necessarily indicative of future results.\nTRADEMARKS\nCHAUS, CHAUS ESSENTIAL, CHAUS SPORT, CHAUS WOMAN and MS. CHAUS are registered trademarks of the Company in the United States for use on\nI-6\nladies' garments. These trademarks are renewable in the years 2004, 2008, 2002, 2004 and 2005, respectively. JOSEPHINE is also a registered trademark of the Company in the United States, renewable in the year 2001 for use on ladies' blouses and sweaters. The Company considers its trademarks to have significant value in the marketing of its products.\nThe Company has also registered its CHAUS and JOSEPHINE marks for ladies' gamrments in certain foreign countries and has applied for registration of its trademarks in certain foreign countries for selected women's accessories including handbags, small leather goods and footwear.\nCOMPETITION\nThe women's apparel industry is highly competitive, both within the United States and abroad. Many apparel companies are larger in size and have greater financial resources than the Company. The updated, moderately- priced apparel which the Company produces constitutes only one of the many types of women's apparel, and the Company is not aware of any comprehensive trade statistics to enable it to determine how many companies in the apparel industry produce garments which compete with the Company's products. However, management believes, based on its knowledge of the market, that the Company is one of the largest producers (measured by sales) of updated, moderately-priced women's sportswear in the United States.\nThe Company believes that an ability to effectively anticipate, gauge and respond to changing consumer demand and tastes relatively far in advance, as well as an ability to operate within substantial production and delivery constraints (including obtaining necessary quota allocations), is necessary to compete successfully in the women's apparel field. Consumer and customer acceptance and support, which depend primarily upon styling, pricing, quality (both in material and production), and product identity, are also important aspects of competition in this industry. The Company believes that its success will depend upon its ability to remain competitive in these areas.\nFurthermore, the Company's traditional department store customers, which account for a very substantial portion of the Company's business, encounter intense competition from so-called \"off-price\" and discount retailers, mass merchandisers, and specialty stores. The Company believes that its ability to increase its present levels of sales will depend on such department store customers' ability to maintain their competitive position and the Company's ability to increase its market share of sales to department stores.\nEMPLOYEES\nAt June 30, 1994, the Company employed 797 full-time employees. Of such employees, 109 were engaged in management and internal administration; 29 in design; 140 in production and production administration; 275 in marketing, merchandising and sales (including 222 employees in the retail outlet store operation); and 107 in shipping. Of the Company's total employees, approximately 137 were located in the Far East and Europe.\nThe Company is a party to a collective bargaining agreement with the Amalgamated Workers Union, Local 88, covering approximately 160 full-time\nI-7\nemployees. This agreement expires in August 1996.\nThe Company considers its relations with its employees to be satisfactory and has not experienced any interruption of operations due to labor disagreements with its employees.\nEXECUTIVE OFFICERS\nThe executive officers of the Company are:\n_____________________\n(1) Effective September 28, 1994, Andrew Grossman commences employment as the Company's Chief Executive Officer and a member of the two-person Office of the Chairman, which he will share with Josephine Chaus. Since September 13, 1994, Mr. Grossman has been a director of the Company. Prior to September 2, 1994, Mr. Grossman was President from 1991-1994 and Executive Vice President from 1990 to 1991 of Jones Apparel Group and Vice President of Merchandising for Jones New York from 1987 through 1990. Prior to joining Jones in 1986, Mr. Grossman was employed by Willi Wear Ltd., Herbert Grossman Enterprises, the Ralph Lauren Womens Wear division of Bidermann Industries, Inc. and the Evan Picone division of Palm Beach Inc.\nExecutive officers serve at the discretion of the Board of Directors.\nBernard Chaus was Chairman of the Board and Chief Executive Officer since founding the Company in 1975 until his death on May 31, 1991.\nRichard Baker has been the President of the Company since February 15, 1993. From 1986 to 1992 he was employed by Esprit de Corp., a firm engaged in the apparel business, first as president of Esprit Sport and then, for five years as president of Esprit de Corp. Womenswear.\nJosephine Chaus has been employed by the Company in various capacities since its inception. She has been a director of the Company since 1977, President from 1980 through February 1993, Vice Chairman of the Board from 1982 through 1991 and Chief Executive Officer and Chairwoman of the Board since July 22, 1991. In September 1994, the Company engaged Andrew Grossman as its Chief Executive Officer (see note (1) above).\nI-8\nMichael Fieman joined the Company and was appointed Executive Vice President - Production in November 1991. Prior to that he was Vice President - International Operations at Liz Claiborne from 1990 to 1991. From 1988 to 1990 he was with Leslie Fay as President of the Shapely Division.\nWayne S. Miller joined the Company and was appointed Executive Vice President - Finance and Administration and Chief Financial Officer of the Company in June 1994. From April 1994 to June 1994 he was Crisis Manager at USA Classic, Inc. From February 1994 to March 1994 he was a consultant to various apparel companies. From October 1990 to January 1994 he was President and Chief Executive Officer of Publix Group, L.P. Prior to that he was Chief Financial Officer at Basco All-American Sportswear Corp.\nMarc A. Zuckerman was appointed Treasurer of the Company in October 1989. He had been employed by the Company from March 1988 to July 1989, as its Director of Corporate Credit. From July to October 1989, he was Director of Corporate Credit and then Assistant Treasurer of Warnaco.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal executive offices are located in modern, leased facilities at 1410 Broadway, New York City, consisting of approximately 39,000 square feet. These facilities also house the Company's showrooms and its sales, design and merchandising staffs. This space is occupied under several leases expiring through 1996. Net base rental expense aggregated approximately $2,060,000 (approximately $800,000 of which is included in restructuring expenses) for fiscal 1994 and are expected to aggregate approximately $1,165,000 (plus an amount to reflect increases in the consumer price index) for fiscal 1995.\nThe Company also leases (pursuant to two leases) approximately 34,000 square feet of space at 520 Eighth Avenue, New York City, which houses its technical production support facilities (including its sample and pattern makers). Net base rental expense for this space aggregated approximately $413,000 for fiscal 1994. The leases for this facility expire in January 1995 and the Company will eliminate one lease, reduce its square feet of space to 19,000 and expects the aggregate base rental expense to be approximately $305,000 for fiscal 1995.\nThe Company leases approximately 455,000 square feet in Secaucus, New Jersey. Such facilities house the Company's production, administrative, finance and accounting personnel, computer operations, one retail outlet store, and serve as its warehouse and distribution centers. The leases for the Secaucus facilities expire in 1996. Base rental expense for the Secaucus facilities aggregated approximately $2,382,000 (approximately $600,000 of which is included in restructuring expenses) for fiscal 1994 and are expected to aggregate approximately $1,403,000 in fiscal 1995.\nThe Company also leases space in Hong Kong, Korea, Taiwan, the Philippines (closed in June 1994) and Italy with annual aggregate rental expense of approximately $715,000 for fiscal 1994. The Company anticipates that aggregate annual rental expense in fiscal 1995 will be comparable to the rental expense made in fiscal 1994.\nThe Company also leases space for its retail outlet operation with the\nI-9\naverage store consisting of approximately 3,000 square feet. The annual aggregate base rental expense for such facilities in fiscal 1994 was approximately $3,300,000 (approximately $1,400,000 of which is included in restructuring expenses) and is expected to be approximately $1,800,000 for fiscal 1995.\nThe Company believes that its existing facilities are well maintained and in good operating condition and will continue to be adequate for its present and anticipated levels of operations.\nSee Note 10 of Notes to Financial Statements for further information regarding the Company's current material lease obligations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nBy order dated September 1, 1992, Federal Judge Shirley Wohl Kram dismissed with prejudice as time-barred the Amended Complaint against the Company and others, in the previously reported consolidated class actions entitled Phifer v. Chaus et al., Goldschlack v. Chaus et al., Susman v. Chaus et al. and I. Bibcoff Inc. Pension Trust Fund v. Chaus et al. In such actions, claims were asserted against the Company and others, including the Company's lead underwriters, for alleged misstatements and omissions contained in the Company's July 1986 Prospectus delivered in connection with the Company's initial public offering and its 1986 and 1987 Annual Reports. Plaintiffs's attorneys filed a notice of appeal, which they subsequently withdrew subject to the right to restore the appeal by January 8, 1993. No such appeal was made and the action was automatically deemed dismissed with prejudice.\nOn April 19, 1993, a Class Action Complaint was filed in the Superior Court of New Jersey, Hudson County, against the Company and others, including the lead underwriter of the Company's 1986 initial public offering, alleging common law fraud and negligent misrepresentation in the sale of the Company's stock in its initial public offering, allegations that are substantially similar to the claims that were dismissed with prejudice in the federal court. One of the plaintiffs from the federal action was originally a party in this action in state court. On June 18, 1993, the Company received by mail, a copy of Jury Demand Class Action in the Superior Court of New Jersey, Hudson County entitled Theodore M. Wietecha and Lisa A. Phifer v. Bernard Chaus, Inc. et al. The complaint was amended in September 1993 to delete Lisa Phifer as a plaintiff. On May 27, 1994, the Company moved to dismiss the complaint and\/or to deny or limit class status. The motion is before the court for decision.\nWhile a negative outcome in this action could have a material adverse effect on the Company, management believes that such action is without merit and that the Company has both substantive and procedural bases for contesting this latest action. The Company intends to defend itself vigorously against this claim. Because the underlying claims asserted in the action have not been the subject of discovery and because of the preliminary procedural posture of the action, no estimate of any possible loss due to this action can presently be made.\nThe Company has also negotiated an agreement with its directors and officers liability insurance carrier whereby the Company will obtain interim reimbursement of certain expenses incurred by the Company in\nI-10\nconnection with these actions because a portion of such expenses may be attributable to the defense of its directors and officers, with full reservation of rights under the policy of the Company, the directors and officers and the insurance carrier upon the ultimate disposition of the actions.\nA claim for indemnification has been asserted by the Company's former Underwriters against the Company. The indemnification claim demands repayment of the legal fees and expenses incurred by the Underwriters in connection with the consolidated class actions entitled Pfifer v. Chaus, et al. Discussions are ongoing with counsel for the Underwriters to resolve this claim.\nThe Company is also involved in various other legal proceedings arising out of the conduct of its business.\nThe Company believes that the eventual outcome of the proceedings referred to above will not have a material adverse effect on the Company's financial condition.\nFor a description of certain duties which may be assessed by Customs against the Company, see \"Manufacturing\" under Item 1 \"Business\" above.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ----------------------------------------------------\nNone.\nI-11\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDERS MATTERS.\nThe Company's Common Stock is traded on the New York Stock Exchange (\"NYSE\") under the symbol \"CHS\". The range of high and low sales prices for the Common Stock on the New York Stock Exchange composite tape (as reported by The National Quotation Bureau) through September 16, 1994 is as follows:\nOn September 16, 1994, the last sales price of the Company's Common Stock, as reported on the New York Stock Exchange Composite Tape (as reported by The Wall Street Journal), was $4.00.\nAs of June 30, 1994 the approximate number of record holders of the Company's Common Stock was 1,300.\nThe Company does not plan to pay any dividends on its Common Stock within the foreseeable future. Any such dividend would, in any event, be subject to compliance with covenants contained in the Company's Financing Agreement (as defined herein), which currently prohibits payment of dividends.\nI-12\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following financial information is qualified by reference to, and should be read in conjunction with, the Financial Statements, related Notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations contained elsewhere herein.\n____________________\n(1) Computed by dividing net (loss) income by the weighted average number of Common and Common Equivalent Shares outstanding during the years. For the fiscal years ended 1994, 1993, and 1991, Common Equivalent Shares were not considered as the inclusion of such would have been antidilutive.\nI-13\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThe following table sets forth, for the years indicated, certain items expressed as a percentage of net sales.\nFISCAL 1994 COMPARED TO FISCAL 1993\nFor the fiscal year ended June 30, 1994, net sales decreased by $29.5 million (12.5%) compared to the prior year. Of this decrease, $7.5 million (58.3%) was attributable to blouses, $7.4 million (11.0%) was attributable to weekend casual sportswear, $1.3 million (5.0%) was attributable to dresses, $15.3 million (14.6%) was attributable to sportswear and $.6 million (13.9%) was attributable to the Company's Canadian operation, offset somewhat by an increase of $2.6 million (12.1%) attributable to the retail outlet operation. All percentages in parenthesis compare net sales in fiscal 1994 to net sales in fiscal 1993. Sales amounts by product line are exclusive of merchandise sold by the retail outlet operation.\nThe sales decrease is primarily due to lower average unit selling prices and higher promotional allowances to accelerate and increase sell-through at the retail level. The Company reduced domestic standard selling prices and anticipated a more favorable business trend which would have enabled it to increase sales; however, the unanticipated continuation of reduced consumer spending for women's apparel resulted in less purchasing of the Company's product. As a result, the Company sold less units at regular price, liquidated excess inventory at reduced prices and had higher promotional allowances to accelerate and increase sell-through at the retail level.\nDuring fiscal year 1994, the Company's retail outlet operation increased from 32 stores on June 30, 1993 to 35 stores on June 30, 1994. The new stores that were opened contributed approximately $1.7 million of the $2.6 million increase in retail operation sales. Comparative same store operations from last year to this year (twenty-one stores) showed a combined total sales decrease of approximately 3.5%. Pursuant to the Company's restructuring as indicated below, the Company closed one store during fiscal 1994 and plans to close four stores in fiscal 1995.\nI-14\nCost of goods sold as a percentage of net sales increased to 90.4% from 79.5% as compared to the prior year. The increase in such costs, as a percentage of net sales, was primarily attributable to the disposal of excess inventories throughout the year at reduced prices, combined with an increase in promotional allowances.\nSelling, general and administrative expenses, as a percent of net sales, increased to 26.9% from 24.3% as compared to the prior year. The actual dollar expense decrease of $2.0 million represents expenses recorded as restructuring and unusual expenses.\nIn June 1994, the Company recorded restructuring expenses of $5,300,000. The restructuring expenses primarily relate to the Company's plan to reduce overhead costs, consolidate its office locations and close selected retail outlet stores. The restructuring expenses include $2,100,000 for the closing of selected retail stores, $2,500,000 for the consolidation of office space in New York, office and warehouse space in New Jersey and the closing of the Company's Philippines office and $700,000 for employee severance. The Company believes that its remaining retail stores will not only provide direct contributions to income but will also enhance the Company's ability to manage its inventory without affecting its principal channels of distribution.\nIn addition, in June 1994, the Company recorded unusual expenses of $1,900,000. These primarily relate to expenses arising from the abandonment of fixed assets, legal fees and winding down of the Company's Canadian joint venture operation.\nInterest expense increased compared with last year primarily due to higher bank borrowings as well as the higher interest rate on subordinated debt.\nFISCAL 1993 COMPARED TO FISCAL 1992\nFor the fiscal year ended June 30, 1993, net sales decreased by $18.4 million (7.2%) compared to the prior year. Of this decrease, $22.1 million (63.1%) was attributable to blouses, $12.7 million (16.1%) was attributable to weekend casual sportswear, $7.9 million (24.0%) was attributable to dresses and $3.1 million (100.0%) was attributable to better sportswear, an operation that was discontinued in fiscal 1992, offset somewhat by increases of $15.4 million (17.2%) attributable to sportswear and $8.0 million (59.8%) attributable to the retail outlet operation. All percentages in parenthesis compare net sales in fiscal 1993 to net sales in fiscal 1992. Sales amounts by product line are exclusive of merchandise sold by the retail outlet operation.\nThe sales decrease was primarily due to a combination of reduced unit sales and lower average unit selling prices. The Company continued its strategy of reduced domestic standard selling prices and anticipated a more favorable business trend which would have enabled it to increase sales; however, weak retail spending patterns for women's apparel resulted in the Company's customers ordering less than was anticipated. As a result, the Company sold less units and had higher than anticipated inventory levels at June 30, 1993.\nDuring fiscal year 1993, the Company continued the expansion of its retail outlet operation from 23 stores on June 30, 1992 to 32 stores on June 30,\nI-15\n1993. The new stores that were opened contributed approximately $5.0 million of the $8.0 million increase in retail operation sales. Comparative same store operations from last year to this year (nine stores) showed a combined total sales decrease of approximately 8.5%.\nCost of goods sold as a percentage of net sales increased to 79.5% from 77.3% as compared to the prior year. The increase in such costs, as a percentage of net sales, was primarily attributable to an increase in the markdown required on our excessive inventory at June 30, 1993 which increased cost of goods sold combined with an increase in returns and allowances which reduced net sales.\nSelling, general and administrative expenses, as a percent of net sales, increased to 24.3% from 19.7% as compared to the prior year. The actual dollar increase of $7.4 million was comprised primarily of increases in the retail outlet operation due to expansion ($2.8 million), an increase in the international operation ($1.0 million) and increased design, merchandising and production costs.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nNet cash (used in) provided by operating activities was ($5,020,000) in fiscal 1994, ($29,053,000) in fiscal 1993 and $16,074,000 in fiscal 1992. The net cash used in operating activities in the current fiscal year resulted primarily from the net loss ($46.8 million) and a reduction in accounts payable ($5.2 million), offset somewhat by decreases in accounts receivable ($12.7 million) and inventories ($20.5 million).\nHistorically, the Company has not required major capital expenditures. In fiscal 1994 and 1993, purchases of fixed assets were $1.4 million and $2.3 million, respectively, consisting primarily of improvements in the Company's New Jersey warehouse facilities, New York design and showroom facilities, additional computer and telecommunications equipment, and for the expansion of the retail outlet operation. In fiscal 1995, the Company anticipates capital expenditures of approximately $1.5 million, consisting primarily of expenditures for its warehouses, design facilities and the purchase of additional computer software systems.\nThe Company has in place a Restated and Amended Financing Agreement (the \"Financing Agreement\") with BNY Financial Corporation (\"BNYF\"), a wholly owned subsidiary of The Bank of New York. Effective as of October 1, 1993, the Financing Agreement provides to the Company a total line of credit up to an aggregate of $60 million, including letter of credit and direct borrowings, with a sublimit for loans and advances of $20 million. The Financing Agreement contains a borrowing base formula which is the sum of (i) 85% of eligible receivables, less reserves, (ii) 40% of eligible inventory, up to $27 million and (iii) 100% of excess cash balances, all as defined in the agreement. However, BNYF may decrease or increase the above percentages in the borrowing base. The Company's indebtedness under the Financing Agreement is collateralized by the Company's accounts receivable and inventory. Such agreement requires the Company to comply quarterly with various financial tests including tangible net worth of at least $47.5 million, working capital of at least $40 million and restrictions on payment of principal and interest on subordinated indebtedness unless certain conditions are met. Such agreement also requires the Company to comply with various other restrictions including, but not limited to, a restriction on the payment of dividends. Interest on direct borrowings is payable monthly at an annual rate which is the higher of (a) 1\/2 of 1% above the prime rate of the Bank of New York (7.25% at June 30, 1994, and 6.0% at June\nI-16\n30, 1993) or (b) 1% above the federal funds rate, as defined. Additional interest at 2-1\/2% per annum is due on amounts not paid when due. In addition, the agreement provides for the payment of minimum service charges and\/or interest which for the fiscal year ended June 30, 1994, aggregated approximately $900,000. The Financing Agreement may be cancelled by the Company any time after July 1, 1995, upon 60 days prior written notice to BNYF or prior to July 1, 1995 upon 60 days written notice to BNYF and the payment of an early termination fee. The Financing Agreement is cancellable by BNYF effective July 1, 1995 or any July 1 thereafter, upon 60 days written notice to the Company.\nDuring all four quarters of fiscal year 1994, the Company was not in compliance with certain financial covenants. BNYF has waived such noncompliance.\nThe Company is currently negotiating with its bank for modification of certain financial covenants for the future in order to provide the latitude and resources necessary for future programs. The Company believes that this negotiation will be successfully completed in the near future. However, there can be no assurance that the Company will be able to obtain the necessary modifications.\nJosephine Chaus has provided a $7.2 million letter of credit expiring April 15, 1995 (increased from previous amounts provided by her of $3.0 million in April 1994 and $5.0 million in June 1994 and extended from the previous expiration date of October 15, 1994) to support the Company's credit facility. In exchange for this letter of credit, BNYF is providing at least an additional $12.2 million of credit availability under the Company's borrowing formula. To compensate Ms. Chaus for the letter of credit, an independent committee of the Company's Board of Directors has authorized the issuance to her of warrants to purchase an aggregate of 544,000 shares of Common Stock at exercise prices ranging from $2.25 to $3.00 (in each case equal to 120% of the market price on the authorization date) and warrants to purchase additional shares of Common Stock at an exercise price equal to 120% of the five days trading average of the closing sale price of the Company's Common Stock commencing September 27, 1994. The precise number of such shares shall be set after the exercise price is determinded. Issuance of the warrants is subject to (i) receipt of an opinion from a nationally recognized investment banking firm that the terms of the warrants are commercially reasonable and (ii) shareholder approval.\nJosephine Chaus has also agreed to purchase $7.2 million of Common Stock of the Company at a purchase price determined by the independent committee equal to the five trading day average of the closing sale price of the Company's Common Stock commencing September 27, 1994. Issuance of the shares is subject to (i) receipt of an opinion from a nationally recognized investment banking firm that the purchase price terms are commercially reasonable and (ii) shareholder approval. Pending such approval, Ms. Chaus has loaned the $7.2 million to the Company and the Company has issued a $7.2 million promissory note to Ms. Chaus, bearing interest at 12%. The note will be exchanged for the shares of Common Stock when the conditions to issuance have been satisfied. Proceeds from such cash infusion are being used for costs and associated expenses related to the signing of the new Chief Executive Officer which costs will be charged to operations in the quarter ending September 30, 1994.\nThe Company has outstanding at June 30, 1994 $19,039,000 of subordinated\nI-17\npromissory notes payable to Josephine Chaus and the Estate of Bernard Chaus, which were originally issued on June 30, 1986 (the \"First Promissory Notes\"). In October 1993 an independent committee of the Board of Directors agreed in principle with the noteholders to modify the First Promissory Notes. The maturity date of the notes was extended until July 1, 1995 and, effective October 18, 1993, it was agreed that the notes would bear interest at a rate of 12% per annum, payable quarterly. It was further agreed that interest which had to be deferred as a result of bank covenant requirements would be added to the New Promissory Note (see below). The noteholder has agreed that all accrued interest added quarterly to the New Promissory Note will be payable on July 1, 1995.\nIn February and March 1991, Bernard Chaus and Josephine Chaus each provided subordinated financing to the Company in the aggregate amount of $10.0 million (the \"Second Promissory Notes\"). In September 1993, both Josephine Chaus and the Estate of Bernard Chaus agreed to convert the remaining balance of the Second Promissory Notes ($2,623,000) and the interest for the quarter ended June 30, 1993 for both the First Promissory Notes and the Second Promissory Notes ($417,432) into a demand note (the \"Demand Note\") in the aggregate amount of $3,040,432.\nIn October 1993, an independent committee of the Board of Directors agreed in principle with the noteholders to modify the Demand Note. The Demand Note was converted into new promissory notes (collectively the \"New Promissory Notes\"). It was agreed that the New Promissory Notes would bear interest at the rate of 10% per annum effective from July 1, 1993, and that such interest would be payable on July 1, 1994. Principal payments on the New Promissory Notes were made in November 1993 ($500,000), February 1994 ($250,000) and August 15, 1994 ($250,000). The noteholder agreed to extend the maturity date for the remaining principal and interest payments which were to have been due on July 1, 1994 to July 1, 1995.\nAggregate annual principal payments of subordinated debt as of June 30, 1994 are $250,000 in fiscal year 1995, and $18,789,000 in fiscal year 1996.\nThe Company has undertaken a number of initiatives to strengthen its financial position, including a cash infusion of $7.2 million from its principal shareholder, a letter of credit issued by this shareholder to facilitate an increase in loan availability, closure of certain retail operations, consolidation of other office facilities, an overhead reduction program and the hiring of certain senior management personnel. The Company believes that these initiatives will have a positive impact on future operating results.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements are included herein commencing on page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nPreviously reported on Form 8-K filed by the Company on June 16, 1994.\nI-18\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 set forth in Part I of this Annual Report on Form 10-K.\nInformation with respect to the directors of the Company is incorporated by reference to the information to be set forth under the heading \"ELECTION OF DIRECTORS\" in the Company's definitive proxy statement relating to its 1994 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A (the \"Company's 1994 Proxy Statement\").\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation called for by Item 11 is incorporated by reference to the information to be set forth under the heading \"EXECUTIVE COMPENSATION\" in the Company's 1994 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation called for by Item 12 is incorporated by reference to the information to be set forth under the heading \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\" in the Company's 1994 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation called for by Item 13 is incorporated by reference to the information to be set forth under the headings \"EXECUTIVE COMPENSATION\" and \"CERTAIN TRANSACTIONS\" in the Company's 1994 Proxy Statement.\nI-19\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: See List of Financial Statements and Financial Statement Schedules on page .\n(b) The Company filed a Form 8-K during the last quarter of its fiscal year ended June 30, 1994.\n(c) Exhibits filed herewith denoted by(*):\nSequentially Numbered Page ------------ Exhibit No. - - ----------- 3.1 Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1,Registration No. 33-5954).\n3.2 By-laws of the Company, as amended (incorporated by reference to Exhibit 3.1 of the Company's Form 10-Q for the quarter ended December 31, 1987).\n10.1 Restricted Stock Purchase Plan (incorporated by reference to Exhibit 10.1 of the Company's Form 10-K for the year ended June 30, 1987).\n10.2 1986 Stock Option Plan, as amended and restated as of January 1, 1987 (incorporated by reference to Exhibit 10.2 of the Company's Form 10-K for the year ended July 1, 1989).\n10.3 Amendment No. 1 to 1986 Stock Option Plan (incorporated by reference to Exhibit 10.3 of the Company's Form 10-K for the year ended July 1, 1989).\n10.4 Incentive Award Plan (incorporated by reference to Exhibit 10.6 of the Company's Registration Statement on Form S-1, Registration No. 33-5954).\n10.13 Agreement, dated June 15, 1988, between the Company and Bernard Chaus and Josephine Chaus, amending the terms of the Company's Subordinated Promissory Notes to each of them, each in the principal amount of $7,365,000, the form of which was filed as Exhibit 10.13 of the Company's Registration Statement on\nIV-20\nForm S-1, Registration No. 33-5954 (incorporated by reference to Exhibit 10.11 of the Company's Form 10-K for the year ended July 2, 1988).\n10.14 Agreement, dated May 17, 1990 between the Company and Bernard Chaus and Josephine Chaus amending the terms of the Company's subordinated Promissory Notes to each of them, each in the principal amount of $7,365,000, the form of which was filed as Exhibit 10.13 of the Company's Registration Statement on Form S-1, Registration No. 33-5954.\n10.15 Agreement, dated August 28, 1987, between Amalgamated Workers Union Local 88,R.W.D.S.U., AFL-CIO and Company, and the Collective Bargaining Agreement, dated September 1, 1984 related thereto (incorporated by reference to Exhibit 10.3 of the Company's Form 10-K for the year ended June 30, 1987).\n10.16 Agreement, dated September 1, 1990, between Amalgamated Workers Union Local 88, R.W.D.S.U., AFL-CIO and Company, and the Collective Bargaining Agreement, dated September 1, 1984 related thereto (incorporated by reference to Exhibit 10.16 of the Company's Form 10-K for the year ended June 30, 1990).\n10.19 Lease, dated January 29, 1987, between L.H. Charney Associates and the Company, of space at the Company's facility at 1410 Broadway, New York, New York (incorporated by reference to Exhibit 10.19 of the Company's Form 10-K for the year ended June 30, 1987).\n10.23 Lease, dated July 27, 1987, between L. H. Charney Associates and the Company, of space at the Company's facility at 1410 Broadway, New York, New York (incorporated by reference to Exhibit 10.23 of the Company's Form 10-K for the year ended July 2, 1988).\n10.31 Agreement dated December 3, 1990 among Bernard Chaus, Inc., Bernard Chaus, Josephine Chaus and National Union Fire Insurance Company of Pittsburgh, Pa., the Company's directors and officers liability carrier.\n10.38 Financing Agreement dated July 1, 1991 between the Company and BNY Financial Corporation.\n10.39 Employment Agreement, dated July 1, 1991,\nIV-21\nbetween the Company and Josephine Chaus.\n10.43 Distribution Agreement, effective June 1, 1991. between Confeccionistas Unidos, S.A. de C.V. and Bernard Chaus, Inc.\n10.60 Employment Agreement, dated November 4, 1991 between Michael Fieman and the Company (incorporated by reference to Exhibit 10.60 of the Company's Form 10-K for the year ended June 30, 1992).\n10.61 Amended and Restated Financing Agreement, dated September 24, 1992, to the Financing Agreement dated July 1, 1991 between the Company and BNY Financial Corporation (incorporated by reference to Exhibit 10.61 of the Company's Form 10-K for the year ended June 30, 1992.\n10.68 Waiver and amendment dated May 13, 1993 to the Restated and Amended Financing Agreement between the Company and BNY Financial corporation effective July 1, 1992 (incorporated by reference to Exhibit 10.68 of the Company's Form 10-Q for the quarter ended March 31, 1993.\n10.71 Employment Agreement, dated February 15, 1993 between Richard A. Baker and the Company (incorporated by reference to Exhibit 10.71 of the Company's Form 10-K for the year ended June 30, 1993).\n10.72 Employment Agreement, dated July 1, 1993 between Michael Root and the Company (incorporated by reference to Exhibit 10.72 of the Company's Form 10-K for the year ended June 30, 1993).\n10.73 Waiver dated September 1, 1993 to the Restated and Amended Financing Agreement between the Company and BNY Financial Corporation effective July 1, 1992 (incorporated by reference to Exhibit 10.73 of the Company's Form 10-K for the year ended June 30, 1993).\n10.74 Agreement, dated February 21, 1991 between the Company and Bernard Chaus and Josephine Chaus amending the terms of the Company's Subordinated Promissory Notes to each of them, each in the principal amount of $7,365,000 (incorporated by reference to Exhibit 10.74 of the Company's Form 10-K for the year ended\nIV-22\nJune 30, 1993).\n10.75 Subordinated Promissory Notes dated March 12, 1991, between the Company and Bernard Chaus and Josephine Chaus, separately, each in the amount of $5,000,000 (incorporated by reference to Exhibit 10.75 of the Company's Form 10-K for the year ended June 30, 1993).\n10.76 Agreement, dated July 31, 1991, between the Company and the Estate of Bernard Chaus and Josephine Chaus amending the terms of the Company's Subordinated Promissory Notes to each of them, each in the principal amount of $7,365,000, (incorporated by reference to Exhibit 10.76 of the Company's Form 10-K for the year ended June 30, 1993).\n10.77 Agreement, dated July 31, 1991, between the Company and the Estate of Bernard Chaus and Josephine Chaus amending the terms of the Company's Subordinated Promissory Notes to each of them, each in the principal amount of $5,000,000 (incorporated by reference to Exhibit 10.77 of the Company's Form 10-K for the year ended June 30, 1993).\n10.78 Agreement, dated July 15, 1992, between the Company and the Estate of Bernard Chaus and Josephine Chaus amending the terms of the Company's Subordinated Promissory Notes to each of them, each in the principal amount of $5,000,000 (incorporated by reference to Exhibit 10.78 of the Company's Form 10-K for the year ended June 30, 1993).\n10.79 Agreement, dated October 30, 1992, between the Company and the Estate of Bernard Chaus and Josephine Chaus amending the terms of the Company's Subordinated Promissory Notes to each of them, each in the principal amount of $7,365,000 (incorporated by reference to Exhibit 10.79 of the Company's Form 10-K for the year ended June 30, 1993).\n10.80 Demand Notes, dated June 30, 1993, between the Company and the Estate of Bernard Chaus and Josephine Chaus, each in the principal amount of $1,520,216 (incorporated by reference to Exhibit 10.80 of the Company's Form 10-K for the year ended June 30, 1993).\n10.81 Agreement, dated September 21, 1993, between the Company and the Estate of Bernard Chaus and Josephine Chaus amending the terms of the Company's Subordinated Promissory Notes to\nIV-23\neach of them, each in the principal amount of $7,365,000 (incorporated by reference to Exhibit 10.81 of the Company's Form 10-K for the year ended June 30, 1993).\n10.82 Waiver dated September 23, 1993 to the Restated and Amended Financing Agreement between the Company and BNY Financial Corporation effective July 1, 1992 (incorporated by reference to Exhibit 10.82 of the Company's Form 10-K for the year ended June 30, 1993).\n10.83 Waiver dated November 5, 1993 to the Restated and Amended Financing Agreement between the Company and BNY Financial Corporation (incorporated by reference to Exhibit 10.83 of the Company's Form 10-Q for the quarter ended September 30, 1993).\n10.84 Amendment, effective October 1, 1993, to the Restated and Amended Financing Agreement between the Company and BNY Financial Corporation (incorporated by reference to Exhibit 10.84 of the Company's Form 10-Q for the quarter ended December 31, 1993).\n10.85 Waiver dated January 13, 1994 to the Restated and Amended Financing Agreement between the Company and BNY Financial Corporation (incorporated by reference to Exhibit 10.85 of the Company's Form 10-Q for the quarter ended December 31, 1993).\n10.86 Waiver dated February 10, 1994 to the Restated and Amended Financing Agreement between the Company and BNY Financial Corporation (incorporated by reference to Exhibit 10.86 of the Company's Form 10-Q for the quarter ended December 31, 1993).\n10.87 Waiver dated May 4, 1994 to the Restated and Amended Financing Agreement between the Company and BNY Financial Corporation (incorporated by reference to Exhibit 10.87 of the Company's Form 10-Q for the quarter ended March 31, 1994).\n*10.89 Employment Agreement dated June 3, 1994 between the Company and Wayne Miller.\n*10.90 Employment Agreement dated September 1, 1994 between the Company and Andrew Grossman with Stock Option Agreement dated as of September 1, 1994 by and between the Company and Andrew Grossman.\nIV-24\n*10.91 Settlement Agreement dated as of September 1994 among Nicole Eskenazi, the Company and certain others.\n*10.92 Severance Agreement dated as of June 16, 1994 between the Company and Anthony M. Pisano.\n*10.93 Waiver dated September 20, 1994 to the Restated and Amended Financing Agreement between the Company and BNY Financial Corporation.\n*10.94 Subordinated Promissory Notes dated August 1, 1993, between the Company and Josephine Chaus and the Estate of Bernard Chaus, separately, each in the amount of $208,716.\n*10.95 Subordinated Promissory Note dated August 1, 1993, between the Company and Josephine Chaus in the amount of $1,311,500.\n*10.96 Subordinated Promissory Note dated August 1, 1993, between the Company and the Estate of Bernard Chaus, in the amount of $1,000,000.\n*10.97 Subordinated Promissory Note dated August 1, 1993, between the Company and the Estate of Bernard Chaus, in the amount of $311,500.\n*10.98 Subordinated Promissory Notes dated December 31, 1993, between the Company and Josephine Chaus and the Estate of Bernard Chaus, separately, each in the amount of $181,056.\n*10.99 Subordinated Promissory Notes dated December 31, 1993, between the Company and Josephine Chaus and the Estate of Bernard Chaus, separately, each in the amount of $412,950.\n*10.100 Agreements dated September 9, 1993, between the Company and Josephine Chaus and the Estate of Bernard Chaus, separately, reflecting amendments to subordinated promissory notes, each in the principal amount of $5,000,000.\n*10.101 Agreements dated October 18, 1993, between the Company and Josephine Chaus and the Estate of Bernard Chaus, separately, reflecting amendments to subordinated promissory notes, each in the principal amount of $1,520,216.\n*10.102 Agreements dated October 18, 1993, between the Company and Josephine Chaus and the Estate of Bernard Chaus, separately, reflecting amendments to subordinated promissory notes, each in the principal amount of $7,365,000.\nIV-25\n*10.103 Agreement dated December 31, 1993, between the Company and Josephine Chaus reflecting amendments to a subordinated promissory note, in the principal amount of $1,311,500.\n*10.104 Agreement dated December 31, 1993, between the Company and the Estate of Bernard Chaus, reflecting amendments to subordinated promissory notes in the principal amounts of $1,000,000 and $311,500.\n22 List of Subsidiaries of the Company (incorporated by reference to Exhibit 22 of the Company's Registration Statement on Form S-1, Registration No. 33-5954).\nIV-26\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 on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, on September 27, 1994.\nBERNARD CHAUS, INC.\nBy: \/s\/ Josephine Chaus ------------------------------------ Josephine Chaus Chairwoman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on September 27, 1994.\nIV-27\nFORM 10-K--ITEM 14(A)(1) AND (2)\nBERNARD CHAUS, INC. AND SUBSIDIARIES\nINDEX OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Bernard Chaus, Inc. and subsidiaries are included in Item 8:\nReports of Independent Auditors .............................. F- 2 Consolidated Balance Sheets--June 30, 1994 and 1993 ................................................... F- 4 Consolidated Statements of Operations--Years Ended June 30, 1994, 1993 and 1992 ............................... F- 5 Consolidated Statements of Stockholders' Equity-- Years Ended June 30, 1994, 1993 and 1992.................... F- 6 Consolidated Statements of Cash Flows--Years Ended June 30, 1994, 1993 and 1992 ............................... F- 7 Notes to Consolidated Financial Statements ................... F- 8\nThe following consolidated financial statement schedules of Bernard Chaus, Inc. and subsidiaries are included in Item 14(d):\nSchedule II --Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees Other than Related Parties ..........F-16 Schedule VIII--Valuation and Qualifying Accounts ...............F-17 Schedule IX --Short-Term Borrowings ...........................F-18\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.\nREPORT OF INDEPENDENT AUDITORS\nStockholders and Board of Directors Bernard Chaus, Inc.\nWe have audited the accompanying consolidated balance sheets of Bernard Chaus, Inc. and subsidiaries as of June 30, 1994 and the related consolidated statement of operations, stockholders' deficit, and cash flows for the year then ended. Our audit also included the financial statements schedules listed in the Index at Item 14(a). 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.\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 and financial statement schedules referred to above present fairly, in all material respects, the consolidated financial position of Bernard Chaus, Inc. and subsidiaries at June 30, 1994, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles.\nDeloitte & Touche LLP\nNew York, New York September 21, 1994\nREPORT OF INDEPENDENT AUDITORS\nStockholders and Board of Directors Bernard Chaus, Inc.\nWe have audited the accompanying consolidated balance sheet of Bernard Chaus, Inc. and subsidiaries as of June 30, 1993 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended June 30, 1993. Our audits also included the financial statement schedules listed in the index at Item 14 (a) for each of the two years in the period ended June 30, 1993. 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 Bernard Chaus, Inc. and subsidiaries at June 30, 1993, and the consolidated results of their operations and their cash flows for each of the two years in the period ended June 30, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth there in.\nERNST & YOUNG LLP\nNew York, New York August 18, 1993\nSee accompanying notes.\nSee accompanying notes.\nSee accompanying notes.\nSee accompanying notes.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nTHE COMPANY: Bernard Chaus, Inc. designs, arranges for the manufacture of and markets an extensive range of women's clothing. The Company sells its products primarily to department and specialty stores throughout the United States.\nPRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the Company and its subsidiaries. Material intercompany accounts and transactions have been eliminated.\nNET (LOSS) INCOME PER SHARE: Net (loss) income per share has been computed by dividing the applicable net (loss) income by the weighted average number of common and common equivalent shares outstanding during the year (1994 - 18,352,000, 1993 - 18,272,000 and 1992 - 18,363,000). For the fiscal years ended 1994 and 1993, common equivalent shares were not considered as the inclusion of such would have been antidilutive.\nREVENUE RECOGNITION: Revenues are recorded at time of merchandise shipment.\nCREDIT TERMS: The Company extends credit to its customers based upon an evaluation of the customer's financial condition and credit history. The Company generally does not require collateral. There have been minimal net credit losses in each of the last three fiscal years. The historic level of credit losses is 0.14% of net sales, and the Company provides for estimated losses. These losses have consistently been below management's expectations. At June 30, 1994 and 1993, respectively, there was approximately 41.5% and 36% of the Company's accounts receivable balance due from the department store customers.\nSALES RETURNS: The Company records sales returns as a reduction to gross sales.\nCOOPERATIVE ADVERTISING: The Company records charges for cooperative advertising as advertising expense, a component of selling, general and administrative expenses.\nFOREIGN CURRENCY TRANSACTIONS: The Company negotiates substantially all of its purchase orders with foreign manufacturers in United States dollars. The Company considers the United States dollar to be the functional currency of its overseas subsidiaries. All foreign currency gains and losses are recorded in the Statement of Operations.\nEMPLOYEE BENEFITS: The Company does not provide postretirement benefits other than pensions to union employees. Accordingly, Statement of Financial Accounting Standards No. 106 \"Employers' Accounting for Postretirement Benefits other than Pensions\" will not affect the Company's financial statements. The Company does not typically provide post employment benefits to its employees. Accordingly, Statement of Financial Accounting Standards No. 112 \"Employers' Accounting for Postemployment Benefits\" will not have a material affect on the Company's financial statements.\nINVENTORIES: Inventories are stated at the lower of cost, using the first-in, first-out method, or market.\nFIXED ASSETS: Furniture and equipment are depreciated principally using the straight-line method over eight years. Leasehold improvements are amortized using the straight-line method over either the term of the lease or the estimated useful life of the improvement, whichever period is shorter. Automobiles are depreciated principally using the straight-line method over five years. Computer software is depreciated using the straight-line method over five years.\nINCOME TAXES: Effective July 1, 1993, the Company adopted Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes.\" Under Statement\n109, 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 enacted tax rates and laws that will be in effect when the differences are expected to reverse. Prior to the adoption of Statement 109, income tax expense was determined using the deferred method. Deferred tax expense was based on items of income and expenses that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated.\nAs permitted by Statement 109, the Company has elected not to restate the financial statements of any prior years. There was no cumulative effect of the change, as well as there being no effect on pre-tax loss for the year ended June 30, 1994.\nCASH EQUIVALENTS: Cash equivalents are short-term, highly liquid investments purchased with an original maturity of three months or less.\n2. INVENTORIES\nInventories consist of:\nInventories include merchandise in transit (principally finished goods) of approximately $11,176,000 at June 30, 1994 and $15,709,000 at June 30, 1993.\n3. FIXED ASSETS Fixed assets at cost, net of accumulated depreciation and amortization, consist of:\n4. INCOME TAXES\nEffective July 1, 1993, the Company adopted Financial Accounting Standards Board 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 operating loss carryforwards are measured using 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 based on items of income and expenses that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated.\nAs permitted by Statement 109, the Company has elected not to restate the financial statements of any prior years. There was no cumulative effect of the change, as well as there being no effect on pre-tax loss for the year ended June 30, 1994.\nSignificant components of the Company's net deferred tax assets as of June 30, 1994 are as follows:\nThere was a change in the valuation allowance for the year ended June 30, 1994 of $19,600,000.\nAt June 30, 1994, the Company has a federal net operating loss carryforward for income tax purposes of approximately $50 million, which will expire between 2006 and 2009.\n5. FINANCIAL AGREEMENTS\nThe Company has in place a Restated and Amended Financing Agreement (the \"Financing Agreement\") with BNY Financial Corporation (\"BNYF\"), a wholly owned subsidiary of The Bank of New York. Effective as of October 1, 1993, the Financing Agreement provides to the Company a total line of credit up to an aggregate of $60 million, including letter of credit and direct borrowings, with a sublimit for loans and advances of $20 million. The Financing Agreement contains a borrowing base formula which is the sum of (i) 85% of eligible receivables, less reserves, (ii) 40% of eligible inventory, up to $27 million and (iii) 100% of excess cash balances, all as defined in the agreement. However, BNYF may decrease or increase the above percentages in the borrowing base. The Company's indebtedness under the Financing Agreement is collateralized by the Company's accounts receivable and inventory. Such agreement requires the Company to comply quarterly with various financial tests including tangible net worth of at least $47.5 million, working capital of at least $40 million and restrictions on payment of principal and interest on subordinate indebtedness unless certain conditions are met. Such agreement also requires the Company to comply with various other restrictions including, but not limited to, a restriction on the payment of dividends. Interest on direct borrowings is payable monthly at an annual rate which is the higher of (a) 1\/2 of 1% above the prime rate of the Bank of New York (7.25% at June 30, 1994, and 6.0% at June 30, 1993) or (b) 1% above the federal funds rate, as defined. Additional interest at 2-1\/2% per annum is due on amounts not paid when due. In addition, the agreement provides for the payment of minimum service charges and\/or interest which for the fiscal year ended June 30, 1994, aggregated approximately $900,000. The Financing Agreement may be cancelled by the Company any time after July 1, 1995, upon 60 days prior written notice to BNYF or prior to July 1, 1995 upon 60 days written notice to BNYF and the payment of an early termination fee. The Financing Agreement is cancellable by BNYF effective July 1, 1995 or any July 1 thereafter, upon 60 days written notice to the Company.\nDuring all four quarters of fiscal year 1994, the Company was not in compliance with certain financial covenants. BNYF has waived such noncompliance.\nThe Company is currently negotiating with its bank for modification of certain financial covenants for the future in order to provide the latitude and resources necessary for future programs. The Company believes that this negotiation will be successfully completed in the near future. However, there can be no assurance that the Company will be able to obtain the necessary modifications.\nJosephine Chaus has provided a $7.2 million letter of credit expiring April 15, 1995 (increased from previous amounts provided by her of $3.0 million in April 1994 and $5.0 million in June 1994 and extended from the previous expiration date of October 15, 1994) to support the Company's credit facility. In exchange for this letter of credit, BNYF is providing at least an additional $12.2 million of credit availability under the Company's borrowing formula. To compensate Ms. Chaus for the letter of credit, an independent committee of the Company's Board of Directors has authorized the issuance to her of warrants to purchase an aggregate of 544,000 shares of Common Stock at exercise prices ranging from $2.25 to $3.00 (in each case equal to 120% of the market price on the authorization date) and warrants to purchase additional shares of Common Stock at an excerise price equal to 120% of the five days trading average of the closing sale price of the Company's Common Stock commencing September 27, 1994. The precise number of such shares shall be set after the exercise price is determined. Issuance of the warrants is subject to (i) receipt of an opinion from a nationally recognized investment banking firm that the terms of the warrants are commercially reasonable and (ii) shareholder approval.\nJosephine Chaus has also agreed to purchase $7.2 million of Common Stock of the Company at a purchase price determined by the independent committee equal to the five trading day average of the closing sale price of the Company's Common Stock commencing September 27, 1994. Issuance of the shares is subject to (i) receipt of an opinion from a nationally recognized investment banking firm that the purchase price terms are commercially reasonable and (ii) shareholder approval. Pending such approval, Ms. Chaus has loaned the $7.2 million to the Company and the Company has issued a $7.2 million promissory note to Ms. Chaus, bearing interest at 12%. The note will be exchanged for the shares of Common Stock when the conditions to\nissuance have been satisfied. Proceeds from such cash infusion are being used for costs and associated expenses related to the signing of the new Chief Executive Officer which costs will be charged to operations in the quarter ending September 30, 1994.\n6. SUBORDINATED PROMISSORY NOTES\nThe Company has outstanding at June 30, 1994 $19,039,000 of subordinated promissory notes payable to Josephine Chaus and the Estate of Bernard Chaus, which were originally issued on June 30, 1986 (the \"First Promissory Notes\"). In October 1993 an independent committee of the Board of Directors agreed in principle with the noteholders to modify the First Promissory Notes. The maturity date of the notes was extended until July 1, 1995 and, effective October 18, 1993, it was agreed that the notes would bear interest at a rate of 12% per annum, payable quarterly. It was further agreed that interest which had to be deferred as a result of bank covenant requirements would be added to the New Promissory Note (see below). The noteholder has agreed that all accrued interest added quarterly to the New Promissory Note will be payable on July 1, 1995.\nIn February and March 1991, Bernard Chaus and Josephine Chaus each provided subordinated financing to the Company in the aggregate amount of $10.0 million (the \"Second Promissory Notes\"). In September 1993, both Josephine Chaus and the Estate of Bernard Chaus agreed to convert the remaining balance of the Second Promissory Notes ($2,623,000) and the interest for the quarter ended June 30, 1993 for both the First Promissory Notes and the Second Promissory Notes ($417,432) into a demand note (the \"Demand Note\") in the aggregate amount of $3,040,432.\nIn October 1993, an independent committee of the Board of Directors agreed in principle with the noteholders to modify the Demand Note. The Demand Note was converted into new promissory notes (collectively the \"New Promissory Notes\"). It was agreed that the New Promissory Notes would bear interest at the rate of 10% per annum effective from July 1, 1993, and that such interest would be payable on July 1, 1994. Principal payments on the New Promissory Notes were made in November 1993 ($500,000), February 1994 ($250,000) and August 15, 1994 ($250,000). The noteholder agreed to extend the maturity date for the remaining principal and interest payments which were to have been due on July 1, 1994 to July 1, 1995.\nAggregate annual principal payments of subordinated debt as of June 30, 1994 are $250,000 in fiscal year 1995, and $18,789,000 in fiscal year 1996.\n7. EMPLOYEE BENEFIT PLANS\nPENSION PLAN: Pursuant to a collective bargaining agreement, all of the Company's union employees are covered by a defined benefit pension plan. Pension expense (recovery) amounted to approximately $61,000, $28,000 and ($33,000) in fiscal 1994, 1993 and 1992, respectively. As of December 31, 1993, the actuarial present value of the accumulated vested and non-vested plan benefits amounted to $415,000 and net assets available for benefits amounted to $308,000.\nSAVINGS PLAN: The Company has a savings plan (the \"Savings Plan\") under which eligible employees may contribute a percentage of their compensation which the Company (subject to certain limitations) will match 50% of the employee's contribution. Company contributions will be invested half in the Common Stock of the Company and half in investment funds selected by the participant and are subject to vesting provisions of the Savings Plan. Expense under the plan was approximately $301,000, $287,000 and $204,000 in fiscal 1994, 1993 and 1992, respectively. An aggregate of 100,000 shares of Common Stock has been reserved for issuance under the Savings Plan.\nINCENTIVE AWARD PLAN: Eligible participants in the Incentive Award Plan may be allocated additional compensation from an annual bonus pool and, in the case of participating sales executives, from their divisions' net sales performance as determined in accordance with the Incentive Award Plan. On January 22, 1992, however, the Incentive Award Plan was terminated by the Board of Directors and\nreplaced by a simplified plan (the \"Simplified Plan\"). Under the Simplified Plan, bonuses may be awarded if net earnings of the Company reach a pre- determined level. In fiscal 1994 no additional compensation was awarded under the Simplified Plan.\nRESTRICTED STOCK PLAN: In November 1987, the Company's shareholders approved the adoption of a restricted stock plan (the \"Plan\"). Pursuant to the Plan, 250,000 restricted shares of the Company's Common Stock were reserved for allocation to key employees of the Company. The restrictions on the shares terminate as to 25 percent of such shares on each anniversary of their date of allocation. As of June 30, 1994, all restricted shares previously allocated have been vested and purchased by certain officers and employees of the Company. The difference between the market value of the shares on the date of allocation and the purchase price has been reflected as deferred compensation on the Company's balance sheet and was amortized over the vesting period of such shares.\nSTOCK OPTION PLAN: Pursuant to the Stock Option Plan, the Company may grant to eligible individuals incentive stock options, as defined in the Internal Revenue Code, and non incentive stock options. At the annual meeting of shareholders in November 1993, the shareholders approved the increase in the number of shares of Common Stock with respect to which options may be granted from 1,500,000 shares to 2,500,000 shares. No stock options may be granted subsequent to 1996 and the exercise price may not be less than 100% of the fair market value on the date of grant for incentive stock options and 85% of the fair market value on the date of grant for non incentive stock options.\nThe stock options become exercisable one year after issuance as to 25%; an additional 25% becomes exercisable on each of the next three anniversary dates. As of June 30, 1994 options to purchase approximately 597,000 shares were exercisable.\nAt June 30, 1994, approximately 2,546,000 shares of Common Stock were reserved for issuance under the Stock Option, Savings and Restricted Stock plans combined.\n8. LICENSE AGREEMENTS\nIn fiscal year 1992 the Company terminated its two licensing agreements (\"Agreements\") originally entered into in fiscal year 1990, whereby the Company had granted certain manufacturers an exclusive right to use the Company's trademarks in connection with the manufacture, sale and promotion of ladies footwear, handbags and small leather accessories.\nDuring fiscal year 1992, the Company recognized royalties of approximately $700,000 under these agreements.\n9. RESTRUCTURING AND UNUSAL EXPENSES\nThe Company has undertaken a number of initiatives to strengthen its financial position, including a cash infusion of $7.2 million from its principal shareholder, a letter of credit issued by this shareholder to facilitate an increase in loan availability, closure of certain retail operations, consolidation of other office facilities, an overhead reduction program and the hiring of certain senior management personnel. The Company believes that these initiatives will have a positive impact on future operating results.\nRelative to the initiatives described, in June 1994, the Company recorded restructuring expenses of $5,300,000. The restructuring expenses primarily relate to the Company's plan to reduce overhead costs, consolidate its office locations and close selected retail outlet stores. The restructuring expenses include $2,100,000 for the closing of selected retail stores, $2,500,000 for the consolidation of office space in New York, office and warehouse space in New Jersey and the closing of the Company's Philippines office and $700,000 for employee severance. The Company believes that its remaining retail stores will not only provide direct contributions to income but will also enhance the Company's ability to manage its inventory without affecting its principal channels of distribution.\nIn addition, in June 1994, the Company recorded unusual expenses of $1,900,000. These primarily relate to expenses arising from the abandonment of fixed assets, legal fees and winding down of the Company's Canadian joint venture operation.\n10. COMMITMENTS, CONTINGENCIES AND OTHER MATTERS\nThe Company leases showroom, distribution and office facilities, retail outlet facilities and equipment under various noncancellable operating lease agreements which expire through 2005. Rental expense for the years ended June 30, 1994, 1993 and 1992 was approximately $12,909,000 (approximately $4,100,000 of which is included in restructuring expenses), $8,066,000 and $6,772,000, respectively.\nThe minimum aggregate rental commitments at June 30, 1994 are as follows:\nThe Company is contingently liable under letters of credit issued by banks to cover contractual commitments for merchandise purchases of approximately $17,000,000 at June 30, 1994.\nBy order dated September 1, 1992, Federal Judge Shirley Wohl Kram dismissed with prejudice as time-barred the Amended Complaint against the Company and others, in the previously reported consolidated class actions entitled Phifer v. Chaus et al., Goldschlack v. Chaus et al., Susman v. Chaus et al. and I. Bibcoff Inc. Pension Trust Fund v. Chaus et al. In such actions, claims were asserted against the Company and others, including the Company's lead underwriters, for alleged misstatements and omissions contained in the Company's July 1986 Prospectus delivered in connection with the Company's initial public offering and its 1986 and 1987 Annual Reports. Plaintiffs's attorneys filed a notice of appeal, which they subsequently withdrew subject to the right to restore the appeal by January 8, 1993. No such appeal was made and the action was automatically deemed dismissed with prejudice.\nOn April 19, 1993, a Class Action Complaint was filed in the Superior Court of New Jersey, Hudson County, against the Company and others, including the lead underwriter of the Company's 1986 initial public offering, alleging common law fraud and negligent misrepresentation in the sale of the Company's stock in its initial public offering, allegations that are substantially similar to the claims that were dismissed with prejudice in the federal court. One of the plaintiffs from the federal action was originally a party in this action in state court. On June 18, 1993, the Company received by mail, a copy of Jury Demand Class Action in the Superior Court of New Jersey, Hudson County entitled Theodore M. Wietecha and Lisa A. Phifer v. Bernard Chaus, Inc. et al. The complaint was amended in September 1993 to delete Lisa Phifer as a plaintiff. On May 27, 1994, the Company moved to dismiss the complaint and\/or to deny or limit class status. The motion is before the court for decision.\nWhile a negative outcome in this action could have a material adverse effect on the Company, management believes that such action is without merit and that the Company has both substantive and procedural bases for contesting this latest action. The Company intends to defend itself vigorously against this claim. Because the underlying claims asserted in the action have not been the subject of discovery and because of the preliminary procedural posture of the action, no estimate of any possible loss due to this action can presently be made.\nThe Company has also negotiated an agreement with its directors and officers liability insurance carrier whereby the Company will obtain interim reimbursement of certain expenses incurred by the Company in connection with these actions because a portion of such expenses may be attributable to the defense of its directors and officers, with full reservation of rights under the policy of the Company, the directors and officers and the insurance carrier upon the ultimate disposition of the actions.\nA claim for indemnification has been asserted by the Company's former Underwriters against the Company. The indemnification claim demands repayment of the legal fees and expenses incurred by the Underwriters in connection with the consolidated class actions entitled Pfifer v. Chaus, et al. Discussions are ongoing with counsel for the Underwriters to resolve this claim.\nThe Company is also involved in various other legal proceedings arising out of the conduct of its business. The Company believes that the eventual outcome of the proceedings referred to above will not have a material adverse effect on the Company's financial condition or results of operations.\nAdvertising expenses for the fiscal years ended June 30, 1994, 1993, and 1992, were approximately $1,649,000, $1,914,000 and $1,740,000.\nThe Company's gross sales in fiscal 1994 to department store customers owned by three single corporate entities were approximately $38,000,000, $38,000,000 and $21,000,000. The Company's gross sales in fiscal 1993 to these department store customers were $52,000,000, $34,000,000 and $22,000,000. In fiscal 1992 gross sales to these department store customers were approximately $63,000,000, $35,000,000 and $24,000,000.\nTaxes paid (refunded) amounted to ($361,000) in fiscal 1994, $180,000 in fiscal 1993 and ($2,000,000) in fiscal 1992. Interest paid amounted to $1,400,000 in fiscal 1994, $1,900,000 in fiscal 1993 and $2,470,000 in fiscal 1992.\nSCHEDULE II\n_____________________\nNote (1): Represents trade accounts receivable from entities controlled by these individuals with usual repayment terms. See \"Certain Transactions\" in the Company's 1994 Proxy Statement.\nNote (2): See \"Certain Transactions\" in the Company's 1994 Proxy Statement.\n___________________________\n(1) The average amount outstanding during the year was computed by dividing the total of the average daily balances by the number of days in the year.\n(2) The weighted average interest rate during the year was computed by dividing the actual interest expense by average short-term borrowings outstanding.","section_15":""}
{"filename":"64923_1994.txt","cik":"64923","year":"1994","section_1":"Item 1. Business.\nMercantile Stores Company, Inc. (\"Company\" or \"Registrant\") was incorporated under the laws of the State of Delaware on January 10, 1919. The Company is listed on the New York Stock Exchange (NYSE designation of MST) and is engaged in general merchandise department store retailing.\nThe Company's business is highly competitive. Its stores compete with other national, regional and local retail establishments including department stores, specialty stores and discount stores, which carry similar lines of merchandise. The Company competitive methodology focuses on customer service, value fashion, selection, advertising and store location.\nThe Company regularly employs on a full or part-time basis an average of approximately 30,200 persons.\nIn addition, the following portions of Registrant's 1993 Annual Report to Stockholders are incorporated herein by reference: Inside Front Cover; Financial Highlights (page 1); Management's Discussion and Analysis (pages 9-12); Ten-Year Selected Financial Data (pages 28-29).\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe following table summarizes the property ownership and accompanying square footage of the ninety-nine department stores and two specialty stores operated by Mercantile Stores Company, Inc., as of January 29, 1994.\nNumber of Square Stores Footage\nOwned Stores 58 8,829,302 Leased Stores 43 7,382,907 ________ __________ Total 101 16,212,209\nStore Divisions and Locations (pages 30-31) of the Registrant's Annual Report to Stockholders for fiscal year ended January 29, 1994, is incorporated herein by reference.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nNote 10 (page 26) of the The Registrant's Annual Report to Stockholders for fiscal year ended January 29, 1994, is 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 Equity and Related Stockholder Matters.\nMarket and Dividend Information (page 1) and Stockholder Information (page 33) of the Registrant's 1993 Annual Report to Stockholders are incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe Ten-Year Financial Summary (pages 28-29) and Notes to Consolidated Financial Statements (pages 19-26) of the Registrant's 1993 Annual Report to Stockholders 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 (pages 9-12) and Notes to Consolidated Financial Statements (pages 19-26) of the Registrant's 1993 Annual Report to Stockholders are incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe Consolidated Financial Statements (pages 15-18), Notes to Consolidated Financial Statements (pages 19-26), Report of Independent Public Accountants, which includes an explanatory paragraph that describes the change in the methods of accounting for income taxes discussed in Note 6 and accounting for postretirement benefits other than pension discussed in Note 7 of the Consolidated Financial Statements (page 14), and Quarterly Results (page 27) of the Registrant's 1993 Annual Report to Stockholders are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe information required with respect to the Registrant's Directors and Executive Officers is included on pages 3-6 of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 25, 1994 and is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required with respect to Executive Compensation is included on pages 7-10 of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 25, 1994 and 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 Security Ownership of Certain Beneficial Owners and Management is included on pages 4-6 of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 25, 1994 and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information required with respect to Certain Relationships and Related Transactions is included on page 10 of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on May 25, 1994 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. 1. The following Consolidated Financial Statements of Mercantile Stores Company, Inc., Notes to Consolidated Financial Statements and Report of Independent Public Accountants, from the Registrant's Annual Report to Stockholders for the fiscal year ended January 29, 1994 are incorporated herein by reference:\n(a) Statements of Consolidated Income and Retained Earnings for the fiscal years ended January 29, 1994 and January 31, 1993 and 1992 - page 15.\n(b) Consolidated Balance Sheets as of Janaury 29, 1994 and January 31,1993 - pages 16 and 17.\n(c) Statements of Consolidated Cash Flows for the fiscal years ended Janaury 29, 1994 and January 31, 1993 and 1992 - page 18.\n(d) Notes to Consolidated Financial Statements - pages 19-26.\n(e) Report of Independent Public Accountants, which includes an explanatory paragraph that describes the change in the methods of accounting for income taxes discussed in Note 6 and accounting for postretirement benefits other than pensions discussed in Note 7 of Notes to Consolidated Financial Statements - page 14.\n2. Financial Statement Schedules of the Registrant and Consolidated Subsidiaries included herein:\n(a) Report of Independent Public Accountants, which includes an explanatory paragraph that describes the change in the methods of accounting for income taxes discussed in Note 6 and accounting for postretirement benefits other than pensions discussed in Note 7 of Notes to Consolidated Financial Statements, listed below.\n(b) Schedule V - Property and Equipment Schedule VI - Accumulated Depreciation and Amortization of Property and Equipment Schedule IX - Short-term Borrowings Schedule X - Supplementary Income Statement Information\nAll other schedules have been omitted as they are inapplicable or the information required is shown in the Financial Statements or the Notes thereto.\n3. Exhibits:\n(3a)- The Restated Certificate of Incorporation of Mercantile Stores Company, Inc., as amended, is incorporated herein by reference from the Registrant's Form 10-K for the fiscal year ended January 31, 1989.\n(3b)- The Registrant's Bylaws, as amended, are incorporated herein by reference from the Registrant's Form 10-K for the fiscal year ended January 31, 1989.\n(4)- The Indenture agreement between Mercantile Stores Company, Inc. and The Fifth Third Bank, as Trustee, dated as of July 1, 1992, is incorporated herein by reference from Registration No. 33-50604, Exhibit 4.1.\n(10)- The Agreement, dated as of February 10, 1992, among Mercantile Stores Company, Inc., MST Acquisition Co., New MB, Inc., Maison Blanche, Inc. and all of the Owners and Registered Holders of All of the Issued and Outstanding Capital Stock of Maison Blanche, Inc. and the Agreement of Purchase and Sale, dated as of February 10, 1992, by and between G\/MB Leasing Company, Limited Partnership and Maison Blanche, Inc., is incorporated herein by reference from the Current Report on Form 8-K of the Company dated February 10, 1992, as amended by Amendment No. 1 dated April 24, 1992 and Amendment No. 2 dated May 12, 1992.\n(13)- The Registrant's Annual Report to Stockholders for the fiscal year ended January 29, 1994.\n(21)- A listing of the subsidiaries of the Registrant.\n(23)- Consent of Independent Public Accountants.\n(24)- Power of Attorney.\nB. No reports on Form 8-K have been filed during the fourth quarter of the fiscal year ended January 29, 1994.\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMERCANTILE STORES COMPANY, INC. (Registrant)\nBY: s\/ David L. Nichols David L. Nichols Chairman of the Board\nDate: April 22, 1994.\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:\ns\/ David L. Nichols ____________________________ ___________________________ David L. Nichols * Thomas J. Malone (Chairman of the Board) (Director) As Principal Executive Officer\ns\/ James M. McVicker ___________________________ ____________________________ James M. McVicker * Rene C. McPherson (Vice President) (Director) As Chief Financial Officer\ns\/ William A. Carr ____________________________ ____________________________ William A. Carr * Gerrish H. Milliken (Treasurer) (Director) As Principal Accounting Officer\n___________________________ ____________________________ * John A. Herdeg * Minot K. Milliken (Director) (Director)\n__________________________ _____________________________ * Roger K. Smith * Roger Milliken (Director) (Director)\n__________________________ ______________________________ * George S. Moore * H. Keith H. Brodie, MD (Director) (Director)\n__________________________ * Francis G. Rodgers (Director)\n*BY: s\/ David L. Nichols David L. Nichols\nDate: April 22, 1994\nAn original Power of Attorney authorizing David L. Nichols, James M. McVicker and William A.Carr and each of them to sign this report hereto as Attorneys for Directors of the Registrant is being filed concurrently with the Securities and Exchange Commission.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of Mercantile Stores Company, Inc.\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Mercantile Stores Company, Inc.'s annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated April 1, 1994. Our report on the consolidated financial statements includes an explanatory paragraph with respect to the change in the method of accounting for income taxes in 1993 and postretirement benefits other than pensions in 1992 as discussed in Notes 6 and 7 to the consolidated financial statements. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in Item 14(A)(2)b 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 a part of the basic financial statements. These schedules have been subjected to 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.\nCincinnati, Ohio, April 1, 1994","section_15":""}
{"filename":"715428_1994.txt","cik":"715428","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nAmerican Exploration Company (\"American\" or the \"Company\") is an independent company engaged in oil and gas development, production and exploration operations. The Company's operating activities are primarily concentrated in three geographic areas of the United States: the onshore Gulf Coast region of Texas and Louisiana; the Permian Basin of West Texas; and offshore in the Gulf of Mexico.\nAt December 31, 1994, the Company had proved reserves of 40.8 million barrels of oil equivalent (\"MMBOE\"), an increase of 75% over proved reserves at year-end 1993. On a BOE basis, approximately 76% of the Company's proved reserves at year-end 1994 were natural gas. All equivalent reserve measures herein are calculated based on a conversion factor of six thousand cubic feet (Mcf) of gas to one barrel (Bbl) of oil.\nAmerican's growth in reserves during the year reflects the replacement of approximately 540% of 1994 production. Approximately 22.9 MMBOE of proved reserves were added through acquisition of interests held by investors in a series of institutional programs managed by American. An additional 2.3 MMBOE of proved reserves were added through development, recompletions, workovers and exploration activities, offset by net downward reserve revisions of 3.9 MMBOE due to lower gas prices and revised estimates of reserves attributable to several fields.\nAt December 31, 1994, American had interests in 1,239 net oil and gas wells and approximately 284,000 net developed acres. Of the Company's total proved reserves, 62% are located in the ten largest fields based on proved reserves, of which seven are operated by American. Overall, American operates fields which represent 71% of total proved reserves. In addition, the Company had interests in approximately 170,000 net undeveloped acres under domestic leases and approximately 75,000 miles of domestic seismic data.\nAmerican was incorporated in Delaware in 1980. The Company's principal executive offices are located at 1331 Lamar, Suite 900, Houston, Texas, 77010, where its telephone number is (713) 756-6000.\nAMERICAN'S GROWTH STRATEGY\nAmerican's growth strategy is to increase production, reserves and cash flow primarily through the development and exploitation of existing properties and the acquisition of properties in the Company's focus areas where American can utilize its technical and operating capabilities to add value through lower operating costs per unit of production and the development of additional reserves. To complement its development, exploitation and acquisition activities, American's strategy also includes selective participation in exploration projects. To enhance operating focus, reduce costs per unit of production and increase profit margins, American also actively sells marginal and non-strategic properties.\nTo implement its growth strategy, American's oil and gas operating and technical group (geologists, geophysicists, production and reservoir engineers and land personnel) is organized into three geographic teams, each responsible for one of the Company's primary operating areas. American believes that an integrated team approach leads to greater efficiency and long-term performance, particularly in the area of identifying and pursuing new projects.\nDuring 1994, American's primary emphasis was to (1) increase production and cash flow through development activities on several fields, (2) develop an inventory of projects with significant reserve potential and (3) to complete the acquisition and consolidation of reserve interests held by partners in eight institutional programs managed by the Company.\nDEVELOPMENT, EXPLOITATION AND EXPLORATION\nThe development component of American's strategy involves the drilling of development wells, recompletions of existing wells into new zones, workovers of existing wells and facilities work to increase production or reduce costs. Development projects generally involve low risk activity and relate to enhancing the value of reserves already classified as proved.\nAmerican also has an active exploitation program which includes drilling projects, workovers and recompletions located primarily in or near oil and gas fields in the Company's three principal operating areas. Typically, the drilling projects involve properties in which the Company has an existing lease or acquires an interest in a lease and with respect to which, in the judgment of the Company based on its interpretation and evaluation of existing data, the drilling of a successful well may add significant production and reserves, but with somewhat greater risk than normal development activities. In identifying and pursuing such projects, the Company utilizes 3-D seismic data and other geological and geophysical techniques to reduce the risk of drilling dry holes. American has also developed expertise in the use of horizontal drilling technology to enhance reserve recovery from water-drive reservoirs.\nDuring 1994, American drilled 95 gross (33.00 net) development and exploitation wells, of which 89 gross (31.52 net) were successful. The Company also performed 70 workovers and recompletions.\nDuring 1994, significant development and exploitation projects were initiated in the Brazos 440-L block, located offshore in the Gulf of Mexico, the Sawyer Field in West Texas and the West McAllen Unit in South Texas. At Brazos, where American has a 46% working interest, development, workovers and recompletions increased the net production from these blocks to 7.6 MMcf per day as of year-end 1994 compared to year-end 1993 levels of 1.2 MMcf per day. In late 1994, American purchased leasehold interests ranging from 50-75% in eight offshore blocks adjacent to the Company's existing Brazos 440L and 446 blocks. American plans to participate in an area wide 3-D seismic survey in 1995 which is expected to lead to further development drilling and the identification of exploration prospects in and around the Company's leases. In the West McAllen Field, recompletions of existing wells and the drilling of two development wells based on 3-D seismic data increased net production from .3 MMcf per day as of year-end 1993 to approximately 3.2 MMcf per day as of year-end 1994. Since year-end, one additional development well has been completed. At the Sawyer Field, which currently represents 27% of American's total proved reserves, 43 development wells and 20 recompletion, workover and facility projects were completed in 1994. This activity and an increase in working interest ownership from 12.5% to 56% increased net production from American's leases at the Sawyer Field from 4.0 MMcf per day at year-end 1993 to 19.8 MMcf per day at year-end 1994. American holds a large inventory of proved undeveloped drilling locations on its acreage and believes there are a large number of additional potential in-fill and step-out drilling locations which would be economic at higher gas prices.\nAmerican's exploration strategy is to allocate a relatively small percentage of its budget to projects where the Company can leverage its operating experience, leasehold position and seismic database to participate in projects with significant reserve potential relative to investment. Where possible, American uses industry partners to reduce risk and leverage returns through promotes. During 1994, American drilled six gross (1.25 net) exploratory wells, of which three gross (.14 net) resulted in discoveries.\nACQUISITIONS\nHistorically, American has been an active acquiror of reserves having made approximately $930 million in acquisitions between 1983 and 1991, a majority of which was funded through institutional partnerships. Since 1992, the Company's acquisition strategy has been to pursue selective acquisitions within the Company's three domestic operating areas. The Company's approach is to identify fields in geologically complex areas where it can use 3-D seismic data or horizontal drilling to attempt to locate, develop and exploit additional reserves and add value. The Company also seeks acquisitions in fields where it currently owns an interest to increase its net ownership or gain operating control. Following this strategy, the Company made six small acquisitions in 1994, including acquiring additional interests of existing fields, for an aggregate of $3.3 million.\nThe largest of these acquisitions was the purchase of a 30% working interest in the Provident City Field, located in Lavaca County, Texas, for $1.6 million.\nThe most significant acquisition for American during 1994 was the acquisition of 22.9 MMBOE of proved oil and gas reserves held by investors in a series of institutional programs (the \"APPL Consolidation\"), which the Company managed but held a relatively small percentage, typically 13%. The consideration paid for the acquisition of the APPL interests was a combination of $31.1 million in cash and 42.7 million shares of the Company's common stock. In addition to the reserves acquired, American eliminated $13.6 million of nonrecourse debt in conjunction with the repurchases of notes issued by and net profits interests in the APPL Programs structured as secured debt financings (the \"APPL Debt Programs\"). In early 1995, the Company repurchased the remaining two investors' interests in the APPL Debt Programs for a combination of $1.3 million in cash and the issuance of 3.4 million shares of the Company's common stock, thereby eliminating the remaining $6.6 million of nonrecourse debt outstanding at year-end 1994. The APPL Consolidation, in addition to increasing proved reserves and production, has provided American with the benefit of increasing its interest in a number of properties that it currently operates, thereby providing greater control over development and operating activities and creating cost efficiencies in terms of production and overhead costs per unit of production.\nIn addition to the acquisition of its interests in certain APPL Programs by American, New York Life Insurance Company (\"New York Life\"), has agreed to transfer certain of its APPL Program interests not acquired in the APPL Consolidation to ANCON Partnership Ltd. (\"ANCON\"), a partnership formed at the end of 1993 between the Company and a subsidiary of New York Life. The transfer of New York Life's APPL Program interests to ANCON is expected to occur in early 1995 with the Company acquiring a 1% interest in such properties at that time. American has the option to acquire up to an additional 19% interest, which represents approximately 2.0 MMBOE of proved reserves as of December 31, 1994, within six months of the transfer.\nOTHER CURRENT YEAR DEVELOPMENTS\nAt the Company's annual meeting held in June 1994, stockholders approved an increase in the number of authorized shares of common stock from 100,000,000 shares to 200,000,000 shares. The increase in authorized shares allowed the Company to privately issue 1.5 million shares of common stock in August 1994, resulting in proceeds of $2.1 million. The proceeds were used to fund various development projects and provide additional working capital. The increased authorized shares also enabled American to issue the necessary shares of common stock required to complete the APPL Consolidation, after obtaining stockholder approval at a special meeting held in November 1994.\nIn December 1994, the Company entered into a new long-term revolving bank credit agreement which amended and restated the bank credit agreement previously in effect. The borrowing base under the new bank credit facility is currently $65.0 million, up from $30.0 million at year-end 1993. In April 1994, New York Life extended to the Company a $40.0 million nonrecourse secured credit facility (\"bridge facility\"), which provided interim financing for the cash portion of the APPL Consolidation. Subsequent to year-end 1994, the bridge facility was refinanced with borrowings under the Company's bank credit facility.\nREGULATION\nThe following discussion of the regulation of the oil and gas industry is necessarily brief and is not intended to constitute a complete discussion of the various statutes, rules, regulations or governmental orders to which operations of the Company may be subject.\nFEDERAL REGULATION OF NATURAL GAS. The sale and transportation of natural gas in interstate commerce are regulated under various federal laws including, but not limited to, the Natural Gas Act of 1938 (\"NGA\") and the Natural Gas Policy Act of 1978 (\"NGPA\"), both of which are administered by the Federal Energy Regulatory Commission (\"FERC\"). Under these acts, producers and marketers have historically been required to obtain from the FERC certificates to make so-called \"first sales\" and abandonment authority to discontinue\nsuch sales. Additionally, first sales have been subject to maximum lawful price regulation. However, the NGPA provided for phased-in price deregulation of most new gas production and, as a result of the enactment of the Natural Gas Wellhead Decontrol Act of 1989, the remaining regulations imposed by the NGA and the NGPA with respect to first sales, including price controls and certificate and abandonment authority regulations, were terminated on January 1, 1993. FERC jurisdiction over transportation and over sales other than first sales has not been affected.\nCommencing in the mid-1980's, the FERC promulgated several orders designed to make gas markets more competitive by, among other things, inducing or requiring interstate natural gas pipeline companies to provide transportation services on an open and nondiscriminatory basis. These orders have had a profound influence upon natural gas markets in the United States and have, among other things, fostered the development of a large spot market for gas.\nIn April 1992, the FERC issued the latest in this series of orders, Order No. 636. Order No. 636 further restructured the sales and transportation services provided by interstate pipeline companies. The FERC considered these changes necessary to improve the competitive structure between interstate pipelines and other gas merchants, including producers, and to create a regulatory framework that would put gas sellers into more direct contractual relations with gas buyers than has historically been the case. Order No. 636 was implemented on a pipeline-by-pipeline basis through negotiated settlements in individual pipeline service restructuring proceedings, designed specifically to \"unbundle\" those services (e.g., transportation, sales and storage) provided by many interstate pipelines so that producers of natural gas may secure services from the most economical source, whether interstate pipelines or other parties. As a result, in many instances, interstate pipelines are no longer wholesalers of natural gas, but instead, provide only natural gas storage and transportation services. In response to numerous requests that the FERC grant a rehearing of Order No. 636, the FERC issued Order Nos. 636-A and 636-B, which largely confirmed Order No. 636. Numerous petitions seeking judicial review of these orders have been filed.\nOrder No. 636 does not regulate gas producers such as the Company. To date, management of the Company believes Order No. 636 has not had any significant impact on the Company as a producer or on the Company's gas marketing efforts. Because the restructuring process is still continuing through various pipeline rate proceedings, it is not possible to predict what effect, if any, the final rule resulting from these orders will have on the Company.\nREGULATION OF DRILLING AND PRODUCTION. Exploration and production operations of the Company are subject to various types of regulation at the federal, state and local levels. Such regulation includes requiring drilling permits, requiring the maintenance of bonds in order to drill or operate wells, and regulating the location of wells, the method of drilling and casing wells, the surface use and restoration of properties upon which wells are drilled and the plugging and abandoning of wells. The operations of the Company are also subject to various conservation regulations, including regulation of the size of drilling and spacing units or proration units, the density of wells that may be drilled and the unitization or pooling of oil and gas properties. In this regard, some states, including states in which the Company operates, allow the forced pooling or integration of lands and leases. In addition, state conservation laws establish maximum rates of production from oil and gas wells, generally prohibit the venting or flaring of gas and impose certain requirements regarding the ratability of production. The effect of these regulations is to limit the amount of crude oil and natural gas the Company can produce from its wells and the number of wells or the locations at which the Company can drill.\nFUTURE LEGISLATION AND REGULATION. The Company's business is and will continue to be affected from time to time in varying degrees by political developments and federal, state and local laws and regulations. The Company is not able to predict the terms of any future legislation or regulations that might ultimately be enacted or the effects of any such legislation or regulations on the Company.\nROYALTY MATTERS\nBy a letter in May 1993 directed to thousands of producers holding interests in federal leases, the United States Department of the Interior (the \"Department\") announced its interpretation of existing federal leases to require the payment of royalties on past natural gas contract settlements which were entered into in the 1980s and 1990s to resolve, among other things, take-or-pay and minimum take claims by producers against pipelines and other buyers. The Department's letter set forth various theories of liability, all founded on the Department's interpretation of the term \"gross proceeds\" as used in federal leases and pertinent federal regulations. In an effort to ascertain the amount of such potential royalties, the Department sent a letter to producers in 1993 requiring producers to provide data on natural gas contract settlements, where gas produced from federal or Indian leases was involved in the settlement. The Company received a copy of this information demand letter. In response to the Department's action, various industry associations and others filed suit seeking an injunction to prevent the collection of royalties on natural gas contract settlement amounts under the Department's theories. This case is currently pending in the United States District Court for the District of Columbia. In partial response to this lawsuit, the Department has filed various \"test\" cases to determine if its theories of liabilities are valid. Because of the pending lawsuit and because of, among other things, the complex nature of the calculations necessary to determine potential additional royalty liability under the Department's theories, it is impossible to predict what, if any, additional or different royalty obligation the Department may assert with respect to the Company's prior natural gas contract settlements. The Company cannot therefore predict what effect, if any, the Department's claims will have on the Company. Furthermore, certain of the Company's natural gas contract settlements provide for the buyer to reimburse the Company for any excess or additional payments to royalty owners required as a result of the Company's receipt of the settlement amounts.\nENVIRONMENTAL MATTERS\nThe Company and its operations are subject to a number of federal, state and local laws and regulations governing the discharge of materials into the environment or otherwise relating to the protection of the environment. These environmental provisions may, among other things, impose liabilities for the cost of pollution clean-up resulting from drilling operations, prohibit drilling on certain lands and impose restrictions on the injection of liquids into underground water sources that may, in turn, contaminate groundwater.\nThe Company has conducted a review of its operations with particular attention to environmental compliance. The Company believes it has acted as a prudent operator and is in substantial compliance with environmental laws and regulations. The Company has and will continue to incur costs in its efforts to comply with these environmental standards. Although the costs incurred by American to date solely to comply with environmental laws and regulations have not had a material adverse effect upon capital expenditures, earnings or the competitive position of the Company, the trend toward stricter environmental laws and regulations is expected to have an increasingly significant impact on the conduct of American's business. The cost of expenditures to comply with evolving regulations and the related future impact on American's business cannot be predicted at this time because of the uncertainties regarding future environmental standards, advances in technology, the timing for expending funds and the availability of insurance and third-party indemnification. However, American believes that the evolving environmental standards do not affect the Company in a materially different manner from other similarly situated companies in the oil and gas industry.\nOIL AND GAS MARKETING\nThe crude oil and condensate produced from the Company's properties are generally sold to other companies at field prices posted by the principal purchasers of crude oil in the areas where such properties are located. As is customary in the industry, this production is generally sold pursuant to short-term contracts.\nThe natural gas produced from the Company's properties is generally sold at the wellhead under contracts which provide for market-sensitive pricing. The price of natural gas is influenced by many factors including the state of the economy, weather and competition from other fuels, including oil and coal. The Company's revenues, cash flows and the value of its gas reserves are all affected by the level of gas prices.\nIn the year ended December 31, 1994, sales to Enron Corp. accounted for approximately 20% of the Company's oil and gas revenues. Management does not believe that the loss of any single customer would adversely affect the Company's operations.\nOPERATING HAZARDS AND UNINSURED RISKS\nThe Company's operations are subject to all of the risks normally incident to the exploration for and the development and production of oil and gas, including blowouts, cratering, uncontrollable flows of oil, gas or well fluids, fires, pollution and other environmental risks. These hazards could result in substantial losses to the Company due to injury and loss of life, severe damage to and destruction of property and equipment, pollution and other environmental damage and suspension of operations. Although the Company is not fully insured against certain of these risks, it maintains insurance coverage considered to be customary in the industry.\nPROGRAM LIABILITY\nThe Company and certain of its subsidiaries act as general partner of a variety of limited partnerships. In such capacity, the Company and such subsidiaries are generally liable for the obligations of the partnerships to the extent that partnership assets are insufficient to discharge liabilities. Several of the investment programs formed by the Company or its subsidiaries require certain levels of insurance to cover operating and other risks inherent in the production of oil and gas. Under the terms of these programs, the Company would be liable for any costs or damages incurred by a program resulting from the Company's failure to carry the required insurance. The Company believes that its insurance coverage is sufficient as required by the program agreements.\nCOMPETITION\nThe oil and gas industry is highly competitive. Major oil and gas companies, independent producers, drilling and production purchase programs and individual producers and operators are active competitors for desirable oil and gas properties. Many competitors have financial resources substantially greater than those of the Company and staffs and facilities substantially larger than those of the Company. The availability of a ready market for the oil and gas production of the Company depends in part on the cost and availability of alternative fuels, the level of consumer demand, the extent of other domestic production of oil and gas, the extent of imports of foreign oil and gas, the cost of and proximity to pipelines and other transportation facilities, regulations by state and federal authorities and the cost of complying with applicable environmental regulations.\nEMPLOYEES\nAt March 1, 1995, American had 202 employees.\nFOREIGN AND DOMESTIC OPERATIONS\nThe Company's only industry segment is oil and gas exploration and production. Certain information concerning the Company's operations by geographic area is set forth in Note 15 to the Consolidated Financial Statements in Item 8, which information is incorporated herein by reference.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below are the names, ages and positions of the executive officers of the Company. All executive officers are elected for a term of one year and serve until their successors are elected and have qualified.\nNAME OFFICE AGE ---- ------ --- Mark Andrews Chairman of the Board and 44 Chief Executive Officer\nJohn M. Hogan Senior Vice President and Chief Financial Officer 50\nHarold M. Korell Senior Vice President - Operations 50\nHarry C. Harper Vice President - Land 56\nRobert R. McBride, Jr. Vice President - Production Operations 39\nSteven L. Mueller Vice President - Exploitation 42\nT. Frank Murphy Vice President - Corporate Finance and Secretary 40\nElliott Pew Vice President - Exploration 40\nMARK ANDREWS, CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER, founded the Company in 1980. Mr. Andrews is also a director of IVAX Corporation.\nJOHN M. HOGAN, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, who previously was Senior Vice President - Finance of the Company during 1985 and 1986, rejoined the Company in August 1992. From 1987 until 1992, Mr. Hogan operated a CPA firm that provided tax, accounting, and management services. He was Vice President and Chief Financial Officer of Ensource, Inc. from 1986 to 1987.\nHAROLD M. KORELL, SENIOR VICE PRESIDENT - OPERATIONS, joined the Company in June 1992. He was Executive Vice President of McCormick Resources, a private independent oil and gas company, from 1989 until 1992. From 1973 to 1989, Mr. Korell was with Tenneco Oil Company where he served in various positions and eventually as Vice President and Manager of Production.\nHARRY C. HARPER, VICE PRESIDENT - LAND, joined the Company in 1990 when it acquired Hershey. He had been Senior Vice President, Secretary and General Counsel of Hershey since 1973.\nROBERT R. MCBRIDE, JR., VICE PRESIDENT - PRODUCTION OPERATIONS, joined the Company in August 1992. From 1988 to 1992, he served in various capacities with British Gas plc, most recently as Exploitation Manager. From 1977 to 1988, he held various production and management positions with Tenneco Oil Company.\nSTEVEN L. MUELLER, VICE PRESIDENT - EXPLOITATION, joined the Company in November 1992. From 1988 to 1992, he was Exploration Manager - South Louisiana Division at FINA, Inc. Prior to that, he served in a variety of positions at Tenneco Oil Company.\nT. FRANK MURPHY, VICE PRESIDENT - CORPORATE FINANCE AND SECRETARY, joined the Company in 1989. He served in a variety of financial positions until December 1991 when he was appointed Vice President - Investor Relations. He was appointed Vice President - Corporate Finance in March 1993 and was appointed Secretary in October 1993. Mr. Murphy was employed by LCS\/Gemisys, a computer software and services company, from 1983 to 1989, initially as a regional manager and then as Vice President - Northeast Region.\nELLIOTT PEW, VICE PRESIDENT - EXPLORATION, joined the Company in October 1992 as a senior geophysicist. He was appointed Vice President - Exploration in July 1993. From 1989 to 1992, he was employed by FINA, Inc. as a division geologist and then as Exploration Manager - South Texas Division.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's producing properties are located principally in three geographic areas of the United States: the onshore Gulf Coast region, primarily in Texas and Louisiana; the Permian Basin of West Texas; and offshore in the Gulf of Mexico.\nMAJOR PROPERTIES\nSet forth below is information concerning each of the Company's four largest fields based on the discounted present value of the estimated pre-tax future net cash flows of $142.1 million at December 31, 1994.\nDESCRIPTION OF FIELDS\nSAWYER FIELD. The Sawyer Field is located in Edwards, Sutton and Schleicher Counties, Texas. The producing trend that encompasses the field covers approximately 400 square miles. The Company owns interests in 696 gas wells in the field with an average net working interest of 56%, up from 12.5% in 1993 as a result of the APPL Consolidation. The main producing formation in the field is the Canyon Sandstone, which is comprised of a series of stacked sands separated by intervals of shale. Gas and condensate are produced from depths ranging from 2,500 to 7,000 feet. The low permeability or \"tight\" character of the Canyon Sandstone necessitates fracture stimulation of the reservoir when new wells are drilled. In 1994, the Company completed 43 development wells with a combined initial gross production rate of 19.3 MMcf per day (9.5 MMcf net to the Company). Due to weak gas prices in late 1994 and early 1995 and a reduced capital budget for 1995, American has deferred further development activity in the Sawyer Field for 1995, except for the drilling of twelve development wells, of which seven were in progress at year-end 1994.\nThe gas that American produces from the Sawyer Field is dedicated under a long-term market sensitive contract through August 2003 to Natural Gas Marketing and Storage Company, a subsidiary of Enron Corp. Gas produced from all wells drilled after August 1993 is subject to a price floor of $1.85 per million British Thermal Unit (\"MMBtu\") unless the buyer determines that the floor price is uneconomical and elects not to purchase such gas. The contract also permits American to sell excess or released gas to third parties under certain conditions.\nBOWDOIN FIELD. The Bowdoin Field, located in Phillips and Valley Counties, Montana, was discovered in 1913. The field produces gas from lenticular and shale sandstones at a depth of approximately 1,500 feet. The reserves being produced from this field are expected to be relatively long-lived and, due to the shallow nature of the wells, production and operating costs are relatively low. The Company owns an average net working interest of approximately 14%, up from 8% in 1993 due to the APPL Consolidation, in 534 wells.\nGas produced from the Bowdoin Field is sold under a life of lease contract to KN Energy, Inc. Pursuant to a 1992 settlement agreement, KN Energy prepaid the Company approximately $2.0 million, which was used to repay a long-term production payment that burdened the field and is currently being recouped without interest by KN Energy out of ongoing gas purchases. American realized an average of $3.25 per Mcf for gas produced from this field during 1994. In February 1995, the Company was served with a lawsuit requesting a reduction of the contract price to market levels. See Note 13 to the Consolidated Financial Statements in Item 8.\nHENDERSON CANYON AREA. The Henderson Canyon Area includes the Henderson Canyon and Angus fields, which are located in Crockett County, Texas. In early 1993, American sold approximately 40% of its interest in the Henderson Canyon Field to several of the Company's NYLOG Programs. American is the operator of 72 wells in these fields with an average net working interest of 32%. Gas produced from these fields is sold at market-sensitive prices. Six development wells were drilled in 1994, with a combined initial gross production rate of 5.0 MMcf per day (1.5 MMcf net to the Company). The Company has currently suspended drilling in the Henderson Canyon Area for 1995 because of low gas prices.\nBRADSHAW FIELD. The Bradshaw Field encompasses over 250 square miles and is located on the western edge of the Hugoton Field in southwestern Kansas. The Company owns interests in 140 gas wells. As a result of the APPL Consolidation, the Company's average net working interest in these wells has increased to 77% compared to 25.7% in 1993. Net production in December 1994 averaged 9.1 MMcf of gas per day. Since assuming operations, the Company has increased daily production to the point that the field is producing near the capacity of the gathering and compression system.\nTITLE TO PROPERTIES\nThe Company's properties are subject to customary royalty interests, liens incident to operating agreements, liens for current taxes and other burdens, including other mineral encumbrances and restrictions. The Company does not believe that any of these burdens materially interfere with the use of such properties in the operation of its business. In addition, substantially all of the properties in which the Company or its subsidiaries own a direct interest are subject to mortgages granted to secure credit facilities.\nA thorough examination of title has been performed with respect to substantially all of the Company's producing properties, and the Company believes that it generally holds satisfactory title to such properties. As is customary in the oil and gas industry, little or no investigation of title is made at the time of acquisition of undeveloped properties (other than a preliminary review of local minerals records). Investigations of title are generally made before commencement of drilling operations and, in most cases, include the receipt of a title opinion of local counsel.\nRESERVES\nAlthough the Company prepares an annual estimate of proved oil and gas reserves, no estimate of total proved net oil and gas reserves of the Company has been filed with or included in reports to any federal authority or agency, other than estimates previously filed with the Securities and Exchange Commission. The Company is not aware of any major discovery or the occurrence of any other favorable or adverse event since December 31, 1994 that would cause material changes in the quantities of proved reserves owned by the Company as of such date. The information in this section should be read in conjunction with the Consolidated Financial Statements of the Company, including the Notes thereto, set forth in a separate section of this Report on Form 10-K.\nThe tables below set forth certain information concerning the proved oil and gas reserves owned by the Company at December 31, 1994. The information contained in the tables is based upon estimates of the proved oil and gas reserves of the Company and the rates of production therefrom. The estimated future net cash flows before income taxes of proved reserves were estimated on the basis of year-end prices, except in those instances where fixed and determinable gas price escalations are covered by contracts. The prices used averaged $15.13 per Bbl of oil and $1.69 per Mcf of gas at December 31, 1994.\nThere are numerous uncertainties inherent in estimating quantities of proved oil and gas reserves and in projecting future rates of production and future net cash flows. The quantities of oil and gas that are ultimately recovered, production and operating costs, the amount and timing of future development expenditures and future oil and gas sales prices may all differ from those assumed in these estimates. Reserve assessment is a subjective process of estimating recovery from underground accumulations of oil and gas that cannot be measured precisely, and estimates of other persons might differ from those of the Company. Accordingly, reserve estimates are often different from the quantities of oil and gas that are ultimately recovered, which differences may be significant. Moreover, the discounted present value shown below should not be construed as the current market value of the estimated oil and gas reserves attributable to the Company's properties. A market value determination would take into account additional factors including, but not limited to, the recovery of reserves not presently classified as proved, anticipated future changes in prices and costs and a discount factor more representative of the time value of money and the risks inherent in reserve estimates.\nThe Company's estimated proved oil and gas reserves at December 31, 1994 are as follows:\nOil Gas Reserves Reserves (MBBLS) (MMCF) ----- ------- Proved developed.............. 8,697 127,838 Proved undeveloped............ 963 58,842 ----- ------- Total proved ............... 9,660 186,680 ===== =======\nThe Company's estimated future net cash flows from proved and proved developed oil and gas reserves at December 31, 1994, and the discounted present value of such cash flows (before income taxes) are as follows (in thousands):\nProved PROVED DEVELOPED ------- --------- 1995 (a)...................... $22,445 $34,942 1996 (a)...................... 26,511 27,049 1997.......................... 26,781 21,026 Remainder..................... 168,541 112,340 ------- ------- Total future net cash flows. $244,278 $195,357\nPresent value before income taxes (discounted at 10%) .. $142,080 $122,328 ======== ========\n(a) For 1995 and 1996, estimated pre-tax future net cash flows from proved reserves are projected to be lower than estimated pre-tax future net cash flows from proved developed reserves due to capital expenditures associated with proved undeveloped reserves during 1995 and 1996 of approximately $17.2 million and $12.6 million, respectively, which are primarily for new development wells.\nDRILLING\nThe following table sets forth the results of drilling activity by the Company for the last three years.\nPRODUCTION\nThe following table summarizes the average prices received with respect to oil and gas produced and sold from, the net volumes of oil and gas produced and sold from and certain additional information relating to, all properties in which the Company held an interest during the last three years.\nPRODUCTIVE WELLS\nThe following table sets forth information regarding the number of productive wells in which the Company held a working interest at December 31, 1994. Productive wells are either producing wells or wells capable of production although currently shut-in. One or more completions in the same well bore are counted as one well.\nGROSS NET ----- ----- United States: Oil......................... 3,115 476 Gas......................... 2,805 763 ----- ----- Total..................... 5,920 1,239 ===== =====\nACREAGE\nThe following table sets forth the approximate developed and undeveloped acreage in which the Company held a leasehold, mineral or other interest at December 31, 1994.\nUndeveloped acreage includes leased acres 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 or not such acreage contains proved reserves. A gross acre is an acre in which an interest is owned. A net acre is deemed to exist when the sum of fractional ownership interests in gross acres equals one. The number of net acres is the sum of the fractional interests owned in gross acres expressed as whole numbers and fractions thereof. Included in the following table are 311,806 gross (14,148 net) U.S. developed mineral acres and 811,446 gross (89,994 net) U.S. undeveloped mineral acres. A mineral acre is an acre in which the Company has a perpetual interest as contrasted to a leased acre in which the Company's interest is typically limited to the life of production or otherwise limited in time.\nDEVELOPED UNDEVELOPED --------------------- --------------------- GROSS NET GROSS NET --------- ------- --------- ------- United States: Arkansas ..................... 11,244 2,703 25,099 2,443 Kansas ....................... 157,824 64,948 23,481 5,219 Louisiana .................... 19,584 2,413 3,223 514 Mississippi .................. 26,855 5,044 179,785 43,545 Montana ...................... 257,199 35,045 147,317 42,539 New Mexico ................... 16,967 3,331 6,905 620 North Dakota ................. 21,905 2,347 7,523 1,122 Oklahoma ..................... 159,375 26,830 111,830 12,159 Texas ........................ 471,084 116,394 431,175 34,279 Utah ......................... 5,002 1,808 21,160 6,112 Wyoming ...................... 11,470 2,831 15,446 3,459 Eleven other states .......... 18,985 6,449 60,648 8,754 Gulf of Mexico ............... 61,450 13,819 15,220 8,733 --------- --------- --------- --------- Total United States ............ 1,238,944 283,962 1,048,812 169,498 --------- --------- --------- --------- International: Canada (a) ................... 22,240 112 149,055 658 New Zealand (a) .............. -- -- 725,992 32,307 --------- --------- --------- --------- Total International ............ 22,240 112 875,047 32,965 --------- --------- --------- --------- Total .......................... 1,261,184 284,074 1,923,859 202,463 ========= ========= ========= =========\n(a) Acreage relates to overriding royalty interest.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nInformation regarding legal proceedings of the Company is set forth in Note 13 to the Consolidated Financial Statements in Item 8, which information is incorporated herein by reference.\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 common stock trades on the American Stock Exchange under the symbol \"AX\". At March 1, 1995, the Company had 5,272 stockholders of record.\nThe following table sets forth the high and low sales prices for the quarters indicated.\nPRICE RANGE OF COMMON STOCK\nHIGH LOW -------- -------- YEAR ENDED DECEMBER 31, 1994 First Quarter ............................ $1 7\/8 $1 3\/8 Second Quarter ........................... 1 1\/2 1 1\/8 Third Quarter ............................ 1 1\/2 1 13\/16 Fourth Quarter ........................... 1 3\/8 7\/8\nYEAR ENDED DECEMBER 31, 1993 First Quarter ............................ $1 3\/4 $1 1\/8 Second Quarter ........................... 1 1\/2 1 Third Quarter ............................ 1 11\/16 1 1\/4 Fourth Quarter ........................... 1 5\/8 1 1\/8\nThe Company has not paid any dividends on its common stock and does not expect to pay dividends on its common stock for the foreseeable future. Payment of dividends on the Company's common stock is also currently prohibited by the terms of various agreements relating to outstanding indebtedness of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial data for the Company as of and for each of the years in the five-year period ended December 31, 1994. The financial data was derived from the consolidated financial statements of the Company and should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related Notes thereto included elsewhere herein.\nAmerican has made several significant acquisitions and dispositions of oil and gas properties and companies during the periods presented in the table above. The Company acquired Hershey in August 1990 and Conquest in February 1991. American sold approximately 40% of its interest in the Henderson Canyon Field in March 1993 and sold its Canadian assets in mid-1993. The Company purchased investors' interests in the APPL Programs in 1994 and early 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThe following table sets forth certain operating information of the Company for the periods presented. See Item 2. in Part I for a breakout of production and prices between U.S. and Canadian operations.\nYEAR ENDED DECEMBER 31, --------------------------- 1994 1993 1992 ------- ------- ------- AVERAGE SALES PRICE: Gas ($\/Mcf) .................................... $ 1.90 $ 1.92 $ 1.59 Oil ($\/Bbl) .................................... 15.39 16.01 18.16 BOE ($\/Bbl) .................................... 12.67 12.99 12.23\nPRODUCTION DATA: Gas (MMcf) ..................................... 16,241 15,336 19,805 Oil (MBbls) .................................... 1,241 1,261 1,488 MBOE ........................................... 3,948 3,817 4,789\nADDITIONAL $\/BOE DISCLOSURES: Production and operating costs ................. $ 5.40 $ 4.19 $ 4.05 Production and severance taxes ................. 0.72 0.64 0.61 Depreciation, depletion and amortization ....... 7.50 6.19 6.30\n1994 COMPARED TO 1993\nREVENUES. Oil and gas sales in 1994 totaled $50.0 million compared to $49.6 million in 1993. The increase in sales was due to higher domestic oil and gas production offset in part by declines in prices and the sales of the Company's Canadian oil and gas properties in mid-1993. On a net basis, gas production increased 6% while oil production decreased 2%, resulting in a net increase to sales of $1.4 million. Excluding the production from the Canadian properties that were sold, gas production increased 29% and oil production increased 4%. The increase in gas production was the result of new development wells drilled, workovers and recompletions of existing wells in the first half of the year and the acquisition of investors' interests in the APPL Programs (see \"Capital Resources and Liquidity\" for discussion), which occurred primarily during the third and fourth quarters of 1994. These increases more than offset the loss of production from the sales of the Company's Canadian assets in mid-1993. As a result of American's 1994 development and acquisition activity, the Company's gas production has increased to a current average daily level of approximately 73.8 MMcf, up 134% over the average daily gas production rate at the end of 1993. For 1994, American's average realized gas price and oil price were down 1% and 4%, respectively, from 1993, decreasing sales by $1.0 million. As a result of the Company hedging a portion of its gas and oil production during 1994, gas sales increased by $1.6 million and oil revenues were reduced by $44,000.\nThe Company recorded gas settlement income of $374,000 in 1994 and $15.6 million in 1993. The 1993 income included amounts received in connection with the settlement of certain litigation with Louisiana Intrastate Gas Corporation (\"LIG\") and for the renegotiation of American's contract to sell gas from the Thomasville Field.\nThe Company recognized a gain on sales of oil and gas properties of $1.1 million in 1994 compared to a loss on sales of oil and gas properties of $6.9 million in 1993. In mid-1993, the Company sold its Canadian assets resulting in losses totaling $5.8 million, including $1.8 million for the elimination of the foreign currency translation adjustment balance. The gain for 1994 and the remaining loss for 1993 resulted from the divestiture of minor properties.\nCOSTS AND EXPENSES. Production and operating expenses were up 33% to $21.3 million in 1994. On a BOE basis, operating costs increased 29% to $5.40 in 1994 compared to $4.19 in 1993. These increases reflect higher U.S. operating costs which more than offset the decreases associated with the sales of the Company's Canadian properties in mid-1993. Higher domestic operating expenses are related to workovers at the Brazos blocks offshore and the Sawyer Field totaling $1.1 million. In addition, American has recorded site remediation costs of $2.4 million in 1994 and anticipates it will incur additional costs from time to time related to continued assessment, testing, disposal, site restoration and other activities in connection with the Company's environmental proceedings. Also, American's operating costs were increased by $3.8 million during the second half of 1994 due to the acquisition of interests pursuant to the APPL Consolidation.\nDepreciation, depletion and amortization (\"DD&A\"), which totaled $29.6 million in 1994, rose 25% from the prior year due to an increase in the Company's DD&A per BOE rate and an increase in gas production. Downward reserve revisions at year-end 1993, including reserve revisions related to low oil prices at year-end 1993, resulted in a DD&A per BOE rate of $7.50 in 1994 compared to $6.19 in 1993. The higher 1994 rate is also due to the fact that the Canadian properties sold in mid-1993 had a lower depletion rate than the average rate for the Company's other properties.\nGeneral and administrative expense (\"G&A\") totaled $10.0 million in 1994, or 35% above 1993 expense of $7.4 million. The higher G&A expense for 1994 primarily relates to the loss of management and technical fee reimbursements as a result of the APPL Consolidation with no significant reductions in G&A expense in 1994. As a result of planned reductions related to the APPL Consolidation, the Company recorded a $2.0 million severance charge in 1994. These increases were partially offset by a decrease in salaries and benefits associated with the reductions in American's work staff in early 1994 and the elimination of Canadian G&A expense.\nTaxes other than income were $1.1 million higher in 1994 compared to 1993. This increase was due primarily to higher production taxes related to increased domestic oil and gas sales and higher ad valorem taxes related to an increase in the Company's oil and gas property base due to the APPL Consolidation.\nExploration expense decreased 66% to $2.6 million in 1994. The decrease in exploration expense reflects steps taken over the past year by American to eliminate its international exploration commitments and to emphasize domestic development and exploitation projects in 1994.\nEffective December 31, 1994, the Company elected to change its accounting policy related to proved oil and gas properties to a policy that is consistent with the provisions of the Financial Accounting Standards Board exposure draft, \"Accounting for the Impairment of Long-Lived Assets\". Under the Company's new policy, if the book value of an individual proved field is greater than its undiscounted future net cash flow from proved reserves, then an impairment is recognized for the difference between the net book value and the fair value. Management's initiative to change its policy was prompted by the considerable volatility of oil and gas prices during the past several years, the resulting economic losses of proved reserves and corresponding increases in the Company's DD&A rate. This change in accounting policy resulted in an approximate $25.0 million noncash impairment charge for 1994 against the book value of certain of American's proved oil and gas properties. Reference is hereby made to Note 2 to the Consolidated Financial Statements in Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item is set forth in a separate section of this Report on Form 10-K. See the accompanying \"Index of Financial Statements\" at Page. Such information 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\n(a) Directors\nThe information set forth under the caption \"Election of Directors\" in the Company's Proxy Statement for its 1995 Annual Meeting of Stockholders, which is to be filed with the Securities and Exchange Commission within 120 days of December 31, 1994 pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the \"Act\"), is incorporated herein by reference.\n(b) Executive Officers\nInformation concerning executive officers is set forth in Item 1. of Part I hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the caption \"Executive Compensation\" in the Company's Proxy Statement for its 1995 Annual Meeting of Stockholders, which is to be filed with the Securities and Exchange Commission within 120 days of December 31, 1994 pursuant to Regulation 14A under the Act, 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 captions \"Principal Security Holders\" and \"Security Ownership of Management\" in the Company's Proxy Statement for its 1995 Annual Meeting of Stockholders, which is to be filed with the Securities and Exchange Commission within 120 days of December 31, 1994 pursuant to Regulation 14A under the Act, is incorporated herein 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 the Company's Proxy Statement for its 1995 Annual Meeting of Stockholders, which is to be filed with the Securities and Exchange Commission within 120 days of December 31, 1994 pursuant to Regulation 14A under the Act, 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\nSee the accompanying \"Index of Financial Statements\" at Page.\n3. Exhibits\nSee the accompanying \"Index of Exhibits\" at Page X-1.\n(b) The registrant filed no reports on Form 8-K 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 on the 30th day of March, 1995.\nAMERICAN EXPLORATION COMPANY (Registrant)\nBy: \/S\/ MARK ANDREWS Mark Andrews 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 indicated, on the 30th day of March, 1995.\nSIGNATURE TITLE --------- -----\n\/S\/ MARK ANDREWS Chairman of the Board Mark Andrews and Chief Executive Officer (Principal Executive Officer)\n\/S\/ JOHN M. HOGAN Senior Vice President John M. Hogan and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)\n\/S\/ O. DONALDSON CHAPOTON Director O. Donaldson Chapoton\n\/S\/ HARRY W. COLMERY, JR. Director Harry W. Colmery, Jr.\n\/S\/ IRVIN K. CULPEPPER, JR. Director Irvin K. Culpepper, Jr.\n\/S\/ WALTER J.P. CURLEY Director Walter J.P. Curley\n\/S\/ PHILLIP FROST, M.D. Director Phillip Frost, M.D.\n\/S\/ PETER G. GERRY Director Peter G. Gerry\n\/S\/ H. PHIPPS HOFFSTOT, III Director H. Phipps Hoffstot, III\n\/S\/ JOHN E. JUSTICE, III Director John E. Justice, III\n\/S\/ MARK KAVANAGH Director Mark Kavanagh\n\/S\/ JOHN H. MOORE Director John H. Moore\n\/S\/ PETER P. NITZE Director Peter P. Nitze\nAMERICAN EXPLORATION COMPANY AND SUBSIDIARIES\nINDEX OF FINANCIAL STATEMENTS\nPAGE Financial Statements: Report of Independent Public Accountants ...............................\nConsolidated Balance Sheets as of December 31, 1994 and 1993 ...........\nConsolidated Statements of Operations for the Three Years Ended December 31, 1994 ....................................................\nConsolidated Statements of Cash Flows for the Three Years Ended December 31, 1994 ....................................................\nConsolidated Statements of Stockholders' Equity for the Three Years Ended December 31, 1994 ........................................\nNotes to Consolidated Financial Statements .............................\nSupplemental Information on Oil and Gas Producing Activities ...........\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors, American Exploration Company:\nWe have audited the accompanying consolidated balance sheets of American Exploration Company (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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of American Exploration 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 Note 2 to the consolidated financial statements, effective December 31, 1994, the Company changed its method of accounting for impairments of proved oil and gas properties.\nARTHUR ANDERSEN LLP\nHouston, Texas March 30, 1995\nCONSOLIDATED BALANCE SHEETS AMERICAN EXPLORATION COMPANY AND SUBSIDIARIES (IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCONSOLIDATED STATEMENTS OF OPERATIONS AMERICAN EXPLORATION COMPANY AND SUBSIDIARIES (IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS AMERICAN EXPLORATION COMPANY AND SUBSIDIARIES (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AMERICAN EXPLORATION COMPANY AND SUBSIDIARIES (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS AMERICAN EXPLORATION COMPANY AND SUBSIDIARIES\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe accompanying consolidated financial statements include the accounts of American Exploration Company and its majority-owned subsidiaries (collectively referred to as \"American\" or the \"Company\"). The Company's investments in associated oil and gas programs are accounted for using the proportionate consolidation method, whereby the Company's proportionate share of each program's assets, liabilities, revenues and expenses is included in the appropriate accounts in the consolidated financial statements. All significant intercompany balances and transactions have been eliminated in consolidation. Certain amounts in prior years' consolidated financial statements have been reclassified to conform with current classifications.\nMINORITY INTEREST\nMinority interest in subsidiary represents the minority stockholders' proportionate share of the net loss of Canadian Conquest Exploration, Inc. (\"Canadian Conquest\"). The Company held slightly more than a 50% interest in Canadian Conquest until September 1992 when the Company increased its ownership to 90% as part of a recapitalization of that entity. In June 1993, American sold its interest in Canadian Conquest (see Note 4).\nINVENTORIES\nInventories are recorded at cost and stated at the lower of cost or market.\nPROPERTY, PLANT AND EQUIPMENT\nThe Company accounts for its oil and gas exploration and production activities using the successful efforts method of accounting. Under this method, acquisition costs for proved and unproved properties are capitalized when incurred. Exploration costs, including geological and geophysical costs and costs of carrying and retaining unproved properties, are charged to expense as incurred. The costs of drilling exploratory wells are capitalized pending determination of whether each well has discovered proved reserves. If proved reserves are not discovered, such drilling costs are charged to expense. Costs incurred to drill and equip development wells, including unsuccessful development wells, are capitalized. Internal costs related to the acquisition, development and exploration of oil and gas properties are expensed as incurred. Interest is capitalized on qualifying assets, primarily unproved and unevaluated properties. Depreciation, depletion and amortization (\"DD&A\") of the cost of producing oil and gas properties is computed on the unit-of-production method. The Company also accrues for platform abandonment costs related to its offshore platform facilities on the unit-of-production method. The Company anticipates total abandonment costs to be approximately $7.2 million. As of December 31, 1994, the Company had accrued $5.1 million, which is included in accumulated DD&A. Unproved properties are assessed periodically, and any impairment in value is recognized currently as impairment expense.\nProperty, plant and equipment other than oil and gas properties are depreciated by the straight-line method at rates based on the estimated useful lives of the assets. Repairs and maintenance are charged to expense as incurred; renewals and betterments are capitalized.\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)\nINVESTMENT PROGRAMS\nThe Company manages various investment programs which were formed during 1983-1992 to acquire interests in producing oil and gas properties. Costs associated with the organization of future investment programs were deferred as other current assets until formation, at which time a reimbursement was received from program investors (see Note 10). The Company charges each investment program fees for reimbursement of expenses incurred in managing the program's operations and certain fees for services provided by technical employees of the Company. Such fees are recorded as reductions to general and administrative expense (see Note 10).\nDERIVATIVES\nThe Company periodically enters into swap agreements in order to hedge against volatility in oil and gas prices. Gains or losses on these transactions are reported as a component of oil and gas sales as the associated production occurs.\nGAS BALANCING\nThe Company utilizes the sales method of accounting for natural gas revenues whereby revenues are recognized based on the amount of gas sold to purchasers. The amount of gas sold may differ from the amount to which the Company is entitled based on its working interests in the properties. At December 31, 1994 and 1993, the Company had recorded a liability of $3.7 million and $2.5 million, respectively, for properties having insufficient reserves to offset the gas imbalance. The increase from 1993 to 1994 primarily relates to imbalances acquired through the Company's acquisition of investors' interests in a series of institutional investment programs (the \"APPL Programs\") (see Note 3).\nFOREIGN CURRENCY TRANSLATION\nThe results of operations attributable to the Company's Canadian operations, which were sold in mid- 1993, were measured using the local currency as the functional currency. The adjustments resulting from the translation of the assets and liabilities and income statement accounts of the Canadian operations were accumulated in the foreign currency translation adjustment component of stockholders' equity. In conjunction with the sales of the Company's Canadian operations, the Company wrote off the foreign currency translation adjustment balance of approximately $1.8 million to loss on sales of oil and gas properties (see Note 4). The U.S. dollar has been the functional currency for the Company's other foreign operations. Foreign currency transaction gains and losses are recognized currently in other income and were not material for 1993 or 1992. The Company had no foreign operational activity during 1994.\nINCOME TAXES\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\". SFAS No. 109 requires 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 differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The adoption of SFAS No. 109 did not have a material impact on the Company's financial position or results of operations (see Note 11).\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)\nNET LOSS PER COMMON SHARE\nNet loss per common share has been computed by dividing net loss, after reductions for certain preferred stock dividends, by the weighted average number of common shares and common share equivalents outstanding during each year. Common share equivalents include the average shares issuable upon assumed exercise of stock options and warrants which would have a dilutive effect in the respective periods. Any assumed conversions of subordinated convertible notes payable or assumed exercise of stock options or warrants were antidilutive for 1994, 1993 and 1992. In addition, any assumed conversion of convertible preferred stock was antidilutive for 1994 and 1993. The weighted average shares used in the primary earnings per share calculations were 80,608,000 in 1994, 69,616,000 in 1993, and 64,195,000 in 1992.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.\n(2) CHANGE IN METHOD OF ACCOUNTING FOR IMPAIRMENTS OF PROVED OIL AND GAS PROPERTIES\nDuring 1990 and 1991, the Company acquired significant proved reserves through the acquisitions of Hershey Oil Corporation and Conquest Exploration Company. These reserves were acquired with an expectation that oil and gas prices would trend upward over time. Since these acquisitions were made, oil and gas prices have been subject to considerable volatility, resulting in economic losses of proved reserves and corresponding increases in the Company's DD&A rate per barrel of oil equivalent. Currently, the Securities and Exchange Commission has required, at a minimum, a company using the successful efforts method of accounting to recognize an impairment of proved oil and gas property costs if, on a company-wide basis, those costs exceed the undiscounted after-tax future net cash flows from proved reserves. The Company has been following that methodology and has been in compliance with it. Effective December 31, 1994, the Company changed its accounting policy related to recognizing impairment of proved oil and gas properties to a policy that is consistent with the provisions of the Financial Accounting Standards Board (\"FASB\") exposure draft, \"Accounting for the Impairment of Long-Lived Assets\".\nUnder the Company's new policy, if the book value of an individual proved field is greater than its undiscounted future net cash flow from proved reserves, then an impairment is recognized for the difference between the net book value and the fair value. The Company has recorded a noncash impairment charge of approximately $25.0 million in 1994. The fair value used to calculate the impairment for an individual field is equal to the present value of its future net cash flows.\n(3) APPL CONSOLIDATION\nDuring the period 1983-1990, American obtained long-term funding for many of its oil and gas property acquisitions through the APPL Programs. As of December 31, 1993, institutional investors had committed $507.7 million to these programs, while the Company had committed $54.7 million. The APPL Programs consisted primarily of limited partnerships (\"APPL Partnerships\") in which the Company acted as general partner and the institutions invested as limited partners. To meet the needs of tax-exempt investors, the Company also formed programs structured as secured debt financings (\"APPL Debt Programs\") and programs which invested in net profits interests.\n(3) APPL CONSOLIDATION (CONTINUED)\nDuring 1994 and January 1995, the Company purchased limited partners' interests in the APPL Partnerships and net profits interests and debt interests in the APPL Debt Programs (the \"APPL Consolidation\"). The consideration paid for the acquisition of the APPL interests in 1994 was a combination of $31.1 million in cash and 42.7 million shares of the Company's common stock. In connection with the transaction, $13.6 million in nonrecourse debt was eliminated, resulting in an extraordinary gain totaling $5.4 million. In January 1995, the Company repurchased the remaining two investors' interests in the APPL Debt Programs for a combination of $1.3 million in cash and the issuance of 3.4 million shares of the Company's common stock, thereby eliminating the remaining $6.6 million of nonrecourse debt outstanding at year-end 1994. The elimination of the APPL debt in 1995 resulted in an extraordinary gain of $2.5 million. No income tax expense has been recognized on the extraordinary gains.\nIn addition to the acquisition of its interests in certain APPL Programs by American, New York Life Insurance Company (\"New York Life\") has agreed to transfer certain of its interests not acquired in the APPL Consolidation to ANCON Partnership Ltd. (\"ANCON\"). ANCON was formed at the end of 1993 by American and a subsidiary of New York Life to consolidate New York Life's other oil and gas holdings. The Company serves as general partner of ANCON and is required to purchase a 1% interest in any properties transferred to the partnership by New York Life. American has the option to acquire up to an additional 19% interest within six months of the transfer as allowed under the partnership agreement. The transfer of New York Life's APPL Program interests to ANCON is expected to occur in early 1995, with the Company acquiring a 1% interest in such properties at that time.\nThe Company financed the cash portion of the APPL Consolidation through a $40.0 million nonrecourse secured credit facility (\"bridge facility\") extended by New York Life (see Note 6).\nThe following pro forma summary of consolidated results of operations for the years ended December 31, 1994 and 1993 give effect to the APPL Consolidation as if it had occurred as of the beginning of 1993.\n(in thousands except per share amounts) YEAR ENDED DECEMBER 31, ------------------------- 1994 1993 ---------- ----------\nPro forma revenues ............................... $ 75,612 $ 94,937\nPro forma loss before extraordinary item ......... (56,034) (16,465)\nPro forma net loss to common stock ............... (57,834) (8,404)\nPro forma net loss per common share: Primary and fully diluted: Loss before extraordinary item ............... $ (.51) $ (.15) Net loss ..................................... (.51) (.08)\nWeighted average shares outstanding: Primary and fully diluted ...................... 113,783 112,286\nThe pro forma amounts do not purport to be indicative of the results of operations of American that may be reported in the future or that would have been reported had this transaction occurred as of January 1, 1993.\n(4) DIVESTITURES\nThe Company received cash proceeds of $2.6 million, $35.7 million and $2.9 million from the sales of oil and gas properties in 1994, 1993 and 1992, respectively. These sales resulted in a gain of $1.1 million in 1994 and losses of $6.9 million in 1993 and $1.3 million in 1992. Property sales in 1994 and 1992 related to the divestiture of low-value properties while the 1993 sales related primarily to the Company's divestiture of its Canadian operations as well as the sale of a partial interest in a significant domestic property.\nIn 1992, the Company decided to sell a portion of its interest in the Henderson Canyon Field and its Canadian foothill properties. As a result, the Company wrote these assets down to their estimated current market value and reported a $39.3 million charge against earnings in 1992. In March 1993, American sold approximately 40% of its interest in the Henderson Canyon Field to several of the Company's investment programs for proceeds of approximately $8.7 million. In June and July 1993, the Company sold its Canadian foothill properties (while retaining a 4% overriding royalty interest in these properties) and also sold its 90% equity interest in Canadian Conquest and its wholly owned subsidiary, Conquest Ventures Canada, Inc., for aggregate proceeds of $26.1 million. The Company recognized losses totaling $4.0 million on the sales of the Canadian assets. In conjunction with the sales of the Canadian subsidiaries, the Company also recognized a $1.8 million loss related to the elimination of the foreign currency translation adjustment balance which was previously recorded as a component of stockholders' equity. Proceeds from these sales were primarily used to reduce bank debt. The remaining $1.1 million loss on sales of oil and gas properties for 1993 related to the sale of minor properties sold at auction in July 1993.\n(5) NYLOG PROGRAMS\nFrom 1985 until early 1992, subsidiaries of the Company and New York Life formed a series of publicly registered limited partnerships, the New York Life Oil & Gas Producing Properties Programs (\"NYLOG Programs\"). The NYLOG Programs invest in the acquisition and further development of producing oil and gas properties acquired by the Company. A total of $229.1 million has been invested by the limited partners in these programs since inception.\nNew York Life and the Company each pay 5% of property acquisition costs of the NYLOG Programs and each receives 7.5% of net revenues until payout. Payout occurs when the limited partners receive distributions equal to their initial investment. After payout, the Company's and New York Life's interests in capital costs and net revenues each increase to 12.5%. One of the NYLOG Programs reached payout during 1992. For the other NYLOG Programs, it is difficult to predict when or if payout will occur due to the uncertainty of future energy prices, oil and gas production and operating and administrative costs.\n(6) DEBT\nThe following table details the components of the Company's debt (in thousands): DECEMBER 31, -------------------- 1994 1993 ------- ------- Bank credit agreement ................... $ 28,000 $ 6,500 Note payable to related party ........... 31,128 -- 11% senior subordinated notes ........... 35,000 35,000 APPL Debt promissory notes .............. 6,582 21,674 Other debt .............................. 284 420 ------- ------- Total ................................ 100,994 63,594\nLess: Current maturities ............... 154 746 ------- ------- Total long-term debt ................. $100,840 $62,848 ======== =======\n(6) DEBT - (CONTINUED)\nBANK DEBT\nIn December 1994, the Company entered into a new long-term revolving bank credit agreement which replaced the bank credit agreement previously in effect. The borrowing base, or amount available, under the new bank credit facility is currently $65.0 million, up from $30.0 million at year-end 1993. The amount outstanding under the facility at December 31, 1994 was $28.0 million, which was classified as long-term debt. The borrowings under this facility during 1994 were used to fund capital projects and reduce existing liabilities. In February 1995, the Company used excess borrowing capacity under this facility to refinance the bridge facility. The Company also had $806,000 in letters of credit outstanding at December 31, 1994 which are collateralized by the Company's borrowing base. The borrowing base under this facility is scheduled to be redetermined semiannually every March and September. In 1994, American paid fees of $663,000 relating to the activation of its new bank credit facility. The borrowing base is currently in the process of being redetermined by the banks. Management expects, based on current discussions with its lenders, that the borrowing base will be at least $65.0 million.\nBorrowings under this facility are secured by substantially all of the assets of the Company, excluding the assets of the APPL Debt financing subsidiaries and the assets acquired through bridge financing, as discussed below. At the option of the Company, borrowings bear interest at (i) LIBOR plus 1.50% or 1.75% or (ii) the higher of (A) the prime rate plus 0.50% or 0.75% or (B) the federal funds rate plus 1.00% or 1.25%. If the total amounts outstanding are less than or equal to 70% of the borrowing base, the lower margins are added to the respective interest rates and vice versa. The weighted average interest on the Company's bank debt at December 31, 1994 was 9.0%. The Company is required to pay quarterly a 0.50% annual commitment fee on the difference between the aggregate commitment of $90.0 million and the daily average amount outstanding under this facility, including letters of credit. Principal on the remaining long-term portion is scheduled to be repaid over twelve quarterly installments commencing March 31, 1997. Interest is payable quarterly or upon maturity of the borrowing, if shorter, in the case of Eurodollar loans and monthly in the case of prime rate or federal funds rate loans.\nNOTE PAYABLE TO RELATED PARTY\nIn April 1994, New York Life extended to the Company a $40.0 million bridge facility to provide bridge financing for the APPL Consolidation and such other property acquisitions as New York Life shall approve. The Company paid a 0.50% commitment fee for the one-year facility and is required to pay a 1.25% financing fee on any amounts borrowed. Borrowings bear interest at the 30-day A1\/P1 commercial paper rate plus 3% to 6% depending upon the time elapsed since the initial funding date. The weighted average interest on the bridge facility at December 31, 1994 was 10.01%. Borrowings under this facility are secured by the interests acquired. At December 31, 1994, the amount outstanding under the bridge facility was $31.1 million and is classified as long-term debt pursuant to management's refinancing of such amount as long-term debt under the bank credit facility in February 1995.\n11% SENIOR SUBORDINATED NOTES\nIn December 1991, the Company privately placed $35.0 million in senior subordinated notes and immediately exercisable detachable warrants with three institutional investors. The notes bear interest at 11% payable semiannually every June and December. The Company is required to begin repaying principal with annual installments of $5.6 million in December 1997. The final principal payment of $12.6 million is payable in December 2001. The warrants grant the holders the right to purchase approximately 11.5 million shares, as adjusted for issuances of stock and warrants subsequent to 1991, of the Company's common stock at an exercise price of $2.26 per share, subject to adjustment. In addition, each holder of the warrants has the option to tender the notes in lieu of cash as consideration for the exercise price.\n(6) DEBT - (CONTINUED)\nAPPL DEBT PROMISSORY NOTES\nDuring 1987 and 1988, wholly owned subsidiaries of the Company financed 90% of the cost of certain property acquisitions by selling promissory notes and production payments to the investors in the APPL Debt Programs. The Company eliminated $13.4 million of the APPL debt in 1994 through the APPL Consolidation. As part of the January 1995 APPL Consolidation transaction, the Company purchased the interests of the remaining investors in the APPL Debt Programs, thereby eliminating the $6.6 million outstanding balance at December 31, 1994. The elimination of the APPL debt through the APPL Consolidation resulted in an extraordinary gain on extinguishment of debt of $5.4 million in 1994 and $2.5 million in January 1995. No income tax expense has been recognized on the extraordinary gains (see Note 3).\nIn 1992, the Company restructured the nonrecourse debt of one of the wholly owned subsidiaries associated with the APPL Debt Programs and recognized an extraordinary gain on extinguishment of debt of $3.1 million, net of transaction costs. No income taxes were recognized on this extraordinary gain since the Company incurred a net loss for 1992.\nFEES RELATED TO DEBT INSTRUMENTS\nThe Company incurs fees related to existing and new credit facilities which are reported as other expense. During 1994, 1993 and 1992, these fees totaled $2.8 million, $739,000 and $1.3 million, respectively.\nDEBT COVENANTS\nThe bank credit agreement and the 11% senior subordinated notes require the Company to comply with certain covenants including, but not limited to, restrictions on indebtedness, investments, payment of dividends and lease commitments. Cash dividends are prohibited on the Company's common stock and preferred dividends are limited to the lesser of 10% of the preferred stock offering proceeds or $7.5 million in any one year. These agreements also include net worth covenants which were amended effective July 1994 in conjunction with the issuance of American common stock related to the APPL Consolidation. Net worth must not be less than $65.0 million less write-downs plus 50% of any equity issuances. For purposes of this test, write-downs may not exceed $6.8 million through June 30, 1994 plus any noncash charges after June 30, 1994 in connection with proposed pronouncements on accounting for impairments of long-lived assets. At December 31, 1994, the Company's calculated net worth requirement was $62.4 million and the Company's stockholders' equity was $87.7 million. In addition, these agreements contain cross-default provisions.\nANNUAL MATURITIES\nBased on the amounts outstanding at December 31, 1994, the aggregate maturities of debt for the next five years are as follows: 1995 - $154,000; 1996 - $130,000; 1997 - $25.3 million; 1998 - $25.3 million; 1999 - $25.3 million. The annual maturities do not include any amounts related to the APPL Debt promissory notes since the promissory notes outstanding at year-end 1994 were eliminated in January 1995 in conjunction with the APPL Consolidation.\n(7) PREFERRED STOCK\nThe Company has authorized 100,000 shares of preferred stock, par value $1.00 per share. The Board of Directors has authority to divide such preferred stock into one or more series and has authority to fix and determine the relative rights and preferences of each such series. At December 31, 1994, American had 4,000 shares of convertible preferred stock outstanding and an additional 85,000 shares of preferred stock reserved under the Company's Stockholder Rights Plan.\nCONVERTIBLE PREFERRED STOCK\nIn December 1993, the Company privately placed 800,000 depositary shares, each representing a 1\/200 interest in a share of $450 Cumulative Convertible Preferred Stock, Series C (the \"Convertible Preferred Stock\"). The Convertible Preferred Stock has a stated value of $5,000 per share, with dividends payable quarterly at the annual rate of $450 per share. The Convertible Preferred Stock is convertible at any time at the option of the holders into shares of the Company's common stock at a conversion price of $1.50 per share, subject to adjustment in certain circumstances. Beginning December 31, 1997, the Convertible Preferred Stock will be redeemable at the option of the Company, in whole or in part, at any time. The initial redemption price is $5,270 per share, declining ratably on December 31 of each year to a redemption price of $5,000 per share on and after December 31, 2003, plus accrued and unpaid dividends.\nThe Convertible Preferred Stock has a special conversion right that becomes effective upon the occurrence of certain types of significant transactions affecting ownership or control of the Company. If the special conversion right becomes effective, the then prevailing conversion price would be reduced to the market value of the common stock, not to be reduced below a minimum conversion price of $1.125 per share of common stock.\nSTOCKHOLDER RIGHTS PLAN\nIn September 1993, the Board of Directors of the Company declared a distribution of one right (\"Right\") for each outstanding share of common stock to stockholders of record at the close of business on October 8, 1993 and for each share of common stock issued by the Company thereafter and prior to the \"Distribution Date\", as defined. Each Right entitles the registered holder to purchase one ten-thousandth of a share (a \"Unit\") of Series B Preferred Stock at a price of $7.50 per Unit, subject to adjustment.\nThe Rights are exercisable only upon the occurrence of certain triggering events, including the acquisition by a person or group of 15% or more of the Company's outstanding common stock, other than those persons that acquired common stock through the APPL Consolidation. If a triggering event occurs, holders of each Right would be entitled to receive, upon exercise, the Units of Series B Preferred Stock (or stock of the acquiring entity, as the case may be) having a value equal to two times the exercise price of the Right. Such Rights do not extend to any holder whose action triggered the Right.\nThe Rights may be redeemed in whole by American at $0.01 per Right any time until the 10th business day following public announcement that a person or group, other than those persons that acquired common stock through the APPL Consolidation, has acquired, obtained the right to acquire or otherwise obtained beneficial ownership of 15% or more of the Company's outstanding common stock.\n(8) COMMON STOCK\nThe Company has authorized 200,000,000 shares of common stock, of which 114,775,000 shares were issued and 114,683,132 shares were outstanding at December 31, 1994. A schedule of the changes in the Company's common stock is provided below:\nAt the Company's annual meeting held in June 1994, American obtained stockholder approval to increase the number of authorized shares of common stock from 100,000,000 shares to 200,000,000 shares. Upon obtaining stockholder approval, the Company reserved 4,444,444 shares for issuance pursuant to the special conversion rights of the Convertible Preferred Stock. The increase in the number of authorized shares also allowed American to privately issue 1.5 million shares of common stock in August 1994, resulting in proceeds of $2.1 million. In addition, the Company was able to issue 46.1 million shares of common stock at fair market value in the APPL Consolidation, including 3.4 million shares of common stock issued in January 1995 (see Note 3).\nAt December 31, 1994, the Company had outstanding two series of warrants to purchase common stock. The first series of warrants was issued in conjunction with the private placement of 11% senior subordinated notes in 1991 and expire in 2001 (the \"2001 Warrants\"). At year-end 1994, the 2001 Warrants were priced at $2.26 per share and are callable by the Company beginning in December 1996, but only in the event that the Company's common stock has traded at a specified price above the exercise price for a specified period.\nThe second series of warrants was issued to an institutional investor in conjunction with the Canadian Conquest restructuring in 1992 and expire in 1999 (the \"1999 Warrants\"). At year-end 1994, the 1999 Warrants were exercisable at a price of $2.32 per share and are callable by the Company at the current exercise price per warrant, but only in the event that the Company's common stock has traded at a specified price above the current exercise price for a specified period.\nBoth the 2001 Warrants and the 1999 Warrants contain provisions which would adjust the exercise price and number of warrants under certain circumstances, most of which have a dilutive effect on equity.\nShares of common stock reserved for future issuance as of December 31, 1994 were as follows:\nExercise of stock options ....................................... 2,896,531 Exercise of 2001 Warrants ....................................... 11,528,254 Exercise of 1999 Warrants ....................................... 3,099,440 Conversion of Convertible Preferred Stock ....................... 13,333,333 Special conversion rights of Convertible Preferred Stock ........ 4,444,444 ---------- Total shares reserved ........................................... 35,302,002 ==========\n(9) EMPLOYEE BENEFIT PLANS\nSTOCK COMPENSATION PLANS\nThe American Exploration Company Stock Compensation Plan established in 1983 (the \"1983 Plan\") provides for the issuance of up to 5,000,000 shares of the Company's common stock. The 1983 Plan also authorizes the issuance of stock appreciation rights in conjunction with stock options and the granting of restricted common stock and performance shares. No restricted common stock was issued in 1994 or 1992. In 1993, the executive officers of the Company purchased 797,250 shares of restricted common stock for $.05 per share. The difference between the aggregate fair market value of the restricted shares purchased and the purchase price is considered unearned compensation at the time of grant and compensation is earned ratably over the vesting period of 33 1\/3% per year commencing with the first anniversary of grant. No stock appreciation rights or performance shares were granted under the 1983 Plan during the three-year reporting period.\nThe exercise price, term and other conditions applicable to each option granted under the 1983 Plan are determined at the time of the grant of each option and may vary with each option granted. No option may be granted at a price less than the stock's fair market value on the date of grant. The purchase price of the shares as to which an option is exercised is payable in cash, the Company's common stock or a combination of cash and stock.\nIn conjunction with the Hershey acquisition in 1990, the Hershey stock option plans were amended and restated such that the Company assumed the obligation for the stock options outstanding under the Hershey plans at the acquisition date. At December 31, 1994, there were 622,655 options outstanding under the amended and restated Hershey plans.\nDetailed information on stock option transactions is provided below:\nYEAR ENDED DECEMBER 31, ------------------------------------- 1994 1993 1992 ----------- ---------- ---------- Options outstanding at beginning of year 3,742,582 5,624,576 4,756,268 Options granted ........................ -- 10,200 1,275,750 Options terminated ..................... (846,051) (1,891,994) (401,192) Options exercised ...................... -- (200) (6,250) ----------- ---------- ---------- Options outstanding at end of year ..... 2,896,531 3,742,582 5,624,576 =========== ========== ==========\nOptions exercisable at end of year ..... 2,424,656 2,711,904 3,447,469 =========== ========== ==========\nOption price range: Options granted ........................ $ -- $1.25-1.44 $1.81-2.88 Options terminated ..................... 1.81-5.00 1.81-5.00 2.50-5.00 Options exercised ...................... -- 1.25-1.44 2.00-2.50 Options outstanding at end of year ..... 1.31-4.75 1.31-5.00 1.81-5.00\nIn November 1994, the Board of Directors adopted the 1994 American Exploration Company Stock Compensation Plan (the \"1994 Plan\"), subject to approval by stockholders at the 1995 Annual Meeting of Stockholders. The purpose of the 1994 Plan is to attract and retain key employees of the Company by providing rewards for past performance and incentives for future service. Under the 1994 Plan, 9,000,000 shares of the Company's common stock are available for the granting of stock options, restricted common stock and performance shares. In addition, performance units may be awarded and stock appreciation rights may be issued in conjunction with the stock options. All terms and conditions of the various awards are determined at the time of grant. In November 1994, the Compensation Committee of the Board of Directors, which administers this plan, granted 2,968,000 stock options, subject to stockholder approval as discussed above, at an exercise price equal to the fair market value of the Company's common stock on the date of\n(9) EMPLOYEE BENEFIT PLANS - (CONTINUED)\ngrant. In addition, several executive officers have the right to receive stock options covering eight shares for each share of common stock they purchase between November 1994 and two months after the 1994 Plan is approved up to a total of 1,600,000 stock options.\nPHANTOM STOCK PLAN\nIn September 1993, the Board of Directors of the Company adopted a Phantom Stock Plan (the \"Phantom Stock Plan\"). The purpose of the Phantom Stock Plan is to provide a further means of motivating and retaining key employees of the Company by providing rewards for past performance and incentives for future service. These rewards currently include restricted units and option units; however, if the 1994 Plan is approved by stockholders, participants in the Phantom Stock Plan have the right to convert their option units to stock options.\nThe executive officers of the Company purchased 298,625 shares of common stock, purchased 797,250 shares of restricted common stock under the 1983 Plan and were awarded 1,594,500 option units under the Phantom Stock Plan. The remaining key employees were granted 56,500 restricted units and 113,000 option units in 1994 and 337,906 restricted units and 675,812 option units in 1993. In each case, the price for the option units equaled the fair market value of the Company's common stock on the date of the awards. The grant price for the restricted units to the remaining key employees was below market value. Consequently, the Company records a noncash charge to operations over the vesting period of the restricted units and option units for the difference between the grant price and the then market value of the common stock. These noncash charges totaled $22,000 and $25,000 in 1994 and 1993, respectively.\nThe restricted units awarded vest at 33 1\/3% per year commencing with the first anniversary of grant, and option units vest at 25% per year from date of grant. Upon vesting, a participant receives a cash payment for the difference between the grant price and the then market value of the common stock for the restricted units and option units. Such cash payments totaled $24,000 for 1994. Under the Phantom Stock Plan, participants do not receive shares of the Company's common stock.\nEMPLOYEE STOCK OWNERSHIP PLAN\nThe employee stock ownership plan is a noncontributory plan to acquire shares of the Company's common stock for the benefit of all employees. The amount of Company contributions to the plan is determined at the discretion of the Compensation Committee of the Board of Directors. There were no Company contributions in 1994 or 1993. The Company contributed $920,000 to the plan during 1992 to acquire 392,420 shares. Company contributions are expensed as incurred.\nIn September 1994, the Board of Directors voted to terminate the plan. Upon obtaining a favorable ruling from the Internal Revenue Service on the plan's termination, distributions to the plan's participants will commence and are expected to be concluded in 1995.\nEXPLORATION GROUP INVESTMENT PLAN\nThe Exploration Group Investment Plan, established in 1991, enables the Company to make available up to 10% of the Company's net revenue interest in certain domestic exploration prospects to certain employees of the Company involved in its exploratory activities. Electing participants pay their designated share of the costs associated with such exploratory prospects and their interests convert into overriding royalties in the successful prospects. During 1994, there was no activity in this plan.\n(10) RELATED-PARTY TRANSACTIONS\nNOTES RECEIVABLE FROM OFFICERS\nAt December 31, 1994, the Company held $142,000 of notes receivable from executive officers of the Company. The Company provided loans to the executive officers to purchase a portion of the common stock issued in September 1993 in conjunction with the Phantom Stock Plan. The notes bear interest at 3.9% and are payable in equal installments through October 1996.\nNEW YORK LIFE\nNew York Life is the second largest stockholder of the Company, owning approximately 9.0% of its voting stock as of December 31, 1994. Since 1983, New York Life had been a substantial investor in each of the Company's APPL Programs, providing 35% of the amount committed by co-investors. New York Life made no investments in the APPL Programs during the past three years. In conjunction with the APPL Consolidation, New York Life sold certain of its APPL Program interests to the Company and agreed to transfer its remaining interests to ANCON (see Note 3). During the period 1985-1992, the Company and a subsidiary of New York Life, as co-general partners, formed the NYLOG Programs which were sold to the public by New York Life agents and independent broker-dealers. New York Life invested $74,000, $1.3 million and $147,000 in the NYLOG Programs for the years ended December 31, 1994, 1993 and 1992, respectively.\nIn December 1993, American and a subsidiary of New York Life formed a new partnership, ANCON (see Note 3). New York Life transferred $9.6 million of oil and gas properties to the partnership in 1993. American acquired a 20% interest in these properties for $1.5 million. No properties were contributed to the partnership in 1994. Capital contributions by New York Life to ANCON for development activity totaled $813,000 in 1994.\nIn April 1994, New York Life extended to the Company a $40.0 million bridge facility (see Note 6). American paid interest, commitment and financing fees on this facility totaling $1.6 million in 1994. At December 31, 1994, the Company had outstanding under this facility $31.1 million. In February 1995, the Company refinanced this amount using excess borrowing capacity under its bank credit facility.\nINVESTMENT PROGRAMS\nThe Company is the operator on certain properties owned by the NYLOG Programs, ANCON and joint ventures and accordingly charges these entities and third party joint interest owners operating fees. The Company is also reimbursed for costs incurred in managing the operations of the NYLOG Programs and ANCON. The administrative and technical fees shown below also include amounts related to the APPL Programs, which were consolidated into American's operations during 1994 and early 1995. The following table summarizes certain fees charged by the Company to the investment programs and ANCON (in thousands): YEAR ENDED DECEMBER 31, ----------------------------------- 1994 1993 1992 ------ ------ ------ Administrative and technical fees ..... $8,121 $8,190 $8,794 Program formation fees................. -- -- 547\nOTHER TRANSACTIONS\nLegal fees incurred for services by a law firm in which a partner is a director of the Company totaled $377,000 in 1994 and $243,000 in 1993. Legal fees paid to this law firm in 1992 were not material.\n(11) INCOME TAXES\nEffective January 1, 1993, the Company adopted SFAS No. 109. The prior year's financial statements were not adjusted to reflect the new accounting method, and the cumulative effect related to the adoption of SFAS No. 109 had no material effect on the Company's financial position or results of operations. SFAS No. 109 requires the use of an asset and liability approach under which 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.\nThe Company reported a 1994 loss before income taxes and extraordinary item totaling $60.7 million, of which $54.0 million related to domestic operations and $6.7 million related to foreign operations. The Company's income tax provision (benefit) for the years ended December 31, 1994, 1993 and 1992 is detailed below (in thousands): YEAR ENDED DECEMBER 31, ---------------------------------- 1994 1993 1992 -------- -------- -------- Current: Federal ............................... $ -- $ 150 $ -- State ................................. 39 476 118 -------- -------- -------- 39 626 118 -------- -------- -------- Deferred: Federal ............................... -- -- -- State ................................. (494) (121) (10) -------- -------- -------- (494) (121) (10) -------- -------- -------- Total ............................... $ (455) $ 505 $ 108 ======== ======== ========\nThe difference between the provision (benefit) for income taxes and the amount which would be determined by applying the statutory federal income tax rate to loss before income taxes and extraordinary items for the years ended December 31, 1994, 1993 and 1992 is analyzed below (in thousands):\nYEAR ENDED DECEMBER 31, ---------------------------------- 1994 1993 1992 -------- -------- -------- Loss before income taxes and extraordinary item ................ $(60,690) $(18,674) $(69,740)\nIncome tax provision (benefit) at the statutory rate ................. $(21,242) $ (6,536) $(23,712) Change in valuation allowance ......... 22,203 (1,133) 18,732 Federal alternative minimum tax ....... -- 150 -- State income tax ...................... 39 476 118 Other ................................. (1,455) 7,548 4,970 -------- -------- -------- Income tax provision (benefit) ..... $ (455) $ 505 $ 108 ======== ======== ========\n(11) INCOME TAXES - (CONTINUED)\nThe Company's deferred income tax liability at December 31, 1994 and 1993 is comprised of the tax benefit (cost) associated with the following items (in thousands): DECEMBER 31, --------------------------- 1994 1993 --------- -------- Deferred tax asset: Minimum tax carryforwards ............... $ 479 $ 556 Investment tax credit carryforwards ..... 1,873 1,759 State income tax ........................ 3,203 3,238 Net operating loss carryforwards ........ 95,732 90,092 --------- -------- Gross deferred tax asset .............. 101,287 95,645 Valuation allowance ....................... (93,221) (71,018) --------- -------- 8,066 24,627 --------- -------- Deferred tax liability: State income tax ........................ (336) (831) Acquisition, exploration and development costs ...................... (8,066) (24,627) --------- -------- Gross deferred tax liability .......... (8,402) (25,458) --------- --------\nNet deferred tax liability ................ $ (336) $ (831) ========= ========\nThe net deferred tax asset valuation allowance of $93.2 million reflects the amounts for which utilization is not assured due to the expiration of net operating loss carryforwards and the effects of future drilling costs.\nAs of December 31, 1994, the Company had cumulative net operating loss carryforwards (\"NOL's\") for federal income tax purposes of approximately $274.0 million, of which approximately 20% will expire in the next five years. Included in the total NOL's are approximately $71.5 million which arose through an acquisition completed in 1987, and $143.7 million which arose through the acquisition of Conquest in 1991. These acquired NOL's may be used to offset the respective subsidiaries' taxable income subject to individual annual and cumulative limits. In addition to the individual limitations, changes in the Company's ownership have resulted in an overall limitation on the amount of benefit to be realized from the NOL carryforwards in the amount of approximately $13.7 million annually. Any unused portion of the benefit is carried forward. For 1995, the cumulative limit for utilization of available NOL's is $67.0 million. Unless utilized, the Company's NOL's will begin expiring in 1995. The Company also has investment tax credit carryforwards of approximately $1.9 million, which begin expiring in 1995. The Company has an alternative minimum tax credit carryforward of approximately $479,000 which does not expire and is available to offset regular income taxes in future years, but only to the extent that regular income taxes exceed the alternative minimum tax in such years.\n(12) DERIVATIVES AND FAIR VALUE OF FINANCIAL INSTRUMENTS\nDERIVATIVES\nThe Company has only limited involvement with derivative financial instruments and does not use or issue them for trading purposes. They are used to manage the risk associated with oil and gas prices.\nAt December 31, 1994, the Company had several swap agreements in place to hedge against a downturn in oil and gas prices over the next six months. For the period January 1995 through March 1995, American has two swap transactions covering 15,000 MMBtu of gas per day hedged at a weighted average fixed price of $2.15 per MMBtu. If the market price is above $2.15, the Company will pay 50% of the difference between\n(12) DERIVATIVES AND FAIR VALUE OF FINANCIAL INSTRUMENTS - (CONTINUED)\n$2.15 and the market price; and if the market price is below $2.15, the Company will receive 100% of the difference. The market price is defined as the price quoted in the first publication of INSIDE F.E.R.C.'S GAS MARKET REPORT for the month of production for Henry Hub or Houston Ship Channel deliveries. For the period January 1995 through June 1995, the Company has 362,000 barrels of oil hedged at a floor of $17.96 per Bbl NYMEX WTI Light Crude Oil. There were no swap agreements in effect at December 31, 1993.\nThe Company is exposed to credit loss in the event of nonperformance by the other party to the swap agreements. However, the Company anticipates that the counterparty will be able to fully satisfy its obligation under the agreements.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following table presents the carrying values and estimated fair values of the Company's financial instruments at December 31, 1994 (in thousands):\nCARRYING FAIR VALUE VALUE -------- ------- Long-term debt (1)................................ $100,994 $98,538 Price swap agreements (2)......................... 57 806\n(1) Fair value is carrying value for the Company's long-term debt, other than the APPL debt promissory notes, based on the fact these financial instruments are at the current interest rates available for debt with similar terms and maturities. Fair value for the APPL debt is the carrying value less the extraordinary gain recognized subsequent to year-end 1994 for the elimination of this debt through the APPL Consolidation.\n(2) The carrying value represents the unamortized premium paid by the Company to enter into the swap agreements. The fair value of the swap agreements is the estimated amount the Company would receive to terminate the agreements at December 31, 1994, based on the closing prices for NYMEX futures contracts on the last available trading date in December.\nThe carrying amounts of cash and cash equivalents, trade receivables and trade payables approximate fair value because of the short maturity of these instruments.\n(13) COMMITMENTS AND CONTINGENCIES\nOPERATING LEASES\nThe Company has operating leases, primarily for office space, which expire over the next seven years. These operating leases frequently include renewal options at the then fair rental value and require that the Company pay a pro rata share of executory costs, including taxes, maintenance and utility expenses, incurred by the landlord. Future minimum payments under all noncancelable operating lease obligations, including an estimated pro rata share of operating expenses, as of December 31, 1994 are as follows (in thousands):\n1995......................................................... $ 2,392 1996......................................................... 2,141 1997......................................................... 2,365 1998......................................................... 2,737 1999......................................................... 2,737 Thereafter................................................... 4,334 ----- Total minimum lease payments............................... $ 16,706 ==========\n(13) COMMITMENTS AND CONTINGENCIES - (CONTINUED)\nThe Company had no minimum rentals under noncancelable subleases as of December 31, 1994. Rent expense totaled $3.9 million, $4.6 million and $5.2 million in 1994, 1993 and 1992, respectively, which includes the Company's share of executory costs associated with its office leases. Sublease rentals received during the past three years were not material.\nPARTNERSHIP COMMITMENTS\nThe Company and certain of its subsidiaries act as general partner of a number of limited partnerships. In such capacity, the Company and such subsidiaries are generally liable for the obligations of the partnerships to the extent that partnership assets are insufficient to discharge liabilities. Several of the investment programs formed by the Company or its subsidiaries require certain levels of insurance to cover operating and other risks inherent in the production of oil and gas. Under the terms of these programs, the Company would be liable for any costs or damages incurred by a program resulting from the Company's failure to carry the required insurance. The Company believes its insurance coverage is sufficient as required by the program agreements.\nAt December 31, 1994, the Company had remaining capital commitments to the NYLOG Programs of $87,000. The Company also has commitments to buy back certain NYLOG partnership units. These annual repurchase commitments are based on formulas contained in the underlying partnership agreements and totaled approximately $241,000 as of December 31, 1994. In addition, the Company has a commitment to purchase a 1% interest in any properties transferred to ANCON by New York Life.\nINTERNATIONAL COMMITMENTS\nDuring 1994, the Company sold its remaining interests in Tunisia and Oman and its permit in offshore Australia. Consequently, the Company has no international commitments for 1995 or future years.\nCONCENTRATION OF CREDIT RISK\nThe Company's revenues are derived principally from uncollateralized sales to customers in the oil and gas industry. The concentration of credit risk in a single industry affects the Company's overall exposure to credit risk because customers may be similarly affected by changes in economic and other conditions. The Company has not experienced significant credit losses on such receivables.\nLEGAL PROCEEDINGS\nIn addition to certain other legal proceedings arising in the ordinary course of its oil and gas business, the Company is involved in the following matters.\nLOUISIANA STATEWIDE CONTRACT. In December 1992, a U.S. District Court ruled that Louisiana Intrastate Gas Corporation (\"LIG\") had underpaid a subsidiary of the Company under a statewide gas purchase contract (\"Statewide Contract\") for the 1989 contract year. Pursuant to the ruling by the U.S. District Court, it was also determined through arbitration that the Company's subsidiary was underpaid for the period January 1990 to October 1992. The Statewide Contract covered certain properties acquired by the Company's subsidiary in 1988 with ownership in these properties assigned to several of the Company's investment programs. In December 1992, the Company's subsidiary agreed to terminate the Statewide Contract effective October 1, 1992 in exchange for a cash payment from LIG and a three-year replacement contract providing for market-based pricing. Upon appeal to the Fifth Circuit Court of Appeals, the Court of Appeals held in December 1994, in a per curiam opinion, that there was no reversible error and affirmed the trial court's ruling. Neither party appealed this ruling and in January 1995, the Company received approximately $1.0 million, net to its interest, after payment of applicable royalties.\n(13) COMMITMENTS AND CONTINGENCIES - (CONTINUED)\nCEMENT I UNIT - CADDO COUNTY, OKLAHOMA. In 1991, an administrative hearing was held by the Oklahoma Corporation Commission (\"OCC\") to establish the cause of the saltwater contamination of the municipal water supply of the city of Cyril, Oklahoma and to formulate a plan of abatement of the pollution. Parties to the hearing included the current and former operators of the Cement, Cement I and West Cement units. The Company owns a 18.56% interest and controls an additional 6.42% interest through investment programs in the Cement I Unit. In August 1992, the administrative law judge granted the Company's motion to dismiss on the grounds that the Company had not violated any statute, rule or regulation of the OCC and that the evidence did not establish that the Company caused any contamination of the aquifer. The ruling was subsequently affirmed by the OCC in December 1992. In January 1993, the current and former operators filed Petitions in Error in the Supreme Court of Oklahoma to appeal the OCC's decision. Matters raised on appeal include the dismissal of the Company. The OCC is requiring the responsible parties to conduct an investigation and formulate a plan of remediation during the pendency of the appeal.\nIt is not presently possible for the Company to determine the extent, if any, to which it may incur liability for alleged saltwater contamination. Under the terms of the Company's Purchase and Sale Agreement covering the Cement I Unit, the predecessor in interest indemnified the Company from and against all loss, damage, cost and expense relating to ownership for operations of the purchased properties prior to October 1986.\nMIDWAY FIELD - LAFAYETTE COUNTY, ARKANSAS. In 1992, the Company and certain subsidiaries and affiliates became defendants in a personal injury lawsuit in the 189th Judicial District court in Harris County, Texas as a result of a rear-end collision on a county road near the Midway Field between vehicles operated by a well-service company traveling to perform work for the Company at the field. The plaintiff is severely injured and alleged that the accident was the result of directions given by the Company. The plaintiff and his family sought actual damages of $48 million and four times that amount in punitive damages, which is in excess of the Company's insurance coverage. In December 1994, this lawsuit was settled within insurance limits.\nBOWDOIN FIELD, PHILLIPS AND VALLEY COUNTIES, MONTANA. In February 1995, two Company affiliates were served with a lawsuit filed by KN Gas Supply Services, Inc. (\"KNGSS\") in Federal District Court in Denver, Colorado, requesting declaratory judgement that KNGSS had the right to reduce the contract price for gas produced from the Bowdoin Field to market levels from October 1, 1993 forward pursuant to certain pricing provisions in the contract. KNGSS also requested declaratory judgement that it has a right to relief from the contract price due to regulatory changes, which it alleges renders the contract commercially impracticable, and that Federal Energy Regulatory Commission Order No. 636 is a condition subsequent which excuses performance under the contract. The Company will vigorously defend its interests in this case and firmly believes that the Bowdoin Field contract price will be upheld by the Court.\nLIMITED PARTNERSHIP LITIGATION. In February 1995, the Company and American Exploration Production Company, a subsidiary of the Company, were served with a lawsuit instituted on October 14, 1994 styled RICHARD RILEY AND FRANCES RILEY V. LEROY WOLF, NEW YORK LIFE INSURANCE COMPANY, NYLIFE EQUITY, INC., NYLIFE REALTY INCOME PARTNERS I, L.P., NEW YORK LIFE OIL AND GAS PRODUCING PROPERTIES II-E, L.P., LINCLAY INVESTMENT PROPERTIES, INC., AMERICAN EXPLORATION PRODUCTION COMPANY, JOHN DOES (1-10) AND A.B.C. CORP. (1-10) Civil Action No. 94.5827 (HAA) presently pending in the United States District Court, District of New Jersey. The plaintiffs allege various causes of action, including inefficient and wasteful management of partnership assets, relating to their investment in real estate and oil and gas limited partnerships. American Exploration Production Company acts as a co-general partner in the oil and gas limited partnership. The plaintiffs seek a recision of their investments, compensatory and punitive damages, and other relief. The Company believes it and its affiliate have conducted themselves properly with respect to such limited partnership and will vigorously defend this lawsuit.\n(13) COMMITMENTS AND CONTINGENCIES - (CONTINUED)\nNORM RELATED PROCEEDINGS\nThe Company and certain subsidiaries, among other operators, have been named as defendants in three lawsuits in Mississippi and three lawsuits in Louisiana alleging various causes of action due to the alleged presence of naturally occurring radioactive materials (\"NORM\") and other hazardous substances. The plaintiffs allege that the NORM contamination is a result of oil and gas operations conducted on properties operated or owned by the Company, its subsidiaries and their predecessors in title, or NORM contaminated pipe delivered to a pipe cleaning facility by the Company and subsidiaries.\nThe Company has conducted a review of its operations with particular attention to environmental compliance. The Company believes it has acted as a prudent operator and is in compliance in all material respects with environmental regulations. As part of the Company's continuing operations, the Company has recorded site remediation costs of $2.4 million in 1994 and anticipates it will incur additional costs from time to time related to the continued assessment, testing, disposal, site restoration and other activities in connection with the Company's environmental proceedings. The Company will continue to vigorously contest liability under the pending proceedings and seek to apportion any resulting liability under such proceedings among the Company, its predecessor operators and other working interest owners. Because of the early stages of these proceedings, it is not possible to quantify what liabilities, if any, the Company might incur.\nA brief summary of each of the lawsuits is listed below.\nBAY SPRINGS FIELD - JASPER COUNTY, MISSISSIPPI. In May 1994, the Company was served with a lawsuit (the \"Complaint\") filed by private landowners against the Company, and other defendants in the Circuit Court of Jasper County, Mississippi, First Judicial District based on the presence of NORM on the plaintiffs' property. The plaintiffs allege that the NORM contamination is a result of oil and gas operations conducted on properties operated by the Company and its predecessors in title and on properties in which the Company does not own an interest. The Complaint seeks compensatory damages of $50 million and punitive damages of $75 million. It is not known at this time the amount of damages sought against the Company since the plaintiffs do not specify damages by individual property.\nThe Company removed the lawsuit to federal court and obtained a ruling from the Court that allowed remediation of the property operated by the Company. The lawsuit has been remanded back to the Circuit Court of Jasper County. The Company has completed a NORM remediation program on the property and the site has been restored. It is the Company's belief that the completion of the remediation effort has significantly reduced the basis for the plaintiffs' damage claims.\nDIAMOND FIELD - WAYNE COUNTY, MISSISSIPPI. The Company and a subsidiary were served in May 1994 with a lawsuit in the Circuit Court of Wayne County, Mississippi based on the presence of NORM and other hazardous materials arising from oil and gas activities on certain tracts in the Diamond Field. Injunctive relief and monetary and punitive damages are sought; however, the plaintiffs do not specify the amount of damages being sought. In November 1994, the Court denied a motion by the plaintiffs to enjoin the Company from remediating the property without approval by the plaintiffs and issued a ruling that allowed the Company to remediate the property without interference. The Company completed remediation in February 1995. It is the Company's belief that the completion of the remediation effort has significantly reduced the basis for the plaintiffs' damage claims.\nBOYCE FIELD - WAYNE COUNTY, MISSISSIPPI. A Company subsidiary, among other defendants, was sued in March 1994 by a landowner in the Boyce Field, Wayne County, Mississippi, in the Circuit Court of Jasper County, Mississippi, First Judicial District, alleging substantially similar causes of action as in the Bay Springs Complaint for $3 million in compensatory damages and $6 million in punitive damages. A NORM remediation program was also undertaken at this property and the site has been completely restored. On October 5, 1994 the lawsuit was dismissed upon motion by the plaintiff. No new complaint has been filed.\n(13) COMMITMENTS AND CONTINGENCIES - (CONTINUED)\nFORDOCHE FIELD, POINT COUPEE PARISH, LOUISIANA. In August 1994, a Company subsidiary and affiliate were served with a lawsuit in the 18th Judicial District Court, Point Coupee Parish, Louisiana. The plaintiffs allege they represent a class of plaintiffs damaged by oil and gas activities, including damages caused by NORM, elevated levels of chlorides and other hazardous oil field wastes and substances, in the Fordoche Field and other fields operated by a third party near Lottie, Louisiana. The class certification has not been approved by the Court. The plaintiffs seek unspecified compensation for actual and exemplary damages. The Company owns a minority interest and does not operate this property. The plaintiffs have granted the Company an indefinite extension of time to answer the lawsuit. The Company intends to vigorously defend itself in this matter.\n51 OIL CORP. FACILITY. A Company subsidiary has been served with two lawsuits relating to the 51 Oil Corp. Facility near Lafayette, Louisiana. In 51 OIL CORP. V. ADOBE RESOURCES CORP. ET AL., Civil Action No. 93-08548, filed in Civil District Court in Orleans Parish, Louisiana, the plaintiff alleges that the Company's subsidiary, among 65 other defendants, supplied pipe contaminated with NORM to the plaintiff. The plaintiff alleges that the defendants failed to warn plaintiff of this condition, among other allegations, and seeks contribution by the defendants for the cost of remediation of its property as well as other damages. The plaintiff's records indicate that the Company subsidiary supplied about one-half of one percent of the pipe to the facility. An agreement to settle the lawsuit for $25,000 has been executed and the lawsuit will be dismissed with prejudice as to the Company's subsidiary.\nIn DANNY BROUSSARD ET AL. V. ADOBE RESOURCES CORP. ET AL., Civil Action No. 94-8019, filed in July 1994 in Civil District Court in Orleans Parish, Louisiana, the plaintiffs, an employee of 51 Oil Corp. and his family, allege that a Company subsidiary delivered pipe contaminated with NORM to 51 Oil Corp., as stated in the preceding case, and such actions caused plaintiff to suffer various personal injuries. The plaintiffs seek compensatory and punitive damages for both medical expenses and other damages; however, the plaintiffs do not specify the amount of damages being sought.\nThe Company does not expect the resolution of the matters discussed above to have a material adverse effect on its financial position or results of operations.\n(14) CASH FLOW INFORMATION\nSupplemental cash flow information is presented below (in thousands):\nYEAR ENDED DECEMBER 31, --------------------------- 1994 1993 1992 ------- ------ ------ CASH PAYMENTS: Interest, net of amounts capitalized (a) ....... $ 6,528 $6,931 $10,470 Income taxes ................................... 39 567 715\nNONCASH INVESTING AND FINANCING ACTIVITIES: APPL Consolidation: Acquisition of oil and gas properties .......... $ 52,222 $ -- $ -- Other assets acquired .......................... 2,287 -- -- Liabilities assumed ............................ 535 -- -- Debt retired ................................... 1,612 -- -- American common stock issued ................... (56,230) -- -- Gain on extinguishment of debt ................. (426) -- --\nIssuance of common stock to officers ........... $ -- $1,237(b) $ --\nRestructuring of APPL Debt promissory note: Net profits interest conveyed .................. $ -- $ -- $ 2,278 Reduction in loan balance ...................... -- -- 5,657\n(a) The Company capitalized approximately $1.5 million, $2.3 million and $3.3 million of interest in 1994, 1993 and 1992, respectively, based on the Company's weighted average bank borrowing rate for the period.\n(b) Amount consists of notes receivable from officers totaling approximately $230,000 and unearned compensation of approximately $1.0 million, which are both included as reductions in stockholders' equity.\n(15) INDUSTRY SEGMENTS AND GEOGRAPHIC AREAS\nThe Company's only industry segment is oil and gas exploration and production. Information regarding the Company's operations by geographic area for the last three years is presented below (in thousands):\nUNITED OTHER STATES(a) CANADA(b) FOREIGN CONSOLIDATED --------- --------- -------- ------------ YEAR ENDED DECEMBER 31, 1994 Sales to unaffiliated customers ... $ 50,033 $ -- $ -- $ 50,033 Loss from operations .............. (44,727) -- (6,706) (51,433) Identifiable assets ............... 223,894 -- -- 223,894\nYEAR ENDED DECEMBER 31, 1993 Sales to unaffiliated customers ... $ 44,334 $ 5,255 $ -- $ 49,589 Income (loss) from operations ..... 844 822 (13,684) (12,018) Identifiable assets ............... 178,642 -- 6,956 185,598\nYEAR ENDED DECEMBER 31, 1992 Sales to unaffiliated customers ... $ 49,505 $ 9,055 $ -- $ 58,560 Loss from operations .............. (21,812) (36,558) (1,309) (59,679) Identifiable assets ............... 195,180 47,015 14,625 256,820\n(a) In 1994, the Company reported an impairment charge of approximately $25.0 million related to the change in accounting policy for impairment of proved oil and gas properties.\n(b) In 1992, the Company reported an impairment charge of $35.1 million related to the proposed sale of its Canadian foothill properties. In mid-1993, the Company sold all of its Canadian assets.\nIn the year ended December 31, 1994, sales to Enron Corp. accounted for approximately 20% of the Company's oil and gas revenues. Management does not believe that the loss of any single customer would adversely affect the Company's operations.\n(16) QUARTERLY RESULTS - (UNAUDITED)\n(In thousands, except for per share data)\nFIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- YEAR ENDED DECEMBER 31, 1994 (a) Oil and gas sales .................. $ 9,366 $ 11,145 $ 13,355 $ 16,167 Total revenues ..................... 9,433 11,442 13,831 16,653 Loss from operations ............... (11,329) (2,413) (4,035) (33,656) Loss before extraordinary item ..... (12,809) (4,273) (5,608) (37,545) Net loss ........................... (12,809) (2,231) (2,657) (37,119)\nNet loss per common share: Loss before extraordinary item... $ (.19) $ (.07) $ (.08) $ (.37) Extraordinary gain on extinguishment of debt........... -- .03 .04 .01 -------- --------- --------- -------- Net loss per common share....... $ (.19) $ (.04) $ (.04) $ (.36) ======== ========= ========= ======== YEAR ENDED DECEMBER 31, 1993 (b) Oil and gas sales.................. $14,025 $ 14,096 $ 11,352 $ 10,116 Total revenues..................... 14,014 17,113 17,416 9,615 Income (loss) from operations...... (1,217) 3,138 (1,448) (12,491) Net income (loss).................. (3,120) 933 (3,183) (13,816)\nNet income (loss) per common share $ (.04) $ .01 $ (.05) $ (.20)\n(a) In the first quarter of 1994, the Company recorded impairment expense of $6.4 million for the write-off of American's remaining leasehold interest in Tunisia. During the fourth quarter, the Company reported an impairment charge of approximately $25.0 million related to the change in accounting policy for impairment of proved oil and gas properties. Also in the fourth quarter, the Company recorded additional impairment expense of $1.4 million associated with several properties on which no further exploratory work is planned and a $2.0 million severance charge as a result of the APPL Consolidation. In the second, third and fourth quarters of 1994, the Company recorded extraordinary gains of $2.0 million, $3.0 million and $426,000, respectively, which resulted from the elimination of nonrecourse debt through the APPL consolidation.\n(b) In the second quarter of 1993, the Company recorded $9.7 million of gas settlement income resulting from the litigation settlement with LIG and recognized a loss of $5.8 million related to the sales of the Company's Canadian assets. The Company recognized $6.2 million of gas settlement income in the third quarter related to the Thomasville settlement. In the third quarter and fourth quarter, American recorded impairment expense of $4.0 million and $6.2 million, respectively, for the write-off of leasehold interests associated with the Company's international properties.\nQuarterly earnings per common share are based on the weighted average number of shares outstanding during the quarter, and the sum of the quarters may not equal annual earnings per common share.\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES AMERICAN EXPLORATION COMPANY AND SUBSIDIARIES\nCAPITALIZED COSTS (In thousands) UNITED OTHER STATES FOREIGN TOTAL -------- ------- -------- AS OF DECEMBER 31, 1994 Proved properties ......................... $294,048 $ -- $294,048 Unproved oil and gas interests ............ 24,405 -- 24,405 -------- ------ -------- Total capitalized costs ................... 318,453 -- 318,453 Less: Accumulated depreciation, depletion and amortization .............. 128,509 -- 128,509 -------- ------ -------- Net capitalized costs ..................... $189,944 $ -- $189,944 ======== ====== ========\nAS OF DECEMBER 31, 1993 Proved properties ......................... $226,261 $ -- $226,261 Unproved oil and gas interests ............ 24,778 6,914 31,692 -------- ------ -------- Total capitalized costs ................... 251,039 6,914 257,953 Less: Accumulated depreciation, depletion and amortization .............. 103,555 -- 103,555 -------- ------ -------- Net capitalized costs ..................... $147,484 $6,914 $154,398 ======== ====== ========\nCOSTS INCURRED IN OIL AND GAS ACQUISITION, EXPLORATION AND DEVELOPMENT ACTIVITIES\n(In thousands)\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - (CONTINUED)\nRESULTS OF OPERATIONS FOR OIL AND GAS PRODUCING ACTIVITIES\n(In thousands)\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - (CONTINUED)\nOIL AND GAS RESERVE INFORMATION - (UNAUDITED)\nThe following summarizes the policies used by the Company in preparing the accompanying oil and gas reserve disclosures, standardized measure of discounted future net cash flows relating to proved oil and gas reserves and the reconciliation of such standardized measure from period to period.\nProved reserves are estimated quantities of crude oil and natural gas which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are proved reserves that can reasonably be expected to be recovered through existing wells with existing equipment and operating methods.\nThe standardized measure of discounted future net cash flows from production of proved reserves was developed by first estimating the quantities of proved reserves and the future periods during which they are expected to be produced based on year-end economic conditions. The estimated future cash flows from proved reserves were then determined based on year-end prices, except in those instances where fixed and determinable price escalations are included in existing contracts. Finally, future cash flows were reduced by estimated production costs, costs to develop and produce the proved reserves, and certain abandonment costs, all based on year-end economic conditions and the estimated effect of future income taxes based on the current tax law.\nThe standardized measure of discounted future net cash flows does not purport, nor should it be interpreted, to present the fair value of the Company's oil and gas reserves. An estimate of fair value would also take into account, among other things, the recovery of reserves not presently classified as proved, anticipated future changes in prices and costs and a discount factor more representative of the time value of money and the risks inherent in reserve estimates.\nThe information presented on the following pages reflects the sales of the Company's Canadian properties in mid-1993.\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - (CONTINUED)\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVES - (UNAUDITED)\n(In thousands) UNITED STATES CANADA TOTAL --------- --------- --------- YEAR ENDED DECEMBER 31, 1994 Future cash inflows ........................ $ 502,989 $ -- $ 502,989 Future production and development costs .... (258,711) -- (258,711) --------- --------- --------- Future net cash flows before income taxes .. 244,278 -- 244,278 Future income taxes ........................ (2,109) -- (2,109) --------- --------- --------- Future net cash flows after income taxes ... 242,169 -- 242,169 Discount at 10% annual rate ................ (101,463) -- (101,463) --------- --------- --------- Standardized measure of discounted future net cash flows ........................... $ 140,706 $ -- $ 140,706 ========= ========= ========= YEAR ENDED DECEMBER 31, 1993 Future cash inflows ........................ $ 326,768 $ -- $ 326,768 Future production and development costs .... (147,481) -- (147,481) --------- --------- --------- Future net cash flows before income taxes .. 179,287 -- 179,287 Future income taxes ........................ (4,528) -- (4,528) --------- --------- --------- Future net cash flows after income taxes ... 174,759 -- 174,759 Discount at 10% annual rate ................ (71,489) -- (71,489) --------- --------- --------- Standardized measure of discounted future net cash flows ........................... $ 103,270 $ -- $ 103,270 ========= ========= ========= YEAR ENDED DECEMBER 31, 1992 Future cash inflows ........................ $ 456,349 $ 181,326 $ 637,675 Future production and development costs .... (187,031) (88,659) (275,690) --------- --------- --------- Future net cash flows before income taxes .. 269,318 92,667 361,985 Future income taxes ........................ (3,201) (18,926) (22,127) --------- --------- --------- Future net cash flows after income taxes ... 266,117 73,741 339,858 Discount at 10% annual rate ................ (126,374) (32,672) (159,046) --------- --------- --------- Standardized measure of discounted future net cash flows ........................... $ 139,743 $ 41,069 $ 180,812 ========= ========= =========\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - (CONTINUED)\nCHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS - (UNAUDITED)\n(In thousands)\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - (CONTINUED)\nRESERVE QUANTITY INFORMATION - (UNAUDITED)\nEXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS\nAmerican Exploration Company Stock Compensation Plan, effective December 9, 1988 (Form S-8, September 21, 1989, Registration No. 31-31202, Exhibit 4(c)).\nAmerican Exploration Company Amended and Restated 1978 Hershey Oil Corporation Non-Qualified Equity Participation Plan (Form S-4, August 8, 1990, Registration No. 33-36268, Exhibit 10(ccc)).\nAmerican Exploration Company Amended and Restated 1983 Stock Option Plan of Hershey Oil Corporation (Form S-4, August 8, 1990, Registration No. 33-36268, Exhibit 10(ddd)).\nAmerican Exploration Company Amended and Restated 1988 Stock Option Plan of Hershey Oil Corporation (Form S-4, August 8, 1990, Registration No. 33-36268, Exhibit 10(eee)).\nAmerican Exploration Company Exploration Group Investment Plan (Form 10-K, December 31, 1991, Exhibit 10(sss)).\nEmployee Stock Ownership Trust of American Exploration Company, as Amended and Restated Effective January 1, 1991 (Form 10-Q, June 30, 1992, Exhibit 10(b)).\nEmployee Stock Ownership Plan of American Exploration Company, as Amended and Restated Effective January 1, 1991 (Form 10-Q, June 30, 1992, Exhibit 10(c)).\nRevised Employment Agreements, dated September 1, 1994, with the executive officers of American Exploration Company (Form 10-Q, September 30, 1994, Exhibit 10(a)).\nPhantom Stock Plan of American Exploration Company, effective September 21, 1993 (Form 10-Q, September 30, 1993, Exhibit 10(b)).\nX-1\nINDEX OF EXHIBITS\n*3(a) - Restated Certificate of Incorporation of American Exploration Company (Form S-3, July 13, 1994, Registration No. 33-54561, Exhibit 4.1), as supplemented by Certificate of Amendment to Restated Certificate of Incorporation of American Exploration Company (Form S-3, July 13, 1994, Registration No. 33-54561, Exhibit 4.2).\n*3(b) - Amended and Restated Bylaws of American Exploration Company (Form 8-A, March 23, 1994, Exhibit 2).\n*4(a) - Rights Agreement, dated as of September 28, 1993, between American Exploration Company and Society National Bank (Form 8-K, September 28, 1993, Exhibit 4), as supplemented by Amendment to Rights Agreement, dated as of August 3, 1994, between American Exploration Company and Society National Bank (Form 8-K, August 31, 1994, Exhibit 4).\n*4(b) - Certificate of Designation of the $450 Cumulative Convertible Preferred Stock, Series C, dated December 14, 1993 (Form S-3, January 4, 1994, Registration No. 33-51795, Exhibit 4.3), as supplemented by Certificate of Correction to the Certificate of Designation of the $450 Cumulative Convertible Preferred Stock, Series C, dated December 29, 1993 (Form S-3, January 4, 1994, Registration No. 33-51795, Exhibit 4.4).\n*4(c) - Deposit Agreement, dated as of December 10, 1993, by and among American Exploration Company, Harris Trust and Savings Bank and the holders from time to time of Depositary Receipts (Form S-3, January 4, 1994, Registration No. 33-51795, Exhibit 4.5).\n*4(d) - Purchase Agreement, dated as of December 10, 1993, by and among American Exploration Company and each of the purchasers referred to therein (Form S-3, January 4, 1994, Registration No. 33-51795, Exhibit 4.6).\n*4(e) - Registration Rights Agreement, dated as of December 17, 1993, by and among American Exploration Company and each of the purchasers referred to therein (Form S-3, January 4, 1994, Registration No. 33-51795, Exhibit 4.7).\n*4(f) - Form of Stock Certificate representing shares of Convertible Preferred Stock (Form 8-A, March 23, 1994, Exhibit 8).\n*4(g) - Form of Depositary Receipt representing Depositary Shares (Form 8-A, March 23, 1994, Exhibit 9).\n*10(a) - Agreement, dated August 11, 1983, by and between American Exploration Company, Phillip Frost and the other parties signatory thereto, to which is attached the related Form of Agreement of Limited Partnership of South States Development, Ltd. (Form S-14, October 18, 1983, Registration No. 2-87234, Exhibit 10(a)).\n*10(b) - Agreement of Limited Partnership of American Production Partnership - VII, Ltd., dated May 30, 1989, and related Agreements by and between American Exploration Company and the Limited Partners listed therein (Form S-2, October 19, 1989, Registration No. 33- 31646, Exhibit 10(e)).\n*10(c) - Conveyance of Net Profits Overriding Royalty Interest, effective June 1, 1989, from American Exploration Company to Sixty Corp. and related Purchase and Sale Agreement (Form S-2, October 19, 1989, Registration No. 33-31646, Exhibit 10(m)).\nX-2\nINDEX OF EXHIBITS - (CONTINUED)\n*10(d) - Conveyance of Net Profits Overriding Royalty Interest, effective June 1, 1989, from American Exploration Company to GEAPPL Corp. and related Purchase and Sale Agreement (Form S-2, October 19, 1989, Registration No. 33-31646, Exhibit 10(o)).\n*10(e) - Forms of New York Life Oil & Gas Production Partnership Agreements (Amendment No. 4 to Form S-2, January 21, 1988, Registration No. 33-18512, Exhibit 10(gg)).\n*10(f) - Agreement of Limited Partnership, dated October 19, 1988, of American Production Partnership - VI, Ltd., by and between American Exploration Company and the Limited Partners listed therein (Form 10-K, December 31, 1988, Exhibit 10(x)).\n*10(g) - Purchase Agreement, dated March 27, 1987, by and between Ameriplor Corp. and the Purchasers named in Annex I thereto and related financing documents (Form 10-K, December 31, 1986, Exhibit 4(m)).\n*10(h) - Purchase Agreement, dated October 23, 1987, by and between Ninian Oil Finance Corp. and the Purchasers named in Annex I thereto and related financing documents (Amendment No. 2 to Form S-2, December 2, 1987, Registration No. 33-18512, Exhibit 4(q)).\n*10(i) - Purchase Agreement, dated October 20, 1988, by and between American Exploration Acquisition - VI Corp. and the Purchasers named in Annex I thereto and related financing documents (Form 10-K, December 31, 1988, Exhibit 4(f)).\n*10(j) - Second Amended and Restated Agreement of Limited Partnership of Amex Production Partnership, Ltd., effective November 30, 1988 (Form S-2, October 19, 1989, Registration No. 33-31646, Exhibit 10(eee)).\n*10(k) - Second Amended and Restated Agreement of Limited Partnership of American Production Partnership - III, Ltd., effective November 30, 1988 (Form S-2, October 19, 1989, Registration No. 33-31646, Exhibit 10(ggg)).\n*10(l) - Amended and Restated Agreement of Limited Partnership of American Production Partnership - IV, Ltd., effective November 30, 1988 (Form S-2, October 19, 1989, Registration No. 33-31646, Exhibit 10(hhh)).\n*10(m) - Amended and Restated Agreement of Limited Partnership of American Production Partnership - V, Ltd., effective November 30, 1988 (Form S-2, October 19, 1989, Registration No. 33-31646, Exhibit 10(iii)).\n*10(n) - American Exploration Company Stock Compensation Plan, effective December 9, 1988 (Form S-8, September 21, 1989, Registration No. 31-31202, Exhibit 4(c)).\n*10(o) - Agreement of Limited Partnership of American Production Partnership-VIII, Ltd., dated May 1, 1990, and related Agreements by and between American Exploration Company and the Limited Partners therein (Form 10-Q, March 31, 1990, Exhibit 10(d)).\n*10(p) - Conveyance of Net Profits Overriding Royalty Interest, effective May 1, 1990, from American Exploration Company to GEAPPL Corp. (Form 10-Q, March 31, 1990, Exhibit 10(e)).\nX-3\nINDEX OF EXHIBITS - (CONTINUED)\n*10(q) - Conveyance of Net Profits Overriding Royalty Interest, effective May 1, 1990, from American Exploration Company to UNUM Life Insurance Company (Form 10-Q, March 31, 1990, Exhibit 10(f)).\n*10(r) - Conveyance of Net Profits Overriding Royalty Interest, effective August 22, 1990, from American Exploration Company to The Chase Manhattan Bank, N.A., as Directed Trustee for the IBM Retirement Plan Trust (Form 10-Q, September 30, 1990, Exhibit 10(b)).\n*10(s) - American Exploration Company Amended and Restated 1978 Hershey Oil Corporation Non-Qualified Equity Participation Plan (Form S-4, August 8, 1990, Registration No. 33- 36268, Exhibit 10(ccc)).\n*10(t) - American Exploration Company Amended and Restated 1983 Stock Option Plan of Hershey Oil Corporation (Form S-4, August 8, 1990, Registration No. 33-36268, Exhibit 10(ddd)).\n*10(u) - American Exploration Company Amended and Restated 1988 Stock Option Plan of Hershey Oil Corporation (Form S-4, August 8, 1990, Registration No. 33-36268, Exhibit 10(eee)).\n*10(v) - Office Lease, dated December 12, 1990, between JMB\/Houston Center Partners Limited Partnership and American Exploration Company (Form S-4, January 9, 1991, Registration No. 33-38546, Exhibit 10(kkk)).\n*10(w) - Master Forward Agreement, dated as of December 18, 1990, between The Chase Manhattan Bank, N.A. and American Exploration Company and related Amendment (Form S-4, January 9, 1991, Registration No. 33-38546, Exhibit 10(lll)).\n*10(x) - Stock Purchase Agreement by and among American Exploration Company and The Dyson-Kissner-Moran Corporation, dated October 21, 1990 (Form 8-K, October 25, 1990, Exhibit 28(a)).\n*10(y) - Master Exchange Agreement, dated as of February 1, 1991, between American Exploration Company and Morgan Guaranty Trust Company of New York (Form 10-Q, March 31, 1991, Exhibit 10(a)).\n*10(z) - Note Purchase Agreement, dated as of December 27, 1991, re: $35,000,000 11% Senior Subordinated Notes due December 30, 2001 (Form 8-K, January 10, 1992, Exhibit 10(a)), as supplemented by the Amendment to Note Purchase Agreement, dated as of February 16, 1993, by and among American Exploration Company (the \"Company\") and the parties named therein (Form 8-K, February 16, 1993, Exhibit 10(a)), as supplemented by letter agreement, dated March 22, 1993, by and among the Company and the parties named therein (Form 10-K, December 31, 1992, Exhibit 10(zz)), as supplemented by Second Amendment to Note Purchase Agreement, dated as of September 30, 1993, by and among the Company and the parties named therein (Form 10-Q, September 30, 1993, Exhibit 10(c)), as supplemented by Third Amendment to Note Purchase Agreement, dated as of March 18, 1994, by and among the Company and the parties named therein (Form 10-K, December 31, 1993, Exhibit 10(tt)), as supplemented by Fourth Amendment to Note Purchase Agreement, dated as of April 28, 1994, by and among the Company and the parties named therein (Form 10-Q, March 31, 1994, Exhibit 10(c)), as supplemented by Fifth Amendment to Note Purchase Agreement, dated as of July 26, 1994, by and among\nX-4\nINDEX OF EXHIBITS - (CONTINUED)\nthe Company and the parties named therein (Form 10-Q, September 30, 1994, Exhibit 10(c)).\n*10(aa) - Warrant Purchase Agreement and Form of Warrants, dated as of December 27, 1991 (Form 8-K, January 10, 1992, Exhibit 10(b)), as supplemented by Amendment No. 1 to Warrant Purchase Agreement, dated as of February 16, 1993, by and among American Exploration Company and the parties named therein (Form 8-K, February 16, 1993, Exhibit 10(b)).\n*10(bb) - American Exploration Company Exploration Group Investment Plan (Form 10-K, December 31, 1991, Exhibit 10(sss)).\n*10(cc) - Employee Stock Ownership Trust of American Exploration Company, as Amended and Restated Effective January 1, 1991 (Form 10-Q, June 30, 1992, Exhibit 10 (b)).\n*10(dd) - Employee Stock Ownership Plan of American Exploration Company, as Amended and Restated Effective January 1, 1991 (Form 10-Q, June 30, 1992, Exhibit 10 (c)).\n*10(ee) - Stock Purchase Agreement, dated as of September 3, 1992, between American Exploration Company and The Prudential Insurance Company of America (Form 8-K, September 3, 1992, Exhibit 10(a)).\n*10(ff) - Stock Purchase Warrant, dated as of September 3, 1992, between American Exploration Company and The Prudential Insurance Company of America (Form 8-K, September 3, 1992, Exhibit 10(b)).\n*10(gg) - Registration Rights Agreement, dated as of September 3, 1992, between American Exploration Company and The Prudential Insurance Company of America (Form 8-K, September 3, 1992, Exhibit 10(c)).\n*10(hh) - Sale of Securities Offer dated June 4, 1993 (Form 8-K, June 14, 1993, Exhibit 10(a)).\n*10(ii) - Purchase and Sale Agreement, dated as of March 31, 1993, by and among Conquest Exploration Company and New York Life Oil & Gas Operating Production Partnership III-F, New York Life Oil & Gas Operating Production Partnership III-G and New York Life Oil & Gas Operating Production Partnership III-H (Form 8-K, June 14, 1993, Exhibit 10(b)).\n*10(jj) - Stock Purchase Agreement, dated July 8, 1993, by and between Equitable Resources Energy Company and American Exploration Company (Form 8-K, July 7, 1993, Exhibit 10(a)).\n*10(kk) - Purchase and Sale Agreement by and between Conquest Exploration Company and Canadian Conquest Exploration, Inc. with respect to Conquest Ventures Canada, Inc. (Form 8-K, July 7, 1993, Exhibit 10(b)).\n*10(ll) - Phantom Stock Plan of American Exploration Company, effective September 21, 1993 (Form 10-Q, September 30, 1993, Exhibit 10(b)).\nX-5\nINDEX OF EXHIBITS - (CONTINUED)\n*10(mm) - Agreement of Limited Partnership of Ancon Partnership Ltd., dated December 10, 1993, by and between American Exploration Company and NYLIFE Resources, Inc. (Form 10-K, December 31, 1993, Exhibit 10(rr)).\n*10(nn) - Letter Agreement, dated as of April 1, 1994, re: $40,000,000 Secured Credit Facility between American Exploration Company and New York Life Insurance Company (Form 10-Q, March 31, 1994, Exhibit 10(b)).\n*10(oo) - Revised Employment Agreements, dated September 1, 1994, with the executive officers of American Exploration Company (Form 10-Q, September 30, 1994, Exhibit 10(a)).\n10(pp) - Amended and Restated Credit Agreement, dated as of December 21, 1994, among American Exploration Company, the banks listed herein and Morgan Guaranty Trust Company of New York, as agent, and Bank of Montreal, as co-agent.\n10(qq) - Amendment No. 1 to Amended and Restated Credit Agreement, dated as of February 16, 1995, among American Exploration Company, the banks listed herein and Morgan Guaranty Trust Company of New York, as agent, and Bank of Montreal, as co-agent.\n12 - Statements Re Computations of Ratios\n18 - Letter from Arthur Andersen LLP, dated March 30, 1995, re: Change in American Exploration Company's Accounting Policy Related to Recognizing Impairment of Proved Oil and Gas Properties.\n21 - Subsidiaries of American Exploration Company\n23 - Consent of Arthur Andersen LLP\n27 - Financial Data Schedule ------------- * Incorporated herein by reference.\nNote: Copies of Exhibits may be obtained for 30 cents per page, prepaid, by writing to the Investor Relations Department.\nX-6","section_15":""}
{"filename":"778439_1994.txt","cik":"778439","year":"1994","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nRayonier Timberlands, L.P. (the Partnership or RTLP) is a Delaware limited partnership formed by Rayonier Inc. (Rayonier) in October 1985 to succeed to substantially all of Rayonier's timberlands business. Rayonier Forest Resources Company (RFR or Managing General Partner), a wholly owned subsidiary of Rayonier formed in September 1985, is the Managing General Partner of the Partnership and Rayonier is the Special General Partner.\nOn November 19, 1985, Rayonier contributed approximately 1.19 million acres of its timberlands owned in fee or held under long-term leases (the Timberlands) to the Partnership in exchange for 20,000,000 Class A Depositary Units (Class A Units) representing Class A limited partners' interests in the Partnership and 20,000,000 Class B Depositary Units (Class B Units) representing Class B limited partners' interests in the Partnership. Also on such date, in a registered public offering, Rayonier offered and sold 5,060,000 Class A Units. Therefore, at all times after such date to and including December 31, 1994, Rayonier has held 74.7 percent of the Partnership's issued and outstanding Class A Units and 100 percent of the Partnership's issued and outstanding Class B Units.\nOn February 28, 1994, ITT Corporation (ITT), Rayonier's sole shareholder, distributed all the Common Shares of Rayonier to ITT's shareholders. In connection with the distribution, Rayonier changed its name from ITT Rayonier Incorporated to Rayonier Inc. and became a publicly traded company listed on the New York Stock Exchange under the symbol RYN. RTLP will continue to be listed separately and trade under the symbol LOG. Class A unitholders' financial interests have not been affected in any manner by ITT's distribution of Rayonier to its shareholders.\nDESCRIPTION OF BUSINESS\nThe Partnership is engaged in the timberlands business, which includes forestry management, reforestation, timber thinning, and the marketing and sale of standing timber from the Timberlands. The Partnership will occasionally purchase, for short term resale, standing timber from other ownerships. The Partnership's business plan is to operate the Timberlands for sustained long-range harvest and to satisfy the Partnership's need to generate regular cash flow in light of its cash distribution policy as determined from time to time by the Managing General Partner's Board of Directors.\nThe Partnership operates through Rayonier Timberlands Operating Company, L.P. (the Operating Partnership or RTOC), a Delaware limited partnership formed by Rayonier in October 1985, in which the Partnership holds a 99 percent limited partner's interest. RFR is the Managing General Partner of the Partnership and the Operating Partnership, and Rayonier is the Special General Partner of both partnerships. As general partners, Rayonier and RFR hold an aggregate 1 percent interest in each partnership and, therefore, have an aggregate 1.99 percent interest in the Partnership and the Operating Partnership on a combined basis. Unless the context otherwise requires, all references in this Form 10-K to the Partnership are also references to the Operating Partnership.\nThe Partnership negotiates and contracts for the sale of standing timber (stumpage) with buyers who generally cut and pay for the trees during the contract period. Current contracts usually entail a 20 percent deposit and\/or performance bond and generally have a 12- to 24- month life. The Partnership conducts, or contracts for third parties to conduct, harvesting operations if the Managing General Partner believes that the timber cannot be sold as profitably as stumpage or that the tract in question is particularly environmentally sensitive. In addition, the Partnership may sell or exchange portions of the Timberlands and acquire additional timber properties for cash, additional Units, or other consideration.\nPartnership sales to Rayonier for use in Rayonier's specialty pulp products and timber and wood products businesses are an important contributor to Partnership results. For further information, see Timber Markets and Sales; Affiliated Party Transactions.\nSales to Rayonier were 13 percent, 17 percent, and 15 percent of total sales in 1994, 1993, and 1992, respectively. Three customers, under common ownership (not affiliated with the Partnership), accounted for approximately 18 percent, 15 percent, and 34 percent of total revenues in 1994, 1993, and 1992, respectively. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations.\nThe Partnership and the Operating Partnership have no officers, directors, or employees; in addition, RFR has no employees. Officers of RFR and officers and employees of Rayonier perform all management functions for the Partnership. As of December 31, 1994, Rayonier had approximately 2,700 employees of which approximately 150 are active in its U.S. Timberlands Management Business.\nFORESTRY OPERATIONS\nThe Partnership's forest management operations and harvesting schedules are based on biological information, environmental issues, and other data concerning species, site index, classification of soils, estimates of timber inventory, and the types, size, and age classification of the timber base. From this information, the Partnership routinely refines its long-term harvest schedule based on existing and anticipated economic and market conditions, with a view toward maximizing the value of its timber and timberland assets.\nParticular forestry practices vary by geographic region and depend upon factors such as soil productivity, tree size, age, and stocking. Forest stands may be thinned periodically to improve stand quality until they are harvested. Different areas within a forest may be planted or seeded in successive years to provide a distribution of age classes within the forest. A distribution of age classes will tend to provide a regular source of cash flow as the various timber stands reach harvestable age. The Partnership's forest management practices include thinning of timber stands, controlled burning, fertilization of timber plantations, disease and insect control, and reforestation. Reforestation activities include intensive land preparation and planting. The Partnership has a fully established tree improvement program in the Southeast which, in conjunction with its seed orchards and seedling nursery, supplies up to 100 percent of the annual planting requirements with first and second generation genetically improved planting stock. The Partnership also maintains a genetics program in the Northwest, but it cannot yet fully supply that region's seedling needs.\nThe Partnership's activities include the maintenance and building of roads as necessary for timber access within the Timberlands. In the Northwest, either the Partnership or the timber purchaser will build and maintain roads, depending on contract requirements. In the Southeast, it is typically the obligation of the landowner. Each of the major regions within the Timberlands has well established road systems that permit access to substantially the entire area throughout the year. The Timberlands contain over 4,000 miles of roads that, together with public roads and roads built by other private landowners, provide such access.\nThe timing of harvest of merchantable timber depends in part on the maturing cycles of timber and on economic conditions. Timber on the Partnership's 369,000 acres of timberlands in the state of Washington (the Northwestern Timberlands), consisting predominantly of conifer species, is currently thinned at approximately 15 years of age and is harvested after attaining approximately 45-50 years of age. The Partnership's long standing policy has been to reach a sustainable annual harvest level in the Northwest by gradually reducing its harvest volume each year. The projected annual harvest in this region will continue to trend down, with the harvest in the year 2000 approaching 80 percent of the 1994 actual harvest.\nTimber on the Partnership's 793,000 acres of timberland in Georgia, Florida, and South Carolina (the Southeastern Timberlands) typically has a shorter maturity cycle than timber in the Northwestern United States. Pine plantations in the Southeastern Timberlands are harvested after they reach approximately 20-25 years of age. Due to intensive forest and land management as well as silvicultural investment, pine volume available for harvest on the Southeastern Timberlands is expected to increase approximately 2 percent annually. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations. By the year 2000, the annual pine harvest rate in this region is now expected to be nearly 7 percent greater than the 1994 harvest.\nSee Federal and State Regulation for a description of issues which may impact Partnership's timber harvest rates.\nDESCRIPTION OF TIMBERLANDS\nThe Timberlands consist of approximately 1.16 million acres, as of December 31, 1994, located in the state of Washington, primarily on the Olympic Peninsula, and in Georgia, Florida, and South Carolina. Approximately 1.03 million acres are owned in fee, while approximately 137,000 acres are held under long-term lease. Each of these regions contains tracts of timber located within the operating radius of a number of pulp and paper mills, sawmills, plywood mills, and wood treating plants.\nACREAGE. The following table sets forth, as of December 31, 1994, the location and type of ownership that the Partnership has with respect to the Timberlands.\n(1) The long-term leases permit the Partnership as lessee to manage and harvest timberlands throughout the term of the lease. These leases typically have initial terms of approximately 30 to 65 years, with renewal provisions in some cases. The remaining portions of the initial terms of these leases averaged 22 years as of December 31, 1994. Annual rentals are paid to the lessor and, in some cases, the leases provide for payment of a percentage of stumpage values to the lessor as timber is cut. In addition, the leases impose certain duties on the lessee regarding management and reforestation of the leased acres. In general, leased acreage has less value than the same acreage would have if owned in fee because of the obligations imposed upon the lessee under the terms of the lease.\nTimber Inventory. The Timberlands owned in fee or held under long-term leases include, as of December 31, 1994, total estimated merchantable timber inventory of approximately 10.3 million cunits of wood, of which approximately 79 percent is softwood. See definition of Merchantable Timber. A cunit represents 100 cubic feet of fiber and is the customary common unit of measure to consolidate regional information based on local commercial measurements such as board feet or tons. The following table sets forth the volumes of merchantable timber on the Timberlands by location and type, as of December 31, 1994.\n(1) The merchantable timber inventory volumes represent estimates by the Partnership for management purposes based on its continuing inventory system, which involves periodic statistical sampling of the Timberlands, with updating adjustments made on the basis of growth estimates and harvest information. It is not a reflection of the amount of timber that will be available to cut in any specific period of time as future growth is not predicted. See Forestry Operations.\nTHE NORTHWESTERN TIMBERLANDS. The Northwestern Timberlands are located in Washington, primarily on the Olympic Peninsula. All of these Timberlands are owned in fee. The Northwestern Timberlands include approximately 314,000 acres of conifer (softwood) stands, approximately 74 percent of which is stocked with hemlock and the remainder of which is stocked with Douglas fir, western red cedar, and white fir. The Northwestern Timberlands also include approximately 18,000 acres of hardwood timber stands, consisting principally of alder and maple, with lesser amounts of conifers. The remaining 37,000 acres are classified as non-forest lands.\nRain, site, and soil conditions typically cause softwood timber in the Northwest, particularly hemlock, to maintain a relatively high growth rate for a longer period of time in comparison with softwood timber in other parts of the United States, resulting in longer rotation cycles. Site indices for conifer lands in the Northwestern United States generally range from 90 to 145, and average approximately 105. The average site index of the conifer lands in the Northwestern Timberlands is also 90 to 145 and averages approximately 110.\nThe Northwestern Timberlands are near ocean ports and are well-positioned to serve the Pacific Rim export market. Approximately 70 percent of the timber sold from the Northwestern Timberlands has been of export quality. Rayonier operates a pulp mill at Port Angeles. There are also eight pulp and paper mills and numerous sawmills, plywood plants, and other wood converting facilities in the region.\nTHE SOUTHEASTERN TIMBERLANDS. The Southeastern Timberlands are located in Georgia, Florida, and South Carolina and include approximately 656,000 acres of timberlands owned in fee and approximately 137,000 acres held under long-term leases. The Southeastern Timberlands include approximately 510,000 acres of pine (softwood) lands, approximately 268,000 acres of hardwood lands, and approximately 15,000 non-forest acres.\nThe predominant pine species are loblolly and slash pine. Site indices for pine lands in the Southeastern United States generally range from 55 to 65 and average approximately 60. The pine lands included in the Southeastern Timberlands have an average site index of 60. Hardwood lands included in the Southeastern Timberlands are principally bottomlands. Principal hardwood species are red oak, sweet gum, black gum, red maple, cypress, and green ash.\nThe Southeastern region is generally recognized as being the most competitive timberlands area in the United States. There are 19 pulp and paper mills and numerous sawmills, plywood plants, and treating plants for poles and pilings located in the area of the Southeastern Timberlands. Rayonier operates two sawmills and two pulp mills in this region.\nSTUMPAGE PRICES AND INDUSTRY CONDITIONS\nStumpage prices vary depending on the market for end-use products that rely on timber and wood fiber as raw materials. Stumpage values tend to be higher for larger diameter trees because of higher-value end uses. Larger diameter trees are used as sawtimber, which is processed into lumber, plywood, and poles, while smaller diameter trees are used as pulpwood for the manufacture of paper and pulp. International as well as domestic supply and demand forces (including the value of the U.S. dollar in foreign exchange markets) also affect U.S. regional stumpage prices. Local stumpage prices are dependent upon factors such as geographic location of the property, proximity to a mill or export facility, logging conditions, accessibility of the timber, size and quality of the timber, species composition of the stand, and the timber volume per acre.\nThe Northwest and the Southeast represent major timber growing regions of the United States. In both areas, timber markets are very competitive, but each region has different types of timber, markets, and competitive factors.\nFor further information see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations and Future Operations.\nCOMPETITION\nThe Partnership's timberlands are located in two major timber growing regions of the United States (the Southeast and the Northwest), where timber markets are fragmented and very competitive. In the Northwest, stumpage sold by Hancock Insurance Company and from Washington state owned public forests is the most significant competition. In both the Northwest and Southeast, smaller forest products companies and private land owners compete with the Partnership. Price is the principal method of competition in this market.\nTIMBER MARKETS AND SALES; AFFILIATED PARTY TRANSACTIONS\nThe Partnership sells timber provided by the Timberlands to Rayonier and to unaffiliated domestic purchasers. See Stumpage Prices and Industry Conditions for a discussion of end-use markets for the Partnership's timber.\nSince the inception of the Partnership, 34 percent of its timber sales in the Northwest and 14 percent of its timber sales in the Southeast have been to Rayonier. The following table shows the volumes of timber sold by the Partnership to Rayonier for the three years ended December 31, 1994. It also shows the volumes of timber on the Timberlands that were sold to unaffiliated purchasers for the periods indicated.\nRayonier continues to rely on the Timberlands as one of its sources of timber for its pulp mills, sawmill facilities, and its log trading business. For example, although Rayonier directly purchased only 5 percent of the Partnership's 1994 Southeast harvest volume, the Partnership estimates that an additional 13 percent of its pulpwood timber sold in the Southeast in 1994 was purchased by Rayonier on the open market from Partnership customers. See Conflicts of Interest. Any shutdowns of plants or curtailments of sales by customers for Partnership timber, including Rayonier, could adversely affect future volumes of timber sales by the Partnership or the prices at which such sales are made.\nRayonier's Timberlands Management business is responsible for management of the Timberlands for the benefit of the Partnership; its organization is separate from Rayonier's log trading and wood procurement businesses, which are responsible for timber procurement by Rayonier. In conducting the activities described in the following paragraphs with respect to negotiations and other relationships between the Partnership and Rayonier, employees of Rayonier's Timberlands Management business act on behalf of the Partnership and employees of Rayonier's log trading and wood procurement businesses act on behalf of Rayonier.\nThe Partnership develops an annual sales plan identifying the specific tracts to be sold. The Partnership's strategy is to award contracts during those periods of the year (typically the first and fourth quarters) in which it expects to receive the best prices. However, under current market conditions, the Partnership is placing fewer sales out for bid at one time. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations.\nBefore the Partnership offers a tract for sale, it determines whether the highest price is likely to be achieved through public bid or direct negotiation. The Partnership considers such factors as timber quality, unusual logging conditions, number of potential bidders, and general market activity. In 1994, approximately 91 percent in the Northwest and 74 percent in the Southeast of the total contract value of contracts entered into by the Partnership were awarded through public bid; when Rayonier submits a bid, it is treated no differently than bids from unaffiliated parties. Occasionally, tract and market circumstances favor a negotiated sale to a target buyer. Of the contract value awarded through direct negotiation in 1994, approximately 3 percent in the Northwest and 7 percent in the Southeast were purchased by Rayonier.\nTypically, the Partnership attempts to structure sales contracts with Rayonier and unaffiliated purchasers as transactions in which the Partnership retains title to the timber until it is severed and the purchaser assumes responsibility for delivery. In these cases, the Partnership recognizes income for both financial statement and tax purposes when and as the timber is cut and measured. Accordingly, there is a time lag between the signing of a sales contract and the recognition by the Partnership of income therefrom.\nThe Partnership's contracts, whether with Rayonier or with unaffiliated purchasers, generally provide for payment of a fixed price per unit (by species and volume in the Northwest and by weight in the Southeast), cutting over periods of up to 24 months in the Northwest and up to 18 months in the Southeast, an initial deposit, and utilization standards that the buyer must satisfy when cutting and removing timber from the property. The Partnership's contracts with unaffiliated purchasers may require a performance bond from the buyer, whereas the Partnership does not require such a bond from Rayonier. All contracts between Rayonier and the Partnership are subject to review by the Conflicts Committee established by RFR's Board of Directors. See Conflicts of Interest.\nFor information as to timber sales contracts in effect at December 31, 1994, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations.\nCONFLICTS OF INTEREST\nConflicts of interest can arise in selecting, pricing, and scheduling timber sold to Rayonier. Other conflicts of interest can arise in allocating revenues and costs between the Class A Units and the Class B Units, in scheduling timber sales to occur before or after the Initial Term expires, and in setting the terms of any loans between the Partnership and Rayonier. The Conflicts Committee of the Board of Directors of RFR, which is comprised of non-employee directors, reviews these transactions and obtains opinions from outside consultants as to their fairness.\nENVIRONMENTAL PROTECTION\nManagement of the Timberlands to protect the environment is a continuing concern of the Partnership. The Partnership expends considerable efforts to comply with regulatory requirements for reforestation, protection of streams and wildlife habitat, use of pesticides, and minimization of stream sedimentation and soil erosion. From time to time the Partnership volunteers to, or may be required to, clean up certain dump sites created by the general public. The Partnership also participates in cooperative projects with environmental agencies, such as a program with the Georgia Department of Natural Resources to monitor hairy rattleweed, a threatened species, and another effort with the U.S. Fish and Wildlife Service to develop an information base on whether Bartram's Ixia constitutes an endangered species. See Federal and State Regulation.\nThe costs of environmental compliance by the Partnership have not been significant and are not expected to be significant in the future. The Partnership does not project any significant capital expenditures for environmental protection.\nFEDERAL AND STATE REGULATION\nIn the management and operation of the Timberlands, the Partnership is subject to various state and federal laws regulating land use. To some degree, these laws may operate as constraints on the manner in which portions of the Timberlands are managed and operated and the markets into which the timber from the Timberlands may be sold.\nRegional timber availability continues to be restricted by legislation, litigation, and pressure from various preservationist groups. Over the past four years, the harvest of timber from private lands in the state of Washington has been restricted as a result of the listing of the northern spotted owl as a threatened species under the Endangered Species Act (ESA). These restrictions have caused the Partnership to restructure and reschedule some of its harvest plans. The U.S. Fish and Wildlife Service has developed a proposed rule under the ESA to redefine protective measures for the northern spotted owl on private lands. This rule, as currently drafted, would reduce the harvest restrictions on private lands except within specified special emphasis areas, where restrictions would be increased. One proposed special emphasis area is on the Olympic Peninsula, where a significant portion of the Partnership's Washington timberlands is located. Separately, the state of Washington Forest Practices Board is in the process of adopting new harvest regulations to protect the northern spotted owl and the marbled murrelet (also recently listed as a threatened species). The State Department of Natural Resources draft of this rule also provides for a special emphasis area to protect the northern spotted owl on the Olympic Peninsula, which would increase harvest restrictions on the Partnership's lands. The Partnership is unable at this time to predict the form in which the federal or state rules will eventually be adopted. However, if either rule is adopted in the form proposed by the respective agencies, the result will be some reduction in the volume of Partnership timber available for harvest.\nThe Partnership's operations are subject to laws restricting or regulating to some extent development and\/or logging activity near coastal shorelines. In addition, land located in areas exposed to flood hazard is subject to regulations specifying acceptable types of development. The federal government regulates the use of \"wetlands\" pursuant to the Clean Water Act, the Rivers and Harbors Act, and the Federal Water Pollution Control Act. The Timberlands include property designated as wetlands, and the Partnership is subject to permit procedures imposed by both federal and state agencies in connection with any logging or developmental activity on such land. In addition, activity is regulated on lands adjacent to scenic rivers designated under federal and state Wild and Scenic Rivers Acts. Reforestation by independent contractor crews is regulated by the federal Migrant and Seasonal Worker Protection Act, which imposes upon the landowner the burden of insuring to the federal government regulatory compliance by the contractor.\nPortions of the Timberlands are located within, or adjacent to, National Forests. Access to such parcels may be obtained generally through road-use permits subject to the terms and conditions of applicable regulations. Access across Forest Service land may be restricted where habitat of threatened or endangered species is involved.\nThe state of Washington has enacted several laws that regulate or limit forestry operations. The most comprehensive of these is the Forest Practices Act, which addresses many growing, harvesting, and processing activities on forest lands. Among other requirements, the Forest Practices Act imposes certain reforestation obligations on the owner of forest land. The Act restricts the size of clear-cut harvests, restricts timber harvest to protect wildlife listed as threatened or endangered, and requires that timber be left standing in stream buffers and wildlife management areas. Other Washington state laws regulate timber slash burning, operations during fire hazard periods, logging activities affecting or utilizing watercourses or in proximity to certain ocean and inland shorelines, and some grading and road construction activities.\nThe states of Georgia and Florida also regulate forestry operations. Subsequent to July 1, 1993, Georgia statutory law mandates all timber sales to be by tonnage or actual measured volume, prohibiting sales where payment is based upon conversion factors from volume to tonnage or vice versa. Florida and Georgia both regulate slash burns, control burns, and logging activities within streamside management zones. Florida law and regulation limit activities allowable or permittable in wetlands, and the state continues to develop integrated regulations under statutory mandate for ecosystem management.\nThe Partnership is complying, and intends to comply, with these federal and state laws regulating its use of the Timberlands and does not expect them, as currently enacted, to be materially burdensome. There can be no assurance, however, that future legislative, regulatory or judicial decisions would not adversely affect the Partnership or its ability to harvest the Timberlands in the manner otherwise contemplated. In particular, although recently imposed restrictions on the export of logs from the Northwest have only affected state lands, political pressure to restrict log exports from the Northwest continues. If, in the future, restrictions should be imposed on the export of logs from private lands, the revenue and earnings of the Partnership could be adversely affected.\nPARTNERSHIP'S TITLE; CLAIMS AND INTERESTS OF OTHERS\nRayonier transferred record title of the Timberlands, excluding any oil, gas or mineral interests, to the Partnership without warranty. The Partnership's title to the Timberlands is subject to presently existing easements, rights of way, flowage rights, servitudes, cemeteries, camp sites, hunting and other leases, licenses, permits, undertakings, and any other existing encumbrances or title defects. Properties acquired by the Partnership in the future generally will be acquired and held on record in the Partnership's name, but Rayonier will have the right to purchase the underlying mineral interests.\nThe Partnership owns only the merchantable timber rights (except for 50 trees per acre) on approximately 17,000 acres of real estate owned by Rayonier and Rayland Company, Inc., a real estate subsidiary of Rayonier.\nThe state of Florida claims title to lands within Florida that were under navigable waters in 1845 when Florida became a state. Affected lands include not only those still under water but lands that are now uplands due to drainage, fill, or other past activity. The Partnership does not believe that the encumbrances or defects to which its title is subject, or any possible reclamation by the state of Florida, would have a material adverse impact on the Timberlands as a whole.\nDESCRIPTION OF PARTNERSHIP\nALLOCATIONS OF PARTNERSHIP INTEREST. The Partnership records all of its activities in two accounts, the Primary Account and the Secondary Account. Income and expenses are recorded in the Primary Account if they affect timber that is expected to be harvested on or before December 31, 2000 (the Initial Term) and in the Secondary Account if they relate to the Partnership's other assets (including timber that is not planned to be harvested until after December 31, 2000). During the\nInitial Term, the Secondary Account is essentially an investment account to which the expenditures and debt related to longer-term harvests are assigned.\nThe Class A unitholders, the Class B unitholders, and the General Partners all participate in both accounts, but in different percentages. The participation of the partners in the revenues and expenses of the Partnership is as follows:\nWhen the Partnership makes a sale of timberland that includes timber, the proceeds are divided between the Primary and Secondary Accounts. Proceeds arising from trees that would have been harvested prior to December 31, 2000 are allocated to the Primary Account. The balance of the proceeds, which apply to the underlying land and timber planned to be harvested beyond the year 2000, are allocated to the Secondary Account.\nTERMS OF THE PARTNERSHIP AGREEMENT. The Partnership Agreement provides that the Partnership continues in existence until December 31, 2035, but that the Initial Term of the Partnership will end on December 31, 2000. At the end of the Initial Term, there will be no distributions of the partners' capital accounts, but the Primary Account will be closed following distribution of any cash remaining in that account (after the repayment of all Partnership borrowings attributed to the Primary Account) concurrently to all partners in accordance with their respective Primary Account percentage interests as indicated in the above table. The Managing General Partner expects that most of the cash credited to the Primary Account (and not used to repay borrowings) will have been distributed prior to the end of the Initial Term. Therefore, unitholders should not expect to receive a return of their original investment or any substantial amount of cash as a result of the end of the Initial Term on December 31, 2000. After 2000, all unitholders and General Partners will only participate in the Secondary Account, so that Class A unitholders will then have a 4 percent interest in all Partnership activities. Through the Initial Term, the Secondary Account will incur substantial debt attributable to reforestation and the management of the timber base to be cut after the year 2000. This debt will have to be repaid from future cash flow beginning in 2001 and will reduce the amount available for distribution after the end of the Initial Term.\nCLASS A UNITHOLDERS SHOULD EXPECT THAT THE MARKET PRICE OF CLASS A UNITS WILL BEGIN TO DECREASE SUBSTANTIALLY SOMETIME PRIOR TO DECEMBER 31, 2000. AS INDICATED ABOVE, THEY WILL PROBABLY NOT RECEIVE ANY SIGNIFICANT AMOUNT OF CASH AS A RESULT OF THE END OF THE INITIAL TERM IN THE YEAR 2000. THE PERCENTAGE OF CASH AVAILABLE TO THEM FROM PARTNERSHIP HARVESTING ACTIVITIES AFTER THAT YEAR (AFTER ALLOWING FOR THE REPAYMENT OF SECONDARY ACCOUNT DEBT) WILL DECLINE FROM 95 PERCENT TO 4 PERCENT.\nDISTRIBUTIONS. A unitholder (Limited Partner) of Rayonier Timberlands, L.P., assuming there are sufficient sales and profits, will receive cash distributions from the Primary Account activity. In accordance with the Partnership Agreement, the distribution policy is to make quarterly distributions to Class A unitholders from cash available from operations after provision for working capital, capital expenditures, asset acquisitions, and such other reserves as the Managing General Partner's Board of Directors deems appropriate.\nOn February 17, 1995, the Board declared a first quarter distribution of $1.90 per Class A Unit payable on March 31, 1995 to unitholders of record February 28, 1995. The amount represents operating results and distribution of excess working capital from fiscal 1994 operations. The previous quarterly distribution was $1.30. A portion of the distribution represents return of capital, depending on each unitholder's tax basis. As the Initial Term approaches its expiration date (December 31, 2000), the Board has determined that capital needs for reserves, acquisitions, and working capital will be less and that excess cash will be distributed. Future distributions will approximate actual Partnership results each year. This will be accomplished by keeping the distribution relatively constant in the second, third, and fourth quarters and by making an adjustment in the first quarter of the year following to bring the cumulative distribution in line with Partnership results. The first quarter 1995 distribution of $1.90 includes this adjustment. It is expected that the second quarter distribution will be less than the first. The Board indicated that it would continue to maintain a minimum of cash in working capital to be distributed following the end of the Initial Term.\nTAXES. Rayonier Timberlands, L.P. is a partnership and is not taxed as a corporation. Each unitholder is responsible for taxes on his or her proportionate share of the Partnership's income. Each year, the Managing General Partner will provide unitholders with the necessary tax information based on the unitholder's apportioned share of income and expense from the Partnership. The income reported for each individual unitholder will vary substantially from the income reported in the financial statements, as the unitholder's income is based on his or her cost of acquisition (the market price of the unit at the time of acquisition), and not on the Partnership's historical cost basis as reported in the financial statements.\nTo the extent distributions exceed the income reported for a unitholder and the unitholder has remaining tax basis in the units, such distributions are treated as a return of capital and are not taxable. As such, the distributions serve to reduce the unitholder's basis in the units.\nBeginning with 1994, only a portion of the Partnership's income will constitute unrelated business income. Tax-exempt entities (including IRAs and other retirement plans) may be required to report their income from the Partnership to the Internal Revenue Service as unrelated business taxable income and pay taxes on such income.\nGLOSSARY OF FORESTRY TERMS\nThe terms defined below relate to the timber industry in general.\nBOARD FOOT (BF): A unit of measure for sawtimber as well as lumber that is 12 inches square and one inch thick.\nBOTTOMLANDS: The flood plains of streams, creeks and rivers that generally support quality hardwood stands.\nCLEAR-CUT: Harvesting all trees in a stand of timber at the same time. Usually done to prepare for establishing a plantation or for converting the land to crop, pasture, or other use.\nCONTROLLED BURNING: Setting fire to the forest floor to reduce the accumulation of logging debris, dead and fallen timber, weeds, and underbrush that pose a wildfire hazard or compete with the trees for water and nutrients.\nCORD: A unit of measure equal to a stack of wood 4x4x8 feet, or 128 cubic feet of wood, bark, and air. A common unit of measure for pricing pulpwood.\nCUNIT: A unit of measure for standing timber equal to 100 cubic feet of solid wood. It is the customary common unit of measure to consolidate regional information based on local commercial measurements such as board feet or tons. A cunit equals approximately .43 MBF or 3.8 tons.\nCUTTING CONTRACTS: A contractual right to cut certain described timber over a specified period of time on a specified tract of property.\nD.B.H.: The abbreviation means \"diameter at breast height,\" a term frequently used to describe a tree measurement taken 4 1\/2 feet above the average ground level.\nHARDWOODS: Trees that usually have broad leaves and are deciduous (losing leaves every year).\nMBF: One thousand board feet. A common unit of measure for pricing standing timber as well as lumber.\nMERCHANTABLE TIMBER: Minimum size timber for which there might be a commercial market. In the South, trees as small as five inches D.B.H. can be used by the industry while in the Northwest trees must be much larger to be usable. For convenience, the Partnership follows the convention that timber older than 13 years in the Southeast and 40 years in the Northwest is of minimum merchantable size. It should be recognized that timber of minimum merchantable size has not yet reached its optimum economic value and the typical harvest cycle is about 25 years in the Southeast and 55 years in the Northwest.\nNATURAL REGENERATION: The process of a forest regenerating itself with seeds from mature trees or sprouts from stumps or roots. Natural regeneration results in new tree growth without regard to genetic quality of the trees.\nNATURAL STAND: A forest stand resulting from natural regeneration.\nNON-FOREST LANDS: Lands consisting of or containing roads, water or easements, such as gas and electric transmission lines, timbered buffers not harvested due to environmental concerns, currently non-commercially viable acreage, and certain wastelands.\nPLANTATION: A timber stand established by planting seedlings in a prepared seedbed. Trees in a plantation are of the same age and size, which tends to simplify harvesting.\nPOLES: Straight, tall trees suitable for manufacturing telephone poles, wharf pilings or the like, typically at least eight inches in diameter at the base and at least 25 feet tall. Trees suitable for use as poles generally command a superior price.\nPRE-MERCHANTABLE TIMBER: Usually young or small size timber for which no commercial market exists. For example, in the Southeast, pine trees under five inches D.B.H. and in the Northwest, timber stands less than 40 years of age.\nPULPWOOD: Wood used to produce pulp in the manufacture of paper and other cellulose products; normally cut from trees that are approximately five to eight inches D.B.H., or trees over eight inches D.B.H. which are either too small, of inferior quality, or the wrong species to be used in the manufacture of lumber or plywood.\nSAWTIMBER: Trees containing logs of sufficient size and quality to be suitable for conversion into lumber or plywood.\nSEEDLINGS: Live trees less than one inch in diameter at ground level.\nSILVICULTURE: The practice of cultivating forest crops based on the knowledge of forestry; more particularly, controlling the establishment, composition, and growth of forests.\nSITE INDEX: A measure of forest site quality, which takes into account topography, soil fertility, moisture, and other factors affecting forest growth rates. A site index indicates the height (in feet) an average dominant tree of a given species will attain on that site in a well-stocked stand in a given period, generally 50 years in the Northwest and 25 years in the Southeast.\nSOFTWOODS: Coniferous trees, usually evergreen and having needles or scale-like leaves, such as Douglas fir, white pine, spruce, and loblolly pine. In the Pacific Northwest, softwood timber is commonly referred to as conifer.\nSTAND: An area of trees possessing sufficient uniformity of age, size, and composition to be distinguishable from adjacent areas so as to form a management unit. The term is usually applied to forests of commercial value.\nSTOCKING: An indication of the number of trees in a stand as compared to the desirable number for best growth and management, such as well-stocked, over-stocked, or partially stocked.\nSTUMPAGE VALUE: The value of standing timber (timber as it stands uncut in the woods).\nSUPERIOR SEEDLINGS: Seedlings that are the product of a genetic breeding program. Superior seedlings produce trees that grow faster, are of higher quality, and are more disease resistant than their ordinary counterparts.\nTHINNING: Removal of selected trees, usually to eliminate overcrowding, to remove diseased trees and to promote more rapid growth of desired trees.\nTIMBER DEED: An instrument conveying certain described timber on a specific tract of property and providing a term during which the timber may be cut and removed.\nTIMBER INVENTORY: As defined under Description of Timberlands - Timber Inventory.\nWOOD FIBER: Generally refers to pulpwood or chips used in the manufacture of pulp and paper.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSee Item 1. Business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is a party to several legal proceedings incidental to its business. Neither the Partnership nor its counsel believes that any liability or costs related to such proceedings will have a material adverse effect on the financial position or results of operations of the Partnership.\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 period covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe above table reflects the range of market prices of RTLP Class A Units as reported in the consolidated transaction reporting system of the New York Stock Exchange, the principal market in which this security is traded, under the trading symbol LOG.\nDuring the two-month period ended February 28, 1995, the high and low market prices of RTLP Class A Units were $38.25 and $35.25.\n(a) Includes a $4.00 per Class A Unit special distribution paid on March 31, 1994.\nOn February 17, 1995, the Board of Directors of RFR declared a first quarter distribution of $1.90 per Class A Unit payable on March 31, 1995 to unitholders of record February 28, 1995. The amount represents operating results and distribution of excess working capital from fiscal 1994 operations. The previous quarterly distribution was $1.30. A portion of the distribution represents return of capital, depending on each unitholder's tax basis. As the Initial Term approaches its expiration date (December 31, 2000), RFR has determined that capital needs for reserves, acquisitions, and working capital will be less and that excess cash will be distributed. Future distributions will approximate actual Partnership results each year. This will be accomplished by keeping the distribution relatively constant in the second, third, and fourth quarters and by making an adjustment in the first quarter of the following year to bring the cumulative distribution in line with Partnership results. The first quarter 1995 distribution of $1.90 includes this adjustment. It is expected that the second quarter distribution will be less than the first. The Board indicated that it would continue to maintain a minimum of cash in working capital to be distributed following the end of the Initial Term. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Cash Flow.\nAs of February 28, 1995, there were approximately 2,900 unitholders of record of Class A Units.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected historical financial information set forth below is derived from the financial statements of Rayonier Timberlands, L.P. Such selected historical financial information should be read in conjunction with such financial statements and notes thereto appearing elsewhere herein.\n(1) The consolidated harvest activity is expressed in cunits, a unit of measure for standing timber equal to 100 cubic feet of solid wood. A cunit is the customary common unit of measure that is used to consolidate regional information based on local commercial measurements such as thousand board feet (MBF) or tons. A cunit equals approximately .43 MBF or 3.8 tons.\n(2) The Northwestern Timberlands are in the state of Washington and consist of approximately 369,000 acres owned in fee, and contain approximately 2.3 million MBF of wood, approximately 92 percent of which is softwood. Stumpage volumes for 1992, 1991, and 1990 exclude the Quinault timberland sales.\n(3) The Southeastern Timberlands are in the states of Georgia, Florida, and South Carolina and consist of approximately 793,000 acres owned in fee or held under long-term leases, and contain approximately 19.0 million tons of wood, approximately 66 percent of which is pine.\n(4) Cash distributions in 1994 include a $4.00 per Class A Unit special distribution paid on March 31, 1994.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nEarnings for 1994 improved 49 percent over 1993 reflecting higher stumpage volume and improved prices in the Partnership's Northwest region as customers carried over 1993 timber sales contracts into the first quarter of 1994.\nThe following table summarizes the sales, operating income, partnership income, and selected operating statistics of the Partnership, for the periods indicated, by United States geographic region (thousands):\nTimber and timberland sales in 1994 were up 43 percent from 1993. Partnership income was up $40.7 million, or $1.96 per Class A Unit, over 1993 results. Sales in 1993 of $116.0 million, decreased $0.4 million from 1992 and partnership income of $82.2 million decreased 4 percent from 1992, which included significant timberland sales.\nTimber harvest sales in 1994 were up 44 percent from 1993, following a 17 percent increase in 1993. Higher 1994 sales resulted from higher stumpage volume and improved prices in the Northwest region as Partnership customers carried over 1993 timber sales contracts into the first quarter of 1994. In 1993, sales reflected an overall improvement in prices due to worldwide concern over timber availability and increased harvest activity in the Southeast region, partially offset by the reduced harvest volume in the Northwest region.\nIn 1994, timber sales to Rayonier represented 13 percent of total timber sales compared to 17 percent in both 1993 and 1992. Timber sales to three customers under common ownership (not affiliated with the Partnership) accounted for approximately 18 percent, 15 percent, and 10 percent of total timber sales in 1994, 1993, and 1992, respectively. In 1992, the\nPartnership also had one other unaffiliated customer who accounted for approximately 12 percent of timber sales. See Note 4 of the accompanying Notes to Financial Statements for further information.\nTimberland sales in 1994 were $1.3 million, up $0.2 million from 1993, which, in turn, were $16.7 million lower than 1992 levels. Sales for 1992 included $16.8 million from two major timberland tract sales in the Northwest region to the Quinault Indian Nation. The tracts sold in 1992 contributed $15.6 million to Partnership income and completed the Partnership's program to divest land within the Quinault Indian Reservation.\nIncome per publicly traded Class A Unit was $6.41 in 1994, up $1.96 from 1993. Results in 1993 were down 4 cents from 1992. Excluding the effect of the 1992 Quinault timberland sales, which generated 61 cents of income per publicly traded Class A Unit, 1993 results improved by 57 cents per unit over the prior year.\nOperating cash flow allocable to Class A unitholders, after capital expenditures and certain provisions for working capital, was $132.8 million in 1994, up $40.3 million, or $1.98 per unit, from 1993. Operating cash flow in 1993 was $0.4 million, or 6 cents per unit, lower than 1992. In 1992, operating cash flow allocable to a Class A Unit includes 63 cents from the Quinault timberland sales.\nMost of the timber from Partnership lands in the Northwest is resold by the Partnership's customers into log export markets, primarily in Japan, Korea, and China. Unfavorable market conditions in 1993 caused many customers to defer harvesting until 1994. As a result, the harvest level was unusually low in 1993 and unusually high in 1994, rising 36 percent to 194 million board feet. Stumpage prices, which also benefited from the carryover of high-priced 1993 contracts, increased 25 percent over the prior year. As a result of increased volume and prices, 1994 timber sales rose 63 percent to $115.0 million and operating income rose 68 percent to $94.6 million. Although timber sales in 1993 increased 9 percent to $70.6 million, operating income decreased 18 percent to $56.2 million reflecting lower 1993 timberland sales. In 1993, average stumpage prices in the Northwest were 53 percent above 1992 levels as limited timber availability throughout the Northwest caused contract stumpage prices to rise steadily late in 1992 and into the second quarter of 1993. During the second half of 1993, prices declined due to high consumer inventories and a marked increase in alternative global timber supplies. Total 1993 sales volume in the Northwest of 143 million board feet represented a decrease of 27 percent from the 1992 levels as harvesting of contract timber slowed in response to changing market conditions and the Partnership's continuing program of gradually reducing the amount of timber offered in the region. See Future Operations.\nIn the Southeast, pulpwood timber is sold by the Partnership's customers for the production of pulp and paper with sawlog timber sold to lumber and plywood manufacturers. Timber sales for 1994 were $50.2 million, up $5.9 million from 1993 and operating income increased $5.7 million to $39.2 million. In 1994, harvest volume peaked in the third quarter due to heavy rains and flooding, which caused customers to accelerate harvesting on drier Partnership lands. Harvest volume returned to a more normal level in the fourth quarter. Overall, 1994 pine volume increased 9 percent over the prior year to 1.9 million tons. Pine prices increased approximately 4 percent, reflecting increased demand for high quality sawlogs. In 1993, timber sales were $44.3 million, up 32 percent from 1992, reflecting both stronger pricing and increased harvest volumes. Operating income in the Southeast rose 42 percent to $33.5 million in 1993. Southeast pine prices were 24 percent higher than 1992 levels, benefiting from worldwide concern over timber availability and from strong demand for lumber as a result of the resurgence in U.S. housing. In 1993, Southeast pine volume was 1.7 million tons, increasing 7 percent from 1992.\nCorporate and other operating income is comprised of general and administrative expenses not specifically attributable to either the Northwest or Southeast regions. Corporate expenses decreased $0.6 million during 1994 to $1.7 million, primarily due to lower commission expenses paid to a foreign sales corporation affiliated with the Partnership's Special General Partner, Rayonier. Legislation, enacted effective August 10, 1993, eliminated tax benefits related to log exports for foreign sales corporations. The Partnership's commission expense was fully allocated to Rayonier and the General Partners, and therefore the legislation did not impact the earnings or cash flows of the publicly traded Class A Units. See Note 1 of the accompanying Notes to Financial Statements for further information. In 1993, corporate expenses decreased $1.0 million to $2.3 million, reflecting lower commission expenses paid to the foreign sales corporation.\nHarvest activity in 1994 peaked in the first quarter due to the carryover of 1993 harvest volume in the Northwest and again in the third quarter due to the unusually wet weather in the Southeast. Overall, 50 percent of the full year harvest was cut by June 30, 1994. During 1993 and 1992, harvest activity followed the historical cutting pattern that is more concentrated in the first half of the year, with 59 percent and 60 percent, respectively, of the total cut completed by June 30.\nThe Partnership is continuing its strategy of gradually reducing the amount of timber offered each year in the Northwest until it reaches a sustainable harvest level. See Future Operations. In the Northwest, the 1995 harvest plan contemplates a harvest volume approximately 7 percent lower than the 1994 volume, which included the 1993 carryover volume. As of December 31, 1994, contracts representing 25 percent of the projected 1995 harvest volume were outstanding. As of\nDecember 31, 1993, outstanding contracts represented 30 percent of the actual 1994 harvest volume. Three customers under common ownership (not affiliated with the Partnership) accounted for approximately 12 percent of the harvest volume under contract as of December 31, 1994. In addition, two other unaffiliated customers accounted for approximately 23 percent and 19 percent, respectively, of the uncut volume under contract at December 31, 1994. Outstanding Northwest contract prices at December 31, 1994 are 14 percent lower than the average of harvest prices realized in 1994. In 1994, realized prices included the effect of the high-priced 1993 carryover volume.\nThe Southeast 1995 harvest plan anticipates a volume reduction of approximately 5 percent from 1994 to balance 1994's higher than planned harvest. In the Southeast, the Partnership awarded contracts for 32 percent of the 1995 harvest plan volume as of December 31, 1994. As of December 31, 1993, outstanding contracts represented 15 percent of the actual 1994 harvest volume. Average prices on uncut contracts at December 31, 1994 are approximately 11 percent higher than those realized for the 1994 actual harvest in the region.\nOperating costs and expenses in 1994 were $37.0 million, up $6.2 million from 1993, which was up $1.0 million from 1992. Cost of timber sold rose $6.5 million in 1994 primarily due to higher logging costs in the Northwest region resulting from increased contract logging and commercial thinning activities. In addition, forest excise taxes and road costs rose due to increased timber sales in the Northwest. In 1993, cost of timber sold rose $2.7 million from 1992, due to higher logging costs in the Northwest region. The cost of timberland sold was $0.4 million in both 1994 and 1993, and was $2.1 million in 1992 due primarily to the Quinault timberland sales.\nInterest income, earned mainly from the Primary Account's investment notes of Rayonier, decreased $1.9 million to $3.2 million in 1994 due to a lower average balance of investment notes. Interest expense on increased loans and advances to the Secondary Account by Rayonier rose $1.6 million to $11.1 million.\nFUTURE OPERATIONS\nThe Partnership's harvesting plans, and therefore its earnings and cash flow, can be substantially affected by the cyclical nature of timber markets both in general and on a geographical basis. In addition, various legislative initiatives, such as major restrictions on timber clear-cutting, export restrictions on logs sourced from privately owned properties, harvest restrictions to protect threatened or endangered species, and limitations on timber harvesting on wetlands, could adversely affect Partnership results. Moreover, in certain economic situations, Partnership results can be adversely affected by reductions in the rate at which stumpage is harvested as well as the failure of buyers to fulfill their contractual obligations.\nThe Partnership's long standing policy has been to reach a sustainable annual harvest level in the Northwest by gradually reducing its harvest volume each year. The projected annual harvest in this region will continue to trend down, with the harvest in the year 2000 approaching 80 percent of the 1994 actual harvest. In the Southeast, due to intensive forest and land management as well as silvicultural investment, pine volume available for harvest is expected to increase approximately 2 percent annually.\nRegional timber availability continues to be restricted by legislation, litigation, and pressure from various preservationist groups. Over the past four years, the harvest of timber from private lands in the state of Washington has been restricted as a result of the listing of the northern spotted owl as a threatened species under the Endangered Species Act (ESA). These restrictions have caused the Partnership to restructure and reschedule some of its harvest plans. The U.S. Fish and Wildlife Service has developed a proposed rule under the ESA to redefine protective measures for the northern spotted owl on private lands. This rule, as currently drafted, would reduce the harvest restrictions on private lands except within specified special emphasis areas, where restrictions would be increased. One proposed special emphasis area is on the Olympic Peninsula, where a significant portion of the Partnership's Washington timberlands is located. Separately, the state of Washington Forest Practices Board is in the process of adopting new harvest regulations to protect the northern spotted owl and the marbled murrelet (also recently listed as a threatened species). The State Department of Natural Resources draft of this rule also provides for a special emphasis area to protect the northern spotted owl on the Olympic Peninsula, which would increase harvest restrictions on the Partnership's lands. The Partnership is unable at this time to predict the form in which the federal or state rules will eventually be adopted. However, if either rule is adopted in the form proposed by the respective agencies, the result will be some reduction in the volume of Partnership timber available for harvest.\nLIQUIDITY AND CASH FLOW\nAs of December 31, 1994, the Partnership held trade and intercompany receivables from Rayonier and affiliates of $4.2 million. In addition, the Primary Account of the Partnership held $42.7 million of short-term investment notes of Rayonier and an additional $5.0 million of long-term investment notes of Rayonier resulting from the cumulative net cash flow, since inception, of the Primary Account after distributions to unitholders. The Partnership can call the investment notes at any time\nto fund Partnership working capital requirements, capital expenditures, and reserves. See Note 5 of the accompanying Notes to Financial Statements for further information. At the end of the first quarter of 1994, the Partnership called, or allowed to mature, $75.0 million of the short-term investment notes to fund a special distribution of $4.00 per Class A Unit, which was paid on March 31, 1994. As a result of this transaction, interest income after March 31, 1994 was significantly below the comparable periods of 1993.\nThe Secondary Account of the Partnership had total outstanding debt of $144.6 million at December 31, 1994, including long-term notes payable to Rayonier of $143.8 million that mainly represent the obligations incurred as a result of Secondary Account advances by Rayonier. See Note 6 of the accompanying Notes to Financial Statements for further information.\nCapital expenditures for reforestation, capitalized lease payments, property taxes, and other improvements to the land and timber assets were $13.1 million, $13.4 million, and $14.0 million in 1994, 1993, and 1992, respectively. Capital expenditures are expected to be approximately $14.4 million in 1995. Funding of future capital requirements is expected to continue from Rayonier.\nThe Partnership made regular distributions of $104.0 million ($5.20 per Class A Unit) and a special distribution of $80.0 million ($4.00 per Class A Unit) in 1994; $92.0 million ($4.60 per Class A Unit) in 1993; and $72.0 million ($3.60 per Class A Unit) in 1992 to all outstanding Class A unitholders. An additional $9.7 million in 1994, $4.8 million in 1993, and $3.8 million in 1992 was distributed in cash to Class B unitholders and to the General Partners. Recontributions of $1.0 million and $1.7 million were made in 1993 and 1992, respectively, by Rayonier and the General Partners of RTLP relating to the commission expense paid to a Rayonier affiliated foreign sales corporation.\nOn February 17, 1995, the Board of Directors of Rayonier Forest Resources Company (RFR) declared a first quarter distribution of $1.90 per Class A Unit payable on March 31, 1995 to unitholders of record February 28, 1995. The amount represents operating results and distribution of excess working capital from fiscal 1994 operations. The previous quarterly distribution was $1.30. A portion of the distribution represents return of capital, depending on each unitholder's tax basis. As the Initial Term approaches its expiration date (December 31, 2000), RFR has determined that capital needs for reserves, acquisitions and working capital will be less and that excess cash will be distributed. Future distributions will approximate actual Partnership results each year. This will be accomplished by keeping the distribution relatively constant in the second, third, and fourth quarters and by making an adjustment in the first quarter of the following year to bring the cumulative distribution in line with Partnership results. The first quarter 1995 distribution of $1.90 includes this adjustment. It is expected that the second quarter distribution will be less than the first. The Board indicated that it would continue to maintain a minimum of cash in working capital to be distributed following the end of the Initial Term.\nWHEN THE INITIAL TERM ENDS ON DECEMBER 31, 2000, THE PRIMARY ACCOUNT OF THE PARTNERSHIP WILL BE CLOSED BUT THERE WILL NOT BE ANY REDEMPTION OF THE PARTNERS' CAPITAL ACCOUNTS. THE INTEREST OF CLASS A UNITHOLDERS IN THE PARTNERSHIP'S FUTURE REVENUES, EXPENSES, AND CASH FLOWS WILL THEN DECREASE FROM 95 PERCENT TO 4 PERCENT. POSITIVE CASH FLOWS WILL BE SUBSTANTIALLY AFFECTED BY SECONDARY ACCOUNT DEBT THAT WILL HAVE TO BE REPAID. AS A RESULT, IT IS EXPECTED THAT THE MARKET PRICE OF CLASS A UNITS SHOULD BEGIN TO DECREASE SUBSTANTIALLY SOMETIME PRIOR TO DECEMBER 31, 2000.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee \"Index to Financial Statements\" on Page ii.\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\nNeither the Partnership nor the Operating Partnership has any directors or officers. Set forth below is certain information concerning directors and executive officers of RFR. Presently, all directors and officers of RFR are elected annually.\n(1) Member of the Conflicts and Audit Committees of RFR's Board of Directors\n(2) Served as a Director of RFR from 1985 to 1991\n(3) Served as a Director of RFR from 1987 to 1991\nRONALD M. GROSS, 61, is Chairman of the Board, President and Chief Executive Officer of Rayonier. He joined Rayonier in March 1978 as President and Chief Operating Officer and a director. He was elected Chief Executive Officer in 1981 and Chairman in 1984. Mr. Gross is also currently a director of Lukens Inc. He serves as a member of the Executive Committee of the Board of Directors of the American Forest and Paper Association (AFPA).\nWILLIAM J. ALLEY, 65, is Chairman of the Executive Committee and director of American Brands, Inc. (global consumer products holding company). He has been a director of American Brands since 1979 and was Chairman of the Board and Chief Executive Officer of that corporation from 1987 to 1994. He is also a director of Rayonier, CIPSCO Incorporated, Central Illinois Public Service Company, Bunn-O-Matic Corporation, Olin Corporation, and Amsted Industries Incorporated (a private company). He is a senior member of The Conference Board.\nMACDONALD AUGUSTE, 46, was elected Treasurer of Rayonier effective February 27, 1989 and Treasurer of RFR on March 6, 1989. From 1983 to February 1989, he was Assistant Treasurer of Rayonier, which he joined in April 1975 as Cash and Financial Planning Coordinator. Previously he was employed by St. Regis Paper Company.\nWILLIAM S. BERRY, 53, is Senior Vice President, Forest Resources and Corporate Development of Rayonier. He was elected Senior Vice President, Forest Resources and Corporate Development, of Rayonier in January 1994. He was Senior Vice President, Land and Forest Resources, of Rayonier from January 1986 to January 1994. From October 1981 to January 1986 he was Vice President and Director of Forest Products Management. Mr. Berry joined Rayonier in 1980 as Director of\nWood Products Management. Since May 1988 he has served as a Senior Vice President of RFR after having been Vice President of RFR from September 1985. He also serves on the Executive Boards of the American Forest Council and the Center for Streamside Studies.\nJOHN B. CANNING, 51, has served as Corporate Secretary and Associate General Counsel of Rayonier since February 1985 and as Corporate Secretary of RFR since September 1985. Mr. Canning joined Rayonier in 1977 as Associate General Counsel - Financial. He is a member of the American Bar Association and of the Corporate Bar Association of Westchester and Fairfield, Inc.\nDONALD W. GRIFFIN, 58, is President and Chief Operating Officer, Olin Corporation (diversified manufacturing corporation). He joined Olin in 1961 and was elected an Executive Vice President of Olin in 1987. He became a director of Olin in 1990, was elected Vice Chairman of the Board for Operations in 1993, and President and Chief Operating Officer in 1994. He is also a director of Rayonier, River Bend Bancshares, Inc., and Illinois State Bank and Trust. He is a trustee of the Buffalo Bill Historical Center, the Olin Charitable Trust, and the National Security Industrial Association. He is a member of the American Society of Metals, the Association of the U.S. Army, and the American Defense Preparedness Association. He is a life member of the Navy League of the United States and the Surface Navy Association.\nKENNETH P. JANETTE, 49, is Vice President and Corporate Controller of Rayonier. He joined Rayonier in August 1994 and was elected Vice President and Corporate Controller of Rayonier and RFR in October 1994. He came to Rayonier from Sunkyong America, Inc., a Korean international trading organization, which he joined in 1990 as Corporate Controller. He became a Vice President in 1992. From 1977 to 1990, he served in various capacities with AMAX Inc., most recently as Assistant Corporate Controller and Director of Auditing. He is a Certified Public Accountant and served with Arthur Andersen & Co.\nTHOMAS W. KEESEE, Jr. 80, is a former Director, President and Chief Executive Officer of Bessemer Securities Corporation and Bessemer Trust Company. He is a corporate director and financial consultant. He is a director emeritus of ITT Corporation (ITT) and of Duke University Asset Management Co. He is former Chairman of the Board of Directors of the National Audubon Society and a former director of King Ranch Inc. From 1985 to 1991, Mr. Keesee served on the Board of Directors of RFR.\nGERALD J. POLLACK, 53, is Senior Vice President and Chief Financial Officer of Rayonier. He was elected Senior Vice President and Chief Financial Officer of Rayonier in May 1992. From July 1986 to May 1992, he was Vice President and Chief Financial Officer. Mr. Pollack joined Rayonier in June 1982 as Vice President and Controller. He served as Controller of RFR from September 1985 until August 1986, when he became a Vice President as well. He was elected Chief Financial Officer of RFR on March 6, 1989 and a Senior Vice President of RFR on July 27, 1992. He is a member of the New York Advisory Board of The Allendale Insurance Co., the financial management committee of AFPA, and the Financial Executive Institute.\nDEROY C. THOMAS, 69, is a partner in the law firm of LeBoeuf, Lamb, Greene & MacRae, a law firm which Rayonier engages from time to time for professional services unrelated to Partnership matters. He is retired President and Chief Operating Officer of ITT. Prior to moving to the parent ITT, Mr. Thomas was Chairman, President and Chief Executive Officer of The Hartford Insurance Group. Before going to The Hartford, Mr. Thomas was assistant general counsel of the Association of Casualty and Surety Companies in New York City and was an associate professor of law at Fordham School of Law. Mr. Thomas serves on the board of directors of ITT Hartford, as well as Connecticut Natural Gas Corporation and Houghton Mifflin Company. He also serves as Chairman of the Old State House, Hartford, CT; Chairman of the Connecticut Health System, Inc., Hartford, CT; Director, Goodspeed Opera House; Trustee, Fordham University; Trustee Emeritus, University of Hartford and as a member of the Advisory Board of Iona College. From 1987 to 1991, Mr. Thomas served on the Board of Directors of RFR.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNeither Rayonier nor RFR receive any compensation as general partners of the Partnership and the Operating Partnership in the form of promotional interests, management fees, acquisition fees, incentive compensation, or otherwise. The Partnership and the Operating Partnership reimburse Rayonier and RFR for all direct costs incurred in organizing and managing such partnerships and indirect costs (principally general and administrative and overhead costs) reasonably allocable to such partnerships. The allocations of direct and indirect costs incurred by Rayonier between the Partnership and Rayonier's other activities will be made solely by Rayonier.\nNeither the Partnership nor the Operating Partnership has any officers or directors. No officers or directors of Rayonier or RFR are compensated by the Partnership or the Operating Partnership. The allocable share of Rayonier's and RFR's general and administrative overhead expenses charged to the Partnership includes a portion of the compensation paid by Rayonier and RFR to their officers and directors. The two directors of RFR who are not also directors or employees of Rayonier receive an annual retainer of $12,000 and a $1,000 fee for each Board or Committee meeting attended. The two directors of RFR who are directors but not employees of Rayonier receive a $750 fee for each Board meeting attended. These fees were paid by RFR and charged to the Partnership. During 1994, the Partnership was charged for compensation paid to 13 officers and directors of RFR in an amount totaling $241,000. The Partnership was not charged for cash compensation to any officer or director of RFR in excess of $100,000.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAll references to beneficial ownership in this Item 12 are as of March 14, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee Item 1. Business for a description of transactions between the Partnership and Rayonier. There are no other transactions or relationships to be reported in response to this item.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Documents filed as a part of this report:\n1. See Index to Financial Statements on page ii for a list of the financial statements filed as part of this report.\n2. See Index to Financial Statement Schedules on page ii for a list of the financial statement schedules filed as a part of this report.\n3. See Exhibit Index on page B and C for a list of the exhibits filed or incorporated herein as a part of this report.\n(b) No report on Form 8-K was filed by the registrant during the period covered by this report.\nREPORT OF MANAGEMENT\nRayonier Timberlands, L.P. (RTLP), through the management of both Rayonier Inc. (Rayonier) (the Special General Partner) and Rayonier Forest Resources Company (RFR) (the Managing General Partner), is responsible for the preparation and integrity of the information contained in the accompanying financial statements and other sections of the Annual Report. The financial statements are prepared in accordance with generally accepted accounting principles, and, where necessary, include amounts that are based on management's informed judgments and estimates. Other information in the Annual Report is consistent with the financial statements.\nRTLP's financial statements are audited by Arthur Andersen LLP, independent public accountants. Management has made available to Arthur Andersen LLP RTLP's financial records and related data and believes that the representations made to the independent public accountants are valid and complete.\nA system of internal controls is a major element in management's responsibility for the fair presentation of the financial statements. These internal controls, including accounting controls and the internal auditing program, are designed to provide reasonable assurance that the assets are safeguarded, that transactions are executed in accordance with management's authorization and are properly recorded, and that fraudulent financial reporting is prevented or detected. An important part of the internal controls system is the involvement of the General Partners who provide all required services to ensure the adequacy of internal controls. Procedures also exist to assess compliance with the terms of the Partnership Agreement and to identify and resolve any business issues arising between the Partnership and the General Partners.\nInternal controls provide for the careful selection and training of personnel and for appropriate division of responsibility. The controls are documented in written codes of conduct, policies and procedures that are communicated to employees of Rayonier and RFR. Management continually monitors the system of internal controls for compliance. Internal auditors independently assess the effectiveness of internal controls and make recommendations for improvement. Arthur Andersen LLP also evaluate internal controls and perform tests of procedures and accounting records to enable them to express their opinion on RTLP's financial statements. They also make recommendations for improving internal controls, policies and practices. Management takes appropriate action in response to each recommendation from the internal auditors and the independent public accountants.\nThe Board of Directors of RFR monitors management's administration of the Partnership's financial and accounting policies and practices and the preparation of financial reports.\nThe Audit Committee of the Board of Directors of RFR, which is comprised of non-employee directors, meets periodically with management and with the internal and external auditors to evaluate the effectiveness of the work performed by them in discharging their respective responsibilities and to assure their independent and free access to the Committee.\nRayonier controls RFR, and depends partially on the Partnership timberlands for timber for use in Rayonier's mills and log trading business. Conflicts of interest can arise in selecting, pricing and scheduling timber sold to Rayonier. Other conflicts of interest can arise in allocating revenues and costs between the Class A Units and the Class B Units, in scheduling timber sales to occur before or after the Initial Term expires, and in setting the terms of any loans between the Partnership and Rayonier. The Conflicts Committee of the Board of Directors of RFR, which is comprised of non-employee directors, reviews these transactions and obtains opinions from outside consultants as to their fairness.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Rayonier Timberlands, L.P.:\nWe have audited the accompanying balance sheets of Rayonier Timberlands, L.P. (a Delaware limited partnership) as of December 31, 1994 and 1993, and the related statements of income, cash flows, and partners' capital for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of Rayonier Timberlands, L.P., through the management of both Rayonier Inc., the Special General Partner, and Rayonier Forest Resources Company, the Managing General Partner of the Partnership. 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 Rayonier Timberlands, 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\nStamford, Connecticut January 31, 1995\nRAYONIER TIMBERLANDS, L.P.\nSTATEMENTS OF INCOME\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994 Thousands, except per unit information\nThe accompanying Notes to Financial Statements are an integral part of these financial statements.\nRAYONIER TIMBERLANDS, L.P.\nBALANCE SHEETS\nAS OF DECEMBER 31, 1994 AND 1993 Thousands\nASSETS\nLIABILITIES AND PARTNERS' CAPITAL\nThe accompanying Notes to Financial Statements are an integral part of these financial statements.\nRAYONIER TIMBERLANDS, L.P.\nSTATEMENTS OF CASH FLOWS\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994 Thousands\nThe accompanying Notes to Financial Statements are an integral part of these financial statements.\nRAYONIER TIMBERLANDS, L.P.\nSTATEMENTS OF PARTNERS' CAPITAL\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994 Thousands\nThe accompanying Notes to Financial Statements are an integral part of these financial statements.\nRAYONIER TIMBERLANDS, L.P.\nNOTES TO FINANCIAL STATEMENTS\n(Dollar amounts in thousands, except per unit information)\n1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION AND CONTROL\nRayonier Timberlands, L.P. (RTLP), a Delaware limited partnership, began operations on November 20, 1985 succeeding to substantially all of the timberlands business of Rayonier Inc. (Rayonier). Rayonier Forest Resources Company (RFR), a wholly owned subsidiary of Rayonier, is the Managing General Partner of RTLP and Rayonier is the Special General Partner of RTLP.\nRTLP operates through Rayonier Timberlands Operating Company, L.P. (RTOC), a Delaware limited partnership, in which RTLP holds a 99 percent limited partner interest, and RFR and Rayonier together hold a 1 percent general partner interest. RFR is the Managing General Partner of RTOC and Rayonier is the Special General Partner of RTOC.\nIn addition to its General Partners' interests, Rayonier is also a Limited Partner and owns 74.7 percent of RTLP's issued and outstanding Class A Units and 100 percent of RTLP's issued and outstanding Class B Units.\nThe officers, directors, and employees of Rayonier and RFR perform all management and business activities for RTLP and RTOC. RTLP and RTOC have no officers, directors, or employees.\nALLOCATIONS OF PARTNERSHIP INTEREST\nRTLP records all of its activities in two accounts, the Primary Account and the Secondary Account. The Class A unitholders, the Class B unitholders, and the General Partners all participate in both accounts, but in different percentages. The participation in the revenues and expenses of RTLP follows:\nIN ACCORDANCE WITH RTLP'S PARTNERSHIP AGREEMENT, THE PRIMARY ACCOUNT WILL BE CLOSED AT THE END OF THE INITIAL TERM ON DECEMBER 31, 2000. SUBSEQUENT TO THAT DATE, THE CLASS A UNITHOLDERS WILL PARTICIPATE IN 4 PERCENT OF THE REVENUES AND EXPENSES OF RTLP AND 4 PERCENT OF ITS CASH FLOW AFTER ALL SECONDARY ACCOUNT DEBT HAS BEEN REPAID.\nINVESTING AND FINANCING ACTIVITIES\nThe excess of operating cash flow generated by the Primary Account over amounts distributed to unitholders is invested with Rayonier in accordance with the Partnership Agreement and are repayable on demand. Interest is due quarterly and the stated interest rates are at least equivalent to the rate Rayonier would be charged by an outside party for equivalent borrowings.\nThe Partnership has expenditures that relate primarily to timber that will be harvested after the Initial Term, such as costs of site preparation, planting, reforestation, pre-commercial thinning, and similar activities, all of which are allocated to the Secondary Account of the Partnership. Rayonier funds these expenditures on behalf of the Partnership and, in accordance with the Partnership Agreement, RTLP incurs obligations to Rayonier that mature on January 1, 2001.\nUnder the terms of the Partnership Agreement, cash credited to the Primary Account may not be loaned or otherwise used for the benefit of the Secondary Account. Accordingly, the Partnership is not permitted to use proceeds from the Primary Account Investment Notes of Rayonier to repay the Secondary Account Long-Term Notes Payable to Rayonier.\nSee Notes 5 and 6 for further information.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nSPECIAL ALLOCATIONS\nIn 1989, the Partnership Agreements of RTLP and RTOC were amended to provide for the special allocation of certain costs to Rayonier's and RFR's interests as General Partners of both Partnerships and to Rayonier's interest as a Limited Partner of RTLP. These costs reduce Rayonier's and RFR's income from RTLP and RTOC and the cash flow attributed to their Partnership interests. The special allocations do not impact the interest of publicly traded Class A Units nor their cash distributions.\nOn January 1, 1989, RTOC entered into a sales agency agreement with a Rayonier-affiliated foreign sales corporation. The affiliate, RayFor Foreign Sales Corporation (FSC), acted as a commission agent in selling Rayonier's interest in stumpage that was eventually exported from the United States. As a result, Rayonier gained certain tax benefits that were only available to tax-paying corporations.\nEffective with the first quarter of 1989, a commission expense was paid by RTOC to FSC. The Board of Directors of the Managing General Partner approved amendments to the Partnership Agreements of both RTLP and RTOC that allowed for the allocation of FSC commission expense and associated administrative expenses only to Rayonier and RFR, as General Partners of RTOC and RTLP, and to Rayonier as a Limited Partner of RTLP, and did not affect the earnings or cash flow of publicly traded Class A Units.\nEffective August 10, 1993, legislation was enacted eliminating tax benefits related to log exports for foreign sales corporations. Accordingly, the Partnership will not incur foreign sales commission expense for sales made after August 10, 1993. However, during the second quarter of 1994, the Partnership recorded commission expenses of $86 to adjust its final accrual for commissions on sales made prior to the legislation's effective date. Since the Partnership's commission expense had been fully allocated to Rayonier and the General Partners, the legislation did not impact the earnings or cash flows of publicly traded Class A Units.\nCONSOLIDATION\nThe financial statements consolidate the accounts of RTLP and RTOC. Intercompany transactions have been eliminated. The Rayonier and RFR 1 percent general partner interest in RTOC is presented as minority interest in these financial statements.\nCertain reclassifications have been made to prior years' financial statements to conform to current year presentation.\nREVENUE RECOGNITION\nTimber sales are generally recognized when legal ownership and the risk of loss passes to the purchaser and the quantity sold is determinable. This generally occurs when the purchaser severs and measures the timber.\nRevenues have been based on actual harvest volumes multiplied by contractually agreed upon prices awarded in sealed-bid auctions or negotiated at arm's length with the purchasers, including Rayonier. These prices are periodically and independently tested for reasonableness to market prices in comparable geographic areas.\nBulk timber sales are generally recognized when legal ownership and the risk of loss passes to the purchaser and the amount of profit is determinable. Timberland and land sales are recognized when legal ownership passes, the amount of profit is determinable, and specified levels of down payment are received.\nTIMBER AND TIMBERLANDS\nThe acquisition cost of land, timber, real estate taxes, lease payments, site preparation, and other costs relating to the planting and growing of timber are capitalized. Such costs attributed to merchantable timber are charged against revenue at the time the timber is harvested based on the relationship of harvested timber to the estimated volume of currently recoverable timber. Timber and timberlands are stated at the lower of cost, net of timber cost depletion or market value. The timber originally contributed by Rayonier is stated at Rayonier's historical cost.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nLOGGING ROADS\nLogging roads, including bridges, are stated at cost, less accumulated amortization. The costs of roads developed for reforestation activities are amortized using the straight-line method over their useful lives estimated at 40 years for roads and 20 years for bridges. Road costs associated with harvestable timber access are charged to a prepaid account and amortized as the related timber is sold, generally within two years.\nPARTNERS' CAPITAL\nThe partners' capital accounts have been included on a historical cost basis as determined by the cash and net book value of assets originally contributed to RTLP by Rayonier and RFR. These accounts have been adjusted for the allocation of revenues and costs in accordance with the Partnership Agreement, for distributions made to partners, and for recontributions made by Rayonier and RFR. Revenues and costs are allocated to Primary and Secondary Accounts based upon their relationship to the harvest plan of the Initial Term (through December 31, 2000) or to the harvest plan subsequently (2001 and thereafter). The partners' capital accounts were adjusted for RTLP distributions and for recontributions to RTLP by Rayonier and RFR as follows:\nThe amount recontributed by Rayonier and RFR is equal to the foreign sales commission expense paid by the Partnership during the year, which was fully allocated to Rayonier and the General Partners. See Special Allocations.\nIn addition to the RTLP distributions, RTOC distributed $1,242, $978, and $764, in 1994, 1993, and 1992, respectively, to its General Partners. Recontributions were also made to RTOC by the General Partners for their interest in the commission expense paid.\n2. INCOME AND OTHER TAXES\nRTLP is not a separate taxable entity for federal or state income tax purposes. Any taxable income or loss is reported by the partners in accordance with the Partnership Agreement. Accrued taxes relating to obligations of RTLP as of December 31 were as follows:\n3. RELATED PARTY TRANSACTIONS\nRTLP is a supplier of timber to Rayonier for use in its log trading business and pulp and lumber manufacturing facilities. Timber sales to Rayonier for the years ended December 31, 1994, 1993, and 1992 totaled $21,935, $19,929, and $16,982, respectively. RTLP's related-party revenues represent the fair market value of timber sold to Rayonier.\nRTLP engages in various transactions with Rayonier and its affiliates that are characteristic of a consolidated group under common control. Receipts, disbursements, and net cash position are currently managed by Rayonier through an RTLP centralized treasury system. Accordingly, cash generated by and cash requirements of RTLP flow through intercompany accounts. Any loans to or borrowings from Rayonier are made at an interest rate equivalent to that which would be charged Rayonier by an unrelated third party for a comparable loan for the same period.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe balances in the current RTLP intercompany accounts with Rayonier as of December 31 were as follows:\nInterest income received from Rayonier on the Primary Intercompany Account balance was $197 and $147 in 1994 and 1993 on an average outstanding receivable of $4,163 and $4,185, respectively. Interest expense paid to Rayonier on the Secondary Intercompany Account was $492 and $334 in 1994 and 1993 on an average outstanding payable of $12,447 and $11,740, respectively.\nRTLP is charged by Rayonier with direct costs and expenses associated with RTLP's operations. In addition, indirect costs were allocated to RTLP for forest management, overhead, and general and administrative expenses related to RTLP's operations. Such allocated costs totaled $6,799, $6,850, and $6,031 in 1994, 1993, and 1992, respectively.\n4. MAJOR UNAFFILIATED CUSTOMERS\nSales for 1994, 1993, and 1992 include timber stumpage sales of $29,300, $16,900, and $10,200, respectively, to three customers affiliated with the Quinault Indian Nation. In addition, sales for 1992 include $16,800 from two major timberland tract sales in the Northwest to the Quinault Indian Nation.\n5. INVESTMENT NOTES OF RAYONIER\nCash balances, including the excess of operating cash flow generated by the Primary Account over amounts distributed to unitholders, are being invested in Rayonier as short-term and long-term investment notes. These funds are invested in accordance with the Partnership Agreement and are repayable on demand. Interest is due quarterly and the interest rates are at least equivalent to the rate Rayonier would be charged by an outside party for equivalent borrowings. At December 31, 1994 and 1993, the RTLP Primary Account included investment notes of Rayonier of $47,700 and $106,200, respectively. The notes bear fixed interest rates that range from 6.8 to 8.1 percent, as of December 31, 1994, and 3.9 to 4.2 percent, as of December 31, 1993. The fair value of the investment notes of Rayonier approximates its carrying value.\nThe weighted average interest rate, based on the principal amount, was 6.9 percent as of December 31, 1994 and 4.1 percent as of December 31, 1993. Interest income earned by the Primary Account on the investment notes of Rayonier was $3,043, $4,964, and $5,718 in 1994, 1993, and 1992, respectively.\n6. LONG-TERM NOTES PAYABLE TO RAYONIER\nThe Partnership has expenditures that relate primarily to timber that will be harvested after the Initial Term, such as costs of site preparation, planting, reforestation, pre-commercial thinning, and similar activities, all of which are allocated to the Secondary Account of the Partnership. Rayonier funds these expenditures on behalf of the Partnership and, in accordance with the Partnership Agreement, RTLP incurs obligations to Rayonier that mature on January 1, 2001. Advances made by Rayonier to the Secondary Account in any year bear interest through December 31 of that year at the actual average rate of Rayonier's revolving credit borrowings. On each such December 31, advances made in that year, including interest, are converted into a note bearing interest through January 1, 2001. The fixed interest rate, which is determined as of that December 31, is equal to an appropriate spread over the yield on U.S. Government Notes having a maturity date in early 2001. Interest is due quarterly, and all or any part of the unpaid principal may be prepaid at any time without penalty or premium. The long-term notes payable to Rayonier amounted to $143,800 and $120,900 as of December 31, 1994 and 1993, respectively. Based on the spread over the current rates of U.S. Government Notes having a maturity date in early 2001, the fair value of the long-term notes payable to Rayonier is $143,500.\nAt both December 31, 1994 and 1993, interest rates on the individual notes range from 6.5 to 10.6 percent, with a weighted average interest rate of 8.7 percent. Interest expense incurred by the Secondary Account on the notes payable to Rayonier was $10,596, $9,118, and $7,737 in 1994, 1993, and 1992, respectively.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n7. LONG-TERM TIMBER OBLIGATIONS\nAs of December 31, 1994 and 1993, total timber obligations amounted to $793 and $931, respectively. Interest rates ranged from 6.0 to 8.6 percent, with a weighted average interest rate of 8.4 percent at both December 31, 1994 and 1993.\nThe obligations are payable as follows: 1995 - $148; 1996 - $159; 1997 - $149; 1998 - $162; and 1999 - $175.\n8. ENVIRONMENTAL MATTERS\nOver the past four years, the harvest of timber from private lands in the state of Washington has been restricted as a result of the listing of the northern spotted owl as a threatened species under the Endangered Species Act (ESA). These restrictions have caused the Partnership to restructure and reschedule some of its harvest plans. The U.S. Fish and Wildlife Service has developed a proposed rule under the ESA to redefine protective measures for the northern spotted owl on private lands. This rule, as currently drafted, would reduce the harvest restrictions on private lands except within specified special emphasis areas, where restrictions would be increased. One proposed special emphasis area is on the Olympic Peninsula, where a significant portion of the Partnership's Washington timberlands is located. Separately, the state of Washington Forest Practices Board is in the process of adopting new harvest regulations to protect the northern spotted owl and the marbled murrelet (also recently listed as a threatened species). The State Department of Natural Resources draft of this rule also provides for a special emphasis area to protect the northern spotted owl on the Olympic Peninsula, which would increase harvest restrictions on the Partnership's lands. The Partnership is unable at this time to predict the form in which the federal or state rules will eventually be adopted. However, if either rule is adopted in the form proposed by the respective agencies, the result will be some reduction in the volume of Partnership timber available for harvest.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n9. COMPUTATION OF INCOME PER CLASS A UNIT\nThe Partnership Agreement provides for the allocation of Partnership income among the General and Limited Partners. The following tables present the computation of income per Class A Unit for the three years ended December 31:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\n10. OPERATING CASH FLOW ALLOCABLE TO CLASS A UNITS\nOperating cash flow allocable to a Class A Unit is calculated by multiplying 99 percent (Limited Partners' interest in RTLP) of operating cash flow allocated to the Primary and Secondary Accounts by the respective 95 percent and 4 percent Class A Unit interest in those accounts. In determining operating cash flow, Partnership results are adjusted for non-cash costs and expenses without the effects of changes in working capital. The following tables present the calculations of operating cash flow allocable to Class A Units for the three years ended December 31:\nQUARTERLY RESULTS FOR 1994 AND 1993 (unaudited): (Thousands, except per unit information)\n(a) Includes a $4.00 per Class A Unit special distribution paid on March 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.\nRAYONIER TIMBERLANDS, L.P. (A Delaware Limited Partnership)\nBy: RAYONIER FOREST RESOURCES COMPANY Managing General Partner\nBy: KENNETH P. JANETTE --------------------------- Kenneth P. Janette Vice President and Corporate Controller 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.\nRAYONIER FOREST RESOURCES COMPANY\n-A-\nEXHIBIT INDEX\n- B -\nEXHIBIT INDEX (CONTINUED)\n* Registrant's only subsidiary is Rayonier Timberlands Operating Company, L.P., a Delaware limited partnership in which Registrant holds a 99% limited partner's interest. See Item 1 - \"Business - Description of Business.\"\n- C -","section_15":""}
{"filename":"92284_1994.txt","cik":"92284","year":"1994","section_1":"Item 1. Business\n(a) General\nDue to the Company's development and finance division's acquiring and selling properties, the number of properties owned, operated, leased and the number of wrap around mortgages held fluctuates constantly. The table below show the various different business holdings for the last five years.\nNote 1. On August 15, 1990, the Company acquired Downtowner passport International Motel Corporation, the owner of Downtowner and Passport registered marks. This acquisition of corporate stock was in the nature of a conveyance in satisfaction of debt. In late 1991 the Company deemed the 1990 acquisition to be flawed and in February of 1992, the Company acquired the assets of Passport International Motel Corporation for assumption of debt and simultaneously conveyed same to Hospitality International, Inc. the Company's franchising subsidiary, for the same consideration.\nNote 2. One property leased from a third party is being operated as a restaurant by Company's sub-lessee.\n(b) Segment Information\nThe Company identifies its significant industry segments as set forth in the table below. All revenue items represent sales to unaffiliated customers, as sales or transfers between industry segments are negligible.\n* Included in Financing & Property Development Information.\n(c) Description of Business\n(I) Products and Services\nThe Company's franchise division offers advertising, reservation, group sales, quality assurance and consulting services to motel owner\/operators.\nThe Company's lodging division, through largely non-affiliated lessees, provides budget to moderate rate motel accommodations to the traveling public.\nThe Company's Financing division provides owner financing to persons acquiring motel properties previously operated and\/or owned by the Company. For amounts of revenue of similar products and services in excess of 15% total, see Item 1 (b) above.\n(II) Status of Products and Segments\nEach of the Company's industry segments is fully developed with an operational history of several years under Company's direction.\n(III) Raw Materials\nIn a sense, independent motel operations seeking national affiliation for their properties constitute raw materials for the Company's franchising division, and sites suitable for development and existing properties which may be acquired constitute raw materials for both the Company's lodging division and its financial division.\nTo date, the Company has experienced little difficulty in obtaining information on locations to be reviewed by either its franchise committee or its evaluation committee.\n(IV) Patents, Trademarks, Licenses, Franchises, and Concessions\nThe Company has no patents. The Company does own the trade names \"Master Hosts Inns,\" \"Red Carpet Inns,\" \"Scottish Inns,\" \"Downtowner Inns,\" \"Passport Inns\" and related trademarks, etc. used in operating lodging facilities under these names.\n(V) Seasonability\nThe Company's financing business by its nature is not subject to seasonal fluctuations. The revenues from the Company's franchising division tends to be concentrated in the Spring and Summer months during peak travel periods.\n(VI) Working Capital\nThe Company's financing receipts are comprised primarily of interest which does not become reflected on its balance sheet until after it is earned, whereas its payments on underlying debts are comprised primarily of principal reduction and the portion which will be returned over the next twelve months is reflected on the balance sheet as a current liability. Because of this, the Company believes a current ratio of less than one to one is appropriate for its business. However, the Company continues to, among other things, (1) reduce and contain overhead costs, (2) seek to dispose of underproductive assets, and (3) seek the most advantageous financing terms available.\n(VII) Customers\nThe Company's business of franchising motels is contingent upon its being able to locate qualified property owner-operators who are seeking national affiliation. Through use of its franchise sales force, the Company has not experienced insurmountable difficulty in locating independent motel owner-operators nor does it anticipate any such difficulty in the future. However, more franchisors are offering multi-level brands, resulting in more down-scaling conversions into the economy lodging sector and, therefore, providing more competition. Likewise, the Company's financing division requires that it locate qualified owner-operators or investors for its properties. Because of its franchise affiliations the financing division has not experienced, nor does it anticipate experiencing too much difficulty in locating qualified investors to purchase its developed properties. However, due to the Company's desire to limit the loans it holds to a manageable number and because third party or institutional financing\nfor used motel properties are difficult to arrange, once a property is sold the Company carries the entire financing package and accordingly, each individual loan represents a larger portion of portfolio than it does with traditional lending institutions. Therefore, the continued performance of each existing loan may be material to the operation of the financing division.\n(IX) Government Contracts\nThe Company is not involved in, nor does it anticipate becoming involved in, any government contracts.\n(X) Competition\nThe Company's franchising, leased lodging and leased food service division each compete with other similar businesses, many of which are larger and have more national recognition than does the Company. Each of these divisions compete on the basis of service and price\/value relationship.\nThe Company's financing division competes with other, more traditional sources of long-term financing, most of which have greater financial resources than does the Company.\nCompetition in developing and financing lodging properties has been significantly affected by over-development in some areas as well as the area's and the country's general economic condition, and by the market force of the Resolution Trust Corporation, the latter of which decreased in the current reporting period.\n(XI) Research and Development\nNo significant research activities were conducted by the Company during the Fiscal year and the Company does not expect to expend sums on research activities during the next Fiscal Year.\n(XII) Environmental Protection\nThe Company is not directly affected by environmental protection measures of federal, state or local authorities to any extent which would reasonably be expected to cause material capital expenditures for compliance, so far as in known. However, it is possible that an approximately five and three-tenths (5.3) acre tract of land held as an investment and acquired as a possible motel site, located on I-10 in Ocean Springs, Mississippi, may under the new guidelines, be determined to be in part \"wetlands.\" If so, its use and value would be adversely affected. On January 27, 1995, 3.2 acres of said tract were sold at a consideration undiminished by the wetlands issue; the value of the remaining 5.3 acres, therefore, may not be diminished.\n(XIII) Employees\nNote 3: These are not employees of the Company at date of this writing, since operations are leased out but are given for comparative purposes.\n(d) Foreign Operations\nThe Company, as of June 30, 1995, was not then currently involved in any business operations outside of the United States of America, except through its franchising division which does do limited business in Canada and has one franchisee in the Bahamas. As of April 30, 1995, the franchising division has two franchisees in Costa Rica and two in Jamaica.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 Properties\nThe following table sets forth certain information, as of this writing, concerning properties on which the Company holds notes secured by mortgages and other types of financing instruments held by the Company:\n* While the indenture in favor of a bank in connection with this receivable is not a mortgage, an original sum of $475,000.00 of the receivable was assigned and pledged in 1990 to a bank and might be considered as being in the nature of an underlying mortgage. Said $475,000 is reduced to $313,070.60.\nThe following table sets forth certain information, as of this writing, concerning motel properties owned by the Company and under management contract or leased to Operators.\nNote 4 These properties, on April 1, 1990, were leased to First Hospitality Management Corporation, a corporation owned by Robert H. Douglas, a Director of the Company and a former employee of the Company.\nNote 5 Title to this property was reacquired by foreclosure December 7, 1990. It re-opened for business April, 1990, under an agreement with Alahunt, Inc., a corporation wholly owned by Richard A. Johnson, a Director of Registrant. During the current reporting period, the Company leased this property to Thelma Pullin, a sister of the Registrant's then president.\nNote 6 The Marietta property in 1992 was operated by the Company. Since 1993, it has been leased to Timothy J. DeSandro, a former employee of the Company.\nNote 7 This property, on April 1, 1990, was leased to First Hospitality Management Corporation. On August 1, 1991, Lessor and Lessee jointly terminated said lease and Company leased the property to Kirby Guimbellot, a brother of the Company's then President. The Company also entered into a contract with Mr. Guimbellot to sell and buy this property at a later date, pursuant to which same was sold to Mr. Kirby Guimbellot on January 5, 1995, for $615,000.00, with the Company taking back a wrap-around note and mortgage for $602,670.63. The Company purchased this property in 1989 for $400,000.\nAlso, until August 2, 1991, the Company operated one \"Omelet House\" restaurant located in New Iberia, Louisiana, which it leases from an individual. On August 1, 1991, the Company entered into a rental agreement with Alfred W. Schoeffler, who operated same from August 3, 1991, through September 24, 1992; the property was vacant until March of 1993 at which time the property was leased to First Hospitality Management Company.\nThe following table sets forth certain information, as of this writing, concerning other properties owned or recently owned by the company.\nNote On 6\/9\/94 our interest in Purvis, MS land was sold subject to then debt for consideration of $250,000 to John M. Hill, a partner of Nelson & Hill, owner of the other undivided 1\/2 interest in said land.\nItem 3","section_3":"Item 3 Legal Proceedings\nWaymon Barron, Plaintiff, v. Southern Scottish Inns, of Mississippi, Inc., et al, Defendants\nOn or about September 4, 1986, a Complaint for damages for negligence and breach of implied warranty was filed in the circuit Court of Warren County, Mississippi, styled Waymon Barron v. Motel Recovery & Development, Ltd., d\/b\/a Scottish Inn of Vicksburg, a Partnership, Lewis Slaughter and Southern Scottish Inns, Inc., General Partner, and Sam Patel, bearing Cause No. 14,307 on the docket of said Court. Service of Process was not had on Registrant.\nOn or about August 10, 1987, an Amended Complaint for damages in the same matter was filed in the same Court, styled Waymon Barron v. Motel Recovery & Development, a Limited Partnership, Lewis Slaughter and Reba Slaughter, General Partners, Scott Yeoman and James Johnstone, Limited Partners; Southern Scottish Inns of Mississippi, Inc., N. V. Patel and Sam Patel, bearing Cause No. 14,307 C on the docket of said Court. Later, Registrant and Hospitality International, Inc., a partially owned subsidiary of the Company, were made additional party Defendants. The Company and its defendant subsidiaries have obtained separate counsel, answered the complaints and are preparing defenses.\nThe Amended Complaint demands judgement of $1,500,00 plus interest and costs of Court, and trial by jury.\nThe Amended Complaint alleges that Plaintiff on October 26, 1985, while a guest in Room 101 of the Scottish Inn in Vicksburg stepped onto a rotten place in the floor, that his leg went through and he fell injuring his back, which injury required surgery and resulted in loss of wage earning ability and loss of his ability to enjoy life.\nOn October 25, 1985, the date Mr. Barron checked into said room and on October 26, 1985, the date of his injury, the record title of the Scottish Inn in Vicksburg was in Defendant Southern Scottish Inns of Miss., Inc. The motel was not being operated by said subsidiary of the Company or the Registrant on either of said dates.\nOn January 26, 1984, this motel was the subject of a Contract For Deed with Defendants Lewis Slaughter and Reba K. Slaughter, his wife. Subsequently, and prior to August of 1984, said Defendants transferred their rights, duties and interest under and in the Contract For Deed to Defendant Motel Recovery and Development, a limited partnership, of which the named individual persons were the general or limited partners. In August of 1984, Motel Recovery and Development, leased the subject motel to Defendant N. V. Patel. On October 2, 1984, Registrant and its defendant subsidiary recognized the transfer from Mr. and Mrs. Slaughter to Motel Recovery and Development and the lease from Motel Recovery and development to N. V. Patel. In May of 1986, Registrant and its defendant subsidiary, through surrender of possession and of operation of Mr. Patel and Motel Recovery and Development regained possession and leased same.\nFor some time, the Plaintiff did not diligently pursue this claim, except for the taking of depositions of the Plaintiff's doctor and of an expert building tradesman. Motions for Summary Judgement were filed by the Co- Defendants, Southern Scottish Inns, Inc. and Southern Scottish Inns of Miss., Inc. Also, Hospitality International, Inc. filed a motion for Summary Judgement. Circa October 31, 1993, the Court file reflects that during the last eight (8) months, the insurer for our Franchisee settled, on behalf of Hospitality, with the plaintiff and Hospitality International, Inc. was dismissed. During the current reporting period, the Registrant was dismissed on Summary Judgement and Southern Scottish Inns, of Mississippi, Inc. was dismissed on Summary Judgements. Plaintiff has appealed both dismissals and the appeals are pending.\nPART II\nItem 5","section_4":"","section_5":"Item 5 Market for Registrant's Common Equity Securities and Related Matters\n(a) The common stock, no par value, of the Registrant is traded on the Over-the-Counter market. The following table sets forth the range of per share bid and asked price quotations during the periods indicated. The following represents quotations between dealers, and do not include retail mark-ups, mark-downs, or other fees or commissions, and do not represent actual transactions.\n(b) As of this writing, there are approximately 910 shareholders of the Registrant's common stock.\n(c) No cash dividends have been paid on the Company's common stock during the two most recent Fiscal Years and none are anticipated to be paid in the foreseeable future.\nItem 6","section_6":"Item 6 Selected Financial Data\nThe following table summarizes selected financial data of the Company for the past five Fiscal Years. It should be read in conjunction with the more detailed consolidated financial statements of the Company appearing elsewhere in this Annual report.\nItem 7","section_7":"Item 7 Management's Discussion and Analysis of Financial Conditions and Results of Operations\nCapital Resources\n(I) No material commitments for capital expenditures are planned other than any possible purchases or development of properties through the financing division.\nHospitality International, Inc. was able to acquire a suitable office facility and moved into same on November 1, 1992. The property consists of 2.76 acres of land and 26,888 square feet of office space, of which 15,592 square feet is in use , of which Hospitality uses 11,296 square feet. The property costs $425,000, of which $409,000 was financed. The loan was guaranteed by Registrant and by Bob Guimbellot, personally. During the first week of February of 1994, the Company moved its offices into this facility. At this time, and for the foreseeable future, Southern Scottish Inns, Inc., Red Carpet Inns International, Inc. and Hospitality International, Inc. are all sharing the same office building.\n(II) The trend in capital resources has resulted in a loosening of credit with regard to new motel construction but has not changed perceptively with regard to older properties. This has forced more sellers of older properties into the seller financed arena creating more competition for the Company in its Finance and Development Division. This fact, coupled with tighter credit on the purchase side, has meant less profitable opportunities for the Company.\nItem 8","section_7A":"","section_8":"Item 8 Financial Statements and Supplemental Data\nThe financial statements and financial statement schedules filed as part of the Annual report are listed in Item 14 below.\nItem 9","section_9":"Item 9 Disagreements of 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\nThe Following persons are the directors and the executive officers of the Registrant.\nThe Board of Directors of the Company held one regularly scheduled meeting in 1994.\nThe term of office for all directors expires at the close of the next annual meeting of shareholders. Officers serve at the please of the Board of Directors.\nBobby E. Guibellot served as President of the Registrant from January of 1976 through 1994. Mr. Guimbellot remains as Chief Executive Officer of Registrant. Mr. Guimbellot is also the principal shareholder and Chairman of the Board of Western Wireline Services, Inc. (\"Western Wireline\"), an oil well service company headquartered in Belle Chasse, Louisiana. Mr. Guimbellot has been Chairman of Red Carpet Inns, International, Inc. a subsidiary of the registrant, since 1982, and has been President of Red Carpet since January 1, 1992.\nMichael M. Bush is President and Chief Executive Officer of the Mississippi River Bank, Belle Chasse, Louisiana, a position which he has held for more than six years.\nDonald Deaton is President of Hospitality International, Inc., a motel franchising company and subsidiary of the Registrant.\nRobert H. Douglas was Director of Motel Operations for the Company until April 1, 1990, and prior to assuming that position has been in the independent plant nursery business. He previously served as Secretary and Treasurer of the Registrant from September 1983, until April 1986. Prior to that, Mr. Douglas was Director of Operations for the Company for 8 years. On April 1, 1990, Mr. Douglas, formed the corporation to whom several of the Company's motels are leased.\nJack M. Dubard is currently the Registrant's President, after having served as the Vice President for several years, and was previously an independent consultant to the Registrant and its affiliates. Prior to that, he held an administrative position with Red Carpet Inns International, Inc. Since early 1994, Mr. Dubard has served as CEO of Hospitality International, Inc., the Company's franchising subsidiary.\nC. Guy Lowe, Jr. is a self-employed real estate developer and also provides office building management services. He has been so engaged for more than 7 years.\nHarry C. McIntire is a retired senior captain (pilot) with Delta Air Lines, Inc. and has been a captain for more than 25 years prior to his retirement. He has served as Vice Chairman of registrant's Board of Directors and as a Vice President. Upon Dr. Hotho's resignation, Captain McIntire was elected as Chairman of the Registrant's Board.\nGretchen W. Nini was a Director, Corporate Secretary, and treasurer of Western Wireline Services, Inc., an oil well service company headquartered in Bell Chasse, Louisiana, a position she held for more than 5 years (See Bobby E. Guimbellot, supra).\nGeorge O. Swindell formerly owned Diamond Realty Construction, Gretna Louisiana; he has been a real estate broker since 1970 and has been a general contractor of over 17 years.\nRichard A. Johnson has had prior experience in construction, manufacturing, health care, agriculture, recreational facilities, apartments and real estate. Since June of 1992, Mr. Johnson served as Franchise Development Coordinator for Hospitality International, Inc., a subsidiary of the Registrant. He resigned in July 1995 from his employment by Hospitality International, Inc.\nMelanie Campbell is the current Corporate Secretary and Treasurer of Western Wireline Services, Inc. She has been with this company for more than six years and during that time has held the position of Office Administrator for Western. (See Bobby E. Guimbellot, supra).\nMelinda P. Hotho - Dr. Vincent W. Hotho, after being a Director of the Registrant for over twenty-two (22) years, the last eighteen (18) of which he served with distinction as Chairman, due to some imprudent personal investments and a potentially ruinous malpractice suit went through a Chapter 7 Bankruptcy proceeding. He felt it to be in the best interest of the Registrant and of the Company that he resign as Director and Chairman. The Board of Directors, pending action of the Stockholders, selected Melinda P. Hotho, his daughter, to serve on an interim basis.\nJohn L. Snyder, Jr. is recently retired from his position as manager of engineering at Mid-America Transportation Company. Mr. Snyder had more than thirty years experience in marine operations. He previously held administrative or managerial positions with Wisconsin Barge Line, Walker Boat Yard and Mid-South Towing Company.\nTimothy J. Desandro has been selected to serve as Director on an interim basis. He is currently the Lessee of the Scottish Inn located in Marietta, Georgia, which property he has managed for the past five (5) years. Previously he functioned in the capacity of oil well service operator, a position that Mr. DeSandro held for 20 years.\nDirectors who have resigned:\nRichard H. Rogers was employed as marketing consultant for the Knoxville's World's Fair from January 1982 to May 1982. From 1978 to January 1982, Mr. Roger served as Vice President and Director of Operations of Cindy's Inc., a hotel company. He became President of Hospitality International, Inc. as subsidiary of the Registrant, in May 1982. On October 1993, Mr. Rogers resigned his presidency of Hospitality International, Inc. He resigned for personal reasons and to pursue other interests. Mr. Rogers resigned as Director of the Registrant in 1994.\nDr. Vincent W. Hotho, M.D., after being a Director of the Registrant for over twenty-two (22) years, the last eighteen (18) of which he served with distinction as Chairman, due to some imprudent personal investments and a potentially ruinous malpractice suit went through a Chapter 7 Bankruptcy proceeding. He felt it to be in the best interest of the Registrant and of the company that ye resign as Director and Chairman. The Board of Directors, pending action of the Stockholders, selected Melinda P. Hotho, his daughter, to serve on an interim basis. The Directors elected Harry C. McIntire as Chairman upon Dr. Hotho's resignation.\nHarry C. Geller, an able and loyal Director for the past fourteen (14) years, in an effort to shed some activities with a view toward his imminent retirement, resigned in 1994 as a Director of the Registrant. Mr. Geller, the sole stockholder and president of Securities Transfer Company, the Registrant's Transfer Agent, has given Registrant notice that he is closing Securities Transfer Company at Calendar year end.\nCommittees of the Board of Directors\nThe Board of Directors of the Registrant does not maintain any standing committees.\nItem 11","section_11":"Item 11 Executive Compensation\nFor services rendered in all capacities to the Company and its subsidiaries during the Fiscal Year ended December 31, 1994, the Company paid aggregate cash compensation in the amount of $92,800.00 to Mr. Guimbellot, the Registrant's then President and present Chief Executive Officer. His salary was partially deferred and he is owed $169,687.27, most of which is from prior periods. His annual salary is $75,000. In 1994, the Company paid aggregate cash compensation in the amount of $61,742.20 to Mr. Dubard, who for most of said period was vice president of Registrant and CEO of its franchising subsidiary, and who for the latter part of said period was Registrant's president and CEO of Hospitality Inc.The Company provides Messrs. Guimbellot and Dubard with automobiles and does not require them to account for the personal use, if any, of the automobiles. The cost is not included in the compensation reported above. However, the Company estimates that the amount, which cannot be specifically or precisely ascertained, does not exceed 10% of the aggregate compensation, paid and unpaid, reported above.\nItem 12","section_12":"Item 12 Security Ownership of Certain Beneficial Owners and Management\nPrincipal Holders\nThe following table sets forth, as of this writing, information with respect to each person who, to the knowledge of the Registrant, might be deemed to own beneficially 5% or more of the outstanding Southern Scottish Inns, Inc. common stock, which is the only class of voting securities of the Registrant. Except, as otherwise indicated, the named beneficial owners possess sole voting power and sole investment power with respect to the shares set forth opposite their respective names.\nNote 8 Based on 2,322,466 shares outstanding.\nNote 9 Includes 470,750 shares owned by Bobby Guimbellot d\/b\/a Coastal Companies, and 35,238 owned by Industrial Funds, an entity of Western Wireline Services, Inc. Mr. Guimbellot's shares also include 17,713 and 1,664 shares owned by Lift Boats, Inc. and Tri Delta Dredge, Inc., respectively and 361,405 shares owned by Shelly Plantation. Ms. Campbell shares voting rights as to Industrial Funds shares with Mr. Guimbellot.\nNote 10 Voting and investment power on 113,331 shares are shared with his wife.\nManagement Ownership\nThe following table sets forth, as of this writing, information concerning the ownership of Southern Scottish Inns, Inc. common stock by all directors and by all directors and officers as a group. Southern Scottish Inns, Inc. common stock is the only class of equity securities of the registrant. Except as otherwise indicated, the named beneficial owners possess sole voting power and sole investment power with respect to the shares set forth opposite their respective names.\nNote 11 Based on 2,322,466 shares outstanding.\nNote 12 Includes 250 shares in the name of his minor son.\nNote 13 Includes 470,750 shares owned by Bobby Guimbellot d\/b\/a Coastal Companies, and 35,238 owned by Industrial Funds, an entity of Western Wireline Services, Inc. Mr. Guimbellot's shares also include 17,713 and 1,664 shares owned by Lift Boats, Inc. and Tri Delta Dredge, Inc., respectively and 361,405 shares owned by Shelly Plantation. Melanie Campbell, the Secretary of Western Wireline Services, Inc., shares voting and investment powers with respect to the 35,235 shares owned by Industrial Funds. Only Ms. Campbell's personal shares of 400 were included in her part of column total.\nNote 14 Includes 413 shares in the name of his wife.\nNote 15 Voting and investment powers on 113,331 shares are shared with his wife.\nNote 16 Includes 639 shares in the name of her minor child.\nItem 13","section_13":"Item 13 Certain Relationships and Related Transactions\nJ. Puckett and Company\/Buena Vista Venture\nThis entity is an ordinary particular Louisiana partnership. The Registrant owns twenty-five (25) of the one hundred (100) partnership units. Bobby E. (Bob) Guimbellot, individually, Registrant's Chief Executive Officer, owns eleven (11) of said partnership units. Additionally, Mr. Guimbellot, d\/b\/a Coastal Companies, owns twenty (20) of said units. Emilee B. Guimbellot, Bob Guimbellot's mother, owns one (1) said units. Shelly Plantation Ventures, a partnership in which Mr. Guimbellot is a principal unit owner and in which his mother is a small unit owner, while not a partner, is a three (3) per cent equity owner in J. Puckett. The Registrant, in June of 1992, borrowed $50,000.00 from J. Puckett. This debt was represented by a demand note bearing interest at twelve (12) % per year and was paid off March 1995. At the present time, Registrant receives income of $200.00 per unit or $5,000 per month from J. Puckett.\nPan American Hospitality\nFrom time to time, and on an as needed basis, the Company has made advances to Pan American Hospitality, a partnership comprised of Red Carpet Inns International, Inc. (a subsidiary of the Registrant), Bobby E. Guimbellot, Emilee Guimbellot (Mr. Guimbellot's mother), Western Wireline Services, Inc., Mildred Puckett, Mary R. Dubard (wife of Jack M. Dubard), and two unrelated individuals. As of December 31, 1994, these advances total $113,783.\nC. Guy Lowe, Jr.\nOn April 4, 1986, the Company acquired from C. Guy Lowe, Jr., (a director of the Registrant) all of the outstanding stock of O.S. of South Louisiana, Inc. in exchange for the Registrant's promissory note in the face amount of $132,448. On May 5, 1986, Mr. Lowe assigned this note to Merchants Trust and Savings Bank. No scheduled payments were made on this note. On July 31, 1990, Red Carpet Inns International, Inc., a consolidated subsidiary of the Company, borrowed $100,000 from Merchants Trust and Savings Bank and loaned it to the Company. The Company, in turn, paid the $100,000 back to Merchants Trust and savings Bank as assignee, in full, compromise settlement of the original note of $132,448 to Mr. Lowe. The Company will lower its basis in its O.S. of South Louisiana, Inc. stock. The new note from Merchants Trust and Savings Bank to Red Carpet Inns International, Inc. was guaranteed by two affiliated entities belonging to the Company President, Bobby E. Guimbellot. The Company is now indebted to Red Carpet Inns International, Inc. in the amount of $70,000 at an interest rate of one and one-half (1 1\/2%) percent over Chase Manhattan Bank prime rate.\nPART IV\nItem 14","section_14":"Item 14 Exhibits, Financial schedules and Reports on Form 8-K\n(a) Listed below are the following documents which are filed as a part of this Annual Report.\n1. Financial statements Auditor's Report. Note 17 Consolidated balance sheets of the Company as of December 31, 1994 and 1993. Consolidated statements of changes in cash flow of the Company for the Fiscal Years ended December 31, 1994, 1993 and 1992. Notes to consolidated financial statements.\n2. Exhibits. The exhibits filed as part of the Annual report are listed on the exhibit index which immediately precedes and is bound with such exhibits.\n(b) No reports on Form 8-K have been filed by the Registrant during the last quarter of the period covered by this Annual Report.\nNote 17 For the company's fiscal years of 1985 through 1990, our Auditor was Robert M. Mosher, C.P.A. of Biloxi, Mississippi. For the Company's fiscal years of 1991 through 1992, our Auditor was the firm of Fountain, Seymour, Mosher & Associates of D'Iberville, Mississippi. In February of 1994 (See Item 7, Capital Resources (I)), Registrant and Company moved to the Atlanta area. About such time and in connection with future audits, the decision was made to change auditors and to employ Robert J. Clark of Roswell, Georgia. Mr. Clark had done the Company's Audits for 1983 and 1984. Mr. Clark had done the Audits of 1992 and 1993 for Red Carpet Inns International, Inc., an affiliate of Registrant. Mr. Clark has done the Audits for Hospitality International, Inc., a partially owned subsidiary of Registrant, continuously since 1982. For the year 1994 and for the foreseeable future, Mr. Clark will do the audits for Southern Scottish Inns, Inc., Red Carpet Inns International, Inc. and Hospitality International, Inc. Mr. Mosher cooperated with Mr. Clark in the transition. In accordance with the SEC PRACTICE SECTION of the A.I.C.P.A., a partner other than the partner in charge must perform a concurring review of the audit report. When the firm is a sole proprietorship, an outside qualified professional must be utilized and one was so utilized.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the 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 SCOTTISH INNS, INC. ---------------------------- (Registrant)\nBy: Bobby E. Guimbelott 9\/5\/95 By: Jack M. Dubard 9\/5\/95 --------------------------- ------------------------ Bobby E. Guimbellot Date Jack M. Dubard Date Chief Executive Officer President & CFO\nSIGNATURES (Cont.)\nPursuant to the requirements of the 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.\nFOR THE BOARD OF DIRECTORS:\nMichael M. Bush Melinda P. Hotho\n- ------------------------ ------ ---------------- ------ Michael M. Bush Date Melinda P. Hotho Date Director Director\nMelanie Campbell Richard A. Johnson\n- ------------------------ ------ ------------------ ------ Melanie Campbell Date Richard A. Johnson Date Director Director\nDonald Deaton C. Guy Lowe, Jr.\n- ------------------------ ------ ----------------- ------ Donald Deaton Date C. Guy Lowe, Jr. Date Director Director\nTimothy D. DeSandro Harry C. McIntire\n- ------------------------ ------ ------------------ ------ Timothy D. DeSandor Date Harry C. McIntire Date Director Director\nRobert H. Douglas Gretchen W. Nini\n- ------------------------ ------ ---------------- ------ Robert H. Douglas Date Gretchen W. Nini Date Director Director\nJack M Dubard John Snyder - ------------------------ ------ ----------------- ------ Jack M. Dubard Date John Snyder Date Director Director\nBobby E. Guimbellot George O. Swindell\n- ------------------------ ------ ------------------ ------ Bobby E. Guimbellot Date George O. Swindell Date Director Director\nSOUTHERN SCOTTISH INNS, INC.\nCONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nPAGE NO.\nINDEPENDENT AUDITOR'S REPORT . . . . . . . . . . . . . . 1\nFINANCIAL STATEMENTS\nCONSOLIDATED BALANCE SHEETS . . . . . . . . . . 2-3\nCONSOLIDATED STATEMENT OF INCOME . . . . . . . . 4\nCONSOLIDATED STATEMENT OF RETAINED EARNINGS. . . 5\nCONSOLIDATED STATEMENT OF CHANGES IN CASH FLOW. . . . . . . . . . . . . . . . . 6-7\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS . . . 8-28\nBoard of Directors Southern Scottish Inns, Inc.\nINDEPENDENT AUDITOR'S REPORT\nWe have audited the accompanying consolidated balance sheets of Southern Scottish Inns, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholder's equity and cash flows for each of the two 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. The financial statements of Southern Scottish Inns, Inc. as of December 31, 1992 were audited by other auditors who expressed an unqualified opinion on those statements.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Southern Scottish Inns, Inc. and subsidiaries at of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nRoswell, Georgia August 18, 1995\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1994 AND 1993\nASSETS\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1994 AND 1993\nLIABILITIES AND STOCKHOLDER'S EQUITY\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED STATEMENT OF RETAINED EARNINGS FOR THE YEAR ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED STATEMENT OF CHANGES IN CASH FLOW FOR YEAR ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of these financial statements.\nSOUTHERN SCOTTISH INNS, INC. CONSOLIDATED STATEMENT OF CHANGES IN CASH FLOW (CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1994\nNote 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: A.-1 BUSINESS COMBINATION\nDuring 1988 the Company acquired a majority interest in Red Carpet Inns Inc., by issuance and exchange of the Company's stock for some Red Carpet Inns, Inc. stock and by purchase of some. The acquisition has been accounted for on a \"business combination at predecessor cost\" method (pooling of interest) and the financial statements of the Company have been retroactively restated to reflect this business combination.\nA.-2 PRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its subsidiaries, after elimination of all significant intercompany balances and transactions. The Company owns a minority interest in two partnerships which are accounted for by the equity method.\nA.-3 ACCOUNTING POLICY - STATEMENT OF CASH FLOWS\nThe Company considers all highly liquid debt instruments with a maturity of three months or less to be cash equivalents.\nDuring 1994, the Company had the following non-cash transactions: 1. The Company exchanged land for an installment note receivable of $13,000.\n2. The Company purchased a building and land by financing $250,000 of the purchase price with a mortgage note.\nIn 1994, the Company paid $985 in income taxes and approximately $236,940 in interest.\nIn 1993, the Company paid approximately $361,361 in interest.\nB. INVENTORIES\nInventories are stated at cost determined on a first-in, first-out basis.\nC. PROPERTIES AND DEPRECIATION\nProperty and Equipment are recorded at cost. Depreciation is provided on the straight-line method over the estimated useful lives of the respective assets. Maintenance and repairs are charged to expense as incurred; major renewals and betterments are capitalized. When items of property or equipment are sold or retired, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is recognized in accordance with generally accepted accounting principles.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 1 - (continued)\nD. ACCOUNTS, MORTGAGES AND NOTES RECEIVABLE\nThe Company has provided an allowance for uncollectible trade accounts receivable based on a percentage of the outstanding accounts. During the year all bad debt write-offs were made to the allowance account. No reserve for uncollectible Mortgages and Notes Receivable is maintained. When and if a Note Receivable not secured by real estate becomes questionable, it is written down to its net realizable value. When a Mortgage or Note Receivable secured by real estate becomes questionable, it is written down to the adjusted basis of the property securing it.\nE. FRANCHISE FEES\nFranchise fee revenues are recognized after the Company has performed all material services and conditions relating to the sale.\nF. REAL ESTATE SALES\nGains on real estate transactions on which substantial down payments are not received are deferred and recognized as income only as the principle amount of the obligation is received. This deferred income is shown on the balance sheet as a deferred credit.\nG. DEFERRED DEBT ISSUE COSTS\nDeferred debt costs (primarily commitment fees) are being amortized over the original term of the long-term debt to which they relate.\nH. ORGANIZATIONAL COSTS\nOrganization costs are being amortized on a straight-line basis over a five year period.\nI. PER SHARE DATA\nEarnings per share of common stock is based on the weighted average number of shares which were outstanding during the year.\nJ. INVESTMENT TAX CREDIT\nInvestment tax credits are accounted for as a reduction of the tax liability in the year the property is placed in service using the flow through method.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNOTE 2 - PROPERTY AND EQUIPMENT\nMajor classifications of property and equipment and their respective depreciable lives are summarized below:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 3 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 3 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 3 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 3 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 3 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 3 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 4 - MORTGAGES AND NOTES PAYABLE\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 4 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 4 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 4 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 4 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 4 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 4 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 4 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNote 4 - (Continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nThe maturity of principle obligations on the long-term notes and mortgages payable is as follows:\nNOTE 5 - RELATED RECEIVABLES CONTINGENCY\nNotes and accounts receivable from a partnership, the principle partners of which are also directors of the Company, in the amount of $874,628, were exchanged in 1991 for a 25% interest in the partnership.\nNOTE 6 - INCOME TAXES\nThe Company and its eligible subsidiaries file a consolidated federal income tax return. The following is an analysis of the income tax liabilities for the years ended December 31:\nThe tax due is from consolidated entities that do not file a consolidated tax return with the parent company and is a result of the taxable income of those entities.\nCertain sales of investment assets, the gains on which have been recognized in the financial statements, are, for tax purposes, being recognized on the installment method. The taxes attributed to these gains have been provided for in the financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNOTE 6 - (Continued)\nThe utilization of tax benefits is the result of net operating loss carry forward of the Company and one of the consolidated subsidiaries that is not part of the Company's consolidated tax return. That Company has a statutory tax on financial statement income before application of net operating loss carry forward.\nNOTE 7 - ANALYSIS OF STOCKHOLDERS' EQUITY\nA Director receives 200 shares for each meeting attended. A non- director employee receives 50 shares for each meeting attended when invited to attend. Outstanding stock has been restated for 1987 shares issued and outstanding for the acquisition of Red Carpet Inns, Inc. shares in 1988.\nNOTE 8 - RELATED PARTY TRANSACTIONS\nFrom time to time on an as needed basis, the Company has made open advances to Pan America Hospitality, a partnership comprised of certain officers and corporate shareholders of the Company. As of December 31, 1994, these advances totaled $123,783.00.\nThe Company has advanced monies to a related partnership through the years. See Note 5, Contingent Receivables for details of the transactions.\nNOTE 9 - CONDEMNED BUILDING WRITE OFF\nIn 1993 an existing building was condemned and written off. The loss shown on the books was $148,904.00. The fixed asset and accumulated depreciation for this property was removed from the corporate books, except for an allowance of $50,000 for salvage of scrap metal. This amount was written off in 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) December 31, 1994\nNOTE 10 - PENDING LITIGATION\nAt present time the company has a pending litigation against them in the amount of $1,500,000.00. The resolution of this lawsuit is unknown at this time.\nNOTE 11 - CHANGE IN METHODOLOGY FOR CALCULATING MINORITY INTEREST IN SUBSIDIARIES\nA change in the calculation for determining minority interest was made in 1993. Minority interest was increased based on requirements stated in Financial Accounting Standard No. 94.\nNOTE 12 - STOCK ISSUANCE TO OFFICERS\nDuring 1993 Common Stock was issued to Corporate officers. These shares were exchanged for Red Carpet Inns, Inc. common stock based on like kind market rules and totaled 3,334 shares.","section_15":""}
{"filename":"47518_1994.txt","cik":"47518","year":"1994","section_1":"ITEM 1. BUSINESS\nHillenbrand Industries, Inc., an Indiana corporation headquartered in Batesville, Indiana, is a diversified, public holding company and the owner of 100% of the capital stock of its five major operating companies. Unless the context otherwise requires, the terms \"Hillenbrand\" and the \"Company\" refer to Hillenbrand Industries, Inc. and its consolidated subsidiaries. Hillenbrand is organized into two business segments: Funeral Services and Health Care. The Funeral Services segment consists of Batesville Casket Company, Inc., a manufacturer of caskets and products for the cremation market, and Forecorp, Inc., a provider of funeral planning insurance products. The Health Care segment consists of Hill-Rom, Inc., a manufacturer of equipment for hospitals and provider of wound care, pulmonary\/trauma and incontinence management services; Block Medical, Inc., a provider of home infusion therapy products; and Medeco Security Locks, Inc., a manufacturer of high security locks and access control products for commercial and residential use. (Medeco does not directly serve the health care industry but is included in the Health Care segment due to its relative size.)\nFUNERAL SERVICES\nBatesville Casket Company, Inc. (\"Batesville\"), an Indiana corporation headquartered in Batesville, Indiana, was founded in 1884 and acquired by the Hillenbrand family in 1906. Batesville manufactures and sells several types of steel, copper, bronze and hardwood caskets, including caskets for the cremation market. In addition to caskets, Batesville manufactures and sells a line of urns used in cremations. All Batesville metal caskets are protective caskets which are electrically welded and made resistant to the entry of air, water and gravesite substances through the use of rubber gaskets and a locking bar mechanism.\nBatesville Monoseal-REGISTRATION MARK- steel caskets also employ a magnesium alloy bar to cathodically protect the casket from rust and corrosion. The Company believes that this system of Cathodic Protection is featured only on Batesville caskets.\nBatesville hardwood caskets are made from walnut, mahogany, cherry, maple, pine, oak and poplar. Except for a limited line of hardwood caskets with a protective copper liner, the majority of hardwood caskets are not protective.\nBatesville caskets are marketed by Batesville's direct sales force to licensed funeral directors operating licensed funeral homes throughout the United States, Australia, Canada and Puerto Rico. Batesville maintains an inventory of caskets at 68 company-operated Customer Service Centers in North America. Batesville caskets are delivered in specially equipped vehicles owned by Batesville.\nIn December 1993, Batesville acquired Industrias Arga, S.A. de C.V., a casket manufacturer in Mexico.\nForecorp, Inc., which was founded in 1985, and its subsidiaries, Forethought Life Insurance Company and The Forethought Group, Inc., are headquartered in Batesville, Indiana. These companies serve the country's largest network of funeral planning professionals with marketing support for Forethought-REGISTRATION MARK- funeral plans funded by life insurance policies. This specialized funeral planning product is offered through licensed funeral homes. Customers choose the funeral home, type of service and merchandise they want. The selected funeral home contracts to provide the funeral services and merchandise when needed. With funds provided by a life insurance policy from Forethought Life Insurance Company, the Forethought program offers inflation protection by enabling the funeral home to guarantee that the planned funeral will be available as specified.\nCertificates of authority to sell life insurance have been obtained in forty-eight (48) states, Puerto Rico and the District of Columbia. Forethought Life Insurance products are available through a network of over 4,000 independent funeral homes in forty-three (43) of these jurisdictions.\nHEALTH CARE\nIn fiscal 1994, Hill-Rom Company, Inc. and SSI Medical Services, Inc. (\"SSI\") were combined to form Hill-Rom, Inc. (\"Hill-Rom\"), an Indiana corporation headquartered in Batesville, Indiana. Hill-Rom is a leading producer of mechanically, electrically and hydraulically controlled adjustable hospital beds, hospital procedural stretchers, hospital patient room furniture and architectural systems specifically designed to meet the needs of medical- surgical, critical care and perinatal providers. It has been in the hospital equipment business since 1929. Hill-Rom (as SSI) has been engaged in the manufacture of therapy beds and support surfaces and the rental of these products in the wound care, pulmonary\/trauma and incontinence management markets since SSI was acquired by Hillenbrand in 1985.\nThe Hill-Rom line of electrically and manually adjustable hospital beds includes models which, through sideguard controls, can be raised and lowered, retracted and adjusted to varied orthopedic and therapeutic contours and positions. Hill-Rom also produces beds for special departments such as intensive care, emergency, recovery rooms and labor and delivery rooms. Other Hill-Rom products include sideguard communications, wood finished bedside cabinets, adjustable height overbed tables, mattresses and wood upholstered chairs. Its architectural products include customized, prefabricated modules, either wall-mounted or on freestanding columns, enabling medical gases, communications and electrical services to be distributed in patient rooms. Hill-Rom also remanufactures hospital beds. Its process includes disassembly, washing, sanding, painting and reassembly with new components.\nHill-Rom products are sold directly to hospitals throughout the United States and Canada by Hill-Rom account executives. Most Hill-Rom products sold in the United States are delivered by trucks owned by Hill-Rom. Hill-Rom also operates a Canadian division which distributes Hill-Rom products, principally in Canada, and a German subsidiary which distributes Hill-Rom products throughout Europe. Hill-Rom also sells its domestically produced products through distributorships throughout the world.\nIn 1991, Hill-Rom acquired Le Couviour, a French company which manufactures a variety of mechanically, hydraulically and electrically controlled beds and patient room furniture. Its products are sold directly to hospitals and nursing homes throughout Europe.\nIn February 1994, Hill-Rom completed the acquisition of L. & C. Arnold A.G., of Schorndorf\/Kempen in western Germany. Arnold is one of the oldest and largest manufacturers of hospital beds in Germany.\nClinical support for Hill-Rom's wound care, pulmonary\/trauma and incontinence management products is provided by a sales force composed of nurses and physician assistants. Technical support is made available by technicians and service personnel who provide maintenance and technical assistance from Hill-Rom Service Centers.\nWithin the wound care market, CLINITRON-REGISTRATION MARK- Air Fluidized Therapy is provided as a therapeutic adjunct in the treatment of advanced pressure sores, flaps, grafts and burns. The CLINITRON unit achieves its support characteristics from the fluid effect created by forcing air up and through medical-grade ceramic microspheres contained in the unit's fluidization chamber.\nHill-Rom also offers low airloss therapy through its EFICA CC-TM- and FLEXICAIR-REGISTRATION MARK- units. FLEXICAIR low airloss therapy is provided for pressure sore prevention and wound treatment when ambulation is a priority or continuous head elevation is desired. The FLEXICAIR unit regulates air pressure in five zones corresponding to patient body areas. EFICA CC-TM Dynamic Air Therapy-REGISTRATION MARK, which was introduced in 1994, offers several modes of operation, including lateral rotation, percussion and vibration, while maintaining optimal low airloss pressure relief. This is the state-of-the-art therapy bed for the pulmonary\/trauma market.\nThe CLENSICAIR-REGISTRATION MARK- Incontinence Management System combines pressure-relieving low airloss therapy with a breakthrough design for managing incontinence.\nOther wound care products include the ACUCAIR-REGISTRATION MARK- Continuous Air Flow System and the CLINISERT-REGISTRATION MARK Pressure Relief System. Both are offered as more effective alternatives to conventional overlays and mattresses.\nHill-Rom therapy systems are made available to hospitals, long-term care facilities and the home environment on a rental basis through over 150 Service Centers located in the United States, Canada and Western Europe.\nBlock Medical, Inc. (\"Block\"), a Delaware corporation, is headquartered in Carlsbad, California, and was acquired by Hillenbrand in 1991. Certain of its manufacturing operations were moved to Mexico during fiscal 1994. Block is a manufacturer of home infusion products for antibiotic, nutritional, chemotherapy and other drug therapies, including HOMEPUMP-TM-, a disposable infusion pump, and VERIFUSE-TM, an ambulatory electronic infusion pump. HOMEPUMP, which can be carried in a pocket or specially designed pouch, provides a simple and convenient way for patients to administer their medication with minimum disruption of their lives. VERIFUSE is a computerized electronic infusion pump that is designed to handle more complex infusion medications while enabling the patient to be ambulatory. It is programmed through the use of a built-in bar- code scanner and is capable of delivering four infusion therapies.\nBlock's products are sold to homecare providers throughout the United States and internationally by a direct sales force and through distributors.\nMedeco Security Locks, Inc. (\"Medeco\"), founded in 1968, was purchased by Hillenbrand in 1984. Medeco manufactures and sells a wide variety of deadbolts, padlocks, switch locks, camlocks, electro-mechanical and other special purpose locks for the high security market. Medeco's double locking mechanism provides a higher level of security than is achievable by more common, single locking devices. Medeco locks are primarily constructed of brass and hardened steel and are manufactured in its Salem, Virginia, plant.\nIn 1991, Medeco created the Medeco Security Electronics (MSE) division and entered the electronic high security market with two innovative products. INSITE VLS-TM- replaces the thousands of mechanical keys used in pay telephone and vending machine collection. The INSITE SITEKEY-TM provides the state-of- the-art in electronic door security.\nMedeco products are sold domestically and internationally by its sales organization to locksmith supply distributors, original equipment manufacturers and government agencies. Original equipment applications include vending machines, pay telephones, safe and lock boxes, computer equipment, coin-operated laundry machines and communications security devices.\nHill-Rom generates the predominant share of the Health Care segment's revenues and operating profit. Medeco and Block had an immaterial effect on the operating results of this segment in 1992, 1993 and 1994.\nBUSINESS SEGMENT INFORMATION\nThe amounts of net revenues, operating profit and identifiable assets attributable to each of the industry segments of the Company are set forth in tables relating to operations by business segment in Note 6 to Consolidated Financial Statements, which statements are included under Item 8.\nRAW MATERIALS\nFUNERAL SERVICES\nBatesville employs carbon and stainless steel, copper and bronze sheet, wood, fabrics, finishing materials, rubber gaskets, zinc and magnesium alloy in the manufacture of its caskets. These materials are available from several sources.\nHEALTH CARE\nPrincipal materials used in Hill-Rom products include steel, aluminum, stainless steel, wood, high pressure laminates, fabrics, silicone-coated soda- lime glass beads and other materials, substantially all of which are available from several sources. Motors for electrically operated beds and certain other components are purchased from one or more manufacturers. Block uses thermo- plastic materials, elastomeric membranes, electronic components, miniature electric motors, machined metal parts and other materials, substantially all of which are available from multiple sources.\nMedeco uses brass, hardened steel, other metals and electronic components, substantially all of which are available from several sources.\nCOMPETITION\nFUNERAL SERVICES\nBatesville believes its dollar volume of sales of finished caskets is the largest in the United States. Batesville competes on the basis of product quality, service to its customers and price, and believes that there are approximately two (2) other companies that also manufacture and\/or sell caskets over a wide geographic area. There are, however, throughout the United States many enterprises that manufacture, assemble, or distribute caskets for sale within a limited geographic area.\nForecorp, Inc. competes on the basis of service to its customers and products offered. Forethought Life sells its products in competition with local and state trusts for pre-need funeral planning as well as other life insurance companies. Forethought Life believes it is the leading provider of insurance funded pre-arranged funerals in the United States.\nHEALTH CARE\nHill-Rom believes it is the U.S. market share leader in the sale of electrically operated hospital beds, competing with approximately ten (10) other manufacturers, some of which have larger financial resources and sell a broader line of products. In Europe, Hill-Rom competes with several other manufacturers and believes that it is a market leader. In both the U.S. and Europe there are other companies which provide low airloss and other methods of patient support and patient relief.\nBlock competes on the basis of product innovation and quality coupled with attention to customer service. Block believes it is the market leader in providing new innovations to the alternative site health care market, even though several competitors have larger financial resources.\nMedeco competes on the basis of product quality and performance, and service to its customers. Medeco believes it is the market share leader in the mechanical high security lock market; however, other lock manufacturers produce a broader product line and have larger financial resources. Medeco believes that its patents and channels of distribution are important to its business.\nRESEARCH\nEach of the Company's operating subsidiaries devotes research efforts to develop and improve its products as well as its manufacturing and production methods. All research and development expenses are Company sponsored and, for new products, amounted to approximately $25,767,000 in 1994, $22,270,000 in 1993, and $20,321,000 in 1992. Additionally, $9,245,000 was spent in 1994, $8,089,000 in 1993, and $7,689,000 in 1992 on research and development pertaining to the improvement of existing products. The above amounts exclude expenditures relative to discontinued operations.\nPATENTS AND TRADEMARKS\nThe Company owns a number of patents on its products and manufacturing processes which are of importance to it, but it does not believe that any single patent or related group of patents are of material significance to the business of the Company as a whole.\nThe Company also owns a number of trademarks and service marks relating to its products and product services which are of importance to it, but it does not believe that any single trademark or service mark is of material significance to the business of the Company as a whole.\nEMPLOYEES\nAs of January 20, 1995, the Company employed approximately 10,000 persons in its operations in North America and Europe.\nENVIRONMENTAL PROTECTION\nHillenbrand Industries, Inc. is committed to operating all of its businesses in a way that protects the environment. The Company has voluntarily entered into remediation agreements with environmental authorities, and has been issued Notices of Violation alleging violations of certain permit conditions. Accordingly, the Company is in the process of implementing plans of abatement in compliance with agreements and regulations. The Company has also been notified as a potentially responsible party in investigations of certain offsite disposal facilities. The cost of all plans of abatement and waste site cleanups in which the Company is currently involved is not expected to exceed $10.0 million. The Company has provided adequate reserves in its financial statements for these matters. Compliance with other current governmental provisions relating to protection of the environment also does not materially affect the Company's capital expenditures, earnings or competitive position. Recent changes in environmental law might affect the Company's future operations, capital expenditures and earnings. The cost of complying with these provisions is not known.\nFOREIGN OPERATIONS AND EXPORT SALES\nInformation about the Company's foreign operations is set forth in tables relating to geographic information in Note 6 to Consolidated Financial Statements, which statements are included under Item 8.\nThe Company's export revenues constituted less than 10% of consolidated revenues in 1994 and prior years.\nORDER BACKLOG\nOrder backlogs are immaterial to the Company and there was no material change in backlogs during 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company are elected each year by the Board of Directors at its first meeting following the Annual Meeting of Shareholders 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 Company.\nW August Hillenbrand, 54, was elected Chief Executive Officer of the Company on April 11, 1989 and has been President since October 21, 1981. Prior to that he had been a Vice President of the Company since 1972 and has been employed by the Company throughout his business career.\nLonnie M. Smith, 50, was elected Senior Executive Vice President, effective January 1, 1982. From 1978 through 1981, he held the position of Executive Vice President of American Tourister, Inc. From 1976 to 1978, he was Senior Vice President of Strategic Planning for the Company. Prior to that he was employed by the Boston Consulting Group, business consultants.\nTom E. Brewer, 56, has been employed by the Company since May 16, 1983, and was elected Senior Vice President and Chief Financial Officer on May 23, 1983 and Treasurer on September 6, 1991. He had been employed by the Firestone Tire and Rubber Company for the prior 22 years, where he served as Corporate Vice President and Treasurer.\nGeorge E. Brinkmoeller, 59, was elected Vice President, Corporate Services on December 2, 1979, had been Director of Corporate Services since January 1, 1975, and had been Manager of Affiliated Operations since January 1, 1971.\nMichael L. Buettner, 37, has been employed by the Company since January 9, 1995, and was elected Vice President, Corporate Development on January 9, 1995. Prior to joining the Company, he was employed by Bausch & Lomb Incorporated for 10 years in various corporate development and finance roles, most recently as Staff Vice President, Corporate Development. He has also served in various finance and marketing positions with Moog Automotive, Inc. and Carboline Company.\nMark E. Craft, 40, has been employed by the Company since February 26, 1990, and was elected Vice President, Public Affairs on May 1, 1994. Prior to that he was Director, Public Affairs. Prior to joining the Company, he was Manager, Public Relations, for Melvin Simon & Associates, Inc., in Indianapolis, Indiana.\nMark R. Lindenmeyer, M.D., 48, was elected Vice President, General Counsel and Secretary of the Company on October 7, 1991. He has been employed by the Company since August 18, 1986 as Litigation Counsel. Prior to joining the Company, Dr. Lindenmeyer served in the U.S. Army as a military trial attorney and judge and was a partner in a Batesville, Indiana law firm. He has been a practicing physician since 1986 and a licensed attorney since 1972.\nBradley K. Reedstrom, 33, was elected Vice President, Corporate Planning on December 1, 1991. He has been employed by the Company since June 13, 1985, serving in various capacities in the Corporate Planning department, most recently as Director.\nJames G. Thorne, 53, has been employed by the Company since June 14, 1993 and was elected Vice President, Human Resources on April 5, 1994. Prior to joining the Company, he was employed by Monsanto Company for 27 years where he served as Vice President, Human Resources for Fisher Controls International, Inc.\nJames D. Van De Velde, 48, was elected Vice President, Controller on May 13, 1991. He joined the Company on September 1, 1980 as Director, Taxes. Prior to that he was employed by the public accounting firm of Price Waterhouse.\nRobyn P. Washburn, 39, was elected Vice President, Continuous Improvement on April 9, 1991. Prior to that, he served as Vice President, Corporate Planning, and has been employed by the Company since May 10, 1982.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal properties of the Company and its subsidiaries are listed below, and are owned by the Company or its subsidiaries subject to no material encumbrances except for those facilities (*) which were constructed with funds obtained through Government Issued Bonds (see Note 3 to the Consolidated Financial Statements). The Company intends to improve the efficiency of certain facilities in Germany during 1995 and 1996. Otherwise, all facilities are suitable for their intended purpose, are being efficiently utilized and are believed to provide adequate capacity to meet demand for the next several years.\nIn addition to the foregoing, the Company leases or owns a number of warehouse distribution centers, service centers and sales offices throughout the United States and Europe.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn 1993, Hill-Rom was notified that it is part of an investigation into the hospital bed industry by the Antitrust Division of the Department of Justice (the \"DOJ\"). As a result, the Company was issued a Civil Investigation Demand by the DOJ and served with a subpoena to allow review of internal Hill-Rom files and business practices to determine any irregularities. The Company is cooperating with the DOJ in its investigation. Although the Company believes that it is not in violation of any antitrust law or statute and expects no material, adverse financial effect, it is impossible to predict with certainty when the investigation will be concluded, what the outcome of the investigation will be and what effect, if any, the outcome might have on the Company's financial condition, results of operations and cash flows.\nOn September 19, 1994, subsequent to trial on the issues, the Company settled a patent infringement suit brought by Kinetic Concepts, Inc. (\"KCI\") against Support Systems International, Inc. and SSI Medical Services, Inc., wholly owned subsidiaries of the Company, for a cash payment of $84.8 million (KINETIC CONCEPTS, INC. V. SUPPORT SYSTEMS INTERNATIONAL, INC. AND SSI MEDICAL SERVICES, INC., U.S. District Court, Western District of Texas, originally filed September 6, 1991). The settlement amount was reflected in third quarter results as an unusual charge and payment was made in the fourth quarter. KCI alleged that SSI's RESTCUE and RESTCUE CC therapy units infringed certain patents owned by KCI. KCI sought an award of actual damages and sought to enjoin SSI from marketing the RESTCUE units. Before the trial, the RESTCUE products had been replaced by a next generation therapy product. From the date of the initial claim until the trial commencing August 29, 1994, the Company believed that the outcome of a trial or any settlement of the matter would not have a significant effect on the Company's financial condition or results of operations. The settlement of the patent infringement suit will not affect future operating results. There is no other pending litigation of a material nature in which the Company or its subsidiaries are involved.\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 3, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION\nHillenbrand Industries' common stock is traded on the New York Stock Exchange under the ticker symbol \"HB\". The following table reflects the range of high and low selling prices of the Company's common stock by quarter for 1994 and 1993.\nHOLDERS\nOn February 10, 1995, there were approximately 29,000 holders of the Company's common stock.\nDIVIDENDS\nThe Company has paid cash dividends on its common stock every quarter since its first public offering in 1971, and those dividends have increased each year since 1972. Dividends are paid near the end of February, May, August and November to shareholders of record near the end of January, April, July and October. Cash dividends of $.57 ($.1425 per quarter) in 1994 and $.45 ($.1125 per quarter) in 1993 were paid on each share of common stock outstanding. Cash dividends will be $.60 ($.15 per quarter) in 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents selected consolidated financial data of Hillenbrand Industries, Inc. for fiscal years 1990 through 1994.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion and analysis should be read in conjunction with the Company's consolidated financial statements and accompanying notes. Hillenbrand's five major operating companies are organized into two business segments. The Funeral Services segment consists of Batesville Casket Company and The Forethought Group. The Health Care segment consists of Hill-Rom, Inc., Block Medical and Medeco Security Locks (included in this segment due to Medeco's relatively small size). In 1994, Hill-Rom and Support Systems International (SSI) were integrated to form a single company. The discussion of results for Hill-Rom includes the operating results of SSI. Results for American Tourister, Inc., which was sold in 1993, have been reported separately as a discontinued operation in the income statement.\nRESULTS OF OPERATIONS\n1994 COMPARED WITH 1993\nSUMMARY Net revenues increased $129.1 million, or 8.9%, to $1.6 billion in 1994. Approximately $30.0 million of this increase can be attributed to the 53rd week in fiscal 1994. Fiscal 1993 was, and fiscal 1995 will be, 52 week years. Operating profit of $159.0 million was down 32.1% and income from continuing operations declined 32.5% to $89.5 million.\nOn September 19, 1994, subsequent to trial on the issues, the Company settled a patent infringement suit brought by Kinetic Concepts, Inc. against the Company, for a cash payment of $84.8 million. The settlement amount was reflected in third quarter results as an unusual charge to operations of $84.8 million ($52.5 million, or $.74 per share, after tax) and payment was made in\nthe fourth quarter. From the date of the initial claim until the trial commencing August 29, 1994, the Company believed that the outcome of the trial or any settlement of the matter would not have a significant effect on the Company's financial condition or results of operations. The settlement of the patent infringement suit will not affect future operating results. In 1993, the Company wrote down goodwill relative to the acquisition of Block Medical in the amount of $14.0 million. Excluding these non-recurring items, operating profit was down 1.8% and income from continuing operations fell 3.1%.\nNET REVENUES Net revenues in the Health Care segment increased $48.4 million, or 5.5%, to $924.1 million in 1994. This increase was due primarily to the acquisition of L. & C. Arnold AG (Arnold) by Hill-Rom in February 1994 and increased therapy rental beds in use in the long-term care and home care markets. Revenue growth was also realized in the remanufactured bed market. Offsetting these gains was a drop in electric bed shipments, especially in the U.S. acute care market. Additionally, there was a shift toward lower priced products in the U.S. acute care therapy rental bed market. In Europe, therapy rental bed revenue was up marginally and capital product shipments, excluding sales for Arnold, were essentially flat. At Block Medical, shipments of both disposable infusion pumps and ambulatory electronic pumps were down. Shipments of disposable pumps were up in the fourth quarter compared with the fourth quarter of 1993. Sales in Medeco's door security, gaming industry, electronic pay telephone and automated teller channels were all higher in 1994. Demand in these markets grew and Medeco's product offerings received strong acceptance. Block and Medeco do not contribute significantly to the overall revenues of the Health Care segment.\nNet revenues in the Funeral Services segment increased $80.7 million, or 14.1%, to $652.9 million in 1994. Despite an essentially flat market for casketed deaths, casket unit volume was up at Batesville Casket due to the additional week in fiscal 1994, acquisitions and new product introductions. Revenues were also favorably impacted by price increases, improved product mix and increased sales of products for the cremation market. Forethought's revenue growth reflected higher investment income due to a larger invested asset base, partially offset by lower yields. Yields began falling in 1993 and continued to decline through mid-1994, from which point they have improved steadily. These trends, while consistent with those of the financial markets overall during this time period, generally lag the market by several months. Earned premium revenue was higher due to increased policies in force, year over year.\nCOST OF REVENUES Cost of revenues as a percentage of revenues increased from 51.6% in 1993 to 53.8% in 1994. This was due to higher costs associated with the manufacturing operations at Arnold (which was acquired in 1994), the shift to lower priced products in the acute care therapy rental bed market and the unfavorable impact of lower acute care electric bed shipments. In the Funeral Services segment, Forethought increased the crediting rate on policies in force for competitive reasons in the fourth quarter. These items offset lower depreciation expense associated with the acquisition of SSI in 1985 and ongoing improvements in manufacturing efficiency and material costs throughout the Company.\nADMINISTRATIVE, DISTRIBUTION AND SELLING EXPENSES These expenses (excluding the litigation settlement of $84.8 million) increased 4.1% in 1994. Excluding the $14.0 million write-down of Block goodwill in 1993, they rose 7.4%, and as a percentage of net revenues, were down from 31.2% in 1993 to 30.8% in 1994. The inclusion of expenses associated with the operations of Arnold and other acquisitions and growth in base businesses were offset by improved efficiency, economies of scale and lower incentive compensation expense.\nOPERATING PROFIT Operating profit in the Health Care segment, excluding the litigation settlement in 1994 and write-down of Block goodwill in 1993, was down $16.2 million, or 11.1%. Softness in the U.S. acute care capital market, price pressure in the U.S. acute care rental market, losses from certain European operations and expenses associated with the integration of Hill-Rom and SSI were partially offset by increased therapy rental beds in use and lower expenses associated with the acquisition of SSI.\nIn the Funeral Services segment, operating profit was up $8.2 million, or 7.2%. Higher casket unit volume (including the effect of the extra week) and improved price, mix and operating efficiencies generated growth at Batesville Casket. Higher earned premium revenue and investment income were offset by the discretionary increase in the crediting rate on policies in force at Forethought.\nOTHER INCOME AND EXPENSE Interest expense increased $2.2 million, or 10.1%, due to increased lines of credit and other debt associated with Hill-Rom's European operations and the issuance of $100.0 million of debentures in February 1994, partially offset by the retirement of a $75.0 million promissory note in May. Investment income was up $4.4 million, or 49.7%, due to higher rates of return and a higher average level of interest earning assets. Other expense, net, of $4.1 million was higher than in 1993 due primarily to increased net expenses associated with the Company's corporate-owned life insurance program and lower foreign currency transaction net gains.\nINCOME TAXES The effective income tax rate on income from continuing operations decreased from 40.2% in 1993 to 38.2% in 1994. The decrease was primarily attributable to two items. The write-down of Block goodwill of $14.0 million in 1993 was not deductible for tax purposes, resulting in an increase in the 1993 effective rate. This item did not reoccur in 1994. Secondly, the state effective rate was reduced in 1994 as a result of certain tax planning strategies. These decreases were partially offset by an increase in the effective foreign income tax rate. This increase was attributable to operating losses in certain European countries, resulting in foreign loss carryforwards for which there is no associated income tax benefit recognized in the current year.\n1993 COMPARED WITH 1992\nSUMMARY Net revenues increased $144.9 million, or 11.1%, to $1.4 billion. Operating profit of $234.3 million was up 19.0% and income from continuing operations increased 19.2% to $132.5 million. Excluding the write-down of Block goodwill of $14.0 million in 1993, operating profit grew 26.2% and income from continuing operations grew 31.8%.\nNET REVENUES Net revenues in the Health Care segment increased $84.7 million, or 10.7%, to $875.7 million in 1993. Growth at Hill-Rom was driven by increased sales of electric beds in the acute care market, birthing beds and refurbished hospital equipment. Capital sales were also higher in Europe and Canada. Therapy rental bed revenue was up due to increased units in use in the acute care, long-term care and home care markets. Rental revenue was down in Europe, despite growth in units in use, due to strong price competition. The acquisition of The Mediscus Group in May 1993 contributed marginally to Hill-Rom's overall revenue growth in 1993. At Block Medical, sales of electronic pumps and disposable administration sets increased modestly in 1993. Sales of disposable infusion pumps were down slightly but improved during the second half of the year. At Medeco, sales of mechanical and electronic telephone locks and door security products increased due to market acceptance of new products and positive consumer spending.\nNet revenues in the Funeral Services segment increased $60.2 million, or 11.8%, to $572.2 million in 1993. Net sales at Batesville Casket were higher due to increased unit shipments (including the marginal effect of acquired distributors), successful new product introductions (including cremation products), improved product mix and a moderate price increase. Forethought's revenue continued its growth pattern in 1993 although, as anticipated, at a rate slightly lower than in prior years. Investment income was up due to a larger invested asset base, partially offset by lower yields. Earned premium revenue was higher due to increased policies in force, year over year.\nCOST OF REVENUES Cost of revenues as a percentage of revenues improved slightly from 51.8% in 1992 to 51.6% in 1993. Increased therapy unit utilization, lower depreciation associated with the acquisition of SSI in 1985, improved product mix at Batesville Casket and increased manufacturing efficiency throughout the Company were offset by revenue growth in lower margin European and refurbished equipment markets at Hill-Rom.\nADMINISTRATIVE, DISTRIBUTION AND SELLING EXPENSES Excluding the write-down of Block goodwill of $14.0 million, these expenses increased 4.7% in 1993 and, as a percentage of revenues, declined from 33.1% to 31.2%. This decrease was due to improved operating efficiency, leveraging of fixed expenses and lower incentive compensation expense throughout the Company. Compensation earned under provisions of the performance compensation plan in 1992 and 1993, based on the performance of certain subsidiaries and the Company in those years, was accrued primarily in 1992. These positive factors were partially offset by the growth of European operations, which have higher expenses relative to revenues.\nOPERATING PROFIT Operating profit in the Health Care segment, excluding the write-down of Block goodwill, was up $30.3 million, or 26.0%, compared with revenue growth of 10.7%. Increased bed sales in the acute care market, higher therapy rental bed revenue in the acute care, long-term care and home care markets, improved operating efficiencies and lower acquisition expenses were partially offset by revenue growth in lower margin European operations.\nIn the Funeral Services segment, operating profit was up $16.5 million, or 16.9%, compared with revenue growth of 11.8%. This reflected improved manufacturing, distribution and administrative efficiencies and improved product mix at Batesville Casket and higher investment income, insurance in force and leveraging of fixed expenses at Forethought.\nOTHER INCOME AND EXPENSE Other expense, net, of $276 thousand was $6.0 million less than in 1992 due to favorable foreign currency transaction experience in 1993 relative to 1992 and lower net expenses associated with the Company's corporate-owned life insurance program.\nINCOME TAXES The effective income tax rate on income from continuing operations increased from 37.5% in 1992 to 40.2% in 1993 primarily as a result of a corporate income tax rate increase enacted retroactive to January 1, 1993 as a part of the 1993 tax legislation and the write-down of Block goodwill, which cannot be deducted for tax purposes. This increase was partially offset by decreases in both the state and foreign effective income tax rates.\nINFLATION Inflation and changing prices had a negligible effect on results of operations in 1994, 1993 and 1992. Improvements in manufacturing and administrative efficiencies continue to minimize the effect of price increases.\nLIQUIDITY AND CAPITAL RESOURCES\nCASH FLOWS Net cash flows from operating activities and selected borrowings represent the Company's primary sources of funds for growth of the business, including capital expenditures and acquisitions. Cash and cash equivalents (excluding the investments of insurance operations) fell from $210.2 million at the end of 1993 to $120.4 million at the end of 1994.\nOPERATING ACTIVITIES Net cash flows from operating activities of $92.0 million in 1994 were significantly lower than the $219.1 million and $201.0 million generated in 1993 and 1992, respectively. The decline in 1994 was due to the litigation payment of $52.5 million after income taxes, lower operating results in the Health Care segment and increased funding of working capital, partially offset by improved operating results in the Funeral Services segment.\nThe $36.7 million increase in accounts receivable and growth in days sales outstanding (DSO) from 70 to 78 reflected strong fourth quarter shipments and lower prepayments in the Health Care segment. The increase in receivables in 1993 was also due to higher fourth quarter shipments in the Health Care segment. DSO at year-end 1993 was up versus 1992 due primarily to the sale of American Tourister, which had DSO considerably below that of the Company as a whole. The decline in accrued expenses in 1994 was due primarily to lower current income taxes payable (resulting from lower earnings) and incentive compensation payments in the first quarter of 1994. The change in other non-cash adjustments to net income was attributable to the liability associated with mortgage-backed dollar roll contracts purchased by Forethought in 1993, the cash flow effect of which was offset in the investments line, and to changes in other non-current items offset in net working capital.\nINVESTING ACTIVITIES The Company invested $145.5 million in property, plant, equipment, acquisitions and other investments in 1994 compared with $128.8 million in 1993, excluding proceeds of $55.3 million on the sale of American Tourister.\nCapital expenditures in 1994 of $99.5 million were $13.2 million lower than in 1993 and essentially equal to the $98.3 million in 1992. The production of therapy units at Hill-Rom increased from $17.4 million in 1992 to $31.8 million in 1993 and $43.1 million in 1994. Capital spending in 1993 included the construction of Batesville Casket's Business Center and new central offices and investments in various processes and facilities in the Health Care segment.\nAcquisition payments in 1994 were primarily for the purchase of L. & C. Arnold AG, a German manufacturer of hospital and nursing home beds. In addition, Batesville Casket acquired Industrias Arga, S.A. de C.V., a Mexican casket manufacturer and distributor, and Lincoln Casket Company, a casket distributor based in Detroit, Michigan. Payments in 1993 and 1992 were primarily for The Mediscus Group and Le Couviour, respectively. The contingent earn-out payments in 1992 represented the final payments relative to the acquisition of SSI in 1985.\nThe Company invested $15.7 million in certain limited partnerships in 1994.\nFINANCING ACTIVITIES The Company's long-term debt-to-equity ratio was 30.1% at year-end 1994 compared with 16.9% at year-end 1993. In the first quarter of 1994, the Company issued $100.0 million of unsecured debentures and, in the second quarter, prepaid (without penalty) an unsecured promissory note in the amount of $75.0 million which was due in annual installments in 1994, 1995 and 1996. Additions and reductions to short-term debt in 1992 and 1993 were relative to Hill-Rom's European operations and acquisitions. The Company also issued $100.0 million of debentures in 1992. In the\nfourth quarter of 1993, the Company filed a registration statement with the Securities and Exchange Commission for the future issuance of up to $200.0 million of debentures. With the issuance of $100.0 million in 1994, $100.0 million remains available, which, when combined with additional debt capacity, existing cash and other working capital, affords the Company considerable flexibility in the funding of internal and external growth.\nQuarterly cash dividends per share were 8.75 cents in 1992, 11.25 cents in 1993 and 14.25 cents in 1994. An additional increase to 15 cents per share was announced in January 1995. The Company expects to continue to share its growth with its shareholders.\nIn 1994, Hillenbrand repurchased 610,300 shares of the Company's common stock at a cost of $19.8 million, which compares with purchases of $14.7 million in 1993 and $38.3 million in 1992.\nINSURANCE ASSETS AND LIABILITIES Insurance assets of $1,556.6 million grew 28.4% over the past year. Cash and invested assets of $1,198.5 million constitute 77.0% of the assets. The investments are concentrated in high grade, Federal Government, Federal agency and corporate bond securities. The invested assets are more than adequate to fund the insurance reserves and other liabilities of $1,074.6 million. Statutory reserves represent 64% of the face value of insurance in force. The statutory capital and surplus as a percent of statutory liabilities of the life insurance subsidiary of Forethought was 9.1% at December 31, 1994, up from 8.6% on December 31, 1993. The long-term deferred tax benefit relative to insurance operations results from differences in recognition of insurance policy revenues and expenses for financial accounting and tax reporting purposes. Financial accounting rules require ratable recognition of insurance product revenues over the lives of the respective policies. These revenues are recognized in the year of policy issue for tax purposes. This results in a deferred future tax benefit. Insurance policy acquisition expenses must be capitalized and amortized for both financial accounting and tax purposes. Financial accounting rules require a greater amount to be capitalized and amortized than for tax reporting. This results in a deferred future tax cost, which partially offsets the deferred future tax benefit. The net deferred future tax benefit increased $9.4 million in 1994, compared to $11.0 million in 1993. The reduction in the year to year net increase is attributable to favorable final regulations issued by the Department of the Treasury which reduced the amount of policy acquisition expenses required to be capitalized for tax purposes.\nSHAREHOLDERS' EQUITY Cumulative treasury stock acquired increased to 10,823,572 shares in 1994, up from 10,213,272 shares in 1993. The Company currently has Board of Directors' authorization to repurchase up to a total of 14,000,000 shares. Repurchased shares are used for general business purposes. From the cumulative shares acquired, 316,274 shares, net of shares converted to cash to pay withholding taxes, were reissued in 1994 to individuals under the provisions of the Company's various stock compensation plans. In addition, a total of 45,648 deferred restricted shares were returned to treasury stock for payment at a future date.\nUnder the restricted stock plan approved by the shareholders of the Company on April 14, 1987, 324,600 shares have been awarded, 268,132 shares have been distributed and\/or deferred, and 56,468 shares have been forfeited to date. No additional awards are contemplated at this time.\nUnder the performance compensation plan approved by the shareholders of the Company on April 7, 1992, 386,096 shares were earned in 1993 based on each subsidiary's and the Company's performance in 1992 and 1993.\nOTHER ISSUES\nACCOUNTING CHANGES In 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 112, \"Employers' Accounting for Post Employment Benefits,\" which establishes standards of financial accounting and reporting for the estimated cost of benefits which will be provided by an employer to former or inactive employees after employment but before retirement. Adoption of this standard did not have a material effect on the Company's financial condition, results of operations or cash flows.\nSFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" was issued in May 1993. SFAS 115 requires that investments in debt and equity securities be accounted for and classified as follows: debt securities that the Company 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 resale in the near term are classified as \"trading securities\" and reported at fair value, with unrealized gains and losses included in earnings; and debt and equity securities not classified as either of the above are classified as \"available- for-sale\" and reported at fair value, with unrealized gains and losses charged or credited directly to a separate component of shareholders' equity. This statement will primarily affect the carrying value and presentation of Forethought's investment assets and will be adopted by the Company in the first quarter of 1995. The predominant share of Forethought's investment assets will be classified as \"available-for-sale.\" Adoption of this statement is expected to result in a reduction in insurance investments of approximately $80.0 million to report these investments at their estimated fair value. Insurance deferred taxes will be increased approximately $28.0 million to reflect the income tax effect and shareholders' equity will be decreased to record the unrealized net loss of approximately $52.0 million. The effect on results of operations and cash flows is not expected to be material.\nIn October 1994, the Financial Accounting Standards Board issued SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\" This statement requires disclosures about the amounts, nature, and terms of certain derivative financial instruments, and requires that a distinction be made between those held or issued for trading purposes and those held or issued for purposes other than trading. The Company's holdings in such instruments is minimal. This statement will be adopted in fiscal year 1995.\nENVIRONMENTAL MATTERS Hillenbrand Industries is committed to operating all of its businesses in a way that protects the environment. The Company has voluntarily entered into remediation agreements with environmental authorities, and has been issued Notices of Violation alleging violations of certain permit conditions. Accordingly, the Company is in the process of implementing plans of abatement in compliance with agreements and regulations. The Company has also been notified as a potentially responsible party in investigations of certain offsite disposal facilities. The cost of all plans of abatement and waste site cleanups in which the Company is currently involved is not expected to exceed $10.0 million. The Company has provided adequate reserves in its financial statements for these matters. Recent changes in environmental law might affect the Company's future operations, capital expenditures and earnings. The cost of complying with these provisions is not known.\nFACTORS THAT MAY AFFECT FUTURE RESULTS Self-reform of the health care industry, both in the U.S. and in Europe, will continue over the next several years. The most significant impact on Hillenbrand Industries has been, and will continue to be, the change in demand for capital goods in the acute care market as evidenced by the decline in revenues and operating profit at Hill-Rom in 1994. Although it is difficult to predict the ultimate outcome of this reform, the Company believes that investments in innovative products and services and process improvements will enable it to compete effectively in this changing market. Hill-Rom's European companies are leaders in the markets they serve. However, the lower profitability of these operations is expected to continue to negatively affect the Company's overall profit margins in 1995. Modernization of Arnold's production facilities and processes will occur during 1995 and 1996. The investigation of Hill-Rom by the Antitrust Division of the Department of Justice (DOJ) has been underway since the third quarter of 1993. The Company is cooperating with the DOJ in its investigation. Although the Company believes that it is not in violation of any antitrust law or statute and expects no material, adverse financial effect, it is impossible to predict with certainty when the investigation will be concluded, what the outcome of the investigation will be and what effect, if any, the outcome might have on the Company's financial condition, results of operations or cash flows.\nThe market for casketed deaths is essentially flat and Batesville Casket's future success in this market will depend largely on its ability to continue providing its customers with innovative products and services. With the introduction of the Options-TM- cremation program in 1993, and the growth realized in 1994, Batesville believes it is well positioned to compete effectively in the growing cremation market.\nAs anticipated, Forethought's revenue growth has slowed somewhat over the past two years as entry into targeted states and other jurisdictions winds down. Forethought's products faced increased competition from trusts in 1994 as yields on those investments improved. Forethought increased the crediting rate on its policies in response to this competition. A solid, conservative investment portfolio, innovative products and services and continued process improvements will allow Forethought to contribute to the future growth of the Funeral Services segment.\nThe Company's investment in operations in Canada and Mexico are minimal. While its presence in Europe is growing, exchange rate fluctuations are not material to the Company's financial position and results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPAGE\nFinancial Statements:\nReport of Independent Accountants 19 Statements of Consolidated Income for the three years ended December 3, 1994 20 Statements of Consolidated Shareholders' Equity for the three years ended December 3, 1994 21 Statements of Consolidated Cash Flows for the three years ended December 3, 1994 22 Consolidated Balance Sheets at December 3, 1994 and November 27, 1993 23 Notes to Consolidated Financial Statements 25 Financial Statement Schedules for the three years ended December 3, 1994: Schedule II-Valuation and Qualifying Accounts 40\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and Board of Directors of Hillenbrand Industries, Inc.\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Hillenbrand Industries, Inc. and its subsidiaries at December 3, 1994 and November 27, 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 3, 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. As discussed in Note 1 to the financial statements, the Company changed its method of accounting for income taxes in 1992.\nPRICE WATERHOUSE LLP\nIndianapolis, Indiana January 16, 1995\nSTATEMENT OF CONSOLIDATED INCOME\nHILLENBRAND INDUSTRIES, INC. AND SUBSIDIARIES (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSTATEMENT OF CONSOLIDATED SHAREHOLDERS' EQUITY\nHILLENBRAND INDUSTRIES, INC. AND SUBSIDIARIES (DOLLARS IN THOUSANDS)\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSTATEMENT OF CONSOLIDATED CASH FLOWS\nHILLENBRAND INDUSTRIES, INC. AND SUBSIDIARIES (DOLLARS IN THOUSANDS)\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nCONSOLIDATED BALANCE SHEET\nHILLENBRAND INDUSTRIES, INC. AND SUBSIDIARIES (DOLLARS IN THOUSANDS)\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting policies specific to insurance operations are summarized in Note 9.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, except for several small subsidiaries which provide ancillary services to the Company and the public. These subsidiaries are not consolidated because of their materiality and are accounted for by the equity method. Their results of operations appear in the income statement, net of income taxes, under the caption \"Other income (expense), net.\" Operating results for American Tourister, which was sold on August 30, 1993, are reported separately as a discontinued operation, net of income taxes, in the income statement. Material intercompany accounts and transactions have been eliminated in consolidation. The Company's fiscal year is the 52 or 53 week period ending the Saturday nearest November 30.\nCASH AND CASH EQUIVALENTS\nThe Company considers investments in marketable securities and other highly liquid instruments with a maturity of three months or less to be cash equivalents.\nINVENTORIES\nInventories are valued at the lower of cost, principally on a last-in, first-out (LIFO) basis, or market. The LIFO reserve, which approximates the excess of the current cost of inventories over the stated LIFO values, declined from $9.3 million at year-end 1992 to $8.2 million at year-end 1993 due to the sale of American Tourister in 1993. Excluding the effect of the sale, the LIFO reserve increased $1.6 million in 1993. The reserve increased to $9.3 million at year- end 1994. Separate accounts for raw materials, work-in-process and finished goods are not maintained.\nEQUIPMENT LEASED TO OTHERS\nEquipment leased to others represents therapy rental units, which are recorded at cost and depreciated on a straight-line basis over their average economic life. These units are leased on a day-to-day basis.\nPROPERTY\nProperty is recorded at cost and depreciated over the estimated useful life of the assets using principally the straight-line method for financial reporting purposes. Generally, when property is retired from service or otherwise disposed of, the cost and related amount of depreciation or amortization are eliminated from the asset and reserve accounts, respectively. The difference, if any, between the net asset value and the proceeds is charged or credited to income. The major components of property at the end of 1994 and 1993 were:\nINTANGIBLE ASSETS\nIntangible assets are stated at cost and are amortized on a straight-line basis over periods ranging from 3 to 40 years. In the fourth quarter of 1993, the Company recorded a $14.0 million charge to reduce the carrying value of the goodwill related to the Block acquisition based on management's expectations for Block's future earnings and discounted cash flows. Accumulated amortization of intangible assets was $133,181 and $119,258 as of December 3, 1994 and November 27, 1993, respectively.\nEARNINGS PER COMMON SHARE\nEarnings per common share are computed by dividing net income by the average number of shares outstanding during each year, including restricted shares issued to employees. Common equivalent shares arising from shares awarded under the Senior Executive Compensation Program, which was initiated in fiscal year 1978, have been excluded from the computation because of their insignificant dilutive effect.\nRETIREMENT PLANS\nThe Company and its subsidiaries have several defined benefit retirement plans covering the majority of employees, including certain employees in foreign countries. The Company contributes funds to trusts as necessary to provide for current service and for any unfunded projected future benefit obligation over a reasonable period. The benefits for these plans are based primarily on years of service and the employee's level of compensation during specific periods of employment. 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 8.0% and 6.0%, respectively, for 1994, 7.5% and 6.0%, respectively, for 1993, and 8.0% and 6.5%, respectively, for 1992. The expected long-term rate of return on assets was 8.0% for 1994, 1993 and 1992.\nNet pension expense includes the following components:\nThe funded status of the plans is shown in the table below:\nIn addition to the above plans, the Company assumed the unfunded liabilities of a defined benefit plan in the acquisition of Arnold in 1994. On December 3, 1994, the unfunded accumulated benefit obligation of this plan, included in accrued expenses, was approximately $13,000. Pension expense in 1994 was approximately $1,000. The Company also sponsors several defined contribution plans covering certain of its employees. Employer contributions are made to these plans based on a percentage of employee compensation. The cost of these defined contribution plans was $7,170 in 1994, $5,928 in 1993, and $5,388 in 1992.\nINCOME TAXES\nThe Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109), in 1992. SFAS 109 is an asset and liability method of accounting for income taxes. The asset and liability method requires the recognition of deferred tax assets and liabilities based upon expected future tax consequences of temporary differences between tax bases and financial reporting bases of assets and liabilities. Net assets as of December 1, 1991 were increased by $10,747 as a result of adopting SFAS 109. For years prior to 1992, income taxes were computed based on Accounting Principles Board Opinion No. 11.\nFOREIGN CURRENCY TRANSLATION\nAssets and liabilities of foreign operations are translated into U.S. dollars at year-end rates of exchange and the income statements are translated at the average rates of exchange prevailing during the year. Adjustments resulting from translation of the financial statements of foreign operations into U.S. dollars are excluded from the determination of net income and included as a separate caption in shareholders' equity. Foreign currency gains and losses resulting from transactions are included in results of operations and are not material.\n2. ACQUISITIONS\nEffective February 7, 1994, the Company's subsidiary, Hill-Rom, Inc., completed the acquisition of L. & C. Arnold AG, a German manufacturer of hospital and nursing home beds. The Company's subsidiary, Batesville Casket Company, Inc., acquired Industrias Arga, S.A. de C.V., a Mexican casket manufacturer and distributor, effective December 9, 1993, and Lincoln Casket Company, a casket distributor based in Detroit, Michigan, effective December 10, 1993. These acquisitions have been accounted for as purchases and the operations of the businesses acquired have been included in the Company's consolidated financial statements from their respective dates of acquisition. The combined purchase price of these companies (the predominant share of which relates to the acquisition of L. & C. Arnold AG) consisted of cash in the amount of $39.9 million and the assumption of net liabilities (including the establishment of reserves to reflect the cost of rationalizing certain acquired operations) of $6.4 million. The resulting goodwill of $46.3 million is being amortized on a straight-line basis, primarily over 40 years.\n3. FINANCING AGREEMENTS\nThe Company's various financing agreements contain no provisions or conditions relating to dividend payments, working capital and additional indebtedness.\nLong-term debt consists of the following:\nThe scheduled payments of the remaining long-term debt as of December 3, 1994 are: $1,805 in 1995; $2,101 in 1996; $1,028 in 1997; $848 in 1998 and $762 in 1999. Short-term debt consists of a non-interest bearing promissory note in the amount of $1,750 payable in 1995 and use of various lines of credit maintained for foreign subsidiaries totaling $23,456. The weighted average interest rate on all short-term borrowings outstanding as of December 3, 1994 and November 27, 1993 was 7% and 8%, respectively.\n4. SHAREHOLDERS' EQUITY\nOne million shares of preferred stock, without par value, have been authorized and none have been issued. The Company's Senior Executive Compensation Program, initiated in fiscal year 1978, provides long-term performance share compensation which contemplates annual payments of common stock of the Company to participants contingent on their continued employment and upon achievement of pre-established financial objectives of the Company over succeeding three-year periods. A total of 1,160,825 shares of common stock of the Company remain reserved for issuance under the program. Total tentative performance shares payable through December 3, 1994, were 16,131. In addition, the Senior Executive Compensation Program provides for participants to defer payment of long-term performance share and other compensation earned in prior years. A total of 203,015 deferred shares are payable as of December 3, 1994. Accruals for payments under these programs are included in \"Other Long-Term Liabilities.\" Members of the Board of Directors may elect to defer fees earned as reinvested in common stock of the Company. A total of 3,615 deferred shares are payable as of December 3, 1994 under this program. On April 7, 1992, the shareholders of the Company approved the adoption of a performance compensation plan whereby key employees will be awarded tentative performance shares based upon achievement of performance targets. A total of 1,296,899 shares of common stock remain reserved for issuance under this plan as of December 3, 1994. In 1993, 386,096 shares were earned based on the Company's performance. A total of 7,721 deferred shares are payable as of December 3, 1994 under this plan. The plan will terminate on November 30, 2001. The Board of Directors has authorized the repurchase, from time to time, of up to 14,000,000 shares of the Company's stock in the open market. The purchased shares will be used for general corporate purposes. As of December 3, 1994, a total of 10,823,572 shares had been purchased. On April 14, 1987, the shareholders of the Company approved the adoption of a restricted stock plan whereby key employees may be granted restricted shares of the Company's stock. The restrictions lapse after six years; or earlier if certain financial goals are exceeded. 2,000,000 shares of common stock were designated for this plan. Remaining authorized restricted shares may be awarded up to April 15, 1997 and the vesting periods begin when the shares are awarded. 324,600 shares have been awarded, 268,132 shares have been distributed and\/or deferred, and 56,468 shares have been forfeited as of December 3, 1994. No additional awards are contemplated at this time.\n5. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments (other than Insurance investments which are described in Note 9) for which it is practicable to estimate that value: The carrying amounts of cash and cash equivalents, trade accounts receivable, other current assets, trade accounts payable, and accrued expenses approximate fair value because of the short maturity of those instruments. The fair value of the Company's debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The estimated fair values of the Company's debt instruments are as follows:\n6. SEGMENT INFORMATION\nINDUSTRY INFORMATION\nThe Health Care segment consists of Hill-Rom, Inc. and Block Medical. Results for Medeco Security Locks are included in this segment due to its relative size. Hill-Rom produces and sells electric hospital beds, patient room furniture and patient handling equipment designed to meet the needs of acute care and perinatal providers. It also provides rental therapy units to health care facilities for wound therapy, the management of pulmonary complications associated with critically ill patients, and incontinence management. Block manufactures and sells home infusion therapy products including disposable infusion pumps and ambulatory electronic infusion pumps for antibiotic, nutritional, chemotherapy and other drug therapies. Medeco produces and sells high-security mechanical locks and lock cylinders and electronic security systems for commercial, residential and government applications. The Funeral Services segment consists of Batesville Casket Company and Forecorp. Batesville manufactures and sells a variety of metal and hardwood caskets and a line of urns and caskets used in cremation. Batesville's products are sold to licensed funeral directors operating licensed funeral homes. Forecorp's subsidiaries, Forethought Life Insurance Company and The Forethought Group, provide funeral planning professionals with marketing support for Forethought-Registered Trademark- funeral plans funded by life insurance policies. Note 9 contains additional information regarding insurance operations.\nFinancial information regarding the Company's industry segments is presented below:\nGEOGRAPHIC INFORMATION\nSales between geographic area are at transfer prices, which are equivalent to market value.\n7. INCOME TAXES\nIn 1992, the Company adopted SFAS 109 \"Accounting for Income Taxes.\" Under SFAS 109, the deferred tax provision is determined using the liability method. This method recognizes deferred tax assets and liabilities measured on differences between financial statement and tax bases of assets and liabilities using presently enacted tax rates.\nThe fiscal year differences between the amounts recorded for income taxes on income from continuing operations for financial statement purposes and the amounts computed by applying the Federal statutory tax rate to income from continuing operations before taxes are explained as follows:\nThe tax effect of temporary differences that give rise to significant portions of the deferred tax balance sheet accounts were as follows:\nRemaining unutilized foreign loss carryforwards were approximately $39.0 million and $8.0 million on December 3, 1994 and November 27, 1993, respectively. A valuation allowance is provided since realization of the tax benefits is not assured.\n8. SUPPLEMENTARY INFORMATION\nThe following amounts were (charged) or credited to income in the year indicated:\nThe table below indicates the minimum annual rental commitments (excluding renewable periods) aggregating $52,396, primarily for warehouses, under noncancellable operating leases.\n- - --------------------------------------------------------------------------------\nThe table below provides supplemental cash flow information.\n9. INSURANCE OPERATIONS\nForecorp, Inc., through its two subsidiaries, The Forethought Life Insurance Company and The Forethought Group, Inc., serves funeral planning professionals with life insurance policies and marketing support for FORETHOUGHT funeral planning, a \"pre-need\" insurance program.\nInvestments are predominantly U.S. Government, Federal agency and corporate debt securities with fixed maturities and are carried on the balance sheet at amortized cost. It is management's intent that these investments be held to maturity. Cash (unrestricted as to use) is held for future investment. The amortized cost and fair values of investments in debt securities at December 3, 1994 are as follows:\nThe amortized cost and fair value of debt securities at December 3, 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties.\nProceeds and realized gains and losses from the sale of investments in debt securities were as follows:\nPremiums received are recorded as an increase to benefit reserves or as unearned revenue. Unearned revenues are recognized over the actuarial life of the contract. Policy acquisition costs, consisting of commissions, policy issue expense and premium taxes, are deferred and amortized consistently with unearned revenues. Benefit reserves are equal to the net cash surrender value available to policyholders. Cash surrender values are determined using Commissioner's Standard Ordinary tables with interest rates from 4.0% to 5.5%. In the first quarter of 1995, the Company will adopt SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" This statement requires that certain investments in debt and equity securities be classified as either \"trading,\" available-for-sale\" or \"held-to-maturity.\" The predominant share of Forethought's investments will be classified as \"available-for-sale.\" Adoption of this statement is expected to result in a reduction in insurance investments of approximately $80.0 million to report these investments at their estimated fair value. Insurance deferred taxes will be increased approximately $28.0 million to reflect the income tax effect and shareholders' equity will be decreased to record the unrealized net loss of approximately $52.0 million. The effect on results of operations and cash flows is not expected to be material.\nSummarized financial information of insurance operations included in the consolidated financial statements is as follows:\nStatutory data at December 31 includes:\n10. UNAUDITED QUARTERLY FINANCIAL INFORMATION\n11. DISCONTINUED OPERATION\nOn August 30, 1993, the Company sold its luggage business, American Tourister, Inc., for a cash payment of $63.8 million. Net proceeds (after disposition costs) were $55.3 million. The gain on the sale of $11.6 million is net of income taxes of $4.7 million. The results of American Tourister, Inc. have been reported separately as a discontinued operation in the Statement of Consolidated Income for the two year period ended November 27, 1993. The income (loss) from discontinued operations is net of income tax provisions (benefits) of $1,091 and ($782) in 1993 and 1992 respectively.\n12. CONTINGENCIES\nIn 1993, the Company's subsidiary, Hill-Rom, Inc., was notified that it is part of an investigation into the hospital bed industry by the Antitrust Division of the Department of Justice (the \"DOJ\"). As a result, the Company was issued a Civil Investigation Demand by the DOJ and served with a subpoena to allow review of internal Hill-Rom files and business practices to determine any irregularities. The Company is cooperating with the DOJ in its investigation. Although the Company believes that it is not in violation of any antitrust law or statute and expects no material, adverse financial effect, it is impossible to predict with certainty when the investigation will be concluded, what the outcome of the investigation will be and what effect, if any, the outcome might have on the Company's financial condition, results of operations or cash flows. The Company has voluntarily entered into remediation agreements with environmental authorities, and has been issued Notices of Violation alleging violations of certain permit conditions. Accordingly, the Company is in the process of implementing plans of abatement in compliance with agreements and regulations. The Company has also been notified as a potentially responsible party in investigations of certain offsite disposal facilities. The cost of all plans of abatement and waste site cleanups in which the Company is currently involved is not expected to exceed $10.0 million. The Company has provided adequate reserves in its financial statements for these matters. Changes in environmental law might affect the Company's future operations, capital expenditures and earnings. The cost of complying with these provisions is not known. On September 19, 1994, subsequent to trial on the issues, the Company settled a patent infringement suit brought by Kinetic Concepts, Inc. against Support Systems International, Inc. and SSI Medical Services, Inc., wholly owned subsidiaries of the Company, for a cash payment of $84.8 million. The settlement amount was reflected in third quarter results as an unusual charge to operations of $84.8 million ($52.5 million, or $.74 per share, after tax) and payment was made in the fourth quarter. From the date of the initial claim until the trial commencing August 29, 1994, the Company believed that the outcome of the trial or any settlement of the matter would not have a significant effect on the Company's financial condition or results of operations. The settlement of the patent infringement suit will not affect future operating results. The Company is subject to various other claims and contingencies arising out of the normal course of business, including those relating to commercial transactions, product liability, safety, health, taxes, environmental and other matters. Management believes that the ultimate liability, if any, in excess of amounts already provided or covered by insurance, is not likely to have a material adverse effect on the Company's financial condition, results of operations or cash flows.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no disagreements with the independent accountants.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation relating to executive officers is included in this report as the last section of Item 1 under the caption \"Executive Officers of the Registrant.\" Information relating to the directors will appear in the section entitled \"Election of Directors\" in the definitive Proxy Statement to be dated March 2, 1995, and to be filed with the Commission relating to the Company's 1995 Annual Meeting of Shareholders, which section is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe section entitled \"Executive Compensation\" in the definitive Proxy Statement dated March 2, 1995, and to be filed with the Commission relating to the Company's 1995 Annual Meeting of Shareholders, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe section entitled \"Election of Directors\" in the definitive Proxy Statement to be dated March 2, 1995, and to be filed with the Commission relating to the Company's 1995 Annual Meeting of Shareholders, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe sections entitled \"About the Board of Directors\" and \"Compensation Committee Interlocks and Insider Participation\" in the definitive Proxy Statement to be dated March 2, 1995, and to be filed with the Commission relating to the Company's 1995 Annual Meeting of Shareholders, 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) The following documents have been filed as a part of this report or, where noted, incorporated by reference:\n(1) Financial Statements\nThe financial statements of the Company and its consolidated subsidiaries listed on the index to Consolidated Financial Statements on page 18.\n(2) Financial Statement Schedules\nThe financial statement schedules filed in response to Item 8 and Item 14(d) of Form 10-K are listed on the index to Consolidated Financial Statements on page 18.\n(3) Exhibits\nThe following exhibits have been filed as part of this report in response to Item 14(c) of Form 10-K.\n3 (i) Form of Restated Certificate of Incorporation of the Registrant (Incorporated herein by reference to Exhibit 3 filed with Form 10-K for the year ended November 28, 1992)\n3 (ii) Form of Amended Bylaws of the Registrant\nThe following management contracts or compensatory plans or arrangements are required to be filed as exhibits to this form pursuant to Item 14 (c) of this report:\n10 (i) Hillenbrand Industries, Inc. Senior Executive Compensation Program\n10 (ii) Hillenbrand Industries, Inc. Performance Compensation Plan (Incorporated herein by reference to the definitive Proxy Statement dated February 28, 1992, and filed with the Commission relative to the Company's 1992 Annual Meeting of Shareholders)\n21 Subsidiaries of the Registrant\n27 Financial Data Schedule\n(b) There were no reports on Form 8-K filed during the quarter ended December 3, 1994.\nSCHEDULE II\nHILLENBRAND INDUSTRIES, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 3, 1994, NOVEMBER 27, 1993, AND NOVEMBER 28, 1992 (DOLLARS IN THOUSANDS)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHILLENBRAND INDUSTRIES, INC.\nBy: \/S\/ W August Hillenbrand ----------------------------------- W August Hillenbrand Dated: January 25, 1995 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.\n\/S\/ Daniel A. Hillenbrand \/S\/ John C. Hancock - - ----------------------------------- ----------------------------------- Daniel A. Hillenbrand John C. Hancock Chairman of the Board Director\n\/S\/ Tom E. Brewer \/S\/ W August Hillenbrand - - ----------------------------------- ----------------------------------- Tom E. Brewer W August Hillenbrand Senior Vice President and Director Chief Financial Officer\n\/S\/ James D. Van De Velde \/S\/ George M. Hillenbrand II - - ----------------------------------- ----------------------------------- James D. Van De Velde George M. Hillenbrand II Vice President, Controller Director\n\/S\/ Lawrence R. Burtschy \/S\/ John A. Hillenbrand II - - ----------------------------------- ----------------------------------- Lawrence R. Burtschy John A. Hillenbrand II Director Director\n\/S\/ Peter F. Coffaro \/S\/ Ray J. Hillenbrand - - ----------------------------------- ----------------------------------- Peter F. Coffaro Ray J. Hillenbrand Director Director\n\/S\/ Edward S. Davis \/S\/ Lonnie M. Smith - - ----------------------------------- ----------------------------------- Edward S. Davis Lonnie M. Smith Director Director\n\/S\/ Leonard Granoff - - ----------------------------------- Leonard Granoff Director\nDated: January 25, 1995\nHILLENBRAND INDUSTRIES, INC. INDEX TO EXHIBITS\n3 (i) Form of Restated Certificate of Incorporation of the Registrant (Incorporated herein by reference to Exhibit 3 filed with Form 10-K for the year ended November 28, 1992)\n3 (ii) Form of Amended Bylaws of the Registrant\n10 (i) Hillenbrand Industries, Inc. Senior Executive Compensation Program\n10 (ii) Hillenbrand Industries, Inc. Performance Compensation Plan (Incorporated herein by reference to the definitive Proxy Statement dated February 28, 1992, and filed with the Commission relative to the Company's 1992 Annual Meeting of Shareholders)\n21 Subsidiaries of the Registrant\n27 Financial Data Schedule","section_15":""}
{"filename":"29322_1994.txt","cik":"29322","year":"1994","section_1":"ITEM 1 - BUSINESS\n(a) General Development of Business\nDixie National Corporation (Corporation) was organized in 1966 as a Mississippi corporation. It is an insurance holding company primarily engaged in the life insurance business through its 99.3% owned subsidiary, Dixie National Life Insurance Company (Dixie Life), a Mississippi corporation organized in 1965. The term \"Company\" as used herein includes the Corporation, Dixie Life and the Corporation's other subsidiaries, as the context indicates.\nVirtually all of the Company's consolidated revenues are represented by premium income and net investment income generated in Dixie Life's insurance operations. For the year ended December 31, 1994, the Company had total revenues of $11,651,343 and a net loss of $2,554,729. The Corporation's financial condition is dependent upon the operations of Dixie Life, as well as on Dixie Life's ability to transfer funds to the Corporation to meet expenses, debt service requirements and other financial needs of the Corporation. In that regard, provisions of the Mississippi insurance law impose restrictions upon the transfer of funds from an insurance company subsidiary, such as Dixie Life, to a parent stockholder, such as the Corporation.\nThe Corporation has signed a Letter of Intent to sell Dixie Life to Standard Management Corporation, an Indiana corporation (SMC). As more fully discussed under \"Recent Developments\" below, this transaction (SMC Transaction), if completed, provides for the satisfaction of substantially all of the Corporation's debt, including a $3,689,000 Term Loan due March 31, 1995 held by a subsidiary of SMC and $1,720,000 in Subordinated Convertible Notes of the Corporation due May 1, 1995 (Convertible Notes). The SMC Transaction also would significantly change the nature of the Corporation's business, including its dependence on receipt of funds from a regulated subsidiary. For further information, see \"(c) Narrative Description of Business,\" below, \"Item 7 - -Management's Discussion and Analysis of Financial Condition and Results of Operations,\" and Notes 2 and 9 of Notes to Consolidated Financial Statements.\nAll of the shares of Dixie Life owned by the Corporation are pledged as collateral under the Term Loan, and the holders of the Convertible Notes also have a security interest in those shares.\nRecent Developments\nProposed Sale of Dixie National Life Insurance Company and Satisfaction of Indebtedness\nOn March 6, 1995, the Corporation entered into a Letter of Intent with SMC to sell to SMC all of the capital stock of Dixie Life which the Corporation owns. Dixie Life represents 94% of the consolidated assets and substantially all of the consolidated operations of the Corporation.\nAt closing SMC will cancel the Term Loan obligation, assume the Corporation's indebtedness of $1,720,000\nunder the Convertible Notes due May 1, 1995, pay the Corporation $2,500,000 in cash and issue to the Corporation SMC common shares equal to $500,000 valued at the average trading price of SMC's shares for the five days prior to closing. The Corporation will also receive the first $175,000 of agent advances that Dixie Life collects after closing. These payments constitute a selling price of at least $8,408,746 and up to $8,583,746 if agent advances equal at least $175,000 at closing and at least $175,000 is subsequently collected. Agent advances, net of allowance for doubtful accounts at December 31, 1994, were approximately $270,000. The selling price will be adjusted by the change in Dixie Life's capital and surplus and asset valuation reserve between December 31, 1994 and closing. In addition, Dixie Life will continue to pay $15,000 per month rent to Vanguard, Inc. (Vanguard), a wholly-owned subsidiary of the Corporation through the December 31, 1996 expiration of an existing lease on the office building occupied by the Corporation and Dixie Life.\nAlthough the SMC Transaction provides means to satisfy the Convertible Subordinated Notes at closing, such notes are due before the anticipated closing date and there are no assurances that the Corporation will be able to extend such notes beyond their May 1, 1995 maturity, or effect any alternative accommodations. However, management is exploring several options and believes that the Convertible Notes will be satisfied or extended at their due date.\nExcept as to the extension of the due date of the Term Loan, a prohibition against the Corporation negotiating with other parties and certain other customary provisions, the Letter of Intent is not binding and is subject to a Definitive Purchase Agreement which the parties intend to sign before April 1, 1995. The Definitive Purchase Agreement will contain usual and customary conditions, including, among others, the receipt of all required regulatory approvals and approval of the transaction by the shareholders of the Corporation at a meeting to be held on or before August 1, 1995. There is no assurance that the SMC Transaction will be consummated. As previously reported, in the first quarter of 1994, the Corporation reached an agreement in principle for the acquisition of the Corporation by SMC in a tax-free merger. A definitive Merger Agreement among the Corporation, SMC and an SMC affiliate was executed June 8, 1994. On August 1, 1994, the Corporation terminated the Merger Agreement as a result of SMC's failure to meet certain conditions of the Merger Agreement. On November 7, 1994, Standard Life Insurance Company of Indiana, a subsidiary of SMC, purchased the Term Loan from the bank which previously held the note.\nSale of Common Stock\nThe Corporation entered into an agreement with Universal Management Services, a Nevada corporation (UMS), as of October 27, 1994 (UMS Agreement). The UMS Agreement provides that UMS will use its best efforts to assist the Corporation in locating potential investors for its Common Stock in non-U.S. markets pursuant to Regulation S of the Securities Act of 1933. On November 29, 1994, with such assistance, the Corporation sold 2,000,000 shares of its Common Stock for which it received 1,230,770 shares of Alanco Environmental Resources, Inc. (Alanco) common stock (November Transaction). The Alanco shares had an aggregate market value of $2,000,000 on November 29, 1994 (see Note 3 of Notes to Consolidated Financial Statements). Alanco is principally engaged in the manufacture and marketing of a pollution control device sold in domestic and foreign markets.\nThe UMS Agreement also gave UMS the right to assist the Corporation in placing an additional 4,425,000 shares of its Common Stock, as previously described in the Corporation's Form 10-Q for the nine months ended September 30, 1994. In light of the SMC Transaction among other factors the Corporation and UMS have agreed to amend and restate the UMS Agreement on the basis described below. A copy of the amended and restated UMS Agreement is expected to be filed as an exhibit to a Form 8-K current report of the Corporation shortly.\nUnder the amended and restated UMS Agreement, UMS has the right to use its best efforts to assist the Corporation in placing up to 12,500,000 additional shares of the Corporation's Common Stock in non-U.S. markets, pursuant to Regulation S. The Corporation expects to:\n1. Issue 2,000,000 shares of its Common Stock in exchange for 16% of the outstanding common shares of Phoenix Medical Management, Inc. (PMM), an Arizona corporation.\n2. If the acquisition of the 16% interest is completed, issue 100,000 of its Common Stock for an option to acquire the remaining 84% of the common shares of PMM for 10,400,000 shares of the Corporation's Common Stock.\n3. Purchase from PMM three specialized health care facilities for approximately $700,000 in cash. The funds for this transaction are expected to be obtained through the placement, with the assistance of UMS, but outside of the UMS Agreement, of approximately 700,000 shares of the Corporation's Common Stock under Regulation S.\nPMM was formed in November 1993 to engage in the ownership and operation of health care facilities specializing in pain care. It's primary business activity is the development of a proprietary multi-state network of medical facilities that specialize in the comprehensive treatment of patients seeking relief of chronic pain. Each facility is designed and equipped to accommodate a multi-modality pain management, psychological and physical rehabilitation program, as well as to accommodate other non- affiliated surgeons who perform their own \"non-pain related\" surgical procedures at these facilities.\nPMM currently has one medical facility open and operating in Phoenix, Arizona, with two additional facilities, in Lafayette and New Orleans, Louisiana, scheduled to open in June and September 1995, respectively. These facilities will operate under the name Surgi-Net and Advanced Pain Management Institute.\nThe combination of all facets of pain management was successfully test marketed by the founders of PMM in Phoenix, Arizona, and Lafayette, Louisiana, over the course of the past two years. PMM is a development stage company which opened its Phoenix facility in January 1995. Accordingly, PMM does not have a meaningful history of operations.\nThe amount of the consideration to be paid by the Corporation for the acquisition of its interest in PMM and the three specialized health care facilities, as described above, bears no relation to PMM's current assets or operations. No assurances can be given, or representations made, as to the results of this venture if, in fact, it proceeds, or whether it, or any diversification by the Corporation into the health care field, will be financially successful.\nThe Corporation understands that PMM is 60% owned by Amarante Financial S.A.(Amarante), a British Virgin Islands corporation, which was one of the investors in the November Transaction. Amarante owns all of the outstanding common stock of UMS. The Corporation also is informed that Alanco and two unaffiliated individuals hold the minority interest in PMM. Amarante has an option to purchase all of the minority interest during June 1995.\nJohn E. Haggar, who is a director of the Corporation is Chief Financial Officer and a director of UMS. James G. Ricketts, who also is a director of the Corporation, is a director of Alanco. The information set forth above regarding the business and operations of PMM is based on information supplied by UMS.\nThe Corporation believes that PMM offers an attractive opportunity for entry into the health care market, and that the investment is a logical strategic move. With the proposed sale of Dixie Life to SMC, the Corporation will have divested itself of its remaining insurance operations, yet will still be involved in an area related to the accident and health insurance business which was a significant part of the Corporation's operations for many years. Assuming that the PMM transactions take place, the Corporation expects that a principal part of its business in the future would be in the health care industry.\nIn view of covenants contained in the Term Loan Agreement, the aquisition of shares of PPM by the Corporation will require certain waivers from SMC, which the Corporation will seek to obtain. However, there is no assurance that such waivers will be obtained, in which case the Corporation will be obliged to reassess the proposed PMM transaction. There are no assurances that any further transactions contemplated by the UMS Agreement will be completed. UMS's rights under the UMS Agreement will expire June 30, 1995.\nIf at least 6,425,000 shares are placed with UMS's assistance, the UMS Agreement provides that the purchasers will be entitled to designate a majority of the Corporation's Board of Directors. This right would be facilitated by the resignation of a sufficient number of directors whose tenure as director predates the UMS Agreement so that designees of the new investors could be appointed until the next annual meeting of the Corporation's stockholders. The UMS Agreement contained three other undertakings of the Corporation which were accomplished at the 1994 annual meeting of the Corporation's stockholders held January 24, 1995. These were (a) reduction of the Corporation's Board of Directors from 15 members to 9 members; (b) election to the Corporation's Board of Directors of three representatives of the parties who purchased the Corporation's Common Stock in the November Transaction; and (c) an increase in the number of authorized shares of the Corporation's Common Stock from 10,000,000 to 50,000,000.\nFuture Plans\nThe acquisition of a 16% interest in PMM, if completed, will mark the Corporation's entry into the health care field. The Corporation expects to utilize any proceeds of the SMC\nTransaction and any sales of its Alanco shares, after satisfaction of the Corporation's debt, to facilitate its diversification into the health care field. At the present time, the Corporation does not expect to reenter the life insurance business if the SMC Transaction is completed. The Corporation is also considering other lines of business.\nSale of Accident and Health Business\nIn 1994 Dixie Life sold virtually all of its accident and health business in two transactions (A&H Sales). The first sale was initiated in December 1993 and completed in February 1994. The second transaction was initiated in July 1994 and completed in September 1994. The Company recognized losses of $324,000 in 1993 and $1,196,000 in 1994 on these transactions. For further information, see \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations-- Liquidity and Capital Resources\" and \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations.\"\n(b) Financial Information About Industry Segments\nThe Company's insurance operations represent the only material industry segment in which the Company is engaged. Financial information concerning the lines of insurance business within the Company's single industry segment is included herein in Note 16 of Notes to Consolidated Financial Statements.\n(c) Narrative Description of Business\nGeneral\nDixie Life has traditionally offered various forms of life, health and annuity insurance products, primarily designed for specialized insurance markets. However, as discussed under \"Recent Developments\" above, Dixie Life sold virtually all of its accident and health business in late 1993 and mid 1994. Consequently, from July 1994, Dixie Life has only been marketing life insurance products, primarily in the burial or final expense market. Dixie Life will continue its present marketing program pending consummation of the SMC Transaction.\nThe following table sets forth information as to life insurance in force and premium income (after giving effect to amounts ceded and assumed) from all business of Dixie Life for the last five years:\n1994 1993 1992 1991 1990 Life Insurance in force (at December 31) $224,782,000 $188,337,000 $330,440,000 $540,989,000 $389,589,000\nPremium income: Life $ 3,878,000 $ 4,935,000 $ 4,455,000 $ 4,466,000 $ 3,803,000 Accident and Health 5,302,000 14,185,000 12,287,000 10,054,000 8,032,000 Annuity 336,000 379,000 437,000 627,000 623,000 ------------ ------------ ------------ ------------ --------- TOTAL $ 9,516,000 $ 19,499,000 $ 17,179,000 $ 15,147,000 $ 12,458,000\nPremium income from new business only for the last five years is shown in the following table:\n1994 1993 1992 1991 1990\nLife $ 301,000 $ 1,068,000 $ 837,000 $ 942,000 $ 1,293,000 Accident and Health 1,530,000 4,012,000 4,184,000 3,857,000 2,685,000\nAnnuity 9,000 ------------ ------------ ------------ ------------ ---------- TOTAL $ 1,831,000 $5,080,000 $5,021,000 $4,808,000 $3,978,000\nIn 1993, a marketing director new to Dixie Life produced a significant amount of new life business. In early 1994, this marketing director ceased producing business for Dixie Life, significantly contributing to the decrease in first year life premiums in 1994. The 1994 decrease in first year accident and health premiums was caused by the A&H sales.\nStatutory Surplus and Accounting\nAn insurance company such as Dixie Life must maintain minimum levels of capital and surplus(Statutory Surplus),as required by the insurance laws and regulations of the insurance company's state of domicile and the various other states in which it operates. See \"Insurance Company Regulation,\" below. At December 31, 1994, Dixie Life's Statutory Surplus was approximately $6,280,000. The highest level of Statutory Surplus required by the laws or regulations of any state in which Dixie Life operates is $3,000,000.\nStatutory accounting practices, as prescribed by the Mississippi Department of Insurance, differ from generally accepted accounting principles in several respects. The most significant of these differences is that statutory accounting practices require that costs incurred in writing new insurance business be expensed as paid, while generally accepted accounting principles require the capitalization of such costs, which are then amortized over the expected life of the insurance products sold. The principal such first year cost expensed in its entirety is commissions, which are significantly greater in the first year compared to renewal commissions. For example, on accident and health policies the first year commission is typically 70% of premium while the renewal commission is typically 20%. On life insurance policies the first year commissions are as much as 105% of premiums while the renewal commission is typically 10%. The excess of first year commissions over renewal commissions is deferred under generally accepted accounting principles, as are other costs associated with the issuance of a policy.\nBecause the high first year costs associated with issuance of a policy are expensed under statutory accounting practices, high levels of new business create drains on statutory net income and therefore Statutory Surplus. Dixie Life experienced increased levels of new business for several years through 1992, creating a strain on Statutory Surplus. However, primarily as a result of the sale of Dixie Life's accident and health business and a 1993 agreement by Dixie Life to cease writing new business in a particular state, the trend did not continue in 1994 and 1993. In order to write an increasing amount of new business while continuing to meet the statutory requirements of the states in which it conducted its insurance operations, it has been necessary for Dixie Life to utilize various forms of surplus relief.\nThe principal source of surplus relief since 1989 has been financial reinsurance agreements, which for GAAP purposes are treated as financing arrangements, but for statutory accounting purposes provide reserve credits that, in equal amount, increase Statutory Surplus. Since September 1992, Dixie Life has had a financial reinsurance agreement with Crown Life Insurance Company, a Canadian corporation (Crown Agreement). Under Dixie Life's agreement with Crown, Dixie Life was entitled to a credit to its statutory reserves of $1,985,000 at December 31, 1994. The amount of this credit will decrease in the amount of $165,000 each calendar quarter beginning in 1995. See \"Reinsurance\", below.\nThe sales of Dixie Life's accident and health business discussed above increased Statutory Surplus by $5,322,000 and $2,125,000 in 1994 and 1993, respectively.\nCapital Requirements of the Corporation\nDuring 1994 and in early 1995, the Corporation devoted significant effort to strengthening the Statutory Surplus of Dixie Life and reducing the Corporation's dependence upon the operations of Dixie Life and its ability to transfer funds to the Corporation. Management's effort resulted in the following:\n1) The UMS Agreement was entered into as a possible source of funds to satisfy the Term Loan and the Convertible Notes.\n2) The SMC Agreement was entered into as a possible means of satisfying the Term Loan and the Convertible Notes. There are no assurances the transaction contemplated by the SMC Agreement will be consummated.\n3) Dixie Life's accident and health business was sold, thereby increasing Dixie Life's Statutory Surplus to a level that reduced the importance of the reserve credit provided by the Crown Agreement. This also allowed Dixie Life to accelerate the recapture of the reserve credit in 1994, further reducing its dependence on the Crown agreement.\nAs previously stated, the financial condition of the Corporation has been dependent upon the operations of Dixie Life, and the ability of Dixie Life to transfer funds to the Corporation. As an insurance company subsidiary of the Corporation and a member of a holding company system with the Corporation, the ability of Dixie Life to transfer funds to the Corporation is, to a significant degree, controlled by statute. Generally, all transactions between members of a holding company system must be \"fair and reasonable.\" The Mississippi Commissioner of Insurance (Commissioner) has wide latitude in evaluating the reasonableness of a transaction and its effect upon a Mississippi insurer, such as Dixie Life. The Commissioner takes the position that a Mississippi insurance company cannot make a loan to any of its shareholders, officers or directors. Mississippi law limits the size of dividends or other distributions that may be made by a Mississippi insurer to another member of its holding company system without approval of the Commissioner. Thus, it is possible for an insurance company to be financially healthy, but for its holding company to be in need of funds under circumstances where it would be difficult or impossible to either transfer the needed funds from\nthe insurance company to its holding company or for the insurance company to obtain the necessary regulatory approval for transfers that require the approval of the Commissioner of Insurance. See \"Insurance Company Regulation,\" below, \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\", and Notes 2 and 9 of Notes to Consolidated Financial Statements.\nProducts and Markets\nLife insurance policies sold in the final expense, or burial market, include fixed premium interest sensitive policies that provide for increasing death benefits, as well as traditional whole life policies. These policies are designed to cover expenses such as funeral, last illness, monument and cemetery lot. The policies provide for a death benefit, generally not in excess of $10,000, and a level premium payment. The products include a cash value which may be borrowed by the policyholder.\nDixie Life's policies sold in other markets include interest sensitive and traditional whole life policies and forms of term policies. The interest sensitive and whole life policies include cash values which may be borrowed by the policyholder. Dixie Life issues policies on both a participating and non-participating basis. See Note 8 of Notes to Consolidated Financial Statements.\nDixie Life conducts insurance operations in 21 states, primarily in the southeastern and southwestern United States, and the District of Columbia. In 1994, the geographic distribution of collected premiums from the sale of accident and health, and life insurance policies, including annuity contracts, was as follows:\nAccident and Health Life State First Year Renewal First Year Renewal Total - ----- ------------ ----------- ----------- ------- ------ Texas 2.6% 8.4% 2.1% 8.1% 21.2% Mississippi 2.0% 9.0% 0.7% 6.2% 17.9% Georgia 2.9% 6.6% 0.6% 2.0% 12.1% Louisiana 1.0% 4.7% 0.2% 4.1% 10.0% Kansas 1.4% 5.7% 0.0% 0.6% 7.7% Other states 7.0% 13.2% 1.1% 9.8% 31.1% ------ ----- ----- ----- ----- 16.9% 47.6% 4.7% 30.8% 100.0%\nSales Force and Employees\nDixie Life's insurance products are offered through a sales force consisting, as of December 31, 1994, of approximately 1,760 agents, 375 general agents, and 50 marketing directors, with whom Dixie Life has non-exclusive contracts. Sales personnel are compensated on a commission basis and are provided incentives for increased production. A relatively small number of Dixie Life's marketing directors generate a significant amount of premium income and the loss of one or more marketing directors could have an adverse economic effect on the Company. In that regard, see \"General,\" above, with respect to the impact of the loss of a marketing director on 1994 new life insurance business.\nAt December 31, 1994, the Company had approximately 31 home office employees, including officers. In connection with the A&H sales, the home office staff was further reduced to 26 at March 15, 1995. At December 31, 1993, such staff numbered approximately 50.\nCompetition\nThe life insurance industry is highly competitive. There are over 2,000 life insurance companies nationwide. Dixie Life's competitors consist of both stock and mutual companies. Because the profits, if any, of mutual companies accrue to the benefit of policyholders, such companies may have certain competitive advantages. Dixie Life is a relatively small, essentially regional, insurance company that competes with life insurance companies that are more widely known, have far greater resources and offer a broader range of insurance products. Dixie Life also competes with other regional insurance companies of a more comparable size. These factors contribute to the competition encountered by the Company in attracting the services of qualified sales agents and may result in higher agent costs. Based on industry data, major life companies generally pay smaller commissions than Dixie Life. Compared to the regional companies in the market area it services, Dixie Life believes it pays similar commissions. The Company expects this pattern to continue in the foreseeable future. Dixie Life believes that its policies and rates, the services performed by its agents, and its claims administration are generally competitive with those offered by both stock and mutual companies in the jurisdictions in which it operates.\nChanges in the market place and individual needs require Dixie Life to continually reevaluate the insurance which it offers in order to remain competitive. Competition is intense, and is increasing, particularly as banks, securities brokerage firms and other financial intermediaries have become involved in the marketing of insurance products.\nInvestments\nDixie Life is required to invest its assets in accordance with applicable provisions of the Mississippi insurance law. The following table shows the composition of Dixie Life's invested assets at December 31, 1994 and 1993, valued on a GAAP basis:\n1994 1993 ---- ----\nCarrying Percent of Carrying Percent of Value Total Value Total -------- ---------- -------- ---------- Fixed maturities $17,332,660 54.7% $13,489,902 43.0% Policy loans 3,060,185 9.7 3,025,981 9.6 Government guaranteed student loans, 5,978,288 18.9 7,159,975 22.9 Short-term investments 4,860,347 15.3 3,040,448 9.7 Cash and cash equivalents 459,109 1.4 4,655,458 14.8 --------- ------- --------- ------ TOTAL $31,690,589 100.0% $31,371,764 100.0%\nDixie Life's fixed maturities consist of obligations issued by U.S. Government agencies and authorities; states, municipalities and political sub-divisions; public utilities; and other corporate issuers. As the table shows there was a substantial increase in fixed maturities, and a substantial decrease in cash and cash equivalents, during 1994. In 1994, the Company completed a plan begun in 1993 to realign the composition of its fixed maturities and short-term investments to create a portfolio with an average life of approximately 10 years.\nFor more information with respect to Dixie Life's investments and the changes that have occurred in its portfolio of fixed maturities and short-term investments, and the effect of those changes on income, see \"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 3 of Notes to Consolidated Financial statements.\nReinsurance\nDixie Life reinsures substantial portions of its life insurance risks with other carriers under its excess coverage reinsurance arrangements. Generally, when the life coverage on any one individual exceeds $55,000, Dixie Life's maximum retention on the insured is $50,000. The excess coverage is reinsured under agreements Dixie Life has entered into with various reinsurers, other than Crown.\nIn addition to its excess coverage reinsurance arrangements, Dixie Life, pursuant to the Crown Agreement, has ceded to Crown 90% of the retained portion of its traditional life and 90% of the retained part of its fixed premium excess interest sensitive life policies in effect as of September 30, 1992. The face amount of policies ceded as of the effective date was approximately $255,455,000. The reinsurance effected under the Crown Agreement is on a combination coinsurance and modified coinsurance basis. It is expected that the coinsurance portion will decrease and the modified coinsurance portion will increase over the term of the Crown Agreement.\nAs the amount of reinsurance on a coinsurance basis decreases under the Crown Agreement the amount of the reserve credit available to Dixie Life is reduced, with a corresponding reduction of Dixie Life Statutory Surplus. The Crown Agreement provided Dixie Life with $4,500,000 of initial reserve credit. At December 31, 1994, the reserve credit was $1,985,000 which may not be reduced by more than $165,000 per quarter ($250,000 per quarter prior to an amendment effective October 31, 1994).. It is anticipated that the Crown Agreement will be terminated in approximately three years from December 31, 1994, when all of the coinsurance portion of the reinsurance is expected to be converted to modified coinsurance, unless the agreement is further amended.\nDixie Life has placed assets in trust equal to 105% of the amount of the reserves on the portion of the ceded block of business originally reinsured under the Crown Agreement on a coinsurance basis. These assets, with a market value of approximately $13,435,000 as of December 31, 1994, have been placed in trust by Dixie Life with a bank.\nUnder the terms of the Crown Agreement, Dixie Life makes quarterly payments to Crown which are generally equal to 1% of the reserve credit being provided under the agreement for the next quarter. The Crown Agreement provides for various premium and other payments to be made between Dixie Life and Crown. These payments may offset each other, resulting in a netting of amounts due. No net quarterly payment to Crown during the remaining life of the Crown Agreement will exceed the payment made in the next preceding quarter.\nUnder all of Dixie Life's reinsurance arrangements, Dixie Life remains liable under its policies to its policyholders, regardless of the ability of the reinsurer to meet its obligation to Dixie Life.\nDixie Life has assumed reinsurance on a block of life insurance business under the Servicemen's Group Life Insurance Program. However, this assumption has virtually no effect on Dixie's earnings from year to year. This assumption increased Dixie Life's total in force life insurance by approximately $141,936,000 at December 31, 1994. Dixie does not have any plans to enter into other assumption reinsurance agreements.\nAdditional information regarding Dixie's reinsurance policies and activities is included in Notes 2 and 13 of Notes to Consolidated Financial Statements.\nRegulatory Factors\nDixie Life is subject to regulation and supervision by the insurance departments of the jurisdictions in which it is licensed to do business. These insurance departments are charged with the responsibility to assure that insurance companies maintain adequate capital and surplus, manage investments within prescribed character and exposure limitations and comply with a variety of operational standards. They also make periodic examinations of individual companies and review annual reports on the financial condition of all companies operating within their respective jurisdictions. Regulations cover many aspects of the life insurance business, including accounting and financial reporting procedures.\nAs a Mississippi domiciled insurer, Dixie Life is primarily subject to regulation by the Mississippi Insurance Department. An annual statement must be filed with the Insurance Department in each state in which Dixie Life is qualified on or before March 1 of each year covering operations and reporting on the financial condition of Dixie Life as of December 31st of the preceding year. Periodically, the Mississippi Insurance Department examines the assets, liabilities and reserves of Dixie Life and performs a full examination of its operations. The Mississippi Insurance Department's most recent complete examination of Dixie Life was as of December 31, 1990.\nIn 1993, the Mississippi Insurance Department completed a targeted examination as of September 30, 1993. In February 1995, the Department began a complete examination as of December 31, 1994. The Department invites other jurisdictions in which Dixie Life does business to participate in its examinations, if they so desire.\nUnder insurance guaranty fund laws in most states, insurers doing business therein can be assessed up to prescribed limits for policyholder losses incurred as a result of insolvent companies that were doing business in the assessing state. The amount of future assessments, if any, of Dixie\nLife under these laws cannot be estimated. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer's own financial strength. In addition,insurers are generally allowed a 100% credit for guaranty assessments paid against future premium tax expense.\nUnder Mississippi law, the Corporation and Dixie Life are members of an insurance holding company system. As members of an insurance holding company system, transactions between the Corporation and Dixie Life are subject to various statutory controls and limitations and may require approval and trigger certain reporting requirements. In addition, Mississippi law provides that certain transactions involving a domestic insurer and any person in its holding company system shall not be entered into unless the insurer has notified the Mississippi Commissioner in writing of the insurer's intention to enter into such transaction at least 30 days prior thereto, or such shorter period as the Mississippi Commissioner may permit, and that the Mississippi Commissioner has not disapproved such transaction within such period.\nGenerally, transactions within a holding company system must be fair and reasonable; charges or fees for services rendered must be reasonable; accounting for expenses incurred and for payments received must be allocated to the insurer in conformity with customary insurance accounting practices consistently applied; the books and records of the parties to all such transactions must clearly and accurately disclose the nature and details of the transactions, including accounting information necessary to support the reasonableness of the charges or fees to the parties; and the insurer's surplus as regards policyholders following any dividend or distribution to a stockholder affiliate must be reasonable in relation to the insurer's outstanding liabilities and adequate to meet its financial needs. Certain transactions are required to be reported to the Commissioner.\nMississippi law prohibits the payment of an extraordinary dividend or any other extraordinary distribution by an insurer to a stockholder until 30 days after the Mississippi Commissioner has received notice of the declaration thereof and has not, within such period, disapproved such payment or has approved such payment within the permitted period.\nAn extraordinary dividend or distribution is one which, together with all other distributions or dividends within the preceding 12 months, exceeds the lesser of (i) 10% of such insurer's surplus as regards policyholders as of December 31st next preceding, or (ii) net gains from operations of such insurer, not including realized capital gains, for the twelve months ending December 31 next preceding. In such computations, the insurer may carry forward net gain from operations from the previous two calendar years that have not already been paid out as dividends. Based upon Dixie Life's net gain from operations in 1994, Dixie Life may pay only a nominal dividend without the approval of the Mississippi Commissioner.\nAlthough the federal government generally does not directly regulate the business of insurance, federal initiatives often have an impact on the business in a variety of ways. Current and proposed federal measures which may significantly affect the insurance business include employee benefit regulation, tax law changes affecting the taxation of insurance companies, the tax treatment of insurance products, and the relative desirability of various personal investment vehicles.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Company's home offices occupy an entire two story building located at 3760 Interstate 55 North, in Jackson, Mississippi. The building and its three quarter acre site are owned by Vanguard.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nAs previously reported in the Corporation's Form 8-K report dated January 14, 1994, Dixie Life is a defendant in a suit filed on January 7, 1994, by David William Becker, plaintiff, in the Circuit Court of Montgomery County, Alabama.\nThe suit alleges that Dixie Life has failed to properly pay dividends to holders of its Charter Contract policies. As discussed in Note 13 of Notes to Consolidated Financial Statements, these policies are participating policies pursuant to which Dixie Life is obligated to apportion dividends to the holders of such policies as a group and on a prorata basis, of not less than 35% of the statutory net profits of Dixie Life, computed by a formula set forth in the policy. The formula utilizes certain information contained in the annual statement filed by Dixie Life with the Mississippi Department of Insurance, as such report was constituted in 1966. The suit was filed as a class action on behalf of the plaintiff and a class of persons allegedly similarly situated and alleges the class consists of over 1,000 persons.\nThe suit seeks judgment in an undetermined amount for alleged underpayment of dividends and an injunction requiring Dixie Life to pay appropriate dividends in the future.\nDixie Life has paid a dividend to holders of the Charter Contract policies in each year since the policies were issued. On a cumulative basis, the total dividends paid to the holders of the Charter Contract policies since issuance exceed 35% of the statutory net profits of Dixie Life for the same period as defined by the policy.\nDixie Life filed an answer to the complaint on March 7, 1994 and intends to vigorously defend the suit. Dixie Life believes serious questions exist as to whether a class action is available relative to the plaintiff's claim, and the identity of the class, if a class action is available. Dixie Life will oppose the certification of any class and, alternatively, will seek to limit the class.\nNo discovery has yet taken place and no class has yet been certified by the court. In the absence of a class, if any, and its composition, if certified, Dixie Life has no reasonable basis upon which to estimate its potential liability, if any.\nThere are no other pending legal proceedings, except for routine litigation incidental to the Company's business, to which the Company or any of its subsidiaries are a part, or to which any of the Company's properly is subject.\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 Corporation's Common Stock is traded in the over-the-counter market and is quoted on the NASDAQ Market System under the symbol DNLC. The tables below set forth the reported high and low sales price as reported by the National Quotation Bureau, Inc. for the quarters indicated. This information does not include retail markups, markdowns, or commissions. High Low Quarter Bid Asked Bid Asked\nFirst 1 1 1\/4 1 1 3\/16 Second 15\/16 1 1\/16 13\/16 15\/16 Third 9\/16 3\/4 1\/2 11\/16 Fourth 3\/4 7\/8 1\/2 5\/8\nHigh Low Quarter Bid Asked Bid Asked\nFirst 7\/8 1 1\/8 7\/8 1 1\/8 Second 13\/16 1 1\/16 13\/16 1 1\/16 Third 1 1\/16 1 1\/4 15\/16 1 1\/8 Fourth 13\/16 1 11\/16 7\/8\nNo dividends were paid on the Corporation's Common Stock during the last two years.\nThe number of holders of record of common stock of the Corporation on March 15, 1995 was 2,464.\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 following should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements and notes thereto appearing elsewhere in this report.\nLiquidity and Capital Resources\nGeneral. In 1994 and early 1995, the Corporation devoted significant effort to strengthening the Statutory Surplus of Dixie Life and reducing the Corporation's dependence upon the operations of Dixie Life and the ability of Dixie Life to transfer funds to the Corporation in order for the Corporation to meet its liquidity requirements. The following steps were taken in 1994 and early 1995:\nThe A&H Sales increased Dixie Life's Statutory Surplus to a level so that Dixie Life is not dependent upon the reserve credit provided by the Crown Agreement to meet minimum levels\nof Statutory Surplus required by any state in which it operates. The A&H Sales also allowed Dixie Life to accelerate the recapture of the Crown reserve credit in 1994, further reducing the dependence on the Crown Agreement.\nThe sale of Alanco shares provides a possible source of funds to satisfy the Convertible Notes.\nThe SMC Transaction provides a possible source of funds to satisfy the Term Loan and the Convertible Notes. There are no assurances the transaction contemplated by the SMC Agreement will be consummated.\nLiquidity Requirements. Most of the operating liquidity requirements of the Company arise from the insurance operations of Dixie Life and generally are met through funds generated by Dixie Life's operations. Premium income and net investment income provide funds that are used to pay claims to policyholders; make policy loans; pay costs of obtaining new business, principally first year commissions; and pay operating expenses. Dixie Life's operations generated positive cash flow of approximately $778,000, $98,000 and $1,074,000 in 1994, 1993 and 1992, respectively.\nDixie Life pays a monthly management fee of $154,000 to the Corporation. Funds provided by the management fee are sufficient to pay operating and interest expenses of the Corporation.\nThe Corporation's significant liquidity need at this time is for debt service. At December 31, 1994, the Corporation owed a subsidiary of SMC approximately $3,689,000 under a Term Loan. The Term Loan (originally due March 31, 1995) is now due at closing of the SMC Transaction or 90 days after the cancellation of the SMC Transaction by either party. Also, the Corporation's 10% Convertible Notes, in the amount of $1,720,000, are due May 1, 1995. Although the SMC Transaction provides a means to satisfy the Convertible Notes at closing, such notes are due before the anticipated closing date and there are no assurances that the Corporation will be able to extend such notes beyond their May 1, 1995 maturity, or effect any alternative accommodations. However, management is exploring several options and believes that the Convertible Notes will be satisfied or extended at their due date. All of the shares of Dixie Life owned by the Corporation are pledged to secure payment of the Term Loan and the Convertible Notes.\nAt December 31, 1994, Vanguard owed a bank approximately $524,000 under a mortgage loan secured by the home office building of Dixie Life. Under a lease agreement, Dixie Life pays Vanguard rent sufficient to cover the debt service under the mortgage.\nThe loan agreement covering the Term Loan contains three financial covenants. First, the covenants include a requirement that Dixie Life maintain statutory capital and surplus of at least $3,500,000 as of the end of each quarter. Dixie Life's statutory capital and surplus at December 31, 1994, was $6,280,000. Second, the Corporation must maintain tangible net worth, as defined, of at least $9,000,000. At December 31, 1994, tangible net worth was $8,487,818. Finally, the Corporation must maintain a ratio of total liabilities to tangible net worth of not more than 4.5 to 1. At December 31, 1994, the ratio of total liabilities to tangible net worth was 4.17 to 1. Failure to satisfy any of the financial covenants is an event of default unless waived by the holder to the Term Loan. Standard\nLife has waived the Corporation's failure to satisfy the tangible net worth covenant.\nThe terms of the Convertible Notes provide that an event of default under the Term Loan, if not cured or waived, is an event of default under the Convertible Notes.\nGoing Concern Considerations. The lack of assurance that the SMC Transaction will be completed raises significant doubt about the Company's ability to continue as a going concern. Completion of the SMC Transaction together with an extension or timely repayment of the Convertible Notes would remove such uncertainties.\nManagement's plans in this regard include the following:\n1. Endeavor to complete the SMC Transaction, thereby satisfying the Term Loan, as well as the Convertible Notes, assuming their due date is extended.\n2. Seek to extend or secure an alternative means of paying the Convertible Notes. Liquidation of a portion of the Alanco shares is a possible source of repayment of at least a portion of the Convertible Notes.\n3. In the event the SMC Transaction is canceled by either party, searching for another purchaser of Dixie Life in the 90 days available to it beyond such cancellation beforthe Term Loan is due.\nThere are no assurances that any of these efforts will be successful.\nInvestment Portfolio Liquidity. Dixie Life's investment strategy emphasizes investments of the highest quality. Accordingly, Dixie Life's policy has been to invest in securities which are considered investment grade by various investor services and the National Association of Insurance Commissioners (\"NAIC\"). Occasionally, securities will fall below investment grade over the life of the securities. At December 31, 1994, Dixie Life's investment in securities not of investment grade was less than 1% of total investments.\nDuring 1994, the Dixie Life increased its investment in fixed maturities by almost $5 million. The funding for this increase came from several sources, including $778,000 from operations, $403,000 from net collections on agent advances, $1,182,000 from net collections on student loans and $2,568,000 from a reduction in cash and short term investments. Dixie Life has completed its program, begun in 1993, to recast its investment portfolio into investments with an average maturity of approximately 10 years. Management believes its investment portfolio provides appropriate liquidity to meet the liabilities of Dixie Life as such liabilities mature.\nAt December 31, 1994, the Company's investments are reported in accordance with the provisions of Statement of Financial Accounting Standards No. 115 (FAS 115) which was issued by the Financial Accounting Standards Board in 1993 and effective for 1994 financial statements. As a result the carrying basis for investments is different in 1994 than in 1993.\nAt December 31, 1994, fixed maturity investments are all classified as available for sale and are carried at market value. Unrealized market gains and losses are reported as a separate component of stockholders' equity. Application of FAS 115 resulted in a reduction of the Corporation's stockholders' equity of $925,000 at December 31, 1994. In 1995, Dixie Life's Board of Directors approved two new investment programs. First, investment of up to $1,200,000 in five year equipment leases on food preparation equipment at a rate of prime plus 4% fixed at closing has been approved. Approximately $540,000 has been funded thus far in 1995. Second, investment of up to $1,000,000 in secured home construction loans in Arizona has been approved. These construction loans will have a loan to value ratio of not more than 65% and carry interest rates of 14.5% to 16.5%, depending on the development. No construction loans have been funded in 1995.\nStatutory Surplus. Minimum required levels of Statutory Surplus vary by state and range from $600,000 to $3,000,000 in states where Dixie Life is licensed. If an insurance company's Statutory Surplus falls below the statutory minimum, that company could be subjected to severe restrictions in the states where such minimum levels are not maintained. Thus any insurance company has a continuing need to maintain required minimum Statutory Surplus levels.\nThe insurance departments of most of the states in which Dixie Life operates, including its domicile state of Mississippi, have broad discretionary powers to require higher levels of Statutory Surplus, or to impose restrictions on operations, including fund transfers and new business sales, when such restrictions are perceived by the departments as necessary or desirable to maintain adequate amounts of Statutory Surplus.\nAt December 31, 1994, Dixie Life's Statutory Surplus was $6,280,000, well in excess of the minimum requirement of any state. Prior to the 1994 A&H Sale, Dixie Life's Statutory Surplus was less than $3,000,000. Further, in order to meet its Statutory Surplus requirements, Dixie Life has, from time to time, depended upon forms of reinsurance agreements that provide surplus relief through reserve credits that, for statutory accounting purposes, increase Statutory Surplus in an amount equal to the reserve credit taken. Dixie Life's principal reinsurance agreement provided a reserve credit of $1,985,000 at December 31, 1994. It also has sold blocks of in force accident and health insurance, thereby generating significant statutory profits.\nResults of Operations\nThe Company incurred a net loss of $2,554,779 in 1994 compared to a net loss of $957,138 in 1993 reflecting a negative change of 167% in 1994 compared to 1993. The net loss in 1993 reflected a negative change of 213% compared to 1992 net income of $848,984. On a per share basis the net loss for 1994 was $.39 compared to a net loss of $.15 in 1993 and net income of $.13 in 1992.\nTotal revenues for 1994 were $11,651,000 compared to $21,530,000 in 1993 and $19,312,000 in 1992, reflecting a 46% decrease in 1994 and an 11% increase in 1993.\nPremium income in 1994 was $9,516,000, a 51% decrease from 1993 premiums of\n$19,499,000. The 1993 level of premiums was 14% greater than 1992 premium income of $17,179,000. The decrease in premiums in 1994 was driven primarily by the A&H Sales which resulted in Dixie Life having no accident and health premiums in the last half of 1994. The composition of premium income in each of the three years was as follows:\nLife and Accident Annuity and Health Total 1994 $4,214,000 $5,302,000 $9,516,000 1993 5,314,000 14,185,000 19,499,000 1992 4,892,000 12,287,000 17,179,000\nNet investment income was $2,134,000 in 1994 compared to $2,005,000 in 1993 and $2,158,000 in 1992, reflecting an increase of 6% in 1994 and a decrease of 7% in 1993. In 1994 and 1993, net investment income was favorably influenced by a planned program to reinvest significant short term holdings in a portfolio with an average life of 10 years. There was also a positive impact in 1994 from rising interest rates. Several factors counteracted these positive factors. First, in 1991 Dixie Life began reinvesting the proceeds of all calls, maturities and sales in short term investments.This program continued throughout 1992 and into the first quarter of 1993. This resulted in a significant decrease in the yield on Dixie Life's investment portfolio. Second, income on student loans has steadily decreased in absolute dollars, driven partly by a reduction in the amount of loans outstanding and the fact that a significant portion of the outstanding loans provide for floating interest rates which have fallen over the periods being compared.\nTotal benefits and expenses were $14,236,000 in 1994, $22,700,000 in 1993 and $18,213,000 in 1992, reflecting a decrease of 37% in 1994 and an increase of 25% in 1993.\nIn 1994, every expense category experienced a significant decrease. The decreases in benefits and claims to policyholders, amortization of deferred policy acquisition costs and commissions largely resulted from the A&H Sales. The composition of these three categories by segment were as follows:\nLife and Accident Annuity and Health Total Benefits and Claims to Policyholders: 1994 $3,512,000 $3,061,000 $ 6,573,000 1993 4,046,000 8,528,000 12,574,000 1992 3,321,000 6,771,000 10,092,000\nAmortization of Deferred Policy Acquisition Costs: 1994 968,000 453,000 1,421,000 1993 1,526,000 980,000 2,506,000 1992 1,337,000 720,000 2,057,000\nCommissions: 1994 882,000 1,012,000 1,894,000 1993 367,000 3,142,000 3,509,000 1992 452,000 2,270,000 2,722,000\nGeneral expenses declined $323,000 in 1994 compared to 1993. Under the terms of the 1994 A&H Sale, Dixie Life continued to administer the business which was sold through December 16, 1994 and received compensation from the purchaser of $671,000 which was credited to general expense. Actual costs of such administration exceeded the compensation received, accounting for the difference in the decrease and the compensation received. The decreases in all recurring categories were offset by the difference in the loss incurred on the A&H Sales in 1994 compared to 1993.\nIn 1993, total benefits and expenses increased $4,487,000 with an increase in benefits and claims to policyholders comprising $2,481,000 of this increase, or 55% of the total increase. This increase in benefits and claims to policyholders was caused by an increase in claims paid of $1,895,117 and an increase in accident and health (A&H) reserves resulting from continued high levels of claims. Dixie Life instituted rate increases on several of its A&H policies because of the higher levels of claims and it continually monitored its claims experience and requested rate increases on its A&H products whenever claims experience warranted rate increases. The rate increases which were approved generally were instituted in the latter part of 1993 or early 1994 and thus had little effect on operations for 1993. Amortization of deferred policy acquisition costs and value of insurance purchased increased $450,000 in 1993 as a result of a general increase in the amount of insurance in force and a somewhat higher level of terminated policies in 1993. Commission expenses increased $787,000 as a result of a relatively higher renewal premium income on A&H products which carry a higher renewal commission structure. General expenses increased $437,000 in 1993 with $217,000 of this increase being caused by increased professional fees.\nIn 1994, a change in deferred taxes on policy liabilities, resulting from an incorrect estimate of the tax basis policy benefits at December 31, 1993, caused a $362,786 reduction of the 1994 tax benefit credited to operations. Consequently the 1994 effective tax rate was less than 2%. Income tax benefit in 1993 was 18% of the loss before income taxes compared to income tax expense of 23% on income before income taxes in 1992 and 18% in 1991.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data called for by this Item are set forth immediately following the Index to Financial Statements and Financial Statement Schedules at page 34.\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\nThe directors of the Corporation are:\nName Age Director Since ----------- --------- ------------------\nT. H. Etheridge 61 1966\nJohn E. Haggar 52 1995\nRobert B. Neal 57 1970\nName Age Director Since ------------ ----------- ------------------ Dennis Nielsen 54 1995\nJoe D. Pegram 54 1991\nS. L. Reed, Jr. 58 1980\nJames G. Ricketts 56 1995\nHerbert G. Rogers, III 52 1992\nW. A. Taylor, Jr. 64 1969\nEach director holds office until the next annual meeting of shareholders or until his successor shall be duly elected and qualified.\nThe executive officers of the Corporation are:\nName Age Executive Officer Since ------------ ---------- ------------------------\nS. L. Reed, Jr. 58 1995 Chairman Chief Executive Officer\nRobert B. Neal 57 1967 President\nT. F. Flowers, Jr. 57 1970 Senior Vice President\n26(A)\nName Age Executive Officer Since ------------- ------------ ------------------------ Jerry M. Greer 52 1970 Senior Vice President and Secretary\nMonroe M. Wright 54 1993 Senior Vice President, Treasurer and Chief Operating Officer\nThe Corporation's officers serve at the pleasure of the Board of Directors.\nBusiness Experience\nThe principal occupations and business experience for the last five years or more of the directors and executive officers of the Corporation are as follows:\nS. L. Reed, Jr. - From January 1995, Chairman of the Board of Directors and Chief Executive Officer of the Corporation. President of Reed Enterprises, Inc. (an aquaculture and investment company) of Belzoni, Mississippi; Director of Delta Industries, Inc., Producers Feed Co. and Venture SystemSource, Inc. He serves as a member of the Executive Committee.\nT. H. Etheridge - President and Chief Executive Officer of Choctaw Maid Farms, Inc., (a food processing and marketing company), of Carthage, Mississippi; Chairman of the Board of Central Industries and Director of Southern Hens, Inc. He serves as a member of the Executive Committee.\nT. F. Flowers - Senior Vice President of the Corporation and Dixie Life, Director of Agencies of Dixie Life and President of Dixie National Life Marketing Corporation, a subsidiary of the Corporation.\nJerry M. Greer - Senior Vice President and Secretary of the Corporation and of Dixie Life.\nJohn E. Haggar - From December 1994 Chief Financial Officer and Director of UMS Previously, Mr. Haggar was a sole practitioner engaged in providing accounting services to the general public. He is a member of the American Institute of Certified Public Accountants and the Washington Society of Certified Public Accountants. Mr. Haggar serves as Chairman of the Audit and Compliance Committee and a member of the Finance and Business Strategy Committee and the Nominating and Stockholder Relations Committee.\n26(B)\nRobert B. Neal - President of the Corporation and also Chairman of the Board of Directors, President and Chief Executive Officer of Dixie Life. He serves as a member of the Executive Committee.\nDennis Nielsen - Self-employed as a business consultant offering assistance to businesses on restructuring, financing, or assisting with possible mergers or acquisitions. Previously he was owner of P&N, Inc. and Hufburn Sales, Inc., both automobile dealerships. Mr. Nielsen serves as a member of the Audit and Compliance Committee and the Nominating and Stockholder Relations Committee.\nJoe D. Pegram - Attorney. He serves as a member of the Audit Committee.\nJames G. Ricketts - President and Chief Executive Officer of International Corrections Corporation of Scottsdale, Arizona, a corporation which he founded in 1990 to develop and operate private prisons and to act as an independent consultant to corrections agencies throughout the United States. Previously he served as Director of Arizona Department of Corrections, Executive Director of the Colorado Department of Corrections and deputy Secretary to the Florida Department of Corrections as well as numerous other positions in the corrections field. In addition, he is a Director of Alanco. Dr. Ricketts serves as Chairman of the Personnel and Compensation Committee and a member of Finance and Business Strategy Committee.\nHerbert G. Rogers, III - President of Rogers Agency, Inc., Rogers LP-Gas Company, Rogers Investments, Inc., Mississippi Realty, Inc. and Roell Realty Corp. of New Albany, Mississippi; Director of the Nashoba Bank and Chairman of the Board of the Gentry Furniture Corporation. He serves as Chairman of the Finance and Business Strategy Committee and a member of the Personnel and Compensation Committee.\nW. A. Taylor, Jr. - Chairman of the Board of Taylor Machine Works of Louisville, Mississippi. He serves as Chairman of the Nominating and Stockholder Relations Committee and a member of the Personnel and Compensation Committee.\nMonroe M. Wright-Senior Vice President and Treasurer of the Corporation and of Dixie Life since February 1993 and Chief Operating Officer since January 1, 1994. He was a practicing CPA for 24 years prior to joining the Corporation and served as a shareholder in Horne CPA Group from 1990 until January 1993 and as a sole practitioner from 1987 to 1990. ------------------------\nThe Corporation was the subject of an investigation by the Securities and Exchange Commission (SEC), which was resolved by means of a settlement. Pursuant to the settlement, on March 9, 1994, the United States District Court for the District of Columbia entered final judgments of permanent injunction against the Corporation and Robert B. Neal, a Director and President of the Corporation. The judgments were entered on the basis of a complaint filed by the SEC. The Corporation and Mr. Neal each consented to the entry of final judgments of permanent injunction without admitting or denying the allegations contained in the SEC's complaint. The final judgments to which the Corporation and Mr. Neal consented enjoin them from violating or\n26(C)\naiding and abetting future violations of sections of the Securities Act of 1933 and the Securities Exchange Act of 1934 and certain rules thereunder.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe following Summary Compensation Table sets forth, for each of the last three years, information concerning the total compensation paid or awarded to the Corporation's Chief Executive Officer and all other executive officers whose total compensation exceed $100,000, for services rendered in all capacities to the Corporation and its subsidiaries.\nSUMMARY COMPENSATION TABLE Name and Principal Annual Compensation All Other Position Year Salary Bonus Compensation - ---------- ------ --------- -------- --------------\nRobert B. Neal 1994 $125,269 None $2,505(1) President 1993 $125,269 None $2,575(1)\n26(D)\nName and Principal Annual Compensation All Other Position Year Salary Bonus Compensation - ---------- ------ --------- ------- --------------- (cont'd) 1992 $121,739 $3,477 $1,217(1)\nMonroe M. Wright 1994 $100,000 None $1,000(1) Senior Vice 1993(2) 85,000 10,000 -0- President Treasurer and Chief Operating Officer\n(1) Includes the Company's contributions under its qualified profit sharing plans for employees, including officers.\n(2) Commenced employment January 1993.\nIn 1994 no stock options were granted to or exercised by Robert B. Neal or Monroe M. Wright and Mr. Wright holds no unexercised options as of December 31, 1994. The following table sets forth information as of December 31, 1994, concerning the unexercised options held by Mr. Neal. None of the options held by Mr. Neal were in-the-money at December 31, 1994. Options are in-the-money when the fair market value of the underlying common stock exceeds the exercise price of the option. The closing prices of the Corporation's common stock on December 31, 1994 were $.50 bid and $.625 ask per share.\n26(E)\nFISCAL YEAR END OPTION VALUES\nNumber of Unexercised Options Value of Unexercised at December 31, 1994 In-the-Money Options ----------------------------- at December 31, 1994 Name Exercisable Unexercisable --------------------\nRobert B. Neal 28,570 0 N\/A\nAt a meeting held on March 24, 1995, the Corporation's Board of Directors approved granting to each director an option to purchase 5,000 shares of the Corporation's Common Stock at the average of the bid and asked price as quoted by NASDAQ on April 3, 1995. The options may be exercised 20% per year beginning March 31, 1996 and expire March 31, 2000. If a person ceases being a director of the Corporation, his option will be canceled 30 days thereafter.\nCompensation of Directors\nDirectors who are also officers of the Corporation receive no additional compensation for serving on the Corporation's Board or committees thereof. All other directors are paid $550 for each Board or committee meeting they attend. During 1994, Rubel Phillips, Chairman of the Board of Directors throughout 1994, was paid $17,000 for his services as Chairman and S.L. Reed, Jr., was paid $9,800 for his services as Vice Chairman of the Board. As a group, Directors who were not officers were paid $63,700 during 1994.\nCompensation Committee Interlocks and Insider Participation\nDuring 1994, the Compensation Committee of the Corporation's Board of Directors consisted of Rubel L. Phillips, Chairman, Edgar L. McKenzie, Samuel Leroy Reed, Jr., William A. Taylor Jr., and Zach Taylor, Jr., none of whom was an executive officer of the Corporation. Mr. Taylor holds or controls $200,000 principal amount of the Corporation's Convertible Notes due May 1, 1995. See \"Item 13 - Certain Relationships and Related Transactions.\"\n26(F)\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Security Ownership of Certain Beneficial Owners\nThe following table sets forth pertinent information as to the beneficial ownership of the Company's common stock as of March 15, 1995, of persons known by the Company to be holders of 5% or more of such common stock. Information as to the number of shares beneficially owned has been furnished by the persons named in the table.\nName and Address Shares of Beneficial Beneficially Percent Owner Owned of Class ---------------- ------------- --------- American Capitol 1,000,144(1) 10.6% Insurance Company 10555 Richmond Avenue Houston, Texas 77042\nS. L. Reed, Jr. 590,942 7.0% 120 North Congress Street Jackson, MS 39201\n26(G)\nName and Address Shares of Beneficial Beneficially Percent Owner Owned of Class ---------------- ------------- --------- (cont'd) Robert B. Neal 533,768(2) 6.2% c\/o Dixie National Corporation 3760 Interstate 55 North Jackson, MS 39211\nW. A. Taylor, Jr. 434,815(2) 5.0% 939 West Main Louisville, MS 39339\n(1) Includes 1,000,000 shares issuable upon conversion of the Company's Convertible Notes due May 1, 1995. See \"Item 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain executive officers, directors and\/or holders of record or beneficially of more than 5% of the Corporation's Common Stock hold more than $60,000 of the Corporation's Convertible Notes which are due May 1, 1995. The Corporation expects to satisfy the Convertible Notes at maturity either by payment or otherwise. The following table summarizes such holdings:\n26(L)\nAmount of Holder Relationship Holdings - ------- ----------- ---------- American Capital Insurance Company 5% Owner $1,000,000\nRobert B. Neal Director, Executive 100,000 Officer and 5% Owner\nW. Cleopha Pigg Director until 100,000 January 24, 1995\nW.A. Taylor Director and 200,000(1) 5% Owner\n(1) Includes $100,000 held by Taylor Equipment & Machine Tool Corp., of which Mr. Taylor is Chairman of the Board and a significant stockholder.\nSee \"Recent Developments - Sale of Common Stock\" under \"Item 1 - Business -\n26(M)\n(a) General Development of Business\" as to the proposed issuance of shares of the Corporation's Common Stock in exchange for shares, and an option for shares, of PMM Common Stock, and the interests of certain persons therein.\n26(N)\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 of Dixie National Corporation and Subsidiaries. See separate Index to Financial Statements and Financial Statement Schedules on page 31.\n3. Exhibits\n*Management contract or compensatory plan.\nRegistrant agrees to file with the Securities and Exchange Commission, upon request, copies of any instrument defining the rights of the holders of its consolidated long-term debt.\nSchedules other than those referred to above are omitted for the reason that they are not required, are not applicable, or the required information is shown in the financial statements or notes thereto, or is incorporated by reference.\n(b) Reports on Form 8-K\nThe Corporation filed the following reports on Form 8-K during the last quarter of the year ended December 31, 1994:\n(c) Exhibits required by Item 601 of Regulation S-K\nThe exhibits listed in Item 14(a)3 of this report, and not incorporated by reference, follow \"SIGNATURES.\" See \"Exhibit Index.\"\n(d) Financial statement schedules required by Regulation S-X\nThe financial statement schedules required by Regulation S-X, filed herewith, are identified in the Index to Financial Statements and Financial Statement Schedules on page 31.\nDIXIE NATIONAL CORPORATION AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nINDEPENDENT AUDITOR'S REPORT\nTo The Shareholders Dixie National Corporation Jackson, Mississippi\nWe have audited the accompanying consolidated balance sheets of Dixie National 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 report 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 Dixie National 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.\nThe accompanying consolidated financial statements have been prepared assuming the Corporation and subsidiaries will continue as a going concern. As discussed in Note 9. to the consolidated financial statements, the Company does not have available the resources to satisfy its short-term debt requirements.\nThis raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to this matter are also described in Note 9. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nHORNE CPA GROUP\nJackson, Mississippi March 20, 1995, except for Note 16., as to which the date is March 24, 1995\nCONSOLIDATED BALANCE SHEETS DIXIE NATIONAL CORPORATION\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF OPERATIONS DIXIE NATIONAL CORPORATION\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY DIXIE NATIONAL CORPORATION YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS DIXIE NATIONAL CORPORATION\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DIXIE NATIONAL CORPORATION DECEMBER 31, 1994\nNOTE 1--SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation: The accompanying financial statements have been prepared in conformity with generally accepted accounting principles (\"GAAP\").\nPrinciples of Consolidation: The consolidated financial statements include the financial statements of Dixie National Corporation (Corporation), its wholly-owned subsidiaries and Dixie National Life Insurance Company (Dixie Life), which is approximately 99% owned (collectively Company). The interests of minority stockholders are not material. All significant intercompany accounts and transactions have been eliminated in consolidation.\nInvestments: At December 31, 1994, the Company's investments are reported in accordance with the provisions of Statement of Financial Accounting Standards No. 115 (FAS 115) which was issued by the Financial Accounting Standards Board in 1993 and effective for 1994 financial statements. As a result the carrying basis for investments is different in 1994 than in 1993.\nAt December 31, 1994, fixed maturity investments are all classified as available for sale and are carried at market value. Unrealized market gains and losses are reported as a separate component of stockholders' equity. Equity securities are classified as trading, which, under the provisions of FAS 115, are reported at market with unrealized market gains or losses being reflected in operations. Because of the provisions of an agreement with Universal Management Services (UMS) discussed in Notes 3 and 16, equity securities are reported at cost at December 31, 1994. At December 31, 1993 fixed maturity investments were carried at amortized cost.\nRealized gains and losses on the disposition of fixed maturity investments are determined on the specific identification basis and are reported in operations when realized.\nPolicy loans are stated at the amounts loaned to policyholders and are collateralized by assignment of the cash value of underlying policies. Student loans are carried at cost less an allowance for uncollectible amounts. Short-term investments will be held to maturity and are due in one year or less and are carried at cost which approximates market.\nCash and Cash Equivalents: Cash and cash equivalents include cash in banks and money-market investments which carry no withdrawal restrictions.\nRecognition of Premium Revenue and Related Expenses: Premiums for traditional life insurance contracts are reported as revenue over the premium-paying period of the policy. Premiums for fixed premium interest sensitive products are added to the policy account value and revenues for such products are recognized as charges to the account value for mortality, administration and surrenders (retrospective deposit method). Profits are also earned to the extent that investment income exceeds policy requirements. The related benefits and expenses are matched with revenues through the provision for future policy benefits and the amortization of deferred acquisition costs in a manner which recognizes profits as they are earned.\nFuture Policy Benefits: The liability for future policy benefits interest sensitive products is represented by the policy account value. The liability for future policy benefits for all other life and health products is provided on the net level premium method based on estimated investment yields, mortality, morbidity, persistency and\nother assumptions. Assumptions are based upon Dixie Life's experience and industry experience, where appropriate, with provision for possible adverse deviation. These estimates are periodically reviewed and compared with actual experience. If it is determined future experience will probably differ significantly from that previously assumed, the estimates are revised.\nDeferred Acquisition Costs: The costs of acquiring new insurance business are deferred. Such deferred costs consist principally of excess first year sales commissions, as well as underwriting expenses and certain other expenses.\nDeferred acquisition costs for other than interest sensitive products are amortized with interest over an estimate of the premium- paying period of the policies in a manner which charges each year's operations in proportion to the receipt of premium income. For interest sensitive products, acquisition costs are amortized with interest in proportion to estimated gross profits. The assumptions used as to interest, withdrawals and mortality are consistent with those used in computing the liability for future policy benefits and expenses. If it is determined future experience will probably differ significantly from that previously assumed, the estimates are revised.\nValue of Life Insurance Purchased: Value of life insurance purchased is being amortized over 12 years, the expected life of the income stream.\nProperty and Equipment: Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method over the estimated useful lives of these assets.\nIncome Taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for changes in tax laws and rates on the date of enactment.\nEarnings Per Share: Earnings per share are based on the weighted average number of common stock and common stock equivalents outstanding during the year.\nReinsurance: Dixie Life cedes and assumes insurance risks with other companies. Liabilities for future policy benefits, premiums and expenses are reported after deduction of amounts relating to policy specific reinsurance ceded and addition of amounts relating to policy specific reinsurance assumed.\nReclassification: Certain amounts in the 1993 and 1992 financial statements have been reclassified to conform to 1994 presentation. These reclassifications had no effect on amounts previously reported as stockholders' equity or net income.\nNOTE 2--STATUTORY ACCOUNTING\nDixie Life is required to file statutory financial statements with state insurance regulatory authorities. Accounting principles used to prepare these statutory financial statements differ from GAAP.\nThe excess, if any, of Dixie Life's stockholders' equity on a GAAP basis over that determined on a statutory basis is not available for distribution to Dixie Life's stockholders. Mississippi law governing insurance companies further restricts payment of dividends to the lessor of (1) the prior year statutory net income plus\nthe excess of statutory net income for the second and third preceding years over distributions in the first and second preceding years or (2) 10% of statutory stockholders' equity. Dixie Life can distribute approximately $200,000 in 1995 without approval of the Mississippi Department of Insurance. The Department can grant permission for extraordinary dividends in excess of the limitations imposed by law.\nA reconciliation of Dixie Life's statutory net income to the Company's consolidated GAAP net income is as follows:\nA reconciliation of Dixie Life's statutory stockholders' equity to the Company's consolidated GAAP stockholders' equity is as follows:\nAt December 31, 1994 Dixie Life is a party to an indemnification reinsurance agreement under which 90% of its retained life insurance in force at September 30, 1992 is reinsured. This transaction is accounted for as a financing transaction in the accompanying financial statements. Dixie Life's statutory financial statements include a reserve credit at December 31, 1994 of $1,985,000 related to this agreement which has the effect of increasing statutory stockholders' equity by that amount.\nNOTE 3--INVESTMENTS\nThe Company's investments in fixed maturity securities available for sale are summarized as follows:\nMaturities of fixed maturity securities held for sale at December 31, 1994 follow:\nFixed maturity and short-term investments with an approximate carrying amount of $2,400,000 were pledged to various state insurance departments for policyowner protection at December 31, 1994. At December 31, 1994, additional securities with an approximate carrying amount of $13,435,000 were pledged under the financing transaction reinsurance treaty (see Note 2).\nNet investment income consists of the following:\nNet realized investment gains (losses) for the year ended December 31 are summarized as follows:\nIn November 1994, the Corporation issued 2,000,000 shares of its Common Stock and received as consideration 1,230,770 shares of Alanco Environmental Resources, Inc. (Alanco) common stock with a market value at the date of the transaction of $2,000,000. Under the terms of the UMS agreement discussed in Note 16, any market appreciation until June 30, 1995 may not be realized because the purchasers of the Corporation's Common Stock have the right to buy the Alanco shares for cash equal to the value on the day of the November Transaction. The purchasers have the obligation to cover any market depreciation, as defined, which might have occurred as of June 30, 1995. Therefore, the Alanco shares will be carried at cost until June 30, 1995. At December 31, 1994, market value of the Alanco shares based on the average of the closing bid and asked price, was $2,153,000.\nNOTE 4--DEFERRED POLICY ACQUISITION COSTS\nAn analysis of deferred policy acquisition costs for the years ended December 31 follows:\nNOTE 5--VALUE OF LIFE INSURANCE PURCHASED\nAn analysis of the value of life insurance purchased for the years ended December 31 follows:\nEstimated annual amortization of the value of life insurance purchased is approximately $160,000 in each of the next five years.\nNOTE 6--PROPERTY AND EQUIPMENT\nA summary of property and equipment at December 31 follows:\nNOTE 7--FUTURE POLICY BENEFIT RESERVES\nA summary of the assumptions used in determining the liability for future policy benefits at December 31, 1994 is as follows:\nLife Insurance\nInterest assumptions:\nMortality assumptions:\nWithdrawal assumptions:\nLinton B or Linton C Lapse Tables\nTermination assumptions:\nTermination assumptions are based on Dixie Life's experience.\nNOTE 8--PARTICIPATING BUSINESS\nLife insurance policies are issued on both a participating and non-participating basis. The following summary presents the approximate percentages of participating life business to total life business for the years indicated:\nThe amount of dividends to be apportioned to participating policies is determined annually by the Board of Directors of Dixie Life. In the past, Dixie Life sold participating life insurance through a policy known as the Charter Contract as well as other participating policies. The Charter Contract policies contain a participation endorsement whereby Dixie Life agreed to apportion dividends to Charter Contract holders, as a group and on a pro rata basis, in an amount which equals at least 35% of Dixie Life's statutory net profits computed by a formula set forth in the policy. As discussed in Note 13, Dixie Life is defendant in litigation alleging that Dixie Life failed to properly pay dividends on its Charter Contract policies. As of December 31, 1994, Dixie\nLife had participating policies in force with a total face amount of approximately $20,486,000 of which approximately $11,721,000 were Charter Contract policies.\nNOTE 9--NOTES PAYABLE AND OTHER DEBT\nThe Company has the following notes payable at December 31:\nIn 1993, the Company replaced an existing note payable to a bank collateralized by common stock of Dixie Life with the Term Loan. In November 1994, the bank sold the Term Loan to Standard Life Insurance Company of Indiana. As discussed in Note 17, the terms of the proposed sale of Dixie Life effectively extend the due date of the Term Loan to closing of the sale or 90 days after any cancellation thereof.\nThe Term Loan agreement contains three covenants as follows:\nThe Company must maintain consolidated tangible net worth, as defined, of not less than $9,000,000. At December 31, 1994, consolidated tangible net worth was $8,487,818.\nThe Company must maintain a ratio of total liabilities to consolidated tangible net worth of not more than 4.5 to 1. At December 31, 1994, this ratio was 4.17 to 1.\nThe Company must cause Dixie Life to maintain statutory capital and surplus of not less than $3,500,000. At December 31, 1994, Dixie Life's statutory capital and surplus was $6,280,400.\nAn unwaived or uncured event of default under the term loan is an event of default under the Notes. Standard Life Insurance Company of Indiana has waived all defaults pending completion of the sale of Dixie Life and for 90 days after any cancellation thereof.\nNotes in the aggregate amount of $550,000 are held or controlled by officers and directors of the Company.\nAs discussed above at December 31, 1994, the Corporation owed a subsidiary of Standard Management Corporation approximately $3,689,000 under a Term Loan originally due March 31, 1995. The Term Loan is now due at closing of the SMC Transaction or 90 days after the SMC Transaction in the event it is canceled by either party. Also, the Corporation's 10% Convertible Notes, in the amount of $1,720,000, are due May 1, 1995. Although the SMC Transaction provides a means to satisfy the Convertible Notes at closing, such notes are due before the anticipated closing date and there are no assurances that the Corporation will be able to extend such notes beyond their May 1, 1995 maturity, or effect any alternative accommodations. However, management is exploring several options and believes that the Convertible Notes will be satisfied or extended at their due date. All of the shares of Dixie Life owned by the Corporation were pledged to secure payment of the Term Loan and the Convertible Notes.\nThe lack of assurance that the SMC Transaction will be completed raises significant doubt about the Company's ability to continue as a going concern. Completion of the SMC Transaction together with an extension or timely repayment of the Convertible Notes would remove such uncertainties.\nManagement's plans in this regard include the following:\n1. Endeavor to complete the SMC Transaction, which contemplates cancellation of the Term Loan. The SMC Transaction would also enable the Corporation to satisfy the Convertible Notes, assuming their due date is extended.\n2. Seek to extend or secure an alternative means of paying the Convertible Notes. Liquidation of a portion of the Alanco shares is a possible source of repayment of at least a portion of the Convertible Notes.\n3. In the event the SMC Transaction is canceled by either party, searching for another purchaser of Dixie Life in the 90 days available to it beyond such cancellation before the Term Loan is due.\nThere are no assurances that any of these efforts will be successful.\nAggregate maturities of notes payable and the present value of net minimum lease payments at December 31, 1994, are as follows:\nNOTE 10--INCOME TAXES\nThe Company and its subsidiaries file a life-nonlife consolidated federal income tax return. The Internal Revenue Code contains several provisions which affect the consolidated tax provision, including a special deduction for small life insurance companies amounting to 60% of taxable income and limitations on the amount of nonlife taxable losses which can be used to reduce life insurance taxable income.\nThe accompanying balance sheet includes a liability for income taxes payable consisting of the following at December 31:\nNet deferred tax liabilities (assets) consists of the following components as of December 31:\nIncome tax (expense) benefit for the year ended December is summarized as follows:\nThe Company's effective income tax expense differs from the expense determined by applying the 34% statutory federal income tax rate to income before income taxes as follows:\nIn 1994, a change in deferred taxes on policy liabilities, resulting from an incorrect estimate of the tax basis policy benefits at December 31, 1993, caused a $362,786 reduction of the 1994 tax benefit credited to operations.\nPrior to 1984, a portion of taxable income was excluded from current taxation and accumulated in a special tax return memorandum account. The December 31, 1983 balance of approximately $876,600 is frozen and will be taxed only if distributed or if it exceeds certain prescribed limits. Deferred income taxes have not been provided on this balance since the Company does not intend to take action nor does it expect events to occur that would cause tax to be payable on that amount.\nNOTE 11-SALE OF BLOCK OF BUSINESS\nDixie Life has sold virtually all of its in force accident & health insurance business to unaffiliated insurance companies in two transactions. Both transactions were closed in 1994 although the first was effective December 31, 1993.\nIn the first transaction, Dixie Life sold all of its in force cancer insurance in South Carolina for $2,125,000, resulting in a statutory gain equal to the selling price in 1993. Under generally accepted accounting\nprinciples, the transaction was not recorded until closing in February 1994 but the Company did record the loss incurred ($324,000) under GAAP in 1993.\nIn 1994, Dixie Life sold virtually all of its remaining accident and health for $5,322,000 in a transaction effective July 1, 1994, again resulting in a statutory gain equal to the selling price. The Company incurred a GAAP loss of approximately $1,197,000 on this sale.\nTogether, these sales resulted in a reduction of deferred policy acquisition costs and policy liabilities of $12,980,000 and $11,084,000, respectively, in 1994.\nNOTE 12--INCENTIVE STOCK OPTION PLANS\nOptions to purchase common stock of the Company have been granted under two incentive stock option plans. One of those plans expired in 1992 and the other in 1993. At December 31, 1994, options to purchase 481,737 shares were outstanding, including 23,179 at $1.16; 92,061 at $1.23; 87,816 at $1.69; 16,991 at $1.77; 34,496 at $1.41; 62,790 at $1.13; 45,161 at $1.38, 48,548 at $1.50 and 70,695 at $1.00.\nNOTE 13--CONTINGENCIES\nReinsurance: Dixie Life reinsures a portion of its insurance risk which is in excess of its retention limits on its life insurance policies. The retention limit for life insurance policies is generally $50,000. Dixie Life would be liable for the reinsured risks ceded to reinsuring other companies to the extent such reinsuring companies are unable to meet their obligations. At December 31, 1994, Dixie Life's possible obligation under excess coverage life insurance risks ceded to other companies was approximately $53,883,000.\nDixie Life also has assumed reinsurance under the Servicemen's Group Life Insurance Program totaling approximately $141,936,000 at December 31, 1994.\nGeographic Concentration of Business: Dixie Life is qualified to sell insurance in 21 states and the District of Columbia. Most of its 1994 business is in Texas (21%), Mississippi (18%), Georgia (12%), Louisiana (10%), and Kansas (8%). Loss of the business in any of these states could have a material adverse affect on the future operations of Dixie Life.\nLitigation: Dixie Life is a Defendant in a suit filed in January, 1994 in the Circuit Court of Montgomery County, Alabama.\nThe suit alleges that Dixie Life has failed to properly pay dividends to holders of its Charter Contract policies. These policies are participating policies pursuant to which Dixie Life is obligated to apportion dividends to the holders of such policies, as a group and on a prorata basis, of not less than 35% of the statutory net profits of Dixie Life computed by a formula set forth in the policy. The formula utilizes certain information contained in the annual report filed by Dixie Life with the Mississippi Department of Insurance, as such report was constituted in 1966. The suit seeks to establish a class consisting of the plaintiff and a group of persons allegedly similarly situated and alleges the class consists of over 1,000 persons. No class has yet been certified.\nThe suit seeks judgment in an undetermined amount for alleged underpayment of dividends and an injunction requiring Dixie Life to pay appropriate dividends in the future.\nDixie Life has paid a dividend to holders of the Charter Contract policies in each year since the policies were issued. On a cumulative basis, the total dividends paid to the holders of the Charter Contract policies since issuance exceed 35% of the net profits of Dixie Life as defined by the policies for the same period.\nAs of February 17, 1994, a total of 76 Charter Contract policies are held by residents of the state of Alabama. In all states at December 31, 1993, a total of 1,421 Charter Contract policies are currently outstanding, of which 324 are in premium paying status.\nDixie Life intends to vigorously defend the suit.\nNo discovery has yet taken place and no class has yet been certified by the court. In the absence of a class, if any, and its composition, if certified, Dixie Life has no reasonable basis upon which to estimate its potential liability, if any.\nThe Company also is involved in ordinary, routine litigation incidental to its business. Management and counsel are of the opinion that the ultimate resolution of these matters will not have a material adverse effect on the Company.\nConcentration of Credit Risk: At December 31, 1994 and 1993, the Company had funds on deposit with a federally insured bank in excess of $100,000 federal deposit insurance coverage limits.\nNOTE 14--PROFIT SHARING PLAN\nThe Company has a profit sharing plan which covers substantially all employees who meet length of service provisions contained in the Plan. Prior to 1992, the plan provided for Company defined contributions based on earnings before income taxes and realized investment gains. In 1992, the Plan was amended to allow employee contributions as provided under Section 401(k) of the Internal Revenue Code. The Company matches 50% of employee contributions up to 4% of compensation and, at the discretion of the Board of Directors, may make additional contributions. Contributions to the Plan charged to expense were approximately $13,000, $18,000 and $7,000 in 1994, 1993, and 1992, respectively.\nNOTE 15--BUSINESS SEGMENT INFORMATION\nThe Company, through Dixie Life, has engaged in the following lines of insurance business: life insurance, individual annuities, and accident and health insurance (A&H). From July 1, 1994, as discussed in Note 11, the Company is no longer engaged in the accident and health line of insurance business. Investment income and certain general expenses have been allocated through the utilization of assumptions, estimates and formulas. Such allocations have been made on a basis considered reasonable under the circumstances; however, it should be understood that other acceptable methods of allocation might produce different results. Financial information by product grouping is as follows:\nNOTE 16--SALE OF COMMON STOCK\nThe Corporation entered into an agreement with Universal Management Services, a Nevada corporation (UMS), as of October 27, 1994 (UMS Agreement). The UMS Agreement provides that UMS will use its best efforts to assist the Corporation in locating potential investors for its Common Stock in non-U.S. markets pursuant to Regulation S of the Securities Act of 1933.\nUnder the UMS Agreement, UMS has the right to assist the Corporation in placing up to 6,425,000 shares, subject to completion of various steps set forth in the Agreement. The first step was completed on November 29, 1994, with the Corporation issuing 2,000,000 shares of its Common Stock for which it received 1,230,770 shares of Alanco Environmental Resources, Inc. (Alanco) common stock (November Transaction). The Alanco shares had an aggregate market value of $2,000,000 on November 29, 1994.\nUnder the UMS Agreement, UMS has the right to assist the Corporation in placing, on a best efforts basis, by June 30, 1995, up to 12,500,000 additional shares of the Corporation's Common Stock. Under the terms of the UMS Agreement, the Corporation expects to:\n1. Issue 2,000,000 shares of its Common Stock in exchange for 16% of the outstanding common shares of Phoenix Medical Management, Inc. (PMM), an Arizona corporation.\n2. Issue, if the acquisition of the 16% interest is completed, 100,000 of its Common Stock for an option to acquire the remaining 84% of the common shares of PMM for 10,400,000 shares of the Corporation's Common Stock.\n3. Purchase from PMM three specialized health care facilities for approximately $700,000 in cash. The funds for this transaction are expected to be obtained through the placement, with the assistance of UMS, but outside the UMS Agreement, of approximately 700,000 shares of the Corporation's Common Stock under Regulation S.\nIn view of covenants contained in the Term Loan Agreement, the aquisition of shares of PMM by the Corporation will require certain waivers from SMC, which the Corporation will seek to obtain. However, there is no assurance that such waivers will be obtained, in which case the Corporation will be obliged to reassess the proposed PMM transaction. There are no assurances that any further transactions contemplated by the UMS Agreement will be completed. UMS's rights under the UMS Agreement will expire June 30, 1995.\nIf at least 6,425,000 shares are placed with UMS's assistance, the UMS Agreement provides that the purchasers will be entitled to designate a majority of the Corporation's Board of Directors. This right would be facilitated by the resignation of a sufficient number of directors whose tenure as director predates the UMS Agreement so that designees of the new investors could be appointed until the next annual meeting of\nthe Corporation's stockholders. The UMS Agreement contained three other undertakings of the Corporation which were accomplished at the 1994 annual meeting of the Corporation's stockholders held January 24, 1995. These were (a) reduction of the Corporation's Board of Directors from 15 members to 9 members; (b) election to the Corporation's Board of Directors of three representatives of the parties who purchased the Corporation's Common Stock in the November Transaction; and (c) an increase in the number of authorized shares of the Corporation's Common Stock from 10,000,000 to 50,000,000.\nNOTE 17--PENDING SALE OF DIXIE LIFE\nOn March 6, 1995, the Corporation entered into a Letter of Intent with SMC to sell to SMC all of the capital stock of Dixie Life which the Corporation owns. Dixie Life represents 94% of the consolidated assets and substantially all of the consolidated operations of the Corporation.\nAt closing SMC will cancel the Term Loan obligation, assume the Corporation's indebtedness of $1,720,000 under the Convertible Notes due May 1, 1995, pay the Corporation $2,500,000 in cash and issue to the Corporation SMC common shares equal to $500,000 valued at the average trading price of SMC's shares for the five days prior to closing. The Corporation will also receive the first $175,000 of agent advances that Dixie Life collects after closing. These payments constitute a selling price of at least $8,408,746 and up to $8,583,746 if agent advances equal at least $175,000 at closing and at least $175,000 is collected. Agent advances, net of allowance for doubtful accounts at December 31, 1994, were approximately $270,000. The selling price will be adjusted by the change in Dixie Life's capital and surplus and asset valuation reserve between December 31, 1994 and closing. In addition, Dixie Life will continue to pay $15,000 per month rent to Vanguard, Inc., a wholly-owned subsidiary of the Corporation, through the December 31, 1996 expiration of an existing lease on the office building occupied by the Corporation and Dixie Life.\nExcept as to the extension of the due date of the Term Loan, a prohibition against the Corporation negotiating with other parties and certain other customary provisions, the Letter of Intent is not binding and is subject to a Definitive Purchase Agreement which the parties intend to sign before April 1, 1995. The Definitive Purchase Agreement will contain usual and customary conditions, including, among others, the receipt of all required regulatory approvals and approval of the transaction by the shareholders of the Corporation at a meeting to be held on or before August 1, 1995. There is no assurance that the SMC Transaction will be consummated.\nIn the first quarter of 1994, the Corporation reached an agreement in principle for the acquisition of the Corporation by SMC in a tax-free merger. A definitive Merger Agreement among the Corporation, SMC and an SMC affiliate was executed June 8, 1994. On August 1, 1994, the Corporation terminated the Merger Agreement as a result of SMC's failure to meet certain conditions of the Merger Agreement. On November 7, 1994, Standard Life Insurance Company of Indiana, a subsidiary of SMC, purchased the Term Loan from the bank which previously held the note.\nINDEPENDENT AUDITOR'S REPORT ON FINANCIAL STATEMENT SCHEDULES\nTo The Shareholders Dixie National Corporation Jackson, Mississippi\nOur audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The financial statement schedules are presented for purposes of additional analysis and are not a required part of the basic consolidated financial statements. The financial statement schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, the financial statement schedules are fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.\nOur report covering the basic consolidated financial statements indicates that there is substantial doubt as to the Company's ability to continue as a going concern, the outcome of which cannot presently be determined and that the consolidated financial statements do not include any adjustments, that might result from the outcome of this uncertainty.\nHORNE CPA GROUP\nJackson, Mississippi March 20, 1995, except for Note 16., as to which the date is March 24, 1995\nSCHEDULE III DIXIE NATIONAL CORPORATION (PARENT ONLY) BALANCE SHEET\n*Eliminated in consolidation\nSee accompany notes to consolidated financial statements.\nSCHEDULE III (CONTINUED) DIXIE NATIONAL CORPORATION (PARENT ONLY) STATEMENTS OF OPERATIONS\n*Eliminated in consolidation\nSee accompanying notes to consolidated financial statements.\nSCHEDULE III (CONTINUED) DIXIE NATIONAL CORPORATION (PARENT ONLY) STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nSCHEDULE III (CONTINUED) DIXIE NATIONAL CORPORATION (PARENT ONLY) NOTES TO CONDENSED FINANCIAL STATEMENTS DECEMBER 31, 1994\n1. The accompanying condensed financial information should be read in conjunction with consolidated financial statements and notes thereto of Dixie national Corporation which are included in this Form 10K.\n2. At December 31, 1994, the notes payable presented in Dixie National Corporation's Parent Only Statements included the following:\nSCHEDULE VI DIXIE NATIONAL CORPORATION AND SUBSIDIARIES REINSURANCE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSCHEDULE VIII DIXIE NATIONAL CORPORATION VALUATION AND QUALIFYING ACCOUNTS YEAR ENDED DECEMBER 31, 1994, 1993 AND 1992\n(1) 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.\nDIXIE NATIONAL CORPORATION -------------------------- (Registrant)\nDate: March 24, 1995 By: \/s\/Samuel Leroy Reed -------------------- Samuel Leroy Reed Chairman of the Board 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\/Samuel Leroy Reed, Jr. March 24, 1995 ---------------------------- Samuel Leroy Reed, Jr. Chairman of the Board Chief Executive Officer (Principal Executive Officer)\nMarch ___, 1995 ---------------------------- Tammy H. Etheridge Director\n\/s\/John E. Haggar March 24, 1995 ---------------------------- John E. Haggar Director\n\/s\/Robert B. Neal March 24, 1995 ---------------------------- Robert B. Neal President and Director\n\/s\/Dennis Nielsen March 24, 1995 ---------------------------- Dennis Nielsen Director\n\/s\/Joe D. Pegram March 24, 1995 ---------------------------- Joe D. Pegram Director\n\/s\/James G. Ricketts March 24, 1995 ---------------------------- James G. Ricketts Director\nMarch ___, 1995 ---------------------------- Herbert G. Rogers, III Director\nMarch ___, 1995 ---------------------------- William A. Taylor, Jr. Director\n\/s\/Monroe M. Wright March 30, 1995 ---------------------------- Monroe M. Wright Senior Vice President And Treasurer (Principal Financial and Accounting Officer)\nEXHIBIT INDEX\nThe following exhibits are filed herewith:","section_15":""}
{"filename":"18783_1994.txt","cik":"18783","year":"1994","section_1":"ITEM 1. BUSINESS.\nCentral Steel and Wire Company (\"the Company\") was first incorporated in Illinois in 1909 and reincorporated in the state of Delaware in 1958. The Company is engaged in a single line of business, the distribution from its service centers of processed and unprocessed, ferrous and non-ferrous metals in many forms purchased in general from producing mills or specialty mills. The Company purchases a full line of products and inventories them until they are sold to its customers. One of the principal characteristics of the Company's business is the ability to promptly supply quality products from its inventory to customers upon receipt of orders. The Company may also arrange direct shipments to its customers from mills when practicable and may purchase items not currently in its inventory in order to meet customer needs. The Company has approximately 1400 employees and four service center facilities located in Chicago, Detroit, Cincinnati and Milwaukee. The Company administers centralized purchasing, inventory and sales policy from its principal service center and home office located in Chicago. The Company inventories a wide range of products including bars, structurals, plates, sheets, coils, tubing and wire. Products are generally available from a variety of sources. The Company is not dependent upon a single source of supply for the majority of the products stocked in its inventory. In 1994 the Company carried approximately 21,000 separate inventory items. The Company's customer base is principally located in a sixteen state area. This includes states in which the Company has service centers as well as other surrounding states. The Company's customers include several thousand firms in virtually all industries that purchase metal products for use in the manufacture of their own products; in repairs and maintenance of property, plant and equipment; in research and development; and for resale. The business of the Company is not especially seasonal or dependent upon any particular industry or customers in any geographical area within the area described above. No single customer accounted for over 10% of the Company's sales in 1994. The Company's sales are generated by salaried sales representatives operating throughout its market area and through inside sales personnel located at its four service center locations. The Company has developed a computer order entry system which allows customers to place orders through their computer terminals connected with any of the four service center locations providing quick, convenient and efficient scheduling of materials. In addition to providing a wide range of products, the Company can perform certain first step processing operations for customers. These processes include cutting of bars, slitting of coil products, burning of plates and shearing of sheets to customers specifications. The Company's Fabricating Department provides cus- tomers with information in cutting the Company's material to the customer's drawings and specifications. The Company's metallurgists continually evaluate products for quality and unique characteristics as they are produced by the producing mills to provide the Company's sales representatives with current product knowledge and customers\nwith materials of a quality for general purpose applications. The Company's Product Specialists for Aluminum, Brass, Copper, Cold and Hot Rolled and Stainless Steel products support customers and sales representatives with extensive product knowledge, and product application information. The Company's business is highly competitive. The Company competes by maintaining and emphasizing its ability to deliver a broad range of quality products quickly and accurately in response to customer orders at competitive prices. Deliveries are made through delivery services with various common and contract carriers throughout the midwest for direct shipment from the Company's service centers to customers' docks where single item or truck load shipments are made on a same day or next day basis. Prompt delivery is essential, and backlog is not a material factor in the Company's business. The Company maintains a broad and deep inventory to allow it to offer this service which requires significant working capital. Unlike many in its industry, the Company has been able to generate working capital without external financing. The Company competes with at least 40 other national or significant regional firms, some of which are independent and some of which are affiliated with producing mills. For many products and at certain order-size levels (which may vary with economic conditions and mill capacity), the producing mills themselves are also significant competitors of the Company. In addition, there are over 200 local steel service centers in the economic regions that include the Company's principal customer base (Great Lakes, Central States and South East) which can be competitors in particular locations. The Company believes that its total sales make it one of the largest independent distributors of metal products, but it is unable to state its relative position within the industry since there are no comparative figures presently available which the Company believes are complete. The Company does not own any material patents, trademarks, licenses, franchises and concessions, and does not engage, to any significant degree, in research activities or product development.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns warehouse and office facilities in the following locations:\nLocation Area Chicago, Illinois 1,464,000 sq. ft.(a) Detroit, Michigan 144,000 sq. ft. Cincinnati, Ohio 173,000 sq. ft. Milwaukee, Wisconsin 107,000 sq. ft.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNone.\n(a) Includes 123,000 sq. ft. utilized as the Company's principal executive office.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNOT APPLICABLE.\nSUPPLEMENTARY ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe Company's executive officers are as follows:\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. Each of the officers' principal business experience during the past five years has been with the Company.\n(b) April 17, 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe common stock of Central Steel and Wire Company is traded in the over-the-counter market. The market is a limited one, with only occasional trading. The Company's profit sharing plan has purchased shares from time to time. The quarterly high-and-low market bid prices of the stock (which do not necessarily represent firm offers or actual transactions), as reported by the National Quotation Bureau, and the quarterly dividends declared during the last two years were:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following information supplements the financial statements and notes thereto found elsewhere in this annual report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe Company is an independent metals distributor with its principal facility in Chicago and other warehouses in Detroit, Cincinnati and Milwaukee. The Company's customer base is in the midwest, where the Company sells, through salaried sales personnel, to a diverse group of customers in many industries. Products are purchased in standard shapes from producing mills, which sell to other independent metals distributors, captive distributors, and directly to industrial users. The market for the Company's products is a highly competitive one. As a distributor, the Company's revenues and margins are directly affected by prices established in the marketplace by the mills. The Company's unit volumes and prices are also affected by\ndemand in its principal market area, which responds to overall economic conditions.\nThe Company competes by maintaining and emphasizing its ability to deliver a broad range of products quickly and accurately in response to customer orders, using modern and efficient facilities. The Company maintains the facilities and personnel necessary to conduct its business in this manner, even though unit volume can vary materially from period to period. Accordingly, operating, selling and administrative expenses, although subject to inflation, are relatively fixed.\nRESULTS OF OPERATIONS\n1994 Compared to 1993\nSales increased 18% in 1994 as a result of higher unit volume and higher unit selling prices due to greatly improved general economic conditions. Unit margins remained unchanged during 1994 as higher unit costs were recovered through higher unit selling prices. Operating expenses increased 13% in 1994 as a result of higher depreciation, insurance, and salaries. Selling and administrative expenses increased slightly from 1993. Interest income increased due to higher interest rates. The result of these factors was a 154% increase in net earnings.\n1993 Compared to 1992\nSales increased 10% in 1993 as a result of higher unit volume due to improving general economic conditions. Unit margins remained unchanged during 1993. Operating expenses increased 6% in 1993 due to relocating certain machinery and equipment at the Chicago Plant and increased maintenance costs. Selling and administrative expenses increased slightly from 1992. Interest income decreased due to lower interest rates and lower funds available for investment. The result of these factors was a 143% increase in earnings before cumulative effect of change in accounting principle.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's liquidity remains strong as operations continued to provide the funds needed for working capital and capital expenditures. Funds in excess of current business needs are invested in cash- equivalents. The Company remained debt free in 1994, for the fifteenth consecutive year, and for the foreseeable future expects funding requirements to be met without external financing. It is the Company's policy to continue to make such expenditures on property, plant and equipment as are necessary to keep its facilities among the most modern in the industry. The Company does not anticipate any material changes in expenditures for these purposes from the levels of the last several years.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCENTRAL STEEL AND WIRE COMPANY\nIndex to Financial Statements and Financial Statement Schedule\nPage ---- Statements of Earnings and Earnings Reinvested in 9 Business for each of the years in the three-year period ended December 31, 1994.\nBalance Sheets as of December 31, 1994 and 1993. 10-11\nStatements of Cash Flow for each of the years in the three-year period ended December 31, 1994. 12\nNotes to Financial Statements. 13-16\nReport of KPMG Peat Marwick LLP, dated February 16, 1995. 17\nSchedule for the years ended December 31, 1994, 1993 and 1992.\nSchedule -------- Valuation and Qualifying Accounts II 18\nAll other Schedules have been omitted because they are not applicable or because information is shown in the financial statements and accompanying notes.\nCENTRAL STEEL AND WIRE COMPANY NOTES TO FINANCIAL STATEMENTS\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCentral Steel and Wire Company is engaged in a single line of business, the distribution from its warehouses of processed and unprocessed ferrous and non-ferrous metals in forms produced, in general, by rolling mills.\nCash-equivalents are highly liquid, low-risk investments that have original maturities within three months.\nInventories are valued at cost using the last-in, first-out method (LIFO) which is lower than market. The excess of current cost over LIFO value amounted to approximately $109.3 million at December 31, 1994 and $99.2 million at December 31, 1993.\nDepreciation is computed under accelerated methods for substantially all plant and equipment.\nEarnings per share are calculated based on average shares outstanding, which were 286,000 in 1994, 286,260 in 1993 and 287,000 in 1992.\n(2) BENEFIT PLANS\nThe Company's defined benefit pension plan, covering substantially all personnel, provides benefits based on final five-year-average compensation and years of service. Contributions are made when allowable under ERISA.\nThe following table sets forth the plan's funded status and amounts recognized in the balance sheet:\nThe assumed weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation was six and three-quarter percent in 1994 and 1993. The expected long-term rates of return on assets and increases in future compensation levels were eight percent and three percent in 1994 and 1993. Plan assets include various debt and equity securities.\nProfit sharing expense amounted to approximately $1.2 million in 1994, $1.0 million in 1993, and $.2 million in 1992.\nThe Company also provides postretirement health benefits for retired employees. Effective January 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The statement requires employers to recognize the cost of providing postretirement benefits to employees over the employees' service periods. The Company has elected to recognize the transition obligation at January 1, 1992, of $14.3 million, as a cumulative effect of change in accounting principle. The Company's policy had been to expense retiree health care costs as they were paid.\nPostretirement health costs for the year ended December 31, included the following:\nThere are no health plan assets and the Company funds benefits as paid.\nThe following table sets forth postretirement amounts recognized in the Company's balance sheet:\nThe health care cost trend rate used to measure the cost in 1994 and 1993 for health care benefits was 12% and 11%, which is graded down to an ultimate trend rate of 4.5% to be achieved in the year 2004. The discount rate used was 7.5% in 1994 and 1993.\nThe effect of a one-percentage point increase in the assumed health care cost trend rates for future years would increase the accumulated postretirement benefit obligation as of December 31, 1994, by $2.0 million. The effect of this change on the aggregate of the service and interest cost components of the net periodic postretirement benefit costs would be an increase of $.2 million for 1994.\nKPMG Peat Marwick LLP Independent Auditors\nTHE BOARD OF DIRECTORS AND STOCKHOLDERS CENTRAL STEEL AND WIRE COMPANY:\nWe have audited the accompanying financial statements of Central Steel and Wire Company as listed in the accompanying index. In connection with our audits of the financial statements, we have also 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 Central Steel and Wire Company at December 31, 1994 and 1993 and the results of its operations and its cash flow 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.\nAs discussed in Note 2 to the 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.\nKPMG PEAT MARWICK LLP Chicago, Illinois February 16, 1995\nSCHEDULE II\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nThe information required by this Part is incorporated by reference to the matter appearing under the captions \"Proxy Statement for Annual Meeting of Stockholders,\" \"Election of Directors,\" \"Compensation of Executive Officers,\" \"Summary Compensation Table\" and \"Pension Plan Table,\" and the matter appearing in the first sentence under the caption \"Compensation Committee Interlocks and Insider Participation\" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held April 17, 1995, which has been filed with the Securities and Exchange Commission. No other portion of the definitive Proxy Statement is incorporated by reference and no other material from the definitive Proxy Statement should be deemed to be filed with the Securities and Exchange Commission.\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 and Schedule\nSee accompanying Index to Financial Statements and Financial Statement Schedule on page 8. Such Financial Statements and Schedule are incorporated herein by reference.\nExhibits\n(a) Documents filed as part of this report:\n3.1 Articles of Incorporation of the registrant. This Exhibit is incorporated by reference to Exhibit 19.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n3.2 By-Laws of the registrant. This Exhibit is incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n27. Financial Data Schedule\n(b) Reports on Form 8-K\nNone filed for 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.\nCENTRAL STEEL AND WIRE COMPANY (Registrant)\nBy: \/s\/ F. A. Troike ________________________ Executive Vice President and Treasurer DATE: 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.\nBy: \/s\/ James R. Lowenstine _____________________________ James R. Lowenstine, Chairman of the Board, President, Chief Executive Officer and Director\nDATE: March 20, 1995.\nBy: \/s\/ F. A. Troike _____________________________ F. A. Troike, Executive Vice President, Treasurer and Director (Principal Financial officer)\nDATE: March 20, 1995\nBy: \/s\/ A. G. Jensen _____________________________ A. G. Jensen, Senior Vice President and Director\nDATE: March 20, 1995\nBy: \/s\/ R.P. Ugolini _____________________________ R. P. Ugolini, Comptroller, Assistant Secretary and Assistant Treasurer\nDATE: March 20, 1995","section_15":""}
{"filename":"38723_1994.txt","cik":"38723","year":"1994","section_1":"Item 1. BUSINESS:\nThe Company, Page 1; Business, Pages 5 - 12; and Financial Statements, Pages 18-30 of Registrant's Annual Report to security holders for the fiscal year ended December 31, 1994 are incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES:\nParagraph 1 of The Company, Page 1; Footnote 7 (Commitments) of Notes to Consolidated Financial Statements, Page 28; and map on back cover of Registrant's Annual Report to security holders for the fiscal year ended December 31, 1994 are incorporated herein by reference.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS:\nThe Company has been named as defendant in the following legal proceedings in the state of Alabama:\nAnnie E. Erkins, et al. v. 1st Franklin, et al.; Filed in the United States District Court for the Northern District of Alabama, Southern Division; Civil Action No. CV-94-N-2500-S. This was a lawsuit originally filed in the Circuit Court for Jefferson County in May, 1994 as a class action suit seeking recovery for an alleged violation of the Alabama Mini-Code and for fraud arising out of the practice of charging for non- filing insurance premiums, charges for credit property insurance and refinancing practices. This case has been dismissed.\nPrincess Nobels, et al. v. 1st Franklin, et al.; Filed in the United States District Court for the Middle District of Alabama, Southern Division; Civil Action No. CV-94-T-699-N. This is a class action pending in federal district court in Montgomery. Alabama. The case was filed in July, 1994 alleging that certain lending practices violated the federal Truth-in- Lending Act and the federal Racketeer Influenced and Corrupt Organizations Act. The Plaintiffs are filing an amendment in which they express claims for liability arising out of the non- filing insurance under the following theories: (a) Antitrust violations; (b) Truth-in-Lending Act violations; (c) Fraud; (d) RICO; (e) Breach of Contract; (f) Conversion. Plantiffs are seeking to have this case certified as a nationwide class. At the present, it is too early to reach any type of informed assessment of the liability of the case. The case is being vigorously defended.\nDorothy C. Jackson and Rudolph Jackson v. 1st Franklin Financial Corporation and Voyager Guaranty Insurance Company; Filed in Circuit Court for Barbour County, Alabama, Clayton Division; Civil Action No. CV-94-052 This class action case attacked the practice of charging for credit life insurance premiums based upon the total payments, rather than for the amount financed, and also attacked the practice of 1st Franklin's obtaining a commission on sales of credit life insurance. The claims were based upon fraud, unconsicionability, and breach of contract. Plantifffs sought to have certified a state-wide class action. The case has been dismissed.\nCarl J. White v. 1st Franklin Financial, et al.; Filed in Circuit Court of Talladega County, Alabama; Civil Action No. CV-94-374. This case involves an individual claim of fraud against 1st Franklin and Voyager Insurance Company arising out of an allegation of fraud in connection with the sale of a policy. The plaintiff has recently died, and the case has not been revived on behalf of his estate. It is unclear whether or not the case will proceed. It will be vigorously defended.\nMose Burks v. 1st Franklin, et al.; Filed May, 1994, in the Circuit Court of Barbour County, Alabama, Clayton Division; Civil Action No. CV-94-084. This case alleges fraud in connection with the sale of credit insurance and in connection with the refinancing of loans. The case is being vigorously defended.\nKaren Hilliary v. 1st Franklin Financial, et al.; Filed September, 1994 in the Circuit Court of Bullock County, Alabama; Civil Action No. CV-94-92. This case alleges fraud in connection with the sale of credit insurance and in connection with the refinancing of loans. The case is being vigorously defended.\nRobbie Martin, et al. v. 1st Franklin Financial, et al.; Filed November, 1994 in the United States District Court for the Middle District of Alabama, Southern Division; Civil Action No. 94-T-1431-S. This case alleges fraud and Mini-Code violations arising out of the sale of non-filing insurance and loan refinancing. The case is being vigorously defended.\nJames Russaw v. 1st Franklin Financial, et al.; Filed February, 1995 in the Circuit Court for Barbour County, Alabama, Clayton Division; Civil Action No. CV-95-023. This case alleges fraud in connection with the sale of credit insurance and in connection with the refinancing of loans. The case is being vigorously defended.\nThese actions (except the two cases which have been dismissed) are in their early stages and their outcome currently is not determinable.\nOther than ordinary routine litigation incidental to the finance business, there are no other material pending legal proceedings.\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:\nSource of Funds, Page 12 of Registrant's Annual Report to security holders for the fiscal year ended December 31, 1994 is incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA:\nSelected Consolidated Financial Information, Page 4 of Registrant's Annual Report to security holders for the fiscal 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 of Operations, Pages 13 - 16 of Registrant's Annual Report to security holders for the fiscal year ended December 31, 1994 is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:\nPages 18 - 30 of Registrant's Annual Report to security holders for the fiscal year ended December 31, 1994 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:\nDIRECTORS ---------\nDirector Since and Date on Which Position Name of Director Age Term Will Expire With Company ---------------- --- ---------------- ------------ W. Richard Acree (1)(2) 67 Since 1970; None When successor elected and qualified\nBen F. Cheek, III (3)(4)(5) 58 Since 1967; Chairman of When successor Board elected and qualified\nLorene M. Cheek (2)(4)(6) 85 Since 1946; None When successor elected and qualified\nJack D. Stovall (1)(2) 59 Since 1983; None When successor elected and qualified\nRobert E. Thompson (1)(2) 63 Since 1970; None When successor elected and qualified\n__________________________________________________________________________\n(1) Member of Audit Committee.\n(2) Mr. Acree is President of Acree Oil Company, a distributor of petroleum products in Northeast Georgia; Mrs. Cheek is an honorary member of the Board of Trustees of Tallulah Falls School; Dr. Thompson is a physician at Toccoa Clinic; and Mr. Stovall is President of Stovall Building Supplies, Inc.\n(3) Reference is made to the business experience of executive officers of the Company as detailed below.\n(4) Member of Executive Committee.\n(5) Son of Lorene M. Cheek.\n(6) Mother of Ben F. Cheek, III.\nEXECUTIVE OFFICERS ------------------\nName, Age, Position and Family Relationship Business Experience ----------------------- -------------------\nBen F. Cheek, III, 58 Joined the Company in 1961 as attorney and became Chairman of Board Vice President in 1962, President in 1972 and Chair- man of Board in 1989.\nT. Bruce Childs, 58 Joined the Company in 1958 and was named Vice President President in charge of Operations in 1973 and No Family Relationship President in 1989.\nLynn E. Cox, 37 Joined the Company in 1983 and became Secretary Secretary in 1989. No Family Relationship\nA. Roger Guimond, 40 Joined the Company in 1976 as an accountant and Vice President and became Chief Accounting Officer in 1978, Chief Chief Financial Officer Officer in 1991 and Vice President in 1992. No Family Relationship\nLinda L. Sessa, 40 Joined the Company in 1984 and became Treasurer Treasurer in 1989. No Family Relationship\nThe term of office of each Executive Officer expires when a successor is elected and qualified. There was no, nor is there presently any arrangement or understanding between any officer and any other person (except directors or officers of the registrant acting solely in their capacities as such) pursuant to which the officer was selected.\nNo event such as bankruptcy, criminal proceedings or securities violation proceeding has occurred within the past 5 years with regard to any Director or Executive Officer of the Company.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION:\n(b) Summary Compensation Table:\nOther All Name Annual Other and Compen- Compen- Principal Salary Bonus sation sation Position Year $ $ $ $ * -------- ---- ------- ------- ------- ------- Ben F. Cheek, III 1994 228,000 189,693 2,760 38,594 Chairman and 1993 216,000 154,653 2,867 44,268 CEO 1992 204,000 124,106 2,592 45,594\nT. Bruce Childs 1994 210,000 188,973 4,682 31,071 President 1993 194,000 153,773 7,179 38,574 1992 178,000 123,066 4,683 34,878\nA. Roger Guimond 1994 108,000 62,174 1,650 20,255 Vice President 1993 96,000 36,790 1,650 15,354 and CFO 1992 84,000 29,145 1,625 11,427\n* Represents Company contributions to profit-sharing plan, and reported compensation from premiums on life insurance policies for the benefit of Ben F. Cheek, III in the amount of $3,816 for 1994, $5,984 for 1993 and $7,310 for 1992.\n(g) Compensation of Directors:\nDirectors who are not employees of the Company receive $1,000 per year for attending scheduled board meetings.\n(k) Board Compensation Committee Report on Executive Compensation:\nThe Company has no official executive compensation committee. Ben F. Cheek, III (Chairman of the Company) establishes the bases for all executive compensation. The Company is a family owned business with Ben F. Cheek, III being the majority stockholder.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT:\n(a) Security Ownership of Certain Beneficial Owners:\nName and Address of Amount and Nature of Percent Beneficial Owner Title of Class Beneficial Ownership Of Class ------------------- -------------- --------------------- --------\nBen F. Cheek, III Common 1,160 Shares - Direct 68.24% 225 Valley Drive Toccoa, Georgia 30577\nJohn Russell Cheek Common 441 Shares - Direct 25.94% 181 Garland Road Toccoa, Georgia 30577\n(b) Security Ownership of Management:\nOwnership listed below represents ownership in 1st Franklin Financial Corporation, of (i) Directors and named Executive Officers of the Company and (ii) all Directors and Executive Officers as a group:\nAmount and Nature of Percent Name Title of Class Beneficial Ownership Of Class ---- -------------- --------------------- --------\nBen F. Cheek, III Common Stock 1,160 Shares - Direct 68.24%\nT. Bruce Childs Common Stock None None\nA. Roger Guimond Common Stock None None __________________________________________\nAll Directors and Executive Officers as a Group Common Stock 1,160 Shares - Direct 68.24%\n(c) The Company knows of no contractual 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 Company leases its Home Office building and print shop for a total of $12,600 per month from Franklin Enterprises, Inc. under leases which expire December 31, 2004. Franklin Enterprises, Inc. is 66.67% owned by Ben F. Cheek, III, a director and executive officer of the Company. In Management's opinion, these leases are at rates which approximate those obtainable from independent third parties.\nBeneficial owners of the Company are also beneficial owners of Liberty Bank & Trust (\"Liberty\"). The Company and Liberty have management and data processing agreements whereby the Company provides certain administrative and data processing services to Liberty for a fee. Income recorded by the Company during the three year period ended December 31, 1994 related to these agreements was $63,800 per year which in Management's opinion approximates the Company's actual cost of these services.\nLiberty leases its office space and equipment from the Company for $4,200 per month, which in Management's opinion are at rates which approximate these obtainable from independent third parties.\nAt December 31, 1994, the Company maintained $300,000 of certificates of deposit and $55,518 in a money market account with Liberty at market rates and terms. The Company also had $1,460,003 in demand deposits with Liberty at 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:\nIncorporated by reference from the Registrant's Annual Report to security holders for the fiscal year ended December 31, 1994:\nReport of Independent Public Accountants.\nConsolidated Statements of Financial Position at December 31, 1994 and 1993.\nConsolidated Statements of Income and Retained Earnings for the three years ended December 31, 1994.\nConsolidated Statements of Cash Flows for the three years ended December 31, 1994.\nNotes to Consolidated Financial Statements.\n2. Financial Statement Schedules:\nNone - Financial statement schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.\n3. Exhibits:\n2. (a) Articles of Merger of 1st Franklin Corporation with and into 1st Franklin Financial Corporation dated December 31, 1994.\n3. (a) Restated Articles of Incorporation as amended December 29, 1983 (incorporated herein by reference from Form 10-K for the fiscal year ended December 31, 1983).\n4. (a) Executed copy of Indenture dated October 31, 1984, covering the Variable Rate Subordinated Debentures - Series 1 (incorporated herein by reference from Registration Statement No. 2-94191, Exhibit 4a).\n(b) Modification of Indenture dated March , 1995.\n9. Not applicable.\n10. (a) Credit Agreement dated May, 1993 between the registrant and SouthTrust Bank of Georgia, N.A.. (Incorporated herein by reference from Form 10-K for the fiscal year ended December 31, 1993.)\n(b) Revolving Credit Agreement dated October 1, 1985 as amended November 10, 1986; March 1, 1988; August 31, 1989 and May 1, 1990, among the registrant and the banks named therein (Incorporated by reference to Exhibit 10 to the registrant's Form SE dated November 9, 1990.)\n(c) Fifth Amendment to Revolving Credit Agreement dated April 23, 1992. (Incorporated by reference to Exhibit 10(c) to the Registrant's Form SE dated November 5, 1992.)\n(d) Sixth Amendment to Revolving Credit Agreement dated July 20, 1992. (Incorporated by reference to Exhibit 10(d) to the Registrant's Form SE dated November 5, 1992.)\n(e) Seventh Amendment to Revolving Credit Agreement dated June 20, 1994.\n(f) Merger of 1st Franklin Corporation with 1st Franklin Financial Corporation Consent, Waiver and Eighth Amendment to Revolving Credit and Term Loan Agreement.\n11. Computation of Earnings per Share is self-evident from the Consolidated Statement of Income and Retained Earnings in the Registrant's Annual Report to Security Holders for the fiscal year ended December 31, 1994, incorporated by reference herein.\n12. Ratio of Earnings to Fixed Charges.\n13. Registrant's Annual Report to security holders for fiscal year ended December 31, 1994.\n18. Not applicable.\n19. Not applicable.\n21. Subsidiaries of Registrant.\n22. Not applicable.\n23. Consent of Independent Public Accountants.\n24. Not applicable.\n27. Financial Data Schedule\n28. Not applicable.\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed by the Registrant 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:\n1st FRANKLIN FINANCIAL CORPORATION\nMarch 30, 1995 By: Ben F. Cheek, III --------------- ---------------------------------- Date Chairman of 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 capacity and on the dates indicated:\nSignatures Title Date ---------- ----- ----\nBen F. Cheek, III Chairman of Board; March 30, 1995 -------------------------- Chief Executive Officer\nT. Bruce Childs President March 30, 1995 --------------------------\nA. Roger Guimond Vice President; March 30, 1995 -------------------------- Chief Financial Officer\nW. Richard Acree Director March 30, 1995 --------------------------\nLorene M. Cheek Director March 30, 1995 --------------------------\nJack D. Stovall Director March 30, 1995 --------------------------\nRobert E. Thompson Director March 30, 1995 -------------------------- Supplemental 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.\n(a) Except to the extent that the materials enumerated in (1) and\/or (2) below are specifically incorporated into this Form by reference (in which case see Rule 12b-23b), every registrant which files an annual report on this Form pursuant to Section 15(d) of the Act shall furnish to the Commission for its information, at the time of filing its report on this Form, four copies of the following:\n(1) Any annual report to security holders covering the registrant's last fiscal year and\n(2) Every proxy statement, form of proxy or other proxy soliciting material sent to more than ten of the registrant's security holders with respect to any annual or other meeting of security holders.\n(b) The foregoing material shall not be deemed to be \"filed\" with the Commission or otherwise subject to the liabilities of Section 18 of the Act, except to the extent that the registrant specifically incorporates it in its annual report on this Form by reference.\n(c) This Annual Report on Form 10-K incorporates by reference portions of the Registrant's Annual Report to security holders for the fiscal year ended December 31, 1994, which is filed as Exhibit 13 hereto. The Registrant is a privately held corporation and therefore does not distribute proxy statements or information statements.","section_15":""}
{"filename":"93751_1994.txt","cik":"93751","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS State Street Boston Corporation (\"State Street\") is a bank holding company organized under the laws of the Commonwealth of Massachusetts.\nState Street was organized in 1970 and conducts its business principally through its subsidiary, State Street Bank and Trust Company (\"State Street Bank\"), which traces its beginnings to the founding of the Union Bank in 1792. The charter under which State Street Bank now operates was authorized by a special act of the Massachusetts Legislature in 1891, and its present name was adopted in 1960.\nState Street is the fourth largest provider of trust services in the United States as ranked on the basis of 1993 fiduciary compensation. State Street had more than $1.6 trillion of assets under custody, $210 billion of bonds under trusteeship, and $160 billion of assets under management at year- end 1994. Ranked on the basis of balance sheet assets as of June 1994, State Street Bank is the 23rd largest commercial bank in the United States. State Street's total assets were $21.7 billion at December 31, 1994, of which $16.0 billion, or 74%, were investment securities and money market assets and $3.2 billion, or 15%, were loans.\nServices are provided from offices in the United States, as well as from offices in Canada, Grand Cayman, Netherland Antilles, the United Kingdom, France, Belgium, Luxembourg, Denmark, Germany, United Arab Emirates, Hong Kong, Taiwan, Japan, Australia, and New Zealand. State Street's executive offices are located at 225 Franklin Street, Boston, Massachusetts. For information as to foreign activities, refer to Note T to the Notes to Financial Statements.\nLINES OF BUSINESS State Street has three lines of business: financial asset services, investment management and commercial lending. In 1994, 72% of net income came from the broad and growing array of financial asset services, 16% of net income came from investment management and 18% came from commercial lending. Corporate items reduced net income by 6%.\nFINANCIAL ASSET SERVICES Financial asset services are primarily accounting, custody and other services for large pools of assets such as mutual funds and pension plans, both defined benefit and defined contribution, and corporate trusteeship. A broad array of other services is provided, including accounting, custody, information services and recordkeeping. Also provided are banking functions of accepting deposits, making loans and trading foreign exchange.\nWith $675 billion of mutual fund assets under custody, State Street is the leading mutual fund custodian in the United States, servicing 36% of the registered funds. State Street began providing mutual fund services in 1924 and servicing pension assets in 1974. Customers who sponsor the 2,200 U.S. mutual funds that State Street services include investment companies, broker\/ dealers, insurance companies and others. In addition, State Street services 252 offshore mutual funds and collective investment funds in other countries.\nState Street's mutual fund services include a full array of services including custody, portfolio and general ledger accounting, pricing, fund administration and information services. Shareholder accounting is provided through a 50%-owned affiliate.\nServicing $664 billion of pension and other assets for North American customers, State Street is ranked as the largest servicer of tax-exempt assets for corporations and public funds in the United States and the largest global custodian for U.S. pension assets. Services include portfolio accounting, securities custody, securitieslending, and other related services for retirement and other financial assets of benefit pension plans, unions, endowments, foundations, and nuclear decommissioning trusts. In addition, State Street provides global and domestic custody-related services for $72.2 billion in assets for customers outside North America.\nState Street acts as participant recordkeeper, securities custodian and trustee for defined contribution plans, such as 401(k) plans and ESOPs, and issues checks for employee benefit distributions. Corporate trust services for asset-backed securities, corporate securities, leveraged leases, and municipal securities are provided to investment banks, corporations, municipalities and government agencies from five offices in the United States. At year ended 1994, bonds under trusteeship totaled $210 billion.\nState Street is a mortgage subservicer through Wendover Funding, Inc. in Greensboro, North Carolina. State Street also provides card replacement and other services for a bank card association, processing of unclaimed securities for state governments, and accounting services for retained assets accounts of insurance companies.\nState Street provides foreign exchange trading and global cash management services to financial institutions and corporations. Funds are gathered in the form of domestic and foreign deposits, federal funds and securities sold under repurchase agreements from local, national and international sources. Trading and arbitrage operations are conducted with government securities, futures and options. Municipal dealer activities include underwriting, trading and distribution of general obligation tax-exempt bonds and notes. Treasury centers are located in Boston, London, Hong Kong, Tokyo, Sydney, Munich and Luxembourg. State Street also provides corporate finance services, including private placement of debt and equity, acquisitions and divestitures and project finance.\nINVESTMENT MANAGEMENT State Street was a pioneer in the development of domestic and international index funds through State Street Global Advisors (\"SSGA\"). The products now offered by SSGA include enhanced index and fully-active equity strategies, short-term investment funds and fixed income products. These products are sold and managed both domestically and from locations outside the United States. State Street is ranked as the largest manager of internationally-indexed assets and the second largest manager of tax-exempt money in the United States. State Street is a leading New England trustee and money manager for individuals, and provides planned gift management services for non-profit organizations throughout the United States. At year-end 1994, institutional and personal trust assets under management totaled $160 billion.\nCOMMERCIAL LENDING State Street provides corporate banking, specialized lending and international banking to business and financial institutions. One-third of the loan portfolio supports the short-term needs of financial asset services customers and securities brokers in conjunction with their trading and settlement activity. Corporate banking services are offered primarily to middle market companies in the Northeast. Specialized Lending is both regional and national, with specialities that include cable television, technology- based companies, publishing, law firms, non-profit institutions, broker\/ dealers and other financial institutions. In addition, State Street offers asset-based finance, leasing, real estate, and trade finance. Trade finance includes letters of credit, collection, payment and other specialized services for importers and exporters.\nSELECTED STATISTICAL INFORMATION The following tables contain State Street's consolidated statistical information relating to, and should be read in conjunction with, the consolidated financial statements. Additionally, certain previously reported amounts have been reclassified to conform to the present method of presentation.\nDISTRIBUTION OF AVERAGE ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL The average statements of condition and net interest revenue analysis for the years indicated are presented below.\nInterest revenue on non-taxable investment securities and loans includes the effect of taxable-equivalent adjustments, using a Federal income tax rate of 35% in 1994 and 1993, and 34% in 1992, adjusted for applicable state income taxes net of the related Federal tax benefit.\nDISTRIBUTION OF AVERAGE ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL (CONTINUED) The table below summarizes changes in interest revenue and interest expense due to changes in volume of interest-earning assets and interest- bearing liabilities, and changes in interest rates. Changes attributed to both volume and rate have been allocated based on the proportion of change in each category.\nRETURN ON EQUITY AND ASSETS AND CAPITAL RATIOS The return on equity, return on assets, dividend payout ratio, equity to assets ratio and capital ratios for the years ended December 31, were as follows: 1994 1993 1992 ---- ---- ---- Net income to: Average stockholders' equity ..... 17.5% 17.4% 18.1% Average total assets ............. .95 .99 1.03 Dividends declared to net income ... 22.1 21.9 20.8 Average equity to average assets ... 5.4 5.7 5.7 Risk-based capital ratios: Tier 1 capital ................... 12.8 12.1 13.2 Total capital .................... 13.4 12.7 14.6\nINVESTMENT PORTFOLIO State Street adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" on January 1, 1994. Under SFAS No. 115, debt securities for which State Street has the intent and ability to hold to maturity may be classified as held-to- maturity securities and reported at amortized cost. Securities that are not classified as held to maturity are to be classified as available-for-sale securities and reported at fair value. Investment securities consisted of the following at December 31:\n1994 1993 1992 ---- ---- ----\n(DOLLARS IN MILLIONS) HELD TO MATURITY (at amortized cost) U.S. Treasury and Federal agencies .. $1,669 $1,272 $ 996 State and political subdivisions .... 1,130 1,084 451 Asset-backed securities ............. 2,347 2,028 1,618 Other investments ................... 41 100 87 ----- ----- ----- Total ........................... $5,187 $4,484 $3,152 ===== ===== ===== AVAILABLE FOR SALE (at fair value *) U.S. Treasuries ..................... $3,148 $1,122 $ 940 Other investments ................... 79 95 ----- ----- ----- Total ........................... $3,227 $1,217 $ 940 ===== ===== ===== * In 1993 and 1992, at lower of cost or market\nThe maturities of investment securities at December 31, 1994 and the weighted average yields (fully taxable equivalent basis) were as follows:\nLOAN PORTFOLIO Domestic and foreign loans at December 31 and average loans outstanding for the years ended December 31, were as follows:\nLoans are evaluated on an individual basis to determine the appropriateness of renewing each loan. State Street does not have a general rollover policy. Unearned revenue included in loans was $4,112,000 and $4,423,000 at December 31, 1994 and 1993, respectively.\nNON-ACCRUAL LOANS It is State Street's policy to place loans on a non-accrual basis when they become 60 days past due as to either principal or interest, or when in the opinion of management, full collection of principal or interest is unlikely. When the loan is placed on non-accrual, the accrual of interest is discontinued and previously recorded but unpaid interest is reversed and charged against current earnings. Past due loans are loans on which principal or interest payments are over 90 days delinquent, but where interest continues to be accrued.\nNON-ACCRUAL LOANS (CONTINUED) The following schedule discloses information concerning non-accrual and past due loans:\nThe interest revenue for 1994 which would have been recorded related to these non-accrual loans is $2,245,000 for domestic loans. The interest revenue that was recorded on these non-accrual loans was $834,000, all of which relates to domestic loans.\nA loan totaling $2,703,000 was restructured in 1994, is performing in accordance with its new terms and is accruing at a market rate.\nALLOWANCE FOR LOAN LOSSES The changes in the allowance for loan losses for the years ended December 31, were as follows:\nALLOWANCE FOR LOAN LOSSES (CONTINUED) State Street establishes an allowance for loan losses to absorb probable credit losses. Management's review of the adequacy of the allowance for loan losses is ongoing throughout the year and is based, among other factors, on the evaluation of the level of risk in the portfolio, the volume of adversely classified loans, previous loss experience, current trends, and expected economic conditions and its effect on borrowers.\nWhile the allowance is established to absorb probable losses inherent in the total loan portfolio, management allocates the allowance for loan losses to specific loans, selected portfolio segments and certain off-balance sheet exposures and commitments. Adversely classified loans in excess of $1 million are individually reviewed to evaluate risk of loss and assigned a specific allocation of the allowance. The allocations are based on an assessment of potential risk of loss and include evaluations of the borrowers' financial strength, cash flows, collateral, appraisals and guarantees. The allocations to portfolio segments and off-balance sheet exposures are based on management's evaluation of relevant factors, including the current level of problem loans and current economic trends. These allocations are also based on subjective estimates and management judgment, and are subject to change from quarter-to-quarter. In addition, a portion of the allowance remains unallocated as a general reserve for the entire loan portfolio.\nThe provision for loan losses is a charge to earnings for the current period which is required to maintain the total allowance at a level considered adequate in relation to the level of risk in the loan portfolio. The provision for loan losses was $11.6 million for 1994, which compares to $11.3 million in 1993.\nAt December 31, 1994, the allowance for loan losses was $58.2 million, or 1.80% of loans. This compares to an allowance of $54.3 million or 2.03% of loans a year ago. This decline reflects improvement in measures of credit quality and improvement in the outlook for general economic conditions and its effect on borrowers. The decline in the allowance for loan losses as a percentage of loan volume is also attributable to the growth in loan exposures to financial asset services customers and securities brokers in conjunction with their trading and settlement activity. These loan exposures are generally short-term, usually overnight, and are structured to have relatively low credit exposure.\nCREDIT QUALITY At December 31, 1994, loans comprised 15% of State Street's assets, compared to over 55% for other banking companies of comparable size. State Street's loan policies limit the size of individual loan exposures to reduce risk through diversification.\nIn 1994, net charge-offs declined from $16.3 million to $7.7 million. Net charge-offs as a percentage of average loans were .23% compared to .63% for 1993.\nAt December 31, 1994, total non-performing assets were $27.4 million, a $10.5 million decrease from year-end 1993. For 1994 and 1993, respectively, non-performing assets include $23.0 million and $26.8 million of non-accrual loans and $4.4 million and $11.1 million of other real estate owned. In 1994, loans placed on non-accrual status were more than offset by charge-offs, payments, and the return to accrual status of several loans. The decline in other real estate owned resulted from property sales.\nIn 1994, measures of credit quality improved, as discussed above, as did the general economic outlook. The economy in the Northeast began to expand modestly after several years of decline. We expect these levels of credit quality to continue in in 1995. It is anticipated that charge-off's in 1995 will approximate the 1994 level and will be primarily in the commercial and financial category.\nCROSS-BORDER OUTSTANDINGS Countries with which State Street has cross-border outstandings (primarily deposits and letters of credit to banks and other financial institutions) of at least 1% of its total assets at December 31, 1994, 1993 and 1992, were as follows:\n1994 1993 1992 ----------- ----------- ----------- (DOLLARS IN THOUSANDS) Japan ................................. $1,708,021 $1,688,130 $1,630,148 United Kingdom ........................ 543,055 613,515 524,352 France ................................ 461,919 519,565 444,637 Australia ............................. 648,697 498,671 174,652 Italy ................................. 527,682 367,931 420,535 Germany ............................... 438,624 339,477 371,657 Canada ................................ 265,322 289,152 220,217 Netherlands ........................... 101,797 224,622 Hong Kong ............................. 206,443 Switzerland ........................... 175,052 ----------- ----------- ----------- Total outstandings ................ $4,695,117 $4,747,506 $3,961,250 =========== =========== ===========\nAggregate of cross-border outstandings in countries having between .75% and 1% of total assets at December 31, 1994 was $176,988,000 (Switzerland); December 31, 1993 was $171,688,000 (Belgium); and at December 31, 1992 was $139,333,000 (Austria). At December 31, 1994 there was $2,308,000 of cross-border risk with Mexico.\nDEPOSITS The average balance and rates paid on interest-bearing deposits for the years ended December 31, were as follows:\nAt December 31, 1994, substantially all foreign time deposit liabilities were in amounts of $100,000 or more. Included in noninterest-bearing deposits were foreign deposits of $44,816,000, $28,519,000 and $41,492,000 at December 31, 1994, 1993 and 1992.\nSHORT-TERM BORROWINGS The following table reflects the amounts outstanding and weighted average interest rates of the primary components of short-term borrowings as of and for the years ended:\nCOMPETITION State Street operates in a highly competitive environment in all areas of its business on a world wide basis, including servicing financial assets, investment management and commercial lending. In addition to facing strong competition from other deposit taking institutions, State Street faces strong competition from investment management firms, private trustees, insurance companies, mutual funds, broker\/dealers, investment banking firms, law firms, benefit consultants, and business service companies. As State Street expands globally, additional sources of competition are encountered.\nEMPLOYEES At December 31, 1994, State Street had 11,127 employees, of whom 10,766 were full-time.\nREGULATION AND SUPERVISION State Street is registered with the Board of Governors of the Federal Reserve System (the \"Board\") as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended (the \"Act\"). The Act, with certain exceptions, limits the activities that may be engaged in by State Street and its non-bank subsidiaries to those which are deemed by the Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making such determination, the Board must consider whether the performance of any such activity by a subsidiary of State Street 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. The Board is authorized to differentiate between activities commenced de novo and those commenced by the acquisition in whole or in part of a going concern. The Board may order a bank holding company to terminate any activity or its ownership or control of a nonbank subsidiary if the Board finds that such activity or ownership or control constitutes a serious risk to the financial safety, soundness or stability of a subsidiary bank and is inconsistent with sound banking principles or statutory purposes. In the opinion of management, all of State Street's present subsidiaries are within the statutory standard or are otherwise permissible.\nThe Act also requires a bank holding company to obtain prior approval of the Board before it may acquire substantially all the assets of any bank or ownership or control of more than 5% of the voting shares of any bank. Until September 29, 1995, the Act prohibits a bank holding company from acquiring shares of a 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 other state. On September 29, 1994, President Clinton signed into law the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Act\"). The Interstate Act generally authorizes bank holding companies to acquire banks located in any state commencing on September 29, 1995. In addition, it generally authorizes national and state chartered banks to merge across state lines (and thereby create interstate branches) commencing June 1, 1997. Under the provisions of the Interstate Act, states are permitted to \"opt out\" of this latter interstate branching authority by taking action prior to the commencement date. States may also \"opt in\" early (i.e., prior to June 1, 1997) to the interstate merger provisions. Further, the Interstate Act provides that states may act affirmatively to permit de novo branching by banking institutions across state lines.\nThe Board has established risk-based capital guidelines that require minimum ratios of capital to risk-weighted assets and certain off-balance sheet credit exposure. The Board also maintains a leverage ratio guideline that is a measure of capital to total average balance sheet assets. Information on State Street's capital appears in State Street's 1994 Annual Report to Stockholders on page 34 and is incorporated by reference.\nState Street and its non-bank subsidiaries are affiliates of State Street Bank under the federal banking laws, which impose certain restrictions on transfers of funds in the form of loans, extensions of credit, investments or asset purchases by State Street Bank to State Street and its non-bank subsidiaries. Transfers of this kind to State Street and its non-bank subsidiaries by State Street Bank are limited to 10% of State Street Bank's capital and surplus with respect to each affiliate and to 20% in the aggregate, and are also subject to certain collateral requirements. 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. Federal law also provides that certain transactions with affiliates must be on terms and under circumstances, including credit standards that are substantially the same, or at least as favorable to the institution as those prevailing at the time for comparable transactions involving other non-qualified companies or, in the absence of comparable transactions, on terms and under circumstances, including credit standards, that in good faith would be offered to, or would apply to, nonaffiliated companies. The Board has jurisdiction to regulate the terms of certain debt issues of bank holding companies.\nState Street, State Street Bank and their affiliates are also subject to restrictions with respect to issuing, floating and underwriting, or publicly selling or distributing, securities in the United States. State Street and its affiliates are able to underwrite and deal in specific categories of securities, including U.S. government and certain agency, state, and municipal securities.\nBoard policy requires a bank holding company to act as a source of financial strength for its subsidiary banks and to commit resources to support such banks. Under this policy, State Street may be required to commit resources to its subsidiary banks in circumstances where it might not do so absent such policy. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority payment.\nThe primary banking agency responsible for regulating State Street and its subsidiaries, including State Street Bank, for both domestic and international operations is the Federal Reserve Bank of Boston. State Street is also subject to the Massachusetts bank holding company statute. The Massachusetts statute requires prior approval by the Massachusetts Board of Bank Incorporation for the acquisition by State Street of more than 5% of the voting shares of any additional bank and for other forms of bank acquisitions.\nState Street's banking subsidiaries are subject to supervision and examination by various regulatory authorities. State Street Bank is a member of the Federal Reserve System and the Federal Deposit Insurance Corporation (the \"FDIC\") and is subject to applicable federal and state banking laws and to supervision and examination by the Federal Reserve Bank of Boston, as well as by the Massachusetts Commissioner of Banks,the FDIC, and the regulatory authorities of those countries in which a branch of State Street Bank is located. Other subsidiary banks are subject to supervision and examination by the Office of the Comptroller of the Currency or by the appropriate state banking regulatory authorities of the states in which they are located. State Street's foreign banking subsidiaries are also subject to regulation by the regulatory authorities of the countries in which they are located. The capital of each of these banking subsidiaries is in excess of the minimum legal capital requirements as set by those authorities.\nRECENT STATUTORY DEVELOPMENTS The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\") broadened the enforcement powers of the federal banking agencies, including increased power to impose fines and penalties, over all financial institutions, including bank holding companies and commercial banks. As a result of FIRREA, State Street Bank and any or all of its subsidiaries can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989, in connection with (a) the default of State Street Bank or any other subsidiary bank or (b) any assistance provided by the FDIC to State Street Bank or any other subsidiary bank in danger of default.\nIn 1990, Massachusetts adopted a law which permits Massachusetts banking institutions to acquire banking institutions located in other states based on a reciprocal basis. The Crime Control Act of 1990 further broadened the enforcement powers of the federal banking agencies in a significant number of areas.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") has as its primary objectives to recapitalize the Bank Insurance Fund and strengthen the regulation and supervision of financial institutions. During 1994, the federal banking agencies continued the process of promulgating regulations to implement the statute.\nThe \"Prompt Corrective Action\" provisions of the FDICIA are for the stated purpose: \"to resolve the problems of insured depository institutions at the least possible long-term loss to the deposit insurance fund.\" Each federal banking agency has implemented prompt corrective action regulations for the institutions that it regulates. The statute requires or permits the agencies to take certain supervisory actions when an insured depository institution falls within one of five specifically enumerated capital categories. It also restricts or prohibits certain activities and requires the submission of a capital restoration plan when an insured institution becomes undercapitalized. The implementing regulations establish the numerical limits for the capital categories and establish procedures for issuing and contesting prompt corrective action directives. The five tiers of capital measurement range from \"well capitalized\" to \"critically undercapitalized\". To be within the category \"well capitalized\", an insured depository institution must have a total risk- based capital ratio of 10.0 percent or greater, a Tier 1 risk-based capital ratio of 6.0 percent or greater, and a leverage ratio of 5.0 percent or greater, and the institution must not be subject to an order, written agreement, capital directive, or prompt corrective action directive to meet specific capital requirements. An insured institution is \"adequately capitalized\" if it has a total risk-based capital ratio of 8.0 percent or greater, a Tier 1 risk-based capital ratio of 4.0 percent or greater, and a leverage ratio of 4.0 percent or greater (or a leverage ratio of 3.0 percent or greater if the institution is rated composite 1 under the regulatory rating system). The final three capital categories are levels of undercapitalized, which trigger mandatory statutory provisions. While other factors in addition to capital ratios determine an institution's capital category, State Street Bank's capital ratios were within the \"well-capitalized\" category at December 31, 1994.\nThe Federal Reserve Board adopted a final rule, as required by the FDICIA, prescribing standards that will limit the risks posed by an insured depository institution's exposure to any other depository institution. Banks are required to develop written policies and procedures to monitor credit exposure to other banks, and to limit to 50% and 25% of total capital exposure to \"undercapitalized\" banks in 1995 and 1996, respectively.\nAs required by the FDICIA, the FDIC adopted a regulation that permits only well capitalized banks, and adequately capitalized banks that have received waivers from the FDIC, to accept, renew or rollover brokered deposits. Regulations have also been adopted by the FDIC to limit the activities conducted as a principal by, and the equity investments of, state-chartered banks to those permitted for national banks. Banks may apply to the FDIC for approval to continue to engage in excepted investments and activities.\nOther FDICIA regulations adopted require independent audits, an independent audit committee of the bank's board of directors, stricter truth- in-savings provisions, and standards for real estate lending. The FDICIA amended deposit insurance coverage and the FDIC has implemented a rule specifying the treatment of accounts to be insured up to $100,000.\nUnder other provisions of FDICIA, the federal banking agencies have proposed safety and soundness standards for banks in a number of areas including: internal controls, internal audit systems, information systems, credit underwriting, interest rate risk, executive compensation and minimum earnings. The agencies have also proposed rules to revise risk-based capital standards to take account of interest rate risk, as required by FDICIA.\nFDICIA and related regulations may result in higher costs for the banking industry in terms of costs of compliance and recordkeeping.\nLegislation enacted as part of the Omnibus Budget Reconciliation Act of 1993 provides that deposits in U.S. offices and certain claims for administrative expenses and employee compensation against a U.S. insured depository institution which has failed will be afforded a priority over other general unsecured claims, including deposits in non-U.S. offices and claims under non-depository contracts in all offices, against such an institution in the \"liquidation of other resolution\" of such and institution by any receiver. Accordingly, such priority creditors (including FDIC, as the subrogee of insured depositors) of State Street Bank will be entitled to priority over unsecured creditors in the event of a \"liquidation or other resolution\" of such institution.\nDIVIDENDS As a bank holding company, State Street is a legal entity separate and distinct from State Street Bank and its other non-bank subsidiaries. State Street's principal source of cash revenues is dividends from State Street Bank and its other non-bank subsidiaries. The right of State Street to participate as a stockholder in any distribution of assets of a subsidiary upon its liquidation or reorganization or otherwise is subject to the prior claims by creditors of the subsidiary, including obligations for federal funds purchased and securities sold under repurchase agreements, as well as deposit liabilities. Payment of dividends by State Street Bank is subject to provisions of the Massachusetts banking law which provides that dividends may be paid out of net profits provided (i) capital stock and surplus remain unimpaired, (ii) dividend and retirement fund requirements of any preferred stock have been met, (iii) surplus equals or exceeds capital stock, and (iv) there are deducted from net profits any losses and bad debts, as defined, in excess of reserves specifically established therefor. Under the Federal Reserve Act, the approval of the Board of Governors of the Federal Reserve System would be required if dividends declared by the Bank in any year would exceed the total of its net profits for that year combined with retained net profits for the preceding two years, less any required transfers to surplus. Under applicable federal and state law restrictions, at December 31, 1994 State Street Bank could have declared and paid dividends of $426,554,000 without regulatory approval. Future dividend payments of the Bank and non-bank subsidiaries cannot be determined at this time.\nECONOMIC CONDITIONS AND GOVERNMENT POLICIES Economic policies of the government and its agencies influence the operating environment of State Street. Monetary policy conducted by the Federal Reserve Board directly affects the level of interest rates and overall credit conditions of the economy. Policy instruments utilized by the Federal Reserve Board include open market operations in U.S. Government securities, changes in reserve requirements for depository institutions, and changes in the discount rate and availability of borrowing from the Federal Reserve.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nState Street's headquarters are located in the State Street Bank Building, a 34-story building at 225 Franklin Street, Boston, Massachusetts, which was completed in 1965. State Street leases approximately 451,000 square feet (or approximately 49% of the space in this building) for a 30-year initial term with two successive extension options of 20 years each at rentals to be negotiated. State Street exercised the first of the two (2) options which will be effective on January 1, 1996 for a term of 20 years.\nState Street owns five buildings located in Quincy, Massachusetts, a suburb of Boston. Four of the buildings, containing a total of approximately 1,365,000 square feet, function as State Street Bank's operations facilities. State Street Bank occupies approximately 1,320,000 square feet and subleases the remaining space. The fifth building, with 186,000 square feet, is leased to Boston Financial Data Services, Inc., a 50% owned affiliate. Additionally, State Street owns a 98,000 square foot building in Westborough, Massachusetts for use as a second data center.\nThe remaining offices and facilities of State Street and its subsidiaries are leased. As of December 31, 1994, the aggregate mortgage and lease payments, net of sublease revenue, payable within one year amounted to $29,066,000, plus assessments for real estate tax, cleaning and operating escalations.\nFor additional information relating to premises, see Note E to the Notes to Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nState Street is subject to pending and threatened legal actions that arise in the normal course of business. In the opinion of management, after discussion with counsel, these can be successfully defended or resolved without a material adverse effect on State Street'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.A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information with regard to each executive officer of State Street. As used herein, the term \"executive officer\" means an officer who performs policy-making functions for State Street.\nAll executive officers are elected by the Board of Directors. There are no family relationships among any of the directors and executive officers of State Street. With the exception of Messrs. Carter, Allinson, Logue and Petersen, all of the executive officers have been officers of State Street for five years or more. Mr. Carter became President of State Street in July, 1991, Chief Executive Officer in January, 1992 and Chairman in January, 1993. Prior to joining State Street, he was with Chase Manhattan Bank for 15 years, including the last three as head of global securities services. Mr. Allinson became an officer of State Street in March, 1990. Prior to joining State Street, he was President of Mitchell Hutchins Asset Management, a subsidiary of PaineWebber Incorporated, responsible for six financial service subsidiaries. Mr. Petersen became an officer of State Street in August, 1991. Prior to joining State Street, he was an Executive Vice President at First Empire State Corporation, a bank holding company, responsible for operations and systems. Mr. Logue became an officer of State Street in 1991. Prior to joining State Street, he was Executive Vice President at Bank of New England Corporation where he was head of processing services. Mr. Sloan retired effective December 31, 1994 and Mr. Fesus resigned effective February 16, 1995, at which time Mr. Spina became Chief Financial Officer and Treasurer.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation concerning the market prices of and dividends on State Street's common stock during the past two years appears on page 35 of State Street's 1994 Annual Report to Stockholders and is incorporated by reference. There were 6,028 stockholders of record at December 31, 1994. During 1994, State Street's common stock was traded on the NASDAQ National Market System, ticker symbol: STBK. In February 1995, State Street's common stock was listed for trading on the New York Stock Exchange, ticker symbol: STT.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information is set forth on page 21 of State Street's 1994 Annual Report to Stockholders and is incorporated by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nThe information required by this item appears in State Street's 1994 Annual Report to Stockholders on pages 3 and 4 and pages 22 through 37 and is incorporated by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL FINANCIAL DATA\nThe Consolidated Financial Statements, Report of Independent Auditors and Supplemental Financial Data appearing on pages 38 through 59 of State Street's 1994 Annual Report to Stockholders and are incorporated by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN OR 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 State Street's directors appears on pages 1 through 6 of State Street's Proxy Statement for the 1995 Annual Meeting of Stockholders under the caption \"Election of Directors\" which Statement is to be filed with the Securities and Exchange Commission. Such information is incorporated by reference.\nInformation concerning State Street's executive officers appears under the caption \"Executive Officers of the Registrant\" in Item 4.A. of this Report.\nInformation concerning compliance with Section 16(a) of the Securities Exchange Act appears on page 8 of State Street's Proxy Statement for the 1995 Annual Meeting of Stockholders under the caption \"Compliance with Section 16 (a) of the Securities Exchange Act.\" Such information is incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation concerning compensation of the executives of State Street appears on pages 9 through 16 in State Street's Proxy Statement for the 1995 Annual Meeting of Stockholders under the caption \"Executive Compensation\". Such information is incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation concerning security ownership of certain beneficial owners and management appears on pages 7 and 8 in State Street's Proxy Statement for the 1995 Annual Meeting of Stockholders under the caption \"Beneficial Ownership of Shares\". Such information is incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation concerning certain relationships and related transactions appears on page 8 in State Street's Proxy Statement for the 1995 Annual Meeting of Stockholders under the caption \"Certain Transactions\". Such information is 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 consolidated financial statements of State Street included in its Annual Report to Stockholders for the year ended December 31, 1994, are incorporated by reference in Item 8 hereof:\nConsolidated Statement of Income--Years ended December 31, 1994, 1993 and 1992 Consolidated Statement of Condition--December 31, 1994 and 1993 Consolidated Statement of Cash Flows--Years ended December 31, 1994, 1993 and 1992 Consolidated Statement of Changes in Stockholders' Equity--Years ended December 31, 1994, 1993 and 1992 Notes to Financial Statements Report of Independent Auditors\n(2) Financial Statement Schedules--Schedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions, are inapplicable, or the information is contained herein and therefore have been omitted.\n(3) Exhibits A list of the exhibits filed or incorporated by reference appears following page 17 of this Report, which information is incorporated by reference.\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 and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, on March 16, 1995, thereunto duly authorized.\nSTATE STREET BOSTON CORPORATION\nREX S. SCHUETTE By -------------------------------- REX S. SCHUETTE Senior Vice President and Comptroller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 16, 1995, by the following persons on behalf of the registrant and in the capacities indicated.\nOFFICERS:\nEXHIBIT INDEX EXHIBIT 2. PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR SUCCESSION\n2.1 Acquisition agreement dated September 27, 1994 among Registrant, Kemper Financial Services, Inc. and DST Systems, Inc. pertaining to the acquisition of IFTC Holdings, Inc. (filed with the Securities and Exchange Commission as Exhibit 2 to Registrant's Quarterly Report on Form 10Q for the quarter ended September 30, 1994 and incorporated by reference).\nEXHIBIT 3. ARTICLES OF INCORPORATION AND BY-LAWS\n3.1 Restated Articles of Organization as amended (filed with the Securities and Exchange Commission as Exhibit 3.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1988 and incorporated by reference)\n3.2 By-laws as amended (filed with the Securities and Exchange Commission as Exhibit 3.2 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference)\n3.3 Certificate of Designation, Preferences and Rights (filed with the Securities and Exchange Commission as Exhibit 3.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference)\nEXHIBIT 4. INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS\n4.1 The description of the Company's Common Stock included in the Company's effective registration statement report on Form 10, as filed with the Securities and Exchange Commission on September 3, 1970 and amended on May 12, 1971 and incorporated by reference.\n4.2 Rights Agreement dated as of September 15, 1988 between State Street Boston Corporation and The First National Bank of Boston, Rights Agent (filed with the Securities and Exchange Commission as Exhibit 4 to Registrant's Current Report on Form 8-K dated September 30, 1988 and incorporated by reference)\n4.3 Amendment to Rights Agreement dated as of September 20, 1990 between State Street Boston Corporation and The First National Bank of Boston, Rights Agent (filed with the Securities and Exchange Commission as Exhibit 4 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1990 and incorporated by reference)\n4.4 Indenture dated as of May 1, 1983 between State Street Boston Corporation and Morgan Guaranty Trust Company of New York, Trustee, relating to the Company's 7 3\/4% Convertible Subordinated Debentures due 2008 (filed with the Securities and Exchange Commission as Exhibit 4 to the Registrant's Registration Statement on Form S-3 filed on April 22, 1983, Commission File No. 2-83251 and incorporated by reference)\n4.5 Indenture dated as of August 2, 1994 between State Street Boston Corporation and The First National Bank of Boston, as trustee (filed with the Securities and Exchange Commission as Exhibit 4 to the Registrant's Current Report on Form 8-K dated October 8, 1994 and incorporated by reference)\nEXHIBIT 10. MATERIAL CONTRACTS\nExecutive Compensation Plans and Agreements:\n10.1 State Street Boston Corporation Long-Term Common Stock Incentive Program, as amended (filed with the Securities and Exchange Commission as Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1981 and incorporated by reference)\n10.2 State Street Boston Corporation 1981 Stock Option and Performance Share Plan, as amended (filed with the Securities and Exchange Commission as Exhibit 10.2 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1981 and incorporated by reference)\n10.3 State Street Boston Corporation 1984 Stock Option Plan (filed with the Securities and Exchange Commission as Exhibit 4(a) to Registrant's Registration Statement on Form S-8 (File No. 2-93157) and incorporated by reference)\n10.4 State Street Boston Corporation 1985 Stock Option and Performance Share Plan (filed with the Securities and Exchange Commission as Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1985 and incorporated by reference)\n10.5 Revised Forms of Termination Agreement with Executive Officers (filed with the Securities and Exchange Commission as Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated by reference)\n10.6 State Street Boston Corporation 1989 Stock Option Plan (filed with the Securities and Exchange Commission as Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated by reference)\n10.7 State Street Boston Corporation 1990 Stock Option and Performance Share Plan (filed with the Securities and Exchange Commission as Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 and incorporated by reference)\n10.8 State Street Boston Corporation Supplemental Executive Retirement Plan, together with individual benefit agreements (filed with the Securities and Exchange Commission as Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference)\n10.9 Individual Pension Agreement with Marshall N. Carter (filed with the Securities and Exchange Commission as Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference)\n10.10 Individual Pension Agreement with A. Edward Allinson (filed with the Securities and Exchange Commission as Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated by reference)\n10.11 Supplemental Retirement Agreement with Norton Q. Sloan (filed with the Securities and Exchange Commission as Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated by reference)\n10.12 Individual Pension Agreement with Albert E. Petersen (filed with the Securities and Exchange Commission as Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated by reference)\n10.13 Termination Benefits Arrangement with Marshall N. Carter (filed with the Securities and Exchange Commission as Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated by reference)\n10.14 State Street Global Advisors Incentive Plan for 1993 (filed with the Securities and Exchange Commission as Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated by reference)\n10.15 State Street Global Advisors Incentive Plan for 1994 (filed with the Securities and Exchange Commission as Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated by reference)\n10.16 Senior Executives Annual Incentive Plan (filed with the Securities and Exchange Commission as Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated by reference)\n10.17 1994 Stock Option and Performance Unit Plan (filed with the Securities and Exchange Commission as Exhibit 10.11 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated by reference)\n10.18 Compensation agreement with J.R. Towers dated September 30, 1994 (filed with the Securities and Exchange Commission as Exhibit 10 to Registrant's Annual Report on Form 10-Q for the year ended September 30, 1994 and incorporated by reference)\n10.19 1995 Annual Incentive Plan for Senior Executive Officers\n10.20 State Street Global Advisors Incentive Plan for 1995\n10.21 Supplemental Defined Benefit Pension Plan for Senior Executive Officers\n10.22 Nonemployee Director Retirement Plan\nEXHIBIT 11. STATEMENT RE COMPUTATION OF PER SHARE EARNINGS\n11.1 State Street Boston Corporation Computation of Earnings Per Share\nEXHIBIT 12. STATEMENT RE COMPUTATION OF RATIOS\n12.1 Statement of ratio of earnings to fixed charges.\nEXHIBIT 13. PORTIONS OF ANNUAL REPORT TO STOCKHOLDERS\n13.1 Five Year Selected Financial Data.\n13.2 Management's Discussion and Analysis of Financial Condition and Results of Operations for the Three Years Ended December 31, 1994 (not covered by the Report of Independent Public Accountants).\n13.3 Letter to Stockholders.\n13.4 State Street Boston Corporation Consolidated Financial Statements and Schedules.\nEXHIBIT 21. SUBSIDIARIES\n21.1 Subsidiaries of State Street Boston Corporation\nEXHIBIT 23. CONSENTS OF EXPERTS AND COUNSEL\n23.1 Consent of Independent Auditors","section_15":""}
{"filename":"27984_1994.txt","cik":"27984","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3\nLEGAL PROCEEDINGS\nIn the action styled GARCIA V. DELTONA ET, AL, Case No. 86-03542, filed in the Circuit Court for Dade County, Florida, on January 30, 1986, the plaintiff had sought to recover $2,000,000 allegedly paid to the Company on four installment land sales contracts, claiming fraud and misrepresentation on the part of one of the Company's independent sales representatives and other violations of law. The Company had cancelled the contracts in question according to their terms for default of the payment obligations by the purchaser. Although the Company negotiated a settlement of this action which provides for the Company to convey to the plaintiff property which has a value equivalent to the monies paid by the plaintiff to the Company under the cancelled contracts, the plaintiff has asserted that the Company has breached the settlement agreement by failing to convey sufficient property which meets the criteria of the settlement agreement. The Company is of the belief that the property conveyed complies with such criteria. The plaintiff could seek a judgment of $5,400,000, plus interest, less the value of the property transferred. The parties are currently attempting to resolve the dispute by reaching an agreement as to transferring alternative property that may be used for settlement purposes.\nThe Company was previously sued by its landlord for breach of lease in the action styled FIVE POINTS LIMITED V. THE DELTONA CORPORATION, Case No. 93-22877, filed in the Circuit Court for Dade County, Florida, which has been settled and a stipulation filed. Although the basic matter has been settled, continuing performance provisions of the settlement agreement are outstanding. The Company has entered into a short term lease agreement with the landlord and\/or its affiliate for a term of lease of one (1) year with a ninety (90) day cancellation provision. Certain payments have been paid to the landlord and a letter of credit in the amount of $500,000, drawable after August 31, 1995, was conveyed to the landlord. Funding of the settlement was obtained through a loan to the Company. The Court continues to retain jurisdiction to enforce the Writ of Possession for removal of the Company in the event the Company fails to vacate its premises after ninety (90) days notice is given in accordance with the short term lease agreement with the landlord.\nIn the action styled ESTATE OF BOBINGER ET AL. V. THE DELTONA CORPORATION, the plaintiff class sued the Company in the Circuit Court of Dade County Case No. 87-45051 for breach of contract and for recovery of monies paid on contracts for Marco property that will not be developed by the Company. The matter was settled pending performance of the settlement agreement. The court entered a final judgment approving the settlement and retained jurisdiction to enforce the settlement. The Company continues to have certain obligations to the class under the settlement. The Company advises that it is negotiating with the class concerning certain unpaid tax obligations and other matters. In the opinion of the Company, residual obligations of the Company that are due and payable in the future pursuant to the settlement may approximate up to $2,000,000. The Company has provided an allowance for Marco permit costs which encompass these obligations. See \"Management's Discussion and Analysis\" and Note 9 to the consolidated financial statements.\nIn the action styled BRUCE WEINER V. THE DELTONA CORPORATION ET AL., the plaintiff, Bruce Weiner, prior Executive Vice President of the Company, sued the Company on April 28, 1994 for alleged breach of employment contract seeking damages of approximately $750,000 and unspecified employee benefits. The proceeding is pending in the Circuit Court of Dade County, Florida, Case No. 94-7825-04. Plaintiff's Motion for Summary Judgment has been denied and a final hearing has been requested. The Company believes that it has defenses to the claim. In the event that the Company is not successful in its defenses or a settlement is not reached, a substantial judgment may be entered against the Company in favor of the plaintiff. The Company at the present time is unable to predict the ultimate outcome of the litigation. The Company intends to continue settlement discussions with plaintiff.\nIn the action styled JOSEPH MANCILLA, JR. V. THE DELTONA CORPORATION, the plaintiff, Joseph Mancilla, Jr., prior Senior Vice President of the Company, sued the Company on May 17, 1994 for alleged breach of employment contract seeking damages in excess of $391,000 plus an unspecified amount in employee benefits, costs and\nattorneys' fees. The proceeding is pending in the Circuit Court of Dade County, Florida, Case No. 94-09116. A final hearing has been set for the week of May 8, 1995. If a settlement is not reached and the Company is not successful in its defenses, a substantial judgment may be entered against the Company. The Company at the present time is unable to predict the ultimate outcome of the litigation. The Company intends to continue settlement discussions with plaintiff.\nIn the action styled MICHELLE GARBIS V. THE DELTONA CORPORATION, the plaintiff, Michelle Garbis, prior Senior Vice President and Corporate Secretary of the Company, sued the Company on August 18, 1994 for alleged breach of employment contract. The Company settled the matter and a general release is expected to be entered into.\nIn an action styled THEODORE MAUREAU V. THE DELTONA CORPORATION, the Company has been sued by a former Vice President and employee asserting breach of an oral contract and a claim based on fraud. The plaintiff asserts unspecified damages and punitive damages. A Motion to Dismiss is pending. The Company believes that the proceeding is without merit.\nThe Company is also a party to certain other legal and administrative proceedings arising in the ordinary course of business. The outcome will not, in the opinion of the Company, have a material adverse effect on the business or financial condition of the Company.\nITEM 5","section_4":"","section_5":"ITEM 5\nPRICE RANGE OF COMMON STOCK AND DIVIDENDS\nThe Company's Common Stock was traded on the New York and Pacific Stock Exchanges under the ticker symbol DLT until trading was suspended on April 6, 1994. The following table sets forth the reported high and low sales prices for the Company's Common Stock during the periods indicated as reported in the record of composite transactions for NYSE listed securities.\nOn April 6, 1994, both the New York and Pacific Stock Exchanges suspended the Company's Common Stock from trading and instituted procedures to delist the Company's Common Stock. On June 16, 1994, the Company's Common Stock was formally removed from listing and registration on the New York Stock Exchange. As of December 31, 1994, the Company's Common Stock was traded on a limited basis in the over-the-counter markets. The bid was 1\/8 and the ask was 3\/8 at the end of the second, third and fourth quarters of 1994.\nThe Company has never paid any cash dividends on its Common Stock. The Company's loan agreements contain certain restrictions which currently prohibit the Company from paying dividends on its Common Stock.\nITEM 6","section_6":"ITEM 6 SELECTED CONSOLIDATED FINANCIAL INFORMATION\nThe following table summarizes selected consolidated financial information and should be read in conjunction with the Consolidated Financial Statements. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nCONSOLIDATED INCOME STATEMENT DATA (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)\nCONSOLIDATED BALANCE SHEET DATA (IN THOUSANDS)\nITEM 7","section_7":"ITEM 7\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOn June 19, 1992, the Company completed a transaction with Selex, which resulted in a change in control of the Company. Under the transaction, Selex loaned the Company $3,000,000 collateralized by a first mortgage on certain of the Company's property in its St. Augustine Shores, Florida community (the \"First Selex Loan\"). The First Selex Loan initially bears interest at the rate of 10% per annum with a term of four years and payment of interest deferred for the first 18 months. Accrued interest due under the First Selex Loan in the amount of $673,800 was unpaid and in default as of December 31, 1994.\nIn conjunction with the First Selex Loan: (i) Empire sold Selex its 2,220,066 shares of the Company's Common Stock and assigned Selex its $1,000,000 Note from the Company, with $225,000 of interest accrued thereon; (ii) Maurice A. Halperin, Chairman of the Board of Empire and former Chairman of the Board of the Company, forgave payment of the $200,000 salary due him for the period of April, 1990 through April, 1991, which was in arrears; and (iii) certain changes occurred in the composition of the Company's Board of Directors. Namely, the six directors serving on the Company's Board who were previously designated by Empire resigned and four Selex designees (Messrs. Marcellus H.B. Muyres, Antony Gram, Cornelis van de Peppel and Cornelis L.J.J. Zwaans) were elected to serve as directors in their stead. Marcellus H.B. Muyres was appointed Chairman of the Board and Chief Executive Officer of the Company. These directors, as well as Leonardus G.M. Nipshagen, a Selex designee, were then elected as directors at the Company's 1992 Annual Meeting and re-elected at the Company's 1993 Annual Meeting.\nAs part of the Selex transaction, Selex was granted an option, approved by the holders of a majority of the outstanding shares of the Company's Common Stock at the Company's 1992 Annual Meeting, to convert the Selex Loan, or any portion thereof, into a maximum of 850,000 shares of the Company's Common Stock at a per share conversion price equal to the greater of (i) $1.25 or (ii) 95% of the market price of the Company's Common Stock at the time of conversion, but in no event greater than $4.50 per share (the \"Option\"). However, on September 14, 1992, Selex formally waived and relinquished its right to exercise the Option as to 250,000 shares of the Company's Common Stock to enable the Company to settle certain litigation involving the Company through the issuance of approximately 250,000 shares of the Company's Common Stock to the claimants, without jeopardizing the utilization of the Company's net operating loss carryforward. On February 17, 1994, Selex exercised the remaining full 600,000 share Option at a conversion price of $1.90 per share, such that $1,140,000 in principal was repaid under the First Selex Loan through such conversion. As a consequence of such conversion, Selex holds 2,820,066 shares of the Company's Common Stock (42.06% of the outstanding shares of Common Stock of the Company based upon the number of shares of the Company's Common Stock outstanding as of March 24, 1995).\nPursuant to the Selex transaction, $1,000,000 of the proceeds from the First Selex Loan was used by the Company to acquire certain commercial and multi-family properties at the Company's St. Augustine Shores community at their net appraised value, from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres. Namely, (i) $416,000 was used to acquire 48 undeveloped condominium units (twelve 4 unit building sites) and 4 completed (and rented) condominium units from Conquistador, in which Messrs. Zwaans and Muyres serve as directors, as well as President and Secretary\/Treasurer, respectively; (ii) $485,000 was used to acquire 4 commercial lots from Swan Development Corporation, in which Messrs. Zwaans and Muyres also serve as directors, as well as President and Secretary, respectively; and (iii) approximately $99,000 was used to reacquire, from Mr. Muyres, all of his rights, title and interest in that certain contract with the Company for the purchase of a commercial tract in St. Augustine Shores, Florida. None of the commercial land and multi-family property acquired by the Company from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres collateralizes the First Selex Loan. In March, 1994, Conquistador exercised its right to repurchase certain of the multi-family property from the Company (which right had been granted in connection with the June, 1992\ntransaction) at a price of $312,000, of which $260,000 was paid in cash to the Company and $52,000 was applied to reduce interest due to Selex under the Second Selex Loan (\"First Conquistador Acquisition\").\nIn December, 1992, Mr. Gram, a director of the Company and beneficial owner of the Common Stock of the Company held by Selex, acquired all of the Company's outstanding bank debt and then assigned same to Yasawa, of which Mr. Gram is also the beneficial owner. Yasawa simultaneously completed a series of transactions with the Company which involved the transfer of certain assets to Yasawa or its affiliated companies, the acquisition by Yasawa of 289,637 shares of the Company's Common Stock through the exercise of warrants previously held by the banks, the provision of a $1,500,000 line of credit to the Company and the restructuring of the remaining debt as a $5,106,000 Yasawa Loan. Principal repayments aggregating $341,000 were made in 1993 and 1994 to reduce the Yasawa Loan to $4,765,000 as of December 31, 1994. On April 30, 1993, Selex loaned the Company an additional amount of $1,000,000 pursuant to the Second Selex Loan and since July 1, 1993 made further loans to the Company aggregating $4,400,000 under the Third Selex Loan. Principal of $39,000 had been repaid under the Second Selex Loan through December 31, 1994. As of December 31, 1994, Yasawa has loaned the Company an additional sum of $2,122,000 pursuant to the Second Yasawa Loan. As a consequence of these transactions, the Company had loans outstanding from Selex, Yasawa and their affiliates on December 31, 1994 in the aggregate amount of approximately $19,470,000, including interest. The Company has approved a Purchase and Sale Agreement with Conquistador Development Corporation (\"Second Conquistador Acquisition\") for the sale of an administration building and multi-family site in the Company's St. Augustine Shores community as well as the remaining lot inventory in the Company's Feather Nest community at Marion Oaks in consideration for the satisfaction of $2,599,300 of principal and accrued interest on the Second and Third Selex Loans. The amount of debt reduction is equivalent to the amount of Mr. Marcel Muyres' participation in those loans as of January 31, 1995. In a separate transaction, Conquistador Development Corporation and the Company approved a Purchase and Sale Agreement (\"Third Conquistador Acquisition\") for the sale of four single family residential lots in the St. Augustine Shores community for $100,000 in cash. The Second and Third Conquistador Acquisitions are anticipated to close by April 30, 1995. The loans from Selex, Yasawa and their affiliates are secured by substantially all of the assets of the Company. See Note 5 to Consolidated Financial Statements.\nThe Company has stated in previous filings with the Commission that the obtainment of additional funds to implement its marketing program and achieve the objectives of its business plan is essential to enable the Company to maintain operations and continue as a going concern. Since December, 1992, the Company has been dependent on loans and advances from Selex, Yasawa and their affiliates in order to implement its marketing program and assist in meeting its working capital requirements. As stated above, during the last six months of 1993, Selex, Yasawa and their affiliates loaned the Company an aggregate of $4,400,000 pursuant to Third Selex Loan. Funds advanced under the Third Selex Loan enabled the Company to commence implementation of the majority of its marketing program in the third quarter of 1993. The full benefits were not realized in 1993 and the Company was unable to secure financing. As of December 31, 1994, Yasawa had advanced (\"Second Yasawa Loan\") a total of $2,122,000 to meet the Company's minimum working capital requirements, pay settlements of outstanding amounts due certain trade creditors reducing the Company's accounts payable by more than $1,000,000 and settle certain litigation reducing the Company's exposure in excess of $5,000,000.\nOn March 10, 1994, the Company was advised that Selex filed Amendment No. 2 dated February 17, 1994 to its Schedule 13D (the \"Amendment\") with the Commission. In the Amendment, Selex reported that it, together with Yasawa and their affiliates were uncertain as to whether they would provide any further funds to the Company. The Amendment further stated that Selex, Yasawa and their affiliates, were seeking third parties to provide financing for the Company and that as part of any such transaction, they would be willing to sell or restructure all or a portion of their loans and Common Stock in the Company.\nInasmuch as funding is not presently available to the Company from external sources and, as stated in their Amendment, Selex, Yasawa and their affiliates have not determined whether they will provide any further funds to the Company, the Company is facing a severe cash shortfall. As a consequence of its liquidity position, the\nCompany has defaulted on certain obligations, including its escrow obligations to the Division pursuant to the Company's 1992 Consent Order and its obligation to make required interest payments under loans from Selex, Yasawa and their affiliates. Furthermore, the Company has not paid delinquent real estate taxes aggregating approximately $2,676,000 at December 31, 1994 and is also subject to certain pending litigation by former employees, which may adversely affect the financial condition of the Company. See \"Legal Proceedings.\"\nThe Company is continuing to seek third parties to provide financing. As part of any such transaction, Selex, Yasawa and their affiliates have indicated that they are willing to sell or restructure all or a portion of their loans and Common Stock in the Company. They have also indicated that they are willing to sell their interests in the Company at a significant discount. Consummation of any such transaction may result in a change in control of the Company. There can be no assurance, however, that any such transaction will result or that any financing will be obtained. Accordingly, the Company's Board of Directors is also considering other appropriate action given the severity of the Company's liquidity position including but not limited to filing for protection under the federal bankruptcy laws. See \"Business: Recent Developments\", \"Legal Proceedings\" and Notes 1, 5 and 8 to Consolidated Financial Statements.\nRESULTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1993\nREVENUES\nTotal revenues were $8,541,000 for 1994 compared to $12,099,000 for 1993.\nGross land sales were $2,994,000 for 1994 versus $3,170,000 for 1993. Net land sales (gross land sales less estimated uncollectible installment sales and contract valuation discount) decreased to $2,058,000 for 1994 from $2,432,000 for 1993. The decrease in sales reflects the curtailment of the Company's marketing program in 1994.\nBulk land sales were $315,000 in 1994 as compared to bulk land sales of $113,000 in 1993. In light of the Company's diminished bulk land sales inventory it is anticipated that in the future, the Company will produce a negligible volume of bulk land sales. See \"Liquidity and Capital Resources: Mortgages and Similar Debt\".\nThe Company re-entered the single-family housing business in December, 1992. Revenues are not recognized from housing sales until the completion of construction and passage of title. Housing revenues were $2,543,000 for 1994 compared to $344,000 in 1993.\nThe following table reflects the Company's real estate product mix for 1994 and 1993 (in thousands):\nImprovement revenues result from recognition of revenues deferred from prior period sales. Recognition occurs as development work proceeds on the previously sold property or customers are exchanged to a developed lot. Improvement revenues totalled $1,214,000 in 1994 as compared to $4,725,000 for 1993. The decrease was due to the Company's financial condition which caused the Company to stop development in the first quarter of 1994.\nInterest income was $1,046,000 for 1994 compared to $1,197,000 for 1993. This decrease is the result of lower contracts receivable balances.\nOther revenues were $629,000 for 1994 compared to $3,401,000 in 1993. This decrease was the result of the termination of its lease on the Marco Shores Country Club on December 31, 1993 and the sale of the Marco Island Realty in November, 1993.\nIncluded in 1994 results is a gain of $1,051,000 from the termination of the lease on the Company's corporate headquarters in Miami.\nCOSTS AND EXPENSES\nCosts and expenses were $12,447,000 for 1994 compared to $20,871,000 in 1993. Cost of sales totalled $3,845,000 for 1994 versus $6,441,000 for 1993. These decreases are primarily due to the termination of development work in the first quarter of 1994 and the sale of the Marco Island Realty and the termination of the lease of the Marco Shores Country Club in 1993. Additionally, the Company completed the first phase of its Compromise and Settlement Agreement program with its trade creditors during the third quarter of 1994. Costs and expenses were reduced by approximately $430,000 as a result of these settlements. Gross profit margins increased to 55.0% from 46.7%. Profit margins are increasing primarily due to increased margins on improvement revenues resulting from favorable cost variances.\nCommissions, advertising and other selling expenses totalled $2,608,000 for 1994 versus $6,008,000 for 1993. Advertising and promotional expenditures decreased to $275,000 in 1994 from $1,521,000 in 1993 as a result of the reduction in the Company's marketing programs.\nGeneral and administrative expenses were $2,984,000 in 1994 versus $3,790,000 for 1993. General and administrative expenses have decreased primarily due to overhead reductions implemented in the first quarter of 1994 and settlement of the Company's lease obligation on its corporate headquarters in October 1994.\nReal estate tax expense was $1,163,000 in 1994 compared to $975,000 in 1993. Included in real estate tax expense is delinquent interest and administrative fees on 1992 and 1993 delinquent taxes, which accrue interest at 18% per annum.\nInterest expense was $1,847,000 for 1994, as compared to $1,257,000 for 1993, or a 47% increase. Total interest costs (including capitalized interest) were $1,847,000 and $1,421,000 for 1994 and 1993, respectively. The increase in interest expense is primarily the result of the increase in debt. No interest was capitalized in 1994 since the Company had stopped land development work at its communities.\nNET INCOME\nThe Company reported a net loss of $3,906,000 for 1994, compared to a net loss of $8,772,000 for 1993. The 1993 results include a provision for contract cancellations of $2,400,000. Included in 1994 results is a gain of $1,051,000 from the termination of the lease on the Company's corporate headquarters in Miami.\nRESULTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, 1993 AND DECEMBER 25, 1992\nREVENUES\nTotal revenues were $12,099,000 for 1993 compared to $12,217,000 for 1992. Included in 1992 revenues is a third quarter gain of $448,000 from the sale of the administration building at the Company's Citrus Springs community.\nGross land sales were $3,170,000 for 1993 versus $2,515,000 for 1992. Net land sales (gross land sales less estimated uncollectible installment sales and contract valuation discount) increased to $2,432,000 for 1993 from $2,092,000 for 1992. The modest increase in sales reflects the introduction of the Company's marketing program which was delayed until the third quarter of the year.\nRetail land sales increased to $3,057,000 from $2,289,000, a 33.5% increase. This increase was due to the third quarter introduction of the Company's marketing program and reflects increased spending in 1993 on advertising and promotional programs to strengthen the Company's marketing organization, rebuild its retail land sales business and re-enter the single-family home business.\nThe Company re-entered the single-family housing business in December, 1992. The Company recognized revenues from housing sales of $344,000 for 1993, primarily during the fourth quarter of the year, and had a backlog of housing sales of $899,000 as of December 31, 1993.\nThe following table reflects the Company's real estate product mix for 1993 and 1992 (in thousands):\nImprovement revenues resulted from the recognition of revenue deferred from prior period sales. Recognition occurs as development work proceeds on previously sold property. Improvement revenues totalled $4,725,000 in 1993 as compared to $2,404,000 for 1992. The increase was due to the Company's resumption of development work in the third quarter of 1992.\nInterest income was $1,197,000 for 1993 compared to $3,584,000 for 1992. This decrease is the result of lower contracts receivable balances.\nOther revenues were $3,401,000 for 1993 compared to $4,137,000 in 1992. Included in other revenues for 1992 is the previously mentioned gain of $448,000 on the sale of the administration building at the Company's Citrus Springs community, as well as revenues from the Company's Sunny Hills golf and country club which was sold in the first quarter of 1993.\nCOSTS AND EXPENSES\nCosts and expenses were $20,871,000 for 1993 compared to $18,935,000 in 1992. Cost of sales totalled $6,441,000 for 1993 versus $4,605,000 for 1992, primarily due to the resumption of development work in the third quarter of 1992. Gross profit margins decreased from 46.7% to 40.9%.\nThe 1993 results include a provision for contract cancellations of $2,400,000. Included in the provision is $1,400,000 for contracts sold in prior years to third parties which the Company is obligated to repurchase. See Note 2 to Consolidated Financial Statements.\nCommissions, advertising and other selling expenses totalled $6,008,000 for 1993 versus $3,917,000 for 1992. Advertising and promotional expenditures increased from $580,000 in 1992 to $1,521,000 in 1993, reflecting the Company's implementation of its marketing program.\nGeneral and administrative expenses were $3,790,000 in 1993 versus $5,844,000 for 1992. General and administrative expenses have decreased primarily due to overhead reductions, as part of the Company's efforts to stabilize its liquidity situation.\nInterest expense was $1,257,000 for 1993, as compared to $3,356,000 for 1992, or a 62.5% decrease. Total interest costs (including capitalized interest) were $1,421,000 and $3,456,000 for 1993 and 1992, respectively. The decrease in interest cost is due to lower debt balances.\nNET INCOME\nThe Company reported a net loss of $8,772,000 for 1993, compared to a net income of $7,336,000 for 1992. The 1993 results include a provision for contract cancellations of $2,400,000. The 1992 results include a gain of $448,000 on the sale of the administration building at the Company's Citrus Springs community, as well as a $10,161,000 extraordinary gain from debt restructuring and a $3,983,000 extraordinary gain from the settlement related to the Company's Marco refund obligation.\nREGULATORY DEVELOPMENTS WHICH MAY AFFECT FUTURE OPERATIONS\nIn Florida, as in many growth areas, local governments have sought to limit or control population growth in their communities through restrictive zoning, density reduction, the imposition of impact fees and more stringent development requirements. Although the Company has taken such factors into consideration in its master plans, the increased regulation has lengthened the development process and added to development costs.\nOn a statewide level, the Florida Legislature adopted and implemented the Florida Growth Management Act of 1985 (the \"Act\") to aid local governments efforts to discourage uncontrolled growth in Florida. The Act precludes the issuance of development orders or permits if public facilities such as transportation, water and sewer services will not be available concurrent with development. Development orders have been issued for, and development has commenced in, the Company's existing communities (with development being virtually completed in certain of these communities). Thus, such communities are less likely to be affected by the new growth management policies than future communities. Any future communities developed by the Company will be strongly impacted by new growth management policies. Since the Act and its implications are consistently being re-examined by the State, together with local governments and various state and local governmental agencies, the Company\ncannot further predict the timing or the effect of new growth management policies, but anticipates that such policies may increase the Company's permitting and development costs.\nIn addition to Florida, other jurisdictions in which the Company's properties are offered for sale have recently strengthened, or are considering strengthening, their regulation of subdividers and subdivided lands in order to provide further assurances to the public, particularly given the adverse publicity surrounding the industry which existed in 1990. The Company has attempted to take appropriate steps to modify its marketing programs and registration applications in the face of such increased regulation, but has incurred additional costs and delays in the marketing of certain of its properties in certain states and countries. For example, the Company has complied with regulations of certain states which require that the Company sell its properties to residents of those states pursuant to a deed and mortgage transaction, regardless of the amount of the down payment. The Company intends to continue to monitor any changes in statutes or regulations affecting, or anticipated to affect, the sale of its properties and intends to take all necessary and reasonable action to assure that its properties and its proposed marketing programs are in compliance with such regulations, but there can be no assurance that the Company will be able to timely comply with all regulatory changes in all jurisdictions in which the Company's properties are presently offered for sale to the public.\nLIQUIDITY AND CAPITAL RESOURCES\nMORTGAGES AND SIMILAR DEBT\nIndebtedness under various purchase money mortgages and loan agreements is collateralized by substantially all of the Company's assets, including stock of certain wholly-owned subsidiaries.\nThe following table presents information with respect to mortgages and similar debt (in thousands):\nIncluded in Mortgage Notes Payable is the $3,000,000 First Selex Loan ($1,860,000 as of December 31, 1994), the $1,000,000 Second Selex Loan ($961,000 as of December 31, 1994) the $4,400,000 Third Selex Loan ($4,362,400 as of December 31, 1994), and the $4,900,000 Yasawa Loan ($4,764,600 as of December 31, 1994) and the Second Yasawa Loan ($2,122,000 as of December 31, 1994). Other loans include the $1,000,000 Empire note and the $1,500,000 Scafholding Loan.\nThese mortgage notes payable and other loans are in default as of December 31, 1994 due to the non-payment of interest and principal. The lenders have not taken any action as a result of these defaults.\nOn June 19, 1992, Selex loaned the Company the sum of $3,000,000 pursuant to the First Selex Loan. The First Selex Loan is collateralized by a first mortgage on certain of the Company's unsold, undeveloped property in its St. Augustine Shores, Florida community. The Loan matures on June 15, 1996 and provides for principal to be repaid at 50% of the net proceeds per lot for lots requiring release from the mortgage, with the entire unpaid balance becoming due and payable at the end of the four year term. It initially bears interest at the rate of 10% per annum, with payment of interest deferred for the initial 18 months of the Loan and interest payments due quarterly thereafter. As part of the Selex transaction, Selex was granted an option, approved by the holders of a majority of the outstanding shares of the Company's Common Stock at the Company's 1992 Annual Meeting,\nwhich, as modified, enabled Selex to convert the First Selex Loan, or any portion thereof, into a maximum of 600,000 shares of the Company's Common Stock at a per share conversion price equal to the greater of (i) $1.25 or (ii) 95% of the market price of the Company's Common Stock at the time of conversion, but in no event greater than $4.50 per share (the \"Option\"). On February 17, 1994, Selex exercised the Option, in full, at a conversion price of $1.90 per share, such that $1,140,000 in principal was repaid under the First Selex Loan through such conversion. As of March 24, 1995, the Company was in default of the First Selex Loan inasmuch as accrued interest in the amount of $716,700 (including $673,800 due December 31, 1994) remained unpaid.\nOne million dollars of the proceeds from the First Selex Loan was used by the Company to acquire certain commercial and multi-family properties at the Company's St. Augustine Shores community at their net appraised value, from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres. Namely, (i) $416,000 was used to acquire 48 undeveloped condominium units (twelve 4 unit building sites) and 4 completed (and rented) condominium units from Conquistador, in which Messrs. Zwaans and Muyres serve as directors, as well as President and Secretary\/Treasurer, respectively; (ii) $485,000 was used to acquire 4 commercial lots from Swan, in which Messrs. Zwaans and Muyres also serve as directors, as well as President and Secretary, respectively; and (iii) approximately $99,000 was used to reacquire, from Mr. Muyres, all of his rights, title and interest in that certain contracts with the Company for the purchase of a commercial tract in St. Augustine Shores, Florida. None of the commercial and multi-family property acquired by the Company from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres collateralizes the First Selex Loan. In March, 1994, Conquistador exercised its right to repurchase certain multi-family property from the Company (which right had been granted in connection with the June, 1992 Selex transaction) at a price of $312,000, of which $260,000 was paid in cash to the Company and $52,000 was applied to reduce interest due to Selex under the Second Selex Loan (\"First Conquistador Acquisition\").\nOn December 2, 1992, the Company entered into various agreements relating to certain of its assets and the restructuring of its debt with Yasawa, which is beneficially owned by Mr. Gram. The consummation of these agreements, which are further described below, was conditioned upon the acquisition by Gram of the Company's outstanding bank loan.\nOn December 4, 1992, Gram entered into an agreement with the lenders, pursuant to which he acquired the bank loan of approximately $25,150,000 (including interest and fees) for a price of $10,750,000. In conjunction with such transaction, the lenders transferred to Gram the warrants which they held that entitled the holder to purchase an aggregate of 277,387 shares of the Company's Common Stock at an exercise price of $1.00 per share. Immediately after the acquisition of the bank loan, Gram transferred all of his interest in the bank loan, including the warrants, to Yasawa.\nOn December 11, 1992, the Company consummated the December 2, 1992 agreements with Yasawa. Under these agreements, Yasawa, its affiliates and the Company agreed as follows: (i) the Company sold certain property at its Citrus Springs community to an affiliate of Yasawa in exchange for approximately $6,500,000 of debt reduction credit; (ii) an affiliate of Yasawa and the Company entered into a joint venture agreement with respect to the Citrus Springs property, providing for the Company to market such property and receive an administration fee from the venture (in March, 1994, the Company and the affiliate agreed to terminate the venture); (iii) the Company sold certain contracts receivable at face value to an affiliate of Yasawa for debt reduction credit of approximately $10,800,000; (iv) the Company sold the Marco Shores Country Club and Golf Course to an affiliate of Yasawa for an aggregate sales price of $5,500,000, with the affiliate assuming an existing first mortgage of approximately $1,100,000 and the Company receiving debt reduction credit of $2,400,000, such that the Company obtained cash proceeds from this transaction of $2,000,000, which amount was used for working capital; (v) an affiliate of Yasawa agreed to lease the Marco Shores Country Club and Golf Course to the Company for a period of approximately one year; (vi) an affiliate of Yasawa and the Company agreed to amend the terms of the warrants to increase the number of shares issuable upon their exercise from 277,387 shares to 289,637 shares and to adjust the exercise price to an aggregate of approximately $314,000; (vii) Yasawa exercised the warrants in exchange for\ndebt reduction credit of approximately $314,000; (viii) Yasawa released certain collateral held for the bank loan; (ix) an affiliate of Yasawa agreed to make an additional loan of up to $1,500,000 to the Company, thus providing the Company with a future line of credit (all of which was drawn and outstanding as of March 24, 1995); and (x) Yasawa agreed to restructure the payment terms of the remaining $5,106,000 of the bank loan as a loan from Yasawa (the \"Yasawa Loan\").\nThe Yasawa Loan bears interest at the rate of 11% per annum, with payment of interest deferred until December 31, 1993, at which time only accrued interest became payable. Commencing January 31, 1994, principal and interest became payable monthly, with all unpaid principal and accrued interest being due and payable on December 31, 1997. During 1994, an assignment of a mortgage receivable and miscellaneous sales of collateral reduced the Yasawa Loan to $4,764,600 as of December 31, 1994. As of March 24, 1995, $5,418,300 in principal and accrued interest was in default under the Yasawa Loan.\nOn April 30, 1993 Selex loaned the Company an additional $1,000,000 collateralized by a first mortgage on certain of the Company's property in its Marion Oaks, Florida community (the \"Second Selex Loan\"). The Second Selex Loan bears interest at 11% per annum, with interest deferred until December 31, 1993. The Second Selex Loan provides for principal to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994 due and payable on April 30, 1994. Although Selex had certain conversion rights under the Second Selex Loan in the event the Company sold any Common Stock or Preferred Stock prior to payment in full of all amounts due to Selex under the Second Selex Loan, such rights were voided as of December 31, 1993. As of March 24, 1995, $39,000 in principal and $52,000 in accrued interest had been repaid under the Second Selex Loan, but accrued interest of $154,600 due under the Loan as of March 24, 1995, as well as the principal balance of $961,000, remained unpaid and in default. The Second Conquistador Acquisition, discussed below, will, when closed, satisfy the debt due and payable under the Second Selex Loan.\nFrom July 9, 1993 through December 31, 1993, Selex loaned the Company an additional $4,400,000 collateralized by a second mortgage on certain of the Company's property on which Selex and\/or Yasawa hold a first mortgage pursuant to a Loan Agreement dated July 14, 1993 and amendments thereto (the \"Third Selex Loan\"). The Third Selex Loan bears interest at 11% per annum, with interest deferred until December 31, 1993. Principal is to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994 due and payable on April 30, 1994. As of March 24, 1995, $37,600 in principal had been repaid under the Third Selex Loan, but accrued interest of $742,600 due under the Loan as of March 24, 1995, as well as the principal balance of $4,362,400, remained unpaid and in default. The Second Conquistador Acquisition, discussed below, will, when closed, provide a reduction of the debt due and payable under the Third Selex Loan.\nIn February, 1994, Yasawa loaned the Company an additional amount of approximately $514,900 at an interest rate of 8% per annum (the \"Second Yasawa Loan\"). Since May, 1994, additional amounts were advanced to the Company under the Second Yasawa Loan to enable the Company to pay certain essential expenses and effectuate settlements with the Company's principal creditors. As of March 24, 1995, an aggregate amount of $2,242,000 had been advanced to the Company under the Second Yasawa Loan and accrued interest of $115,600 remains unpaid.\nThe Company has approved a Purchase and Sale Agreement with Conquistador Development Corporation (\"Second Conquistador Acquisition\") for the sale of an administration building and multi-family site in the Company's St. Augustine Shores community as well as the remaining lot inventory in the Company's Feather Nest community at Marion Oaks in consideration for the satisfaction of $2,599,300 of principal and accrued interest on the Second and Third Selex Loans. The amount of debt reduction is equivalent to the amount of Mr. Marcel Muyres' participation in those loans as of January 31, 1995. In a separate transaction, Conquistador Development Corporation and the Company approved a Purchase and Sale Agreement (\"Third Conquistador Acquisition\") for\nthe sale of four single family residential lots in the St. Augustine Shores community for $100,000 in cash. The Second and Third Conquistador Acquisitions are anticipated to close by April 30, 1995.\nAs previously stated, Messrs. Muyres and Zwaans also serve as directors and executive officers of M&M. The Company has leased certain office space to M&M at its St. Augustine Shores community pursuant to a Lease Agreement dated August 10, 1990. Although the aggregate annual rental payments under such Lease are less than $60,000, as of March 24, 1995, M&M was in default of its obligations under the Lease inasmuch as delinquent rental payments (including reimbursement for real estate taxes) of approximately $21,300 remain unpaid. Payment of delinquent rental payments will be made upon closing of the Second Conquistador Acquisition.\nInterest due to Selex, Yasawa and their affiliates as of December 31, 1994 in the aggregate amount of $2,899,500 remained unpaid and in default as of March 24, 1995. Through March 24, 1995, $1,140,000 in principal was repaid under the First Selex Loan through the exercise of the above described Option, $39,000 in principal and $52,000 in accrued interest was repaid under the Second Selex Loan, $37,600 in principal was repaid under the Third Selex Loan, and $133,900 in principal and $346,000 in accrued interest was repaid under the Yasawa loan. As of March 24, 1995, the Company had loans outstanding from Selex, Yasawa and their affiliates in the aggregate amount of approximately $19,999,400, including interest, all of which are in default, including approximately $10,359,600, which is owed to Selex, including accrued and unpaid interest of approximately $2,176,200 (10% per annum on the First Selex Loan, 11% per annum on the Second and Third Selex Loans and 12% per annum on the $1,000,000 Empire Note assigned to Selex); approximately $7,772,000, which owed to Yasawa, including accrued and unpaid interest of approximately $765,400 (11% per annum on the Yasawa Loan and 8% per annum on the Second Yasawa Loan); and approximately $1,864,000, which is owed to an affiliate of Yasawa, including accrued and unpaid interest of approximately $364,000 (12% per annum). The loans from Selex, Yasawa and their affiliates are secured by substantially all of the assets of the Company.\nOn March 10, 1994, the Company was advised that Selex filed an Amendment to its Schedule 13D filed with the Commission. In the Amendment, Selex reported that it, together with Yasawa and their affiliates, were uncertain as to whether they would provide any further funds to the Company. The Amendment further stated that Selex, Yasawa and their affiliates were seeking third parties to provide financing for the Company and that as part of any such transaction, they would be willing to sell or restructure all or a portion of their loans and Common Stock in the Company.\nThe Company has stated in previous filings with the Commission that the obtainment of additional funds to implement its marketing program and achieve the objectives of its business plan is essential to enable the Company to maintain operations and continue as a going concern. Since December, 1992, the Company has been dependent on loans and advances from Selex, Yasawa and their affiliates in order to implement its marketing program and assist in meeting its working capital requirements. As stated above, during the last six months of 1993, Selex, Yasawa and their affiliates loaned the Company an aggregate of $4,400,000 pursuant to Third Selex Loan. Funds advanced under the Third Selex Loan enabled the Company to commence implementation of the majority of its marketing program in the third quarter of 1993. The full benefits of the program could not be realized in 1993 and the Company was unable to secure financing in 1994 to meet its ongoing working capital requirements and continue its marketing program. However in 1994, Yasawa advanced (\"Second Yasawa Loan\") a total of $2,122,000 as of December 31, 1994 to meet the Company's minimum working capital requirements, to pay settlements with certain trade creditors and to settle certain litigation.\nInasmuch as funding is not presently available to the Company from external sources and, as stated in their Amendment, Selex, Yasawa and their affiliates have not determined whether they will provide any further funds to the Company, the Company is facing a severe cash shortfall. As a consequence of its liquidity position, the Company has defaulted on certain obligations, including its escrow obligations to the Division pursuant to the Company's 1992 Consent Order and its obligation to make required interest payments under loans from Selex, Yasawa and their affiliates. Furthermore, the Company has not paid delinquent real estate taxes which aggregate\napproximately $2,676,000 as of December 31, 1994 and is also subject to certain pending litigation from former employees, which may adversely affect the financial condition of the Company. See \"Legal Proceedings.\"\nThe Company is continuing to seek third parties to provide financing. As part of any such transaction, Selex, Yasawa and their affiliates have indicated that they are willing to sell or restructure all or a portion of their loans and Common Stock in the Company. They have also indicated that they are willing to sell their interests in the Company at a significant discount. Consummation of any such transaction may result in a change in control of the Company. There can be no assurance, however, that any such transaction will result or that any financing will be obtained. Accordingly, the Company's Board of Directors is also considering other appropriate action given the severity of the Company's liquidity position including, but not limited, to protection under federal bankruptcy laws. See \"Business: Recent Developments\", \"Legal Proceedings\" and Notes 1, 5 and 8 to Consolidated Financial Statements.\nCONTRACTS AND MORTGAGES RECEIVABLE SALES\nIn December, 1992, as described above, the Company sold $10,800,000 of contracts and mortgages receivable to an affiliate of Yasawa at face value, applying the proceeds therefrom to reduce the Bank Loan acquired by Yasawa.\nIn March, 1993 the Company transferred $1,600,000 in contracts and mortgages receivable generating approximately $1,059,000 in proceeds to the Company, which was used for working capital and the creation of a holdback account in the amount $150,000. As of December 31, 1994, the balance of the holdback account was $107,000.\nIn June, 1992 and February, 1990, the Company completed sales of contracts and mortgages receivable totalling $13,500,000 and $17,000,000, respectively, which generated approximately $8,000,000 and $13,900,000, respectively, in net proceeds to the Company. The anticipated costs of the June, 1992 transaction were included in the extraordinary loss from debt restructuring for 1991 since the restructuring was dependent on the sale. The Company recorded a loss of $600,000 on the February, 1990 sale. In conjunction with these sales the Company granted the purchaser a security interest in certain additional contracts receivable of approximately $2,700,000 and conveyed all of its rights, title and interest in the property underlying such contracts to a collateral trustee. In addition, these transactions, among other things require that the Company replace or repurchase any receivable that becomes 90 days delinquent upon the request of the purchaser. Such requirement can be satisfied from contracts in which the purchaser holds a security interest (approximately $1,297,000 as of December 31, 1994). The purchaser of these receivables has experienced financial difficulty and filed in 1994 for protection under Chapter 11 of the Federal Bankruptcy Code. The Company is unable to determine what effect this will have, if any, on future cancellations, since it is unable to determine how the bankruptcy will impact servicing and collection procedures and the customers' determination to continue to pay under those contracts. The Company has fully reserved for the amount of the holdback account and the estimated future cancellations based on the Company's historical experience for receivables the Company services. However, due to the uncertainty noted above, the Company does not feel there is sufficient information to estimate future cancellations and is unable to determine the adequacy of its reserves to replace or repurchase receivables that become delinquent. The Company was unable to replace or repurchase $1,148,000 in delinquent contracts in 1994, which amount was deducted from the deposit held by the purchaser of the receivables as security.\nThe Company was the guarantor of approximately $25,608,000 of contracts receivable sold or transferred as of December 31, 1994, for the transactions described above, had $775,000 on deposit with purchasers of the receivables as security to assure collectibility as of such date and had established $775,000 as a liability for the Company's obligation under the recourse provisions. The Company has been in compliance with all receivable transactions since the consummation of sales.\nThe Company anticipates that it will be necessary to complete additional sales and financings of a portion of its receivables in 1995. There can be no assurance, however, that such sales and\/or financings can be accomplished.\nOTHER OBLIGATIONS\nAs a result of the delays in completing the land improvements to certain property sold in certain of its Central and North Florida communities, the Company fell behind in meeting its contractual obligations to its customers. In connection with these delays, the Company, in February, 1980, entered into a Consent Order with the Division which provided a program for notifying affected customers. The Consent Order, which was restated and amended, provided a program for notifying affected customers of the anticipated delays in the completion of improvements (or, in the case of purchasers of unbuildable lots in certain areas of the Company's Sunny Hills community, the transfer of development obligations to core growth areas of the community); various options which may be selected by affected purchasers; a schedule for completing certain improvements; and a deferral of the obligation to install water mains until requested by the purchaser. Under an agreement with Topeka, Topeka's utility companies have agreed to furnish utility service to the future residents of the Company's communities on substantially the same basis as such services were provided by the Company. The Consent Order also required the establishment of an improvement escrow account as assurance for completing such improvement obligations. In June, 1992, the Company entered into the 1992 Consent Order with the Division, which replaced and superseded the original Consent Order, as amended and restated. Among other things, the 1992 Consent Order consolidated the Company's development obligations and provided for a reduction in its required monthly escrow obligation to $175,000 from September, 1992 through December, 1993. Beginning January, 1994 and until development is completed or the 1992 Consent Order is amended, the Company is required to deposit $430,000 per month into the escrow account. To meet its current escrow and development obligations under the 1992 Consent Order, the Company is required to deposit into escrow $5,160,000 in 1994 and $3,519,000 in 1995. As part of the assurance program under the 1992 Consent Order, the Company and its lenders granted the Division a lien on certain contracts receivable (approximately $7,528,000 as of December 31, 1994) and future receivables. The Company defaulted on its obligation to escrow $430,000 per month for the period of January, 1994 through the present and, in accordance with the 1992 Consent Order, collections on Division receivables were escrowed for the benefit of purchasers from March 1, 1994 through April 30, 1994. In May, 1994 the Company implemented a program to exchange purchasers who contracted to purchase property which is undeveloped to property which is developed. As of March 24, 1995, approximately 75% of the customers whose lots are currently undeveloped have opted to exchange. The Company's goal is to eliminate its development obligation (with the exception of its maintenance obligation in Marion Oaks) under the 1992 Consent Order through this exchange program, completion of two commercial areas in Marion Oaks, sale of its second Citrus Springs Golf Course (with the buyer assuming the development obligation) and settlement of all remaining maintenance and improvements obligations in Citrus Springs through a final agreement with Citrus County (scheduled for approval in April 1995). Consequently, the Division has allowed the Company to utilize collections on receivables since May 1, 1994. Pursuant to the 1992 Consent Order, the Company has limited the sale of single-family lots to lots which front on a paved street and are ready for immediate building. Because of the Company's default, the Division could also exercise other available remedies under the 1992 Consent Order, which remedies entitle the Division, among other things, to halt all sales of registered property. As of December 31, 1994, the Company had estimated development obligations of approximately $2,412,000 on sold property, an estimated liability to provide title insurance and deeding costing $1,300,000 and an estimated cost of street maintenance, prior to assumption of such obligations by local governments, of $2,948,000, all of which are included in deferred revenue. The total cost, including the previously mentioned obligations, to complete improvements at December 31, 1994 to lots subject to the 1992 Consent Order and to lots in the St. Augustine Shores community was estimated to be approximately $17,600,000. As of December 31, 1994 and December 31, 1993 the Company had in escrow approximately $911,000 and $1,664,000, respectively, specifically for land improvements at certain of its Central and North Florida communities.\nThe Company's continuing liquidity problems have precluded the timely payment of the full amount of its 1992 and 1993 real estate taxes, in addition to its 1994 real estate taxes, which are currently due. On properties where customers have contractually assumed the obligation to pay into a tax escrow maintained by the Company, the Company has and will continue to pay real estate taxes as monies are collected from customers. Delinquent real estate taxes aggregated approximately $2,676,000 as of December 31, 1994.\nThe Company's corporate performance bonds to assure the completion of development at its St. Augustine Shores community expired in March and June, 1993. Such bonds cannot be renewed due to a change in the policy of the Board of County Commissioners of St. Johns County which precludes allowing any developer to secure the performance of development obligations by the issuance of corporate bonds. In the event that St. Johns County elects to undertake and complete such development work, the Company would be obligated with respect to 1,000 improved lots at St. Augustine Shores in the amount of approximately $6,200,000. The Company intends to submit an alternative assurance program for the completion of such development and improvements to the County for its approval.\nOn September 30, 1988, the Company entered into an agreement with Citrus County, Florida to establish the procedure for transferring final maintenance responsibilities for roads in the Company's Citrus Springs subdivision to Citrus County. The agreement obligated the Company to complete certain remedial work on previously completed improvements within the Citrus Springs subdivision by June 1, 1991. The Company was unable to complete this work by the specified date and negotiated with Citrus County for the transfer of final maintenance responsibility for the roads to the County. It is anticipated that the final agreement will be accepted by Citrus County in April 1995.\nFollowing the consummation of the Sixth Restatement, the Company conveyed certain properties to the landlord in satisfaction of its outstanding lease obligations for its executive office building in Miami, Florida. The Company also entered into a modification of its lease agreement, providing for a reduction of its rental expenses through June 30, 1994, at which time the Company would have the option of acquiring the leased premises or reinstating the lease according to its original terms. Should the landlord sell the leased premises to a third party at any time that the lease, or any modification thereof, is in effect, then the lease with the Company would be cancelled. In December, 1993, the landlord filed suit against the Company alleging that the Company defaulted in its obligation to make rental payments under the lease and seeking to accelerate lease payments. The Company completed a settlement of this litigation on October 27, 1994 as a result of funds being advanced under the Second Yasawa Loan and the posting of a letter of credit by Mr. Antony Gram, Chairman and Chief Executive Officer of the Company. See \"Business: Recent Developments\" and \"Legal Proceedings\".\nThe Company placed certain properties in trust to meet its refund obligation to affected customers. On September 14, 1992, the Circuit Court of Dade County, Florida approved a settlement of certain class action litigation instituted by customers affected by the Marco permit denials, under the terms of which the Company was required, among other things, to convey more than 120 acres of multi-family and commercial land that had been placed in trust to the trustee of the 809 member class. As part of the settlement, the Company guaranteed the amount to be realized from the sale of the conveyed property. This guaranteed amount shall not exceed $2,000,000. Such settlement enabled the Company to resolve the claims of an additional 12.7% of its affected customers and re-evaluate the allowance for Marco permit costs. As a result of such analysis, the Company was able to reduce such allowance by $12,200,000, resulting in a $3,983,000 extraordinary gain in 1992 and a $500,000 credit to accrued expenses to be credited to paid-in capital following issuance of 250,000 shares of restricted Common Stock of the Company to the class members. At December 31, 1994, $2,897,000 remained in the allowance for Marco permit costs, including $578,000 relating to interest accrued on such obligations. Based upon the Company's experience with affected customers, the Company believes that its total obligations to the three remaining affected customers will not materially exceed the amount provided for in the accompanying Consolidated Financial Statements.\nLIQUIDITY\nSince 1986, the Company has directed its marketing efforts to rebuilding retail land sales in an attempt to obtain a more stable income stream and achieve a balanced growth of retail land sales and bulk land sales. Retail land sales typically have a higher gross profit margin than bulk land sales and the contracts receivable generated from retail land sales provide a continuing source of income. However, retail land sales also have traditionally produced negative cash flow through the point of sale. This is because the marketing and selling expenses have generally been paid prior to or shortly after the point of sale, while the land is generally paid for in installments. The Company's ability to rebuild retail land sales has been substantially dependent on its ability to sell or otherwise finance contracts receivable and\/or secure other financing sources to meet its cash requirements.\nTo alleviate the negative cash flow impact arising from retail land sales while attempting to rebuild its sales volume, the Company implemented several new marketing programs which, among other things, adjusted the method of commission payments and required larger down payments. However, the nationwide economic recession, which was especially pronounced in the real estate industry, adverse publicity surrounding the industry which existed in 1990, the resulting, more stringent regulatory climate, and worldwide economic uncertainties have severely depressed retail land sales beginning in mid-1990 and continuing thereafter, resulting in a continuing liquidity crisis.\nBecause of this severe liquidity crisis, the Company ceased development work late in the third quarter of 1990 and did not resume development work until the third quarter of 1992. From September 29, 1990 through the fourth quarter of 1991, when the Company ceased selling undeveloped lots, sales of undeveloped lots were accounted for using the deposit method. Under this method, all payments were recorded as a customer deposit liability. In addition, because of the increasing trend in delinquencies during 1990, since the beginning of 1991, the Company has not recognized any sale until 20% of the contract sales price has been received. As a result, the reporting and recognition of revenues and profits on a portion of the Company's retail land sales contracts is being delayed. See Note 1 to Consolidated Financial Statements.\nThe continued economic recession and the increasing adverse effects of such recession on the Florida real estate industry not only resulted in the Company's sales remaining at depressed levels, but caused greater contract cancellations in 1991, particularly in the second half of the year, than were anticipated. Such cancellations required the Company to record an additional provision to its allowance for uncollectible sales of approximately $12,200,000 in the 1991 third quarter, impacting net income by approximately $8,900,000. While the Company is making every effort to reduce its cancellations, should this trend continue, the Company could be required to record additional provisions in the future.\nThe Company had defaulted on its bank debt in the third quarter of 1990, and was engaged in negotiating the repayment and restructuring of such debt through 1991 and the first half of 1992. On October 11, 1991, as described above, the Company completed the first phase of the restructuring of its bank debt by conveying to the lenders certain real estate assets which had been held for future development or bulk sales purposes, and on June 18, 1992, the Company finalized the restructuring of its remaining bank debt by entering into the Sixth Restatement.\nIn December, 1992, such bank debt was acquired by Mr. Gram and assigned to Yasawa. Through the sale of certain assets to Yasawa and its affiliates, including certain contracts receivable, and the exercise of the warrants by Yasawa, the Company was able to reduce such remaining debt from approximately $25,150,000 (including interest and fees) to approximately $5,106,000. During 1994, the Yasawa Loan was reduced to $4,764,600. The agreement with Yasawa also provided the Company with a future line of credit of $1,500,000, all of which was drawn and outstanding as of December 31, 1994. During 1993, Selex loaned the Company an additional $5,400,000 pursuant to the Second and Third Selex Loans, of which $5,323,400 was outstanding as of December 31, 1994, and Yasawa loaned the Company an additional $2,122,000 as of December 31, 1994, pursuant to the Second Yasawa\nLoan. The loans from Selex, Yasawa and their affiliates are collateralized by substantially all of the Company's assets.\nOn March 10, 1994, the Company was advised that Selex filed an Amendment to its Schedule 13D with the Commission. In the Amendment, Selex reported that it, together with Yasawa and their affiliates, were uncertain as to whether they would provide any further funds to the Company. The Amendment further stated that Selex, Yasawa and their affiliates were seeking third parties to provide financing for the Company and that as part of any such transaction, they would be willing to sell or restructure all or a portion of their loans and Common Stock in the Company.\nThe Company has stated in previous filings with the Commission and elsewhere herein that the obtainment of additional funds to implement its marketing program and achieve the objectives of its business plan is essential to enable the Company to maintain operations and continue as a going concern. Since December, 1992, the Company has been dependent on loans and advances from Selex, Yasawa and their affiliates in order to implement its marketing program and assist in meeting its working capital requirements. As previously stated, during the last nine months of 1993, Selex, Yasawa and their affiliates loaned the Company an aggregate of $4,400,000 pursuant to Third Selex Loan. Funds advanced under the Third Selex Loan enabled the Company to commence implementation of the majority of its marketing program in the third quarter of 1993. The full benefits of the program were not realized in 1993 and the Company was unable to secure financing in 1994 to meet its working capital requirements and continue its marketing program. However in 1994, Yasawa advanced (\"Second Yasawa Loan\") a total of $2,122,000 as of December 31, 1994, to meet the Company's minimum working capital requirements, to pay settlements with certain trade creditors reducing the Company's accounts payable by more than $1,000,000 and to settle certain litigation reducing the Company's exposure in excess of $5,000,000.\nInasmuch as funding is not presently available to the Company from external sources and, as stated in their Amendment, Selex, Yasawa and their affiliates have not determined whether they will provide any further funds to the Company, the Company is facing a severe cash shortfall. As a consequence of its liquidity position, the Company has defaulted on certain obligations, including its previously described escrow obligations to the Division pursuant to the Company's 1992 Consent Order and its obligation to make required interest payments under loans from Selex, Yasawa and their affiliates. Furthermore, the Company has not paid certain real estate taxes which aggregate approximately $2,676,000 as of December 31, 1994 and is also subject to certain pending litigation filed by former employees, which may adversely affect the financial condition of the Company. See \"Legal Proceedings.\"\nThe Company is continuing to seek third parties to provide financing. As part of any such transaction, Selex, Yasawa and their affiliates have indicated that they are willing to sell or restructure all or a portion of their loans and Common Stock in the Company. They have also indicated that they are willing to sell their interests in the Company at a significant discount. Consummation of any such transaction may result in a change in control of the Company. There can be no assurance, however, that such transaction will result or that any financing will be obtained. Accordingly, the Company's Board of Directors is also considering other appropriate action given the severity of the Company's liquidity position including, but not limited, to filing for protection under the federal bankruptcy laws. See \"Business: Recent Developments\", \"Legal Proceedings\" and Notes 1, 5 and 8 to Consolidated Financial Statements.\nITEM 8","section_7A":"","section_8":"ITEM 8\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF THE DELTONA CORPORATION:\nWe have audited the consolidated balance sheets of The Deltona Corporation and subsidiaries (the \"Company\") as of December 31, 1994 and 1993 and the related statements of consolidated operations, consolidated stockholders' equity (deficiency) and consolidated 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 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, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 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.\nAs discussed in Note 2, uncertainty exists as to the Company's ability to estimate future cancellations of certain contracts and mortgages receivable sold with recourse and is unable to determine the adequacy of its reserves to replace or repurchase receivables that become delinquent. Accordingly, no provision for any additional reserves that may be necessary upon the resolution of this matter has been made in the financial statements.\nThe accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company incurred substantial operating losses during 1994, 1993 and 1992, has continued to experience severe liquidity crises, causing the Company to be unable to meet certain contractual obligations, in some cases resulting in litigation that may have a substantial impact on the Company, and has a stockholders' deficiency at December 31, 1994. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans concerning these matters are described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nDELOITTE & TOUCHE LLP Certified Public Accountants Miami, Florida March 24, 1995\nCONSOLIDATED BALANCE SHEETS\nTHE DELTONA CORPORATION AND SUBSIDIARIES\nASSETS (IN THOUSANDS)\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSOLIDATED BALANCE SHEETS\nTHE DELTONA CORPORATION AND SUBSIDIARIES\nLIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY) (IN THOUSANDS EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of the consolidated financial statements.\nSTATEMENTS OF CONSOLIDATED OPERATIONS THE DELTONA CORPORATION AND SUBSIDIARIES (IN THOUSANDS EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of the consolidated financial statements.\nSTATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY (DEFICIENCY)\nTHE DELTONA CORPORATION AND SUBSIDIARIES (IN THOUSANDS)\nFOR THE YEARS ENDED DECEMBER 31, 1994, DECEMBER 31, 1993 AND DECEMBER 25, 1992\nThe accompanying notes are an integral part of the consolidated financial statements.\nSTATEMENTS OF CONSOLIDATED CASH FLOWS\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n(IN THOUSANDS)\nThe accompanying notes are an integral part of the consolidated financial statements.\nSTATEMENTS OF CONSOLIDATED CASH FLOWS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n(IN THOUSANDS)\nRECONCILIATION OF NET INCOME (LOSS) TO NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES:\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION - GOING CONCERN\nThe accompanying financial statements of The Deltona Corporation and subsidiaries (the \"Company\") have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.\nAlthough the Company reported net income of $7,336,000 for 1992, primarily due to extraordinary gains of $10,161,000 from debt restructuring and $3,983,000 from a settlement related to the Marco refund obligation, such that it was able to reduce the stockholders' deficiency to $5,519,000 as of December 25, 1992, the Company incurred a loss from operations for 1992 of $6,808,000, for 1993 of $8,772,000 and for 1994 of $3,906,000, resulting in a stockholders' deficiency of $16,821,000 as of December 31, 1994. The Company has continued to experience liquidity problems, causing it to be unable to fully implement its marketing program and to meet certain contractual obligations, primarily relating to the repayment of debt and the completion of improvements. The Company must obtain additional financing to accomplish the objectives of satisfying or substantially reducing its current debt obligations and provide the financial stability that will allow the Company to accomplish the objectives of a successful business plan. These matters raise substantial doubt about the Company's ability to continue as a going concern.\nFollowing the completion of the restructuring of its bank debt in 1992 (see Note 5), the Company commenced the implementation of its business plan by undertaking a new marketing program which included the Company's re-entry into the single-family housing business. To accomplish the objectives of its business plan required the Company to obtain financing during 1993 and 1994 and will require the Company to obtain additional financing in 1995. The transactions described in Note 5 with Selex International B.V., a Netherlands corporation (\"Selex\"), Yasawa Holding, N.V., a Netherlands Antilles corporation (\"Yasawa\"), and their affiliates provided the Company with a portion of its financing requirements enabling the Company to commence implementation of the marketing program and attempt to accomplish the objectives of its business plan, but additional financing will be required in 1995. Selex, Yasawa and their affiliates are uncertain as to whether they will provide any further funds to the Company. While the Company, together with Selex, Yasawa and their affiliates, is seeking third parties to provide financing for the Company and, as part of any such transaction, Selex, Yasawa and their affiliates have indicated their willingness to sell or restructure all or a portion of their loans and Common Stock in the Company, such financing has not yet become available. As a consequence of its liquidity position, the Company has defaulted on certain obligations, including its escrow account obligations to the State of Florida, Department of Business Regulation, Division of Land Sales, Condominiums and Mobile Homes (the \"Division\") pursuant to the Company's 1992 Consent Order with the Division (the \"1992 Consent Order\"), its obligation to pay certain real estate taxes, and its obligation to make required interest payments under loans from Selex, Yasawa and their affiliates. Additionally, the Company is subject to certain pending litigation by former employees which may adversely affect the financial condition of the Company (See Notes 5 and 8).\nThere can be no assurance that the Company will be able to timely secure the necessary financing to resolve its present liquidity situation, that the pending litigation will be favorably concluded, or that a new business plan will be successfully implemented. Consequently, there can be no assurance that the Company can continue as a going concern. In the event that these matters are not successfully addressed, the Company's Board of Directors will consider other appropriate action given the severity of the Company's liquidity position, including, but not limited to, filing for protection under the federal bankruptcy laws.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)\nSee \"Legal Proceedings\", \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 5 and 8 to Consolidated Financial Statements.\nThe consolidated financial statements do not include any adjustments relating to the recoverability of asset amounts or the amounts of liabilities should the Company be unable to continue as a going concern.\nSIGNIFICANT ACCOUNTING POLICIES\nThe Company's consolidated financial statements are prepared in accordance with generally accepted accounting principles. Material intercompany accounts and transactions are eliminated.\nSince 1986, the Company has used a 52-53 week fiscal year ending on the last Friday of the year. The year ended December 31, 1993 contained 53 weeks, and the year ended December 25, 1992 contained 52 weeks. The effect on the financial statement of the extra week in 1993 was not material. Commencing in 1994, the Company returned to a fiscal year ended December 31.\nThe Company sells homesites under installment contracts which provide for payments over periods ranging from 2 to 10 years. Sales of homesites are recorded under the percentage-of-completion method in accordance with Statement of Financial Accounting Standards No. 66, \"Accounting for Sales of Real Estate\" (\"FASB No. 66\"). Since 1991, the Company has not recognized a sale until it has received 20% of the contract sales price.\nBecause of the severe liquidity crisis faced by the Company as discussed above, the Company ceased development work late in the third quarter of 1990. From September 29, 1990 through the fourth quarter of 1991, all sales of undeveloped lots were accounted for using the deposit method. Since the fourth quarter of 1991 and in compliance with the 1992 Consent Order, the Company has been offering only developed lots for sale (see Note 8).\nAt the time of recording a sale the Company records an allowance for the estimated cost to cancel the related contracts receivable through a charge to the provision for uncollectible sales. The amount of this provision and the adequacy of the allowance is determined by the Company's continuing evaluation of the portfolio and past cancellation experience. While the Company uses the best information available to make such evaluations, future adjustments to the allowance may be necessary as a result of future national and international economic and other conditions that may be beyond the Company's control. Changes in the Company's estimate of the allowance for previously recognized sales will be reported in earnings in the period in which they become estimable and are charged to the provision for uncollectible contracts.\nLand improvement costs are allocated to individual homesites based upon the relationship that the homesite's sales price bears to the total sales price of all homesites in the community. The estimated costs of improving homesites are based upon independent engineering estimates made in accordance with sound cost estimation and provide for anticipated cost-inflation factors. The estimates are systematically reviewed. When cost estimates are revised, the percentage relationship they bear to deferred revenues is recalculated on a cumulative basis to determine future income recognition as performance takes place.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)\nBulk land sales are recorded and profit is recognized in accordance with FASB No. 66. Bulk land sales of approximately $315,000, $113,000 and $226,000 are included in gross land sales for the years ended December 31, 1994, December 31, 1993 and December 25, 1992, respectively.\nSales of houses and vacation ownership units, as well as all related costs and expenses, are recorded at the time of closing.\nInterest costs directly related to, and incurred during, a project's construction period are capitalized. Such capitalized interest amounted to $-0-, $164,000 and $100,000 for the years ended December 31, 1994, December 31, 1993 and December 25, 1992, respectively.\nProperty, plant and equipment is stated at cost. Depreciation is provided by the straight-line method over the estimated useful lives of the respective assets. Additions and betterments are capitalized, and maintenance and repairs are charged to income as incurred. Generally, upon the sale or retirement of assets, the accounts are relieved of the costs and related accumulated depreciation and any gain or loss is reflected in income.\nWhen property exchanges and refund transactions are consummated under the Company's Marco Island-Marco Shores customer programs (see Note 9), any resulting loss is charged to the allowance for Marco permit costs. When property exchanges and refund transactions are consummated under the Consent Order (see Note 8), any resulting loss is charged against the allowance included in accrued expenses and other. The Company accrues interest on its refund obligations in accordance with the various customer refund programs.\nFor the purposes of the statements of cash flows, the Company considers its investments, which are comprised of short term, highly liquid investments purchased with a maturity of three months or less, to be cash equivalents.\nCertain amounts in the 1992 financial statements have been reclassified for comparative purposes to the 1993 and 1994 presentation.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n2. CONTRACTS AND MORTGAGES RECEIVABLE\nAt December 31, 1994, interest rates on contracts receivable outstanding ranged from 5.0% to 12.0% per annum (weighted average approximately 8.4%). The approximate principal maturities of contracts receivable (including $50,470 restricted for use in the Marco refund program, see Note 9) were:\nIf a regularly scheduled payment on a contract remains unpaid 30 days after its due date, the contract is considered delinquent. Aggregate delinquent contracts receivable at December 31, 1994 and December 31, 1993 approximate $2,140,000 and $1,717,000, respectively.\nInformation with respect to interest rates and average contract lives used in valuing new contracts receivable generated from sales follows:\nIn December, 1992, as described above, the Company sold $10,800,000 of contracts and mortgages receivable to an affiliate of Yasawa at face value, applying the proceeds therefrom to reduce the Bank Loan acquired by Yasawa.\nIn March, 1993 the Company transferred $1,600,000 in contracts and mortgages receivable generating approximately $1,059,000 in proceeds to the Company, which was used for working capital and the creation of a holdback account in the amount $150,000. As of December 31, 1994, the balance of the holdback account was $107,000.\nIn June, 1992 and February, 1990, the Company completed sales of contracts and mortgages receivable totalling $13,500,000 and $17,000,000, respectively, which generated approximately $8,000,000 and $13,900,000, respectively, in net proceeds to the Company. The anticipated costs of the June, 1992 transaction were included in the extraordinary loss from debt restructuring for 1991 since the restructuring was dependent on the sale. The Company recorded a loss of $600,000 on the February, 1990 sale. In conjunction with these sales the Company granted the purchaser a security interest in certain additional contracts receivable of approximately $2,700,000 and conveyed all of its rights, title and interest in the property underlying such contracts to a collateral trustee. In addition, these transactions, among other things require that the Company replace or repurchase any receivable that becomes 90 days delinquent upon the request of the purchaser. Such requirement can be satisfied from contracts in which the purchaser holds a security interest (approximately $1,297,000 as of December 31, 1994). The\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n2. CONTRACTS AND MORTGAGES RECEIVABLE - (CONTINUED)\npurchaser of these receivables has experienced financial difficulty and filed in 1994 for protection under Chapter 11 of the Federal Bankruptcy Code. The Company is unable to determine what effect this will have, if any, on future cancellations, since it is unable to determine how the bankruptcy will impact servicing and collection procedures and the customers' determination to continue to pay under those contracts. The Company has fully reserved for the amount of the holdback account and the estimated future cancellations based on the Company's historical experience for receivables the Company services. However, due to the uncertainty noted above, the Company does not feel there is sufficient information to estimate future cancellations and is unable to determine the adequacy of its reserves to replace or repurchase receivables that become delinquent. The Company was unable to replace or repurchase $1,148,000 in delinquent contracts in 1994, which amount was deducted from the deposit held by the purchaser of the receivables as security.\nThe Company was the guarantor of approximately $25,608,000 of contracts receivable sold or transferred as of December 31, 1994, for the transactions described above, had $775,000 on deposit with purchasers of the receivables as security to assure collectibility as of such date and had established $775,000 as a liability for the Company's obligation under the recourse provisions. The Company has been in compliance with all receivable transactions since the consummation of sales.\nThe Company anticipates that it will be necessary to complete additional sales and financings of a portion of its receivables in 1995. There can be no assurance, however, that such sales and\/or financings can be accomplished.\nOn July 24, 1991, the Company assigned mortgages receivable, including accrued interest and payments collected thereon from December 1990 through July 1991, of approximately $6,400,000 to its principal lending banks to be applied to reduce its outstanding bank debt. (See Note 5)\n3. INVENTORIES\nInformation with respect to the classification of inventory of land and improvements including land held for sale or transfer is as follows:\nLand and land improvements include approximately $202,000 of land placed in the Marco Island and Marco Shores trusts for the Marco refund program as of December 31, 1994 and December 31, 1993 (see Note 9). Other inventories consists primarily of vacation ownership units completed (see Note 5).\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n4. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment and accumulated depreciation consist of the following:\nDepreciation charged to operations for the years ended December 31, 1994, December 31, 1993 and December 25, 1992 was approximately $86,000, $104,000 and $175,000, respectively.\n5. MORTGAGES AND SIMILAR DEBT\nIndebtedness under various purchase money mortgages and loan agreements is collateralized by substantially all of the Company's assets, including stock of certain wholly-owned subsidiaries.\nThe following table presents information with respect to mortgages and similar debt (in thousands):\nIncluded in Mortgage Notes Payable is the $3,000,000 First Selex Loan ($1,860,000 as of December 31, 1994), the $1,000,000 Second Selex Loan ($961,000 as of December 31, 1994), the $4,400,000 Third Selex Loan ($4,362,400 as of December 31, 1994), and the $4,900,000 Yasawa Loan ($4,764,600 as of December 31, 1994) and the Second Yasawa Loan ($2,122,000 as of December 31, 1994). Other loans include the $1,000,000 Empire note and the $1,500,000 Scafholding Loan.\nThese mortgage notes payable and other loans are in default as of December 31, 1994 due to the non-payment of interest and principal. The lenders have not taken any action as a result of these defaults.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n5. MORTGAGES AND SIMILAR DEBT - (CONTINUED)\nOn June 19, 1992, Selex loaned the Company the sum of $3,000,000 pursuant to the First Selex Loan. The First Selex Loan is collateralized by a first mortgage on certain of the Company's unsold, undeveloped property in its St. Augustine Shores, Florida community. The Loan matures on June 15, 1996 and provides for principal to be repaid at 50% of the net proceeds per lot for lots requiring release from the mortgage, with the entire unpaid balance becoming due and payable at the end of the four year term. It initially bears interest at the rate of 10% per annum, with payment of interest deferred for the initial 18 months of the Loan and interest payments due quarterly thereafter. As part of the Selex transaction, Selex was granted an option, approved by the holders of a majority of the outstanding shares of the Company's Common Stock at the Company's 1992 Annual Meeting, which, as modified, enabled Selex to convert the First Selex Loan, or any portion thereof, into a maximum of 600,000 shares of the Company's Common Stock at a per share conversion price equal to the greater of (i) $1.25 or (ii) 95% of the market price of the Company's Common Stock at the time of conversion, but in no event greater than $4.50 per share (the \"Option\"). On February 17, 1994, Selex exercised the Option, in full, at a conversion price of $1.90 per share, such that $1,140,000 in principal was repaid under the First Selex Loan through such conversion. As of March 24, 1995, the Company was in default of the First Selex Loan inasmuch as accrued interest in the amount of $716,700 (including $673,800 due December 31, 1994) remained unpaid.\nOne million dollars of the proceeds from the First Selex Loan was used by the Company to acquire certain commercial and multi-family properties at the Company's St. Augustine Shores community at their net appraised value, from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres. Namely, (i) $416,000 was used to acquire 48 undeveloped condominium units (twelve 4 unit building sites) and 4 completed (and rented) condominium units from Conquistador, in which Messrs. Zwaans and Muyres serve as directors, as well as President and Secretary\/Treasurer, respectively; (ii) $485,000 was used to acquire 4 commercial lots from Swan Development Corporation, in which Messrs. Zwaans and Muyres also serve as directors, as well as President and Secretary, respectively; and (iii) approximately $99,000 was used to reacquire, from Mr. Muyres, all of his rights, title and interest in that certain contracts with the Company for the purchase of a commercial tract in St. Augustine Shores, Florida. None of the commercial and multi-family property acquired by the Company from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres collateralizes the First Selex Loan. In March, 1994, Conquistador exercised its right to repurchase certain multi-family property from the Company (which right had been granted in connection with the June, 1992 Selex transaction) at a price of $312,000, of which $260,000 was paid in cash to the Company and $52,000 was applied to reduce interest due to Selex under the Second Selex Loan (\"First Conquistador Acquisition\").\nOn December 2, 1992, the Company entered into various agreements relating to certain of its assets and the restructuring of its debt with Yasawa, which is beneficially owned by Mr. Gram. The consummation of these agreements, which are further described below, was conditioned upon the acquisition by Gram of the Company's outstanding bank loan.\nOn December 4, 1992, Gram entered into an agreement with the lenders, pursuant to which he acquired the bank loan of approximately $25,150,000 (including interest and fees) for a price of $10,750,000. In conjunction with such transaction, the lenders transferred to Gram the warrants which they held that entitled the holder to purchase an aggregate of 277,387 shares of the Company's Common Stock at an exercise price of $1.00 per share. Immediately after the acquisition of the bank loan, Gram transferred all of his interest in the bank loan, including the warrants, to Yasawa.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n5. MORTGAGES AND SIMILAR DEBT - (CONTINUED)\nOn December 11, 1992, the Company consummated the December 2, 1992 agreements with Yasawa. Under these agreements, Yasawa, its affiliates and the Company agreed as follows: (i) the Company sold certain property at its Citrus Springs community to an affiliate of Yasawa in exchange for approximately $6,500,000 of debt reduction credit; (ii) an affiliate of Yasawa and the Company entered into a joint venture agreement with respect to the Citrus Springs property, providing for the Company to market such property and receive an administration fee from the venture (in March, 1994, the Company and the affiliate agreed to terminate the venture); (iii) the Company sold certain contracts receivable at face value to an affiliate of Yasawa for debt reduction credit of approximately $10,800,000; (iv) the Company sold the Marco Shores Country Club and Golf Course to an affiliate of Yasawa for an aggregate sales price of $5,500,000, with the affiliate assuming an existing first mortgage of approximately $1,100,000 and the Company receiving debt reduction credit of $2,400,000, such that the Company obtained cash proceeds from this transaction of $2,000,000, which amount was used for working capital; (v) an affiliate of Yasawa agreed to lease the Marco Shores Country Club and Golf Course to the Company for a period of approximately one year; (vi) an affiliate of Yasawa and the Company agreed to amend the terms of the warrants to increase the number of shares issuable upon their exercise from 277,387 shares to 289,637 shares and to adjust the exercise price to an aggregate of approximately $314,000; (vii) Yasawa exercised the warrants in exchange for debt reduction credit of approximately $314,000; (viii) Yasawa released certain collateral held for the bank loan; (ix) an affiliate of Yasawa agreed to make an additional loan of up to $1,500,000 to the Company, thus providing the Company with a future line of credit (all of which was drawn and outstanding as of March 24, 1995); and (x) Yasawa agreed to restructure the payment terms of the remaining $5,106,000 of the bank loan as a loan from Yasawa (the \"Yasawa Loan\").\nThe Yasawa Loan bears interest at the rate of 11% per annum, with payment of interest deferred until December 31, 1993, at which time only accrued interest became payable. Commencing January 31, 1994, principal and interest became payable monthly, with all unpaid principal and accrued interest being due and payable on December 31, 1997. During 1994, an assignment of a mortgage receivable and miscellaneous sales of collateral reduced the Yasawa Loan to $4,765,000 as of December 31, 1994. As of March 24, 1995, $5,418,300 in principal and accrued interest was in default under the Yasawa Loan.\nOn April 30, 1993 Selex loaned the Company an additional $1,000,000 collateralized by a first mortgage on certain of the Company's property in its Marion Oaks, Florida community (the \"Second Selex Loan\"). The Second Selex Loan bears interest at 11% per annum, with interest deferred until December 31, 1993. The Second Selex Loan provides for principal to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994 due and payable on April 30, 1994. Although Selex had certain conversion rights under the Second Selex Loan in the event the Company sold any Common Stock or Preferred Stock prior to payment in full of all amounts due to Selex under the Second Selex Loan, such rights were voided as of December 31, 1993. As of March 24, 1995, $39,000 in principal and $52,000 in accrued interest had been repaid under the Second Selex Loan, but accrued interest of $154,600 due under the Loan as of March 24, 1995, as well as the principal balance of $961,000, remained unpaid and in default. The Second Conquistador Acquisition, discussed below, will, when closed, satisfy the debt due and payable under the Second Selex Loan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n5. MORTGAGES AND SIMILAR DEBT - (CONTINUED)\nFrom July 9, 1993 through December 31, 1993, Selex loaned the Company an additional $4,400,000 collateralized by a second mortgage on certain of the Company's property on which Selex and\/or Yasawa hold a first mortgage pursuant to a Loan Agreement dated July 14, 1993 and amendments thereto (the \"Third Selex Loan\"). The Third Selex Loan bears interest at 11% per annum, with interest deferred until December 31, 1993. Principal is to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994 due and payable on April 30, 1994. As of March 24, 1995, $37,600 in principal had been repaid under the Third Selex Loan, but accrued interest of $742,600 due under the Loan as of March 24, 1995, as well as the principal balance of $4,362,400, remained unpaid and in default. The Second Conquistador Acquisition, discussed below, will, when closed, provide a reduction of the debt due and payable under the Third Selex Loan.\nIn February, 1994, Yasawa loaned the Company an additional amount of approximately $514,900 at an interest rate of 8% per annum (the \"Second Yasawa Loan\"). Since May, 1994, additional amounts were advanced to the Company under the Second Yasawa Loan to enable the Company to pay certain essential expenses and to effectuate settlements with the Company's principal creditors. As of March 24, 1995, an aggregate amount of $2,242,000 had been advanced to the Company under the Second Yasawa Loan and $115,600 in accrued interest remains unpaid.\nThe Company has approved a Purchase and Sale Agreement with Conquistador Development Corporation (\"Second Conquistador Acquisition\") for the sale of an administration building and multi-family site in the Company's St. Augustine Shores community as well as the remaining lot inventory in the Company's Feather Nest community at Marion Oaks in consideration for the satisfaction of $2,599,300 of principal and accrued interest on the Second and Third Selex Loans. The amount of debt reduction is equivalent to the amount of Mr. Marcel Muyres' participation in those loans as of January 31, 1995. In a separate transaction, Conquistador Development Corporation and the Company approved a Purchase and Sale Agreement (\"Third Conquistador Acquisition\") for the sale of four single family residential lots in the St. Augustine Shores community for $100,000 in cash. The Second and Third Conquistador Acquisitions are anticipated to close by April 30, 1995.\nAs previously stated, Messrs. Muyres and Zwaans also serve as directors and executive officers of M&M. The Company has leased certain office space to M&M at its St. Augustine Shores community pursuant to a Lease Agreement dated August 10, 1990. Although the aggregate annual rental payments under such Lease are less than $60,000, as of March 24, 1995, M&M was in default of its obligations under the Lease inasmuch as delinquent rental payments (including reimbursement for real estate taxes) of approximately $21,260 remain unpaid. Payment of delinquent rental payments will be made upon closing of the Second Conquistador Acquisition.\nInterest due to Selex, Yasawa and their affiliates as of December 31, 1994 in the aggregate amount of $2,899,500 remained unpaid and in default as of March 24, 1995. Through March 24, 1995, $1,140,000 in principal was repaid under the First Selex Loan through the exercise of the above described Option, $39,000 in principal and $52,000 in accrued interest was repaid under the Second Selex Loan, $37,600 in principal was repaid under the Third Selex Loan, and $133,900 in principal and $346,000 in accrued interest was repaid under the Yasawa loan. As of March 24, 1995, the Company had loans outstanding from Selex, Yasawa and their affiliates in the aggregate amount of approximately $19,999,400 including interest, all of which are in default, including approximately $10,359,600, which is owed to Selex, including accrued and unpaid interest of approximately\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n5. MORTGAGES AND SIMILAR DEBT - (CONTINUED)\n$2,176,200 (10% per annum on the First Selex Loan, 11% per annum on the Second and Third Selex Loans and 12% per annum on the $1,000,000 Empire Note assigned to Selex); approximately $7,776,000, which owed to Yasawa, including accrued and unpaid interest of approximately $769,200 (11% per annum on the Yasawa Loan and 8% per annum on the Second Yasawa Loan); and approximately $1,864,000, which is owed to an affiliate of Yasawa, including accrued and unpaid interest of approximately $364,000 (12% per annum). The loans from Selex, Yasawa and their affiliates are secured by substantially all of the assets of the Company.\n6. INCOME TAXES\nFor 1992, the Company had income before consideration of any net operating loss carryforwards for book purposes. Deferred taxes were provided for alternative minimum tax. The deferred provision for 1992 for alternative minimum tax resulted from the enactment of the alternative minimum tax provisions under the Tax Reform Act of 1986. Under these federal income tax provisions, a corporation may offset only 90% of its alternative minimum taxable income with net operating loss carryovers.\nPrior to December 26, 1992, the Company accounted for income taxes in accordance with Accounting Principles Board Opinion No. 11. Effective December 26, 1992, the Company adopted Statement of Accounting Standard No. 109 \"Accounting for Income Taxes.\" There was no effect from the adoption of this standard. Under this standard deferred income assets and liabilities are computed annually for the difference between financial statements and the tax bases of assets and liabilities that will result in taxable or deductible amounts in the future bases on enacted tax and rates applicable to periods in which the differences are expected to affect taxable income. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred assets and liabilities.\nFor the years ended December 31, 1994 and 1993, the Company had a net loss for tax purposes and, as a result, there was no tax payable or refundable and there was no change in the net deferred tax asset. Accordingly, there was no tax provision for such years.\nAs of December 31, 1993, the Company had a net deferred tax asset of approximately $25,564,000 which primarily resulted from the tax effect of the Company's net operating loss carryforward of $21,719,000 and losses on subsidiaries sold in prior years of $3,944,000. A valuation allowance of $25,564,000 has been established against the net deferred tax asset.\nAs of December 31, 1994, the Company had a net deferred tax asset of approximately $25,437,000 which primarily resulted from the tax effect of the Company's net operating loss carryforward of $21,289,000 and losses on subsidiaries sold in prior years of $3,960,000. A valuation allowance of $25,437,000 has been established against the net deferred tax asset.\nThe Company's regular net operating loss carryover for tax purposes is estimated to be $55,182,000 at December 31, 1994, of which $6,555,000 will be available through 1995, $4,733,000 through 1996, $11,022,000 through 1999, $364,000 through 2002, $9,189,000 through 2005, $9,780,000 through 2006, and the remainder through 2009. In addition to the net operating loss carryover, investment tax credit carryovers of approximately $259,000, which expire from 1994 through 2001, are available to reduce federal income tax liabilities only after the net operating loss carryovers have been utilized.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n6. INCOME TAXES - (CONTINUED)\nThe utilization of the Company's net operating loss and tax credit carryforwards would be impaired or reduced under certain circumstances, pursuant to changes in the federal income tax laws effected by the Tax Reform Act of 1986. Events which affect these carryforwards include, but are not limited to, cumulative stock ownership changes of 50% or more over a three-year period, as defined, and the timing of the utilization of the tax benefit carryforwards.\n7. LIABILITY FOR IMPROVEMENTS\nThe Company has an obligation to complete land improvements upon deeding which, depending on contractual provisions, typically occurs within 90 to 120 days after the completion of payments by the customer. The estimated cost to complete improvements to lots and tracts at December 31, 1994 and December 31, 1993 was approximately $17,600,000 and $18,574,000 (as adjusted for the 1992 Consent Order), respectively. The foregoing estimates reflect the Company's current development plans at its communities (see Note 8). These estimates include estimated development obligations applicable to sold lots of approximately $2,412,000 and $2,825,000, respectively, a liability to provide title insurance and deeding costing $1,300,000 and $951,000, respectively, and an estimated cost of street maintenance, prior to assumption of such obligations by local governments, of $2,948,000 and $3,852,000, respectively, all of which are included in deferred revenue. Included in cash at December 31, 1994 and December 31, 1993, are escrow deposits of $911,000 and $1,664,000, respectively, restricted for completion of improvements in certain of the Company's communities.\nIn May, 1994 the Company implemented a program to exchange purchasers who contracted to purchase property which is undeveloped to property which is developed. As of March 24, 1995, approximately 75% of the customers whose lots are currently undeveloped have opted to exchange. The Company's goal is to eliminate its development obligation (with the exception of its maintenance obligation in Marion Oaks) under the 1992 Consent Order through this exchange program, completion of two commercial areas in Marion Oaks, sale of its second Citrus Springs Golf Course (with the buyer assuming the development obligation) and settlement of all remaining maintenance and improvements obligations in Citrus Springs through a final agreement with Citrus County (scheduled for approval in April 1995).\nThe anticipated expenditures for land improvements to complete areas from which sales have been made through December 31, 1994 are as follows:\n8. COMMITMENTS AND CONTINGENT LIABILITIES\nTotal rental expense for the years ended December 31, 1994, December 31, 1993 and December 25, 1992 was approximately $773,000, $808,000 and $1,164,000, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n8. COMMITMENTS AND CONTINGENT LIABILITIES - (CONTINUED)\nThe Company has no real estate leases that extend beyond 1995. Estimated rental expense under these leases is expected to be approximately $175,000. The Company has no material equipment leases.\nDuring 1983 the Company entered into a sale-leaseback agreement on its executive office building. Following the consummation of the Sixth Restatement, the Company conveyed certain properties to the landlord in satisfaction of its outstanding lease obligations for its executive office building in Miami, Florida. The Company also entered into a modification of its lease agreement, providing for a reduction of its rental expenses through June 30, 1994, at which time the Company would have the option of acquiring the leased premises or reinstating the lease according to its original terms. If the landlord were to sell the leased premises to a third party at any time that the lease, or any modification thereof, is in effect, then the lease with the Company would be cancelled. In the action styled FIVE POINTS LIMITED V. THE DELTONA CORPORATION, Case No. 93-22877, filed in the Circuit Court for Dade County, Florida and served upon the Company on December 8, 1993, the plaintiff sought damages against the Company for an alleged breach of the lease for its office building. The complaint alleged that the Company had defaulted on its obligation to make payments under the lease and sought damages in excess of $272,000 for additional past due rent, plus damages for acceleration of lease payments in excess of $4,000,000. On February 17, 1994 the Court entered an Order requiring the Company to pay uncontested back rent of approximately $240,000, plus uncontested monthly rents of approximately $48,000, commencing on March 1, 1994. As of December 31, 1994, approximately $41,500 had been garnished by the Court under this Order. The Plaintiff has obtained multiple judgments in the amount of $647,000 as of December 31, 1994. These judgments have been recorded in certain of the Company's communities. As set forth in the Company's filing on September 1, 1994 of its Form 10-K for the fiscal year ended December 31, 1993, the Company had entered into a Settlement Agreement with the plaintiff which needed to be consummated on or before October 17, 1994. The Company also stated that new financing would be required to consummate the settlement agreement and that failure to fund this agreement would result in continued litigation and a likely substantial judgement against the Company. The settlement agreement was consummated on October 27, 1994 as a result of funds being advanced by Yasawa and the posting of a letter of credit by Mr. Antony Gram, Chairman and Chief Executive Officer of the Company.\nThe profit on the sale-leaseback agreement was included in deferred revenue and amortized as a reduction in rent expense over the term of the lease which, according to its terms would expire March 31, 1998. At December 31, 1993, $1,205,000 of the profit remained in deferred revenue. On October 27, 1994, the date on which the above referenced settlement agreement was consummated, all of the profit remaining in deferred revenue was recognized resulting in a gain of $1,051,000.\nHomesite sales contracts provide for the return of all monies paid in (including paid-in interest) should the Company be unable to meet its contractual obligations after the use of reasonable diligence. If a refund is made, the Company will recover the related homesite and any improvement thereto. The aggregate amount of all monies paid in (including paid-in interest) on all homesite contracts having outstanding contractual obligations (primarily to complete improvements) at December 31, 1994 was approximately $7,343,200.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n8. COMMITMENTS AND CONTINGENT LIABILITIES - (CONTINUED)\nAs a result of the delays in completing the land improvements to certain property sold in certain of its Central and North Florida communities, the Company fell behind in meeting its contractual obligations to its customers. In connection with these delays, the Company, in February, 1980, entered into a Consent Order with the Division which provided a program for notifying affected customers. The Consent Order, which was restated and amended, provided a program for notifying affected customers of the anticipated delays in the completion of improvements (or, in the case of purchasers of unbuildable lots in certain areas of the Company's Sunny Hills community, the transfer of development obligations to core growth areas of the community); various options which may be selected by affected purchasers; a schedule for completing certain improvements; and a deferral of the obligation to install water mains until requested by the purchaser. Under an agreement with Topeka, Topeka's utility companies have agreed to furnish utility service to the future residents of the Company's communities on substantially the same basis as such services were provided by the Company. The Consent Order also required the establishment of an improvement escrow account as assurance for completing such improvement obligations. In June, 1992, the Company entered into the 1992 Consent Order with the Division, which replaced and superseded the original Consent Order, as amended and restated. Among other things, the 1992 Consent Order consolidated the Company's development obligations and provided for a reduction in its required monthly escrow obligation to $175,000 from September, 1992 through December, 1993. Beginning January, 1994 and until development is completed or the 1992 Consent Order is amended, the Company is required to deposit $430,000 per month into the escrow account. To meet its current escrow and development obligations under the 1992 Consent Order, the Company is required to deposit into escrow $5,160,000 in 1994 and $3,519,000 in 1995. As part of the assurance program under the 1992 Consent Order, the Company and its lenders granted the Division a lien on certain contracts receivable (approximately $7,528,000 as of December 31, 1994) and future receivables. The Company defaulted on its obligation to escrow $430,000 per month for the period of January, 1994 through the present and, in accordance with the 1992 Consent Order, collections on Division receivables were escrowed for the benefit of purchasers from March 1, 1994 through April 30, 1994. In May, 1994 the Company implemented a program to exchange purchasers who contracted to purchase property which is undeveloped to property which is developed. As of March 24, 1995, approximately 75% of the customers whose lots are currently undeveloped have opted to exchange. The Company's goal is to eliminate its development obligation (with the exception of its maintenance obligation in Marion Oaks) under the 1992 Consent Order through this exchange program, completion of two commercial areas in Marion Oaks, sale of its second Citrus Springs Golf Course (with the buyer assuming the development obligation) and settlement of all remaining maintenance and improvements obligations in Citrus Springs through a final agreement with Citrus County (scheduled for approval in April 1995). Consequently, the Division has allowed the Company to utilize collections on receivables since May 1, 1994. Pursuant to the 1992 Consent Order, the Company has limited the sale of single-family lots to lots which front on a paved street and are ready for immediate building. Because of the Company's default, the Division could also exercise other available remedies under the 1992 Consent Order, which remedies entitle the Division, among other things, to halt all sales of registered property. As of December 31, 1994, the Company had estimated development obligations of approximately $2,412,000 on sold property, an estimated liability to provide title insurance and deeding costing $1,300,000 and an estimated cost of street maintenance, prior to assumption of such obligations by local governments, of $2,948,000, all of which are included in deferred revenue. The total cost, including the previously mentioned obligations, to complete improvements at December 31, 1994 to lots subject to the 1992 Consent Order and to lots in the St. Augustine Shores community was estimated to be approximately $17,600,000. As of December 31, 1994 and December 31, 1993 the Company had in escrow approximately $911,000 and $1,664,000, respectively, specifically for land improvements at certain of its Central and North Florida communities.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n8. COMMITMENTS AND CONTINGENT LIABILITIES - (CONTINUED)\nBased upon the Company's experience with affected customers, the Company believes that the total refunds arising from delays in completing such improvements will not materially exceed the amount provided for in the consolidated financial statements. Approximately $49,000 and $64,000 of the provision for the total refunds relating to the delays of improvements remained in accrued expenses and other at December 31, 1994 and December 31, 1993, respectively.\nThe Company's corporate performance bonds to assure the completion of development at its St. Augustine Shores community expired in March and June, 1993. Such bonds cannot be renewed due to a change in the policy of the Board of County Commissioners of St. Johns County which precludes allowing any developer to secure the performance of development obligations by the issuance of corporate bonds. In the event that St. Johns County elects to undertake the completion of such development work, the Company would be obligated with respect to 1,000 improved lots at St. Augustine Shores in the amount of approximately $6,200,000. The Company intends to submit an alternative assurance program for the completion of such development and improvements to the County for its approval.\nIn addition to the matters discussed above and in Note 9, the Company is a party to other litigation relating to the conduct of its business which is routine in nature and, in the opinion of management, should have no material effect upon the Company's operation. See \"Legal Proceedings\".\n9. MARCO ISLAND-MARCO SHORES PERMITS\nOn April 16, 1976, the U.S. Army Corps of Engineers (the \"Corps\") denied the Company's application for dredge and fill permits required to complete development of the Marco Island community. These denials adversely affected the Company's ability to obtain the required permits for the Marco Shores community as originally platted. Following the denials, the Company instituted legal proceedings, implemented various programs to assist its customers affected by the Corps' action, and applied for permits from certain administrative agencies for other areas of the Company's Marco ownership.\nOn July 20, 1982, the Company entered into an agreement with the State of Florida and various state and local agencies (the \"Settlement Agreement\"), endorsed by various environmental interest groups, to resolve pending litigation and administrative proceedings relative to the Marco permitting issues. The Settlement Agreement became effective when, pursuant thereto, approximately 12,400 acres of the Company's Marco wetlands were conveyed to the State in exchange for approximately 50 acres of State-owned property in Dade County, Florida. In October, 1987, the Company sold the Dade County property for $9,000,000. The Settlement Agreement also allowed the Company to develop as many as 14,500 additional dwelling units in the Marco vicinity. On October 11, 1991, 1,300 acres of Marco property (7,000 dwelling units) were conveyed to the Company's lenders pursuant to the Conveyance Agreement.\nThe Company placed certain properties in trust to meet its refund obligation to affected customers. On September 14, 1992, the Circuit Court of Dade County, Florida approved a settlement of certain class action litigation instituted by customers affected by the Marco permit denials, under the terms of which the Company was required, among other things, to convey more than 120 acres of multi-family and commercial land that had been placed in trust to the trustee of the 809 member class. As part of the settlement, the Company guaranteed the amount to be realized from the sale of the conveyed property. This guaranteed amount shall not exceed $2,000,000.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n9. MARCO ISLAND-MARCO SHORES PERMITS - (CONTINUED)\nSuch settlement enabled the Company to resolve the claims of an additional 12.7% of its affected customers and re-evaluate the allowance for Marco permit costs. As a result of such analysis, the Company was able to reduce such allowance by $12,200,000, resulting in a $3,983,000 extraordinary gain in 1992 and a $500,000 credit to accrued expenses to be credited to paid-in capital following issuance of 250,000 shares of restricted Common Stock of the Company to the class members. At December 31, 1994, $2,897,000 remained in the allowance for Marco permit costs, including $578,000 relating to interest accrued on such obligations. Based upon the Company's experience with affected customers, the Company believes that its total obligations to the three remaining affected customers will not materially exceed the amount provided for in the accompanying Consolidated Financial Statements. See \"Legal Proceedings\".\nInformation with respect to the allowance for Marco permit costs follows:\n10.COMMON STOCK AND EARNINGS PER SHARE INFORMATION\nUnder the Company's 1987 Stock Incentive Plan (the \"Stock Plan\"), an aggregate of 500,000 shares of Common Stock have been reserved for the granting of non-qualified stock options and the award of incentive shares to such executive officers and other key employees of the Company as may be determined by the Committee administering the Stock Plan. The extent to which incentive shares are earned and charged to expense will be determined at the end of the three-year award cycle, based on the achievement of the Company's net income goal for the award cycle. Payment of incentive shares earned may be made in shares of the Company's Common Stock and\/or cash. If paid in cash, such payment will be based on the average daily closing price of the Company's Common Stock during the last month of the award cycle. The option features of the Stock Plan are substantially the same as the Company's incentive stock option plan described above. A total of 79,940 shares were issued and $233,412 was paid with respect to awards earned under the Stock Plan as of December 29, 1989 and no additional awards were granted until March 1993 when Bruce Weiner was granted 20,000 shares of the Company's Common Stock at a price of $4.00 per share, which was in excess of the market value of the Company's Common Stock on the grant date. Such option expired unexercised following Mr. Weiner's removal as an officer of the Company in 1994.\nOn June 18, 1992, in conjunction with the Sixth Restatement, the Company issued warrants to its lenders for the purchase of 277,387 shares of Common Stock at $1.00 per share (the Warrants\"). The Warrants became exercisable on June 18, 1992, were subject to mandatory repurchase by the Company at the request of the holder at any time after December 18, 1993 at 75% of the market price of the Company's Common Stock (unless such repurchase would cause a default under the Sixth Restatement or unless the Company elected to effect an underwritten public offering on a firm commitment basis), and expired on the later of: (i) 30 days after payment in full of all debt under the Sixth Restatement; (ii) July 31, 1997, or (iii) such later date as to which the expiration date had been extended to implement the provisions applicable to the mandatory repurchase option.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n10.COMMON STOCK AND EARNINGS PER SHARE INFORMATION - (CONTINUED)\nOn December 2, 1992, the Company entered into a Warrant Exercise and Debt Reduction Agreement with Yasawa, providing for the number of shares issuable upon acquisition of the Warrants by Yasawa and the exercise of such Warrants by Yasawa to be increased from 277,387 shares of Common Stock to 289,637 shares of Common Stock, and adjusting the exercise price to an aggregate of approximately $314,000. On December 11, 1992, following the acquisition of the Bank Loan and the Warrants by Mr. Gram and the immediate transfer of the Bank Loan and the Warrants by Mr. Gram to Yasawa, Yasawa exercised the Warrants in exchange for debt reduction credit to the Company of approximately $314,000.\nAs part of the Selex transaction, Selex was granted an option which was approved by the holders of a majority of the outstanding shares of the Company's Common Stock at the Company's 1992 Annual Meeting, to convert the Selex Loan, or any portion thereof, into a maximum of 850,000 shares of the Company's Common Stock at a per share conversion price equal to the greater of (i) $1.25 or (ii) 95% of the market price of the Company's Common Stock at the time of conversion, but in no event greater than $4.50 per share (the \"Option\"). However, on September 14, 1992, Selex formally waived and relinquished its right to exercise the Option as to 250,000 shares of the Company's Common Stock to enable the Company to settle certain litigation involving the Company through the issuance of approximately 250,000 shares of the Company's Common Stock to the claimants, without jeopardizing the utilization of the Company's net operating loss carryforward. On February 17, 1994, Selex exercised the remaining full 600,000 share Option at a conversion price of $1.90 per share, such that $1,140,000 in principal was repaid under the First Selex Loan through such conversion. As a consequence of such conversion, Selex holds 2,820,066 shares of the Company's Common Stock (42.06% of the outstanding shares of Common Stock of the Company based upon the number of shares of the Company's Common Stock outstanding as of March 24, 1995).\nEarnings (loss) per common and common equivalent share were computed by dividing net income (loss) by the weighted average number of shares of Common Stock and common stock equivalents outstanding during each period. The earnings (loss) per share and the average number of shares of Common Stock and common stock equivalents used to calculate earnings per share for 1994, 1993 and 1992 were $(3,906,000), $(8,772,000) and $7,336,000 and 6,668,765, 6,065,743 and 5,694,236, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)\nTHE DELTONA CORPORATION AND SUBSIDIARIES\n11. BUSINESS SEGMENTS\nSUPPLEMENTAL UNAUDITED QUARTERLY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nITEM 14","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14\nEXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) 1. FINANCIAL STATEMENTS\nSee Item 8, Index to Consolidated Financial Statements and Supplemental Data.\n(A) 2. FINANCIAL STATEMENT SCHEDULES\nPAGE ----\nIndependent Auditors' Report......................... 62\nSchedule VIII - Valuation and qualifying accounts for the three years ended December 31, 1994................................. 63\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 or the 1995 Annual Meeting Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, incorporated herein by reference.\n(A) 3. EXHIBITS\nSee the Exhibit Index included herewith.\n(B) REPORTS ON FORM 8-K\nAs stated in the Company's Annual Report on Form 10-K for 1993, a Report on Form 8-K dated February 17, 1994 responding to Item 5 \"Other Events\" was filed on March 14, 1994.\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF THE DELTONA CORPORATION:\nWe have audited the consolidated financial statements of The Deltona Corporation and subsidiaries (the \"Company\") 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 March 24, 1995 (which expresses an unqualified opinion and includes explanatory paragraphs relating to the Company's ability to continue as a going concern and uncertainty as to the Company's ability to estimate future cancellations of certain contracts and mortgages receivable sold with recourse), included elsewhere in this Annual Report on Form 10-K. Our audits also included the financial statement schedules listed in Item 14(a)2 of this Annual Report on Form 10-K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP Certified Public Accountants Miami, Florida March 24, 1995\nSCHEDULE VIII\nTHE DELTONA CORPORATION AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTHE DELTONA CORPORATION (Company)\nBy \/s\/ EARLE D. CORTRIGHT, JR. DATE: March 31,1995 ------------------------------------ Earle D. Cortright, Jr., PRESIDENT & CHIEF OPERATING OFFICER\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 indicated on the date indicated.\n\/s\/ ANTONY GRAM \/s\/ CORNELIS VAN DE PEPPEL - -------------------------------- ---------------------------- Antony Gram, CHAIRMAN OF THE Cornelis van de Peppel, BOARD OF DIRECTORS & CHIEF DIRECTOR EXECUTIVE OFFICER\n\/s\/ EARLE D. CORTRIGHT, JR. \/s\/ CORNELIS L.J.J. ZWAANS - -------------------------------- ------------------------------ Earle D. Cortright, Jr., Cornelis L.J.J. Zwaans, PRESIDENT & CHIEF OPERATING DIRECTOR OFFICER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)\n\/s\/ NEIL E. BAHR - ------------------------------- Neil E. Bahr, DIRECTOR\n\/s\/ GEORGE W. FISCHER - ------------------------------- George W. Fischer, DIRECTOR\n\/s\/ THOMAS B. MCNEILL - ------------------------------- Thomas B. McNeill, DIRECTOR\n\/s\/ MARCELLUS H.B. MUYRES - ------------------------------- Marcellus H.B. Muyres, DIRECTOR\n\/s\/ LEONARDUS G.M. NIPSHAGEN - ------------------------------- Leonardus G.M. Nipshagen, DIRECTOR DATE: March 31, 1995","section_15":""}
{"filename":"799036_1994.txt","cik":"799036","year":"1994","section_1":"ITEM 1. BUSINESS -----------------\nGENERAL\nPioneer Financial Services, Inc. (the Company) markets and underwrites life insurance and health insurance in selected niche markets throughout the United States. The Company concentrates on three core insurance businesses: Life Insurance, Senior Health Insurance and Group Medical. The Company also has a Medical Utilization Management unit which in part supports the Group Medical Division.\nThe Life Insurance Division underwrites mid-sized term insurance, interest sensitive and universal life insurance for the middle income and Senior markets. In January 1995, the Company acquired Connecticut National Life Insurance Company which will increase gross annual revenue by approximately $35 million and total assets by over $350 million.\nThe Life Insurance Division is organized to sell its products through a national network of brokerage general agents (BGAs). Manhattan National Life has developed a network of 50 BGAs who in the aggregate contract with approximately 10,000 brokers across the nation to sell the Company's product line to fit their niche needs. With the addition of Connecticut National Life, 50 BGAs and approximately 10,000 brokers are added to this national distribution system. Since the distribution systems of Connecticut National Life and Manhattan National Life are nearly mirror images, the blending of companies enhances the product portfolios of each company.\nThe Senior Health Insurance Division concentrates on underwriting and administering a full range of specialty health insurance for Americans age 65 and older. The products include traditional Medicare supplement, Medicare Select, group Medicare supplement, long term care and home health care. A nationwide brokerage network of 15,000 individual agents sells the Company's Senior products. These agents also distribute the Company's life insurance and annuity products, with this revenue being reflected in the Life Insurance Division. The Senior Health Insurance Division accounted for 34% of the Company's health insurance premiums in 1994.\nThe Group Medical Division markets, underwrites and administers small group and individual major medical policies and markets managed care products (health maintenance organizations--HMOs) for self-employed individuals and small business owners. The Division also provides insurance and non- insurance marketing services for unaffiliated insurance companies and associations. The Company's marketing subsidiaries in this Division receive commission overrides and other fee income from these client companies, which increases revenues without adding to the insurance underwriting risk liability. The Division markets through two sales units: a nationwide force of approximately 1,800 trained career agents, an a network of over 50 professional telemarketing representatives who access approximately 9,500 independent insurance brokers nationwide through the Company's computer database. The Company also has an established telemarketing subsidiary with facilities in Phoenix, Arizona, and Arlington, Texas. The Division accounted for 66% of the Company's health insurance premiums in 1994.\nThe Company's Medical Utilization Management unit provides healthcare coordination to control medical expense costs for insurance companies, government agencies, self-insured businesses, unions, HMOs and third party\nadministrators. Services include precertification of care, provider networks and case management. This unit's services provide significant claims cost savings for the Company's Group Medical Division. In addition, the unit markets its services to many unaffiliated companies and organizations. In 1994, approximately 68% of the unit's revenue was derived from services provided to unaffiliated organizations.\nThe Company was organized in Delaware in 1982 as a successor to an Illinois holding company formed in 1957. The Company's largest operating insurance subsidiary is Pioneer Life Insurance Company of Illinois (Pioneer Life), a successor to a company organized in 1926. Health and Life Insurance Company of America, National Group Life Insurance Company, Manhattan National Life Insurance Company and Continental Life & Accident Company were acquired in 1985, 1986, 1990 and 1993, respectively, primarily for specialized marketing purposes.\nThe executive offices of the Company are located at 1750 East Golf Road, Schaumburg, Illinois 60173, and it telephone number is (708) 995-0400. The term \"Company\" refers to Pioneer Financial Services, Inc. (PFS) and, unless the context otherwise requires, its subsidiaries.\nInformation on revenue and pre-tax income by Business Division is set forth in Note 20 of the Notes to Consolidated Financial Statements.\nPRODUCTS\nLIFE INSURANCE DIVISION\nSubstantially all of the Company's life insurance policies are individually and medically underwritten and issued, other than small accidental death benefit policies, which are not material to the Company.\nThe following table sets forth the breakdown of premiums collected (including receipts not related to policy charges) among traditional life policies (term and whole life), interest sensitive and universal life policies and annuities for the periods shown:\nYear Ended December 31, ---------------------------------------------------------- 1994 1993 1992 ---------------- ----------------- ----------------- Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- (Dollars in thousands)\nTraditional $32,238 44 $26,353 50 $20,300 45 Int Sensitive & Univ Life 17,590 24 16,300 31 18,399 41 Annuties 22,807 32 10,004 19 6,212 14 ------- --- ------- --- ------- --- Total $72,635 100 $52,657 100 $44,911 100\nFor 1992, premium collected from the Company's life insurance products were approximately 27% first year and 73% renewal, for 1993 approximately 24% were first year and 76% renewal, and for 1994 premiums collected were approximately 28% first year and 72% renewal.\nThe Company's gross life insurance in force was as follows at the dates shown:\nDecember 31, ------------------------------ 1994 1993 1992 ---- ---- ---- (Dollars in millions) Traditional $10,803 $10,320 $ 8,757 Interest Sensitive & Universal Life Policies 1,779 1,503 1,582 ------- ------- ------- Total $12,582 $11,823 $10,339\nTRADITIONAL LIFE. The largest portion of the Life Insurance Division's business is in term life insurance, specializing in face amounts of $100,000 to $500,000, sold to middle and higher income families. Marketed under the name \"Super Saver Term,\" this series features low cost 5, 10 and 15 year term life insurance products.\nIn 1994 the Company also began selling a significant amount of smaller unit whole life insurance policies specifically designed to cover final expenses for senior citizens.\nFor a number of years, the Company's subsidiary, Manhattan National Life, has offered individually underwritten insurance on lives of persons who, to varying degrees, do not meet the requirements of standard insurability. Higher premiums are charged for these \"impaired\" or \"substandard\" lives, and, where the amount of insurance is large or the risk is significant, a portion of the risk is reinsured.\nINTEREST SENSITIVE LIFE AND UNIVERSAL LIFE. The Company's interest sensitive and universal life insurance products provide life insurance with rates of return which are adjusted in relation to prevailing interest rates. The policies permit the Company to change the rate of interest credited to the policy from time to time. Universal life insurance products credit current interest rates to cash value accumulations, permit adjustments in benefits and premiums at the policyholder's option, and deduct mortality and expense charges monthly. Under other interest sensitive policies, premiums are flexible, allowing the policyholders to vary the frequency and amount of premium payments, but typically death benefit changes may not be made by the policyholders. Some universal life products offer lower premiums for non- smokers in good health. For both universal life and other interest sensitive policies, surrender charges, if any, are deducted from the policyholder's account value at the time of surrender. No surrender charges are deducted if death benefits are paid or if the policy remains in force for a specified period.\nThe Company's \"Interest Sensitive Series\" includes whole life policies ideally suited for the impaired risk market. This product series provides permanent protection with a fixed, guaranteed level premium and an interest rate persistency bonus. The \"Financial Lifestyle II\" is a highly flexible back-load universal life policy providing low-cost protection with tax- deferred cash accumulation.\nANNUITIES. The Company's single and flexible premium deferred annuities are offered to individuals. An annuity contract generally involves the accumulation of premiums at a compound interest rate until the maturity date, at which time the policyholder can choose one of the various payment options. Options include periodic payments during the annuitant's lifetime or the lifetime of the annuitant and spouse, with or without a guaranteed minimum\nperiod; periodic payments for a fixed period regardless of the survival of the annuitant; or lump sum cash payment of the accumulated value. The Company's annuities typically provide for the crediting of interest at rates set from time to time by the Company.\nSENIOR HEALTH INSURANCE DIVISION\nThe Company's Senior Health products, all of which are individually underwritten and issued, include Medicare supplement insurance, long term care, home health care and various specialty health coverages.\nMEDICARE SUPPLEMENT. Since the inception of the Medicare program in 1966, the Company has offered policies designed to supplement Medicare benefits. Such policies accounted for approximately 37% of health premiums in 1992, approximately 33% of health premiums in 1993 and approximately 27% of health premiums in 1994. These policies provide payment for deductibles and the excess over maximum limits of the federal Medicare program. Under these policies, annual premiums may be increased if policy benefits increase as a result of changes in Medicare coverage. In 1991 the National Association of Insurance Commissioners (NAIC) defined 10 model Medicare supplement policies. In states which have adopted the NAIC model, only those 10 policies can be sold. In most states, the Company markets 8 of the 10 model policies--those which the Company believes are most applicable to the Company's market. All states have adopted the NAIC model or similar legislation which specifically defines policy models.\nThe federal government began a test program, allowing 15 specified states to participate in a \"Medicare Select\" program. Medicare Select policies combine the cost advantages of a preferred provider organization with a Medicare supplement policy to provide a reduced premium cost for policyholders. Utilizing specified medical providers, certain costs are reduced and these savings are passed on to the consumer through the insurance company. The Company markets Medicare Select policies in a number of states and has plans to expand into the other available states. In addition, if the federal government allows the Medicare Select program to expand to other states, the Company plans to also expand its marketing to those additional states.\nLONG TERM CARE AND HOME HEALTH CARE. The Company also offers long term care and home health care products designed principally for Senior citizens. Long term care policies generally provide specified per day benefits for nursing home confinements. Home health care policies provide specified per day benefits for required health services received in the home, and comprehensive coverages which provide benefits for all levels of nursing home care, home health care and adult day care.\nSPECIALTY HEALTH. The Company offers various specialty health products which typically are sold in conjunction with the Company's principal health products. Policies include hospital indemnity, private duty nursing and cancer plans.\nGROUP MEDICAL DIVISION\nThe Group Medical Division's products include health insurance products individually underwritten and issued. For 1992, 1993 and 1994, the Division produced health insurance premium revenue of approximately $306,880,000, $357,784,000 and $431,831,000, respectively. The Division also derives marketing commission revenue and other fee income through marketing insurance and other products of unaffiliated companies and associations.\nThe insurance products marketed and underwritten by the Company's subsidiaries include major hospital and specialty health insurance products.\nMAJOR HOSPITAL. The Company offers major hospital insurance plans on an individual basis and on a group trust and association basis and has issued master policies for such plans to several trusts and associations. These plans are designed to cover in-hospital expenses for self-employed individuals, small business owners, employees and their families. Hospital, surgical and other medical expenses are covered on an expense incurred basis with certain benefit limits after a prescribed deductible. The Company provides products with benefit alternatives such as increased deductibles and different benefit structures designed to enable policyholders to maintain insurance protection without increased premium rates. In 1994 the Company introduced \"ChoicePlus,\" a product which combines HMO-type wellness features within a specific provider network along with in-network and out-of-network indemnity benefits.\nIn December 1991, the NAIC adopted the Small Employers Availability Act (Act). This Act affects the rating and underwriting methodology that can be applied to insurance coverage sold to small employers, generally categorized as those employing 25 people or less. In response to the Act, the Company has modified and continues to modify its new products for sale in those states adopting the Act or adopting other healthcare reforms.\nThe Marketing Unit of the Group Medical Division also derives revenue through sales of products of unaffiliated insurance companies. These products include medical insurance for medium-sized groups (50 or more), employer self-funded plans, flexible premium universal life insurance, disability income protection and annuities. The Company also markets HMO products in areas where these products have a significant competitive advantage over traditional indemnity insurance products. The HMO products are sold in selected states through marketing relationships with regional HMOs. In addition to commission revenue, sales of these HMOs provide the sales force with opportunities to cross-sell the Company's other products.\nAnother unit of this Division markets membership benefit packages to various national associations. These packages include discounts on dental services, hotels\/motels, airfares, prescription drugs, vision and hearing aid equipment and other services.\nPREMIUMS AND LOSS RATIOS\nIn both the Senior Health Insurance Division and the Group Medical Division, the Company may adjust premium rates by class, policy form and state in which the policy is issued subject to applicable regulation in order to maintain anticipated loss ratios. Since premium rate adjustments can have the tendency to increase policy lapses, conservation and customer service activities are emphasized. As a result, the Company has successfully avoided any significant increases in policy lapses in both the small business and Senior citizen markets. Both health insurance divisions follow a proactive approach involving strict scrutiny of all health premium rates on a monthly basis. The matching of pricing structure with the actual claims experience varies by product line and state. This ongoing analysis provides the time basis necessary for orderly adjustment of premiums.\nThe Company's loss ratios have varied over the years reflecting changes in medical claim costs and the frequency of benefit utilization by its insureds. The following table sets forth the earned premiums, losses and loss adjustment expenses incurred and loss ratios for the Company's accident and\nhealth business. Earned premiums reflect written premiums adjusted for reinsurance and changes in unearned premiums. In the Company's statement of consolidated operations, premiums represent premiums written, adjusted for reinsurance; the changes in unearned premiums are reflected in benefits, together with losses and loss adjustment expenses. Losses and loss adjustment expenses include losses incurred on insurance policies and the expenses of settling insurance claims, including legal and other related fees and expenses.\nYear Ended December 31, ---------------------------------------------- 1994 1993 1992 1991 1990 ------ ------ ------ ------ ------ (Dollars in thousands)\nSenior Health Earned premiums . . . . . $225,604 $243,482 $264,697 $298,653 $249,409 Losses and loss adjustment expenses . . . . . . . 137,853 154,561 176,149 200,446 173,307 Loss ratio . . . . . . . 61% 63% 67% 67% 69% Group Medical Earned premiums . . . . . $443,599 $375,275 $302,881 $294,431 $234,004 Losses and loss adjustment expenses . . . . . . . 279,419 251,955 200,781 176,222 168,939 Loss ratio . . . . . . . 63% 67% 66% 60% 72% Total Accident and Health Earned premiums . . . . . $669,203 $618,757 $567,578 $593,084 $483,413 Losses and loss adjustment expenses . . . . . . . $417,272 $406,516 376,930 376,668 342,246 Loss ratio . . . . . . . 62% 66% 66% 64% 71%\nPREMIUM DISTRIBUTION\nThe Company's insurance subsidiaries collectively are licensed to sell insurance in 49 states and the District of Columbia. The importance to the Company of particular states may vary over time as the composition of its agency network changes. The geographic distribution of collected premiums (before reinsurance) of the Company's subsidiaries in 1994 was as follows:\nTotal Percent _____ _______ (Dollars in thousands)\nTexas $77,298 10.3 Florida 77,151 10.2 California 57,779 7.7 Illinois 57,087 7.6 North Carolina 31,640 4.2 Ohio 22,992 3.1 Pennsylvania 22,891 3.0 Other (1) 406,471 53.9 -------- ----- Total $753,309 100.0\n(1) Includes 42 other states, the District of Columbia, and certain U.S. territories and foreign countries, each of which account for less than 3% of collected premiums.\nUNDERWRITING\nA major portion of the Company's insurance coverages are individually underwritten to assure that policies are issued by the Company's insurance subsidiaries based upon the underwriting standards and practices established by the Company. Applications for insurance are reviewed to determine if any additional information is required to make an underwriting decision, which depends on the amount of insurance applied for and the applicant's age and medical history. Such additional information may include medical examinations, statements from doctors who have treated the applicant in the past and, where indicated, special medical tests. If deemed necessary, the Company uses investigative services to supplement and substantiate information. For certain coverages, the Company may verify information with the applicant by telephone. After reviewing the information collected, the Company either issues the policy as applied for, issues the policy with an extra premium charge due to unfavorable factors, issues the policy excluding benefits for certain conditions for a period of time or rejects the application. For certain of its coverages, the Company has adopted simplified policy issue procedures in which the applicant submits a simple application for coverage typically containing only a few health related questions instead of a complete medical history.\nIn common with other life and health insurance companies, the Company may be exposed to the risk of claims based on AIDS. The Company's AIDS claims to date have been insignificant. Because of its emphasis on policies written for the senior citizen market and its underwriting procedures and selection processes, the Company believes its risk of AIDS claims is less than the risk to the industry in general.\nREINSURANCE\nThe Company's insurance subsidiaries reinsure portions of the coverages provided by their insurance products with other insurance companies on both an excess of loss and co-insurance basis. Co-insurance generally transfers a fixed percentage of the Company's risk on specified coverages to the reinsurer. Excess of loss insurance generally transfers the Company's risk on coverages above a specified retained amount. Under its excess of loss reinsurance agreements, the maximum risk retained by the Company on one individual in the case of life insurance is $100,000 ($250,000 in the case of Manhattan National Life) and in the case of accident and health insurance is $250,000.\nReinsurance agreements are intended to limit an insurer's maximum loss on the specified coverages. The ceding of reinsurance does not discharge the primary liability of the original insurer to the insured, but it is the practice of insurers (subject to certain limitations of state insurance statutes) to account for risks which have been reinsured with other approved companies, to the extent of the reinsurance, as though they are not risks for which the original insurer is liable. See Note 6 of Notes to Consolidated Financial Statements.\nThe Company has occasionally used assumption reinsurance to acquire blocks of business from other insurers. In addition, the Company has from time to time entered into agreements to assume certain insurance business from companies for which it is marketing insurance products. The Company intends to continue these programs if they assist in expanding product lines and marketing territories.\nINVESTMENTS\nInvestment income represents a significant portion of the Company's\ntotal revenues. Insurance company investments are subject to state insurance laws and regulations which limit the types and concentration of investments. The following table provides information on the Company's investments as of the dates indicated.\nDecember 31, ------------------------------------- 1994 1993 -------------- ------------- Amount % Amount % ------ --- ------ --- (Dollars in thousands)\nFixed maturities to be held to maturity: U.S. Treasury $ 8,891 1% $ 9,124 1% States and political subdivisions 8,888 1 5,200 1 Foreign governments 2,992 1 - - Corporate securities 147,419 20 119,276 18 Mortgage-backed securities 210,460 29 192,912 29 -------- ---- -------- ---- Total fixed maturities to be held to maturity 378,650 52 326,512 49\nFixed maturities available for sale: U.S. Treasury 21,852 3 26,894 4 States and political subdivisions 25,819 3 21,571 3 Foreign governments 3,465 1 4,056 1 Corporate securities 89,401 12 73,981 11 Mortgage-backed securities 78,211 11 131,215 19 -------- ---- -------- ---- Total fixed maturities available for sale 218,748 30 257,717 38 -------- ---- -------- ----\nEquity securities........... 15,440 2 17,436 3 Real estate................. 16,959 2 - - Mortgage and policy loans... 24,888 4 27,189 4 Short-term investments...... 69,152 10 45,352 6 -------- ---- -------- ----\nTotal Investments....... $723,837 100% $674,206 100% ======== ==== ======== ====\nAt December 31, 1994, the average expected term of the Company's fixed maturity investments was approximately five years. The results of the investment portfolio for the periods shown were as follows:\nYear Ended December 31, ----------------------------------- 1994 1993 1992 -------- -------- -------- (Dollars in thousands)\nAverage month-end investments . $679,331 $592,546 $549,643 Net investment income . . . . . 42,786 40,242 43,555\nAverage annualized yield on investments (1) . . . . . . . 6.3% 6.8% 7.9% Realized investment losses (2) . . . . . . . . . . $ (383) $ (1,336) $ (47)\n(1) Not computed on a taxable equivalent basis. Includes interest income paid or accrued on fixed maturity securities and loans and dividends on equity securities.\n(2) See Note 4 of Notes to Consolidated Financial Statements for information on unrealized appreciation (depreciation) on investments.\nThe Company's investment policy is to balance its portfolio between long-term and short-term investments so as to achieve investment returns consistent with preservation of capital and maintenance of liquidity adequate to meet payment of policy benefits and claims. Current policy is to invest primarily in fixed income securities of the U.S. government and its agencies and authorities, and in fixed income corporate securities with investment grade ratings of Baa or better. At December 31, 1994, less than 1% of the Company's total investment portfolio was below investment grade or unrated. The Company intends to invest no more than 4% of its admitted assets in securities below investment grade.\nFor a detailed discussion of the Company's investment portfolio, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nPOLICY LIABILITIES\nThe Company records reserves for future policy benefits to meet future obligations under outstanding policies. These reserves are amounts which are calculated to be sufficient to meet policy and contract obligations as they mature. The amount of reserves for insurance policies is calculated using assumptions for interest, mortality and morbidity, expenses and withdrawals. Reserves are established at the time the policy is issued and adjusted periodically based on reported and unreported claims or other information. See Note 1 of Notes to Consolidated Financial Statements.\nCOMPETITION\nThe insurance business is highly competitive and includes a large number of insurance companies, many of which have substantially greater financial resources and larger and more experienced staffs than the Company. The Company competes with other insurers to attract and retain the allegiance of its independent agents and marketing organizations who at this time are responsible for most of the Company's premiums. Methods of competition include the Company's ability to offer competitive products and to service these programs efficiently. Other competitive factors applicable to the Company's business include policy benefits, service to policyholders and premium rates.\nHEALTHCARE REFORM\nMany proposals have been introduced in Congress and various state legislatures to reform the present healthcare system. Most of these proposals are specifically directed at the small group healthcare market, a significant portion of the Company's health business. At the state level, a number of states have passed or are considering legislation that would limit the differentials in rates that carriers could charge between new business\nand renewal business with respect to similar demographic groups. Legislation also has been adopted or is being considered that would make health insurance available to all small groups by requiring coverage of all employees and their dependents, by limiting the applicability of pre-existing conditions exclusions, by requiring carriers to offer a basic plan exempt from certain mandated benefits as well as a standard plan and by establishing a mechanism to spread the risk of high risk employees to all small group carriers.\nAt the federal level, it is not possible to predict which proposal, if any, will be adopted by Congress or when such a proposal may be enacted. However, we do expect there to be insurance market reforms in any package that would be passed. The Company is monitoring developments concerning healthcare reform and preparing its strategic responses to different possible reform scenarios. In response to existing legislation and in anticipation of future healthcare reform, the Company has broadened its senior health insurance, life insurance and medical utilization management business and has continued to diversify products and services in selected market areas that the Company believes will be consistent with its targeted market focus and be less affected by healthcare reform. It is likely that healthcare reform at the federal and state levels will require the Company to make significant changes to the way it conducts its health insurance business, but it is not possible at this time to predict the nature or effects of healthcare reform or how soon it will be adopted and implemented, if at all. If state small group reform continues to add restrictions to insurance business and the federal government assumes responsibility for regulation and payment of much of the healthcare that is now handled by the private sector, this would significantly reduce or eliminate the Company's group medical insurance business.\nGOVERNMENT REGULATION\nIn common with all domestic insurance companies, the Company's insurance subsidiaries are subject to regulation and supervision in the jurisdictions in which they do business under statutes which typically delegate regulatory, supervisory and administrative powers to state insurance commissions. The method of such regulation varies, but regulation relates generally to the licensing of insurers and their agents, the nature of and limitations on investments, approval of policy forms, reserve requirements, the standards of solvency which must be met and maintained, deposits of securities for the benefit of policyholders, periodic examination of insurers, and trade practices, among other things. The Company's accident and health coverages generally are subject to rate regulation by state insurance departments which in certain cases require that certain minimum loss ratios be maintained.\nCertain states also have insurance holding company laws which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The Company's insurance subsidiaries are subject to such laws and are registered as controlled insurers in those jurisdictions in which such registration is required. Such laws vary from state to state but typically require periodic disclosure concerning the corporation which controls the registered insurers and all subsidiaries of such corporation, and prior notice to, or approval by, the state insurance department of intercorporate transfers of assets and other transactions (including payments of dividends in excess of specified amounts by the insurance subsidiary) within the holding company system.\nEMPLOYEES\nAs of December 31, 1994, the Company employed approximately 1,900 persons on a full-time basis. The Company considers its employee relations to be good.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning the executive officers and directors of the Company is set forth below:\nPeter W. Nauert............... 51 Chairman, Chief Executive Officer, Director\nCharles R. Scheper............ 42 President - Life Division and Director\nThomas J. Brophy.............. 59 President - Health Division and Director\nWilliam B. Van Vleet.......... 70 Executive Vice President, General Counsel, and Director\nAnthony J. Pino............... 47 Executive Vice President\nPhilip J. Fiskow.............. 38 Senior Vice President and Chief Investment Officer\nErnest T. Giambra, Jr..........47 Executive Vice President\nDavid I. Vickers.............. 34 Vice President, Treasurer and Chief Financial Officer\nMichael A. Cavataio........... 50 Director\nRichard R. Haldeman........... 51 Director\nR. Richard Bastian, III....... 48 Director\nKarl-Heinz Klaeser............ 62 Director\nMichael K. Keefe.............. 50 Director\nRobert F. Nauert.............. 70 Director\nCarl A. Hulbert............... 72 Director\nAll executive officers are elected annually and serve at the pleasure of the Board of Directors.\nPeter W. Nauert has been Chief Executive Officer and a director of the Company since its incorporation in 1982. He was President of the Company from 1982 to 1988 and became Chairman of the Company in 1988. On September 1, 1991, he was again elected President. Since 1968, Mr. Nauert has been employed in an executive capacity by one or more of the Company's insurance subsidiaries.\nCharles R. Scheper was elected President of the Company in March 1995. He was Vice President of the Company from 1991 to March 1995 and was Chief Financial Officer from May 1993 to December 1993. In March 1992, he was elected Executive Vice President. Since February 14, 1992, he has been President and Vice Chairman of the Board of Manhattan National Life. Prior\nto the Company's acquisition of Manhattan National Life, Mr. Scheper was Manhattan's Senior Vice President and Chief Financial Officer, a position which he held from May 1987. Prior to joining Manhattan National Life, Mr. Scheper was with Union Central Life from 1979, having served as Vice President and Controller since 1985.\nThomas J. Brophy was elected President of the Company in March 1995. He was Senior Vice President since joining the Company in November 1993. Prior to joining the Company, Mr. Brophy was President and Chief Operating Officer of Southwestern Life Insurance Company from June 1990 to September 1993. Mr. Brophy also held senior executive positions with various I.C.H. Corporation subsidiaries from March 1974 to his joining of the Company in November 1993.\nWilliam B. Van Vleet has been Executive Vice President of the Company since 1986 and a director of the Company since 1982. He was General Counsel of the Company from 1982 to 1988. In June 1991, he was again elected General Counsel. Mr. Van Vleet has served Pioneer Life since 1948 as General Counsel and a Director. Mr. Van Vleet also serves as an Officer and Director of other subsidiaries of the Company.\nAnthony J. Pino was elected Executive Vice President of the Company in May 1993. He was Senior Vice President of the Company from March 1992 to May 1993 and was President of National Group Life Insurance Company from July 1991 to June 1992. Mr. Pino has served as President of National Health Services since 1992. Prior to joining the Company, Mr. Pino was Chief Operating Manager of American Postal Workers' Union Health Plan, a position which he held from October 1982.\nPhilip J. Fiskow has been Senior Vice President since May 1993 and the Chief Investment Officer since joining the Company in 1991. He was Vice President of the Company from June 1991 until May 1992. He is also an officer of other subsidiaries of the Company. Mr. Fiskow was with Asset Allocation and Management as an Investment Advisory Portfolio Manager from January 1989 to June 1991. From May 1987 to December 1988 he was an Investment Advisor with Van Kampen Merritt and a Portfolio Manager with Aon Corporation from May 1981 to May 1987.\nErnest T. Giambra, Jr. was elected Senior Vice President of the Company in June 1993. Prior to joining the Company, Mr. Giambra had been with Bankers Life Holding Corporation since 1969 where he had served as Vice President of Sales since 1988.\nDavid I. Vickers has been with the Company since June 1992 and has been a Vice President of the Company since December 1992, Treasurer since May 1993 and Chief Financial Officer since January 1994. He is also an Officer and Director of several subsidiaries of the Company. Prior to joining the Company he was with the public accounting firm of Ernst & Young since 1983 where he was a Senior Manager in the Insurance Division. Mr. Vickers also serves as Treasurer for certain of the Company's insurance subsidiaries.\nMichael A. Cavataio has been a Director of the Company since 1986. Mr. Cavataio has also been President of Lillians, a chain of retail clothing stores, since 1980.\nRichard R. Haldeman has been a Director of the Company since 1986 and was Secretary from 1988 to June 1990. Mr. Haldeman has been a partner of Haldeman & Associates, a law firm, since June 1990. He was a partner of Williams & McCarthy, P.C., a law firm, from 1975 to May 1990.\nR. Richard Bastian, III has been a Director of the Company since December 1994. Mr. Bastian is a management consultant, specializing in strategic planning and organizational development. Mr. Bastian's career includes over twenty-eight years in the financial services industry, most recently as President and Chief Executive Officer of Heritage Bank & Trust of Racine, Wisconsin. Prior to Heritage, he served as Chairman, President and Chief Executive Officer of Bank One, Rockford and its predecessor, First Community Bancorp, an $800 million multi-bank holding company. He has also held management positions at banks in Tulsa and Philadelphia where his banking career began in 1966.\nKarl-Heinz Klaeser has been a Director of the Company since 1986. Mr. Klaeser has also been a Director of LSW Holding Corporation and Insurance Investors Life Insurance Company and the Chairman of the Board of Life Insurance Company of the Southwest since 1989 and a Director of Personal Assurance Company PLC (United Kingdom) since 1991.\nMichael K. Keefe has been a Director of the Company since March 1994. Mr. Keefe has been Chief Executive Officer and Chairman of the Board of Keefe Real Estate, Inc., a family owned real estate brokerage operation since 1982. Mr. Keefe has also been Chairman of the Board of Southern Wisconsin Bankshares, Inc. since 1988.\nRobert F. Nauert has been a Director of the Company since November 1991. Mr. Nauert has also been a Director and President of Pioneer Life since 1988 and is a Director and Officer of various subsidiaries of the Company. Mr. Nauert is the brother of Peter W. Nauert.\nCarl A. Hulbert was elected Director of the Company in March 1995. Mr. Hulbert is a management consultant, specializing in the insurance industry. Mr. Hulbert is a past Insurance Commissioner of the state of Utah. He has also been a Director for numerous insurance companies during his 49 year business career.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties -------------------\nThe principal executive offices of the Company are located in Schaumburg, Illinois in a building purchased by the Company in January 1994. The Company, through a subsidiary, owns three buildings in Rockford, Illinois. The Company believes these facilities will adequately serve its needs for the foreseeable future and could accommodate expansion of the Company's business. The Company, through another subsidiary, also owns a building in the Dallas, Texas metropolitan area which currently serves as the main administrative office for the Company's Group Medical Division. The Company leases the office of its other regional service centers. The executive and administrative offices of Manhattan National Life are located in Cincinnati, Ohio in leased space.\nItem 3.","section_3":"Item 3. Legal Proceedings --------------------------\nThe Company and its subsidiaries are named as defendants in various legal actions, some claiming significant damages, arising primarily from claims under insurance policies, disputes with agents, and other matters. The Company's management and its legal counsel are of the opinion that the disposition of these actions 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 ------------------------------------------------------------\nNONE\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholders Matters -----------------------------------------------------------------------\nThe Company's Common Stock is traded on the New York Stock Exchange and Chicago Stock Exchange. The following table sets forth, for the periods indicated, the high and low last reported sale prices for the Common Stock on the New York Stock Exchange as reported on the consolidated transaction reporting system.\nHigh Low -------- ------- Quarter ended:\nMarch 31, 1993.............. 5 1\/2 4 3\/4 June 30, 1993............... 9 1\/8 5 1\/4 September 30, 1993.......... 10 7\/8 8 3\/8 December 31, 1993........... 14 10 1\/2\nMarch 31, 1994.............. 14 3\/4 11 1\/8 June 30, 1994............... 12 10 September 30, 1994.......... 10 1\/2 8 3\/4 December 31, 1994........... 10 8 3\/4\nAs of December 31, 1994, there were approximately 550 holders of record of the Company's Common Stock.\nOn March 18, 1994, the Company's Board of Directors announced a quarterly common stock dividend of 3.75 cents per share with a total of 15 cents per share paid in 1994.\nOn March 18, 1995, the Company's Board of Directors announced a quarterly common stock dividend of 4.5 cents per share with an expectation of a total of 18 cents per share to be paid for 1995.\nItem 6.","section_6":"Item 6. Selected Consolidated Financial Data ---------------------------------------------\nThe following selected consolidated financial data for the five years ended December 31, 1994; 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.\n(In thousands except per share amounts) Year Ended December 31, -------------------------------------------- 1994 1993 1992 1991 1990 ------ ------ ------ ------ ------\nOperating Data:\nAccident and health premiums$659,180 $601,684 $559,894 $593,236 $508,957 Life and annuity premiums and policy charges 44,929 39,282 35,219 33,321 30,693 Net investment income 42,786 40,242 43,555 47,974 48,416 Other income and realized\ninvestment gains\/losses 27,260 17,920 17,305 34,207 22,951 ------- ------- ------- ------- ------- Total revenues 774,155 699,128 655,973 708,738 611,017\nAccident and health benefits 407,249 397,963 368,046 376,820 367,790 Life and annuity benefits 42,947 39,419 47,622 46,128 46,889 ------- ------- ------- ------- ------- Total benefits 450,196 437,382 415,668 422,948 414,679 ------- ------- ------- ------- ------- Total benefits and expenses 748,133 680,364 681,409 695,418 625,178 ------- ------- ------- ------- -------\nIncome (loss) before income taxes 26,022 18,764 (25,436) 13,320 (14,161)\nNet income (loss) 17,149 12,145 (16,959) 8,872 (9,346)\nPreferred stock dividends 1,904 2,021 2,039 2,039 2,164 ------- -------- ------- -------- --------\nIncome (loss) applicable to common stockholders $15,245 $ 10,124 $(18,998) $ 6,833 $(11,510) ======= ======== ========= ======== =========\nNet income (loss) per common share Primary $ 2.36 $ 1.51 $(2.85) $ 1.02 $(1.72) Fully diluted 1.58 1.26 (2.85) 1.02 (1.72)\nDividends declared per common share .15 - - - -\nAverage common and common equivalent shares outstanding Primary 6,459 6,724 6,660 6,699 6,690 Fully diluted 12,734 10,731 8,195 8,234 8,226\n(In thousands except per share amounts) December 31, ------------------------------------------- Balance Sheet Data 1994 1993 1992 1991 1990 ------ ------ ------ ------ ------\nTotal investments $723,837 $674,206 $568,349 $528,725 $563,807 Deferred policy acquisition costs 225,618 260,432 269,674 313,453 309,016 Total assets 1,075,700 1,108,271 978,689 969,190 990,560 Policy liabilities 868,608 903,105 805,696 776,571 739,845 Short-term notes payable 20,093 5,575 12,931 6,371 16,218 Long-term notes payable 2,520 1,125 25,170 21,600 27,000 Subordinated Debentures 57,427 57,477 - - - Redeemable Preferred Stock 21,682 23,675 23,990 23,990 23,990 Stockholders' equity 68,328 68,872 62,732 75,470 64,738 Stockholders' equity per common share $ 11.55 $ 10.86 $ 9.21 $ 11.39 $ 9.77\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and\nResults of Operations -------------------------------------------------------------------------\nRESULTS OF OPERATIONS\n1994 COMPARED TO 1993\nDIVISION OVERVIEW -----------------\nThe income (loss) before income taxes by Division for 1994 and 1993 is as follows (in thousands):\n1994 1993 ---- ----\nGroup Medical $ 10,889 $ 6,528 Senior Health 13,420 12,255 Life Insurance 8,537 7,623 Medical Utilization Mgmt 2,026 (1,211) Corporate (8,850) (6,431) -------- -------- Total $ 26,022 $ 18,764 ======== ========\nGROUP MEDICAL -------------\nThe increase in pre-tax income for 1994 was due primarily to inclusion of the profits of Continental Life & Accident Company (CLAC), acquired in August 1993, and continued cost reduction plans. CLAC produced pre-tax profits of $2,787,000 in 1994 compared to a small loss in 1993.\nThe Division incurred a pre-tax charge of $1,700,000 in the third quarter of 1994 which was the net effect of a $16,700,000 adjustment to the deferred acquisition cost (DAC) asset and a reduction of group medical claim reserve margins of $15,000,000. Through its periodic review of the DAC asset, the Company recognized the impact of state healthcare reforms on the future profitability of certain of its group medical products. These reforms include mandated benefits, guaranteed issue requirements and limitations on premium rate increases. The Company identified blocks of this business that are not anticipated to achieve the future profit margins originally assumed.\nThe Company has also historically held margins in its group accident and health claim reserves to provide for potential adverse deviation. The claim reserve estimates are continually reviewed and adjusted as necessary. Based on payments through the first nine months of 1994, the Company determined that claim reserves contained significantly higher margins than originally projected. As a result, claim reserve margins of $15,000,000 were released in the third quarter of 1994. The Company continues to hold additional margins which it considers to be reasonable in its group medical claim reserves.\nSENIOR HEALTH -------------\nThe increase in pre-tax income was due to the reduction in loss ratios, from 63.5% to 61.1%, primarily on a mature block of nursing home business and realized investment gains compared to realized losses of $2,520,000 in 1993.\nThe improvements were offset by a 6.8% reduction in collected premium revenue during 1994.\nLIFE INSURANCE --------------\nThe increase in pre-tax income for the Life Insurance Division was due to a substantial increase in new sales, improved spreads on interest sensitive business, and a slight improvement in the unit cost per policy. Despite the decline in the average annual investment yield in 1994, the Division continued to aggressively manage the interest rate crediting strategy. The unit cost per policy improved 5% to approximately $76 in 1994 as compared to $80 in 1993. The mortality was consistent with levels experienced in 1993. Realized investment losses were $158,000 in 1994 compared to realized investment gains of $621,000 in 1993.\nMEDICAL UTILIZATION MANAGEMENT ------------------------------\nThe improvement in pre-tax profitability of this Division in 1994 compared to losses experienced in 1993 was due to the elimination of an unprofitable operating subsidiary in the fourth quarter of 1993 and a significant increase in new sales to unaffiliated customers. The revenue from unaffiliated customers increased 131% to $10,416,000 in 1994 of which 53% or $5,498,000 was related to the 1993 acquisition of Healthcare Review Corporation. The consolidation of certain operations in July 1994 resulted in reduced expense levels the second half of the year.\nCORPORATE EXPENSE AND INTEREST ------------------------------\nInterest expense increased in 1994 as compared to 1993 due to the issuance of the convertible subordinated debentures in July 1993 and the increase in other notes payable in 1994.\nCONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS ----------------------------------------------------------\nThe Company reported net income of $17,149,000 for the twelve months ended December 31, 1994, compared to $12,145,000 for the comparable period in 1993. The increase was due to profits from Continental Life & Accident Company (CLAC), improved loss ratios in the Senior Health Division, expense reductions and improved spreads in the Life Insurance Division, and increased revenue and margins in the Medical Utilization Management Division.\nTotal revenues increased $75,027,000 or 11% for the twelve month period in 1994 as compared to 1993. The increase in revenue is primarily due to the increase in premiums and policy charges of $63,143,000.\nAccident and health insurance premiums increased $57,496,000, or 10% in 1994 as compared to 1993. Premiums from major hospital plans increased $81,472,000 in 1994 as compared to 1993 primarily due to the acquisition of CLAC completed in August 1993. Total premiums attributable to the remaining mix of Medicare supplement and long-term care products decreased $23,976,000 or 4%.\nNet investment income increased $2,544,000 or 6% in 1994 compared to 1993. Annualized investment yields decreased from 6.8% in 1993 to 6.3% in 1994. The decrease in the investment yield was principally due to the\nshortening of the Company's average duration and the increased emphasis on tax-exempt securities included in the Company's portfolio.\nOther income and realized investment gains and losses increased $9,340,000 or 52% in 1994 compared to 1993. The increase in other income was due to the acquisitions of Healthcare Review Corporation (HRC) and CLAC in August 1993. In addition, the Company realized increased sales to unaffiliated customers in the Medical Utilization Management Division and by its marketing subsidiaries. Realized investment losses were $383,000 in 1994 compared to $1,336,000 in 1993. The remaining other income generated by the Company's other non-insurance subsidiaries remained relatively unchanged.\nTotal benefits increased $12,814,000 or 3% in 1994 as compared to 1993. Life and annuity benefits increased $3,528,000 or 9% in 1994 as compared to 1993 due to higher mortality on a closed block of universal life and an increase in in-force business. Accident and health benefits, which include the change in unearned premiums, increased $9,286,000 or 2%. The increase was due primarily to the increased amount of collected premiums. The accident and health loss ratios decreased to 62% from 66% in 1994 as compared to 1993. The improved loss ratios were due primarily to the previously discussed reduction in the group medical claim reserve margins.\nIn 1994 and 1993, managed healthcare efforts resulted in estimated net savings to the Company's Health Insurance Division of $67,000,000 and $41,000,000, respectively. These savings were primarily used to lower the amount of premium increases for policyholders, which the Company believes generally has the effect of decreasing lapse rates of these policies. The principal efforts and their approximate relative contributions to these estimated savings were as follows:\n1994* 1993* ---- ----\nPPOs (preferred provider organization) networks 40% 49% Precertification 10 5 Large case management 22 32 Usual and customary, rebundling, and prompt pay discounts 28 14 --- --- 100% 100% === ===\n--------------------- * Percent of total estimated savings from managed healthcare efforts.\nThe Company expects to continue to emphasize medical utilization management procedures to control claim costs. Although the Company cannot accurately determine the amount of savings which may be realized from such efforts in the future, the Company believes that it will be increasingly difficult to maintain this level of growth in cost savings due to the efficiencies that have already been achieved.\nGeneral expenses as a percent of premiums decreased in 1994 as compared to 1993 due to the continued emphasis on cost reduction in the Health and Life Insurance Divisions. However, insurance and general expenses (which include commission compensation to agents) increased $29,979,000 or 18% in 1994 compared to 1993. The increase was primarily caused by the increase in premium and policy charges and the acquisitions of HRC and CLAC.\nInterest expense increased in 1994 due to the issuance of the convertible subordinated debentures in July 1993 and the increase in other notes payable in 1994.\nAmortization of deferred policy acquisition costs (DAC) increased $23,198,000 or 30% in 1994 as compared to 1993. The increase was due primarily to the adjustment in the DAC asset on group and individual medical business issued in recent years. These blocks of business have achieved lower margins than expected due primarily to mandated state healthcare reforms. The Company is now assuming a lower level of profitability on these blocks. The Company continues to monitor the profitability of its business. Increased lapses or unprofitability on the business could result in an increase in the amortization rate of DAC, which would adversely impact future earnings.\nThe effective tax rate of the Company decreased to approximately 34% in 1994 from 35% in 1993. The decrease was due to the increased investment in tax-exempt securities included in the Company's portfolio and net operating loss carryforwards utilized from CLAC.\nThe Company acquired the building containing its corporate headquarters in Schaumburg, Illinois, in January 1994 resulting in the increase in investment real estate. Cash decreased due to increased investment in short- term investments. Reinsurance receivables decreased due to the timing of payments due from reinsurers. Deferred policy acquisition costs decreased as a result of the third quarter write-down and the decrease in new business issues in 1994. General expenses and other liabilities decreased due to the timing of payments for federal income taxes and amounts due to reinsurers. Notes payable increased due to the utilization of the line of credit by the Company.\n1993 COMPARED TO 1992\nCONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS ----------------------------------------------------------\nThe Company reported net income of $12,145,000 for the twelve months ended December 31, 1993, compared to a net loss of $16,959,000 for the comparable period in 1992. The net loss for 1992 was primarily attributable to a $30,000,000 pre-tax write-down of deferred policy acquisition costs. The remaining increase was due to improved loss ratios on the Medicare supplement business, expense reductions in the Life Insurance Division and increased revenue and margins in the Group Medical Division.\nTotal revenues increased $47,751,000 or 7% for the twelve month period in 1993 as compared to 1992. The increase in revenue is due to the increase in premiums and policy charges of $50,449,000 which was partially offset by reduced levels of net investment income.\nAccident and health insurance premiums increased $41,790,000, or 7%, in 1993 as compared to 1992. Premiums from major hospital plans increased $56,694,000 in 1993 as compared to 1992 due to rate increases implemented in 1993, and approximately $11,000,000 from the acquisition of Continental Life & Accident Company. Offsetting the increase was a decline in Medicare supplement premiums of $9,176,000 due to lower than anticipated new sales and a $3,496,000 decrease in premiums of specialty health care plans. Life and annuity premiums and policy charges increased $8,659,000 due to an increase in new life sales during 1993.\nNet investment income decreased $3,313,000 or 8% in 1993 compared to 1992. Annualized investment yields decreased from 7.9% in 1992 to 6.8% in 1993. The decrease in investment yield was due to the general decline in current interest rates and a higher quality portfolio with a shortened duration.\nOther income and realized investment gains and losses increased $615,000, or 4% in 1993 as compared to 1992. Other income increased $1,904,000 in 1993 due to increased sales to unaffiliated customers in both the Group Medical Division and the Medical Utilization Management Division. Realized investment losses increased $1,289,000 due to write-downs on certain mortgage-backed derivative securities.\nTotal benefits increased $26,310,000 or 6% in 1993 as compared to 1992. Life and annuity benefits decreased $3,607,000 or 8% due to the general decline in credited rates during 1993 and improved mortality over the higher levels experienced during 1992. Accident and health benefits, which includes the change in unearned premiums, increased $29,917,000 or 8% in 1993 as compared to 1992. The change was primarily due to the 7% increase in accident and health premiums. The Company's accident and health loss ratios were unchanged over 1992 at 66%. The improved loss ratios on the Medicare supplement business were offset by the fourth quarter loss ratio on Continental Life & Accident business of 79%. The Company is attempting to control claim costs on this block of business by implementing additional managed healthcare efforts.\nIn 1993 and 1992, managed healthcare efforts resulted in estimated net savings to the Company's Health Insurance Unit of $41,000,000 and $27,000,000, respectively. These savings were primarily used to lower the amount of premium increases for policyholders, which the Company believes generally has the effect of decreasing lapse rates of these policies. The principal efforts and their approximate relative contributions to these estimated savings were as follows:\n1993* 1992* ---- ---- PPOs (preferred provider organization) networks 49% 64% Precertification 5 17 Large case management 32 11 Other 14 8 ___ ___ 100% 100% === ===\n----------------\n* Percent of total estimated savings from managed healthcare efforts.\nAmortization of deferred policy acquisition costs (DAC) decreased $23,840,000, or 24%, in 1993 as compared to 1992. The decrease was due to the $30,000,000 pre tax write-down of DAC in the fourth quarter of 1992 primarily on major medical policies sold in the self-employed and small business owner market. The 1993 amortization rate on Medicare supplement is higher than 1992 because of the accelerated rate increase implementation which occurred in 1993.\nThe Company's effective tax rate was approximately 35% in 1993. The Company recorded a tax benefit for 1992 due to the operating loss incurred. The effective federal income tax rate increased in 1993 due to the Revenue\nReconciliation Act of 1993.\nEffective January 1, 1993, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 113 \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\" FASB Statement No. 113 requires that reinsurance receivables, including amounts related to claims incurred but not reported, and prepaid insurance premiums, be reported as assets as opposed to reductions in the related liabilities. As a result of the adoption of FASB Statement No. 113, amounts on deposit and due from reinsurers and policy liabilities each increased $19,453,000 at December 31, 1993.\nEffective January 1, 1993, the Company also 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 FASB Statement No. 109 was not significant.\nInvestments, equipment, policy liabilities, and general expenses and other liabilities increased due to the acquisition of Continental Life & Accident. Other assets increased primarily due to expenses capitalized in conjunction with the public offering of the convertible subordinated debentures.\nDEFERRED POLICY ACQUISITION COSTS\nUnder generally accepted accounting principles, a deferred acquisition cost asset (DAC) is established to properly spread the acquisition costs for a block of policies against the expected future revenues from the policies. The acquisition costs which are capitalized and amortized consist of first year commissions in excess of renewal commissions and certain home office expenses related to selling, policy issue, and underwriting.\nThe deferred acquisition costs for accident and health policies and traditional life policies are amortized over future revenues of the business to which the costs are related. The rate of amortization depends on the expected pattern of future revenues for the block of policies. The scheduled amortization for a block of policies is established when the policies are issued.\nThe amortization schedule is based on the expected persistency and profitability of the policies. The actual amortization of DAC reflects the actual persistency and profitability of the business. For example, if actual policy terminations are higher than expected or actual profits are lower than originally assumed, DAC could be amortized more rapidly than originally scheduled.\nEFFECT OF INFLATION\nIn pricing its insurance products, the Company gives effect to anticipated levels of inflation; however, the Company believes that the high rate of medical cost inflation during recent years had an adverse impact on its major hospital accident and health claims experience. The Company continues to implement rate increases in response to this experience.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's consolidated liquidity requirements are created and met primarily by operations of its insurance subsidiaries. The insurance subsidiaries' primary sources of cash are premiums, investment income, and investment sales and maturities. The primary uses of cash are operating\ncosts, policy acquisition costs, payments to policyholders and investment purchases.\nIn addition, liquidity requirements of the Company are created by the dividend requirements of the $2.125 Preferred Stock, common stock dividends, interest payments on the Convertible Subordinated Debentures and other debt service requirements. The Company's liquidity requirements are met primarily by dividends declared by its subsidiaries. Payments of dividends by the insurance subsidiaries to the Company is subject to certain regulatory restrictions. (See Note 11 of the consolidated financial statements).\nThe Company's life and health insurance subsidiaries require capital to fund acquisition costs incurred in the initial year of policy issuance and to maintain adequate surplus levels for regulatory purposes. These capital requirements have been met principally from internally generated funds, including premiums and investment income, and capital provided from reinsurance and the financing or sale of agent debit balances.\nThe Company has offered agent commission financing to certain of its agents and marketing organizations which consists primarily of annualization of first year commissions. This means that when the first year premium is paid in installments, the Company will advance a percentage of the commissions that the agent would otherwise receive over the course of the first policy year. The Company through a subsidiary has entered into agreements with an unaffiliated corporation to provide financing for its agent commission financing program through the sale of agent receivables. Proceeds from such sales during 1994 and 1993 were $24,393,0l00 and $25,376,000, respectively. The termination date of the current program is December 31, 1997, subject to extension or termination as provided therein.\nIn July 1993 the Company issued $57,477,000 of 8% convertible subordinated debentures due 2000. Net proceeds from the offering totaled $54,000,000. The debentures are convertible into the Company's common stock at any time prior to maturity, unless previously redeemed, at a conversion price of $11.75 per share.\nIn August 1993 a subsidiary of the Company borrowed $1,500,000 to finance the acquisition of Healthcare Review Corporation. Interest on the note is payable quarterly at six percent. The note requires principal repayments of $75,000 per quarter through July 31, 1998.\nShort-term notes payable included $18,950,000 at December 31, 1994, drawn under a line of credit arrangement. In March 1995, $15,000,000 of the line of credit was replaced with a five year term loan. The remaining balance under the line of credit is due in October 1995.\nAt December 31, 1994, a subsidiary of the Company had an unsecured loan of $1,125,000. The portion of the loan due in 1995 of $300,000 is included in short-term notes payable. The remainder of the note is included in long- term notes payable. The note bears interest currently at prime and is payable quarterly with the final payment due July 1998.\nAt December 31, 1994 a subsidiary of the Company had two unsecured loans totaling $2,275,000. The portion of the loans due in 1995 of $580,000 is included in short-term notes payable. The remainder of the notes are included in long-term notes payable. The notes bear interest at prime and are payable quarterly with the final payment due December 1999. The Company has guaranteed payment of the notes.\nIn March, June, September and December 1994, the Company's Board of Directors announced a quarterly Common Stock dividend of $.0375 per share, for a total of 15 cents per share to be paid for 1994.\nThe concept of risk-based capital has been adopted for regulatory monitoring of the life and health insurance industry. Risk based capital standards are used by regulators to set in motion appropriate regulatory actions relating to insurers which show signs of weak or deteriorating conditions. The Company's insurance subsidiaries, total adjusted capital, authorized control risk based capital, and related ratio by company as disclosed in the 1994 annual statement are as follows:\nAuthorized Adjusted Control Company Capital Level RBC RBC Ratio ------ -------- ---------- --------- (Dollars in thousands) Pioneer Life Insurance Company of Illinois $87,591 $25,595 342%\nManhattan National Life Insurance Company 43,096 4,974 866%\nNational Group Life Insurance Company 42,932 10,461 410%\nContinental Life & Accident Company 17,518 5,205 337%\nHealth and Life Insurance Company of America 3,921 273 1,440%\nInterest paid amounted to $4,950,000, $1,023,000 and $2,274,000 for 1994, 1993, and 1992, respectively.\nManagement believes that the diversity of the Company's investment portfolio and the liquidity attributable to the large concentration of investments in highly liquid United States government agency securities provide sufficient liquidity to meet foreseeable cash requirements. Prior to January 1, 1994, the Company's fixed maturity portfolio was segregated into two components: fixed maturities held-to-maturity and fixed maturities available-for-sale. Fixed maturities, where the intent was to hold to maturity, were carried at amortized cost, adjusted for other-than-temporary impairments. Fixed maturities that were available for sale were carried, on an aggregate basis, at the lower of amortized cost or fair value.\nIn 1993, the Financial Accounting Standards Board (FASB) issued Statement 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Statement 115 requires that fixed maturity securities are to be classified as either held-to-maturity, available-for-sale, or trading. The Company adopted Statement 115 as of January 1, 1994, with no effect on net income and a $3,605,000 increase in stockholders' equity.\nThe Company believes that it has the ability and intent to hold to maturity its fixed maturity investments that are classified as \"held-to- maturity.\" However, the Company also recognizes that there may be circumstances where it may be appropriate to sell a security prior to maturity in response to unforeseen changes in circumstances. Recognizing the need for the ability to respond to changes in market conditions and in tax\nposition, the Company has designated a portion of its investment portfolio as available-for-sale. As required by Statement 115, the Company adjusted the carrying value of it fixed maturity investments that are classified as investments available-for-sale to fair value at January 1, 1994.\nAt January 1, 1994, the remainder of the Company's portfolio of fixed maturity investments was classified as held-to-maturity. Although the Company has the ability and intent to hold those securities to maturity, there could occur infrequent and unusual conditions under which it would sell certain of those securities. Those conditions would include unforeseen changes in asset quality, significant changes in tax law affecting the taxation of securities, a significant business acquisition or disposition, and changes in regulatory capital requirements or permissible investments.\nLife insurance and annuity liabilities are generally long term in nature although subject to earlier surrender as a result of the policyholder's ability to withdraw funds or surrender the policy, subject to surrender and withdrawal penalties. The Company believes its policyholder liabilities should be backed by an investment portfolio that generates predictable investment returns. The Company seeks to limit exposure to risks associated with interest rate fluctuations by concentrating its invested assets principally in high quality, readily marketable debt securities of intermediate duration and by attempting to balance the duration of its invested assets with the estimated duration of benefit payments arising from contract liabilities.\nINVESTMENT PORTFOLIO\nAt December 31, 1994, the Company had invested assets of $723,837,000, compared to $674,206,000 at December 31, 1993. The Company manages all of its investments internally with resource and evaluation assistance provided by independent investment consultants. Government and mortgage-backed obligations and corporate fixed maturity securities collectively comprised approximately 83% and 87% of the Company's investment portfolio at December 31, 1994 and 1993, respectively. The remainder of the invested assets were in short-term investments, equity securities, real estate, policy loans and mortgage loans.\nFixed Maturity Investments. With the adoption of risk based capital rules and consumer concerns over insurance company solvency and financial stability, the asset quality of insurance companies' investment portfolios has become of greater concern to policyholders and has come under closer scrutiny by insurance regulators and investors. In response, the Company holds investments in below-investment grade fixed maturity securities in an amount less than 1% of its invested assets at December 31, 1994. This reduction resulted from sales and writedowns of the carrying value of such securities in prior periods, and the elimination of new purchases. The Company has a policy not to invest more than 4% of its admitted assets in securities below investment grade.\nInvestments in below-investment grade fixed maturity securities generally have greater risks (and potentially greater returns) than other corporate fixed maturity investments. Risk of loss upon default by the issuer is significantly greater for these securities because they are generally unsecured and are often subordinated to other creditors of the issuer, and 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. Also, the market for below-investment grade securities is less liquid and not as\nactively traded as the market for investment grade securities.\nThe investment objectives of the Company are to maximize investment yield without sacrificing high investment quality and matched liquidity.\nThe Company continually evaluates the creditworthiness of each issuer of securities held in its portfolio. When the fair value of an individual security declines materially, or when the Company's ongoing evaluation indicates that it may be likely that the Company will be unable to realize the carrying value of its investment, significant review and analytical procedures are increased to determine the extent to which such declines are attributable to changing market expectations regarding general interest rates and inflation and other factors, such as a perceived increase in the credit risk of the issuer, a general decrease in a particular industry sector or an overall economic decline.\nDeclines in fair value attributable to factors other than market expectations regarding general interest rates and inflation are reviewed and analyzed in further detail to determine if the decline in value is other than temporary, and the carrying amount of the investment is reduced to its fair value based principally on available market prices. The amount of the reduction is reported as a realized loss on investments and the net fair value becomes the new cost basis of the investment. In addition, the Company reverses any accrued interest income previously recorded for the investment and records future interest income only when cash is received.\nYields recognized in future periods on such investments may be less than yields recognized on other investments and will be less than the yield expected when the fixed maturity security was originally purchased. The affect on net income from declines in interest income and portfolio yield from impaired securities in future periods will depend on many factors, including, in life insurance business, the level of interest rates credited to policyholder account balances. Inasmuch as interest rates credited to the Company's policyholders are typically only guaranteed for one year, the Company does not expect any material adverse affect on net income in future periods from declines in yields from impaired securities.\nMortgage-Related Securities. At December 31, 1994, the Company had $293,481,000, or 49%, of its fixed maturities portfolio in mortgage-related securities ($324,127,000 at December 31, 1993). The yield characteristics of mortgage-related securities differ from those of traditional fixed income securities. The major differences typically include more frequent interest and principal payments, usually monthly, and the possiblity that prepayments of principal may be made at any time. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic, social and other factors and cannot be predicted with certainty. The yields to maturity of the mortgage-related securities will be affected by the actual rate of payment (including prepayments) of principal of the underlying mortgage loans.\nIn general, prepayments on the underlying mortgage loans, and subsequently the mortgage-related securities backed by these loans, increases when the level of prevailing interest rates declines significantly below the interest rates on such loans. When declines in interest rates occur, the proceeds from the prepayment of such securities are likely to be reinvested at lower rates than the Company was earning on such securities.\nThe Company's mortgage-related securities portfolio is well diversified as to collateral, maturity\/duration and other characteristics. The majority\nof the mortgage-related securities portfolio has the guarantee or backing of agencies of the United States government. Generally, the mortgage-related securities consist of pools of single-family, residential mortgages.\nDerivative securities were acquired to protect the Company in the event of adverse interest rate fluctuations. The yields and fair values of the derivative securities are generally more sensitive to changes in interest rates and prepayments than other mortgage-related securities.\nThe Company's mortgage-related securities portfolio at December 31, 1994, included $84,016,000 of CMOs and pass-through certificates issued by non-government agencies ($37,049,000 at December 31, 1993). The Company's holdings consist solely of senior securities in the CMO structures which are collateralized by first mortgage liens on single family residences. These securities are rated AAA or AA by Standard & Poor's, or the comparable equivalent rating by another independent nationally recognized rating agency.\nThe creditworthiness of these securities is based solely on the underlying mortgage loan collateral and credit enhancements in the form of senior\/subordinated structures, letters of credit, mortgage insurance or surety bonds. The underlying mortgage loan collateral principally consists of whole loan mortgages that exceed the maximum imposed by both the Federal National Mortgage Associaton and the Federal Home Loan Mortgage Corporation and, as such, the collateral tends to be concentrated in states with the greatest number of higher priced single family residences, including California, New York, New Jersey, Maryland, Virginia and Illinois. The maximum average loan-to-value ratio for the collateral is 80%.\nThe following table summarizes the components of the Company's mortgage- related securities portfolio at December 31, 1994, and December 31, 1993 (in thousands):\nDecember 31, 1994 December 31, 1993 ----------------- ----------------- Carrying Fair Carrying Fair Value Value Value Value -------- ----- -------- -----\nInverse floaters and interest only CMO tranches $ 14,961 $ 8,940 $ 18,954 $ 13,551 Accrual bonds: U.S. government agency - - 6,968 7,386\nOther CMOs: U.S. government agency 151,697 137,138 187,871 190,141 Non-government agency 29,379 27,404 21,154 21,919 ------- ------- -------- -------- Total other CMOs 181,076 164,542 209,025 212,060\nU.S. government agency pass-through 42,807 39,414 73,285 74,004 Non-government agency pass-through 54,637 50,555 15,895 16,041 -------- ------- -------- -------- Total mortgage-backed securities $293,481 $263,451 $324,127 $323,042 ======== ======== ======== ========\nRECENTLY ISSUED ACCOUNTING STANDARDS\nFor a discussion of a new investments accounting standard, a new income tax accounting standard and a new reinsurance accounting standard and the\nimpact these standards had on the financial statements of the Company, see Note 2 of Notes to Consolidated Financial Statements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -----------------------------------------------------\nConsolidated Financial Statements are included in Part IV, Item 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 section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders in connection with the Company's 1995 annual meeting of stockholders entitled \"Election of Directors\" is incorporated herein by this reference.\nFor information on executive officers of the registrant, reference is made to the item entitled \"Executive Officers of the Registrant\" in Part I of this report.\nItem 11.","section_11":"Item 11. Executive Compensation --------------------------------\nThe section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders in connection with the Company's 1995 annual meeting of stockholders entitled \"Executive Compensation\" is incorporated herein by this reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management -------------------------------------------------------------\nThe section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders in connection with the Company's 1995 annual meeting of stockholders entitled \"Principal Holders of Securities\" is incorporated herein by this reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions --------------------------------------------------------\nThe section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders in connection with the Company's 1994 annual meeting of stockholders entitled \"Certain Transactions\" is incorporated herein by this reference.\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:\nPIONEER FINANCIAL SERVICES, INC.\n1. Financial Statements --------------------\nReport of Independent Auditors . . . . . . . . . . . Consolidated Financial Statements . . . . . . . . . . . . Statements of Consolidated Operations . . . . . . Consolidated Balance Sheets . . . . . . . . . . . Statements of Consolidated Stockholders' Equity. . Statements of Consolidated Cash Flows . . . . . . Notes to Consolidated Financial Statements . . . .\n2. Financial Statement Schedules -----------------------------\nSchedule I - Consolidated Summary of Investments - Other Than Investments in Related Parties . . . . . .\nSchedule II - Condensed Financial Information of Registrant - Condensed Balance Sheets . . . . . .\nSchedule II - Condensed Financial Information of Registrant - Condensed Statements of Operations . . .\nSchedule II - Condensed Financial Information of Registrant - Condensed Statements of Cash Flows. . . . . . . . . . . . . . . . . . . . . .\nSchedule II - Note to Condensed Financial Statements Schedule III - Supplementary Insurance Information. . Schedule IV - Reinsurance . . . . . . . . . . . . . .\nSchedule V - 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 financial statements or notes thereto.\n3. Exhibits --------\nSee Exhibit Index below.\n(b) Reports on Form 8-K -------------------\nThe Company filed no reports on Form 8-K during the fourth quarter of 1994.\n(c) Index to Exhibits\n-----------------\nExhibit Sequentially Number Description of Document Numbered Page ------ ----------------------- -------------\n3 (a) Certificate of Incorporation of the Company (filed as Exhibit 3(a) to the Company's Registration Statement on Form S-1 (No. 33-7759) and incorporated herein by reference)\n3 (b) Amended Bylaws of the Company (filed as Exhibit 3(b) to Amendment No. 1 to the Company's Registration Statement on Form S-1 (No. 33-30017) and incorporated herein by reference)\n4 (a) Certificate of Designations with respect to the Company's $2.125 Cumulative Convertible Exchangeable Preferred Stock (\"Preferred Stock\") (filed as Exhibit 4(a) to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-1 (No. 33-30017) and incorporated herein by reference)\n4 (b) Proposed form of Indenture with respect to the Company's 8 1\/2% Convertible Subordinated Debentures due 2014 into which the Preferred Stock is exchangeable (filed as Exhibit 4(b) to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-1 (No. 33-30017) and incorporated herein by reference)\n4 (c) Rights Agreement dated as of December 12, 1990 between the Company and First Chicago Trust Company of New York as Rights Agent (including exhibits thereto) (filed as Exhibit 1 to the Company's registration statement on Form 8-A dated December 14, 1990 and incorporated herein by reference)\n10 (a) Form of contract with independent agents (filed as Exhibit 10(f) to the Company's Registration Statement on Form S-1 (No. 33-7759) and incorporated herein by reference)\n*10 (b) Nonqualified Stock Option Plan (filed as Exhibit 10(g) to the Company's Registration Statement on Form S-1 (No. 33-7759) and incorporated herein by reference)\n*10 (c) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(d)\nto the Company's Registration Statement on Form S-8 (No. 33-26455) and incorporated herein by reference)\n*10 (d) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(c) to the Company's Registration Statement on Form S-1 (No. 33-17011) and incorporated herein by reference)\n*10 (e) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(e) to the Company's registration statement on Form S-8 (No. 33-37305) and incorporated herein by reference)\n10 (f) Amended and Restated Receivables Purchase Agreement dated as of October 1, 1992 by and between Design Benefit Plans, Inc. (formerly National Group Marketing Corporation) and National Funding Corporation (filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)\n*10 (g) Employment Agreement dated December 3, 1993 by and between the Company and Peter W. Nauert (filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)\n10 (h) Administrative Service Agreement dated December 23, 1991, by and between Administrative Service Corporation and Pioneer Life Insurance Company of Illinois (filed as Exhibit 10(v) to the Company's Annual Report on Form 10-K (No. 0-14977) and incorporated herein by reference)\n10 (i) Administrative Service Agreement dated December 23, 1991, by and between Administrative Service Corporation and National Group Life (filed as Exhibit 10(w) to the Company's Annual Report on Form 10-K (No. 0-14977) and incorporated herein by reference)\n*10 (j) Employment Agreement dated December 31, 1991 by and between National Benefit Plans, Inc. and Peter W. Nauert (filed as Exhibit 10(x) to the Company's Annual Report on Form 10-K (No. 0-14977) and incorporated herein by reference)\n*10 (k) Amendment to Employment Agreement dated March 26, 1993 by and between National Benefit Plans, Inc. and Peter W. Nauert (filed as Exhibit 10(k) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)\n*10 (l) Employment Agreement dated December 31, 1991 by and between Direct Financial Services, Inc. and Peter W. Nauert (filed as Exhibit 10(y) to the Company's Annual Report on Form 10-K (No. 0-14977) and incorporated herein by reference)\n*10 (m) Amendment to Employment Agreement dated March 26, 1993 by and between Direct Financial Services, Inc. and Peter W. Nauert (filed as Exhibit 10(m) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)\n10 (n) Credit Agreement dated as of December 22, 1993 by and among the Company and American National Bank and Trust Company of Chicago, as Agent and American National Bank and Trust Company of Chicago, Firstar Bank Milwaukee, N.A. and Bank One, Rockford, N.A., as Banks (filed as Exhibit 10(n) to the Company's Annual Report on Form 10-K (No. 1-10522) and incorporated herein by reference)\n10 (o) Stock Purchase Agreement dated November 21, 1994 among the Company, United Life Holdings, Inc. and GRENEL Financial Corporation (filed as Exhibit 2(a) to the Company Current Report on Form 8-K, dated January 31, 1995 and incorporated herein by reference)\n10 (p) Second Amended and Restated Receivables Purchase Agreement dated as of October 1, 1994 by and between Design Benefit Plans, Inc. (formerly National Group Marketing Corporation) and National Funding Corporation (filed herewith)\n10 (q) Consent and Agreement dated as of October 1, 1994 among Design Benefit Plans, Inc., Pioneer Financial Services, Inc., American National Bank and Trust Company of Chicago, and National Funding Corporation (filed herewith)\n11 Statement of Computation of per share net income or loss (filed herewith)\n21 List of subsidiaries (filed herewith)\n23 Consent of Ernst & Young LLP (filed herewith)\n27 Financial Data Schedule\n* Indicates management employment contracts or compensatory plans or arrangements.\nReport of Independent Auditors\nBoard of Directors Pioneer Financial Services, Inc.\nWe have audited the accompanying consolidated balance sheets of Pioneer Financial Services, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related statements of consolidated 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pioneer Financial Services, 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 schedules, when considered in relation to the consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 2 to the consolidated financial statements, in 1994, the Company changed its method of accounting for investments in debt and equity securities.\nERNST & YOUNG LLP Chicago, Illinois March 22, 1995\nPioneer Financial Services, Inc. and Subsidiaries Statements of Consolidated Operations (In Thousands, Except Per Share Amounts)\nYEAR ENDED DECEMBER 31 1994 1993 1992 ---- ---- ---- REVENUES Premiums and policy charges (Note 6): Accident and health $ 659,180 $ 601,684 $ 559,894 Life and annuity 44,929 39,282 35,219 --------- --------- --------- 704,109 640,966 595,113 Net investment income (Note 4) 42,786 40,242 43,555 Other income and realized investment gains and losses (Note 4) 27,260 17,920 17,305 --------- --------- --------- 774,155 699,128 655,973 BENEFITS AND EXPENSES Benefits: Accident and health 407,249 397,963 368,046 Life and annuity 42,947 39,419 47,622 --------- --------- --------- 450,196 437,382 415,668 Insurance and general expenses 192,810 162,831 162,837 Interest expense (Notes 9 and 12) 5,054 3,276 2,189 Amortization of deferred policy acquisition costs (Note 10) 100,073 76,875 100,715 --------- --------- --------- 748,133 680,364 681,409 --------- --------- --------- Income (loss) before income taxes 26,022 18,764 (25,436) Income taxes (benefit) (Note 5): Current 6,570 10,858 2,878 Deferred 2,303 (4,239) (11,355) --------- --------- --------- 8,873 6,619 (8,477) --------- --------- --------- Net income (loss) 17,149 12,145 (16,959)\nPreferred stock dividends (Note 13) 1,904 2,021 2,039 --------- --------- --------- Income (loss) applicable to common stockholders $ 15,245 $ 10,124 $ (18,998) ========= ========== =========\nNet income (loss) per common share: Primary $ 2.36 $ 1.51 $ (2.85) Fully diluted 1.58 1.26 (2.85)\nDividends declared per common share .15 - -\nAverage common and common equivalent shares outstanding: Primary 6,459 6,724 6,660 Fully diluted 12,734 10,731 8,195\nSee notes to consolidated financial statements.\nPioneer Financial Services, Inc. and Subsidiaries Consolidated Balance Sheets (In Thousands, Except Share and Per Share Amounts)\nDECEMBER 31 1994 1993 -------------------- ASSETS\nInvestments (Note 4 and 19): Securities available-for-sale: Fixed maturities, at fair value $218,748 Fixed maturities, at cost - $257,717 Equity securities, at fair value 15,440 17,436 Fixed maturities held-to-maturity, principally at amortized cost 378,650 326,512 Real estate - at cost, less accumulated depreciation 16,959 - Mortgage loans at unpaid balance 1,806 3,201 Policy loans at unpaid balance 23,082 23,988 Short-term investments at cost, which approximates fair value 69,152 45,352 ---------- ---------- Total investments 723,837 674,206\nCash 8,612 23,379 Premiums and other receivables, less allowance for doubtful accounts (Notes 7 and 18) 20,102 20,734 Reinsurance receivables and amounts on deposit with reinsurers (Note 6) 41,426 74,366 Accrued investment income 8,873 8,482 Deferred policy acquisition costs (Note 10) 225,618 260,432 Land, building, and equipment at cost, less accumulated depreciation (Note 18) 20,314 22,248 Deferred federal income taxes (Note 5) 7,262 3,922 Other 19,656 20,502 ---------- ----------\n$1,075,700 $1,108,271 ========== ==========\nDECEMBER 31 1994 1993 --------------------\nLIABILITIES, REDEEMABLE PREFERRED STOCK, AND STOCKHOLDERS' EQUITY Policy liabilities: Future policy benefits: Life $246,953 $244,249 Annuity 210,132 208,155 Accident and health 163,477 158,330 Unearned premiums 76,266 87,945 Policy and contract claims (Note 8) 155,373 189,389 Other 16,407 15,037 ---------- ----------- 868,608 903,105 General liabilities: General expenses and other liabilities 37,042 48,442 Short-term notes payable (Notes 9, 21 and 22) 20,093 5,575 Long-term notes payable (Notes 9, 19, 21 and 22) 2,520 1,125\nConvertible subordinated debentures (Notes 12 and 19) 57,427 57,477 ---------- ----------- Total liabilities 985,690 1,015,724\nCommitments and contingencies (Notes 5 to 11 and 16)\nRedeemable Preferred Stock, no par value (Note 13): $2.125 cumulative convertible exchangeable preferred stock: Authorized: 5,000,000 shares Issued and outstanding: (1994 - 867,300 shares; 1993 - 947,000 shares) 21,682 23,675\nStockholders' equity (Notes 5 and 11 to 15): Common Stock, $1 par value: Authorized: 20,000,000 shares Issued, including shares in treasury (1994 - 6,996,157; 1993 - 6,900,000) 6,996 6,900 Additional paid-in capital 29,299 28,814 Unrealized appreciation (depreciation) of available-for-sale securities (Notes 2 and 4) (7,193) 3,285 Retained earnings 48,960 34,645 Treasury stock at cost (1994 - 1,078,400 shares; 1993 - 556,800 shares) (9,734) (4,772) ---------- ----------- Total stockholders' equity 68,328 68,872 ---------- ----------- $1,075,700 $1,108,271 ========== ===========\nSee notes to consolidated financial statements.\nPioneer Financial Services, Inc. and Subsidiaries Statements of Consolidated Stockholders' Equity (In Thousands, Except Share and Per Share Amounts)\nPioneer Financial Services, Inc. and Subsidiaries Statements of Consolidated Cash Flows (In Thousands)\nYEAR ENDED DECEMBER 31 1994 1993 1992 ---- ---- ---- OPERATING ACTIVITIES Net income (loss) $ 17,149 $ 12,145 $ (16,959) Adjustments to reconcile net income or loss to net cash provided by operating activities: Decrease (increase) in premiums receivable 4,981 (3,912) 5,673 Increase (decrease) in policy liabilities (34,498) 31,132 12,734 Deferral of policy acquisition costs (65,258) (67,633) (56,936) Amortization of deferred policy acquisition costs (Note 10) 100,073 76,875 100,715 Deferred income tax expense (benefit) 2,303 (4,239) (11,355) Change in other assets and liabilities 21,392 (13,423) (10,597) Depreciation, amortization, and accretion (102) 9,795 10,303 Realized losses (Note 4) 383 1,336 47 --------- ---------- --------- Net cash provided by operating activities 46,423 42,076 33,625\nINVESTING ACTIVITIES Securities available-for-sale: Purchases - fixed maturities (110,416) (120,228) (29,001) Sales - fixed maturities 99,865 51,780 13,367 Maturities - fixed maturities 44,116 18,836 17,106 Purchases - equity securities (4,609) (5,532) (4,085) Sales - equity securities 2,558 14,845 13,651 Securities held-to-maturity: Purchases (84,010) (256,579) (587,931) Sales 9,427 126,072 424,404 Maturities 21,472 102,535 90,453 Purchase of investment real estate (17,442) - - Net decrease (increase) in other investments (21,499) 26,038 22,080 Net purchases of property and equipment (2,957) (3,956) (4,434) Purchase of subsidiaries including a cash overdraft of $1,019 (Note 3) - (9,685) - --------- ---------- --------- Net cash used by investing activities (63,495) (55,871) (44,390)\nFINANCING ACTIVITIES Net proceeds from issuance of convertible subordinated debentures (Note 12) - 54,055 - Increase in notes payable 21,225 - 14,030 Repayment of notes payable (5,362) (31,401) (3,900) Proceeds from sale of agent receivables (Note 7) 24,393 25,376 20,347 Transfer of collections on previously sold agent receivables (Note 7) (28,743) (22,981) (22,437) Dividends paid - preferred (1,904) (2,021) (2,039) Dividends paid - common (930) - - Stock options exercised 495 451 165 Purchase of treasury stock (4,963) (4,720) (52) Retirement of preferred stock (1,993) (315) - Other 87 44 717 --------- ---------- --------- Net cash provided by financing activities 2,305 18,488 6,831 --------- ---------- ---------\nIncrease (decrease) in cash (14,767) 4,693 (3,934) Cash at beginning of year 23,379 18,686 22,620 --------- ---------- --------- Cash at end of year $ 8,612 $ 23,379 $ 18,686 ========= ========== =========\nPioneer Financial Services, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements\n1. ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) and include the accounts and operations, after intercompany eliminations, of Pioneer Financial Services, Inc. (PFS) and its subsidiaries.\nINVESTMENTS\nPrior to January 1, 1994, PFS' fixed maturity portfolio was segregated into two components: fixed maturities held-to-maturity and fixed maturities available-for-sale. Fixed maturities, where the intent was to hold to maturity, were carried at amortized cost, adjusted for other-than-temporary impairments. Fixed maturities that were available for sale were carried, on an aggregate basis, at the lower of amortized cost or fair value.\nIn 1993, the Financial Accounting Standards Board (\"FASB\") issued Statement 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Statement 115 requires that fixed maturity securities are to be classified as either held-to-maturity, available-for-sale, or trading. PFS adopted Statement 115 as of January 1, 1994, with no effect on net income and a $3,605,000 increase in stockholders' equity (see Note 2).\nPFS believes that it has the ability and intent to hold to maturity its fixed maturity investments that are classified as \"held-to-maturity.\" However, PFS also recognizes that there may be circumstances where it may be appropriate to sell a security prior to maturity in response to unforeseen changes in circumstances. Recognizing the need for the ability to respond to changes in market conditions and in tax position, PFS has designated a portion of its investment portfolio as available-for-sale. As required by Statement 115, PFS adjusted the carrying value of its fixed maturity investments that are classified as investments available-for-sale to fair value at January 1, 1994.\nAt January 1, 1994, the remainder of PFS' portfolio of fixed maturity investments was classified as held-to-maturity. Although PFS has the ability and intent to hold those securities to maturity, there could occur infrequent and unusual conditions under which it would sell certain of those securities. Those conditions would include unforeseen changes in asset quality, significant changes in tax law affecting the taxation of securities, a significant business acquisition or disposition, and changes in regulatory capital requirements or permissable investments.\nSales of two held-to-maturity securities in 1994 with an amortized cost of $9,803,000 resulted after discussions with an insurance rating agency regarding specific investments of PFS' insurance subsidiaries and evidence of a significant deterioration in credit worthiness. Sales of these securities, all of which were owned at January 1, 1994, resulted in a realized loss of $376,000.\nSubsequent to January 1, 1994, all securities purchased are designated for inclusion in either the available-for-sale or held-to-maturity categories based on PFS' intent and the nature of the securities purchased.\nChanges in fair values of available-for-sale securities, after adjustment of deferred policy acquisition costs (\"DAC\"), if any, and deferred income taxes, are reported as unrealized appreciation or depreciation directly in stockholders' equity and, accordingly, have no effect on net income. DAC offsets to the unrealized appreciation or depreciation represent valuation adjustments or reinstatements of DAC that would have been required as a change or credit to operations had such unrealized amounts been realized.\nThe amortized cost of fixed maturity investments classified as available-for- sale and as held-to-maturity is adjusted for amortization of premiums and accretion of discounts. That amortization or accretion is included in net investment income.\nFor the mortgage-backed portion of the fixed maturity securities portfolio, PFS recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the security is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the security. That adjustment is included in net investment income.\nAs regards equity securities, changes in unrealized appreciation or temporary depreciation, after deferred income tax effects, are reported directly in stockholders' equity.\nRealized gains and losses on the sale of investments, and declines in value considered to be other-than-temporary, are recognized in operations on the specific identification basis.\nREVENUES\nRevenues for interest-sensitive life insurance and annuities consist of charges assessed against policy account values. For accident and health and other life insurance, premiums are recognized as revenue when due. Accident and health group association dues and fees, included in other revenues, are recognized as revenue when received.\nFUTURE POLICY BENEFITS\nThe liabilities for future policy benefits related to the annuity and interest-sensitive life insurance policies are calculated based on accumulated fund values. As of December 31, 1994, interest credited during the contract accumulation period ranged from 5.0% to 8.0%. Investment spreads and mortality gains are recognized as profits when realized, based on the difference between actual experience and amounts credited or charged to policies.\nThe liabilities for future policy benefits on other life insurance and accident and health insurance policies have been computed by a net level method based on estimated future investment yield, mortality or morbidity, and withdrawals, including provisions for adverse deviation. Interest rate assumptions range from 3.5% to 8.5% depending on the year of issue. The provisions for future policy benefits and the deferral and amortization of policy acquisition costs are intended to result in benefits and expenses being associated with premiums proportionately over the policy periods.\nUNEARNED PREMIUMS\nUnearned premiums are calculated using the monthly pro-rata basis.\nDEFERRED POLICY ACQUISITION COSTS\nCosts that vary with, and are primarily related to, the production of new business are deferred. Such costs are primarily related to accident and health business and principally include the excess of new business commissions over renewal commissions and underwriting and sales expenses.\nFor annuities and interest-sensitive life insurance policies, deferred costs are amortized generally in proportion to expected gross profits arising from the difference between investment and mortality experience and amounts credited or charged to policies. That amortization is adjusted retrospectively when estimates of current or future gross profits (including the impact of realized investment gains and losses) to be realized from a group of products are revised. For other life and accident and health policies, costs are amortized over the premium-paying period of the policies, using the same mortality or morbidity, interest, and withdrawal assumptions that are used in calculating the liabilities for future policy benefits.\nThe unamortized cost of purchased insurance in force is included in DAC ($21,291,000 and $23,078,000 at December 31, 1994 and 1993, respectively). Amortization of these amounts is in relation to the present value of estimated gross profits over the estimated remaining life of the related insurance in force.\nPOLICY AND CONTRACT CLAIMS\nThe liabilities for policy and contract claims, principally accident and health, are determined using case-basis evaluations and statistical analyses based on past experience and represent estimates of the ultimate net cost of incurred claims and the related claim adjustment expenses. Although considerable variability is inherent in such estimates, management believes that these liabilities are adequate. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations. PFS maintains an additional provision for adverse deviation in its accident and health claim liability estimates.\nREINSURANCE\nReinsurance premiums, commissions, expense reimbursements, and receivables related to reinsured business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums reinsured to other companies have been reported as reductions of premium revenues. Amounts recoverable for reinsurance related to future policy benefits, unearned premium reserves, and claim liabilities have been reported as reinsurance receivables; expense allowances received in connection with reinsurance have been accounted for as a reduction of the related DAC and are deferred and amortized accordingly.\nAcquisition costs relating to the production of new business result in a reduction of statutory-basis net income. PFS had entered into certain financial reinsurance agreements that had the effect of deferring this statutory-basis reduction and amortizing costs over future periods. The remaining effect of such reinsurance has been eliminated from the accompanying consolidated financial statements.\nFEDERAL INCOME TAXES\nFederal income tax provisions are based on income or loss reported for financial statement purposes and tax laws and rates in effect for the years presented. For 1992, deferred federal income taxes were provided for the differences between the recognition of income and loss determined for financial reporting purposes and income tax purposes. Effective January 1, 1993, deferred federal income taxes have been provided using the liability method an accordance with FASB Statement No. 109 \"Accounting for Income Taxes.\" Under this method deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities and are measured using enacted tax rates. The cumulative effect of adopting Statement No. 109 as of January 1, 1993, was not significant and has not been separately disclosed.\nDEPRECIATION\nBuilding, equipment and investment real estate are recorded at cost and are depreciated using principally the straight-line method.\nNET INCOME OR LOSS PER COMMON SHARE\nPrimary net income or loss per share of Common Stock is determined by dividing net income or loss, less dividends on Preferred Stock, by the weighted-average number of Common Stock and Common Stock equivalents (dilutive stock options) outstanding. Where the effect of Common Stock equivalents on net income or loss per share would be antidilutive, they are excluded from the average shares outstanding. Fully diluted net income or loss per share is computed as if the Preferred Stock and Convertible Subordinated Debentures had been converted to Common Stock. Where the effect of the assumed conversion on net income or loss per share would be antidilutive, fully diluted net income or loss per share represents the primary amount.\nCOST IN EXCESS OF NET ASSETS OF COMPANIES ACQUIRED\nThe cost in excess of net assets of companies acquired (goodwill) ($5,317,000 and $5,449,000 at December 31, 1994 and 1993, respectively) is included in other assets and is being amortized principally on a straight-line basis over periods from seven to forty years.\nTREASURY STOCK\nThe board of directors has authorized PFS to buy back shares of its own common and preferred stock on the open market from time to time. During 1994, 1993 and 1992 PFS repurchased 521,600, 546,200 and 10,600 shares, respectively, of their common stock. During 1994 and 1993, PFS repurchased 78,900 and 13,400 shares of their preferred stock. Treasury stock is accounted for using the cost method.\nCASH FLOW INFORMATION\nCash includes cash on hand and demand deposits.\nRECLASSIFICATIONS\nCertain amounts in the 1992 and 1993 financial statements have been reclassified to conform to the 1994 presentation.\n2. CHANGES IN ACCOUNTING PRINCIPLES\nFASB Statement 115, \"Accounting for Certain Investments in Debt and Equity Securities\" was adopted by PFS as of January 1, 1994. In accordance with Statement 115, PFS' prior year financial statements have not been restated to reflect the change in accounting principle. Under Statement 115, securities are classified as available-for-sale, held-to-maturity, or trading. PFS classified a portion of its fixed maturity securities portfolio as available- for-sale with the remainder classified as held-to-maturity. Securities classified as available-for-sale are carried at fair value and unrealized gains and losses on such securities are reported as a separate component of stockholders' equity. Securities classified as held-to-maturity are carried at cost, adjusted for amortization of premium or discount.\nWith the classification of a portion of the portfolio as available-for-sale, the January 1, 1994, balance of stockholders' equity was increased by $3,605,000 (net of adjustments to deferred income taxes) to reflect the net unrealized gains on fixed maturity securities classified as available-for- sale that were previously carried at amortized cost. The adoption of Statement 115 had no effect on net income or PFS' accounting policy for equity securities.\nEffective January 1, 1993, PFS 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 have not been restated. The cumulative effect of adopting Statement No. 109 as of January 1, 1993, was not significant.\nEffective January 1, 1993, PFS changed its method of accounting for reinsurance contracts in accordance with FASB Statement No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\" Under Statement No. 113, all assets and liabilities related to reinsured insurance contracts are reported on a gross basis rather than the previous practice of reporting such assets and liabilities net of reinsurance. The effect of adopting Statement No. 113 was to increase both assets and liabilities by $19,453,000 at December 31, 1993. The adoption of Statement No. 113 had no effect on net income.\nThe Financial Accounting Standards Board has issued Statements No. 114 and 118 which relate to accounting by creditors for impairment of a loan. The Statements require that impaired loans are to be valued at the present value of expected future cash flows, at the loan's observable market price, or at the fair value of the collateral if the loan is collateral dependent. PFS anticipates adopting these Statements in its 1995 financial statements as required. Implementation of these Statements is not expected to have a material effect on PFS' financial statements.\n3. BUSINESS COMBINATIONS\nOn January 31, 1995, Pioneer acquired for a cost of $24,000,000 (purchase price $23,700,000 and $300,000 of additional costs), the outstanding common shares of Connecticut National Life Insurance Company.\nThe acquisition will be accounted for by the purchase method and, accordingly, the purchase price is allocated to assets and liabilities acquired based on estimates of their fair values. These allocations, summarized below, may be adjusted upon final determination of such values:\n(IN THOUSANDS) --------------\nAssets Acquired Cash $ 2,900 Investments 287,500 Value of insurance in force 1,500 Receivables and amounts on deposit with reinsurers 87,100 Other assets 6,700\nLiabilities Assumed Policy liabilities 353,700 Other liabilities 8,000 -------\nTotal purchase price $ 24,000 =======\nThe value of insurance inforce will be amortized over the estimated remaining life of the insurance inforce.\nThe following unaudited pro-forma consolidated results of operations have been prepared as if the acquisition had been made as of January 1, 1994:\nYEAR ENDED DECEMBER 31, 1994 (IN THOUSANDS) -----------------\nRevenues $809,500 Net income 18,700 Net income per share Primary 2.60 Fully-diluted 1.70\nThe foregoing pro-forma information is not necessarily indicative of either the results of operations that would have occurred had the acquisition been effective on January 1, 1994, or of future results of operations of the consolidated companies.\nIn August 1993, PFS purchased 80% of the outstanding common stock of Continental Life & Accident Company and 100% of the outstanding common stock of Continental Marketing Corporation for $7,100,000 in cash. The total assets acquired at the purchase date were approximately $80,000,000.\nAlso in August 1993, PFS purchased Healthcare Review Corporation, a managed care company, for $1,566,000 in cash. The total assets acquired at the purchase date were approximately $2,000,000.\nRevenues included in PFS' 1993 consolidated statements of operations relating to these acquired entities were $25,671,000. The operations of the entities did not have a material effect on PFS' 1993 net income.\n4. INVESTMENTS\nRealized investment gains (losses), including provisions for other-than- temporary impairments on investments held, and the change in unrealized appreciation (depreciation) on fixed maturities, equity securities, and other investments during the years shown are summarized as follows:\nFIXED EQUITY MATURITIES SECURITIES OTHER TOTAL\n---------- ---------- ----- ----- (IN THOUSANDS) REALIZED $ (94) $ 211 $ (500) $ (383) UNREALIZED (44,685) (2,098) - (46,783) ---------- --------- ------- --------- $ (44,779) $ (1,887) $ (500) $(47,166) ========== ========= ======= =========\nRealized $ (1,638) $ 293 $ 9 $ (1,336) Unrealized 3,864 442 - 4,306 ---------- --------- ------- --------- $ 2,226 $ 735 $ 9 $ 2,970 ========== ========= ======= =========\nRealized $ (91) $ 44 $ - $ (47) Unrealized (11,144) 6,998 - (4,146) ---------- --------- ------- --------- $ (11,235) $ 7,042 $ - $ (4,193) ========== ========= ======= =========\nThe cost of available-for-sale equity securities was $12,484,000 at December 31, 1994, and $12,382,000 at December 31, 1993. At December 31, 1994, gross unrealized appreciation on available-for-sale equity securities was $3,514,000 and gross unrealized depreciation was $558,000. At December 31, 1993, gross unrealized appreciation on equity securities was $5,067,000 and gross unrealized depreciation was $13,000.\nA comparison of amortized cost to fair value of fixed maturity investments by category is as follows:\nGROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ----- ----- (IN THOUSANDS) At December 31, 1994: HELD TO MATURITY U.S. Treasury $ 8,891 $ 25 $ (840) $ 8,076 States and political subdivisions 8,888 - (810) 8,078 Foreign governments 2,992 - (197) 2,795 Corporate securities 147,419 90 (13,158) 134,351 Mortgage-backed securities 210,460 558 (25,778) 185,240 --------- -------- --------- --------- $378,650 $ 673 $(40,783) $338,540 ========= ======== ========= ========= AVAILABLE FOR SALE U.S. Treasury $ 23,207 $ 2 $ (1,357) $ 21,852 States and political subdivisions 26,579 - (760) 25,819 Foreign governments 4,024 - (559) 3,465 Corporate securities 95,939 - (6,538) 89,401 Mortgage-backed securities 83,020 37 (4,846) 78,211 --------- -------- --------- --------- $232,769 $ 39 $(14,060) $218,748 ========= ======== ========= ========= At December 31, 1993: HELD TO MATURITY\nU.S. Treasury $ 9,124 $ 100 $ (61) $ 9,163 States and political subdivisions 5,200 - - 5,200 Corporate securities 119,276 2,653 (312) 121,617 Mortgage-backed securities 192,912 1,908 (5,260) 189,560 --------- -------- --------- --------- $ 326,512 $ 4,661 $ (5,633) $325,540 ========= ======== ========= ========= AVAILABLE FOR SALE U.S. Treasury $ 26,894 $ 570 $ (26) $ 27,438 State and political subdivisions 21,571 121 - 21,692 Foreign governments 4,056 2 (119) 3,939 Corporate securities 73,981 744 (465) 74,260 Mortgage-backed securities 131,215 5,029 (310) 135,934 --------- -------- --------- --------- $ 257,717 $ 6,466 $ (920) $263,263 ========= ======== ========= =========\nThe amortized cost and fair value of fixed maturities 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 prepayment penalties.\nAMORTIZED FAIR COST VALUE --------- ----- HELD TO MATURITY: (IN THOUSANDS) Due in 1995 $ 510 $ 512 Due 1996-2000 51,247 47,784 Due 2001-2005 69,574 62,956 Due after 2005 46,859 42,048 Mortgage-backed securities 210,460 185,240 --------- -------- $378,650 $338,540 ========= ======== AVAILABLE FOR SALE: Due in 1995 $ 830 $ 831 Due 1996-2000 59,914 56,399 Due 2001-2005 62,665 57,900 Due after 2005 26,340 25,407 Mortgage-backed securities 83,020 78,211 --------- -------- $232,769 $218,748 ========= ========\nProceeds from sales of investments (principally fixed maturities) during 1994, 1993 and 1992 were $111,850,000, $192,697,000 and $451,422,000, respectively. Gross gains of $1,448,000, $10,834,000 and $8,073,000 and gross losses of $1,542,000, $12,472,000 and $8,164,000 were realized on fixed maturity sales in 1994, 1993 and 1992, respectively.\nMajor categories of net investment income are summarized as follows:\n1994 1993 1992 ---- ---- ---- (IN THOUSANDS) Fixed maturities $40,172 $34,529 $39,384 Short-term investments 1,549 2,691 2,083 Other 4,189 4,069 3,733 -------- -------- --------\nTotal investment income 45,910 41,289 45,200 Investment expenses (3,124) (1,047) (1,645) -------- -------- -------- Net investment income $42,786 $40,242 $43,555 ======== ======== ========\nAt December 31, 1994 and 1993 the net appreciation (depreciation) of available-for-sale securities in stockholders' equity consisted of gross appreciation (depreciation) of ($11,066,000) and $5,054,000, respectively, net of deferred tax assets (liabilities) of $3,873,000 and ($1,769,000), respectively.\nAt December 31, 1994, securities with a carrying value of $96,247,000 were on deposit with various government authorities to meet regulatory requirements.\nAt December 31, 1994, the amortized cost of fixed maturity investments in any one entity, other than the U.S. government or a U.S. government agency or authority, which exceeded 10% of PFS' consolidated stockholders' equity were as follows:\nGE Capital Mortgage Services, Inc. $23,576,000 Prudential Home 11,131,000 Ford Capital 10,648,000 Nomura Asset Securities 10,102,000 State of Washington 9,651,000 GMAC 9,877,000 Associates Corporation 7,237,000 Citibank 6,900,000\nInvestment real estate (net of $483,000 of accumulated depreciation) at December 31, 1994 consists principally of land and a building used, in part, as PFS' corporate headquarters.\nAt December 31, 1994, PFS held unrated or less-than-investment-grade securities with a carrying value of $6,269,000 and an aggregate fair value of $5,479,000. Those holdings amounted to less than 1% of PFS' total investments at December 31, 1994.\nAt December 31, 1994, fixed maturities with a carrying value of $16,400,000 had been non-income producing for the preceding 12-month period.\n5. FEDERAL INCOME TAXES\nPFS adopted FASB Statement No. 109 as of January 1, 1993. The cumulative effect of the change in accounting for income taxes was not significant. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of PFS' deferred tax liabilities and assets are as follows:\nDECEMBER 31 1994 1993 ---- ---- (IN THOUSANDS) DEFERRED TAX LIABILITIES Deferred policy acquisition costs $72,306 $86,545 Net unrealized appreciation on available-for-sale securities - 1,769 Other 1,537 1,367\n-------- -------- Total deferred tax liabilities 73,843 89,681 -------- --------\nDEFERRED TAX ASSETS Policy liabilities 69,101 77,493 Financial reinsurance 3,788 11,150 Net unrealized depreciation on available-for-sale securities 3,873 - Other 8,213 8,830 -------- -------- Total deferred tax assets 84,975 97,473 Valuation allowance for deferred tax assets (3,870) (3,870) -------- --------\nDeferred tax assets net of valuation allowance 81,105 93,603 -------- -------- Net deferred tax asset $ 7,262 $ 3,922 ======== ========\nThe nature of PFS' deferred tax assets and liabilities are such that the reversal pattern for these temporary differences should generally result in realization of PFS' deferred tax assets. PFS establishes a valuation allowance for any portion of the deferred tax asset that management believes may not be realized. There was no change in the valuation allowance in 1994, and in 1993 the valuation allowance increased by $1,221,000 principally due to the acquisition of Continental Life & Accident Company (See Note 3).\nThe deferred tax benefit for 1992 includes the effects of the following items (in thousands):\nDeferred policy acquisition costs $(16,232) Policy liabilities 2,966 Decrease in operating loss carryforward 143 General expenses 1,537 Financial statement capital gains greater than tax capital gains 148 Other 83 --------- Deferred federal income tax benefit $(11,355) =========\nPFS' effective federal income tax rate varied from the statutory federal income tax rate as follows:\nLIABILITY METHOD DEFERRED METHOD 1994 1993 1992 AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- (DOLLARS IN THOUSANDS)\nStatutory federal income tax rate applied to income or loss before income taxes $ 9,108 35.0% $ 6,567 35.0% $(8,648) 34.0% Nondeductible goodwill amortization 109 .4 319 1.7 192 (.8) Tax exempt interest (307) (1.2) (99) (.5) - -\nOther (37) (.1) (168) (.9) (21) .1 -------- ----- -------- ----- -------- ----- Income taxes (benefit) and effective rate $ 8,873 34.1% $ 6,619 35.3% $(8,477) 33.3% ======== ===== ======== ===== ======== =====\nTaxes paid amounted to $9,731,000, $5,735,000, and $8,828,000 for 1994, 1993, and 1992, respectively.\nUnder pre-1984 life insurance company income tax laws, a portion of a life insurance company's gain from operations was not subjected to current income taxation but was accumulated, for tax purposes, in a memorandum account designated as the policyholders' surplus account. The balance in this account at December 31, 1994 for PFS' life insurance subsidiaries was $10,040,000. Should the policyholders' surplus accounts of PFS' life insurance subsidiaries exceed their respective maximums, or should distributions in excess of their tax-basis shareholders' surplus account be made by the life insurance subsidiaries, such excess or distribution would be subject to federal income taxes at rates then in effect. Deferred taxes of $3,500,000 have not been provided on amounts included in the policyholders' surplus accounts, since PFS contemplates no such taxable events in the foreseeable future.\nAs of December 31, 1994, PFS' life insurance subsidiaries had combined tax- basis shareholders' surplus accounts of $46,000,000. Distributions up to that amount would result in no income tax liability.\n6. REINSURANCE\nPFS' insurance subsidiaries reinsure risks with other companies to permit the recovery of a portion of the direct losses. These reinsured risks are treated as though, to the extent of the reinsurance, they are risks for which the subsidiaries are not liable. PFS remains liable to the extent that the reinsuring companies do not meet their obligations under these reinsurance treaties.\nPFS' premiums were reduced for reinsurance premiums by $37,273,000, $40,592,000, and $30,469,000 in 1994, 1993, and 1992, respectively. Under various reinsurance arrangements, PFS' premiums were increased by $16,928,000, $19,338,000, and $15,403,000 in 1994, 1993, and 1992, respectively. PFS' policy benefits have been reduced for reinsurance recoveries of $23,319,000 in 1994, $21,871,000 in 1993, and $22,171,000 in 1992. At December 31, 1994, approximately 40% of PFS' reinsurance receivables and amounts on deposit with reinsurers were due from Employers Reinsurance Corporation, 14% from North American Reassurance, and 12% from The Universe Life Insurance Company. The amounts due from The Universe Life Insurance Company were held in a financial institution trust account.\n7. SALE OF AGENT RECEIVABLES\nIn 1994, 1993, and 1992 a subsidiary of PFS sold agent receivables to an unaffiliated company for proceeds of $24,393,000, $25,376,000, and $20,347,000, respectively. The outstanding balances of such agent receivables sold that remained uncollected at December 31, 1994 and 1993 were $7,937,000 and $9,815,000, respectively. PFS remains subject to a maximum credit exposure under this agreement amounting to 10% of agent receivables at December 31, 1994.\n8. RECONCILIATION OF LIABILITY FOR POLICY AND CONTRACT CLAIMS\nThe following table provides a reconciliation of the beginning and ending policy and contract claim liability balances reported in PFS' balance sheets:\nYEAR ENDED DECEMBER 31 1994 1993 1992 ---- ---- ---- (IN THOUSANDS)\nPolicy and contract claim liability beginning of year $189,389 $148,141 $151,577\nIncurred claims 445,794 410,607 377,063\nDeduct claims paid related to:\nCurrent year 350,210 260,702 251,773 Prior years 129,600 108,657 128,726 --------- --------- --------- Total claims paid 479,810 369,359 380,499 --------- --------- ---------\nPolicy and contract claim liability end of year $155,373 $189,389 $148,141 ========= ========= =========\nPFS has historically held margins in its accident and health claim reserves to provide for potential adverse deviation. The claim reserve estimates are continually reviewed and adjusted as necessary. Based on payments through the first nine months of 1994, PFS determined that claim reserves contained significantly higher margins than originally projected. As a result, claim reserve margins of $15,000,000 were released in the third quarter of 1994. PFS continues to hold additional margins which it considers to be reasonable in its medical claim reserves.\n9. NOTES PAYABLE\nShort-term notes payable included $18,950,000 at December 31, 1994, drawn under a line of credit arrangement. The borrowings are due in 1995 and bear interest at prime and payable quarterly (See Note 22). The remaining balance under the line of credit is due in October 1995.\nAt December 31, 1994, a PFS subsidiary had an unsecured loan of $1,125,000. The portion of the loan due in 1995 of $300,000 is included in short-term notes payable. The remainder of the note is included in long-term notes payable. The note bears interest currently at prime and is payable quarterly with the final payment due July 1998.\nAt December 31, 1994, a PFS subsidiary has two unsecured loans totaling $2,275,000. The portion of the loans due in 1995 of $580,000 are included in short-term notes payable. The remainder of the notes are included in long- term notes payable. The notes bear interest at prime and are payable quarterly with the final payment due December 1999. PFS has guaranteed payment of the notes.\nAt December 31, 1994, PFS had $263,000 of short-term debt liability for which a PFS agency subsidiary's future renewal commissions were pledged as collateral.\nThe weighted average interest rate on short-term notes payable at year end\nwas 7.7%, 5.0% and 5.6% in 1994, 1993 and 1992, respectively.\nInterest paid amounted to $4,950,000, $1,023,000, and $2,274,000 for 1994, 1993, and 1992, respectively.\n10. ACCIDENT AND HEALTH BUSINESS\nIn making the determination that policy liabilities, future premiums, and anticipated investment income will be adequate to provide for future claims and expenses (including the amortization of deferred policy acquisition costs), PFS has made assumptions with regard to each of these items. Although there is significant variability inherent in these estimates, management believes that these assumptions are reasonable.\nPursuant to an actuarial study performed in the third quarter of 1994, PFS revised certain of these assumptions to reflect present and anticipated future experience. This study resulted in increased amortization of deferred policy acquisition costs of $16,700,000 in the third quarter of 1994. A similar actuarial study performed in 1992 resulted in increased amortization of deferred policy acquisition costs of $30,000,000 in the fourth quarter of 1992.\n11. STATUTORY-BASIS FINANCIAL INFORMATION\nThe following tables compare combined net income and stockholders' equity for PFS' insurance subsidiaries determined on the basis as prescribed or permitted by regulatory authorities (statutory basis) with consolidated net income (loss) and stockholders' equity reported in accordance with GAAP. Statutory basis accounting emphasizes solvency rather than matching revenues and expenses during an accounting period. The significant differences between statutory basis accounting and GAAP are as follows:\nDeferred Policy Acquisition Costs. Costs of acquiring new policies are expensed when incurred on a statutory basis rather than capitalized and amortized over the term of the related polices in the GAAP financial statements.\nPolicy Liabilities. Certain policy liabilities are calculated based on statutorily required methods and assumptions on a statutory basis rather than on estimated expected experience or, for annuity and interest- sensitive life insurance, actual account balances for GAAP.\nFinancial Reinsurance. The effects of certain financial reinsurance transactions are included in the statutory basis financial statements but are eliminated from the GAAP financial statements.\nDeferred Federal Income Taxes. Deferred federal income taxes are not provided on a statutory basis for differences between financial statement and tax return amounts.\nSurplus Notes. Surplus notes are reported in capital and surplus on a statutory basis rather than as liabilities in the GAAP financial statements.\nNon-insurance Companies' Equity. Contributions by PFS to the capital and surplus of its insurance subsidiaries increases the stockholders' equity of those insurance subsidiaries on a statutory basis but does not effect the consolidated stockholders' equity on a GAAP basis.\nUnrealized Depreciation On Fixed Maturities Available-For-Sale. Fixed maturity securities classified as available-for-sale are carried principally at amortized cost on a statutory basis rather than at fair value with unrealized gains and losses on such securities reported as a separate component of stockholders' equity in the GAAP financial statements.\n1994 1993 1992 ---- ---- ---- (IN THOUSANDS)\nCombined net income on a statutory basis $ 6,986 $ 10,155 $ 3,629\nAdjustments for: Deferred policy acquisition costs (34,814) (12,842) (43,779) Policy liabilities 26,544 (18,494) (19,957) Financial reinsurance 17,544 34,017 33,118 Deferred federal income taxes (2,303) 4,239 11,355 Non-insurance companies, eliminations, and other adjustments 3,192 (4,930) (1,325) ---------- --------- ----------\nConsolidated net income (loss) in accordance with GAAP $ 17,149 $ 12,145 $ (16,959) ========== ========= ==========\nDECEMBER 31 1994 1993 ------------------ (IN THOUSANDS)\nCombined stockholders' equity on a statutory basis $ 124,284 $ 106,567\nAdjustments for: Deferred policy acquisition costs 225,618 260,432 Policy liabilities (180,422) (206,966) Financial reinsurance (12,748) (30,292) Deferred federal income taxes 7,262 3,922 Non-admitted assets 10,813 11,743 Surplus notes (4,436) (4,116) Unrealized depreciation on available-for-sale fixed maturities (14,021) - Other (12,296) (12,229) --------- ----------\nCombined insurance subsidiaries stockholders' equity on a GAAP basis 144,054 129,061\nNon-insurance companies equity, eliminations and other adjustments (75,726) (60,189) --------- ----------\nConsolidated stockholders' equity in accordance with GAAP $ 68,328 $ 68,872 ========= ==========\nDividends from PFS' insurance subsidiaries unassigned surplus are limited to the greater of the prior-year statutory-basis net gain from operations or 10% of statutory-basis surplus. The total amount of dividends that could be paid\nin 1995 without regulatory approval is $7,419,000. At December 31, 1994, PFS' retained earnings was $34,460,000 in excess of the combined statutory- basis unassigned surplus of the insurance subsidiaries.\nPFS is required to maintain adequate amounts of statutory-basis capital and surplus to satisfy regulatory requirements and provide capacity for production of new business. Acquisition costs relating to the production of new business result in a reduction of statutory-basis net income and capital and surplus.\n12. CONVERTIBLE SUBORDINATED DEBENTURES\nIn July 1993 PFS issued $57,477,000 of 8% convertible subordinated debentures due in 2000. Interest on the debentures is payable in January and July of each year. Net proceeds from the offering totaled approximately $54,000,000 and were used, in part, to repay long-term notes payable. The debentures are convertible into PFS' Common Stock at any time prior to maturity, unless previously redeemed, at a conversion price of $11.75 per share.\nThe debentures are redeemable by PFS under certain conditions after July 1996.\nAt December 31, 1994, 4,887,404 shares of PFS' Common Stock were reserved for conversion of the outstanding convertible subordinated debentures.\n13. REDEEMABLE PREFERRED STOCK\nIn 1989, PFS issued 1,000,000 shares of $2.125 Cumulative Convertible Exchangeable Preferred Stock. The proceeds of the public offering were $23,337,000 after reduction for expenses of $1,663,000, which expenses were charged to additional paid-in capital. The Preferred Stock is carried on PFS' balance sheet at the redemption and liquidation value of $25 per share.\nEach share of Preferred Stock is convertible by the holders at any time into 1.6 shares of PFS Common Stock. Annual cumulative dividends of $2.125 per share are payable quarterly. The preferred stock is nonvoting unless dividends are in arrears. At December 31, 1994, 1,387,680 shares of PFS' Common Stock were reserved for conversion of the outstanding preferred stock.\nThe Preferred Stock is redeemable at the option of the holders upon certain acquisitions or other business combinations involving PFS Common Stock.\nThe Preferred Stock is redeemable by PFS at redemption prices of $26.06 per share in 1994, declining to $25 in 1999. The Preferred Stock is exchangeable in whole at PFS' option on any dividend payment date for PFS' 8 1\/2% Convertible Subordinated Debentures due in 2014 at the rate of $25 principal amount of Subordinated Debentures for each share of Preferred Stock.\n14. SHAREHOLDER RIGHTS AGREEMENT\nIn 1990, PFS distributed one preferred share purchase right for each outstanding share of Common Stock. The rights are intended to cause substantial dilution to a person or group that attempts to acquire PFS on terms not approved by PFS' directors. The rights expire in 2000 or PFS may redeem the rights prior to exercise for $.01 per right.\nThe rights are not exercisable unless a person or group acquires, or offers to acquire, 20% or more of PFS' Common Stock under certain circumstances. The rights, when exercisable, entitle the holder to purchase one-tenth of a\nshare of a new series of PFS Series A Junior Preferred Stock at a purchase price of $45. Such preferred shares, of which 2,000,000 are authorized, would be voting and would be entitled to distributions that are ten times the distributions to common shareholders. Subsequent to exercise of the rights, in the event of certain business combinations involving PFS, a holder of rights would have the right to receive PFS Common Stock with a value of two times the exercise price of the rights.\n15. STOCK OPTIONS AND RIGHTS\nPFS has a nonqualified stock option plan and certain stock incentive programs principally for directors and key employees of PFS and its subsidiaries. PFS' Board of Directors grants the options and specifies the conditions of the options. The number of shares of common stock available for benefits under the plan is equal to 15% of the average fully diluted shares outstanding for the prior fiscal year. Options expire ten years after grant. Information with respect to these options is as follows:\n1994 1993 NUMBER NUMBER OF EXERCISE OF EXERCISE SHARES PRICE SHARES PRICE ------ -------- ------ -------- Options outstanding at beginning of year 733,250 $5.50 - $12.00 594,250 $5.50 - $12.00 Granted 480,321 8.88 - 11.38 225,000 5.50 Exercised 85,500 5.50 - 11.00 72,000 5.50 - 12.00 Canceled\/repurchased 82,500 5.50 - 12.00 14,000 5.50 --------- -------------- ------- -------------- Options outstanding at end of year 1,045,571 $5.50 - $12.00 733,250 $5.50 - $12.00 ========= =======\nOptions exercisable at end of year 561,250 573,250 ========= =======\nUnoptioned shares available for granting of options 1,535,201 22,900 ========= =======\n16. COMMITMENTS AND CONTINGENCIES\nPFS and its subsidiaries are named as defendants in various legal actions, some claiming significant damages, arising primarily from claims under insurance policies, disputes with agents, and other matters. PFS' management and its legal counsel are of the opinion that the disposition of these actions will not have a material adverse effect on PFS' financial position.\nPFS leases various office facilities furniture and equipment and computer equipment under noncancelable operating leases. Rent expense was $4,530,000, $4,516,000, and $3,700,000 in 1994, 1993, and 1992, respectively. Minimum future rental commitments in connection with noncancelable operating leases are as follows:\n1995 $ 3,203,000 1996 2,445,000 1997 939,000 1998 258,000\n1999 106,000\nPFS has entered into employment agreements with certain officers.\nThe number of insurance companies that are under regulatory supervision has increased, and that increase is expected to result in an increase in assessments by state guaranty funds to cover losses to policyholders of insolvent or rehabilitated companies. Those mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. For all assessment notifications received, PFS has accrued for those assessments net of estimated future premium tax reductions.\n17. BENEFIT PLAN\nPFS has a defined-contribution employee benefit plan that covers substantially all home office employees who have attained age 21 and completed one year of service. Plan participants may contribute from 1% to 10% of their total compensation subject to an annual maximum. The plan also provides for PFS to match participants' contributions up to $1,000 per year and 50% of participants, contributions above $1,000 up to the annual Internal Revenue Service limit ($9,240 in 1994). PFS makes employer contributions to the plan in cash or in PFS Common Stock at the discretion of PFS' Board of Directors. At December 31, 1994, the Plan's assets included PFS Common Stock of $2,915,775, at fair value. PFS' contibutions charged to operations were $1,365,000 in 1994, $1,073,000 in 1993, and $852,000 in 1992.\nA PFS subsidiary, which owns insurance and agency companies, had a stock purchase plan that allowed certain eligible agents to purchase common stock in the subsidiary at the subsidiary's per share book value. The plan was terminated in November 1992. In accordance with the plan's provisions, agents became fully vested. Eligible agents were given the option to participate in a new agent stock purchase plan. This new plan allows agents to purchase PFS Common Stock. Stock purchases are limited to a specific percentage of the agent's commission as determined by PFS but in no event to be less than 3%. Under the plan the agents are also credited with additional shares of PFS Common Stock as determined by PFS. In 1994, 1993 and 1992, 6,332 shares, 8,057 shares and 163,566 shares, respectively, of PFS Common Stock were issued under this plan.\n18. ALLOWANCES AND ACCUMULATED DEPRECIATION\nAllowances for doubtful accounts related to other receivables amounted to $895,000 at December 31, 1994, and $1,271,000 at December 31, 1993.\nAccumulated depreciation related to building and equipment amounted to $19,325,000 at December 31, 1994, and $16,891,000 at December 31, 1993.\n19. FAIR VALUE INFORMATION\nThe following methods and assumptions were used by PFS in estimating its fair values for financial instruments:\nCash, short-term investments, short-term notes payable, and accrued investment income: The carrying amounts reported in the balance sheets for these instruments approximate their fair values.\nInvestment securities: Fair values for fixed maturity securities (including redeemable preferred stocks) are based on quoted market prices, where available. For fixed maturity securities not actively\ntraded, fair values are estimated using values obtained from independent pricing services, or, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield quality, and maturity of the investments. The fair values for equity securities are based on quoted market prices.\nMortgage loans and policy loans: The carrying amount of PFS' mortgage loans approximates their fair values. The fair values for policy loans are estimated using capitalization of earnings methods, using interest rates currently being offered for similar loans to borrowers with similar credit ratings.\nInvestment contracts: Fair values for PFS' liabilities under investment-type insurance contracts are based on current cash surrender values.\nFair values for PFS' insurance policies other than investment contracts are not required to be disclosed. However, the fair values of liabilities under all insurance policies are taken into consideration in PFS' overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance policies.\nLong-term notes payable: The fair value of PFS' long-term notes payable approximates the carrying value.\nConvertible subordinated debentures: The fair value of PFS' convertible subordinated debentures is based on quoted market prices.\nThe fair values of certain financial instruments along with their corresponding carrying values of December 31, 1994 and 1993 are as follows:\n1994 1993 FAIR CARRYING FAIR CARRYING VALUE VALUE VALUE VALUE ----- -------- ----- -------- (IN THOUSANDS) Financial Assets\nFixed Maturities: Available-or-sale $218,748 $218,748 $263,263 $257,717 Held-to-maturity 338,540 378,650 325,540 326,512 Equity securities 15,440 15,440 17,436 17,436 Mortgage loans 1,806 1,806 3,201 3,201 Policy loans 22,025 23,082 21,011 23,988\nFinancial Liabilities\nInvestment contracts 194,072 203,654 191,816 200,894 Long-term notes payable 2,520 2,520 1,125 1,125 Subordinated debentures 54,843 57,427 70,122 57,477\nDuring the fourth quarter of 1994, PFS began using exchange-traded treasury futures contracts as part of its overall interest rate risk management strategy for a small portion of its life and annuity business. The initial margin deposit paid for the futures represents their cost basis which is adjusted to fair value in the financial statements. Realized and unrealized gains and losses, which were immaterial in 1994, are recognized as an adjustment to the carrying amount of the asset being hedged.\n20. SEGMENT INFORMATION\nPFS has four business segments: Group Medical, Senior Health, Life Insurance, and Medical Utilization Management. The segments are based on PFS' main Divisions. Allocations of investment income and certain general expenses are based on various assumptions and estimates, and reported operating results by segment would change if different methods were applied. Assets are not individually identifiable by segment and have been allocated based on the amount of policy liabilities by segment and by other formulas. Depreciation expense and capital expenditures are not considered material. Realized investment gains and losses are allocated to the appropriate segment. General corporate expenses are not allocated to the individual segments. Revenues, income or loss before income taxes, and identifiable assets by business segment are as follows:\n1994 1993 1992 ---- ---- ---- (IN THOUSANDS) REVENUES -------- Group Medical: Unaffiliated $ 457,633 $ 379,742 $ 327,033 Inter-segment 35,373 30,439 26,500 Senior Health 235,031 247,100 258,608 Life Insurance 71,075 67,780 68,411 Medical Utilization Management: Unaffiliated 10,416 4,506 1,921 Inter-segment 4,927 4,358 2,041 ---------- ---------- --------- 814,455 733,925 684,514 Eliminations 40,300 34,797 28,541 ---------- ---------- --------- Total $ 774,155 $ 699,128 $ 655,973 ========== ========== =========\nINCOME (LOSS) BEFORE INCOME TAXES --------------------------------- Group Medical $ 10,889 $ 6,528 $(25,235) Senior Health 13,420 12,255 1,966 Life Insurance 8,537 7,623 340 Medical Utilization Management 2,026 (1,211) 335 Corporate expenses (8,850) (6,431) (2,843) ---------- ---------- --------- Total $ 26,022 $ 18,764 $(25,437) ========== ========== =========\nIDENTIFIABLE ASSETS AT YEAR-END ------------------------------- Group Medical $ 245,763 $ 287,713 $ 206,194 Senior Health 291,703 301,700 292,449 Life Insurance 533,070 514,154 478,529 Medical Utilization Management 5,164 4,704 1,517 ---------- ---------- --------- Total $1,075,700 $1,108,271 $ 978,689 ========== ========== =========\n21. CREDIT ARRANGEMENTS\nPFS has a line of credit arrangement for short-term borrowings with three\nbanks amounting to $20,000,000 through April 1996, of which $18,950,000 was used at December 31, 1994. The line of credit arrangement can be terminated, in accordance with the agreement, at PFS' option.\n22. SUBSEQUENT EVENT\nAs discussed in Note 3, on January 31, 1995, PFS acquired all of the outstanding common shares of Connecticut National Life Insurance Company for a cost of $24,000,000. To fund the acquisition, PFS utilized $15,000,000 from its available line of credit and internal cash sources. The line of credit was replaced with a five year term loan totaling $15,000,000 in March 1995.\n23. QUARTERLY FINANCIAL DATA (UNAUDITED)\nA summary of unaudited quarterly results of operations for 1994 and 1993 is as follows (in thousands, except per share amounts):\n---- 1ST 2ND 3RD 4TH --- --- --- --- Premiums and policy charges $172,898 $176,803 $176,190 $178,219\nNet investment income and other 18,367 16,926 17,674 17,079\nNet income 4,500 4,403 3,321 4,926\nNet income per share: Primary .60 .59 .44 .73 Fully diluted .40 .40 .32 .46\n---- 1ST 2ND 3RD 4TH --- --- --- --- Premiums and policy charges $155,343 $154,189 $154,132 $177,302\nNet investment income and other 14,369 13,928 15,802 14,063\nNet income 2,295 2,627 3,128 4,095\nNet income per share: Primary .26 .31 .40 .54 Fully diluted .26 .31 .31 .37\nSCHEDULE I\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES\nDecember 31, 1994\nAmount Shown in the Consolidated Amortized Fair Balance Type of Investment Cost Value Sheet ------------------ --------- ----- ------------ (in thousands) Fixed maturities to be held to maturity: U.S. Treasury $ 8,891 $ 8,076 $ 8,891 States and political subdivisions 8,888 8,078 8,888 Foreign governments 2,992 2,795 2,992 Corporate securities 147,419 134,351 147,419 Mortgage-backed securities 210,460 185,240 210,460 -------- -------- -------- TOTAL FIXED MATURITIES TO BE HELD TO MATURITY 378,650 338,540 378,650 -------- -------- --------\nFixed maturities available for sale: U.S. Treasury 23,207 $ 21,852 21,852 States and political subdivisions 26,579 25,819 25,819 Foreign governments 4,024 3,465 3,465 Corporate securities 95,939 89,401 89,401 Mortgage-backed securities 83,020 78,211 78,211 -------- -------- -------- TOTAL FIXED MATURITIES AVAILABLE FOR SALE 232,769 218,748 218,748 -------- -------- --------\nEquity securities: Common stocks: Banks, trusts, and insurance companies 9,145 $ 12,526 12,526 Nonredeemable preferred stocks 3,339 2,914 2,914 -------- -------- --------\nTOTAL EQUITY SECURITIES 12,484 $ 15,440 15,440 -------- ======== --------\nReal estate 16,959 16,959 Mortgage loans on real estate 1,806 1,806 Policy loans 23,082 23,082 Short-term investments 69,152 69,152 -------- --------\nTOTAL INVESTMENTS $734,902 $723,837 ======== ========\nSCHEDULE II\nPIONEER FINANCIAL SERVICES, INC. (Parent Company) CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (In thousands, except share and per share amounts)\nDecember 31 1994 1993 ------ ------ ASSETS Investments in subsidiaries* $122,310 $107,620 Cash 157 1,711 Note receivable from United Group Holdings* 38,704 37,495 Other notes receivable from subsidiaries* 3,517 403 Due from affiliates* 132 1,014 Prepaid expenses 592 573 Deferred debenture offering expenses 3,214 3,799 Other assets 2,014 363 -------- --------- $170,640 $152,978 ======== =========\nLIABILITIES, REDEEMABLE PREFERRED STOCK, AND STOCKHOLDERS' EQUITY Liabilities: General expenses and other liabilities $ 3,481 $ 2,444 Preferred stock dividends payable 772 510 Short-term notes payable 18,950 - Convertible subordinated debentures 57,427 57,477 -------- -------- 80,630 60,431 Redeemable Preferred Stock, no par value: $2.125 cumulative convertible exchangeable preferred stock Authorized: 5,000,000 shares Issued and outstanding: (1994-867,300 shares; 21,682 23,675 1993-947,000 shares)\nStockholders' equity: Common Stock, $1 par value: Authorized: 20,000,000 shares Issued, including shares in treasury (1994 - 6,996,157; 1993 - 6,900,000) 6,996 6,900 Additional paid-in capital 29,299 28,814 Unrealized appreciation (depreciation) of equity securities (7,193) 3,285 Retained earnings 48,960 34,645 Less treasury stock at cost (1994 - 1,078,400) 1993 - 556,800) (9,734) (4,772) -------- -------- Total stockholders' equity 68,328 68,872 -------- -------- $170,640 $152,978 ======== ========\nSee note to condensed financial statements.\n*Eliminated in consolidation.\nSCHEDULE II\nPIONEER FINANCIAL SERVICES, INC. (Parent Company)\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT--Continued\nCONDENSED STATEMENTS OF OPERATIONS (In thousands)\nYear Ended December 31 1994 1993 1992 ------ ------ ------\nRevenues: Interest income from subsidiaries* $ 2,972 $ 1,090 $ 1,835 Other investment income 109 62 15 Dividends from consolidated subsidiaries* 10,225 10,345 10,482 -------- -------- -------- 13,306 11,497 12,332\nExpenses: Operating and administrative expenses 5,672 4,702 2,154 Interest expense 4,894 3,204 2,206 -------- -------- -------- 10,566 7,906 4,360 -------- -------- --------\nIncome before equity in undistributed net income or loss of subsidiaries 2,740 3,591 7,972\nEquity in undistributed net income (loss) of subsidiaries* 14,409 8,554 (24,931) -------- -------- --------\nNet income (loss) 17,149 12,145 (16,959)\nPreferred stock dividends 1,904 2,021 2,039 -------- -------- --------\nIncome (loss) applicable to common stockholders $ 15,245 $ 10,124 $(18,998) ======== ======== ========\nSee note to condensed financial statements.\n*Eliminated in consolidation.\nSCHEDULE II\nPIONEER FINANCIAL SERVICES, INC. (Parent Company)\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT--Continued\nCONDENSED STATEMENTS OF CASH FLOWS (In thousands)\nYear Ended December 31 1994 1993 1992 ------ ------ ------\nOPERATING ACTIVITIES Net income (loss) $ 17,149 $ 12,145 $(16,959) Adjustments to reconcile net income or loss to net cash provided by operating activities: Change in other assets and liabilities 1,095 1,678 (929) Equity in undistributed net (income) loss of subsidiaries* (14,409) (8,554) 24,931 -------- -------- --------\nNET CASH PROVIDED BY OPERATING ACTIVITIES 3,835 5,269 7,043\nINVESTING ACTIVITIES Additional investment in consolidated subsidiaries* (10,758) (15,219) (13)\nFINANCING ACTIVITIES Decrease (increase) in notes receivable from PLIC - 29,128 (11,597) Increase in notes receivable from UGH (1,209) (37,495) - Net proceeds from issuance of convertible subordinated debentures - 54,055 - Increase in notes payable 18,950 - 10,000 Repayment of notes payable (50) (31,600) (3,900) Decrease (increase) in other notes receivable from subsidiaries* (3,114) 3,591 (447) Stock options exercised 495 451 165 Dividends paid-preferred (1,904) (2,021) (2,039) Dividends paid-common (930) - - Purchase of treasury stock (4,963) (4,720) (52) Retirement of preferred stock (1,993) (315) - Other 87 44 717 -------- -------- --------\nNET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 5,369 11,118 (7,153) -------- -------- --------\nINCREASE (DECREASE) IN CASH (1,554) 1,168 (123)\nCASH AT BEGINNING OF YEAR 1,711 543 666 -------- -------- --------\nCASH AT END OF YEAR $ 157 $ 1,711 $ 543\n======== ======== ========\nSee note to condensed financial statements.\n*Eliminated in consolidation.\nSCHEDULE II\nPIONEER FINANCIAL SERVICES, INC. (Parent Company)\nNOTE TO CONDENSED FINANCIAL STATEMENTS\nThe accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Pioneer Financial Services, Inc.\nAt December 31, 1994 and 1993, the notes receivable from United Group Holdings of Delaware (UGH) represents the purchase of National Group Life Insurance Company from the parent company. The note bears interest at the rate of 8% and matures on December 31, 1998.\nSCHEDULE III\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nSUPPLEMENTARY INSURANCE INFORMATION (In thousands)\nDecember 31 ----------------------------------------------------- Deferred Future Policy Policy Benefits and Acquisition Policy and Unearned Other Policy Segment Costs Contract Claims Premiums Liabilities ------- ----------- --------------- -------- -------------\n1994: Group Medical $ 68,608 $121,098 $ 16,176 $ 4,343\nSenior Health 95,191 191,800 60,090 4,461\nLife Insurance 61,819 463,037 - 7,603\nMedical Utilization Management - - - - -------- -------- -------- -------- $225,618 $775,935 $ 76,266 $ 16,407 ======== ======== ======== ========\n1993: Group Medical $ 92,153 $126,684 $ 15,844 $ 3,862\nSenior Health 111,708 215,232 72,101 4,204\nLife Insurance 56,571 458,207 - 6,971\nMedical Utilization Management - - - - -------- -------- -------- -------- $260,432 $800,123 $ 87,945 $ 15,037 ======== ======== ======== ========\n1992: Group Medical $ 81,408 $ 85,257 $ 14,028 $ 1,361\nSenior Health 133,749 203,709 76,852 1,471\nLife Insurance 54,517 417,590 - 5,428\nMedical Utilization Management - - - - -------- -------- -------- -------- $269,674 $706,556 $ 90,880 $ 8,260 ======== ======== ======== ========\nSCHEDULE III (continued)\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nSUPPLEMENTARY INSURANCE INFORMATION (In thousands)\nAmortization Net of Premiums Investment Deferred and Income and Policy Other Policy Realized Gains Acquisition Other Operating Segment Charges and Losses* Benefits Costs Income Expenses* ------- ------ ------------- -------- ---------- ------ ---------\n1994:\nGroup Medical $431,831 $ 9,184 $267,450 $ 62,281 $ 16,618 $117,013\nSenior Health 227,349 6,516 139,799 29,807 1,166 52,005\nLife Insurance 44,929 26,700 42,947 7,985 (554) 11,606\nMedical Utilization Management - 3 - - 10,413 8,390\nCorporate Expenses - - - - - 8,850 -------- -------- -------- -------- --------- -------- $704,109 $ 42,403 $450,196 $100,073 $ 27,643 $197,864 ======== ======== ======== ======== ========= ========\n1993:\nGroup Medical $357,784 $ 8,033 $246,117 $ 36,189 $ 13,925 $ 90,908\nSenior Health 243,900 2,393 151,846 30,132 800 52,860\nLife Insurance 39,282 28,478 39,419 10,554 27 10,191\nMedical Utilization Management - 2 - - 4,504 5,717\nCorporate Expenses - - - - - 6,431 -------- -------- -------- -------- --------- -------- $640,966 $ 38,906 $437,382 $ 76,875 $ 19,256 $166,107 ======== ======== ======== ======== ========= ========\n1992:\nGroup Medical $306,880 $ 6,806 $197,058 $ 55,701 $ 13,348 $ 99,510\nSenior Health 253,014 3,476 170,988 35,928 2,117 49,724\nLife Insurance 35,219 33,222 47,622 9,086 (30) 11,363\nMedical Utilization Management - 4 - - 1,917 1,586\nCorporate Expenses - - - - - 2,843\n-------- -------- -------- -------- --------- -------- $595,113 $ 43,508 $415,668 $100,715 $ 17,352 $165,026 ======== ======== ======== ======== ========= ========\n*Allocations of net investment income and other operating expenses are based on a number of assumptions and estimates and results would change if different methods were applied. Interest expense has been included with other operating expenses. Realized investment gains and losses were allocated to the appropriate segment.\nSCHEDULE IV\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nREINSURANCE (In thousands)\nAssumed Percentage Ceded to from of Amount Gross Other Other Net Assumed Amount Companies Companies Amount to net ------- --------- --------- ------ ----------\nYear Ended December 31, 1994: Life insurance in force*$12,581,797 $ 3,801,387 $ - $8,780,410 - =========== =========== ========== ========== ====\nPremiums and Policy Charges:\nGroup Medical $ 435,166 $ 19,121 $ 15,786 $ 431,831 3.6% Senior Health 227,349 - - 227,349 - Life Insurance 61,939 18,152 1,142 44,929 2.5 Medical Utilization Managment - - - - ----------- ----------- ---------- ---------- $ 724,454 $ 37,273 $ 16,928 $ 704,109 =========== =========== ========== ==========\nYear Ended December 31, 1993: Life insurance in force*$11,823,127 $ 3,859,945 $ - $7,963,182 - =========== =========== ========== ========== ====\nPremiums and Policy Charges:\nGroup Medical $ 362,888 $ 24,154 $ 19,050 $ 357,784 5.3% Senior Health 243,899 - - 243,899 - Life Insurance 55,433 16,438 288 39,283 .7 Medical Utilization Management - - - - ----------- ----------- ---------- ---------- $ 662,220 $ 40,592 $ 19,338 $ 640,966 =========== =========== ========== ==========\nYear Ended December 31, 1992: Life insurance in force*$10,338,557 $ 3,929,621 $ - $6,408,936 - =========== =========== ========== ========== ====\nPremiums and Policy Charges:\nGroup Medical $ 305,833 $ 14,328 $ 15,375 $ 306,880 5.0% Senior Health 253,014 - - 253,014 - Life Insurance 51,332 16,141 28 35,219 .1 Medical Utilization Management - - - - ----------- ----------- ---------- ---------- $ 610,179 $ 30,469 $ 15,403 $ 595,113 =========== =========== ========== ==========\n*At end of year\nSCHEDULE V\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\n(In thousands)\nDeductions- Doubtful Accounts Written Balance at Additions- off During Balance Beginning Charged to the Year at End Description of Year Expense \/Disposals of Year ----------- --------- ---------- ---------- --------\nYear Ended December 31, 1994: Allowance for doubtful accounts$ 1,271 $ 2,425 $ 2,801 $ 895 Accumulated depreciation on building and equipment 16,891 5,532 3,098 19,325\nYear Ended December 31, 1993: Allowance for doubtful accounts 1,504 1,171 1,404 1,271 Accumulated depreciation on building and equipment 11,646 5,515 270 16,891\nYear Ended December 31, 1992: Allowance for doubtful accounts 147 1,475 118 1,504 Accumulated depreciation on building and equipment 9,122 3,245 721 11,646\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPIONEER FINANCIAL SERVICES, INC.\nBY: \/S\/ Peter W. Nauert _______________________________________ Peter W. Nauert, Chairman\/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 22, 1995\n\/S\/ Peter W. Nauert \/S\/ Michael A. Cavataio __________________________________ ___________________________________ Peter W. Nauert, Chairman, Michael A. Cavataio Chief Executive Officer, and Director Director\n\/S\/ William B. Van Vleet \/S\/ R. Richard Bastian, III __________________________________ ___________________________________ William B. Van Vleet, Executive R. Richard Bastian, III Vice President and Director Director\n\/S\/ David I. Vickers \/S\/ Karl-Heinz Klaeser __________________________________ ___________________________________ David I. Vickers, Treasurer Karl-Heinz Klaeser and Chief Financial Officer Director\n\/S\/ Robert F. Nauert \/S\/ Richard R. Haldeman __________________________________ ___________________________________ Robert F. Nauert Richard R. Haldeman Director Director\n\/S\/ Charles R. Scheper \/S\/ Michael K. Keefe __________________________________ ___________________________________ Charles R. Scheper Michael K. Keefe President - Life Division Director and Director\n\/S\/ Thomas J. Brophy \/S\/ Carl A. Hulbert __________________________________ ___________________________________ Thomas J. Brophy Carl A. Hulbert President - Health Division Director and Director","section_15":""}
{"filename":"202131_1994.txt","cik":"202131","year":"1994","section_1":"ITEM 1. BUSINESS. THE COMPANY AND ITS SUBSIDIARIES\nThe Company, incorporated in Texas in 1976, is a holding company operating principally in two business segments, the electric utility business and the cable television business. The Company conducts its operations primarily through three subsidiaries: HL&P, its principal operating subsidiary, KBLCOM and HI Energy. For a description of the Company's status under the Public Utility Holding Company Act of 1935 (1935 Act), see \"REGULATION OF THE COMPANY.\"\nHL&P is engaged in the generation, transmission, distribution and sale of electric energy and serves over 1.4 million customers in a 5,000 square-mile area of the Texas Gulf Coast, including Houston. As of December 31, 1994, the total assets and common stock equity of HL&P represented 88 percent of the Company's consolidated assets and 114 percent of the Company's consolidated common stock equity, respectively. For the year ended December 31, 1994, the operations of HL&P accounted for 114 percent of the Company's consolidated net income.\nThe cable television operations of the Company are conducted through KBLCOM and its subsidiaries. This segment includes five cable television systems located in four states and a 50 percent interest in Paragon Communications (Paragon), a Colorado partnership which owns systems located in seven states. As of December 31, 1994, KBLCOM's wholly-owned systems served approximately 690,000 basic cable customers and Paragon served approximately 967,000 basic cable customers.\nThe Company has entered into an agreement to dispose of its cable television operations. Under an agreement executed on January 26, 1995, KBLCOM will become a wholly-owned subsidiary of Time Warner Inc. (Time Warner). Closing of the transaction, which is expected to occur in the second half of 1995, is subject to the approval of certain franchise authorities and other governmental entities. Time Warner will issue one million shares of its common stock and 11 million shares of a newly-issued series of its convertible preferred stock to the Company and will purchase certain intercompany debt of KBLCOM from the Company for approximately $600 million, subject to adjustment. For a further discussion of the transaction, see \"Management's Discussion and Analysis of Financial Condition - LIQUIDITY AND CAPITAL RESOURCES - Company - Sources of Capital Resources and Liquidity\" in Item 7 of this Report and Note 21(a) to the Company's Consolidated Financial Statements in Item 8 of this Report.\nHI Energy participates in domestic and foreign power generation projects and invests in the privatization of foreign electric utilities.\nAs of December 31, 1994, the Company and its subsidiaries had 11,498 full-time employees.\nFor certain financial information with respect to each of the Company's two principal business segments, see Note 16 to the Company's Consolidated Financial Statements in Item 8 of this Report.\nBUSINESS OF HL&P\nHL&P, incorporated in Texas in 1906, is engaged in the generation, transmission, distribution and sale of electric energy. Sales are made to residential, commercial and industrial customers in a 5,000 square-mile area of the Texas Gulf Coast, including Houston.\nCERTAIN FACTORS AFFECTING HL&P'S ELECTRIC UTILITY BUSINESS\nAs an electric utility, HL&P has been affected, to varying degrees, by a number of factors affecting the electric utility industry in general. These factors include an increasingly competitive environment; slower growth in the domestic utility industry; the high cost of compliance with environmental and nuclear regulations; changes in the regulation of the generation and transmission of electricity at the federal and state level; and prudence audits and other litigation relating to the operation of the South Texas Project Electric Generating Station (South Texas Project). HL&P is unable to predict the future effect of these or other factors upon its operations and financial condition. For a discussion of various regulatory changes affecting HL&P and other electric utilities (including the impact of increased competition in the electric utility industry), see \"Competition\" and \"Regulatory Matters\" below.\nA major factor that will affect HL&P during 1995 is the resolution of its pending rate proceeding. For information concerning the proposed settlement of such proceeding and other contingencies relating to the South Texas Project see Notes 1(f), and 2 through 5 to the Company's Consolidated and HL&P's Financial Statements (Financial Statements) included in Item 8 of this Report.\nNATURE OF SERVICE AREA\nAlthough the Houston economy slowly continues to expand and diversify in numerous areas, such as medical, professional and engineering services, HL&P's service area is still dependent, to a large degree, on companies engaged in the oil, gas and chemical industries. These industries accounted for approximately $292 million of HL&P's 1994 base (non-fuel) revenues, representing 42 percent of industrial electric base revenues and 11 percent of total electric base revenues.\nMAXIMUM HOURLY FIRM DEMAND AND CAPABILITY\nThe following table sets forth, for the years indicated, information with respect to HL&P's net capability, maximum hourly firm demand and the resulting reserve margin:\nHL&P currently expects maximum hourly firm demand for electricity to grow at a compound annual rate of about 1.7 percent over the next ten years. Assuming average weather conditions and including the net effects of HL&P's demand-side management (DSM) programs, reserve margins are projected to decrease from an estimated 23 percent in 1995 to an estimated 17 percent in 1999 as a result of growth in firm demand and the expiration of a firm purchased power contract. For long-term planning purposes, HL&P intends to maintain reserve margins in the range of 15 to 20 percent in excess of maximum hourly firm demand load requirements.\nHL&P experiences significant seasonal variation in its sales of electricity. Sales during the summer months are typically higher than sales during other months of the year due, in large part, to the reliance on air conditioning in HL&P's service territory. HL&P's 1994 maximum hourly firm demand decreased 1.3 percent compared to 1993, a year of unusually warm summer weather. See Note 20 to the Financial Statements in Item 8 of this Report for a presentation of certain quarterly unaudited financial information for 1993 and 1994.\nCOMPETITION\nHL&P and other members of the electric utility industry, like other regulated industries, are being subjected to technological, regulatory and economic pressures that are increasing competition and offer the possibility for fundamental changes in the industry and its regulation. The electric utility industry historically has been composed of vertically integrated companies which largely have been the exclusive providers of electric service within a governmentally- defined geographic area. Prices for that service have been set by governmental authority under\nprinciples that were designed to provide the utility with an opportunity to recover its costs of providing electric service plus a reasonable return on its invested capital.\nBy legislation adopted in 1978, Congress contributed to the development of new sources of electric generation by freeing cogenerators (i.e., facilities which produce electrical energy along with thermal energy used for industrial processes, usually the generation of steam) from most regulatory constraints applicable to traditional utilities, such as state and federal pricing regulation and organizational restrictions arising under the 1935 Act. This legislation contributed to the development of approximately 40 cogeneration facilities in the highly industrialized Houston area, with a power generation capability of over 5,000 MW. As a consequence, HL&P has lost some industrial customers to self-generation (representing approximately 2,500 MW), and additional projects continue to be considered by customers.\nIn 1992 Congress authorized, in the Energy Policy Act, another category of wholesale generators, Exempt Wholesale Generators (EWGs). Like cogenerators, these entities exist to sell electric energy at wholesale, but unlike cogenerators, EWGs may be formed for the generation of electricity without regard to the simultaneous production of thermal energy. Congress chose to free EWGs from the structural constraints applicable to traditional utilities under the 1935 Act, but Congress also authorized traditional utilities to form such entities themselves without being burdened by those restrictions. At the same time, Congress placed significant limitations on the ability of traditional utilities to purchase power in their own service territories from an affiliated EWG.\nThere are increasing pressures today by both cogenerators and exempt wholesale generators for access to the electric transmission and distribution systems of the regulated utilities in order to have greater flexibility in moving power to other purchasers, including access for the purpose of making retail sales to either affiliates of the unregulated generator or to other customers of the regulated utility. In February 1995, a new entity sought permission from the Public Utility Commission of Texas (Utility Commission) to construct a transmission line within HL&P's service territory for the purpose of transmitting power from a cogeneration facility owned by an industrial concern to an affiliate of that concern. This proceeding has been docketed by the Utility Commission, but currently is in its early stages.\nNeither federal nor Texas law currently permits retail sales by unregulated entities. However, changes to the Federal Power Act made in the Energy Policy Act of 1992 increase the power of the Federal Energy Regulatory Commission (FERC) to order utilities to transmit power generated by both regulated and unregulated entities to other wholesale customers, and efforts are underway in some states that may lead to broader authorization of transmission access for such entities and even to retail sales by such entities. HL&P anticipates that some of those arguments will be advanced in the current session of the Texas legislature during the consideration of the re-enactment to the Public Utility Regulatory Act (PURA), which governs electric regulation in Texas.\nTraditional utilities such as HL&P also face increased competition from alternate energy sources, primarily natural gas. Gas suppliers increasingly are seeking to supplant traditional electric loads with gas-powered equipment, such as gas-powered chillers in air conditioning installations.\nHL&P continues to maintain an aggressive approach in attempting to preserve its existing customer base. HL&P has instituted various programs to reduce its costs and has adopted aggressive marketing programs to identify and respond to customer needs. One example is HL&P's development of the San Jacinto Steam Electric Station, a rate-based cogeneration facility that will begin service in 1995. In addition, in February 1995, the Utility Commission approved a new tariff proposed by HL&P that will allow special pricing for industrial customers who can demonstrate the ability to obtain electric service on terms more favorable than HL&P's traditional tariff offerings. While such pricing may retain such customers and minimize the prospect that HL&P would be left with stranded investment whose costs might have to be borne by customers who have no other alternatives, HL&P's revenues and earnings will be reduced from such pricing tariffs.\nIn addition, HL&P and nine other Texas investor-owned utilities are supporting a legislative proposal for amendment to the PURA. That proposal calls for (i) a streamlined resource planning process, (ii) competitive bidding for new generation capacity requirements, (iii) regulatory incentives that reward efficiency and innovation and (iv) granting utilities pricing flexibility to meet the changing needs of their customers. These changes, if adopted in the form proposed by the utilities, would enhance the flexibility of regulated entities to address competition, while also providing utility customers with the benefits of more diverse energy supplies.\nUnder rules adopted by the Utility Commission and under interconnection guidelines adopted by the Electric Reliability Council of Texas, Inc., through which a number of utilities and unregulated suppliers are connected, HL&P and other Texas utilities have provided for movement of power for both regulated and unregulated power suppliers at compensatory rates. Unregulated power suppliers continue to seek additional access and more favorable pricing provisions.\nAt this time it is impossible to predict what changes to the electric utility industry will emerge as a result of any legislative changes that may be adopted by the Texas legislature. Nor is it possible to predict what other changes to the industry will emerge from federal regulatory and legislative initiatives or from regulatory decisions of the Utility Commission, though, it seems likely that such changes ultimately will increase the competition HL&P faces in supplying electric energy to its customers.\nCAPITAL PROGRAM\nHL&P has a continuous program to maintain its existing production and transmission facilities and to expand its physical plant in response to customer needs. Currently, HL&P does not forecast a need for additional generating capacity until the year 2000. Thereafter, HL&P intends to satisfy such needs through the construction of combined cycle gas turbines at existing HL&P plant sites, the development of cogeneration projects, or through other means, such as purchased power contracts or DSM techniques.\nIn 1994, HL&P's capital expenditures were approximately $413 million, excluding Allowance for Funds Used During Construction (AFUDC). HL&P's capital program (excluding AFUDC) is currently estimated to cost approximately $364 million in 1995, $385 million in 1996 and $338 million in 1997. HL&P's capital program for the three-year period 1995 through 1997 consists primarily of improvements to its existing electric generating, transmission and distribution facilities. For the three-year period 1995 through 1997, HL&P's projected capital program consists of the following estimated principal expenditures:\nAmount Percent of Total (millions) Expenditures ---------- ----------------- Generating facilities ........................ $ 337 31% Transmission facilities ...................... 26 2% Distribution facilities ...................... 436 40% Substation facilities ........................ 89 8% General plant facilities ..................... 159 15% Nuclear fuel ................................. 40 4% ------ --- Total ................................... $1,087 100% ====== ===\nActual capital expenditures will vary from estimates as a result of numerous factors, including but not limited to changes in the rate of inflation, availability and relative cost of fuel and purchased power, changes in environmental laws, regulatory and legislative changes, and the effect of regulatory proceedings.\nFor information regarding expenditures associated with (i) HL&P's share of nuclear fuel costs and (ii) environmental programs, see \"Fuel - Nuclear Fuel - - Supply\" and \"Regulatory Matters - Environmental Quality\" below.\nFUEL Based upon various assumptions relating to the cost and availability of fuels, plant operation schedules, actual in-service dates of HL&P's planned generating facilities, load growth, load management and environmental protection requirements, HL&P's estimate of its future energy mix is as follows:\nEnergy Mix (%) ----------------------------------- Estimated Historical ----------------------- 1994 1995 1997 1999 ---------- ---- ---- ----\nGas .................................... 34 39 36 40 Coal and Lignite ....................... 43 40 40 41 Nuclear ................................ 7 7 8 8 Purchased Power (cogeneration) ......... 16 14 16 11 --- --- --- --- Total ......................... 100 100 100 100 === === === ===\nThere can be no assurance that the various assumptions upon which the estimates set forth in the table above are based will prove to be correct. Accordingly, HL&P's actual energy mix in future years may vary from the percentages shown in the table.\nNATURAL GAS SUPPLY. During 1994, HL&P purchased approximately 68 percent of its natural gas requirements pursuant to long-term contracts with various suppliers. The remaining 32 percent of HL&P's natural gas requirements was purchased on the spot market. In 1994, no individual supplier provided more than 26 percent of HL&P's natural gas requirements. Substantially all of HL&P's natural gas supply contracts contain pricing provisions based on fluctuating market prices.\nHL&P believes that it will be able to renew its long-term contracts as they expire or enter into similar contractual arrangements with other natural gas suppliers. HL&P has gas transportation arrangements with gas pipelines connected to certain of its generating facilities. HL&P also has a long-term contract for gas storage which provides working storage capacity of up to 3,500 billion British thermal units (BBtu) of natural gas. HL&P's average daily gas consumption during 1994 was 611 BBtu with peak consumption of 1,297 BBtu. HL&P's average cost of natural gas in 1994 was $1.90 per million British thermal units (MMBtu). HL&P's average cost of natural gas in 1993 and 1992 was $2.21 and $1.92 per MMBtu, respectively.\nAlthough natural gas has been relatively plentiful in recent years, supplies available to HL&P and other consumers are vulnerable to disruption due to weather conditions, transportation disruptions, price changes and other events. As a result of this vulnerability, supplies of natural gas may become unavailable from time to time, or prices may increase rapidly in response to temporary supply disruptions or other factors.\nCOAL AND LIGNITE SUPPLY. Substantially all of the coal for HL&P's four coal-fired units at the W. A. Parish Electric Generating Station (W. A. Parish) is purchased under two long-term contracts from mines in the Powder River Basin area of Wyoming. Additional coal is obtained on the spot market. The coal is transported under terms of a long-term rail transportation contract to the W. A. Parish coal handling facilities. A substantial portion of the coal requirements for the projected operating lives of the four coal-fired units at W. A. Parish is expected to be met under such contracts.\nThe lignite used to fuel the two units of the Limestone Electric Generating Station (Limestone) is obtained from a mine adjacent to the plant. HL&P owns the mining equipment, facilities and a portion of the lignite leases at the mine, which is operated by a contract miner under a long-term agreement. The lignite reserves currently under lease and contract are expected to provide a substantial portion of the fuel requirements for the projected operating lives of the Limestone units.\nNUCLEAR FUEL. SUPPLY. The supply of fuel for nuclear generating facilities involves the acquisition of uranium concentrates, conversion of such concentrates into uranium hexafluoride, enrichment of the uranium hexafluoride and fabrication of nuclear fuel assemblies. The South Texas Project fuel requirements are procured in common by the South Texas Project owners. HL&P and the other South Texas Project owners have on-hand or have contracted for the raw\nmaterials and services they expect to need for operation of the South Texas Project units through the years shown in the following table:\nUranium ....................................... 1996(1) Conversion .................................... 1996(1) Enrichment .................................... 2014(2) Fabrication ................................... 2005\n(1) The South Texas Project owners have entered into contracts for uranium concentrates and conversion services that will provide approximately 50 percent of the uranium needed for operation of the South Texas Project units from 1997 through 2000.\n(2) The South Texas Project owners cancelled the October 2000 through September 2002 portion of the current enrichment services contract because the South Texas Project owners believe that other, lower-cost options will be available.\nAlthough HL&P and the other South Texas Project owners cannot predict the future availability of uranium and related services, they do not currently anticipate difficulty in obtaining requirements for the remaining years of South Texas Project operation.\nSPENT FUEL DISPOSAL. By contract, the United States Department of Energy (DOE) has committed itself to ultimately take possession of all spent fuel generated by the South Texas Project. HL&P has been advised that the DOE plans to place the spent fuel in a permanent underground storage facility in an as-yet undetermined location. The DOE contract currently requires payment of a spent fuel disposal fee on nuclear plant-generated electricity of one mill (one-tenth of a cent) per net kilowatt-hour (KWH) sold. This fee is subject to adjustment to ensure full cost recovery by the DOE. Although the DOE's efforts to arrange long-term disposal have been unsuccessful to date, the South Texas Project is designed to have sufficient on-site storage facilities to accommodate over 40 years of the spent fuel discharges for each unit.\nENRICHMENT DECONTAMINATION AND DECOMMISSIONING ASSESSMENT FEES. The Energy Policy Act of 1992 includes a provision that assesses a fee upon domestic utilities having purchased nuclear fuel enrichment services from the DOE before October 24, 1992. This fee covers a portion of the cost to decontaminate and decommission the enrichment facilities. The South Texas Project assessment was approximately $2 million in 1994 and will be approximately $2 million each year thereafter (subject to escalation for inflation), of which HL&P's share is 30.8 percent. This assessment will continue until the earlier of 15 years or when $2.25 billion (adjusted for inflation) has been collected from domestic utilities. HL&P has a remaining estimated liability of $7.0 million for such assessments.\nOIL SUPPLY. Fuel oil is maintained in inventory by HL&P to provide for fuel needs in emergency situations in the event sufficient supplies of natural gas are not available. In addition, certain of HL&P's generating plants have the ability to use fuel oil if oil becomes a more economical fuel than incremental gas supplies. HL&P has storage facilities for over six million barrels of oil located at those generating plants capable of burning oil. HL&P's oil inventory is adjusted periodically to accommodate changes in the availability of primary fuel supplies.\nRECOVERY OF FUEL COSTS. Utility Commission rules provide for the recovery of certain fuel and purchased power costs through an energy component of electric rates (fixed fuel factor). The fixed fuel factor is established during either a utility's general rate proceeding or a fuel factor proceeding and is to be generally effective for a minimum of six months. In any event, a reconciliation of the fuel revenues and the fuel costs is required every three years. HL&P can request a revision to its fuel factor in April and October each year. For information relating to the cost of fuel over the last three years, see \"Operating Statistics of HL&P\" below and \"RESULTS OF OPERATIONS - HL&P - Fuel and Purchased Power Expense\" in Item 7 of this Report. For information relating to HL&P's most recent fuel reconciliation for the period April 1, 1990 through July 31, 1994 and the effect of the proposed settlement, see Note 3 to the Financial Statements included in Item 8 of this Report.\nREGULATORY MATTERS\nRATES AND SERVICES. HL&P operates under a certificate of convenience and necessity granted by the Utility Commission which covers HL&P's present service area and facilities. In addition, HL&P holds franchises to provide electric service within the incorporated municipalities in its service territory. None of such franchises expires before 2007.\nUnder PURA, the Utility Commission has original jurisdiction over electric rates and services in unincorporated areas of the State of Texas and in the incorporated municipalities that have relinquished original jurisdiction. Original jurisdiction over electric rates and services in the remaining incorporated municipalities served by HL&P is exercised by such municipalities, including Houston, but the Utility Commission has appellate jurisdiction over electric rates and services within those incorporated municipalities.\nIn its 1995 legislative session, the Texas legislature is expected to consider several significant proposals to amend PURA in connection with a \"Sunset Review\" process of the Utility Commission. Such proposals cover issues which include, among other items, tax issues relating to public utilities, the organization and authority of the Utility Commission, competitive issues and Integrated Resource Planning.\nUTILITY COMMISSION RATE PROCEEDINGS. In February 1994, the Utility Commission initiated a proceeding (Docket No. 12065) to determine whether HL&P's existing rates are just and reasonable. The Utility Commission also initiated a separate proceeding to review issues regarding the prudence of the operation of the South Texas Project. For more information on these proceedings (Docket Nos. 12065 and 13126) and a proposed settlement of such proceedings, see Note 3 to the Financial Statements in Item 8 of this Report, which note is incorporated herein by reference.\nFor information concerning the Utility Commission's orders with respect to HL&P's prior applications for general rate increases with the Utility Commission (Docket No. 9850 for the 1991 rate case and Docket No. 8425 for the 1988 rate case) and the municipalities within HL&P's service area and the appeals of such orders, see Notes 4(a) and 4(b) to the Financial Statements in Item 8 of this Report, which notes are incorporated herein by reference.\nPRUDENCE REVIEW OF CONSTRUCTION OF THE SOUTH TEXAS PROJECT. For information concerning the Utility Commission's orders with respect to a prudence review of the planning, management and construction of the South Texas Project (Docket No. 6668) and the appeals of such orders, see Note 4(d) to the Financial Statements in Item 8 of this Report, which note is herein incorporated by reference.\nDEFERRED ACCOUNTING DOCKETS. For information concerning the Utility Commission's orders allowing deferred accounting treatment for certain costs associated with the South Texas Project (Docket Nos. 8230, 9010 and 8425), the appeals of such orders and related proceedings, see Notes 1(f), 4(b) and 4(c) to the Financial Statements in Item 8 of this Report, which notes are incorporated herein by reference.\nENVIRONMENTAL QUALITY. GENERAL. HL&P is subject to a number of federal, state and local environmental requirements that govern its discharge of emissions into the air and water and regulate its handling of solid and hazardous waste. HL&P has incurred substantial expenditures in the past to comply with these requirements and anticipates that further expenditures will be incurred in the future. Most of the environmental requirements applicable to HL&P are implemented by the Texas Natural Resource Conservation Commission (TNRCC), which shares regulatory jurisdiction with the United States Environmental Protection Agency (EPA).\nAIR QUALITY. Both the TNRCC and the EPA are presently implementing sweeping amendments to the Federal Clean Air Act that were enacted in 1990. A major provision affecting electric utilities is the Acid Rain Program, which is designed to reduce emissions of sulfur dioxide (SO2) from electric utility generating units. The Acid Rain Program requires that after a certain date a utility must have been granted a regulatory \"allowance\" for each ton of SO2 emitted from its facilities. Allowances have been distributed to utilities by the EPA based on the utility's historic operations. If a utility is not allocated sufficient allowances to cover its future SO2 emissions, it must either purchase allowances from other utilities or reduce SO2 emissions from its units through the installation of additional controls and equipment. HL&P believes that it has been allocated a sufficient number of emission allowances for it to continue operating its existing facilities for the foreseeable future.\nProvisions of the Clean Air Act dealing with urban air pollution require establishing new emission limitations for nitrogen oxides (NOx) from existing sources. Initial limitations were finalized in 1993, but the implementation of these emission reductions has been delayed by the EPA and TNRCC until 1997. The cost of modifications to HL&P in 1994 was $4 million. Up to an additional $40 million may be incurred by HL&P in order to fully comply with new NOx requirements after 1997.\nAdditionally, to ensure compliance with these new regulatory programs, the Clean Air Act requires electric utilities to install continuous emission monitoring equipment, which cost HL&P approximately $4 million in 1994 and is expected to cost an additional $7 million in 1995. To implement these new Clean Air Act programs, a new Operating Permit Program was established that will be administered in Texas by the TNRCC. Among other requirements, the Operating Permit Program is funded by fees imposed by the TNRCC. The annual cost of these fees is approximately $1 million.\nWATER QUALITY. The Federal Clean Water Act governs the discharge of any pollutants into surface waters and is administered jointly in Texas by the TNRCC and the EPA. HL&P has obtained permits from both the TNRCC and the EPA for all of its facilities that require such permits and anticipates obtaining renewal of such permits as they expire.\nSOLID AND HAZARDOUS WASTE. HL&P's handling and disposal of solid waste are also subject to regulation by the TNRCC. HL&P's cost in 1994 for commercial disposal of industrial solid waste was approximately $4 million.\nELECTRIC AND MAGNETIC FIELDS. The issue of whether exposure to electric and magnetic fields (EMFs) may result in adverse health effects or damage to the environment is currently being debated. EMFs are produced by all devices which carry or use electricity, including home appliances as well as electric transmission and distribution lines. Results of studies concerning the effect of EMFs have been inconclusive and EMFs are not the subject of any federal, state or local regulations affecting HL&P. However, lawsuits have arisen in several states against electric utilities and others alleging that the presence or use of electric power transmission and distribution lines has an adverse effect on health and\/or property values. One such suit (BICKI, ET AL. V. HOUSTON INDUSTRIES INCORPORATED, ET AL.), for unspecified damages, was filed against the Company and HL&P in December 1994 in the 129th District Court of Harris County, Texas by the families of 11 children alleged to have been diagnosed with, or to have died from, childhood cancers caused by exposure to EMFs created by HL&P's transmission and distribution lines and unbalanced electric circuits in the children's homes and schools. While no prediction can be made as to the ultimate outcome of any of the pending suits, the impact on the Company and on the electric industry as a whole could be significant if litigation of this type is successful.\nFEDERAL REGULATION OF NUCLEAR POWER. Under the 1954 Atomic Energy Act and the 1974 Energy Reorganization Act, operation of nuclear plants is extensively regulated by the United States Nuclear Regulatory Commission (NRC), which has broad power to impose licensing and safety requirements. In the event of non-compliance, the NRC has the authority to impose fines or shut down nuclear plants, or both, depending upon its assessment of the severity of the situation, until compliance is achieved.\nFor information concerning a diagnostic evaluation that was completed by the NRC at the South Texas Project, the removal of the South Texas Project from the NRC watch list, and related matters, see \"CURRENT ISSUES - HL&P\" in Item 7 of this Report and Note 2(b) to the Financial Statements in Item 8 of this Report, which note is incorporated herein by reference.\nLOW-LEVEL RADIOACTIVE WASTE DISPOSAL. In response to the 1980 federal Low-Level Radioactive Waste Policy Act which assigns responsibility for low-level waste disposal to the states, Texas has created the Texas Low-Level Radioactive Waste Disposal Authority (Waste Disposal Authority) to build and operate a low-level waste disposal facility. HL&P's portion of the State of Texas assessment for the development work on this facility was approximately $0.7 million in 1994 and will be approximately $1.3 million for 1995. Nuclear facilities in Texas formerly had access to the low-level waste disposal facility at Barnwell, South Carolina which was closed in June 1994 to generators of radioactive waste located in states which are not members of the Southeast compact.\nHL&P has constructed a temporary low-level radioactive waste storage facility at the South Texas Project which will be utilized for interim storage of low-level radioactive waste prior to the opening of the Texas Low-Level Radioactive Waste Site. The Waste Disposal Authority currently estimates that the Texas site could begin receiving waste in mid-1997.\nNUCLEAR INSURANCE AND NUCLEAR DECOMMISSIONING\nFor information concerning nuclear insurance and nuclear decommissioning, see Notes 2(d) and 2(e) to the Financial Statements in Item 8 of this Report, which notes are incorporated herein by reference.\nLABOR MATTERS\nAs of December 31, 1994, HL&P had 9,558 full-time employees of whom 3,724 were hourly-paid employees represented by the International Brotherhood of Electrical Workers under a collective bargaining agreement which expires on May 25, 1995.\nOPERATING STATISTICS OF HL&P\nBUSINESS OF KBLCOM GENERAL\nThe cable television operations of the Company are conducted through KBLCOM's subsidiaries, which own and operate five cable television systems located in four states. KBLCOM also indirectly owns a 50 percent interest in Paragon, which in turn owns twenty systems located in seven states. KBLCOM's 50 percent interest in Paragon is recorded in the financial statements using the equity method of accounting. The remaining 50 percent interest in Paragon is owned by subsidiaries of American Television and Communications (ATC), a subsidiary of Time Warner. ATC serves as the general manager for all but one of the Paragon systems.\nOn January 26, 1995, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with KBLCOM, Time Warner and TW KBLCOM Acquisition Corp. (Acquisition Corp.), a newly-formed, wholly-owned subsidiary of Time Warner. Pursuant to the Merger Agreement, Acquisition Corp. will merge with KBLCOM, and KBLCOM will become a wholly-owned subsidiary of Time Warner.\nThe merger is conditioned upon, among other things, (i) the parties obtaining necessary consents of certain franchise authorities and other governmental entities, (ii) the absence of any change that might have a material adverse effect on KBLCOM or Time Warner, (iii) the absence of any material litigation and (iv) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Act of 1976, as amended. See Note 21(a) to the Financial Statements included in Item 8 of this Report with respect to the terms of the sale and accounting therefor.\nUnless otherwise indicated or the context otherwise requires, all references in this section to \"KBLCOM\" mean KBLCOM and its subsidiaries and all references to Paragon mean the Paragon partnership. All information pertaining to Paragon has been provided to KBLCOM by Paragon's managing partner, ATC, unless stated otherwise.\nCABLE TELEVISION SERVICES\nThe cable television business of KBLCOM consists primarily of selling to subscribers, for a monthly fee, television programming that is distributed through a network of coaxial and fiber optic cables. KBLCOM offers its subscribers both basic services and, for an extra monthly charge, premium services. Each of the KBLCOM systems carries the programming of all three major television networks, programming from independent and public television stations and certain other local and distant (out-of-market) broadcast television stations. KBLCOM also offers to its subscribers locally produced or originated video programming, advertiser-supported cable programming (such as ESPN and CNN), premium programming (such as HBO and Showtime) and a variety of other types of programming services such as sports, family and children, news, weather and home shopping programming. As is typical in the industry, KBLCOM subscribers may terminate their cable television service on notice. KBLCOM's business is generally not considered to be seasonal.\nAll of KBLCOM's systems are \"addressable,\" allowing individual subscribers, among other things, to electronically select pay-per-view programs. Approximately 48 percent of KBLCOM's customers presently have converters permitting addressability. This allows KBLCOM to offer pay-per-view services for various movies, sports events, concerts and other entertainment programming.\nOVERVIEW OF SYSTEMS AND DEVELOPMENT\nThe KBLCOM systems, located in San Antonio and Laredo, Texas; the Minneapolis, Minnesota metropolitan area; Portland, Oregon; and Orange County, California, have channel capacities ranging from 44 channels to 120 channels. Although all of these systems are considered fully built, annual capital expenditures are required to accommodate growth within the service areas and to replace and upgrade existing equipment. In 1994, property additions and other cable-related investments totaled approximately $84 million.\nParagon owns cable television systems that serve a number of cities, towns or other areas in Texas (including El Paso), Arizona, Florida (including the Tampa Bay area), New Hampshire, New York (including a portion of Manhattan), Maine and southern California (areas in Los Angeles County). Paragon made capital expenditures of approximately $60 million in 1994.\nFor information regarding KBLCOM's financial results and liquidity and the financing of KBLCOM, see \"RESULTS OF OPERATIONS - KBLCOM\" in Item 7 of this Report and Notes 10(b) and 14(c) to the Financial Statements in Item 8 of this Report.\nThe following table summarizes certain information relating to the cable television systems owned by KBLCOM and Paragon:\nSOURCES OF REVENUES AND RATES TO SUBSCRIBERS\nFor the year ended December 31, 1994, the average monthly revenue per subscriber for KBLCOM was approximately $32.94. Approximately 65 percent of KBLCOM's revenue was derived from monthly fees paid by subscribers for basic cable services, and 17 percent was derived from premium programming services. Rates to subscribers vary from system to system and in accordance with the type of service selected. As of December 31, 1994, the average monthly basic revenue per subscriber for the KBLCOM systems generally ranged from $17.80 to $23.44. As of December 31, 1994, approximately 38 percent of KBLCOM's customers subscribed to one or more premium channels. KBLCOM's premium units and premium revenue increased during 1994. The increases are due primarily to new packaging of premium units and multiplexing, which is the delivery of multiple channels of a premium service (with programs beginning at different times) with no change in price to the subscriber.\nThe remainder of KBLCOM's revenues for the year ended December 31, 1994 was derived from advertising, pay-per-view services, installation fees and other ancillary services. KBLCOM's management believes that, within its present markets, the sale of commercial advertising, pay-per-view services and other ancillary services offer the potential for increased revenues. Advertising revenues for the year ended December 31, 1994 increased $1.8 million or 11.5 percent over the previous year while pay-per-view and the other ancillary revenues increased by $4.8 million or 18.3 percent.\nAs of December 31, 1994, the average monthly revenue per subscriber for the Paragon systems was approximately $30.56. Approximately 61 percent of Paragon's revenues was derived from monthly fees for basic services, and 22 percent was derived from premium services. As of December 31, 1994, the average monthly basic revenue per subscriber for the Paragon systems ranged from $18.01 to $24.45. As of December 31, 1994, approximately 31 percent of Paragon's customers subscribed to one or more premium channels.\nFRANCHISES\nKBLCOM's cable television systems generally operate pursuant to non-exclusive franchises or permits awarded by local governmental authorities, and accordingly, other applicants may obtain franchises or permits in franchise areas served by KBLCOM. See \"Regulation\" below. As of December 31, 1994, KBLCOM held 70 franchises with unexpired terms ranging from under one year to approximately 17 years. A single franchise agreement with San Antonio, which expires in 2003, covered approximately 30 percent of KBLCOM's subscribers as of December 31, 1994. The expiration periods and approximate percentages of subscribers for KBLCOM's franchises are as follows:\nPercent of Expiration Period Subscribers of Remaining Franchises ----------- ----------------------- 20% 1995-1998 16% 1999-2002 60% after 2002 4% No expiration date\nAs of December 31, 1994, Paragon held 158 franchises with unexpired terms ranging from 1995 to 2010. The single largest franchise, which covers a portion of Manhattan, included 20 percent of Paragon's subscribers as of December 31, 1994. This franchise expires in 1998.\nThe provisions of state and local franchises are subject to federal regulation under the Cable Communications Policy Act of 1984 (1984 Cable Act), as amended by the Cable Television Consumer Protection and Competition Act of 1992 (1992 Cable Act). See \"Regulation\" below. Cable television franchises generally can be terminated prior to their stated expiration date under certain circumstances such as a material breach of the franchise by the cable operator. Franchises typically contain a number of provisions dealing with, among other things, minimum technical specifications for the systems; operational requirements; total channel capacity; local governmental, community and educational access; franchise fees (which range up to 5 percent of cable system revenues) and procedures for renewal of the franchise. Sometimes conditions of franchise renewal require improved facilities, increased channel capacity or enhanced services. One franchise, with approximately 87,000 subscribers as of December 31, 1994, held by an indirect subsidiary of KBLCOM, provides that the city granting the franchise may, at any time, require the subsidiary to sell, at fair market value, its franchise and operations in the city to another cable television operator with a franchise for another portion of the city.\nKBLCOM's franchises are also subject to renewal and generally are not transferable without the prior approval of the franchising authority. In addition, some franchises provide for the purchase of the franchise under certain circumstances, such as a failure to renew the franchise. To date, KBLCOM's franchises have generally been renewed or extended upon their stated expirations, but there can be no assurance of renewal of franchises in the future.\nPROGRAMMING CONTRACTS\nA substantial portion of KBLCOM's programming is obtained under contracts with terms that typically extend for more than one year. KBLCOM generally pays program suppliers a monthly fee per subscriber. Certain of these contracts have price escalation provisions.\nCOMPETITION\nCable television systems experience competition from a variety of sources, including broadcast television signals, multipoint microwave distribution systems, direct broadcast satellite systems (satellite signals sent directly to a subscriber's satellite dish) and satellite master antenna systems (a satellite dish which receives signals and distributes them within a multiple dwelling unit). The effectiveness of such competition depends, in part, upon the quality of the signals and the variety of the programming offered over such competitive technologies and the cost thereof as compared with cable television systems. These competitive technologies are not generally subject to the same form of local regulation that affects cable television. Cable television systems also compete, to varying degrees, with other communications and entertainment media such as motion picture theaters and video cassette rental stores, and such competition may increase with the development and growth of new technologies.\nTwo national direct broadcast satellite (DBS) systems commenced operation in 1994. These national DBS providers compete in all KBLCOM franchise areas and are expected to constitute significant new competition to such KBLCOM systems. As a result of the programming access requirements contained in the 1992 Cable Act, these two national DBS providers will have access to virtually all cable television programming services. Additionally, within the next two years, there may be significant development in the provision of video dialtone programming over telephone company facilities. This new source of competition will result from telephone companies leasing video capacity to independent programmers in KBLCOM service areas. Finally, both federal legislation and Federal Communications Commission (FCC) proceedings are currently underway which may allow telephone companies to own and distribute their own programming over their own facilities in direct competition with cable systems. Specifically, US West has indicated, in an FCC filing, that it intends to upgrade facilities in at least one KBLCOM service area in order to provide either video dialtone service or to own and distribute its own video programming services.\nSince KBLCOM's systems operate under non-exclusive franchises, other companies may obtain permission to build cable television systems in areas where KBLCOM presently operates. The 1992 Cable Act prohibits franchising authorities from unreasonably refusing to grant franchises to competing cable systems and permits franchising authorities to operate cable systems without franchises. The legality of the franchising process and of various specific franchise requirements is likely to be in a state of flux until there is a definitive ruling by the U.S. Supreme Court on the scope of First Amendment protection to which the cable television industry\nis entitled. The constitutionally permissible bounds of cable franchising and particular franchise requirements cannot be predicted at the present time, nor can any prediction be made at this time as to whether additional franchises will be granted to any competitors, or if granted and a cable television system is constructed, what the impact on KBLCOM and the Company might be.\nKBLCOM competes with a variety of other media in the sale of advertising time on its cable television systems.\nREGULATION\nCable television is subject to regulation at the federal, local and, in some cases, state level.\nThe 1992 Cable Act, which became law in October 1992, expanded the scope of cable industry regulation. The act mandated that the FCC establish rate standards and procedures governing regulation of basic cable service rates.\nThe FCC issued rate regulation rules (Rate Rule), which became effective September 1993, establishing \"competitive benchmark\" rate formulas, to calculate a permitted \"per channel\/per month subscriber charge.\" At the time, the FCC stated that rates charged by the average cable system were 10 percent higher than rates charged by cable systems in markets with effective competition. Therefore, it required cable operators to reduce rates to the higher of (i) a level 10 percent below the level that existed as of September 30, 1992, adjusted for inflation or (ii) the applicable benchmark. In March 1994, the FCC issued revised benchmark rules (Rate Rule II) and established an interim cost-of-service rule (Interim COS Rule). Under Rate Rule II, cable operators were required to reduce their existing rates to the higher of (i) the rates calculated using revised benchmark formulas (Revised Benchmarks) or (ii) a level 17 percent below the cable operators' rates as of September 30, 1992, adjusted for inflation and certain increases in programming costs. Cable operators which cannot or do not wish to comply with the Revised Benchmarks may choose to justify their existing rates under the Interim COS Rule, which establishes a cost-of-service rate system which evaluates the rates charged by cable systems based on their operating expenses and capital costs.\nIn November 1994, the FCC 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.\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, such pricing is reasonable and operators do not remove programming services from existing service tiers and offer them on the NPT.\nRegulations issued under the 1992 Cable Act are lengthy and complex. KBLCOM has adjusted its rates for regulated services in accordance with these rules. Due to continuing ambiguity and uncertainty in the enforcement of the 1992 Cable Act, KBLCOM's basic, tier, equipment and installation fees may be further reduced. Any possible decline in revenue due to such rules is not expected to have a material adverse effect on KBLCOM's financial position or results of operations.\nMUST CARRY\/RETRANSMISSION CONSENT. The 1992 Cable Act specified certain rights for mandatory carriage on cable systems for local broadcast stations, known as must carry rights. A cable operator can be compelled to allocate up to one-third of its channel capacity for carriage of local commercial broadcast television stations. In addition, a cable operator can also be required to allocate up to three additional channels to local non-commercial broadcast television stations. Alternatively, local commercial broadcasters can elect retransmission consent and require a cable operator to make payments as a condition to granting its consent for the carriage of the broadcast station's signal on the cable system.\nIn April 1993, a special three-judge federal district court for the District of Columbia issued a decision upholding the constitutional validity of the must carry signal carriage requirements. This decision was vacated by the United States Supreme Court in June 1994 and remanded to the district court for further development of a factual record.\nPROGRAMMING ACQUISITION. The 1992 Cable Act directs the FCC to promulgate regulations regarding the sale and acquisition of cable programming between cable operators and programming services in which the cable operator has an attributable interest. The legislation and the subsequent FCC regulations will preclude most exclusive programming contracts, will limit volume discounts that can be offered to affiliated cable operators and will generally prohibit cable programmers from providing terms and conditions to affiliated cable operators that are more favorable than those provided to unaffiliated operators. Furthermore, the 1992 Cable Act requires that such cable programmers make their programming services available to competing video technologies, such as multi-channel, microwave distribution systems and direct broadcast satellite systems, on terms and conditions that do not discriminate against such competing technologies.\nCUSTOMER SERVICE\/TECHNICAL STANDARDS. The 1992 Cable Act requires the FCC to promulgate regulations establishing minimum standards for customer service and technical system performance. Franchising authorities are allowed to enforce stricter customer service requirements than the standards so promulgated by the FCC.\nThe majority of the provisions of the 1984 Cable Act remain in place. The 1984 Cable Act continues to: (a) restrict the ownership of cable systems by prohibiting cross-ownership by a telephone company, except as noted below, within its operating area and cross-ownership by\nlocal television broadcast station owners; (b) require cable television systems with 36 or more \"activated\" channels to reserve a percentage of such channels for commercial use by unaffiliated third parties; (c) permit franchise authorities to require the cable operator to provide channel capacity, equipment and facilities for public, educational and governmental access; (d) limit the amount of fees required to be paid by the cable operator to franchise authorities to a maximum of 5 percent of annual gross revenues; (e) grant cable operators access to public rights of way and utility easements; (f) establish a federal privacy policy regulating the use of subscriber lists and subscriber information; (g) establish civil and criminal liability for unauthorized reception or interception of programming offered over a cable television system or satellite delivered service; (h) authorize the FCC to preempt state regulation of rates, terms and conditions for pole attachments unless the state has issued effective rules; (i) require the sale or lease to subscribers of devices enabling them to block programming considered offensive; (j) require the FCC to prescribe rules governing horizontal and vertical concentration in the cable television industry including rules governing the sale and distribution of cable programming by vertically integrated operators and cable programmers; (k) prohibit operators from requiring cable subscribers to purchase service tiers above basic as a condition to purchasing premium programming except that cable systems that do not have addressable technology or converters in place are given up to ten years to comply with this provision; (l) prohibit cable operators from selling the assets of a cable system within three years of acquisition or construction of such cable system; and (m) contain provisions governing cable operators' compliance with equal employment opportunity requirements.\nThe 1992 Cable Act, together with the 1984 Cable Act, creates a comprehensive regulatory framework for cable television. Violation by a cable operator of the statutory provisions or the rules and regulations of the FCC can subject the operator to substantial monetary penalties and other significant sanctions. While many of the specific obligations imposed on cable television systems under the 1992 Cable Act are complex, burdensome and have increased KBLCOM's costs of doing business, due to the evolving nature of the regulation, it is difficult to assess the continuing impact of the 1992 Cable Act.\nA federal cross-ownership restriction has historically limited entry into the cable television business by potentially strong competitors such as telephone companies. This restriction has generally prohibited telephone companies from owning or operating cable television systems within their own service areas. Several federal district courts have struck down the 1984 Cable Act's cable\/telephone cross-ownership provision as facially invalid and inconsistent with the First Amendment. A final affirmation of these decisions could result in additional direct competition to KBLCOM. The FCC recently amended its rules to permit local telephone companies and long distance telephone companies such as AT&T to offer video dialtone service for video programmers, including channel capacity for the carriage of video programming as well as certain non-common carrier activities such as video processing, billing and collection and joint marketing arrangements. The FCC concluded that the 1984 Cable Act does not require a local exchange carrier (LEC), a long distance carrier or their programmer customers to obtain a franchise to\nprovide video dialtone service. 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 telephone company provided facilities.\nIn January 1995, the FCC adopted a FOURTH FURTHER NOTICE OF PROPOSED RULEMAKING. 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 other issues including the establishment of structural safeguards to prevent cross- subsidization of video dialtone and programming activities and whether an 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.\nA number of bills that would have permitted telephone companies to provide cable television services in competition with cable systems were considered during the last Congress, but none was adopted. 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.\nEMPLOYEES\nExcluding employees of Paragon, KBLCOM had 1,689 full-time employees as of December 31, 1994, none of whom are represented by a union. As of December 31, 1994, Paragon had 1,756 full-time employees of whom 357 were represented by unions.\nBUSINESS OF HI ENERGY\nThe Company formed HI Energy in 1993 to seek investment opportunities in domestic and foreign power generation projects and the privatization of foreign electric utilities. Although HI Energy's investment strategy is to seek opportunities in which the Company has the potential to earn a greater rate of return than its regulated utility operations, the nature of these investments entails a higher degree of risk than exists in HL&P's traditional regulated operations, and there can be no assurance that such objectives will be achieved. Moreover, it is anticipated that at least in the near term these investments are likely to have only a minimal impact on the Company's earnings.\nHI Energy's current investments include the following:\nIn January 1995, HI Energy acquired for $15.7 million a 90 percent equity interest in an electric utility operating company in the province of Santiago del Estero, a rural province in the north central part of Argentina. The utility system serves approximately 100,000 customers in an area of 136,000 square kilometers.\nHI Energy also owns an indirect 17 percent interest in an electric utility company and related generation company operating in La Plata, a province adjoining Buenos Aires, Argentina. The La Plata utility system, which serves approximately 250,000 customers, was acquired in 1992 for a purchase price of $115 million (of which HI's share was $37.4 million).\nDuring 1994, HI Energy began construction of the Ford Heights Tire-To-Energy Project, a $106 million electric generating plant south of Chicago, Illinois. HI Energy is committed to fund $21 million through combined equity contributions and loans as a result of its participation in this project.\nHI Energy is providing operation and maintenance services under contract to the Shell Oil Corporation at a cogeneration facility located at Shell's petrochemical plant (in Deer Park, Texas).\nInternational operations are subject to certain risks that are inherent in conducting business abroad, including possible nationalization or expropriation, price and exchange controls, adverse regulatory action by local governments, limitations on foreign participation in local governmental enterprises, and other restrictive actions.\nHI Energy had 57 full-time employees as of December 31, 1994, of whom 14 were represented by a union.\nREGULATION OF THE COMPANY FEDERAL\nThe Company is a holding company as defined in the 1935 Act; however, based upon the intrastate operations of HL&P and the exemptions applicable to the affiliates of HI Energy, the Company is exempt from regulation as a \"registered\" holding company under the 1935 Act except with respect to the acquisition of voting securities of other domestic public utility companies and holding companies. The Company has no present intention of entering into any transaction which would cause it to become a registered holding company subject to regulation by the Securities and Exchange Commission (SEC) under the 1935 Act. In November 1994, the SEC issued a Concept Release that called for comments on a broad range of topics relevant to regulation of both registered and exempt companies under the 1935 Act. In calling for comments, the SEC acknowledged that significant changes are affecting the electric utility industry, and in responding, some utilities have argued for repeal or substantial modification of the 1935 Act and the regulation it provides. At this time, no prediction can be made as to what changes, if any, will result from this review by the SEC, but repeal or significant modification to the 1935 Act may have an effect on the electric utility industry. In addition, it is possible that changes to the 1935 Act and its interpretation would eliminate some distinctions between exempt and registered companies in their regulation under the 1935 Act, possibly in ways that would increase the regulatory burdens on exempt companies such as the Company.\nSTATE\nThe Company is not subject to regulation by the Utility Commission under PURA or by the incorporated municipalities served by HL&P. Those regulatory bodies do, however, have authority to review accounts, records and contracts relating to transactions by HL&P with the Company and its other subsidiaries. The exemption for foreign utility affiliates of the Company from regulation under the 1935 Act as \"public utility companies\" is dependent upon certification by the Utility Commission to the SEC to the effect that it has the authority to protect HL&P's ratepayers from any adverse consequences of the Company's investment in foreign utilities and that it intends to exercise its authority. The Utility Commission has provided such certification to the SEC subject, however, to its being revised or withdrawn by the Utility Commission as to any future acquisition.\nEXECUTIVE OFFICERS OF THE COMPANY\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company considers its property and the property of its subsidiaries to be well maintained, in good operating condition and suitable for their intended purposes.\nHL&P\nAll of HL&P's electric generating stations and all of the other operating properties of HL&P are located in the State of Texas.\nELECTRIC GENERATING STATIONS. As of December 31, 1994, HL&P owned eleven electric generating stations (60 generating units) with a combined turbine nameplate rating of 13,411,368 KW, including a 30.8 percent interest in one nuclear generating station (two units) with a combined turbine nameplate rating of 2,623,676 KW.\nSUBSTATIONS. As of December 31, 1994, HL&P owned 203 major substations (with capacities of at least 10.0 megavolt amperes (Mva)) having a total installed rated transformer capacity of 55,279 Mva (exclusive of spare transformers), including a 30.8 percent interest in one major substation with an installed rated transformer capacity of 3,080 Mva.\nELECTRIC LINES-OVERHEAD. As of December 31, 1994, HL&P operated 23,947 pole miles of overhead distribution lines and 3,626 circuit miles of overhead transmission lines including 578 circuit miles operated at 69,000 volts, 2,011 circuit miles operated at 138,000 volts and 1,037 circuit miles operated at 345,000 volts.\nELECTRIC LINES-UNDERGROUND. As of December 31, 1994, HL&P operated 8,833 circuit miles of underground distribution lines and 12.6 circuit miles of underground transmission lines including 8.1 circuit miles operated at 138,000 volts and 4.5 circuit miles operated at 69,000 volts.\nGENERAL PROPERTIES. HL&P owns various properties including division offices, service centers, telecommunications equipment and other facilities used for general purposes.\nTITLE. The electric generating plants and other important units of property of HL&P are situated on lands owned in fee by HL&P. Transmission lines and distribution systems have been constructed in part on or across privately owned land pursuant to easements or on streets and highways and across waterways pursuant to authority granted by municipal and county permits, and by permits issued by state and federal governmental authorities. Under the laws of the State of Texas, HL&P has the right of eminent domain pursuant to which it may secure or perfect rights-of-way over private property, if necessary.\nThe major properties of HL&P are subject to liens securing long-term debt, and titles to some of its properties are subject to minor encumbrances and defects, none of which impairs the use of such properties in the operation of its business. KBLCOM\nThe principal tangible assets (other than real estate) relating to KBLCOM's cable television operations consist of operating plant and equipment for each of its cable television systems. These include signal receiving apparatus, headend facilities, coaxial and fiber optic cable or wire and related electronic equipment over which programming and data are distributed, and decoding converters attached to subscribers' television receivers. The signal receiving apparatus typically includes a tower, antennae, ancillary electronic equipment and earth stations for reception of video, audio and data signals transmitted by satellite. Headend facilities, which consist of associated electronic equipment necessary for the reception, amplification, switching and modulation of signals, are located near the signal receiving apparatus and control the programming and data signals distributed on the cable system. For certain information with respect to property owned directly or indirectly by KBLCOM, see \"BUSINESS OF KBLCOM\" in Item 1 of this Report.\nOTHER SUBSIDIARIES\nFor certain information with respect to property owned directly or indirectly by HI Energy, see \"BUSINESS OF HI ENERGY\" in Item 1 of this Report.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nFor a description of certain legal and regulatory proceedings affecting the Company and its subsidiaries (including (i) HL&P's rate cases, (ii) certain environmental matters and (iii) litigation related to the South Texas Project), see \"Business - Regulatory Matters - Environmental Quality\" in Item 1 of this Report, \"LIQUIDITY AND CAPITAL RESOURCES - HL&P - Environmental Expenditures\" in Item 7 of this Report and Notes 1(f) and 2 through 5 to the Financial Statements in Item 8 of this Report, which sections and notes are incorporated herein by reference.\nHL&P is a defendant in litigation arising out of the environmental remediation of a site in Corpus Christi, Texas. The site in question was operated as a metals reclaiming operation for a number of years, and, though HL&P neither operated nor had any ownership interest in the site, some transformers and other equipment that HL&P sold as surplus allegedly were delivered to that site, where the site operators subsequently disposed of the materials in ways that caused environmental damage. In one case, DUMES, ET AL. V. HL&P, ET AL., pending in the U.S. District Court for the Southern District of Texas, Corpus Christi Division, a group of approximately 70 landowners near the site are seeking damages primarily for lead contamination to their property. They have pled damages of approximately $1 million each and also seek punitive damages totaling $51 million. The Plaintiffs seek to impose responsibility on HL&P and the other utility that undertook to clean up the property, neither of which contributed more than an insignificant amount of lead to the site, on the theory that lead was deposited on their properties during the site remediation itself. In addition, Gulf States Utilities Company (Gulf States) filed suit (GULF STATES UTILITIES CO. V. HOUSTON LIGHTING & POWER CO., ET AL.) in the United States District Court for the Southern District of Texas, Houston Division, against HL&P and two other utilities concerning a site in Houston, Texas, which allegedly has been contaminated by polychlorinated biphenyls and which Gulf States has undertaken to remediate pursuant to an EPA order. HL&P does not believe, based on its records, that it contributed material to that site and in October 1994, Gulf States dismissed its claims against HL&P. HL&P remains in the case on cross-claims asserted by two co-defendants. The ultimate outcome of these pending cases cannot be predicted at this time. Based on information currently available, the Company and HL&P believe that none of these cases will result in a material adverse effect on the Company's or HL&P's financial condition or results of operations.\nHL&P and the other owners of the South Texas Project filed suit in 1990 against Westinghouse Electric Corporation (Westinghouse) in the 23rd District Court for Matagorda County, Texas (Cause No. 90-S-0684-C), alleging breach of warranty and misrepresentation in connection with the steam generators supplied by Westinghouse for the South Texas Project. In recent years, other utilities have encountered stress corrosion cracking in steam generator tubes in Westinghouse units similar to those supplied for the South Texas Project. Failure of such tubes can result in a reduction of plant efficiency, and, in some cases, utilities have replaced their steam generators. During an inspection concluded in the fall of 1993, evidence was found of stress corrosion cracking consistent with that encountered with Westinghouse steam generators at other facilities, and a small number of tubes were found to require plugging. To date, stress corrosion cracking has not had a significant impact on operation of either unit; however, the owners of the South Texas Project have approved remedial operating\nplans and have undertaken expenditures to minimize and delay further corrosion. The litigation, which is in discovery, seeks appropriate damages and other relief from Westinghouse and is currently scheduled for trial in July 1995. No prediction can be made as to the ultimate outcome of this litigation.\nIn April 1994, two former employees of HL&P filed a class action and shareholder derivative suit on behalf of all shareholders of the Company. This lawsuit (PACE AND FUENTEZ V. HOUSTON INDUSTRIES INCORPORATED) alleges various acts of mismanagement against certain officers and directors of the Company and HL&P and, seeks unspecified actual and punitive damages for the benefit of shareholders of the Company. The Company and HL&P believe that the suit is without merit. The lawsuit is pending in the 122nd Judicial District of Galveston County, Texas.\nIn June 1994, a former employee of HL&P filed a lawsuit (PACE, INDIVIDUALLY AND AS A REPRESENTATIVE OF ALL OTHERS SIMILARLY SITUATED V. HOUSTON LIGHTING & POWER COMPANY) in the 56th Judicial District Court of Galveston County, Texas alleging that HL&P has been overcharging ratepayers and owes a refund of more than $500 million. The claim was based on the argument that the Utility Commission failed to allocate to ratepayers alleged tax benefits accruing to the Company and HL&P because HL&P's federal income taxes are paid as part of a consolidated group. The court has granted HL&P's motion for summary judgment, which has now become final.\nIn July 1990, the Company paid approximately $104.5 million to the Internal Revenue Service (IRS) in connection with an IRS audit of the Company's 1983 and 1984 federal income tax returns. In November 1991, the Company filed a refund suit in the U.S. Court of Federal Claims seeking the return of $52.1 million of tax, $36.3 million of accrued interest, plus interest on both of those amounts accruing after July 1990. The major contested issue in the refund case involved the IRS's allegation that certain amounts related to the over-recovery of fuel costs should have been included as taxable income in 1983 and 1984 even though HL&P had an obligation to refund the over-recoveries to its ratepayers. In October 1994, the Court granted the Company's Motion for Partial Summary Judgment on the fuel cost over-recovery issue. On February 21, 1995, the Court entered partial judgment in favor of the Company for this issue. The U.S. Government (Government) must file its notice of appeal on or before April 24, 1995. If the Government does not appeal or if the Government appeals but does not prevail, the Company would be entitled to a refund of overpaid tax, interest paid on the overpaid tax in July 1990 and interest on both of those amounts from July 1990. Although, the Company would not be entitled to a refund until all appeals are decided in its favor, the amount owed to the Company will continue to accrue interest. If the Government appeals and prevails, the Company's ultimate financial exposure should be immaterial because of offsetting tax deductions to which the Company is entitled in the year the over-recovery was refunded to ratepayers (and which the IRS has conceded).\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 of the Company or HL&P 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 Company's Common Stock, which at February 1, 1995 was held of record by approximately 66,663 shareholders, is listed on the New York, Chicago (formerly Midwest) and London Stock Exchanges (symbol: HOU). All of HL&P's common equity is directly or indirectly held by the Company. The following table sets forth the high and low sales prices of the Company's Common Stock on the composite tape during the periods indicated, as reported by THE WALL STREET JOURNAL, and the dividends declared for such periods. Third quarter 1993 includes two quarterly dividends of $.75 per share due to a change in the timing of the Company's Board of Directors' declaration of dividends. Dividend payout was $3.00 per share for 1994 and 1993. The dividend declared during the fourth quarter of 1994 is payable in March 1995.\nMarket Price Dividend ------------------- Declared High Low Per Share ------ ------ --------- First Quarter ................... $ 0.75 January 3 ................. $47 3\/4 March 31 .................. $34 3\/4\nSecond Quarter .................. $ 0.75 April 21 .................. $37 1\/4 May 10 .................... $30\nThird Quarter ................... $ 0.75 July 1 .................... $32 1\/2 August 2 .................. $36 5\/8\nFourth Quarter .................. $ 0.75 November 23 ............... $32 December 15 ............... $36 1\/2\nFirst Quarter ................... $ 0.75 January 8 ................. $44 3\/4 February 4 ................ $48 3\/4\nSecond Quarter .................. $ 0.75 April 15 .................. $48 3\/8 June 22 ................... $42 1\/2\nThird Quarter ................... $ 1.50 July 6 .................... $43 3\/8 August 31 ................. $47 1\/8\nFourth Quarter .................. $ 0.75 November 2 ................ $49 3\/4 November 30 ............... $44 3\/4\nOn December 31, 1994, the consolidated book value of the Company's common stock was $27.28 per share, and the closing market price was $35.63 per share.\nThere are no contractual limitations on the payment of dividends on the Company's Common Stock or on the common stock of the Company's subsidiaries other than KBL Cable, Inc. (KBL Cable), the principal operating subsidiary of KBLCOM. Restrictions on distributions and other financial covenants in KBL Cable's credit agreements and other debt instruments affecting KBL Cable will effectively prevent the payment of common stock dividends by KBL Cable for the foreseeable future. For a discussion of the Company's agreement to dispose of its cable television operations, see Note 21(a) to the Company's Consolidated Financial Statements in Item 8 of this Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA OF THE COMPANY.\nThe following table sets forth selected financial data with respect to the Company's consolidated financial condition and results of consolidated operations and should be read in conjunction with the Company's Consolidated and HL&P's Financial Statements and the related notes in Item 8 of this Report.\nITEM 6. SELECTED FINANCIAL DATA OF HL&P.\nThe following table sets forth selected financial data with respect to HL&P's financial condition and results of operations and should be read in conjunction with the Financial Statements and the related notes in Item 8 of this Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nCURRENT ISSUES\nHOUSTON LIGHTING & POWER COMPANY (HL&P)\nRATE REVIEW, FUEL RECONCILIATION AND OTHER PROCEEDINGS. In February 1994, the Public Utility Commission of Texas (Utility Commission) initiated a proceeding (Docket No. 12065) to determine whether HL&P's existing rates are just and reasonable. Subsequently, the scope of the docket was expanded to include a reconciliation of HL&P's fuel costs from April 1, 1990 to July 31, 1994. The Utility Commission also initiated a separate proceeding (Docket No. 13126) to review issues regarding the prudence of operation of the South Texas Project Electric Generating Station (South Texas Project) from the date of commercial operation through the present. That review would encompass the outage at the South Texas Project during 1993 through 1994.\nIn February 1995, all major parties to these proceedings signed a settlement agreement resolving the issues with respect to HL&P, including the prudence issues related to operation of the South Texas Project (Proposed Settlement). Approval of that settlement by the Utility Commission will be required. To that end, the parties have established procedural dates for a hearing on issues raised by the parties who are opposed to the Proposed Settlement. A decision by the Utility Commission on the Proposed Settlement is not anticipated before early summer.\nUnder the Proposed Settlement, HL&P's base rates would be reduced by approximately $62 million per year, effective retroactively to January 1, 1995, and rates would be frozen for three years, subject to certain conditions. Under the Proposed Settlement, HL&P would amortize its remaining investment of $218 million in the cancelled Malakoff Electric Generating Station (Malakoff) plant, over a period not to exceed seven years. HL&P also would increase its decommissioning expense for the South Texas Project by $9 million per year.\nUnder the Proposed Settlement, approximately $70 million of fuel expenditures and related interest incurred by HL&P during the fuel reconciliation period would not be recoverable from ratepayers. This $70 million was recorded as a one-time, pre-tax charge to reconcilable fuel revenues to reflect the anticipation of approval of the Proposed Settlement. HL&P would also establish a new fuel factor approximately 17 percent below that currently in effect and would refund to customers the balance in its over-recovery account, estimated to be approximately $180 million after giving effect to the amounts not recoverable from ratepayers. For additional information regarding HL&P's rate proceeding, see Note 3 to Houston Industries Incorporated's (Company) Consolidated and HL&P's Financial Statements (Financial Statements) in Item 8","section_7A":"","section_8":"Item 8 of this Report. These increases were partially offset by the cessation of property loss amortization in 1993.\nOther taxes decreased $22.1 million in 1993 primarily due to state franchise tax refunds totaling approximately $33 million, partially offset by increased property taxes due to increased tax rates.\nInterest on long-term debt was $35.2 million lower in 1993 than in 1992 because of refinancing activities and the reduction of long-term debt. Reductions of intercompany borrowings and fuel cost under-recoveries resulted in a $7.2 million decrease in other interest expense in 1993.\nKBLCOM\nSummary of selected financial data for KBLCOM is set forth below:\nYear Ended December 31, ------------------------- Percent 1994 1993 Change ----------- ----------- ------- (Thousands of Dollars)\nRevenues................................. $ 255,772 $ 244,067 5 Operating Expenses (1)................... 156,084 148,325 5 Gross Operating Margin (1)............... 99,688 95,742 4 Depreciation, Amortization, Interest and Other................................ 102,422 100,318 2 Income Taxes (Benefit)................... (2,851) 8,436 - Income (Loss) Before Long-Term Financing Cost with Parent........... 117 (13,012) - -------------- Basic Subscribers (000).................. 690 605 14\nYear Ended December 31, ------------------------- Percent 1993 1992 Change ----------- ----------- ------- (Thousands of Dollars)\nRevenues................................. $ 244,067 $ 235,258 4 Operating Expenses (1)................... 148,325 140,242 6 Gross Operating Margin (1)............... 95,742 95,016 1 Depreciation, Amortization, Interest and Other............................ 100,318 124,466 (19) Income Taxes (Benefit)................... 8,436 (8,201) - Loss Before Long-Term Financing Cost with Parent.......................... (13,012) (21,249) 39 -------------- Basic Subscribers (000).................. 605 577 5\n(1) Exclusive of depreciation and amortization.\nGENERAL\n1994 COMPARED TO 1993. KBLCOM's results of operations for 1994 improved from 1993 due to higher revenues resulting from the addition of approximately 85,000 customers, including 51,000 served at year end by three cable companies acquired by KBLCOM in July 1994 (Acquisition). For a discussion of the Acquisition, see Note 18 to the Financial Statements in Item 8 of this Report. KBLCOM's operating margin for 1994 was 39.0 percent, compared to 39.2 percent for 1993.\nIn 1994, KBLCOM's income tax benefit of $2.8 million was primarily due to a $7.5 million reduction of deferred state income tax liabilities.\nKBLCOM's future earnings outlook is dependent, to a large degree, on the success of its marketing programs to increase basic subscribers and premium programming services, its success in marketing other services, such as advertising and pay-per-view, and the general economic conditions in the areas it serves. In addition, the cable television industry in general, including KBLCOM, is faced with various uncertainties, including the impact of recent regulation of basic service rates by municipalities, the potential entry of telephone companies into the cable business and increased competition from other entities. Recent changes to the legislative and regulatory environment in which the cable television industry operates could limit KBLCOM's ability to increase prices charged for cable television services in the future. See \"CURRENT ISSUES - KBLCOM - 1992 Cable Act.\"\n1993 COMPARED TO 1992. KBLCOM's net loss per share declined due to increased revenues, reduced interest expense and increased earnings from the Paragon Communications (Paragon) partnership, which is discussed below. KBLCOM's operating margin for 1993 was 39.2 percent, compared to 40.4 percent for 1992.\nThe 1 percent general corporate income tax rate increase imposed by OBRA negatively impacted KBLCOM's 1993 results by $6.8 million.\nThe following discussions of operating revenues and sales and depreciation and interest expense relate to KBLCOM and its wholly-owned subsidiaries, excluding the investment in Paragon, which is not included because it is accounted for under the equity method of accounting.\nOPERATING REVENUES AND SALES\n1994 COMPARED TO 1993. In 1994, cable television revenues were favorably impacted by the addition of approximately 34,000 basic subscribers, excluding the Acquisition, an increase of 5.6 percent and 85,000 basic subscribers, including the Acquisition, an increase of 14.1 percent. Excluding the Acquisition, basic service revenues decreased $3.2 million or 2.0 percent in 1994 as compared to 1993 primarily because revenues from additional outlets declined by $7.1 million. However, including the Acquisition, basic service revenues increased $1.7 million or 1.1 percent. Basic service revenue increases are due primarily to additional customers and the Acquisition partially offset by lower rates for basic service, including additional outlets, mandated by the 1992 Cable Act, which were placed in effect in September 1993 and July 1994. See \"CURRENT ISSUES - KBLCOM - 1992 Cable Act.\"\nAncillary service revenues from sources, such as advertising and installation fees, increased $6.9 million, or 22.3 percent, in 1994 from the prior year. This increase was due primarily to increased advertising sales and telephony-related and premium fees. Pay-per-view revenues declined 3.1 percent in 1994 from 1993 primarily due to the lack of major feature movies and local pay-per-view sporting events in 1994. Premium revenues increased $3.4 million, or 8.8 percent due primarily to new packaging of premium units and multiplexing, which is the delivery of multiple channels of premium service with no change in price to the subscriber. The Acquisition did not have a material impact on these revenue categories.\n1993 COMPARED TO 1992. Basic service revenues increased $5.4 million, or 3.4 percent, primarily due to the addition of 28,000 basic subscribers. However, the revenue increase related to the additional subscribers was partially offset by a reduction in basic rates effective on September 1, 1993 implemented as a result of the 1992 Cable Act. A large portion of this reduction resulted from the loss of revenues from additional outlets.\nAncillary service revenues from sources, such as advertising and installation fees, increased $3.2 million, or 11.8 percent, in 1993 from the prior year. This increase was due primarily to increased advertising sales and higher installation and other related transaction fees. Pay-per-view revenues were approximately the same in 1993 as in 1992. Premium revenues were approximately the same in 1993 as in 1992, ending a long decline in this revenue category.\nDEPRECIATION AND INTEREST EXPENSE\n1994 COMPARED TO 1993. Excluding the Acquisition, depreciation and amortization increased $4.2 million or 5.5 percent in 1994 compared to 1993 due primarily to asset additions. Including the Acquisition, such costs increased $6.8 million or 8.7 percent in 1994. In 1994, interest expense increased $1.0 million, or 2.0 percent, due to an increase in interest rates.\n1993 COMPARED TO 1992. Depreciation and amortization increased $2.3 million, or 3.0 percent, in 1993 due primarily to asset additions. In 1993, interest expense decreased $18.7 million, or 26.8 percent, due to reduced interest rates and lower debt balances. The Company recapitalized KBLCOM to reduce the amount of debt in its capital structure. As part of this recapitalization, the Company contributed $177.3 million of equity which was used to reduce KBLCOM's indebtedness. This recapitalization increased KBLCOM's equity, reduced the financial risks associated with indebtedness and increased KBLCOM's financial flexibility.\nPARAGON PARTNERSHIP\n1994 COMPARED TO 1993. A subsidiary of KBLCOM owns a 50 percent interest in Paragon, a Colorado partnership, which, in turn, owns cable television systems which served approximately 967,000 basic cable customers in seven states as of December 31, 1994. Paragon's revenues were favorably impacted in 1994 by the addition of approximately 35,000 basic subscribers, an increase of 3.8 percent from 1993. KBLCOM's 1994 equity interest in the pre-tax earnings of Paragon was $33.5 million, compared to $32.2 million in 1993. The increase was due to increased revenue and reduced interest expense at Paragon, partially offset by the impact of the 1992 Cable Act.\n1993 COMPARED TO 1992. Paragon served approximately 932,000 basic cable customers in seven states as of December 31, 1993. Paragon's revenues were favorably impacted in 1993 by the addition of approximately 31,000 subscribers, an increase of 3.4 percent. KBLCOM's 1993 equity interest in the pre-tax earnings of Paragon was $32.2 million, compared to $24.9 million in 1992. The increase was due to increased revenue, improved operating margins and reduced interest expense at Paragon, partially offset by the impact of the 1992 Cable Act. LIQUIDITY AND CAPITAL RESOURCES\nOVERVIEW\nThe Company's cash requirements stem primarily from operating expenses, capital expenditures, payment of common stock dividends, payment of preferred stock dividends, and interest and principal payments on debt. Net cash provided by operating activities totaled $1.2 billion in 1994.\nNet cash used in investing activities in 1994 totaled $561.8 million, primarily due to electric capital expenditures of $418.5 million (including Allowance for Borrowed Funds Used During Construction (AFUDC)), and cable television additions and investments of approximately $84.2 million.\nFinancing activities for 1994 resulted in a net cash outflow of $639.7 million. The Company's primary financing activities were the payment of dividends, repayment of short-term borrowings, redemption of preferred stock and payment of long-term debt.\nThe liquidity and capital requirements of the Company and its subsidiaries are affected primarily by capital programs and debt service requirements. The capital requirements for 1994, and as estimated for 1995 through 1997, are as follows: Millions of Dollars ------------------------------ 1994 1995 1996 1997 ---- ---- ---- ---- Electric capital and nuclear fuel (excluding AFUDC)........................................ $413 $364 $385 $338 Cable television additions and other cable-related investments (1).............. 84 91 Cable acquisitions............................. 80 Corporate headquarters expenditures (excluding capitalized interest) (2).................. 44 79 6 Non-regulated electric power project expenditures(3)............................ 35 Maturities of long-term debt, preferred stock and minimum capital lease payments......... 55 65 476 384 ---- ---- ---- ---- Total.......................................... $676 $634 $867 $722 ===== ==== ==== ==== - -------------- (1) Due to the pending disposition of KBLCOM, capital requirements after 1995 have not been presented.\n(2) In December 1993, a subsidiary of the Company acquired a new headquarters building in downtown Houston. Structural improvements and various renovations have been ongoing to accommodate the Company's business requirements.\n(3) Additional capital expenditures are dependent upon the nature and extent of future project commitments entered into by Houston Industries Energy, Inc. (HI Energy).\nFor a discussion of the Company's commitments for capital expenditures, see Note 14 to the Financial Statements in Item 8 of this Report.\nCOMPANY\nSOURCES OF CAPITAL RESOURCES AND LIQUIDITY\nThe Company has consolidated its financing activities in order to provide a coordinated, cost-effective method of meeting short and long-term capital requirements. As part of the consolidated financing program, the Company has established a \"money fund\" through which its subsidiaries can borrow or invest on a short-term basis. The funding requirements of individual subsidiaries are aggregated and borrowing or investing is conducted by the Company based on the net cash position. In 1994, net funding requirements were met with borrowings under the Company's commercial paper program, except that HL&P's borrowing requirements were generally met with HL&P's commercial paper program. In 1995, net funding requirements of the Company and HL&P are expected to be met with a combination of commercial paper and bank borrowings. As of December 31, 1994, the Company had a bank credit facility of $600 million (exclusive of bank credit facilities of subsidiaries), which was used to support its commercial paper program. At December 31, 1994, the Company had approximately $423 million of commercial paper\noutstanding. Rates paid by the Company on its short-term borrowings are generally lower than the prime rate. In March 1995, the Company's bank credit facility was increased to $800 million.\nOn January 26, 1995, the Company entered into an agreement with Time Warner to sell all of its cable television operations. In exchange for KBLCOM's common stock, Time Warner will issue to the Company one million shares of its common stock and 11 million shares of a newly-issued series of its convertible preferred stock (with a liquidation value of $100 per share). The preferred stock will be convertible into approximately 22.9 million shares of Time Warner common stock. After four years, Time Warner will have the right to exchange the preferred stock for common stock at the stated conversion rate, unless the Company elects to convert the shares before such time. In addition, Time Warner will purchase KBLCOM's intercompany debt for an estimated $600 million in cash. Approximately $685 million of KBLCOM's third party debt and other liabilities will be assumed by Time Warner upon the closing of the sale. Closing of the transaction, which is expected to occur in the second half of 1995, is subject to the approval of certain franchise authorities and other governmental entities.\nBased on a Time Warner common stock price of $35.50 and assuming the closing occurs on September 30, 1995, the Company estimates that it will recognize an after-tax gain of approximately $650 million. The Company anticipates that it will record a portion of this gain (estimated to be approximately $100 million) in the first quarter of 1995 in recognition of the deferred tax asset arising from the Company's excess tax basis in KBLCOM stock. The remainder of the gain will be recognized at closing. The Company believes that the transaction will improve its liquidity by exchanging the Company's investment in KBLCOM for cash and marketable securities. In addition, the terms of the preferred stock to be issued by Time Warner provide for the payment of an annual cash dividend of $3.75 per share for four years. Assuming Time Warner common stock were to continue to pay its current dividend of $.36 per share, the Company would expect to receive after-tax dividend payments on the Time Warner common and preferred stock of approximately $37 million per year.\nIt is anticipated that the $600 million proceeds to be received in connection with the sale of KBLCOM's intercompany debt would be used for general corporate purposes, including but not limited to the redemption of or retirement of indebtedness of the Company, the advance or contribution of funds to one or more subsidiaries to be used for their general corporate purposes or (depending on market and other conditions) the possible repurchase of certain outstanding shares of the Company's common stock. For additional information regarding the proforma presentation of the Company's 1994 Statement of Consolidated Income to reflect KBLCOM on a discontinued operations basis for the entire year, see Note 21(a) to the Financial Statements in Item 8 of this Report.\nThe Company has registered with the Securities and Exchange Commission (SEC) $250 million principal amount of debt securities which remain unissued. Proceeds from any sales of these debt securities are expected to be used for general corporate purposes, including investments in and loans to subsidiaries.\nThe Company also has registered with the SEC five million shares of its common stock. Proceeds from the sale of these securities will be used for general corporate purposes, including,\nbut not limited to, the redemption, repayment or retirement of outstanding indebtedness of the Company or the advance or contribution of funds to one or more of the Company's subsidiaries to be used for their general corporate purposes, including, without limitation, the redemption, repayment or retirement of indebtedness or preferred stock.\nHL&P\nHL&P's cash requirements stem primarily from operating expenses, capital expenditures, payment of common stock dividends, payment of preferred stock dividends, and interest and principal payments on debt. HL&P's net cash provided by operating activities for 1994 totaled approximately $1.2 billion. Net cash used in HL&P's investing activities for 1994 totaled $434.3 million including AFUDC.\nIn July 1994, HL&P contributed as equity its rights to receive certain railroad settlement payments to HL&P Receivables, Inc., a wholly-owned subsidiary of HL&P. Following the transfer of such receivables to a trust, HL&P received $66.1 million, which was recorded as a reduction to its reconcilable fuel expense in July 1994. The reduction to reconcilable fuel expense had no effect on earnings. For a further discussion of this transaction, see Note 19 to the Financial Statements in Item 8 of this Report.\nHL&P's financing activities for 1994 resulted in a net cash outflow of $569.2 million. Included in these activities were the payment of dividends, repayment of short-term borrowings, the redemption of preferred stock, and the repayment of matured long-term debt. For information with respect to these matters, see Notes 9 and 10(a) to the Financial Statements in Item 8 of this Report.\nCAPITAL PROGRAM\nHL&P's capital and nuclear fuel expenditures (excluding AFUDC) for 1994 totaled $413 million, which was below the authorized budgeted level of $478 million. Estimated expenditures for 1995, 1996 and 1997 are $364 million, $385 million and $338 million, respectively. Maturities of long-term debt, preferred stock subject to mandatory redemption, and capital leases for this same period include $49 million in 1995, $200 million in 1996 and $254 million in 1997.\nHL&P's capital program for the next three years is expected to relate to costs for production, transmission, distribution, and general plant. HL&P began construction of the San Jacinto Steam Electric Station (San Jacinto Station), formerly the E. I. du Pont de Nemours Company (DuPont) project, in 1993 in order to provide generating capacity in 1995. The San Jacinto Station is being constructed pursuant to an agreement between HL&P and DuPont, whereby HL&P will construct, own, and operate two 80 megawatt gas turbine units located at DuPont's La Porte, Texas facility. The project will supply DuPont with process steam while all electrical energy will be used in the HL&P system. HL&P's capital program is subject to periodic review and portions may be revised from time to time due to changes in load forecasts, changing regulatory and environmental standards and other factors.\nSOURCES OF CAPITAL RESOURCES AND LIQUIDITY\nHL&P expects to finance its 1995 through 1997 capital program with funds generated internally from operations.\nHL&P has registered with the SEC $230 million aggregate liquidation value of its preferred stock and $580 million aggregate principal amount of its debt securities that may be issued as first mortgage bonds and\/or as debt securities collateralized by first mortgage bonds. Proceeds from any sale of these securities are expected to be used for general corporate purposes including the purchase, redemption (to the extent permitted by the terms of the outstanding securities), repayment or retirement of outstanding indebtedness or preferred stock of HL&P.\nIn 1994, HL&P's interim financing requirements were met with commercial paper. In 1995, HL&P's interim financing requirements are expected to be met with a combination of commercial paper and bank borrowings. At December 31, 1994, HL&P had approximately $236 million in short-term investments and no commercial paper borrowings. HL&P's commercial paper program is supported by a bank credit facility of $400 million.\nHL&P's capitalization at December 31, 1994 was 42 percent long-term debt, 7 percent preferred stock and 51 percent common stock equity.\nENVIRONMENTAL EXPENDITURES\nThe new requirements of the Clean Air Act will require HL&P to increase its environmental expenditures. Modifying its existing facilities to reduce emissions of nitrogen oxides (NOx) cost $4 million in 1994. The date for additional compliance has been delayed by the United States Environmental Protection Agency (EPA) and the Texas Natural Resource Conservation Commission until it becomes certain that additional expenditures for NOx emission reductions will be required under the provisions of the Clean Air Act. Up to an additional $40 million may be incurred by HL&P in order to fully comply with new NOx requirements after 1997. In addition, it is anticipated that $7 million in 1995 will be expended to install continuous emission monitoring equipment; approximately $4 million was incurred for this equipment in 1994.\nThe EPA identified HL&P as a potentially responsible party under the Comprehensive Environmental Response, Compensation, and Liability Act for the costs of cleaning up a site located adjacent to one of HL&P's transmission lines. In October 1992, the EPA issued an Administrative Order to HL&P and several other companies purporting to require them to manage the remediation of the site. Because of various defenses it believes are available to it, HL&P has not complied with this Order. To date, neither the EPA nor any other potentially responsible party has instituted a claim against HL&P for cleanup costs; however, under current law, potentially responsible parties could be determined to be jointly and severally liable for such costs. The cleanup of the entire site may cost $80 million. If, despite its defenses, HL&P were ultimately held to be responsible for the site, it may be subject to substantial fines and damages. Although no prediction can be made at this time as to the ultimate outcome of this matter, in light of all the circumstances involved, the Company and HL&P do not believe any costs that HL&P will incur\nin this matter will have a material adverse effect on the Company's or HL&P's financial condition or results of operation.\nKBLCOM\nKBLCOM's cash requirements stem primarily from operating expenses, capital expenditures, and interest and principal payments on debt. KBLCOM's net cash provided by operating activities was $48.7 million in 1994.\nNet cash used in KBLCOM's investing activities for 1994 totaled $88.1 million, primarily due to property additions and other cable-related investments of approximately $84.2 million. These amounts were financed principally through internally generated funds and intercompany advances. A substantial portion of KBLCOM's 1995 capital requirements is expected to be met through internally generated funds. It is expected that any shortfall will be met through intercompany borrowings. For a discussion of the pending disposition of KBLCOM, see Note 21(a) to the Financial Statements in Item 8 of this Report.\nKBLCOM's financing activities for 1994 resulted in a net cash inflow of $39.5 million. Included in these activities was the reduction of third party debt through scheduled principal payments and repayments of debt assumed in the Acquisition.\nFINANCING ACTIVITIES\nIn the first quarter of 1994 and 1995, KBLCOM made mandatory repayments of $10.4 million and $15.8 million, respectively, principal amount of its senior notes and senior subordinated notes. In January 1994, KBLCOM's letter of credit and term loan facility was terminated. As of December 31, 1993, the facility was utilized in the form of letters of credit aggregating approximately $89.3 million which supported debt service obligations on senior subordinated notes.\nIn July 1994, KBLCOM acquired the stock of three cable companies then serving approximately 48,000 customers in the Minneapolis area in exchange for 587,646 shares of common stock of the Company. The total purchase price of approximately $80 million included the assumption of approximately $60 million in liabilities. Notes were repaid in connection with the Acquisition in the amount of $57.7 million.\nSOURCES OF CAPITAL RESOURCES AND LIQUIDITY\nAdditional borrowing under a KBLCOM bank credit facility is subject to certain covenants which relate primarily to the maintenance of certain financial ratios, principally debt to cash flow and interest coverages. KBLCOM presently is in compliance with such covenants. At December 31, 1994, KBLCOM had $76 million available for borrowing under its credit facility. The facility has scheduled reductions in March of each year until it is terminated in March 1999.\nHI ENERGY\nThe Company formed HI Energy in 1993 to seek investment opportunities in domestic and foreign power generation projects and the privatization of foreign electric utilities. The international market for private power development has recently emerged and is currently where HI Energy is concentrating most of its resources.\nDuring 1994, HI Energy began construction of the Ford Heights Tire-To-Energy Project, a $106 million electric generating plant south of Chicago, Illinois. HI Energy is committed to fund $21 million through combined equity contributions and loans as a result of its participation in this project.\nIn January 1995, HI Energy acquired for $15.7 million a 90 percent equity interest in an electric utility operating company in the province of Santiago del Estero, a rural province in the north central part of Argentina. The utility system serves approximately 100,000 customers in an area of 136,000 square kilometers.\nAdditional capital expenditures are dependent upon the nature and extent of future project commitments entered into by HI Energy.\nNEW ACCOUNTING ISSUES\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 facilities recorded on the financial statements of electric utilities. In response to these questions, the Financial Accounting Standards Board has agreed to review the accounting for removal costs, including decommissioning. If the 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 of decommissioning expense.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nHOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED INCOME (THOUSANDS OF DOLLARS)\nSee Notes to Consolidated Financial Statements.\nHOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED RETAINED EARNINGS (THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)\nSee Notes to Consolidated Financial Statements.\nHOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (THOUSANDS OF DOLLARS)\nASSETS\nSee Notes to Consolidated Financial Statements.\nHOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (THOUSANDS OF DOLLARS)\nCAPITALIZATION AND LIABILITIES\nSee Notes to Consolidated Financial Statements.\nHOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CAPITALIZATION (THOUSANDS OF DOLLARS)\nSee Notes to Consolidated Financial Statements.\nHOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED CASH FLOWS\nINCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (THOUSANDS OF DOLLARS)\nSee Notes to Consolidated Financial Statements.\nHOUSTON LIGHTING & POWER COMPANY\nSTATEMENTS OF INCOME (THOUSANDS OF DOLLARS)\nSee Notes to Financial Statements.\nHOUSTON LIGHTING & POWER COMPANY\nSTATEMENTS OF RETAINED EARNINGS (THOUSANDS OF DOLLARS)\nSee Notes to Financial Statements.\nHOUSTON LIGHTING & POWER COMPANY\nBALANCE SHEETS (THOUSANDS OF DOLLARS)\nASSETS\nSee Notes to Financial Statements.\nHOUSTON LIGHTING & POWER COMPANY\nBALANCE SHEETS (THOUSANDS OF DOLLARS)\nCAPITALIZATION AND LIABILITIES\nSee Notes to Financial Statements.\nHOUSTON LIGHTING & POWER COMPANY\nSTATEMENTS OF CAPITALIZATION (THOUSANDS OF DOLLARS)\nSee Notes to Financial Statements.\nHOUSTON LIGHTING & POWER COMPANY\nSTATEMENTS OF CASH FLOWS\nINCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (THOUSANDS OF DOLLARS)\nSee Notes to Financial Statements.\nHOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) SYSTEM OF ACCOUNTS AND EFFECTS OF REGULATION. The accounting records of Houston Lighting & Power Company (HL&P), the principal subsidiary of Houston Industries Incorporated (Company), are maintained in accordance with the Federal Energy Regulatory Commission's (FERC) Uniform System of Accounts. HL&P's accounting practices are subject to regulation by the Public Utility Commission of Texas (Utility Commission), which has adopted the FERC system of accounts.\nAs a result of Utility Commission regulation, HL&P follows the accounting set forth in Statement of Financial Accounting Standards (SFAS) No. 71 \"Accounting for the Effects of Certain Types of Regulation\". This statement requires a rate-regulated entity to reflect the effects of regulatory decisions in its financial statements. In accordance with the statement, the Company has deferred certain costs pursuant to rate actions of the Utility Commission and is recovering or expects to recover such costs in electric rates charged to customers. The regulatory assets are included in plant held for future use and other assets on the Company's Consolidated and HL&P's Balance Sheets. The regulatory liabilities are included in deferred credits on the Company's Consolidated and HL&P's Balance Sheets. In the event the Company is no longer able to apply SFAS No. 71 due to future changes in regulation or competition, the Company's ability to recover these assets and\/or liabilities may not be assured.\nFollowing are significant regulatory assets and liabilities:\nDecember 31, 1994 --------------------- (Millions of Dollars)\nDeferred plant costs - net............................ $ 639 Malakoff Electric Generating Station (Malakoff) investment.......................................... 252 Regulatory tax asset - net............................ 235 Unamortized loss on reacquired debt................... 117 Deferred debits....................................... 105 Unamortized investment tax credit..................... (412) Accumulated deferred income taxes - regulatory tax asset.............................................. (82)\n(b) PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.\nAll significant intercompany transactions and balances are eliminated in consolidation except for, prior to 1993, sales of accounts receivable to Houston Industries Finance, Inc. (Houston\nIndustries Finance), a former subsidiary of the Company, which were not eliminated because of the distinction for regulatory purposes between utility and non-utility operations. In January 1993, Houston Industries Finance sold the receivables back to the respective subsidiaries and ceased operations. HL&P is now selling its accounts receivable and most of its accrued unbilled revenues to a third party.\nInvestments in affiliates in which the Company has a 20 percent to 50 percent interest, or a lesser percent in which the Company has management influence, which include the investments in Paragon Communications (Paragon) and Empresa Distribuidora La Plata S.A. (EDELAP), are recorded using the equity method of accounting. See Note 7.\n(c) ELECTRIC PLANT. Additions to electric plant, betterments to existing property and replacements of units of property are capitalized at cost. Cost includes the original cost of contracted services, direct labor and material, indirect charges for engineering supervision and similar overhead items and an Allowance for Funds Used During Construction (AFUDC). Customer payments for construction reduce additions to electric plant.\nHL&P computes depreciation using the straight-line method. The depreciation provision as a percentage of the depreciable cost of plant was 3.2 percent for 1994, 3.1 percent for 1993 and 3.2 percent for 1992.\n(d) CABLE TELEVISION PROPERTY. KBLCOM Incorporated (KBLCOM), the Company's cable television subsidiary, records additions to property at cost, which include amounts for material, labor, overhead and interest. Depreciation is computed using the straight-line method. Depreciation as a percentage of the depreciable cost of property was 11.3 percent for 1994 and 1993, and 12.1 percent for 1992. Expenditures for maintenance and repairs are expensed as incurred. In January 1995, Time Warner Inc. (Time Warner) and the Company reached an agreement under which Time Warner will acquire KBLCOM. For a discussion of the agreement, see Note 21(a).\n(e) CABLE TELEVISION FRANCHISES AND INTANGIBLE ASSETS. The acquisition cost in excess of the fair market value of the tangible assets and liabilities is recorded on KBLCOM's and the Company's Consolidated Balance Sheets as cable television franchises and intangible assets. Such amounts are amortized over periods ranging from 8 to 40 years on a straight-line basis. KBLCOM periodically reviews the carrying value of cable television franchises and intangible assets in relation to current and expected operating results of the business in order to assess whether there has been a permanent impairment of such amounts.\n(f) DEFERRED PLANT COSTS. The Utility Commission authorized deferred accounting treatment for certain costs related to the South Texas Project Electric Generating Station (South Texas Project) in two contexts. The first was \"deferred accounting\" where HL&P was permitted to continue to accrue carrying costs in the form of AFUDC and defer and capitalize depreciation and other operating costs on its investment in the South Texas Project until such costs were reflected in rates. The second was the \"qualified phase-in plan\" where HL&P was permitted to capitalize as deferred charges allowable costs, including return, deferred for future recovery under the approved plan. The accumulated deferrals for \"deferred accounting\" and \"qualified\nphase-in plan\" are being recovered over the estimated depreciable life of the South Texas Project and within the ten year phase-in period, respectively. The amortization of these deferrals totaled $25.8 million for each of the years 1994, 1993, and 1992 and is included on the Company's Statements of Consolidated Income and HL&P's Statements of Income in depreciation and amortization expense. Under the terms of the settlement agreement regarding the issues raised in Docket Nos. 12065 and 13126 (Proposed Settlement), see Note 3, the South Texas Project deferrals will continue to be amortized using the schedules discussed above.\n(g) REVENUES. HL&P records electricity sales under the full accrual method, whereby unbilled electricity sales are estimated and recorded each month in order to better match revenues with expenses. Prior to January 1, 1992, electric revenues were recognized as bills were rendered (see Note 6).\nCable television revenues are recognized as the services are provided to subscribers, and advertising revenues are recorded when earned.\n(h) INCOME TAXES. The Company follows a policy of comprehensive interperiod income tax allocation. Investment tax credits are deferred and amortized over the estimated lives of the related property.\n(i) EARNINGS PER COMMON SHARE. Earnings per common share for the Company are computed by dividing net income by the weighted average number of shares outstanding during the respective period.\nIn the third quarter of 1994, the Company adopted the American Institute of Certified Public Accountants Statement of Position 93-6 (SOP 93-6), \"Employers' Accounting for Employee Stock Ownership Plans,\" effective January 1, 1994. Pursuant to the adoption of SOP 93-6, the number of weighted average common shares outstanding reflects a reduction for Employee Stock Ownership Plan (ESOP) shares not yet committed for release to savings plan participants (unallocated shares). In accordance with SOP 93-6, earnings per common share for periods prior to January 1, 1994 have not been restated. The unallocated shares as of December 31, 1994 and 1993, were 7,770,313 and 8,317,649, respectively. See also Note 12(b).\n(j) STATEMENTS OF CONSOLIDATED CASH FLOWS. For purposes of reporting cash flows, cash equivalents are considered to be short-term, highly liquid investments readily convertible to cash.\n(k) RECLASSIFICATION. Certain amounts from the previous years have been reclassified to conform to the 1994 presentation of financial statements. Such reclassifications do not affect earnings.\n(2) JOINTLY-OWNED NUCLEAR PLANT\n(a) HL&P INVESTMENT. HL&P is the project manager (and one of four co-owners) of the South Texas Project, which consists of two 1,250 megawatt nuclear generating units. HL&P has a 30.8 percent interest in the project and bears a corresponding share of capital and operating\ncosts associated with the project. As of December 31, 1994, HL&P's investments (net of accumulated depreciation and amortization) in the South Texas Project and in nuclear fuel, including AFUDC, were $2.1 billion and $99 million, respectively.\n(b) UNITED STATES NUCLEAR REGULATORY COMMISSION (NRC) INSPECTIONS AND OPERATIONS. Both generating units at the South Texas Project were out of service from February 1993 to February 1994, when Unit No. 1 was returned to service. Unit No. 2 was returned to service in May 1994. HL&P removed the units from service in February 1993 when a problem was encountered with certain of the units' auxiliary feedwater pumps.\nIn February 1995, the NRC removed the South Texas Project from its \"watch list\" of plants with weaknesses that warranted increased NRC attention. The NRC placed the South Texas Project on the \"watch list\" in June 1993, following the issuance of a report by an NRC Diagnostic Evaluation Team (DET) which conducted a review of the South Texas Project operations.\nCertain current and former employees of HL&P or contractors of HL&P have asserted claims that their employment was terminated or disrupted in retaliation for their having made safety-related complaints to the NRC. Civil proceedings by the complaining personnel and administrative proceedings by the Department of Labor remain pending against HL&P, and the NRC has jurisdiction to take enforcement action against HL&P and\/or individual employees with respect to these matters. Based on its own internal investigation, in October 1994 the NRC issued a notice of violation and proposed a $100,000 civil penalty against HL&P in one such case in which HL&P had terminated the site access of a former contractor employee. In that action, the NRC also requested information relating to possible further enforcement action in this matter against two HL&P managers involved in such termination. HL&P strongly disagrees with the NRC's conclusions, and has requested the NRC to give further consideration of its notice. In February 1995, the NRC conducted an enforcement conference with respect to that matter, but no result has been received.\nHL&P has provided documents and other assistance to a subcommittee of the U. S. House of Representatives (Subcommittee) that is conducting an inquiry related to the South Texas Project. Although the precise focus and timing of the inquiry has not been identified by the Subcommittee, it is anticipated that the Subcommittee will inquire into matters related to HL&P's handling of employee concerns and to issues related to the NRC's 1993 DET review of the South Texas Project. In connection with that inquiry, HL&P has been advised that the U. S. General Accounting Office (GAO) is conducting a review of the NRC's inspection process as it relates to the South Texas Project and other plants, and HL&P is cooperating with the GAO in its investigation and with the NRC in a similar review it has initiated. While no prediction can be made at this time as to the ultimate outcome of these matters, the Company and HL&P do not believe that they will have a material adverse effect on the Company's or HL&P's financial condition or results of operations.\n(c) LITIGATION WITH CO-OWNERS OF THE SOUTH TEXAS PROJECT. In February 1994, the City of Austin (Austin), one of the four co-owners of the South Texas Project, filed suit (Austin II Litigation) against HL&P. That suit is pending in the 152nd District Court for Harris County, Texas, which has set a trial date for October 1995. Austin alleges that the outages at the South Texas\nProject from early 1993 to early 1994 were due to HL&P's failure to perform obligations it owed to Austin under the Participation Agreement among the four co-owners of the South Texas Project (Participation Agreement). Austin also asserts that HL&P breached certain undertakings voluntarily assumed by HL&P under the terms and conditions of the Operating Licenses and Technical Specifications relating to the South Texas Project. Austin claims that such failures have caused Austin damages of at least $125 million due to the incurrence of increased operating and maintenance costs, the cost of replacement power and lost profits on wholesale transactions that did not occur. In May 1994, the City of San Antonio (San Antonio), another co-owner of the South Texas Project, intervened in the litigation filed by Austin against HL&P and asserted claims similar to those asserted by Austin. San Antonio has not identified the amount of damages it intends to seek from HL&P. HL&P is contesting San Antonio's intervention and has called for arbitration of San Antonio's claim under the arbitration provisions of the Participation Agreement. The trial court has denied HL&P's requests, but review of these decisions is currently pending before the 1st Court of Appeals in Houston.\nIn a previous lawsuit (Austin I Litigation) filed in 1983 against the Company and HL&P, Austin alleged that it had been fraudulently induced to participate in the South Texas Project and that HL&P had failed to perform properly its duties as project manager. In May 1993, the courts entered a judgement in favor of the Company and HL&P, concluding, among other things, that the Participation Agreement did not impose on HL&P a duty to exercise reasonable skill and care as project manager. During the course of the Austin I Litigation, San Antonio and Central Power and Light Company (CPL), a subsidiary of Central and South West Corporation, two of the co-owners in the South Texas Project, also asserted claims for unspecified damages against HL&P as project manager of the South Texas Project, alleging HL&P breached its duties and obligations. San Antonio and CPL requested arbitration of their claims under the Participation Agreement. In 1992, the Company and HL&P entered into a settlement agreement with CPL (CPL Settlement) providing for CPL's withdrawal of its demand for arbitration. San Antonio's claims for arbitration remain pending. Under the Participation Agreement, San Antonio's arbitration claims will be heard by a panel of five arbitrators consisting of four arbitrators named by each co-owner and a fifth arbitrator selected by the four appointed arbitrators.\nAlthough the CPL Settlement did not directly affect San Antonio's pending demand for arbitration, HL&P and CPL reached certain understandings in such agreement which contemplated that: (i) CPL's previously appointed arbitrator would be replaced by CPL; (ii) arbitrators approved by CPL or HL&P in any future arbitrations would be mutually acceptable to HL&P and CPL; and (iii) HL&P and CPL would resolve any future disputes between them concerning the South Texas Project without resorting to the arbitration provision of the Participation Agreement. Austin and San Antonio have asserted in the pending Austin II Litigation that such understandings have rendered the arbitration provisions of the Participation Agreement void and that neither Austin nor San Antonio should be required to participate in or be bound by such proceedings.\nAlthough HL&P and the Company do not believe there is merit to either Austin's or San Antonio's claims and have opposed San Antonio's intervention in the Austin II Litigation, there can be no assurance as to the ultimate outcome of these matters.\n(d) NUCLEAR INSURANCE. HL&P and the other owners of the South Texas Project maintain nuclear property and nuclear liability insurance coverage as required by law and periodically review available limits and coverage for additional protection. The owners of the South Texas Project currently maintain the maximum amount of property damage insurance currently available through the insurance industry, consisting of $500 million in primary property damage insurance and excess property insurance in the amount of $2.25 billion. Under the excess property insurance which became effective on March 1, 1995 and under portions of the excess property insurance coverage in effect prior to March 1, 1995, HL&P and the other owners of the South Texas Project are subject to assessments, the maximum aggregate assessment under current policies being $26.9 million during any one policy year. The application of the proceeds of such property insurance is subject to the priorities established by the NRC regulations relating to the safety of licensed reactors and decontamination operations.\nPursuant to the Price Anderson Act (Act), the maximum liability to the public for owners of nuclear power plants, such as the South Texas Project, was decreased from $9.0 billion to $8.92 billion effective in November 1994. Owners are required under the Act to insure their liability for nuclear incidents and protective evacuations by maintaining the maximum amount of financial protection available from private sources and by maintaining secondary financial protection through an industry retrospective rating plan. The assessment of deferred premiums provided by the plan for each nuclear incident is up to $75.5 million per reactor subject to indexing for inflation, a possible 5 percent surcharge (but no more than $10 million per reactor per incident in any one year) and a 3 percent state premium tax. HL&P and the other owners of the South Texas Project currently maintain the required nuclear liability insurance and participate in the industry retrospective rating plan.\nThere can be no assurance that all potential losses or liabilities will be insurable, or that the amount of insurance will be sufficient to cover them. Any substantial losses not covered by insurance would have a material effect on HL&P's and the Company's financial condition.\n(e) NUCLEAR DECOMMISSIONING. HL&P and the other co-owners of the South Texas Project are required by the NRC to meet minimum decommissioning funding requirements to pay the costs of decommissioning the South Texas Project. Pursuant to the terms of the order of the Utility Commission in Docket No. 9850, HL&P is currently funding decommissioning costs for the South Texas Project with an independent trustee at an annual amount of $6 million, which is recorded in depreciation and amortization expense. HL&P's funding level is estimated to provide approximately $146 million, in 1989 dollars, an amount which exceeds the current NRC minimum.\nThe Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective January 1, 1994. At December 31, 1994, the securities held in the Company's nuclear decommissioning trust totaling $25.1 million (reflected on the Company's Consolidated and HL&P's Balance Sheets in deferred debits and deferred credits) are classified as available for sale. Such securities are reported on the balance sheets at fair value, which at December 31, 1994 approximates cost, and any unrealized gains or losses will be reported as a separate component of common stock equity. Earnings, net of taxes and administrative costs, are reinvested in the funds.\nIn May 1994, an outside consultant estimated HL&P's portion of decommissioning costs to be approximately $318 million, in 1994 dollars. The consultant's calculation of decommissioning costs for financial planning purposes used the DECON methodology (prompt removal\/dismantling), one of the three alternatives acceptable to the NRC, and assumed deactivation of Unit Nos. 1 and 2 upon the expiration of their 40 year operating licenses. Under the terms of the Proposed Settlement, HL&P would increase funding of decommissioning costs to an annual amount of approximately $14.8 million consistent with such study. While the current and projected funding levels presently exceed minimum NRC requirements, no assurance can be given that the amounts held in trust will be adequate to cover the actual decommissioning costs of the South Texas Project or the assumptions used in estimating decommissioning costs will ultimately prove to be correct.\n(3) RATE REVIEW, FUEL RECONCILIATION AND OTHER PROCEEDINGS\nIn February 1994, the Utility Commission initiated a proceeding (Docket No. 12065) to determine whether HL&P's existing rates are just and reasonable. Subsequently, the scope of the docket was expanded to include reconciliation of HL&P's fuel costs from April 1, 1990 to July 31, 1994. The Utility Commission also initiated a separate proceeding (Docket No. 13126) to review issues regarding the prudence of operation of the South Texas Project from the date of commercial operation through the present. That review would encompass the outage at the South Texas Project during 1993 through 1994.\nHearings began in Docket No. 12065 in January 1995, and the Utility Commission has retained a consultant to review the South Texas Project for the purpose of providing testimony in Docket No. 13126 regarding the prudence of HL&P's management of operation of the South Texas Project. In February 1995, all major parties to these proceedings signed the Proposed Settlement resolving the issues with respect to HL&P, including the prudence issues related to operation of the South Texas Project. Approval of the Proposed Settlement by the Utility Commission will be required. To that end, the parties have established procedural dates for a hearing on issues raised by the parties who are opposed to the Proposed Settlement. A decision by the Utility Commission on the Proposed Settlement is not anticipated before early summer.\nUnder the Proposed Settlement, HL&P's base rates would be reduced by approximately $62 million per year, effective retroactively to January 1, 1995, and rates would be frozen for three years, subject to certain conditions. Under the Proposed Settlement, HL&P would amortize its remaining investment of $218 million in the cancelled Malakoff plant over a period not to exceed seven years. HL&P also would increase its decommissioning expense for the South Texas Project by $9 million per year.\nUnder the Proposed Settlement, approximately $70 million of fuel expenditures and related interest incurred by HL&P during the fuel reconciliation period would not be recoverable from ratepayers. This $70 million was recorded as a one-time, pre-tax charge to reconcilable fuel revenues to reflect the anticipation of approval of the Proposed Settlement. HL&P also would establish a new fuel factor approximately 17 percent below that currently in effect and would\nrefund to customers the balance in its fuel over-recovery account, estimated to be approximately $180 million after giving effect to the amounts not recoverable from ratepayers.\nHL&P recovers fuel costs incurred in electric generation through a fixed fuel factor that is set by the Utility Commission. The difference between fuel revenues billed pursuant to such factor and fuel expense incurred is recorded as an addition to or a reduction of revenue, with a corresponding entry to under- or over-recovered fuel, as appropriate. Amounts collected pursuant to the fixed fuel factor must be reconciled periodically against actual, reasonable costs as determined by the Utility Commission. Currently, HL&P has an over-recovery fuel account balance that will be refunded pursuant to the Proposed Settlement.\nIn the event that the Proposed Settlement is not approved by the Utility Commission, including issues related to the South Texas Project, Docket No. 12065 will be remanded to an Administrative Law Judge (ALJ) to resume detailed hearings in this docket. Prior to reaching agreement on the terms of the Proposed Settlement, HL&P argued that its existing rates were just and reasonable and should not be reduced. Other parties argued that rate decreases in annual amounts ranging from $26 million to $173 million were required and that additional decreases might be justified following an examination of the prudence of the management of the South Texas Project and the costs incurred in connection with the outages at the South Texas Project. Testimony filed by the Utility Commission staff included a recommendation to remove from rate base $515 million of HL&P's investment in the South Texas Project to reflect the staff's view that such investment was not fully \"used and useful\" in providing service, a position HL&P vigorously disputes.\nIn the event the Proposed Settlement is not approved by the Utility Commission, the fuel reconciliation issues in Docket Nos. 12065 and 13126 would be remanded to an ALJ for additional proceedings. A major issue in Docket No. 13126 will be whether the incremental fuel costs incurred as a result of outages at the South Texas Project represent reasonable costs. HL&P filed testimony in Docket No. 13126, which testimony concluded that the outages at the South Texas Project did not result from imprudent management. HL&P also filed testimony analyzing the extent to which regulatory issues extended the outages. In that testimony an outside consultant retained by HL&P concluded that the duration of the outages was controlled by both the resolution of NRC regulatory issues as well as necessary equipment repairs unrelated to NRC regulatory issues and that the incremental effect of NRC regulatory issues on the duration of the outages was only 39 days per unit. Estimates as to the cost of replacement power may vary significantly based on a number of factors, including the capacity factor at which the South Texas Project might be assumed to have operated had it not been out of service due to the outages. However, HL&P believes that applying a reasonable range of assumptions would result in replacement fuel costs of less than $10 million for the 39 day periods identified by HL&P's consultant and less than $100 million for the entire length of the outages. Any fuel costs determined to have been unreasonably incurred would not be recoverable from customers and would be charged against the Company's earnings.\nAlthough the Company and HL&P believe that the Proposed Settlement is in the best interest of HL&P, its ratepayers, and the Company and its shareholders, no assurance can be given that (i) the Utility Commission ultimately will approve the terms of the Proposed Settlement or\n(ii) in the event the Proposed Settlement is not approved and proceedings against HL&P resumed, that the outcome of such proceedings would be favorable to HL&P.\n(4) APPEALS OF PRIOR UTILITY COMMISSION RATE ORDERS\nPursuant to a series of applications filed by HL&P in recent years, the Utility Commission has granted HL&P rate increases to reflect in electric rates HL&P's substantial investment in new plant construction, including the South Texas Project. Although Utility Commission action on those applications has been completed, judicial review of a number of the Utility Commission orders is pending. In Texas, Utility Commission orders may be appealed to a District Court in Travis County, and from that Court's decision an appeal may be taken to the Court of Appeals for the 3rd District at Austin (Austin Court of Appeals). Discretionary review by the Supreme Court of Texas may be sought from decisions of the Austin Court of Appeals. The pending appeals from the Utility Commission orders are in various stages. In the event the courts ultimately reverse actions of the Utility Commission in any of these proceedings, such matters would be remanded to the Utility Commission for action in light of the courts' orders. Because of the number of variables which can affect the ultimate resolution of such matters on remand, the Company and HL&P generally are not in a position at this time to predict the outcome of the matters on appeal or the ultimate effect that adverse action by the courts could have on the Company and HL&P. On remand, the Utility Commission's action could range from granting rate relief substantially equal to the rates previously approved to a reduction in the revenues to which HL&P was entitled during the time the applicable rates were in effect, which could require a refund to customers of amounts collected pursuant to such rates. Judicial review has been concluded or currently is pending on the final orders of the Utility Commission described below.\n(a) 1991 RATE CASE. In HL&P's 1991 rate case (Docket No. 9850), the Utility Commission approved a non-unanimous settlement agreement providing for a $313 million increase in HL&P's base rates, termination of deferrals granted with respect to Unit No. 2 of the South Texas Project and of the qualified phase-in plan deferrals granted with respect to Unit No. 1 of the South Texas Project, and recovery of deferred plant costs. The settlement authorized a 12.55 percent return on common equity for HL&P. Rates contemplated by the settlement agreement were implemented in May 1991 and remain in effect (subject to the outcome of the current rate proceeding described in Note 3).\nThe Utility Commission's order in Docket No. 9850 was affirmed on review by a District Court, and the Austin Court of Appeals affirmed that decision on procedural grounds due to the failure of the appellant to file the record with the court in a timely manner. On review, the Texas Supreme Court has remanded the case to the Austin Court of Appeals for consideration of the appellant's challenges to the Utility Commission's order, which include issues regarding deferred accounting, the treatment of federal income tax expense and certain other matters. As to federal tax issues, a recent decision of the Austin Court of Appeals, in an appeal involving GTE-SW (and to which HL&P was not a party), held that when a utility pays federal income taxes as part of a consolidated group, the utility's ratepayers are entitled to a fair share of the tax savings actually realized, which can include savings resulting from unregulated activities. The\nTexas Supreme Court has agreed to hear an appeal of that decision, but on points not involving the federal income tax issues, though tax issues could be decided in such opinion.\nBecause the Utility Commission's order in Docket No. 9850 found that HL&P would have been entitled to rate relief greater than the $313 million agreed to in the settlement, HL&P believes that any disallowance that might be required if the court's ruling in the GTE decision were applied in Docket No. 9850 would be offset by that greater amount. However, that amount may not be sufficient if the Austin Court of Appeals also concludes that the Utility Commission's inclusion of deferred accounting costs in the settlement was improper. For a discussion of the Texas Supreme Court's decision on deferred accounting treatment, see Note 4(c). Although HL&P believes that it could demonstrate entitlement to rate relief equal to that agreed to in the stipulation in Docket No. 9850, HL&P cannot rule out the possibility that a remand and reopening of that settlement would be required if decisions unfavorable to HL&P are rendered on both the deferred accounting treatment and the calculation of tax expense for rate making purposes.\nThe parties to the Proposed Settlement have agreed to withdraw their appeals of the Utility Commission's orders in such docket, subject to HL&P's dismissing its appeal in Docket No. 6668.\n(b) 1988 RATE CASE. In HL&P's 1988 rate case (Docket No. 8425), the Utility Commission granted HL&P a $227 million increase in base revenues, allowed a 12.92 percent return on common equity, authorized a qualified phase-in plan for Unit No. 1 of the South Texas Project (including approximately 72 percent of HL&P's investment in Unit No. 1 of the South Texas Project in rate base) and authorized HL&P to use deferred accounting for Unit No. 2 of the South Texas Project. Rates substantially corresponding to the increase granted were implemented by HL&P in June 1989 and remained in effect until May 1991.\nIn August 1994, the Austin Court of Appeals affirmed the Utility Commission's order in Docket No. 8425 on all matters other than the Utility Commission's treatment of tax savings associated with deductions taken for expenses disallowed in cost of service. The court held that the Utility Commission had failed to require that such tax savings be passed on to ratepayers, and ordered that the case be remanded to the Utility Commission with instructions to adjust HL&P's cost of service accordingly. Discretionary review is being sought from the Texas Supreme Court by all parties to the proceeding.\nThe parties to the Proposed Settlement have agreed to dismiss their respective appeals of Docket No. 8425, subject to HL&P's dismissing its appeal in Docket No. 6668. A separate party to this appeal, however, has not agreed to dismiss its appeal.\n(c) DEFERRED ACCOUNTING. Deferred accounting treatment for certain costs associated with Unit No. 1 of the South Texas Project was authorized by the Utility Commission in Docket No. 8230 and was extended in Docket No. 9010. Similar deferred accounting treatment with respect to Unit No. 2 of the South Texas Project was authorized in Docket No. 8425. For a discussion of the deferred accounting treatment granted, see Note 1(f).\nIn June 1994, the Texas Supreme Court decided the appeal of Docket Nos. 8230 and 9010, as well as all other pending deferred accounting cases involving other utilities, upholding deferred accounting treatment for both carrying costs and operation and maintenance expenses as within the Utility Commission's statutory authority and reversed the Austin Court of Appeals decision to the extent that the Austin Court of Appeals had rejected deferred accounting treatment for carrying charges. Because the lower appellate court had upheld deferred accounting only as to operation and maintenance expenses, the Texas Supreme Court remanded Docket Nos. 8230 and 9010 to the Austin Court of Appeals to consider the points of error challenging the granting of deferred accounting for carrying costs which it had not reached in its earlier consideration of the case. The Texas Supreme Court opinion did state, however, that when deferred costs are considered for addition to the utility's rate base in an ensuing rate case, the Utility Commission must then determine to what extent inclusion of the deferred costs is necessary to preserve the utility's financial integrity. Under the terms of the Proposed Settlement, South Texas Project deferrals will continue to be amortized under the schedule previously established.\nThe Office of the Public Utility Counsel (OPUC) has agreed, pursuant to the Proposed Settlement, to withdraw and dismiss its appeal if the Proposed Settlement becomes effective and on the condition that HL&P dismisses its appeal in Docket No. 6668. However, the appeal of the State of Texas remains pending.\n(d) PRUDENCE REVIEW OF THE CONSTRUCTION OF THE SOUTH TEXAS PROJECT. In June 1990, the Utility Commission ruled in a separate docket (Docket No. 6668) that had been created to review the prudence of HL&P's planning and construction of the South Texas Project that $375.5 million out of HL&P's $2.8 billion investment in the two units of the South Texas Project had been imprudently incurred. That ruling was incorporated into HL&P's 1988 and 1991 rate cases and resulted in HL&P's recording an after-tax charge of $15 million in 1990. Several parties appealed the Utility Commission's decision, but a District Court dismissed these appeals on procedural grounds. The Austin Court of Appeals reversed and directed consideration of the appeals, and the Texas Supreme Court denied discretionary review in 1994. At this time, no action has been taken by the appellants to proceed with the appeals. Unless the order in Docket No. 6668 is modified or reversed on appeal, the amount found imprudent by the Utility Commission will be sustained.\nUnder the Proposed Settlement, OPUC, HL&P and the City of Houston each has agreed to dismiss its respective appeals of Docket No. 6668. A separate party to this appeal, however, has not agreed to dismiss its appeal. If this party does not elect to dismiss its appeal, HL&P may elect to maintain its appeal, whereupon OPUC and City of Houston shall also be entitled to maintain their appeals.\n(5) MALAKOFF\nThe scheduled in-service dates for the Malakoff units were postponed during the 1980's as expectations of continued strong load growth were tempered. In 1987, all developmental work was stopped and AFUDC accruals ceased. These units have been cancelled due to the availability of other cost effective resource options.\nIn Docket No. 8425, the Utility Commission allowed recovery of certain costs associated with the cancelled Malakoff units by amortizing those costs over ten years for rate making purposes. Such recoverable costs were not included in rate base and, as a result, no return on investment is being earned during the recovery period. The remaining balance at December 31, 1994 is $34 million with a recovery period of 66 months.\nAlso as a result of the final order in Docket No. 8425, the costs associated with the engineering design work for the Malakoff units were included in rate base and are earning a return. Subsequently, in December 1992, HL&P determined that such costs would have no future value and reclassified $84.1 million from plant held for future use to recoverable project costs. In 1993, an additional $7 million was reclassified to recoverable project costs. Amortization of these amounts began in 1993. The balance at December 31, 1994 was $65 million with a remaining recovery period of 60 months. The amortization amount is approximately equal to the amount currently earning a cash return in rates. The Utility Commission's decision to allow treatment of these costs as plant held for future use has been challenged in the pending appeal of the Docket No. 8425 final order. See Note 4(b) for a discussion of this proceeding.\nIn June 1990, HL&P purchased from its then fuel supply affiliate, Utility Fuels, Inc. (Utility Fuels), all of Utility Fuels' interest in the lignite reserves and lignite handling facilities for Malakoff. The purchase price was $138.2 million, which represented the net book value of Utility Fuels' investment in such reserves and facilities. As part of the June 1990 rate order (Docket No. 8425), the Utility Commission ordered that issues related to the prudence of the amounts invested in the lignite reserves be considered in HL&P's next general rate case which was filed in November 1990 (Docket No. 9850). However, under the October 1991 Utility Commission order in Docket No. 9850, this determination was postponed to a subsequent docket.\nHL&P's remaining investment in Malakoff lignite reserves as of December 31, 1994 of $153 million is included on the Company's Consolidated and HL&P's Balance Sheets in plant held for future use. HL&P anticipates that an additional $8 million of expenditures relating to lignite reserves will be incurred in 1995 and 1996.\nIn Docket No. 12065, HL&P filed testimony in support of the amortization of substantially all of its remaining investment in Malakoff, including the portion of the engineering design costs for which amortization had not previously been authorized and the amount attributable to related lignite reserves which had not previously been addressed by the Utility Commission. Under the Proposed Settlement of Docket No. 12065, HL&P would amortize its investment in Malakoff over a period not to exceed seven years such that the entire investment will be written off no later than December 31, 2002. See Note 3. In the event that the Utility Commission does not approve the Proposed Settlement, and if appropriate rate treatment of these amounts is not ultimately received, HL&P could be required to write off any unrecoverable portions of its Malakoff investment.\n(6) CHANGE IN ACCOUNTING METHOD FOR REVENUES\nDuring the fourth quarter of 1992, HL&P adopted a change in accounting method for revenues from a cycle billing to a full accrual method, effective January 1, 1992. Unbilled revenues represent the estimated amount customers will be charged for service received, but not yet billed, as of the end of each month. The accrual of unbilled revenues results in a better matching of revenues and expenses. The cumulative effect of this accounting change, less income taxes of $48.5 million, amounted to $94.2 million, and was included in 1992 income.\n(7) INVESTMENTS\n(a) CABLE TELEVISION PARTNERSHIP. A KBLCOM subsidiary owns a 50 percent interest in Paragon, a Colorado partnership that owns cable television systems. The remaining interest in the partnership is owned by American Television and Communications Corporation (ATC), a subsidiary of Time Warner. The partnership agreement provides that at any time after December 31, 1993 either partner may elect to divide the assets of the partnership under certain pre-defined procedures set forth in the agreement. Paragon is party to a $225 million revolving credit agreement with a group of banks. Paragon also has outstanding $50 million principal amount of 9.56% senior notes, due 1995. In each case, borrowings are non-recourse to the Company and to ATC. For a discussion of the pending disposition of KBLCOM, see Note 21(a).\n(b) FOREIGN ELECTRIC UTILITY. Houston Argentina S.A. (Houston Argentina), an indirect subsidiary of the Company, owns a 32.5 percent interest in Compania de Inversiones en Electricidad S. A. (COINELEC), an Argentine holding company which acquired, in December 1992, a 51 percent interest in EDELAP, an electric utility company operating in La Plata, Argentina and surrounding regions. Houston Argentina's share of the purchase price was approximately $37.4 million. Subsequent to the acquisition, the generating assets of EDELAP were transferred to Central Dique S. A., an Argentine Corporation, 51 percent of the stock of which is owned by COINELEC. See Note 21(b) for discussion of an additional investment in Argentina in January 1995.\n(8) COMMON STOCK\n(a) DIVIDENDS. In 1993, the timing of the Company's Board of Directors declaration of dividends changed resulting in five quarterly dividend declarations in 1993. The Company paid four regular quarterly dividends in 1993 aggregating $3.00 per share on its common stock pursuant to dividend declarations made in 1993. In December 1993, the Company declared its regular quarterly dividend of $.75 per share to be paid in March 1994. All dividends declared in 1993 have been included in 1993 common stock dividends on the Company's Statements of Consolidated Retained Earnings and, with respect to the dividends declared in December 1993, in dividends accrued at December 31, 1993 on the Company's Consolidated Balance Sheets.\n(b) LONG-TERM INCENTIVE COMPENSATION PLANS (LICP). In May 1989, the Company adopted, with shareholder approval, an LICP (1989 LICP Plan), which provided for the issuance of certain stock incentives (including performance-based restricted shares and stock options). A maximum\nof 500,000 shares of common stock may be issued under the 1989 LICP Plan. Beginning one year after the grant date, the options become exercisable in one-third increments each year. The options expire ten years from the grant date.\nIn May 1993, the Company adopted, with shareholder approval, a new LICP (1994 LICP Plan), providing for the issuance of certain stock incentives (including performance-based restricted shares and stock options) of the general nature provided by the 1989 LICP Plan. A maximum of 2,000,000 shares of common stock may be issued under the 1994 LICP Plan. Beginning one year after the grant date, the options will become exercisable in one-third increments each year. The options expire ten years from the grant date.\nPerformance-based restricted shares issued were 50,262, 73,282 and 790 for 1994, 1993 and 1992, respectively. Stock option activity for the years 1992 through 1994 is summarized below: Option Price at Number Date of Grant of Shares or Exercise --------- --------------- Non-statutory stock options:\nOutstanding at December 31, 1991............. Options Granted............................. 67,984 $43.50 Options Exercised........................... Options Cancelled........................... (2,113)\nOutstanding at December 31, 1992............. 65,871 Options Granted ............................ 65,776 $46.25 Options Exercised........................... (662) $43.50 Options Cancelled........................... (5,036)\nOutstanding at December 31, 1993............. 125,949 Options Granted............................. 65,726 $46.50 Options Exercised........................... Options Cancelled........................... (40,386)\nOutstanding at December 31, 1994............. 151,289\nExercisable at: December 31, 1994........................... 53,836 $43.50-$46.25 December 31, 1993........................... 21,430 $43.50\n(c) SHAREHOLDER RIGHTS PLAN. In July 1990, the Company adopted a shareholder rights plan and declared a dividend of one right for each outstanding share of the Company's common stock. The rights, which under certain circumstances entitle their holders to purchase one one-hundredth of a share of Series A Preference Stock for an exercise price of $85, will expire on July 11, 2000. The rights will become exercisable only if a person or entity acquires 20 percent or more of the Company's outstanding common stock or if a person or entity commences a tender offer or exchange offer for 20 percent or more of the outstanding common stock. At any\ntime after the occurrence of such events, the Company may exchange unexercised rights at an exchange ratio of one share of common stock, or equity securities of the Company of equivalent value, per right. The rights are redeemable by the Company for $.01 per right at any time prior to the date the rights become exercisable.\nWhen the rights become exercisable, each right will entitle the holder to receive, in lieu of the right to purchase Series A Preference Stock, upon the exercise of such right, a number of shares of the Company's common stock (or under certain circumstances cash, property, other equity securities or debt of the Company) having a current market price (as defined in the plan) equal to twice the exercise price of the right, except pursuant to an offer for all outstanding shares of common stock which a majority of the independent directors of the Company determines to be a price which is in the best interests of the Company and its shareholders (Permitted Offer).\nIn the event that the Company is a party to a merger or other business combination (other than a merger that follows a Permitted Offer), rights holders will be entitled to receive, upon the exercise of a right, a number of shares of common stock of the acquiring company having a current market price (as defined in the plan) equal to twice the exercise price of the right.\n(d) ESOP. In October 1990, the Company amended its savings plan to add an ESOP component. The ESOP component of the plan allows the Company to satisfy a portion of its obligation to make matching contributions under the plan. For additional information with respect to the ESOP component of the plan, see Note 12(b).\n(e) INVESTOR'S CHOICE PLAN. Effective December 1994, the Company registered with the Securities and Exchange Commission four million shares of its common stock for purchase through the new Investor's Choice Plan, which is an amendment to the existing dividend reinvestment plan.\n(9) PREFERRED STOCK OF HL&P\nAt December 31, 1994, HL&P's cumulative preferred stock could be redeemed at the following per share prices, plus any unpaid accrued dividends to the date of redemption: Redemption Series Price Per Share ------ --------------- Not Subject to Mandatory Redemption: $4.00........................................... $105.00 $6.72........................................... 102.51 $7.52........................................... 102.35 $8.12........................................... 102.25 Variable Term Preferred A (a)................... 100.00 Variable Term Preferred B (a)................... 100.00 Variable Term Preferred C (a)................... 100.00 Variable Term Preferred D (a)................... 100.00\nSubject to Mandatory Redemption: $8.50 (b)....................................... $100.00 $9.375 (c)...................................... ---\n(a) Rates for Variable Term Preferred stock as of December 31, 1994 were as follows:\nSeries Rate ------------------------- ----- Variable Term Preferred A 4.69% Variable Term Preferred B 4.62% Variable Term Preferred C 5.15% Variable Term Preferred D 4.58%\n(b) HL&P is required to redeem 200,000 shares of this series annually beginning June 1, 1994.\n(c) HL&P is required to redeem 257,000 shares annually beginning April 1, 1995. This series is redeemable at the option of HL&P at $100 per share beginning April 1, 1997.\nIn June 1994 and June 1993, HL&P redeemed 200,000 and 400,000 shares, respectively, of its $8.50 cumulative preferred stock at $100 per share pursuant to sinking fund provisions. Annual mandatory redemptions of HL&P's preferred stock are $45.7 million in 1995 and 1996, and $25.7 million for 1997, 1998 and 1999.\n(10) LONG-TERM DEBT\n(a) HL&P. Sinking or improvement fund requirements of HL&P's first mortgage bonds outstanding will be approximately $36 million for each of the years 1995 through 1999. Of such requirements, approximately $34 million for each of the years 1995 through 1999 may be satisfied by certification of property additions at 100 percent of the requirements, and the remainder through certification of such property additions at 166 2\/3 percent of the requirements. Sinking or improvement fund requirements for 1994 and prior years have been satisfied by certification of property additions.\nHL&P has agreed to expend an amount each year for replacements and improvements in respect of its depreciable mortgaged utility property equal to $1,450,000 plus 2 1\/2 percent of net additions to such mortgaged property made after March 31, 1948 and before July 1 of the preceding year. Such requirement may be met with cash, first mortgage bonds, gross property additions or expenditures for repairs or replacements, or by taking credit for property additions at 100 percent of the requirements. At the option of HL&P, but only with respect to first mortgage bonds of a series subject to special redemption, deposited cash may be used to redeem first mortgage bonds of such series at the applicable special redemption price. The replacement fund requirement to be satisfied in 1995 is approximately $288 million.\nThe amount of HL&P's first mortgage bonds is unlimited as to issuance, but limited by property, earnings, and other provisions of the Mortgage and Deed of Trust dated as of November 1, 1944, between HL&P and South Texas Commercial National Bank of Houston (Texas Commerce Bank National Association, as Successor Trustee) and the supplemental indentures thereto. Substantially all properties of HL&P are subject to liens securing HL&P's long-term debt under the mortgage.\nIn January 1994, HL&P repaid at maturity $19.5 million principal amount of Series A collateralized medium-term notes. HL&P's annual maturities of long-term debt and minimum capital lease payments are approximately $4 million in 1995, $154 million in 1996, $228 million in 1997, $40 million in 1998, and $171 million in 1999.\n(b) KBLCOM AND SUBSIDIARIES. KBL Cable, Inc. (KBL Cable), a subsidiary of KBLCOM, is a party to a $475.2 million revolving credit and letter of credit facility agreement with annual mandatory commitment reductions (which may require principal payments). At December 31, 1994, KBL Cable had $76 million available under such credit facility. The credit facility has scheduled reductions in March of each year until it is terminated in March 1999. Loans have generally borne interest at an interest rate of London Interbank Offered Rate plus an applicable margin. The margin was .75% and .625% at December 31, 1994 and 1993, respectively. The credit facility includes restrictions on dividends, sales of assets and limitations on total indebtedness. The amount of indebtedness outstanding at December 31, 1994 and 1993 was $364 million. Commitment fees are required on the unused capacity of the credit facility.\nIn October 1989, KBL Cable entered into interest rate swaps to effectively fix the interest rate on $375 million of loans under the bank credit facility. The objective of the swaps was to reduce the financial exposure to increases in interest rates. Interest rate swaps aggregating $75 million and $150 million terminated in October 1992 and October 1994, respectively. As of December 31, 1994, KBL Cable had one remaining interest rate swap terminating in 1996 which effectively fixes the rate on $50 million of debt under the bank credit facility at 8.88% plus the applicable margin. As of December 31, 1994 and 1993, the effective interest rate on such debt was approximately 9.63%. The differential to be paid or received under the swaps is accrued and is recognized as interest expense or income over the term of the swap. KBL Cable is exposed to risk of nonperformance by the other party to the swap. However, KBL Cable does not anticipate nonperformance by the other party.\nAs of December 31, 1994, KBL Cable had outstanding $62.5 million of 10.95% senior notes and $78.1 million of 11.30% senior subordinated notes. Both series mature in 1999 with annual principal payments which began in 1992. The agreement under which the notes were issued contains restrictions and covenants similar to those contained in the KBL Cable credit facility.\nFor a discussion of the pending disposition of KBLCOM, see Note 21(a).\n(c) COMPANY. Consolidated annual maturities of long-term debt and minimum capital lease payments for the Company are approximately $20 million in 1995, $430 million in 1996, $358 million in 1997, $181 million in 1998 and $313 million in 1999. (11) SHORT-TERM FINANCING\nThe interim financing requirements of the Company's operating subsidiaries are met through short-term bank loans, the issuance of commercial paper and short-term advances from the Company. The Company and its subsidiaries had bank credit facilities aggregating $1 billion at December 31, 1994 and $750 million at December 31, 1993, under which borrowings are classified as short-term indebtedness. In March 1995, the facilities aggregated $1.2 billion as a result of a $200 million increase in the Company's bank credit facility. These bank facilities limit total short-term borrowings and provide for interest at rates generally less than the prime rate. The Company's weighted average short-term borrowing rates for commercial paper for the year ended December 31, 1994 and 1993 were 4.35% and 3.45%, respectively. Outstanding commercial paper was $423 million at December 31, 1994 and $591 million at December 31, 1993. Facility fees are required on the credit facilities. For a description of the bank credit facility of KBL Cable, borrowings under which are classified as long-term debt or current maturities of long-term debt, see Note 10(b).\n(12) RETIREMENT PLANS\n(a) PENSION. The Company has noncontributory retirement plans covering substantially all employees. The plans provide retirement benefits based on years of service and compensation. The Company's funding policy is to contribute amounts annually in accordance with applicable regulations in order to achieve adequate funding of projected benefit obligations. The assets of the plans consist principally of common stocks and high quality, interest-bearing obligations.\nNet pension cost for the Company includes the following components:\nYear Ended December 31, ---------------------------------- 1994 1993 1992 --------- -------- --------- (Thousands of Dollars) Service cost - benefits earned during the period ...................... $ 22,715 $ 25,932 $ 24,282 Interest cost on projected benefit obligation ............................. 46,416 51,343 45,585 Actual (return) loss on plan assets ...... 5,402 (39,477) (26,934) Net amortization and deferrals ........... (51,846) (557) (11,749) --------- -------- --------- Net pension cost ......................... $ 22,687 $ 37,241 $ 31,184 ========= ======== =========\nThe funded status of the Company's retirement plans was as follows:\nDecember 31, ------------------------- 1994 1993 ---------- ---------- (Thousands of Dollars) Actuarial present value of: Vested benefit obligation ....................... $ 443,200 $ 446,825 ========== ========== Accumulated benefit obligation .................. $ 476,347 $ 506,567 ========== ========== Plan assets at fair value ........................ $ 499,940 $ 491,759 Projected benefit obligation ..................... 638,312 655,593 ---------- ---------- Assets less than projected benefit obligation .... (138,372) (163,834) Unrecognized transitional asset .................. (15,340) (17,260) Unrecognized prior service cost .................. 21,456 23,380 Unrecognized net loss ............................ 72,286 81,826 ---------- ---------- Accrued pension cost ............................. $ (59,970) $ (75,888) ========== ==========\nThe projected benefit obligation was determined using an assumed discount rate of 8.0 percent in 1994 and 7.25 percent in 1993. A long-term rate of compensation increase ranging from 4.5 percent to 6.5 percent was assumed for 1994 and ranging from 3.9 percent to 6 percent was assumed for 1993. The assumed long-term rate of return on plan assets was 9.5 percent in 1994 and 1993. The transitional asset at January 1, 1986, is being recognized over approximately 17 years, and the prior service cost is being recognized over approximately 15 years.\n(b) SAVINGS PLAN. The Company has an employee savings plan that qualifies as cash or deferred arrangements under Section 401(k) of the Internal Revenue Code of 1986, as amended (IRC). Under the plan, participating employees may contribute a portion of their compensation, pre-tax or after-tax, up to a maximum of 16 percent of compensation limited by an annual deferral limit ($9,240 for calendar year 1994) prescribed by IRC Section 402(g) and the IRC Section 415 annual additions limits. The Company matches 70 percent of the first 6 percent of each employee's compensation contributed, subject to a vesting schedule which entitles the employee to a percentage of the matching contributions depending on years of service. Substantially all of the Company's match is invested in the Company's common stock.\nIn October 1990, the Company amended its savings plan to add a leveraged ESOP component. The Company may use ESOP shares to satisfy its obligation to make matching contributions under the savings plan. Debt service on the ESOP loan is paid using all dividends on shares in the ESOP, interest earnings on funds held in the ESOP and cash contributions by the Company. Shares of the Company's common stock are released from encumbrance of the ESOP loan based on the proportion of debt service paid during the period.\nIn the third quarter of 1994, the Company adopted SOP 93-6 which requires that the Company recognize benefit expense for the ESOP equal to fair value of the ESOP shares committed to be released. Following the adoption of SOP 93-6, the Company no longer reports the ESOP\nloan as a note receivable from the ESOP or recognizes interest income on such receivable. The Company was instead required to establish a new contra-equity account (unearned ESOP shares) which reflects shares not yet committed for release at their original purchase price. As shares are committed to be released, they are credited to the unearned ESOP shares account based on the original purchase price of the shares. The difference between the fair value of the shares at the time such shares are committed for release and the original purchase price is charged or credited to common stock. Dividends on allocated ESOP shares are recorded as a reduction to retained earnings; dividends on unallocated ESOP shares are recorded as a reduction of debt or accrued interest on the ESOP loan. SOP 93-6 is effective only with respect to financial statements for periods after January 1, 1994 and no restatement was permitted for prior periods. At the time of adoption of SOP 93-6 in the third quarter of 1994, earnings were reduced by $12.8 million. For a discussion of the impact of SOP 93-6 on the earnings per common share calculation, see Note 1(i).\nThe Company's savings plan benefit expense was $18.3 million, $17.3 million and $20.0 million in 1994, 1993 and 1992, respectively. HL&P's portion of the savings plan expense was $16.5 million, $15.9 million and $15.4 million in 1994, 1993 and 1992, respectively. The ESOP shares were as follows: December 31, ------------------------ 1994 1993 --------- --------- Allocated Shares......................... 1,575,543 1,031,187 Unallocated Shares....................... 7,770,313 8,317,649 --------- --------- Total ESOP Shares.................... 9,345,856 9,348,836 ========= =========\nFair value of unallocated ESOP shares ... $276,817,401 $396,128,034\n(c) POSTRETIREMENT BENEFITS. The Company and HL&P adopted SFAS No. 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions,\" effective January 1, 1993. SFAS No. 106 requires companies to recognize the liability for postretirement benefit plans other than pensions, primarily health care. The Company and HL&P previously expensed the cost of these benefits as claims were incurred. SFAS No. 106 allows recognition of the transition obligation (liability for prior years' service) in the year of adoption or to be amortized over the plan participants' future service period. The Company and HL&P have elected to amortize the estimated transition obligation of approximately $213 million (including $211 million for HL&P) over 22 years. In March 1993, the Utility Commission adopted a rule governing the rate making treatment of postretirement benefits other than pensions. This rule provides for recovery in rate making proceedings (which, in HL&P's case, has not occurred) of the cost of postretirement benefits calculated in accordance with SFAS No. 106 including amortization of the transition obligation. The Proposed Settlement of HL&P's pending rate proceeding would require HL&P to fund during each year in an irrevocable external trust the amount of postretirement benefit costs included in rates, a total of approximately $22 million.\nThe net postretirement benefit cost for the Company includes the following components: Year Ended December 31, --------------------- 1994 1993 ------- ------- (Thousands of Dollars) Service cost - benefits earned during the period .............................. $ 9,131 $ 9,453 Interest cost on projected benefit obligation .............................. 10,265 18,354 Actual return on plan assets ............. -- -- Net amortization and deferrals ........... 7,868 9,773 ------- ------- Net postretirement benefit cost .......... $27,264 $37,580 ======= =======\nThe funded status of the Company's postretirement benefit costs was as follows: December 31, ------------------------ 1994 1993 --------- ---------- (Thousands of Dollars) Accumulated benefit obligation: Retirees ................................. $ (98,828) $ (130,336) Fully eligible active plan participants .. (22,251) (22,913) Other active plan participants ........... (23,378) (20,810) --------- ---------- Total ................................... (144,457) (174,059) Plan assets at fair value ................... -- -- --------- ---------- Assets less than accumulated benefit obligation ................................. (144,457) (174,059) Unrecognized transitional obligation ........ 193,500 203,273 Unrecognized net gain ....................... (91,477) (55,682) --------- ---------- Accrued postretirement benefit cost ......... $ (42,434) $ (26,468) ========= ==========\nFor 1992, the Company recognized postretirement benefit costs other than pensions on a \"pay-as-you-go\" basis. The Company made postretirement benefit payments in 1992 of $8.6 million.\nThe assumed health care cost trend rates used in measuring the accumulated postretirement benefit obligation in 1994 are as follows:\nMedical - under 65 9.0% Medical - 65 and over 10.0% Dental 9.0%\nThe assumed health care rates gradually decline to 5.4 percent for both medical categories and 3.7 percent for dental by the year 2001. The accumulated postretirement benefit obligation was determined using an assumed discount rate of 8.0 percent for 1994 and 7.25 percent for 1993.\nIf the health care cost trend rate assumptions were increased by 1 percent, the accumulated postretirement benefit obligation as of December 31, 1994 would be increased by approximately 8 percent. The annual effect of the 1 percent increase on the total of the service and interest costs would be an increase of approximately 11 percent.\n(d) POSTEMPLOYMENT BENEFITS FOR THE COMPANY AND HL&P. The Company and HL&P adopted SFAS No. 112, \"Employer's Accounting for Postemployment Benefits,\" effective January 1, 1994. SFAS No. 112 requires the recognition of a liability for benefits, not previously accounted for on the accrual basis, provided to former or inactive employees, their beneficiaries and covered dependents, after employment but before retirement. In the Company's and HL&P's case, this liability is principally health care and life insurance benefits for participants in the long-term disability plan. As required by SFAS No. 112, the Company and HL&P expensed the transition obligation (liability from prior years) upon adoption, and recorded a one-time, after-tax charge to income of $8.2 million in the first quarter of 1994. Ongoing 1994 charges to income were not material.\n(13) INCOME TAXES\nThe Company and HL&P record income taxes under SFAS No. 109, which among other things, (i) requires the liability method be used in computing deferred taxes on all temporary differences between book and tax bases of assets other than nondeductible goodwill; (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. SFAS No. 109 requires that regulated enterprises 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. KBLCOM has significant temporary differences related to its 1986 and 1989 acquisitions of cable television systems, the tax effects of which were recognized when SFAS No. 109 was adopted.\nDuring 1993, federal tax legislation was enacted that changed the income tax consequences for the Company and HL&P. The principal provision of the new law which affected the Company and HL&P was the change in the corporate income tax rate from 34 percent to 35 percent. A net regulatory asset and the related deferred federal income tax liability of $71.3 million were recorded by HL&P in 1993. The effect of the new law, which decreased the Company's net income by $14.3 million, was recognized as a component of income tax expense in 1993. The effect on the Company's deferred taxes as a result of the change in the new law was $10.9 million in 1993.\nThe Company's current and deferred components of income tax expense are as follows: Year Ended December 31, ------------------------------ 1994 1993 1992 -------- -------- -------- (Thousands of Dollars)\nCurrent................................ $150,493 $113,534 $130,360 Deferred............................... 68,120 117,584 34,249 -------- -------- -------- Income taxes before cumulative effect of change in accounting.............. $218,613 $231,118 $164,609 ======== ======== ========\nThe Company's effective income tax rates are lower than statutory corporate rates for each year as follows:\nFollowing are the Company's tax effects of temporary differences resulting in deferred tax assets and liabilities: December 31, ------------------------ 1994 1993 ---------- ---------- (Thousands of Dollars) Deferred Tax Assets: Alternative minimum tax .................. $ 60,932 $ 120,576 IRS audit assessment ..................... 74,966 74,966 Disallowed plant cost - net .............. 23,496 24,304 Loss and ITC carryforwards ............... 56,080 55,822 Other .................................... 83,740 68,503 ---------- ---------- Total deferred tax assets .............. 299,214 344,171 Less valuation allowance ................. 57,919 57,661 ---------- ---------- Total deferred tax assets - net ....... 241,295 286,510 ---------- ---------- Deferred Tax Liabilities: Depreciation ............................. 1,404,290 1,271,153 Identifiable intangibles ................. 244,636 236,476 Deferred plant costs - net ............... 207,746 215,472 Regulatory assets - net .................. 235,463 246,763 Capitalized taxes, employee benefits and removal costs ....................... 110,476 110,252 Other .................................... 118,155 193,730 ---------- ---------- Total deferred tax liabilities ........ 2,320,766 2,273,846 ---------- ---------- Accumulated deferred income taxes - net ........................ $2,079,471 $1,987,336 ========== ==========\nAt December 31, 1994 pursuant to the acquisition of cable systems, KBLCOM has unutilized Separate Return Limitation Year (SRLY) net operating loss tax benefits of approximately $22.1 million and unutilized SRLY investment tax credits of approximately $14.0 million which expire in the years 1995 through 2008, and 1995 through 2003, respectively. In addition, KBLCOM has unutilized restricted state loss tax benefits of $20.0 million, which expire in the years 1995 through 2009, and unutilized minimum tax credits of $1.8 million. The Company does not anticipate full utilization of these losses and tax credits and, therefore, has established a valuation allowance. Utilization of preacquisition carryforwards in the future would not affect income of the Company and KBLCOM, but would be applied to reduce the carrying value of cable television franchises and intangible assets.\n(14) COMMITMENTS AND CONTINGENCIES\n(a) HL&P. HL&P has various commitments for capital expenditures, fuel, purchased power, cooling water and operating leases. Commitments in connection with HL&P's capital program are generally revocable by HL&P subject to reimbursement to manufacturers for expenditures incurred or other cancellation penalties. HL&P's other commitments have various quantity requirements and durations. However, if these requirements could not be met, various alternatives are available to mitigate the cost associated with the contracts' commitments.\nHL&P has entered into several long-term coal, lignite and natural gas contracts which have various quantity requirements and durations. Minimum obligations for coal and transportation agreements are approximately $169 million in 1995, $174 million in 1996 and $177 million in 1997. In addition, the minimum obligations under the lignite mining and lease agreements will be approximately $19 million in 1995 and 1996 and $16 million in 1997. HL&P has entered into several gas purchase agreements containing contract terms in excess of one year which provide for specified purchase and delivery obligations. Minimum obligations for natural gas purchase and natural gas storage contracts are approximately $55.0 million in 1995, $56.6 million in 1996 and $38.2 million in 1997. Collectively, the gas supply contracts included in these figures could amount to 11 percent of HL&P's annual natural gas requirements. The Utility Commission's rules provide for recovery of the coal, lignite and natural gas costs described above through the energy component of HL&P's electric rates. Nuclear fuel costs are also included in the energy component of HL&P's electric rates based on the cost of nuclear fuel consumed in the reactor.\nHL&P has commitments to purchase firm capacity from cogenerators of approximately $32 million in 1995, and $22 million in 1996 and 1997. The Utility Commission's rules allow recovery of these costs through HL&P's base rates for electric service and additionally authorize HL&P to charge or credit customers for any variation in actual purchased power cost from the cost utilized to determine its base rates. In the event that the Utility Commission, at some future date, does not allow recovery through rates of any amount of purchased power payments, the two principal firm capacity contracts contain provisions allowing HL&P to suspend or reduce payments and seek repayment for amounts disallowed.\nHL&P's service area is heavily dependent on oil, gas, refined products, petrochemicals and related business. Significant adverse events affecting these industries would negatively impact the revenues of the Company and HL&P.\n(b) KBLCOM COMMITMENTS AND OBLIGATIONS UNDER CABLE FRANCHISE AGREEMENTS. KBLCOM and its subsidiaries presently have certain cable franchises containing provisions for construction of cable plant and service to customers within the franchise area. In connection with certain obligations under existing franchise agreements, KBLCOM and its subsidiaries obtain surety bonds and letters of credit guaranteeing performance to municipalities and public utilities. Payment is required only in the event of non-performance. KBLCOM and its subsidiaries have fulfilled all of their obligations such that no payments have been required.\n(15) ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amount and estimated fair value of the Company's financial instruments are as follows:\nThe fair values of cash and short-term investments, short-term and other notes payable and bank debt are estimated to be equivalent to the carrying amounts.\nThe fair values of the ESOP loan, the Company's debentures, HL&P's cumulative preferred stock subject to mandatory redemption, HL&P's first mortgage bonds, pollution control revenue bonds issued on behalf of HL&P and KBL Cable senior and senior subordinated notes are estimated using rates currently available for securities with similar terms and remaining maturities.\nThe fair value of interest rate swaps is the estimated amount that the swap counterparties would receive or pay to terminate the swap agreements, taking into account current interest rates and the current creditworthiness of the swap counterparties.\n(16) BUSINESS SEGMENT INFORMATION\nThe Company operates principally in two business segments: electric utility and cable television. Financial information by business segment is summarized as follows:\nYear Ended December 31, --------------------------------------------- 1994 1993 1992 ------------- ------------ ------------ (Thousands of Dollars) Revenues: Electric utility ............. $ 3,746,085 $ 4,079,863 $ 3,826,841 Cable television (a) ......... 255,772 244,067 235,258 ------------- ------------ ------------ Total revenues ............ $ 4,001,857 $ 4,323,930 $ 4,062,099 ============= ============ ============ Operating Income (Expense): Electric utility (b) ......... $ 997,875 $ 1,005,750 $ 923,801 Cable television (a) ......... 15,007 17,830 19,394 Other operations ............. (1,057) (1,163) (1,327) ------------- ------------ ------------ Total operating income ..... 1,011,825 1,022,417 941,868 Other income ................. 11,198 47,882 43,789 Interest and other charges ... (396,949) (423,145) (480,561) ------------- ------------ ------------ Income before income taxes and cumulative effect of change in accounting .... $ 626,074 $ 647,154 $ 505,096 ============= ============ ============ Depreciation and Amortization: Electric utility ............. $ 398,142 $ 385,731 $ 371,645 Cable television (a) ......... 84,681 77,912 75,622 Other operations ............. 1,057 1,163 1,327 ------------- ------------ ------------ Total depreciation and amortization ............ $ 483,880 $ 464,806 $ 448,594 ============= ============ ============ Identifiable Assets (end of period): Electric utility ............. $ 10,850,981 $ 10,753,616 $ 10,790,052 Cable television (a) ......... 1,510,052 1,372,595 1,345,770 Other operations ............. 189,225 141,542 328,231 Adjustments and eliminations . (256,111) (37,576) (42,386) ------------- ------------ ------------ Total assets .............. $ 12,294,147 $ 12,230,177 $ 12,421,667 ============= ============ ============ Capital Expenditures: Electric utility (excluding AFUDC) ...................... $ 412,899 $ 329,016 $ 337,082 Cable television (a) ......... 84,166 60,385 44,306 Other (excluding capitalized interest) ................... 44,704 61,830 1,625 ------------- ------------ ------------ Total capital expenditures $ 541,769 $ 451,231 $ 383,013 ============= ============ ============\n(a) Amounts do not include amounts attributable to Paragon, which is accounted for under the equity method, except identifiable assets which includes net equity investment in Paragon.\n(b) 1992 amount includes the effect of a charge of $86.4 million which relates to HL&P's restructuring of operations as a result of the implementation of the Success Through Excellence in Performance (STEP) program (see Note 17 below).\n(17) RESTRUCTURING\nHL&P recorded a one-time, pre-tax charge of $86.4 million in the first quarter of 1992 to reflect the implementation of the STEP program, a restructuring of its operations. This charge includes $42 million related to the acceptance of an early retirement plan by 468 employees of HL&P, $31 million for severance benefits related to the elimination of an additional 1,100 positions and $13 million in other costs associated with the restructuring.\n(18) CABLE TELEVISION ACQUISITION\nIn July 1994, KBLCOM acquired the stock of three cable companies then serving approximately 48,000 customers in the Minneapolis area in exchange for 587,646 shares of common stock of the Company valued at approximately $20.1 million. The total purchase price of approximately $80 million included the assumption of approximately $60 million in liabilities. Notes were repaid in connection with the acquisition in the amount of $57.7 million.\n(19) RAILROAD SETTLEMENT PAYMENTS\nIn July 1994, HL&P contributed as equity its rights to receive certain railroad settlement payments to HL&P Receivables, Inc. (HLPR), a wholly-owned subsidiary of HL&P. HLPR transferred the receivables to a trust. A bank purchased certificates evidencing a senior interest in the trust and HLPR holds a certificate evidencing a subordinate interest in the trust. HL&P received as a dividend from HLPR approximately $66.1 million, an amount equal to HLPR's proceeds from the sale. Consistent with the manner in which HL&P recorded receipts of the settlement payments, HL&P recorded the transaction as a $66.1 million reduction to reconcilable fuel expense in July 1994. The reduction to reconcilable fuel expense had no effect on earnings.\n(20) UNAUDITED QUARTERLY INFORMATION\nThe following unaudited quarterly financial information includes, in the opinion of management, all adjustments (which comprise only normal recurring accruals) necessary for a fair presentation. Quarterly results are not necessarily indicative of a full year's operations because of seasonality and other factors, including rate increases and variations in operating expense patterns.\nEarnings per Operating Net Common Quarter Ended Revenues Income Income Share (a) ------------- ---------- --------- -------- --------- (Thousands of Dollars) ---- March 31 ............... $ 865,959 $127,981 $ 27,055 $ 0.21 June 30 ................ 1,067,753 247,686 100,209 0.77 September 30 ........... 1,416,332 513,860 260,409 2.00 December 31 ............ 973,886 132,890 28,363 0.22\n---- March 31 ............... $ 882,101 $150,673 $ 25,898 $ 0.21 June 30 ................ 1,066,660 300,797 126,725 1.03 September 30 ........... 1,215,980 464,038 235,968 1.92 December 31 ............ 837,116 96,317 10,670 0.09\n(a) Quarterly earnings per common share are based on the weighted average number of shares outstanding during the quarter, and the sum of the quarters may not equal annual earnings per common share.\n(21) SUBSEQUENT EVENTS\n(a) KBLCOM. On January 26, 1995, Time Warner and the Company reached an agreement in which Time Warner would acquire KBLCOM in a tax-deferred, stock-for-stock merger with a subsidiary of Time Warner for a sales price of approximately $2.2 billion, subject to closing adjustments. Time Warner will issue one million shares of Time Warner common stock and 11 million shares of a newly-issued series of its convertible preferred stock, which will have a liquidation value of $100 per share, to the Company. The preferred stock will be convertible into approximately 22.9 million shares of Time Warner common stock and, until the earlier of conversion or the fourth anniversary of its issuance, pays an annual dividend of $3.75 per share. After four years, Time Warner will have the right to exchange the Time Warner preferred stock for Time Warner common stock at the stated conversion rate. In addition, at the closing Time Warner will purchase for cash certain intercompany debt of KBLCOM from the Company for approximately $600 million subject to adjustment for changes in or levels of specified indebtedness and liabilities, working capital, capital expenditures and related items. Closing of this transaction, which is subject to, among other things, (i) the parties obtaining necessary consents of certain franchise authorities and other governmental entities, (ii) the absence of any change that might have a material adverse effect on KBLCOM or Time Warner, (iii) the absence of any material litigation and (iv) the expiration or termination of the waiting period under the Hart-Scott- Rodino Antitrust Improvement Act of 1976, as amended, is expected to take place in the second half of 1995.\nThe consolidated balance sheet of the Company includes KBLCOM assets of approximately $1.5 billion and liabilities of approximately $841 million at December 31, 1994. Revenues from KBLCOM totaled approximately $256 million for 1994. Proforma presentation of the Company's 1994 Statement of Consolidated Income to reflect KBLCOM on a discontinued operations basis for the entire year would result in summarized operations as follows:\nYear Ended December 31, 1994 (Thousands of Dollars) except per share amounts)\nIncome Before Income Taxes, Discontinued Operations and Cumulative Effect of Change in Accounting....... $ 654,409 Income Taxes.......................................... 230,424 --------- Income Before Discontinued Operations and Cumulative Effect of Change in Accounting...................... 423,985 Loss from Discontinued Operations of KBLCOM (net of income tax benefit of $11,811)...................... (16,524) --------- Income Before Cumulative Effect of Change in Accounting.......................................... 407,461 Cumulative Effect of Change in Accounting for Postemployment Benefits (net of income taxes of $4,415).......................................... (8,200) --------- Net Income............................................ $ 399,261 =========\nEarnings Per Common Share: Earnings Per Common Share Before Discontinued Operations and Cumulative Effect of Change in Accounting.......................................... $ 3.45 Discontinued Operations............................... (.13) Cumulative Effect of Change in Accounting for Postemployment Benefits............................. (.07) --------- Earnings Per Common Share............................. $ 3.25 =========\nLoss from discontinued operations of KBLCOM excludes the effects of corporate overhead charges and includes interest expense relating to the amount of intercompany debt that Time Warner is purchasing from the Company.\nBased on a Time Warner common stock price of $35.50 and assuming the closing occurs on September 30, 1995, the Company estimates that it will recognize an after-tax gain of approximately $650 million. The Company anticipates that it will record a portion of this gain (estimated to be approximately $100 million) in the first quarter of 1995 in recognition of the deferred tax asset arising from the Company's excess tax basis in KBLCOM stock. The remainder of the gain will be recognized at closing.\n(b) HOUSTON INDUSTRIES ENERGY, INC. (HI ENERGY). In January 1995, HI Energy, a subsidiary of the Company, acquired for $15.7 million a 90 percent equity interest in an electric utility operating company in the province of Santiago del Estero, a rural province in the north central part of Argentina. The utility system serves approximately 100,000 customers in an area of 136,000 square kilometers.\nHOUSTON LIGHTING & POWER COMPANY\nNOTES TO FINANCIAL STATEMENTS\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994\nExcept as modified below, the Notes to the Company's Consolidated Financial Statements are incorporated herein by reference insofar as they relate to HL&P: (1) Summary of Significant Accounting Policies, (2) Jointly-Owned Nuclear Plant, (3) Pending Rate Proceedings, (4) Appeals of Prior Utility Commission Rate Orders, (5) Malakoff, (6) Change in Accounting Method for Revenues, (9) Preferred Stock of HL&P, (10) Long-Term Debt, (12) Retirement Plans, (13) Income Taxes, (14) Commitments and Contingencies, (15) Estimated Fair Value of Financial Instruments, (17) Restructuring, and (19) Railroad Settlement Payments.\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(i) EARNINGS PER COMMON SHARE. All issued and outstanding Class A voting common stock of HL&P is held by the Company and all issued and outstanding Class B non-voting common stock of HL&P is held by Houston Industries (Delaware) Incorporated, a wholly owned subsidiary of the Company. Accordingly, earnings per share is not computed.\n(j) STATEMENTS OF CASH FLOWS. At December 31, 1994, HL&P had affiliate investments (considered to be cash equivalents) of $227.6 million. At December 31, 1993, HL&P did not have any investments with affiliated companies. At December 31, 1992, HL&P had affiliate investments of $2.1 million.\n(11) SHORT-TERM FINANCING\nIn 1993 and 1994, the interim financing requirements of HL&P were primarily met through the issuance of commercial paper. HL&P had bank credit facilities of $400 million and $250 million at December 31, 1994 and 1993, respectively, which limited total short-term borrowings and provided for interest at rates generally less than the prime rate. HL&P's weighted average short-term borrowing rates for commercial paper for the year ended December 31, 1994 and 1993 were 3.71% and 3.31%, respectively. HL&P had no commercial paper outstanding at December 31, 1994, and had approximately $171 million outstanding at December 31, 1993. Facility fees are required on HL&P's bank credit facility.\n(12) RETIREMENT PLANS\n(a) PENSION. Net pension cost for HL&P includes the following components:\nYear Ended December 31, 1994 1993 1992 -------- -------- -------- (Thousands of Dollars) Service cost - benefits earned during the period ................................ $ 21,335 $ 24,640 $ 23,211 Interest cost on projected benefit obligation ................................ 45,064 49,950 44,580 Actual (return) loss on plan assets ........ 4,737 (38,668) (26,334) Net amortization and deferrals ............. (50,012) (683) (11,605) -------- -------- -------- Net pension cost ........................... $ 21,124 $ 35,239 $ 29,852 ======== ======== ========\nThe funded status of HL&P's retirement plan was as follows:\nDecember 31, ------------------------- 1994 1993 ---------- ---------- (Thousands of Dollars) Actuarial present value of: Vested benefit obligation ..................... $ 429,279 $ 434,797 ========== ========== Accumulated benefit obligation ................ $ 460,760 $ 492,301 ========== ========== Plan assets at fair value ........................ $ 486,100 $ 478,515 Projected benefit obligation ..................... 617,690 636,724 ---------- ---------- Assets less than projected benefit obligation .... (131,590) (158,209) Unrecognized transitional asset .................. (15,157) (17,062) Unrecognized prior service cost .................. 21,275 23,183 Unrecognized net loss ............................ 67,093 77,937 ---------- ---------- Accrued pension cost ............................. $ (58,379) $ (74,151) ========== ==========\n(c) POSTRETIREMENT BENEFITS. The net postretirement benefit cost for HL&P includes the following components:\nYear Ended December 31, ----------------------- 1994 1993 ------- ------- (Thousands of Dollars)\nService cost - benefits earned during the period .... $ 8,904 $ 9,297 Interest cost on projected benefit obligation ....... 9,946 18,134 Actual return on plan assets ........................ -- -- Net amortization and deferrals ...................... 7,757 9,658 ------- ------- Net postretirement benefit cost ..................... $26,607 $37,089 ======= =======\nThe funded status of HL&P's postretirement benefit costs was as follows:\nDecember 31, ----------------------- 1994 1993 --------- --------- (Thousands of Dollars) Accumulated benefit obligation: Retirees ......................................... $ (97,200) $(128,122) Fully eligible active plan participants .......... (20,126) (22,691) Other active plan participants ................... (22,706) (20,576) --------- --------- Total ........................................ (140,032) (171,389) Plan assets at fair value .......................... -- -- --------- --------- Assets less than accumulated benefit obligation .... (140,032) (171,389) Unrecognized transitional obligation ............... 191,225 200,883 Unrecognized net gain .............................. (92,786) (55,577) --------- --------- Accrued postretirement benefit cost ................ $ (41,593) $ (26,083) ========= =========\nFor 1992, HL&P recognized postretirement benefit costs on a \"pay-as-you-go\" basis and made payments of $8.6 million.\n(13) INCOME TAXES\nHL&P records income taxes under SFAS No. 109. During 1993, federal tax legislation was enacted that changed the income tax consequences for HL&P. The principal provision of the new law which affected HL&P was the change in the corporate income tax rate from 34 percent to 35 percent. A net regulatory asset and the related deferred income tax liability of $71.3 million were recorded by HL&P in 1993. The effect of the new law, which decreased HL&P's net income by $8.0 million, was recognized as a component of income tax expense in 1993. The effect on HL&P's deferred taxes as a result of the change in the new law was $4.5 million in 1993.\nHL&P's current and deferred components of income tax expense are as follows:\nYear Ended December 31, ------------------------------------- 1994 1993 1992 --------- --------- --------- (Thousands of Dollars)\nCurrent .............................. $ 184,669 $ 115,745 $ 134,514 Deferred ............................. 70,324 123,719 40,217 --------- --------- --------- Federal income tax expense ........... 254,993 239,464 174,731 Federal income taxes charged to other income ........................ (836) (2,993) (1,062) --------- --------- --------- Income taxes before cumulative effect of change in accounting ...... $ 254,157 $ 236,471 $ 173,669 ========= ========= =========\nHL&P's effective income tax rates are lower than statutory corporate rates for each year as follows:\nYear Ended December 31, --------------------------------------- 1994 1993 1992 --------- --------- --------- (Thousands of Dollars) Income before income taxes, preferred dividends and cumulative effect of change in accounting ............... $ 749,121 $ 720,694 $ 588,951 Statutory rate ....................... 35% 35% 34% --------- --------- --------- Income taxes at statutory rate ....... 262,192 252,243 200,243 --------- --------- --------- Net reduction in taxes resulting from: AFUDC - other included in income ... 1,440 1,229 2,097 Amortization of investment tax credit ........................... 19,416 19,797 19,926 Difference between book and tax depreciation for which deferred taxes have not been normalized ... (15,455) (12,976) (13,466) Excess deferred taxes .............. 3,537 9,625 17,403 Other - net ........................ (903) (1,903) 614 --------- --------- --------- Total ............................ 8,035 15,772 26,574 --------- --------- --------- Income taxes before cumulative effect of change in accounting .... $ 254,157 $ 236,471 $ 173,669 ========= ========= ========= Effective rate ....................... 33.9% 32.8% 29.5%\nFollowing are HL&P's tax effects of temporary differences resulting in deferred tax assets and liabilities:\nDecember 31, ----------------------------- 1994 1993 ------------ ------------ (Thousands of Dollars) Deferred Tax Assets: Alternative minimum tax ..................... $ 51,506 IRS audit assessment ........................ $ 48,513 48,513 Disallowed plant cost - net ................. 23,496 24,304 Other ....................................... 60,174 47,906 ------------ ------------ Total deferred tax assets ................. 132,183 172,229 ------------ ------------\nDeferred Tax Liabilities: Depreciation ................................ 1,335,265 1,210,410 Regulatory assets - net ..................... 235,463 246,763 Deferred plant costs - net .................. 207,746 215,472 Capitalized taxes, employee benefits, and removal costs .......................... 111,681 111,333 Other ....................................... 118,328 187,227 ------------ ------------ Total deferred tax liabilities ........... 2,008,483 1,971,205 ------------ ------------\nAccumulated deferred income taxes - net ..... $ 1,876,300 $ 1,798,976 ============ ============\n(15) ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amount and estimated fair value of additional HL&P financial instruments are as follows: December 31, --------------------------------------- 1994 1993 ------------------- ----------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- -------- ------- ------- (Thousands of Dollars) Financial assets: Cash and short-term investments .... $235,867 $235,867 $12,413 $12,413\nFinancial liabilities: Short-term notes payable ........... 171,100 171,100\n(20) UNAUDITED QUARTERLY INFORMATION\nThe following unaudited quarterly financial information includes, in the opinion of management, all adjustments (which comprise only normal recurring accruals) necessary for a fair presentation. Quarterly results are not necessarily indicative of a full year's operations because of seasonality and other factors, including rate increases and variations in operating expense patterns.\nIncome After Operating Preferred Quarter Ended Revenues Income Dividends ------------- ---------- -------- --------- (Thousands of Dollars) - ---- March 31 .................. $ 805,685 $113,160 $ 31,574 June 30 ................... 1,005,149 189,066 105,765 September 30 .............. 1,355,339 355,221 271,594 December 31 ............... 913,690 108,839 40,817\n- ---- March 31 .................. $ 821,581 $122,879 $ 41,686 June 30 ................... 1,004,906 216,842 142,478 September 30 .............. 1,150,946 320,859 251,092 December 31 ............... 768,652 82,302 17,925\n22) PRINCIPAL AFFILIATE TRANSACTIONS\nYear Ended December 31, Affiliated --------------------------------- Company Description 1994 1993 1992 ---------- -------------------------- --------- --------- --------- (Thousands of Dollars)\nHouston Dividends................. $ 328,996 $ 342,982 $ 345,748 Industries Service Fees (a).......... 26,913 21,864 18,215 Money Fund Income (b)..... 6,025 2,748 930\nHouston Industries Finance Discount Expenses (a) 21,053\n(a) Included in Operating Expenses (b) Included in Other Income (Expense)\nDuring 1992, Houston Industries Finance purchased accounts receivable of HL&P. In January 1993, Houston Industries Finance sold the receivables back to HL&P and ceased operations. HL&P is now selling its accounts receivable and most of its accrued unbilled revenues to an unaffiliated third party.\nINDEPENDENT AUDITORS' REPORT\nHouston Industries Incorporated:\nWe have audited the accompanying consolidated balance sheets and the consolidated statements of capitalization of Houston Industries Incorporated and its subsidiaries as of December 31, 1994 and 1993, and the related statements of consolidated income, consolidated retained earnings and consolidated cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the Company's financial statement schedule listed in 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 the 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, 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 Notes 6, 12(b), and 12(d), respectively, to the consolidated financial statements, the Company changed its method of accounting for (i) revenues in 1992, (ii) the Employee Stock Ownership Plan to conform with AICPA Statement of Position 93-6 in 1994, and (iii) postemployment benefits to conform with Statement of Financial Accounting Standards No. 112 in 1994.\nDELOITTE & TOUCHE LLP\nHouston, Texas February 23, 1995\nINDEPENDENT AUDITORS' REPORT\nHouston Lighting & Power Company:\nWe have audited the accompanying balance sheets and the statements of capitalization of Houston Lighting & Power Company (HL&P) 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. Our audits also included the financial statement schedule of HL&P listed in Item 14(a)(2). These financial statements and financial statement schedule are the responsibility of HL&P'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 financial statements present fairly, in all material respects, the financial position of HL&P 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 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 6 and 12(d), respectively, to the financial statements, HL&P changed its method of accounting for (i) revenues in 1992, and (ii) postemployment benefits to conform with Statement of Financial Accounting Standards No. 112 in 1994.\nDELOITTE & TOUCHE LLP\nHouston, Texas February 23, 1995\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 COMPANY AND HL&P.\n(a) The Company\nThe information called for by Item 10, to the extent not set forth under Item 1 \"Business- EXECUTIVE OFFICERS OF THE COMPANY\", is or will be set forth in the definitive proxy statement relating to the Company's 1995 annual meeting of shareholders pursuant to the Commission's Regulation 14A. Such definitive proxy statement relates to a meeting of shareholders involving the election of directors and the portions thereof called for by Item 10 are incorporated herein by reference pursuant to Instruction G to Form 10-K.\n(b) HL&P\nThe information set forth under Item 1. \"Business - EXECUTIVE OFFICERS OF HL&P\" is incorporated herein by reference.\nEach member of the board of directors of HL&P is also a member of the board of directors of the Company. Each member of the board of directors of HL&P is elected annually for a one-year term. The HL&P annual shareholder's meeting, at which the Company elects members to the HL&P board of directors, is expected to occur on May 3, 1995. Information is set forth below with respect to the business experience for the last five years of each person who currently serves as a member of the board of directors of HL&P, certain other directorships held by each such person and certain other information. Unless otherwise indicated, each person has had the same principal occupation for at least five years.\nMILTON CARROLL, age 44, has been a director since 1992. Mr. Carroll is Chairman, President and Chief Executive Officer of Instrument Products Inc., an oil field supply manufacturing company, in Houston, Texas. He is a director of Panhandle Eastern Corporation and the Federal Reserve Bank of Dallas.\nJOHN T. CATER, age 59, has been a director since 1983. Mr. Cater is Chairman, Chief Executive Officer and a director of River Oaks Trust Company in Houston, Texas. He also serves as President and a director of Compass Bank-Houston. Until his retirement in 1990, Mr. Cater served as President, Chief Operating Officer and a director of MCorp, a Texas bank holding company. He served as a director of MCorp until July 1994.\nROBERT J. CRUIKSHANK, age 64, has been a director since 1993. Mr. Cruikshank is primarily engaged in managing his personal investments in Houston, Texas. Prior to his retirement in 1993, he was a Senior Partner in the accounting firm of Deloitte & Touche. Mr. Cruikshank is Vice-Chairman of the Board of Regents of the University of Texas System and serves as a director of MAXXAM Inc., Kaiser Aluminum Corporation, Compass Bank and Texas Biotechnology Corporation.\nLINNET F. DEILY, age 49, has been a director since 1993. Ms. Deily is Chairman, Chief Executive Officer and President of First Interstate Bank of Texas, N.A. She has served as Chairman since 1992, Chief Executive Officer since 1991 and President since 1988. (1)\nJOSEPH M. HENDRIE, Ph.D., age 69, has been a director since 1985. Dr. Hendrie is a Consulting Engineer in Bellport, New York, and a Senior Scientist at the Brookhaven National Laboratory in Upton, New York, having previously served as Chairman and Commissioner of the U.S. Nuclear Regulatory Commission and as President of the American Nuclear Society. He is also a director of Entergy Operations, Inc. of Jackson, Mississippi.\nHOWARD W. HORNE, age 68, has been a director since 1978. Mr. Horne is Vice-Chairman of Cushman & Wakefield of Texas, Inc., a subsidiary of a national real estate brokerage firm. Until 1990, he was Chairman of the Board of The Horne Company, a Houston realty firm.\nDON D. JORDAN, age 62, has been a director of the Company since 1977 and of HL&P since 1974. Mr. Jordan is Chairman and Chief Executive Officer of the Company and Chairman and Chief Executive Officer of HL&P. He also serves as a director of Texas Commerce Bancshares, Inc. and BJ Services Company, Inc.\nALEXANDER F. SCHILT, Ph.D., age 54, has been a director since 1992. Dr. Schilt is Chancellor of the University of Houston System. Prior to 1990, he was President of Eastern Washington University in Cheney and Spokane, Washington.\nKENNETH L. SCHNITZER, SR., age 65, has been a director since 1983. Mr. Schnitzer is Chairman of the Board of Schnitzer Enterprises Inc., a Houston commercial real estate development company, having previously served as a director of American Building Maintenance Industries Incorporated and Weingarten Realty, Inc. (2)\nDON D. SYKORA, age 64, has been a director since 1982. Mr. Sykora is President and Chief Operating Officer of the Company. He also serves as a director of Powell Industries, Inc., Pool Energy Services Co., Inc. and TransTexas Gas Corporation. (3)\nJACK T. TROTTER, age 68, has been a director since 1985. Mr. Trotter is primarily engaged in managing his personal investments in Houston, Texas. He also serves as a director of First Interstate Bank of Texas, N.A., Howell Corporation and Weingarten Realty Investors.\nBERTRAM WOLFE, Ph.D., age 67, has been a director since 1993. Dr. Wolfe is on the Nuclear Advisory Committee of Pennsylvania Power and Light and is a member of the International\nAdvisory Committee of Concord Industries. Prior to his retirement in 1992, he was Vice President and General Manager of General Electric Company's nuclear energy business in San Jose, California. - ------------------- (1) First Interstate and certain of its affiliates participate in various credit facilities with HL&P, the Company and certain of HL&P's affiliates and other entities in which the Company has an ownership interest. Under these agreements, First Interstate and certain of its affiliates have maximum aggregate loans and loan commitments of approximately $79.3 million, as of December 31, 1994.\n(2) HL&P and certain of its affiliates currently lease office space in buildings owned or controlled by affiliates of Mr. Schnitzer. HL&P and certain of its affiliates paid a total of approximately $5.6 million to affiliates of Mr. Schnitzer during 1994, and it is expected that approximately $3.7 million will be paid in 1995. HL&P believes such payments are comparable to those that would have been made to other non-affiliated firms for comparable facilities and services. During 1994, Mr. Schnitzer consented to the entry of an order by the Office of Thrift Supervision (OTS) whereunder he may not hold office in, or participate in the conduct of the affairs of, any federally regulated depository institution without the prior approval of the OTS and, if applicable, any other appropriate federal banking agency. The order arose out of Mr. Schnitzer's prior service as a director of BancPLUS Savings and Loan Association, a Houston, Texas-based thrift that was taken over by federal regulators in 1989. Mr. Schnitzer consented to the order to avoid the time and expense of defending an OTS administrative proceeding, without admitting whether there were any grounds for such a proceeding.\n(3) Mr. Sykora will not seek reelection to the Company's Board of Directors in 1995 and will retire as a director of the Company and HL&P at the May 3, 1995 annual shareholders' meetings.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\n(a) The Company\nThe information called for by Item 11, with respect to the Company, is or will be set forth in the definitive proxy statement relating to the Company's 1995 annual meeting of shareholders pursuant to the Commission's Regulation 14A. Such definitive proxy statement relates to a meeting of shareholders involving the election of directors and the portions thereof called for by Item 11 (excluding any 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.\n(b) HL&P\nSUMMARY COMPENSATION TABLE. The following table shows, for the years ended December 31, 1992, 1993 and 1994, the annual, long-term and certain other compensation of the chief executive officer and the other four most highly compensated executive officers of HL&P (Named Officers).\nSUMMARY COMPENSATION TABLE\nSTOCK OPTION GRANTS. The following table contains information concerning grants during 1994 of stock options under the Company's long-term incentive compensation plan to the Named Officers.\nOPTION GRANTS IN 1994\nSTOCK OPTION VALUES. The following table sets forth information on the unexercised options to purchase Common Stock previously granted to each of the Named Officers under the Company's long-term incentive compensation plan and held as of December 31, 1994. None of the options are in-the-money, having been granted at exercise prices that are higher than the market value of the option shares on December 31, 1994. No options were exercised by the Named Officers during 1994. 1994 YEAR-END OPTION VALUES\nLONG-TERM INCENTIVE COMPENSATION. The following table sets forth information concerning awards made during 1994 for the 1994-1996 performance cycle under the Company's long-term incentive compensation plan to each of the Named Officers. The table represents potential payouts of awards for shares of Common Stock based on the achievement of certain performance goals over a three year performance cycle. The performance goals include Company consolidated and subsidiary or business unit goals, weighted 25 percent on consolidated performance and 75 percent on subsidiary or business unit performance. The performance goals are generally based on financial objectives. The Company consolidated goal applicable to each of the Named Officers shown below is achieving a certain level of total shareholder return in relation to a group of other companies. The subsidiary or business unit goals applicable to each of the Named Officers shown below are maintaining certain base electric rates and achieving certain cash flow performance in relation to a group of other companies. An additional subsidiary or business unit goal applicable to Messrs. Jordan and Kelly is achieving certain increases in cable television operating profits. If a change in control of the Company occurs before the end of a performance cycle, the payouts of awards for performance shares will occur without regard to achievement of the performance goals. See Note 1 to the OPTION GRANTS IN 1994 table for information regarding the definition of a change in control under the Company's long-term incentive compensation plan.\nLONG-TERM INCENTIVE PLAN AWARDS IN 1994\nRETIREMENT PLANS, RELATED BENEFITS AND OTHER AGREEMENTS. The following table shows the estimated annual benefit payable under the Company's retirement plan, benefit restoration plan and, in certain cases, supplemental agreements, to officers in various compensation classifications upon retirement at age 65 after the indicated periods of service, determined on a single-life annuity basis. The amounts in the table are not subject to any deduction for Social Security or other offsetting amounts. PENSION PLAN TABLE\nNOTE: The qualified pension plan limits compensation in accordance with Section 401(a)(17) of the Internal Revenue Code and also limits benefits in accordance with Section 415 of the Internal Revenue Code. Pension benefits based on compensation above the qualified plan limit or in excess of the limit on annual benefits are provided through the benefit restoration plan.\nFor the purpose of the pension table above, final average annual compensation means the average of covered compensation for 36 consecutive months out of the 120 consecutive months immediately preceding retirement in which the participant's covered compensation was the highest. Covered compensation only includes the amounts shown in the \"Salary\" and \"Bonus\" columns of the Summary Compensation Table. At December 31, 1994, the credited years of service for the following persons are: 35 years for Mr. Jordan; 21 years for Mr. Letbetter; 20 years for Mr. Kelly, 10 of which result from a supplemental agreement; 2 years for Mr. Cottle; and 28 years for Mr. Greenwade.\nThe Company maintains an executive benefits plan that provides certain salary continuation, disability and death benefits to key officers of the Company and certain of its subsidiaries, including HL&P. The Named Officers participate in this plan pursuant to individual agreements that generally provide for (i) a salary continuation benefit of 100 percent of the officer's current salary for twelve months after his death during active employment and then 50 percent of his salary for nine years or until the deceased officer would have attained age 65, if later, and (ii) if the officer retires after attainment of age 65, an annual post-retirement death benefit of 50 percent of the officer's preretirement annual salary payable for six years.\nThe Company has established an executive life insurance plan providing split-dollar life insurance in the form of a death benefit for certain officers and members of the Company's Board of Directors. The death benefit coverage for each of the Named Officers and members of the Board of Directors varies but in each case is based on coverage (either single life or second to die) that is available for the same amount of premium that could purchase coverage equal to two times current salary for Messrs. Kelly, Cottle and Greenwade; four times current salary for Mr. Letbetter; ten million dollars for Mr. Jordan; five million dollars for Mr. Sykora (in his capacity as an executive officer of the Company) and six times the annual retainer for the Company's non-employee directors (except in the case of Mr. Trotter, who has a separate agreement providing for similar coverage, as described below under \"Compensation of Directors\"). The plan also provides that the Company may make payments to the covered individuals designed to compensate for tax consequences with respect to imputed income that they must recognize for federal income tax purposes based on the term portion of the annual premiums. If a covered executive retires at age 65 or at an earlier age under circumstances approved for this purpose by the Board of Directors, rights under the plan vest so that coverage is continued based on the same death benefit in effect at the time of retirement. Upon death, the Company will receive the balance of the insurance proceeds payable in excess of the specified death benefit which by design is expected to be at least sufficient to cover the Company's cumulative outlays to pay premiums and the after-tax cost to the Company of the tax reimbursement payments. There is no arrangement or understanding under which any covered individuals will receive or be allocated any interest in any cash surrender value under the policy.\nThe Company has entered into employment agreements with each of Mr. Jordan and Mr. Sykora (in their capacities as executive officers of the Company) which provide for benefits in the event of termination of employment following a change in control of the Company and for a two year extension of employment if the covered executive is employed by the Company at age 65 without there having occurred a change in control. The Company has also entered into severance agreements with certain executive officers, including Messrs. Letbetter, Kelly, Cottle and Greenwade, that provide for the payment of certain benefits in the event that, within three years following a change in control of the Company, the officer's employment is terminated by the Company or any subsidiary or successor to the Company for reasons other than cause or disability or by the officer following certain changes in job responsibilities, job location or compensation and benefits from those applicable to him immediately prior to such change in control. For the purposes of these agreements, the meaning of a change in control generally is the same as provided in the Company's long-term incentive compensation plan which is described in Note 1 to the OPTION GRANTS IN 1994 table. All benefits payable under these agreements would be payments by the Company and not HL&P.\nHL&P and Mr. Cottle have entered into an employment agreement commencing on April 5, 1993 and continuing indefinitely, subject to termination by either party on 30 days' notice (Employment Period). The agreement generally provides for employment of Mr. Cottle as Group Vice President - Nuclear or in such other executive capacities as may be determined from time to time, a minimum annual base salary ($235,000), bonuses and participation in those employee benefit plans and programs available to similarly situated employees during the Employment Period. In addition, if the Employment Period terminates after April 5, 2003, Mr. Cottle will be eligible for supplemental pension, disability or death benefits determined as if his employment had commenced ten years prior to the initial date of the Employment Period.\nCOMPENSATION OF DIRECTORS. Each non-employee director receives an annual retainer fee of $20,000, a fee of $1,000 for each board meeting attended and a fee of $700 for each committee meeting attended. Directors may defer all or a part of their annual retainer fees (minimum deferral $2,000) and meeting fees under the Company's deferred compensation plan.\nNon-employee directors participate in a director benefits plan pursuant to which a director who serves at least one full year will receive an annual benefit in cash equal to the annual retainer payable in the year the director terminates service. Benefits under this plan will be payable to a director, commencing the January following the later of the director's termination of service or attainment of age 65, for a period equal to the number of full years of service of the director.\nNon-employee directors may also participate in the Company's executive life insurance plan described above under \"Retirement Plans, Related Benefits and Other Agreements,\" providing split-dollar life insurance with a death benefit equal to six times the director's annual retainer with coverage continuing after termination of service as a director. This plan also permits the Company to provide for a tax reimbursement payment to make the directors whole for any imputed income recognized with respect to the term portion of the annual insurance premiums. Upon death, the Company will receive the balance of the insurance proceeds payable in excess\nof the specified death benefit which, by design, is expected to be at least sufficient to cover the Company's cumulative outlays to pay premiums and the after-tax cost to the Company of the tax reimbursement payments. Mr. Trotter, who does not participate in this plan, has a separate agreement with the Company providing for payment in the event of his death in a lump sum amount equal to eight times his final annual retainer, which, because it is subject to taxation at distribution, approximates on an after-tax basis the amount of the death benefit that would have been payable had he participated in the executive life insurance plan.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a) The Company\nThe information called for by Item 12 is or will be set forth in the definitive proxy statement relating to the Company's 1995 annual meeting of shareholders pursuant to the Commission's Regulation 14A. Such definitive proxy statement relates to a meeting of shareholders involving the election of directors and the portions thereof called for by Item 12 are incorporated herein by reference pursuant to Instruction G to Form 10-K.\n(b) HL&P\nAs of the date of this Report, the Company owned all 1,000 authorized, issued and outstanding shares of HL&P's Class A voting common stock, without par value.\nThe following table sets forth information as of March 1, 1995, with respect to the beneficial ownership of shares of the Company's Common Stock by each current director, the chief executive officer and the other four most highly compensated executive officers of HL&P and, as a group, by such persons and other executive officers of HL&P. No person or member of the group listed owns any equity securities of HL&P or any other subsidiary of the Company. Unless otherwise indicated, each person or member of the group listed has sole voting and sole investment power with respect to the shares of Common Stock listed. No ownership shown in the table represents 1 percent or more of the outstanding shares of Common Stock.\nShares of Common Stock Name Beneficially Owned - ---- ---------------------- Milton Carroll .......................................... 1,200 John T. Cater ........................................... 1,000(1) William A. Cottle ....................................... 2,445(2)(3)(4) Robert J. Cruikshank .................................... 1,000 Linnet F. Deily ......................................... 1,000(5) Jack D. Greenwade ....................................... 17,234(2)(3)(4) Joseph M. Hendrie ....................................... 451(4)(5) Howard W. Horne ......................................... 6,339(4) Don D. Jordan ........................................... 85,750(2)(3)(6) Hugh Rice Kelly ......................................... 20,931(2)(3)(4) R. Steve Letbetter ...................................... 16,361(2)(3) Alexander F. Schilt ..................................... 400 Kenneth L. Schnitzer, Sr. ............................... 4,650 Don D. Sykora ........................................... 41,154(2)(3)(4) Jack T. Trotter ......................................... 1,000 Bertram Wolfe ........................................... 110 All of the above and other executive officers as a group (19 persons) ............................ 222,239(2)(3)(4) - -------------- (1) Mr. Cater disclaims beneficial ownership of these shares, which are owned by his adult children.\n(2) Includes shares held under the Company's savings plan, as to which the participant has sole voting power (subject to such power being exercised by the plan's trustees in the same proportion as directed shares in the savings plan are voted in the event the participant does not exercise voting power). The shares held under the plan are reported as of December 31, 1994, except in the case of two executive officers whose individual savings plan accounts include shares allocated during 1995 as a result of rollovers from individual retirement accounts.\n(3) The ownership shown in the table includes shares which may be acquired within 60 days on exercise of outstanding stock options granted under the Company's long-term incentive compensation plan by each of the persons and group, as follows: Mr. Cottle - 674 shares; Mr. Greenwade - 3,862 shares; Mr. Jordan - 26,454 shares; Mr. Kelly - 5,326 shares; Mr. Letbetter - 4,641 shares; Mr. Sykora - 14,160 shares; and the group - 61,142 shares.\n(4) Includes shares held under the Company's dividend reinvestment plan as of December 31, 1994.\n(5) Voting power and investment power with respect to the shares listed for Ms. Deily and for Dr. Hendrie are shared with the individual's spouse.\n(6) Voting power and investment power with respect to 576 of the shares listed are shared with Mr. Jordan's spouse.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\n(a) The Company\nThe information called for by Item 13 is or will be set forth in the definitive proxy statement relating to the Company's 1995 annual meeting of shareholders pursuant to the Commission's Regulation 14A. Such definitive proxy statement relates to a meeting of shareholders involving the election of directors and the portions thereof called for by Item 13 are incorporated herein by reference pursuant to Instruction G to Form 10-K.\n(b) HL&P\nThe information set forth in Notes 1 and 2 to Item 10(b) above is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nSee Index of Exhibits on page 126, which also includes the 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.\n(b) REPORTS ON FORM 8-K. None\nHOUSTON INDUSTRIES INCORPORATED AND SUBSIDIARIES SCHEDULE VIII - RESERVES\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994 (THOUSANDS OF DOLLARS)\nNotes:\n(A) Deductions from reserves represent losses or expenses for which the respective reserves were created. In the case of the uncollectible accounts reserve, such deductions are net of recoveries of amounts previously written off. (B) During 1992, Houston Industries Finance purchased accounts receivable of HL&P and of certain KBLCOM subsidiaries. In January 1993, Houston Industries Finance sold the receivables back to the respective subsidiaries and ceased operations. HL&P is now selling its accounts receivable and most of its accrued unbilled revenues to a third party.\nHOUSTON LIGHTING & POWER COMPANY SCHEDULE VIII - RESERVES\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994 (THOUSANDS OF DOLLARS)\n- --------------- Notes:\n(A) Deductions from reserves represent losses or expenses for which the respective reserves were created. (B) HL&P has no reserves for uncollectible accounts due to sales of accounts receivable.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE 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 HOUSTON AND STATE OF TEXAS, ON THE 15TH DAY OF MARCH, 1995.\nHOUSTON INDUSTRIES INCORPORATED (Registrant)\nBy DON D. JORDAN (Don D. Jordan, 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 DATE INDICATED.\nSignature Title Date --------- ----- ---- Chairman and Chief Executive >| DON D. JORDAN Officer and Director | (Don D. Jordan) (Principal Executive and | Principal Financial Officer) | | MARY P. RICCIARDELLO Comptroller | (Mary P. Ricciardello) (Principal Accounting Officer) | | MILTON CARROLL Director | (Milton Carroll) | | JOHN T. CATER Director | (John T. Cater) | | ROBERT J. CRUIKSHANK Director | (Robert J. Cruikshank) | | LINNET F. DEILY Director | (Linnet F. Deily) | | JOSEPH M. HENDRIE Director > March 15, 1995 (Joseph M. Hendrie) | | HOWARD W. HORNE Director | (Howard W. Horne) | | ALEXANDER F. SCHILT Director | (Alexander F. Schilt) | | KENNETH L. SCHNITZER, SR. Director | (Kenneth L. Schnitzer, Sr.) | | DON D. SYKORA Director | (Don D. Sykora) | | JACK T. TROTTER Director | (Jack T. Trotter) | | BERTRAM WOLFE Director >| (Bertram Wolfe)\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE 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 HOUSTON AND STATE OF TEXAS, ON THE 15TH DAY OF MARCH, 1995. THE SIGNATURE OF HOUSTON LIGHTING & POWER COMPANY SHALL BE DEEMED TO RELATE ONLY TO MATTERS HAVING REFERENCE TO SUCH COMPANY AND ANY SUBSIDIARIES THEREOF.\nHOUSTON LIGHTING & POWER COMPANY (Registrant) By DON D. JORDAN (Don D. Jordan, 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 DATE INDICATED. THE SIGNATURE OF EACH OF THE UNDERSIGNED SHALL BE DEEMED TO RELATE ONLY TO MATTERS HAVING REFERENCE TO HOUSTON LIGHTING & POWER COMPANY AND ANY SUBSIDIARIES THEREOF.\nSignature Title Date --------- ----- ---- Chairman and Chief Executive >| DON D. JORDAN Officer and Director | (Don D. Jordan) (Principal Executive Officer) | | DAVID M. McCLANAHAN Group Vice President - Finance | (David M. McClanahan) and Regulatory Relations | (Principal Financial Officer) | | KEN W. NABORS Vice President and Comptroller | (Ken W. Nabors) (Principal Accounting Officer) | | MILTON CARROLL Director | (Milton Carroll) | | JOHN T. CATER Director | (John T. Cater) | | ROBERT J. CRUIKSHANK Director | (Robert J. Cruikshank) | | LINNET F. DEILY Director > March 15, 1995 (Linnet F. Deily) | | JOSEPH M. HENDRIE Director | (Joseph M. Hendrie) | | HOWARD W. HORNE Director | (Howard W. Horne) | | ALEXANDER F. SCHILT Director | (Alexander F. Schilt) | | KENNETH L. SCHNITZER, SR. Director | (Kenneth L. Schnitzer, Sr.) | | DON D. SYKORA Director | (Don D. Sykora) | | JACK T. TROTTER Director | (Jack T. Trotter) | | BERTRAM WOLFE Director | (Bertram Wolfe) >|\nHOUSTON INDUSTRIES INCORPORATED HOUSTON LIGHTING & POWER COMPANY\nEXHIBITS TO THE ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1994\nINDEX OF EXHIBITS\nExhibits not incorporated by reference to a prior filing are designated by a cross (+); all exhibits not so designated are incorporated herein by reference to a prior filing as indicated. Exhibits designated by an asterisk (*) are 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.\n(a) Houston Industries Incorporated","section_15":""}
{"filename":"71391_1994.txt","cik":"71391","year":"1994","section_1":"ITEM 1. BUSINESS.\nThe registrant was incorporated under the laws of the State of Idaho on February 27, 1930, for the primary purpose of exploring and the development of mining properties. Prior to 1993, the Company had owned fifteen unpatented lode mining claims in the Coeur d'Alene Mining District of Shoshone County, Idaho. Due to the increased fees from the Bureau of Land Management on unpatented mining claims, and the depressed prices for silver and lead, the Company decided to abandon these mining claims in 1993. The Company is now an inactive mining company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe registrant abandoned all properties in 1993.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe registrant is not a party to any litigation.\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 fiscal year ended March 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe registrant's common stock is traded on the national over-the-counter market. (\"On pink sheets\")\nFISCAL YEAR MARCH 31, 1993 Quarter Low Bid High Bid\n01\/01\/92 to 06\/30\/92 $0.01 $0.01 07\/01\/92 to 09\/30\/92 $0.01 $0.01 10\/01\/92 to 12\/31\/92 $0.01 $0.01 01\/01\/93 to 03\/31\/93 $0.01 $0.01\nFISCAL YEAR MARCH 31, 1994 Quarter Low Bid High Bid\n04\/01\/93 to 06\/30\/93 $0.01 $0.01 07\/01\/93 to 09\/30\/93 $0.01 $0.01 10\/01\/93 to 12\/31\/93 $0.01 $0.01 01\/01\/94 to 03\/31\/94 $0.01 $0.01\nAs of March 31, 1994, there were 1,676 registered holders of the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following data should be read in conjunction with the Company's financial statements and the notes thereto:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe Company has ceased all exploratory mining activities and has abandoned all of its mining claims. The Company's only asset is 857,100 shares of common stock of United Mines, Inc., with a market value of $34,284. Total liabilities are $26,482, which are comprised of accounts payable of $11,341 and advances from officers of $15,141.\nThe Company has no revenues. Any working capital needs are provided as loans or advances from the corporate officers.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS.\nCONTENTS\nPage\nStatement of Financial Position as of March 31, 1994 and 1993\nStatement of Operations for the Years Ended March 31, 1994, 1993 and 1992\nStatement of Changes in Stockholders' Equity for the Years Ended March 31, 1994, 1993 and 1992\nStatement of Cash Flows for the Years Ended March 31, 1994, 1993 and 1992\nNotes to Financial Statements\nNEW HILARITY MINING COMPANY Statement of Financial Position as (Unaudited) Of March 31, 1994 and 1993\nASSETS\nPrepared by management.\nThe accompanying notes are an integral part of these financial statements.\nNEW HILARITY MINING COMPANY Statement of Operations for the (Unaudited) Years Ended March 31, 1993, 1992 and 1991\nPrepared by management.\nThe accompanying notes are an integral part of these financial statements.\nNEW HILARITY MINING COMPANY Statement of Changes in (Unaudited) Stockholder's Equity for the Years Ended March 31, 1994, 1993 and 1992\nPrepared by management.\nThe accompanying notes are an integral part of these financial statements.\nNEW HILARITY MINING COMPANY Statement of Cash Flows for the (Unaudited) Years Ended March 31, 1994, 1993 and 1992\nPrepared by management.\nThe accompanying notes are an integral part of these financial statements.\nNEW HILARITY MINING COMPANY Notes to Financial Statements (Unaudited)\nNOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES\nThe Company was originally incorporated as Lexington Mining Company on February 27, 1930 under the laws of the State of Idaho for the primary purpose of mining and exploring for nonferrous and precious metals, primarily silver, lead and zinc. On April 17, 1945, the Company was reorganized, and the name changed to New Hilarity Mining Company. For many years the Company explored for precious metal deposits, but no commercial ore bodies were discovered. In early 1993, the Company abandoned its fifteen unpatented lode mining claims located in the Coeur d'Alene Mining District of Shoshone County, Idaho.\nEarnings (losses) per share are computed on the weighted average number of shares outstanding.\nMarketable trading securities are carried at market value which is based on published over-the-counter market quotes.\nThe preparation of financial statements in conformity with generally accepted accounting principles requires the use of the Company's management estimates for various accounts.\nNOTE 2. MARKETABLE SECURITIES.\nThe Company owns 857,100 shares of common stock of United Mines, Inc., which is quoted on the over-the-counter market.\nNOTE 3. RELATED PARTY TRANSACTIONS.\nFormer officers of the Company have periodically loaned the Company money for various working capital requirements. These loans are non-interest bearing and are due upon demand.\nNOTE 4. COMMON STOCK.\nThe Company was originally incorporated on February 27, 1930, with an authorized capital of 2,000,000 shares of assessable common stock with a par value of $.05 per share. On April 17, 1945, the shareholders increased the authorized common stock to 3,000,000 shares with a par value of $.10 per share and the common stock was changed from assessable to non-assessable. On August 18, 1982, the shareholders increased the authorized common stock to 15,000,000 shares with a par value of $.10 per share.\nNOTE 5. INCOME TAXES.\nThe Company has a net operating loss carryover of $411,215 to the fiscal year ended March 31, 1995. These loss carryovers will commence to expire in 2007. The Company has not recorded a deferred tax asset for the net operating loss carryover because it is highly uncertain if the Company will have future taxable income.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS\nNone\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nTerry Dunne, 48, is the president of the Company and a director. Mr. Dunne is a Certified Public Accountant with over 25 years of experience in public accounting. Mr. Dunne has a Master Degree in Business Administration and a Master Degree in Taxation.\nRobert O'Brien, 61, is the secretary of the Company and a director. Mr. O'Brien has recently served as an officer and director of Gold Securities Corporation and Inland Resources, Inc. From 1977 to 1985, Mr. O'Brien was self employed as a general contractor, and from 1958 to 1976, he was executive vice-president of Hamer's, Inc., a chain of high fashion men's clothing stores located in Spokane, Washington.\nMr. O'Brien graduated from Gonzaga University with a degree in economics.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe officers and directors of the Company have served without compensation.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe officers and directors own no common stock of the Company.\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.\nNone, other than what is already shown in this 10-K report.\nSIGNATURES\nPursuant to the requirements of Section 13 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.\nDated this 27 day of November, 1996.\nNew Hilarity Mining Company (Registrant)\nBy: \/s\/ Terrence J. Dunne, President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following person on behalf of the registrant and in the capacity and on the date indicated.\nDated this 27th day of November, 1996.\nBy: \/s\/ Terrence J. Dunne, President","section_15":""}
{"filename":"65358_1994.txt","cik":"65358","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nUnited Capital Corp. (the \"Registrant\"), incorporated in 1980 in the State of Delaware, has four industry segments:\n1. Real Estate Investment and Management.\n2. Manufacture and Sale of Resilient Vinyl Flooring.\n3. Manufacture and Sale of Antenna Systems.\n4. Manufacture and Sale of Engineered Products.\nThe Registrant also invests excess available cash in marketable securities and other financial instruments.\nDESCRIPTION OF BUSINESS\nREAL ESTATE INVESTMENT AND MANAGEMENT\nThe Registrant is engaged in the business of investing in and managing real estate properties. Most real estate properties owned by the Registrant are leased under net leases pursuant to which the tenants are responsible for all expenses relating to the leased premises, including taxes, utilities, insurance and maintenance. The Registrant also owns properties that it manages which are operated by the City of New York as day-care centers and offices and other properties leased as department stores or shopping centers around the country. In addition, the Registrant owns properties available for sale and lease with the assistance of a consultant or a realtor working in the locale of the premises.\nThe majority of properties are leased to single tenants. Approximately 98% of the total square footage of the Registrant's properties are currently leased.\nRESILIENT VINYL FLOORING\nIn March 1994 the Registrant purchased substantially all of the operating assets of Kentile Floors, Inc. (\"Kentile Floors\"), a major manufacturer and supplier of resilient vinyl flooring. This acquisition was completed through a new wholly-owned subsidiary of the Registrant known as Kentile, Inc. (\"Kentile\").\nKentile's operations are conducted from a 315,000 square foot manufacturing facility located in Chicago, Illinois. Kentile's products include resilient vinyl tile for use in the commercial flooring industry, a line of vinyl wall base products marketed under the Kencove brandname and other supporting products which include adhesives, cleaners and waxes. These products are sold through a nationwide network of distributors which service the regional markets in which they are located.\nThe acquisition of the operating assets of Kentile Floors was accounted for by the purchase method of accounting and, accordingly, the results of operations of Kentile have been included with those of the Registrant for periods subsequent to the date of acquisition. Also see Note 2 of Notes to Consolidated Financial Statements.\nNet sales by the resilient vinyl flooring segment to its largest distributor (those in excess of 10% of the segment's net sales) accounted for approximately 14% of the segment's net sales for 1994.\nANTENNA SYSTEMS\nThe Registrant designs and manufactures antenna systems marketed internationally under the Dorne & Margolin trade name. Its products include airborne and ground-based navigation, communication and satellite communication antennas for military, commercial transport and general aviation aircraft. These products are sold internationally to military, commercial and general aviation original equipment manufacturers as well as to the end user as replacement and spare antenna systems.\nIn April 1992, the Registrant acquired the operating assets of Chu Associates, Inc. (\"Chu Associates\") and affiliated companies which broadens the scope of its antenna systems segment. This addition, which is now known as D&M\/Chu Technology, Inc. (\"D&M\/Chu\"), has been consolidated with the operations of the Registrant's Dorne & Margolin subsidiary in its Bohemia, New York facility. Here, it designs and manufactures communication and navigation antenna systems for land and naval based applications. D&M\/Chu's product line, which is marketed internationally, complements Dorne & Margolin's specialty in airborne communication and navigation antenna systems.\nApproximately 69% and 71% of the antenna systems sold by the Registrant in 1994 and 1993, respectively, were for use by the United States Government and purchased by the United States Government or its contractors.\nENGINEERED PRODUCTS\nThe Registrant's engineered products are manufactured through the Technical Products Division of Metex Corporation (\"Metex\") and AFP Transformers, Inc. (\"AFP Transformers\"), wholly-owned subsidiaries of the Registrant. The knitted wire products and components manufactured by Metex must function in adverse environments and meet rigid performance requirements. The principal areas in which these products have application are as high temperature gaskets, seals, components for use in airbags, shock and vibration isolators, noise reduction elements and air, liquid and solid filtering devices.\nMetex has been an original equipment manufacturer for the automobile industry since 1974 and presently supplies several automobile manufacturers with exhaust seals and components for use in exhaust emission control devices.\nThe Registrant's transformer products are marketed under several brandnames including Field Transformer, ISOREG and EPOXYCAST for a wide variety of industrial and research applications. AFP Transformers also provides a full line of power conditioners and uninterruptible power supplies, as well as its Spectrum line of specialty transformers for high powered ultraviolet lamps used in the printing and chemical industries.\nSales by the Engineered Products segment to its two largest customers (each in excess of 10% of the segment's net sales) accounted for approximately 23% and 26% of the segment's sales for 1994 and 1993, respectively.\nSUMMARY FINANCIAL INFORMATION\nThe following table sets forth the revenues, income (loss) from operations and identifiable assets of each business segment of the Registrant for 1994, 1993 and 1992.\nDISTRIBUTION\nThe Registrant's manufactured products are distributed by a direct sales force and through distributors to dealers, contractors, industrial consumers, original equipment manufacturers and the United States Government.\nPRODUCT METHODS AND SOURCES OF RAW MATERIALS\nThe Registrant's products are manufactured at its own facilities. The Registrant purchases raw materials, including resins, drawn wire, castings and electronic components from a wide range of suppliers of such materials. Most raw materials purchased by the Registrant are available from several suppliers. The Registrant has not had and does not expect to have any problems fulfilling its raw material requirements during 1995.\nPATENTS AND TRADEMARKS\nThe Registrant owns several patents, patent licenses and trademarks including the Kentile trademark which is significant to the Registrant's resilient vinyl flooring operations. The loss of this trademark could have a material adverse effect on such operations.\nWhile the Registrant considers that in the aggregate its other patents and trademarks used in the resilient vinyl flooring, antenna systems and engineered products operations are significant to those businesses, it does not believe that any of these patents or trademarks are of such importance that the loss of one or more of such patents or trademarks would materially affect its consolidated financial condition or results of operations.\nEMPLOYEES\nAt March 22, 1995, the Registrant employed approximately 900 persons. Certain of the Registrant's employees are represented by unions. The Registrant believes that its relationships with its employees are good.\nCOMPETITION\nThe Registrant competes with at least five other companies in the sale of resilient floor tile; at least 20 other companies in the sale of antenna systems; and at least 19 other companies in the sale of engineered products. The Registrant stresses product performance and service in connection with the sale of resilient vinyl floor tile, antenna systems, and engineered products. The principal competition faced by the Registrant results from the sales price of the products sold by its competitors.\nBACKLOG\nThe dollar value of unfilled orders of the Registrant's resilient vinyl flooring segment was approximately $2,283,000 at December 31, 1994. It is anticipated that substantially all such backlog will be filled in 1995.\nThe dollar value of unfilled orders of the Registrant's antenna systems segment was approximately $12,331,000 at December 31, 1994 as compared with $10,324,000 at December 31, 1993. The Registrant anticipates that approximately 90% of the 1994 year-end backlog will be filled in 1995.\nThe dollar value of unfilled orders of the Registrant's engineered products segment was approximately $2,823,000 at December 31, 1994, as compared with $2,141,000 at December 31, 1993. It is anticipated that substantially all such backlog will be filled in 1995. The order backlog referred to above does not include any order backlog with respect to sales of knitted wire mesh components for exhaust emission control devices or exhaust seals because of the manner in which customer orders are received.\nENVIRONMENTAL REGULATIONS\nFederal, state and local requirements regulating the discharge of materials into the environment or otherwise relating to the protection of the environment, have had and will continue to have a significant impact upon the operations of the Registrant. It is the policy of the Registrant to manage, operate and maintain its facilities in compliance, in all material respects, with applicable standards for the prevention, control and abatement of environmental pollution to prevent damage to the quality of air, land and resources.\nThe Registrant has undertaken the completion of environmental studies and\/or remedial action at Metex' two New Jersey facilities.\nThe process of remediation has begun at one facility pursuant to a plan filed with the New Jersey Department of Environmental Protection and Energy (\"NJDEPE\"). Environmental experts engaged by the Registrant estimate that under the most probable remediation scenario the remediation of this site is anticipated to require initial expenditures of $860,000, including the cost of capital equipment, and $86,000 in annual operating and maintenance costs over a 15-year period.\nEnvironmental studies at the second facility indicate that remediation may be necessary. Based upon the facts presently available, environmental experts have advised the Registrant that under the most probable remediation scenario, the estimated cost to remediate this site is anticipated to require $2.3 million in initial costs, including capital equipment expenditures, and $258,000 in annual operating and maintenance costs over a 10-year period. The Registrant may revise such estimates in the future due to the uncertainty regarding the nature, timing and extent of any remediation efforts that may be required at this site, should an appropriate regulatory agency deem such efforts to be necessary.\nThe foregoing estimates may also be revised by the Registrant as new or additional information in these matters become available or should the NJDEPE or other regulatory agencies require additional or alternative remediation efforts in the future. It is not currently possible to estimate the range or amount of any such liability.\nAlthough the Registrant believes that it is entitled to full defense and indemnification with respect to environmental investigation and remediation costs under its insurance policies, the Registrant's insurers have denied such coverage. Accordingly, the Registrant has filed an action against certain insurance carriers seeking defense and indemnification with respect to all prior and future costs incurred in the investigation and remediation of these sites (see Item 3, \"Legal Proceedings\"). Upon the advice of counsel, the Registrant believes that based upon a present understanding of the facts and the present state of the law in New Jersey, it is probable that the Registrant will prevail in the pending litigation and thereby access all or a very substantial portion of the insurance coverage it claims; however, the ultimate outcome of litigation cannot be predicted.\nAs a result of the foregoing, the Registrant has not recorded a charge to operations for the environmental remediation, noted above, in the consolidated financial statements, as anticipated proceeds from insurance recoveries are expected to offset such liabilities. The Registrant has reached settlements with several insurance carriers in this matter. Those recoveries anticipated to be received within twelve months are included in prepaid expenses and other current assets in the accompanying consolidated balance sheet.\nIn the opinion of management, these matters will be resolved favorably and such amounts, if any, not recovered under the Registrant's insurance policies will be paid gradually over a period of years and, accordingly, should not have a material adverse effect upon the business, liquidity or financial position of the Registrant. However, adverse decisions or events, particularly as to the merits of the Registrant's factual and legal basis could cause the Registrant to change its estimate of liability with respect to such matters in the future.\nEffective January 1, 1994 the Registrant adopted the provisions of Staff Accounting Bulletin 92 and accordingly has recorded the expected liability associated with remediation efforts as a component of other long-term liabilities and the anticipated insurance recoveries as a component of prepaid expenses and other current assets and other assets in the Registrant's consolidated financial statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nREAL PROPERTY HELD FOR RENTAL\nAs of March 22, 1995 the Registrant owned 217 properties strategically located throughout the United States. The properties are primarily leased under long-term net leases. The Registrant's classification and gross carrying value of its properties at December 31, 1994 are as follows:\nSHOPPING CENTERS AND RETAIL OUTLETS\nShopping centers and retail outlets include 26 department stores and other properties which are primarily leased under net leases. Taxes, maintenance of the properties and all other expenses are the responsibility of the tenants. The leases for certain shopping centers and retail outlets provide for additional rents based on sales volume and renewal options at higher rents. The department stores include 16 K-Mart stores, five Carter Hawley Hale stores and an IKEA store with a total of approximately 1,600,000, 715,000 and 160,000 square feet, respectively. The K-Mart stores are primarily located in the Midwest region of the United States. The Carter Hawley Hale and IKEA stores are primarily located in the Pacific Coast and Southwest regions of the United States.\nCOMMERCIAL PROPERTIES\nCommercial properties consist of properties leased as 102 restaurants, 30 Midas Muffler Shops, three convenience stores, seven office buildings and miscellaneous other properties. Commercial properties are primarily leased under net leases which in certain cases, have renewal options at higher rents. Certain of these leases also provide for additional rents based on sales volume. The 102 restaurants, located throughout the United States, include properties leased as Boston Chicken, Roy Rogers, Pizza Huts, Hardee's, Wendy's and Kentucky Fried Chicken.\nDAY-CARE CENTERS AND OFFICES\nThe 12 day-care centers and offices are located in New York City and are leased to the City of New York. The Registrant has been negotiating with the City of New York to extend, on a long-term basis, many of these leases which expired in years through 1993. To date, one such long-term lease has been signed and the remainder have received numerous short-term extensions. Although there can be no assurance that the Registrant will in fact receive such leases the Registrant believes that with continued negotiations with the City of New York, such leases should be forthcoming.\nHOTEL PROPERTIES\nThe Registrant's two hotel properties are located in Georgia and California. In February 1992, upon the expiration of an existing lease, the Registrant began operating its California hotel and in May 1992 the Registrant began operating its Georgia hotel. The Registrant's hotel properties are managed through a local on-site management company which is responsible for all day-to-day operations of the hotels.\nThe following summarizes real property held for rental by geographic area at December 31, 1994:\nGross Number of Carrying Properties Value ---------- ------------\nNortheast 98 $ 30,090,809 Southeast 46 24,734,188 Midwest 46 25,964,029 Southwest 9 9,810,792 Pacific Coast 9 30,437,330 Pacific Northwest 6 2,098,198 Rocky Mountain 6 3,504,992 --- ------------ 220 $126,640,338 === ============\nMANUFACTURING FACILITIES\nThe Registrant's resilient vinyl flooring operations, which were acquired in March 1994, are located on 12.4 acres in Chicago, Illinois. This facility is comprised of seven contiguous one and two story buildings totaling approximately 309,000 square feet and an adjacent building of approximately 6,000 square feet.\nThe Registrant maintains facilities located at 2950 Veterans Memorial Highway, Bohemia, New York, on a ten-acre site approximately two miles from MacArthur Airport on Long Island for use in its antenna systems business. This site contains four one story buildings aggregating approximately 90,000 square feet of floor space, an outdoor antenna testing area, several pattern ranges and airframe mock-ups. Approximately 30,000 square feet was added during 1994 to accommodate the consolidation of the D&M\/Chu operations into this facility. The Registrant owns the site together with the structures.\nThe Registrant has leased the 35,000 square foot facility in Littleton, Massachusetts, formerly used in the operations of D&M\/Chu, at market rates, which is sufficient to cover the carrying costs of the property, and is exploring possibilities to lease the remaining 60,000 square foot facility and develop\nthe unused land at the Whitcomb Avenue site. The Registrant owns the sites together with the structures.\nThe Registrant's engineered products are manufactured at 970 New Durham Road, Edison, New Jersey, in a one-story building having approximately 53,000 square feet of floor space and also in a second facility at 206 Talmadge Road in Edison, New Jersey which has approximately 54,500 square feet of space. The Registrant owns these facilities together with the sites.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nMETEX CORPORATION VS. VIC MANUFACTURING CO.\nOn April 17, 1991, Metex filed an action in the Superior Court of New Jersey, Middlesex County, against VIC Manufacturing Co., the manufacturer of a vapor absorption system used by Metex in its operations. The complaint sought damages caused by improper design, instruction and installation of the VIC unit resulting in the discharge of contaminants to the New Durham Road facility in Edison, New Jersey.\nIn January 1995 this suit was settled favorably by Metex.\nMETEX CORPORATION VS. AFFILIATED FM INSURANCE CO., ET AL.\nOn June 27, 1990, Metex filed an action in the Superior Court of New Jersey, Chancery Division, Middlesex County, against several insurance companies that provided Metex with liability insurance between 1967 and 1986. These companies are: Affiliated FM Insurance Co., Atlanta International Insurance Co., The Camden Fire Insurance Association, Cigna Property and Casualty Company, Continental Casualty Company, Eric Reinsurance Company, Federal Insurance Co., General Accident Insurance Company of America, Hudson Insurance Company, Insurance Company of North America, New Jersey Manufacturers Insurance Co., The North River Insurance Company, North Star Reinsurance Corporation, and Puritan Insurance Company. To date Metex has reached settlements with Atlanta International Insurance Co., New Jersey Manufacturers Insurance Co., General Accident Insurance Company of America and The North River Insurance Company. The action seeks both declaratory relief and monetary damages in connection with reimbursement of the costs incurred and to be incurred by Metex in connection with the completion of environmental studies and remedial action required at its two Edison, New Jersey facilities. The declaratory relief sought is a determination that the terms of the liability insurance policies at issue obligate the defendants to defend and indemnify Metex with respect to all costs and expenses related to these environmental matters. Metex also seeks monetary damages in an unspecified amount for breach of the defendants' duty to indemnify Metex. This action is in the final stages of pretrial discovery. It is anticipated that this matter will go to trial in mid-1995. The Registrant intends to continue to vigorously pursue this action.\nDAVISON VS. FIRST PENNCO, ET AL.\nOn March 24, 1991, plaintiffs, including 55 investors and limited partners in three limited partnerships, commenced a civil action in United States District Court for the Southern District of New York against 31 defendants, including the Registrant, asserting causes of action under the Racketeer Influenced and Corrupt Organizations Act. The action seeks actual, punitive and treble damages in a total unspecified amount. On July 16, 1991, plaintiffs filed an amended complaint that did not substantially alter the claims made against the Registrant or the recovery sought.\nIn December 1991 the Registrant filed a motion to dismiss the complaint on the grounds that, among other things, the claims are the subject of a release granted in the Registrant's favor and also that the complaint was filed outside the statute of limitations. In August 1992 the Court granted the motion to dismiss on the grounds that the complaint failed to set out sufficient detail in regard to the acts alleged to have been engaged in by the defendants. The dismissal was \"without prejudice\" and allowed the plaintiffs to file an amended complaint setting out more detail concerning the alleged acts.\nIn January 1993 two separate amended complaints were filed on behalf of two separate groups of the same plaintiffs. The Registrant filed motions to dismiss each of the amended complaints. In October 1993 the Court again granted the motion to dismiss these complaints on the grounds that the complaints failed to state a legal claim against the Registrant but again granted plaintiff's the right to file an amended complaint against the Registrant. In December 1993 the plaintiffs filed new amended complaints. In February 1994 the Registrant filed a motion to dismiss all claims set out in the amended complaints. In February 1995 the court denied such motion. Discovery is now underway in this matter. The Registrant continues to believe that the material allegations in this matter are without merit and intends to vigorously defend this action.\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 Registrant's Common Stock is traded on the American Stock Exchange under the symbol AFP. The table below shows the high and low sales prices as reported in the composite transactions for the American Stock Exchange.\nHigh Low ------ ------ ---- First quarter $11 $9 Second quarter 12-5\/8 9-3\/4 Third quarter 11-7\/8 10-1\/2 Fourth quarter 10-3\/8 8-3\/8\n---- First quarter $7-1\/2 $3-1\/4 Second quarter 11-1\/2 6-1\/2 Third quarter 10 8-3\/4 Fourth quarter 11 8-3\/4\nAs of March 22, 1995, there were approximately 675 record holders of the Registrant's Common Stock. The closing sales price for the Registrant's Common Stock on such date was $8 5\/8. The Registrant has never paid any cash dividends on its Common Stock. The payment of dividends is within the discretion of the Registrant's Board of Directors, however in view of potential working capital needs and in order to finance future growth, it is unlikely that the Registrant will pay any cash dividends on its Common Stock in the near future.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe selected consolidated financial data presented below should be read in conjunction with, and is qualified in its entirety by reference to, the Consolidated Financial Statements and the Notes thereto.\nNOTES TO SELECTED CONSOLIDATED FINANCIAL DATA\n(1) Certain reclassifications have been reflected in the financial data to conform prior years' data to the current classifications.\n(2) Included in the 1990 net loss is approximately $10,949,000 of realized losses from the sale of substantially all of the Registrant's holdings in General Development Corporation.\n(3) The weighted average number of common shares outstanding was 10,744,477 in 1990, 8,645,416 in 1991, 6,569,215 in 1992, 6,267,540 in 1993 and 6,169,031 in 1994.\n(4) Operating results for 1992 include the results of D&M\/Chu Technology, Inc. and AFP Transformers, Inc. since April 2, and October 23, 1992, respectively.\n(5) The 1993 financial results include the cumulative effect of an accounting change of $702,000 or $.11 per share resulting from the adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\n(6) Operating results for 1994 include the results of Kentile, Inc. since March 14, 1994.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS 1994 AND 1993\nGENERAL\nThe following discussion of the Registrant's financial condition and results of operations should be read in conjunction with the description of the Registrant's business and properties contained in Items 1 and 2 of Part I and the Consolidated Financial Statements and Notes thereto, included elsewhere in this report.\nTotal revenues generated by the Registrant during 1994 were $106,888,000, an increase of $37,332,000 from total 1993 revenues of $69,556,000. Net income for the current year was $2,933,000 or $.48 per share versus $5,069,000 or $.81 per share for 1993.\nREAL ESTATE OPERATIONS\nRental revenues from real estate operations during 1994 increased $1,173,000 or 6% over those of the prior year primarily as a result of the renewal of existing leases at higher rents and additional revenues generated from the operations of the Registrant's two hotel properties. Of the total increase, $726,000 results from the renewal of existing leases at higher rents while the remaining increase of $447,000 results from additional hotel related revenues.\nMortgage interest expense for 1994 decreased by $436,000 as compared to such expense incurred during 1993. This decrease of 8% results from the continuing amortization of mortgages which approximated $4.7 million during the current year. No new encumbrances were added to the Registrant's real estate portfolio during 1994.\nDepreciation expense associated with real properties held for rental increased approximately $34,000 or less than 1% from such expense incurred in the preceding year. This increase primarily results from depreciation associated with additional properties purchased and improvements to existing properties added in the current year and is offset by depreciation associated with the sale of several properties in the current and prior year.\nOther operating expenses associated with the management of real properties increased approximately $292,000 during 1994 versus such expenses incurred during 1993. This increase primarily results from additional operating costs incurred in connection with the operation of the Registrant's hotel properties of approximately $246,000.\nANTENNA SYSTEMS\nThe Registrant's antenna systems segment includes Dorne & Margolin, Inc. and D&M\/Chu Technology, Inc. The operating results of the antenna systems segment for the years ended December 31, 1994 and 1993 are as follows:\n1994 1993 -------- -------- (in thousands)\nNet sales $ 19,495 $ 21,098 ======== ========\nCost of sales $ 15,665 $ 14,290 ======== ========\nSelling, general and administrative expenses $ 5,357 $ 6,039 ======== ========\nIncome (loss) from operations ($ 1,527) $ 769 ======== ========\nNet sales of the antenna systems segment decreased approximately $1,603,000 or 8% during 1994 as compared to such sales of the preceding year. Reductions in military and commercial sales continued to seriously effect this segment of the Registrant's business. Further emphasis has been placed on expanding commercial product applications and existing market niches. Several management changes have taken place, including naming a new President to the antenna systems segment with a primary focus on reversing the current trend in sales and profits.\nCost of sales as a percentage of net sales of the antenna systems segment increased approximately 12% from that of 1993. This increase is the result of the following factors: incurring additional manufacturing costs as a result of the transition of certain D&M\/Chu products which are now being manufactured at Dorne & Margolin; the recording of certain realization allowances for inventory as a result of the continuing decline in military sales and the uncertainty that such sales will increase in the future; changes in the mix of product sold between years; and from additional overhead incurred as the company moved to consolidate production of its two manufacturing facilities. These factors are not expected to continue in the future as experience is gained in the production of these products and operations are completely consolidated.\nSelling, general and administrative expenses (\"SG&A\") of the antenna systems segment decreased by approximately $682,000 during 1994 as compared to such costs incurred in the previous year. Administrative savings from the consolidation of the Dorne & Margolin and D&M\/Chu operations and from previously implemented cost containment measures are the primary cause of this decline.\nENGINEERED PRODUCTS\nThe Registrant's engineered products segment includes Metex Corporation and AFP Transformers, Inc. The operating results of the engineered products segment for the years ended December 31, 1994 and 1993 are as follows:\n1994 1993 ------- ------- (in thousands)\nNet sales $35,511 $27,643 ======= =======\nCost of sales $27,043 $20,958 ======= =======\nSelling, general and administrative expenses $ 5,991 $ 5,100 ======= =======\nIncome from operations $ 2,477 $ 1,585 ======= =======\nNet sales of the engineered products segment increased approximately $7,868,000 or 28% during 1994 versus such results for the preceding year. This is the result of substantially higher sales at Metex' Technical Products Division and is offset by slightly lower sales generated by AFP Transformers. Virtually all of Metex' markets showed sales growth. However, overall results of this segment continue to be negatively impacted by the results of the segment's transformer operations, which posted a loss of approximately $1 million during the current year.\nCost of sales as a percentage of net sales was virtually unchanged between the current and prior year. This percentage remained at 76% despite fluctuations in the mix of products sold.\nSG&A expenses of the engineered products segment increased approximately $891,000 or 17% during 1994, as compared to such costs in the preceding year. This increase primarily results from additional selling related expenses associated with the 28% rise in sales noted above.\nRESILIENT VINYL FLOORING\nThe Registrant's resilient vinyl flooring segment, which is now known as Kentile, Inc. (\"Kentile\"), was acquired on March 14, 1994 through the acquisition of substantially all of the operating assets of Kentile Floors, Inc. The operating results of Kentile have been included in the accompanying consolidated statements of income since the date of acquisition. The following unaudited pro forma results of Kentile assume that the acquisition had occurred at the beginning of each period presented. In addition to combining historical results of operations, the pro forma calculations include adjustments to historical assets, liabilities and results of operations which occur in a purchase.\nUnaudited Pro Forma Results of Operations --------------------- 1994 1993 -------- -------- (in thousands)\nNet sales $ 36,958 $ 50,314 ======== ========\nCost of sales $ 29,826 $ 38,988 ======== ========\nSelling, general and administrative expenses $ 8,452 $ 11,357 ======== ========\nLoss from operations ($ 1,320) ($ 31) ======== ========\nOn a pro forma basis, net sales of the resilient vinyl flooring segment decreased over $13 million or 27% from such sales of the previous year. This decline is the result of substantial changes in the Company's distribution network and from the continued effect of Kentile Floors' transition from Chapter 11, prior to the Registrant's acquisition of the operating assets. Actual 1994 sales generated by this segment and included in the accompanying consolidated statements of income, since acquisition, were approximately $29.9 million.\nCost of sales as a percentage of net sales increased approximately 3.2% on a pro forma basis over 1993 levels. This increase is primarily attributable to comparable raw material price increases experienced by this segment during 1994.\nSG&A expenses were down approximately $2.9 million dollars on a pro forma basis during 1994 as compared to such expenses in the preceding year. However, as a percentage of net sales such costs were virtually unchanged, reflecting the corresponding decline in sales noted above.\nThe above financial information is not necessarily indicative of the actual results that would have occurred had the acquisition of Kentile been consummated at the beginning of the periods presented or of future operations of the company. See Note 2 of Notes to Consolidated Financial Statements, contained elsewhere in this report, for a further explanation of the acquisition.\nGENERAL AND ADMINISTRATIVE EXPENSES\nGeneral and administrative expenses not associated with the manufacturing operations decreased approximately $758,000 during 1994 as compared to such expenses incurred in the preceding year. This represents a decrease of less than 1% of consolidated revenues and is primarily the result of lower professional costs incurred in the current year.\nOTHER INCOME AND EXPENSE, NET\nOther income and expense, net for 1994 of approximately $2.8 million is comprised of $1.4 million in gains from the sales of real estate assets, $1.2 million from realized gains on the sale of marketable securities, $46,000 in income from equity investments which represents nonrecurring cash distributions, and $171,000 in miscellaneous other income.\nThe 1993 components of other income and expense, net were as follows: approximately $1.1 million in gains from the sale of real estate; the recovery of $744,000 in previously recorded unrealized losses on marketable securities; $578,000 in income from equity investments; and $1.7 million in other income. During 1993, the Registrant received a $2 million settlement from Metex' insurance carrier in connection with the class action civil suit brought by the former shareholders of Metex. This settlement is included in other income in 1993, net of approximately $450,000 of costs incurred in the defense of this action incurred during 1993. All such defense costs incurred prior to 1993 were included in general and administrative expenses.\nRESULTS OF OPERATIONS 1993 AND 1992\nREAL ESTATE OPERATIONS\nRental revenues from real estate operations increased $1,272,000 or 7% during 1993 primarily as a result of additional revenues generated from two hotel properties that the Registrant began operating in February and May 1992, respectively. Of the total increase in revenues, $950,000 is from additional hotel related revenues while the remaining increase of $322,000 results from the renewal of existing leases at higher rents, increased percentage rents and additional revenues associated with mid-1992 property acquisitions.\n1992 rental revenues include approximately $520,000 in percentage rents collected by the Registrant in 1992 as a result of a favorable arbitration award. These amounts were earned over a four-year period but not previously accrued.\nMortgage interest expense associated with the Registrant's real estate portfolio decreased by $543,000 during 1993 versus that incurred during 1992. This decrease of 9% results from mortgage amortization of approximately $5 million as well as the maturity of certain mortgages and is offset by a full year of interest associated with mortgages secured by properties acquired by the Registrant in mid-1992.\nDepreciation expense for 1993 decreased by approximately $165,000 or 3% from such expense in 1992. This decrease results from the reclassification of depreciation on the Registrant's hotel properties to operating expenses and from the sale of several properties in 1993 and 1992.\nOther operating expenses associated with those properties managed by the Registrant increased by approximately $1,068,000 during 1993 versus such expenses incurred in 1992. This increase primarily results from a full year of operating costs incurred in connection with the leasing of two hotel properties which accounts for $880,000 of this increase, while the timing of certain maintenance costs and additional lease renewal costs incurred in 1993 account for the remaining increase of approximately $188,000.\nANTENNA SYSTEMS\nThe Registrant's antenna systems segment includes Dorne & Margolin, Inc. and D&M\/Chu Technology, Inc. The operating results of D&M\/Chu have been included here and in the accompanying consolidated statements of income since its acquisition by the Registrant in April 1992. See Note 2 of Notes to Consolidated Financial Statements, contained elsewhere in this report, for pro forma results of operations.\nThe operating results of the antenna systems segment for the years ended December 31, 1993 and 1992 are as follows:\n1993 1992 ------- ------- (in thousands)\nNet sales $21,098 $24,513 ======= =======\nCost of sales $14,290 $16,197 ======= =======\nSelling, general and administrative expenses $ 6,039 $ 5,057 ======= =======\nIncome from operations $ 769 $ 3,259 ======= =======\nNet sales of the antenna systems segment decreased by $3,415,000 or 14% during 1993 as compared to such sales in 1992. This decrease is the result of continued weakness in the U. S. Military and commercial aviation markets. Sales by Dorne & Margolin during 1993 were 23% lower than those of 1992. As a result of the mid-1992 acquisition of D&M\/Chu by the Registrant and therefore a full year of sales in 1993, sales of D&M\/Chu increased by 9% during this period. The reductions in military and commercial sales continue to seriously effect the Registrant's antenna systems segment and management is concentrating on reversing this trend.\nCost of sales as a percentage of net sales of the antenna systems segment increased in 1993 by approximately 2% from 1992 levels. This increase is primarily the result of changes in the mix of product sales and differences in the gross margins of Dorne & Margolin and D&M\/Chu product lines.\nSG&A expenses of the antenna systems segment have increased by $982,000 in 1993. This is a result of a full year of SG&A costs associated with D&M\/Chu in 1993 versus only nine months of such costs in 1992 and from approximately $365,000 in costs incurred in 1993 as a result of the decision to consolidate the operations of D&M\/Chu into that of Dorne & Margolin.\nENGINEERED PRODUCTS\nThe Registrant's engineered products segment includes Metex Corporation and AFP Transformers, Inc. The operating results of AFP Transformers have been included here and in the accompanying consolidated statements of income since October 1992. Pro forma results of operations have not been separately disclosed as amounts are not material.\nThe operating results of the engineered products segment for the years ended December 31, 1993 and 1992 are as follows:\n1993 1992 ------- ------- (in thousands)\nNet sales $27,643 $26,819 ======= =======\nCost of sales $20,958 $19,412 ======= =======\nSelling, general and administrative expenses $ 5,100 $ 4,720 ======= =======\nIncome from operations $ 1,585 $ 2,687 ======= =======\nNet sales generated by the engineered products segment increased by $824,000 during 1993 versus that of 1992. Sales of Metex decreased by $1,540,000 during this period, while sales of AFP Transformers increased $2,364,000. This increase in the sales of AFP Transformers is primarily the result of the Registrant's acquisition of the operating assets of Isoreg Corporation, a manufacturer of Epoxycast transformers, in October 1992.\nCost of sales as a percentage of net sales increased approximately 3% during 1993. This increase is primarily the result of lower profit margins on knitted wire sales resulting from lower automotive and European sales.\nSG&A expenses of the engineered products segment increased $380,000 during 1993, as compared to such costs in 1992. This increase of approximately 1% as a percentage of net sales results from additional SG&A costs of AFP Transformers including the costs associated with the relocation of operations of Isoreg, which was acquired in October 1992, from Massachusetts to New Jersey.\nGENERAL AND ADMINISTRATIVE EXPENSES\nGeneral and administrative expenses not associated with the manufacturing operations decreased $270,000 in 1993 from a year earlier. This decrease is primarily the result of lower professional fees incurred in 1993 and represents a change of less than 1% of consolidated revenues.\nOTHER INCOME AND EXPENSE, NET\nOther income and expense, net for 1993 of approximately $4.1 million is comprised of $1.1 million in gains from the sale of real estate, the recovery of $744,000 in previously recorded unrealized losses on marketable securities, $578,000 in income from equity investments which represent nonrecurring cash distributions and $1.7 million in other income. The Registrant received a $2 million settlement in 1993 from Metex' insurance carrier in connection with the class action civil suit brought by the former shareholders of Metex. This settlement is included in other income in 1993, net of approximately $450,000 of current year costs incurred in the defense of this action. All defense costs incurred prior to 1993 were included in general and administrative expenses.\nThe components of other income and expense, net in 1992 include approximately $449,000 in gains from the sale of real estate, $723,000 in unrealized losses on marketable securities, $142,000 in income from equity investments and $249,000 in other income.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1994, the Registrant's current liabilities exceeded current assets by approximately $5.2 million. The change in working capital since December 31, 1993 has resulted from financing the purchase of long-term assets utilizing short-term borrowings primarily in connection with the acquisition of Kentile. Management is confident that through cash flow generated from operations, the sale of select assets and the refinancing of certain current liabilities on a long-term basis, all obligations will be satisfied as they become due.\nThe Registrant has an unsecured line of credit with a bank which provides for borrowings up to $15 million at the bank's prime lending rate. At December 31, 1994 there was $6 million outstanding under this facility. The maximum amount outstanding under this facility during 1994 was approximately $6.6 million. This demand facility is reviewed by the bank annually on May 31.\nOn March 14, 1994, the Registrant purchased substantially all of the operating assets of Kentile Floors for approximately $9.6 million, of which approximately $6.5 million consists of new bank financing. See Note 2 to Consolidated Financial Statements, \"Acquisition of Operating Companies.\"\nKentile maintains a revolving credit facility with a bank which provides for maximum borrowings of the lessor of $7 million or the borrowing base, as defined, at the bank's prime lending rate plus 1 1\/2%. Such borrowings are collateralized by all accounts receivable, inventory and equipment of Kentile.\nAt December 31, 1994 approximately $4.6 million was outstanding under this facility, which matures in April 1996 and includes, among other things, several financial covenants regarding capital expenditures and debt-to-equity ratios. At December 31, 1994 the Registrant was not in compliance with certain of these covenants. The bank has granted a waiver of the debt-to-equity covenant through March 31, 1996 and the capital expenditure covenant through December 31, 1995.\nThe Registrant has undertaken the completion of environmental studies and remedial action at Metex' two New Jersey facilities and has filed an action against certain insurance carriers seeking recovery of costs incurred and to be incurred in these matters. Based upon the advice of counsel, management believes such recovery is probable and therefore should not have a material effect on the liquidity or capital resources of the Registrant. To date settlements have been reached with several carriers in this matter. Those recoveries anticipated to be received within twelve months are included in prepaid expenses and other current assets in the accompanying consolidated balance sheet. See Item 1, \"Business-Environmental Regulations,\" Item 3, \"Legal Proceedings\" and Note 16 to Consolidated Financial Statements, \"Contingencies.\"\nThe cash needs of the Registrant have been satisfied from funds generated by current operations and additional borrowings. It is expected that future operational cash needs will also be satisfied from ongoing operations and additional borrowings. The primary source of capital to fund additional real estate acquisitions will come from the sale, financing and refinancing of the Registrant's properties and from third party mortgages and purchase money notes obtained in connection with specific acquisitions.\nIn addition to the acquisition of properties for consideration consisting of cash and mortgage financing proceeds, the Registrant may acquire real properties in exchange for the issuance of the Registrant's equity securities. The Registrant may also finance acquisitions of other companies in the future with borrowings from institutional lenders and\/or the public or private offerings of debt or equity securities.\nFunds of the Registrant in excess of that needed for working capital, purchasing real estate and arranging financing for real estate acquisitions are invested by the Registrant in corporate equity securities, corporate notes, certificates of deposit and government securities.\nBUSINESS TRENDS\nTotal revenues of the Registrant increased over $37 million or 54% during 1994 as compared to such results of the preceding year. Of these additional revenues approximately $30 million, were generated by Kentile, since its acquisition by the Registrant in March 1994. The Registrant's real estate and engineered products segments also contributed to the increased revenues during the year, while sales of the antenna systems segment continued to decline.\nThe improved results of the Registrant's real estate operations reflect the renewal of existing leases at higher rents and improved results from the Registrant's hotel properties. These results can be expected to continue in the future as older leases are renewed with current market rates.\nThe Registrant's engineered products segment continues to reflect sales growth in virtually all market segments. This has resulted in an increase of $7,868,000 or 28% in revenues during the year versus comparable 1993 results. With continued increases in U.S. automobile demand and as more vehicles are outfitted with air bags, demand for these products should continue.\nAs noted above, the acquisition of Kentile has contributed approximately $30 million in sales during 1994. However, the operating results of Kentile, since acquisition, reflect a loss of $608,000. This is primarily attributable to lower than anticipated sales, changes in the Company's distribution network and higher raw material costs. Management is focusing on these issues and reversing the negative impact that they have on the operating results of the Registrant.\nThe results of the Registrant's antenna systems segment reflect an 8% decline in sales as compared to 1993. This segment experienced a $1.5 million loss from operations during the year primarily as a result of the following: reductions in sales; the recording of inventory realization allowances as a result of the continuing decline in military sales and the uncertainty that such sales will increase in the future; and additional costs incurred in the manufacture of certain products as a result of the transition of personnel and the consolidation of facilities. Several management changes have recently been made including naming a new President for this segment. The business is focused on reversing the declining revenue and profit trend and is seeking new markets and new applications for its products.\nAlthough there can be no assurance as to how the events discussed above, or other changes in the economy, will impact the future financial condition or results of operations of the Registrant, management continues to monitor such developments and has implemented measures to minimize any possible negative effects they may have upon these businesses.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary information filed as part of this Item 8 are listed under Part IV, Item 14, \"Exhibits, Financial Statements and Schedules and Reports on Form 8-K\" and are contained in this Form 10-K at page.\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\nThis information will be contained in the Proxy Statement of the Registrant for the 1995 Annual Meeting of Stockholders under the captions \"Election of Directors\" and \"Executive Officers\" and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThis information will be contained in the Proxy Statement of the Registrant for the 1995 Annual Meeting of Stockholders under the caption \"Executive Compensation and Compensation of Directors\" and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information will be contained in the Proxy Statement of the Registrant for the 1995 Annual Meeting of Stockholders under the captions \"Security Ownership\" and \"Election of Directors\" and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis information will be contained in the Proxy Statement of the Registrant for the 1995 Annual Meeting of Stockholders under the caption \"Certain Relationships and Related Transactions\" and is incorporated herein by reference. Also see Note 11, \"Transactions with Related Parties,\" of Notes to Consolidated Financial Statements, contained elsewhere in this report.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1) CONSOLIDATED FINANCIAL STATEMENTS. The following Consolidated Financial Statements and Consolidated Financial Statement Schedules of the Registrant are included in this Form 10-K at the pages indicated:\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE\nReport of Independent Public Accountants Consolidated Balance Sheets as of December 31, 1994 and 1993 Consolidated Statements of Income for the Years Ended December 31, 1994, 1993 and 1992 to\nConsolidated 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 to\nNotes to Consolidated Financial Statements to\n(2) CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nSchedule II -- Allowance for Doubtful Accounts Schedule III -- Real Property Held for Rental and Accumulated Depreciation Schedule IV -- Mortgage Loans on Real Estate\n(3) Supplementary Data\nQuarterly Financial Data (Unaudited)\nSchedules not listed above are omitted as not applicable or the information is presented in the financial statements or related notes.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Registrant during the last quarter of fiscal 1994.\n(c) Exhibits\n3.1. Amended and restated Certificate of Incorporation of the Registrant (incorporated by reference to exhibit 3.1 filed with the Registrant's report on Form 10-K for the fiscal year ended December 31, 1993).\n3.2. By-laws of the Registrant (incorporated by reference to exhibit 3 filed with the Registrant's report on Form 10-K for the fiscal year ended December 31, 1980).\n*10.1. 1988 Incentive Stock Option Plan of the Registrant, as amended.\n*10.2. 1988 Joint Incentive and Non-Qualified Stock Option Plan, as amended.\n10.3. Employment Agreement dated as of January 1, 1990 by and between the Registrant and A. F. Petrocelli (incorporated by reference to exhibit 10.9 filed with the Registrant's report on Form 10-K for the fiscal year ended December 31, 1989).\n10.4. Amendment dated as of December 3, 1990 to Employment Agreement dated as of January 1, 1990, by and between the Registrant and A. F. Petrocelli (incorporated by reference to exhibit 10.10 filed with the Registrant's report on Form 10-K for the fiscal year ended December 31, 1990).\n10.5. Amendment dated as of June 8, 1993 to Employment Agreement dated as of January 1, 1990 by and between the Registrant and A. F. Petrocelli (incorporated by reference to exhibit 10.5 filed with the Registrant's report on Form 10-K for the fiscal year ended December 31, 1993).\n10.6. Employment Agreement dated as of July 1, 1991 by and between the Registrant and Dennis S. Rosatelli (incorporated by reference to Exhibit 10.10 filed with the Registrant's report on Form 10-K for the fiscal year ended December 31, 1991).\n10.7. Option Agreement dated June 20, 1991 between the Registrant and A. F. Petrocelli (incorporated by reference to Exhibit 10.12 filed with the Registrant's report on Form 10-K for the fiscal year ended December 31, 1991).\n10.8. Form of Option Agreements dated July 17, 1991 between the Registrant and Robert L. Frome, Howard M. Lorber, Arnold S. Penner, Dennis S. Rosatelli (incorporated by reference to Exhibit 10.13 filed with the Registrant's report on Form 10-K for the fiscal year ended December 31, 1991).\n10.9. Amendment dated as of April 16, 1993 to Option Agreement dated as of July 17, 1991 by and between the Registrant and Robert L. Frome (incorporated by reference to exhibit 10.9 filed with the Registrant's report on Form 10-K for the fiscal year ended December 31, 1993).\n10.10. Amended and Restated Asset Purchase Agreement dated as of July 9, 1993 by and between the Registrant and Kentile Floors, Inc. (incorporated by reference to Exhibit 99(a) filed with the Registrant's Current Report on Form 8-K dated March 28, 1994).\n*21. Subsidiaries of the Registrant\n*23. Accountants' consent to the incorporation by reference in Registrant's Registration Statements on Form S-8 of the Report of Independent Public Accountants included herein.\n-----------------\n* Filed herewith\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUNITED CAPITAL CORP.\nDated: MARCH 22, 1995 By:\/s\/ A. F. Petrocelli ----------------------------- A. F. Petrocelli 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.\nDated: MARCH 22, 1995 By:\/s\/ A. F. Petrocelli ----------------------------- A. F. Petrocelli Chairman, President and Chief Executive Officer\nDated: MARCH 22, 1995 By:\/s\/ Howard M. Lorber ----------------------------- Howard M. Lorber Director\nDated: MARCH 22, 1995 By:\/s\/ Arnold S. Penner ----------------------------- Arnold S. Penner Director\nDated: MARCH 22, 1995 By:\/s\/ Dennis S. Rosatelli ----------------------------- Dennis S. Rosatelli Chief Financial Officer, Chief Accountant, Secretary and Director\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of\nUnited Capital Corp.:\nWe have audited the accompanying consolidated balance sheets of United Capital 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 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 United Capital 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.\nAs discussed in Note 12 to the consolidated financial statements, effective January 1, 1993, 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. The schedules listed in the index of financial statements and schedules are presented for purposes of complying with the Securities and Exchange Commission's rules and are not a 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\nRoseland, New Jersey March 22, 1995\nUNITED CAPITAL CORP. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1994 AND 1993\nThe accompanying notes to consolidated financial statements are an integral part of these balance sheets.\nUNITED CAPITAL CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nUNITED CAPITAL CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nUNITED CAPITAL CORP. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(A) Changes in assets and liabilities, net of effects from business acquisitions for the years ended December 31, 1994, 1993 and 1992 are as follows:\n(B) Acquisition of Chu Associates, Inc. and Isoreg Corporation in 1992 and Kentile, Inc. in 1994 -- See Note 2 to Consolidated Financial Statements.\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nUNITED CAPITAL CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1994, 1993 AND 1992\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nNATURE OF BUSINESS-\nUnited Capital Corp. (the \"Registrant\") and its subsidiaries are currently engaged in the investment and management of real estate and in the manufacture and sale of resilient vinyl flooring, antenna systems, and engineered products.\nPRINCIPLES OF CONSOLIDATION-\nThe consolidated financial statements include the accounts of the Registrant and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nIncome Recognition -- REAL ESTATE OPERATIONS-\nThe Registrant leases substantially all of its properties to tenants under net leases. Under this type of lease, the tenant is obligated to pay all operating costs of the property including real estate taxes, insurance, repairs and maintenance. Rental income is recognized based on the terms of the leases. Certain lease agreements provide for additional rent based on a percentage of tenants' sales. Such additional rents are recorded as income when they can be reasonably estimated. Gains on sales of real estate assets are recorded when the gain recognition criteria under generally accepted accounting principles have been met.\nMARKETABLE SECURITIES-\nInvestments in debt securities are classified as held-to-maturity and measured at amortized cost in the consolidated balance sheet only if the Registrant has the positive intent and ability to hold those securities to maturity. Debt and equity securities that are purchased and held principally for the purpose of selling in the near term will be measured at fair value and classified as trading securities. For the purpose of calculating realized gains and losses, the cost of investments sold is determined using the first-in, first-out method. Unrealized gains and losses on trading securities are included in current earnings. All securities not classified as trading or held-to-maturity are classified as available-for-sale and measured at fair value. Unrealized gains and losses on securities available-for-sale are recorded net, as a separate component of stockholders' equity until realized. Management determines the appropriate classification of securities at the time of purchase and reassesses the appropriateness of the classification at each reporting date.\nThe Registrant adopted Statement of Financial Accounting Standard No.115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS 115\") effective January 1, 1994. The effect of the adoption increased stockholders' equity by approximately $350,000, net of tax at such date.\nUnder the previous accounting policy, securities were carried at the lower of cost or market value with a charge to income for unrealized holding losses. Unrealized gains were recognized only to the extent that previously unrealized losses had been recognized. As prescribed, this new standard was not applied retroactively to prior years.\nINVENTORIES-\nInventories are stated at the lower of cost or market and include material, labor and manufacturing overhead.\nThe first-in, first-out (FIFO) method is used to determine the cost of inventories in all of the Registrant's business segments, except the resilient vinyl flooring operations, which utilizes the last-in, first-out (LIFO) method. Approximately 32% of the Registrant's December 31, 1994 inventories are valued using the LIFO method. Had the FIFO method been used to cost all inventories, the amount at which inventories are stated would have been approximately $306,000 less at December 31, 1994.\nThe components of inventory at December 31, 1994 and 1993 are as follows-\n1994 1993 ----------- ----------\nRaw materials $ 4,813,658 $4,261,991 Work in process 2,628,595 2,195,927 Finished goods 5,672,306 1,611,357 ----------- ----------\n$13,114,559 $8,069,275 =========== ==========\nDEPRECIATION AND AMORTIZATION-\nDepreciation and amortization are provided on a straight-line basis over the estimated useful lives of the related assets as follows-\nReal property held for rental- Buildings 7 to 39 years Equipment 5 to 7 years\nProperty, plant and equipment- Buildings and improvements 18 to 40 years Machinery and equipment 3 to 10 years\nPREPAID EXPENSES AND OTHER CURRENT ASSETS-\nThe Registrant capitalizes certain promotional materials in connection with its resilient vinyl flooring operations. These costs are classified as prepaid assets until the materials are distributed to the market place. Selling expense is recorded when materials are distributed.\nREAL PROPERTY HELD FOR RENTAL-\nReal property held for rental is carried at cost less accumulated depreciation. Major renewals and betterments are capitalized. Maintenance and repairs are expensed as incurred.\nCertain mortgage obligations assumed by the Registrant contain provisions whereby the mortgage holder may acquire, under certain conditions, an interest in the properties securing the obligation, for a nominal amount. The Registrant considers any costs incurred as a result of these provisions to be a cost of acquisition and the basis in such properties is adjusted accordingly.\nRESEARCH AND DEVELOPMENT-\nThe Registrant expenses research, development and product engineering costs as incurred. Approximately $814,000, $618,000 and $713,000 of such costs were incurred by the Registrant in 1994, 1993 and 1992, respectively. Provisions for losses are made for research and development contracts when the estimated costs under such contracts exceed the proceeds.\nNET INCOME (LOSS) PER COMMON SHARE-\nNet income (loss) per common share is computed based upon the weighted average number of common and dilutive common equivalent shares outstanding during the period. Fully diluted and primary earnings per common share are the same amounts for each of the periods presented.\nPRIOR YEAR FINANCIAL STATEMENTS-\nCertain amounts have been reclassified in the December 31, 1993 and 1992 financial statements and notes thereto to present them on a basis consistent with the current year.\n(2) ACQUISITION OF OPERATING COMPANIES:\nOn March 14, 1994 the Registrant, through a new wholly-owned subsidiary known as Kentile, Inc. (\"Kentile\"), purchased substantially all of the operating assets of Kentile Floors, Inc. (\"Kentile Floors\") for approximately $9.6 million. The purchase price was comprised of approximately $6.5 million in new bank financing and approximately $3.1 million in cash.\nThe $3.1 million cash payment included $775,000 that was advanced to Kentile Floors by the Registrant during 1993 and was also partially derived from a total of $4 million in short-term borrowings by the Registrant during the first quarter of 1994. These funds were used by Kentile Floors to repay amounts outstanding under its asset-based lending agreement, thereby relieving the Registrant of its obligation under the letter of credit, discussed below.\nIn November 1992, Kentile Floors filed for protection under Chapter 11 of the United States Bankruptcy Code. Subsequent thereto, the Registrant acquired a 1\/3 equity interest in Kentile Floors together with an option to purchase an additional equity interest in the future. In consideration for this interest and option in Kentile Floors, the Registrant provided a $2 million letter of credit to partially guarantee borrowings under Kentile Floors' asset-based lending agreement. The letter of credit arrangement was made pursuant to Bankruptcy Court approval on a priority basis. In light of the uncertain outcome of Kentile Floors' bankruptcy proceedings, no value was assigned to the equity interest acquired by the Registrant.\nThe acquisition of Kentile has been accounted for under the purchase method of accounting and, accordingly, the purchase price, including associated costs of the acquisition, was allocated to assets acquired and liabilities assumed based on their fair value at the date of acquisition as follows (in thousands)-\nNet current assets and liabilities $ 4,690 Property, plant and equipment 2,608 Noncurrent assets 2,463 Long-term liabilities (154) -------\nAllocated purchase price $ 9,607 =======\nThe results of operations of Kentile have been included in the accompanying consolidated statements of income from the date of acquisition, March 14, 1994.\nIncluded in prepaid expenses and other current assets in the accompanying December 31, 1994 consolidated financial statements is approximately $800,000 related to unutilized equipment acquired in the acquisition of Kentile, which is to be sold under a contract entered into in March 1995. The Registrant has valued the equipment in accordance with this agreement and included this transaction in the allocation of the purchase price, noted above. Accordingly, no gain has been recognized in the accompanying consolidated financial statements.\nIn February 1994, the Registrant also acquired the underlying mortgage secured by Kentile Floors' South Plainfield facility for $2,250,000. This note has a face amount outstanding of approximately $6.5 million plus delinquent accrued interest. The Registrant has accounted for this mortgage as an insubstance foreclosure and, accordingly, recorded the purchase price as a component of real property held for rental in the accompanying consolidated balance sheet.\nAs of April 2, 1992, the Registrant, through a wholly-owned subsidiary of Metex Corporation (\"Metex\"), purchased the net operating assets of Chu Associates, Inc. and affiliated companies, a manufacturer of antenna systems for naval and land-based applications, now known as D&M\/Chu Technology, Inc. (\"D&M\/Chu\"), for $3,675,000. The purchase price was satisfied by $2,475,000 in cash and a $1,200,000 note to the sellers. The $2,475,000 cash payment was derived from a total of $4,750,000 in bank borrowings by the Registrant in connection with the acquisition and the refinancing of certain of the existing debt of Chu Associates, Inc.\nThe acquisition has been accounted for under the purchase method of accounting and, accordingly, the purchase price, including associated costs of the acquisition, was allocated to assets acquired and liabilities assumed based on their fair value at the date of acquisition as follows (in thousands)-\nNet current assets and liabilities ($ 157) Property, plant and equipment 5,181 Noncurrent assets 860 Long-term liabilities (2,054) -------\nAllocated purchase price $ 3,830 =======\nThe results of operations of D&M\/Chu have been included in the accompanying consolidated statements of income from the date of acquisition.\nThe following unaudited pro forma consolidated results of operations of the Registrant assume that the acquisition of D&M\/Chu had occurred at the beginning of 1992 and that the acquisition of Kentile had occurred at the beginning of 1993 and 1994. In addition to combining historical results of operations of the companies, the pro forma calculations include adjustments to historical assets, liabilities and results of operations which occur in a purchase.\nUNAUDITED PRO FORMA CONSOLIDATED RESULTS OF OPERATIONS\n(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)\n1994 1993 1992 -------- -------- -------\nRevenues $113,952 $119,870 $73,083 ======== ======== =======\nNet income $ 2,051 $ 4,117 $ 2,758 ======== ======== =======\nNet income per common share $ .33 $ .66 $ .42 ======== ======== =======\nThe above financial information is not necessarily indicative of the actual results that would have occurred had the acquisitions of D&M\/Chu or Kentile been consummated at the beginning of the periods presented or of future operations of the combined companies.\nIn October 1992, AFP Transformers, Inc. (\"AFP Transformers\"), a wholly-owned subsidiary of the Registrant, purchased the operating assets of Isoreg Corporation in a foreclosure sale from a bank for approximately $761,000, including all costs associated with the acquisition. The results of operations of AFP Transformers have been included in the accompanying consolidated statements of income from the date of acquisition. Pro forma results have not been separately disclosed as amounts are not material.\n(3) REAL PROPERTY HELD FOR RENTAL:\nThe Registrant is the lessor of real estate under operating leases which expire in various years through 2070.\nThe following is a summary of real property held for rental at December\n1994 1993 ------------ ------------\nLand $ 12,244,736 $ 11,703,007 Buildings 114,395,602 107,947,423 ------------ ------------\nTotal 126,640,338 119,650,430 ------------ ------------\nLess- Accumulated depreciation (51,569,038) (45,257,746) ------------ ------------\n$75,071,300 $74,392,684 ============ ============\nAs of December 31, 1994, total minimum future rentals to be received under noncancellable leases for each of the next five years and thereafter are as follows-\nYear Ended December 31- 1995 $13,725,000 1996 11,843,000 1997 10,604,000 1998 9,337,000 1999 8,390,000 Thereafter 50,786,000 -------------\nTotal Minimum Future Rentals $104,685,000 =============\nMinimum future rentals do not include additional rentals that may be received under certain leases which provide for such rentals based upon a percentage of lessees' sales. Percentage rents included in the determination of net income in 1994, 1993 and 1992 were approximately $915,000, $1,037,000, and $1,271,000, respectively.\nIncluded in 1992 percentage rents are approximately $520,000 collected from a tenant as a result of an arbitration award. These amounts were earned over a four-year period but not previously accrued.\n(4) PROPERTY, PLANT AND EQUIPMENT:\nProperty, plant and equipment is principally used in the Registrant's manufacturing operations and consists of the following at December 31-\n1994 1993 ------------ ------------\nLand $ 1,189,369 $ 1,132,950 Buildings and improvements 5,276,556 3,888,953 Machinery and equipment 11,008,466 7,731,628 ------------ ------------ 17,474,391 12,753,531\nLess- Accumulated depreciation (4,977,480) (3,840,345) ------------ ------------\n$ 12,496,911 $ 8,913,186 ============ ============\nAt December 31, 1994 property, plant and equipment includes approximately $2.3 million of land and buildings used in the Registrant's D&M\/Chu antenna business. These operations are being consolidated with those of the Registrant's Dorne & Margolin subsidiary. The Registrant has leased one of the D&M\/Chu facilities (which is classified as real property held for rental at December 31, 1994) at rates which are sufficient to cover the carrying costs of the property, and is exploring possibilities to lease the remaining facility and to develop the unused land at the site.\n(5) MARKETABLE SECURITIES:\nThe aggregate market value of marketable securities, which were all available-for-sale, was $594,070 at December 31, 1994, while gross unrealized holding gains were $61,863 on a net of tax basis. At December 31, 1993 the aggregate market value and the gross unrealized holding gains of the Registrant's marketable security portfolio were $2,296,318 and $578,041, respectively.\nProceeds from the sales of securities, which were designated as available-for-sale in 1994, and the resulting gross realized gains and losses included in the determination of net income for the years ended December 31, 1994, 1993 and 1992 are as follows-\n1994 1993 1992 ----------- ----------- -----------\nProceeds $ 2,979,985 $ 0 $ 1,005 =========== =========== ===========\nRealized gains $ 1,233,389 $ 0 $ 20,596 =========== =========== ===========\nRealized losses ($ 29,926) $ 0 $ 0 =========== =========== ===========\n(6) NOTES RECEIVABLE:\nNotes receivable consist of the following at December 31-\n1994 1993 ---------- ----------\nMortgage notes receivable (a) $ 722,913 $ 908,509 Advances to affiliate (b) 0 775,000 Due from related party (Note 11) 360,000 628,494 Loan receivable (Note 11) 0 88,333 ---------- ----------\n1,082,913 2,400,336 Less- Current portion included in notes and accounts receivable 386,685 1,577,795 ---------- ----------\n$ 696,228 $ 822,541 ========== ==========\n(a) As partial consideration in the sale of several properties, the Registrant received mortgage notes in the aggregate amount of $2,080,000. The notes, which are secured by the properties sold, bore interest in 1993 and 1994 at various rates ranging between 8% and 15% and bear interest in future periods at rates ranging between 9% and 11%. Interest under the notes is due monthly. Principal repayment terms vary with periodic installments through December 2008. One such note, with an original face amount of $200,000 was satisfied during 1994.\nIn accordance with generally accepted accounting principles, the gains from the sales of certain of these properties are being recognized under the installment method, and accordingly, the carrying value of noncurrent notes receivable has been reduced by deferred gains of approximately $941,000 and $991,000 at December 31, 1994 and 1993, respectively. The deferred gains are being recognized as income as payments are received under the note.\n(b) During 1993 the Registrant advanced $775,000 to Kentile Floors. Such advances were made on a priority basis pursuant to Bankruptcy Court approval granted in this matter. In 1992 the Registrant acquired a one-third interest in Kentile Floors subsequent to Kentile Floors' filing for protection under Chapter 11 of the U.S. Bankruptcy Code. In March 1994 the Registrant acquired the operating assets of Kentile Floors and such advances were included in the determination of the purchase price of this acquisition. See Note 2, \"Acquisition of Operating Companies.\"\n(7) OTHER ASSETS:\nOther assets consist of the following at December 31-\n(a) In accordance with Staff Accounting Bulletin 92 the Registrant has recorded the anticipated recoveries from its insurance carriers in connection with the environmental investigation and remediation costs to be incurred at two of its manufacturing sites in New Jersey. See Note 16, \"Contingencies.\"\n(8) LONG-TERM DEBT:\nLong-term debt consists of the following at December 31-\n1994 1993 ----------- -----------\nFirst mortgages on real property (a) $50,516,000 $55,044,727 Second mortgages on real property (b) 390,902 585,074 Loan payable to bank (c) 3,280,829 4,550,832 Loan payable to bank (d) 2,756,251 3,937,501 Loan payable to bank (e) 520,000 0 Note payable (f) 1,200,000 1,200,000 Note payable (g) 0 1,158,335 Other 471,421 472,784 ----------- -----------\n59,135,403 66,949,253 Less- Current maturities 9,755,590 8,309,052 ----------- -----------\n$49,379,813 $58,640,201 =========== ===========\n(a) First mortgages bearing interest at rates ranging from 7.875% to 11% per annum are collateralized by the related real property. Such amounts are scheduled to mature at various dates from September 1995 through February 2010.\n(b) Second mortgages bearing interest at rates of approximately 10.125% per annum are collateralized by the related real property. Such amounts are scheduled to mature at various dates from October 2001 through November 2002.\n(c) In July 1992, the Registrant borrowed $6,350,000 from a bank to refinance a note to a former shareholder which was issued in connection with the merger of BMG Equities, Corp. (\"BMG\"). This note bore interest at the bank's prime lending rate plus 1\/4% until April 1993 when it was converted to a fixed rate note at 6.2% for the remainder of the term. The note is due in 60 equal principal installments, together with accrued interest thereon, through July 1997. The loan agreement contains, among other things, several financial covenants regarding net worth and debt-to-equity ratios. At December 31, 1994 the Registrant was not in compliance with certain of these covenants. The bank has granted a waiver for such noncompliance and has modified certain covenants through December 31, 1995. The Registrant believes it will be in compliance with the foregoing agreements.\n(d) In connection with the acquisition of the operating assets of Chu Associates, Inc., the Registrant entered into a $4,725,000 loan agreement with a bank. The loan bore interest at the bank's prime lending rate plus 1\/4% until April 1993 when it was converted to a fixed rate note at 6.3% for the remainder of the term. The note is payable monthly, with 48 equal monthly principal installments beginning in May 1993. The loan agreement contains several financial covenants regarding working capital, net worth, capital expenditures and debt-to-equity ratios. At December 31, 1994 the Registrant was not in compliance with certain of these covenants. The bank has granted a waiver for such noncompliance and has modified certain covenants through December 31, 1995. The Registrant believes it will be in compliance with the foregoing agreements.\n(e) In connection with the acquisition of the operating assets of Kentile Floors the Registrant entered into a $600,000 term loan with a bank. The loan bears interest at the bank's prime lending rate plus 2% which was 10.5% at December 31, 1994. The loan is due in 60 equal principal installments, together with accrued interest thereon, through March 1999. Amounts outstanding are guaranteed by the Registrant and secured by the accounts receivable, inventory and equipment of Kentile. The loan contains, among other things, several financial covenants regarding capital expenditures and debt-to-equity ratios. At December 31, 1994 the Registrant was not in compliance with certain of these covenants. The bank has granted a waiver of the debt-to-equity covenant through March 31, 1996 and the capital expenditure covenant through December 31, 1995.\n(f) As partial consideration in the acquisition of D&M\/Chu the Registrant issued a $1,200,000 note to the sellers. The note bore interest at 6.5% between May 1992 and May 1994. Thereafter the interest rate is adjusted annually by no more than a 1% increase or decrease from the rate of the immediately preceding twelve-month period to the published prime rate charged by U. S. banks. This rate was 6.75% between May and December 1994. The note requires quarterly interest payments and matures in May 1997. Under certain conditions, the Registrant may offset certain amounts against this note.\n(g) In connection with the acquisition of D&M\/Chu the Registrant assumed a note held by the Massachusetts Industrial Finance Agency which was secured by one of D&M\/Chu's manufacturing facilities. The note bore interest at 8.75% and was fully satisfied during 1994.\nThe approximate aggregate maturities of these obligations at December 31, 1994 are as follows-\n1995 $9,755,590 1996 9,608,669 1997 7,563,472 1998 4,962,717 1999 4,649,138 Thereafter 22,595,817 -----------\n$59,135,403 ===========\n(9) REVOLVING CREDIT FACILITIES:\nThe Registrant maintains an unsecured line of credit arrangement with a bank which provides for borrowings up to $15,000,000 at the bank's prime lending rate, which was 8.5% at December 31, 1994 and 6% at December 31, 1993. This demand facility is reviewed by the bank annually on May 31. At December 31, 1994 there was $6 million outstanding under this facility. There were no borrowings outstanding under this facility at December 31, 1993.\nBorrowings under this facility are jointly and severally guaranteed by both the Registrant and its subsidiaries. Unless extended, any amounts outstanding are due and payable within 30 days of the expiration of this facility.\nKentile maintains a revolving credit facility with a bank which provides for maximum borrowings of the lessor of $7 million or the borrowing base, as defined, at the bank's prime lending rate plus 1 1\/2% which was 10% at December 31, 1994. Such borrowings are collateralized by all accounts receivable, inventory and equipment of Kentile. At December 31, 1994 approximately $4.6 million was outstanding under this facility which is due on demand and matures in April 1996. This facility includes, among other things, several financial covenants regarding capital expenditures and debt-to-equity ratios. At December 31, 1994 the Registrant was not in compliance with certain of these covenants. The bank has granted a waiver of the debt-to-equity covenant through March 31, 1996 and the capital expenditure covenant through December 31, 1995.\n(10) STOCKHOLDERS' EQUITY:\nAUTHORIZED CAPITAL AND TREASURY STOCK-\nThe stockholders of the Registrant ratified a plan during the 1993 Annual Meeting of Stockholders to reduce the authorized capital of the Registrant to 7,500,000 shares of $.10 par value common stock. In addition, the Registrant has retired all shares of common stock previously held in treasury.\nSTOCK OPTIONS-\nThe Registrant has two stock option plans under which qualified and nonqualified options may be granted to key employees to purchase the Registrant's common stock at the fair market value at the date of grant. Under both plans, the options become exercisable in three equal installments, beginning one year from the date of grant. The 1988 Incentive Stock Option Plan (the \"Incentive Plan\") provides for the granting of incentive stock options not to exceed 325,000 options in the aggregate. The 1988 Joint Incentive and Non-Qualified Stock Option Plan (the \"Joint Plan\") provides for the granting of incentive or nonqualified stock options, also not to exceed 325,000 options in the aggregate.\nDuring 1993 employees of the Registrant were granted 83,000 and 43,000 options pursuant to the Joint Plan and Incentive Plan, respectively. Such options are exercisable at $11 per share subject to the vesting period noted above. Included in the 1993 grants are 70,000 and 30,000 options granted to the Chairman of the Board pursuant to the Joint Plan and Incentive Plan, respectively.\nAt December 31, 1994, there were 119,516 and 49,594 options outstanding under the Joint Plan and Incentive Plan, respectively. At December 31, 1993, 149,088 and 117,240 options were outstanding under the Joint Plan and Incentive Plan, respectively.\nIn addition to options outstanding under the Joint Plan and Incentive Plan, 180,000 and 240,000 options were outstanding at December 31, 1994 and 1993, respectively. Such options were previously granted to Directors and certain officers of the Registrant and are presently exercisable at $5.50 per share, which price was equal to or greater than the market value per share on the date of grant. If unexercised, these options expire 30 days after the end of a Director's term. During 1994 directors of the Registrant exercised options to purchase 60,000 of such shares.\nTransactions involving stock options are summarized below-\n1994 1993 ------------ ------------\nOutstanding, beginning of year 506,328 391,017 Granted 0 126,000 Canceled (44,297) (9,989) Exercised (112,921) (700) ------------ ------------\nOutstanding, end of year 349,110 506,328 ============ ============\nExercisable, end of year 268,443 380,328 ============ ============\nPrice range of options outstanding $5.00-$16.38 $5.00-$16.38 ============ ============\n(11) TRANSACTIONS WITH RELATED PARTIES:\nIn April 1994, the Registrant participated in a $5 million loan transaction secured by a second mortgage covering a leasehold estate. The Registrant advanced $2,253,000 in connection with this loan. The remaining amounts were advanced by the following: Directors of the Registrant, $830,000; the wife of the Board Chairman, $1 million; Officers of the Registrant, $39,000; and $878,000 by unrelated parties.\nThe note bore interest at 15% per annum, payable monthly and was fully satisfied together with accrued interest in February 1995. In addition, the participants received a commitment fee of 3% on their advances from the borrower.\nIn February 1993, the Registrant participated in a $7.5 million loan transaction secured by a second mortgage covering the leasehold estate on a prime hotel property in New York City. During 1993 a total of $6,250,000 had been advanced, including approximately $1,652,000 by the Registrant, $2,532,000 by certain Directors, $200,000 by the wife of the Board Chairman, $100,000 by two adult daughters of a director, $100,000 by a trust under will in which a Director has a partial remainder interest and approximately $1,666,000 by unrelated parties.\nIn connection with this loan, a commitment fee in the net amount of $270,000 was prorated among the participants in relation to the principal amount advanced and committed to be advanced by each participant. The note bore interest at 15% per annum, payable monthly and was fully satisfied together with accrued interest in December 1993.\nIn June 1993 the Registrant advanced approximately $89,000 in connection with a $265,000 loan transaction secured by a first mortgage on a Brooklyn, New York property. The loan bore interest at 15% per annum, payable monthly, and matured and was fully satisfied in June 1994. A Director of the Registrant and an unrelated party also held 1\/3 interests in this loan.\nIn connection with the purchase of an interest in a real estate loan from a Director in 1992 the Registrant issued a note in the amount of $198,000. The note bore interest at 10% and was fully satisfied in February 1995.\nDuring 1994 and 1993 the Registrant advanced, in the aggregate, $360,000 and $3,411,833, respectively, to the Chairman of the Board. Such advances bore interest at 1% over the Registrant's borrowing rate under its revolving credit facility which was 8.5% at December 31, 1994 and 6% at December 31, 1993. Amounts outstanding at December 31, 1994 and 1993 of $360,000 and $628,494, respectively, together with accrued interest thereon were repaid in January 1995 and 1994, respectively.\n(12) INCOME TAXES:\nEffective January 1, 1993 the Registrant adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). In prior years, the Registrant accounted for income taxes using Accounting Principles Board Opinion No. 11 (\"APB 11\"). Under SFAS 109, deferred tax assets and liabilities are determined based on the difference between the tax basis of an asset or liability and its reported amount in the consolidated financial statements using enacted tax rates. Future tax benefits attributable to these differences are recognized to the extent that realization of such benefits is more likely than not.\nUnder the provisions of SFAS 109, the Registrant has elected not to restate prior years' consolidated financial statements. The cumulative effect of this accounting change on years prior to 1993 resulted in a benefit of $702,000, or $.11 per share which is reflected in the accompanying consolidated statement of income for 1993. In addition, the effect of this change on income before cumulative effect of an accounting change in 1993 was an increase of approximately $700,000 or $.11 per share.\nThe cumulative benefit recorded by the Registrant primarily arises from basis differences of real properties held for rental for financial statement and income tax purposes. Based upon the Registrant's historical and projected levels of pretax income, management believes it is more likely than not that the Registrant will realize such benefits in the future and accordingly no valuation reserve has been recorded.\nThe components of the net deferred tax asset (liability) at December 31, 1994 and 1993, are as follows-\nIncome tax provision (benefit) reflected in the accompanying consolidated statements of income for the years ended December 31, 1994, 1993 and 1992, is summarized as follows-\n1994 1993 1992 ----------- ----------- ----------- Current- Federal $ 1,926,000 $ 2,511,000 $ 2,390,000 State 1,131,000 770,000 705,000 Deferred (405,000) (237,000) (156,000) ----------- ----------- -----------\n$ 2,652,000 $ 3,044,000 $ 2,939,000 =========== =========== ===========\nA reconciliation of tax provision computed at statutory rates to the amounts shown in the accompanying consolidated statements of income for the years ended December 31, 1994, 1993 and 1992 is as follows-\n(13) OTHER INCOME AND EXPENSE:\nThe components of other income and expense in the accompanying consolidated statements of income for the years ended December 31, 1994, 1993 and 1992 are as follows-\n(a) In 1994 unrealized gains and losses on marketable securities, which were all available-for-sale, have been recorded net, as a separate component of stockholders' equity in accordance with SFAS 115. In prior years unrealized losses were included in the determination of net income while unrealized gains were only recognized to the extent of previously unrecognized losses. See Note 1.\n(b) Income from equity investments principally represents nonrecurring cash distributions received by the Registrant in connection with interests held in certain real estate ventures which were acquired in the 1991 merger with BMG. Such investments were valued at historical cost at the date of acquisition.\n(c) In 1993, the Registrant received a $2 million settlement from Metex' insurance carrier in connection with the class action civil suit brought by the former shareholders of Metex. This settlement is reflected in other income, net of approximately $450,000 of costs incurred in defense of this action during 1993. All defense costs incurred prior to 1993 were included in general and administrative expenses.\n(14) RETIREMENT PLAN:\nCertain of the Registrant's subsidiaries have noncontributory defined benefit pension plans that cover substantially all full-time employees of the engineered products segment and all hourly employees of the resilient vinyl flooring segment.\nThe following table sets forth the funded status of the plans and amounts recognized in the Registrant's consolidated financial statements as of December 31, 1994 and 1993. The defined benefit plan covering the employees of the resilient vinyl flooring segment has been included here and in the accompanying consolidated financial statements since the acquisition of Kentile in March, 1994.\nNet periodic pension (income) expense for 1994 and 1993 includes the following components-\nIn determining the projected benefit obligation for 1994 and 1993, the weighted average assumed discount rate was 7.5% for both plans, while the rate of expected increases in future salary levels was 3.5% for those employees of the engineered products segment. No such escalation is required under the plan covering the employees of the resilient vinyl flooring segment. The expected long-term rate of return on assets used in determining net periodic pension cost was 9% and 8% for the engineered products and resilient vinyl flooring plans, respectively. No contributions were made during 1994 or 1993.\n(15) BUSINESS SEGMENTS:\nAt December 31, 1994, the Registrant had four business segments: real estate investment and management, the manufacture and sale of resilient vinyl flooring, the manufacturing and sale of engineered products and the manufacture and sale of antenna systems. Information on the Registrant's business segments for 1994, 1993 and 1992 is as follows-\nThrough the Registrant's antenna systems segment, approximately 13%, 21% and 23% of consolidated revenues were derived from sales to the United States Government or its contractors in 1994, 1993 and 1992, respectively.\nSales by the Registrant's engineered products segment to automobile original equipment manufacturers accounted for approximately 16%, 20% and 23% of 1994, 1993 and 1992 consolidated revenues, respectively.\n(16) CONTINGENCIES:\nThe Registrant has undertaken the completion of environmental studies and\/or remedial action at Metex' two New Jersey facilities.\nThe process of remediation has begun at one facility pursuant to a plan filed with the New Jersey Department of Environmental Protection and Energy (\"NJDEPE\"). Environmental experts engaged by the Registrant estimate that under the most probable remediation scenario the remediation of this site is anticipated to require initial expenditures of $860,000, including the cost of capital equipment, and $86,000 in annual operating and maintenance costs over a 15-year period.\nEnvironmental studies at the second facility indicate that remediation may be necessary. Based upon the facts presently available, environmental experts have advised the Registrant that under the most probable remediation scenario, the estimated cost to remediate this site is anticipated to require $2.3 million in initial costs, including capital equipment expenditures, and $258,000 in annual operating and maintenance costs over a 10-year period. The Registrant may revise such estimates in the future due to the uncertainty regarding the nature, timing and extent of any remediation efforts that may be required at this site, should an appropriate regulatory agency deem such efforts to be necessary.\nThe foregoing estimates may also be revised by the Registrant as new or additional information in these matters become available or should the NJDEPE or other regulatory agencies require additional or alternative remediation efforts in the future. It is not currently possible to estimate the range or amount of any such liability.\nAlthough the Registrant believes that it is entitled to full defense and indemnification with respect to environmental investigation and remediation costs under its insurance policies, the Registrant's insurers have denied such coverage. Accordingly, the Registrant has filed an action against certain insurance carriers seeking defense and indemnification with respect to all prior and future costs incurred in the investigation and remediation of these sites. Upon the advice of counsel, the Registrant believes that based upon a present understanding of the facts and the present state of the law in New Jersey, it is probable that the Registrant will prevail in the pending litigation and thereby access all or a very substantial portion of the insurance coverage it claims; however, the ultimate outcome of litigation cannot be predicted.\nAs a result of the foregoing, the Registrant has not recorded a charge to operations for the environmental remediation, noted above, in the consolidated financial statements, as anticipated proceeds from insurance recoveries are expected to offset such liabilities. The Registrant has reached settlements with several insurance carriers in this matter. Those recoveries anticipated to be received within twelve months are included in prepaid expenses and other current assets in the accompanying consolidated balance sheet.\nIn the opinion of management, these matters will be resolved favorably and such amounts, if any, not recovered under the Registrant's insurance policies will be paid gradually over a period of years and, accordingly, should not have a material adverse effect upon the business, liquidity or financial position of the Registrant. However, adverse decisions or events, particularly as to the merits of the Registrant's factual and legal basis could cause the Registrant to change its estimate of liability with respect to such matters in the future.\nEffective January 1, 1994 the Registrant adopted the provisions of Staff Accounting Bulletin 92 and accordingly has recorded the expected liability associated with remediation efforts as a component of other long-term liabilities and the anticipated insurance recoveries as a component of prepaid expenses and other current assets and other assets in the Registrant's consolidated financial statements.\nThe Registrant is involved in various other litigation and legal matters which are being defended and handled in the ordinary course of business. None of these matters are expected to result in a judgment having a material adverse effect on the Registrant's consolidated financial position or results of operations.\nSCHEDULE II\nUNITED CAPITAL CORP. AND SUBSIDIARIES\nALLOWANCE FOR DOUBTFUL ACCOUNTS\nThe accompanying notes to consolidated financial statements are an integral part of these schedules.\nUNITED CAPITAL CORP. AND SUBSIDIARIES SCHEDULE III REAL PROPERTY HELD FOR RENTAL AND ACCUMULATED DEPRECIATION\nNotes: (a) Reconciliations of the carrying value of real property held for rental for the three years ended December 31, 1994 are as follows-\n(b) Reconciliations of accumulated depreciation for the three years ended December 31, 1994 are as follows-\n(c) The aggregate cost for Federal income tax purposes is approximately $182,860,000.\nThe accompanying notes to consolidated financial statements are an integral part of these schedules.\nSCHEDULE IV UNITED CAPITAL CORP. AND SUBSIDIARIES\nMORTGAGE LOANS ON REAL ESTATE\nDECEMBER 31, 1994\nNOTES:\n(a) A reconciliation of mortgage loans on real estate for the year ended December 31, 1994 is as follows-\nBalance at beginning of period $ 908,509 Additions during period- New mortgage loans 0 Deductions during period- Collection of principal (185,596) ---------\nBalance at end of period $ 722,913 =========\n(b) In accordance with generally accepted accounting principles the gains from the sale of these properties are being recognized under the installment method and, accordingly, notes receivable have been reduced by the following deferred gains at December 31, 1994:\nMortgage note receivable in connection with sale of property in-\nMontgomery, Alabama $265,575 Beaumont, Texas 458,221 Waterbury, Connecticut 186,536 Augusta, Georgia 30,491 --------\n$940,823 ========\n(c) The carrying value for Federal income tax purposes is substantially equal to the carrying amount for book purposes.\nThe accompanying notes to consolidated financial statements are an integral part of these schedules.\nUNITED CAPITAL CORP. AND SUBSIDIARIES\nQUARTERLY FINANCIAL DATA\n(UNAUDITED)\n(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)","section_15":""}
{"filename":"29905_1994.txt","cik":"29905","year":"1994","section_1":"Item 1. BUSINESS\nGeneral\nDover Corporation (\"Dover\" or the \"Company\") was originally incorporated in 1947 in the State of Delaware and commenced operations as a public company in 1954 with four operating divisions, engaged primarily in the manufacture of metal fabricated industrial products. Primarily through acquisitions, the Company has grown to encompass over 60 different businesses which manufacture, install and service elevators, and manufacture a broad range of specialized industrial products and electronic components and sophisticated manufacturing equipment.\nThe Company's businesses are divided into five business segments. Dover Elevator manufactures, installs and services elevators primarily in North America. Dover Resources manufactures products primarily to serve the automotive, fuel handling and service and petroleum industries. Dover Industries makes products for use in the waste handling, bulk transport, automotive service, commercial food service and machine tool industries. Dover Technologies builds primarily sophisticated automated electronic assembly equipment and to a lesser degree specialized electronic components. Dover Diversified builds heat transfer equipment, specialized compressors, sophisticated assembly and production machines, as well as sophisticated products and control systems for use in the defense, aerospace and commercial building industries. Dover sells its products and services both directly and through various distributors, sales and commission agents and manufacturers representatives, in all cases consistent generally with the custom of the industry and market being served. For more information on these segments and their products, sales, markets served, earnings before tax and total assets for the six years ended December 31, 1994, see pages 6 through 20 of the 1994 Annual Report, which are hereby incorporated by reference.\nDuring the past five years, Dover has spent approximately $736 million on acquisitions of which $188 million was expended in 1994. For more detail regarding acquisitions, see pages 1 through 5 of the 1994 Annual Report as well as Note 2 to the Consolidated Financial Statements on pages 27-28 of the 1994 Annual Report, which are hereby incorporated by reference.\nRaw Materials\nDover's operating companies use a wide variety of raw materials, primarily metals and semi-processed or finished components, which are generally available from a number of sources. Temporary shortages may occur occasionally, but have not resulted in business interruptions or major problems, nor are any such problems\nanticipated. During 1994, prices for steel and aluminum, which are used by a large number of Dover companies, began to increase and are expected to continue to increase in 1995. To date these cost increases have not had a material impact on operating profits.\nResearch and Development\nDover's operating companies are encouraged to develop new products as well as upgrade and improve existing products to satisfy customer needs, expand sales opportunities, improve product reliability and reduce production costs. During 1994, approximately $97 million was spent on research and development, compared with $60 million and $68 million in 1993 and 1992, respectively.\nDover holds or is licensed to use a substantial number of U.S. patents covering a number of its product lines, and to a far lesser degree patents in certain foreign countries where it conducts business. Dover licenses some of its patents to other companies for which it collects royalties which are not significant. These patents have been obtained over a number of years and expire at various times. Although patents in the aggregate are important to Dover, the loss or expiration of any one patent or group of patents would not materially affect Dover or any of its segments. Where patents have expired, Dover believes that its commitment to leadership in continuous engineering improvements, manufacturing techniques, and other sales, service and marketing efforts are significant to maintaining its general market leadership position.\nTrademarks and Tradenames\nMany of the Company's products are sold under various trademarks and tradenames owned or licensed by the Company. Among the most significant are: A-C Compressor, Annubar, Blackmer. Brown & Sharpe, DEK, Dover, Duncan, Groen, Heil, Marathon, Norris, OPW, Rotary Lift, Sargent, SWEP, Tipper Tie and Universal.\nSeasonality\nDover's operations are generally not seasonal, although their performance tends to be stronger in the second and fourth quarters of the year..\nCustomers\nDover's businesses serve thousands of customers, no one of which accounted for more than 10% of sales in 1994. Within each of the five segments, no customer accounted for more than 10% of segment sales in 1994.\nBacklog\nBacklog generally is not considered a significant factor in Dover's businesses, as most products have relatively short delivery periods. The only exceptions are in those businesses which produce larger and more sophisticated machines, or have long-term government contractor subcontracts: A-C Compressor, Belvac, Dover Elevator, Heil, Sargent Controls and Universal.\nTotal Company backlog as of December 31, 1994 and 1993 was $927 million and $711 million, respectively.\nCompetition\nDover's competitive environment is complex because of the wide diversity of products manufactured and markets served. In general, Dover companies are market leaders which compete with only a few companies. In addition, since most of Dover's manufacturing operation are in the United States, Dover usually is a more significant competitor domestically than in foreign markets. There are some exceptions.\nIn the Elevator segment, Dover competes for the manufacture and installation of elevators with a few generally large multinational competitors and maintains a strong domestic position. For service work, there are numerous local, regional and national competitors.\nIn the Technologies segment, Dover competes globally against a few very large companies, primarily based in Japan or Europe.\nWithin the other three segments, there are a few companies whose markets and competition are international, particularly Belvac, Civacon, CRL, De-Sta-Co, Duncan, Norris, OPW Fueling Components, Ronningen-Petter, Tipper Tie\/Technopak, Tranter and Wittemann.\nInternational\nFor foreign sales and assets, see Note 3 to the Consolidated Financial Statements on page 28 of the 1994 Annual Report and information about the Company's Operations in Different Geographic Areas on page 33 of the 1994 Annual Report, which are incorporated herein by reference. Export sales of domestic operations were $560 million in 1994 and $413 million in 1993.\nAlthough international operations are subject to certain risks, such as price and exchange rate fluctuations and foreign governmental restrictions, Dover intends to increase its expansion into foreign markets, particularly with respect to its elevator business, as domestic markets mature.\nThe countries where most of Dover's foreign subsidiaries and affiliates are based are Canada, Great Britain and Germany.\nEnvironmental Matters\nDover believes its operations generally are in substantial compliance with applicable regulations. In some instances, particular plants and businesses have been the subject of administrative and legal proceedings with governmental agencies relating to the discharge or potential discharge of materials. Where necessary, these matters have been addressed with specific consent orders to achieve compliance. Dover believes that continued compliance will not have any material impact on the Company's financial position going forward and will not require significant capital expenditures.\nEmployees\nThe Company had approximately 23,000 employees as of December 31, 1994.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. DESCRIPTION OF PROPERTY\nThe number, type, location and size of the Company's properties are shown on the following charts, by segment.\nThe facilities are generally well maintained and suitable for the operations conducted. While the productive capacity of its plants is generally adequate for current\nneeds, several businesses, particularly Heil, Hill Phoenix and Universal, have completed or are committed to significant plant expansion to meet current demand.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nDover is party to a number of legal proceedings arising out of the normal course of its businesses. In general, most claims arise in connection with activities of its Elevator segment operations and certain of its other businesses which make products used by the public. For several years, Dover has also been involved with the Internal Revenue Service regarding tax assessments for the eight years ended December 31, 1989, which matters were settled in early 1995. In addition, matters have arisen under various environmental laws, as well as under local regulatory compliance agencies. For a further description of such matters, see Note 13 to the Consolidated Financial Statements on pages 32-33 of the 1994 Annual Report, which is incorporated herein by reference.\nBased on insurance availability, established reserves and periodic reviews of those matters, management is of the opinion that the ultimate resolution of current pending claims and known contingencies should not have a material adverse effect on Dover's financial position taken as a whole.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nAll officers are elected annually at the first meeting of the Board of Directors following the annual meeting of stockholders and are subject to removal at any time by the Board of Directors. The executive officers of Dover as of March 17, 1995, and their positions with the Company (and where relevant prior business experience) for the past five years are as follows:\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe principal market in which the Company's Common Stock is traded is the New York Stock Exchange. Information on the high and low prices of such stock and the frequency and the amount of dividends paid during the last two years, is set forth on Page 35 of the 1994 Annual Report and incorporated herein by reference.\nThe number of holders of record of the Registrant's Common Stock as of February 28, 1995 is approximately 3,200.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe information for the years 1984 through 1994 is set forth in the Annual Report on pages 38 and 39 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 set forth in the Annual Report on pages 36 and 37 is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information set forth in the Annual Report on pages 22 through 35 is 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\nThe information with respect to the directors of the Company required to be included pursuant to this Item 10 is included under the caption \"Election of Directors\" in the 1995 Proxy Statement relating to the 1995 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission (the \"Commission\") pursuant to Rule 14a-6 under the Securities Exchange Act of 1934, as amended, and is incorporated in this Item 10 by reference. The information with respect to the executive officers of the Company required to be included pursuant to this Item 10 is included under the caption \"Executive Officers of the Company\" in Part I of this Annual Report on Form 10-K.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information with respect to executive compensation required to be included pursuant to this Item 11 is included under the caption \"Executive Compensation\" in the 1995 Proxy Statement and is incorporated in this Item 11 by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information regarding security ownership of certain beneficial owners and management that is required to be included pursuant to this Item 12 is included under the captions \"General\" and \"Security Ownership\" in the 1995 Proxy Statement and is incorporated in this Item 12 by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information with respect to any reportable transaction, business relationship or indebtedness between the Company and the beneficial owners of more than 5% of the Common Stock, the directors or nominees for director of the Company, the executive officers of the Company or the members of the immediate families of such individuals that is required to be included pursuant to this Item 13 is included under the caption \"Election of Directors\" in the 1995 Proxy Statement and is incorporated in this Item 13 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 consolidated financial statements of Dover Corporation and its subsidiaries are set forth in the 1994 Annual Report, which financial statements are incorporated herein by reference:\n(A) Independent Auditors' Report.\n(B) Consolidated balance sheets as of December 31, 1994, 1993 and 1992.\n(C) Consolidated statements of earnings for the years ended December 31, 1994, 1993 and 1992.\n(D) Consolidated statements of retained earnings for the years ended December 31, 1994, 1993 and 1992.\n(E) Consolidated statements of cash flows for the years ended December 31, 1994, 1993 and 1992.\n(F) Notes to consolidated financial statements.\n(2). Financial Statement Schedules\nThe following financial statement schedule is included in Part IV of this report:\nIndependent Auditors' Report on Schedules and Consent\nII -- Valuation and Qualifying Accounts\nAll other schedules are not required and have been omitted.\n(b) No reports on Form 8-K were filed during the fourth quarter of the fiscal year ended December 31, 1994.\n(c) Exhibits:\n(3) (a) Restated Certificate of Incorporation and Amendments thereto.\n(b) By-laws, as amended.\n(4) The Company agrees to furnish to the Commission, upon request, copies of any instruments defining the rights of holders of long-term debt with respect to which the total amount of securities authorized does not exceed 10 percent of the total consolidated assets of the Company.\n(10)(a) 1984 Incentive Stock Option and Cash Performance Program.*\n(b) Employee Savings and Investment Plan.*\n(c) 1995 Incentive Stock Option and Cash Performance Program.*\n(13) Incorporated portions of Dover's Annual Report to Stockholders for its fiscal year ended December 31, 1994.\n(21) Subsidiaries of Dover.\n(23) Independent Auditors' consent.\n(24) Powers of Attorney.\n(27 Financial Data Schedules (in Edgar filing only).\n* Executive compensation plan or arrangement.\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.\nDOVER CORPORATION\nBy: ---------------------------- Thomas L. Reece President and 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 in the capacities and on the dates indicated.\n* By: \/s\/ Robert G. Kuhbach ----------------------- Robert G. Kuhbach Attorney-in-Fact\nSCHEDULE II\nDOVER CORPORATION AND SUBSIDIARIES\nValuation and Qualifying Accounts\nYears Ended December 31, 1994, 1993, 1992\nNotes:\n(1) Represents uncollectible accounts written off and reductions of prior years' over-provision less recoveries of accounts previously written off, net of additions and deductions relating to acquired and divested companies.\nEXHIBIT INDEX\n(3) (a) Restated Certificate of Incorporation and Amendments thereto, filed as Exhibit 3(a) to Form 10-K for year ended December 31, 1989, is incorporated by reference.\n(b) By-laws, as amended, filed as an Exhibit to Quarterly Report on Form 10-Q for period ended September 30, 1993, is incorporated by reference.\n(10) (a) 1984 Incentive Stock Option and Cash Performance Program, filed as an Exhibit 10(a) to Annual Report on Form 10-K for year ended December 31, 1984, is incorporated by reference.\n(b) Employee Savings and Investment Plan, filed as Exhibit 4.1 to Form S-8 filed under Securities Act of 1933 (Reg. 2-91561), is incorporated by reference.\n(c) 1995 Incentive Stock Option and Cash Performance Program, filed as Exhibit A to the 1995 Proxy Statement, is incorporated by reference.\n(13) Incorporated portions of Dover's Annual Report to Stockholders for its fiscal year ended December 31, 1994.\n(21) Subsidiaries of Dover.\n(23) Independent Auditors' Consent. (See Independent Auditors' Report on Schedules and Consent)\n(24) Powers of Attorney\n(27) Financial Data Schedules (in Edgar filing only).","section_15":""}
{"filename":"789073_1994.txt","cik":"789073","year":"1994","section_1":"Item 1. Business.\n(a) General development of business.\nRegistrant is a holding company with subsidiaries engaged in various businesses. Subsidiaries of Registrant are engaged in the manufacture and sale of cigarettes, cigars and smoking tobaccos, principally in the United Kingdom (\"U.K.\"), the distilled spirits business, and the manufacture and sale of various types of hardware and home improvement products, office products, supplies and accessories, golf products and, principally in the U.K., the businesses of retail distribution and houseware products.\nRegistrant was incorporated under the laws of Delaware in 1985 and until 1986 conducted no business. Prior to 1986, the businesses of Registrant's subsidiaries were conducted by American Brands, Inc., a New Jersey corporation organized in 1904 (\"American New Jersey\"), and its subsidiaries. American New Jersey was merged into The American Tobacco Company on December 31, 1985, and the shares of the principal first-tier subsidiaries formerly held by American New Jersey were transferred to Registrant. In addition, Registrant assumed all liabilities and obligations in respect of the public debt securities of American New Jersey outstanding immediately prior to the merger. Unless the context otherwise indicates, references herein to American Brands, Inc. and to Registrant for all periods prior to January 1, 1986 are to American New Jersey.\nAs a holding company, Registrant is a legal entity separate and distinct from its subsidiaries. Accordingly, the right of Registrant, and thus the right of Registrant's creditors (including holders of its debt securities and other obligations) and stockholders, to participate in any distribution of the assets or earnings of any subsidiary is subject to the claims of creditors of the subsidiary, except to the extent that claims of Registrant itself as a creditor of such subsidiary may be recognized, in which event Registrant's claims may in certain circumstances be subordinate to certain claims of others. In addition, as a holding company, a principal source of Registrant's unconsolidated revenues and funds is dividends and other payments from its subsidiaries. Registrant's principal subsidiaries currently are not limited by long-term debt or other agreements in their abilities to pay cash dividends or to make other distributions with respect to their capital stock or other payments to Registrant.\nIn recent years Registrant has been engaged in a strategy seeking to enhance the operations of its subsidiaries in certain major businesses. Pursuant to such strategy Registrant has made acquisitions in the distilled spirits business, the office products business and the hardware and home improvement products business, which acquisitions were financed at least in part by debt or debt securities convertible into Common Stock. In addition, Registrant has been making dispositions of businesses considered to be nonstrategic to its long-term operations. Since January 1, 1994, these dispositions have included the sale of American Franklin Company, Registrant's life insurance business, to American General Corporation for $1.17 billion on January 31, 1995, the sale of The American Tobacco Company\n(\"ATCO\"), Registrant's domestic tobacco subsidiary, to Brown & Williamson Tobacco Corporation, a subsidiary of B.A.T Industries p.l.c., for $1 billion on December 22, 1994, and the sale of Dollond & Aitchison Group PLC, a subsidiary of Gallaher Limited (\"Gallaher\"), for total consideration of $146 million on July 12, 1994. Registrant has announced that it is planning to dispose of a number of other non-strategic business and product lines, including U.K.-based Prestige and Forbuoys, for total consideration anticipated to be in the range of $150 - $175 million.\nRegistrant continues to pursue this strategy and in furtherance thereof explores other possible acquisitions in fields related to its major businesses. Registrant also cannot exclude the possibility of acquisitions in other fields or further dispositions. Although no assurance can be given as to whether or when any acquisitions or dispositions will be consummated, if agreement with respect to any acquisitions were to be reached, Registrant might finance such acquisitions by issuance of additional debt or equity securities. The additional debt from any acquisitions, if consummated, would increase Registrant's debt-to-equity ratio and such debt or equity securities might, at least in the near term, have a dilutive effect on earnings per share. Registrant also continues to consider other corporate strategies intended to enhance stockholder value. It cannot be predicted whether or when any such strategies might be implemented or what the financial effect thereof might be upon Registrant's debt or equity securities.\n(b) Financial information about industry segments.\nSee the table captioned \"Information on Business Segments\" in the Notes to Consolidated Financial Statements contained in the 1994 Annual Report to Stockholders of Registrant, which table is incorporated herein by reference.\n(c) Narrative description of business.\nThe following is a description of the business of the subsidiaries of Registrant in the industry segments of International Tobacco, Distilled Spirits, Hardware and Home Improvement Products, Office Products and Golf and Leisure Products, as well as in other industries as discussed under \"Other Businesses\" below. For financial information about the above industry segments, see the table captioned \"Information on Business Segments\" in the Notes to Consolidated Financial Statements contained in the 1994 Annual Report to Stockholders of Registrant, which table is incorporated herein by reference.\nInternational Tobacco\nGallaher is engaged primarily in the manufacture of tobacco products in the U.K. and the Republic of Ireland and sells these products principally in the European Community and the Commonwealth of Independent States (\"C.I.S.\"). Its sales of tobacco products are the largest in the U.K. Gallaher's share of consumer sales of cigarettes was 39.7% in 1994, as compared with 40.6% in 1993. For 1994, Gallaher held approximately 38.8% of the cigarette market (measured by sales to the trade) in the U.K., compared with approximately 41.7% and 41.5% for 1993 and 1992, respectively. Total unit sales of cigarettes to retail outlets and\nwholesalers in that country by foreign and domestic manufacturers decreased by 3.8% in 1994, increased by 1.9% in 1993 and decreased by 6.7% in 1992. Gallaher's total unit sales of cigarettes to retail outlets and wholesalers decreased by 10.4% in 1994, increased by 2.3% in 1993 and decreased by 10.9% in 1992. Year to year comparisons are distorted by changes in the timing of the U.K. budget. It is estimated that consumer demand declined about 3% in 1994. It is likely that unit sales will decline in 1995. In 1994, approximately 21.5% of Gallaher's total cigarette unit sales were to export markets, compared with 12.5% and 10% in 1993 and 1992, respectively. The 1994 increase in export sales reflects a full year's shipments of Benson and Hedges to Europe and increased shipments of other cigarette products to the C.I.S. Gallaher's principal export markets in 1994 were Greece, France, Germany and the C.I.S.\nGallaher's principal cigarette brands in the U.K. are Benson and Hedges Special Filter, Silk Cut, Berkeley Superkings, Benson and Hedges Superkings, Kensitas Club and Mayfair. Rights to some of these brands in various other countries are claimed by others. Gallaher also markets other tobacco products, among which are Hamlet cigars, Condor and Benson and Hedges Mellow Virginia smoking tobaccos and Old Holborn roll-your-own cigarette tobacco. Sales are made to retail outlets and wholesalers.\nOn June 30, 1993, ATCO acquired the Benson and Hedges cigarette trademark in Europe (other than the U.K. and Republic of Ireland, where Gallaher already owned the trademark) in exchange for the assignment of the Lucky Strike and Pall Mall overseas cigarette trademarks, $107.2 million in cash and future payments based on volumes. Immediately following the acquisition, Gallaher entered into an exclusive trademark license agreement with ATCO pursuant to which Gallaher manufactures and sells Benson and Hedges products in tax-paid European markets (other than the U.K. and the Republic of Ireland) and pays a royalty based on volumes. In May 1994, the above described Benson and Hedges trademark rights acquired by ATCO and related license agreement were transferred from ATCO to another subsidiary of Registrant.\nGallaher's principal competitors in the U.K. are Imperial Tobacco and Rothmans, the latter also distributing Philip Morris brands, and there is also competition from imported brands, which include those of R.J. Reynolds. Gallaher competes on the basis of the quality of its products and price and its responsiveness to consumer preferences.\nGallaher buys its leaf tobacco from foreign sources, including the United States (\"U.S.\"). In accordance with industry practice, large inventories of leaf tobacco are maintained by Gallaher. Sufficient inventories of finished product are maintained by Gallaher to respond promptly to orders.\nThere has been social and political unrest in Northern Ireland for many years. Notwithstanding this situation, there has been no consequential damage to Gallaher's manufacturing facilities there.\nIncreases in the U.K. excise duties on tobacco products in recent years have resulted in increases in the price of a typical pack of cigarettes as follows:\nEffective Amount of Date Increase --------- ---------\nMarch 16, 1993 10 pence November 30, 1993 11 pence November 29, 1994 10 pence January 1, 1995 6 pence\nIt is believed that the continuing impact of price increases, principally due to substantial excise tax increases in recent years, has led to an overall reduction in unit sales, greater price competition and increased trading down by consumers to lower priced brands. In addition, the U.K. Chancellor has announced that he intends to increase tobacco duties on average by at least 3% a year in excess of the inflation rate in future budgets. The effect of any further excise duty increases cannot be determined, but such increases and any new duties or taxes, if enacted, will likely add to the overall industry declines and the shift to lower priced brands.\nAn agreement took effect in January 1995 between representatives of the U.K. tobacco industry and the United Kingdom Health Ministers with respect to tobacco products and advertising and promotion. Among other things, the agreement provides for limitations on expenditures on cigarette brand poster advertisements, and for the removal of external cigarette advertising signs at retail premises by the end of 1996. Specified warning statements are required to be printed on cigarette packages and to appear in advertisements. Regulations promulgated in the U.K. in July 1991 to implement a Council Directive of the European Community require, effective January 1, 1992, that all tobacco product packaging bear the warning statement \"Tobacco Seriously Damages Health\", and that cigarette packaging bear additional warning statements and carry an indication of tar and nicotine yield. In addition, the Independent Television Commission Code of Advertising Standards and Practice of December 1990, implementing a Council Directive of the European Community, prohibits, effective October 1991, the advertising of all tobacco products on television in the U.K. Television and radio advertising of cigarettes has been prohibited in the U.K. for many years. Also, a Council Directive of the European Community has been proposed by the Commission of the European Community to provide for a total ban on tobacco advertising and sponsorship throughout the European Community and to restrict the use of tobacco brand names on non-tobacco products. In February 1992 the European Parliament, an advisory body, approved such a total ban. Any such Council Directive, even though approved by the European Parliament and the Commission, must be adopted by the Council of Ministers of the member states of the Community by a qualified majority of the member states prior to becoming effective and may be adopted so as to be binding or non-binding on individual member states.\nA Council Directive of the European Community adopted in May 1990 required that the tar yield of cigarettes marketed in the European Community should not be greater than 15 milligrams per cigarette after\nDecember 31, 1992, and 12 milligrams per cigarette after December 31, 1997. None of Gallaher's cigarette brands has had a tar yield in excess of 15 milligrams per cigarette since December 31, 1992.\nThe Treaty of Rome has as an objective the removal of certain restrictions on trading among the member states of the European Community, and since January 1, 1993 trading barriers within the Community have been eliminated in accordance with the Single European Act. Actions taken by the Community effective January 1, 1993 in connection with the implementation of the Single European Act include the removal of constraints on quantities of tobacco products for personal consumption that may be purchased duty-paid in one member state and carried to another without payment of additional duty. The Treaty of Rome, including implementation of the Single European Act and other actions taken by the Community, has resulted in increased competition in the market for tobacco products in the U.K. and in other member states and caused a shift in sales of tobacco products brands, particularly roll-your-own cigarette tobacco, from certain member states, such as the U.K., to other member states in which prices of those brands are lower, mainly as a result of excise taxes.\nOn July 18, 1989 the Council of Ministers enacted a non-binding Council Resolution, as part of its on-going \"Europe Against Cancer\" program, inviting member states to introduce legislation that would ban smoking in most public places. In addition, various member states have adopted legislation or non-binding guidelines that address smoking in public places.\nIt is not possible to state whether additional legislation, directives, regulations or action will be enacted, promulgated or taken in or by the U.K. or the European Community or the nature of any such legislation, directives, regulations or action, nor is it possible to predict the effect any such legislation, directives, regulations or action may have on the industry generally or on Gallaher.\nGallaher's subsidiary, Gallaher (Dublin) Limited (\"Dublin\"), manufactures and sells tobacco products in the Republic of Ireland. Dublin has the leading position with approximately 40% of the cigarette market (measured by sales to the trade) in 1994, compared with approximately 38.2% and 36.3% for 1993 and 1992, respectively. Dublin's principal cigarette brands are Benson and Hedges Special Filter and Silk Cut.\nSee Item 3, \"Legal Proceedings\".\nFor a description of the business of other subsidiaries of Gallaher, see \"Distilled Spirits\" and \"Other Businesses - Retail distribution - Housewares\".\nDistilled Spirits\nJim Beam Brands Co. (\"Beam\") and its predecessors have been distillers of bourbon whiskey since 1795. Beam, together with its subsidiaries, currently produces, or imports, and markets a broad line of distilled spirits, including bourbon and other whiskeys, cordials, gin, vodka and rum.\nBeam's nine leading brand names are Jim Beam bourbon, Windsor Canadian Supreme Whisky, Lord Calvert Canadian Whisky, DeKuyper cordials, Gilbey's gin, Gilbey's vodka, Kamchatka vodka, Wolfschmidt vodka and Kessler American Blended Whiskey. Principal bourbon brand names are Jim Beam, the largest-selling bourbon whiskey in the U.S. and in the world, Old Grand-Dad, the largest-selling bonded bourbon in the U.S. and in the world, Booker's, a super-premium bourbon whiskey, Old Taylor and Old Crow. Beam also produces Jim Beam Bourbon Whiskey and Cola, which combines bourbon with a cola soft drink. DeKuyper is the top-selling domestically-produced cordial line in the U.S. Beam also produces Chateaux and Leroux cordials, Beam's 8-Star Blend and Calvert Extra blended whiskeys, Dark Eyes vodka and Calvert Gin, and imports, in bottle or in bulk, Canada House Canadian whisky, The Dalmore and The Claymore scotch whiskies, Kamora coffee liqueur, Ronrico, Pusser's and San Tropique rums, Molinari Sambuca and Aalborg Akvavit.\nBeam's products are bottled in the U.S. and are sold through various distributors and, in the 18 \"control\" states (and one county) which have established government control of the purchase and distribution of alcoholic beverages, through state (or county, as the case may be) liquor authorities. Beam products are also bottled in ten foreign countries. Beam's international volume, which accounted for approximately 23% and 20% of its total unit sales in 1994 and 1993, respectively, is exported to over 80 foreign markets for sale through distributors and brokers.\nThe distilled spirits business is highly competitive, with many brands sold in the consumer market. Registrant believes there are approximately ten major competitors worldwide and many smaller distillers and bottlers. Registrant also believes that, based on unit sales, Beam is the second largest producer and marketer of distilled spirits in the U.S., with six million-case-selling brands, and is among the ten major competitors worldwide. Beam competes on the basis of the quality and price of its products and its responsiveness to consumer preferences.\nThe U.S. market for beverage alcohol has in recent years demanded an increasingly broad variety of products. Demand for distilled spirits, particularly for bourbon and other whiskeys, generally has declined resulting in increased price competition as competitors vie for market share. It is estimated that unit sales of distilled spirits (which do not include bulk sales) in the U.S. declined by approximately 3% in 1992, 2.2% in 1993 and 3% in 1994. Total unit sales of Beam's brands in the U.S. increased by approximately 35% in 1992, primarily due to an acquisition of trademarks for seven brands, decreased 4.6% in 1993 and decreased 5.7% in 1994. Total unit sales of Beam's brands, including export sales, increased 29% in 1992, primarily due to the trademark acquisition, decreased 1.7% in 1993 and decreased 2.4% in 1994. In 1994 and 1993, bourbon accounted for approximately 26% and 25% and other whiskeys for approximately 27% and 28% of Beam's total unit sales in the U.S., respectively.\nBeam's leading brands are owned by Beam and its subsidiaries, except that DeKuyper cordials are produced and sold by Beam in the U.S. under a perpetual license and Gilbey's gin and Gilbey's vodka are produced and sold by Beam in the U.S. under a long-term license and the Kamchatka brand is claimed by another entity in California.\nRaw materials for the production, storage and aging of Beam's products are principally corn, rye, barley malt and white oak barrels and are readily available from a number of sources, except that white oak barrels are available from only two major sources, one of which is owned by a competitor of Beam. Because whiskeys are aged for various periods, generally from four to eight years, Beam maintains, in accordance with industry practice, substantial inventories of bulk whiskey in warehouse facilities. In addition, whiskey production is generally scheduled to meet demand for four to eight years in the future, and production schedules are adjusted from time to time to bring inventories into balance with estimated future demand.\nIn Canada, a line of distilled spirits, including Windsor Canadian Supreme Whisky, is produced by a subsidiary, Alberta Distillers Limited. In Australia, a subsidiary, Fortune Brands Pty. Ltd., markets and distributes Beam's products as well as several brands under agency agreements.\nThe production, storage, transportation, distribution and sale of Beam's products are subject to regulation by federal, state and local authorities. Various local jurisdictions prohibit or restrict the sale of distilled spirits in whole or in part.\nIn the U.S., Canada and many other countries, distilled spirits are subject to excise taxes and\/or customs duties. State, local and other governmental authorities in such countries also impose taxes on distilled spirits. On January 1, 1991, the U.S. federal excise tax on distilled spirits was increased by one dollar per proof gallon, and proposals were made in 1994 to increase the federal excise tax on distilled spirits to help offset the cost of the Clinton Administration's health care proposals. In addition, there are proposals pending to increase or impose new distilled spirits taxes in various jurisdictions. It is believed that the federal excise tax increase in 1991 contributed to the decline in distilled spirits unit sales for the industry, including Beam. The effect of any future excise tax increases cannot be determined, but it is possible that any future tax increases would have an adverse effect on unit sales and add to continuing industry declines.\nThe Alcoholic Beverage Labeling Act of 1988 and regulations promulgated thereunder by the Bureau of Alcohol, Tobacco and Firearms of the Department of the Treasury (the \"Bureau\") require that containers of alcoholic beverages bottled on or after November 18, 1989 for sale or distribution in the U.S. or for sale, distribution or shipment to members of the United States Armed Forces abroad bear the statement: \"GOVERNMENT WARNING: (1) According to the Surgeon General, women should not drink alcoholic beverages during pregnancy because of the risk of birth defects. (2) Consumption of alcoholic beverages impairs your ability to drive a car or operate machinery, and may cause health problems.\" The Alcoholic Beverage Labeling Act of 1988 and the regulations prohibit any other requirement of a statement relating to alcoholic beverages and health on any beverage alcohol container or package containing such a container. If the Secretary of the Treasury, after appropriate investigation and consultation with the Surgeon General, finds available scientific information justifying a change in, addition to or deletion of all or part of the required statement, he is required to report such information to the United States Congress together with specific recommendations with respect\nthereto. On March 8, 1991, the Bureau issued a request for information to \"enable the agency to determine whether the wording . . . should be amended.\" Registrant understands that the Bureau has recommended that the current warning statements are sufficient and has reported its findings to the United States Congress. It is not possible to state whether any legislation or additional regulations or action imposing additional labeling or other warning statement requirements will be enacted, promulgated or taken in the U.S. or export markets served by Beam, nor is it possible to predict the effect, if any, that the existing labeling requirement or any additional labeling or other warning statement requirements may have on the industry generally or on Beam.\nSee Item 3, \"Legal Proceedings\".\nThe Whyte & Mackay Group PLC (\"Whyte & Mackay\"), a subsidiary of Gallaher, has its origins as a distiller of scotch whisky in 1844. During the fourth quarter of 1993, Whyte & Mackay completed the acquisition of Invergordon Distillers Group PLC (\"Invergordon\"), another distiller, blender and marketer of scotch whisky. Whyte & Mackay produces, bottles, markets and sells blended and single malt scotch whiskies, markets and sells vodka and sells scotch whisky in bulk. The principal brand names are Whyte & Mackay Special Reserve, The Claymore, The Dalmore, Cluny, Mackinlay, Isle of Jura and Bruichladdich scotch whiskies, Glayva scotch whisky liqueur and Vladivar vodka. Whyte & Mackay believes that in both 1993 and 1992, its shares of the U.K. scotch whisky and vodka markets were approximately 14% and 11%, respectively. In 1994, its shares were approximately 25% of the U.K. whisky market, reflecting the inclusion of Invergordon, and 10% of the U.K. vodka market. Whyte & Mackay's products are sold in the U.K. through its own sales force and outside the U.K., through independent distributors.\nIt is estimated that total case sales of scotch whisky in the U.K. decreased by approximately 5% in 1992, increased by approximately 5% in 1993, and decreased by approximately 1% in 1994. Worldwide scotch whisky sales increased by approximately 1% and 7% in 1992 and 1993, respectively, and by approximately 4% in 1994. Whyte & Mackay's total case sales of scotch whisky in the U.K. declined by approximately 3% in 1992, and increased by approximately 20% and 38% in 1993 and 1994, respectively, reflecting the inclusion of Invergordon. Whyte & Mackay's total case sales of scotch whisky worldwide (including shipments of bulk whisky exported for bottling) increased by approximately 1% in 1992, and increased by approximately 24% and 68% in 1993 and 1994, respectively, reflecting the inclusion of Invergordon. During 1994, 73% of Whyte & Mackay's total case sales were derived from scotch whisky. In addition, 53% of Whyte & Mackay's total scotch whisky case sales were made in the U.K. in 1994.\nBlended scotch whiskies comprise a variety of grain and malt whiskies blended to provide a consistent product. The industry is therefore dependent on a high level of trading of whiskies between whisky companies. Whyte & Mackay owns and operates seven malt whisky distilleries and one grain whisky distillery in Scotland whose products are used in the production of Whyte & Mackay's blended whiskies and for trading purposes. Production is also bottled as malt whiskies and as a single grain whisky from individual distilleries.\nWhyte & Mackay has recently discontinued its production at three distilleries - Tamnavulin, Tullibardine and Bruichladdich - for a prolonged period. The single malt whiskies from these three distilleries will continue to be available for sale as there are sufficient inventories to meet several years' requirements. These distilleries will also continue to provide warehousing facilities.\nWhyte & Mackay imports and markets in the U.K. a number of brands, including Jim Beam bourbon, under agency arrangements. In the U.S., Beam is an importer and distributor of Whyte & Mackay's brands.\nThe United Kingdom Finance Acts, 1993 and 1994 did not provide for any increase in the excise duties on distilled spirits. A supplementary U.K. budget introduced on December 8, 1994, effective January 1, 1995, provided for an increase in the excise duties on distilled spirits equivalent to 26 pence on the price of a typical 700 milliliter bottle of scotch whisky. The effect of the recent and any future U.K. or other excise duty increases cannot be determined, but it is possible that any tax increases would have an adverse effect on unit sales, add to the continuing industry decline and lead to an increase in already competitive pricing pressures.\nHardware and Home Improvement Products\nMasterBrand Industries, Inc. (\"MasterBrand\") is a holding company for subsidiaries in the Hardware and Home Improvement Products business. Subsidiaries include Moen Incorporated (\"Moen\"), Master Lock Company (\"Master Lock\"), Aristokraft, Inc. (\"Aristokraft\") and Waterloo Industries, Inc. (\"Waterloo\").\nMoen manufactures and packages single- and two-handle faucets, sinks and plumbing accessories and parts and a wide variety of plumbing supply and repair products in the U.S. and East Asia. Faucets are sold under a variety of tradenames, including Moen, Moentrol, Touch Control, One-Touch, Riser, Monticello, Concentrix, Chateau, Legend, Pulsation and Sani-Stream, and other products are sold under the Moen, Chicago Specialty, Dearborn Brass, Wrightway, Anchor Brass and Hoov-R-Line brand names. Some of the plumbing parts and repair products are purchased from other manufacturers. Products are sold principally in the U.S. and also in Canada, East Asia and Mexico. Sales are made through Moen's own sales force and independent manufacturers' representatives primarily to wholesalers, mass merchandisers and home centers and also to industrial distributors, repackagers and original equipment manufacturers.\nLegislation has been introduced in the U.S. Congress that would if enacted endorse a voluntary industry standard that establishes maximum allowable leachate levels of certain substances, including lead from plumbing fittings and pumps, and which would require EPA to evaluate the effectiveness of the standard within twelve months of enactment. Legislation that was introduced previously in the Congress and is expected to be introduced in the current session of the Congress would if enacted require a reduction in the lead content of plumbing fittings and pumps used for drinking water, if an appropriate maximum leachate standard for lead is not voluntarily adopted. In September 1994, the EPA endorsed a voluntary standard that establishes maximum leachate levels of those substances, including lead from new plumbing fittings and fixtures. It is not\npossible to predict whether federal, state or local legislation, regulations or action will be enacted, promulgated or taken or the nature of any such legislation, regulations or action, nor is it possible to predict the effect any such legislation, regulations or action may have on the industry generally or on Moen.\nMaster Lock manufactures key-controlled and combination padlocks, chain and cable locks, bicycle locks, built-in locker locks and other specialty security devices, and also manufactures door lock sets and door hardware. Sales of products designed for consumer use are made to wholesale distributors and to hardware and other retail outlets, while sales of lock systems are made to industrial and institutional users, original equipment manufacturers and retail outlets. Most sales are brokered through independent manufacturers' representatives, primarily in the U.S. and Canada.\nAristokraft manufactures kitchen cabinets and bathroom vanities. Stock and semi-custom cabinets are sold under the brand names of Aristokraft and Decora, respectively. Sales under the Aristokraft brand name are made in the U.S. primarily through stocking distributors for resale to kitchen and bath specialty dealers, lumber and building material dealers, remodelers and builders. Decora products are sold primarily to kitchen and bath specialty dealers and regional home centers.\nWaterloo is the world's leading manufacturer of tool storage products, consisting primarily of high quality steel tool boxes, tool chests, workbenches and related products manufactured for private label sale by one of the largest national retailers in the U.S. Similar products are sold under the Waterloo and All American brand names to specialty industrial and automotive dealers, mass merchandisers, home centers and hardware stores. Waterloo also manufactures hospital carts and storage units and sells such products to institutional users.\nSee Item 3, \"Legal Proceedings\".\nOffice Products\nACCO World Corporation (\"ACCO\") and its subsidiaries are engaged worldwide in designing, developing, manufacturing and marketing a wide variety of traditional and computer-related office products and supplies, time management products, presentation aids, workstation furniture and accessories. Products are manufactured by subsidiaries, joint ventures and licensees of ACCO, or manufactured to such subsidiaries' specification, throughout the world, principally in the U.S., Canada, Western Europe and Australia.\nACCO USA, Inc., a subsidiary of ACCO, manufactures binders, fasteners, paper clips, punches, staples, stapling equipment and storage products, as well as computer binders, supplies and accessories, in the U.S. ACCO Canada Inc., a subsidiary of ACCO, manufactures and distributes a similar range of office products in Canada. Principal brands include ACCO products, Swingline staples and stapling equipment, Wilson Jones binders and columnar pads and Perma Products corrugated board storage products. Products are sold throughout the U.S. and Canada by their respective sales forces to office products wholesalers, retailers and\ndealers and are sold to mass merchandisers either directly or brokered through independent manufacturers' representatives.\nSubsidiaries of ACCO Europe PLC, a subsidiary of ACCO, manufacture and distribute a wide range of office supplies and machines and storage and retrieval filing systems. Their products are sold primarily in the U.K., Ireland, Western Europe and Australia through their own sales forces and distributors.\nDay-Timers, Inc., a subsidiary of ACCO, manufactures personal organizers and planners in the U.S. and is estimated by management to be the leading direct marketer of time management aids in North America. Products are sold in the U.S. by Day-Timers, and in Canada, Australia and Europe by subsidiaries, through direct mail advertising and catalogs to consumers and businesses. In addition, products are sold through ACCO USA, Inc. to retailers and mass merchandisers. A subsidiary also conducts time management seminars for personnel of corporations, as well as other entities throughout the U.S., Canada, Australia and Europe. Another subsidiary markets, principally in the U.S., art and craft supplies primarily to schools.\nVogel Peterson Furniture Company, a subsidiary of ACCO, manufactures in the U.S. and distributes chairs, workstation components, office coat racks and partitions. Products are sold in the U.S. and Canada to office product and furniture dealers.\nKensington Microware Limited, a subsidiary of ACCO, designs, develops and markets a range of computer accessories and supplies, principally in the U.S.\nGolf and Leisure Products\nAcushnet Company (\"Acushnet\") is comprised of the Titleist and Foot-Joy Worldwide Division and the Acushnet Golf Division. The Titleist and Foot-Joy Worldwide Division is a leading manufacturer and distributor of golf balls, golf shoes, golf clubs, and golf gloves. Other products include bags, carts, dress and athletic shoes as well as socks and accessories. Acushnet's leading brands are Titleist and Pinnacle golf balls, DCI and Bulls Eye golf clubs, Classics and DryJoys golf shoes and Sta-Sof and Weather-Sof golf gloves. Acushnet products are sold primarily to golf pro shops throughout the U.S. by the Titleist and Foot-Joy Worldwide sales force and to sporting goods stores and mass merchants through the Acushnet Golf Division. Sales are made in the U.K., Canada, Germany, Austria, Denmark, France, Sweden and The Netherlands through subsidiaries, in Japan through a majority-owned joint venture, in Ireland through a U.K. branch and outside these areas through distributors or agents.\nOther Businesses\nOther businesses includes the retail distribution and houseware products businesses of Gallaher subsidiaries. Registrant has announced that it plans to dispose of the houseware products business and a significant portion of its retail distribution business in 1995.\nRetail Distribution\nForbuoys PLC, a subsidiary of Gallaher, operates approximately 700 retail newspaper, tobacco, confectionery and stationery outlets in the U.K. TM Group PLC, a subsidiary of Gallaher, is the largest vending machine operator in the U.K., and also operates in France and Germany; the company dispenses cigarettes, snack foods and hot drinks through approximately 41,500 on-site machines. Another subsidiary of Gallaher, Marshell Group Limited, operates approximately 165 kiosks that sell tobacco products primarily in large stores in the U.K.\nHousewares\nThe Prestige Group PLC (\"Prestige\"), a subsidiary of Gallaher, manufactures and sells houseware products, including cookware, bakeware, kitchen tools and carpet sweepers, in the U.K. and elsewhere. Its principal brand names are Prestige, Skyline and Ewbank. A subsidiary of Registrant is operated in conjunction with Prestige and manufactures and sells kitchen utensils in the U.S.\nOther Matters\nEmployees\nRegistrant and its subsidiaries had, as of December 31, 1994, the following number of employees, a substantial number of whom were covered by collective bargaining agreements with various unions:\nRegistrant and subsidiaries excluding Gallaher: --------------------------- Distilled Spirits 1,430 Hardware and Home Improvement Products 8,560 Office Products 8,700 Golf and Leisure Products 3,200 Corporate Headquarters 200 ------ 22,090 ------ Gallaher Limited: ---------------- Tobacco Products 3,990 Distilled Spirits 1,100 Other Businesses: Retail Distribution 6,610 Housewares 930 Other 100 ------ 12,730 ------ Total 34,820 ======\nEnvironmental matters\nRegistrant and its subsidiaries are subject to federal, state and local laws and regulations concerning the discharge of materials into the environment and the handling, disposal and clean-up of waste materials and otherwise relating to the protection of the environment. While it is not possible to quantify with certainty the potential impact of actions regarding environmental matters, particularly remediation and other compliance efforts that Registrant's subsidiaries may undertake in the future, in the opinion of management of Registrant, compliance with the present environmental protection laws, before taking into account estimated recoveries from third parties, will not have a material adverse effect upon the capital expenditures, financial condition, results of operations or competitive position of Registrant and its subsidiaries.\nSee Item 3, \"Legal Proceedings\".\n(d) Financial information about foreign and domestic operations and export sales.\nRegistrant's subsidiaries operate in the United States, Europe (principally the U.K.) and other areas (principally Canada and Australia). See the table captioned \"Information on Business Segments\" contained in the 1994 Annual Report to Stockholders of Registrant, which table is incorporated herein by reference. As is disclosed in such table, Registrant has sizable investments in, and derives substantial income from, Europe (principally the U.K.), and, therefore, changes in the value of foreign currencies (principally sterling) can have a material effect on Registrant's financial statements when expressed in dollars.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nRegistrant leases its principal executive offices in Old Greenwich, Connecticut. The following is a description of properties of Registrant's subsidiaries.\nInternational Tobacco\nThe principal properties of Gallaher and its subsidiaries include Gallaher's head office in Weybridge, Surrey, England, a distribution facility in Crewe, Cheshire, England, office and warehouse facilities in Northolt, Middlesex, England, a factory in Northern Ireland for the manufacture of cigarettes and smoking tobaccos, a factory in England for the manufacture of cigarettes and a factory in Wales for the manufacture of cigars. Each of these properties is owned by Gallaher or one of its subsidiaries. The principal properties of Gallaher and its subsidiaries also include a factory in the Republic of Ireland, owned and operated by Gallaher (Dublin) Limited, for the manufacture of cigarettes and smoking tobaccos. Gallaher also has a research laboratory in the Northern Ireland factory complex. For a description of properties of other subsidiaries of Gallaher, see \"Distilled Spirits\" and \"Other Businesses\".\nDistilled Spirits\nBeam leases its executive offices in Deerfield, Illinois, and a subsidiary leases an office in Burnaby, British Columbia. Beam and its subsidiaries own and operate four bottling plants, three distilleries and 93 warehouses for the aging of bulk whiskies, and lease and operate 16 regional sales offices and several warehouses for the storage of promotional material, all located in the U.S., Australia and Canada. Beam also owns and operates approximately 70 U.S. bonded warehouses. Whyte & Mackay leases its head office in Glasgow, Scotland and a subsidiary, Invergordon, owns its head office in Edinburgh, Scotland. Whyte & Mackay and its subsidiaries own and operate seven malt distilleries, one grain distillery and three blending and bottling plants in Scotland.\nHardware and Home Improvement Products\nMasterBrand leases its executive offices in Deerfield, Illinois and a subsidiary, Moen, owns its executive offices in North Olmsted, Ohio. Principal properties of subsidiaries of MasterBrand include eighteen plants, three distribution centers and one warehouse owned and operated in the U.S. A 50%-owned joint venture in Taiwan owns and operates one plant. In addition, subsidiaries of MasterBrand lease and operate three plants and four warehouses in the U.S. and eleven distribution centers, of which eight are in the U.S. and one is in each of Canada, Japan and Mexico.\nOffice Products\nACCO leases its executive offices in Deerfield, Illinois. Principal properties of subsidiaries of ACCO include eight plants owned and operated in the U.S., seven in the U.K., and one in each of Germany, Italy, France, Australia, The Netherlands, the Republic of Ireland and Mexico. In addition, subsidiaries of ACCO lease and operate eleven facilities in the U.S., five in the U.K., three in Canada, two in Australia and one in each of France, Germany and Italy. Of these leased facilities, (i) four in the U.S., two in the U.K., three in Canada and one in each of Australia, Germany and France, are combined manufacturing and distribution facilities, (ii) five in the U.S., three in the U.K. and one in each of Italy and Australia, are distribution facilities and (iii) two in the U.S. are manufacturing facilities.\nGolf and Leisure Products\nAcushnet owns a combined executive office and research and development facility and a warehouse in Fairhaven, Massachusetts. In addition, it owns and operates four plants, a warehouse and a test facility, all located in the U.S. Acushnet also leases three warehouses, a test facility, a retail store, and a research and development facility, all located in the U.S. Acushnet also leases an office in Taiwan. A subsidiary of Acushnet leases two combined sales office and warehouse facilities in Canada. Other Acushnet subsidiaries own and operate a plant and a warehouse in England, lease a sales office and warehouse in each of Germany, France and Sweden and lease a sales office in each of Austria, Denmark, The Netherlands and the Republic of Ireland. Acushnet's majority- owned joint venture in Japan leases two sales offices and a warehouse facility there. Acushnet's majority-owned joint ventures in Thailand lease and operate two plants there.\nOther Businesses\nPrestige leases its head office in Egham, England and owns and operates a plant in Burnley, England. Prestige also owns and operates a plant in each of Spain and Australia. A subsidiary of Registrant, which is operated in conjunction with Prestige, leases one plant in North Carolina.\nRegistrant and its subsidiaries are of the opinion that their properties are suitable to their respective businesses and have productive capacities adequate to the needs of such businesses.\nItem 3.","section_3":"Item 3. Legal Proceedings.\n(a) (i) Registrant's former subsidiary, The American Tobacco Company (\"ATCO\"), and other leading tobacco manufacturers have been sued by parties seeking damages for cancer and other ailments claimed to have resulted from tobacco use and by certain asbestos manufacturers seeking unspecified amounts in indemnity or contribution in third-party actions against all or most of the major domestic tobacco manufacturers. Although there was a jury award which was overturned on appeal against a tobacco manufacturer in one case, there has been no actual recovery of damages to date in any such action against the tobacco manufacturers. Registrant has been named as a defendant in some of the cases brought against ATCO and is currently named as a defendant in six of these cases, two of which are brought by individuals, one alleging health ailments caused by the inhalation of environmental tobacco smoke (Dunn, described below) and the other alleging chronic lung disease and other medical and psychological problems associated with addiction to cigarettes (Michener, described below); three of which are brought by the attorneys general of Mississippi (Moore, described below), West Virginia (McGraw, described below) and Florida (State of Florida, described below), respectively, seeking unspecified compensatory and punitive damages and various forms of equitable relief, including restitution of the expenditures by the state for the cost of medical care provided by the state to its citizens for numerous diseases allegedly caused by cigarettes and other tobacco products; and one of which is an alleged class action on behalf of all members of the class allegedly addicted to cigarettes through the manipulation of nicotine levels (Castano, described below).\nThe following sets forth the principal parties to the above- described six pending proceedings in which Registrant is currently named as a defendant, the court in which such proceedings are pending and the date such proceedings were instituted against Registrant: Castano v. The American Tobacco Company, Inc., et al., United States District Court for the Eastern District of Louisiana, March 29, 1994; Dunn v. RJR Nabisco Holdings Corporation, et al., Superior Court State of Indiana, County of Delaware, August 23, 1993; McGraw v. The American Tobacco Company, et al., Circuit Court of Kanawha County, State of West Virginia, November 1, 1994; Michener v. The American Tobacco Company, et al., District Court of Oklahoma County, State of Oklahoma, December 16, 1994; Moore v. The American Tobacco Company, et al., Chancery Court of Jackson County, State of Mississippi, June 1, 1994; and State of Florida v. The American Tobacco Company, et al., Circuit Court of Palm Beach County, State of Florida, March 5, 1995.\nIt has been reported that certain groups of attorneys, and attorneys general of various states, are interested in promoting product liability and other suits against the tobacco manufacturers. It has also been reported that other claims against the tobacco manufacturers may be made seeking damages for alleged injuries claimed to have resulted from exposure to tobacco smoking of others.\nOn December 22, 1994, Registrant sold ATCO to Brown & Williamson Tobacco Corporation, a wholly-owned subsidiary of B.A.T Industries p.l.c. Brown & Williamson Tobacco Corporation and ATCO have agreed to indemnify Registrant against claims arising from smoking and health and fire safe cigarette matters relating to the tobacco business of ATCO.\nRegistrant's counsel have advised that, in their opinion, on the basis of their investigations generally with respect to suits and claims of this character, Registrant has meritorious defenses to the above-mentioned actions and threatened actions. The actions will be vigorously contested.\n(ii)(A) Dean v. Gallaher Limited is an action commenced in the High Court of Justice in Northern Ireland in which plaintiff seeks unspecified damages including lost income for claimed personal injuries allegedly related to cigarette smoking. In March 1988, plaintiff obtained Legal Aid to proceed up to the point of trial. He served his Writ of Summons in August 1988 and his Statement of Claim in August 1989. Plaintiff filed an amended Statement of Claim on October 6, 1993. Gallaher subsequently filed a motion to strike from the amended Statement of Claim a predecessor to Gallaher, Hergall (1981) Limited (In Liquidation) (\"Hergall\"), as a second defendant in the action. The motion was heard on November 30, 1993 and was granted on March 9, 1994. Plaintiff served a Writ of Summons on Hergall on December 1, 1993 and a Statement of Claim against Hergall on February 22, 1994. Plaintiff's lawyers also purported to re-amend the Statement of Claim against Gallaher. On March 11, 1994, Gallaher and Hergall filed applications to strike certain parts of plaintiff's Statements of Claim in both actions as irrelevant, which were referred to the High Court for decision. These applications were denied by Mr. Justice Nicholson on May 31, 1994, with leave to appeal. Gallaher's and Hergall's appeal of this decision was heard in December, 1994, and refused by a unanimous panel of the Court of Appeal. After the Court of Appeal denied Gallaher and Hergall leave to appeal, Gallaher and Hergall filed a petition for leave to appeal with the House of Lords on March 17, 1995. A decision on this appeal is now pending. In addition, the companies obtained orders extending the time in which their defenses must be served until after the hearing of the \"strike-out\" applications.\n(B) On January 31, 1995, the English Legal Aid Board granted limited legal aid certificates to approximately 200 claimants seeking to bring proceedings against tobacco manufacturers for the harm they have allegedly suffered through smoking cigarettes. This is the first time that English legal aid has been granted to support a significant number of claims of this type. These applications were first filed with the Newcastle Legal Aid Board in England in the summer of 1992, and were originally denied on September 2, 1992. Thereafter, applicants successfully petitioned for judicial review of that decision, and on June 24, 1994, the High Court ruled that the Legal Aid Board had applied inconsistent procedural standards in refusing applicants' legal aid, and ordered that the applications be remanded for reconsideration. The Legal\nAid Board began considering the remanded applications on December 22, 1994, and announced its decision on January 31, 1995.\n(C) In Brennan v. Gallaher Limited, pending in the High Court of Justice in Northern Ireland, plaintiff, a former employee of Gallaher, seeks unspecified damages for claimed personal injuries from the alleged \"provision of cigarettes for [sic] the plaintiff\". Plaintiff served her Writ of Summons in October 1990, and no Statement of Claim has been received. On March 22, 1994, plaintiff served a summons seeking leave to substitute Hergall as the named defendant in the action. This motion was granted on March 24, 1995.\n(D) Further, Gallaher has received a letter before action dated October 11, 1994, from a solicitor in Scotland stating that a client, Edward Havelin, has instructed him to make a claim against Gallaher for Buerger's disease claimed to have been caused by smoking. No formal claim has been received. Mr. Havelin recently applied to the Scottish Legal Aid Board for legal aid to pursue this claim against Gallaher and another tobacco manufacturer. On February 21, 1995, Gallaher submitted representations in opposition to this application, and the matter is now pending review by the Scottish Legal Aid Board.\n(E) Registrant's counsel have advised that, in their opinion, on the basis of their investigations generally with respect to suits and claims of this character, Gallaher has meritorious defenses to these actions and claims, and they will be vigorously defended on the merits.\n(b) People of the State of California ex rel. Daniel E. Lungren, Attorney General of the State of California v. American Standard, et al., is an action commenced on December 15, 1992 against Moen and 15 other faucet manufacturers and distributors in the Superior Court of the State of California, County of San Francisco. The Attorney General of California alleges violations of California Health and Safety Code Sections 25249.5 and 25249.6 (Proposition 65), as well as two violations of the California Business and Professions Code Section 17200, for alleged intentional discharge of lead from faucets to sources of drinking water and failure to provide clear and reasonable warnings to consumers, and seeks civil penalties of up to $2,500 per day per violation on each cause of action. The Attorney General also seeks injunctive relief prohibiting further discharges of lead from faucets into drinking water sources or, in the alternative, requiring clear and reasonable warnings regarding lead in faucets, restitution to consumers and other relief. A related action against these companies and others, including Moen, MasterBrand and Registrant, has also been brought by environmental groups in the same court, Natural Resources Defense Council, et al., v. Price Pfister, Inc., et al. In that case, plaintiffs allege the same claims as the Attorney General's action and also allege certain other violations, including violation of the Consumer Legal Remedies Act, Civil Code Section 1750. The plaintiffs seek similar injunctive relief and establishment of a public information campaign concerning lead from faucets, restitution and disgorgement of funds obtained from California consumers by unlawful or unfair business practices and establishment of a fund for medical monitoring of infants exposed to lead from faucets. The plaintiffs also seek compensatory damages, statutory penalties, punitive damages, reasonable attorneys' fees and costs. On July 26, 1993, an Order was filed whereby plaintiffs in Natural Resources Defense Council dismissed without\nprejudice the action as to MasterBrand and Registrant. The plaintiffs in both actions moved for injunctive relief to require certain of the defendants to post prescribed warnings. In Natural Resources Defense Council, the court refused to issue any order regarding the motion pending resolution of defendants' demurrer challenging plaintiffs' standing to bring the action, which demurrer was filed on April 16, 1993. By order dated May 10, 1994, the court denied defendants' demurrer based on standing but ruled plaintiffs are not entitled to restitution or compensatory damages. Defendants' motion to dismiss or stay this case was denied on October 21, 1994. In Lungren, on May 17, 1993, the court issued an order requiring certain of the defendants in the action, including Moen, to provide warnings in accordance with the protocol voluntarily proposed by the defendants. The court made no finding of liability for failure to warn. On April 16, 1993, defendants filed a demurrer in respect of plaintiffs' claims based on defendants' alleged intentional discharge of lead from faucets to sources of drinking water. A hearing on the demurrer has been scheduled for March 30, 1995. A trial date of January 2, 1996 has been set in the Lungren matter; a trial date of March 4, 1996 has been set in the Natural Resources Defense Council matter. These actions are being vigorously contested.\n(c) It is not possible to predict the outcome of the pending litigation, but management believes that there are meritorious defenses to the pending actions and that the pending actions will not have a material adverse effect upon the results of operations, cash flow or financial condition of the Registrant. See the note captioned \"Pending Litigation\" in the Notes to Consolidated Financial Statements contained in the 1994 Annual Report to Stockholders of Registrant, which note is incorporated herein by reference.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNone.\nItem 4a. Executive Officers of the Registrant.\nThe name, present positions and offices with Registrant, principal occupations during the past five years and age of each of Registrant's present executive officers are as follows:\nPresent positions and offices with Registrant and principal occupations Name during the past five years Age ---- ------------------------------------ ---\nThomas C. Hays Chairman of the Board and Chief Executive 59 Officer of Registrant since January 1995; President and Chief Operating Officer of Registrant prior thereto\nJohn T. Ludes President and Chief Operating Officer of 58 Registrant since January 1995; Group Vice President of Registrant, President and Chief Executive Officer of Acushnet prior thereto\nPresent positions and offices with Registrant and principal occupations Name during the past five years Age ---- ------------------------------------ ---\nRobert L. Plancher Senior Vice President and Chief Accounting 63 Officer of Registrant\nRobert J. Rukeyser Senior Vice President -- Corporate Affairs 52 of Registrant since 1990; Vice President -- Operations of Registrant prior thereto\nGilbert L. Klemann, II Senior Vice President and General Counsel 44 of Registrant since 1991; Vice President and Associate General Counsel of Registrant during 1991; Partner, Chadbourne & Parke (law firm) prior thereto\nDudley L. Bauerlein, Jr. Senior Vice President and Chief Financial 48 Officer since January 1995; Vice President and Treasurer of Registrant prior thereto\nSteven C. Mendenhall Senior Vice President and Chief 46 Administrative Officer of Registrant since January 1995; Vice President and Chief Administrative Officer from 1993 through 1994; Vice President -- Human Resources prior thereto\nRandall W. Larrimore Vice President -- Hardware and Home 47 Improvement Products of Registrant; President and Chief Executive Officer of MasterBrand\nBarry M. Berish Vice President -- Distilled Spirits of 62 Registrant since 1990; Chairman of the Board and Chief Executive Officer of Beam since 1993; President and Chief Executive Officer of Beam prior thereto\nNorman H. Wesley Vice President -- Office Products of 45 Registrant since 1990; President and Chief Executive Officer of ACCO since 1990; President and Chief Operating Officer of ACCO prior thereto\nCharles H. McGill Vice President -- Corporate Development 53 since February 1995; Corporate Vice President -- Acquisitions of The Dun & Bradstreet Corporation prior thereto\nMr. Peter M. Wilson, who has been a member of the Executive Committee of the Board of Directors of Registrant and Chairman and Chief Executive of Gallaher since February 1, 1994, is deemed to be an executive officer of Registrant for the purposes of this Item 4a. Mr. Wilson was\nDeputy Chairman of Gallaher and Chairman and Chief Executive of Gallaher Tobacco Limited prior thereto. His age is 53.\nIn the case of each of the above-listed executive officers, the occupation or occupations given were his principal occupation and employment during the period or periods indicated. None of such executive officers is related to any other such executive officer. None was selected pursuant to any arrangement or understanding between him and any other person. All executive officers are elected annually.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nSee the information in the tables captioned \"Quarterly Common Stock Dividend Payments\" and \"Quarterly Composite Common Stock Prices\" and the discussion relating thereto contained in the 1994 Annual Report to Stockholders of Registrant, which information and discussion are incorporated herein by reference. On March 17, 1995, there were 59,740 record holders of Registrant's Common Stock, par value $3.125 per share.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nSee the information in the table captioned \"Eleven-Year Consolidated Selected Financial Data\" contained in the 1994 Annual Report to Stockholders of Registrant, 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 discussion and analysis under the captions \"Results of Operations\" and \"Financial Condition\" contained in the 1994 Annual Report to Stockholders of Registrant, which discussion and analysis are incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSee the information in the Consolidated Balance Sheet, Consolidated Statement of Income, Consolidated Statement of Cash Flows, Consolidated Statement of Common Stockholders' Equity, Notes to Consolidated Financial Statements and Report of Independent Accountants contained in the 1994 Annual Report to Stockholders of Registrant, which information is incorporated herein by reference. For unaudited selected quarterly financial data, see the table captioned \"Quarterly Financial Data\" contained in the 1994 Annual Report to Stockholders of Registrant, which table 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.\nSee the information under the caption \"Election of Directors\" contained in the Proxy Statement for the Annual Meeting of Stockholders of Registrant to be held on May 2, 1995, which information is incorporated herein by reference. See also the information with respect to executive officers of Registrant under Item 4a of Part I hereof, which information is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nSee the information up to but not including the subcaption \"Report of the Compensation and Stock Option Committee on Executive Compensation\" under the caption \"Executive Compensation\" contained in the Proxy Statement for the Annual Meeting of Stockholders of Registrant to be held on May 2, 1995, which information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nSee the information in the table and notes related thereto and in the third to last paragraph under the caption \"Election of Directors\" and the information under the caption \"Certain Information Regarding Security Holdings\" contained in the Proxy Statement for the Annual Meeting of Stockholders of Registrant to be held on May 2, 1995, which information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nSee the information in the second to last paragraph under the caption \"Election of Directors\" contained in the Proxy Statement for the Annual Meeting of Stockholders of Registrant to be held on May 2, 1995, 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) Financial Statements, Financial Statement Schedules and Exhibits.\n(1) Financial Statements (all financial statements listed below are of Registrant and its consolidated subsidiaries)\nConsolidated Balance Sheet as of December 31, 1994 and 1993 contained in the 1994 Annual Report to Stockholders of Registrant is incorporated herein by reference.\nConsolidated Statement of Income for the years ended December 31, 1994, 1993 and 1992 contained in the 1994 Annual Report to Stockholders of Registrant is incorporated herein by reference.\nConsolidated Statement of Cash Flows for the years ended December 31, 1994, 1993 and 1992 contained in the 1994 Annual Report to Stockholders of Registrant is incorporated herein by reference.\nConsolidated Statement of Common Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992 contained in the 1994 Annual Report to Stockholders of Registrant is incorporated herein by reference.\nNotes to Consolidated Financial Statements contained in the 1994 Annual Report to Stockholders of Registrant are incorporated herein by reference.\nReport of Independent Accountants contained in the 1994 Annual Report to Stockholders of Registrant is incorporated herein by reference.\n(2) Financial Statement Schedules\nSee Index to Financial Statement Schedules of Registrant and subsidiaries at page, which Index is incorporated herein by reference.\n(3) Exhibits\n3(i). Certificate of Incorporation of Registrant as in effect on the date hereof is incorporated herein by reference to Exhibit 3a2 to the Quarterly Report on Form 10-Q of Registrant dated May 14, 1990.\n3(ii). By-laws of Registrant as in effect on the date hereof are incorporated herein by reference to Exhibit 3(ii)b to the Current Report on Form 8-K of Registrant dated February 8, 1995.\n10a1. Article XII (\"Incentive Compensation\") of the By-laws of Registrant is incorporated herein by reference to Exhibit 3(ii)b to the Current Report on Form 8-K of Registrant dated February 8, 1995.*\n10b1. Stock Option Plan of American Brands, Inc., as amended is incorporated herein by reference to Exhibit 10b1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10b2. Amendment to Stock Option Plan of American Brands, Inc. constituting Exhibit 10b1 hereto is incorporated herein by reference to Exhibit 10a to the Quarterly Report on Form 10-Q of Registrant dated November 11, 1993.*\n10b3. 1986 Stock Option Plan of American Brands, Inc. and amendments thereto is incorporated herein by reference to Exhibit 10b2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10b4. Amendment to 1986 Stock Option Plan of American Brands, Inc. constituting Exhibit 10b3 hereto is incorporated herein by reference to Exhibit 10b to the Quarterly Report on Form 10-Q of Registrant dated November 11, 1993.*\n10b5. Amendment to 1986 Stock Option Plan of American Brands, Inc. constituting Exhibits 10b3 and 10b4 hereto is incorporated herein by reference to Exhibit 10b to the Quarterly Report on Form 10-Q of Registrant dated August 11, 1994.*\n10b6. 1990 Long-Term Incentive Plan of American Brands, Inc. (As Amended and Restated as of January 1, 1994) is incorporated herein by reference to Exhibit 10a to the Quarterly Report on Form 10-Q of Registrant dated August 11, 1994.*\n10c1. Amended Supplemental Retirement Plan of American Brands, Inc.*\n10c2. Trust Agreement, made as of the 1st day of February, 1989, among Registrant, The Chase Manhattan Bank (National Association) (\"Chase\"), et al. establishing a trust in favor of William J. Alley for purposes of paying amounts under the Amended Supplemental Retirement Plan constituting Exhibit 10c1 hereto is incorporated herein by reference to Exhibit 10c2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1988 maintained in Commission File No. 1-9076.*\n10c3. Amendment made as of the 1st day of November, 1993 to Trust Agreement constituting Exhibit 10c2 hereto is incorporated herein by reference to Exhibit 10c3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10c4. Amendment made as of the 1st day of January, 1995, to the Trust Agreement constituting Exhibits 10c2 and 10c3 hereto.*\n10c5. Schedule identifying substantially identical agreements to the Trust Agreement and the Amendments thereto constituting Exhibits 10c2, 10c3 and 10c4 hereto, respectively, in favor of Thomas C. Hays, Arnold Henson, John T. Ludes, Robert L. Plancher, Gilbert L. Klemann, II, Robert J. Rukeyser, Randall W. Larrimore, Steven C. Mendenhall and Dudley L. Bauerlein, Jr.*\n10c6. Trust Agreement, made as of the 1st day of November, 1993, among William J. Alley, Registrant and Chase establishing a grantor trust in favor of William J. Alley for purposes of paying amounts under the Amended Supplemental Retirement Plan constituting Exhibit 10c1 hereto is incorporated herein by reference to Exhibit 10c5 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10c7. Schedule identifying substantially identical agreements to the Trust Agreement constituting Exhibit 10c6 hereto in favor of Thomas C. Hays, Arnold Henson, John T. Ludes, Robert L. Plancher, Gilbert L. Klemann, II, Robert J. Rukeyser, Randall W. Larrimore, Steven C. Mendenhall and Dudley L. Bauerlein, Jr.*\n10d1. Executive mortgage program of Registrant in connection with relocation of corporate headquarters is incorporated herein by reference to Exhibit 10d1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10e1. Resolutions of the Board of Directors of Registrant adopted on October 28, 1986 and July 26, 1988 adopting and amending a retirement plan for directors of Registrant who are not officers or employees of Registrant or a subsidiary thereof are incorporated herein by reference to Exhibit 10e1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10e2. Resolutions of the Board of Directors of Registrant adopted on July 26, 1994 amending the resolutions constituting Exhibit 10e1 hereto.*\n10f1. Retirement Agreement, made as of January 1, 1995, between Registrant and Thomas C. Hays.*\n10g1. Gallaher Limited Executive Incentive Plan adopted on October 20, 1994.*\n10g2. Trust Deed dated March 24, 1983 between Gallaher Limited (\"Gallaher\") and Gallaher Pensions Limited, and amendments thereto, providing supplemental retirement benefits to certain executives of Gallaher are incorporated herein by reference to Exhibits 10g2 and 10g3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1989 maintained in Commission File No. 1-9076.*\n10g3. Trust Deed dated June 3, 1992 further amending Exhibit 10g2 hereto is incorporated herein by reference to Exhibit 10g3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10g4. Trust Deed dated January 24, 1994 further amending Exhibits 10g2 and 10g3 hereto is incorporated herein by reference to Exhibit 10g4 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10h1. ACCO World Corporation Management Incentive Plan is incorporated herein by reference to Exhibit 10h1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10i1. ACCO World Corporation Supplemental Benefit Plan for Key Employees is incorporated herein by reference to Exhibit 10k1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1989 maintained in Commission File No. 1- 9076.*\n10j1. Jim Beam Brands Co. Senior Executive and Key Manager Incentive Plan is incorporated herein by reference to Exhibit 10m4 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10j2. Jim Beam Brands Co. Amended Excess Benefit Plan.*\n10j3. Trust Agreement, made as of December 24, 1991, among Jim Beam Brands Co. (\"Beam\"), Chase and Hewitt Associates, establishing a trust in favor of Barry M. Berish for purposes of paying amounts under the Amended Excess Benefit Plan constituting Exhibit 10j2 hereto is incorporated herein by reference to Exhibit 10m3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10j4. Amendment made as of the 17th day of November, 1993 to Trust Agreement constituting Exhibit 10j3 hereto is incorporated herein by reference to Exhibit 10k4 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10j5. Trust Agreement, made as of the 15th day of December, 1993, among Barry M. Berish, Beam and Chase establishing a grantor trust in favor of Barry M. Berish for purposes of paying amounts under the Amended Excess Benefit Plan constituting Exhibit 10j2 hereto is incorporated herein by reference to Exhibit 10k5 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10k1. Resolution of the Board of Directors of Registrant adopted on December 11, 1985 with respect to retirement and health benefits provided to William J. Alley is incorporated herein by reference to Exhibit 10e2 to the Registration Statement on Form 8-B of Registrant dated January 27, 1986.*\n10k2. Agreement dated as of March 1, 1988 between Registrant and William J. Alley and amendments thereto providing certain retirement benefits is incorporated herein by reference to Exhibit 10l2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10l1. Resolutions of the Board of Directors of Registrant adopted on December 11, 1985 and February 23, 1988 with respect to retirement and health benefits provided to Arnold Henson is incorporated herein by reference to Exhibit 10m1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10m1. Resolution of the Board of Directors of Registrant adopted on November 27, 1990 with respect to retirement and health benefits provided to Gilbert L. Klemann, II is incorporated herein by reference to Exhibit 10p1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10n1. Service Agreement dated November 9, 1994 between Gallaher and Peter M. Wilson.*\n10n2. Letter dated September 20, 1991 from Gallaher in respect of retirement benefits provided to Peter M. Wilson is incorporated herein by reference to Exhibit 10o2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10n3. Letter dated March 15, 1994 amending Exhibit 10n2 hereto is incorporated herein by reference to Exhibit 10o3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10o1. ACCO World Corporation Supplemental Retirement Plan.*\n10o2. Trust Agreement, made as of the 1st day of July, 1994, among ACCO World Corporation, Chase, et al. establishing a trust in favor of Norman H. Wesley for purposes of paying amounts under the ACCO World Corporation Supplemental Retirement Plan constituting Exhibit 10o1 hereto.*\n10o3. Trust Agreement, made as of the 1st day of July, 1994, among Norman H. Wesley, ACCO World Corporation and Chase establishing a grantor trust in favor of Norman H. Wesley for purposes of paying amounts under the ACCO World Corporation Supplemental Retirement Plan constituting Exhibit 10o1 hereto.*\n10p1. Employment Agreement entered into as of June 8, 1987 by and between ACCO International Inc. (a predecessor of ACCO USA, Inc.) and Norman H. Wesley is incorporated herein by reference to Exhibit 10r1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1990.*\n10q1. Letters dated July 31, 1984 and February 26, 1990 from Registrant with respect to deferred payment of fees to Eugene R. Anderson are incorporated herein by reference to Exhibit 10t1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10r1. Agreement dated January 2, 1991 between Registrant and Gilbert L. Klemann, II is incorporated herein by reference to Exhibit 10s1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10r2. Amendment dated November 28, 1994 to the Agreement constituting Exhibit 10r1 hereto.*\n10r3. Schedule identifying substantially identical agreements to the Agreement and the Amendment thereto constituting Exhibits 10r1 and 10r2 hereto, respectively, entered into by Registrant with Thomas C. Hays, John T. Ludes, Robert L. Plancher, Robert J. Rukeyser, Randall W. Larrimore, Steven C. Mendenhall, Dudley L. Bauerlein, Jr., and Charles H. McGill.*\n10s1. Trust Agreement, made as of the 2nd day of January, 1991, among Registrant, Chase, et al. establishing a trust in favor of Gilbert L. Klemann, II for purposes of paying amounts under the Agreement constituting Exhibits 10r1 and 10r2 hereto.*\n10s2. Amendment made as of the 1st day of November, 1993 to Trust Agreement constituting Exhibit 10s1 hereto.*\n10s3. Schedule identifying substantially identical agreements to the Trust Agreement and Amendment thereto constituting Exhibits 10s1 and 10s2 hereto, respectively, in favor of Thomas C. Hays, John T. Ludes, Robert L. Plancher, Robert J. Rukeyser, Randall W. Larrimore, Steven C. Mendenhall and Dudley L. Bauerlein, Jr.*\n10t1. Agreement dated as of March 1, 1988 and amendments thereto between Registrant and Thomas C. Hays are incorporated herein by reference to Exhibit 10v1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10t2. Amendment effective as of January 1, 1995 to the Agreement constituting Exhibit 10t1 hereto.*\n10t3. Amendment effective as of January 1, 1995 to the Agreement and Amendment thereto constituting Exhibits 10t1 and 10t2 hereto, respectively.*\n10u1. Agreement dated as of January 2, 1991 between Registrant and Gilbert L. Klemann, II and amendment thereto is incorporated herein by reference to Exhibit 10y1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10u2. Agreement dated as of October 28, 1991 amending the Agreement constituting Exhibit 10u1 hereto is incorporated herein by reference to Exhibit 10w2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10u3. Amendment effective as of January 1, 1995 to the Agreement and Amendment thereto constituting Exhibits 10u1 and 10u2 hereto, respectively.*\n10u4. Schedule identifying substantially identical agreements to the Agreement and Amendments thereto constituting Exhibits 10u1, 10u2 and 10u3 hereto entered into by Registrant with John T. Ludes, Robert L. Plancher, Robert J. Rukeyser, Steven C. Mendenhall and Dudley L. Bauerlein, Jr.*\n10v1. Agreement dated March 7, 1988 between Registrant and Randall W. Larrimore and amendments thereto is incorporated herein by reference to Exhibit 10x1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10v2. Amendment effective as of January 1, 1995 to the Agreement constituting Exhibit 10v1 hereto.*\n10w1. Agreement dated February 24, 1995 between Registrant and Charles H. McGill.*\nl0x1. Agreement dated as of February 1, 1990 between Beam and Barry M. Berish is incorporated herein by reference to Exhibit 10pp1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1990.*\nl0y1. Rights Agreement dated as of December 13, 1987 between Registrant and First Chicago Trust Company of New York, as Rights Agent, and amendments thereto is incorporated herein by reference to Exhibit 10aa1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n11. Statement setting forth net income for computation of earnings per Common share, primary and fully diluted, and statement setting forth computation of weighted average number of Common shares outstanding on a fully diluted basis.\n12. Statement re computation of ratio of earnings to fixed charges.\n13. 1994 Annual Report to Stockholders of Registrant.\n21. Subsidiaries of Registrant.\n23(i)a. Consent of Independent Accountants, Coopers & Lybrand L.L.P.\n23(i)b. Consent of Counsel, Chadbourne & Parke.\n24. Powers of Attorney relating to execution of this Annual Report on Form 10-K.\n27. Financial Data Schedule (Article 5).\n* Indicates that exhibit is a management contract or compensatory plan or arrangement.\nIn lieu of filing certain instruments with respect to long-term debt of the kind described in Item 601(b)(4) of Regulation S-K, Registrant agrees to furnish a copy of such instruments to the Securities and Exchange Commission upon request.\n(b) Reports on Form 8-K.\nRegistrant filed a Current Report on Form 8-K, dated October 21, 1994, in respect of Registrant's press release dated October 21, 1994 announcing Registrant's financial results for the three-month and nine-month periods ended September 30, 1994 (Items 5 and 7(c)).\nRegistrant filed a Current Report on Form 8-K, dated October 28, 1994, in respect of Registrant's press release dated October 27, 1994 announcing that the Federal Trade Commission would challenge the sale of The American Tobacco Company (Items 5 and 7(c)).\nRegistrant filed a Current Report on Form 8-K, dated November 30, 1994, in respect of Registrant's press release dated November 30, 1994 announcing that Registrant had executed a definitive agreement for the sale of Registrant's Franklin Life Insurance business to American General Corporation for $1.17 billion in cash (Items 5 and 7(c)).\nRegistrant filed a Current Report on Form 8-K, dated December 22, 1994 in respect of Registrant's press releases dated December 22, 1994 announcing that the Federal Trade Commission (\"FTC\") approved a\nsettlement with B.A.T Industries p.l.c. that removed the FTC's opposition to the sale of Registrant's subsidiary, The American Tobacco Company, to B.A.T and that Registrant and B.A.T had completed such sale that day and the simultaneous transfer by Registrant's U.K.- based subsidiary, Gallaher Limited, of the Silk Cut trademark to B.A.T in exchange for a long-term manufacturing arrangement (Items 5 and 7(c)).\nRegistrant filed a Current Report on Form 8-K, dated January 5, 1995, in respect of Registrant's pro forma financial information in connection with the sale of Registrant's subsidiary, The American Tobacco Company, on December 22, 1994 (Items 2 and 7(b) and (c)).\nRegistrant filed a Current Report on Form 8-K, dated January 24, 1995, in respect of Registrant's press release dated January 24, 1995 announcing Registrant's financial results for the three-month and twelve-month periods ended December 31, 1994 (Items 5 and 7(c)).\nRegistrant filed a Current Report on Form 8-K, dated January 31, 1995, announcing that the sale of Registrant's Franklin Life Insurance business to American General Corporation for $1.17 billion in cash was completed on January 31, 1995 (Items 5 and 7(c)).\nRegistrant filed a Current Report on Form 8-K, dated February 8, 1995, in respect of (i) Registrant's pro forma financial information in connection with the sale of Registrant's Franklin Life Insurance business on January 31, 1995 and (ii) amendments to Registrant's By- laws adopted on January 31, 1995 (Items 2 and 7(b) and (c)).\nRegistrant filed a Current Report on Form 8-K, dated February 16, 1995, in respect of certain statements by Registrant to a consumer analyst group (Items 5 and 7(c)).\nThis annual report shall not be construed as a waiver of the right to contest the validity or scope of any or all of the provisions of the Securities Exchange Act of 1934, as amended, under the Constitution of the United States, or the validity of any rule or regulation made or to be made under such Act.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMERICAN BRANDS, INC. (Registrant)\nBy Thomas C. Hays Thomas C. Hays Chairman of the Board and Date: March 28, 1995 Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of Registrant and in the capacities and on the dates indicated.\nThomas C. Hays Thomas C. Hays, Chairman of the Board and Chief Executive Officer (principal executive officer) and Director Date: March 28, 1995\nJohn T. Ludes* John T. Ludes, President and Chief Operating Officer and Director Date: March 28, 1995\nRobert L. Plancher* Robert L. Plancher, Senior Vice President and Chief Accounting Officer (principal accounting officer) Date: March 28, 1995\nDudley L. Bauerlein, Jr. Dudley L. Bauerlein, Jr., Senior Vice President and Chief Financial Officer (principal financial officer) Date: March 28, 1995\nWilliam J. Alley* William J. Alley, Director Date: March 28, 1995\nEugene R. Anderson* Eugene R. Anderson, Director Date: March 28, 1995\nPatricia O. Ewers* Patricia O. Ewers, Director Date: March 28, 1995\nJohn W. Johnstone, Jr.* John W. Johnstone, Jr., Director Date: March 28, 1995\nWendell J. Kelley* Wendell J. Kelley, Director Date: March 28, 1995\nSidney Kirschner* Sidney Kirschner, Director Date: March 28, 1995\nGordon R. Lohman* Gordon R. Lohman, Director Date: March 28, 1995\nCharles H. Pistor, Jr.* Charles H. Pistor, Jr., Director Date: March 28, 1995\nPeter M. Wilson* Peter M. Wilson, Director Date: March 28, 1995\n*By A. Robert Colby A. Robert Colby, Attorney-in-Fact\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nPages ----- AMERICAN BRANDS, INC. AND SUBSIDIARIES\nReport of Independent Accountants\nSchedules ---------\nI Condensed Financial Information of Registrant As of December 31, 1994 and 1993 and for the years ended December 31, 1994, 1993 and 1992\nII Valuation and qualifying accounts For the years ended December 31, 1994, 1993 and 1992\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of American Brands, Inc.:\nOur report on the consolidated financial statements of American Brands, Inc. and Subsidiaries has been incorporated by reference in this Form 10-K from the 1994 Annual Report to Stockholders of American Brands, 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.\nCOOPERS & LYBRAND L.L.P.\n1301 Avenue of the Americas New York, New York February 1, 1995\nAMERICAN BRANDS, INC. (PARENT COMPANY) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEET (In millions) December 31, ----------------------- 1994 1993 ---- ---- (Restated)\nAssets\nCurrent assets Cash and cash equivalents $ 3.4 $ - Receivables from affiliated companies 579.7 565.8 Net assets of discontinued operations 1,170.0 - Other current assets 32.0 51.4 -------- -------- Total current assets 1,785.1 617.2 -------- -------- Investment in subsidiaries 2,382.4 2,222.5 Long-term receivables from affiliated companies 3,143.0 3,724.8 Net assets of discontinued operations - 1,344.0 Other assets 138.5 141.2 -------- -------- Total assets $7,449.0 $8,049.7 ======== ======== Liabilities and stockholders' equity\nCurrent liabilities Commercial paper $ 103.3 $ 711.3 Payables to affiliated companies 128.9 113.2 Other current liabilities 477.2 265.9 Current portion of long-term debt 485.4 156.5 -------- -------- Total current liabilities 1,194.8 1,246.9\nLong-term debt 1,493.6 2,438.4 Postretirement and other liabilities 123.1 93.0 -------- -------- Total liabilities 2,811.5 3,778.3 -------- -------- Convertible preferred stock - redeemable at Company's option 15.7 17.1 -------- -------- Common stockholders' equity 4,621.8 4,254.3 -------- -------- Total liabilities and stockholders' equity $7,449.0 $8,049.7 ======== ========\nThe \"Notes to Consolidated Financial Statements of American Brands, Inc. and Subsidiaries\" contained in the 1994 Annual Report to Stockholders of Registrant are an integral part of these statements.\nSee accompanying \"Notes to Condensed Financial Information of Registrant.\"\nAMERICAN BRANDS, INC. (PARENT COMPANY) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENT OF INCOME (In millions)\nFor the Years Ended December 31, ------------------------------- 1994 1993 1992 ---- ---- ---- (Restated)(Restated)\nInterest from affiliates $ 296.5 $332.6 $357.8\nExpenses: Corporate administrative expenses 69.9 78.1 80.7 Interest: affiliates 10.0 12.9 8.2 non-affiliates 191.6 203.7 219.8 Other expenses, net 16.3 12.9 12.1 ------- ------ ------\nTotal expenses 287.8 307.6 320.8\nGain on disposal of business 577.9 - - ------- ------ ------ Income from continuing operations before income taxes and other items 586.6 25.0 37.0 Income tax expense (benefit) 54.2 4.1 (3.1) ------- ------ ------ Income from continuing operations before equity in net income of subsidiaries and cumulative effect of accounting changes 532.4 20.9 40.1\nEquity in net income of subsidiaries 352.7 349.5 746.8 ------- ------ ------ Income from continuing operations before cumulative effect of accounting changes 885.1 370.4 786.9\nIncome (loss) from discontinued operations (151.0) 127.0 96.9 Cumulative effect of accounting changes (net of income taxes of $16.9) - (27.6) - ------- ------ ------\nNet income $ 734.1 $469.8 $883.8 ======= ====== ======\nThe \"Notes to Consolidated Financial Statements of American Brands, Inc. and Subsidiaries\" contained in the 1994 Annual Report to Stockholders of Registrant are an integral part of these statements.\nSee accompanying \"Notes to Condensed Financial Information of Registrant.\"\nAMERICAN BRANDS, INC. (PARENT COMPANY) SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENT OF CASH FLOWS (In millions) For the Years Ended December 31, --------------------------------- 1994 1993 1992 ---- ---- ---- (Restated)(Restated)\nNet cash provided from operating activities $ 390.7 $ 618.4 $ 625.1 --------- ------- ------- Investing activities Proceeds from the disposition of operations 989.4 - - Additional investment in subsidiary - - (1.8) Other, net (0.8) 4.4 (4.0) --------- ------- ------- Net cash provided (used) by investing activities 988.6 4.4 (5.8) --------- ------- ------- Financing activities (Decrease) increase in short-term debt (908.0) 278.0 261.6 Issuance of long-term debt 32.6 473.0 351.4 Repayment of long-term debt (359.5) (364.7) (672.6) Dividends to stockholders (403.1) (399.1) (377.8) Cash purchases of Common stock for treasury (20.1) (57.9) (100.4) Change in intercompany balances, net 242.5 (592.3) (14.2) Redemption and purchases of $2.75 Preferred stock - - (134.4) Other financing activities, net 1.9 (4.9) 12.0 --------- ------- ------- Net cash used by financing activities (1,413.7) (667.9) (674.4) --------- ------- ------- Cash provided by discontinued operations 37.8 45.1 55.1 --------- ------- ------- Net increase in cash and cash equivalents $ 3.4 $ - $ - ========= ======= ======= Cash and cash equivalents at Beginning of year $ - $ - $ -\nEnd of year $ 3.4 $ - $ - ========= ======= ======= Cash paid during the year for Interest $ 207.7 $ 220.2 $ 233.6 ========= ======= ======= Income taxes $ 195.3 $ 238.5 $ 280.8 ========= ======= =======\nThe \"Notes to Consolidated Financial Statements of American Brands, Inc. and Subsidiaries\" contained in the 1994 Annual Report to Stockholders of Registrant are an integral part of these statements.\nSee accompanying \"Notes to Condensed Financial Information of Registrant.\"\nNOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT ------------------------------------------------------\n1. Basis of Presentation Pursuant to the rules and regulations of the Securities and Exchange Commission, the Condensed Financial Statements of the Registrant do not include all of the information and notes normally included with financial statements prepared in accordance with generally accepted accounting principles. Therefore, these Condensed Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the Annual Report to Stockholders of Registrant as referenced in Form 10-K, Part II, Item 8.\nThe financial statements have been restated for discontinued operations. The accompanying notes present amounts related only to continuing operations.\n2. Dispositions On December 22, 1994, the Registrant sold The American Tobacco Company, its domestic tobacco business, for $1 billion in cash, before related expenses. The gain on this disposal increased income from continuing operations before income taxes by $577.9 million or $508.3 million after applicable income taxes of $69.6 million.\n3. Discontinued Operations On November 30, 1994, the Registrant entered into an agreement to sell The Franklin Life Insurance business (\"Franklin\") for $1.17 billion in cash, before related expenses. The sale was completed on January 31, 1995. The net assets and results of operations of Franklin have been reclassified to identify them as discontinued operations.\n4. Accounting Changes On January 1, 1993, Registrant adopted FAS Statement No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and FAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" The initial effects of adopting these statements were recorded as cumulative changes in accounting principles.\n5. Investment in Subsidiaries During 1994, $361 million of long-term receivables from affiliated companies was contributed to the capital of subsidiaries by Registrant.\nDuring 1993, $134.8 million of receivables from affiliated companies was contributed to the capital of a subsidiary by Registrant.\n6. Cash Dividends from Subsidiaries Dividends of $374.6 million in 1994, $634.7 million in 1993, and $593 million in 1992 were paid to Registrant by its subsidiaries, excluding Franklin.\nNOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Concluded)\n7. Debt The components of long-term debt are as follows (In millions):\n1994 1993 ---- ----\nNotes payable $ - $ 300.0 Revolving credit notes 26.4 195.8 Other notes 274.0 356.5 5 3\/4% Eurodollar Convertible Debentures, Due 2005 200.0 200.0 7 5\/8% Eurodollar Convertible Debentures, Due 2001 150.0 150.0 Other Eurodollar Convertible Debentures 40.7 41.0 8 1\/2% Notes, Due 2003 200.0 200.0 5 1\/4% Notes, Due 1995 200.0 200.0 8 5\/8% Debentures, Due 2021 150.0 150.0 9 1\/8% Debentures, Due 2016 150.0 150.0 7 7\/8% Debentures, Due 2023 150.0 150.0 7 1\/2% Notes, Due 1999 150.0 150.0 9% Notes, Due 1999 100.0 100.0 9 1\/2% Eurosterling Notes, Due 1994 - 74.0 9 1\/4% Eurosterling Notes, Due 1998 78.3 74.0 12% Eurosterling Notes, Due 1995 62.6 59.2 12 1\/2% Sterling Loan Stock, Due 2009 47.0 44.4 -------- -------- 1,979.0 2,594.9 Less current portion 485.4 156.5 -------- -------- $1,493.6 $2,438.4 ======== ========\nEstimated payments for maturing debt and sinking fund requirements during the next five years, assuming the one-time put option on the 5 3\/4% Eurodollar Convertible Debentures is exercised in 1995, are as follows: 1995, $485.4 million; 1996, $101 million; 1997, $53.8 million; 1998, $172.8 million; and 1999, $280.9 million.\nAt December 31, 1994, the Registrant guaranteed short-term committed credit facilities of a U.K.-based subsidiary which provided for unsecured borrowings of up to $513 million, of which $57.8 million was outstanding.\nAMERICAN BRANDS, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1994, 1993 and 1992 (In millions) --------------------------------------------------------------------------- Col. A Col. B Col. C Col. D Col. E ------ ------ ------ ------ ------ Additions --------- Charged Balance Balance at to Costs at End Beginning and of Description of Period Expenses Deductions Period --------------------------------------------------------------------------- 1994: Allowance for cash discounts $ 6.3 $ 93.0 $ 92.7 (1) $ 5.3 1.3 (4) Allowance for returns 21.9 90.9 93.2 (1) 12.6 7.0 (4) Allowance for doubtful accounts 34.3 11.3 (0.9)(2) 34.1 9.5 (3) 2.9 (4) ----- ------ ------ ----- $62.5 $195.2 $205.7 $52.0 ===== ====== ====== ===== 1993: Allowance for cash discounts $ 7.9 $ 87.3 $ 88.9 (1) $ 6.3\nAllowance for returns 17.3 150.6 146.0 (1) 21.9\nAllowance for doubtful accounts 34.8 11.7 11.7 (3) 34.3 0.5 (2) ----- ------ ------ ----- $60.0 $249.6 $247.1 $62.5 ===== ====== ====== ===== 1992: Allowance for cash discounts $ 7.5 $ 88.6 $ 88.2 (1) $ 7.9\nAllowance for returns 9.3 114.3 106.0 (1) 17.3 0.3 (2) Allowance for doubtful accounts 39.3 11.9 13.1 (3) 34.8 3.3 (2) ----- ------ ------ ----- $56.1 $214.8 $210.9 $60.0 ----------------------------- ===== ====== ====== ===== (1) Cash discounts and returns allowed customers. (2) Effect of changes in foreign exchange rates. (3) Doubtful accounts written off, net of recoveries. (4) Balance at disposal date of subsidiaries.\nEXHIBIT INDEX\n3(i). Certificate of Incorporation of Registrant as in effect on the date hereof is incorporated herein by reference to Exhibit 3a2 to the Quarterly Report on Form 10-Q of Registrant dated May 14, 1990.\n3(ii). By-laws of Registrant as in effect on the date hereof are incorporated herein by reference to Exhibit 3(ii)b to the Current Report on Form 8-K of Registrant dated February 8, 1995.\n10a1. Article XII (\"Incentive Compensation\") of the By-laws of Registrant is incorporated herein by reference to Exhibit 3(ii)b to the Current Report on Form 8-K of Registrant dated February 8, 1995.*\n10b1. Stock Option Plan of American Brands, Inc., as amended is incorporated herein by reference to Exhibit 10b1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10b2. Amendment to Stock Option Plan of American Brands, Inc. constituting Exhibit 10b1 hereto is incorporated herein by reference to Exhibit 10a to the Quarterly Report on Form 10-Q of Registrant dated November 11, 1993.*\n10b3. 1986 Stock Option Plan of American Brands, Inc. and amendments thereto is incorporated herein by reference to Exhibit 10b2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10b4. Amendment to 1986 Stock Option Plan of American Brands, Inc. constituting Exhibit 10b3 hereto is incorporated herein by reference to Exhibit 10b to the Quarterly Report on Form 10-Q of Registrant dated November 11, 1993.*\n10b5. Amendment to 1986 Stock Option Plan of American Brands, Inc. constituting Exhibits 10b3 and 10b4 hereto is incorporated herein by reference to Exhibit 10b to the Quarterly Report on Form 10-Q of Registrant dated August 11, 1994.*\n10b6. 1990 Long-Term Incentive Plan of American Brands, Inc. (As Amended and Restated as of January 1, 1994) is incorporated herein by reference to Exhibit 10a to the Quarterly Report on Form 10-Q of Registrant dated August 11, 1994.*\n10c1. Amended Supplemental Retirement Plan of American Brands, Inc.*\n10c2. Trust Agreement, made as of the 1st day of February, 1989, among Registrant, The Chase Manhattan Bank (National Association) (\"Chase\"), et al. establishing a trust in favor of William J. Alley for purposes of paying amounts under the Amended Supplemental Retirement Plan constituting Exhibit 10c1 hereto is\nincorporated herein by reference to Exhibit 10c2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1988 maintained in Commission File No. 1-9076.*\n10c3. Amendment made as of the 1st day of November, 1993 to Trust Agreement constituting Exhibit 10c2 hereto is incorporated herein by reference to Exhibit 10c3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10c4. Amendment made as of the 1st day of January, 1995, to the Trust Agreement constituting Exhibits 10c2 and 10c3 hereto.*\n10c5. Schedule identifying substantially identical agreements to the Trust Agreement and the Amendments thereto constituting Exhibits 10c2, 10c3 and 10c4 hereto, respectively, in favor of Thomas C. Hays, Arnold Henson, John T. Ludes, Robert L. Plancher, Gilbert L. Klemann, II, Robert J. Rukeyser, Randall W. Larrimore, Steven C. Mendenhall and Dudley L. Bauerlein, Jr.*\n10c6. Trust Agreement, made as of the 1st day of November, 1993, among William J. Alley, Registrant and Chase establishing a grantor trust in favor of William J. Alley for purposes of paying amounts under the Amended Supplemental Retirement Plan constituting Exhibit 10c1 hereto is incorporated herein by reference to Exhibit 10c5 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10c7. Schedule identifying substantially identical agreements to the Trust Agreement constituting Exhibit 10c6 hereto in favor of Thomas C. Hays, Arnold Henson, John T. Ludes, Robert L. Plancher, Gilbert L. Klemann, II, Robert J. Rukeyser, Randall W. Larrimore, Steven C. Mendenhall and Dudley L. Bauerlein, Jr.*\n10d1. Executive mortgage program of Registrant in connection with relocation of corporate headquarters is incorporated herein by reference to Exhibit 10d1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10e1. Resolutions of the Board of Directors of Registrant adopted on October 28, 1986 and July 26, 1988 adopting and amending a retirement plan for directors of Registrant who are not officers or employees of Registrant or a subsidiary thereof are incorporated herein by reference to Exhibit 10e1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10e2. Resolutions of the Board of Directors of Registrant adopted on July 26, 1994 amending the resolutions constituting Exhibit 10e1 hereto.*\n10f1. Retirement Agreement, made as of January 1, 1995, between Registrant and Thomas C. Hays.*\n10g1. Gallaher Limited Executive Incentive Plan adopted on October 20, 1994.*\n10g2. Trust Deed dated March 24, 1983 between Gallaher Limited (\"Gallaher\") and Gallaher Pensions Limited, and amendments thereto, providing supplemental retirement benefits to certain executives of Gallaher are incorporated herein by reference to Exhibits 10g2 and 10g3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1989 maintained in Commission File No. 1-9076.*\n10g3. Trust Deed dated June 3, 1992 further amending Exhibit 10g2 hereto is incorporated herein by reference to Exhibit 10g3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10g4. Trust Deed dated January 24, 1994 further amending Exhibits 10g2 and 10g3 hereto is incorporated herein by reference to Exhibit 10g4 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10h1. ACCO World Corporation Management Incentive Plan is incorporated herein by reference to Exhibit 10h1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10i1. ACCO World Corporation Supplemental Benefit Plan for Key Employees is incorporated herein by reference to Exhibit 10k1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1989 maintained in Commission File No. 1- 9076.*\n10j1. Jim Beam Brands Co. Senior Executive and Key Manager Incentive Plan is incorporated herein by reference to Exhibit 10m4 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10j2. Jim Beam Brands Co. Amended Excess Benefit Plan.*\n10j3. Trust Agreement, made as of December 24, 1991, among Jim Beam Brands Co. (\"Beam\"), Chase and Hewitt Associates, establishing a trust in favor of Barry M. Berish for purposes of paying amounts under the Amended Excess Benefit Plan constituting Exhibit 10j2 hereto is incorporated herein by reference to Exhibit 10m3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10j4. Amendment made as of the 17th day of November, 1993 to Trust Agreement constituting Exhibit 10j3 hereto is incorporated herein by reference to Exhibit 10k4 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10j5. Trust Agreement, made as of the 15th day of December, 1993, among Barry M. Berish, Beam and Chase establishing a grantor trust in favor of Barry M. Berish for purposes of paying amounts under the Amended Excess Benefit Plan constituting Exhibit 10j2 hereto is incorporated herein by reference to Exhibit 10k5 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10k1. Resolution of the Board of Directors of Registrant adopted on December 11, 1985 with respect to retirement and health benefits provided to William J. Alley is incorporated herein by reference to Exhibit 10e2 to the Registration Statement on Form 8-B of Registrant dated January 27, 1986.*\n10k2. Agreement dated as of March 1, 1988 between Registrant and William J. Alley and amendments thereto providing certain retirement benefits is incorporated herein by reference to Exhibit 10l2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10l1. Resolutions of the Board of Directors of Registrant adopted on December 11, 1985 and February 23, 1988 with respect to retirement and health benefits provided to Arnold Henson is incorporated herein by reference to Exhibit 10m1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10m1. Resolution of the Board of Directors of Registrant adopted on November 27, 1990 with respect to retirement and health benefits provided to Gilbert L. Klemann, II is incorporated herein by reference to Exhibit 10p1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10n1. Service Agreement dated November 9, 1994 between Gallaher and Peter M. Wilson.*\n10n2. Letter dated September 20, 1991 from Gallaher in respect of retirement benefits provided to Peter M. Wilson is incorporated herein by reference to Exhibit 10o2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10n3. Letter dated March 15, 1994 amending Exhibit 10n2 hereto is incorporated herein by reference to Exhibit 10o3 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1993.*\n10o1. ACCO World Corporation Supplemental Retirement Plan.*\n10o2. Trust Agreement, made as of the 1st day of July, 1994, among ACCO World Corporation, Chase, et al. establishing a trust in favor of Norman H. Wesley for purposes of paying amounts under the ACCO World Corporation Supplemental Retirement Plan constituting Exhibit 10o1 hereto.*\n10o3. Trust Agreement, made as of the 1st day of July, 1994, among Norman H. Wesley, ACCO World Corporation and Chase establishing a grantor trust in favor of Norman H. Wesley for purposes of paying amounts under the ACCO World Corporation Supplemental Retirement Plan constituting Exhibit 10o1 hereto.*\n10p1. Employment Agreement entered into as of June 8, 1987 by and between ACCO International Inc. (a predecessor of ACCO USA, Inc.) and Norman H. Wesley is incorporated herein by reference to Exhibit 10r1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1990.*\n10q1. Letters dated July 31, 1984 and February 26, 1990 from Registrant with respect to deferred payment of fees to Eugene R. Anderson are incorporated herein by reference to Exhibit 10t1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10r1. Agreement dated January 2, 1991 between Registrant and Gilbert L. Klemann, II is incorporated herein by reference to Exhibit 10s1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10r2. Amendment dated November 28, 1994 to the Agreement constituting Exhibit 10r1 hereto.*\n10r3. Schedule identifying substantially identical agreements to the Agreement and the Amendment thereto constituting Exhibits 10r1 and 10r2 hereto, respectively, entered into by Registrant with Thomas C. Hays, John T. Ludes, Robert L. Plancher, Robert J. Rukeyser, Randall W. Larrimore, Steven C. Mendenhall, Dudley L. Bauerlein, Jr., and Charles H. McGill.*\n10s1. Trust Agreement, made as of the 2nd day of January, 1991, among Registrant, Chase, et al. establishing a trust in favor of Gilbert L. Klemann, II for purposes of paying amounts under the Agreement constituting Exhibits 10r1 and 10r2 hereto.*\n10s2. Amendment made as of the 1st day of November, 1993 to Trust Agreement constituting Exhibit 10s1 hereto.*\n10s3. Schedule identifying substantially identical agreements to the Trust Agreement and Amendment thereto constituting Exhibits 10s1 and 10s2 hereto, respectively, in favor of Thomas C. Hays, John T. Ludes, Robert L. Plancher, Robert J. Rukeyser, Randall W. Larrimore, Steven C. Mendenhall and Dudley L. Bauerlein, Jr.*\n10t1. Agreement dated as of March 1, 1988 and amendments thereto between Registrant and Thomas C. Hays are incorporated herein by reference to Exhibit 10v1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10t2. Amendment effective as of January 1, 1995 to the Agreement constituting Exhibit 10t1 hereto.*\n10t3. Amendment effective as of January 1, 1995 to the Agreement and Amendment thereto constituting Exhibits 10t1 and 10t2 hereto, respectively.*\n10u1. Agreement dated as of January 2, 1991 between Registrant and Gilbert L. Klemann, II and amendment thereto is incorporated herein by reference to Exhibit 10y1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1991.*\n10u2. Agreement dated as of October 28, 1991 amending the Agreement constituting Exhibit 10u1 hereto is incorporated herein by reference to Exhibit 10w2 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10u3. Amendment effective as of January 1, 1995 to the Agreement and Amendment thereto constituting Exhibits 10u1 and 10u2 hereto, respectively.*\n10u4. Schedule identifying substantially identical agreements to the Agreement and Amendments thereto constituting Exhibits 10u1, 10u2 and 10u3 hereto entered into by Registrant with John T. Ludes, Robert L. Plancher, Robert J. Rukeyser, Steven C. Mendenhall and Dudley L. Bauerlein, Jr.*\n10v1. Agreement dated March 7, 1988 between Registrant and Randall W. Larrimore and amendments thereto is incorporated herein by reference to Exhibit 10x1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n10v2. Amendment effective as of January 1, 1995 to the Agreement constituting Exhibit 10v1 hereto.*\n10w1. Agreement dated February 24, 1995 between Registrant and Charles H. McGill.*\nl0x1. Agreement dated as of February 1, 1990 between Beam and Barry M. Berish is incorporated herein by reference to Exhibit 10pp1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1990.*\nl0y1. Rights Agreement dated as of December 13, 1987 between Registrant and First Chicago Trust Company of New York, as Rights Agent, and amendments thereto is incorporated herein by reference to Exhibit 10aa1 to the Annual Report on Form 10-K of Registrant for the Fiscal Year ended December 31, 1992.*\n11. Statement setting forth net income for computation of earnings per Common share, primary and fully diluted, and statement setting forth computation of weighted average number of Common shares outstanding on a fully diluted basis.\n12. Statement re computation of ratio of earnings to fixed charges.\n13. 1994 Annual Report to Stockholders of Registrant.\n21. Subsidiaries of Registrant.\n23(i)a. Consent of Independent Accountants, Coopers & Lybrand L.L.P.\n23(i)b. Consent of Counsel, Chadbourne & Parke.\n24. Powers of Attorney relating to execution of this Annual Report on Form 10-K.\n27. Financial Data Schedule (Article 5).\n* Indicates that exhibit is a management contract or compensatory plan or arrangement.\nIn lieu of filing certain instruments with respect to long-term debt of the kind described in Item 601(b)(4) of Regulation S-K, Registrant agrees to furnish a copy of such instruments to the Securities and Exchange Commission upon request.","section_15":""}
{"filename":"50485_1994.txt","cik":"50485","year":"1994","section_1":"Item 1. BUSINESS Ingersoll-Rand Company (the company) was organized in 1905 under the laws of the State of New Jersey as a consolidation of Ingersoll-Sergeant Drill Company and the Rand Drill Company, whose businesses were established in the early 1870's. Over the years the company has supplemented its original business, which consisted primarily of the manufacture and sale of rock drilling equipment, with additional products which have been developed internally or obtained through acquisition.\nEffective October 1, 1992, the company and Dresser Industries, Inc. (Dresser) formed Ingersoll-Dresser Pump Company (IDP), a partnership which is owned 51 percent by the company and 49 percent by Dresser. This joint venture includes the majority of the worldwide pump operations of the two companies, and its results have been included in the consolidated financial statements of the company since the formation date.\nThe following acquisitions have been accounted for as purchases and, accordingly, each purchase price was allocated to the acquired assets and assumed liabilities based on their estimated fair values. The results of operations since the dates of acquisition are included in the consolidated financial statements.\no In early 1992, the company acquired Industrias del Rodamiento, S.A. (IRSA) for $14.0 million in cash and $1.8 million in notes. IRSA manufactures and markets an extensive line of bearings, as well as wheel kits and automotive accessories.\no In August 1993, the company acquired the Kunsebeck, Germany, needle and cylindrical bearing business of FAG Kugelfischer Georg Schafer AG of Schweinfurt, Germany, for $42.5 million in cash, subject to final contract negotiations.\no In April 1994, the company acquired full ownership of the ball bearing joint venture with GMN Georg Mueller of America, Inc. for $4.9 million in cash.\no In June 1994, the company acquired Montabert S.A., a French manufacturer of hydraulic rock-breaking and drilling equipment for $18.4 million in cash plus assumption of liabilities.\no In August 1994, the company acquired the Ecoair air compressor product line from MAN Gutehoffnungshutte AG (MAN GHH) for $10.6 million in cash. The company also entered into a 50\/50 joint venture, GHH-RAND Schraubenkompressoren GmbH & Co. KG (GHH-RAND) with MAN GHH to manufacture airends. The company invested approximately $17.6 million in GHH-RAND.\nIn addition, on March 28, 1995, the company announced that it had made a proposal to acquire Clark Equipment Company in a cash merger transaction at a total purchase price of approximately $1.3 billion. Clark's business is the design, manufacture and sale of skid steer loaders, construction machinery and transmissions for off-highway equipment.\nDispositions that the company has made in recent years are as follows:\no The company sold the assets of several small business units in 1993, as well as substantially all of the assets of its coal- mining machinery and aerospace bearings businesses for $55.5 million in cash.\no In 1994, the assets of the IDP Australian operations were sold in return for shares of the purchaser. The company and Dresser Industries sold IRI International Corporation, a 50\/50 joint venture that is a manufacturer of mobile drilling rigs, to a third party.\nProducts The company manufactures and sells primarily nonelectrical machinery and equipment. Principal products include the following:\nAbrasive blasting and recovery Hoists systems Industrial pumps Air compressors Lubrication equipment Air dryers Material handling equipment Air logic controls Monitoring drills Air motors Needle roller bearings Air tools Pavement-milling machines Architectural hardware trim Paving equipment Asphalt compactors Pellet mills Automated-parts finishing Pneumatic cylinders systems Pneumatic valves Automated production systems Portable compressors Automotive components Portable generators Ball bearings Portable light towers Blasthole drills Pulp-processing machinery Construction equipment Road-building machinery Dewatering presses Rock drills Diaphragm pumps Roller bearings Door closers Roller mills Door hardware Rotary drills Door locks Rough-terrain forklifts Emergency exit devices Separation equipment Engineered pumps Soil compactors Engine-starting systems Spray-coating systems Extrusion systems Waterjet-cutting systems Fluid-handling equipment Water well drills Food-processing equipment Winches Foundation drills\nThese products are sold primarily under the company's name and also under other names including Torrington, Fafnir, Klemm, Schlage, CPM, LCN Closers, Von Duprin, Aro, ABG, Ingersoll-Dresser Pumps, Pacific, Worthington, Jeumont-Schneider Pumps and Pleuger.\nDuring the past three years, the division of the company's sales between capital goods and expendables has been in the approximate ratio of 55 percent and 45 percent, respectively. The company generally defines as expendables those products which are not capitalized by the ultimate user. Examples of such products are parts sold for replacement purposes, power tools and needle bearings.\nThe seasonal business of the company is not material.\nAdditional information on the company's business and financial information about industry segments is presented in Footnote 15 of the Annual Report to Shareowners for 1994, incorporated by reference in this Form 10-K Annual Report.\nDistribution The company's products are distributed by a number of methods which the company believes are appropriate to the type of product. Sales are made domestically through branch sales offices and through distributorships and dealers across the United States. International sales are made through approximately 60 subsidiary sales and service companies with a supporting chain of distributors in over 100 countries.\nWorking Capital The working capital requirements of the company vary with respect to the many products and industries in which it is involved. In general, the requirements of its Engineered Equipment Segment, which manufactures machinery for specialized customer needs, involve a relatively long lead time and, at times, more significant company investment with respect to the particular product or order. Historically, these orders are generally covered by progress payments, which reduce the company's investment in the amount of inventory maintained by this segment. The products manufactured by the company's Standard Machinery and Bearings, Locks and Tools segments are more in the nature of standard equipment. Consequently, a wider variety must usually be more readily available to meet rapid delivery requirements. Such working capital requirements are not, however, in the opinion of management, materially different from those experienced by the company's major competitors.\nCustomers No material part of the company's business is dependent upon a single customer or very few customers, the loss of any one of which would have a material adverse effect on the company's operations.\nCompetitive Conditions The company's products are sold in highly competitive markets throughout the world against products produced by both foreign and domestic corporations. The principal methods of competition in these markets relate to price, quality and service. The company believes that it is one of the leading manufacturers in the world of a broad line of air compression systems, anti-friction bearings, construction equipment, air tools and pumps (through the IDP joint venture). In addition, it believes it is a leading supplier in domestic markets for locks and other door hardware products.\nInternational Operations Sales to customers outside the United States, including domestic sales for export, accounted for approximately 42 percent of the consolidated net sales in 1994. Information as to operating income by geographic area is set forth in Footnote 15 of the Annual Report to Shareowners for 1994, incorporated by reference in this Form 10-K Annual Report. Sales outside of the United States are made in more than 100 countries; therefore, the attendant risks of manufacturing or selling in a particular country, such as nationalization and establishment of common markets, would not have a significant effect on the company's international operations.\nRaw Materials The company manufactures many of the components included in its products. The principal raw materials required for the manufacture of the company's products are purchased from numerous suppliers, and the company believes that available sources of supply will generally be sufficient for its needs for the foreseeable future.\nBacklog The company's approximate backlog of orders at December 31, 1994, believed by it to be firm, was $176 million for the Standard Machinery Segment, $395 million for the Engineered Equipment Segment and $438 million for the Bearings, Locks and Tools Segment as compared to $134 million, $393 million and $395 million, respectively, at December 31, 1993. These backlog figures are based on orders received. While the major portion of the company's products are built in advance of order and either shipped or assembled from stock, orders for specialized machinery or specific customer application are submitted with extensive lead time and are often subject to revision, deferral, cancellation or termination. The company estimates that approximately 90 percent of the backlog will be shipped during the next twelve months.\nResearch, Engineering and Development The company maintains extensive research, engineering and development facilities for experimenting, testing and developing high quality products. The company employs approximately 1,500 professional employees for its research, engineering and development activities. The company spent $155 million in 1994, $150 million in 1993 and $138 million in 1992 on research, engineering and development.\nPatents and Licenses The company owns numerous patents and patent applications and is licensed under others. While it considers that in the aggregate its patents and licenses are valuable, it does not believe that its business is materially dependent on its patents or licenses or any group of them. In the company's opinion, engineering and production skills, and experience are more responsible for its market position than patents or licenses.\nEnvironmental Matters The company is subject to extensive environmental laws and regulations. It is the company's policy to comply with all environmental regulatory requirements and the company is in substantial compliance with those laws and regulations. While there is some degree of uncertainty associated with the compliance costs resulting from new regulatory initiatives, the ongoing cost of compliance has not had, nor is it expected to have, a material adverse effect upon the company's capital expenditures, financial position, results of operations, liquidity or cash flows.\nFederal Superfund and similar state laws impose joint and several responsibility for cleaning up designated hazardous sites not only on the owner and operator but also on any person who contributed hazardous waste to the site. As of December 31, 1994, the company has been identified as a potentially responsible party (\"PRP\") in connection with 26 federal and state superfund sites. At all these sites there are other PRPs and to date there is no indication the company will be liable for more than its pro rata share of remediation costs at any site. While some of these sites are still under investigation, in the aggregate, the company's anticipated pro rata share of responsibility at these sites is not deemed to be material. Additional lawsuits and claims involving environmental matters are likely to arise from time to time. In addition, the company continues to investigate and remediate environmental contamination from past operations at its facilities.\nIn 1994, the company spent approximately $7 million in connection with environmental compliance and remediation and an additional $7 million on capital projects for pollution abatement and control. Based upon the company's experience to date with environmental claims and litigation and with site investigation and remediation, its expenditures for environmental purposes have not been and are not expected to be material or to have a material adverse effect on the company's capital expenditures, earnings or competitive position. (See also Financial Review and Management Analysis in the Annual Report to Shareowners for 1994 included as Exhibit 13 to this report.)\nEmployees There are approximately 35,900 employees of the company throughout the world, of whom approximately 23,200 work in the United States and 12,700 in foreign countries. Approximately 17 percent of the company's production and maintenance employees, who work in 9 plants in the United States, are represented by 7 unions. The company believes relations with its employees are satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES The company's executive offices are located at Woodcliff Lake, New Jersey. Manufacturing and assembly operations are conducted in 47 plants in the United States; 6 plants in Canada; 27 plants in Europe; 5 plants in the Far East; 5 plants in Latin America; 2 plants in Asia and 1 plant in Africa. The company also maintains various warehouses, offices and repair centers in the United States, Canada and abroad.\nSubstantially all plant facilities are owned by the company and the remainder are under long-term lease. The company believes that its plants and equipment have been well maintained and are generally in good condition. The company has several closed facilities that it is actively marketing with the intent of selling them at their net realizable value.\nThe operating segments for which the facilities are primarily used are as described below. Facilities that produce products in several operating segments are classified by the products which they primarily manufacture. Facilities under long-term lease are included below and are not significant to each operating segment's total number of plants or square footage.\nStandard Machinery This segment's products include machinery regularly used in general manufacturing and in industries such as mining and construction. Products range from blasthole drills used in mining and construction to small air compressors found worldwide in auto service stations. The segment is aligned into two operating groups: Air Compressor Group and Construction and Mining Group. The segment's manufacturing locations are as follows: Approximate Number of Plants Square Footage\nDomestic 7 1,884,000 International 12 2,139,000\nTotal 19 4,023,000\nEngineered Equipment The products manufactured by this segment are predominantly designed for specific customer applications. The segment's diverse product line includes pumps, liquid\/solid separation and densification machinery. The segment is organized into two operating groups: Pump Group and Process Systems Group. The segment's manufacturing facilities are as follows: Approximate Number of Plants Square Footage\nDomestic 12 2,516,000 International 19 2,444,000\nTotal 31 4,960,000\nBearings, Locks and Tools This segment primarily serves the automotive, capital goods, energy and construction industries. Products in this segment include bearings for specialized and industrial application, locks and door hardware for residential and commercial buildings, air tools for industrial use, air winches, hoists and engine starting systems, and automated production systems for transportation equipment manufacturers. There are three operating groups in this segment: Bearings and Components Group, Production Equipment Group and Door Hardware Group. The segment's manufacturing facilities are as follows: Approximate Number of Plants Square Footage\nDomestic 28 6,288,000 International 15 1,596,000\nTotal 43 7,884,000\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS In the normal course of business, the company is involved in a variety of lawsuits, claims and legal proceedings, including proceedings for the cleanup of 26 waste sites under federal Superfund and similar state laws. In the opinion of the company, pending legal matters are not expected to have a material adverse effect on its operations or financial condition.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the company's security holders during the last quarter of its fiscal year ended December 31, 1994.\nThe following information is included in accordance with the provision of Part III, Item 10. Date of Service as Principal Occupation and an Executive Other Information Name and Age Officer for Past Five Years\nJames E. Perrella(59) 5\/4\/77 Chairman of the Board, President and Chief Executive Officer, Director (President and Director, September 1992 - October 1993; Executive Vice President, 1982 - 1992) William G. Mulligan(64) 5\/2\/73 Executive Vice President J. Frank Travis(59) 2\/7\/90 Executive Vice President and President of the Production Equipment Group (Vice President and President of the Bearings and Components Group, February 1992 - December 1993; President of the Air Compressor Group, 1989 - February 1992) Thomas F. McBride(59) 9\/5\/79 Senior Vice President and Chief Financial Officer (Senior Vice President and Comptroller, February 1992 - May 1993; Vice President and Comptroller, 1981 - 1992) William J. Armstrong(53) 8\/3\/83 Vice President and Treasurer Paul L. Bergren(45) 12\/2\/92 Vice President, President of the Air Compressor Group, and President of Ingersoll-Rand Europe (Vice President and General Manager - Centrifugal Compressor Division, 1989 - 1992) Frederick W. Hadfield(58) 8\/1\/79 Vice President and President of IDP (Vice President, 1979 - March 1994) Daniel E. Kletter(56) 2\/7\/90 Vice President (Vice President and President of the Construction and Mining Group 1989 - 1994)\nDate of Service as Principal Occupation and an Executive Other Information Name and Age Officer for Past Five Years\nPatricia Nachtigal(48) 11\/2\/88 Vice President and General Counsel (Secretary and Managing Attorney, 1988 - 1991) Allen M. Nixon(54) 2\/1\/95 Vice President and President of Bearing and Components Group (Vice President and General Manager Torrington Needle Bearings Division, 1983 - 1994) James R. O'Dell(56) 12\/3\/88 Vice President Larry H. Pitsch(54) 2\/7\/90 Vice President and President of the Process Systems Group Donald H. Rice(50) 2\/1\/95 Vice President (Executive Director - Human Resources 1994; Vice President, Human Resources - Bearings and Components Group, 1988 - 1993) Gerald E. Swimmer(50) 5\/1\/82 Vice President R. Barry Uber(49) 2\/7\/90 Vice President and President of the Construction and Mining Group (Vice President and President of the Production Equipment Group 1989 - 1994) Ronald G. Heller(48) 2\/6\/91 Secretary and Assistant General Counsel (Assistant General Counsel, 1988 - 1991)\nNo family relationship exists between any of the above-listed executive officers of the company. All officers are elected to hold office for one year or until their successors are elected and qualify.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Information regarding the principal market for the company's common stock and related stockholder matters are as follows:\nQuarterly share prices and dividends for the common stock are shown in the following tabulation. The common shares are listed on the New York Stock Exchange and also on the London and Amsterdam exchanges.\nCommon Stock High Low Dividend First quarter $41 5\/8 $34 5\/8 $.175 Second quarter 38 7\/8 32 3\/4 .175 Third quarter 38 3\/4 34 3\/8 .185 Fourth quarter 36 1\/4 29 1\/2 .185\nHigh Low Dividend\nFirst quarter $36 1\/4 $28 3\/4 $.175 Second quarter 35 3\/8 29 1\/2 .175 Third quarter 39 3\/4 31 .175 Fourth quarter 39 7\/8 35 .175\nThe Bank of New York (Church Street Station, P.O. Box 11258, New York, NY 10286-1258, (800)524-4458) is the transfer agent, registrar and dividend reinvestment agent.\nThere are no significant restrictions on the payment of dividends. The approximate number of record holders of common stock as of March 10, 1995 was 14,800.\nItem 7.","section_6":"","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 included as Financial Review and Management Analysis in Exhibit 13 - the Annual Report to Shareowners for 1994 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 The following financial statements and supplementary financial information included in the accompanying Annual Report to Shareowners for 1994 are incorporated by reference in this Form 10-K Annual Report:\n(a) The consolidated financial statements and the report thereon of Price Waterhouse LLP dated January 31, 1995, are included as Exhibit 13 - the Annual Report to Shareowners (excluding the Financial Review and Management Analysis) for 1994.\n(b) The unaudited quarterly financial data for the two-year period ended December 31, 1994, is as follows (in thousands except per share amounts):\nEarnings per Net Cost of Operating Net common 1994 sales goods sold income earnings share\nFirst quarter $1,010,308 $ 775,924 $ 60,127 $ 33,012 $0.31 Second quarter 1,143,808 865,976 91,766 51,569 0.49 Third quarter 1,113,670 840,171 88,965 48,379 0.46 Fourth quarter 1,239,684 894,978 136,149 78,180 0.74 Year 1994 $4,507,470 $3,377,049 $377,007 $211,140 $2.00\nFirst quarter $ 952,105 $ 728,042 $ 45,150 $ 3,628 $0.04 Second quarter 1,006,773 752,816 69,344 35,937 0.34 Third quarter 973,524 736,244 64,505 35,186 0.33 Fourth quarter 1,088,669 799,588 112,515 67,773 0.65 Year 1993 $4,021,071 $3,016,690 $291,514 $142,524 $1.36\no The reductions in LIFO inventory quantities increased net earnings per share by $0.01 and $0.06 in the third and fourth quarters of 1994 and $0.02 and $0.05 in the second and fourth quarters of 1993, respectively.\no During the fourth quarter of 1993, the company retroactively changed its method of accounting for postemployment benefits. The effect of this change on the company amounted to $21.0 million (net of tax) and resulted in the restatement of the company's net earnings for the first quarter from $24.6 million ($0.24 per share) to $3.6 million ($0.04 per share).\no During the second quarter of 1993, the company recorded a $5.0 million ($0.03 per share) restructure of operations charge, related to the sale of substantially all of the underground coal-mining machinery assets (see Note 4 to the Consolidated Financial Statements).\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT 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 required by Item 10 is (i) incorporated by reference in this Form 10-K Annual Report from pages 2 through 6 of the company's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 27, 1995, and (ii) included in Part I on pages 11 and 12 of this Form 10-K Annual Report.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION Information on executive compensation is incorporated by reference in this Form 10-K Annual Report from pages 6 through 20 of the company's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 27, 1995.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information on security ownership of directors and nominees, directors and officers as a group and certain beneficial owners is incorporated by reference in this Form 10-K Annual Report on pages 4 and 5 of the company's definitive proxy statement for the Annual Meeting of Shareholders to be held on April 27, 1995.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required by Item 13 is incorporated by reference in this Form 10-K Annual Report from page 15 of the company's definitive proxy statement for the Annual Meeting of Shareholders 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\n(a) 1. and 2. Financial statements and financial statement schedules The financial statements, together with the report thereon of Price Waterhouse LLP dated January 31, 1995, included as Exhibit 13 (excluding Financial Review and Management Analysis) and the unaudited quarterly financial data included in Part II Item 8(b) are incorporated by reference in this Form 10-K Annual Report. The financial statement schedule listed in the accompanying index should be read in conjunction with the financial statements in such Annual Report to Shareowners for 1994.\nSeparate financial statements for all 50 percent or less owned companies, accounted for by the equity method have been omitted because no individual entity constitutes a significant subsidiary.\n3. Exhibits The exhibits listed on the accompanying index to exhibits are filed as part of this Form 10-K Annual Report.\n(b) Reports on Form 8-K None.\nINGERSOLL-RAND COMPANY\nAND FINANCIAL STATEMENT SCHEDULES (Item 14 (a) 1 and 2)\nForm 10-K Consolidated Financial Statements: Report of independent accountants . . . . . . . . . . * Consolidated balance sheet at December 31, 1994 and 1993 . . . . . . . . . . . . * For the years ended December 31, 1994, 1993 and 1992: Consolidated statement of income . . . . . . . . . * Consolidated statement of shareowners' equity . . . . . . . . . . . . . . . . . . . . . * Consolidated statement of cash flows . . . . . . . * Notes to consolidated financial statements . . . . . * Selected unaudited quarterly financial data . . . . . . 14\nFinancial Statement Schedule: Report of independent accountants on financial statement schedule . . . . . . . . . . . 18 Consolidated schedule for the years ended December 31, 1994, 1993 and 1992: Schedule II -- Valuation and Qualifying Accounts . . . . . . . . . . . . . . . . . . . . 19\n* See Exhibit 13 - Ingersoll-Rand Company Annual Report to Shareowners for 1994.\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 financial statements or notes thereto.\nFinancial statements of the company's 50 percent or less owned companies, are omitted because individually they do not meet the significant subsidiary test of Rule 3-09 of Regulation S-X.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors and Shareowners of Ingersoll-Rand Company:\nOur audits of the consolidated financial statements referred to in our report dated January 31, 1995 included as part of Exhibit 13 - the Annual Report to Shareowners for 1994 of Ingersoll-Rand 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.\n\/S\/ Price Waterhouse LLP PRICE WATERHOUSE LLP Morristown, New Jersey January 31, 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-3 (No. 33-53811) and Form S-8 (Post-Effective Amendment No. 4 to No. 2-64708, No. 2-67834, No. 2-98258 and No. 33-35229) of Ingersoll-Rand Company of our report dated January 31, 1995 included as part of Exhibit 13 - the Annual Report to Shareowners for 1994, 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 on this page.\n\/S\/ Price Waterhouse LLP PRICE WATERHOUSE LLP Morristown, New Jersey March 30, 1995\nSCHEDULE II\nINGERSOLL-RAND COMPANY\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 and 1992 (Amounts in thousands)\nAdditions charged to Balance at costs and Balance beginning expenses Deductions at end Description of year (*) (**) of year\nDoubtful accounts $22,089 $12,636 $ 8,820 $25,905\nDoubtful accounts $23,057 $10,218 $11,186 $22,089\nDoubtful accounts $18,772 $12,590 $ 8,305 $23,057\n(*) \"Additions\" include foreign currency translation and in 1992 amounts contributed by Dresser Industries, Inc. to Ingersoll-Dresser Pump.\n(**) \"Deductions\" include accounts and advances written off, less recoveries.\nINGERSOLL-RAND COMPANY INDEX TO EXHIBITS (Item 14(a)) Description Page 3 (i) Amendment to Restated Certificate of Incorporation of Ingersoll-Rand Company filed May 28, 1992. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 30-32 of the 1993 Form 10-K). -\n3 (ii) Restated Certificate of Incorporation of Ingersoll-Rand Company as amended through May 28, 1992. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 33-60 of the 1993 Form 10-K). -\n3 (iii) By-Laws of Ingersoll-Rand Company, as amended through December 7, 1994. 25-38\n4 (i) Rights agreement, dated as of December 7, 1988, as amended by Amendment No. 1 thereto dated as of December 7, 1994. Incorporated by reference from Form 8-A of Ingersoll- Rand Company filed on December 12, 1988, and Form 8-A\/A of Ingersoll-Rand Company filed December 15, 1994. -\n4 (iii) Ingersoll-Rand Company is a party to several long-term debt instruments under which in each case the total amount of securities authorized does not exceed 10% of the total assets of Ingersoll-Rand Company and its subsidiaries on a consolidated basis. Pursuant to paragraph 4(iii)(A) of Item 601(b) of Regulation S-K, Ingersoll-Rand Company agrees to furnish a copy of such instruments to the Securities and Exchange Commission upon request. -\n10 (iii) The following exhibits constitute management contracts or compensatory plans or arrangements required by Item 601 of Regulation S-K.\n10 (iii) (a) Management Incentive Unit Plan of Ingersoll- Rand Company. Amendment to the Management Incentive Unit Plan, effective January 1, 1982. Amendment to the Management Incentive Unit Plan, effective January 1, 1987. Amendment to the Management Incentive Unit Plan, effective June 3, 1987. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 78-92 of the 1993 Form 10-K). -\nINGERSOLL-RAND COMPANY INDEX TO EXHIBITS (Item 14(a)) (Continued) Description Page\n10 (iii) (b) Description of Compensation Plan for Retired Directors of Ingersoll-Rand Company. 39-47\n10 (iii) (c) Form of Contingent Compensation Agreements with Executive Vice Presidents and Group Presidents of Ingersoll-Rand Company. 48-53\n10 (iii) (d) Description of Bonus Arrangements for Chairman, President and Staff Officers. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See page 100 of the 1993 Form 10-K). -\n10 (iii) (e) Form of Change of Control Arrangements with Chairman and Chief Executive Officer. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 101-113 of the 1993 Form 10-K). -\n10 (iii) (f) Form of Change of Control Arrangements with selected executive officers. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 114-126 of the 1993 Form 10-K). -\n10 (iii) (g) Executive Supplementary Retirement Plan for selected senior executives. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 127-132 of the 1993 Form 10-K). -\n10 (iii) (h) Incentive Stock Plan of 1985 of Ingersoll- Rand Company. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 133-151 of the 1993 Form 10-K). -\n10 (iii) (i) Forms of insurance and related letter agreements with certain executive officers. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 152-160 of the 1993 Form 10-K). -\nINGERSOLL-RAND COMPANY INDEX TO EXHIBITS (Item 14(a)) (Continued) Description Page\n10 (iii) (j) Incentive Stock Plan of 1990 of Ingersoll- Rand Company. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 161-182 of the 1993 Form 10-K). -\n10 (iii) (k) Restated Supplemental Pension Plan effective January 1, 1992. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 183-188 of the 1993 Form 10-K). -\n10 (iii) (l) Supplemental Stock and Savings Investment Plan effective as of January 1, 1989. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 189-198 of the 1993 Form 10-K). -\n10 (iii) (m) Supplemental Retirement Account Plan effective as of January 1, 1989. Incorporated by reference to Form 10-K of Ingersoll-Rand Company for Fiscal Year Ended December 31, 1993. (See pages 199-206 of the 1993 Form 10-K). -\n11 (i) Computation of Primary Earnings Per Share. 54-55\n11 (ii) Computation of Fully Diluted Earnings Per Share. 56-57\n12 Computations of Ratios of Earnings to Fixed Charges. 58\n13 Ingersoll-Rand Company Annual Report to Shareowners for 1994. (Not deemed to be filed as part of this report except to the extent incorporated by reference). 59-120\n21 List of Subsidiaries of Ingersoll-Rand Company. 121-123\n27 Financial Data Schedule. 124\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINGERSOLL-RAND COMPANY (Registrant)\nBy \/S\/ Thomas F. McBride Thomas F. McBride Senior Vice President and Chief Financial 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.\nSignature Title Date\nChairman, President, Chief Executive Officer and Director (Principal \/S\/ James E. Perrella Executive Officer) March 30, 1995 (James E. Perrella)\nSenior Vice President Chief Financial Officer (Principal Financial \/S\/ Thomas F. McBride Officer) March 30, 1995 (Thomas F. McBride)\nController - Accounting and Reporting (Principal Accounting \/S\/ Richard A. Spohn Officer) March 30, 1995 (Richard A. Spohn)\n\/S\/ Donald J. Bainton Director March 30, 1995 (Donald J. Bainton)\n\/S\/ Theodore H. Black Director March 30, 1995 (Theodore H. Black)\nSignature Title Date\n\/S\/ Brendan T. Byrne Director March 30, 1995 (Brendan T. Byrne)\n\/S\/ Joseph P. Flannery Director March 30, 1995 (Joseph P. Flannery)\n\/S\/ Constance J. Horner Director March 30, 1995 (Constance J. Horner)\n\/S\/ Alexander H. Massad Director March 30, 1995 (Alexander H. Massad)\n\/S\/ John E. Phipps Director March 30, 1995 (John E. Phipps)\n\/S\/ Donald E. Procknow Director March 30, 1995 (Donald E. Procknow)\n\/S\/ Cedric E. Ritchie Director March 30, 1995 (Cedric E. Ritchie)","section_15":""}
{"filename":"840467_1994.txt","cik":"840467","year":"1994","section_1":"Item 1. Business\nBeckman Instruments, Inc. (\"Beckman\" or \"the Company\") is one of the world's leading manufacturers of instrument systems that make laboratories more efficient by simplifying and automating biologically based processes. The Company designs, manufactures, markets and services a broad range of laboratory instrument systems, reagents and related products, which customers typically use to conduct basic scientific research, new product research and development or diagnostic analysis of patient samples. In 1993 about 60 percent of total sales were for diagnostic applications, principally in hospital laboratories, while about 40 percent of sales were for life sciences applications in universities, medical schools and research institutes, or new product research and development in pharmaceutical and biotechnology companies. About half of reported sales were to customers outside the United States.\nBackground\nThe Company was founded in 1934 by Dr. Arnold O. Beckman to manufacture analytical instruments and became a publicly traded corporation in 1952, subsequently being listed on the New York Stock Exchange in 1955. In 1968 the Company expanded its laboratory instrument focus to include health care applications in clinical diagnostics. Beckman was acquired by SmithKline Corporation to form SmithKline Beckman Corporation (\"SmithKline Beckman\") in 1982 and the Company was operated as a wholly owned subsidiary of SmithKline Beckman until November 4, 1988. At that time approximately 16% of Beckman's common stock was sold in a public offering and the stock was listed on the New York Stock Exchange. On July 26, 1989, SmithKline Beckman distributed the remainder of its Beckman common stock as a tax free dividend to the stockholders of SmithKline Beckman. This was part of a transaction involving the merger of SmithKline Beckman and Beecham Group p.l.c., a public limited company organized under the laws of the United Kingdom (\"Beecham\"). Since that time Beckman has operated as a fully independent publicly owned company.\nSimplification and Automation of Laboratory Processes\nThe Company's primary expertise and activity is the integration of chemical, biological, engineering and software sciences into complete systems that simplify and automate biologically focused laboratory processes and the distribution and support of those systems around the world. These laboratory processes can generally be grouped into four categories:\nSynthesis and Sample Preparation\/Handling - Synthesizing compounds useful in subsequent analysis and scientific investigation or placing material into a proper container, with necessary pretreatment, dilution, measurement, weighing and identification.\nSeparation - Isolating materials of interest from extraneous material or separating mixtures into individual constituents, often in preparation for subsequent processes.\nDetection, Measurement and Characterization - Determining the identity, structure, or quantity of specific analytes (compounds or molecules of interest) present in sample specimens.\nData Processing - Acquiring, reporting, analyzing, archiving or calculating the results of laboratory analysis.\nBeckman's experience, knowledge and ability in simplifying and automating these processes for biological laboratories forms a technological continuum that extends across the Company. From this common technical base comes a range of products that are configured to meet specific needs of academic research, pharmaceutical and biotechnology companies, hospitals and reference laboratories (large central laboratories to which hospitals and physicians refer specialized tests). By serving several customer groups with differing needs related through common science, the Company has the opportunity to broadly apply its technology.\nThere is a corresponding scientific and technical continuum reflected in customer laboratories. Virtually all new analytical methods and tests originate in academic research in universities and medical schools. If the utility of a new method or test is demonstrated by fundamental research, it often will then be used by pharmaceutical investigators, biotechnology companies, teaching hospitals or specialized clinical laboratories in an investigatory mode. In some cases these new techniques eventually emerge in routine, high volume clinical testing at hospitals and reference labs. Generally instruments used at each stage from research to routine clinical applications employ the same fundamental processes but may differ in operating features such as number of tests performed per hour and degree of automation.\nMarkets\nBeckman's products facilitate a wide range of laboratory processes in facilities concerned with cells, sub-cellular particles, biochemical compounds and analysis of patient samples. In 1993 the worldwide market for the types of products the Company provides was about $5.9 billion. Slightly over half of this market was in clinical diagnostic applications, with the remaining portion of the market in more general purpose life science applications. Other similar or related product categories not currently offered by the Company represent an additional market potential which is estimated to be approximately $10 billion. The size and growth of markets for the Company's products are influenced by technological innovation in bioanalytical practice, government funding for basic and disease related research (for example, heart disease, AIDS and cancer), research and development spending by biotechnology and pharmaceutical companies, health care spending and physician practice.\nProducts\nThe Company offers a wide range of instrument systems and related products, including consumables, accessories, and support services, which can be grouped into categories by type of laboratory process or application:\nSynthesis and Sample Preparation\/Handling Separation Processes Detection, Measurement and Characterization Data Processing Automated General Chemistry for Clinical Diagnostics Special Chemistry Applications for Clinical Diagnostics\nPRODUCT SALES AS A PERCENT OF TOTAL PRODUCT SALES\nFOR CATEGORIES REPRESENTING\nMORE THAN 10 PERCENT OF SALES\n1993 1992 1991 ____ ____ ____\nSeparation Processes 27 28 29\nAutomated General Chemistry for Clinical Diagnostics 40 39 39\nSpecial Chemistry Applications for Clinical Diagnostics 20 21 20\nSynthesis and Sample Preparation\/Handling\nDNA Synthesizers\nDNA synthesizers automate the process of making synthetic oligonucleotides from organic chemicals. The Beckman Oligo 1000 significantly reduces the time required for synthesis and informs the user of synthesis progress by providing reaction and reagents status throughout the process. The system's ease-of-use is enhanced by convenient chemicals packaging that minimize reagent preparation and replacement. Oligo 1000 systems sell in the $18,000 price range.\nRobotic Workstation\nThe Biomek(R) automated laboratory workstations perform complex operations involving liquids, including dispensing measured samples, adding reagents, diluting, mixing and transferring small volumes between reaction vessels. The systems handle multiple samples in parallel and may be equipped with a photometer for detection purposes. Biomek systems range in price from $35,000 to over $80,000.\nSeparation Processes\nCentrifuges\nCentrifuges separate liquid sample mixtures on the basis of density (weight per unit volume) differences between the mixture's components. Samples are put into tubes which are placed in rotors and spun at speeds varying from a few thousand to 120,000 revolutions per minute (\"rpm\"). The resulting centrifugal forces cause sample components to separate according to their density.\nCentrifuges are used for the nondestructive separation of protein and DNA fractions, cellular components and other materials of interest in modern biology and biotechnology. In addition to efficiency (low power consumption), reliability and an environmentally friendly design (e.g., without freon) on many models, Beckman centrifuges are distinguished from those of competitors by the wide variety of rotor designs available to meet the precise needs of customer applications, including the separation of blood cells from serum, an important use in clinical diagnostic laboratories.\nBeckman manufactures a broad line of centrifuges with varying speed characteristics ranging from \"low speed\" (few thousand rpm) to \"high speed\" (10,000 to 35,000 rpm) to \"ultracentrifuges\" (35,000 to 120,000 rpm) and sample capacities ranging from microliters (one millionth of a liter) to liters. Prices of these units vary from about $2,000 for a small low speed centrifuge to over $50,000 for an ultracentrifuge and over $100,000 for an analytical ultracentrifuge.\nHigh Performance Liquid Chromatographs (\"HPLC\")\nHPLC systems rely upon the difference in the rates of passage of the components in a chemical mixture through a tubular column filled with chemically active material. HPLC systems are powerful separation devices for biologically active compounds, since they are generally non-destructive, sensitive and capable of resolving very complex mixtures of similar compounds. The System Gold(R) HPLC manufactured by Beckman, which is designed to be particularly useful in life sciences laboratories, consists of several instrument modules that are used in various combinations, consumables, accessories and software tailored to specific applications, such as drug metabolism assays. Beckman's HPLC systems typically sell for $20,000 to $55,000.\nProtein Sequencers\nBeckman manufactures and sells protein sequencer systems and related chemicals. Protein sequencing is used to determine the primary structure, i.e., the amino acid sequence, of a protein. Protein sequencer systems sell in the range of $90,000 to $130,000.\nElectrophoresis\nElectrophoresis systems separate mixtures of proteins, DNA, and other molecules principally on the basis of differences in mass and electrical charge. The P\/ACE(TM) capillary electrophoresis product line represents a powerful extension of electrophoresis technology by combining the speed of traditional electrophoresis with the discrimination powers of chromatography. The result is an automated system for high speed, high sensitivity separation of proteins, nucleic acids and other biological materials. P\/ACE systems typically sell for $40,000 to $60,000.\nDetection and Measurement\nSpectrophotometer Systems\nSpectrophotometers detect and measure the presence of compounds in liquid mixtures by sensing the absorption of specific wavelengths of light as that light passes through the sample. Some Beckman spectrophotometers have the capability of measuring changes in absorption during biological reactions. These spectrophotometers, in conjunction with Beckman software, automatically control the time, temperature and wavelength of the measurement while computing and recording the results of the experiment. Depending on the specific model, accessories or software, Beckman spectrophotometers sell in the $9,000 to $25,000 range.\nNuclear Counters\nRadioactive \"labeling,\" which is the substitution or addition of a radioactive atom into a compound of interest, is a powerful and accepted method for tracing the path of a biochemical in a living system. A labeled compound which is fed to or injected into a test animal or plant can then be traced to specific tissue or waste product by detecting the presence of the radioactive label. Scintillation counters can be used for this purpose. Beckman scintillation counters are distinguished by sophisticated software and system features that combine accurate measurement with user convenience. They typically sell in the $15,000 to $30,000 range.\nData Processing\nIn addition to the software associated directly with Beckman's instrument systems, the Company produces computer software programs to aid in the data processing functions of analytical laboratories. These systems control laboratory instruments, direct data acquisition from the instruments, and compute, store and report the results in formats needed for internal purposes and satisfaction of regulatory requirements. Beckman's data management systems are characterized by several features, including the capability to operate on a variety of manufacturers' computers and applications flexibility which lets customers configure the system to meet their individual needs. These systems vary greatly in cost depending upon the customer's requirements, but typically range from $50,000 to $250,000.\nAutomated General Chemistry for Clinical Diagnostics\nAutomated general chemistry systems automatically detect and quantify various chemical substances of clinical interest (analytes) in human blood, urine and other body fluids. Beckman offers several general chemistry systems with a range of capabilities to meet specific customer requirements, principally for use in medium to large hospital laboratories, but also with some application in reference laboratories.\nSYNCHRON(R) Systems\nThe Company's SYNCHRON(R) line of automated general chemistry systems is a family of modular automated diagnostic instruments and the reagents, standards and other consumable products required to perform commonly requested diagnostic tests. The SYNCHRON analyzer series includes the SYNCHRON AS(R) system, originally introduced as the ASTRA(R), which is an automated \"stat\" (immediate test) routine multi-channel analyzer. The original system, since extended, determines the concentration of eight of the most commonly measured analytes.\nIn response to changes in reimbursement policies for hospitals and clinical laboratories, which required them to be more efficient, the Company developed a newer series of instrument systems, the SYNCHRON CX(R) line. The SYNCHRON CX systems have been designed as compatible modules which may be used independently or in various combinations with each other, to meet the specific needs of individual customers. The smallest of these modules, the SYNCHRON CX3 analyzer, is an upgrade of the ASTRA analyzer offering improved software, easier operation and reduced reagent consumption.\nThe SYNCHRON CX4CE, CX5CE and CX7 are enhanced models with industry leading, innovative software features. The CX(R)4CE clinical system has up to 24 customer selected \"on-board\" types of tests available, drawn from a menu of over 60 different types of tests. The extensive menu includes immunoproteins, therapeutic drugs and a complete listing of general chemistries. Drawing from the same menu, the CX(R)5CE has 28 \"on-board\" types of tests and the CX(R)7 has 32 \"on-board\" types of tests. These systems all enhance productivity by providing bi-directional communication with laboratory information systems. SYNCHRON systems range in price from $56,000 to over $185,000 and are sold principally based on their ability to improve laboratory efficiency.\nOther Automated Clinical Chemistry Products\nThe Company has a family of electrolyte analyzers that provide automated analysis of patient electrolyte concentrations such as sodium, potassium, and chloride. These analyzers include the E4A, E2A, LABLYTE(R) and SYNCHRON EL-ISE(R) series and range in price from $6,000 to $20,000. Beckman also offers a family of low cost instruments that perform manual analyses of glucose, blood urea nitrogen and creatinine.\nSpecial Chemistry Applications For Clinical Diagnostics\nImmunochemistry Systems\nThe Array(R) 360 Protein and Therapeutic Drug Monitoring Systems combine automated instrumentation and advanced software that significantly enhance the efficiency of protein and drug analysis. The Array provides automated random access testing which allows the operator to mix samples at random, eliminating the need to run identical analytes in batches. At the customer's option, it can incorporate a computer enhancement that allows automatic reading of bar-coded sample tubes for positive sample identification and bi- directional communication with the laboratory's information system. Array systems sell in the $45,000 to $55,000 price range.\nElectrophoresis For Clinical Diagnostics\nThe Appraise(R) densitometer and the Paragon(R) Electrophoresis Systems allow the Company to offer a full range of electrophoresis products that provide specialized protein analysis for clinical laboratories. Paragon reagent kits are used in the diagnosis of diabetes, cardiac, liver and other diseases. The Appraise densitometer can be used in conjunction with Paragon kits. It ranges in price from $17,000 to $24,000.\nOther Special Chemistry Products\nThe Company also produces a series of single use, self- contained diagnostic test \"kits\" for use in physicians' offices and group practices. For example, the Hemoccult(R) disposable fecal occult blood testing kit is used in the diagnosis of gastrointestinal disease.\nCompetition\nThe markets for the Company's products are highly competitive, with hundreds of companies participating in one or more portions of the market. There are a number of competitors which sell both life sciences and diagnostic products, including the Hitachi Ltd.\/ Boehringer Mannheim GmbH collaboration, E.I. du Pont de Nemours & Co. Inc., Bio-Rad Laboratories, Inc. and LKB Pharmacia AB. Additional competitors focused more directly on life sciences include Hewlett-Packard Co., Millipore Corporation, and The Perkin-Elmer Corporation. Additional competitors in the clinical laboratory market include Abbott Laboratories, Eastman Kodak Company, Hoechst Corporation (Behring Diagnostics Division), and Bayer Diagnostics. Competitors include divisions or subsidiaries of corporations with substantial resources. In addition the Company competes with several companies that sell reagents for laboratory instruments that are manufactured by Beckman and others.\nThe Company competes primarily on the basis of improved laboratory productivity, product quality and technology, service and price. Discounting is used as a competitive tool when necessary. Management believes that its extensive installed instrument base provides the Company with a competitive advantage in obtaining both instrument and after-market follow-on business.\nResearch, Development and Engineering\nThe Company's new products originate from four sources: internal research, development and engineering (\"RD&E\") programs; external collaborative efforts with individuals in academic institutions and technology companies; devices or techniques that are generated in customers' laboratories; and business acquisitions. The Company's RD&E teams are skilled in optics, chemistry, electronics, mechanical and other engineering disciplines and software, in addition to a broad range of biological and chemical sciences. Research studies are usually conducted in conjunction with individuals in academic institutions or other outside scientists. Development programs focus on production of new generations of existing product lines, such as the SYNCHRON(R) analyzers, as well as new product categories not currently offered by the Company. Other areas of pursuit include innovative approaches to immunochemistry, molecular biology and advanced electrophoresis technologies, such as capillary electrophoresis.\nThe Company's RD&E expenditures for fiscal years 1993, 1992, and 1991 were $93.3 million, $85.9 million and $82.2 million, respectively. Management intends to maintain the present level of the Company's investment in RD&E spending.\nSales and Service\nThe Company has sales in over 120 countries and maintains its own marketing, service and sales forces throughout the world. While nearly all of the Company's products are distributed by Beckman sales groups throughout the world, the Company employs independent distributors to serve those markets that are more efficiently reached through such channels. Beckman's sales force is technically educated and trained in the operation and application of the Company's products. The sales force is supported by a staff of scientists and technical specialists in each product line and in each major scientific discipline served by the Company's products. In addition to direct sales of its instruments, the Company leases certain instruments, principally those sold for clinical diagnostic applications in hospitals.\nBeckman provides accessory products, consumables and service for its instruments worldwide. Service offices and inventory depots are associated with sales offices, subsidiaries and dealer locations. The Company considers its reputation for service responsiveness and competence to be an important competitive asset.\nPatents and Trademarks\nTo complement and protect the innovations created by the Company's RD&E efforts, the Company has an active patent protection program which includes nearly 600 active U.S. patents and patent applications. The Company also files important corresponding applications in principal foreign countries. The Company has taken an aggressive posture in protecting its patent rights; however, no one patent is considered essential to the success of the business.\nThe Company's primary trademark is \"Beckman\", with the trade name also being Beckman or Beckman Instruments, Inc. The Company vigorously protects its primary trademark, which is used on the Company's products and is recognized throughout the worldwide scientific and diagnostic community. The Company owns and uses secondary trademarks on various products, but none of these secondary trademarks is considered of primary importance to the business.\nGovernment Regulations\nCertain of the Company's products are subject to regulations of the U.S. Food and Drug Administration (the \"FDA\") which require such products to be manufactured in accordance with \"good manufacturing practices\". Such laws and regulations also require that such products be safe and effective and that the labeling of those products conform with specific requirements. Testing is conducted to demonstrate performance claims and to provide other necessary assurances. Clinical systems and reagents must be reviewed by the FDA before sale and, in some instances, are subject to product standards, other special controls or a formal FDA premarket approval process. Implementation in 1994 of federal regulations under the Clinical Laboratory Improvement Amendments of 1988 will require FDA review and approval of quality assurance protocols for the Company's clinical reagent products. While adding to the overall regulatory review process, this is not expected to materially affect the sale of the Company's products. Certain of the Company's products are subject to comparable regulations in foreign countries.\nIn January 1993 the European Community (EC) countries began implementation of their plan for a new unified EC market with reduced trade barriers and harmonized regulations. The EC adopted a significant international quality standard, the International Organization for Standardization Series 9000 Quality Standards (\"ISO 9000\"). The Company's manufacturing operations in its Brea, Carlsbad, Fullerton, Palo Alto, Paso Robles and Porterville, California; Allendale, New Jersey; Sharon Hill, Pennsylvania; Naguabo, Puerto Rico and Galway, Ireland facilities have been certified as complying with the requirements of ISO 9000. Many of the Company's international sales subsidiaries have also been certified, including those located in Australia, Canada, France, Germany, Italy, The Netherlands, South Africa, Spain, Sweden, Switzerland and the United Kingdom.\nThe design of the Company's products and the potential market for their use may be directly or indirectly affected by U.S. and foreign regulations concerning reimbursement for clinical testing services. The configuration of new products, such as the SYNCHRON(R) series of clinical analyzers, reflects the Company's response to the changes in hospital capital spending patterns such as those engendered by the Medicare Diagnostic Related Groups (\"DRGs\"). Under the DRG system, a hospital is reimbursed a fixed sum for the services rendered in treating a patient, regardless of the actual cost of the services provided.\nPrior to the U.S. Government fiscal year which began October 1, 1991, inpatient capital costs incurred by a hospital were an exception to the DRG system and were reimbursed, to the extent of Medicare utilization, through a supplement to the DRG payment known as \"capital cost pass-through.\" Effective October 1, 1991, the capital cost payment provisions of the Medicare Prospective Payment System were changed to provide for the transition from a \"pass- through\" payment methodology to a \"prospective DRG based capital payment\" methodology for all inpatient capital related costs incurred by a hospital.\nUnder this new payment methodology, \"low capital costs\" hospitals are expected to receive greater capital payments from Medicare than they would have had they remained under the prior capital payment system. \"High capital costs\" hospitals are paid under a \"hold harmless\" payment methodology which assures the hospital of certain minimum payment levels for historical capital costs and new capital costs during the ten year transition period to a \"fully prospective\" payment system for inpatient capital costs.\nTo date, the Company has not experienced, and does not expect to experience in the future, any material financial impact from the change in Medicare's payment for inpatient capital costs.\nThe current health care reform efforts in the United States and in some foreign countries are expected to further alter the methods and financial aspects of doing business in the health care field. The Company is closely following these developments so that it may position itself to take advantage of them. However, the Company cannot predict the effect on its business of these reforms should they occur nor of any other future government regulation.\nEnvironmental Matters\nThe Company is subject to federal, state, local and foreign environmental laws and regulations. The Company believes that its operations comply in all material respects with applicable federal, state, and local environmental laws and regulations. Although the Company continues to make expenditures for environmental protection, it does not anticipate any significant expenditures in order to comply with such laws and regulations which would have a material impact on the Company's operations or financial position.\nIn 1983 the Company discovered organic chemicals in the groundwater near a waste storage pond at a Company facility in Porterville, California. SmithKline Beckman, the Company's former controlling stockholder, agreed to indemnify the Company with respect to this matter for any costs incurred by the Company in excess of applicable insurance, eliminating any impact on the Company's earnings or financial position. SmithKline Beecham Corporation, the surviving entity of the 1989 merger between SmithKline Beckman and Beecham, assumed the obligations of SmithKline Beckman in this respect.\nIn 1984 the Company sold approximately 40 acres of land in Irvine, California to The Prudential Insurance Company of America (\"Prudential\"). In 1988 the Company was sued by Prudential in U.S. District Court in California for recovery of costs and other alleged damages with respect to soil and groundwater contamination allegedly caused by operations on the property. In 1990 the Company entered into an agreement with Prudential for settlement of the lawsuit and for sharing current and future costs of investigation, remediation and other claims. Prudential has since sold the property to Mola Development Corporation which subsequently sold a portion of the property to F.C. Irvine, Inc., each local property developers. This has resulted in additional litigation against the Company and Prudential. See \"Legal Proceedings\" herein.\nInvestigations conducted on the property have determined that soil and groundwater remediation is required and such remediation is underway. During 1993 the Company made substantial progress in remediating the soil, although there remain some areas of soil contamination that may require further remediation. The Company also operated a groundwater treatment system throughout most of 1993 and in the fourth quarter expanded the capacity of the system. The expanded system is believed to be adequate to remediate the groundwater based upon information available in 1993. In addition a series of test wells were drilled on the property which provided additional information concerning the area of groundwater contamination. The Company believes that it has established adequate reserves for remediation of any remaining soil contamination, operation and maintenance of the expanded treatment system and any necessary additional groundwater investigations.\nInvestigations on the property are continuing and there can be no assurance that further investigation will not reveal additional contamination or result in additional costs. The Company believes that additional remediation costs, if any, beyond those already provided for the contamination discovered by the current investigations will not have a material adverse effect on the Company's operations or financial position.\nEmployee Relations\nThe Company and its subsidiaries presently employ approximately 6,600 persons throughout the world, including approximately 4,600 in the United States. The Company considers that its relations with its employees are generally good.\nGeographic Area Information\nInformation with respect to the above-captioned item is incorporated by reference to Note 11 Business Segment Information of the Company's Annual Report to stockholders for the year ended December 31, 1993.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's primary instrument assembly and manufacturing facilities are located in Fullerton, Brea, and Palo Alto, California. Central manufacturing support facilities for parts and electronic subassemblies are located in Porterville and Paso Robles, California. An additional manufacturing facility is located in Galway, Ireland. Reagents are manufactured in Carlsbad, California, Naguabo, Puerto Rico, and Galway, Ireland. The Company's computer software products business is located in Allendale, New Jersey. The Company's facility for the production of Hemoccult(R) test kits and related products is located in Sharon Hill, Pennsylvania.\nAll U.S. manufacturing facilities, including land and buildings, are owned by the Company with the exception of Allendale and Sharon Hill which are leased facilities, and Palo Alto, where the Company has built and owns its buildings on a long-term land lease expiring in 2054. All manufacturing facilities outside the U.S. are leased. The central production facilities for the Company also include plastics fabrication and machine shop capabilities in Fullerton to serve the entire Company. This facility, in conjunction with electronic subassembly work done in Porterville and Paso Robles, supplies the primary parts and subassemblies for the instrument systems to the various instrument assembly locations in California. The Company's principal U.S. distribution locations are in Brea and Fullerton, California and Somerset, New Jersey. In addition, the Company plans to establish a European administration center at a facility in Nyon, Switzerland during the first quarter of 1994.\nThe Company believes that its production facilities meet applicable government environmental, health and safety regulations, and industry standards for maintenance, and that its facilities in general are adequate for its current business.\nItem 3.","section_3":"Item 3. Legal Proceedings\nAs previously reported, in 1991 Forest City Properties Corporation and F.C. Irvine, Inc. (collectively, \"Forest City\"), current owners and developers of a portion of the same real property in Irvine referred to under the caption \"Environmental Matters\" herein, filed suit against Prudential in the California Superior Court for the County of Los Angeles, alleging breach of contract and damages caused by the pollution of the property. Forest City seeks damages of more than $20 million and additional remediation of the property. Although the Company is not a named defendant in the Forest City action, it may be obligated to contribute to any resolution of that action pursuant to the Company's 1990 settlement agreement with Prudential. See \"Environmental Matters\" herein. The Company has established a reserve for the resolution of this lawsuit and believes that any additional liability beyond that provided for will not have a material adverse effect on the Company's operations or financial position.\nAs previously reported, in July 1993 a toxic tort action was filed in Maricopa County Superior Court, Arizona against the Company and a number of other defendants, including Motorola, Inc., Siemens Corporation, the Cities of Phoenix and Scottsdale, and others. Please see the Company's report to the Securities and Exchange Commission on form 10-Q for the quarter ended September 30, 1993 for details. This lawsuit was served on the Company in December 1993 and the Company has undertaken its legal defense of the action. The Company is indemnified by SmithKline Beecham Corporation, the successor of its former controlling stockholder, for any costs incurred in this matter in excess of applicable insurance, and thus the outcome of this litigation, even if unfavorable to the Company, should have no effect on the Company's earnings or financial position.\nIn addition, the Company and its subsidiaries are involved in a number of lawsuits which the Company considers ordinary and routine in view of its size and the nature of its business. The Company does not believe that any ultimate liability resulting from any such lawsuits will have a material adverse effect on the operations or financial position of the Company. See also \"Environmental Matters\" herein.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of stockholders during the fourth quarter of the fiscal year covered by this report.\nExecutive Officers of the Company\nThe following is a list of the executive officers of the Company as of February 7, 1994, showing their ages, present positions and offices with the Company and their business experience during the past five or more years. Officers are elected by the Board of Directors and serve until the next annual Organization Meeting of the Board. Officers may be removed by the Board at will. There are no family relationships among any of the named individuals, and no individual was selected as an officer pursuant to any arrangement or understanding with any other person.\nLouis T. Rosso, 60, Chairman of Mr. Rosso was named Chairman of the Board and Chief Executive the Board of the Company in Officer 1989, was named Chief Executive Officer in 1988 and was its President from 1982 until 1993. He also served as a Vice President of SmithKline Beckman from 1982 to 1989. Mr. Rosso first joined the Company in 1959 and was named Corporate Vice President in 1974. He is a director of Allergan, Inc. and of the Beckman Laser Institute and Medical Clinic. He is on the Board of Trustees of St. Jude Medical Center in Fullerton, California and Harvey Mudd College and is a member of the Board of Visitors of the Graduate School of Management of the University of California Irvine. Mr. Rosso has been a director of the Company since 1988.\nJohn P. Wareham, 52, Director, Mr. Wareham was named President President, and Chief Operating and Chief Operating Officer of Officer the Company effective October 15, 1993. On December 1, 1993 he was elected to the Board of Directors. Mr. Wareham joined the Company in 1984 as Vice President, Diagnostic Systems Group and served in that capacity until his appointment as President. Prior thereto he had been President of Norden Laboratories, Inc., a wholly owned subsidiary of SmithKline Beckman engaged in developing, manufacturing and marketing veterinary products. Mr. Wareham first joined SmithKline Beckman in 1968. He is a director of the Little Rapids Corporation and The John Henry Foundation.\nMichael T. O'Neill, 53, Senior Mr. O'Neill was named Senior Vice President, Commercial Vice President, Commercial Operations Operations of the Company effective October 15, 1993. He had been Vice President, Bioanalytical Systems Group since 1989. Prior thereto he had been Vice President, International Operations for the Bioanalytical systems Group since 1985. Mr. O'Neill first joined the Company in 1973.\nDennis K. Wilson, 58, Vice Mr. Wilson was named Vice President, Finance and Chief President, Finance and Chief Financial Officer Financial Officer of the Company effective December 24, 1993. He was Vice President, Treasurer of the Company from 1989 until his current appointment. Prior thereto he had been Vice President, Corporate Accounting and Assistant Controller of SmithKline Beckman since 1984. Mr. Wilson first joined the Company in 1969.\nJames T. Glover, 43, Vice Mr. Glover was appointed to his President and Controller present position as Vice President and Controller of the Company in May 1993. From 1989 until assuming his current position, he was Vice President, Controller - Diagnostic Systems Group. Mr. Glover joined the Company in 1983 and prior to that held management positions with KPMG Peat Marwick and R.J. Reynolds, Inc.\nWilliam H. May, 51, Vice Mr. May has been General President, General Counsel and Counsel and Secretary of the Secretary Company since 1984 and has been Vice President, General Counsel and Secretary of the Company since 1985. Mr. May first joined the Company in 1976.\nRichard K. Sears, 61, Vice Mr. Sears has been Vice President, Human Resources President, Human Resources of the Company since 1991. Prior thereto he had been President of Haiku\/Hawaii, a building material and development company, from 1989 to 1990. Before that he was Vice President - Corporate Administration of the Irvine Company of Newport Beach, California, a major California real estate developer, from 1984 to 1987, and served as the principal of his own consulting practice in the field of planning and general management from 1987 to 1989. Mr. Sears originally joined the Company in 1955 when he served in a number of administrative and management positions for a period of 14 years.\nBruce A. Tatarian, 45, Vice Mr. Tatarian was named Vice President, Bioresearch President Bioresearch Commercial Operations Commercial Operations International International of the Company effective January 1, 1994. He was Vice President, Marketing Operations for the Bioanalytical Systems Group from 1991 until his current appointment. Prior thereto he had been Vice President - Manager, Analytical Business Unit from 1990 to 1991. He rejoined the Company in 1989 as Director of Product Planning and Technical Assessment of the Bioanalytical Systems Group. Mr. Tatarian originally joined the Company in 1973 when he served in a number of marketing positions for a period of ten years.\nArthur A. Torrellas, 63, Vice Mr. Torrellas was named Vice President, Diagnostic President, Diagnostic Commercial Operations Commercial Operations of the Company effective January 1, 1994. He had been Vice President, International Operations for the Diagnostic Systems Group since 1985. Mr. Torrellas first joined the Company in 1977.\nAlbert R. Ziegler, 55, Vice Mr. Ziegler was named Vice President, Diagnostics President, Diagnostics Development Center Development Center of the Company effective January 1, 1994. He joined the Company in 1986 as Vice President, North America Operations for the Diagnostic Systems Group. Prior thereto he had been President of Branson Ultrasonics Corporation, a manufacturer of industrial ultrasound instruments and a subsidiary of SmithKline Beckman until the divestiture of SmithKline Beckman's industrial instruments businesses in 1984. Mr. Ziegler first joined SmithKline Beckman in 1971.\nPaul Glyer, 37, Treasurer Mr. Glyer was named Treasurer of the Company effective December 24, 1993. He served as Assistant Treasurer since 1989 when he first joined the Company.\nGeorge Kilmain, 60, Director, Mr. Kilmain was Vice President, Vice President, Finance and Finance and Chief Financial Chief Financial Officer Officer of the Company from 1984 until December 1993 when he retired. Mr. Kilmain was also a director of the Company from 1988 until he resigned effective December 1, 1993. He first joined the Company in 1961.\nRoger G. Novesky, 55, Vice Mr. Novesky was Vice President President, Spinco Business Unit and general manager of the Spinco Business Unit of the Company from 1985 until December 1993 when he elected early retirement which will be effective as of the end of February, 1994. Mr. Novesky first joined the Company in 1963.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nInformation with respect to the above-captioned item is incorporated herein by reference to the sections entitled \"Stock Exchanges and Prices\" and \"Dividends\" of the Company's Annual Report to stockholders for the year ended December 31, 1993. During 1992 the Company paid a quarterly dividend of $.07 per share of common stock for the first and second quarters and $.08 per share for the third and fourth quarters, for a total of $.30 per share for the year. During 1993 the Company paid four consecutive quarterly dividends of $.09 per share of common stock, for a total of $.36 per share for the year. Information with respect to dividend restrictions is incorporated by reference to Note 5 Debt of the Company's Annual Report to stockholders for the year ended December 31, 1993. In addition, as of January 24, 1994, there were approximately 10,855 holders of record of the Company's common stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nInformation with respect to the above-captioned item is incorporated herein by reference to the section entitled \"Five-Year Financial and Statistical Data\" of the Company's Annual Report to stockholders for the year ended December 31, 1993.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nInformation with respect to the above-captioned item is incorporated herein by reference to the section entitled \"FINANCIAL REVIEW\" of the Company's Annual Report to stockholders for the year ended December 31, 1993.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nInformation with respect to the above-captioned item is incorporated herein by reference to the consolidated financial statements, including all the notes thereto, and the sections entitled \"Report by Management,\" \"Independent Auditors' Report,\" and \"Quarterly Data (Unaudited)\" of the Company's Annual Report to stockholders for the year ended December 31, 1993.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nDirectors - The information with respect to directors required by this Item is incorporated herein by reference to those parts of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held March 30, 1994 entitled \"ELECTION OF DIRECTORS\" and \"Board of Directors Information.\"\nExecutive Officers - The information with respect to executive officers required by this Item is set forth in Part I of this report.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information with respect to executive compensation required by this Item is incorporated by reference to that part of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held March 30, 1994 entitled \"EXECUTIVE COMPENSATION.\"\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information with respect to security ownership required by this Item is incorporated by reference to that part of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held March 30, 1994 entitled \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\"\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information with respect to certain relationships and related transactions required by this Item is incorporated by reference to that part of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held March 30, 1994 entitled \"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)(1), (a)(2) Financial Statements and Financial Statement Schedules\nThe financial statements and financial statement schedules filed as part of the report are listed or incorporated by reference in the \"Index of Financial Statements and Schedules\" following this Part IV.\n(a)(3) Exhibits\nManagement contracts and compensatory plans or arrangements are identified by *.\n3.1 Third Restated Certificate of Incorporation of the Company, June 5, 1992 (incorporated by reference to Exhibit 3.1 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1992, File No. 001-10109).\n3.2 Amended and Restated By-Laws of the Company, as of January 27, 1993.\n4.1 Specimen Certificate of Common Stock (incorporated by reference to Exhibit 4.1 of Amendment No.1 to the Company's Form S-1 registration statement, File No. 33-24572).\n4.2 Rights Agreement between the Company and Morgan Shareholder Services Trust Company, as Rights Agent, dated as of March 28, 1989 (incorporated by reference to Exhibit 4 of the Company's current report on Form 8-K filed with the Securities and Exchange Commission on April 25, 1989, File No. 1-10109).\n4.3 First amendment to the Rights Agreement dated as of March 28, 1989 between the Company and First Chicago Trust Company of New York (formerly Morgan Shareholder Services Trust Company), as Rights Agent, dated as of June 24, 1992 (incorporated by reference to Exhibit 1 of the Company's current report on Form 8-K filed with the Securities and Exchange Commission on July 2, 1992, File No. 001-10109).\n10.1 Cross-Indemnification Agreement between the Company and SmithKline Beckman Corporation (incorporated by reference to Exhibit 10.1 of Amendment No.1 to the Company's Form S-1 registration statement, File No. 33-24572).\n10.2 Tax Sharing Agreement between the Company and SmithKline Beckman Corporation (incorporated by reference to Exhibit 10.2 of Amendment No. 1 to the Company's Form S-1 registration statement, File No. 33-24572).\n* 10.3 SmithKline Beckman Corporation Supplemental Benefits Plan (incorporated by reference to Exhibit 10(d) of SmithKline Beckman Corporation's Annual Report to the Securities and Exchange Commission on form 10-K for the fiscal year ended December 31, 1987, File No. 1-4077).\n* 10.4 Beckman Instruments, Inc. Supplemental Pension Plan, adopted by the Company October 24, 1990 (incorporated by reference to Exhibit 10.4 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December, 31 1990, File No. 001-10109).\n* 10.5 The Company's Incentive Compensation Plan, as amended by the Company's Board of Directors on October 26, 1988 and as amended and restated by the Company's Board of Directors on March 28, 1989 (incorporated by reference to Exhibit 10.16 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December, 31 1989, File No. 001-10109).\n10.6 Distribution Agreement, dated as of April 11, 1989, among SmithKline Beckman Corporation the Company and Allergan, Inc. (incorporated by reference to Exhibit 3 to SmithKline Beckman Corporation's Current Report on Form 8-K filed with the Securities and Exchange Commission on April 14, 1989, File No. 1-4077).\n10.7 Tax Agreement, dated as of April 11, 1989, between SmithKline Beckman Corporation and the Company (incorporated by reference to Exhibit 4 to SmithKline Beckman Corporation's Current Report on Form 8-K filed with the Securities and Exchange Commission on April 14, 1989, File No. 1-4077).\n10.8 Amendment to the Distribution Agreement effective as of June 1, 1989 between SmithKline Beckman Corporation, the Company and Allergan, Inc. (incorporated by reference to Exhibit 10.26 of Amendment No. 2 to the Company's Form S-1 registration statement, File No. 33-28853).\n* 10.9 The Company's Executive Bonus Plan, adopted by the Company in 1992 (incorporated by reference to Exhibit 10.18 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1992, File No. 001-10109).\n* 10.10 Form of Change in Control Agreement, dated as of May 1, 1989, between the Company, each of its Executive Officers and certain other key employees (incorporated by reference to Exhibit 10.34 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1989, File No. 001-10109).\n* 10.11 Form of Restricted Stock Agreement, dated as of September 16, 1991, between the Company, each of its Executive Officers and certain other key employees (incorporated by reference to Exhibit 10.19 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1991, File No. 001-10109).\n10.12 Revolving Credit Agreement, dated as of July 2, 1992, among the Company, the lenders named therein and Citicorp USA, Inc. as Agent (incorporated by reference to Exhibit 10.16 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1992, File No. 001-10109).\n10.13 First Amendment to Revolving Credit Agreement, dated as of December 31, 1993, among the Company, the lenders named therein and Citicorp USA, Inc. as Agent.\n10.14 Note Agreement, dated as of February 5, 1993, among the Company, Nationwide Life Insurance Company and three other insurance companies named therein (incorporated by reference to Exhibit 10.17 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1992, File No. 001-10109).\n* 10.15 The Company's Executive Bonus Plan, adopted by the Company in 1993.\n* 10.16 The Company's Stock Option Plan for Non-Employee Directors, as restated with amendments of January 29, 1992, amendments approved by stockholders May 6, 1992 (incorporated by reference to Exhibit 10.19 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1992, File No. 001-10109).\n* 10.17 The Company's Incentive Compensation Plan of 1990, as restated with amendments of January 29, 1992, amendments approved by stockholders May 6, 1992 (incorporated by reference to Exhibit 10.20 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1992, File No. 001-10109).\n10.18 Line of Credit Promissory Note in favor of Mellon Bank, N.A., dated as of October 6, 1993 (incorporated by reference to Exhibit 10.21 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1992, File No. 001-10109).\n10.19 Trust Agreement between the Company and Mellon Bank, N.A. as Trustee, for the benefit of Participating Employees, dated as of January 31, 1993 (incorporated by reference to Exhibit 10.22 of the Company's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1992, File No. 001-10109).\n* 10.20 Form of Legended Stock Agreement and Election For Deferral of a Portion of the FY 93 Executive Bonus Plan, between the Company and some of its Executive Officers and other key employees.\n10.21 Loan Agreement (Multiple Advance), dated September 30, 1993, between Beckman Instruments (Japan) Limited and the Industrial Bank of Japan, Limited (English translation, including certification as to accuracy; original document executed in Japanese).\n10.22 Term Loan Agreement, dated as of September 30, 1993, between Beckman Instruments (Japan) Limited and Citibank, N.A., Tokyo Branch.\n10.23 Term Loan Agreement, dated as of December 9, 1993, between Beckman Instruments (Japan) Limited and The Dai-Ichi Kangyo Bank Limited (English translation, including certification as to accuracy; original document executed in Japanese).\n* 10.24 Agreement Regarding Retirement Benefits of Arthur A. Torrellas, dated December 20, 1993, between the Company and Arthur A. Torrellas.\n11. Statement regarding computation of per share earnings: This information is incorporated by reference to Note 1 Summary of Significant Accounting Policies of the Company's Annual Report to stockholders for the year ended December 31, 1993.\n13. FINANCIAL REVIEW section of the Company's Annual Report to stockholders for the year ended December 31, 1993.\n22. List of principal subsidiaries of the Company.\n24. Consent of KPMG Peat Marwick, February 8, 1994.\n(b) Reports on Form 8-K During Fourth Quarter ended December 31, 1993.\nNo Reports on Form 8-K were filed during the quarter ended December 31, 1993.\nKPMG Peat Marwick Certified Public Accountants Orange County Office Center Tower 650 Town Center Drive Costa Mesa, CA 92626\nThe Stockholders and Board of Directors Beckman Instruments, Inc.:\nUnder the date of January 20, 1994 we reported on the consolidated balance sheets of Beckman Instruments, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of operations and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the 1993 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related supplementary financial schedules as listed in the accompanying index. These supplementary financial schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these supplementary financial schedules based on our audits.\nIn our opinion, such supplementary financial 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 and Note 7 to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, and Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits other Than Pensions, in 1993.\nKPMG PEAT MARWICK\nOrange County, California January 20, 1994\nBeckman Instruments, Inc.\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nThe consolidated financial statements of the Company and the related report of KPMG Peat Marwick dated January 20, 1994 are incorporated by reference to the section entitled \"FINANCIAL REVIEW\" of the Company's Annual Report to stockholders for the year ended December 31, 1993.\nThe supplemental financial schedules for each of the years in the three-year period ended December 31, 1993 that follow this index should be read in conjunction with the financial statements in the Company's 1993 Annual Report to stockholders. Schedules not included in this additional financial data have been omitted because they are not applicable or the required information is presented in the consolidated financial statements or in the notes to the consolidated financial statements.\nSUPPLEMENTARY FINANCIAL SCHEDULES\nV Property, plant and equipment\nVI Accumulated depreciation of property, plant and equipment\nVIII Allowance for doubtful accounts\nIX Short-term borrowings\nX Supplementary income statement information\nBeckman Instruments, Inc.\nSCHEDULE V\nPROPERTY, PLANT AND EQUIPMENT\nFor the years ended December 31, 1993, 1992 and 1991 (Dollars in millions)\nBalance at Other Balance Beginning Additions Changes at End Classification of Period at Cost Retirements Add(Deduct) of Period\nDecember 31, 1993 Land $ 11.9 $ 0.1 $ 1.7 $ - $ 10.3\nBuildings 134.6 5.5 4.0 (1.4) (a) 133.1 (1.6) (b) Machinery & Equip. 351.9 87.2 42.6 (14.5) (a) 380.7 (1.3) (b) ______ _____ _____ _______ ______\n$498.4 $92.8 $48.3 $(18.8) $524.1\nDecember 31, 1992 Land $ 12.0 $ - $ 0.1 $ - $ 11.9\nBuildings 130.0 6.8 1.2 (0.4) (a) 134.6 (0.6) (b) Machinery & Equip. 315.0 84.6 38.1 (9.2) (a) 351.9 (0.4) (b) ______ _____ _____ _______ ______\n$457.0 $91.4 $39.4 $(10.6) $498.4\nDecember 31, 1991 Land $ 12.0 $ - $ - $ - $ 12.0\nBuildings 129.3 6.1 0.9 (1.1) (a) 130.0 (3.4) (b) Machinery & Equip. 289.2 63.6 41.3 (6.1) (a) 315.0 9.6 (b) ______ _____ _____ _______ ______\n$430.5 $69.7 $42.2 $ (1.0) $457.0\n(a) Adjustments from translating at current exchange rates. (b) Transfers to\/from other accounts.\nBeckman Instruments, Inc.\nSCHEDULE VI\nACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT\nFor the years ended December 31, 1993, 1992 and 1991 (Dollars in millions)\nBalance at Other Balance Beginning Additions Changes at End Classification of Period at Cost Retirements Add(Deduct) of Period\nDecember 31, 1993 Buildings $ 58.1 $ 5.7 $ 2.3 $(0.7) (b)$ 60.8\nMachinery & Equip. 227.3 56.6 28.5 (8.1) (b) 246.5 (0.8) (c) ______ _____ _____ _______ ______\n$285.4 $62.3 $30.8 $(9.6) $307.3\nDecember 31, 1992 Buildings $ 53.6 $ 5.8 $ 1.1 $(0.2) (b)$ 58.1\nMachinery & Equip. 200.4 58.1 24.7 (5.3) (b) 227.3 (1.2) (c) ______ _____ _____ _______ ______\n$254.0 $63.9 $25.8 $(6.7) $285.4\nDecember 31, 1991 Buildings $ 49.8 $ 6.5 $ 0.7 $(0.5) (b)$ 53.6 (1.5) (c) Machinery & Equip. 177.6 49.0 30.8 (3.1) (b) 200.4 (1.2) (c) ______ _____ _____ _______ ______\n$227.4 $55.5 $31.5 $ 2.6 $254.0\n(a) Buildings are depreciated over 15 to 40 years, except for leasehold improvements which are depreciated over the life of the lease. Machinery and equipment are depreciated over 3 to 10 years. (b) Adjustments from translating at current exchange rates. (c) Transfers to\/from other accounts.\nBeckman Instruments, Inc.\nSCHEDULE VIII\nALLOWANCE FOR DOUBTFUL ACCOUNTS\nFor the years ended December 31, 1993, 1992 and 1991 (Dollars in millions)\nAdditions Balance at Charged to Balance Beginning Cost and at End Description of Period Expenses Deductions of Period\nDecember 31, 1993 $12.1 $2.4 (a) $2.0 (b) $11.9 0.6 (d) _____ _____ _____ _____\nDecember 31, 1992 $12.1 $1.6 (a) $1.5 (b) $12.1 0.4 (c) 0.5 (d) _____ _____ _____ _____\nDecember 31, 1991 $10.9 $1.2 (a) $0.4 (b) $12.1 0.7 (c) 0.3 (d) _____ _____ _____ _____\n(a) Provision charged to earnings. (b) Accounts written off. (c) Collection of accounts previously written off. (d) Adjustments from translating at current exchange rates.\nBeckman Instruments, Inc.\nSCHEDULE IX\nSHORT-TERM BORROWINGS For the years ended December 31, 1993, 1992 and 1991 (Dollars in millions)\nCategory Maximum Average Weighted of Weighted Amount Amount Average Aggregate Balance Average Outstanding Outstanding Interest Rate Short-Term at End Interest During During During Borrowings of Period Rate the Period the Period the Period\nDecember 31, 1993\nBank Loans $29.4 6.71% $78.7 $46.1 7.94% Current portion of Long-term Debt 2.3 _____ TOTAL $31.7\nDecember 31, 1992\nBank Loans $41.9 10.55% $55.3 $40.5 11.32% Current portion of Long-term Debt 2.5 _____ TOTAL $44.4\nDecember 31, 1991\nBank Loans $28.0 10.42% $61.8 $42.8 13.11% Current portion of Long-term Debt 2.5 _____ TOTAL $30.5\nGeneral terms of short-term borrowings are incorporated by reference to Note 5 Debt of the Company's Annual Report to Stockholders for the year ended December 31, 1993.\nThe average amounts outstanding during the period were computed using month-end balances.\nThe weighted average interest rates during the period were computed by dividing the associated interest expense for the period by the average amounts of short- term borrowing outstanding during the period.\nBeckman Instruments, Inc.\nSCHEDULE X\nSUPPLEMENTARY INCOME STATEMENT INFORMATION\nFor the years ended December 31, 1993, 1992 and 1991 (Dollars in millions)\nThe following amounts have been charged to earnings:\nItem Description 1993 1992 1991\nMaintenance and repairs $ 7.7 $ 9.0 $ 8.8 Depreciation and amortization of intangible assets (1) Taxes, other than payroll and income taxes $10.2 $ 9.6 $ 9.0 Royalties (1) Advertising costs $15.2 $20.0 $17.6\n(1) Amount does not meet 1% of total sales and revenues.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. BECKMAN INSTRUMENTS, INC.\nDate: January 28, 1994 By LOUIS T. ROSSO Louis T. Rosso Chairman of the Board 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 and in the capacities and on the dates indicated.\nSignature Title Date _________ _____ ____\nChairman of the Board and Chief Executive Officer (Principal LOUIS T. ROSSO Executive Officer) January 28, 1994 Louis T. Rosso\nPresident, Chief Operating Officer JOHN P. WAREHAM and Director January 27, 1994 John P. Wareham\nVice President, Finance and Chief Financial Officer (Principal Financial DENNIS K. WILSON and Accounting Officer) January 27, 1994 Dennis K. Wilson\nVice President and JAMES T. GLOVER Controller January 27, 1994 James T. Glover\nEARNEST H. CLARK, JR. Director January 26, 1994 Earnest H. Clark, Jr.\nSignature Title Date _________ _____ ____\nCAROLYNE K. DAVIS, PH.D. Director January 26, 1994 Carolyne K. Davis, Ph.D.\nDENNIS C. FILL Director January 26, 1994 Dennis C. Fill\nGAVIN S. HERBERT Director January 31, 1994 Gavin S. Herbert\nWILLIAM N. KELLEY, M.D. Director January 26, 1994 William N. Kelley, M.D.\nFRANCIS P. LUCIER Director January 28, 1994 Francis P. Lucier\nC. RODERICK O'NEIL Director January 31, 1994 C. Roderick O'Neil\nDAVID S. TAPPAN, JR. Director January 31, 1994 David S. Tappan, Jr.\nHENRY WENDT Director January 26, 1994 Henry Wendt\nINDEX TO EXHIBITS\nSequentially Exhibit Numbered Number Exhibit Page _______ _______ ____________\n3.2 Amended and Restated By-Laws, as of January 27, 1993.\n10.13 First Amendment to Revolving Credit Agreement, dated as of December 31, 1993, among the Company, the lenders named therein and Citicorp USA, Inc. as Agent.\n10.15 The Company's Executive Bonus Plan, adopted by the Company in 1993.\n10.20 Form of Legended Stock Agreement and Election For Deferral of a Portion of the FY 93 Executive Bonus Plan, between the Company and some of its Executive Officers and other key employees.\n10.21 Loan Agreement (Multiple Advance), dated September 30, 1993, between Beckman Instruments (Japan) Limited and the Industrial Bank of Japan, Limited (English translation, including certification as to accuracy; original document executed in Japanese).\n10.22 Term Loan Agreement, dated as of September 30, 1993, between Beckman Instruments (Japan) Limited and Citibank, N.A., Tokyo Branch.\n10.23 Term Loan Agreement, dated as of December 9, 1993, between Beckman Instruments (Japan) Limited and The Dai-Ichi Kangyo Bank Limited (English translation, including certification as to accuracy; original document executed in Japanese).\n10.24 Agreement Regarding Retirement Benefits of Arthur A. Torrellas, dated December 20, 1993, between the Company and Arthur A. Torrellas.\nSequentially Exhibit Numbered Number Exhibit Page _______ _______ ____________\n13. FINANCIAL REVIEW section of the Company's Annual Report to stockholders for the year ended December 31, 1993.\n22. List of principal subsidiaries of the Company.\n24. Consent of KPMG Peat Marwick, February 8, 1994.","section_15":""}
{"filename":"310431_1994.txt","cik":"310431","year":"1994","section_1":"Item 1. Business\n(a) The Registrant, CBI Industries, Inc. and its subsidiaries (CBI), classifies its operations in three major business segments: Industrial Gases, Contracting Services and Investments. CBI was incorporated in Delaware in 1979, as a holding company. The Industrial Gases segment of CBI is comprised of Liquid Carbonic Industries Corporation, and its subsidiaries, which was founded in 1888 and acquired by CBI in 1984. CBI's Contracting Services segment is comprised of a number of separate companies, including the original Chicago Bridge & Iron Company, which was founded in 1889. The Investments segment of CBI includes CBI Investments, Inc. and its subsidiaries including Statia Terminals.\n(b) Financial information by business segment appears under Financial Summary in CBI's 1994 Annual Report to Shareholders and is incorporated herein by reference.\n(c) The percentage of revenues contributed by each business segment over the past three years was: 1994 1993 1992 ---- ---- ---- Industrial Gases 48% 49% 45% Contracting Services 44 44 47 Investments 8 7 8 ---- ---- ---- 100% 100% 100% ==== ==== ==== A description of the business done by each of CBI's industry segments follows. Items that are not considered material to an understanding of the business taken as a whole have been omitted.\nCBI holds patents and licenses for certain items incorporated into its products. However, none are so essential that their loss would materially affect the businesses of CBI.\nFor information regarding working capital practices, refer to Financial Review - Financial Condition - Liquidity and Capital Resources in CBI's 1994 Annual Report to Shareholders, which is incorporated herein by reference.\nCBI has incurred expenses during the year for the purpose of complying with environmental regulations, but their impact on the financial statements has not been material.\nIndustrial Gases\nLiquid Carbonic Industries Corporation (Liquid Carbonic) is the parent company of the Industrial Gases segment companies. CBI believes Liquid Carbonic is the world's largest supplier of carbon dioxide in its various forms. Liquid Carbonic also produces, processes and markets a wide variety of other industrial\/medical and specialty gases, including oxygen, nitrogen, argon, hydrogen, acetylene, carbon monoxide, nitrous oxide and liquefied natural gas. The segment also assembles and sells industrial gas-related equipment. Liquid Carbonic conducts its business through various separate companies and\/or units, each of which either generally provides different products or services or conducts business in a different geographical area than the other companies or units. The business of Liquid Carbonic is generally broken down into companies and units which engage in domestic production and sales of industrial gases and cylinder gas products; domestic carbon monoxide, hydrogen gas and methanol production and pipeline sales; Canadian carbon dioxide processing and industrial gas production and sales; and international business outside of the United States and Canada, which involves primarily the processing and sale of carbon dioxide and other gases and chemicals in 23 other countries. The major Liquid Carbonic companies and business units are the following:\nThe Liquid Carbonic U.S. Industrial Gases unit which is engaged in the domestic production and sale of bulk carbon dioxide, bulk industrial and medical gases, specialty cylinder gases and other gas products. Carbon dioxide is used in the refrigeration, freezing, processing and preservation of food, beverage carbonation, chemical production, water treatment and the enhancement of oil and gas production. Liquid Carbonic U.S. Industrial Gases operates carbon dioxide plants and receives by-product carbon dioxide from other plants operated by suppliers. It also owns and operates plants to produce dry ice. Liquid Carbonic U.S. Industrial Gases also sells oxygen, nitrogen and argon (atmospheric gases) to industrial customers for refrigeration, as a pressure medium and for other applications; and to medical customers for resuscitative and therapeutic purposes. Air separation plants are operated for the production of these atmospheric gases. Industrial gases are sold mainly to small and medium sized \"merchant\" accounts near supply sources, and medical gases are sold primarily to group purchasing organizations and individual medical centers. Liquid Carbonic U.S. Industrial Gases is also engaged in the domestic production and sale of specialty and other cylinder gases. It sells highly purified gases, acetylene, oxygen, nitrogen, argon and nitrous oxide. The highly purified gases are produced and distributed from regional gas laboratories and sold to universities, research centers, clinics and industry.\nThe Liquid Carbonic Process Plants unit produces and sells gaseous and liquid carbon monoxide, gaseous hydrogen and methanol. These products are mainly sold by pipeline to customers located in Louisiana, Ohio and West Virginia.\nLiquid Carbonic Corporation is the parent company for the Liquid Carbonic companies which operate outside the United States. The principal subsidiaries are in Argentina, Belize, Bolivia, Brazil, Canada, Chile, Colombia, Costa Rica (acquired October 1994), Mexico, Paraguay, Peru, Poland, Spain, Thailand and Venezuela. Liquid Carbonic Corporation also owns a non-majority interest in a number of affiliated companies located in Barbados, Guyana, Haiti, Jamaica, Japan, Korea, Trinidad, Turkey and Uruguay. Most of these companies process and sell carbon dioxide and produce industrial and medical gases, chemicals (including precipitated calcium carbonate, a chemical ingredient used in the manufacture of a variety of consumer and industrial products) and other products. These companies operate by-product and combustion plants for the processing of carbon dioxide, dry ice plants and air separation plants.\nLiquid Carbonic's strength in the carbon dioxide market is in part due to its ability over the years to secure adequate supplies of product from diverse sources. Most carbon dioxide sold by Liquid Carbonic is purchased from by- product sources. By-product carbon dioxide is obtained from various sources, including chemical plants, refineries and industrial processes, or from carbon dioxide wells, and is processed in Liquid Carbonic's own plants to produce commercial carbon dioxide. Liquid Carbonic also purchases commercial carbon dioxide from by-product sources having their own carbon dioxide plants. Liquid Carbonic has supply contracts which require the purchase of specified minimum quantities of carbon dioxide. Generally, these contracts do not obligate the supplier to continue to produce carbon dioxide or to supply specified minimum quantities; however, these provisions have historically had no material adverse effect on Liquid Carbonic's source of supply.\nThis segment is not dependent upon any single customer or group of customers, and the loss of any single customer would not have a material adverse effect on the business.\nLiquid Carbonic's principal competitors in North America are the Airco subsidiary of the BOC Group, Air Products and Chemicals, Inc., the Cardox subsidiary of L'Air Liquide, and Praxair, Inc. It also faces competition from a number of regional and local competitors.\nAs of December 31, 1994, Liquid Carbonic employed 86 people engaged full- time in the research and development of new products and services or the improvement of existing products and services. This is comparable to 98 people employed at December 31, 1993 and 106 at December 31, 1992. This segment incurred expenses of approximately $10,987,000 in 1994, $10,616,000 in 1993 and $8,765,000 in 1992 for its research and development activities. This segment also performs certain research and development activities for customers.\nApproximately 7,100 people were employed by this segment at the end of 1994.\nContracting Services\nChicago Bridge & Iron Company (Chicago Bridge) is the parent company of the Contracting Services segment companies. Chicago Bridge is organized as a worldwide construction group that provides, through separate subsidiaries, a broad range of services, including design, engineering, fabrication, project management, general contracting and specialty construction services, including non-destructive inspection and post-weld heat treatment.\nThe traditional products constructed by the Chicago Bridge companies have been a wide variety of fabricated metal plate structures including, but not limited to, elevated water tanks, penstocks and tunnel liners for hydroelectric dams, low temperature and cryogenic vessels and systems, and flat-bottom tanks, pressure vessels, and other vessels and structures utilized in the chemical, petroleum refining and petrochemical industries. In recent years, Chicago Bridge companies have broadened their capabilities so as to be in a better position to provide additional products and services to address a more diverse base of customers. Other products and services include the construction of experimental test facilities, environmental chambers, advanced energy systems and structures, power plant maintenance and repair, turnkey water and wastewater treatment facilities, non-destructive testing, post-weld heat treating and refractory bake-outs, and vessels, tanks and other structures for corrosion-resistant applications. Chicago Bridge conducts these activities through various separate companies, the major of which are the following:\nCBI Na-Con, Inc. provides domestic construction-related services which include, but are not limited to, the construction of commercial and municipal water and wastewater treatment plants, defense-related facilities, industrial expansion projects, refinery turnarounds and turnkey storage terminals. CBI Na-Con, Inc. has district offices located in Norcross, Georgia; Houston, Texas; Fontana, California; and Plainfield, Illinois. It also has metal plate fabrication capabilities at its Houston and Fontana facilities.\nCBI Services, Inc. provides fabricated metal plate products and other specialized domestic construction services for the power generation industries, the government and other industrial customers. The product lines of CBI Services, Inc. include, but are not limited to, petroleum, petrochemical and chemical storage tanks; pressure, cryogenic and low temperature vessels; and miscellaneous metal plate structures. CBI Services has district offices located in New Castle, Delaware; Concord, California; and Kankakee, Illinois. It also has metal plate fabrication capabilities at its Kankakee facility.\nChicago Bridge & Iron Company, incorporated in Illinois, is the original company which was formed in 1889 and is the parent company for Contracting Services companies which operate outside the United States. Regional offices of international subsidiaries are located in London (England), Singapore, Fort Erie (Canada), and Houston, Texas. Other subsidiary offices and facilities are located in Caracas (Venezuela), Dammam (Saudi Arabia), Dubai (U.A.E.), Blacktown (Australia), Johannesburg (South Africa), Kuala Lumpur (Malaysia), Manila (Philippines), Jakarta (Indonesia), Bangkok (Thailand) and Tokyo (Japan).\nOther Chicago Bridge companies include: CBI Walker, Inc., which designs and supplies equipment used to treat municipal and industrial water and wastewater; Chicago Bridge and Iron Technical Services Company, which provides engineering and research services for the Chicago Bridge subsidiaries and for outside parties; MQS Inspection, Inc., which provides non-destructive examination and testing services; Cooperheat, Inc. which provides post-weld heat treating and refractory bake-outs as field services and sells associated equipment; and Ershigs, Inc., which is an engineering, manufacturing and construction company which specializes in fiberglass reinforced plastic and dual-laminate vessels, tanks and other structures for corrosion-resistant applications.\nThe principal raw materials used by the Contracting Services segment are metal plate and structural steel. These materials are available from various domestic and international mills. Chicago Bridge does not anticipate having difficulty in obtaining adequate amounts of raw materials.\nThis segment is not dependent upon any single customer or group of customers and the loss of any single customer would not have any material adverse effect on the business.\nThis segment had a backlog of work to be completed on contracts of $287,500,000 at December 31, 1994 and $424,900,000 at December 31, 1993. Approximately 87% of the backlog as of December 31, 1994 is expected to be completed in 1995.\nAdequate industry statistics relating to this segment of the business in which CBI competes are not available. Several large companies offer metal plate products that compete with some, but not all, of those of Chicago Bridge. Local and regional companies offer strong competition in one or more geographical areas, but not in other areas where Chicago Bridge operates. Therefore, it is impossible to state Chicago Bridge's position in the industry. Quality, reputation, delivery and price are the principal methods of competition within the industry. Competition is based primarily on performance and the ability to provide the design, engineering, fabrication, project management and construction required to complete projects in a timely and cost-efficient manner. Chicago Bridge believes its position is among the top in the field.\nAs of December 31, 1994, this segment employed 37 people engaged full-time in the research and development of new products and services or the improvement of existing products and services. This is comparable to 45 people employed at December 31, 1993 and 40 at December 31, 1992. This segment incurred expenses of approximately $2,844,000 in 1994, $3,078,000 in 1993 and $2,961,000 in 1992 for its research and development activities. This segment also performs certain research and development activities for customers.\nApproximately 7,100 people were employed by this segment at the end of 1994.\nInvestments\nCBI Investments, Inc. is the parent company of the Investments segment companies. The Investments segment includes Statia Terminals (Statia), which is the sole operating company within the Investments segment. Statia provides transshipment, storage, bunkering and blending services for hydrocarbon products at the island of St. Eustatius in the Caribbean and in Nova Scotia, Canada and operates a special products terminal in Brownsville, Texas. In addition, CBI Investments, Inc. has interests in real estate and several other companies.\nStatia primarily provides services and therefore does not depend heavily on raw materials.\nApproximately 240 people were employed by Statia at the end of 1994.\nThe investment in Petroterminal de Panama, S.A. was reduced to zero in the current year due the to receipt of dividends and losses incurred. In December 1994, CBI sold its equity interest in Tankstore, Pte. Ltd.\n(d) Financial information by geographic area of operation is shown in Notes to Financial Statements - Note 12 - Operations by Business Segment and Geographic Area in CBI's 1994 Annual Report to Shareholders and is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nIndustrial Gases\nLiquid Carbonic owns or leases the facilities used in its business. Liquid Carbonic believes these facilities are adequately utilized and sufficient to meet its customer needs. The following list summarizes the principal properties:\nType of Facility by Number of Facilities Geographic Area Owned or Leased ___________________ ____________________ United States By-product CO2 23 owned Air separation 4 owned, 3 leased Carbon monoxide\/hydrogen\/methanol 1 owned Carbon monoxide\/hydrogen 2 owned Liquefied natural gas 1 owned Research center 1 leased\nInternational By-product CO2 55 owned, 1 leased Combustion 33 owned Air separation 22 owned Research centers 2 owned\nIn addition to the above, Liquid Carbonic also owns facilities in Brazil, Mexico, and Argentina used in the production of precipitated calcium carbonate, and has interests in a number of distributor operations in Canada. Liquid Carbonic also owns or leases cylinder distribution centers, a number of sales offices and other facilities throughout the world.\nContracting Services\nChicago Bridge owns or leases the properties used to conduct its business. The capacities of these facilities depend upon the mix of products being manufactured. As the product mix is constantly changing, the extent of utilization of these facilities cannot be accurately stated. Chicago Bridge believes that these facilities are adequate to meet its requirements. The following list summarizes the principal owned properties:\nType of Square Location Facility Footage ________ __________ _______ United States Fontana, California fabrication plant, warehouse and office 36,000 Houston, Texas fabrication plant, warehouse and office 253,000 Kankakee, Illinois fabrication plant, warehouse and office 396,000 Norcross, Georgia warehouse and office 36,000 Plainfield, Illinois engineering and research center 176,000 warehouse and office 12,000\nInternational Blacktown, New South Wales, fabrication plant, Australia warehouse and office 134,000 Fort Erie, Ontario, Canada fabrication plant, warehouse and office 208,000\nIn addition to the above, Chicago Bridge has interests in other fabrication facilities in Saudi Arabia, Thailand, Indonesia, Venezuela, South Africa and Australia. Chicago Bridge also owns or leases a number of field construction offices, warehouses and equipment maintenance centers strategically located throughout the world.\nInvestments\nThe total storage capacity for Statia is, in millions of barrels, as follows:\nCaribbean (Island of St. Eustatius, Netherlands Antilles) terminal 6.3 United States (Brownsville, Texas) terminal 1.6 Canada (Cape Breton Island, Nova Scotia) terminal 7.4\nEffective as of the end of January 1995, Statia Terminals assumed operational responsibility, under a lease agreement, of an additional 5 million barrels of new storage capacity, along with a related single-point mooring system, at St. Eustatius.\nCBI currently owns approximately 2,300 acres of undeveloped real estate in Virginia, Texas and Utah.\nCBI also owns its corporate headquarters located in Oak Brook, Illinois. The buildings have approximately 196,000 square feet of space.\nItem 3.","section_3":"Item 3. Legal Proceedings\nMARATHON\/TEXAS CITY LITIGATION. On October 30, 1987, CBI Na-Con, Inc. (\"CBI Na-Con\") was working in the Marathon Petroleum Company refinery in Texas City, Texas. While a lift was being made by a crane supplied and operated by others, the crane became unstable, causing the operator to drop the load on a hydrofluoric acid tank which released part of its contents into the atmosphere. The community surrounding the refinery was evacuated after the incident and a substantial number of persons evacuated sought medical attention. CBI Na-Con has reached settlements with all but about 6 of the 4,300 (approximate) third-party plaintiffs who brought suit as a result of the incident.\nAfter CBI's insurers declined to indemnify CBI for this incident based on their interpretation of certain pollution exclusions contained in CBI's insurance policies, CBI filed suit in Harris County, Texas against its insurers seeking a court ruling that the policies covered the incident. The Trial Court, on the insurers' preliminary motion, sustained the insurers' position that coverage did not exist. The Texas Court of Appeals reversed the Trial Court and found that CBI should be allowed to proceed with its lawsuit and related discovery against the insurers. The insurers immediately appealed the Court of Appeals decision in CBI's favor to the Texas Supreme Court, which accepted the case for review. On March 2, 1995 the Texas Supreme Court reversed the Court of Appeals and affirmed the judgment of the Trial Court that coverage did not exist. CBI will file a motion asking the Supreme Court to reconsider its decision. CBI's management presently believes that its reserves are adequate to cover remaining potential liabilities resulting from the occurrence at Texas City.\nANTITRUST MATTERS. Liquid Carbonic Industries Corporation (\"Liquid Carbonic\") has been or is currently involved in civil litigation and governmental proceedings relating to antitrust matters. In this regard, since April 1992, several lawsuits have been filed against Liquid Carbonic and various competitors. These cases have been consolidated in the United States District Court for the Middle District of Florida, Orlando Division. The lawsuits allege generally that, beginning not later than 1968 and continuing through October 1992, defendants conspired to allocate customers, fix prices and rig bids for carbon dioxide in the United States in violation of the antitrust laws. On April 19, 1993, the court certified a class in the consolidated cases consisting of direct purchasers of carbon dioxide from defendants in the continental United States for the period from January 1, 1968, to and including October 26, 1992.\nPlaintiffs seek from defendants unspecified treble damages, civil penalties, injunctive relief, costs and attorneys' fees. In addition, suits have been brought against Liquid Carbonic and others under the antitrust laws of the States of Alabama and California based upon the foregoing allegations. The company believes that the allegations made against Liquid Carbonic in all of these lawsuits are without merit and Liquid Carbonic intends to defend itself vigorously. Liquid Carbonic and its subsidiaries also, from time to time, furnish documents and witnesses in connection with governmental investigations of alleged violations of the antitrust laws.\nIn 1994, several claims were filed against Liquid Carbonic, Inc., a wholly owned Canadian subsidiary of Liquid Carbonic, and various competitors generally alleging that for the period 1954 to 1990 the defendants conspired to fix prices for bulk and cylinder gas oxygen in Canada in violation of the Canadian competition laws. The complainants consist mainly of hospitals located in the Provinces of British Columbia and Ontario. The company believes that the damages sought by the plaintiffs are wholly without merit and the company intends to vigorously defend against these claims.\nWhile the outcome of any particular lawsuit or governmental investigation cannot be predicted with certainty, the company believes that these antitrust matters will not have a materially adverse effect on its operations or financial condition.\nItem 3. Legal Proceedings (Continued)\nENVIRONMENTAL LITIGATION. Chicago Bridge & Iron Company (\"Chicago Bridge\") was a minority shareholder from 1934 to 1954 in a company which owned or operated at various times several wood treating facilities at sites in the United States, some of which are currently under investigation, monitoring or remediation under various environmental laws. Chicago Bridge is involved in litigation concerning environmental liabilities, which are currently undeterminable, in connection with certain of those sites. Chicago Bridge denies any liability for each site and believes that the successors to the wood treating business are responsible for cost of remediation of the sites. Chicago Bridge has reached settlements for environmental clean-up at most of the sites. The company believes that any remaining potential liability will not have a materially adverse effect on its operations or financial condition.\nCORPORATE LITIGATION. A purported class action on behalf of all holders of CBI common stock is pending in the Chancery Court of Delaware against the company and certain of its Directors. This lawsuit, WILLIAM STEINER V. CBI INDUSTRIES, et al, was commenced on December 22, 1994. It alleges that the defendants breached their fiduciary duty to shareholders by rejecting proposals by Airgas, Inc. for the company to either merge with Airgas or to sell Liquid Carbonic to Airgas, and by amending the Amendment and Restatement of Rights Agreement dated as of August 8, 1989, between the company and First Chicago Trust Company of New York, as Rights Agent, as amended (the \"Rights Agreement\"). Plaintiff seeks to (a) enjoin the Directors to carry out their fiduciary duties; (b) declare the Rights Agreement null and void; (c) enjoin the company and its Directors from erecting unlawful barriers to the acquisition of the company; and (d) recover from defendants unspecified monetary damages sustained by shareholders of CBI as a result of the alleged acts of the Board of Directors. The company intends to vigorously defend against this action.\nOTHER LITIGATION. In addition to the above lawsuits, CBI is a defendant in a number of other lawsuits arising from the conduct of its business. While it is impossible at this time to determine with certainty the ultimate outcome of these other lawsuits, CBI's management believes that adequate provisions have been made for probable losses with respect thereto as best as can be determined at this time and that the ultimate outcome, after provisions therefor, will not have a material adverse effect on the financial position of CBI. The adequacy of reserves applicable to the potential costs of being engaged in litigation and potential liabilities resulting from litigation are reviewed as developments in the litigation warrant.\nCBI also is jointly and severally liable for some liabilities of partnerships and joint ventures and has also given certain guarantees in connection with the performance of contracts and repayment of obligations by its subsidiaries and other ventures in which CBI has a financial interest. CBI's management believes that the aggregate liability, if any, for these matters will not be material to 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 fourth quarter ended December 31, 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nCBI's common stock is listed on the New York Stock Exchange (symbol CBI). The approximate number of holders of record of common stock at February 15, 1995 was 8,000. Information appearing under Quarterly Financial Data - Quarterly Operating Results, and Common Stock Prices and Dividends in CBI's 1994 Annual Report to Shareholders is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe summary of selected financial data appearing under Financial Summary in CBI'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 appearing under Financial Review in CBI'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 consisting of Statements of Income, Balance Sheets, Statements of Cash Flows, Statements of Common Capital Stock, Notes to Financial Statements and Report of Independent Public Accountants in CBI's 1994 Annual Report to Shareholders is incorporated herein by reference.\nThe supplemental financial information appearing under Quarterly Financial Data - Quarterly Operating Results, and Common Stock Prices and Dividends in CBI's 1994 Annual Report to Shareholders is incorporated herein by reference.\nAdditional financial information and schedules can be found in Part IV of this report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures\nCBI has neither changed its independent accountants nor had any disagreements on accounting and financial disclosure with its independent accountants during the two most recent fiscal years.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\n(a) Information appearing under Election of Directors in CBI's 1995 Proxy Statement is incorporated herein by reference.\n(b) The executive officers of CBI as of March 23, 1995 are as follows:\nServed as Executive Officer Name Age Title of CBI Since\n____ ___ _____ _________________ John E. Jones 60 Chairman of the Board, President and Chief Executive Officer 1980 Lewis E. Akin 57 Executive Vice President 1986 Robert J. Daniels 61 Executive Vice President 1988 George L. Schueppert 56 Executive Vice President-Finance and Chief Financial Officer 1987 Charles O. Ziemer 55 Senior Vice President and General Counsel 1984 Buel T. Adams 62 Vice President and Treasurer 1983 Stephen M. Duffy 45 Vice President-Human Resources 1993 Alan J. Schneider 49 Vice President and Controller 1991\n(d) There are no family relationships between any executive officers and directors. Executive officers are usually elected at the meeting of the Board of Directors immediately preceding the Annual Meeting of Shareholders and serve until successors are elected.\n(e) With the exception of Stephen M. Duffy, all of the above named officers have been employed by CBI in an executive or management capacity for more than five years. Stephen M. Duffy was formerly a Vice President with Sunbeam Appliance Company.\nInformation with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934 appears under Section 16(a) Reporting Delinquencies in CBI's 1995 Proxy Statement and is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation appearing under Executive Compensation in CBI's 1995 Proxy Statement is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation appearing under Common Stock Ownership By Certain Persons and Management in CBI's 1995 Proxy Statement 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 following financial statements and Report of Independent Public Accountants previously incorporated by reference under Item 8 of Part II of this report are herein incorporated by reference.\nFinancial Statements: Statements of Income - For the years ended December 31, 1994, 1993 and 1992 Balance Sheets - For the years ended December 31, 1994, 1993 and 1992 Statements of Cash Flows - For the years ended December 31, 1994, 1993 and 1992 Statements of Common Capital Stock - For the years ended December 31, 1994, 1993 and 1992 Notes to Financial Statements Report of Independent Public Accountants\n2. Financial Statement Schedules\nThese schedules have been omitted because the schedules are either not applicable or the required information is shown in the financial statements or notes thereto incorporated by reference under Item 8 of Part II of this report.\nQuarterly financial data for the years ended December 31, 1994 and 1993 is shown in the supplemental financial information incorporated by reference under Item 8 of Part II of this report.\nCBI's interest in 50 percent or less owned affiliates, when considered in the aggregate, does not constitute a significant subsidiary, therefore summarized financial information has been omitted.\n3. Exhibits\nThe Exhibit Index on page 13 and Exhibits being filed are submitted as a separate section of this report.\n(b) Reports on Form 8-K\nA Form 8-K was filed under Item 5, Other Events and Item 7, Financial Statements and Exhibits. The date of that report was December 21, 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.\nCBI INDUSTRIES, INC.\nDate: March 23, 1995\nBy: \/s\/ George L. Schueppert ___________________________ George L. Schueppert Executive Vice President-Finance, Chief Financial Officer and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 23, 1995.\nSignature Title\n\/s\/ John E. Jones Chairman of the Board, President, _______________________________ Chief Executive Officer (Principal Executive Officer) and Director John E. Jones\n\/s\/ Lewis E. Akin Executive Vice President and Director _______________________________ Lewis E. Akin\n\/s\/ Robert J. Daniels Executive Vice President and Director _______________________________ Robert J. Daniels\n\/s\/ George L. Schueppert Executive Vice President-Finance, _______________________________ Chief Financial Officer (Principal Financial Officer) and Director George L. Schueppert\n\/s\/ Wiley N. Caldwell Director and Chairman of the Audit Committee _______________________________ Wiley N. Caldwell\n\/s\/ E.H. Clark, Jr. Director and Member of the Audit Committee _______________________________ E.H. Clark, Jr.\n\/s\/ John F. Riordan Director and Member of the Audit Committee _______________________________ John F. Riordan\n\/s\/ Robert G. Wallace Director and Member of the Audit Committee _______________________________ Robert G. Wallace\n\/s\/ Alan J. Schneider Vice President and Controller _______________________________ Alan J. Schneider (Principal Accounting Officer)\n1994 FORM 10-K ANNUAL REPORT EXHIBIT INDEX Item 14 (a) 3 Exhibit\n(3) Articles of Incorporation and By-Laws.\nArticles of Incorporation. Restated Certificate of Incorporation can be found in CBI's Form 10-Q dated August 15, 1994 and is incorporated herein by reference.\nBy-Laws. By-laws as amended can be found in CBI's Form 10-Q dated May 13, 1994 and are incorporated herein by reference.\n(4) Instruments Defining the Rights of Security Holders, Including Indentures.\n1. Indenture between CBI and Chemical Bank, as Trustee, dated March 1, 1994 can be found in CBI's Form 10-Q dated May 13, 1994 and is incorporated herein by reference.\n2. 6 1\/4% Notes due June 30, 2000. The indenture between CBI and Bank of America Illinois (formerly known as Continental Bank, National Association), as Trustee, dated June 1, 1993 filed as Exhibit 4(a) can be found in CBI's Form S-3 Registration Statement Number 33-64052 dated June 22, 1993 and is incorporated herein by reference.\n3. 6 5\/8% Notes due March 15, 2003. The indenture between CBI and Bank- America National Trust Company, as Trustee, dated March 1, 1993 filed as Exhibit 4(a) can be found in CBI's Form S-3 Registration Statement Number 33-58940 dated February 26, 1993 and is incorporated herein by reference.\n4. Series A Preferred Stock Purchase Rights Agreement as amended can be found in CBI's Form 8-K dated December 21, 1994 and is incorporated herein by reference.\n5. Description of Convertible Voting Preferred Stock, Series C can be found in CBI's Form 8-K dated April 19, 1988 and is incorporated herein by reference.\n6. $300,000,000 Credit Agreement dated as of December 4, 1992 among CBI Industries, Inc., the banks listed therein and Ibis Investments, Inc. as Bid Advance Agent. (a) Amendment No. 1 dated January 11, 1993. (b) Amendment No. 2 dated as of June 1, 1993. (c) Successor Agreements dated January 1, 1995. (d) Letter extending the termination date of the Credit Agreement to December 31, 1997.\n7. Pursuant to paragraph 4(iii)(A) of Item 601(b) of Regulation S-K, various instruments defining the rights of holders of long-term debt of CBI are not being filed because the total of securities authorized under each such instrument does not exceed 10% of the total assets of CBI. CBI hereby agrees to furnish a copy of such instruments to the Securities and Exchange Commission upon request.\n(10) Material Contracts.\nExecutive Contracts and Compensation Plans. 1. Directors' Deferred Fee Plan, as amended, can be found in CBI's Form 10-K dated March 30, 1993 and is incorporated herein by reference.\n2. Agreement between John E. Jones and CBI can be found in CBI's Form 10-K dated March 29, 1983 and is incorporated herein by reference.\n1994 FORM 10-K ANNUAL REPORT EXHIBIT INDEX (Continued)\n(10) Material Contracts (continued) 3. A summary of the Termination Agreements can be found in CBI's Form 8-K dated October 10, 1986 and is incorporated herein by reference.\n4. Agreement between George L. Schueppert and CBI can be found in CBI's Form 10-K dated March 29, 1989 and is incorporated herein by reference.\n5. CBI Industries Stock Option Plan, as amended, can be found in CBI's Form S-8 dated October 10, 1990 and is incorporated herein by reference.\n6. CBI Executive Life Insurance Plan can be found in CBI's Form 10-K dated March 30, 1993 and is incorporated herein by reference.\n7. CBI Officers' Bonus Plan.\n8. CBI 1994 Restricted Stock Award Plan.\n(11) Computation of Per Share Earnings.\n(13) Portions of the 1994 Annual Report to Shareholders expressly incorporated by reference into this report.\n(21) Subsidiaries of the Registrant.\n(23) Consent of Independent Public Accountants.\n(27) Financial Data Schedule.","section_15":""}
{"filename":"110430_1994.txt","cik":"110430","year":"1994","section_1":"ITEM 1. BUSINESS\nOverview As used herein, the terms (Wainoco) and (Company) refer to Wainoco Oil Corporation and its subsidiaries. Wainoco was originally incorporated in Canada in 1949 and changed its jurisdiction of incorporation to Wyoming in 1976. The Company's Canadian assets are held by Wainoco Oil Corporation, a Wyoming corporation, its United States oil and gas assets are held through its subsidiary, Wainoco Oil & Gas Company, a Delaware corporation, and its refining assets are held through its subsidiary, Frontier Holdings Inc. (Frontier), a Delaware corporation. The Company directs its activities from its corporate office in Houston, Texas and its division offices in Calgary, Alberta, Canada and Denver, Colorado. Wainoco explored for and produced oil and gas in western Canada, selected areas of the midcontinent, the Los Angeles Basin and the Gulf Coast (onshore and offshore) during 1994. In the fourth quarter of 1994, Wainoco announced that it intended to cease all exploration activities in the United States and sell its United States oil and gas assets. Wainoco is in the process of selling all of its United States oil and gas properties, except for its Conroe field reserves and other minor properties. Wainoco is also engaged in the business of crude oil refining and wholesale marketing of refined petroleum products, including various grades of gasoline, diesel fuel, asphalt, natural gas liquids and petroleum coke. In addition, the Company purchases the crude oil to be refined and markets the refined petroleum products produced by the Refinery.\nOil and Gas Exploration and Production Operations The oil and gas activities of the Company consist of geological and geophysical evaluation of prospective oil and gas properties, the acquisition of oil and gas leases or other interests in exploratory prospects, the drilling of test wells, the acquisition of interests in developed or partially developed properties and the development and operation of properties for the production of oil and gas. At December 31, 1994, approximately 85% of the Company's proved reserves, on a British Thermal Unit (BTU) equivalent basis, was natural gas. During 1994, oil represented 34% and gas represented 66% of oil and gas revenues. The Company's oil and gas exploration and production activities are conducted directly by the Company or through joint drilling and operating arrangements. Wainoco acts as the operator of the majority of its production and prospects. Canada Activities in Canada are conducted through Wainoco Oil Corporation with emphasis on exploration, development and production in the western Canadian provinces of British Columbia and Alberta. At December 31, 1994, approximately 77% of estimated proved gas reserves, approximately 28% of estimated proved oil reserves and approximately 26% of identifiable assets of the Company were located in western Canada. For the year ended December 31, 1994, Canadian operations contributed approximately 58% of the Company's oil and gas revenue. During 1994, the exchange rate of the Canadian dollar averaged approximately U.S. $.7322. The accounts of the Canadian division have been translated in accordance with generally accepted accounting principles as described in Note 1 of the Financial Statements in the 1994 Annual Report to Shareholders which is incorporated herein by reference. United States Activities in the United States are conducted through Wainoco Oil & Gas Company with the production of properties in selected areas of the midcontinent, the Los Angeles Basin and the Gulf Coast (onshore and shallow offshore regions). See \"Business - Overview\" for a discussion of the sale of United States properties.\nRefining Operations Wainoco's refining activities are conducted through Frontier (the Refinery), which was acquired in October 1991. The Refinery is located on approximately 120 acres in Cheyenne, Wyoming, which property is owned by the Company. The Refinery has a permitted crude capacity of 41,000 bpd with an effective operating capacity of 38,000 bpd, which represents approximately 7% of the rated crude distillation capacity in the Rocky Mountain region. The Refinery can also process in excess of 4,000 bpd of purchased natural gasoline, butanes and other petroleum liquids. One of Frontier's competitive advantages relative to most other Rocky Mountain refineries is that it includes substantially all of the major refinery units that comprise a complex refinery, including a coker. Therefore, the Refinery has the capability of producing a higher yield of lighter, more valuable petroleum products such as gasoline and diesel fuel from heavier, less costly feedstocks such as heavy sour crude oil. The Refinery's units have the capacity to process a high percentage (up to 90%) of lower cost, more abundant sour crude oil. The plant's downstream unit configuration affords the Refinery gasoline octane capability equal to or higher than that of most of its competitors. Frontier also owns a 25,000 bpd undivided interest in a crude oil pipeline from Guernsey, Wyoming to Cheyenne. This pipeline was constructed to help serve the Refinery's long-term strategic crude oil needs. The Refinery's gasoline and distillates sales each accounted for more than 10% of consolidated revenues. As a percent of consolidated revenue, gasoline sales were 49%, 50% and 53% and distillates sales were 31%, 29% and 28% in 1994, 1993 and 1992, respectively.\nIndustry Segments The Company's industry segment information for the three years ended December 31, 1994, is set forth in Note 7 of the Financial Statements in the 1994 Annual Report to Shareholders which is incorporated herein by reference. The Company's discussion of the restructuring of its United States oil and gas operations is set forth in Note 9 of the Financial Statements in the 1994 Annual Report to Shareholders which is incorporated herein by reference.\nOperating Hazards and Risks The Company's oil and gas exploration and production operations are subject to all of the risks normally incident to the exploration for and production of oil and gas including blow-outs, cratering, pollution and fires, each of which could result in damage to or destruction of oil and gas wells or production facilities or damage to persons and property. As is common in the oil and gas industry, the Company is not fully insured against all of these risks, either because insurance is not available or because the Company has elected not to insure due to high premium costs. The occurrence of a significant event that is not fully insured against could have a material adverse effect on the Company and its financial position and results of operation. The Company's refinery operations are subject to significant interruption if the refinery were to experience a major accident or fire or if it were damaged by severe weather or other natural disaster. Should the crude oil pipeline become inoperative, crude oil would be supplied to the Refinery by an alternative pipeline and from additional tank trucks. A substantial portion, but not all, of such loss would be covered by business interruption, property or other insurance carried by Frontier. Frontier's safety measures substantially mitigate but do not eliminate the risk of damage to the Refinery or the environment and personal injury should a major adverse event occur. The occurrence of a significant event that is not fully insured against could have a material adverse effect on the Company and its financial position and results of operation.\nCompetition Oil and gas operations The Company encounters strong competition from other independent operators and from major oil companies in acquiring properties suitable for exploration, in contracting for drilling equipment, in securing trained personnel and in marketing oil and gas production. Many of these competitors have financial resources and staffs substantially larger than those available to the Company. The availability of a ready market for oil and gas discovered by the Company depends on numerous factors beyond its control including the extent of production and imports and exports of oil and gas, the demand for its products, the proximity and capacity of natural gas pipelines and the effect of state, provincial or federal regulations. Competition in the acquisition of oil and gas prospects and properties has been intense and remains so for prime prospects. The Company's ability to discover reserves depends on its ability to select and acquire suitable prospects for future exploration. Although the Company generates the major portion of its oil and gas prospects internally, it depends to some extent upon prospects offered to it by independent consultants and other persons or entities in the petroleum industry.\nRefining operations Frontier's business is highly competitive and price is the principal basis of competition. The most important competitive product marketing area in the Rocky Mountain region is the Denver market, principally because it is the major population center in the Rockies. There are at least 17 refineries in the Rocky Mountain region (including those owned by several major integrated oil companies). In addition, two refineries are located in Denver and three product pipelines from outside the Rockies terminate in the area. Frontier also serves western Nebraska and eastern Wyoming. Many of the refineries in the Rocky Mountain region are owned by companies that have significantly greater financial resources and\/or refining capacity than Frontier. Certain of these competitors, as integrated oil companies, also have the advantage of owning or controlling crude oil reserves or other sources of crude oil supply, crude oil and product pipelines and service stations and other product marketing outlets. Principal Competitors. Based on proximity to the Denver and Cheyenne areas, Frontier's principal competitors in the wholesale segment are Sinclair Oil Company (Sinclair) with a 54,000 bpd refinery near Rawlins, Wyoming and a 22,000 bpd refinery in Casper, Wyoming, Total Petroleum (North America) Ltd. (Total) with a 32,000 bpd refinery in Denver, Colorado and Conoco, Inc. (Conoco) with a 50,000 bpd refinery in Denver, Colorado. Frontier sells its products exclusively at wholesale, principally to independent retailers, jobbers and major oil companies, while Sinclair, Total and Conoco service both the retail and wholesale markets. Frontier is favorably positioned to purchase its crude oil and feedstock requirements. Because many other refiners in the Rocky Mountain region have significantly lower sour crude capacity, Frontier is able to purchase a significant amount of its sour crude oil and all of its sweet crude oil from the region. Regional production of crude oil still exceeds regional refining capacity. Frontier also purchases Canadian sour crude oil, which is available via pipeline into Guernsey, Wyoming. Frontier and its principal competitors all service the Denver market. Because their refineries are located in Denver, Total's and Conoco's product transportation costs in servicing that area are lower than those of Frontier. Conversely, Frontier has lower crude transportation costs due to its proximity to Guernsey, Wyoming, the major crude oil pipeline hub in the Rocky Mountain region, and further due to its ownership interest in the crude oil pipeline. Capital Improvement Program. Since its acquisition by Wainoco, Frontier has completed a significant capital improvement program for the refinery. The most significant projects included: (i) the construction of new sulfur recovery and amine treating units which increased sour crude processing capacity, (ii) the expansion of the capacity of the delayed coker unit from 8,200 bpd to 10,000 bpd, (iii) the upgrading and expansion of the distillate hydrotreater and construction of a hydrogen plant for adequate hydrogen supply and (iv) several projects, including 1994 projects, which improve the reliability and safety of various refinery units. The capital improvement program enables the Refinery to produce low sulfur diesel as required by the Clean Air Act Amendments of 1990, increases the amount of sour crude processed and improves the operating reliability of the Refinery. The improvements also increased the Refinery's diesel capacity. In addition, Frontier has incurred capital expenditures as a result of studies required under the Occupational Safety and Health Act (OSHA). Strategic Position. Because the Refinery includes substantially all of the major refinery units that comprise a complex refinery, Wainoco believes that it potentially has three significant advantages over its principal competitors and most other refineries in the region. First, the Refinery has the capacity to process a high percentage (up to 90%) of sour crude oil, while most refineries in the Rocky Mountain region can process only sweet crude or smaller percentages of sour crude. Refineries that have the ability to process sour crude can benefit from the lower cost of sour relative to sweet crude oil, which is often referred to as the \"sweet\/sour spread.\" During 1994, Frontier's cost for sour crude oil has ranged from approximately $3.26 to $4.20 per barrel lower than its cost for sweet crude. Second, Frontier owns a 10,000 bpd coker, which, among other things, enables the Refinery to upgrade resid and other heavy feedstocks into lighter, more valuable petroleum products. Coker capacity was expanded to 10,000 bpd at the end of 1992 to accommodate a 10-year agreement to process heavy feedstocks for Conoco. There are presently only four other cokers in the region. Third, because of Frontier's combination of downstream process units, the Company believes that the Refinery has octane capability equal to or greater than most of its competitors. This capability enabled Frontier to be the first to introduce 91 octane premium unleaded gasoline to the Rocky Mountain region. (Due to different altitudes, gasoline used in the Rocky Mountain region generally has an octane rating two points lower than corresponding grades of gasoline elsewhere in the United States.) In addition, as a result of stringent environmental protection laws and the high cost of the requisite plant modifications, Wainoco believes that, in general, refiners in the Rocky Mountain region will face barriers to substantially expanding refinery capacities or sour crude processing capability. Based in part on the foregoing factors, the Company believes that Frontier is capable of competing effectively in its market. In particular, Frontier has sold and expects to continue to sell refined products at competitive prices. Markets. Frontier sells to a broad base of independent retailers, jobbers and major oil companies in the region. Its largest customer, CITGO Petroleum Products, comprises approximately 17% of Frontier's 1994 sales. Prices are determined by local marketing conditions and at the \"terminal rack\" such that the customer typically supplies his own truck transportation. Effect of Crude Oil and Refined Product Prices. Frontier's income and cash flow are derived from the margin between its costs to obtain and refine crude oil and the price for which it can sell products produced in its refining process. The price at which Frontier can sell gasoline and its other refined products will be strongly influenced by the price of crude oil. Although an increase or decrease in the price of crude oil generally results in a corresponding increase or decrease in the price of gasoline and refined products, changes in the prices of refined products generally lag behind changes in the price for crude oil, both upward and downward. Frontier maintains inventories of crude oil, intermediate products and refined products, the value of each of which is subject to rapid fluctuations in market prices. Inventories are recorded at the lower of cost on a first in, first out (FIFO) basis or market. A rapid and significant movement in the market prices for crude oil or refined products could have an adverse short-term impact on earnings and cash flow. Crude oil prices, in general, are affected by a number of factors, including domestic and international demand, domestic and foreign energy legislation, production guidelines established by the Organization of Petroleum Exporting Countries (OPEC), relative supplies of other fuels, such as natural gas, and changing international economic and political conditions. Frontier can process a high percentage of sour crude oil, enabling it to benefit from the lower cost of sour crude relative to sweet crude. Because income and cash flow from refining operations are dependent in part on this cost differential, any narrowing of the sweet\/sour crude spread would likely cause a reduction in operating margin and a decrease in earnings and cash flow of the Refinery. A narrowing of the sweet\/sour crude spread could result from, among other things, a decrease in the supply of sour crude or an increase in sour crude refining capacity of the Refinery's competitors. General Wainoco competes with other oil and gas concerns and other investment opportunities, whether or not related to the petroleum industry, in raising capital. The Company's ability to compete successfully in the capital markets is largely dependent on the success of its oil and gas exploration activities, refining activities and the economic environment in which it operates.\nGas Markets The Company continues to sell the majority of its natural gas production under long-term gas contracts managed by companies (aggregators) who purchase large volumes of natural gas from many producers and resell this gas throughout North America. The price paid for this gas is a \"net-back\" price per unit of gas established by subtracting transportation, processing, storage and administrative costs from the total revenue generated from all the monthly sales of gas. Since 1993, North America appears to have established a better balance of demand and supply of natural gas. During earlier periods of lower load factors, the Company negotiated the right to market such excess volumes not taken by the primary purchaser, to other markets. Such excess volumes are sold in the spot market. To diversify gas sales and optimize production, Wainoco also sells a portion of its gas production under short-term contracts. Generally, one-year renewable contracts have been used for this purpose with gas prices that are normally negotiated annually as a fixed price per unit of sales or an indexed price compared to the New York Mercantile Exchange (NYMEX) futures price. Firm transportation and gas processing capacity from major pipeline companies have been obtained in Canada to ensure continued ability to produce pursuant to these contracts. The tariffs associated with this firm pipeline capacity must be paid regardless of the Company's natural gas productive capacity. The Company has not committed for pipeline capacity in excess of our existing deliverability dedicated to short- term gas contracts. Any productive capacity above our firm pipeline capacity must be marketed on an interruptible basis. The Company's commitment for firm pipeline capacity is approximately $3.5 million in 1995, $1.2 million in 1996, $.9 million in 1997 and $.6 million a year from 1998 through 2001. The 1995 commitment represents approximately 55% of gross productive capacity, which thereafter will range from 17% to 28% through 2001.\nGovernment Regulations Oil & Gas Operations Environmental Laws and Regulations. The Company's oil and gas exploration and production activities are subject to laws and regulations relating to environmental quality and pollution control. The Company believes that such legislation and regulations have had no material adverse effect on its present method of operation. In the future, changes in Canadian or United States federal, state, provincial and local government environmental controls could require the Company to make significant expenditures. The magnitude of such expenditures cannot be predicted. Environmental legislation in Alberta has undergone a major revision to update and consolidate the various acts now applicable to the industry into the Environmental Protection and Enhancement Act (EPEA) effective September 1, 1993. The EPEA brings a wider range of activities within the scope of environmental regulation. Environmental standards and penalties are generally stricter under the EPEA than under the environmental regulatory regime it replaces. Wainoco's Canadian oil and gas production is subject to the payment to provincial governments, among others, of a specified percentage of production revenue as a royalty. Royalties paid to the Province of Alberta are subject to a rebate called the Alberta Royalty Tax Credit (ARTC). Prior to 1995, the ARTC was based on a price- sensitive formula using the average West Texas Intermediate (WTI) quarterly oil price. The maximum annual ARTC limit was $1.4 million in each of 1994 and 1993 and $1.5 million in 1992. The Company recognized ARTC's of $1.1 million, $621,000 and $590,000 in 1994, 1993 and 1992, respectively. The Alberta government has made changes and continues to consider further changes in its royalty structure (including royalty exemption periods). During 1994, the Province of Alberta announced various changes regarding determination of the ARTC effective January 1, 1995. Gas prices will now be included in determination of the ARTC rate. Also the maximum qualifying royalty amount and the maximum royalty rebate percentages are to be reduced. These changes will result in a decrease of approximately 10% in the ARTC to be received by Wainoco. The North American Free Trade Agreement (NAFTA) implemented in 1994 is between the Governments of Canada, the United States and Mexico. NAFTA carrys forward most of the material energy terms contained in the Free Trade Agreement (FTA). The FTA implemented in 1989 between Canada and the United States was intended to foster a more open North American marketplace with a minimum of direct government interference. Under FTA both countries are prohibited from imposing minimum export or import price requirements or maintaining any discriminatory export taxes, duties or charges. FTA also provides for the elimination of the United States tariffs and the elimination of customs user fees which were previously imposed. NAFTA provides for the reduction of Mexican restrictive trade practices in the energy sector and prohibits discriminatory border restrictions and export taxes. NAFTA also provides for clearer disciplines on regulators to avoid discriminatory actions and to minimize disruption of contractual arrangements, which is important for Canadian natural gas exports. Refinery Operations The Company's refinery operations are subject to laws and regulations relating to environmental quality and pollution control. Potentially to be among these requirements are regulations recently proposed by the Environmental Protection Agency under the authority of Title 3 of the Clean Air Act Amendments of 1990 (the \"Act\") which, if promulgated, may require the Company to expend approximately $4 million over the next four years to improve the Refinery's control of emissions of certain petroleum materials designated as hazardous by the Act. Because other refineries will be required to make similar expenditures, the Company does not expect such expenditures to materially adversely impact its competitive position. Frontier is party to formal agreements with both state and federal agencies requiring the investigation and possible eventual remediation of certain areas of the Refinery's property which may have been impacted by past operational activities. The Company has been addressing, over the past nine years, tasks required under a consent decree (Consent Decree) entered by the Wyoming State District Court on November 28, 1984 and involving the State of Wyoming, Department of Environmental Quality and the predecessor owners of the Refinery. This action primarily addressed the threat of groundwater and surface water contamination at the Refinery. As a result of these investigative efforts, substantial capital expenditures and remediation of conditions found to exist have already taken place or are in progress. The continuing requirement for groundwater remediation activities is the only significant task remaining in connection with the Consent Decree. Additionally, Frontier entered into a consent order with the federal Environmental Protection Agency on September 24, 1990 pursuant to the Resource Conservation and Recovery Act. The order requires the technical investigation of the Refinery to determine if certain areas of the Refinery have been adversely impacted by past operational activities. Based upon the results of the investigation, additional remedial action could be required. In the wake of new state legislation, the Company and the Wyoming Department of Environmental Quality have recently been negotiating the terms of an administrative consent decree that would generally parallel the above-referenced federal order and, upon finalization, replace the Consent Decree. Completion of this effort will result in the elimination of certain equivocal state Consent Decree requirements, the unification of state and federal regulatory expectations regarding site investigation and remediation and, consequently, a streamlining of the Company's current environmental obligations. It is further anticipated that, upon eventual state administration of the federal corrective actions program, the federal Administrative Order on Consent may be rescinded. The Company has been and will be responsible for costs related to compliance with or remediations resulting from environmental regulations. There are currently no identified environmental remediation projects of which the costs can be reasonably estimated. However, the continuation of the present investigative process, other more extensive investigations over time or changes in regulatory requirements could result in future liabilities.\nSeasonality At the Refinery, due to seasonal increases in tourist related volume and road construction work, a higher demand exists in the Rocky Mountain region for gasoline and asphalt products during the summer months than during the winter months. Diesel demand is relatively constant throughout the year because two major east-west truck routes, and at least two railroads, extend into or through Frontier's principal marketing area. However, reduced road construction during the winter months does somewhat reduce demand for diesel. The Refinery normally schedules its maintenance turnaround work during the spring of each year. During the spring of 1995, the Refinery has scheduled no significant turnaround work on its major operating units.\nEmployees At December 31, 1994, the Company had 400 full-time employees, down from 417 a year earlier. The Company's 86 full-time employees in oil and gas operations include 6 geologists, 1 geophysicist, 3 land men in exploration and development and 8 petroleum engineers in drilling and production. In conjunction with the sale of United States oil and gas properties, the Company currently expects to further reduce its United States oil and gas staff by 17 full-time employees during 1995. The Company employs 303 full-time people in the refining operations, 40 at the Denver office and 263 at the Refinery. The Refinery employees include 83 administrative and technical personnel and 180 union members. The union members are represented by seven bargaining units, the largest being the Oil, Chemical and Atomic Workers International Union. Six AFL-CIO affiliated unions represent the Refinery's craft workers. The Company considers relations with all of its employees to be good. The current three-year contracts expire in May 1996.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES As used in this Form 10-K, bbl means one barrel, bpd means one barrel per day, bopd means one barrel of oil per day, mbbls means one thousand barrels, mmbbls means one million barrels, mmbblse means one million barrels equivalent, mcf means one thousand cubic feet, mmcf means one million cubic feet, bcf means one billion cubic feet, and bcfe means one billion cubic feet equivalent. Equivalent gas is based on British Thermal Units at a ratio of six mcf of gas to one bbl of oil.\nRefining Operations\nOil and Gas Operations Wainoco is in the process of selling all of its United States oil and gas properties, except for its Conroe field reserves and other minor properties. At December 31, 1994, the sales of United States properties have not been reflected in the following oil and gas information. See principal oil and gas properties for a summary of the Conroe field, the major property to remain after completion of the property sales. See \"Business - Overview\" for a discussion of the sale of United States properties. Production The following table summarizes the Company's net oil and gas production, average daily production, weighted average sales prices and average production (lifting) cost per dollar of oil and gas sales for the periods indicated. Average daily production is computed by dividing net production by the number of days per year. Average sales prices are presented in United States dollars before deduction of production taxes. Production costs are expressed in United States dollars including lifting costs and production taxes. Average production cost is computed by dividing production costs by gross oil and gas sales.\nOil and gas drilling activities The following table shows the number of completed wells in which the Company has participated, the net interest to the Company in those wells and the results thereof for the periods indicated (excluding those wells drilled under farm out arrangements). As of December 31, 1994, the Company had no wells in progress.\nPrincipal oil and gas properties The following presentation is a summary description of the Company's most significant oil and gas properties. During 1994, the Company's production was not curtailed other than for mechanical problems relating to pipeline and compressor repairs and maintenance. In the Monias area (British Columbia) the Company has an average working interest of 41.6%. Two pipelines collect gas from the area, allowing the Company flexibility in seeking gas purchasers. In 1994, Wainoco sold 86% under long-term contract to CanWest Gas Supply Inc. (CanWest), Northwest Pacific Energy Marketing Inc. and B.C. Gas Inc. and 14% to Canadian industrial gas users or exported to the United States under short-term contracts. In the Maple Glen-Leo area (Alberta) the Company has an average working interest of 45%. During 1994, 98% of gas sales were made under long-term contracts with Pan-Alberta Gas Ltd. (Pan-Alta) and Western Gas Marketing Limited (WGML) and Altresco Pittsfield, a cogeneration market, while 2% was sold into the Alberta industrial gas market. In the Oak field (British Columbia) the Company has an average working interest of 44.4%. During 1994, all production was sold to CanWest under long-term contracts. In the Wardlow area (Alberta) the Company has an average working interest of 85.6% and 27 additional undeveloped well locations on proved acreage. Wainoco holds overriding royalty interests in 17,280 gross proved acres and 2,560 gross unproved acres. All 1994 production was sold under long-term contracts to Pan-Alta and WGML. In the North Cache field (British Columbia) the Company has an average working interest of 68.5%. During 1994, 98% of production was sold under long-term contracts to CanWest and 2% was sold to Canadian industrial gas users or to export markets in the United States under short-term contracts. In the Septimus area (British Columbia) the Company has an average working interest of 59.1%. Annual production was sold to Canadian industrial gas users or export markets in the United States under short-term contracts. In the Conroe field (Texas) the Company has a unit working interest of 18%. Oil production was sold to Exxon Company U.S.A. and Texaco Trading and Transportation and plant products and gas production were sold to Union Pacific Resources. The following table presents data for the year and as of December 31, 1994.\n(1) Gross wells: 1 unit with 160 wells.\nProductive wells The following table shows the Company's gross and net interests in productive oil and gas wells at December 31, 1994.\n(1) One or more completions in the same bore hole are counted as one well. The data in the table includes 43 gross (34.6 net) gas wells and one gross (1 net) oil well with multiple completions. (2) Includes producing units which contain numerous wells. Each unit is counted as one gross well and the unit working interest is included in the net wells.\nAcreage The table below summarizes the Company's interest in productive and undeveloped acreage as of December 31, 1994.\nReserves Incorporated herein by reference is the Supplemental Financial Information contained in the 1994 Annual Report to Shareholders which presents the estimated net quantities of the Company's proved oil and gas reserves and the standardized measure of discounted future net cash flows attributable to such reserves. Pursuant to regulations of the United States Department of Energy, Wainoco is required to file an annual report of proved reserves with the Federal Energy Regulatory Commission (FERC). The reserve information included in the Supplemental Financial Information is not inconsistent with the reserve information which will be furnished to the FERC. Wainoco has not filed oil or gas reserve information with any other federal agency within the past year, other than information similar to that included herein.\nOther Properties The Company leases approximately 27,000 square feet of office space in Houston for its corporate and U.S. oil and gas exploration and production headquarters under a six-year lease expiring in 1998. In Canada, the Company leases approximately 17,000 square feet in Calgary for its Canadian oil and gas exploration and production office under a lease expiring in 2000. Frontier leases approximately 23,000 square feet in Denver, Colorado for its refining operations headquarters under a lease expiring in 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS There are no legal proceedings which in the opinion of management would have a material adverse impact on the Company. See Item 1. Business - Government Regulations regarding certain ongoing proceedings regarding environmental matters.\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 STOCK AND RELATED STOCKHOLDER MATTERS The information in the 1994 Annual Report to Shareholders under the heading \"Common Stock\" is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA The information in the 1994 Annual Report to Shareholders under the heading \"Five Year Financial Data\" is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information in the 1994 Annual Report to Shareholders under the heading \"Financial Review\" is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and the data contained in the 1994 Annual Report to Shareholders are incorporated herein by reference. See index to financial statements and supplemental data appearing under Item 14(a)1.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.\nPART III\nThe information called for by Part III of this Form is incorporated by reference from the Company's definitive proxy statement to be filed with the Commission pursuant to Regulation 14A within 120 days after the close of its last fiscal year.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n*Reference to pages in the 1994 Annual Report to Shareholders (as published), which portions thereof are incorporated herein by reference.\n(a)2. Financial Statements Schedules Report of Independent Public Accountants Schedule I - Condensed Financial Information of Registrant 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.\n(a)3. List of Exhibits * 3.1 - Articles of Domestication of the Company, as amended (filed as Exhibit 2.3 to Registration Statement No. 2-62518 and Exhibit 2.2 to Registration Statement No. 2-69149). * 3.2 - Fourth restated By-Laws of the Company as amended through February 20, 1992 (filed as Exhibit 3.2 to Form 10-K dated December 31, 1992). * 4.1 - Indenture dated as of October 1, 1978, between the Company and First City National Bank of Houston, as Trustee relating to the Company's 10 % Subordinated Debentures due 1998 (filed as Exhibit 2.5 to Registration Statement No. 2-59649). * 4.2 - Agreement of Resignation, Appointment and Acceptance by and among the Company, First City National Bank of Houston (Resigning Trustee) and Texas Commerce Bank National Association, Houston, (Successor Trustee) relating to the Company's 10 3\/4 % Subordinated Debentures due 1998 (filed as Exhibit 4.2 to Form 10-K dated December 31, 1985). * 4.3 - First Supplemental Indenture dated as of January 20, 1987 between the Company and Texas Commerce Bank National Association, supplementing and amending the Indenture dated as of October 1, 1978, relating to the Company's 10 3\/4% Subordinated Debentures due 1998 (filed as Exhibit 4.3 to Form 10-K dated December 31, 1986). * 4.6 - Indenture dated as of June 1, 1989 between the Company and Texas Commerce Trust Company of New York as Trustee relating to the Company's 7 3\/4% Convertible Subordinated Debentures due 2014 (filed as Exhibit 4.6 to Form 10-K dated December 31, 1989). * 4.7 - Indenture dated as of August 1, 1992 between the Company and Bank One, N.A., as Trustee relating to the Company's 12% Senior Notes due 2002 (filed as Exhibit 4.7 to Form 10-K dated December 31, 1992). * 10.1 - Amended and Restated Credit Agreement dated June 29, 1994 with certain banks and Morgan Bank of Canada (filed as Exhibit 10.01 to Form 10-Q dated June 30, 1994). * 10.2 - Amended and Restated Credit and Guaranty Agreement dated May 31, 1994 with certain banks and Morgan Guaranty Trust Company of New York (filed as Exhibit 10.02 to Form 10-Q dated June 30, 1994). * 10.3 - Revolving Credit and Letter of Credit Agreement dated August 10, 1992 among Frontier Oil and Refining Company, certain banks and Union Bank (filed as Exhibit 10.8 to Form 10-K dated December 31, 1992). * 10.4 - First Amendment dated October 8, 1992 to Loan Agreement among Frontier Oil and Refining Company, certain banks and Union Bank (filed as Exhibit 10.9 to Form 10-K dated December 31, 1992). * 10.5 - Waiver and Amendment dated March 17, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.19 to Form 10-K dated December 31, 1993). * 10.6 - Second Amendment dated April 30, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.20 to Form 10-K dated December 31, 1993). * 10.7 - Waiver letter dated August 31, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.21 to Form 10-K dated December 31, 1993). * 10.8 - Waiver letter dated October 15, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.22 to Form 10-K dated December 31, 1993). * 10.9 - Third Amendment dated December 31, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.23 to Form 10-K dated December 31, 1993). *10.10 - Fourth Amendment dated July 6, 1994 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.03 to Form 10-Q dated June 30, 1994). *10.11 - Credit Agreement dated September 10, 1993 among Wainoco Oil & Gas Company and Cullen Center Bank and Trust (filed as Exhibit 10.24 to Form 10-K dated December 31, 1993). *10.12 - Interest Rate Swap Agreement dated August 5, 1991 between the Company and Morgan Guaranty Trust Company of New York (filed as Exhibit 10.10 to Form 10-K dated December 31, 1992). *10.13 - Waiver and Amendment Agreement dated May 1, 1992 between the Company and Morgan Guaranty Trust Company of New York (filed as Exhibit 10.11 to Form 10-K dated December 31, 1992). *10.14 - Amendment Agreement dated December 31, 1992 to Interest Rate Swap Agreement dated August 5, 1991 between the Company and Morgan Guaranty Trust Company of New York (filed as Exhibit 10.12 to Form 10- K dated December 31, 1992). *10.15 - The 1968 Incentive Stock Option Plan as amended and restated (filed as Exhibit 10.1 to Form 10-K dated December 31, 1987). *10.16 - The 1977 Stock Option Plan as amended and restated (filed as Exhibit 10.2 to Form 10-K dated December 31, 1989). *10.17 - Employment Agreement dated May 26, 1992 between the Company and Clark Johnson (filed as Exhibit 10.16 to Form 10-K dated December 31, 1992). *10.18 - Engagement Contract between the Company and John B. Ashmun (filed as Exhibit 10.1 to Form 10-Q dated March 31, 1994). 10.19 - Wainoco Deferred Compensation Plan dated October 29, 1993. 10.20 - Wainoco Deferred Compensation Plan for Directors dated May 1, 1994. 13.1 - Portions of the Company's 1994 Annual Report covering pages 12 through 16 and 18 through 36. * 21.1 - Subsidiaries of the Registrant (filed as Exhibit 22.1 to Form 10-K dated December 31, 1992). 23 - Consent of Arthur Andersen LLP. 27 - Financial Data Schedule.\n*Asterisk indicates exhibits incorporated by reference as shown.\n(b) Reports on Form 8-K No reports on Form 8-K have been filed by the Company during the fourth quarter of 1994.\n(c) Exhibits The Company's 1994 Annual Report is available upon request. Shareholders of the Company may obtain a copy of any other exhibits to this Form 10-K at a charge of $.25 per page. Requests should be directed to: Mrs. Michal King Corporate Communications Wainoco Oil Corporation 1200 Smith Street, Suite 2100 Houston, Texas 77002-4367\n(d) Schedules Report of Independent Public Accountants on Financial Statement Schedules:\nTo Wainoco Oil Corporation: We have audited in accordance with generally accepted auditing standards, the financial statements included in Wainoco Oil Corporation's annual report to 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 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 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\nHouston, Texas February 21, 1995\nThe \"Notes to Condensed Financial Information of Registrant\" and the \"Notes to Financial Statements of Wainoco Oil Corporation and Subsidiaries\" are an integral part of these financial statements.\nThe \"Notes to Condensed Financial Information of Registrant\" and the \"Notes to Financial Statements of Wainoco Oil Corporation and Subsidiaries\" are an integral part of these financial statements.\nThe \"Notes to Condensed Financial Information of Registrant\" and the \"Notes to Financial Statements of Wainoco Oil Corporation and Subsidiaries\" are an integral part of these financial statements.\nWainoco Oil Corporation Notes to Condensed Financial Information of Registrant December 31, 1994 Schedule I - ----------------------------------------------------------------------\n(1) General\nThe accompanying condensed financial statements of Wainoco Oil Corporation (Registrant) should be read in conjunction with the consolidated financial statements of the Registrant and its subsidiaries included in the Registrant's 1994 Annual Report to Shareholders.\n(2) Oil and gas properties\nAll of the Registrant's oil and gas properties are located in Canada. Information relating to the Registrant's oil and gas operations is disclosed in the \"Notes to the Financial Statements of Wainoco Oil Corporation and Subsidiaries.\"\n(3) Long-term debt\nThe components (in thousands) of long-term debt are as follows:\n(4) Five-year maturities of long-term debt\nThe estimated five-year maturities of long-term debt are $2.5 million in 1996 and 1997 and $5.0 million in 1998.\n(5) Restructuring of operations\nWainoco's subsidiary, Wainoco Oil & Gas Company, intends to cease oil and gas exploration activities in the United States and sell all of its United States oil and gas properties, except for its Conroe field and some minor properties. Information relating to the restructuring and sale are disclosed in the \"Notes to Financial Statements of Wainoco Oil Corporation 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 on the date indicated.\nWAINOCO OIL CORPORATION\nBy: \/s\/ James R. Gibbs James R. Gibbs President (chief executive officer)\nDate: February 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 Wainoco Oil Corporation and in the capacities and on the date indicated.\n\/s\/ James R. Gibbs \/s\/ Paul B. Loyd, Jr. - ------------------------------ -------------------------- James R. Gibbs Paul B. Loyd, Jr. President and Director Director (chief executive officer)\n\/s\/ Julie H. Edwards - ------------------------------ -------------------------- Julie H. Edwards James S. Palmer Senior Vice President - Finance Director and Chief Financial Officer (principal financial officer)\n\/s\/ George E. Aldrich \/s\/ Derek A. Price - ------------------------------ -------------------------- George E. Aldrich Derek A. Price Vice President - Controller Director (principal accounting officer)\n\/s\/ Douglas Y. Bech \/s\/ Carl W. Schafer - ------------------------------ -------------------------- Douglas Y. Bech Carl W. Schafer Director Director\nDate: February 21, 1995","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*Reference to pages in the 1994 Annual Report to Shareholders (as published), which portions thereof are incorporated herein by reference.\n(a)2. Financial Statements Schedules Report of Independent Public Accountants Schedule I - Condensed Financial Information of Registrant 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.\n(a)3. List of Exhibits * 3.1 - Articles of Domestication of the Company, as amended (filed as Exhibit 2.3 to Registration Statement No. 2-62518 and Exhibit 2.2 to Registration Statement No. 2-69149). * 3.2 - Fourth restated By-Laws of the Company as amended through February 20, 1992 (filed as Exhibit 3.2 to Form 10-K dated December 31, 1992). * 4.1 - Indenture dated as of October 1, 1978, between the Company and First City National Bank of Houston, as Trustee relating to the Company's 10 % Subordinated Debentures due 1998 (filed as Exhibit 2.5 to Registration Statement No. 2-59649). * 4.2 - Agreement of Resignation, Appointment and Acceptance by and among the Company, First City National Bank of Houston (Resigning Trustee) and Texas Commerce Bank National Association, Houston, (Successor Trustee) relating to the Company's 10 3\/4 % Subordinated Debentures due 1998 (filed as Exhibit 4.2 to Form 10-K dated December 31, 1985). * 4.3 - First Supplemental Indenture dated as of January 20, 1987 between the Company and Texas Commerce Bank National Association, supplementing and amending the Indenture dated as of October 1, 1978, relating to the Company's 10 3\/4% Subordinated Debentures due 1998 (filed as Exhibit 4.3 to Form 10-K dated December 31, 1986). * 4.6 - Indenture dated as of June 1, 1989 between the Company and Texas Commerce Trust Company of New York as Trustee relating to the Company's 7 3\/4% Convertible Subordinated Debentures due 2014 (filed as Exhibit 4.6 to Form 10-K dated December 31, 1989). * 4.7 - Indenture dated as of August 1, 1992 between the Company and Bank One, N.A., as Trustee relating to the Company's 12% Senior Notes due 2002 (filed as Exhibit 4.7 to Form 10-K dated December 31, 1992). * 10.1 - Amended and Restated Credit Agreement dated June 29, 1994 with certain banks and Morgan Bank of Canada (filed as Exhibit 10.01 to Form 10-Q dated June 30, 1994). * 10.2 - Amended and Restated Credit and Guaranty Agreement dated May 31, 1994 with certain banks and Morgan Guaranty Trust Company of New York (filed as Exhibit 10.02 to Form 10-Q dated June 30, 1994). * 10.3 - Revolving Credit and Letter of Credit Agreement dated August 10, 1992 among Frontier Oil and Refining Company, certain banks and Union Bank (filed as Exhibit 10.8 to Form 10-K dated December 31, 1992). * 10.4 - First Amendment dated October 8, 1992 to Loan Agreement among Frontier Oil and Refining Company, certain banks and Union Bank (filed as Exhibit 10.9 to Form 10-K dated December 31, 1992). * 10.5 - Waiver and Amendment dated March 17, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.19 to Form 10-K dated December 31, 1993). * 10.6 - Second Amendment dated April 30, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.20 to Form 10-K dated December 31, 1993). * 10.7 - Waiver letter dated August 31, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.21 to Form 10-K dated December 31, 1993). * 10.8 - Waiver letter dated October 15, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.22 to Form 10-K dated December 31, 1993). * 10.9 - Third Amendment dated December 31, 1993 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.23 to Form 10-K dated December 31, 1993). *10.10 - Fourth Amendment dated July 6, 1994 to Loan Agreement dated August 10, 1992 with certain banks and Union Bank (filed as Exhibit 10.03 to Form 10-Q dated June 30, 1994). *10.11 - Credit Agreement dated September 10, 1993 among Wainoco Oil & Gas Company and Cullen Center Bank and Trust (filed as Exhibit 10.24 to Form 10-K dated December 31, 1993). *10.12 - Interest Rate Swap Agreement dated August 5, 1991 between the Company and Morgan Guaranty Trust Company of New York (filed as Exhibit 10.10 to Form 10-K dated December 31, 1992). *10.13 - Waiver and Amendment Agreement dated May 1, 1992 between the Company and Morgan Guaranty Trust Company of New York (filed as Exhibit 10.11 to Form 10-K dated December 31, 1992). *10.14 - Amendment Agreement dated December 31, 1992 to Interest Rate Swap Agreement dated August 5, 1991 between the Company and Morgan Guaranty Trust Company of New York (filed as Exhibit 10.12 to Form 10- K dated December 31, 1992). *10.15 - The 1968 Incentive Stock Option Plan as amended and restated (filed as Exhibit 10.1 to Form 10-K dated December 31, 1987). *10.16 - The 1977 Stock Option Plan as amended and restated (filed as Exhibit 10.2 to Form 10-K dated December 31, 1989). *10.17 - Employment Agreement dated May 26, 1992 between the Company and Clark Johnson (filed as Exhibit 10.16 to Form 10-K dated December 31, 1992). *10.18 - Engagement Contract between the Company and John B. Ashmun (filed as Exhibit 10.1 to Form 10-Q dated March 31, 1994). 10.19 - Wainoco Deferred Compensation Plan dated October 29, 1993. 10.20 - Wainoco Deferred Compensation Plan for Directors dated May 1, 1994. 13.1 - Portions of the Company's 1994 Annual Report covering pages 12 through 16 and 18 through 36. * 21.1 - Subsidiaries of the Registrant (filed as Exhibit 22.1 to Form 10-K dated December 31, 1992). 23 - Consent of Arthur Andersen LLP. 27 - Financial Data Schedule.\n*Asterisk indicates exhibits incorporated by reference as shown.\n(b) Reports on Form 8-K No reports on Form 8-K have been filed by the Company during the fourth quarter of 1994.\n(c) Exhibits The Company's 1994 Annual Report is available upon request. Shareholders of the Company may obtain a copy of any other exhibits to this Form 10-K at a charge of $.25 per page. Requests should be directed to: Mrs. Michal King Corporate Communications Wainoco Oil Corporation 1200 Smith Street, Suite 2100 Houston, Texas 77002-4367\n(d) Schedules Report of Independent Public Accountants on Financial Statement Schedules:\nTo Wainoco Oil Corporation: We have audited in accordance with generally accepted auditing standards, the financial statements included in Wainoco Oil Corporation's annual report to 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 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 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\nHouston, Texas February 21, 1995\nThe \"Notes to Condensed Financial Information of Registrant\" and the \"Notes to Financial Statements of Wainoco Oil Corporation and Subsidiaries\" are an integral part of these financial statements.\nThe \"Notes to Condensed Financial Information of Registrant\" and the \"Notes to Financial Statements of Wainoco Oil Corporation and Subsidiaries\" are an integral part of these financial statements.\nThe \"Notes to Condensed Financial Information of Registrant\" and the \"Notes to Financial Statements of Wainoco Oil Corporation and Subsidiaries\" are an integral part of these financial statements.\nWainoco Oil Corporation Notes to Condensed Financial Information of Registrant December 31, 1994 Schedule I - ----------------------------------------------------------------------\n(1) General\nThe accompanying condensed financial statements of Wainoco Oil Corporation (Registrant) should be read in conjunction with the consolidated financial statements of the Registrant and its subsidiaries included in the Registrant's 1994 Annual Report to Shareholders.\n(2) Oil and gas properties\nAll of the Registrant's oil and gas properties are located in Canada. Information relating to the Registrant's oil and gas operations is disclosed in the \"Notes to the Financial Statements of Wainoco Oil Corporation and Subsidiaries.\"\n(3) Long-term debt\nThe components (in thousands) of long-term debt are as follows:\n(4) Five-year maturities of long-term debt\nThe estimated five-year maturities of long-term debt are $2.5 million in 1996 and 1997 and $5.0 million in 1998.\n(5) Restructuring of operations\nWainoco's subsidiary, Wainoco Oil & Gas Company, intends to cease oil and gas exploration activities in the United States and sell all of its United States oil and gas properties, except for its Conroe field and some minor properties. Information relating to the restructuring and sale are disclosed in the \"Notes to Financial Statements of Wainoco Oil Corporation 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 on the date indicated.\nWAINOCO OIL CORPORATION\nBy: \/s\/ James R. Gibbs James R. Gibbs President (chief executive officer)\nDate: February 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 Wainoco Oil Corporation and in the capacities and on the date indicated.\n\/s\/ James R. Gibbs \/s\/ Paul B. Loyd, Jr. - ------------------------------ -------------------------- James R. Gibbs Paul B. Loyd, Jr. President and Director Director (chief executive officer)\n\/s\/ Julie H. Edwards - ------------------------------ -------------------------- Julie H. Edwards James S. Palmer Senior Vice President - Finance Director and Chief Financial Officer (principal financial officer)\n\/s\/ George E. Aldrich \/s\/ Derek A. Price - ------------------------------ -------------------------- George E. Aldrich Derek A. Price Vice President - Controller Director (principal accounting officer)\n\/s\/ Douglas Y. Bech \/s\/ Carl W. Schafer - ------------------------------ -------------------------- Douglas Y. Bech Carl W. Schafer Director Director\nDate: February 21, 1995","section_15":""}
{"filename":"5611_1994.txt","cik":"5611","year":"1994","section_1":"ITEM 1 BUSINESS\n(a) FINA, Inc. (and subsidiaries, collectively the \"Company\" and \"FINA\") was organized in 1956 as American Petrofina, Incorporated and is part of an international group of about 166 companies in 34 countries which are affiliated with Petrofina S.A., a publicly-held corporation organized under the laws of the Kingdom of Belgium. Petrofina Delaware, Incorporated (\"PDI\") owns approximately 85% and 100% of the Class A and Class B common stock of the Company, respectively. Petrofina S.A. owns 100% of American Petrofina Holding Company which owns 75% of the stock of PDI. The remaining 25% of PDI's stock is owned by Petrofina S.A.\nFINA, Inc. is engaged, through its wholly-owned, main operating subsidiary, Fina Oil and Chemical Company (\"FOCC\"), in crude oil and natural gas exploration and production; petroleum products refining, supply and transportation and marketing; and chemicals manufacturing and marketing. A wholly-owned subsidiary of the Company, Fina Natural Gas Company, is engaged in natural gas marketing. Fina Technology, Inc., a subsidiary of the Company, licenses certain proprietary processes to others.\nThe Company entered the year with a strategic plan to strengthen its balance sheet and better position itself for future profit growth by focusing on items within management's control. Implementation of the plan, which included further consolidation of the Upstream and Downstream businesses through sales of non-strategic assets, constrained capital expenditures and productivity improvements reduced debt by more than $160 million, or 20%, and reduced the total debt to total capital ratio from 42% to 36%. Asset sales reflected the Company's strategic objectives of geographic consolidation and organizational streamlining. Capital expenditures were $136 million, or 9% above the prior year's $125.4 million.\nCapital expenditures by segments of the Company are shown in Note 12 to the Consolidated Financial Statements on pages 30 and 31. Expenditures associated with refining, supply and transportation and marketing were $48.8 million of the total capital expenditures primarily due to safety and environmental projects at both refineries. Expenditures of $49.3 million for exploration and production were attributable primarily to development activity. Expenditures relating to chemicals were $33.6 million. Capital expenditures are expected to increase to $215 million in 1995.\nNo major individual assets or subsidiaries were acquired or disposed of during the five years ending December 31, 1994.\n(b) Segment data is shown in Note 12 \"Segment Data\" to consolidated financial statements on pages 30 and 31 herein.\n(c) The Company has grouped its businesses into (1) crude oil and natural gas exploration and production, and natural gas marketing; (2) petroleum products refining, supply and transportation and marketing; and (3) chemicals manufacturing and marketing, primarily petrochemicals and plastics including polypropylene, polystyrene, styrene monomer, high density polyethylene, and aromatics, and the licensing of certain chemical processes. The energy products are produced and refined by FOCC, a Delaware corporation. Petrochemicals and plastics are manufactured by FOCC and by Cos-Mar Company, a 50% owned joint venture.\nThe Company markets gasoline and other refined products under the FINA(R) brand and also markets some unbranded products. FINA(R) fuel products are primarily sold through 231 independent businesses which supply approximately 2,569 branded retail outlets, located in 11 states in the Southeastern and Southwestern regions of the United States. The Company also markets petrochemicals and plastics under the FINA(R) brand. Fina Natural Gas Company is engaged in natural gas marketing.\nFOCC also markets naphtha, jet fuel, distillates, diesel fuel, heavy oils, and asphalt.\nFollowing are products which accounted for more than 10% of consolidated revenues in 1994, 1993 and 1992, and their appropriate percentage of revenues for the last three years:\nAdditional segment data is shown in Note 12 \"Segment Data\" to consolidated financial statements on pages 30 and 31 herein.\nSufficient raw material is available in the foreseeable future for supplying the needs of the various manufacturing units of the Company, although political situations in the important oil producing nations can aggravate the supply situation in the United States where imports of oil are necessary to meet demand.\nThe Company licenses its patented chemical processes throughout the world, but the net earnings derived from licensing were not material to the consolidated results of operations in 1994, 1993 and 1992.\nThe business of the Company cannot be considered seasonal and is sensitive to crude oil and natural gas pricing, margins between crude oil and refined products and chemicals margins. There are, however, fluctuations, such as increased demand for gasoline during summer months. Inflation increases the costs of labor and supplies and increases costs of acquiring and replacing property, plant and equipment.\nInventories of refined products fluctuate and crude oil inventories vary according to the overall supply picture and in anticipation of price increases or decreases. Payments for crude oil are generally expected by the 20th day of the month following the month in which the crude oil was delivered. Payments for refined products are generally expected within 10 days of billing. Payments for chemicals are generally expected within 30 days of billing. Credit is sometimes extended for a longer period on products when there is a surplus, and in some cases, credit terms are influenced by credit history and financial stability.\nNo material part of the business is dependent on a single customer or a few customers. Most of the Company's customers are located in the South and Midwest regions of the United States, except with respect to chemicals where customers are located throughout the United States. No single customer accounted for more than 5% of the Company's sales in 1994, 1993 or 1992, and no account receivable from any customer exceeded 5% of the Company's consolidated stockholders' equity at December 31, 1994, 1993 or 1992.\nNo material portion of the business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.\nIn both the crude oil and natural gas exploration and production and natural gas marketing segment and the petroleum products refining, supply and transportation and marketing segment, the principal methods of competition are price and availability of product. In the petroleum products and chemicals segments, quality of the product is also a competitive factor.\nDuring 1994, $21.7 million was expended on pollution control and environmental protection capital projects. It is estimated that environmental protection facilities will require capital expenditures in 1995 of approximately $19.3 million companywide. Additionally, during 1994, $51.6 million was charged to expense relating to various environmental activities.\nThe number of persons employed on December 31, 1994 was 2,716 full time and 54 part time.\n(d) Sales, operating profit (loss), and identifiable assets as of and for the three years ended December 31, 1994 were substantially all attributable to domestic operations.\n(e) \"Executive Officers of the Registrant\" are described in Part III, Item 10.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES\n(a) The Company owns and operates two refineries in Texas. The total raw materials processed at both refineries averaged 215,000 barrels per day for the year. The Port Arthur, Texas refinery is located on 1,231 acres in Jefferson County, Texas and the Big Spring, Texas refinery is located on 1,259 acres in Howard County, Texas.\nIn 1990, the plant located in Carville, Louisiana became the largest single site polystyrene manufacturing plant in the United States and the second largest in the world with total net capacity of approximately 700 million pounds per year. The world's largest single production train is installed at the plant. The Carville, Louisiana plant, and the adjacent styrene monomer plant discussed below, are located on 358 acres in Iberville Parish, Louisiana.\nThe Company owns and operates a polypropylene plant at La Porte, Texas on 76.5 acres of land in Harris County, Texas. The throughput capacity is approximately 960 million pounds per year. The La Porte, Texas, plant is the third largest single site polypropylene manufacturing facility in the United States.\nSigma Coatings, which conducted the Company's paint and industrial coatings business, was sold in 1993 to an affiliate of Petrofina S.A. in an arm's length transaction. The sales price was $7.8 million plus working capital. No gain or loss was recorded.\nThe Company purchased a high density polyethylene plant in 1992. The plant is located in Harris County, Texas, in the Bayport area. The plant has a demonstrated capacity of 360 million pounds per year and is situated on 54.7 acres of land.\nFOCC operates, for a 50% owned joint venture, a styrene monomer plant located in Carville, Louisiana. Gross production capacity is 1.9 billion pounds per year. This plant is the largest single site styrene production facility in the world.\nThrough a 26% ownership interest in a joint venture with Hercules, Incorporated, the Company owned an interest in a paraxylene facility rated at a 600 million pound capacity per year and located in St. Croix, V.I. The plant was closed by the end of 1992.\nA subsidiary of the Company owns a 33% interest in a propylene splitter at Mont Belview, Texas with an approximate 650 million pounds per year capacity. Approximately two-thirds of the output is currently supplied as raw material to the Company's La Porte polypropylene plant.\nOver 1,455 miles of crude oil gathering and mainline pipelines are owned and operated by the Company, together with 372 miles of products pipelines which are leased. The Company also owns storage terminals and owns and leases rail tank cars which are used in its distribution systems.\nOf the approximately 2,607 branded service stations in the Company's marketing network, 85 are owned in fee, and 35 are leased.\nAt the end of 1993, the Company had one 225,000 DWT, 1.5 million barrel capacity tanker, the T\/T Brooklyn under time charter for a remaining period of 5 years. During 1994, the T\/T Brooklyn had its long-term lease terminated and the vessel was re-delivered to its owners. Another vessel, T\/T Williamsburgh, had its long-term lease terminated in 1993, and the vessel was re-delivered to its owners.\n(b) Reserve Quantity information is shown in \"Supplemental Oil and Gas Data (Unaudited)\" to consolidated financial statements on pages 34 and 35 herein.\n(c) 1. Location of Reserves. The Company's major crude oil reserves are located in West Texas in the Permian Basin and the Company's major gas reserves are located in High Island A571 offshore in the Gulf of Mexico, at Mecom and LaTerre in Louisiana, and in the Texas Rio Grande Valley. All of the Company's proved oil and gas reserves are located in the United States.\n2. Reserves Reported to Other Agencies\nTotal proved net oil and gas reserves as of December 31, 1993 were reported to the Energy Information Agency of the U.S. Department of Energy in May 1994 (EIA-28) in the amounts of 36 million barrels of crude oil and natural gas liquids and 439 BCF of natural gas.\nThe reserve estimates reported above do not vary by more than five percent from the similar amounts reported to the SEC for the same date.\n3. Production\nAll of the Company's production is located in the United States. Any volumes of natural gas liquids resulting from ownership of processing plant facilities are not significant.\n4. Productive Wells and Acreage\nAs of December 31, 1994:\n5. Undeveloped Lease Acreage\nFee, mineral and royalty acreage was 1,036,342 net acres as of December 31, 1994.\n6. Drilling Activity\n7. Present Activity as of December 31, 1994\n8. At all times the Company has contractual obligations to deliver natural gas, usually on an \"as needed\" basis. Therefore, contract quantities are not fixed and determinable. In May of 1989, the Company began purchasing gas produced by unaffiliated companies for resale to the Company's customers. During 1994, 247,916 MMCF of gas was purchased and resold from both affiliated and unaffiliated companies. The Company's obligations to deliver natural gas have been met.\nOn December 31, 1994, the Company was obligated to deliver 4,762,562 barrels of crude oil in January 1995, 4,283,372 barrels in February, 2,077,676 barrels in March and 1,014,059 barrels in April. The Company purchases crude oil either at the lease, on the spot market or on the futures market to fulfill its commitments. The Company met its contractual obligations to date.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nAs of December 31, 1994, neither FINA, Inc. nor any of its subsidiaries was a party to, nor was any of their property subject to, any uninsured material pending legal proceedings or claim which exceeds 10% of the current assets.\nManagement believes that there is no environmental liability pertaining to proceedings involving a governmental authority in excess of $100,000 which is reasonably foreseeable in relation to its business activities and operational permits other than:\n1. The United States Environmental Protection Agency (\"EPA\") is empowered by the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") to investigate hazardous waste disposal sites and to remove, or to cause responsible parties to remove, or treat hazardous substances and to restore the sites to a safe condition. FOCC and Cos-Mar, for which FOCC acts as operator, have been named as potentially responsible parties with respect to the Brio site in Harris County, Texas. FOCC and Cos-Mar, along with other potentially responsible parties, have signed a consent decree with the EPA, agreeing to treat or remove certain hazardous substances. FOCC's share of the cleanup costs, both individually and as 50% owner of Cos-Mar, is $395,000.\n2. FOCC has also been named a potentially responsible party by the State of New Jersey at the Duane Marine site in Perth Amboy, New Jersey. A group of potentially responsible parties, including FOCC, have agreed to conduct an investigation. It is not possible at this time to estimate the amount of monies for which FOCC will be liable, if any.\n3. The EPA has listed the hazardous waste disposal area of a refinery located in El Dorado, Kansas, as a Superfund site pursuant to CERCLA. As a former owner of the site, FOCC would be liable for 65% of the clean-up cost which is currently estimated to be $4,170,000. FOCC signed a consent order with the State of Kansas and the present owner of the site. The State of Kansas and the EPA have approved a plan for cleanup.\n4. FOCC's Windsor, New Jersey, plant was closed in 1989. Under New Jersey's closing law, surface cleanup of the site was conducted at a cost of $1,000,000. The remaining groundwater cleanup was initiated in 1994 at an estimated total cost of $675,000 and will take a number of years to complete.\n5. FOCC and 8 other potentially responsible parties have been required by the Texas Natural Resource Conservation Commission (TNRCC) to conduct an investigation of the closed Col-Tex refinery located near Colorado City, Texas. For a portion of the site, FOCC has covered pits which could harm birds, provided fencing around the area, and installed a hydrocarbon abatement system to stop oil from seeping into the Colorado River. The other named potentially responsible parties have appealed the TNRCC's Order regarding remediation to the state district court.\n6. A hazardous waste operating permit has been issued to the Big Spring Refinery. Pursuant to the permit, FOCC initiated interim corrective action to recover free product from ground water. FOCC is also obligated to submit a remediation plan.\n7. FOCC is engaged in several underground storage tank (UST) removal and remediation activities in several states. These activities are conducted pursuant to applicable state regulations, and a substantial portion of costs are reimbursable from various state UST remediation funds.\nEnvironmental contingencies and the Company's policy regarding environmental costs are discussed in Note 11 to the consolidated financial statements, on page 29. A reserve has been established in accordance with the policy. Although the level of future expenditures for environmental matters, including clean-up obligations, is impossible to determine with any degree of certainty, it is management's opinion that the costs, although potentially significant to any one accounting period, when finally determined will not have a material adverse effect on the consolidated financial position or liquidity of the Company.\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 Company's fiscal year ended December 31, 1994.\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR THE REGISTRANTS' COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe Class A Common Stock of the Company is traded on the American Stock Exchange under the symbol FI. On January 27, 1995, there were 14,594,902 Class A Common Shares outstanding and 2,651 holders of the shares.\nCOMMON STOCK MARKET PRICES BY QUARTER AND DIVIDEND PAID PER QUARTER\nThe Stock Transfer Agent and Registrar of Stock is First Chicago Trust Company of New York, P.O. Box 2500, Jersey City, New Jersey 07303-2500.\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA\nFINA, INC. AND SUBSIDIARIES\nSUMMARY OF FINANCIAL AND OPERATING DATA\n- ---------------\n(1) Cumulative effect to January 1, 1992 of change in accounting for postretirement benefits other than pensions.\nITEM 7","section_7":"ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nDISCUSSION OF FINANCIAL INFORMATION\nFina's net income for 1994 was $102 million compared to $70 million in 1993 and $24 million in 1992 (before cumulative effect of accounting change). Net income for 1994 includes $13 million of gain from sale of assets and $33 million of inventory gains, after-tax, related to improved crude, product and chemical prices since the beginning of the year. These gains were partially offset by a $30 million after-tax charge for establishment of reserves for various contingencies including $12.8 million after-tax for future environmental remediation projects.\nNet income for 1993 included a $75 million after-tax gain from sale of assets and a $33 million after-tax charge to state inventories at the lower of LIFO cost or market.\nThe net loss for 1992 includes an after-tax charge of $34.3 million from adoption of Financial Accounting Standards Board Statement No. 106, which relates to employee post-retirement benefits other than pensions.\nEarnings per common share in 1994 were $6.54 compared to $4.51 in 1993 and a net loss in 1992 of $.65 per share ($1.55 per share net earnings before cumulative effect of accounting change). The Company paid total dividends of $3.60 per share in 1994 and $3.20 per share in 1993 and 1992.\nSales and other operating revenues for 1994 at $3.4 billion were essentially unchanged from 1993 and 1992, with higher chemical prices and volumes offsetting lower petroleum and natural gas prices and volumes. The increase in 1992 over 1991 of $100 million was a result of higher volumes and natural gas prices offsetting lower petroleum and chemical prices.\nTotal assets in 1994 and 1993 remained constant at $2.5 billion. Total assets decreased by $413 million in 1993 from 1992. The decrease in 1993 was principally due to price and volume related inventory declines, depreciation, depletion and amortization in excess of capital expenditures and a decrease in receivables. Book value of assets sold, excluding receivables, was $58.4 million in 1993.\nCost of raw materials and products purchased and direct operating expenses as a percent of sales and other operating revenues were relatively constant for 1994, 1993 and 1992.\nSelling, general and administrative expenses have decreased over the three year period because of a cost reduction program.\nInterest expense decreased from 1992 to 1993 and again in 1994 primarily because of decreased debt levels and lower interest rates on floating interest rate debt in 1993 and 1994.\nInterest and other income for 1993 includes $106.6 million from gain on sale of assets, including $101.8 million from exploration and production related properties.\nLong-term obligations less current installments were $532 million at the end of 1994, compared to $766 million in 1993 and $951 million in 1992. Total debt was $650 million at year-end 1994, compared to $811 million at year-end 1993 and $1.215 billion at year-end 1992. The principal paydown was primarily from operating income, working capital reductions, and the proceeds from asset sales, as part of the plan to reduce debt. The increase in total debt in 1992 was due primarily to the large capital expenditure associated with the acquisition of the HDPE plant described herein under the subheading \"Chemicals\" and to expenditures to upgrade the Port Arthur, Texas Refinery.\nStockholders' equity was $1.145 billion, or $73.41 per common share, in 1994 compared to $1.099 billion, or $70.47 per common share, in 1993 and $1.077 billion, or $69.16 per common share, in 1992. The increase in stockholders' equity in 1994 and 1993 was attributable to net income after annual dividends of $3.60 per share in 1994 and $3.20 per share in 1993.\nCrude oil and refined products and chemicals are priced at the lower of cost (last-in, first-out, \"LIFO\") or market on an aggregate basis. Materials and supplies are priced at average cost, not in excess of market; in the case of material salvaged, an allowance is made for obsolescence and depreciation. Because of a significant decline in the price of crude oil and refined products, the Company recorded a valuation reserve in 1993 of $47,048,000 pre-tax to reduce the LIFO cost of inventory to net realizable value. The price of crude oil, petroleum products and chemicals increased in 1994 allowing restoration through income of the full amount of the reserve established in 1993. The excess of replacement cost of crude oil and refined products and chemicals over LIFO cost at December 31, 1994 was approximately $8.4 million.\nEffective January 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 106 \"Employers' Accounting for Postretirement Benefits Other than Pensions\" (Statement 106), which establishes a new accounting principle for the cost of retiree health care and other postretirement benefits. Prior to 1992, the Company recognized these benefits on the pay-as-you-go basis. The effect of adopting Statement 106 for the year ended December 31, 1992 was to increase net periodic postretirement benefits costs by $1,500,000 ($.10 per share), decrease earnings before cumulative effect of accounting change by $990,000 ($.06 per share) and increase net loss by $35,310,000 ($2.26 per share).\nThe impact of the various lines of business on the financial position and results of operations is discussed in the following text under appropriate operating unit subheadings.\nExploration and Production and Natural Gas Marketing\nRevenues and earnings (loss) before interest and income tax were $549.2 million and ($3.4 million), $519.8 million and $121.1 million and $456.9 million and $51.1 million for 1994, 1993 and 1992, respectively.\nExploration and production earnings before interest and taxes decreased $124.5 million from 1993 including an $89 million decrease in gain from asset sales. Asset sales gains were $12.7 million in 1994 and $101.8 million in 1993. The remainder of the decrease was because of lower oil and gas prices and volumes partially offset by lower operating costs.\nAverage crude oil, condensate and natural gas liquids production was 12,500 barrels per day, a decline from 16,200 barrels in 1993 because of natural declines, divestitures and limited drilling. Natural gas production in 1994 was 145 MMCF per day and 186 MMCF per day in 1993. Natural gas wellhead sales volumes declined due to asset sales and mild winter weather.\nAverage wellhead prices for crude fell $1.39 per barrel to $14.27 in 1994. Average wellhead prices for natural gas were $1.85 per MCF in 1994 down from $2.11 per MCF in 1993.\nThe drilling program for 1994 got off to a slow start with significant resources devoted to the sale of lower value properties and geographic consolidation, a strategy initiated in 1993. Reserve additions were 7.5 million barrels oil equivalent. Total reserves fell 18% after production of 13.4 million barrels oil equivalent. Divestitures accounted for 49% of the decline. Finding and development costs in 1994 were $5.71 per barrel oil equivalent compared to $5.74 in 1993 and $3.90 in 1992. Lifting costs, at $5.28 per barrel oil equivalent was up from $5.09 in 1993.\nThe Company participated in 3 net exploratory wells, compared to 11 in 1993 and 18 in 1992. The success rate was 56% compared to 54% in 1993 and 50% in 1992.\nNatural Gas Marketing in 1994 increased sales 27% compared to 1993. Sales volume was 711 million cubic feet per day. Income from gas trading increased 11%. This was accomplished with no increase in per-unit marketing costs. Overall, gas marketing activities added 17 cents per thousand cubic feet to the value of the Company's natural gas production.\nRefining, Marketing, Supply & Transportation\nRevenues and earnings (loss) before interest and income tax were $2.0 billion and $47.2 million, $2.1 billion and ($8.3 million), and $2.2 billion and ($61.4 million) for 1994, 1993 and 1992, respectively.\nThe earnings for 1994 include $25.4 million of inventory gains from the reversal of a 1993 valuation reserve due to price increases of crude oil and petroleum products since the beginning of the year and a $6.2 million gain from the sale of the Company's retail operations in the Minneapolis\/St. Paul area. Offsetting these gains were $29.4 million of established reserves including $18.7 for future environmental remediation. Sale of the Minneapolis\/St. Paul area retail operation will allow increased focus on a single Dallas\/Fort Worth area retail operations.\nDuring 1994, the Downstream was reorganized into two geographic Business Units which contributed to improved results. The business unit structure improved communications and teamwork across business lines and increased focus on key elements of the business, while facilitating better productivity and lower cost of operations. This reorganization is expected to provide further benefits in 1995. Record-setting refinery operations and greater productivity contributed to the improved earnings, even in a persistently difficult industry business environment characterized by low refining margins.\nRefining margins were disappointing, specifically the fuels margin. Industry fuels margins were only 7 cents per barrel better than 1993, which was a very low year, and were 50 cents per barrel below the historical five-year average. Aromatics margins were strong, about 65 cents per barrel above 1993. This was especially helpful at the Port Arthur refinery where the Company is among the industry leaders in aromatics production compared to crude throughput. Margins at the Big Spring refinery were improved from 1993 primarily because\nof improved yields. Overall, poor industry margins continued to negatively affect earnings and mask significant improvements in refining operations.\nRefinery operations were excellent in 1994 with a new record throughput of 215,000 barrels per day. Yields were substantially improved over 1993 with throughput records set in numerous units, including the catalytic cracking units, reformers and hydrotreaters. Both refineries have turnaround activity scheduled for 1995 in the reforming areas.\nChemicals\nRevenues and earnings before interest and income taxes were $890.3 million and $164.4 million, $794.8 million and $53.7 million, and $729.7 million and $102.8 million for 1994, 1993 and 1992, respectively. Earnings for 1994 include an inventory gain from the reversal of a 1993 valuation reserve of $16 million from price recovery since the first of the year.\nChemicals was the largest contributor to earnings, as demands and margins for the Company's products continued to increase. With all plants operating at maximum capacity, total demand for some products could not be met.\nAs with the Downstream, the Chemicals segment was reorganized into business units of Styrenics, Polypropylene and Polyethylene. The business units, which facilitated enhanced teamwork and focus, were particularly important at a time when demands grew rapidly, resulting in critically low inventories and the need for close and effective coordination between plant and sales personnel. The benefits were apparent in more optimized plant scheduling and in helping manage customer relations as on-time deliveries became more difficult.\nIndustry margins growth exceeded expectations reflecting strong product demand growth and increased capacity utilization. Industry demands for polypropylene, polystyrene, and HDPE resulted in industry capacity utilization levels in the 90-95% range. Margins for all products improved as the year progressed in spite of rapidly increasing raw material costs. Petrochemical demand and prices are expected to remain strong through 1995.\nTotal chemicals sales growth continued in 1994 with volumes up 7 percent compared to 1993. Total production and sales volumes were 3.1 billion pounds in 1994 compared to 3.0 billion pounds in 1993 and 2.7 billion pounds in 1992.\nEarly in 1995, plans were announced for debottlenecking the polystyrene plant in Carville, Louisiana. The first quarter 1995 project will increase capacity on all production lines, and will increase annual polystyrene capacity by 45 million pounds, to 775 million pounds. FINA also will build a new 250 million pound crystal polystyrene production line utilizing proprietary technology at the Carville site. It will commence operations in the third quarter of 1996 and will increase total polystyrene capacity to 1.025 billion pounds per year, making the Carville plant the largest single site polystyrene facility in the world.\nAn expansion at the LaPorte polypropylene plant to increase capacity by 400 million pounds per year is scheduled for completion in the fourth quarter of 1995. After completion, at a capacity of 1.4 billion pounds per year, it will be the largest polypropylene plant in the world.\nSigma Coatings, a manufacturer of paint and industrial coatings was sold in 1993 to an affiliate of Petrofina S.A. for $7.8 million plus working capital. No gain or loss was recorded.\nENVIRONMENTAL MATTERS\nThe Company is subject to extensive federal, state and local environmental laws and regulations, including the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA or Superfund), the Resource Conservation and Recovery Act (RCRA), the Clean Water Act and the Clean Air Act. These regulations, which are constantly changing, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or\nrelease of petroleum or chemical substances at various sites, including Superfund sites, service stations, terminals and other operating or inactive facilities.\nEnvironmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a non-capital nature are recorded when environmental assessment and\/or remediation is probable, and the costs can be reasonably estimated.\nIn 1994, the Company spent approximately $21.7 million in capital expenditures for environmental protection and for compliance with federal, state and local environmental laws and regulations. Environmental costs charged to expense in 1994 were $51.6 million. Costs charged to operating expense include ongoing administration and maintenance activities at operating facilities, and reserves associated with site remediation at current operating facilities, former operating facilities, and off-premises waste disposal sites.\nTotal environmental cash expenditures at the Company's operating locations are expected to increase over the next several years as the Company complies with present and future regulatory requirements. These costs are likely to be substantial, and will be incurred over an extended period of time. Estimated capital expenditures for 1995 related to environmental matters are $19.3 million.\nThe Company has been advised it may be a Potentially Responsible Party (PRP) at 19 Federal Superfund sites and one state Superfund site. Due to the number of PRPs involved at most sites, the number of possible remedial solutions, the number of years of remedial activity required, and the evolutionary nature of the technology involved, the Company is unable to assess and quantify the extent of its responsibilities at the majority of the sites.\nThe Company and Cos-Mar, a joint venture for which the Company acts as operator, have been named as potentially responsible parties for a Superfund site, the Brio site, in Harris County, Texas. The Company and Cos-Mar, along with other potentially responsible parties, have signed a consent decree with the EPA, agreeing to treat or remove certain hazardous substances. FOCC's share of the cleanup costs, both individually and as 50% owner of Cos-Mar, is $395,000.\nThe EPA has listed the hazardous waste disposal area of a refinery located in El Dorado, Kansas, as a Superfund site. As a former owner of the site, the Company would be liable for 65% of the clean-up cost which is currently estimated to be $4,170,000. The Company signed a consent order with the State of Kansas and the present owner of the site which recommends cleanup alternatives. The State of Kansas and the EPA have approved a clean-up plan for surface impoundments at the site and remediation began in late 1994.\nIn response to an Administrative Order from the Texas Natural Resources Conservation Commission to 9 PRPs, the Company agreed to conduct an investigation of a closed refinery located near Colorado City, Texas. The other named PRP's have appealed the order. A comprehensive investigation of the site is now underway. The Company also operates a hydrocarbon abatement system, which captures contaminated groundwater before it reaches the Colorado River.\nA hazardous waste operating permit issued to the Big Spring refinery requires an investigation of the sources of soil and groundwater contamination at the site. An environmental assessment of inactive waste management units is ongoing, and widespread on site and off site groundwater contamination has been confirmed. The Company has taken action to define the extent of contamination and has initiated interim groundwater recovery. The design of a full-scale groundwater collection and treatment system is nearing completion.\nDiscussions are also ongoing with governmental agencies regarding the scope of investigation and remediation activities at operating and inactive locations. Although the level of future expenditures for environmental matters, including cleanup obligations, is impossible to determine with any degree of certainty, it is management's opinion that the costs, although potentially significant to any one accounting period, when finally determined will not have a materially adverse effect on the financial position or liquidity of the Company.\nCAPITAL RESOURCES AND LIQUIDITY\nThe Company's cash liquidity requirements for working capital, capital expenditures, acquisitions and debt reductions over the past three years were financed primarily by a combination of funds generated from operations, borrowings and dispositions of assets.\nThe Company had working capital of $115.7 million at December 31, 1994 and $164.9 million at December 31, 1993. Excluding short term obligations and the current portion of total debt, working capital increased from 1993 by $24.5 million.\nCash flow from operations was $275.4 million in 1994, $378.3 million in 1993 and $119.3 million in 1992. The 1994 cash flow from operations decreased primarily because of an increase in inventories and accounts receivable. The 1993 cash flow from operations increased primarily because of substantial decreases in inventories, and accounts receivable, including an $80 million sale of accounts receivable during 1993. Cash flow in 1992 decreased because of lower earnings and changes in various working capital components.\nDuring 1994, the Company furthered its debt reduction plan and, as a result, total debt at year-end 1994 was reduced to $650 million from a level of $1.24 billion during the first quarter of 1993. Debt was reduced primarily with proceeds from the sale of assets and funds from operations. The majority stockholder of the Company has not been the principal lender in the past two fiscal years.\nIn 1993, the Company entered into long-term note agreements with certain insurance companies that provided for unsecured borrowings aggregating $275 million under Series A, Series B, and Series C Senior Notes. Proceeds from these notes were used to repay other debt.\nThe Company had an unsecured revolving credit facility with a group of banks in the amount of $450 million at December 31, 1993. Under the facility, the Company has available credit in an amended amount of $400 million through May 2000. No borrowings were outstanding under this facility at December 31, 1994.\nThe Company paid dividends of $3.60 per share in 1994 and $3.20 per share in 1993 and 1992.\nThe Company believes that cash provided by operations, together with borrowings available under the revolving credit facility with banks, will be sufficient to fund the Company's working capital requirements, capital expenditures, principal, interest and dividends.\nCapital Expenditures\n- ---------------\n(1) Includes a $32 million non-cash item.\n1994 capital expenditures were 9% above 1993. Projected capital expenditures in 1995 are $215 million.\nIMPACT OF INFLATION AND CHANGING PRICES\nThe business of the Company is not seasonal but is sensitive to crude oil and natural gas pricing, margins between crude oil and refined products, and chemical margins. Inflation impacts the Company by increasing costs of labor and supplies, and increasing costs of acquiring and replacing property, plant and equipment. The replacement cost of property, plant and equipment is generally greater than the historical cost as a result of inflation.\nMarket conditions continue to be the primary factor in determining the prices and costs of Company products.\nMANAGEMENT RESPONSIBILITY FOR CONSOLIDATED FINANCIAL STATEMENTS\nThe management of FINA, Inc. is responsible for the financial information and representations contained in the Consolidated Financial Statements and other sections of this Annual Report on Form 10-K. The Company believes that the financial statements fairly reflect the substance of its transactions and present its consolidated financial position and results of operations in conformity with generally accepted accounting principles. In preparing the Consolidated Financial Statements, the Company is required to include amounts that are based on estimates and judgments which the Company believes are reasonable under the circumstances.\nThe Company has developed and maintains a system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded from loss or unauthorized use and that transactions are properly recorded. In establishing and maintaining internal controls, management must exercise judgment in determining that the cost of such controls does not exceed the benefits to be derived.\nThe Board of Directors exercises its oversight role for the Consolidated Financial Statements through its Audit Committee, which is composed solely of directors who are not officers or employees of the Company. The Audit Committee meets with Company management, internal auditors, and the independent auditors to review the audit scope and any recommendations for improvements in the Company's internal accounting controls. The independent auditors are engaged to provide an objective, independent view of the fairness of reported operating results and financial condition.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFINA, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nAll other schedules are omitted as the required information is inapplicable or presented in the consolidated financial statements or related notes.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders FINA, Inc.:\nWe have audited the consolidated financial statements of FINA, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the consolidated financial statement schedule as listed in the accompanying index. 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 FINA, 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 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 7 to the consolidated financial statements, 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\" in 1992.\nKPMG Peat Marwick LLP\nDallas, Texas January 27, 1995\nFINA, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)\nASSETS\nSee accompanying notes to consolidated financial statements.\nFINA, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS THREE YEARS ENDED DECEMBER 31, 1994 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nFINA, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1994 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nFINA, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1994 (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1994\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) GENERAL\nFINA, Inc. and subsidiaries (the Company) is engaged in crude oil and natural gas exploration and production and natural gas marketing; petroleum products refining, supply and transportation and marketing; and chemicals manufacturing and marketing. Most of the Company's customers are located in the United States. Raw materials are readily available and the Company is not dependent upon a single supplier or a few suppliers.\nClass A and Class B common stock are identical in all respects except Class B stockholders elect one more than a majority of the members of the Board of Directors of the Company. Class A stockholders are entitled to elect the remaining members of the Board of Directors. Petrofina Delaware, Incorporated (PDI) owns 100% of the Class B common stock and approximately 85% of the Class A common stock. Petrofina S.A. (Petrofina), a Belgian publicly-held corporation, owns 100% of American Petrofina Holding Company which owns 75% of the stock of PDI. The remaining 25% of PDI's stock is owned by Petrofina.\n(B) PRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and all of its significant subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\n(C) STATEMENTS OF CASH FLOWS\nFor purposes of reporting cash flows, all certificates of deposit and short term highly liquid debt instruments, such as U.S. Treasury bills and notes, with original maturities of three months or less are considered cash equivalents.\nThe indirect method is used to present cash flows from operating activities. Additional cash flow information follows:\nCapital lease obligations of $27,548,000 in 1994 and $26,501,000 in 1993 were converted into debt as a result of termination of time charters relating to tankers.\nIn connection with the exchange discussed in note 6, the Company transferred nonmonetary assets with an estimated fair value of $32,000,000 in 1992.\n(D) INVESTMENTS IN AFFILIATES\nInvestments in affiliates in which the Company owns between 20% and 50% of the voting stock are carried at amortized cost adjusted for changes in equity since acquisition.\n(E) INVENTORIES\nCrude oil and refined products and chemicals are priced at the lower of cost (last-in, first-out) (LIFO) or market on an aggregate basis. Materials and supplies are priced at average cost, not in excess of market; in the case of material salvaged, an allowance is made for obsolescence and depreciation. Because of price declines in crude oil and refined products in 1993, a valuation reserve of $47,048,000 was established to reduce the LIFO cost of inventory to net realizable value. As prices increased in 1994 the valuation reserve was eliminated. The\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nexcess of replacement cost of crude oil and refined products and chemicals over LIFO cost was $8,262,000 at December 31, 1994.\nDuring 1994, certain inventory quantities were reduced, resulting in liquidations of LIFO inventory which decreased pretax earnings by approximately $5,600,000.\nA summary of inventories follows:\n(F) PROPERTY, PLANT AND EQUIPMENT\nOil and gas properties are accounted for in accordance with Statement of Financial Accounting Standards No. 19. Costs to acquire mineral interests in oil and gas properties, to drill exploratory wells that find proved reserves and to drill and equip development wells are capitalized. Geological and geophysical costs and costs to drill exploratory wells that do not find proved reserves are expensed.\nUnproved oil and gas properties that are individually significant are periodically assessed for impairment of value and, if necessary, a loss is recognized by providing an impairment allowance. The remaining unproved oil and gas properties are aggregated and an overall impairment allowance is provided based on prior experience. Capitalized costs of proved oil and gas properties are depreciated and depleted by the unit-of-production method based on proved oil and gas reserves estimated by Company engineers.\nSubstantially all other property, plant and equipment is depreciated by the straight-line method at rates based on the estimated useful lives of the classes of property.\nInterest is capitalized as a component of the cost of construction and development projects in progress.\nRepairs and maintenance are charged to earnings as incurred. Renewals and betterments are capitalized. When assets are sold, retired or otherwise disposed of, the applicable costs and reserves are removed from the accounts and the resulting gain or loss is recognized.\n(G) RESEARCH AND DEVELOPMENT\nResearch and development costs, which are expensed as incurred, amounted to $12,932,000 in 1994, $12,233,000 in 1993 and $11,298,000 in 1992.\n(H) INCOME TAXES\nThe Company files a consolidated Federal income tax return with PDI and its affiliates. Under the terms of the tax sharing agreement with PDI, the Company is allocated Federal income taxes on a separate return basis.\nEffective January 1, 1992, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109 (Statement 109), \"Accounting for Income Taxes.\" The effect of adopting Statement 109 was not material.\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(I) EARNINGS PER COMMON SHARE\nEarnings per common share is based on the weighted average number of outstanding shares. Shares issuable upon the exercise of stock options are excluded from the computation since their effect is insignificant.\n(J) FINANCIAL INSTRUMENTS\nInterest rate swap agreements are used to help manage interest rate exposure. The differential to be paid or received under these agreements is accrued as interest rates change and is recognized over the life of the agreements.\nThe Company uses futures contracts and forward purchase commitments to reduce its exposure to fluctuations in the prices of crude oil and natural gas. The Company hedges crude oil purchase and sales commitments, firm natural gas purchase and sales commitments and anticipated crude oil purchases. Gains and losses related to qualifying hedges of firm commitments or anticipated transactions are deferred and recognized in income when the hedged transaction occurs.\nThe Company enters into agreements with institutions of high credit quality; therefore the risk of nonperformance by counterparties is considered to be negligible.\n(K) RECLASSIFICATIONS\nCertain previously reported financial information has been reclassified to conform to the 1994 presentation.\n(2) PROPERTY, PLANT AND EQUIPMENT\nA summary of property, plant and equipment follows:\nProperty, plant and equipment includes capitalized lease obligations of $4,653,000 and $69,364,000 and related accumulated depreciation of $3,866,000 and $67,943,000 at December 31, 1994 and 1993.\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(3) CURRENT AND LONG TERM DEBT\nShort term obligations due to various banks were $27,000,000 and $33,000,000, at December 31, 1994 and 1993 and bear interest at weighted average rates of 6.15% and 3.4%, respectively. Short term obligations due to PDI were $55,000,000 at December 31, 1994, and bear interest at 6.18% as to $5 million, 6.20% as to $25 million and 6.30% as to $25 million.\nA summary of long term debt follows:\nThe Company has a $400,000,000 revolving bank credit facility through May 2000 (no borrowings were outstanding under the facility at December 31, 1994 or 1993) and a $150,000,000 credit facility with PDI through 1997. The Company intends to use borrowings under these facilities to finance the repayment of $25,000,000 of short term obligations due to various banks and the $75,000,000 note bearing interest at 6.01% to PDI, and has classified these borrowings as long term debt at December 31, 1994. Borrowings under the credit facilities bear interest at various market rate options.\nThe Senior Notes, a note payable to a bank, the bank revolving credit facility and the PDI loan agreements contain provisions that limit sales of assets and mergers, limit the incurrence of indebtedness and restrict payments to stockholders. No material amounts of long term debt are collateralized by Company assets.\nLetters of credit are maintained with various banks, aggregating $28,956,000 at December 31, 1994; principally for pollution control and worker's compensation obligations.\nInterest rate swap agreements, which expire at various dates through 2003, effectively convert an aggregate principal amount of $155,000,000 of fixed rate long term debt into variable rate borrowings. Under these agreements, interest is paid at variable market rates, and interest is received at fixed rates. At December 31, 1994 and 1993, the weighted average variable interest rate under these agreements was 6.19% and 3.41%. The estimated fair value of these agreements (based on current market rates) approximated a net payable of $9,898,000 at December 31, 1994 and a net receivable of $4,032,000 at December 31, 1993. Exposure to credit loss is only when the fair value of the agreement is a net receivable.\nThe outstanding borrowings due to PDI and various banks bear interest at current market rates and thus, the carrying amount of debt approximates estimated fair value. The estimated fair value of the debt instruments that bear interest at fixed rates was $348,000,000 ($379,000,000 carrying value) at December 31, 1994, and approximated the carrying amount of these instruments at December 31, 1993.\nThe aggregate maturities of long term debt and capitalized lease obligations for the five years ending December 31, 1999 are as follows: 1995 -- $61,014,000; 1996 -- $109,825,000; 1997 -- $135,710,000; 1998 -- $62,008,000; and 1999 -- $53,705,000.\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(4) INCOME TAXES\nActual income tax expense (benefit) differs from the \"normal\" income tax expense at U.S. statutory rates as follows:\nThe tax effects of the primary temporary differences giving rise to the deferred Federal income tax assets and liabilities as determined under Statement 109 are as follows:\nAt December 31, 1994, alternative minimum tax credit carryforwards of approximately $59,943,000 are available to reduce future Federal regular income taxes payable over an indefinite period.\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(5) EMPLOYEE STOCK OPTIONS\nOptions to purchase shares of Class A common stock have been granted to officers and employees under a stock option plan adopted in 1979. The stock option plan expired in 1989, and no further grants will be made under that plan. A summary of transactions follows:\nThe option price for options granted is the market value at date of grant. Each option granted may be exercised in cumulative annual installments of one-third of grant upon completion of two years of continued employment and expires ten years from date of grant. No amounts are recorded until options are exercised, at which time proceeds in excess of the par value of the shares are credited to additional paid-in capital.\n(6) INVESTMENTS IN JOINT VENTURES\nThe Company had 25.85% ownership interest in two joint ventures engaged primarily in the production and worldwide marketing of terephthalates, the basic raw materials for polyesters, which were accounted for by the equity method. In August 1992, the Company exchanged its 25.85% interest in one of the joint ventures and $53,983,000 in cash for a high density polyethylene plant and related working capital of $24,820,000. A gain of $6,373,000 was recognized based on the fair value of the assets exchanged. Investments in and advances to the joint venture were $2,105,000 and $2,804,000 at December 31, 1994 and 1993 and equity in earnings of the joint ventures was $76,000 in 1994, $33,000 in 1993 and $3,271,000 in 1992. The Company sold chemicals aggregating $16,444,000 in 1992 to an affiliate of one of the joint ventures.\nThe Company and GE Plastics, a wholly owned subsidiary of General Electric Company (GE), are joint venturers in Cos-Mar Company, a chemical operation. The Company's interest is 50% and is accounted for by the equity method. The venturers reimburse the joint venture for the costs of operating the facility and raw material and finished product inventories are the property of the venturers. Direct operating expenses include charges from the joint venture of $16,011,000 in 1994, $15,990,000 in 1993 and $16,411,000 in 1992. Investments in and advances to the joint venture were $8,829,000 and $21,379,000 at December 31, 1994 and 1993. The Company has guaranteed the joint venture's borrowings from a bank, which aggregated $40,000,000 at December 31, 1994. GE has guaranteed the joint venture's borrowings from a bank, which aggregated $74,200,000 at December 31, 1994.\n(7) EMPLOYEE AND POST RETIREMENT BENEFITS\nThe Company and its subsidiaries have two defined benefit pension plans covering substantially all employees. The benefits are based on years of service and the employee's final average monthly compensation. The Company's funding policy is to contribute annually not less than the minimum required nor more than 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.\nA restoration benefit plan provides supplemental pension benefits to certain participants whose benefits are limited by the defined benefit pension plans. The funding policy is to contribute annually amounts equal to benefit payments made.\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nA summary of the plans' funded status and the amounts recognized in the consolidated balance sheets follows:\nA summary of the components of pension expense (income) follows:\nThe weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 8.75% and 4.5%, respectively, as of December 31, 1994, and 7.5% and 4.5%, respectively, as of December 31, 1993 and 9% and 6%, respectively, as of December 31, 1992. The expected long term rate of return on assets was 11% for 1994, 1993\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nand 1992. The effect on the projected benefit obligation of these changes was a decrease of approximately $24,100,000 in 1994 and an increase of approximately $14,800,000 in 1993.\nIn addition to providing pension benefits, certain health care and life insurance benefits are provided to active and retired employees. During 1994, substantially all covered employees were eligible for those benefits after they reach normal retirement age. The health care benefits in excess of certain limits and the life insurance benefits are insured. The cost of providing these benefits for active employees are expensed when the insurance premiums and claims as paid. The cost of providing these benefits for active employees was $10,092,000 in 1994, $11,219,000 in 1993 and $12,055,000 in 1992.\nEffective January 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 106 \"Employers' Accounting for Postretirement Benefits Other than Pensions\" (Statement 106). The effect of adopting Statement 106 for the year ended December 31, 1992 was to increase net periodic postretirement benefit cost by $1,500,000, decrease earnings before cumulative effect of accounting change by $990,000 ($.06 per share) and increase net loss by $35,310,000 ($2.26 per share).\nA summary of the postretirement plan's funded status and the amounts recognized in the consolidated balance sheets follows:\nA summary of the components of net periodic postretirement benefit cost follows:\nFor measurement purposes, an 8.67% and 7.50% weighted average annual rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) for pre-65 and post-65 years of age, respectively, was assumed for 1995; the rate was assumed to decrease gradually to 5% by the year 2002 and remain at that level thereafter. A 10.13% and 9.23% annual rate for pre-65 and post-65 years of age, respectively, was assumed for 1994. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1994 by $3,653,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1994 by $439,000.\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8.75%, 7.5% and 9% at December 31, 1994, 1993 and 1992. The effect on the accumulated benefit obligation of these changes was a decrease of $11,665,000 in 1994 and an increase of $10,600,000 in 1993.\nDefined contribution retirement savings plans (Thrift Plans) are available to substantially all employees. The Thrift Plans permit employees to elect salary deferral contributions of up to 10% of their compensation on a tax-deferred basis and requires the Company to match up to the first 6% of the participants' compensation. The expense for the Company's contribution was $5,963,000 in 1994, $6,007,000 in 1993 and $5,883,000 in 1992.\n(8) SALE OF ACCOUNTS AND NOTES RECEIVABLE\nCertain accounts and notes receivable were sold with recourse. At December 31, 1994, and 1993, $80,000,000 of accounts receivable and $32,100,000 and $34,300,000, respectively, of notes receivable sold were outstanding under these agreements. The Company remains obligated to reimburse the purchasers for or repurchase any uncollectible amounts pursuant to the recourse provisions of the agreements.\n(9) LEASES\nThe Company occupies certain marketing and manufacturing facilities and uses certain equipment under leases expiring at various dates over the next 20 years. Under terms of certain lease agreements, the Company has agreed not to mortgage certain of its interests in oil and gas properties.\nAt December 31, 1994, minimum lease payments on capital and operating leases were as follows:\n- ---------------\n(i) Substantially all leases provide that the Company shall pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased properties. The Company terminated tanker leases in 1993 and 1994.\n(ii) Minimum payments have not been reduced by minimum sublease rentals of approximately $3,164,000 which are due in the future under noncancellable subleases.\n(iii) Presented in the consolidated balance sheets as current installments and noncurrent lease obligations of $818,000 and $986,000 and $6,493,000 and $26,418,000 at December 31, 1994 and 1993.\nTotal rental expense was $26,962,000 (net of $1,191,000 subleases) in 1994, $32,749,000 (net of $1,345,000 subleases) in 1993 and $29,944,000 (net of $1,372,000 subleases) in 1992. Contingent rentals were not significant.\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(10) RELATED PARTY TRANSACTIONS\nSales and other operating revenues for 1993 and 1992 include $37,300,000 and $4,000,000, respectively, of reimbursements from business interruption and property damage insurance resulting from operating problems in 1992 at the Port Arthur refinery and a fire at the Big Spring refinery in 1993. The Company's insurance provider on these claims is a wholly-owned subsidiary of Petrofina.\nThe Company has a 50% interest in joint ventures with PDI in Texas and with Petrofina in Hong Kong which market chemicals in international trade. The Company sold chemicals aggregating $1,401,000 in 1994, $985,000 in 1993 and $6,447,000 in 1992 to the joint ventures.\nAccounts receivable include $10,719,000 and $3,996,000 at December 31, 1994 and 1993, respectively, from affiliates.\nAccounts payable include $6,539,000 and $8,817,000 at December 31, 1994 and 1993, respectively, to affiliates.\nDuring 1994 the Company assumed a $50,000,000 note from PDI payable to a bank in 1995. Interest expense relating to borrowings from PDI (see note 3) was $13,916,000 in 1994, $28,565,000 in 1993 and $48,127,000 in 1992. Accrued liabilities include accrued interest of $791,000 and $3,580,000 at December 31, 1994 and 1993, respectively, which is payable to PDI for such borrowings.\nCrude oil and natural gas aggregating $16,626,000 in 1994, $21,145,000 in 1993 and $8,879,000 in 1992 were purchased from PDI in the ordinary course of business.\nRefined products and chemicals aggregating $34,963,000 in 1994, $50,992,000 in 1993 and $56,997,000 in 1992 were purchased from Petrofina and its affiliates other than PDI in the ordinary course of business.\n(11) CONTINGENCIES\nThe Company was contingently liable at December 31, 1994, under pending lawsuits and other claims, some of which involved substantial sums. Considering certain liabilities that have been set up for the lawsuits and claims, and the difficulty in determining the ultimate liability in some of these matters, internal counsel is of the opinion that the amounts, if any, that ultimately might be due in connection with such lawsuits and claims would not have a material adverse effect upon the Company's consolidated financial condition.\nThe Company is subject to extensive Federal, state and local environmental laws and regulations. These regulations, which are constantly changing, 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 or chemical substances at various sites. Such contingencies may exist for various sites including, but not limited to: Superfund Sites for which the Company has been named as a potentially responsible party, operating and closed refineries, chemical facilities, oil fields, service stations, terminals and land development areas. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefit are expensed. Liabilities for expenditures of a noncapital nature are recorded when environmental assessment and\/or remediation is probable, and the costs can be reasonably estimated. The level of future expenditures for environmental matters, including cleanup obligations, is impossible to determine with any degree of probability. Although potentially significant with respect to results of operations for any one accounting period, management believes that such costs will not have a material adverse effect on liquidity or financial position.\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(12) SEGMENT DATA\nThe Company is engaged in crude oil and natural gas exploration and production and natural gas marketing; petroleum products refining, supply and transportation and marketing; and chemicals manufacturing and marketing. Segment data as of and for the three years ended December 31, 1994 follows (in thousands):\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFINA, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nConsolidated totals are after elimination of inter-segment amounts. Operating profit (loss) is sales less operating expenses and is substantially all derived from domestic operations. Identifiable assets are those assets that are used in the operations in each business segment.\nMost customers are located in the South and Midwest regions of the United States. No single customer accounted for more than 5% of sales in 1994, 1993 or 1992, and no account receivable from any customer exceeded 5% of consolidated stockholders' equity at December 31, 1994, 1993 or 1992.\n(13) QUARTERLY FINANCIAL DATA (UNAUDITED)\nGross profit is defined as sales and other operating revenues less cost of raw materials and products purchased; direct operating expenses; taxes, other than on income; and depreciation, depletion, amortization and lease impairment.\nFINA, INC. AND SUBSIDIARIES\nSUPPLEMENTAL OIL AND GAS DATA\nSUPPLEMENTAL OIL AND GAS DATA (UNAUDITED)\nThe following tables set forth supplementary disclosures for oil and gas producing activities in accordance with Statement of Financial Accounting Standards No. 69.\n(A) CAPITALIZED COSTS\nCapitalized costs relating to oil and gas producing activities and the related amounts of accumulated depreciation, depletion, amortization and lease impairment follow:\n(B) COSTS INCURRED\nA summary of costs incurred in oil and gas property acquisition, exploration and development activities (both capitalized and charged to expense) for the three years ended December 31, 1994 follows:\nThe above costs were incurred in the United States.\nFINA, INC. AND SUBSIDIARIES\nSUPPLEMENTAL OIL AND GAS DATA -- (CONTINUED)\n(C) RESULTS OF OPERATIONS FOR PRODUCING ACTIVITIES\nThe following table presents the results of operations for oil and gas producing activities for the three years ended December 31, 1994.\n(D) RESERVE QUANTITY INFORMATION\nThe following table presents the Company's estimate of its proved oil and gas reserves, all of which are located in the United States. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise than those of producing oil and gas properties. Accordingly, the estimates are expected to change as future information becomes available. The estimates have been prepared by the Company's internal petroleum reservoir engineers.\nOil reserves, which include condensate and natural gas liquids, are stated in thousands of barrels and gas reserves are stated in millions of cubic feet.\nFINA, INC. AND SUBSIDIARIES\nSUPPLEMENTAL OIL AND GAS DATA -- (CONTINUED)\n(E) STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS AND CHANGES THEREIN RELATING TO PROVED OIL AND GAS RESERVES\nThe following table, which presents a standardized measure of discounted future net cash flows and changes therein relating to proved oil and gas reserves, is presented pursuant to Statement of Financial Accounting Standards No. 69. In computing this data, assumptions other than those required by the Financial Accounting Standards Board could produce different results. Accordingly, the data should not be construed as representative of the fair market value of the Company's proved oil and gas reserves.\nFuture cash inflows were computed by applying year end prices of oil and gas relating to proved reserves to the estimated year end quantities of those reserves. Future price changes were considered only to the extent provided by contractual arrangements in existence at year end. Future development and production 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. Future income tax expenses were computed by applying the year end statutory tax rate adjusted for tax credits, with consideration of future tax rates already legislated, to the future pretax net cash flows relating to proved oil and gas reserves, less the tax basis of the properties involved. The standardized measure of discounted future cash flows represents the present value of estimated future net cash flows using a discount rate of 10% a year.\nSCHEDULE VIII\nFINA, INC. AND SUBSIDIARIES\nCONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 1994 (IN THOUSANDS)\n- ---------------\n(1) Bad debts written off, less recoveries.\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no changes in accountants or disagreements by the Registrant with its accountants on accounting or financial disclosures.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThere is incorporated by reference pages 3 through 6 of the Company's Proxy Statement for the Annual Meeting of Security Holders to be held April 12, 1995.\nITEM 11","section_11":"ITEM 11 EXECUTIVE COMPENSATION\nThere is incorporated by reference pages 2 through 3 and 8 through 13 of the Company's Proxy Statement for the Annual Meeting of Security Holders to be held April 12, 1995.\nITEM 12","section_12":"ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThere is incorporated by reference the first page and pages 2 through 5 of the Proxy Statement for the Annual Meeting of Security Holders to be held April 12, 1995.\nITEM 13","section_13":"ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere is incorporated by reference pages 4 through 5, 12 and 18 of the Company's Proxy Statement for the Annual Meeting of Security Holders to be held April 12, 1995.\nPART IV\nITEM 14","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following are incorporated by reference or filed as part of this Annual Report:\n1. and 2. Consolidated Financial Statements and Schedules:\nReference is made to page 14 of this Form 10-K for a list of all consolidated financial statements and schedules filed as part of this Form 10-K.\n3. Exhibits:\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFINA, Inc. (Registrant)\nBy: \/s\/ CULLEN M. GODFREY Cullen M. Godfrey, Vice President, Secretary and General Counsel\nDate: March 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.\nEXHIBIT INDEX","section_15":""}
{"filename":"710983_1994.txt","cik":"710983","year":"1994","section_1":"ITEM 1. BUSINESS.\nGeneral\nThe Registrant designs and manufactures intelligent controllers which enhance the graphics capabilities and performance of computer printing and imaging systems. The Registrant incorporates its controllers, which consist of software implemented on printed circuit boards, into computer printing and imaging systems which it markets, sells and supports. The Registrant also markets its controllers separately for incorporation into products marketed by others.\nThe Registrant was incorporated under the laws of the State of Alabama in 1977 and reincorporated as a Delaware corporation in 1982. Its principal executive offices are located at One Magnum Pass, Mobile, Alabama 36625, (205) 633-4300. Effective January 15, 1995 the telephone number will change to (334) 633-4300.\nProducts1\nThe Registrant's principal products are intelligent nonimpact print systems consisting of purchased print engines, proprietary hardware and software, proprietary intelligent printer-to-computer interfaces and other components. The Registrant also designs, markets and supports intelligent raster image processors implemented as either proprietary software or hardware; proprietary intelligent printer-to-computer interfaces to enable printers marketed by others to perform specialized publishing applications; intelligent processors with proprietary hardware, software and intelligent printer-to-computer interfaces to enable impact printers marketed by others to produce graphics such as labels and bar codes used in the automatic identification market segment; and intelligent processors with proprietary hardware, software and intelligent interfaces to perform specialized office functions including printing, copying, scanning and faxing.\nThe majority of the Registrant's products support the functionality of Adobe Systems Incorporated's PostScript page description language, and Hewlett Packard's PCL(R) page description language. The Registrant offers products with PostScript Level 1 from Adobe as well as products with UltraScript(TM), a QMS-developed PostScript interpreter that is compatible with Adobe's PostScript Levels I and II. All but a small number of products that support UltraScript also support the QMS-developed PCL5 page description language.\nThe nonimpact printing products marketed by the Registrant address the printing needs of customers in electronic publishing, general business, automatic identification, scientific and engineering environments. The Registrant's nonimpact printing products include both color and monochrome printer systems with a variety of speeds, paper-handling and performance characteristics.\nThe Registrant's intelligent processor products are used in impact printers for interfacing and industrial graphics applications and in nonimpact printers for electronic publishing and document-processing applications.\nThe Registrant also markets accessories, add-ons and software for use with its nonimpact printing systems and offers spare parts, fonts, consumables, maintenance services and other support for its products.\nThe majority of the Registrant's new product offerings during fiscal 1994 were based on the Registrant's Crown advanced document-processing technology, which provides a combination of high-performance capabilities. RISC (Reduced Instruction Set Computing) processors, support for multiple page description languages, simultaneously active computer and network interfaces, and the ability to differentiate the resident languages supported by a product and switch between them without user intervention are among the features Crown technology provides.\nDuring fiscal 1994, the Registrant enhanced its product line by introducing print systems with capabilities to support simultaneous network connectivity to multiple protocol stacks. This capability, called QMS CrownNet(TM), is a line of adapter cards and software which enhances the entire Crown product line with additional connectivity in the IBM OS\/2 marketplace and significantly enhances its support in the Novell Netware arena. It also provides superior performance to several other network options.\nThree new monochrome printers were introduced which utilize Crown technology. Two of the monochrome printers use hardware architectures which revolve around the Registrant's first set of highly integrated ASIC technology designs. These ASICs provide considerable space and power savings over earlier designs that afforded the Registrant the ability to introduce a new 10 page per minute (ppm), 600 dot per inch (dpi) printer, and to introduce a new 16 ppm, 1200x600 dpi printer with the ability to support supersize page formats. The Registrant also introduced a 38 ppm, 600 dpi monochrome laser print system designed to address the general purpose and high-volume document printing needs of large work groups as well as data processing, on-demand printing and distributed printing applications. All these printers combine the performance, seamless network printing interoperability and software loadable upgradability of Crown with highly advanced paper handling and print capabilities.\nThe Registrant also introduced a new color laser print system which combines the multi-tasking, networking capabilities of Crown technology with the ability to print high quality laser text and graphics at 600x600 dpi in color and black and white. This print system can print on plain paper, on a variety of paper stocks, and on transparencies. In addition, the Registrant introduced a multifunction desktop office system designed to seamlessly integrate common business office communication functions into a single device to improve office productivity.\nMost of the Registrant's products provide high-resolution (600x600 and 1200x600 dots per inch), large format laser printing (monochrome and\/or color), advanced document-handling features, optional network connectivity or a combination of these features.\nSALES AND MARKETING\nThe market for the Registrant's products is related to the market for computer systems generally. Current end users of the Registrant's products include many Fortune 500 companies, governmental agencies and educational institutions. In the United States, the Registrant sells its products primarily through its direct sales channel and through resellers including national and regional distributors and computer dealers.\nAs of September 30, 1994, the Registrant operated direct sales offices in 29 cities in 21 states.\nWholly owned subsidiaries of the Registrant operate in Europe, Canada, Australia and Japan. The Registrant, either directly or through its international network, markets its products in approximately 68 countries outside of the United States.\nThe Registrant's 10 largest customers accounted for an aggregate of approximately 28% of total net sales during fiscal 1994. During fiscal 1994, no single customer accounted for more than 10% of the Registrant's total net sales.\nThe Registrant's products are advertised in the United States and international markets and exhibited at industry trade shows in the United States and internationally under the Registrant's name and under the names of its wholly owned subsidiaries. The Registrant also provides field sales support, including training for customers and resellers, trade show exhibits, sales training and assistance to sales representatives to facilitate sales. The Registrant believes that this support has been well- received by its customers and sales organizations and has assisted the Registrant in the introduction of new products.\nINTERNATIONAL OPERATIONS\nIn fiscal 1992, 1993 and 1994, international sales totaled $103,517,000, $128,782,000 and $135,532,000 respectively, representing approximately 40%, 43% and 46%, respectively, of the Registrant's net sales. The Registrant derives its international sales primarily from Western Europe, Canada, the United Kingdom, Scandinavia, Australia and Japan. To a lesser degree, international sales have been generated in various Far Eastern and Pacific Rim countries (in addition to Japan) and in Central and South America. The Registrant generally invoices customers in their local currency and therefore is exposed to currency translation risks.\nIn terms of the cost of goods sold of components used in the Registrant's products, the Registrant purchases a substantial majority of such components abroad, primarily from Japanese companies. Accordingly, the cost of such components may increase as the value of the United States dollar depreciates relative to the currency of the source country.\nThe financial statements of the Registrant's foreign subsidiaries are affected by foreign currency fluctuations. See Note 1 and Note 13 of Notes to the Registrant's Consolidated Financial Statements. For financial information regarding the Registrant's foreign and domestic operations and export sales, see Note 13 under Item 8 --- Financial Statements and Supplementary Data.\nSERVICE, SUPPORT AND WARRANTY\nThe Registrant provides a high level of technical and software support and maintenance service and support to its end users directly and through distributors, resellers and third party service providers. A staff of engineers and technicians provides systems applications support, field service support and customer training for the use and maintenance of the Registrant's products. In the United States, the Registrant provides technical hardware and software support and maintenance service from its home office in Mobile, Alabama, and from field offices located in 53 cities in 34 states. Technical support is provided via telephone and electronic bulletin boards while a national service organization provides choices of return to depot or factory, on site and special contractual service. Internationally, the Registrant provides technical service in Europe from its office located in Utrecht, the Netherlands, and in Australia and Canada. In Canada, the Registrant provides service through its direct service organization as well as through certain authorized dealers.\nThe Registrant warrants its products for a period of from 90 days to 2 years from the date of shipment, depending on the product. The Registrant's annual warranty costs have not been significant relative to the Registrant's net sales.\nCOMPETITION\nCompetition in the computer printing industry is extremely intense and a number of the Registrant's competitors have far greater financial, technical, marketing and manufacturing resources than the Registrant. Management believes that performance, reliability, versatility of features, product support and price are the primary bases of competition in this market. Further, in some of its markets, the Registrant competes against noncomputerized means of labeling products, such as offset printing. The Registrant would be adversely affected if its competitors successfully marketed products that were technologically superior or significantly lower in price.\nThe Registrant's intelligent print systems are positioned to compete in the low- and medium-speed, nonimpact page printer market. Nonimpact laser printing competes with other technologies in the computer printer market, including inkjet, dye sublimation, ion disposition, magnetic, thermal and impact printers. Companies whose nonimpact printers compete with the Registrant's include Apple Computers Inc., Canon, Inc., Oki Electric Industry Company, Ltd., Digital Equipment Corporation, Hewlett- Packard Company, Lexmark (International Business Machines Corporation), NEC Technologies, Inc., Seiko Epson Corp., Tektronix, Inc. and Xerox Corporation.\nIn addition to selling intelligent print systems for the nonimpact page printer market, the Registrant also markets other products. The Registrant competes against a variety of vendors in the marketing of these other products such as its software raster image processors. Other companies also offer products that have some capabilities which compete with those of certain of the Registrant's MAGNUM series products for impact printers. Many of these competitors are larger companies with greater financial resources than those of the Registrant.\nMANUFACTURING AND QUALITY CONTROL\nThe Registrant assembles its intelligent processors by adding components to printed circuit boards manufactured according to its designs and specifications. Essentially, the Registrant manufactures its products by assembling components and subassemblies manufactured by others. The intelligent processors, which include electronic circuitry and software designed by the Registrant, are tested to assure quality and consistency of production and design.\nMost of the parts, components and subassemblies used in the Registrant's products are available to the Registrant from a variety of sources. When management determines that a particular supplier is sufficiently reliable, however, the Registrant generally chooses to rely on a single source for its requirements in order to ensure a sufficient supply to meet its needs. If the Registrant were required to change its sources of certain of those materials unexpectedly, the Registrant might be adversely affected during the time it would take to negotiate new arrangements with another vendor and to integrate those materials into its production process. See \"Print Engines\" below.\nDuring fiscal 1994, the Registrant performed manufacturing and assembly operations in Mobile, Alabama; Utrecht, the Netherlands; and Utsunomiya, Japan.\nOne of the Registrant's wholly owned subsidiaries manufactures prototype printed circuit boards for the Registrant and for sale to third parties. This subsidiary has provided the Registrant with partial vertical integration in the production of printed circuit boards.\nIn addition to in-house manufacturing, the Registrant routinely contracts with certain vendors to manufacture high-volume, standard products.\nORDER BACKLOG\nOnly firm purchase orders are included in the Registrant's backlog. Backlog generally is deliverable within 12 months from the date of the purchase orders. As of October 1, 1993 and September 30, 1994, backlog consisted of orders to purchase worth $13,045,000 and $8,577,000, respectively, of QMS products and services. These figures include orders generated by the Registrant's international operations. The Registrant expects to fill all of the September 30, 1994 backlog during fiscal 1995.\nThe Registrant does not believe that sales of its products are subject to significant seasonal fluctuations.\nThe Registrant attempts to maintain adequate finished goods inventory to ship goods off the shelf whenever possible. Because a substantial portion of the sales in any given month historically has been derived from new orders received during the month, backlog is not necessarily an accurate indicator of future revenues.\nPRINT ENGINES\nThe Registrant purchases substantially all of the print engines for its products from third-party manufacturers. The Registrant has agreements to purchase print engines for its products from Canon U.S.A., Inc. and Mitsubishi Electronics America, Inc. The Registrant also purchases print engines from other vendors, including Ricoh Company, Ltd., Hitachi America, Ltd., Minolta Co., Ltd., and Oce'-Nederland B.V. While other sources are available, the Registrant currently relies on these suppliers' abilities to make print engines available as needed by the Registrant. Some of these print engines are supplied to the Registrant pursuant to the terms of contracts entered into which specify prices to be paid for each print engine depending upon the annual volume of print engines purchased from that manufacturer. Certain of the Registrant's supply contracts with foreign manufacturing sources are subject to adjustment for exchange rate fluctuations.\nThe Registrant believes that its requirements for print engines for fiscal 1995 will be adequately met under the terms of existing arrangements and those expected to be entered into in fiscal 1995. The Registrant has some flexibility to adjust delivery schedules and quantities as demand for specific print engines changes as a result of changes in product mix and customer demand. Although print engines are available from a variety of sources, most of the Registrant's print engines are supplied by Canon U.S.A., Inc. Consequently, disruption of the Registrant's contracts with this supplier would adversely affect the Registrant during the time required to negotiate new arrangements with a different print engine supplier or suppliers and to bring the new product to market.\nRESEARCH AND DEVELOPMENT\nThe Registrant's research and development program examines new technologies as they relate to current product offerings, develops new and improved applications for the Registrant's products and provides insights into new directions for the Registrant's business.\nThe Registrant places significant emphasis on the addition of new features for its nonimpact print systems and enhancement of these systems to satisfy new applications. The Registrant solicits and receives continuing advice from its end users and various resellers in identifying appropriate additions. To augment in-house development efforts, the Registrant also contracts with third parties to develop products to its specifications or to license applications and other software. In addition, the Registrant assists certain software design firms in adapting their existing software for use with the Registrant's products.\nAs of September 30, 1994, approximately 13% of the Registrant's employees were employed in its research and development department. During fiscal 1992, 1993 and 1994, the Registrant spent approximately $16,987,000, $17,810,000 and $15,960,000, respectively, for research and development and software costs and received no customer-sponsored expenditures for research and development. In fiscal years 1992, 1993 and 1994, approximately $6,102,000, $8,803,000 and $7,056,000, respectively, of the software costs for those fiscal years were capitalized in accordance with Financial Accounting Standards (FAS) Statement No. 86.\nPATENTS AND TRADEMARKS\nThe Registrant currently holds United States patents on certain of its products; however, most of the Registrant's revenue is derived from products for which there is no patent protection. Because of rapid technological changes in the computer industry in general and in the electronic printing industry in particular, the Registrant does not believe that patents offer a significant degree of protection for most products and technological advances. The Registrant's strategy for maintaining its competitive position is to continue to emphasize product research and development, coupled with a high level of customer support.\nThe Registrant has obtained registration of many of its trademarks and currently has applications pending on others in the United States and other countries.\nENVIRONMENTAL MATTERS\nManagement believes the Registrant is in compliance in all material respects with applicable federal, state and local statutes and ordinances regulating the discharge of materials into the environment. Management does not believe the Registrant will be required to expend any material amounts in order to remain in compliance with these laws and regulations or that compliance will materially affect its capital expenditures, earnings or competitive position.\nEMPLOYEES\nAs of September 30, 1994, the Registrant employed 1,130 permanent employees in the United States. The Registrant has four foreign operating subsidiaries employing an aggregate of 255 permanent employees: QMS Europe B.V., with sales and support organizations in the Netherlands and in offices in Germany, France, the United Kingdom and Sweden, employing a total of 110 permanent employees; QMS Canada, Inc., with sales and support organizations in Ontario, Quebec, British Columbia and Alberta, employing a total of 80 permanent employees; QMS Australia, with sales and support organizations in Melbourne and Sydney, employing a total of 22 permanent employees; and QMS Japan, Inc., with sales and support organizations in Tokyo and Utsunomiya, employing a total of 43 permanent employees.\nManagement believes that much of its future success depends on its ability to attract and retain skilled personnel. The Registrant has implemented a Cash or Deferred Retirement Plan and maintains stock option plans for officers and key employees.\nThe Registrant's employees are not subject to collective bargaining agreements and there have been no work stoppages due to labor difficulties. Management of the Registrant believes that its relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Registrant's headquarters facilities cover an aggregate of 117,000 square feet, of which 50,000 square feet are used for product research and development. The Registrant's primary manufacturing and warehousing facility covers 152,000 square feet. Both of these facilities are located on 20 of the 77 acres owned by the Registrant in Mobile, Alabama. The Registrant rents approximately 40,000 additional square feet of warehousing and office space in the Mobile area.\nIn Fort Walton Beach, Florida, one of the Registrant's subsidiaries owns and operates a 35,000 square foot facility on ten acres of land. The Registrant and its other subsidiaries lease additional space in United States cities in which the Registrant operates sales and\/or service offices, as well as in France, the Netherlands, Sweden, Germany, the United Kingdom, Canada, Australia, and Japan.\nIn Santa Clara, California, the Registrant has sales, service and engineering operations in a 37,000 square foot leased facility. This facility is occupied under a lease expiring May 31, 1998, with fixed monthly rental payments.\nThe Registrant's properties are utilized approximately five and one- half days per week, with no significant underutilization of facilities. The Registrant believes that its owned and leased properties are sufficient for its current and foreseeable needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Registrant is a defendant in a case styled SHARON L. MCNIDER V. QMS, INC., ET AL. in the Circuit Court of Mobile County, Alabama. The case involves allegations of wrongful conduct by the Registrant and certain officers associated with the plaintiff's fiscal year 1993 incentive compensation plan. An answer has been filed on behalf of the Registrant and the individual defendants denying the allegations of wrongful conduct. The case is currently scheduled for trial before a jury on January 30, 1995. Although the Registrant cannot predict the outcome of a jury trial on this matter, the Registrant does not expect the outcome to have a material impact on the financial condition of the Registrant.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nMARKET PLACE AND DIVIDEND INFORMATION\nThe Company's common stock is listed on the New York Stock Exchange under the ticker symbol \"AQM.\" The table below sets forth the per share quarterly high and low closing prices of QMS common stock for the fiscal years ended September 30, 1994 and October 1, 1993. No cash dividends were declared in either of the last two fiscal years and the Board of Directors has no present intention to pay cash dividends in the foreseeable future. See Note 6 to the Consolidated Financial Statements regarding restrictions on the payment of dividends. There were 1,794 holders of record of the Company's common stock at November 28, 1994.\n1994 1993 Fiscal Quarter High Low High Low\nFirst 11 3\/4 8 5\/8 13 1\/4 7 1\/8 Second 9 7\/8 7 7\/8 16 5\/8 12 1\/8 Third 8 1\/4 7 17 8 1\/4 Fourth 10 3\/4 6 7\/8 9 7\/8 7 3\/4\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nFIVE-YEAR SUMMARY - FINANCIAL AND OTHER DATA\nFor the fiscal years ended September 30, 1994, October 1, 1993, October 2, 1992, September 27, 1991 and September 28, 1990\nDollars in thousands, except per share amounts 1994 1993 1992 1991 1990 Operating results Net sales $292,688 $297,380 $260,691 $304,266 $276,250 Cost of goods sold 196,538 201,804 168,431 192,182 175,598 Marketing and selling 48,812 48,702 42,816 38,897 34,857 Research and develop- ment 8,904 9,018 10,885 9,064 8,449 General and adminis- trative 31,156 39,246 37,983 33,764 30,466 ------ ------ ------ ------ ------ Operating income (loss) 7,278 (1,390) 576 30,359 26,880 Interest income 80 756 468 600 172 Interest expense (3,235) (3,342) (3,037) (3,768) (4,555) Miscellaneous expense (83) (946) (2,384) (211) (720) ------ ------ ------ ------ ------ Income (loss) before income taxes 4,040 (4,922) 4,377 26,980 21,777 Income tax provision (benefit) 1,080 (1,526) (1,444) 8,903 7,223 ------ ------ ------ ------ ------ Net income (loss) $ 2,960 $(3,396) $(2,933) $ 18,077 $ 14,554 ====== ====== ====== ====== ======\nEarnings (loss) per common share Primary $ 0.28 $ (0.31) $ (0.27) $ 1.60 $ 1.33 Fully diluted 0.28 (0.31) (0.27) 1.59 1.33\nWeighted average number of shares used in computing earnings per share: Primary 10,723 10,792 10,994 11,275 10,965 Fully diluted 10,761 10,821 10,994 11,386 10,965\nBalance sheet Total assets $182,023 $170,217 $168,007 $170,226 $168,885 Net working capital 79,390 78,359 73,961 80,907 88,627 Long-term debt obli- gation 35,687 41,527 31,424 21,780 43,828 Stockholders' equity 89,002 85,729 89,419 97,688 77,727\nOther data Current ratio 2.44 2.82 2.59 2.66 3.05 Gross profit margin 32.9% 32.1% 35.4% 36.8% 36.4% Net profit (loss) margin 1.0% (1.1)% (1.1)% 5.9% 5.3% Return on average stockholders' equity 3.3% (3.9)% (3.1)% 20.6% 20.1% Year-end employment 1,382 1,425 1,584 1,538 1,378\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nFiscal Years 1994, 1993 and 1992 Compared GENERAL\nFiscal 1994 resulted in a return to profitability that can primarily be attributed to operating expense reduction and containment. The Company reduced its worldwide work force by about 200 people (approximately 12%) in September 1993. This reduction, along with other cost saving measures, reduced the Company's ongoing operating expense run-rate by about 10%. A one-time charge was recorded in the fourth quarter of fiscal 1993, primarily due to the work force reduction. After the reduction, the Company was able to contain operating expenses at $88.9 million for fiscal 1994, compared to nearly $97 million in fiscal 1993 including the charge referred to above and approximately $94 million excluding the charge. In identifying the cost reduction initiatives, the Company was careful not to reduce areas below a critical mass and also to ensure that product development and customer service areas were still able to meet customer expectations. During fiscal 1994, the Company introduced five new print systems, significantly improved networking capability for the entire line of print system products and restructured to an improved customer service focus.\nRESULTS OF OPERATIONS\nThe following table displays, for the periods indicated, the percentage of net sales represented by certain items in the Consolidated Statements of Operations:\n1994 1993* 1992 NET SALES 100.0% 100.0% 100.0% COST OF SALES 67.1% 67.9% 64.6% ------ ------ ------ GROSS PROFIT 32.9% 32.1% 35.4%\nOPERATING EXPENSES 30.4% 32.6% 35.2% ------ ------ ------ OPERATING INCOME (LOSS) 2.5% (0.5)% 0.2%\nOTHER EXPENSE 1.1% 1.2% 1.9%\nPRETAX INCOME (LOSS) 1.4% (1.7)% (1.7)% TAX PROVISION (BENEFIT) 0.4% (0.5)% (0.5)% ------ ------ ------ NET INCOME (LOSS) 1.0% (1.2)% (1.2)% *1993 results include a one-time charge taken in Q4.\nNET SALES TABLE 1: NET SALES COMPARISONS FOR KEY CHANNELS YEAR-TO-YEAR NET SALES INCREASES\/(DECREASES) (IN THOUSANDS) 1994 1993 1992 1994 1993 U.S. DIRECT $114,228 $93,556 $109,779 $20,672 ($16,223) U.S. RESELLER 33,374 64,334 34,970 (30,960) 29,364 QMS EUROPE 78,572 81,409 66,200 (2,837) 15,209 QMS JAPAN 31,743 18,466 6,392 13,277 12,074 QMS CANADA 18,187 18,974 20,851 (787) (1,877) QMS AUSTRALIA 7,437 8,932 5,010 (1,495) 3,922 QMS CIRCUITS 3,438 3,625 3,751 (187) (126) ALL OTHER 5,709 8,084 13,738 (2,375) (5,654) ------ ------ ------ ------ ------ TOTAL $292,688 $297,380 $260,691 ($4,692) $36,689 ======= ======= ======= ======= ======\nThe U.S. direct sales and service channel sells the higher end of the Company's product offerings and consumables to major corporate accounts and supports those sales with nationwide service capability. Generally, product gross margins and the cost of distribution are higher in this channel than in the reseller channel. During fiscal 1994, the U.S. direct sales and service channel operations resulted in a net sales increase of $20.7 million (22%) compared to fiscal 1993 after having declined by $16.2 million (15%) in fiscal 1993 compared to fiscal 1992. The Company plans to continue to develop new products for the direct sales and service organizations and believes that one fundamental key to success is increasing sales of the higher end products such as the QMS(R)3825, which was introduced into this channel late in fiscal 1994.\nThe U.S. reseller channel is responsible for attracting and qualifying resellers of the lower end of the Company's product line. Generally, gross margins and distribution costs are lower in this channel than in the direct channel. The U.S. reseller channel experienced a net sales decline in fiscal 1994 of nearly $31 million (48%) when compared to fiscal 1993, after having achieved a net sales increase of over $29 million (84%) in fiscal 1993 compared to fiscal 1992. Fiscal 1993 was positively impacted by exceptional sales of the QMS(R) 860 print system, which was introduced near the end of fiscal 1992. During fiscal 1994, the U.S. reseller channel product mix was under extreme competitive pressure which resulted in lower sales volume and price declines compared to fiscal 1993. Two new products, the QMS(R)1060 and the QMS(R)1660 print systems, which were introduced into the channel late in fiscal 1994, should have a positive impact for the channel in fiscal 1995. This channel is important to the Company as it provides a higher volume distribution than the direct channel, yielding a level of name recognition in addition to absorbing fixed operations costs and providing reasonable profitability.\nQMS Europe B.V., a wholly owned subsidiary headquartered in the Netherlands, sells the entire line of the Company's print system products primarily to an established network of distributors throughout western Europe, the Middle East and Africa, and provides support and consumables after the sale. QMS Europe sales declined slightly in fiscal 1994 compared to fiscal 1993, after having increased by $15.2 million (23%) in fiscal 1993 compared to fiscal 1992. The European operations are an integral, well-established segment of the Company's business.\nQMS Japan, Inc., a wholly owned subsidiary headquartered in Tokyo, has consistently provided exceptional growth. QMS Japan sells primarily the lower end of the Company's product offerings to distributors in Japan and Southeast Asia (\"SEA\"). QMS Japan began management of the SEA portion of the Company's business during fiscal 1994, when the Company closed its Hong Kong office. The Company has made a significant development commitment to the special language requirements for the Japanese market. During fiscal 1994, QMS Japan achieved a net sales increase of $13.3 million (72%) compared to fiscal 1993 after having increased net sales by $12.1 million (189%) in fiscal 1993 compared to fiscal 1992. While continued sales growth can reasonably be expected, the business environment for the Company's products in Japan has become more competitive, which could result in lower rates of growth in the future.\nQMS Canada, Inc., a wholly owned subsidiary headquartered in Montreal, sells the entire line of products, including service and accessories, directly to end users and also through resellers, as does QMS Australia, Ltd., a wholly owned subsidiary headquartered in Melbourne. These two entities have experienced essentially flat net sales during the years of comparison. The Company has awarded exclusive distribution rights to a third party distribution company in New Zealand. Accordingly, the Company dissolved its QMS New Zealand entity in fiscal 1994 without material adverse impact. QMS Circuits, Inc., a wholly owned subsidiary based in Fort Walton Beach, Florida, manufactures and markets printed circuit boards for the Company and for third-party sales. During fiscal 1994, 1993 and 1992, the Company also sold Magnum(R) controller boards, board level products to original equipment manufacturers and printer products into Latin America.\nGROSS PROFIT\nGross profit dollars increased slightly in fiscal 1994 despite the fact that sales were lower than in fiscal 1993. Gross profit as a percentage of sales improved to 32.9% in fiscal 1994 from 32.1% in fiscal 1993. The gross profit percentage improvement reflects a higher percentage of total sales being generated through the U.S. direct channel where the higher end of the Company's product offering is sold directly to end users.\nOPERATING EXPENSE\nDuring fiscal 1994, operating expenses were contained at $88.9 million, a decrease of $8.1 million compared to fiscal 1993 and $2.8 million compared to fiscal 1992. Fiscal 1993 operating expenses included a one-time charge of approximately $3 million as a result of reducing the Company's work force by about 12% and the consolidation of several of the Company's leased facilities around the world. Excluding the one-time charge, operating expenses were $94 million in fiscal 1993, a 2.5% increase over fiscal 1992. As a percentage of sales (excluding the 1993 one-time charge), operating expenses were 30.4%, 31.6% and 35.2% in fiscal 1994, 1993 and 1992, respectively. The Company continues to make a concerted effort to contain operating expenses.\nIn fiscal 1994, research and development expenses were essentially the same as in fiscal 1993 after having decreased in fiscal 1993 by approximately 17% compared to fiscal 1992. Capitalized software costs amounted to $7.1 million, $8.8 million and $6.1 million for fiscal 1994, 1993 and 1992, respectively. Total research and development spending, including amounts capitalized, was $16.0 million in fiscal 1994, $17.8 million in fiscal 1993 and $17.0 million in fiscal 1992. Management believes that continued investment in product research and development is critical to the Company's future growth and competitive position in the marketplace, and is directly related to continued, timely development of new and enhanced products.\nOTHER INCOME (EXPENSE)\nNet interest was essentially the same in fiscal 1994, 1993 and 1992. Other income in fiscal 1994 included net foreign currency transaction gains of $290,000. The Company did not enter into foreign currency hedging contracts.\nIn fiscal 1993 and 1992, the Company entered into foreign exchange contracts against forecasted European sales in local currencies to minimize, or offset, the risk of exchange rate fluctuations. In fiscal 1993, net foreign currency gains were $343,362, compared to 1992 net losses of $1,366,737.\nINCOME TAX\nIn fiscal 1994, a provision of 26.7% of pretax income was recognized. An income tax benefit was recognized in fiscal 1993 and fiscal 1992 of 31% and 33% of pretax loss, respectively. Effective October 3, 1992, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" The adoption of this standard had no material impact on the consolidated financial statements for fiscal 1993.\nRecent audits by tax authorities in Japan, the Netherlands, Canada and the U.S. were all resolved with no adverse tax consequences. Fiscal years 1993 and forward are still subject to review.\nFACTORS WHICH MAY AFFECT FUTURE RESULTS\nA number of uncertainties may affect the Company's future operating results, including: the financial condition and stability of major resellers that market the Company's products, the Company's ability to manufacture products in sufficient quantity to meet demand, the availability and cost of certain components, and the Company's ability to develop new products in a timely, cost-effective manner and increasingly competitive pressures in the Company's markets.\nThe Company's sales strategy includes significant dependence on third-party resellers for the Company's products. The Company believes that the selection process for these resellers is adequate in establishing creditworthiness and in determining the resellers' ability to provide capacity to meet growth expectations; however, if significant members of the reseller group in the United States, Europe or Japan were to experience major financial difficulties, the Company's operating results could be adversely impacted.\nThe Company contracts with third-party manufacturers to provide capacity for high volume products. The Company has the capability of increasing internal manufacturing to a certain degree and generally does not depend on a sole source for external manufacturing, but operating results could be adversely impacted if a major external supplier were unable to meet the Company's demand for products.\nThe Company's products include components, primarily microprocessors and dynamic random-access memory devices, that from time to time are sensitive to market conditions that result in limited availability and\/or extreme price fluctuations. An interruption in the supply line or significant changes in price for these components could have an adverse effect on the Company's operating results. The Company purchases significant quantities of print engine mechanisms from Japanese suppliers. An appreciation of the value of the yen to the dollar results in higher prices, which can be mitigated through yen-sharing arrangements with suppliers, foreign exchange contracts and price negotiations; however, severe price increases could develop which would adversely affect operating results.\nBecause the Company competes in an industry of rapid technological advance, it is important that the Company be able to develop new products in a timely, cost-effective manner. The Company has invested significantly in its Crown advanced document processing technology which, in addition to providing significantly improved functionality, is intended to reduce the time it takes to develop products. New product introduction delays could, however, have an adverse impact on operating results.\nThese factors, including increasingly competitive pressures in the Company's markets, along with others that may affect operating results, mean that past financial performance may not be a reliable indicator of future performance. Investors should not use historical trends to anticipate results or trends in future periods. In addition, the Company participates in a highly dynamic industry, which can result in significant volatility of the Company's common stock price.\nLIQUIDITY AND CAPITAL RESOURCES\nCash and cash equivalents were $5.0 million at September 30, 1994, compared to $3.6 million and $8.1 million at the end of the two previous years. The cash flow from operations was $23.2 million for fiscal 1994 up from $3.1 million in fiscal 1993 and $18.0 million in fiscal 1992. The Company's financing for fiscal 1994 came principally from an increase in cash flow from operations, capital leases and a secured revolving credit agreement. During fiscal 1993 and 1992, the Company's financing came principally from borrowings under a secured revolving credit agreement.\nThe Company's working capital was $79.4 million in fiscal 1994, up from $78.4 million in fiscal 1993 and $74.0 million in fiscal 1992. During fiscal 1994, the Company reduced its total long-term debt levels to $34.3 million, down from $40.6 million in fiscal 1993. Bank borrowings under the Company's secured revolving credit agreement were reduced to $23.2 million at the end of fiscal 1994 compared to $25.5 million at the end of fiscal 1993. The total borrowing capacity under the secured revolving credit agreement is $30.0 million. During fiscal 1993, the Company obtained a supplemental line of credit to the secured revolving credit agreement, increasing its borrowing capacity to $37.5 million. As a result of increasing cash flows from operations in fiscal 1994, the supplemental line of credit was not renewed.\nAt September 30, 1994, the Company was not in compliance with certain covenants in its credit agreement. The Company requested and received a waiver of non-compliance from its lenders. One member of the three-member bank group has expressed a desire to exit the credit agreement. The Company is currently negotiating to secure a replacement bank before the end of January 1995. See Note 6 of the Notes to the Company's Consolidated Financial Statements.\nManagement believes that the Company's working capital and capital expenditure needs will be met by cash flow from operations and by the secured revolving credit agreement.\nINFLATION\nInflationary factors have not had a significant effect on the Company's operations in the past three years. A significant increase in inflation would adversely affect the Company's operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFor the fiscal years ended September 30, 1994, October 1, 1993 and October 2, 1992\nDollars in thousands, except per share amounts 1994 1993 1992\nNet sales $ 292,688 $ 297,380 $ 260,691 Cost of goods sold 196,538 201,804 168,431 -------- -------- -------- Gross profit 96,150 95,576 92,260 -------- -------- -------- Operating expenses Marketing and selling 48,812 48,702 42,816 Research and development 8,904 9,018 10,885 General and administrative 31,156 39,246 37,983 -------- -------- -------- Total 88,872 96,966 91,684 -------- -------- -------- Operating income (loss) 7,278 (1,390) 576 -------- -------- -------- Other income (expense) Interest income 80 756 468 Interest expense (3,235) (3,342) (3,037) Miscellaneous expense (83) (946) (2,384) -------- -------- -------- Total (3,238) (3,532) (4,953) -------- -------- -------- Income (loss) before income taxes 4,040 (4,922) (4,377) Income tax provision (benefit) 1,080 (1,526) (1,444) -------- -------- -------- Net income (loss) $ 2,960 $ (3,396) $ (2,933) -------- -------- -------- Earnings (loss) per common share\nPrimary $ 0.28 $ (0.31) $ (0.27) Fully diluted $ 0.28 $ (0.31) $ (0.27) Weighted average number of shares used in computing earnings (loss) per common share Primary 10,723 10,792 10,994 Fully diluted 10,761 10,821 10,994\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nFor the fiscal years ended October 2, 1992, October 1, 1993 and September 30, 1994\nCommon Stock Foreign Add'l Currency Dollars in Shares Paid-In Retained Number Trans- thousands Issued Amt Capital Earnings of Shares Amt lation\nBalance September 27, 1991 11,832,806 $118 $39,754 $66,270 728,910 $(8,008) $(446) Stock Op- tions exer- cised 103 (134,223) 1,115 Purchase of treasury shares 557,500 (6,343) Translation adjustment (211) Net loss (2,933) ---------- ---- ------- ------- --------- ------- ------ Balance October 2, 1992 11,832,806 118 39,857 63,337 1,152,187 (13,236) (657) Stock Op- tions exer- cised 132 (55,394) 423 Purchase of treasury shares 30,500 (306) Translation adjustment (543) Net loss (3,396) ---------- ---- ------- ------- --------- ------- ------ Balance October 1, 1993 11,832,806 118 39,989 59,941 1,127,293 (13,119) (1,200) Stock Op- tions exer- cised 1 (8,602) 66 Purchase of treasury shares 40,700 (287) Translation adjustment 533 Net income 2,960 ---------- ---- ------- ------- --------- ------- ------ Balance September 30, 1994 11,832,806 $118 $39,990 $62,901 1,159,391 $(13,340) $(667) ========== ==== ======= ======= ========= ======== ======\nSee notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEETS\nAt September 30, 1994 and October 1, 1993\nDollars in thousands 1994 1993\nASSETS Current assets Cash and cash equivalents $ 4,956 $ 3,582 Trade receivables (less allowance for doubtful accounts of $504 in 1994 and $580 in 1993) 51,462 39,471 Inventories, net 69,770 70,461 Other current assets 8,335 7,806 ------ ------ Total current assets 134,523 121,320\nProperty, plant and equipment, net 30,826 32,666 Other assets, net 16,674 16,231 ------ ------ Total $ 182,023 $170,217 ====== ======\nLIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Accounts payable $ 20,791 $ 11,060 Income taxes payable 641 0 Current maturities of long-term debt and capital lease obligations 5,099 4,753 Other current liabilities 28,602 27,148 ------ ------ Total current liabilities 55,133 42,961\nLong-term debt 34,340 40,648 Capital lease obligations 1,347 879 Deferred income taxes 2,201 0 ------ ------ Total liabilities 93,021 84,488 ====== ====== Stockholders' equity Preferred stock-authorized, 500,000 shares of no par value, none issued Common stock-authorized, 50,000,000 shares of $.01 par value; issued, 11,832,806 shares in 1994 and 11,832,806 in 1993 118 118 Additional paid-in capital 39,990 39,989 Retained earnings 62,901 59,941 Treasury stock, at cost (13,340) (13,119) Foreign currency translation (667) (1,200) ------ ------ Total stockholders' equity 89,002 85,729 ------ ------ Total $ 182,023 $170,217 ====== ======\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFor the fiscal years ended September 30, 1994, October 1, 1993 and October 2, 1992\nDollars in thousands 1994 1993 1992\nCASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 2,960 $(3,396) $(2,933) Adjustments to reconcile net income (loss)to net cash provided by operating activities: Depreciation of property, plant and equipment 9,496 9,106 7,963 Amortization of capitalized and deferred software and other 8,147 7,540 5,899 Loss on disposal of property, plant and equipment 161 21 520 Provision for losses on accounts receivable 228 326 575 Provision for losses on inventory 5,388 8,923 5,357 Foreign currency transaction gain (loss) (165) 536 (121) Changes in assets and liabilities which provided (used) cash: Trade receivables (11,301) 3,653 12,590 Inventories (4,381) (17,881) (7,197) Other current assets (1,409) (1,008) 702 Other assets 373 (985) (820) Accounts payable 9,725 (3,621) (255) Income taxes payable 805 (2,759) (4,589) Other current liabilities 935 3,185 1,775 Deferred income taxes 2,201 (525) (1,441) ------ ------ ------ Total adjustments 20,203 6,511 20,958 ------ ------ ------ Net cash provided by operating activities 23,163 3,115 18,025 ------ ------ ------\nCASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment (6,115) (8,188) (13,309) Additions to capitalized software costs (7,056) (8,803) (6,102) Additons to deferred software costs (836) (1,189) (257) Proceeds from disposal of property, plant and equipment 198 254 33 Proceeds from sale of short-term investments 0 0 3,801 ------ ------ ------ Net cash used in investing activities (13,809) (17,926) (15,834) ------ ------ ------\nCash flows from financing activities: Proceeds from long-term debt 0 21,000 14,500 Payments of long-term debt, including current maturities (6,195) (9,483) (4,421) Payments of capital lease obligation, including current maturities (1,004) (1,036) (1,165) Proceeds from stock options exercised 67 555 1,218 Purchase of treasury stock (287) (306) (6,343) ------ ------ ------ Net cash provided by (used in) financing activities (7,419) 10,730 3,789 ------ ------ ------ EFFECT OF EXCHANGE RATE CHANGES ON CASH (561) (423) 233 ------ ------ ------ NET CHANGE IN CASH AND CASH EQUIVALENTS 1,374 (4,504) 6,213 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 3,582 8,086 1,873 ------ ------ ------ CASH AND CASH EQUIVALENTS, END OF YEAR $ 4,956 $ 3,582 $ 8,086 ====== ====== ====== See notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION - The accompanying consolidated financial statements include the accounts of QMS, Inc. and its wholly owned subsidiaries. All material intercompany items have been eliminated.\nFISCAL YEAR - The Company's fiscal year ends on the Friday closest to September 30. Fiscal 1994 and 1993 included 52 weeks as compared to 53 weeks in fiscal 1992.\nCASH EQUIVALENTS - The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nINVENTORIES - Inventories are stated at the lower of cost or market. Cost, which includes materials, labor and production and material overhead, is determined on the first-in, first-out basis. Market is based on replacement cost or net realizable value, as appropriate.\nPROPERTY, PLANT AND EQUIPMENT - Expenditures for property, plant and equipment; major renewals; and betterments are capitalized at cost. Certain assets are financed under lease contracts which have been capitalized. Aggregate lease payments, discounted at appropriate rates, have been recorded as long-term debt, the related leased assets have been capitalized, and the amortization of such assets is included in depreciation expense.\nExpenditures for maintenance, repairs and minor renewals are charged to expense. When items are disposed of, the cost and accumulated depreciation are eliminated from the respective accounts, and the resulting gain or loss is included in the statement of operations.\nDepreciation is provided on the straight-line method over the estimated useful lives of the assets or the lease term, whichever is shorter.\nREVENUE RECOGNITION - Sales are recorded upon shipments of products to customers.\nDEFERRED SERVICE REVENUES - Amounts billed for service contracts are credited to deferred service revenue and reflected in revenues over the terms of the contracts, which range from one to three years.\nDEFERRED SOFTWARE COSTS - Purchased computer software costs are amortized based on current and future revenue for each product with an annual minimum amortization equal to straight-line amortization over the remaining estimated economic life of the product.\nCAPITALIZED SOFTWARE COSTS - The Company capitalizes the qualifying costs of developing proprietary software included in its products. Capitalization of costs requires that technological feasibility has been established. Upon completion of projects, amortization is determined based on the larger of the amounts computed using (a) the ratio that current gross revenue 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.\nCapitalized software costs for fiscal 1994, 1993 and 1992 totaled $7,056,000, $8,803,000 and $6,102,000, respectively. For fiscal 1994, 1993 and 1992, $7,345,000, $6,835,000, and $5,039,000, respectively, were charged as amortization expense on completed projects, and included in cost of goods sold. For fiscal 1993, amortization included net realizable value adjustments of $86,850. The amortization for fiscal 1994 and 1992 includes no net realizable value adjustment.\nRESEARCH AND DEVELOPMENT - The Company expenses research and development costs, including expenditures related to development of the Company's software products that do not qualify for capitalization.\nINCOME TAX - In February 1992, the Financial Accounting Standards Board issued the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" which was adopted by the Company, effective October 3, 1992. The adoption of this Standard had no material effect on the Company's fiscal 1993 operations. Under this method, deferred tax liabilities and assets are determined based on the difference between 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 12.) Prior year financial statements have not been restated to apply the provisions of the statement. Prior to fiscal 1993, income taxes were accounted for under Accounting Principles Board Opinion No. 11 \"Accounting for Income Taxes.\"\nEARNINGS PER COMMON SHARE - Earnings per common share are computed based on the weighted average number of common and common equivalent shares outstanding, as appropriate. Common equivalent shares result from the assumed exercise of outstanding stock options that have a dilutive effect when applying the treasury stock method.\nFOREIGN CURRENCY TRANSLATION - The Company's subsidiary in Europe transacts a significant amount of business in U.S. dollars. Accordingly, the U.S. dollar is deemed to be the functional currency of this subsidiary, and all foreign currency gains and losses are included in income currently.\nThe financial position and results of operations of the Company's other foreign subsidiaries are measured using local currency as the functional currency. Assets and liabilities of such subsidiaries are translated using current exchange rates. Revenues and expenses of such subsidiaries have been translated at rates approximating the actual rates on the dates of the transactions. Translation adjustments are included as a separate component of shareholders' equity. Foreign currency transaction gains were $290,000 in fiscal 1994 and $634,007 in fiscal 1992. Foreign currency transaction losses were $1,408,533 in fiscal 1993.\nFOREIGN EXCHANGE CONTRACTS - Foreign exchange contracts are legal agreements between two parties to purchase and sell a foreign currency, for a price specified at the contract date, with delivery and settlement in the future. Gains and losses associated with currency rate exchanges on foreign exchange contracts are recorded currently in income unless the contract hedges a firm commitment, in which case any gains and losses are deferred and included as a component of the related transaction.\nIn fiscal 1993 and 1992, the Company entered into foreign exchange contracts against forecasted European sales in local currencies to minimize, or offset, the risk of exchange rate fluctuations. All related gains and losses are included in other income (expense). Also, the Company entered into yen call options as a hedge against possible exchange rate fluctuation on the purchase of print engines. These contracts are hedges of firm commitments; the net gains or losses are included as a component of cost of goods sold. In fiscal 1994, the Company did not enter into any foreign exchange contracts.\nRECLASSIFICATIONS - Certain reclassifications have been made to fiscal 1993 and 1992 amounts to conform to the fiscal 1994 presentation.\nNOTE 2 INVENTORIES\nInventories at September 30, 1994 and October 1, 1993 are summarized as follows (in thousands):\n1994 1993\nRaw materials $ 24,003 $ 26,104 Work in process 5,842 4,052 Finished goods 46,733 46,609 Inventory reserve (6,808) (6,304) ------- ------- $ 69,770 $ 70,461 ======= =======\nInventory reserves are calculated based on specific identification of items that are potentially excess or obsolete. Reserves are also recorded on a routine basis due to rapid obsolescence of certain inventory items.\nNOTE 3 OTHER ASSETS\nOther assets at September 30, 1994 and October 1, 1993 are summarized as follows (in thousands):\n1994 1993\nCapitalized software costs, net $ 12,982 $ 13,357 Deferred software costs, net 977 702 Other 2,715 2,172 ------ ------ $ 16,674 $ 16,231 ====== ======\nAccumulated amortization of capitalized software cost amounted to $16,509,000 and $14,838,000 at September 30, 1994 and October 1, 1993, respectively. Accumulated amortization of deferred software cost amounted to $1,987,000 and $1,417,000 at September 30, 1994 and October 1, 1993, respectively.\nNOTE 4 PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at September 30, 1994 and October 1, 1993 are summarized as follows (in thousands):\n1994 1993\nLand $ 1,408 $ 1,408 Buildings and improvements 20,682 20,246 Machinery and equipment 42,365 37,622 Office furniture and equipment 8,425 7,164 ------ ------ 72,880 66,440 Less accumulated depreciation 42,054 33,774 ------ ------ $ 30,826 $ 32,666 ====== ======\nNOTE 5 OTHER CURRENT LIABILITIES\nOther current liabilities at September 30, 1994 and October 1, 1993 are summarized as follows (in thousands):\n1994 1993\nEmployment costs $ 8,670 $ 7,442 Deferred service revenue 11,374 9,065 Accrued royalties 1,061 1,348 Accrued warranty 825 779 Accrued interest 371 422 Sales and use tax payable 1,688 1,078 Other 4,613 7,014 ------ ------ $ 28,602 $ 27,148 ====== ======\nNOTE 6 LONG-TERM DEBT\nLong-term debt at September 30, 1994 and October 1, 1993 is summarized as follows (in thousands):\n1994 1993\nIndebtedness to banks under secured revolving credit agreements (8.50% at September 30, 1994) $ 23,200 $ 25,500 10.13% senior unsecured notes payable in equal semi-annual installments of $1,052,632 plus interest through 1998 7,368 9,474 6.15% senior secured notes payable in monthly installments of $194,026 including interest through 1998 7,780 9,569 ------ ------ 38,348 44,543 Less current portion of long-term debt 4,008 3,895 ------ ------ $ 34,340 $ 40,648 ====== ======\nLong-term debt outstanding at September 30, 1994 matures as follows: $27,208,000 in fiscal 1995, $4,128,000 in fiscal 1996, $4,256,000 in fiscal 1997, $2,756,000 in fiscal 1998 and $0 thereafter.\nThe Amended and Restated Secured Revolving Credit Agreement, dated October 2, 1992, is with a group of banks. The total borrowing capacity under the agreement is $30,000,000. The agreement expires in January 1996 and will be reviewed in January 1995 for possible extension to January 1997. The agreement has a stated rate of interest on outstanding borrowings of the lesser of the lead bank's prime rate plus 3\/4 of 1 percent or the maximum rate, which is the highest nonusurious rate of interest permitted by law. The agreement provides that the rate may be reduced as low as the lead bank's prime rate if certain performance tests are met. The average rate paid in fiscal 1994 was 7.37%. The Company is required to pay a commitment fee of 1\/4 of 1 percent per annum on the average daily unborrowed amounts.\nThe secured revolving credit agreement is secured by the Company's domestic accounts receivable and inventory. The senior secured notes are secured by a first priority lien on portions of the Company's land and buildings located in Mobile, Alabama.\nThe convenants for both senior note agreements and the secured revolving credit agreement place certain restrictions on the Company and its subsidiaries as to disposal of subsidiaries, sale of assets, working capital, other indebtedness, payments of dividends and guaranties. Among other things, the Company and its subsidiaries must maintain a 2:1 working capital ratio, and $38,450,500 of retained earnings at September 30, 1994 were restricted as to the payment of dividends.\nAt September 30, 1994, the Company was not in compliance with certain covenants contained in its credit agreements. The Company has requested and received a waiver of non-compliance from the lenders. One member of the three-member bank group has expressed a desire to exit the credit agreement. The Company is currently negotiating to secure a replacement bank before the end of January 1995. In an agreement reached December 9, 1994, the Company and the lenders agreed to add and modify certain covenants, such as the addition of minimum net income requirements and a future reduction in borrowings available from inventory. Management believes the revised borrowing base will yield sufficient borrowing capacity.\nFollowing is the Company's disclosure in accordance with Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments.\" The fair value of the Company's long-term debt is estimated based on the quoted prices for the same or similar issues. The fair value, as of September 30, 1994 and October 1, 1993, has been estimated as follows (in thousands):\n1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value\nSecured revolving credit facility $23,200 $23,200 $ 25,500 $25,500 10.13% senior unsecured notes 7,368 7,627 9,476 10,253 6.15% senior secured notes 7,780 7,524 9,569 9,569\nNOTE 7 LEASES\nThe Company has capital leases that expire through fiscal 1999. The Company is obligated under operating leases for certain sales and service offices expiring through fiscal 2003. Future minimum lease payments under capital and operating leases with noncancelable terms in excess of one year as of September 30, 1994 were as follows (in thousands):\nCapital Lease Operating Fiscal Year Obligations Leases\n1995 $ 1,247 $ 4,796 1996 792 4,031 1997 596 1,906 1998 69 974 1999 1 520 Thereafter 0 1,342 ------ ------ Total minimum payments $ 2,705 $ 13,569 ======= Less amounts representing interest 267 ------ Present value of minimum payments 2,438 Less current maturities under capital lease obligations 1,091 ------- $ 1,347 -------\nRent expense under operating leases for fiscal 1994, 1993 and 1992 was $7,233,000, $7,120,000 and $5,711,000, respectively.\nAssets recorded under capital leases (included in property, plant and equipment in the accompanying consolidated balance sheets) at September 30, 1994 and October 1, 1993 are summarized as follows (in thousands):\n1994 1993\nMachinery and equipment $ 3,835 $ 2,786 Office furniture and equipment 1,920 1,383 ------ ------ 5,755 4,169 Less accumulated depreciation 3,330 2,622 ------ ------ $ 2,425 $ 1,547 ====== ======\nNOTE 8 EMPLOYEE BENEFIT PLANS\nThe Company has a Cash or Deferred Retirement Plan which covers substantially all employees and is a qualified plan under Section 401(k) of the Internal Revenue Code. Employees may make a pretax contribution of up to 10% of their annual salaries and are provided investment choices from among a Retirement Preservation Trust, a Corporate Bond Fund, a Capital Fund, a Basic Value Fund and a Company Stock Fund. The Company matches employee contributions at varying rates up to a maximum of 3.5% of annual salary, and Company contributions are made on an annual basis. Employees are fully vested on the date of the Company contribution. The plan is a calendar year plan. In fiscal 1994, 1993 and 1992 the Company contributed $1,046,137, $1,029,391 and $914,461 to the plan, respectively.\nNOTE 9 STOCK OPTION PLANS\nThe Company's stock option plans allow incentive or non-qualified stock options to be granted to key employees and directors providing the right, when exercisable, to purchase up to an aggregate of 1,905,238 shares of the Company's common stock. In the case of incentive stock options, the option price is not less than the fair market value at date of grant. A non- qualified optionee may receive the right to receive cash upon the exercise of a non-qualified option in an amount intended to approximate 100% of the amount of the federal, state and local income tax payable by that optionee due to the optionee's exercise of the option and the Company's payment to the optionee of a bonus to pay that income tax liability.\nFor employees with less than one year of service with the Company, one- fourth of the granted options may be exercised one year after the date of grant, with an additional one-fourth exercisable each year thereafter, although other exercise provisions are allowed. For employees with greater than one year of service, one-fifth of the granted options may be exercised on the date of grant, with an additional one-fifth exercisable each year thereafter, although other exercise provisions are allowed. Options that expire or are canceled prior to exercise are restored to the shares available for future grants. At September 30, 1994, the Company had reserved 699,687 shares for the future grant of options under these plans.\nThe Company's stock option plans also provide that, in the event of a change of control (as defined in each of the plans), all options then outstanding would become exercisable immediately either in full or in part.\nUnder the Company's 1987 plan, no more than 500,000 shares may be issued to directors, whether or not they are also key employees. Stock options under the plan expire not later than ten years from the date of grant.\nThe Company's 1984 plan expired during fiscal 1994, and no additional options can be granted under the plan. Outstanding stock options under the plan were not affected by the plan's expiration.\nDuring fiscal 1994, the Company adopted the Stock Option Plan for Directors whereby non-employee directors receive non-qualified stock option grants annually and may make an irrevocable election annually to receive stock options at a below-market exercise price in lieu of cash directors' fees.\nA summary of stock option activity is as follows:\nNumber Per of Shares Share Total Outstanding, September 27, 1991 1,033,075 $4.62 to $ 23.38 $ 13,179,638 Granted 317,650 7.38 to 24.12 4,504,938 Exercised (134,223) 4.62 to 17.88 (1,216,131) Terminated (115,178) 4.62 to 23.38 (1,308,350) ========== ==========\nNumber Per of Shares Share Total Outstanding, October 2, 1992 1,101,324 4.62 to 24.12 15,160,095 Granted 269,550 8.50 to 16.25 2,719,100 Exercised (55,394) 4.62 to 15.00 (554,920) Terminated (197,710) 6.62 to 22.38 (3,218,562) ========== ==========\nNumber Per of Shares Share Total Outstanding, October 1, 1993 1,117,770 6.75 to 24.12 14,105,713 GRANTED 238,571 4.38 to 10.50 2,011,273 EXERCISED (8,602) 7.50 to 14.00 (66,848) TERMINATED (142,188) 7.50 to 24.12 (1,762,637) ========== ==========\nOutstanding, September 30, 1994 1,205,551 $4.38 to $ 24.12 $ 14,287,501 ========== ==========\nExercisable, September 30, 1994 619,810 ==========\nNOTE 10 SUPPLEMENTAL EXECUTIVE RETIREMENT AGREEMENTS\nIn fiscal 1992, the Company entered into separate agreements with three officers of the Company, under which each officer is entitled to a monthly benefit upon either the officer's leaving the Company's employment, retirement or departure following a change in control of the Company, to be paid over a ten-year benefit period. In fiscal 1994, 1993 and 1992, the Company expensed $291,806, $441,938 and $517,236, respectively, related to these benefits.\nNOTE 11 STOCKHOLDER RIGHTS PLAN\nIn November 1988, the Company adopted a Stockholder Rights Plan and pursuant to the plan declared a dividend on its common stock of one right (a \"Right\") for each share of common stock then outstanding and for each share of common stock issued thereafter and prior to the time the Rights expire or become exercisable. Upon the occurrence of certain events, each Right becomes exercisable to purchase one one-hundredth of a share of Series A Participating Preferred Stock at a price of $40. The Rights expire on November 30, 1998 and, prior to the occurrence of certain events, may be redeemed at a price of $.01 per Right. Of the Company's 500,000 authorized shares of preferred stock, no par value, the Board of Directors has designated 250,000 shares as Series A Participating Preferred Stock.\nNOTE 12 INCOME TAXES\nThe components of income (loss) before income taxes and the provision (benefit) for income taxes (both domestic and foreign), for fiscal 1994, 1993 and 1992 are summarized as follows (in thousands):\n1994 1993 1992\nIncome (loss) before income taxes: Domestic $ 6,527 $ (540) $ (4,497) Foreign (2,487) (4,382) 120 ------- ------- ------- Total $ 4,040 $ (4,922) $ (4,377) ======= ======= =======\nProvision (benefit) for income taxes: Current: Federal $ 436 $ 169 $ 0 Foreign 452 (2,119) 532 State 439 0 0 ------- ------- ------- $ 1,327 $ (1,950) $ 532 ------- ------- -------\nDeferred: Federal $ 0 $ 0 $ (1,974) Foreign (247) 424 190 State 0 0 (192) ------- ------- ------- (247) 424 (1,976) ------- ------- ------- Total $ 1,080 $ (1,526) $ (1,444) ======= ======= =======\nAt September 30, 1994, the Company had domestic operating loss carryovers of approximately $4,200,000 which will expire in fiscal 2007, and general business credit carryovers of approximately $1,700,000 which will expire during fiscal 2002 through 2007. Foreign tax credit carryforwards of approximately $1,600,000 existed at September 30, 1994 and will expire in fiscal 1996 through 1998.\nThe Company has not recorded deferred income taxes applicable to earnings that are indefinitely reinvested in foreign operations. Undistributed earnings expected to be indefinitely reinvested totaled approximately $4,542,000 at September 30, 1994. Determinations of the amount of domestic taxes which would be payable if such foreign earnings are remitted is not practicable.\nDuring fiscal 1994, the Company settled outstanding issues with tax authorities in Japan, the Netherlands, Canada and the U.S. without adverse results.\nA reconciliation of the statutory federal income tax rate to the effective rate for fiscal 1994, 1993 and 1992 is as follows (in thousands):\n1994 1993 1992\nTax at federal statutory rate $ 1,415 $(1,723) $(1,488) State income taxes, net of federal benefit 283 (127) Research and development credit, net (165) Utilization of carryovers (1,465) Foreign sales corporation benefit (423) (221) 0 Tax effect of international operations, net 1,075 (161) 681 Other, net 195 579 (345) ------ ------ ------ Total $ 1,080 $(1,526) $(1,444) ====== ====== ======\nDeferred tax assets and liabilities that arise as a result of temporary differences at September 30, 1994 and October 1, 1993 are summarized as follows (in thousands):\n1994 1993\nDeferred tax assets: Inventory reserves $ 2,085 $ 1,040 Restructuring reserves 0 757 Vacation accrual 357 254 General business credits carryforwards 1,742 1,624 Net operating loss carryforwards 1,575 3,031 Other reserves 549 801 Deferred income 747 97 AMT credit carryover 191 194 Contribution carryover 0 77 Deferred compensation 275 313 Other 272 2 ------- ------- Total gross deferred tax assets 7,793 8,190 Deferred tax asset valuation allowance (1,075) (1,269) ------- ------- Total deferred tax asset 6,718 6,921\nDeferred tax liabilities: Depreciation (1,190) (1,618) Capitalized software costs (4,842) (4,982) Deferred software costs (341) (243) Deferred tooling (98) (78) ------- ------- Total deferred tax liability (6,471) (6,921) ------- ------- Net deferred tax asset $ 247 $ 0 ======= =======\nThe valuation allowance was established based on certain assumptions about levels of future pretax income that are consistent with historical results. As the Company had losses in fiscal 1993 and 1992, the deferred tax asset valuation allowance reflects an evaluation which recognizes uncertainties related to the future utilization of certain carryovers. The valuation allowance for deferred tax assets decreased by $194,000 during fiscal 1994.\nNOTE 13 BUSINESS SEGMENT AND FOREIGN OPERATIONS\nThe Company's domestic operations and those of its wholly owned European, Canadian, Australian, New Zealand and Japanese subsidiaries for fiscal 1994, 1993 and 1992 are summarized as follows (in thousands):\n1994 1993 1992\nNet sales to unaffiliated customers from: United States $ 157,156 $ 169,853 $ 162,237 Europe 78,572 81,413 66,200 Canada 18,186 18,974 20,850 Australia 7,083 7,601 3,731 New Zealand 1,490 1,331 1,280 Japan 30,201 18,208 6,393 Net transfer between geographic areas 60,984 53,188 41,249 Adjustments and eliminations (60,984) (53,188) (41,249) ------- ------- ------- Consolidated $ 292,688 $ 297,380 $ 260,691 ======= ======= =======\nSubstantially all transfers between geographic areas are sales from the U.S. parent to its foreign subsidiaries.\n1994 1993 1992\nOperating income (loss): United States $ 22,056 $ 14,303 $ 11,987 Europe 2,136 1,862 5,204 Canada (262) (568) 2,280 Australia 115 614 0 New Zealand 354 2 (151) Japan 2,012 757 (1,206) Adjustments and eliminations (552) 522 684 ------- ------- ------- Consolidated operating profit 25,859 17,492 18,798 General corporate expenses (18,581) (18,882) (18,222) Interest income 80 756 468 Interest expense (3,235) (3,342) (3,037) Miscellaneous expense (83) (946) (2,384) ------- ------- ------- Consolidated income (loss) before income taxes $ 4,040 $ (4,922) $ (4,377) ======= ======= =======\nIdentifiable assets: United States $ 131,179 $ 127,227 $ 127,194 Europe 23,009 21,360 19,205 Canada 6,711 6,424 6,189 Australia 3,076 2,028 1,270 New Zealand 492 607 726 Japan 13,077 7,143 3,372 Adjustments and eliminations (2,180) (1,166) (1,397) ------- ------- ------- 175,364 163,623 156,559 Corporate assets 6,659 6,594 11,448 ------- ------- ------- Total assets $ 182,023 $ 170,217 $ 168,007 ======= ======= =======\nThe transfers between geographic areas are priced at cost plus a reasonable profit.\nA summary of the Company's foreign sales to indicated geographic areas for fiscal 1994, 1993 and 1992 is as follows (in thousands):\n1994 1993 1992\nEurope $ 74,305 $ 76,561 $ 63,594 Canada 18,198 18,992 20,859 Far East & Pacific Rim 39,187 27,390 12,860 Other 6,654 5,839 6,204 ------- ------- ------- Total $ 138,344 $ 128,782 $ 103,517 ======= ======= =======\nU.S. export sales included in the above summary for fiscal 1994, 1993 and 1992 were $2,802,489, $1,298,769 and $5,103,000, respectively.\nNo customer accounted for 10% or more of consolidated net sales for fiscal 1994, 1993 and 1992.\nNOTE 14 SUPPLEMENTAL CASH FLOW INFORMATION\nCash paid for interest and income taxes for fiscal 1994, 1993 and 1992 is as follows (in thousands):\n1994 1993 1992\nInterest $ 3,235 $ 3,143 $ 2,726 Income taxes 1,193 5,033 5,940\nAdditions to capital lease assets and related obligations were $1,705,000, $41,000 and $761,000 in fiscal 1994, 1993 and 1992, respectively, as a result of the Company entering into equipment leases.\nNOTE 15 COMMITMENTS AND CONTINGENCIES\nAt September 30, 1994, the Company had a commitment of approximately $13.7 million under contracts to purchase print engines.\nThe Company was contingently liable for approximately $4.6 million as of September 30, 1994, principally the result of written letters of credit, with various expiration dates, issued in the normal course of business for the purchase of inventory. These letters are not collateralized by the Company.\nThe Company is a defendant in various litigation in the normal course of business. Based on consultation with various counsel in these matters, management is of the opinion that the ultimate resolution of such claims will not materially affect the Company's financial position or results of operations.\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS\nThe management of QMS, Inc. is responsible for the preparation, integrity and objectivity of the consolidated financial statements and all other sections of this annual report. The financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the consolidated financial statements, management made informed estimates and judgments of the expected effects of events and transactions based upon currently available facts and circumstances.\nManagement maintains a system of internal accounting controls which it believes is adequate to provide reasonable assurance that assets are safeguarded, transactions are executed in accordance with management authorization and the financial records are reliable for preparing the consolidated financial statements. The concept of reasonable assurance recognizes that the cost of a system of internal accounting controls should not exceed the benefits derived and that there are inherent limitations in the effectiveness of any system of internal accounting controls.\nThe Company's independent auditors, Deloitte & Touche LLP, have audited the Company's consolidated financial statements and expressed an opinion that such statements present fairly the Company's financial position, results of operations and cash flows in conformity with generally accepted accounting principles. Their audit was conducted in accordance with generally accepted auditing standards and included such procedures believed by them to be sufficient to provide reasonable assurance that the consolidated financial statements are free of material misstatement.\nThe Board of Directors, acting through its Audit Committee, oversees management's responsibilities in the preparation of the consolidated financial statements. In performing this function, the Audit Committee, which is composed of directors who are not employees of the Company, meets periodically with management and the independent auditors to review the work of each. Deloitte & Touche LLP has 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.\nWe believe these policies and procedures provide reasonable assurance that our operations are conducted with a high standard of business conduct and that the financial statements reflect fairy the financial position, results of operations and cash flows of the Company.\n\/s\/James L. Busby President and Chief Executive Officer\n\/s\/Charles D. Daley Executive Vice President, Finance and Administration and Chief Financial Officer\nQUARTERLY DATA\nUnaudited quarterly data for the fiscal years ended September 30, 1994 and October 1, 1993.\nDollars in thousands, except First Second Third Fourth per share amounts Quarter Quarter Quarter Quarter\nNet sales $ 70,654 $ 71,283 $ 73,538 $ 77,213 Gross profit 23,832 23,270 23,748 25,300 Net income (loss) (366) 551 1,205 1,570 Earnings (loss) per common share: Primary $ (.03) $ .05 $ .11 $ .15 Fully diluted $ (.03) $ .05 $ .11 $ .15\nDollars in thousands, except First Second Third Fourth per share amounts Quarter Quarter Quarter Quarter\nNet sales $ 77,273 $ 82,491 $ 70,455 $ 67,161 Gross profit 25,967 27,883 22,730 18,996 Net income (loss) 1,359 1,968 (1,237) (5,486) Earnings (loss) per common share: Primary $ .13 $ .18 $ (.11) $ (.51) Fully diluted $ .13 $ .18 $ (.11) $ (.51)\nINDEPENDENT AUDITORS' REPORT\nWe have audited the accompanying consolidated balance sheets of QMS, Inc. and subsidiaries as of September 30, 1994 and October 1, 1993 and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three fiscal years in the period ended September 30, 1994. Our audits also included the financial statement schedule listed in the index at Item 14. 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, such consolidated financial statements present fairly, in all material respects, the financial position of QMS, Inc. and subsidiaries at September 30, 1994 and October 1, 1993 and the results of their operations and their cash flows for each of the three fiscal years in the period ended September 30, 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\nMobile, Alabama October 20, 1994, except for Note 6 as to which the date is December 9, 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND ACCOUNTING 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 information under the captions \"Proposal 1 - Election of Directors - Directors and Director Nominees and - Compliance with Section 16(a) of the Securities Exchange Act of 1934\" on pages 2-4 of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held on January 25, 1994 (the \"Proxy Statement\") and \"Executive Officers\" on page 4 of the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this item is incorporated by reference to information under the captions \"Proposal 1 - Election of Directors - Director Compensation\" on page 4, \"Executive Compensation Tables\" on pages 5-7, \"Stock Performance Graph\" on page 8, \"Executive Agreements\" on pages 8- 9 and \"Report of the Compensation Committee of the Board of Directors of QMS, Inc.\" on pages 9-11 of 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 information under the caption \"Beneficial Ownership of Common Stock\" on page 5 of 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 information under the caption \"Compensation Committee Interlocks and Insider Participation\" on page 11 of 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 part of this report:\n1. Financial Statements\nThe following financial statements are included in Item 8 of Part II:\nConsolidated Statements of Operations for the Fiscal Years Ended September 30, 1994, October 1, 1993 and October 2, 1992.\nConsolidated Statements of Changes in Stockholders' Equity for the Fiscal Years Ended September 30, 1994, October 1, 1993 and October 2, 1992.\nConsolidated Balance Sheets at September 30, 1994 and October 1, 1993.\nConsolidated Statements of Cash Flows for the Fiscal Years Ended September 30, 1994, October 1, 1993 and October 2, 1992.\nNotes to Consolidated Financial Statements for the Fiscal Years Ended September 30, 1994, October 1, 1993 and October 2, 1992.\n2. Financial Statement Schedules\nThe schedule listed below is included herein immediately after the signature pages hereto. Schedules not listed below have been omitted because they are not applicable or the required information is included in the financial statements or notes thereto.\nSchedule Number Description\nVIII Valuation and Qualifying Accounts and Reserves for the Three Fiscal Years Ended September 30, 1994.\nThe Registrant's independent auditors' report on the financial statements and financial statement schedule listed above is located at Item 8 of Part II.\n3. Exhibits:\nExhibit Number Description\n3(a) Restated Certificate of Incorporation, as amended as of February 17, 1987\/1\/ and Certificate of Amendment thereto filed with the Secretary of State of Delaware as of January 31, 1991.\/2\/\n3(b) Bylaws of Registrant.\/1\/\n4(a) The rights of security holders are defined in Articles 4, 9 and 10 of the Restated Certificate of Incorporation of the Registrant, Articles II, VI and VII of the Bylaws of the Registrant and the Rights Agreement. [Incorporated herein by reference to Exhibits 3(a), 3(b) and 4(b), respectively.]\n4(b) Rights Agreement dated November 30, 1988.\/3\/\n10(a)(i) Cash or Deferred Retirement Plan, as amended and restated as of December 17, 1993.\/4\/\/*\/\n10(a)(ii) Trust Agreement dated November 1, 1993 relating to the Cash or Deferred Retirement Plan as amended by an Amendment to the Trust Agreement dated December 28, 1993.\/4\/\n10(b) QMS, Inc. Annual Individual Incentive Compensation Plan - Fiscal Year 1994.\/4\/\/*\/\n10(c)(i) Form of 1987 Stock Option Plan, as amended and restated as of December 13, 1990.\/2\/\/*\/\n10(c)(ii) Form of First Amendment to the 1987 Stock Option Plan effective November 7, 1991.\/2\/\/*\/\n10(d) Supplemental Executive Retirement Plan Agreements dated September 30, 1991.\/4\/\/*\/\n10(e)(i) Worldwide Master Purchase Agreement 90-01 among Canon U.S.A., Inc., Canon Europa, N.V. and QMS, Inc. dated October 1, 1990.\/5\/\n10(e)(ii) SX\/TX\/LX Worldwide Master Purchase Agreement 90-02 among Canon U.S.A., Inc., Canon Europa, N.V. and QMS, Inc. dated October 1, 1990.\/5\/\n10(e)(iii) LBP-20 Purchase Agreement 90- 03-LBP-20 between Canon U.S.A., Inc. and QMS, Inc. dated October 1, 1990.\/5\/\n10(f) Note Agreement dated March 15, 1988 (\"Note Agreement\") delivered by QMS, Inc. to Connecticut General Life Insurance Company for $20,000,000 in aggregate principal amount of QMS, Inc.'s 10.13% Senior Unsecured Notes due March 31, 1998 (the \"Senior Notes\").\/6\/\n10(f)(iv) Amendment to Guaranty Agreement, made as of January 30, 1991, regarding the Senior Notes.\/5\/\n10(f)(v) Second Amendment to Security and Trust Agreement, dated as of October 2, 1992, regarding the Senior Notes.\/5\/\n10(f)(vi) Subordination Agreement, dated as of October 2, 1992, by and among certain subsidiaries of QMS, Inc. in favor of AmSouth Bank, N.A., First Union National Bank of North Carolina and First National Bank of Louisville.\/5\/\n10(f)(vii) Waiver Agreement, dated as of November 30, 1992. \/5\/\n10(f)(viii) Consolidating Amendment to Note Agreement dated June 30, 1993.\/7\/\n10(f)(ix) Supplemental Subordination Agreement, dated as of June 30, 1993, by and among certain subsidiaries of QMS, Inc., in favor of AmSouth Bank N.A., National City Bank, Kentucky and NationsBank of Georgia, N.A.\/7\/\n10(f)(x) Waiver Agreement dated as of November 23, 1993 waiving certain provisions of the Note Agreement.\/4\/\n10(f)(xi) Waiver Agreement dated as of February 25, 1994 waiving certain provisions of the Note Agreement.\/8\/\n10(f)(xii) Waiver Agreement dated as of May 3, 1994 waiving certain provisions of the Note Agreement.\/9\/\n10(f)(xiii) Waiver Agreement dated as of August 12, 1994 waiving certain provisions of the Note Agreement.\n10(f)(xiv) Waiver Agreement dated as of November 30, 1994 waiving certain provisions of the Note Agreement.\n10(g)(i) Amended and Restated Secured Revolving Credit Agreement (\"Amended and Restated Credit Agreement\") by and among QMS, Inc. and QMS Circuits, Inc. (Borrowers), AmSouth Bank, N.A. (Agent), and AmSouth Bank, N.A., First Union National Bank of North Carolina and First National Bank of Louisville (Lenders), with respect to $30,000,000, dated October 2, 1992.\/5\/\n10(g)(ii) Revolving Credit Notes, each dated October 2, 1992, with First National Bank of Louisville ($7,500,000), First Union National Bank of North Carolina ($7,500,000), and AmSouth Bank, N.A. ($15,000,000).\/5\/\n10(g)(iii) Second Amended Agreement Among Borrowers, made as of October 2, 1992.\/5\/\n10(g)(iv) Waiver of Non-Compliance, dated October 29, 1992.\/5\/\n10(g)(v) Supplemental Agreement for Fiscal Year 1993, made as of November 30, 1992.\/5\/\n10(g)(vi) First Amendment to Amended and Restated Credit Agreement, dated April 2, 1993.\/7\/\n10(g)(vii) Second Amendment to Amended and Restated Credit Agreement, dated June 30, 1993.\/7\/\n10(g)(viii) Supplemental Secured Revolving Credit Agreement (\"Supplemental Secured Credit Agreement\") by and among QMS, Inc. and QMS Circuits, Inc. (Borrowers), AmSouth Bank N.A., (Agent), and AmSouth Bank N.A., National City Bank, Kentucky and NationsBank of Georgia, N.A. (Lenders), with respect to $7,500,000, dated June 30, 1993.\/7\/\n10(g)(ix) Supplemental Revolving Credit Notes, each dated June 30, 1993, with National City Bank, Kentucky ($1,875,000), NationsBank of Georgia, N.A. ($1,875,000) and AmSouth Bank N.A. ($3,750,000).\/7\/\n10(g)(x) Third Amendment to Security and Trust Agreement, dated June 30, 1993 between QMS, Inc. and QMS Circuits, Inc. and AmSouth Bank N.A., as Trustee.\/7\/\n10(g)(xi) Assignment dated April 2, 1993 by First Union National Bank of North Carolina to NationsBank of Georgia, N.A. of its rights under the Amended and Restated Revolving Credit Agreement dated October 12, 1992.\/4\/\n10(g)(xii) Revolving Credit Note in the amount of $7,500,000 dated April 2, 1993 issued by QMS, Inc. and QMS Circuits, Inc. in favor of NationsBank of Georgia, N.A. replacing the Revolving Credit Note dated October 2, 1992 issued to First Union National Bank of North Carolina.\/4\/\n10(g)(xiii) Third Amendment to Amended and Restated Credit Agreement dated November 19, 1993.\/4\/\n10(g)(xiv) First Amendment to Supplemental Secured Credit Agreement dated November 19, 1993.\/4\/\n10(g)(xv) Fourth Amendment to Amended and Restated Credit Agreement dated April 22, 1994.\/8\/\n10(g)(xvi) Waiver Agreement dated as of May 3, 1994 waiving certain provisions of the Note Agreement.\/9\/\n10(g)(xvii) Waiver Agreement dated as of August 23, 1994 waiving certain provisions of the Note Agreement.\n10(g)(xviii) Fifth Amendment to Amended and Restated Credit Agreement dated as of December 9, 1994.\n10(h) Form of Executive Agreement entered into with: James L. Busby; Donald L. Parker, Ph.D.; Charles D. Daley; and Raymond A. Rosewall.\/10\/\/*\/\n10(l)(i) Note Agreement dated June 30, 1993 (\"1993 Note Agreement\") between QMS, Inc. and Connecticut General Life Insurance Company for $10,000,000 in aggregate principal amount of QMS, Inc.'s 6.15% Senior Secured Notes due June 15, 1998.\/7\/\n10(l)(ii) Mortgage, Trust and Security Agreement dated June 30, 1993 between QMS, Inc. and First Alabama Bank of Mobile, as Trustee, for QMS, Inc. $10,000,000 aggregate principal amount of 6.15% Senior Secured Notes due June 15, 1998.\/7\/\n10(l)(iii) Senior Secured Notes, each dated July 1, 1993, with CIG & CO. ($3,500,000) and ($3,500,000) and ZANDE & Co ($3,000,000).\/7\/\n10(l)(iv) Waiver Agreement dated November 23, 1993 waiving certain provisions of the 1993 Note Agreement\/4\/\n10(l)(v) Waiver Agreement dated as of February 25, 1994 waiving certain provisions of the Note Agreement.\/8\/\n10(l)(vi) Waiver Agreement dated as of May 3, 1994 waiving certain provisions of the 1993 Note Agreement.\/9\/\n10(l)(vii) Waiver Agreement dated as of August 12, 1994 waiving certain provisions of the 1993 Note Agreement.\n10(l)(viii) Waiver Agreement dated as of November 30, 1994 waiving certain provisions of the 1993 Note Agreement.\n10(o) Stock Option Plan, dated July 30, 1984,\/11\/\/*\/ together with First Amendment thereto effective as of January 1, 1987\/1\/\/*\/, Second Amendment thereto effective as of November 10, 1987,\/1\/\/*\/ Third Amendment thereto effective as of April 6, 1989,\/10\/\/*\/ Fourth Amendment thereto effective as of January 1, 1990\/6\/\/*\/ and Fifth Amendment thereto effective as of November 7, 1991.\/2\/\/*\/\n10(p) Stock Option Plan for Directors.\/12\/\/*\/\n11 Statement Regarding Computation of Earnings Per Share.\n21 Subsidiaries of the Registrant.\n23 Consent of Deloitte & Touche LLP, independent auditors.\n27 Financial Data Schedules\n\/*\/ Indicates a management contract or compensatory plan or arrangement.\n\/1\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended October 2, 1987 (Commission File No. 1-9348).\n\/2\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended September 27, 1991 (Commission File No. 1-9348).\n\/3\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended September 30, 1988 (Commission File No. 1-9348).\n\/4\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended October 1, 1993 (Commission File No. 1-9348).\n\/5\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended October 2, 1992 (Commission File No. 1-9348).\n\/6\/ Incorporated herein by reference to exhibit of same number in Registrant's quarterly report on Form 10-Q for the quarter ended April 1, 1988 (Commission File No. 1-9348).\n\/7\/ Incorporated herein by reference to exhibit of same number in Registrant's quarterly report on Form 10-Q for the fiscal quarter ended July 2, 1993 (Commission File No. 1-9348).\n\/8\/ Incorporated herein by reference to exhibit of same number in Registrant's quarterly report on Form 10-Q for the fiscal quarter ended April 1, 1994 (Commission File No. 1-9348).\n\/9\/ Incorporated herein by reference to exhibit of same number in Registrant's quarterly report on Form 10-Q for the fiscal quarter ended July 1, 1994 (Commission File No. 1-9348).\n\/10\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended September 29, 1989 (Commission File No. 1-9348).\n\/11\/ Incorporated herein by reference to exhibit of same number in Registrant's Registration Statement on Form S-1, filed September 19, 1984 (Registration No. 2-93329).\n\/12\/ Incorporated herein by reference to Appendix B to the Registrant's Proxy Statement for the Annual Meeting of Stockholders held on January 25, 1994 (Commission File No. 1- 9348).\n(b) Reports on Forms 8-K: None.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nQMS, Inc.\nDate: December 21, 1994 By: \/s\/James L. Busby James L. Busby President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate: December 21, 1994 By: \/s\/James L. Busby James L. Busby President and Director (Principal Executive Officer)\nDate: December 21, 1994 By: \/s\/Charles D. Daley Charles D. Daley Executive Vice President, Finance and Administration, Treasurer, Chief Financial Officer and Director (Principal Financial and Accounting Officer)\nDate: December 21, 1994 By: \/s\/Donald L. Parker, Ph.D. Donald L. Parker, Ph.D. Director\nDate: December 21, 1994 By: \/s\/Jack R. Altherr Jack R. Altherr Director\nDate: December 21, 1994 By: \/s\/Lucius E. Burch Lucius E. Burch Director\nDate: December 21, 1994 By: \/s\/Michael C. Dow Michael C. Dow Director\nDate: December 21, 1994 By: \/s\/G. William Speer G. William Speer Director\nSCHEDULE VIII QMS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE THREE FISCAL YEARS ENDED SEPTEMBER 30, 1994\nAdditions Balance at Charged to Beginning Costs and Deductions Balance at Description of Year Expenses (a) End of Year\nAllowance for doubtful accounts--deducted from receivables in the balance sheet\nYEAR ENDED OCTOBER 2, 1992.... $ 653,000 $ 575,000 $ 610,000 $ 618,000 ========= ========= ========= =========\nYEAR ENDED OCTOBER 1, 1993.... $ 618,000 $ 326,000 $ 364,000 $ 580,000 ========= ========= ========= =========\nYEAR ENDED SEPTEMBER 30, 1992..$ 580,000 $ 228,000 $ 304,000 $ 504,000 ========= ========= ========= =========\nAdditions Balance at Charged to Beginning Costs and Deductions Balance at Description of Year Expenses (b) End of Year\nInventory reserve-- deducted from inven- tory in the balance sheet\nYEAR ENDED OCTOBER 2, 1992.... $ 7,499,000 $ 5,357,000 $ 6,840,000 $ 6,016,000 ========= ========= ========= =========\nYEAR ENDED OCTOBER 1, 1993.... $ 6,016,000 $ 8,923,000 $ 8,635,000 $ 6,304,000 ========= ========= ========= =========\nYEAR ENDED SEPTEMBER 30, 1992..$ 6,304,000 $ 5,388,000 $ 4,884,000 $ 6,808,000 ========= ========= ========= =========\n(a) Uncollectible accounts written off (b) Disposal of inventory\nINDEX\n3. Exhibits:\nExhibit Page Number Description Number\n3(a) Restated Certificate of Incorporation, as amended as of February 7, 1987\/1\/ and Certificate of Amendment thereto filed with the Secretary of State of Delaware as of January 31, 1991,\/2\/\n3(b) Bylaws of Registrant\/1\/\n4(a) The rights of security holders are defined in Articles 4, 9 and 10 of the Restated Certificate of Incorporation of the Regis- trant, Articles II, VI and VII of the Bylaws of the Registrant and the Rights Agreement. [Incorporated herein by reference to Exhibits 3(a), 3(b) and 4(b), respectively.]\n4(b) Rights Agreement dated November 30, 1988.\/3\/\n10(a)(i) Cash or Deferred Retirement Plan, as amended and restated as of December 17, 1993. \/4\/\/*\/\n10(a)(ii) Trust Agreement dated November 1, 1993 relating to the Cash or Deferred Retirement Plan as amended by an Amendment to the Trust Agreement dated December 28, 1993.\/4\/\n10(b) QMS, Inc. Annual Individual Incentive Compen- sation Plan - Fiscal Year 1994.\/4\/\/*\/\n10(c)(i) Form of 1987 Stock Option Plan, as amended and restated as of December 13, 1990.\/2\/\/*\/\n10(c)(ii) Form of First Amendment to the 1987 Stock Option Plan effective November 7, 1991.\/2\/\/*\/\n10(d) Supplemental Executive Retirement Plan Agreements dated September 30, 1991. \/4\/\/*\/\n10(e)(i) Worldwide Master Purchase Agreement 90-01 among Canon U.S.A., Inc., Canon Europa, N.V. and QMS, Inc. dated October 1, 1990.\/5\/\n10(e)(ii) SX\/TX\/LX Worldwide Master Purchase Agreement 90-02 among Canon U.S.A., Inc., Canon Europa, N.V. and QMS, Inc. dated October 1, 1990.\/5\/\n10(e)(iii) LBP-20 Purchase Agreement 90-03-LBP-20 between Canon U.S.A., Inc. and QMS, Inc. dated October 1, 1990.\/5\/\n10(f) Note Agreement dated March 15, 1988 (\"Note Agreement\") delivered by QMS, Inc. to Connecticut General Life Insurance Company for $20,000,000 in aggregate principal amount of QMS, Inc.'s 10.13% Senior Unsecured Notes due March 31, 1998 (the \"Senior Notes\").\/6\/\n10(f)(iv) Amendment to Guaranty Agreement, made as of January 30, 1991, regarding the Senior Notes.\/5\/\n10(f)(v) Second Amendment to Security and Trust Agreement, dated as of October 2, 1992, regarding the Senior Notes.\/5\/\n10(f)(vi) Subordination Agreement, dated as of October 2, 1992, by and among certain subsidiaries of QMS, Inc. in favor of AmSouth Bank, N.A., First Union National Bank of North Carolina and First National Bank of Louisville.\/5\/\n10(f)(vii) Waiver Agreement, dated as of November 30, 1992.\/5\/\n10(f)(viii) Consolidating Amendment to Note Agreement dated June 30, 1993.\/7\/\n10(f)(ix) Supplemental Subordination Agreement, dated as of June 30, 1993, by and among certain subsidiaries of QMS, Inc., in favor of AmSouth Bank N.A., National City Bank, Kentucky and NationsBank of Georgia, N.A.\/7\/\n10(f)(x) Waiver Agreement dated as of November 23, 1993 waiving certain provisions of the Note Agreement.\/4\/\n10(f)(xi) Waiver Agreement dated as of February 25, 1994 waiving certain provisions of the Note Agreement.\/8\/\n10(f)(xii) Waiver Agreement dated as of May 3, 1994 waiving certain provisions of the Note Agreement.\/9\/\n10(f)(xiii) Waiver Agreement dated as of August 12, 48 1994 waiving certain provisions of the Note Agreement.\n10(f)(xiv) Waiver Agreement dated as of November 30, 50 1994 waiving certain provisions of the Note Agreement.\n10(g)(i) Amended and Restated Secured Revolving Credit Agreement (\"Amended and Restated Credit Agreement\") by and among QMS, Inc. and QMS Circuits, Inc. (Borrowers), AmSouth Bank, N.A. (Agent), and AmSouth Bank, N.A., First Union National Bank of North Carolina and First National Bank of Louisville (Lenders), with respect to $30,000,000, dated October 2, 1992.\/5\/\n10(g)(ii) Revolving Credit Notes, each dated October 2, 1992, with First National Bank of Louisville ($7,500,000), First Union National Bank of North Carolina ($7,500,000), and AmSouth Bank, N.A. ($15,000,000).\/5\/\n10(g)(iii) Second Amended Agreement Among Borrowers, made as of October 2, 1992.\/5\/\n10(g)(iv) Waiver of Non-Compliance, dated October 29, 1992.\/5\/\n10(g)(v) Supplemental Agreement for Fiscal Year 1993, made as of November 30, 1992.\/5\/\n10(g)(vi) First Amendment to Amended and Restated Credit Agreement, dated April 2, 1993.\/7\/\n10(g)(vii) Second Amendment to Amended and Restated Credit Agreement, dated June 30, 1993.\/7\/\n10(g)(viii) Supplemental Secured Revolving Credit Agreement (\"Supplemental Secured Credit Agreement\") by and among QMS, Inc. and QMS Circuits, Inc. (Borrowers), AmSouth Bank N.A., (Agent), and AmSouth Bank N.A., National City Bank, Kentucky and NationsBank of Georgia, N.A. (Lenders), with respect to $7,500,000, dated June 30, 1993.\/7\/\n10(g)(ix) Supplemental Revolving Credit Notes, each dated June 30, 1993, with National City Bank, Kentucky ($1,875,000), NationsBank of Georgia, N.A. ($1,875,000) and AmSouth Bank N.A. ($3,750,000).\/7\/\n10(g)(x) Third Amendment to Security and Trust Agreement, dated June 30, 1993 between QMS, Inc. and QMS Circuits, Inc. and AmSouth Bank N.A., as Trustee.\/7\/\n10(g)(xi) Assignment dated April 2, 1993 by First Union National Bank of North Carolina to NationsBank of Georgia, N.A. of its rights under the Amended and Restated Revolving Credit Agreement dated October 12, 1992.\/4\/\n10(g)(xii) Revolving Credit Note in the amount of $7,500,000 dated April 2, 1993 issued by QMS, Inc. and QMS Circuits, Inc. in favor of Nations- Bank of Georgia, N.A. replacing the Revolving Credit Note dated October 2, 1992 issued to First Union National Bank of North Carolina.\/4\/\n10(g)(xiii) Third Amendment to Amended and Restated Credit Agreement dated November 19, 1993.\/4\/\n10(g)(xiv) First Amendment to Supplemental Secured Credit Agreement dated November 19, 1993.\/4\/\n10(g)(xv) Fourth Amendment to Amended and Restated Credit Agreement dated April 22, 1994.\/8\/\n10(g)(xvi) Waiver Agreement dated as of May 3, 1994 waiving certain provisions of the Note Agreement.\/9\/\n10(g)(xvii) Waiver Agreement dated as of August 23, 1994 52 waiving certain provisions of the Note Agreement.\n10(g)(xviii) Fifth Amendment to Amended and Restated Credit 53 Agreement dated as of December 9, 1994.\n10(h) Form of Executive Agreement entered into with: James L. Busby; Donald L. Parker, Ph.D.; Charles D. Daley; and Raymond A. Rosewall.\/10\/\/*\/\n10(l)(i) Note Agreement dated June 30, 1993 (\"1993 Note Agreement\") between QMS, Inc. and Connecticut General Life Insurance Company for $10,000,000 in aggregate principal amount of QMS, Inc.'s 6.15% Senior Secured Notes due June 15, 1998.\/7\/\n10(l)(ii) Mortgage, Trust and Security Agreement dated June 30, 1993 between QMS, Inc. and First Alabama Bank of Mobile, as Trustee, for QMS, Inc. $10,000,000 aggregate principal amount of 6.15% Senior Secured Notes due June 15, 1998.\/7\/\n10(l)(iii) Senior Secured Notes, each dated July 1, 1993, with CIG & CO. ($3,500,000) and ($3,500,000) and ZANDE & Co ($3,000,000).\/7\/\n10(l)(iv) Waiver Agreement dated November 23, 1993 waiving certain provisions of the 1993 Note Agreement.\/4\/\n10(l)(v) Waiver Agreement dated as of February 25, 1994 waiving certain provisions of the Note Agreement.\/8\/\n10(l)(vi) Waiver Agreement dated as of May 3, 1994 waiving certain provisions of the 1993 Note Agreement.\/9\/\n10(l)(vii) Waiver Agreement dated as of August 12, 1994 57 waiving certain provisions of the 1993 Note Agreement.\n10(l)(viii) Waiver Agreement dated as of November 30, 1994 59 waiving certain provisions of the 1993 Note Agreement.\n10(o) Stock Option Plan, dated July 30, 1984,\/11\/\/*\/ together with First Amendment thereto effective as of January 1, 1987\/1\/\/*\/, Second Amendment thereto effective as of November 10, 1987,\/1\/\/*\/ Third Amendment thereto effective as of April 6, 1989,\/10\/\/*\/ Fourth Amendment thereto effective as of January 1, 1990\/6\/\/*\/ and Fifth Amendment thereto effective as of November 7, 1991.\/2\/\/*\/\n10(p) Stock Option Plan for Directors.\/12\/\/*\/\n11 Statement Regarding Computation of Earnings Per 61 Share.\n21 Subsidiaries of the Registrant. 62\n23 Consent of Deloitte & Touche LLP, independent 63 auditors.\n27 Financial Data Schedules 64\n\/*\/ Indicates a management contract or compensatory plan or arrangement.\n\/1\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended October 2, 1987 (Commission File No. 1-9348).\n\/2\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended September 27, 1991 (Commission File No. 1-9348).\n\/3\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended September 30, 1988 (Commission File No. 1-9348).\n\/4\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended October 1, 1993 (Commission File No. 1-9348).\n\/5\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended October 2, 1992 (Commission File No. 1-9348).\n\/6\/ Incorporated herein by reference to exhibit of same number in Registrant's quarterly report on Form 10-Q for the quarter ended April 1, 1988 (Commission File No. 1-9348).\n\/7\/ Incorporated herein by reference to exhibit of same number in Registrant's quarterly report on Form 10-Q for the fiscal quarter ended July 2, 1993 (Commission File No. 1-9348).\n\/8\/ Incorporated herein by reference to exhibit of same number in Registrant's quarterly report on Form 10-Q for the fiscal quarter ended April 1, 1994 (Commission File No. 1-9348).\n\/9\/ Incorporated herein by reference to exhibit of same number in Registrant's quarterly report on Form 10-Q for the fiscal quarter ended July 1, 1994 (Commission File No. 1-9348).\n\/10\/ Incorporated herein by reference to exhibit of same number in Registrant's annual report on Form 10-K for the fiscal year ended September 29, 1989 (Commission File No. 1-9348).\n\/11\/ Incorporated herein by reference to exhibit of same number in Registrant's Registration Statement on Form S-1, filed September 19, 1984 (Registration No. 2-93329).\n\/12\/ Incorporated herein by reference to Appendix B to the Registrant's Proxy Statement for the Annual Meeting of Stockholders held on January 25, 1994 (Commission File No. 1- 9348).\n(b) Forms 8-K: None. _______________________________ 1 The following registered trademarks of the Registrant are used herein: QMS-PS(R), ColorScript(R), Crown(R), and MAGNUM(R). PostScript is a trademark of Adobe Systems Incorporated, which may be registered in certain jurisdictions, and PCL(R) is a registered trademark of Hewlett Packard Company.","section_15":""}
{"filename":"92416_1994.txt","cik":"92416","year":"1994","section_1":"ITEM 1. BUSINESS\nThe registrant, Southwest Gas Corporation (the Company), is incorporated under the laws of the State of California effective March 1931, and is comprised of two segments: natural gas operations and financial services. The natural gas operations segment (gas segment) includes natural gas transmission and distribution operations in Arizona, Nevada and California. The financial services segment consists of PriMerit Bank (the Bank), a wholly owned subsidiary, which operates principally in the thrift industry. See Selected Financial Data for financial information related to each business segment.\nThe executive offices of the Company are located at 5241 Spring Mountain Road, P.O. Box 98510, Las Vegas, Nevada 89193-8510, telephone number (702) 876-7237.\nNATURAL GAS OPERATIONS\nGENERAL DESCRIPTION\nThe Company is subject to regulation by the Arizona Corporation Commission (ACC), the Public Service Commission of Nevada (PSCN) and the California Public Utilities Commission (CPUC). These commissions regulate public utility rates, practices, facilities and service territories in their respective states. The service areas certificated to the Company by the respective regulatory commissions having jurisdiction over it are exclusive. They remain exclusive unless the Company defaults on its obligations to provide adequate service and another utility can be found that is willing and able to supply the service. The CPUC also regulates the issuance of all securities by the Company, with the exception of short-term borrowings. Certain of the Company's accounting practices, transmission facilities and rates are subject to regulation by the Federal Energy Regulatory Commission (FERC).\nThe Company purchases, transports and distributes natural gas to approximately 980,000 residential, commercial and industrial customers in geographically diverse portions of Arizona, Nevada and California. There were 48,000 customers added to the system during 1994. See Natural Gas Operations Segment - Capital Resources and Liquidity of Management's Discussion and Analysis (MD&A) for discussion of capital requirements to meet the Company's expected future growth.\nThe table below lists the Company's percentage of operating margin (operating revenues less net cost of gas) by major customer class for the years indicated:\nThe volume of sales and transportation activity for electric utility generating plants varies greatly according to demand for electricity and the availability of alternative energy sources; however, it is not material in relation to the Company's earnings. In addition, the Company is not dependent on any one or a few customers to the extent that the loss of any one or several would have a significant adverse impact on the Company.\nTransportation of customer-secured gas to end-users on the Company's system continues to have a significant impact on the Company's throughput, accounting for 51 percent of total system throughput in 1994. Although the volumes were significant, these customers provide a much smaller proportionate share of the Company's operating margin as indicated in the table above. In 1994, customers who utilized this service transported 915 million therms.\nThe demand for natural gas is seasonal, and it is management's opinion that comparisons of earnings for interim periods do not reliably reflect overall trends and changes in the Company's operations. Also, earnings for interim periods can be significantly affected by the timing of general rate relief.\nPROPERTIES\nThe plant investment of the Company consists primarily of transmission and distribution mains, compressor stations, peak shaving\/storage plants, service lines, meters and regulators which comprise the pipeline systems and facilities located in and around the communities served. The Company also includes other properties such as land, buildings, furnishings, work equipment and vehicles in plant investment. The Company's northern Nevada and northern California properties are referred to as the northern system; the Arizona, southern Nevada and southern California properties are referred to as the southern system. Several properties are leased by the Company, including a Liquefied Natural Gas (LNG) storage plant on its northern Nevada system and a portion of the corporate headquarters office complex located in Las Vegas, Nevada. See Note 6 of the Notes to Consolidated Financial Statements for additional discussion regarding these leases. Total gas plant, exclusive of leased property, at December 31, 1994, was $1.5 billion, including construction work in progress. It is the opinion of management that the properties of the Company are suitable and adequate for its purposes.\nSubstantially all of the Company's gas mains and service lines are constructed across property owned by others under right-of-way grants obtained from the record owners thereof, on the streets and grounds of municipalities under authority conferred by franchises or otherwise, or on public highways or public lands under authority of various federal and state statutes. None of the Company's numerous county and municipal franchises are exclusive, and some are of limited duration. These franchises are renewed regularly as they expire, and the Company anticipates no serious difficulties in obtaining future renewals.\nWith respect to the right-of-way grants, the Company has had continuous and uninterrupted possession and use of all such rights-of-way, and the associated gas mains and service lines, commencing with the initial stages of the construction of such facilities. Permits have been obtained from public authorities in certain instances to cross, or to lay facilities along, roads and highways. These permits typically are revocable at the election of the grantor, and the Company occasionally must relocate its facilities when requested to do so by the grantor. Permits have also been obtained from railroad companies to cross over or under railroad lands or rights-of-way, which in some instances require annual or other periodic payments and are revocable at the grantors' elections.\nThe Company operates two major pipeline transmission systems: (i) a system owned by Paiute Pipeline Company (Paiute), a wholly owned subsidiary of the Company, extending from the Idaho-Nevada border to the Reno, Sparks and Carson City areas and communities in the Lake Tahoe area in both California and Nevada and other communities in northern and western Nevada; and (ii) a system extending from the Colorado River at the southern tip of Nevada to the Las Vegas distribution area.\nThe Company also owns a 35,000 acre site in northern Arizona which was acquired for the purpose of constructing an underground natural gas storage facility, known as the Pataya Gas Storage Project (Pataya), to serve its southern system. Based upon current studies and the continued restructuring of the utility industry, the Company believes that it will need an underground natural gas storage facility, such as Pataya, in the future to meet the needs of its customers on the southern system. In addition to the gas storage facility, the Company is considering other opportunities for other portions of the site, such as the partial sale of its water rights. Other potential uses for the land include sites for solar generating facilities, cogeneration facilities and various other business ventures. Project costs of $11.1 million have been capitalized through December 1994 and include land acquisition and related development costs.\nThe map below shows the locations of the Company's major facilities and major transmission lines, and principal communities to which the Company supplies gas either as a wholesaler or distributor. The map also shows major supplier transmission lines that are interconnected with the Company's systems.\n[MAP]\n[DESCRIPTION: Map of Arizona, Nevada, and southern California indicating the location of the Company's service areas. Service areas in Arizona include most of the central and southern areas of the state including Phoenix, Tucson, Yuma and surrounding communities. Service areas in northern Nevada include Carson City, Yerington, Fallon, Lovelock, Winnemucca and Elko. Service areas in southern Nevada include the Las Vegas valley (including Henderson and Boulder City), and Laughlin. Service areas in southern California include Barstow, Big Bear, Needles and Victorville. Service areas in northern California include the north shore of Lake Tahoe. Companies providing gas transportation services for the Company are indicated by showing the location of their pipelines. Major transporters include El Paso Natural Gas Company, Northwest Pipeline Corporation and Southern California Gas Company. The location of Paiute Pipeline Company's transmission pipeline (extending from the Idaho\/Nevada border to the Reno\/Tahoe area) and the Company's pipeline (extending from Laughlin\/Bullhead City to the Las Vegas valley) are indicated. The LNG facility is located near Lovelock, Nevada. The liquefied petroleum gas facility is located near Reno, Nevada.]\nRATES AND REGULATION\nRates that the Company is authorized to charge its distribution system customers are determined by the ACC, CPUC and PSCN in general rate cases and are derived using rate base, cost of service and cost of capital experienced in a historical test year, as adjusted in Arizona and Nevada, and projected for a future test year in California. The FERC regulates the northern Nevada transmission and LNG storage facilities of Paiute and the rates it charges for transportation of gas directly to certain end-users and to various local distribution companies (LDCs). The LDCs transporting on Paiute's system are: Sierra Pacific Power Company (Reno and Sparks, Nevada), Washington Water Power Company (South Lake Tahoe, California) and Southwest Gas Corporation (North Lake Tahoe, California and various locations throughout northern Nevada).\nRates charged to customers vary according to customer class and are fixed at levels allowing for the recovery of all prudently incurred costs, including a return on rate base sufficient to pay interest on debt, preferred dividends, and a reasonable return on common equity. The Company's rate base consists generally of the original cost of utility plant in service, plus certain other assets such as working capital and inventories, less accumulated depreciation on utility plant in service, net deferred income tax liabilities, and certain other deductions. The Company's rate schedules in all of its service areas contain purchased gas adjustment (PGA) clauses which permit the Company to adjust its rates as the cost of purchased gas changes. Generally, the Company's tariffs provide for annual adjustment dates for changes in purchased gas costs. However, the Company may request to adjust its rates more often than once each year, if conditions warrant. These changes have no significant impact on the Company's profit margin.\nThe table below lists the docketed rate filings initiated and\/or completed within each ratemaking area in 1994 and the first quarter of 1995:\n- ---------------\n(1) See Natural Gas Operations Segment - Rates and Regulatory Proceedings of MD&A for a discussion on the final order by the PSCN of certain rate case issues.\n(2) Interim rates reflecting the increased revenues became effective in April 1993. The rates were subject to refund until a final order was issued in January 1995.\nSee Natural Gas Operations Segment -- Rates and Regulatory Proceedings of MD&A for a discussion of the financial impact of recent general rate cases.\nCOMPETITION\nElectric utilities are the Company's principal competitors for the residential and small commercial markets throughout the Company's service areas. Competition for space heating, general household and small commercial energy needs generally occurs at the initial installation phase when the customer typically makes the decision as to which type of equipment to install and operate. The customer will generally continue to use the chosen energy source for the life of the equipment due to its relatively high replacement cost. As a result of\nits success in these markets, the Company has experienced consistent growth among the residential and small commercial customer classes.\nUnlike residential and small commercial customers, certain large commercial, industrial and electric generation customers have the capability to switch to alternative energy sources. Rates for these customers are set at levels competitive with alternative energy sources such as fuel oils and coal. The Company has been able to maintain the maximum allowable prices for most of its alternate fuel capable customers. As a result, management does not anticipate any material adverse impact on its operating margin. The Company maintains no backlog on its orders for gas service.\nThe Company continues to compete with interstate transmission pipeline companies, such as El Paso Natural Gas Company (El Paso), Kern River Gas Transmission Company (Kern River), and the proposed Tuscarora pipeline, to provide service to end-users. End-use customers located in close proximity to these interstate pipelines pose a potential bypass threat and, therefore, require the Company to monitor closely each customer's situation and provide competitive service in order to retain the customer. The Company has experienced no significant financial impact to date from the threat of bypass. However, industry restructuring as a result of the capacity release provisions of FERC Order No. 636, whereby shippers can release available pipeline capacity on a temporary or permanent basis, could increase the viability of end-use customer bypass directly to interstate pipeline companies.\nDEMAND FOR NATURAL GAS\nDeliveries of natural gas by the Company are made under a priority system established by each regulatory commission having jurisdiction over the Company. The priority system is intended to ensure that the gas requirements of higher-priority customers, primarily residential customers and nonresidential customers who use 50,000 cubic feet of gas per day or less, are fully satisfied on a daily basis before lower-priority customers, primarily electric utility and large industrial customers able to use alternative fuels, are provided any quantity of gas or capacity.\nDemand for natural gas is greatly affected by temperature. On cold days, use of gas by residential and commercial customers may be as much as eight times greater than on warm days because of increased use of gas for space heating. To fully satisfy this increased high-priority demand, gas is withdrawn from storage, or peaking supplies are purchased from suppliers. If necessary, service to interruptible lower-priority customers may also be curtailed to provide the needed delivery system capacity.\nNATURAL GAS SUPPLY\nThe Company believes that natural gas supplies will remain plentiful and readily available. The Company primarily obtains its gas supplies for its southern system from producing regions in New Mexico (San Juan basin), Texas (Permian basin) and Oklahoma (Anadarko basin). For its northern system, the Company primarily obtains gas from Rocky Mountain producing areas and from Canada. The Company arranges for transportation of gas to its Arizona, Nevada and California service territories through the pipeline systems of El Paso, Kern River, Northwest Pipeline Corporation and Southern California Gas Company (SoCal). The Company continually monitors supply availability on both short-term and long-term bases to ensure the continued reliability of service to its customers.\nThe Company's primary objective with respect to gas supply is to ensure that adequate, as well as economical, supplies of natural gas are available from reliable sources. The Company acquires its gas from a wide variety of sources, including suppliers on the spot market and those who provide firm supplies over short-term and longer-term durations. Balancing firm supply assurances against the associated costs dictate a continually changing natural gas purchasing mix within the Company's supply portfolio. The Company believes its portfolio provides security as well as the operating flexibility needed to meet changing market conditions. During 1994, the Company acquired gas supplies from nearly 60 suppliers.\nThe purchase of natural gas at the wellhead is not regulated. During 1991, price ceilings on wells drilled after July 1989 were abolished and the remaining price ceilings on existing wells were abolished in\nJanuary 1993. The elimination of price ceilings has had no direct impact on the Company because natural gas is selling well below the previous regulatory ceilings, and supplies are adequate. The last few years have generally demonstrated seasonal volatility in the price of natural gas, with higher prices in the heating season and lower prices during the summer or off-peak consumption period.\nNatural Gas Industry Changes. In 1992, FERC Order No. 636 required open-access interstate pipelines to significantly restructure their services prior to the 1993\/94 winter heating season. Interstate pipelines discontinued their traditional role of gas supplier and began offering unbundled common carrier services, such as transportation, storage, and capacity release. Additionally, pipelines were required to implement a new method of rate design and to provide the information necessary for natural gas buyers and sellers to arrange transportation service on a more flexible basis. As a result of the new method of rate design, the Company is experiencing higher costs, which are currently being recovered through its PGA provisions.\nBecause of these and other utility industry changes, the Company continues to evaluate natural gas storage as an option to enable the Company to take advantage of seasonal price differentials and to otherwise protect the Company from the uncertainties associated with spot market purchases and the Company's need to obtain natural gas from a variety of sources to meet the growing demand of its customers.\nIn order to increase its options concerning gas supplies, the Company signed an agreement with SoCal in November 1992 to use a portion of SoCal's underground storage facilities. The agreement had many significant precedent conditions, all of which needed to be satisfied before the agreement could be implemented. Many of these conditions have not been satisfied and management now believes it is doubtful that all of the issues can be satisfactorily resolved. The Company continues to research and review other options concerning gas supplies, including other gas storage possibilities.\nENVIRONMENTAL MATTERS\nFederal, state and local laws and regulations governing the discharge of materials into the environment have had little direct impact upon either the Company or its subsidiaries. Environmental efforts, with respect to matters such as protection of endangered species and archeological finds, have resulted in the Company spending a greater amount of time in obtaining pipeline rights-of-way and sites for other facilities. However, increased environmental legislation and regulation are also perceived to be beneficial to the natural gas industry. Because natural gas is one of the most environmentally safe fuels currently available, its use will allow energy users to comply with stricter environmental standards. For example, management is of the opinion that legislation, such as the Clean Air Act Amendments of 1990 and the Energy Policy Act of 1992, has a positive effect on natural gas demand, including provisions encouraging the use of natural gas vehicles, cogeneration and independent power production.\nEMPLOYEES\nAt December 31, 1994, the natural gas operations segment had 2,359 regular full-time employees. The Company believes it has a good relationship with its employees. No employees are represented by a union.\nReference is hereby made to Item 10 in Part III of this report on Form 10-K for information relative to the executive officers of the Company.\nFINANCIAL SERVICES ACTIVITIES\nGENERAL DESCRIPTION\nThe Bank is a federally chartered stock savings bank conducting business through branch offices in Nevada. The Bank was organized in 1955 as Nevada Savings and Loan Association which, in 1988, changed its name to PriMerit Bank and its charter from a state chartered stock savings and loan association to a federally chartered stock savings bank. Deposit accounts are insured to the maximum extent permitted by law by the Federal Deposit Insurance Corporation (FDIC) through the Savings Association Insurance Fund (SAIF). The Bank is regulated by the Office of Thrift Supervision (OTS) and the FDIC, and is a member of the Federal Home Loan Bank (FHLB) system.\nThe Bank's principal business is to attract deposits from the general public and make loans secured by real estate and other collateral to enable borrowers to purchase, refinance, construct or improve such property. Revenues are derived from interest on real estate loans and debt securities and, to a lesser extent, from interest on nonmortgage loans, gains on sales of loans and debt securities, and fees received in connection with loans and deposits. The Bank's major expense is the interest it pays on savings deposits and borrowings.\nSince December 31, 1990, total assets have declined from $2.7 billion to $1.8 billion at December 31, 1994 as management restructured the balance sheet to more effectively operate under the guidelines of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). The decrease is also part of a long-term Strategic Business Plan \"right size-right structure\" strategy to optimize the Bank's size and earnings potential under the strict capital requirements of FIRREA.\nThe rising interest rate environment during 1994 has slowed prepayments within the loan and debt security portfolios, and has put pressure on the cost of funds. Net interest margin increased in 1994 despite this environment, in large part due to the ability to lag increases in rates paid on deposits versus increases in the wholesale market.\nThe following table sets forth certain ratios for the Bank for each of the periods stated:\nLENDING ACTIVITIES\nThe Bank's loan portfolio totaled $938 million at December 31, 1994, representing 52 percent of total assets at that date. The loan portfolio consists principally of intermediate-term and long-term real estate loans and, to a lesser extent, secured and unsecured commercial loans, and consumer loans including: home improvement, recreational vehicle, mobile home, marine and auto loans. The contractual maturity of loans secured by single-family dwellings has historically been 30 years, although in recent years the Bank has made a number of loans with maturities of 23 years or less. In January 1994, the Bank sold its credit card portfolio and entered into an agent bank relationship with the purchaser to issue credit cards to the Bank's customers. The Bank recognized a gain of $1.7 million ($1.1 million net of charge-offs).\nThe following table sets forth the composition of the loan portfolio by type of loan at the dates indicated (thousands of dollars):\n- ---------------\n(1) The Bank's portfolio of construction and land loans is generally due in one year or less.\nLoan Origination and Credit Risk\nOne of the Bank's primary businesses is to make and acquire loans secured by real estate and other collateral to enable borrowers to purchase, refinance, construct and improve such property. These activities entail potential credit losses, the size of which depends on a variety of economic factors affecting borrowers and the real estate collateral. While the Bank has adopted underwriting guidelines and credit review procedures to minimize credit losses, some losses will inevitably occur. Therefore, periodic reviews are made of the assets in an attempt to identify and deal appropriately with potential credit losses.\nThe Bank originates both fixed- and adjustable-rate loans in the single-family residential, commercial mortgage, and consumer home equity portfolios. The Bank's adjustable-rate loans in these portfolios are based on various indices, including the prime rate, the one-year constant maturity Treasury, six-month London Interbank Offering Rate (LIBOR), and to a lesser extent the 11th District cost of funds. Other consumer loans are generally fixed-rate, while construction and non-real estate commercial loans are generally adjustable-rate prime-based loans.\nThe Bank currently originates single-family residential (SFR) adjustable-rate mortgages (ARM) which generally have an initial interest rate below the current market rate and adjust to the applicable index plus a defined spread, subject to caps, after the first year. The Bank's ARM generally provide that the maximum rate that can be charged cannot exceed the initial rate by more than six percentage points. The annual interest rate adjustment on the Bank's ARM loans is generally limited to two percentage points.\nMany of the other adjustable-rate loans contain limitations as to both the amount and the interest rate change at each repricing date (periodic caps) and the maximum rates the loan can be repriced over the life of\nthe loan (lifetime caps). At December 31, 1994, periodic caps in the adjustable loan portfolio ranged from 25 to 800 basis points. Lifetime caps ranged from 9.75 to 22 percent.\nSee Financial Services Segment -- Risk Management -- Interest Rate Risk Management of MD&A for the static gap table which includes the maturity and repricing sensitivity of the Bank's loan portfolio.\nThe Bank's loan policies and underwriting standards are the primary means used to reduce credit risk exposure. The loan approval process is intended to assess both: (i) the borrower's ability to repay the loan by determining whether the borrower meets the established underwriting criteria; and (ii) the adequacy of the proposed collateral by determining whether the appraised value of (and, if applicable, the cash flow from) the collateral property is sufficient for the proposed loan. Under OTS regulations, management is held responsible for developing, implementing and maintaining prudent appraisal policies.\nThe Bank reviews adherence to approved lending policies and procedures, including proper approvals, timely completion of quarterly asset reviews, early identification of problem loans, reviewing the quality of underwriting and appraisals, tracking trends in asset quality and evaluating the adequacy of the allowance for credit losses. To further control its credit risk, the Bank monitors and manages its credit exposure in portfolio concentrations. Portfolio concentrations, including collateral types, industry groups, geographic locations, and loan types are assessed and the exposure is managed through the establishment of limitations of aggregate exposures.\nThe Bank maintains a comprehensive risk-rating system used in determining classified assets and allowances for estimated credit losses. The system involves an ongoing review of all assets containing an element of credit risk including loans, real estate and investment securities. The review process assigns a risk rating to each asset reviewed based upon various credit criteria. If the review indicates that it is probable that some portion of an asset will result in a loss, the asset is written down to its expected recovery value. An allocated general valuation allowance is established for each asset reviewed which has been assigned a risk classification. The allowance is determined, subject to certain minimum percentages, based upon probability of default (in the case of loans), estimated ranges of recovery, and probability of each estimate of recovery value. An allowance for estimated credit losses on classified assets not subject to a detailed review is established by multiplying a percentage by the aggregate balances of the assets outstanding in each risk category. The percentages assigned increase based on the degree of risk and reflect management's estimate of potential future losses from assets in a specific risk category. With respect to loans not subject to specific reviews, principally single-family residential and consumer loans, the allowance is established based upon historical loss experience. Additionally, an unallocated allowance is established to reflect economic and other conditions that may negatively affect the portfolio in the aggregate.\nAs part of the regular asset review process, management reviews factors relating to the possibility and magnitude of prospective loan and real estate losses, including historical loss experience, prevailing market conditions and classified asset levels. The Bank is required to classify assets and establish prudent valuation allowances in accordance with OTS regulations.\nEach loan portfolio contains unique credit risks for which the Bank has developed policies and procedures to manage as follows:\nSingle-Family Residential Lending. SFR mortgage loans comprise 56 percent of the loan portfolio at December 31, 1994 compared to 55 percent at December 31, 1993. This portfolio represents the largest lending component and is the component which contains the least credit risk.\nIt is the general policy of the Bank not to make SFR loans which have a loan-to-value ratio in excess of 80 percent unless insured by private mortgage insurance, Federal Housing Authority (FHA) insurance, or guaranteed by the Veterans Administration (VA). Single-family loans are generally underwritten to underwriting guidelines established by FHA, VA, Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) or preapproved private investors. On its SFR ARM offered with initial below market rates, the Bank qualifies the applicants using the fully indexed rate.\nThe Bank requires title insurance on all loans secured by liens on real property. The Bank also requires fire and other hazard insurance be maintained in amounts at least equal to the replacement cost of improvements on all properties securing its loans. Earthquake insurance, however, is not required.\nConsumer Lending. Consumer loans include installment loans secured by recreational vehicles, boats, autos and mobile homes, home equity loans, and loans secured by deposit accounts. Approximately 96 percent of the consumer loan portfolio is collateralized at December 31, 1994. The credit risk of the consumer loan portfolio is managed through both the origination function and the collection process. All consumer loan origination and collection efforts, except those secured by deposits, are performed at a central location in order to provide greater control in the process and a more uniform application of credit standards.\nThe Bank originates a majority of its installment loans through automobile, recreational vehicle and marine vehicle dealers. These loans are subject to underwriting by Bank personnel. Additionally, credit reviews of the dealers are performed on a periodic basis. The Bank pays dealers a fee for these loans based upon the excess of the contractual interest rate of the loan over the Bank's stated rate schedule.\nThe Bank utilizes a credit scoring model to assist in the analysis of loan applications and credit reports. Additionally, as a follow up to the application process, a review of selected originations is performed to monitor adherence to credit standards.\nCommercial and Construction. The commercial and construction portfolios consist of amortizing mortgage loans on multi-family residential and nonresidential real estate, construction and development loans secured by real estate, and commercial loans secured by collateral other than real estate. Residential tract construction loans are generally underwritten with a discounted loan-to-value ratio of less than 85 percent, while commercial income property loans are generally underwritten with a ratio less than 75 percent.\nConstruction loans involve risks different from completed project lending because loan funds are advanced upon the security of the project under construction, and if the loan goes into default, additional funds may have to be advanced to complete the project before it can be sold. Moreover, construction projects are subject to uncertainties inherent in estimating construction costs, potential delays in construction time, market demand and the accuracy of the estimate of value upon completion.\nThe Bank manages its risk in these portfolios through its credit evaluation, approval and monitoring processes. In addition to obtaining appraisals on real estate collateral-based loans, a review of actual and forecasted financial statements and cash flow analyses is performed. After such loans are funded, they are monitored by obtaining and analyzing current financial and cash flow information on a periodic basis.\nTo further control its credit risk in this portfolio, the Bank monitors and manages credit exposure on portfolio concentrations. The Bank regularly monitors portfolio concentrations by collateral types, industry groups, loan types, and individual and related borrowers. Such concentrations are assessed and exposures managed through establishment of limitations of aggregate exposures. The Bank no longer originates new construction and commercial loans in California and Arizona. At December 31, 1994, 48 percent or $19.5 million of the Bank's outstanding commercial secured loan portfolio consisted of loans to borrowers in the gaming industry, with additional unfunded commitments of $11.5 million. These loans are generally secured by real estate and equipment. The Bank's portfolio of loans, collateralized by real estate, consists principally of real estate located in Nevada, California and Arizona. Collectibility is, therefore, somewhat dependent on the economies and real estate values of these areas and industries. Construction loans and commercial real estate loans (including multi-family) generally have higher default rates than single-family residential loans. See Financial Services Segment -- Risk Management -- Credit Risk Management of MD&A for a table that sets forth the amounts of classified assets by type of loan.\nOrigination, Purchase and Sale of Loans\nThe Bank originates the majority of its loans within the state of Nevada; however, under current laws and regulations, the Bank may also originate and purchase loans or purchase participating interests in loans without regard to the location of the secured property. During 1994, the Bank originated $466 million in new loans, virtually all of which were secured by property located in Nevada. In the first quarter of 1994, the Bank\npurchased $41.9 million of single-family residential whole loans. During 1993, the Bank originated $500 million in new loans, of which 90 percent were secured by property located in Nevada, 8 percent were secured by property located in Arizona, and 2 percent were secured by property in California. As of December 31, 1994, 82 percent of the loan portfolio was secured by property located in Nevada, 12 percent secured by property located in California and 6 percent secured by property located in Arizona. The Bank originates real estate and commercial loans principally through its in-house personnel.\nSecondary Marketing Activity\nThe Bank has been involved in secondary mortgage market transactions through the sale of whole loans. In accordance with the Bank's Accounting Policy, fixed-rate residential loans with maturities greater than 25 years have been designated as held for sale. At December 31, 1994, $2.1 million of residential loans are designated as held for sale. See Note 4 of the Notes to Consolidated Financial Statements for additional discussion relating to such loans.\nUnder its loan participation and whole loan sale agreements, the Bank may continue to service the loans and collect payments on the loans as they become due. The amount of loans serviced for others was $415 million at December 31, 1994, compared to $477 million at year-end 1993, including $68 million and $93 million, respectively, of loans serviced for mortgage-backed securities (MBS) originated and owned by the Bank. The Bank pays the participating lender, under the terms of the participation agreement, a yield on the participant's portion of the loan, which is usually less than the interest agreed to be paid by the borrower. The difference is retained by the Bank as servicing income.\nIn connection with mortgage loan sales, the Bank makes representations and warranties customary in the industry relating to, among other things, compliance with laws, regulations and program standards and accuracy of information. In the event of a breach of these representations and warranties, or under certain limited circumstances, regardless of whether there has been such a breach, the Bank may be required to repurchase such mortgage loans. Typically, any documentation defects with respect to these mortgage loans that caused them to be repurchased, are corrected and the mortgage loans are resold. Certain repurchased mortgage loans may remain in the Bank's loan portfolio and, in some cases, repurchased mortgage loans are foreclosed and the acquired real estate sold.\nLoan Fees\nThe Bank receives loan origination fees for originating loans and commitment fees for making commitments to originate construction, income property and multi-family residential loans. It also receives loan fees and charges related to existing loans, including prepayment charges, late charges and assumption fees. The amount of loan origination fees, commitment fees and discounts received varies with loan volumes, loan types, purchase commitments made, and competitive and economic conditions. Loan origination and commitment fees, offset by certain direct loan origination costs, are being deferred and recognized over the contractual life of such loans as yield adjustments.\nASSET QUALITY\nNonperforming Assets. Nonperforming assets may be comprised of nonaccrual assets, restructured loans and real estate acquired through foreclosure. Nonaccrual assets are those on which management believes the timely collection of interest is doubtful. Assets are transferred to nonaccrual status when payments of interest or principal are 90 days past due or if, in management's opinion, the accrual of interest should be ceased sooner. There are no assets on accrual status which are over 90 days delinquent or past maturity.\nNonaccrual assets are restored to accrual status when, in the opinion of management, the financial condition of the borrower and\/or debt service capacity of the security property has improved to the extent that collectibility of interest and principal appears assured and interest payments sufficient to bring the asset current are received.\nRestructured loans represent loans for which the borrower is complying with the terms of a loan modified as to rate, maturity, or payment amount.\nThe following table summarizes nonperforming assets as of the dates indicated (thousands of dollars):\nThe increase in restructured loans in 1994 is a result of the classification of $13.9 million of single-family residential loan modifications made for borrowers with earthquake-related damage in California. Federal agencies encouraged financial institutions to modify loan terms for certain borrowers who were affected by the earthquake which occurred in January 1994. The terms of these modifications were generally three- to six-month payment extensions with no negative credit reporting regarding the borrower. These loans were on a nonaccrual basis during the extension period. Current interpretation by the OTS concerning the modifications made requires the loans to be classified as \"troubled debt restructured\" until they mature, are paid off, or are sold. The Bank reviewed the earthquake-related loans and classified $3.1 million as special mention and $677,000 as substandard and considered all of the loans in the overall general valuation analysis. The remainder of the earthquake-related loans are not classified and are deemed to have adequate reserves as they carry no more risk than any other SFR loan.\nAt December 31, 1994, all nonaccrual loans and real estate acquired through foreclosure are classified substandard. Additionally, $2.3 million of the restructured loans are classified substandard.\nThe amount of interest income that would have been recorded on the nonaccrual and restructured assets if they had been current under their original terms was $2.1 million for 1994. Actual interest income recognized on these assets was $970,000, resulting in $1.1 million of interest income foregone for the year. See further discussion below in Provision and Allowance for Credit Losses.\nClassified Assets. OTS regulations require the Bank to classify certain assets and establish prudent valuation allowances. Classified assets fall in one of three categories --\"substandard,\" \"doubtful,\" and \"loss.\" In addition, the Bank can designate an asset as \"special mention.\"\nAssets classified as \"substandard\" are inadequately protected by the current net worth or paying capacity of the obligor or the collateral pledged, if any. Assets which are designated as \"special mention\" possess weaknesses or deficiencies deserving close attention, but do not currently warrant classification as \"substandard.\" See Financial Services Segment -- Risk Management -- Credit Risk Management of MD&A for the amounts of the Bank's classified assets and ratio of classified assets to total assets, net of charge-offs.\nProvision and Allowance for Credit Losses. The provision for credit losses is dependent upon management's evaluation as to the amount needed to maintain the allowance for losses at a level considered appropriate to the perceived risk of future losses. A number of factors are weighed by management in determining the adequacy of the allowance, including internal analyses of portfolio quality measures and trends, specific economic and market conditions affecting valuation of the security properties and certain other factors. In addition, the OTS considers the adequacy of the allowance for credit losses and the net carrying value of real estate owned in connection with periodic examinations of the Bank. The OTS has the ability to require the Bank to recognize additions to the allowance or reductions in the net carrying value of real estate owned based on their judgement at the time of such examinations. In connection with the 1993 examination by the OTS, no additional reserves were required to be recorded by the Bank. The OTS commenced their 1994 examination of the Bank in February 1995.\nActivity in the allowances for credit losses on loans and real estate is summarized as follows (thousands of dollars):\n- ---------------\n* Ratio = Net charge-offs to average loans and real estate outstanding\nIncluded in net charge-offs are $1.7 million, $1.4 million, $1.9 million, $2.6 million and $2.6 million of recoveries from 1990 through 1994, respectively.\nThe real estate write-downs for 1992 were primarily the result of a decrease in the net realizable value and slower sales activity of five California single-family real estate development projects. The largest of these involved write-downs of $9.3 million as a result of an appraisal reflecting the continuing market decline in the California market and difficulty in obtaining third party construction financing.\nAllocation of Allowance for Credit Losses. The following is a breakdown of allocated loan loss allowance amounts by major categories. However, in management's opinion, the allowance must be viewed in its entirety.\nREAL ESTATE DEVELOPMENT ACTIVITIES\nThe Bank's investment in real estate held for development, net of allowance for estimated losses, excluding real estate acquired through foreclosure, decreased from $28.1 million at December 31, 1991 to $771,000 at December 31, 1994. The Bank's pretax loss from real estate operations was $612,000 in 1994, $910,000 in 1993, and $15.3 million in 1992.\nThe Bank and its subsidiaries have ceased making investments in new real estate development activities as a result of legislative and regulatory actions which have placed certain restrictions on the Bank's ability to invest in real estate. See Regulation -- General herein for additional discussion. The Bank and its subsidiaries are continuing the sale and wind down of remaining real estate investments.\nINVESTMENT ACTIVITIES\nFederal regulations require thrifts to maintain certain levels of liquidity and to invest in various types of liquid assets. The Bank invests in a variety of securities, including commercial paper, certificates of deposit, U.S. government and U.S. agency obligations, short-term corporate debt, municipal bonds, repurchase agreements and federal funds. The Bank also invests in longer term investments such as MBS and collateralized mortgage obligations (CMO) to supplement its loan production and to provide liquidity to meet unforeseen cash outlays. Income from cash equivalents and debt securities provides a significant source of revenue for the Bank, constituting 43 percent, 41 percent and 32 percent of total revenues for each of the years ended December 31, 1992, 1993 and 1994, respectively.\nThe Bank's activities in derivatives are limited to investments in CMO, interest rate swaps, and forward sale commitments. CMO are discussed in the following tables. Interest rate swaps and forward sale commitments are discussed in Note 17 of the Notes to Consolidated Financial Statements, and in Risk Management -- Interest Rate Risk Management of MD&A.\nIn order to mitigate the interest rate risk (IRR) and credit risk exposure in the debt security portfolio, the Bank has established guidelines within its Investment Portfolio Policy for maximum duration, credit quality, concentration limits per issuer, and counterparty capital requirements. The Investment Portfolio Policy also sets forth the types of permissible investment securities and unsuitable investment activities.\nAdditionally, the debt security portfolio is subject to the Asset Classification Policy of the Bank based on credit risk as determined by private rating firms, such as Standard and Poor's Corporation and Moody's Investors Services.\nOn December 31, 1993, the Bank adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" In conjunction with adoption, the Bank designated the vast majority of its debt security portfolio as available for sale. At December 31, 1993\nand 1994, no securities were designated as \"trading securities.\" See Note 2 of the Notes to Consolidated Financial Statements for further discussion.\nThe following tables present the composition of the debt security portfolios as of the dates indicated. See Financial Services Segment -- Capital Resources and Liquidity of MD&A and Note 3 of the Notes to Consolidated Financial Statements for further discussion of the portfolios:\nThe following schedule of the expected maturity of debt securities held to maturity is based upon dealer prepayment expectations and historical prepayment activity (thousands of dollars):\nThe expected maturities of MBS and CMO are based upon dealer prepayment expectations and historical prepayment activity. The following schedule reflects the expected maturities of MBS and CMO and the contractual maturity of all other debt securities available for sale (thousands of dollars):\n- ---------------\n(1) The yields are completed based on amortized cost.\nDEPOSIT ACTIVITIES\nDeposit accounts are the Bank's primary source of funds constituting 75 percent of the Bank's total liabilities at December 31, 1994. The Bank solicits both short-term and long-term deposits in the form of transaction related and certificate of deposit accounts.\nThe Bank's average retail deposit base has remained steady during the past three years, despite the effect of the sale of Arizona-based deposit liabilities (Arizona sale) in 1993. See Note 2 of the Notes to Consolidated Financial Statements for further discussion of the Arizona sale. Average retail deposits, as a percentage of average interest-bearing liabilities, were 80 percent in 1994, compared to 79 percent in 1993 and 83 percent in 1992. The Bank has emphasized retail deposits over wholesale funding sources in an effort to reduce the volatility of its cost of funds. Additionally, the Bank has emphasized growth in transaction based accounts versus term accounts in order to reduce its overall cost of funds.\nThe Bank's deposits increased $32 million during 1994. Due to the rising interest rate environment, many customers moved their transaction deposits into higher-yielding certificate of deposit accounts. The growth in retail deposits has been achieved through marketing programs, increased emphasis on customer service and strong population growth in southern Nevada.\nAt December 31, 1994, the Bank maintained over $291 million in collateral, at market value, which could be borrowed against or sold to offset any run-offs which could occur in retail deposits in a declining or low interest rate environment. The Bank considers this level of excess collateral to be adequate and considers the likelihood of substantial run-offs occurring to be remote.\nThe average balances in and average rates paid on deposit accounts for the years indicated are summarized as follows (thousands of dollars):\nSee Note 7 of the Notes to Consolidated Financial Statements for further discussion.\nCertificates of deposit include approximately $169 million, $152 million, and $223 million in time certificates of deposits in amounts of $100,000 or more at December 31, 1994, 1993, and 1992, respectively. The following table represents time certificates of deposits, none of which are brokered, in amounts of $100,000 or more by time remaining until maturity as of December 31, 1994 (thousands of dollars):\nBORROWINGS\nSources of funds other than deposits have included advances from the FHLB, reverse repurchase agreements and other borrowings.\nFHLB Advances. As a member of the FHLB system, the Bank may obtain advances from the FHLB pursuant to various credit programs offered from time to time. The Bank borrows these funds from the FHLB principally on the security of certain of its mortgage loans. See Regulation -- Federal Home Loan Bank System herein for additional discussion. Such advances are made on a limited basis to supplement the Bank's supply of lendable funds, to meet deposit withdrawal requirements and to lengthen the maturities of its borrowings. See Note 11 of the Notes to Consolidated Financial Statements for additional discussion.\nSecurities Sold Under Repurchase Agreements. The Bank sells securities under agreements to repurchase (reverse repurchase agreements). Reverse repurchase agreements involve the Bank's sale of debt securities to a broker\/dealer with a simultaneous agreement to repurchase the same debt securities on a specified date at a specified price. The initial price paid to the Bank under reverse repurchase agreements is less than the fair market value of the debt securities sold, and the Bank may be required to pledge additional collateral if the fair market value of the debt securities sold declines below the price paid to the Bank for these debt securities. See Note 8 of the Notes to Consolidated Financial Statements for additional discussion of the terms and description of the reverse repurchase agreements.\nReverse repurchase agreements are summarized as follows (thousands of dollars):\nAt December 31, 1994, the balance of reverse repurchase agreements included $19.7 million in long-term fixed-rate flexible reverse repurchase agreements with a weighted average interest rate of 8.70 percent.\nEMPLOYEES\nAt December 31, 1994 the Bank had 586 full-time equivalent employees. No employees are represented by any union or collective bargaining group and the Bank considers its relations with its employees to be good.\nCOMPETITION\nThe Bank experiences substantial competition in attracting and retaining deposit accounts and in making mortgage and other loans. The primary factors in competing for deposit accounts are interest rates paid on deposits, the range of financial services offered, the quality of service, convenience of office locations and the financial strength of an institution. Direct competition for deposit accounts comes from savings and loan associations, commercial banks, money market mutual funds, credit unions and insurance companies. During 1993, the Bank experienced deposit outflows from certificate of deposit accounts as customers sought higher yielding alternative investments in a low interest rate environment. The Bank has sought to retain relationships with these customers by establishing an agreement with a third party broker to offer uninsured investment alternatives in the Bank's branches. With the rising interest rate environment and the mediocre and poor performance of many stock and bond mutual funds in 1994, many investors have returned to certificates of deposits as a safe investment vehicle.\nThe primary factors in competing for loans are interest rates, loan origination fees, quality of service and the range of lending services offered. Competition for origination of first mortgage loans normally comes from savings and loan associations, mortgage banking firms, commercial banks, insurance companies, real estate investment trusts and other lending institutions.\nPROPERTIES\nThe Bank occupies facilities at 25 locations in Nevada, of which 12 are owned. The Bank leases the remaining facilities. The Bank may add branches in the future in order to achieve the deposit goals set forth in the Bank's Strategic Plan. The Bank intends to build three new branches in metropolitan Las Vegas and one in Reno. During 1994, specific strategic areas were identified: Northwest Las Vegas, Green Valley, the Lakes and Reno. The Lakes site is currently under construction. See Note 6 of the Notes to Consolidated Financial Statements for a schedule of net future minimum rental payments that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1994.\nREGULATION\nGeneral\nIn August 1989, FIRREA was enacted into law. FIRREA had and will continue to have a significant impact on the thrift industry including, among other things, imposing significantly higher capital requirements and providing funding for the liquidation of insolvent thrifts. In December 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) was enacted into law. This legislation included changes in the qualified thrift lender test, deposit insurance assessments and capital standards.\nRegulatory Infrastructure. The Bank's principal supervisory agency is the OTS, an agency reporting to the U.S. Treasury Department. The OTS is responsible for the examination and regulation of all thrifts and for the organization, incorporation, examination and regulation of federally chartered thrifts.\nThe FDIC is the Bank's secondary regulator and is the administrator of the SAIF which generally insures the deposits of thrifts.\nDeposit Insurance Premiums. Deposit accounts are insured to the maximum extent permitted by law by the FDIC through the SAIF. During 1993, the FDIC implemented a risk-based deposit insurance premium assessment. Under the regulation, annual deposit insurance premiums ranging from 23 to 31 basis points (bp) are imposed on institutions based upon the institution's level of capital and a supervisory risk assessment. In February 1995, the FDIC proposed a significant reduction in the premiums banks pay to the Bank Insurance Fund (BIF). The amended rate schedule will be changed from the current range of 23 bp to 31 bp to a\nproposed range of 4 bp to 31 bp; thereby substantially reducing the premiums that well-capitalized, low risk-rated institutions will pay. However, the FDIC is proposing to retain the current SAIF premium schedule until the SAIF is recapitalized.\nCapital Standards. Effective December 1989, the OTS issued the minimum regulatory capital regulations (capital regulations) required by FIRREA.\nThe capital regulations require that all thrifts meet three separate capital standards as follows:\n1. A tangible capital requirement equal to at least 1.5 percent of adjusted total assets (as defined).\n2. A core capital requirement equal to at least three percent of adjusted total assets (as defined).\n3. A risk-based capital requirement equal to at least eight percent of risk-weighted assets (as defined).\nThe OTS may establish, on a case by case basis, individual minimum capital requirements for a thrift institution which may vary from the requirements which would otherwise be applicable under the capital regulations. The OTS has not established such minimum capital requirements for the Bank.\nA thrift institution which fails to meet one or more of the applicable capital requirements is subject to various regulatory limitations and sanctions, including a prohibition on growth and the issuance of a capital directive by the OTS requiring the following: an increase in capital, a reduction of rates paid on savings accounts, cessation of or limitations on deposit taking and lending, limitations on operational expenditures, an increase in liquidity, and such other actions as are deemed necessary or appropriate by the OTS. In addition, a conservator or receiver may be appointed under certain circumstances.\nFDICIA requires federal banking regulators to take prompt corrective action if an institution fails to satisfy minimum capital requirements. Under FDICIA, capital requirements include a leverage limit, a risk-based capital requirement, and any other measure of capital deemed appropriate by the federal banking regulators for measuring the capital adequacy of an insured depository institution. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying management fees which are not in capital requirement compliance or if such payment would cause the institution to fail to satisfy minimum levels for any of its capital requirements.\nInsured institutions are divided into five capital categories -- (1) well capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. The categories are defined as follows:\n- ---------------\nCritically undercapitalized if tangible equity to total assets ratio 2%\nInstitutions must meet all three capital ratios in order to qualify for a given category. At December 31, 1994, the Bank was classified as \"well capitalized.\" At December 31, 1994, under fully phased-in capital rules applicable to the Bank at July 1, 1996, the Bank would have exceeded the \"adequately capitalized\" fully phased-in total risk-based, tier 1 risk-based, and tier 1 leverage ratios by $46.7 million, $72.8 million, and $38.7 million, respectively. See Financial Services Segment -- Financial and Regulatory Capital of MD&A for further discussion.\nIn January 1993, the OTS issued a Thrift Bulletin limiting the amount of deferred tax assets that can be used to meet capital requirements. Under the bulletin, for purposes of calculating regulatory capital, net deferred tax assets are limited to the amount which could be theoretically realized from carryback potential\nplus the lesser of the tax on one year's projected earnings or ten percent of core capital. Transitional provisions apply to deferred tax assets existing at December 31, 1992 which are not subject to the limitation. At December 31, 1994 the Bank's net deferred tax asset is less than this limitation. Management does not anticipate this regulation will impact the Bank's compliance with capital standards in the foreseeable future.\nIn November 1994, the OTS announced its decision to reverse immediately its 1993 interim policy requiring associations to include unrealized gains and losses, net of income taxes, on available-for-sale (AFS) debt securities in regulatory capital. Under the revised OTS policy, associations exclude any unrealized gains and losses, net of income taxes, on a prospective basis, on AFS debt securities reported as a separate component of equity capital pursuant to SFAS No. 115.\nThe capital regulations specify that only the following elements may be included in tangible capital: stockholder's equity, noncumulative perpetual preferred stock, retained earnings and minority interests in the equity accounts of fully consolidated subsidiaries. Further, goodwill and investments in and loans to subsidiaries engaged in activities not permitted by national banks must be deducted from assets and capital. See Regulation -- General -- Separate Capitalization of Nonpermissible Activities herein for additional discussion.\nIn calculating adjusted total assets under the capital regulations, certain adjustments are made to give effect to the exclusion of certain assets from tangible capital and to appropriately account for the investments in and assets of both includable and nonincludable activities.\nCore capital under the current regulations may include only tangible capital, plus certain intangible assets up to a limit of 25 percent of core capital, provided such assets are: (i) separable from the thrift's assets; (ii) valued at an established market value through an identifiable stream of cash flows with a high degree of certainty that the asset will hold this market value notwithstanding the prospects of the thrift and (iii) salable in a market that is liquid. In addition, prior to January 1, 1995, certain qualifying \"supervisory\" goodwill was includable as core capital. At December 31, 1994, $6.6 million of supervisory goodwill is includable in core capital. Under the regulation, on January 1, 1995, none of the Bank's supervisory goodwill is includable in core capital.\nRegarding the risk-based capital requirement, under the capital regulations, assets are assigned to one of four \"risk-weighted\" categories (zero percent, 20 percent, 50 percent or 100 percent) based upon the degree of perceived risk associated with the asset. The total amount of a thrift's risk-weighted assets is determined by multiplying the amount of each of its assets by the risk weight assigned to it, and totaling the resulting amounts.\nThe capital regulation also establishes the concept of \"total capital\" for the risk-based capital requirement. As defined, total capital consists of core capital and supplementary capital. Supplementary capital includes: (i) permanent capital instruments such as cumulative perpetual preferred stock, perpetual subordinated debt and mandatory convertible subordinated debt (capital notes), (ii) maturing capital instruments such as subordinated debt, intermediate-term preferred stock, mandatory convertible subordinated debt (commitment notes) and mandatory redeemable preferred stock, subject to an amortization schedule and (iii) general valuation loan and lease loss allowances up to 1.25 percent of risk-weighted assets.\nThe OTS issued a regulation which added a component to an institution's risk-based capital calculation in 1994. The regulation requires a reduction of an institution's risk-based capital by 50 percent of the decline in the institution's net portfolio value (NPV) exceeding two percent of assets under a hypothetical 200 basis point increase or decrease in market interest rates. Based on the OTS's measurement of the Bank's September 30, 1994 and December 31, 1994 IRR, the Bank may be required to reduce its risk-based capital by approximately $1.5 million on June 30, 1995 and $1.9 million on September 30, 1995, in the absence of corrective action to reduce the Bank's IRR exposure or significant change in market interest rates in the interim. As of December 31, 1994, the Bank has sufficient risk-based capital to allow it to continue to be classified as \"well capitalized\" under FDICIA capital requirements after such reduction for IRR exposure. Management is currently reviewing possible strategies for reducing the Bank's IRR exposure.\nSee Note 2 of the Notes to Consolidated Financial Statements for the calculation of the Bank's regulatory capital and related excesses as of December 31, 1994 and 1993.\nSeparate Capitalization of Nonpermissible Activities. For purposes of determining a thrift's capital under all three capital requirements, its entire investment in and loans to any subsidiary engaged in an activity not permissible for a national bank must be deducted from the capital of the thrift. The capital regulations provide for a transition period with respect to this provision. During the transition period, a thrift is permitted to include in its calculation the applicable percentage (as provided below) of the lesser of the thrift's investments in and loans to such subsidiaries on: (i) April 12, 1989 or (ii) the date on which the thrift's capital is being determined, unless the FDIC determines with respect to any particular thrift that a lesser percentage should be applied in the interest of safety and soundness.\nIn July 1992, legislation was enacted which delayed the increased transitional deduction from capital for real estate investments, and allowed thrifts to apply to the OTS for use of a delayed schedule. The Bank applied for and received approval for use of the delayed phase-out schedule. The Bank had $1.6 million in investments in and loans to nonpermissible activities at December 31, 1994. These investments, which fall under this section of FIRREA, will be deductible from capital by 60 percent from July 1, 1995 to June 30, 1996 and thereafter, totally deductible. Included in this amount are investments in real estate, land loans and certain foreclosed real estate.\nLending Activities. FIRREA limits the amount of commercial real estate loans that a federally chartered thrift may make to four times its capital (as defined). Based on core capital of $117 million at December 31, 1994, the Bank's commercial real estate lending limit was $468 million. At December 31, 1994, the Bank had $178 million invested in commercial real estate loans; therefore, this limitation should not unduly restrict the Bank's ability to engage in commercial real estate loans.\nFIRREA conformed thrifts' loans-to-one-borrower limitations to those applicable to national banks. After December 31, 1991 thrifts generally are not permitted to make loans to a single borrower in excess of 15 percent to 25 percent of the thrift's unimpaired capital and unimpaired surplus (depending upon whether the loan is collateralized and the type of collateral), except that a thrift may make loans to one borrower in excess of such limits under one of the following circumstances: (i) for any purpose, in any amount not to exceed $500,000 and (ii) to develop domestic residential housing units, in an amount not to exceed the lesser of $30 million, or 30 percent, of the thrift's unimpaired capital and unimpaired surplus, provided the thrift meets fully phased-in capital requirements and certain other conditions are satisfied. The Bank was in compliance with the loans-to-one-borrower limitation of $17.1 million at December 31, 1994. This limitation is not expected to materially affect the operations of the Bank.\nIn December 1992, the OTS issued a regulation (Real Estate Lending Standards) as mandated by FDICIA, which became effective in March 1993. The regulation requires insured depository institutions to adopt and maintain comprehensive written real estate lending policies which include: prudent underwriting standards; loan administration procedures; portfolio diversification standards; and documentation, approval and reporting requirements. The policies must be reviewed and approved annually to ensure appropriateness for current market conditions. The regulation also provides supervisory loan-to-value limits for various types of real estate based loans. Loans may be originated in excess of these limitations up to a maximum of 100 percent of total regulatory capital. The regulation has not made a material impact on the Bank's lending operations.\nIn August 1993, the OTS issued revised guidance for the classification of assets and a new policy on the classification of collateral-dependent loans (where proceeds from repayment can be expected to come only from the operation and sale of the collateral). With limited exceptions, effective September 1993, for troubled collateral-dependent loans where it is probable that the lender will be unable to collect all amounts due, an institution must classify as \"loss\" any excess of the recorded investment in the loan over its \"value,\" and classify the remainder as \"substandard.\" The \"value\" of a loan is either the present value of the expected future cash flows, the loan's observable market price or the fair value of the collateral. The policy did not materially impact the Bank.\nThe federal agencies regulating financial institutions issued a joint policy statement in December 1993 providing quantitative guidance and qualitative factors to consider in determining the appropriate level of general valuation allowances that institutions should maintain against various asset portfolios. The policy statement also requires institutions to maintain effective asset review systems and to document the institution's process for evaluating and determining the level of its general valuation allowance. Management believes the Bank's current policies and procedures regarding general valuation allowances and asset review procedures are consistent with the policy statement.\nFDICIA amended the Qualified Thrift Lender (QTL) test prescribed by FIRREA by reducing the qualified percentage to 65 percent and adding certain investments as qualifying investments. A savings institution must meet the percentage in at least 9 of every 12 months. At December 31, 1994, the Bank's QTL ratio was approximately 80 percent. A thrift that fails to meet the QTL test must either become a commercial bank or be subject to a series of restrictions.\nSafety and Soundness Standards. Pursuant to statutory requirements, the OTS issued a proposed rule in November 1993, that prescribes certain \"safety and soundness standards.\" The standards are intended to enable the OTS to address problems at savings associations before the problems cause significant deterioration in the financial condition of the association. The proposed regulation provides operational and managerial standards for internal controls and information systems, loan documentation, internal audit systems, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. The proposed regulation also requires a savings association to maintain a ratio of classified assets to total capital and ineligible allowances that is no greater than 1.0. A minimum earnings standard is also included in the proposed regulation requiring earnings sufficient to absorb losses without impairing capital. Earnings would be sufficient under the proposed regulation if the institution meets applicable capital requirements and would remain in capital compliance if its net income or loss over the last four quarters of earnings continued over the next four quarters of earnings. An institution that fails to meet any of the standards must submit a compliance plan. Failure to submit an acceptable compliance plan or to implement the plan could result in an OTS order or other enforcement action against the association. The Bank's level of adversely classified assets is less than its total capital plus ineligible allowances at December 31, 1994 as defined under the proposed rule. This proposed rule has not been issued as final as of March 1995.\nFederal Home Loan Bank System\nThe FHLB system consists of 12 regional FHLB banks, which provide a central credit facility primarily for member institutions. The Bank, as a member of the FHLB of San Francisco, is required to own capital stock in that institution in an amount at least equal to: one percent of the aggregate outstanding balance at the beginning of the year of its outstanding residential mortgage loans, home purchase contracts and similar obligations; 0.3 percent of total assets; or five percent of its advances from the FHLB, whichever is greater. The Bank is in compliance with this requirement, with an investment in FHLB stock at December 31, 1994 of $17.3 million.\nLiquidity\nThe Bank is required to maintain an average daily balance of liquid assets equal to at least five percent of its liquidity base (as defined in the Regulation) during the preceding calendar month. The Bank is also required to maintain an average daily balance of short-term liquid assets equal to at least one percent of its liquidity base. The Bank has complied with these regulatory requirements. For the month of December 1994, the Bank's liquidity ratios were 13.4 percent and 8.3 percent, respectively. See Financial Services Segment -- Capital Resources and Liquidity of MD&A for additional discussion.\nInvestments\nA Federal Financial Institutions Examinations Council Supervisory Policy Statement on Securities Activities (Policy Statement): (1) addresses the selection of securities dealers, (2) requires depository institutions to establish prudent policies and strategies for securities transactions, (3) defines securities trading or sales practices that are viewed by the agencies as being unsuitable when conducted in an investment\nportfolio, (4) indicates characteristics of loans held for sale or trading, and (5) establishes a framework for identifying when certain mortgage derivative products are high-risk mortgage securities which must be held either in a trading or held for sale account. Management believes that items (1) through (4) have not unduly restricted the operating strategies of the Bank. Item (5) has not affected the Bank's treatment of its $1 million investment in CMO residuals since the Policy Statement includes a grandfathering provision whereby any mortgage derivative owned prior to the date of adoption by the OTS is exempt from the tests. However, the Bank will have to apply the specified tests to any mortgage derivative product, including CMO, Real Estate Mortgage Investment Conduits (REMIC), CMO and REMIC residuals and stripped MBS purchases in the future.\nInsurance of Deposits\nThe Bank's deposits are insured by the FDIC through the SAIF up to the maximum amount permitted by law, currently $100,000 per insured depositor. The SAIF requires quarterly insurance premium payments in 1995 instead of semi-annual payments as in prior years. See Regulation -- General -- Deposit Insurance Premiums herein for additional discussion of insurance premiums to be paid by SAIF members.\nInsurance of deposits may be terminated by the FDIC, after notice and hearing, upon a finding by the FDIC that a thrift has engaged in unsafe or unsound practices, or is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the OTS and FDIC. Management of the Bank is not aware of any practice, condition, or violation that might lead to termination of its deposit insurance.\nCommunity Reinvestment Act\nThe Community Reinvestment Act of 1977 (CRA) and regulations promulgated under the act encourage savings associations to help meet the credit needs of the communities they do business in, particularly the credit needs of low and moderate income neighborhoods. The OTS periodically evaluates the Bank's performance under CRA. This evaluation is taken into account in determining whether to grant approval for new branches, relocations, mergers, acquisitions and dispositions. The Bank received a \"satisfactory\" evaluation in its most recent examination.\nFederal Reserve System\nThe Board of Governors of the Federal Reserve System (the Federal Reserve) has adopted regulations that require depository institutions to maintain noninterest earning reserves against their transaction accounts (primarily negotiable order of withdrawal (NOW), demand deposit accounts, and Super NOW accounts) and nonpersonal money market deposit accounts. These regulations generally require that reserves of three percent be maintained against aggregate transaction accounts in an institution, up to $49.8 million, and an initial reserve of ten percent be maintained against that portion of total transaction accounts in excess of such amount. In addition, an initial reserve of three percent must be maintained on nonpersonal money market deposit accounts (which include borrowings with maturities of less than four years). These accounts and percentages are subject to adjustment by the Federal Reserve. The balances maintained to meet the reserve requirements imposed by the Federal Reserve may be used to satisfy liquidity requirements which may be imposed by the OTS. At December 31, 1994, the Bank was required to maintain approximately $1.6 million in noninterest earning reserves and was in compliance with this requirement.\nAs a creditor and financial institution, the Bank is subject to various additional regulations promulgated by the Federal Reserve, including, without limitation, Regulation B (Equal Credit Opportunity Act), Regulation E (Electronic Funds Transfer Act), Regulation F (Interbank Liabilities), Regulation Z (Truth-in-Lending Act), Regulation CC (Expedited Funds Availability Act), Regulation O (Insider Lending) and Regulation DD (Truth-in-Savings Act).\nHOLDING COMPANY MATTERS\nThe Bank is a wholly owned subsidiary of the Company. As a unitary savings bank holding company, the Company is subject to certain OTS regulation, examination, supervision and reporting requirements. The Bank is generally prohibited from engaging in certain transactions with the Company and is subject to certain OTS restrictions on the payment of dividends to the Company.\nIn 1990, the OTS issued a regulation governing limitations of capital distributions, including dividends. Under the regulation, a tiered system keyed to capital is imposed on capital distributions. Insured thrifts fall under one of three tiers.\n1. Tier 1 includes those thrifts with net capital exceeding fully phased-in requirements and with Capital, Assets, Management, Earnings and Liquidity (CAMEL) ratings of 1 or 2. (The CAMEL system was established by the FDIC and adopted by the OTS to comprehensively and uniformly grade all thrifts with regard to financial condition, compliance with laws and regulations, and overall operating soundness.)\n2. Tier 2 includes those thrifts having net capital above their regulatory capital requirement, but below the fully phased-in requirement.\n3. Tier 3 includes those thrifts with net capital below the current regulatory requirement.\nUnder the regulation, insured thrifts are permitted to make dividend payments as follows:\n1. Tier 1 thrifts are permitted to make (without application but with notification) capital distributions of half their surplus capital (as defined) at the beginning of a calendar year plus 100 percent of their earnings to date for the year.\n2. Tier 2 thrifts can make (without application but with notification) capital distributions ranging from 25 to 75 percent of their net income over the most recent four quarter period, depending upon their level of capital in relation to the fully phased-in requirements.\n3. Tier 3 thrifts are prohibited from making any capital distributions without prior supervisory approval.\nBased upon these regulations, the Bank is currently restricted to paying no more than 75 percent of its net income over the last four quarters in dividends to its parent. The Bank did not pay any cash dividends during the past three years.\nIn December 1994, the OTS proposed an amendment to the capital distributions regulation to conform to the FDICIA prompt corrective action system. Under the proposal, a savings association that is not held by a savings and loan holding company and that has a CAMEL rating of \"1\" or \"2\" need not notify the OTS before making a capital distribution. Other institutions that remain adequately capitalized after making a capital distribution would be required to provide notice to the OTS. Troubled and undercapitalized institutions must file and receive approval from the OTS prior to making capital distributions. This proposed regulation will have no material impact on the Bank.\nGenerally transactions between a savings and loan association and its affiliates are required to be on terms as favorable to the association as comparable transactions with nonaffiliates. In addition, certain of these transactions are restricted to a percentage of the association's capital. Affiliates of the Bank include the Company. In addition, a savings and loan association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of such affiliates. It is not permissible for bank holding companies to operate a gas utility. Therefore, loans by the Bank to the Company and purchases of the Company's securities by the Bank are prohibited.\nThe Company, at the time that it acquired the Bank, agreed to assist the Bank in maintaining levels of net worth required by the regulations in effect at the time or as they were thereafter in effect so long as it controlled the Bank. The enforceability of a net worth maintenance agreement of this type is uncertain. However, under current regulations, a holding company that has executed a capital maintenance obligation of this type may not divest control of a thrift if the thrift has a capital deficiency, unless the holding company\neither provides the OTS with an agreement to infuse sufficient capital into the thrift to remedy the deficiency or the deficiency is satisfied.\nThe Company is prohibited from issuing any bond, note, lien, guarantee or indebtedness of any kind pledging its utility assets or credit for or on behalf of a subsidiary which is not engaged in or does not support the business of the regulated public utility. As a result, there are limitations on the Company's ability to assist the Bank in maintaining levels of capital required by applicable regulations.\nThe Company also stipulated in connection with the acquisition of the Bank that dividends paid by the Bank to the Company would not exceed 50 percent of the Bank's cumulative net income after the date of acquisition, without approval of the regulators. In addition, the Company agreed that the Bank would not at any time declare a dividend that would reduce the Bank's regulatory net worth below minimum regulatory requirements in effect at the time of the acquisition or thereafter. Since the acquisition, the Bank's cumulative net income is $37.1 million, resulting in maximum dividends payable of $18.6 million as of December 31, 1994. Since the acquisition, the Bank has paid the Company $1.8 million in capital distributions, net of $20 million of capital contributions received from the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe information appearing in Part I, Item 1, pages 2 and 18 in this report is incorporated herein by reference.\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\nThe principal market in which the common stock of the Company is traded is the New York Stock Exchange. At March 3, 1995, there were 20,730 holders of record of common stock. The market price of the common stock was $15.00 as of March 3, 1995. Prices shown are those as quoted by the Dow Jones News Retrieval Service.\nCOMMON STOCK PRICE AND DIVIDEND INFORMATION\nSee Holding Company Matters and Note 2 of the Notes to Consolidated Financial Statements for a discussion of limitations on the Bank's ability to make capital distributions to the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nCONSOLIDATED SELECTED FINANCIAL STATISTICS (THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)\nSEGMENT DATA\nNATURAL GAS OPERATIONS (THOUSANDS OF DOLLARS)\nSEGMENT DATA\nFINANCIAL SERVICES (THOUSANDS OF DOLLARS)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company is comprised of two business segments; natural gas operations and financial services. The gas segment purchases, transports and distributes natural gas to residential, commercial, and industrial customers in geographically diverse portions of Arizona, Nevada, and California. The financial services segment (the Bank) is engaged in retail and commercial banking. The Bank's principal business is to attract deposits from the general public and make consumer and commercial loans secured by real estate and other collateral. During 1994, the gas segment contributed $23.5 million and the financial services segment contributed $2.8 million towards consolidated net income of $26.3 million.\nCONSOLIDATED CAPITAL RESOURCES AND LIQUIDITY\nThe capital requirements and resources of the Company generally are determined independently for the natural gas operations and financial services segments. Each business segment is generally responsible for securing its own financing sources.\nLiquidity refers to the ability of an enterprise to generate adequate amounts of cash to meet its cash requirements. General factors that could affect consolidated capital resources and liquidity significantly in future years include inflation, growth in the economy and changes in income tax laws. In addition, other factors specific to the two operating segments of the Company include: the level of natural gas prices, interest rates, and changes in the ratemaking policies of regulatory commissions for the gas segment; and new banking regulations, interest rate sensitivity, credit risk, and competition for the financial services segment.\nInflation, as measured by the Consumer Price Index for all urban consumers averaged 2.7 percent in 1994, 2.7 percent in 1993 and 2.9 percent in 1992. See separate discussions of each business segment for impact of inflation on operations.\nIn May 1994, the Company's Board of Directors (the Board) declared a quarterly common stock dividend of 20.5 cents per share payable September 1, 1994, a 1 cent, or five percent, increase from the previous level. The increase was established in accordance with the Company's dividend policy which states that the Company will pay common stock dividends at a prudent level that is within the normal dividend payout range for its respective businesses, and that the dividend will be established at a level considered sustainable in order to minimize business risk and maintain a strong capital structure throughout all economic cycles.\nThe Board continues to review the Company's investment in the Bank with an emphasis on the Bank's capital position relative to its capital requirements. The Company presently does not anticipate having to contribute additional capital to the Bank.\nThe Bank's capital position has continued to improve. Accordingly, it now has the ability to pay cash dividends to the Company, subject to regulatory limitations. During 1994, the Company did not receive any dividends from the Bank. The Bank's Board of Directors (the BOD) will determine the amount of dividends, if any, the Bank will pay to the Company in 1995.\nConsolidated cash and cash equivalents increased $8.7 million during 1994, the result of increased cash flow from the gas segment of $4 million and from the financial services segment of $4.7 million. The increase from the gas segment is mainly attributable to the proceeds from the issuance of notes payable, offset by increased construction expenditures. The increase from the financial services segment is primarily due to deposit inflows.\nIn November 1994, Moody's Investors Service, Inc. upgraded the Company's unsecured debt rating from Ba1 to Baa3. In February 1995, Standard and Poor's Ratings Group reaffirmed the unsecured long-term debt rating at BBB- (triple B minus). Duff and Phelps Credit Rating Company's unsecured debt rating remained unchanged at BB+ (double B plus).\nSee Capital Resources and Liquidity for separate discussions of each business segment.\nRESULTS OF CONSOLIDATED OPERATIONS\n1994 vs. 1993\nConsolidated net income increased $10.9 million compared to consolidated net income from the same period a year ago. The increase resulted from a $9.8 million increase in net income contributed by the gas segment, and a $1.1 million improvement in net income contributed by the financial services segment. See separate discussions of each business segment for an analysis of these changes.\nEarnings per share increased 51 cents to $1.22 per share in 1994. Dividends paid increased 6 cents to 80 cents per share, the result of the Board's two decisions to increase quarterly dividends. Average shares outstanding increased by 349,000 shares.\n1993 vs. 1992\nConsolidated net income decreased $2.3 million compared to consolidated net income from the prior year. The decrease resulted from an $18.5 million decrease in net income contributed by the gas segment, offset by a $16.2 million improvement in net income contributed by the financial services segment ($13.2 million before cumulative effect of accounting change). See separate discussions of each business segment for an analysis of these changes.\nIn January 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" and applied the provisions prospectively. The cumulative effect of this change in method of accounting was an increase in net income of $3 million. See Note 14 of the Notes to Consolidated Financial Statements for additional discussion.\nEarnings per share decreased 10 cents to 71 cents per share in 1993. Dividends paid increased 4 cents to 74 cents per share, the result of the Board's decision to increase the quarterly dividend in May 1993. Average shares outstanding increased by 131,000 shares.\nRECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS\nIn May 1993, the Financial Accounting Standards Board (FASB) issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan.\" This statement is applicable to all creditors and to all loans, uncollateralized as well as collateralized, except for large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, loans that are measured at fair value or at lower of cost or fair value, leases, and debt securities as defined in SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 114 requires that an impaired loan be measured at the present value of expected future cash flows by discounting those cash flows at the loan's effective interest rate or, in the case of a collateral dependent loan such as a mortgage loan, at the fair value of the collateral. 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. The statement amends SFAS No. 15, \"Accounting by Debtors and Creditors for Troubled Debt Restructurings,\" to require a creditor to account for a troubled debt restructuring involving a modification of terms at fair value as of the date of the restructuring. The statement also amends SFAS No. 5, \"Accounting for Contingencies,\" to clarify that a creditor should evaluate the collectibility of both contractual interest and principal of a receivable when\nassessing the need for a loss accrual. The provisions of the statement apply to financial statements issued for fiscal years beginning after December 15, 1994, with earlier application permitted. Retroactive restatement of previously issued annual financial statements is not permitted. In October 1994, the FASB issued SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures.\" The Statement amends SFAS No. 114 to allow a creditor to use existing methods for recognizing interest income on impaired loans. The statement is effective for financial statements issued for fiscal years beginning after December 15, 1994. The Company will adopt these statements on January 1, 1995 and does not anticipate a material impact on results of operations as a result of implementation.\nIn October 1994, the FASB also issued SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\" The statement was adopted by the Company as of December 31, 1994. See Note 17 of the Notes to Consolidated Financial Statements for additional discussion.\nNATURAL GAS OPERATIONS SEGMENT\nThe Company is engaged in the business of purchasing, transporting, and distributing natural gas in portions of Arizona, Nevada and California. Its service areas are geographically as well as economically diverse. The Company is the largest distributor in Arizona, selling and transporting gas in most of southern, central and northwestern Arizona. The Company is also the largest distributor and transporter of natural gas in Nevada. The Company also distributes and transports gas in portions of California, including the Lake Tahoe area and high desert and mountain areas in San Bernardino County.\nAs of December 31, 1994, the Company had approximately 980,000 residential, commercial, industrial and other customers, of which 583,000 customers were located in Arizona, 292,000 in Nevada and 105,000 in California. Residential and commercial customers represented over 99 percent of the Company's customer base. During 1994, the Company added 48,000 customers, a five percent increase, of which 20,000 customers were added in Arizona, 26,000 in Nevada, and 2,000 in California. These additions are largely attributable to continued population growth in the Company's service areas. Customer growth over the past three years averaged four percent annually. Based on current commitments from builders, the Company expects to add approximately 60,000 customers by the end of 1995. During 1994, 57 percent of operating margin was earned in Arizona, 32 percent in Nevada, and 11 percent in California. This pattern is consistent with prior years and is expected to continue.\nThe Company's total gas plant in service increased from $1.2 billion to $1.4 billion, or at an annual rate of seven percent, during the three-year period ended December 31, 1994, reflecting continued customer growth within the Company's service territories.\nCAPITAL RESOURCES AND LIQUIDITY\nThe growth of the gas segment during the last several years has required capital resources in excess of the amount of cash flow generated from operating activities (net of dividends paid). During 1994, the gas segment's capital expenditures were $141 million. Cash flow from operating activities (net of dividends) provided $70 million, or approximately 50 percent, of the required capital resources pertaining to these construction expenditures. The remainder was provided from net external financing activities. The Company received no dividends from the Bank during 1994 and is not dependent upon such dividends to meet the gas segment's cash requirements.\nThe Company currently estimates that construction expenditures for its gas segment during 1995 through 1997 will be approximately $410 million, and debt maturities and repayments, and other cash requirements are expected to approximate $15 million. In January 1995, term loan facilities totaling $165 million were refinanced with a new $200 million term loan facility which does not mature until 1998. See Note 11 of Notes to Consolidated Financial Statements for further discussion. It is currently estimated that cash flow from operating activities (net of dividends) will generate approximately one-half of the gas segment's total financing requirements during 1995 through 1997. A portion of the remaining financing requirements will be provided by $83 million of funds held in trust from the 1993 Clark County, Nevada, Series A issue and 1993\nCity of Big Bear Lake, California, Series A issue industrial development revenue bonds (IDRB). The remaining cash requirements are expected to be provided by external financing sources. The timing, types, and amounts of these additional external financings will be dependent on a number of factors, including conditions in the capital markets, timing and amounts of rate relief, and growth factors in the Company's service areas. These external financings may include the issuance of both debt and equity securities, bank and other short-term borrowings, and other forms of financing.\nIn September 1994, the Company filed a shelf registration statement with the Securities and Exchange Commission. The shelf registration allows the Company to offer from time to time, in one or more series, its unsecured debt securities, shares of preferred stock, $50 par value, and shares of its common stock, $1 par value. These securities will have a maximum aggregate offering price of $300 million and will be offered on terms to be determined at the time of the sale.\nThe gas segment's costs of natural gas, labor and construction are the categories most significantly impacted by inflation. Changes to the Company's cost of gas are generally recovered through PGA mechanisms and do not significantly impact net earnings. Labor is a component of the cost of service, and construction costs are the primary component of rate base. In order to recover increased costs, and earn a fair return on rate base, general rate cases are filed by the Company, when deemed necessary, for review and approval by its regulatory authorities. Regulatory lag, that is, the time between the date increased costs are incurred and the time such increases are recovered through the ratemaking process, can impact earnings. See Rates and Regulatory Proceedings for discussion of recent rate case proceedings.\nRESULTS OF NATURAL GAS OPERATIONS\n1994 vs. 1993\nContribution to consolidated net income was $23.5 million, an increase of $9.8 million from 1993, the result of increased operating margin, partially offset by increased operations and maintenance expenses, depreciation expense and general taxes. The recognition of the Arizona pipe replacement program disallowances during 1993 also contributed to the change.\nOperating margin increased $22.8 million, or seven percent, during 1994 compared to 1993. This increase was primarily due to annualized rate relief totaling $9.5 million in the Arizona, southern California, and federal rate jurisdictions. The balance of the increase in margin is attributed to customer growth and weather. Increased demand for natural gas, through the addition of 48,000 customers, directly benefitted margin. Differences in heating demand between periods also positively impacted the change in margin, since weather more closely approximated normal in 1994 compared to 1993's warmer than normal conditions.\nOperations and maintenance expenses increased $8.4 million, or five percent, reflecting a general increase in labor costs, increased costs of materials and contractor services related to maintenance and other operating expenses. These increases are attributable to the incremental costs of providing service to the Company's steadily growing customer base.\nDepreciation expense and taxes other than income taxes increased $3.4 million, or four percent, primarily due to an increase in average gas plant in service of $80 million, or six percent. This is attributable to capital expenditures for the upgrade of existing operating facilities and the expansion of the system to accommodate customer growth.\nOther expenses for 1993 include the Arizona pipe replacement program disallowances. See Arizona Pipe Replacement Program Disallowances herein for additional information.\nNet interest deductions increased $7.6 million, or 15 percent, in 1994. Average debt outstanding during 1994 increased 13 percent compared to 1993, and consisted of a $38 million increase in average long-term debt, net of funds held in trust, and a $41 million increase in average short-term debt. The increase in debt is attributed primarily to borrowings for construction expenditures and operating activities as well as the drawdown of the IDRB funds previously held in trust. Higher interest rates on the variable-rate term loan facilities and short-term debt accounted for $2.7 million of the increase in net interest deductions.\nCarrying costs allocated to the Bank consist primarily of costs associated with the Company's investment in the Bank (principally interest) net of taxes.\n1993 vs. 1992\nContribution to consolidated net income was $13.7 million, a decrease of $18.5 million from 1992, the result of increased operations and maintenance expenses, depreciation expense and general taxes partially offset by increased operating margin. An increase in net interest deductions and the recognition of the Arizona pipe replacement program disallowances also contributed to the decrease in net income.\nOperating margin during 1993 increased $6.7 million, or two percent, compared to 1992. This increase was primarily due to increased transportation volumes, and continued customer growth in all of the Company's service areas, combined with annualized rate relief of $1.4 million effective January 1993 in its southern California jurisdiction, rate relief in its FERC jurisdiction (subject to refund) effective April 1993, and $6.5 million in its central Arizona jurisdiction effective September 1993. Weather also had a significant impact on margin.\nOperating margin from weather-sensitive customers increased $1.3 million due to the rate relief in Arizona and California, and the addition of 35,000 customers system-wide during the 12-month period. However, differences in heating demand between periods negatively impacted operating margin from these customers largely offsetting the favorable occurrences.\nOperating margin from other customers, primarily transportation, increased $5.4 million. Transportation volumes increased by 11 percent over 1992 as cogeneration and electric generation customers increased throughput.\nOperations and maintenance expenses increased $10 million, or six percent, reflecting a general increase in labor costs, increased costs of materials and contractor services related to maintenance and other operating expenses. These increases are attributable to the incremental costs of providing service to the Company's steadily growing customer base.\nDepreciation expense and other operating expenses (primarily property taxes) increased $4.6 million, or six percent. During 1993, average gas plant in service increased $105 million, or nine percent. This is attributable to capital expenditures for the continued upgrade of existing operating facilities and the expansion of the system to accommodate substantial customer growth, including the capacity expansion project on Paiute's pipeline system.\nNet interest deductions increased $6.6 million, or 15 percent, in 1993. Higher average outstanding long-term debt balances with associated higher average interest rates are the primary reasons for the increased interest expense. The increase in the average long-term debt balance is attributable to the net impact of the issuances of $100 million in Series F Debentures and $130 million in tax-exempt IDRB during the second half of 1992. The Company used $80 million from the sale of the fixed-rate Series F Debentures to retire existing variable-rate indebtedness, which included $40 million of short-term borrowings. The remaining $20 million was used for general corporate purposes, including the planned expansion and replacement of utility plant. The Company used $80 million from the sale of the fixed-rate IDRB to retire existing variable-rate IDRB. The remaining $50 million was used to finance qualifying construction expenditures in the Company's Southern Nevada Division. The Company replaced the variable-rate long-term debt instruments with fixed-rate debt instruments in order to take advantage of the low interest rate environment. While interest costs have increased in the short term, the Company believes that it will achieve overall interest costs savings in the long term.\nArizona Pipe Replacement Program Disallowances. In August 1990, the ACC issued its opinion and order (Decision No. 57075) on the Company's 1989 general rate increase requests applicable to the Company's Central and Southern Arizona Divisions. Among other things, the order stated that $16.7 million of the total capital expenditures incurred as part of the Company's Central Arizona Division pipe replacement program were disallowed for ratemaking purposes and all costs incurred as part of the Company's Southern Arizona Division pipe replacement program were excluded from the rate case and rate consideration was deferred to the Company's next general rate application, which was filed in November 1990.\nIn October 1990, the Company filed a Complaint in the Superior Court of the State of Arizona, against the ACC, to seek a judgement modifying or setting aside this decision. In February 1991, the Company filed a Motion for Summary Judgement in the Superior Court to seek a judgement summarily determining that Decision No. 57075 of the ACC is unreasonable and unlawful and, in accordance with that determination, modifying or setting aside Decision No. 57075 and allowing the Company to establish and collect reasonable, temporary rates under bond, pending the establishment of reasonable and lawful rates by the Commission. In June 1991, the Court affirmed the ACC's rate order without explanation or opinion. In August 1991, the Company appealed to the Arizona Court of Appeals from the Superior Court's judgement. In April 1993, Division Two of the Arizona Court of Appeals issued a Memorandum Decision affirming the ACC's opinion and order. Based on this decision, the Company filed a Motion for Reconsideration in the Court of Appeals in May 1993. The Motion for Reconsideration was denied and the Company, in July 1993, filed a Petition for Review with the Arizona Supreme Court. In February 1994, immediately following the denial of the Petition for Review by the Arizona Supreme Court, the Court of Appeals issued its Mandate ordering the Company to comply with its April 1993 Memorandum Decision.\nAs a result of the Arizona Court of Appeals Division Two Mandate, the Company wrote off in December 1993 $15.9 million in gross plant related to the central and southern Arizona pipe replacement program disallowances. The impact of these disallowances, net of accumulated depreciation, tax benefits and other related items, was a noncash reduction to 1993 net income of $9.3 million, or $0.44 per share.\nIn addition, as part of the southern Arizona settlement (see Rates and Regulatory Proceedings -- Arizona below for further information), the Company agreed to write off $3.2 million of gross plant in service related to southern Arizona pipe replacement programs in addition to the $1.3 million disallowance previously written off in December 1993. The settlement also established a disallowance formula to be used in future rate cases for expenditures related to defective materials and\/or installation. Cumulatively, the Company has written off $19.1 million in gross plant related to both central and southern Arizona pipe replacement programs. The impact of these disallowances, net of accumulated depreciation, tax benefits and other related items, was a noncash reduction to net income of $9.6 million, or $0.45 per share, $9.3 million of which was recognized in December 1993. The Company believes this settlement effectively resolves all financial issues associated with currently challenged Arizona pipe replacement programs, that it has adequately provided for future disallowances and does not anticipate further material effects on results of operations as a result of gross plant disallowances related to these pipe replacement programs.\nRATES AND REGULATORY PROCEEDINGS\nCalifornia\nEffective January 1994, the Company received approval of an attrition allowance to increase annual margin by $1.5 million for its southern and northern California rate jurisdictions. Pursuant to the CPUC rate case processing plan, the Company filed a general rate application in January 1994 to increase annual margin by $1.1 million for its southern and northern California rate jurisdictions effective January 1995. In December 1994, the CPUC approved a settlement agreement effective January 1995 authorizing a $1.1 million increase in margin. The settlement, which is in effect through 1998, suspends the supply adjustment mechanism (SAM) previously utilized in California. SAM is a mechanism by which actual margin is adjusted to the margin authorized in the Company's current tariff. The Company is now able to retain excess margin generated from additional volumes sold, but is also at risk for reductions in margin resulting from lower than projected sales volumes. In addition, the settlement suspends required annual attrition filings for southern California, but retains attrition adjustments in northern California for certain safety-related improvements.\nNevada\nIn March 1993, the Company filed general rate cases with the PSCN seeking approval to increase revenues by $9.4 million, or eight percent, annually for its southern Nevada rate jurisdiction and $3.3 million, or nine percent, annually for its northern Nevada rate jurisdiction. The Company's last general rate cases were September 1987 for southern Nevada and December 1988 for northern Nevada. Since that time, general rate cases had not been necessary in these jurisdictions primarily because of ongoing customer growth and Company initiated cost containment measures. The Company was seeking recovery of increased operating costs in these ratemaking areas and the restructuring of its tariffs and rates to reflect current changes within the natural gas industry. The PSCN issued its rate order in October 1993 and ordered the Company to reduce general rates by $648,000 in southern Nevada and authorized a $799,000 increase in northern Nevada. The primary reasons for the difference between the Company's requested annual revenue increases and the amounts authorized by the PSCN included lower authorized returns on rate base and lower authorized depreciation expenses. The Company filed a motion for reconsideration and rehearing on several issues following the issuance of the rate order. In January 1994, the PSCN granted the rehearing of certain rate case issues. In December 1994, the PSCN modified its previous decision and authorized the Company to increase rates in Nevada by approximately $250,000.\nArizona\nIn October 1993, the Company filed a rate application with the ACC seeking approval to increase annual revenues by $10 million, or 9.3 percent, for its southern Arizona jurisdiction. The Company sought to recover increased operating costs and obtain a return on construction expenditures, and had proposed tariff restructurings which would be consistent with the tariff modifications authorized by the ACC in its August 1993 central Arizona decision. In July 1994, the ACC approved a settlement agreement of the southern Arizona general rate case. The agreement was reached through negotiations between the Company, the ACC staff, and the Residential Utility Consumer Office. The agreement specifies a $4.3 million, or 3.9 percent, rate increase which became effective July 1994. The Company also agreed not to file another general rate request for its southern Arizona jurisdiction before November 1996.\nFERC\nIn October 1992, Paiute filed a general rate case with the FERC requesting approval to increase revenues by $6.8 million annually. Paiute sought recovery of increased costs associated with its capacity expansion project that was placed into service in February 1993. Interim rates reflecting the increased revenues became effective in April 1993, which were subject to refund until a final order was issued. In January 1995, the FERC approved a settlement authorizing a $4.3 million increase in revenue. Refunds of approximately $5 million, including interest, were made to customers in March 1995. These refunds were fully reserved as of December 31, 1994.\nFINANCIAL SERVICES SEGMENT\nThe Bank recorded net income of $7.7 million for the year ended December 31, 1994 compared to net income of $6.6 million and a net loss of $9.8 million for the years ended December 31, 1993 and 1992, respectively. The Bank's 1994 net income is comprised of $11.3 million from core banking operations compared to $7.9 million in 1993. The growth in the 1994 income was attributable to an increased net interest margin along with increased operational efficiency.\nFINANCIAL AND REGULATORY CAPITAL\nAt December 31, 1994, stockholder's equity totaled $166 million. Stockholder's equity decreased $10.6 million compared to December 31, 1993, as a result of the decline in unrealized gains, after tax, on debt securities available for sale partially offset by net income of $7.7 million. The Bank has not paid any cash dividends to the Company since 1989. The Bank may pay cash dividends to the Company of 50 percent of cumulative net income. Cash dividends in excess of this amount require regulatory approval. In addition, under OTS regulations, the Bank is restricted to paying no more than 75 percent of its net income over the preceding four quarters to the Company.\nDuring 1994, the Bank's regulatory capital levels and ratios decreased under each of the three fully phased-in FDICIA capital standards. OTS regulations effective in 1993 included unrealized gains, net of tax, on debt securities in regulatory capital for all three capital measures. In 1994, the OTS and other federal banking regulators issued regulations excluding this component from regulatory capital. Other factors contributing to the change in regulatory capital levels include a decrease in the amount of includable goodwill and real estate investments.\nAs discussed in Note 2 of the Notes to Consolidated Financial Statements, as of December 31, 1994 and 1993, the Bank exceeded all three fully phased-in minimum capital requirements under the regulatory capital regulations issued under FDICIA.\nDuring 1993, the Bank achieved \"well capitalized\" status through a combination of increased capital from net income and unrealized gains from debt securities, and the reduction of assets and goodwill through the Arizona sale. It is management's intent to maintain and improve the level of capital through earnings and the stabilization of the asset base. The Bank maintained its \"well capitalized\" status throughout 1994.\nThe Bank is subject to an OTS regulation requiring institutions with IRR exposure classified as \"above normal\" to reduce their risk-based capital by 50 percent of the amount by which the IRR exposure exceeds a specified \"normal\" threshold. Based on the OTS's measurement of the Bank's September 30, 1994 and December 31, 1994 IRR, the Bank may be required to reduce its risk-based capital by approximately $1.5 million on June 30, 1995 and $1.9 million on September 30, 1995, in the absence of corrective action to reduce the Bank's IRR exposure or a significant change in market interest rates in the interim. As of December 31, 1994, the Bank has sufficient risk-based capital to allow it to continue to be classified as \"well capitalized\" under FDICIA capital requirements after such a reduction for IRR exposure. Management is currently reviewing possible strategies for reducing the Bank's IRR exposure to a \"normal\" level or below.\nUnder SFAS No. 115, unrealized gains and losses, net of tax, on securities available for sale are recorded as an adjustment to stockholder's equity. Under OTS regulations in 1993, this component of equity was included as regulatory capital under all three capital measures. In 1994, OTS and other federal banking regulators issued regulations excluding this component from regulatory capital. Approximately $8.8 million of unrealized gain was includable in capital for 1993, whereas in 1994 no such gain (or loss) was included.\nCAPITAL RESOURCES AND LIQUIDITY\nLiquidity is defined as the Bank's ability to have sufficient cash reserves on hand and unencumbered assets, which can be sold or utilized as collateral for borrowings at a reasonable cost, or with minimal losses. The Bank's debt security portfolio provides the Bank with adequate levels of liquidity so that the Bank is able to meet any unforeseeable cash outlays and regulatory liquidity requirements.\nPotential liquidity demands may include funding loan commitments, deposit withdrawals, and other funding needs. In order to achieve sufficient liquidity for the Bank without taking a large liquid or illiquid position and avoiding funding concentrations, the Bank has taken the following actions: 1) maintaining lines of credit with authorized brokers\/dealers; 2) managing the debt security portfolio to ensure that maturities meet liquidity needs; 3) limiting investment or lending activities at certain times and 4) establishing maximum borrowing limits for meeting liquidity needs.\nThe OTS has issued regulations regarding liquidity requirements which state that the Bank is required to maintain an average daily balance of liquid assets equal to at least five percent of its liquidity base (as defined in the OTS Regulations) during the preceding calendar month. The Bank is also required to maintain an average daily balance of short-term liquid assets equal to at least one percent of its liquidity base as defined in the regulations. Throughout 1994, the Bank exceeded both regulatory liquidity requirements. For the month of December the Bank's liquidity ratios were 13.4 percent and 8.3 percent, respectively. The Bank's liquidity ratio is substantially higher than the regulatory requirement due to the Bank's increasing level of transaction accounts. The regulatory requirement is aimed at a more traditional savings institution which has a higher level of certificate of deposit accounts versus transaction accounts.\nBorrowings, in the form of reverse repurchase agreements, increased from $259 million at December 31, 1993 to $282 million at December 31, 1994. During 1994, the Bank repaid $29.4 million in long-term fixed-rate borrowings while increasing short-term borrowings by $52.3 million.\nThe Bank has adequate levels of liquidity and unencumbered assets to meet its day-to-day operational needs and to meet the regulatory requirements for liquidity. The daily operational liquidity needs of the Bank in 1994 were primarily met through $603 million of repayments on loans and debt securities, $28.4 million of borrowings from the FHLB, $46.1 million of loan sales, and $32.1 million in deposit growth.\nThe Bank's borrowing capacity is a function of the availability of its readily marketable, unencumbered assets and the Bank's financial condition. Secured borrowings may be obtained from the FHLB in the form of advances and from authorized broker\/dealers in the form of reverse repurchase agreements. At December 31, 1994, the Bank maintained in excess of $319 million of unencumbered assets, with a market value of $311 million, which could be borrowed against, or sold, to increase liquidity levels.\nThe primary management objective of the investment portfolio is to invest the excess funds of the Bank. This includes ensuring that the Bank maintains adequate levels of liquidity so it is able to meet any unforeseeable cash outlays. This task is accomplished by active investment in securities that provide the greatest return, for a given price and credit risk, in order to maximize the total return to the Bank.\nThe secondary management objective of the investment portfolio is to serve as the Bank's primary short-term tool to manage the IRR exposure of the institution. The Bank's asset\/liability management objective generally requires a trade-off between achieving the highest profitability in terms of net interest income, while maintaining acceptable levels of IRR. To accomplish these objectives, management can change the composition of the investment portfolio allowing management to quickly adjust the IRR exposure of the Bank, and take advantage of interest rate changes in the markets. The tables in Note 3 of the Notes to Consolidated Financial Statements depict the amortized cost, estimated fair values, contractual maturity, and yields of the debt security portfolios.\nAs of December 31, 1994, the Bank's debt security portfolio was composed of securities with a fair value of $629 million (amortized cost of $646 million) with a yield of 6.79 percent compared to a debt security portfolio with a fair value of $664 million (amortized cost of $652 million) yielding 6.17 percent at December 31, 1993.\nDuring 1994, the debt security portfolio balance declined by $34 million. Purchases of debt securities and poolings of loans into debt securities approximated the total of sales, maturities, and prepayments during 1994. The decline in the portfolio is primarily the result of a $28 million decline in the unrealized gain in debt securities available for sale. Debt securities available for sale included a $13.5 million unrealized gain at December 31, 1993, which declined to a $14.5 million unrealized loss at December 31, 1994 as a result of increases in interest rates during the period.\nThe Bank's assets and liabilities consist primarily of monetary assets (cash, cash equivalents, debt securities and loans receivable) and liabilities (savings deposits and borrowings) which are, or will be converted into a fixed amount of dollars in the ordinary course of business regardless of changes in prices. Monetary assets lose purchasing power due to inflation, but this is offset by gains in the purchasing power of liabilities, as these obligations are repaid with inflated dollars.\nThe level and movement of interest rates is of much greater significance. Inflation is but one factor that can cause interest rate volatility and changes in interest levels. The results of operations of the Bank are dependent upon its ability to manage such movements. See Risk Management -- Interest Rate Risk Management herein for additional discussion.\nRISK MANAGEMENT\nThe financial services industry has certain risks. In order to be successful and profitable, in an increasingly volatile and competitive marketplace, the Bank must accept some forms of risk and manage these risks in a safe and sound manner. Generally, transactions that the Bank enters into require the Bank to accept some measure of credit risk and IRR, and utilize equity capital. The Bank has established certain guidelines in order to manage the Bank's assets and liabilities. These guidelines will help ensure that the risks taken and consumption of capital are optimized to achieve maximum profitability, while minimizing risks to equity and the federal deposit insurance fund. See Note 17 of Notes to Consolidated Financial Statements for further discussion of Interest Rate Risk Management.\nInterest Rate Risk (IRR) Management\nThe Bank has established certain guidelines to manage the exposure of the Bank's net interest income, net income, and net portfolio value (NPV) to interest rate fluctuations. NPV represents a theoretical estimate of the market value of the Bank's stockholder's equity, calculated as the net present value of expected cash flows from financial assets and liabilities, plus the book values of all nonfinancial assets and liabilities. The guidelines establish acceptable activities and instruments to manage IRR and include limits on overall IRR exposure, methods of accountability and specific reports to be provided by management for periodic review.\nThe Bank maintains an IRR simulation model which enables management to measure the Bank's IRR exposure using various assumptions and interest rate scenarios, and to incorporate alternative strategies for the reduction of IRR exposure. The Bank measures its IRR using several methods to provide a comprehensive view of its IRR from various perspectives. These methods include projection of current NPV and future periods' net interest income after rapid and sustained interest rate movements, static analysis of repricing and maturity mismatches, or gaps, between assets and liabilities, and analysis of the size and sources of basis risk.\nStatic gap analysis measures the difference between financial assets and financial liabilities scheduled and expected to mature or reprice within a specified time period. The gap is positive when repricing and maturing assets exceed repricing and maturing liabilities, where as the gap is negative when repricing and maturing liabilities exceed repricing and maturing assets. A positive or negative cumulative gap indicates in a general way how the Bank's net interest income should respond to interest rate fluctuations. A positive cumulative gap for a period generally means that rising interest rates would be reflected sooner in financial assets than in financial liabilities, thereby increasing net interest income over that period. A negative cumulative gap for a period would produce an increase in net interest income over that period if interest rates declined.\nAt December 31, 1994, the Bank had financial assets of $1.7 billion with a weighted average yield of 7.26 percent, and financial liabilities of $1.6 billion with a weighted average rate of 4.10 percent. The Bank's cumulative one-year static gap was a negative $145 million, or eight percent of financial assets. The Bank's financial assets and financial liabilities are presented according to their frequency of repricing, and scheduled or expected maturities in the following table (thousands of dollars):\nSTATIC GAP AS OF DECEMBER 31, 1994\n- ---------------\nNote: Loans receivable exclude allowance for credit losses, discount reserves, deferred loan fees, loans in process, and accrued interest on loans.\nSTATIC GAP ASSUMPTIONS AS OF DECEMBER 31, 1994\n(1) Based on the contractual maturity or term to next repricing of the instrument(s).\n(2) Maturity sensitivity is based upon characteristics of underlying loans. Portions represented by adjustable-rate certificates are included in the \"Within 1 Year\" category, as underlying loans are subject to interest rate adjustment at least semiannually or annually. Portions represented by fixed-rate loans are based on contractual maturity, and projected repayments and prepayments of principal.\n(3) Adjustable-rate loans are included in each respective category depending on the term to next repricing and projected repayments and prepayments of principal.\n(4) Maturity sensitivity is based upon contractual maturity, and projected repayments and prepayments of principal.\n(5) FHLB stock has no contractual maturity. The Bank receives quarterly dividends on all shares owned and the balance is therefore included in the \"Within 1 Year\" category. The amount of such dividends is not fixed, and varies quarterly.\n(6) Interest-bearing demand, money market deposits, and savings deposits may be subject to daily interest rate adjustment and withdrawal on demand, and are therefore included in the \"Within 1 Year\" category.\n(7) Noninterest-bearing demand deposits have no contractual maturity, and are included in each repricing category based on the Bank's historical attrition of such accounts.\n(8) Floating-rate reverse repurchase agreements are included in the \"Within 1 Year\" category. Principal repayments of flexible reverse repurchase agreements are based on the projected timing of construction or funding of the underlying project.\n(9) Hedging consisted of fixed rate interest rate swaps as of December 31, 1994.\n(10) Based on expected maturity.\nWhile the static gap analysis is a useful asset\/liability management tool, it does not fully assess IRR. Static gap analysis does not address the effects of customer options (such as early withdrawal of time deposits, withdrawal of deposits with no stated maturity, and mortgagors' options to prepay loans) and Bank strategies (such as delaying increases in interest rates paid on certain interest-bearing demand and money market deposit accounts) on the Bank's net interest income, net income, and NPV. In addition, the static gap analysis assumes no changes in the spread relationships between market rates on interest-sensitive financial instruments (basis risk), or in yield curve relationships. Therefore, a static gap analysis is only one tool with which to analyze IRR, and must be reviewed in conjunction with other asset\/liability management reports.\nCredit Risk Management\nManagement has also established certain guidelines and criteria in order to manage the credit risk of the Bank's debt security portfolios, including concentration limits, credit rating and geographic distribution requirements. The following table presents the credit quality of the debt security portfolios:\nThe other category primarily includes the Bank's investment in the privately issued MBS classified as substandard, as further explained in this section.\nOTS regulations require the Bank to classify certain assets into one of three categories -- \"substandard,\" \"doubtful\" and \"loss.\" An asset which does not currently warrant classification as substandard but which\npossesses weaknesses or deficiencies deserving close attention is considered a criticized asset and is designated as \"special mention.\" The Bank designated $32.2 million of its assets as \"special mention\" at December 31, 1994.\nThe following table sets forth the amounts of the Bank's classified assets and ratio of classified assets to total assets, net of specific reserves and charge-offs, as of the dates indicated (thousands of dollars):\nThe Bank's \"substandard\" assets decreased from $79 million at December 31, 1993 to $60 million at December 31, 1994, primarily as a result of upgrade of loans to special mention, payoffs of real estate loans, repayments on the classified investment security, and disposition of foreclosed real estate. Assets classified as \"substandard\" are inadequately protected by the current net worth or paying capacity of the obligor or the collateral pledged, if any. Foreclosed real estate decreased $2.1 million during 1994, principally as a result of partial sales on insubstance foreclosures of $1.8 million and other sales and write-downs. It is the Bank's practice to charge off all assets which it considers to be \"loss.\" As a result, none of the Bank's assets, net of charge-offs, were classified as \"loss\" at December 31, 1994.\nThe investment classified as substandard represents a privately issued MBS collateralized by apartments, office buildings, town homes, shopping centers and day care centers located in various states along the southeastern seaboard which is supported by a credit enhancement feature. The single A credit rating of this security was withdrawn by the rating agency in January 1993, due to the delinquency of a large number of the loans underlying the security. Because of the limited number of owners of the security, no quoted market value is available on the MBS. Therefore, the Bank's management performed a credit review of the loans underlying the MBS to determine the appropriate fair value of the security. Based on such reviews, the Bank determined that only a portion of the underlying loans met the criteria for substandard classification. However, the entire investment security is classified as substandard because the OTS does not have a policy for the \"split rating\" of a security.\nThe current level of the Bank's classified assets reflects significant improvement from the prior two years. Aggressive management of the resolution of these assets along with some stabilization within the economy contributed to the success in reducing the classified asset portfolio. Although progress has been positive, the Bank is unable to predict at this time what level, if any, of these assets may subsequently be charged off or may result in actual losses. The rising interest rate environment could have an adverse impact on both the level of classified assets and the level of charge-offs on interest rate sensitive assets.\nAs a result of the Bank's internal review process, the general allowance for estimated credit losses increased to $17.7 million at December 31, 1994, from $16.3 million at December 31, 1993. During 1994, the Bank established provisions for estimated credit losses totaling $7.4 million, of which $7.2 million related to the Bank's loan, foreclosed real estate, and debt security portfolio and $200,000 was related to its real estate investment portfolio. In 1993, the Bank established provisions for estimated credit losses totaling $7.2 million, of which $1 million related to the Bank's real estate investment portfolio and $6.2 million related to its loan, foreclosed real estate portfolio, and debt security portfolio.\nThe Bank's loan portfolio is concentrated primarily in Nevada, California and Arizona. The following table summarizes the geographic concentrations of the Bank's loan portfolios at December 31, 1994 (thousands of dollars):\nLOANS BY REGION\nAt December 31, 1994, 48 percent or $19.5 million of the Bank's outstanding commercial secured loan portfolio consisted of loans to borrowers in the gaming industry, with additional unfunded commitments of $11.5 million. These loans are generally secured by real estate and equipment. The Bank's portfolio of loans, collateralized by real estate, consists principally of real estate located in Nevada, California and Arizona. Collectibility is, therefore, somewhat dependent on the economies and real estate values of these areas and industries.\nThe following table sets forth by geographic location the amount of classified assets at December 31, 1994 (thousands of dollars):\nCLASSIFIED ASSETS BY GEOGRAPHIC LOCATION\nThe mortgage loans of $22 million in other states represents the classified MBS collateralized by loans in states along the southeastern seaboard. Classified construction and land loans include committed but undisbursed loan amounts.\nThe following table sets forth by type of collateral, the amount of classified assets at December 31, 1994 (thousands of dollars):\nCLASSIFIED ASSETS BY TYPE OF LOAN\nThe largest substandard loan at December 31, 1994 was an $8.2 million multi-family real estate loan in Nevada. In addition, the Bank had three other substandard loans at December 31, 1994 in excess of $1 million: two hotel loans and one multi-family loan, all located in Nevada.\nThe largest parcel of foreclosed real estate owned by the Bank at December 31, 1994, was a $1.4 million land parcel located in California. The Bank also owns two parcels of foreclosed real estate at December 31, 1994 with book values in excess of $1 million: one apartment complex located in Nevada and a single-family construction property located in California.\nSubstandard real estate held for investment includes an $860,000 Arizona branch facility not included as part of the Arizona sale. This branch facility was formerly included in premises and equipment. See Note 2 of the Notes to Consolidated Financial Statements for further discussion.\nThe following table presents the Bank's net charge-off experience for loans receivable and real estate acquired through foreclosure by loan type (thousands of dollars):\nThe $959,000 of commercial mortgage charge-offs for the year ended December 31, 1994 were comprised principally of two apartment complex properties totaling $765,000, both located in Nevada. Construction and land losses in 1994 consisted primarily of two California loans totaling $747,000 and one land parcel in Nevada for $145,000. Nonmortgage loan charge-offs were principally comprised of $1.4 million of losses in installment loans, $558,000 of credit card charge-offs, and $432,000 in charge-offs from the merchant services portfolio in 1994. SFR charge-offs for 1994 and 1993 consist primarily of California-based loans and real estate acquired through foreclosure.\nRESULTS OF FINANCIAL SERVICES OPERATIONS\nThe Bank's net income depends in large part on the difference, or interest rate spread, between the yield it earns from its loan and debt security portfolios and the rates it pays on deposits and borrowings.\nThe following table reflects, for the periods indicated, the components of net interest income of the Bank, setting forth average assets, liabilities and equity; interest income on interest-earning assets and interest expense on interest-bearing liabilities; average yields on interest-earning assets and interest-bearing liabilities; and net interest income (thousands of dollars):\n- ---------------\nNote: Loans receivable include accrued interest and loans on nonaccrual, and are net of undisbursed funds, valuation allowances, discounts and deferred loan fees.\nThe following table shows, for the periods indicated, the effects of the two primary determinants of the Bank's net interest income: interest rate spread and the relative amounts of interest-sensitive assets and liabilities. The table also shows the extent to which changes in interest rates and changes in the volumes of interest sensitive assets and liabilities have affected the Bank's interest income and expense for the periods indicated. Changes from period to period are attributed to: (i) changes in rate (change in weighted average interest rate multiplied by prior period average portfolio balance); (ii) changes in volume (change in average portfolio balance multiplied by prior period rate); and (iii) net or combined changes in rate and volume. Any changes attributable to both rate and volume that cannot be segregated have been allocated proportionately between the two factors.\n1994 vs. 1993\nThe Bank recorded net income of $7.7 million for the year ended December 31, 1994, compared to net income of $6.6 million for the year ended December 31, 1993. The increase in net income was principally due to an improved net interest margin, along with increased operational efficiency.\nThe lower interest-earning asset base is the result of the Bank's strategy of reducing its total asset size. The increase in the average yield on interest-earning assets is the result of the repricing of interest sensitive loans and debt securities, repayment of lower yielding loans and debt securities, and the replacement of such loans and debt securities with higher yielding originations and purchases.\nThe following summarizes the significant effects of these factors:\n(i) Interest on cash equivalents increased due to the higher yield which was a result of the higher interest rates, and increased volume during the year.\n(ii) Debt securities, in total, decreased principally as a result of the sale of $334 million to fund the transfer of the Arizona-based deposit liabilities in 1993 (Arizona sale) and paydowns within the\nportfolio, offset partially by purchases of $296 million. The decrease in average balance of debt securities also resulted in a decrease of the interest on debt securities. As the Arizona sale did not occur until the last half of 1993, the average balance of the debt securities was higher in 1993. The increase in the yield was due to sales of lower coupon securities in 1993 and to the purchase of higher yielding debt securities in 1994.\n(iii) The average loans receivable portfolio increased principally due to a decrease in loan payoffs from 1994 compared to 1993, partially offset by decreased loan originations. Total loan originations for 1994 were $466 million compared to originations of $500 million for 1993. The decline in loan originations for 1994 was due to the rising interest rate environment and the corresponding decline in refinance activity. The rise in interest rates also slowed down the prepayments within the Bank's mortgage loan portfolio. The average yield on loans declined as a result of lower interest rates on newly funded adjustable-rate mortgage loans.\n(iv) Dividends on FHLB stock increased as a result of a higher declared dividend rate in 1994.\n(v) The average balance for deposits decreased as a result of the Arizona sale of $321 million in 1993. The average balance of deposits was higher in 1993 because the sale occurred in the last half of the year. The decrease in the cost of savings was due to the lower interest rate environment.\n(vi) The decrease in interest on securities sold under agreements to repurchase was due to net repayments of borrowings during the year, partially offset by an increase in the cost.\n(vii) The increase in the average balance for FHLB advances was due to the new borrowings during the year, partially offset by repayment of advances. The decrease in the cost of these advances was due to lower interest rates on the new borrowings versus the higher rates on these advances paid off.\n(viii) Interest on notes payable declined primarily as a result of the repayment of $10.4 million in the third quarter of 1993.\n(ix) Interest on unsecured senior notes declined as a result of the pay-off of the $25 million balance in the third quarter of 1993.\nThe Bank's cost of hedging activities increased principally as a result of the Bank entering into interest rate swaps of $72.5 million (notional amount) in 1994 compared to $7.5 million (notional amount) of interest rate swaps in 1993. See Note 17 of the Notes to Consolidated Financial Statements for further discussion.\nProvisions for estimated credit losses increased in 1994 versus 1993 as a result of management's evaluation of the adequacy of the allowances for estimated credit losses. See Risk Management -- Credit Risk Management herein and Note 5 of the Notes to Consolidated Financial Statements for further discussion.\nThe net gain on sale of loans decreased $1.5 million from $1.7 million in 1993 to $247,000 in 1994, due to a decrease in the amount of loans sold from $78 million in 1993 to $46 million in 1994. Net gains on the sale of debt securities decreased from a net gain of $8 million in 1993 to a net gain of $34,000 in 1994, primarily due to the sale in 1993 of $361 million in debt securities, of which $334 million were sold to fund the sale of the Arizona-based deposit liabilities. In January 1994, the Bank sold its credit card portfolio and recognized a gain of $1.7 million ($1.1 million net of charge-offs). Other income decreased principally due to a legal settlement of $1.2 million received in 1993, while legal fees of $810,000 were incurred in 1994 associated with a Las Vegas apartment complex which the Bank built.\nGeneral and administrative expenses decreased $4.8 million, or 10 percent, in 1994. This decrease was due to the general and administrative expenses associated with the Arizona operations which were incurred in 1993 until the sale in the third quarter of that year, which were not incurred in 1994 along with increases in efficiency and focus on cost reduction.\nThe Bank's effective tax rate was 45.4 percent in 1994 primarily as a result of goodwill amortization.\n1993 vs. 1992\nThe Bank recorded net income of $6.6 million for the year ended December 31, 1993 compared to a net loss of $9.8 million for the year ended December 31, 1992. The increase in net income was principally due to the decrease in provisions for estimated credit losses, the gain recorded on the sale of debt securities in connection with the Arizona sale, the cumulative effect of change in method for accounting for income taxes and an improved net interest margin, offset partially by the write-off of goodwill as the result of the Arizona sale as described in Note 2 of the Notes to Consolidated Financial Statements.\nThe lower interest-earning asset base is the result of the Bank's strategy of reducing its total asset size. The decline in the average yield on interest-earning assets is the result of the repricing of interest sensitive loans and debt securities, repayment of higher yielding loans and debt securities and the replacement of such loans and debt securities with lower yielding originations and purchases.\nThe following summarizes the significant effects of these factors:\n(i) Interest on cash equivalents decreased due to the lower yield which was a result of the lower interest rates during the year.\n(ii) Interest on debt securities, in total, decreased principally as a result of $294 million of payoffs and principal amortization in the portfolio and the third quarter effect of the sale of $334 million to fund the transfer of the Arizona-based deposit liabilities, offset partially by $113 million in debt security purchases. The decrease in debt securities held to maturity was the result of the reclassification of the majority of the portfolio to debt securities available for sale category during the second quarter. This resulted in the increase in debt securities available for sale offset partially by the sale of $334 million to fund the sale of the Arizona-based deposit liabilities. The decrease in yield was due to sales of higher coupon securities in 1992 and 1993 and to repricing of adjustable-rate debt securities, repayments, and purchase of lower yielding debt securities.\n(iii) The average loans receivable portfolio decreased principally due to payoffs exceeding originations of loans held for investment. The average yield on loans declined as a result of lower interest rates on newly funded loans, repricing of adjustable loans, and payoffs of higher yielding loans.\n(iv) Dividends on FHLB stock increased as a result of a higher declared dividend rate in 1993.\n(v) The average balance for deposits decreased as a result of the Arizona sale of $321 million. The decrease in the cost of savings was due to the Arizona sale, the lower interest rates, and the disintermediation of certificates of deposit accounts to transaction accounts.\n(vi) The increase in interest on securities sold under agreements to repurchase was due to new borrowings during the first part of 1993, partially offset by a decrease in the cost.\n(vii) The decrease in the average balance for FHLB advances was due to the repayment of advances in the early part of 1993 somewhat offset by new borrowings later in the year. The decrease in the cost of these advances was due to lower interest rates on the new borrowings versus the higher rates on these advances which paid off.\n(viii) The decrease in interest on bonds payable was the result of the payoff of mortgage-backed bonds during the second quarter of 1992. The bonds were called on June 30, 1992.\n(ix) Interest on notes payable declined as a result of the repayment of $10.4 million in the third quarter of 1993.\n(x) Interest on unsecured senior notes declined as a result of the pay-off of the $25 million balance in the third quarter of 1993.\nThe Bank's cost of hedging activities decreased principally as a result of the cancellation of $300 million (notional amount) of interest rate swaps outstanding during the second and third quarters of 1992 and only $7.5 million (notional amount) of interest rate swaps were entered into in late 1993.\nProvisions for estimated credit losses decreased in 1993 versus 1992 as a result of management's evaluation of the adequacy of the allowances for estimated credit losses. See Risk Management -- Credit Risk Management herein and Note 5 of the Notes to Consolidated Financial Statements for further discussion.\nThe net gain on sale of loans decreased $2.9 million from $4.6 million in 1992 to $1.7 million in 1993 due to a decrease in the amount of loans sold from $240 million in 1992 to $78 million in 1993. The gain on sale of mortgage loan servicing decreased $1.9 million in 1993, as there were no sales of mortgage loan servicing in 1993. Net gains on the sale of debt securities, including the interest rate swap loss, increased from a net loss of $809,000 in 1992 to a net gain of $8 million in 1993, primarily due to the sale of $361 million in debt securities, of which $334 million were sold to fund the sale of the Arizona-based deposit liabilities. The net loss on the termination of the interest rate swaps in 1992 was $14.1 million. No similar activity occurred in 1993. The net loss on the termination of the interest rate swaps was related to the cancellation of $300 million (notional amount) of interest rate swaps which hedged loans and debt securities sold during 1992 as part of the balance sheet restructuring. Loan related fees decreased $1.3 million due to the decrease in loan servicing volume. Deposit fees increased $984,000 due to an increase in the fee structure. Other income increased principally due to a legal settlement received of $1.2 million.\nGeneral and administrative expenses increased $3 million, or seven percent, in 1993. This increase was due to the reinstatement of employee merit increases and incentive awards during 1993, a scheduled rent increase on office space, and increased professional services fees from legal efforts related to California real estate development projects.\nThe Bank's effective tax rate was 64.1 percent in 1993 primarily as a result of goodwill amortization and goodwill write-offs not deductible for tax purposes.\n(This page intentionally left blank)\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF FINANCIAL POSITION\n(THOUSANDS OF DOLLARS)\nASSETS\nThe accompanying notes are an integral part of these statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS)\nThe accompanying notes are an integral part of these statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these statements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGeneral\nBasis of Presentation -- The Company follows generally accepted accounting principles (GAAP) in all of its businesses. Accounting for the Company's gas utility operations conforms with GAAP as applied to regulated companies and as prescribed by federal agencies and the commissions of the various states in which the utility operates.\nConsolidation -- The accompanying financial statements are presented on a consolidated basis and include the accounts of the Company, including the Bank. Intercompany balances and transactions have been eliminated.\nCash Flows -- For purposes of reporting consolidated cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and other financial instruments with a maturity of three months or less.\nExcess of Cost Over Net Assets Acquired -- The Company amortizes excess of cost over net assets acquired on a straight-line basis over 25 years.\nIncome Taxes -- Effective January 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" which required a change from the deferred method of accounting for income taxes to the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.\nFor years prior to 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 tax rate applicable for the year of the calculation. Under the deferred method, deferred taxes were not adjusted for subsequent changes in tax rates.\nInvestment tax credits (ITC) related to gas utility operations are deferred and amortized over the life of related fixed assets.\nEarnings Per Common Share -- Earnings per common share are calculated based on the weighted average number of shares outstanding during the period.\nReclassifications -- Certain reclassifications have been made to prior years' amounts to conform to the current year presentation.\nGas Utility\nGas Utility Property, Net -- Gas utility property, net includes gas plant at original cost, less the accumulated provision for depreciation and amortization, plus the unamortized balance of acquisition adjustments. Original cost includes contracted services, material, payroll and related costs such as taxes and benefits, general and administrative expenses, and an allowance for funds used during construction less contributions in aid of construction.\nDepreciation and Amortization -- Depreciation is computed on the straight-line remaining life method at composite rates considered sufficient to amortize costs over estimated service lives. Acquisition adjustments are amortized as ordered by regulatory bodies at the date of acquisition, which periods approximate the\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)\nremaining estimated life of the acquired properties. Costs related to refunding utility debt and debt issuance expenses are deferred and amortized over the weighted average lives of the new issues.\nDeferred Gas Costs -- The Company is authorized by the various regulatory authorities having jurisdiction to adjust its billing rates for changes in the cost of gas purchased. The difference between the current cost of gas purchased and the cost of gas recovered in billed rates is deferred. Generally, these deferred amounts are recovered or refunded within one year.\nUtility Revenues -- Gas revenues are accrued from the date the customer was last billed to the end of the accounting period. In California, through 1994, the Company was authorized to adjust gas revenues to reflect changes in operating margins from authorized levels related to all customer classes. This mechanism was discontinued effective January 1995.\nCapitalization of Interest -- The Company capitalized $653,000, $381,000 and $934,000 of interest expense and a portion of the cost of equity funds related to natural gas utility operations for each of the years ended December 31, 1994, 1993 and 1992. The cost of equity funds used to finance the construction of utility plant is reported net within the consolidated statements of income as a reduction of interest charges. Utility plant construction costs, including cost of equity funds, are recovered in authorized rates through depreciation when completed projects are placed into operation.\nFinancial Services\nDebt Securities -- On December 31, 1993, the Bank adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The statement requires classification of investments in debt and equity securities into one of three categories: held to maturity, available for sale, or trading. At the time of purchase, the Bank designates a security into one of these three categories.\nDebt securities classified as held to maturity are those which the Bank has the positive intent and ability to hold to maturity. These securities are carried at cost adjusted for the amortization of the related premiums or accretion of the related discounts into interest income using methods approximating the level-yield method or a method based on principal repayments over the actual lives of the underlying loans. The Bank has the ability and it is its policy to hold the debt securities so designated until maturity. The Bank's current accounting policy is that no security with a remaining maturity greater than 25 years may be designated as held to maturity.\nSecurities classified as available for sale are those which the Bank intends to hold for an indefinite period and which may be sold in response to changes in market interest rates, changes in the security's prepayment risk, the Bank's need for liquidity, changes in the availability and yield of alternative investments, and other asset\/liability management needs. Securities classified as available for sale are stated at fair value in the Consolidated Statements of Financial Position. Changes in fair value are reported net of tax as a separate component of stockholders' equity, but are not included in net income. Realized gains or losses are recorded into income when sold.\nTrading securities are those which are bought and held principally for the purpose of selling in the near term. Trading securities include MBS held for sale in conjunction with mortgage banking activities. Trading securities are measured at fair value with changes in fair value included in earnings. At December 31, 1994 and 1993, no securities were designated as \"trading securities.\"\nLoans Receivable -- Real estate loans are recorded at cost, net of the undisbursed loan funds, loan discounts, unearned interest, deferred loan fees and provisions for estimated losses. Interest on loans receivable is credited to income when earned. Generally, if a loan becomes 90 days contractually delinquent, the accrual\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)\nof interest is ceased and all previously accrued, but uncollected, interest income is reversed. Interest income on loans placed on nonaccrual status is generally recognized on a cash basis.\nFees are charged for originating and in some cases, for committing to originate loans. Loan origination and commitment fees, offset by certain direct origination costs, are deferred, and the net amounts amortized as an adjustment of the related loans' yields over the contractual lives thereof. Unamortized fees are recognized as income upon the sale or payoff of the loan.\nUnearned interest, premiums and discounts on consumer installment, equity and property improvement loans are amortized to income over the expected lives of the loans using a method which approximates the level-yield method.\nMortgage Banking Activities -- The Bank's accounting policy is to designate all fixed-rate interest-sensitive assets with maturities greater than or equal to 25 years (which possess normal qualifying characteristics required for sale) as held for sale or available for sale, along with single-family residential loans originated for specific sales commitments. Fixed-rate interest-sensitive assets with maturities less than 25 years, and all adjustable-rate interest-sensitive assets continue to be held for investment unless designated as held for sale at time of origination.\nLoans held for sale are carried at the lower of amortized cost or fair value as determined by outstanding investor commitments or, in the absence of such commitments, current investor yield requirements calculated on an aggregate basis. Valuation adjustments are charged against gain (loss) on sale of loans. Gains and losses on loan and MBS sales are determined using the specific identification method. Gains and losses are recognized to the extent that sales proceeds exceed or are less than the carrying value of the loans and MBS. Loans sold with servicing retained include a normal servicing fee to be earned by the Bank as income over the life of the loan. Loans held for sale may be securitized into MBS and designated as trading securities and recorded at fair value.\nReal Estate Acquired Through Foreclosure -- Real estate acquired through foreclosure is stated at the lower of cost or fair value less cost to sell. Included in real estate acquired through foreclosure is $2.9 million and $5.5 million of loans foreclosed in-substance at December 31, 1994 and 1993, respectively. Write downs to fair value, disposition gains and losses, and operating income and costs are charged to the allowance for estimated credit losses.\nLoans foreclosed in-substance consist of loans accounted for as foreclosed property even though actual foreclosure has not occurred. Although the collateral underlying these loans has not been repossessed, the borrower has little or no equity in the collateral at its current estimated fair value. Proceeds for repayment are expected to come only from the operation or sale of the collateral, and it is doubtful the borrower will rebuild equity in the collateral or repay the loan by other means in the foreseeable future. The amounts ultimately recovered from loans foreclosed in-substance could differ from the amounts used in arriving at the net carrying value of the assets because of future market factors beyond management's control or changes in strategy for recovering the investment.\nAllowance for Estimated Credit Losses -- On a routine basis, management evaluates the adequacy of the allowances for estimated losses on loans, investments and real estate, and establishes additions to the allowances through provisions to expense. The Bank utilizes a comprehensive internal asset review system and general valuation allowance methodology. General valuation allowances are established for each of the loan, investment and real estate portfolios for unforeseen losses. A number of factors are taken into account in determining the adequacy of the level of allowances including management's review of the extent of existing risks in the portfolios, prevailing and anticipated economic conditions, actual loss experience, delinquencies, regular reviews of the quality of the loan and real estate portfolios and examinations by regulatory authorities.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)\nCharge-offs are recorded on particular assets when it is determined that the fair or net realizable value of an asset is below the carrying value. When a loan is foreclosed, the asset is written down to fair value based on a current appraisal of the subject property.\nWhile management uses currently available information to evaluate the adequacy of allowances and estimate identified losses for charge off, ultimate losses may vary from current estimates. Adjustments to estimates are charged to earnings in the period in which they become known.\nInterest Rate Exchange Agreements -- The Bank uses interest rate swaps and interest rate collars to hedge its exposure to interest rate risk. These instruments are used only to hedge asset and liability portfolios and are not used for speculative purposes. Premiums, discounts and fees associated with these interest rate exchange agreements are amortized to expense on a straight-line basis over the lives of the agreements. The net interest received or paid is included in interest expense as a cost of hedging. Gains or losses resulting from the cancellation of agreements hedging assets and liabilities which remain outstanding are deferred and amortized over the remaining contract lives. Gains or losses are recognized in the current period if the hedged asset or liability is retired.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA\nSummarized consolidated financial statement data for the Bank is as follows. Certain reclassifications have been made to conform presentations for prior years with the current year's presentation:\nCONSOLIDATED STATEMENTS OF INCOME (THOUSANDS OF DOLLARS)\n- ---------------\n(1) Includes after-tax allocation of costs from parent.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)\nCONSOLIDATED STATEMENTS OF FINANCIAL POSITION (THOUSANDS OF DOLLARS)\n- ---------------\n* These items are not comprised of financial instruments subject to fair value disclosure under SFAS No. 107. See SFAS No. 107 discussion herein.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nSFAS No. 107, \"Disclosures About Fair Value of Financial Instruments,\" requires that the Bank disclose estimated fair values for its financial instruments.\nThe fair value estimates were made at a discrete point in time based on relevant market information and other information about the financial instruments. Because no active market exists for a significant portion of the Bank's financial instruments, fair value estimates were based on judgements regarding current economic conditions, risk characteristics of various financial instruments, prepayment assumptions, future expected loss experience and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.\nIn addition, the fair value estimates were based on existing on-balance sheet and off-balance sheet financial instruments without attempting to estimate the value of existing and anticipated future customer relationships and the value of assets and liabilities that were not considered financial instruments. Significant assets and liabilities that were not considered financial assets or liabilities include the Bank's retail branch network, deferred tax assets and liabilities, furniture, fixtures and equipment, and goodwill.\nAdditionally, the Bank intends to hold a significant portion of its assets and liabilities to their stated maturities. Therefore, the Bank does not intend to realize any significant differences between carrying value and fair value through sale or other disposition. No attempt should be made to adjust equity to reflect the fair value disclosures.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)\nMethods and assumptions used to determine estimated fair values are set forth below for the Bank's financial instruments as of December 31, 1994 and 1993.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)\nREGULATORY CAPITAL\nThe Bank is subject to various capital adequacy requirements under a uniform framework by federal banking agencies. Specific capital guidelines require the Bank to maintain minimum amounts and ratios as set forth below.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required the federal banking agencies to adopt regulations implementing a system of progressive constraints as capital levels decline at banks and savings institutions. Federal banking agencies have enacted uniform \"prompt corrective action\" rules which classify banks and savings institutions into one of five categories based upon capital adequacy, ranging from \"well capitalized\" to \"critically undercapitalized.\" Banks become subject to prompt corrective action when their ratios fall below \"adequately capitalized\" status. A reconciliation of stockholder's equity, as shown in the accompanying Consolidated Statements of Financial Position, to the FDICIA capital standards and the Bank's resulting ratios are set forth in the table below (thousands of dollars):\nAs of December 31, 1994 and 1993, PriMerit Bank exceeded the adequately capitalized ratios and was categorized as \"well capitalized.\"\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)\nThe regulatory capital standards contain certain phase-in requirements concerning the amount of supervisory goodwill which is includable in tier 1 and risk-based capital as well as the amount of real estate investments which are required to be deducted from capital under all three standards. On January 1, 1995, all supervisory goodwill must be deducted from regulatory capital. Based upon this limitation, the Bank's risk-based and tier 1 capital levels declined by $6.6 million on January 1, 1995.\nThe decline in the Bank's capital ratios over prior year-end is principally the result of the change in the allowable supervisory goodwill and the inclusion of $8.8 million of unrealized gain, net of tax, on debt securities available for sale in regulatory capital for 1993; partially offset by year-to-date net income of $7.7 million. At December 31, 1994, under fully phased-in capital rules applicable at July 1, 1996, the Bank would have exceeded the \"adequately capitalized\" fully phased-in, total risk-based, tier 1 risk-based, and tier 1 leverage ratios by $46.7 million, $72.8 million and $38.7 million, respectively.\nThe Bank is subject to an OTS regulation requiring institutions with IRR exposure classified as \"above normal\" to reduce their risk-based capital by 50 percent of the amount by which the IRR exposure exceeds a specified \"normal\" threshold. The normal IRR threshold is defined as a two percent decline of an institution's net portfolio value as a percentage of its market value of assets after a hypothetical 200 basis point immediate and sustained increase or decrease in market interest rates. The reduction of an institution's risk-based capital resulting from its exceeding the IRR threshold becomes effective at the end of the third calendar quarter after the measurement date, unless the institution's IRR exposure returns to a \"normal\" level or below in the interim.\nBased on the OTS's measurement of the Bank's September 30, 1994 and December 31, 1994 IRR, the Bank may be required to reduce its risk-based capital by approximately $1.5 million on June 30, 1995 and $1.9 million on September 30, 1995, in the absence of corrective action to reduce the Bank's IRR exposure or a significant change in market interest rates in the interim. As of December 31, 1994, the Bank has sufficient risk-based capital to allow it to continue to be classified as \"well capitalized\" under FDICIA capital requirements after such a reduction for IRR exposure. Management is currently reviewing possible strategies for reducing the Bank's IRR exposure to a \"normal\" level or below.\nOTHER REGULATORY MATTERS\nIn conjunction with the acquisition of the Bank in 1986, the Company agreed that as long as it controls the Bank, adequate capital as required by applicable regulations, will be maintained at the Bank and if required, the Company will infuse additional capital into the Bank to assure compliance with such requirements. The Company presently does not anticipate having to contribute additional capital to the Bank.\nThe Company also stipulated in connection with the acquisition of the Bank that dividends paid by the Bank to the Company would not exceed 50 percent of the Bank's cumulative net income after the date of acquisition without approval of the regulators. Since the acquisition, the Bank's cumulative net income is $37.1 million, resulting in maximum dividends payable of $18.6 million as of December 31, 1994. Since the acquisition, the Bank has paid the Company $1.8 million in capital distributions, net of $20 million in capital contributions received from the Company in 1991 and 1992.\nCapital distributions, including dividends, are also governed by an OTS regulation which limits distributions by applying a tiered system based on capital levels. Under the regulation, the Bank is restricted to paying no more than 75 percent of its net income over the preceding four quarters to the Company. The Bank did not pay any dividends to the Company during the last three years.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 -- SUMMARIZED FINANCIAL STATEMENT DATA -- (CONTINUED)\nSALE OF ARIZONA BRANCH OPERATIONS\nIn May 1993, the Bank signed a Definitive Agreement with World Savings and Loan Association (World) of Oakland, California, whereby World agreed to acquire the Bank's Arizona branch operations, including all related deposit liabilities of approximately $321 million. The transaction was approved by the appropriate regulatory authorities and closed in August 1993. During 1993, the Bank recorded a $6.3 million loss, which included a write-off of $5.9 million in goodwill (excess of cost over net assets acquired) and $367,000 of other related net costs. The Bank sold $334 million of MBS to effect the sale of the Bank's Arizona-based deposit liabilities to World and to maintain the Bank's interest rate risk position. The sale of the securities resulted in a gain of $7.4 million ($4.9 million after tax) included in gain on sale of debt securities in the Consolidated Statements of Income. The final disposition resulted in an after-tax loss of approximately $1 million.\nNOTE 3 -- DEBT SECURITIES\nDebt securities held to maturity are stated at amortized cost. The yields on these securities are computed based upon amortized cost. The amortized cost, estimated fair values and yields of debt securities held to maturity are as follows (thousands of dollars):\nThe following schedule of the expected maturity of debt securities held to maturity is based upon dealer prepayment expectations and historical prepayment activity (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 3 -- DEBT SECURITIES -- (CONTINUED)\nDebt securities available for sale are stated at fair value. The yields on these securities are computed based upon amortized cost. The amortized cost, estimated fair values and yields of debt securities available for sale are as follows (thousands of dollars):\nThe following schedule reflects the expected maturity of MBS and CMO and the contractual maturity of all other debt securities available for sale. The expected maturity of MBS and CMO are based upon dealer prepayment expectations and historical prepayment activity (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4 -- LOANS RECEIVABLE\nLoans receivable held for investment, recorded at amortized cost, are summarized as follows (thousands of dollars):\nLoans receivable held for sale, recorded at lower of aggregate cost or market, are summarized as follows (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4 -- LOANS RECEIVABLE -- (CONTINUED)\nAdditional loan information (thousands of dollars):\nOutstanding commitments to originate loans represent agreements to originate real estate secured loans to customers at specified rates of interest. Commitments generally expire in 30 to 60 days and may require payment of a fee. Some of the commitments are expected to expire without being drawn upon, therefore the total commitments do not necessarily represent future cash requirements.\nThe Bank has designated portions of its portfolio of residential real estate loans and credit card accounts as held for sale. These loans are carried at the lower of aggregate cost, market or sales commitment price. In January 1994, the Bank sold its credit card portfolio held for sale and recognized a gain of approximately $1.7 million ($1.1 million net of charge-offs).\nAt December 31, 1994, 48 percent, or $19.5 million, of the Bank's outstanding commercial secured loan portfolio consisted of loans to borrowers in the gaming industry, with additional unfunded commitments of $11.5 million. These loans are generally secured by real estate, machinery and equipment. The Bank's portfolio of loans, collateralized by real estate, consists principally of real estate located in Nevada, California, and Arizona. Collectibility is, therefore, somewhat dependent on the economies and real estate values of these areas and industries.\nThe Bank's loan approval process is intended to assess both: (i) the borrower's ability to repay the loan by determining whether the borrower meets the Bank's established underwriting criteria, and (ii) the adequacy of the proposed security by determining whether the appraised value of the security property is sufficient for the proposed loan.\nIt is the general policy of the Bank not to make single-family residential loans when the loan-to-value ratio exceeds 80 percent unless the loans are insured by private mortgage insurance, FHA insurance or VA guarantee. Residential tract construction loans are generally underwritten with the discounted loan-to-value ratio less than 85 percent, while commercial\/income property loans are generally underwritten with a ratio of less than 75 percent.\nManagement considers the above mentioned factors when evaluating the adequacy of the allowance for estimated credit losses.\nMany of the Bank's adjustable-rate loans contain limitations as to both the amount the interest rate can change at each repricing date (periodic caps) and the maximum rates the loan can be repriced to over the life of the loan (lifetime caps). At December 31, 1994, periodic caps in the adjustable loan portfolio ranged from 25 to 800 basis points. Lifetime caps ranged from 9.75 to 22 percent.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 5 -- ALLOWANCES AND RESERVES\nActivity in the allowances for losses on loans and real estate held for sale or development is summarized as follows (thousands of dollars):\nThe Bank establishes allowances for estimated credit losses by portfolio through charges to expense. On a regular basis, management reviews the level of loss allowances which have been provided against the portfolios. Adjustments are made thereto in light of the level of problem loans and current economic conditions. Included in net charge-offs are $1.9 million, $2.6 million and $2.6 million of recoveries for 1992, 1993, and 1994, respectively. Write-downs to fair value, disposition gains and losses, and operating income and costs affiliated with real estate acquired through foreclosure are charged to the allowance for estimated credit losses.\nThe Company's business activity with respect to gas utility operations is conducted with customers located within the three state region of Arizona, Nevada and California. Any credit risk the Company is exposed to related to utility operations is minimized by the taking of security deposits. Provisions for uncollectible accounts are recorded monthly and are recovered from customers through billed rates. Activity in the reserve for uncollectibles is summarized as follows (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 6 -- PROPERTY, PLANT AND EQUIPMENT\nGas utility property as of December 31, 1994 and 1993 was as follows (thousands of dollars):\nDepreciation expense on gas utility property was $56.5 million, $54 million and $51.3 million during the years ended December 31, 1994, 1993 and 1992, respectively.\nLeases and Rentals. The Company leases a portion of its corporate headquarters office complex in Las Vegas and the LNG facilities on its northern Nevada system. The leases provide for initial terms which expire in 1997 and 2003, respectively, with optional renewal terms available at the expiration dates. The rental payments are $3.1 million annually, and $7.7 million in the aggregate over the remaining initial term for the Las Vegas facility, and $6.7 million annually and $56.6 million in the aggregate for the LNG facilities.\nRentals included in operating expenses with respect to these leases amounted to $9.8 million in each of the three years in the period ended December 31, 1994. Both of these leases are accounted for as operating leases and are treated as such for regulatory purposes. Other operating leases of the Company are immaterial individually and in the aggregate.\nThe Bank leases certain of its facilities under noncancelable operating lease agreements. The more significant of these leases expire between 1995 and 2029 and provide for renewals subject to certain escalation clauses. Net rental expense for the Bank was $2.7 million in 1994, $3.1 million in 1993 and $3 million in 1992.\nThe following is a schedule of net future minimum rental payments for the Bank under various operating lease agreements that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1994 (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7 -- DEPOSITS\nDeposits are summarized as follows (thousands of dollars):\nThe above balance includes $5.8 million deposited by the State of Nevada that is collateralized by real estate loans and debt securities with a fair value of approximately $8.5 million at December 31, 1994. There were no brokered deposits at December 31, 1994 or December 31, 1993.\nInterest expense on deposits for the years ended December 31, is summarized as follows (thousands of dollars):\nCertificates of deposit maturity schedule (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 8 -- CASH EQUIVALENTS AND SECURITIES SOLD UNDER REPURCHASE AGREEMENTS\nCash Equivalents\nCash equivalents are stated at cost, which approximates fair value, and include the following (thousands of dollars):\nSecurities purchased under resale agreements at December 31, 1994 and at December 31, 1993 matured within 11 days and 24 days, respectively, and called for delivery of the same securities. The collateral for these agreements consisted of debt securities which at December 31, 1994 and 1993 were held on the Bank's behalf by its safekeeping agents and safekeeping agents for various broker\/dealers. The securities purchased under resale agreements represented 47 percent of the Bank's stockholder's equity at December 31, 1994 and 31 percent at December 31, 1993.\nThe average amount of securities purchased under resale agreements outstanding during the years ended December 31, 1994 and 1993 were $36.2 million and $26.6 million, respectively. The maximum amount of resale agreements outstanding at any month end was $77.7 million during 1994 and $60 million during 1993.\nSecurities Sold Under Repurchase Agreements\nThe Bank sells securities under agreements to repurchase (reverse repurchase agreements). Reverse repurchase agreements are treated as borrowings and are reflected as liabilities in the accompanying Consolidated Statements of Financial Position. Reverse repurchase agreements are summarized as follows (thousands of dollars):\nAll agreements are collateralized by MBS and U.S. Treasury notes and require the Bank to repurchase identical securities as those which were sold. The MBS collateralizing the agreements are reflected as assets with a carrying value of $17 million in excess of borrowing amount and a weighted average maturity of 1.35 years. Agreements were transacted with the following dealers: Morgan Stanley & Co., Inc.; Lehman Brothers; and Bear Stearns. Reverse repurchase agreements are collateralized as follows (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 8 -- CASH EQUIVALENTS AND SECURITIES SOLD UNDER REPURCHASE AGREEMENTS -- (CONTINUED)\nAt December 31, 1994, borrowings of $144 million were in accordance with a long-term agreement executed with Morgan Stanley & Co., Incorporated (primary dealer). The agreement, which allows for a maximum borrowing of $300 million with no minimum, matures in July 1997. The interest rate on the borrowings is adjusted monthly based upon a spread over or under the one month London Interbank Offering Rate (LIBOR), dependent upon the underlying collateral.\nThe Bank is also party to two separate flexible reverse repurchase agreements (flex repos) totaling $19.7 million at December 31, 1994. A flex repo represents a long-term fixed-rate contract to borrow funds through the primary dealer, collateralized by MBS with a flexible repayment schedule. The principal balance of the Bank's flex repo agreements will decline over the stated maturity period based upon the counterparty's need for the funds.\nPrincipal payments on flex repos at December 31, 1994 are projected as follows (thousands of dollars):\nActual principal payments may differ from those shown above due to the actual timing of the funding being faster or slower than originally projected.\nNOTE 9 -- COMMITMENTS AND CONTINGENCIES\nLegal Proceedings. The Company has been named as defendant in various legal proceedings. The ultimate dispositions of these proceedings are not presently determinable; however, it is the opinion of management that no litigation to which the Company is subject will have a material adverse impact on its financial position or results of operations.\nNOTE 10 -- SHORT-TERM DEBT\nThe Company has an agreement with several banks for committed credit lines which aggregate $150 million at December 31, 1994. The agreement provides for the payment of interest at competitive market rates. The lines of credit also require the payment of a facility fee based on the long-term debt rating of the Company. The committed credit lines have no compensating balance requirements and expire in July 1995. Short-term borrowings at December 31, 1994 and 1993 were $92 million and $86 million, respectively. The weighted average interest rates on these borrowings were 6.36 percent and 3.80 percent.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11 -- LONG-TERM DEBT\nThe Company had two term loan facilities totaling $165 million as of December 31, 1994. The first term loan facility was a Restated and Amended Credit Agreement (Credit Agreement) dated April 1990 in the amount of $125 million. During 1994 and 1993, the average cost of this facility was 4.99 percent and 3.89 percent, respectively. The second term loan was a $40 million Bridge Term Loan Facility (Bridge Loan) which was used to refinance the $40 million Amended and Restated Domestic Credit Agreement in August 1994. During 1994, the average interest rate for the Bridge Loan and the Amended and Restated Domestic Credit Agreement was 5.26 percent.\nIn January 1995, the Company closed a new $200 million term-loan facility with a group of banks. This new facility was utilized to refinance the existing $125 million Credit Agreement and the $40 million Bridge Loan which were to mature in April 1995. In addition to refinancing $165 million of term loans, $35 million of\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11 -- LONG-TERM DEBT -- (CONTINUED)\nshort-term notes payable were refinanced with the proceeds from this new facility, and are classified as long-term debt at December 31, 1994. The $200 million facility provides for a revolving period through January 1998 at which time any amounts borrowed under the agreement become payable on demand. Direct borrowing options provide for the payment of interest at either the prime rate, LIBOR, or certificate of deposit rate plus a margin based on the Company's credit rating. In addition to direct borrowing options, a letter of credit is available to provide credit support for the issuance of commercial paper.\nIn December 1993, the Company borrowed $75 million in Clark County, Nevada, tax-exempt IDRB. The IDRB have an annual coupon rate of 6.50 percent, are noncallable for 10 years and have a final maturity in December 2033. The proceeds from the sale of the IDRB will be used to finance certain additions and improvements to the Company's natural gas distribution and transmission system in Clark County, Nevada.\nIn December 1993, the City of Big Bear Lake, California sold $50 million of tax-exempt IDRB which are secured as to the payment of principal and interest by the Company. The net proceeds from these sales were placed with a trustee and will be drawn down as required to finance certain additions and improvements to the Company's natural gas distribution and transmission system in San Bernardino County, California. The interest rate on the bonds is established on a weekly basis and averaged 3.85 percent during 1994 and 3.53 percent for December 1993. At the option of the Company, the interest period can be converted from a weekly rate to a daily term or variable term rate.\nThe fair value of the term loan facilities approximates carrying value. Market values for debentures and fixed-rate bonds of the Company, excluding the Bank, were determined based on dealer quotes using trading records for December 31, 1994 and 1993, as applicable, and other secondary sources which are customarily consulted for data of this kind. The carrying value of the IDRB Series due 2028 was used as the estimate of fair value based upon the variable interest rate of the bonds.\nRequirements to retire long-term debt, excluding those of the Bank, at December 31, 1994 for the next five years are expected to be $5 million, $5 million, $5 million, $211 million and $11 million, respectively.\nPrincipal payments on Bank borrowings at December 31, 1994 are due as follows (thousands of dollars):\nCoupon interest rates on Bank borrowings are as follows:\nThe effective rate of the advances from the FHLB at December 31, 1994 was 5.68 percent.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 11 -- LONG-TERM DEBT -- (CONTINUED)\nIn 1994, the FHLB established a Financing Availability for the Bank which is currently 25 percent of the Bank's assets with terms up to 360 months. All borrowings from the FHLB must be collateralized by mortgages or securities. The Bank also has the capability of borrowing up to $5 million in federal funds from Bank of America. At December 31, 1994 and 1993, there were no outstanding draws from this line of credit which expires in August 1995.\nBank borrowings are collateralized as follows (thousands of dollars):\nNOTE 12 -- PREFERRED AND PREFERENCE STOCKS\nThe Company is authorized to issue up to 500,000 shares each of its Cumulative Preferred and Second Preference Stock, respectively. The Company is required to redeem 8,000 shares, or $800,000 annually, through 1999, of the $100 Cumulative Preferred Stock, 9.5 Percent Series. All outstanding Cumulative Preferred shares are redeemable at the option of the Company at any time upon 30 days notice at par plus accrued dividends and a percentage premium equal to the dividend rate in the first year commencing December 1979, and declining ratably each year thereafter to par value in 1999.\nThe estimated fair value of the Company's Cumulative Preferred Stock at December 31, 1994 and 1993 was $4 million and $5 million, respectively. These figures were based on a yield-to-maturity of 9.05 percent\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12 -- PREFERRED AND PREFERENCE STOCKS -- (CONTINUED)\nand 8.14 percent, respectively, and a required redemption of 8,000 shares per year. Since this issue is not traded, yield-to-maturity was estimated based on the weighted average yield-to-maturity of the Company's outstanding debentures, adjusted for historical spreads between Moody's Baa rated utility debt and Baa utility preferred stock issues.\nDuring 1994, the Company redeemed, as required, the remaining shares of its Second Preference Stock, Third Series. The dividend rate on Second Preference Stock was cumulative and varied from 3 to 16 percent, based on a formula tied to operating results with respect to the gas distribution system purchased from Arizona Public Service Company. During each of the last three years, the dividend rate was three percent.\nThe Articles of Incorporation provide that in the event of involuntary liquidation, before distributions may be made to holders of any other class of stock, holders of the Cumulative Preferred Stock are entitled to payment at par value, together with any accumulated and unpaid dividends.\nNOTE 13 -- EMPLOYEE POSTRETIREMENT BENEFITS\nThe Company has a qualified retirement plan covering the employees of its natural gas operations segment. The plan is noncontributory with defined benefits, and covers substantially all employees. It is the Company's policy to fund the plan at not less than the minimum required contribution nor more than the tax deductible limit. Plan assets are held in a master trust whose investments consist of common stock, corporate bonds, government obligations, real estate, an insurance company contract and cash or cash equivalents.\nThe plan covering the natural gas operations provides that an employee may earn benefits for a period of up to 30 years and will be vested after 5 years of service. Retirement plan costs were $7.8 million, $6.6 million, and $6.1 million for each of the three years ended December 31, 1994, 1993 and 1992, respectively.\nThe following table sets forth, for the gas segment, the plan's funded status and amounts recognized on the Company's consolidated statements of financial position and statements of income. The Bank has a separate retirement plan whose cost and liability are not significant.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 13 -- EMPLOYEE POSTRETIREMENT BENEFITS -- (CONTINUED)\nIn addition to the basic retirement plans, the Company has separate unfunded supplemental retirement plans for its natural gas operations and financial services segments, which are limited to certain officers. The gas segment's plan is noncontributory with defined benefits. Senior officers who retire with ten years or more of service with the Company are eligible to receive benefits. Other officers who retire with 20 years or more of service with the Company are eligible to receive benefits. Plan costs were $2 million, $1.5 million and $1.5 million for each of the three years ended December 31, 1994, 1993 and 1992, respectively. The accumulated benefit obligation of the plan was $13.3 million, including vested benefits of $12.4 million, at December 31, 1994. The cost and liability of the financial services supplemental retirement plan are not significant. The Company also has an unfunded retirement plan for directors not covered by the employee retirement plan. The cost and liability for this plan are not significant.\nThe Company has a deferred compensation plan for all officers and members of the Board. The plan provides the opportunity to defer from a minimum of $2,000 up to 50 percent of annual compensation. The Company matches one-half of amounts deferred up to six percent of an officer's annual salary. Payments of compensation deferred, plus interest, commence upon the participant's retirement in equal monthly installments over 10, 15 or 20 years, as determined by the Company. Deferred compensation earns interest at a rate determined each January. The interest rate represents 150 percent of Moody's Seasoned Corporate Bond Index.\nThe Employees' Investment Plan (401k) provides for purchases of the Company's common stock or certain other investments by eligible gas segment employees through deductions of up to 16 percent of base compensation, subject to IRS limitations. The Company matches one-half of amounts deferred up to six percent of an employee's annual compensation. The cost of the plan was $2.6 million, $1.9 million and $1.7 million for each of the three years ended December 31, 1994, 1993 and 1992, respectively. The Bank has a separate 401k plan which provides for purchases of certain securities by eligible employees through deductions of up to 15 percent of base compensation, subject to IRS limitations. The Bank matches 100 percent of amounts deferred up to six percent of employee base compensation. The cost of this plan is not significant.\nAt December 31, 1994, 464,050 common shares were reserved for issuance under provisions of the Employee Investment Plan and the Company's Dividend Reinvestment and Stock Purchase Plan.\nThe Company provides postretirement benefits other than pensions (PBOP) to its qualified gas segment retirees for health care, dental and life insurance. The Bank does not provide PBOP to its retirees. In December 1990, the FASB issued SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The statement requires the Company to account for PBOP on an accrual basis rather than reporting these benefits on a pay-as-you-go basis. The Company adopted SFAS No. 106 in January 1993. The PSCN, CPUC and FERC have approved the use of SFAS No. 106 for ratemaking purposes, subject to certain\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 13 -- EMPLOYEE POSTRETIREMENT BENEFITS -- (CONTINUED)\nconditions, including funding. The Company did not receive approval to recover PBOP costs on an accrual basis in its Arizona rate jurisdictions, but was authorized to continue to recover the pay-as-you-go costs for ratemaking purposes. The Company began funding the non-Arizona portion of the PBOP liability in 1994. Plan assets are combined with the pension plan assets in the master trust.\nThe following table sets forth, for the gas segment, the PBOP funded status and amounts recognized on the Company's consolidated statements of financial position and statements of income.\nThe Company makes fixed contributions, based on age and years of service, to retiree spending accounts for the medical and dental costs of employees who retire after 1988. The Company pays up to 100 percent of the medical coverage costs for employees who retired prior to 1989. The medical inflation assumption in the table above applies to the benefit obligations for pre-1989 retirees only. This inflation assumption was estimated at ten percent in 1995 and decreases one percent per year until 1997 and one-half of one percent per year until 2003, at which time the annual increase is projected to be five percent. A one percent increase in these assumptions would change the accumulated postretirement benefit obligation by approximately $1 million and $1.1 million for the years ended December 31, 1994 and 1993, respectively. The 1995 and 1994 annual benefit cost would increase $90,000 and $160,000, respectively.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 14 -- INCOME TAXES\nThe Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" in January 1993. That statement requires the use of the asset and liability approach for financial reporting of income taxes. As permitted under SFAS No. 109, the prior year's (1992) financial statements were not restated. The cumulative effect of this change in accounting method was an increase in net income of $3 million, which was reported in the year of adoption.\nIncome tax expense (benefit) consists of the following (thousands of dollars):\nDeferred income tax expense (benefit) consists of the following significant components (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 14 -- INCOME TAXES -- (CONTINUED)\nThe consolidated effective income tax rate for the period ended December 31, 1994 and the two prior periods differs from the federal statutory income tax rate. The sources of these differences and the effect of each are summarized as follows:\nDeferred tax assets and liabilities consist of the following (thousands of dollars):\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 14 -- INCOME TAXES -- (CONTINUED)\nPrior to 1981, federal income tax expense for the gas segment was reduced to reflect additional depreciation and other deductions claimed for income tax purposes (flow-through method). Subsequently, deferred taxes have been provided for all differences between book and taxable income (normalization method) in all jurisdictions. The various utility regulatory authorities have consistently allowed the recovery of previously flowed-through income tax benefits on property related items by means of increased federal income tax expense in determining cost of service for ratemaking purposes. Pursuant to SFAS No. 109, a deferred tax liability and corresponding regulatory asset of approximately $28.8 million are included in the financial statements at December 31, 1994 to reflect the expected recovery of income tax benefits previously flowed-through.\nFor regulatory and financial reporting purposes, the Company has deferred recognition of investment tax credits (ITC) by amortizing the benefit over the depreciable lives of the related properties. Pursuant to SFAS No. 109, a deferred tax asset and corresponding regulatory liability of approximately $13.8 million are included in the financial statements at December 31, 1994 to reflect the Company's expected reduction to future income tax expense that will result from the amortization of ITC through utility rates.\nUnder the Internal Revenue Code, the Bank is allowed a special bad debt deduction (unrelated to the amount of losses charged to earnings) based on a percentage of taxable income (currently eight percent). Under SFAS No. 109, no deferred taxes are provided on bad debt reserves arising prior to December 31, 1987, unless it becomes apparent that these differences will reverse in the foreseeable future. At December 31, 1994, the portion of tax bad debt reserves not expected to reverse is $14.3 million, which results in a retained earnings benefit of $5 million, recognized in years prior to 1988.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 15 -- SEGMENT INFORMATION\nThe financial information pertaining to the Company's gas and financial services segments for each of the three years in the period ended December 31, 1994, is as follows (thousands of dollars):\n- ---------------\n* Combined assets of the business segments do not equal consolidated assets as certain reclassifications were made during consolidation.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 16 -- QUARTERLY FINANCIAL DATA (UNAUDITED)\nCONSOLIDATED QUARTERLY FINANCIAL DATA\n- ---------------\n* The sum of quarterly earnings (loss) per average common share may not equal the annual earnings (loss) per share due to the ongoing change in the weighted average number of common shares outstanding.\nThe demand for natural gas is seasonal, and it is management's opinion that comparisons of earnings for the interim periods do not reliably reflect overall trends and changes in the Company's operations. Also, the timing of general rate relief can have a significant impact on earnings for interim periods. See MD&A for additional discussion of the Company's operating results.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 16 -- QUARTERLY FINANCIAL DATA (UNAUDITED)\nBANK QUARTERLY FINANCIAL DATA\nNOTE 17 -- INTEREST RATE RISK MANAGEMENT\nThe Bank is exposed to interest rate risk (IRR) resulting from (a) timing differences in the maturity and\/or repricing of the Bank's assets, liabilities, and off-balance sheet contracts; (b) the exercise of options embedded in the Bank's financial instruments and accounts, such as prepayments of loans before scheduled maturity, caps on the amounts of interest rate movement permitted for adjustable-rate loans, and withdrawals of funds on deposit with and without stated terms to maturity; and (c) differences in the behavior of lending and funding rates, referred to as basis risk. The role of the Bank's asset\/liability management function is to prevent the erosion of the Bank's earnings and equity capital due to interest rate fluctuations. Changes in the Bank's IRR exposure affect the current market values of the Bank's loan, debt securities, deposit and borrowing portfolios, as well as the Bank's future earnings. The level of IRR exposure can also adversely affect the Bank's regulatory capital.\nThe Bank's Board of Directors (BOD) has established certain guidelines to manage the exposure of the Bank's net interest income, net income, and net portfolio value (NPV) to interest rate fluctuations. NPV represents a theoretical estimate of the market value of the Bank's stockholder's equity, calculated as the net present value of expected cash flows from financial assets and liabilities, plus the book values of all non-financial assets and liabilities. The guidelines include limits on overall IRR exposure, methods of accountability and specific reports to be provided to the BOD by management for periodic review, and established acceptable activities and instruments to manage IRR.\nThe Bank maintains an IRR simulation model which enables the Bank to measure IRR exposure using various assumptions and interest rate scenarios, and to incorporate alternative strategies for the reduction of IRR exposure. The Bank measures its IRR using several methods to provide a comprehensive view of its IRR from various perspectives. These methods include projection of current NPV and future periods' net interest\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 17 -- INTEREST RATE RISK MANAGEMENT -- (CONTINUED) income after rapid and sustained interest rate movements, static analysis of repricing and maturity mismatches, or gaps, between assets and liabilities, and analysis of the size and sources of basis risk.\nUsing the Bank's IRR simulation model, the following table presents management's estimate of the Bank's NPV after a hypothetical, instantaneous 200 basis points (bp) change in the market interest rates at December 31, 1994 and 1993 (thousands of dollars):\nAs shown above, the Bank's estimated NPV increased from December 31, 1993 to December 31, 1994 by $10.2 million and $31.8 million under assumed changes in market interest rates of zero bp and -200 bp, respectively. Over the same period, however, the Bank's estimated NPV declined by $10.9 million under an assumed change in market rates of +200 bp.\nDuring 1994, market interest rates generally increased. Although the Bank's estimated NPV had been expected to decline in a rising rate environment in IRR simulations run as of December 31, 1993, the opposite actually occurred as a result of actions taken by management. During 1994, the intangible value of the Bank's core deposits increased as the Bank was able to lag increases in the interest rates it pays on such deposits relative to increases in market interest rates. During 1994, management also acted to acquire long-term deposits and borrowings at historically low interest rates, and implemented several off-balance sheet hedges to effectively convert certain fixed-rate loans to adjustable-rate loans. These actions had a net effect of outweighing other declines in the estimated market values of the Bank's assets, resulting in a net increase in the Bank's estimated NPV as of December 31, 1994. These actions also benefited the Bank's net interest margin and resulted in an increase in the net yield of the Bank's interest-earning assets from 3.15 percent in 1993 to 3.69 percent in 1994.\nManagement also measures the Bank's IRR using static gap analysis to further identify sources of IRR and its potential impact on net interest income. Static gap analysis measures the difference between financial assets and financial liabilities scheduled and expected to mature or reprice within a specified time period. The gap for that period is positive when repricing and maturing assets exceed repricing and maturing liabilities. The gap for that period is negative when repricing and maturing liabilities exceed repricing and maturing assets. A positive or negative cumulative gap indicates in a general way how the Bank's net interest income should respond to interest rate fluctuations. A positive cumulative gap for a period generally means that rising interest rates would be reflected sooner in financial assets than in financial costing liabilities, thereby increasing net interest income over that period. A negative cumulative gap for a period would produce an increase in net interest income over that period if interest rates declined.\nAt December 31, 1994 and 1993, the Bank's cumulative one-year static gap was $(145) million and $(39.4) million, respectively, or negative eight percent and negative two percent of financial assets.\nThe financial instruments approved by the BOD to manage the Bank's IRR exposure in its balance sheet include the Bank's debt security portfolio, interest rate swaps, interest rate caps, interest rate collars, interest rate futures, and put and call options. These financial instruments provide effective methods of reducing the impact of changes in interest rates on the market values of and earnings provided by the Bank's assets and liabilities. The Bank also actively manages its retail and wholesale funding sources to minimize its cost of funds and provide stable funding sources for its loan and investment portfolios. Management's use of particular financial instruments is based on a complete analysis of current IRR exposure and the projected effect of any\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 17 -- INTEREST RATE RISK MANAGEMENT -- (CONTINUED)\nproposed strategy. In addition, to manage the IRR exposure associated with the Bank's held for sale loan portfolio, the Bank utilizes forward sale commitments.\nAt December 31, 1994 and 1993, the Bank utilized interest rate swap agreements as a hedge to convert permanent fixed-rate loans into adjustable-rate loans. The agreements require the Bank to make fixed-rate payments and in turn, the Bank receives floating interest payments based on the six month LIBOR.\nThe following table presents the notional amount of interest rate swaps outstanding, unrealized gains and losses of the swaps, the weighted average interest rates payable and receivable, and the remaining term (thousands of dollars).\nDECEMBER 31, 1994\nDECEMBER 31, 1993\nThe notional amount of interest rate swaps do not represent amounts exchanged by the parties and, thus, are not a measure of the Bank's exposure through its use of derivatives. The amounts exchanged are determined by reference to the notional amounts and the interest rates.\nThe Bank is exposed to credit-related losses in the event of nonperformance by counterparties to financial instruments but does not expect any counterparties to fail to meet their obligations. The Bank deals only with highly rated broker\/dealers. The current credit exposure of derivatives is represented by the fair value of contracts with a positive fair value (unrealized gain) at the reporting date.\nDuring 1992, in conjunction with the restructuring of the Bank's balance sheet and the sale of long-term fixed-rate assets, $300 million (notional amount) of interest rate swaps hedging such assets were canceled at a cost of $14.1 million, which is included as an expense in the accompanying Consolidated Statements of Income. In addition, $35 million (notional amount) of interest rate swaps matured during 1992. No interest rate swaps matured or were terminated during 1993 and 1994. The interest rate swap agreements at December 31, 1994 are collateralized with MBS with a fair value of $2.7 million. The net expense on interest rate swaps of $485,000, $24,000 and $4.8 million in 1994, 1993 and 1992, respectively, are included in interest expense as a cost of hedging activities in the accompanying Consolidated Statements of Income.\nThe Bank is also exposed to IRR through the issuance of fixed-rate loan commitments and builder loan commitments. Fixed-rate loan commitments represent firm commitments to originate loans secured by real estate to specific borrowers at a specified rate of interest. Builder commitments represent agreements to home builders for the Bank to provide loans secured by real estate to unspecified qualified customers of the builder at interest rates not to exceed specified levels. Fixed-rate loan commitments generally expire in 30 to 60 days and builder commitments generally expire within 6 to 12 months. The Bank generally receives a fee for both of these types of commitments. Many of the commitments are expected to expire without fully being drawn upon and therefore, the total commitments do not necessarily represent future cash requirements.\nSOUTHWEST GAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 17 -- INTEREST RATE RISK MANAGEMENT -- (CONTINUED)\nThe Bank hedges IRR on fixed-rate loan commitments expected to be sold in the secondary market and the inventory of loans held for sale through a combination of commitments from permanent investors, optional delivery commitments, and mandatory forward contracts. Outstanding firm commitments to sell loans represent agreements to sell loans to a third party at a specified price on a specified date. These commitments are used to hedge loans for sale and to hedge outstanding commitments to originate loans. Outstanding master commitments to sell loans represent agreements to sell a stated volume of loans to a third party within a specified period of time without regard to price. Master commitments are entered in order to ensure availability of a buyer for loans meeting specified underwriting criteria and to maximize the sales price at the time a firm commitment is executed. Related hedging gains and losses are recognized at the time gains and losses are recognized on the related loans. See Note 2 for commitments outstanding and their estimated fair value.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders, Southwest Gas Corporation:\nWe have audited the accompanying consolidated statements of financial position of Southwest Gas Corporation (a California corporation, hereinafter referred to as the 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, the financial statements referred to above present fairly, in all material respects, the financial position of the Company 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.\nAs discussed in notes 1, 13 and 14 of the notes to consolidated financial statements, and as required by generally accepted accounting principles, the Company changed its methods of accounting for investments in certain debt and equity securities, postretirement benefits other than pensions and income taxes in 1993.\nARTHUR ANDERSEN LLP\nLas Vegas, Nevada February 8, 1995\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\n(a) Identification of Directors. Information with respect to Directors is set forth under the heading \"Election of Directors\" in the Company's definitive Proxy Statement dated March 1995, which by this reference is incorporated herein.\n(b) Identification of Executive Officers. The name, age, position and period position held during the last five years for each of the Executive Officers of the Company are as follows:\n(c) Identification of Certain Significant Employees.\nNone.\n(d) Family Relationships. None of the Company's Directors or Executive Officers are related to any other either by blood, marriage or adoption.\n(e) Business Experience. Information with respect to Directors is set forth under the heading \"Election of Directors\" in the Company's definitive Proxy Statement dated March 1995, which by this reference is incorporated herein. All Executive Officers have held responsible positions with the Company for at least five years as described in (b) above.\n(f) Involvement in Certain Legal Proceedings.\nNone.\n(g) Item 405 Review. Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (SEC) and the New York Stock Exchange. Officers, directors and beneficial owners of more than ten percent of any class of equity securities are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.\nThe Company has adopted procedures to assist its directors and executive officers in complying with Section 16(a) of the Securities and Exchange Act of 1934, which includes assisting in the preparation of forms for filing. For 1994, all the required reports were filed timely. In addition, amended Form 5s for 1992 and 1993 were filed for Lloyd T. Dyer to reflect dividend reinvestment plan holdings that, through an oversight, were omitted from the original Form 5 filings.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to executive compensation is set forth under the heading \"Executive Compensation and Benefits\" in the Company's definitive Proxy Statement dated March 1995, which by this reference is incorporated herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Not applicable.\n(b) Information with respect to security ownership of management is set forth under the heading \"Securities Ownership by Nominees and Executive Officers\" in the Company's definitive Proxy Statement dated March 1995, which by this reference is incorporated herein.\n(c) Not applicable.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to certain relationships and related transactions is set forth under the heading \"Certain Relationships and Related Transactions\" in the Company's definitive Proxy Statement dated March 1995, which by this reference is incorporated herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report on Form 10-K:\n(1) The following are included in Part II, Item 8 of this form:\n(2) None\n(3) See list of exhibits.\n(b) Reports on Form 8-K\nThe Company filed a Form 8-K, dated February 9, 1995, reporting summary financial information for the year ended December 31, 1994.\n(c) See Exhibits.\nLIST OF EXHIBITS\n- ---------------\n(1) Incorporated herein by reference to the Company's Registration Statement on Form S-16, No. 2-68833.\n(2) Incorporated herein by reference to the Company's report on Form 10-K for the year ended December 31, 1982.\n(3) Incorporated herein by reference to the Company's Registration Statement on Form S-2, No. 2-92938.\n(4) Incorporated herein by reference to the Company's Registration Statement on Form S-3, No. 33-7931.\n(5) Incorporated herein by reference to the Company's report on Form 10-K for the year ended December 31, 1986.\n(6) Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended March 31, 1987.\n(7) Incorporated herein by reference to the Company's report on Form 8-K dated August 23, 1988.\n(8) Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended June 30, 1992.\n(9) Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended September 30, 1992.\n(10) Incorporated herein by reference to the Company's report on Form 10-K for the year ended December 31, 1992.\n(11) Incorporated herein by reference to the Company's report on Form 10-K for the year ended December 31, 1993.\n(12) Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended June 30, 1994.\n(13) Incorporated herein by reference to the Company's Registration Statement on Form S-3, No. 33-55621.\nSIGNATURES\nPursuant to the requirements of Section 15(d) of the 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 GAS CORPORATION\nBy MICHAEL O. MAFFIE ---------------------------------- Michael O. Maffie, President (Chief Executive Officer)\nDate: March 6, 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 dates indicated.\nSIGNATURES\nPursuant to the requirements of Section 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nGLOSSARY OF TERMS","section_15":""}
{"filename":"70578_1994.txt","cik":"70578","year":"1994","section_1":"ITEM 1. BUSINESS\nNational Steel Corporation, a Delaware corporation, and its consolidated subsidiaries (the \"Company\") is the fourth largest integrated steel producer in the United States as measured by production and is engaged in the manufacture and sale of a wide variety of flat rolled carbon steel products, including hot rolled, cold rolled, galvanized, tin and chrome plated steels. The Company targets high value added applications of flat rolled carbon steel for sale to the automotive, metal buildings and container markets. Since 1984, the Company has invested approximately $2 billion in capital improvements to enhance the Company's competitive position and penetrate growing segments of these markets.\nThe Company was formed through the merger of Great Lakes Steel, Weirton Steel and Hanna Iron Ore Company and was incorporated in Delaware on November 7, 1929. The Company built a finishing facility, now the Midwest Division, in 1961 and in 1971 purchased Granite City Steel Corporation, now the Granite City Division. On September 13, 1983, the Company became a wholly-owned subsidiary of National Intergroup, Inc., which in October 1994 changed its name to Foxmeyer Health Corporation (collectively, with its subsidiaries, hereinafter referred to as \"FOX\"), through a restructuring. On January 11, 1984, the Company sold the principal assets of its Weirton Steel Division and retained certain liabilities related thereto. On August 31, 1984, NKK Corporation (collectively, with its subsidiaries, \"NKK\") purchased a 50% equity interest in the Company from FOX. On June 26, 1990, NKK purchased an additional 20% equity interest in the Company from FOX. In April 1993, the Company completed an initial public offering of its Class B Common Stock. In October 1993, FOX converted all of its shares of Class A Common Stock to an equal number of shares of Class B Common Stock and subsequently sold substantially all of its shares of Class B Common Stock in the market in January 1994, resulting in NKK owning 75.6% voting interest in the Company at December 31, 1994. On February 1, 1995, the Company completed a primary offering of 6.9 million shares of Class B Common Stock. Subsequent to the transaction, NKK's voting interest decreased to 67.6%.\nThe Company's principal executive offices are located at 4100 Edison Lakes Parkway, Mishawaka, Indiana 46545-3440; telephone (219) 273-7000.\nSTRATEGY\nThe Company's mission is to achieve sustained profitability, thereby enhancing stockholder value, by reducing the costs of production and improving productivity and product quality. Management has developed a number of strategic initiatives designed to achieve the Company's goals. These initiatives focus on:\n. Reducing the cost of hot rolled bands, the largest component of the Company's finished product cost;\n. Reducing the cost of poor quality, which currently results in the sale of non-prime products at lower prices and requires substantial reprocessing costs;\n. Installing a predictive maintenance program which is designed to maximize production and the useful life of equipment while minimizing unscheduled equipment outages;\n. Increasing steel production capabilities by identifying and eliminating manufacturing bottlenecks;\n. Enhancing the Company's cooperative partnership with the United Steelworkers of America (the \"USWA\") by increasing employee participation at all levels of the production process; and\n. Improving information and cost control systems to enable management to exercise greater control over production costs.\nIn addition, the Company plans to more fully utilize its alliance with its principal stockholder, NKK, and its partnership with customers and to better utilize equipment and facilities, many of which have been enhanced by the Company's $2 billion capital investment program.\nStrategic Initiatives\nReduction in Production Costs. Management's primary focus is to reduce the costs of producing hot rolled bands, the largest component of the Company's finished product cost. Reducing all costs associated with the production process is essential to the Company's overall cost reduction program. As a first step in this process, management reopened National Steel Pellet Company (\"NSPC\"), which had been idled by a work stoppage since August 1993, after achieving a $4 per gross ton savings in delivered iron ore pellet costs at NSPC compared to pre-strike costs. Based upon NSPC's estimated production of 5 million tons of pellets per year, this will result in savings of $20 million annually compared to the Company's pre-strike costs. Management intends to reduce production costs by better utilizing existing equipment, improving productivity, involving labor in improving operating practices and by the cost efficient use of steelmaking inputs. In addition, the Company's facility engineers, who have access to a wide range of NKK process technologies, analyze and implement innovative steelmaking and processing methods on an ongoing basis.\nQuality Improvement. An important element of the Company's strategy is to reduce the cost of poor quality, which currently results in the sale of non- prime products at lower prices and requires substantial reprocessing costs. The Company will seek to achieve this increase by improving process control, utilizing employee based problem solving methods, eliminating dependence on final inspection and reducing internal rejections and extra processing. In addition, in June 1994, the Company created a new senior management position with responsibility solely for quality assurance and customer satisfaction.\nNew Maintenance Program. Management is installing a predictive maintenance program designed to maximize production and equipment life while minimizing unscheduled equipment outages. This program should improve operations stability through improved equipment reliability, which is expected to result in improved productivity and reduced costs. Although the Company believes this system will result in certain immediate improvements, the full benefits of this system will not be realized until the system is fully implemented in approximately two to three years.\nElimination of Manufacturing Bottlenecks. Manufacturing bottlenecks result in, among other things, reduced production, delays in customer shipments and increased costs due to operating inefficiencies. Management has initially identified three major manufacturing bottlenecks: the Granite City Division caster, the Great Lakes Division melt shop and the Midwest Division pickle line. The Company is presently negotiating with state environmental authorities in order to permit higher production levels at the caster at the Granite City Division. The Company has received a temporary waiver of existing production limits at the Granite City facility to allow the Company to compensate for production lost as a result of a planned blast furnace outage in 1995. The Company also intends to increase the number of heats per day at its Great Lakes facility through improved maintenance and equipment reliability, material handling and logistics and refinement of operating practices. This initiative should result in increased steelmaking production. Finally, the Company intends to increase the steel throughput of the pickle line at the Midwest Division through improved welder performance, implementation of a large coil program and more effective crew training.\nCooperative Employee Partnership. Since 1986, the Company has had cooperative labor agreements with the USWA, which represents approximately 78% of the Company's employees. The Company entered into a new six year cooperative labor agreement with the USWA effective as of August 1, 1993 (the \"1993 Settlement Agreement\"). The cooperative labor agreement with the USWA entered into with the reopening of NSPC (the \"NSPC Labor Agreement\") runs concurrently with the 1993 Settlement Agreement. The employment security provisions contained in the Company's labor agreements were the first in the domestic steel industry and have provided the Company with increased flexibility to improve productivity and consolidate job functions. These labor agreements, in combination with retirements and attrition, have also allowed the Company to reduce the number of employees and achieve productivity gains while increasing the percentage of employee compensation which is productivity based. See \"Employees\".\nManagement believes that greater emphasis on labor cooperation as well as employee involvement in identifying and solving problems in all areas of production and delivery present significant opportunities to lower production costs and improve quality. One immediate result of this emphasis was the reopening of NSPC in August 1994.\nImprove Information and Cost Control Systems. Management intends to enhance its current information systems in order to exercise greater control over production costs, as well as to provide access to profitability analysis by customer and product line. To attain greater control over production costs, on January 1, 1995, the Company installed an actual cost system to replace the current standard cost system.\nAlliance with NKK\nThe Company has a strong alliance with its principal stockholder, NKK, the second largest steel company in Japan and the fifth largest in the world as measured by production. Since 1984, the Company has had access to a wide range of NKK's steelmaking, processing and applications technology. The Company's engineers include approximately 40 engineers transferred from NKK, who now serve primarily at the Company's Divisions. These engineers, as well as engineers and technical support personnel at NKK's facilities in Japan, assist in improving operating practices and developing new manufacturing processes. This support also includes providing input on ways to improve raw steel to finished product yields.\nIn addition, NKK has provided financial assistance to the Company in the form of investments, loans and introductions to Japanese financial institutions and trading companies. While no assurances can be given with respect to the extent of NKK's future financial support beyond existing contractual commitments, NKK has indicated that it presently plans to continue to provide technical support and research and development services of the nature and to the extent currently provided to the Company.\nCustomer Partnership\nThe Company's customer partnership enables the Company to differentiate its products through superior quality and service. Management believes it is able to differentiate the Company's products and promote customer loyalty by establishing close relationships through early customer involvement, providing technical services and support and utilizing its Product Application Center and Technical Research Center facilities.\nThe Company operates a research and development facility near its Great Lakes Division to develop new products, improve existing products and develop more efficient operating procedures to meet the constantly increasing demands of the automotive, metal buildings and container markets. The research center employs approximately 50 chemists, physicists, metallurgists and engineers. The research center is responsible for, among other things, the development of five new high strength steels for automotive weight reduction and a new galvanized steel for the metal buildings market. In addition, the Company operates a Product Application Center near Detroit dedicated to providing product and technical support to customers. The Product Application Center assists customers with application engineering (selecting optimum metal and manufacturing methods), application technology (evaluating product performance) and technical developments (performing problem solving at plants). The Company spent $7.9 million, $9.4 million and $9.5 million for research and development in 1994, 1993 and 1992, respectively. In addition, the Company participates in various research efforts through the American Iron and Steel Institute (the \"AISI\").\nMarketing Strategy\nThe Company's marketing strategy has concentrated on increasing the level of sales of higher value added products to the automotive, metal buildings and container markets. These segments demand high quality products, on-time delivery and effective and efficient customer service. This strategy is designed to increase margins, reduce competitive threats and maintain high capacity utilization rates by shifting the Company's product mix to higher quality products and providing superior customer service.\nTo enable the Company to more efficiently meet the needs of its target markets and focus on higher value added products, the Company has entered into two separate joint ventures to build hot dip galvanizing facilities. One joint venture is with NKK and an unrelated third party and has been built to service the automotive industry. The second joint venture has been built to service the construction industry. See \"Properties-DNN Galvanizing Limited Partnership\" and \"-Double G Coatings, L.P.\" Additionally, in February 1995, the Company announced plans for a 270,000 ton galvanizing line to be constructed at its Granite City Division. The $67 million line, which is expected to be completed by mid 1996, will serve the metal buildings market.\nCapital Investment Program\nSince 1984, the Company has invested over $2 billion in capital improvements aimed at upgrading the Company's steelmaking and finishing operations to meet its customers' demanding requirements for higher quality products and to reduce production costs. As described above, one of the Company's strategic initiatives is to more effectively utilize these substantial capital improvements. Major projects include an electrolytic galvanizing line, a continuous caster, a ladle metallurgy station, a vacuum degasser, a complete coke oven battery rebuild and a high speed pickle line, each of which services the Great Lakes Division (located near Detroit, Michigan), and a continuous caster and a ladle metallurgy station, each of which services the Granite City Division (located near St. Louis, Missouri). Major improvements at the Midwest Division (located near Chicago, Illinois) include the installation of process control equipment to upgrade its finishing capabilities. Management believes that the completion of this $2 billion capital investment program will substantially reduce the amount of capital investments in the future. Capital investments for each of 1994, 1993 and 1992 were $137.5 million, $160.7 million and $283.9 million, respectively. Capital investments for 1995 and 1996 are expected to total approximately $241.2 million. In early 1991, the Company became the first major integrated U.S. steel producer to continuously cast 100% of its raw steel production.\nCUSTOMERS\nThe Company is a major supplier of hot and cold rolled steel and galvanized coils to the automotive industry, one of the most demanding steel consumers. Car and truck manufacturers require wide sheets of steel, rolled to exact dimensions. In addition, formability and defect-free surfaces are critical. The Company has been able to successfully meet these demands. Its steels have been used in a variety of automotive applications including exposed and unexposed panels, wheels and bumpers.\nThe Company is a leading supplier of steel to the domestic metal buildings market. Roof and building panels are the principal applications for galvanized and Galvalume(R) steel in this market. Management believes that demand for Galvalume(R) steel will exhibit strong growth for the next several years partially as a result of a trend away from traditional building products and that the Company is well positioned to profit from this growth as a result of both its position in this market and additional capacity referred to above.\nThe Company produces chrome and tin plated steels to exact tolerances of gauge, shape, surface flatness and cleanliness for the container industry. Tin and chrome plated steels are used to produce a wide variety of food and non-food containers. In recent years, the market for tin and chrome plated steels has been both stable and profitable for the Company.\nThe Company also supplies the pipe and tube and service center markets with hot rolled, cold rolled and coated sheet. The Company is a key supplier to transmission pipeline, downhole casing and structural pipe producers. Service centers generally purchase steel coils from the Company and may process them further or sell them directly to third parties without further processing.\nThe following table sets forth the percentage of the Company's revenues from various markets for the past five years.\nShipments to General Motors, the Company's largest customer, accounted for approximately 10%, 11% and 12% of net sales in each of 1994, 1993 and 1992, respectively. Export sales accounted for approximately 0.9% of revenue in 1994, .1% in 1993 and .5% in 1992. The Company's products are sold through the Company's six sales offices located in Chicago, Detroit, Houston, Kansas City, Pittsburgh and St. Louis. Substantially all of the Company's net revenues are based on orders for short-term delivery. Accordingly, backlog is not meaningful when assessing future results of operations.\nOPERATIONS\nThe Company operates three principal facilities: two integrated steel plants, the Great Lakes Division in Ecorse and River Rouge, Michigan, near Detroit and the Granite City Division in Granite City, Illinois, near St. Louis and a finishing facility, the Midwest Division in Portage, Indiana, near Chicago. The Company's centralized corporate structure, the close proximity of the Company's principal steel facilities and the complementary balance of processing equipment shared by them, enable the Company to closely coordinate the operations of these facilities in order to maintain high operating rates throughout its processing facilities and to maximize the return on its capital investments.\nThe following table details effective steelmaking capacity, actual production, effective capacity utilization and percentage of steel continuously cast for the Company and the domestic steel industry for the years indicated.\nRAW STEEL PRODUCTION DATA\n* Information as reported by the AISI. The 1994 industry information is estimated by the AISI.\nEffective capacity increased to 6,000,000 net tons in 1994 due to the fact that the Company did not reline any blast furnaces during this period. The effective capacity of the Company decreased to 5,355,000 net tons in 1992 as a result of a scheduled blast furnace reline. Effective capacity utilization fell to 92.5% in 1991 due, in part, to an unusually high level of inventory carried forward from 1990, along with scheduled maintenance outages at major finishing units and a low demand for steel products during the first half of the year.\nRAW MATERIALS\nIron ore. The metallic iron requirements of the Company are supplied primarily from iron ore pellets that are produced from a concentration of low grade ores. The Company, directly through NSPC and through an affiliate, has reserves of iron ore adequate to produce approximately 500 million gross tons of iron ore pellets. The Company's iron ore reserves are located in Minnesota, Michigan and Quebec, Canada. Excluding the effects of the thirteen month period from August 1, 1993 through August 28, 1994 when NSPC was idled, a significant portion of the Company's average annual consumption of iron ore pellets was obtained from the deposits of the Company or those of its affiliate during the last five years. The remaining iron ore pellets consumed by the Company were purchased from third parties. Agreements reached with the USWA and other suppliers to NSPC in 1994 have resulted in a $4 per gross ton reduction in delivered pellet costs, making the cost of NSPC pellets competitive with market prices. Iron ore pellets available to the Company from its own deposits, its affiliate and outside suppliers are sufficient to meet the Company's total iron ore requirements for the foreseeable future.\nCoal. In 1992, the Company decided to exit the coal mining business. At that time, the Company owned underground coal properties in Pennsylvania, Kentucky and West Virginia as well as undeveloped coal reserves in Pennsylvania and West Virginia. During 1993, the Pennsylvania and Kentucky properties were sold except for the coal reserves which were leased on a long term basis. Negotiations are in process for the sale and\/or lease of the West Virginia properties. While the undeveloped coal reserves are for sale, there are no interested parties at the present time. The remaining coal assets totaling $40.1 million are included in the assets of the Company and constitute less than 2% of the Company's total assets. Adequate supplies of coal are readily available at competitive market prices.\nCoke. The Company operates two efficient coke oven batteries servicing the Granite City Division and a newly rebuilt No. 5 coke oven battery at the Great Lakes Division. The No. 5 coke battery enhances the quality and stability of the Company's coke supply, and incorporates state-of-the-art technology while meeting the requirements of the Clean Air Act. With the No. 5 coke battery rebuild, the Company has significantly improved its self-sufficiency and can supply approximately 60% of its annual coke requirements. The remaining coke requirements are met through competitive market purchases.\nLimestone. The Company, through an affiliated company, has limestone reserves of approximately 78 million gross tons located in Michigan. During the last five years, approximately 60% of the Company's average annual consumption of limestone was derived from these reserves. The Company's remaining limestone requirements were purchased.\nScrap and Other Materials. Supplies of steel scrap, tin, zinc and other alloying and coating materials are readily available at competitive market prices.\nPATENTS AND TRADEMARKS\nThe Company has the patents and licenses necessary for the operation of its business as now conducted. The Company does not consider its patents and trademarks to be material to the business of the Company.\nEMPLOYEES\nAs of December 31, 1994, the Company employed 9,711 people. In January 1995, the Company completed a plan that will reduce its salaried non-represented workforce by approximately 400 employees. Approximately 7,600 (78%) of the Company's employees are represented by the USWA. The Company believes that its relationships with its collective bargaining units are good.\nOn August 27, 1993, the 1993 Settlement Agreement between the Company and the USWA was ratified by USWA members at the Company's three steel divisions and corporate headquarters. The new agreement, effective August 1, 1993 through July 1, 1999, protects the Company and the USWA from a strike or lockout for the duration of the agreement. Either the Company or the USWA may reopen negotiations after three years, except with respect to pensions and certain other matters, with any unresolved issues subject to binding arbitration. Under the 1993 Settlement Agreement, represented employees will receive improved pension benefits, bonuses to be paid over the term of the agreement, a $.50 per hour wage increase effective in August 1995, and an additional paid holiday for the years 1994, 1995 and 1996. The 1993 Settlement Agreement provides for the establishment of a Voluntary Employee Benefit Association Trust (the \"VEBA Trust\") to which the Company has agreed to contribute a minimum of $10 million annually and, under certain circumstances, additional amounts calculated as set forth in the 1993 Settlement Agreement. The Company has agreed to grant to the VEBA Trust a second mortgage on the No. 5 coke oven battery at the Great Lakes Division. The 1993 Settlement Agreement also provides for opportunities to reduce health care costs and for flexible work practices and opportunities to reduce manning levels through attrition. In addition, the 1993 Settlement Agreement grants the USWA the right to nominate a candidate, subject to the approval of the Company's Board of Directors and stockholders, for a seat on the Company's Board of Directors. During January 1995, this Board of Directors position was filled.\nIn July 1994, a labor agreement was reached between NSPC and the USWA. The NSPC Labor Agreement is effective July 1, 1994 through July 31, 1999. The NSPC Labor Agreement provides for a wage increase of approximately 3% over three years and modest increases in benefits, while simultaneously providing for work rule changes designed to increase productively levels and operational efficiencies. With the agreement, and the subsequent reopening of the facility, all labor disputes between the Company, NSPC and the USWA regarding the idling of the NSPC facility were resolved. The NSPC Labor Agreement may be reopened in 1996 along with the 1993 Settlement Agreement.\nCOMPETITION\nThe Company is in direct competition with domestic and foreign flat rolled carbon steel producers and producers of plastics, aluminum and other materials which can be used in place of flat rolled carbon steel in manufactured products. Price, service and quality are the primary types of competition experienced by the Company. The Company believes it is able to differentiate its products from those of its competitors by, among other things, providing technical services and support and utilizing its Product Application Center and Technical Research Center facilities and by its focus on improving product quality through, among other things, capital investment and research and development, as described above.\nImports. Domestic steel producers face significant competition from foreign producers and have been adversely affected by unfairly traded imports. Imports of finished steel products accounted for approximately 19%, 14% and 15% of the domestic market in 1994, 1993 and 1992, respectively. Many foreign steel producers are owned, controlled or subsidized by their governments. Decisions by these foreign producers with respect to production and sales may be influenced to a greater degree by political and economic policy considerations than by prevailing market conditions.\nIn 1992, the Company and eleven other domestic steel producers filed unfair trade cases with the Commerce Department and the International Trade Commission (the \"ITC\") against foreign steel producers covering imports of flat rolled carbon steel products. In June 1993, the Commerce Department imposed final antidumping and subsidy margins averaging 37% for all products under review. In July 1993, the ITC made final determinations that material injury had occurred in cases representing an estimated 51% of the dollar value and 42% of the volume of all flat rolled carbon steel imports under investigation. In the four product categories, injury was found in cases relating to 97% of the volume of plate steel, 92% of the volume of higher value-added corrosion resistant steel and 36% of the volume of cold rolled steel. No injury was found with respect to hot rolled steel products. During 1994, approximately 42% of the Company's shipments consisted of hot rolled steel, while 31% consisted of corrosion resistant steel, 16% consisted of cold rolled steel and less than 1% consisted of plate steel. Imports of products not covered by affirmative ITC injury determinations have increased and may continue to increase, which may have an adverse effect on the Company's shipments of these products and the prices it realizes for such products. The Company and the other domestic producers who filed these cases have appealed the negative decisions of the ITC and are defending appeals brought by foreign producers involving decisions favorable to domestic producers. These appeals are proceeding before the Court of International Trade in New York and, in the case of Canada, before Binational Dispute Panels under the U.S.-Canada Free Trade Agreement. The Court of International Trade has affirmed the ITC's injury determinations regarding hot rolled and cold rolled carbon steel sheet. In addition, the Court remanded limited portions of the Department of Commerce determinations in the dumping cases against cold rolled steel from the Netherlands and all four classes of steel from France. Additional decisions from the Court are expected in the first half of 1995. Separate Binational Dispute Panels upheld the ITC's injury determinations with regard to imports of corrosion resistant steel from Canada in November, 1994 and the majority of the Commerce Department's dumping margin determination in October, 1994. The Commerce Department has sent the results of its remand calculations to the Court and, in the case of Canada, to the Binational Panel for affirmance. The remand results do not substantially affect the final margins for products from those countries subject to the antidumping orders. Future increases in other steel imports are also possible, particularly if the value of the dollar should rise in relation to foreign currencies.\nReorganized\/Reconstituted Mills. The intensely competitive conditions within the domestic steel industry have been exacerbated by the continued operation, modernization and upgrading of marginal steel production facilities through bankruptcy reorganization procedures, thereby perpetuating overcapacity in certain industry product lines. Overcapacity is also caused by the continued operation of marginal steel production facilities that have been sold by integrated steel producers to new owners, who operate such facilities with a lower cost structure.\nMini-mills. Domestic integrated producers, such as the Company, have lost market share in recent years to domestic mini-mills. Mini-mills provide significant competition in certain product lines, including hot rolled and cold rolled sheets, which represented, in the aggregate, approximately 57% of the Company's shipments in 1994. Mini-mills are relatively efficient, low-cost producers which produce steel from scrap in electric furnaces, have lower employment and environmental costs and target regional markets. Thin slab casting technologies have allowed mini-mills to enter certain sheet markets which have traditionally been supplied by integrated producers. One mini-mill has constructed two such plants and announced its intention to start a third in a joint venture with another steel producer. Certain companies have announced plans for, or have indicated that they are currently considering, additional mini-mill plants for sheet products in the United States.\nSteel Substitutes. In the case of many steel products, there is substantial competition from manufacturers of other products, including plastics, aluminum, ceramics, glass, wood and concrete. Conversely, the Company and certain other manufacturers of steel products have begun to compete in recent years in markets not traditionally served by steel producers.\nENVIRONMENTAL MATTERS\nThe Company's operations are subject to numerous laws and regulations relating to the protection of human health and the environment. The Company currently estimates that it will incur capital expenditures in connection with matters relating to environmental control of approximately $15.9 million and $7.0 million for 1995 and 1996, respectively. In addition, the Company expects to record expenses for environmental compliance, including depreciation, of approximately $78.0 million and $85.0 million for 1995 and 1996, respectively. Since environmental laws and regulations are becoming increasingly stringent, the Company's environmental capital expenditures and costs for environmental compliance may increase in the future. In addition, due to the possibility of future factual or regulatory developments, the amount and timing of future environmental expenditures could vary substantially from those currently anticipated. The costs for environmental compliance may also place the Company at a competitive disadvantage with respect to foreign steel producers, as well as manufacturers of steel substitutes, that are subject to less stringent environmental requirements.\nIn 1990, Congress passed amendments to the Clean Air Act which impose stringent standards on air emissions. The Clean Air Act amendments will directly affect the operations of many of the Company's facilities, including its coke ovens. Under such amendments, coke ovens generally will be required to comply with progressively more stringent standards over the next thirty years. The Company believes that the costs for complying with the Clean Air Act amendments will not have a material adverse effect, on an individual site basis or in the aggregate, on the Company's financial position, results of operations or liquidity.\nIn 1990, the EPA released a proposed rule which establishes standards for the implementation of a corrective action program under the Resource Conservation Recovery Act of 1976, as amended (\"RCRA\"). The corrective action program requires facilities that are operating under a permit, or are seeking a permit, to treat, store or dispose of hazardous wastes to investigate and remediate environmental contamination. Currently, the Company is conducting an investigation at its Midwest Division facility. The Company estimates that the potential capital costs for implementing corrective actions at such facility will be approximately $8 million payable over the next several years. At the present time, the Company's other facilities are not subject to corrective action.\nSince 1989, the EPA and the eight Great Lakes states have been developing the Great Lakes Initiative, which will impose standards that are even more stringent than the best available technology standards currently being enforced. As required under section 118 of the Clean Water Act, as amended, which is intended to codify the efforts of the EPA and such states under the Great Lakes Initiative, on April 16, 1993, the EPA published the proposed Guidance Document. Once finalized, the Guidance Document will establish minimum water quality standards and other pollution control policies and procedures for waters within the Great Lakes System. The EPA is required to publish the final Guidance Document by March 1995. Preliminary studies conducted by the AISI prior to publication of the proposed Guidance Document estimated that the potential capital cost for a fully integrated steel mill to comply with draft standards under the Great Lakes Initiative could range from approximately $50 million to $175 million and the potential annual operating and maintenance cost will be approximately 15% of the estimated capital cost. Until the Guidance Document is finalized and corresponding state laws and regulations are promulgated, the Company is unable to determine whether such estimates are accurate and whether the Company's actual costs for compliance will be comparable. Although the Company believes only the Great Lakes Division would be required to incur significant costs for compliance, there can be no assurances that compliance with the Great Lakes Initiative will not have a material adverse effect, on an individual site basis or in the aggregate, on the Company's financial position, results of operations or liquidity.\nThe Company has recorded the reclamation costs to restore its coal and iron ore mines at its shut down locations to their original and natural state, as required by various federal and state mining statutes.\nThe Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), and similar state superfund statutes generally impose joint and several liability on present and\nformer owners and operators, transporters and generators for remediation of contaminated properties regardless of fault. Currently, an inactive site located at the Great Lakes Division facility is listed on the Michigan Environmental Response Act Site List, but remediation activity has not been required by the Michigan Department of Natural Resources (\"MDNR\"). In addition, the Company and certain of its subsidiaries are involved as potentially responsible parties (\"PRPs\") in a number of off-site CERCLA or state superfund site proceedings. The more significant of these matters are described in the legal proceedings section. At several of these sites, any remediation costs incurred by the Company would be satisfied by FOX's $10.0 million prepayment, and any costs in excess of $10.0 million would constitute Weirton Liabilities or other environmental liabilities for which FOX has agreed to indemnify the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Granite City Division.\nThe Granite City Division, located in Granite City, Illinois, has an effective steelmaking capacity of 2.4 million tons. With the start-up of a second continuous caster in early 1991, all steel at this Division is now produced by continuous casting. The Granite City Division also uses ladle metallurgy to refine the steel chemistry to enable it to meet the exacting specifications of its customers. The Division's ironmaking facilities consist of two coke batteries and two blast furnaces. Finishing facilities include an 80 inch hot strip mill, a continuous pickler and two hot dip galvanizing lines. The Granite City Division ships approximately 20% of its total production to the Midwest Division for finishing. Principal products of the Granite City Division include hot rolled, cold rolled, hot dipped galvanized, grain bin and high strength, low alloy steels.\nThe Granite City Division is located on 1,540 acres and employs approximately 2,950 people. The Division's proximity to the Mississippi River and other interstate transit systems, both rail and highway, provides easy accessibility for receiving raw materials and supplying finished steel products to customers. In February 1995, the Company announced its plans to build a 270,000 ton coating line at the Granite City Division. The $67 million line, which is expected to be completed by mid 1996, will service the metal buildings market.\nThe Great Lakes Division.\nThe Great Lakes Division, located in Ecorse and River Rouge, Michigan, is an integrated facility engaged in steelmaking primarily for use in the automotive market with an effective steelmaking capacity of 3.6 million tons. With the start-up of a second continuous caster in late 1987, all steel at this Division is now produced by continuous casting. The Division's ironmaking facilities consist of a recent 85-oven coke battery rebuild and three blast furnaces. The Division also operates steelmaking facilities consisting of a vacuum degasser and a ladle metallurgy station. Finishing facilities include a hot strip mill, a skinpass mill, a shear line, a new high speed pickle line, a tandem mill, a batch annealing station, two temper mills and two customer service lines, and an electrolytic galvanizing line. The Great Lakes Division ships approximately 40% of its production to the Midwest Division for finishing. Principal products of the Great Lakes Division include hot rolled, cold rolled, electrolytic galvanized, and high strength, low alloy steels.\nThe Great Lakes Division is located on 1,100 acres and employs approximately 3,850 people. The Division is strategically located with easy access to lake, rail and highway transit systems for receiving raw materials and supplying finished steel products to customers.\nThe Midwest Division.\nThe Midwest Division, located in Portage, Indiana, finishes hot rolled bands produced at the Granite City and Great Lakes Divisions primarily for use in the automotive, metal buildings and container markets. The Division's facilities include a continuous pickling line, two cold reduction mills and two continuous galvanizing lines, a 48 inch wide line which can produce galvanized or Galvalume(R) steel products and which services the metal buildings market and a 72 inch wide line which services the automotive market; finishing facilities for cold rolled products consisting of a batch annealing station, a sheet temper mill and a continuous stretcher leveling line; and an electrolytic cleaning line, a continuous annealing line, two tin temper mills, two tin recoil lines, an electrolytic tinning line and a chrome line which services the container markets. Principal products of the Midwest Division include tin mill products, hot dipped galvanized and Galvalume(R) steel, cold rolled, and electrical lamination steels.\nThe Midwest Division is located on 1,100 acres and employs approximately 1,400 people. Its location provides excellent access to rail, water and highway transit systems for receiving raw materials and supplying finished steel products to customers.\nNational Steel Pellet Company\nNSPC, located on the western end of the Mesabi Iron Ore Range in Keewatin, Minnesota, mines, crushes, concentrates and pelletizes low grade taconite ore into iron ore pellets. NSPC operations include two primary crushers, ten primary mills, five secondary mills, a concentrator and a pelletizer. The facility has a current annual effective iron ore pellet capacity of 5 million gross tons and has a combination of rail and vessel access to the Company's integrated steel mills.\nDNN Galvanizing Limited Partnership\nAs part of its strategy to focus its marketing efforts on high quality steels for the automotive industry, the Company has entered into an agreement with NKK and Dofasco Inc., a large Canadian steel producer (\"Dofasco\"), to build and operate DNN, a 400,000 ton per year, hot dip galvanizing facility in Windsor, Ontario, Canada. This facility incorporates state-of-the-art technology to galvanize steel for critically exposed automotive applications. The facility is modeled after NKK's Fukuyama Works Galvanizing Line that has provided high quality galvanized steel to the Japanese automotive industry for several years. The Company is committed to utilize 50% of the available line time of the facility and pay a tolling fee designed to cover fixed and variable costs with respect to 50% of the available line time, whether or not such line time is utilized. The plant began production in January 1993 and is currently operating at full capacity. The Company's steel substrate requirements will be provided to DNN by the Great Lakes Division.\nCertain types of galvanized steel coated for the Company by DNN and shipped to the United States are subject to an anti-dumping duty order and to cash deposits of estimated anti-dumping duties. Dofasco has requested an administrative review of the duty calculation, which could result in a change in the amount of cash deposits being paid by the Company. The Company does not believe that the costs associated with the anti-dumping duty order and cash deposits will have a material adverse effect on the Company's financial condition.\nDouble G Coatings, L.P.\nTo continue to meet the needs of the growing metal buildings market, the Company and an unrelated party formed a joint venture to build and operate Double G. Coatings, L.P. (\"Double G\"), a 270,000 ton per year hot dip galvanizing and Galvalume(R) steel facility near Jackson, Mississippi. The facility is capable of coating 48 inch wide steel coils with zinc to produce a product known as galvanized steel and a zinc and aluminum coating to produce a product known as Galvalume(R) steel. Double G will primarily serve the metal buildings segment of the construction market in the south central United States. The Company is committed to utilize and pay a tolling fee in connection with 50% of the available line time at the facility. The joint venture commenced production in the second quarter of 1994 and is expected to reach full operating capacity in 1995. The Company's steel substrate requirements will be provided to Double G by the Great Lakes and Midwest Divisions.\nProCoil Corporation\nProCoil Corporation (\"ProCoil\"), a joint venture between the Company, Marubeni Corporation, Mitsubishi Corporation and NKK, located in Canton, Michigan, operates a steel processing facility which began operations in 1988 and a warehousing facility which began operations in 1992. The Company and Marubeni Corporation each own a 44% equity interest in ProCoil. ProCoil blanks, slits and cuts steel coils to desired lengths to service automotive market customers. In addition, ProCoil warehouses material to assist the Company in providing just-in-time delivery to customers.\nOTHER PROPERTIES\nGenerally, the Company's properties are well maintained, considered adequate and being utilized for their intended purposes. The Company's corporate headquarters is located in Mishawaka, Indiana.\nExcept as stated below, the steel production facilities are owned in fee by the Company. A continuous caster and related ladle metallurgy facility and an electrolytic galvanizing line, which each service the Great Lakes Division, and a coke battery, which services the Granite City Division, are operated pursuant to the terms of operating leases with third parties and are not subject to a lien securing the Company's First Mortgage Bonds. The electrolytic galvanizing line lease, the coke battery lease and the continuous caster and related metallurgy facility lease are scheduled to expire in 2001, 2004, and 2008, respectively. Upon expiration, the Company has the option to extend the respective lease or purchase the facility at fair market value.\nAll land (excluding certain unimproved land), buildings and equipment (excluding, generally, mobile equipment) that are owned in fee by the Company at the Great Lakes Division, Granite City Division and Midwest Division are subject to a lien securing the First Mortgage Bonds, with certain exceptions, including a vacuum degasser and a pickle line which service the Great Lakes Division, a continuous caster which services the Granite City Division and the corporate headquarters in Mishawaka, Indiana. Additionally, the Company has agreed to grant to the VEBA Trust a second mortgage on the No. 5 coke oven battery at the Great Lakes Division.\nFor a description of certain properties related to the Company's production of raw materials, see \"Raw Materials.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn addition to the matters specifically discussed below, the Company is involved in various legal proceedings occurring in the normal course of its business. In the opinion of the Company's management, adequate provision has been made for losses which are likely to result from these actions. To the extent that such reserves prove to be inadequate, the Company would incur a charge to earnings, which could have a material adverse effect on the Company's results of operations for the applicable period. The outcome of these proceedings, however, is not expected to have a material adverse effect on the financial condition of the Company. For a description of certain environmental matters involving the Company, see \"Environmental Matters\" below.\nBaker's Port, Inc. v. National Steel Corporation. On July 1, 1988, Baker's Port, Inc. (\"BPI\") and Baker Marine Corporation (\"BMC\") filed a lawsuit in the District Court for San Patricio County, Texas against the Company, two of its subsidiaries, NS Land Company (\"NS Land\") and Natland Corporation (\"Natland\"), and several other defendants, alleging breach of their general warranty of title and encumbrances, violation of the Texas Deceptive Trade Practice Act (the \"DTPA\") and fraud, in connection with the sale by Natland to BPI in 1981 of approximately 3,000 acres of land near Corpus Christi, Texas. Approximately $24.7 million of the purchase price was in the form of a note (the \"Note\") secured by a Deed of Trust (mortgage) and BMC's guarantee. BPI and BMC sought actual damages in excess of $55 million, or, alternatively, rescission of the sale, and exemplary damages in excess of $155 million, as well as treble damages under the DTPA. Natland counterclaimed for the amount defaulted on by BPI under the Note which totaled approximately $19 million at the time of trial. The State of Texas also claimed the rights to certain riparian land. On September 7, 1990, after trial, a judgment was entered, holding, among other things, (i) that the affirmative claims of BPI and BMC were barred, except that the finding of $22 million in damages for fraud could be used as a setoff against the Note and except as set forth in (iii) below, (ii) that recovery by Natland on the Note was deemed offset by the setoff referred to in (i) above, (iii) that BPI was entitled to approximately $.4 million plus pre-judgment interest thereon in the sum of approximately $.5 million, plus post-judgment interest thereon and (iv) that Natland's Deed of Trust lien on the property was fully released and discharged.\nOn June 30, 1993, the Court of Appeals issued an opinion generally in favor of the Company and its subsidiaries. The Court of Appeals affirmed in part and reversed and remanded in part the judgment of the trial court. Specifically, the Court of Appeals (i) affirmed the dismissal by the trial court of the title claims brought by the State of Texas, (ii) reversed the finding by the trial court of $22 million of damages for fraud, which had been applied to offset the entire amount then owing on the Note, (iii) reversed the trial court's award of approximately $.4 million plus pre-judgment interest thereon in the amount of approximately $.5 million plus post-judgment interest and (iv) remanded the case for a new trial on one remaining title claim. All parties filed appeals with the Texas Supreme Court which subsequently declined to hear them. As a result, the appellate rights available to the parties have been exhausted, and the case has been remanded for a new trial on limited issues. A trial date has been tentatively set by the trial court for November 1995. The plaintiffs have again claimed they are entitled to rescission and other damages. The trial court has stated in a letter to counsel that the new trial will be on limited issues, although no order has yet been entered with respect to the causes to be retried. As of December 31, 1994, approximately $13.3 million in principal and $12.8 million in interest was due under the Note. The Company has reserved the entire amount owing under the Note and an additional $.9 million in its financial statements.\nDetroit Coke Corporation v. NKK Chemical USA, Inc. On October 4, 1991, Detroit Coke Corporation (\"Detroit Coke\") filed a lawsuit against NKK Chemical USA, Inc. (\"NKK Chemical\") and the Company in the United States District Court for the Eastern District of Michigan, Southern Division. Plaintiff alleged that its damages exceeded $120 million. The cause of action arises out of a coal supply and coke purchasing arrangement entered into between Detroit Coke and NKK Chemical. In turn, NKK Chemical entered into agreements with Natcoal, Inc. (\"Natcoal\"), a wholly-owned subsidiary of the Company, to purchase and ship coal to Detroit Coke, which would convert it into coke to be sold to NKK Chemical and, in turn, by NKK Chemical to the Company's Great Lakes Division. Plaintiff claims, among other things, that certain coal blends supplied by the Company (allegedly acting through Natcoal) failed to meet blend specifications,\nallegedly causing environmental problems and damage to its ovens, all of which resulted in Detroit Coke having to shut down its facility. The Company filed an Answer and Affirmative Defenses. A Motion to Transfer the action to the United States District Court for the Western District of Pennsylvania was granted and the case was transferred on July 2, 1992. On or about October 9, 1992, plaintiff filed a First Amended Complaint adding a new defendant, Trans-Tech Corporation, as well as claiming an additional $1.4 million allegedly due for coke and coke oven gas supplied under the coke purchasing agreement between Detroit Coke and NKK Chemical. The Company denied all of plaintiff's allegations. More recently, on February 6, 1995, plaintiff filed a Second Amended Complaint asserting a new legal theory of recovery. Again, the Company has denied all allegations. The Company has been granted the opportunity to supplement its pending Motion for Summary Judgment to address plaintiff's new legal theory, and this supplemental pleading will be filed shortly. In an Answer to Interrogatories, plaintiff claimed damages as great as $160 million. Discovery has been completed and all parties have filed pretrial statements. All defendants have filed Motions for Summary Judgment; however, no decisions have been rendered as to any Motions for Summary Judgment, with the exception that the Court has held that Trans-Tech Corporation should be dismissed as a defendant. This matter will not reach the trial stage before the summer of 1995.\nDonner-Hanna Coke Joint Venture. Hanna Furnace Corporation (\"Hanna\"), a wholly-owned subsidiary of the Company, was a 50% participant, along with LTV Steel Company, Inc. (\"LTV\"), in the Donner-Hanna Coke Joint Venture (\"Donner- Hanna\") which ceased its coke making operations in 1982. LTV filed a petition in July 1986 with the United States Bankruptcy Court for the Southern District of New York for relief under Chapter 11 of the Bankruptcy Code, and, with the approval of the Bankruptcy Court, rejected the Donner-Hanna Coke Joint Venture Agreement. As a result of LTV's actions, Donner-Hanna has failed to make its annual minimum pension contributions to the trustee of its salaried and hourly pension plans (the \"Plans\") for each of the plan years 1985 through 1993 in the aggregate amount of approximately $7.9 million. The Company estimates the 1994 minimum contribution to be $.7 million, which also has not been made. The Company has fully reserved for these amounts at December 31, 1994. The total unfunded liability of the Plans was determined to be $15.5 million on May 20, 1993, for purposes of settling Hanna's bankruptcy claim against LTV. Since July 1991, the Pension Benefit Guaranty Corporation (the \"PBGC\") has funded the monthly pension benefits under the hourly pension plan. On August 13, 1993, the Internal Revenue Service assessed Hanna, as a general partner of Donner-Hanna, approximately $2.7 million for excise taxes (including interest through August 31, 1993) and penalties for plan years 1985 through 1991 arising from the failure to meet minimum funding standards for the Plans. In November 1993, Hanna contributed approximately $1.2 million to the salaried plan, representing proceeds from the sale of LTV stock received for Hanna's claim in the LTV bankruptcy proceeding. On December 30, 1993, the PBGC notified Hanna and the Pension Committee for the Plans that the PBGC was terminating the hourly plan retroactive to July 1, 1991, and was terminating the salaried plan as of December 31, 1993. In February 1994, the PBGC submitted a proposed Termination Agreement to the Company for review. The PBGC and the Pension Committee for the Plans did not reach agreement on the PBGC's proposed Termination Agreement, and, on July 8, 1994, the PBGC filed an application in the United States District Court for the Western District of New York to terminate Donner-Hanna's hourly pension plan retroactively to July 1, 1991 and the salaried plan retroactively to December 31, 1993. The Court has ordered that the Plans be terminated no later than the dates requested by the PBGC. Hanna has been granted leave to intervene in this proceeding for the purpose of contending that the Plans should be deemed to have been terminated as of an earlier date. Hanna is liable to the PBGC for the underfunding of the Plans. Depending upon the date the Plans are deemed to have been terminated, Hanna's liability is estimated to range from $12.3 million to $16.9 million. The Company has accrued the maximum amount in this range. There has been no funding in 1994 of either of the Plans. The PBGC has indicated that it may seek to hold the Company liable for the unfunded liability of the Plans. Although the Company believes that under applicable law Hanna is solely liable and the Company has valid defenses to any such action by the PBGC, the Company is unable to predict with certainty the final outcome of any such action by the PBGC. On January 4, 1995, Hanna and the Company tentatively agreed with the PBGC to a settlement of the PBGC's claim with respect to the Plans. The settlement provides that the Company will pay the PBGC $8.5 million in cash and will make a supplemental contribution to the Hanna Iron Ore Division Pension Plan of $4.5 million. Such supplemental contribution would not be utilized for the period through 1999 as a credit in the funding standard account for such plan. The proposed settlement is in full release of the Company and its subsidiaries and affiliates from any liability\nin connection with the Plans. The settlement is conditioned on a resolution satisfactory to Hanna and the Company of the IRS claims against Hanna for any excise tax liability and related penalties arising from the failure to meet minimum funding standards for the period through the date of termination.\nUSX Corporation v. National Steel Corporation.\nIn June of 1994, USX Corporation (\"USX\") sued the Company, three of its directors, six other individuals who became officers of the company on June 1, 1994 and NKK Corporation in Indiana State Court, alleging that the defendants misappropriated trade secrets and other confidential information of U.S. Steel's Gary Works, interfered with USX's relationship with its former employees, and engaged in corporate raiding and unfair trade practices involving USX's tin plate and automotive business with the intent to cause injury. The core of the claims is that the Company had hired five management employees and one former management employee of Gary Works who had signed confidentiality agreements while employees of USX. None of the six former USX employees had signed employment agreements or covenants not to compete. USX requested injunctive relief and unspecified monetary damages. Following a hearing on the request for the preliminary injunction, the Indiana trial court in June of 1994 denied USX's preliminary injunction request, holding that there had been no showing that any of the six former USX employees had misappropriated USX trade secrets or had engaged in any illegal conduct. USX's claims for a permanent injunction and monetary relief remain pending. No material developments have occurred in the litigation since the denial of the request for a preliminary injunction.\nManagement believes that the final disposition of the Baker's Port, Detroit Coke, Donner-Hanna Coke, and USX matters will not have a material adverse effect, either individually or in the aggregate, on the Company's financial condition or results of operations, but could have a material adverse effect on liquidity.\nENVIRONMENTAL MATTERS\nThe Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), and similar state superfund statutes generally impose joint and several liability on present and former owners and operators, transporters and generators for remediation of contaminated properties regardless of fault. Currently, an inactive site located at the Great Lakes Division facility is listed on the Michigan Environmental Response Act Site List, but remediation activity has not been required by the Michigan Department of Natural Resources (\"MDNR\"). In addition, the Company and certain of its subsidiaries are involved as potentially responsible parties (\"PRPs\") in a number of off-site CERCLA or state superfund site proceedings. The more significant of these matters are described below. At several of these sites, any remediation costs incurred by the Company would be satisfied by FOX's $10 million prepayment, and any costs in excess of $10 million would constitute Weirton Liabilities or other environmental liabilities for which FOX has agreed to indemnify the Company.\nIlada Energy Company Site. The Company and certain other PRPs have performed a removal action pursuant to an order issued by the EPA under Section 106 of CERCLA at this waste oil\/solvent reclamation site located in East Cape Girardeau, Illinois. The Company received a special notice of liability with respect to this site on December 21, 1988. The Company believes that there are approximately sixty-three PRPs identified at such site. Pursuant to an Administrative Order of Consent (\"AOC\"), the Company and other PRPs are currently performing a remedial investigation and feasibility study (\"RI\/FS\") at this site to determine whether the residual levels of contamination of soil and groundwater remaining after the removal action pose any threat to either human health or the environment and therefore whether or not the site will require further remediation. During the RI\/FS, a floating layer of material, which the Company believes to be aviation fuel, was discovered above the groundwater. The Company does not know the extent of this contamination. Furthermore, the Company believes that this material is not considered to be a hazardous substance as defined under CERCLA. To date, neither the Company nor the other PRPs have agreed to remediate or take any action with respect to this material. Due to legal and factual uncertainties remaining at this site, the Company is unable to estimate its ultimate potential liability. To date, the Company has paid approximately $2 million for work and oversight costs.\nBuck Mine Complex. This is a proceeding involving a large site, called the Buck Mine Complex, two discrete portions of which were formerly owned or operated by a subsidiary of the Company. This subsidiary was subsequently merged into the Company. The Company received a notice of potential liability from the Michigan Department of Natural Resources (\"MDNR\") with respect to this site on June 24, 1992. The Company's subsidiary had conducted mining operations at only one of these two parcels and had leased the other parcel to a mining company for numerous years. The MDNR alleges that this site discharged and continues to discharge heavy metals into the environment, including the Iron River. Because the Company and approximately eight other PRPs have declined to undertake a RI\/FS, the MDNR has advised the Company that it will undertake the investigation at this site and charge the costs thereof to those parties ultimately held responsible for the cleanup. The Company has received advice from various sources that the cost of the RI\/FS and the remediation at this site will be in the range of $250,000 to $400,000, which cost will be allocated among the parties ultimately held responsible. The Company does not have complete information regarding the relationship of the other PRPs to the site, does not know the extent of the contamination or of any cleanup that may be required and, consequently, is unable to estimate its potential liability, if any, in connection with this site.\nPort of Monroe Site. In February 1992, the Company received a notice of potential liability from the MDNR as a generator of waste materials at this landfill. The Company believes that there are approximately 80 other PRPs identified at this site. The Company's records indicate that it sent some material to the landfill. A draft RI\/FS for remediation work has been prepared by the owner\/operator PRPs and submitted to the MDNR for its approval. The cost of this RI\/FS was approximately $280,000. In March 1994, the MDNR demanded reimbursement from the PRPs for its past and future response costs. The MDNR has since agreed to accept $500,000 as reimbursement for its past response costs incurred through October 1993. This settlement has been embodied in a consent decree. The owner\/operators of this site and certain of the generator\/transporter PRPs (including the Company) have reached an agreement regarding an interim allocation that will generate sufficient funds to satisfy the PRPs' obligations under the above-described settlement with the MDNR. The Company's share under this interim allocation is approximately $50,000, which amount has been paid to the State. The owner\/operator PRPs have advised the Company orally that the overall cost of the remedy for the site is expected to be less than $10 million. However, the Company does not yet have sufficient information regarding the nature and extent of contamination at the site and the nature and extent of the wastes that the other PRPs have sent to the site to determine whether the $10 million estimate is accurate. Based on currently available information, the Company believes that its proportionate share of the ultimate liability at this site will be no more than 10% of the total costs and has accrued for this exposure.\nHamtramck Site. In January 1993, the City of Hamtramck filed a complaint against the Sherwin-Williams Company and six other defendants seeking contribution of costs incurred in connection with the remediation of certain property located in Hamtramck, Michigan. In February 1993, the Sherwin-Williams Company filed a third party complaint against the Company and seven other third party defendants seeking contribution in connection with the site. The complaint alleges that the Company's Great Lakes Division engaged a third party waste oil hauler and processor that operated a tank farm at the site to haul and\/or treat some of the Division's waste oil. The Company entered into an agreement with the City of Hamtramck in 1983 pursuant to which the Company, without admitting liability, contributed to the funding of the cleanup of the tank farm, in return for which the City agreed to indemnify the Company for any releases. The Company has notified the City of this proceeding, and the City has agreed to defend and indemnify the Company in this matter. On June 8, 1994, a judicially-mandated mediation hearing took place for purposes of allocating costs incurred as of the date of the mediation hearing. The mediation panel issued a non-binding decision that the Company's apportioned liability for all response costs incurred as of June 8, 1994 in connection with this site is zero. The Company believes that it is not likely to have any liability for past or future response costs with respect to this site, and further believes that if any liability for such costs is ultimately assessed against the Company, it will be paid for by the City of Hamtramck.\nMartha C. Rose Chemicals Superfund Site. This proceeding involves a former PCB storage, processing and treatment facility located in Holden, Missouri. The Company received an initial request for information with respect to this site on December 2, 1986. The Company believes that there are over 700 PRPs identified\nat this site. The Company believes that it sent only one empty PCB transformer there. In July 1988, the Company entered into a Consent Party Agreement with the other PRPs and paid $48,134 in connection with the remediation of such site. A record of decision selecting the final remedial action and an order pursuant to Section 106 of CERCLA requiring certain PRPs, not including the Company, to implement the final remedy have been issued by the EPA. Completion of construction of the remedy is scheduled for early 1995. To date, the PRP steering committee has raised approximately $35 million to pay for past removal actions, the remedial investigation and feasibility study and the final remedial action. The remediation project manager for the PRP group has advised that the final cost of the remedy will be less than $35 million.\nSpringfield Township Site. This is a proceeding involving a disposal site located in Springfield Township, Davisburg, Michigan in which approximately twenty-two PRPs have been identified. The Company received a general notice of liability with respect to this site on January 23, 1990. The Company and eleven other PRPs have entered into AOCs with the EPA for the performance of partial removal actions at such site and reimbursement of past response costs to the EPA. The Company's share of costs under the AOCs was $48,000. The PRPs are currently negotiating with the EPA regarding the final remedial action at such site. The EPA and the PRP steering committee have estimated the cost to implement the final remedy at approximately $33 million and $20 million, respectively, depending upon the final remedy. The Company is currently negotiating with the other PRPs with respect to its share of such cost and has offered to pay $175,000 in connection with the final remedy. On November 10, 1993, the EPA issued a unilateral order pursuant to Section 106 of CERCLA requiring the PRP steering committee to implement the groundwater portion of the final remedy. The members of the PRP steering committee have entered into an agreement among themselves for the implementation of this unilateral order. Subject to a final determination by the EPA as to what must be included, a preliminary estimate by the PRP steering committee of the cost of such work is approximately $300,000. Additionally, in response to a demand letter from the MDNR, the PRP steering committee and the MDNR have negotiated an AOC pursuant to which the MDNR will be reimbursed approximately $700,000 for its past response costs incurred through July 1993. The Company has paid its share of this settlement amount, which was approximately $11,000. The Company has recorded its overall estimated liability for this matter, which totals approximately $175,000.\nRasmussen Site. The Company and nine other PRPs have entered into a Consent Decree with the EPA in connection with this disposal site located in Livingston, Michigan. The Company received a general notice of liability with respect to this site on September 27, 1988. The Company believes that there are approximately twenty-three PRPs at this site. A record of decision selecting the final remedial action for this site was issued by the EPA in March 1991. The PRP steering committee has revised its estimate of site remediation costs upward from approximately $18.5 million to $19.7 million. Pursuant to a participation agreement among the PRPs, the Company's share of such costs is approximately $444,000, which has been accrued by the Company. To date, the Company has paid approximately $244,000, and $200,000 remains to be paid.\nBerlin and Farro Liquid Incineration Site. The Company has been identified as a generator of small amounts of hazardous materials allegedly deposited at this industrial waste facility located in Swartz Creek, Michigan. The Company received an initial request for information with respect to this site on September 19, 1983. The Company believes that there are approximately 125 PRPs at this site. A record of decision selecting the final remedial action for this site was issued by the EPA in September 1991. The EPA and the PRP steering committee have estimated the cost of the selected remedy at approximately $8 million and $10.5 million, respectively. A third-party complaint has been filed against the Company by three PRPs for recovery of the EPA's past and future response costs. The Company has entered into a consent decree with the EPA, which was lodged with the court on February 25, 1994. Pursuant to such consent decree the Company's share of liability for past and future response costs and natural resource damages is $105,000, which amount has been paid. The terms of the consent decree provide that settling defendants who are plaintiffs in the above-referenced cost recovery action will execute and file a dismissal with prejudice as to their claims against the \"de minimis\" settling defendants, including the Company. In addition, the MDNR has demanded that the Company reimburse the State for its past response costs incurred at this site. In July 1993, the MDNR offered and the Company accepted a \"de minimis\" buyout settlement of the State's claims for approximately $1,500, which amount has been paid.\nIron River (Dober Mine) Site. On July 15, 1994, the State of Michigan served M.A. Hanna Company (\"M.A. Hanna\") with a complaint seeking response costs in the amount of approximately $365,000, natural resource damages in the amount of approximately $2 million and implementation of additional response activities related to an alleged discharge to the Iron and Brule Rivers of acid mine drainage. M.A. Hanna operated the Dober Mine pursuant to a management agreement with the Company. M.A. Hanna has requested that the Company defend and indemnify it, and the Company has undertaken the defense of the State's claim. The Company, however, reserved the right to terminate such defense. The Company filed on behalf of M.A. Hanna an answer to the complaint denying liability at this site. On September 21, 1994 and November 9, 1994, respectively, the Company filed a third party complaint and an amended third party complaint naming a total of seven additional defendants. Additionally, on November 15, 1994, the Company negotiated a case management order with the State pursuant to which the court must rule on liability issues prior to addressing other aspects of the case. That order also stays the third party actions pending the court's decision regarding the liability issues. The Company has accrued $365,000, the amount of the claimed response costs, for this matter. However, the Company is unable to estimate its ultimate potential liability, if any, at this site because the Company believes there are numerous legal issues relating to whether M.A. Hanna is responsible for the alleged discharge, as well as uncertainties concerning the nature and extent of the contamination at this site, the validity of the State's natural resource damage and additional claims, the involvement of other PRPs and the nature of the remedy to be implemented.\nConservation Chemical Company Site. In a General Notice of Potential Liability letter dated September 28, 1994, the EPA advised that it has information that the Company's Midwest Division is a PRP with respect to the Conservation Chemical Company site located in Gary, Indiana. The letter further advised that EPA plans to implement a removal action at the site. Attached to the General Notice Letter was a list of the PRPs which received the letter. That list consists of 225 entities. On November 10, 1994, a meeting was held at which the EPA provided the PRPs with information concerning the proposed removal action. At that meeting, the EPA advised that its estimate of the cost of this removal action would be in the range of $6 to $10 million (this estimate does not include the cost of groundwater remediation, if any is determined to be necessary). Additionally, the EPA advised that it had incurred response and oversight cost of approximately $2.8 million through August 1994. Based upon preliminary information, it appears that PRPs who sent less than 300,000 gallons of material to the site would be considered \"de minimis.\" Because the Company's Midwest Division sent approximately 10,000 gallons of material to this site, it is likely that the Company will qualify for participation in the \"de minimis\" group. Although the EPA advised that it hoped to have an AOC in place by February 1995 pursuant to which the PRPs will perform the removal action, the Company has received no further information from EPA regarding this AOC.\nWaste, Inc. Site. On December 30, 1994, the EPA notified the Company's Midwest Division that it was a PRP with respect to a site located in Michigan City, Indiana known as the Waste, Inc. Landfill Site. The EPA has informed the Company that there are approximately 25 non-\"de minimis\" PRPs, as well as approximately 200 \"de minimis\" PRPs at this site. The EPA has further informed the Company that it may have only contributed a small amount of waste to the site and that the Company may be a \"de minimis\" PRP. The EPA has estimated the cost of the remedy to be between $16 and $16.5 million. The Company does not have complete information regarding the relationship of the other PRPs to the site or the quantity and nature of waste contributed by the PRPs to the site and, consequently, is unable to estimate its potential liability, if any, in connection with this site.\nFOX Sites.\nRemediation costs incurred by the Company at the following sites constitute Weirton Liabilities or other environmental liabilities for which FOX has agreed to indemnify the Company: The Swissvale Site, Swissvale, Pennsylvania; Buckeye Site, Bridgeport, Ohio; Lowry Landfill Site, Aurora, Colorado; and Weirton Steel Corporation Site, Weirton, West Virginia. The Company was notified of potential liability with respect to each of these sites as follows: the Swissvale Site -- February 1985; Buckeye Site -- September 1991; Lowry Landfill Site -- December 1990; and Weirton Steel Corporation Site -- January 1993. In accordance with the terms of an agreement between the Company and FOX, in January 1994, FOX paid the Company $10.0 million as an unrestricted prepayment for environmental obligations which may arise after such\nprepayment and for which FOX has previously agreed to indemnify the Company. Since FOX retains responsibility to indemnify the Company for any remaining environmental liabilities arising before such prepayment or arising after such prepayment and in excess of $10.0 million, these environmental liabilities are not expected to have a material adverse effect on the Company's liquidity. However, the failure of FOX to satisfy any such indemnity obligations could have a material adverse effect on the Company's liquidity. The Company's ability to fully realize the benefits of FOX's indemnification obligation is necessarily dependent upon FOX's financial condition at the time of the resolution of any claim with respect to such obligations. FOX is subject to the informational requirements of the Exchange Act and, in accordance therewith, files reports and other information with the Securities and Exchange Commission.\nLowry Landfill Site. The Company, Earth Sciences, Inc. and Southwire Company are general partners in the Alumet Partnership (\"Alumet\"), which has been identified by the EPA as one of approximately 260 PRPs at the Lowry Landfill Superfund Site. Alumet has presented information to the EPA in support of its position that the material it sent to this site is not a hazardous substance. To date, however, the EPA has rejected this position, and on November 15, 1993, Alumet received a demand letter from the EPA requesting approximately $15.3 million for its past response costs incurred as of the date of the letter. The Company believes that the same demand letter was sent to all PRPs that sent over 300,000 gallons of waste to the site. The owners and operators of the Lowry Landfill -- the City and County of Denver, Waste Management of Colorado, Inc. and Chemical Waste Management, Inc. -- are performing the remediation activities at the site. The City and County of Denver (the \"Plaintiffs\") in December 1991 filed a complaint against 40 of the PRPs seeking reimbursement for past and future response costs incurred by the Plaintiffs at the Lowry Landfill site. Subsequently, the Plaintiffs reached a confidential settlement agreement with Earth Sciences, Inc. and unsuccessfully attempted to add Alumet as a third-party defendant. In June 1993, Alumet received a settlement demand from the owners and operators of the Lowry Landfill for response costs associated with Alumet's wastes that were not covered by the earlier confidential settlement agreement with Earth Sciences, Inc. On May 11, 1994, the EPA issued a Special Notice Letter to Alumet alleging that Alumet is a PRP under CERCLA for cleanup of the Lowry Landfill Site and demanding payment of the EPA's past and future response costs. The City and County of Denver, Waste Management of Colorado, Inc. and Chemical Waste Management have filed a complaint against multiple entities, including Alumet, FOX, the Company and Southwire. The complaint alleges that Alumet, FOX, Southwire and the Company are liable under CERCLA for the costs of cleaning up the Lowry Landfill Site. On November 22, 1994, Alumet received a unilateral administrative order (the \"Order\") from the EPA directing recipients of the Order to perform the remedial design and remedial action at the Lowry Landfill. The Company has until April 11, 1995 to respond to the Order. EPA has determined that Alumet's percentage of the total volumetric contribution attributed to the 27 generator respondents listed on the Order is 4.33%. Sitewide past costs are currently $48,300,000 and sitewide remedy costs are estimated to be $93,848,000. Alumet has received and is considering a comprehensive and confidential settlement proposal from EPA. The Company believes that its liability associated with this site will be covered by the FOX $10.0 million prepayment and indemnity obligations.\nBuckeye Site. In connection with the Buckeye Site, the Company and thirteen other PRPs have entered into a consent order with the EPA to perform a remedial design. The Company's allocated share for the remedial design, as established by a participation agreement for the remedial design executed by the PRPs, is 4.63% for the first $1.6 million and 5.05% thereafter. The EPA and the PRP steering committee have estimated the cost for the remedial design to be approximately $3 million. The EPA and the PRP steering committee have estimated the total cost for remediation activities at this site at approximately $35 million. The PRPs are currently negotiating with the EPA to reduce the scope of the remediation activities at the site and, therefore, the ultimate cost of remediation at this site is not estimable. Additionally, the Company and the other thirteen PRPs are discussing an additional participation agreement and allocation governing the costs of the final remedial action and are continuing to identify other PRPs. The Company believes that its share of the final remedial action costs will not exceed 5.05%. On March 30, 1994, the Company was served with a complaint filed by Consolidation Coal Company, a former owner and operator of the site. Among other claims, the complaint seeks participation from the Federal Abandoned Mine Reclamation Fund, joinder of certain public entities, one of which delivered waste to the site, and damages and indemnity from current owners of the site. One count of the complaint names the Company and nine other industrial PRPs and\nseeks a determination of the allocation of responsibility among the alleged industrial generators involved with the site. The Company has filed an answer to the complaint and intends to defend all claims against it. Because this litigation is in the early stages, the Company is unable to estimate what liability, if any, it may have to the plaintiff.\nWeirton Site. In January 1993, the Company was notified that the West Virginia Division of Environmental Protection (the \"WVDEP\") had conducted an investigation at a site in Weirton, West Virginia which was formerly owned by the Company's Weirton Steel Division and is currently owned by Weirton Steel Corporation. The WVDEP alleged that samples taken from four groundwater monitoring wells located at this site contained elevated levels of contamination. Weirton Steel Corporation has agreed to cooperate with the WVDEP with respect to conducting a ground water monitoring program at the site. Because there has been no activity on this matter since the samples were taken, the Company does not have sufficient information to estimate its potential liability, if any, at this site.\nSwissvale Site. The Company has been named as a third-party defendant in a governmental action for reimbursement of the EPA's response costs in connection with the Swissvale Site. The Company understands that on December 2, 1993, the EPA and the original defendants reached a tentative settlement agreement regarding the EPA's cost recovery claim for $4.5 million. Pursuant to that tentative settlement agreement, the original defendants will pay a total of $1.5 million. The original defendants have requested that the eighteen third-party defendants, including the Company, pay a total of $375,000. The Company has made a settlement offer and believes that its share should be less than $20,000.\nOther.\nThe Company and its subsidiaries have been conducting steel manufacturing and related operations at numerous locations, including their present facilities, for over sixty years. Although the Company believes that it has utilized operating practices that were standard in the industry at the time, hazardous materials may have been released on or under these currently or previously-owned sites. Consequently, the Company potentially may also be required to remediate contamination at some of these sites. The Company does not have sufficient information to estimate its potential liability in connection with any potential future remediation. However, based on its past experience and the nature of environmental remediation proceedings, the Company believes that if any such remediation is required, it will occur over an extended period of time. In addition, the Company believes that many of these sites may also be subject to indemnities by FOX to the Company.\nIn addition to the aforementioned proceedings, the Company is or may be involved in proceedings with various regulatory authorities which may require the Company to pay various fines and penalties relating to violations of environmental laws and regulations, comply with applicable standards or other requirements or incur capital expenditures to add or change certain pollution control equipment or processes.\nWayne County Air Pollution Control Department Proceeding. Since 1992, the Wayne County Air Pollution Control Department (the \"WCAPCD\") has issued approximately 90 notices of violation to the Company in connection with alleged exceedances of particulate emissions standards covering various process and fugitive emissions sources. The Company and the WCAPCD have agreed to a settlement of these notices of violation whereby the Company would pay a $227,250 penalty and implement an environmental credit program valued at $227,250. Settlement documentation is currently being negotiated.\nGreat Lakes Division Outfalls Proceedings. In connection with certain outfalls located at the Great Lakes Division facility, including the outfall at the 80- inch hot strip mill, the U.S. Coast Guard (the \"USCG\") issued certain penalty assessments in 1992 and 1993. All of these assessments have been settled. Additionally, the USCG issued five penalty assessments in 1994. The Company has settled three of these assessments for $21,500. Of the remaining assessments, the Company plans to settle one for $3,000. The Company will submit information to the USCG regarding the other assessment in an attempt to persuade the USCG to reduce the amount of the penalty from $10,000 to $5,000. The MDNR, in April 1992, also notified the Company of a potential enforcement action alleging approximately 63 exceedances of limitations at the\noutfall at the 80-inch hot strip mill. The Company requested the MDNR to provide more information concerning these exceedances. In April 1993, the MDNR identified the dates of the alleged exceedances, but no further action has taken place. Additionally, in July 1994, the MDNR requested that the Company submit a comprehensive plan for addressing oil discharges from the 80-inch hot strip mill. The Company submitted the proposed plan, which includes installation of certain control systems and changes to operational procedures, in August 1994. By letter dated December 9, 1994, the MDNR identified two alternative settlement options. One option would require the Company to make an immediate commitment to install additional control systems at a cost of approximately $13 million. The second option involves reaching an agreement pursuant to which the effectiveness of the comprehensive plan (scheduled to be completely implemented by February 1995) would be evaluated over a one year period. Furthermore, under the second option, the Company would be required to make a commitment to install additional control systems in the future in the event the actions taken under the comprehensive plan do not adequately address the oil discharges. The Company has proposed to the MDNR that it will proceed with the preliminary engineering stage of the first option, while the effectiveness of the comprehensive plan is evaluated. In the event the comprehensive plan does not adequately address the oil discharges, the Company will proceed to fully implement the first option.\nDetroit Water and Sewage Department Proceeding. The coke oven by-products plant at the Great Lakes Division currently discharges wastewater to the Detroit Water and Sewerage Department (\"DWSD\") treatment facility pursuant to a permit issued by the DWSD. The DWSD treats the Company's wastewater along with large volumes of wastewater from other sources and discharges such treated wastewaters to the Detroit River. The Company has appealed the total cyanide limit in the permit and has requested that the DWSD issue to the Company a variance from the cyanide limit. The DWSD denied the Company's request for a variance in April 1994, and the Company subsequently filed a timely petition for reconsideration. The Company and the DWSD are currently involved in technical discussions regarding the cyanide limit. In the event that the DWSD denies the Company any relief from the challenged cyanide limit, the Company likely will be required to install its own treatment facility at an estimated cost of approximately $8 million.\nIn connection with certain of these proceedings, the Company has only commenced investigation or otherwise does not have sufficient information to estimate its potential liability, if any. Although the outcomes of the proceedings described above or any fines or penalties that may be assessed in any such proceedings, to the extent that they exceed any applicable reserves, could have a material adverse effect on the Company's results of operations and liquidity for the applicable period, the Company has no reason to believe that any such outcomes, fines or penalties, whether considered individually or in the aggregate, will have a material adverse effect on the Company's financial condition. The Company's accrued environmental liabilities at December 31, 1994 and 1993 were $17.1 million and $11.7 million, respectively. Additionally, the Company has recorded a $10 million liability to offset the $10 million prepayment received by FOX in January 1994.\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 STOCK AND RELATED STOCKHOLDER MATTERS\nThe Class B Common stock is listed on the New York Stock Exchange (the \"NYSE\") and traded under the symbol \"NS.\" The following table sets forth for the periods indicated the high and low sales prices of the Class B Common Stock as reported on the NYSE Composite Tape. Prior to March 30, 1993, the Company did not have any publicly traded shares.\nAs of December 31, 1994, there were approximately 103 registered holders of Class B Common Stock. (See Note B - Capital Structure and Primary Offering of Class B Common Stock.) The Company has not paid dividends on its Common Stock since 1984, with the exception of an aggregate dividend payment of $6.7 million in 1989. The Company is currently prohibited from paying cash dividends on its Common Stock, including the Class B Common Stock, by covenants contained in certain of the Company's financing arrangements. In the event the payment of dividends is not prohibited in the future by such covenants, the decision whether to pay dividends on the Common Stock will be determined by the Board of Directors in light of the Company's earnings, cash flows, financial condition, business prospects and other relevant factors. Holders of Class A Common Stock and Class B Common Stock will be entitled to share ratably, as a single class, in any dividends paid on the Common Stock. In addition, dividends with respect to the Common Stock are subject to the prior payment of cumulative dividends on any outstanding series of Preferred Stock, including the Series A Preferred Stock and Series B Preferred Stock, and must be matched by an equal payment into the VEBA Trust, until the asset value of the VEBA Trust exceeds $100 million, under the terms of the 1993 Settlement Agreement.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSELECTED FINANCIAL INFORMATION (dollars in millions, except per share and per ton data)\nITEM 7.","section_7":"ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nChange in Senior Management\nOn June 1, 1994, the Board of Directors replaced certain members of the Company's senior management for the purpose of improving operating performance and achieving sustained profitability. V. John Goodwin, who has twenty seven years of experience in the steel industry, was appointed President and Chief Operating Officer and Robert M. Greer, who has thirty three years of steel industry and related business experience, was appointed Senior Vice President and Chief Financial Officer. Four other managers experienced in the areas of quality control, primary steel production and finishing, and human resources joined the remaining members of management. Mr. Goodwin and the other new members of the Company's management are credited with substantially improving operating performance and labor relations and reducing production costs in their previous employment.\nPrimary Offering Of Class B Common Stock\nOn February 1, 1995, the Company completed a primary offering of 6,900,000 shares of Class B Common Stock, bringing the total number of shares of Class B Common Stock issued and outstanding to 21,176,156. The issuance of this stock generated net proceeds of approximately $105 million, a substantial portion of which will be used for debt reduction. Subsequent to the offering, NKK, through its ownership of all 22,100,000 issued and outstanding shares of Class A Common Stock, holds 67.6% of the combined voting power of the Company. The remaining 32.4% of the combined voting power is held by the public.\nRESULTS OF OPERATIONS - COMPARISON OF THE YEARS ENDED DECEMBER 31, 1994 AND 1993\nNet Sales\nNet sales for 1994 totaled $2.70 billion, an 11.6% increase when compared to 1993. This increase was attributable to both an increase in volume and realized selling prices, as well as an improvement in product mix to higher margin coated products from lower margin secondary products. Steel shipments for 1994 were a record 5,208,000 tons, a 4.1% increase compared to the 5,005,000 tons shipped during 1993. Raw steel production was 5,763,000 tons, a 3.8% increase compared to the 5,551,000 tons produced during 1993.\nCost of Products Sold\nCost of products sold as a percentage of net sales decreased to 87.2% in 1994 from 93.2% in 1993. This decrease is primarily the result of improvements in realized selling prices, product mix and performance yields, as well as a reduction in product costs.\nUnusual Items\nDuring 1994, the Company recorded a net unusual credit aggregating $135.9 million as discussed below.\nReduction in Workforce - During the fourth quarter of 1994, the Company finalized and implemented a plan to reduce the salaried non-represented workforce by approximately 400 employees. Accordingly, an unusual charge of $34.2 million, $25.6 million net of tax, was recorded at December 31, 1994. This charge and the amount reserved at December 31, 1994 was comprised of: retiree health care benefits (\"OPEB\") $22.0 million, severance $10.9 million, a pension credit of $1.8 million and other charges totalling $3.1 million. The severance and other charges will require the utilization of cash within the next twelve months, whereas the net OPEB and pension charge will require the utilization of cash over the retirement lives of the affected employees. The Company expects to record an additional charge of approximately $5.0 million during the first quarter of 1995 related to this matter.\nTemporary Idling of National Steel Pellet Company - NSPC was temporarily idled in October 1993, following a strike by the USWA on August 1, 1993, and the subsequent decision to satisfy the Company's iron ore pellet requirements from external sources. At December 31, 1993, it was the previous management's intention to externally satisfy its iron ore pellet requirements for a period of at least three years, which would have caused NSPC to remain idle for that period. The magnitude of the expenses associated with the idling of NSPC were such that the reopening of the facility in the near future was not anticipated by the previous management. In the absence of specific accounting guidance related to the idling, the Company determined that, in accordance with Statement of Financial Accounting Standards No. 5, \"Accounting for Contingencies\" (\"SFAS 5\"), a contingent liability of $108.6 million related to the idle period had been incurred, which was recorded as an unusual charge during the fourth quarter of 1993. This charge and the amount reserved at December 31, 1993 were primarily comprised of employee benefits such as pensions and OPEBs, which totaled $68.6 million, along with $40.0 million of expenses directly related to the idling of the facility. The $40.0 million idle reserve was comprised of salary and benefits ($17.4 million), utilities ($5.2 million), noncancelable leases ($3.3 million), production taxes ($7.3 million), supplies ($3.2 million) and other miscellaneous expenses related to the idling ($3.6 million). Substantially all components of the $108.6 million reserve were expected to require the future utilization of cash. Minnesota law requires that an idled facility be maintained in a \"hot idled\" mode for a period of one year, which significantly increased the cost to idle NSPC. None of the $108.6 million reserve, including the $40.0 million related to the idle period, related to the current or future procurement of iron ore pellets from outside sources in the marketplace.\nIn June 1994, in an effort to reduce delivered iron ore pellet costs and improve pellet mix, as well as to strengthen the cooperative partnership approach to labor relations, management considered the feasibility of reopening the NSPC facility. They determined that if a total reduction of $4 per gross ton in delivered pellet costs from pre-strike costs could be achieved, NSPC could be reopened on a cost effective basis. After a series of negotiations, the NSPC Labor Agreement was reached. The NSPC Labor Agreement led to negotiations with other stakeholders such as public utilities, transportation companies, property owners and suppliers and resulted in the achievement of the requisite $4 per gross ton savings in delivered pellet costs and the reopening of the facility in August 1994. During the third quarter of 1994, the Company recorded start-up expenses of $4.4 million and $2.1 million of expenses related to the NSPC Labor Agreement. These expenses were directly related to the reopening of NSPC and were charged to cost of products sold. Based upon NSPC's estimated production of 5 million tons of pellets per year, this will result in a savings of $20 million annually compared to the Company's pre-strike costs.\nThe reopening of NSPC necessitated a reevaluation of the unexpended portion of the $108.6 million reserve recorded during 1993 related to the idling of the facility. As 179 employees had accepted a one month pension window offered by NSPC during the third quarter of 1994, the Company was able to finalize the accounting for the charges related to pensions and OPEB's. Accordingly, approximately $39.3 million of the $68.6 million unusual charge related to employee benefits was reversed during the third quarter of 1994. The remaining employee benefit reserve of $29.3 million at December 31, 1994 relates to the cost of the aforementioned early retirement window, which will be paid over the remaining lives of the retirees.\nAs discussed in further detail below, approximately $20.2 million of the $40.0 million idle reserve had been expended in 1994 during the eight month idle period. Upon the reopening of NSPC, the remaining balance of $19.8 million was reversed, bringing the $40.0 million idle reserve balance to zero at December 31, 1994.\nThe following represents the components of the $108.6 million reserve recorded at December 31, 1993, the cash utilizations during the idle period, the adjustments to the reserve upon the reopening of NSPC and the balance at December 31, 1994:\n(1) All utilizations required the use of cash except for a total of $1.2 million related to Salary and Benefits and Other.\n(2) All adjustments were directly related to the reopening of NSPC.\n(3) Balances remaining for Special Pension Termination charges and OPEB Curtailment charges are carried in the accrued liabilities for pensions and OPEB's, respectively, and are related to an early retirement window offered by NSPC in August 1994.\nAs mentioned previously, the Company followed the guidance provided by SFAS 5 in accounting for the idling of NSPC. During August 1994, the Emerging Issues Task Force (the \"EITF\") issued EITF 94-3 regarding accounting for restructuring charges. Additionally, in November 1994 and January 1995, the EITF expressed its conclusions regarding when a company should recognize a liability for costs, other than employee termination benefits, that are directly associated with a plan to exit an activity. Certain of the costs reflected above may not have been accruable under the EITF's most recent decisions.\nB&LE Litigation - On January 24, 1994, the United States Supreme Court denied the Bessemer & Lake Erie Railroad's (the \"B&LE\") petition to hear the appeal in the Iron Ore Antitrust Litigation, thus sustaining the judgment in favor of the Company against the B&LE. On February 11, 1994, in satisfaction of this judgment, the Company received approximately $111.0 million, including interest, which was recognized as an unusual gain. The Company did not recognize any income taxes associated with these proceeds, other than alternative minimum taxes of $3.1 million, as regular federal income tax expense was offset by the utilization of previously reserved tax assets. The Company utilized a portion of the proceeds from this judgment to repurchase $40.6 million aggregate principal amount of its outstanding 8.375% First Mortgage Bonds. Pursuant to the 1993 Settlement Agreement, approximately $11 million of the proceeds was deposited into the VEBA Trust established to prefund OPEB's for represented employees.\nIncome Taxes\nDuring 1994, the Company recognized income tax credits of $29.8 million based upon future projections of income. These credits were offset by $3.1 million in alternative minimum tax expense related to the receipt of the B&LE proceeds and a $10.0 million deferred tax charge reflecting the reversal of a portion of the tax benefit recorded in 1993 related to the temporary idling of NSPC, resulting in a net income tax credit of $16.7 million for the year ended December 31, 1994.\nComparability of Earnings Per Share\nWhile the Company has chosen to amortize its transition obligation under Statement of Financial Accounting Standards, No. 106, \"Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106 or OPEB\") over twenty years, most of the Company's competitors have chosen to immediately recognize their respective SFAS 106 transition obligations. As a result, any earnings per share (\"EPS\") comparison between the Company and these competitors should be adjusted for the per share adverse impact of this amortization. The Company's after tax EPS was negatively impacted by $.45 and $.51 for 1994 and 1993, respectively.\nDiscount Rate Assumptions\nAs a result of an increase in long term interest rates in the United States, at December 31, 1994, the Company increased the discount rate used to calculate the actuarial present value of its accumulated benefit obligation for OPEB and pensions by 100 basis points and 125 basis points, respectively, to 8.75%, from the rates used at December 31, 1993. The effect of these changes did not impact 1994 expense. However, the increase in the discount rate used to calculate the pension obligation decreased the minimum pension liability recorded on the Company's balance sheet from $134.7 million at December 31, 1993 to $76.7 million at December 31, 1994 and substantially eliminated the $5.9 million charge to stockholder's equity recorded at the end of 1993.\nAdoption of SFAS 119\nIn October 1994, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments\" (\"SFAS 119\"). At December 31, 1994, the Company does not have any derivative financial instruments, therefore; the provisions of SFAS 119 do not have any financial impact.\nRESULTS OF OPERATIONS - COMPARISON OF THE YEARS ENDED DECEMBER 31, 1993 AND 1992\nNet Sales\nNet sales for 1993 increased by 1.9% to $2.42 billion, due primarily to increases in volume and realized selling prices, coupled with a favorable shift in product mix. Steel shipments in 1993 were 5,005,000 tons, a slight increase from 4,974,000 tons in 1992. Raw steel production increased to 5,551,000 tons, a 3.2% increase from the 5,380,000 tons produced in 1992.\nCost of Products Sold\nCost of products sold as a percentage of net sales increased from 88.8% in 1992 to 93.2% in 1993. Cost of products sold increased approximately $147 million primarily as the result of significant operating problems, including an explosion and fire at the Company's electrolytic galvanizing line, difficulties in achieving on-time deliveries for ultra-low carbon steel as a result of a rapid increase in demand which led to operating inefficiencies and production of non-prime products, which totalled approximately $47 million, together with increased costs totaling approximately $6 million resulting from the negotiation of the 1993 Settlement Agreement and increased non-cash OPEB expenses of approximately $59 million resulting from the Company's implementation of SFAS 106, effective January 1, 1993. Finally, approximately $25 million of present value interest relating to postretirement benefit liabilities and certain Weirton Benefit Liabilities, previously recorded for facility sales and restructurings and charged to interest expense, was charged to cost of products sold.\nDepreciation, Depletion and Amortization\nDepreciation expense for 1993 increased by $22.6 million, or 19.7% as compared to 1992, primarily as a result of the completion of the rebuild of the No. 5 coke oven battery at the Great Lakes Division in November 1992.\nUnusual Items Related to the Temporary Idling of NSPC\nSee - \"Results of Operations - Comparison of the Years Ended December 31, 1994 and 1993\".\nFinancing Costs\nNet financing costs decreased by $0.3 million from 1992 to 1993. Interest expense associated with the financing of the No. 5 coke oven battery rebuild was $25.1 million in 1993. However, this was largely offset by a $20.5 million reduction in financing costs for present value interest expense attributable to postretirement benefits which are now being charged to cost of products sold.\nIncome Taxes\nThe Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), at December 31, 1992. At that time, available tax planning strategies served as the only basis for determining the amount of the net deferred tax asset to be recognized. As a result, a full valuation allowance was recorded, except for the $43 million recognized pursuant to a tax planning strategy based upon the Company's ability to change the method of valuing the Company's inventories from LIFO to FIFO. In 1993, the Company determined it was more likely than not that sufficient future taxable income would be generated to justify increasing the net deferred tax asset after valuation allowance to $80.6 million. Accordingly, the Company recognized an additional deferred tax asset of $37.6 million in 1993 based upon future projections of income, which had the effect of decreasing the Company's net loss by a like amount.\nCumulative Effect of Accounting Change\nDuring the fourth quarter of 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employer's Accounting for Postemployment Benefits\" (\"SFAS 112\"), which requires accrual accounting for benefits payable to inactive employees who are not retired. The cumulative effect as of January 1, 1993 of this change was to decrease net income by $16.5 million or $.49 per share. The results of operations for the first quarter of 1993 have been restated to reflect the effect of adopting SFAS 112 at January 1, 1993. The effect of the change on 1993 income before the cumulative effect of the change was not material; therefore, the remaining quarters of 1993 have not been restated.\nAdoption of SFAS 106\nDuring the first quarter of 1993, the Company adopted SFAS 106, which requires the accrual of retiree medical and life insurance costs as these benefits are earned, rather than recognition of these costs as claims are paid. At January 1, 1993, the Company calculated its transition obligation to be $622.1 million with $66.1 million recorded prior to implementation of SFAS 106 in connection with facility sales and restructurings. The Company has elected to amortize its transition obligation over a period of 20 years. Total postretirement benefit cost in 1993 was $123.7 million, or $85.6 million excluding the $38.1 million of curtailment charges related primarily to the idling of NSPC. Excluding these curtailment charges, the excess of postretirement benefit expense recorded under SFAS 106 over the Company's former method of accounting for these benefits was $59.5 million, or $1.08 per share net of tax.\nDiscount Rate Assumptions\nAs a result of a decline in long term interest rates in the United States, at December 31, 1993, the Company reduced the discount rate used to calculate the actuarial present value of its accumulated benefit obligation for OPEB by 100 basis points to 7.75% and for pensions by 125 basis points to 7.50%, from the rate used at December 31, 1992. The effect of these changes did not impact 1993 expense. However, this decline in the discount rate used to calculate the pension obligation increased the minimum pension liability recorded on the Company's balance sheet to $134.7 million and increased the related intangible asset to $128.8 million, with the remaining $5.9 million charged to stockholders' equity. While the same reduction in the discount rate as of December 31, 1993 also applies to the actuarial present value of the Company's OPEB obligation, such reductions do not result in any increase in the recorded liability or potential charge to equity because of different required accounting principles.\nAdoption of SFAS 115\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\"). Beginning in 1994, SFAS 115 requires certain investments to be recorded at fair value rather than cost basis. The Company's investments consist of short term liquid investments whose cost approximates fair value and, therefore, SFAS 115 will not have any financial impact.\nUSWA Agreement\nOn August 27, 1993, the 1993 Settlement Agreement between the Company and the USWA was ratified by union members of the Company's three steel divisions and corporate headquarters. The 1993 Settlement Agreement, effective August 1, 1993 through July 31, 1999, protects the Company and the USWA from a strike or lockout for the duration of the agreement. Either the Company or the USWA may reopen negotiations, except with respect to pensions and certain other matters, after three years, with any unresolved issues subject to binding arbitration.\nLIQUIDITY AND SOURCES OF CAPITAL\nThe Company's liquidity needs arise primarily from capital investments, principal and interest payments on its indebtedness and working capital requirements. The Company has satisfied these liquidity needs over the last three years primarily with funds provided by long-term borrowings, cash provided by operations and proceeds of the Company's initial public offering (the \"IPO\") of Class B Common Stock in 1993. The Company's available sources of liquidity include a new $180 million receivables purchase agreement (the \"Receivables Purchase Agreement\") and $15 million in an uncommitted, unsecured line of credit (the \"Uncommitted Line of Credit\"). Prior to entering into the Receivables Purchase Agreement, the Company had satisfied its liquidity needs with a $100 million revolving secured credit arrangement (the \"Revolver\") and a $150 million subordinated loan agreement (the \"Subordinated Loan Agreement\"), both of which have been terminated at the Company's request. The Company is currently in compliance with all material covenants of, and obligations under, the Receivables Purchase Agreement, Uncommitted Line of Credit and other debt instruments. The Company has satisfied its liquidity needs with minimal use of its credit facilities.\nCash and cash equivalents totaled $161.9 million and $5.3 million as of December 31, 1994 and 1993, respectively. This increase is primarily the result of the receipt on February 11, 1994 of approximately $111.0 million, including interest, in satisfaction of the judgment in favor of the Company against the B&LE, net of certain uses of the B&LE proceeds. The Company used a portion of the proceeds in 1994 to repurchase $40.6 million aggregate principal amount of the Company's 8.375% First Mortgage Bonds and contributed approximately $11.0 million to the VEBA Trust established to prefund OPEB's for represented employees. The remaining B&LE proceeds will be used for further debt reduction, none of which will be related party indebtedness, working capital and general corporate purposes.\nCash Flows from Operating Activities\nFor the year ended December 31, 1994, cash provided from operating activities increased by $257.9 million compared to the same 1993 period. This increase was primarily attributable to an improvement in operating results along with the receipt of approximately $111.0 million of proceeds from the satisfaction of the judgment in favor of the Company against the B&LE.\nFor the year ended December 31, 1993, cash provided from operating activities decreased by $73.2 million compared to 1992, due to the effect of working capital items, along with a reduction in net income after adjusting for the effect of noncash items on operations. Changes in working capital items reduced cash flows by $27.2 million during 1993, as a substantial decrease in accounts payable was combined with the smaller negative effects of accounts receivable and accrued liabilities changes. In 1992, working capital items had a $36.0 million favorable impact on cash flows from operations, due primarily to the timing of cash disbursement clearings.\nCash Flows from Investing Activities\nCapital investments for the years ended December 31, 1994 and 1993 amounted to $137.5 million and $160.7 million, respectively. The 1994 spending was largely attributable to the completion of a pickle line servicing the Great Lakes Division, which was financed under a turnkey contract and did not become the property of the Company until completion and acceptance of the facility during the first quarter of 1994. The 1993 spending was mainly related to the rebuild of the No. 5 coke oven battery servicing the Great Lakes Division and the relining of a blast furnace at the same location.\nBudgeted capital investments approximating $241.2 million, of which $55 million is committed at December 31, 1994, are expected to be made during 1995 and 1996. These budgeted capital investments relate primarily to the construction of a coating line and the relining of a blast furnace both scheduled to occur in 1995 at the Granite City Division.\nCash Flows from Financing Activities\nTotal borrowings for the years ended December 31, 1994 and 1993 amounted to $88.0 million and $40.6 million, respectively, representing primarily the commencement of the permanent financing for the pickle line servicing the Great Lakes Division and the remaining financing commitment for the rebuild of the No. 5 coke oven battery at the Great Lakes Division, respectively. This increase in borrowings in 1994 was largely offset by the repurchase of $40.6 million aggregate principal amount of the Company's 8.375% First Mortgage Bonds and $14.0 million aggregate principal amount of Series 1985 River Rouge Pollution Control Bonds.\nIn April 1993, the Company completed its IPO of 10,861,100 shares of its Class B Common Stock, at an offering price of $14 per share, which generated net proceeds to the Company of approximately $141.4 million. On May 4, 1993, the Company utilized $67.8 million of the IPO proceeds to fund the early redemption of 10,000 shares of the Series B Preferred Stock held by FOX. An additional $20 million of the IPO proceeds were used to reduce the amount of construction financing outstanding and the permanent financing commitment for a pickle line servicing the Great Lakes Division. The remaining proceeds were used for general working capital purposes.\nOn February 1, 1995, the Company completed a primary offering of 6.9 million shares of Class B Common Stock, bringing the total number of shares of Class B Common Stock issued and outstanding to 21,176,156. The issuance of this stock generated net proceeds of approximately $105 million, a substantial portion of which will be used for debt reduction.\nSources of Financing\nEffective May 16, 1994, the Company entered into a Purchase and Sale Agreement with National Steel Funding Corporation (\"NSFC\"), a newly created wholly owned subsidiary. Effective on that same date, NSFC entered into the Receivables Purchase Agreement with a group of twelve banks. The total commitment of the banks is $180 million, including up to $150 million in letters of credit. To implement the arrangement, the Company sold substantially all of its accounts receivable, and will sell additional receivables as they are generated, to NSFC. NSFC will finance its ongoing purchase of receivables from a combination of cash received from receivables already in the pool, short-term intercompany notes and the cash proceeds derived from selling interests in the receivables to the participating banks from time to time.\nThe Certificates of Participation sold to the banks by NSFC have been rated AAA by Standard & Poor's Corporation, resulting in lower borrowing costs to the Company. As of December 31, 1994, no funded participation interests had been sold under the facility, although $89.7 million in letters of credit had been issued. With respect to the pool of receivables at December 31, 1994, after reduction for letters of credit outstanding, the amount of participating interests eligible for sale was $90.3 million. During 1994, the eligible amount ranged from $69.5 million to $91.0 million. The banks' commitments are currently scheduled to expire on May 16, 1997. The Company will continue to act as servicer of the assets sold into the program and will continue to make billings and collections in the ordinary course of business according to established practices.\nThe Company terminated the Revolver, which included a letter of credit facility on May 16, 1994. On the same date, the Company also terminated the Subordinated Loan Agreement. No borrowings were outstanding under the Revolver from 1987 until its termination. On February 7, 1994, the Company borrowed $20 million under the Subordinated Loan Agreement, all of which was repaid on February 17, 1994.\nThe Uncommitted Line of Credit permits the Company to borrow up to $15 million on an unsecured, short-term basis for periods of up to thirty days. This arrangement has no fixed expiration date but may be withdrawn at any time without notice. During 1993, the Company borrowed a maximum of $7.7 million under its Uncommitted Line of Credit, which was repaid the following day. No borrowings were outstanding at December 31, 1993 and 1992. However, in February 1994, the Company borrowed a maximum of $5.0 million under the Uncommitted Line of Credit which was repaid later in the month.\nDuring 1993, the Company utilized $20 million of the proceeds from the IPO to reduce the amount of construction financing outstanding and the permanent financing commitment for a pickle line servicing the Great Lakes Division to $90 million. As of December 31, 1993, the construction financing was being provided by the contractor and was not a liability of the Company. In January 1994, upon completion and acceptance of the pickle line pursuant to the construction contract, the permanent financing commenced with repayment scheduled to occur over a fourteen-year period. The pickle line is not subject to the lien securing the Company's First Mortgage Bonds, but is subject to a first mortgage in favor of the lender.\nWeirton Liabilities and Preferred Stock\nIn connection with the Company's June 1990 recapitalization, the Company received $146.6 million from FOX in cash and recorded a net present value equivalent liability with respect to certain released Weirton Benefit Liabilities, primarily healthcare and life insurance. As a result of this transaction, the Company's future cash flow will decrease as the released Weirton Benefit Liabilities are paid. During 1994, such cash payments were $16.6 million compared to $20.0 million during 1993.\nOn October 28, 1993, FOX converted all of its 3,400,000 shares of Class A Common Stock to an equal number of shares of Class B Common Stock. During January 1994, FOX sold substantially all of such shares of Class B Common Stock. As previously agreed, the Company received $10 million of proceeds from the sale of such shares from FOX as an unrestricted prepayment for environmental obligations which may arise after such prepayment and for which FOX has previously agreed to indemnify the Company. The Company is required to repay to FOX portions of the $10 million to the extent the Company's expenditures for such environmental liabilities do not reach specified levels by certain dates over a twenty year period. Since FOX retains responsibility to indemnify the Company for remaining environmental liabilities arising after such prepayment and in excess of $10 million as reduced by any above described repayments to FOX, these environmental liabilities are not expected to have a material adverse effect of the Company's liquidity. However, the failure of FOX to satisfy any such indemnity obligations could have a material adverse effect on the Company's liquidity.\nIn connection with the June 1990 recapitalization, the Series B Preferred Stock was issued to FOX. On May 4, 1993, the Company redeemed 10,000 shares of Series B Preferred Stock held by FOX. These shares were subject to mandatory redemption on August 5, 1995. Pursuant to the terms of the Series B Preferred Stock and certain other agreements between the Company and FOX, the Company paid the redemption amount directly to a pension trustee and released FOX from a corresponding amount of FOX's indemnification obligations with respect to certain employee benefit liabilities of the Company retained in connection with the sale of its Weirton Steel Division.\nAt December 31, 1994, there were 10,000 remaining shares of Series B Preferred Stock issued and outstanding, all of which were held by FOX. The Series B Preferred Stock carries annual cumulative dividend rights of $806.30 per share, which equates to approximately an 11% yield. At December 31, 1994 and 1993, $66.5 million and $68.0 million, respectively, of the Series B Preferred Stock was outstanding.\nDividends on the Series B Preferred Stock are cumulative and payable quarterly in the form of a release of FOX from its obligation to indemnify the Company for a corresponding amount of the remaining unreleased portion of the Weirton Benefit Liabilities to the extent such liabilities are due and owing, with the balance, if any, payable in cash. The Series B Preferred Stock dividend permitted release and payment of $7.1 million and $10.6 million of previously unreleased Weirton Benefit Liabilities during 1994 and 1993, respectively, and cash dividends of $1.0 million and $1.5 million during 1994 and 1993, respectively, to reimburse FOX for an obligation previously incurred in connection with the Weirton Benefit Liabilities.\nThe remaining Series B Preferred Stock is presently subject to mandatory redemption by the Company on August 5, 2000 at a redemption price of $58.3 million and may be redeemed beginning January 1, 1998 without the consent of FOX at a redemption price of $62.2 million. Based upon the Company's actuarial analysis, the unreleased Weirton Benefit Liabilities approximate the aggregate remaining dividend and redemption payments with respect to the Series B Preferred Stock and accordingly, such payments are\nexpected to be made in the form of releases of FOX from its obligations to indemnify the Company for corresponding amounts of the remaining unreleased Weirton Benefit Liabilities. Dividend and redemption payments with respect to the Series B Preferred Stock reduce the Company's cash flow, even though they are paid in the form of a release of FOX from such obligations, because the Company is obligated, subject to certain limited exceptions, to pay such amounts to the trustee of the pension plan included in the Weirton Benefit Liabilities.\nIf any dividend or redemption payment otherwise required pursuant to the terms of the Series B Preferred Stock is less than the amount required to satisfy FOX's then current indemnification obligation, FOX would be required to pay such shortfall in cash to the Company. The Company's ability to fully realize the benefits of FOX's indemnification obligations is necessarily dependent upon FOX's financial condition at the time of any claim with respect to such obligations.\nThe June 1990 recapitalization agreement also created the Series A Preferred Stock which carries annual cumulative dividend rights of $806.30 per share, which equates to an 11% yield. The Series A Preferred Stock is held by NKK and $36.7 million was outstanding at December 31, 1994 and 1993. Dividends on the Series A Preferred Stock are paid quarterly in cash and totalled $4 million in each of the years ended December 31, 1994, 1993 and 1992.\nMiscellaneous\nAt December 31, 1994, obligations guaranteed by the Company approximated $37.7 million, compared to $41.0 million at December 31, 1993.\nTotal debt and redeemable preferred stock as a percentage of total capitalization improved to 68.6% at December 31, 1994 as compared to 80.2% at December 31, 1993, primarily as a result of an improvement in operating results, along with the receipt of approximately $111.0 million of proceeds from the satisfaction of the judgment in favor of the Company against the B&LE.\nENVIRONMENTAL\nThe Company's operations are subject to numerous laws and regulations relating to the protection of human health and the environment. The Company will incur significant capital expenditures in connection with matters relating to environmental control and will also be required to expend additional amounts in connection with ongoing compliance with such laws and regulations, including, without limitation, the Clean Air Act amendments of 1990. Proposed regulations establishing standards for corrective action under RCRA and the Guidance Document published pursuant to the Great Lakes Initiative may also require further significant expenditures by the Company in the future. Additionally, the Company is currently one of many potentially responsible parties at a number of sites requiring remediation. The Company has estimated that it will incur capital expenditures for matters relating to environmental control of approximately $15.9 million and $7.0 million for 1995 and 1996, respectively. In addition, the Company expects to record expenses for environmental compliance, including depreciation, in the amount of approximately $78.0 million and $85.0 million for 1995 and 1996, respectively. Since environmental laws are becoming increasingly more stringent, the Company's environmental capital expenditures and costs for environmental compliance may increase in the future. See \"Business-Environmental Matters.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements and financial statement schedule of the Company are submitted pursuant to the requirements of Item 8:\nNATIONAL STEEL CORPORATION AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENTS, SUPPLEMENTARY DATA AND FINANCIAL STATEMENT SCHEDULE\nPAGE ----\nReport of Ernst & Young LLP Independent Auditors 39\nStatements of Consolidated Income - Years Ended December 31, 1994, 1993 and 1992 40\nConsolidated Balance Sheets - December 31, 1994 and 1993 41\nStatements of Consolidated Cash Flows - Years Ended December 31, 1994, 1993 and 1992 42\nStatements of Changes in Consolidated Stockholders' Equity and Redeemable Preferred Stock - Series B - Years Ended December 31, 1994, 1993 and 1992 43\nNotes to Consolidated Financial Statements 44\nSchedule II - Valuation and Qualifying Accounts 65\nREPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS\nBoard of Directors National Steel Corporation\nWe have audited the accompanying consolidated balance sheets of National Steel Corporation and subsidiaries (the \"Company\") as of December 31, 1994 and 1993, and the related statements of consolidated income, cash flows, and changes in stockholders' equity and redeemable preferred stock-Series B 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 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 the Company 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 A to the Consolidated Financial Statements, the Company made certain accounting changes in 1993 and 1992.\nErnst & Young LLP\nFort Wayne, Indiana January 25, 1995, except for the fifth paragraph of Note B, as to which the date is February 1, 1995\nNATIONAL STEEL CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED INCOME (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nNATIONAL STEEL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nNATIONAL STEEL CORPORATION AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED CASH FLOWS (IN THOUSANDS OF DOLLARS)\nSee notes to consolidated financial statements.\nNATIONAL STEEL CORPORATION AND SUBSIDIARIES STATEMENTS OF CHANGES IN CONSOLIDATED STOCKHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK - SERIES B (IN THOUSANDS OF DOLLARS)\nSee notes to consolidated financial statements.\nNATIONAL STEEL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1994\nNOTE A - SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation: The consolidated financial statements include the accounts of National Steel Corporation and its majority owned subsidiaries (the \"Company\").\nCash Equivalents: Cash equivalents are short-term liquid investments which consist principally of time deposits at cost which approximates market. These investments have maturities of three months or less at the time of purchase.\nInventories: Inventories are stated at the lower of last-in, first-out (\"LIFO\") cost or market. If the first-in, first-out (\"FIFO\") cost method of inventory accounting had been used, inventories would have been approximately $150.2 million and $169.5 million higher than reported at December 31, 1994 and 1993, respectively. During each of the last three years certain inventory quantity reductions caused liquidations of LIFO inventory values. These liquidations increased net income for the quarter and year ended December 31, 1994 by $.3 million and decreased net income for the quarters and years ended December 31, 1993 and 1992 by $3.0 million and $3.4 million, respectively.\nInvestments: Investments in affiliated companies (corporate joint ventures and 20% to 50% owned companies) are stated at cost plus equity in undistributed earnings since acquisition. Undistributed earnings of affiliated companies included in retained earnings at December 31, 1994 and 1993 amounted to $6.2 million and $7.2 million, respectively.\nProperty, Plant and Equipment: Property, plant and equipment are stated at cost and include certain expenditures for leased facilities. Interest costs applicable to facilities under construction are capitalized. Capitalized interest amounted to $3.7 million in 1994, $5.8 million in 1993 and $14.4 million in 1992. Amortization of capitalized interest amounted to $5.6 million in 1994, $5.7 million in 1993 and $4.6 million in 1992.\nDepreciation, Depletion and Amortization: Depreciation of production facilities and amortization related to capitalized lease obligations are generally provided by charges to income computed by the straight-line method. Provisions for depreciation and depletion of certain raw material facilities and furnace relinings are computed on the basis of tonnage produced in relation to estimated total production to be obtained from such facilities.\nEnvironmental: Estimated losses from environmental contingencies are accrued and charged to income when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. (See Note L - Environmental Liabilities.)\nResearch and Development: Research and development costs are expensed when incurred and are charged to cost of products sold. Expenses for 1994, 1993 and 1992 amounted to approximately $7.9 million, $9.4 million and $9.5 million, respectively.\nIncome Taxes: Effective January 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"SFAS 109\"), whereby deferred items are determined based on differences between the financial reporting and tax basis of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Prior to 1992, the Company accounted for income taxes under Accounting Principles Board Opinion No. 11 (\"APB 11\").\nFinancial Instruments: The Company's financial instruments, as defined by Statement of Financial Accounting Standards No. 107, consist of cash and cash equivalents, long term obligations (excluding capitalized lease obligations), and the Series B Preferred Stock (defined below). The Company's estimate of the fair value of these financial instruments approximates their carrying amounts at December 31, 1994. In October 1994, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments\" (\"SFAS 119\"). Effective for 1994 calendar year financial statements, this pronouncement requires additional disclosures about derivative financial instruments. At December 31, 1994, the Company does not have any derivative financial instruments, therefore, the provisions of SFAS 119 do not have any financial impact.\nAccounting Changes: During 1993, the Company adopted two new Financial Accounting Standards Board Statements, \"Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\" or \"OPEB\") and \"Employer's Accounting for Postemployment Benefits\" (\"SFAS 112\"). (See Note E - Postretirement Benefits Other Than Pensions and Note F - Postemployment Benefits.)\nAdoption of SFAS 115: 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\"). Beginning in 1994, SFAS 115 requires certain investments to be recorded at fair value rather than cost basis. The Company's investments consist of short term liquid investments whose cost approximates fair value and, therefore, SFAS 115 did not have any financial impact.\nEarnings per Share: Earnings (loss) per share of Common Stock (\"EPS\") is computed by dividing net income or loss applicable to common stockholders by the sum of the weighted average of the shares of common stock outstanding during the period plus common stock equivalents, if dilutive.\nBusiness Segment: The Company is engaged in a single line of business, the production and processing of steel. The Company targets high value added applications of flat rolled carbon steel for sale to the automotive, metal buildings and container markets. The Company also sells hot and cold rolled steel to a wide variety of other users including the pipe and tube industry and independent steel service centers. In 1994, a single customer accounted for approximately 10% of net sales and approximately 11% and 12% of net sales in 1993 and 1992, respectively. Sales of the Company's products to the automotive market accounted for approximately 29%, 29% and 27% of the Company's total net sales in 1994, 1993 and 1992, respectively. Concentration of credit risk related to the Company's trade receivables is limited due to the large numbers of customers in differing industries and geographic areas.\nReclassifications: Certain items in prior years have been reclassified to conform with the current year presentation.\nNOTE B - CAPITAL STRUCTURE AND PRIMARY OFFERING OF CLASS B COMMON STOCK\nIn April 1993, the Company completed an initial public offering (the \"IPO\") of 10,861,100 shares of its Class B Common Stock, par value $.01 per share (the \"Class B Common Stock\"), at an offering price of $14 per share, which generated net proceeds to the Company of approximately $141.4 million.\nIn connection with the IPO, 30,000,000 shares of Class A Common Stock, par value $.01 per share (the \"Class A Common Stock\"), were authorized and the then outstanding 75,000 shares of existing common stock received a 340 for 1 stock split effectuated in the form of a stock dividend and the then existing common stock was automatically converted to Class A Common Stock. Stockholders' equity at December 31, 1991 has been retroactively adjusted to reflect this stock dividend. As a result of the IPO, all preferred stock outstanding became non- voting.\nOn October 28, 1993, National Intergroup, Inc., which in October 1994 changed its name to Foxmeyer Health Corporation (collectively with its subsidiaries, \"FOX\"), converted all of its 3,400,000 shares of Class A Common Stock to 3,400,000 shares of Class B Common Stock, bringing the total number of outstanding shares of Class A and Class B Common Stock to 22,100,000 and 14,261,100, respectively, at December 31, 1993. During 1994, an additional 15,056 shares of Class B Common Stock were issued in connection with the exercise of stock options bringing the total number of outstanding shares of Class B Common Stock to 14,276,156 at December 31, 1994.\nOwnership: During January 1994, FOX sold substantially all of its 3,400,000 shares of Class B Common Stock in the market, increasing public ownership of the Company's common stock to 24.4% of the combined voting power of the Common Stock. At December 31, 1994, 75.6% of the combined voting power of the Company's outstanding shares of Common Stock was held by NKK Corporation (collectively with its subsidiaries \"NKK\").\nOn February 1, 1995, the Company completed a primary offering of 6,900,000 shares of Class B Common Stock, bringing the total number of shares of Class B Common Stock issued and outstanding to 21,176,156. The issuance of this stock generated net proceeds of approximately $105 million, a substantial portion of which will be used for debt reduction. Subsequent to the offering, NKK, through its ownership of all 22,100,000 issued and outstanding shares of Class A Common Stock, holds 67.6% of the combined voting power of the Company. The remaining 32.4% of the combined voting power is held by the public.\nAt December 31, 1994 the Company's capital structure was as follows:\nSeries A Preferred Stock\nAt December 31, 1994, there were 5,000 shares of Series A Preferred Stock, par value $1.00 per share (the \"Series A Preferred Stock\"), issued and outstanding. Annual dividends of $806.30 per share on the Series A Preferred Stock are cumulative and payable quarterly. The Series A Preferred Stock is not subject to mandatory redemption by the Company and is non-voting. All outstanding Shares of Series A Preferred Stock are owned by NKK.\nSeries B Redeemable Preferred Stock\nOn May 4, 1993, the Company redeemed 10,000 shares of the Series B Redeemable Preferred Stock, par value $1.00 per share (the \"Series B Preferred Stock\"), held by FOX. These shares were subject to mandatory redemption on August 5, 1995. The cost of the redemption totaled $67.8 million and was funded from proceeds received from the IPO. If the redemption of these shares had occurred at the beginning of the year, EPS for 1993 would have increased by $.06. Pursuant to the terms of the Series B Preferred Stock and certain other agreements between the Company and FOX, the Company paid the redemption amount directly to a pension trustee and released FOX from a corresponding amount of FOX's indemnification obligations with respect to certain employee benefit liabilities of the Company retained in connection with the sale of its Weirton Steel Division. (See Note I - Weirton Liabilities.)\nAt December 31, 1994, there were 10,000 remaining shares of Series B Preferred Stock issued and outstanding and held by FOX. Annual dividends of $806.30 per share on the Series B Preferred Stock are cumulative and payable quarterly. Dividends and redemption proceeds, to the extent required by the Stock Purchase and Recapitalization Agreement (the \"Recapitalization Agreement\"), are used to release FOX from its indemnification obligations with respect to the remaining unreleased liabilities for certain employee benefits of its former Weirton Steel Division (\"Weirton\") employees (the \"Weirton Benefit Liabilities\"). (See Note I - - Weirton Liabilities.) The Series B Preferred Stock dividend permitted release and payment of $7.1 million and $10.6 million of previously unreleased Weirton Benefit Liabilities during 1994 and 1993, respectively, and a cash payment of $1.0 million and $1.5 million during 1994 and 1993, respectively, to reimburse FOX for an obligation previously incurred in connection with the Weirton Benefit Liabilities. Upon the occurrence of certain events detailed in the Recapitalization Agreement, prior to or coincident with the Series B Preferred Stock final redemption, the released Weirton Benefit Liabilities will be recalculated by an independent actuary. Any adjustment to bring the balances of the released Weirton Benefit Liabilities to such recalculated amount will be dealt with in the Series B Preferred Stock redemption proceeds or otherwise settled. If the Company does not meet its preferred stock dividend and redemption obligations when due, FOX has the right to cause NKK to purchase the Company's preferred stock dividend and redemption obligations. The Series B Preferred Stock is nontransferable and nonvoting.\nThe remaining Series B Preferred Stock is subject to mandatory redemption on August 5, 2000 at a redemption price of $58.3 million and may not be redeemed prior to January 1, 1998 without the consent of FOX. On January 1, 1998, the redemption price for the Series B Preferred Stock would be $62.2 million.\nPeriodic adjustments are made to consolidated retained earnings for the excess of the book value of the Series B Preferred Stock at the date of issuance over the redemption value. Based upon the Company's actuarial analysis, the unreleased Weirton Benefit Liabilities approximate the aggregate remaining dividend and redemption payments with respect to the Series B Preferred Stock and accordingly, such payments are expected to be made in the form of releases of FOX from its obligations to indemnify the Company for corresponding amounts of the remaining unreleased Weirton Benefit Liabilities. At that time, the Company will be required to deposit cash equal to the redemption amount in the Weirton Retirement Trust, thus leaving the Company's net liability position unchanged. The Series B Preferred Stock, with respect to dividend rights and rights on liquidation, ranks senior to the Company's common stock and equal to the Series A Preferred Stock.\nClass A Common Stock\nAt December 31, 1994, the Company had 30,000,000 shares of $.01 par value Class A Common Stock authorized, of which 22,100,000 shares were issued and outstanding and owned by NKK. Each share of Class A Common Stock is entitled to two votes. No cash dividends were paid on the Class A Common Stock in 1994, 1993 or 1992.\nClass B Common Stock\nAt December 31, 1994, the Company had 65,000,000 shares of $.01 par value Class B Common Stock authorized and 14,276,156 shares issued and outstanding. No cash dividends were paid on the Class B Common Stock in 1994 or 1993. Subsequent to FOX's January 1994 sale of substantially all of its 3,400,000 shares of Class B Common Stock, discussed above substantially all of the issued and outstanding shares of Class B Common Stock became publicly traded. (See discussion above regarding a primary offering of 6,900,000 shares of the Company's Class B Common Stock completed on February 1, 1995.)\nThe Company is restricted from paying cash dividends on Common Stock by various debt covenants. (See Note C - Long-Term Obligations and Related Party Indebtedness.)\nNOTE C - LONG TERM OBLIGATIONS AND RELATED PARTY INDEBTEDNESS\nLong term obligations and related party indebtedness were as follows:\nFuture minimum payments for all long term obligations and leases as of December 31, 1994 are as follows:\nOperating leases include a coke battery facility which services the Granite City Division and expires in 2004, a continuous caster and the related ladle metallurgy facility which services the Great Lakes Division and expires in 2008, and an electrolytic galvanizing facility which services the Great Lakes Division (the \"EGL\") and expires in 2001. Upon expiration, the Company has the option to extend the leases or purchase the equipment at fair market value.\nThe Company's remaining operating leases cover various types of properties, primarily machinery and equipment, which have lease terms generally for periods of 2 to 20 years, and which are expected to be renewed or replaced by other leases in the normal course of business. Rental expense for operating leases total $70.4 million in 1994, $70.7 million in 1993 and $79.8 million in 1992.\nDuring 1993, the Company borrowed $40.5 million from a United States subsidiary of NKK, thereby completing the $350.0 million construction period financing for the No. 5 coke oven battery rebuild at the Great Lakes Division. During 1994 and 1993, the Company paid $13.3 million and $6.7 million in principal, and recorded $25.2 million and $25.1 million in interest expense, respectively, on the coke battery loan. Accrued interest on the loan as of December 31, 1994 and 1993 was $10.1 million and $10.5 million, respectively. Additionally, deferred financing costs related to the loan were $4.2 million and $4.5 million, respectively, as of December 31, 1994 and 1993.\nIn March 1992, a wholly-owned subsidiary of the Company finalized a turnkey contract for the construction and permanent financing of a pickle line (the \"Pickle Line\") servicing the Great Lakes Division. The total financing commitment amounted to $110 million, of which $20 million was prepaid using proceeds from the Company's 1993 initial public stock offering, reducing the amount of construction borrowings outstanding and the total commitment to $90 million. As of December 31, 1993, the construction period financing was being provided by the contractor and was not a liability of the Company. In January 1994, upon completion and acceptance of the Pickle Line, the permanent financing commenced with repayment to occur over a fourteen-year period. The Pickle Line is not subject to the lien securing the Company's First Mortgage Bonds, but is subject to a first mortgage in favor of the lender.\nDuring 1994, the Company utilized a portion of the proceeds from the antitrust litigation judgment in favor of the Company against the Bessemer & Lake Erie Railroad (\"B&LE\") to repurchase $40.6 million aggregate principal amount of its outstanding 8.375% First Mortgage Bonds. (See Note J - Unusual Items.)\nCredit Arrangements\nEffective May 16, 1994, the Company entered into a Purchase and Sale Agreement with National Steel Funding Corporation (\"NSFC\"), a newly created wholly-owned subsidiary. Effective on the same date, NSFC entered into a Receivables Purchase Agreement with a group of twelve banks. The total maximum commitment of the banks is $180 million, including up to $150 million in letters of credit. To implement the arrangement, the Company sold substantially all of its accounts receivable, and will sell additional receivables as they are generated, to NSFC. NSFC will finance its ongoing purchase of receivables from a combination of cash received from receivables already in the pool, short-term intercompany notes and the cash proceeds derived from selling interests in the receivables to the participating banks from time to time.\nThe Certificates of Participation sold to the banks by NSFC have been rated AAA by Standard & Poor's Corporation, resulting in lower borrowing costs to the Company. As of December 31, 1994, no funded participation interests had been sold under the facility, although $89.7 million in letters of credit had been issued. With respect to the pool of receivables at December 31, 1994, after reduction for letters of credit outstanding, the amount of participating interests eligible for sale was $90.3 million. During the year ended December 31, 1994, the eligible amount ranged from $69.5 million to $91.0 million. The banks' commitments are currently scheduled to expire on May 16, 1997. The Company will continue to act as servicer of the assets sold into the program and will continue to make billings and collections in the ordinary course of business according to established practices.\nAt December 31, 1993, the Company's credit arrangements included a $100 million revolving secured credit arrangement (the \"Revolver\"), a $150 million subordinated loan agreement (the \"Subordinated Loan Agreement\") and $25 million in uncommitted, unsecured lines of credit (the \"Uncommitted Lines of Credit\"). The Revolver and the Subordinated Loan Agreement were terminated on May 16, 1994 in connection with the Receivables Purchase Agreement discussed above.\nThe Revolver was amended and restated in December 1992 to extend the expiration date to December 31, 1994. The Revolver permitted the Company to borrow up to $100 million on a short term basis, and provided the Company with the ability to issue up to $150 million in letters of credit. The Revolver was secured by the accounts receivable and inventories of the Company. This arrangement had interest rates which approximated current market rates for periods of one, two, three or six months. At December 31, 1993, no borrowings were outstanding and letters of credit outstanding amounted $113.7 million under the Revolver.\nThe Subordinated Loan Agreement, which was entered into in May 1991 with a United States subsidiary of NKK, was also extended in December 1992 to an expiration date of April 1, 1995. As discussed above, the Subordinated Loan Agreement was terminated on May 16, 1994. This arrangement had interest rates which approximated current market rates for periods from one month to six months and permitted the Company to borrow up to $150 million on an unsecured, short term basis. The Revolver required that the first $50 million in borrowings by the Company in excess of thirty days must come from the Subordinated Loan Agreement. Additional amounts borrowed would alternate between the Revolver and the Subordinated Loan Agreement up to $25 million in each increment. There were no borrowings under the Subordinated Loan Agreement during 1993. In February 1994, the Company borrowed $20 million, all of which was repaid within the same month.\nThe Uncommitted Lines of Credit permitted the Company to borrow up to $25 million on an unsecured, short-term basis for periods of up to thirty days. One of these arrangements ($10 million) expired on March 31, 1994, while the other ($15 million) has no fixed expiration date and may be withdrawn at any time without notice. During 1993, the Company borrowed a maximum of $7.7 million under its Uncommitted Lines of Credit, which was repaid the next day. No borrowings were outstanding at December 31, 1994 or 1993.\nAt December 31, 1994, the Company was prohibited from paying cash dividends on Common Stock due to the dividend covenant contained in the EGL lease agreement. The Company is not restricted from paying its annual Series A and B Preferred Stock dividend obligations.\nNOTE D - PENSIONS\nThe Company has various non-contributory defined benefit pension plans covering substantially all employees. Benefit payments for salaried employees are based upon a formula which utilizes employee age, years of credited service and the highest five consecutive years of pensionable earnings during the last ten years preceding normal retirement. Benefit payments to most hourly employees are the greater of a benefit calculation utilizing fixed rates per year of service or the highest five consecutive years of pensionable earnings during the last ten years preceding retirement, with a premium paid for years of service in excess of thirty years. The Company's funding policy is to contribute, at a minimum, the amount necessary to meet minimum funding standards as prescribed by applicable law. The Company utilizes a long term rate of return of 8.5% for funding purposes. The Company's pension contributions for the 1994 and 1993 plan years were $18.3 million and $30.8 million, respectively. The decrease in contributions from 1993 to 1994 is the result of plan assets earning significantly more than assumed in 1993.\nPension expense and related actuarial assumptions utilized are summarized below:\nIn connection with the temporary idling of National Steel Pellet Company (\"NSPC\"), a wholly-owned subsidiary of the Company, special termination benefits of $31.9 million related to hourly NSPC plan participants were recorded at December 31, 1993 and included in 1993 pension expense. In August 1994, NSPC was re-opened and $13.3 million of the special termination benefits reserve was reversed during the third quarter of 1994. The remaining portion of the NSPC curtailment charge, or $18.6 million, relates to an early retirement window offered by NSPC during the third quarter of 1994. (See Note O - Temporary Idling of National Steel Pellet Company.) In 1994, the Company recorded a special termination credit of $1.8 million related to the restructuring of the salaried workforce. (See Note J - Unusual Items.)\nThe funded status of the Company's plans at year end along with the actuarial assumptions utilized are as follows:\nAs a result of an increase in long term interest rates during 1994, at December 31, 1994, the Company increased the discount rate used to calculate the actuarial present value of its ABO by 125 basis points to 8.75% from the rate used at December 31, 1993.\nThe adjustment required to recognize the minimum pension liability of $76.7 million and $134.7 million at December 31, 1994 and 1993, respectively, represents the excess of the ABO over the fair value of plan assets, including unfunded accrued pension cost, in underfunded plans. The unfunded liability in excess of the unrecognized prior service cost of $5.9 million was recorded as a reduction in stockholders' equity at December 31, 1993. Due to the aforementioned increase in the discount rate, substantially all of this charge was reversed at December 31, 1994.\nAt December 31, 1994, the Company's pension plans' assets were comprised of approximately 51% equity investments, 41% fixed income investments, 2% cash and 6% in other investments including real estate.\nNOTE E - POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company provides contributory health care and life insurance benefits for certain retirees and their dependents. Generally, employees are eligible to participate in the medical benefit plans if they retired under one of the Company's pension plans on other than a deferred vested basis, and at the time of retirement had at least 15 years of continuous service. However, salaried employees hired after January 1, 1993 are not eligible to participate in the plans.\nEffective January 1, 1993, the Company implemented SFAS 106 which requires accrual of retiree medical and life insurance benefits as these benefits are earned rather than recognition of these costs as claims are paid. In 1993, the excess of total postretirement benefit expense recorded under SFAS 106 over the Company's former method of accounting for these benefits was $97.6 million, or $59.5 million excluding curtailment charges, or $1.77 and $1.08 per share net of tax, respectively. In 1994 and 1993 the Company's cash OPEB payments were\napproximately $35 million and $32 million, respectively. In 1992, prior to the adoption of SFAS 106, the Company recorded OPEB expense on the former \"pay as you go\" method of $26.8 million. Health care benefits are funded as claims are paid; thus adoption of SFAS 106 had no impact on the cash flows of the Company. However, as discussed below, in 1994 the Company began prefunding the OPEB obligation for certain employees represented by the United Steelworkers of America (the \"USWA\"). The Company elected to amortize the unrecognized transition obligation, which was calculated to be $556.0 million at January 1, 1993, over a period of 20 years. Amortization of the remaining transition obligation will adversely impact EPS on an after tax basis by approximately $.45 per year for the next 18 years based upon shares of common stock outstanding at December 31, 1994.\nThe components of postretirement benefit cost and related actuarial assumptions were as follows:\nIn connection with the temporary idling of NSPC, curtailment charges of $36.7 million related to hourly NSPC plan participants were recorded at December 31, 1993 and included in total postretirement benefit cost at December 31, 1993. In August 1994, NSPC was re-opened and $26.0 million of the OPEB curtailment reserve was reversed during the third quarter of 1994. The remaining portion of the NSPC curtailment charge, or $10.7 million, relates primarily to an early retirement window offered by NSPC during the third quarter of 1994. (See Note O - Temporary Idling of National Steel Pellet Company.) In 1994, the Company recorded special termination benefits of $22.0 million related to the restructuring of the salaried workforce. (See Note J - Unusual Items.)\nThe following represents the plans' funded status reconciled with amounts recognized in the Company's balance sheet and related actuarial assumptions:\nAs a result of the increase in the long term interest rates at December 31, 1994, the Company increased the discount rate used to calculate the actuarial present value of its APBO by 100 basis points to 8.75% from the rate used at December 31, 1993, which had the impact of decreasing the APBO by $57.8 million. The assumed health care cost trend rate of 7.8% in 1995 decreases gradually to the ultimate trend rate of 5.0% in 2002 and thereafter. A 1.0% increase in the assumed health care cost trend rate would have increased the APBO at December 31, 1994 and postretirement benefit cost for 1994 by $55.7 million and $7.0 million, respectively.\nIn connection with the 1993 Settlement Agreement between the Company and the USWA, the Company began prefunding the OPEB obligation with respect to USWA represented employees in 1994. Pursuant to the terms of the 1993 Settlement Agreement, a Voluntary Employee Benefit Association trust (the \"VEBA Trust\") was established. Under the terms of the agreement, the Company agreed to contribute a minimum of $10 million annually and, under certain circumstances, additional amounts calculated as set forth in the 1993 Settlement Agreement. In 1994 the Company contributed $21.0 million to the VEBA Trust, comprised of the $10 million annual minimum contribution together with $11.0 million related to the proceeds received in connection with the B&LE litigation settlement. (See Note J - Unusual Items.)\nNOTE F - POSTEMPLOYMENT BENEFITS\nDuring the fourth quarter of 1993, the Company adopted SFAS 112 which requires accrual accounting for benefits payable to inactive employees who are not retired. Among the more significant benefits included are worker's compensation, long term disability and continued medical coverage for disabled employees and surviving spouses. The Company previously followed the practice of accruing for many of these benefits but did not base these accruals on actuarial analyses.\nFinancial statements prior to 1993 have not been restated to reflect the change in accounting method. The cumulative effect as of January 1, 1993 of this change was to increase the net loss by $16.5 million or $.49 per share. The results of operations for the first quarter of 1993 have been restated to reflect the effect of adopting SFAS 112 at January 1, 1993. The effect of the change on 1993 income before the cumulative effect of the change was not material, therefore the remaining quarters of 1993 have not been restated. On an ongoing basis, the excess of postemployment benefit under SFAS 112 compared to the former method of accounting for these benefits is not material.\nNOTE G - OTHER LONG TERM LIABILITIES\nOther long term liabilities at December 31, 1994 and 1993 consisted of the following:\nNOTE H - INCOME TAXES\nEffective January 1, 1992, the Company changed its method of accounting for income taxes from the deferred method to the liability method as required by SFAS 109. The cumulative effect of adopting SFAS 109, as of January 1, 1992, was to decrease the net loss for 1992 by $76.3 million.\nDeferred income taxes reflect the net effects of temporary differences between the carrying amount 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 are as follows:\nIn 1992, available tax planning strategies served as the only basis for determining the amount of the net deferred tax asset to be recognized. As a result, a full valuation allowance was recorded in 1992, except for the $43.0 million recognized pursuant to a tax planning strategy based upon the Company's ability to change the method of valuing inventories from LIFO to FIFO. In 1994 and 1993, the Company determined that it was more likely than not that sufficient future taxable income would be generated to justify increasing the net deferred tax asset after valuation allowance. Accordingly, the Company recognized an additional deferred tax asset of $20.7 million and $37.6 million in 1994 and 1993, respectively.\nSignificant components of the provision for income taxes are as follows:\nThe reconciliation of the income tax computed at the federal statutory tax rates to the recorded total tax provision (credit) is:\nAt December 31, 1994, the Company had unused NOL carryforwards of approximately $286.9 million which expire as follows: $70.5 million in 2006, $99.4 million in 2007 and $117.0 million in 2008.\nTo date, the Company believes that it has not undergone an ownership change for federal income tax purposes, as described in Section 382 of the Internal Revenue Code. However, there can be no assurance that the Company will not undergo such a change in the future. Future events, some of which may be beyond the Company's control, could cause an ownership change. An ownership change may substantially limit the Company's ability to offset future taxable income with its net operating loss carryforwards.\nAt December 31, 1994, the Company had unused alternative minimum tax credit carryforwards of approximately $8.0 million which may be applied to offset its future regular federal income tax liabilities. These tax credits may be carried forward indefinitely.\nNOTE I - WEIRTON LIABILITIES\nOn January 11, 1984, the Company completed the sale of substantially all of the assets of its Weirton Steel Division (\"Weirton\") to Weirton Steel Corporation. In connection with the sale of Weirton, the Company retained certain existing and contingent liabilities (the \"Weirton Liabilities\") including the Weirton Benefit Liabilities, which consist of, among other things, pension benefits for the then active employees based on service prior to the sale, pension, life and health insurance benefits for the then retired employees and certain environmental liabilities.\nAs part of the 1984 sale of a 50% interest in the Company to NKK, FOX agreed, as between FOX and the Company, to provide in advance sufficient funds for payment and discharge of, and to indemnify the Company against, all obligations and liabilities of the Company, whether direct, indirect, absolute or contingent, incurred or retained by the Company in connection with the sale of Weirton. As part of the 1990 ownership transaction whereby NKK purchased an additional 20% ownership in the Company, the Company released FOX from indemnification of $146.6 million of certain defined Weirton Benefit Liabilities. FOX also reaffirmed its agreement to indemnify the Company for Weirton environmental liabilities as to which the Company is obligated to Weirton Steel Corporation. On May 4, 1993, the Company released FOX from an additional $67.8 million of previously unreleased Weirton Benefit Liabilities in connection with an early redemption of 10,000 shares of Series B Preferred Stock. During January 1994, FOX sold substantially all of its 3,400,000 shares of Class B Common Stock. In connection with the IPO, the Company entered into an agreement (the \"Definitive Agreement\") with FOX and NKK which amends certain terms and conditions of the Recapitalization Agreement. Pursuant to the Definitive Agreement, FOX paid the Company $10.0 million as an unrestricted prepayment for environmental obligations\nwhich may arise after such prepayment and for which FOX has previously agreed to indemnify the Company. Such prepayment accrues interest at a variable interest rate based upon prime rate. The interest on such prepayment was 11% at December 31, 1994. The Company is required to repay to FOX portions of $10.0 million to the extent the Company's expenditures for such environmental liabilities do not reach specified levels by certain dates over a twenty year period. FOX retains responsibility to indemnify the Company for remaining environmental liabilities arising after such prepayment and in excess of $10.0 million (as reduced by any above described repayments to FOX). At December 31, 1994, the Company has recorded a liability payable to FOX which totals $10.0 million.\nAt December 31, 1994, the net present value of the released Weirton Benefit Liabilities, based upon a discount factor of 12.0% per annum, is $138.1 million. FOX continues to indemnify the Company for the remaining unreleased Weirton Benefit Liabilities and other liabilities. Since the Company is indemnified by FOX for such remaining liabilities, they are not recorded in the Company's consolidated balance sheet. Such Weirton Liabilities are comprised of (i) the unreleased Weirton Benefit Liabilities, the amount of which, based on the Company's actuarial analysis, approximates the aggregate remaining dividend and redemption payments of $104.8 million with respect to the Series B Preferred Stock and (ii) other contingent liabilities, such as environmental liabilities, that are not currently estimable.\nNOTE J - UNUSUAL ITEMS\nDuring 1994, the Company recorded a net unusual credit aggregating $135.9 million relating to the receipt of proceeds from an antitrust lawsuit with the B&LE, the decision to reopen NSPC and the restructuring of the salaried non- represented workforce. (See Note O - Temporary Idling of National Steel Pellet Company, regarding the reopening of NSPC.)\nDuring the fourth quarter of 1994, the Company finalized and implemented a plan to reduce the salaried non-represented workforce by approximately 400 employees. Accordingly, an unusual charge of $34.2 million, $25.6 million net of tax, was recorded at December 31, 1994. This charge and the amount reserved at December 31, 1994 was comprised of: OPEB's $22.0 million, severance $10.9 million, a pension credit of $1.8 million and other charges totalling $3.1 million. The severance and other charges will require the utilization of cash within the next twelve months, whereas the net OPEB and pension charge will require the utilization of cash over the retirement lives of the affected employees. The Company expects to record an additional charge of approximately $5.0 million during the first quarter of 1995 related to this matter.\nOn January 24, 1994, the United States Supreme Court denied the B&LE petition to hear the appeal in the Iron Ore Antitrust Litigation, thus sustaining the judgment in favor of the Company against the B&LE. On February 11, 1994, the Company received $111.0 million, including interest, in satisfaction of this judgment, which was recorded as an unusual gain during the first quarter of 1994. Pursuant to the terms of the 1993 Settlement Agreement, approximately $11 million of the proceeds were deposited into a VEBA Trust established to prefund the Company's retiree OPEB obligation with respect to USWA represented employees.\nDuring 1993, the Company recorded unusual charges which totaled $111.0 million, primarily relating to the temporary idling of NSPC. (See Note O - Temporary Idling of National Steel Pellet Company.) A fourth quarter charge of $108.6 million was recorded to recognize various liabilities incurred in connection with the idling, most notably pensions and postemployment benefits. Additionally, the Company recorded a charge of $4.5 million relating to the acceptance by represented office and technical employees of a voluntary pension window offered by the Company as a part of its functional consolidation and reorganization plan.\nIn 1992, the Company recorded unusual charges aggregating $37.0 million relating principally to a pension window and the Company's decision to exit the coal mining business. A charge of $13.3 million was recognized relating to a 1992 pension window as part of the consolidation of certain staff functions and the relocation of its corporate office to Mishawaka, Indiana from Pittsburgh, Pennsylvania. As a result of management's decision to exit the coal mining business, an unusual charge of $24.9 million was recognized during the fourth quarter to reduce certain coal properties to net realizable value and record postemployment, environmental and other liabilities.\nNOTE K - RELATED PARTY TRANSACTIONS\nSummarized below are transactions between the Company and NKK, FOX and the Company's affiliated companies accounted for under the equity method.\nThe Company had borrowings outstanding with an NKK affiliate totaling $330.0 million and $343.3 million as of December 31, 1994 and 1993, respectively. (See Note C - Long Term Obligations and Related Party Indebtedness.) Accounts receivable and accounts payable with related parties totalled $3.2 million and $2.5 million, respectively, at December 31, 1994 and 1993. During 1994, the Company purchased approximately $20.8 million of slabs produced by NKK, with such purchases made from trading companies in arms' length transactions.\nThe Company's selling, general and administrative expenses for 1992 included charges of $2.2 million for facilities provided and direct services performed by FOX for the benefit of the Company, all of which arrangements have expired or have been terminated. During January 1994, FOX completed the sale of substantially all of its 3,400,000 shares of Class B Common Stock.\nIn both 1994 and 1993, cash dividends of $4.0 million were paid on the Series A Preferred Stock. Accrued dividends of $0.6 million were recorded as of December 31, 1994 and 1993 related to the Series A Preferred Stock. For 1994 and 1993, Series B Preferred Stock dividend payments totaling $8.1 million and $12.0 million were made through the release and payment of $7.1 million and $10.6 million of previously unreleased Weirton Benefit Liabilities and $1.0 million and $1.4 million of cash to reimburse FOX for an obligation previously incurred in connection with certain Weirton Liabilities, respectively. At December 31, 1994 and 1993, accrued dividends related to the Series B Preferred Stock totalled $1.3 million and $1.2 million, respectively.\nThe Company is contractually required to purchase its proportionate share of raw material production from certain affiliated companies. Such purchases of raw materials and services aggregated $87.0 million in 1994, $65.9 million in 1993 and $63.3 million in 1992. Additional expenses were incurred in connection with the operation of a joint venture agreement. (See Note M - Other Commitments and Contingencies.) Accounts payable at December 31, 1994 and 1993 included amounts with affiliated companies accounted for by the equity method of $24.1 million and $29.1 million, respectively.\nNOTE L - ENVIRONMENTAL LIABILITIES\nThe Company's operations are subject to numerous laws and regulations relating to the protection of human health and the environment. Because these environmental laws and regulations are quite stringent and are generally becoming more stringent, the Company has expended, and can be expected to expend in the future, substantial amounts for compliance with these laws and regulations.\nIt is the Company's policy to expense or capitalize, as appropriate, environmental expenditures that relate to current operating sites. Environmental expenditures that relate to past operations and which do not contribute to future or current revenue generation are expensed. With respect to costs for environmental assessments or remediation activities, or penalties or fines that may be imposed for noncompliance with such laws and regulations, such costs are accrued when it is probable that liability for such costs will be incurred and the amount of such costs can be reasonably estimated. The Company has recorded approximately $1.2 million and $1.7 million for these items at December 31, 1994 and 1993, respectively.\nThe Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), and similar state superfund statutes generally impose joint and several liability on present and former owners and operators, transporters and generators for remediation of contaminated properties regardless of fault. The Company and certain of its subsidiaries are involved as a potentially responsible party (\"PRP\") at a number of off-site CERCLA or state superfund site proceedings. At some of these sites, any remediation costs incurred by the Company would constitute liabilities for which Foxmeyer Health Corporation, formerly known as National Intergroup, Inc., (collectively with its subsidiaries, \"FOX\") is required to indemnify the Company (\"FOX Environmental Liabilities\"). In addition, at some of these sites, the Company does not have sufficient information regarding the nature and extent of the contamination, the wastes contributed by other PRPs, or the required remediation activity to estimate its potential liability. With respect to those sites for which the Company has sufficient information to estimate its potential liability, the Company has recorded an aggregate liability for CERCLA claims of approximately $4.1 million and $2.0 million as of December 31, 1994 and 1993, respectively, which it anticipates paying over the next several years.\nIn connection with those sites involving FOX Environmental Liabilities, in January, 1994, the Company received $10.0 million from FOX as an unrestricted prepayment for such liabilities for which the Company recorded $10.0 million as a liability in its consolidated balance sheet. The Company is required to repay FOX portions of the $10.0 million to the extent the Company's expenditures for such FOX Environmental Liabilities do not meet specified levels by certain dates over a twenty year period. FOX will continue to be obligated to indemnify the Company for all other FOX Environmental Liabilities (i) arising before such prepayment or (ii) arising after such prepayment and exceeding the $10.0 million prepayment. (See Note I - Weirton Liabilities.) The balance in this liability totalled $10.0 million at December 31, 1994.\nThe Company has also recorded the reclamation and other costs to restore its coal and iron ore mines at its shutdown locations to their original and natural state, as required by various federal and state mining statutes. The Company has recorded an aggregate liability of approximately $11.8 million and $8.0 million at December 31, 1994 and 1993, respectively, relating to these properties.\nSince the Company has been conducting steel manufacturing and related operations at numerous locations for over sixty years, the Company potentially may be required to remediate or reclaim any contamination that may be present at these sites. The Company does not have sufficient information to estimate its potential liability in connection with any potential future remediation at such sites. Accordingly, the Company has not accrued for such potential liabilities.\nAs these matters progress or the Company becomes aware of additional matters, the Company may be required to accrue charges in excess of those previously accrued. However, although the outcome of any of the matters described, to the extent they exceed any applicable reserves, could have a material adverse effect on the Company's results of operations and liquidity for the applicable period, the Company has no reason to believe that such outcomes, whether considered individually or in the aggregate, will have a material adverse effect on the Company's financial condition. For a full discussion of environmental liabilities see \"Part 1, Item 3 - Legal Proceedings.\"\nIn April 1993, the United States Environmental Protection Agency published a proposed guidance document establishing minimum water quality standards and other pollution control policies and procedures for the Great Lakes System. Until such guidance document is finalized, the Company cannot estimate its potential costs for compliance, and there can be no assurances that such compliance will not have a material adverse effect on the Company's financial condition.\nNOTE M - OTHER COMMITMENTS AND CONTINGENCIES\nThe Company has an agreement providing for the availability of raw material loading and docking facilities through 2002. Under this agreement, the Company must make advance freight payments if shipments fall below the contract requirements. At December 31, 1994, the maximum amount of such payments, before giving effect to certain credits provided in the agreement, totaled approximately $16 million or $2 million per year. During the three years ended December 31, 1994, no advance freight payments were made as the Company met all of the contract requirements. The Company anticipates meeting the specified contract requirements in 1995.\nIn September 1990, the Company entered into a joint venture agreement to build a $240 million continuous galvanizing line to serve North American automakers. This joint venture, which was completed in 1993, coats steel products for the Company and an unrelated third party. The Company is a 10% equity owner of the facility, an unrelated third party is a 50% owner, and a subsidiary of NKK owns the remaining 40%. The Company has contributed $5.9 million in equity capital, which represents its total equity requirement. In addition, the Company is committed to utilize and pay a tolling fee in connection with 50% of the available line-time of the facility. The agreement extends for 20 years after the start of production, which commenced in January 1993.\nIn March 1992, a wholly-owned subsidiary of the Company finalized a turnkey contract for the construction and permanent financing of the Pickle Line servicing the Great Lakes Division. The total financing commitment amounted to $110 million. During 1993 the Company utilized $20 million of the proceeds from the IPO to reduce the amount of construction borrowings outstanding and the total commitment to $90 million. As of December 31, 1993 the construction period financing was being provided by the contractor and was not a liability of the Company. In January 1994, upon completion and acceptance of the Pickle Line, the permanent financing commenced with repayment occurring over a fourteen-year period. The Pickle Line is not subject to the lien securing the Company's First Mortgage Bonds, but is subject to a first mortgage in favor of the lender.\nIn May 1992, the Company signed an agreement to enter into a joint venture with an unrelated third party. The joint venture, Double G Coatings Company, L.P. (\"Double G\"), of which the Company owns 50%, constructed a $90 million steel coating facility near Jackson, Mississippi to produce galvanized and Galvalume(R) steel sheet for the metal buildings market. Approximately 20% of the total cost was financed equally through partners' capital contributions with the remaining 80% financed by a group of third party lenders. As of December 31, 1994, the Company has invested $8.5 million in capital contributions. The Company is committed to utilize and pay a tolling fee in connection with 50% of the available line time at the facility through May 10, 2004. This facility commenced production in May 1994.\nIn August 1992, Double G entered into a loan agreement with a consortium of lenders that provides up to $75 million in construction-period financing which converted to a 10 year loan upon completion and acceptance of the facility by Double G. In May 1994, upon completion and acceptance of the facility, Double G borrowed $59.7 million under the loan agreement. Repayment of the permanent loan is scheduled to commence 18 months after completion and acceptance of the facility. Double G provided a first mortgage on its property, plant and equipment and the Company has separately guaranteed $27.4 million of the debt as of December 31, 1994.\nThe Company has agreements to purchase approximately 1.4 million gross tons of iron ore pellets per year through 1999 from an affiliated company, and .5 million gross tons in 1995 from various non-affiliated companies. In 1995, purchases under such agreements will approximate $50 million and $16 million, respectively. The Company is currently renegotiating its purchase agreement for iron ore pellets with its affiliated Company. Additionally, the Company has agreed to purchase its proportionate share of the limestone production of an affiliated company, which will approximate $2 million per year.\nThe Company is guarantor of specific obligations of ProCoil Corporation, an affiliated company, approximating $10.3 million and $10.8 million at December 31, 1994 and 1993, respectively.\nFor a discussion regarding other contingent liabilities see \"Part 1, Item 3 - Legal Proceedings.\"\nNOTE N - EXTRAORDINARY ITEM\nThe Rockefeller Amendment, which became effective February 1, 1993, is designed to provide funding for the United Mine Workers of America (\"UMWA\") retiree medical and life insurance benefits programs by transferring funds from other sources and imposing a liability on all signatories to certain UMWA collective bargaining agreements for current fund deficits and present and future benefit costs for qualifying UMWA retirees. The Company has subsidiaries that are signatories of the 1988 UMWA Wage Agreement and thus falls within the Rockefeller Amendment's provisions. The Rockefeller Amendment also extends, jointly and severally, the liability for the cost of retiree medical and life insurance benefits to any members of the signatory operator's control group, which would include the Company.\nDuring 1992, the Company recorded an extraordinary charge of $50 million, representing management's best estimate of its liability for UMWA beneficiaries. Based upon preliminary assignments from the Secretary of Health and Human Services received during 1994 and 1993, the Company believes this reserve is adequate. However, the amount is subject to future adjustment when additional information relating to beneficiaries becomes available.\nNOTE O - TEMPORARY IDLING OF NATIONAL STEEL PELLET COMPANY\nNSPC was temporarily idled in October 1993, following a strike by the USWA on August 1, 1993, and the subsequent decision to satisfy the Company's iron ore pellet requirements from external sources. At December 31, 1993, it was the previous management's intention to externally satisfy its iron ore pellet requirements for a period of at least three years, which would have caused NSPC to remain idle for that period. In the absence of specific guidance related to the idling, the Company determined that, in accordance with Statement of Financial Accounting Standards No. 5, \"Accounting for Contingencies\" (\"SFAS 5\"), a contingent liability of $108.6 million related to the idle period had been incurred, which was recorded as an unusual charge during the fourth quarter of 1993. (See Note J - Unusual Items.) This charge and the amount reserved at December 31, 1993 was primarily comprised of employee benefits such as pensions and OPEBs, which totaled $68.6 million, along with $40.0 million of expenses directly related to the idling of the facility. The $40.0 million idle reserve was comprised of salary and benefits ($17.4 million), utilities ($5.2 million), noncancelable leases ($3.3 million), production taxes ($7.3 million), supplies ($3.2 million) and other miscellaneous expenses related to the idling ($3.6 million). Substantially all components of the $108.6 million reserve were expected to require the future utilization of cash. Minnesota law requires that an idled facility be maintained in a \"hot idled\" mode for a period of one year, which significantly increased the cost to idle NSPC. None of the $108.6 million reserve, including the $40.0 million related to the idle period, related to the current or future procurement of iron ore pellets from outside sources in the marketplace.\nEffective June 1, 1994, the Company's Board of Directors appointed a new Chief Operating Officer and President, a new Chief Financial Officer and Senior Vice President, and a new Vice President-Human Resources. Earlier in the year, new USWA presidents were elected at both the international and local levels. In an effort to reduce delivered iron ore pellet costs and improve pellet mix, as well as to strengthen the cooperative partnership approach to labor relations, management considered the feasibility of reopening the NSPC facility. Management determined that if a total reduction of $4 per gross ton in delivered pellet costs from pre-strike costs could be achieved, NSPC could be reopened on a cost effective basis. After a series of negotiations, a labor agreement (the \"NSPC Labor Agreement\") was reached between the USWA and NSPC. The NSPC Labor Agreement led to negotiations with other stakeholders such as public utilities, transportation companies, property owners and suppliers and resulted in the achievement of the requisite $4 per gross ton reduction in delivered pellet costs and the reopening of the facility in August 1994. During the third quarter of 1994, the Company recorded start-up expenses of $4.4 million and $2.1 million of expenses related to the NSPC labor agreement. These expenses were directly related to the reopening of NSPC and were charged to cost of products sold.\nThe reopening of NSPC necessitated a reevaluation of the unexpended portion of the $108.6 million reserve recorded during 1993 related to the idling of the facility. As 179 employees had accepted a one month pension window offered by NSPC during the third quarter of 1994, the Company was able to finalize the accounting for the charges related to pensions and OPEB's. Accordingly, approximately $39.3 million of the $68.6 million unusual charge related to employee benefits was reversed during the third quarter of 1994. The remaining employee benefit reserve of $29.3 million at December 31, 1994 relates to the cost of the aforementioned early retirement window, which will be paid over the remaining lives of the retirees.\nAs discussed in further detail below, approximately $20.2 million of the $40.0 million idle reserve had been expended in 1994 during the eight month idle period. Upon the reopening of NSPC, the remaining balance of $19.8 million was reversed, bringing the $40.0 million idle reserve balance to zero at December 31, 1994.\nThe following represents the components of the $108.6 million reserve recorded at December 31, 1993, the cash utilizations during the idle period, the adjustments to the reserve upon the reopening of NSPC and the balance at December 31, 1994:\n(1) All utilizations required the use of cash except for a total of $1.2 million related to Salary and Benefits and Other.\n(2) All adjustments were directly related to the reopening of NSPC.\n(3) Balances remaining for Special Pension Termination charges and OPEB Curtailment charges are carried in the accrued liabilities for pensions and OPEB's, respectively, and are related to an early retirement window offered by NSPC in August 1994.\nAs mentioned previously, the Company followed the guidance provided by SFAS 5 in accounting for the idling of NSPC. During August 1994, the Emerging Issues Task Force (the \"EITF\") issued EITF 94-3 regarding accounting for restructuring charges. Additionally, in November 1994 and January 1995, the EITF expressed its conclusions regarding when a company should recognize a liability for costs, other than employee termination benefits, that are directly associated with a plan to exit an activity. Certain of the costs reflected above may not have been accruable under the EITF's most recent decisions.\nAt December 31, 1993, the USWA had filed 19 unfair labor practice charges with the National Labor Relations Board (the \"NLRB\") regarding the NSPC dispute. All NLRB charges have subsequently been dropped.\nNOTE P - LONG TERM INCENTIVE PLAN\nThe Long Term Incentive Plan was established in 1993 in connection with the IPO and has authorized the grant of options for up to 1,100,000 shares of Class B Common Stock to certain executive officers, non-employee directors and other employees of the Company. The exercise price of the options equals the fair market value of the Common Stock on the date of grant. All options granted have ten year terms and generally vest and become fully exercisable at the end of three years of continued employment. However, in the event that termination is by reason of retirement, permanent disability or death, the option must be exercised in whole or in part within 24 months of such occurrences.\nThe Company currently follows the provision of Accounting Principles Board Opinion No. 25, \"Accounting for Stock Issued to Employees,\" which requires compensation expense for the Company's options to be recognized only if the market price of the underlying stock exceeds the exercise price on the date of grant. Accordingly, the Company has not recognized compensation expense for its options granted in 1994 or 1993.\nA reconciliation of the Company's stock option activity, and related information, from January 1, 1993 through December 31, 1994 follows:\nOutstanding stock options did not enter into the determination of EPS in 1994 or 1993 as their dilutive effect was less than 3%.\nNOTE Q - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nFollowing are the unaudited quarterly results of operations for the years 1994 and 1993. The quarter ended March 31, 1993 has been restated to reflect adoption of SFAS 112 retroactive to the beginning of the year. The remaining quarters of 1993 were not impacted by the changes. Reference should be made to Note J - Unusual Items concerning adjustments affecting the fourth quarters of 1994 and 1993.\nNATIONAL STEEL CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (THOUSANDS OF DOLLARS)\nNOTE 1 - Doubtful accounts charged off, net of recoveries, claims and discounts allowed and reclassification to other assets.\nNOTE 2 - Represents the increase or (decrease) in the net deferred tax asset.\nNOTE 3 - Provision for doubtful accounts of $(3,155), $(2,693) and $2,434 for 1994, 1993 and 1992, respectively and other charges consisting primarily of claims for pricing adjustments and discounts allowed.\nNOTE 4 - Represents the amount of the valuation allowance at January 1, 1992, the adoption date of SFAS 109.\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. EXECUTIVE OFFICERS\nThe following table sets forth, as of December 31, 1994, certain information with respect to the executive officers of the Company. Executive officers are chosen by the Board of Directors of the Company at the first meeting of the Board after each annual meeting of stockholders. Officers of the Company serve at the discretion of the Board of Directors and are subject to removal at any time.\nCertain information with respect to Directors as required by this Item is incorporated by reference from the Company's Proxy Statement for the 1995 Annual Meeting of Stockholders. With the exception of the information specifically incorporated by reference, the Company's Proxy Statement is not to be deemed filed as part of this report for purposes of this Item.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference from the Company's Proxy Statement for the 1995 Annual Meeting of Stockholders. With the exception of the information specifically incorporated by reference, the Company's Proxy Statement is not to be deemed filed as part of this report for purposes of this Item.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated by reference from the Company's Proxy Statement for the 1995 Annual Meeting of Stockholders. With the exception of the information specifically incorporated by reference, the Company's Proxy Statement is not to be deemed filed as part of this report for purposes of this Item.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated by reference from the Company's Proxy Statement for the 1995 Annual Meeting of Stockholders. With the exception of the information specifically incorporated by reference, the Company's Proxy Statement is not to be deemed filed as part of this report for purposes of this Item.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) The list of financial statements filed as part of this report is submitted as a separate section, the index to which is located on page 39.\n(2) The financial statement schedule required to be filed by Item 8 is listed on page 38.\nAll other schedules of National Steel Corporation and subsidiaries 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) Exhibits:\nExhibit Number Exhibit Description ------ -------------------\n2-A Assets Purchase Agreement between Weirton Steel Corporation and the Company, dated as of April 29, 1983, together with collateral agreements incident to such Assets Purchase Agreement, filed as Exhibit 2 to the report of National Intergroup, Inc. on Form 8-K dated January 10, 1984, is incorporated herein by reference.\n2-B Stock Purchase Agreement by and among NKK Corporation, National Intergroup, Inc. and the Company, dated August 22, 1984, together with certain collateral agreements incident to such Stock Purchase Agreement and certain schedules to such agreements are incorporated by reference to Exhibit (2) (sequential pages 5 to and including 248 to National Intergroup, Inc.'s Form 8-K dated August 31, 1984, Commission File No. 1-8549). Other schedules to such agreements identified therein have been omitted, but any of such schedules will be furnished supplementally to the Commission upon request.\n2-C Stock Purchase and Recapitalization Agreement by and among National Intergroup, Inc., NII Capital Corporation, NKK Corporation, NKK U.S.A. Corporation and the Company, dated as of June 26, 1990, filed as Exhibit 2 to the current report of the Company on Form 8-K dated July 10, 1990, is incorporated herein by reference.\n2-D Amendment to Stock Purchase and Recapitalization Agreement by and among, National Intergroup, Inc., NII Capital Corporation, NKK Corporation, NKK U.S.A. Corporation and the Company, dated July 31, 1991, filed as Exhibit 2-F to the annual report of the Company on Form 10-K, for the year ended December 31, 1991, is incorporated herein by reference.\n3-A The Sixth Restated Certificate of Incorporation of the Company, filed as Exhibit 3.1 to the Company's Registration Statement on Form S-1, Registration No. 33-57952, is incorporated herein by reference.\n3-B Form of Amended and Restated By-laws of the Company, filed as Exhibit 3-A to the quarterly report of the Company on Form 10-Q for the quarter ended June 30, 1994, is incorporated herein by reference.\n4-A NSC Stock Transfer Agreement between National Intergroup, Inc., the Company, NKK Corporation and NII Capital Corporation, filed as Exhibit 4-M to the quarterly report of the Company on Form 10-Q for the quarter ended June 30, 1986, is incorporated herein by reference.\n4-B Certificate of Designation of Series A Preferred Stock dated June 26, 1990, filed as Exhibit 4-M to the annual report of the Company on Form 10-K, for the year ended December 31, 1990, is incorporated herein by reference.\n4-C Certificate of Designation of Series B Preferred Stock dated June 26, 1990, filed as Exhibit 4-N to the annual report of the Company on Form 10-K, for the year ended December 31, 1990, is incorporated herein by reference.\n10-A Amended and Restated Lease Agreement between the Company and Wilmington Trust Company, dated as of December 20, 1985, relating to the EGL, filed as Exhibit 10-A to the annual report of the Company on Form 10-K, for the year ended December 31, 1985, is incorporated herein by reference.\n10-B Lease Agreement between The Connecticut National Bank as Owner Trustee and Lessor and National Acquisition Corporation as Lessee dated as of September 1, 1987 for the Ladle Metallurgy and Caster Facility located at Ecorse, Michigan, filed as Exhibit 10-F to the annual report of the Company on Form 10-K, for the year ended December 31, 1987, is incorporated herein by reference.\n10-C Lease Supplement No. 1 dated as of September 1, 1987 between The Connecticut National Bank as Owner Trustee and National Acquisition Corporation as the Lessee for the Ladle Metallurgy and Caster Facility located at Ecorse, Michigan, filed as Exhibit 10-G to the annual report of the Company on Form 10-K, for the year ended December 31, 1987, is incorporated herein by reference.\n10-D Lease Supplement No. 2 dated as of November 18, 1987 between The Connecticut National Bank as Owner Trustee and National Acquisition Corporation as Lessee for the Ladle Metallurgy and Caster Facility located at Ecorse, Michigan, filed as Exhibit 10-H to the annual report of the Company on Form 10-K, for the year ended December 31, 1987, is incorporated herein by reference.\n10-E Purchase Agreement dated as of March 25, 1988 relating to the Stinson Motor Vessel among Skar-Ore Steamship Corporation, Wilmington Trust Company, General Foods Credit Investors No. 1 Corporation, Stinson, Inc. and the Company, and Time Charter between Stinson, Inc. and the Company, filed as Exhibit 10-E to the annual report of the Company on Form 10-K, for the year ended December 31, 1988, are incorporated herein by reference.\n10-F Amended and Restated Weirton Agreement dated June 26, 1990, between National Intergroup, Inc., NII Capital Corporation and the Company, filed as Exhibit 10-F to the annual report of the Company on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\n10-G Amended to Amended and Restated Weirton Liabilities Agreement dated July 31, 1991 between National Intergroup, Inc., NII Capital Corporation and the Company, filed as Exhibit 10-H to the annual report of the Company on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference.\n10-H Indenture of Mortgage and Deed of Trust, dated May 1, 1952, between the Company and Great Lakes Steel Corporation and City Bank Farmers Trust Company and Ralph E. Morton, as Trustees, filed as Exhibit 4.1 to the Company's Registration Statement on Form S-1 (Registration No. 2-9639), is incorporated herein by reference.\n10-I Second Supplemental Indenture, dated as of January 1, 1957, between the Company and City Bank Farmers Trust Company and Francis M. Pitt, as Trustees, filed as Exhibit 2-C to the Company's Registration Statement on Form S-9 (Registration No. 2-15070), is incorporated herein by reference.\n10-J Fourth Supplemental Indenture, dated as of December 1, 1960, between the Company and First National City Trust Company and Francis M. Pitt, as Trustees, filed as Exhibit 4(b)(5) to the Registration Statement of the M. A. Hanna Company on Form S-1 (Registration No. 2-19169), is incorporated herein by reference.\n10-K Fifth Supplemental Indenture dated as of May 1, 1962 between the Company, First National City Trust Company, as Trustee, and First National City Bank, as Successor Trustee, filed as Exhibit 19-A to the annual report of the Company on Form 10-K, for the year ended December 31, 1988, is incorporated herein by reference.\n10-L Eighth Supplemental Indenture, dated as of September 19, 1973, between the Company and First National City Bank and E. J. Jaworski, as Trustees, filed as Exhibit 2-I to the Company's Registration Statement on Form S-7 (Registration No. 2-56823), is incorporated herein by reference.\n10-M Ninth Supplemental Indenture, dated as of August 1, 1976, between the Company and Citibank, N.A., and E. J. Jaworski, as Trustees, filed as Exhibit 2-J to the Company's Registration Statement on Form S-7 (Registration No. 2-56823), is incorporated herein by reference.\n10-N Indenture, dated as of December 1, 1964, between Granite City Steel Company and Chemical Bank New York Trust Company, Trustee, filed as Exhibit 4(a) to the Registration Statement of Granite City Steel Company on Form S-1 (Registration No. 2-22916), is incorporated herein by reference.\n10-O Supplemental Indenture dated as of August 8, 1984 between National Intergroup, Inc., the Company and Chemical Bank as Trustee, filed as Exhibit 19-A to the annual report of the Company on Form 10-K, for the year ended December 31, 1987, is incorporated herein by reference.\n10-P Put Agreement by and among NII Capital Corporation, NKK U.S.A. Corporation and the Company, dated June 26, 1990, filed as Exhibit 4-O to the annual report of the Company on Form 10-K, for the year ended December 31, 1990, is incorporated herein by reference.\n10-Q Subordinated Loan Agreement dated May 8, 1991, between NUF Corporation and the Company, filed as Exhibit 4-P to the annual report of the Company on Form 10-K, for the year ended December 31, 1991, is incorporated herein by reference.\n10-R First Amendment to Subordinated Loan Agreement dated December 9, 1991, between NUF Corporation and the Company, filed as Exhibit 4-Q to the annual report of the Company on Form 10-K, for the year ended December 31, 1991, is incorporated herein by reference.\n10-S Second Amendment to Subordinated Loan Agreement, dated December 29, 1992, between NUF Corporation and the Company, filed as Exhibit 10-S to the annual report of the Company on Form 10-K, dated February 5, 1993, is incorporated herein by reference.\n10-T Amended and Restated Loan Agreement, dated October 30, 1992, between NUF Corporation and the Company filed as Exhibit 10-T to the annual report of the Company on Form 10-K, dated February 5, 1993, is incorporated herein by reference.\n10-U First Amendment to Amended and Restated Loan Agreement dated February 1, 1993, between NUF Corporation and the Company filed as Exhibit 10-U to the annual report of the Company on Form 10-K, dated February 5, 1993, is incorporated herein by reference.\n10-V 1993 National Steel Corporation Long-Term Incentive Plan, filed as Exhibit 10.1 to the Company's Registration Statement on Form S-1, Registration No. 33-57952, is incorporated herein by reference.\n10-W 1993 National Steel Corporation Non-Employee Directors' Stock Option Plan, filed as Exhibit 10.2 to the Company's Registration Statement on Form S-1, Registration No. 33-57952, is incorporated herein by reference.\n10-X National Steel Corporation Management Incentive Compensation Plan dated January 30, 1989, filed as Exhibit 10.3 to the Company's Registration Statement on Form S-1, Registration No. 33-57952, is incorporated herein by reference.\n10-Y Purchase and Sale Agreement, dated as of May 16, 1994 between the Company and National Steel Funding Corporation, filed as Exhibit 10-A to the quarterly report of the Company on Form 10-Q\/A for the quarter ended March 31, 1994, is incorporated herein by reference.\n10-Z Form of Indemnification Agreement, filed as Exhibit 10.5 to the Company's Registration Statement on Form S-1, Registration No. 33-57952, is incorporated herein by reference.\n10-AA Shareholders' Agreement, dated as of September 18, 1990, among DNN Galvanizing Corporation, 904153 Ontario Inc., National Ontario Corporation and Galvatek America Corporation, filed as Exhibit 10.27 to the Company's Registration Statement on Form S-1, Registration No. 33-57952, is incorporated herein by reference.\n10-BB Partnership Agreement, dated as of September 18, 1990, among Dofasco, Inc., National Ontario II, Limited, Galvatek Ontario Corporation and DNN Galvanizing Corporation, filed as Exhibit 10.28 to the Company's Registration Statement on Form S-1, Registration No. 33-57952, is incorporated herein by reference.\n10-CC Amendment No. 1 to the Partnership Agreement, dated as of September 18, 1990, among Dofasco, Inc., National Ontario II, Limited, Galvatek Ontario Corporation and DNN Galvanizing Corporation, filed as Exhibit 10.29 to the Company's Registration Statement on Form S-1, Registration No. 33-57952, is incorporated herein by reference.\n10-DD Agreement, dated as of February 3, 1993, among the Company, NKK, NKK U.S.A. Corporation, NII and NII Capital Corporation, filed as Exhibit 10.30 to the Company's Registration Statement on Form S-1, Registration No. 33-57952, is incorporated herein by reference.\n10-EE Second Amendment to Amended and Restated Loan Agreement dated May 19, 1993, between NUF Corporation and the Company, filed as Exhibit 10-EE to the annual report of the Company on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n10-FF Agreement, dated as of May 19, 1993, among the Company and NKK Capital of America, Inc., filed as Exhibit 10-FF to the annual report of the Company on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n10-GG Employment Agreement, dated October 14, 1993, between the Company and Ronald H. Doerr, former President and Chief Executive Officer of the Company, filed as Exhibit 10-GG to the annual report of the Company on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n10-HH Amended and Restated Employment Agreement, dated as of May 31, 1994, between the Company and V. John Goodwin, filed as Exhibit 10-A to the quarterly report of the Company on Form 10-Q for the quarter ended June 30, 1994, is incorporated herein by reference.\n10-II Amended and Restated Employment Agreement, dated as of May 31, 1994, between the Company and Robert M. Greer, filed as Exhibit 10-B to the quarterly report of the Company on Form 10-Q for the quarter ended June 30, 1994, is incorporated herein by reference.\n10-JJ Agreement between Ronald H. Doerr and National Steel Corporation, dated as of December 22, 1994, a copy of which is attached hereto.\n10-KK Receivables Purchase Agreement, dated as of March 16, 1994, between the Company and National Steel Funding Corporation, filed as exhibit 10-A to the quarterly report of the Company on Form 10-Q\/A for the quarter ended June 30, 1994, is incorporated herein by reference.\n21 List of Subsidiaries of the Company, a copy of which is attached hereto.\n23 Consent of Independent Auditors, a copy of which is attached hereto.\n27 Financial Data Schedule, a copy of which is attached hereto.\n(b) No reports on Form 8-K were filed during the last quarter of 1994.\n(c) Exhibits 10-JJ, 21, 23 and 27, which are required by Item 601 of Regulation S-K are filed as part of this report.\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, in the City of Mishawaka, State of Indiana, on March 9, 1995.\nNATIONAL STEEL CORPORATION\nBy: \/s\/ Robert M. Greer ------------------------------------------------- Robert M. Greer 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 Company in the capacities indicated on March 9, 1995.\nNAME TITLE ---- -----\n\/s\/ Osamu Sawaragi Director and Chairman -------------------------- Osamu Sawaragi\n\/s\/ V. John Goodwin Director, President and Chief Operating Officer -------------------------- V. John Goodwin\n\/s\/ Keisuke Murakami Director Vice President - Administration -------------------------- Keisuke Murakami\n\/s\/ Hiroshi Matsumoto Director, Vice President and Assistant to the -------------------------- President Hiroshi Matsumoto\n\/s\/ Edwin V. Clarke, Jr. Director -------------------------- Edwin V. Clarke, Jr.\nFrank J. Lucchino Director -------------------------- Frank J. Lucchino\n\/s\/ Masayuki Hanmyo Director -------------------------- Masayuki Hanmyo\n\/s\/ Kenichiro Sekino Director -------------------------- Kenichiro Sekino\n\/s\/ Robert J. Slater Director -------------------------- Robert J. Slater\n\/s\/ Robert M. Greer Senior Vice President and Chief Financial -------------------------- Officer Robert M. Greer\n\/s\/ Carl M. Apel Corporate Controller, Accounting and Assistant -------------------------- Secretary Carl M. Apel\nNATIONAL STEEL CORPORATION\nANNUAL REPORT ON FORM 10-K\nEXHIBIT INDEX\nYEAR ENDED DECEMBER 31, 1994\n10-JJ Agreement between Ronald H. Doerr and National Steel Corporation, dated December 22, 1994, a copy of which is attached hereto.\n21 List of Subsidiaries of the Company, a copy of which is attached hereto.\n23 Consent of Independent Auditors, a copy of which is attached hereto.\n27 Financial Statement Data Schedule, a copy of which is attached hereto.","section_15":""}
{"filename":"311259_1994.txt","cik":"311259","year":"1994","section_1":"Item 1. Business 1(a) General\nEastern Enterprises (\"Eastern\") is an unincorporated voluntary association (commonly referred to as a \"Massachusetts business trust\") established and existing under a Declaration of Trust dated July 18, 1929, as from time to time amended.\nEastern's principal subsidiaries are Boston Gas Company (\"Boston Gas\") and Midland Enterprises Inc. (\"Midland\"). Boston Gas is a regulated utility that distributes natural gas in and around Boston, Massachusetts. Midland is engaged in barge transportation, principally on the Ohio and Mississippi river systems. On November 8, 1994, Eastern announced its intention to sell its subsidiary, WaterPro Supplies Corporation (\"WaterPro\"). The anticipated sale will complete the disposition of Eastern's Water Products Group, which had consisted of WaterPro and another subsidiary, Ionpure Technologies Corporation (\"Ionpure\"), which was sold as of October 1, 1993. As described in Note 10 appearing on pages 27 and 28, the Water Products Group has been accounted for as a discontinued operation.\nEastern provides management and staff services to its operating subsidiaries. Boston Gas and Midland are financed primarily through their own funded debt, which is not guaranteed by Eastern. Many of the debt instruments relating to Boston Gas and Midland borrowings contain restrictive covenants, including restrictions on the payment of dividends to Eastern. In the opinion of management, none of these restrictions has any material impact upon the operations of Eastern and its subsidiaries.\n1(b) Financial Information About Industry Segments\nInformation with respect to this item may be found in Note 2 appearing on page 22. Such information is incorporated herein by reference.\n1(c) Description of Business\nBoston Gas Company\nBoston Gas is engaged in the transportation, distribution and sale of natural gas to residential, commercial, and industrial customers in Boston, Massachusetts, and 73 other communities in eastern and central Massachusetts. Boston Gas also sells gas for resale in Massachusetts and other states (see \"Competition\" section). Boston Gas has one subsidiary, Massachusetts LNG Incorporated (\"Mass LNG\"), which holds a long-term lease on two liquefied natural gas (\"LNG\") facilities. Boston Gas is the largest natural gas distribution company in New England, has been in business for 172 years and is the second oldest gas company in the United States. Since 1929, all of the common stock of Boston Gas has been owned by Eastern.\nGas Sales and Transportation\nGas is sold and transported for \"firm\" and \"non-firm\" customers. Principal uses of natural gas include central, space and water heating, cooking, drying, steam generation and a variety of industrial applications.\n\"Firm\" sales and transportation services are generally provided without interruption throughout the year, although uninterrupted seasonal services are available to firm customers for periods of less than 365 days. Firm services are provided under either filed rate schedules or through individually negotiated contracts. Firm sales and transportation of natural gas used for central or space heating are directly related to weather conditions. Consequently, temperature variations can have a significant impact, both favorable and unfavorable, upon Boston Gas' revenues and earnings. Compared to normal, actual billing temperatures were 1% colder, 1% warmer and 4% colder in 1994, 1993 and 1992, respectively.\n\"Non-firm\" sales and transportation services are generally provided to large commercial and industrial customers who can use gas and oil interchangeably or to other gas distribution utilities for resale. Non-firm services are dependent upon a number of factors, including the price of gas compared to competing fuels, gas supply availability, weather conditions and system capacity, both local and interstate. Non-firm services\nare provided through individually negotiated contracts and, in most cases, the price charged takes into account the price of the customer's alternative fuel, which is generally residual fuel oil. Beginning November 1, 1993, gross margins from non-firm sales and transportation services ($10.9 million in 1994 and $8.2 million in 1993) in excess of a threshold based upon the prior season's experience are shared between firm customers and shareholders, 75% and 25%, respectively.\nThe following table provides information with respect to the volumes of gas sold and transported by Boston Gas during the three years 1992-1994. The table is in billions of cubic feet (\"BCF\") of natural gas at 1,000 B.T.U. per cubic foot. Years Ended December 31, 1994 1993 1992 Firm Sales and Transportation Residential Heating 37.8 38.1 37.9 Residential Non-Heating 3.6 3.8 3.9 Commercial 25.1 26.0 25.8 Industrial 4.8 5.0 4.9 Seasonal Firm Contracts 10.4 10.0 6.4 Total Firm Sales 81.7 82.9 78.9 Firm Transportation 13.8 12.4 7.4 Total Firm Throughput 95.5 95.3 86.3 Non-Firm Sales and Transportation Interruptible 6.4 8.1 14.5 Special Sales for Resale 7.6 2.1 4.2 Total Non-Firm Sales 14.0 10.2 18.7 Non-Firm Transportation 34.9 39.3 27.3 Total Non-Firm Throughput 48.9 49.5 46.0 Total Throughput 144.4 144.8 132.3\nResidential heating sales include all gas sold to customers having central or space heating. Commercial sales include all gas sold to retail establishments and commercial properties including central-metered apartment houses and condominiums with five or more units. The growth in Boston Gas' firm transportation services, as depicted below, reflects changes in the gas industry (see \"Gas Supply\" and \"Competition\" sections).\nFIRM THROUGHPUT (in BCF) [Bar Chart--plot points below] 1990 1991 1992 1993 1994\nSales 65.4 64.3 78.9 82.9 81.7 Transportation 0.0 0.0 7.4 12.4 13.8 65.4 64.3 86.3 95.3 95.5\nBoston Gas' operations are subject to Massachusetts statutes applicable to gas utilities as described in the \"Regulation\" section. Facility expansion is regulated by the Massachusetts Department of Public Utilities (\"DPU\"). Municipal, state and federal authorities have jurisdiction over the use of public ways, land and waters for gas mains and other distribution facilities.\nGas Supply\nThe following table provides statistical information with respect to Boston Gas' sources of supply during 1992-1994. The table is in BCF of natural gas at 1,000 B.T.U. per cubic foot. Years Ended December 31, 1994 1993 1992 Natural Gas Purchases 92.2 86.3 94.1 LNG Purchases 4.2 13.4 12.4 Total Purchases 96.4 99.7 106.5 Change in Storage Gas 4.5 (4.0) (5.2) Company Use, Unbilled and Other (5.2) (2.6) (3.7) Total Sales 95.7 93.1 97.6\nBoston Gas purchases approximately 70% of its pipeline gas supplies directly from domestic and Canadian producers and marketers pursuant to long-term contracts which have been reviewed and approved by the DPU. Boston Gas purchases its remaining pipeline supplies from domestic sources pursuant to short-term, firm winter service agreements and on a spot basis. Boston Gas has diversified its pipeline gas supplies across major North American producing regions, including on and off-shore Gulf of Mexico and mid-continent areas in the United States, as well as from western Canada.\nPipeline supplies are transported on interstate pipeline systems to Boston Gas' service territory pursuant to transportation agreements approved by the Federal Energy Regulatory Commission (\"FERC\"). Boston Gas has also contracted with pipeline companies and others for the storage of natural gas and related transportation services from underground storage fields located in West Virginia, New York and Pennsylvania. Supplemental supplies of LNG and propane are purchased and produced from foreign and domestic sources.\nAll interstate pipelines serving Boston Gas have implemented service restructuring plans on terms and conditions approved pursuant to FERC Order No. 636. FERC Order No. 636, issued April 8, 1992, required interstate pipeline companies to unbundle gas sales contracts into separate gas sales, transportation and storage services. Accordingly, Boston Gas' firm bundled service with Algonquin Gas Transmission Company (\"Algonquin\"), a wholly-owned subsidiary of Texas Eastern Transmission Corporation (\"Texas Eastern\"), was converted to an annual firm transportation entitlement of 87.4 BCF. Similarly, Boston Gas' firm bundled sales service with Texas Eastern has been converted into an annual firm transportation entitlement of 102.3 BCF; and its firm bundled sales service with Tennessee Gas Pipeline Company (\"Tennessee\") has been converted to an annual transportation and storage entitlement of 79.4 BCF. In addition, Boston Gas has firm entitlements on interstate pipelines upstream of Tennessee, Texas Eastern, and Algonquin, with direct access to supply areas. Together, these transportation entitlements are used to transport natural gas purchased by Boston Gas from producing regions described above and from underground storage facilities to its service territory. Boston Gas holds direct entitlements to 17.2 BCF of storage capacity with Tennessee, Texas Eastern and others. The underlying transportation and storage agreements with Algonquin, Texas Eastern, and Tennessee have terms generally expiring no earlier than November 1996, April 2012, and November 2000, respectively. Boston Gas is provided rights of first refusal under FERC Order No. 636 to extend the terms of the majority of these transportation and storage contracts. Boston Gas considers the service reliability of its current natural gas portfolio to be comparable to that existing prior to FERC Order No. 636.\nIn addition to its domestic supply arrangements, Boston Gas has three contracts for the purchase of Canadian gas supplies. Boston Gas' contract with Boundary, Inc. provides for the purchase of 3.8 BCF of gas annually and expires in January 2003. Boston Gas also has contracts with Alberta Northeast Gas, Ltd. to purchase up to 4.8 BCF of gas annually, and with Imperial Oil of Canada, Ltd. for the purchase of 12.8 BCF of gas annually. These contracts expire in November 2003 and April 2007, respectively. Boston Gas has\ncontracted with Iroquois Gas Transmission System, Tennessee and Algonquin to transport these gas supplies from the Canadian border to delivery points in Boston Gas' service territory.\nBoston Gas has contracts, expiring in 1998, with Distrigas of Massachusetts Corporation (\"DOMAC\") for the purchase of an annual quantity of up to 2.0 BCF of LNG and for 1.0 BCF of LNG storage capacity and related vaporization services. Boston Gas also purchases LNG from DOMAC on a spot basis when prices are competitive with alternative supplies. DOMAC's affiliate, Distrigas Corporation, imports the LNG from Algeria pursuant to agreements with Sonatrach, the Algerian National Energy Company.\nBoston Gas relies on supplemental supplies of storage gas, LNG and propane to meet firm sendout requirements which are greater than its firm pipeline capacity entitlements. The number of days that peak sendout can be maintained is limited by the capacity of Boston Gas' storage facilities for supplemental gas supplies and the rate at which these supplies can be sent out and subsequently replenished. Boston Gas owns or leases facilities which enable it to store the equivalent of 4.6 BCF of natural gas in liquid form as LNG and vaporize it for use during periods of high demand. The inventory for these facilities is provided by liquefaction of pipeline gas and from purchased LNG. Over the past five years, increased pipeline capacity has reduced Boston Gas' dependence on these more costly supplemental supplies. Boston Gas considers its peak day sendout capability, based on its total supply resources, adequate to meet the requirements of its firm customers.\nRegulation\nBoston Gas' operations are subject to Massachusetts statutes applicable to gas utilities. Rates, the territorial limit of Boston Gas' service area, purchase of gas, pipeline safety regulations, issuance of securities and affiliated party transactions are regulated by the DPU. Rates for firm sales and transportation provided by Boston Gas are subject to approval by, and are on file with, the DPU. In addition, Boston Gas has a cost of gas adjustment clause which allows for the adjustment of billing rates for firm gas sales to enable it to recover the actual cost of gas delivered to firm customers.\nOn October 30, 1993, the DPU allowed Boston Gas an annual revenue increase of $37.7 million, effective November 1, 1993, and also approved several rate design changes that reduce the volatility of its margins attributable to weather. The DPU also ordered a four-year phase-in of the cost of post-retirement benefits other than pensions. Boston Gas began billing the second year phase-in on November 1, 1994.\nChanges stemming from FERC Order 636 are being considered at state levels. The DPU has initiated a proceeding to review alternative regulatory approaches, including regulation that is incentive or performance based.\nBoston Gas and Eastern were granted an intrastate exemption from the provisions of the Public Utility Holding Company Act of 1935 (\"the Act\") under Section 3(a)(1) thereof, pursuant to an order of the Securities and Exchange Commission (the \"SEC\") dated February 28, 1955, as amended by orders dated November 3, 1967 and August 28, 1975. On February 7, 1989, the SEC issued a proposed rule under the Act which would provide limits for non-utility related diversification by intrastate public utility holding companies, such as Eastern, that are exempt under the Act. Since its proposal in 1989, the SEC has taken no action with respect to this proposed rule. Eastern and Boston Gas cannot predict whether this proposed rule will be adopted or whether it will affect their exemption under the Act.\nSeasonality and Working Capital\nBoston Gas' revenues, earnings and cash flows are highly seasonal as most of its firm sales and transportation are directly related to temperature conditions. The majority of Boston Gas' earnings are generated in the first quarter with a seasonal loss occurring in the third quarter. Since the bulk of its revenues are billed in the November through April heating season, significant cash flows are generated from late winter to early summer. In addition, through the cost of gas adjustment clause, Boston Gas bills its customers over the heating season for pipeline demand charges paid by Boston Gas over the entire year. This difference, along with other costs of gas distributed but unbilled, is reflected as deferred gas costs and results in short-term borrowings. Short-term borrowings are also required from time to time to finance normal business operations. As a result of all factors, short-term borrowings are generally highest during the late fall and early winter.\nCompetition\nBoston Gas competes with suppliers of fuel oil and electricity for residential, commercial and industrial customers. In addition, Boston Gas faces competition from other suppliers of natural gas for large commercial and industrial applications. Boston Gas' marketing efforts emphasize the continuing environmental benefits of natural gas, together with its reliability and long-term economic value as compared to oil and electricity. The clean burning nature of natural gas combustion and the absence of on-site fuel storage problems are major environmental advantages for natural gas.\nBoston Gas increased annualized firm throughput by an estimated 3.8 BCF during 1994 through volume additions of 2.3 BCF in the firm residential and commercial\/industrial markets and additions of 1.5 BCF through special contracts and transportation arrangements.\nIncreased activity in new residential construction, together with the accelerated marketing efforts to encourage conversion to natural gas, resulted in the addition of approximately 5,300 residential heating customers. Approximately 45% of Boston Gas' existing residential customers do not use gas for central heating, representing a prime marketing opportunity. Boston Gas targets this group through special programs with the objective of increasing the rate of heating conversion to natural gas. No customer, or group of customers under common control, accounted for 3% or more of the total firm revenues in 1994.\nConsiderable growth opportunity exists in the commercial and industrial markets, where Boston Gas' market penetration is only two-thirds the national average due to historical capacity limitations and the relatively late introduction of natural gas into New England. Despite low oil prices in 1994, the environmental advantages of natural gas and customers' desire for long-term value and price stability generated the highest level of new sales in this market segment in the past five years.\nIn June 1992, FERC granted Boston Gas the authority to make sales for resale in interstate commerce under the terms of a blanket marketing certificate. This additional sales authority allows Boston Gas to maximize the use of its supply entitlements, thereby minimizing the cost of gas to firm customers and making its sales rates more competitive.\nFERC Order No. 636 and other regulatory changes have increased competition among existing and new suppliers of natural gas in Boston Gas' service area, particularly in the large commercial and industrial sectors (see \"Gas Supply\"). Boston Gas provides firm and interruptible transportation-only service to customers who may engage in direct purchases of natural gas from other suppliers. Firm transportation tariffs provide equal gross margin opportunity for Boston Gas regardless of whether the customer purchases gas directly from Boston Gas or purchases gas from a third party and arranges for transportation-only service on Boston Gas' distribution system. These services allow flexibility for customers and encourage conversions to natural gas, while providing increased opportunities for Boston Gas to increase throughput on its system and generate increased margins. Boston Gas has also received DPU approval to enter into contracts designed to compete for commercial and industrial customers with alternative energy options. As a result of these factors, Boston Gas believes it is well positioned to respond to such competition.\nBoston Gas continues to pursue market opportunities in natural gas-powered vehicles as the passage of federal legislation has enhanced opportunities in this market. The City of Boston Fire Department recently removed restrictions which barred natural gas vehicles from city tunnels and major bridges, thus making the use of these vehicles more practical. Boston Gas achieved significant progress in 1994 through cooperative efforts with state and federal government agencies to obtain access to federal funding grants for fueling station infrastructure development. This funding will help provide additional commercial and municipal fleet fueling sites in the near future. Boston Gas' program in this market includes the installation of two Boston Gas-owned fueling stations, conversion of 103 Boston Gas vehicles and the establishment of pilot programs with a number of large fleet operators for on-site fueling to demonstrate the advantage of choosing natural gas to meet alternative fuel vehicle requirements.\nEnvironmental Matters\nBoston Gas may have or share responsibility for environmental remediation of certain former manufactured gas plant sites, as described in Note 11 appearing on pages 28 and 29. A subsidiary of New England Electric System has assumed responsibility for remediating 11 of the 15 such sites owned by Boston\nGas, subject to a limited contribution by Boston Gas. A 1990 regulatory settlement with the DPU provides for recovery by Boston Gas of environmental costs associated with such sites over separate, seven-year amortization periods without a return on the unamortized balance. Although Boston Gas does not possess at this time sufficient information to reasonably determine the ultimate cost to it of such remediation, it believes that it is not probable that such costs will materially affect its financial condition or results of operations.\nProperties\nBoston Gas and Mass LNG own or lease facilities which enable them to liquefy natural gas in periods of low demand, store the resulting LNG and vaporize it for use in periods of high demand. Boston Gas owns and operates such a facility in Dorchester, Massachusetts, and Mass LNG leases one such facility in Lynn, Massachusetts, and a storage facility in Salem, Massachusetts. In addition, Boston Gas owns propane-air facilities at several locations throughout its service territory.\nOn December 31, 1994, Boston Gas' distribution system included approximately 5,700 miles of gas mains, 397,000 services and 522,000 active customer meters.\nBoston Gas' mains and services are generally located on public ways or private property not owned by it. Boston Gas' occupation of such property is generally pursuant to easements, licenses, permits or grants of location. Except as stated above, the principal items of property of Boston Gas are owned in fee. A portion of the utility properties and franchises of Boston Gas is pledged as security for its First Mortgage Bonds.\nIn 1994, Boston Gas' capital expenditures were $53.5 million. Capital expenditures were principally made for improvements to the distribution system, for system expansion to meet customer demand and for productivity enhancement initiatives. Boston Gas plans to spend approximately $58 million for similar purposes in 1995.\nEmployees\nAs of December 31, 1994, Boston Gas had 1,700 employees, 71% of whom were organized in six local unions with which Boston Gas has collective bargaining agreements. In 1993, after a seventeen-week work stoppage, Boston Gas entered into six-year labor contracts with the bargaining units, which provided for, among other things, annual wage increases of approximately 4%, updated work rules and changed health care coverage to a managed care program with cost sharing. Midland Enterprises Inc.\nMidland is primarily engaged through wholly-owned subsidiaries (together \"Midland\") in the operation of a fleet of barges and towboats, principally on the Ohio and Mississippi Rivers and their tributaries, the Gulf Intracoastal Waterway and the Gulf of Mexico. Midland transports bulk commodities, a major portion of which is coal. Midland also performs repair work on marine equipment and operates two coal dumping terminals, a phosphate rock and phosphate chemical fertilizer terminal, and a marine fuel supply facility. In December 1993 Midland sold Chotin, its liquid barge operations, including its sole contract and trade name. In June 1994 Midland sold its barge construction and repair facility located in Louisiana.\nSales\nThe following table indicates the tonnages transported (in millions) for the period 1992--1994: Years ended December 31, 1994 1993 1992 Dry Cargo 69.6 60.9 60.8 Liquid Cargo -- 1.6 1.6 Total Tonnage 69.6 62.5 62.4\nTonnage in 1994 increased 11% over 1993 to a record 69.6 million tons, despite the absence of the liquid business, primarily due to a stronger economy as evidenced by increased shipments of coal, aggregates, ores, steel products and scrap. Coal tonnage in 1993 was negatively impacted by a prolonged United Mine Workers strike that disrupted coal shipments. Tonnage in 1993 increased slightly over 1992 due to increased shipments of non-coal commodities.\nThe following chart summarizes the ton miles of cargo transported (in billions) for the period 1990-1994:\nTON MILES BY COMMODITY (in billions) [Bar chart--plot points below] 1990 1991 1992 1993 1994 Coal 14.1 15.6 15.2 14.0 15.2\nGrain 7.0 6.2 6.3 4.8 4.4 Other* 8.8 8.6 9.3 11.9 15.7 Liquid 2.0 1.7 1.6 1.5 0.0 Total 32.0 32.1 32.4 32.2 35.3\n* Other includes sand, stone, gravel, iron, scrap, steel, coke, phosphate, towing for others, and other dry cargo.\nTon miles are the product of tons and distance transported. The record ton miles in 1994 reflected the 11% increase in tonnage noted above. The slight decline in ton miles from 1992 to 1993 reflected shorter average hauls of approximately equal tonnage. In addition to changes in ton miles transported, Midland's revenues and earnings are affected by other factors such as competitive conditions, weather and the segment of the river system traveled, as described in the \"Seasonality\" and \"Competition\" sections.\nThe following table summarizes Midland's backlog of transportation and terminalling business under long-term contracts: Years ended December 31, 1994 1993\nTons (in millions) 168.8 165.5 Revenues (in millions) $422.8 $585.5 Portions of revenue backlog not expected to be filled within the current fiscal year 77% 80%\nThe 1994 revenue backlog (which is based on contracts that extend beyond December 31, 1995) is shown at prices in effect on December 31, 1994, which are subject to escalation\/de-escalation provisions. Since services under many of the long-term contracts are based on customer requirements, Midland has estimated its backlog based on its forecast of the anticipated requirements of these long-term contract customers. The 1994 revenue backlog decline from 1993 primarily reflects the amended terms of a contract with Gulf Power Company, which was in dispute at December 31, 1993. As amended, the contract's term and average trip length were reduced, accounting for a 35% decline in the revenue backlog. Other long-term contract extensions and additions were partially offsetting. The tonnage backlog was reduced 11% as a result of the Gulf Power contract amendment. However, this reduction was more than offset by other long-term contract additions and extensions, including the five-year contract extension with the Cincinnati Gas & Electric Company, Midland's largest customer, negotiated early in 1994.\nThe only significant raw material required by Midland is the diesel fuel to operate its towboats. Diesel fuel is purchased from a variety of sources and Midland regards the availability of diesel fuel as adequate for its operations.\nSeasonality\nRevenues during winter months tend to be lower than revenues for the remainder of the year due to the freezing of some northern rivers and waterways during winter months, increased coal consumption by electric utilities during the summer months, and the seasonal fall harvest of grain.\nCompetition\nMidland's marine transportation business competes on the basis of price, service and equipment availability. Midland's primary competitors include other barge lines and railroads, including one integrated rail-barge carrier. There are a number of companies offering transportation services on the waterways served by Midland. In recent years, competition among major barge line companies has been intense due to an imbalance between barge supply and customer demand, impacted by economic conditions as well as at times by weak grain and coal export markets. This in turn has led to revenue and margin erosion, prompted cost and productivity improvements and some industry consolidation. During the second half of 1994, however, barge demand and supply moved closer to equilibrium with rates and margins improving. However, it is uncertain whether these short-term gains will be sustained.\nBarge operators have maintained relatively low rate structures due to ongoing improvements in operating efficiencies and productivity. Consequently, the barge industry has generally been able to retain its competitive position with alternate methods of transportation for bulk commodities when the origin and destination of such movements are contiguous to navigable waterways.\nDue to the capital-intensive, high fixed-cost nature of Midland's business, the negotiation of long-term contracts, which facilitate steady and efficient utilization of equipment is important to profitable operations. Midland's long-term transportation and terminalling contracts expire at various dates from January 1996 through June 2003. During 1994, approximately 38% of Midland's consolidated revenues resulted from these contracts. A substantial portion of the contracts provide for rate adjustments based on changes in various costs, including diesel fuel costs, and, additionally, contain \"force majeure\" clauses which excuse performance by the parties to the contracts when performance is prevented by circumstances beyond their reasonable control. Many of these contracts have provisions for termination for specified causes, such as material breach of the contract, environmental restrictions on the burning of coal, or loss by the customer of an underlying commodity supply contract. Penalties for termination for such causes are not generally specified. However, some contracts provide that in the event of an uncured material breach by Midland which results in termination of the contract, Midland would be responsible for reimbursing its customer for the differential between the contract price and the cost of substituted performance.\nNo customer, or group of customers under common control, accounted for 10% or more of the total revenues in 1994. On the basis of past experience and its competitive position, Midland considers that the simultaneous loss of several of its largest customers, while possible, is unlikely to happen.\nTowboats, such as those operated by Midland, are capable of moving in one tow (barge configuration) approximately 22,500 tons of cargo (equivalent to 225 one hundred-ton capacity railroad cars) on the Ohio River and upper Mississippi River and approximately 60,000 tons (equivalent to 600 one hundred-ton capacity railroad cars) on the lower Mississippi River, where there are no locks to transit. Average rates charged per ton mile for barge transportation are generally substantially below those charged by railroads.\nEnvironmental Matters\nMidland is subject to the provisions of the Federal Water Pollution Control Act, the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, the Superfund Amendment and Reauthorization Act, the Resource Conservation and Recovery Act of 1976, and the Oil Pollution Act of 1990, which permit the Coast Guard and the Environmental Protection Agency to assess penalties and clean-up costs for oil, hazardous substance, and hazardous waste discharges. Some of these acts also allow third parties to seek damages for losses caused by such discharges. Compliance with these acts has had no material effect on Midland's capital expenditures, earnings, or competitive position, and no such effect is anticipated.\nProperties\nAs of December 31, 1994, Midland's marine equipment consisted of 2,378 dry cargo barges and 90 towboats. A substantial portion of this equipment is either mortgaged to secure Midland's equipment financing obligations or chartered under long-term leases from third parties.\nIn 1994, Midland's capital expenditures were $4.3 million. These expenditures were made principally for renewal of existing equipment. In 1995 Midland expects to spend approximately $25 million for capital equipment. The increase in capital expenditures reflects primarily the replacement of barges.\nEmployees\nAs of December 31, 1994, Midland employed 1,300 persons, of whom approximately 35% are represented by labor unions. One of Midland's labor contracts expires in July 1995.\nDiscontinued Operations\nAs previously noted, in November 1994 Eastern announced its intention to sell WaterPro. On March 2, 1995, Eastern signed a purchase and sale agreement to sell WaterPro at a cash price approximately equivalent to book value, subject to certain post-closing adjustments. The closing is scheduled to occur in the second quarter of 1995.\nWaterPro is a wholesale distributor of components for the repair, improvement and expansion of municipal water supply and wastewater collection systems. WaterPro, headquartered in Edina, Minnesota, operates 28 distribution centers serving 20 states and has approximately 300 employees.\nThe primary products distributed by WaterPro include pipes, fire hydrants, valves, fittings, meters and other water system components which are purchased from a variety of sources, including nationally branded products made by prominent manufacturers. WaterPro regards these sources as adequate. Components are typically warehoused by WaterPro and then sold to contractors, as well as cities, towns and private water utilities for new systems, rehabilitation and improvement to existing lines and system expansion. WaterPro's business is affected by housing starts and related construction activity, municipal infrastructure spending levels and seasonal weather conditions.\nCompetition in WaterPro's business is intense and is based principally on price, service and product offering.\nGeneral Environmental Matters\nCertain information with respect to Eastern's compliance with Federal and state environmental statutes may be found in Item 1(c) under \"Boston Gas Company\" and \"Midland Enterprises Inc.\" and Note 11 appearing on pages 28 and 29.\nEmployees\nEastern and its wholly-owned subsidiaries employed 3,000 employees for continuing operations at December 31, 1994.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nInformation with respect to this item may be found in Item 1(c) under \"Boston Gas Company\" and \"Midland Enterprises Inc.\" Such information is incorporated herein by reference.\nItem 3.","section_3":"Item 3. Legal Proceedings\nInformation with respect to certain legal proceedings may be found in Notes 11 and 12 appearing on pages 28 through 29 and in Item 1(c) hereof under \"Boston Gas Company\" and \"Midland Enterprises Inc.\" Such information is incorporated herein by reference.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Securities Holders\nNo matter was submitted to a vote of security holders in the fourth quarter of 1994.\nExecutive Officers of the Registrant\nGeneral\nThe table below identifies the executive officers of Eastern, who are appointed annually and serve at the pleasure of Eastern's Trustees. Office Held Name Title Age Since J. Atwood Ives Chairman and Chief Executive Officer 58 1991 Richard R. Clayton President and Chief Operating Officer 56 1991 Walter J. Flaherty Senior Vice President and Chief Financial Officer 46 1992 Richard J. Klau Senior Vice President--President of WaterPro Supplies Corporation 46 1991 Chester R. Messer Senior Vice President--President of Boston Gas Company 53 1988 Fred C. Raskin Senior Vice President--President of Midland Enterprises Inc. 46 1991 L. William Law, Senior Vice President, General Counsel Jr. and Secretary 50 1995\nBusiness Experience\nPrior to joining Eastern in 1991, J. Atwood Ives was Vice Chairman, Chief Financial Officer and a member of the Office of the Chairman of General Cinema Corporation (now Harcourt General, Inc.) and The Neiman Marcus Group, Inc.\nPrior to joining Eastern in 1987 as Executive Vice President and Chief Administrative Officer, Richard R. Clayton was Chairman, President and Chief Executive Officer of Vermont Castings, Inc. He was Executive Vice President and Chief Operating Officer of Eastern from 1990 to 1991.\nWalter J. Flaherty was Senior Vice President-Administration of Boston Gas from 1988 until joining Eastern in 1991 as its Senior Vice President and Chief Administrative Officer. He has been an employee of Eastern or its subsidiaries since 1971.\nRichard J. Klau was President of Ionpure from 1989 to 1991. Prior to joining Ionpure in 1989, he was Vice President and General Manager of the Process Water Division of Millipore Corporation.\nChester R. Messer was Executive Vice President of Boston Gas in 1988. He was elected a Senior Vice President of Eastern in 1988, when he became President of Boston Gas. He has been an employee of Boston Gas since 1963.\nFred C. Raskin was Executive Vice President of Midland from 1988 to 1991. He was elected a Senior Vice President of Eastern in 1991, when he became President of Midland. He has been an employee of Eastern or its subsidiaries since 1978.\nL. William Law, Jr. has been General Counsel and Secretary of Eastern since 1987. He was elected Senior Vice President in 1995. He has been an employee of Eastern or its subsidiaries since 1975.\nPART II. Item 5.","section_5":"Item 5. Market For Registrant's Common Equity and Related Stockholder Matters\nEastern's common stock is traded on the New York, Boston and Pacific Stock Exchanges (ticker symbol EFU). The approximate number of shareholders at December 31, 1994 was 5,100.\nInformation with respect to this item may be found in the sections captioned \"Cash Dividends Per Share\" and \"Stock Price Range\" appearing on the inside back cover of the annual report to shareholders for the year ended December 31, 1994. Such information is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSUMMARY OF OPERATIONS\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following commentary should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to Financial Statements.\n1994 COMPARED TO 1993\nOverview\nThe Company had net earnings of $51.1 million, or $2.46 per share, in 1994 compared to a net loss of $77.7 million, or $3.45 per share, in 1993. Net earnings from continuing operations, which consist of Eastern's two continuing business segments--Boston Gas and Midland, were $38.9 million, or $1.87 per share, in 1994, reflecting increases of 50% and 63%, respectively, over the comparable results of $26.0 million, or $1.15 per share, in 1993. As a result of Eastern's announced intention to sell WaterPro Supplies, the financial statements for 1994 and prior periods have been restated to account for Eastern's Water Products Group, which consisted of Ionpure Technologies, prior to its sale in 1993, and WaterPro, as a discontinued operation. See Note 10. Eastern's financial results for 1993 and 1994 reflect a number of one-time gains and charges as well as the impact of unusual operating conditions that had a material effect on earnings in both years. Adjusting for these year-to-year variations, management estimates that earnings and earnings per share from continuing operations increased by approximately 14% and 23%, respectively, over 1993 results.\nThe net loss in 1993 included the effects of three substantial charges totaling $99.8 million, net of tax, or $4.43 per share, relating to an extraordinary provision for coal miners retiree health care obligations ($45.5 million, net of tax, or $2.02 per share), a write-down of WaterPro's goodwill ($45.0 million, with no tax benefit, or $2.00 per share) and the loss on the sale of Ionpure ($9.3 million, net of tax, or $.41 per share). See Notes 12 and 10, respectively, for discussion of these matters. The latter two charges are included in the loss from discontinued operations for 1993. In addition, the combined effects of a seventeen-week work stoppage at Boston Gas, severe flooding throughout the Midwest and a strike by the United Mine Workers (\"UMW\") significantly reduced operating results in 1993.\nIncluded in 1994 is an after-tax gain of $8.0 million, or $.38 per share, resulting from the settlement of Eastern's lawsuit relating to its 1989 acquisition of Ionpure, offset in part by costs relating to the anticipated sale of WaterPro. This net gain is reflected in earnings from discontinued operations. Included in earnings from continuing operations is a gain of $1.5 million, or $.07 per share, resulting from the sale of Midland's barge construction and repair facility. Unusual weather patterns in 1994 had a negative impact on earnings and partially offset the combined favorable impact of these one-time items. Although record cold temperatures early in 1994 generated higher sales to Boston Gas firm customers, the margin benefit of those sales was more than offset by increased costs for both Boston Gas and Midland caused by the extreme weather. In addition, significantly warmer than normal weather materially reduced revenue and operating earnings at Boston Gas in the fourth quarter of 1994.\n(In millions) 1994 1993 Change Revenues: Boston Gas $660.2 $614.3 7% Midland 264.7 254.9 4% Total $924.9 $869.2 6%\nThe increase in consolidated revenues from 1993 to 1994 reflects the impact of Boston Gas' November 1993 rate increase and significantly increased tonnages transported by Midland, partly offset by lower freight rates and the absence of revenues from its liquid barge business, which was sold in December 1993.\n(In millions) 1994 1993 Change Operating Earnings: Boston Gas $65.8 $49.1 34% Midland 35.8 33.0 8% Headquarters (4.2) (4.7) 10% Total $97.4 $77.4 26%\nThe improvement in operating earnings from 1993 to 1994 primarily reflects the impact of Boston Gas' 1993 rate increase, partially offset by higher depreciation and property taxes, and at Midland, the effect of\ncost reduction and productivity improvement programs and better operating conditions, partially offset by lower rates for coal transportation contracts. A seventeen-week work stoppage at Boston Gas, record flooding in the Midwest and the UMW strike, which increased operating costs and disrupted traffic patterns at Midland, decreased operating earnings in 1993.\nEarnings from continuing operations before income taxes increased to $63.4 million in 1994 from $44.5 million in 1993, primarily reflecting the increase in operating earnings described above, with higher interest expense and lower interest income offset by higher other income, as described in Note 8. The increase in interest expense reflects additional borrowings at Boston Gas and a full year of dividends paid on its preferred stock. The repurchase of shares in the fourth quarter of 1993 reduced funds available for investment in 1994, resulting in lower interest income in 1994. The effective tax rate in 1993 was 3% higher than in 1994 because of the additional deferred tax requirements resulting from the 1% increase in the federal tax rate, effective January 1, 1993.\nAs mentioned earlier, the 1993 net loss included an extraordinary provision of $70.0 million ($45.5 million, net of tax, or $2.02 per share) for coal miners retiree health care representing the estimated undiscounted liability for health care and death benefit premiums imposed by the Coal Industry Retiree Health Benefit Act of 1992, as described in Note 12.\nBoston Gas\nA $37.7 million annualized rate increase, which took effect November 1, 1993, increased 1994 revenues by $29.9 million. Increased sales to new and existing firm customers increased Boston Gas' revenues by $7.5 million. Although temperatures varied widely relative to normal over the course of 1994, they averaged 1.5% warmer than in 1993 and only 0.6% colder than normal in 1994. The record cold weather during the first quarter more than offset 18% warmer than normal weather in the fourth quarter, increasing revenues for the year by $5.5 million. The balance of the revenue increase was attributable to increased sales to non-firm customers. Most of the gross margins on these sales are credited to firm customers.\nOperating earnings increased by $16.7 million as the benefit of the rate increase, stable labor conditions and sales of gas to new firm customers were partially offset by higher depreciation, property taxes and bad debts. In total, the weather decreased 1994 operating earnings by about $3 million, reflecting higher workload-related labor and operating costs associated with the unusually cold weather in the first quarter, partially offset by additional gross margins attributable to the weather.\nMidland Enterprises\nRevenues and operating earnings increased 4% and 8%, respectively, in 1994 over 1993 due to significant increases in dry cargo transportation, reduced operating and administrative expenses achieved through ongoing cost reduction and productivity programs, as well as the absence of increased costs associated with inefficiencies caused by the Mississippi River flooding and the UMW strike in 1993. Partially offsetting were contractual and market rate reductions negotiated early in 1994, the absence of the liquid barge business, which contributed 5% and 7% of 1993 revenues and operating earnings, respectively, and higher operating expenses associated with flooding and severe winter icing conditions early in 1994. Reflecting improved market and operating conditions, revenues and operating earnings for the second half of 1994 increased by 12% and 48%, respectively, over the comparable period in 1993.\nTonnages and ton miles increased 11% and 10%, respectively, in 1994 as increased shipments of coal, aggregates, ores and towing for others more than offset the sale of Midland's liquid barge business, which accounted for approximately 5% of ton miles in 1993. Coal tonnage increased 11% from 1993, reflecting a significant increase in spot shipments and increased demand for utility coal under long-term contracts. Excluding the liquid barge business, non-coal tonnage increased 20% over 1993, despite a 15% reduction in grain tonnage, primarily as a result of increased shipments of aggregates, steel, scrap and ores. The reduction in grain tonnage reflected management's decision to de-emphasize its commitment to the grain market and to concentrate on other business areas, principally on the Ohio and the lower Mississippi rivers.\nIn June 1994 Midland recognized a pretax gain of $2.3 million on the sale of its barge construction and repair facility in Louisiana. Midland had recorded a $3.5 million reserve in December 1993 for the shutdown\ncosts and carrying charges associated with this facility. As mentioned earlier, Midland sold its liquid barge business at a pretax gain of $8.0 million in December 1993. These transactions are included in \"Other income.\"\nDiscontinued Operations--Water Products Group\nAs described in Note 10, Eastern's Water Products Group has been accounted for as a discontinued operation as a result of the decision to sell WaterPro. For the ten months ended October 31, 1994, WaterPro's revenues increased 19% from the comparable period in 1993 and its operating earnings increased from $2.8 million to $7.8 million, reflecting market share gains, improved productivity and increased construction activity. Earnings from discontinued operations in 1994 also include $9.0 million received in settlement of a lawsuit relating to Eastern's acquisition of Ionpure and related legal expenses. Revenues from discontinued operations in 1993 include $40.7 million from Ionpure through its sale, effective October 1, 1993. The loss from discontinued operations in 1993 includes a $45.0 million write-down of WaterPro's goodwill, an operating loss of $1.9 million at Ionpure and a loss of $13.0 million on the sale of Ionpure. The estimated loss of $2.5 million, net of tax, from disposition of the Water Products Group reflects the anticipated losses through the closing date plus the estimated expenses associated with the sale of WaterPro.\n1993 COMPARED TO 1992\n(In millions) 1993 1992 Change Revenues: Boston Gas $614.3 $594.3 3% Midland 254.9 263.6 (3)% Total $869.2 $857.9 1%\nConsolidated revenues increased slightly in 1993. Although a variety of market and economic factors affected the change, continued growth in the Boston Gas firm customer base offset decreases in coal and grain transportation at Midland.\n(In millions) 1993 1992 Change Operating Earnings: Boston Gas $49.1 $63.1 (22)% Midland 33.0 38.3 (14)% Headquarters (4.7) (5.1) 8% Total $77.4 $96.3 (20)%\nConsolidated operating earnings decreased from 1992, due primarily to the absence of a one-time benefit in 1992 that resulted from a modification to the gas cost recovery mechanism at Boston Gas that increased operating earnings by $11.6 million. In addition, record flooding in the Midwest and strikes by the UMW and Boston Gas union employees decreased revenues and increased operating expenses.\nEarnings from continuing operations before income taxes decreased from $65.0 million in 1992 to $44.5 million in 1993, primarily reflecting the decrease in operating earnings described above, lower interest income and higher interest expense. Interest income decreased due to lower investment balances and rates. The increase in interest expense primarily reflected additional dividends paid on subsidiary preferred stock. The higher income tax rate in 1993 resulted from the 1% increase in the federal statutory rate, as described in Note 9.\nThe loss from discontinued operations for 1993 reflected the write-down of WaterPro goodwill and the loss on the sale of Ionpure, as described above.\nNet earnings of $46.1 million in 1992 decreased to a loss of $77.7 million in 1993, reflecting the above-described 1993 extraordinary provision charge for coal miners retiree health care and the absence of the $8.2 million benefit recorded in 1992 for a change in the accounting for income taxes, as described in Note 9.\nBoston Gas\nIncreased sales to Boston Gas firm customers, primarily to an electric utility on a seasonal-firm basis, increased revenue by $21.8 million and operating earnings by $4.9 million. Relatively low residual oil prices throughout 1993 limited sales to non-firm customers and reduced comparative revenues by nearly $15.0\nmillion. However, the November 1993 rate increase and the pass through of higher gas costs were somewhat offsetting. The weather in 1993, which was 4.5% warmer than 1992, was 1.3% warmer than normal, decreasing revenues by $9.8 million and operating earnings by $1.7 million.\nExcluding the $11.6 million benefit in 1992 of the modification to the gas cost recovery mechanism, operating earnings decreased by $2.4 million as the partial impact of the rate increase in combination with the benefit of ongoing load growth offset much of the increased expenses attributable primarily to the work stoppage.\nMidland\nMidland's transportation revenues decreased in 1993 primarily as a result of reduced coal and grain shipments caused by the severe flooding on the Mississippi and Illinois Rivers and reduced exports of both commodities, the curtailment of coal shipments under a major long-term contract and lower deliveries to electric utilities caused by the UMW strike. Midland's tonnage and ton miles were unchanged from 1992 despite several significant events that negatively affected the barge industry in general and Midland specifically. A decline in coal tonnage from 1992 primarily reflected reduced shipments to electric utilities due to the UMW strike (resolved in December), disruption in river traffic caused by flooding, and the cessation of coal shipments under a long-term contract. An increase in non-coal tonnage, despite a significant reduction in grain tonnage, served to replace the lower coal volume, although at lower margins. Benefits of cost savings programs helped to offset much of the lost margins. Higher coal terminal throughput was offset by lower phosphate terminalling.\nIn addition to restricting tonnage and altering traffic patterns, flooding increased operating costs and shifted business to less profitable markets.\nLIQUIDITY AND CAPITAL RESOURCES\nManagement believes that projected cash flow from operations, in combination with currently available resources, is more than sufficient to meet Eastern's 1995 capital expenditure and working capital requirements, normal debt repayments and anticipated dividends to shareholders.\nIn addition to cash and short-term investments in excess of $60 million, Eastern also maintains a $100 million long-term revolving credit agreement plus other lines, all of which are available for general corporate purposes. At December 31, 1994 there were no borrowings outstanding under any of these facilities.\nEastern's capital structure is depicted in the chart below. The decrease in equity in 1993 reflects the impact of non-cash charges associated with the provision for coal miners retiree health care, the write-down of WaterPro goodwill and the loss on the sale of Ionpure. Through a combination of increased equity and debt, Eastern expects to continue its policy of capitalizing Boston Gas and Midland with approximately equal amounts of equity and long-term debt. Both subsidiaries maintain \"A\" ratings with the major rating agencies.\nCAPITAL STRUCTURE ($ in millions) [Bar chart--plot points below]\n1990 1991 1992 1993 1994 Debt 297 327 357 329 365 Equity 513 503 518 364 374 Total Capital 810 830 875 693 740 L-T Debt\/Total Capital 37% 39% 41% 47% 49%\nDuring 1994 Boston Gas issued $50.0 million of Medium-Term Notes Series B, with a weighted average maturity of 21 years and coupon of 7.20%.\nTo meet working capital requirements which reflect the seasonal nature of the gas distribution business, Boston Gas had notes outstanding of $62.5 million at December 31, 1994, a decrease of $43.8 million from the prior year, primarily reflecting the use of proceeds from the issuance of medium-term notes.\nBoston Gas also maintains a bank credit agreement which supports the issuance of up to $90 million of commercial paper to fund its inventory of gas supplies. At December 31, 1994, Boston Gas had outstanding $53.6 million of commercial paper for this purpose.\nConsolidated capital expenditures are budgeted at approximately $83 million for 1995, two-thirds of which are for Boston Gas and the balance for Midland.\nDuring 1994 Eastern repurchased 603,500 shares of its common stock for $14.6 million.\nOTHER MATTERS\nBoston Gas may have or share responsibility for environmental remediation of certain former manufactured gas plant sites, as described in Note 11. A subsidiary of New England Electric System has assumed responsibility for remediating eleven of the fifteen such sites owned by Boston Gas, subject to a limited contribution by the latter. A 1990 regulatory settlement agreement provides for recovery by Boston Gas of environmental costs associated with such sites over separate, seven-year amortization periods without a return on the unamortized balance. Although Eastern does not possess at this time sufficient information to reasonably determine the ultimate cost to Boston Gas of such remediation, it believes that it is not probable that such costs will materially affect Eastern's financial condition or results of operations.\nEastern may share responsibility for environmental remediation in the vicinity of a former coal tar processing facility in Everett, Massachusetts, as described in Note 11. Eastern does not possess at this time sufficient information to reasonably determine or estimate the ultimate cost to it of such remediation.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPage Consolidated Statements of Operations 17 Consolidated Balance Sheets 18 Consolidated Statements of Cash Flows 19 Consolidated Statements of Shareholders' Equity 20 Notes to Financial Statements 21 Unaudited Quarterly Financial Information 32 Independent Auditors' Report 33 Management's Report on Responsibility 33\nCONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31, (In thousands, except per share amounts) 1994 1993 1992 Revenues $924,850 $869,215 $857,947 Operating costs and expenses: Operating costs 668,287 642,603 619,754 Selling, general and administrative expenses 100,332 96,024 94,392 Depreciation and amortization 58,856 53,199 47,545 Operating earnings 97,375 77,389 96,256 Other income (expense): Interest income 1,901 3,213 4,703 Interest expense (38,464) (35,039) (33,537) Other, net 2,553 (1,056) (2,414) Earnings from continuing operations before income taxes 63,365 44,507 65,008 Provision for income taxes 24,458 18,485 23,896 Earnings from continuing operations before extraordinary item and accounting change 38,907 26,022 41,112 Earnings (loss) from discontinued operations, net of tax 12,212 (58,182) (3,206) Earnings (loss) before extraordinary item and accounting change 51,119 (32,160) 37,906 Extraordinary provision for coal miners retiree health care, net of tax -- (45,500) -- Cumulative effect of change in accounting for income taxes -- -- 8,209 Net earnings (loss) $ 51,119 $(77,660) $ 46,115 Earnings per share from continuing operations before extraordinary item and accounting change $1.87 $1.15 $1.81 Discontinued operations .59 (2.58) (.14) Extraordinary provision for coal miners retiree health care, net of tax -- (2.02) -- Cumulative effect of change in accounting for income taxes -- -- .37 Net earnings (loss) per share $2.46 $(3.45) $2.04 The accompanying notes are an integral part of these financial statements.\nCONSOLIDATED BALANCE SHEETS\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.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO FINANCIAL STATEMENTS\n1. Accounting Policies\nThe consolidated financial statements include the accounts of Eastern Enterprises (\"Eastern\"), Boston Gas Company (\"Boston Gas\") and Midland Enterprises Inc. (\"Midland\"). Financial information for Water Products Group, consisting of WaterPro Supplies Corporation (\"WaterPro\") and Ionpure Technologies Corporation (\"Ionpure\"), has been restated to conform to discontinued operations presentation (See Note 10).\nCertain prior year financial statement information has been reclassified to be consistent with the current presentation. All material intercompany balances and transactions have been eliminated in consolidation. Certain accounting policies followed by Eastern and its subsidiaries are described below:\nCash and short-term investments: Highly liquid instruments with original maturities of three months or less are considered cash equivalents.\nInventories: Inventories are valued at the lower of cost or market using the first-in, first-out (FIFO) or average cost method. The components of inventories were as follows: December 31, (In thousands) 1994 1993\nSupplemental gas supplies $46,844 $53,152 Other materials, supplies and marine fuel 13,363 17,984 $60,207 $71,136\nInvestment in U.S. Filter: Eastern holds 3,041,092 shares or 18% of the voting stock of U.S. Filter. Eastern accounts for its investment in U.S. Filter using the equity method, with a lag of one fiscal quarter. The difference of approximately $20 million between the carrying value of Eastern's investment and its share of the underlying net assets of U.S. Filter is being amortized over a period of 40 years.\nOther current liabilities: Included in other current liabilities were:\nDecember 31, (In thousands) 1994 1993 Pipeline refunds due utility customers $18,720 $ 8,029 Pipeline transition costs regulatory liability 11,560 24,174 Reserves for insurance claims 8,809 8,285 Dividends payable 7,154 7,930 Coal miners retiree health care 10,538 6,940\nRevenue recognition: Boston Gas' revenues are recorded when billed. Boston Gas defers the cost of any firm gas that has been distributed, but is unbilled at the end of a period, to the period in which the gas is billed to customers. Midland recognizes revenue on tows in progress on the percentage of completion method based on miles traveled.\nDepreciation and amortization: Depreciation and amortization are provided using the straight-line method at rates designed to allocate the cost of property and equipment over their estimated useful lives. Because the rates of depreciation on commercial equipment vary with each property unit, it is impractical to state each rate individually. Depreciation and amortization as a percentage of average depreciable assets was as follows:\nYears Ended December 31, 1994 1993 Boston Gas 5.2% 4.0% Midland 3.9% 4.2% Headquarters 12.4% 11.2%\nNOTES TO FINANCIAL STATEMENTS--(Continued)\nEarnings per share: Earnings per share are based on the weighted average number of common and common equivalent shares outstanding. Such shares amounted to 20,789,000 in 1994, 22,530,000 in 1993 and 22,654,000 in 1992. Fully diluted earnings per share were not materially different from primary earnings per share.\n2. Business Segment Information\nOperating results and other financial data are presented for Eastern's two business segments: Boston Gas, a local gas distribution company serving eastern and central Massachusetts, and Midland, a barge transportation company operating on the inland waterways.\n(In thousands) 1994 1993 1992 Revenues: Boston Gas $ 660,158 $ 614,294 $ 594,330 Midland 264,692 254,921 263,617 $ 924,850 $ 869,215 $ 857,947 Operating earnings: Boston Gas $ 65,791 $ 49,063 $ 63,120 Midland 35,805 33,001 38,277 Headquarters (4,221) (4,675) (5,141) $ 97,375 $ 77,389 $ 96,256 Identifiable assets, net of depreciation and reserves: Boston Gas $ 833,620 $ 834,440 $ 738,604 Midland 345,625 373,144 395,097 Headquarters 160,074 155,607 264,149 $1,339,319 $1,363,191 $1,397,850 Capital expenditures: Boston Gas $ 53,504 $ 47,057 $ 51,136 Midland 4,337 14,191 29,327 Headquarters 42 202 75 $ 57,883 $ 61,450 $ 80,538 Depreciation and amortization: Boston Gas $ 35,809 $ 27,566 $ 22,493 Midland 22,659 25,288 24,607 Headquarters 388 345 445 $ 58,856 $ 53,199 $ 47,545\nOperating loss under \"Headquarters\" reflects unallocated corporate general and administrative expenses. Identifiable assets under \"Headquarters\" include primarily cash, short-term investments, WaterPro net assets held for sale and the investment in U.S. Filter.\nNOTES TO FINANCIAL STATEMENTS--(Continued)\n3. Long-Term Obligations and Current Debt\nCredit agreement and lines of credit: In 1994 Eastern negotiated a credit agreement with a group of banks which provides for the borrowing by Eastern and certain subsidiaries of up to $100,000,000 at any time through December 31, 1999. In addition, Boston Gas maintains committed lines of credit totaling $40,000,000. At December 31, 1994 and 1993 no borrowings were outstanding under credit agreements. The interest rate for borrowings is the agent bank's prime rate or, at Eastern's option, various alternatives. The agreement and lines require facility or commitment fees, which average 1\/8 of 1% of the commitment. Boston Gas utilizes the credit agreement and the lines of credit to back its commercial paper borrowings. In addition, Eastern and Boston Gas have various uncommitted lines of credit which are utilized for short-term borrowings and provide for interest at federal funds, money market or prime rates. Included in current debt were $62,530,000 and $106,300,000 of commercial paper and notes payable with weighted average interest rates of 5.93% and 3.50% at December 31, 1994 and 1993, respectively.\nGas inventory financing: Boston Gas maintains a credit agreement with a group of banks which provides for the borrowing of up to $90,000,000 for the exclusive purpose of funding its inventory of gas supplies or for backing commercial paper issued for the same purpose. All costs related to this funding are recoverable from customers. Boston Gas had $53,578,000 and $59,297,000 of commercial paper outstanding to fund its inventory of gas supplies at December 31, 1994 and 1993, respectively. Since the commercial paper is supported by the credit agreement, these borrowings have been classified as non-current in the accompanying consolidated balance sheets. The credit agreement includes a one-year revolving credit which may be converted to a two-year term loan at the option of Boston Gas if the one-year revolving credit is not renewed by the banks. Boston Gas may select interest rate alternatives based on prime or Eurodollar rates and requires a facility fee of 1\/10 of 1% on the commitment. No borrowings were outstanding under this agreement during 1994 and 1993.\nDescription of long-term debt: Long-term debt: December 31, (In thousands) 1994 1993 Boston Gas: 7.95%-9% Sinking Fund Debentures, due 1997-2001 $ 60,000 $ 63,142 8.33%-9.75% Medium-Term Notes, Series A, due 2005-2022 100,000 100,000 6.93-8.50% Medium-Term Notes, Series B, due 2006-2024 50,000 -- First Mortgage Bonds-8.375% Series, due 1996 2,880 3,360 Capital leases 5,690 7,008 Less--current portion (1,890) (2,165) 216,680 171,345 Midland: First Preferred Ship Mortgage Bonds- 9.9% Series, due 2008 48,758 48,692 8.1%-9.85% Medium-Term Notes, Series A, due 2002-2012 71,000 75,000 Promissory Note, due 1995 -- 3,031 8.8% Ship Financing Bond, due 1996 -- 938 Capital leases 32,404 35,804 Less--current portion (3,354) (5,871) 148,808 157,594 $365,488 $328,939\nNOTES TO FINANCIAL STATEMENTS--(Continued)\nIn 1994 Boston Gas issued $50,000,000 of Medium-Term Notes, Series B, with a weighted average maturity of 21 years and coupon of 7.2%. The Series B Notes include $12,000,000 maturing in 2006 with a put option at par in 1999 and an interest rate step up from 8.09% to 8.59% in 1999. Proceeds from the issuances reduced current debt.\nBoston Gas' First Mortgage Bonds are secured by a first mortgage lien on a portion of Boston Gas' utility properties and franchises.\nMidland's First Preferred Ship Mortgage Bonds and Medium-Term Notes are secured by certain transportation equipment.\nCapital leases consist of property and equipment lease obligations with a weighted average interest rate of 9.68%. Minimum lease payments under these agreements are due in installments through 2003.\nFive-year operating lease and sinking fund commitments: In addition to the property and equipment financed under capital leases, Eastern and its subsidiaries lease certain facilities, vessels and equipment under long-term operating leases which expire on various dates through the year 2008. Total rentals charged to expense were $10,882,000 in 1994, $10,131,000 in 1993 and $8,653,000 in 1992.\nFuture minimum lease commitments under operating leases are $9,547,000, $8,586,000, $5,372,000, $2,633,000, $1,925,000 for 1995 through 1999, respectively, and $7,176,000 thereafter.\nSinking fund requirements and maturities, net of amounts acquired in advance are $5,243,000, $7,593,000, $13,086,000, $12,975,000 and $18,482,000 for 1995 through 1999, respectively.\n4. Preferred Stock of Subsidiary\nIn 1992 Boston Gas sold 1,200,000 shares of variable-term cumulative preferred stock, which is non-voting and has a liquidation value of $25 per share. In 1993, Boston Gas selected a Final Term ending September 1, 2018 and fixed the annual dividend rate at 6.421%, payable quarterly. The Final Term requires 5% annual sinking fund payments beginning on September 1, 1999. The preferred stock cannot be called prior to 2003.\n5. Stock Plans\nEastern has a stock option plan which provides for the issuance of non-qualified stock options, incentive stock options and stock appreciation rights (\"SARs\") to its officers and key employees. Options and SARs may be granted at prices not less than fair market value on the date of grant for periods not extending beyond ten years from the date of grant. Exercise of an option requires surrender of the related SAR, if any. Exercise of an SAR requires surrender of the related option.\nShares available for future grants under the stock option plans were 98,988 at December 31, 1994, 199,334 at December 31, 1993 and 188,806 at December 31, 1992. Stock options exercisable at December 31, 1994 and 1993 were 438,291 and 389,188 respectively. SARs exercisable at December 31, 1994 and 1993 were 124,150 and 121,100, respectively.\nOption activity during the past three years was as follows:\nAverage Stock option price options SARs Outstanding at December 31, 1991 $25.72 631,281 169,595 Granted 27.06 2,000 -- Exercised 21.79 (20,569) (22,647) Surrendered 21.49 (22,647) (1,850) Canceled 28.47 (5,220) (2,410) Outstanding at December 31, 1992 $26.00 584,845 142,688 Exercised 21.93 (10,109) (8,588) Surrendered 21.97 (8,588) (120) Canceled 29.16 (1,940) (970)\nNOTES TO FINANCIAL STATEMENTS--(Continued) Average Stock option price options SARs Outstanding at December 31, 1993 $26.12 564,208 133,010 Granted 24.24 108,000 -- Exercised 20.38 (7,547) (150) Surrendered 21.69 (150) -- Canceled 29.29 (9,800) (4,900) Outstanding at December 31, 1994 $25.83 654,711 127,960\nUnder Restricted Stock Plans for key employees and non-employee trustees, Eastern awarded 6,000 shares in 1994, 4,000 shares in 1993 and 52,500 shares in 1992. Eastern recognized compensation expense of $450,000 in 1994, $367,000 in 1993 and $292,000 in 1992 in accordance with the vesting terms of these awards. Shares available for future awards under these plans were 42,500 shares at December 31, 1994 and 48,500 at December 31, 1993.\n6. Common Stock Purchase Rights\nOn February 22, 1990, Eastern declared a distribution to shareholders of record on March 5, 1990, pursuant to the terms of a Common Stock Rights Agreement between Eastern and the Rights Agent (currently The First National Bank of Boston), of one common stock purchase right for each outstanding share of common stock. Each right would initially entitle the holder to purchase one share of common stock at an exercise price of $100.00, subject to adjustment to prevent dilution. The rights become exercisable on the 10th business day after a person acquires 20% or more of Eastern's stock or commences a tender offer for 20% or more of Eastern's stock, or on the 10th business day after Eastern's Board of Trustees determines that a shareholder owning at least 10% of Eastern's stock is an \"adverse person,\" based on criteria specified in the rights agreement. The rights may be redeemed by Eastern at a price of $.01 at any time prior to the 10th day after a 20% position has been acquired. The rights will expire on March 5, 2000.\nIf Eastern is acquired in a merger or other business combination, each right will entitle its holder to purchase common shares of the acquiring company having a market value of twice the exercise price of each right (i.e., at a 50% discount). If an acquiror purchases 20% of Eastern's common stock or has been determined to be an \"adverse person,\" each right will entitle its holder to purchase a number of Eastern's common shares having a market value of twice the right's exercise price.\n7. Interest Expense Years Ended December 31, (In thousands) 1994 1993 1992 Interest on long-term debt $32,430 $31,326 $31,781 Other, including amortization of debt expense 5,040 3,488 2,988 Less--capitalized interest (932) (1,164) (1,637) Subsidiary preferred stock dividends 1,926 1,389 405 Interest expense $38,464 $35,039 $33,537 Interest payments $36,686 $34,040 $33,002\nNOTES TO FINANCIAL STATEMENTS--(Continued)\n8. Other Income (Expense)\nYears Ended December 31, (In thousands) 1994 1993 1992\nShutdown and subsequent sale of barge construction facility $2,600 $(3,500) $ -- Gain on sale of liquid barge business -- 7,988 -- Provision for environmental expenses (725) (5,715) (2,500) Other 678 171 86 $2,553 $(1,056) $(2,414)\n9. Income Taxes\nThe table below reconciles the statutory U.S. Federal income tax provision from continuing operations to the recorded income tax provision:\nYears Ended December 31, (In thousands) 1994 1993 1992 Statutory rate 35% 35% 34% Computed provision for income taxes at statutory Federal rate $22,178 $15,577 $22,103 Increase (decrease) from statutory rate resulting principally from: State taxes, net of Federal benefit 2,083 1,636 2,165 Deferred tax effect of change in statutory rate -- 1,419 -- Other, net 197 (147) (372) Provision for income taxes $24,458 $18,485 $23,896 Effective rate 39% 42% 37%\nFollowing is a summary of the provision for income taxes:\nYears Ended December 31, (In thousands) 1994 1993 1992 Current: Federal $18,059 $ 9,598 $14,059 State 821 1,197 3,677 Total current provision 18,880 10,795 17,736 Deferred: Federal 3,194 6,370 5,560 State 2,384 1,320 600 Total deferred provision 5,578 7,690 6,160 Provision for income taxes $24,458 $18,485 $23,896 Tax payments $17,951 $10,809 $ 6,656\nEffective January 1, 1992, Eastern adopted Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes\" by recording a credit to income of approximately $8,209,000 or $.37 per share, which represents the net decrease to the deferred tax liabilities for non-utility operations as of that date. This amount has been reflected in the consolidated statement of operations as the cumulative effect of the accounting change. The cumulative effect for Boston Gas and the impact of the 1993 tax increase have been recorded as a regulatory asset and are being recovered in accordance with Boston Gas' 1993 rate order.\nThe Revenue Reconciliation Act of 1993 increased the statutory Federal income tax rate from 34% to 35%, effective January 1, 1993. The provision for income tax in 1993 includes approximately $447,000 for the impact of the rate change on current earnings, and approximately $1,419,000 to reflect the additional deferred tax requirements for non-utility operations as of January 1, 1993, in accordance with SFAS 109.\nNOTES TO FINANCIAL STATEMENTS--(Continued)\nSignificant items making up deferred tax liabilities and deferred tax assets are as follows: December 31, (In thousands) 1994 1993 Assets: Unbilled revenue $ 30,978 $ 30,924 Coal miners retiree health care 24,043 24,500 Bad debt reserve 6,285 5,429 Regulatory liabilities 5,233 5,494 Deferred investment tax credits 5,213 5,437 Other 15,561 12,464 Total deferred tax assets 87,313 84,248 Liabilities: Accelerated depreciation (131,310) (130,005) Deferred gas costs (23,455) (23,861) Other (25,245) (17,830) Total deferred tax liabilities (180,010) (171,696) Total deferred taxes $ (92,697) $ (87,448)\n10. Discontinued Operations\nOn November 8, 1994, Eastern announced its intention to sell WaterPro. On March 2, 1995, Eastern signed a purchase and sale agreement to sell WaterPro at a cash price approximately equivalent to book value, subject to certain post-closing adjustments. The sale of WaterPro, which is scheduled to close in the second quarter of 1995, will complete the disposition of Eastern's Water Products Group, which consisted of WaterPro and Ionpure prior to the sale of the latter in 1993. The disposal of Water Products Group has been accounted for as a discontinued operation and accordingly, its net assets and operating results for both the current and prior periods are segregated and reported as discontinued operations in the accompanying consolidated financial statements.\nFollowing is a summary of results of operations for the Water Products Group through the measurement date of October 31, 1994 and the estimated gain or loss on disposition:\n(In thousands) 1994 1993 1992 Revenues $189,125 $230,632 $233,487 Earnings (loss) before income taxes $ 17,544 $(61,129) $ (1,977) Provision (benefit) for income taxes 2,832 (2,947) 1,229 Earnings (loss) from operations of discontinued operations 14,712 (58,182) (3,206) Loss on disposition before income taxes (3,850) -- -- Benefit for income taxes 1,350 -- -- Loss on disposition (2,500) -- -- Net earnings (loss) from discontinued operations $ 12,212 $(58,182) $ (3,206)\nThe tax provision from operations in 1994 includes a benefit of $1,760,000 related to a tax examination of Ionpure concluded during that year. The net loss on disposition of $2,500,000 reflects an accrual for estimated expenses on the sale of WaterPro, including anticipated losses from operations from the measurement date through the expected disposal date.\nNOTES TO FINANCIAL STATEMENTS--(Continued)\nEarnings (loss) from operations of discontinued operations include the following:\n(In thousands) 1994 1993 1992 Operations $6,591 $(2,094) $(2,150) Writedown of WaterPro goodwill -- (45,000) -- Sale of Ionpure 1,038 (9,300) -- Settlement of lawsuit concerning Ionpure acquisition, net of legal costs 7,083 (1,788) (1,056) $14,712 $(58,182) $(3,206) 11. Environmental Matters\nBoston Gas, like many other companies in the natural gas industry, is party to governmental actions requiring investigation and possible remediation of former manufactured gas plant (\"MGP\") sites. Boston Gas currently owns fifteen former MGP sites. Massachusetts Electric Company (\"MEC\"), a wholly-owned subsidiary of New England Electric System (\"NEES\"), has assumed full responsibility for remediating one such MGP site in Lynn, Massachusetts, pursuant to the decision of the First Circuit Court of Appeals in John S. Boyd Inc. et al. v. Boston Gas Company, et al., which affirmed that NEES and its subsidiaries are responsible for remediating the site as prior owners and operators. Pursuant to a settlement agreement between MEC and Boston Gas (the \"Settlement Agreement\"), MEC has also assumed responsibility for remediating ten other sites owned by Boston Gas, subject to limited contribution by Boston Gas. Boston Gas is working with the Massachusetts Department of Environmental Protection (the \"DEP\") to determine the extent of remediation which may be required at the four former MGP sites currently owned by Boston Gas and not covered by the Settlement Agreement or the Boyd decision. Boston Gas is aware of other former MGP sites located within Boston Gas' service territory but not currently owned by Boston Gas. A 1990 settlement agreement with the Massachusetts Department of Public Utilities provides for recovery by Boston Gas through the cost of gas adjustment clause of any environmental response costs associated with MGP sites over separate, seven-year amortization periods without a return on the unamortized balance. Due to uncertainties as to the extent and sources of releases of compounds, as well as the nature and extent of any required remediation, management does not possess at this time sufficient information to reasonably determine the ultimate cost to Boston Gas of remediation at such sites, but believes that it is not probable that such costs will materially affect Eastern's financial condition or results of operations, particularly given Boston Gas' limited financial exposure due to the Settlement Agreement as well as its ability to recover all such costs incurred.\nEastern is aware of certain non-utility sites, associated with operations in which it is no longer involved, for which it may have or share environmental remediation responsibility. While Eastern has provided reserves that cover some anticipated costs of remediation of the site of a former coal tar processing facility in Everett, Massachusetts (the \"Facility\") and believes that it has provided adequate reserves to cover the estimated costs of remediation of the other such sites, the extent of Eastern's potential liability at such sites is not yet determinable.\nThe Facility, which was located on a 10-acre parcel of land formerly owned by Eastern, was operated by predecessors of Allied-Signal, Inc. from the early 1900s until 1937 and by Koppers Company, predecessor of Beazer East, Inc. (and Eastern's controlling stockholder until 1951) from 1937 until 1960 when the Facility was shut down. The Facility processed coal tar purchased from Eastern's adjacent by-product coke plant, also shut down in 1960. Eastern, Beazer and Allied-Signal entered into an Administrative Consent Order with the DEP in 1989 which requires that they jointly investigate and develop a remedial response plan for the Facility site, including any area where a release from that site may have come to be located. The companies have entered into a cost-sharing agreement under which each company has agreed to bear one-third of the costs of compliance with the Consent Order, while preserving any claims it may have against the other companies. In 1993 the companies completed preliminary remedial measures, including abatement of seepage of materials into the adjacent Island End River, a 29-acre tidal river which is part of Boston harbor. Studies\nNOTES TO FINANCIAL STATEMENTS--(Continued)\nhave identified compounds that may be associated with coal tar and\/or oil in soil and ground water at the site and adjacent areas and in the Island End River sediments. The National Oceanic and Atmospheric Administration and the Coast Guard are working with the DEP in connection with further investigation and possible remediation of river sediment conditions. In addition, the U.S. Environmental Protection Agency is currently evaluating the Facility site and the Island End River for possible designation as a federal priority Superfund site. In light of uncertainties as to the extent and sources of releases of compounds, the nature of any required remediation, the area and volume of soil, ground water and\/or sediments that may be included, the possibility of participation by additional potentially responsible parties and the apportionment of liability, Eastern does not possess at this time sufficient information to reasonably determine or estimate the ultimate cost to it of such remedial measures. Eastern is recovering certain costs of its legal defense and may be entitled to recovery of remediation costs from its insurers with respect to this matter.\n12. Coal Miners Retiree Health Care\nIn September 1993 Eastern received notice from the Social Security Administration (\"SSA\") claiming that Eastern is responsible for health care and death benefit premiums for certain retired coal miners and their beneficiaries under the federal Coal Industry Retiree Health Benefit Act of 1992 (the \"Coal Act\"). The amount of premiums requested aggregates in excess of $5,000,000 to cover an initial 20 month period ending September 30, 1994, and relates to retired miners who are said to have worked for Eastern's Coal Division prior to the transfer of those operations to a subsidiary in 1965. Eastern has not yet received a bill for subsequent periods. Eastern has filed a lawsuit in the Federal District Court for Massachusetts challenging the constitutionality of the Coal Act as applied to it, and asserting a claim against Peabody Holding Company, Inc. (\"Peabody\"), to which Eastern sold its coal subsidiaries in 1987, that any liabilities under the Coal Act should be borne by Peabody and such subsidiaries. Eastern has posted security to delay payment of premiums pending the outcome of its constitutional challenge. Eastern is aware of several other lawsuits challenging the constitutionality of the Coal Act.\nIn 1993 Eastern recorded a reserve of $70,000,000 to provide for its estimated undiscounted obligations under the Coal Act. This amount was reflected as an extraordinary item of $45,500,000 net of tax or $2.02 per share, in accordance with the conclusions of the Financial Accounting Standard Board's Emerging Issues Task Force, which has determined that any entity such as Eastern which no longer has operations in the coal industry should account for its entire obligation under the Coal Act as an extraordinary item. Eastern's obligation could range from zero to more than $100 million depending on the outcome of its constitutional challenge or its claim against Peabody, or other factors including administrative review of assigned individuals, medical inflation rates, Medicare reimbursements and other changes in government health care programs.\n13. Retiree Benefits\nEastern and its subsidiaries, through various company administered plans and other union retirement and welfare plans under collective bargaining agreements, provide retirement benefits for the majority of their employees, including pension and certain health care and life insurance benefits. Normal retirement age is 65 but provision is made for earlier retirement. Pension benefits for salaried plans are based on salary and years of service, while union retirement and welfare plans are based on negotiated benefits and years of service. Employees hired before 1993 who are participants in the pension plans become eligible for health care benefits if they reach retirement age while working for Eastern. The funding of retirement and employee benefit plans is in accordance with the requirements of the plans and collective bargaining agreements and, where applicable, in sufficient amounts to satisfy the \"Minimum Funding Standards\" of the Employee Retirement Income Security Act (\"ERISA\"). The net cost for these plans and agreements charged to expense was as follows:\nNOTES TO FINANCIAL STATEMENTS--(Continued)\nPensions Years Ended December 31, (In thousands) 1994 1993 1992 Service cost $ 4,792 $ 4,282 $ 3,852 Interest cost on projected benefit obligation 10,005 9,791 8,940 Actual return on plan assets (6,540) (21,690) (12,945) Net amortization and deferral (3,903) 10,674 2,572 Total net pension cost of company-administered plans 4,354 3,057 2,419 Multi-employer union retirement and welfare plans 309 377 321 Total net pension cost $ 4,663 $ 3,434 $ 2,740\nHealth Care Years Ended December 31, (In thousands) 1994 1993 1992\nService cost $ 907 $ 1,566 $ 1,459 Interest cost on accumulated benefits obligation 6,038 8,035 8,847 Actual return on plan assets (755) (282) (173) Net amortization and deferral (2,739) (1,183) (247) Boston Gas deferral 3,472 (2,275) (4,447) Total retiree health care cost $ 6,923 $ 5,861 $ 5,439\nThe following table sets forth the funded status of company-administered plans and amounts recorded in Eastern's consolidated balance sheet as of December 31, 1994 and 1993 using actuarial measurement dates as of October 1, 1994 and 1993:\nPensions Health Care (In thousands) 1994 1993 1994 1993 Accumulated benefit obligation: Vested benefits $113,306 $104,355 $ 75,983 $ 67,492 Non-vested benefits 15,195 13,275 15,069 15,741 128,501 117,630 91,052 83,233 Effect of future salary increases 18,896 18,820 -- -- Projected benefit obligation (\"PBO\") $147,397 $136,450 $ 91,052 $ 83,233 Plan assets at fair value $155,808 $152,925 $ 11,611 $ 10,856 Less PBO 147,397 136,450 91,052 83,233 Plan assets in excess of (less than) PBO 8,411 16,475 (79,441) (72,377) Unrecognized net obligation at December 31, 1985 being amortized over 15 years 2,542 2,951 -- -- Unrecognized net (gain) loss (12,498) (19,638) (7,119) (15,171) Unrecognized prior service cost (benefit) 16,313 15,837 (15,822) (17,182) Amounts contributed to plans during fourth quarter 534 476 -- -- Unfunded accumulated benefits (2,591) (1,291) -- -- Net asset (reserve) at $ $ December 31 12,711 14,810 $(102,382) $(104,730)\nThe above vested health care benefits include $66,544,000 and $58,380,000 for retirees in 1994 and 1993, respectively. To fund health care benefits under its collective bargaining agreements Boston Gas maintains a Voluntary Employee Beneficiary Association (\"VEBA\"), to which it makes contributions from time to time. Plan assets are invested in equity securities, fixed-income investments and money market instruments.\nNOTES TO FINANCIAL STATEMENTS--(Continued)\nFollowing are the assumptions used in the actuarial measurements:\n1994 1993 Discount rate 7.5% 7.5% Return on plan assets 8.5% 8.5% Increase in future compensation 5.0% 5.0% Health care inflation trend 11.0% 12.0%\nThe health care inflation trend is assumed to drop gradually to 5% after 6 years. A one-percentage-point increase in the assumed health care cost trend would have increased the net periodic post-retirement benefit cost charged to expense and the accumulated benefit obligation by $73,000 and $7,227,000 and, $62,000 and $6,440,000, respectively, in 1994 and 1993.\n14. Fair Values of Financial Instruments\nEffective January 1, 1994, Eastern adopted Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires investments in debt and equity securities other than those accounted for under the equity method to be carried at fair value or amortized cost for debt securities expected to be held to maturity. Pursuant to SFAS 115, Eastern has classified its investments in debt and equity securities as available for sale. Accordingly, the net unrealized gains and losses computed in marking these securities to market have been reported as a component of shareholders' equity. At December 31, 1994 the difference between the fair value and the original cost of these securities is a net gain of $633,000.\nThe following methods and assumptions were used to estimate the fair value disclosures for financial instruments:\nCash, short-term investments and debt: The carrying amounts approximate fair value because of the short maturity of those instruments. Short-term debt includes notes payable, gas inventory financing and other miscellaneous short-term liabilities.\nLong-term debt and preferred stock of subsidiary: The fair values are based on currently quoted market prices.\nThe carrying amounts and estimated fair values of Eastern's financial instruments are as follows:\nDecember 31, (In thousands) 1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value\nCash and short-term investments $ 60,854 $ 60,854 $ 52,211 $ 52,211 Short-term debt 116,108 116,108 165,596 165,596 Long-term debt 370,732 372,869 336,975 384,850 Preferred stock of subsidiary 29,229 26,250 29,197 30,600\nNOTES TO FINANCIAL STATEMENTS--(Continued)\n15. Unaudited Quarterly Financial Information\nFor the three months ended (In thousands, except per June Sept share amounts) Mar 31, 30, 30, Dec 31 1994: Revenues $372,468 $191,793 $139,222 $221,367 Operating earnings (loss) 57,126 14,256 (478) 26,471 Earnings (loss) from continuing operations before income taxes 47,832 7,970 (9,413) 16,976 Earnings (loss) from continuing operations 28,862 5,015 (5,594) 10,624 Earnings (loss) from discontinued operations (174) 1,146 2,481 8,759 Net earnings (loss) $ 28,688 $ 6,161 $ (3,113) $ 19,383 Earnings (loss) per share from continuing operations $1.38 $.24 $(.27) $.52 Earnings (loss) per share from discontinued operations (.01) .05 .13 .42 Net earnings (loss) per share $1.37 $29 $(.14) $.94 1993: Revenues $324,077 $195,312 $123,033 $226,793 Operating earnings (loss) 49,230 12,832 (7,142) 22,469 Earnings (loss) from continuing operations before income taxes 41,109 5,184 (14,652) 12,866 Earnings (loss) from continuing operations before extraordinary item 25,340 3,581 (10,370) 7,471 Loss from discontinued operations (2,315) (317) (10,628) (44,922) Extraordinary item net of tax -- -- -- (45,500) Net earnings (loss) $ 23,025 $ 3,264 $(20,998) $(82,951) Earnings (loss) per share from continuing operations before extraordinary item $1.12 $.16 $(.46) $ .33 Loss per share from discontinued operations (.10) (.02) (.47) (1.99) Extraordinary item net of tax -- -- -- (2.02) Net earnings (loss) per share $1.02 $.14 $(.93) $(3.68)\nINDEPENDENT AUDITORS' REPORT\nTo the Trustees and Shareholders of Eastern Enterprises:\nWe have audited the accompanying consolidated balance sheets of Eastern Enterprises (a Massachusetts voluntary association) 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. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Eastern Enterprises 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 9 to the consolidated financial statements, effective January 1, 1992 the company changed its method of accounting for income taxes. As explained in Note 14 to the consolidated financial statements, effective January 1, 1994 the company changed its method of accounting for securities.\nArthur Andersen LLP\nBoston, Massachusetts January 25, 1995 (except with respect to the matter discussed in Note 10, as to which the date is March 2, 1995).\nMANAGEMENT'S REPORT ON RESPONSIBILITY\nThe management of Eastern Enterprises is responsible for the preparation, integrity and fair presentation of the company's financial statements. These statements have been prepared in accordance with generally accepted accounting principles and, as such, include amounts based on management's informed judgments and estimates. The financial statements have been audited by the independent accounting firm of Arthur Andersen LLP which was given unrestricted access to all financial records and related data.\nEastern maintains a system of internal control over financial reporting which is designed to provide reasonable assurance to the company's management and Board of Trustees regarding the preparation of reliable financial statements and the safeguarding of assets. The system includes a documented organizational structure and division of responsibility, an internal audit staff, the careful selection and development of personnel and established policies and procedures, including policies to foster a strong ethical climate and control environment, which are communicated throughout Eastern.\nThe Audit Committee of the Board of Trustees, consisting solely of outside trustees, meets periodically with management, internal auditors and the independent auditors to review internal accounting controls, and the accounting principles and practices used to report financial condition and the results of operations. The Audit Committee also annually recommends to the Board of Trustees the selection of independent auditors.\nJ. Atwood Ives Chairman and Chief Executive Officer\nWalter J. Flaherty Senior Vice President and Chief Financial Officer\nJames J. Harper Vice President and Controller\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 Registrant\nInformation with respect to this item may be found in the section captioned \"Information With Respect to Nominees and Trustees\" appearing on pages 4 through 6 of the 1995 definitive Proxy Statement. Such information is incorporated herein by reference. See also the item captioned \"Executive Officers of the Registrant\" at the end of Part I hereof.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation with respect to this item may be found in the section captioned \"Compensation of Executive Officers\" appearing on pages 8 through the second full paragraph on page 13 of the 1995 definitive Proxy Statement. Such information 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 may be found in the sections captioned \"Information With Respect to Certain Shareholders\" appearing on pages 2 and 3 and \"Stock Ownership of Trustees and Executive Officers\" appearing on page 7 of the 1995 definitive Proxy Statement. Such information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation with respect to this item may be found in the last paragraph in the section captioned \"Compensation of Trustees\" appearing on page 12 of the 1995 definitive 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 (a) (1) and (2) List of Financial Statements and Financial Statement Schedules\nExhibits and Financial Statement Schedules to the Form 10-K have been included only with the copies of the Form 10-K filed with the SEC. A copy of this Form 10-K, including a list of exhibits and Financial Statement Schedules is available free of charge upon written request to: Corporate Relations Department, Eastern Enterprises, 9 Riverside Road, Weston, MA 02193.\nTRUSTEES AND OFFICERS\nTrustees Officers J. Atwood Ives(1) Thomas W. Jones(2) J. Atwood Ives Chairman and President and Chairman and Chief Executive Officer Chief Operating Officer Chief Executive Officer Eastern Enterprises Teachers Insurance and Richard R. Clayton Richard R. Clayton Annuity Association\/ President and President and College Retirement Chief Operating Officer Chief Operating Officer Equities Fund Walter J. Flaherty Eastern Enterprises New York, NY Senior Vice President and Nelson J. Darling, Jr.(2,3) Harold T. Miller(1,3,4) Chief Financial Officer Trustee and Director Retired Chairman and Richard J. Klau Boston, MA Chief Executive Officer Senior Vice President and Samuel Frankenheim(2,3) Houghton Mifflin Company President, WaterPro Counsel Boston, MA Supplies Corporation Ropes & Gray William J. Pruyn Chester R. Messer Boston, MA Retired Chairman Senior Vice President and Dean W. Freed(1,2) Eastern Enterprises President, Boston Gas Director and William G. Salatich(1,4) Company Retired Chairman President Fred C. Raskin EG&G, Inc. William G. Salatich Senior Vice President and Wellesley, MA Consulting Inc. President, Midland Robert P. Henderson(1,3,4) Northfield, IL Enterprises Inc. Chairman Rina K. Spence(3,4) L. William Law, Jr. Greylock Management Corp. President and Senior Vice President, Boston, MA Chief Executive Officer General Counsel and Leonard R. Jaskol(4) RKS Health Ventures Secretary Chairman and Cambridge, MA Michael J. Cawley Chief Executive Officer Vice President-- Lydall, Inc. Risk Management Manchester, CT James J. Harper Vice President and Controller Jane W. McCahon Vice President-- (1) Executive Committee Corporate Relations (2) Audit Committee Jean A. Scholtens (3) Nominating Committee Vice President and (4) Compensation Committee Treasurer\n(3) LIST OF EXHIBITS\n3.1 -- Declaration of Trust of Eastern Enterprises, as amended through April 27, 1989 (filed as Exhibit 3.1 to Quarterly Report of Eastern Enterprises on Form 10-Q for the quarter ended June 30, 1989).* 3.2 -- By-Laws of Eastern Enterprises, as amended through July 23, 1992 (filed as Exhibit 3.1 to Quarterly Report of Eastern on Form 10-Q for the quarter ended June 30, 1992).* (NOTE: Eastern agrees to furnish to the Securities and Exchange Commission upon request a copy of any instrument with respect to long-term debt of Eastern or any of its subsidiaries. Such instruments are not filed herewith since no such instrument authorizes securities in an amount greater than 10% of the total assets of Eastern and its subsidiaries on a consolidated basis.) 4.1 -- Common Stock Rights Agreement between Eastern and The Bank of New York, dated as of February 22, 1990, and Exhibits attached thereto (filed as Exhibits to Form 8-K of Eastern dated March 1, 1990).* 4.1.1 -- Agreement between Eastern and The First National Bank of Boston, dated January 30, 1995, with respect to Common Stock Rights Agreement. 10.1 -- Gas Transportation Contract between Boston Gas Company and Tennessee Gas Pipeline Company dated as of September 1, 1993 (filed as Exhibit 10.1 to Annual Report of Boston Gas Company on Form 10-K for the year ended December 31, 1993 (File no. 2-23416)).* 10.2 -- Gas Transportation Contracts between Boston Gas Company and Texas Eastern Transmission Corporation dated December 30, 1993 (filed as Exhibits 10.2 and 10.3 to Annual Report of Boston Gas Company on Form 10-K for the year ended December 31, 1993 (File no. 2-23416)).* 10.3 -- Gas Transportation Contracts between Boston Gas Company and Algonquin Gas Transmission Company dated December 30, 1993 (filed as Exhibits 10.4 and 10.5 to Annual Report of Boston Gas Company on Form 10-K for the year ended December 31, 1993 (File no. 2-23416)).* 10.4 -- Gas Sales Contract between Boston Gas Company and Esso Resources Canada, Limited, dated as of May 1, 1989, as amended, (filed as Exhibits 10.12 and 10.12.1 to the Annual Report of Boston Gas Company on Form 10-K for the year ended December 31, 1989 (File no. 2-23416)).* 10.5 -- Gas Sales Agreement between Boston Gas Company and Alberta Northeast Gas Limited, dated as of February 7, 1991 (filed as Exhibit 10.16 to the Annual Report of Boston Gas Company on Form 10-K for the year ended December 31, 1990 (File no. 2-23416)).* 10.6 -- Firm Gas Transportation Agreement between Boston Gas Company and Iroquois Gas Transmission System, L.P., dated as of February 7, 1991 (filed as Exhibit 10.17 to the Annual Report of Boston Gas Company on Form 10-K for the year ended December 31, 1990 (File no. 2-23416)).* 10.7 -- Eastern's Deferred Compensation Plan for Trustees, as amended (filed as Exhibit 10.7 to Annual Report of Eastern on Form 10-K for the year ended December 31, 1993).*(a) 10.8 -- Eastern's 1982 Stock Option Plan, as amended (filed as Exhibit 10.2 to Quarterly Report of Eastern on Form 10-Q for the quarter ended March 31, 1992).*(a) 10.9 -- Eastern's 1995 Stock Option Plan. (a) 10.10 -- Eastern's Supplemental Executive Retirement Plan, as amended (filed as Exhibit 10.1 to Quarterly Report of Eastern on Form 10-Q for the quarter ended March 31, 1994).*(a) 10.11 -- Trust Agreement between Eastern and Shawmut Bank of Boston, N.A., as amended (filed as Exhibit 10.12 to the Annual Report of Eastern on Form 10-K for the year ended December 31, 1990).*(a) 10.12 -- Eastern's Executive Incentive Compensation Plan, as amended (filed as Exhibit 10.3 to Quarterly Report of Eastern on Form 10-Q for the quarter ended March 31, 1992).*(a) 10.13 -- Salary Continuation Agreements between Eastern and certain officers (filed as Exhibit 10.2 to Quarterly Report of Eastern on Form 10-Q for quarter ended September 30, 1994).*(a)\n10.14 -- Agreement dated November 27, 1991 between Eastern and J. Atwood Ives (filed as Exhibit 10.14 to the Annual Report of Eastern on Form 10-K for the year ended December 31, 1991).*(a) 10.15 -- Agreement dated October 25, 1991 between Eastern and Richard R. Clayton (filed as Exhibit 10.15 to the Annual Report of Eastern on Form 10-K for the year ended December 31, 1991).*(a) 10.16 -- Agreement dated April 28, 1994 between Eastern and J. Atwood Ives (filed as Exhibit 10.2 to Quarterly Report of Eastern on Form 10-Q for the quarter ended March 31, 1994).*(a) 10.17 -- Agreement dated April 28, 1994 between Eastern and Richard R. Clayton (filed as Exhibit 10.3 to Quarterly Report of Eastern on Form 10-Q for the quarter ended March 31, 1994).*(a) 10.18 -- Eastern's Headquarters Retirement Plan, as amended and restated (filed as Exhibit 10.1 to Quarterly Report of Eastern on Form 10-Q for the quarter ended September 30, 1991).*(a) 10.18.1-- Amendment to Eastern's Headquarters Retirement Plan, dated October 27,1994. (a) 10.19 -- Midland Enterprises Inc. Salaried Retirement Plan, as amended and restated (filed as Exhibit 10.2 to Quarterly Report of Eastern on Form 10-Q for the quarter ended September 30, 1991).*(a) 10.19.1-- Amendment to Midland Enterprises Inc. Salaried Retirement Plan, dated November 4, 1994.(a) 10.20 -- Boston Gas Company Retirement Plan, as amended and restated (filed as Exhibit 10.3 to Quarterly Report of Eastern on Form 10-Q for the quarter ended September 30, 1991).*(a) 10.20.1-- Amendment to Boston Gas Company Retirement Plan, dated December 5, 1994. (a) 10.21 -- Trust Agreement made as of October 2, 1987 between Eastern and The Bank of New York, as amended (filed as Exhibit 10.19 to the Annual Report of Eastern on Form 10-K for the year ended December 31, 1990).*(a) 10.22 -- Eastern's Retirement Plan for Non-Employee Trustees, as amended (filed as Exhibit 10.22 to Annual Report of Eastern on Form 10-K for the year ended December 31, 1992).*(a) 10.23 -- Eastern's 1992 Restricted Stock Plan (filed as Exhibit 10.1 to Quarterly Report of Eastern on Form 10-Q for the quarter ended March 31, 1992).*(a) 10.24 -- Eastern's Restricted Stock Plan for Non-Employee Trustees (filed as Exhibit 10.24 to Annual Report of Eastern on Form 10-K for the year ended December 31, 1992).*(a) 10.25 -- Eastern's 1994 Deferred Compensation Plan (filed as Exhibit 10.22 to Annual Report of Eastern on Form 10-K for year ended December 31, 1993).*(a) 10.26 -- Eastern's Executive Stock Purchase Loan Plan (filed as Exhibit 10.1 to Quarterly Report of Eastern on Form 10-Q for quarter ended September 30, 1994).*(a) 13.1 -- Portions incorporated herein of annual report to shareholders for the year ended December 31, 1994. With the exception of the sections captioned \"Cash Dividends Per Share\" and \"Stock Price Range\" appearing on the inside back cover of the said annual report which are incorporated by reference in Item 5 of this Form 10-K, said annual report is not deemed filed as part of this report. 21.1 -- Subsidiaries of the registrant.\nEastern will furnish a copy of any exhibit not included herewith to any holder of Eastern's common stock upon payment of the cost of reproduction and mailing.\n(B) REPORTS ON FORM 8-K There were no reports on Form 8-K filed in the fourth quarter of 1994.\n*Not filed herewith. In accordance with Rule 12b-32 of the General Rules and Regulations under the Securities and Exchange Act of 1934, reference is made to the document previously filed with the Commission. (a) Indicates a management contract or compensatory plan or arrangement.\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. EASTERN ENTERPRISES Registrant By \/s\/ JAMES J. HARPER JAMES J. HARPER Vice President and Controller (Chief Accounting Officer) Date: 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 indicated on the 15th day of March, 1995.\nSIGNATURE TITLE\n\/s\/ J. ATWOOD IVES ----------------------- J. ATWOOD IVES Chairman and Chief Executive Officer and Trustee\n\/s\/ RICHARD R. CLAYTON ----------------------- RICHARD R. CLAYTON President and Chief Operating Officer and Trustee\n\/s\/ WALTER J. FLAHERTY ----------------------- WALTER J. FLAHERTY Senior Vice President and Chief Financial Officer\n\/s\/ NELSON J. DARLING, JR. ----------------------- NELSON J. DARLING, JR. Trustee\n\/s\/ SAMUEL FRANKENHEIM ----------------------- SAMUEL FRANKENHEIM Trustee\n\/s\/ DEAN W. FREED ----------------------- DEAN W. FREED Trustee\n\/s\/ ROBERT P. HENDERSON ----------------------- ROBERT P. HENDERSON Trustee\n\/s\/ LEONARD R. JASKOL ----------------------- LEONARD R. JASKOL Trustee\n\/s\/ THOMAS W. JONES ----------------------- THOMAS W. JONES Trustee\n\/s\/ HAROLD T. MILLER ----------------------- HAROLD T. MILLER Trustee\n\/s\/ WILLIAM J. PRUYN ----------------------- WILLIAM J. PRUYN Trustee\n\/s\/ WILLIAM G. SALATICH ----------------------- WILLIAM G. SALATICH Trustee\n\/s\/ RINA K. SPENCE ----------------------- RINA K. SPENCE Trustee\nEASTERN ENTERPRISES AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES DECEMBER 31, 1994 (SUBMITTED IN ANSWER TO ITEMS 14(A)(1) AND (2) OF FORM 10-K, SECURITIES AND EXCHANGE COMMISSION) FINANCIAL STATEMENTS\nPage\nEASTERN ENTERPRISES AND SUBSIDIARIES: Report of independent public accountants on schedules Consent of independent public accountants\nSCHEDULES (PAGES THROUGH)\nII Valuation and qualifying accounts and reserves\nSchedules not listed above are omitted as not applicable or not required under the rules of Regulation S-X.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTO EASTERN ENTERPRISES:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Eastern Enterprises Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 25, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the index on page are the responsibility of Eastern'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.\nBoston, Massachusetts January 25, 1995 ARTHUR ANDERSEN LLP\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation by reference of our reports, dated January 25, 1995, included in, and incorporated by reference into, Eastern Enterprises Annual Report on this Form 10-K for the year ended December 31, 1994, into Eastern's previously filed Post-Effective Amendment No. 1 to Form S-16 Registration Statement No. 2-71614 on Form S-3 and Form S-8 Registration Statements No. 2-77146, No. 33-19990, No. 33-40862 and No. 33-56424.\nBoston, Massachusetts March 15, 1995 ARTHUR ANDERSEN LLP\nSCHEDULE II\nEASTERN ENTERPRISES AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES For the Year Ended December 31, 1994 (Thousands)\nAdditions Deductions Charges for Balance Charged Which Balance December to Costs Charged Reserves December 31, and to Other Were 31, Description 1993 Expenses Accounts Created 1994 Reserves deducted from assets-- Reserves for doubtful accounts $ 13,945 $15,864 $ 0 $(13,718) $ 16,091 Reserves for loss on investments $ 19 $ 0 $ 0 $ 0 $ 19 Reserves included in liabilities-- Reserve for post-retirement health care $104,730 $ 1,103 $ 2,186 $ (5,637) $102,382 Reserve for coal miners retiree health care 70,000 0 0 (1,307) 68,693 Reserves for employee benefits 10,661 8,716 1,279 (8,203) 12,453 Reserves for environmental expenses 10,866 175 125 (1,316) 9,850 Reserves for insurance claims 9,167 7,004 2,127 (8,408) 9,890 Other 19,611 7,854 (4,255) (4,457) 18,753 Total liability reserves $225,035 $24,852 $ 1,462 $(29,328) $222,021\nSCHEDULE II EASTERN ENTERPRISES AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES For the Year Ended December 31, 1993 (Thousands)\nAdditions Deductions Charges for Balance Charged Which Balance December to Costs Charged Reserves December 31, and to Other Were 31, Description 1992 Expenses Accounts Created 1993 Reserves deducted from assets-- Reserves for doubtful accounts $ 11,835 $13,127 $ 0 $(11,017) $ 13,945 Reserves for loss on investments $ 19 $ 0 $ 0 $ 0 $ 19 Reserves included in liabilities-- Reserve for post-retirement health care $102,221 $ 1,331 $ 6,805 $ (5,627) $104,730 Reserve for coal miners retiree health care 0 70,000 0 0 70,000 Reserves for employee benefits 11,473 8,635 (692) (8,755) 10,661 Reserves for environmental expenses 6,746 5,639 (159) (1,360) 10,866 Reserves for insurance claims 9,202 6,369 1,098 (7,502) 9,167 Other 23,252 7,532 (6,887) (4,286) 19,611 Total liability reserves $152,894 $99,506 $ 165 $(27,530) $225,035\nSCHEDULE II EASTERN ENTERPRISES AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES For the Year Ended December 31, 1992 (Thousands)\nAdditions Deductions Charges for Balance Charged Which Balance December to Costs Charged Reserves December 31, and to Other Were 31, Description 1991 Expenses Accounts Created 1992 Reserves deducted from assets-- Reserves for doubtful accounts $ 10,443 $12,444 $ 0 $(11,052) $ 11,835 Reserves for loss on investments $ 19 $ 0 $ 0 $ 0 $ 19 Reserves included in liabilities-- Reserve for post-retirement health care $102,181 $10,040 $ 432 $(10,432) $102,221 Reserves for employee benefits 10,897 9,300 (130) (8,594) 11,473 Reserves for environmental expenses 7,367 2,500 282 (3,403) 6,746 Reserves for insurance claims 10,235 7,032 232 (8,297) 9,202 Other 13,034 3,762 15,844 (9,388) 23,252 Total liability reserves $143,714 $32,634 $16,660 $(40,114) $152,894\nEXHIBIT INDEX\nSee Item 14(a)(3), \"List of Exhibits,\" for statement of the location of exhibits incorporated by reference.\nExhibit\n3.1 -- Declaration of Trust of Eastern Enterprises, as amended through April 27, 1989 (incorporated by reference). 3.2 -- By-Laws of Eastern Enterprises, as amended through July 23, 1992 (incorporated by reference). 4.1 -- Common Stock Rights Agreement between Eastern and The Bank of New York, dated as of February 22, 1990, and Exhibits attached thereto (incorporated by reference). 4.1.1-- Agreement between Eastern and The First National Bank of Boston, dated January 30, 1995. 10.1 -- Gas Transportation Contract between Boston Gas Company and Tennessee Gas Pipeline Company dated as of September 1, 1993 (incorporated by reference). 10.2 -- Gas Transportation Contracts between Boston Gas Company and Texas Eastern Transmission Corporation dated December 30, 1993 (incorporated by reference). 10.3 -- Gas Transportation Contracts between Boston Gas Company and Algonquin Gas Transmission Company dated December 30, 1993 (incorporated by reference). 10.4 -- Gas Sales Contract between Boston Gas Company and Esso Resources Canada, Limited, dated as of May 1, 1989, as amended (incorporated by reference). 10.5 -- Gas Sales Agreement between Boston Gas Company and Alberta Northeast Gas Limited, dated as of February 7, 1991 (incorporated by reference). 10.6 -- Firm Gas Transportation Agreement between Boston Gas Company and Iroquois Gas Transmission System, L.P., dated as of February 7, 1991 (incorporated by reference). 10.7 -- Eastern's Deferred Compensation Plan for Trustees, as amended (incorporated by reference). 10.8 -- Eastern's 1982 Stock Option Plan, as amended (incorporated by reference). 10.9 -- Eastern's 1995 Stock Option Plan. 10.10 -- Eastern's Supplemental Executive Retirement Plan, as amended (incorporated by reference). 10.11 -- Trust Agreement between Eastern and Shawmut Bank of Boston N.A., as amended (incorporated by reference). 10.12 -- Eastern's Executive Incentive Compensation Plan, as amended (incorporated by reference). 10.13 -- Salary Continuation Agreements between Eastern and certain officers, as amended (incorporated by reference). 10.14 -- Agreement dated November 27, 1991 between Eastern and J. Atwood Ives (incorporated by reference). 10.15 -- Agreement dated October 25, 1991 between Eastern and Richard R. Clayton (incorporated by reference). 10.16 -- Agreement dated April 28, 1994, between Eastern and J. Atwood Ives (incorporated by reference). 10.17 -- Agreement dated April 28, 1994, between Eastern and Richard R. Clayton (incorporated by reference). 10.18 -- Eastern's Headquarters Retirement Plan, as amended and restated (incorporated by reference). 10.18.1-- Amendment to Eastern's Headquarters Retirement Plan dated October 27, 1994. 10.19 -- Midland Enterprises Inc. Salaried Retirement Plan, as amended and restated (incorporated by reference). 10.19.1-- Amendment to Midland Enterprises Inc. Salaried Retirement Plan, dated November 4, 1994. 10.20 -- Boston Gas Company Retirement Plan, as amended and restated (incorporated by reference). 10.20.1-- Amendment to Boston Gas Company Retirement Plan, dated December 5, 1994. 10.21 -- Trust Agreement made as of October 2, 1987 between Eastern and The Bank of New York, as amended (incorporated by reference). 10.22 -- Eastern's Retirement Plan for Non-Employee Trustees, as amended (incorporated by reference). 10.23 -- Eastern's 1992 Restricted Stock Plan (incorporated by reference). 10.24 -- Eastern's Restricted Stock Plan for Non-Employee Trustees (incorporated by reference).\n10.25 -- Eastern's 1994 Deferred Compensation Plan (incorporated by reference). 10.26 -- Eastern's Executive Stock Purchase Loan Plan (incorporated by reference). 13.1 -- Portions incorporated herein of annual report to shareholders for the year ended December 31, 1994. 21.1 -- Subsidiaries of the registrant.","section_15":""}
{"filename":"33619_1994.txt","cik":"33619","year":"1994","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business.\nEsterline Technologies Corporation (the \"Company\") conducts business through 13 principal domestic and foreign subsidiaries in three business segments described in sub-item (c) below. The Company was organized in August 1967.\nOn March 30, 1992 the Company sold substantially all of the assets of Hollis Automation Co., an Esterline subsidiary which was not significant to the Company in terms of operations or financial condition. Hollis was in the Company's Automation Group.\nIn the fourth quarter of 1993, the Company recorded a $40.6 million restructuring charge ($27.2 million net of income tax effect). It provided for the sale or shutdown of certain small operations in each of the Company's three business segments. On a pretax basis, $21.1 million of the restructuring charge related to the Aerospace and Defense Group, $8.9 million to the Instrumentation Group and $8.4 million to the Automation Group. The affected operations represented approximately 10% of the Company's fiscal 1993 sales. The charge further provided for the consolidation of plants and product lines, including employees' severance, write-off of intangible assets which no longer had value and the write-down and sale of two vacant facilities.\nActions completed through fiscal 1994 associated with the restructuring included the sale of Republic Electronics Co. (an Aerospace and Defense Group operation), the sale of a vacant facility in Torrance, California (an Automation Group property), most elements of employees' severance, and the intangibles write-off, and comprised $19.1 million (before tax) of the recorded provision.\n(b) Financial Information About Industry Segments.\nA summary of net sales to unaffiliated customers, operating earnings and identifiable assets attributable to the Company's business segments for the fiscal years ended October 31, 1994, 1993 and 1992 is incorporated herein by reference to Note 12 to the Company's Consolidated Financial Statements on pages 41 and 42 of the Annual Report to Shareholders for the fiscal year ended October 31, 1994.\n(c) Narrative Description of Business.\nThe Company consists of 13 individual businesses whose results can vary widely based on a number of factors, including domestic and foreign economic conditions and developments affecting the specific industries and customers they serve. The products sold by most of these businesses represent capital investment by either the initial customer or the ultimate end user. Also, a significant portion of the sales and profitability of some Company businesses is derived from defense and other government contracts or the commercial aircraft industry. Changes in general economic conditions or conditions in specific industries, capital acquisition cycles, and government policies, collectively or individually, can have a significant effect on the Company's performance.\nSpecific comments covering all of the Company's fiscal 1994 business segments and operating units are set forth below.\nAUTOMATION GROUP\nThis Group produces and markets automated drilling equipment for the printed circuit board (PCB) manufacturing industry (principally computer, telecommunications and automotive equipment); and automated metal fabrication equipment for transportation, heavy equipment and other related markets.\nExcellon Automation produces automated drilling equipment for the PCB manufacturing industry. Excellon's products emphasize productivity and are designed to provide a highly efficient automated production system for PCB manufacturers. Excellon's latest product development combines multiple spindle microdrilling of circuit boards, automatic board loading and unloading, and fully integrated material handling capabilities. During fiscal 1994, Excellon acquired Amtech, a manufacturer of unique material handling systems used in PCB production.\nExcellon products are sold worldwide to the PCB manufacturing industry, including both large and small electronics equipment manufacturers as well as component manufacturers, independent circuit board fabricators and custom drilling operations.\nIn fiscal 1994, 1993 and 1992, printed circuit board drilling equipment accounted for 18%, 16% and 12%, respectively, of the Company's consolidated net sales.\nTulon produces tungsten carbide drill and router bits, commonly ranging in size from 5.6mm down to .25mm--some as small as .10mm--for use in PCB drilling equipment. Tulon utilizes computerized equipment which automatically inspects drill bits and provides the product consistency customers need for higher-technology drilling.\nW.A. Whitney produces automated equipment for the fabrication of structural steel, sheet metal and plate components and related material-handling equipment. This equipment performs such functions as punching, cutting, shearing and tapping. W.A. Whitney historically has specialized in equipment for punching and cutting mid- to heavy-guage plate metal, utilizing plasma-arc air torch systems and hydraulic punching. Its customers consist principally of large metal fabricators, such as truck, farm implement and construction equipment manufacturers, and a wide range of independent fabricators.\nW.A. Whitney also produces a line of specialized screw machine and turret lathe tooling attachments under the Boyar-Schultz name. These products are sold to a wide range of customers primarily for use in tool room and production operations.\nEquipment Sales Co. acts as a sales representative for various manufacturers' products sold to the PCB assembly industry, including high-speed assembly equipment.\nAt October 31, 1994, the backlog of the Automation Group (all of which is expected to be filled during fiscal 1995) was $29.9 million compared with $9.2 million one year earlier. The increase was primarily attributable to strengthening markets and strong customer acceptance of newer products at key Group companies.\nAEROSPACE AND DEFENSE GROUP\nThis Group provides a broad range of measuring and sensing devices, high-performance elastomers and clamping systems, and specialized metal finishing principally for commercial aircraft and jet engine manufacturers; also combustible ammunition components and electronic and electrical cable assemblies for both domestic and foreign defense agencies and contractors. During fiscal 1994, a group operating company, Republic Electronics Co., was sold in connection with the Company's 1993 restructuring plan.\nArmtec Defense Products manufactures molded fiber cartridge cases, mortar increments, igniter tubes and other combustible ammunition components for the United States armed forces and domestic and foreign defense contractors. Armtec currently is the sole U.S. producer of combustible ordnance, including the 120mm combustible case used on the main armament system on the Army's M-1A1 tank and of 120mm, 81mm and 60mm combustible mortar increments for the U.S. Army. The majority of Armtec's sales are to ordnance suppliers to the U.S. Armed Forces.\nIn fiscal 1994, 1993 and 1992, combustible ordnance components accounted for 9%, 9% and 12%, respectively, of the Company's consolidated net sales.\nAuxitrol, headquartered in France, manufactures temperature and pressure sensors for use in aerospace and aviation applications, liquid level measurement devices for ships and storage tanks, pneumatic accessories (including pressure gauges and regulators) and industrial alarms, as well as electrical penetration devices and alarm systems for European and other foreign nuclear power plants. This subsidiary also distributes products manufactured by others, including valves, temperature and pressure switches and flow gauges. The markets served by Auxitrol principally consist of jet engine manufacturers, aerospace equipment manufacturers, shipbuilders, petroleum companies, process industries and electric utilities. Auxitrol has a joint venture with a Russian company to facilitate use of Auxitrol technology in retrofitting the aging nuclear plants in Eastern Europe. Exhaust gas temperature sensing equipment for a jet engine manufacturer constitute a significant portion of Auxitrol's sales.\nHytek Finishes provides specialized metal finishing and inspection services, including plating, anodizing, polishing, non-destructive testing and organic coatings, primarily to the commercial aircraft, aerospace and electronics markets. Hytek also has an automated tin-lead plating line, employing the latest automated plating technology, to serve the semi- conductor industry.\nMidcon Cables manufactures electronic and electrical cable assemblies and cable harnesses for the military, government contractors and the commercial electronics market, offering both product design services and assembly of product to customer specifications.\nTA Mfg. designs and manufactures specialty clamps and elastomeric compounds in custom molded shapes for wiring and tubing installations for airframe and jet engine manufacturers as well as military and commercial airline aftermarkets. TA's products include elastomers which are specif- ically formulated for various applications, including high-temperature environments.\nAt October 31, 1994, the backlog of the Aerospace and Defense Group (of which $4.1 million is expected to be filled after fiscal 1995) was $38.9 million, compared with $40.8 million one year earlier.\nINSTRUMENTATION GROUP\nThis Group designs and manufactures a variety of meters, gauges and measurement and analysis equipment for public utilities and industrial manufacturers; also lighted indicators, switches and control components for the commercial aerospace and defense industries.\nKorry Electronics designs and manufactures illuminated information and control components, and integrated thin-panel data systems, such as switches, indicators, panels and keyboards which act as man-machine interfaces in a broad variety of control and display applications. Korry's customers include original equipment manufacturers and the aftermarkets (equipment operators and spare parts distributors), primarily in the commercial aviation, general aviation, military airborne, ground- based military equipment and shipboard military equipment markets. A significant portion of Korry's sales are to suppliers of military equipment to the U.S. Government and to a commercial aircraft manufacturer.\nFederal Products manufactures a broad line of high-precision analog and digital dimensional and surface measurement and inspection instruments and systems for a wide range of industrial quality control and scientific applications. Federal also distributes certain products which complement its manufactured product lines. These products constitute three major business segments: gauging, which includes dial indicators, air gauges and other precision gauges; instrumentation, which includes electronic gauges for use where ultra-precision measurement is required; and engineered products, which include custom-built and dedicated semi- automatic and automatic gauging systems. Distributed products manufac- tured by others include laser interferometer systems used primarily to check machine tool calibrations. Federal Products' equipment is used extensively in precision metal working. Its customers include the automotive, farm implement, construction equipment, aerospace, ordnance and bearing industries.\nIn each of fiscal years 1994, 1993 and 1992, gauge products manufac- tured by Federal Products accounted for 13% of the Company's consolidated net sales.\nScientific Columbus (formerly Jemtec Electronics) produces analog and digital meters, electrical transducers and instruments for the monitoring, controlling and billing of electrical power. Included among these products are solid-state devices for calibration of electric utility instrumentation and a line of solid state-meters, including programmable multi-function billing meters. The latest products of Scientific Columbus are multi- function, microprocessor-based meters which offer a broad range of features on a modular basis. Scientific Columbus' products are sold to electrical utilities and industrial power users.\nAngus Electronics manufactures recording instruments together with other analytical and process and environmental monitoring instrumentation. These include analog strip chart and digital printout recorders as well as electronic and multi-channel microprocessor-based recording equipment. Customers of Angus Electronics include industrial equipment manufacturers, electric utilities, scientific laboratories, pharmaceutical manufacturers and process industries.\nAt October 31, 1994, the backlog of the Instrumentation Group (of which $7.2 million is expected to be filled after fiscal 1995) was $28 million compared with $24.4 million one year earlier.\nMARKETING AND DISTRIBUTION\nAutomation Group products manufactured by Excellon are marketed domestically principally through employees and in foreign markets through employees, independent distributors, and affiliated distributors. Tulon products are marketed in the United States through employees and independent distributors and elsewhere principally through independent distributors. W.A. Whitney products are sold principally through independent distributors and representatives.\nAerospace and Defense Group products manufactured by Auxitrol are marketed through employees, independent representatives, and an affiliated U.S. distributor. The products of Armtec Defense Products are marketed domestically and abroad by employees and independent representatives. Midcon Cables' products are marketed domestically by employees and independent representatives. Hytek's services are marketed domestically through employees. TA Mfg. products are marketed domestically and abroad by employees and independent representatives.\nInstrumentation Group products manufactured by Angus Electronics are marketed domestically through employees, independent representatives and distributors, and abroad through independent representatives and employees of Esterline's Auxitrol subsidiary. Scientific Columbus' products are sold through independent representatives. The products of Federal Products are marketed domestically principally through employees, and in foreign markets through both employees and independent representatives. Korry Electronics' products are marketed domestically and abroad principally through employees and independent representatives.\nFor most of the Company's products, the maintenance of a service capability is an integral part of the marketing function.\nRESEARCH AND DEVELOPMENT\nThe Company's subsidiaries conduct product development and design programs with approximately 175 professional engineers, technicians and support personnel, supplemented by independent engineering and consulting firms when needed. In fiscal 1994, approximately $13.7 million was expended for research, development and engineering, compared with $14 million in 1993 and $13.4 million in 1992.\nFOREIGN OPERATIONS\nThe Company's principal foreign operations consist of manufacturing facilities of Auxitrol located in France and Spain, a manufacturing facility of Tulon located in Mexico, sales and service operations of Excellon located in England, Germany and Japan, and sales offices of TA Mfg and Korry Electronics located in England and France, respectively. In addition, W.A. Whitney has a small manufacturing and distribution facility in Italy. For information as to sales, operating results and assets by geographic area and export sales, reference is made to Note 1 to the Consolidated Financial Statements on page 33, and Note 12 to the Consolidated Financial Statements on pages 41, 42 and 43, of the Company's Annual Report to Shareholders for the fiscal year ended October 31, 1994, which is incorporated herein by reference.\nEMPLOYEES\nDuring fiscal 1994, restructuring plan actions included the sale of a small operating company and most elements of employees' severance, as discussed earlier in this report. Notwithstanding these actions, the Company and its subsidiaries had approximately 2,800 employees at October 31, 1994, level with the prior year.\nCOMPETITION AND PATENTS\nThe Company's subsidiaries experience varying degrees of competition with respect to all of their products and services. Most subsidiaries are in specialized market niches with relatively few competitors. In automated drilling equipment for printed circuit board manufacturing, Excellon Automation is a leader in its field and believes it has the largest installed base in the world of automated drilling machines for the production of printed circuit boards. In molded fiber cartridge cases, mortar increments and other combustible ammunition components, Armtec currently is the sole supplier to the U.S. Army. In addition, Hytek is one of the largest metal finishers on the West Coast, and Korry Electronics, Federal Products, W.A. Whitney, and TA Mfg. are among the leaders in their respective markets.\nThe Company's subsidiaries generally compete with many larger companies with substantially greater volume and financial resources. The Company believes the main competitive factors for the Company's products is product performance and service. Overall, the Company believes its ongoing product development and design programs, coupled with a strong customer service orientation, keep its various product groups competitive in the marketplace.\nThe subsidiaries hold a number of patents but in general rely on technical superiority, exclusive features in their equipment and marketing and service to customers to meet competition. Licenses which help maintain a significant advantage over competition include a long- term license agreement under which Auxitrol manufactures and sells electrical penetration assemblies.\nSOURCES AND AVAILABILITY OF RAW MATERIALS AND COMPONENTS\nThe Company's subsidiaries are not materially dependent for their raw materials and components upon any one source of supply except for certain components and supplies such as hydraulic components purchased by W.A. Whitney and certain other raw materials and components purchased by other subsidiaries. In such instances, ongoing efforts are conducted to develop alternative sources or designs to help avoid the possibility of any business impairment.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales. \t See \"Foreign Operations\" above.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table summarizes the principal properties (in excess of 15,000 square feet) owned or leased by the Company and its subsidiaries as of October 31, 1994:\n- -----------------\t\nThe Company group (business segment) operating each facility described above is indicated by the letter following the description of the facility, as follows:\n(A) - Automation (D) - Aerospace and Defense (I) - Instrumentation\nIn addition to the properties listed above, a 64,000 square foot facility in Nashua, NH is owned by the Company and planned for sale. Liabilities have been accrued for environmental remediation costs expected to be incurred in the disposition of this facility.\nIn the opinion of the management of the Company, the subsidiaries' plants and equipment are in good condition, adequate for current operations and provide sufficient capacity for up to 25% expansion at most locations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company has various lawsuits and claims, both offensive and defensive, and contingent liabilities arising from the conduct of business, including those associated with government contracting activities, none of which, in the opinion of management, is expected to have a material 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\nNo matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended October 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe following information which appears in the Company's Annual Report to Shareholders for fiscal 1994 is hereby incorporated by reference:\n(a)\tThe high and low market prices of the Company's common stock for each quarterly period during the fiscal years ended October 31, 1994 and 1993, respectively (page 28 of the Annual Report to Shareholders).\n\t(b)\tThe approximate number of holders of common stock (page 28 of \t\tthe Annual Report to Shareholders).\n\t(c)\tRestrictions on the ability to pay future cash dividends \t\t(Note 4 to Consolidated Financial Statements, pages 34 and \t\t35 of the Annual Report to Shareholders).\nNo cash dividends were paid during the fiscal years ended October 31, 1994 and 1993 as the Company continued its policy of retaining all internally generated funds to support the long-term growth of the Company and to retire debt obligations.\nThe principal market for the Company's common stock is the New York Stock Exchange.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Company hereby incorporates by reference the Selected Financial Data of the Company which appears on page 28 of the Company's Annual Report to Shareholders for fiscal 1994.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company hereby incorporates by reference Management's Discussion and Analysis of Results of Operations and Financial Condition which is set forth on pages 25, 26 and 27 of the Company's Annual Report to Shareholders for fiscal 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company hereby incorporates by reference the Consolidated Financial Statements and the report thereon of Deloitte & Touche LLP, dated December 5, 1994, which appear on pages 29 - 44 of the Company's Annual Report to Shareholders for fiscal 1994, including Note 13, page 43, which contains unaudited quarterly financial data.\nITEM 9.","section_9":"ITEM 9.\t 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\t(a) Directors.\nThe Company hereby incorporates by reference the information set forth under \"Election of Directors\" in the definitive form of the Company's Proxy Statement, relating to its Annual Meeting of Shareholders to be held on March 8, 1995, filed with the Securities and Exchange Commission and the New York Stock Exchange on January 13, 1995.\n(b) Executive Officers.\nThe names and ages of all executive officers of the Company and the positions and offices held by such persons as of January 25, 1995 are as follows:\nMr. Hurlbut has been Chairman, President and Chief Executive Officer since January 1993. From February 1989 through December 1992, he was President and Chief Executive Officer.\nMr. Stevenson has been Executive Vice President and Chief Financial Officer, Secretary and Treasurer since October 1987.\nMr. Cremin has been Senior Vice President and Group Executive since December 1990. From October 1987 to December 1990, he was Group Vice President.\nMr. Kring has been Group Vice President since August 1993. For more than five years prior to that date, he was President of Heath Tecna Aerospace Co., a unit of Ciba Composites Division, Anaheim, California.\nMr. Larson has been Group Vice President since April 1991. For more than five years prior to that date, he held various executive positions with Korry Electronics, including President and Executive Vice President, Marketing.\nMs. Greenberg has been Vice President, Human Relations since March 1993. For more than five years prior to that date, she was a partner in the law firm of Bogle & Gates, Seattle, Washington.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Company hereby incorporates by reference the information set forth under \"Executive Compensation\" in the definitive form of the Company's Proxy Statement, relating to its Annual Meeting of Shareholders to be held on March 8, 1995, filed with the Securities and Exchange Commission and the New York Stock Exchange on January 13, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Company hereby incorporates by reference the information with respect to stock ownership set forth under \"Security Ownership of Certain Beneficial Owners and Management\" in the definitive form of the Company's Proxy Statement, relating to its Annual Meeting of Shareholders to be held on March 8, 1995, filed with the Securities and Exchange Commission and the New York Stock Exchange on January 13, 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.\nThe following consolidated financial statements, together with the report thereon of Deloitte & Touche LLP, dated December 5, 1994, appearing on pages 29 - 44 of the Company's Annual Report to Shareholders for fiscal 1994, are hereby incorporated 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 Annual Report to Shareholders for the fiscal year ended October 31, 1994:\nIndependent Auditors' Report Schedule VIII-- Valuation and Qualifying Accounts and Reserves\n\t(a) (3) Exhibits.\n\t(b) Reports on Form 8-K.\n\tNo reports on Form 8-K were filed during the fourth quarter of fiscal \t1994.\n\t\t\t\t SIGNATURES\n\tPursuant 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.\n\t\t\t\tESTERLINE TECHNOLOGIES CORPORATION \t\t (Registrant)\n\t\t\t By \/s\/ Robert W. Stevenson ---------------------------- \t\t\t\tRobert W. Stevenson \t\t\t\tExecutive Vice President and \t\t\t\tChief Financial Officer, Secretary \t\t\t\tand Treasurer (Principal Financial \t\t\t\tand Accounting Officer)\n\tDated: January 27, 1995 ----------------\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 and on the dates indicated.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Esterline Technologies Corporation Bellevue, Washington\nWe have audited the consolidated financial statements of Esterline Technologies Corporation as of October 31, 1994 and 1993, and for each of the three years in the period ended October 31, 1994, and have issued our report thereon dated December 5, 1994; 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 Esterline Technologies 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 financial statements taken as a whole, present fairly in all material respects the information set forth therein.\n\/s\/ Deloitte & Touche LLP - ------------------------- Seattle, Washington December 5, 1994\n\t ESTERLINE TECHNOLOGIES CORPORATION AND SUBSIDIARIES SCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (in thousands)\nFor Years Ended October 31, 1994, 1993 and 1992\n\t\t\t ESTERLINE TECHNOLOGIES CORPORATION \t\t Form 10-K Report for Fiscal Year Ended October 31, 1994\n\t\t INDEX TO EXHIBITS -----------------","section_15":""}
{"filename":"310183_1994.txt","cik":"310183","year":"1994","section_1":"Item 1. Business --------\nMissouri Pacific Railroad Company (the \"Registrant\") includes the Registrant, a Class I Railroad incorporated in Delaware and a wholly-owned, indirect subsidiary of Union Pacific Corporation (the \"Corporation\"), as well as a number of wholly-owned and majority-owned subsidiaries of the Registrant engaged in various railroad and related operations, and various terminal companies in which the Registrant has minority interests.\nThe Registrant operates in the midwestern and southwestern states of Arkansas, Colorado, Illinois, Kansas, Louisiana, Missouri, Nebraska, Oklahoma, Tennessee and Texas. The Registrant maintains coordinated schedules with other carriers for the handling of freight to and from the Atlantic Coast, the Pacific Coast, the Southeast, the Southwest, Canada and Mexico. Export and import traffic is moved through Gulf Coast ports and across the Texas-Mexico border. The Registrant's operations have been coordinated with those of Union Pacific Railroad Company (\"UPRR\"), another wholly-owned, indirect subsidiary of the Corporation. The two railroads operate as a unified system. See Note 2 to the Registrant's Financial Statements for information on related party transactions.\nIn 1994, the Registrant had transportation revenues of $2.3 billion, approximately 98.4 percent of which were derived from rail freight operations. Percentages of revenue ton-miles (\"RTM\") and rail commodity revenue for major commodities during 1994, 1993 and 1992 were as follows:\n1994 1993 1992 ----------------- ----------------- ----------------- Commodity Commodity Commodity RTM Revenue RTM Revenue RTM Revenue ----- --------- ----- --------- ----- --------- (Percent of Total)\nEnergy 29.9% 15.4% 29.0% 14.8% 26.7% 14.6% Chemicals 22.6 29.2 22.3 29.1 22.6 30.1 Metals\/Minerals\/ Forest 16.9 18.7 17.7 20.2 19.0 20.6 Grain and Grain Products 15.9 10.1 16.7 10.9 17.5 11.0 Intermodal 6.1 8.7 5.2 7.4 5.0 6.5 Automotive 4.2 12.6 4.6 12.1 4.4 11.7 Food\/Consumer\/ Government 4.4 5.3 4.5 5.5 4.8 5.5 ------ ------ ------ ------ ------ ------\nTotal 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% ====== ====== ====== ====== ====== ====== Amount in Billions 89.6 $2.3 82.3 $2.1 78.2 $2.1 ====== ====== ====== ====== ====== ======\nBy order issued March 7, 1995, the Interstate Commerce Commission (\"ICC\") approved the application of the Corporation and Chicago and North Western Transportation Company (\"CNW\") for an order authorizing the common control of the rail subsidiaries of the Corporation and CNW. The ICC's order is scheduled to become effective on April 6, 1995 and will permit the Corporation to (i) convert its 29.13 percent equity ownership interest in CNW, currently in the form of non-voting common stock, into shares of voting common stock of CNW (the \"CNW Shares\"), (ii) acquire additional CNW Shares and (iii) increase its representation on the CNW Board of Directors from one director out of seven to three directors out of nine. The ICC's order is subject to a standard labor protection condition and a requirement that the Soo Line Railroad Company (\"Soo\") be permitted to admit third parties to certain joint facilities operated by Soo and CNW.\nOn March 16, 1995, the Corporation and CNW entered into a definitive merger agreement (the \"Merger Agreement\"), pursuant to which UP Rail, Inc., a subsidiary of the Corporation, will acquire 100 percent of the outstanding CNW Shares not otherwise owned by the Corporation or its affiliates for $35 per share in cash pursuant to a tender offer and a second-step merger. Following consummation of the tender offer, UP Rail, Inc. will be merged into CNW with CNW being the surviving corporation and CNW will become a wholly-owned subsidiary of the Corporation. In addition, following consummation of the tender offer, and in accordance with the Merger Agreement, the Corporation intends to elect a majority of the directors on the CNW Board of Directors.\nThe tender offer for the CNW Shares was commenced on March 23, 1995 and will expire on April 19, 1995 unless extended. The tender offer is conditioned upon, among other things, (i) there having been validly tendered and not withdrawn prior to the expiration of the offer a number of CNW Shares which, when added to the shares of non-voting common stock of CNW beneficially owned by the Corporation and its subsidiaries (assuming conversion thereof into CNW Shares and the exercise of outstanding options for CNW Shares) constitutes at least a majority of the CNW Shares outstanding on a fully-diluted basis (assuming conversion of the non-voting common stock into CNW Shares) and (ii) the ICC's March 7, 1995 order approving the common control of the Corporation's and CNW's rail subsidiaries having become final and effective prior to the expiration of the tender offer. The second-step merger is also conditioned upon a number of things, including without limitation (i) the consummation of the tender offer, (ii) approval of the merger by CNW stockholders (which will not be required if 90 percent or more of the CNW Shares, including CNW Shares now owned by the Corporation, are acquired pursuant to the offer or otherwise) and (iii) the ICC either having determined that the terms of the merger are just and reasonable or having issued a declaratory order that such a determination is not required.\nUP Rail, Inc. and CNW have also entered into a Company Stock Option Agreement, dated as of March 16, 1995 (the \"Option Agreement\"). Subject to UP Rail, Inc. and its affiliates owning at lease 85 percent of the outstanding CNW Shares (assuming the conversion of the non-voting common stock to CNW Shares), the Option Agreement will permit UP Rail, Inc. to purchase from CNW, at the tender offer price, a sufficient number of additional CNW Shares such that the CNW Shares purchased pursuant to the Option Agreement plus the CNW Shares owned by the Corporation or UP Rail, Inc. would represent 90.01 percent of the outstanding CNW Shares (assuming conversion of the non-voting common stock into CNW Shares).\nThe Corporation, UP Rail, Inc., CNW and CNW's directors have been named as defendants in five lawsuits commenced on March 9 and 13, 1995 in the Court of Chancery in and for New Castle County, Delaware. Each suit purports to be a class action brought on behalf of all public stockholders of CNW except for the defendants and their affiliates. The complaints allege, among other things, that (i) directors of CNW breached their fiduciary duties to the CNW stockholders in considering approving the acquisition and (ii) as the controlling stockholder of CNW, the Corporation and UP Rail, Inc. breached their fiduciary duties to the other stockholders of CNW in agreeing to enter into the acquisition. In particular, the complaints allege that the directors agreed to sell CNW at an inadequate price and without proper information concerning the true value of CNW and its shares because they failed to use an auction or an active market check or to explore other strategic alternatives, and failed to create a special committee of fully disinterested directors. One complaint adds the claim that the whole CNW Board is disqualified from acting because of various contractual agreements with the Corporation. Another complaint alleges that the Corporation's 29 percent control of CNW permitted the Corporation to control the terms of any buyout transaction and no bona fide negotiations could take place. In addition, all claim the Corporation and UP Rail, Inc. had access to confidential and proprietary non-public information about CNW and used that information to acquire CNW at an inadequate price in violation of the Corporation's obligations as a controlling stockholder of CNW to assure that the transaction be entirely fair and at the best price. On March 28, 1995, an amended complaint was filed in two of the suits reiterating the claims made in the earlier complaints which it amended, and alleging, among other things, (i) that the investment bank retained by the CNW directors to render a fairness opinion in connection with the tender offer was not disinterested or independent and had a conflict of interest with regard to the tender offer, (ii) that the CNW directors breached or aided and abetted breaches of their duties of good faith and loyalty by approving for themselves and members of CNW's senior management lucrative compensation packages and other financial benefits, (iii) that the defendants structured the transaction in such a way as to prevent CNW's public stockholders from voting on the merger or exercising dissenters' rights, and (iv) that the defendants breached their duties of candor and full disclosure by failing adequately to disclose, among other things, the information described above, the reasons why the CNW's Board failed to implement a stockholders' rights plan and the reasons for alleged discrepancies and variations between valuation ranges for CNW Shares as prepared by the financial advisors of the Corporation and CNW, respectively.\nAs relief, the complaints seek, among other things, an injunction against consummation of the transacton and damages in an unspecified amount. The Corporation and CNW believe that all of the lawsuits are without merit, and both companies intend to vigorously defend such actions.\nCompetition -----------\nThe Registrant is subject to competition from other railroads, motor carriers and barge operators, based on both price and service. Most of its railroad operations are conducted in corridors served by competing railroads and by motor carriers. Motor carrier competition is particularly strong for intermodal traffic. Because of the proximity of the Registrant's routes to major inland and Gulf Coast waterways, barge competition can be particularly pronounced for bulk commodities.\nEmployees ---------\nAs is true with employees of all the principal railroads in the country, the majority of the Registrant's employees are organized along craft lines and represented by national labor unions. The Registrant continues to adapt agreements from the previous round of national negotiations to meet local requirements throughout its system. The Registrant has implemented two-person crews for all through-freight trains and for a portion of yard and local operations. Expansion of two-person crews is planned for other areas of the system.\nWith respect to 1995 national negotiations, both the unions and the carriers have taken the necessary steps to commence labor negotiations, with the filing of their initial bargaining positions. Whether unions are required to bargain nationally with all railroads at once, or can bargain with individual railroads, is currently being litigated with two unions. Negotiations on substantive issues are proceeding with other unions. The negotiations will likely continue through 1995 and beyond.\nGovernmental Regulation -----------------------\nThe Registrant's operations are subject to the regulatory jurisdiction of the ICC, other Federal agencies and various state agencies. The ICC has jurisdiction over rates charged on certain regulated rail traffic; freight car compensation; issuance or guarantee of railroad and certain railroad holding company securities; transfer, extension or abandonment of rail lines; and acquisition of control of rail common carriers and motor carriers by rail common carriers. The United States Congress and Clinton Administration appear to be in agreement that the ICC should be eliminated and that some of its rail and truck regulatory functions should be transferred to other Federal agencies. It is unclear whether the transfer of such functions, in particular the jurisdiction over the acquisition of control of rail common carriers and motor carriers, will involve the imposition of different or more burdensome regulatory requirements and what effect such transfer will have on the Registrant's operations.\nOther Federal agencies have jurisdiction over safety, movement of hazardous materials, movement and disposal of hazardous waste, and equipment standards. State agencies regulate intrastate rail freight rates to the extent that such agencies have adopted Federal standards and procedures and continue to follow such procedures. However, several states in which railroad operations are conducted have ceded intrastate rail rate regulation to the ICC. Various state and local agencies also have jurisdiction over disposal of hazardous wastes and seek to regulate movement of hazardous materials.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ----------\nOperating Equipment -------------------\nAt December 31, 1994 the Registrant owned or leased from others 1,168 locomotives, 29,442 freight cars and 1,967 units of work equipment. Substantially all of the Registrant's railroad rolling stock is subject to the liens of the Registrant's First Mortgage and General (Income) Mortgage as well as the lien of the First Mortgage of the Texas and Pacific Railway Company, its predecessor in interest (collectively the \"Mortgages\"). In addition, a portion\nof this property is subject to various equipment obligations which are superior to the liens of one or more of the Mortgages.\nRail Property -------------\nThe Registrant operates approximately 9,600 miles of track, including 7,900 miles of main line and 1,700 miles of branch line. Approximately 10 percent of the main line track consists of trackage rights over track owned by others. The Registrant's right-of-way and tracks are subject to one or more of the Mortgages.\nItem 3.","section_3":"Item 3. Legal Proceedings -----------------\nIn December 1992, the Texas Natural Resources Conservation Commission (\"TNRCC\") served the Registrant with a Notice of Violation for alleged discharges and fuel spills at the Registrant's San Antonio, Texas railyard. The TNRCC proposed penalties totalling $500,000. The Registrant and the TNRCC settled this matter for a penalty payment of $300,000 plus the implementation of certain supplemental environmental projects in Texas costing $275,000.\nIn addition to the foregoing, the Registrant has received notices from the Environmental Protection Agency (\"EPA\") and state environmental agencies alleging that it is or may be liable under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 and\/or other Federal or state environmental legislation for the remediation costs associated with alleged contamination or for violations of environmental requirements at various sites throughout the United States. There are approximately 13 sites for which such notices have been received which are currently on the Superfund National Priorities List or state superfund lists. Although specific claims have been made by the EPA and state regulators with respect to some of these sites, the ultimate impact of these proceedings and suits by third parties cannot be predicted at this time because of the number of potentially responsible parties involved, the degree of contamination by various wastes, the scarcity and quality of volumetric data related to many of the sites and\/or the speculative nature of remediation costs. Nevertheless, at some of the superfund sites, the Registrant believes it will have little or no exposure because no liability should be imposed under applicable law, one or more other financially able parties generated all or most of the contamination, or a settlement of the Registrant's exposure has been reached although regulatory proceedings at the sites involved have not been formally terminated. Additional information relating to the Registrant's potential environmental costs is set forth in Note 9 to the Financial Statements, contained on page of this report.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders ---------------------------------------------------\nOmitted in accordance with General Instruction J of Form 10-K.\nPART II -------\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ---------------------------------------------------------------------\nAll of the Common Stock and Class A Stock of the Registrant is owned by a wholly-owned indirect subsidiary of the Corporation. Accordingly, there is no market for the Registrant's capital stock. Dividends on the Registrant's Common Stock, which are paid on a quarterly basis, totalled $90.6 million in 1994 and $90 million in 1993. Through 1993, no dividends had been declared or paid on the Registrant's Class A Stock; however, a $3.4 million special cash dividend was paid in 1994 and a $6.3 million special cash dividend will be paid on the Class A Stock in 1995. See Notes 5 and 7 to the Registrant's financial statements for a discussion of dividend restrictions on the Common Stock and Class A Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data -----------------------\nOmitted in accordance with General Instruction J of Form 10-K.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations ---------------------\nOmitted in accordance with General Instruction J of Form 10-K. In lieu thereof, a narrative analysis is presented on Page.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -------------------------------------------\nThe financial statements and supplementary information related thereto, listed on the Index to Financial Statements, 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 --------------------------------------------------\nOmitted in accordance with General Instruction J of Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation ----------------------\nOmitted in accordance with General Instruction J of Form 10-K.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management --------------------------------------------------------------\nOmitted in accordance with General Instruction J of Form 10-K.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions ----------------------------------------------\nOmitted in accordance with 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 ---------------------------------------------------------------\n(a) (1) and (2) Financial Statements and Schedules ----------------------------------------------\nSee Index to Financial Statements.\n(a) (3) Exhibits ------------\n(3)(a) - Registrant's Certificate of Incorporation, amended effective as of August 12, 1988, is incorporated herein by reference to Exhibit 3(i) to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1988.\n(3)(b) - Registrant's By-laws, amended effective as of September 1, 1992, are incorporated herein by reference to Exhibit 3 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1992.\n(4) - Pursuant to various indentures and other agreements, the Registrant has issued long-term debt; however, no such agreement has securities or obligations covered thereby which exceed 10% of the Registrant's total consolidated assets. The Registrant agrees to furnish the Commission with a copy of any such indenture or agreement upon request by the Commission.\n(24) - Powers of attorney executed by the directors of the Registrant.\n(27) - Financial Data Schedule.\n(b) Reports on Form 8-K -------------------\nNo reports on Form 8-K were filed by the Registrant 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, on this 30th day of March, 1995.\nMISSOURI PACIFIC RAILROAD COMPANY\nBy \/s\/ Richard K. Davidson ------------------------------------ Richard K. Davidson, Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below, on this 30th day of March, 1995, by the following persons on behalf of the Registrant and in the capacities indicated.\nBy \/s\/ Richard K. Davidson ------------------------------------ Richard K. Davidson, Chairman and Chief Executive Officer and a Director\n\/s\/ L. White Matthews, III ------------------------------------ L. White Matthews, III, Chief Financial Officer and a Director\n\/s\/ Morris B. Smith ------------------------------------ Morris B. Smith, Vice President-Finance\n\/s\/ Charles E. Billingsley ------------------------------------ Charles E. Billingsley, Chief Accounting Officer\nSIGNATURES - (Continued)\nRobert P. Bauman* Drew Lewis*\nRichard B. Cheney* Richard J. Mahoney*\nE. Virgil Conway* Claudine B. Malone*\nSpencer F. Eccles* Jack L. Messman*\nElbridge T. Gerry, Jr.* John R. Meyer*\nWilliam H. Gray III* Thomas A. Reynolds, Jr.*\nJudith R. Hope* James D. Robinson III*\nLawrence M. Jones* Robert W. Roth*\nRichard D. Simmons*\n* By \/s\/ Judy L. Swantak ----------------------------------------- Judy L. Swantak, Attorney-in-fact\nEXHIBIT INDEX -------------\nExhibit Number --------------\n(3)(a) - Registrant's Certificate of Incorporation, amended effective as of August 12, 1988, is incorporated herein by reference to Exhibit 3(i) to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1988.\n(3)(b) - Registrant's By-laws, amended effective as of September 1, 1992, are incorporated herein by reference to Exhibit 3 to the Registrant's Report on Form 10-Q for the quarter ended September 30, 1992.\n(4) - Pursuant to various indentures and other agreements, the Registrant has issued long-term debt; however, no such agreement has securities or obligations covered thereby which exceed 10% of the Registrant's total consolidated assets. The Registrant agrees to furnish the Commission with a copy of any such indenture or agreement upon request by the Commission.\n(24) - Powers of attorney executed by the directors of the Registrant.\n(27) - Financial Data Schedule.\nMISSOURI PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY COMPANIES\nPage ----\nIndependent Auditors' Report\nFinancial Statements:\nStatement of Consolidated Financial Position - December 31, 1994 and 1993 -\nStatement of Consolidated Income and Retained Earnings - For the Years Ended December 31, 1994, 1993 and 1992\nStatement of Consolidated Cash Flows - For the Years Ended December 31, 1994, 1993 and 1992\nAccounting Policies\nNotes to Consolidated Financial Statements -\nManagement's Narrative Analysis of the Results of Operations\nNo schedules are required to be filed because of the absence of conditions under which they would be required or because the required information is set forth in the financial statements referred to above.\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTo the Board of Directors Missouri Pacific Railroad Company Omaha, Nebraska\nWe have audited the accompanying statements of consolidated financial position of Missouri Pacific Railroad Company (a wholly-owned indirect subsidiary of Union Pacific Corporation) and subsidiary companies (the \"Registrant\") as of December 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 December 31, 1994. These financial statements are the responsibility of the Registrant'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 consolidated financial statements present fairly, in all material respects, the financial position of the Registrant 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.\nAs discussed in Note 1 to the consolidated financial statements, the Registrant changed its method of accounting for postretirement benefits other than pensions, income taxes and transportation revenue and expense recognition in January 1993.\n\/s\/ DELOITTE & TOUCHE LLP\nOmaha, Nebraska January 19, 1995\nMISSOURI PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY COMPANIES\nACCOUNTING POLICIES -------------------\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Missouri Pacific Railroad Company and all subsidiaries (the \"Registrant\"). The Registrant is a wholly-owned, indirect subsidiary of Union Pacific Corporation (the \"Corporation\"). Investments in affiliated companies (20% to 50% owned) are accounted for on the equity method. All material intercompany transactions are eliminated.\nINVENTORIES\nInventories consist primarily of materials and supplies carried at the lower of average cost or market.\nREVENUE RECOGNITION\nTransportation revenues are recognized on a percentage-of-completion basis, while delivery costs are recognized as incurred (See Note 1).\nPROPERTIES\nProperties are stated at cost. Upon sale or retirement of units of depreciable operating property, gains and losses are charged to accumulated depreciation. With respect to all other property sold or retired (principally land sold for industrial development or as surplus property), cost and any related accumulated depreciation are removed from the accounts and a gain or loss is recognized upon disposition.\nDEPRECIATION\nProvisions for depreciation are computed principally on the straight-line method based on estimated service lives of depreciable properties.\nINTANGIBLE ASSETS\nIntangible and other assets include the cost in excess of fair value of net assets of acquired businesses associated with the Registrant's 1988 purchase of The Missouri-Kansas-Texas Railroad Company (the \"Katy\"). Amortization is recorded over 40 years on a straight-line basis. The Registrant regularly assesses the recoverability of costs in excess of net assets of acquired businesses through a review of cash flows and fair values of those businesses.\nHEDGING TRANSACTIONS\nThe Registrant periodically hedges hydrocarbon purchases (See Note 3). Gains and losses from these transactions are recognized upon receipt of the commodity.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------\n1. Accounting Changes\nIn January 1993, the Registrant adopted the following accounting changes with a cumulative after-tax charge to earnings of $125.2 million.\nOther Postretirement Benefits (\"OPEB\") (See Note 8)\nStatement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", requires that the cost of non-pension benefits for retirees be accrued during their period of employment. The adoption of this Statement does not affect future cash funding requirements for these benefits. The OPEB component of the cumulative effect adjustment was a $73.5 million charge.\nIncome Taxes (See Note 4)\nSFAS No. 109, \"Accounting For Income Taxes\", requires the balance-sheet approach of accounting for income taxes, whereby assets and liabilities are recorded at the tax rates currently enacted. The Registrant's future results may be affected by changes in the corporate income tax rate. The income tax component of the cumulative effect adjustment was a $42.2 million charge.\nRevenue Recognition\nThe Registrant changed its method of transportation revenue and expense recognition from accruing both revenues and expenses at the inception of service to the industry practice of allocating revenues between reporting periods based on relative transit time, while recognizing expenses as incurred. The revenue recognition component of the cumulative effect adjustment was a $9.5 million charge.\n2. Related Party Transactions\nThe Registrant is an affiliate of Union Pacific Railroad Company (\"UPRR\") and has significant interline rail shipments, equipment rents, and fuel and diesel power exchanges with that railroad. These transactions are settled in a manner similar to that used for comparable transactions with nonaffiliated railroads. Balances representing interline receivables and payables with UPRR are classified as due to affiliated companies.\nCertain management and staff functions of the Registrant have been combined with those of UPRR. In addition, the affiliated railroads have centralized purchasing and disbursing functions which are handled by UPRR. Also, repairs to locomotives and freight cars are made on a system-wide basis without regard to ownership or usage. Marketing, administrative and other expenses (including, but not limited to, those discussed above) are allocated to the Registrant based on revenue contribution, gross ton-miles or time in service.\nA summary of directly-incurred and allocated costs included in operating expenses is as follows:\nAmounts due to and from affiliates, including the Corporation, bear interest at an annually determined rate which considers the Corporation's cost of debt. Net intercompany interest expense on such amounts was $65.2 million, $65.5 million and $71.1 million in 1994, 1993 and 1992, respectively.\n3. Financial Instruments\nHedging\nThe Registrant uses derivative financial instruments to protect against diesel fuel price increases. While the use of these hedging arrangements limits the downside risk of adverse price movements, it may also limit benefits from\nfavorable movements. All hedging is accomplished pursuant to exchange-traded contracts or master swap agreements based on standard forms. The Registrant does not hold or issue financial instruments for trading purposes and addresses market risk by selecting instruments whose value fluctuations correlate strongly with the underlying item or risk being hedged. Credit risk related to hedging activities, which is minimal, is managed by requiring minimum credit standards for counterparties, periodic settlements and\/or mark-to-market evaluations. The Registrant has not been required to provide, nor has it received any significant amount of collateral relating to its hedging activity.\nHedging arrangements fix diesel fuel prices using price swaps in which the Registrant pays fixed prices in exchange for market prices for equivalent notional amounts of fuel; however, at December 31, 1994, the Registrant had no hedging agreements in place.\nFair Value of Financial Instruments\nThe fair market value of the Registrant's long and short-term debt has been estimated using quoted market prices or current borrowing rates. At December 31, 1994, the carrying value of total debt exceeded the fair market value by approximately 48%. The carrying value of all other financial instruments approximates fair market value.\nOff-Balance-Sheet Risk\nThe Registrant has sold, on a revolving basis, an undivided ownership interest in a designated pool of its accounts receivable to UPRR. The undivided ownership interest has been sold by UPRR to third parties. Collection risk on the pool of receivables is minimal. Under the terms of the agreement, UPRR acts as a collection agent for the Registrant. At both December 31, 1994 and 1993, accounts receivable are presented net of $137 million in proceeds generated from the receivables sold.\n4. Income Taxes\nThe Registrant is included in the consolidated income tax return of the Corporation. The consolidated income tax liability of the Corporation is allocated among the parent and its subsidiaries on the basis of their separate contributions to the consolidated income tax liability, with full benefit of tax losses and credits made available through consolidation being allocated to the individual companies generating such losses and credits.\nIn August 1993, President Clinton signed the Omnibus Budget Reconciliation Act of 1993 into law raising the Federal corporate income tax rate to 35 percent from 34 percent retroactive to January 1, 1993. As a result, 1993 income tax expense increased by $26.5 million: $23.1 million for the one-time non-cash recognition of deferred income taxes related to prior periods and $3.4 million of incremental 1993 Federal income tax expense.\nComponents of income tax expense for the Registrant are as follows:\nThe 1992 components of tax expense (in thousands), which have not been restated to reflect the adoption of SFAS No. 109 (see Note 1), were $59,952 for current Federal income tax expense and $38,916 for deferred Federal income tax expense.\nThe tax effect of differences in the timing of revenues and expenses for tax and financial reporting purposes is as follows:\nA reconciliation between statutory and effective tax rates is as follows:\nPayments of income taxes were $108.2 million in 1994 and $101.8 million in 1993. No taxes were paid for the year 1992. The Corporation believes it has adequately provided for income taxes.\n5. Debt\nTotal debt at December 31, 1994 and 1993 is summarized below:\nMaturities of long-term debt (in thousands of dollars) for each year 1996 through 1999 are $24,462, $23,934, $7,178 and $6,446, respectively. Substantially all properties secure the outstanding equipment obligations and mortgage bonds.\nCertain debt agreements impose dividend restrictions on the Registrant. The amount of retained earnings available for dividends at December 31, 1994 was $961.3 million. See Note 7 for other dividend restrictions.\nTerms of certain of the Registrant's mortgage bonds, the 5% income debentures and the 5-1\/2% subordinated income debentures require that interest be paid only from \"available income\", as defined in the indenture agreements. The mortgage bonds and 5% income debentures impose sinking fund and other restrictions in the event all interest is not paid. All interest was paid on the mortgage bonds and 5% income debentures for each of 1994, 1993 and 1992.\nThe Registrant assumed the 5-1\/2% subordinated income debentures (the \"Debentures\") in connection with the Katy acquisition. Current interest must be paid only to the extent that there is available income remaining after allocation to a capital fund for the purpose of reimbursing the Registrant for certain capital expenditures. Unpaid interest accumulates to an amount not in excess of 16-1\/2% of the principal amount of the Debentures and is paid only to the extent that there is available income remaining after payment of the current interest.\nThe certificates constituting a charge on income (the \"Certificates\"), which were also assumed as part of the Katy acquisition, do not bear interest and payments to a sinking fund for the Certificates are made only from available income, as defined in such Certificates. Available income must be applied to the capital fund, current and accumulated interest on the Debentures and a sinking fund for the Debentures before any payment is made to the sinking fund for the Certificates.\nAvailable income of $19.1 million was generated in 1994 with respect to the Debentures and the Certificates. As a result, an interest payment on the Debentures of $1.5 million will be made in 1995, representing 1994 interest. In addition, $7.4 million of available income will be applied to the capital fund, $3.9 million will be applied to the sinking funds for the Debentures and the Certificates, and $6.3 million will be applied as dividends on the Registrant's Class A stock (See Note 7). Amounts applied to sinking funds may be covered by the cost of securities previously repurchased by the Registrant or the Katy. Amounts in the capital fund which are unused or unappropriated for the reimbursement of capital expenditures may not exceed $4.0 million at any time, and after the application of 1994 available income, there will be no unused or unappropriated capital fund balance. During 1994, $866,000 of the outstanding Debentures were reacquired.\nThe Registrant's total interest payments approximate interest expense net of intercompany interest described in Note 2.\n6. Lease Commitments\nThe Registrant leases a general office building, computer equipment and transportation equipment under long-term and contingent lease agreements. The following amounts relating to capital leases are included in properties:\nFuture minimum lease payments for capital and operating leases with initial or remaining noncancellable lease terms in excess of one year as of December 31, 1994 are as follows:\nA summary of rental expense charged to operations is as follows:\n7. Capital Stock\nConcurrent with the acquisition of the Katy, 80 shares of the Registrant's $1.00 par value common stock were exchanged for 80 shares of $1.00 par value Class A stock. The remaining 920 shares of common stock outstanding and the 80 shares of Class A stock have identical voting rights and other privileges except with respect to dividends.\nThe Class A stock is entitled to a cash dividend whenever a dividend is declared on the common stock, in an amount which equals 8% of the sum of the dividends on both the Class A stock and the common stock. However, dividends may be declared and paid on the Class A stock only when there is unappropriated available income in respect of prior calendar years which is sufficient to make a sinking fund payment equal to 25% of such dividend for the benefit of the Debentures or the Certificates (see Note 5). To the extent that dividends are paid on the common stock but not the Class A stock because the amount of unappropriated available income is insufficient to make such a sinking fund payment, a special cash dividend on the Class A stock shall be paid when sufficient unappropriated available income exists to make the sinking fund payment. Such insufficiency does not affect the Registrant's right to declare dividends on the common stock. Available income for 1994 will be sufficient to provide for a $6.3 million special cash dividend on the Class A stock to be paid in 1995. After such payment, dividends in arrears on the Class A stock will total $26.6 million.\nThere are no other dividend restrictions on the Registrant's capital stock other than those described in Note 5.\n8. Retirement Plans\nThe Registrant participates in the Corporation's defined benefit pension plans covering substantially all salaried employees. Pension plan benefits are based on years of service and compensation during the last years of employment.\nCompany contributions to the plans are calculated based on the Projected Unit Credit actuarial funding method and are not less than the minimum funding standards set forth in the Employee Retirement Income Security Act of 1974, as amended. Pension expense allocated to the Registrant under the Corporation's plans amounted to $19.7 million in 1994, $17.7 million in 1993, and $14.8 million in 1992. In addition, the Registrant's employees are covered by the Railroad Retirement System. Contributions made to the system are expensed as incurred.\nThe Registrant provides postretirement health care and life insurance benefits to substantially all salaried and certain hourly employees through participation in the Corporation's postretirement benefit plans. The Corporation adopted the provisions of SFAS No. 106 (See Note 1) in January 1993. Agreement employees' health care benefits are covered by a separate multiemployer plan and therefore are not subject to the provisions of this Statement. The Corporation does not currently prefund health care and life insurance benefit costs. The Registrant's cash payments for these benefits were $5 million in each of 1994 and 1993 and its 1994 and 1993 postretirement benefit expenses were $5 million and $9 million, respectively. At December 31, 1994 and 1993, the Registrant's Accumulated Postretirement Benefit Obligations were $92 million and $93 million, respectively, while its total OPEB liability on each of the same dates was $119 million.\n9. Contingent Liabilities\nThere are various lawsuits pending against the Registrant. In addition, the Registrant generates, transports, remediates and disposes of hazardous and non- hazardous waste in its current and former operations, and is subject to Federal, state and local environmental laws and regulations. The Registrant is currently participating in the investigation and remediation of numerous sites. Where the remediation costs can be reasonably determined, and where such remediation is probable, the Registrant has recorded a liability. The liability includes future costs for remediation and restoration of sites as well as for ongoing monitoring costs, but excludes any anticipated recoveries from third parties. Cost estimates were based on information available for each site, financial viability of other potentially responsible parties, and existing technology, laws and regulations. Certain Federal legislation imposes joint and several liability for the remediation of identified sites; consequently, the Registrant's ultimate environmental liability may include costs relating to other parties in addition to costs relating to its own activities at each site. The Registrant believes that it has adequately accrued for its ultimate share of costs at sites subject to joint and several liability. The Registrant does not expect that the lawsuits or environmental costs will have a material material adverse effect on its consolidated financial condition or results of operations.\n10. Supplemental Quarterly Financial Information (Unaudited)\nSelected unaudited quarterly financial information for 1994 and 1993 are as follows:\nMISSOURI PACIFIC RAILROAD COMPANY AND CONSOLIDATED SUBSIDIARY COMPANIES\nMANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS\n1994 COMPARED TO 1993 ---------------------\nNet income for the Registrant was $247.5 million in 1994. Before the effects of the 1993 accounting adjustments (comprising the changes in accounting principles described in Note 1 to the Financial Statements and the $23.1 million one-time recognition of deferred income taxes related to prior periods described in Note 4 to the Financial Statements), earnings would have improved $25.4 million (11%) from $222.1 million a year ago. 1993 results also included the adverse effects of the flooding in the Midwest and the severe winter.\nOPERATING REVENUES ------------------ Operating revenues increased $172 million (8%) to $2.3 billion, reflecting a 10% increase in carloadings offset by a 1% decline in average revenue per car, principally resulting from volume growth for lower-rated commodities (intermodal and energy). Carloadings increased in intermodal (24%), energy (17%), automotive (15%), chemicals (6%) and food\/consumer\/government (5%), while decreases occurred in grain and grain products (3%), and metals\/minerals\/forest (1%).\nOPERATING EXPENSES ------------------ Operating expenses totaled $1.9 billion, $116 million (7%) higher than a year ago. Volume growth and inflation accounted for a $50 million rise in equipment and other rents. Employee injury expense rose $19 million as continuing declines in the number of injuries were more than offset by higher average settlement costs per injury. In addition, other costs grew $29 million due to a reduction in cost offsets associated with car repairs for other carriers and other services performed for outside parties. Wage and benefit costs also rose $10 million, as higher volumes and inflation were partially offset by continued improvements in labor productivity. Depreciation expense grew $9 million because of continued investment in equipment and capacity. Fuel and utilities costs rose only $1 million as lower fuel prices and an improved consumption rate combined to offset the impact of volume growth.\nOPERATING INCOME ---------------- Operating income rose $56 million (14%) to $466 million as a result of volume growth and improved operating efficiencies and labor productivity.\nOTHER CHANGES ------------- Interest expense decreased $8 million, primarily as a result of lower interest on equipment trust obligations. Other income decreased $15 million, due to reduced gains on extinguishment of debt and other miscellaneous items. Income taxes were essentially unchanged as higher pretax earnings offset last year's recognition of deferred income taxes relating to prior periods.","section_15":""}
{"filename":"771178_1994.txt","cik":"771178","year":"1994","section_1":"ITEM 1. BUSINESS GENERAL The Company owns and operates nonwireline cellular telephone systems in the Eastern United States and has been in business since 1984. Based on its 7.5 million aggregate pops as of December 31, 1994, including 400,000 pops under contract as of year-end and acquired in January 1995, the Company believes it is the largest independent operator of solely nonwireline cellular telephone systems in the United States. The Company's 28 control cellular markets are grouped into five operating metro-clusters consisting of the Mid-Atlantic Supersystem and the Florida, Carolinas, New England and West Virginia metro-clusters. The Mid-Atlantic Supersystem, together with the New England metro-cluster, represent over 76% of the Company's pops and are contiguous to four of the nation's seven largest MSAs -- New York, Philadelphia, Baltimore\/Washington and Boston. The Company has pursued a strategy of forming regional metro-clusters in an effort to provide better service to customers and to achieve marketing and operating efficiencies through economies of scale. This strategy has permitted it to provide a larger area of uninterrupted service as the subscriber travels throughout the region and to expand geographic coverage within a subscriber's home market, which reduces the subscriber's need to use roamer access codes when traveling outside of the home market and, in some cases, eliminates the payment of higher roaming fees. In addition, the Company believes clustering reduces capital and operating costs through technical integration and the sharing of common marketing and sales management. Among other things, this clustering strategy enabled the Company to reduce the number of telephone switching offices that otherwise would be required to operate its markets and to decrease the number of technical and management personnel required to staff its operations. The Company's total number of subscribers and operating results have improved in each of the years 1990 through 1994. During the five-year period 1990 to 1994, the number of subscribers in the Company's majority-owned markets grew from 38,900 at the beginning of 1990, to 245,000 at year-end 1994, a compounded annual growth rate of approximately 44%, while the Company's subscriber penetration rate, based on 1994 \"pops,\" increased from 2.34 to 3.56%. Service revenues grew from $46.5 million in 1990 to $146.4 million in 1994, a compounded annual growth rate of 33%. The Company began generating positive Operating Cash Flow in the second quarter of 1991 and Operating Cash Flow grew from $4.4 million in 1991 to $35.9 million in 1994, representing a compounded annual growth rate of 101%. See \"Item 6. Selected Consolidated Financial Data\", \"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition,\" and \"Item 8. Financial Statements and Supplementary Notes and Subscribers.\" The Company's primary objective over the next several years will be to maximize long-term Operating Cash Flow and operating income through a threefold strategy of (i) increasing operating cash flow margins through balanced subscriber and revenue growth and control of selling, general and administrative expenses, (ii) accelerating its cellular network buildout, and (iii) expanding metro-cluster service areas through strategic acquisitions and by maximizing the level of \"seamless\" coverage available to current and future subscribers. Operating Cash Flow is used by the Company to satisfy its debt service obligations, capital expenditure and other operational needs as well as provide funds for strategic acquisitions and investments. In addition, Operating Cash Flow historically has been used by lenders and the investment community to determine the current borrowing capacity and long-term value of companies in the telecommunications\/media industry. INCREASING OPERATING CASH FLOW MARGINS. The Company's goal is to continue to improve annual Operating Cash Flow margins by increasing incremental year-to-year subscriber growth, while maintaining stable levels of average monthly revenue per subscriber and controlling the growth of related marketing and selling, general and administrative expenses. The Company has been successful in increasing both the absolute number of subscribers and the annual growth rate of subscribers in each of 1991, 1992, 1993 and 1994 through a combination of an internal sales force targeting business customers and outside distribution channels focused primarily on retail customers and through acquisitions. See \"Subscribers.\" Average monthly revenue per subscriber remained relatively stable decreasing only 1% from 1991 to 1993 compared with an overall industry decline of 24% during the same period. During the year ended December 31, 1994 the Company had a reduction of revenue per subscriber of approximately 8% compared to the same period in 1993 due primarily to the Company's subscriber growth rate exceeding the rate of growth of roaming revenues. See \"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\" The Company attributes its success in stabilizing revenue per subscriber to the design of its monthly rate plans, which offer prepaid minutes at higher fixed monthly charges, and its sales commission structures, which are linked to monthly access fee revenues generated. The Company also strives to control the level of selling, general and administrative expenses associated with its increased subscriber and revenue growth. The continuing automation of such high volume processes as billing, credit and\ncollections, and rapid subscriber activations as well as the centralization of back office accounting, engineering and financial service operations resulted in reduced general and administrative expenses as a percentage of service revenues in each of 1991, 1992, 1993 and 1994. Additionally, selling and marketing costs per net new subscriber have declined in each of these years and the Company will work to continue this trend through a highly productive internal sales organization, cost-effective outside distribution channels and sales commissions based upon rate plans and customer retention. CELLULAR NETWORK BUILDOUT. Cellular systems are capital intensive, requiring significant levels of investment for equipment, construction and cell site acquisition. As of December 31, 1994, the Company had approximately $184.2 million of installed property and equipment and approximately $16.1 million of construction in progress. Company engineers manage the initial construction and subsequent expansion and modification of each cellular system for which the Company owns a majority interest. The Company believes that this procedure improves its overall system engineering and construction quality and reduces the expense and time required to make and keep a system operational. The Company historically has incurred capital expenditures primarily based upon capacity needs in its existing markets resulting from continued subscriber growth. During 1994, the Company initiated a plan to double the number of cell sites in order to increase geographic coverage and provide for additional portable usage in the Company's cellular markets. As a result of this accelerated network buildout and the continued growth of the Company's subscriber base, capital expenditures were $62.6 million during the 1994 and should approximate $130.0 million during 1995. INCREASING METRO-CLUSTER SERVICE AREAS. The Company intends to increase its metro-cluster service areas through strategic acquisitions and by maximizing the level of \"seamless\" coverage available to current and future customers. Seamless coverage permits subscribers, as they travel through the network, to receive calls and otherwise to use their cellular telephones as if they were in their home markets. Through the use of a mobile telephone switching office (\"MTSO\") serving multiple markets, the Company already has been able to implement such seamless coverage throughout most of its Mid Atlantic Supersystem. The Company will continue to broaden the area of seamless coverage within its networks by implementing switch interconnection plans for MTSOs located in adjoining markets owned by other carriers. In addition, the Company has begun to interconnect certain Company MTSOs with switches in large cities like Philadelphia and Boston using \"IS-41\" technical interfaces. This technical interface, developed by the cellular industry, allows carriers that have a variety of types of equipment to integrate their systems towards the eventual goal of establishing a national seamless network. The Company has integrated its switches into, the North American Cellular Network, which allows the Company's subscribers to place and receive calls automatically in over 3,000 cities throughout the United States. The Company also continues to evaluate further consolidation of its ownership in existing cellular markets and acquisitions of new cellular properties in markets that will further expand its metro-clusters. In evaluating acquisition targets, the Company considers, among other things, demographic factors, including population size and density, traffic patterns, cell site coverage and required capital expenditures, including the ability of the target market to utilize existing switching capacity. In pursuing such acquisitions, the Company may exchange interests in nonconsolidated markets for interests in existing or new markets that serve to expand its networks. In December 1994, the Company consummated the acquisition of the Binghamton, New York MSA and the Elmira, New York MSA for an aggregate purchase price of $6.1 million in cash and approximately 1.8 million shares of the Company's Class A Common Stock. In addition, in January, 1995, the Company acquired the Union, Pennsylvania (PA-8) RSA for an aggregate purchase price of $51.3 million in cash. See \"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\" NEW OPPORTUNITIES. The Company is also pursuing new opportunities that complement its core cellular business. The Company has entered into a strategic alliance with Geotek Communications, Inc. (\"Geotek\"), a telecommunications company that is developing a wireless communications network in the United States based on its FHMA digital technology. This alliance primarily consists of a $30 million investment in Geotek common stock with options to purchase additional stock and a five-year agreement pursuant to which the Company will provide management consulting services to Geotek. The Company also has developed a billing and management information system, called Flexcell. The Company has entered into its first contract for Flexcell with American Mobile Satellite Corporation (\"AMSC\") but has ceased marketing Flexcell to third parties for the remainder of 1995 in order to assure that it can meet the selling needs of the Company and AMSC. See \"New Opportunities -- Flexcell\". INTERNATIONAL INITIATIVES. The Company is actively pursuing opportunities in the development of cellular and other communications systems throughout the world, both directly, through joint ventures with local entities and others, and indirectly through its minority ownership interest in International Wireless Communications, Inc., See \"International Initiatives.\"\nSUBSCRIBERS The Company's customers are primarily business users who utilize the cellular telephone to improve productivity. Historically, the Company's business users were individuals who worked extensively from their cars, in such professions as construction and real estate. As a result of the growing acceptance and the declining cost of portable and transportable phones, as well as the Company's marketing efforts, the Company's business users now are drawn from a wider range of occupations. Business users normally generate more revenues than nonbusiness consumers. While the Company anticipates increasing nonbusiness consumer acceptance of cellular telephone service, business users are expected to generate the majority of the Company's revenues for the foreseeable future. The following table sets forth the aggregate number of subscribers in the Company's majority-owned markets at the end of the periods indicated.\nThe incremental subscriber growth and the rate of subscriber growth is set forth in the following table for the periods indicated.\nThe following table sets forth the number of subscribers and the penetration percentages in majority-owned markets as of the dates indicated.\n* Based on year-end pops Subscriber growth and increased penetration in 1992, 1993 and 1994 was a product of moderate economic recovery in the Company's operating regions, an increase of marketing efforts and productivity by the Company and increasing product awareness. In addition, 1994 subscriber growth was augmented by approximately 14,000 subscribers associated with the acquisition of certain cellular markets. PRODUCTS AND SERVICES The Company's primary line of business is the sale of cellular telephone service. Customers are offered several pricing options combining different monthly access and usage charges and charges for related services. The Company initiated new rate plans in 1991 with higher monthly access charges and greater numbers of prepaid minutes of usage. For example, in several of the Company's markets, the lowest rate plan offered has increased from a $7.50 per month access charge with no prepaid minutes of usage to a $24.95 per month charge, which includes 30 prepaid minutes of usage. This pricing strategy was designed to stabilize the Company's revenues by increasing the portion of revenues from monthly access charges. Business usage typically drops in the winter months of December, January and February when people spend less time in their cars and in months with holidays and fewer business days. The Company believes that the rate\nstructure has reduced this seasonality and has stabilized revenue per subscriber by encouraging increased usage through offering a higher number of prepaid minutes at an overall lower cost per minute. The Company has entered into agreements with other cellular companies that allow its subscribers to roam in all 306 MSAs and a large majority of the 428 RSAs throughout the country. Roaming allows the Company's subscribers to be pre- registered in cellular systems outside the Company's operating regions and to receive service while they are outside their home systems for a usage charge and an additional daily fee in most cases. The Company provides regional service among its own contiguous markets, such as those within the Mid-Atlantic Supersystem. Utilizing this regional service a customer can conveniently place and receive calls throughout the network without any additional daily fee and often at the same incremental rate per minute as in his or her home market. In certain adjacent cellular markets not owned by the Company, similar regional pricing has been made available through the Company to its subscribers. In many instances, the Company charges its customers who roam into adjacent cellular markets at rates consistent with those rates it charges in its own markets rather than passing through higher roaming rates customarily charged by many cellular carriers. This billing practice, while creating a marketing advantage by providing the customer with a broader virtual service area, has caused the Company to incur increased net costs related to providing these services. The rapid subscriber growth that has occurred in the past year has made this larger virtual service area available to significantly more customers, which has caused greater net costs to be incurred by the Company. The Company is continuing its efforts to reduce these costs through the continued negotiation of more favorable roaming agreements with both wireline and nonwireline cellular service providers. See \"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\" The Company sells and rents cellular equipment to its customers in order to encourage use of its services. Losses on cellular equipment reflect the Company's continued practice of selling telephones at or below cost in response to competitive pressures as well as the Company's increased subscriber growth. The Company offers a subscriber equipment rental program that many subscribers have found to be an economical means of acquiring the use of cellular equipment. Under the terms of the rental program, subscribers obtain the use of a cellular telephone for a monthly charge. Although the Company retains ownership of this equipment, the subscribers have the option to purchase their cellular telephones at any time during the rental period. The Company often utilizes a promotion under which the first year's rental charge is waived when the subscriber agrees to a one-year service contract. WIRELESS DATA SERVICES. The Company is exploring additional revenue sources such as wireless data services for delivery over its existing cellular networks. During 1993, the Company and other cellular carriers participated in the United States' first nationwide cellular data service for United Parcel Service (\"UPS\"). This service allows UPS drivers, who record package tracing information on an electronic clipboard, to send the information over the networks of cellular carriers through the country, including the Company's networks, to UPS's private network and ultimately to UPS's mainframe computers. Currently certain cellular operators have formed a consortium to test packet-switching technology, which may create significant new opportunities in the wireless data market. Packet-switching technology is designed to allow data to be transmitted much more efficiently than the current circuit-switching technology. Packet-switching uses the intervals between voice traffic on cellular channels to send packets of data, instead of tying up dedicated cellular channels. The packets of information, which may be transmitted using several different channels, are reassembled and directed to the correct party at the receiving end. 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, including fax and electronic mail transmissions and communications between laptop units and local area networks or other computer databases. The Company anticipates that it may begin offering data transmission services using packet-switching technology in its larger markets during 1996. MARKETING The Company coordinates the marketing strategy for each cellular system in which it owns a majority interest. In marketing its service, the Company stresses that cellular telephones are affordable, easy to use and produce immediate and direct benefits to subscribers, including increased productivity and convenience. The Company also emphasizes its customer service orientation. See \"Customer Service.\" Like the nonwireline licensees in many other markets, the cellular systems controlled by the Company conduct business under the service mark Cellular One(Register mark), which is licensed by the Cellular One Group at reasonable cost to nonwireline cellular licensees in an effort to reinforce consumer identification. The Company owns a minority interest in the Cellular One Group and therefore has input into business decisions regarding the use of this service mark.\nAs of December 31, 1994, the Company's sales force consisted of approximately 300 sales and administrative employees and approximately 500 independent agents. Each sales employee and independent agent solicits cellular customers exclusively for the Company. The Company's direct sales force focuses on business users. Since 1991, these sales employees have been compensated on a base salary plus commission basis. The Company believes that this compensation structure has provided a more stable and efficient sales force and reduces incremental marketing costs per new subscriber. Marketing and selling costs per net subscriber addition decline substantially under this compensation structure, particularly when the volume of activations is high. In 1992, 1993 and 1994 marketing and selling expenses per net subscriber addition, including net loss on cellular equipment, was $799, $629 and $493, respectively. See \"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\" In order to maintain a knowledgeable, customer-oriented sales force, the Company developed and administers its own sales training program designed to educate the sales representatives for its markets. The Company believes that by offering a core curriculum of mobile technologies, cellular equipment prospecting, sales techniques, and the customer service process, its sales representatives are able to address existing and potential customer needs in a professional, knowledgeable and productive manner. As a result, it is believed that this sales training contributes to building a subscriber base more quickly and attracting subscribers who will produce high service revenues. The Company also maintains a telemarketing program. This program is intended to aid the Company by providing sales follow-up and support, securing additional and better qualified sales referrals, upgrading existing subscribers to higher access rate plans and promoting new custom-calling features. The Company's agents are independent contractors, either in the business of selling or servicing cellular telephones exclusively or engaged in businesses whose customers are likely to become cellular subscribers. Examples of the latter are new car dealers, electronics stores and car stereo companies. CUSTOMER SERVICE The Company has devoted substantial resources to insuring consistently high quality customer service. The Company spends approximately $3 million annually for this purpose. Several customer service operations are centralized in the Company's Greensboro headquarters. The central customer service department is open 24 hours daily, including weekends and holidays, and handles all customer service inquiries. Customer service personnel are trained in certain core competencies such as general mobile technology, available cellular equipment, roaming and cellular billing. The Company believes that this training provides these employees with the requisite knowledge to handle customer inquiries quickly and competitively, resulting in greater customer satisfaction. This training, which was developed and is administered by the Company, requires employees to demonstrate competency through testing. The Company has developed a billing and management information system, Flexcell(tm), which it believes provides several service advantages to its customers. Customer service representatives are able to access current billing information quickly in order to handle customer inquiries promptly. In addition, this computerized system collects and integrates customer related data from various Company operations such as sales and marketing into a single database. Using this database, service calls are systematically analyzed each month to proactively address key customer issues. The customer database also provides the basis for customer satisfaction information. The Company has entered into a contract to provide billing software and support to American Mobile Satellite Corporation, but has ceased marketing Flexcell to third parties for the remainder of 1995 in order to assure that it can meet the selling needs of the Company and American Mobile Satellite Corporation. See \"New Opportunities -- Flexcell(tm)\". To supplement the Company's customer service operation, the Company's telemarketing group contacts customers on a regular basis to determine customer satisfaction with the Company's service in order to identify problems that can lead to subscriber cancellations. The Company also recently developed an integrated feature, called \"Rapid Activation,\" designed to reduce dramatically the time to activate service for a new customer. Rapid Activation now allows the Company to perform a credit check, complete order entry and activate a cellular subscriber in approximately five minutes. Previously, this process consumed approximately one hour. To ensure quality installation and customer satisfaction, the Company has established its own installation repair centers in most of its markets. These Cellular One installation\/repair centers provide one-stop shopping for the Company's customers and better enable the Company to control installation quality and scheduling and inventory levels. These centers are also authorized to perform warranty repair work for mobile-telephone manufacturers.\nCELLULAR TELEPHONE INDUSTRY Cellular telephone service is a form of telecommunications capable of high quality, high capacity mobile and portable telephone services. Cellular systems are engineered so that a service area is divided into multiple cells approximately four to 10 miles in radius. Each cell contains a relatively low power transmitter, a receiver and signaling equipment (the base station). The base station in each cell is connected by microwave or telephone line to the MTSO. The MTSO controls the automatic transfer of calls from cell to cell as a subscriber travels, coordinates calls to and from a mobile unit, allocates calls among the cells within the system, and connects calls to the local landline telephone system or to a long-distance telephone network. Each conversation in a cellular system involves a radio transmission between a subscriber unit and a base station and the transmission of the call between the base station and the MTSO. The MTSO and base stations periodically monitor the signal strength of calls in progress. The signal strength of the transmission between a subscriber unit and the base station in any cell declines as the mobile unit moves away from the base station. When the signal strength of a call declines to a predetermined level, the switching station hands off the call in a fraction of a second to the base station of another cell where the transmission strength is greater. If the subscriber unit leaves the service area of the cellular system, the call is disconnected unless an appropriate IS-41 technical interface has been established with the adjacent system. The FCC has allocated the cellular telephone systems frequencies in the 800 MHz band of the radio spectrum. Each of the two licenses in a cellular market is assigned 416 frequency pairs. Each conversation on a cellular system occurs on a pair of radio talking paths, thus providing full duplex (i.e., simultaneous two-way) service. Two distinguishing features of cellular telephone systems are: (i) frequency reuse, enabling the simultaneous use of the same frequency in two adequately separated cells, and (ii) call hand-off. A cellular telephone system's frequency reuse and call hand-off features result in highly efficient use of available frequencies and enable cellular telephone systems to process more simultaneous calls and service more users over a greater area than conventional mobile telephone systems. A cellular telephone system's capacity can be increased in various ways. Within certain limitations, increasing demand may be met by simply adding available frequency capacity to cells as required or, by using directional antennas, dividing a cell into discrete multiple sectors or coverage areas, thereby facilitating frequency reuse in other cells. Furthermore, an area within a system may be served by more than one cell through procedures that utilize available channels in adjacent cells. When all possible channels are in use, further growth can be accomplished through a process called \"cell splitting.\" Cell splitting entails dividing a single cell into a number of smaller cells serviced by lower-power transmitters, thereby increasing the reuse factor and the number of calls that can be handled in a given area. Expected digital transmission technologies will provide cellular licensees with additional capacity to handle calls on cellular frequencies. Because of the present state of technology and assigned spectrum, there are limits to the number of signals that can be transmitted simultaneously in a given area. In highly populated MSAs, the level of demand for mobile and portable service is often large in relation to the existing capacity of most systems. Based on the demographics of its markets, the Company does not anticipate that the provision of mobile and portable service within its networks will require as large a proportion of the systems' capacities. Therefore, the Company's systems will have more capacity with which to pursue data applications and other expanded cellular services, which may enhance revenue and limit market opportunities for competitive mobile data systems. All cellular telephones are designed to be compatible with cellular systems in all market areas within the United States so that a cellular telephone may be used wherever a subscriber is located. Changes of cellular telephone numbers or other technical adjustments to mobile units by the manufacturer or local cellular telephone service businesses are generally required to enable the subscriber to change from one cellular service provider to another within a service area. Cellular system operators may provide service to subscribers from other cellular systems temporarily located in, or traveling through, their service area. The cellular system providing service to the roamer generally receives 100% of the revenues from such service. The cellular mobile telephone services available to customers and the sources of revenue available to a system operator are similar to those available with standard home and office telephones. For example, cellular systems can offer a variety of features, including call forwarding, call waiting, conference calling, voice message and retrieval, and data transmission. Because cellular systems are fully interconnected with the landline telephone network, subscribers can receive and originate both local and long distance calls from their cellular telephones. The subscribers generally are charged separately for monthly access, air time, toll calls and custom calling features.\nCellular telephone systems operate under interconnection agreements with various local exchange carriers (\"LECs\") and interexchange (long distance) carriers (\"IXCs\"). The interconnection agreements establish the manner in which the cellular telephone system integrates with other telecommunications systems. The cellular operator and the local landline telephone company must cooperate in the interconnection between the cellular and landline telephone systems to permit cellular subscribers to call landline subscribers and vice versa. The technical and financial details of such interconnection arrangements are subject to negotiation and vary from system to system. There are a number of recent technical developments in the cellular industry. Currently, while most of the MTSOs process information digitally, the radio transmission of cellular telephone calls is done predominantly on an analog basis. Digital technology offers advantages, including improved voice quality, larger system capacity, and perhaps lower incremental costs for additional subscribers. The conversion from analog to digital radio technology is expected to be an industry-wide process that will take a number of years. The cellular equipment currently employed by the Company in its systems is \"digital ready\" and can work in either an analog or digital mode. As a result, the Company should be able to transition from analog to digital mode with minimal expense. However, the specific timing and costs of such a conversion are yet unknown. COMPETITION WIRELINE COMPETITION. The cellular telephone business is a regulated duopoly. The FCC awards only two licenses in each market (although certain markets have been subdivided as a result of voluntary settlements), one to a nonwireline company and one to a wireline company, which is usually the local telephone company or affiliate. Each licensee has the exclusive grant of a defined frequency band within each market. The primary competition, therefore, for the Company's cellular service in any market will come from the wireline licensee in that market. Competition is principally on the basis of services and enhancements offered, the technical quality of the system, the quality and responsiveness of customer service and price. In the Company's control markets, its competitors are affiliates of the following companies:\n(1) Bell Atlantic Mobile Systems, Inc. and NYNEX Mobile Communications have announced plans to combine their properties. (2) Acquired in January 1995. (3) Jointly controlled through the Company's 50% ownership of a joint venture with GTE.\nCOMPETITION FROM OTHER TECHNOLOGIES. Several recent FCC initiatives indicate that the Company is likely to face greater competition in the future. The FCC has licensed ESMR system operators to construct digital mobile communications systems on existing ESMR frequencies in many metropolitan areas throughout the United States. When constructed, these multi-site configuration systems will offer interconnected mobile telephone service and are expected to compete with the Company's cellular service. One such operator, NEXTEL Communications, Inc., initiated services in the Los Angeles metropolitan area in the spring of 1994 and has announced plans to initiate service in numerous metropolitan areas including Philadelphia, Washington, D.C. and Boston during 1995 and 1996. At this time, the Company is unable to predict the extent to which NEXTEL or other ESMR system operators will offer competitive services to cellular either in the Company's markets or in adjacent metropolitan cities. In June 1994, the FCC allocated radio frequency spectrum for broadband PCS. Pursuant to the FCC's decision, six new licenses will be granted: three 30 MHz blocks and three 10 MHz blocks. By comparison, the two cellular carriers in each market currently have 25 MHz of spectrum each. Two of the 30 MHz licenses, the A and B blocks, will authorize the holders to provide service in one of 51 geographic market areas covering the United States referred to as Major Trading Areas (MTAs). The remaining 30 MHz license and each of the three 10 MHz licenses will cover one of 492 Basic Trading Areas, which represent smaller areas within the MTAs. The rules adopted by the FCC permit a licensee to acquire up to 40 MHz in a single service area. The rules do not restrict cellular licensees from participating in PCS in areas outside of their cellular service areas, although cellular licensees (defined as entities owning more than 20% of a cellular system) are only permitted to obtain 10 MHz PCS blocks in their cellular service areas in which they cover 10% of the population. The FCC is using competitive bidding procedures to award PCS licenses and has adopted rules requiring simultaneous multiple round auctions for licenses. Auctioning of both the A and B block 30 MHz MTA licenses has been completed, although the FCC is not expected to issue licenses for several months. Dates have not been set for the remaining blocks, but are expected to occur in the second half of 1995, or in 1996, depending upon pending legal challenges to the remaining 30 MHz designated entity block. The Company expects that certain PCS services may be competitive with the Company's cellular service; however, the exact nature of those services, and the timing of when those services might be offered are not presently known by the Company at this time. The Company is currently evaluating the opportunities that PCS might provide in its markets that could not be presently provided through existing spectrum allocated to the Company through its cellular licenses. Based upon the results of these studies, the Company may choose to participate in the upcoming auction process for the remaining PCS licenses. Continuing technological advances in the communications field make it difficult to predict the extent of future competition to cellular systems. REGULATION OF CELLULAR SYSTEMS FEDERAL REGULATION. The construction and operation of cellular systems in the United States are regulated by the FCC pursuant to the Communications Act of 1934, as amended (the Communications Act). The FCC has promulgated regulations governing the construction and operation of cellular systems, the licensing and administrative appeals process, purchase and sale of interests, and the technical standards for the provision of cellular telephone service. The FCC also regulates coordination of proposed frequency usage, height and power of base station transmitting facilities and types of signals emitted by such stations. In addition, the FCC has the authority to regulate certain aspects of the business operations of cellular systems. The FCC has declined to regulate the price and terms of offerings to the public. These rules and regulations, together with other applicable rules and regulations promulgated by the FCC, are referred to herein as the FCC rules. The FCC established 734 discrete geographically defined market areas comprising 306 MSAs and 428 RSAs for initial licensing. In each market the FCC awarded up to two licenses authorizing the use of radio frequencies for cellular telephone service. Changes in a licensee's network plan considered by the FCC to be major (generally, changes in the proposed service area) must be approved in advance by the FCC. Changes not considered to be major, such as changes in cell site locations that do not result in any enlargement of the service area, are authorized by notification to the FCC. The Company has obtained FCC operating authority for each of its systems. Upon commencement of operation, an initial operating license is granted for a period of ten years from the date of grant of the construction permit and is renewable upon application to the FCC for additional periods of ten years. Five years after the initial licenses are granted, unserved areas within markets previously granted to licensees may be applied for by both wireline and nonwireline entities and by third parties. The FCC has rules that govern the procedures for filing and granting such applications and has established requirements for constructing and operating systems in such areas.\nIn addition to regulation by the FCC, cellular systems are subject to certain Federal Aviation Administration tower height regulations respecting the siting and construction of cellular transmitter towers and antennas. The Communications Act prohibits the issuance of a license to, or the holding of a license by, any corporation of which any officer or director is a non-U.S. citizen or of which more than 20% of the capital stock is owned of record or voted by non-U.S. citizens or their representatives or by a foreign government or a representative thereof, or by any corporation organized under the laws of a foreign country. The Communications Act also prohibits the issuance of a license to, or the holding of a license by, any corporation directly or indirectly controlled by any other corporation of which any officer or more than 25% of the directors are non-U.S. citizens or of which more than 25% of the capital stock is owned of record or voted by non-U.S. citizens or their representatives or by a foreign government or representative thereof, or by any corporation organized under the laws of a foreign country, although the FCC has the power in appropriate circumstances to waive these restrictions. The FCC has interpreted these restrictions to apply to partnerships and other business entities as well as corporations, subject to certain modifications. Failure to comply with these requirements may result in denial or revocation of licenses. STATE REGULATION AND LOCAL APPROVALS. Following the grant of an FCC construction permit to an applicant, and prior to the commencement of commercial service (prior to construction in certain states), the permittee must also obtain any necessary approvals from the appropriate regulatory bodies in certain of the states in which it will offer cellular service. In 1981, the FCC preempted the states from exercising jurisdiction in the areas of licensing, technical standards and market structure. More recently, the FCC ordered states to cease regulating cellular rates on August 10, 1994, unless the state (i) has regulated such rates and applies to the FCC to continue doing so, and the FCC agrees, or (ii) determines that cellular carriers are not engaged in meaningful competition, applies to the FCC and the FCC agrees. Currently, six states have applied to the FCC seeking continued rate regulation authority, including New York in which the Company will operate three markets after consummation of pending acquisitions. While such regulation affects the manner in which the Company conducts its business, it should not place it at a competitive disadvantage with other cellular providers. The siting and construction of the cellular transmitter towers, antennas and equipment shelters may be subject to state or local zoning, land use and other local regulation. Before changes to a system can be put into commercial operation, a licensee must obtain all necessary zoning and building permit approvals (zoning approvals) for cell sites and switching locations and secure state certification if still applicable, and, if needed, tariff approvals. The time needed to obtain zoning approvals and the requisite state permits varies from market to market and state to state. There can be no assurance that any state or local regulatory requirements currently applicable to the Company's systems may not be changed in the future or that applicable regulatory requirements will not be adopted in those states and localities that currently have none. LICENSE RENEWAL. The FCC has established rules and procedures to process cellular renewal applications filed by existing carriers and the competing applications filed by renewal challengers. Subject to one exception discussed below, the renewal proceeding is a two-step hearing process. The first step of the hearing process is to determine whether the existing cellular licensee is entitled to a renewal expectancy, and otherwise remains basically qualified to hold a cellular license. Two criteria are evaluated to determine whether the existing licensee will receive a renewal expectancy. The first criterion is whether the licensee has provided \"substantial\" service during its past license term, defined as service which is sound, favorable and substantially above a level of mediocre service which minimally might justify renewal. The second criterion requires that the licensee must have substantially complied with applicable FCC rules and policies and the Communications Act. Under this second criterion, the FCC determines whether the licensee has demonstrated a pattern of compliance. The second criterion does not require a perfect record of compliance, but if a licensee has demonstrated a pattern of noncompliance it will not receive a renewal expectancy. If the FCC grants the licensee a renewal expectancy during the first step of the hearing process and the licensee is basically qualified, its license renewal application will be automatically granted and any competing applications will be denied. If however, the FCC denies the licensee's request for renewal expectancy, the licensee's application will be comparatively evaluated under specifically enumerated criteria with the applications filed by competing applicants. The exception to the two-step renewal hearing process allows a competing applicant proposing to provide service that far exceeds the service presently being provided by the incumbent licensee to request a waiver of the two-step process. If the waiver request is granted, the FCC will hold only a comparative hearing, i.e., it will not make a threshold determination in the first instance as to whether the incumbent licensee is entitled to a renewal expectancy. The Company filed its first renewal application in August 1994, with renewal filings for its remaining markets ranging from 1995 to 2003. The Company has no reason to believe that a renewal expectancy will not be granted for each of its control markets.\nNEW OPPORTUNITIES FLEXCELL(tm). The Company has developed a billing and management information system, Flexcell(tm), which the Company believes provides greater speed, capacity and flexibility than most similar generally available systems. Flexcell(tm) is currently being used to bill the Company's 245,000 cellular subscribers as of December 31, 1994. The Company has entered into its first contract with American Mobile Satellite Corporation (AMSC), an unrelated third party, to provide billing software, custom development and support but the Company does not intend to market Flexcell to additional third parties, for at least the remainder of 1995. AMSC has an FCC license to provide satellite telecommunications services. Flexcell will be used by AMSC in all aspects of its customer service and billing functions. The total value of the transaction is approximately $7 million, to be recognized during the seven-year term of the contract. The contract obligates the Company to provide its core software product together with certain custom enhancements and maintenance to the product during the contract period. GEOTEK. In February 1994, the Company purchased for $30 million from Geotek 2.5 million shares of Geotek common stock and options to invest up to $167 million for an aggregate of 10 million additional shares. Geotek is a telecommunications company that is developing a wireless communications network in the United States based on its FHMA(tm) digital technology. Geotek's common stock is traded on the NASDAQ National Market System. The options purchased by the Company were issued in three series as follows: (i) Series A for 2 million shares at $15 per share, (ii) Series B for 2 million shares at $16 per share and (iii) Series C for 3 million shares at $17 per share and 3 million shares at $18 per share. All options are exercisable immediately and expire at various dates over the next several years. The Company has also entered into a five-year management consulting agreement to provide operational and marketing support to Geotek in exchange for 300,000 shares of Geotek common stock per year. However, should any portion of the Series A, B or C options expire, the management consulting agreement is immediately terminated. See \"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\" The objectives of the Company's investment include assisting Geotek to exploit the commercial application of its FHMA(tm) technology by providing support in the areas of network engineering and buildout, customer care, marketing and many of the administrative functions required of a wireless communications service provider. In addition, the Company believes that its investment in and strategic alliance with Geotek will allow it to realize administrative and technical synergies which will serve the customers of both companies, gain access to potential wireless subscribers in the major population centers of the Northeast where the Company does not currently provide wireless service, and gain access to technologies developed by Geotek that may offer future wireless applications. The Company also believes that having an investment interest in Geotek at predetermined prices over the next several years provides a significant potential return as Geotek completes the buildout of its systems and begins commercial operation. The investment also allows the Company and Geotek to work together to explore international wireless opportunities. INTERNATIONAL INITIATIVES The Company believes that foreign markets offer significant opportunities for wireless communications suppliers because of the limited availability of traditional landline telephone systems in many countries and the increasing demand for communications services. The Company's strategy is to pursue opportunities in the international arena as they arise without diverting the Company's financial and personnel resources from its primary business. Accordingly, the Company has pursued such opportunities through joint ventures with local entities and others and its investment in International Wireless Communications, Inc. (IWC). The Company currently owns a 19.9% equity interest in IWC and holds a right to purchase an additional 15%. While several wireless communications license applications are pending and certain licenses are granted in which the Company has an interest, through joint ventures or through IWC, the Company currently does not have an ownership in any significant operations. There is no assurance that the Company's international activities will prove successful. EMPLOYEES As of December 31, 1994, the Company had approximately 1050 full-time employees, including approximately 300 employees associated with its direct sales force. None of those employees are represented by a labor organization. Management considers its employee relations to be good. ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The Company owns or leases certain properties in addition to the interests in cellular licenses presently owned by the Company. The Company leases its principal executive offices located in Greensboro, North Carolina, consisting of approximately 66,000 square feet of office space. The rental payments at this facility are fixed over five years except for escalations\nto cover certain related costs such as property taxes and maintenance. The Company also currently owns or leases an aggregate of approximately 120,000 square feet of office and retail space in its operating cellular markets. In addition, the Company either owns or leases under long-term contracts 200 cell site locations and seven cellular switch locations. ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS In June, 1989, an action was commenced by 17 plaintiffs in the United States District Court for the District of Columbia alleging that they were partners in the San Juan Cellular Settlement Partnership (SJCSP) and asserting claims against the Company and two of its officers. SJCSP was a partnership that was the tentative selectee for a construction permit for a nonwireline cellular telephone system in San Juan, Puerto Rico. Ultimately, SJCSP dismissed its application as part of the settlement of a challenge to the award of the San Juan construction permit to SJCSP. Plaintiffs alleged that two officers of the Company, acting for the Company, were involved in the negotiation of the aforementioned settlement. Plaintiffs asserted one claim for fraud and one for breach of fiduciary duty, each against all three defendants. The plaintiffs alleged that the defendants bargained away the SJCSP interest in the San Juan market for less than its full value in order to obtain for the Company the rights to certain other cellular systems. Plaintiffs sought judgment against the defendants, jointly and severally, in the amount of $49 million for compensatory damages, $50 million for punitive damages and the imposition of a constructive trust for the benefit of the plaintiffs on the Company's interests in the nonwireline cellular systems serving Reading, York and Lancaster, Pennsylvania, as well as costs and other relief as the court may deem proper. The Company has settled with all of the plaintiffs. The financial impact of the settlements is not material to the Company. See \"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\" The only other legal proceedings pending against the Company or any of its subsidiaries are routine filings with the FCC and state regulatory authorities and customary regulatory proceedings pending in connection with acquisitions and interconnection rates and practices, proceedings concerning the telecommunications industry generally and other proceedings which management believes, even if resolved unfavorably to the Company, would not have a materially adverse effect on the Company's business. ITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters that were submitted to a vote of security holders of the Company during the quarter ended December 31, 1994. ITEM 4 A. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information about each of the Company's executive officers:\nStuart S. Richardson has been a director since 1985 and was elected Chairman of the Board of Directors in 1986. Since 1985, Mr. Richardson has been an executive, presently Vice Chairman of the Board, of Piedmont Management Company, Inc., a public holding company that owns the Reinsurance Company of New York and Lexington Management Corporation, a diversified financial services company. Mr. Richardson is the former Chairman of the Board of Richardson -- Vicks, Inc. Mr. Richardson's second cousin, L. Richardson Preyer, Jr., and Mr. Preyer's father, L. Richardson Preyer, Sr. are also directors. Haynes G. Griffin is President and Chief Executive Officer, a director and a co-founder of the Company. Mr. Griffin is a member of the Boards of Directors of Piedmont Management Company, Inc., a public holding company and of Geotek\nCommunications, Inc. Mr. Griffin currently serves on the United States Advisory Council on the National Information Infrastructure. He is the past Chairman of the Cellular Telecommunications Industry Association. L. Richardson Preyer, Jr. is Vice Chairman of the Board, Executive Vice President, Treasurer and co-founder of the Company. Mr. Preyer serves as Administrative Trustee of Piedmont Associates and Southeastern Associates, investment partnerships. Stephen R. Leeolou is Executive Vice President, Chief Operating Officer, Secretary, a director and co-founder of the Company. Prior to joining the Company, from 1983 to 1984, Mr. Leeolou was President and Secretary of Caro-Cell Communications, Inc., and from 1978 to 1983 was a television news anchorman with three successive network-affiliated stations. Stephen L. Holcombe is Senior Vice President and Chief Financial Officer of the Company. From 1978 to 1985, Mr. Holcombe served in various positions with KPMG Peat Marwick and was a senior audit manager when he left to join the Company in 1985. Mr. Holcombe is a member of the North Carolina Association of Certified Public Accountants. Richard C. Rowlenson is Senior Vice President and General Counsel of the Company. From 1975 until joining the Company in 1987, Mr. Rowlenson was engaged in the practice of communications law in Washington, D.C. Mr. Rowlenson is a member of the Federal Communications Bar Association. Timothy G. Biltz joined the Company as Vice President -- Marketing and Customer Service in August 1989 and was promoted to Senior Vice President in November 1990. Prior to joining the Company, Mr. Biltz was Regional Manager for Providence Journal Cellular Management Services, Inc. in Raleigh, N.C. from 1987 to 1989, and was responsible for the development of regional marketing and operations programs for several operating markets. S. Tony Gore, III is a Senior Vice President of Acquisitions and Corporate Development. He is presently a task force member of the North Carolina International Commission on Economic Development. Prior to joining the Company in 1985, Mr. Gore was Chief Executive Officer of Atlantic Coast Entertainment Systems, Inc. Dennis B. Francis joined the Company as Director of Technical Services in September 1992 and was promoted to Vice President in 1993 and Senior Vice President in 1995. Prior to joining the Company, Mr. Francis was with Southwestern Bell Mobile Systems for nine years, most recently as Vice President of Network Operations for the Washington\/Baltimore cellular system.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF COMMON STOCK\nThe high and low last sale prices are as reported by the NASDAQ National Market System. On March 15, 1995, there were approximately 1,180 shareholders of record. As discussed in Note 4 to the Consolidated Financial Statements and Management's Discussion and Analysis, the agreements related to the Company's long-term revolving credit facility limit the payment of cash dividends on common stock. The Company has not paid any cash dividends on its common stock since its inception.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\n(1) In 1994, in order to conform to industry practice, the Company reclassified certain pass-through items previously recognized as service revenue to offset the related cost of service expenses. These reclassified items relate to charges associated with the Company's subscribers roaming into adjacent cellular markets. Appropriate reclassifications have been made in each period presented. (2) Effective January 1, 1994, the Company changed its depreciation period for approximately 30% of its property and equipment from 7 years to 10 to 20 years. The effect of this change was to reduce depreciation for the year ended December 31, 1994 by $4,500. (3) The 1990 gain resulted primarily from the contribution of cellular interests to the Company's 50% owned joint venture. (4) The extraordinary loss for the years ended December 31, 1994 and 1993 of $8,402 and $3,715, respectively, reflect the write-off of deferred financing costs associated with the Company's credit facilities that were replaced during 1994 and 1993. (5) Adjusted to reflect the Company's three-for-two Class A Common Stock split effected August 24, 1994. (6) Income (loss) from operations before depreciation and amortization. Does not represent and should not be considered as an alternative to net income or operating income as determined by generally accepted accounting principles as an indicator of operating performance.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1994 AND 1993 In 1994, the Company reclassified certain pass-through items previously recognized as service revenue in its Statements of Operations to offset the related cost of service expenses. These reclassified items relate to charges associated with the Company's subscribers roaming into adjacent cellular markets. Appropriate reclassifications have been made in each period presented in the accompanying financial statements. These reclassifications were made to conform the treatment in the Company's financial statements to the accounting treatment common in the industry. Unless otherwise indicated all information in this report has been adjusted for the Company's 3 for 2 stock split paid in the form of a stock dividend on August 24, 1994. Service revenues increased by $47.5 million or 48% primarily as a result of an 85% increase in the number of subscribers in majority owned markets to approximately 245,000 as of December 31, 1994 as compared to the end of 1993. Total net subscribers in the Company's majority owned markets increased by 112,700 during 1994 as compared to an increase of 40,000 in 1993. Of the total increase during 1994, 98,300 net activations occurred in markets operated by the Company in both periods while 14,400 of the net subscribers were attributable to markets acquired by the Company during the year. The 146% growth rate of net subscriber additions in markets operated in both periods is the result of an increase in productivity by sales personnel which the Company believes has been augmented by increased sales training, and the growing acceptance of cellular communications. The growth in net subscriber additions also reflects the number of agents in the Company's indirect distribution channels combined with moderate economic growth in the Company's operating regions. Service revenues attributable to the Company's own subscribers increased 52% during 1994 to $110.1 million as compared to 1993 while service revenues from customers from other cellular markets roaming into the Company's markets increased 37% to $36.3 million. When combining revenue from the Company's customers with roaming revenue, overall average monthly revenue per subscriber, which is based upon service fees for the period and averages of subscribers computed on a quarterly basis, declined 8% to $70 for the year from $76 a year ago. Substantially all of this decline was the result of the Company's subscriber growth rate exceeding the rate of growth for roaming revenues. Cellular equipment revenues increased $8.6 million or 87% to $18.5 million for 1994 as compared to $9.9 million for 1993. This increase was primarily due to the 146% increase in 1994 of net subscriber additions in markets operated by the Company in both periods. Cost of cellular equipment increased 123% to $29.9 million during 1994. The Company continued to sell telephones at or below cost in response to competitive pressures and also continued the availability of its rental program. Cost of service expenses decreased as a percentage of service fees from 15% for 1993 to 14% in 1994. In many instances in 1994, the Company's customers who roam into adjacent cellular markets were charged at rates consistent with those rates the Company charges in its own markets rather than passing through higher roaming rates customarily charged by many cellular carriers. This billing practice, while creating a marketing advantage by providing the customer with a broader virtual service area, has increased net costs related to the provision of these services by approximately $7.5 million in 1994 as compared to approximately $4.7 million during 1993. The rapid subscriber growth that has occurred in the past year has made this larger virtual service area available to significantly more customers which has caused greater net costs to be incurred by the Company in connection with this billing practice. The Company is continuing its efforts to reduce these costs through the negotiation of more favorable roaming agreements with both wireline and non-wireline cellular service providers. In addition, the continued negotiation of more favorable interconnection agreements with local exchange carriers should contribute to stability in cost of service as a percentage of service fees. General and administrative expenses increased 29% or $9.8 million during 1994 but decreased as a percentage of service fees to 30% from 35% in 1993. These expenses declined as a percentage of service fees primarily as a result of controlled increases of many overhead expenses resulting in higher utilization of the Company's existing personnel and systems. General and administrative expenses should continue to decline as a percentage of service fees as the Company continues to add more subscribers without commensurate increases in general and administrative overhead. Marketing and selling expenses increased 71% to $37.1 million during 1994 as compared to 1993 and as a percentage of service fees these expenses increased to 25% from 22%. Marketing and selling expenses, including the net loss on subscriber equipment, increased 93% to $48.5 million during 1994 as compared to 1993. The increase was primarily attributable to the higher rate of growth in the net subscriber additions described above for 1994 as compared to 1993 and the resulting increase\nin salaries and commissions. Marketing and selling expenses per net subscriber addition, including the loss on cellular equipment, (excluding the number of subscribers in acquired markets at the time of acquisition) declined 22% to $493 in 1994 from $629 during 1993. Depreciation and amortization decreased $1.1 million or 4% during 1994. The primary reason for this decrease was that the Company changed the depreciable lives of certain of its property and equipment to more closely approximate its historical experience and the estimated useful lives of these assets. These life changes affected assets representing approximately 30% of the cost of the Company's depreciable assets. This change reduced depreciation expense and net loss for 1994 by approximately $4.5 million or $0.12 per share. This effect of the depreciable life changes was offset in part by approximately $63.0 million and $21.0 of new property and equipment placed in service during 1994 and 1993, respectively. Interest expense increased $6.7 million or 44% during 1994 as a result of increased average borrowings of approximately $73.2 million and, to a lesser extent, an increase in average interest rates charged. Net loss before extraordinary item decreased from $15.3 million or $0.40 per share in 1993 to $13.9 million or $0.36 per share in 1994. The decrease in net loss per share was primarily attributable to an increase in \"Operating Cash Flow -- EBITDA\" (income from operations before depreciation and amortization ) of $10.7 million or 42% to $35.9 million. In December 1994, the Company completed the closing of a $675 million credit facility which refinanced its existing $390 million facility. In connection with this refinancing, the Company recorded an extraordinary loss of $8.4 million ($0.22 per share), which represented the write-off of all unamortized deferred financing costs related to the refinanced facility. The increase in net loss was primarily attributable to the extraordinary item and increased interest expense described above as well as $3.5 million of other expense in connection with accumulated legal fees and costs associated with the resolution of pending litigation. YEARS ENDED DECEMBER 31, 1993 AND 1992 Service fee revenues increased by $26.2 million or 36% primarily as a result of a 43% increase in the number of subscribers in majority owned markets to approximately 132,300 as of December 31, 1993. All of the increase in the number of subscribers was due to subscriber growth in markets controlled by the Company in both years. Total net subscribers in the Company's majority owned markets increased by 40,000 during 1993 as compared to 23,100 during 1992. This 73% increase in the number of net subscriber additions was primarily attributable to the same factors resulting in the increase for 1994 as described above. Service fees attributable to the Company's own subscribers increased 38% during 1993 to $72.4 million while service fees from customers from other cellular markets roaming into the Company's markets increased 31% to $26.6 million. When combining revenue from the Company's customers with roaming revenues, overall average monthly service revenue per subscriber decreased 1% to $76 in 1993 from $77 in 1992. Cellular equipment revenues increased 66% to $9.9 million and cost of cellular telephone equipment increased 77% to $13.4 million resulting in a net loss on cellular equipment of $3.5 million. Cost of service expenses as a percentage of service fee revenues remained constant at 15% for the years ended December 31, 1993 and 1992. The Company estimates that its billing practice with respect to customers roaming into adjacent markets increased cost of service by $4.7 million and $2.4 million in 1993 and 1992, respectively. General and administrative expenses increased 17% or $4.9 million but decreased as a percentage of service fees to 35% from 40% in 1992. Increases in the overall amount of expenses were primarily attributable to the same factors resulting in the increase for 1994. Marketing and selling expenses increased 29% to $21.7 million during 1993, but as a percentage of service fees, these expenses declined during 1993 to 22% from 23% in 1992. The higher rate of growth in net subscriber additions described above during 1993 and the resulting increase in salaries and commissions contributed to the overall increase in marketing and selling expenses. This increased growth rate in net subscriber additions combined with an emphasis on shifting variable marketing costs to fixed also caused marketing and selling expenses per net subscriber addition, including the net loss on cellular equipment, to decline 21% to $629 from $799 in 1992. Depreciation and amortization increased $3.1 million or 14% during 1993 as a result of approximately $39.2 million in new capital equipment being placed in service during 1993 and 1992. As a percentage of service fees, depreciation and amortization declined to 25% during 1993 from 30% during 1992.\nInterest expense decreased $788,000 or 5% during 1993 as the result of declines in interest rates charged on borrowings partially offset by an increase in average borrowings of approximately $20.0 million. Net loss before extraordinary item decreased from $26.7 million or $0.72 per share for the year ended December 31, 1992 to $15.3 million or $0.40 per share in the 1993 period. The decrease in net loss per share was primarily due to an increase in Operating Cash Flow-EBITDA. In April 1993, the Company completed the closing of a $290 million credit facility (the \"1993 Loan Agreement\") which refinanced its existing $275 million credit facility. In connection with the refinancing of the $275 million credit facility, the Company recorded an extraordinary loss of $3.7 million $(0.10) per share which represented the write-off of all unamortized deferred financing costs related to that facility. Net loss decreased from $26.7 million or $0.72 per share for the year ended December 31, 1992 to $19.0 million or $0.50 per share in 1993. LIQUIDITY AND CAPITAL RESOURCES The Company requires capital to acquire, construct, and expand its cellular systems. The Company intends to continue to pursue acquisitions of cellular systems and properties as well as other investment opportunities. In addition, although the primary buildout of its cellular system is complete, the Company will continue to construct additional cell sites and purchase cellular equipment to increase capacity as subscribers are added and usage increases, to expand geographic coverage and to provide for increased portable usage. The specific capital requirements of the Company will depend primarily on the timing and size of any additional acquisitions and other investments as well as property and equipment needs associated with the rate of subscriber growth. Operating Cash Flow (or EBITDA) has been a significant source of internal funding in recent years, but the Company does not expect Operating Cash Flow to grow sufficiently to meet both its property and equipment and debt service requirements for at least the next two years. In recent years, the Company has met its capital requirements primarily through bank financing and private issuances of its Class A Common Stock. 1994 CREDIT FACILITY. On December 23, 1994, the Company completed the closing of a $675 million credit facility, pursuant to an Amended and Restated Loan Agreement (the \"1994 Credit Facility\"), with various lenders led by The Toronto-Dominion Bank and The Bank of New York. The 1994 Credit Facility provides the Company with additional financial and operating flexibility and enables the Company to accelerate its cellular network buildout and pursue business opportunities that may arise in the future. The 1994 Credit Facility refinanced the 1993 Loan Agreement. The 1993 Loan Agreement closed in April 1993 and refinanced the Company's previously existing credit facility. The 1994 Credit Facility consists of a \"Term Loan\" and a \"Revolving Loan.\" The Term Loan, in the amount of $325 million, was used to repay the Company's borrowings under the 1993 Loan Agreement. The Revolving Loan, in the amount of up to $350 million, is available for capital expenditures, to make acquisitions of and investments in cellular and other wireless communication interests, and for other general corporate purposes. As security for borrowings under the 1994 Credit Facility, the Company has pledged substantially all of its tangible and intangible assets and future cash flows. Among other restrictions, the 1994 Credit Facility restricts the payment of cash dividends, limits the use of borrowings, limits the creation of additional long-term indebtedness and requires the maintenance of certain financial ratios. The requirements of the 1994 Credit Facility were established in relation to the Company's projected capital needs and projected results of operations and cash flow. These requirements generally were designed to require continued improvement in the Company's operating performance such that its Operating Cash Flow -- EBITDA would be sufficient to continue servicing the debt as repayments are required. The Company is in compliance with all loan covenants. As of December 31, 1994, $348.5 million had been borrowed under the 1994 Credit Facility. Under the restrictive covenants of the facility, future borrowing availability generally increases as the Company's operating performance improves. The Company does not expect these covenants to curtail planned borrowings. As of December 31, 1994, the most restrictive of these convenants would limit available borrowings during the first quarter of 1995 to $210.3 million. The outstanding amount of the Term Loan as of March 30, 1998 is to be repaid in increasing quarterly installments commencing on March 31, 1998 and terminating at its maturity date of December 31, 2003. The quarterly installment payments begin at 1.875% of the outstanding principal amount at March 30, 1998 and gradually increase to 5.625% at March 31, 2003. The available borrowings under the Revolving Loan shall be reduced on a quarterly basis also commencing on March\n31, 1998 and terminating on December 31, 2003. The quarterly reduction begins at 1.875% of the Revolving Loan Commitment at March 30, 1998 and gradually increases to 5.625% on March 31, 2003. The Term Loan and the Revolving Loan bear interest at a rate equal to the Company's choice of the Prime Rate or Eurodollar Rate plus an applicable margin based upon a leverage ratio for the most recent fiscal quarter. As of December 31, 1994 the leverage ratio, which is computed as the ratio of Total Debt (as defined) to Adjusted Cash Flow (as defined), was at such a level as to cause the applicable margins on the borrowings to be 0.375% and 1.625% per annum for the Prime Rate and Eurodollar Rate, respectively. ACQUISITIONS. The Company completed several acquisitions in 1994 and early 1995. On April 26, 1994, the Company completed the acquisition of the Altoona, PA MSA and the Chambersburg, PA (PA-10) RSA, which are contiguous to its Mid-Atlantic Supersystem in exchange for $4.4 million in cash, the exchange of the Hagerstown, MD cellular market and the Company's minority ownership interest in one cellular market. The Company purchased in October 1994, for $6.9 million in cash and $3.3 million in the Company's Class A Common Stock, the Washington, Maine (ME-4) RSA and three of the four counties of the Mason, West Virginia (WV-1) RSA. The Maine RSA is approximately 40 miles north of the Portland, Maine MSA, which is already operated by the Company. The West Virginia RSA is contiguous to the Company's Charleston, West Virginia MSA. On December 14, 1994, the Company purchased the Binghamton, New York MSA and the Elmira, New York MSA (\"Binghamton\/Elmira Transaction\") for a purchase price of approximately 1.8 million shares of the Company's Class A Common Stock and $6.1 million in cash borrowed under the 1993 Loan Agreement, subject to post-closing adjustments. These markets are contiguous to the Company's Mid-Atlantic Supersystem. All markets that have been acquired as of December 31, 1994 are operational cellular systems. Condensed pro forma financial information for these markets as of December 31, 1994 is contained in Note 3 to the consolidated financial statements. In January 1995, the Company purchased the Union, Pennsylvania (PA-8) RSA for a cash price of $51.3 million with borrowings under its 1994 Credit Facility. The PA-8 RSA lies in the center of the Company's Mid-Atlantic Supersystem. GEOTEK COMMUNICATIONS, INC.. In February 1994, the Company purchased for $30.0 million from Geotek Communications, Inc. (Geotek), 2.5 million shares of Geotek common stock and received options to invest up to $167.0 million for an aggregate of 10 million shares. Geotek is a telecommunications company that is developing an Enhanced Specialized Mobile Radio (ESMR) wireless communications network in the United States based on its proprietary Frequency Hopping Multiple Access (FHMA) digital technology. Geotek's common stock is traded on the NASDAQ National Market System. The options received by the Company were issued in three series as follows: (i) Series A for 2 million shares at $15 per share; (ii) Series B for 2 million shares at $16 per share; and (iii) Series C for 3 million shares at $17 per share and 3 million shares at $18 per share. All options are immediately exercisable. The Series A options expire upon the commercial validation (as defined) of Geotek's first ESMR system using FHMA (the Series A Expiration Date). The series B and Series C options expire 1 year and 2 years, respectively, after the Series A Expiration Date. However, the Company may extend the Series B and Series C options by six months and the Series C options by an additional six months and, if any portion of any series of options expires, all unexercised options expire immediately. The Company has also entered into a five-year management consulting agreement to provide operational and marketing support in exchange for 300,000 shares of Geotek common stock per year. However, should any portion of the Series A, B or C options expire, the management consulting agreement is immediately terminated. During 1994, approximately 250,000 shares were earned under this management agreement. If all options are exercised and all shares are earned and received under the management consulting agreement, the Company would own an aggregate of approximately 20% of Geotek's common stock on a fully diluted basis. Under the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", which are effective for 1994, this investment is classified as \"available for sale\". As such, the investment is recorded at its market value and any unrealized gains or losses are recognized as a separate component of shareholders' equity, but do not affect results of operations. The Company funded its initial $30.0 million investment in Geotek using borrowings under the 1993 Loan Agreement. The 1994 Credit Facility permits borrowings to fund the exercise of approximately $30.0 million of these options but requires\na waiver for borrowings to exercise additional amounts. If such a waiver was not granted the Company would require other sources of financing to exercise the remaining options. CAPITAL EXPENDITURES. As of December 1994, the Company had approximately $184.0 million of property and equipment placed in service. The Company historically has incurred capital expenditures primarily based upon capacity needs in its existing markets resulting from continued subscriber growth. During 1994, the Company initiated a plan to double the number of cell sites in order to increase geographic coverage and provide for additional portable usage in the Company's cellular markets. As a result of this accelerated network buildout and the continued growth of the Company's subscriber base, capital expenditures were approximately $63.0 million during 1994. During 1995, the Company plans to accelerate this buildout further. Capital expenditures for 1995 are estimated to be approximately $130 million and are expected to be funded primarily with proceeds from the 1994 Credit Facility. CASH FLOW GOALS. Operating Cash Flow improved $10.7 million to $35.9 million during 1994. The Company's primary goal over the next several years will be to maximize operating cash flow. In order to do so the Company must minimize decreases in monthly revenue per subscriber and continue to have rapid subscriber growth with low incremental marketing and sales costs. The Company believes its business strategy and sales force will generate continued net subscriber growth and that its focus on higher revenue customers, principally business users, will assist in supporting revenue per subscriber. The Company has substantially completed the development of its managerial, administrative and marketing functions, as well as the primary buildout of the cellular networks in its existing markets, and believes that the rate of service fee growth will exceed the rate of growth of operating expenses. Although there can be no assurance that any of the foregoing growth goals will be achieved, the Company believes that its internally generated funds and its available bank lines of credit will be sufficient during the next several years to complete its planned network expansion and acquisitions, to fund operating expenses and debt service described above and to provide flexibility to pursue business opportunities that might arise in the future. INFLATION The Company believes that inflation affects its business no more than it generally affects other similar businesses.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements and notes to consolidated financial statements of the Registrant and its subsidiaries are included in this Form 10-K following the Index to Financial Statements and Schedules. ITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS 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 with respect to directors appearing under the heading, \"Election of Directors\" in the Registrant's proxy statement for the Annual Meeting of Shareholders to be held May 10, 1995, is incorporated herein by reference. Other information with respect to executive officers is contained in Part I -- Item 4 (a) under the caption Executive Officers of the Registrant. ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION Information with respect to executive compensation appearing under the heading \"Executive Compensation\" in the Registrant's proxy statement for the Annual Meeting of Shareholders to be held May 10, 1995, is incorporated herein by reference. ITEM 12.","section_12":"ITEM 12. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information with respect to securities ownership of certain beneficial owners and management appearing under the headings \"Voting Securities Outstanding\" and \"Security Ownership of Management\" in the Registrant's proxy statement for the Annual Meeting of Shareholders to be held May 10, 1995, is incorporated herein by reference. ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS NONE\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nSIGNATURES Pursuant to the requirements of the Section 13 and 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VANGUARD CELLULAR SYSTEMS, INC. By: HAYNES G. GRIFFIN HAYNES G. GRIFFIN, PRESIDENT AND CHIEF EXECUTIVE OFFICER Date: March 31, 1995 Pursuant to the requirements of the Securities and 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.\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULE The following consolidated financial statements and Supplemental Schedule of Vanguard Cellular Systems, Inc. and Subsidiaries are filed as part of this report.\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.\nVANGUARD CELLULAR SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (DOLLAR AMOUNTS IN THOUSANDS)\nThe accompanying notes to consolidated financial statements are an integral part of these balance sheets.\nVANGUARD CELLULAR SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nVANGUARD CELLULAR SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DOLLAR AMOUNTS IN THOUSANDS)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nVANGUARD CELLULAR SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLAR AMOUNTS IN THOUSANDS)\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1: ORGANIZATION Vanguard Cellular Systems, Inc. (Vanguard) (a North Carolina corporation) is a provider of cellular telephone service to various markets throughout the eastern United States. The activities of Vanguard, its wholly owned subsidiaries and its majority owned cellular entities (collectively referred to as the Company) include acquiring interests in entities which have been granted nonwireline Federal Communications Commission (FCC) permits to construct or authorizations to operate cellular telephone systems, and constructing and operating cellular telephone systems. All of the Company's cellular entities operate under the trade name of CELLULARONE(Register mark), which is the trade name many nonwireline carriers have adopted to provide conformity throughout the industry. The trade name is owned by a partnership in which the Company holds a minority ownership interest. NOTE 2: SIGNIFICANT ACCOUNTING AND REPORTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Vanguard, its wholly owned subsidiaries and the entities in which it has a majority ownership interest. Investments in which the Company exercises significant influence but does not exercise control through majority ownership have been accounted for using the equity method of accounting. Investments in which the Company does not exercise significant influence or control through majority ownership have been accounted for using the cost method of accounting. All significant intercompany accounts and transactions have been eliminated. CELLULAR TELEPHONE INVENTORIES Inventories, consisting primarily of cellular telephones held for resale, are valued at the lower of first-in, first-out (FIFO) cost or market. INVESTMENTS INVESTMENTS IN CELLULAR ENTITIES -- Investments in cellular entities consist of the costs incurred to acquire FCC licenses or interests in entities that have been awarded FCC licenses to provide cellular service, and capital contributions to unconsolidated cellular entities. Acquisition costs, referred to as deferred cellular license acquisition costs, consist primarily of amounts paid for the acquisition of ownership interests and payments of other acquisition related expenses, net of the Company's share of the fair value of the net assets acquired. Exchanges of minority ownership interests in cellular entities are recorded based on the fair value of the ownership interests acquired. The Company recognizes its pro rata share of the net income or losses generated by the unconsolidated cellular entities carried on the equity method. OTHER INVESTMENTS -- Other investments consist of the market value of the Company's investment in Geotek Communications, Inc. and the cost of the Company's investment in International Wireless Communications, Inc. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost. Depreciation is calculated on a straight-line basis for financial reporting purposes over the following estimated useful lives:\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 2: SIGNIFICANT ACCOUNTING AND REPORTING POLICIES -- CONTINUED Effective January 1, 1994, the Company changed the depreciable lives of certain of its property and equipment to more closely approximate its historical experience and the useful lives of these assets. These life changes affected assets representing approximately 30% of the cost of the Company's depreciable assets. This change reduced depreciation expense and net loss for 1994 by approximately $4,500. At December 31, 1994 and 1993, construction in progress was composed primarily of the cost of uncompleted additions to the Company's cellular telephone systems in majority owned cellular markets. The Company capitalized interest costs of $684, $188 and $188 in 1994, 1993 and 1992, respectively, as part of the cost of cellular telephone systems. Maintenance, repairs and minor renewals are charged to operations as incurred. Gains or losses at the time of disposition of property and equipment are reflected in the statements of operations currently. Cellular telephones are rented to certain customers generally with a contract for a minimum stipulated length of service. Such customers have the option to purchase the cellular telephone at any time during the term of the agreement. OTHER ASSETS Other assets include deferred financing costs (Note 4) which are being amortized over the period of the related agreements. Amortization of $1,196, $953 and $709 has been included in interest expense in the accompanying December 31, 1994, 1993 and 1992 Statements of Operations, respectively. In addition, payments related to agreements not to compete in certain cellular markets are being amortized over the period of the related agreements. Amortization expense relating to these agreements of $160, $1,325 and $1,316 has been included in the accompanying December 31, 1994, 1993 and 1992 Statements of Operations, respectively. Other assets also include $4,200 allocated to the acquired customer bases in connection with the acquisitions of the Binghamton and Elmira MSAs which occured in December 1994. REVENUE RECOGNITION Service fees are recognized at the time cellular services are provided and service fees related to prebilled services are not recognized until earned. Cellular telephone equipment revenues consist primarily of sales of cellular telephones to subscribers and are recognized at the time equipment is delivered to the subscriber. INCOME TAXES In February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The Company adopted this Statement effective January 1, 1993. The effect of the change in accounting on the Company's financial position and results of operations is immaterial. NET LOSS PER SHARE Net loss per share is computed based upon the weighted average number of common shares outstanding during the year. Stock options have not been included in the calculation of net loss per share as their effect would be antidilutive. STATEMENTS OF CASH FLOWS Additional required disclosures of noncash investing and financing activities for the years ended December 31, 1994, 1993 and 1992 are as follows:\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 2: SIGNIFICANT ACCOUNTING AND REPORTING POLICIES -- CONTINUED The Company acquired ownership interests in certain cellular entities and other investments for cash and noncash consideration, as follows:\nThe Company acquired property and equipment for cash and noncash consideration, as follows:\nRECLASSIFICATION Certain amounts in the 1993 and 1992 financial statements have been reclassified to conform to the 1994 presentation. The Company reclassified certain direct pass through items previously recognized as service revenue in its Statements of Operations to cost of service expenses to conform with industry practice. These reclassified items relate to charges associated with the Company's subscribers roaming into adjacent cellular markets. The reclassification has had no effect on the Company's net loss or net loss per share.\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 3: INVESTMENTS Investments consist of the following as of December 31, 1994 and 1993:\nInvestments in Cellular Entities The Company continues to expand its ownership of cellular markets through strategic acquisitions. The Company's significant activity relating to its cellular investments is as follows: CONSOLIDATED CELLULAR ENTITIES The Company completed the acquisition of the PA-11 RSA in March 1992, for a purchase price of $2,615 including a covenant not to compete of $480. The purchase price consisted of cash, 101,674 shares of the Company's Class A common stock and the exchange of certain minority interests. In August 1992, the Company purchased an additional 5.88% ownership interest in the Harrisburg, PA MSA in exchange for $2,517 in cash. In August 1993, the Company completed the acquisition of the PA-12 RSA for a purchase price of $9,735 which consisted of cash and the issuance of 464,064 shares of the Company's Class A common stock. In October 1993, the Company completed the acquisition, valued at approximately $23,000, of additional ownership interests in four majority owned markets in the Mid-Atlantic Supersystem in exchange for ownership interests in certain minority owned cellular markets outside its regional metro-clusters and $18,200 in cash. In April 1994, the Company completed the acquisition of the Altoona, PA MSA and the Chambersburg, PA (PA-10) RSA, which are contiguous to its Mid-Atlantic Supersystem in exchange for $4,400 in cash, the exchange of Hagerstown, MD cellular market and the Company's minority ownership interest in one cellular market. The Company purchased in October 1994, for $6,900 in cash and $3,300 in the Company's Class A common stock, the Washington, Maine (ME-4) RSA and three of the four counties of the Mason, West Virginia (WV-1) RSA. The Maine RSA is approximately 40 miles north of the Portland, Maine MSA, which is already operated by the Company. The West Virginia RSA is contiguous to the Company's Charleston, West Virginia MSA. On December 14, 1994, the Company purchased the Binghamton, New York MSA and the Elmira, New York MSA for a purchase price consisting of 1,766,674 shares of the Company's Class A common stock and $6,100 in cash. These markets are contiguous to the Company's Mid-Atlantic Supersystem.\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 3: INVESTMENTS -- CONTINUED Pro forma consolidated results of operations, as if the acquisitions of the Altoona, PA MSA, the ME-4 RSA, the WV-1 RSA, the Binghamton, New York MSA and the Elmira, New York MSA had occurred January 1, 1993, are as follows:\nIn January 1995, the Company purchased the Union, Pennsylvania (PA-8) RSA for a cash purchase price of $51,300 with borrowings under its credit facility. The PA-8 RSA lies in the center of the Company's Mid-Atlantic Supersystem. CELLULAR ENTITIES ON THE EQUITY METHOD The Company holds an investment in a joint venture, owned 50% by the Company, created to acquire, own and operate various cellular markets located primarily in eastern North Carolina. The underlying net assets of the joint venture consist principally of its investment in the FCC licenses in the Wilmington, NC and Jacksonville, NC cellular markets. CELLULAR ENTITIES ON THE COST METHOD The investment balance of $16,885, at December 31, 1994 represents the Company's investment in approximately 50 cellular markets with ownership interests ranging from 0.3% to 18.3%. The Company holds these ownership interests for investment purposes. Other Investments GEOTEK COMMUNICATIONS, INC. In February 1994, the Company purchased for $30,000 from Geotek Communications, Inc. (Geotek) 2,500,000 shares of Geotek common stock and options to invest up to $167,000 for an aggregate of 10,000,000 additional shares. Geotek is a telecommunications company that is developing an Enhanced Specialized Mobile Radio (ESMR) wireless communications network in the United States based on its Frequency Hopping Multiple Access digital technology (FHMA). Geotek's common stock is traded on the NASDAQ National Market System. The options purchased by the Company were issued in three series as follows: (i) Series A for 2,000,000 shares at $15 per share; (ii) Series B for 2,000,000 shares at $16 per share; and (iii) Series C for 3,000,000 shares at $17 per share and 3,000,000 shares at $18 per share. All options are exercisable immediately. The Series A options expire upon the commercial validation (as defined) of Geotek's first SMR system using FHMA (the Series A Expiration Date). The Series B and Series C options expire 1 year and 2 years, respectively, after the Series A Expiration Date. However, the Company may extend the Series B and Series C options by six months and the Series C options by an additional six months and, if any portion of any series of options expires, all unexercised options expire immediately. The Company has also entered into a 5-year management consulting agreement to provide operational and marketing support in exchange for 300,000 shares of Geotek common stock per year. However, should any portion of the Series A, B or C options expire, the management consulting agreement is immediately terminated. The Company recognized revenues of $2,496 related to the provision of management consulting services to Geotek during 1994. As of December 31, 1994, the Company has purchased or earned under the management consulting agreement approximately 2,750,000 shares of Geotek common stock representing approximately 5.5% of Geotek's outstanding shares. If all options are exercised and all shares are earned and received under the management consulting agreement, the Company would own an aggregate of approximately 20% of Geotek's common stock on a fully diluted basis.\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 3: INVESTMENTS -- CONTINUED Under the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", this investment is classified as \"available for sale\". As such, the investment is recorded at its market value, and a net unrealized holding loss of $9,310 has been recognized as a separate component of shareholders' equity. The Company funded its initial $30,000 investment in Geotek using borrowings under its credit facility. Under the terms of its credit facility, the Company is permitted to fund the exercise of the Series A options for $30,000. In order to exercise any of the Series B or C options, the Company will be required to seek lender approval for borrowings under the credit facility or other financing alternatives. INTERNATIONAL WIRELESS COMMUNICATIONS, INC. The Company owns 19.9% of the outstanding stock of International Wireless Communications, Inc. (\"IWC\") representing an aggregate investment of $6,600. IWC is a development stage company specializing in securing, building and operating wireless businesses other than cellular telephone systems primarily in Latin America and Southeast Asia. The Company's investment in IWC is carried at cost in the accompanying financial statements. NOTE 4: LONG-TERM DEBT Long-term debt consisted of the following as of December 31, 1994 and 1993:\nThe future maturities of the principal amount outstanding at December 31, 1994 were as follows:\nOn December 23, 1994, the Company completed the closing of a $675 million credit facility, pursuant to an Amended and Restated Loan Agreement (the \"1994 Credit Facility\"), with various lenders led by The Toronto-Dominion Bank and The Bank of New York. The 1994 Credit Facility is available to provide the Company with additional financial and operating flexibility and enable it to pursue business opportunities that may arise in the future. The 1994 Credit Facility refinanced the Company's then existing $390 million credit facility (the \"1993 Loan Agreement\"). The 1993 Loan Agreement closed in April 1993 and refinanced the Company's previously existing credit facility. In connection with the refinancings, the Company recorded\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 4: LONG-TERM DEBT -- CONTINUED extraordinary losses of $8,402 ($0.22 per share) in 1994 and $3,715 ($0.10 per share) in 1993, which represented the write-offs of all unamortized deferred financing costs related to the refinanced facilities. The 1994 Credit Facility consists of a \"Term Loan\" and a \"Revolving Loan.\" The Term Loan, in the amount of $325,000, was used to repay the Company's borrowings under the 1993 Loan Agreement. The Revolving Loan, in the amount of up to $350,000, is available for capital expenditures, to make acquisitions of and investments in cellular and other wireless communication interests, and for other general corporate purposes. As of December 31, 1994, $326,500 was available for future expenditures under the Revolving Loan, as amended. The outstanding amount of the Term Loan as of March 30, 1998 is to be repaid in increasing quarterly installments commencing on March 31, 1998 and terminating at the maturity date of December 31, 2003. The quarterly installment payments begin at 1.875% of the outstanding principal amount at March 30, 1998 and gradually increase to 5.625% at March 31, 2003. The available borrowings under the Revolving Loan shall be reduced on a quarterly basis also commencing on March 31, 1998 and terminating on December 31, 2003. The quarterly reduction begins at 1.875% of the Revolving Loan commitment at March 30, 1998 and gradually increases to 5.625% on March 31, 2003. The outstanding borrowings under the Term Loan are due and the Revolving Loan commitment is reduced quarterly as follows:\nThe Term Loan and the Revolving Loan bear interest at a rate equal to the Company's choice of the Prime Rate or Eurodollar Rate plus an applicable margin based upon a leverage ratio for the most recent fiscal quarter. The ranges for this applicable margin are 0.0% to 1.375% for the Prime Rate and 1.125% to 2.625% for the Eurodollar Rate. As of December 31, 1994 the leverage ratio, which is computed as the ratio of Total Debt (as defined) to Adjusted Cash Flow (as defined), was at such a level as to cause the applicable margins on the borrowings to be 0.375% and 1.625% per annum for the Prime Rate and Eurodollar Rate, respectively. At December 31, 1994, the Company's effective interest rate on its outstanding borrowings was 8.875%. As security for borrowings under the 1994 Credit Facility, the Company has pledged substantially all of its tangible and intangible assets and future cash flows. Among other restrictions, the credit facility restricts the payment of cash dividends, limits the use of borrowings, limits the creation of additional long-term indebtedness and requires the maintenance of certain financial ratios. The Company is in compliance with all loan covenants. The Company maintains interest rate swaps and interest rate caps which provide protection against interest rate risk. At year-end the Company had interest rate cap agreements in place covering a notional amount of $270,000. The interest rate cap agreements provide protection to the extent that LIBOR exceeds 5.5% through July 1995 or 9.0% through December 1997. The total cost of these interest rate cap agreements of $687 has been recorded in other assets in the consolidated balance sheets and is being amortized over the lives of the agreements as a component of interest expense. Additionally, the Company maintains interest rate swap agreements that fix the LIBOR interest rate at 6.9% on a notional amount of $100,000 through June 1995 and 6.1% on a notional amount of $210,000 through March 1995. Under these swap agreements, the Company benefits if LIBOR interest rates increase above the fixed rates and incurs additional\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 4: LONG-TERM DEBT -- CONTINUED interest expense if rates remain below the fixed rates. Any amounts received or paid under these agreements are reflected as interest expense over the period covered. The fair value of these interest rate protection agreements is estimated to be $1,800 and reflects the quoted market value of these contracts at December 31, 1994. The effect of interest rate protection agreements on the operating results of the Company was to increase interest expense by $95, $884 and $2,510 in 1994, 1993 and 1992, respectively. NOTE 5: COMMITMENTS AND CONTINGENCIES OPERATING LEASES The Company leases office space, furniture, equipment, vehicles and land under noncancelable operating leases expiring through 2019. As of December 31, 1994, the future minimum rental payments under these lease agreements having an initial or remaining term in excess of one year were as follows:\nRent expense under operating leases was $4,178, $3,461 and $3,242, for the years ended December 31, 1994, 1993 and 1992, respectively. CONSTRUCTION AND CAPITAL COMMITMENTS Capital expenditures for 1995 are estimated to be approximately $130,000 for the Company, and are expected to be funded primarily with proceeds from the 1994 Credit Facility (Note 4). LITIGATION In June 1989, a suit was filed by a group of former partners in the San Juan Cellular Settlement Partnership which alleged that the Company and two of its officers breached fiduciary duties and acted fraudulently in connection with settlement of licensing proceedings concerning the San Juan, PR market and certain other markets. The Company settled this litigation with all plaintiffs and such amounts are included in the accompanying financial statements. Additionally, the Company is involved in various other legal proceedings arising in the normal course of business. In the opinion of management, the outcome of the above legal proceedings will not have a material adverse effect on the consolidated financial position or results of operations of the Company. NOTE 6: INCOME TAXES As of January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). SFAS 109 requires recognition of future tax benefits, to the extent that realization of such benefits is more likely than not, attributable to deductible temporary differences between the financial statement and income tax basis of assets and liabilities and to tax net operating loss carryforwards. The adoption of SFAS 109 did not impact the Company's financial position or results of operations.\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 6: INCOME TAXES -- CONTINUED The components of net deferred taxes as of December 31, 1994 and 1993 were as follows:\nThe valuation allowance of $57,880 as of December 31, 1993 was provided because, in the Company's assessment, it was uncertain whether the net deferred tax assets would be realized. In addition, the Company provided an additional valuation allowance to offset the 1994 net deferred tax benefit of $3,552 because of its continuing assessment that it is uncertain whether the net deferred tax assets will be realized. For Federal income tax reporting purposes, the Company had net operating loss carryforwards of approximately $315,000 at December 31, 1994. These losses may be used to reduce future taxable income, if any, and expire through 2009. These carryforwards may be subject to annual limitation in the future in accordance with the Tax Reform Act of 1986. The primary differences between the accumulated deficit for financial reporting purposes and the income tax loss carryforwards relate to the differences in the treatment of certain deferred cellular license acquisition costs, certain gains on dispositions of cellular interests, partnership losses, depreciation methods, estimated useful lives and compensation earned under the stock compensation plan. Of the total net operating loss carryforwards, approximately $79,000 relates to additional deductions arising from restricted stock bonuses, stock options and stock purchase warrants. To the extent that the benefit of these carryforwards is realized in future years, the tax benefit will be recorded directly to additional capital in excess of par. NOTE 7: CAPITAL STOCK COMMON STOCK In July 1994, the Board of Directors declared a 3 for 2 stock split of the Company's Class A common stock which was effected in the form of a dividend paid to shareholders on August 24, 1994 with cash paid for resultant fractional shares. The effect of the split has been retroactively applied to all Class A common stock and per share amounts disclosed in the accompanying financial statements and footnotes. ACQUISITION OF CELLULAR INTERESTS During 1990, the Company registered 4,500,000 shares of its Class A common stock and 3,000,000 shares of its Class B common stock. The shares may be offered in connection with the acquisition of entities which have received or may receive an authorization or license from the FCC to provide cellular service. Through December 31, 1994, 2,707,957 shares of Class A common stock have been issued in conjunction with the acquisitions of the PA-12, PA-11, PA-5, WV-1, and ME-4 RSAs, and the Binghamton and Elmira MSAs. STOCK COMPENSATION PLANS Under the provisions of the Stock Compensation Plan (the Plan), the Company may grant up to 5,850,000 shares of the Company's Class A common stock to officers, directors and key employees in the form of nonqualified stock options,\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 7: CAPITAL STOCK -- CONTINUED restricted stock bonuses or incentive stock options. Nonqualified stock options must require exercise prices of not less than 85% of the fair market value of the Company's Class A common stock on the date of the grant, except where nonqualified stock options are issued for the conversion of stock purchase warrants. As of December 31, 1994, 24,213 shares were available for future grants. During 1989, the Board adopted the 1989 Stock Option Plan (the 1989 Plan). Under the provisions of the 1989 Plan, the Company may grant up to 3,000,000 shares of the Company's Class A common stock to officers and key employees in the form of nonqualified or incentive stock options. Nonqualified stock options must require exercise prices of not less than the fair market value of the Company's Class A common stock on the date of the grant. As of December 31, 1994, 586,417 shares were available for future grants. During 1994, the Board adopted the 1994 Long-Term Incentive Plan (the 1994 Plan). Under the provisions of the 1994 Plan, the Company may grant up to 3,000,000 shares of the Company's Class A common stock to officers, directors and key employees in the form of nonqualified stock options, incentive stock options, stock appreciation rights, unrestricted stock, restricted stock and performance shares. All stock options must require exercise prices of not less than the fair market value of the Company's Class A common stock on the date of the grant, except that certain incentive stock options must require exercise prices of not less than 110% of fair market value of the Company's Class A common stock on the date of the grant. As of December 31, 1994, 2,250,000 shares were available for future grants. Options granted under the Plans may not have a term greater than ten years from the date of grant and are not transferable except upon death. RESTRICTED STOCK BONUSES During 1987, the Board granted restricted stock bonuses for a total of 3,469,554 shares of Class A common stock (i) to three key officers for 1,077,768 shares each and (ii) to a director and a key employee for an aggregate of 236,250 shares. In the event of a change in control of the Company prior to December 31, 1998, the participants will be reimbursed for certain individual income tax payments, as defined, on the shares vesting after February 1991. As of December 31, 1994, all of the shares have vested. STOCK PURCHASE WARRANTS Stock purchase warrants for 150,000 shares at a price of $8.00 per share were exercised in 1992, and as of December 31, 1994, the Company has no outstanding stock purchase warrants. STOCK OPTIONS Under the terms of the Company's Stock Compensation Plans, the Board has granted incentive stock options and nonqualified stock options requiring exercise prices approximating the fair market value of the Company's Class A common stock on the date of the grant.\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 7: CAPITAL STOCK -- CONTINUED Stock option activity under the Plans was as follows:\nThese options expire at various dates through 2004. Options for 1,692,125 shares had vested at December 31, 1994 and were exercisable at prices ranging from $2.22 to $24.00. SHARES RESERVED FOR ISSUANCE At December 31, 1994, 6,637,747 shares of the Company's Class A common stock are reserved primarily for exercise and grant under the Company's stock compensation plans. In addition, 1,792,043 shares of Class A common stock and 3,000,000 shares of Class B common stock are reserved for issuance in conjunction with the acquisition of cellular interests discussed above. NOTE 8: ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses were composed of the following at December 31, 1994 and 1993:\nVANGUARD CELLULAR SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS -- CONTINUED NOTE 9: QUARTERLY INFORMATION (UNAUDITED)\n(1) The fourth quarter of 1994 includes an extraordinary item of $8,402 ($0.22 per share) relating to the write-off of deferred financing costs associated with the Company's 1993 Loan Agreement that was refinanced in December 1994. (2) The second quarter of 1993 includes an extraordinary item of $3,715 ($0.09 per share) relating to the write-off of deferred financing costs associated with the Company's 1989 credit facility that was refinanced in April, 1993.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Vanguard Cellular Systems, Inc.: We have audited the accompanying consolidated balance sheets of Vanguard Cellular Systems, Inc. (a North Carolina corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, 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. 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 Vanguard Cellular Systems, 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. 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 to financial statements and schedule 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 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. ARTHUR ANDERSEN LLP Greensboro, North Carolina, February 20, 1995.\nVANGUARD CELLULAR SYSTEMS, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1992, 1993 AND 1994 (DOLLAR AMOUNTS IN THOUSANDS)\n(1) Accounts written off during the period. (2) Represents allowance for doubtful accounts for entities acquired during the period.\nINDEX TO EXHIBITS\n* Incorporated by reference to the statement or report indicated.","section_15":""}
{"filename":"805022_1994.txt","cik":"805022","year":"1994","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nBuckeye Partners, L.P. (the \"Partnership\"), the Registrant, is a limited partnership organized in 1986 under the laws of the state of Delaware.\nThe Partnership conducts all its operations through subsidiary entities. These operating subsidiaries are Buckeye Pipe Line Company, L.P. (\"Buckeye\"), Laurel Pipe Line Company, L.P. (\"Laurel\"), Everglades Pipe Line Company, L.P. (\"Everglades\") and Buckeye Tank Terminals Company, L.P. (\"BTT\"), each of which is 99 percent owned. (Each of Buckeye, Laurel, Everglades and BTT is referred to as an \"Operating Partnership\" and collectively as the \"Operating Partnerships\").\nBuckeye is one of the largest independent pipeline common carriers of refined petroleum products in the United States, with 3,291 miles of pipeline serving 10 states. Laurel owns a 344-mile common carrier refined products pipeline located principally in Pennsylvania. Everglades owns 37 miles of refined products pipeline in Florida. Buckeye, Laurel and Everglades conduct the Partnership's refined products pipeline business. BTT provides bulk storage service through leased facilities with an aggregate capacity of 235,000 barrels of refined petroleum products.\nThe Partnership acquired its interests in the Operating Partnerships from American Premier Underwriters, Inc. (\"American Premier\"), formerly The Penn Central Corporation, on December 23, 1986 (the \"Acquisition\"). The Operating Partnerships (other than Laurel) had been organized by American Premier for purposes of the Acquisition and succeeded to the operations of predecessor companies owned by American Premier, including Buckeye Pipe Line Company (an Ohio corporation) and its subsidiaries (\"Pipe Line\"), in November 1986. Laurel was formed in October 1992 and succeeded to the operations of Laurel Pipe Line Company (\"Laurel Corp\") (an Ohio corporation) which was a majority owned corporate subsidiary of the Partnership until the minority interest was acquired in December 1991.\nBuckeye Management Company (the \"General Partner\"), a wholly owned subsidiary of American Premier formed in 1986, owns a 1 percent general partnership interest in, and serves as sole general partner of, the Partnership. A corporate subsidiary of the General Partner, Buckeye Pipe Line Company (a Delaware corporation) (the \"Manager\"), owns a 1 percent general partnership interest in, and serves as sole general partner and manager of, each Operating Partnership.\nREFINED PRODUCTS BUSINESS\nThe Partnership receives petroleum products from refineries, connecting pipelines and marine terminals, and transports those products to other locations. In 1994, refined products accounted for substantially all of the Partnership's consolidated revenues, consolidated operating income and consolidated property, plant and equipment.\nThe Partnership transported an average of approximately 1,028,800 barrels per day of refined products in 1994. The following table shows the volume and percentage of refined products transported over the last three years.\nVOLUME AND PERCENTAGE OF REFINED PRODUCTS TRANSPORTED(1)(2) (VOLUME IN THOUSANDS OF BARRELS PER DAY)\n- - -------- (1) Excludes crude oil volumes of 0.7 thousand barrels per day for the year ended December 31, 1992. No crude oil volumes were transported during 1993 or 1994. (2) Excludes local product transfers. (3) Includes diesel fuel, heating oil, kerosene and other middle distillates.\nThe Partnership provides service in the following states: Pennsylvania, New York, New Jersey, Indiana, Ohio, Michigan, Illinois, Connecticut, Massachusetts, Washington and Florida.\nPennsylvania--New York--New Jersey\nBuckeye serves major population centers in the states of Pennsylvania, New York and New Jersey through 1,171 miles of pipeline. Refined products are received at Linden, New Jersey. Products are then transported through two lines from Linden, New Jersey to Allentown, Pennsylvania. From Allentown, the pipeline continues west, through a connection with Laurel, to Pittsburgh, Pennsylvania (serving Reading, Harrisburg, Altoona\/Johnstown and Pittsburgh) and north through eastern Pennsylvania into New York State (serving Scranton\/Wilkes-Barre, Binghamton, Syracuse, Utica and Rochester and, via a connecting carrier, Buffalo). Products received at Linden, New Jersey are also transported through two lines to John F. Kennedy International and LaGuardia Airports and to commercial bulk terminals at Long Island City and Inwood, New York. The pipeline presently supplies Kennedy, LaGuardia and Newark International airports with substantially all of each airport's jet fuel requirements.\nLaurel transports refined products through a 344-mile pipeline extending westward from five refineries in the Philadelphia area to Pittsburgh, Pennsylvania.\nIndiana--Ohio--Michigan--Illinois\nBuckeye transports refined products through 1,994 miles of pipeline (of which 246 miles are jointly owned with other pipeline companies) in southern Illinois, central Indiana, eastern Michigan, western and northern Ohio and western Pennsylvania. A number of receiving lines and delivery lines connect to a central corridor which runs from Lima, Ohio, through Toledo, Ohio to Detroit, Michigan. Products are received at East Chicago, Indiana; Robinson, Illinois and at the corridor connection points of Detroit, Toledo and Lima. Major areas served include Huntington\/Fort Wayne, Indiana; Bay City, Detroit and Flint, Michigan; Cleveland, Columbus, Lima and Toledo, Ohio; and Pittsburgh, Pennsylvania.\nOther Refined Products Pipelines\nBuckeye serves Connecticut and Massachusetts through 112 miles of pipeline that carry refined products from New Haven, Connecticut to Hartford, Connecticut and Springfield, Massachusetts.\nEverglades carries primarily jet fuel on a 37-mile pipeline from Port Everglades, Florida to Hollywood-Ft. Lauderdale International Airport and Miami International Airport.\nBuckeye carries jet fuel on a 14-mile pipeline from Tacoma, Washington to McChord Air Force Base.\nOTHER BUSINESS ACTIVITIES\nBTT provides bulk storage services through leased facilities located in Pittsburgh, Pennsylvania and Bay City, Michigan, which have the capacity to store up to an aggregate of approximately 235,000 barrels of refined petroleum products. Each facility is served by Buckeye and provides bulk storage and loading facilities for shippers or other customers.\nCOMPETITION AND OTHER BUSINESS CONSIDERATIONS\nThe Operating Partnerships do business without the benefit of exclusive franchises from government entities. In addition, the Operating Partnerships generally operate as common carriers, providing transportation services at posted tariffs and without long-term contracts. As providers of such service, the Operating Partnerships do not own the products they transport. Demand for such service arises, ultimately, from demand for petroleum products in the regions served and the ability and willingness of refiners, marketers and end- users to supply such demand by deliveries through the Partnership's pipelines. Demand for refined petroleum products is primarily a function of price, prevailing economic conditions and weather. The Operating Partnerships' businesses are, therefore, subject to a variety of factors partially or entirely beyond their control. Multiple sources of pipeline entry and multiple points of delivery, however, have historically helped maintain stable total volumes even when volumes at particular source or destination points have changed.\nThe Partnership's business may in the future be affected by changing prices or demand for oil and for other fuels. The Partnership may also be affected by energy conservation, changing sources of supply, structural changes in the oil industry and new energy technologies. The General Partner is unable to predict the effect of such factors.\nA substantial portion of the refined petroleum products transported by the Partnership's pipelines are ultimately used as fuel for motor vehicles and aircraft. Changes in transportation and travel patterns in the areas served by the Partnership's pipelines could adversely affect the Partnership's results of operations.\nIn 1994, the Operating Partnerships had approximately 120 customers, most of which were either major integrated oil companies or smaller marketing companies. The largest two customers accounted for 7.1 percent and 6.6 percent, respectively, of consolidated revenues, while the 20 largest customers accounted for 74.4 percent of consolidated revenues.\nGenerally, pipelines are the lowest cost method for long-haul overland movement of refined petroleum products. Therefore, the Operating Partnership's most significant competitors for large volume shipments are other pipelines, many of which are owned and operated by major integrated oil companies. Although it is unlikely that a pipeline system comparable in size and scope to the Operating Partnership's will be built in the foreseeable future, new pipelines (including pipeline segments that connect with existing pipeline systems) could be built to effectively compete with the Operating Partnerships in particular locations.\nIn some areas, the Operating Partnerships compete with marine transportation. Tankers and barges on the Great Lakes account for some of the volume to certain Michigan, Ohio and upstate New York locations during the approximately eight non-winter months of the year. Barges are presently a competitive factor for deliveries to the New York City area, the Pittsburgh area, Connecticut and Ohio.\nTrucks competitively deliver product in a number of areas served by the Operating Partnerships. While their costs may not be competitive for longer hauls or large volume shipments, trucks compete effectively with the Operating Partnerships in many areas. The availability of truck transportation places a significant competitive constraint on the ability of the Operating Partnerships to increase their tariff rates.\nPrivately arranged exchanges of product between marketers in different locations are an increasing but unquantified form of competition. Generally, such exchanges reduce both parties' costs by eliminating or reducing transportation charges.\nDistribution of refined petroleum products depends to a large extent upon the location and capacity of refineries. In past years, a significant quantity of domestic refining capacity has been shut down. To date, the aggregate impact of these shut-downs has affected the Operating Partnerships' volumes favorably, as these shut-downs have resulted in the transportation of product over longer distances to certain locations. Because the Operating Partnerships' pipelines have numerous source points, the General Partner does not believe that the shut-down of any particular refinery would have a material adverse effect on the Partnership. However, the General Partner is unable to determine whether additional shut-downs will occur or what their effects might be.\nThe Operating Partnerships' mix of products transported tends to vary seasonally. Declines in demand for heating oil during the summer months are, to a certain extent, offset by increased demand for gasoline and jet fuels. Overall, operations have been only moderately seasonal, with somewhat lower than average volume being transported during March, April and May as compared to the rest of the year.\nNeither the Partnership nor any of the Operating Partnerships have any employees. All of the operations of the Operating Partnerships are managed and operated by employees of the Manager. At December 31, 1994, the Manager had 607 full-time employees, 161 of whom were represented by two labor unions. The collective bargaining agreement with each of these unions is subject to renewal in 1996. The Operating Partnerships (and their predecessors) have never experienced any significant work stoppages or other significant labor problems.\nCAPITAL EXPENDITURES\nThe General Partner anticipates that the Partnership will continue to make ongoing capital expenditures to maintain and enhance its assets and properties, including improvements to meet customers' needs and those required to satisfy new environmental and safety standards. In 1994, total capital expenditures were $15.4 million. Projected capital expenditures for 1995 amount to $14.9 million. Planned capital expenditures in 1995 include, among other things, tanks to accommodate specific new business opportunities, renewal and replacement of pipe, new valves, metering systems, field instrumentation, communications facilities and testing equipment. Capital expenditures are expected to increase over time primarily in response to increasingly rigorous governmental safety and environmental requirements as well as industry standards. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources.\"\nREGULATION\nGeneral\nBuckeye is an interstate common carrier subject to the regulatory jurisdiction of the Federal Energy Regulatory Commission (\"FERC\") under the Interstate Commerce Act and the Department of Energy Organization Act. FERC regulation requires that interstate oil pipeline rates be posted publicly and that these rates be \"just and reasonable\" and non-discriminatory. FERC regulation also enforces common carrier obligations and specifies a uniform system of accounts. In addition, Buckeye, and the other Operating Partnerships, are subject to the jurisdiction of certain other federal agencies with respect to environmental and pipeline safety matters.\nThe Operating Partnerships are also subject to the jurisdiction of various state and local agencies, including, in some states, public utility commissions which have jurisdiction over, among other things, intrastate tariffs, the issuance of debt and equity securities, transfers of assets and pipeline safety.\nTariffs\nFERC has jurisdiction over Buckeye's interstate tariffs. In July 1988, in the midst of a rate proceeding involving Buckeye, FERC issued an order that provided Buckeye with the opportunity to qualify for an unspecified alternative form of \"light-handed\" rate regulation if Buckeye could establish that it lacked significant market power. On December 31, 1990, after extensive testimony and hearings, FERC issued an opinion which found that in most of its relevant market areas, Buckeye operated in a competitive environment in which it could not exercise significant market power and that Buckeye's tariff rates in those markets were just and reasonable. Based on these findings, FERC permitted Buckeye to implement a \"light-handed\" rate regulation program on an experimental basis for three years beginning in March 1991. Under the program, in markets where Buckeye does not have significant market power, individual rate increases: (a) will not exceed a real (i.e., exclusive of inflation) increase of 15 percent over any two-year period (the \"rate cap\"), and (b) will be allowed to become effective without suspension or investigation if they do not exceed a \"trigger\" equal to the change in the GDP implicit price deflator since the date on which the individual rate was last increased, plus 2 percent. Individual rate decreases will be presumptively valid upon a showing that the proposed rate exceeds marginal costs. In markets where Buckeye was found to have significant market power and in certain markets where no market power finding was made: (i) individual rate increases cannot exceed the volume weighted average rate increase in markets where Buckeye does not have significant market power since the date on which the individual rate was last increased, and (ii) any volume weighted average rate decrease in markets where Buckeye does not have significant market power must be accompanied by a corresponding decrease in all of Buckeye's rates in markets where it does have significant market power. Shippers retain the right to file complaints or protests following notice of a rate increase, but are required to show that the proposed rates violate or have not been adequately justified under the experimental program, that the proposed rates are unduly discriminatory, or that Buckeye has acquired significant market power in markets previously found to be competitive.\nIn October 1992, the Energy Policy Act of 1992 (the \"Policy Act\") was enacted. Title XVIII of the Policy Act, \"Oil Pipeline Regulatory Reform,\" provided, among other things, that certain tariff rates that were in effect on October 25, 1991 were deemed \"just and reasonable, \" and that FERC was directed by October 24, 1993 to promulgate a rule establishing a simplified and generally applicable ratemaking methodology for oil pipelines. FERC was also directed to issue a rule streamlining certain procedural aspects of its proceedings.\nOn October 22, 1993, FERC issued a final rule pursuant to the Policy Act with respect to rate regulation of oil pipelines. The rule relies primarily on an index methodology, whereby a pipeline would be allowed to change its rates in accordance with an index that FERC believes reflects cost changes appropriate for application to pipeline rates. In the alternative, a pipeline is allowed to charge market-based rates if the pipeline establishes that it does not possess significant market power in a particular market. In addition, the rule provides for the rights of both pipelines and shippers to demonstrate that the index should not apply to an individual pipeline's rates in light of the pipeline's costs. The final rule became effective on January 1, 1995.\nOn February 22, 1994, Buckeye filed a tariff and justification material to extend its \"experimental\" rate regulation program for an indefinite period. No protests or interventions were filed and, on March 24, 1994, FERC found that the program should be extended but that Buckeye would be subject to the generic regulations on oil pipeline rates as of January 1, 1995. On October 26, 1994, Buckeye filed a motion that requested FERC to permit Buckeye to continue its existing rate program indefinitely, as an exception to the generic oil pipeline rate regulations. On December 6, 1994, FERC issued an order granting that motion and extended the operation of Buckeye's rate program indefinitely, commencing January 1, 1995. The Buckeye rate program will be subject to reevaluation at the same time FERC reviews the index selected in the generic oil pipeline regulations, currently scheduled to occur five years after the effective date of the generic rules. Independent of regulatory considerations, it is expected that tariff rates will continue to be constrained by competition and other market factors.\nEnvironmental Matters\nThe Operating Partnerships are subject to federal and state laws and regulations relating to the protection of the environment. Although the General Partner believes that the operations of the Operating Partnerships comply in all material respects with applicable environmental regulations, risks of substantial liabilities are inherent in pipeline operations, and there can be no assurance that material environmental liabilities will not be incurred. Moreover, it is possible that other developments, such as increasingly rigorous environmental laws, regulations and enforcement policies thereunder, and claims for damages to property or persons resulting from the operations of the Operating Partnerships, could result in substantial costs and liabilities to the Partnership. See \"Legal Proceedings\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--Environmental Matters.\"\nThe Oil Pollution Act of 1990 (\"OPA\") amends certain provisions of the federal Water Pollution Control Act of 1972, commonly referred to as the Clean Water Act (\"CWA\") and other statutes as they pertain to the prevention of and response to oil spills into navigable waters. The OPA subjects owners of facilities to strict joint and several liability for all containment and clean- up costs and certain other damages arising from a spill. The CWA provides penalties for any discharges of petroleum products in reportable quantities and imposes substantial liability for the costs of removing a spill. State laws for the control of water pollution also provide varying civil and criminal penalties and liabilities in the case of releases of petroleum or its derivatives into surface waters or into the ground. Regulations are currently being developed under OPA and state laws which may impose additional regulatory burdens on the Partnership.\nContamination resulting from spills or releases of refined petroleum products are not unusual in the petroleum pipeline industry. The Partnership's pipelines cross numerous navigable rivers and streams. Although the General Partner believes that the Operating Partnerships comply in all\nmaterial respects with the spill prevention, control and countermeasure requirements of federal laws, any spill or other release of petroleum products into navigable waters may result in material costs and liabilities to the Partnership.\nThe Resource Conservation and Recovery Act (\"RCRA\"), as amended, establishes a comprehensive program of regulation of \"hazardous wastes.\" Hazardous waste generators, transporters, and owners or operators of treatment, storage and disposal facilities must comply with regulations designed to ensure detailed tracking, handling and monitoring of these wastes. RCRA also regulates the disposal of certain non-hazardous wastes. As a result of recently issued regulations, many previously non-hazardous wastes generated by pipeline operations have become \"hazardous wastes\" which are subject to more rigorous and costly disposal requirements.\nThe Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\"), also known as \"Superfund,\" governs the release or threat of release of a \"hazardous substance.\" Disposal of a hazardous substance, whether on or off-site, may subject the generator of that substance to liability under CERCLA for the costs of clean-up and other remedial action. Pipeline maintenance and other activities in the ordinary course of business could subject the Operating Partnerships to the requirements of these statutes. As a result, to the extent hydrocarbons or other petroleum waste may have been released or disposed of in the past, the Operating Partnerships may in the future be required to remedy contaminated property. Governmental authorities such as the Environmental Protection Agency (\"EPA\"), and in some instances third parties, are authorized under CERCLA to seek to recover remediation and other costs from responsible persons, without regard to fault or the legality of the original disposal. In addition to its potential liability as a generator of a \"hazardous substance,\" the property or right-of-way of the Operating Partnerships may be adjacent to or in the immediate vicinity of Superfund and other hazardous waste sites. Accordingly, the Operating Partnerships may be responsible under CERCLA for all or part of the costs required to cleanup such sites, which costs could be material.\nThe Clean Air Act, amended by the Clean Air Act Amendments of 1990 (the \"Amendments\"), imposes controls on the emission of pollutants into the air. The Operating Partnerships may be affected in several ways by the Amendments, including required changes in operating procedures and increased capital expenditures. The Amendments require states to develop permitting programs over the next several years to comply with new federal programs. Existing operating and air-emission permits like those held by the Operating Partnerships will have to be reviewed to determine compliance with the new programs. It is possible that new or more stringent controls will be imposed upon the Operating Partnerships through this permit review. In addition, the Amendments impose new requirements on the composition of fuels transported by the Operating Partnerships. While the principal impact of these new requirements will be on refiners and marketers of such fuels, the Operating Partnerships may have to institute additional quality control procedures and provide additional tankage in order to satisfy customer needs for segregated storage of these reformulated fuels.\nThe Operating Partnerships are also subject to environmental laws and regulations adopted by the various states in which they operate. In certain instances, the regulatory standards adopted by the states are more stringent than applicable federal laws.\nIn connection with the Acquisition, Pipe Line obtained an Administrative Consent Order (\"ACO\") from the New Jersey Department of Environmental Protection and Energy (\"NJDEPE\") under the New Jersey Environmental Cleanup Responsibility Act of 1983 (\"ECRA\") for all six of Pipe Line's facilities in New Jersey. The ACO permitted the Acquisition to be completed prior to full compliance with ECRA, but required Pipe Line to conduct in a timely manner a sampling plan for environmental contamination at the New Jersey facilities and to implement any required clean-up plan. Sampling continues in an effort to identify areas of contamination at the New Jersey facilities, while clean-up\noperations have begun at certain of the sites. The obligations of Pipe Line were not assumed by the Partnership, and the costs of compliance will be paid by American Premier. Through December 1994, Buckeye's costs of approximately $2,353,000 have been funded by American Premier.\nSafety Matters\nThe Operating Partnerships are subject to regulation by the United States Department of Transportation (\"DOT\") under the Hazardous Liquid Pipeline Safety Act of 1979 (\"HLPSA\") relating to the design, installation, testing, construction, operation, replacement and management of their pipeline facilities. HLPSA covers petroleum and petroleum products and requires any entity which owns or operates pipeline facilities to comply with applicable safety standards, to establish and maintain a plan of inspection and maintenance and to comply with such plans.\nThe Pipeline Safety Reauthorization Act of 1988 required increased coordination of safety regulation between federal and state agencies, testing and certification of pipeline personnel, and authorization of safety-related feasibility studies. In 1990, the Manager initiated a random drug testing program to comply with the regulations promulgated by the Office of Pipeline Safety, DOT, and in January 1995, the Manager instituted a program to comply with new DOT regulations that require alcohol testing of certain pipeline personnel.\nHLPSA requires, among other things, that the Secretary of Transportation consider the need for the protection of the environment in issuing federal safety standards for the transportation of hazardous liquids by pipeline. The legislation also requires the Secretary of Transportation to issue regulations concerning, among other things, the identification by pipeline operators of environmentally sensitive areas; the circumstances under which emergency flow restricting devices should be required on pipelines; training and qualification standards for personnel involved in maintenance and operation of pipelines; and the periodic integrity testing of pipelines in environmentally sensitive and high-density population areas by internal inspection devices or by hydrostatic testing. Significant expenses would be incurred if, for instance, additional valves were required, if leak detection standards were amended to exceed the current control system capabilities of the Operating Partnerships or additional integrity testing of pipeline facilities were to be required. The General Partner believes that the Operating Partnerships' operations comply in all material respects with HLPSA. However, the industry, including the Partnership, could be required to incur substantial additional capital expenditures and increased operating costs depending upon the requirements of final regulations issued by DOT pursuant to HLPSA, as amended.\nThe Operating Partnerships are also subject to the requirements of the Federal Occupational Safety and Health Act (\"OSHA\") and comparable state statutes. The General Partner believes that the Operating Partnerships' operations comply in all material respects with OSHA requirements, including general industry standards, recordkeeping, hazard communication requirements and monitoring of occupational exposure to benzene and other regulated substances.\nThe General Partner cannot predict whether or in what form any new legislation or regulatory requirements might be enacted or adopted or the costs of compliance. In general, any such new regulations would increase operating costs and impose additional capital expenditure requirements on the Partnership, but the General Partner does not presently expect that such costs or capital expenditure requirements would have a material adverse effect on the Partnership.\nTAX TREATMENT OF PUBLICLY TRADED PARTNERSHIPS UNDER THE INTERNAL REVENUE CODE\nThe Internal Revenue Code of 1986, as amended (the \"Code\"), imposes certain limitations on the current deductibility of losses attributable to investments in publicly traded partnerships and treats certain publicly traded partnerships as corporations for federal income tax purposes. The following\ndiscussion briefly describes certain aspects of the Code that apply to individuals who are citizens or residents of the United States without commenting on all of the federal income tax matters affecting the Partnership or its unitholders (the \"Unitholders\"), and is qualified in its entirety by reference to the Code. UNITHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISOR ABOUT THE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES TO THEM OF AN INVESTMENT IN THE PARTNERSHIP.\nCharacterization of the Partnership for Tax Purposes\nThe Code treats a publicly traded partnership that existed on December 17, 1987, such as the Partnership, as a corporation for federal income tax purposes beginning in the earlier of (i) 1998 or (ii) the year in which it adds a substantial new line of business unless, for each taxable year of the Partnership beginning in the earlier of such years, 90 percent or more of its gross income consists of qualifying income. Qualifying income includes interest, dividends, real property rents, gains from the sale or disposition of real property, income and gains derived from the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas, oil or products thereof), or the marketing of any mineral or natural resource (including fertilizer, geothermal energy and timber), and gain from the sale or disposition of capital assets that produced such income.\nBecause the Partnership is engaged primarily in the refined products pipeline transportation business, the General Partner believes that 90 percent or more of the Partnership's gross income has been qualifying income. If this continues to be true and no subsequent legislation amends this provision, the Partnership would continue to be classified as a partnership and not as a corporation for federal income tax purposes.\nPassive Activity Loss Rules\nThe Code provides that an individual, estate, trust or personal service corporation generally may not deduct losses from passive business activities, to the extent they exceed income from all such passive activities, against other income. Income which may not be offset by passive activity \"losses\" includes not only salary and active business income, but also portfolio income such as interest, dividends or royalties or gain from the sale of property that produces portfolio income. Credits from passive activities are also limited to the tax attributable to any income from passive activities. The passive activity loss rules are applied after other applicable limitations on deductions, such as the at-risk rules and the basis limitation. Certain closely held corporations are subject to slightly different rules, which can also limit their ability to offset passive losses against certain types of income.\nUnder the Code, net income from publicly traded partnerships is not treated as passive income for purposes of the passive loss rule, but is treated as non- passive income. Net losses and credits attributable to an interest in a publicly traded partnership are not allowed to offset a partner's other income. Thus, a Unitholder's proportionate share of the Partnership's net losses may be used to offset only Partnership net income from its trade or business in succeeding taxable years or, upon a complete disposition of a Unitholder's interest in the Partnership to an unrelated person in a fully taxable transaction, may be used to (i) offset gain recognized upon the disposition, and (ii) then against all other income of the Unitholder. In effect, net losses are suspended and carried forward indefinitely until utilized to offset net income of the Partnership from its trade or business or allowed upon the complete disposition to an unrelated person in a fully taxable transaction of a Unitholder's interest in the Partnership. A Unitholder's share of Partnership net income may not be offset by passive activity losses generated by other passive activities. In addition, a Unitholder's proportionate share of the Partnership's portfolio income, including portfolio income arising from the investment of the Partnership's working capital, is not treated as income from a passive activity and may not be offset by such Unitholder's share of net losses of the Partnership.\nDeductibility of Interest Expense\nThe Code generally provides that investment interest expense is deductible only to the extent of a non-corporate taxpayer's net investment income. In general, net investment income for purposes of this limitation includes gross income from property held for investment, gain attributable to the disposition of property held for investment (except for net capital gains for which the taxpayer has elected to be taxed at a maximum rate of 28 percent) and portfolio income (determined pursuant to the passive loss rules) reduced by certain expenses (other than interest) which are directly connected with the production of such income. Property subject to the passive loss rules is not treated as property held for investment. However, the IRS has issued a Notice which provides that net income from a publicly traded partnership (not otherwise treated as a corporation) may be included in net investment income for purposes of the limitation on the deductibility of investment interest. A Unitholder's investment income attributable to its interest in the Partnership will include both its allocable share of the Partnership's portfolio income and trade or business income. A Unitholder's investment interest expense will include its allocable share of the Partnership's interest expense attributable to portfolio investments.\nUnrelated Business Taxable Income\nCertain entities otherwise exempt from federal income taxes (such as individual retirement accounts, pension plans and charitable organizations) are nevertheless subject to federal income tax on net unrelated business taxable income and each such entity must file a tax return for each year in which it has more than $1,000 of gross income from unrelated business activities. The General Partner believes that substantially all of the Partnership's gross income will be treated as derived from an unrelated trade or business and taxable to such entities. The tax-exempt entity's share of the Partnership's deductions directly connected with carrying on such unrelated trade or business are allowed in computing the entity's taxable unrelated business income. ACCORDINGLY, INVESTMENT IN THE PARTNERSHIP BY TAX-EXEMPT ENTITIES SUCH AS INDIVIDUAL RETIREMENT ACCOUNTS, PENSION PLANS AND CHARITABLE TRUSTS MAY NOT BE ADVISABLE.\nState Tax Treatment\nThe Partnership owns property or does business in the states of Pennsylvania, New York, New Jersey, Indiana, Ohio, Michigan, Illinois, Connecticut, Massachusetts, Washington and Florida. A Unitholder will likely be required to file state income tax returns and to pay applicable state income taxes in many of these states and may be subject to penalties for failure to comply with such requirements. Some of the states have proposed that the Partnership withhold a percentage of income attributable to Partnership operations within the state for Unitholders who are non-residents of the state. In the event that amounts are required to be withheld (which may be greater or less than a particular Unitholder's income tax liability to the state), such withholding would generally not relieve the non-resident Unitholder from the obligation to file a state income tax return.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1994, the principal facilities of the Operating Partnerships included 3,672 miles of 6-inch to 24-inch diameter pipeline, 44 pumping stations, 105 delivery points and various sized tanks having an aggregate capacity of approximately 10.1 million barrels.\nThe Operating Partnerships own substantially all of their facilities subject, in the case of Buckeye, to a mortgage and security interest granted to secure payment of the outstanding balance of Buckeye's First Mortgage Notes due serially through 2010. See Note 7 to Consolidated Financial Statements of Buckeye Partners, L.P. In addition, certain portions of Buckeye's pipeline in Connecticut and Massachusetts are subject to security interests in favor of the owners of the right-of-way to secure future lease payments.\nIn general, the Operating Partnerships' pipelines are located on land owned by others pursuant to rights granted under easements, leases, licenses and permits from railroads, utilities, governmental entities and private parties. Like other pipelines, certain of the Operating Partnerships' rights are revocable at the election of the grantor or are subject to renewal at various intervals, and some require periodic payments. The Operating Partnerships have not experienced any revocations or lapses of such rights which were material to its business or operations, and the General Partner has no reason to expect any such revocation or lapse in the foreseeable future. Most pumping stations and terminal facilities are located on land owned by the Operating Partnerships.\nThe General Partner believes that the Operating Partnerships have sufficient title to their material assets and properties, possess all material authorizations and franchises from state and local governmental and regulatory authorities and have all other material rights necessary to conduct their business substantially in accordance with past practice. Although in certain cases the Operating Partnerships' title to assets and properties or their other rights, including their rights to occupy the land of others under easements, leases, licenses and permits, may be subject to encumbrances, restrictions and other imperfections, none of such imperfections are expected by the General Partner to interfere materially with the conduct of the Operating Partnerships' businesses.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership, in the ordinary course of business, is involved in various claims and legal proceedings, some of which are covered in whole or in part by insurance. The General Partner is unable to predict the timing or outcome of these claims and proceedings. Although it is possible that one or more of these claims or proceedings, if adversely determined, could, depending on the relative amounts involved, have a material effect on the Partnership's results of operations for a future period, the General Partner does not believe that their outcome will have a material effect on the Partnership's consolidated financial condition.\nFREEPORT LANDSLIDE\nOn March 30, 1990, a landslide near Freeport, Pennsylvania caused a rupture to one of the Partnership's pipelines which resulted in the release of approximately 58,000 gallons of petroleum products. Undetermined amounts of petroleum products saturated the soils surrounding the landslide area and flowed into Knapp Run and eventually into the Allegheny River. Buckeye promptly conducted extensive emergency response and remediation efforts.\nAfter the emergency phase of the clean-up was complete, Buckeye and the Pennsylvania Department of Environmental Resources (\"DER\") reached an agreement on remediation and erosion and sedimentation control at the site. Under this agreement, Buckeye is collecting and treating surface runoff water from the site and has instituted further erosion and sedimentation control measures under a DER-approved plan.\nFollowing the release, various agencies and departments of both the federal and state governments, including the United States Department of Justice, the Pennsylvania Office of Attorney General, DER, the Pennsylvania Department of Transportation, EPA, the National Transportation Safety Board, and DOT, commenced investigations into the circumstances of the pipeline rupture. In May 1994, Buckeye began discussions with DER and other state agencies concerning potential settlement of natural resource damage claims and civil penalties that the state agencies indicated they might assert against Buckeye. In January 1995, DER filed a complaint for civil penalties with the Commonwealth of Pennsylvania Environmental Hearing Board based on alleged violations by Buckeye of various state strict liability environmental laws. Buckeye's negotiations with DER and other state agencies concerning the alleged civil penalties, as well as potential natural resource damage claims, are continuing. In addition, in January 1995, a complaint was filed against Buckeye\nin the United States District Court for the Western District of Pennsylvania by the United States of America. The complaint charges Buckeye with two criminal misdemeanor violations of environmental laws. One count of the complaint alleges a violation of the strict liability provisions of the Rivers and Harbors Act, and the other count alleges negligence in violation of the Clean Water Act. Buckeye is actively engaged in discussions with the government seeking disposition of these charges.\nIn addition to the above governmental proceedings, eight civil class actions against the Partnership, Buckeye and certain affiliates were filed in four Pennsylvania counties. Plaintiffs in these lawsuits seek both injunctive and monetary relief, including punitive damages and attorneys' fees, based on a number of legal theories. The parties have consolidated these actions in a single class action in the Court of Common Pleas for Allegheny County, Pennsylvania, but the proposed class has not yet been certified and there has been no significant activity in the case. At this time, it is not possible to predict the likely outcome of such case.\nBuckeye maintains insurance in amounts believed by the General Partner to be adequate covering certain liabilities and claims arising out of pipeline accidents above a self-insured retention amount. The insurance is written generally on an indemnity basis, which requires Buckeye to seek reimbursement from its carriers for covered claims after paying such claims directly. Various entities that allegedly incurred costs or damages as a result of this incident have filed claims with Buckeye's insurance adjusters. Certain claims have been paid by Buckeye and other claims remain outstanding. The insurance carriers are reimbursing Buckeye for covered claims subject to the terms of the policy.\nFor the reasons set forth above, Buckeye is unable to estimate the total amount of environmental clean-up and other costs and liabilities that may be incurred in connection with this incident. However, based on information currently available to it, Buckeye believes that its net expense after insurance recoveries will not be material to its financial condition or results of operations.\nOTHER ENVIRONMENTAL PROCEEDINGS\nWith respect to other environmental litigation, certain Operating Partnerships (or their predecessors) have been named as a defendant in several lawsuits or have been notified by federal or state authorities that they are a potentially responsible party (\"PRP\") under federal laws or a respondent under state laws relating to the generation, disposal or release of hazardous substances into the environment. Typically, an Operating Partnership is one of many PRPs for a particular site and its contribution of total waste at the site is minimal. However, because CERCLA and similar statutes impose liability without regard to fault and on a joint and several basis, the liability of the Operating Partnerships in connection with these proceedings could be material. Potentially material proceedings affecting the Operating Partnerships are described below.\nIn July 1986, Buckeye was named as one of several PRPs for the Whitmoyer Laboratories site in Myerstown, Pennsylvania. Buckeye previously owned part of the site and sold it to a purchaser now believed to be primarily responsible for the reported substantial chemical contamination at the site. Without knowledge of the contamination, Buckeye subsequently repurchased a small portion of the site on which it constructed a pumping station. After completion of a remedial investigation and feasibility study and consideration of proposed remediation plans, EPA issued two Records of Decision in December 1990 proposing a clean-up estimated to cost approximately $125 million. In 1992, EPA entered into a Consent Decree with the two PRPs that were former owners of Whitmoyer Laboratories. These PRPs agreed to assume the cost of clean-up at the site, and to reimburse EPA for future response costs and a portion of its past response costs. These two PRPs have instituted suit against each other to determine their relative responsibility for the Whitmoyer Laboratories site clean-up. One of the PRPs served a third-party complaint against Buckeye for the stated purpose of tolling the statute of limitations to preserve its rights, if any, against Buckeye. Buckeye\nsubsequently settled the third-party complaint that had been filed against it. In consideration of mutual releases and the PRP's agreement to cleanup Buckeye's portion of the site, Buckeye agreed to remove its booster pump station, to reroute its pipeline around the site and to reimburse the PRP for the cost of removing the original pipeline, if such removal is required by EPA. Buckeye estimates at this time that the costs of complying with the terms of the settlement agreement will be between $1 million and $2 million. Buckeye has not entered into any agreements with the EPA or the other PRP involved at the site, and Buckeye has not waived any rights to recover for any claim arising out of the PRP's activities at the site or any claims brought by any governmental agency or third party based upon environmental conditions at the site. In the event that claims were asserted by any party in connection with the site, Buckeye believes that it would have meritorious defenses, but its potential liability, if any, related to such claims, cannot be estimated at this time.\nIn July 1987, the NJDEPE ordered Buckeye and 27 other parties to provide site security and conduct a preliminary clean-up at the Borne Chemical site located in Elizabeth, New Jersey. Twenty of the parties (including Buckeye) agreed to provide security and to remove certain materials from the site. Buckeye agreed to pay approximately $64,000 of the $4 million estimated cost of this activity. This removal work has been completed. The NJDEPE is requiring that all parties (including Buckeye) which are alleged to have contributed hazardous substances to the site, conduct a remedial investigation\/feasibility study to determine the scope of additional contamination, if any, that may exist at the site. Buckeye's involvement with this site is based on allegations that a small amount of Buckeye's waste was stored at this site pending its ultimate disposal elsewhere. Buckeye believes that it has meritorious defenses, but its potential liability, if any, for future costs cannot be estimated at this time.\nIn March 1989, the NJDEPE issued a directive to Buckeye and 113 other parties demanding payment of approximately $9.2 million in remediation costs incurred by NJDEPE at the Bridgeport Rental & Oil Services site in Logan Township, New Jersey. This site is subject to a remediation being conducted by EPA under CERCLA. In March 1992, an action was commenced by Rollins Environmental Services (NJ), Inc., and others, against the United States of America and certain additional private parties seeking reimbursement for remediation expenses incurred by plaintiffs in connection with the site. In June 1992, the United States of America brought an action against Rollins Environmental Services (NJ), Inc., and additional private parties, seeking reimbursement of approximately $29 million for response costs incurred by EPA at the site. Buckeye has not been designated by EPA as a PRP with respect to the site, and has not been named as a defendant in any litigation connected with the site. Buckeye believes that it is, at most, a de minimis contributor of waste to this site. Although EPA has estimated remediation costs at the site to be over $100 million, Buckeye expects that its liability, if any, will not be material.\nIn May 1993, Buckeye was notified by EPA that EPA had reason to believe that Buckeye was a PRP under CERCLA regarding certain hazardous substances located at a former waste processing\/management facility located in Niagara Falls, New York known as the Frontier Chemical Superfund Site. Buckeye is one of several hundred parties that have been informed by EPA that they are potential PRPs in connection with the site. In its notification letter, EPA requested the PRPs to refund approximately $376,000 in costs already incurred by EPA in connection with the management of the site, and to fund the clean-up and removal of certain alleged hazardous materials contained in drums and liquid waste holding tanks at the site. The estimated cost of the removal activity has been estimated by EPA at approximately $4,700,000. In addition, EPA noted that certain subsequent clean-up activities may be required at the site, but that such work would be the subject of a future letter to the PRPs and would be addressed under a separate administrative order. Buckeye has entered into a PRP Group Participation Agreement with other PRPs in order to facilitate a joint approach to EPA and to the clean-up of the site. Buckeye believes that it is, at most, a de minimis contributor of\nwaste to the site. Although the cost of the ultimate remediation of the site cannot be determined at this time, Buckeye expects that its liability, if any, will not be material.\nIn July 1994, Buckeye was named as a defendant in an action filed by the Michigan Department of Natural Resources (\"MDNR\") in Circuit Court, Oakland County, Michigan. The complaint also names three individuals and three other corporations as defendants. The complaint alleges that under the Michigan Environmental Response Act, the Michigan Water Resource Commission Act and the Leaking Underground Storage Tank Act, the defendants are liable to the state of Michigan for remediation expenses in connection with alleged groundwater contamination in the vicinity of Sable Road, Oakland County, Michigan. The complaint asserts that contaminated groundwater has infiltrated drinking water wells in the area. The complaint seeks past response costs in the amount of approximately $1.2 million and a declaratory judgment that the defendants are liable for future response costs and remedial activities at the site. Buckeye believes that its pipeline in the vicinity of the contaminated groundwater has not been a source of the contaminants and that Buckeye has no responsibility with respect to past or future clean-up costs at the site. Buckeye's liability, if any, cannot be estimated at this time.\nIn July 1994, Buckeye was named as a defendant in an action entitled Waste Management Inc., et. al. v. Aerospace America, Inc., et. al. filed in the United States District Court for the Eastern District of Michigan. One of the plaintiffs, SCA Services, Inc. (\"SCA\"), entered into a consent order with the state of Michigan in 1980, pursuant to which SCA agreed to remedy a portion of a Superfund site known as the Hartley & Hartley landfill located in Kawkawlin, Bay County, Michigan. In the pending action, plaintiffs are seeking contributions from Buckeye and over 100 other defendants of approximately $5.7 million in response costs alleged to have been incurred to date and for future response and remediation costs that may be incurred in connection with future remediation at the site. Plaintiffs' claim against Buckeye is purportedly brought pursuant to the provisions of CERCLA. Buckeye believes that it is, at most, a de minimis contributor of wastes to the site. Although the cost of the ultimate remediation of the site cannot be determined at this time, Buckeye expects that its liability, if any, will not be material.\nAdditional claims for the cost of cleaning up releases of hazardous substances and for damage to the environment resulting from the activities of the Operating Partnerships or their predecessors may be asserted in the future under various federal and state laws, but the amount of such claims or the potential liability, if any, cannot be estimated. See \"Business--Regulation-- Environmental Matters.\"\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the holders of LP Units during the fourth quarter of the fiscal year ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S LP UNITS AND RELATED UNITHOLDER MATTERS\nThe LP Units of the Partnership are listed and traded principally on the New York Stock Exchange. The high and low sales prices of the LP Units in 1994 and 1993, as reported on the New York Stock Exchange Composite Tape, were as follows:\nDuring the months of December 1994 and January 1995, the Partnership gathered tax information from its known LP Unitholders and from brokers\/nominees. Based on the information collected, the Partnership estimates its number of beneficial LP Unitholders to be approximately 18,000.\nCash distributions paid quarterly during 1993 and 1994 were as follows:\nIn general, the Partnership makes quarterly cash distributions of substantially all of its available cash less such retentions for working capital, anticipated expenditures and contingencies as the General Partner deems appropriate.\nOn February 1, 1995, the Partnership announced a quarterly distribution of $0.70 per LP Unit payable on February 28, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following tables set forth, for the period and at the dates indicated, the Partnership's income statement and balance sheet data for the years ended December 31, 1994, 1993, 1992, 1991 and 1990. The tables should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following is a discussion of the liquidity and capital resources and the results of operations of the Partnership for the periods indicated below. Amounts in the Management's Discussion and Analysis of Financial Condition and Results of Operations relate to continuing operations unless otherwise indicated. This discussion should be read in conjunction with the consolidated financial statements and notes thereto, which are included elsewhere in this Report.\nRESULTS OF OPERATIONS\nThrough its Operating Partnerships, the Partnership is principally engaged in the transportation of refined petroleum products including gasoline, jet fuel, diesel fuel, heating oil and kerosene. The Partnership's revenues are principally a function of the volumes of refined petroleum products transported by the Partnership, which are in turn a function of the demand for refined petroleum products in the regions served by the Partnership's pipelines and the tariffs or transportation fees charged for such transportation. Results of operations are affected by factors which include competitive conditions, demand for products transported, seasonality and regulation. See \"Business-- Competition and Other Business Considerations.\"\n1994 Compared With 1993\nRevenue for the year ended December 31, 1994 was $186.3 million, $10.8 million, or 6.2 percent greater than revenue of $175.5 million for 1993. Volume delivered during 1994 averaged 1,028,800 barrels per day, 47,700 barrels per day or 4.9 percent greater than volume of 981,100 barrels per day delivered in 1993. Greater revenue in 1994 was related to increased gasoline and distillate deliveries and to the effect of tariff rate increases (see \"Tariff Changes\" below). Gasoline volumes increased primarily due to higher end-use demand in response to continued economic recovery and moderate growth in market share. Higher distillate shipments were the result of increased demand due to colder weather early in the year and the effect of carrying two distillate inventories, both high and low sulfur product, as required by Clean Air Act regulations that became effective in October 1993. Turbine fuel shipments increased slightly due to market demand growth at major airports.\nCosts and expenses during 1994 were $113.9 million, $5.3 million or 4.9 percent greater than costs and expenses of $108.6 million during 1993. Categories of increased expenses included payroll and employee benefits, maintenance services, power, supplies and casualty loss. A significant portion of these increased expenses were directly related to the transportation of additional volume. In addition, costs incurred in connection with environmental remediation activities were $2.9 million greater than the prior year. See \"Environmental Matters.\"\nOther income (expenses) consist of interest income, interest and debt expense, and minority interests and other. Net reductions in debt, plus refinancing of debt at lower interest rates, resulted in a decline in interest expense of $0.9 million from 1993 levels.\n1993 Compared With 1992\nRevenue for the year ended December 31, 1993 was $175.5 million, $12.5 million, or 7.7 percent greater than revenue of $163.0 million for 1992. Volume delivered during 1993 averaged 981,100 barrels per day, 67,900 barrels per day or 7.4 percent greater than volume of 913,200 barrels per day delivered in 1992. Greater revenue in 1993 was related to increased gasoline, distillate and turbine fuel deliveries and to the effect of tariff rate increases implemented in July 1992 and August 1993. Gasoline and distillate volume increases were due primarily to higher end-use demand in response to moderate economic recovery and a return to normal winter temperatures. In addition, 1993 volume improved as a result of new business captured from barge and other pipelines, a decline in Canadian imports to upstate New York and extended refinery maintenance activities that required transportation of additional refined products into the Partnership's service areas. Increased turbine fuel volume was due to a moderate improvement in domestic and international air travel and continued growth in air cargo business.\nCosts and expenses during 1993 were $108.6 million, $8.8 million or 8.8 percent greater than costs and expenses of $99.8 million during 1992. Categories of increased expenses included payroll and employee benefits, maintenance services, power and supplies. A significant portion of these increased expenses were directly related to the transportation of additional volume and related maintenance activities.\nOther income (expenses) consist of interest income, interest and debt expense, and minority interests and other. Interest and debt expense of $25.9 million in 1993 was $1.6 million less than interest and debt expense of $27.5 million in 1992 reflecting lower debt outstanding following payment of $16.3 million of Series E First Mortgage Notes in December 1992.\nTariff Changes\nIn November 1994, July 1993 and June 1992, Buckeye filed proposed changes in certain tariff rates that represented, on average, increases of 0.4 percent, 1.4 percent and 3.0 percent, respectively.\nThe November 1994, July 1993 and June 1992 changes were projected to generate approximately $0.4 million, $1.5 million and $4.0 million in additional revenue per year, respectively. Each of these proposed changes became effective during the month after they were filed.\nChange in Accounting Principle\nIn December 1992, the Partnership adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\") effective as of January 1, 1992. As a result, the Partnership recorded a one-time, non-cash charge of $25.5 million as of the first quarter of 1992 to reflect the cumulative effect of the change in accounting principle for periods prior to 1992. In addition, quarterly results for 1992 were restated to reflect an additional $1.5 million, or approximately $0.4 million per quarter, in related operating expenses throughout the year.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Partnership's financial condition at December 31, 1994, 1993 and 1992 is highlighted in the following comparative summary:\nLiquidity and Capital Indicators\nCash Provided by Operations\nDuring 1994, cash provided by operations of $58.1 million was derived principally from $48.1 million of income from continuing operations before an extraordinary charge and $11.2 million of depreciation. Operating working capital decreased by $0.7 million. Increases in accrued and other current liabilities, trade receivables, temporary investments and prepaid and other current assets account for the majority of the change. Remaining cash uses, totaling $0.5 million, were related to an extraordinary charge on early extinguishment of debt of $2.3 million, changes in minority interests and changes in other non-current liabilities.\nDuring 1993, cash provided by operations of $52.9 million was derived principally from $41.7 million of income from continuing operations before an extraordinary charge, $11.0 million of depreciation and $3.7 million of operating working capital changes. Operating working capital changes relate to a decrease in trade receivables and an increase in accrued and other current liabilities. Remaining cash uses, totaling $3.5 million, were related to an extraordinary charge on early extinguishment of debt of $2.2 million and changes in minority interests and other non-current liabilities.\nDuring 1992, cash provided by operations of $52.2 million was derived principally from $34.5 million of income from continuing operations before the cumulative effect of a change in accounting principle, $10.7 million of depreciation and $3.5 million of changes in operating working capital. Other net cash sources, totaling $3.5 million, were largely provided by discontinued operations and an increase in other non-current liabilities.\nDebt Obligation and Credit Facilities\nThe indenture pursuant to which the First Mortgage Notes were issued (the \"Mortgage Note Indenture\") was amended in March 1994 by a Fourth Supplemental Indenture to permit Buckeye to issue additional First Mortgage Notes from time to time under certain circumstances; so long as the aggregate principal amount of First Mortgage Notes outstanding after any such issuance does not exceed $275 million.\nAt December 31, 1994, the Partnership had $214.0 million in outstanding current and long-term debt representing the First Mortgage Notes of Buckeye which does not include $45.0 million in First Mortgage Notes which had been retired by in-substance defeasance. The First Mortgage Notes are collateralized by substantially all of Buckeye's currently existing and after acquired property, plant and equipment. Debt outstanding at December 31, 1994 includes $15 million of additional First Mortgage Notes, Series N, bearing interest at a rate of 7.93 percent. The First Mortgage Notes, Series N, were issued on April 11, 1994 and are due December 2010. Current and long-term debt excludes $20 million of 9.72 percent First Mortgage Notes, Series I, due December 1996, which were retired by an in-substance defeasance with the proceeds of the Series N First Mortgage Notes and an additional defeasance of $5 million in December 1994. Also excluded from long-term debt is $5 million of 11.18 percent First Mortgage Notes, Series J, which were retired by an in-substance defeasance in December 1994. Total debt due beyond 1994 that was retired by an in-substance defeasance during 1994 amounted to $25 million with total new debt issued during 1994 of $15.0 million. During 1994, the Partnership also paid $16 million of principal on the First Mortgage Notes, Series G, that became due in December 1994.\nAt December 31, 1993, the Partnership had $240.0 million in outstanding current and long-term debt representing the First Mortgage Notes of Buckeye which does not include $20.0 million in First Mortgage Notes which had been retired by in-substance defeasance. Debt outstanding at 1993 year end included $35 million of additional First Mortgage Notes (Series K, L and M) bearing interest rates from 7.11 percent to 7.19 percent which were issued on January 7, 1994 in accordance with an agreement entered into on December 31, 1993 and excluded $20 million of 9.50 percent First Mortgage Notes, Series H, due December 1995 that were retired by an in-substance defeasance with a portion of the proceeds from such additional First Mortgage Notes. During 1993, the Partnership paid $17.5 million of principal on the First Mortgage Notes, Series F, that became due in December 1993. In December 1993, Buckeye entered into an agreement with the purchaser of the $35 million of additional First Mortgage Notes which permits Buckeye, under certain circumstances, to issue up to $40 million of additional First Mortgage Notes to such purchaser.At December 31, 1994, Buckeye has the capacity to borrow up to $25.0 million of additional First Mortgage Notes under this agreement.\nThe Partnership has a $15 million unsecured short-term revolving credit facility with a commercial bank. This facility, which has options to extend borrowings through September 1999, is available to the Partnership for general purposes, including capital expenditures and working capital. In addition, Buckeye has a $10 million short-term line of credit secured by accounts receivable. Laurel has an unsecured $1 million line of credit. At December 31, 1994, there were no outstanding borrowings under these facilities.\nThe ratio of total debt to total capital was 46 percent, 50 percent, and 51 percent at December 31, 1994, 1993 and 1992, respectively. For purposes of the calculation of this ratio, total capital consists of current and long-term debt, minority interests and partners' capital.\nCash Distributions\nPursuant to the Mortgage Note Indenture, cash distributions by Buckeye to the Partnership cannot exceed Net Cash Available to Partners (generally defined to equal net income plus\ndepreciation and amortization less (a) capital expenditures funded from operating cash flows, (b) payments of principal of debt and (c) certain other amounts, all on a cumulative basis since the formation of the Partnership). The maximum amount available for distribution by Buckeye to the Partnership under the formula as of December 31, 1994 amounted to $11.0 million. The Partnership is also entitled to receive cash distributions from Everglades, BTT and Laurel.\nCapital Expenditures\nAt December 31, 1994, property, plant and equipment was approximately 94 percent of total consolidated assets. This compares to 92 percent and 93 percent for the years ended December 31, 1993 and 1992, respectively. Capital expenditures are generally for expansion of the Operating Partnerships' service capabilities and sustaining the Operating Partnerships' existing operations.\nCapital expenditures by the Partnership were $15.4 million, $13.3 million and $10.8 million for 1994, 1993 and 1992, respectively. Projected capital expenditures for 1995 amount to $14.9 million. Planned capital expenditures include, among other things, tanks to accommodate specific new business opportunities, renewal and replacement of pipe and station facilities, new valves, metering systems, field instrumentation, communication facilities and testing equipment. Capital expenditures are expected to increase over time primarily in response to increasingly rigorous governmental safety and environmental requirements as well as industry standards.\nEnvironmental Matters\nThe Operating Partnerships are subject to federal and state laws and regulations relating to the protection of the environment. These regulations, as well as the Partnership's own standards relating to protection of the environment, cause the Operating Partnerships to incur current and ongoing operating and capital expenditures. During 1994, the Operating Partnerships incurred operating expenses of $5.9 million and capital expenditures of $4.3 million related to environmental matters. Capital expenditures of $4.5 million for environmental related projects are included in the Partnership's plans for 1995. Expenditures, both capital and operating, relating to environmental matters are expected to increase due to the Partnership's commitment to maintain high environmental standards and to increasingly rigorous environmental laws.\nCertain Operating Partnerships (or their predecessors) have been named as a defendant in lawsuits or have been notified by federal or state authorities that they are a PRP under federal laws or a respondent under state laws relating to the generation, disposal, or release of hazardous substances into the environment. These proceedings generally relate to potential liability for clean-up costs. The total potential remediation costs to be borne by the Operating Partnerships relating to these clean-up sites cannot be reasonably estimated and could be material. With respect to each site, however, the Operating Partnership involved is one of several or as many as several hundred PRPs that would share in the total costs of clean-up under the principle of joint and several liability. The General Partner believes that the generation, handling and disposal of hazardous substances by the Operating Partnerships and their predecessors have been in material compliance with applicable environmental and regulatory requirements.\nAt the Whitmoyer Laboratories site in Myerstown, Pennsylvania, Buckeye is one of several PRPs for a clean-up estimated to cost approximately $125 million. However, in 1992, EPA entered into an agreement with the estate of one of the PRPs to recover a portion of EPA's past costs and a Consent Decree with the two PRPs that were former owners of Whitmoyer Laboratories to assume the cost of clean-up at the site and to reimburse EPA for future response costs and a portion of its past response costs. These two PRPs have instituted suit against each other to determine their relative responsibility for the Whitmoyer Laboratories site clean-up. One of the PRPs served a third-party complaint against Buckeye for the stated purpose of tolling the statute of limitations to\npreserve its rights, if any, against Buckeye. Buckeye subsequently settled the third-party complaint that had been filed against it. In consideration of mutual releases and the PRP's agreement to cleanup Buckeye's portion of the site, Buckeye agreed to remove its booster pump station, to reroute its pipeline around the site and to reimburse the PRP for the cost of removing the original pipeline, if such removal is required by EPA. Buckeye has not entered into any agreements with the EPA or the other PRP involved at the site, and Buckeye has not waived any rights to recover for any claim arising out of the PRP's activities at the site or any claims brought by any governmental agency or third party based upon environmental conditions at the site. Although the exact costs of the settlement are not known, Buckeye estimates at this time that the costs of complying with the terms of the settlement agreement will be between $1 million and $2 million.\nBuckeye has worked with the U.S. Coast Guard and other federal, state and local agencies since October 15, 1994 to remedy the environmental consequences of a pipeline release in New Haven, Connecticut. Product released from one of Buckeye's pipelines contaminated the groundwater in the area and, for a short period of time, discharged into the Quinnipiac River. Buckeye replaced approximately 2,000 feet of pipe in the area of the release site and presently has in place facilities to remedy groundwater contamination associated with the release. Although it is possible that costs related to this incident could increase to a level which would materially effect the Partnership's results of operations for a future period, the General Partner does not believe, based upon information currently available, that costs arising out of this event will have a material adverse effect on the Partnership's consolidated financial condition or annual results of operations. During 1994, Buckeye paid claims and other charges in the amount of $1.4 million and made capital expenditures of $0.5 million related to this incident.\nIn March 1990, a landslide near Freeport, Pennsylvania caused a rupture to one of Buckeye's pipelines which resulted in the release of approximately 58,000 gallons of petroleum products. During 1994, Buckeye paid claims and other charges related to this incident in the amount of $0.3 million. Substantially all of this amount has been reimbursed by Buckeye's insurance carriers. Buckeye is unable to estimate the total amount of environmental clean-up and other costs and liabilities that may be incurred in connection with this incident. However, based on information currently available to it, Buckeye believes that its net expense after insurance recoveries will not be material to its financial condition or results of operations. See \"Legal Proceedings--Freeport Landslide.\"\nVarious claims for the cost of cleaning up releases of hazardous substances and for damage to the environment resulting from the activities of the Operating Partnerships or their predecessors have been asserted and may be asserted in the future under various federal and state laws. Although the Partnership has made a provision for certain legal expenses relating to these matters, the General Partner is unable to determine the timing or outcome of any pending proceedings or of any future claims and proceedings. See \"Business--Regulation--Environmental Matters\" and \"Legal Proceedings.\"\nDiscontinued Operations\nIn the fourth quarter of 1990, the Partnership recorded a non-cash charge to earnings of $19.1 million, net of estimated earnings during phase-out, relating to the Partnership's decision to discontinue its 16-inch crude oil pipeline and a refined products terminal. The Partnership closed the sale of the 16-inch crude oil pipeline, together with associated real and personal property to Sun Pipe Line Company on February 1, 1993. Proceeds from the sale amounted to $9.2 million. Remaining discontinued operations consisting of petroleum facilities at a refined products terminal were dismantled and removed during the first quarter 1993. Disposal of these discontinued operations resulted in a loss of $127,000 in 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nBUCKEYE PARTNERS, L.P.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nSchedules other than those listed above are omitted because they are either not applicable or not required or the information required is included in the consolidated financial statements or notes thereto.\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Buckeye Partners, L.P.:\nWe have audited the accompanying consolidated balance sheets of Buckeye Partners, L.P. and its subsidiaries (the \"Partnership\") 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. 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Partnership as of December 31, 1994 and 1993, and the 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 10 to the consolidated financial statements, in 1992 the Partnership changed its method of accounting for postretirement benefits other than pensions to conform with Statement of Financial Accounting Standards Number 106.\nDeloitte & Touche\nPhiladelphia, Pennsylvania January 27, 1995\nBUCKEYE PARTNERS, L.P. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)\nSee notes to consolidated financial statements.\nBUCKEYE PARTNERS, L.P. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nBUCKEYE PARTNERS, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\n(IN THOUSANDS)\nSee notes to consolidated financial statements.\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1994 AND 1993 AND FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1. ORGANIZATION\nBuckeye Partners, L.P. (the \"Partnership\") is a limited partnership organized in 1986 under the laws of the state of Delaware. The Partnership owns 99 percent limited partnership interests in Buckeye Pipe Line Company, L.P. (\"Buckeye\"), Laurel Pipe Line Company, L.P. (\"Laurel\"), Everglades Pipe Line Company, L.P. (\"Everglades\") and Buckeye Tank Terminals Company, L.P. (\"BTT\"). The foregoing entities are hereinafter referred to as the \"Operating Partnerships.\" Laurel owns a 98.01 percent limited partnership interest in Buckeye Pipe Line Company of Michigan, L.P. (\"BPL Michigan\") which discontinued operations in 1993 (see Note 5).\nDuring December 1986, the Partnership sold 12,000,000 limited partnership units (\"LP Units\") in a public offering representing an aggregate 99 percent limited partnership interest in the Partnership. Concurrently, the Partnership sold 121,212 units representing a 1 percent general partnership interest in the Partnership (\"GP Units\") to Buckeye Management Company (the \"General Partner\"), a wholly owned subsidiary of American Premier Underwriters, Inc. (\"American Premier\"), formerly The Penn Central Corporation. The Partnership used the proceeds from such sales to purchase from subsidiaries of American Premier the 99 percent limited partnership interests in the then existing Operating Partnerships and an 83 percent stock interest in Laurel Pipe Line Company (\"Laurel Corp\"). In December 1991, the Partnership acquired the minority interest in Laurel Corp. Laurel was formed in October 1992 and succeeded to the operations of Laurel Corp. During 1994, the Partnership issued an additional 16,060 limited partnership units and 162 general partnership units under its Unit Option and Distribution Equivalent Plan. At December 31, 1994, there were 12,016,060 limited partnership units and 121,374 general partnership units outstanding (see Note 14 and Note 16).\nA subsidiary of the General Partner, Buckeye Pipe Line Company (the \"Manager\"), owns a 1 percent general partnership interest in, and serves as sole general partner and manager of, each Operating Partnership. The Manager also owns a 1 percent general partnership interest and a 0.99 percent limited partnership interest in BPL Michigan.\nThe Partnership maintains its accounts in accordance with the Uniform System of Accounts for Pipeline Companies, as prescribed by the Federal Energy Regulatory Commission (\"FERC\"). Reports to FERC differ from the accompanying consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles, generally in that such reports calculate depreciation over estimated useful lives of the assets as prescribed by FERC.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation\nThe accompanying financial statements of the Partnership have been prepared using the purchase method of accounting. An allocation of the purchase price to the net assets acquired was made on their relative fair market values as appraised. The financial statements include the accounts of the Operating Partnerships on a consolidated basis. All significant intercompany transactions have been eliminated in consolidation.\nFinancial Instruments\nThe fair value of financial instruments is determined by reference to various market data and other valuation techniques as appropriate. Unless otherwise disclosed, the fair values of financial instruments approximate their recorded values (see Note 7).\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nCash and Cash Equivalents\nAll highly liquid debt instruments purchased with a maturity of three months or less are classified as cash equivalents.\nTemporary Investments\nIn accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" all temporary investments are considered to be trading securities. The aggregate market value of temporary investments approximates cost as of December 31, 1994. The adoption of SFAS 115 did not have a material effect on the Partnership's net income for the year ended December 31, 1994.\nRevenue Recognition\nSubstantially all revenue is derived from interstate and intrastate transportation of petroleum products. Such revenue is recognized as products are delivered to customers. Such customers are major integrated oil companies, major refiners and large regional marketing companies. While the consolidated Partnership's continuing customer base numbers approximately 120, no customer during 1994 contributed more than 10 percent of total revenue. The Partnership does not maintain an allowance for doubtful accounts.\nInventories\nInventories, consisting of materials and supplies, are carried at cost which does not exceed realizable value.\nProperty, Plant and Equipment\nProperty, plant and equipment consist primarily of pipeline and related transportation facilities and equipment. For financial reporting purposes, depreciation is calculated primarily using the straight-line method over the estimated useful life of 50 years. Additions and betterments are capitalized and maintenance and repairs are charged to income as incurred. Generally, upon normal retirement or replacement, the cost of property (less salvage) is charged to the depreciation reserve, which has no effect on income.\nIncome Taxes\nFor federal and state income tax purposes, the Partnership and Operating Partnerships are not taxable entities. Accordingly, the taxable income or loss of the Partnership and Operating Partnerships, which may vary substantially from income or loss reported for financial reporting purposes, is generally includable in the federal and state income tax returns of the individual partners. In October 1992 (see Note 1), Laurel Corp and its parent LE Holdings, Inc. (\"LEH\") were merged into Laurel. Laurel Corp and its parent, LEH, as corporations, had been separate taxpaying entities whose taxable income was included in a consolidated federal income tax return. As a result of the merger, the then existing deferred income taxes of $3,697,000 were charged directly to the Partnership's capital accounts. The provision for federal income taxes on operations of Laurel Corp and LEH prior to the merger approximates the statutory tax rate applied to the pretax accounting income. As of December 31, 1994, the Partnership's reported amount of net assets for financial reporting purposes exceeded its tax basis by approximately $179 million.\nEnvironmental Expenditures\nEnvironmental 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\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) are recorded when environmental assessments and\/or clean-ups are probable, and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with the Partnership's commitment to a formal plan of action.\nPensions\nThe Manager maintains a defined contribution plan and a defined benefit plan (see Note 9) which provide retirement benefits to substantially all of its regular full-time employees. Certain hourly employees of the Manager are covered by a defined contribution plan under a union agreement.\nPostretirement Benefits Other Than Pensions\nThe Manager provides postretirement health care and life insurance benefits for certain of its retirees. In 1992, the Manager adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\") (see Note 10) to account for the cost of these plans. Certain other retired employees are covered by a health and welfare plan under a union agreement.\nReclassifications\nCertain amounts in the consolidated financial statements for the periods prior to 1994 have been reclassified to conform to the current presentation.\n3. CONTINGENCIES\nThe Partnership, and the Operating Partnerships, in the ordinary course of business, are involved in various claims and legal proceedings, some of which are covered in whole or in part by insurance. The General Partner is unable to predict the timing or outcome of these claims and proceedings. Although it is possible that one or more of these claims or proceedings, if adversely determined, could, depending on the relative amounts involved, have a material effect on the Partnership's results of operations for a future period, the General Partner does not believe that their outcome will have a material effect on the Partnership's consolidated financial condition.\nEnvironmental\nIn accordance with its accounting policy on environmental expenditures, the Partnership recorded expenses of $5.9 million, $3.0 million and $3.1 million for 1994, 1993 and 1992, respectively, which were related to the environment. Expenditures, both capital and operating, relating to environmental matters are expected to increase due to the Partnership's commitment to maintain high environmental standards and to increasingly strict environmental laws and government enforcement policies.\nCertain Operating Partnerships (or their predecessors) have been named as a defendant in lawsuits or have been notified by federal or state authorities that they are a potentially responsible party (\"PRP\") under federal laws or a respondent under state laws relating to the generation, disposal, or release of hazardous substances into the environment. These proceedings generally relate to potential liability for clean-up costs. The total potential remediation costs relating to these clean-up sites cannot be reasonably estimated. With respect to each site, however, the Operating Partnership involved is one of several or as many as several hundred PRPs that would share in the total costs of clean-up under the principle of joint and several liability. The General Partner believes\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nthat the generation, handling and disposal of hazardous substances by the Operating Partnerships and their predecessors have been in material compliance with applicable environmental and regulatory requirements. Additional claims for the cost of cleaning up releases of hazardous substances and for damage to the environment resulting from the activities of the Operating Partnerships or their predecessors may be asserted in the future under various federal and state laws. Although the Partnership has made a provision for certain legal expenses relating to these matters, the General Partner is unable to determine the timing or outcome of any pending proceedings or of any future claims and proceedings.\nGuaranteed Investment Contract\nThe Buckeye Pipe Line Company Retirement and Savings Plan (the \"Plan\") held a guaranteed investment contract (\"GIC\") issued by Executive Life Insurance Company (\"Executive Life\"), which entered conservatorship proceedings in the state of California in April 1991. The GIC was purchased in July 1989, with an initial principal investment of $7.4 million earning interest at an effective rate per annum of 8.98 percent through June 30, 1992. As a result of the conservatorship proceedings, no payment of principal or interest was made on the maturity date. A Plan of Rehabilitation was approved by the Superior Court of the state of California, and the Rehabilitation Plan was consummated on September 3, 1993. Various policy holders and creditors have, however, appealed certain aspects of the Plan of Rehabilitation, including the priority status of entities such as the Plan which purchased GICs subsequent to January 1, 1989. Pursuant to the Plan of Rehabilitation, the Plan has received an interest only contract from Aurora National Life Assurance Company in substitution for its Executive Life GIC. The contract provides for semi-annual interest payments at a rate of 5.61 percent per annum through September 1998, the maturity date of the contract. In addition, the Plan is to receive certain additional cash payments, the amounts of which cannot be accurately estimated at this time, over the next four years pursuant to the Plan of Rehabilitation. The timing and amount of payment with respect to the GIC is dependent upon the outcome of the pending appeals as well as clarification of various provisions of the Rehabilitation Plan. In May 1991, the General Partner, in order to safeguard the basic retirement and savings benefits of its employees, announced its intention to enter an arrangement with the Plan that would guarantee that the Plan would receive at least its initial principal investment of $7.4 million plus interest at an effective rate per annum of 5 percent from July 1, 1989. The General Partner's present intention is to effectuate its commitment no later than September 1998, the maturity date of the Aurora contract. The costs and expenses of the General Partner's employee benefit plans are reimbursable by the Partnership under the applicable limited partnership and management agreements. The General Partner believes that an adequate provision has been made for costs which may be incurred by the Partnership in connection with the guarantee.\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n4. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consist of the following:\nDepreciation expense was $11,203,000, $11,002,000 and $10,745,000 for the years 1994, 1993 and 1992, respectively.\n5. DISCONTINUED OPERATIONS\nIn the fourth quarter of 1990, the Partnership recorded a non-cash charge to earnings of $19.1 million, net of estimated earnings during phase-out, relating to the Partnership's decision to discontinue its 16-inch crude oil pipeline and a refined products terminal. The Partnership closed the sale of the 16-inch crude oil pipeline, together with associated real and personal property to Sun Pipe Line Company on February 1, 1993. Proceeds from the sale amounted to $9.2 million. Remaining discontinued operations consisting of petroleum facilities at the refined products terminal were dismantled and removed during the first quarter 1993. Disposal of these discontinued operations resulted in a loss of $127,000 in 1993.\n6. ACCRUED AND OTHER CURRENT LIABILITIES\nAccrued and other current liabilities consist of the following:\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n7. LONG-TERM DEBT AND CREDIT FACILITIES\nLong-term debt (excluding current maturities) consists of the following:\nMaturities of debt outstanding at December 31, 1994 are as follows: None in 1995; none in 1996; $11,900,000 in 1997; $16,900,000 in 1998; $16,900,000 in 1999 and a total of $168,300,000 in the period 2000 through 2010.\nIn accordance with SFAS 107, \"Disclosure about Fair Value of Financial Instruments,\" the fair value of the Partnership's debt is estimated to be $221 million and $285 million as of December 31, 1994 and 1993, respectively. These values were calculated using interest rates currently available to the Partnership for issuance of debt with similar terms and remaining maturities.\nThe First Mortgage Notes are collateralized by a mortgage on and a security interest in substantially all of the currently existing and after-acquired property, plant and equipment (the \"Mortgaged Property\") of Buckeye.\nThe indenture pursuant to which the First Mortgage Notes were issued (the \"Mortgage Note Indenture\"), as amended by Supplemental Indentures, contains covenants which generally (a) limit the outstanding indebtedness of Buckeye under the Mortgage Note Indenture at any time to $275 million plus up to $15 million of short-term borrowings for working capital purposes, (b) prohibit Buckeye from creating or incurring additional liens on its property, (c) prohibit Buckeye from disposing of substantially all of its property or business to another party and (d) prohibit Buckeye from disposing of any part of the Mortgaged Property unless the proceeds in excess of $1 million in a fiscal year are available for reinvestment in assets subject to the lien of the Mortgage Note Indenture.\nIn December 1993, Buckeye entered into an agreement to issue $35 million of additional First Mortgage Notes in accordance with provisions under a Third Supplemental Indenture and as permitted under the Mortgage Note Indenture. These additional First Mortgage Notes, which were issued on January 7, 1994, mature from 2007 to 2009 and bear interest at rates ranging from 7.11 percent to 7.19 percent. A portion of the proceeds of these notes was used to complete an in-substance defeasance of principal and interest with respect to Buckeye's $20 million, 9.50 percent First Mortgage Notes (Series H) due December 1995 (see Note 11). Remaining proceeds of the additional notes were used for working capital purposes. In addition, Buckeye entered into an agreement with the purchaser of the $35 million of additional First Mortgage Notes which permitted Buckeye, under certain circumstances, to issue up to $40 million of additional First Mortgage Notes to such purchaser (the \"Mortgage Note Facility\").\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDuring March 1994, Buckeye entered into an agreement with such purchaser to issue $15 million of additional First Mortgage Notes under the Mortgage Note Facility and in accordance with provisions under a Fourth and Fifth Supplemental Indenture and the Mortgage Note Indenture. These additional First Mortgage Notes mature in 2010 and bear interest at 7.93 percent. The proceeds of these notes, plus additional cash of $1.6 million, were used to complete an in-substance defeasance of principal and interest with respect to $15 million of 9.72 percent First Mortgage Notes (Series I) due December 1996. In addition, in December 1994, Buckeye completed an in-substance defeasance of $5 million of Buckeye's 9.72 percent Series I First Mortgage Notes and $5 million of Buckeye's 11.18 percent Series J First Mortgage Notes (see Note 11). As of December 1994, Buckeye has the capacity to borrow up to $25 million of additional First Mortgage Notes under the Mortgage Note Facility.\nThe Amended and Restated Agreement of Limited Partnership of the Partnership (the \"Partnership Agreement\") contains certain restrictions which limit the incurrence of any debt by the Partnership or any Operating Partnership to the First Mortgage Notes, any additional debt of Buckeye permitted by the Mortgage Note Indenture and other debt not in excess of an aggregate consolidated principal amount of $25 million plus the aggregate proceeds from the sale of additional partnership interests.\nThe Partnership maintains a $15 million unsecured revolving credit facility with a commercial bank which is available to the Partnership for general purposes, including capital expenditures and working capital. Interest on any borrowings under this facility is calculated on the bank's Alternate Base Rate (\"ABR\") or LIBOR plus one percent. ABR is defined as the highest of the bank's prime rate, the three month secondary CD rate plus one percent, and the Federal Funds Rate plus one-half of one percent. At December 31, 1994, there was no amount outstanding under this facility.\nBuckeye has a line of credit from two commercial banks (the \"Working Capital Facility\") which permits short-term borrowings of up to $10 million outstanding at any time. Borrowings under the Working Capital Facility bear interest at each bank's prime rate and are secured by the accounts receivable of Buckeye. The Mortgage Note Indenture contains covenants requiring that, for a period of 45 consecutive days during any year, no indebtedness be outstanding under the Working Capital Facility. In addition, Laurel has an unsecured line of credit from a commercial bank which permits short-term borrowings of up to $1 million outstanding at any time. Borrowings bear interest at the bank's prime rate. Laurel's unsecured line of credit contains covenants requiring that, for a period of 30 consecutive days during any year, no indebtedness be outstanding under this facility. At December 31, 1994, there were no amounts outstanding under either of these facilities.\n8. OTHER NON-CURRENT LIABILITIES\nOther non-current liabilities consist of the following:\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n9. PENSION PLANS\nThe Manager provides retirement benefits, primarily through noncontributory pension plans, for substantially all of its regular full-time employees, except those covered by certain labor contracts, under which the Manager contributes 5 percent of each covered employee's salary, and a retirement income guarantee plan (a defined benefit plan) which generally guarantees employees hired before January 1, 1986 a retirement benefit at least equal to the benefit they would have received under a previously terminated defined benefit plan. The Manager's policy is to fund amounts as are necessary to at least meet the minimum funding requirements of ERISA. All of these plans were assumed by the Manager.\nNet pension expense (benefit) for 1994, 1993 and 1992 for the defined benefit plans included the following components:\nThe pension expense for the defined contribution plan included in the consolidated statements of income approximated $1,471,000, $1,403,000 and $1,342,000 for 1994, 1993 and 1992, respectively.\nThe following table sets forth the funded status of the Manager's defined benefit plans and amounts recognized in the Partnership's consolidated balance sheets at December 31, 1994 and 1993 related to those plans:\nAs of December 31, 1994, approximately 39.6 percent of plan assets were invested in debt securities, 56.1 percent in equity securities and 4.3 percent in cash equivalents.\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 8.5 percent and 6.0 percent, respectively. The expected long-term rate of return on assets was 8.5 percent as of January 1, 1994 and 1995.\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Manager also participates in a multi-employer retirement income plan which provides benefits to employees covered by certain labor contracts. Pension expense for the plan was $152,000, $156,000 and $137,000 for 1994, 1993 and 1992, respectively.\n10. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nEffective January 1, 1992, the Partnership adopted SFAS 106. This statement requires that the cost of postretirement benefits other than pensions be accrued over the employee's years of service. Prior to the adoption of SFAS 106, the cost of these postretirement benefits was expensed on a \"pay as you go\" basis.\nThe Manager provides postretirement health care and life insurance benefits to certain of its retirees. To be eligible for these benefits an employee had to be hired prior to January 1, 1991 and has to meet certain service requirements. The Manager does not pre-fund this postretirement benefit obligation. On January 1, 1992, the accumulated postretirement benefit obligation (\"APBO\") amounted to $25,544,000. The Manager chose to recognize immediately the APBO as expense in 1992 for financial reporting purposes.\nNet postretirement benefit costs for 1994, 1993 and 1992 included the following components:\nThe following table sets forth the amounts related to postretirement benefit obligations recognized in the Partnership's consolidated balance sheets as of December 31, 1994 and 1993:\nThe weighted average discount rate used in determining the APBO was 8.5 percent. The assumed rate for plan cost increases in 1994 was 12.3 percent and 10.4 percent for non-Medicare eligible and Medicare eligible retirees, respectively. The assumed annual rates of cost increase decline each year through 2005 to a rate of 5.75 percent, and remain at 5.75 percent thereafter for both non-Medicare eligible and Medicare eligible retirees. The effect of a 1 percent increase in the health care cost trend rate for each future year would have increased the aggregate of service and interest cost components by $391,200 in 1994 and the APBO would have increased by $3,421,300 as of December 31, 1994.\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Manager also contributes to a multi-employer postretirement benefit plan which provides health care and life insurance benefits to employees covered by certain labor contracts. The cost of providing these benefits was approximately $130,000, $123,000 and $112,000 for 1994, 1993 and 1992, respectively.\n11. EARLY EXTINGUISHMENT OF DEBT\nIn March 1994, Buckeye entered into an agreement to issue $15 million of additional First Mortgage Notes (Series N) bearing interest at 7.93 percent (see Note 7). The proceeds from the issuance of these First Mortgage Notes, plus additional amounts approximating $1.6 million, were used to purchase U.S. Government securities. These securities were deposited into an irrevocable trust to complete an in-substance defeasance of $15 million of Buckeye's 9.72 percent, Series I, First Mortgage Notes. In addition, during December 1994, Buckeye purchased approximately $10.7 million of U.S. Government securities. These securities were deposited into an irrevocable trust to complete an in- substance defeasance of $5 million of Buckeye's 9.72 percent, Series I, First Mortgage Notes and $5 million of Buckeye's 11.18 percent, Series J, First Mortgage Notes. The funds placed in trust in 1994 will be used solely to satisfy the interest due and principal amounts of $20 million Series I Notes due December 1996 and $5 million Series J Notes due serially through December 2006. Accordingly, these U.S. Government securities, the Series I First Mortgage Notes and $5 million of the Series J First Mortgage Notes have been excluded from the 1994 balance sheet. This debt extinguishment resulted in an extraordinary charge of $2,269,000 in 1994.\nIn December 1993, Buckeye entered into an agreement to issue $35 million of additional First Mortgage Notes (Series K, L and M) bearing interest at rates ranging from 7.11 percent to 7.19 percent (see Note 7). A portion of the proceeds from the issuance of these First Mortgage Notes were used to purchase approximately $22.2 million of U.S. Government securities. These securities were deposited into an irrevocable trust to complete an in-substance defeasance of Buckeye's 9.50 percent, Series H, First Mortgage Notes. The funds in the trust will be used solely to satisfy the interest due and principal amount of $20 million due at maturity in December 1995. Accordingly, these U.S. Government securities and the Series H First Mortgage Notes have been excluded from the balance sheets. This debt extinguishment resulted in an extraordinary charge of $2,161,000 in 1993.\n12. LEASES\nThe Operating Partnerships lease certain land and rights-of-way. Minimum future lease payments for these leases as of December 31, 1994 are approximately $2.6 million for each of the next five years. Substantially all of these lease payments can be cancelled at any time should they not be required for operations.\nThe Manager leases space in an office building and certain copying equipment and Buckeye leases certain computing equipment and automobiles. The rent on such leases is charged to the Operating Partnerships. Future minimum lease payments under these noncancellable operating leases at December 31, 1994 were as follows: $859,000 for 1995, $733,000 for 1996, $620,000 for 1997, $493,000 for 1998, $351,000 for 1999, and $2,381,000 thereafter.\nRent expense for all operating leases was $4,834,000, $4,890,000 and $4,417,000 for 1994, 1993 and 1992, respectively.\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n13. RELATED PARTY TRANSACTIONS\nThe Partnership and the Operating Partnerships are managed and controlled by the General Partner and the Manager. Under certain partnership agreements and management agreements, the General Partner, the Manager, and certain related parties are entitled to reimbursement of all direct and indirect costs related to the business activities of the Partnership and the Operating Partnerships. These costs, which totaled $52.5 million, $52.7 million and $46.3 million in 1994, 1993 and 1992, respectively, include insurance fees, consulting fees, general and administrative costs, compensation and benefits payable to officers and employees of the General Partner and Manager, tax information and reporting costs, legal and audit fees and an allocable portion of overhead expenses.\nIn 1986, Buckeye's predecessor (then owned by a subsidiary of American Premier) obtained an Administrative Consent Order (\"ACO\") from the New Jersey Department of Environmental Protection and Energy under the New Jersey Environmental Cleanup Responsibility Act of 1983 for all six of its facilities in New Jersey. The ACO required Pipe Line to conduct in a timely manner a sampling plan for environmental contamination at the New Jersey facilities and to implement any required clean-up plan. Sampling continues in an effort to identify areas of contamination at the New Jersey facilities, while clean-up operations have begun at certain of the sites. The obligations of Pipe Line were not assumed by the Partnership and the costs of compliance will be paid by American Premier. Through December 1994, Buckeye's costs of approximately $2,353,000 have been funded by American Premier.\n14. PARTNERS' CAPITAL\nChanges in partners' capital for the years ended December 31, 1992, 1993, and 1994 were as follows:\nThe net income per unit for 1994 was calculated using the weighted average outstanding units of 12,131,640. The net income per unit for 1993 and 1992 was calculated using 12,121,212 outstanding units.\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe Partnership Agreement provides that without prior approval of limited partners of the Partnership holding an aggregate of at least two-thirds of the outstanding LP Units, the Partnership cannot issue more than 4,800,000 additional LP Units, or issue any additional LP Units of a class or series having preferences or other special or senior rights over the LP Units. At December 31, 1994, the Partnership has the ability to issue up to 4,783,940 additional LP Units without prior approval of the Limited Partners of the Partnership.\n15. CASH DISTRIBUTIONS\nThe Mortgage Note Indenture covenants permit cash distributions by Buckeye to the Partnership so long as no default exists under the Mortgage Note Indenture and provided that such distributions do not exceed Net Cash Available to Partners (generally defined to equal net income plus depreciation and amortization less (a) capital expenditures funded from operating cash flows, (b) payments of principal of debt and (c) certain other amounts, all on a cumulative basis since the formation of the Partnership). The maximum amount available for distribution by Buckeye to the Partnership under the formula as of December 31, 1994 amounted to $11.0 million. The Partnership is also entitled to receive cash distributions from Everglades, BTT and Laurel.\nThe Partnership makes quarterly cash distributions to Unitholders of substantially all of its available cash, generally defined as consolidated cash receipts less consolidated cash expenditures and such retentions for working capital, anticipated cash expenditures and contingencies as the General Partner deems appropriate or as are required by the terms of the Mortgage Note Indenture. In 1994, quarterly distributions of $0.70 per GP and LP Unit were paid in February, May, August and November. In 1993 and 1992, quarterly distributions of $0.65 per GP and LP Unit were paid in February, May, August and November. All such distributions were paid on the then outstanding GP and LP Units. Cash distributions aggregated $33,968,000 in 1994 and $31,515,000 in each of 1993 and 1992.\nOn February 1, 1995, the General Partner announced a quarterly distribution of $0.70 per GP and LP Unit payable on February 28, 1995.\n16. UNIT OPTION AND DISTRIBUTION EQUIVALENT PLAN\nThe Partnership has a Unit Option and Distribution Equivalent Plan (the \"Option Plan\"), which was approved by the Board of Directors of the General Partner on April 25, 1991 and by holders of the LP Units on October 22, 1991. The Option Plan authorizes the granting of options (the \"Options\") to acquire LP Units to selected key employees (the \"Optionees\") of the General Partner or any subsidiary, not to exceed 360,000 LP Units in the aggregate. The price at which each LP Unit may be purchased pursuant to an Option granted under the Option Plan is generally equal to the market value on the date of the grant. Options may be granted with a feature that allows Optionees to apply accrued credit balances (the \"Distribution Equivalents\") as an adjustment to the aggregate purchase price of such Options. The Distribution Equivalents shall be an amount equal to (i) the Partnership's per LP Unit regular quarterly distribution, multiplied by (ii) the number of LP Units subject to such Options that have not vested. Vesting in the Options is determined by the number of anniversaries the Optionee has remained in the employ of the General Partner or a subsidiary following the date of the grant of the Option. Options become vested in varying amounts beginning generally three years after the date of grant and remain exercisable for a period of five years. The aggregate number of Options granted during 1994, 1993 and 1992 were 26,750 units, 23,500 units and 22,250 units, respectively, with a purchase price of $39.438, $32.750 and $27.688, respectively. All such Options\nBUCKEYE PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nwere granted with Distribution Equivalents. During 1994, a total of 16,060 Options were exercised at an exercise price ranging from $18.025 to $29.450 per unit. At December 31, 1994, there were 76,540 Options outstanding and none of the outstanding Options were exercisable.\n17. QUARTERLY FINANCIAL DATA (NOT COVERED BY INDEPENDENT AUDITORS' REPORT)\nSummarized quarterly financial data for 1994 and 1993 are set forth below. Quarterly results were influenced by seasonal factors inherent in the Partnership's business.\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 does not have directors or officers. The directors and officers of the General Partner and the Manager perform all management functions. Directors and officers of the General Partner and the Manager are selected by American Premier.\nDIRECTORS AND EXECUTIVE OFFICERS OF THE GENERAL PARTNER\nSet forth below is certain information concerning the directors and executive officers of the General Partner. All of such persons were elected to their present positions with the General Partner in October 1986, except as noted below.\n- - -------- * Also a director of the Manager.\nThe General Partner has an Audit Committee, which currently consists of three directors: A. Leon Fergenson, William C. Pierce and Robert H. Young. Messrs. Fergenson, Pierce and Young are neither officers nor employees of the General Partner or any of its affiliates.\nThe General Partner also has a Compensation Committee, which currently consists of four directors: Alfred W. Martinelli, Brian F. Billings, Ernest R. Varalli and Robert H. Young. The Compensation Committee is concerned primarily with establishing executive compensation policies for officers of the Manager and administering of the Partnership's Option Plan. See \"Executive Compensation--Compensation Committee Interlocks and Insider Participation in Compensation Decisions.\"\nDIRECTORS AND EXECUTIVE OFFICERS OF THE MANAGER\nSet forth below is certain information concerning the directors and executive officers of the Manager. Messrs. Billings and Martinelli were elected as directors of the Manager in March 1987, and Mr. Varalli was elected as a director of the Manager in July 1987.\n- - -------- * Also Secretary of the General Partner since February 1992.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth the total compensation earned by the Chief Executive Officer of the General Partner and the four most highly compensated executive officers of the General Partner and the Manager for services rendered to the Partnership, the General Partner or the Manager for the fiscal year ended December 31, 1994, as well as the total compensation earned by such individuals for the two previous fiscal years. Alfred W. Martinelli, Chairman of the Board, Chief Executive Officer and Director of the General Partner, did not receive any cash compensation for serving as an officer of the General Partner in 1994, but received fees for serving as a Director of the General Partner. See \"Director Compensation\" below. Executive officers of the Manager, including Messrs. Wilson, Epperly, Muther and Ramsey, are compensated by the Manager and, pursuant to management agreements with each of the Operating Partnerships, such compensation is reimbursed by the Operating Partnerships in accordance with an allocation formula based upon the results of the prior year's operations.\nSUMMARY COMPENSATION TABLE\n- - -------- (1) Represents amounts awarded by the Compensation Committee as cash bonuses earned under the Manager's Annual Incentive Compensation Plan (\"AIC Plan\"). Under the AIC Plan, individual awards are granted to participants based upon satisfaction of such participant's target award opportunities and such awards are paid to participants as soon as practicable after they are granted. (2) Represents options granted under the Partnership's Unit Option and Distribution Equivalent Plan (the \"Option Plan\"). See \"Long Term Compensation--Option Plan\" below. Certain officers of the Manager are also eligible to participate in the American Premier Stock Option Plan (the \"American Premier Option Plan\"). No cost or expense relating to the American Premier Option Plan is borne by the Partnership. No options were awarded in 1992, 1993 or 1994 under the American Premier Option Plan to the Chief Executive Officer of the General Partner or the four most highly compensated executive officers of the General Partner and the Manager. (3) Represents payments received during the applicable year under the Manager's Long-Term Incentive Compensation Plans (the \"LTIC Plans\"). See \"Long-Term Compensation--Long-Term Incentive Plans\" below. (4) Represents consulting fees paid by PCEM and reimbursed by the Partnership prior to the termination of Mr. Martinelli's consulting arrangement in July 1992. (5) Represents lease payments made by the Partnership for an automobile used by Mr. Martinelli. (6) During the year indicated, no perquisites or non-cash compensation exceeded the lesser of $50,000 or an amount equal to 10 percent of such person's salary and bonus.\n(7) Represents director fees which commenced in July 1992. See \"Director Compensation\" below. (8) Represents the amount contributed by the Manager to the Manager's defined contribution retirement plan and the Manager's matching contributions under the Manager's savings plan and, for Messrs. Wilson, Epperly, Muther and Ramsey an additional $18,313, $7,150, $5,000 and $3,000, respectively, under the Manager's Benefit Equalization Plan for 1994. Mr. Wilson and Mr. Epperly received an additional $733 and $379, respectively, in 1993 and Mr. Wilson received an additional $10,748 in 1992 under the Manager's Benefit Equalization Plan. In addition to participation in the Manager's defined contribution plan, Messrs. Wilson, Epperly and Ramsey are guaranteed certain defined benefits upon retirement under the Manager's retirement income guarantee plan. See \"Retirement and Savings Plans\" below.\nLONG-TERM COMPENSATION\nOption Plan\nThe following table sets forth additional information regarding options granted under the Option Plan to the Chief Executive Officer of the General Partner and the four most highly compensated executive officers of the General Partner and Manager during 1994.\nOPTION GRANTS IN LAST FISCAL YEAR\n- - -------- (1) Represents LP Unit options granted under the Option Plan. Options shown in the table were granted with a feature that allows optionees to apply accrued credit balances (the \"Distribution Equivalents\") as a reduction to the aggregate purchase price of such options. The Distribution Equivalents are equal to (i) the Partnership's per LP Unit regular quarterly distribution as declared from time to time by the Board of Directors of the General Partner, multiplied by (ii) the number of LP Units subject to options that have not vested. Vesting in the options is determined by the number of anniversaries the optionee has remained in the employ of the General Partner or a subsidiary following the date of the grant of the option. Vesting shall be at the rate of 0 percent if the number of anniversaries are less than three, 60 percent if the number of anniversaries are three but less than four, 80 percent if the number of anniversaries are four but less than five and 100 percent if the number of anniversaries are five or more. In addition, the optionee may become fully vested upon death, retirement, disability or a determination by the Board of Directors of the General Partner or the Compensation Committee that acceleration of the vesting in the option would be desirable for the Partnership. Up to 95 percent of the LP Unit purchase price and up to 100 percent of any taxes required to be withheld in connection with the purchase of the LP Units pursuant to such options may be financed through a loan program established by the General Partner.\n(2) The dollar amounts under these columns are the values of options (not including accrual of any Distribution Equivalents) at the 5 percent and 10 percent rates set by the Securities and Exchange Commission and therefore are not intended to forecast possible future appreciation, if any, of the price of LP Units. No alternative formula for a grant date valuation was used, as the General Partner is not aware of any formula which will determine with reasonable accuracy a present value based on future unknown or volatile factors.\nThe following table sets forth information regarding options exercised in 1994 and values of unexercised options as of December 31, 1994 for the Chief Executive Officer of the General Partner and the four most highly compensated executive officers of the General Partner and the Manager.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\n- - -------- (1) The values of the unexercised options do not include any accrual for Distribution Equivalents.\nIn 1994, Mr. Muther exercised options to purchase 546 shares of American Premier with a net value realized of $3,784. In 1993, Messrs. Wilson, Epperly and Muther exercised options to purchase 11,294 shares, 1,636 shares and 1,090 shares of American Premier, respectively, with a net value realized of $63,559, $22,141 and $8,916, respectively. All shares were acquired pursuant to the American Premier Option Plan. No cost or expense relating to the exercise of these options was incurred by the Partnership.\nLong-Term Incentive Plans\nPrior to 1991 when the Option Plan went into effect, the Manager created a LTIC Plan each year which permitted the Board of Directors of the General Partner or the Compensation Committee to grant cash awards to certain employees of the Manager for performance during three-year periods. Although cash award payments continued under these LTIC Plans through 1994, no new LTIC plans were established after 1990. In addition to the LTIC Plans, the Manager created a transition plan which grants to each participant an additional cash award in an amount equal to the difference between the target amount under the 1990-1992 LTIC Plan and the sum of (i) amounts received pursuant to LTIC Plans and (ii) the value of Distribution Equivalents vested under the Option Plan for each year from 1992 through 1995.\nAwards under LTIC Plans were based on achievement of certain long-term financial performance goals for the Partnership and could not exceed 150 percent of the target award opportunity established by the Board of Directors of the General Partner or the Compensation Committee at the beginning of such period (or as soon as practicable thereafter) for such period. A participant's target award opportunity under the LTIC Plans could not exceed 25 percent of such\nparticipant's aggregate base salary earned during the three-year period. If the Partnership met or exceeded the interim financial performance goals under the LTIC Plans, cash payments up to the full amount of the target award were made in the following installments: 10 percent in the second year of the award period, 30 percent in the third year of the award period and 60 percent in the first year following the award period. Any cash award in excess of the target award was paid in the second year following the award period with 10 percent simple interest.\nRETIREMENT AND SAVINGS PLANS\nEffective December 31, 1985, Pipe Line terminated its defined benefit retirement plan (the \"Retirement Plan\") and adopted a new defined contribution plan (the \"New Retirement Program\"). Those employees hired prior to January 1, 1986 are covered by a retirement income guarantee plan (the \"RIGP\"). These plans were assumed by the Manager.\nThe Operating Partnerships reimburse the Manager for cash costs incurred in connection with the New Retirement Program, the RIGP, the Equalization Plan (described below) and the Savings Plan (described below).\nUnder the New Retirement Program, the Manager makes contributions equal to 5 percent of an employee's covered compensation, which includes base salary plus overtime, annual cash bonuses and any periodic salary continuance payments but does not include extraordinary cash bonuses, deferred awards, other forms of deferred compensation, lump-sum severance pay, fees or any other kind of special or extra compensation. Employees may elect to have the Manager's contributions invested in any of five investment funds.\nThe RIGP generally provides for an additional retirement benefit equal to the amount, if any, by which the aggregate of the annuity equivalent of the employee's accrued benefit under the former Retirement Plan at December 31, 1985 plus the annuity equivalent of the vested portion of employer contributions under the New Retirement Program for the account of such employee (plus or minus aggregate investment gains or losses thereon) is less than the retirement benefit that the employee would have received if the former Retirement Plan had continued. The vesting formula for the New Retirement Program and the RIGP provides for 100 percent vesting after 5 years of service. Service under the former Retirement Plan is carried over to the new plans. The minimum retirement benefit guaranteed under the RIGP is based on the highest average compensation during any five consecutive calendar years of employment within the last ten years of employment preceding retirement (\"Highest Average Compensation\"). For purposes of the RIGP, compensation is defined to include the same components as under the New Retirement Program, except that periodic salary continuance payments are not included. The former Retirement Plan benefit, which the RIGP was established to guarantee, provides for a retirement benefit equal to 1.75 percent per year of service (maximum of 60 percent) of the Highest Average Compensation, reduced by 1.46 percent for each year of service (with a maximum offset of 50 percent) of the estimated primary insurance amount that an employee is entitled to receive upon retirement, other termination of employment or, if earlier, attainment of age 65 under the Social Security Act.\nThe Manager also assumed Pipe Line's Benefit Equalization Plan (the \"Equalization Plan\"), which generally makes up the reductions caused by Internal Revenue Code limitations in the annual retirement benefit determined pursuant to the RIGP and in the Manager's contributions on behalf of an employee pursuant to the New Retirement Program and the Savings Plan. Those amounts not payable under the RIGP (or under affiliated company retirement plans and employee transfer policies), the New Retirement Program or the Savings Plan are payable under the Equalization Plan.\nEstimated annual benefits under the RIGP and the Equalization Plan, calculated under the single life annuity option form of pension, payable to participants at the normal retirement age of 65, are illustrated in the following table.\nThe amounts shown in the above table have been reduced by the percentage equal to 1.46 percent for each year of service of the estimated maximum annual benefits payable under the Social Security Act in respect of each category. The amounts shown in the table would be further reduced, as described above, by the accrued benefit under the former Retirement Plan as of December 31, 1985, as well as by the aggregate amount of vested employer contributions under the New Retirement Program (plus or minus aggregate investment gains or losses thereon).\nMessrs. Wilson, Epperly and Ramsey have 20, 29 and 13 full credited years of service with the Manager and its affiliates, respectively, under the New Retirement Program, the RIGP and the Equalization Plan. Each of them is 100 percent vested under such plans. Mr. Muther has four full years of credited service with the Manager. He is not covered under the RIGP and is currently vested under the New Retirement Program.\nOfficers of the Manager are also eligible to participate on a voluntary basis in the Manager's Savings Plan (the \"Savings Plan\"). An employee may elect to contribute to the Savings Plan annually a specified percentage of his pay, subject to certain limitations. The Manager will contribute to the Savings Plan, out of its current or accumulated profits, for the benefit of each participating employee, an amount equal to his contributions up to a maximum of 5 percent of his pay (6 percent of pay if the employee has completed 20 or more years of service). Employees may elect to have the Manager's contributions invested in any of four investment funds. The Manager's contributions vest immediately for the first 2 percent of the employee's pay and at the rate of 20 percent per year of service (excluding the first year of service) for the remainder, with 100 percent vesting upon death, disability, retirement or attainment of age 65. Benefits are payable, at the election of the employee, in a lump-sum cash distribution after termination of employment or as an annuity upon retirement or a combination of the two.\nDIRECTOR COMPENSATION\nThe fee schedule for directors of the General Partner other than Messrs. Martinelli, Hahl and Wilson is as follows: annual fee, $15,000; attendance fee for each Board of Directors meeting, $1,000; and attendance fee for each committee meeting, $750. Directors' fees paid by the General Partner in 1994 to such directors amounted to $118,500.\nMr. Martinelli, Chairman of the Board, Chief Executive Officer and Director of the General Partner is entitled to receive the following fees as Chairman of the Board of Directors: annual fee $20,000; attendance fee for each Board of Directors meeting, $1,500; and attendance fee for each committee meeting, $1,000. Director's fees paid by the General Partner in 1994 to Mr. Martinelli amounted to $24,500.\nMr. Hahl, President and Director of the General Partner, is an employee of American Premier and devotes substantially all of his time to American Premier rather than to the General Partner or the Partnership. Consequently, no compensation or other benefits payable to Mr. Hahl is paid or reimbursed by the Partnership for Mr. Hahl's services as a director of the General Partner.\nMr. Wilson, Chairman of the Board, President and Chief Operating Officer of the Manager and Director of the General Partner, is compensated by the Partnership for his services to the Manager (see \"Summary Compensation Table\") and does not receive any additional compensation or other benefits with respect to his services as a director of the General Partner.\nMembers of the Board of Directors of the Manager were not compensated for their services as directors, and it is not currently anticipated that any such compensation will be paid in the future to directors of the Manager who are full-time employees of the Manager or any of its affiliates.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION DECISIONS\nThe Compensation Committee consists of Messrs. Martinelli, Varalli, Billings and Young. Messrs. Martinelli and Varalli are executive officers of the General Partner and Mr. Billings is a former executive officer of the General Partner. Mr. Martinelli is on the American Premier Compensation Committee. The members of the Board of Directors of the General Partner are chosen by American Premier, as beneficial owner of all outstanding capital stock of the General Partner. See \"Certain Relationships and Related Transactions.\" Mr. Hahl, the President and Director of the General Partner, also serves as Senior Vice President and Director of American Premier, although he does not serve on the Compensation Committee. Mr. Young, who is also a member of the Compensation Committee, is counsel to the law firm of Morgan, Lewis and Bockius, which supplies legal services to the Partnership.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNo person or group is known to be the beneficial owner of more than 5 percent of the LP Units as of February 1, 1995.\nThe following table sets forth certain information, as of February 1, 1995, concerning the beneficial ownership of LP Units by each director of the General Partner, the Chief Executive Officer of the General Partner, the four most highly compensated officers of the General Partner and the Manager and by all directors and executive officers of the General Partner and the Manager as a group. Such information is based on data furnished by the persons named. Based on information furnished to the General Partner by such persons, no director or executive officer of the General Partner or the Manager owned beneficially, as of February 1, 1995, more than 1 percent of any class of equity securities of the Partnership or any of its subsidiaries outstanding at that date.\n- - -------- (1) Unless otherwise indicated, the persons named above have sole voting and investment power over the LP Units reported. (2) The LP Units owned by Messrs. Epperly, Pierce and Ramsey have shared voting and investment power with their respective spouses.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Partnership and the Operating Partnerships are managed and controlled by the General Partner and the Manager, respectively, pursuant to the Amended and Restated Agreement of Limited Partnership of the Partnership (the \"Partnership Agreement\"), the several Amended and Restated Agreements of Limited Partnership of the Operating Partnerships (the \"Operating Partnership Agreements\") and the several Management Agreements between the Manager and the Operating Partnerships (the \"Management Agreements\").\nUnder the Partnership Agreement and the Operating Partnership Agreements, as well as the Management Agreements, the General Partner, the Manager 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 Partnerships. These costs and expenses include insurance fees, consulting fees, general and administrative costs, compensation and benefits payable to officers and other employees of the General Partner and Manager, tax information and reporting costs, legal and audit fees and an allocable portion of overhead expenses. Such reimbursed amounts constitute a substantial portion of the revenues of the General Partner and the Manager. These costs and expenses reimbursed by the Partnership totaled $52.2 million in 1994.\nThe Partnership receives management consulting services from PCEM. The cost of this management consulting service allocated to the Partnership in 1994 totaled $337,600. See \"Executive Compensation--Summary Compensation and Compensation Committee Interlocks and Insider Participation in Compensation Decisions.\"\nThe Partnership and the General Partner have entered into incentive compensation arrangements which provide for incentive compensation payable to the General Partner in the event quarterly or special distributions to Unitholders exceed certain specified targets. In general, subject to certain limitations and adjustments, if a quarterly cash distribution exceeds a target of $0.65 per LP Unit, the Partnership will pay the General Partner, in respect of each outstanding LP Unit, incentive compensation equal to (i) 15 percent of that portion of the distribution per LP Unit which exceeds the target quarterly amount of $0.65 but is not more than $0.75 plus (ii) 25 percent of the amount, if any, by which the quarterly distribution per LP Unit exceeds $0.75. The General Partner is also entitled to incentive compensation, under a comparable formula, in respect of special cash distributions exceeding a target special distribution amount per LP Unit. The target special distribution amount generally means the amount which, together with all amounts distributed per LP Unit prior to the special distribution compounded quarterly at 13 percent per annum, would equal $20.00 (the initial public offering price of the LP Units) compounded quarterly at 13 percent per annum from the date of the closing of the initial public offering. Incentive compensation paid by the Partnership, to the General Partner totaled $360,000 in 1994.\nOn February 1, 1995, the General Partner announced a quarterly distribution of $0.70 per GP and LP Unit payable on February 28, 1995. As such distribution exceeds a target of $0.65 per LP Unit, the Partnership will pay the General Partner incentive compensation aggregating $90,000 as a result of this distribution.\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) and (2) Financial Statements and Financial Statement Schedules--see Index to Financial Statements and Financial Statement Schedules appearing on page 22.\n(3) Exhibits, including those incorporated by reference. The following is a list of exhibits filed as part of this Annual Report on Form 10-K. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated in parentheses.\n- - -------- (1) Previously filed with the Securities and Exchange Commission as the Exhibit to the Buckeye Partners, L.P. Annual Report on Form 10-K for the year 1986.\n(2) Previously filed with the Securities and Exchange Commission as the Exhibit to the Buckeye Partners, L.P. Quarterly Report on Form 10-Q for the quarter ended March 31, 1988.\n(3) Previously filed with the Securities and Exchange Commission as the Exhibit to Buckeye Partners, L.P. Annual Report on Form 10-K for the year 1992.\n(4) The Amended and Restated Agreements of Limited Partnership of the other Operating Partnerships are not filed because they are identical to Exhibit 10.1 except for the identity of the partnership.\n(5) The Management Agreements of the other Operating Partnerships are not filed because they are identical to Exhibit 10.4 except for the identity of the partnership.\n(6) Represents management contract or compensatory plan or arrangement.\n(7) Previously filed with the Securities and Exchange Commission as the Exhibit to the Buckeye Partners, L.P. Quarterly Report on Form 10-Q for the quarter ended September 30, 1991.\n(8) Previously filed with the Securities and Exchange Commission as the Exhibit to the Buckeye Partners, L.P. Annual Report on Form 10-K for the year 1993.\n(9) Previously filed with the Securities and Exchange Commission as the Exhibit to the Buckeye Partners, L.P. Quarterly Report on Form 10-Q for the quarter ended March 31, 1994.\n* Filed herewith\n(b) Reports on Form 8-K filed during the quarter ended December 31, 1994:\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.\nBuckeye Partners, L.P. (Registrant)\nBy: Buckeye Management Company, as General Partner\n\/s\/ Alfred W. Martinelli Dated: March 14, 1995 By: _________________________________ Alfred W. Martinelli 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\/ Brian F. Billings Dated: March 14, 1995 By: _________________________________ Brian F. Billings Director\n\/s\/ A. Leon Fergenson Dated: March 14, 1995 By: _________________________________ A. Leon Fergenson Director\n\/s\/ Neil M. Hahl Dated: March 14, 1995 By: _________________________________ Neil M. Hahl President and Director\n\/s\/ Edward F. Kosnik Dated: March 14, 1995 By: _________________________________ Edward F. Kosnik Director\n\/s\/ Alfred W. Martinelli Dated: March 14, 1995 By: _________________________________ Alfred W. Martinelli Chairman of the Board and Director (Principal Executive Officer)\n\/s\/ William C. Pierce Dated: March 14, 1995 By: _________________________________ William C. Pierce Director\n\/s\/ Ernest R. Varalli Dated: March 14, 1995 By: _________________________________ Ernest R. Varalli Executive Vice President, Chief Financial Officer, Treasurer and Director (Principal Accounting and Financial Officer)\n\/s\/ C. Richard Wilson Dated: March 14, 1995 By: _________________________________ C. Richard Wilson Director\n\/s\/ Robert H. Young Dated: March 14, 1995 By: _________________________________ Robert H. Young Director\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Buckeye Partners, L.P.:\nWe have audited the consolidated financial statements of Buckeye Partners, L.P. 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 27, 1995; such report is included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedules of Buckeye Partners, L.P. and subsidiaries referred to in Item 14. These consolidated financial statement schedules are the responsibility of the Partnership's management. Our responsibility is to express an opinion based on our audits. In our opinion, such 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\nPhiladelphia, Pennsylvania January 27, 1995\nS-1\nSCHEDULE I\nBUCKEYE PARTNERS, L.P. REGISTRANT'S CONDENSED FINANCIAL STATEMENTS (IN THOUSANDS)\nBALANCE SHEETS\nSTATEMENTS OF INCOME\nSee footnotes to consolidated financial statements of Buckeye Partners, L.P.\nS-2\nSCHEDULE II\nBUCKEYE PARTNERS, L.P. VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)\n- - -------- (a) Represents disposition of discontinued operations upon sale of net assets of discontinued operations during 1993. (b) Reversal of corporate deferred income taxes.\nS-3\nINDEX TO EXHIBITS","section_15":""}
{"filename":"66960_1994.txt","cik":"66960","year":"1994","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS.\nUtiliCorp United Inc. (the company) is an energy company which consists of electric and natural gas utility operations, gas marketing, exploration and production operations and independent power generation projects. The company was formed in 1985 from Missouri Public Service Company. Today the company operates electric and gas utilities in eight states and one Canadian province. In addition, the company has ownership interests in 16 independent power projects in various locations in the United States and Jamaica. The company has various natural gas, natural gas liquids, gas transmission and gathering operations in Texas and Oklahoma. At December 31, 1994, the company had approximately 1.2 million utility customers and a total of 4,683 employees.\nThe utility operating divisions of UtiliCorp are Missouri Public Service, WestPlains Energy, Peoples Natural Gas, Michigan Gas Utilities, West Virginia Power, Northern Minnesota Utilities and Kansas Public Service. West Kootenay Power operates as a Canadian subsidiary. In addition to these utility operations, the company is active in non-regulated areas that complement the utility business primarily through two subsidiaries, Aquila Energy Corporation (Aquila) and UtilCo Group. The company also markets natural gas in the United Kingdom through several joint ventures and owns a joint venture interest in an electric utility in New Zealand.\nAquila was originally purchased as part of Peoples Natural Gas. It was made a wholly-owned subsidiary of UtiliCorp in 1986 to take advantage of the many marketing and transportation opportunities created by changes in the natural gas industry. See page 5 for further discussion.\nFormed in 1986, UtilCo Group held ownership interests in 16 independent power projects in six states and Jamaica at December 31, 1994. These projects have an aggregate capacity of 792 MW. UtilCo Group's ownership interests range from 21% to 50%, and its share of project assets at the end of 1994 totaled $379.8 million.\nUtiliCorp U.K., Inc., the company's natural gas marketing venture in the United Kingdom (U.K.), markets natural gas in areas of the U.K. The company and six regional electric distribution utilities in the U.K. have entered into joint venture agreements to supply gas to large volume customers in the electric utilities' service areas through facilities owned by British Gas.\nIn July 1993, the company finalized a joint venture arrangement with the Waikato Electricity Authority in New Zealand. Under the arrangement, UtiliCorp N.Z., Inc., a subsidiary of the company, agreed to purchase a 33% interest in Waikato-based WEL Energy Group Ltd. (WEL). UtiliCorp N.Z., Inc. paid $2.7 million at closing and agreed to pay approximately $17 million over time, as needed for specific investments, upon call of the WEL Board of Directors. The $17 million was called in December 1994 and paid in February 1995.\nThe business of the company is seasonal to the extent that weather patterns have an effect on revenues. The electric revenues of the company's Missouri Public Service and WestPlains Energy divisions peak during the summer months while the electric revenues of its West Virginia Power division and the West Kootenay Power subsidiary peak during the winter months. The company's gas and energy related businesses revenues peak during the winter months.\nThe company's strategy is to balance its services by business segment, region, climate, and regulatory jurisdiction. In pursuit of these goals, the company actively seeks expansion opportunities in both the regulated and non- regulated segments of the industry.\nIn December 1994, the company announced that it was realigning its operations to take advantage of changes in the company's business environment. To respond to these changes, the company is realigning its present structure into four business groups: Energy Delivery will distribute energy to electric and gas utility customers; Power Services will generate electric power and maintain related transmission facilities; Energy Resources will market natural gas and electric power and operate Aquila's other businesses; and Marketing Services will manage large account sales, new product development and marketing services under the EnergyOne(SM) brand.\nIn connection with the operational realignment, the company is currently in the process of reviewing its key customer and administrative work practices. As part of this realignment, it is anticipated that certain functions will be centralized that may result in employee relocations, facility consolidations and other related changes. Management expects long-term cost savings to result from this realignment. Realignment costs incurred in the year ended December 31, 1994 were not significant.\nAdditional information related to key events in 1994 can be found under \"Key Events of 1994\" on page 19 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\nSegment information for the three years ended December 31, 1994 appears in Note 12 on page 47 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nNARRATIVE DESCRIPTION OF BUSINESS.\nELECTRIC OPERATIONS\nThrough three of its divisions, Missouri Public Service (\"MPS\"), WestPlains Energy (\"WPE\") and West Virginia Power (\"WVP\"), and one subsidiary, West Kootenay Power, Ltd. (\"WKP\"), the company serves approximately 426,414 electric customers in four states and British Columbia.\nOver each of the last three years, the largest customer class has been residential sales which have accounted for approximately 35%, 36% and 35% of megawatt-hour (\"MWH\") sales during 1994, 1993 and 1992, respectively, and 44%, 43% and 42% of total electric revenues during the same period. A summary of the company's electric revenues, MWH sales, and customers, by class is set forth under \"Electric Operations\" on page 20 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nThe electric segment has generated an average of 61% of its energy requirements over the past three years while purchasing the remainder through firm contracts and spot market purchases. The following table shows the overall fuel and purchased power mix for the past three years:\nA divisional summary of generation capability, firm purchased power contracts and cost of energy is set forth in Exhibit 99(a) to this Annual Report on Form 10-K and is incorporated by reference herein.\nIn late 1992 and early 1993, the company renegotiated its major coal supply and rail contracts, all at favorable prices. These contracts supply a substantial portion of the company's coal requirements. The company also purchases coal in the spot market when market conditions dictate.\nA summary of the electric operations is set forth on pages 20 and 21 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nCOMPETITION\nSee page 21 of the company's Annual Report to Shareholders incorporated by reference herein for a discussion regarding competition.\nGAS OPERATIONS\nThe company serves approximately 779,630 customers in eight states through its Peoples Natural Gas (\"PNG\"), Michigan Gas Utilities (\"MGU\"), Northern Minnesota Utilities (\"NMU\"), Kansas Public Service (\"KPS\"), WVP and MPS divisions.\nResidential sales have accounted for approximately 58%, 55% and 54% of gas revenues during 1994, 1993 and 1992, respectively, and approximately 55%, 51% and 50% of thousand cubic feet (\"MCF\") tariff gas volumes sold during 1994, 1993 and 1992, respectively. Gas volumes delivered for third parties have averaged approximately 48% of total MCF deliveries over the past three years due primarily to the deregulation within the natural gas industry. A summary of the company's gas revenues, MCF sales and customers, by class, for the past three years is set forth under \"Gas Operations\" on page 22 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nIn 1994, the company's gas divisions purchased approximately 43% of their gas supply requirements through spot market purchases. A divisional summary of information on contract and spot market purchases and gas costs is set forth in Exhibit 99(b) to this Annual Report on Form 10-K, and is incorporated by reference herein.\nRECENT ACQUISITIONS\nOn February 1, 1993, the company purchased the Nebraska gas distribution system of NorAm Energy Corp. (formerly Arkla, Inc.) for approximately $106 million, including $21 million in working capital. The Nebraska System serves about 124,000 gas customers.\nOn September 30, 1994, the company purchased the Kansas gas distribution system and selected pipeline properties from NorAm Energy Corp. for approximately $23.0 million. The Kansas system serves approximately 22,000 customers.\nOn January 5, 1995, the company purchased a Missouri intrastate natural gas pipeline system from Edisto Resources Corporation. The $75 million purchase price includes the gas distribution system at Fort Leonard Wood, Missouri and a pipeline that crosses the Mississippi river north of St. Louis.\nA summary of the gas operations is set forth on pages 22 and 23 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nCOMPETITION\nThe company's gas divisions are subject to competition in the industrial sector from fuel oil, propane, coal and waste wood. The company has been able to maintain its customer base through flexible tariff rates, attractive storage pricing and transportation services. The company believes it can continue to retain industrial customers through such mechanisms in the future.\nResidential customer competition comes primarily from electric utility incentives and low-cost financing offers. The company has been able to maintain its customer base through similar programs of its own.\nENERGY RELATED BUSINESSES\nAquila formed three business units in 1989 to focus on various segments of its operations: Aquila Energy Marketing Corporation, Aquila Energy Resources Corporation and Aquila Gas Pipeline Corporation (formerly Aquila Gas Systems Corporation). In October 1993, Aquila Gas Pipeline Corporation (AGP) sold, in an initial public offering, 5.4 million shares of common stock, representing about 18% of the outstanding stock of AGP.\nAquila Energy Marketing Corporation (AEM) has a marketing, supply and transportation network consisting of relationships with more than 1,000 gas producers and 500 local distribution companies and end-users throughout the United States, Mexico and Canada. Through more than 350 transportation agreements, it has over 17,500 gas receiving and delivery points available on a network of 33 pipelines.\nAquila Energy Resources Corporation (AER) acquires proven gas and oil reserves and operates onshore and offshore production facilities. Supplementary information on gas and oil-producing activities appears in Note 13 on pages 48 and 49 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nAGP owns and operates a 2,700-mile intrastate gas transmission and gathering network and four processing plants that extract and sell natural gas liquids and markets natural gas.\nAER's net gas and oil production, average gross sales price per MCF of gas and per barrel of oil, and average production costs of gas and oil stated on an MCF equivalent basis are reflected below:\nAEM has entered into numerous long-term gas supply contracts at fixed prices. At December 31, 1994, AEM had minimum fixed price sales obligations of 20.7, 15.2, 15.2, 15.2 and 15.2 BCF for deliveries in the year 1995 to 1999, respectively, at prices that range from $1.60 to $3.50 per MCF.\nIn 1993, Aquila implemented a new business strategy and recorded a $69.8 million charge against income ($45 million after tax) for disposal of selected gas sales contracts, impairment of certain offshore assets, and other restructuring costs. See Note 2 on page 38 in the Annual Report to Shareholders for more information. In 1992, the company and Aquila filed a lawsuit against two former officers of AER, as well as the wife of one of them, seeking to recover actual and punitive damages for improper payments related to the acquisition of gas and oil reserves. See page 13 for more information.\nCOMPETITION\nAquila has many competitors in the markets it serves, including other marketing companies, gas pipelines, distribution companies, major oil and gas companies and alternative fuels. Aquila's ability to compete successfully and grow in this environment is contingent upon performance, price and the stability of the gas markets.\nThe competition Aquila encounters in acquiring assets typically comes from pipeline and production companies. The primary focus of all groups is to find strategically located reserves to support their individual markets.\nREGULATION\nThe following table summarizes the regulatory jurisdictions under which each of the Company's regulated businesses operates.\nDivision Jurisdiction -------- ------------ Kansas Public Service Kansas Corporation Commission Michigan Gas Utilities Michigan Public Service Commission Missouri Public Service Public Service Commission of the State of Missouri Federal Energy Regulatory Commission Northern Minnesota Utilities Minnesota Public Utilities Commission Peoples Natural Gas Minnesota Public Utilities Commission Iowa State Utilities Board Kansas Corporation Commission Public Utilities Commission of the State of Colorado West Kootenay Power, Ltd. British Columbia Utilities Commission West Virginia Power Public Service Commission of West Virginia WestPlains Energy Kansas Corporation Commission Public Utilities Commission of the State of Colorado Federal Energy Regulatory Commission\nThere is no state regulatory body in Nebraska which has jurisdiction over utility operations. However, in Nebraska, municipalities which are served by PNG regulate rates and services therein.\nAGP's pipeline volumes and rates are regulated by the Texas Railroad Commission.\nENVIRONMENTAL\nThe company is regulated by certain local, state and federal agencies in the United States and by provincial and federal agencies in Canada. The company is subject to various environmental regulations including air quality standards and emission limitations, clean water criteria pertaining to certain facilities and the handling and disposal of hazardous substances. Compliance with existing regulations, and those which may be promulgated in the future, can result in considerable capital expenditures and operation and maintenance expense. A further discussion of environmental matters is set forth in Note 10 under \"Environmental\" on page 45 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nExecutive Officers of the Company ---------------------------------\nRichard C. Green, Jr. Chairman of the Board of Directors, President and Chief Executive Officer. Age 40. Chairman of the Board of Directors since February 1989 and President and Chief Executive Officer since May 1985.\nJohn R. Baker Vice Chairman of the Board of Directors. Age 68. Present position three years. Prior position was Senior Vice President, Corporate Development for six years.\nRobert K. Green Managing Executive Vice President. Age 33. Present position since May 1993. Previously Executive Vice President for four months. Prior executive positions at the company's Missouri Public Service division, beginning in 1988, included two years as President.\nJoseph J. Colosimo Managing Senior Vice President. Age 44. Present position since May 1993. Previously Vice President, Human Resources since 1991. Prior positions include Corporate Director, Human Resources & Ethics, Loral Aerospace, 1990 - 1991; Director, Personnel & Organization, Ford Aerospace, 1988 - 1990.\nRobert L. Howell Managing Senior Vice President. Age 54. Present position since May 1993. Previously Vice President, Corporate Development since 1988.\nAlbert J. Budney, Jr. Managing Vice President, Power Services. Age 47. Present position since September, 1994. Previously President, Missouri Public Service, 1993-94. Prior to being employed by the company, Mr. Budney was Vice President, Stone & Webster Engineering Corporation, 1991-92, Vice President, Stone & Webster Management Consultants, 1990-91. General Manager, Strategic Planning, Budgeting and Financial Analysis, Public Service Electric and Gas Company 1988-90.\nB. C. Burgess Managing Vice President, Marketing Services. Age 49. Present position since September, 1994. Mr. Burgess was employed as a Vice President from January, 1994. Prior to being employed by the company, Mr. Burgess was Vice President, Information Services, Bell Atlantic Corporation, 1993 and Vice President, Marketing-Business Services, 1991-1993 and Vice President, Corporate Market Planning, 1990-1991 with Sprint Corporation.\nCharles K. Dempster Managing Vice President, Energy Resources. Age 52. Present position since September, 1994. Also serves as President of Aquila Energy, a position held since January 1993. Prior to being employed by the company, Mr. Dempster was President of Reliance Pipeline Company since 1987.\nJames G. Miller Managing Vice President, Energy Delivery. Age 46. Present position since September, 1994. President, WestPlains Energy, 1991-94. President, Michigan Gas Utilities, 1983-91.\nWilliam D. Bandt Vice President. Age 47. Present position since April, 1994. Prior to being employed by the company, Mr. Bandt was Managing Director, Hale Investments since 1988.\nJames S. Brook Vice President. Age 44. Present position effective November 1993. Prior position was Senior Vice President of the Company's Missouri Public Service division for four years. Mr. Brook also held several positions at West Kootenay Power, including Treasurer and Chief Financial Officer from 1980 - 1982 and Vice President -Finance from 1982 - 1990.\nMichael D. Bruhn Vice President. Age 40. Present position effective February 1994. Prior position was Director - Corporate Development for the Company since 1991. Prior to joining the Company, Mr. Bruhn held the position of Senior Vice President - Corporate Finance at B.C. Christopher Securities Co. for four years and Vice President - Corporate Finance at George K. Baum & Co. for over three years.\nPhilip A. Daddona Vice President. Age 52. Present position since April, 1994. Prior to being employed by the company, Mr. Daddona was with International Business Machines Corporation as Corporate Director, Information and Telecommunication systems from 1992 to 1993 and General Manager, Headquarters Information and Telecommunications Region from 1988 to 1992.\nJon R. Empson Vice President. Age 50. Present position since 1993. Prior to current position, Mr. Empson was Senior Vice President, Administration for Peoples Natural Gas from 1988.\nSally C. McElwreath Vice President. Age 54. Present position since October, 1994. Prior to being employed by the company, Ms. McElwreath was Vice President, Corporate Communication for Macmillan, Inc. from 1991 to 1993 and was General Manager, Corporate Communications for Official Airline Guides from 1990 to 1991. From 1988 to 1990, Ms. McElwreath owned her own company.\nLeo E. Morton Vice President. Age 49. Present position since February 1994. Prior to being employed by the company, Mr. Morton was Vice President, AT&T Microelectronics from 1988.\nJudith A. Samayoa Vice President. Age 42. Present position since September 1993. Previously Vice President, Accounting since 1987.\nDale J. Wolf Vice President, Treasurer and Corporate Secretary. Age 55. Present position five years. Prior position was Vice President, Finance and Treasurer for four years.\nAll officers are elected annually by the Board of Directors for a term of one year. Robert K. Green is the brother of Richard C. Green, Jr., and Avis G. Tucker, Director, is the aunt of Richard C. Green, Jr. and Robert K. Green.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe company owns, through its divisions and Canadian subsidiary, electric production, transmission and distribution systems and gas transmission and distribution systems throughout its service territory. The company owns, through Aquila, proven natural gas and oil reserves and gas gathering, processing and pipeline systems.\nSubstantially all of MGU's utility plant is mortgaged under terms pursuant to an Indenture of Mortgage and Deed of Trust dated July 1, 1951, as supplemented (the \"MGU Indenture\"). Substantially all of the Company's WKP subsidiary's utility plant is mortgaged under terms pursuant to a separate indenture.\nUTILITY FACILITIES\nThe company's electric production facilities, as of December 31, 1994, are as follows:\nAt December 31, 1994, the company owned substations aggregating 9,393,434 KVA, 5,346 miles of transmission line ranging from 34,500 volt to 345,000 volt, 16,138 miles of overhead distribution line and 2,396 miles of underground distribution line.\nAt December 31, 1994, the company's gas operations had 2,951 miles of gas gathering and transmission pipelines and 19,963 miles of distribution mains and services located throughout its divisional service territories.\nAQUILA ENERGY CORPORATION PROPERTIES\nSupplementary information on gas and oil producing activities of Aquila and non-regulated operations of a utility division is set forth under \"Reserve Quantity Information (Unaudited)\" on pages 48 and 49 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nThe number of productive gas and oil wells in which Aquila has an interest at December 31, 1994 is reflected below:\nThe following table sets forth the gross and net, developed and undeveloped acreage in which Aquila has an interest as of December 31, 1994:\nAquila drilled 20 gross (8.1 net) exploratory wells during 1994 of which 17 gross (7.1 net) went dry. It drilled 1 gross (.3 net) well in 1993 and no wells in 1992. The number of development wells completed and wells acquired during 1994, 1993 and 1992 follows:\nAt December 31, 1994, Aquila had 13 gross (4.2 net) wells in the process of being drilled. The company abandoned 7 gross and 7 net wells in 1994.\nAGP has 10 natural gas pipeline systems having an aggregate length of approximately 2,718 miles and 67 compressor stations having approximately 84,259 horsepower. These pipelines do not form an interconnected system. Set forth below is information with respect to AGP's pipeline systems as of December 31, 1994:\nAGP owns and operates four natural gas processing and treating plants with aggregate gas throughput capacity of 373,000 MCF. Set forth below is information with respect to AGP's processing plants as of December 31, 1994.\nThe availability of natural gas reserves to AGP depends on their development in the area served by its pipelines and on AGP's ability to purchase gas currently sold to or transported through other pipelines. The development of additional gas reserves will be affected by many factors including the prices of natural gas and crude oil, exploration and development costs and the presence of natural gas reserves in the areas served by AGP's systems.\nAdditional information regarding Aquila's property and other non-regulated property is set forth in Note 4 on page 39 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nOTHER PROPERTIES\nInformation regarding the company's UtilCo Group subsidiary's generating projects is set forth in Exhibit 99(c) to this Annual Report on Form 10-K and incorporated by reference herein.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn June 17, 1992, a class action suit was filed in the United States District Court for the Western District of Missouri by a stockholder against the Company and certain unnamed employees of the Company and\/or its subsidiary, Aquila Energy Corporation. Plaintiff subsequently dismissed its claims against all defendants except the Company. The case caption is WILLIAM ALPERN VS. UTILICORP UNITED INC.. In this case, plaintiff alleges that the Company violated various securities laws, including Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 of the Securities and Exchange Commission, both by making misrepresentations and omitting to state material facts in connection with public disclosures. Plaintiff also alleges a claim under Section 11 of the Securities Act of 1933, as amended. Among other relief, plaintiff seeks unspecified compensatory damages. The District Court has dismissed the case by granting summary judgment to UtiliCorp. The plaintiffs have asked the District Court to reconsider that decision and they have appealed that decision to the United States Court of Appeals for the Eighth Circuit.\nThe lawsuit UTILICORP ET AL. V. STEGALL ET AL, which has previously been reported on in the company's Forms 10-Q for the quarters ended March 31, 1994, and June 30, 1994, has now been resolved just prior to its scheduled trial setting of October 24, 1994. In August and September, the plaintiffs, UtiliCorp and Aquila Energy Resources Corporation, reached settlements with several minor defendants. On October 6, the plaintiffs concluded a settlement with one of the major defendants which provides for payment of $4,310,000 to plaintiffs. On October 18, the Court granted plaintiffs summary judgment on the remaining defendants, in which all counterclaims and third-party claims of defendants are to be dismissed and agreed upon judgments are to be entered for plaintiffs against these defendants. The company believes that, due to the financial condition of these defendants, any substantial recovery upon these judgments is remote.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo such matters were submitted 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, Pacific and Toronto stock exchanges under the symbol UCU. At December 31, 1994, the company had 37,255 common shareholders of record. Information relating to market prices of Common Stock and cash dividends on Common Stock is set forth in Note 14 on page 50 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nCash dividends on the Common Stock of the company and its predecessor have been paid each year since 1939.\nCash dividends on and acquisition of the company's capital stock are restricted by provisions of the MGU Indenture and by the Preference Stock provisions of the Certificate of Incorporation. Under the most restrictive of these provisions, contained in the MGU Indenture, the company may not declare or pay any dividend (other than a dividend payable in shares of its capital stock), whether in cash, stock or otherwise, or make any other distribution, on or with respect to any class of its capital stock, or purchase or otherwise acquire any shares of, any class of its capital stock if, after giving effect thereto, the sum of (i) the aggregate amount of all dividends declared and all other distributions made (other than dividends declared or distributions made in shares of its capital stock) on shares of its capital stock, of any class, subsequent to December 31, 1984, plus (ii) the excess, if any, of the amount applied to or set apart for the purchase or other acquisition of any shares of its capital stock, of any class, subsequent to December 31, 1984, over such amounts as shall have been received by the company as the net cash proceeds of sales of shares of its capital stock, of any class, subsequent to December 31, 1984, would exceed the sum of the net income of the company since January 1, 1985, plus $50 million. In addition, the company may not declare such dividends unless it maintains a tangible net worth of at least $250 million and the aggregate principal amount of its outstanding indebtedness does not exceed 70% of its capitalization. None of the company's retained earnings was restricted as to payment of cash dividends on its capital stock as of December 31, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation regarding the five-year selected financial data is set forth on pages 52 and 53 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein. Information regarding the restructuring charge and gain on sale of subsidiary stock can be found in Note 2 on page 38 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein. Information concerning utility and energy related acquisitions and non-regulated property and investments appears in Note 3 and Note 4, respectively, on pages 38 and 39 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein. Information related to the company's capitalization is set forth under \"Consolidated Statement of Capitalization\" on page 34 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\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 can be found under \"Operations and Finance\" on pages 19 through 30 of the company's 1994 Annual Report to Shareholders. Such information is incorporated by reference herein.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements, together with the report thereon of Arthur Andersen LLP dated January 31, 1995, are set forth on pages 32 through 51 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\nNone\nPART III\nITEMS 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY, EXECUTIVE COMPENSATION, SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding these items appears in the company's definitive proxy statement for its annual meeting of shareholders to be held May 3, 1995 and is hereby incorporated by reference in this Annual Report on Form 10-K, pursuant to General Instruction G(3) of Form 10-K. For information with respect to the executive officers of the company, see \"Executive Officers of the Company\" following Item 1 in Part I.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K\nPage(s) -------\n(a) The following documents are filed as part of this report: (1) Financial Statements: Consolidated Statements of Income for the three years ended December 31, 1994....................... *32 Consolidated Balance Sheets at December 31, 1994, 1993, and 1992...................................... *33 Consolidated Statements of Capitalization at December 31, 1994, 1993, and 1992......................... *34 Consolidated Statements of Common Share- holders' Equity for the three years ended December 31, 1994......................................... *34 Consolidated Statements of Cash Flows for the three years ended December 31, 1994............... *35 Notes to Consolidated Financial Statements................. *36-50 Report of Arthur Andersen LLP.............................. *51\n*Incorporated by reference from the indicated pages of the 1994 Annual Report to Shareholders.\n(2) Financial Statement Schedule:\nReport of Independent Accountant on Financial Statement Schedule 17\nII Valuation and Qualifying Accounts for the years 1994, 1993 and 1992 18\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(3) List of Exhibits: Incorporated herein by reference to the Index to Exhibits.\nThe following exhibits relate to a management contract or compensatory plan or arrangement:\n10(a)(2) UtiliCorp United Inc. Deferred Income Plan. 10(a)(3) UtiliCorp United Inc. 1986 Stock Incentive Plan. 10(a)(4) UtiliCorp United Inc. Annual and Long-Term Incentive Plan. 10(a)(5) UtiliCorp United Inc. 1990 Non-Employee Director Stock Plan. 10(a)(6) Supplemental Executive Retirement Agreement dated October 13, 1988, between the company and Dale J. Wolf. 10(a)(7) Severance Compensation Agreement dated as of May 3, 1989, between the company and each Executive of the Company. 10(a)(8) Executive Severance Payment Agreement. 10(a)(9) Temporary Contract Employee Agreement. 10(a)(10) Split Dollar Agreement. 10(a)(11) Supplemental Retirement Agreement.\n(b) Reports on Form 8-K.\nNone\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements for 1994, 1993 and 1992 described on page 51 of UtiliCorp United Inc.'s Annual Report to the Board of Directors and Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 31, 1995. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The Financial Statements Schedule listed in Item 14(a)2 is presented for the purposes of complying with the Securities and Exchange Commission's rules and is not part 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\nKansas City, Missouri January 31, 1995\nCONSENT OF INDEPENDENT ACCOUNTANTS\nAs Independent Public Accountants we hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Form S-3 (No. 33-16990, No. 33-47289, and No. 33-39466) and on Form S-8 (No. 33-45525, No. 33-50260, No. 33-45074 and No. 33-52094) of UtiliCorp United Inc. of our report dated January 31, 1995 appearing on page 51 of the 1994 Annual Report to the Board of Directors and 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. It should be noted that we have not audited any financial statements of UtiliCorp United Inc. subsequent to December 31, 1994 or performed any audit procedures subsequent to the date of our report.\nARTHUR ANDERSEN LLP\nKansas City, Missouri March 14, 1995\nUTILICORP UNITED INC.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994 (In millions)\nIndex to Exhibits -----------------\n*3(a)(1) Certificate of Incorporation of the Company. (Exhibit 3(a)(1) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*3(a)(2) Certificate of Amendment to Certificate of Incorporation of the Company. (Exhibit 4(a)(1) to Registration Statement No. 33-16990 filed September 3, 1987.)\n*3(a)(3) Certificate of Designation of the Preference Stock (Cumulative), $2.05 Series. (Exhibit 3(a)(4) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*3(a)(4) By-laws of the Company as amended. (Exhibit 3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993.)\n*4(a)(1) Certificate of Incorporation of the Company. (Exhibit 4(a)(1) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*4(a)(2) Certificate of Amendment to Certificate of Incorporation of the Company. (Exhibit 4(a)(1) to Registration Statement No. 33-16990 filed September 3, 1987.)\n*4(a)(3) Certificate of Designation of the Preference Stock (Cumulative), $2.05 Series. (Exhibit 4(a)(4) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*4(a)(4) By-laws of the Company as amended. (Exhibit 3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993.)\n*4(b)(1) Indenture, dated as of November 1, 1990, between the Company and The First National Bank of Chicago, Trustee. (Exhibit 4(a) to the Company's Current Report on Form 8-K, dated November 30, 1990.)\n*4(b)(2) First Supplemental Indenture, dated as of November 27, 1990. (Exhibit 4(b) to the Company's Current Report on Form 8-K, dated November 30, 1990.)\n*4(b)(3) Second Supplemental Indenture, dated as of November 15, 1991. (Exhibit 4(a) to UtiliCorp United Inc.'s Current Report on Form 8-K dated December 19, 1991.)\n*4(b)(4) Third Supplemental Indenture, dated as of January 15, 1992. (Exhibit 4(c)(4) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*4(b)(5) Fourth Supplemental Indenture, dated as of February 24, 1993. (Exhibit 4(c)(5) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.)\n*4(b)(6) Fifth Supplemental Indenture, dated as of April 1, 1993. (Exhibit 4(c)(6) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.)\n*4(b)(7) Sixth Supplemental Indenture, dated as of November 1, 1994. (Exhibit 4(d)(7) to the Company's Registration Statement on Form S-3 No. 33-57167, filed January 4, 1995.)\n*4(c) Twentieth Supplemental Indenture, dated as of May 26, 1989, Supplement to Indenture of Mortgage and Deed of Trust, dated July 1, 1951. (Exhibit 4(d) to Registration Statement No. 33-45382, filed January 30, 1992.)\nLong-Term debt instruments of the Company in amounts not exceeding 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis will be furnished to the Commission upon request.\n*10(a)(1) Agreement for the Construction and Ownership of Jeffrey Energy Center, dated as of January 13, 1975, among Missouri Public Service Company, The Kansas Power and Light Company, Kansas Gas and Electric Company and Central Telephone & Utilities Corporation. (Exhibit 5(e)(1) to Registration Statement No. 2-54964, filed November 7, 1975.)\n*10(a)(2) UtiliCorp United Inc. Deferred Income Plan. (Exhibit 10(a)(2) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*10(a)(3) UtiliCorp United Inc. 1986 Stock Incentive Plan. (Exhibit 10(a)(3) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n10(a)(4) UtiliCorp United Inc. Annual and Long-Term Incentive Plan.\n*10(a)(5) UtiliCorp United Inc. 1990 Non-Employee Director Stock Plan. (Exhibit 10(a)(5) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*10(a)(6) Supplemental Executive Retirement Agreement dated October 13, 1988, between the Company and Dale J. Wolf. (Exhibit 10(a)(10) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.)\n*10(a)(7) Severance Compensation Agreement dated as of May 3, 1989, between the Company and each Executive of the Company. (Exhibit 10(a)(13) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.)\n*10(a)(8) Executive Severance Payment Agreement (Exhibit 10 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended September 30, 1993.)\n*10(a)(9) Temporary Contract Employee Agreement. (Exhibit 10(a)(10) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(a)(10) Split Dollar Agreement dated as of June 12, 1985, between the Company and James G. Miller.\n10(a)(11) Supplemental Retirement Agreement dated as of January 27, 1983, between the Company and James G. Miller.\n*10(a)(12) Lease Agreement dated as of August 15, 1991, between Wilmington Trust Company, as Lessor, and the Company, as Lessee. (Exhibit 10(a)(13) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*10(a)(13) Credit Agreement dated as of December 13, 1993 among the Company as Borrower, the Banks Named Therein as Banks, and Citibank, N.A., as Agent [Three-Year Facility]. (Exhibit 10(a)(12) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(a)(14) Letter Amendment dated as of December 8, 1994 [Three-year Facility].\n*10(a)(15) Credit Agreement dated as of December 13, 1993 among the Company as Borrower, the Banks Named Therein as Banks, and Citibank, N.A., as Agent [360-Day Facility]. (Exhibit 10(a)(13) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(a)(16) Letter Amendment dated as of December 8, 1994 [360-Day Facility].\n11 Statement regarding Computation of Per Share Earnings.\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.\nUTILICORP UNITED INC.\nBy: \/s\/ Richard C. Green, Jr. ------------------------------ Richard C. Green, Jr. President and Chief Executive Officer\nDate: March 14, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, which include the Principal Executive Officer, the Principal Financial Officer, the Principal Accounting Officer and a majority of the Board of Directors, on behalf of the Company and in the capacities and on the dates indicated.\nMarch 14, 1995 Chairman of the Board of Directors, President and Chief Executive Officer (Principal Executive Officer) \/s\/ Richard C. Green, Jr. ------------------------------ Richard C. Green, Jr.\nMarch 14, 1995 Vice President and Corporate Secretary (Principal Financial Officer) \/s\/ Dale J. Wolf ------------------------------ Dale J. Wolf\nMarch 14, 1995 Vice President (Principal Accounting Officer) \/s\/ James S. Brook ------------------------------ James S. Brook\nMarch 14, 1995 Managing Executive Vice President and Director \/s\/ Robert K. Green ------------------------------ Robert K. Green\nMarch 14, 1995 Vice Chairman of the Board of Directors \/s\/ John R. Baker ------------------------------ John R. Baker\nMarch 14, 1995 Director \/s\/ Avis G. Tucker ------------------------------ Avis G. Tucker\nMarch 14, 1995 Director \/s\/ Robert F. Jackson ------------------------------ Robert F. Jackson\nMarch 14, 1995 Director \/s\/ Don R. Armacost ------------------------------ Don R. Armacost\nMarch 14, 1995 Director \/s\/ L. Patton Kline ------------------------------ L. Patton Kline\nMarch 14, 1995 Director \/s\/ Herman Cain ------------------------------ Herman Cain\nMarch 14, 1995 Director \/s\/ Stanley O. Ikenberry ------------------------------ Stanley O. Ikenberry","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\nPage(s) -------\n(a) The following documents are filed as part of this report: (1) Financial Statements: Consolidated Statements of Income for the three years ended December 31, 1994....................... *32 Consolidated Balance Sheets at December 31, 1994, 1993, and 1992...................................... *33 Consolidated Statements of Capitalization at December 31, 1994, 1993, and 1992......................... *34 Consolidated Statements of Common Share- holders' Equity for the three years ended December 31, 1994......................................... *34 Consolidated Statements of Cash Flows for the three years ended December 31, 1994............... *35 Notes to Consolidated Financial Statements................. *36-50 Report of Arthur Andersen LLP.............................. *51\n*Incorporated by reference from the indicated pages of the 1994 Annual Report to Shareholders.\n(2) Financial Statement Schedule:\nReport of Independent Accountant on Financial Statement Schedule 17\nII Valuation and Qualifying Accounts for the years 1994, 1993 and 1992 18\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(3) List of Exhibits: Incorporated herein by reference to the Index to Exhibits.\nThe following exhibits relate to a management contract or compensatory plan or arrangement:\n10(a)(2) UtiliCorp United Inc. Deferred Income Plan. 10(a)(3) UtiliCorp United Inc. 1986 Stock Incentive Plan. 10(a)(4) UtiliCorp United Inc. Annual and Long-Term Incentive Plan. 10(a)(5) UtiliCorp United Inc. 1990 Non-Employee Director Stock Plan. 10(a)(6) Supplemental Executive Retirement Agreement dated October 13, 1988, between the company and Dale J. Wolf. 10(a)(7) Severance Compensation Agreement dated as of May 3, 1989, between the company and each Executive of the Company. 10(a)(8) Executive Severance Payment Agreement. 10(a)(9) Temporary Contract Employee Agreement. 10(a)(10) Split Dollar Agreement. 10(a)(11) Supplemental Retirement Agreement.\n(b) Reports on Form 8-K.\nNone\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements for 1994, 1993 and 1992 described on page 51 of UtiliCorp United Inc.'s Annual Report to the Board of Directors and Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 31, 1995. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The Financial Statements Schedule listed in Item 14(a)2 is presented for the purposes of complying with the Securities and Exchange Commission's rules and is not part 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\nKansas City, Missouri January 31, 1995\nCONSENT OF INDEPENDENT ACCOUNTANTS\nAs Independent Public Accountants we hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Form S-3 (No. 33-16990, No. 33-47289, and No. 33-39466) and on Form S-8 (No. 33-45525, No. 33-50260, No. 33-45074 and No. 33-52094) of UtiliCorp United Inc. of our report dated January 31, 1995 appearing on page 51 of the 1994 Annual Report to the Board of Directors and 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. It should be noted that we have not audited any financial statements of UtiliCorp United Inc. subsequent to December 31, 1994 or performed any audit procedures subsequent to the date of our report.\nARTHUR ANDERSEN LLP\nKansas City, Missouri March 14, 1995\nUTILICORP UNITED INC.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994 (In millions)\nIndex to Exhibits -----------------\n*3(a)(1) Certificate of Incorporation of the Company. (Exhibit 3(a)(1) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*3(a)(2) Certificate of Amendment to Certificate of Incorporation of the Company. (Exhibit 4(a)(1) to Registration Statement No. 33-16990 filed September 3, 1987.)\n*3(a)(3) Certificate of Designation of the Preference Stock (Cumulative), $2.05 Series. (Exhibit 3(a)(4) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*3(a)(4) By-laws of the Company as amended. (Exhibit 3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993.)\n*4(a)(1) Certificate of Incorporation of the Company. (Exhibit 4(a)(1) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*4(a)(2) Certificate of Amendment to Certificate of Incorporation of the Company. (Exhibit 4(a)(1) to Registration Statement No. 33-16990 filed September 3, 1987.)\n*4(a)(3) Certificate of Designation of the Preference Stock (Cumulative), $2.05 Series. (Exhibit 4(a)(4) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*4(a)(4) By-laws of the Company as amended. (Exhibit 3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993.)\n*4(b)(1) Indenture, dated as of November 1, 1990, between the Company and The First National Bank of Chicago, Trustee. (Exhibit 4(a) to the Company's Current Report on Form 8-K, dated November 30, 1990.)\n*4(b)(2) First Supplemental Indenture, dated as of November 27, 1990. (Exhibit 4(b) to the Company's Current Report on Form 8-K, dated November 30, 1990.)\n*4(b)(3) Second Supplemental Indenture, dated as of November 15, 1991. (Exhibit 4(a) to UtiliCorp United Inc.'s Current Report on Form 8-K dated December 19, 1991.)\n*4(b)(4) Third Supplemental Indenture, dated as of January 15, 1992. (Exhibit 4(c)(4) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*4(b)(5) Fourth Supplemental Indenture, dated as of February 24, 1993. (Exhibit 4(c)(5) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.)\n*4(b)(6) Fifth Supplemental Indenture, dated as of April 1, 1993. (Exhibit 4(c)(6) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.)\n*4(b)(7) Sixth Supplemental Indenture, dated as of November 1, 1994. (Exhibit 4(d)(7) to the Company's Registration Statement on Form S-3 No. 33-57167, filed January 4, 1995.)\n*4(c) Twentieth Supplemental Indenture, dated as of May 26, 1989, Supplement to Indenture of Mortgage and Deed of Trust, dated July 1, 1951. (Exhibit 4(d) to Registration Statement No. 33-45382, filed January 30, 1992.)\nLong-Term debt instruments of the Company in amounts not exceeding 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis will be furnished to the Commission upon request.\n*10(a)(1) Agreement for the Construction and Ownership of Jeffrey Energy Center, dated as of January 13, 1975, among Missouri Public Service Company, The Kansas Power and Light Company, Kansas Gas and Electric Company and Central Telephone & Utilities Corporation. (Exhibit 5(e)(1) to Registration Statement No. 2-54964, filed November 7, 1975.)\n*10(a)(2) UtiliCorp United Inc. Deferred Income Plan. (Exhibit 10(a)(2) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*10(a)(3) UtiliCorp United Inc. 1986 Stock Incentive Plan. (Exhibit 10(a)(3) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n10(a)(4) UtiliCorp United Inc. Annual and Long-Term Incentive Plan.\n*10(a)(5) UtiliCorp United Inc. 1990 Non-Employee Director Stock Plan. (Exhibit 10(a)(5) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*10(a)(6) Supplemental Executive Retirement Agreement dated October 13, 1988, between the Company and Dale J. Wolf. (Exhibit 10(a)(10) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.)\n*10(a)(7) Severance Compensation Agreement dated as of May 3, 1989, between the Company and each Executive of the Company. (Exhibit 10(a)(13) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990.)\n*10(a)(8) Executive Severance Payment Agreement (Exhibit 10 to the Company's Quarterly Report on Form 10-Q filed for the quarter ended September 30, 1993.)\n*10(a)(9) Temporary Contract Employee Agreement. (Exhibit 10(a)(10) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(a)(10) Split Dollar Agreement dated as of June 12, 1985, between the Company and James G. Miller.\n10(a)(11) Supplemental Retirement Agreement dated as of January 27, 1983, between the Company and James G. Miller.\n*10(a)(12) Lease Agreement dated as of August 15, 1991, between Wilmington Trust Company, as Lessor, and the Company, as Lessee. (Exhibit 10(a)(13) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.)\n*10(a)(13) Credit Agreement dated as of December 13, 1993 among the Company as Borrower, the Banks Named Therein as Banks, and Citibank, N.A., as Agent [Three-Year Facility]. (Exhibit 10(a)(12) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(a)(14) Letter Amendment dated as of December 8, 1994 [Three-year Facility].\n*10(a)(15) Credit Agreement dated as of December 13, 1993 among the Company as Borrower, the Banks Named Therein as Banks, and Citibank, N.A., as Agent [360-Day Facility]. (Exhibit 10(a)(13) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.)\n10(a)(16) Letter Amendment dated as of December 8, 1994 [360-Day Facility].\n11 Statement regarding Computation of Per Share Earnings.\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.\nUTILICORP UNITED INC.\nBy: \/s\/ Richard C. Green, Jr. ------------------------------ Richard C. Green, Jr. President and Chief Executive Officer\nDate: March 14, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, which include the Principal Executive Officer, the Principal Financial Officer, the Principal Accounting Officer and a majority of the Board of Directors, on behalf of the Company and in the capacities and on the dates indicated.\nMarch 14, 1995 Chairman of the Board of Directors, President and Chief Executive Officer (Principal Executive Officer) \/s\/ Richard C. Green, Jr. ------------------------------ Richard C. Green, Jr.\nMarch 14, 1995 Vice President and Corporate Secretary (Principal Financial Officer) \/s\/ Dale J. Wolf ------------------------------ Dale J. Wolf\nMarch 14, 1995 Vice President (Principal Accounting Officer) \/s\/ James S. Brook ------------------------------ James S. Brook\nMarch 14, 1995 Managing Executive Vice President and Director \/s\/ Robert K. Green ------------------------------ Robert K. Green\nMarch 14, 1995 Vice Chairman of the Board of Directors \/s\/ John R. Baker ------------------------------ John R. Baker\nMarch 14, 1995 Director \/s\/ Avis G. Tucker ------------------------------ Avis G. Tucker\nMarch 14, 1995 Director \/s\/ Robert F. Jackson ------------------------------ Robert F. Jackson\nMarch 14, 1995 Director \/s\/ Don R. Armacost ------------------------------ Don R. Armacost\nMarch 14, 1995 Director \/s\/ L. Patton Kline ------------------------------ L. Patton Kline\nMarch 14, 1995 Director \/s\/ Herman Cain ------------------------------ Herman Cain\nMarch 14, 1995 Director \/s\/ Stanley O. Ikenberry ------------------------------ Stanley O. Ikenberry","section_15":""}
{"filename":"106413_1994.txt","cik":"106413","year":"1994","section_1":"ITEM 1. BUSINESS.\nGeneral\nWestinghouse Electric Corporation was founded in 1886 and since 1889 has operated under a corporate charter granted by the Commonwealth of Pennsylvania in 1872. Today, Westinghouse is a diversified, global, technology-based corporation operating in the principal business arenas of television and radio broadcasting, advanced electronic systems for the defense industry, environmental services, management services at government-owned facilities, services and fuel for the nuclear energy market, services and equipment for the power generation market, transport temperature control equipment, land development for luxury communities, and office furniture systems.\nFor management reporting purposes, Westinghouse applies a business unit concept to its operating organizations, with each business unit consisting of one or more divisions or subsidiaries that meet certain internal criteria for profit center decentralization.\nIn November 1992, the Corporation announced a plan (the Plan) that included exiting its Financial Services business through the disposition of its asset portfolios and the sales of the Distribution and Control Business Unit (DCBU) and Westinghouse Electric Supply Company (WESCO). The disposition of Financial Services assets involved the sale of real estate and corporate finance portfolios over a three-year period and the liquidation of the leasing portfolio over a longer period in accordance with contractual terms. Financial Services, DCBU and WESCO have been accounted for as discontinued operations in accordance with Accounting Principles Board Opinion No. 30, \"Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions\" (APB 30). See note 2 to the financial statements included in Part II, Item 8 of this report.\nIn 1994, the Corporation's continuing operations were realigned. As a result of the realignment, the former Power Systems segment was replaced by separate segments for Energy Systems and Power Generation and the former Industries segment was replaced by separate segments for Thermo King and Other Businesses. Other Businesses include those non-strategic businesses that have been identified for sale: the Industrial Products and Services businesses, Resource Energy Systems and Controlmatic. Controlmatic, which was sold in May 1994, and Resource Energy Systems, were formerly part of the Government & Environmental Services segment. Westinghouse Communications has been transferred from the former Industries segment to the Broadcasting segment. For financial reporting purposes, the Corporation's Continuing Operations are aligned into the following nine segments: Broadcasting, Electronic Systems, Government & Environmental Services, Thermo King Corporation (Thermo King), Energy Systems, Power Generation, The Knoll Group (Knoll), WCI Communities, Inc. (WCI) and Other Businesses.\nThe financial results of manufacturing and service entities located outside the United States, export sales and foreign licensee income are included in the financial information of the segment that has operating responsibility for such activity. Financial and other information by segment and geographic area is included in note 20 to the financial statements included in Part II, Item 8 of this report.\nFor information about principal acquisitions and divestitures, see notes 2 and 19 to the financial statements included in Part II, Item 8 of this report.\nDuring 1994, the largest single customer of Westinghouse was the United States Government and its agencies, whose purchases accounted for 26% of 1994 consolidated sales of products and services. No material portion of the Corporation's business was seasonal in nature.\nREPORTING SEGMENTS\nBROADCASTING\nWestinghouse Broadcasting Company (Group W) provides a variety of communications services consisting primarily of commercial broadcasting, program production, distribution and telecommunications. It sells advertising time to radio, television and cable advertisers through national and local sales organizations. Westinghouse Broadcasting Company, Inc. and a number of its subsidiaries were merged into the Corporation and, beginning in 1995, Group W is operated primarily as a division of the Corporation.\nGroup W currently owns and operates five network affiliated television broadcasting stations and 16 radio stations. Group W's television stations are located in Baltimore, Boston, Philadelphia, Pittsburgh and San Francisco and their signals reach approximately ten percent of the United States viewing audience. Four of the five Group W television stations are currently rated either first or second in prime time and in news among adult viewers.\nGroup W's radio stations form the largest non-network radio group in the United States. They are located in Boston, Chicago, Detroit, Houston, Los Angeles, New York City, Philadelphia, Pittsburgh and San Francisco, which includes eight of the top ten radio markets in the nation. In addition, WINS, Group W's all-news radio station in New York City, currently has more listeners over the age of 18 than any other radio station in the United States.\nGroup W Satellite Communications provides sports programming and the marketing and advertising sales for two country music entertainment channels. Group W Satellite Communications is also the industry leader in providing technical services to broadcast and cable television networks. Further, the Westinghouse Communications division provides a comprehensive range of telecommunication solutions to business and industry. Its products and services include wide area and local area voice and data communications services.\nThe Broadcasting segment also includes Group W's program production and distribution business, Group W Productions, which supplies television series and special programs through national syndication to broadcast television stations and cable networks throughout the United States.\nIn July 1994, Westinghouse Broadcasting Company and CBS, Inc. (CBS) announced an agreement to enter into a comprehensive strategic alliance that would establish long-term station affiliations between CBS and all of Group W's television stations; form new, jointly-held entities that would acquire additional stations, expand both companies' distribution and programming capabilities nationwide, and merge their advertising sales representation operations. The agreement is subject to the execution of definitive documentation and approval by the Federal Communications Commission.\nGroup W's broadcast stations have many competitors, both large and small, and compete principally on the basis of audience ratings, price and service. Group W's commercial broadcast television business experiences competition from cable television which provides program diversification in addition to improved reception. Broadcast television stations and cable television systems are also in competition in varying degrees with other communications and entertainment media, including movie theaters, videocassette distributors and over-the-air pay television. Due to the rapid pace of technological advancement, broadcast television stations can expect continued strong competition in the future. Still, after years of such intense competition, these broadcast television stations remain, by a wide margin, the premier distributors of news and entertainment programming in their geographic markets.\nELECTRONIC SYSTEMS\nElectronic Systems is a world leader in the research, development, production and support of advanced electronic systems for defense, government, and commercial customers.\nProducts provided to the Department of Defense (DoD) and foreign governments include surveillance and fire control radars, electronic countermeasures equipment, electro-optical systems, missile launching and handling systems, marine propulsion and power generation systems, anti-submarine warfare systems and torpedoes and satellite-based sensors. Products for government and commercial customers include air traffic control systems, satellite communications terminals, mail processing systems, and security and information\nsystems. Sales to the DoD accounted for 64% of 1994 Electronic Systems sales. International sales were 23% of total sales.\nIn general, sales to the DoD, international, and other government customers are made through competitive procurements. Contract awards are based primarily on performance and cost evaluations. Contract types vary from fixed-price on production programs to cost-type on development activities. Changes in budgetary plans, procurement policies, and economic and political conditions strongly influence Electronic Systems business. In general, sales to the United States government and foreign military sales through the United States government, are subject to termination procedures prescribed by statute. This segment encounters significant domestic and foreign competition from large electronic companies, on the basis of technology, price, service, warranty and product performance. On any weapon or avionics system procurement, Electronic Systems might be a prime bidder, competing against or teamed with any one of the major domestic or international aerospace companies. Electronic Systems' competitors in the security and information system markets are fewer in number.\nGOVERNMENT & ENVIRONMENTAL SERVICES\nThe Westinghouse Government & Environmental Services Company includes Environmental Services, the management of certain government-owned facilities and the United States naval nuclear reactors programs.\nEnvironmental Services provides a variety of toxic, hazardous and radioactive waste remediation and treatment services. Through Aptus, Inc., the Corporation offers toxic and hazardous waste incineration, treatment, transportation, storage and analysis services. These services are performed at facilities located in Kansas, Utah and Minnesota. Westinghouse is presently negotiating the sale of Aptus. Westinghouse Remediation Services, Inc. provides comprehensive toxic and hazardous waste remediation services, including mobile, on-site environmental treatment technologies. The Scientific Ecology Group, Inc. offers a broad range of on- and off-site services to manage radioactive materials and mixed wastes, including the only commercially-licensed radioactive waste incinerator and the only recycling facility for radioactive contaminated metals in the United States.\nThrough the Westinghouse Savannah River Company and other subsidiaries and divisions, the Corporation manages four government-owned facilities under contracts with the United States Department of Energy (DOE). The principal mission at these sites is cleanup, waste management and the safe storage and handling of the nation's nuclear materials inventory. These businesses are under contracts with the federal government, which reserves the right to terminate these contracts for convenience.\nThe government-funded U.S. naval nuclear reactors programs consist of the Corporation's nuclear and technical support businesses for the United States Navy. These businesses include the Bettis Atomic Power Laboratory, the Plant Apparatus Division, the Machinery Apparatus Operation and the Machinery Technology Division.\nCompetition for services provided by businesses in the Government & Environmental Services segment is based on price, technology preference, environmental experience, performance reputation and, with respect to certain businesses, availability of permitted treatment or disposal facilities.\nTHERMO KING\nThermo King, a world leader in its primary businesses, manufactures a complete line of transport temperature control equipment, including units for trucks, truck trailers, container ships, buses and railway cars and service parts to support these units. The transport refrigeration units are powered by diesel fuel, gasoline, propane or electricity. Thermo King maintains international manufacturing facilities in Ireland, Brazil, Spain, the Dominican Republic, Puerto Rico, the United Kingdom, the Czech Republic and the People's Republic of China. It has dealerships throughout the world, and its equipment is used in virtually every country.\nThermo King is subject to competition worldwide for all of its products. Its products compete on the basis of service, technology, warranty, product performance, and cost. In addition, Thermo King's customers and\nend users are concerned about environmental issues, especially chlorofluorocarbons, noise pollution and engine emissions. Thermo King designs its products to meet or exceed all current environmental requirements.\nENERGY SYSTEMS\nThe Energy Systems business unit primarily serves the worldwide nuclear energy market. It also designs and develops solar-based energy systems and process control systems for nuclear and fossil-fueled power plants and industrial facilities. About 40% of the world's operating commercial nuclear power plants incorporate Westinghouse technology. The business unit focuses on supplying a wide range of operating plant services, ranging from performance-based maintenance programs to new products and services that enhance plant performance. The business unit also has complete capabilities for supplying customers with nuclear fuel for pressurized water reactors. The annual market for operating plant services and fuel is over $10 billion in the United States and $30 billion globally. The business unit is actively marketing new nuclear power plants and components for new plants to the worldwide market. The business unit is also working with government agencies and industry leaders to revitalize the nuclear energy option, and is developing a simplified nuclear power plant design that incorporates passive safety systems.\nEnergy Systems has a number of domestic and foreign competitors in the electric utility industry where Westinghouse is recognized as a significant supplier. Positive factors with respect to competitive position are technology, service and worldwide presence. Negative factors are an increasing number of foreign and small competitors, particularly in the service area. The principal vehicles of competition are technology, product development and performance, customer service, pricing and financing.\nPOWER GENERATION\nThe Power Generation business unit designs, manufactures and services steam turbine-generators for commercial nuclear and fossil-fueled power plants, as well as combustion turbine-generators for natural gas and oil-fired power plants. In addition to serving the regulated electric utility industry, the business unit supplies, services and operates power plants for independent power producers and other non-utility customers. Growing demand for electrical energy has contributed to the business unit's growth. In 1994, the business unit was awarded orders for approximately 5,900 megawatts of new power generating capacity. The domestic market for new generating equipment over the next ten years is expected to be nearly 140 gigawatts; the international market is expected to be over six times the size of the domestic market. The Power Generation business unit recently entered into a joint venture with Long Yuan Power Technology Exploitation Corporation (LYPTEC) and is in final contract negotiations with Shanghai Turbine Works for the sale and joint manufacture of steam turbines to meet China's rapidly growing energy needs. With more than 2,800 operating units worldwide based on Westinghouse power generation technology, the business unit has a substantial base for its service business. The business unit reentered the renewable energy market through a business alliance. The alliance will develop, manufacture and service power projects based on renewable sources of generation, such as wind turbines, small hydro projects and photovoltaics. The Power Generation business unit is a participant in the development of emerging technologies which could shape the future of power generation.\nPower Generation has a number of domestic and foreign competitors in the electric utility industry where Westinghouse is recognized as a significant supplier. Positive factors with respect to competitive position are technology, service and worldwide presence. Negative factors are an increasing number of foreign and regional competitors, particularly in the service area. The principal vehicles of competition are technology, product performance, customer service, pricing and financing.\nKNOLL\nKnoll consists of the Corporation's office furniture business. Knoll provides a wide range of furniture products ranging from designer-oriented individual pieces to systems designed to improve work environments and contribute to productivity. Products include individually hand-crafted furniture, executive furniture, general office furniture, furniture-grade textiles, office accessories and furniture systems.\nKnoll is subject to a high degree of competition (including price, service, design and product performance) for sales of products to the interior design, construction, industrial and consumer markets from both large and small competitors.\nWCI\nWCI develops land into master-planned luxury communities located primarily in Florida, Arizona and California. Among WCI's major community developments are Coral Springs, Parkland, Bermuda Bay, Pelican Bay, Pelican Marsh, Pelican Landing, Gateway and Bay Colony, all in Florida, Redhawk in Tucson, Arizona and Bighorn in Palm Springs, California.\nWCI is subject to a high degree of competition. Competition is based on reputation, price, quality and service. WCI holds a preeminent position in all of its markets.\nThe Corporation is reviewing alternatives for monetizing WCI.\nOTHER BUSINESSES\nOther Businesses is a diverse group of businesses providing products and services to commercial, industrial, utility, and government customers. These products and services include: watches; operations at waste-to-energy plants; process rectifiers and associated renewal parts; electro-mechanical parts; copper rod and magnet wire, liquid insulation and resins, and flexible insulation; decorative and industrial high-pressure laminates; large industrial motors; and commercial printing.\nOther Businesses competes in local geographic markets based on price, performance reputation, technology preference and experience. These businesses are deemed non-strategic and are expected to be sold.\nDISCONTINUED OPERATIONS\nDiscontinued Operations consists of Financial Services, DCBU and WESCO.\nDuring 1994, the Corporation continued to liquidate Financial Services, resulting in a reduction of assets and debt. Financial Services' remaining portfolio investments consist primarily of the leasing portfolio, the Corporation's investment in LW Real Estate Investments, L.P. (LW) and other assets, mostly real estate properties and investments in partnerships. The leasing portfolio is expected to be liquidated in accordance with contractual terms. A significant portion of LW and all of the other remaining assets are expected to be liquidated by the end of 1995.\nOn January 31, 1994, the Corporation completed the sale of DCBU, excluding its Australian subsidiary, to Eaton Corporation for a purchase price of $1.1 billion and the assumption by the buyer of certain liabilities. The sale of its Australian subsidiary was completed in March 1994.\nOn February 28, 1994, the Corporation completed the sale of WESCO to an affiliate of Clayton, Dubilier & Rice, Inc., a private investment firm, for a purchase price of approximately $340 million. The proceeds consisted of approximately $275 million in cash, approximately $50 million in first mortgage notes, and the remainder in stock and options of the new company.\nRAW MATERIALS\nThe Corporation has experienced no significant difficulty with respect to sources and availability of raw materials essential to the business.\nPATENTS\nWestinghouse owns or is licensed under a large number of patents and patent applications in the United States and other countries that, taken together, are of material importance to its business. Such patent rights are, in the judgment of the Corporation, adequate for the conduct of its business. None of its important products, however, is covered by exclusive controlling patent rights that preclude the manufacture of competitive products by others.\nBACKLOG\nThe backlog of firm orders of the Corporation from Continuing Operations, excluding amounts associated with uranium supply contract settlements, was $10,416 million and $9,925 million at December 31, 1994 and 1993, respectively. Of the 1994 backlog, $6,375 million is expected to be liquidated after 1995. In addition to the reported backlog, the Corporation provides certain non-Westinghouse products primarily for nuclear steam supply systems customers.\nBacklog for the Corporation is as follows:\nElectronic Systems backlog at year-end 1994 and 1993 was $3,897 million and $3,835 million. Backlog of $2,276 million is expected to be liquidated after 1995.\nGovernment & Environmental Services backlog at year-end 1994 and 1993 was $128 million and $87 million. Backlog of $30 million is expected to be liquidated after 1995.\nThermo King backlog at year-end 1994 and 1993 was $280 million and $159 million. Backlog of $11 million is expected to be liquidated after 1995.\nEnergy Systems backlog at year-end 1994 and 1993 was $2,623 million and $2,574 million. Backlog of $1,775 million is expected to be liquidated after 1995.\nPower Generation backlog at year-end 1994 and 1993 was $2,682 million and $2,340 million. Backlog of $1,709 million is expected to be liquidated after 1995.\nKnoll backlog at year-end 1994 and 1993 was $100 million and $108 million. Backlog is expected to be liquidated during 1995.\nOther Businesses backlog at year-end 1994 and 1993 was $655 million and $759 million. Backlog of $564 million is expected to be liquidated after 1995.\nAlso included in backlog at year-end 1994 and 1993 was $51 million and $63 million attributable to Corporate and Other, of which $10 million is expected to be liquidated after 1995.\nENVIRONMENTAL MATTERS\nInformation with respect to Environmental Matters is incorporated herein by reference to Management's Discussion and Analysis -- Environmental Matters included in Part II, Item 7 and in note 16 to the financial statements included in Part II, Item 8 of this report.\nRESEARCH AND DEVELOPMENT\nData with respect to research and development is incorporated herein by reference to note 20 to the financial statements included in Part II, Item 8 of this report.\nEMPLOYEE RELATIONS\nDuring 1994, Westinghouse employed an average of 84,400 people, with approximately 74,800 located in the United States. During the same period, approximately 11,000 domestic employees were represented in collective bargaining by 20 labor organizations. Of these employees, 48% were represented by unions that are affiliated with, and\/or bargain in conjunction with, one of three national unions, namely, the International Brotherhood of Electrical Workers; the International Union of Electronic, Electrical, Salaried, Machine and Furniture Workers; and the Federation of Westinghouse Independent Salaried Unions.\nIn August 1994, the Corporation negotiated four-year agreements with these unions, representing about 5,300 employees. The basic agreements provide wage increases of 2.5% in August 1995 and 1996, and 3% in August 1997. They also provide a one-time salary bonus payment of $1,000 in September 1994 and a $500 bonus in April 1995. In addition, there are seven (7) potential cost-of-living increases.\nFOREIGN AND DOMESTIC OPERATIONS\nData with respect to foreign and domestic operations and export sales is incorporated herein by reference to note 20 to the financial statements included in Part II, Item 8 of this report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nAt December 31, 1994, the Corporation's Continuing Operations owned or leased 902 locations totalling more than 40 million square feet of floor area in the United States and 32 foreign countries. Domestic operations of Continuing Operations comprised approximately 82% of the total space.\nFacilities leased in the United States accounted for approximately 25% of the total space occupied by Continuing Operations and facilities leased in foreign countries accounted for approximately 8% of the total space occupied by Continuing Operations. No individual lease was material.\nA number of manufacturing plants and other facilities formerly used in operations are either vacant, partially utilized, or leased to others. All of these plants are expected to be sold, leased, or otherwise utilized. Except for these facilities, the Corporation's physical properties are adequate and suitable, with an appropriate level of utilization, for the conduct of its business in the future.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\n(a) On December 1, 1988, the Republic of the Philippines (Republic) and National Power Corporation (NPC) filed a lawsuit in the United States District Court (USDC) for the District of New Jersey asserting claims against the Corporation, Westinghouse International Projects Company and Burns and Roe Enterprises, Inc. (Burns and Roe) relating to a contract between NPC and Westinghouse for the construction of a nuclear power plant in the Philippines as well as an earlier consulting contract between NPC and Burns and Roe relating to the same project. The complaint alleges, among other things, bribery and other fraudulent conduct, tortious interference with the fiduciary duty owed by Ferdinand E. Marcos to the Republic and the people of the Philippines, common law fraud, and violations of various New Jersey and federal statutes, including the Federal Racketeer Influenced and Corrupt Organizations Act (RICO) statute. This action seeks recision of the Westinghouse and Burns and Roe contracts and restitution of all money and other property paid to Westinghouse and Burns and Roe or, alternatively, reformation of the NPC-Westinghouse contract. Plaintiffs requested compensatory, punitive and treble damages, costs and expenses of the lawsuit, and such other relief as the USDC deems just and proper.\nAlso on December 1, 1988, Westinghouse filed a request for arbitration with the International Chamber of Commerce Court of Arbitration (ICC) pursuant to the NPC-Westinghouse contract, setting forth certain claims Westinghouse has against NPC and the Republic and asking for arbitration of the anticipated claims of the Republic and NPC related to the Philippines nuclear power plant. The Republic and NPC challenged the jurisdiction of the ICC, arguing that the contract between the parties, including its arbitration provision, was invalid due to alleged bribery in the procurement of the contract. In December 1991, the ICC arbitration panel issued its award finding that the Republic and NPC had failed to carry their burden of proving the alleged bribery by the Corporation. The panel thereby concluded that the arbitration clause and contract were valid and that the panel has jurisdiction over the remaining disputes between NPC and the Corporation. In January 1992, NPC filed an action for annulment of the award by the ICC arbitration panel in the Swiss Federal Supreme Court. In September 1993, the Swiss Federal Supreme Court issued an order dismissing NPC's annulment action and assessing costs against NPC. Arbitration before the ICC was concluded in October 1994 and the parties await a decision.\nWith respect to the suit filed in the USDC, Westinghouse filed a motion requesting that the action filed there be stayed in its entirety pending arbitration of the Republic's claims. In 1989, the Court granted a motion brought by the Corporation and ordered 14 of the 15 counts in the lawsuit stayed pending arbitration. The Court retained jurisdiction over the remaining count involving an alleged intentional interference with a fiduciary relationship. Trial commenced with respect to this one count in March 1993. In May 1993, a jury verdict was rendered in favor of the Corporation with respect to all claims relating to the alleged intentional\ninterference with a fiduciary relationship. NPC and the Republic have indicated that they intend to appeal this decision.\n(b) In October 1990, Commonwealth Edison Company (Commonwealth Edison) filed a lawsuit against the Corporation and four individual defendants (all employees of the Corporation or a Corporation subsidiary company) in Circuit Court in Cook County, Illinois, for an unspecified amount of damages, including treble and punitive damages, based on the Corporation's supply of nuclear steam supply systems for Commonwealth Edison's Zion, Byron and Braidwood plants. The complaint sets forth counts of common law fraud against the Corporation and the employees, and violation of the Illinois Consumer Fraud and Deceptive Practices Act and violations of the RICO statute against the Corporation. In November 1991 Commonwealth Edison dismissed the individual defendants and the parties are currently engaged in discovery. A trial date is set for the first quarter of 1996.\n(c) In October 1990, Houston Lighting and Power Company (HLP) and its co-owners filed a lawsuit against the Corporation and two individual defendants (one current and one retired employee of the Corporation) in the District Court of Matagorda County, Texas, for an unspecified amount of damages. The claims arise out of the Corporation's supply of nuclear steam supply systems for the South Texas Project. Subsequently, HLP disclosed that it is seeking $780 million for estimated past and future damages. The petition alleges breach of contract warranty, misrepresentation, negligent misrepresentation and violation of the Texas Deceptive Trade Practices Act. In January 1991, the parties reached agreement to dismiss the individual defendants. The parties are continuing discovery, and a trial date is set for the second quarter of 1995.\n(d) In April 1991, Duquesne Light Company (Duquesne) and its co-owners filed a lawsuit against the Corporation in the USDC for the Western District of Pennsylvania for an undetermined amount of damages, including treble and punitive damages. Subsequently Duquesne disclosed that it was seeking approximately $320 million for damages. The claims arose out of the Corporation's supply of nuclear steam supply systems for the Beaver Valley plants. Duquesne asserted counts for breach of contract, fraud, negligent misrepresentation, and violations of the RICO statute. In July 1994, the judge dismissed the negligent misrepresentation claims and portions of its RICO claims. The case went to trial on September 12, 1994. At the close of the evidence, the judge dismissed all remaining counts except common law fraud. On December 6, 1994, the jury returned a verdict in favor of the Corporation on the remaining count. On January 5, 1995, Duquesne Light filed an appeal.\n(e) In February 1993, Portland General Electric Company (Portland) filed a lawsuit against the Corporation in the USDC for the Western District of Pennsylvania seeking unspecified damages based on claims for breach of contract, negligence, fraud, negligent misrepresentation, and violations of the federal RICO statute and the Oregon RICO statute relating to the Corporation's design, manufacture and installation of steam generators at the Trojan Nuclear Plant, an electric generating facility located in Ranier, Oregon. Also in February 1993, the Eugene Water & Electric Board (the Board), a 30% owner of the Trojan Nuclear Plant, filed a suit containing essentially the same allegations and seeking unspecified damages. A declaratory judgment that the steam generators are defective and the Corporation is liable to plaintiff for expenses, including replacement power, incurred as a result of the alleged defects was also sought in both cases. Although the Board's suit was filed in the USDC for the District of Oregon, its motion to change the venue to the USDC for the Western District of Pennsylvania was granted. In April 1993, on Portland's motion, the Board's case was consolidated with the Portland case. The parties are seeking total damages of approximately $350 million. In June 1993, the court granted the Corporation's motion to dismiss plaintiffs' claims for negligence and negligent misrepresentation. The court also dismissed, in part, the plaintiffs' claims under Section 1962(b) of the federal RICO statute relating to the Trojan project enterprise. The parties continue to engage in discovery. This case could go to trial in 1995.\n(f) In July 1993, Northern States Power Company (NSP) filed a lawsuit against the Corporation in the USDC for the District of Minnesota for an unspecified amount of damages, including treble and punitive damages, based on the Corporation's supply of steam generators at NSP's Prairie Island Nuclear Plant. The complaint sets forth counts for breach of contract, fraud, negligent misrepresentation, violations of the RICO and violations of the Minnesota Prevention of Consumer Fraud Act. Discovery has commenced.\n(g) In August 1988, the Pennsylvania Department of Environmental Resources (DER) filed a complaint against the Corporation alleging violations of the Pennsylvania Clean Streams Law at the Corporation's Gettysburg, Pennsylvania, elevator plant. The DER requested that the Environmental Hearing Board assess a penalty in the amount of $9 million. The Corporation has denied these allegations. The parties completed discovery and a portion of the hearing on the complaint began in 1991. The hearing resumed in 1992 and concluded in February 1993. All post-trial briefs have been filed and the parties await a decision.\n(h) The Corporation has been defending consolidated class and derivative actions and an individual lawsuit brought by shareholders of the Corporation against the Corporation, Westinghouse Financial Services, Inc. (WFSI) and Westinghouse Credit Corporation (WCC), previously subsidiaries of the Corporation, and\/or certain present and former directors and officers of the Corporation, as well as other unrelated parties. Together, these actions allege various federal securities law and common law violations arising out of alleged misstatements or omissions contained in the Corporation's public filings concerning the financial condition of the Corporation, WFSI and WCC in connection with a $975 million charge to earnings announced on February 27, 1991, a public offering of Westinghouse common stock in May 1991, a $1,680 million charge to earnings announced on October 7, 1991, and alleged misrepresentations regarding the adequacy of internal controls at the Corporation, WFSI and WCC. The consolidated class and derivative actions are pending in the USDC for the Western District of Pennsylvania. In July 1993, the court dismissed in its entirety the derivative claim and dismissed most of the class action claims, with leave to replead certain claims in both actions. Both actions were subsequently replead. On September 27, 1994, the court denied plaintiffs' motion for reinstatement of certain of the dismissed class action claims against the Corporation. On January 20, 1995, the court again dismissed the derivative complaint in its entirety with prejudice. On February 8, 1995, certain of the plaintiffs appealed the dismissal of these claims. Also on January 20, 1995, the court dismissed the class action claims, but granted plaintiffs the right to replead certain of the class action claims. Plaintiffs did not replead the claims and on February 28, 1995, the court dismissed the class action claims in their entirety. The plaintiffs have notified the Corporation that they intend to appeal this dismissal. The remaining individual action was dismissed by the USDC for the Southern District of Texas on December 20, 1994. An appeal was dismissed on February 14, 1995.\n(i) In February 1993, the Corporation was sued by 108 former employees who were laid off subsequent to the cancellation by the federal government of all contracts pertaining to the carrier-based A-12 aircraft program. The complaint alleges age discrimination on the part of the Corporation. The suit was filed in the USDC for the District of Maryland. The plaintiffs seek back pay with benefits and reinstatement of jobs or front pay. Also, in April 1993, the Equal Employment Opportunity Commission (EEOC) filed a class-action, age discrimination suit against Westinghouse in the USDC for the District of Maryland on behalf of 388 former Westinghouse employees (which includes the aforementioned 108 employees) who were laid off or involuntarily terminated from employment subsequent to the federal government's cancellation of all contracts pertaining to the carrier-based A-12 aircraft program. The suit alleges age discrimination and discriminatory employment practices. The suit seeks back pay, interest, liquidated damages, reinstatement of jobs, court costs and other appropriate relief. These two cases have been consolidated by the court. The parties are currently involved in the discovery process. The court adopted a case management plan which calls for a series of trials centered on separate Electronic Systems' divisions. The first trial is scheduled for September 5, 1995. Currently, no other trials are scheduled.\n(j) Beginning in early 1990 and continuing into 1994, numerous asbestos lawsuits have been filed against the Corporation and numerous other defendants in the Circuit Court of Jackson County, Mississippi. The plaintiffs allege personal injury, wrongful death and loss of consortium claims arising out of exposure to products containing asbestos that were manufactured, supplied or installed by the defendants. In April 1993, trial commenced in the Circuit Court with respect to the claims of nine plaintiffs against a number of defendants, including the Corporation. In August 1993, a jury awarded a verdict in favor of five of the plaintiffs against the Corporation and certain other defendants and awarded a defense verdict in favor of the Corporation against the four other plaintiffs. The jury found Westinghouse approximately 38% liable on the aggregate damage verdict of some $8.75 million awarded the five plaintiffs, with punitive damages at 10% of compensatory damages. The Corporation is entitled to offsets on these verdicts from settlements previously paid by certain defendants and will also apply its insurance coverage to these verdicts. The judge has\npreviously ruled that the jury's findings on certain questions may apply to approximately 6,400 other cases pending which, however, would still have to be tried on issues of exposure, causation and the amount of compensatory damages, if any. The judge denied the motions of the Corporation and the other defendants who were found liable for a judgment notwithstanding the verdict and a new trial. The Corporation has appealed the verdict.\nThe Corporation was a direct defendant in approximately 550 of 2,100 consolidated claims, as well as a third party defendant in an additional 2,200 claims, alleging personal injury, wrongful death and loss of consortium claims arising from alleged exposure to asbestos-containing products manufactured, supplied or installed by various defendants, including the Corporation. Westinghouse has removed 508 of the direct claims to Federal Court from the Baltimore City Circuit Court where they were originally filed, leaving approximately 50 cases still in the Baltimore City Circuit Court. A common issues trial commenced in June 1994. The trial focused on five exemplary plaintiffs, none of whom had claims against Westinghouse. At issue for Westinghouse, however, were questions of failure to warn and negligence with respect to two of its products.\nIn December 1994, the Baltimore jury returned a verdict, finding the two Westinghouse products defective due to their asbestos content and the Corporation's alleged failure to warn adequately of the health hazards associated with those products. The jury also found that Westinghouse can be held liable for punitive damages in certain cases using a multiplier of two times the compensatory damages. The jury's findings on product defect and punitive damages may be binding in future litigation with the plaintiffs remaining in this consolidation who have claims against Westinghouse. Each of these plaintiffs, however, will be required to prove at trial that they developed an asbestos-related disease, that they were exposed to one of the two Westinghouse products at issue, and that this exposure was a substantial factor in the development of the disease. Any compensatory awards will be divided among other defendants also found liable to the plaintiffs, and will be covered in large part by insurance. The Corporation intends to appeal the common issues judgment.\nIn addition to the Mississippi and Baltimore asbestos lawsuits described herein, the Corporation is a defendant in other asbestos lawsuits which have been brought in various other jurisdictions.\n(k) In August of 1993, the bankruptcy Trustee for the Bonneville Pacific Corporation (Bonneville) sued over 70 defendants, including Westinghouse, in federal district court in Salt Lake City, Utah. The Trustee's claims against the group of defendants, including Westinghouse; Deloitte & Touche; Mayer, Brown & Platt; Piper Jaffray, Inc.; and Kidder Peabody and Company, are numerous, but consist primarily of common law fraud and aiding and abetting in breaches of fiduciary duty on the part of former officers and directors of Bonneville. There are also claims by the Trustee for the tort of conspiracy and civil RICO violations. Westinghouse has filed numerous motions seeking dismissal of the claims and has filed a denial of the allegations. The Corporation's involvement with Bonneville consisted of four sale\/lease back transactions in co-generation projects through its former subsidiary, WCC.\nThe case is now entering the deposition phase. On October 6, 1994, the Trustee filed its preliminary damage calculation which totalled $647 million against a group of defendants, including Westinghouse, on a theory of joint and several liability. The Trustee is also seeking treble damages based upon the Trustee's position that a violation of civil RICO has occurred. Westinghouse continues to reject the validity of the claims and believes that the preliminary damage calculations are without merit. In the course of discovery, Westinghouse will challenge these damage calculations.\n(l) On August 16, 1994, the Official Committee of Unsecured Creditors of Phar-Mor, Inc. filed suit against Westinghouse and others in the United States Bankruptcy Court for the Northern District of Ohio, alleging that an August 1991 tender offer conducted by Phar-Mor, Inc. (Phar-Mor) was a fraudulent conveyance and therefore should be rescinded. Westinghouse participated in the tender offer and received approximately $30 million. The suit also alleges that Westinghouse must repay approximately $20 million it received in the tender offer as proceeds from the tender of stock by the DeBartolo Family Limited Partnership (DeBartolo). Westinghouse received the proceeds from DeBartolo's tender of Phar-Mor stock pursuant to a pre-existing loan to DeBartolo from Westinghouse collateralized by DeBartolo's holdings in Phar-Mor. DeBartolo also has been named as a defendant in this litigation and has separately been sued for the same $20 million.\nCounsel for DeBartolo has filed a motion with the Judicial Panel on Multidistrict Litigation requesting that the fraudulent conveyance action be transferred to the United States District Court (USDC) for the Western District of Pennsylvania for consolidation with approximately 40 other Phar-Mor-related cases currently pending in the USDC. Among these 40 cases is an action filed by Westinghouse in October 1992 in connection with loans to, and equity investments in, Phar-Mor. Westinghouse's suit against Phar-Mor asserts, among other things, federal securities law fraud claims and state law claims for fraud and negligent misrepresentation against various defendants, including principally Phar-Mor's independent accountants (Coopers & Lybrand), its Chief Executive Officer and Treasurer (David S. Shapira), and its controlling shareholder (Giant Eagle, Inc.). Westinghouse has filed a pretrial statement of damages with the Court claiming total damages in excess of $162 million.\nAmong the other Phar-Mor-related cases pending in the USDC are claims by creditors and investors in Phar-Mor against Coopers & Lybrand and\/or David Shapira and Giant Eagle, and an action by Phar-Mor against Coopers & Lybrand. Beginning in December 1993 and thereafter, Coopers & Lybrand, David Shapira and\/or Giant Eagle asserted cross-claims or third-party complaints in numerous of these cases against Westinghouse and others for contribution and indemnification, alleging, that Westinghouse, by virtue of attendance by its representatives at meetings of Phar-Mor's Board of Directors, became a \"de facto\" member of the board of directors and thus should share jointly and severally in the payment of damages. Westinghouse has filed an answer denying the allegations contained in the cross-claims and third-party complaints. Total damage claims being asserted in cross-claims and third-party complaints amount to in excess of $1.5 billion.\nThe parties are currently involved in fact discovery in the litigation currently pending in the USDC. Pre-trial statements have been submitted by the parties. This case could go to trial in the second half of 1995.\n(m) A description of the derivative litigation involving certain of the Corporation's current and past directors is incorporated herein by reference to \"Litigation Involving Derivative Claims Against Directors\" in the Proxy Statement.\n(n) On November 4, 1993, the Wisconsin Department of Natural Resources (DNR) issued a notice of violation to the Corporation alleging that it violated the Wisconsin Hazardous Waste Management Act by failing, with respect to its former Milwaukee repair facility, to notify the Department of the presence of PCBs and for failing to remediate the PCBs at the facility. The matter was referred to the Wisconsin Department of Justice (DOJ). The case has been settled, and Westinghouse paid a $150,000 fine pursuant to the Consent Decree.\nLitigation is inherently uncertain and always difficult to predict. Substantial damages are sought in the foregoing matters and although management believes a significant adverse judgment is unlikely, any such judgment could have a material adverse effect on the Corporation's results of operations for a quarter or a year. However, based on its understanding and evaluation of the relevant facts and circumstances, management believes that the Corporation has meritorius defenses to the litigation described in items (a) through (m) above, and management believes that the litigation should not have a material adverse effect on the financial condition of the Corporation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone during the fourth quarter of 1994\nEXECUTIVE OFFICERS\nThe name, offices, and positions held during the past five years by each of the executive officers of the Corporation as of March 1, 1995 are listed below. Officers are elected annually. There are no family relationships among any of the executive officers of the Corporation.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe principal markets for the Corporation's common stock are identified on page 1 of this report. The remaining information required by this item appears on page 52 of this report and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by this item appears on page 52 of 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.\nThe information required by this item appears on pages 16 through 25 of this 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, together with the report of Price Waterhouse LLP dated January 31, 1995, appears on pages 26 through 51 of 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.\nNone.\nManagement's Discussion and Analysis\nOVERVIEW\nDuring 1994, the Corporation benefitted from the results of management's initiatives to strengthen its financial position and improve its competitiveness. Evidence of the Corporation's progress includes:\n- - Customer orders for 1994 increased 4%. The largest improvement, an increase of 12%, occurred in the fourth quarter, with the Corporation's Power Generation and Electronic Systems businesses each receiving awards totalling approximately $1 billion. Backlog exceeded $10 billion at year-end 1994.\n- - Excluding special charges, operating profit for 1994 was $690 million compared to $701 million in 1993. The 1994 results included a $103 million increase in pension costs.\n- - The Corporation made progress on its restructuring activities. Through December 31, 1994, involuntary employee separations as a result of implementing the 1993 restructuring initiative totalled approximately 3,200 compared to a two-year target of 3,400. Nearly 1,100 other employees left through attrition. New restructuring initiatives identified during 1994 will result in an additional 1,200 employee separations.\n- - The Corporation made additional progress in rebuilding its equity base through the issuance of preferred stock. In addition, net debt was reduced by $1.7 billion.\nThe Corporation reported net income of $77 million, or $.07 per share, for 1994. Net losses in 1993 and 1992 were $326 million and $1,394 million, or $1.07 and $4.11 per share, respectively. See note 14 to the financial statements for a discussion of earnings per share.\nIncluded in 1994 results were pre-tax provisions of $71 million ($51 million after-tax) for additional restructuring activities and $308 million ($195 million after-tax) for the settlement of a portion of the Corporation's pension obligation. Included in 1993 results was a pre-tax provision of $750 million ($493 million after-tax) for restructuring, the disposition of certain non-strategic businesses and certain litigation and environmental contingencies. The 1993 results also included after-tax charges of $95 million for Discontinued Operations and $56 million for the adoption of Statement of Financial Accounting Standards (SFAS) No. 112, \"Employers' Accounting for Postemployment Benefits.\" Included in 1992 results were after-tax charges of $1,413 million to record the estimated loss on disposal of Discontinued Operations and $338 million for the adoption of both SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and SFAS No. 109, \"Accounting for Income Taxes.\" See the notes to the financial statements for further discussion of these matters.\nExcluding the after-tax effect of the special charges described above, income from Continuing Operations was $323 million, or $.71 per share, for 1994 compared to $318 million, or $.76 per share, for 1993 and $357 million, or $.95 per share, for 1992. The higher pension costs in 1994 reduced per share earnings by $.17.\nIn 1995, the Corporation expects to continue implementation of its programs to improve both the operating performance and competitive positions of its core businesses. The focus on customer orientation and international opportunities will continue. Furthermore, the Corporation will persist in its aggressive drive to reduce costs and improve competitiveness. Cost reduction initiatives will be undertaken when the resulting benefits are substantial in relation to the cost of the programs and are realizable in the near term. Net periodic pension costs in 1995 are expected to decline by approximately $25 million from the 1994 level. While subject to many variables, management currently believes that anticipated revenue increases coupled with cost reductions should improve earnings significantly for the full year 1995. However, the Corporation's first quarter 1995 earnings are expected to be approximately flat compared to the prior year period excluding certain 1994 nonrecurring gains.\nDuring 1995, the Corporation also expects to continue the divestitures of non-strategic businesses and apply the proceeds to further reduce debt. Alternative strategies for monetizing WCI Communities, Inc. (WCI) continue to be explored.\nRESULTS OF OPERATIONS--CONTINUING OPERATIONS\nIn 1994, the Corporation expanded the number of reported business segments and realigned certain businesses to reflect more closely the Corporation's core businesses. Segment information for 1993 and 1992 has been restated to reflect these changes.\nThe Corporation's consolidated revenues from sales of products and services were essentially flat in 1994 compared to 1993, totalling approximately $8.8 billion. Operating profit for each of the last three years included special charges primarily related to the Corporation's restructuring activities. All restructuring charges, which totalled $71 million in 1994, $350 million in 1993 and $36 million in 1992, were distributed to the applicable segments. Other special charges included in operating profit in 1993 were $125 million for litigation costs, $60 million for Corporate environmental costs and $20 million for asset writeoffs associated with projects that were discontinued. Other special charges in 1992 also included $35 million related to a workforce reduction at Electronic Systems.\nAlso included in 1994 segment operating profit are increases in pension costs totalling $103 million. The increase is attributable primarily to the effects of changes in actuarial assumptions and reduced levels of anticipated asset earnings. See note 3 to the financial statements.\nBroadcasting\nRevenues for Broadcasting increased 7% to $870 million in 1994 reflecting growth in advertising revenues, particularly in television. The 1994 Olympics and political campaigns contributed to the increased advertising revenues. Group W Satellite Communications (GWSC) also reported higher revenues. Revenues for Broadcasting were flat in 1993 compared to 1992 as a weak west coast television market and lower volume at\nRESULTS OF OPERATIONS--CONTINUING OPERATIONS (in millions)\nGroup W Productions were offset by stronger performance in radio and GWSC. In addition, 1992 benefitted from advertising revenues generated by the 1992 Olympics and political campaigns.\nIncluded in 1993 operating profit was $12 million for restructuring costs, of which $2 million was subsequently not required and adjusted in 1994. Excluding restructuring amounts, operating profit increased 28% to $201 million in 1994 compared to $157 million in 1993 due to the increased advertising revenues and improvements in productivity resulting from cost reduction programs. Excluding restructuring, operating profit decreased 5% in 1993 compared to 1992 due to an unfavorable mix of sales.\nThe strategic alliance between CBS and Westinghouse Broadcasting Company announced in 1994 is expected to increase the number of television stations owned by the parties and expand their distribution and programming capabilities nationwide. See note 19 to the financial statements.\nElectronic Systems\nRevenues for Electronic Systems decreased 5% to $2,467 million in 1994 compared to 1993 and 9% in 1993 compared to 1992. Lower revenues from Department of Defense (DoD) contracts in both years and the 1992 divestitures of the Electrical Systems and Copper Laminates divisions were the primary causes of the decreased revenues.\nOperating profit reflected restructuring charges of $11 million and $137 million in 1994 and 1993, respectively, and a $35 million charge in 1992 for a workforce reduction. Excluding these charges in each of the three years, operating profit decreased 20% to $176 million in 1994, primarily as a result of higher pension costs and lower DoD revenues, which were partially offset by savings from cost reduction programs. Operating profit excluding special charges decreased 15% to $220 million in 1993 from lower DoD revenues.\nElectronic Systems' business is influenced by changes in the budgetary plans and procurement policies of the U.S. government. Reductions in defense spending and program cancellations in recent years have adversely affected operating results. The Corporation intends to maintain a strong focus on DoD opportunities and believes that through continual streamlining of its operations, it is well positioned over the long term to benefit from the demand for advanced electronic systems by the U.S. and foreign governments.\nGovernment & Environmental Services\nRevenues for Government & Environmental Services increased 15% to $389 million in 1994 due to increased volume in hazardous waste remediation services and radioactive waste incineration, increased work scope and fees for the naval nuclear program, and higher award fees at several Department of Energy (DOE) sites operated and managed by the Corporation. Revenues decreased 9% in 1993 compared to 1992 due to lower volume and reduced prices in the hazardous waste remediation and incineration businesses.\nIncluded in 1994 and 1993 operating profits were $4 million and $32 million, respectively, for restructuring activities and other actions. Excluding the charges in both years, operating profit decreased 5% to $62 million in 1994 because price compression in the hazardous waste remediation and incineration markets more than offset the increased award fees in government operations. Operating profit excluding special charges decreased 35% in 1993 compared to 1992 due to the lower volume and price compression in the hazardous waste remediation and incineration markets.\nThe Corporation continues to review its portfolio of environmental businesses to determine how best to focus its efforts. In 1994, the Corporation signed a letter of intent to sell Aptus, its hazardous waste incineration business. See note 19 to the financial statements. The DOE has recently announced its intention to open for bid certain of its operating and maintenance contracts as they expire. The Corporation intends to vigorously pursue the retention of its current contracts and selectively bid on sites not currently managed by the Corporation.\nThermo King\nRevenues for Thermo King increased 22% to $877 million in 1994 due to volume increases in the domestic truck and trailer, service parts, and container product lines as well as in the international truck and trailer product line. Revenues for 1993 compared to 1992 increased only 2% because lower European revenues partially offset strong performance in the domestic truck and trailer and service parts product lines.\nOperating profit increased 19% to $130 million in 1994 compared to 1993 and 6% in 1993 compared to 1992 primarily as a result of the increased volume.\nEnergy Systems\nRevenues for Energy Systems decreased 6% to $1,235 million in 1994 due to reduced licensee income and the favorable 1993 effect of a change in accounting for nuclear fuel revenues. Revenues were flat in 1993 compared to 1992 as the increase from the change in revenue recognition offset the decrease resulting from higher 1992 revenues on large nuclear projects.\nIncluded in 1994 operating profit was $26 million for restructuring activities related to the separation of approximately 400 employees in late 1994. Included in the 1993 operating loss was $170 million for restructuring, litigation and other costs. Excluding special charges in both years, operating profit decreased 70% to $33 million in 1994 compared to 1993 and 4% in 1993 compared to 1992. The decrease in operating profit in 1994 was attributed to lower licensee income, the change in accounting for nuclear fuel revenue in 1993 and increased pension costs. Cost savings from restructuring activities were beginning to materialize in late 1994. The decrease in operating profit from 1992 to 1993 was a result of an unfavorable mix of sales.\nPower Generation\nRevenues for Power Generation decreased 4% to $1,715 million in 1994 due to lower revenues from project purchase-resale items for major projects and steam operating plant service, largely offset by higher combustion turbine and field services sales. Revenues also decreased 4% in 1993 compared to 1992 due to a decrease in purchase-resale items and a depressed power generation field service market.\nIncluded in the 1993 operating loss was $126 million for restructuring activities, of which $5 million was redeployed to other businesses in 1994. Excluding the impact of restructuring in both years, operating profit increased slightly to $105 million in 1994 compared to $103 million in 1993. Cost improvements from restructuring activities in 1994 were essentially offset by higher pension costs. Excluding the 1993 charge for restructuring, operating profit decreased 15% in 1993 compared to 1992 due to the lower volume and an unfavorable mix of sales.\nPower Generation continues to focus on international opportunities. Of the $2.5 billion of orders received in 1994, more than 60% were from customers outside the U.S. Particular successes were achieved in China, where Power Generation received orders for four units, and in South Korea.\nThe Knoll Group\nRevenues for The Knoll Group (Knoll) increased 11% to $567 million in 1994 compared to 1993 due to both market and market share growth in North America. Revenues decreased 12% in 1993 compared to 1992 due to lower shipments and reduced prices in the domestic market and poor economic conditions in Europe.\nKnoll's operating results for the last three years have included restructuring charges totalling $40 million in 1994, $9 million in 1993 and $26 million in 1992. A major restructuring program was begun in mid-1994 and will be completed in the first half of 1995. The results of this program were evident in the North American results for the fourth quarter of 1994, while European operations are expected to improve as those restructuring activities are completed. Knoll's total operating loss, which increased by $16 million in 1993, decreased by 10% in 1994 reflecting the improvement in North America.\nWCI Communities, Inc.\nRevenues for WCI decreased slightly to $248 million in 1994 compared to 1993 due to the continued weak real estate markets in California. These depressed markets were partially offset by strong land and condominium sales in Coral Springs and Naples, Florida. Revenues increased 8% in 1993 compared to 1992 as strong sales in South Florida were partially offset by the weak Southern California market.\nIncluded in 1994 operating profit was a $3 million reduction of the $10 million restructuring charge in 1992. Excluding the impact of restructuring, operating profit was flat at $65 million in 1994 compared to 1993 after decreasing 33% from 1992 due to an unfavorable mix of sales. The Corporation continues to explore alternatives for monetizing WCI.\nOther Businesses\nThe Other Businesses segment is a diverse group of businesses that the Corporation views as non-strategic. During 1994, the Corporation completed the sales of Controlmatic and Gladwin Corporation. See note 19 to the financial statements. The Corporation continues to pursue the disposition of the remaining businesses in this segment.\nRevenues of Other Businesses decreased 9% to $497 million in 1994 due to the May 1994 sale of Controlmatic. Revenues decreased 4% in 1993 compared to 1992 due to lower production and delayed deliveries at Westinghouse Motor Company and the weak economic conditions in Controlmatic's European market.\nIncluded in the 1993 operating loss was $5 million for restructuring. Excluding restructuring costs, the operating loss decreased 54% to $27 million in 1994 after increasing $45 million in 1993. The significant loss in 1993 reflected project cost overruns at Controlmatic and lower volume at Westinghouse Motor Company.\nRESTRUCTURING OF OPERATIONS\nThe Corporation is committed to strengthening its core businesses and improving its profitability through certain restructuring actions including changes in business and product line strategies, as well as downsizing for process reengineering and productivity improvements. The Corporation expects to continue to implement restructuring initiatives as competitive conditions dictate in an ongoing effort to reduce its overall cost structure and improve its competitiveness. An overview of the Corporation's recent restructuring actions follows. See note 19 to the financial statements.\nRestructuring of Operations--1993 Initiative\nShortly after joining the Corporation in June 1993, Chairman and Chief Executive Officer Michael Jordan initiated an extensive review by management of all of the Corporation's businesses. As a result of this review, management developed a plan to restructure its continuing businesses to improve productivity and operating performance. This plan was expected to result in the reduction of approximately 6,000 employees during the subsequent two years; approximately 2,600 through normal attrition and 3,400 through involuntary separations.\nAs part of its extensive review, management identified the individual projects to be included in the restructuring plan and identified the affected employee groups. Generally, separated employees receive benefits under the Corporation's Employee Security and Protection (ES&P) Plan, including permanent job separation benefits, retraining and outplacement assistance. The amount included for these benefits in the restructuring charge represents the incremental cost of such benefits over those amounts previously accrued under SFAS No. 112.\nAlthough the 1993 restructuring initiative involved substantially all of the Corporation's continuing businesses, particular focus was placed on Corporate overhead functions and on the Electronic Systems and Power Generation business units. The current estimated cost of the Corporation's 1993 restructuring initiative totalled $350 million, consisting of $206 million for employee separation costs, $22 million for a noncash pension curtailment charge, $68 million for asset writedowns and $54 million for facility closure and rationalization costs.\nThrough December 31, 1994, employee reductions as a result of implementing the 1993 restructuring initiative totalled 3,181. In addition, nearly 1,100 employees left through attrition. Completion of the remaining involuntary separations under the 1993 initiative is expected in 1995. The 3,400 employee separations that were included as part of the 1993 restructuring provision are expected to result in annual pre-tax savings of approximately $100 million, primarily through reduced employment costs. Approximately 75% of this annual savings was realized in 1994.\nThe total cash expenditures related to the 1993 restructuring initiative are expected to approximate $260 million with the remaining noncash charges consisting primarily of asset writedowns and the pension curtailment charge. Cash expenditures through year-end 1994 totalled almost $200 million. Beginning in 1995, cash savings from these initiatives are expected to exceed remaining cash expenditures.\nRestructuring of Operations--1994 Initiative\nDuring the fourth quarter of 1994, management approved additional restructuring projects totalling $113 million primarily for costs associated with approximately 1,200 additional employee separations. Certain amounts accrued for restructuring in 1992 and miscellaneous adjustments were applied to these program costs to reduce the required restructuring charge to $71 million. Separated employees generally receive benefits under the Corporation's ES&P Plan. The new restructuring initiative primarily relates to Knoll and involves major cost reduction efforts in both its North American and European operations. The 1994 initiative also includes further employee reductions at Energy Systems and certain other business units.\nThe restructuring activities included in the 1994 restructuring provision are expected to result in annual pre-tax savings of approximately $70 million, primarily from reduced employment costs.\nTotal cash expenditures, which approximate $82 million, are expected to be funded in 1995 through operating cash flows of Continuing Operations. These expenditures, however, are expected to be largely offset by savings, resulting in a net cash outflow of approximately $12 million in 1995.\n1994 PENSION SETTLEMENT\nThe Corporation's restructuring activities contributed to a high level of lump sum cash distributions from the Corporation's pension fund during 1994. The magnitude of these cash distributions required that the Corporation apply the provisions of SFAS No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,\" and recognize a settlement loss of $308 million during the fourth quarter of 1994. This noncash charge to income represents the pro-rata portion of unrecognized losses associated with the pension obligation that was settled.\nThe settlement loss did not impact shareholders' equity because the decrease resulting from the income statement provision was fully offset by a reduction in the charge to shareholders' equity related to the minimum pension liability. See note 3 to the financial statements.\nDISPOSITION OF NON-STRATEGIC BUSINESSES\nDuring the fourth quarter of 1993, the Corporation recorded a $215 million charge to dispose of certain non-strategic businesses. Of this amount, $20 million related to asset writedowns was charged to operating profit. Non-strategic businesses included parts of the former Environmental Services business unit and all of the businesses in the Industrial Products and Services business unit. During 1994, the Corporation completed the sales of Controlmatic and Gladwin Corporation. The Corporation continues to pursue the disposition of the remaining non-strategic businesses.\nActivity relating to the liability for disposition of non-strategic businesses for the year ended December 31, 1994 is summarized below:\nThe asset writedowns primarily consisted of permitting and site preparation costs for two projects that the Corporation no longer intends to pursue.\nOTHER INCOME AND EXPENSES\nFor the year ended December 31, 1994, other income and expense, which was a net expense of $285 million, consisted primarily of the $308 million charge for the settlement of a portion of the Corporation's pension obligation. The Corporation recorded an additional $17 million provision for the estimated loss on disposition of non-strategic businesses to reflect actual sales experience and revised estimates of proceeds and selling costs for the remaining businesses to be sold. These charges were partially offset by gains totalling $42 million from the sale of two radio stations and a shopping center development. See notes 18 and 19 to the financial statements for additional discussion of these matters.\nFor the year ended December 31, 1993, other income and expense, which was a net expense of $165 million, consisted primarily of a $195 million provision for the estimated loss on disposition of non-strategic businesses. This charge was offset by a gain on the sale of an equity participation in a production company.\nNo significant other income or expense items were recorded in 1992.\nINTEREST EXPENSE\nInterest expense decreased $40 million to $177 million in 1994 compared to 1993 primarily due to lower average outstanding short-term debt. Average outstanding short-term debt of Continuing Operations decreased $772 million in 1994 compared to 1993. Average short-term debt of Continuing Operations is expected to increase in 1995 because of the fourth quarter 1994 transfer of debt from Discontinued Operations. See note 10 to the financial statements.\nInterest expense decreased $8 million to $217 million in 1993 compared to 1992 due to lower effective interest rates on average outstanding debt, partially offset by higher fees associated with the revolving credit facility and the replacement of short-term floating-rate debt with higher coupon long-term fixed-rate debt.\nINCOME TAXES\nThe Corporation's 1994 provision for income taxes of $71 million was 45.2% of income before taxes and minority interest.\nThe Corporation's 1993 benefit for income taxes was 32.6% of the losses from all sources. The 1993 benefit totalled $153 million consisting of $70 million from Continuing Operations, $53 million from Discontinued Operations and $30 million from the cumulative effect of the change in accounting principle.\nThe 1992 benefit was 52.7% of the losses from all sources. The 1992 benefit totalled $1,530 million and consisted of $187 million tax expense on income from Continuing Operations, offset by benefits of $882 million from Discontinued Operations and $835 million from the cumulative effect of changes in accounting principles.\nNumerous items have caused these effective tax rates to differ from the U.S. statutory income tax rates of 35% for 1994 and 1993 and 34% for 1992. The Corporation's effective tax rate varies depending on the specific dollar amounts of permanent tax differences and the relationship of those differences to income before income taxes and minority interest. An analysis of these items is set forth in the Effective Tax (Benefit) Rate for Continuing Operations table included in note 5 to the financial statements.\nThe net deferred tax asset at December 31, 1994 was $2,380 million as shown in the Consolidated Deferred Income Tax Sources table in note 5 to the financial statements.\nThe three significant components of the deferred tax asset balance are: (i) the tax effect of net operating loss carryforwards of $2,944 million, $472 million of which will expire by the year 2007 and the balance by 2008, (ii) the tax effect of cumulative net temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes of $2,736 million that represents future net income tax deductions. Of this net temporary difference, approximately $1,200 million represents a net pension obligation and approximately $1,270 million represents an obligation for postretirement and postemployment benefits, and (iii) alternative minimum tax credit carryforwards of $261 million which have no expiration date.\nManagement believes that the Corporation will have sufficient future taxable income to make it more likely than not that the net deferred tax asset will be realized. In making this assessment, management considered the net losses generated in 1992 and 1993 as aberrations caused in part by the liquidation of a substantial portion of Financial Services assets and not recurring conditions. Further, the Corporation's Continuing Operations have been consistently profitable and the loss from Continuing Operations in 1993 was due to restructuring and other actions. Management also considered the actual historic operating performance and taxable income generated by Continuing Operations.\nCertain of the tax losses will not occur until future years. Each tax loss year would receive a new 15-year carryforward period. Under a conservative assumption, however, that all net cumulative temporary differences other than net operating loss carryforwards reversed in 1994, the Corporation would have through the year 2009 to recover the tax asset. This would require the Corporation to generate a minimum of approximately $400 million of annual taxable income. Management believes that average annual future taxable income will exceed this minimum amount.\nIn addition, there are certain tax planning strategies that could be employed to utilize a net operating loss carryforward that would otherwise expire. Some of the strategies that would be most feasible are sale and leaseback of facilities, change in the method of tax deductible depreciation, purchase of leases that would generate taxable income, and capitalization of research and development expense for tax purposes.\nThe following table shows a reconciliation of income or loss from Continuing Operations before income taxes to taxable income from Continuing Operations:\nRECONCILIATION OF INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES TO TAXABLE INCOME (in millions)\nDISCONTINUED OPERATIONS\nIn November 1992, the Corporation announced a plan (the Plan) that included exiting its Financial Services business through the disposition of its asset portfolios and the sales of the Distribution and Control Business Unit (DCBU) and Westinghouse Electric Supply Company (WESCO). See notes 1 and 2 to the financial statements for a discussion of the Plan. The disposition of Financial Services assets involved the sale of real estate and corporate finance portfolios over a three-year period and the liquidation of the leasing portfolio over a longer period in accordance with contractual terms. Financial Services, DCBU and WESCO have been accounted for as discontinued operations in accordance with Accounting Principles Board Opinion No. 30, \"Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions\" (APB 30).\nUpon adoption of the Plan, the Corporation recorded a pre-tax charge of $2,201 million consisting of $2,350 million for an addition to the valuation allowance for Financial Services portfolios, $300 million for estimated losses from operations of Financial Services during the phase-out period and $144 million for restructuring charges related to the change in corporate strategy. These charges were partially offset by an estimated $449 million gain from the dispositions of DCBU and WESCO and an estimated $144 million of earnings from those operations during their phase-out periods. The after-tax charge for the estimated loss on the disposal of Discontinued Operations was $1,383 million.\nBased on its quarterly review of the assumptions used in determining the estimated loss from Discontinued Operations, the Corporation recorded an additional pre-tax provision for loss on disposal of Discontinued Operations of $148 million in 1993. This change in the estimated loss resulted from a reduction of the expected selling prices of WESCO and the Australian subsidiary of DCBU; a decision to sell in bulk a Financial Services residential development that the Corporation, upon adoption of the Plan, had intended to develop; and revision to the estimated interest costs expected to be incurred by Discontinued Operations during the disposal period.\nOn January 31, 1994, the Corporation completed the sale of DCBU, excluding its Australian subsidiary, to Eaton Corporation for a purchase price of $1.1 billion and the assumption by the buyer of certain liabilities. The sale of the Australian subsidiary was completed in March 1994.\nOn February 28, 1994, the Corporation completed the sale of WESCO to an affiliate of Clayton, Dubilier & Rice, Inc., a private investment firm, for a purchase price of approximately $340 million. The proceeds consisted of approximately $275 million in cash, approximately $50 million in first mortgage notes, and the remainder in stock and options of the new company.\nThe portfolio investments of Financial Services have been reduced from $8,967 million at year-end 1992 to $1,230 million at December 31, 1994. Substantially all of the remaining real estate assets of $297 million at December 31, 1994 are expected to be liquidated in 1995. The corporate portfolio essentially has been liquidated. The leasing portfolio, which totalled $924 million at December 31, 1994, is expected to continue to liquidate through 2015 in accordance with contractual terms.\nThe remaining liability for the estimated loss on disposal of Discontinued Operations at December 31, 1994 of $145 million is expected to be utilized in the following manner:\nESTIMATED REQUIREMENT--LIABILITY FOR THE ESTIMATED LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS (in millions)\nThe estimated reserve requirement for Financial Services includes future operating losses and estimated credit losses, primarily related to the leasing portfolio. Partially offsetting the operating and credit losses are estimated future gains from sales of the remaining real estate assets.\nFuture disposition costs relating to the sales of DCBU and WESCO include product warranty claims, medical claims, employee separation costs and potential environmental remediation costs.\nManagement believes that the liability for the estimated loss on disposal of Discontinued Operations is adequate. The adequacy of this liability is evaluated each quarter.\nThe following table presents sales and operating profit (loss) for Discontinued Operations for each of the three years in the period ended December 31, 1994:\nRESULTS OF OPERATIONS (in millions)\nDCBU and WESCO\nOperating results for the year ended December 31, 1994 include the operating results of DCBU for the month ended January 31, 1994 and of WESCO for the two months ended February 28, 1994, their respective dates of sale.\nOperating profit decreased 35% in 1993 compared to 1992 due primarily to a 2% decline in revenues, an unfavorable mix of sales and non-recurring costs for strategic initiatives at WESCO.\nFinancial Services\nDuring 1994, the Corporation continued to liquidate Financial Services, resulting in a reduction in assets and debt. Financial Services revenues of $41 million for 1994 decreased $264 million compared to 1993, reflecting the significant reduction in assets through dispositions during 1993 and 1994. Revenues of $305 million for 1993 decreased 59% compared to 1992 due primarily to a reduction in assets through dispositions.\nAt December 31, 1994, Financial Services portfolio investments totalled $1,230 million, a decrease of $321 million from $1,551 million at year-end 1993. Portfolio investments at December 31, 1994 and 1993 included $913 million and $1,062 million, respectively, of receivables, and $317 million and $489 million, respectively, of other portfolio investments. Of the receivables at December 31, 1994 and 1993, $886 million and $969 million, respectively, were leasing receivables, and the remainder consisted primarily of residential real estate loans and corporate receivables from highly leveraged transactions. Other portfolio investments at December 31, 1994 and 1993 included the Corporation's investment in LW Real Estate Investments, L.P. (LW) of $133 million in both periods, real estate properties of $88 million and $141 million, respectively, and other investments of $96 million and $215 million, respectively, consisting primarily of investments in real estate and leasing partnerships. The leasing portfolio is expected to liquidate in accordance with contractual terms. Management expects substantially all of the Corporation's investment in LW and the remaining real estate assets to be liquidated by the end of 1995.\nLeasing receivables consist of direct financing and leveraged leases. At December 31, 1994 and 1993, 81% and 77%, respectively, related to aircraft and 18% and 19%, respectively, related to cogeneration facilities. Certain leasing receivables classified as performing and totalling approximately $139 million at December 31, 1994 have been identified by management as potential problem receivables. This amount consists primarily of leveraged leases related to aircraft leased by major U.S. airlines. Such leasing receivables were current as to payments and performing in accordance with contractual terms at December 31, 1994.\nNet Debt of Discontinued Operations A summary of changes in net debt of Discontinued Operations for the year ended December 31, 1994 is presented in the table below:\nOf the remaining $1.2 billion of net debt of Discontinued Operations, approximately $700 million is expected to be repaid in 1995. Approximately $300 million is expected to be repaid through the liquidation of portfolio investments of Financial Services. The remaining 1995 debt repayment of $400 million will occur as cash is received from Continuing Operations, the timing of which is expected to coincide with sales of non-strategic businesses. The Corporation expects to reduce the debt of Discontinued Operations to that amount which is supportable by the leasing portfolio and can be repaid as that portfolio liquidates over its contractual terms. As a result, additional cash may be required from Continuing Operations.\nLIQUIDITY AND CAPITAL RESOURCES\nOverview\nThe Corporation manages its liquidity as a consolidated enterprise without regard to whether assets or debt are classified for balance sheet purposes as part of Continuing Operations or Discontinued Operations. As a result, the discussion below focuses on the Corporation's consolidated cash flows and capital structure.\nThe Corporation seeks to ensure that it has adequate resources for reinvestment in its core businesses and for strategic acquisitions. Based on its ongoing review of the Corporation's capital structure and associated interest costs, management believes that the Corporation's operating and financial flexibility will benefit from lower leverage.\nDuring 1994, the Corporation took several actions to reduce its leverage and rebuild its capital structure, including the continued liquidations of assets of Discontinued Operations, the issuance of preferred stock and the reduction of the common stock dividend. As a result, net debt (total debt less cash and cash equivalents) was reduced by $1.7 billion. The Corporation intends to continue to reduce its consolidated net debt by up to an additional $1 billion in 1995. This reduction will be achieved principally by the sale of portfolio investments of Discontinued Operations and the disposition of other non-strategic businesses of Continuing Operations.\nManagement expects that cash from Continuing Operations and availability under its revolving credit facilities will continue to be sufficient to meet future business needs. Other sources of liquidity generally available to the Corporation include cash and cash equivalents, proceeds from sales of non-strategic assets and borrowings from other sources, including funds from the capital markets.\nOperating Activities\nThe operating activities of Continuing Operations provided $303 million of cash during the year ended December 31, 1994, a decrease of $432 million from the amount provided in 1993. The two major factors contributing to this decrease were pension contributions and restructuring costs.\nCash contributions of approximately $300 million were made to the Corporation's pension plans in 1994, whereas the 1993 contribution consisted primarily of assets of Discontinued Operations. During 1995, management expects to contribute approximately $300 million in cash to the Corporation's pension plans.\nDuring 1994, the Corporation expended approximately $200 million for expenditures related to its 1993 restructuring initiative. Savings from the Corporation's restructuring activities are expected to essentially offset related cash expenditures in 1995.\nA significant use of operating cash in 1994 involved an increase in working capital related to uncompleted contracts with progress billing terms. Customers are exerting increasingly greater pressure to delay payments under major contracts for as long as possible. The Corporation will focus significant effort in 1995 on reducing long-term contract and inventory investments in an overall effort to improve working capital turnover.\nThe operating activities of Discontinued Operations used $357 million of cash during 1994 compared to cash provided of $45 million during 1993. The primary operating cash requirements of Discontinued Operations for 1994 were interest and operating costs of Financial Services and divestiture costs of DCBU and WESCO. Operating activities for 1993 included cash generated by the operations of DCBU and WESCO, both of which were sold in early 1994. The future operating cash requirements of Discontinued Operations are primarily attributable to interest costs on debt, operating costs and disposition costs related to DCBU and WESCO.\nInvesting Activities\nInvesting activities provided $1,353 million of cash during 1994 compared to $2,668 million of cash provided in 1993. During 1994, the Corporation sold two radio stations, an investment in a joint venture and two non-strategic businesses (Gladwin Corporation and Controlmatic), generating cash totalling $88 million. The Corporation purchased the Norden Unit of United Technologies Corporation, the KPIX-AM and FM radio stations in San Francisco and a minority interest in Group W Radio for total cash expenditures of $109 million. Proceeds from the first quarter 1994 sales of DCBU and WESCO generated $1.4 billion of cash, while liquidations of Financial Services portfolio investments generated additional cash of $323 million. Cash generated by the liquidations of Financial Services portfolio investments was significantly greater in 1993 because of the early success of the liquidation plan.\nCapital expenditures were $259 million for 1994, a decrease of $13 million from 1993. Capital expenditures in 1995 are expected to approximate the 1994 level.\nIn 1995, the Corporation expects to generate approximately $300 million of cash through the continued liquidation of portfolio investments of Discontinued Operations. In addition, sales of non-strategic businesses, as well as the potential monetization of WCI, are expected to generate cash proceeds to the Corporation.\nFinancing Activities\nCash used by financing activities during 1994 totalled $2,203 million compared to cash used of $3,754 million during 1993.\nNet debt was reduced by $1,709 million during 1994 to $3,393 million at year-end reflecting lower borrowings under the revolving credit facilities. As the Corporation's financial condition improved in 1994, a significant level of its cash and cash equivalents were used to repay debt. As a result, total debt of the Corporation was $3,737 million at December 31, 1994, a decrease of $2,613 million from $6,350 million at December 31, 1993. Further debt reductions of $750 million to $1 billion are expected in 1995.\nTwo new revolving credit agreements with more favorable terms and conditions than the previous facility were executed in August 1994 (see Revolving Credit Facilities). Total borrowings under the revolvers were $919 million at December 31, 1994. These borrowings carried a composite interest rate of 6.7% at year-end 1994 and were based on the London Interbank Offer Rate (LIBOR).\nIn March 1994, the Corporation sold in a private placement depositary shares representing 3,600,000 shares of Series C preferred stock for net proceeds of $505 million. These shares will convert to common shares in June 1997.\nAt the beginning of 1994, the Corporation reduced its common stock dividend from $.40 per share to $.20 per share. This reduction resulted in annual cash savings to the Corporation of approximately $70 million. Dividends paid in 1994 also included dividends for the Series C preferred stock issued in March 1994.\nAs a result of the financing activities described above, the Corporation's net debt at December 31, 1993 fell from 83% of consolidated net capitalization to 65% at December 31, 1994. As net debt declines further during 1995 and equity grows through consistent earnings of Continuing Operations, this percentage is expected to continue to improve.\nOn August 26, 1992, the Corporation filed a registration statement on Form S-3 for the issuance of up to $1 billion of debt securities. At December 31, 1994, $400 million of this shelf registration remained unused.\nRevolving Credit Facilities\nOn August 5, 1994, the Corporation replaced its December 1991 revolver with two revolving credit agreements (revolvers). These facilities have a combined commitment level of $2.5 billion, with $2.0 billion maturing on August 4, 1997 (three-year revolver) and $500 million maturing on August 4, 1995 (364-day revolver). Borrowings under the revolvers are used for general corporate purposes, including the repayment of maturing long-term debt. The interest rates for borrowings under the revolvers are determined at the time of each borrowing and are based on one of a variety of floating rate indices plus a margin based on the Corporation's long-term debt ratings.\nUnused capacity under the revolvers equalled $1,581 million and $996 million at December 31, 1994 and 1993, respectively. Borrowing availability is subject to compliance with certain covenants, representations and warranties. At December 31, 1994, the Corporation was in compliance with these covenants.\nHedging Activities\nPrior to the adoption of the Plan, Financial Services entered into interest rate and currency exchange agreements to manage the interest rate and currency risk associated with various debt instruments. No transactions were speculative or leveraged. Given their nature, these agreements have been accounted for as hedging transactions.\nThe Corporation's credit exposure under interest rate and currency exchange agreements is limited to the cost of replacing an agreement in the event of non-performance by its counterparty. To minimize this risk, Financial Services selected high credit quality counterparties. At December 31, 1994, the aggregate credit exposure to counterparties totalled approximately $78 million. This exposure resulted primarily from an interest rate and currency swap with an A-rated counterparty. The contract matures in February 1996.\nIn 1994, outstanding interest rate exchange agreements resulted in a net increase in the average borrowing rate for Discontinued Operations of approximately 0.6% and a net increase in the corresponding interest expense of approximately $12 million. The hedging policy followed by Financial Services targeted a mix of fixed and floating rate debt that was attainable through the issuance of debt instruments with particular rate reset characteristics and\/or the use of interest rate exchange agreements. Therefore, interest expense would not have been materially different had the fixed\/floating target been attained without the use of interest rate exchange agreements.\nThe Corporation continually monitors its economic exposure to changes in foreign exchange rates and enters into foreign exchange forward or option contracts to hedge its transaction exposure when appropriate. As a result, the Corporation's unhedged foreign exchange exposure is not significant. Furthermore, changes in foreign exchange rates whether favorable or unfavorable are not expected to have a significant impact on the Corporation's financial results or operating activities.\nWith respect to the Corporation's operations in highly inflationary and unstable economies that are accounted for in accordance with SFAS No. 52, \"Foreign Currency Translation,\" the combined total sales for those operations were less than 0.5% of the Corporation's sales for 1994. Any translation adjustments resulting from converting the local currency balance sheets and income statements of designated hyperinflationary subsidiaries into U.S. dollars are recorded as period costs in accordance with SFAS No. 52.\nSecurities Ratings\nThe Corporation's debt and preferred stock are currently rated by Moody's Investor Service (Moody's), Standard and Poor's Corporation (S&P) and Fitch Investor's Service, Inc. (Fitch). The following table summarizes the agencies' ratings for outstanding securities at December 31, 1994 and 1993.\nSECURITIES RATINGS\nManagement believes that the Corporation made significant progress during 1994 in strengthening its financial position by rebuilding its equity base and substantially reducing its debt. Further debt reductions in 1995, accompanied by continued improvement in operating results, should facilitate improvement in the Corporation's financial ratings over time.\nENVIRONMENTAL MATTERS\nCompliance with federal, state and local regulations relating to the discharge of substances into the environment, the disposal of hazardous wastes and other related activities affecting the environment have had and will continue to have an impact on the Corporation. While it is difficult to estimate the timing and ultimate costs to be incurred in the future due to uncertainties about the status of laws, regulations, technology and information available for individual sites, management has estimated the total probable and reasonably possible remediation costs that could be incurred by the Corporation based on the facts and circumstances currently known. See note 16 to the financial statements.\nAt December 31, 1994, the Corporation had accrued liabilities totalling $73 million for sites where it has been either named a potentially responsible party (PRP) or has other remedial responsibilities, $70 million for the Bloomington sites and $40 million for decommissioning costs at facilities where the Corporation has ongoing operations. In conjunction with the sales of certain of its businesses, the Corporation has also provided for remediation costs related to past operations of such sites. Annual environmental costs include approximately $5 million for estimated future environmental closure costs at operating sites and approximately $25 million related to current management of hazardous substances and pollution. Capital expenditures for environmental controls, which totalled $12 million in 1994, may vary from year to year.\nManagement believes that the Corporation has adequately provided for its present environmental obligations and that complying with existing government regulations will not materially impact the Corporation's financial position, liquidity or results of operations.\nLEGAL MATTERS\nThe Corporation is defending a number of lawsuits on various matters. See note 16 to the financial statements. Costs to defend these lawsuits are charged to operations in the period in which the services are rendered.\nIn the last two years, the Corporation has entered into agreements to resolve six litigation claims in connection with alleged tube degradation in steam generators sold by the Corporation as components for nuclear steam supply systems. These agreements generally require the Corporation to provide certain products and services at prices discounted at varying rates. The future impact of these discounts on operating results will be incurred over the next 15 years with the greatest impact occurring during the next nine years.\nLitigation is inherently uncertain and always difficult to predict. Substantial damages are sought in certain of these cases and, although management believes a significant adverse judgment is unlikely, any such judgment could have a material adverse effect on the Corporation's results of operations for a quarter or a year. However, based on its understanding and evaluation of the relevant facts and circumstances, management believes that the Corporation has meritorious defenses to the litigation referenced above, and management believes that the litigation should not have a material adverse effect on the financial condition of the Corporation.\nINSURANCE RECOVERIES\nThe Corporation has filed actions against more than 100 of its insurance carriers seeking recovery for environmental, product and property damage liabilities, and certain other matters. The Corporation has settled with several of these carriers and has received recoveries related to these actions. Amounts received to date generally have been applied to cover obligations assumed through the settlements or litigation costs. The Corporation has not accrued for any future insurance recoveries.\nREPORT OF MANAGEMENT\nThe Corporation has prepared the consolidated financial statements and related financial information included in this report. Management has the primary responsibility for the financial statements and other financial information and for ascertaining that the data fairly reflect the financial position, results of operations and cash flows of the Corporation. The financial 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 with appropriate consideration given to materiality. Financial information included elsewhere in this report is presented on a basis consistent with the financial statements.\nThe Corporation maintains a system of internal accounting controls, supported by adequate documentation, to provide reasonable assurance that assets are safeguarded and that the books and records reflect the authorized transactions of the Corporation. Limitations exist in any system of internal accounting controls based on the recognition that the cost of the system should not exceed the benefits derived. Westinghouse believes its system of internal accounting controls, augmented by its corporate auditing function, appropriately balances the cost\/benefit relationship.\nThe independent accountants provide an objective assessment of the degree to which management meets its responsibility for fair financial reporting. They regularly evaluate the system of internal accounting controls and perform such tests and procedures as they deem necessary to express an opinion on the fairness of the financial statements.\nThe Board of Directors pursues its responsibility for the Corporation's financial statements through its Audit Review Committee composed of directors who are not officers or employees of the Corporation. The Audit Review Committee meets regularly with the independent accountants, management and the corporate auditors. The independent accountants and the corporate auditors have direct access to the Audit Review Committee, with and without the presence of management representatives, to discuss the scope and results of their audit work and their comments on the adequacy of internal accounting controls and the quality of financial reporting.\nWe believe that the Corporation's policies and procedures, including its system of internal accounting controls, provide reasonable assurance that the financial statements are prepared in accordance with the applicable securities laws and with a corresponding standard of business conduct.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Westinghouse Electric Corporation\nIn our opinion, the accompanying consolidated financial statements appearing on pages 27 through 51 of this Form 10-K present fairly, in all material respects, the financial position of Westinghouse Electric 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 Corporation's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in note 1 to these financial statements, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 112, \"Employers' Accounting for Postemployment Benefits,\" in 1993 and SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and SFAS No. 109, \"Accounting for Income Taxes,\" in 1992.\n[GRAPHIC OMITTED]\nPrice Waterhouse LLP 600 Grant Street Pittsburgh, Pennsylvania 15219-9954 January 31, 1995\nCONSOLIDATED STATEMENT OF INCOME\nThe Notes to the Financial Statements are an integral part of these financial statements.\nCONSOLIDATED BALANCE SHEET\nThe Notes to the Financial Statements are an integral part of these financial statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS\nThe Notes to the Financial Statements are an integral part of these financial statements and include descriptions of noncash transactions.\nNOTES TO THE FINANCIAL STATEMENTS\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation\nThe consolidated financial statements include the accounts of Westinghouse Electric Corporation (Westinghouse) and its subsidiary companies (together, the Corporation) after elimination of intercompany accounts and transactions. Investments in joint ventures and in other companies in which the Corporation does not control but has the ability to exercise significant management influence over operating and financial policies are accounted for by the equity method.\nCertain previously reported amounts have been reclassified to conform to the 1994 presentation.\nDiscontinued Operations\nIn November 1992, the Corporation's Board of Directors adopted a plan (the Plan) that included exiting Financial Services and other non-strategic businesses. The Corporation classified the operations of Distribution and Control Business Unit (DCBU), Westinghouse Electric Supply Company (WESCO) and Financial Services as discontinued operations in accordance with Accounting Principles Board Opinion No. 30, \"Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions\" (APB 30).\nRevenue Recognition\nSales are recorded primarily as products are shipped and services are rendered. The percentage-of-completion method of accounting is used for major power generation systems with a cycle time in excess of one year, major nuclear fuel and related equipment orders, and certain projects where this method of accounting is consistent with industry practice. For certain long-term contracts in which development and production are combined and cycle times are in excess of two years, revenue is recognized as development milestones are completed or units are delivered.\nAmortization of Intangible Assets\nGoodwill and other acquired intangible assets are amortized using the straight-line method over their estimated lives, but not in excess of 40 years for assets acquired prior to January 1, 1994 and not in excess of 15 years for assets acquired after December 31, 1993.\nSubsequent to the acquisition of an intangible asset, the Corporation continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful life of an intangible asset may warrant revision or that the remaining balance of such an asset may not be recoverable. When factors indicate that an intangible asset should be evaluated for possible impairment, the Corporation uses an estimate of the related business' undiscounted future cash flows over the remaining life of the asset in measuring whether the intangible asset is recoverable. If such an analysis indicates that impairment has in fact occurred, the Corporation writes down the book value of the intangible asset to its fair market value.\nCash and Cash Equivalents\nThe Corporation considers all investment securities with a maturity of three months or less when acquired to be cash equivalents. All cash and temporary investments are placed with high credit quality financial institutions and the amount of credit exposure to any one financial institution is limited. At December 31, 1994 and 1993, cash and cash equivalents included restricted funds of $61 million and $73 million, respectively.\nInventories\nInventories are stated at the lower of standard cost, which approximates actual cost on a first-in, first-out (FIFO) basis, or market. The elements of cost included in inventories are direct labor, direct material and certain overheads including factory depreciation. Long-term contracts in process include costs incurred plus estimated profits on contracts accounted for using the percentage-of-completion method.\nPlant and Equipment\nPlant and equipment assets are recorded at cost and depreciated generally using the straight-line method over their estimated useful lives. Leasehold improvements are amortized over the terms of the respective leases. Expenditures for additions and improvements are capitalized, and costs for repairs and maintenance are charged to operations as incurred. The Corporation limits capitalization of newly acquired assets to those assets with cost in excess of $1,500.\nEnvironmental Costs\nThe Corporation expenses or capitalizes, if appropriate under the Corporation's capitalization policy, environmental expenditures that relate to current operations. Expenditures that relate to an existing condition caused by past operations and which do not contribute to current or future revenue generation are expensed. The Corporation records liabilities when environmental assessments or remedial efforts are probable and the costs can be reasonably estimated. Such estimates are adjusted if necessary based on the completion of a formal study or the Corporation's commitment to a formal plan of action.\nThe Corporation accrues over their estimated remaining useful lives the anticipated future costs of dismantling incinerators and decommissioning nuclear licensed sites.\nOff-Balance-Sheet Hedging\nDebt Instruments\nThe Corporation has entered into interest rate and currency exchange agreements to manage exposure to fluctuations in interest and foreign exchange rates. Interest rate exchange agreements generally involve the exchange of interest payments without exchange of the underlying principal amounts. The Corporation does not enter into speculative or leveraged derivative transactions.\nThe differentials paid or received on interest rate swap agreements are accrued and recognized as adjustments to interest expense; gains and losses realized upon settlement of these agreements are deferred and amortized to interest expense over the term of the original agreement if the underlying hedged instrument remains outstanding or immediately if the underlying hedged instrument is settled. At December 31, 1994 and 1993, the Corporation had no deferred gains or losses from terminated interest rate swaps recorded on its balance sheet.\nForeign Exchange\nThe Corporation's foreign exchange policy includes matching purchases and sales in national currencies when possible and hedging unmatched transactions in excess of $250,000. In accordance with this policy, the Corporation has entered into various foreign exchange agreements in which it sells a currency forward to hedge a receivable or purchases a currency forward to hedge a payable.\nGains and losses on foreign currency contracts offset gains and losses resulting from currency fluctuations inherent in the underlying transactions. Gains and losses on contracts that hedge specific foreign currency commitments are deferred and recognized in net income in the period in which the transaction is consummated.\nChanges in Accounting Principles\nIn December 1993, the Corporation adopted, retroactive to January 1, 1993, Statement of Financial Accounting Standards (SFAS) No. 112, \"Employers' Accounting for Postemployment Benefits.\" This statement requires employers to adopt accrual accounting for workers' compensation, salary continuation, medical and life insurance continuation, severance benefits and disability benefits provided to former or inactive employees after employment but before retirement. The Corporation's previous practice was to expense these costs as incurred. See note 4 to the financial statements.\nEffective January 1, 1992, the Corporation adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" on the immediate recognition basis. This statement requires that the expected costs of providing postretirement health care and life insurance benefits be accrued during the employees' service with the Corporation. The Corporation's previous practice was to expense these costs as incurred. See note 4 to the financial statements.\nIn the first quarter of 1992, the Corporation adopted SFAS No. 109, \"Accounting for Income Taxes.\" This statement replaced SFAS No. 96, which the Corporation previously used to account for income taxes. SFAS No. 109 permitted the Corporation to recognize certain deferred tax benefits not recognized under SFAS No. 96. See note 5 to the financial statements.\nNOTE 2: DISCONTINUED OPERATIONS\nIn November 1992, the Corporation announced the Plan that included exiting Financial Services through the disposition of its asset portfolios and the sales of DCBU and WESCO. The disposition of Financial Services assets involved the sale of the real estate and corporate finance portfolios over a three-year period and the liquidation of the leasing portfolio over a longer period of time in accordance with contractual terms. Financial Services, DCBU and WESCO have been accounted for as discontinued operations in accordance with APB 30.\nUpon adoption of the Plan, the Corporation recorded a pre-tax charge of $2,201 million in Discontinued Operations consisting of $2,350 million for an addition to the valuation allowance for Financial Services portfolios; $300 million for estimated losses from operations for Financial Services during the phase-out period; and $144 million for restructuring charges related to the change in corporate strategy. These charges were partially offset by an estimated $449 million gain from the dispositions of DCBU and WESCO and an estimated $144 million of earnings from those operations during their phase-out periods. The after-tax charge for the estimated loss on the disposal of Discontinued Operations was $1,383 million.\nBased on its quarterly review of the assumptions used in determining the estimated loss from Discontinued Operations, the Corporation recorded in the fourth quarter of 1993 an additional pre-tax provision for loss on disposal of Discontinued Operations of $148 million. This change in the estimated loss resulted from a reduction of the expected selling prices of WESCO and the Australian subsidiary of DCBU; a decision to sell in bulk a Financial Services residential development that the Corporation, upon adoption of the Plan, had intended to develop; and a revision to the estimated interest costs expected to be incurred by the Discontinued Operations during the disposal period.\nOn January 31, 1994, the Corporation completed the sale of DCBU, excluding its Australian subsidiary, to Eaton Corporation for a purchase price of $1.1 billion and the assumption by the buyer of certain liabilities. The sale of the Australian subsidiary was completed in March 1994.\nOn February 28, 1994, the Corporation completed the sale of WESCO to an affiliate of Clayton, Dubilier & Rice, Inc., a private investment firm, for a purchase price of approximately $340 million. The proceeds consisted of approximately $275 million in cash, approximately $50 million in first mortgage notes, and the remainder in stock and options of the new company.\nThe portfolio investments of Financial Services have been reduced from $8,967 million at year-end 1992 to $1,230 million at December 31, 1994. Substantially all of the remaining real estate assets of $297 million at December 31, 1994 are expected to be liquidated in 1995. The Financial Services corporate portfolio essentially has been liquidated. The leasing portfolio, which totalled $924 million at December 31, 1994, is expected to continue to liquidate through 2015 in accordance with contractual terms.\nThe assets and liabilities of Discontinued Operations have been separately classified on the balance sheet as net assets (liabilities) of Discontinued Operations. A summary of these assets and liabilities follows:\nNET ASSETS (LIABILITIES) OF DISCONTINUED OPERATIONS (in millions)\nOf the remaining $1.2 billion of net debt of Discontinued Operations, approximately $700 million is expected to be repaid in 1995. Approximately $300 million is expected to be repaid through the liquidation of portfolio investments of Financial Services. The remaining 1995 debt repayment of $400 million will occur as cash is received from Continuing Operations, the timing of which is expected to coincide with sales of non-strategic businesses. The Corporation expects to reduce the debt of Discontinued Operations to that amount which is supportable by the leasing portfolio and can be repaid as that portfolio liquidates over its contractual term. As a result, additional cash may be required from Continuing Operations.\nThe cash receipts from Continuing Operations represent reimbursements for deferred income tax benefits related to the prior losses of Discontinued Operations that have been or are expected to be utilized by the Corporation to offset tax obligations of Continuing Operations.\nManagement believes that the combination of the net proceeds anticipated from the continued liquidation of assets of Discontinued Operations and from the ultimate realization of deferred income tax benefits will be sufficient to fund Discontinued Operations. Management further believes that the liability for the estimated loss on disposal of Discontinued Operations is adequate. The adequacy of this liability is evaluated each quarter.\nPortfolio Investments Portfolio investments by category of investment and financing at December 31, 1994 and 1993 are summarized in the table below:\nPORTFOLIO INVESTMENTS (in millions)\nOther portfolio investments at December 31, 1994 and 1993 included the Corporation's investment in LW Real Estate Investments, L.P. (LW) of $133 million in both periods, real estate properties of $88 million and $141 million, respectively, and other investments of $96 million and $215 million, respectively, primarily consisting of investments in real estate and leasing partnerships. The remaining portfolio investments, other than the leasing assets, are expected to be substantially liquidated by the end of 1995.\nNon-earning receivables at December 31, 1994 and 1993 totalled $30 million. There were no reduced earning receivables at December 31, 1994 and 1993.\nLeasing receivables consist of direct financing and leveraged leases. At December 31, 1994 and 1993, 81% and 77%, respectively, related to aircraft and 18% and 19%, respectively, related to cogeneration facilities. Certain leasing receivables classified as performing and totalling $139 million at December 31, 1994 have been identified by management as potential problem receivables. This amount consists primarily of leveraged leases related to aircraft leased by major U.S. airlines. Such leasing receivables were current as to payments and performing in accordance with contractual terms at December 31, 1994.\nThe components of the Corporation's net investment in leases at December 31, 1994 and 1993 are as follows:\nNET INVESTMENT IN LEASES (in millions)\nAt December 31, 1994 and 1993, deferred investment tax credits totalled $25 million and $34 million, respectively. These deferred investment tax credits are recognized as income over the contractual terms of the respective leases.\nContractual maturities for the Corporation's leasing receivables at December 31, 1994 are as follows:\nCONTRACTUAL MATURITIES FOR LEASING RECEIVABLES (in millions)\nLiability for Estimated Loss on Disposal\nAt the beginning of 1992, the Financial Services valuation allowance totalled $2,330 million. During the first eleven months of 1992, Financial Services wrote off portfolio investments totalling $1,126 million and made additional provisions totalling $205 million. Upon adoption of the Plan in November 1992, the balance of $1,409 million became part of the liability for estimated loss on disposal of Discontinued Operations.\nThe following table is a reconciliation of the liability for the estimated loss on disposal of Discontinued Operations from the adoption of the Plan through December 31, 1994:\nLIABILITY FOR ESTIMATED LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS (in millions)\nTransfers among Plan components have been made to better reflect estimated reserve requirements until completion of the Plan. The ending balance of $145 million is reflected on the summary of net assets (liabilities) of Discontinued Operations as one amount. Any variances from estimates which may occur for one Plan component will be considered in conjunction with those for other components in determining whether an adjustment of the total liability is necessary.\nIn accordance with APB 30, the consolidated financial statements reflect the operating results of Discontinued Operations separately from Continuing Operations. Summarized operating results of Discontinued Operations follow:\nOPERATING RESULTS OF DISCONTINUED OPERATIONS (in millions)\nNOTE 3: PENSIONS\nThe Corporation has various pension arrangements covering substantially all employees. Most plan benefits are based on either years of service and compensation levels at the time of retirement or a formula based on career earnings. Pension benefits are paid from trusts funded by contributions from employees and the Corporation. The pension funding policy for qualified plans is consistent with the funding requirements of U.S. federal and other government laws and regulations. Plan assets consist primarily of listed stocks, fixed income securities and real estate investments. Included in plan assets at December 31, 1994 are 5,612,600 shares of the Corporation's common stock having a market value of approximately $69 million. Dividends paid by the Corporation during 1994 on shares held by the pension fund totalled approximately $2 million.\nNET PERIODIC PENSION COSTS (in millions)\nNet periodic pension cost increased $103 million in 1994 compared to 1993, due primarily to changes in pension plan assumptions and reduced levels of anticipated asset earnings.\n1994 Pension Settlement\nThe Corporation's restructuring activities contributed to a high level of lump sum cash distributions from the Corporation's pension fund during 1994. The magnitude of these cash distributions required that the Corporation apply the provisions of SFAS No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits,\" and recognize a settlement loss of $308 million during the fourth quarter of 1994. This noncash charge to income represents the pro-rata portion of unrecognized losses associated with the pension obligation that was settled.\nA curtailment charge of $22 million related to the 1993 restructuring initiative was included in the loss from Continuing Operations for the year ended December 31, 1993. See note 19 to the financial statements. In addition, $54 million was included in the estimated loss on disposal of Discontinued Operations for the year ended December 31, 1992 in accordance with the provisions of SFAS No. 88.\nSIGNIFICANT PENSION PLAN ASSUMPTIONS\nThe requirement of SFAS No. 87 to adjust the discount rate to reflect current and expected-to-be-available interest rates on high quality fixed income investments resulted in the increase in the Corporation's assumed discount rate from 7.25%, which was used at December 31, 1993, to 8.5% at December 31, 1994.\nFUNDING STATUS--PENSIONS (in millions)\nDuring 1994, the Corporation contributed $310 million to its pension plans. The 1993 pension contribution, which totalled $273 million, consisted primarily of assets of Discontinued Operations.\nThe unfunded accumulated benefit obligation at December 31, 1994 decreased by $108 million compared to December 31, 1993. This decrease resulted from the net effect of numerous factors including 1994 employer contributions, negotiated pension plan changes, the discount rate assumption change, current year service and interest costs, and 1994 actuarial losses.\nFor financial reporting purposes, a pension plan is considered unfunded when the fair value of plan assets is less than the accumulated benefit obligation. When that is the case, a minimum pension liability must be recognized for the sum of the unfunded amount plus any prepaid pension cost. In recognizing such a liability, an intangible asset is usually recorded. However, the amount of the intangible asset may not be greater than the sum of the prior service cost not yet recognized and the unrecognized transition obligation as shown in the Funding Status table. When the liability to be recognized is greater than the intangible asset limit, a charge must be made to shareholders' equity for the difference, net of any tax effects which could be recognized in the future.\nAt December 31, 1994, a minimum pension liability of $1,577 million was recognized for the sum of the unfunded amount of $1,174 million plus the prepaid pension cost of $403 million. An intangible asset of $114 million and a charge to shareholders' equity of $1,463 million, which was reduced to $962 million due to tax deferrals of $501 million, offset the pension liability. As a result of this remeasurement, year-end 1994 shareholders' equity was increased by $253 million from December 31, 1993.\nAt December 31, 1993, a minimum pension liability of $2,143 million was recognized for the sum of the unfunded amount of $1,282 million plus the prepaid pension cost of $861 million. An intangible asset of $295 million and a charge to shareholders' equity of $1,848 million, which was reduced to $1,215 million due to tax deferrals of $633 million, offset the pension liability.\nNOTE 4: POSTRETIREMENT BENEFITS OTHER THAN PENSIONS AND POSTEMPLOYMENT BENEFITS\nThe Corporation has defined benefit postretirement plans that provide medical, dental and life insurance for eligible retirees and dependents.\nThe components of net periodic postretirement benefit cost follow:\nNET PERIODIC POSTRETIREMENT BENEFIT COST (in millions)\nThe adoption of SFAS No. 106 on the immediate recognition basis, concurrent with the adoption of SFAS No. 109 as of January 1, 1992, resulted in a net charge to first quarter 1992 earnings of $742 million, net of $431 million of deferred income tax benefits.\nSIGNIFICANT POSTRETIREMENT BENEFIT PLAN ASSUMPTIONS\nThe Corporation's accumulated postretirement benefit obligation consists of the following:\nFUNDING STATUS--POSTRETIREMENT BENEFITS (in millions)\nThe accumulated postretirement benefit obligation was calculated using the terms of the Corporation's medical, dental and life insurance plans, including the effects of established maximums on covered costs.\nThe effect of a 1% annual increase in the assumed health care cost trend rates would increase the accumulated postretirement benefit obligation by approximately $67 million and would increase net periodic postretirement benefit cost by approximately $7 million.\nCertain of the Corporation's non-U.S. subsidiaries have private and government- sponsored plans for retirees. The cost of these plans is not significant to the Corporation.\nThe Corporation provides certain postemployment benefits to former or inactive employees and their dependents during the time period following employment but before retirement. In December 1993, the Corporation adopted retroactive to January 1, 1993, SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" Prior to 1993, postemployment benefits were recognized primarily as they were paid. The Corporation's charge for adoption of SFAS No. 112 at January 1, 1993 was $56 million, net of $30 million of deferred taxes, and was immediately recognized as the cumulative effect of a change in accounting for postemployment benefits.\nAt December 31, 1994 and 1993, the Corporation's liability for postemployment benefits totalled $77 million and $91 million, respectively.\nNOTE 5: INCOME TAXES\nINCOME TAXES FROM CONTINUING OPERATIONS (in millions)\nCONSOLIDATED INCOME TAXES (in millions)\nDeferred federal income taxes for 1993 include a benefit of $62 million resulting from the enactment of an increase in the statutory federal income tax rate from 34% to 35%.\nIncome tax expense (benefit) included in the consolidated financial statements follows:\nCOMPONENTS OF CONSOLIDATED INCOME TAXES (in millions)\nIn addition to the amounts in the table above, during 1994, 1993 and 1992, $132 million of income tax expense, $378 million of income tax benefit and $255 million of income tax benefit, respectively, were recorded against shareholders' equity as a result of the pension liability adjustment. See note 3 to the financial statements.\nIn January 1992, the Corporation adopted SFAS No. 109. This statement replaced SFAS No. 96 which the Corporation had used to account for income taxes since 1988. The effect of adopting SFAS No. 109 on the Corporation was to permit the recognition of deferred tax benefits as shown in the following table:\nDEFERRED TAX BENEFITS RECOGNIZED UPON ADOPTION OF SFAS NO. 109 (in millions)\nThe foreign portion of income or loss before income taxes and minority interest in income of consolidated subsidiaries in the consolidated statement of income consisted of losses of $34 million in 1994 and $6 million in 1993 and income of $61 million in 1992. Such income or loss consisted of profits and losses generated from foreign operations and can be subject to both U.S. and foreign income taxes.\nDeferred federal income taxes have not been provided on cumulative undistributed earnings from foreign subsidiaries, totalling $383 million at December 31, 1994, in which the earnings have been reinvested for an indefinite time. It is not practicable to determine the income tax liability that would result were such earnings repatriated. The amount of withholding taxes that would be payable upon such repatriation is estimated to be $24 million.\nIncome from Continuing Operations includes income of certain manufacturing operations in Puerto Rico which are eligible for tax credits against U.S. federal income tax and partially exempt from Puerto Rican income tax under grants of industrial tax exemptions. These tax exemptions provided net tax benefits of $17 million in 1994, $21 million in 1993 and $21 million in 1992. The exemptions will expire at various dates from 2002 through 2007.\nDeferred income taxes result from temporary differences in the financial bases and tax bases of assets and liabilities. The types of differences that give rise to significant portions of deferred income tax liabilities or assets are shown in the accompanying table:\nCONSOLIDATED DEFERRED INCOME TAX SOURCES (in millions)\nThe valuation allowance for deferred taxes represents foreign tax credits not anticipated to be utilized and operating loss carryforwards of certain foreign subsidiaries. The net balance of deferred income taxes is intended to offset income taxes on future taxable income expected to be earned by the Corporation's continuing businesses.\nAt December 31, 1994, for federal income tax purposes, there were regular tax net operating loss carryforwards of $472 million which expire by the year 2007, $2,472 million which expire by the year 2008, alternative minimum tax operating loss carryforwards of $123 million which expire by the year 2007 and $2,462 million which expire by the year 2008 and alternative minimum tax credit carryforwards of $261 million which have no expiration date. At December 31, 1994, there were $183 million of net operating loss carryforwards attributable to foreign subsidiaries. Of this total, approximately $28 million has no expiration date. The remaining amount will expire not later than 2001. A valuation allowance has been established for $58 million of the deferred tax benefit related to those loss carryforwards for which it is considered likely that the benefit will not be realized.\nEFFECTIVE TAX (BENEFIT) RATE FOR CONTINUING OPERATIONS\nEFFECTIVE TAX (BENEFIT) RATE FOR CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES\nThe federal income tax returns of the Corporation and its wholly owned subsidiaries are settled through the year ended December 31, 1986. The Corporation has reached a tentative agreement with the Internal Revenue Service regarding intercompany pricing adjustments applicable to operations in Puerto Rico for the years 1987 through 1992. Management believes that adequate provisions for taxes have been made through December 31, 1994.\nNOTE 6: CUSTOMER RECEIVABLES\nCustomer receivables at December 31, 1994 included $197 million which represented the sales value of material shipped under long-term contracts but not billed to the customer and $72 million which represented claims receivable on terminated or nondefinitized government contracts. Such claims are recorded only when collectibility is assured. Billings will occur upon shipment of major components of the contract or upon definitive resolution of the outstanding claims, respectively. Collection of these receivables is expected to be substantially completed within one year.\nAllowances for doubtful accounts of $59 million and $54 million at December 31, 1994 and 1993, respectively, were deducted from customer receivables.\nAt December 31, 1994 and 1993, approximately 10% and 8%, respectively, of the Corporation's customer receivables were from sales on open account with various agencies of the U.S. government, which is the Corporation's largest single customer. The Corporation performs ongoing credit evaluations of its customers and generally does not require collateral.\nNOTE 7: INVENTORIES AND COSTS AND BILLINGS ON UNCOMPLETED CONTRACTS\nINVENTORIES (in millions)\nCOSTS AND BILLINGS ON UNCOMPLETED CONTRACTS (in millions)\nRaw materials, work in process and finished goods included contract-related costs of approximately $811 million at December 31, 1994, and $770 million at December 31, 1993. Substantially all costs in long-term contracts in process, progress payments to subcontractors, and recoverable engineering and development costs were contract-related.\nInventories other than those related to long-term contracts are generally realized within one year. Inventoried costs do not exceed realizable values.\nNOTE 8: PLANT AND EQUIPMENT\nPLANT AND EQUIPMENT (in millions)\nFor the years ended December 31, 1994 and 1993, depreciation expense totalled $275 million and $272 million, respectively. Of these amounts, $252 million and $253 million, respectively, is included in costs of products and services, and $23 million and $19 million, respectively, is included in marketing, administrative and general expenses.\nNOTE 9: INTANGIBLE AND OTHER NONCURRENT ASSETS\nINTANGIBLE AND OTHER NONCURRENT ASSETS (in millions)\nGoodwill and other acquired intangible assets are shown net of accumulated amortization of $162 million and $139 million at December 31, 1994 and 1993, respectively.\nJoint ventures and other affiliates include investments in companies over which the Corporation exercises significant influence but does not control.\nNOTE 10: SHORT-TERM DEBT\nOn August 5, 1994, the Corporation replaced its December 1991 revolver with two revolving credit agreements (revolvers). The facilities have a combined commitment level of $2.5 billion, with $2.0 billion maturing on August 4, 1997 (three-year revolver) and $500 million maturing on August 4, 1995 (364-day revolver). Contemporaneous with entering into the revolvers, outstanding borrowings under the December 1991 revolver were repaid with borrowings from the three-year revolver.\nAvailability under the revolvers is subject to compliance with certain covenants, representations and warranties, including a no material adverse change provision with respect to the Corporation taken as a whole, restrictions on the incurrence of liens, a maximum leverage ratio, minimum interest coverage ratio and minimum consolidated net worth. Certain of these covenants become more restrictive over the terms of the revolvers. At December 31, 1994, the Corporation was in compliance with these covenants.\nInterest rates for borrowings under the revolvers are determined at the time of each borrowing and are based on one of a variety of floating rate indices plus a margin based on the Corporation's debt ratings. The indices include the following: London Interbank Offer Rate (LIBOR), certificate of deposit rate and prime rate. The cost of the revolvers includes facility fees which are based on the Corporation's debt ratings and are assessed on the revolver commitment level.\nThe interest rates for the borrowings under the revolvers at December 31, 1994 and 1993 were based on LIBOR. There are no compensating balance requirements under the revolvers.\nAs a result of rating agency actions and management's assessment of the capital markets in October 1992, the Corporation discontinued the sale of commercial paper and replaced this debt with borrowings under the December 1991 revolver.\nSHORT-TERM DEBT--CONTINUING OPERATIONS (in millions)\nAverage outstanding borrowings for Continuing Operations were determined based on daily amounts outstanding for the revolving credit facilities and commercial paper, and on monthly balances outstanding for short-term foreign bank loans.\nDuring the fourth quarter of 1994, $625 million of revolving credit borrowings were transferred from Discontinued Operations to Continuing Operations.\nSHORT-TERM DEBT--DISCONTINUED OPERATIONS (in millions)\nAverage outstanding borrowings for Discontinued Operations were determined based on daily amounts outstanding for revolving credit facilities and commercial paper.\nTo manage interest costs on its short-term and long-term debt, Financial Services entered into various types of interest rate and currency exchange agreements. In connection with the fourth quarter 1994 transfer of revolving credit borrowings, $272 million of related fixed rate interest rate swaps were transferred to Continuing Operations. A summary of notional amounts outstanding at December 31, 1994 and 1993 is presented in the table below:\nINTEREST RATE AND CURRENCY EXCHANGE AGREEMENTS NOTIONAL AMOUNTS OUTSTANDING (in millions)\nThe $655 million decrease during 1994 in the total notional amount outstanding was due to the maturity of several agreements. The average remaining maturity of interest rate and currency exchange agreements was 1.5 years and 1.6 years at December 31, 1994 and 1993, respectively.\nOf the total notional amount outstanding at year-end 1994, $422 million relates to interest rate swaps with rate and maturity characteristics set forth in the table below:\nCONTRACTUAL MATURITIES OF INTEREST RATE SWAPS (in millions)\nUnder the majority of the swap agreements, the floating rate received or paid is based on the average 30-day commercial paper rate for the relevant period. This rate was 6.0% on December 31, 1994. The floating rate received or paid on the remaining agreements is based on six month LIBOR and is set on dates specified in the agreements. This rate was 7.0% on December 31, 1994.\nThe remaining $249 million notional amount outstanding at December 31, 1994 consists of a $25 million forward interest rate swap agreement, which is exercisable at the option of a counterparty, a $150 million interest rate floor agreement and a $74 million interest rate and currency swap.\nAt December 31, 1993, interest rate swap agreements in which Financial Services paid a fixed interest rate totalled $575 million and had a weighted average rate of 8.7% with an average remaining maturity of 1.3 years. In addition, those interest rate swap agreements in which Financial Services received a fixed interest rate totalled $430 million at December 31, 1993 and had a weighted average rate of 8.1% with an average remaining maturity of approximately 10 months.\nThe remaining $321 million notional amount outstanding at December 31, 1993 includes $80 million of forward interest rate exchange agreements, a $150 million interest rate floor agreement, $83 million of interest rate and currency exchange agreements and an $8 million basis swap agreement.\nNOTE 11: OTHER CURRENT LIABILITIES\nOTHER CURRENT LIABILITIES (in millions)\nNOTE 12: LONG-TERM DEBT\nLONG-TERM DEBT--CONTINUING OPERATIONS (in millions)\nAt December 31, 1994, medium-term notes of Continuing Operations had interest rates ranging from 8.5% to 9.4%, with an average interest rate of 8.91% and an average remaining maturity of 3.5 years.\nIn September 1993, the Corporation issued $275 million of 6-7\/8% notes due September 1, 2003 and $325 million of 7-7\/8% debentures due September 1, 2023. These notes and debentures were offered at a discount and were issued under the Corporation's $1 billion shelf registration, of which $400 million was unused as of December 31, 1994.\nLONG-TERM DEBT--DISCONTINUED OPERATIONS (in millions)\nAt December 31, 1994, medium-term notes of Discontinued Operations had interest rates ranging from 5.9% to 9.4%, with an average interest rate of 8.88% and an average remaining maturity of 2.4 years.\nDuring 1994, $623 million of medium-term notes were repaid at maturity. In addition, all of the interest rate swaps associated with the Corporation's medium-term notes matured.\nAt December 31, 1994, $4 million of medium-term notes issued on a variable-rate basis had an interest rate of 7.08%, while $420 million of medium-term notes issued on a fixed-rate basis had a weighted average interest rate of 8.89%.\nAt December 31, 1993, $291 million of medium-term notes had been issued either on a variable-rate basis or swapped to a variable-rate basis. A total of $11 million of these notes were issued on a variable-rate basis with an interest rate of 3.85% on December 31, 1993. The remaining $280 million were issued on a fixed-rate basis with a weighted average interest rate of 7.71% and, through interest rate swap agreements, were converted to a floating-rate basis with a weighted average interest rate of 3.69% on December 31, 1993.\nAt December 31, 1993, $756 million of medium-term notes had been issued either on a fixed-rate basis or swapped to a fixed-rate basis. Approximately $706 million of these notes were issued on a fixed-rate basis with a weighted average interest rate of 8.86% on December 31, 1993. The remaining $50 million of these notes had been issued on a floating-rate basis with an interest rate of 4.3% and, through an interest rate swap agreement, were converted to a fixed-rate basis with an interest rate of 5.3% on December 31, 1993.\nAt December 31, 1993, the average interest rate, after the effects of the interest rate swap agreements, was 7.2%, and the average remaining maturity for all medium-term notes was 1.6 years.\nAt December 31, 1994 and 1993, all of the 8-7\/8% senior notes due 1995 were subject to an interest rate swap agreement as well as an interest rate floor agreement. The net effect of these agreements reduced the effective interest rate on these notes to 7.4% for both years.\nNone of the Corporation's long-term debt outstanding at December 31, 1994 or 1993 may be redeemed prior to maturity.\nThe scheduled maturities of the Corporation's total long-term debt outstanding at December 31, 1994 for each of the next five years are as follows: 1995--$247 million; 1996--$588 million; 1997--$5 million; 1998--$156 million; and 1999--$47 million.\nNOTE 13: OTHER NONCURRENT LIABILITIES\nOTHER NONCURRENT LIABILITIES (in millions)\nNOTE 14: SHAREHOLDERS' EQUITY\nSHAREHOLDERS' EQUITY (in millions)\nIn March 1994, the Corporation sold, in a private placement, 36,000,000 depositary shares (the $1.30 Depositary Shares) at $14.44 per share. Each of the $1.30 Depositary Shares represents ownership of one-tenth of a share of the Corporation's $1.00 par value Series C Conversion Preferred Stock (Series C Preferred) and entitles the owner to all of the proportionate rights, preferences and privileges of the Series C Preferred. A total of 3,600,000 Series C Preferred shares were deposited.\nThe net proceeds to the Corporation, after commissions, fees and out-of-pocket expenses, totalled $505 million. As a result, the par value of Series C Preferred was established for $4 million, and capital in excess of par was increased by $501 million.\nThe annual dividend rate for each $1.30 Depositary Share is $1.30 (equivalent to $13.00 for each Series C Preferred), payable quarterly in arrears on the first day of March, June, September and December. Dividends are cumulative and must be declared by the Board of Directors to be payable. Payments commenced on June 1, 1994.\nEach $1.30 Depositary Share will automatically convert into one share of common stock on June 1, 1997 unless called on May 30, 1997 by the Corporation or redeemed at any time prior to June 1 by the holder. If called by the Corporation, each $1.30 Depositary Share will convert into common stock at a rate between .885 and 1 share. If redeemed by the holder, each $1.30 Depositary Share will convert into .885 of a share of common stock. Conversion of the outstanding $1.30 Depositary Shares (and the Series C Preferred) will also occur upon certain mergers, consolidations or similar extraordinary transactions involving the Corporation or in connection with certain events, as described in the Offering Memorandum.\nIn June 1992, the Corporation sold 32,890,000 depositary shares (the $1.53 Depositary Shares) at $17.00 per share. Each of the $1.53 Depositary Shares represents ownership of one-quarter of a share of the Corporation's $1.00 par value Series B Conversion Preferred Stock (Series B Preferred) and entitles the owner to all of the proportionate rights, preferences and privileges of the Series B Preferred. A total of 8,222,500 Series B Preferred shares were deposited.\nThe net proceeds to the Corporation from the sale of the $1.53 Depositary Shares, after commissions, fees and out-of-pocket expenses, totalled $543 million. As a result, the par value of Series B Preferred was established for $8 million, and capital in excess of par value was increased by $535 million.\nThe annual dividend rate for each $1.53 Depositary Share is $1.53 (equivalent to $6.12 for each Series B Preferred), payable quarterly in arrears on the first day of March, June, September and December. Dividends are cumulative and must be declared by the Board of Directors to be payable. Payments commenced on September 1, 1992.\nOn September 1, 1995, each of the outstanding $1.53 Depositary Shares will automatically convert into (i) one share of common stock (equivalent to four shares for each Series B Preferred) subject to adjustment if certain events occur, and (ii) the right to receive in cash all accrued and unpaid dividends thereon, or, in certain circumstances, a number of shares of common stock equal to 110% of such cash amount divided by the market value of the common stock. Conversion of the outstanding $1.53 Depositary Shares (and the Series B Preferred) will also occur upon certain mergers, consolidations or similar extraordinary transactions involving the Corporation or in connection with certain other events, as described in the prospectus.\nPrior to September 1, 1995, the Corporation may call the outstanding Series B Preferred (and thereby the $1.53 Depositary Shares) for redemption. Upon any such redemption, each owner of $1.53 Depositary Shares will receive, in exchange for each $1.53 Depositary Share, shares of common stock having a market value initially equal to $26.23 (equivalent to $104.92 for each Series B Preferred), declining by $.002095 (equivalent to $.008380 for each Series B Preferred) on each day following the date of issue of the Series B Preferred to $23.93 (equivalent to $95.72 for each Series B Preferred) on July 1, 1995, and equal to $23.80 (equivalent to $95.20 for each Series B Preferred) thereafter (the Call Price), plus an amount in cash equal to all proportionate accrued and unpaid dividends thereon.\nAt December 31, 1994 and 1993, 8,222,500 shares of Series B Preferred were issued and outstanding. At December 31, 1994, 3,600,000 shares of Series C Preferred were issued and outstanding.\nCOMMON SHARES (shares in thousands)\nEarnings (loss) per common share is computed by dividing income, after deducting the preferred dividend requirements, by the weighted average number of common shares outstanding during the year plus the weighted average common stock equivalents. Common stock equivalents consist of shares subject to stock options, shares potentially issuable under deferred compensation programs and the Series B Preferred. For this computation, net income or loss was adjusted for the after-tax interest expense applicable to the deferred compensation programs.\nFor the calculation of primary and fully diluted earnings per share, the Series B Preferred are considered common stock equivalents at a rate of four Series B Preferred to one common share. The Series C Preferred are considered outstanding common stock at a rate of ten Series C Preferred to one common share.\nWhen the Series B Preferred have an anti-dilutive effect on earnings per share, the related common stock equivalent shares are excluded from weighted average shares outstanding and the dividend requirement is deducted from net income in computing earnings available to common shareholders. During 1994 and 1993, the Series B Preferred shares were anti-dilutive for earnings per share calculations. During 1992, the Series B Preferred shares were dilutive for the earnings per share calculation in the second quarter, and anti-dilutive for the third and fourth quarters and for the full year.\nIn accordance with prevalent practice at the time of issuance, the Series C Preferred were treated as outstanding common stock for the calculation of earnings per share during 1994. If the Series C Preferred had been treated as common stock equivalents for the calculation of earnings per share, the Corporation's 1994 per share results would have been a loss of $.02.\nThe weighted average number of common shares used for computing earnings or loss per share was 383,736,000 in 1994, 352,902,000 in 1993 and 346,103,000 in 1992.\nNOTE 15: STOCK OPTIONS AND OTHER LONG-TERM INCENTIVE COMPENSATION AWARDS\nThe 1993, 1991 and 1984 Long-Term Incentive Plans provide for the granting of stock options and other performance awards to employees of the Corporation.\nAt December 31, 1994 and 1993, approximately 7.5 million and 4 million shares, respectively, had been authorized for awards under the 1993 Plan. Shares available for stock options and other awards under the 1993 Plan at December 31, 1994 and 1993 totalled 3,435,107 and 1,787,500, respectively. At December 31, 1994 and 1993, an aggregate of 22.2 million and 19.2 million shares, respectively, had been authorized for awarding under the 1991 and 1984 Plans. Shares available for stock options and other awards under the 1991 and 1984 Plans at December 31, 1994 and 1993 totalled 1,815,457 and 2,141,708, respectively.\nThe option price under the Plans may not be less than the fair market value of the shares on the grant date. The options were granted for terms of 10 years and generally become exercisable in whole or in part after the commencement of the second year of the term.\nGenerally, options outstanding under the 1984, 1991 and 1993 Plans, except those granted during 1994, were exercisable at December 31, 1994. Options granted during 1994 under the 1993 Plan will not be exercisable until 1995. Outstanding options have expiration dates ranging from 1995 through 2004.\nSTOCK OPTION INFORMATION (shares in thousands)\nDuring 1994, 1993 and 1992, Equity Plus dollar grants totalling approximately $17 million for the 1992 to 1994 measurement period were granted to employees of the Corporation. Equity Plus dollar grants have the potential to increase in value through both financial performance and stock price appreciation. Payment of these grants is approved by a committee of the Board of Directors and is contingent on achieving performance targets over the measurement period. Certain of these grants were prorated or cancelled upon termination of employment. In February 1995, 154,300 shares of Westinghouse common stock and cash payments totalling $81,000 were issued to employees, and deferrals with future principal payments of $1,761,000 or 127,500 shares of Westinghouse common stock were made for these Equity Plus grants.\nNOTE 16: CONTINGENT LIABILITIES AND COMMITMENTS\nUranium Settlements\nThe Corporation had previously provided for the estimated future costs for the resolution of all uranium supply contract suits and related litigation. The remaining uranium reserve balance includes assets required for certain settlement obligations and reserves for estimated future costs. The reserve balance at December 31, 1994, is deemed adequate considering all facts and circumstances known to management. The future obligations require providing the remainder of the fuel deliveries running through 2013 and the supply of equipment and services through approximately 1995. Variances from estimates which may occur are considered in determining if an adjustment of the liability is necessary.\nLitigation\nPhilippines\nIn December 1988, a 15-count lawsuit was filed against the Corporation alleging bribery and other fraudulent conduct in connection with the construction of a nuclear power plant in the Philippines. Of the 15 claims, 14 were stayed pending arbitration before the International Chamber of Commerce (ICC). With respect to the remaining count alleging bribery, a jury verdict was rendered in favor of the Corporation on May 18, 1993, but is expected to be appealed. A similar finding was made by the ICC in 1991. Arbitration proceedings before the ICC on issues relating to the construction of the plant were concluded in October 1994, and the parties await a decision.\nSteam Generators\nThe Corporation has been defending various lawsuits brought by utilities claiming a substantial amount of damages in connection with alleged tube degradation in steam generators sold by the Corporation as components of nuclear steam supply systems. Settlement agreements have been entered resolving six litigation claims. These agreements generally require the Corporation to provide certain products and services at prices discounted at varying rates. Two cases were resolved in favor of the Corporation after trial or arbitration, although an appeal has been filed in one of the cases. Four lawsuits are pending.\nThe Corporation is also a party to six tolling agreements with utilities or utility plant owners' groups. The tolling agreements delay initiation of any litigation for various specified periods of time and permit the parties time to engage in discussions.\nSecurities Class Actions--Financial Services\nThe Corporation is defending derivative and class action lawsuits alleging federal securities law and common law violations arising out of purported misstatements or omissions contained in the Corporation's public filings concerning the financial condition of the Corporation and certain of its former subsidiaries in connection with charges to earnings of $975 million in 1990 and $1,680 million in 1991 and a public offering of Westinghouse common stock in 1991.\nLitigation is inherently uncertain and always difficult to predict. Substantial damages are sought in each of the foregoing cases and although management believes a significant adverse judgment is unlikely, any such judgment could have a material adverse effect on the Corporation's results of operations for a quarter or a year. However, based on its understanding and evaluation of the relevant facts and circumstances, management believes that the Corporation has meritorious defenses to the litigation described above, and management believes that the litigation should not have a material adverse effect on the financial condition of the Corporation.\nEnvironmental Matters\nCompliance with federal, state and local regulations relating to the discharge of substances into the environment, the disposal of hazardous wastes and other related activities affecting the environment have had and will continue to have an impact on the Corporation. While it is difficult to estimate the timing and ultimate costs to be incurred in the future due to uncertainties about the status of laws, regulations, technology and information available for individual sites, management has estimated the total probable and reasonably possible remediation costs that could be incurred by the Corporation based on the facts and circumstances currently known.\nPRP Sites\nWith regard to remedial actions under federal and state Superfund laws, the Corporation has been named as a potentially responsible party (PRP) at numerous sites located throughout the country. At many of these sites, the Corporation is either not a responsible party or its site involvement is very limited or de minimis. However, the Corporation may have varying degrees of cleanup responsibilities at 54 sites. With regard to cleanup costs at these sites, in many cases the Corporation will share these costs with other responsible parties and the Corporation believes that any liability incurred will be satisfied over a number of years. Management believes that the Corporation's total remaining probable costs for remediation of these sites as of December 31, 1994 are approximately $73 million, all of which has been accrued.\nBloomington Sites\nThe Corporation is a party to a 1985 Consent Decree relating to remediation of six sites in Bloomington, Indiana and has additional responsibility for two other sites in Bloomington. In the Consent Decree, the Corporation agreed to construct and operate an incinerator, which would be permitted under federal and state law, to burn excavated material.\nOn February 8, 1994, the Consent Decree parties filed with the court a status report advising of the parties' intention to investigate alternatives. The Corporation believes it is probable that the Consent Decree will be modified to an alternate remedial action, which could include a combination of containment, treatment, remediation and monitoring. As a result, the Corporation estimates that its cost to implement the most reasonable and likely alternative would total approximately $70 million for the eight sites, all of which has been accrued. Approximately $18 million of this estimate represents the present value, assuming a 5% discount rate, of operating and maintenance costs which will be incurred over an approximate 30-year period. The undiscounted cost of operating and maintenance expenditures approximates $46 million. The remaining portion of the $70 million estimate represents site construction and other related costs and is valued as of the year of expenditure. Other alternatives, while considered less likely, could cause such costs to be as much as $125 million.\nThe parties recognize that at the end of the process, they may conclude that the remedy currently provided in the Consent Decree is the most appropriate. The parties also recognize that the Consent Decree shall remain in full force during this process.\nOther\nThe Corporation is involved with several administrative actions alleging violations of federal, state or local environmental regulations. For these matters the Corporation has estimated its remaining reasonably possible costs and determined them to be insignificant.\nThe Corporation currently manages under contract several government-owned facilities, which among other things are engaged in the remediation of hazardous and nuclear wastes. To date, under the terms of the contracts, the Corporation is not responsible for costs associated with environmental liabilities, including environmental cleanup costs, except under certain circumstances associated with negligence and willful misconduct. There are currently no known claims for which the Corporation believes it is responsible. In 1994, the U.S. Department of Energy (DOE) announced its intention to renegotiate its existing contracts for maintenance and operation of DOE facilities to further address environmental issues.\nThe Corporation has or will have responsibilities for environmental closure activities, such as dismantling incinerators or decommissioning nuclear licensed sites. The Corporation has estimated the total potential cost to be incurred for these actions to be approximately $112 million, of which $40 million had been accrued at December 31, 1994. The Corporation's policy is to accrue these costs over the estimated life of the individual facilities, which in most cases is approximately 20 years. The anticipated annual costs currently being accrued are $5 million.\nAs part of the agreements for the sales of certain of its businesses or sites, the Corporation has agreed to assume obligations for remediation as a result of contamination caused during the Corporation's operation of the sites. The Corporation has provided for all known environmental liabilities related to these agreements.\nCapital expenditures related to environmental remediation activities in 1994 and 1993 totalled $12 million and $5 million, respectively. Operating expenses which are recurring and associated with managing hazardous substances and pollution in ongoing operations in 1994 and 1993 totalled $25 million and $17 million, respectively.\nManagement believes that the Corporation has adequately provided for its present environmental obligations and that complying with existing government regulations will not materially impact the Corporation's financial position, liquidity or results of operations.\nInsurance Recoveries\nThe Corporation has filed actions against over 100 of its insurance carriers seeking recovery for environmental, product and property damage liabilities, and certain other matters. The Corporation has settled with several of these carriers and has received recoveries related to these actions. Amounts received to date generally have been applied to cover obligations assumed through the settlements or litigation costs. The Corporation has not accrued for any future insurance recoveries.\nFinancing Commitments\nDiscontinued Operations\nFinancial Services commitments with off-balance-sheet credit risk represent financing commitments to provide funds, including loan or investment commitments, guarantees, standby letters of credit and standby commitments, generally in exchange for fees. The remaining commitments have fixed expiration dates from 1995 through 2002.\nAt December 31, 1994, Financial Services commitments with off-balance-sheet credit risk totalled $80 million, compared to $111 million at year-end 1993. Of the $80 million of commitments at December 31, 1994, $71 million were guarantees, credit enhancements and other standby agreements and $9 million were commitments to extend credit. Of the $111 million of commitments at year-end 1993, $90 million were guarantees, credit enhancements and other standby agreements and $21 million were commitments to extend credit. Management expects the remaining commitments to either expire unfunded, be assumed by the purchaser in asset dispositions or be funded with the resulting assets being sold shortly after funding.\nContinuing Operations\nWCI Communities, Inc. (WCI) was contingently liable at December 31, 1994 under guarantees for $55 million of sewer and water district borrowings. The proceeds of the borrowings were used for sewer and water improvements on residential and commercial real estate projects of WCI. Management expects these borrowings to be repaid as the projects are completed and sold, and the guarantees for such borrowings to expire unfunded.\nIn the ordinary course of business, standby letters of credit are issued by commercial banks on behalf of the Corporation related to performance obligations primarily under contracts with customers.\nOther Commitments\nThe Corporation's other commitments consisting primarily of those for the purchase of plant and equipment totalled approximately $46 million at December 31, 1994.\nNOTE 17: LEASES\nThe Corporation has commitments under operating leases for certain machinery and equipment and facilities used in various operations. Rental expense for Continuing Operations in 1994, 1993 and 1992 was $182 million, $220 million and $225 million, respectively. These amounts include immaterial amounts for contingent rentals. Rental expense for 1994 included $18 million of sublease income, which was not material in 1993 or 1992.\nMINIMUM RENTAL PAYMENTS--CONTINUING OPERATIONS (in millions)\nNOTE 18: OTHER INCOME AND EXPENSES, NET\nOTHER INCOME AND EXPENSES, NET (in millions)\nThe Corporation recognized a pension settlement loss of $308 million during the fourth quarter of 1994. This noncash charge to income represents the pro-rata portion of unrecognized losses associated with the pension obligation that was settled. See note 3 to the financial statements.\nThe gain on disposition of other assets for the year ended December 31, 1994 includes a gain of $32 million from the sale of two Sacramento radio stations and a gain of $10 million from the sale of an investment in a shopping center development joint venture at WCI. The 1993 gain on disposition of other assets includes a gain of $21 million on the sale of an equity participation in a production company. See note 19 to the financial statements.\nThe expected losses on disposition of non-strategic businesses of $17 million and $195 million were recorded for the years ended December 31, 1994 and 1993, respectively, to reflect the Corporation's announced plan to dispose of these businesses. All items in the other category are less than $10 million each.\nNOTE 19: RESTRUCTURING, MERGERS, ACQUISITIONS AND DIVESTITURES\nRestructuring of Operations\nAn overview of the Corporation's recent restructuring actions follows:\nRestructuring of Operations--1993 Initiative\nShortly after joining the Corporation in June 1993, Chairman and Chief Executive Officer Michael Jordan initiated an extensive review by management of all of the Corporation's businesses. As a result of this review, management developed a plan to restructure its continuing businesses to improve productivity and operating performance. This plan was expected to result in the reduction of approximately 6,000 employees over the subsequent two years; approximately 2,600 through normal attrition and 3,400 through involuntary separations.\nGenerally, separated employees receive benefits under the Corporation's Employee Security and Protection (ES&P) Plan, including permanent job separation benefits, retraining and outplacement assistance. The amount included for these benefits in the restructuring charge represents the incremental cost of such benefits over those amounts previously accrued under SFAS No. 112.\nThe 1993 restructuring initiative involved substantially all of the Corporation's continuing businesses. For segment reporting purposes, a $104 million charge for corporate restructuring was allocated to the operating business segments. See note 20 to the financial statements. A summary of restructuring charges by business segment follows:\nRESTRUCTURING COSTS--1993 INITIATIVE (dollars in millions)\nExpenditures based on the Corporation's current estimates are expected to total $228 million for incremental employee separation and related costs, $68 million for asset writedowns and $54 million for facility closure and rationalization costs.\nEmployee costs primarily include severance, outplacement services and pension curtailment costs. The workforce reductions result primarily from the closing or consolidation of certain production facilities and the consolidation, centralization or redesign of administrative support functions.\nAsset writedowns are also attributable to management's plans to exit certain projects or to reengineer processes. Certain assets that are considered to be redundant or no longer required due to a process change or exit strategy have been written down to their net realizable value.\nFacility closure and rationalization costs include costs expected to be incurred from the consolidation of manufacturing facilities or product lines and closing of support offices.\nThrough December 31, 1994, employee reductions as a result of implementing the 1993 restructuring initiative totalled 3,181. Completion of the remaining involuntary separations is expected in 1995.\nThe following table is a reconciliation of accrued restructuring costs related to the 1993 initiative for the year ended December 31, 1994:\nRestructuring of Operations--1994 Initiative\nDuring the fourth quarter of 1994, management approved additional restructuring projects totalling $113 million primarily for costs associated with approximately 1,200 additional employee separations. Certain amounts accrued for restructuring in 1992 and miscellaneous adjustments were applied to these program costs to reduce the required restructuring charge to $71 million. At December 31, 1994, 534 employee separations were completed. While the remainder of the employees generally were notified of the pending actions, completion of the separations is not expected until the first half of 1995. Separated employees generally receive benefits under the Corporation's ES&P Plan. The following table presents the restructuring charges related to each business segment:\nRESTRUCTURING COSTS--1994 INITIATIVE (dollars in millions)\nThe asset writedowns and facility closure costs related to the 1994 initiative are specifically associated with exiting certain product lines and facilities.\nAdjustments in the table above include amounts that were redeployed from the 1992 restructuring program and minor modifications of the 1993 restructuring costs based on actual spending to date and estimated remaining costs under those programs.\nMergers, Acquisitions and Divestitures\nIn December 1994, the Corporation filed a Schedule 13D with the Securities and Exchange Commission wherein it announced its intention to consider the sale of the Corporation's 62% ownership interest in MICROS Systems, Inc. (MICROS), which is included in the Corporation's Electronic Systems segment. MICROS had sales for the year ended December 31, 1994 of approximately $100 million.\nIn August 1994, the Corporation signed a letter of intent to sell Aptus, Inc., an environmental services subsidiary, for a combination of cash and securities.\nIn July 1994, Westinghouse Broadcasting Company (Group W) and CBS, Inc. (CBS) announced an agreement to enter into a comprehensive strategic alliance that would establish long-term station affiliations between CBS and all of Group W's television stations; form new, jointly held entities that would expand both companies' distribution and programming capabilities nationwide; and merge their advertising sales representation operations. The agreement is subject to the execution of definitive documentation and approval by the Federal Communications Commission.\nIn June 1994, the Corporation sold its 40% interest in a shopping center development joint venture for net proceeds of $13 million, resulting in a gain of $10 million.\nIn May 1994, the Corporation acquired the Norden Unit of United Technologies Corporation. Norden manufactures airborne and shipboard radar systems, air traffic control systems, and surveillance and intelligence management systems for underseas applications.\nIn connection with its announced plan to dispose of certain non-strategic businesses, during 1994 the Corporation completed the sales of Gladwin Corporation and Controlmatic.\nIn January 1994, the Corporation sold its KFBK-AM and KGBY-FM radio stations located in Sacramento, California, for net proceeds of $48 million, resulting in a gain of $32 million.\nNOTE 20: SEGMENT INFORMATION\nWestinghouse is a diversified, global, technology-based corporation operating in the principal business arenas of television and radio broadcasting, defense electronics, environmental services, transport refrigeration and the electric utility markets. The Corporation's continuing businesses are aligned for reporting purposes into the following eight segments: Broadcasting, Electronic Systems, Government & Environmental Services, Thermo King, Energy Systems, Power Generation, Knoll and WCI. Results of international manufacturing entities, export sales and foreign licensee income are included in the financial information of the segment that has operating responsibility.\nBroadcasting provides a variety of communications services consisting primarily of commercial broadcasting, program production and distribution. It sells advertising time to radio, television and cable advertisers through national and local sales organizations. Broadcasting currently owns and operates five network affiliated television broadcasting stations and 16 radio stations. Broadcasting also provides programming and distribution services to the cable television industry. Group W Satellite Communications (GWSC) provides sports programming and the marketing and advertising for two country music entertainment channels. Westinghouse Communications, which is included in GWSC, provides a comprehensive range of telecommunications services to business and industry.\nThe Electronic Systems segment is a world leader in the research, development, production and support of advanced electronic systems for the Department of Defense (DoD), Federal Aviation Administration, other government agencies and U.S. allies. Products include surveillance and fire control radars, command and control systems, electronic countermeasures equipment, electro- optical systems, spaceborne sensors, missile launching and\nhandling equipment, anti-submarine warfare and communications equipment. The group also engages in related non-DoD markets such as air traffic control, security and information systems.\nThe Government & Environmental Services segment combines the Corporation's toxic, hazardous and radioactive waste services, the management and operation of several government-owned facilities and the U.S. naval nuclear reactors program.\nThermo King is a leading supplier of mobile temperature control equipment for trucks, trailers and seagoing containers, as well as air conditioning for buses and rail cars.\nThe Energy Systems segment serves the worldwide nuclear energy market and is a leader in designing, manufacturing and servicing nuclear power plants. Energy Systems is also a leading supplier of reload nuclear fuel and distributed control systems.\nThe Power Generation segment designs, manufactures and services steam and combustion turbine generators. In addition to serving the regulated electric utility industry, Power Generation also supplies, services and operates power plants for independent power producers and other non-utility customers worldwide.\nKnoll designs, manufactures and distributes office furniture to an expanding global market.\nWCI develops land into master-planned luxury communities primarily in Florida and California.\nOther Businesses segment is a diverse group of businesses providing a wide range of goods and services to wholesale, industrial, utility and governmental customers. These businesses are deemed to be non-strategic and are expected to be sold.\nThe Corporate and Other segment includes corporate activities that are managed for the benefit of the entire Corporation.\nSegment sales of products and services include products that are transferred between segments generally at inventory cost plus a margin. Segment operating profit or loss consists of sales of products and services less segment operating expenses which include costs of products and services, marketing, administrative and general expenses, depreciation and amortization, and restructuring costs.\nIn 1994, a $71 million charge, net of adjustments, was recorded in the fourth quarter for restructuring. Prior to this provision, operating profit totalled $201 million for Broadcasting, $176 million for Electronic Systems, $62 million for Government & Environmental Services, $33 million for Energy Systems, $105 million for Power Generation, $65 million for WCI and a loss of $27 million for Knoll.\nIn 1993, a $750 million charge was recorded in the fourth quarter for restructuring and other actions of which $555 million was charged to operating profit. Prior to that provision, operating profit totalled $157 million for Broadcasting, $220 million for Electronic Systems, $65 million for Government & Environmental Services, $111 million for Energy Systems, $103 million for Power Generation, $65 million for WCI and losses of $30 million for Knoll, $59 million for Other Businesses and $40 million for Corporate and Other.\nIn 1992, a $36 million charge was recorded in Continuing Operations for corporate restructuring related to the previous strategy to sell Knoll and WCI. Prior to that charge, the operating loss for Knoll was $14 million and the operating profit for WCI was $97 million.\nSALES OF PRODUCTS AND SERVICES AND SEGMENT OPERATING PROFIT FROM CONTINUING OPERATIONS (in millions)\nOTHER FINANCIAL INFORMATION (in millions)\nAssets not identified to segments in the table above principally include cash and marketable securities, deferred income taxes, prepaid pension cost and the intangible pension asset.\nIncluded in income from Continuing Operations is income of subsidiaries located outside the U.S. These subsidiaries reported losses of $10 million in 1994, $21 million in 1993 and income of $32 million in 1992. Subsidiaries located outside the U.S. comprised 5% of total assets of Continuing Operations in 1994, 6% in 1993 and 5% in 1992. Subsidiaries located outside the U.S. comprised 4% of total liabilities of Continuing Operations in 1994 and 2% in 1993 and 1992.\nFINANCIAL INFORMATION BY GEOGRAPHIC AREA (in millions)\nThe Corporation sells products manufactured domestically to customers throughout the world using domestic divisions and subsidiaries doing business primarily outside the U.S. Generally, products manufactured outside the U.S. are sold outside the U.S.\nSALES FROM PRODUCTS AND SERVICES SOLD OUTSIDE THE U.S. FROM CONTINUING OPERATIONS (in millions)\nThe largest single customer of the Corporation is the U.S. government and its agencies, whose purchases accounted for 26% of sales of products and services from Continuing Operations during 1994 and 30% in 1993 and 1992. Of the 1994 purchases, 81% were from the Electronic Systems segment. No other customer made purchases totalling 10% or more of sales of products and services.\nRESEARCH AND DEVELOPMENT FROM CONTINUING OPERATIONS (in millions)\nNOTE 21: FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair value of financial instruments has been determined by the Corporation using the best available market information and appropriate valuation methodologies. However, considerable judgment was necessary in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts that the Corporation could realize in a current market exchange or the value that ultimately will be realized by the Corporation upon maturity or disposition. Additionally, because of the variety of valuation techniques permitted under SFAS No. 107, \"Disclosures about Fair Values of Financial Instruments,\" comparability of fair values among entities may not be meaningful. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nFAIR VALUE OF FINANCIAL INSTRUMENTS--CONTINUING OPERATIONS (in millions)\nFAIR VALUE OF FINANCIAL INSTRUMENTS--DISCONTINUED OPERATIONS (in millions)\nThe following methods and assumptions were used to estimate the fair value of financial instruments for which it was practicable to estimate that value.\nCash and Cash Equivalents\nThe carrying amount for cash and cash equivalents approximates fair value.\nNoncurrent Customer and Other Receivables\nThe fair value of noncurrent customer and other receivables is estimated by discounting the expected future cash flows at interest rates commensurate with the creditworthiness of the customers and other third parties.\nPortfolio Investments\nAt December 31, 1994, the fair value of portfolio investments, which are primarily real estate investments, was determined using financial information prepared by independent third parties, discounted cash flow projections, financial statements for investee companies and letters of intent or other asset sale agreements.\nAt December 31, 1993, the fair value of portfolio investments was determined as follows:\nExcept for the Corporation's investment in LW Real Estate Investments, L.P., which is valued at cost, the real estate portfolio, including receivables, real estate properties and real estate investments in partnerships and other entities, was valued using the Resolution Trust Corporation's DIV method.\nThe corporate portfolio, including receivables, investments in partnerships and other entities and nonmarketable equity securities, was valued using various valuation techniques, including trading desk values, which arise from actual or proposed current trades of identical or similar assets, plus other factors.\nShort-term Debt\nThe carrying amount of the Corporation's borrowings under the revolving credit facilities and other arrangements approximate fair value.\nLong-term Debt\nThe fair value of long-term debt has been estimated using quoted market prices or discounted cash flow methods based on the Corporation's current borrowing rates for similar types of borrowing arrangements with comparable terms and maturities.\nInterest Rate and Currency Exchange Agreements\nThe fair value of interest rate and currency exchange agreements is the amount that the Corporation would receive or pay to terminate the agreements, based on quoted market prices or discounted cash flow methods, considering current interest rates, currency exchange rates and remaining maturities.\nFinancial Guarantees\nThe fair value of guarantees is based on the estimated cost to terminate or otherwise settle the obligations with the counterparties.\nFinancing Commitments\nMost of the unfunded commitments relate to, and are inseparable from, specific portfolio investments. When establishing the fair value for those portfolio investments, consideration was given to the related financing commitments.\nForeign Currency Exchange Contracts\nThe fair value of foreign exchange contracts is based on quoted market prices to terminate the contracts.\nQUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nFIVE-YEAR SUMMARY\nSELECTED FINANCIAL AND STATISTICAL DATA (UNAUDITED) (in millions except per share amounts)\nPreviously reported amounts have been restated to segregate the results of Discontinued Operations from Continuing Operations.\n(1) See notes 1, 4 and 5 to the financial statements.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nPart of the information concerning executive officers required by this item is set forth in Part I pursuant to General Instruction G to Form 10-K and part is incorporated herein by reference to \"Security Ownership\" in the Proxy Statement.\nThe information as to directors is incorporated herein by reference to \"Election of Directors\" in the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this item is incorporated herein by reference to \"Executive Compensation\" 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 to \"Security Ownership\" 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 \"Transactions Involving Directors and Executive Officers\" in 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 required by this item are listed under Item 8, which list is incorporated herein by reference.\n(A)(2) FINANCIAL STATEMENT SCHEDULES\nThe following financial statement schedule for Westinghouse Electric Corporation and the Report of Independent Accountants thereon are included in Part IV of this report:\nOther schedules are omitted because they are not applicable or because the required information is included in the financial statements or notes thereto.\n(A) EXHIBITS\n* Identifies management contract or 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.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Westinghouse Electric Corporation\nOur audits of the consolidated financial statements referred to in our report dated January 31, 1995 appearing on page 26 of this Form 10-K of Westinghouse Electric Corporation (which report and consolidated financial statements are included in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in Item 14(a)(2) 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 600 Grant Street Pittsburgh, Pennsylvania 15219-9954 January 31, 1995\nSCHEDULE VIII\nVALUATION AND QUALIFYING ACCOUNTS\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, on the 7th day of March, 1995.\nWESTINGHOUSE ELECTRIC CORPORATION\nBy: \/s\/ Fredric G. Reynolds -------------------------------- Fredric G. Reynolds Executive Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.\nSignature and Title ------------------- Frank C. Carlucci, Director Gary M. Clark, President and Director George H. Conrades, Director William H. Gray, III, Director Michael H. Jordan, Chairman and Chief Executive Officer (principal executive officer) and Director David T. McLaughlin, Director By: \/s\/ Fredric G. Reynolds Rene C. McPherson, Director --------------------------- Richard M. Morrow, Director Fredric G. Reynolds Paula Stern, Director Attorney-In-Fact Richard R. Pivirotto, Director March 7, 1995 Fredric G. Reynolds, Executive Vice President and Chief Financial Officer (principal financial officer) Robert D. Walter, Director Louis J. Valerio, Vice President and Controller (principal accounting officer)\nOriginal powers of attorney authorizing Michael H. Jordan, Fredric G. Reynolds, and Louis J. Valerio, individually, to sign this report on behalf of the listed directors and officers of the Corporation and a certified copy of a resolution of the Board of Directors of the Corporation authorizing each of said persons to sign on behalf of the Corporation have been filed with the Securities and Exchange Commission and are included as Exhibit 24 to this report.\nEXHIBIT INDEX\n- --------------------------------------------------------------------------------\n* Incorporated by reference","section_15":""}
{"filename":"57528_1994.txt","cik":"57528","year":"1994","section_1":"ITEM 1. BUSINESS\nThe Registrant manufactures and sells snack foods and bakery products directly and through its subsidiaries, Midwest Biscuit Company and Vista Bakery, Inc.\nThe Registrant manufactures, distributes and sells packaged snack and bread basket items primarily under the LANCE label. The principal snack items are cracker sandwiches, cookie sandwiches, peanuts, potato chips, corn chips, popcorn, cakes, cookies, candies, chewing gum, beef snacks and sausages. The principal new snack items introduced in 1994 include the Swiss Roll, Fat Free Apple Bar, Fat Free Cranberry Bar, Reduced Fat Toastchee and Reduced Fat Gold-N-Chees. During the year, the Registrant discontinued its line of chewing gum and began distributing Wrigley's Chewing Gum(R). The principal bread basket items are wafers, crackers and bread sticks, individually packaged and sold to restaurants and similar institutions.\nThe Registrant's products are sold under various trade names and registered trademarks that it owns, including TOASTCHEE, LANCHEE, RYE CHEE, CHOC-O-LUNCH, VAN-O-LUNCH, NEKOT, GOLD-N-CHEES, BIG TOWN and CAPTAIN'S WAFERS.\nThe Registrant packages several of its most popular snack and bread basket items in convenience packs and distributes them to grocers and supermarkets. In addition, the Registrant distributes large bags of potato chips and large size bags and boxes of its snack and bread basket items to grocers and supermarkets. Various items that are purchased from others and resold by the Registrant account for 21% of net sales and other operating revenue.\nMidwest Biscuit Company manufactures and sells cookies and crackers, through its own sales representatives and brokers, to wholesale grocers, supermarkets and distributors throughout the United States and portions of Canada, under customer private labels and the VISTA label. Vista Bakery, Inc. manufactures cookies and crackers which are sold through Midwest Biscuit Company under customer private labels and the VISTA label.\nThe following table shows the approximate percentages of the Registrant's net sales and other operating revenue for 1994, 1993 and 1992 contributed by snack items and bread basket items:\nThe principal raw materials and supplies used in the manufacture of snack foods and bakery products are flour, peanuts, oils and shortenings, potatoes, shelled corn and popcorn, cornmeal, pork skins, tree nuts, starch, sugar, cheese, corn syrup, cocoa, fig paste, seasonings and packaging materials. These raw materials and supplies are generally available in adequate quantities in the open market either from sources in the United States or from other countries and are generally contracted for a season in advance.\nThe principal supplies of energy used in the manufacture of these products are electricity, natural and propane gas, fuel oil and diesel fuel, all of which are currently available in adequate quantities.\nThe Registrant sells its products through its own sales organization to convenience stores, independent and chain supermarkets, discount stores, restaurants, military commissaries and exchanges, schools, hospitals, caterers, industrial, recreational and commercial establishments, and similar customers in 36 states and the District of Columbia. The Registrant's distribution operations are administered through 27 sales districts which are divided into 350 sales areas, each under the direction of a branch manager. There are 2,309 sales territories, each serviced by one sales representative. In 1994, the Registrant continued the development of its distributor and broker network, principally in the Western United States.\nThe Registrant owns a fleet of tractors and trailers, which make weekly deliveries of its products to the sales territories. The Registrant provides sales representatives with stockroom space for their inventory requirements. The sales representatives load their own trucks from these stockrooms for delivery to their customers.\nA significant portion of the Registrant's total sales is through vending machines, which are made available to its customers on a rental, commission or sales basis. The machines are not designed or manufactured specifically for the Registrant, and their use is not limited to any particular sales area or class of customer.\nCaronuts, Inc., a subsidiary of the Registrant, owns a peanut buying facility that purchases peanuts directly from growers and sells all of its peanuts to the Registrant. The facility is operated on a seasonal basis, during the peanut harvest.\nAll of the Registrant's products are sold in highly competitive markets in which there are many competitors. In the case of many of its products, the Registrant competes with manufacturers with greater total revenues and greater resources than the Registrant. The principal methods of competition are price, delivery, service and product quality. Generally, the Registrant believes that it is competitive in these methods as a whole. The methods of competition and the Registrant's competitive position varies according to the locality, the particular products and the policies of its competitors. Although reliable statistics are unavail-\nable as to production and sales by others in the industry, the Registrant believes that in its areas of distribution it is one of the largest producers of peanut butter filled cracker sandwiches.\nOn December 31, 1994, the Registrant and its subsidiaries had 5,818 employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant's principal plant and general offices are located in Charlotte, North Carolina on a 288 acre tract owned by the Registrant. The main facility is an air-conditioned and sprinklered plant, office building and cafeteria of brick and steel containing approximately 670,000 square feet. The manufacturing plant houses seven oven lines and is equipped with storage facilities to handle many of the Registrant's raw materials in bulk. Adjacent to the main facility is an air-conditioned and sprinklered plant of brick and steel used for the processing of potato chips, corn chips and similar products containing approximately 140,000 square feet. Both plants are operated on two eight-hour shifts. Also adjacent to the main facility are a 70,400 square foot precast concrete building, which houses a vending machine repair and maintenance facility, an 11,000 square foot brick and steel building, which houses vehicle maintenance operations, 40,000 square foot and 13,000 square foot metal warehouse buildings and a 5,500 square foot brick veneer office building.\nThe Registrant owns a plant located on a 105 acre tract in Greenville, Texas. The plant is an air-conditioned and sprinklered building of brick and steel containing approximately 290,000 square feet. The plant houses two oven lines and storage facilities that can handle many of the Registrant's raw materials in bulk. Both of the oven lines are operated on two eight-hour shifts. Adjacent to the plant is a building of steel construction which contains approximately 29,000 square feet of vending repair, office and garage space.\nThese facilities, unless otherwise noted, are used to produce both snack and bread basket items.\nThe Registrant leases office space and most of its stockroom space in various towns and cities, mainly on month-to-month tenancies. The Registrant currently owns 188 stockroom locations with steel frame buildings, which range in size from 400 to 6,400 square feet and contain an aggregate of 988 stockroom spaces.\nMidwest Biscuit Company owns a plant located on an 18.5 acre tract in Burlington, Iowa. The plant is of masonry and steel and contains approximately 230,000 square feet. This plant houses six oven lines and is operated on two eight-hour shifts. Adjacent to the plant is a steel storage building of approximately 10,000 square feet.\nVista Bakery, Inc. owns a 243,000 square foot plant on a 137 acre tract in Columbia, South Carolina. The plant is of brick and steel construction and houses three oven lines and is operated on two eight-hour shifts.\nThe Registrant believes that it has sufficient production capacity to meet foreseeable increases in demand in 1995.\nThe peanut buying facility owned by Caronuts, Inc. is located on a 20 acre tract in Boykins, Virginia. The facility consists of six peanut storage tanks and related metal buildings and sheds.\nSEPARATE ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation as to executive officers of the Registrant who are directors or nominees of the Registrant is incorporated herein by reference to the section captioned Election of Directors in the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held April 21, 1995. Information as to each executive officer of the Registrant who is not a director or a nominee is as follows:\nAll the Company's executive officers were appointed to their current positions at the Annual Meeting of the Board of Directors on April 15, 1994, except Mr. Duggan who was appointed at a Special Meeting of the Board of Directors on July 12, 1994. In addition, at the Meeting of the Board of Directors on February 21, 1995, Thomas B. Horack and Gerald K. Smith were elected Executive Vice Presidents, Earl D. Leake was elected Vice President and Mr. Helms was elected Treasurer. All of the Registrant's executive officers' terms of office extend until the next Annual Meeting of the Board of Directors and until their successors shall have been duly elected and qualified.\nItems 3 and 4 are inapplicable and have been omitted.\nPART II\nItems 5 through 8 are incorporated herein by reference to pages 10 through 27 of the Registrant's 1994 Annual Report to Stockholders.\nItem 9","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"Item 9 is inapplicable and has been omitted.\nPART III\nItems 10 through 13 are incorporated herein by reference to the sections captioned Principal Stockholders and Holdings of Management, Election of Directors, Compensation\/Stock Option Committee Interlocks and Insider Participation, Executive Officer Compensation and Director Compensation in the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held April 21, 1995 and to the Separate Item in Part I of this Annual Report captioned Executive Officers of the Registrant.\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.\nSee Table of Contents to Financial Statements filed herewith as a separate part of this Annual Report.\n2. Financial Schedules.\nSchedules have been omitted because of the absence of conditions under which they are required or because information required is included in financial statements or the notes thereto.\n3. Exhibits.\n3.1 Restated Charter of Lance, Inc. incorporated herein by reference to Exhibit 3(a) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 26, 1992.\n3.2 Bylaws of Lance, Inc. incorporated herein by reference to Exhibit 3(ii) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 25, 1993.\n4 See 3.1 and 3.2 above.\n10.1 Lance, Inc. 1991 Stock Option Plan incorporated herein by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-8, Registration No. 33-41866.\n10.2 The Lance, Inc. Key Executive Employee Benefit Plan incorporated herein by reference to Exhibit 10 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1983.\n10.3 Form of Executive Employment Agreement between Lance, Inc. and the Key Executives incorporated herein by reference to Exhibit 10(c) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 26, 1992.\n10.4 Lance, Inc. 1983 Incentive Stock Option Plan incorporated herein by reference to Exhibit 10.1 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 26, 1987.\n10.5 Lance, Inc. Key Executive Employee Benefit Plan Trust, dated December 3, 1993, between Lance, Inc. and First Union National Bank of North Carolina incorporated herein by reference to Exhibit 10(v) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 25, 1993.\n13 The Registrant's 1994 Annual Report to Stockholders. This Annual Report to Stockholders is furnished for the information of the Commission only and, except for the parts thereof incorporated by reference in this Report on Form 10-K, is not to be deemed \"filed\" as a part of this filing.\n21 List of the Subsidiaries of the Registrant incorporated herein by reference to Exhibit 22 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 26, 1992.\n23 Consent of KPMG Peat Marwick LLP.\n27 Financial Data Schedule. (Filed in electronic format only. Pursuant to Rule 402 of Regulation S-T, this schedule 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.)\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K required to be filed by the Registrant during the 17 weeks 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 Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nLANCE, INC.\nDated: March 29, 1995 By: \/s\/ E. D. Leake ---------------------------- E. D. Leake Vice President\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C.\nFORM 10-K FOR CORPORATIONS\nITEM 14(a) - FINANCIAL STATEMENTS\nFINANCIAL STATEMENTS AND SCHEDULES OMITTED\nThe above listed financial statements are presented on only a consolidated basis since the Company is primarily an operating company and its subsidiaries included for the periods presented in the consolidated financial statements are totally-held subsidiaries. Schedules have been omitted because of the absence of conditions under which they are required or because information required is included in financial statements or the notes thereto.\nSECURITIES AND EXCHANGE COMMISSION Washington, D.C.\nEXHIBITS Item 14(a)(3)\nFORM 10-K ANNUAL REPORT\nFor the fiscal year ended Commission File Number December 31, 1994 0-398\nLANCE, INC.\nEXHIBIT INDEX","section_15":""}
{"filename":"714310_1994.txt","cik":"714310","year":"1994","section_1":"ITEM 1. BUSINESS\nValley National Bancorp (\"Valley\") is a New Jersey corporation incorporated as a bank holding company under the Bank Holding Company Act of 1956. At December 31, 1994, Valley had consolidated total assets of $3.7 billion, total deposits of $3.3 billion, and total shareholders' equity of $300.2 million. Its principal subsidiary is Valley National Bank (\"VNB\").\nVNB is a national banking association chartered in 1927 under the laws of the United States. VNB provides a full range of commercial and retail banking services through 62 branch offices located in northern New Jersey. These services include the acceptance of demand, savings and time deposits; extension of consumer, real estate, Small Business Administration and other commercial credits; and the offer of full personal and corporate trust services, as well as pension and fiduciary services.\nVNB has three New Jersey wholly-owned subsidiaries which include a mortgage servicing company which services loans for VNB as well as others, a real estate company which holds and disposes of real estate which VNB may acquire through foreclosure, and an investment company which holds, maintains and manages investment assets for VNB.\nRECENT ACQUISITION\nOn November 30, 1994, Valley acquired Rock Financial Corporation (\"RFC\") and its five branch subsidiary, Rock Bank (\"Rock\"), located in North Plainfield, New Jersey. Valley issued approximately 1.7 million shares of its common stock to the shareholders of RFC. Rock had assets of $186.3 million, deposits of $165.7 million and shareholders' equity of $18.2 million. The merger was accounted for using the pooling of interests method of accounting.\nPENDING ACQUISITIONS\nOn November 9, 1994, Valley and VNB entered into an Agreement and Plan of Merger providing for the merger of American Union Bank (\"American\"), with its two branch offices located in Union and Roselle Park, New Jersey, with and into VNB. American shareholders will receive 0.50 shares, subject to adjustment, of Valley common stock for each share of American common stock. The merger has received approval of the shareholders of American and the Office of the Comptroller of the Currency (\"OCC\"), and is expected to close February 28, 1995. American has approximately $56 million in assets, $52 million in deposits and $4 million in shareholders' equity.\nOn January 26, 1995, Valley and VNB entered into a letter of intent providing for the acquisition by Valley of Lakeland First Financial Group, Inc. (\"LFG\") and its principal savings bank subsidiary, Lakeland Savings Bank (\"Lakeland\"), headquartered in Succasunna, New Jersey. LFG, with assets of $661 million, deposits of $521 million and equity of $51 million, is a bank holding company which owns 100% of the outstanding stock of Lakeland, a state chartered savings bank with sixteen branch offices located in Morris, Sussex and Warren counties. The letter of intent provides for the taxfree exchange of 1.225 shares of Valley common stock for each of the 3,881,398 shares outstanding of LFG common stock and the conversion of LFG stock options into Valley stock options. The merger is expected to be accounted for under the pooling of interests method of accounting. In conjunction with the execution of the letter of intent, LFG also granted an option to Valley, at $21 per share to acquire 1,250,000 shares of LFG's authorized, but unissued common stock to be purchased by Valley in the event another institution gains control of LFG. The parties are working towards the execution of a definitive agreement which is expected by the end of February, 1995. The transaction is subject to the approval of the shareholders of LFG, the OCC, and the Federal Reserve Bank of New York. It is expected that this transaction will close during the third quarter of 1995.\nCOMPETITION\nThe market for banking and bank related services is highly competitive. Valley and its subsidiary compete with other providers of financial services such as other bank holding companies, commercial and savings\nbanks, savings and loan associations, credit unions, money market and mutual funds, mortgage companies, and a growing list of other local, regional and national institutions which offer financial services. Mergers between financial institutions within New Jersey and in neighboring states have added competitive pressure. Competition is expected to intensify as a consequence of interstate banking laws now in effect or that may be in effect in the future. Valley and its subsidiary compete by offering quality products and convenient services at competitive prices. In order to maintain and enhance its competitive position, Valley regularly reviews its products, locations and various acquisition prospects and periodically engages in discussions regarding such possible acquisitions.\nValley receives applications for automobile loans from customers referred by a major insurance company. Over the last several years the amount of loans referred through the program has grown and Valley is continuously working to further expand the relationship. The insurance company has referred loans in this manner for approximately 40 years.\nEMPLOYEES\nAt year-end 1994, VNB and its subsidiaries employed 1,168 full-time equivalent persons. Management considers relations with employees to be satisfactory.\nSUPERVISION AND REGULATION\nThe banking industry is highly regulated. Statutory and regulatory controls increase a bank holding company's cost of doing business and limit the options of its management to deploy assets and maximize income. The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on the bank. It is intended only to briefly summarize some material provisions.\nBANK HOLDING COMPANY REGULATION\nValley is a bank holding company within the meaning of the Bank Holding Company Act of 1956. As a bank holding company, Valley is supervised by the Board of Governors of the Federal Reserve System (the \"FRB\") and is required to file reports with the FRB and provide such additional information as the FRB may require.\nThe Bank Holding Company Act prohibits Valley, with certain exceptions, from acquiring direct or indirect ownership or control of more than five percent 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 subsidiary banks, except that it may, upon application, 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.\" The Bank Holding Company Act requires prior approval by the FRB of the acquisition by Valley of more than five percent of the voting stock of any additional bank. Under current law, a New Jersey based bank holding company, like Valley, is permitted to acquire banks located in New Jersey and in certain other states if the states had enacted laws specifically to permit acquisitions of banks by out-of-state bank holding companies having the largest proportion of their deposits in New Jersey. Satisfactory capital ratios and Community Reinvestment Act ratings are generally prerequisites to obtaining federal regulatory approval to make acquisitions. Acquisitions through Valley National Bank require approval of the Comptroller of the Currency of the United States (\"OCC\"). Statewide branching is permitted in New Jersey. The Bank Holding Company Act does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies.\nThe Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Banking and Branching Act\") passed by Congress and signed into law on September 29, 1994, significantly changed interstate banking rules. Pursuant to the Interstate Banking and Branching Act, a bank holding company will be able to acquire banks in states other than its home state beginning September 29, 1995, regardless of\napplicable state law. Until such provisions are effective, interstate acquisitions by bank holding companies will continue to be subject to current state law restrictions.\nThe Interstate Banking and Branching Act also authorizes banks to merge across state lines, thereby creating interstate branches, beginning June 1, 1997. Under such legislation, each state has the opportunity either to \"opt out\" of this provision, thereby prohibiting interstate branching in such states, or to \"opt in\" at an earlier time, thereby allowing interstate branching within that state prior to June 1, 1997. Furthermore, a state may \"opt-in\" with respect to de novo branching, thereby permitting a bank to open new branches in a state in which the bank does not already have a branch. Without de novo branching, an out-of-state bank can enter the state only by acquiring an existing bank.\nThe New Jersey legislature is presently examining whether it will opt-in with respect to earlier interstate banking and branching, as well as whether it will authorize de novo branching and the entry into New Jersey of foreign banks. New Jersey law presently prohibits foreign banks from entering New Jersey unless the foreign bank first acquired a domestic bank in another state.\nProposals to change the laws and regulations governing the banking industry are frequently introduced in Congress, in the state legislatures and before the various bank regulatory agencies. The likelihood and timing of any such changes and the impact such changes might have on Valley cannot be determined at this time.\nThe policy of the FRB provides that a bank holding company is expected to act as a source of financial strength to its subsidiary bank and to commit resources to support such subsidiary bank in circumstances in which it might not do so absent such policy.\nREGULATION OF BANK SUBSIDIARY\nValley National Bank (\"VNB\") is subject to the supervision of, and to regular examination by, the OCC.\nVarious laws and the regulations thereunder applicable to Valley and its bank subsidiary impose restrictions and requirements in many areas, including capital requirements, the maintenance of reserves, establishment of new offices, the making of loans and investments, consumer protection and other matters. There are various legal limitations, including Sections 23A and 23B of the Federal Reserve Act, on the extent to which a bank subsidiary may finance or otherwise supply funds to its holding company or its non-bank subsidiaries. Under federal law, no bank subsidiary may, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, its parent or non-bank subsidiaries of its parent (other than direct subsidiaries of such bank) or, subject to broader exceptions, take their securities as collateral for loans to any borrower. Each bank subsidiary is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.\nDIVIDEND LIMITATIONS\nValley is a legal entity separate and distinct from its subsidiaries. Valley's revenues (on a parent company only basis) result substantially from dividends paid to Valley by its subsidiary. Payment of dividends to Valley by VNB, without prior regulatory approval, is subject to regulatory limitations. Under the National Bank Act, dividends may be declared only if, after payment thereof, capital would be unimpaired and remaining surplus would equal 100 percent of capital. Moreover, a national bank may declare, in any one year, dividends only in an amount aggregating not more than the sum of its net profits for such year and its retained net profits for the preceding two years. At December 31, 1994, under such requirements, VNB could have declared dividends in an amount aggregating $65.2 million. In addition, the bank regulatory agencies have the authority to prohibit a bank subsidiary from paying dividends or otherwise supplying funds to Valley if the supervising agency determines that such payment would constitute an unsafe or unsound banking practice.\nFIRREA\nUnder the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (\"FIRREA\"), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured\ndepository 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 conservatory or receiver and \"in danger of default\" is defined generally as the existence of certain conditions, including a failure to meet minimum capital requirements, indicating that a \"default\" is likely to occur in the absence of regulatory assistance. These provisions have commonly been referred to as FIRREA's \"cross guarantee\" provisions. Further, under FIRREA the failure to meet capital guidelines could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including the termination of deposit insurance by the FDIC.\nFIRREA also imposed certain independent appraisal requirements upon a bank's real estate lending activities and further imposed certain loan to value restrictions on a bank's real estate lending activities. The bank regulators have promulgated regulations in these areas.\nFDICIA\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), which became law in December of 1991, required each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of non-traditional activities. In addition, pursuant to FDICIA, each federal banking agency has promulgated regulations, specifying the levels at which a financial institution would be considered \"well capitalized\", \"adequately capitalized\", \"undercapitalized\", \"significantly undercapitalized\", or \"critically undercapitalized\", and to take certain mandatory and discretionary supervisory actions based on the capital level of the institution.\nThe OCC's regulations implementing these provisions of FDICIA provide that an institution will be classified as \"well capitalized\" if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a Tier 1 leverage ratio of at least 5.0 percent, and (iv) meets certain other requirements. An institution will be classified as \"adequately capitalized\" if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 4.0 percent, (iii) has Tier 1 leverage ratio of (a) at least 4.0 percent or (b) at least 3.0 percent if the institution was rated 1 in its most recent examination, and (iv) does not meet the definition of \"well capitalized\". An institution will be classified as \"undercapitalized\" if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, or (iii) has a Tier 1 leverage ratio of (a) less than 4.0 percent or (b) less than 3.0 percent if the institution was rated 1 in its most recent examination. An institution will be classified as \"significantly undercapitalized\" if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 3.0 percent, or (iii) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as \"critically undercapitalized\" if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination.\nInsured institutions are generally prohibited from paying dividends or management fees if after making such payments, the institution would be \"undercapitalized\". An \"undercapitalized\" institution also is required to develop and submit to the appropriate federal banking agency a capital restoration plan, and each company controlling such institution must guarantee the institution's compliance with such plan. The liability of a holding company under any such guarantee is limited to the lesser of five percent of the institution's total assets at the time it became undercapitalized or the amount needed to comply with all applicable capital standards. The FDIC is accorded a priority over the claims of unsecured creditors in any bankruptcy proceeding of a holding company that has guaranteed an institution's compliance with a capital restoration plan. Further, \"undercapitalized\", \"significantly undercapitalized\", and \"critically undercapitalized\" institutions are subject to increasingly extensive requirements and limitations, including mandatory sale of stock, forced mergers, and ultimately receivership or conservatorship. A \"critical undercapitalized\" institution, beginning 60 days after it becomes \"critically undercapitalized\", generally is prohibited from making any payment of principal or interest on the institution's subordinated debt.\nUnder FDICIA, only \"well capitalized\" banks and those \"adequately capitalized\" banks which have obtained waiver from the FDIC may accept brokered deposits. Those \"adequately capitalized\" banks that are permitted to accept brokered deposits may not pay rates that significantly exceed the rates paid on deposits of similar maturity from the bank's normal market area or the national rate on deposits of comparable maturity, as determined by the FDIC, for deposits from outside the bank's normal market area.\nFDICIA also required that the FDIC insurance assessments move from flat-rate premiums to a system of risk-based premium assessments, in order to recapitalize the Bank Insurance Fund (\"BIF\") at a reserve ratio specified in FDICIA. Beginning in January, 1993, BIF members paid an annual assessment rate of between 23 and 31 cents per $100 of domestic deposits, depending on the risk classification assigned by the FDIC to the BIF member. The FDIC was also granted authority under FDICIA to impose special assessments on insured depositary institutions to repay FDIC borrowings from the United States Treasury or other sources. In February, 1995, the FDIC announced that the risk based assessments for BIF institutions would drop to as low as $.04 for the best managed and well-capitalized institutions starting in late 1995. On the other hand, deposits insured under the Savings Association Insurance Fund (\"SAIF\") must remain at $.23 for at least two more years. Due to various acquisitions, Valley pays some deposit premiums to SAIF.\nFDICIA also contained the Truth in Savings Act, which requires certain disclosures to be made in connection with deposit accounts offered to consumers. The FRB has adopted regulations implementing the provisions of the Truth in Savings Act.\nIn addition, significant provisions of FDICIA required federal banking regulators to draft standards in a number of other important areas to assure bank safety and soundness, including internal controls, information systems and internal audit systems, credit underwriting, asset growth, compensation, loan documentation and interest rate exposure. FDICIA also required the regulators to establish maximum ratios of classified assets to capital, and minimum earnings sufficient to absorb losses without impairing capital. The legislation also contained other provisions which restricted the activities of state-chartered banks, amended various consumer banking laws, limited the ability of \"undercapitalized\" banks to borrow from the Federal Reserve's discount window, and required federal banking regulators to perform annual on-site bank examinations and set standards for real estate lending.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporate headquarters and principal office of Valley are located in leased facilities in Wayne, New Jersey. The operations and data processing center for the bank is located in Passaic, New Jersey and retail lending is located in Fairlawn, New Jersey, both of which are owned by VNB. During 1995, it is planned that a consolidation of operations will commence with relocation to Wayne of many departments to an owned building adjacent to our corporate headquarters.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere were no material pending legal proceedings to which Valley, the subsidiary bank or companies were a party, other than ordinary routine litigations incidental to business and which had no material effect on the presentation of the consolidated financial statements contained in this report.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nAll officers serve at the pleasure of the Board of Directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nEffective December 1, 1993, Valley National Bancorp common stock began trading on the New York Stock Exchange (NYSE) under the symbol VLY. Prior to December 1, 1993, Valley common stock was traded on the National Association of Security Dealers Automated Quotations System (NASDAQ) under the symbol VNBP. The following table sets forth for each quarter period indicated the high and low prices for the common stock of Valley, which had been restated to give effect to a 10% stock dividend in May 1994.\nFederal laws and regulations contain restrictions on the ability of Valley and VNB to pay dividends. For information regarding restrictions on dividends, see Part I, Item I, \"Business -- Supervision and Regulation\" and Part II, Item 8, \"Financial Statements and Supplementary Data -- Note 15 of the Notes to Consolidated Financial Statements\".\nThere were 4,852 shareholders of record as of December 31, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data should be read in conjunction with Valley National Bancorp's Consolidated Financial Statements and the accompanying notes presented elsewhere herein. The data for years prior to 1994 have been restated to include Rock Financial Corp. which was acquired on November 30, 1994 in a transaction accounted for as a pooling of interests.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe purpose of this analysis is to provide the reader with information relevant to understanding and assessing Valley National Bancorp's (\"Valley\") results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis the reader is encouraged to review the consolidated financial statements and statistical data presented in this document.\nRECENT ACQUISITION\nOn November 30, 1994 Valley acquired Rock Financial Corporation (\"RFC\") and Rock Bank (\"Rock\"). Rock, a commercial bank, with five branches headquartered in North Plainfield, New Jersey with total assets of $186.3 million. Each share of common stock of RFC was converted into 1.85 common shares of Valley, for a total of 1.7 million shares. The transaction was accounted for using the pooling of interests method of accounting and, therefore, all of the financial data presented has been restated to include the combined entities.\nPENDING ACQUISITIONS\nOn November 9, 1994, Valley entered into a definitive merger agreement with American Union Bank (\"American\"), headquartered in Union, New Jersey, with approximately $56 million in assets and two branches. The transaction is scheduled to close by the end of February, 1995 and will be accounted for using the pooling of interests method of accounting. Each share of common stock of American will be exchanged for 0.50 shares of Valley common stock.\nOn January 26, 1995 Valley entered into a letter of intent to acquire the $661 million Lakeland First Financial Group, Inc. (\"LFG\"), the holding company for Lakeland Savings Bank (\"Lakeland\"), a state chartered saving bank headquartered in Succasunna, New Jersey, with sixteen branches in Morris, Sussex and Warren counties, New Jersey. The letter of intent stipulates that 1.225 shares of common stock of Valley will be exchanged for each of the 3,881,398 shares of common stock of LFG. Valley and LFG also entered into a separate stock option agreement which gives Valley the option to purchase 1.25 million shares of authorized, but unissued common stock of LFG at an exercise price of $21.00 per share in the event that another party obtains control of LFG.\nEARNINGS SUMMARY\nNet income grew to $59.0 million, or $2.06 per share in 1994 compared with $56.4 million or $2.00 per share in 1993 (all amounts have been restated for the Rock Financial Corporation merger and the 1993 per share amounts have been restated to give effect to a 10% stock dividend in 1994). This increase is largely attributable to an increase in net interest income of $5.1 million or 3.5%, and a decrease in the provision for loan losses of $2.8 million or 44.2%. This was offset by a decrease in other operating income of $4.0 million or 15.2% and was further offset by increased operating expenses in most non-interest expense categories. The return on average assets decreased in 1994 to 1.60% from 1.62% in 1993, while the return on average equity also decreased to 20.0% in 1994 from 21.4% at year-end 1993.\nNET INTEREST INCOME\nNet interest income is the largest source of Valley's operating income. Net interest income on a tax equivalent basis increased to $157.8 million for 1994 as compared to $151.8 million for 1993. The increase in 1994 was due primarily to the increase in total interest earning assets, partially offset by a decline in rates on those assets of 21 basis points from 1993 and a smaller increase in total interest bearing deposit liabilities, offset by a decline in rates on those liabilities of 12 basis points. The net interest margin decreased 6 basis points to 4.56% for 1994 compared to 4.62% for all of 1993.\nThe decrease in net interest margin was caused substantially by the upward movement in interest rates during 1994. This increase in rates caused depositors to shift funds from short term savings accounts to longer term certificates of deposit. Deposit rates increased faster than loan rates in 1994, leading to a decline in the net interest margin. The prime lending rate increased from 6.00% to the most recent level of 9.00% on\nFebruary 3, 1995, one year later. If rates continue their movement upward there may be a further decline in the net interest margin.\nAverage interest earning assets increased $180.0 million in 1994, or 5.5% over the 1993 amount. This increase was mainly the result of increased automobile loan and commercial mortgage loan volume, due to lower interest rates during early 1994. Loans increased by $279.2 million or 15.9% over the 1993 amount. The average rate on loans decreased 29 basis points, but combined with the increase in average loan volume, interest income on loans for 1994 increased by $17.2 million over 1993. Offsetting this increase, was a decline in the average amount of investment securities of $100.3 million or 6.8% from the amount in the portfolio in 1993. The average balance of taxable investment securities decreased by $168.9 million or 13.8% over the 1993 average balance. Tax-exempt investments increased $68.6 million or 27.0% taking advantage of the increased yield available over taxable investments.\nAverage interest-bearing liabilities grew 4.2% or $118.9 million due mainly to internal deposit growth. Deposit growth, similar to the past few years, was held to a small increase due to competitive factors and alternative investment opportunities for consumers. Average demand deposits continued to grow and increased by $46.8 million or 12.1% over 1993 balances. Savings deposits increased by $89.4 million or 5.5%, while time deposits recorded a smaller increase of $17.9 million or 1.6%.\nThe net interest margin decreased to 4.56% in 1994 from 4.62% in 1993, the result of an increase in loan volume at a rate of 29 basis points less than the prior year and offset by the effects of increased deposits rates, which decreased only 12 basis points. The decrease in the net interest margin of 6 basis points, coupled with the increase in average earning assets over average interest-bearing liabilities, was the basis for the increase in net interest income.\nThe following table reflects the components of net interest income for each of the three years ended December 31, 1994.\nANALYSIS OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY AND NET INTEREST EARNINGS ON A TAX EQUIVALENT BASIS\n- ---------------\n(1) Interest income is presented on a tax equivalent basis using a 35% tax rate for 1994 and 1993 and a 34% tax rate for 1992.\n(2) Loans are stated net of unearned income.\n(3) Net interest income on a tax equivalent basis as a percentage of earning assets.\nThe following table demonstrates the relative impact on net interest income of changes in volume of earning assets and interest bearing liabilities and changes in rates earned and paid by Valley on such assets and liabilities.\nCHANGE IN INTEREST INCOME AND EXPENSE ON A TAX EQUIVALENT BASIS\n- ---------------\n(1) Interest income is adjusted to a tax equivalent basis using a 35% tax rate for 1994 and 1993 and a 34% tax rate for 1992.\n(2) Variances resulting from a combination of changes in volume and rates are allocated to the categories in proportion to the absolute dollar amounts of the change in each category.\nNON-INTEREST INCOME\nThe following table presents the components of non-interest income for the years ended December 31, 1994, 1993 and 1992.\nNon-interest income continues to represent a considerable source of income for Valley. Excluding gains on securities transactions and the gain on the sale of loans, total non-interest income amounted to $15.9 million in 1994 compared with $15.8 million in 1993.\nService charges on deposit accounts increased $330 thousand or 5.5% from 1993 to 1994. A majority of this increase is due to the expansion of account volume and increased fees charged on deposit accounts.\nFees from mortgage servicing decreased by 12.9% from $3.8 million in 1993 to $3.3 million in 1994. These fees represent gross servicing fees and related ancillary fees for servicing mortgage portfolios by VNB Mortgage Services, Inc. (\"MSI\"), VNB's mortgage servicing subsidiary. This decrease represents in part the decline in the investor owned portfolio due to large prepayments during 1993 and continuing into early 1994. MSI serviced a total of $1.20 and $1.17 billion of loans as of December 31, 1994 and 1993, respectively, of which $536.6 and $467.0 million, respectively, are serviced for VNB. The portfolio remained almost unchanged between year-end 1994 and 1993. This was due to the acquisition of four small portfolios totalling approximately $111 million, the new origination of loans by VNB, net of prepayments of $48 million and prepayments of approximately $150 million of the portfolio serviced for outside investors. Amortization expense decreased during 1994 to $1.6 million from $3.7 million in 1993, reflecting the slow down in prepayments. An analysis is completed quarterly to determine amortization expense, based on all principal payments. At the current higher interest rate levels, the expected life of the portfolio has increased, causing amortization expense to decrease, which is in direct relation to the portfolio size and the level of expected future cash flows and service fees.\nGains on the sales of loans were $544 thousand for 1994 compared to $3.5 million for 1993. In 1994 Valley stopped selling its new originated loans in order to maintain its loan growth. Loans awaiting sale are classified as loans held for sale, and are recorded at lower of cost or market value on the consolidated statement of financial condition at December 31, 1994 and 1993.\nNet gains on securities transactions in 1994 and 1993 amounted to $6.0 million and $7.2 million, respectively. This was the result of the sale of securities due to rising interest rates beginning in early 1994 and Valley's decision to take advantage of the increased yields available.\nNON-INTEREST EXPENSE\nThe following table presents the components of non-interest expense for the years ended December 31, 1994, 1993 and 1992.\nNON-INTEREST EXPENSE\nNon-interest expense totalled $79.0 million for 1994, $2.4 million, or 3.1% above the 1993 level. The largest component of non-interest expense is salaries and employee benefit expense which totalled $39.1 million in 1994 compared to $36.0 million in 1993, an increase of $3.1 million or 8.4%. At December 31, 1994, full-time equivalent staff was 1,168, compared to 1,161 at the end of 1993.\nInsurance premiums assessed by the Federal Deposit Insurance Corporation (\"FDIC\") increased by $217 thousand, or 3.1% to $7.3 million in 1994, from $7.1 million in 1993. This increase was reflective of the additional insurance premium for growth in deposits during 1994. The current rate charged for insurance by the FDIC with respect to Valley, is .23% of deposits and has been at that level since September 1991. Overall,\nassessment rates can range from .23% for well capitalized institutions with no supervisory concerns to .31% for undercapitalized institutions with substantial supervisory concerns. There has been some discussion by the FDIC that premium amounts may decrease during 1995, since the Bank Insurance Fund (\"BIF\") is expected to be restored to levels required by FDICIA. Valley has $3.3 billion of deposits of which approximately $2.6 billion are insured by BIF and approximately $700 million are insured by the Savings Association Insurance Fund (\"SAIF\"). If there is a reduction in the BIF rate, Valley would benefit by a decrease in FDIC insurance premium expense. SAIF rates are not expected to decline at this time.\nNet occupancy expense increased to $7.0 million in 1994 from $6.2 million in 1993. The increase of $792 thousand represents additional rent, utilities, tax and maintenance expense on facilities utilized by Valley. During the second quarter of 1993 Valley acquired a 62,000 square foot building for $3.3 million located adjacent to its current administrative headquarters in Wayne, New Jersey in order to consolidate sections of its operations. This facility is currently occupied by a small number of tenants and rental income is being collected to partially offset the expense of this building. Renovations are currently being made to prepare the building for Valley's use and during 1995 the relocation of many departments will take place.\nFurniture and equipment expense increased $426 thousand, or 9.6%, which is indicative of the growth during 1994 of the operations. This includes depreciation, maintenance and repairs.\nAmortization of intangible assets decreased to $2.7 million in 1994 from $5.0 million in 1993, representing a decrease of $2.3 million, or 46.3%. The majority of this decrease, as discussed previously in relation to fees from mortgage servicing, represents amortization of purchased mortgage servicing rights of $1.6 million during 1994, compared with $3.7 million for 1993, a decrease of $2.1 million, or 57.3%.\nThe efficiency ratio measures a bank's gross operating expense as a percentage of fully-taxable equivalent net interest income and other non-interest income without taking into account security gains and losses and other non-recurring items. Valley's efficiency ratio as of December 31, 1994 is 45.4%, one of the lowest in the industry, compared with an efficiency ratio for 1993 and 1992 of 44.8% and 46.1%, respectively. Valley strives to control its efficiency ratio and expenses as a means of producing increased earnings for its shareholders.\nINCOME TAXES\nIncome tax expense as a percentage of pre-tax income declined to 33.7% in 1994 compared to 35.1% in 1993. This decrease was attributable to a higher amount of non-taxable income on investment securities, a lower state tax rate for a new investment subsidiary which began operating in 1994, and the elimination in the State of New Jersey corporate income tax surcharge of .375%.\nStatement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes,\" was issued by the Financial Accounting Standards Board in February 1992. Valley adopted SFAS No. 109 prospectively as of January 1, 1993. The cumulative effect of this change in accounting for income taxes reduced net income by $402 thousand and is reported separately in the consolidated statement of income for the year ended December 31, 1993.\nASSET\/LIABILITY MANAGEMENT\nINTEREST RATE SENSITIVITY\nThe following table illustrates Valley's interest rate gap position as of December 31, 1994 on a 90 day, between 90 and 365 days and after 365 day basis.\nINTEREST RATE SENSITIVITY ANALYSIS\nManaging net interest margin continues to be the single most important factor in maximizing earnings. Through its Asset\/Liability Policy, Valley strives to maintain a consistent net interest rate differential by managing the sensitivity and repricing of its assets and liabilities to interest rate fluctuations.\nValley seeks to achieve a sufficient level of rate sensitive assets to equal its rate sensitive liabilities, and analyzes the maturity and repricing of earning assets and sources of funds at various intervals. The level by which repricing earning assets exceed or are exceeded by repricing sources of funds is expressed as a ratio and dollar value (interest sensitivity gap) and is used as a measure of interest rate risk.\nAt December 31, 1994, rate sensitive liabilities exceeded rate sensitive assets at the 90 day interval and resulted in a negative gap of $271 million or a ratio of .80:1. Rate sensitive liabilities also exceeded rate sensitive assets at the 91 to 365 day interval by $217 million or a ratio of .42:1 and resulted in a negative gap.\nThe total negative gap repricing within 365 days as of December 31, 1994 is $488.4 million or .72:1. Valley has strived to reduce its negative gap in view of the present climate of rising interest rates. Management is attempting to reduce this negative gap, and does not view these amounts as presenting an unusually high risk potential, although no assurances can be given that Valley is not at risk from rate increases or decreases.\nThe above gap results take into account repricing and maturities of assets and liabilities, but fails to consider the interest rate sensitivities of those asset and liability accounts. Management has prepared for its use an income simulation model to project future net interest income streams in light of the current gap position. Management has also prepared for its use alternative scenarios to measure levels of net interest income associated with various factors including changes in interest rates. According to this computer model, an interest rate increase of 300 basis points and a decrease of 100 basis points resulted in an impact on future net interest income which is consistent with target levels contained in Valley's Asset\/Liability Policy. Management cannot provide any assurance about the actual effect of changes in interest rates on Valley's net interest income.\nLIQUIDITY\nLiquidity measures the ability to satisfy current and future cash flow needs as they become due. Maintaining a level of liquid funds through asset-liability management seeks to ensure that these needs are met at a reasonable cost. On the asset side, liquid funds are maintained in the form of cash and due from banks, federal funds sold, investments securities held to maturity maturing within one year, securities available for sale and loans held for sale. At December 31, 1994, liquid assets amounted to $671 million, as compared to $1.13 billion at December 31, 1993. This represents 19.2% and 32.6% of earning assets, and 17.9% and 33.9% of total assets at December 31, 1994 and year-end 1993, respectively.\nOn the liability side, the primary source of funds available to meet liquidity needs is Valley's core deposit base, which generally excludes certificates of deposit over $100 thousand. Core deposits averaged approximately $2.65 billion and $2.24 billion at December 31, 1994 and year-end 1993, respectively, representing 76.6% and 68.2% of average earning assets. Short term borrowings and large dollar certificates of deposit, generally those over $100 thousand, are used as supplemental funding sources during periods when growth in the core deposit base does not keep pace with that of earning assets. Additional liquidity is derived from scheduled loan and investment payments of principal and interest, as well as prepayments received. Proceeds from the sales of investment securities were $228.2 million, and proceeds of $298.6 million were generated from investment maturities. Purchases of investment securities during the same year were $406.2 million. Short term borrowings and certificates of deposit over $100 thousand amounted to $271.5 million and $207.0 million, on average, for the year ending December 31, 1994 and 1993, respectively.\nThe following table lists, by maturity, all certificates of deposit of $100,000 and over at December 31, 1994. These certificates of deposit are generated primarily from core deposit customers and are not brokered funds.\nThe parent company's cash requirements consist primarily of dividends to shareholders. This cash need is routinely satisfied by dividends collected from its subsidiary bank. Projected cash flows from this source are expected to be adequate to pay dividends, given the current capital levels and current profitable operations of its subsidiary.\nINVESTMENT SECURITIES\nMATURITY DISTRIBUTION OF INVESTMENT SECURITIES HELD TO MATURITY AT DECEMBER 31, 1994\nMATURITY DISTRIBUTION OF INVESTMENT SECURITIES AVAILABLE FOR SALE AT DECEMBER 31, 1994\n- ---------------\n(1) Maturities are stated at cost less principal reductions, if any, and adjusted for accretion of discounts and amortization of premiums.\n(2) Average yields are calculated on a yield-to-maturity basis.\n(3) Average yields on obligations of states and political subdivisions are generally tax-exempt and calculated on a tax-equivalent basis using a statutory federal income tax rate of 35%.\n(4) Excludes equity securities which have indefinite maturities.\nValley's investment portfolio is comprised of U.S. government and federal agency securities, tax-exempt issues of states and municipalities, mortgage backed securities and equity and other securities. There were no securities in the name of any one issuer exceeding 10% of shareholders' equity, except for securities issued by the United States and its political subdivisions and agencies. The portfolio generates substantial interest income which serves as a source of liquidity. The decision to purchase or sell securities is based upon the current assessment of long and short term economic and financial conditions, including the interest rate environment and other statement of financial condition components.\nAs of December 31, 1994 Valley has $458.2 million of securities available for sale compared with $461.1 million at December 31, 1993. Those securities are recorded at their fair value on an aggregate basis as of December 31, 1994. These securities are not considered trading account securities, which may be sold on a continuous basis, but rather securities which may be sold to meet the various liquidity and interest rate requirements of Valley.\nDuring 1993, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities.\" The statement is effective for fiscal years beginning after December 15, 1993, applied prospec-\ntively. SFAS 115 requires debt and equity securities classified as available-for-sale securities to be reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity, net of deferred tax. This SFAS may have a significant and fluctuating impact on shareholders' equity, depending on changes in market interest rates. Valley has adopted this statement prospectively on January 1, 1994, and has classified its investment portfolio into investments held to maturity and available for sale on the consolidated statement of financial condition at December 31, 1994. The financial impact represents the difference between the amortized cost and fair value of those investments available for sale. As of December 31, 1994 the investment securities available for sale had an unrealized loss of $16.2 million, net of deferred taxes. Gains or losses are realized from the portfolio for income purposes only when the securities available for sale are sold.\nTotal investment securities, including securities classified as held to maturity and available for sale, decreased $148.3 million during 1994 to $1.30 billion. U.S. Treasury securities decreased $123.3 million or 40.8%, tax-exempt issues of states and municipalities increased $37.7 million or 13.1%, and mortgage backed securities increased $16.6 million or 2.2%.\nFASB issued SFAS 119 \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments\" which applies to financial statements with fiscal years ending after December 15, 1994. This statement requires disclosure about derivative financial instruments of which Valley has none.\nLOAN PORTFOLIO\nThe following table reflects the composition of the loan portfolio for the five years ended December 31, 1994.\nLOAN PORTFOLIO\nThe composition of Valley's loan portfolio continues to change due to the local economy and loan demand. Commercial lending increased by the largest percentage after slow growth during 1993 and automobile loans and commercial mortgage loans have continued their steady increase. Residential loans were increasing steadily throughout 1993 and slowed considerably since the early part of 1994, as interest rates began to rise. The increase in automobile lending is reflective of Valley's increased market penetration, and may be indicative of greater consumer confidence in the economy during 1994. There is no guarantee that the level of automobile lending will continue at the brisk pace of 1994, especially in light of the increases in lending rates.\nAutomobile loans outstanding at year end include customer loans which were referred to VNB by a major insurance company. Approximately 35% of the automobile loan portfolio and 11% of the total loan portfolio outstanding at December 31, 1994 represent loans originated by VNB thorugh this referral program. Over the last several years the amount of loans referred through this program has grown and VNB is continuously working to further expand the relationship. The insurance company has referred loans in this manner for approximately 40 years and current relations between the parties are excellent.\nResidential mortgage loans, including residential mortgages held for sale increased by 8.2% or $52.3 million to a total of $689.2 million at December 31, 1994, and represent 31.5% of the loan portfolio. Valley, historically did not have a large residential loan portfolio and, therefore, most of this growth came from Valley's competition. Installment loans, including predominantly automobile and credit card loans, totalled $645.7 million at December 31, 1994, increasing by $101.7 million over 1993 or 18.7% and representing 29.5% of the loan portfolio. Commercial mortgages increased 19.6% or $85.6 million from December 1993 to December 1994, also the result of refinancing activity.\nIt is not known if the trend of increased automobile and commercial mortgage loans will be as predominant as the effects of rising interest rates are felt throughout the economy. Valley continues to take advantage of loan demand in those sectors of the economy where it is most prevalent.\nValley has continued to offer various types of fixed rate residential mortgage loans and is also offering a large array of adjustable rate loans. During 1993 Valley periodically sold some of its 15 year fixed loans into the secondary market, allowing Valley to keep its portfolio mixed between fixed rate and variable rate loans, as well as maintaining a shorter maturity of its portfolio. During 1994 Valley decided to keep its residential mortgage loans being originated so that the portfolio could grow as demand by Valley for loans increased.\nAs part of the acquisition of Rock, Valley became a preferred Small Business Administration (\"SBA\") lender with authority to make loans without the prior approval of the SBA. Approximately 70% of each loan is guaranteed by the SBA and is sold into the secondary market, with the balance retained in the portfolio. Valley intends to expand this area of lending as it provides a solid source of fee income and loans with floating interest rates tied to the prime lending rate.\nEfforts are made to maintain a diversified portfolio as to type of borrower and loan. There were no loan concentrations at December 31, 1994 other than those disclosed above.\nThe following table reflects the maturity distribution of the loan portfolio as of December 31, 1994.\nThe majority of payments due after 1 year represent loans with floating interest rates.\nPrior to maturity of each loan, Valley generally conducts a review which normally includes an analysis of the borrower's financial condition and, if applicable, a review of the adequacy of collateral. A rollover of the loan at maturity may require a principal paydown.\nNON-PERFORMING ASSETS\nNon-performing assets include non-accrual loans and other real estate owned (OREO). Loans are generally placed on a non-accrual status when they become past due in excess of 90 days as to payment of principal and interest. Exceptions to the non-accrual policy may be permitted if the loan is sufficiently collateralized and in the process of collection. OREO is acquired through foreclosure on loans secured by land or real estate. OREO is reported at the lower of cost or fair value at the time of acquisition and at the lower of fair value, less estimated costs to sell, or cost thereafter.\nNon-performing assets decreased from 1993 to 1994 as the economy continued its strength and recovery. Non-performing assets were $25.7 million at December 31, 1994 compared with $26.7 million at December 31, 1993 and decreased by $1.0 million, or 3.9%. Non-performing assets at December 31, 1994 and 1993, respectively, amounted to 1.17% and 1.40% of loans and other real estate owned.\nThe following table sets forth non-performing assets and accruing loans which are 90 days or more past due as to principal or interest payments on the dates indicated, in conjunction with asset quality ratios for Valley.\nLOAN QUALITY\nASSET QUALITY AND RISK ELEMENTS\nLending is one of the most important functions performed by Valley, and by its very nature, lending is also the most complicated, riskiest and profitable part of Valley's business. A separate credit department is responsible for risk assessment, credit file maintenance and periodically evaluating overall creditworthiness of a borrower. Additionally, efforts are made to limit concentrations of credit within the loan portfolio so as to minimize the impact of a downturn in any one economic sector. Valley's portfolio, in total, is diversified as to type of borrower and loan, even though much of its lending is in New Jersey, thereby limiting its concentration of credit risk.\nManagement realizes that some degree of risk must be expected in the normal course of lending activities. Reserves are maintained to absorb such potential loan and off-balance sheet credit losses. The allowance for loan losses and related provision are an expression of management's evaluation of the credit portfolio and economic climate.\nThe following table sets forth the relationship among loans, loans charged-off and loan recoveries, the provision for loan losses and the allowance for loan losses for the past five years:\nThe allowance for possible loan losses is maintained at a level believed by management to be appropriate to absorb potential loan losses and other credit risk related charge-offs. It is the result of an analysis which relates outstanding balances to expected reserve levels required to absorb future credit losses. Current economic problems are addressed through management's assessment of anticipated changes in the regional economic climate, changes in composition and volume of the loan portfolio and variances in levels of classified loans, non-performing assets and other past due amounts. Additional factors include consideration of exposure to loss including size of credit, existence and nature of collateral, credit record, profitability and general economic conditions.\nDuring the year, continued emphasis was placed on the current economic climate and the condition of the real estate market in the Northern New Jersey area. Management addressed these current economic conditions and applied that information to changes in the composition of the loan portfolio. The decline in non-performing assets, coupled with the continued recovery of the economy among other things was responsible for the decision to decrease the provision from $6.4 million in 1993 to $3.5 million in 1994.\nThe following table summarizes the allocation of the allowance for loan losses to specific loan categories for the past five years:\nNet charge-offs decreased during 1994 as a result of improved current economic conditions. The amount of anticipated charge-offs for 1995 is estimated to be consistent with 1994, but there can be no assurance that changing economic conditions will not cause charge-offs to increase.\nValley's allowance for loan loss stayed virtually unchanged from 1993 to 1994. At December 31, 1994 the allowance for loan losses amounted to $36.4 million or 1.67% of loans, including loans held for sale, net of unearned income, as compared to $36.6 million or 1.9% at year-end 1993.\nThe allowance is adjusted by provisions charged against income and loans charged-off, net of recoveries. Net loan charge-offs were $3.7 million for the year ended December 31, 1994 compared with $4.2 million for the year ended December 31, 1993. The ratio of net charge-offs to average loans amounted to 0.18% for 1994 compared with 0.24% for 1993.\nAlthough substantially all risk elements at December 31, 1994 have been disclosed, Management believes that the current economic conditions may affect the ability of certain borrowers to comply with the contractual repayment terms on certain real estate and commercial loans. As part of the analysis of the loan portfolio by management, it has been determined that there are approximately $8.0 million in potential problem loans at December 31, 1994 which have not been classified as non-performing or past due. Potential problem loans are defined as loans for which management believes that the borrower's ability to repay the loan may be impaired. Approximately $2.3 million has been provided for in the allowance for loan losses for these potential problem loans. There can be no assurance that Valley has identified all of its problem loans.\nFASB issued Statement of Financial Accounting Standard No. 114, \"Accounting by Creditors for Impairment of a Loan\" and Statement of Financial Accounting Standard No. 118 \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure\" which apply to financial statements for fiscal years beginning after December 15, 1994. These Statements require that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or at the fair value of the collateral if the loan is collateral dependent. Valley has reviewed its impaired loans and has determined that there is no material impact expected on the financial position or operations of Valley as a result of adopting these statements, prospectively, during 1995.\nCAPITAL ADEQUACY\nA significant measure of the strength of a financial institution is its shareholders' equity, which must expand in close proportion to asset growth. At December 31, 1994, shareholders' equity totalled $300.2 million or 8.0% of total assets, compared with $282.5 million or 7.8% at year-end 1993. Valley has achieved steady internal capital generation throughout the past five years.\nRisk-based guidelines define a two-tier capital framework. Tier 1 capital consists of common shareholders' equity less disallowed intangibles, while Total risk-based capital consists of Tier 1 capital and the\nallowance for loan losses up to 1.25% of risk-adjusted assets. Risk-adjusted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities.\nThe following tables detail Valley's capital components and ratios as of December 31, 1994, 1993 and 1992.\nCAPITAL ANALYSIS\n- ---------------\n(1) During 1994, the regulatory agencies determined that the FASB 115 adjustment does not enter into the calculation of capital ratios.\n(2) Limited to 1.25% of risk-weighted assets, with the excess deducted from risk-weighted assets.\nCAPITAL RATIOS\nValley's capital position at December 31, 1994 under risk-based capital guidelines was $311.9 million, or 13.7% of risk-weighted assets, for Tier 1 capital and $340.4 million, or 15.0% for Total risked-based capital. The comparable ratios at December 31, 1993 were 14.1% for Tier 1 capital and 15.4% for Total risk-based capital. Valley's ratios at December 31, 1994 are above the \"well capitalized\" requirements, which require Tier 1 capital of at least 6% and Total risk-based capital of 10%. The Federal Reserve Board requires \"well capitalized\" bank holding companies to maintain a minimum leverage ratio of 5.0%. At December 31, 1994 and 1993, Valley was in compliance with the leverage requirement having a Tier 1 leverage ratio of 8.3% and 7.7%, respectively.\nThe primary source of capital growth is through retention of earnings. Valley's rate of earnings retention, derived by dividing undistributed earnings by net income was 51.7% at December 31, 1994, compared to 60.5% at December 31, 1993. Cash dividends declared amounted to $.98 per share, equivalent to a dividend payout ratio of 48.3%, up from the 39.5% for the year 1993. The current quarterly dividend rate of $.25 per share provides for an annual rate of $1.00 per share. Valley's Board of Directors continues to believe that cash dividends are an important component of shareholder value and that at its current level of performance and capital, Valley expects to continue its current dividend policy of a quarterly distribution of earnings to its shareholders.\nRESULTS OF OPERATIONS -- 1993 COMPARED TO 1992\nValley reported net income for 1993 of $56.4 million, or $2.00 per share, 30% above the $43.4 million, or $1.56 per share earned in 1992 (all amounts have been restated for the RFC merger and the per share amounts have been restated to give effect to a 10% stock dividend in 1994, a five for four stock split in 1993 and a three for two stock split in 1992).\nValley acquired the $223.2 million, seven branch Peoples Bank, N.A. on June 18, 1993. The merger was accounted for under the purchase method of accounting, and as such, the consolidated financial statements include the results of operations and assets and liabilities of Peoples from June 18, 1993 forward. (See Note 2, Acquisitions in the Consolidated Financial Statements)\nNet interest income on a tax equivalent basis rose $22.8 million, or 17.6% to $151.8 million in 1993. The increase in 1993 was due primarily to the significant decrease in interest rates on all liability accounts of 109 basis points, which was greater than the decline of 70 basis points on all interest earning assets. The net interest margin increased to 4.62% in 1993 from 4.31% in 1992, which was substantially the result of changes in market interest rates. The increase in the net interest margin of 31 basis points, coupled with the increase in average earning assets over average interest-bearing liabilities, was the basis for the increase in net interest income.\nA provision for loan losses was recorded totalling $6.4 million in 1993 compared with $16.3 million in 1992. The decline in non-performing assets, coupled with the continued recovery of the economy was responsible for the decision to decrease the provision.\nNon-interest income in 1993 amounted to $26.5 million, a decrease of $4.5 million, or 14.4% compared with 1992. This decrease includes gains on securities transactions of $7.2 million in 1993, an increase of $864 thousand compared to 1992. This resulted from restructuring the investment portfolio, to alter maturities and to protect the portfolio from substantial and volatile prepayments on mortgage backed securities due to declining interest rates and heavy refinancing activity. The decrease in non-interest income is partially from the decline in mortgage servicing fees by MSI. Mortgage servicing fees totalled $3.8 million during 1993, a decrease of $587 thousand, or 13.3% compared to 1992. These fees were the result of servicing a $1.17 billion loan portfolio at December 31, 1993 which included $467.0 million serviced for VNB. The decline in servicing fees was the result of large amounts of prepayments of loans serviced causing the fee income to decline in proportion to the portfolio decline. Service charges on deposit accounts increased $1.4 million, or 31.1% during 1993 compared with 1992, which was due to increased volume due to the Peoples seven branch acquisition increasing the number of deposit accounts and increases to fees charged on transactions. Other non-interest income decreased by $1.1 million primarily due to the reduction of transactions with the RTC from the prior year.\nNon-interest expense totalled $76.6 million in 1993, an increase of $5.8 million, or 8.2% compared with 1992. This increase was directly attributable to the seven branches acquired during 1993 from Peoples Bank. Salaries and employee benefit expense increased $2.8 million or 8.5%, and a result of number of the full-time equivalent employees increasing from 973 at the end of 1992 to 1,081 at the end of 1993. FDIC insurance premiums increased $1.0 million or 17.0% and was attributable to the deposits acquired in connection with the Peoples acquisition. Net occupancy expense, and furniture and equipment expense increased $950 thousand, or 16.5% as a result of the increased costs associated with the acquisitions during 1993 and 1992. Amortization of intangible assets increased $890 thousand or 21.5% representing the increased amortization due to approximately $21.3 million of mortgage servicing acquired during 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' 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\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (NOTE 1)\nBasis of Presentation\nThe consolidated financial statements of Valley National Bancorp and its wholly-owned subsidiary (\"Valley\") include the accounts of its principal commercial bank subsidiary, Valley National Bank (\"VNB\") and its wholly-owned subsidiaries. All material intercompany transactions and balances have been eliminated. The financial statements of prior years have been restated to include Rock Financial Corporation (\"RFC\"), which was acquired on November 30, 1994 in a transaction accounted for as a pooling of interest. Certain reclassifications have been made in the consolidated financial statements for 1993 and 1992 to conform to the classifications presented for 1994.\nStatement of Cash Flows\nThe Consolidated Statements of Cash Flows are presented using the indirect method. Cash and cash equivalents are defined as cash and due from banks.\nInvestment Securities Held to Maturity and Available for Sale\nInvestment Securities held to maturity, except for equity securities, are carried at cost and adjusted for amortization of premiums and accretion of discounts by using the interest method over the term of the investment.\nThe Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"). \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires debt and equity securities classified as available-for-sale securities to be reported at fair value, with unrealized gains and losses reported as a separate component of shareholders' equity, net of deferred tax. Gains and losses are realized from the portfolio for income purposes only when the securities available for sale are sold. Valley has adopted this statement prospectively on January 1, 1994.\nManagement has identified those investment securities which may be sold prior to maturity. These investment securities are classified as available for sale on the accompanying consolidated statements of financial condition and are recorded at fair value on an aggregate basis and unrealized holding gains and losses (net of related tax effects) on such securities are excluded from earnings, but are included as a separate component of shareholders' equity, net of deferred tax.\nRealized gains or losses on the sale of investment securities available for sale are recognized by the specific identification method and shown as a separate component of non-interest income.\nLoans and Loan Fees\nLoans are stated net of unearned income. Unearned income on discounted loans is recognized based upon methods which approximate a level yield. Loan origination and commitment fees, net of related costs, are deferred and amortized as an adjustment of loan yield over the estimated lives of the loans approximating the effective interest method.\nInterest income is not accrued on loans where interest or principal is 90 days or more past due or if in management's judgement the ultimate collectibility of the interest is doubtful. Exceptions may be made if the loan is sufficiently collaterized and in the process of collection. When a loan is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected.\nValley originates loans guaranteed by the Small Business Administration(\"SBA\"). These loans are guaranteed up to 70% by the SBA. Valley sells the guaranteed portions of these loans and retains the unguaranteed portions as well as the right to service the loans. Gains are recorded on loan sales based on premiums paid by the purchasers. A portion of the gains are deferred and recorded as income over the estimated average life of the loans.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nLoans Held for Sale\nLoans held for sale include residential mortgage loans originated with the intent to sell. Loans held for sale are carried at the lower of aggregate cost or fair value.\nAllowance for Possible Loan Losses\nThe allowance for possible loan losses (\"allowance\") is increased through provisions charged against current earnings and additionally by crediting amounts of recoveries received, if any, on previously charged-off loans. The allowance is reduced by charge-offs on loans which are determined to be a loss, in accordance with established policies when all efforts of collection have been exhausted.\nThe allowance is maintained at a level necessary to absorb potential loan losses and other credit risk related charge-offs. It is the result of an analysis which relates outstanding balances to expected reserve levels required to absorb future credit losses. Current and economic problems are addressed through management's assessment of anticipated changes in the regional economic climate, changes in composition and volume of the loan portfolio and variances in levels of classified loans, non-performing assets and other past due amounts.\nPremises and Equipment\nPremises and equipment are stated at cost less accumulated depreciation computed using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are stated at cost less accumulated amortization computed on a straight-line basis over the term of the lease or estimated useful life of the asset, whichever is shorter. Major improvements are capitalized, while repairs and maintenance costs are charged to operations as incurred. Upon retirement or disposition, any gain or loss is credited or charged to operations.\nOther Real Estate Owned\nReal estate formally acquired in partial or full satisfaction of loans is classified as other real estate owned. These assets are recorded at the lower of cost or fair value at the time of acquisition, with any excess charged to the allowance for loan losses and at the lower of fair value, less estimated costs to sell, or cost thereafter. Subsequent declines in value are charged to other real estate expense.\nIntangible Assets\nIntangible assets resulting from acquisitions under the purchase method of accounting consist of goodwill and core deposit intangibles. Goodwill recorded prior to 1987 is being amortized on a straight-line basis over 25 years. Core deposit intangibles are amortized on accelerated methods over the estimated lives of the assets. Goodwill and core deposit intangibles included in other assets at December 31, 1994.\nMortgage Servicing\nServicing fee income, representing reimbursement for loan administrative services performed on contractually serviced mortgages, are credited to income as earned.\nPurchased mortgage servicing rights are capitalized and amortized over the estimated lives of related loans and approximate the amount by which the present value of estimated future servicing revenues exceeds the present value of expected servicing costs.\nIncome Taxes\nStatement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes\", required a change from the deferred method under APB Opinion 11 to the asset and liability method of SFAS 109. Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nEffective January 1, 1993, Valley adopted SFAS 109 prospectively and has reported the cumulative effect of that change in method of accounting for income taxes in the 1993 consolidated statement of income.\nDeferred income taxes have been provided in 1992 for timing differences relating to items of income and expense recognized for financial reporting purposes in a different period than for tax purposes.\nEarnings Per Share\nEarnings per share is calculated by dividing net income by the weighted average number of shares outstanding during each period. All share and per share amounts have been restated to reflect the ten percent stock dividend on May 3, 1994, five for four stock split on April 16, 1993 and the three for two stock split on April 24, 1992. Shares issuable upon exercise of options and warrants are not included in the calculation of earnings per share since their effect is not material.\nTreasury Stock\nTreasury stock is recorded using the cost method and accordingly is presented as an unallocated reduction of shareholders' equity.\nACQUISITIONS (NOTE 2)\nOn November 30, 1994, Valley acquired approximately $190 million in assets of Rock Financial Corporation (\"RFC\"), based in North Plainfield, New Jersey and its five branch subsidiary, Rock Bank (\"Rock\"). Each share of RFC common stock outstanding was converted into 1.85 shares of Valley common stock for a total of approximately 1.7 million shares. The acquisition has been accounted for as a pooling of interests and the consolidated financial statements of Valley include the accounts of RFC for all periods presented. Separate results of the combining entities are as follows:\nOn June 18, 1993, Valley issued approximately 421,000 shares of its common stock at a cost of $10,962,000 in exchange for approximately 661,000 shares of common stock of Peoples Bancorp (\"Peoples\") of Fairfield, New Jersey, a New Jersey Corporation and a registered bank holding company of Peoples Bank, National Association, a banking association. The merger was accounted for under the purchase method of accounting, and as such, the consolidated financial statements include the results of operations and assets and liabilities of Peoples from June 18, 1993 forward.\nUnder the purchase method of accounting the assets acquired and liabilities assumed were recorded at their estimated fair value at the merger date, which resulted in an inmaterial amount of negative goodwill, which was allocated to bank premises.\nThe proforma results of operations for the period January 1 to June 18, 1993 and for the year ended December 31, 1992, assuming Peoples had been acquired as of January 1, 1992, would not have been significantly different from those presented in the Consolidated Statements of Income.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe acquisition of Peoples resulted in the following statement of condition increases as of the acquisition date:\nINVESTMENT SECURITIES HELD TO MATURITY (NOTE 3)\nThe amortized cost, fair value and unrealized gains and losses of securities held to maturity at December 31, 1994 and 1993 were as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe contractual maturities of investments in debt securities held to maturity at December 31, 1994 are set forth in the following table:\nActual maturities of debt securities may differ from those presented above as certain obligations provide the issuer the right to call or prepay the obligation prior to scheduled maturity without penalty. Equity and other securities do not have contractual maturities.\nThe amortized cost of securities pledged to secure public deposits, treasury tax and loan deposits, repurchase agreements and for other purposes required by law approximated $126,834,000 and $71,728,000 at December 31, 1994 and 1993, respectively.\nGross gains (losses) realized on sales, maturities and other securities transactions for the year ended December 31, 1992 were as follows:\nCash proceeds from sales transactions approximated $266,615,000 for the year ended 1992.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nINVESTMENT SECURITIES AVAILABLE FOR SALE (NOTE 4)\nThe amortized cost, approximate fair value and unrealized gains and losses of securities available for sale at December 31, 1994 and 1993 were as follows:\nThe contractual maturities of investments in debt securities available for sale at December 31, 1994 are set forth in the following table:\nActual maturities on debt securities may differ from those presented above as certain obligations provide the issuer the right to call or prepay the obligation prior to scheduled maturity without penalty. Equity securities do not have contractual maturities.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nGross gains (losses) realized on sales, maturities and other securities transactions for the years ended December 31, 1994 and 1993 were as follows:\nCash proceeds from sales transactions approximated $187,096,000 and $330,546,000 for the years ended 1994 and 1993, respectively.\nLOANS (NOTE 5)\nThe detail of the loan portfolio as of December 31, 1994 and 1993 was as follows:\nVNB grants loans in the ordinary course of business to their directors, executive officers and their affiliates, on the same terms and under the same risk conditions as those prevailing for comparable transactions with outside borrowers.\nThe following table summarizes the change in the total amounts of loans and advances to directors, executive officers, and their affiliates during the year 1994:\nNon-performing assets include non-accrual loans and other real estate owned.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe outstanding balances of accruing loans which are 90 days or more past due as to principal or interest payments and non-performing assets at December 31, 1994 and 1993 were as follows:\nThe amount of interest income that would have been recorded on non-accrual loans in 1994, 1993 and 1992 had payments remained in accordance with the original contractual terms approximated $2,433,000, $3,076,000 and $2,830,000 while the actual amount of interest income recorded on these types of assets in 1994, 1993 and 1992 totalled $901,000, $759,000 and $360,000, resulting in lost interest income of $1,532,000, $2,317,000 and $2,470,000, respectively.\nAt December 31, 1994, there were no commitments to lend additional funds to borrowers whose loans were non-accrual or contractually past due in excess of 90 days and still accruing interest.\nALLOWANCE FOR POSSIBLE LOAN LOSSES (NOTE 6)\nTransactions in the allowance for possible loan losses during 1994, 1993 and 1992 were as follows:\nMORTGAGE SERVICING (NOTE 7)\nVNB Mortgage Services, Inc. (\"MSI\"), a subsidiary of VNB, is a servicer of residential mortgage loan portfolios. MSI purchases the rights to service these portfolios in the secondary market and is compensated for loan administrative services performed.\nThe aggregate principal balances of mortgage loans serviced by MSI approximated $1,204,980,000, $1,174,939,000 and $1,228,710,000 at December 31, 1994, 1993 and 1992, respectively. These amounts included $536,601,000, $467,003,000 and $395,716,000 as of December 31, 1994, 1993 and 1992, respectively, of loans serviced on behalf of VNB. The outstanding balance of loans serviced for others is not included in the consolidated statement of financial condition.\nThe costs associated with acquiring mortgage servicing rights are included in other assets in the consolidated financial statements and are being amortized over the estimated periods which the related loans are expected to generate income. The remaining unamortized costs at December 31, 1994, 1993 and 1992, amounted to $5,998,000, $6,193,000 and $9,961,000, respectively. Amortization expense for 1994, 1993 and 1992 amounted to $1,585,000, $3,715,000 and $2,793,000, respectively, and is included in amortization of intangible assets.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPREMISES AND EQUIPMENT (NOTE 8)\nAt December 31, 1994 and 1993, premises and equipment consisted of:\nDepreciation and amortization included in non-interest expense for the years ended December 31, 1994, 1993 and 1992 amounted to approximately $5,039,000, $4,422,000 and $3,775,000, respectively.\nOTHER ASSETS (NOTE 9)\nAt December 31, 1994 and 1993, other assets consisted of the following:\nDEPOSITS (NOTE 10)\nThe carrying value of deposits at December 31, 1994 and 1993 were as follows:\nInterest expense on certificates of deposits of $100,000 or more totaled approximately $13,925,000, $4,227,000 and $8,883,000 in 1994, 1993 and 1992, respectively.\nOTHER BORROWINGS (NOTE 11)\nAt December 31, 1994 and 1993, other borrowings consisted of the following:\nThe capitalized lease obligation is due to be repaid in May of 1995.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nBENEFIT PLANS (NOTE 12)\nPension Plan\nVNB has a non-contributory benefit plan covering substantially all of its employees. The benefits are based upon years of credited service, primary social security benefits and the employee's highest average compensation as defined. It is VNB's funding policy to contribute annually the maximum amount that can be deducted for federal income tax purposes. In 1994 and 1993, contributions totaling $1,091,000 and $927,000 were made, while in 1992 no contributions were made due to the full funding limitations of the Internal Revenue Code. In addition, VNB has a supplemental non-qualified, non-funded retirement plan which is designed to supplement the pension plan for key employees.\nThe following table sets forth the funded status of the plans and amounts recognized in Valley's financial statements at December 31, 1994 and 1993:\nNet periodic pension expense for 1994, 1993 and 1992 included the following components:\nThe weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of benefit obligations for the plan were 8.00% and 6.00%, respectively, for 1994, 7.50% and 6.00% for 1993 and 8.00% and 6.00% for 1992. The expected long term rate of return on assets was 9.00% for 1994, 1993 and 1992, and the weighted average discount rate used in computing pension cost was 7.50%, 8.00% and 8.00% for 1994, 1993, and 1992, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nBonus Plan\nVNB and its subsidiaries award incentive and merit bonuses to its officers and employees based upon a percentage of the covered employees compensation and determined by the achievement of certain performance objectives. Amounts charged to salaries expense during 1994, 1993 and 1992 were $1,495,000, $1,439,000 and $1,271,000, respectively.\nSavings Plan\nDuring the early part of 1992, VNB implemented a contribution matching 401K Savings and Investment Plan. This plan, which replaced a defined contribution profit sharing plan, covers eligible employees of VNB and its subsidiaries. The 401K plan allows employees to contribute from 1% to 12% of their salary with VNB matching the first 3% out of its current years earnings with the distribution of VNB's contributions subject to a vesting schedule. 401K and profit sharing expense for 1994, 1993 and 1992 amount to $586,000, $663,000 and $502,000, respectively.\nSTOCK INCENTIVE PLAN\nValley maintains a stock incentive plan pursuant to which 1,759,076 shares of common stock have been authorized for issuance to certain key employees in the form of stock options, stock appreciation rights and restricted stock awards. Shares of Valley's common stock may be purchased under qualified and non-qualified stock options at 100 percent and 80 percent, respectively, of the fair market value of such shares on the date of the grant. The options granted under this plan are, in general, exercisable not earlier than one year after the date of grant, and expire not more than ten years after the date of the grant, and are subject to a vesting schedule. Changes in total options outstanding during 1994, 1993 and 1992 are as follows:\nOptions exercisable under the Plan's vesting schedule at December 31, 1994, 1993 and 1992, were 178,258, 144,137 and 109,129 options, respectively.\nOptions exercisable under the Plan's vesting schedule at December 31, 1994, 1993 and 1992, were 11,137, 8,910 and 6,682 options, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRestricted stock is awarded to key employees providing for the immediate award of Valley's common stock subject to certain vesting and restrictions. The awards are recorded at fair market value and amortized into salaries expense over the vesting period. The following table sets forth the changes in restricted stock awards outstanding at December 31, 1994, 1993 and 1992.\nThe amount of compensation costs included in salaries expense in 1994, 1993 and 1992 amounted to $254,000, $232,000 and $131,000, respectively.\nINCOME TAXES (NOTE 13)\nAs discussed in Note 1, Valley adopted SFAS No. 109 as of January 1, 1993. The cumulative effect of this change in accounting for income taxes of $402 thousand is determined as of January 1, 1993 and is reported separately in the consolidated statement of income for the year ended December 31, 1993. Prior years' financial statements have not been restated to apply the provision of SFAS No. 109.\nIncome tax expense(benefit) included in the financial statements consisted of the following:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe significant components of deferred income tax expense (benefit) for the years ended December 31, 1994, 1993 and 1992 are as follows:\nThe tax effects of temporary differences that give rise to the deferred tax assets and liabilities as of December 31, 1994 and 1993 are as follows:\nA reconciliation between the reported income tax expense from operations and the amount computed by multiplying income before taxes by the statutory federal income tax rate is as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCOMMITMENTS AND CONTINGENCIES (NOTE 14)\nCash Reserves\nAt December 31, 1994, cash reserves maintained in accordance with Federal Reserve regulations amounted to $41,940,000.\nLease Commitments\nCertain bank facilities are occupied under non-cancelable long term operating leases which expire at various dates through 2005. Certain lease agreements provide for renewal options and increases in rental payments based upon increases in the consumer price index or the lessor's cost of operating the facility. Minimum aggregate lease payments for the remainder of the lease terms are as follows:\nNet occupancy and equipment expense for 1994, 1993 and 1992 includes approximately $1,834,000, $2,318,000 and $1,730,000, respectively, of rental expenses for bank facilities.\nFinancial Instruments With Off-Balance Sheet Risk\nIn the ordinary course of business of meeting the financial needs of its customers, Valley, through its subsidiary VNB, is a party to various financial instruments which are properly not reflected in the consolidated financial statements. These financial instruments include standby and commercial letters of credit, unused portions of lines of credit and commitments to extend various types of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated financial statements. The commitment or contract amount of these instruments is an indicator of VNB's level of involvement in each type of instrument as well as the exposure to credit loss in the event of non-performance by the other party to the financial instrument. VNB seeks to limit any exposure of credit loss by applying the same credit underwriting standards, including credit review, interest rates and collateral requirements or personal guarantees, as for on-balance sheet lending facilities.\nThe following table provides a summary of the contract amount of financial instruments with off-balance sheet risk at December 31, 1994.\nStandby letters of credit represent the guarantee by VNB of the obligations or performance of a customer in the event the customer is unable to meet or perform its obligations to a third party. Obligations to advance funds under commitments to extend credit, including commitments under unused lines of credit, are agreements to lend to a customer as long as there is no violation of any condition established in the contract.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCommitments generally have specified expiration dates, which may be extended upon request, or other termination clauses and generally require payment of a fee.\nThe amounts set forth above do not necessarily represent future cash requirements as it is anticipated that many of these commitments will expire without being fully drawn upon. Most of VNB's lending activity is to customers within the state of New Jersey.\nLitigation\nIn the normal course of business, Valley may be a party to various outstanding legal proceedings and claims. In the opinion of management, the consolidated financial position of Valley will not be materially affected by the outcome of such legal proceedings and claims.\nAcquisition\nOn November 9, 1994, Valley entered into an Agreement and Plan of Merger to acquire American Union Bank (\"American\"), a $55 million, two office bank headquartered in Union, New Jersey. Shareholders of American will receive 0.50 shares of Valley common stock for each of the 549,970 outstanding shares of common stock of American, resulting in the issuance by Valley of 274,985 shares of Valley common stock.\nSTOCKHOLDERS' EQUITY (NOTE 15)\nDividend Restrictions\nVNB, a national banking association, is subject to a limitation in the amount of dividends it may pay to Valley, VNB's only shareholder. Prior approval by the Comptroller of the Currency (\"OCC\") is required to the extent the total of all dividends to be declared by VNB in any calendar year exceeds net profits, as defined, for that year combined with its retained net profits from the preceding two calendar years, less any transfers to capital surplus. Under this limitation, VNB could declare dividends in 1995 without prior approval of the OCC of up to $65,187,000 plus an amount equal to VNB's net profits for 1995 to the date of such dividend declaration.\nWarrants for Purchase of Common Stock\nPursuant to the Merger Agreement between Valley and Mayflower, Valley issued 449,883 warrants valued at approximately $225,000 in exchange for all issued and outstanding common shares of Mayflower. The warrants, which became exercisable on June 30, 1991 and expire on December 31, 1995, provide the warrant holder the right to acquire 2.0625 shares of Valley's common stock at a price of $27.50. At December 31, 1994, 273,971 warrants remain exercisable which provide the holders with the right to acquire 565,065 shares at a purchase price of approximately $13.33 per share.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED) (NOTE 16)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPARENT COMPANY INFORMATION (NOTE 17)\nCondensed Statements of Income\nCondensed Statements of Financial Condition\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCondensed Statements of Cash Flows\nFAIR VALUES OF FINANCIAL INSTRUMENTS (NOTE 18)\nStatement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments\", requires disclosure of estimated fair values for financial instruments.\nLimitations: The fair value estimates made at December 31, 1994 and 1993 were based on pertinent market data and relevant information on the financial instrument at that time. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire portion of the financial instruments. Because no market exists for a portion of the financial instruments, fair value estimates may be 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 and involve\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nuncertainties and matters of significant judgment 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 that are not considered financial instruments. For instance, Valley has certain fee-generating business lines (e.g. its mortgage servicing operation and trust department) that were not considered in these estimates since these activities are not financial instruments. In addition, the tax implications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in many of the estimates.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments:\nCash and short-term investments: For such short-term investments, the carrying amount is considered to be a reasonable estimate of fair value.\nInvestment securities held to maturity and investment securities available for sale: Fair values are based on quoted market prices.\nLoans and loans held for sale: Fair values were estimated by obtaining quoted market prices, when available. The fair value of other loans were estimated by discounting the future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loan.\nDeposit liabilities: Current carrying amounts approximate estimated fair value of demand deposits and savings accounts. The fair value of time deposits was based on the discounted value of contractual cash flows using estimated rates currently offered for deposits of similar remaining maturity.\nShort term liabilities: Current carrying amounts approximate estimated fair value.\nOther borrowings: The fair value was estimated by discounting future cash flows based on rates currently available for debt with similar terms and remaining maturity.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe carrying amounts and estimated fair values of financial instruments were as follows at December 31, 1994 and 1993:\nThe estimated fair value of financial instruments with off-balance sheet risk, consisting of unamortized fee income at December 31, 1994 and 1993 is not material.\nSUBSEQUENT EVENT (UNAUDITED) (NOTE 19)\nOn January 26, 1995 Valley entered into a letter of intent to acquire the $661 million Lakeland First Financial Group, Inc. (\"LFG\"), the holding company for Lakeland Savings Bank (\"Lakeland\"), a state chartered savings bank headquartered in Succasunna, New Jersey, with sixteen branches in Morris, Sussex and Warren counties, New Jersey. The letter of intent stipulates that 1.225 shares of common stock of Valley will be exchanged for each of the 3,881,398 shares of common stock of LFG. Valley also entered into a separate stock option agreement which gives Valley the option to purchase 1.25 million shares of authorized, but unissued common stock of LFG at an exercise price of $21.00 per share in the event that another party obtains control of LFG.\nINDEPENDENT AUDITORS' REPORT\n[K P M G Peat Marwick L O G O]\nKPMG Peat Marwick LLP Certified Public Accountants\nNew Jersey Headquarters 150 John F. Kennedy Parkway Short Hills, NJ 07078\nThe Board of Directors and Shareholders Valley National Bancorp:\nWe have audited the accompanying consolidated statements of financial condition of Valley National Bancorp and subsidiaries 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 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 Valley National Bancorp 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, Valley National Bancorp and subsidiaries adopted 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\" in 1994 and Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" in 1993.\nJanuary 25, 1995\n\/s\/ K P M G Peat Marwick 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 regarding directors of the registrant are incorporated by reference to the Proxy Statement for the Annual Meeting of Shareholders to be held on March 23, 1995 except for certain information on Executive Officers of the Registrant which is included in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding executive compensation is incorporated by reference to the Proxy Statement for the Annual Meeting of Shareholders to be held March 23, 1995.\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 by reference in the Proxy Statement for the Annual Meeting of Shareholders to be held March 23, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain relationships and related transactions is incorporated by reference in the Proxy Statement for the Annual Meeting of Shareholders to be held March 23, 1995.\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 financial statements listed on the index of this Annual Report on Form 10-K are filed as part of this Annual Report.\nAll financial statement schedules are omitted because they are either inapplicable or not required, or because the required information is included in the Consolidated Financial Statements or notes thereto.\n(b) Current Reports on Form 8-K during the quarter ended December 31, 1994:\n(1) On October 19, 1994 to report the signing of a Letter of Intent to effect a merger between Valley National Bancorp, Valley National Bank and American Union Bank.\n(2) On October 31, 1994 to report the quarterly release of earnings for September 30, 1994 for Valley National Bancorp.\n(3) On October 16, 1994 to report the signing of the Agreement and Plan of Merger, dated November 9, 1994 by and among Valley National Bancorp, Valley National Bank and American Union Bank.\n(4) On December 5, 1994 to report the merger of Rock Financial Corporation into Valley National Bancorp at the close of business on November 30, 1994.\n(c) Exhibits (numbered in accordance with Item 601 of Regulation S-K):\n(2) Plan of Acquisition:\nA. Agreement and Plan of Merger and Stock Option Agreement, dated November 9, 1994, by and among Valley National Bancorp, Valley National Bank and American Union Bank is incorporated by reference to Registrant's Registration Statement on Form S-4 (No.33-55765) filed with the Securities and Exchange Commission on October 4, 1994.\nB. Letter of Intent and Stock Option Agreement, dated January 26, 1995, by and among Valley National Bancorp, Valley national Bank, Lakeland First Financial Group, Inc., and Lakeland Savings Bank is incorporated by reference to Registrant's Form 8-K filed with the Securities and Exchange Commission on February 2, 1995.\n(3) Articles of Incorporation and Bylaws:\n(10) Material Contracts:\n- ---------------\n* This document is incorporated herein by reference from the Registrant's Form 10-K Annual Report for the fiscal period ending December 31, 1990.\n** This document is incorporated herein by reference from the Registrant's Notice of Annual Meeting of Shareholders and Proxy dated March 1, 1994.\n*** This document is incorporated herein by reference from the Registrant's Form 10-K Annual Report for the fiscal period ending December 31, 1993.\n(21) List of Subsidiaries:\n(23) Consents of Experts and Counsel\nConsent of KPMG Peat Marwick LLP.\n(27) 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.\nVALLEY NATIONAL BANCORP\nBy: \/s\/ GERALD H. LIPKIN --------------------------------- Gerald H. Lipkin, Chairman of the Board and Chief Executive Officer\nDated: February 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 February 24, 1995.\nEXHIBIT INDEX\n(2) Plan of Acquisition:\nA. Agreement and Plan of Merger and Stock Option Agreement, dated November 9, 1994, by and among Valley National Bancorp, Valley National Bank and American Union Bank is incorporated by reference to Registrant's Registration Statement on Form S-4 (No.33-55765) filed with the Securities and Exchange Commission on October 4, 1994.\nB. Letter of Intent and Stock Option Agreement, dated January 26, 1995, by and among Valley National Bancorp, Valley national Bank, Lakeland First Financial Group, Inc., and Lakeland Savings Bank is incorporated by reference to Registrant's Form 8-K filed with the Securities and Exchange Commission on February 2, 1995.\n(3) Articles of Incorporation and Bylaws:\n(10) Material Contracts:\n- ---------------\n* This document is incorporated herein by reference from the Registrant's Form 10-K Annual Report for the fiscal period ending December 31, 1990.\n** This document is incorporated herein by reference from the Registrant's Notice of Annual Meeting of Shareholders and Proxy dated March 1, 1994.\n*** This document is incorporated herein by reference from the Registrant's Form 10-K Annual Report for the fiscal period ending December 31, 1993.\n(21) List of Subsidiaries:\n(23) Consents of Experts and Counsel\nConsent of KPMG Peat Marwick LLP.\n(27) Financial Data Schedule","section_15":""}
{"filename":"868016_1994.txt","cik":"868016","year":"1994","section_1":"Item 1. Business\nGENERAL\nSummit Securities, Inc. (Summit) is engaged in the business of investing in Receivables through funds provided by Receivable investment proceeds, certificate sales, and preferred stock sales. Summit's goal is to achieve a positive spread between the return on its Receivable investments and its cost of funds. Summit may also engage in other businesses or activities without restriction in accordance with the provisions of its Articles of Incorporation.\nSummit was originally organized as a wholly-owned subsidiary of Metropolitan Mortgage & Securities Co., Inc., a Washington corporation (Metropolitan). On September 9, 1994, Summit, Metropolitan and C. Paul Sandifur, Jr. completed a sale of the common stock of Summit to National Summit Corporation. National Summit Corporation is a holding company wholly owned by C. Paul Sandifur Jr. Mr. Sandifur holds effective control over Metropolitan. Prior to the sale, Mr. Sandifur held effective control of Summit, through Metropolitan. Following the sale, Mr. Sandifur holds effective control of Summit through National Summit Corporation. Prior to the sale, the officers and directors of Summit were also officers or directors of Metropolitan and\/or its affiliates. Contemporaneously with the sale, the officers and directors resigned and new officers and directors were elected. The newly elected officers and directors are employees of Metropolitan, but not officers or directors of Metropolitan or any of its subsidiaries. There are no plans to make any material changes in the business, operations or administration of Summit as a result of the sale. See \"CERTAIN TRANSACTIONS\".\nSummit has reached an agreement with Metropolitan whereby effective January 31, 1995, Summit will acquire Metropolitan Investment Securities, Inc. (MIS) from Metropolitan. MIS is the broker\/dealer for this offering and the offering of Metropolitan's securities. MIS had total assets and stockholder's equity of $380,000 and $283,000 respectively, at September 30, 1994. Also, effective January 31, 1995, Summit Property Development, Inc. (a subsidiary of Summit) will commence real estate development activities previously performed by Metropolitan. Additionally, Summit is currently negotiating the purchase of Old Standard Life Insurance Company (Old Standard) from Metropolitan. Old Standard is a wholly-owned subsidiary of Metropolitan. Old Standard had total assets and stockholder's equity of $47 million and $2.5 million, respectively at September 30, 1994. See \"CERTAIN TRANSACTIONS\".\nMANAGEMENT\nAs of September 30, 1994, Summit's personnel consisted of its officers and directors, See \"MANAGEMENT\", an accountant and an attorney. Each of those individuals is also employed by Metropolitan. It is anticipated that they will continue to devote substantially all of their time to their duties related to their respective positions with Metropolitan and its other affiliates subject to the necessary commitment of time to ensure that Summit fulfills its obligations to Preferred shareholders and its duties under the Indenture pursuant to which it issues Investment Certificates and such other duties and responsibilities as Summit may undertake in the conduct of its business or as may be required by law. No additional employees are expected to be necessary or hired during the foreseeable future.\nMetropolitan provides management, Receivable acquisition and Receivable collection services for a fee to Summit pursuant to the terms of a Management Acquisition and Servicing Agreement. The Receivable acquisition fees are based upon a yield requirement established by Summit. Summit pays as its Receivable acquisition service fee the difference between the yield requirement and the yield which Metropolitan actually negotiates when the Receivable is acquired. In 1994, Summit paid total service fees to Metropolitan of $497,132. Management believes that the terms and conditions of the agreements with Metropolitan are at least as favorable to Summit as those that could have been obtained by a non-affiliated third party. The agreements are non-exclusive and may be terminated in whole or part by either party upon notice to the other party.\nRECEIVABLE INVESTMENTS\nThe Receivables consist primarily of notes secured by real estate mortgages, deeds of trust and conditional real estate sales contracts. To a lesser extent, Summit also acquires other types of Receivables, including but not limited to annuities and lottery prizes. All such Receivables are purchased at prices calculated to provide a desired yield. Often, in order to obtain the desired yield, the Receivables will be purchased at a discount from their face amount. See \"BUSINESS - -Yield and Discount Considerations\".\nSummit's investments in Receivables are financed primarily by the cash flow from Receivables, the sale of Certificates, and the sale of Preferred Stock.\nSources of Receivables\nSummit acquires its Receivables through the services of Metropolitan. See \"BUSINESS-Management\". Metropolitan acquires approximately 80% of the Receivables through independent brokers located throughout the country. These brokers typically deal directly with private individuals or organizations who own and wish to sell a Receivable. These independent brokers contact one of Metropolitan's branch offices to submit the Receivable for evaluation by Metropolitan. It is the opinion of management that its responsiveness to the independent Receivable brokers, and to Receivable sellers has been a key to Metropolitan's ability to attract and purchase quality Receivables at acceptable yields.\nMetropolitan is also approached directly by prospective Receivable sellers. These direct contacts are generally the result of a referral or a previous business contact. Metropolitan also negotiates the acquisition of portfolios of Receivables from banks, savings and loan associations, the Resolution Trust Corporation and the Federal Deposit Insurance Corporation. Summit has acquired Receivables from such sources through Metropolitan.\nYield and Discount Considerations\nSummit's management establishes Summit's yield requirements based upon its cost of funds, and market conditions. Summit's yield requirements are provided to Metropolitan, which negotiates Receivable purchases at prices calculated to provide a desired yield. Often this results in a purchase price less than the Receivable's unpaid balance. The difference between the unpaid balance and the purchase price is the \"discount.\" The amount of the discount will vary in any given transaction depending upon Summit's yield requirements at the time of the purchase and the terms and nature of the Receivable. Yield requirements are established in light of capital costs, market conditions, the characteristics of particular classes or types of Receivables and the risk of default by the Receivable payor. See Also \"BUSINESS-RECEIVABLE INVESTMENTS-Underwriting\"\nFor Receivables of all types, the discounts originating at the time of purchase, net of capitalized acquisition costs, are amortized using the level yield (interest) method over the remaining contractual term of the contract. For Receivables which were acquired after September 30, 1992, these net purchase discounts are amortized on an individual contract basis using the level yield method over the contractual remaining life of the contract. For those Receivables acquired before October 1, 1992, these net purchase discounts were pooled by the fiscal year of purchase and by similar contract types, and amortized on a pool basis using the level yield method over the expected remaining life of the pool. For these older Receivables, the amortization period, which is approximately 78 months, estimates a constant prepayment rate of 10-12 percent per year on scheduled balances, which is consistent with Summit's prior experience with similar loans and Summit's expectations.\nSummit's management establishes the yield requirements for Receivable investments by assuming that all payments on the Receivables will be made and that a certain percentage of unpaid balances will be prepaid on an annual basis (9% for fiscal 1994). During fiscal 1994, Summit's average initial yield requirement was 11%-14%. However, to the extent that Receivables are purchased at a discount and payments are received earlier than anticipated, the discount is earned more quickly resulting in an increase in the yield. Conversely, to the extent that payments are received later than anticipated, the discount is earned less quickly resulting in a lower yield.\nA greater effective yield can also be achieved through negotiating amendments to the Receivable agreements. These amendments may involve adjusting the interest rate and\/or monthly payments, extension of financing in lieu of a required balloon payment or other adjustments in cases of delinquencies where the payor appears able to resolve the delinquency. As a result of these amendments, the cash flow may be maintained or accelerated, the latter of which increases the yield realized on a Receivable purchased at a discount.\nUnderwriting\nThe review of the Receivables (underwriting) is performed for Summit by Metropolitan. When Metropolitan is offered a Receivable, an initial study of the terms of the Receivable, including any associated documents, is performed by Metropolitan's underwriting and closing staff. If the Receivable appears acceptable, the purchase price for the Receivable is calculated based on Summit's yield requirements at that time. If the broker and\/or seller accepts the proposed purchase price, a written agreement to purchase is executed, subject to Metropolitan's full underwriting review. Metropolitan also negotiates the purchases of \"partial\" interests in Receivables. Partial purchases are purchases of the right to receive a portion of the Receivable's balance, and where the seller's right to the unsold portion of the Receivable is subordinated to the interest of Summit. These \"partials\" generally result in a reduced level of investment risk to the purchaser than if the entire Receivable cash flow is purchased.\nThe underwriting guidelines adopted by Summit for Receivables secured by real estate include a requirement that the ratio of Summit's investment in a Receivable compared to the appraised value of the property which secures the Receivable may not exceed 75% on Receivables secured by single family residences; and that the ratio of the investment to the property's appraised value may not exceed 70% on Receivables secured by other types of improved property; and 55% on unimproved raw land. These more stringent than conventional investment to collateral ratios provide higher than conventional levels of collateral to protect Summit's investment in the event of a default on a Receivable.\nFor each Receivable secured by real estate, a current market value appraisal of the real estate providing security is obtained. These appraisals are obtained through licensed independent appraisers or through one of Metropolitan's licensed staff appraisers. These appraisals are based on drive-by and comparative sales analysis. Each independent appraisal is also subject to review by a staff appraiser.\nAdditionally, every proposed investment in a Receivable secured by real estate is evaluated by Metropolitan's demography department utilizing computerized data which identifies local trends in property values, personal income, population and other social and economic indicators. Other underwriting functions related to Receivables secured by real estate may include obtaining and evaluating credit reports on the Receivable payors; evaluation of the potential for environmental risks; verifying payment histories and current payment status; and obtaining title reports to verify the record status of the Receivable and other matters of record.\nSummit also acquires Receivables from Metropolitan which are not secured by real estate, such as annuities and lottery prizes. The annuities often arise out of the settlement of legal disputes where the prevailing party is awarded a sum of money payable over a period of time. In the case of such settlement annuity purchases, the underwriting guidelines of Summit generally require that Metropolitan review the settlement agreement. In the case of all annuity purchases, Summit's underwriting guidelines generally require that Metropolitan review the annuity policy, related documents, the credit rating of the payor (generally an insurance company), determination of the existence of any state insurance fund designed to protect annuity holders, and the review of other factors relevant to the risk of purchasing a particular annuity as deemed appropriate by the underwriting committee in each circumstance. In the case of lottery prizes, the underwriting guidelines generally include a review of the documents providing proof of the prize, and a review of the credit rating of the insurance company, or other entity, making the lottery prize payments. Where the lottery prize is from a state run lottery, the underwriting guidelines generally include a determination of whether the prize is backed by the general credit of the state, and confirmation with the respective lottery commission of the prize winners right to sell the prize, and acknowledgment from the lottery commission of their notice of the sale. In many states, in order to sell a state lottery prize, the winner must obtain a court order permitting the sale. In those states, Summit requires a certified copy of the court order.\nReceivable investments which are identified for legal review are referred to Metropolitan's in-house legal department which currently includes a staff of five attorneys. All Receivable purchases which involve investments greater than $150,000 ($100,000 if the real property collateral is not an owner-occupied single family residence) are submitted to an additional special risk evaluation committee, and are subject to legal department review. In addition, transactions involving investments of more than $500,000 are subject to approval by Summit's Board of Directors.\nUpon completion of the underwriting process and the approval of the investment, appropriate closing and transfer documents are executed by the seller and\/or broker, and the transaction is funded.\nManagement believes that the underwriting functions that are employed in its Receivable investment activity are as thorough as reasonably possible considering the nature of this business. Summit's acquisition of Receivables secured by real estate should be distinguished from the conventional mortgage lending business which involves substantial first-hand contact by lenders with each borrower and the ability to obtain an interior inspection appraisal prior to granting a loan.\nCurrent Mix of Receivable Investment Holdings\nSummit's investments in Receivables are secured by first or second liens primarily on single family residential property. Summit believes that these Receivables present lower credit risks than a portfolio of mortgages secured by commercial property or raw land, and that much of the risk in the portfolio is dissipated by the large numbers of relatively small individual Receivables and their geographic dispersion.\nThe following table presents information about Summit's investments in Receivables as of September 30, 1994 and 1993:\nAs of September 30, 1994, approximately 77% of Summit's investments in Receivables are in first lien position Receivables with the balance in second lien positions. The Receivables are secured by residential, business and commercial properties with residential properties securing approximately 84% of such investments as of September 30, 1994. The Receivables acquired by Summit are primarily generated by private individuals or businesses and are therefore not government insured loans.\nDuring fiscal 1993, Summit purchased, from an affiliate of Metropolitan, approximately $6.0 million of timeshare Receivables, of which approximately $5.5 million were outstanding at September 30, 1993. These Receivables were originated by an affiliate of Metropolitan in connection with sales of its timeshare resort condominiums in Hawaii. These Receivables had an approximate contractual interest rate of 13% and were purchased at par (eg. at the amount of their outstanding principal balance). In conjunction with the purchase, Summit withheld a 10% performance holdback of $600,000 to cover any realized losses from these Receivables. The holdback was maintained at a balance of approximately 10% of the outstanding timeshare Receivables and was released as principal was paid down. At September 30, 1993, Summit held approximately $680,000 of delinquent timeshare contracts purchased from the affiliate. Summit believes that the performance holdback of $600,000 was adequate to cover any losses related to these certain timeshare Receivables. At September 30, 1993, timeshare Receivables represented approximately 27% of the total outstanding principal for Receivables owned by Summit. These timeshare receivables were sold to Metropolitan at par on February 18, 1994.\nSummit's receivable investments at September 30, 1994 were secured by properties located throughout the United States with not more than 3% (by dollar amount) in any single state except as follows:\nArizona . . . . . . 6% California . . . . 11% Oregon . . . . . . 5% Texas . . . . . . . 20% Washington . . . . 10% Florida . . . . . . 3% Georgia . . . . . . 4% North Carolina. . . 3% South Carolina. . . 3%\nSUMMIT SECURITIES, INC. RECEIVABLES SECURED BY REAL ESTATE September 30, 1994\nSummit held 795 Receivables as of September 30, 1994. The average stated interest rate (weighted by principal balances) on Receivables held by Summit on that date was approximately 10%. See Note 2, to Consolidated Financial Statements.\nDelinquency Experience & Collection Procedures\nThe principal amount of Receivables held by Summit (as a percentage of the total outstanding principal amount of Receivables) which was in arrears for more than ninety days at September 30, 1994 was 3.8% compared to 8.0% and 4.2% at September 30, 1993 and 1992, respectively. The decrease in 1994 is attributable to the sale of the timeshare receivables to Metropolitan and improved collection efforts. The increase in the amount for September 30, 1993 includes approximately $680,000 of timeshare contracts purchased from an affiliate. Without the effect of the delinquent timeshare receivables, the 1993 delinquency rate would have been 6.5%. Because Receivables purchased by Summit are typically not of the same quality as mortgages that are subsequently securitized and sold in the secondary market with government guarantees, higher delinquency rates are expected. However, because these Receivables are purchased at a discount, losses on sales after repossession are generally lower than might otherwise be expected given these higher delinquency rates.\nReceivable collection services are performed for Summit by Metropolitan, pursuant to the following guidelines. When a Receivable becomes delinquent, the payor is initially contacted by telephone (generally on the 17th day following the payment due date). If the default is not promptly cured (generally within three to six days after the initial call), then additional collection activity, including written correspondence and further telephone contact, is pursued. If these collection procedures are unsuccessful, then the account is referred to a committee who analyzes the basis for default, the economics of the situation and the potential for environmental risks. When appropriate, a phase I environmental study is obtained prior to foreclosure. Based upon this analysis, the Receivable is considered for a workout arrangement, further collection activity, or foreclosure of any property providing security for the Receivable. Collection activity may also involve the initiation of legal proceedings against the payor of the Receivable payments. Such legal proceedings, when necessary are generally initiated within approximately ninety days after the initial default. If accounts are reinstated prior to completion of the legal action, then attorney fees, costs, expenses and late charges are generally collected from the payor, or added to the receivable balance, as a condition of reinstatement.\nAllowance for Losses on Real Estate Assets\nSummit establishes an allowance for losses on Receivables and repossessed real estate based on an evaluation of delinquent Receivables and appraisals for real estate held. During 1992, Summit adopted an appraisal policy to require annual appraisals on properties securing delinquent receivables when the Receivable balances exceed a threshold equal to 1\/2% of total assets of Summit. Biannual appraisals are required on all other delinquent Receivables with balances in excess of $50,000. The allowance for losses was .9%, .5% and .5% of the face value of Receivables at September 30, 1994, 1993 and 1992, respectively.\nProperties\nSummit owns various repossessed properties held for sale. At September 30, 1994, eight properties, acquired in satisfaction of debt, with a combined carrying amount of approximately $453,000 were held.\nMethod of Financing\nSummit's continued growth is expected to depend on its ability to market its securities to the public and to invest the proceeds in higher-yielding investments. Financing needs are intended to be met primarily by the sale of its Investment Certificates and Preferred Stock. Such funds may be supplemented by short term bank financing and borrowing from affiliates. As of the date of this document, Summit had not established any formal lines of credit with banks or other lending institutions.\nThe availability of Receivables offered for investment in the national market is believed by management to be adequate to meet the needs of Summit which are in addition to the needs of Metropolitan.\nCompetition\nSummit's ability to compete for Receivable investments is currently dependent upon Metropolitan. Metropolitan competes with various real estate financing firms, real estate brokers, banks and individual investors for the Receivables it acquires. The largest single competitors are subsidiaries of much larger companies such as Associates First Capital Corporation, a subsidiary of Ford Motor Company, while the largest number of competitors are a multitude of individual investors. The primary competitive factors are the amounts offered and paid to Receivable sellers and the speed with which the processing and funding of the transaction can be completed. Competitive advantages enjoyed by Summit include access to Metropolitan's branch office system which allows it access to markets throughout the country; its ability to purchase long-term Receivables; availability of funds; and its in-house capabilities for processing and funding transactions. Competitive disadvantages include the length of time required to process and fund approved transactions (up to thirty days); an investment policy which excludes purchases of Receivables which involve discounts of less than $2,500; and relatively high yield requirements.\nMANAGEMENT\nDirectors and Executive Officers (As of December 31, 1994)\nName Age Position\nJohn Trimble 64 President\/Director J. Evelyn Sandifur 81 Vice President\/Director Philip Sandifur 23 Vice President\/Director Tom Turner 44 Secretary\/Treasurer\/Director Ernest Jurdana 50 Chief Financial Officer\nJohn Trimble was elected President on September 28, 1994. He has been an employee of Metropolitan since 1980. From 1980-1985 he served as a loan officer for Metropolitan. From 1985-1994, he was an officer of Metropolitan. From 1985, to the present, he has been a member of the Receivable Evaluation Committee.\nJ. Evelyn Sandifur is the wife of C. Paul Sandifur Sr., founder of Metropolitan Mortgage & Securities Co., Inc, and mother of C. Paul Sandifur Jr., who is the controlling shareholder of Metropolitan, and also the controlling shareholder of the parent company of Summit, National Summit Corp. She is not active in the day to day operations of Summit except to the extent necessary to carry out duties as Vice President and Director.\nPhilip Sandifur is the son of C. Paul Sandifur Jr., who is the sole controlling shareholder of National Summit Corp., the parent company of Summit Securities and also the controlling shareholder of Metropolitan Mortgage & Securities Co., Inc. Philip graduated in 1993 from Santa Clara University receiving a BA in Business. He is not active in the day to day operations of Summit except to the extent necessary to carry out his duties as Vice President and Director.\nTom Turner was elected Secretary\/Treasurer of Summit on September 28, 1994. He has been an employee of Metropolitan since 1985, as a financial analyst. From 1983-1985, Mr. Turner was employed by Olsten Temporary Services. Prior to 1983, Mr. Turner was self- employed, principally doing business in the real estate industry.\nErnest Jurdana joined Metropolitan as Chief Financial Officer in June of 1994. Since that date he has also been the Chief Financial Officer for Summit. From 1990 to June 1994 he was Senior Vice President and Chief Financial Officer for Continental Savings of America. Prior to that time, he was Senior Vice President for Financial Management with Washington Mutual Savings Bank where he served in various accounting and financial positions from 1966. He received a MBA designation from City University, and was licensed as a Certified Public Accountant in 1986.\nThe directors of Summit are elected for one-year terms at annual shareholder meetings. The officers of Summit serve at the direction of the Board of Directors.\nSummit's officers and directors will continue to hold their respective positions with Metropolitan and do not anticipate that their responsibilities with Summit will involve a significant amount of time. They will, however, devote such time to the business and affairs of Summit as may be necessary for the proper discharge of their duties.\nEXECUTIVE COMPENSATION\nThe officers and directors do not receive any compensation for services rendered on behalf of Summit but they are entitled to reimbursement for any expenses incurred in the performance of such services. Such expenses include only items such as travel expense incurred for attendance at corporate meetings or other business. No such expenses have been incurred to date.\nINDEMNIFICATION\nSummit's Articles of Incorporation provide for indemnification of Summit's directors, officers and employees for expenses and other amounts reasonably required to be paid in connection with any civil or criminal proceedings brought against such persons by reason of their service of or position with Summit unless it is adjudged in such proceedings that the person or persons are liable due to willful malfeasance, bad faith, gross negligence or reckless disregard of his duties in the conduct of his office. Such right of indemnification is not exclusive of any other rights that may be provided by contract of other agreement or provision of law.\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to Summit's officers, directors or controlling persons pursuant to the foregoing provisions, Summit has been informed 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.\nPRINCIPAL SHAREHOLDERS\nThe following table sets forth information with respect to the beneficial owners of more than five percent of Summit's voting stock as of September 30, 1994.\nNational Summit Corp. is wholly-owned by C. Paul Sandifur, Jr.\nCERTAIN TRANSACTIONS\nSummit was originally organized as a wholly-owned subsidiary of Metropolitan. On September 9, 1994, the controlling interest in Summit was acquired by National Summit Corp., a Delaware corporation which is wholly owned by C. Paul Sandifur, Jr. The change in control was made pursuant to a reorganization wherein Summit redeemed all the common shares held by its former parent company, Metropolitan which consisted of 100% of the outstanding common stock of Summit. Contemporaneously with this redemption, Summit issued 10,000 shares of common stock to National Summit Corp., a Delaware Corporation, for $100,000. In addition, various investors in Metropolitan's common and preferred stock, including members of Mr. Sandifur's immediate family acquired 30,224 shares of Summit's Preferred Stock Series S-1 for $100 per share in exchange for preferred and common shares of Metropolitan with a value of approximately $3 million dollars. Following this sale, Metropolitan will continue to provide, for a fee, principally all the management services to Summit. See \"BUSINESS-RECEIVABLE INVESTMENTS.\"\nMr. Sandifur holds effective control of Metropolitan. Prior to the sale, Mr. Sandifur held effective control of Summit through Metropolitan. Following the sale, Mr. Sandifur holds effective control of Summit through National Summit.\nPrior to the sale, the officers and directors of Summit, were also officers or directors of Metropolitan and\/or its affiliates. Contemporaneously with the sale, the officers and directors resigned and new officers and directors were elected. The newly elected officers and directors are employees of Metropolitan but not officers or directors of Metropolitan or any of its subsidiaries.\nSummit considered the sale to be in its best interest due to regulatory considerations and other business considerations. The regulatory considerations include the impact of regulations imposed upon Metropolitan by its state of domicile. In the opinion of management, these regulations penalized Summit in its prior corporate structure.\nOn December 15, 1994, Metropolitan and Summit entered into an understanding that on January 31, 1995 Metropolitan Investment Securities (MIS) will be sold to Summit. MIS is a limited-purpose broker dealer and the exclusive broker\/dealer for the securities sold by Metropolitan and Summit. It is not anticipated that this sale will materially affect the business of MIS or Summit. Also on December 15, 1994, Metropolitan and Summit entered into an understanding that on January 31, 1995, Metropolitan will discontinue its property development division, which consists of a group of employees experienced in real estate development. On the same date, Summit will commence the operation of a property development division employing those same individuals who had previously been employed by Metropolitan. Summit Property Development Corporation is negotiating an agreement with Metropolitan to provide property development services to Metropolitan. See \"BUSINESS\"\nMetropolitan Investment Securities, Inc. (MIS) is a securities broker-dealer which is wholly-owned by Metropolitan. MIS is currently the exclusive selling agent for securities issued by Metropolitan and Summit. Summit has entered into Selling Agreements with MIS to provide for the sale of the Certificates and Preferred Stock pursuant to which MIS will be paid commissions ranging from .25% to 6% of the investment amount in each transaction. During the fiscal year ended September 30, 1994, Summit paid or accrued commissions to MIS in the amount of $299,748 upon the sale of $10,539,684 of Certificates and commissions of $7,552 upon the sale of $149,512 of preferred stock. MIS also maintains, on behalf of Summit, certain investor files and information pertaining to investments in Summit's Certificates.\nTransactions between Metropolitan and Summit take place in the normal course of Summit's business. Such transactions include rental of office space, provision of administrative and data processing support, accounting and legal services and similar matters. Receivable acquisition and servicing agreements have been entered into between Summit and Metropolitan and are summarized under \"Business\". See also Note 9, to Consolidated Financial Statements, for additional information. Summit believes that such transactions are and will continue to be made on terms at least as favorable as could be obtained from non-affiliated parties.\nSummit is currently negotiating the purchase of Old Standard Life Insurance (Old Standard) from Metropolitan. Old Standard is engaged in the sale of annuities and life insurance. It is currently anticipated that this proposed purchase may occur during the first quarter of calendar 1995.\nPART I (cont.)\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nSee Item 1.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no material legal proceedings or actions pending or threatened against Summit or to which its property is 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 Equity and Related Stockholder Matters.\n(a) There is no market for the registrant's common stock\n(b) There was one Common Stockholder at September 30, 1994\n(c) See \"Item 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 for the Three Fiscal Years Ended September 30, 1994\nRESULTS OF OPERATIONS\nRevenues of Summit increased to $3.4 million in 1994, from $2.8 million in 1993 and $2.4 million in 1992. The growth from 1993 to 1994 is attributable primarily to increased investment earnings on additional outstanding Receivables along with gains realized on the sale of a portion of the Receivable portfolio. These increases were offset partially, in 1994 by a reduction in revenues associated with the sale of repossessed property. The growth from 1992 to 1993 is attributable primarily to increased investment earnings on additional outstanding Receivables and increased revenues associated with the sale of repossessed property. These increases were partially offset by a reduction in dividends received on investments in an affiliated company. Summit has increased its investment in Receivables from $11.6 million at September 30, 1992 to $19.5 million at September 30, 1993 to $27.3 million at September 30, 1994.\nSummit continued to realize income from operations during 1994. Net income for the fiscal year ended September 30, 1994 was $262,000 compared to $283,000 in 1993 and $661,000 in 1992. The relatively small decrease from 1993 to 1994 was the result of Summit being able to realize gains on the sales of Receivables, improve other income sources and reduce operating expenses, all of which were necessary as Summit experienced a reduced margin between interest sensitive income and interest sensitive expense along with increases in the provisions for losses on real estate assets. The 1993 decrease in net income was attributable to a reduced margin between interest sensitive income and interest sensitive expense along with increased operating expenses associated with the increased volume of Certificate sales, Receivable investments and real estate held for sale. Additionally, during 1993, Summit experienced a slight increase in the loss from the sale of real estate repossessions and also increased its provision for losses on real estate assets.\nSince the date of its incorporation through approximately the end of calendar year 1993, Summit generally benefitted from a declining interest rate environment with lower money costs and relatively consistent yields on Receivables. In addition, a declining rate environment positively impacted earnings by increasing the value of the portfolio of predominantly fixed rate Receivables. This was evident in 1994 as Summit was able to realize gains from the sale of Receivables. Higher than normal prepayments in the Receivable portfolio were experienced during 1994, 1993 and 1992, allowing Summit to recognize unamortized discounts on Receivables at an accelerated rate. During 1994, Metropolitan, Summit's former parent through September 9, 1994 and the primary supplier of Summit's Receivable investments, began charging underwriting fees associated with Receivable acquisitions. The charging Summit of the underwriting fee has resulted in a slightly lower yield over the life of the new Receivables, however, management believes this yield to be superior to other investment opportunities. See \"BUSINESS-RECEIVABLE INVESTMENTS.\"\nMaintaining efficient collection efforts and minimizing delinquencies in Summit's Receivable portfolio are ongoing management goals. During 1994,Summit realized a gain on the sale of repossessed real estate of $12,300 compared to losses of $18,400 and $5,300 in 1993 and 1992, respectively. In relation to the increasing size of Summit's Receivable and real estate portfolios, Summit has increased its provision for losses on real estate assets. Provisions for losses have been $155,000, $51,000 and $18,800 for 1994, 1993 and 1992, respectively. At September 30, 1994, Summit had an allowance for losses on real estate assets of $251,000 compared to $97,000 at September 30, 1993.\nIn April 1992, the Accounting Standards Division of the American Institute of Certified Public Accountants issued Statement of Position (SOP) No. 92-3, \"Accounting for Foreclosed Assets,\" which provides guidance on determining the accounting treatment for foreclosed assets. SOP 92-3 requires that foreclosed assets be carried at the lower of (a) fair value minus estimated costs to sell, or (b) cost. Summit applied the provisions of SOP 92-3 effective October 1, 1992. The initial charge for its application was approximately $10,000, before the application of related income taxes, and is included in operations in 1993.\nInterest Sensitive Income and Expense\nManagement continually monitors the interest sensitive income and expense of Summit. Interest sensitive expense is predominantly the interest costs of Certificates, while interest sensitive income includes interest and earned discounts on Receivables, dividends and other investment income.\nThe spread between interest sensitive income and interest sensitive expense was $925,000 in 1992, $696,000 in 1993 and $543,000 in 1994. The decrease from 1993 to 1994 of approximately $153,000 was attributable to several factors including: (1) charging of underwriting fees by Metropolitan which reduced 1994 interest income by approximately $60,000; (2) the sale of $4.5 million of high yielding, timeshare Receivables to Metropolitan in February 1994; (3) lower yields on acquired Receivables; and (4) the accumulation of cash, which was invested in low yielding overnight investments, which was necessary for the September 1994 payment of $3.6 million to Metropolitan to redeem its outstanding common stock. The decrease in interest spread from 1992 to 1993 of approximately $230,000 was the result of management's decision to accumulate cash to fund a contract purchase commitment in excess of $7 million from an affiliate in December 1992. Included in the Receivables purchased were approximately $6.0 million of timeshare Receivables, which were collateralized by timeshares located at a single project in Hawaii. These Receivables were sold to Metropolitan at carrying value on February 18, 1994. Also, Summit recognized $366,935 of dividend income (13% dividend rate) from its preferred stock investment in its affiliate in 1992 and paid interest to Metropolitan at prime plus 1 1\/2% on the borrowings used to finance the purchase of the preferred stock. In March 1992, Summit transferred the preferred stock to Metropolitan in full satisfaction of the $6 million payable. Therefore, there were no dividends received by Summit in fiscal 1994 or 1993 on the preferred stock. See Note 9 to the Consolidated Financial Statements.\nOther Income\nOther income increased from approximately $16,600 in 1992 to $42,700 in 1993 and $60,700 in 1994. Other income is predominantly miscellaneous fees and charges related to Receivables, thus its growth is primarily due to the growth in Receivables.\nOther Expenses\nOperating expenses increased from approximately $178,300 in 1992 to $244,600 in 1993 and remained relatively stable at $231,400 in 1994. In general, the increases have been the result of increased volume of Certificate sales and Receivable investments. During 1994, Summit was able to improve efficiency and reduce some operating expenses while increasing the volume of Certificate sales and Receivable investments.\nProvision for Losses on Real Estate Receivables and Repossessed Real Estate\nThe provision for losses on Receivables and repossessed real estate has increased as the size of the portfolio of Receivables and repossessed real estate has grown. The following table summarizes Summit's allowance for losses on Receivables and repossessed real estate:\nGain\/Loss on Real Estate Sold\nDuring 1994, Summit experienced a gain on the sale of real estate of approximately $12,000. At the end of fiscal 1994, Summit had $453,000 in real estate held for sale, less than 2% of total real estate assets.\nEffect of Inflation\nDuring the three year period ended September 30, 1994, inflation has had a generally positive impact on Summit's operations. This impact has primarily been indirect in that the level of inflation tends to influence inflation expectations, which tends to impact interest rates on both Summit's assets and liabilities. Thus, with lower inflation rates over the past three years, interest rates have been generally declining during this period, which has reduced Summit's cost of funds. Interest rates on Receivables acquired, due to their nature, have not declined to the same extent as the cost of Summit's borrowings. In addition, inflation has not had a material effect on Summit's operating expenses. The main reason for the increase in operating expenses has been an increase in the number of Receivables acquired and serviced and increased sales of Certificates.\nRevenues from real estate sold are influenced in part by inflation, as historically, real estate values have fluctuated with the rate of inflation. However, Summit is unable to quantify the effect of inflation in this respect.\nAsset\/Liability Management\nAs most of Summit's assets and liabilities are financial in nature, Summit is subject to interest rate risk. In fiscal 1995, more of Summit's financial assets (primarily Receivables and fixed income investments) will reprice or mature more quickly than its financial liabilities (primarily Certificates). In a rising interest rate environment, this factor will tend to increase earnings as cash flow from assets is reinvested at higher rates of interest. However, for a number of periods subsequent to fiscal 1995, financial liabilities are scheduled to reprice or mature more quickly than financial assets. During this period, earnings will tend to decline as funds available for investing are obtained at a higher interest cost. Also, yields on Receivables have not been as sensitive to rate fluctuations as have Certificate rates. Therefore, the benefit of an increase in interest rates during the initial period would be reduced to the extent that required yields on Receivable investments were not increased in concert with general market rates of interest. In a falling interest rate environment, when financial assets reprice or mature more quickly than financial liabilities, earnings will tend to decrease as cash flow from assets is reinvested at lower rates of interest. This effect is mitigated to the extent that yields on Receivables may be less sensitive to rate fluctuations than are rates on Certificates.\nDuring fiscal 1995, approximately $6.4 million of interest sensitive assets (cash and Receivables) are expected to reprice or mature. For liabilities, approximately $2.6 million of Certificates will mature during fiscal 1995, along with about $10,500 of other debt payable. These estimates result in repricing of interest sensitive assets in excess of interest sensitive liabilities of approximately $3.8 million, or a ratio of interest sensitive assets to interest sensitive liabilities of approximately 245%.\nNew Accounting Rules\nIn the fourth quarter of fiscal 1993, Summit adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), retroactive to October 1, 1992 and resulted in no significant effect on Summit's financial position. In 1992, Summit accounted for income taxes as required by Accounting Principles Board Opinion No. 11. See Note 1 to the Consolidated Financial Statements.\nIn May 1993, Statement of Financial Accounting Standards No. 114 (SFAS No. 114) \"Accounting by Creditors for Impairment of a Loan\" was issued. SFAS No. 114 requires that certain impaired loans be measured based on the present value of expected future cash flows discounted at the loans' effective interest rate or the fair value of the collateral. Summit is required to adopt this new standard by October 1, 1995. Summit does not anticipate that the adoption of SFAS No. 114 will have a material effect on the financial statements.\nIn December 1991, Statement of Financial Accounting Standards No. 107 (SFAS No. 107), \"Disclosures about Fair Value of Financial Instruments,\" was issued. SFAS No. 107 requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. SFAS No. 107 is effective for financial statements issued for fiscal years ending after December 31, 1995 (Summit's fiscal year ending September 30, 1996) for entities with less than $150 million in total assets. This pronouncement does not change any requirements for recognition, measurement or classification of financial instruments in Summit's financial statements.\nLiquidity and Capital Resources\nAs a financial institution, Summit's liquidity is largely tied to its ability to renew, maintain or obtain additional sources of cash. Summit has successfully performed this task during the past three years and has continued to invest funds generated by operations and financing activities.\nSummit has continued to generate cash from operations with net cash provided of $2.3 million in 1994, $1.4 million in 1993 and $1.4 million in 1992. Cash utilized by Summit in its investing activities was $6.3 million in 1994, $9.2 million in 1993 and $2.6 million in 1992. Cash provided by Summit's financing activities was $4.1 million in 1994, $5.8 million in 1993 and $5.0 million in 1992. These cash flows have resulted in year end cash and cash equivalent balances of $3.6 million in 1994, $3.6 million in 1993 and $5.6 million in 1992.\nDuring 1994, the cash provided by operating activities of $2.3 million plus cash provided by financing activities of $4.1 million was used entirely to support the net investing activities of $6.3 million. Cash from operating activities of $2.3 million resulted primarily from net income of $.3 million, increases in compound and accrued interest on Certificates of $1.2 million and other accrual adjustments of $.6 million. Cash used in investing activities of $6.3 million primarily included acquisition of Receivables, net of payments and sales, of $8.0 million being offset by the collection of advances from related parties of $1.7 million. Cash from financing activities of $4.1 million resulted primarily from: (1) issuance of Certificates, net of repayment and related debt issue costs, of $7.5 million; (2) issuance of common and preferred stock of $.2 million; less (3) redemption of common stock, owned by its former parent, of $3.6 million.\nDuring 1993, the $2.1 million decrease in cash and cash equivalents resulted from cash provided by operating activities of $1.4 million less cash used in investing activities of $9.2 million plus cash provided by financing activities of $5.7 million. Cash from operating activities resulted primarily from net income of $.3 million and the increase in compound and accrued interest on Certificates of $1.0 million. Cash used in investing activities primarily included: (1) acquisition of real estate Receivables, net of payments and sales, of $7.6 million; and (2) an advance to its parent company of $1.7 million for the purchase of Receivables. Cash provided by financing activities included: (1) issuance of Certificates, net of repayments and related debt issue costs, of $7.0 million; less (2) repayment of amounts due its parent of $.4 million; and (3) repayment to banks and others of $.9 million.\nSummit's investing activities during 1993 were supported by cash from operations and external financing. Summit's increases in Receivables were primarily funded by sales of Certificates. During 1992, the $3.9 million increase in cash and cash equivalents resulted from cash provided by operating activities of $1.4 million less cash used in investing activities of $2.5 million plus cash provided by financing activities of $5.0 million. Cash from operating activities resulted primarily from net income of $.7 million and the increase in compound and accrued interest on Certificates of $.7 million. Cash used in investing activities primarily included the acquisition of real estate Receivables, net of payments and sales, of $3.0 million less $.5 million advance repaid by its parent. Cash provided by financing activities included: (1) issuance of Certificates, net of repayments and related debt issue costs, of $4.7 million; (2) borrowings from its parent of $.4 million; less (3) repayment to banks and others of $.1 million.\nDuring 1992, Summit's investing activities were supported by internal cash from operations and external cash from financing. Summit's increases in Receivables were primarily funded by sales of Certificates.\nManagement believes that cash flow from operating activities and financing activities and the liquidity provided from current investments will be sufficient for Summit to conduct its business and meet its anticipated obligations as they mature during fiscal 1995 including the planned acquisition of Old Standard, MIS and commencement of operations of Summit Property Development, Inc. Summit has not defaulted on any of its obligations since its founding in 1990.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED SEPTEMBER 30, 1994, 1993, AND 1992\nReports of Independent Certified Public Accountants...................................\nConsolidated Balance Sheets..............................\nConsolidated Statements of Income........................\nConsolidated Statements of Stockholder's Equity..........\nConsolidated Statements of Cash Flows....................\nNotes to Consolidated Financial Statements...............\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Directors and Stockholders Summit Securities, Inc.\nWe have audited the accompanying consolidated balance sheets of Summit Securities, Inc. and subsidiary as of September 30, 1994 and 1993, and the related consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Summit Securities, Inc. and subsidiary as of September 30, 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.\nAs discussed in Note 1, the Company changed its methods of accounting for repossessed real property and income taxes in 1993.\n\/s\/ Coopers & Lybrand L.L.P.\nCOOPERS & LYBRAND L.L.P.\nSpokane, Washington November 21, 1994, except for Note 9 as to which the date is December 15, 1994\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Board of Directors of Summit Securities, Inc.\nWe have audited the accompanying statements of income, stockholders' equity and cash flows of Summit Securities, Inc. (a wholly-owned subsidiary of Metropolitan Mortgage & Securities Co., Inc.) for the year ended September 30, 1992. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our 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 results of operations and cash flows for the year ended September 30, 1992 of Summit Securities, Inc. in conformity with generally accepted accounting principles.\n\/s\/ BDO Seidman\nBDO SEIDMAN\nSpokane, Washington December 7, 1992\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS September 30, 1994 and 1993 ____________\nThe accompanying notes are an integral part of the consolidated financial statements.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF INCOME For the Years Ended September 30, 1994, 1993 and 1992 ____________\nThe accompanying notes are an integral part of the consolidated financial statements.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended September 30, 1994, 1993 and 1992 ____________\nThe accompanying notes are an integral part of the consolidated financial statements.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended September 30, 1994, 1993 and 1992 ____________\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nCONSOLIDATED CASH FLOWS, Continued For the Years Ended September 30, 1994, 1993 and 1992 ____________\nThe accompanying notes are an integral part of the consolidated financial statements.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS ____________\n1. Summary of Accounting Policies\nBusiness and Reorganization\nSummit Securities, Inc., d\/b\/a National Summit Securities, Inc. in the states of New York and Ohio (\"Summit\" or \"the Company\"), was incorporated on July 25, 1990. Prior to September 9, 1994, Summit was a wholly-owned subsidiary of Metropolitan Mortgage & Securities Co., Inc. (\"Metropolitan\"). On September 9, 1994, the controlling interest in Summit was acquired by National Summit Corp., a Delaware corporation which is wholly-owned by C. Paul Sandifur, Jr. The change in control was made pursuant to a reorganization wherein Summit redeemed all the common shares held by its former parent company, Metropolitan, which consisted of 100% of the outstanding common stock of Summit for $3,600,000 cash, which approximated the net book value of Summit at the transaction date. Contemporaneously with this redemption, Summit issued 10,000 shares of common stock to National Summit Corp. for $100,000 cash. In addition, various investors holding Metropolitan's common and preferred stock, including members of Mr. Sandifur's immediate family, acquired 30,224 shares of Summit's preferred stock Series S-1 for $100 per share in exchange for preferred and common shares of Metropolitan. The preferred shares issued for the Metropolitan shares were recorded at their face value which approximated recent issuances to unrelated parties. The face value of the preferred shares approximates fair value due to the variable dividend rate associated with such shares (see Note 3).\nMetropolitan is effectively controlled by C. Paul Sandifur, Jr. through his common stock ownership and voting control. National Summit Corp. is wholly-owned by C. Paul Sandifur, Jr. through ownership of 100% of the voting stock. National Summit Corp. did not have any operations or activities other than the acquisition of Summit. The consolidated financial statements include the accounts of Summit and its wholly-owned subsidiary, Summit Property Development, Inc. All significant intercompany transactions and balances have been eliminated in consolidation.\nSummit purchases contracts and mortgage notes collateralized by real estate, with funds generated from the public issuance of debt securities in the form of investment certificates, cash flow from receivables and sales of real estate.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n1. Summary of Accounting Policies, Continued\nCash and Cash Equivalents\nFor purposes of balance sheet classification and the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a remaining maturity of three months or less to be cash equivalents. Cash includes all balances on hand and on deposit in banks and financial institutions. The Company periodically evaluates the credit quality of its financial institutions. Substantially all cash and cash equivalents are on deposit with one financial institution and balances periodically exceed the FDIC insurance limit.\nInvestments in Affiliated Companies\nInvestments in equity securities of Metropolitan are carried at cost, which approximates market.\nReal Estate Contracts and Mortgage Notes Receivable\nReal estate contracts and mortgage notes held for investment purposes are carried at amortized cost. Discounts originating at the time of purchase net of capitalized acquisition costs are amortized using the level yield (interest) method. For contracts acquired after September 30, 1992, net purchase discounts are amortized on an individual contract basis using the level yield method over the remaining contractual term of the contract. For contracts acquired before October 1, 1992, the Company accounts for its portfolio of discounted loans using anticipated prepayment patterns to apply the level yield (interest) method of amortizing discounts. Discounted contracts are pooled by the fiscal year of purchase and by similar contract types. The amortization period, which is approximately 78 months, estimates a constant prepayment rate of 10-12 percent per year and scheduled payments, which is consistent with the Company's prior experience with similar loans and the Company's expectations.\nIn May 1993, Statement of Financial Accounting Standards No. 114 (SFAS No. 114), \"Accounting by Creditors for Impairment of a Loan,\" was issued. SFAS No. 114 requires that certain impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral. The Company is required to adopt this new standard by October 1, 1995. The Company does not anticipate that the adoption of SFAS No. 114 will have a material effect on the financial statements.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n1. Summary of Accounting Policies, Continued\nReal Estate Held for Sale\nReal estate is valued at the lower of cost or market. The Company principally acquires real estate through foreclosure or forfeiture. Cost is determined by the purchase price of the real estate or, for real estate acquired by foreclosure, at the lower of (a) the fair value of the property at the date of foreclosure less estimated selling costs, or (b) cost (unpaid contract carrying value). Periodically, the Company reviews its carrying values of real estate held for sale by obtaining new or updated appraisals, and adjusts its carrying values to the lower of cost or net realizable value, as necessary.\nProfit on sales of real estate is recognized when the buyers' initial and continuing investment is adequate to demonstrate that (1) a commitment to fulfill the terms of the transaction exists, (2) collectibility of the remaining sales price due is reasonably assured, and (3) the Company maintains no continuing involvement or obligation in relation to the property sold and transfers all the risks and rewards of ownership to the buyer.\nIn April 1992, the Accounting Standards Division of the American Institute of Certified Public Accountants issued Statement of Position (SOP) No. 92-3, \"Accounting for Foreclosed Assets,\" which provides guidance on determining the accounting treatment of foreclosed assets. SOP 92-3 requires that foreclosed assets be carried at the lower of (a) fair value minus estimated costs to sell, or (b) cost. The Company applied the provisions of SOP 92-3 effective October 1, 1992. The application of SOP 92-3, estimated to be approximately $10,000 before the application of related income taxes, is included in continuing operations for the year ended September 30, 1993.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n1. Summary of Accounting Policies, Continued\nAllowance for Losses on Real Estate Assets\nThe established allowances for losses on real estate assets include amounts for estimated probable losses on both real estate held for sale and real estate contracts and mortgage notes receivable. Specific allowances are established for all delinquent contract receivables with net carrying values in excess of $100,000. Additionally, the Company establishes general allowances, based on prior delinquency and loss experience, for currently performing receivables and smaller delinquent receivables. Allowances for losses are determined on the net carrying values of the contracts, including accrued interest. Accordingly, the Company continues interest accruals on delinquent loans until foreclosure, unless the principal and accrued interest on the loan exceed the fair value of the collateral, net of estimated selling costs. The Company obtains new or updated appraisals on appropriate delinquent receivables, and adjusts the allowance for losses as necessary, such that the net carrying value does not exceed net realizable value.\nDeferred Costs\nCommission and other expenses incurred in connection with the registration and public offering of investment certificates are capitalized and amortized using the interest method over the estimated life of the related investment certificates, which range from 6 months to 5 years.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n1. Summary of Accounting Policies, Continued\nIncome Taxes\nThe Company was included in the group of companies which file a consolidated income tax return with Metropolitan, its former parent through September 9, 1994. Subsequent to that date, the Company is included in the group of companies which file a consolidated income tax return with National Summit Corp. The Company is allocated a current and deferred tax provision from Metropolitan or National Summit Corp. as if the Company filed a separate tax return. Effective October 1, 1992, Metropolitan adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109). Under this method, deferred tax liabilities and assets are determined on temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse. There was no effect on the Company's financial statements of adopting SFAS No. 109. In 1992, Metropolitan and the Company accounted for income taxes as required by Accounting Principles Board Opinion No. 11. In association with the disaffiliation with Metropolitan in 1994, the Company received certain income tax benefits, principally associated with the allocation of the Metropolitan consolidated group's net operating loss carryforwards, which resulted in a reduction of deferred taxes of approximately $207,000. This benefit has been recorded as additional paid-in capital due to the affiliation between Metropolitan and the Company.\nFinancial Instruments\nIn December 1991, Statement of Financial Accounting Standards No. 107 (SFAS No. 107), \"Disclosures about Fair Value of Financial Instruments,\" was issued. SFAS No. 107 requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. SFAS No. 107 is effective for financial statements issued for fiscal years ending after December 31, 1995 (Summit's fiscal year ending September 30, 1996) for entities with less than $150 million in total assets. This pronouncement does not change any requirements for recognition, measurement or classification of financial instruments in the Company's financial statements.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n1. Summary of Accounting Policies, Continued\nReclassifications\nCertain amounts in the 1993 financial statements have been reclassified to conform with the current year's presentation. These reclassifications had no effect on net income or retained earnings as previously reported.\n2. Real Estate Contracts and Mortgage Notes Receivable\nReal estate contracts and mortgage notes receivable include mortgages collateralized by property located throughout the United States. At September 30, 1994, the Company held first position liens associated with contract and mortgage notes receivable with a face value of approximately $21,900,000 and second position liens of approximately $6,500,000. Approximately 22% of the face value of the Company's real estate contracts and mortgage notes receivable are collateralized by property located in the Southwest (Texas and New Mexico), approximately 18% by property located in the Pacific Southwest (California, Nevada and Arizona), approximately 16% by property located in the Pacific Northwest (Washington, Idaho, Montana and Oregon) and approximately 14% by property located in the Southeast (Florida, Georgia, North Carolina and South Carolina).\nContracts totaling approximately $6,000,000 which were collateralized by property in Hawaii were purchased from a Metropolitan affiliated company during fiscal 1993. At September 30, 1993, approximately $5,500,000 of these contracts were outstanding. These contracts relate to the sale of timeshare units in a condominium resort development which is owned by a Metropolitan affiliated company. On February 18, 1994, the Company sold its remaining timeshare contracts at their carrying values to Metropolitan.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n2. Real Estate Contracts and Mortgage Notes Receivable, Continued\nThe face value of the Company's real estate contracts and mortgage notes receivable as of September 30, 1994 and 1993 are grouped by the following dollar ranges:\nContractual interest rates on the face value of the Company's real estate contracts and mortgage notes receivable as of September 30, 1994 and 1993 are as follows:\nThe weighted average contractual interest rate on these receivables at September 30, 1994 is approximately 10%. Maturity dates range from 1994 to 2024. The constant effective yield on contracts purchased in fiscal 1994 and 1993 was approximately 11.5% and 12%, respectively.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n2. Real Estate Contracts and Mortgage Notes Receivable, Continued\nThe following is a reconciliation of the face value of the real estate contracts and mortgage notes receivable to the Company's carrying value at September 30, 1994 and 1993:\nThe principal amount of receivables with required principal or interest payments being in arrears for more than three months was approximately $1,085,000 and $1,662,000 at September 30, 1994 and 1993, respectively. Included in the amount for September 30, 1993 was approximately $680,000 of delinquent contracts purchased from an affiliate during 1993. The Company had a performance holdback of $600,000 to cover any losses related to certain timeshare unit contracts, including these delinquent contracts. On February 18, 1994, the Company sold the remaining timeshare receivables, related to the holdback provisions, at their carrying value to Metropolitan. During the year ended September 30, 1994, the Company sold approximately $10,400,000 of receivables without recourse and recognized a gain of approximately $172,000.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n2. Real Estate Contracts and Mortgage Notes Receivable, Continued\nAggregate amounts of receivables (face amount) expected to be received, based upon prepayment patterns, are as follows:\n3. Investments in Affiliated Companies\nAt September 30, 1994, the Company owns the following preferred and common shares of Metropolitan:\nCost and Type Number Carrying of Shares of Shares Value _________ _________ _______\nClass A common 9 $ 420,205 Preferred: Series C 116,094 1,160,942 Series D 24,328 243,278 Series E-1 105,800 1,058,000 Series E-4 1,400 140,000 --------- $ 3,022,425 ==========\nClass A common stock is the only voting class of Metropolitan's stock. Class A common stock is junior to Class B common stock as to liquidation preference. At September 30, 1994, Summit owned 7.12% of the outstanding Class A common stock.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n3. Investments in Affiliated Companies, Continued\nThe preferred stock have par value of $10 per share and have liquidation preferences equal to their issue price. They are non- voting and are senior to the common shares as to dividends. Dividends are cumulative and at variable rates; however, dividends shall be no less than 6% or greater than 14% per anum. At September 30, 1994, the preferred Series C, D and E-1 had dividend rates of 8.612%. The preferred Series E-4 had a dividend rate of 9.112%. Neither the common nor preferred shares are traded in a public market; however, the preferred stock trades at face value on a trading list maintained by Metropolitan.\n4. Debt Payable\nAt September 30, 1994 and 1993, debt payable consists of:\n5. Investment Certificates\nAt September 30, 1994 and 1993, investment certificates consist of:\n6. Deferred Costs\nAn analysis of unamortized commissions and other capitalized expenses incurred in connection with the sale of investment certificates for the years ended September 30, 1994 and 1993 is as follows:\nNo valuation allowance has been established to reduce the deferred tax assets, as it is more likely than not that these assets will be realized due to the future reversals of existing taxable temporary differences. As of September 30, 1994, the Company's net operating loss carryforwards of approximately $1,011,000 expire in 2006.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY NOTES TO FINANCIAL STATEMENTS, Continued ____________\n7. Income Taxes, Continued\nThe provision for income taxes is computed by applying the statutory federal income tax rate to income before income taxes as follows:\nDuring the year ended September 30, 1992, the Company recognized an extraordinary credit of $49,772 by the utilization of net operating loss carryforwards of approximately $146,000.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n8. Stockholders' Equity\nA summary of preferred and common shares at September 30, 1994 and 1993 is as follows:\nIssued and Outstanding Shares _________________________________ 1994 1993 _________________________________\nAuthorized Shares Amount Shares Amount Shares __________ ________ ______ ________ ________\nRegistered preferred stock, Series S-1 150,000 $ 317,194 31,719 $ -- -- ========= ======== ====== ======== ======\nCommon stock 2,000,000 $ 100,000 10,000 $ 200,000 20,000 ========= ======== ====== ======== ======\nIn addition to the shares above, the Company has authorized 10,000,000 total shares of Series S preferred stock, of which 150,000 shares were registered at September 30, 1994.\nSeries S-1 preferred stock is cumulative and the holders thereof are entitled to receive monthly dividends at an annual rate equal to the highest of the \"Treasury Bill Rate,\" the \"Ten Year Constant Maturity Rate\" or the \"Twenty Year Constant Maturity Rate\" as defined in the Series S-1 offering prospectus determined immediately prior to declaration date. The board of directors may, at its sole option, declare a higher dividend rate; however, dividends shall be no less than 6% or greater than 14% per annum.\nSeries S-1 preferred stock has a par value of $10 per share and was sold to the public at $100 per share. Series S-1 shares are callable at the sole option of the board of directors at $102 per share prior to January 1, 1995 and $100 per share thereafter.\nAll preferred stock has liquidation preferences equal to their issue price, are non-voting and are senior to the common shares as to dividends. All preferred stock dividends are based upon the original issue price.\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n9. Related Party Transactions\nThrough September 9, 1994, the date of disaffiliation, Summit received accounting, data processing, contract servicing and other administrative services from Metropolitan. Charges for these services were approximately $58,000 in fiscal 1994, $97,000 in fiscal 1993 and $50,000 in fiscal 1992 and were assessed based on the number of real estate contracts and mortgage notes receivable serviced by Metropolitan on Summit's behalf. Other indirect services provided by Metropolitan to Summit, such as management and regulatory compliance, were not directly charged to Summit.\nManagement believes that this allocation is reasonable and results in the reimbursement to Metropolitan of all significant direct expenses incurred on behalf of Summit. Currently, management anticipates that Metropolitan will continue to supply these services in the future.\nSUMMIT SECURITIES, INC. AND SUBSIDIARIES\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n9. Related Party Transactions, Continued\nSummit had the following related party transactions with Metropolitan and affiliates during fiscal years 1994, 1993 and 1992:\nSUMMIT SECURITIES, INC. AND SUBSIDIARY\nNOTES TO FINANCIAL STATEMENTS, Continued ____________\n9. Related Party Transactions, Continued\nAdvances to parent of $1,710,743 at September 30, 1993 represent advances to Metropolitan for the purchase of Summit's investments in real estate contracts and mortgage notes receivable.\nAdvances due Metropolitan of $267,735 at September 30, 1994 represent real estate contracts and mortgage notes and related costs advanced by Metropolitan on behalf of Summit and are included in accounts payable.\nIn December 1994, the Company reached an agreement with Metropolitan whereby it will acquire Metropolitan Investment Securities, Inc. (MIS) effective January 31, 1995. Additionally, the Company is negotiating the purchase of Old Standard Life Insurance Company (Old Standard) from Metropolitan. Both MIS and Old Standard are wholly-owned subsidiaries of Metropolitan.\n10. Supplemental Disclosures for Statements of Cash Flows\nSupplemental information on interest and income taxes paid during the years ended September 30, 1994, 1993 and 1992 is as follows:\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nN\/A. The Company reported a change in accountants in its Form 8-K dated June 25, 1993.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of Registrant.\nSee \"Executive Compensation\" under Item 1.\nItem 11.","section_11":"Item 11. Executive Compensation.\nSee \"Executive Compensation\" under Item 1.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nSee \"Principal Shareholders\" under Item 1.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nSee \"Certain Transactions\" under Item 1.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) 1. Financial Statements Included in Part II, Item 8 of this report:\nReports of Independent Certified Public Accountants Consolidated Balance Sheets at September 30, 1994, and 1993 Consolidated Statements of Income for the Years Ended September 30, 1994, 1993 and 1992. Consolidated Statements of Stockholder's Equity for the years Ended September 30, 1994, 1993 and Consolidated Statements of Cash Flows for the Years Ended September 30, 1994, 1993 and 1992 Notes to Consolidated Financial Statements\n2. Financial Statements Schedules\nIncluded in Part IV of this report:\nReports of Independent Certified Public Accountants on Financial Statement Schedules.\nSchedule VIII -- Valuation and Qualifying Accounts Schedule XII -- Mortgage Loans on Real Estate\nOther Schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.\n3. Exhibits\n3(a)(i). Articles of Incorporation of the Company. (Exhibit 3(a) to (Registration No. 33-36775).\n*3(a)(ii). Amendment to Articles of Incorporation dated January 20, 1994.\n3(b). Bylaws of the Company. (Exhibit 3(b) to Registration No. 33-36775).\n4(a). Indenture dated as of November 15, 1990 between Summit and West One Bank, Idaho, N.A., Trustee. (Exhibit 4(a) to Registration No. 33-36775).\n4(b). Amendment to Indenture dated as of November 15, 1990 between Summit and West One Bank, Idaho, N.A., Trustee. (Exhibit 4(b) to Registration No. 33-36775).\n4(c). Form of Statement of Rights, Designations and Preferences of Variable Rate Cumulative Preferred Stock Series S-1.\n4(d). Form of Variable Rate Cumulate Preferred Stock Certificate.\n4(e). Form of Investment Certificate.\n*10(a). Management, Acquisition and Servicing Agreement between Summit and Metropolitan Mortgage & Securities Co., Inc. dated September 9, 1994.\n11. Computation of Earnings Per Common Share. (See Financial Statements.)\n*27. Financial Data Schedules\n*Filed herewith\n(b) Reports on Form 8-K On or about September 15, 1994 Summit filed a Form 8-K reporting a change in control and including proforma financial information dated June 30, 1994 and September 30, 1993.\n(c) See Exhibit Volume hereinabove.\n(d) Financial Statement Schedules hereinbelow\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULES\nThe Directors and Stockholder Summit Securities, Inc.\nOur report on the consolidated financial statements of Summit Securities, Inc. and subsidiary as of September 30, 1994 and 1993 and for the years then ended, is included in Item 8 herein. In connection with our audits of such financial statements, we have also audited the 1994 and 1993 financial statement schedules listed in Item 14 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic 1994 and 1993 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.\nCoopers & Lybrand L.L.P.\nSpokane, Washington November 21, 1994\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULES\nThe Directors and Stockholders Summit Securities, Inc.\nThe audit referred to in our report dated December 7, 1992, relating to the financial statements of Summit Securities, Inc., for the year ended September 30, 1992, which is contained in Item 8 of this Form 10-K, included the audit of the financial statement schedules listed under Item 16(b) as of September 30, 1992 and for the year then ended. 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 audit.\nIn our opinion, such financial statement schedules present fairly, in all material respects, the information set forth therein.\n\/s\/ BDO SEIDMAN\nBDO Seidman\nSpokane, Washington December 7, 1992\nSCHEDULE VIII\nSUMMIT SECURITIES, INC. VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992\nSchedule XII\nSUMMIT SECURITIES, INC. MORTGAGE LOANS ON REAL ESTATE September 30, 1994\nSchedule XII Continued\nSUMMIT SECURITIES, INC. MORTGAGE LOANS ON REAL ESTATE 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.\nSUMMIT SECURITIES, INC.\n\/S\/ John Trimble\nBy_______________________________________________ John Trimble, President\/Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated:\nSignature Title Date\n\/S\/ John Trimble President\/Director _________________________ 1\/12\/95 John Trimble\n\/S\/ Philip Sandifur Vice President\/Director 1\/12\/95 _________________________ Philip Sandifur\n\/S\/ Tom Turner Secretary\/Treasurer _________________________ Director 1\/12\/95 Tom Turner\n\/S\/ Ernest Jurdana Chief Financial Officer 1\/12\/95 ________________________ Ernest Jurdana\nAs filed with the Securities and Exchange Commission on January 12, 1995. SEC File No. 33-36775\nSECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549\n__________________________________\nFORM 10-K\nUnder\nTHE SECURITIES EXCHANGE ACT OF 1934\n- ----------------------------------\n(Exact name of registrant as specified in charter)\nSUMMIT SECURITIES, INC.\nIdaho 6799\n(State or other jurisdiction of (Primary Standard Industrial incorporation or organization Classification Code Number)\nWest 929 Sprague Avenue Spokane, Washington 99204 82-0438135 (509) 838-3111 (I.R.S. Employer (Address, including zip code Identification No.) and telephone number, including area code, of registrant's principal executive offices)\nJohn Trimble President Summit Securities, Inc. W. 929 Sprague Avenue Spokane, WA 99204 Telephone No. (509) 838-3111 _____________________________________ (Name, address, including zip code, and telephone number, including area code, of agent for service) _____________________________________\nEXHIBIT VOLUME\nEXHIBIT INDEX\nPage Number\n*3(a)(ii). Amendment to Articles of Incorporation dated January 20, 1994.\n*10(a). Management, Acquisition and Servicing Agreement between Summit and Metropolitan Mortgage & Securities Co., Inc. dated September 9, 1994.\n*27. Financial Data Schedules\n*Filed herewith\nExhibit 3(a)(ii)\nARTICLES OF AMENDMENT\nOF\nSUMMIT SECURITIES INC.\nArticles of Amendment of the Articles of Incorporation of SUMMIT SECURITIES INC. are herein executed by said corporation, pursuant to the provisions of Title 30 Idaho Business Corporation Act, Section 30- 1-61.\n1. The name of the corporation is SUMMIT SECURITIES INC.\n2. Article 4 of the Articles of Incorporation is amended and restated as follows effective January 20, 1994:\nThe authorized capital stock of the corporation shall consist of two million shares of a single class of common stock and ten million shares of a single class of preferred stock.\nThe shares of common stock shall be of the par value of $10.00 each. The holders of shares of common stock shall be entitled to receive dividends out of the funds of the corporation legally available therefor at the rate, and at the time or times, whether cumulative or non-cumulative, as may be authorized by the Board of Directors. The holders of shares of common stock shall have the right, on the basis of one vote per share, to vote for the election of members of the Board of Directors of the corporation and all other matters on which stockholders are required by law, or requested by the Board of Directors, to vote.\nThe shares of preferred stock shall be of the par value of $10.00 each. The holders of preferred stock shall be entitled to receive cumulative dividends out of the funds of the corporation legally available therefor at the rate, and at the time or times as may be authorized by the Board of Directors before any dividend shall be paid on or set apart for the common stock. The holders of shares of preferred stock shall have no voting rights except as may be required by law.\nThe Board of Directors is hereby expressly authorized to divide the shares of preferred stock into series, to designate the same and to fix and determine the rights and preferences of the shares of each series so established including dividend rates; redemption provisions; sinking fund provisions for redemption or repurchase; and conversion or exchange privileges and liquidation rights and priorities.\nAll or any part of the authorized common stock and preferred stock may be issued by the corporation from time to time and for such consideration as may be determined upon and fixed by the Board of Directors.\n3. Said Amendment was adopted at a meeting of the shareholders of said Corporation on January 20, 1994.\n4. The number of shares outstanding and entitled to vote thereon is 20,000.\n5. The number of shares for or against the amendment is as follows:\nFor the amendment: 20,000\nAgainst the amendment: 0\n6. The Amendment does not provide for an exchange, reclassification or cancellation of existing shares.\n7. The Amendment does not effect a change in the amount of stated capital.\nDATED: January 20, 1994 SUMMIT SECURITIES INC.\n\/s\/ Reuel Swanson ___________________________ Reuel Swanson, Secretary\nEXHIBIT 10\nMANAGEMENT, ACQUISITION AND SERVICING AGREEMENT\nAgreement made this 9th day of September, 1994 by and between Summit Securities, Inc. (hereinafter \"SUMMIT\"), a Washington corporation with principal offices at 1000 West Hubbard, Suite 140, Coeur d'Alene, ID 83814, and Metropolitan Mortgage & Securities Co., Inc. (hereinafter \"METROPOLITAN\"), a Washington corporation with its principal office at W. 929 Sprague Ave., Spokane, Washington 99204, (also hereinafter referred to jointly as the \"Parties\".) WITNESSETH WHEREAS, METROPOLITAN engages in the business of purchasing and servicing receivables, and maintains subsidiaries, internal staff, and operations to support such activities, and; WHEREAS, SUMMIT also engages in the business of investing in receivables, but SUMMIT does not maintain internal staff or operations to support the purchasing and servicing of receivables, and; WHEREAS, METROPOLITAN has the personnel, systems and expertise to provide to SUMMIT general support services, receivable acquisition services and receivable collection and management services, and; WHEREAS, SUMMIT desires to obtain from METROPOLITAN general support services, receivable acquisition services and receivable collection and management services; NOW THEREFORE, for the foregoing reasons and in consideration of the mutual promises, covenants and agreements set forth herein, the parties promise, covenant and agree as follows: I. REPRESENTATIONS AND WARRANTIES OF METROPOLITAN: METROPOLITAN REPRESENTS AND WARRANTS TO SUMMIT THAT: 1. METROPOLITAN is a corporation duly organized, validly existing and in good standing under the laws of the State of Washington. 2. METROPOLITAN is licensed, or qualified, and in good standing in each of the states where the laws require licensing or qualification in order to conduct METROPOLITAN'S receivable acquisition, collection and management activities, or METROPOLITAN is exempt under applicable law from such licensing or qualification. 3. The consummation of the transactions contemplated herein have been validly authorized and all requisite corporate action has been taken by METROPOLITAN to make this agreement binding upon METROPOLITAN in accordance with its terms. 4. The consummation of the transactions contemplated by this agreement are in the ordinary course of business of METROPOLITAN. 5. The execution and delivery of this agreement, the servicing of receivables by METROPOLITAN, the other services and transactions contemplated hereby, and the fulfillment of and compliance with the terms and conditions of this agreement, will not conflict with or result in a breach of any of the terms of METROPOLITAN's articles of incorporation, bylaws or any other agreement, instrument, law, regulation, rule, order, or judgment to which METROPOLITAN is now a party or by which it is bound. METROPOLITAN is not subject to any agreement, instrument, law, regulation, rule, order or judgment which would impair the ability of SUMMIT to collect its receivables or impair the value of SUMMIT'S receivables. 6. METROPOLITAN does not believe, nor does it have any reason or cause to believe, that it cannot perform each and every covenant contained in this agreement.\n7. There is no action, suit, proceeding or investigation pending or threatened against METROPOLITAN which, either in any one instance or in the aggregate, may result in any material adverse change in the business, operations, financial condition, properties or assets of METROPOLITAN, or in any material impairment of the right or ability of METROPOLITAN to carry on its business substantially as now conducted, or which would draw into question the validity of this agreement or of any action taken or to be taken in connection with the obligations of METROPOLITAN contemplated herein, or which would be likely to impair materially the ability of METROPOLITAN to perform under the terms of this agreement. 8. No consent, approval, authorization or order of any court or governmental agency or body is required for METROPOLITAN'S execution, delivery and performance of or compliance with this agreement. 9. The receivables acquisition practices, receivable collection practices and other services provided hereunder shall each be conducted in accordance with generally accepted business practices in all respects, as applicable to each respective activity. II. REPRESENTATIONS AND WARRANTIES OF SUMMIT SUMMIT REPRESENTS AND WARRANTS TO METROPOLITAN THAT: 1. SUMMIT is a corporation duly organized, validly existing and in good standing under the laws of the State of Idaho. 2. SUMMIT is licensed or qualified, and in good standing in each of the states where the laws require licensing or qualification in order to hold and enforce the terms of its receivables and conduct its business, or SUMMIT is exempt under applicable law from such licensing or qualification. 3. The consummation of the transactions contemplated herein have been validly authorized and all requisite corporate action has been taken by SUMMIT to make this agreement binding upon SUMMIT in accordance with its terms. 4. The consummation of the transactions contemplated by this agreement are in the ordinary course of business of SUMMIT. 5. The execution and delivery of this agreement, the fulfillment of and compliance with the terms and conditions of this agreement, will not conflict with or result in a breach of any of the terms of SUMMITS articles of incorporation, bylaws or any other agreement, instrument, law, regulation, rule, order, or judgment to which SUMMIT is a party, by which it is bound or its property is subject, which would impair the ability of METROPOLITAN to service and collect the receivables in accordance with the terms of this Agreement. 6. SUMMIT does not believe, nor does it have any reason or cause to believe, that it cannot perform each and every covenant contained in this agreement. 7. There is no action, suit or proceeding or investigation pending or threatened against SUMMIT which, either in any one instance or in the aggregate, may result in any material adverse change in the business, operations, financial condition, properties or assets of SUMMIT, or in any material impairment of the right or ability of SUMMIT to carry on its business substantially as now conducted, or which would draw into question the validity of this agreement or of any action taken or to be taken in connection with the obligations of SUMMIT contemplated herein, or which would be likely to impair materially the ability of SUMMIT to perform under the terms of this agreement. 8. No consent, approval, authorization or order of any court or governmental agency or body is required for SUMMIT's execution, delivery and performance of or compliance with this agreement. III. GENERAL SUPPORT SERVICES: 1. DESCRIPTION OF SERVICES a. Administrative Support Services: METROPOLITAN shall provide SUMMIT administrative support services including but not limited to Human Resources, Information Systems, Art & Advertising, Accounting, legal, check processing, and cashiering services. b. Financial Services: METROPOLITAN shall provide financial advice to SUMMIT. c. Office Space: METROPOLITAN shall lease or sublease to SUMMIT sufficient office space for SUMMIT'S business needs at METROPOLITAN'S headquarters facility in Spokane, Washington and\/or such other location as agreed to by the parties. Any such lease may include lease of office furnishing and equipment. 2. FEES FOR GENERAL SUPPORT SERVICES SUMMIT will pay METROPOLITAN monthly fees for General Support Services provided by METROPOLITAN to SUMMIT. Fees for General Support Services shall be determined by mutual agreement of the parties. IV. RECEIVABLE ACQUISITION SERVICES 1. GENERAL DUTIES AND AUTHORITY METROPOLITAN shall provide receivable acquisition services to SUMMIT which shall be performed substantially in compliance with the following: a. METROPOLITAN shall secure opportunities for SUMMIT to purchase receivables through the use of METROPOLITAN's branch office system, industry contacts and the other methods developed by METROPOLITAN for its own receivable purchases. b. In reviewing the receivables offered to SUMMIT, METROPOLITAN shall review, among other things, the receivable loan to value ratio, security value, security condition, payment record, payor's credit, security title reports and legal documents, taking into account the investment guidelines provided by SUMMIT. c. METROPOLITAN or its agent, shall close the receivable purchase in a manner and using practices which are consistent with industry standards for the location where the receivable is closed. d. Loans resulting from financing that may be provided by METROPOLITAN as a means to induce the purchase of property (e.g. for the financing of repossession resales or other seller financing) may be placed in SUMMIT's receivable portfolio if such receivables are consistent with SUMMIT's investment guidelines. e. METROPOLITAN shall prepare and maintain such books, records, computer systems and procedures as shall be required and necessary to maintain control over the day to day activities regarding offers to purchase and closing of receivable purchases. f. METROPOLITAN shall furnish to SUMMIT such periodic, special or other reports or information as requested by SUMMIT including reports of total receivables purchased, closing periods and closing costs. All such reports, documents or information shall be provided by and in accordance with all reasonable instructions and directions which SUMMIT may give. g. METROPOLITAN may carry out any other activity or procedure, which in METROPOLITAN's discretion, is necessary or appropriate in connection with the acquisition and closing of the receivables for the benefit of SUMMIT. 2. RECEIVABLE ACQUISITION SERVICES FEE: SUMMIT shall pay METROPOLITAN fees for Receivable Acquisition and Support Services provided by METROPOLITAN to SUMMIT. Fees shall be determined by mutual agreement of the parties. 3. RIGHT TO REJECT. SUMMIT shall have the right at anytime to review the receivables acquired pursuant to this agreement and to reject any receivables which in SUMMIT's opinion are not consistent with its investment guidelines as such guidelines existed at the time of the acquisition. Any receivables not rejected within three months of acquisition are deemed accepted. Any receivable which is rejected shall be purchased by METROPOLITAN at its face amount or such other amount as agreed to by the parties. V. RECEIVABLE COLLECTION AND MANAGEMENT SERVICES 1. SERVICING: METROPOLITAN or its agents shall perform collection and management services for SUMMIT substantially in compliance with the following: a. Hold and safe keep all original receivable documents and files. b. Prepare and maintain such books, records, computer systems and procedures as shall be required and necessary to maintain control over the day to day activities regarding the collection and enforcement of the rights, obligations and performance of each receivable subject to this agreement. c. Furnish to SUMMIT such periodic, special, or other reports, documents or information as requested by SUMMIT including, but not limited to, cash receipt reports, aging of all receivables balances on a contractual basis, and itemizations of unearned or deferred income all in accordance with generally accepted accounting and statutory accounting principles. All such reports, documents or information shall be provided by and in accordance with all reasonable instructions and directions which SUMMIT may give. d. METROPOLITAN shall manage the receipt of receivable payments substantially as follows: i. Deposit all monies received from the receivable payors into a general collection account maintained by METROPOLITAN, or its agent, which account may contain other monies and funds which may be held for others. Within a reasonable time the amounts collected and deposited on behalf of SUMMIT shall be transferred to an account designated by SUMMIT. ii. For the purposes of this subparagraph d, reasonable time shall mean two to three business days, unless extraordinary circumstances beyond METROPOLITAN'S control, such as computer failure, makes such time frame unreasonable, in which case the reasonable time shall be two to three days following elimination of the circumstances causing the delay. e. Accept and remit to appropriate parties any amounts designated as reserves for the payment of real estate taxes, insurance premiums or similar items as may be provided by the receivable documents; f. Monitor the tax, insurance and other payments required to be paid directly by receivable payor to third parties, or collect from the receivable payors and remit to the appropriate third parties any amounts due for any taxes imposed upon the real estate securing any receivable, any insurance premiums and any other sums required to be paid by the receivable payor pursuant to the terms of any receivable. Any funds so collected by METROPOLITAN or subsidiaries shall be held in escrow if required by the receivable documents or applicable regulations, or METROPOLITAN shall pay such sums to SUMMIT as provided in Paragraph V.1.d. hereinabove. METROPOLITAN shall pay out such monies to such taxing authorities or other parties or persons as shall be authorized to receive such payments. g. Implement routine collection procedures (including telephone calls and the preparation and mailing of written notices) as METROPOLITAN may, in its discretion, deem to be reasonable or appropriate and in accordance with its customary practice and procedure in the servicing of its own accounts, on delinquent receivables; h. When appropriate, in METROPOLITAN's discretion, METROPOLITAN or its agent may undertake any legal action, whether judicial or non- judicial, to enforce the payment of any sums due or other performance required by the terms of any receivable documents or to foreclose upon or forfeit any real estate or other security securing a receivable. i. Whenever METROPOLITAN shall commence suit to enforce the terms of a receivable which is subject to this agreement, METROPOLITAN shall be deemed to be the authorized legal agent and representative of SUMMIT in any court of law in any federal, state, or commonwealth, or other court of competent jurisdiction, and to so act, without receiving any other prior authority of SUMMIT, to enforce, sue, settle, compromise, and\/or collect such monies and recover any and all such real estate security which shall be the subject of any receivable. Any such action may be maintained in the name of \"SUMMIT\" or \"METROPOLITAN\", at METROPOLITAN's discretion. j. Carry out any other activity or procedure which, in METROPOLITAN'S discretion, is necessary or appropriate in connection with the maintenance and enforcement of the receivables for the benefit of SUMMIT. 2. COOPERATION BY SUMMIT SUMMIT agrees to cooperate with METROPOLITAN in the enforcement of all receivables, make personnel available to METROPOLITAN and cause such personnel to execute documents, and to make such documents, records, papers, or other items of evidence available as needed to assist METROPOLITAN in the collection and servicing of the receivables subject to this agreement. 3. RECEIVABLE COLLECTION AND MANAGEMENT SERVICES FEES SUMMIT agrees to compensate METROPOLITAN for its duties performed hereunder in the following manner and amounts: a. SUMMIT agrees to pay in addition to any applicable taxes a monthly management and servicing fee. Such sum shall be due whether or not a receivable is in default. The Receivable Collection and Management Services Fee shall be determined by mutual agreement of the parties. b. In addition, SUMMIT shall reimburse METROPOLITAN for all outside attorney costs and all third party fees and charges which may be incurred in performance of the collections services. c. SUMMIT agrees that as additional compensation to METROPOLITAN for such management and collection efforts that METROPOLITAN shall be entitled to retain any and all late charges, extension charges, and any other charges or costs imposed upon a delinquent obligor that do not relate to changing the terms or conditions of the loan to effect a restructuring or otherwise. VI. GENERAL TERMS AND CONDITIONS 1. ADJUSTMENTS TO FEES METROPOLITAN may, from time to time, change the method for determining any or all of the fees charged pursuant to this agreement so long as the new method conforms with the intent of the parties, is reasonable and reflects changes in market rates and\/or the cost for providing such services. 2. REVIEW OF FEES SUMMIT shall have the right at any time to review the method for determining the fees charged pursuant to this Agreement. If, in SUMMIT's opinion, any fee is unacceptable SUMMIT may request a review by the officers of SUMMIT and METROPOLITAN, who shall use their best efforts to resolve any objection in consideration of the best interests of both parties. 3. NON-EXCLUSIVITY OF AGREEMENT a. This agreement is non-exclusive. SUMMIT reserves the right and privilege to employ and engage, from time to time, any other entity or person to perform any of the services which are the subject of this agreement, or may itself perform any such services. Such actions by SUMMIT shall not be construed as an event of termination of this agreement. b. SUMMIT may withdraw any receivable at any time from those being serviced pursuant to this agreement, which action shall not be a breach or termination of this agreement. 4. DELEGATION METROPOLITAN may utilize, delegate to or subcontract with any of its subsidiaries, divisions, affiliates or third parties in connection with its performance of the terms of this agreement, in full or in part, as deemed appropriate at METROPOLITAN's discretion. 5. RIGHT TO EXAMINE METROPOLITAN'S RECORDS SUMMIT shall have the right to examine and audit any and all of the books, records, or other information of METROPOLITAN, with respect to or concerning this agreement or the receivables during business hours or at such other times as may be reasonable under applicable circumstances. 6. EVENT OF DEFAULT The following shall be construed as an event of default: a. The failure by METROPOLITAN to deliver any and all monies received by METROPOLITAN which METROPOLITAN is obligated to pay to SUMMIT pursuant to the terms of this agreement; b. The failure by SUMMIT to deliver any sums required to be paid to METROPOLITAN pursuant to the terms of this agreement. c. The failure of either party to perform in accordance with the terms and conditions of this agreement to the extent that such failure to perform shall constitute a material breach of a term or condition of this agreement. d. In the event that METROPOLITAN shall file bankruptcy or otherwise be determined to be insolvent, this agreement may be terminated by SUMMIT and SUMMIT may take immediate steps to employ another entity to collect and service the receivables then being serviced by METROPOLITAN. 7. TERMINATION a. Either party may terminate this agreement by providing written notice of termination to the other party, in which event this agreement shall terminate immediately upon receipt of such notice or at such later date as provided in said notice. b. In the event of a default as defined in paragraph VI.6. hereinabove, the non-defaulting party may, in lieu of immediately terminating this agreement, provide written notice of default to the defaulting party, which notice shall set forth the time-period for cure, which shall be no less than ten (10) days from receipt of the notice by the defaulting party. If the breaching party does not cure the default within the time period set forth in the notice, this agreement shall terminate upon expiration of said time period. 8. NOTICE Notice under this agreement shall be in writing, and delivered by hand, receipt acknowledged, or delivered by registered certified United States mail, return receipt requested, and if refused, by regular United States mail, addressed to the parties as stated below: a. ATTN: PRESIDENT METROPOLITAN MORTGAGE & SECURITIES CO., INC. W. 929 Sprague Ave. Spokane, WA 99204.\nb. ATTN: PRESIDENT SUMMIT SECURITIES INC. 1000 W. Hubbard, Suite 140 Coeur d'Alene, ID 83814\n9. BINDING EFFECT This agreement sets forth the entire agreement between the parties, and shall be binding upon all successors and assigns of both of the parties hereto, and shall be construed under the laws of the State of Washington. 10. PRIOR AGREEMENTS This agreement replaces and supercedes each and every prior agreement executed by the parties related to the management, Receivable acquisition and Receivable collection services provided by METROPOLITAN to SUMMIT. This agreement is executed the day, month, and year first above written by the duly authorized officers of each party. METROPOLITAN MORTGAGE & SUMMIT SECURITIES, INC. SECURITIES CO., INC.\n\/S\/ C. Paul Sandifur, Jr. \/S\/ John Trimble By: By: C. Paul Sandifur, Jr. John Trimble President President\nAttest \/S\/ Susan Thomson Attest \/S\/ Tom Turner Susan Thomson Tom Turner Assistant Secretary Secretary\/Treasurer\nADDENDUM TO MANAGEMENT, ACQUISITION AND SERVICING AGREEMENT\nBETWEEN\nSUMMIT SECURITIES, INC.\nAND\nMETROPOLITAN MORTGAGE & SECURITIES CO., INC.\nDATE OF ORIGINAL AGREEMENT: September 9, 1994\nDATE OF THIS ADDENDUM: September 9, 1994\nADDENDUM NUMBER: 1\n1. FEES FOR GENERAL SUPPORT SERVICES a. Administrative Support Fees: i. SUMMIT will pay METROPOLITAN a monthly fee for general office services provided by METROPOLITAN to SUMMIT. It is the intent of the parties hereto that the Administrative Support Fees be calculated at a fair and equitable rate that reflects the current market cost for comparable services.\nii. METROPOLITAN has developed and shall continue to maintain a cost-allocation system designed to measure the activity of the general support services departments used by both parties, to provide a basis for allocation of the costs generated by those departments. The cost allocation system shall be expressed in terms of labor hours, machine hours, square footage, and\/or other appropriate measures. The cost allocation system will be used to support charges found in the market place for comparable services and may be used as a proxy for market charges when the market cost for such services cannot be determined and as agreed to by the parties.\nb. Financial Services Fees: i. SUMMIT shall pay to METROPOLITAN an agreed amount to METROPOLITAN for METROPOLITAN providing financial consultation and advice. ii. The financial consultation and advice, when provided, shall be charged at a fee negotiated by the parties in each instance and based upon the expertise and hours required to provide the service. c. Office Space Rental Fees: i. SUMMIT shall also pay to METROPOLITAN an agreed amount of rent for the real and personal property utilized by SUMMIT during the term hereof, which amount shall be determined on the basis of a triple net lease. ii. The lease for office space and related triple net charges shall be determined on a square foot basis, based upon a percentage of the building's total expenses, or such other appropriate measure as determined by the parties. 2. RECEIVABLE ACQUISITION SERVICES FEE: a. METROPOLITAN shall acquire receivables for SUMMIT, which, after deduction of METROPOLITAN's fee, earn a minimum net yield equivalent to the yield obtainable in the market place for assets of comparable credit quality (estimated to approximate 400 basis points over the average Treasury Mortgage Equivalent Yield). Calculation of this fee shall be determined by mutual agreement of the parties. b. The minimum fee to METROPOLITAN will be no less than 100 basis points for all receivables purchased through its origination network. c. The following formula sets forth the initial method for calculating the fee and corresponds to the sample calculation set forth in Exhibit A. i. Determine the net carrying value (net book value) of the receivables(s) by decreasing its\/their face amount by the purchase discount, and adding back the capitalized closing costs. For the purposes of this paragraph, purchase discount is the difference between the face value of the receivable and its purchase price paid to the third party seller. ii. Determine the weighted average remaining contractual term of the receivable(s). iii. Set forth the expected average remaining life for the receivable(s), which expectation shall be determined after applying the prepayment assumption set forth in paragraph v. The average remaining life is equal to the life in which the average balance is reached. iv. Determine the weighted average coupon (weighted average interest rate) for the receivable(s). v. Set forth the expected prepayment assumption for the receivable(s) which shall be determined by considering the weighted average coupon (set forth in iv. hereinabove) in light of the current interest rate environment. vi. Determine the average weekly treasury yield for the expected average time to maturity of the receivable(s) as set forth in paragraph IV.2.c.iii. over the time period that the receivable(s) was\/were acquired. The weekly yield shall be a weekly average calculated on a consistent basis, such as the average weekly rate published by the Bloomberg Investment System. The rate used may reflect an interpolation between proximate treasury yields and terms. The rate may be the result of rounding to the nearest whole year, e.g. an expected receivable average term of 4.6 years may be rounded to 5.0 years. vii. Determine the mortgage equivalent (monthly payment equivalent) for the average weekly treasury yield set forth in vi. hereinabove. viii. Add the appropriate spread to the mortgage yield equivalent (IV.2.a.). The result is the receivable yield to SUMMIT (subject to IV.2.b.). ix. Determine the percent of the face value of the receivable which SUMMIT can pay to achieve its yield requirement as set forth in viii. hereinabove. x. Set forth the dollar amount which results from applying the percent in paragraph ix, to the face amount of the receivable. xi. The difference between the amount SUMMIT can pay to obtain its desired yield (ix.) and the net carrying value (i.), is the acquisition services fee. xii. Determine that the fee prescribed in (xi) is equal to or greater than the minimum fee prescribed in IV.2.b. If the fee derived from the above formula is less than the minimum then recalculate the fee at the prescribed minimum. d. The receivable acquisition services fee may be calculated by METROPOLITAN, at its discretion, on an individual receivable basis, or on a pooled basis. 3. COMPENSATION FOR CONTRACT SERVICES SUMMIT agrees to compensate METROPOLITAN for its duties performed hereunder in the following manner and amounts: a. SUMMIT agrees to pay in addition to any applicable taxes a monthly management and servicing fee. Such sum shall be due whether or not a receivable is in default. The fee shall be calculated based on the cost for similar services in the market place. The charge will be derived based generally on the following methodology: The standard servicing charge in the market place for conventional residential loans (currently 25 basis points) will be applied to the average Washington, regional, or national average loan balance. The parties may agree to further segregate the charges between residential, commercial or other loan property types. The resulting annual per loan charge will be divided by the recent average SUMMIT loan balance and multiplied by one plus a factor that considers the additional servicing cost attendant to the types of loan products generally acquired by SUMMIT.\nMETROPOLITAN MORTGAGE & SUMMIT SECURITIES, INC. SECURITIES CO., INC.\nBy: \/S\/ C. Paul Sandifur, Jr. By: \/S\/ John Trimble C. Paul Sandifur, Jr. John Trimble President President\nAttest \/S\/ Susan Thomson Attest \/S\/ Tom Turner Susan Thomson Tom Turner Assistant Secretary Secretary\/Treasurer\nExhibit 27\n[ARTICLE]5 [MULTIPLIER] 1,000","section_15":""}
{"filename":"865937_1994.txt","cik":"865937","year":"1994","section_1":"ITEM 1. BUSINESS\nCatellus Development Corporation is an owner, developer and manager of industrial, retail and office properties, undeveloped land and real estate joint ventures located principally in California and in ten other states in the West, Southwest and Midwest. The Company was organized in the state of Delaware in 1984 as an indirect, wholly-owned subsidiary of Santa Fe Pacific Corporation (SFP) to conduct the non-railroad real estate activities of Santa Fe Industries and Southern Pacific Company. In December 1989, SFP sold 19.9% of the Company to Bay Area Real Estate Investment Associates, L.P., a California limited partnership whose general partner is JMB\/Bay Area Partners and whose limited partner is the California Public Employees' Retirement System. The Company changed its name from Santa Fe Pacific Realty Corporation to Catellus Development Corporation in June 1990. SFP completed its disposition of Catellus by distributing, in the form of a stock dividend, its remaining 80.1% interest in the Company to its stockholders in December 1990. Catellus' principal office is located at 201 Mission Street, San Francisco, California, 94105; its telephone number is (415) 974-4500.\nCOMPANY STRATEGIES\nIn September 1994, the Company began a major redesign of its organization and operations. This effort has resulted in a substantial reduction in staffing. The Company reduced its workforce by over 40% (89 employees) between September 15, 1994 and February 28, 1995. In November 1994, the Company announced a major restructuring which consists of three initiatives: Reorganization, Decentralization and a focus on Recurring Revenue to improve the Company's long- term cash position.\nReorganization - The November 1994 restructuring resulted in a workforce reduction of 76 employees (from 209 to 133) out of the total staffing reduction noted above. Management believes these reductions, when combined with cost savings from moving the corporate headquarters to a smaller, less expensive facility and other cost-reduction measures, will result in projected annual savings of approximately $10 million. These restructuring activities resulted in a $3.1 million non-recurring operating expense in 1994. Substantially all of the restructuring charges will result in cash outlays. As of December 31, 1994, $.7 million of the restructuring charges had been paid, with the remainder to be paid over the following nine months.\nDecentralization - The Company is being organized along specific customer- oriented product groups rather than by general functional areas. The business functions - developing, leasing, selling and managing - will be concentrated and focused within each of the product groups - industrial, retail, office and land development. This new, customer-oriented organization will make Catellus more competitive because each group will be staffed by professionals who understand and serve the needs of the end users of our products.\nRecurring Revenue - Generating recurring revenue, rather than selling assets to balance cash flows, is an integral part of the Company's restructuring plan. The following mechanisms will be employed: exchanging non-revenue-producing assets for those which produce revenue; entering into long-term land leases of developable land rather than selling land; maximizing interim uses of land; generating additional development and management fee income; and increasing the net cash flow from existing income-producing assets. A combination of these activities and the reduction of overhead expenditures can lead Catellus to a position where it no longer needs to sell its assets to meet cash flow needs.\nDespite the change of emphasis from sales to recurring revenue, asset sales are an important ingredient in an overall growth strategy. The Company owns many assets which should be sold and the proceeds strategically redeployed. Ideally, however, these sales will be made for strategic purposes, not to meet the Company's cash flow requirements.\nPROPERTY PORTFOLIO\nIn conjunction with the 1994 restructuring, the Company's properties have been segregated into five asset categories: Industrial, Retail, Office, Land Development and Diverse Holdings.\nSUMMARY -------\nThe following table provides a summary of the acreage, square footage and current value for each asset category.\nPORTFOLIO BY ASSET CATEGORY\n\/1\/ Represents 1993 current value of properties owned as of December 31, 1994. \/2\/ Includes interests in two hotels, an apartment complex, an office development, a design center and 103 acres of land available for future development. Value reflects the Company's proportionate share.\n\/3\/ Represents existing income producing buildings which will be razed as development proceeds. \/4\/ The Company generally owns mineral rights for 900,176 acres owned in fee and has retained mineral rights on 123,036 acres of land previously sold.\nThe following summarizes leasing statistics for the entire Company.\nLEASING STATISTICS\nFor the five years from 1995 through 1999, leases for 13.9%, 19.7%, 13.0%, 8.1%, and 8.4% of total rentable square footage are scheduled to expire.\nThe following summarizes sales statistics for the entire Company.\nRECENT SALES ACTIVITY (DOLLARS IN THOUSANDS)\n(1) Excludes the recognition of deferred revenue. (2) Includes one sale of 169,000 acres of land.\nThe following table illustrates the relationship between property sales and prior year current value estimates for each of the four years in the period ended December 31, 1994.\nSALES AS A PERCENTAGE OF CURRENT VALUE (DOLLARS IN THOUSANDS)\n---------------- (1) Excludes the recognition of deferred revenue.\nINDUSTRIAL ----------\nAs of the end of 1994, the Company's industrial portfolio included approximately 11.2 million square feet of existing buildings and an additional 440,000 square feet of industrial buildings currently under construction. It also included 55 acres of land leased for industrial uses and 7,469 acres of land suitable for industrial development. In addition, the Company has an interest in a venture which owns approximately 51 acres in Southern California.\nThe Company's industrial buildings are primarily located in California, Arizona, Texas and Illinois, all of which experienced positive job growth in 1994. At the year end, the Company had 173 buildings in its industrial portfolio which were 95.7% leased.\nThe Company has restructured its asset management function along asset type in order to be more responsive to tenant needs. Its intent is to focus on lease renewals and meeting tenants' expansion requirements, whether at existing facilities, on Company land or on land owned by others.\nFrom 1991 through 1994, the Company completed industrial projects for 3.2 million square feet, which were 100% leased as of December 31, 1994. In 1994, these projects included a 261,920 square foot warehouse for Interceramic Inc. in Garland, Texas as well as two buildings for the Los Angeles Times in Orange County totalling 44,075 square feet. In 1995, the Company has started construction on 440,000 square feet of space.\nThe Company's industrial land portfolio is larger than could be reasonably developed by Catellus over the near and mid-term. As a result, the Company is exploring a variety of alternatives, including strategic alliances with local developers, exchange of land for income-producing assets, entry into land leases and other means to more quickly monetize the land portfolio for redeployment for strategic purposes.\nProperty - The following table summarizes the Company's industrial property by region as of December 31, 1994.\nOccupancy - The following table summarizes the leasing performance of the Company's industrial buildings over the past four years.\nDevelopment - The following table summarizes the Company's industrial development completed during the past four years.\nProperty Sales - Historically, the Company's sales strategy generally consisted of selling surplus properties to provide cash flow which was used for the Company's development activities and to fund corporate overhead. Initially, property sales consisted principally of the sale of land which was not targeted for development in the near-term and agricultural, mountain and desert properties. Industrial property sales were, therefore, minimal. However, more recently, because of changes in the real estate industry, the composition of sales has increasingly shifted to include more income-producing properties and developable land. Management intends to shift the Company's focus from the sale of assets in order to meet cash flow needs to recurring revenue.\nRETAIL ------\nAs of the end of 1994, the Company's retail portfolio consisted of 813,000 square feet of existing buildings, 55 acres of land leased for retail uses and 623 acres of land for retail development.\nThe existing income-producing retail portfolio was 90.6% leased as of December 31, 1994. The Company's projects are primarily located in California which has experienced a significant increase in retail sales activities in 1994. The largest retail project, East Baybridge Center, is located on 40 acres just across the Bay from\nSan Francisco in the cities of Emeryville and Oakland. The 270,000 square foot Phase I of this project opened in mid-1994 and was pre-leased to such national retailers as Home Depot, Sportmart, OfficeMax, Safeway's Pak 'n Save and CompUSA. A 117,000 square foot building for Kmart will be added to the center in 1995.\nThe Company has 623 acres of land suitable for retail development. In addition, there are retail sites located within the Company's major projects, particularly Mission Bay and Los Angeles Union Station. These properties are included within the \"Land Development\" category until they are ready for retail development, at which time they will either be transferred to the retail category or sold to third party developers.\nThe Company is currently exploring the possible development of urban entertainment centers at several locations, including a 10-acre property near the waterfront in San Diego, as well as sites within Mission Bay and Los Angeles Union Station.\nProperty - The following table summarizes the Company's retail property by region as of December 31, 1994.\nOccupancy - The following table summarizes the leasing performance of the Company's retail buildings over the past four years.\nDevelopment - The following table summarizes the Company's retail development completed during the past four years.\nOFFICE ------\nAt the end of 1994, the Company's office portfolio consisted of approximately 1.7 million square feet of office buildings, 121 acres of land leased for office purposes, and 148 acres of land suitable for office development, all located primarily in major metropolitan areas. Additionally, the Company has a 67% interest in a joint venture which owns a 211,000 square foot office project in Torrance, California as well as land that it leases to owners of onsite office improvements. The most significant office projects owned by the Company are the South Bay Center in San Jose, California, 424,192 square feet, and the Railway Exchange Building in Chicago, Illinois, 374,929 square feet.\nThe markets in which the Company has significant office building holdings - the San Francisco Bay Area, Southern California and Chicago - are beginning to experience a reduction in vacancy rates as a result of increasing demand for new space. However, vacancy rates in these markets are still significant and rental rates have not increased materially. At year-end 1994, this portfolio was 93.2% leased.\nThere has been relatively little new office space development in the Company's market areas. This lack of new supply, in conjunction with increasing demand as a result of job growth and economic recovery, should cause continued improvement in the office sector.\nThe Company's portfolio of land suitable for office development represents the potential for future growth; however, the Company will only consider developing new office product with substantial pre-leasing and on economic terms which provide sufficient returns to justify new construction.\nProperty - The following table summarizes the Company's office property by region as of December 31, 1994.\nOccupancy - The following table summarizes the leasing performance of the Company's office buildings over the past four years.\nDevelopment - The following table summarizes the Company's office development completed during the past four years.\nLAND DEVELOPMENT\nThe Company's land development portfolio consists of four major mixed use development projects and seven other sites totaling 4,129 acres of land which are suitable primarily for residential uses. The portfolio also includes buildings located on the major mixed use development sites which produce current revenue. These buildings have not been included in the industrial or retail groups since they will be razed as development proceeds.\nFour major development properties represent the potential for generating significant revenue over time. However, because of the financial implications of major mixed-use development, the Company is conducting a detailed review of entitlements, product mix, phasing and financing sources for each of these properties. The Company is required to make various payments to municipalities and construct or pay for certain public amenities in order to retain its entitlements on several of these properties.\nThe Company has completed the evaluation of the Pacific Greens project in Fremont, California and concluded that a commercial development of retail, industrial, research and development, and office uses will be more profitable than the approved golf course residential community.\nThe other three properties - Mission Bay, Los Angeles Union Station and the Santa Fe, New Mexico Railyard - present attractive development opportunities. The Company expects to complete its evaluation of these projects during the third quarter of 1995.\nThe Company has seven sites which offer potential for primarily residential development. Development on several of these properties can be completed more quickly than for the larger mixed use projects which adds an important dimension to the revenue potential of the Land Development portfolio.\nDescribed below are the Company's largest mixed-use development projects.\nUnion Station in Los Angeles. The Company completed the acquisition of the historic Union Station in downtown Los Angeles in early 1990 and is proceeding with plans to develop the 50-acre site as a regional transportation center and mixed-use complex of office buildings and retail space. Amtrak, the region's commuter rail system, suburban bus lines and the City's new subway system serve this station daily. The site currently is entitled for government uses. The Company is working on a master plan to develop approximately 7 million square feet of primarily commercial and governmental uses, including approximately 5.5 million square feet of office buildings, 180,000 square feet of retail space, residential units, two hotels and a conference center. The Company must enter and conclude the entitlement process with the City (projected to be completed by year end 1995 or early 1996) prior to starting any commercial development at this site. The targeted users for the initial office buildings are public or quasi-public agencies; the site does not need new entitlement approvals for such uses. The Company has no current plan to commence construction of any commercial office building on this site that is not substantially pre-leased.\nConstruction of the first building on the site, the 626,000 square foot headquarters facility for the Metropolitan Transportation Authority (MTA), started in 1993 and is scheduled to be completed in September 1995. The MTA building, which will be owned and occupied by the MTA, is the first component of Gateway Center (part of the Union Station project), a multi-phased project that consists of two office towers comprising over 1.2 million square feet, a 3.5- acre regional public transit center and bus plaza, 20,000 square feet of service retail, an underground parking garage and a new transit concourse connecting the bus and train terminals.\nUnion Station has also been selected as the site of the new headquarters facility for the Metropolitan Water District (MWD). Negotiations are proceeding with the MWD and a final agreement is expected in the first half of 1995 under which Catellus would sell a 4.2 acre site to the MWD and construct a 550,000 square foot, 12 story office building for the MWD on the site. Construction is scheduled to begin in mid-1996 with building completion and occupancy targeted for late 1998.\nMission Bay in San Francisco. The Mission Bay development is one of the largest urban projects in the United States. The proposed plan would transform a 313-acre area one mile south of downtown San Francisco into a new neighborhood composed of residential, office, retail and commercial. The project is expected to be developed over a 20-year period. This site includes acreage owned by the Company, the City and Port of San Francisco and the State of California. The parties are now undertaking various land transfers to enable development to proceed. During the development of the project, the Company will dedicate to various governmental authorities certain properties, including parks, streets, and affordable housing sites.\nThe Company has received entitlements to develop the project pursuant to a development agreement entered into with the City of San Francisco effective March 31, 1991. The development agreement permits development of 4.8 million square feet of office space, 900,000 square feet of commercial\/light industrial space, 731,000 square feet of retail space, approximately 8,700 housing units, and a 500-room hotel. In addition, the development agreement calls for 68 acres of parks and open space along with 16 acres of public facilities.\nThe Company is currently conducting a detailed review of entitlements, product mix, phasing and financing sources. The Company has entered into an alliance with the San Francisco Giants and the Cow Palace to study the feasibility of a sports and entertainment center, the results of which are expected in 1995. The Company is also considering a possible change in land use to accommodate a \"big box\" retail use on approximately 10 acres of the property.\nPacific Greens in Fremont. In March 1995, the Company announced its intention to pursue a retail, industrial and commercial development rather than a previously proposed golf course residential community on its 600-acre vacant site bordering Interstate 880 in Fremont, California. These are uses which were called for by the City's General Plan designation prior to the approval of the golf course residential project, and they are consistent with the current land uses of adjacent property. This decision was made after thoroughly reevaluating the entitlements, land uses, phasing and financing sources of the proposed golf course residential project.\nThe Company plans to file the appropriate applications for amendment to the City's General Plan to accommodate the proposed commercial development. However, the current plan designation permits sufficient retail and industrial uses to accommodate the Company's near-term plans for development during the General Plan amendment process.\nBuena Park, California. The Company owns 70 acres in Buena Park, which is located near Fullerton in the northern part of Orange County. The property is currently zoned for research and development uses; however, the City of Buena Park has indicated it is receptive to rezoning the site for residential uses. The Company is currently pursuing entitlements for the development of approximately 400 homes on the site. If entitlements are received, development on the site could begin in 1996.\nUnion City, California. The Company is working with Union City, located 10 miles south of Oakland, to develop a portion of the 107 acres the Company owns in the Decoto Redevelopment District as a single family, small lot residential district. The proposed plan calls for 99 acres of residential development (69 acres currently owned by the Company and 30 acres to be acquired from adjacent landowners). All of the property is currently zoned for residential. However, the density proposed will require an amendment to the Redevelopment Plan. If approvals are received, development on the site could begin in 1996.\nProperty - The following table summarizes the Company's Land Development properties:\nOccupancy - The following table summarizes the leasing performance of the buildings located on the Company's Land Development properties over the past four years.\nDIVERSE HOLDINGS\nThe Company's Diverse Holdings consist of a wide variety of property types and present unique opportunities. However, the Company recognizes that the diversity of its portfolio may not be conducive to maximizing stockholder value and is focusing attention on many of these assets for exchange or disposition. Other assets in this category offer significant potential for recurring revenue, including:\nNew Orleans Hilton. The Company owns an interest in the 1602-room New Orleans Hilton Hotel. This property is strategically located between the dock for the Flamingo Riverboat Casino and the new landside casino, currently under construction.\nGolden Gate Fields. The Company owns Golden Gate Fields in Albany, across the Bay from San Francisco, which is leased to Ladbroke Racing Corporation, the operator of the racetrack. The property has recently been approved as the site of a card club.\nUrban Housing. The Company has a number of properties which are appropriate for high density urban housing development. The Company has not historically been in the multi-family housing business and hence these properties are in the category of \"Diverse Holdings.\" However, the demand for well-located, well-designed rental housing in urban areas of California is extremely high and the Company's land holdings present interesting opportunities which will be pursued.\nEnvironmental. Many of our properties have revenue potential from uses such as wind farms, solid waste disposal and mitigation credits. The Company's property in Collinsville, California (located near the northeastern portion of the San Francisco Bay) is well suited for dredge disposal and the Company is now processing permit applications.\nProperty - The following table summarizes the Company's Diverse Holdings properties by region as of December 31, 1994.\nDevelopment - Historically, development within the Diverse Holdings category relates primarily to hotels and apartments which were built, and are currently owned, in joint ventures with other entities. Future development of residential sites is planned for in Emeryville at the East Baybridge project, where it is anticipated that Phase III will commence in 1996. Other significant residential sites not included in the Company's Land Development asset class include 10.4 acres in downtown Los Angeles, 2.3 acres in downtown San Diego, 9.1 acres in Oceanside, California, and 5.5 acres in downtown Dallas, Texas.\nRemaining future development in the Diverse Holdings category relates to the environmental category. This includes 3,968 acres of land in Collinsville, California where the Montezuma Wetlands dredge disposal project is to be located and 676 acres of land in Riverside, California where the best use has been determined to be a wind farm.\nProperty Sales\nHistorically, the Company has sold land from the Diverse Holdings category to cover some of the costs associated with pre-development, operating and holding the Company's substantial real estate assets and paying preferred stock dividends. Sales included mountain, desert, agricultural and other non- strategic lands, as well as lands that the Company feels might be developable in the future. Despite the change of emphasis from sales to recurring revenue, asset sales are an important ingredient in an overall growth strategy. The Company owns many assets which should be sold and the proceeds strategically redeployed. Ideally, however, these sales will be made for strategic purposes, not to meet the Company's cash flow requirements.\nThird Party Management\nThe Company also functions as the exclusive agent for the management and sale of non-operating railroad properties (approximately 26,000 acres) owned by the Atchison, Topeka & Santa Fe Railway Company (ATSF). A wholly-owned subsidiary of the Company has been established for this function. This subsidiary had 33 employees (immediately following the workforce reduction referred to under \"Employees\"). Fees of $4.2 million, $4.8 million and $5.7 million were earned in 1994, 1993 and 1992, under this agreement. This agreement was renegotiated and extended in 1994 and is subject to termination by either party on 180 days notice. The earliest possible termination date is December 31, 1995.\nENVIRONMENTAL MATTERS\nVarious federal, state and local laws and regulations covering the discharge of materials into the environment, or otherwise relating to the protection of the environment, may affect the Company's operations and costs. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -Environmental Matters.\" Such regulations can increase the cost of planning, designing, developing, managing and maintaining the Company's properties. The Company has expended and will continue to expend significant financial and managerial resources to comply with environmental regulations and local permitting requirements. While the Company or outside consultants have evaluated the environmental liabilities associated with most of the Company's properties, any evaluation necessarily is based upon then prevailing law and identified site conditions. In addition,\nmany of the Company's properties are in the early stages of development and the environmental studies and investigations which have been performed are preliminary. It is possible that significant unknown costs and liabilities may arise in the future relating to these properties and that certain development projects may be significantly delayed, modified or cancelled as a result of associated remediation costs. In addition, other properties presently or formerly owned by the Company or its corporate predecessors have required or may require remediation. Although there can be no assurance, the Company does not believe that such costs will have a material adverse effect on its business, financial condition or results of operations.\nThe Company has been or may be named a defendant or a potentially responsible party (\"PRP\") under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended (\"CERCLA\"), or analogous state statutes. At the Marina Bay site in the City of Richmond, the Company has been sued by the City of Richmond and others in a CERCLA cost recovery action. This action is more fully described in Item 3 \"Legal Proceedings\". With respect to a site in Livermore, California, the Regional Water Quality Control Board has issued a Tentative Site Cleanup Order naming the Company as one of 11 responsible parties. In February 1994, the Company reached a settlement with plaintiffs and all of the other potentially responsible parties pursuant to which the Company paid $67,650 into a fund covering certain past and future remediation costs in exchange for a qualified release of liability. The Company has been named a PRP with respect to several additional sites. Remediation of those sites has been completed by the Company or is being completed by third parties at their expense. The Company does not expect to incur material additional costs with respect to those sites.\nCOMPETITION\nReal estate markets are regional, and levels of competition vary by market. The Company encounters significant competition for leasing and sales of real estate in each of its market areas, but no one competitor is dominant. The Company is not dependent on any one customer for a significant portion of its revenues.\nEMPLOYEES\nIn September 1994, the Company began a major redesign of its organization and operations. This effort has resulted in a substantial reduction in staffing. The Company reduced its workforce by over 40% (89 employees) between September 15, 1994 and February 28, 1995.\nIn November 1994, the Company announced a restructuring and workforce reduction resulting in a significant reduction in employees as of January 1, 1995. Prior to the workforce reduction, as of December 31, 1994 the Company had 205 employees, including 39 employees of the Company's management subsidiary which manages certain ATSF properties. Immediately following the effective date of the workforce reduction the Company had 129 employees, including 33 employees of the management subsidiary.\nThe Company engages third parties to manage properties in locations which are not in close proximity to the Company's regional or field offices. In addition, the Company engages outside consultants such as architects and design firms in connection with its pre-development activities. The Company also employs third party contractors on development projects for infrastructure and building construction.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nCatellus' principal executive office is located in San Francisco, and it has regional or field offices in five other locations in the United States. Catellus believes that its property and equipment are generally well maintained, in good condition and adequate for its present needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCatellus, its subsidiaries and other related companies are named defendants in several lawsuits arising from normal business activities, are named parties in certain governmental proceedings (including environmental actions) and are the subject of various environmental remediation orders of local governmental agencies arising in the ordinary course of its business. The matters described below may involve substantial claims for damages. While the outcome of these lawsuits or other proceedings against the Company and the cost of compliance with any governmental order cannot be predicted with certainty, management does not expect any of these matters to have a material adverse effect on the business or financial condition of the Company.\nCity of Richmond, et al. v. United States of America, et al. (United States ------------------------------------------------------------ District Court, Northern District of California; filed August 1989) is an action brought by the City of Richmond and Richmond Redevelopment Agency (collectively, \"Richmond\") and various developers against the Company and others, claiming that property, formerly Richmond Shipyard Number 2, purchased by Richmond in 1977 from the Company's predecessor, Santa Fe Land Improvement Company, is contaminated. The United States and United States Maritime Administration are also named defendants. By third-party complaint, the Company has sued Kaiser Aluminum & Chemical Corporation (\"Kaiser\") and James L. Ferry & Son, Inc. (\"Ferry\") for indemnity.\nThe plaintiffs seek damages exceeding $48.6 million for environmental response costs, natural resources damages and declaratory relief under CERCLA, compensatory damages under state law theories of nuisance, trespass, negligence and strict liability, compensatory and punitive damages for alleged fraudulent concealment and indemnity, and also seek declaratory relief. The plaintiffs estimate that their environmental response costs will total approximately $16 million.\nEvidence to date indicates that the contamination at the property was the result of World War II shipbuilding operations by Kaiser between approximately 1941 and 1945. As the owner of the property at that time, the Company is a PRP under CERCLA, as is Kaiser, the tenant and operator on the property. The United States also may be considered a PRP inasmuch as Kaiser's wartime operations on the property were apparently controlled by the government. Richmond and the plaintiff developers are PRPs because they currently own and operate the property, and Ferry, a Richmond dredging contractor, may be considered a PRP because it was responsible for spreading contaminated soils on the site.\nThe Company has substantial defenses to state common law claims, including the fraudulent concealment claim, and also believes that it has substantial contribution and indemnity claims against Kaiser and Ferry. In addition, the Company instituted an action against its insurers and insurers of the Company's former tenants to recover certain costs. The Company has recorded a liability for potential reimbursement of the plaintiffs' clean-up costs for this site, but has deferred part of this amount because the Company believes it is probable that it will recoup from prior tenants, operators and\/or insurers substantially all of payments the Company might make.\nThe California Environmental Protection Agency's Department of Toxic Substances Control has issued a remedial action plan regarding the clean-up activities at this property. The plan contains a preliminary non-binding allocation of responsibility allocating an 11% share to the Company.\nIn 1994, the plaintiffs reached a settlement agreement with the United States pursuant to which the United States agreed to pay $3.6 million plus 35% of future cleanup costs. Settlement discussions between the plaintiffs and the Company are ongoing.\nThe settlement between plaintiffs and the United States has been approved by the Court. As a result, the Company's CERCLA contribution claims against the United States are barred and have been dismissed. However, the Company estimates that it will recoup all or some portion of its costs and damages through its contribution and indemnity claims against Kaiser and Ferry, and from potential insurance carriers. It is not possible now to predict reliably the amount of the Company's recovery.\nThe Company tendered defense of this action to its insurer, Employers Casualty Insurance Company (Employers). However, on January 6, 1994, Employers was placed into receivership. The Company, Employers and its receiver entered into a settlement agreement pursuant to which the Company has received $300,000 and the receiver and Employers stipulate that the Company has a valid claim for an additional $700,000 for past defense costs against Employers' assets in the receivership. The agreement is subject to receivership court approval. The Company does not know the extent of other claims which will be made against the assets in receivership or the extent of the assets which will be available to satisfy such claims. Therefore, the Company does not know how much, if any, of the $700,000 or future defense costs will be paid out of the assets in receivership.\nEfforts are being made to recover additional sums from other insurers, including those who provided excess coverage and insurers who issued policies to the Company's former tenants. As of March 16, 1995, agreements have been reached with several insurers pursuant to which the Company will receive approximately $1.4 million. It is not clear at this time how much additional monies will be obtained.\nThe Atchison, Topeka & Santa Fe Railway Co. v. The Testate and Intestate ------------------------------------------------------------------------ Successors of Grace Richards, et al. (Superior Court of California, County of ------------------------------------ San Diego; filed May 1983) and Herbert Lincoln Hubbard, et al. v. The Atchison, ------------------------------------------------ Topeka & Santa Fe Railway Company, Santa Fe Land Improvement Company, et al. ---------------------------------------------------------------------------- (Superior Court of California, County of San Diego; filed January 1988) are consolidated cases in which both the Company and the litigants claim title to a 550 foot by 75 foot strip of property located on and along the Santa Fe Depot site in downtown San Diego. The opposing litigants also seek damages for alleged fraud, interference with prospective economic advantage, and inverse condemnation. The trial court ruled that the Company and some of the opposing litigants each own an undivided one-half fee interest in the property, subject to a perpetual railroad easement in favor of The Atchison, Topeka & Santa Fe Railway Company. The trial court also rejected all of the opposing litigants' damage claims. The Company has appealed the portion of the trial court's judgment granting the opposing litigants a one-half undivided fee interest in the property and the opposing litigants have appealed all other aspects of the judgment. The cases are awaiting oral argument before the California Court of Appeals.\nKhachaturian v. Catellus Development Corporation, et al. (Superior Court of -------------------------------------------------------- California, County of Alameda; filed April 1991) is an action by an auto dealer who contracted to purchase land from the Company in an auto mall in Fremont, California, in June 1990. The complaint alleged the Company had reneged on an oral agreement to pay the plaintiff a 3% commission on each land transaction in the auto mall, and stated breach of contract, fraud, false promise, bad faith denial of contract, and quantum meruit causes of action. The Company asserted, among other things, that no such agreement existed and that it denied plaintiff's claim in good faith and with probable cause.\nIn November 1993, a jury found for plaintiff on his breach of contract and bad faith denial claims, awarding him $441,780.87 in damages and $7.7 million in punitive damages. The Company believes these verdicts are not supported by the evidence or the law, and that numerous errors at trial substantially prejudiced it. The Company filed its notice of appeal on February 3, 1994. Briefing will be completed in early 1995 and a hearing on the appeal is expected during 1995.\nTruck Insurance Exchange v. City of Ontario, et al. (Superior Court of --------------------------------------------------- California, San Bernardino County, Case No. RCY050056) involves a subrogation claim by insurance companies for the Ontario Auto Center dealerships against adjacent property owners, including the Company, for damages of approximately $4.5 million caused by sand blowing onto auto dealers' properties. As described above, the Company's insurer in this matter, Employers, has filed for receivership. At this time, the Company is unable to ascertain what impact, if any, the receivership will have upon the Company's coverage for indemnification and defense costs in this matter.\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.\nEXECUTIVE OFFICERS OF THE COMPANY ---------------------------------\nThe following persons are the executive officers of Catellus.\nAdditional information concerning the business background of each executive officer of Catellus is set forth below:\nMr. Rising has served as President and Chief Executive Officer and a Director of Catellus since September 1994. For more than five years prior to joining Catellus, Mr. Rising was a Senior Partner of Maguire Thomas Partners, a Los Angeles-based commercial developer with projects in Southern California, Dallas and Philadelphia.\nMr. Beaudin was elected Vice President Property Operations in February 1995. For more than five years prior to that, Mr. Beaudin served as Senior Vice President - Managing Officer of Financial Services at CB Commercial Real Estate Group, a national real estate brokerage firm.\nMr. Bender was elected Vice President Development in April 1990. Mr. Bender joined Catellus as Director of Development in July 1989. For more than five years prior to such time, he served as Vice President Development of Fifield Development Corporation, a Chicago-based real estate development firm.\nMr. Gwin was elected Vice President Development in June 1988. From January 1985 through May 1988, Mr. Gwin served as a Regional Director of Catellus.\nMr. Matheson was elected Vice President Sales and Land Management in April 1990. Mr. Matheson served as Catellus' Director of Sales & Land Management from July 1989; Regional Manager, Property Sales from November 1986; and Director of Outlying Lands from January 1985.\nMr. Parker was elected Vice President Bay Area Development in March 1995. From January 1994 to March 1995, Mr. Parker was the Executive Director of the Alameda Reuse and Redevelopment Authority for the conversion of the naval air station. For more than five years prior to that, Mr. Parker was a partner and project director of the Marina Village Mixed-Use Community in Alameda, California.\nMr. Stimpson was elected Vice President Finance in February 1992. Mr. Stimpson served as Assistant Vice President Finance from February 1990; Director of Finance and Planning from June 1988; and Director of Planning from February 1986.\nMs. Sullivan was elected Vice President Law, General Counsel and Secretary in March 1990. For five years prior to that, Ms. Sullivan was a partner in the real estate department of the law firm of Brobeck, Phleger and Harrison.\nMr. Tanner was elected Vice President Development in February 1992. Mr. Tanner served as Director of Development from September 1989 to February 1992. From March 1988 through August 1989, he was Vice President of Cal Fed Enterprises, a real estate subsidiary of Cal Fed, Inc.\nMr. Perna joined Catellus as Controller in March 1990. He had served as Director of Internal Audit for SFP from 1988 to 1990.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock commenced trading on December 5, 1990 and is traded on the New York Stock Exchange, the Chicago Stock Exchange and the Pacific Stock Exchange under the symbol \"CDX.\" The following table sets forth the high and low sale prices of the common stock, as reported on the New York Stock Exchange Composite Tape, during the periods indicated.\nNo cash dividends have been paid on the Company's common stock and the Company does not anticipate paying any cash dividends on its common stock in the foreseeable future. The most restrictive of the Company's loan agreements limit dividends to $27.6 million per year.\nAt March 1, 1995, there were approximately 59,603 holders of record of the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe following selected income statement and balance sheet data with respect to each of the years in the five-year period ended December 31, 1994 have been derived from the annual Consolidated Financial Statements. The operating and cash flow data have been derived from the Company's underlying financial and management records and are unaudited. This information should be read in conjunction with the Consolidated Financial Statements and related Notes thereto. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for a discussion of results of operations for 1994, 1993 and 1992.\n-----------------\n(1) Net income in 1993 reflects extraordinary expense relating to a redemption premium paid to a lender and write-off of deferred financing costs on the Company's $388.2 million first mortgage loan. (2) Per share amounts are computed by dividing the appropriate amounts by the average number of shares of common stock outstanding during the period, after giving retroactive effect to the share issuance and recapitalization effected in connection with the distribution referred to in Note 3 to the Consolidated Financial Statements. (3) Current value basis balance sheet data has been presented at December 31 of each year to provide supplemental information about management's estimates of financial position; current value is not intended to represent net realizable value or market value taken as a whole. See Item 1 of this report and Note 2 to the Consolidated Financial Statements. (4) Includes all buildings in the Company's portfolio, including those under construction. Leased percentage excluding buildings under construction would have been 94.8%, 93.6%, 90.9%, 85.1% and 81.2%, respectively.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCOMPANY STRATEGIES\nIn September 1994, the Company began a major redesign of its organization and operations. This effort has resulted in a substantial reduction in staffing. The Company reduced its workforce by over 40% (89 employees) between September 15, 1994 and February 28, 1995. In November 1994, the Company announced a major restructuring which consists of three initiatives: Reorganization, Decentralization and a focus on Recurring Revenue to improve the Company's long-term cash position.\nReorganization - The November 1994 restructuring resulted in a workforce reduction of 76 employees (from 209 to 133) out of the total staffing reduction noted above. Management believes these reductions, when combined with cost savings from moving the corporate headquarters to a smaller, less expensive facility and other cost-reduction measures, will result in projected annual savings of approximately $10 million. These restructuring activities resulted in a $3.1 million non-recurring operating expense in 1994. Substantially all of the restructuring charges will result in cash outlays. As of December 31, 1994, $.7 million of the restructuring charges had been paid, with the remainder to be paid over the following nine months.\nDecentralization - The Company is being organized along specific customer- oriented product groups rather than by general functional areas. The business functions - developing, leasing, selling and managing - will be concentrated and focused within each of the product groups - industrial, retail, office and land development. This new, customer-oriented organization will make Catellus more competitive because each group will be staffed by professionals who understand and serve the needs of the end users of our products.\nRecurring Revenue - Generating recurring revenue, rather than selling assets to balance cash flows, is an integral part of the Company's restructuring plan. The following mechanisms will be employed: exchanging non-revenue-producing assets for those which produce revenue; entering into long-term land leases of developable land rather than selling land; maximizing interim uses of land; generating additional development and management fee income; and increasing the net cash flow from existing income-producing assets. A combination of these activities and the reduction of overhead expenditures can lead Catellus to a position where it no longer needs to sell its assets to meet cash flow needs.\nDespite the change of emphasis from sales to recurring revenue, asset sales are an important ingredient in an overall growth strategy. The Company owns many assets which should be sold and the proceeds strategically redeployed. Ideally, however, these sales will be made for strategic purposes, not to meet the Company's cash flow requirements.\nLIQUIDITY AND CAPITAL RESOURCES\nHistorically, the aggregate costs associated with pre-development, operating and holding the Company's substantial real estate assets and paying preferred stock dividends have exceeded the revenue from property operations, development and other recurring sources. In the following table, cash flow from operating activities, as presented under generally accepted accounting principles, is adjusted (a) to remove the impact of property sales, (b) to include certain fixed charges associated with the Company's operations, (c) to include distributions from joint ventures and (d) to include net cash expended for capital improvements to the Company's properties. This results in an amount representing cash flow before sales and after fixed charges and capital expenditures. The Company believes that the presentation of the data set forth in the table below, which for 1993 and 1992 has been previously supplied in all material respects in prior Company reports, provides a helpful summary of its historical cash flows.\nThe Company has relied primarily on proceeds from property sales to meet the cash flow shortfalls in the table above. Proceeds from sales of properties, net of required debt paydowns, totalled $35.3 million in 1994, $48 million in 1993 and $59.3 million in 1992. Remaining cash shortfall amounts have been met through use of available cash.\nIn order to meet future cash flow requirements, the Company intends to shift its focus from the sale of assets to generating recurring revenue. This can be accomplished in a variety of ways, including exchanging non-revenue- producing assets for those which produce revenue; entering into long-term land leases of developable land rather than selling land; maximizing interim uses of land; generating additional development and management fee income; and increasing the net cash flow from existing income producing properties. A combination of these activities and the reduction of overhead costs (approximately $10 million) expected to be realized in connection with the reorganization described above can lead Catellus to a position where the need to sell property to meet cash flow requirements will be reduced over time. The Company currently anticipates net cash flow from property sales in the range of $25 to $50 million during 1995 in order to meet expected cash flow needs.\nHistorically, shortfall amounts could have been reduced by limiting capital expenditures, and such a strategy could be employed in the future if necessary. In addition, as the Company puts into place its programs to reduce reliance on sales to meet cash flow needs, the capital resources available to the Company include over $200 million in non-strategic assets available for sale, as well as cash balances and working capital line availability.\nCash flow from operating activities\nCash provided by operating activities reflected in the statement of cash flows in 1994, 1993 and 1992 was $51.1 million, $26.6 million and $51.6 million. The increase in 1994 is primarily attributable to a decrease in interest costs from refinancing of the Company's debt, and the decrease in 1993 resulted primarily from a reduction in cash generated from land sales partially offset by an increase in cash from rental operations.\nCash generated from sales of land was $21.5 million, $17.8 million and $43.4 million in 1994, 1993 and 1992. Cash generated from rental operations increased principally because of higher occupancy from existing buildings. At December 31, 1994, the Company's total building portfolio was 94.8% leased compared to 93.6% and 90.9% at December 31, 1993 and 1992. For the five years from 1995 through 1999, leases for 13.9%, 19.7%, 13.0%, 8.1%, and 8.4% of total square footage are scheduled to expire.\nCash flow from investing activities\nNet cash flow from investing activities reflected in the statement of cash flows decreased $65.4 million from 1993 to 1994 and increased $40.6 million from 1992 to 1993. The decrease in 1994 is primarily attributable to the investment of cash into short-term commercial paper and government securities, a reduction in proceeds from sales of operating properties and an increase in capital expenditures. The increase in 1993 resulted primarily from a reduction in capital expenditures and an increase in proceeds from sales of operating properties. Net cash used for investing activities included capital expenditures totalling $73.9 million, $61.1 million and $87.9 million in 1994, 1993 and 1992; such amounts include capitalized interest and property taxes totalling $26.5 million, $28.2 million and $32.6 million, respectively.\nCash flow from financing activities\nNet cash used by financing activities reflected in the statement of cash flows in 1994 was $100.4 million; net cash provided by financing activities in 1993 and 1992 was $120.2 million and $7.7 million. These amounts reflect borrowing and repayment activity relating to operating properties (including principal amortization), capital expenditures and general corporate purposes. The 1994 and 1993 amounts reflect principally the net proceeds from the Series A and B preferred stock offerings, and the use of a part of those proceeds to repay debt, as described below. In 1994, the Company also closed $9 million of mortgage loans and a $12.2 million secured term loan for previously financed projects. Proceeds from these loans were used to repay construction loans. The Company also closed construction loans totalling $2.2 million.\nAt December 31, 1994, the Company had total outstanding debt of $530.6 million, of which 75% was non-recourse to the Company and secured by the underlying property only, 21% was recourse to the Company and also secured by underlying property, and 4% was unsecured. During the next twelve months, $78.1 million of debt matures; 88% of this amount is construction financing or intermediate term loans, which are expected to be extended, refinanced and converted into permanent loans or repaid.\nRefinancing of Prudential Mortgage Loan\nIn February 1994, the Company refinanced its $388.2 million mortgage loan from The Prudential Insurance Company of America with cash generated from the issuance of preferred stock and a $280 million mortgage loan due March 1, 2004. In connection with this refinancing, the Company also paid down $10 million of another mortgage loan from Prudential due January 1, 1996, and incurred an extraordinary expense of $11.9 million ($7.4 million, net of income tax benefits). This extraordinary expense consisted of a $10 million redemption premium paid to Prudential and the write-off of deferred financing costs associated with the $388.2 million loan. The reduced interest resulting from the above debt paydowns, as well as other debt paydowns in 1993 and 1994, was partially offset by the increased dividend requirements of the preferred stock sold in 1993.\nConversion of Debenture and issuance of Series A and Series B Preferred Stock\nIn February 1993, the Company restructured a portion of its debt. At that time, Bay Area Real Estate Investment Associates L.P. (BAREIA) converted a debenture (which then had an accreted balance of $111.4 million) into common stock with a value of $141 million. At the same time, the Company issued 3,449,999 shares of Series A preferred stock for $172.5 million. BAREIA purchased 40.7% of the issuance, the same percentage as its common stock ownership.\nThe net proceeds of $164.4 million were used to repay $69 million of an unsecured revolving credit facility and to invest $50 million in securities held for the refinancing of the Company's $388.2 million mortgage loan, with the remainder invested in short-term marketable securities to be used to repay debt and for general corporate purposes.\nIn November 1993, the Company completed a private placement of 3,000,000 shares of Series B preferred stock for $150 million. The net proceeds of $143.5 million were used to repay $24 million of an unsecured term facility, with the remainder being used to repay debt that matures through 1997, and for general corporate purposes.\nDebt covenants\nCertain of the Company's loan agreements contain restrictive financial covenants and several agreements are cross-defaulted. The most restrictive dividend and debt covenants limit annual dividends to $27.6 million and total debt to $1.9 billion. The most restrictive equity covenants require stockholders' equity on a current value basis to be no less than $800 million and on a historical cost basis to be no less than $475 million. The Company has substantial excess value, or a cushion, under the current value covenant. As it appeared that the historical cost covenant would not be met as of the end of 1994, the Company sought and obtained an amendment, effective December 31, 1994, to the most restrictive covenant changing the stockholders' equity requirement from $508 million to $475 million. As a result, as of December 31, 1994, the Company had a cushion of $24.7 million under that covenant.\nCash balances and available borrowings\nAt December 31, 1994, cash, restricted cash and short-term investments totalled $52 million. In addition, the Company had available $72.9 million under its working capital facility, $10.7 million under its construction facilities (excluding amounts available under the construction facility entered into in January 1995 as described below), and $1.1 million under its secured term loan facilities.\nIn January 1995, the Company entered into an $85 million revolving construction line of credit. This credit facility renews and increases a $75.5 million credit line. A new feature enables the Company to use the funds to develop projects on either owned land or land to be acquired from third parties.\nThe Company's working capital facility has been extended to April 30, 1995. The Company currently is in discussions with its lenders regarding the renewal of the facility and believes it will be able to maintain, on acceptable terms, the financing required for its operations. If the facility is not renewed, the Company will be able to borrow up to $66 million and the facility would convert to a 32-month secured term loan.\nThe Company reported a net loss applicable to common stockholders for the second consecutive year. The Company's future ability to generate necessary capital resources to meet its needs will depend, in part, upon its ability to reverse these results and report positive results.\nRESULTS OF OPERATIONS\nThe table below identifies the components of gross profit on property sales and income from operating properties. Operating properties include not only income producing properties, but also holding costs on undeveloped land.\nComparison of 1994 to 1993\nDuring 1994 and 1993, the Company experienced several events that significantly impacted the financial results. The 1994 results included a $3.1 million restructuring charge and a $24.1 million write-down of certain properties where carrying costs exceeded estimated net realizable value. The 1993 events are described later.\nBefore the 1994 and 1993 charges described above, the Company had 1994 net income of $13.9 million, compared to 1993 net income of $10.7 million. Income before taxes was $23.4 million in 1994 compared to $17 million in 1993. The 1994 improvement was due to significantly reduced interest expense and improved results from the Company's joint ventures. Gross profit from property sales, however, was lower due to the Company's decision to retain certain assets that have recurring revenue potential. Income from operating properties decreased slightly.\nThe decrease in gross profit from property sales, shown in the table above, resulted from both lower sales and higher cost basis in properties sold. Property sales in 1994 included $28.2 million from sales of buildings and land leases, which generated gross profit of $3.2 million, and land sales of $25.6 million which generated gross profit of $10.2 million. For 1993, sales and gross profit for buildings and land leases were $46.9 million and $23.3 million; land sales of $25.7 million generated gross profit of $9.9 million.\nIncome from operating properties, shown in the table above, decreased only 1% from 1993, despite the sale of several buildings and land leases in late 1993 and in 1994. Excluding the negative impact of these sales, income from rental operations increased $4.5 million over 1993 due to both higher rental revenue and lower expenses. Nearly 60% of the growth in rental revenue came from existing properties, with the remainder coming from buildings completed in 1994. The increase from existing buildings was primarily the result of higher occupancy.\nEquity in earnings of joint ventures increased significantly in 1994 as a result of property sales by one joint venture and greatly improved operating results of another. Other revenue was higher because of the favorable settlement of two environmental matters. The increase in general and administrative expenses was caused by\nexecutive severance and search costs, as well as increased use of outside professional services. Interest expense decreased principally because of the refinancing of the Prudential loan at a lower interest rate, as well as paydown of other loans and the conversion of the debenture.\nComparison of 1993 to 1992\nDuring 1993, the Company experienced several events that significantly impacted the financial results. The 1993 results included a $29.6 million charge for the conversion of the convertible debenture into common stock, an $11.9 million extraordinary expense in connection with the Prudential refinancing, an $8.3 million reserve for a litigation award, and a $32.5 million write-down of certain properties where carrying costs exceeded estimated net realizable value. Finally, as required under current accounting guidance, the Company increased its tax expense by $3 million as a result of legislation increasing the federal corporate tax rate from 34% to 35% effective January 1, 1993.\nBefore the charges described above, the Company had 1993 net income of $10.7 million, compared to 1992 net income of $1.2 million. Income before taxes was $17 million (before the charges described above) in 1993 compared to $2.4 million in 1992.\nThe significant improvement in 1993 was due to a combination of factors. Income from operating properties increased, interest income increased from investment of the cash proceeds from equity offerings, and interest expense decreased from conversion of the debenture and repayment of debt. This was partially offset by lower gross profit from property sales.\nThe decrease in gross profit from property sales, shown in the table above, resulted from a combination of lower sales and higher cost basis in properties sold. Property sales in 1993 included $46.9 million from sales of buildings and land leases, which generated gross profit of $23.3 million; land sales generated sales of $25.7 million and gross profit $9.9 million. For 1992, gross profit included $14.9 million from the sale of buildings and land leases, a $6.4 million loss on the sale of a joint venture interest, and gross profit of $31.8 million on land sales.\nIncome from operating properties, shown in the table above, increased 18% due to higher rental revenue coupled with only a slight increase in operating expenses. Nearly 85% of the growth in rental revenue came from existing properties, with the remainder coming from buildings completed in 1993. Over 80% of the increase in rental revenue from existing buildings was the result of higher occupancy and the remainder from higher rental rates.\nThe increase in interest income resulted from the investment of the net proceeds of the preferred stock issuances. The increase in equity in earnings of joint ventures in 1993 was caused primarily by the suspension of recording losses incurred by Pacific Design Center. This began when the Company's interest in cumulative losses of that joint venture exceeded its original investment plus its interest in cumulative earnings. The equity in earnings of joint ventures was also affected by the 1992 sale of the Company's interest in a joint venture in a San Francisco office building. The Company's other joint ventures, as a group, showed an overall improvement in operating results compared to 1992. Interest expense decreased as a result of the conversion of the debenture as well as paydowns on the working capital facility. This decrease, however, was partially offset by other borrowings and by reduced capitalized interest due mainly to decreased construction activity.\nIncome Taxes\nAt December 31, 1994, the Company's deferred tax liability consisted of deferred tax assets totalling $97 million and deferred tax liabilities of $209 million. Deferred tax assets included $17 million relating to net operating loss carryforwards (NOLs) of $21.3 million, $16.9 million, $6.5 million and $.3 million, which expire in 2006, 2007, 2008 and 2009, respectively. The Company's other deferred tax assets of $80 million relate primarily to differences between book and tax basis of properties. These deferred tax assets are not subject to expiration and will be realized at the time of taxable dispositions of the properties. Deferred tax liabilities in excess of deferred tax\nassets are often associated with the same property, with the result that the deferred tax asset will be realized in a taxable disposition, without regard to other taxable income. The Company believes it is more likely than not that it will realize the benefit of its deferred tax assets, and that no valuation allowance is required. In making this determination, the Company considered: the nature of its deferred tax assets (and liabilities); the amounts and expiration dates of its NOLs; the historical levels of taxable income; the significant unrealized appreciation of its properties, including surplus properties likely to be sold during the NOL carryforward periods; and its ability to control the timing of property sales in order to assure that deferred tax assets will be offset by deferred tax liabilities or realized appreciation.\nENVIRONMENTAL MATTERS\nMany of the Company's properties are in urban and industrial areas and may have been leased to commercial or industrial tenants who may have discharged hazardous materials. From 1992 to 1994, expensed and capitalized environmental costs, including legal fees, totalled $19.8 million. The Company expects to spend $4.5 million for such costs in 1995. These costs may increase as the Company develops its major projects.\nFuture environmental costs are difficult to estimate with certainty. The Company and outside consultants have evaluated the environmental liabilities associated with most of the Company's properties, however any evaluation necessarily is based on the prevailing law and identified site conditions at that time. Although the Company closely monitors its environmental costs, the size of the portfolio precludes extensive review of every property on a regular basis.\nEnvironmental costs incurred in connection with operating properties and properties previously sold are expensed. At December 31, 1994, the Company's estimate of its potential liability for identified environmental costs ranged from $2.9 million to $29.8 million for properties where costs would be charged to operations. These costs are expected to be incurred over an estimated ten- year period, with a substantial portion incurred over the next five years. Costs relating to undeveloped properties are capitalized as part of development costs. At December 31, 1994, the Company's estimate of its potential liability for identified environmental costs relating to developable properties ranged from $17.6 million to $63.4 million. These costs generally will be capitalized as they are incurred, over the course of the estimated development period of approximately 20 years.\nThe Company maintains a reserve for the known, probable costs of environmental remediation to be incurred in connection with operating properties and properties previously sold. Although an unexpected event could have a material impact on the results of operations for any period, the Company does not believe that such costs for identified liabilities will have a material adverse effect on its financial condition. See Note 4 to the Consolidated Financial Statements.\nSUPPLEMENTAL CURRENT VALUE\nThe Company annually provides a current value balance sheet in addition to historical cost financial statements. Management believes current value provides meaningful information regarding the financial condition and the value of its properties in today's real estate market.\nAt December 31, 1994, stockholders' equity on a current value basis was $1.02 billion or $9.62 per share, compared to $1 billion or $9.31 per share at December 31, 1993. Assuming conversion of all Series A and B preferred stock in each year, stockholders' equity per share on a current value basis would have been $9.55 at December 31, 1994 and would have been anti-dilutive at December 31, 1993.\nAt December 31, 1994, the current value of the Company's real estate properties was $1.827 billion, compared to $1.756 billion in 1993, an increase of $71 million. The table below identifies the components of this increase (in millions):\nRevaluation of properties and improvements held at beginning and end of year $128\nProperties sold (57) ---- Change from December 31, 1993 $ 71 ====\nIncreases in the current value of properties held at the beginning and end of the year are primarily due to operating properties, including new buildings and joint ventures.\nThe current value of the Company's existing building portfolio increased $48 million (9.0%) reflecting improving market conditions. New or soon-to-be completed buildings accounted for an increase of $25 million. The current value of the Company's joint venture interests increased $29 million or 58%, due primarily to significantly improved operating results and lower debt levels at the joint venture level. Finally, values of other properties increased $26 million\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and schedules required under Regulation S-X promulgated under the Securities Act of 1933 are identified in Item 14 and are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nExcept for the information relating to the executive officers of the Company set forth in Part I of this Annual Report on Form 10-K, the information required by the following items will be included in the Company's definitive Proxy Statement (\"1995 Proxy Statement\") which will be filed with the Securities and Exchange Commission in connection with the 1995 Annual Meeting of Stockholders.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information in the section captioned \"Election of Directors\" in the 1995 Proxy Statement is incorporated herein by reference.\nThe information in the section captioned \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the 1995 Proxy Statement is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information in the sections captioned \"Election of Directors-- Directors' Compensation,\" \"Employment and Severance Agreements\" and \"Compensation of Executive Officers\" included 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 in the sections captioned \"Security Ownership of Directors, Nominees and Executive Officers\" and \"Security Ownership of Certain Beneficial Owners\" in the 1995 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information in the section captioned \"Certain Transactions\" 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\n(A)(1) AND (A)(2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nSee Index to Financial Statements and Financial Statement Schedules at herein.\nAll other Schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(A)(3) EXHIBITS\nExhibit No. --------\n3.1 Form of Restated Certificate of Incorporation of the Registrant (1) 3.1A Amendment to Restated Certificate of Incorporation of the Registrant (9) 3.3 Form of Certificate of Designations, Preferences and Rights of $3.25 Series A Cumulative Convertible Preferred Stock (2) 3.4 By-Laws, as amended* 3.5 Form of Certificate of Designations, Preferences and Rights of $3.625 Series B Cumulative Convertible Exchangeable Preferred Stock (8) 4.1 Form of stock certificate representing Common Stock (1) 4.9 Form of stock certificate representing $3.75 Series A Cumulative Convertible Preferred Stock (2) 4.10 Form of stock certificate representing $3.625 Series B Cumulative Convertible Exchangeable Preferred Stock (9) 4.11 Loan Agreement dated as of February 16, 1994 between the Registrant and The Prudential Insurance Company of America (10) 10.1 Exploration Agreement and Option to Lease dated December 28, 1989 between the Registrant and Santa Fe Pacific Minerals Corporation (1) 10.3 Long-Term Stockholders Agreement dated as of December 29, 1989 among the Registrant, Bay Area Real Estate Investment Associates L.P. (\"BAREIA\"), Olympia & York SF Holdings Corporation (\"O&Y\") and Itel Corporation (\"Itel\") (1) 10.4 Registration Rights Agreement dated as of December 29, 1989 among the Registrant, BAREIA, O&Y and Itel (1) 10.6 Restated Tax Allocation and Indemnity Agreement dated December 29, 1989 among the Registrant and certain of its subsidiaries and Santa Fe Pacific Corporation (\"SFP\") (1) 10.7 State Tax Allocation and Indemnity Agreement dated December 29, 1989 among the Registrant and certain of its subsidiaries and SFP (1) 10.8 Executive Employment Agreement dated April 1, 1989 between Vernon B. Schwartz and the Registrant (4) 10.9 Registrant's Annual Performance Bonus Program (4) 10.13 Registrant's Incentive Stock Compensation Plan (4) 10.14 Management Agreement between ATSF and Catellus Management Corporation dated October 15, 1994* 10.15 Termination, Substitution and Guarantee Agreement between ATSF and the Registrant dated December 21, 1990 (5) 10.16 Registrant's Stock Option Plan (5) 10.17 Development Agreement dated April 1, 1991 between the Registrant and the San Francisco Board of Supervisors (6)\nExhibit No. Exhibits ------- --------\n10.21 Executive Stock Option Plan (3) 10.21A Amended and Restated Executive Stock Option Plan (9) 10.25 Agreement dated as of January 14, 1993 between the Registrant and BAREIA (7) 10.25A Amendment No. 1 to Agreement, dated as of January 14, 1993 between the Registrant and BAREIA* 10.26 Form of First Amendment to Registration Rights Agreement among the Registrant, BAREIA, O&Y and Itel (7) 10.27 Form of Stockholders Agreement among the Registrant, BAREIA, O&Y and Itel (7) 10.28 Agreement dated February 22, 1994 between the Registrant and Vernon B. Schwartz (9) 10.29 Executive Employment Agreement dated July 27, 1994 between the Registrant and Nelson C. Rising* 10.30 Executive Employment Agreement dated February 10, 1995 between the Registrant and Timothy J. Beaudin* 10.31 Stock Option Agreement dated July 27, 1994 between the Registrant and Joseph R. Seiger* 10.32 Special Severance Pay Plan and Summary Plan Description* 10.33 Form of Memorandum Regarding Reduction-In-Force Program* 10.34 Consulting Agreement dated December 23, 1994 between the Registrant and James G. O'Gara* 10.35 Memorandum of Understanding dated December 22, 1994, addressed to James W. Augustino* 10.36 Memorandum of Understanding dated December 19, 1994, addressed to Thomas W. Gille* 21.1 Subsidiaries of the Registrant* 23.1 Consent of Independent Accountants* 23.2 Consent of Independent Real Estate Appraisers* 24.1 Powers of Attorney from directors with respect to the filing of the Form 10-K* 27 Financial Data Schedule*\nThe Registrant has omitted instruments with respect to long-term debt where the total amount of the securities authorized thereunder does not exceed 10 percent of the assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant agrees to furnish a copy of such instrument to the Commission upon request.\n(b) Reports on Form 8-K\nNone.\n----------- * Filed with this report on Form 10-K.\n(1) Incorporated by reference to Exhibit of the same number of the Registration Statement on Form 10 (Commission File No. 0-18694) as filed with the Commission on July 18, 1990 (\"Form 10\"). (2) Incorporated by reference to Exhibit of the same number on the Form 8 constituting a Post-Effective Amendment No. 1 to the Form 8-A as filed with the Commission on February 19, 1993. (3) Incorporated by reference to Exhibit of the same number of Registration Statement on Form S-3 (Commission File No. 33-56082) as filed with the Commission on December 21, 1992 (\"Form S-3\"). (4) Incorporated by reference to Exhibit of the same number of the Form 8 constituting Post-Effective Amendment No. 1 to the Form 10 as filed with the Commission on November 20, 1990. (5) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1990. (6) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1990, referred to therein as \"Development Agreement dated February 19, 1991 between the Registrant and the San Francisco Board of Supervisors\". (7) Incorporated by reference to Exhibit of the same number of Amendment No. 2 to Form S-3 as filed with the Commission on February 4, 1993.\n(8) Incorporated by reference to Exhibit of the same number on the Form 10-Q for the quarter ended September 30, 1993. (9) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1993. (10) Incorporated by reference to Exhibit of the same number of Amendment No. 1 to the 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, Catellus Development Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCATELLUS DEVELOPMENT CORPORATION\nBy \/s\/ Nelson C. Rising ---------------------------------- Nelson C. Rising 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 Catellus Development Corporation and in the capacities and on the date indicated.\nSignature Title Date --------- ----- ----\n\/s\/ Nelson C. Rising President, Chief Executive March 30, 1995 ------------------------- Officer and Director Nelson C. Rising Principal Executive Officer\n\/s\/ Douglas B. Stimpson Vice President Finance March 30, 1995 ------------------------- Principal Financial Douglas B. Stimpson Officer\n\/s\/ David M. Perna Controller March 30, 1995 -------------------------- Principal Accounting David M. Perna Officer\nSignature Title Date --------- ----- ----\n* Director -------------------------- Joseph F. Alibrandi\n* Director -------------------------- Darla Totusek Flanagan\n* Director -------------------------- Gary M. Goodman\n* Director -------------------------- Robert D. Krebs\n* Director -------------------------- Judd D. Malkin\n* Chairman of the Board, -------------------------- Director Joseph R. Seiger\n* Director -------------------------- Jacqueline R. Slater\n* Director -------------------------- Thomas M. Steinberg\n* Director -------------------------- Tom C. Stickel\n* Director -------------------------- John E. Zuccotti\nBy \/s\/ David M. Perna ------------------------ David M. Perna March 30, 1995 Attorney-in-fact\nAND FINANCIAL STATEMENT SCHEDULES (ITEMS 14(A)(1) AND (A)(2)) -------------------------------------\n(A)(2) FINANCIAL STATEMENT SCHEDULES\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Catellus Development Corporation\nWe have audited the accompanying historical cost basis consolidated balance sheet of Catellus Development Corporation and its subsidiaries (the Company) as of December 31, 1994 and 1993, and the related historical cost basis consolidated statements of income, of stockholders' equity and of cash flows for each of the three years in the period ended December 31, 1994. We have also audited the supplemental current value basis consolidated balance sheet of the Company as of December 31, 1994 and 1993 and the related supplemental current value basis consolidated statement of changes in revaluation equity for the years ended December 31, 1994 and 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 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 historical cost basis consolidated financial statements referred to above present fairly, in all material respects, the financial position of Catellus Development 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.\nAs described in Note 2, the supplemental current value basis consolidated balance sheets have been prepared by management to present relevant financial information that is not provided by the historical cost basis financial statements and are not intended to be a presentation in conformity with generally accepted accounting principles. In addition, the supplemental current value basis consolidated balance sheets do not purport to present net realizable, liquidation, or market value of the Company as a whole.\nCurrent values of real estate are estimated by management in accordance with the procedures described in Note 2, which included receipt of an appraisers' concurrence report from Landauer Associates, Inc. We have tested the procedures used by management in arriving at their estimate of current value and have tested the underlying documentation. In the circumstances, we believe the procedures are reasonable and the documentation appropriate. Because of the subjectivity inherent in any estimate of current value of real estate, and because, generally, the Company's real estate assets are held for long-term operation and appreciation and thus are not presently for sale, amounts realized by the Company from the operation and ultimate disposition of real estate assets may vary significantly from the current values presented.\nIn our opinion, the supplemental consolidated current value basis financial statements referred to above present fairly, in all material respects, the information set forth therein on the basis of accounting described in Note 2.\n\/s\/ Price Waterhouse LLP ------------------------ Price Waterhouse LLP San Francisco, CA February 28, 1995\nREPORT OF INDEPENDENT REAL ESTATE APPRAISERS\nTo the Board of Directors and Stockholders of Catellus Development Corporation and Price Waterhouse LLP\nWe have reviewed the estimate of aggregate current value of the portfolio of real estate holdings of Catellus Development Corporation (the Company) as of December 31, 1994 and 1993. The property interests at December 31, 1994 include approximately 243 income producing buildings; 54 land lease positions; approximately 893,000 acres of undeveloped land; and 9 joint venture interests. The property interests were valued subject to tenants' leases, but before debt.\nThe aggregate current value of the interests, estimated by the Company as of December 31, 1994 and 1993, was $1,781,182,000 and $1,712,217,000, respectively. These totals represent the Company's estimate of the aggregate current value of the interests in the entire property portfolio and assume that the individual assets are marketable and would be disposed of in an orderly manner, allowing a sufficient time period for exposure of each property interest to potential purchasers. The current valuation of the portfolio has applied neither a premium nor a discount with regard to a bulk sale of the entire portfolio.\nBased upon our review, we concur with the Company's estimates of aggregate current value of the portfolio. By this we mean it is our opinion that the current value estimates by the Company are within ten percent (10%) of the aggregate value which we would estimate in a full and complete market value appraisal of the same interests. A variation of less than ten percent (10%) between appraisers implies substantial agreement as to the most probable current value of such property interests.\nThe data used in our review were supplied to us in summary form by the Company. We have had complete and unrestricted access to all underlying documents. We have relied upon the Company's interpretation and summaries of leases, operating agreements, estimate of environmental remediation costs, etc. During 1993 and 1994, we physically inspected Company properties with combined individual current value estimates representing approximately 80% of the aggregate current value estimate.\nWe certify that neither Landauer Associates, Inc. nor the undersigned have any present or prospective interest in the Company's properties, and we have no personal interest or bias with respect to the parties involved. To the best of our knowledge and belief, the facts upon which the analysis and conclusion were based are materially true and correct. No one other than the undersigned, assisted by members of our staff, performed the analyses and reached the conclusions resulting in the opinion expressed in this letter. Our fee for this assignment was not contingent on any action or event resulting from the analyses, opinions, or conclusions in, or the use of, this review.\nThis review has been prepared in conformity with the Code of Ethics and Standards of Professional Practice of the Appraisal Institute. As of the date of this letter, James C. Kafes has completed the requirements of the continuing education program of the Appraisal Institute.\nRespectfully submitted, Landauer Associates, Inc.\n\/s\/ James C. Kafes, MAI, CRE \/s\/ John F. Brengelman ---------------------------- ---------------------- James C. Kafes, MAI, CRE John F. Brengelman Managing Director Senior Vice President New York, NY February 27, 1995\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED BALANCE SHEET HISTORICAL COST BASIS AND SUPPLEMENTAL CURRENT VALUE BASIS (IN THOUSANDS, EXCEPT SHARE DATA)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF INCOME HISTORICAL COST BASIS (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF INCOME HISTORICAL COST BASIS (CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY HISTORICAL COST BASIS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF CASH FLOWS HISTORICAL COST BASIS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF CASH FLOWS HISTORICAL COST BASIS-(CONTINUED) (IN THOUSANDS)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nCONSOLIDATED STATEMENT OF CHANGES IN REVALUATION EQUITY - SUPPLEMENTAL CURRENT VALUE BASIS (IN THOUSANDS)\nSee notes to consolidated financial statements.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. DESCRIPTION OF BUSINESS\nHeadquartered in San Francisco, Catellus Development Corporation (the Company) is an owner, developer and manager of industrial, retail and office projects. These properties and the Company's other land holdings and joint venture interests are located in major markets in California and 11 other states. The Company develops and manages its operating properties which consist primarily of industrial facilities and a limited number of office and retail buildings located in California, Arizona, Illinois and Texas. The Company has substantial undeveloped land holdings primarily in California, Texas, New Mexico and Utah.\nNOTE 2. CURRENT VALUE PRESENTATION\nCurrent value reporting\nCurrent value basis consolidated balance sheets presented as of December 31, 1994 and 1993 provide supplemental information about the economic condition of the Company. Because of the low historical cost basis of the Company's real estate assets, management believes that the historical cost basis presentation used in customary financial statements does not reflect the true economic value of the Company's holdings. Current value reporting provides recognition that, over time, real property generally appreciates in value, and that value may be realized through the development process and effective management of income producing assets. It does not represent the net realizable value of the Company as a whole, nor does it contemplate liquidation or a distressed sale of the Company's assets. Management believes that current value information provides meaningful information regarding the Company's economic condition and the value of its holdings in today's real estate market.\nCurrent value accounting continues to represent an experimental approach; authoritative criteria have not been established for its preparation and presentation. As experimentation continues, preparation and presentation methods may be modified in future reporting periods.\nBasis of valuation\nThe following methods for estimating current value are based on management's best judgments regarding the economy, market trends and operating results. These factors cannot be precisely quantified and verified. As a result, estimates may change based on ongoing evaluation of future economic and market trends.\nBuildings-The Company estimates the current value of buildings using the discounted cash flow method. Operating cash flows were projected based on current lease terms and management's estimate of potential future rents, operating costs, tenant improvement costs, leasing commissions and structural repairs. Buildings were assumed sold after a ten year holding period. Sales prices were determined by capitalizing stabilized income in the year following sale at capitalization rates ranging from 9% to 14.5% in 1994 and 9% to 13% in 1993. Operating cash flows and cash from property sales were discounted back to the balance sheet date at discount rates ranging from 10% to 14% in 1994 and 1993.\nLand leases-The Company generally estimates the current value of land leases using the discounted cash flow method, where annual cash flows are projected based on existing lease agreements and management's estimate of future rents and operating costs. The underlying land was assumed sold at the expiration of the lease term and, where applicable, exhaustion of all renewal options. Land values were based on the direct sales comparison approach and were projected to increase at an annual rate of 3% through the date of sale. The projected cash flow for each lease together with the projected sales price, less estimated costs to ready the property for sale, were discounted back to the balance sheet date using a discount rate of 10% for both 1994 and 1993.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nJoint venture investments-Current values for investments in joint ventures represent the Company's proportionate equity in the underlying net assets of the ventures. The current values of assets and liabilities of joint ventures were based on methods and assumptions similar to those used to estimate the current values of similar assets and liabilities of the Company.\nUndeveloped land-Estimates of current value are made primarily using the direct sales comparison method. However, in cases where relevant comparable sales data is not available, current value is estimated using the residual land analysis method.\nUnder the direct sales comparison approach, recent sales of similar properties are used as a basis for estimating current value. Current value estimates for large contiguous parcels include a discount to reflect current market absorption rates for undeveloped land.\nUnder the residual land analysis approach, current value is derived based on anticipated future cash flows associated with the Company's intended development plan. Infrastructure costs, development costs (including costs to remediate known environmental contamination), operating cash flow and a residual sales amount are projected over an assumed period of development and operation. These amounts are discounted to the balance sheet date using a discount rate the Company believes is appropriate given the level of project risk.\nEnvironmental costs-Current values calculated using the above methods are adjusted to reflect the estimated costs to remediate known environmental contamination.\nEstimated disposition costs-Selling commissions and other estimated disposition costs have been provided at 2.5% of the current value of the Company's properties and joint venture investments.\nDeferred income taxes-Deferred income taxes on a current value basis represent the present value of estimated income tax payments based on projections of taxable income through the year 2028 for 1993 and 2029 for 1994. The differences between the current value and historical cost bases of the Company's properties should be realized over an extended, indefinite period of time through future operations or sales. The Company has no current intention of selling any significant portion of its operating properties and fully expects that current values will be realized through operations. The projections of taxable income are based on cash flow assumptions and include anticipated sales of currently owned properties, as well as projected investment in properties currently planned for development. The projections reflect deductions for anticipated depreciation on developed properties and other holding costs. The deferred tax calculations are based on the current provisions of the Internal Revenue Code. The discount rate used to compute the present value of income taxes is similar to the rate used to compute the current values of real estate assets which are the source of the taxable income.\nOther assets and liabilities-Certain deferred assets and liabilities have been excluded from the current value balance sheet because they are already considered in the current value of real estate assets or have no current value. The remaining amounts are carried in the current value balance sheet at historical costs which approximate current value. Assessment district debt in 1993 is reflected in the current values of related properties. As a result, current value has been reduced by this debt and no current value amount has been reflected in the caption \"mortgage and other debt.\" In 1994, such debt is not reflected in the current values of related properties, but instead is reflected separately in the caption \"mortgage and other debt\".\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nRevaluation equity-The difference between the current value basis and historical cost basis of the Company's assets and liabilities is reported as revaluation equity in the stockholders' equity section of the consolidated current value basis balance sheet. The components of revaluation equity at December 31, 1994 and 1993 are as follows (in thousands):\nNOTE 3. CAPITAL STRUCTURE\nPrior to December 29, 1989, the Company was wholly owned by Santa Fe Pacific Corporation (SFP). On December 29, 1989, the Company issued 19.9% of its common stock to Bay Area Real Estate Investment Associates L.P. (BAREIA) for $398 million cash. In connection with the stock issuance, BAREIA also purchased from the Company, at par, a $75 million convertible debenture (Debenture). BAREIA is a California limited partnership whose general partner is JMB\/Bay Area Partners and whose limited partner is the California Public Employees' Retirement System. On December 4, 1990, SFP distributed, in the form of a stock dividend, its remaining 80.1% interest in the Company to its stockholders (Distribution).\nOn February 11, 1993, BAREIA converted the Debenture (which then had an accreted value of $111.4 million) into common stock with a value of $141 million. This is treated as a non-cash item in the statement of cash flows. After the conversion, BAREIA owned 40.7% of the outstanding common stock. At that time, the Company incurred a non-recurring non-cash expense of $29.6 million ($28.3 million, net of income tax benefit), representing the excess of the value of the common stock issued over the accreted value of the Debenture at the date of conversion. Concurrently with the conversion, the Company issued 3,449,999 shares (of a total 3,500,000 authorized) of $3.75 Series A Cumulative Convertible Preferred Stock (Series A preferred stock) for $172.5 million, of which BAREIA purchased 1,405,702 shares (approximately 40.7% of the total). The Series A preferred stock has an annual dividend of $3.75 per share, a stated value of $50 per share and a liquidation preference of $50 per share plus accrued and unpaid dividends. It is convertible into common stock at a price of $9.06 per common share, subject to adjustment in certain events. It is also redeemable, at the option of the Company, at any time after February 16, 1996, at $52.625 per share and thereafter at prices declining to $50 per share on or after February 16, 2003.\nThe net proceeds of the Series A preferred stock issuance were used to repay $69 million of the working capital facility and to invest $50 million in securities to be held for the benefit of The Prudential Insurance Company of America (Prudential) and committed to the paydown and refinancing of the Company's $388.2 million first mortgage loan with Prudential (Note 6). The balance of the proceeds were invested in short-term marketable securities.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nOn November 4, 1993, the Company sold, in a private placement, 3,000,000 shares (of a total 4,600,000 authorized) of $3.625 Series B Cumulative Convertible Exchangeable Preferred Stock (Series B preferred stock) for $150 million. The Series B preferred stock has an annual dividend of $3.625 per share, a stated value of $50 per share and a liquidation preference of $50 per share plus accrued and unpaid dividends. It is convertible into the Company's common stock at a price of $9.80 per common share, subject to adjustment in certain events. The Series B preferred stock is exchangeable, at the Company's option, at any time after November 15, 1995, into 7.25% Convertible Subordinated Debentures due November 15, 2018, at a rate of $50 of debentures for each share of Series B preferred stock. It is also redeemable, at the option of the Company, at any time after November 15, 1996, at $52.5375 per share and thereafter at prices declining to $50 per share on or after November 15, 2003. The proceeds of the Series B preferred stock issuance are being used to repay debt that matures through 1997, and for general corporate purposes.\nThe Company has reserved 19,039,735 and 15,306,000 shares of common stock for issuance on conversion of the Series A and Series B preferred stock, respectively, and 5,400,000 shares for issuance pursuant to various compensation programs.\nNOTE 4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation-The accompanying financial statements include the accounts of the Company and investees over 50% owned which are controlled by the Company. All other investees are accounted for using the equity method.\nRevenue recognition-Rental revenue, in general, is recognized when due from tenants; however, revenue from leases with rent concessions is recognized on a straight-line basis over the initial term of the lease. Direct costs of negotiating and consummating a lease are deferred and amortized over the term of the related lease.\nThe Company recognizes revenue from the sale of properties using the accrual method. Sales not qualifying for full recognition at the time of sale are accounted for under the installment method. In general, specific identification is used to determine the cost of sales. Estimated future costs to be incurred by the Company after completion of each sale are included in cost of sales.\nCash, restricted cash and short-term investments-The Company considers all highly liquid investments with a maturity of three months or less at time of purchase to be cash equivalents. Restricted cash in 1994 represents amounts held in escrow in connection with a property transaction; these amounts were made available to the Company in February 1995. Restricted cash in 1993 represents amounts held for the paydown of the Company's mortgage loan with Prudential; these amounts were used to pay down this loan in February 1994. Short-term investments represent primarily commercial paper and government securities, mature within one year from time of purchase, and have an average yield of 5.42%.\nProperty and deferred costs-Real estate is stated at the lower of cost or estimated net realizable value. In cases where the Company determines that the carrying costs for properties held for sale exceeds estimated net realizable value, or an impairment has been sustained, a write-down to estimated net realizable value is recorded. A property is considered impaired when it is probable that the property's estimated undiscounted future cash flow is less than its book value. This evaluation is made on a property by property basis. The Company capitalizes construction and development costs. Costs associated with financing or leasing projects are also capitalized and amortized over the period benefitted by those expenditures.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nDepreciation is computed using the straight-line method. Buildings and improvements are depreciated using lives of between 20 and 40 years. Tenant improvements are depreciated over the primary terms of the leases (generally 3- 15 years), while furniture and equipment are depreciated using lives ranging between 3 and 10 years.\nMaintenance and repair costs are charged to operations as incurred, while significant improvements, replacements and major renovations are capitalized.\nAllowance for uncollectible accounts-Accounts receivable are presented net of an allowance for uncollectible accounts totalling $1.9 million at December 31, 1994 and 1993. The provision for uncollectible accounts in 1994, 1993 and 1992 totalled $1.0 million, $.1 million and $.9 million, respectively.\nEnvironmental Costs-The Company incurs on-going environmental remediation costs, including clean-up costs, consulting fees for environmental studies and investigations, monitoring costs, and legal costs relating to clean-up, litigation defense, and the pursuit of responsible third parties. Costs incurred in connection with operating properties and properties previously sold are expensed. Costs relating to undeveloped land are capitalized as part of development costs. Environmental costs charged to operations for 1994, 1993 and 1992 were $4.6 million, $5.5 million and $4.9 million. Environmental costs capitalized in 1994, 1993 and 1992 were $1.2 million, $1.4 million and $2.2 million. The Company maintains a reserve, included in the caption \"deferred credits and other liabilities\", for known, probable costs of environmental remediation to be incurred in connection with operating properties and properties previously sold. This reserve was $8.4 million and $5.6 million at December 31, 1994 and 1993. When there is a legal requirement for environmental remediation of developable land, the Company will accrue for the estimated cost of remediation and capitalize that amount. Where there is no legal requirement for remediation, costs will be capitalized, as incurred, as part of the project costs.\nThe Company also considers potential future costs of environmental remediation relating to individual development properties in conjunction with its analysis of current value and net realizable value. The current value of the Company's properties reflect the Company's best estimate of possible remediation costs.\nIncome taxes-Income taxes are recorded based on the future tax effects of the difference between the tax and financial reporting basis of the Company's assets and liabilities. In estimating future tax consequences, all expected future events are considered except for potential income tax law or rate changes.\nEarnings per share-Net income (loss) per share of common stock is computed by dividing net income (loss), after reduction for preferred stock dividends, by the weighted average number of shares of common stock outstanding during the year. Fully diluted earnings per share amounts have not been presented because assumed conversion of the Series A and Series B preferred stock would be anti- dilutive for all relevant periods. Assuming conversion of the Debenture on January 1, 1993, the net loss and loss before extraordinary item for 1993 would have been $.93 and $.84 per share.\nReclassifications-Certain prior year amounts have been reclassified to conform with the current year financial statement presentation.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nNOTE 5. RESTRUCTURING OPERATIONS\nIn September 1994, the Company began a major redesign of its organization and operations. This effort has resulted in a substantial reduction in staffing. The Company reduced its workforce by over 40% (89 employees) between September 15, 1994 and February 28, 1995.\nIn November 1994, the Company announced a major restructuring which consists of three initiatives: reorganization, decentralization and a focus on recurring revenue to improve the Company's long-term cash position. The November 1994 restructuring resulted in a workforce reduction of 76 employees (from 209 to 133) out of the total staffing reduction noted above. This restructuring, which is expected to be implemented over the next year, resulted in a $3.1 million non-recurring operating expense in 1994. Costs associated with the restructuring included $1.9 million related to employee termination benefits, $.8 million related to lease cancellation fees and costs attributable to permanently idle leased facilities, and $.4 million for the consolidation of operations. Substantially all of the restructuring charges will result in cash outlays. As of December 31, 1994, $.7 million of the restructuring charges had been paid.\nNOTE 6. MORTGAGE AND OTHER DEBT\nMortgage and other debt at December 31, 1994 and 1993 consisted of the following (in thousands):\n(a) The Company refinanced its $388.2 million first mortgage loan with The Prudential Insurance Company of America (Prudential) on February 18, 1994 with a $280 million first mortgage loan. In connection with this refinancing, the Company incurred an extraordinary expense of $11.9 million ($7.4 million, net of income tax benefits). This extraordinary expense, which was recognized in 1993, consisted primarily of a redemption premium paid to Prudential and the write-off of deferred financing costs associated with the $388.2 million loan. The loan is collateralized by a majority of the Company's operating properties and by an assignment of rents generated by the underlying properties. This loan has a penalty if paid prior to maturity.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\n(b) These first mortgage loans are collateralized by certain of the Company's operating properties and by an assignment of rents generated by the underlying properties. A majority of these loans have penalties if paid prior to maturity.\n(c) The Company's secured term loans are collateralized by certain operating properties and by an assignment of rents generated by the underlying properties. At December 31, 1994, $1.1 million was available for future borrowings.\n(d) The Company has a $75 million unsecured revolving facility and a $22 million unsecured term facility. In November 1994, the revolving facility was extended to April 30, 1995. As of December 31, 1994, nothing was outstanding under the revolving facility; however $2.1 million was used to provide letters of credit, leaving $72.9 million available for future borrowings.\n(e) The Company's construction loans are used to finance development projects and are secured by the related land and buildings and by an assignment of rents generated by the underlying properties. In January 1995, the Company entered into an $85 million revolving construction line of credit. This credit facility renews and increases a $75.5 million credit line. A new feature enables the Company to use the funds to develop projects on either owned land or land to be acquired from third parties. At December 31, 1994, $10.7 million was available for future borrowings under all construction loans.\n(f) The assessment district bonds are issued through local municipalities to fund the construction of public infrastructure and improvements which benefit the Company's properties. These bonds are secured by certain of the Company's properties.\nCertain loan agreements contain restrictive financial covenants. The most restrictive dividend and debt covenants limit annual dividends to $27.6 million and total debt to $1.9 billion; up to $180 million of this debt may be for non- property related activities. The most restrictive equity covenants require stockholders' equity on a current value basis to be no less than $800 million and on a historical cost basis to be no less than $475 million. Other covenants accelerate payment upon certain change of control events and contain negative pledges with respect to certain of the Company's properties. The Company was in compliance with all such covenants at December 31, 1994.\nThe maturities of mortgage and other debt outstanding as of December 31, 1994 are summarized as follows:\nInterest costs incurred during 1994, 1993 and 1992 relating to mortgage and other debt totalled $45.8 million, $64.0 million and $78.3 million. Total interest costs, which also includes loan fee amortization and other interest costs, amounted to $48.7 million, $69.6 million and $82.6 million in 1994, 1993 and 1992. Of these amounts, $24.0 million, $25.6 million and $29.3 million were capitalized during 1994, 1993 and 1992.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nNOTE 7. INCOME TAXES\nTotal income taxes (benefit) reflected in the consolidated statement of income differ from the amounts computed by applying the federal statutory rate (35% in 1994 and 1993, 34% in 1992) to income (loss) before extraordinary item as follows (in thousands):\nDeferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities and for operating loss and tax credit carryforwards. Significant components of the Company's net deferred tax liability as of December 31, 1994 are as follows (in thousands):\nDuring 1994, 1993 and 1992, the Company generated net operating loss carryforwards of $.3 million, $6.5 million and $16.9 million for tax purposes which expire in 2009, 2008 and 2007. Deferred income tax expense was reduced to reflect the benefit of these amounts.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nThe Company increased its tax expense and related deferred tax liability by $3 million in 1993 as a result of legislation enacted in August 1993 increasing the federal tax rate from 34% to 35% commencing January 1, 1993.\nNOTE 8. JOINT VENTURE INVESTMENTS\nThe Company is involved in a variety of real estate-oriented joint venture activities. At December 31, 1994, these included two hotels, one office building, a 900,000 square foot trade mart center for the contract and home furnishing industries, an apartment complex and other projects in the early stages of development.\nThe Company had a loan outstanding to one of its joint ventures in the amount of $1.7 million at December 31, 1994 and 1993. The loan bears interest at one percentage point over the rate payable under the joint venture's note to its creditor bank (9.9% at December 31, 1994) and is secured by a second lien on the joint venture property. Principal and interest are due on or before February 1, 1996. At December 31, 1993, the Company had outstanding a loan and related accrued interest to a joint venture partner in the aggregate amount of $.6 million. During 1994, this amount was exchanged for additional ownership in the related joint venture.\nThe condensed combined balance sheets and statements of income of the joint ventures, along with the Company's proportionate share, are summarized as follows (in thousands):\nThe Company's proportionate share of venturers' deficit is an aggregate amount for all ventures. Because the Company's ownership percentage differs from venture to venture, and certain ventures have accumulated deficits while others have accumulated equity, the Company's percentage of venturers' deficit is not reflective of the Company's ownership percentage of the ventures.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nNOTE 9. PROPERTY\nProperty and capitalized property costs at December 31, 1994 and 1993 consisted of the following (in thousands):\nNOTE 10. LEASES\nThe Company, as lessor, has entered into noncancelable operating leases expiring at various dates through 2052. Rental revenue under these leases totalled $102.3 million in 1994, $105.1 million in 1993 and $94.7 million in 1992. Included in this revenue are rentals contingent on lease operations of $2.8 million in 1994, $3.2 million in 1993 and $3.9 million in 1992. Future minimum rental revenue under existing noncancelable operating leases as of December 31, 1994 are summarized as follows (in thousands):\nThe book value of the Company's properties under operating leases or held for rent are summarized as follows (in thousands):\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nThe Company, as lessee, has entered into noncancelable operating leases expiring at various dates through 2033. Rental expense under these leases totalled $2.8 million in 1994, rental expense and related sublease income totalled $4 million and $1.3 million in 1993 and $5.9 million and $1.9 million in 1992. Future minimum lease payments as of December 31, 1994 are summarized as follows (in thousands):\nNOTE 11. TRANSACTIONS WITH AFFILIATES\nThe Company has a management agreement with The Atchison, Topeka & Santa Fe Railway Company (ATSF), a subsidiary of SFP, under which the Company acts as exclusive management and selling agent for ATSF's non-operating railroad properties. Fees of $4.2 million, $4.8 million and $5.7 million were earned in 1994, 1993 and 1992, under this agreement. This agreement was renegotiated and extended in 1994 and is subject to termination by either party on 180 days notice. The earliest possible termination date is December 31, 1995.\nThe Company had an agreement to exchange certain desert properties for certain ATSF properties with comparable market value. The Company transferred approximately 154,000 acres ($10.3 million market value) of primarily desert land in exchange for five developable properties in 1992. The exchange had no impact on the historical cost of the Company's total assets. The Company concluded the exchange agreement during 1992 by selling an additional 169,000 acres of desert land and 4,000 acres of mineral rights to an affiliate of ATSF and recognized a gain of $6.3 million.\nSFP leases approximately 250,000 square feet of office space in Chicago from the Company for annual rental of approximately $7 million for 1992 through 1994. SFP may terminate the lease after April 1, 1995, however, over 90% of SFP's space has been leased to tenants who currently pay rent at a rate of approximately $5 million per year. Any leases of SFP's space existing at the time of SFP's lease termination will remain in place.\nNOTE 12. EMPLOYEE BENEFIT AND STOCK OPTION PLANS\nThe Company has a profit sharing and savings plan for all employees. Funding consists of employee contributions along with matching and discretionary contributions by the Company. Total expense for the Company under this plan was $.6 million, $.6 million and $.7 million in 1994, 1993 and 1992.\nThe Company has various plans through which employees may purchase common stock of the Company.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nThe Incentive Stock Compensation Plan (Substitute Plan) was adopted to provide substitute awards to employees whose awards under certain SFP plans were forfeited as a result of the Distribution. The number of shares, exercise price and expiration dates of these awards were set so the participant retained the full unrealized potential value of the original SFP grant. Options became exercisable after March 5, 1992 and expire from 1997 through 1999. The Company also has a Stock Option Plan under which the Board of Directors may issue options to purchase up to 250,000 shares of common stock at a price not less than the fair market value at the date of grant. Options are exercisable no earlier than six months from the date of grant and generally expire ten years after the date of grant. All options granted to date are exercisable in installments on a cumulative basis at a rate of 25% each year commencing on the first anniversary of the date of grant.\nUnder the Executive Stock Option Plan, the Board of Directors may issue non-qualified stock options to officers and directors to purchase up to 4,250,000 shares of common stock at a price not less than fair market value at the date of grant. Options are exercisable no earlier than six months from the date of grant and generally expire ten years after the date of grant. Each non- management director is automatically granted an option, upon initial election to the Board of Directors, to purchase 5,000 shares of common stock at a price of 127.63% of the fair market value on the date of grant, increasing 5% on each anniversary of the grant date commencing on the sixth anniversary. The options are exercisable in installments on a cumulative basis at a rate of 20% each year. Unless otherwise provided at the time of grant, the exercise price for all other options will be the fair market value on the date of grant, increasing 5% on each anniversary of the grant date, and the options are exercisable in full on the fifth anniversary of the grant date. Options to purchase 2,083,500 shares of common stock were issued in 1994. For 1,283,500 of the options issued in 1994, the exercise price does not increase by 5% on each anniversary of the date of grant.\nTransactions under these plans during 1993 and 1994 are summarized below:\nIn addition, in 1992 restrictions lapsed on a total of 4,781 shares of common stock awarded under the Substitute Plan to holders of SFP restricted stock.\nCATELLUS DEVELOPMENT CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nIn 1994, the Company terminated its Long-Term Incentive Compensation Program. No benefits were paid under this plan.\nNOTE 13. COMMITMENTS AND CONTINGENCIES\nIn April 1991, a lawsuit was brought against the Company alleging breach of contract for a finder's fee in connection with an August 1990 sale of land in Fremont, California. On November 1, 1993, the jury returned a verdict in favor of the plaintiff and made an award of approximately $440,000 which, together with pre-judgment interest, totals approximately $600,000. Additionally, the jury awarded approximately $7.7 million in punitive damages for what it found was the Company's bad faith denial of an alleged contract. While the Company is vigorously pursuing an appeal, it provided $8.3 million as a non-recurring expense in the consolidated statement of income for the year ended December 31, 1993.\nThe Company has obtained standby letters of credit and surety bonds in favor of local municipalities or financial institutions to guarantee performance on real property improvements or financial obligations. As of December 31, 1994, $29.9 million was outstanding, including a $12.4 million surety bond related to the lawsuit described above.\nThe Company, as a partner in certain joint ventures, has made certain financing guarantees which do not individually or collectively represent a material commitment.\nThe Company is a party to a number of legal actions arising in the ordinary course of business. While the Company cannot predict with certainty the final outcome of these proceedings, considering the substantial legal defenses available, management believes that none of these actions, when finally resolved, will have a material adverse effect on the consolidated financial position or results of operations of the Company.\nInherent in the operations of the real estate business is the possibility that environmental pollution conditions may relate to properties owned or previously owned. The Company may be required in the future to take action to correct or reduce the environmental effects of prior disposal or release of hazardous substances by third parties, the Company, or its corporate predecessors. Future environmental costs are difficult to estimate due to such factors as the unknown magnitude of possible contamination, the unknown timing and extent of the corrective actions which 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 insurance.\nAt December 31, 1994, management estimates that future costs for remediation of identified or suspected environmental contamination which will be treated as an expense may be in the range of $2.9 million to $29.8 million. It is anticipated that such costs will be incurred over the next ten years. The Company has provided a reserve for such costs (Note 4). Management also estimates that similar costs relating to the Company's developable properties may range from $17.6 million to $63.4 million. These amounts generally will be capitalized as components of development costs when incurred, which is anticipated to be over a period of twenty years. These estimates were developed based on extensive reviews which took place over several years based upon then prevailing law and identified site conditions. Because of the breadth of its portfolio, the Company is unable to review extensively each property on a regular basis. Such estimates are not precise and are always subject to the availability of further information about the prevailing conditions at the site, the future requirements of regulatory agencies and the availability of other parties to pay some or all of such costs.\nSUMMARIZED QUARTERLY RESULTS (UNAUDITED)\nThe Company's earnings and cash flow are determined to a large extent by property sales. Sales and net income have fluctuated significantly from quarter to quarter, as evidenced by the following summary of unaudited quarterly consolidated results of operations. Property sales fluctuate from quarter to quarter, reflecting general market conditions and the Company's intent to sell property when it can obtain attractive prices. Cost of sales may also vary widely because it is determined by the Company's historical cost basis in the underlying land.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Catellus Development Corporation\nOur audits of the consolidated historical cost basis financial statements referred to in our report dated February 28, 1995, appearing on page of this Form 10-K of Catellus Development Corporation, also included an audit of the Financial Statement Schedules listed in Item 14(a)(2) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated historical cost basis financial statements.\n\/s\/ Price Waterhouse LLP ------------------------ Price Waterhouse LLP San Francisco, CA February 28, 1995\nS-1\nCATELLUS DEVELOPMENT CORPORATION\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 1994 (IN THOUSANDS)\n--------------------- Notes: (1) Balances written off as uncollectible. (2) Costs of unsuccessful projects written off. (3) Environmental costs incurred.\nS-2\nCATELLUS DEVELOPMENT CORPORATION SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1994 (DOLLARS IN THOUSANDS)\n--------------------------- Notes: (1) A reserve of $977,000 against predevelopment has been established for projects to be abandoned. (2) The aggregate cost for Federal income tax purposes is approximately $951,000,000. (3) See Attachment A to Schedule III for reconciliation of beginning of period total to total at close of period. (4) Excludes investments in joint ventures and furniture and equipment. (5) Reference is made to Note 4 to the Consolidated Financial Statements for information related to depreciation. (6) Net incremental revenues.\nS-3\nCATELLUS DEVELOPMENT CORPORATION ATTACHMENT A TO SCHEDULE III RECONCILIATION OF COST OF REAL ESTATE AT BEGINNING OF PERIOD WITH TOTAL AT END OF PERIOD (IN THOUSANDS)\nRECONCILIATION OF REAL ESTATE ACCUMULATED DEPRECIATION AT BEGINNING OF PERIOD WITH TOTAL AT END OF PERIOD (IN THOUSANDS)\nS-4\nEXHIBIT INDEX\nExhibit No. -------\n3.1 Form of Restated Certificate of Incorporation of the Registrant (1) 3.1A Amendment to Restated Certificate of Incorporation of the Registrant (9) 3.3 Form of Certificate of Designations, Preferences and Rights of $3.25 Series A Cumulative Convertible Preferred Stock (2) 3.4 By-Laws, as amended* 3.5 Form of Certificate of Designations, Preferences and Rights of $3.625 Series B Cumulative Convertible Exchangeable Preferred Stock (8) 4.1 Form of stock certificate representing Common Stock (1) 4.9 Form of stock certificate representing $3.75 Series A Cumulative Convertible Preferred Stock (2) 4.10 Form of stock certificate representing $3.625 Series B Cumulative Convertible Exchangeable Preferred Stock (9) 4.11 Loan Agreement dated as of February 16, 1994 between the Registrant and The Prudential Insurance Company of America (10) 10.1 Exploration Agreement and Option to Lease dated December 28, 1989 between the Registrant and Santa Fe Pacific Minerals Corporation (1) 10.3 Long-Term Stockholders Agreement dated as of December 29, 1989 among the Registrant, Bay Area Real Estate Investment Associates L.P. (\"BAREIA\"), Olympia & York SF Holdings Corporation (\"O&Y\") and Itel Corporation (\"Itel\") (1) 10.4 Registration Rights Agreement dated as of December 29, 1989 among the Registrant, BAREIA, O&Y and Itel (1) 10.6 Restated Tax Allocation and Indemnity Agreement dated December 29, 1989 among the Registrant and certain of its subsidiaries and Santa Fe Pacific Corporation (\"SFP\") (1) 10.7 State Tax Allocation and Indemnity Agreement dated December 29, 1989 among the Registrant and certain of its subsidiaries and SFP (1) 10.8 Executive Employment Agreement dated April 1, 1989 between Vernon B. Schwartz and the Registrant (4) 10.9 Registrant's Annual Performance Bonus Program (4) 10.13 Registrant's Incentive Stock Compensation Plan (4) 10.14 Management Agreement between ATSF and Catellus Management Corporation dated October 15, 1994* 10.15 Termination, Substitution and Guarantee Agreement between ATSF and the Registrant dated December 21, 1990 (5) 10.16 Registrant's Stock Option Plan (5) 10.17 Development Agreement dated April 1, 1991 between the Registrant and the San Francisco Board of Supervisors (6) 10.21 Executive Stock Option Plan (3) 10.21A Amended and Restated Executive Stock Option Plan (9) 10.25 Agreement dated as of January 14, 1993 between the Registrant and BAREIA (7) 10.25A Amendment No. 1 to Agreement, dated as of January 14, 1993 between the Registrant and BAREIA* 10.26 Form of First Amendment to Registration Rights Agreement among the Registrant, BAREIA, O&Y and Itel (7) 10.27 Form of Stockholders Agreement among the Registrant, BAREIA, O&Y and Itel (7) 10.28 Agreement dated February 22, 1994 between the Registrant and Vernon B. Schwartz (9) 10.29 Executive Employment Agreement dated July 27, 1994 between the Registrant and Nelson C. Rising* 10.30 Executive Employment Agreement dated February 10, 1995 between the Registrant and Timothy J. Beaudin* 10.31 Stock Option Agreement dated July 27, 1994 between the Registrant and Joseph R. Seiger* 10.32 Special Severance Pay Plan and Summary Plan Description* 10.33 Form of Memorandum Regarding Reduction-In-Force Program* 10.34 Consulting Agreement dated December 23, 1994 between the Registrant and James G. O'Gara* 10.35 Memorandum of Understanding dated December 22, 1994, addressed to James W. Augustino* 10.36 Memorandum of Understanding dated December 19, 1994, addressed to Thomas W. Gille* 21.1 Subsidiaries of the Registrant* 23.1 Consent of Independent Accountants* 23.2 Consent of Independent Real Estate Appraisers* 24.1 Powers of Attorney from directors with respect to the filing of the Form 10-K* 27 Financial Data Schedule*\nThe Registrant has omitted instruments with respect to long-term debt where the total amount of the securities authorized thereunder does not exceed 10 percent of the assets of the Registrant and its subsidiaries on a consolidated basis. The Registrant agrees to furnish a copy of such instrument to the Commission upon request.\n----------- * Filed with this report on Form 10-K.\n(1) Incorporated by reference to Exhibit of the same number of the Registration Statement on Form 10 (Commission File No. 0-18694) as filed with the Commission on July 18, 1990 (\"Form 10\"). (2) Incorporated by reference to Exhibit of the same number on the Form 8 constituting a Post-Effective Amendment No. 1 to the Form 8-A as filed with the Commission on February 19, 1993. (3) Incorporated by reference to Exhibit of the same number of Registration Statement on Form S-3 (Commission File No. 33-56082) as filed with the Commission on December 21, 1992 (\"Form S-3\"). (4) Incorporated by reference to Exhibit of the same number of the Form 8 constituting Post-Effective Amendment No. 1 to the Form 10 as filed with the Commission on November 20, 1990. (5) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1990. (6) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1990, referred to therein as \"Development Agreement dated February 19, 1991 between the Registrant and the San Francisco Board of Supervisors\". (7) Incorporated by reference to Exhibit of the same number of Amendment No. 2 to Form S-3 as filed with the Commission on February 4, 1993. (8) Incorporated by reference to Exhibit of the same number on the Form 10-Q for the quarter ended September 30, 1993. (9) Incorporated by reference to Exhibit of the same number on the Form 10-K for the year ended December 31, 1993. (10) Incorporated by reference to Exhibit of the same number of Amendment No. 1 to the Form 10-K for the year ended December 31, 1993.","section_15":""}
{"filename":"914179_1994.txt","cik":"914179","year":"1994","section_1":"Item 1. Business\nUnless the context otherwise requires, the term \"Company\" refers to Canandaigua Wine Company, Inc. and its subsidiaries, all references to \"net sales\" refer to gross revenues less excise taxes and returns and allowances to conform with the Company's method of classification, and all references to the Company's fiscal year shall refer to the year ended August 31 of the indicated year. Market share and industry data disclosed in this Report have been obtained from the following industry publications: Wines & Vines; The Gomberg-Fredrikson Report; Jobson's Liquor Handbook; Jobson's Wine Handbook; The U.S. Wine Market: Impact Databank Review and Forecast, 1994 Edition; The U.S. Beer Market: Impact Databank Review and Forecast, 1994 Edition; Beer Marketer's Insights: 1994 Import Insights; and 1994 Beer Industry Update. The Company has not independently verified this data. References to market share data are based on unit volume.\nThe Company is a Delaware corporation organized in 1972 as the successor to a business founded in 1945 by Marvin Sands, Chairman of the Board of the Company.\nThe Company is a leading producer and marketer of branded beverage alcohol products, with over 125 national and regional brands which are distributed by over 1,000 wholesalers throughout the United States and in selected international markets. The Company is the second largest supplier of wines, the fourth largest importer of beers and the eighth largest supplier of distilled spirits in the United States. The Company's beverage alcohol brands are marketed in five general categories: table wines, sparkling wines, dessert wines, imported beer and distilled spirits, and include the following principal brands:\n. Table Wines: Almaden, Inglenook, Paul Masson, Taylor California Cellars, Cribari, Manischewitz, Taylor New York, Marcus James, Deer Valley and Dunnewood\n. Sparkling Wines: Cook's, J. Roget, Great Western and Taylor New York\n. Dessert Wines: Richards Wild Irish Rose, Cisco, Taylor New York and Italian Swiss Colony\n. Imported Beer: Corona, St. Pauli Girl, Modelo Especial, Tsingtao and Pacifico\n. Distilled Spirits: Barton's Gin and Vodka, Ten High Bourbon Whiskey, Crystal Palace Gin and Vodka, Montezuma Tequila, Northern Light Canadian Whisky, Lauder's Scotch Whisky and Monte Alban Mezcal\nBased on available industry data, the Company believes it has a 21% share of the wine market, a 10% share of the imported beer market and a 4% share of the distilled spirits market in the United States. Within the wine market, the Company believes it has a 31% share of the non-varietal table wine market, a 10% share of the varietal table wine market, a 50% share of the dessert wine market and a 32% share of the sparkling wine\nmarket. Many of the Company's brands are leaders in their respective categories in the United States, including Corona, the second largest selling imported beer brand, Almaden and Inglenook, the fifth and sixth largest selling wine brands, Richards Wild Irish Rose, the largest selling dessert wine brand, Cook's champagne, the second largest selling sparkling wine brand, Montezuma, the second largest selling tequila brand, and Monte Alban, the largest selling mezcal brand.\nDuring the past four years, the Company has diversified its product portfolio through a series of strategic acquisitions that have resulted in an increase in the Company's net sales from $176.6 million in fiscal 1991 to $876.4 million on a pro forma basis in fiscal 1994. Through these acquisitions, the Company acquired strong market positions in growing product categories in the beverage alcohol industry, such as varietal table wine and imported beer. The Company ranks second and fourth in the varietal table wine and imported beer categories, respectively. Over the past four years, industry shipments of varietal table wine and imported beer have grown 64% and 7%, respectively. The Company has successfully integrated the acquired businesses into its existing business and achieved significant cost reductions through reduced product and organizational costs. The Company has also strengthened its relationship with wholesalers, expanded its distribution and enhanced its production capabilities as well as acquired additional management, operational, marketing and research and development expertise.\nIn October 1991, the Company acquired the Cook's, Cribari, Dunnewood and other brands and related facilities and assets (the \"Guild Acquisition\") from Guild Wineries and Distillers (\"Guild\"), which enabled the Company to establish a significant market position in the California sparkling wine category and to enter the California table wine market. The Company acquired Barton Incorporated (\"Barton\") in June 1993, further diversifying into the imported beer and distilled spirits categories (the \"Barton Acquisition\"). On October 15, 1993, the Company acquired the Paul Masson, Taylor California Cellars and other brands and related facilities and assets of Vintners International Company, Inc. (\"Vintners\") (the \"Vintners Acquisition\"). On August 5, 1994, the Company acquired the Almaden, Inglenook and other brands, a grape juice concentrate business and related facilities and assets (the \"Almaden\/Inglenook Product Lines\") from Heublein Inc. (the \"Almaden\/Inglenook Acquisition,\" and together with the Barton Acquisition and the Vintners Acquisition, the \"Acquisitions\"). See \"Recent Acquisitions.\"\nThe Company's business strategy is to continue to strengthen its market position in each of its principal product lines. Key elements of its strategy include: (i) making selective acquisitions in the beverage alcohol industry to improve market position and capitalize on growth trends within the industry; (ii) improving operating efficiencies through reduced product and organizational costs of existing and acquired businesses; (iii) capitalizing on strong wholesaler relationships resulting from its expanded portfolio of brands; and (iv) expanding distribution into new markets and increasing penetration of existing markets primarily through line extensions and promotional activities.\nIn furtherance of its business strategy of improving operating efficiencies of acquired businesses, the Company announced a plan to restructure the operations of its California wineries, including a consolidation of facilities, centralization of bottling operations and\nreduction of overhead, including the elimination of approximately 260 jobs (the \"Restructuring Plan\"). As a result of the Restructuring Plan, the Company has taken a charge in the fourth quarter of fiscal 1994 which reduced after-tax income for fiscal 1994 by $14.9 million, or $0.91 per share on a fully diluted basis. The Company anticipates that the Restructuring Plan will result in net cost savings of approximately $1.7 million in fiscal 1995 and approximately $13.3 million of annual net cost savings beginning in fiscal 1996. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nRECENT ACQUISITIONS\nThe Barton Acquisition. On June 29, 1993, the Company acquired all of the outstanding shares of capital stock of Barton. Barton is the United States' fourth largest importer of beers and eighth largest supplier of distilled spirits. The Barton Acquisition has enabled the Company to diversify within the beverage alcohol industry by participating in the imported beer and distilled spirits markets, which have similar marketing approaches and distribution channels to the Company's wine business, and to take advantage of the experienced management team that developed Barton as a successful company. With this acquisition, the Company acquired the right to distribute Corona and Modelo Especial beer in 25 primarily western states, national distribution rights for St. Pauli Girl and Tsingtao and a diversified line of distilled spirits including Barton Gin and Vodka, Ten High Bourbon Whiskey and Montezuma Tequila.\nBarton is being operated independently by its current management as a subsidiary of the Company. Until August 31, 1996, consistent with past practices and subject to annual approval by the Company's Board of Directors of an annual operating plan for the coming year, Ellis M. Goodman, the Chief Executive Officer of Barton, has full and exclusive strategic and operational responsibility for Barton and all of its subsidiaries.\nThe Vintners Acquisition. On October 15, 1993, the Company acquired substantially all of the assets of Vintners, and assumed certain liabilities. Vintners was the United States' fifth largest supplier of wine with two of the country's most highly recognized brands, Paul Masson and Taylor California Cellars. The Vintners Acquisition enabled the Company to expand its wine portfolio to include several large and highly recognized table wine brands that are distributed by a substantially common wholesaler network. Vintners' operations were immediately integrated with those of the Company at the closing of the acquisition. With this acquisition, the Company acquired the Paul Masson, Taylor California Cellars, Taylor New York, Deer Valley, St. Regis (non- alcoholic) and Great Western brands and related facilities.\nThe Almaden\/Inglenook Acquisition. On August 5, 1994, the Company acquired the Almaden and Inglenook brands, the fifth and sixth largest selling table wines in the United States, a grape juice concentrate business, and wineries in Madera and Escalon, California, from Heublein. The Company also acquired Belaire Creek Cellars, Chateau La Salle and Charles Le Franc table wines, Le Domaine champagne and Almaden, Hartley and Jacques Bonet brandy. The accounts receivable and the accounts payable related to the acquired assets were not acquired by the Company.\nAs a result of the Almaden\/Inglenook Acquisition, the Company has strengthened its position as the second largest supplier of wines in the United States. The acquisition of the Inglenook brand significantly expands the Company's restaurant and bar on-premises presence. The Company intends to maintain the existing sales force and distribution network of the Almaden and Inglenook brands. Further, the Almaden\/Inglenook Acquisition has resulted in the Company becoming the leading grape juice concentrate producer in the United States. The Company believes that the Almaden\/Inglenook Acquisition will enable the Company to achieve significant cost savings through the consolidation of its California winery operations.\nHeublein also agreed not to compete with the Company in the United States and Canada for a period of five years following the closing of the Almaden\/Inglenook Acquisition in the production and sale of grape juice concentrate or sale of packaged wines bearing the designation \"Chablis\" or \"Burgundy\" except where, among other exceptions, such designations are currently used with certain brands retained by Heublein. Certain companies acquired by Heublein, however, may compete directly with the Company.\nINDUSTRY\nThe beverage alcohol industry in the United States consists of the production, importation, marketing and distribution of beer, wine and distilled spirits products. Over the past five years there has been increasing consolidation at the supplier, wholesaler and, in some markets, retailer tiers of the beverage alcohol industry. As a result, it has become advantageous for certain suppliers to expand their portfolio of brands through acquisitions and internal development in order to take advantage of economies of scale and to increase their importance to a more limited number of wholesalers and, in some markets, retailers. From 1978 through 1993, the overall per capita consumption of beverage alcohol products in the United States has generally declined. However, table wines, and in particular varietal table wines, and imported beer consumption have increased during the period.\nThe following table sets forth the industry unit volumes for shipments of beverage alcohol products in the Company's five principal beverage alcohol product categories in the United States for the five calendar years ended December 31, 1993:\n(a) Units are in thousands of gallons. Data exclude sales of wine coolers. (b) Includes other special natural (flavored) wines under 14% alcohol. (c) Includes dessert wines, other special natural (flavored) wines over 14% alcohol and vermouth. (d) Units are in thousands of cases (2.25 gallons per case). (e) Units are in thousands of 9-liter cases (2.378 gallons per case).\nTable Wines. Wines containing 14% or less alcohol by volume are generally referred to as table wines. Within this category, table wines are further characterized as either \"non-varietal\" or \"varietal.\" Non- varietal wines include wines named after the European regions where similar types of wines were originally produced (e.g., burgundy), niche products and proprietary brands. Varietal wines are those named for the grape that comprises the principal component of the wine. Table wines that retail at less than $5.75 per 750 ml. bottle are generally considered to be popularly priced while those that retail at $5.75 or more per 750 ml. bottle are considered premium wines.\nFrom 1989 to 1993, shipments of domestic table wines increased at an average compound annual rate of approximately 1.5%. In 1992, domestic table wine shipments increased 8% from the previous year; this rate of increase was markedly larger than in previous years and was attributed in large part to the November 1991 CBS television 60 Minutes, French Paradox broadcast about the healthful benefits of moderate red wine consumption. In 1993, domestic table wine shipments declined by 2.3% when compared to 1992. This decline has been attributed to an overall wholesale and retail wine inventory surplus at the end of 1992. Based on shipments of California table wines, which constituted approximately 94% of the total domestically produced table wine market in 1993, shipments of varietal wines have grown at an average compound annual rate of 13.3% since 1989, with shipments in the first half of 1994 increasing 16% over the prior year. In contrast, shipments of non-varietal table wines have generally declined over the same period although they showed a slight increase in\n1992 as compared to 1991. For the first half of calendar 1994, shipments of California table wines increased approximately 7% over the same period in 1993. Shipments of imported table wines have generally decreased over the last six years, decreasing from 58.9 million gallons in 1989 to 52.4 million gallons in 1993. Imported table wines constituted 15% of the United States table wine market in calendar 1993.\nDessert Wines. Wines containing more than 14% alcohol by volume are generally referred to as dessert wines. Dessert wines generally fall into the same price categories as table wines. Dessert wine consumption in the United States has been declining for many years reflecting a general shift in consumer preferences to table and sparkling wines. For calendar year 1993, shipments of domestic dessert wines decreased 9.9% over calendar year 1992, a lesser rate than from 1989 to 1993, during which period shipments of domestic dessert wines declined at an average compound annual rate of 14.2%. Dessert wines, which are generally popularly priced, have been adversely affected by the January 1, 1991 increase in federal excise taxes which had the effect of increasing the cost of these products to the consumer disproportionately with certain other beverage alcohol products. Shipments of dessert wines continued to decline during the first half of calendar 1994 as compared to the first half of calendar 1993 as is evidenced by a 7% decline during this period in shipments of California dessert wines, which constituted approximately 73% of the domestically produced dessert wine market in 1993.\nSparkling Wines. Sparkling wines include effervescent wines like champagne and spumante. Sparkling wines generally fall into the same price categories as table wines. Shipments of sparkling wines declined at an average compound annual rate of 2.9% from 1989 to 1993; with shipments of domestic sparkling wines declining 0.8% in calendar 1993 as compared to calendar 1992. The decline in sparkling wine consumption is believed to reflect mounting concerns about drinking and driving, as a large part of sparkling wine consumption occurs outside the home at social gatherings and restaurants. Shipments of sparkling wines continued to decline during the first half of 1994 as compared to the first half of 1993 as is evidenced by a decline of 12% during this period in shipments of California sparkling wines which constituted approximately 92% of the domestically produced sparkling wine market in 1993. The Company believes that shipments in the first half of 1994 were also adversely affected by high levels of retail inventory at the beginning of the period.\nImported Beer. Shipments of imported beers have increased at an average compound annual rate of 1.7% from 1989 to 1993. Shipments of Mexican beers in calendar 1993 increased 10.4% over 1992. During the first half of calendar 1994 as compared to the corresponding period in 1993, shipments of Mexican beers increased 14.5% as compared to an increase of 19.3% for the entire imported beer category. In 1993, imported beers constituted 4.9% of the United States beer market. This reflects an increase from 1992 when imported beers constituted 4.4% of the United States beer market. Imported beers are generally priced above the leading domestic premium brands. This price category also includes beers produced by microbreweries and super-premium priced domestic beers.\nDistilled Spirits. Shipments of distilled spirits in the United States declined at an average compound annual rate of 1.9% from 1989 to 1993. Although shipments increased slightly in calendar 1992 as compared to calendar 1991, shipments again declined in calendar 1993 by 2.6% when\ncompared to calendar 1992. Shipments of distilled spirits have been affected by many of the same trends evident in the rest of the beverage alcohol industry. Over the past five years, whiskey sales have declined significantly while sales of rum, tequila, cordials and liqueurs have increased. The Company believes that distilled spirits can be divided into two general price segments, with distilled spirits selling for less than $7.00 a 750 ml. bottle being referred to as price value products and those selling for over $7.00 a 750 ml. bottle being referred to as premium products.\nPRODUCT CATEGORIES\nThe Company produces, imports and markets beverage alcohol products in five principal product categories: table wines, dessert wines, sparkling wines, imported beer and distilled spirits. The table below sets forth the unit volumes (in thousands of gallons) and net sales (in thousands) for all of the table, dessert and sparkling wines, grape juice concentrate and other wine related products and services sold by the Company and under brands and products acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition for the 1992, 1993 and 1994 fiscal years.\n(a) Data for fiscal years ended August 31, 1992, 1993 and 1994. The data for the Company's fiscal year ended August 31, 1994 excludes the net sales for the brands and other products acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition.\n(b) Data for fiscal years ended July 31, 1992 and 1993 and for the twelve months ended August 31, 1994.\n(c) Data for fiscal years ended September 30, 1992 and 1993 and for the twelve months ended August 31, 1994.\nTable Wines. The Company sells over 45 different brands of non- varietal table wines, substantially all of which are marketed in the popularly priced segment which constituted approximately 43% of the domestic table wine market in the United States for the 1993 calendar year. The Company also sells over 15 different brands of varietal table wines in both the popularly priced and premium categories. The table\nbelow sets forth the unit volumes (in thousands of gallons) for the domestic table wines sold by the Company and under domestic table wine brands acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition for the 1992, 1993 and 1994 fiscal years:\n(a) Excludes sales of wine coolers but includes sales of wine in bulk.\nThe Company's table wine brands include:\nAlmaden: The fifth largest selling table wine brand and the ninth largest varietal wine brand in the United States. Almaden is one of the oldest and best known table wines in the United States.\nInglenook: The sixth largest selling table wine brand and the seventh largest varietal wine in the United States with a significant restaurant and bar presence.\nPaul Masson: The 11th largest selling table wine brand in the United States which is offered in all major varietal and non-varietal product categories in a full range of sizes.\nTaylor California Cellars: The 14th largest domestic selling table wine brand in the United States which is also offered in all major varietal and non-varietal product categories in a full range of sizes.\nCribari: A well known brand of both varietal and non-varietal table wines marketed in the popularly priced segment.\nManischewitz: The largest selling brand of kosher wine in the United States.\nTaylor New York: One of the United States' oldest brands of non- varietal wine marketed primarily in the eastern half of the United States.\nRichards Wild Irish Rose: A brand of table wine possessing unique taste characteristics which is a line extension of the nation's leading dessert wine brand.\nDeer Valley: This line of California varietal and non-varietal table wines introduced in 1989 has had significant success in California. The Company is in the process of introducing this brand in other regions of the country.\nCook's: This varietal wine was created to take advantage of the brand recognition associated with Cook's sparkling wines.\nDunnewood: From California's north coast, unit volumes of this varietal wine have also increased significantly. This brand is marketed at the lower end of the premium price category.\nThe Company has pursued a strategy of increasing its unit volume sales in the table wine segment by acquiring new brands and by growing existing brands. The Company's unit volume sales of non-varietal table wines increased from approximately 9.3 million gallons in fiscal 1992 to approximately 52.6 million gallons on a pro forma basis for fiscal 1994 as a result of the Vintners Acquisition and the Almaden\/Inglenook Acquisition. Likewise, the Company's unit volume sales of varietal table wines increased from approximately 1.1 million gallons in fiscal 1992 to over 12.8 million gallons on a pro forma basis for fiscal 1994 as a result of the Vintners Acquisition and the Almaden\/Inglenook Acquisition. The Company believes that its recent acquisition of the Almaden\/Inglenook Product Lines, including the Almaden and Inglenook brands, creates additional opportunities for growth in this product category.\nThe 1993 decrease in unit volume of Vintners' table wines resulted from a number of factors including a significant decrease in Vintners' expenditures for advertising, promotion and selling activities during the three year period ended July 31, 1993. The Company believes that this decrease resulted in a reduction in the level of wholesaler attention paid to Vintners' brands, and the Company believes that certain of Vintners' products were not competitively priced. During the Company's fiscal 1994, unit volume sales of Vintners table wines continued to decline. During fiscal 1994, the Company implemented steps to address this decline, including a reduction in prices for its Taylor California brands, the implementation of new promotional programs and repackaging of selected products. As a result of these efforts, the Company believes that sales of Vintners' brands have begun to stabilize.\nThe Company also markets a selection of popularly priced imported table wines. These brands include:\nMarcus James: One of the largest selling imported varietal wines in the United States. Marcus James is a line of varietal table wines which includes white zinfandel, chardonnay, cabernet sauvignon and merlot. The Company owns the Marcus James brand and contracts for its production in Brazil.\nPartager: A popularly priced French table wine with both varietal and non-varietal products. The Company owns the Partager brand and contracts for its production in France.\nMateus: The second largest selling Portuguese table wine and a highly recognized brand name. This brand is imported by the Company under a distribution agreement.\nThe Company's unit volume sales of imported wine increased steadily from 1.3 million gallons in fiscal 1992 to 1.9 million gallons in fiscal 1994. This increase is attributable primarily to increased sales of the Marcus James brand and the inclusion of a full year of Mateus sales. Including sales of Partager by Vintners prior to its acquisition by the Company, on a pro forma basis for fiscal 1994, the Company sold approximately 2.0 million gallons of imported table wines.\nDessert Wines. The Company markets substantially all of its dessert wines in the lower end of the popularly priced segment. The popularly priced segment represented approximately 88% of the dessert wine market in calendar 1993. Sales of dessert wines comprised 10.2% of the Company's total revenues during the fiscal year ended August 31, 1994, on a pro forma basis. The table below sets forth the unit volumes (in thousands of gallons) for the domestic dessert wines sold by the Company and under domestic dessert wine brands acquired in the Vintners Acquisition for the 1992, 1993 and 1994 fiscal years:\nThe Company's dessert wines include:\nRichards Wild Irish Rose: The largest selling dessert wine brand in the United States and the Company's leading dessert wine brand in unit volume sales.\nCisco: The fourth largest selling dessert wine brand in the United States. Cisco is a flavored dessert wine positioned higher in price than Richards Wild Irish Rose.\nTaylor New York: Premium dessert wines, including port and sherry.\nThe Company's unit volume sales of dessert wines have declined over the last three years. The decline can be attributed to a general decline in dessert wine consumption in the United States. The Company's unit volume sales of its dessert wine brands (including the brands acquired from Vintners) have decreased 26.9% from fiscal 1992 to fiscal 1994.\nSparkling Wines. The Company markets substantially all of its sparkling wines in the popularly priced segment, which constituted\napproximately 48% of the domestic sparkling wine market in calendar 1993. The table below sets forth the unit volumes (in thousands of gallons) for the domestic sparkling wines sold by the Company and under domestic sparking wine brands acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition for the 1992, 1993 and 1994 fiscal years:\nThe Company's sparkling wine brands include:\nCook's: The second largest selling domestic sparkling wine in the United States. This brand of champagne is marketed in a bell shaped bottle and is cork-finished, packaging generally associated with higher priced products.\nJ. Roget: The sixth largest selling domestic sparkling wine in the United States, priced slightly below Cook's.\nGreat Western: A premium priced champagne, fermented in the bottle.\nTaylor New York: A well known premium priced champagne also fermented in the bottle.\nCodorniu: The second largest Spanish sparkling wine imported in the United States; sold in the premium price category.\nJacques Bonet: Priced in the economy segment, this product appeals to restaurants and caterers.\nThe Company has maintained sales levels of sparkling wine over the last three years in contrast to a general industry decline in sales for this product category.\nGrape Juice Concentrate. As part of its wine business, the Company produces grape juice concentrate. Grape juice concentrate is sold to the food and wine industries as a raw material for the production of juice- based products, no-sugar-added foods and beverages. Grape juice concentrate competes with other domestically produced and imported fruit- based concentrates. As a result of the Almaden\/Inglenook Acquisition, the Company believes that it is the leading grape juice concentrate producer in the United States. Sales of grape juice concentrate accounted for approximately 11% and 12% of the Company's net sales for its fiscal years ended 1992 and 1993, respectively. The table below sets forth the unit volumes (in thousands of gallons) for the grape juice concentrate sold by the Company and the grape juice concentrate business acquired in the Almaden\/Inglenook Product Lines for the 1992, 1993 and 1994 fiscal years:\nOther Wine Product and Related Services. The Company's other wine related products and services include: grape juice; St. Regis, the leading non-alcoholic line of wines in the United States; Paul Masson and other brandies; wine coolers sold primarily under the Sun Country brand name; cooking wine; and wine for the production of vinegar. The Company also provides various bottling and distillation production services for third parties.\nBeer. The Company is the fourth largest marketer of imported beers in the United States. The Company distributes Corona, St. Pauli Girl, Modelo Especial and Tsingtao, four of the top imported beer brands in the United States. The table below sets forth the unit volume (in thousands of cases) and net sales (in thousands) for the beer sold by Barton for the years ended August 31:\n1992 1993 1994\nNET VOLUME NET VOLUME NET VOLUME SALES SALES SALES\n$131,868 10,152 $158,359 12,422 $173,883 14,100\nThe Company's principal imported beer brands include:\nCorona: The number one selling beer in Mexico and the second largest selling imported beer in the United States. In addition, the Company believes that Corona is the largest selling import in the territory in which it is distributed by the Company. The Company has represented the supplier of Corona since 1978 and currently sells Corona and its related Mexican beer brands in 25 primarily western states.\nSt. Pauli Girl: The 15th largest selling imported beer in the United States, and the second largest selling German import.\nModelo Especial: One of the family of products imported from the supplier of Corona, Modelo Especial is the number one selling canned beer in Mexico and is growing in the United States with 1994 shipments into the United States increasing by 57% over 1993 shipments in the same period.\nTsingtao: The largest selling Chinese beer in the United States.\nThe Company's other imported beer brands include Pacifico and Negra Modelo from Mexico, Peroni from Italy and Double Diamond from the United\nKingdom. In September 1992 the Company acquired the Stevens Point Brewery, a regional brewer located in Wisconsin, together with its brands including Point Special.\nNet sales and unit volumes of the Company's beer brands have grown during the previous two fiscal years as a result of the acquisition of the St. Pauli Girl and Double Diamond brands on July 1, 1992, the acquisition of the Point brands in September 1992 and increased sales of Corona and the Company's other Mexican beer brands. The Company's selling prices were not increased significantly over this time period.\nDistilled Spirits. The Company is the eighth largest producer, importer and marketer of distilled spirits in the United States. The Company produces, bottles, imports and markets a diversified line of quality distilled spirits, and also exports distilled spirits to more than 15 foreign countries. The table below sets forth the unit volumes (in thousands of 9-liter cases) and net sales (in thousands) for the distilled products case goods sold by Barton for the years ended August 31:\n1992 1993 1994\nNET VOLUME NET VOLUME NET VOLUME SALES SALES SALES\n$82,677 5,609 $82,270 5,529 $81,367 5,370\nThe Company's leading distilled spirits brands include:\nMonte Alban: A premium priced product which the Company believes is the number one selling mezcal in the United States.\nMontezuma: This brand is the number two selling tequila in the United States.\nTen High Bourbon: One of the leading bourbon brands in the United States.\nBarton Gin and Vodka: Well-known leading national brands.\nOther products include Crystal Palace Gin and Vodka, Lauder's, House of Stuart and Highland Mist Scotch whiskeys, Kentucky Gentleman, Very Old Barton and Tom Moore bourbon whiskeys, Sabroso coffee liqueur, Northern Light, Canadian Host and Canadian Supreme Canadian whiskeys and Imperial, Barton Reserve and Barton Premium blended whiskeys. Substantially all of the Company's unit volume consists of products marketed in the price value segment, which the Company believes constituted approximately 50% of the distilled spirits market in calendar 1993.\nNet sales and unit volumes of the Company's distilled spirits brands have decreased 1.6% and 4.3%, respectively, over the periods shown, there have been changes in sales of particular brands. Unit volumes of vodka and tequila have increased while Scotch and bourbon have experienced\ndecreases in unit volume. Net sales have generally not been affected by price increases.\nIn addition to the branded products described above, the Company also sells distilled spirits in bulk and provides contract production and bottling services. These activities accounted for net sales during the 12 month periods ended August 31, 1992, 1993 and 1994 of $11.8 million, $10.6 million and $7.0 million, respectively.\nMarketing and Distribution\nThe Company's products are distributed and sold throughout the United States through over 1,000 wholesalers, as well as through state alcoholic beverage control agencies. The Company employs a full-time in-house sales organization of approximately 350 people to develop and service its sales to wholesalers and state agencies. The Company's sales force is organized in four sales units: a beer unit, a spirits unit and two wine units, one of which focuses on the newly acquired brands purchased in the Almaden\/Inglenook Acquisition. The Company believes that the organization of its sales force into four divisions positions it to maintain a high degree of focus on each of its principal product categories.\nThe Company's marketing strategy places primary emphasis upon promotional programs directed at its broad national distribution network (and to the retailers served by that network). The Company closely manages its advertising expenditures in relation to the performance of its brands. The Company has extensive marketing programs for its brands including television, radio, outdoor and print advertising, promotional programs on both a national basis and regional basis in accordance with the strength of the brands, event sponsorship, market research, point-of- sale materials, trade advertising and public relations.\nTrademarks and Distribution Agreements\nThe Company's wine products are sold under a number of trademarks. All of these trademarks are either owned by the Company or used by the Company under exclusive license or distribution agreements.\nThe Company also owns the following trademarks used in its distilled spirits business: Montezuma, House of Stuart, Highland Mist, Kentucky Gentleman, Barton, Canadian Supreme and Sabroso. The Monte Alban trademark for use outside of Mexico is jointly owned by the Company and the supplier of Monte Alban Mezcal. The Company owns the world-wide sales and marketing rights outside of Mexico.\nIn September 1989, Barton purchased certain assets from Hiram Walker & Sons, Inc. (\"Hiram Walker\") and obtained licenses to use the trade names Ten High, Crystal Palace, Northern Light, Lauder's, and Imperial for an initial seven year period. Under an agreement dated January 28, 1994, the Company paid $5.1 million to Hiram Walker for the extension of licenses to use these brand names and certain other spirits brands, for varying periods, the longest of which terminates in 2116.\nAll of the Company's imported beer products are marketed and sold pursuant to exclusive distribution agreements from the suppliers of these products. These agreements have terms that vary and prohibit the Company from importing other beers from the same country. The Company's agreement\nto distribute Corona and its other Mexican beer brands exclusively throughout 25 states was renewed effective January 1994 and expires in December 1998 with automatic renewal thereafter for one year periods from year to year unless terminated. Under this agreement, the Mexican supplier has the right to consent to Mr. Goodman's successor as Chairman and Chief Executive Officer of Barton's beer subsidiary, which consent may not be unreasonably withheld, and, if such consent is properly withheld, to terminate the agreement. The Company's agreement for the importation of St. Pauli Girl expires in 1998 with automatic renewal until 2003 unless the Company terminates the Agreement. The Company's agreement for the exclusive importation of Tsingtao throughout the entire United States was renewed effective January 1994 and expires in December 1996 with an automatic renewal to December 1999. Prior to their expiration, these agreements may be terminated if the Company fails to meet certain performance criteria. The Company believes it is currently in compliance with all of its material distribution agreements. Given the Company's long-term relationships with its suppliers, the Company does not believe that these agreements will be terminated and expects that such agreements will be renewed prior to their expiration.\nCOMPETITION\nThe beverage alcohol industry is highly competitive. The Company competes on the basis of quality, price, brand recognition and distribution. The Company's beverage alcohol products compete with other alcoholic and non-alcoholic beverages for consumer purchases, as well as shelf space in retail stores and for marketing focus by the Company's wholesalers. The Company competes with numerous multinational producers and distributors of beverage alcohol products, many of which have significantly greater resources than the Company. The Company's principal competitors include E&J Gallo Winery in the wine category, Van Munching & Co., Molson Breweries USA and Guinness in the imported beer category and United Distillers Glenmore and Jim Beam Brands in the distilled spirits category.\nPRODUCTION\nThe Company's wines are produced from several varieties of wine grapes grown principally in California and New York. The grapes are crushed at the Company's wineries and stored as wine, grape juice or concentrate. Such grape products may be made into wine for sale under the Company's brand names, sold to other companies for resale under their own labels, or shipped to customers in the form of juice, juice concentrate, unfinished wines, high-proof grape spirits or brandy. Most of the Company's wines are bottled and sold within 18 months after the grape crush. The Company's inventories of wines, grape juice and concentrate are usually at their highest levels in November and December, immediately after the crush of each year's grape harvest, and are substantially reduced prior to the subsequent year's crush.\nThe bourbon whiskeys, domestic blended whiskeys and light whiskeys marketed by the Company are primarily produced and aged by the Company at its distillery in Bardstown, Kentucky, though it may from time to time supplement its inventories through purchases from other distillers. At its Atlanta, Georgia facility, the Company produces all of the grain neutral spirits used by it in the production of vodka, gin and blended whiskey sold by it to customers in the state of Georgia. The Company's\nrequirements of Canadian and Scotch whiskeys, and tequila, mezcal, and the grain neutral spirits used by it in the production of gin and vodka for sale outside of Georgia, and other spirits products, are purchased from various suppliers.\nSources and Availability of Raw Materials\nThe principal components in the production of the Company's branded beverage alcohol products are: packaging materials, primarily glass; grapes; and other agricultural products, such as grain.\nThe Company utilizes glass bottles and other materials, such as caps, corks, capsules, labels and cardboard cartons in the bottling and packaging of its products. Glass bottle costs is one of the largest components of the Company's cost of product sold. The glass bottle industry is highly concentrated with only a small number of producers. The Company has traditionally obtained, and continues to obtain, its glass requirements from a limited number of producers. The Company has not experienced difficulty in satisfying its requirements with respect to any of the foregoing and considers its sources of supply to be adequate. However, the inability of any of the Company's glass bottle suppliers to satisfy the Company's requirements could adversely affect the Company's operations.\nMost of the Company's annual grape requirements are satisfied by purchases from each year's harvest, which occurs from July through October. The Company owns no vineyards in California and purchases grapes from over 1,000 independent growers principally in California and New York. In connection with the Vintners Acquisition and the Almaden\/Inglenook Acquisition, the Company acquired certain long term grape purchase contracts. The Company enters into written purchase agreements with a majority of these growers on a year-to-year basis. As a result of this ample grape supply the Company believes that its exposure to phylloxera and other agricultural risks is minimal.\nThe distilled spirits manufactured by the Company require various agricultural products, neutral grain spirits and bulk spirits. The Company fulfills its requirements through purchases from various sources, through contractual arrangements and through purchases on the open market. The Company believes that adequate supplies of the aforementioned products are available at the present time.\nGOVERNMENT REGULATION\nThe Company's operations are subject to extensive federal and state regulation. These regulations cover, among other matters, sales promotion, advertising and public relations, labeling and packaging, changes in officers or directors, ownership or control, distribution methods and relationships, and requirements regarding brand registration and the posting of prices and price changes. All of the Company's facilities are also subject to federal, state and local environmental laws and regulations and the Company is required to obtain permits and licenses to operate its facilities. The Company believes that it is in compliance in all material respects with all presently applicable governmental laws and regulations and that the cost of administration of compliance with such laws and regulations does not have, and is not\nexpected to have, a material adverse impact on the Company's financial condition or results of operations.\nEMPLOYEES\nThe Company has approximately 2,650 full-time employees, approximately 900 of whom are covered by collective bargaining agreements. The Company's collective bargaining agreement covering 368 employees at the Mission Bell winery has expired and negotiations have commenced. Additional workers may be employed by the Company during the grape crushing season. The Company considers its employee relations to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company currently operates 15 wineries, two bottling and distilling plants, one bottling and rectifying plant and a brewery, all of which include warehousing and distribution facilities on the premises. The Company considers its principal facilities to be the Mission Bell winery in Madera, California, the Canandaigua, New York winery, and the Gonzales, California winery and the distilling and bottling facility located in Bardstown, Kentucky. Under the Restructuring Plan, the Central Cellars winery located in Lodi, California and the Soledad, California winery will be closed and offered for sale to reduce excess capacity.\nIn New York, the Company operates four wineries located in Canandaigua, Naples, Batavia and Hammondsport. The Hammondsport winery lease, acquired in the Vintners Acquisition, expires in April 1995. Production at this winery will be consolidated at the Company's other New York wineries.\nThe Company currently operates 11 winery facilities in California, including Central Cellars and Soledad Cellars which are to be closed. In the Almaden\/Inglenook Acquisition, the Company acquired two new facilities located in Escalon and Madera, California. The Madera winery (known as the Mission Bell winery) is a crushing, wine production, bottling and distribution facility and a grape juice concentrate production facility. The Mission Bell winery will absorb the production of Central Cellars. The Escalon facility is operated under a long-term lease with an option to buy. As part of the Restructuring Plan, the branded wine bottling operations at the Gonzales, California facility where Paul Masson and Taylor Cellars are currently bottled will be moved to the Mission Bell winery during fiscal 1995. The other wineries operated in California are located in Lodi, McFarland, Madera, Fresno and Ukiah.\nThe Company operates three facilities that produce and\/or bottle and store distilled spirits. It owns production, bottling and storage facilities in Bardstown, Kentucky and Atlanta, Georgia, and operates a bottling plant in Carson, California, near Los Angeles, under a management contract. The Bardstown facility distills, bottles and warehouses whiskey for the Company's account and on a contractual basis for other participants in the industry. The Company also owns a production plant in Atlanta, Georgia which produces vodka, gin and blended whiskeys. The Carson plant receives distilled spirits in bulk from Bardstown and outside vendors, which it bottles and distributes. The Company also performs contract bottling at the Carson plant.\nThe Company owns a brewery in Stevens Point, Wisconsin where it produces and bottles Point beer. In addition, the Company owns and maintains its corporate headquarters in Canandaigua, New York, and leases office space in Chicago, Illinois, for its Barton headquarters.\nThe Company believes that all of its facilities are in good condition and working order and have adequate capacity to meet its needs for the foreseeable future.\nMost of the Company's real property has been pledged under the terms of collateral security mortgages as security for the payment of outstanding loans under the Credit Facility.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are subject to litigation from time to time in the ordinary course of business. Although the amount of any liability with respect to such litigation cannot be determined, in the opinion of management, such liability will not have a material adverse effect on the Company's financial condition or results of operations.\nIn connection with an investigation in the State of New Jersey into regulatory trade practices in the beverage alcohol industry, one employee of the Company was arrested in March 1994 and another employee has subsequently come under investigation in connection with providing \"free goods\" to retailers in violation of New Jersey beverage alcohol laws. Employees of several wholesalers and other alcoholic beverage manufacturers were also arrested or are under active investigation. Although the New Jersey Attorney General's office may expand its criminal investigation to include the Company and other manufacturers, to date, no grand jury subpoenas have been issued and no charges have been brought. The Company has cooperated with the Attorney General's office and, as a result of extensive discussions, the Attorney General's office has requested and the Company has submitted a detailed proposal to achieve a resolution of all civil, criminal and regulatory issues. The Company does not believe that the dollar amount of such a settlement or its effect on the Company's operations, if any, will be material.\nThe United States Environmental Protection Agency (the \"EPA\") and the Georgia Environmental Protection Division (the \"GEPD\") conducted a Compliance Evaluation Inspection (\"CEI\") of Barton Brands of Georgia, Inc. (\"Barton Georgia\"), a subsidiary of Canandaigua Wine Company, Inc., on February 15, 1994. The CEI was conducted to determine compliance with the Resource Conservation and Recovery Act (\"RCRA\"). Following the inspection, the EPA sent a report of its findings together with a transmittal letter, dated March 7, 1994, to Barton Georgia.\nBy letter dated March 21, 1994, the GEPD implemented enforcement action by serving Barton Georgia with a formal Notice of Violation alleging that between August 1991 and August 1993, Barton Georgia has violated certain regulations pertaining to (i) generation and accumulation of hazardous waste and (ii) hazardous waste burning in boilers. These alleged violations relate to the burning of fusel oil which is a mixture of alcohols created by the distillation process used\nin manufacturing various types of liquor products. Accompanying the Notice of Violation was a proposed settlement agreement in the form of a Consent Order between the GEPD and Barton Georgia. Following counterproposals, on October 21, 1994, Barton Georgia entered into a settlement agreement under the terms of a final Consent Order (the \"Order\") with the GEPD with respect to this matter. Under the Order, Barton Georgia has paid a stipulated civil penalty of $99,000, and will incur approximately $16,000 of other costs. Barton Georgia is not burning fusel oil in its current operations. The signing of the settlement agreement by Barton Georgia does not constitute any finding, determination or adjudication of liabiity on the part of Barton Georgia, nor any finding, determination or adjudication of a violation of any State or Federal laws, rules, standards or requirements; nor did Barton Georgia make any admission with respect thereto by signing the settlement agreement.\nExecutive Officers of the Company\nThe following table sets forth information with respect to the executive officers of the Company:\nNAME AGE OFFICE HELD\nMarvin Sands 70 Chairman of the Board Richard Sands 43 President and Chief Executive Officer Robert Sands 36 Executive Vice President and General Counsel Ellis M. Goodman 57 Executive Vice President of the Company and Chief Executive Officer of Barton Incorporated Lynn K. Fetterman 47 Senior Vice President, Chief Financial Officer and Secretary Chris Kalabokes 47 Senior Vice President, President of Wine Division Bertram E. Silk 62 Senior Vice President\nMarvin Sands is the founder of the Company, which is the successor to a business he started in 1945. He has been a director of the Company and its predecessor since 1946 and was Chief Executive Officer until October 1993. Marvin Sands is the father of Richard Sands and Robert Sands.\nRichard Sands, Ph.D. has been employed by the Company in various capacities since 1979. He was elected Executive Vice President and a director in 1982, became President and Chief Operating Officer in May 1986 and was elected Chief Executive Officer in October 1993. He is a son of Marvin Sands and the brother of Robert Sands.\nRobert Sands was appointed Executive Vice President, General Counsel in October 1993. He was elected a director of the Company in January 1990 and served as Vice President, General Counsel since June 1990. From June 1986, until his appointment as Vice President, General Counsel, Mr. Sands was employed by the Company as General Counsel. He is a son of Marvin Sands and the brother of Richard Sands.\nEllis M. Goodman has been a director and Vice President since July 1993 and was elected Executive Vice President in October 1993. Mr. Goodman has been Chief Executive Officer of Barton Incorporated since\n1987 and Chief Executive Officer of Barton Brands, Ltd. (predecessor to Barton Incorporated) since 1982.\nLynn K. Fetterman joined the Company during April 1990 as its Vice President, Finance and Administration, Secretary and Treasurer and was elected Senior Vice President, Chief Financial Officer and Secretary in October 1993. For more than 10 years prior to that, he was employed by Reckitt and Colman in various executive capacities, including Vice President, Finance of its Airwick Industries Division and Vice President, Finance of its Durkee-French Foods Division. Mr. Fetterman's most recent position with Reckitt and Colman was as its Vice President-Controller. Reckitt and Colman's principal business relates to consumer food and household products.\nChris Kalabokes joined the Company during October 1991 as President and Chief Executive Officer of the Company's Guild Wineries & Distilleries, Inc. subsidiary. During September 1992, he was appointed to the position of Vice President, President of the Wine Division of the Company and in October 1993 was appointed a Senior Vice President. For more than five years prior to joining the Company, he was employed by Guild. Mr. Kalabokes joined Guild in April 1985 as its Chief Financial Officer and continued in that position until June 1987 when he was promoted to President and Chief Executive Officer.\nBertram E. Silk has been a director and Vice President of the Company since 1973 and was elected Senior Vice President in October 1993. He has been employed by the Company since 1965. Currently, Mr. Silk is in charge of the Company's grape grower relations in California. Before moving from Canandaigua, New York to California in 1989, Mr. Silk was in charge of production for the Company. From 1989 to August 1994, Mr. Silk was in charge of the Company's grape juice concentrate business in California.\nPART II\nItem 5.","section_4":"","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nThe Company's Class A Common Stock and Class B Common Stock are quoted on the Nasdaq National Market under the symbols \"WINEA\" and \"WINEB\", respectively. The following table sets forth for the periods indicated the high and low sales prices of the Class A Common Stock and the Class B Common Stock as reported on the Nasdaq National Market.\nProperty, plant and equipment - Property, plant and equipment is stated at cost. Major additions and betterments are charged to property accounts, while maintenance and repairs are charged to operations as incurred. The cost of properties sold or otherwise disposed of and the related allowance for depreciation are eliminated from the accounts at the time of disposal and resulting gains or losses are included as a component of operating income.\nOther assets - Other assets which consist of goodwill, distribution rights, agency license agreements, trademarks, deferred financing costs, cash surrender value of officers' life insurance and other amounts, are stated at cost, net of accumulated amortization. Amortization is calculated on a straight-line or effective interest basis over periods ranging from five to forty years. At August 31, 1994, the weighted average of the remaining useful lives of these assets was approximately thirty-five years. The face value of the officers' life insurance policies totaled $2,852,000 in both 1994 and 1993.\nDepreciation - Depreciation is computed primarily using the straight-line method over the following estimated useful lives:\nDescription Depreciable Life Buildings and improvements 10 to 33 1\/3 years Machinery and equipment 7 to 15 years Motor vehicles 3 to 7 years\nAmortization of assets capitalized under capital leases is included with depreciation expense. Amortization is calculated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.\nIncome taxes -\nThe Company uses the liability method of accounting for income taxes. The liability method accounts for deferred income taxes by applying statutory rates in effect at the balance sheet date to the difference between the financial reporting and tax basis of assets and liabilities. In fiscal 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" which replaced Statement of Financial Accounting Standards No. 96, which was the standard the Company previously used. The cumulative effect of this change in accounting principle was not material to the Company's financial statements and was included in the fiscal 1992 tax provision.\nEnvironmental - Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and\/or remedial efforts are probable, and the cost can be reasonably estimated. Generally, the timing of these accruals coincides with completion of a feasibility study or the Company's commitment to a formal plan of action. At August 31,1994 and 1993, liabilities for environmental costs of $100,000 and $1,300,000, respectively, are recorded in other accrued liabilities.\nCommon stock - The Company has two classes of common stock: Class A Common Stock and Class B Common Stock. Class B Common Stock shares are convertible into shares of Class A Common Stock on a one-to-one basis at any time at the option of the holder. Holders of Class B Common Stock are entitled to ten votes per share. Holders of Class A Common Stock are entitled to only one vote per share but are entitled to a cash dividend premium. If the Company pays a cash dividend on Class B Common Stock, each share of Class A Common Stock will receive an amount at least ten percent greater than the amount of the cash dividend per share paid on Class B Common Stock. In addition, the Board of Directors may declare and pay a dividend on Class A Common Stock without paying any dividend on Class B Common Stock.\nOn September 26, 1991 and June 1, 1992, the Company approved three-for-two stock splits of both Class A and Class B Common Stock to stockholders of record on October 11, 1991 and June 22, 1992, respectively. All references in the consolidated financial statements to weighted average number of shares and issued shares have been retroactively restated to reflect the splits (see Note 10).\nNet income per common and common equivalent share - Primary net income per common and common equivalent share is based on the weighted average number of common and common equivalent shares (stock options and stock appreciation rights determined under the treasury stock method) outstanding during the year for Class A Common Stock and Class B Common Stock. Fully diluted earnings per common and common equivalent share assumes the conversion of the 7% convertible subordinated debentures under the \"if converted method\" and assumes exercise of stock options and stock appreciation rights using the treasury stock method.\nAll share and per share amounts have been adjusted for the three-for-two stock splits (see Note 10).\n2. ACQUISITIONS:\nGuild - On October 1, 1991, the Company acquired Cook's, Cribari, Dunnewood and other brands and substantially all of the assets and assumed certain liabilities (the Guild Acquisition) from Guild Wineries and Distilleries (Guild). The assets acquired included accounts receivable, inventories, property, plant and equipment and other assets. The Company also assumed certain liabilities consisting primarily of accounts payable. The aggregate purchase price, after adjustments based on a post-closing audit, was approximately $69,300,000. With respect to the purchase price, the Company paid approximately $59,400,000 in cash at closing, assumed liabilities of approximately $11,400,000 of which approximately $1,600,000 was discharged immediately and, based upon the results of a post-closing audit, received from Guild during October 1992 approximately $1,500,000, exclusive of accrued interest. The Company also paid approximately $2,700,000 of direct acquisition costs and $2,600,000 in escrow to finance the purchase of grapes related to Guild's 1991 grape harvest.\nThe Guild Acquisition was accounted for using the purchase method; accordingly, the assets and liabilities of Guild have been recorded at their estimated fair market value at the date of acquisition. The excess of purchase price over the estimated fair market value of the net assets acquired (goodwill), $1,344,000, is being amortized on a straight-line basis over forty years. The results of operations of Guild have been included in the Consolidated Statements of Income since the date of acquisition.\nBarton - On June 29, 1993, pursuant to the terms of a Stock Purchase Agreement (the Stock Purchase Agreement) among the Company, Barton Incorporated (Barton) and the Selling Stockholders, the Company acquired from the Selling Stockholders all of the outstanding shares of the capital stock of Barton (the Barton Acquisition), a marketer of imported beers and imported distilled spirits and a producer and marketer of distilled spirits and domestic beers.\nThe aggregate consideration for Barton consisted of approximately $65,510,000 in cash, one million shares of the Company's Class A Common Stock and payments of up to an aggregate amount of $57,300,000 (the Earn-Out Amounts) which are payable to the Selling Stockholders in cash over a three year period upon the satisfaction of certain performance goals. In addition, the Company paid approximately $1,981,000 of direct acquisition costs, $2,269,000 of direct financing costs, and assumed liabilities of approximately $47,926,000.\nThe purchase price was funded through a $50,000,000 term loan (see Note 7), through $18,835,000 of revolving loans under the Company's Credit Agreement (see Note 7), and through approximately $925,000 of accrued expenses. In addition, one million shares of the Company's Class A Common Stock were issued at $13.59 per share, which reflects the closing market price of the stock at the closing date, discounted for certain restrictions on the issued shares. Of these shares, 428,571 were delivered to the Selling Stockholders and 571,429 were delivered into escrow to secure the Selling Stockholders' indemnification obligations to the Company. Subsequent to year end, the 571,429 shares were released from escrow and delivered to the Selling Stockholders.\nThe Earn-Out Amounts consist of four payments scheduled to be made over a three year period ending November 29, 1996. The first payment of $4,000,000 is required to be made to the Selling Stockholders upon satisfaction of certain performance goals. These goals have been satisfied and this payment was accrued at August 31, 1993 and was made on December 31, 1993. The second payment of $28,300,000 has been accrued at August 31, 1994 and will be made to the Selling Stockholders on December 30, 1994, as a result of satisfaction of certain performance goals and the achievement of targets for earnings before interest and taxes at August 31, 1994. These additional payments have been properly accounted for as additional purchase price for the Barton acquisition. The remaining payments are contingent upon Barton achieving and exceeding certain targets for earnings before interest and taxes and certain other performance goals and are to be made as follows: up to $10,000,000 is to be made on November 30, 1995; and up to $15,000,000 is to be made on November 29, 1996. Such payment obligations are secured in part by the Company's standby irrevocable letter of credit (see Note 7) under the Credit Agreement in an original maximum face amount of $28,200,000 and are subject to acceleration in certain events as defined in the Stock Purchase Agreement. All Earn-Out amounts will be accounted for as additional purchase price for the Barton acquisition when the contingency has been satisfied in accordance with the Stock Purchase Agreement and allocated based upon the fair market value of the underlying assets.\nPursuant to Barton's Phantom Stock Plan (the Phantom Stock Plan) effective April 1, 1990 and amended and restated for Units (as defined in the Phantom Stock Plan) granted after March 31, 1992, certain participants received payments at closing amounting in the aggregate to $1,959,000 in connection with the Barton acquisition. Certain other participants will receive payments only upon vesting in the Phantom Stock Plan during years subsequent to the acquisition. All participants under the Phantom Stock Plan may receive additional payments in the event of satisfaction of the performance goals set forth in the Stock Purchase Agreement and upon release of the shares held in escrow. In the event the maximum payments are received under the Stock Purchase Agreement, the participants will receive an additional $2,137,000 in connection therewith. At August 31, 1994, $554,000 has been accrued under the Phantom Stock Plan and will be paid on January 3, 1995.\nThe Acquisition was accounted for using the purchase method; accordingly, Barton's assets were recorded at fair market value at the date of acquisition. The fair market value of Barton totaled $236,178,000 which was adjusted for negative goodwill of $72,390,000 and an additional deferred tax liability of $24,326,000 based on the difference between the fair market value of Barton's assets and liabilities as adjusted for allocation of negative goodwill and the tax basis of those assets and liabilities which was allocated on a pro-rata basis to noncurrent assets. The results of operations of Barton have been included in the Consolidated Statements of Income since the date of Acquisition.\nVintners - On October 15, 1993, the Company acquired substantially all of the tangible and intangible assets of Vintners International Company, Inc. (Vintners) other than cash and the Hammondsport Winery (the Vintners Assets), and assumed certain current liabilities associated with the ongoing business (the Vintners Acquisition). Vintners was the United States fifth largest supplier of wine with two of the country's most\nhighly recognized brands, Paul Masson and Taylor California Cellars. The wineries acquired from Vintners are the Gonzales winery in Gonzales, California and the Paul Masson wineries in Madera and Soledad, California. In addition, the Company is leasing from Vintners the Hammondsport winery in Hammondsport, New York. The lease is for a period of 18 months from the date of the Vintners Acquisition.\nThe aggregate purchase price of $148,900,000 (the Cash Consideration), is subject to adjustment based upon the determination of the Final Net Current Asset Amount (as defined below). In addition, the Company incurred $8,961,000 of direct acquisition and financing costs. The Company also delivered options to Vintners and Household Commercial of California, Inc., one of Vintners' lenders, to purchase an aggregate of 500,000 shares (the Vintners Option Shares) of the Company's Class A Common Stock, at an exercise price per share of $18.25, which are exercisable at any time until October 15, 1996. These options have been recorded at $8.42 per share, based upon an independent appraisal and $4,210,000 has been reflected as a component of additional paid-in capital. Subsequent to year-end, 432,067 of the Vintners Option Shares have been exercised (see Note 10).\nThe Cash Consideration was funded by the Company pursuant to (i) approximately $12,600,000 of Revolving Loans under the Credit Facility of which $11,200,000 funded the Cash Consideration and $1,400,000 funded the payment of direct acquisition costs; (ii) an accrued liability of approximately $7,700,000 for the holdback described below and (iii) the $130,000,000 Subordinated Bank Loan (see Note 7).\nAt closing the Company held back from the Cash Consideration approximately 10% of the then estimated net current assets of Vintners purchased by the Company, and deposited an additional $2,800,000 of the Cash Consideration into an escrow to be held until October 15, 1995. If the amount of the net current assets as determined after the closing (the Final Net Current Asset Amount) is greater than 90% and less than 100% of the amount of net current assets estimated at closing (the Estimated Net Current Asset Amount), then the Company shall pay into the established escrow an amount equal to the Final Net Current Asset Amount less 90% of the Estimated Net Current Asset Amount. If the Final Net Current Asset Amount is greater than the Estimated Net Current Asset Amount, then, in addition to the payment described above, the Company shall pay an amount equal to such excess, plus interest from the closing, to Vintners. If the Final Net Current Asset Amount is less than 90% of the Estimated Net Current Asset Amount, then the Company shall be paid such deficiency out of the escrow account. As of August 31, 1994, no adjustment to the established escrow was required and the Final Net Current Asset Amount has not been determined.\nThe Vintners Acquisition was accounted for using the purchase method; accordingly, the Vintners Assets were recorded at fair market value at the date of acquisition. The excess of the purchase price over the estimated fair market value of the net assets acquired (goodwill), $42,049,000, is being amortized on a straight-line basis over forty years. The results of operations of Vintners have been included in the Consolidated Statements of Income since the date of acquisition.\nAlmaden\/Inglenook -\nOn August 5, 1994 the Company acquired the Almaden and Inglenook brands, the fifth and sixth largest selling table wines in the United States, a grape juice concentrate business, and wineries in Madera and Escalon, California, from Heublein, Inc. (Heublein) (the Almaden\/Inglenook Acquisition). The Company also acquired Belaire Creek Cellars, Chateau La Salle and Charles Le Franc table wines, Le Domaine champagne and Almaden, Hartley and Jacques Bonet brandy. The accounts receivable and the accounts payable related to the acquired assets were not acquired by the Company.\nThe aggregate consideration for the acquired brands and other assets consisted of $130,600,000 in cash, assumption of certain current liabilities and options to purchase an aggregate of 600,000 shares of Class A Common Stock (the Almaden Option Shares). Of the Almaden Option Shares, 200,000 are exercisable at a price of $30 per share and the remaining 400,000 are exercisable at a price of $35 per share. All of the options are exercisable at any time until August 5, 1996. The 200,000 and 400,000 options have been recorded at $5.83 and $4.19 per share, respectively based upon an independent appraisal, and $2,842,000 has been reflected as a component of additional paid-in capital. The source of the cash payment made at closing, together with payment of other costs and expenses required by the Almaden\/Inglenook Acquisition, was financing provided by the Company pursuant to a term loan under the Credit Facility (see Note 7).\nThe cash purchase price is subject to adjustment based upon the determination of the Final Net Asset Amount as defined in the Asset Purchase Agreement; and, based upon a closing statement delivered to the company by Heublein, was reduced by $9,297,000. In accordance with the terms of the Asset Purchase Agreement, Heublein is obligated to the pay Company this amount plus interest from the closing date. The purchase price for the Almaden\/Inglenook Acquisition at August 31, 1994, reflects the purchase price as adjusted for the payment expected to be received from Heublein. However, as of August 31, 1994, the Final Net Asset Amount has not been determined.\nHeublein also agreed not to compete with the Company in the United States and Canada for a period of five years following the closing of the Almaden\/Inglenook Acquisition in the production and sale of grape juice concentrate or sale of packaged wines bearing the designation \"Chablis\" or \"Burgundy\" except where, among other exceptions, such designations are currently used with certain brands retained by Heublein. Certain companies acquired by Heublein, however, may compete directly with the Company.\nThe Almaden\/Inglenook Acquisition was accounted for using the purchase method; accordingly, the Almaden\/Inglenook assets were recorded at fair market value at the date of acquisition. The excess of purchase price over the estimated fair market value of the net assets acquired (goodwill), $43,939,000, is being amortized on a straight-line basis over forty years. The results of operations of Almaden\/Inglenook have been included in the Consolidated Statement of Income since the date of the acquisition.\nThe following table sets forth unaudited pro forma consolidated statements of income of the Company for the years ended August 31, 1994 and 1993. The fiscal 1994 pro forma consolidated statement of income\ngives effect to the Almaden\/Inglenook Acquisition and the Vintners Acquisition as if they occurred on September 1, 1993. The fiscal 1993 pro forma consolidated statement of income gives effect to the Almaden\/Inglenook Acquisition, the Vintners Acquisition and the Barton Acquisition as if they occurred on September 1, 1992. The August 31, 1994 and 1993 unaudited pro forma consolidated income statements are presented after giving effect to certain adjustments for depreciation, amortization of goodwill, interest expense on the acquisition financing and related income tax effects. The pro forma consolidated statements of income are based upon currently available information and upon certain assumptions that the Company believes are reasonable under the circumstances. The pro forma consolidated statements of income do not purport to represent what the Company's results of operations would actually have been if the aforementioned transactions in fact had occurred on such date or at the beginning of the period indicated or to project the Company's financial position or results of operations at any future date or for any future period.\nSenior Credit Facility - During fiscal 1993, the Company amended its Credit Agreement which provided for $50,000,000 of term loans, up to $55,000,000 in revolving credit loans and a standby, irrevocable letter of credit with a maximum\nface amount of $28,200,000. At August 31, 1993, the Company had outstanding borrowings of $50,000,000 under the term loan and $9,000,000 under the Revolving Credit Loans. At August 31, 1993, the Company had available Revolving Credit Loans totaling $46,000,000 under the amended Credit Agreement. Interest, as described in the agreement, was payable quarterly or on the last day of each interest period based upon either the base rate (higher of the Federal Funds Rate plus 1\/2 of 1% or the bank's prime rate) or the Eurodollar rate, as defined in the Credit Agreement, at the discretion of the Company.\nDuring fiscal 1994, the Company further amended its Credit Agreement in connection with the Vintners and the Almaden\/Inglenook Acquisitions. The amended Credit facility provides for (i) a $224,000,000 Term Loan (the Term Loan) facility due in June 2000, (ii) a $185,000,000 Revolving Credit (the Revolving Credit Loans) facility, which expires in June 2000 and (iii) the continuation of the existing $28,200,000 Letter of Credit related to the contingent payments incurred with the Barton Acquisition. At August 31, 1994, the Company has outstanding Term Loan borrowings of $177,000,000 and Revolving Credit Loans of $19,000,000. On October 24, 1994 the Company borrowed an additional $47,000,000 on the Term Loan and used the proceeds to repay a portion of the outstanding balance on the Revolving Credit Loans incurred since August 31, 1994. The Term Loan Commitment was fully utilized after this borrowing. The Term Loans borrowed under the Credit Facility may be either base rate loans or Eurodollar base rate loans. Base rate loans have an interest rate equal to the higher of either the Federal Funds rate plus 0.5% or the prime rate. Eurodollar rate loans have an interest rate equal to LIBOR plus a margin of 1.25%. The current interest rate margin for both base rate and Eurodollar rate loans may be increased by up to 0.25% and Eurodollar rate loans may be decreased by up to .375%, depending on the Company's debt coverage ratio and long-term senior secured securities' ratings. The principal of the Term Loans is to be repaid in twenty-two quarterly installments of $7,000,000 each beginning December 15, 1994, with a final quarterly payment of $70,000,000 due June 15, 2000. The Company may prepay the principal of the Term Loans and the Revolving Credit Loans at its discretion and must prepay the principal with 65% of its annual excess cash flow, as defined, with proceeds from the sale of certain assets in excess of $10,000,000 and the first $60,000,000 of the net proceeds from any issuance of equity plus 50% of any net proceeds in excess of $60,000,000 (see Note 10). These prepayments must be first applied against regular payments due with respect to the Term Loans in their inverse order of maturity until the Term Loans are fully retired and any further prepayments will be applied to reduce the outstanding Revolving Credit Loans.\nThe $185,000,000 revolving credit available under the Credit Facility may be utilized by the Company either in the form of Revolving Credit Loans or as revolving letters of credit up to a maximum of $12,000,000. At August 31, 1994 the Company had available Revolving Credit Loans under the Senior Credit Facility of $163,753,000. As with Term Loans, Revolving Credit Loans may be either base rate loans or Eurodollar rate loans. Revolving Credit Loans will mature and must be repaid June 15, 2000. For thirty consecutive days at any time during the last two quarters of each fiscal year, the aggregate outstanding principal amount of Revolving Credit Loans combined with the revolving letters of credit cannot exceed $50,000,000.\nThe banks under the Credit Facility have been given security interests in substantially all of the assets of the Company including mortgage liens on certain real property. The Credit Facility requires the Company to meet certain covenants and provides for restrictions on mergers, consolidations and sales of assets, payment of dividends, incurring of other debt, liens or guarantees and the making of investments. The primary financial covenants as defined in the Credit Facility require the maintenance of minimum defined tangible net worth, a debt to cash flow coverage ratio, a fixed charges ratio, maximum capital expenditures, an interest coverage ratio and a current ratio. Among the most restrictive covenants contained in the Credit Facility, the Company is required to maintain a fixed charges ratio not less than 1.0 to 1.0 at the last day of each fiscal quarter of each fiscal year.\nThe Revolving Credit Loans require commitment fees totaling .375% per annum on the daily average unused balance. Commitment fees totaled approximately $223,000, $228,000 and $154,000 in fiscal 1994, 1993 and 1992, respectively.\nThe Company maintains in accordance with the Senior Credit Facility a collar agreement, which protects the Company against three-month London Interbank Offered Rates exceeding 7.5% per annum with a floor rate of 3.3% per annum in an amount equal to $25,000,000 expiring in July 1995. At August 31, 1993, there were no interest rate swap agreements outstanding. At August 31, 1992, the Company had a contract applicable to $22,000,000 of short-term seasonal borrowings which effectively guaranteed a fixed interest rate of 6.82% for seasonal borrowing during the four month period ended September 15, 1992. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements. The Company has not incurred any credit losses in connection with these agreements.\nSenior Subordinated Notes - During fiscal 1994, the Company borrowed $130,000,000 under the Senior Subordinated Loan Agreement. The Company repaid the Subordinated Loan in December 1993 from the proceeds from the Senior Subordinated Notes offering together with revolving loan borrowings. The $130,000,000 Notes are due in 2003 with a stated interest rate of 8.75% per annum. Interest is payable semi-annually on June 15 and December 15 of each year. The Notes are unsecured and subordinated to the prior payment in full of all senior indebtedness of the Company, which includes the Credit Agreement. The Notes are guaranteed, on a senior subordinated basis, by all of the Company's significant operating subsidiaries.\nThe indenture relating to the Notes contains certain covenants, including, but not limited to, (i) limitation on indebtedness; (ii) limitation on restricted payments; (iii) limitation on transactions with affiliates; (iv) limitation on senior subordinated indebtedness; (v) limitation on liens; (vi) limitation on sale of assets; (vii) limitation on issuance of guarantees of and pledges for indebtedness; (viii) restriction on transfer of assets; (ix) limitation on subsidiary capital stock; (x) limitation on the creation of any restriction on the ability of the Company's subsidiaries to make distributions and other payments; and (xi) restrictions on mergers, consolidations and the transfer of all or substantially all of the assets of the Company to another person. The limitation on indebtedness covenant is governed by a rolling four quarter fixed charge coverage ratio covenant requiring a specified minimum.\nConvertible subordinated debentures -\nOn July 23, 1986, the Company issued $60,000,000 7% convertible subordinated debentures used to expand the Company's operations through capital expenditures and acquisitions. The debentures were convertible at any time prior to maturity, unless previously redeemed, into Class A Common Stock of the Company at a conversion price of $18.22 per share, subject to adjustment in the event of future issuances of Common Stock.\nDuring fiscal 1993, an aggregate principal amount of $977,000 of these debentures was converted to 53,620 shares of Class A Common Stock.\nOn October 18, 1993, the Company called its Convertible Debentures for redemption on November 19, 1993 at a redemption price of 102.1% plus accrued interest. Bondholders had until November 19, 1993 to convert their debentures to common stock; any debentures remaining unconverted after that date would be redeemed for cash in accordance with the terms of the original indenture.\nDuring the period September 1, 1993, through November 19, 1993, debentures in an aggregate principal amount of $58,960,000 were converted to 3,235,882 shares of the Company's Class A Common Stock at a price of $18.22 per share. Debentures in an aggregate principal amount of approximately $63,000 were redeemed. Interest was accrued on the debentures until the date of conversion but was forfeited by the debenture holders upon conversion. Accrued interest of approximately $1,370,000, net of the related tax effect of $520,000 was recorded as an addition to additional paid-in capital.\nAt the redemption date, the capitalized debenture issuance costs of approximately $2,246,000 net of accumulated amortization of approximately $677,000 were recorded as a reduction of additional paid-in-capital.\nLoans payable - Loans payable, secured by officers' life insurance policies, carry an interest rate of 5%. The notes carry no due dates and it is management's intention not to repay the notes during the next fiscal year.\nCapitalized lease agreements-Industrial Development Agencies - Certain capitalized lease agreements require the Company to make lease payments equal to the principal and interest on certain bonds issued by Industrial Development Agencies (IDA's). The bonds are secured by the leases and the related facilities. Upon payment of the outstanding bonds, title to the facilities will be conveyed to the Company. These transactions have been treated as capital leases with the related assets acquired to date ($10,731,000) included in property, plant and equipment and the lease commitments included in long-term debt. Accumulated amortization of the foregoing assets under capital leases at August 31, 1994 and 1993 is approximately $8,456,000 and $7,803,000 respectively.\nAmong the provisions under the debenture and lease agreements are covenants that define minimum levels of working capital and tangible net worth and the maintenance of certain financial ratios as defined in the debt agreements.\nPrincipal payments required under long-term debt obligations during the next five fiscal years are as follows:\nYear Ending August 31: (in thousands)\n1995 $ 31,001 1996 29,220 1997 28,698 1998 28,118 1999 28,118 Thereafter 174,968 $320,123\n8. INCOME TAXES:\nDeferred income taxes are provided to reflect the effect of temporary differences primarily related to: (1) using the FIFO basis to value certain inventories for income tax purposes and the LIFO basis for financial reporting purposes; (2) the use of accelerated depreciation methods for income tax purposes and the straight-line method for financial reporting purposes; (3) differences in the treatment of advertising expense and other accruals for financial reporting and income tax purposes and (4) differences between the financial reporting and tax basis of assets and liabilities.\nThe provision for federal and state income taxes consists of the following for the years ended August 31:\nThe deferred tax provision has been increased by approximately $45,000 and $235,000 in fiscal 1994 and 1993, respectively for the impact of the change in the federal statutory rate.\nA reconciliation of total tax provision to the amount computed by applying the expected U.S. Federal income tax rate to income before provision for income taxes is as follows for the years ended August 31:\n9. PROFIT SHARING RETIREMENT PLAN AND RETIREMENT SAVINGS PLAN:\nThe Company's profit-sharing retirement plan, which covers substantially all employees, provides for contributions by the Company in such amounts as the Board of Directors may annually determine and for voluntary contributions by employees. The plan has qualified as tax-exempt under the Internal Revenue Code and conforms with the Employee Retirement Income Security Act of 1974. Company contributions to the plan were $3,414,000, $1,290,000, and $1,249,000 in fiscal 1994, 1993 and 1992, respectively.\nThe Company's retirement savings plan, established pursuant to Section 401(k) of the Internal Revenue Code, permits substantially all full-time employees of the Company to defer a portion of their compensation on a pre-tax basis. Participants may defer up to 10% of their compensation for the year. The Company makes a matching contribution of 25% of the first 4% of compensation an employee defers. Company contributions to this plan were $207,000, $131,000, and $109,000 in fiscal 1994, 1993 , 1992, respectively.\nIn connection with the Barton acquisition, the Company assumed Barton's profit-sharing plan which covers all salaried employees. The amount of Barton's contribution is at the discretion of its Board of Directors, subject to limitations of the plan. Contribution expense was $1,395,000 in fiscal 1994 and $230,000 from the date of acquisition to August 31, 1993.\n10. STOCKHOLDERS' EQUITY:\nStock option and stock appreciation right plan - Canandaigua Wine Company, Inc. has in place a Stock Option and Stock Appreciation Right Plan (the Plan). Under the Plan, non-qualified stock options and incentive stock options may be granted to purchase and stock appreciation rights may be granted with respect to, in the aggregate, not more than 3,000,000 shares of the Company's Class A Common Stock. Options and stock appreciation rights may be issued to employees, officers, or directors of the Company. Non-employee directors are eligible to receive only non-qualified stock options and stock appreciation rights. The option price of any incentive stock option may not be less than the fair market value of the shares on the date of grant. The exercise price of any non-qualified stock option must equal or exceed 50% of the fair market value of the shares on the date of grant. Options are exercisable as determined by the Compensation Committee of the Board of Directors. Changes in the status of the stock option plan during fiscal 1994, 1993 and 1992 are summarized as follows:\nPursuant to the original Plan, on December 21, 1987, the Company granted to key employees stock appreciation rights with respect to 38,250 shares of the Company's Class A Common Stock at a base price of $4.40 per share (the average closing price per share for November 1987 adjusted for the effect of the stock splits). Such rights entitled the employees to payment in stock and cash of market price increases in the Company's stock in the excess of the base price in equal twenty-five percent increments on September 30, 1989 through 1992. In September 1992 and 1991, employees exercised their stock appreciation rights with respect to 4,104 and 2,556 shares of Class A Common Stock, respectively. In addition, an aggregate of 4,950 of the rights were canceled through August 31, 1992. During fiscal 1993, stock appreciation rights previously granted under the Plan expired in accordance with the terms of the Plan.\nEmployee stock purchase plan - In fiscal 1989, the Company approved a stock purchase plan under which 1,125,000 shares of Class A Common Stock can be issued. Under the terms of the plan, eligible employees may purchase shares of the Company's Class A Common Stock through payroll deductions. The purchase price is the lower of 85% of the fair market value of the stock on the first or last day of the purchase period. During fiscal 1993, the plan was amended to allow the participation of Barton employees. During fiscal 1994, 1993 and 1992, employees purchased 58,955, 21,071 and 18,526 shares, respectively.\nCommon stock - On September 26, 1991 and June 1, 1992, the Company's Board of Directors declared three-for-two splits of the Company's common shares. The new shares were distributed on November 8, 1991 and July 20, 1992 to holders of record on October 11, 1991 and June 22, 1992, respectively. At August 31,1994, there were 12,617,301 shares of Class A Common Stock and 3,390,051 shares of Class B Common Stock outstanding, net of treasury stock. All per share amounts have been retroactively restated to give effect to the splits.\nOn June 28, 1993, the Company approved an increase in the number of authorized shares of the Company's Class A Common Stock from 15,000,000 shares to 60,000,000 shares and an increase in the number of authorized shares of the Company's Class B Common Stock from 5,000,000 shares to 20,000,000 shares.\nStock offering - During February 1992, the Company completed a public offering of 2,589,750 shares of its Class A Common Stock resulting in net proceeds after underwriters' discounts and commissions and expenses to the Company, of approximately $31,981,000. Under the terms of the Credit Agreement, approximately $16,000,000, constituting approximately 50% of the net proceeds, was applied to reduction of the Term Loans, and $5,000,000 was applied by the Company to reduce the balances outstanding under the Revolving Credit Loans.\nOn November 10, 1994, the Company completed a public offering of 3,000,000 shares of its Class A Common Stock resulting in net proceeds after underwriters' discounts and commissions and estimated expenses to the Company, of approximately $95,428,000 . In connection with the offering, 432,067 of the Vintners Option Shares were exercised and the Company received proceeds of $7,885,000. Under the terms of the amended Credit Agreement, approximately $82,000,000, will be used to repay a portion of the Term Loan under the Company's Credit Agreement. The balance of net proceeds will be used for working capital purposes and will initially be used to repay Revolving Credit Loans under the Credit Facility.\n11. COMMITMENTS AND CONTINGENCIES:\nOperating leases - Future payments under noncancelable operating leases having initial or remaining terms of one year or more are as follows:\nYear ending August 31: (in thousands) 1995 $1,487 1996 1,352 1997 1,358 1998 1,114 1999 831 Thereafter 3,543 $9,685\nRental expense was approximately $3,318,000 in fiscal 1994, $1,841,000 in fiscal 1993 and $1,460,000 in fiscal 1992.\nPurchase commitments - The Company has two agreements with certain suppliers to purchase blended Scotch whisky through December 31, 1999. The purchase prices under the agreements are denominated in British pounds sterling and based upon exchange rates at August 31, 1994, the Company's aggregate future obligation will be approximately $13,124,000 to $16,306,000 for the contracts expiring on December 31, 1995 and approximately $11,160,000 to $13,640,000 for the contracts expiring on December 31, 1999.\nIn connection with the Vintners Acquisition, and the Almaden\/Inglenook Acquisition, the Company has assumed purchase contracts with certain growers and suppliers. Under the grape purchase contracts, the Company is committed to purchase all grape production yielded from a specified number of acres for a period of time ranging up to ten years. The actual tonnage and price of grapes that must be purchased by the Company will vary each year depending on certain factors, including weather, time of harvest, overall market conditions and the agricultural practices and location of the growers and suppliers under contract.\nThe Company purchased $ 25,167,000 of grapes under these contracts during the period October 15, 1993 through August 31, 1994. Based on current production yields and published grape prices, the Company estimates that the aggregate purchases under these contracts over the remaining term of the contracts will be approximately $394,467,000. During fiscal 1994, in connection with the Vintners Acquisition and the Almaden\/Inglenook Acquisition, the Company established a reserve for the estimated loss on these firm purchase commitments of approximately $62,664,000.\nThe Company's aggregate obligations under the grape crush and processing contracts will be approximately $5,503,000 over the remaining term of the contracts which expire through fiscal 1997.\nCurrency forward contracts - At August 31, 1994 and 1993, the Company had open currency forward contracts to purchase German deutsche marks of $6,674,000 and $6,031,000 respectively, and British pounds of $579,000 and $928,000, respectively,\nall of which mature within 12 months; their fair market values, based upon August 31, 1994 and 1993 market exchange rates, were $7,382,000 and $6,262,000, respectively, for German deutsche marks and $614,000 and $929,000 respectively for British pounds.\nEmployment contracts - The Company has employment contracts with certain of its executive officers and certain other management personnel with remaining terms ranging up to five years. These agreements provide for minimum salaries, as adjusted for annual increases, and may include incentive bonuses based upon attainment of specified management goals. In addition, these agreements also provide for severance payments in the event of specified terminations of employment. The aggregate commitment for future compensation and severance, excluding incentive bonuses, was approximately $7,300,000 as of August 31, 1994.\nLegal matters - The Company is subject to litigation from time to time in the ordinary course of business. Although the amount of any liability with respect to such litigation cannot be determined, in the opinion of management, such liability will not have a material adverse effect on the Company's financial condition or results of operations.\n12. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK:\nThe Company sells its products principally to wholesalers for resale to retail outlets including grocery stores, package liquor stores, club and discount stores and restaurants. Gross sales to the five largest wholesalers of the Company represented 23.7%, 25.1% and 28.5% of the Company's gross sales for the fiscal years ended August 31, 1994, 1993 and 1992, respectively. Gross sales to the Company's largest wholesaler represented 12.3% of the Company's gross sales for the fiscal year ended August 31, 1994; no single wholesaler was responsible for greater than 10% of gross sales during the fiscal years ended August 31, 1993 and 1992. Gross sales to the Company's five largest wholesalers are expected to continue to represent a significant portion of the Company's revenues. The Company's arrangements with certain of its wholesalers may, generally, be terminated by either party with prior notice. The Company performs ongoing credit evaluations of its customers' financial position, and management of the Company is of the opinion that any risk of significant loss is reduced due to the diversity of customers and geographic sales area.\n13. THE RESTRUCTURING PLAN\nIn the fourth quarter, the Company provided for costs to restructure the operations of its California wineries (the Restructuring Plan). Under the Restructuring Plan, all bottling operations at the Central Cellars winery in Lodi, California and the branded wine bottling operations at the Monterey Cellars Winery in Gonzales, California will be moved to the Mission Bell Winery located in Madera, California which was acquired by the Company in the Almaden\/Inglenoook Acquisition. The Monterey Cellars Winery will continue to be used as a crushing, winemaking and contract bottling facility. The Central Cellars Winery and the winery in Soledad, California will be closed and offered for sale to reduce surplus capacity. The\nRestructuring Plan reduced income before income taxes and net income by approximately $24,005,000 and $14,883,000, respectively or $.91 per share, on a fully diluted basis. Of the total pretax charge, approximately $16,481,000 is to recognize estimated losses associated with the revaluation of land, buildings and equipment related to the facilities described above to their estimated net realizable value; and approximately $7,524,000 relates to severance and other benefits associated with the elimination of 260 jobs. The Restructuring Plan will require the Company to make capital expenditures of approximately $20,000,000 during fiscal 1995 to expand storage capacity and install certain relocated equipment. As of August 31,1994, the Company has a remaining accrual of approximately $9,106,000 with respect to the Restructuring Plan. The Company expects to have the Restructuring Plan fully implemented by the end of fiscal 1995.\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nSELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (In thousands, except per share data)\nQUARTER ENDED 11\/30\/93 2\/28\/94 5\/31\/94 8\/31\/94 YEAR\nNet sales $154,485 $140,031 $154,223 $180,845 $629,584 Gross profit 44,655 41,668 42,775 53,275 182,373 Net income 5,653 5,741 6,655 (6,316) 11,733 Earnings per share: Primary .40 .35 .41 (.39) .74 Fully diluted .37 .35 .41 (.38) .74\nQUARTER ENDED 11\/30\/92 2\/28\/93 5\/31\/93 8\/31\/93 YEAR\nNet sales $71,109 $58,782 $60,495 $115,922 $306,308 Gross profit 21,537 17,693 18,411 33,737 91,378 Net income 3,604 2,952 3,391 5,657 15,604 Earnings per share: Primary .31 .25 .29 .45 1.30 Fully diluted .28 .24 .27 .41 1.20\nQUARTER ENDED 11\/30\/91 2\/28\/92 5\/31\/92 8\/31\/92 YEAR\nNet sales $63,580 $56,942 $65,068 $59,652 $245,242 Gross profit 17,834 17,211 18,829 16,683 70,557 Net income 2,410 2,128 3,357 3,461 11,356 Earnings per share: Primary .26 .23 .29 .30 1.08 Fully diluted .25 .22 .27 .27 1.01\nPer share amounts have been appropriately adjusted to reflect the Company's stock splits (see Note 10 in the Company's consolidated financial statements).\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE V CANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nPROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\nBalance at Transfers, Balance Beginning Addition Retirements at End Classification of Year at Cost or Sales of Year\nYEAR ENDED AUGUST 31, 1992: Land $ 1,206 $ 2,925 $ - $ 4,131 Buildings and improvements 19,926 6,370 - 26,296 Machinery and equipment 57,606 25,126 60 82,672 Motor vehicles 1,792 19 - 1,811 Construction in progress 937 3,702 2,425 2,214 $81,467 $38,142 $ 2,485 $117,124\nYEAR ENDED AUGUST 31, 1993: Land $ 4,131 $ 472 $ 298 $ 4,305 Buildings and improvements 26,296 3,839 - 30,135 Machinery and equipment 82,672 9,095 606 91,161 Motor vehicles 1,811 1,495 752 2,554 Construction in progress 2,214 5,404 5,543 2,075 $117,124 $20,305 $ 7,199 $130,230\nYEAR ENDED AUGUST 31, 1994: Land $ 4,305 $ 9,889 $ 380 $ 13,814 Buildings and improvements 30,135 34,160 1,855 62,440 Machinery and equipment 91,161 90,006 12,936 168,222 Motor vehicles 2,554 171 173 2,552 Construction in progress 2,075 6,964 59 8,989 $130,230 $141,190 $15,403 $256,017\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE VI\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nACCUMULATED DEPRECIATION AND AMORTIZATION OF\nPROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\nBalance at Retirements Balance at Beginning and Other End of Classification of Year Provision Disposals Year\nYEAR ENDED AUGUST 31, 1992: Buildings and improvements $ 5,990 $ 760 $ - $ 6,750 Machinery and equipment 31,523 5,150 3 36,670 Motor vehicles 962 172 - 1,134 $38,475 $6,082 $ 3 $44,554\nYEAR ENDED AUGUST 31, 1993: Buildings and improvements $ 6,750 $ 918 $ - $ 7,668 Machinery and equipment 36,670 6,315 9 42,976 Motor vehicles 1,134 156 304 986 $44,554 $7,389 $313 $51,630\nYEAR ENDED AUGUST 31, 1994: Buildings and improvements $ 7,668 $ 1,361 $ 2 $ 9,027 Machinery and equipment 42,976 8,989 296 51,669 Motor vehicles 986 184 132 1,038 $51,630 $10,534 $430 $61,734\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE IX\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nSHORT-TERM BORROWINGS\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\n1994 1993 1992\nNotes Payable to Banks for Short-Term Borrowings\nBalance at August 31, $19,000 $ 9,000 $ -\nWeighted average interest rate on notes payable to banks at end of year 6.45% 5.7% -\nMaximum amount of notes payable outstanding at any month-end 185,000 35,000 14,000\nWeighted average amount of notes payable outstanding during the year (a) 55,375 18,500 4,000 Weighted average interest rate on notes payable outstanding during the year (b) 6.07% 5.7% 7.3%\n(a) The weighted average amount of notes payable outstanding for fiscal 1994, 1993 and 1992 was calculated by dividing the sum of total short-term borrowings outstanding at each month end by the number of months in the fiscal year.\n(b) The weighted average interest rate on notes payable outstanding during fiscal 1994, 1993 and 1992 was calculated by dividing the total interest expense on all short-term borrowings by the average daily amount outstanding.\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE X\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nSUPPLEMENTARY OPERATING STATEMENT INFORMATION\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\nCharged to Cost and Expenses Item 1994 1993 1992\nExcise taxes $231,475 $83,109 $59,875\nAdvertising 64,540 33,002 24,285\nMaintenance and repairs 5,221 2,563 2,171\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\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 (except for the information regarding executive officers required by Item 401 of Regulation S-K which is included in Part I hereof in accordance with General Instruction G(3)) is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995 under the heading \"Nomination and Election of Directors\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\nItem 11. Executive Compensation.\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995, under the heading \"Executive Compensation\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995, under the headings \"Beneficial Ownership\" and \"Nomination and Election of Directors\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\nItem 13. Certain Relationships and Related Transactions\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995, under the heading \"Executive Compensation\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\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 Company are submitted herewith:\nReport of Independent Public Accountants\nConsolidated Balance Sheets - August 31, 1994 and 1993\nConsolidated Statements of Income for the years ended August 31, 1994, 1993 and 1992\nConsolidated Statements of Changes in Stockholders' Equity for the years ended August 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the years ended August 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe following consolidated financial information is submitted herewith:\nSchedule V Property, Plant and Equipment for the years ended August 31, 1994, 1993 and 1992\nSchedule VI Accumulated Depreciation and Amortization of Property, Plant and Equipment for the years ended August 31, 1994, 1993 and 1992\nSchedule IX Short-term Borrowings for the years ended August 31, 1994, 1993 and 1992\nSchedule X Supplementary Operating Statement Information for the years ended August 31, 1994, 1993 and 1992\nSelected Financial Data -- Five-Year Summary\nSelected Quarterly Financial Information (Unaudited)\nAll other schedules are not submitted because they are not applicable or not required under Regulation S-X or because the required information is included in the financial statements or notes thereto.\nIndividual financial statements of the Registrant have been omitted because the Registrant is primarily an operating company and no subsidiary included in the consolidated financial statements has minority equity interests and\/or non-current indebtedness, not guaranteed by the Registrant, in excess of 5% of total consolidated assets.\n3. Exhibits required to be filed by Item 601 of Regulation S-K\nThe following exhibits are filed herewith or incorporated herein by reference, as indicated:\n2.1 Asset Purchase Agreement dated August 2, 1991 between the Registrant and Guild Wineries and Distilleries, as assigned to an acquiring subsidiary (filed as Exhibit 2(a) to the Registrant's Report on Form 8-K dated October 1, 1991 and incorporated herein by reference). 2.2 Stock Purchase Agreement dated April 27, 1993 among the Registrant, Barton Incorporated and the stockholders of Barton Incorporated, Amendment No. 1 to Stock Purchase Agreement dated May 3, 1993, and Amendment No. 2 to Stock Purchase Agreement dated June 29, 1993 (filed as Exhibit 2(a) to the Registrant's Current Report on Form 8-K dated June 29, 1993 and incorporated herein by reference). 2.3 Asset Sale Agreement dated September 14, 1993 between the Registrant and Vintners International Company, Inc. (filed as Exhibit 2(a) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 2.4 Amendment dated as of October 14, 1993 to Asset Sale Agreement dated as of September 14, 1993 by and between Vintners International Company, Inc. and the Registrant (filed as Exhibit 2(b) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 2.5 Amendment No. 2 dated as of January 18, 1994 to Asset Sale Agreement dated as of September 14, 1993 by and between Vintners International Company, Inc. and the Registrant (filed as Exhibit 2.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended February 28, 1994 and incorporated herein by reference). 2.6 Asset Purchase Agreement dated August 3, 1994 between the Registrant and Heublein, Inc. (filed as Exhibit 2(a) to the Registrant's Current Report on Form 8-K dated August 5, 1994 and incorporated herein by reference). 2.7 Amendment dated November 8, 1994 to Asset Purchase Agreement between Heublein, Inc. and Registrant (filed as Exhibit 2.2 to the Registrant's Registration Statement on Form S-3 (Amendment No. 2) (Registration No. 33-55997) filed with the Securities and Exchange Commission on November 8, 1994 and incorporated herein by reference).\n2.8 Amendment dated November 18, 1994 to Asset Purchase Agreement between Heublein, Inc. and the Registrant (filed herewith). 3.1 Restated Certificate of Incorporation of the Company (filed as Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 3.2 Amended and Restated By-laws of the Company (filed as Exhibit 4.2 to the Registrant's Registration Statement on Form S-8 (Registration No. 33-56557) and incorporated herein by reference).\n4.1 Specimen of Certificate of Class A Common Stock of the Company (filed as Exhibit 1.1 to the Registrant's Registration Statement on Form 8-A, dated April 28, 1992 and incorporated herein by reference). 4.2 Specimen of Certificate of Class B Common Stock of the Company (filed as Exhibit 1.2 to the Registrant's Registration Statement on Form 8-A, dated April 28, 1992 and incorporated herein by reference). 4.3 Indenture dated as of December 27, 1993 among the Registrant, its Subsidiaries and Chemical Bank (filed as Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1993 and incorporated herein by reference). 4.4 First Supplemental Indenture dated as of August 3, 1994 among the Registrant, Canandaigua West, Inc. and Chemical Bank (filed as Exhibit 4.5 to the Registrant's Registration Statement on Form S-8 (Registration No. 33- 56557) and incorporated herein by reference). 10.1 The Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Appendix B of the Company's Definitive Proxy Statement dated December 23, 1987 and incorporated herein by reference). 10.2 Amendment No. 1 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1992 and incorporated herein by reference). 10.3 Amendment No. 2 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 28 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1992 and incorporated herein by reference). 10.4 Amendment No. 3 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Rights Plan (filed as Exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.5 Amendment No. 4 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1993 and incorporated herein by reference). 10.6 Amendment No. 5 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended February 28, 1994 and incorporated herein by reference). 10.7 Employment Agreement between Barton Incorporated and Ellis M. Goodman dated as of October 1, 1991 as amended by Amendment to Employment Agreement between Barton Incorporated and Ellis M. Goodman dated as of June 29, 1993 (filed as Exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.8 Barton Incorporated Management Incentive Plan (filed as Exhibit 10.6 to the Registrant's Annual Report on Form\n10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.9 Ellis M. Goodman Split Dollar Insurance Agreement (filed as Exhibit 10.7 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.10 Barton Brands, Ltd. Deferred Compensation Plan (filed as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.11 Marvin Sands Split Dollar Insurance Agreement (filed as Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.12 Amendment and Restatement dated as of June 29, 1993 of Credit Agreement among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(b) to the Registrant's Current Report on Form 8-K dated June 29, 1993 and incorporated herein by reference). 10.13 Amendment No. 1 dated as of October 15, 1993 to Amendment and Restatement dated as of June 29, 1993 of Credit Agreement among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(c) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 10.14 Senior Subordinated Loan Agreement dated as of October 15, 1993 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as Agent (filed as Exhibit 2(d) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 10.15 Second Amendment and Restatement dated as of August 5, 1994 of Amendment and Restatement of Credit Agreement dated as of June 29, 1993 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(b) to the Registrant's Current Report on Form 8-K dated August 5, 1994 and incorporated herein by reference). 10.16 Amendment No. 1 (dated as of August 5, 1994) to Second Amendment and Restatement dated as of August 5, 1994 of Amendment and Restatement of Credit Agreement dated as of June 29, 1993 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed herewith). 10.17 Security Agreement dated as of August 5, 1994 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(c) to the Registrant's Current Report on Form 8-K dated August 5, 1994 and incorporated herein by reference. 11.1 Statement of computation of per share earnings (filed herewith). 21.1 Subsidiaries of Registrant (filed herewith). 23.1 Consent of Arthur Andersen & Co. (filed herewith).\n(b) Reports on Form 8-K\nThe following Current Reports on Form 8-K were filed with the Securities and Exchange Commission during the fourth quarter of the Company's 1994 fiscal year:\n1. Form 8-K dated June 23, 1994. This Form 8-K reported information under Item 5 (Other Events).\n2. Form 8-K dated August 5, 1994. This Form 8-K reported information under Item 2 (Acquisition or Disposition of Assets), Item 5 (Other Events) and 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":"64670_1994.txt","cik":"64670","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS. Medtronic, Inc. (together with its subsidiaries, \"Medtronic\" or the \"company\") was incorporated as a Minnesota corporation in 1957. Medtronic is the world's leading therapeutic medical device company, developing, manufacturing and marketing therapies for improved cardiovascular and neurological health. Primary products include implantable pacemaker systems used for treatment of bradycardia, implantable tachyarrhythmia management devices for treatment of ventricular arrhythmias, mechanical and tissue heart valves, balloon and guiding catheters used in angioplasty, implantable neurostimulation and drug delivery systems, and perfusion systems including blood oxygenators, centrifugal blood pumps, autotransfusion systems and cannula products. More than half of Medtronic's revenues are generated from the sale of implantable cardiac pacemaker systems for treatment of bradycardia (\"brady pacemakers\"). These systems consist of implantable pulse generators (\"IPGs\") and leads, which are the insulated wires that carry electrical impulses from the IPG to the heart.\nIn March 1994, Medtronic acquired substantially all assets and liabilities of DLP, Inc. for approximately $128.3 million in cash. DLP is the market leader in the development, manufacture, and sale of cannula products used in heart surgery. Other DLP products are used in marking and targeting suspected malignancies during diagnostic and interventional procedures. DLP will operate as part of the company's Cardiac Surgery business.\nIn April 1994, Medtronic acquired all of the outstanding common stock of Electromedics, Inc. for approximately $95.3 million. The purchase price consisted of approximately $39.1 million payable in cash and approximately 778,000 shares of common stock valued at $56.2 million. Electromedics designs, manufactures and markets blood management and blood conservation equipment for use in autotransfusion, or retransfusion of a patient's own blood, during major medical procedures. Electromedics will operate as part of the company's Cardiac Surgery business.\nIn April 1994, Medtronic also acquired all of the remaining outstanding common stock of Carbon Implants, Inc. Carbon Implants is an innovator in pyrolytic carbon coating processes and the design and manufacture of mechanical heart valves using these processes for enhanced durability and biocompatibility. The total purchase price was approximately $34.6 million in cash.\nIn July 1993, Medtronic sold substantially all the assets of its Medtronic Andover Medical, Inc. (\"AMI\") subsidiary. AMI manufactured electrodes, cables and related devices for the neurological and cardiovascular markets. Annual sales of AMI were approximately $23 million. Medtronic has now completed its recent strategy to divest businesses that do not directly support its core implantable and invasive medical technology businesses.\nMedtronic operates in a single industry segment, that of providing products for medical applications. Its revenues, operating profits and assets for the past three fiscal years (1992-1994) have been attributable to this single industry segment.\nBUSINESS NARRATIVE. Medtronic generally has vertically integrated manufacturing operations, and makes its own lithium batteries, feedthroughs, integrated and hybrid circuits, and certain other components. Sales of pacemaker and tachyarrhythmia management products, such as IPGs, the implantable pacer\/cardioverter\/defibrillator (\"PCD(R)\") device, leads and instrumentation accounted for 67.2% of Medtronic's net sales during the fiscal year ended April 30, 1994 (\"fiscal 1994\"), 65.7% of net sales in fiscal 1993 and 66.1% of net sales in fiscal 1992.\nMedtronic produces various models of brady pacemakers and leads. These include pacemakers which can be noninvasively programmed by the physician to adjust sensing, electrical pulse intensity, duration, rate, and other characteristics, as well as pacemakers which can sense in both the upper and lower chambers of the heart and produce impulses to cause upper or lower chamber contractions, or both, in appropriate relation to heart activity. Medtronic produces LEGEND II(R) and ELITE II(R) pacemakers, which are rate variable in response to patient activity levels. LEGEND II(R) and ELITE II(R) models currently account for a substantial portion of Medtronic's U.S. and international single chamber and dual chamber pacemaker product sales, respectively. The Thera(R) pacing system, consisting of a new line of pulse generators, a new specialized lead and a new model 9790 programmer which can be used with all brady pacing products as well as the Jewel(tm) family of PCD(R) devices, was commercially released outside the U.S. in March 1994, and the pulse generators are in clinical evaluation in the U.S. In addition to the \"Medtronic\" line of pacemakers, the company also produces a separate line of IPGs and leads under the brand name \"Vitatron.\"\nThe Pacing business also produces the PCD(R), an implantable device for treating ventricular tachyarrhythmias using a tiered therapy of pacing, cardioversion and defibrillation. In December 1993, the Transvene(R) lead system was commercially introduced in the U.S. This transvenous lead system allows the PCD(R) device to be implanted without a thoracotomy, thereby reducing patient trauma and hospitalization time. Medtronic's Transvene(R) leads and the PCD(R) comprise the first complete transvenous, tiered therapy system to be cleared by the FDA in the United States.\nThe next generation of tachyarrhythmia devices is the Jewel(TM) family, which is designed to be implanted in the chest rather than the abdomen. The Jewel(TM) PCD(R) implantable defibrillator, which allows shorter implant procedures and reduced hospital stays, was commercially released outside the U.S. in December 1993 and has been in clinical evaluation in the U.S. since September 1993.\nMedtronic's products, other than brady pacing and tachyarrhythmia management products, accounted for the following percentages of its net sales in fiscal 1994: other cardiovascular products, which include heart valves, oxygenators, blood pumps, angioplasty catheters and other related cardiovascular products, 23.6% (22.9% for fiscal 1993 and 21.4% for fiscal 1992); and neurological and other businesses, which include implantable neurostimulation devices, drug administration systems, and venture-related products, 9.2% (11.4% for fiscal 1993 and 12.5% for fiscal 1992). The decrease in percentage of revenue contributed by neurological and other businesses is due to divested product lines during fiscal 1993 and 1994.\nGOVERNMENT REGULATION. The industry segment in which Medtronic competes involves development, production and sales of medical devices. In the United States, the FDA, among other governmental agencies, is responsible for regulating the introduction of new medical devices, laboratory and manufacturing practices, and labeling and recordkeeping for medical devices, as well as for reviewing manufacturers' required reports of adverse experience to identify potential problems with marketed medical devices. The FDA can ban certain medical devices, detain or seize adulterated or misbranded medical devices and order repair, replacement, or refund, and require notification of health professionals and others with regard to medical devices that present unreasonable risks of substantial harm to the public health. The FDA may also enjoin and restrain certain violations of the Food, Drug and Cosmetic Act and the Safe Medical Devices Act pertaining to medical devices, or initiate action for criminal prosecution of such violations. Many of the devices that Medtronic develops and markets are in a category for which the FDA has implemented stringent clinical investigation and premarket clearance requirements. Moreover, the FDA administers certain controls over the export of such devices from the United States.\nThe number of medical devices approved by the FDA for commercial release has decreased significantly in recent years due to more rigorous clinical evaluation requirements, increased enforcement actions, and enactment of the Safe Medical Devices Act of 1990, which reflect a trend toward more stringent product regulation by the FDA. Rigorous regulatory action may be taken in response to deficiencies noted in inspections or to any product performance problems. The risks in the United States of lengthened introduction times for new products and additional expense have increased substantially. In addition, the requirements for post-market surveillance and device tracking under the Safe Medical Devices Act will continue to increase the expense of the regulatory process.\nMedical device laws are also in effect in many of the countries in which Medtronic does business outside the United States. These range from comprehensive device approval requirements for some or all of Medtronic's medical device products to requests for product data or certifications. The number and scope of these requirements is increasing. This trend toward increasing product regulation is evident in the European Economic Community, where efforts are underway to harmonize the regulatory systems.\nPresident Clinton's administration has introduced a health care reform bill that would cause significant changes in health care delivery. Congress is currently considering this bill and others, and it is generally expected that Congress will pass a health care reform bill in some form which could affect health care expenditures in the United States. Similar initiatives to limit the growth of health care costs, including price regulation, are also underway in several other countries in which the company does business. These changes are causing the marketplace to place increased emphasis on the delivery of more cost-effective medical therapies. Although the company believes it is well positioned to respond to changes resulting from health care reform, the uncertainty as to the outcome of any proposed legislation or change in the marketplace precludes the company from predicting the impact such reform may have on future operating results.\nThe U.S. Health Care Financing Agency, which determines Medicare reimbursement policy and practice, appears to be changing its practice of reimbursing hospitals for procedures involving medical devices in clinical evaluation. Such a change in practice is causing some hospitals to treat Medicare patients only with medical devices that have been cleared for commercial release by the FDA. This action will probably limit the scope of clinical trials in the U.S., force more clinical research to non-U.S. markets and increase the cost and time required to complete clinical evaluations in the U.S.\nMedtronic is also subject to various environmental laws and regulations both in the United States and abroad. The operations of the company, like those of other medical device companies, involve the use of substances regulated under environmental laws, primarily in manufacturing and sterilization processes. In addition, many of these substances contain chlorofluorocarbons which, under federal law, must be phased out in the mid-1990s. Medtronic believes that alternatives are available and plans to eliminate the use of chlorofluorocarbons in compliance with such requirements. While it is difficult to quantify the potential impact of compliance with environmental protection laws, management believes that such compliance will not have a material impact on the company's financial position.\nSALES, MARKETS AND DISTRIBUTION METHODS. The primary markets for Medtronic's products are hospitals, other medical institutions and physicians, both in the United States and abroad. No one customer individually accounts for a material amount of Medtronic's total sales.\nMedtronic sells most of its products and services directly through its staff of trained, full-time sales representatives. Sales by these representatives accounted for approximately 94.5% of Medtronic's U.S. sales and approximately 61.7% of its sales from other countries in fiscal 1994. The remaining sales were made through independent distributors. Medtronic maintains inventories of its high volume sales products in various locations in the United States and in the rest of the world.\nNEW PRODUCTS. New products recently introduced by Medtronic include, in part, the following: (i) the Thera(TM) pacing system, consisting of a new line of pulse generators, a new specialized lead and a new 9790 programmer which can be used with all brady pacing products as well as the Jewel(TM) family of PCD(R) devices, was commercially released outside the U.S. in March 1994, and the pulse generators are in clinical evaluation in the U.S.; (ii) the Premier(TM) pacing system, consisting of a single chamber pacemaker and steroid-eluting lead in one package, began clinical trials in non-U.S. markets in November 1993; (iii) the Legend Plus(TM) dual sensor, single chamber pacemaker was commercially released in selected non-U.S. markets in April 1994; (iv) the Diamond(TM) dual chamber, dual sensor pacemaker was commercially released in Europe in January 1994 under the \"Vitatron\" brand name; (v) the Saphir(TM), a single-lead, atrial tracking pacemaker, was commercially released in Europe in May 1994 under the \"Vitatron\" brand name; (vi) the CapSure(R) Z steroid-eluting lead began clinical evaluation in Europe in October 1993; (vii) the Jewel(TM) PCD(R) implantable defibrillator, whose smaller size permits the device to be implanted in the chest rather than the abdomen, was commercially released outside the U.S. in December 1993 and has been in clinical evaluation in the U.S. since September 1993; (viii) the Jewel(TM) PCD(R) with the Active Can(TM) technology, which features a single tripolar transvenous lead that simplifies implantation, began clinical evaluation in non-U.S. markets in November 1993 and in the U.S. in April 1994; (ix) the Atakr(R) RF Ablation System, the world's first battery-operated radio frequency ablation system designed to automatically maintain temperature control, has been granted \"expedited review\" status by the FDA; (x) the Spirit(TM) balloon catheter for coronary angioplasty, offering superior control and maneuverability, was cleared for commercial release by the FDA in August 1993; (xi) the long-balloon version of the Gold Xchange(TM) rapid-exchange catheter for PTCA was commercially released outside the U.S. in 1993, while a new long-balloon model of the 14K(R) over-the-wire catheter was released worldwide in 1993, with both models permitting treatment of long arterial lesions that otherwise would require repositioning and repeat inflation with shorter balloons; (xii) the Panther(TM) PTCA balloon catheter, which offers superior flexibility, strength and angioscopic visualization, was cleared for commercial release in the U.S. in November 1993; (xiii) the Ascent(TM) guiding catheter, with a stiffer shaft for maximum balloon support, a larger lumen to increase visualization and compatibility with a wide range of balloons and adjunctive interventional devices, was cleared for commercial release in the U.S. in February 1994; (xiv) the Sculptor(TM) annuloplasty ring, which is used in repairing the heart's natural valves to improve control of blood flow and circulation, was commercially released in the U.S. in June 1993; (xv) the Hancock(R) M.O. II porcine tissue valve, a bioprosthetic heart valve that offers significant advantages in hemodynamics and durability for the older patient, was cleared for commercial release in the U.S. in December 1993; (xvi) the Mosaic(TM) porcine tissue valve, designed to combine the best features of earlier Medtronic tissue valves and serve each patient longer, began non-U.S. clinical evaluations in February 1994; (xvii) the Parallel(TM) bileaflet mechanical heart valve, made with an innovative pyrolytic carbon coating process to offer excellent biocompatibility and mechanical durability, began clinical evaluations in Europe in May 1994; (xviii) the Hall(TM) collagen impregnated aortic valved conduit, which reduces potential surgical complications by eliminating the need for preclotting prior to surgery, was cleared for commercial release in the U.S. in May 1994; and (xix) the Maxima Plus(TM) membrane oxygenator received clearance for commercial release in the U.S. in February 1994.\nRAW MATERIALS AND PRODUCTION. Medtronic purchases many of the parts and materials used in manufacturing its products from external suppliers and internally manufactures certain of its product components. Medtronic's single- and sole-sourced materials include medical adhesives and resins, certain integrated circuits, power sources, switches, sensors, crystals, polyurethane, silicone rubber, certain electrolytic capacitors, pyrolytic carbon discs, Lioresal(R)* (baclofen, USP) Intrathecal, computer and other peripheral equipment, cable connector assemblies, MP-35N wire, and drawn-brazed stranded wire. Medtronic believes that its suppliers of polyurethane and medical adhesive are the sole U. S. suppliers of such materials. The other noted parts and materials are purchased from single sources for reasons of quality assurance and cost effectiveness. Medtronic works closely with its suppliers to assure continuity of supply while maintaining high quality and reliability. However, the medical device industry was recently advised that, in an effort to reduce potential product liability exposure, certain suppliers have terminated or are planning to terminate sales of certain materials and parts to customers that manufacture implantable medical devices. Medtronic believes that various design, material or supplier alternatives can be found for these materials and components without a significant interruption in production. - ----------- * Registered trademark of CIBA-GEIGY Corporation.\nPATENTS AND LICENSES. Medtronic owns patents on certain of its inventions, and obtains licenses from others as it deems necessary to its business. Medtronic's policy is to obtain patents on its inventions whenever practical. Technological advancement has been characteristically rapid in the industry in which Medtronic competes, and Medtronic does not consider its business to be materially dependent upon any individual patent.\nCOMPETITION AND INDUSTRY. Medtronic sells therapeutic medical devices in the United States and throughout the world. In the businesses in which Medtronic competes, the company faces a mixture of competitors ranging from large multi-national industrial manufacturers to diversified pharmaceutical companies, as well as regional or national manufacturers that offer a limited number of products. Important factors to Medtronic's customers include product reliability and performance, product technology that provides for improved patient benefits, product price, and related product services provided by the manufacturer. Major shifts in industry market shares have occurred in connection with product problems, physician advisories and safety alerts, reflecting the importance and risks of product quality in the medical device industry.\nMedtronic is the leading manufacturer and supplier of brady pacemakers in both the U.S. and non-U.S. markets. Worldwide, approximately ten manufacturers compete in the pacemaker industry. In the U.S., Medtronic and four other manufacturers account for a significant portion of pacemaker sales. Medtronic and five other manufacturers account for most of the non-U.S. pacemaker sales.\nIn the tachyarrhythmia management device market, Medtronic and two other manufacturers based in the U.S. account for most sales of implantable defibrillators within and outside the U.S. Medtronic and one of these other manufacturers has a transvenous lead system cleared for commercial sale in the U.S. Medtronic's PCD(R) device is commercially available with the company's Transvene(TM) leads in U.S. and non-U.S. markets. Five other companies have devices in various stages of development and clinical evaluation.\nIn the angioplasty device market, including balloon and guiding catheters used in coronary artery procedures, there are numerous competitors worldwide. Four competitors based in the United States account for a significant portion of sales of angioplasty devices both in the United States and abroad.\nMedtronic is the second largest manufacturer and supplier of tissue heart valves and also of mechanical heart valves within and outside the U.S. Another large manufacturer and distributor of hospital products and services is the major competitor in tissue heart valves and another company is the major competitor in mechanical heart valves. These two companies and Medtronic are the primary manufacturers and suppliers of heart valves within the U.S. These three companies plus a few competitors outside the U.S. account for most of the non-U.S. heart valve sales.\nIn the blood oxygenator market, there are approximately seven companies that account for a significant portion of the U. S. and non-U.S. markets. Medtronic believes it is the largest manufacturer and supplier of blood oxygenators worldwide. Medtronic is the leading manufacturer of centrifugal blood pumps worldwide.\nMedtronic recently entered the cannula market with the acquisition of DLP, Inc., the market leader in cannula products. See \"General Development of Business\" above. Medtronic and four competitors account for a significant portion of cannulae sales in the U.S.\nMedtronic recently entered the autotransfusion market with the acquisition of Electromedics, Inc. See \"General Development of Business\" above. Medtronic and three competitors account for a significant portion of autotransfusion sales in both U.S. and non-U.S. markets.\nIn neurological devices, Medtronic is the leading manufacturer and supplier of implantable neurostimulation systems. There are a few competitors worldwide. Medtronic and one competitor account for most worldwide sales of implantable drug delivery systems.\nMarket complexity has been intensifying in the medical device industry in recent years. Factors such as relative patent portfolios, government regulation, including the regulatory approval process for medical devices, a more rigorous enforcement climate at the FDA, anticipated significant health care reform, government reimbursement systems for health care costs, product liability litigation and the rapid rate of technological change are increasingly important considerations for existing medical device manufacturers and any potential entrants to the industry.\nRESEARCH AND DEVELOPMENT. Medtronic spent $156.3 million on research and development (11.2% of net sales) in fiscal 1994, $133.0 million (10.0% of net sales) in fiscal 1993 and $109.2 million (9.3% of net sales) in fiscal 1992. Such amounts have been applied toward improving existing products, expanding their applications, and developing new products. Medtronic's present research and development projects span such areas as sensing and treatment of cardiovascular disorders (including bradycardia and tachyarrhythmia, fibrillation, and sinus node abnormalities); improved heart valves, membrane oxygenators and centrifugal blood pump systems; implantable drug delivery systems for pain and other neurological applications; muscle and neurological stimulators; therapeutic catheters; coronary stents and treatments for restenosis; implantable physiologic sensors; cardiac assist systems (cardiomyoplasty) and other applications of transformed muscle; and materials and coatings to enhance blood and device interface.\nMedtronic has not engaged in significant customer or government sponsored research.\nEMPLOYEES. On April 30, 1994, Medtronic and its subsidiaries employed 8,709 persons on a regular, full-time basis and, including temporary and part-time employees, a total of 9,856 employees on a full-time equivalent basis.\nU.S. AND NON-U.S. OPERATIONS AND EXPORT SALES. Medtronic sells products in the following markets: United States, Canada, Latin America, Europe, Middle East, Africa, Japan and other Asia\/Pacific. For financial reporting purposes, the revenues, profitability, and identifiable assets attributable to significant geographic areas are presented in Note 14 to the consolidated financial statements, incorporated herein by reference to Medtronic's 1994 Annual Shareholder Report on page 51. U.S. export sales to unaffiliated customers comprised less than one percent of Medtronic's consolidated sales in each of fiscal 1994, 1993 and 1992.\nOperation in countries outside the U.S. is accompanied by certain financial and other risks. Relationships with customers and effective terms of sale frequently vary by country, often with longer-term receivables than are typical in the U.S. Inventory management is an important business concern due to the potential for rapidly changing business conditions and currency exposure. Currency exchange rate fluctuations can affect income from, and profitability of, non-U.S. operations. Medtronic attempts to hedge these exposures to reduce the effects on net earnings of foreign currency fluctuations. Certain countries also limit or regulate the repatriation of earnings to the United States. Non-U.S. operations in general present complex tax and money management questions requiring sophisticated analysis and precise execution of strategy to meet the company's financial objectives.\nEXECUTIVE OFFICERS OF MEDTRONIC\nSet forth below are the names and ages of current executive officers of Medtronic, Inc., as well as information regarding their positions with Medtronic, Inc., their periods of service in these capacities, and their business experience for the past five or more years. Executive officers generally serve terms of office of approximately one year. There are no family relationships between any of the officers named, nor is there any arrangement or understanding pursuant to which any person was selected as an officer.\nWILLIAM W. GEORGE, age 51, has been President and Chief Executive Officer since May 1991, was President and Chief Operating Officer from March 1989 to April 1991, and has been a director since March 1989. Prior to joining the company, Mr. George was President, Space and Aviation Systems Business, at Honeywell Inc. from December 1987 to March 1989. During his 11 years with Honeywell, Mr. George served in several other executive positions including President, Industrial Automation and Control, from May 1987 to December 1987; and Executive Vice President of that business from January 1983 to May 1987.\nGLEN D. NELSON, M.D., age 57, has been Vice Chairman since July 1988, and has been a director since 1980. From September 1986 to July 1988, he was Executive Vice President of the company. Dr. Nelson was Chairman and Chief Executive Officer of American MedCenters, Inc., an HMO management corporation, from July 1984 to August 1986.\nARTHUR D. COLLINS, JR., age 46, has been Chief Operating Officer since January 1994. From June 1992 to January 1994, Mr. Collins was Executive Vice President and President of Medtronic International. Prior to joining the company, Mr. Collins was Corporate Vice President, Diagnostic Medical Products, at Abbott Laboratories from October 1989 to May 1992 and Divisional Vice President, Diagnostic Medical Products, from May 1984 to October 1989. Mr. Collins held various other management positions at Abbott Laboratories in the United States and Europe from March 1978 to May 1984. Prior to joining Abbott Laboratories, Mr. Collins was a consultant with Booz, Allen & Hamilton.\nBOBBY I. GRIFFIN, age 57, has been Executive Vice President since July 1988, and President, Pacing, since March 1991. From September 1985 to July 1988, Mr. Griffin was Vice President of the Pacing Business Unit.\nBILL K. ERICKSON, age 50, has been Senior Vice President and President, Americas, since January 1994. From May 1992 to January 1994, Mr. Erickson was Senior Vice President and President, U.S. Cardiovascular Sales and Marketing Division. Mr. Erickson was Senior Vice President, U.S. Cardiovascular Division, from January 1990 to May 1992 and was Vice President, U.S. Cardiovascular Distribution, from January 1982 to December 1989.\nRONALD E. LUND, age 59, has been Senior Vice President and General Counsel since November 1990, and Secretary since July 1992, and was Vice President and General Counsel from February 1989 to November 1990. Prior to joining the company, Mr. Lund held various legal and management positions during his 28 years of employment with The Pillsbury Company, which included serving as Vice President and Associate General Counsel from 1984 to February 1989.\nROBERT L. RYAN, age 51, has been Senior Vice President and Chief Financial Officer since April 1993. Prior to joining the company, Mr. Ryan was Vice President, Finance, and Chief Financial Officer of Union Texas Petroleum Corp. from May 1984 to April 1993, Controller from May 1983 to May 1984, and Treasurer from March 1982 to May 1983. Prior to that, Mr. Ryan held several managerial positions at Citibank and McKinsey & Company.\nJANET S. FIOLA, age 52, has been Senior Vice President, Human Resources since March 1994. She was Vice President, Human Resources, from February 1993 to March 1994, and was Vice President, Human Resources Development, from February 1988 to February 1993.\nWILLARD H. LEWIS, age 62, has been Senior Vice President and President, Cardiac Surgery, since March 1994 and was Vice President and President, Cardiac Surgery, from March 1991 to March 1994. He was Vice President from January 1989 to March 1994 and General Manager, Vascular Business\/Cardiopulmonary, from January 1989 to March 1991. Mr. Lewis was a consultant in medical business management from January 1986 to December 1988, which included responsibility for the operations of the company's Cardiopulmonary Business from October 1987 to December 1988. Prior to that, Mr. Lewis held various positions with Bentley Laboratories, including President from July 1978 to January 1986.\nJOHN A. MESLOW, age 55, has been Senior Vice President and President, Neurological Business, since March 1994. He was Vice President and President, Neurological Business, from March 1991 to March 1994, and was Vice President, Neurological Division, from March 1985 to March 1991.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES Medtronic's principal offices are owned by the company and located in the Minneapolis, Minnesota metropolitan area. Manufacturing or research facilities are located in Arizona, California, Colorado, Massachusetts, Michigan, Minnesota, Texas, Puerto Rico, Canada, France, Germany, Italy, the Netherlands and Japan. Approximately 81% of total manufacturing and research space (approximately 1,382,943 square feet) is owned by the company, and the balance is leased.\nMedtronic also maintains sales and administrative offices inside the United States at 48 locations in 27 states and outside the United States at 87 locations in 20 countries. Most of these locations are leased.\nMedtronic is utilizing substantially all of its currently available productive space to develop, manufacture and market its products. The company's facilities are in good operating condition, suitable for their respective uses and adequate for current needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS Notes 11 and 12 to the consolidated financial statements appearing on page 50 of Medtronic's 1994 Annual Shareholder Report are incorporated herein by reference.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR MEDTRONIC'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe information in the sections entitled \"Price Range of Medtronic Stock\" and \"Investor Information\" on page 53 of Medtronic's 1994 Annual Shareholder Report is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA The information for the years 1984 through 1994 on page 52 of Medtronic's 1994 Annual Shareholder Report 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 on pages 35 through 39 of Medtronic's 1994 Annual Shareholder Report is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements, together with the report thereon of independent accountants dated May 23, 1994, appearing on pages 40 through 51 of Medtronic's 1994 Annual Shareholder Report are incorporated herein by reference.\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 MEDTRONIC\nThe information on pages 1 through 6 of Medtronic's Proxy Statement for its 1994 Annual Shareholders' Meeting and on page 10 of such Proxy Statement regarding Section 16(a) requirements is incorporated herein by reference. See also \"Executive Officers of Medtronic\" on pages 6 and 7 hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION The sections entitled \"Election of Directors -- Director Compensation\" and \"Executive Compensation\" on pages 7 through 9 and 14 through 19, respectively, of Medtronic's Proxy Statement for its 1994 Annual Shareholders' Meeting are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT \"Shareholdings of Certain Owners and Management\" on pages 9 and 10 of Medtronic's Proxy Statement for its 1994 Annual Shareholders' Meeting is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information on pages 8 and 9 of Medtronic's Proxy Statement for its 1994 Annual Shareholders' Meeting, concerning services provided to the company by the Chairman of the Board and the Founder of the company in fiscal 1994, is incorporated herein by reference.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. FINANCIAL STATEMENTS\nReport of Independent Accountants (incorporated herein by reference to page 40 of Medtronic's 1994 Annual Shareholder Report)\nStatement of Consolidated Earnings -- years ended April 30, 1994, 1993, and 1992 (incorporated herein by reference to page 41 of Medtronic's 1994 Annual Shareholder Report)\nConsolidated Balance Sheet -- April 30, 1994 and 1993 (incorporated herein by reference to page 42 of Medtronic's 1994 Annual\nStatement of Consolidated Cash Flow -- years ended April 30, 1994, 1993, and 1992 (incorporated herein by reference to page 43 of Medtronic's 1994 Annual Shareholder Report)\nNotes to Consolidated Financial Statements (incorporated herein by reference to pages 44 through 51 of Medtronic's 1994 Annual Shareholder Report)\n2. FINANCIAL STATEMENT SCHEDULES\nV Property, Plant, and Equipment -- years ended April 30, 1994, 1993, and\nVI Accumulated Depreciation of Property, Plant, and Equipment -- years ended April 30, 1994, 1993, and 1992\nVIII Valuation and Qualifying Accounts -- years ended April 30, 1994, 1993, and 1992\nIX Short-term Borrowings -- years ended April 30, 1994, 1993, and 1992\nX Supplementary Income Statement Information -- years ended April 30, 1994, 1993, and 1992\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n3. Exhibits\n(a) Incorporated herein by reference to the cited Appendix in Medtronic's Proxy Statement for its 1994 Annual Meeting of Shareholders filed with the Commission on July 27, 1994.\n(b) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1993, filed with the Commimssion on July 23, 1993.\n(c) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1992, filed with the Commission under cover of Form SE dated July 24, 1992.\n(d) Incorporated herein by reference to the cited exhibit in Medtronic's Proxy Statement for its 1991 Annual Meeting of Shareholders, filed with the Commission on July 24, 1991.\n(e) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1991, filed with the Commission under cover of Form SE dated July 24, 1991.\n(f) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1990, filed with the Commission under cover of Form SE dated July 20, 1990.\n(g) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1989, filed with the Commission under cover of Form SE dated July 20, 1989.\n*Items that are management contracts or compensatory plans or arrangements required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\n(b) REPORTS ON FORM 8-K\nNo reports on Form 8-K were filed by Medtronic during the quarter ended April 30, 1994. 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. MEDTRONIC, INC. Dated: July 25, 1994\nBY: \/S\/ WILLIAM W. GEORGE WILLIAM W. GEORGE PRESIDENT AND CHIEF EXECUTIVE OFFICER\nPursuant to the requirements of the Securities Exchange Act of 1934, the report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Dated: July 25, 1994\nBY: \/S\/ WILLIAM W. GEORGE WILLIAM W. GEORGE PRESIDENT AND CHIEF EXECUTIVE OFFICER Dated: July 25, 1994\nBY: \/S\/ ROBERT L. RYAN ROBERT L. RYAN SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)\nEARL E. BAKKEN F. CALEB BLODGETT WILLIAM W. GEORGE ANTONIO M. GOTTO, JR., M.D. BERNADINE P. HEALY, M.D. VERNON H. HEATH THOMAS E. HOLLORAN EDITH W. MARTIN, PH.D. DIRECTORS GLEN D. NELSON, M.D. RICHARD L. SCHALL JACK W. SCHULER GERALD W. SIMONSON GORDON M. SPRENGER RICHARD W. SWALIN, PH.D. WINSTON R. WALLIN\nRonald E. Lund, by signing his name hereto, does hereby sign this document on behalf of each of the above named directors of the Registrant pursuant to powers of attorney duly executed by such persons.\nDated: July 25, 1994\nBY: \/S\/ RONALD E. LUND RONALD E. LUND ATTORNEY-IN-FACT REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Medtronic, Inc.\nOur audits of the consolidated financial statements referred to in our report dated May 23, 1994 appearing on page 40 of the 1994 Annual Shareholder Report of Medtronic, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in Item 14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/S\/ PRICE WATERHOUSE\nPRICE WATERHOUSE Minneapolis, Minnesota May 23, 1994\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in each Prospectus constituting part of the Registration Statements on Form S-8 (Registration Nos. 2-65157, 2-68408, 33-169, 33-36552, 2-65156, 33-24212, 33-37529, and 33-44230) and Form S-4 (Registration No. 33-52751) of Medtronic, Inc. of our report dated May 23, 1994 appearing on page 40 of the 1994 Annual Shareholder Report 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 as shown above.\n\/S\/ PRICE WATERHOUSE\nPRICE WATERHOUSE Minneapolis, Minnesota July 25, 1994\nMEDTRONIC, INC. AND SUBSIDIARIES SCHEDULE V -- PROPERTY, PLANT, AND EQUIPMENT(B) (IN THOUSANDS OF DOLLARS)\n(a) Completed and transferred to other categories.\n(b) Depreciation is provided using the straight-line method over the following estimated useful lives: Land improvements -- 10 to 20 years Buildings -- 10 to 40 years Equipment -- 3 to 8 years.\n(c) Includes assets associated with the acquisitions of DLP, Electromedics and Carbon Implants in fiscal 1994.\n(d) Includes sales of assets of the Andover Medical, Inc. division in fiscal 1994 and CardioCare and Nortech divisions in fiscal 1993.\nMEDTRONIC, INC. AND SUBSIDIARIES SCHEDULE VI -- ACCUMULATED DEPRECIATION OF PROPERTY, PLANT, AND EQUIPMENT (IN THOUSANDS OF DOLLARS)\n(a) Includes sales of the assets of Andover Medical, Inc. in fiscal 1994 and CardioCare and Nortech in fiscal 1993.\nMEDTRONIC, INC. AND SUBSIDIARIES SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS OF DOLLARS)\n(a) Uncollectible accounts written off, less recoveries.\n(b) Reflects the sale of all assets of the CardioCare division.\n(c) Reflects reclassification of assets retained in the sale of the Nortech division.\n(d) Includes both current and noncurrent amounts.\n(e) Claims settled, less reimbursement by insurance carrier.\nSCHEDULE IX -- SHORT-TERM BORROWINGS (IN THOUSANDS OF DOLLARS)\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION (IN THOUSANDS OF DOLLARS)\n(a) Does not include $18,000 of accelerated intangible assets amortization, a significant portion of which related to the Nortech division. UC9401963-EN\nCommission File Number: 1-7707\nSECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549\n---------------\nEXHIBITS\nTO\nFORM 10-K\nANNUAL REPORT PURSUANT TO SECTION 13\nOF\nTHE SECURITIES EXCHANGE ACT OF 1934\nFOR THE FISCAL YEAR ENDED APRIL 30, 1994\n---------------\nLOGO\nMEDTRONIC, INC. 7000 CENTRAL AVENUE N.E. MINNEAPOLIS, MINNESOTA 55432 TELEPHONE: 612\/574-4000\nEXHIBIT INDEX\n(a) Incorporated herein by reference to the cited Appendix in Medtronic's Proxy Statement for its 1994 Annual Meeting of Shareholders filed with the Commission on July 27, 1994.\n(b) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1993, filed with the Commission on July 23, 1993.\n(c) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1992, filed with the Commission under cover of Form SE dated July 24, 1992.\n(d) Incorporated herein by reference to the cited exhibit in Medtronic's Proxy Statement for its 1991 Annual Meeting of Shareholders, filed with the Commission on July 24, 1991.\n(e) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1991, filed with the Commission under cover of Form SE dated July 24, 1991.\n(f) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1990, filed with the Commission under cover of Form SE dated July 20, 1990.\n(g) Incorporated herein by reference to the cited exhibit in Medtronic's Annual Report on Form 10-K for the year ended April 30, 1989, filed with the Commission under cover of Form SE dated July 20, 1989.","section_15":""}
{"filename":"35527_1994.txt","cik":"35527","year":"1994","section_1":"ITEM 1. BUSINESS\nORGANIZATION\nRegistrant was organized in 1974 under the laws of the State of Ohio. It began operations in 1975 upon reorganization of its principal subsidiary, The Fifth Third Bank. The executive offices of the Registrant are located in Cincinnati, Ohio. The Registrant is a two-tiered, multi-bank holding company as defined in the Bank Holding Company Act of 1956, as amended, and is registered as such with the Board of Governors of the Federal Reserve System. The Registrant is also a multi-savings-and-loan holding company and is registered with the Office of Thrift Supervision. Registrant has thirteen wholly-owned subsidiaries: Fifth Third Kentucky Bank Holding Company; The Fifth Third Bank; The Fifth Third Bank of Columbus; The Fifth Third Bank of Northwestern Ohio, National Association; The Fifth Third Bank of Southern Ohio; The Fifth Third Bank of Western Ohio; Fifth Third Trust Co. & Savings Bank, FSB; Fifth Third Bank of Northern Kentucky, Inc.; The Fifth Third Bank of Central Indiana; The Fifth Third Bank of Southeastern Indiana; Fifth Third Community Development Company; Fifth Third Investment Company; and Fountain Square Insurance Company. Unless the context otherwise indicates the term \"Company\" as used herein means the Registrant and the term \"Bank\" means its wholly-owned subsidiary, The Fifth Third Bank.\nAs of December 31, 1994, the Company's consolidated total assets were $14,957,009,000 and stockholders' equity totalled $1,398,774,000.\nFifth Third Kentucky Bank Holding Company has two wholly-owned subsidiaries: Fifth Third Bank of Kentucky, Inc. and The Fifth Third Savings Bank of Western Kentucky, FSB. In addition, the Bank has four wholly-owned subsidiaries: Midwest Payment Systems, Inc.; Fifth Third Securities, Inc.; The Fifth Third Company; and The Fifth Third Leasing Company.\nPRIOR ACQUISITIONS\nThe Company is the result of mergers and acquisitions over the years involving 27 financial institutions throughout Ohio, Indiana, Kentucky, and Florida. The Company made the following acquisitions during 1994:\nOn May 20, 1994, the Company purchased $294 million in deposits from Equitable Savings Bank. The seven offices were located in southern and central Ohio and were acquired by the Bank, The Fifth Third Bank of Columbus and The Fifth Third Bank of Southern Ohio.\nOn June 3, 1994, the Company acquired The National Bancorp of Kentucky, Inc., with consolidated assets of approximately $90 million, in a transaction accounted for as a pooling of interests. The Consolidated Financial Statements for prior periods have not been restated for this acquisition due to immateriality. National Bancorp's subsidiaries, First National Bank of Falmouth and National Bank of Cynthiana, were merged with Fifth Third Bank of Northern Kentucky, Inc. and Fifth Third Bank of Kentucky, Inc. (formerly Fifth Third Bank of Central Kentucky, Inc.), respectively.\nPage 3\nOn August 26, 1994, the Company acquired The Cumberland Federal Bancorporation, Inc., with consolidated assets of approximately $1.1 billion, and its wholly- owned subsidiary, The Cumberland Federal Savings Bank (\"Cumberland FSB\") in a transaction accounted for as a pooling of interests. Financial information for all prior periods has been restated. In concurrent transactions, Fifth Third Bank of Kentucky, Inc. purchased substantially all of the assets and assumed substantially all of the liabilities of The Cumberland FSB, and The Cumberland FSB's main office was relocated to Mayfield, Kentucky and renamed The Fifth Third Savings Bank of Western Kentucky, FSB.\nCOMPETITION\nThere are hundreds of commercial banks, savings and loans and other financial services providers in Ohio, Kentucky, Indiana, Florida and nationally, which provide strong competition to the Company's banking subsidiaries. As providers of a full range of financial services, these subsidiaries compete with national and state banks, savings and loan associations, securities dealers, brokers, mortgage bankers, finance and insurance companies, and other financial service companies. With respect to data processing services, the Bank's data processing subsidiary, Midwest Payment Systems, Inc., competes with other third party service providers such as Deluxe Data Services, EDS and Electronic Payment Systems.\nThe earnings of the Company are affected by general economic conditions as well as by the monetary policies of the Federal Reserve Board. Such policies, which include regulating the national supply of bank reserves and bank credit, can have a major effect upon the source and cost of funds and the rates of return earned on loans and investments. The Federal Reserve influences the size and distribution of bank reserves through its open market operations and changes in cash reserve requirements against member bank deposits.\nREGULATION AND SUPERVISION\nThe Company, as a bank holding company, is subject to the restrictions of the Bank Holding Company act of 1956, as amended. This Act provides that the acquisition of control of a bank is subject to the prior approval of the Board of Governors of the Federal Reserve System. The Company is required to obtain the prior approval of the Federal Reserve Board before it can acquire control of more than 5% of the voting shares of another bank. The Act does not permit the Federal Reserve Board to approve an acquisition by the Company, or any of its subsidiaries, of any bank located in a state other than Ohio, unless the acquisition is specifically authorized by the law of the state in which such bank is located.\nOn September 29, 1994, the Act was amended by The Interstate Banking and Branch Efficiency Act of 1994 which authorizes interstate bank acquisitions anywhere in the country effective one year after the date of enactment, and interstate branching by acquisition and consolidation effective June 1, 1997, in those states that have not opted out by that date. The impact of this amendment on the Company cannot be measured at this time.\nPage 4\nThe Company's subsidiary state banks are primarily subject to the laws of the state in which each is located, the Board of Governors of the Federal Reserve System and\/or the Federal Deposit Insurance Corporation. The subsidiary banks which are organized under the laws of the United States are primarily subject to regulation by the Comptroller of the Currency and the Federal Deposit Insurance Corporation. The Company and Fifth Third Kentucky Bank Holding Company, as savings and loan holding companies, and their savings and loan subsidiaries are subject to regulation by the Office of Thrift Supervision.\nThe Company and its subsidiaries are subject to certain restrictions on intercompany loans and investments. The Company and its subsidiaries are also subject to certain restrictions with respect to engaging in the underwriting and public sale and distribution of securities. In addition, the Company and its subsidiaries are subject to examination at the discretion of supervisory authorities.\nThe Bank Holding Company Act limits the activities which may be engaged in by the Company and its subsidiaries to ownership of banks and those activities which the Federal Reserve Board has deemed or may in the future find to be so closely related to banking as to be a proper incident thereto.\nThe Financial Reform, Recovery and Enforcement Act of 1989 (FIRREA) provides that a holding company's controlled insured depository institutions are liable for any loss incurred by the Federal Deposit Insurance Corporation in connection with the default of, or any FDIC-assisted transaction involving, an affiliated insured bank or savings association.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (the \"FDIC Improvement Act\") covers a wide expanse of banking regulatory issues. The FDIC Improvement Act deals with the recapitalization of the Bank Insurance Fund, with deposit insurance reform, including requiring the FDIC to establish a risk-based premium assessment system, and with a number of other regulatory and supervisory matters. The full effect of the FDIC Improvement Act generally on the financial services industry, and specifically on the Company, is not determinable.\nEMPLOYEES\nAs of December 31, 1994, there were no employees of the Company. Subsidiaries of the Company employed 6,045 employees--1,015 were officers and 1,237 were part-time employees.\nSTATISTICAL INFORMATION\nPages 6 to 12 contain statistical information on the Company and its subsidiaries.\nPage 5\nSECURITIES PORTFOLIO\nThe securities portfolio as of December 31 for each of the last five years, and the maturity distribution and weighted average yield of securities as of December 31, 1994, are incorporated herein by reference to the securities tables on page 30 of the Company's 1994 Annual Report to Stockholders attached to this filing as Exhibit 13.\nThe weighted average yields for the securities portfolio are yields to maturity weighted by the par values of the securities. The weighted average yields on securities exempt from income taxes are computed on a taxable equivalent basis. The taxable equivalent yields are net after-tax yields to maturity divided by the complement of the full corporate tax rate (35%). In order to express yields on a taxable equivalent basis, yields on obligations of states and political subdivisions (municipal securities) have been increased as follows:\nUnder 1 year 2.16% 1 - 5 years 2.61% 6 - 10 years 2.63% Over 10 years 2.74% Total municipal securities 2.49%\nAVERAGE BALANCE SHEETS\nThe average balance sheets are incorporated herein by reference to Table 1 on pages 26 and 27 of the Company's 1994 Annual Report to Stockholders attached to this filing as Exhibit 13.\nANALYSIS OF NET INTEREST INCOME AND NET INTEREST INCOME CHANGES\nThe analysis of net interest income and the analysis of net interest income changes are incorporated herein by reference to Table 1 and Table 2 and the related discussion on pages 26 through 28 of the Company's 1994 Annual Report to Stockholders attached to this filing as Exhibit 13.\nReserve for Credit Losses - -------------------------\nThe reserve for credit losses is established through charges to operations by a provision for credit losses. Loans and leases which are determined to be uncollectible are charged against the reserve and any subsequent recoveries are credited to the reserve. The amount charged to operations is based on several factors. These include the following:\n1. Analytical reviews of the credit loss experience in relationship to outstanding loans and leases to determine an adequate reserve for credit losses required for loans and leases at risk. 2. A continuing review of problem or at risk loans and leases and the overall portfolio quality. 3. Regular examinations and appraisals of the loan and lease portfolio conducted by the Bank's examination staff and the banking supervisory authorities. 4. Management's judgement with respect to the current and expected economic conditions and their impact on the existing loan and lease portfolio.\nThe amount provided for credit losses exceeded actual net charge-offs by $18,306,000 in 1994, $20,963,000 in 1993 and $20,335,000 in 1992.\nManagement reviews the reserve on a quarterly basis to determine whether additional provisions should be made after considering the factors noted above. Based on these procedures, management is of the opinion that the reserve at December 31, 1994 of $155,918,000 is adequate.\nMaturity Distribution of Domestic Certificates of Deposit of $100,000 - --------------------------------------------------------------------- and Over at December 31, 1993 ($000's) --------------------------------------\nThree months or less $142,325 Over three months through six months 70,936 Over six months through twelve months 23,816 Over twelve months 25,325 -------- Total certificates - $100,000 and over $262,402 ========\nNote: Foreign office deposits are denominated in amounts greater than $100,000.\nShort-Term Borrowings - ---------------------\nShort-term borrowings is comprised of various short-term sources of funds, primarily Federal funds borrowed from correspondent banks, securities sold under agreements to repurchase, short-term bank notes and commercial paper issuances. A summary of the average amount outstanding, maximum month-end balance and weighted average interest rate for the years ended December 31 follows ($000's):\n1994 1993 1992 ------ ------ ------ Average outstanding $1,967,819 1,365,070 1,229,664\nMaximum month-end balance $2,452,218 1,734,920 1,551,092\nWeighted average interest rate 4.12% 3.17 3.80\nReturn on Equity and Assets - ---------------------------\nThe following table presents certain operating ratios:\n1994 1993 1992 ------ ------ ------ Return on assets (A) 1.77% 1.71 1.63\nReturn on equity (B) 18.6% 17.8 16.9\nDividend payout ratio (C) 32.3% 31.7 33.0\nEquity to assets ratio (D) 9.50% 9.61 9.62 - ------------------------------------ (A) net income divided by average assets (B) net income divided by average equity (C) dividends declared per share divided by fully diluted net income per share (D) average equity divided by average assets\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's executive offices and the main office of the Bank are located on Fountain Square Plaza in downtown Cincinnati, Ohio, located in a 32-story office tower and a 5-story office building and parking garage known as the Fifth Third Center and the William S. Rowe Building, respectively. One of the Bank's subsidiaries owns 100% of these buildings.\nThe Company, through its subsidiary banks and savings banks, five located in Ohio, three in Kentucky, two in Indiana and one in Florida, operate 353 banking centers, of which 177 are owned and 176 are leased. The properties owned are free from mortgages and encumbrances.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are not parties to any material legal proceedings other than routine litigation 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\nThe information required by this item is incorporated herein by reference to Page 1 of Registrant's 1994 Annual Report to Stockholders attached to this filing as Exhibit 13.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is incorporated herein by reference to page 35 of Registrant's 1994 Annual Report to Stockholders attached to this filing as Exhibit 13.\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 pages 26 through 34 of Registrant's 1994 Annual Report to Stockholders attached to this filing as Exhibit 13.\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 pages 13 through 25 and page 35 of Registrant's 1994 Annual Report to Stockholders attached to this filing 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 information required by this item concerning Directors is incorporated herein by reference under the caption \"ELECTION OF DIRECTORS\" of the Registrant's 1995 Proxy Statement. The names, ages and positions of the Executive Officers of the Company as of January 31, 1995 are listed below along with their business experience during the past 5 years. Officers are appointed annually by the Board of Directors at the meeting of Directors immediately following the Annual Meeting of Stockholders.\nCURRENT POSITION AND NAME AND AGE BUSINESS EXPERIENCE DURING PAST 5 YEARS - ------------ ---------------------------------------- George A. Schaefer, Jr., 49 PRESIDENT AND CEO. President and Chief Executive Officer of the Company and the Bank since January, 1991. Previously, Mr. Schaefer was President and COO of the Company and the Bank.\nGeorge W. Landry, 54 EXECUTIVE VICE PRESIDENT. Executive Vice President of the Company and the Bank.\nStephen J. Schrantz, 46 EXECUTIVE VICE PRESIDENT. Executive Vice President of the Company and the Bank.\nMichael D. Baker, 44 SENIOR VICE PRESIDENT. Senior Vice President of the Company since March, 1993, and of the Bank.\nP. Michael Brumm, 47 SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER. CFO of the Company and the Bank since June, 1990, and Senior Vice President of the Bank.\nRobert P. Niehaus, 48 SENIOR VICE PRESIDENT. Senior Vice President of the Company since March 1993, and Senior Vice President of the Bank. Previously, Mr. Niehaus was Vice President of the Company.\nJames R. Gaunt, 49 SENIOR VICE PRESIDENT. Senior Vice President of the Company and President and CEO of Fifth Third Bank of Kentucky, Inc. since August, 1994. Previously, Mr. Gaunt was Senior Vice President of the Bank.\nMichael K. Keating, 39 SENIOR VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY. Senior Vice President and General Counsel of the Company since March, 1993 and Senior Vice President and Counsel of the Bank since November, 1989, and Secretary of the Company and the Bank since January, 1994. Mr. Keating is a son of Mr. William J. Keating, Director.\nCURRENT POSITION AND NAME AND AGE BUSINESS EXPERIENCE DURING PAST 5 YEARS - ------------ ------------------------------------------ Neal E. Arnold, 34 TREASURER. Treasurer of the Company and the Bank since October, 1990 and Senior Vice President of the Bank since April, 1993. Previously, Mr. Arnold was Vice President of the Bank since October, 1990. Previously, Mr. Arnold was CFO and Senior Vice President with First National Bank of Grand Forks, North Dakota.\nGerald L. Wissel, 38 AUDITOR. Auditor of the Company and the Bank since March 1990 and Senior Vice President of the Bank since November 1991. Previously, Mr. Wissel was Vice President of the Bank since March 1990. Mr. Wissel was formerly with Deloitte and Touche LLP, independent public accountants.\nRoger W. Dean, 32 CONTROLLER. Controller of the Company and Vice President of the Bank since June, 1993. Previously, Mr. Dean was with Deloitte & Touche LLP, independent public accountants.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated herein by reference under the caption \"EXECUTIVE COMPENSATION\" of the Registrant's 1995 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 under the captions \"CERTAIN BENEFICIAL OWNERS, ELECTION OF DIRECTORS, AND EXECUTIVE COMPENSATION\" of the Registrant's 1995 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is incorporated herein by reference under the caption \"CERTAIN TRANSACTIONS\" of the Registrant's 1995 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\na) Documents Filed as Part of the Report PAGE\n1. Index to Financial Statements\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 Changes in 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* Incorporated by reference to pages 13 through 25 of Registrant's 1994 Annual Report to Stockholders attached to this filing as Exhibit 13.\n2. Financial Statement Schedules\nThe schedules for Registrant and its subsidiaries are omitted because of the absence of conditions under which they are required, or because the information is set forth in the consolidated financial statements or the notes thereto.\n3. Exhibits\nEXHIBIT NO.\n3- Amended Articles of Incorporation and Code of Regulations**\n10(a)- Fifth Third Bancorp Unfunded Deferred Compensation Plan for Non-Employee Directors ***\n10(b)- Fifth Third Bancorp 1990 Stock Option Plan ****\n10(c)- Fifth Third Bancorp 1987 Stock Option Plan *****\n10(d)- Fifth Third Bancorp 1982 Stock Option Plan ******\n10(e)- Fifth Third Bancorp Stock Option Plan for Employees of The Fifth Third Bank of Miami Valley, National Association *******\n10(f)- Fifth Third Bancorp Stock Option Plan for Employees of The Fifth Third Bank of Eastern Indiana ********\n10(g)- Indenture effective November 19, 1992 between Fifth Third Bancorp, Issuer and NBD Bank, N.A., Trustee *********\n10(h)- Fifth Third Bancorp Amended and Restated Stock Option Plan for Employees and Directors of The TriState Bancorp **********\n10(i)- Fifth Third Bancorp 1993 Discount Stock Purchase Plan ***********\n10(j)- Fifth Third Bancorp Amended and Restated Stock Incentive Plan for selected Executive Officers, Employees and Directors of The cumberland Federal Bancorporation, Inc. ************\n10(k)- Fifth Third Bancorp Master Profit Sharing Plan*************\n11- Computation of Consolidated Net Income Per Share for the Years Ended December 31, 1994, 1993, 1992, 1991 and 1990\n13- Fifth Third Bancorp 1994 Annual Report to Stockholders\n21- Fifth Third Bancorp Subsidiaries\n23- Independent Auditors' Consent\nb) Reports on Form 8-K\nNONE. ____________________\n** Incorporated by reference to Registrant's Registration Statement, Exhibits 3.1 and 3.2, on Form S-4, Registration No. 33-19965 which is effective.\n*** Incorporated in this Form 10-K Annual Report by reference to Form 10-K filed for fiscal year ended December 31, 1985.\n**** Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 34075, which is effective.\n***** Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 13252, which is effective.\n****** Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 2-98550, which is effective.\n******* Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 20888, which is effective.\n******** Incorporated by reference to Registrant's filing with the Securities and Exchange Commission on November 18, 1992 a Form 8-K Current Report as an exhibit to a Registration Statement on Form S-8, Registration No. 33-30690, which is effective.\n********* Incorporated by reference to Registrant's filing with the Securities and Exchange Commission on November 18, 1992 a Form 8-K Current Report dated November 16, 1992 and as Exhibit 4.1 to a Registration Statement on Form S-3, Registration No. 33-54134, which is effective.\n********** Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 51679, which is effective.\n*********** Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 60474, which is effective.\n************ Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 55223, which is effective.\n************* Incorporated by reference to Registrant's filing with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form S-8, Registration No. 33- 55553, which is effective.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFIFTH THIRD BANCORP (Registrant)\n\/s\/George A. Schaefer, Jr. February 21, 1995 - ----------------------------- George A. Schaefer, Jr. President and CEO (Principal Executive Officer)\nPursuant to requirements of the Securities Exchange Act of 1934, this report has been signed on February 21, 1995 by the following persons on behalf of the Registrant and in the capacities indicated.\n\/s\/P. Michael Brumm \/s\/Roger W. Dean - --------------------------------- ------------------------------ P. Michael Brumm Roger W. Dean Senior Vice President and CFO Controller (Chief Financial Officer) (Principal Accounting Officer)\n\/s\/John F. Barrett - --------------------- ----------------------- ------------------------- John F. Barrett Ivan W. Gorr Michael H. Norris Director Director Director\n\/s\/Joseph H. Head, Jr. \/s\/Brian H. Rowe - --------------------- ----------------------- ------------------------- Milton C. Boesel, Jr. Joseph H. Head, Jr. Brian H. Rowe Director Director Director\n\/s\/George A. Schaefer, Jr. - --------------------- ----------------------- ------------------------- Clement L. Buenger Joan R. Herschede George A. Schaefer, Jr. Director Director Director\n\/s\/Gerald V. Dirvin \/s\/William G. Kagler \/s\/John J. Schiff, Jr. - --------------------- ----------------------- ------------------------- Gerald V. Dirvin William G. Kagler John J. Schiff, Jr. Director Director Director\n\/s\/William J. Keating \/s\/Dennis J. Sullivan, Jr. - --------------------- ----------------------- ------------------------- Thomas B. Donnell William J. Keating Dennis J. Sullivan, Jr. Director Director Director\n\/s\/James D. Kiggen - --------------------- ----------------------- ------------------------- Richard T. Farmer James D. Kiggen Dudley S. Taft Director Director Director\n\/s\/John D. Geary - --------------------- ----------------------- John D. Geary Robert B. Morgan Director Director","section_15":""}
{"filename":"806393_1994.txt","cik":"806393","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":"715577_1994.txt","cik":"715577","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL Burr-Brown Corporation (and its wholly-owned subsidiaries and majority-owned affiliated companies, \"Burr-Brown\" or the \"Company\") is primarily engaged in the design, manufacture and marketing of a broad line of proprietary, standard, high-performance, analog and mixed signal integrated circuits used in the processing of electronic signals. The Company's products are used primarily in electronic and medical instrumentation, process and industrial control systems, manufacturing automation, automatic test equipment, digital audio, telecommuni- cations, power conversion products, and computer peripherals. The Company also offers a product line of system components which include personal computer data acquisition and signal processing products, data collection systems and data entry terminals. The Company was incorporated in Arizona in 1956 and rein- corporated in Delaware in 1983. The Company's management and technical team has many years of experience in the design, manufacture, and worldwide marketing of highly complex, high performance analog integrated circuits and in solving customer problems in the markets served.\nTHE INDUSTRY Integrated circuits are electronic building blocks used in Original Equipment Manufacturers (OEM) products such as computers, process control systems, test equipment, communications networks, and consumer electronics. Worldwide inte- grated circuit sales are estimated by industry analysts to have been in excess of $92 billion in 1994. Industry analysts estimate that analog integrated circuits represent approximately 16 percent of total integrated circuits and are expected to remain at this level in the near future.\nElectronic signals may be categorized in two forms: analog (linear) and digital. Integrated circuits that are used to process these electronic signals can be categorized as either analog or digital depending upon the technique used in the circuits to process or act on the signal. Mixed signal devices are those that use both analog and digital techniques for signal processing. The general characteristic that separates digital and analog circuits is this: digital circuits operate using digital techniques which use many repetitive circuit elements that are either on or off to represent the \"ones\" and \"zeros\" of the binary number system used in digital computers for computation. Some digital circuits may process analog signals by representing the analog signal in digital form. Examples of digital circuits that are used to manipulate or process electronic signals are memory devices, logic devices, microprocessors, and digital signal processors.\nAnalog circuits process electronic signals using analog techniques, that is, through the use of circuit elements whose output is a continuously varying representation of the input signal. Unlike digital signals which have two states, analog signals effectively have an infinite number of states. In analog processing, signals continuously vary as an analogy of continuously varying conditions such as temperature, pressure, position, frequency, sound and speed. In some cases, digital data are represented as analog signals such as in a modem in which the digital data are represented by the frequency of an analog signal. Analog circuits also provide the power control signals that are required to activate switches for the control of processes or equipment, and regulate voltages for electronic systems. Examples of analog circuits are amplifiers, voltage-to-frequency converters, and products that perform math- ematical functions. Other analog circuits convert analog signals to digital (analog-to-digital converter) so that the signals may be processed by digital processors or digital data to analog signals (digital-to-analog converter) so that the analog signal may be used to drive a \"real world\" element such as a speaker to create sound.\nThe Company believes production of analog circuits has some important advan- tages as compared to digital circuits. The market for analog integrated circuits is generally more stable; prices for analog integrated circuits are usually less volatile than digital circuits. Analog circuits are more dependent on circuit design, circuit layout, and matching of circuit elements. Analog circuit uniqueness and competitive advantage are achieved through inno- vative circuit design in concert with the subtleties of the wafer fabrication and packaging processes. - 2 -\nIn contrast, digital circuits rely heavily on the wafer fabrication process capability to achieve exceptionally high circuit element density, small feature size and low cost. Small circuit dimensions are usually not required to produce most high-performance state-of-the-art analog devices. As a result, production of analog circuits requires significantly less capital investment than that demanded by digital circuits.\nPRODUCTS The Company operates predominately in one segment, the electronic component industry. The Company has various classes of products within that one segment.\nThe following table shows the approximate product line revenues as a percentage of total Company revenues:\nPRODUCT LINE 1994 1993 1992 ____________ ______ ______ ______ Analog Integrated Circuits 43% 42% 37% Data Conversion Integrated Circuits 38% 41% 39% Power Conversion Products 10% 6% 5% Other 9% 11% 19%\nANALOG INTEGRATED CIRCUITS Demand for analog circuits primarily has been driven by the need for increased productivity manifested as the need for lower cost, lower power, smaller size, greater functionality, and higher precision products. Semiconductor technology has provided many effective solutions to this demand. The availability of effective solutions has accelerated with the advent of more advanced digital processing. This has led to greater use of digital computers or processors to provide massive computational power, to control processes and equipment, and in general to greater automation in industry. Since the early seventies, the availability of low cost digital microprocessors and later digital signal pro- cessing, in cost-effective single chip form, has enabled an acceleration of the trend toward digitization of systems. This has led to a high degree of hier- archaically distributed computational power leading to increased use of computers or imbedded processors to measure, control, monitor, or process electronic signals nearer or adjacent to the sensor that is detecting physical conditions. This, in turn, has created the need for products that enable digital computers, microprocessors, and digital signal processors to interact with electronic signals derived from physical or analog phenomena. Burr-Brown designs and manufactures the integrated circuits which perform the analog signal conditioning and data conversion functions critical to this interaction.\nProcess control sensors generate continuously varying electronic signals, called analog or linear signals, which represent the physical phenomenon being measured or controlled. In many circumstances these analog signals are rela- tively weak and contaminated with a large amount of electrical noise. The Company's signal processing components are used to strengthen, filter, transmit and otherwise process the signal. The resulting signal, still in analog form, must be converted into a digital signal before it can be processed by a com- puter. The Company's analog-to-digital circuits effect this conversion. After the digital signal is processed by the computer, it is often necessary to convert the digital signal back to analog form, and the Company's digital-to- analog circuits also accomplish this reverse conversion. The resulting analog signal controls the process.\nThe market requirements for analog signal processing and conversion products range from high performance industrial applications to high volume consumer applications. The Company's product strategy has been to concentrate on pro- prietary high precision or high performance analog, data conversion, and integrated analog\/digital (mixed signal) circuits. The Company identifies significant markets in which new or enhanced high performance products of this type are required. The Company then attempts to develop and supply as com- plete a function as is permitted by technological and cost constraints.\nThe Company's signal processing and data conversion products are generally designed into a customer's product and usually remain a part of that product throughout its life. The Company's experience has been that there is generally a four-year period before the sales level of its products fully matures, and\n- 3 -\nthe sales life of the products may extend to eight years or more. Once the Company's component has been designed into a customer's product, the relatively low volume, high performance characteristics of the component significantly deter potential competitors. As a result, the Company is often that customer's sole source for that particular component.\nAnalog signal processing integrated circuits are used to process and transmit analog data signals prior to their conversion to digital signals. The Company's analog circuits include operational amplifiers, power amplifiers, instrumenta- tion amplifiers, programmable gain amplifiers, isolation amplifiers, current transmitters and other analog signal processing components. These components are used in the construction of complete data acquisition systems, automatic test equipment, analytical instruments, medical instruments and systems, military equipment, industrial controls, computer peripherals and communica- tions equipment.\nOPERATIONAL AMPLIFIERS--Operational amplifiers are used to detect and amplify weak (low level) analog signals and are included in many measurement and con- trol systems. The operational amplifier is the fundamental building block in analog systems design. In addition to amplification, it can perform mathema- tical functions such as integration and differentiation. The Company's high performance operational amplifiers are generally capable of amplifying typical analog signals in the micro-volt range up to 100,000 times and provide ultra- low drift, low bias current, low noise, high bandwidth and fast settling time. Certain models provide high voltage and high current operation for special applications. These high performance amplifiers are required to treat signals generated in numerous applications, including scramblers for satellite communi- cations systems, robotic vision systems and magnetic resonance and computer- aided tomography (CAT) body scanning systems.\nOTHER AMPLIFIERS--The Company manufactures a number of other amplifiers, includ- ing instrumentation amplifiers, programmable gain amplifiers and isolation amplifiers. These products perform a variety of functions related to the ampli- fication and isolation of analog signals. Among other uses, these components permit the measurement of weak signals in the presence of unwanted \"noise\" and protect sensitive instruments from the effects of transient high-magnitude, potentially damaging voltages caused by sources such as lightning or switching of high voltage equipment. These amplifiers are used in many diverse applica- tions ranging from temperature measurement in industrial processes to the protection of sensitive medical instruments, and to isolate electrical power line disturbances and faults.\nOTHER SIGNAL PROCESSING AND TRANSMITTER COMPONENTS--The Company manufactures a variety of other analog signal processing components including mathematical function circuits, current transmitters and voltage-to-frequency converters. Mathematical function circuits are used when information sought can be effec- tively derived only through its mathematical relationship to analog signals. Current transmitters send analog signal information from a process sensor to measurement or control equipment in the form of a current on the same wires that produce the power to the transmitter and sensor. Voltage-to-frequency converters convert process signals to a frequency, making the signal immune to electrical noise and permitting more efficient storage and processing of the information.\nDATA CONVERSION INTEGRATED CIRCUITS Data conversion components are integrated circuit devices used to convert ana- log signals to digital form (A\/D converters) and vice versa (D\/A converters). This conversion is necessary in virtually all applications in which digital computers or processors measure and control the analog signals from a physical, \"real world\" process.\nGENERAL PURPOSE CONVERSION PRODUCTS--The majority of the Company's data conver- sion components revenue is derived from moderate speed, high resolution and high accuracy converters. These general purpose converters are used primarily in manufacturing process instrumentation, electronic test instrumentation, auto- matic test systems and health care systems. For example, in a robot controller, the position of the robot arm must be precisely measured and manipulated. Analog signals from the robot's position sensors are converted by an A\/D converter for computer processing and, in turn, a D\/A converter converts the digital control signal from the computer to analog form to drive the actuators and servo motors to position the robot arm accurately.\n- 4 -\nHIGH SPEED CONVERSION PRODUCTS--In the early 1980's the Company began develop- ing high speed, high resolution analog-to-digital and digital-to-analog converters at speeds many times greater than general purpose products. These products utilize a unique combination of technologies and design expertise to achieve state-of-the-art performance.\nHigh speed converters are used in a variety of applications such as image processing, digital oscilloscopes, ultrasound, radar and sonar, as well as the front end of advanced systems using digital-signal-processing (DSP) technology. The Company believes that due to the unique combination of technologies involved, competition in the high speed, high resolution product area is limited.\nDIGITAL AUDIO D\/A CONVERTERS--The Company believes that it was the first to introduce a viable low cost, high precision, single chip digital-to-analog con- verter for the consumer market, a pulse-code-modulated (PCM) conversion device. This product was being used by Japanese customers as early as 1979 and was introduced publicly in 1982. Designed for the consumer high fidelity stereo market, this D\/A converter plays an essential role in digital audio systems, which use laser technology to achieve improved audio reproduction performance. These systems are playback units that use lasers to read Compact Discs (CD's) containing stereo music encoded in digital form. The Company's component con- verts the digital signals for each stereo channel into audio. The Company believes it is one of the largest merchant market suppliers of such devices worldwide.\nSeveral generations of products of this type have been developed and introduced for use in digital audio systems. Similar products produced by the Company have been designed into digital audio tape (DAT) products. Digital audio tape sys- tems are used to record and play back digitized high fidelity audio signals on tape rather than the discs used in compact disc audio systems. PCM converters have now found their way into musical instruments, computers, automobiles, interfaces to digital signal processors, CD-ROMs for multimedia, and set top box tuners for cable and satellite TV.\nThe Company believes that the technology developed for the digital audio D\/A converter enables the Company to develop products for other markets. For example, serving the compact disc market expedited the Company's development of complete 16-bit digital-to-analog converter integrated circuits for the military and industrial markets. The Company believes it holds a strong posi- tion in the 16-bit and higher precision converter market. Involvement in the compact disc market also helped the Company's early entry into the DAT (digital audio tape) market and multi-media markets.\nDATA COLLECTION SYSTEMS, COMPONENT MICROTERMINAL DEVICES AND PERSONAL COMPUTER INSTRUMENTATION The products of Intelligent Instrumentation Inc. (III), a majority-owned affiliate of Burr-Brown, address the rapidly growing markets for PC-based data collection and automation.\nIII's data acquisition product line includes a broad range of plug-in boards, portable data acquisition systems, and supporting software for IBM compatible PC's, as well as a broad line of signal conditioning accessories for such systems. These products are applied worldwide in a myriad of industrial and scientific applications. III believes that these products compare well with competition in performance, cost-effectiveness, and ease-of-use.\nA key part of the data acquisition product line is software that is easy to use, yet flexible enough to accomplish diverse applications. III's premier software product for data acquisition is Visual Designer, a graphical develop- ment environment which enables users to design applications by connecting functional blocks, called icons, in a flow diagram. Once the diagram is completed, Visual Designer generates code which runs under Microsoft Windows on a standard PC.\nThe LANpoint line of products for enterprise data collection take advantage of a widespread trend toward the use of networks of personal computers. These products integrate a complete Ethernet-ready PC into a small rugged industrial package, along with bar code and magnetic stripe capabilities, digital I\/O and\n- 5 -\nserial ports. In addition, network drivers and tools are provided for Novell, LAN Manager, LANtastic, and TCP\/IP networks, making the products usable in almost any PC networking environment. These products are being marketed through an established network of Value Added Resellers (VARs).\nIII also offers integrated data collection systems which not only collect the data, but format and deliver that data to the customer's information system in real time. This is achieved through the integration of III's data collection hardware and software products to meet a customer's specific needs. The engineering of such systems is a fertile source of inputs for new products, both hardware and software.\nIII's line of microterminals is aimed at the market for embedded applications of microprocessors. Microterminals communicate on a serial link, providing numerous functions and options for the system designer and user. With their aggressively low cost, excellent functionality, and rugged yet attractive packages, microterminals offer system architects a desirable alternative to the designing of customized panels.\nPOWER CONVERSION PRODUCTS The products of Power Convertibles Corporation (PCC), a majority-owned affiliate of Burr-Brown, address DC-to-DC conversion and battery chargers. PCC is one of the leading suppliers of low power DC\/DC converters as well as products to con- dition and charge many types of batteries including cellular telephones. All products are manufactured using surface mount technology with automated pro- cesses at PCC's ISO9001 certified plants in Arizona and Mexico. Its products are supplied worldwide to the computer, medical, industrial, telecommunications, data communications and instrumentation markets.\nPCC has numerous competitors in the low end DC\/DC power conversion market. PCC competes favorably in this market. Their competitive factors include surface mount manufacturing techniques, price and quality. There are several new products under development which will enable PCC to move into the higher end power conversion market where high power density is critical to market success. PCC's new products for this market are being designed to possess some of the highest density ratings in the industry.\nPCC also designs, produces and markets battery chargers for the cellular tele- phone market. A significant proportion of PCC's revenues is generated from a single customer in this market. PCC has established marketing and custom design capabilities in an effort to increase its customer base in this area.\nPRODUCT DEVELOPMENT One of the important factors that distinguishes the analog integrated circuit business from the digital integrated circuit business is the importance of the contribution of innovative individual design engineers. Digital circuits have an exceptional amount of repetition of circuit elements and are highly depen- dent upon the ability to produce chips with vary high circuit element density to minimize chip size and maximize speed. This type of wafer processing of extremely small dimensions leads to the need for state-of-the-art, inordinately costly capital investment in wafer fabrication facilities.\nAnalog circuits, on the other hand, require the ability to accurately match elements and place elements with respect to one another. In addition, analog circuits may require the ability to handle large voltages and currents and therefore demand relatively large circuit element and spacing dimensions. Although these requirements place stringent processing requirements on an analog wafer fabrication facility, the necessary equipment and facilities are substantially less costly and longer lived than required for digital circuit processing.\nDesigners of analog circuits must take into account complex interrelationships between the manufacturing process, the circuit elements, and the packaging process, all of which may seriously affect the circuits' performance. The number of creative design engineers who have the training and the experience to handle these complexities is very limited. The Company's ability to compete depends heavily on its continued introduction of innovatively designed and cost effective new products. Therefore, the Company must continually invest in design engineering talent, engineering tools, production processes, and test equipment. - 6 -\nThe Company emphasizes the development of proprietary standard and application specific products. The Company's product strategy is to identify markets in which the application of microelectronics technology may be used to provide competitive advantage for its customers through improved methods of precision in measuring, monitoring and controlling physical processes and conditions. Examples of these markets are: robotics, factory automation, process control, automatic test, medical instrumentation, computers, communications and digital audio. Within these markets the Company selects specific applications in which the Company's unique design and processing technology may make an important contribution to its customers.\nThe Company spent approximately $21.9 million in 1994, $19.8 million in 1993, and $18.1 million in 1992 for product and process development. This represents an expenditure of approximately 11 percent of sales in each of 1994, 1993 and 1992. (See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's Annual Report to Shareholders, incor- porated by reference to Item 7 of this report.) The Company's current product research and development efforts are focused primarily on the development of ultra high speed and high precision data converters which use mixed signal design techniques and topologies, and high precision signal conditioning inte- grated circuits. The Company also continues to focus on broadening its range of hardware and software offerings to the markets for factory data collection, digital signal processing technology, and the use of personal (PC) and other computer platforms in industrial control, test and laboratory environments.\nBACKLOG Burr-Brown's products are generally standard items with a relatively short delivery cycle. The Company's backlog is usually three months or less of sales although some portion may be scheduled for delivery four to eighteen months into the future. Therefore, the order backlog at the end of any specific quarter is not generally indicative of the level of sales to be expected in succeeding quarters. It is the policy of the Company to include in backlog only those orders that have firm scheduled delivery dates. The Company's back- log as of December 31, 1994, 1993 and 1992 was approximately $45.5 million, $31.4 million, and $29.6 million, respectively.\nMARKETING Burr-Brown markets its products in all the major markets in the industrialized world through its direct sales force, independent sales representatives, and distributors.\nIn approximately 45 countries and the less significant domestic markets where the Company does not have a direct sales force, independent sales representa- tives sell all of the Company's products. The majority of the Company's sales people hold engineering degrees and the balance have relevant engineering experience.\nThe Company markets its line of component and system products to over 22,000 customers. The largest customer accounted for approximately 3 percent of sales in 1994. Burr-Brown products are sold to original equipment manufacturers, systems assemblers and, to a lesser extent, manufacturing concerns which build their own test and process control systems. The Company's components are generally proprietary and are frequently \"designed in\" to its customers' products at the product development state. Accordingly, the Company is often a customer's sole source for a particular component. Over 40 percent of the orders received in 1994 for analog and data conversion integrated circuits were for products introduced within the preceding five years. Representative major customers of the Company include Elsay Bailey Group, Hewlett-Packard Co., Matsushita Electric Corp. of America, Northern Telecom Inc., Siemens AG, Sony Electronics Inc., Toshiba America Electronic Components Inc., Mitsubishi Corp., Alcatel Answare, Nokia Corporation Finland, Advantest Corp., NEC America Inc., IBM, Fujitsu Ltd., Ericsson, and Hughes Network Systems Inc.\nSales outside the United States accounted for approximately 62 percent of total sales in 1994, 64 percent of total sales in 1993 and 61 percent of total sales in 1992. (See the note labeled \"Foreign Operations, Geographic, and Segment Data\" in \"Notes to Consolidated Financial Statements\" in the Company's Annual Report to Shareholders, incorporated by reference to Item 8 of this report.) To support its international marketing organization, the Company has established product development centers and manufacturing facilities in Scotland and Japan. The Company also has four product development centers at the corporate head- quarters in Tucson.\n- 7 -\nA large percentage of international sales are denominated in local currencies and the Company's foreign revenues and net income are therefore subject to currency exchange rate fluctuations. However, the Company borrows funds in local currencies and purchases forward contracts to hedge its foreign currency exposure. Some of the Company's products are subject to export regulations and other international trading restrictions, but the Company has not experienced any material difficulties from these limitations. No assurance can be given, however, that such material difficulties will not be experienced in the future.\nCOMPETITION Burr-Brown estimates that it is among the top 4 manufacturers of high perform- ance amplifiers and data conversion integrated circuits. The Company's major competitor in the high performance analog integrated circuits market in Analog Devices Inc., believed to be the largest supplier of these devices. Other com- petitors include Linear Technology Corp. and Maxim Integrated Products Inc. With respect to a small number of products, the Company also competes with National Semiconductor Corp., Harris Corp., Motorola Inc., Texas Instruments Inc., Cirrus Logic Inc., Signal Processing Technologies, Datel Inc., Sipex Corp., and Unitrode Corp.\nThe Company is not aware of any significant competition from foreign companies providing analog integrated circuits, personal computer instrumentation pro- ducts, and data collection products for the industrial and military markets; however, there can be no assurance that foreign competitors will not enter these markets in the future. The Company's PCM product line does compete with several U.S. and foreign manufacturers of \"digital audio\" D\/A converters for use in digital compact disc stereo systems, including Analog Devices Inc., Cirrus Logic Inc., Asahi Kasei Micro, Sony Electronics Inc., Hitachi America Ltd., Matsushita Electric Corp. of America, Mitsubishi Corp, and Philips Semiconductors. While some of these competitors have greater financial and marketing resources than Burr-Brown, none of them compete with the Company in all of its product areas.\nThe Company believes that competition with respect to component products is based primarily on design and process innovation, product performance and reli- ability, technical service, availability of a broad range of specialized products, standard product availability; and secondarily, on price. The Company believes that reliable performance and service are more important than price when the Company is the sole source of a product. Price is more of a competi- tive factor when an equivalent product is available from other sources, as in the case of commodity products. Burr-Brown competes with this type of product only in limited areas.\nLarge semiconductor manufacturers have generally concentrated their product and marketing efforts on high volume, relatively low priced, general purpose compo- nents. The Company does not usually compete in these markets. Whereas most large semiconductor companies tend to generalize a component to achieve the broadest high volume usage possible, Burr-Brown follows a strategy of narrowly defining its products for application markets demanding very high, difficult to achieve performance. The Company believes that its products' high performance requirements and relatively low unit sales volumes will continue to make it impractical for larger semiconductor suppliers to market a broad line of competing components.\nMANUFACTURING The Company's manufacturing technology has evolved substantially over the past two decades. Initially, the Company manufactured its products by assembling purchased resistors, transistors, diodes and other discrete components onto printed circuit boards. The Company has since migrated to integrated circuits, which required the development of semiconductor manufacturing technologies in its Tucson wafer fabrication facility.\nThe Company can utilize its in-house process technology, purchase wafer process- ing foundry services, or buy components already incorporating the necessary technology in order to meet customer needs. It must combine relatively diverse technologies to produce the integrated circuits necessary to meet the stringent performance requirements of its customers. For example, some of the Company's integrated circuit products combine high precision linear integrated circuit wafer fabrication processing with compatible laser-trimmed thin film technology and dielectric isolation (DI) wafer processing.\n- 8 -\nThe Company offers several bipolar, CMOS and BiCMOS processes which provide circuits for the analog, data acquisition and PCM markets. Burr-Brown processes have the added capability of making high quality capacitors and trimmable resis- tors that enable the Company to manufacture high precision, cost effective products. The following describes the various processes that Burr-Brown offers and the market that each one addresses:\n40 VOLT BIPOLAR PROCESS: This is a high voltage (40V) bipolar (+\/- 15V or 36V power supplies) used to make high voltage operational and instrumentation ampli- fiers. High precision in these products is made possible by the capability of ion implanted JETS and trimmable resistors. Typical products made from this process are instrumentation amplifiers, universal active filters, isolation amplifiers and high voltage power amplifiers.\n20 VOLT BIPOLAR PROCESS: This is a lower voltage (20V) bipolar process especially suited to data acquisition and PCM components. There are faster circuits utilizing smaller devices with lower Rc. Trimmable resistors allow high precision products.\nDIELECTRICALLY ISOLATED BIPOLAR PROCESS: This is a dielectrically isolated high voltage (40V) bipolar process used for low noise, high precision and low drift. Very high performance amplifiers are built by this process where the noise and drift characteristics are important, especially in the medical equipment markets served.\nCOMPLIMENTARY BIPOLAR DIELECTRICALLY ISOLATED PROCESS: Dielectrically isolated process with complementary NPN and PNP bipolar transistors. This process is used to manufacture high voltage operational amplifiers, voltage-to-frequency converters, and sample\/hold circuits.\nIn addition to the processes at the Company's Tucson wafer fabrication facility, foundries are used for processes not available internally. Processes currently used include a variety of CMOS processes ranging from 3 microns to 0.6 microns for products such as single and dual analog-to-digital and digital-to-analog converters; a 2 micron BiCMOS process for PCM DACs and ADCs; a very high fre- quency bipolar process used for products such as video amplifiers.\nASSEMBLY AND TEST The Company has integrated circuit assembly operations in Tucson and Scotland. In addition, much of the assembly demand is met by using contract assembly companies located in Japan, Taiwan, Malaysia, Korea, Thailand and the Philip- pines. To achieve lower cost without compromising high performance, the Company has expanded its monolithic capability to complement multi-chip-module assembly in its Tucson manufacturing facility.\nThe Company utilizes proprietary laser trimming techniques to produce high performance bipolar integrated circuits and thin film resistors. This opera- tion uses proprietary deposition technology and computer-controlled laser trimming techniques to achieve the desired high precision. Depending upon the performance requirements, integrated circuits may be packaged as single chip products; or combined on ceramic substrates with the Company's thin film resistors and purchased parts, such as discrete power devices, transformers and optical diodes to form hybrid integrated circuits.\nThe Company's Tucson facility incorporates a computerized shop floor control software system specifically designed to enhance the Company's ability to effectively manage the operations.\nThe Company has developed and implemented a quality and productivity improve- ment (QPI) program designed to aid in reducing waste, increasing yields, improving communications and achieving overall high quality across all product lines. The QPI program incorporates statistical process control (SPC) and total quality management (TQM) techniques. The Company has maintained ISO9001 Quality Certification since 1993.\nTo provide better service to its European and Japanese customers, and to achieve an improved competitive position, the Company maintains manufacturing and product development facilities in both areas. In Europe, a manufacturing\n- 9 -\nand product development site is located in Livingston, Scotland. This facility designs and assembles integrated circuits for sale in Europe and for export to other markets.\nThe Company's manufacturing plant in Scotland is certified to meet the requirements of the United Kingdom's Ministry of Defense specification BS9000. Subsequent to receiving this certification, the Company has qualified products to the United Kingdom's specification BS9450.\nIn Japan, the Company's Atsugi Technical Center near Tokyo performs product development, final product testing, quality and reliability testing for the PCM product line for sale in Japan and export to other markets.\nThe principle raw materials used by the Company in the manufacture of its monolithic integrated circuits are silicon wafers, chemicals and gases used in processing wafers, gold wire and ceramic, metal and epoxy packages that enclose the chip and provide the external connections for the circuit. Silicon wafers and other raw materials may be obtained from several suppliers. From time to time, particularly during periods of increased industry-wide demand, silicon wafers and other materials have been in short supply. As is typical in the industry, the Company allows for a significant period of lead time between order and delivery of raw materials. In addition, the Company sometimes enters into long term supplier-customer relationships with key suppliers of such materials to mitigate problems of possible shortages.\nGovernment regulations impose various controls on the discharge of certain chemicals and gases into the environment that have been used in semiconductor processing. The Company believes that its manufacturing processes conform to present environmental regulations but there can be no assurance that future changes in such regulations will not result in increased costs or impede operat- ing performance. The Company is on target to eliminate the use of ozone- depleting chemicals and gases by the end of 1995.\nThe Company is continuing to implement the necessary actions for the site remediation as required under the provisions of the Consent Decree Agreement with EPA. The cost for the implementation required in 1994 was approximately $100,000.\nHUMAN RESOURCES At December 31, 1994, the Company employed 1928 people worldwide, including 1223 people in manufacturing and assembly, 219 people in research and development, 282 in sales and marketing and 204 in management and administration. Many of the Company's employees are highly skilled and the Company's continued success will depend, in part, on its ability to attract and retain such employees, who are generally in great demand. At times, like other semiconductor manufac- turers, the Company has had difficulty hiring engineering personnel. The Company has never experienced a work stoppage; no employees are represented by labor organizations, and the Company considers its employee relations to be very good.\nPATENTS AND LICENSES The Company owns 107 United States patents expiring from 1995 to 2014, and has applications for 6 additional patents pending in the United States as well as patents issued and pending in several other countries. Although the Company pursues a policy of maintaining a strong patent portfolio, the Company believes that its success depends primarily upon the experience and creative skills of its people rather than upon the ownership of patents. As is common in the semiconductor industry, from time to time, the Company has been notified of claims regarding the possible infringement of patents issued to others, and similarly, the Company has on occasion notified others of possible infringements of its patents.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The Company's major manufacturing and engineering facilities and administrative offices are located in four company-owned buildings, aggregating 220,000 square feet, on its 18 acre site in Tucson, Arizona. The Company also leases approx- imately 85,000 square feet in Tucson. Approximately 25,000 square feet of this leased space is on short term contracts of two years or less. The major single\n- 10 -\nbuilding lease is for 60,000 square feet and will expire in March 1997. The aggregate current gross rental for all Tucson properties is approximately $490,000 per year. All leases have options for renewal. The Company also owns approximately 113 acres of land in Tucson which is being held in reserve for future expansion.\nIn Filderstadt, Germany, the Company's sales office occupies 30,000 square feet of space leased for a ten year period; this lease expires in 1999. The Company has the option to sublease and renew this lease for three to five years. The Company's Scottish manufacturing subsidiary leases a 32,000 square foot build- ing on 6.65 acres in Livingston, Scotland for a 15 year period; this lease expires in 1997. The Company also owns approximately 20 acres of land in Livingston, Scotland. The Company's Atsugi Technical Center in Atsugi, Japan, is a 44,500 square foot building which houses sales, product testing, and research and development activities; the Company has a fifteen year lease of this facility which expires in 2001.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS The following four proceedings are the only litigation matters other than ordinary pending litigations.\nEach of these proceedings relate to the same factual situation of the release of contaminants including Trichloroethylene (TCE) into the ground waters causing damage to the plaintiffs.\na. BAHRS ET.AL. VERSUS HUGHES AIRCRAFT COMPANY, BURR-BROWN COMPANY, ET.AL., Superior Court, State of Arizona, Pima County. Filed on January 13, 1992. The plaintiffs are charging that they and their respective properties are damaged and they are asking for monetary damages. The Company spent the first year discussing a stipulated dismissal which was not granted. The Company has now requested the Superior Court to begin consideration for dismissal.\nb. YSLAVA ET.AL. VERSUS HUGHES AIRCRAFT COMPANY, U.S. District Court, District of Arizona. Filed on September 20, 1991 against Hughes. On September 30, 1993, Burr-Brown and other companies were identified as third party co-defendants in a Motion to File a Third-Party Complaint.\nc. LANIER VERSUS HUGHES AIRCRAFT COMPANY, U.S. District Court, District of Arizona. Filed on August 7, 1992 against Hughes. On March 7, 1994, Burr-Brown and other companies were identified as third party co-defendants in a Motion to File a Third-Party Complaint.\nd. ARELLANO VERSUS HUGHES AIRCRAFT COMPANY, U.S. District Court, District of Arizona. Filed on January 9, 1995 against Hughes. Plaintiffs are asking for medical monitoring. Burr-Brown was served as third party defendant on March 7, 1995. The Company will issue an answer denying the allegations as in the above cases.\nRisk exposure to the defendants is not ascertainable at this time. The Company has factual records that indicate it is an improper party to these actions. The Company's insurer, under a reservation of rights, has agreed to the partial payment of reasonable and necessary fees for the defense 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 the Company's security holders during the quarter ended December 31, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT At December 31, 1994, there were 3 individuals designated as executive officers by the Board of Directors. The following sets forth certain informa- tion with regard to the executive officer of Burr-Brown who is not a Director:\n- 11 -\nJohn L. Carter (age 60) joined the Company in August, 1993 as Executive Vice President, responsible for Components Operations and was then appointed Chief Financial Officer in July 1994. Most recently, Mr. Carter served as a consul- tant to Burr-Brown. Before joining the Company, he served as President and CEO of Qualtronics, Inc. From 1956 to 1987 he was with IBM in various manufac- turing and general management positions, including General Manager of Tucson IBM operations.\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 appears in the 1994 Annual Report to Stockholders on page 21, which is included as 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 appears in the 1994 Annual Report to Stockholders on page 24, which is included as Exhibit 13 to this report, and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS The information appearing under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 21, 22 and 23 of the 1994 Annual Report to Stockholders which is included as 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 financial statements and supplementary data required by this item appear in the 1994 Annual Report to Stockholders on pages 10 through 21, included as Exhibit 13 to this report and incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information regarding Directors and certain Executive Officers who are also Directors appearing under the caption \"Election of Directors\" in the Registrant's Proxy Statement for the 1995 Annual Meeting of Stockholders on pages 4 and 5 is incorporated herein by reference. Information regarding other executive officers appears in Part I of this report under the caption \"Executive Officers of the Registrant\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION The information appearing under the caption \"Executive Compensation and Other Information\" on pages 7 through 12 of the Registrant's Proxy Statement for the 1995 Annual Meeting of Stockholders with respect to Executive Compensation is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information appearing under the caption \"Principal and Management Stock- holders\" on pages 2 and 3 of the Registrant's Proxy Statement for the 1995 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None\n- 12 -\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K\na(1) Financial Statements:\nThe following consolidated financial statements are incorporated by reference under Part II, Item 8, from the Registrant's 1994 Annual Report to Stockholders. Pages of 1994 Annual Report to Stockholders Incorporated by Reference\nReport of Ernst & Young LLP, Independent Auditors 21\nConsolidated Statements of Financial Position 11 at December 31, 1994 and 1993\nConsolidated Statements of Income for the 10 years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Changes in Stock- 10 holders' Equity for the years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the 12 years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements 13 to 20\na(2) Financial Statement Schedules: Form 10-K For the years ended December 31, 1994, 1993 and 1992 Page\nSchedule II - Valuation and Qualifying Accounts 19\nAll other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements.\n- 13 -\na(3) Exhibits\n3.1 Restated Certificate of Incorporation of the Registrant. Incorporated by reference to Exhibit 3.1 of the Registrant's 10-K filing for the period ended December 31, 1987.\n3.2 Restated By-laws of the Registrant dated October 21, 1994, filed herein.\n4.1 Article Four of the Certificate of Incorporation of the Registrant. (Included in Exhibit 3.1).\n4.2 Rights Agreement dated July 21, 1989 between the Registrant and Valley National Bank of Arizona, incorporated by reference to Exhibit 4.2 of the Registrant's 10-K filing for the period ended December 31, 1989.\n9.1 Voting Trust Agreement dated October 3, 1988 among Thomas R. Brown, Jr., individually, Sarah M. Brown Smallhouse and Mary B. Brown and Thomas R. Brown, Jr., as Trustee under the Last Will and Testament of Helen Mason Brown. Incorporated by reference to Exhibit 9.1 of the Registrant's 10-K filing for the period ended December 31, 1988. Amendment dated December 17, 1992, whereby John S. Anderegg, Jr. was appointed Successor Trustee. Incorporated by reference to Exhibit 9.1 of the Registrant's 10-K filing for the period ended December 31, 1993.\n9.2 Voting Trust Agreement dated October 3, 1988 between Mary Buchanan Brown and Sarah M. Brown Smallhouse as Shareholders, and Sarah M. Brown Smallhouse, Mary Buchanan Brown and David W. Richter as Co-trustees. Incorporated by reference to Exhibit 9.2 of the Registrant's 10-K filing for the period ended December 31, 1988. Amendment dated December 17, 1992, whereby John S. Anderegg, Jr. was appointed Co-trustee. Incorporated by reference to Exhibit 9.2 of the Registrant's 10-K filing for the period ended December 31, 1993.\n9.3 Brown Management Limited Partnership Agreement dated November 11, 1988 among Thomas R. Brown, Jr., Mary B. Brown and Sarah B. Smallhouse. Incorporated by reference to Exhibit 9.3 of the Registrant's 10-K filing for the period ended December 31, 1988.\n10.1 Agreement dated as of May 31, 1982 between Analog Devices, Inc. and Registrant (with certain confidential information deleted). Incorporated by reference to Exhibit 10.1 of the Registrant's Statement #2-82045 dated February 24, 1983.\n10.2 Grant offer of the Scottish Economic Planning Department dated October 6, 1981 and acceptance letter of Registrant dated December 15, 1981. Incorporated by reference to Exhibit 10.3 of the Registrant's Registration Statement #2-82045 dated February 24, 1983.\n10.3 Registrant's Stock Bonus Plan. Incorporated by reference to Exhibit 10.7 of the Registrant's 10-K filing for the period ended December 31, 1987. Amendments thereof, dated June 27, 1989. Incorporated by reference to Exhibit 10.7 of the Reg- istrant's 10-K filing for the period ended December 31, 1989. Amended July 23, 1993, to name John L. Carter Co-trustee. Incorporated by reference to Exhibit 10.4 of the Registrant's 10-K filing for the period ended December 31, 1993.\n10.4 Lease dated November 13, 1986 between Bay Colony Development Company, Inc. and Registrant. Incorporated by reference to Exhibit 10.8 of the Registrant's 10-K filing for the period ended December 31, 1986.\n10.5 Lease dated October 1, 1986 between Yugen Kaisha Kato Shoji and Registrant. Incorporated by reference to Exhibit 10.9 of the Registrant's 10-K filing for the period ended December 31, 1986.\n- 14 -\n10.6 Purchase Agreement between Mr. Hermann Weinmann and Registrant. Incorporated by reference to Exhibit 10.10 of the Registrant's 10-K filing for the period ended December 31, 1986.\n10.7 Lease dated February 28, 1985 between Livingston Development Corporation and the Registrant as amended. Incorporated by reference to Exhibit 10.13 of the Registrant's 10-K filing for the period ended December 31, 1984.\n10.8 Grant Offer of the Livingston Development Corporation dated September 20, 1989. Incorporated by reference to Exhibit 10.14 of the Registrant's 10-K filing for the period ended December 31, 1989.\n10.9 Lease dated November 13, 1986 between Bay Colony Development and Registrant amended August 25, 1989. Incorporated by reference to Exhibit 10.17 of the Registrant's 10-K filing for the period ended December 31, 1989.\n10.10 Provisional Agreement of Building Lease Agreement dated June 24, 1985 between Kazuo Kato and Registrant. Incorporated by reference to Exhibit 10.18 of the Registrant's 10-K filing for the period ended December 31, 1985.\n10.11 Lease dated June 1, 1988 between EMBE Leasing Agency Ltd. and Registrant. Translation only incorporated by reference to Exhibit 10.19 of the Registrant's 10-K filing for the period ended December 31, 1988.\n10.12 Stock Option Agreement dated June 26, 1984 between Intelligent Instrumentation, Inc. and the Registrant, as amended. Incorporated by reference to Exhibit 10.11 of the Registrant's 10-K filing for the period ended December 31, 1985.\n10.13 Stock Option Agreement dated October 3, 1984 between Power Convertibles Corporation, fka Analog Microsystems, Inc., and the Registrant, as amended. Incorporated by reference to Exhibit 10.23 of the Registrant's 10-K filing for the period ended December 31, 1985.\n10.14 Series C Stock Purchase Agreement dated December 31, 1988 between Power Convertibles Corporation, fka Analog Micro- systems, Inc., and the Registrant. Incorporated by reference to Exhibit 10.24 of the Registrant's 10-K filing for the period ended December 31, 1988.\n10.15 Stock Purchase Agreement dated January 10, 1985 between Dataforth Corporation and the Registrant. Incorporated by reference to Exhibit 10.25 of the Registrant's 10-K filing for the period ended December 31, 1986.\n10.16 Patent License Agreement dated January 15, 1987 between Linear Technology Corporation and Registrant. Incorporated by reference to Exhibit 10.26 of the Registrant's 10-K filing for the period ended December 31, 1986.\n10.17 Burr-Brown Employee Retirement Plan dated January 1, 1988. Incorporated by reference to Exhibit 10.27 of the Registrant's 10-K filing for the period ended December 31, 1988. Replaced by the restated Burr-Brown Corporation Employee Retirement Plan which is dated as of the January 1, 1988 date of the original plan, filed herein.\n10.18 Lease Agreement dated October 20, 1989 between the Registrant and Kaiyo Kaium, Inc. Translation only, incorporated by reference to Exhibit 10.31 of the Registrant's 10-K filing for the period ended December 31, 1989.\n- 15 -\n10.19 Lease dated October 30, 1987 between Bay Colony Development Company, Inc. and Registrant. Incorporated by reference to Exhibit 10.29 of the Registrant's 10-K filing for the period ended December 31, 1990.\n10.20 License Agreement dated August 27, 1990 between Gunnar Hartig III and Burr-Brown Corporation. Incorporated by reference to Exhibit 10.31 of the Registrant's 10-K filing for the period ended December 31, 1990.\n10.21 Consent Decree filed with the United States District Court on March 13, 1990 between the United States of America on behalf of the Administrator of the United States Environmental Protection Agency (EPA) and Burr-Brown Corporation. Incorporated by reference to Exhibit 10.32 of the Registrant's 10-K filing for the period ended December 31, 1991.\n10.22 Amendment dated January 10, 1991 to that certain Lease dated October 30, 1987, incorporated by reference as Exhibit 10.24 of the Registrant's 10-K filing for the period ended December 31, 1990 by and between Bay Colony Development, Inc. and Burr-Brown Corporation. Incorporated by reference to Exhibit 10.44 of the Registrant's 10-K filing for the period ended December 31, 1991.\n10.23 Amendment dated January 21, 1992 to that certain Lease dated October 30, 1987, incorporated by reference to Exhibit 10.24 of the Registrant's 10-K filing for the period ended December 31, 1990 and Amendment dated January 10, 1991 by and between Bay Colony Development, Inc. and Burr-Brown Corporation. Incor- porated by reference to Exhibit 10.45 of the Registrant's 10-K filing for the period ended December 31, 1991.\n10.24 Master Lease Agreement dated July 31, 1992 and amended September 23, 1992 between AT&T Commercial Finance Corporation and Burr- Brown Corporation. Incorporated by reference to Exhibit 10.37 of the Registrant's 10-K filing for the period ended December 31, 1992.\n10.25 Master Lease Agreement Schedules dated July 31, 1992 and September 23, 1992 between AT&T Commercial Finance Corporation and Burr-Brown Corporation. Incorporated by reference to Exhibit 10.38 of the Registrant's 10-K filing for the period ended December 31, 1992.\n10.26 Purchase Agreements dated July 31, 1992 and September 23, 1992 between AT&T Commercial Finance Corporation and Burr-Brown Corporation. Incorporated by reference to Exhibit 10.39 of the Registrant's 10-K filing for the period ended December 31, 1992.\n10.27 Master Equipment Lease Agreement dated June 20, 1990 between General Electric Capital Corporation, fka Ellco Leasing Corpor- ation and Burr-Brown Corporation. Incorporated by reference to Exhibit 10.44 of the Registrant's 10-K filing for the period ended December 31, 1992. Amendment dated December 21, 1994, filed herein.\n10.28 Trust Agreement for Future Investment Trust dated October 12, 1993, between Burr-Brown Corporation and First Interstate Bank of Arizona. Incorporated by reference to Exhibit 10.37 of the Registrant's 10-K filing for the period ended December 31, 1993.\n10.29 Burr-Brown Corporation amended Stock Incentive Plan dated February 11, 1994 which replaces the Stock Incentive Plan dated February 11, 1993, filed herein.\n10.30 Future Investment Trust Plan dated July 23, 1993 replaced by the Burr-Brown Corporation Future Investment Trust dated February 24, 1987. Incorporated by reference to Exhibit 10.39 of the Registrant's 10-K filing for the period ended December 31, 1993. Replaced by the Future Investment Trust Plan dated December 20, 1994, filed herein.\n- 16 -\n10.31 Loan Agreement dated July 25, 1994 by and among Burr-Brown Corporation, First Interstate Bank of Arizona, N.A. and Bank One, Arizona, N.A., filed herein.\n10.32 Revolving Credit Note dated July 25, 1994 between Burr-Brown Corporation and First Interstate Bank of Arizona, N.A., filed herein.\n10.33 Revolving Credit Note dated July 25, 1994 between Burr-Brown Corporation and Bank One, Arizona, N.A., filed herein.\n10.34 Security Agreement dated July 29, 1994 between Burr-Brown Corporation and First Interstate Bank of Arizona, N.A., filed herein.\n11. Computation of per share earnings, filed herein.\n13. Portions of the Annual Report to Shareholders for the year ended December 31, 1994 are expressly incorporated by reference to the Annual Report Form 10-K, filed herein.\n21. Subsidiaries of the Registrant, filed herein.\n23.1 Consent of Ernst & Young LLP, Independent Auditors, filed herein.\n24.1 Power of Attorney, filed herein.\nb. No reports on Form 8-K have been filed during the fourth quarter of 1994.\n- 17 -\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.\nBURR-BROWN CORPORATION ______________________ Registrant\nBy: SYRUS P. MADAVI Date: March 17, 1995 ______________________ _______________ Syrus P. Madavi President and Chief Executive Officer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Syrus P. Madavi, his attorney-in-fact, 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 said attorney-in-fact, or his substi- tute or substitutes, may do or cause to be done by virtue hereof.\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 Regis- trant and in the capacities and on the dates indicated.\nName Title Date _______ _________ ________\nSYRUS P. MADAVI President and Chief March 17, 1995 ___________________________ Executive Officer Syrus P. Madavi\nJOHN L. CARTER Executive Vice President March 17, 1995 ___________________________ and Chief Financial Officer John L. Carter\nTHOMAS R. BROWN, JR. Chairman of the Board March 17, 1995 ___________________________ Thomas R. Brown, Jr.\nTHOMAS J. TROUP Vice Chairman of the Board March 17, 1995 ___________________________ Thomas J. Troup\nFRANCIS J. AGUILAR Director March 17, 1995 ___________________________ Francis J. Aguilar\nJOHN ANDEREGG, JR. Director March 17, 1995 ___________________________ John Anderegg, Jr.\nBOB J. JENKINS Director March 17, 1995 ___________________________ Bob J. Jenkins\nJAMES A. RIGGS Director March 17, 1995 ___________________________ James A. Riggs\n- 18 -\nEXHIBIT 21 BURR-BROWN CORPORATION AND SUBSIDIARIES\nJurisdiction Name of Corporation of Incorporation ____________________________________________ ________________\n1. Burr-Brown International Holding Corporation Delaware\n2. Burr-Brown Limited United Kingdom\n3. Burr-Brown Japan Limited Japan\n4. Burr-Brown International Limited United Kingdom\n5. Burr-Brown International S.A. France\n6. Burr-Brown International S.r.L. Italy\n7. Burr-Brown International BV The Netherlands\n8. Burr-Brown International GmbH Germany\n9. Burr-Brown Research GesmbH Austria\n10. Burr-Brown AG Switzerland\n11. Burr-Brown Foreign Sales Corporation Barbados\n12. Burr-Brown Europe Limited Scotland\n13. Power Convertibles Corporation Arizona (fka Analog Microsystems, Inc.)\n14. PCC de Mexico S.A. de C.V. Mexico\n15. Power Convertibles Ireland Limited Ireland\n16. Intelligent Instrumentation, Inc. Arizona\n17. Intelligent Instrumentation Japan, KK Japan\n18. Intelligent Instrumentation GmbH Germany\n19. Intelligent Instrumentation Limited United Kingdom\n20. Intelligent Instrumentation S.r.l. Italy\n21. Intelligent Instrumentation S.A. France\n22. Intelligent Instrumentation, Inc. Foreign Barbados Sales Corporation\n- 21 -","section_15":""}
{"filename":"66904_1994.txt","cik":"66904","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":"725684_1994.txt","cik":"725684","year":"1994","section_1":"ITEM 1. BUSINESS\nTHE PARTNERSHIP. Cable TV Fund 11-B, 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-C, Ltd. (\"Fund 11-C\") and Cable TV Fund 11- D, Ltd. (\"Fund 11-D\") are the other partnerships that were formed pursuant to the Program. The Partnership, Fund 11-A, Fund 11-C and Fund 11-D formed a general partnership known as Cable TV Joint Fund 11 (the \"Venture\") in which the Partnership owns an 8 percent interest, Fund 11-A owns an 18 percent interest, Fund 11-C owns a 27 percent interest and Fund 11-D owns a 47 percent interest. The Partnership and the Venture were formed for the purpose of acquiring and operating cable television systems.\nThe Partnership directly owns cable television systems serving the communities of Lancaster, Lockport and Orchard Park, New York (the \"New York Systems\"), and the Venture operates a cable television system in Manitowoc, Wisconsin (the \"Manitowoc System\"). 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 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 Partnership's Systems operated approximately 842 miles of cable plant, passing approximately 57,000 homes, representing an approximate 69% penetration rate, and the Venture's Systems operated approximately 200 miles of cable plant, passing approximately 15,000 homes, representing an approximate 67% penetration rate. Figures for numbers of\nsubscribers, miles of cable plant and homes passed are compiled from the General Partner's records and may be subject to adjustments.\nCABLE TV FUND 11-B, LTD.\nFranchise expiration dates range from May 1993 to August 2003. The Village of Lancaster franchise has been operating under a temporary operating authority. The General Partner and the franchise authorities are currently in the process of negotiating a longer term franchise.\nCABLE TV JOINT FUND 11\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 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 3,156.\nItem 6.","section_6":"Item 6. Selected Financial Data\n(a) Net income resulted primarily from the sale of the Wisconsin Systems by Joint Fund 11. (b) Net income resulted primarily from the sale of the Grand Island System by Cable TV Fund 11-B.\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-B\nResults of Operations\n1994 Compared to 1993\nRevenues of the Partnership increased $869,525, or approximately 7 percent, from $11,922,307 in 1993 to $12,791,832 in 1994. An increase in basic subscribers primarily accounted for the increase in revenues. Basic subscribers increased 1,742, or approximately 5 percent, from 35,877 at December 31, 1993 to 37,619 at December 31, 1994. 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 the Partnership complied effective September 1, 1993. No other factors individually were significant to the increase in revenues.\nOperating, general and administrative expenses decreased $17,759, less than 1 percent, from $7,476,761 in 1993 to $7,459,002 in 1994. The decrease in operating, general and administrative expense was due primarily to decreases in personnel related and marketing related expenses. These decreases were partially offset by increases in programming fees and plant maintenance costs. No other factors individually were significant to the decrease in operating, general and administrative expenses. Operating, general and administrative expense represented 58 percent of revenues in 1994 compared to 63 percent in 1993. Management fees and allocated overhead from the General Partner increased $208,152, or approximately 15 percent, from $1,421,026 in 1993 to $1,629,178 in 1994 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 allocated to the Partnership.\nDepreciation and amortization increased $485,366, or approximately 26 percent, from $1,874,101 in 1993 to $2,359,467 in 1994 due to capital additions in 1993 and 1994.\nOperating income increased $193,766, or approximately 17 percent, from $1,150,419 in 1993 to $1,344,185 in 1994 due to the increase in revenues exceeding the increases in operating, general and administrative expenses, management fees and allocated overhead from the General Partner and depreciation and amortization expense. Operating income before depreciation and amortization increased $679,132, or approximately 22 percent, from $3,024,520 in 1993 to $3,703,652 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.\nInterest expense increased $485,096, or approximately 73 percent, from $661,307 in 1993 to $1,146,403 in 1994 due to higher outstanding balances on interest bearing obligations and higher effective interest rates. Income before equity in net income of cable television joint venture decreased $353,561, or approximately 77 percent, from $461,481 in 1993 to $107,920 in 1994 due to the increase in interest expense exceeding the increase in operating income.\n1993 Compared to 1992\nRevenues of the Partnership increased $104,883, or approximately 1 percent, from $11,817,424 in 1992 to $11,922,307 in 1993. Disregarding the effect of the Grand Island System sale on July 1, 1992, revenues increased approximately 9 percent. An increase in basic subscribers in the New York Systems accounted for approximately 52 percent of the increase in revenues. Basic subscribers increased 2,325, or approximately 7 percent, from 33,552 at December 31, 1992 to 35,877 at December 31, 1993. Basic service rate adjustments in the New York Systems in July 1992 accounted for approximately 19 percent of the increase in revenues. An increase in advertising sales revenues primarily accounted for the remainder of the increase in revenues. 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 the Partnership complied effective September 1, 1993. No other factors individually were significant to the increase in revenues.\nOperating, general and administrative expenses increased $535,184, or approximately 8 percent, from $6,941,577 in 1992 to $7,476,761 in 1993. Operating, general and administrative expense represented 63 percent of revenues in 1993 compared to 59 percent in 1992. Increases in programming fees, personnel expense, advertising sales cost and marketing expense primarily accounted for the increase in expenses. No other factors individually were significant to the increase in\noperating, general and administrative expenses. Management fees and allocated overhead from the General Partner increased $16,506, or approximately 1 percent, from $1,404,520 in 1992 to $1,421,026 in 1993 due to the increase in revenues, upon which such fees and allocations are based, as well as an increase in expenses allocated from the General Partner.\nDepreciation and amortization increased $136,644, or approximately 8 percent, from $1,737,457 in 1992 to $1,874,101 in 1993 due to capital additions in 1992 and 1993.\nOperating income decreased $583,451, or approximately 34 percent, from $1,733,870 in 1992 to $1,150,419 in 1993. This decrease was due primarily to the increases in operating, general and administrative expenses, management fees and allocated overhead from the General Partner and depreciation and amortization expense exceeding the increase in revenues.\nInterest expense decreased $71,972, or approximately 10 percent, from $733,279 in 1992 to $661,307 in 1993. This decrease was due to lower average balances on interest bearing obligations and lower effective interest rates. The Partnership used a portion of the proceeds from the sale of the Grand Island System to reduce indebtedness in 1992. Income before equity in net income of cable television joint venture decreased $12,413,777 from $12,875,258 in 1992 to $461,481 in 1993. This decrease was due primarily to the gain on sale of assets of $11,884,967 recognized in 1992.\nIn addition to the New York Systems owned by it, the Partnership also owns an approximate 8 percent interest in 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 General Partner is currently soliciting indications of interest in the New York Systems. Pursuant to the terms of the Partnership's limited partnership agreement, the General Partner may purchase the New York Systems, provided that the General Partner submits the highest acceptable bid in a public bidding process and the bid is no less than the average of three separate independent appraisals of the New York Systems. Any sale of the New York Systems will be subject to the approval of the holders of a majority of the Partnership's limited partnership interests.\nThe Partnership expended approximately $7,371,000 on capital improvements during 1994. Of this total, approximately 75 percent related to the continuation of the rebuild and upgrade of the New York Systems as required by the terms of the New York System's franchises, and the construction of a new operations facility. The remainder of the expenditures were for plant extensions and various other enhancements in the New York Systems. Funding for these expenditures was provided by cash generated from operations, cash on hand and borrowings under the Partnership's credit facility. Anticipated capital additions for 1995 are approximately $3,797,000. The continuation of the rebuild and upgrade of the New York Systems will account for approximately 43 percent of the expected capital expenditures. Approximately 28 percent of the expected capital expenditures will relate to plant extensions and service drops to homes. The remainder of the capital expenditures will be used for various other enhancements in the New York Systems. Depending upon the timing of the potential sale of the New York Sysems as discussed above, the Partnership will likely only make the portion of the budgeted capital expenditures scheduled to be made during the Partnership's continued ownership of the New York Systems. Funding for these expenditures is expected to be provided by cash generated from operations and borrowings from the Partnership's existing credit facility.\nDuring March 1992, the Partnership entered into a $25,000,000 revolving credit and term loan agreement. As a result of the subsequent sale of the Partnership's cable television system serving Grand Island, New York (the \"Grand Island System\"), the maximum amount available was reduced to $20,000,000 in July 1992. The revolving credit period expired December 31, 1994, at which time the outstanding balance converted to a term loan payable in 24 consecutive quarterly installments commencing March 31, 1995. As of December 31, 1994, $20,000,000 was outstanding under this agreement. On February 28, 1995, the term loan was renegotiated and the Partnership entered into a new $25,000,000 revolving credit and term loan agreement. The revolving credit period expires December 31, 1996, at which time the outstanding balance converts to a term loan payable in 24 consecutive quarterly installments commencing March 31, 1997. Interest payable on outstanding amounts under the new credit facility is at the Partnership's option of the base rate plus 1\/2 percent or LIBOR plus 1-3\/8 percent. The Partnership paid a loan facility fee of $75,000 upon closing of the credit facility renegotiation.\nThe Partnership has sufficient sources of capital available to meet its presently anticipated needs from its ability to generate cash from operations and from borrowings available under its new credit facility.\nIn addition to the New York Systems owned by it, the Partnership owns an interest of approximately 8 percent in Joint Fund 11. This investment is accounted for under the equity method. When compared to the December 31, 1993 balance, this investment has increased by $29,033 from $521,450 at December 31, 1993 to $550,483 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.\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.\nThe Partnership has filed a cost-of-service showing for the New York Systems and thus 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.\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.\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-B 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-B:\nWe have audited the accompanying balance sheets of CABLE TV FUND 11-B (a Colorado limited 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 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-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.\nCABLE TV FUND 11-B (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV FUND 11-B (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV FUND 11-B (A Limited Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 11-B (A Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 11-B (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 11-B (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nCable TV Fund 11-B, Ltd. (the \"Partnership\"), a Colorado limited partnership, was formed on June 17, 1983, 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. (\"Intercable\"), a publicly held Colorado corporation, is the \"General Partner\" and manager of the Partnership. 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 for affiliated entities.\nThe Partnership owns and operates the cable television systems serving the municipalities of Lancaster, Lockport and Orchard Park, New York (the \"New York Systems\"). On July 1, 1992, the Partnership sold the Grand Island System to Adelphia Communications Corporation for a purchase price of $14,500,000, subject to normal closing adjustments. The Partnership recognized a gain of $11,884,967 on this sale. Proceeds from the sale of the Grand Island System were used to reduce debt, and a distribution was made to the limited partners of the Partnership in July 1992 in the aggregate amount of $9,859,381, which represented $518.56 per $1,000 investment in the Partnership. Such distribution, together with prior distributions, represents the return of an amount equal to capital initially contributed to the Partnership by the limited partners. In addition to the New York Systems, the Partnership owns an interest of approximately 8 percent in Cable TV Joint Fund 11 (\"Joint Fund 11\") through capital contributions made during 1984 of $3,500,000.\nContributed Capital\nThe capitalization of the Partnership is set forth in the accompanying statements of partners' capital. No limited partner is obligated to make any additional contribution to partnership capital.\nIntercable 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 Intercable, 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 due to the Partnership's influence on Joint Fund 11 as a general partner. When compared to the December 31, 1993 balance, this investment has increased by $29,033. This increase represents the Partnership's proportionate 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 30 to 39.\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment 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.\nAllocation of Cost of Purchased Cable Television Systems\nThe Partnership allocated the total contract purchase price of cable television systems acquired as follows: first, to the fair value of net tangible assets acquired; second, to the value of subscriber lists; and third, to franchise costs. Brokerage fees paid to an affiliate of Intercable and other system acquisition costs were capitalized and charged to distribution systems.\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\nIntercable 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. For the years ended December 31, 1994, 1993 and 1992 management fees paid to Intercable, excluding the Partnership's approximate 8 percent interest in Joint Fund 11, were $639,592, $596,115, and $590,871, 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 Intercable. 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 sale or refinancing of the 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 Intercable. In July 1990, $9,153,740 of the limited partners' initial capital contributions was distributed to the limited partners from funds received from Joint Fund 11. In July 1992, the remaining amount of limited partners' initial capital ($9,859,381) was distributed to the limited partners from funds received from the sale of the Grand Island System. Any future distributions will be made 75 percent to the limited partners and 25 percent to Intercable.\nThe Partnership reimburses Intercable 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 Partnership. These reimbursements are limited to 25 percent of the gross revenues of the Partnership. 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 revenues and\/or assets managed for the partnership. 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 the Intercable 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. Reimbursements by the Partnership to the General Partner for allocated overhead and\nadministrative expenses, excluding the Partnership's approximate 8 percent interest in Joint Fund 11, were $989,586, $824,911 and $813,649 for the years ended December 31, 1994, 1993 and 1992, respectively.\nThe Partnership was charged interest during 1994 at an average interest rate of 10 percent on amounts due Intercable, which approximated Intercable's weighted average cost of borrowings. Total interest charged by the General Partner was $14,287, $13,350 and $20,961 in 1994, 1993 and 1992, respectively.\nPayments to\/from Affiliates for Programming Services\nThe Partnership receives programming from Product Information Network, Superaudio and The Mind Extension University, affiliates of Intercable. Payments to Superaudio totalled approximately $21,977, $21,590 and $22,651 in 1994, 1993 and 1992, respectively. Payments to The Mind Extension University totalled approximately $19,914, $12,565 and $12,981 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 $186 during 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 the following:\nDuring March 1992, the Partnership entered into a $25,000,000 revolving credit and term loan agreement. As a result of the subsequent sale of the Grand Island System, the maximum amount available was reduced to $20,000,000 in July 1992. The revolving credit period expired December 31, 1994, at which time the outstanding balance converted to a term loan payable in 24 consecutive quarterly installments commencing March 31, 1995. As of December 31, 1994, $20,000,000 was outstanding under this agreement. On February 28, 1995, the term loan was renegotiated and the Partnership entered into a new $25,000,000 revolving credit and term loan agreement. The revolving credit period expires December 31, 1996, at which time the outstanding balance converts to a term loan payable in 24 consecutive quarterly installments commencing March 31, 1997. Interest payable on outstanding amounts under the new credit facility is at the\nPartnership's option of the base rate plus 1\/2 percent or LIBOR plus 1-3\/8 percent. The Partnership paid a loan facility fee of $75,000 upon closing of the credit facility renegotiation. The effective interest rates on outstanding obligations as of December 31, 1994 and 1993 were 6.77 percent and 4.66 percent, respectively.\nInstallments due on debt principal for each of the five years in the period ending December 31, 1999 and thereafter, respectively, are $2,637,159, $3,237,159, $3,437,159, $3,679,052, $3,800,000 and $4,000,000. Substantially all of the Partnership's property, plant and equipment are pledged as security for the above indebtedness.\n(6) 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 Intercable.\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 or losses and the net income or losses reported in the 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 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 a cost-of-service showing for the New York Systems and thus anticipates no further reductions in rates. The cost-of-service showing has not 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.\nThe Partnership rents office and other facilities under various long-term lease arrangements. Rent expense paid under such lease arrangements totalled $16,093, $31,480 and $37,468, 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:\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 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.\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. During the year ended December 31, 1994, the Partnership received revenues from PIN of $186, and the Venture received revenues from PIN of $510.\nThe charges to the Partnership 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-B. (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)\n10.1.2 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Barker, New York. (Fund 11-B) (2)\n10.1.3 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Clarence, New York. (Fund 11-B) (1)\n10.1.4 Copy of order renewing franchise adopted 12\/11\/91. (Fund 11-B) (3)\n10.1.5 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Cheektowaga, New York. (Fund 11-B) (4)\n10.1.6 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Elma, New York. (Fund 11-B) (1)\n10.1.7 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Lancaster, New York. (Fund 11-B) (1)\n10.1.8 Copy of renewal order adopted 12\/11\/91. (Fund 11-B) (3)\n10.1.9 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Village of Lancaster, New York. (Fund 11-B) (1)\n10.1.10 Copy of renewal order adopted 5\/4\/88. (Fund 11-B) (3)\n10.1.11 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Lockport, New York. (Fund 11-B) (3)\n10.1.12 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Newfane, New York. (Fund 11-B) (1)\n10.1.13 Copy of renewal order adopted 12\/11\/91. (Fund 11-B) (3)\n10.1.14 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town and Village of Orchard Park, New York. (Fund 11-B) (1)\n10.1.15 Resolution #1 dated 3\/7\/90 authorizing renewal of franchise term. (Fund 11-B) (3)\n10.1.16 Letter dated 5\/2\/90 extending operating rights. (Fund 11-B) (3)\n10.1.17 Order approving renewal adopted 12\/11\/91. (Fund 11-B) (3)\n10.1.18 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Somerset, New York. (Fund 11-B) (2)\n10.2.1 Copy of Loan Agreement between Fund 11-B and The Connecticut National Bank, dated as of 3\/31\/92. (Fund 11-B) (3)\n10.2.2 Copy ofletter amendment to Loan Agreement dated as 7\/1\/92. (Fund 11-B) (3)\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(2) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.\n(3) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.\n(4) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal 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.\nCABLE TV FUND 11-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 20, 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-B. (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)\n10.1.2 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Barker, New York. (Fund 11-B) (2)\n10.1.3 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Clarence, New York. (Fund 11-B) (1)\n10.1.4 Copy of order renewing franchise adopted 12\/11\/91. (Fund 11-B) (3)\n10.1.5 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Cheektowaga, New York. (Fund 11-B) (4)\n10.1.6 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Elma, New York. (Fund 11-B) (1)\n10.1.7 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Lancaster, New York. (Fund 11-B) (1)\n10.1.8 Copy of renewal order adopted 12\/11\/91. (Fund 11-B) (3)\n10.1.9 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Village of Lancaster, New York. (Fund 11-B) (1)\n10.1.10 Copy of renewal order adopted 5\/4\/88. (Fund 11-B) (3)\n10.1.11 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Lockport, New York. (Fund 11-B) (3)\n10.1.12 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town of Newfane, New York. (Fund 11-B) (1)\n10.1.13 Copy of renewal order adopted 12\/11\/91. (Fund 11-B) (3)\n10.1.14 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the Town and Village of Orchard Park, New York. (Fund 11-B) (1)\n10.1.15 Resolution #1 dated 3\/7\/90 authorizing renewal of franchise term. (Fund 11-B) (3)\n10.1.16 Letter dated 5\/2\/90 extending operating rights. (Fund 11-B) (3)\n10.1.17 Order approving renewal adopted 12\/11\/91. (Fund 11-B) (3)\n10.1.18 Copy of a franchise and related documents thereto granting a community antenna television system franchise for Somerset, New York. (Fund 11-B) (2)\n10.2.1 Copy of Loan Agreement between Fund 11-B and The Connecticut National Bank, dated as of 3\/31\/92. (Fund 11-B) (3)\n10.2.2 Copy ofletter amendment to Loan Agreement dated as 7\/1\/92. (Fund 11-B) (3)\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(2) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.\n(3) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.\n(4) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990.","section_15":""}
{"filename":"86104_1994.txt","cik":"86104","year":"1994","section_1":"ITEM 1. BUSINESS\nSAFECO Corporation (the Corporation, or SAFECO) is a Washington Corporation which directly or indirectly owns the stock of operating subsidiaries engaged in various segments of the insurance business and other operating subsidiaries engaged in other financially-related lines of business. The Corporation also manages the SAFECO family of mutual funds. The home offices of the Corporation and its principal subsidiaries are in Seattle, Washington and Redmond, Washington. The Corporation and its subsidiaries had 7,550 employees at December 31, 1994.\nThe insurance subsidiaries are engaged in two principal lines: property and casualty insurance, and life and health insurance. Both are subject to regulation and supervision in every jurisdiction in which they do business. The nature and extent of such regulation varies, but generally has its source in statutes which delegate regulatory, supervisory and administrative powers to state insurance commissioners. Such regulation, supervision and administration relate, among other things, to the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature of limitation on investments; deposits of securities for the benefit of policyholders; approval of policy forms and premium rates; periodic examination of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; the amount of dividends which may be distributed to a parent corporation; requirements regarding reserves for unearned premiums and losses and other matters. Regulation requires that property and casualty rates be adequate but not excessive nor unfairly discriminatory. See page 26 in the Annual Report to Stockholders, hereby incorporated by reference (Exhibit 13), for more information on certain regulatory matters. In 1988, California voters narrowly passed Proposition 103, an initiative which significantly affects the property and casualty insurance business in that state. See Note 6 on page 55 in the 1994 Annual Report to Stockholders for more details.\nAll areas of the insurance business are highly competitive due to the marketing structure and the large number of stock and mutual insurance companies and other entities competing. These factors prevent any one insurance company or group of insurers from dominating the market.\nProperty and Casualty Operations\nSubsidiaries engaged in the property and casualty insurance business, which insure commercial, personal and surety lines, are SAFECO Insurance Company of America, General Insurance Company of America, First National Insurance Company of America, SAFECO National Insurance Company, SAFECO Insurance Company of Illinois, SAFECO Lloyds Insurance Company, SAFECO Surplus Lines Insurance Company, F. B. Beattie & Co., Inc., COMAV Managers, Inc., and Whitehall Insurance Brokers, Inc. Coverages include automobile, homeowners, fire and allied lines, commercial multi-peril, miscellaneous casualty, fidelity and workers' compensation. Their products are primarily sold through independent insurance agents in nearly all states and the District of Columbia. SAFECO sold its Canadian property and casualty operations in 1991. See page 29 in the 1994 Annual Report to Stockholders for more information.\n- 1 - PART I\nITEM 1. BUSINESS (Continued)\nThe following table shows consolidated property and casualty gross premiums written for SAFECO's ten largest states (amounts in thousands):\nVoluntary personal, commercial and surety lines (which excludes assigned risk, FAIR plans, etc.) comprise approximately 69%, 26% and 4%, respectively, of the 1994 gross premiums written. The gross premiums written growth of 6.7% in 1994 is comprised of a 6.6% increase for personal, and increases of 7.1% for commercial and 7.1% for surety lines. Gross premiums written growth of 10.2% in 1993 was comprised of a 10.4% increase for personal, and increases of 10.3% for commercial and 5.7% for surety lines.\nThe growth in personal lines premiums is the result of both rate increases and an increase in policies in force. The number of vehicles insured increased 1.3% in 1994, compared with increases of 2.2% in 1993 and 6.2% in 1992. This trend in the number of vehicles insured has been caused primarily by rate increases placed in effect in recent years. The number of homes insured increased 2.7% in 1994, 8.0% in 1993 and 10.8% in 1992. This trend in the growth rate is also due in part to rate increases placed in effect in recent years. SAFECO's commercial lines premiums increased in 1994 and 1993 as a result of both growth in policies in force and some rate increases. Continued growth in commercial premiums written is expected in 1995. The increase in surety premiums in 1994 is primarily due to new commercial and contract accounts acquired.\nAdditional financial information about SAFECO's business segments is set forth in Note 15 on page 62 of the 1994 Annual Report to Stockholders.\n- 2 - PART I\nITEM 1. BUSINESS (Continued)\nThe consolidated financial statements include the estimated liability (reserves) for unpaid losses and loss adjustment expense of SAFECO's property and casualty insurance subsidiaries. The liability is presented net of amounts recoverable from salvage and subrogation recoveries and gross of amounts recoverable from reinsurance.\nReserves for losses that have been reported to SAFECO and certain legal expenses are established on a \"case basis\" method. Claims incurred but not reported (IBNR) and other adjustment expense are estimated using statistical procedures. Salvage and subrogation recoveries are accrued using the \"case basis\" method for large claims and statistical procedures for smaller claims.\nThese reserves aggregate SAFECO's best estimates of the total ultimate cost of claims that have been incurred but have not yet been paid. The estimates are based on past claims experience and consider current claims trends as well as social, legal and economic conditions, including inflation. The reserves are not discounted.\nLoss and adjustment expense reserve development is reviewed on a regular basis to determine that the reserving assumptions and methods are appropriate. Reserves initially determined are compared to the amounts ultimately paid. A statistical estimate of the projected amounts necessary to settle outstanding claims is made regularly and compared to the recorded reserves.\nThe table on page 4 provides an analysis of changes in losses and adjustment expense reserves for 1994, 1993 and 1992 (net of reinsurance amounts). Changes in the reserves are reflected in the income statement for the year when the changes are made. Operations were credited $81.3 million, $96.9 million and $44.6 million in 1994, 1993, and 1992, respectively, as a result of a reduction in the estimated amounts needed to settle prior years' claims.\n- 3 - PART I\nITEM 1. BUSINESS (Continued)\nAnalysis of Changes in Losses and Adjustment Expense Reserves - (Net of reinsurance amounts):\nReconciliation of Liability for Losses and Adjustment Expense Reserves (per property and casualty balance sheet):\nThe table on page 5 presents the development of the losses and ` adjustment expense reserves for 1984 through 1994. The top lines of the table show the estimated liability for unpaid losses and adjustment expense at December 31 for each of the indicated years, both gross and net of related reinsurance amounts. The upper portion of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. The next section shows the re-estimated amount of the previously recorded liability based on experience as of each succeeding year. The estimate is increased or decreased as more information becomes known about individual claims and as changes in conditions and claim trends become apparent.\n- 4 - PART 1 ITEM 1.BUSINESS (Continued)\n- 5 - PART I\nITEM 1. BUSINESS (Continued)\nThe lower section of the table on Page 5 shows the cumulative redundancy (deficiency) developed with respect to the previously recorded liability as of the end of each succeeding year. For example, the 1984 reserve of $629.4 million developed a $52.1 million deficiency after one year which grew over ten years to a deficiency of $310.5 million. The reserve development deficiencies indicated for the years 1984 through 1987 were due to the emergence of liabilities for pollution, asbestos and other hazardous toxic claims and related legal expenses and adverse development from the automobile liability and workers' compensation lines due to significant medical inflation and trends in the civil justice system. In this same period, loss adjustment expenses were increasing rapidly, reflecting higher legal costs and increased litigation.\nThe table below presents the approximate amounts of adverse reserve development by major category for the calendar years 1984-1987 viewed as of December 31, 1994. Note that each year below stands on its own and the years should not be added together. For example, the amount of adverse development recorded in 1987 or subsequent for losses incurred in 1982, is included in the adverse development amounts for each year shown below.\nAs the trends noted above became apparent, SAFECO aggressively increased reserves to address these deficiencies.\nFor 1988 and subsequent years, SAFECO's reserve development has been favorable. This trend reflects the aggressive reserving undertaken in prior years to correct deficiencies which is no longer necessary, favorable legislation in the workers' compensation area, moderation of medical costs and inflation and claims department changes. The favorable legislation in the workers' compensation area, which relates primarily in the states of Oregon and California, has helped reduce fraud, allowed for final settlement of claims and made it more difficult to reopen claims -- all of which reduced SAFECO's ultimate loss costs. The cost of claim settlements in several lines of business has benefited from changes in the organization of SAFECO's claims department which has established separate specialized units for workers' compensation, environmental exposures and fraud investigation. In addition, increased focus on adjustment expenses has helped reduce these costs.\n- 6 - PART I\nITEM 1. BUSINESS (Continued)\nThe impact of reinsurance on the development information presented on Page 5 is not significant. Reserve development gross of reinsurance for the previous three years is as follows (in thousands):\nSAFECO'S objective is to set reserves which are adequate; that is, the amounts originally recorded as reserves should at least equal the amounts ultimately required to settle losses. Analysis indicates that SAFECO's reserves are adequate and probably slightly redundant at December 31, 1994, 1993 and 1992. Operations were credited $81.3 million, $96.9 million and $44.6 million in 1994, 1993 and 1992, respectively, as a result of a reduction in the estimated amounts needed to settle prior years' claims.\nIn evaluating the information contained in the reserve development table on page 5, and the table on page 6, it should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, the amount of the redundancy shown for the December 31, 1993 reserves that relate to losses incurred in 1984 will be included in the cumulative redundancy or deficiency amount for the years 1984 through 1992. This table does not present accident or policy year development data, which some 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.\nSAFECO's property and casualty companies' reserves for losses and adjustment expense for liability coverages related to environmental, asbestos and other toxic claims totaled $108.2 million at December 31, 1994, compared with $113.4 million at December 31, 1993. These amounts are before the effect of reinsurance, which is insignificant. These reserves are approximately 5% of total property and casualty reserves for losses and adjustment expense at both December 31, 1994 and 1993. The reserves include estimates for both reported and IBNR losses and related legal expenses.\nThe vast majority of SAFECO's property and casualty insurance subsidiaries' environmental, asbestos and other toxic claims result from the general liability line of business. A few of these types of losses occur in other coverages such as umbrella and small commercial package policies. Approximately 1,100 of these claims were pending at December 31, 1994 computed on an occurrence basis. For the last three years, an average of 606 claims were opened and an average of 576 claims were closed each year. Most of SAFECO's pending environmental claims involve some type of environmental-related coverage dispute. The average settlement cost of each environmental, asbestos and other toxic claim for the last three years was $18,300 including legal expenses and $10,300 excluding legal expenses.\n- 7 - PART I\nITEM 1. BUSINESS (Continued)\nThe components of these reserves at December 31, 1994 are as follows (in thousands):\nThe following table presents the loss reserve activity analysis for liability coverages related to environmental, asbestos and other toxic claims. (in thousands)*\n* Amounts are before the effect of reinsurance, which is insignificant.\nIn view of the changes in environmental regulations and legal decisions which affect the development of loss reserves, the process to estimate loss reserves for environmental, asbestos and other toxic claims results in imprecise estimates. Quantitative techniques have to be supplemented by subjective considerations and managerial judgment. In view of these conditions, trends that have affected development of these liabilities in the past may not necessarily occur in the future. The reserves carried for these claims at December 31, 1994 are estimates based on the known facts and current law and are believed to be adequate. SAFECO has generally avoided writing coverages for larger companies with substantial exposure in these areas.\nThe property and casualty insurance subsidiaries are required to file annual statements with state regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis). The difference between the liability at December 31, 1994 for losses and adjustment expense reported in the consolidated financial statements in accordance with generally accepted accounting principles (GAAP) of $2,236,804,000 and $2,092,946,000 reported in the annual statement filed with state regulatory authorities relates to reinsurance recoverables. Under FASB Statement 113 the GAAP-basis liability for losses and adjustment expense is reported gross of amounts recoverable from reinsurance. Statutory-basis financial statements show the liability net of reinsurance.\n- 8 - PART I\nITEM 1. BUSINESS (Continued)\nSAFECO's property and casualty subsidiaries protect themselves from excessive losses by reinsuring on treaty and facultative bases. Reinsurance recoverables relating to unpaid losses and adjustment expense were $143.9 million at December 31, 1994 and $100.1 million at December 31, 1993. This increase is due to amounts recoverable by SAFECO from its reinsurers related to the Los Angeles earthquake. Reinsurance costs for catastrophe coverages have increased in the last few years and are expected to remain higher in the foreseeable future, given the large amount of catastrophe losses in recent years. SAFECO's catastrophe property reinsurance program for 1995 covers 90% of $282 million of single event losses in excess of a $75 million retention. In the event of a substantial catastrophe, SAFECO would, therefore, retain the first $75 million of losses, 10% of the next $282 million and all losses in excess of $357 million. The 1995 catastrophe property reinsurance contract includes a provision for one reinstatement for a second catastrophe event in 1995 at current rates. Both the retention level and the aggregate coverage limit for 1995 are higher than in prior years.\nSAFECO's insurance subsidiaries do not enter into retrospective reinsurance contracts and have not participated in any unusual or nonrecurring reinsurance transactions such as \"swaps\" of reserves or portfolio loss transfers. SAFECO does not use \"funding covers\" and has not participated in any surplus relief transactions. None of SAFECO's significant reinsurers are experiencing financial difficulties. Additional information on reinsurance can be found in Note 5 on page 54 in the Annual Report to Stockholders.\nIn 1993, approximately 2,400 active insurance companies competed for $242 billion in property and casualty insurance premiums in the United States. The SAFECO group of property and casualty companies ranked 26th among significant groups of such companies, based on net premiums written.\n- 9 - PART I\nITEM 1. BUSINESS (Continued)\nLife and Health Operations\nSubsidiaries engaged in the life and health insurance business are SAFECO Life Insurance Company, SAFECO National Life Insurance Company, First SAFECO National Life Insurance Company of New York and SAFECO Administrative Services, Inc. These companies offer individual and group insurance products, pension plans and annuity products. SAFECO Life's major market in the group operations is excess loss medical insurance, sold to self-insured employers. Products are marketed through professional agents in all states and the District of Columbia.\nSAFECO Life Insurance Company reinsures portions of its individual and group life, accident and health insurance through commercial reinsurance treaties, thus providing protection against large risks and catastrophe situations.\nIn the life and health insurance field, SAFECO Life Insurance Company competes against some of the largest corporations in the United States. On the basis of 1993 statutory premiums, SAFECO Life Insurance Company ranked 47th among life insurance companies doing business in the United States.\nMany life insurance companies' pension and annuity products have been impacted by general economic conditions, volatile investment returns, rating downgrades, increased competition and decisions by plan sponsors to diversify assets and fund management. SAFECO Life Insurance Company has experienced an increase in the level of withdrawal of funds from its pension and annuity business (see Statement of Consolidated Cash Flows on page 40 of the 1994 Annual Report to Stockholders -- Return of Funds Held Under Deposit Contracts), due to scheduled payouts on distribution-type products and the interest rate environment. However, SAFECO Life Insurance Company's overall withdrawal experience remains relatively modest, and recent interest rate increases have increased SAFECO Life Insurance Company's sales of fixed income pension and annuity products. The table on page 11 sets forth a summary of the components of \"Funds Held Under Deposit Contracts\" at December 31, 1994 and describes the applicable surrender charges and surrender experience.\n- 10 - DETAIL OF SAFECO LIFE INSURANCE COMPANIES' FUNDS HELD UNDER DEPOSIT CONTRACTS\n- 11 - PART I\nITEM 1. BUSINESS (Continued)\nInvestments\nA description of SAFECO's investment portfolio begins on Page 33 of the 1994 Annual Report to Stockholders. SAFECO's consolidated investments in mortgage-backed securities (primarily residential collateralized mortgage obligations, or CMOs, and pass-throughs) totaled $2.2 billion at market value at December 31, 1994. Approximately 97% of these securities are held in the life and health insurance portfolio, with the balance held in the property and casualty insurance portfolio. Approximately 94% of the mortgage- backed securities are government\/agency backed or AAA rated at December 31, 1994. Less than 1% of SAFECO's mortgage-backed securities are of the riskier, highly volatile type (e.g., interest only, inverse floaters, etc.). SAFECO has intentionally not invested significant amounts in the riskier types of mortgage-backed securities. The following two tables detail SAFECO's consolidated holdings of mortgage-backed securities.\nSAFECO Consolidated Holdings of Mortgage-Backed Securities at December 31, 1994 (dollar amounts in millions):\n- 12 - PART I\nITEM 1. BUSINESS (Continued)\nThe quality distribution of SAFECO's mortgage-backed security portfolio as of December 31, 1994 as a percentage of GAAP market value is as follows:\nThe following table presents pretax investment income yields for SAFECO's property and casualty and life and health insurance subsidiaries (calculations based on GAAP amortized cost):\nThe declines in the investment income yields for both portfolios are primarily due to the lower interest rate environment in 1992, 1993 and for the first part of 1994. Rising rates in 1994 have resulted in higher yields on new money invested. The property and casualty decreases also reflect the higher percentage of tax-exempt securities in this portfolio.\nOther Operations\nThe other subsidiaries of the Corporation, which are engaged in lines of business other than insurance, have been acquired or organized since 1966 in the course of a program of diversification. These include SAFECO Properties, Inc. and its subsidiaries (including Winmar Company, Inc. and SAFECARE Company, Inc.), SAFECO Credit Company, Inc., SAFECO Asset Management Company, SAFECO Securities, Inc., SAFECO Services Corporation, SAFECO Trust Company, PNMR Securities, Inc. and Talbot Financial Corporation.\nWinmar Company, Inc., acquired in 1967, invests in and manages real estate properties, primarily regional shopping centers. These properties are located in or near Burlington, Seattle, Vancouver and Silverdale, Washington; Cleveland and Columbus, Ohio; Louisville, Kentucky; West Valley City, Utah; Rancho Mirage, California; Boise, Idaho; Medford, Albany, Tigard and Jantzen Beach, Oregon; Milwaukee, Wisconsin; and San Antonio, Texas. Winmar also offers real estate services, including property management, design and construction management and tenant leasing services. See Item 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties, for additional information.\nSAFECO Properties, Inc. sold its hospital operating and management company (SAFECARE Health Services, Inc.) in May of 1992. See page 32 of the 1994 Annual Report to Stockholders for more information.\n- 13 - PART I\nITEM 1. BUSINESS (Continued)\nSAFECO Credit Company, Inc., organized in 1969, provides loans and equipment financing and leasing to commercial businesses. Approximately 10 to 15% of the business of SAFECO Credit Company, Inc. consists of loans to other members of the SAFECO group. These loans are limited to 50% or less of the total loans outstanding.\nSAFECO Asset Management Company, acquired by the Corporation in 1973, serves as the investment advisor to the SAFECO Mutual Funds and various institutional accounts of unrelated organizations.\nSAFECO Securities, Inc., organized in 1967, is the principal underwriter of the SAFECO Mutual Funds including: the SAFECO Common Stock Trust, SAFECO Bond Trust, SAFECO Tax-Exempt Bond Trust and the SAFECO Money Market Trust, totaling fourteen separate investment portfolios, which are marketed directly to the public; the SAFECO Institutional Series Trust which is marketed to institutions and has one investment portfolio; the SAFECO Advisor Series Trust which is sold to the public through broker\/dealers and which has eight investment portfolios each of which has three classes of stock. In addition, SAFECO Securities, Inc. is the principal underwriter for the SAFECO Resource Series Trust mutual fund which has five separate investment portfolios and for the variable insurance products issued by SAFECO Resource Variable Account B, SAFECO Separate Account SL and SAFECO Variable Account C, all of which are separate accounts of SAFECO Life Insurance Company.\nSAFECO Services Corporation, organized in 1972, is the transfer agent for the SAFECO Mutual Funds.\nSAFECO Trust Company, organized in 1994, provides asset management and trust administrative services to high net worth individuals and unrelated organizations.\nPNMR Securities, Inc., organized in 1986, acts as a broker-dealer, making shares of unaffiliated and affiliated mutual funds and proprietary and non-proprietary variable insurance products available to the public through its registered representatives.\nTalbot Financial Corporation, acquired by the Corporation in 1993, is a broad-based insurance brokerage with a heavy emphasis on the distribution of qualified and non-qualified annuity products and mutual funds through the banking and brokerage arenas.\n- 14 - PART I\nITEM 2. PROPERTIES\nFollowing is a brief description of the materially important properties owned and leased by SAFECO and its subsidiaries.\nSAFECO's property and casualty group leases from General America Corporation (wholly-owned subsidiary of SAFECO Corporation), its home office building complex located in Seattle, Washington. This complex totals 574,000 gross square feet. A 700-car parking garage is connected to the complex.\nSAFECO's life and health insurance companies lease their home office building complex, located in Redmond, Washington, from General America Corporation. This complex totals 232,000 gross square feet.\nOther buildings owned and occupied by the Companies include a service facility in Redmond, Washington, as well as regional and branch offices in Atlanta, GA; Fountain Valley, CA; Cincinnati, OH; Denver, CO; Portland, OR; St. Louis, MO; and Redmond and Spokane, WA, comprising 949,000 gross square feet.\nAll owned buildings are of modern construction, including air conditioning. All other branch and service offices utilize leased premises comprising 422,000 gross square feet, generally for periods of five years or less.\nWinmar Company, Inc. is engaged in the investment in and management of a wide variety of real estate projects, primarily regional shopping centers, located throughout the United States. The projects are owned by subsidiaries of Winmar and in conjunction with other investors, and others are leased under long-term leases.\nThe following is a summary of the property leased to others. All construction is of steel or steel and concrete.\nWinmar also owns or leases pursuant to long-term ground leases 1,497 acres of undeveloped land, primarily in Washington, Oregon, Texas and California.\n- 15 - PART I\nITEM 2. PROPERTIES (Continued)\nSAFECARE Company, Inc. owns and leases healthcare facilities, which contain approximately 400 beds, to qualified operators. SAFECARE also owns and leases to third parties medical office buildings totaling 46,000 square feet.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe insurance and other subsidiaries of the Corporation, because of the nature of their business, are subject to certain legal actions filed or threatened, all in the ordinary course of business.\nThe property and casualty insurance subsidiaries of the Corporation are parties to a number of lawsuits for liability coverages related to environmental claims, for which adequate reserves have been established. The loss and adjustment expense with respect to any such lawsuit, or all lawsuits related to a single incident combined, is not expected to exceed $15 million. See Pages 7 and 8 of Item 1 for more information regarding the liability of such subsidiaries for environmental claims.\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\nAs of March 16, 1995 these are the names, ages and positions of the executive officers of the Registrant as required by Item 10. No family relationships exist.\n- 16 - PART I\nEXECUTIVE OFFICERS OF THE REGISTRANT (Continued)\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS.\nPages 35 and 63 of the 1994 Annual Report to Stockholders are hereby incorporated by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nPages 64 through 67 of the 1994 Annual Report to Stockholders are hereby incorporated by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPages 25 through 35 of the 1994 Annual Report to Stockholders are hereby incorporated by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPages 37 through 63 of the 1994 Annual Report to Stockholders 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\nThe definitive proxy statement to be filed within 120 days after December 31, 1994, excluding the Annual Report of the Compensation Committee on Executive Compensation appearing on Pages 9 through 16, is hereby incorporated by reference to fulfill the requirements of Item 10, \"Directors and Officers\" (except for that portion of 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) FINANCIAL STATEMENTS AND EXHIBITS\nConsent of Independent Auditors\nSAFECO Corporation and Subsidiaries:\nFinancial Statements (pages 36 through 63 of the 1994 Annual Report to Stockholders, containing the following statements, are hereby incorporated by reference):\nConsolidated Balance Sheet, December 31, 1994 and 1993.\nStatement of Consolidated Income for the Three Years Ended December 31, 1994.\nStatement of Consolidated Cash Flows for the Three Years Ended December 31, 1994.\nNotes to Financial Statements for the Three Years Ended December 31, 1994.\nReport of Independent Auditors.\nSAFECO Corporation and Subsidiaries Supplemental Consolidating Information:\nBalance Sheet, December 31, 1994 and 1993.\nStatement of Income for the Year Ended December 31, 1994.\nStatement of Cash Flows for the Year Ended December 31, 1994.\nSchedules:\nSchedule I - Summary of Investments - Other Than Investments in Related Parties, December 31, 1994.\nSchedule II - Condensed Financial Information of the Registrant (Parent Company Only).\nBalance Sheet, December 31, 1994 and 1993.\nStatement of Income for the Three Years Ended December 31, 1994.\nStatement of Cash Flows for the Three Years Ended December 31, 1994.\nStatement of Changes in Stockholders' Equity for the Three Years Ended December 31, 1994. (See page 42 of the 1994 Annual Report to Stockholders which is hereby incorporated by reference.)\nSchedule III - Supplementary Insurance Information for the Years Ended December 31, 1994, 1993 and 1992.\nSchedule IV - Reinsurance for the Years Ended December 31, 1994, 1993 and 1992.\n- 18 - PART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K: (Continued)\nSchedule VI - Supplemental Information Concerning Property\/Casualty Insurance Operations for the Years Ended December 31, 1994, 1993 and 1992.\nThe following Article 7 schedules are omitted because the information is provided elsewhere in the Annual Report (Form 10-K) or because of the absence of conditions under which they are required:\nSchedule V\nExhibits:\n- 19 - PART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K: (Continued)\n(b) EXHIBITS AND REPORTS ON FORM 8-K\nNo Form 8-Ks were filed, nor required to be filed for any event during the quarter ended December 31, 1994.\n- 20 - 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 this 16th day of March, 1995.\nSAFECO CORPORATION\nBy ROGER H. EIGSTI --------------------------------- Roger H. Eigsti, Chairman, Chief Executive Officer 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- 21 -\n- 22 -\nCONSENT OF INDEPENDENT AUDITORS\nSAFECO Corporation:\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of SAFECO Corporation of our report dated February 10, 1995, included in the 1994 Annual Report to Shareholders of SAFECO Corporation.\nOur audits also included the financial statement schedules of SAFECO Corporation listed in Item 14(a). These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. 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 Registration Statements (Form S-8 Nos. 2-58654 and 33-14381 and Form S-3 No. 33-52863) of SAFECO Corporation of our report dated February 10, 1995, with respect to the consolidated financial statements and schedules of SAFECO Corporation included and\/or incorporated by reference in the Annual Report (Form 10-K) for the year ended December 31, 1994.\nERNST & YOUNG LLP\nSeattle, Washington March 15, 1995\nSAFECO CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONSOLIDATING INFORMATION BALANCE SHEET, DECEMBER 31, 1994 (In Thousands)\nSAFECO CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONSOLIDATING INFORMATION (CONTINUED) BALANCE SHEET, DECEMBER 31, 1993 (In Thousands)\nSAFECO CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONSOLIDATING INFORMATION STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1994 (In Thousands)\nSAFECO CORPORATION AND SUBSIDIARIES SUPPLEMENTAL CONSOLIDATING INFORMATION STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1994 (In Thousands)\nSchedule I SAFECO CORPORATION AND SUBSIDIARIES\nSUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1994 (In Thousands)\n(1) The carrying value of investments in fixed maturities, mortgage loans and real estate that have not produced income for the last twelve months is less than one percent of the total of such investments at December 31, 1994.\nSchedule II SAFECO CORPORATION (Parent Company Only)\nBalance Sheet (In Thousands Except Share Amounts) _____________________\nSchedule II SAFECO CORPORATION (Parent Company Only)\nSTATEMENT OF INCOME (In Thousands)\nSchedule II SAFECO CORPORATION (Parent Company Only)\nSTATEMENT OF CASH FLOWS (In Thousands)\nSCHEDULE III\nSAFECO CORPORATION AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (In Thousands)\nSchedule III\nSAFECO CORPORATION AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(In Thousands)\n(1) Property and casualty insurance companies' investments are available for payment of claims and benefits for all product lines within the segments; therefore, such investments and the related investment income have not been identified with specific segments. In the life and health companies, a major portion of investment income and assets is specifically identifiable within an industry segment. The remainder of these amounts has been allocated in proportion to the mean policy reserves and liabilities identified with each segment.\nSchedule IV SAFECO CORPORATION AND SUBSIDIARIES\nREINSURANCE FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (In Thousands)\nSchedule VI\nSAFECO CORPORATION\nSUPPLEMENTAL INFORMATION CONCERNING PROPERTY\/CASUALTY INSURANCE OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (In Thousands)\nSAFECO CORPORATION AND SUBSIDIARIES\nEXHIBIT INDEX*\nSAFECO CORPORATION AND SUBSIDIARIES (Continued)\nEXHIBIT INDEX*\n* Copies of Exhibits are available without charge by making a written request to:\nRod A. Pierson Senior Vice President, Secretary and Controller SAFECO Corporation SAFECO Plaza Seattle, WA 98185","section_15":""}
{"filename":"356080_1994.txt","cik":"356080","year":"1994","section_1":"ITEM 1. BUSINESS\nA. H. Belo Corporation (the \"Company\" or \"Belo\") owns and operates newspapers and network-affiliated television stations in seven U.S. cities. The Company traces its roots to The Galveston Daily News, which began publishing in 1842. Incorporated in Texas in 1926, the Company was reorganized as a Delaware corporation in 1987. (References herein to \"Company\" or \"Belo\" mean A. H. Belo Corporation and its wholly-owned subsidiaries unless the context otherwise specifies.)\nThe Company's principal newspaper is The Dallas Morning News. In addition, the Company publishes eight community newspapers for certain suburbs in the Dallas-Fort Worth metropolitan area. The Company also owns and operates network- affiliated VHF television broadcast stations in Dallas-Fort Worth and Houston, Texas; Seattle-Tacoma, Washington; Sacramento-Stockton-Modesto, California; Norfolk-Portsmouth-Newport News-Hampton, Virginia; New Orleans, Louisiana; and Tulsa, Oklahoma. The assets of television station WWL-TV in New Orleans, Louisiana, were purchased by the Company on June 1, 1994 for $110,000,000. Further, on February 1, 1995, the Company completed the acquisition of the assets of television station KIRO-TV in Seattle, Washington, for $162,500,000, excluding final adjustments.\nNote 12 to the Consolidated Financial Statements, included on page 38 of this document, contains information about the Company's industry segments for the years ended December 31, 1994, 1993 and 1992.\nNEWSPAPER PUBLISHING\nThe Company's wholly-owned subsidiary, The Dallas Morning News, Inc., publishes the Company's principal newspaper, The Dallas Morning News, seven days a week. Published continuously since 1885, The Dallas Morning News provides coverage of local, state, national and international news. The Morning News is distributed throughout the Southwest, though its circulation is concentrated primarily in the twelve counties surrounding Dallas: Collin, Dallas, Denton, Ellis, Henderson, Hood, Hunt, Johnson, Kaufman, Parker, Rockwall and Tarrant counties.\nThe Dallas Morning News strives to serve the public interest by maintaining a strong and independent voice in matters of public concern. It is the policy of the Company to allocate such resources as may be necessary to maintain excellence in news reporting and editorial comment in The Dallas Morning News.\nThe Dallas Morning News serves a large readership in its primary market. Average paid circulation for the six months ended September 30, 1994, according to the unaudited Publisher's Statement of the Audit Bureau of Circulations, an independent agency, was 524,567 daily, down slightly from the 1993 average daily circulation of 527,387. Sunday's average paid circulation was 797,206, down 2.1 percent from the six months ended September 30, 1993 average of 814,404.\nThe Dallas Morning News competes for advertising with television and radio stations (including a television station owned and operated by the Company), magazines, direct mail, cable television, billboards and other newspapers (including the other newspapers owned and operated by the Company). Also competing with The Dallas Morning News is the Fort Worth Star-Telegram, owned by Capital Cities\/ABC, Inc..\nThe basic material used in publishing The Dallas Morning News is newsprint. The average unit price of newsprint consumed during 1994 was slightly less than that of the prior year. However, recent market-wide increases in newsprint prices are expected to result in substantially higher newsprint prices during 1995. At present, newsprint is purchased from nine suppliers. During 1994, the Company's three largest providers of newsprint supplied approximately 57 percent of the annual requirements, but the Company is not dependent on any one of them. Management believes its sources of newsprint, along with alternate sources that are available, are adequate for its current needs.\nDFW Suburban Newspapers, Inc. publishes six paid and two free circulation newspapers for suburban communities in the Dallas-Fort Worth metropolitan area. These publications are delivered either one or two days a week. Each of the Company's community publications has its own sales, circulation, news and editorial personnel, and several of the publications maintain separate offices. All administrative functions are centralized and all of the newspapers are printed at a plant in Arlington, Texas. This plant is owned and operated by DFW Printing Company, Inc., a wholly-owned subsidiary of the Company, which, in addition to printing the suburban newspapers, is the site of the Company's commercial printing operations.\nTELEVISION BROADCASTING\nThe following table lists relevant information about the Company's television broadcasting stations:\n________________________\n(1) Designated Market Area (\"DMA\") is an exclusive geographic area consisting of all counties in which the local stations receive a preponderance of total viewing hours. DMA data, which is published by the A. C. Nielsen Company (\"Nielsen\"), is a significant factor in determining television advertising rates. All the information shown in the table is as of the November 1994 Nielsen ratings book.\n(2) An application for renewal of the license for WFAA-TV is pending before the Federal Communications Commission, and the station's license is by statute continued in effect pending action thereon.\n(3) On February 1, 1995, the Company purchased television station KIRO-TV for $162,500,000, excluding final adjustments. At that time, KIRO-TV was being operated as a CBS affiliate. As of March 13, 1995, the station began operating as a United Paramount Network affiliate.\n(4) Effective March 6, 1995, KXTV became an ABC television affiliate. Prior to March 6, 1995, KXTV was being operated as a CBS affiliate.\nCommercial television stations generally fall into one of three categories. The first category of stations consists of stations affiliated with one of the three major national networks (ABC, CBS and NBC). The second category is comprised of stations affiliated with newer national networks, such as Fox and the recently formed United Paramount Network (\"UPN\") and the WB (Warner Brothers) Television Network. The third category includes independent stations that are not affiliated with any network and that rely principally on local and syndicated programming.\nAffiliation with a television network can have a significant influence on the revenues of a television station because the audience share drawn by a network's programming can affect the rates at which a station can sell advertising time. The Federal Communications Commission (\"FCC\") regulates certain provisions of television stations' network affiliation contracts. The television networks compete for affiliations with licensed television stations through program commitments and local marketing support. From time to time, local television stations also solicit network affiliations on the basis of their ability to provide a network better access to a particular market.\nGenerally, rates for national and local spot advertising sold by the Company are determined by each station, which receives all of the revenues, net of agency commissions, for that advertising. Rates are influenced both by the demand for advertising time and the popularity of the station's programming. Most advertising during network programs is sold by the networks, which pay their affiliated stations negotiated fees for broadcasting such programs and advertising.\nThe Company's television broadcast properties compete for advertising revenues directly with other media such as newspapers (including those owned and operated by the Company), billboard advertising, magazines, direct mail advertising, radio stations, other television stations, cable television systems, and indirectly, with motion picture theaters and other news and entertainment media. The success of broadcast operations depends on a number of factors, including the general strength of the national and local economy, the ability to provide attractive programming, audience ratings, relative cost efficiency in reaching audiences as compared to other advertising media, technical capabilities and governmental regulations and policies.\nThe three major national television networks are represented in each television market in which the Company has a television broadcast station. Fox-affiliated stations also compete in each of Belo's markets for advertising sales and local viewers. Competition for advertising sales and local viewers within each market is intense, particularly among the network-affiliated commercial VHF television stations. See the table on page two of this document for information regarding the number of competing stations in each of the Company's television broadcast markets.\nREGULATION OF TELEVISION BROADCASTING\nThe Company's television broadcasting operations are subject to the jurisdiction of the FCC under the Communications Act of 1934, as amended (the \"Act\"). Among other things, the Act empowers the FCC to assign frequency bands; determine stations' frequencies, location and power; issue, renew, revoke and modify station licenses; regulate equipment used by stations; impose penalties for violation of the Act or of FCC regulations; impose fees for processing applications and other administrative functions; and adopt regulations to carry out the Act's provisions. The Act also prohibits the assignment of a broadcast license or the transfer of control of a broadcast licensee without prior FCC approval. Under the Act, the FCC also regulates certain aspects of the operation of cable television systems and other electronic media that compete with broadcast stations.\nThe Act would prohibit the Company's subsidiaries from continuing as broadcast licensees if record ownership or power to vote more than one-fourth of the Company's stock were to be held by aliens or foreign governments or their representatives, or if an officer or more than one-fourth of the Company's directors were aliens.\nUnder the Act, television broadcast licenses may be granted for maximum periods of five years and are renewable upon proper application for additional five-year terms. Renewal applications are granted without hearing if there are no competing applications or issues raised by petitioners to deny such applications that would cause the FCC to order a hearing. A full comparative hearing is required if competing applications are filed. A federal court of appeals has affirmed an FCC decision that recognizes an incumbent licensee's \"renewal expectancy\" based on\nsubstantial service to its community. The precise parameters of licensees' renewal expectancies in comparative proceedings are ambiguous at the present time. This ambiguity may lead to new FCC rules or policies as the result of pending FCC rulemaking proceedings, or Congressional legislation reforming the comparative renewal process.\nAn application for renewal of the broadcast license for WFAA-TV is pending before the FCC. The station's license is by statute continued pending action thereon. The current license expiration dates for each of the Company's television broadcast stations are set forth in the table under \"Business-Television Broadcasting.\"\nFCC rules limit the total number of television broadcast stations that may be under common ownership, operation and control, or in which a single person or entity may hold office or have more than a specified interest or percentage of voting power. FCC rules also place certain limits on common ownership, operation and control of, or cognizable interests or voting power in, (a) broadcast stations serving the same area, (b) broadcast stations and daily newspapers serving the same area and (c) television broadcast stations and cable systems serving the same area. The Company's ownership of The Dallas Morning News and WFAA-TV, which are both located in the Dallas-Fort Worth area and serve the same market area, predates the adoption of the FCC's rules regarding cross-ownership, and the Company's ownership of The Dallas Morning News and WFAA-TV has been \"grandfathered\" by the FCC.\nThese FCC rules affect the number, type and location of newspaper, broadcast and cable television properties that the Company might acquire in the future. For example, under current rules, the Company could not acquire any daily newspaper, broadcast or cable television properties in a market in which it now owns or has an interest deemed attributable under FCC rules in a television station, except that the FCC's rules and policies provide that waivers of their restrictions could be available to permit the Company's acquisition of radio stations in the Dallas, Houston, Seattle and Sacramento markets. Under current FCC regulations, and in light of the Company's current investments, the Company could not acquire outright any more television stations in other markets (but not including \"satellite\" television stations located within a parent station's grade B service contour which rebroadcast all or most of the parent station's programming) without disposing of another television station. The FCC has instituted proceedings looking toward possible relaxation of certain of these rules regulating television station ownership and changes in the standards used to determine what type of interests are considered to be attributable under it's rules.\nThe FCC has significantly reduced its past regulation of broadcast stations, including elimination of formal ascertainment requirements and guidelines concerning amounts of certain types of programming and commercial matter that may be broadcast. There are, however, FCC rules and policies, and rules and policies of other federal agencies, that regulate matters such as network-affiliate relations, cable systems' carriage of syndicated and network television programming on distant stations, political advertising practices, obscene and indecent programming, equal employment opportunity, application procedures and other areas affecting the business or operations of broadcast stations. The FCC has modified its rules which restrict network participation in program production and syndication. The U.S. Supreme Court has refused to review a lower court decision that upheld FCC action invalidating most aspects of the Fairness Doctrine, which had required broadcasters to present contrasting views on controversial issues of public importance. The FCC may, however, continue to regulate other aspects of fairness obligations in connection with certain types of broadcasts. The FCC has adopted rules to implement the Children's Television Act of 1990, which, among other provisions, limits the permissible amount of commercial matter in children's television programs and requires each television station to present educational and informational children's programming.\nThe FCC has adopted various regulations to implement certain provisions of the Cable Television Consumer Protection and Competition Act of 1992 (\"1992 Cable Act\") which, among other matters, includes provisions respecting the carriage of television stations' signals by cable television systems and requiring mid-license term review of television stations' equal employment opportunity practices. Certain provisions of the 1992 Cable Act, including the provisions respecting cable systems' carriage of local television stations, are the subject of pending judicial review proceedings. The FCC has also modified its rules to enable local telephone companies to provide a \"video dialtone\" service that would be similar to the ordinary telephone dialtone and would provide access for consumers to a wide variety of services, including video programming. This decision is the subject of pending judicial review proceedings.\nProposals for additional or revised regulations and requirements are pending before and are being considered by Congress and federal regulatory agencies from time to time. The FCC is at present considering revision or elimination of rules which now limit the permissible amount of primetime network programming which television stations in the top 50 markets may carry; rules relating to telephone company ownership of cable television systems; and policies with respect to high definition television. The Company cannot predict the effect of existing and proposed federal regulations and policies on its broadcast business.\nThe foregoing does not purport to be a complete summary of all the provisions of the Act or the regulations and policies of the FCC thereunder. Also, various of the foregoing matters are now, or may become, the subject of court litigation, and the Company cannot predict the outcome of any such litigation or the impact on its broadcast business.\nEMPLOYEES\nAs of December 31, 1994, the Company had 3,082 full-time employees. At such date, there were 28 full-time and 1 part-time television broadcasting employees of WFAA-TV represented by a union under a contract that expires on September 11, 1996. Furthermore, WWL-TV had 90 full-time and 1 part-time television broadcasting employees represented by unions under two separate contracts that expire on September 24, 1996 and January 8, 1997. As of February 1, 1995, KIRO-TV employed 228 employees, including 117 full-time and 13 part-time employees represented by three unions under five different agreements. Two of these agreements expired on December 31, 1994 and are currently under negotiation, two of the agreements expire on April 30, 1995 and the fifth agreement expires on May 31, 1997.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate operations, several departments of The Dallas Morning News and certain broadcast administrative functions have offices that are located in downtown Dallas in a portion of a 17-story office building owned by the Company.\nThe Company owns and operates a newspaper printing facility in Plano, Texas (the \"North Plant\"), in which eight high-speed offset presses are housed to print The Dallas Morning News. The remainder of The Morning News' operations are housed in a Company-owned five-story building in downtown Dallas. This facility is equipped with computerized input and photocomposition facilities and other equipment that is used in the production of both news and advertising copy.\nDFW Suburban Newspapers, Inc. and DFW Printing Company, Inc. operations are located at a Company-owned plant in Arlington, Texas. This facility is pledged as security for certain industrial revenue bonds issued in 1985.\nThe studios and offices of WFAA-TV occupy Company-owned facilities in downtown Dallas. The Company also owns 50 percent of the outstanding capital stock of Hill Tower, Inc. (\"Hill Tower\"), owner of a 1,500-foot transmitting tower and antennas located in Cedar Hill, Texas. The remaining 50 percent of Hill Tower is owned by the CBS television affiliate in Dallas, a subsidiary of Argyle Television Holding, Inc.. This property is used by both WFAA and the CBS television affiliate.\nKHOU-TV operates from Company-owned facilities located in Houston. The station's transmitter is located near DeWalt, Texas and includes a 2,000-foot tower.\nKIRO-TV operates from Company-owned facilities located in Seattle, Washington. The station's transmitting facility, which includes a 535-foot tower, is also located in Seattle.\nKXTV operates from Company-owned facilities located in Sacramento, California. The station's 2,000-foot tower and transmitter system are located in Sacramento County, California. The tower and transmitter building are\nowned by a joint venture between the Company and a subsidiary of River City Broadcasting, Inc., which owns and operates the ABC television affiliate in Stockton. KXTV leases the transmitter site from the joint venture.\nWVEC-TV operates from Company-owned facilities in Hampton and Norfolk, Virginia. The transmitting facility includes a 980-foot tower and antenna in Driver, Virginia. WVEC also leases additional building space adjacent to the Company- owned facilities that is used by the marketing and business departments.\nWWL-TV operates from Company-owned facilities in New Orleans, Louisiana. The transmitting facility includes a 960- foot tower in Gretna, Louisiana. WWL-TV also leases space in New Orleans, which is used as an additional broadcast studio.\nKOTV operates from Company-owned facilities located in Tulsa, Oklahoma. The station's transmitting system is located near Tulsa. The transmitter site and 1,839-foot tower are owned by a joint venture between the Company and Scripps Howard Inc., owner and operator of the NBC television affiliate in Tulsa. The balance of KOTV's transmitting equipment is owned by the station.\nAll of the foregoing subsidiaries have additional leasehold interests that are used in their respective operations.\nThe Company believes its properties are in good condition and well maintained, and that such properties are adequate for present operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are legal proceedings pending against the Company, including a number of actions for alleged libel. In the opinion of management, liabilities, if any, arising from these actions are either covered by insurance or would not have a material adverse effect on the consolidated operations or financial position 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 security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal 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 authorized common equity consists of 150,000,000 shares of Common Stock, par value $1.67 per share. The Company currently has two series of Common Stock outstanding, Series A and Series B. Shares of the two series are identical in all respects except that Series B shares are entitled to ten votes per share on all matters submitted to a vote of shareholders, while the Series A shares are entitled to one vote per share; transferability of the Series B shares is limited to family members and affiliated entities of the holder; and Series B shares are convertible at any time on a one-for-one basis into Series A shares. Shares of the Company's Series A Common Stock are traded on the New York Stock Exchange (NYSE symbol: BLC). There is no established public trading market for shares of Series B Common Stock. The Company has also issued certain Preferred Stock Purchase Rights that accompany the outstanding shares of the Company's Common Stock. See Note 9 of Notes to Consolidated Financial Statements.\nThe following table lists the high and low trading prices and the closing prices for Series A Common Stock as reported by the New York Stock Exchange for the last two years.\nOn February 28, 1995, the closing price for the Company's Series A Common Stock, as reported on the New York Stock Exchange, was $56 3\/8 and the approximate number of shareholders of record of the Series A Common Stock at the close of business on such date was 723. On February 28, 1995, there were approximately 559 holders of record of shares of Series B Common Stock.\nOn February 22, 1995, the Company announced a two-for-one stock split in the form of a stock dividend whereby one additional share of Series A and Series B Common Stock will be issued for each share of Series A and Series B Common Stock outstanding on May 19, 1995, the record date for the split. The stock split will be effected on June 9, 1995. On February 22, 1995, the Board of Directors also declared a quarterly dividend increase from $.075 to $.08 per share to be paid on a post-split basis on June 9, 1995 to shareholders of record on May 19, 1995. The effect of the stock split will be to double the number of shares outstanding and reduce earnings per share and other per share amounts by one- half. Total shareholders' equity and the proportionate ownership in the Company of individual shareholders will not be affected by the stock split. All information in this report is set forth on a pre-split basis.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents selected financial data of the Company for each of the five years in the period ending December 31, 1994. It is intended to highlight significant trends in Belo's financial condition and results of operations. For a more complete understanding of this selected financial data, please see Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements, including the Notes thereto.\n(A) Broadcasting revenues for 1994 include seven months' revenue of WWL-TV, which was purchased by Belo on June 1, 1994.\n(B) Net earnings for 1993 include an increase of $6,599,000 (33 cents per share) representing the cumulative effect of adopting Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993.\n(C) Belo purchased substantially all of the operating assets of the Dallas Times Herald newspaper for $55,673,000 in December 1991 and in June 1994, Belo purchased substantially all of the operating assets of television station WWL-TV for approximately $110,000,000.\n(D) The purchase of WWL-TV in June 1994 was financed with proceeds from Belo's revolving credit agreement.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION\nCash provided by operations is Belo's primary source of liquidity. During 1994, net cash provided by operations was $138,785,000, compared to $84,818,000 in 1993, a 63.6 percent increase. The increase resulted primarily from increased earnings from operations and changes in the components of working capital, primarily accounts receivable, accounts payable, accrued compensation and benefits and income taxes payable. The increase in accounts receivable is the result of higher revenues. Accounts payable were higher due primarily to larger payables for capital expenditures and timing of payments for newsprint. Accrued compensation and benefits were higher due to more employees and higher performance bonus accruals at the end of 1994. Higher income taxes payable are attributable to the earnings increase and timing of payments. Cash provided by operations was sufficient to fund capital expenditures, common stock dividends and the repurchase of 644,000 shares of treasury stock for $32,073,000. These shares were subsequently retired.\nOn June 1, 1994, Belo acquired the assets of television station WWL-TV, the CBS affiliate in New Orleans, Louisiana, from Rampart Operating Partnership for approximately $110,000,000 in cash. The acquisition has been accounted for as a purchase. See Other Matters on page 13 for a discussion of additional borrowings of revolving debt to finance an acquisition subsequent to December 31, 1994.\nAt December 31, 1994, Belo had access to a $600,000,000 variable rate revolving credit agreement, on which borrowings at that time were $305,000,000. The agreement expires on August 5, 1999 with an extension to August 5, 2000 at the request of the Company and consent of the participating banks. Revolving debt increased $55,000,000 from December 31, 1993 due to the net effect of the $110,000,000 in borrowings in June 1994 to finance the WWL-TV acquisition and debt repayments. From time to time, short-term unsecured notes are also used as a source of financing. Based on the Company's intent and ability to renew short-term notes through the revolving credit facility, short-term borrowings are classified as long-term. At December 31, 1994, there was $19,000,000 in short-term notes outstanding.\nBecause substantially all of Belo's outstanding debt is currently financed under the revolving credit agreement, the Company is subject to interest rate volatility. While average revolving debt rates for 1994 were 4.8 percent, the weighted average revolving debt rate at December 31, 1994 was 6.3 percent. If this condition continues in 1995, interest expense will be higher than in 1994. During 1994, Belo had four interest rate cap agreements that were designed to limit the interest rate on $75,000,000 of its revolving debt to 6 percent. During the first quarter of 1995, Belo sold these financial instruments for $1,395,000.\nThe Company has in place a stock repurchase program authorizing the purchase of up to $2,500,000 of Company stock annually. In addition, the Company has the authority to purchase approximately 765,000 shares of Series A Common Stock from time to time under a previous authorization from the Board of Directors.\nAlthough the Company believes its current financial condition and credit relationships will enable it to adequately fund its current obligations and near-term growth, Belo's Board of Directors has authorized the Company to file a shelf registration statement that would allow it, from time to time, to offer up to $200,000,000 of debt securities. The Company's current intentions would be to use the proceeds from any such offering to refinance existing indebtedness, to repurchase common stock under the Company's stock repurchase program and for general corporate purposes, including acquisitions.\nOn December 31, 1994, Belo's ratio of long-term debt to total capitalization was 46.3 percent, compared to 44.5 percent at the end of 1993. The change during 1994 is due to additional borrowings to finance the acquisition of WWL-TV and the effect on shareholders' equity of the repurchase and subsequent retirement of treasury shares.\nCapital expenditures in 1994 were $47,371,000. Capital projects for the year included additional production equipment for The Dallas Morning News and significant building projects at two of Belo's broadcast stations. Belo expects to finance future capital expenditures using net cash generated from operations and, when necessary,\nborrowings of revolving debt. Required future payments for capital expenditures in 1995 are $13,677,000 and relate primarily to additional newspaper publishing equipment and the renovation of certain newspaper publishing operating facilities. Total capital expenditures in 1995 are expected to be somewhat less than $40,000,000.\nBelo paid dividends of $11,984,000 or 60 cents per share on Series A and Series B Common Stock outstanding during 1994 compared to $11,128,000 or 56 cents per share in 1993.\nCONSOLIDATED RESULTS OF OPERATIONS\nBelo recorded 1994 net earnings of $68,867,000 or $3.41 per share, compared to $51,077,000 ($2.53 per share) in 1993 and $37,170,000 ($1.90 per share) in 1992. Results for 1994 include a one-time charge to net earnings of $1,567,000 (8 cents per share) from the donation of shares of Stauffer Communications, Inc. stock to The Dallas Morning News--WFAA Foundation. The transaction included a $9,271,000 gain on the write-up of the shares to fair market value, less a charge of $16,675,000 for the subsequent donation of those shares to the Foundation, and the related income tax benefit of $5,837,000. Upon consummation of an outstanding tender offer for the remaining Stauffer shares, Belo expects this transaction to increase earnings per share by approximately 8 cents in 1995, assuming the transaction occurs before June 9, 1995, the effective date of the stock split. See Market for Registrant's Common Equity and Related Stockholder Matters on page 7. Belo also reversed $631,000 of music license fee accruals (2 cents per share) during 1994 in response to a final agreement between the All Industry Television Music License Committee and Broadcast Music, Inc., which established final television music performance rights fee levels through 1994. Excluding these nonrecurring items, net earnings for 1994 were $3.47 per share. These earnings include seven months of WWL-TV results, which contributed approximately 5 cents per share to current year earnings after consideration of incremental interest and amortization.\nSeveral one-time items are included in 1993 net earnings, including a $6,599,000 increase (33 cents per share) representing the cumulative effect of adopting Statement of Financial Accounting Standards (\"SFAS\") No. 109 in January 1993. This increase was partially offset in the third quarter, when Belo recorded a $2,249,000 (11 cents per share) adjustment to deferred taxes following an increase in the federal income tax rate from 34 percent to 35 percent. Also included in 1993 earnings was a $5,822,000 (19 cents per share) restructuring charge related primarily to the write-off of goodwill and a reduction in the carrying value of production assets associated with the newspaper operations of Dallas-Fort Worth Suburban Newspapers, Inc., a wholly-owned subsidiary of Belo. In addition, Belo reversed certain music license fee accruals totaling $3,349,000 (10 cents per share) in 1993 in response to an agreement between the All Industry Television Music License Committee and the American Society of Composers, Authors and Publishers, defining the formula used to compute licensing fees for the use of certain music in television broadcasts from 1984 to 1994. Net earnings for 1993, excluding these special one-time items, were $2.40 per share.\nIn 1992, net earnings included a $4,019,000 (16 cents per share) increase from a property damage settlement with the United States Navy. Excluding this one-time gain, comparable 1992 earnings were $1.74 per share.\nInterest expense in 1994 was $16,112,000 compared to $15,015,000 in 1993 and $24,159,000 in 1992. The decrease in interest expense from 1992 to 1993 was primarily due to lower interest rates. During 1992, Belo had $200,000,000 of fixed-rate notes outstanding, with an average rate of 9 percent while revolving rates were approximately 4 percent. In January 1993, $100,000,000 of the fixed-rate debt was converted to revolving debt, and in December of 1993, the remaining $100,000,000 was replaced with revolving debt. These transactions lowered the average rate on total debt to approximately 5.4 percent for 1993. The 1994 average rate on revolving debt was 4.8 percent. However, rate savings were offset by higher average borrowings due to the acquisition of WWL-TV in June 1994. Capitalization of interest also affected interest expense in each period, mostly in 1993 during The Dallas Morning News' North Plant expansion project. Capitalized interest for 1994, 1993 and 1992 was $138,000, $1,961,000 and $395,000, respectively.\nOther income and expense for 1994 includes the charge associated with the donation of Stauffer Communications, Inc. stock. Other income and expense in 1993 included a gain of $986,000 on the sale of two\nparcels of non-operating real estate and in 1992, included the $4,019,000 gain on the property damage settlement with the United States Navy.\nThe effective tax rate for 1994 of 36.2 percent includes the tax benefit associated with the Stauffer Communications, Inc. stock donation. The 1993 effective tax rate of 41.1 percent was affected by an increase in the federal income tax rate, which resulted in a $2,249,000 increase in deferred tax expense to adjust deferred taxes to the 35 percent rate. In addition, the 1993 rate was favorably impacted by the reversal of certain tax accruals as a result of new tax legislation regarding amortization of intangibles. Excluding these items, the effective tax rates for 1994 and 1993 were 38.9 percent and 39.5 percent, while the effective rate in 1992 was 39.6 percent.\nNEWSPAPER PUBLISHING\nIn 1994, newspaper publishing revenues represented 58.8 percent of total revenues, compared to 61.6 percent in 1993 and 61 percent in 1992. Although publishing revenues increased 10 percent in 1994 from 1993, they have decreased as a percent of total revenues due to a disproportionate increase in broadcast revenues during 1994, partially due to the WWL-TV acquisition. The composition of publishing revenues has remained fairly consistent year to year, with advertising revenues accounting for 86 percent of revenues in 1994 and 87 percent in 1993 and 1992. Circulation revenues represent 10 percent of 1994 publishing revenue and 11 percent in 1993 and 1992. Other publishing revenues, primarily commercial printing, contributed the remainder.\nNewspaper advertising volume for The Dallas Morning News, Belo's principal newspaper, is measured in column inches. Volume for the last three years was as follows:\nRevenues from newspaper publishing for 1994 were $369,366,000, an increase of $33,724,000 or 10 percent over 1993 revenues. Classified and general advertising revenues contributed the majority of the increase in year-to-year revenue gains. As noted above, linage in these two categories increased 5.8 percent and 3.3 percent, respectively, which combined with significant rate increases, resulted in an increase in classified and general advertising revenues of $27,580,000. Strong demand for employment advertising and a good automotive market drove the improvement in classified linage. The telecommunications industry was a significant component of the general advertising year-to-year increase. Retail ROP revenues for 1994 were down slightly when compared to 1993 due to volume declines of 8.3 percent, partially offset by an increase in the average rate of 8.7 percent. The retail volume declines were primarily attributable to a shift by certain department stores to preprints, which increased 15.6 percent over 1993 preprint revenue. Circulation revenues in 1994 were up 2.1 percent from 1993 despite a slight decrease in the Sunday average circulation, due to price increases in April and July.\nTotal publishing revenues in 1993 were $335,642,000, up 6.7 percent from revenues of $314,701,000 earned in 1992. Classified advertising revenues were nearly 11 percent better than 1992 due to both linage and rate increases. The increase in linage was primarily attributable to automotive and employment advertising. Retail and general advertising revenues also improved in 1993 relative to 1992, primarily due to increased rates. Circulation revenues increased 5.9 percent in 1993, mostly because of a January 1, 1993 increase in the price of a Sunday single-copy and the weekend subscription rate.\nThe Company believes that its advertising rates continue to compare favorably with competing media. Future demand for advertising in the Dallas-Fort Worth area will continue to depend on general economic conditions of the Southwest region and the United States as a whole. Thus, the ability of the Company to generate continued growth in circulation and advertising revenues will likely depend on its ability to compete successfully in the highly\ncompetitive Dallas-Fort Worth media market, where numerous news and advertising alternatives are available. In addition, various market and demographic factors, such as circulation and readership trends, retail sales activity, inflation and population growth will affect future revenues.\nNewspaper publishing earnings from operations in 1994 were $66,568,000 compared to $44,293,000 in 1993. Operating results in 1993 included a $5,822,000 restructuring charge related to Belo's suburban newspaper operations. Excluding this one-time charge, comparable 1993 operating earnings were $50,115,000. The 32.8 percent increase in 1994 from adjusted 1993 operating earnings is due to the 10 percent increase in 1994 revenues, partially offset by a 6 percent increase in operating expenses, resulting in an operating margin of 18 percent compared to an adjusted margin of 14.9 percent in 1993. Salaries, wages and employee benefits increased in 1994 due to a larger employment base, merit increases, higher performance-based bonuses and an increase in related benefit costs. Other production, distribution and operating costs were also higher due to increased distribution and outside solicitation expenses associated with circulation efforts and higher advertising and promotion expense. Rack conversion costs to accommodate single copy price increases also contributed to higher 1994 expense. Depreciation expense was up as well, due to a full year's depreciation of The Dallas Morning News' North Plant expansion project that was completed in late 1993. Newsprint expense, which currently represents approximately 29 percent of total newspaper publishing operating costs, was only slightly higher in 1994 than in 1993. The increase was primarily due to slightly higher consumption offset by lower average prices. However, recent and proposed newsprint price increases could cause newsprint expense at The Dallas Morning News to increase by as much as 40 percent over 1994. The Company plans to offset this increase by limiting 1995 spending increases in all other operating expense categories, maintaining 1994 employee-count levels and raising advertising rates.\nNewspaper publishing earnings from operations in 1993 (excluding the $5,822,000 restructuring charge) increased 16.6 percent from 1992. Although total publishing revenues increased 6.7 percent, operating expenses (excluding the charge) increased only 5.1 percent, resulting in an operating margin of 14.9 percent versus 13.7 percent in 1992. Salaries, wages and employee benefits rose primarily as a result of merit increases and more full-time employees. Newsprint expense was up due to both increased consumption associated with the linage increase and a higher average cost per ton. Contributing to the increase in linage was the publishing of special sports sections in connection with the Dallas Cowboys' appearance in the Super Bowl. The higher consumption accounted for approximately 60 percent of the overall increase in newsprint expense. In addition, expansion of delivery routes resulted in increased distribution expenses. Depreciation expense was higher in 1993 than in 1992 following the completion of The Dallas Morning News' North Plant expansion project. Partially offsetting these increases were savings in outside services, bad debt expense and property taxes.\nBROADCASTING\nBelo's television broadcast subsidiaries contributed 41.2 percent of total 1994 revenues compared to 38.4 percent in 1993 and 39 percent in 1992. Broadcast revenues for 1994, which include seven months' revenue for WWL-TV, were $258,759,000. These results represent an increase of 23.7 percent over 1993 revenues of $209,193,000. In 1993, revenues improved 4 percent from the $201,241,000 of the previous year.\nEach station contributed to the increase in 1994 revenues with improvement in every revenue category. The greatest improvements were in local and political advertising. Local advertising revenues, which improved 25 percent overall, were up most significantly in Dallas, Houston and Tulsa while the New Orleans station contributed more than 10 percent of total 1994 local revenues. Advertising for automobiles was a significant factor in each of Belo's local market gains. National revenues benefited from the broadcast of the 1994 Winter Olympics on Belo's CBS-affiliated stations, but were offset somewhat by losses associated with the baseball strike and the move of NFL Football from CBS to the Fox network. Political revenues were up considerably in 1994 due to active gubernatorial and senate races in several states. The recent and dramatic changes in the structure of the network television industry in 1994 led to the renegotiation of several of Belo's network affiliation agreements, resulting in a significant increase in 1994 network compensation, beginning in the third quarter. Belo anticipates 1995 network compensation will exceed 1994 network compensation levels as well. This increase, however, is expected to be offset by the anticipated decline in political advertising.\nLocal and national advertising revenues in 1993 increased 6.2 percent and 6.6 percent, respectively, compared to 1992 revenues. Stations in Houston, Virginia and Tulsa combined for an overall revenue gain of $9,266,000 while Dallas station revenues were relatively flat and the California station experienced a slight revenue decline. In 1993, all but one of Belo's broadcast stations experienced an increase in local advertising revenues. National advertising revenues increased at all but another of Belo's stations. Contributing factors to the 1993 improvements include strong ratings performances and healthier local economies. The industry categories contributing the most to advertising revenues were restaurants, automobiles, department stores and health care. Partially offsetting these revenue gains, however, were a significant decrease in political advertising compared to 1992, a weaker California economy and other competitive forces.\nBroadcast earnings from operations were $80,445,000 in 1994 compared to $63,240,000 in 1993. Included in 1994 earnings are WWL-TV operations since June 1, 1994. Also included in broadcast earnings in 1994 and 1993 are increases to earnings of $631,000 and $3,349,000, respectively, for the reversal of certain music license fee accruals from previous years. Excluding the music license fee adjustments, operating earnings for 1994 and 1993 were $79,814,000 and $59,891,000, respectively. Revenue improvements were partially offset by higher operating costs. Salaries, wages and employee benefits were higher in 1994 due to increases in sales commissions, more employees, merit increases, higher profit performance bonuses and an increase in benefit costs. Other production, distribution and operating costs were higher in 1994 than in 1993 (excluding the music license fee adjustments) due primarily to an increase in programming expenses from increased contract rates for several syndicated program packages and costs to produce a new local morning show and weekly news show in Dallas. Advertising and promotion costs, as well as repair and maintenance expenses, were also higher in 1994. These increases were slightly offset by lower bad debt and outside services expense. Depreciation and amortization expense increased as a result of the purchase of WWL-TV assets.\nBroadcast earnings from operations for 1993, excluding the music license fee adjustment, were $59,891,000 compared to $56,461,000 in 1992, an increase of 6.1 percent. Although revenues increased 4 percent, operating costs increased only 3.3 percent, excluding the music license fee adjustment. Contributing to the increase in 1993 expenses were higher salaries, wages and employee benefits, due to merit increases, higher benefit costs and an increase in the number of broadcast employees. Communications and travel expenses were higher in 1993 than in 1992 due to coverage of significant news stories, including the Dallas Cowboys' appearance in the 1993 Super Bowl, the Presidential Inauguration, and the Branch Davidian story in Waco, Texas. These increases were partially offset by savings in 1993 programming expense.\nIn recent years, the television broadcasting industry has been affected by increased competition for viewing audiences. Belo continues to compete aggressively for advertisers and viewing audiences in markets that offer many alternative media outlets. Future earnings growth will likely depend on the ability to offer competitive audience delivery to advertisers and on general economic conditions.\nOTHER MATTERS\nOn February 1, 1995, Belo completed the acquisition of certain assets of television station KIRO-TV in Seattle, Washington for a purchase price of $162,500,000, excluding final adjustments. Belo borrowed funds from its revolving credit agreement to complete the transaction, which will be accounted for as a purchase. Although a complete purchase price allocation will not be finalized until later in 1995, it is estimated that the majority of the purchase price will be allocated to property, plant and equipment and intangible assets. The Company intends to operate the television station as a United Paramount affiliate, with an emphasis on local news programming. Management expects the acquisition to be dilutive in 1995.\nThe net effect of inflation on Belo's revenues and net earnings from operations has not been material in the last few years because of a relatively low rate of inflation during this period, combined with efforts to lessen the effect of rising costs through improved productivity, cost control and, when warranted, increased prices.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements, together with the report of independent auditors, are included on pages 23 through 40 of this document. Financial statement schedules have been omitted because the required information is contained in the Consolidated Financial Statements or related notes, or because such information is not applicable.\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 headings \"Outstanding Capital Stock and Stock Ownership of Directors, Certain Executive Officers and Principal Shareholders,\" \"Executive Officers of the Company\" and \"Election of Directors\" contained in the definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 3, 1995, is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the heading \"Executive Compensation and Other Matters\" and \"Election of Directors\" contained in the definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 3, 1995, 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 heading \"Outstanding Capital Stock and Stock Ownership of Directors, Certain Executive Officers and Principal Shareholders\" contained in the definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 3, 1995, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth under the headings \"Executive Compensation and Other Matters\" and \"Election of Directors\" contained in the definitive Proxy Statement for the Company's Annual Meeting of Shareholders to be held on May 3, 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) The financial statements listed in the Index to Financial Statements included in the Table of Contents are filed as part of this report.\n(2) The financial schedules required by Regulation S-X are either not applicable or are included in the information provided in the Notes to Consolidated Financial Statements, which are filed as part of this report.\n(3) Exhibits\nThe exhibits to this report are hereby incorporated by reference, as specified:\nEXHIBIT NUMBER DESCRIPTION\n3.1 Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K dated March 19, 1992 (the \"1991 Form 10-K\"))\n3.2 Certificate of Correction to Certificate of Incorporation dated May 13, 1987 (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K dated March 18, 1993 (the \"1992 Form 10-K\"))\n3.3 Certificate of Designation of Series A Junior Participating Preferred Stock of the Company dated April 16, 1987 (incorporated by reference to Exhibit 3.3 to the 1991 Form 10-K)\n3.4 Certificate of Amendment of Certificate of Incorporation of the Company dated May 4, 1988 (incorporated by reference to Exhibit 3.4 to the 1992 Form 10-K)\n3.5 Amended Certificate of Designation of Series A Junior Participating Preferred Stock of the Company dated May 4, 1988 (incorporated by reference to Exhibit 3.5 to the 1992 Form 10-K)\n3.6 Certificate of Designation of Series B Common Stock of the Company dated May 4, 1988 (incorporated by reference to Exhibit 3.6 to the 1992 Form 10-K)\n3.7 Bylaws of the Company, effective February 22, 1995\n4.1 Certain rights of the holders of the Company's Common Stock are set forth in Exhibits 3.1-3.6 above\n4.2 Specimen Form of Certificate representing shares of the Company's Series A Common Stock (incorporated by reference to Exhibit 4.2 to the 1992 Form 10-K)\n4.3 Specimen Form of Certificate representing shares of the Company's Series B Common Stock (incorporated by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K dated March 20, 1989)\n4.4 Form of Rights Agreement, dated March 10, 1986 between the Company and RepublicBank Dallas, National Association as Rights Agent, which includes as Exhibit B thereto the Form of Right Certificate (incorporated by reference to Exhibit 4.8 to the 1991 Form 10-K)\n4.5 Supplement No. 1 to Rights Agreement (incorporated by reference to Exhibit 4.9 to the 1991 Form 10-K)\n4.6 Supplement No. 2 to Rights Agreement (incorporated by reference to Exhibit 4.9 to the 1992 Form 10-K)\n4.7 Supplement No. 3 to Rights Agreement (incorporated by reference to Exhibit 4.10 to the 1992 Form 10-K)\n4.8 Supplement No. 4 to Rights Agreement dated December 12, 1988 substituting Manufacturers Hanover Trust Company as Rights Agent (incorporated by reference to Exhibit 4.8 to the Company's Annual Report on Form 10-K dated March 18, 1994 (the \"1993 Form 10-K\"))\n4.9 Supplement No. 5 to Rights Agreement (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1993)\n4.10 Supplement No. 6 to Rights Agreement\nEXHIBIT NUMBER DESCRIPTION\n10.1 Contracts relating to television broadcasting:\n(1) Contract for Affiliation between KOTV in Tulsa, Oklahoma and CBS, with Network Affiliation Consent (incorporated by reference to Exhibit 10.1(1) to the 1991 Form 10-K)\n(2) Contract for Affiliation between KHOU-TV in Houston, Texas and CBS, with Network Affiliation Consent (incorporated by reference to Exhibit 10.1(2) to the 1991 Form 10-K)\n(3) Letter Amendment to Contract for Affiliation between KHOU-TV in Houston, Texas and CBS (incorporated by reference to Exhibit 10.1(3) to the 1993 Form 10-K)\n(4) Contract for Affiliation between KXTV in Sacramento, California and CBS (incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1993 (the \"First Quarter 1993 Form 10-Q\"))\n(5) Contract for Affiliation between WFAA-TV in Dallas, Texas and ABC, with Network Affiliation Consent (incorporated by reference to Exhibit 10.1(4) to the Company's Annual Report on Form 10-K dated March 28, 1991 (the \"1990 Form 10-K\"))\n(6) Rider One to Contract for Affiliation between WFAA-TV in Dallas, Texas and ABC (incorporated by reference to Exhibit 10.1 to the First Quarter 1993 Form 10-Q)\n(7) Contract for Affiliation between WVEC-TV in Hampton-Norfolk, Virginia and ABC, with Network Affiliation Consent (incorporated by reference to Exhibit 10.1(5) to the 1991 Form 10-K)\n(8) Contract for Affiliation between WWL-TV in New Orleans, Louisiana, and CBS\n10.2 Contracts relating to newspaper publication:\n(1) Founding Agreement between the Company and Newsprint South, Inc. for newsprint supply (incorporated by reference to Exhibit 10.2(2) to the 1990 Form 10-K)\n(2) Amendment to the Founding Agreement between the Company and Newsprint South, Inc. for newsprint supply (incorporated by reference to Exhibit 10.2(3) to the 1990 Form 10-K)\n10.3 (1) Management Security Plan (incorporated by reference to Exhibit 10.4(1) to the 1991 Form 10-K)\n(2) Stock Option Plan (incorporated by reference to Exhibit 10.4(2) to the 1991 Form 10-K)\n(3) Amendment to Stock Option Plan by the Compensation Committee of the Board of Directors (incorporated by reference to Exhibit 10.4(3) to the 1991 Form 10-K)\n(4) Amendments to Stock Option Plan (incorporated by reference to Exhibit 10.4(4) to the 1991 Form 10-K)\n(5) Amendment to Stock Option Plan dated December 19, 1986 (incorporated by reference to Exhibit 10.4(5) to the 1991 Form 10-K)\n(6) Amendment to Stock Option Plan dated February 22, 1989 (incorporated by reference to Exhibit 10.3(6) to the 1993 Form 10-K)\nEXHIBIT NUMBER DESCRIPTION\n(7) 1986 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.4(7) to the 1991 Form 10-K)\n(8) Amendment No. 1 to 1986 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.4(8) to the 1991 Form 10-K)\n(9) Amendment No. 2 to 1986 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.3(9) to the 1992 Form 10-K)\n(10) Amendment No. 3 to 1986 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.3(10) to the 1993 Form 10-K)\n(11) Amendment No. 4 to 1986 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.3(11) to the 1993 Form 10-K)\n(12) Amendment No. 5 to 1986 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.3(12) to the 1993 Form 10-K)\n(13) Amendment No. 6 to 1986 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.3(13) to the 1992 Form 10-K)\n(14) The A. H. Belo Corporation Employee Savings and Investment Plan\n(15) First Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan (incorporated by reference to Exhibit 10.3(15) to the 1992 Form 10-K)\n(16) Second Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan (incorporated by reference to Exhibit 10.3(16) to the 1992 Form 10-K)\n(17) Third Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan (incorporated by reference to Exhibit 10.2 to the First Quarter 1993 Form 10-Q)\n(18) Fourth Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan (incorporated by reference to Exhibit 4.14 to Post-Effective Amendment No. 1 to Form S-8 dated January 18, 1994 (Registration No. 33-30994))\n(19) Fifth Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan (incorporated by reference to Exhibit 10.3(19) to the 1993 Form 10-K)\n(20) Sixth Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan (incorporated by reference to Exhibit 10.3(1) to the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1994 (\"Second Quarter 1994 Form 10-Q\"))\n(21) Seventh Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan\n(22) Eighth Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan\n(23) The G. B. Dealey Retirement Pension Plan (as amended and restated effective January 1, 1988) (incorporated by reference to Exhibit 10.3(20) to the 1993 Form 10-K)\n(24) First Amendment to the G. B. Dealey Retirement Pension Plan (incorporated by reference to Exhibit 10.3(21) to the 1993 Form 10-K)\nEXHIBIT NUMBER DESCRIPTION\n(25) Second Amendment to the G. B. Dealey Retirement Pension Plan (incorporated by reference to Exhibit 10.3(22) to the 1993 Form 10-K)\n(26) Third Amendment to the G. B. Dealey Retirement Pension Plan (incorporated by reference to Exhibit 10.3(23) to the 1993 Form 10-K)\n(27) Fourth Amendment to the G. B. Dealey Retirement Pension Plan (incorporated by reference to Exhibit 10.3(24) to the 1993 Form 10-K)\n(28) Fifth Amendment to the G. B. Dealey Retirement Pension Plan (incorporated by reference to Exhibit 10.3(25) to the 1993 Form 10-K)\n(29) Sixth Amendment to the G. B. Dealey Retirement Pension Plan (incorporated by reference to Exhibit 10.3(2) to the Second Quarter 1994 Form 10-Q)\n(30) Seventh Amendment to the G. B. Dealey Retirement Pension Plan\n(31) Eighth Amendment to the G. B. Dealey Retirement Pension Plan\n(32) Master Trust Agreement, effective as of July 1, 1992, between A. H. Belo Corporation and Mellon Bank, N. A. (incorporated by reference to Exhibit 10.3(26) to the 1993 Form 10-K)\n(33) A. H. Belo Corporation Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.3(27) to the 1993 Form 10-K)\n(34) Trust Agreement dated February 28, 1994, between the Company and Mellon Bank, N. A. (incorporated by reference to Exhibit 10.3(28) to the 1993 Form 10-K)\n(35) Summary of A. H. Belo Corporation Executive Compensation Program (incorporated by reference to Exhibit 10.3(18) to the 1992 Form 10-K)\n(36) Employment and Consultation Agreement between A. H. Belo Corporation and James P. Sheehan (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1993)\n10.4 (1) Loan Agreement dated October 1, 1985, between City of Arlington Industrial Development Corporation and Dallas-Fort Worth Suburban Newspapers, Inc. (incorporated by reference to Exhibit 10.5(2) to the 1991 Form 10-K)\n(2) Letter of Credit and Reimbursement Agreement dated as of June 2, 1987, between Dallas-Fort Worth Suburban Newspapers, Inc. and The Sanwa Bank, Limited, Dallas Agency covering $6,400,000 City of Arlington Industrial Development Corporation Industrial Development Revenue Bonds (incorporated by reference to Exhibit 10.5(3) to the 1991 Form 10-K)\n(3) Credit Agreement dated as of August 5, 1994 among the Company and Citicorp Securities, Inc., as Syndication Agent, The First National Bank of Chicago, as Administrative Agent, Texas Commerce Bank National Association, as Documentation Agent and The Banks Listed Therein, as Lenders (incorporated by reference to Exhibit 10.4(1) to the Second Quarter 1994 Form 10-Q)\n(4) Amendment and Waiver Agreement dated as of August 5, 1994, by and between the Company and The Sanwa Bank, Limited, Dallas Agency\n21 Subsidiaries of the Company\n23 Consent of Ernst & Young LLP\n27 Financial Data Schedule (filed electronically with the Securities and Exchange Commission)\nExecutive Compensation Plans and Arrangements\nManagement Security Plan--1991 Form 10-K, Exhibit 10.4(1)\nStock Option Plan--1991 Form 10-K, Exhibit 10.4(2)\nAmendment to Stock Option Plan by the Compensation Committee of the Board of Directors--1991 Form 10-K, Exhibit 10.4(3)\nAmendments to Stock Option Plan--1991 Form 10-K, Exhibit 10.4(4)\nAmendment to Stock Option Plan dated December 19, 1986--1991 Form 10-K, Exhibit 10.4(5)\nAmendment to Stock Option Plan dated February 22, 1989--1993 Form 10-K, Exhibit 10.3(6)\n1986 Long-Term Incentive Plan--1991 Form 10-K, Exhibit 10.4(7)\nAmendment No. 1 to 1986 Long-Term Incentive Plan --1991 Form 10-K, Exhibit 10.4(8)\nAmendment No. 2 to 1986 Long-Term Incentive Plan --1992 Form 10-K, Exhibit 10.3(9)\nAmendment No. 3 to 1986 Long-Term Incentive Plan--1993 Form 10-K, Exhibit 10.3(10)\nAmendment No. 4 to 1986 Long-Term Incentive Plan--1993 Form 10-K, Exhibit 10.3(11)\nAmendment No. 5 to 1986 Long-Term Incentive Plan--1993 Form 10-K, Exhibit 10.3(12)\nAmendment No. 6 to 1986 Long-Term Incentive Plan--1992 Form 10-K, Exhibit 10.3(13)\nThe A. H. Belo Corporation Employee Savings and Investment Plan--filed herewith as Exhibit 10.3(14)\nFirst Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan--1992 Form 10-K, Exhibit 10.3(15)\nSecond Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan--1992 Form 10-K, Exhibit 10.3(16)\nThird Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan--First Quarter 1993 Form 10- Q, Exhibit 10.2\nFourth Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan--Post-Effective Amendment No. 1 to Form S-8 dated January 18, 1994, Exhibit 4.14\nFifth Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan--1993 Form 10-K, Exhibit 10.3(19)\nSixth Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan--Second Quarter 1994 Form 10-Q, Exhibit 10.3(1)\nSeventh Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan--filed herewith as Exhibit 10.3(21)\nEighth Amendment to the A. H. Belo Corporation Employee Savings and Investment Plan--filed herewith as Exhibit 10.3(22)\nThe G. B. Dealey Retirement Pension Plan (as amended and restated effective January 1, 1988)--1993 Form 10-K, Exhibit 10.3(20)\nFirst Amendment to the G. B. Dealey Retirement Pension Plan--1993 Form 10-K, Exhibit 10.3(21)\nSecond Amendment to the G. B. Dealey Retirement Pension Plan--1993 Form 10-K, Exhibit 10.3(22)\nThird Amendment to the G. B. Dealey Retirement Pension Plan--1993 Form 10-K, Exhibit 10.3(23)\nFourth Amendment to the G. B. Dealey Retirement Pension Plan--1993 Form 10-K, Exhibit 10.3(24)\nFifth Amendment to the G. B. Dealey Retirement Pension Plan--1993 Form 10-K, Exhibit 10.3(25)\nSixth Amendment to the G. B. Dealey Retirement Pension Plan--Second Quarter 1994 Form 10-Q, Exhibit 10.3(2)\nSeventh Amendment to the G. B. Dealey Retirement Pension Plan--filed herewith as Exhibit 10.3(30)\nEighth Amendment to the G. B. Dealey Retirement Pension Plan--filed herewith as Exhibit 10.3(31)\nA. H. Belo Corporation Supplemental Executive Retirement Plan--1993 Form 10-K, Exhibit 10.3(27)\nSummary of A. H. Belo Corporation Executive Compensation Program--1992 Form 10-K, Exhibit 10.3(18)\nEmployment and Consultation Agreement between A. H. Belo Corporation and James P. Sheehan--Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1993, Exhibit 10.1\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.\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.\nA. H. BELO CORPORATION\nBy: \/S\/Robert W. Decherd Robert W. Decherd Chairman of the Board, President & Chief Executive Officer\nDated: March 8, 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 Company and in the capacities and on the dates indicated:\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders A. H. Belo Corporation\nWe have audited the accompanying consolidated balance sheets of A. H. Belo Corporation and subsidiaries 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. 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 A. H. Belo Corporation and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their 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 5 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for income taxes.\n\/S\/ERNST & YOUNG LLP\nDallas, Texas January 26, 1995 except for Note 13, as to which the date is February 1, 1995.\nCONSOLIDATED STATEMENTS OF EARNINGS A. H. BELO CORPORATION AND SUBSIDIARIES\nSee accompanying Notes to Consolidated Financial Statements.\nCONSOLIDATED BALANCE SHEETS A. H. BELO CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (CONTINUED) A. H. BELO CORPORATION AND SUBSIDIARIES\nSee accompanying Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY A. H. BELO CORPORATION AND SUBSIDIARIES\nSee accompanying Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS A. H. BELO CORPORATION AND SUBSIDIARIES\nSee accompanying Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. Belo Corporation and Subsidiaries\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA) Principles of Consolidation The consolidated financial statements include the accounts of A. H. Belo Corporation (the \"Company\" or \"Belo\") and its wholly-owned subsidiaries after the elimination of all significant intercompany accounts and transactions.\nCertain amounts for the prior years have been reclassified to conform to the current year presentation.\nB) Statements of Cash Flows For the purpose of the Consolidated Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with a remaining maturity of three months or less to be temporary cash investments. Such temporary cash investments are classified as available for sale and carried at fair value.\nC) Accounts Receivable Accounts receivable are net of a valuation reserve that represents an estimation of amounts considered uncollectible. Expense for such uncollectible amounts, which is included in other production, distribution and operating costs, was $4,506,000, $4,617,000 and $3,758,000 in 1994, 1993 and 1992, respectively. Accounts written off during these years were $4,231,000, $4,408,000 and $7,235,000, respectively.\nD) Inventories Inventories, consisting primarily of newsprint, ink and other supplies used in printing newspapers, are stated at the lower of average cost or market value.\nE) Property, Plant and Equipment Depreciation of property, plant and equipment is provided principally on a straight-line basis over the estimated useful lives of the assets as follows:\nF) Intangible Assets, Net Amortization of excess cost over values assigned to tangible assets of purchased subsidiaries is recorded on a straight-line basis over 40 years. The carrying value of intangible assets is periodically reviewed to determine whether impairment exists. In 1993, the Company determined that excess cost associated with its suburban newspaper operations was not recoverable (see Note 3). Also included in intangible assets, net is an intangible asset acquired in 1991 that is being amortized on a straight-line basis over its estimated useful life of 18 years.\nAccumulated amortization of intangible assets was $126,326,000 and $112,775,000 at December 31, 1994 and 1993, respectively.\nG) Earnings Per Common and Common Equivalent Share Earnings per common and common equivalent share are based on the weighted average number of shares outstanding during the period, including common equivalent shares representing dilutive stock options.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. Belo Corporation and Subsidiaries\nNOTE 2: ACQUISITION\nOn June 1, 1994, Belo acquired the assets of television station WWL-TV, the CBS affiliate in New Orleans, Louisiana, from Rampart Operating Partnership for approximately $110,000,000 in cash. The acquisition has been accounted for as a purchase.\nThe cost of the acquisition has been allocated on the basis of the estimated fair market value of the assets acquired. This allocation resulted in excess cost over values assigned to tangible assets of purchased subsidiaries of $81,673,000, which is being amortized on a straight-line basis over 40 years.\nThe pro forma financial results of operations below assumes the transaction was financed with the revolving credit facility, and include certain other purchase price adjustments regarding depreciation, amortization and taxes. The pro forma financial results further assume the transaction was completed at the beginning of each of the years ended December 31, 1994 and 1993:\nThe pro forma financial information is provided for informational purposes only and is not necessarily representative of the operating results that would have occurred had the acquisition been completed as of the indicated dates, nor are they indicative of future operating results.\nNOTE 3: RESTRUCTURING CHARGE\nThe Consolidated Statement of Earnings for 1993 includes a $5,822,000 charge related to Dallas-Fort Worth Suburban Newspapers, Inc. (\"DFWSN\"), that consists primarily of the write-off of goodwill and a reduction in the carrying value of production assets to their fair value. The production assets adjusted include building and improvements and publishing equipment. The charge was recognized in conjunction with the decision to restructure DFWSN upon the determination that the carrying value of these assets was not recoverable. Fair value of production assets was determined principally by market value. The restructuring was substantially completed in January 1994.\nNOTE 4: LONG-TERM DEBT\nLong-term debt consists of the following:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nAt the end of 1994, the Company had a revolving credit facility for $600,000,000. Borrowings of revolving debt were $305,000,000 and $250,000,000 at December 31, 1994 and 1993, respectively. Loans under the revolving credit agreement bear interest at a rate based, at the option of the Company, on the bank's alternate base rate, LIBOR or competitive bid. The rate obtained through competitive bid is either a Eurodollar rate or a rate agreed to by the Company and the bank. Average interest rates were 4.8 percent and 3.7 percent during 1994 and 1993, respectively. At December 31, 1994, the weighted average borrowing rate was 6.3 percent. The agreement also provides for a facility fee of 1\/8 of one percent on the total commitment. The agreement expires on August 5, 1999, with an extension to August 5, 2000, at the request of the Company and consent of the participating banks.\nThe revolving credit agreement contains certain covenants, including the maintenance of cash flow in relation to both the Company's leverage and its fixed charges and a limitation on repurchases of the Company's stock. The Company is in compliance with these covenants at December 31, 1994.\nDuring 1994, the Company used various short-term unsecured notes as an additional source of financing. For the years ended December 31, 1994 and 1993, the average interest rate on this debt was 4.8 percent and 3.7 percent, respectively. Due to the Company's intent to renew the short-term notes and its continued ability to refinance this debt on a long-term basis through its revolving credit agreement, $19,000,000 and $21,000,000 of short-term notes outstanding at December 31, 1994 and 1993, respectively, have been classified as long-term.\nDuring 1993, Belo entered into interest-rate cap agreements to reduce the effect of increases in interest rates on its revolving debt. At December 31, 1994, the Company had four interest-rate cap agreements outstanding. These agreements entitled the Company to receive the amount, if any, by which three-month LIBOR on $75,000,000 of borrowings exceeded 6 percent. No such payments were received during 1994 or 1993. The fair value of these cap agreements was approximately $1,400,000 at December 31, 1994, based on the subsequent selling price of the caps.\nIn 1994, 1993 and 1992, the Company incurred interest costs of $16,250,000, $16,976,000 and $24,554,000, respectively, of which $138,000, $1,961,000 and $395,000, respectively, were capitalized as components of construction cost.\nAt December 31, 1994, the Company had outstanding letters of credit of $8,032,000 issued in the ordinary course of business.\nBecause substantially all of the Company's debt is due under the variable rate revolving credit agreement, no significant differences exist between the carrying value and fair value.\nNOTE 5: INCOME TAXES - --------------------------------------------------------------------------------\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\" changing to 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 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. As permitted by SFAS No. 109, prior years' financial statements were not restated to reflect the change. The cumulative effect of adopting SFAS No. 109 as of January 1, 1993 increased 1993 net earnings by $6,599,000 or 33 cents per share.\nIn August 1993, subsequent to the adoption of SFAS No. 109, the federal income tax rate was increased from 34 percent to 35 percent, retroactive to January 1, 1993. The Company's deferred taxes were adjusted to reflect the new tax rate, resulting in an increase in deferred tax expense of $2,249,000. Deferred tax expense in 1993 also reflects a decrease of $1,000,000 for the reversal of certain tax accruals as a result of new tax legislation regarding the amortization of intangibles.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nIncome tax expense for the years ended December 31, 1994, 1993 and 1992 consists of the following:\nIncome tax provisions for the years ended December 31, 1994, 1993 and 1992 differ from amounts computed by applying the applicable U.S. federal income tax rate as follows:\nSignificant components of the Company's deferred tax liabilities and assets as of December 31, 1994 and 1993, are as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nThe sources of deferred income taxes and the tax effect of each prior to the adoption of SFAS No. 109 are as follows:\nNOTE 6: EMPLOYEE RETIREMENT PLANS - -------------------------------------------------------------------------------- The Company sponsors a noncontributory defined benefit pension plan covering substantially all employees. The benefits are based on years of service and the average of the employee's five years of highest annual compensation earned during the most recently completed ten years of employment.\nThe funding policy is to contribute annually to the plan an amount at least equal to the minimum required contribution for a qualified retirement plan, but not in excess of the maximum tax deductible contribution.\nThe following table sets forth the plan's funded status and prepaid pension costs (included in other assets on the Consolidated Balance Sheets) at December 31, 1994 and 1993:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nThe net periodic pension cost (benefit) for the years ended December 31, 1994, 1993 and 1992 includes the following components:\nAssumptions used in the accounting for the defined benefit plan are as follows:\nThe Company sponsors a defined contribution plan that covers substantially all of its employees. Subject to certain dollar limits, employees may contribute a percentage of their salaries to this plan, and the Company will match a portion of the employee's contributions. The Company's contributions totaled $2,568,000, $1,825,000 and $1,074,000 in 1994, 1993 and 1992, respectively. Contributions have increased in recent years due to a mid-1993 change in the Company's matching percentage from 35 to 50 percent.\nThe Company also sponsors non-qualified retirement and death benefit plans for key employees. Expense for the plans recognized in 1994, 1993 and 1992 was $1,232,000, $1,412,000 and $908,000, respectively.\nNOTE 7: LONG-TERM INCENTIVE PLAN\nThe Company's current long-term incentive plan has been in place since 1986. There are, however, stock options awarded under a prior plan, which will remain outstanding until they are exercised, canceled or expire. The following table presents the status of the stock options awarded under the prior plan. At December 31, 1994, all of these options were exercisable.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nAwards under the 1986 long-term incentive plan may be granted to employees in the form of incentive stock options, non- qualified stock options, restricted shares or performance units, the values of which are based on the long-term performance of the Company. In addition, options may be accompanied by stock appreciation rights and limited stock appreciation rights. Rights and limited rights may also be issued without accompanying options. The plan was amended in 1988 to provide for a one-time grant of non-qualified options to purchase 2,500 shares of Series A Common Stock to non-employee directors and to eliminate the previous limit on the number of restricted shares that may be issued. The plan was also amended in 1992 to provide for automatic annual grants through 1997 of non-qualified options to non-employee directors serving after the 1992 Annual Meeting of Shareholders and an additional one-time grant of options to purchase 10,000 shares of Series A Common Stock to those directors subsequently elected. The amendment also increased the number of shares for which awards could be made under the plan.\nThe maximum aggregate number of shares of common stock that may be granted in relation to options, restricted shares and rights, and limited rights issued without accompanying options is 3,600,000, less the number of performance units granted under the plan. The maximum number of performance units that may be granted under the plan is 3,600,000, less the number of options, restricted shares and rights, and limited rights issued without accompanying options granted.\nGrants made under the 1986 long-term incentive plan during 1994, 1993 and 1992 are summarized below:\nThe non-qualified options granted under the Company's long-term incentive plan become exercisable in cumulative installments over a period of three years. On December 31, 1994, of the 1,495,100 options outstanding, 906,867 were exercisable. Shares of Series A Common Stock reserved for grants under the plan were 250,531 and 613,874 at December 31, 1994 and 1993, respectively.\nA provision for the restricted shares is made ratably over the restriction period. Expense recognized under the plan for restricted shares was $2,146,000, $3,598,000 and $2,723,000 in 1994, 1993 and 1992, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nNOTE 8: COMMITMENTS AND CONTINGENT LIABILITIES\nThe Company is involved in certain claims and litigation related to its operations. In the opinion of Management, liabilities, if any, arising from these claims and litigation are either covered by insurance or would not have a material adverse effect on the consolidated financial statements of the Company.\nCommitments for the purchase of broadcast film contract rights totaled approximately $141,098,000 at December 31, 1994 for broadcasts scheduled through August 2000.\nAdvance payments on plant and equipment expenditures at December 31, 1994 primarily relate to newspaper production equipment, broadcast equipment and building renovations and improvements. Required future payments for capital expenditures for 1995, 1996, 1997 and 1998 are $13,677,000, $8,998,000, $5,489,000 and $3,350,000, respectively.\nTotal lease expense for property and equipment was $3,131,000, $5,447,000 and $6,130,000 in 1994, 1993 and 1992, respectively. Lease expense was lower in 1994 following the Company's 1993 purchase of the building in which it had been leasing office space.\nFuture minimum rental payments for operating lease agreements are as follows:\nNOTE 9: COMMON AND PREFERRED STOCK - -------------------------------------------------------------------------------- The Company has two series of common stock authorized, issued and outstanding, Series A and Series B. The shares are identical except that Series B shares are entitled to ten votes per share on all matters submitted to a vote of shareholders, while the Series A shares are entitled to one vote per share. Transferability of the Series B shares is limited to family members and affiliated entities of the holder. Series B shares are convertible at any time on a one-for-one basis into Series A shares.\nEach outstanding share of common stock is accompanied by one preferred share purchase right, which entitles shareholders to purchase 1\/200 of a share of Series A Junior Participating Preferred Stock. The rights will not be exercisable until a party either acquires beneficial ownership of 30 percent of the Company's common stock or makes a tender offer for at least 30 percent of its common stock. The rights expire in 1996. If the Company is acquired in a merger or business combination, each right has an initial exercise price of $87.50 (subject to adjustment) and can be used to purchase the common stock of the surviving company having a market value of twice the exercise price of each right. The number of shares of Series A Junior Participating Preferred Stock reserved for possible conversion of these rights is equivalent to 1\/200 of the number of shares of common stock issued and outstanding plus the number of shares reserved for grant under the 1986 Long-Term Incentive Plan and Stock Option Plan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nNOTE 10: OTHER INCOME AND EXPENSE - -------------------------------------------------------------------------------- In 1994, Belo donated 58,835 shares of Stauffer Communications, Inc. stock to The Dallas Morning News--WFAA Foundation. The fair market value of the shares at the time of the transfer, as determined by an outstanding tender offer from a third party, exceeded the carrying value of the stock, resulting in a gain of $9,271,000, which was offset by a charge for the charitable contribution of $16,675,000. The transaction, net of a $5,837,000 income tax benefit, resulted in a decrease in 1994 net earnings of $1,567,000 (8 cents per share).\nNOTE 11: SUPPLEMENTAL CASH FLOW INFORMATION - -------------------------------------------------------------------------------- Net cash provided by operations reflects cash payments for interest and income taxes during the years ended December 31, 1994, 1993 and 1992 as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\nNOTE 12: INDUSTRY SEGMENT INFORMATION\nThe Company operates in two industries: newspaper publishing and television broadcasting. Operations in the newspaper publishing industry involve the sale of advertising space in published issues, the sale of newspapers to distributors and individual subscribers and commercial printing. Operations in the broadcast industry involve the sale of air time for advertising and the broadcast of entertainment, news and other programming for both local markets and syndication. Net operating revenues by industry segment include sales to unaffiliated customers and intersegment revenues, which before their elimination, are accounted for on the same basis as revenues from unaffiliated customers.\nSelected segment data for the years ended December 31, 1994, 1993 and 1992 is as follows:\n(A) In 1994, the Broadcasting segment data includes the effect of WWL-TV, which Belo purchased on June 1, 1994 (see Note 2).\n(B) Included in Newspaper publishing earnings from operations in 1993 is a $5,822,000 restructuring charge consisting primarily of the write-off of goodwill and a reduction in the carrying value of production assets related to the restructuring of DFWSN (see Note 3).\n(C) Broadcasting earnings from operations include the reversal of certain music license fee accruals of $631,000 in 1994 and $3,349,000 in 1993.\nNOTE 13: SUBSEQUENT EVENT\nOn February 1, 1995, the Company completed the acquisition of television station KIRO-TV in Seattle, Washington for $162,500,000, excluding final adjustments. The acquisition was financed with borrowings from the revolving credit agreement. The transaction will be accounted for as a purchase. Although a complete purchase price allocation will not be finalized until later in 1995, the purchase price will be allocated to property, plant and equipment and intangible assets.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. H. BELO CORPORATION AND SUBSIDIARIES\n(A) Included in Broadcasting earnings from operations for the first quarter of 1994 and the fourth quarter of 1993 is the reversal of certain music license fee accruals of $631,000 and $3,349,000, respectively.\n(B) Amount represents the cumulative effect of adopting SFAS No. 109, \"Accounting for Income Taxes\" (see Note 5).\n(C) Broadcasting results include the effect of WWL-TV, which Belo purchased on June 1, 1994 (see Note 2).\n(D) Net earnings for the third quarter of 1994 include the net charge of $1,567,000 related to the Stauffer Communications, Inc. stock donation (see Note 10).\n(E) Belo's income tax provision in the third quarter of 1993 reflects a $2,249,000 charge representing an adjustment to deferred taxes following an increase in the federal income tax rate from 34 percent to 35 percent (see Note 5).\n(F) Included in Newspaper publishing earnings from operations for the fourth quarter of 1993 is a $5,822,000 restructuring charge consisting primarily of the write-off of goodwill and a reduction in the carrying value of production assets related to the restructuring of DFWSN (see Note 3).\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS\nThe Management of A. H. Belo Corporation is responsible for the preparation of the Company's consolidated financial statements, as well as for their integrity and objectivity. Those statements are prepared using generally accepted accounting principles, they include amounts that are based on our best estimates and judgments, and we believe they are not misstated due to material fraud or error. Management has also prepared the other information in the Annual Report and is responsible for its accuracy and its consistency with the financial statements.\nManagement maintains a system of internal control that is designed to provide reasonable assurance of 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. This system of internal control provides for appropriate division of responsibility, and is documented in written policies and procedures. These policies and procedures are updated as necessary and communicated to those employees having a significant role in the financial reporting process. Management continually monitors the system of internal control for compliance.\nManagement believes that as of December 31, 1994, the Company's system of internal control is adequate to accomplish the objectives described above. Management recognizes, however, that no system of internal control can ensure the elimination of all errors and irregularities, and it recognizes that the cost of the internal controls should not exceed the value of the benefits derived.\nFinally, Management recognizes its responsibility for fostering a strong ethical climate within the Company according to the highest standards of personal and professional conduct, and this responsibility is delineated in the Company's written statement of business conduct. This statement of business conduct addresses, among other things, the necessity for due diligence and integrity, avoidance of potential conflicts of interest, compliance with all applicable laws and regulations, and the confidentiality of proprietary information.\n\/S\/Robert W. Decherd Robert W. Decherd Chairman of the Board, President and Chief Executive Officer\n\/S\/Michael D. Perry Michael D. Perry Senior Vice President and Chief Financial Officer\nE-1\nE-2\nE-3\nE-4\nE-5","section_15":""}
{"filename":"62737_1994.txt","cik":"62737","year":"1994","section_1":"ITEM 1 BUSINESS\nGENERAL At April 2, 1994, Marsh Supermarkets, Inc. (the \"Company\" or \"Marsh\") operated 87 supermarkets and 177 Village Pantry convenience stores in central Indiana and western Ohio. The Company believes Marsh supermarkets have one of the largest market shares of supermarket chains operating in its market area and Village Pantry has one of the largest market shares of convenience stores in its market area. Marsh also owns and operates a specialized convenience store distribution business which services its Village Pantry stores as well as over 1,300 unaffiliated convenience stores in an eight-state area.\nSUPERMARKETS At April 2, 1994, the Company operated 87 supermarkets, 74 in central Indiana and 13 in western Ohio. The 35 stores in the Indianapolis metropolitan market area constitute the Company's major market. The remaining supermarkets operate in 35 other communities. Sales from supermarket operations represent approximately 73% of the Company's fiscal 1994 consolidated sales and other revenues.\nThe Company's supermarket merchandising strategy emphasizes service, quality and convenient one-stop shopping at competitive prices. Of the Company's supermarkets, 62 are open 24 hours a day, 16 are open until midnight, with the remainder having various other schedules. All stores are open seven days a week.\nThe Company believes a commitment to providing quality merchandise is an important factor in maintaining and expanding its customer base. In recent years, the Company has devoted a greater proportion of new and remodeled stores to fresh, high quality perishables such as produce, delicatessen items, baked goods, prepared foods, seafood and floral items. The Company believes fresh produce is an important customer draw; therefore, it focuses on buying premium quality produce worldwide. The geographic concentration of the supermarkets enables the Company to deliver fresh items to its stores quickly and frequently.\nThe Company's new and expanded large supermarket store format offers customers convenient one-stop shopping. Its Marsh supermarkets feature an extended line of traditional grocery store items as well as a broad array of service and specialty departments such as delicatessens, bakeries, prepared foods, prime cut meats, fresh seafood, floral and video rental. The Company features nationally advertised and distributed merchandise and products under its own trademarks, service marks and trade names. Service and specialty departments included in Marsh supermarkets include delicatessens and prepared foods (87 stores), bakeries (87), prime cut service meat (58), fresh service seafood (61), floral shops (57), imported cheese shops (46), salad bars (49), video rental (85), and shoe repair (21). Twenty of the Company's supermarkets include pharmacies in food and drug combination stores. To combat increasing competition from other retail formats such as wholesale clubs, 46 of the Company's supermarkets also include warehouse-type sections offering large size and multi-pack products typically featured by wholesale clubs, priced competitively with club prices. In addition, banks or savings institutions operate branch facilities in 38 of the Company's stores.\nThe Company has expanded on its large supermarket store format with a new generation superstore in excess of 75,000 square feet. The Company currently operates three such stores and plans to build an additional one in Indianapolis within the next year. Approximately one-third of the sales area in this type of store is devoted to merchandising fresh, high quality perishable products, with heavy emphasis on delicatessens\/bakeries, prepared foods and produce. In addition, up to approximately 5,000 square feet are devoted to the warehouse-type merchandising of bulk club pack merchandise.\nThe Company has developed a smaller, low-price supermarket format with limited service and specialty departments as an alternative to the large, full service supermarket. The Company currently operates seven of its supermarkets under this concept. The stores operate under the trade name LoBill. There is an ongoing development program within its market area to construct new LoBill stores and to remodel selected Marsh stores to the LoBill format. The Company believes the LoBill format offers the opportunity to maximize its market area by expanding into smaller communities that can be better served by that format, and to appeal to the price motivated consumer in markets currently serviced by traditional Marsh store. The Company's supermarkets range in size from 15,000 to 81,530 square feet. The average size is approximately 35,400 square feet. The Company has an ongoing development program of constructing larger Marsh stores within its market area and remodeling, enlarging and replacing existing supermarkets. Future development will continue to focus on a food and drug combination store format of approximately 50,000 to 60,000 square feet, with superstores in excess of 80,000 square feet in select locations. The Company believes a larger store format enables it to offer a wider variety of products and expanded service and specialty departments, thereby strengthening its competitive position. The following summarizes the number of stores by size categories:\nThe Company advertises through various media, including circulars, newspapers, radio and television. Printed circulars are used extensively on a weekly basis to advertise featured items. The focus of the television campaign promotes a quality and service image rather than specific products and prices. The Indianapolis television market covers approximately 80% of the Company's stores. Various sales enhancement promotional activities, including free grocery and other programs designed to encourage repeat shoppers, are conducted as an important part of the Company's merchandising strategy.\nCONVENIENCE STORES At April 2, 1994, the Company operated 177 convenience stores under the Village Pantry trade name. These self-service stores offer a broad selection of grocery, bakery, dairy and delicatessen items including freshly prepared food products. Approximately 60% of the stores also offer petroleum products. Sales from the convenience stores represented approximately 13% of the Company's fiscal 1994 consolidated sales and other revenues. Cold beer, a high-volume item typically found in convenience stores in other states, may only be sold by package liquor stores in Indiana; accordingly, it is not sold in the Company's Indiana convenience stores. All but eight of the convenience stores are open 24 hours a day. The remainder close at either midnight or 11:00 p.m. All stores are open seven days a week.\nThese stores offer fresh donuts and sandwiches prepared in the stores. The Company has added higher margin food and beverage products, such as store-prepared pizza (35 stores), broasted chicken (38 stores), self-service fountain drinks, as well as sit-down eating areas in a number of stores. The Company has an ongoing program of remodeling, upgrading and replacing existing Village Pantry stores with particular emphasis on developing locations that will yield a high volume of gasoline sales. New stores generally average 3,700-4,400 square feet, compared to 1,800-2,500 square feet for older stores. The larger size accommodates the new food products. In constructing new, and remodeling and expanding existing stores, the Company tailors the format to each specific market, with heavy emphasis on food service in areas which the Company believes to be less susceptible to intense competition from major fast food operators, such as smaller towns and high density neighborhoods.\nCONVENIENCE STORE DISTRIBUTING COMPANY (\"CSDC\") CSDC, a wholly-owned subsidiary of the Company, serves Village Pantry stores and over 1,300 unaffiliated stores in an eight-state area. CSDC distributes a wide range of products typically sold in convenience stores, including groceries, cigarette and other tobacco products, snack items, housewares and health and beauty aids. Customers have the opportunity to order most product lines in single units. CSDC owns a 187,000 square foot warehouse and distribution facility in Richmond, Indiana, which the Company estimates presently is operated at 70% of capacity. CSDC utilizes its own trucks and drivers for its transportation needs. The CSDC sales staff of approximately 27 employees services existing customers and is actively soliciting new customers. The CSDC wholesale operation accounted for approximately 14% of the Company's fiscal 1994 consolidated sales and other revenues.\nSUPPLY AND DISTRIBUTION The Company supplies its supermarkets from three Company-operated distribution facilities. Dry grocery and frozen food products are distributed from a 409,000 square foot leased facility in Indianapolis. Produce and meat products are distributed from a leased 128,000 square foot perishable products facility in Yorktown, Indiana. Non-food products are distributed from 180,000 square feet of the 388,000 square foot Company owned warehouse (and former corporate headquarters facility) in Yorktown. In addition, the Company leases a 150,000 square foot warehouse for storage of forward purchases of merchandise and seasonal items. Additional outside warehouse space is leased as needed to meet seasonal demand.\nThe Company's distribution centers are modern and highly automated. Merchandise is controlled through an on-line computerized buying and inventory control system. The Company believes its distribution centers are adequate for its needs for the foreseeable future without major additional capital investment. The Company estimates its supermarket distribution centers presently are operated at approximately 75% of capacity. Approximately 80% of the delivery trips from distribution centers to supermarkets are 75 miles or less.\nThe Company believes centralized direct buying from major producers and growers and its purchasing and distribution functions provide it with advantages compared to purchasing from a third-party wholesaler. Direct buying, centralized purchasing, and controlled distribution reduce merchandise cost by allowing the Company to minimize purchases from wholesalers and distributors and to take advantage of volume buying opportunities and forward purchases of merchandise. Centralized purchasing and distribution promote a consistent merchandising strategy throughout the Company's supermarkets. Rapid inventory turnover at the warehouse permits the Company's stores to offer consistently fresh, high-quality products. Through frequent deliveries to the stores, the Company is able to reduce in-store stockroom space and increase square footage available for retail selling.\nSome products, principally bakery, dairy and beverage items, and snack foods are delivered directly to the supermarkets and convenience stores by distributors of national and regional brands.\nCSDC supplies most grocery, produce, housewares, and health and beauty aid products to the Company's convenience stores.\nThe Company operates a commissary to produce products sold through the delicatessen departments of its supermarkets and convenience stores and to third parties through CSDC. A Company owned greenhouse provides many of the live potted plants sold in the supermarket floral departments.\nThe Company's supermarket transportation function is performed by Ruan Transportation Management Systems (\"Ruan\"), an unaffiliated transportation management and equipment leasing company. This service is provided under a subcontract arrangement entered into on September 18, 1987 and extending to September 18, 1994, with an automatic renewal for successive one year terms unless canceled by Ruan or the Company at least sixty days prior to the anniversary date, subject to early cancellation in stages under certain conditions. Under the arrangement, Ruan employs the drivers, dispatchers and maintenance personnel who perform the Company's distribution function. A subsidiary of the Company leases most of its tractor\/trailer fleet from Ruan under long-term, full service leases.\nMANAGEMENT INFORMATION SYSTEMS All of the Company's supermarkets are equipped with electronic scanning checkout systems. This minimizes item pricing, allows more efficient and accurate checkout line operation, and provides product movement data for merchandising decisions and other purposes.\nThe Company utilizes in-store micro-computers in the supermarkets to automate various tasks, such as processing the receiving and billing of vendor direct-store-delivered (DSD) merchandise at the store level, processing of video rentals, processing pharmacy records in the 20 food and drug combination stores, and time keeping for payroll processing. Future applications, currently under development, include computer-assisted reordering and electronic messaging.\nAll convenience stores are equipped with micro-computers which are utilized for electronic transmission of accounting and merchandising data to headquarters, electronic messaging and processing DSD merchandise receiving and billing.\nA point-of-sale electronic funds transfer and credit card system is in place in 53 supermarkets. Through the use of a bank debit card, a customer can authorize the immediate transfer of funds from the customer's account to the Company at the point of purchase.\nCOMPETITION The retail food industry is highly competitive. Marsh believes competitive factors include quality of perishable products, service, price, location, product variety, physical layout and design of store interior, ease of ingress and egress to the store and minimal out-of-stock conditions. Marsh endeavors to concentrate its efforts on all of these factors with special emphasis on maintaining high quality store conditions, high quality perishable products, expanded service and specialty departments, and competitive pricing.\nThe Company believes that it is one of the largest supermarket chains operating in its market area. The Company's supermarkets are subject to competition from local, regional and national supermarket chains, independent supermarkets, and other retail formats, such as discount stores and wholesale clubs. The number of competitors and degree of competition experienced by the Company's supermarkets vary by location, with the Indianapolis metropolitan market generally being subject to more price competition than the smaller markets.\nIn recent years, the principal supermarket chain competitors have been The Kroger Co. and Super Valu Food Stores, Inc., operating in the Indianapolis market through its \"Cub Foods\" stores. Meijer, Inc. currently operates two of its large food and general merchandise combination stores in the Company's market area in Ohio and recently opened two stores in the Indianapolis market and has two other stores under construction that are scheduled to open during the next twelve months.\nThe Company believes Village Pantry is one of the largest convenience store chains operating in its market area. Its major competitors are petroleum marketing companies which have been converting or expanding gasoline locations to include convenience food operations. Major national convenience store chains do not have a significant presence in the Company's marketing area. The Company believes the principal competitive factor for convenience stores is location, and it actively pursues the acquisition of attractive sites for replacing existing stores and future development of new stores.\nThe Company believes the primary competitive factors in CSDC's wholesale distribution business are pricing, timeliness and accuracy of deliveries. CSDC's major competitors are McLane Company, Inc. and several regional wholesale distributors.\nSEASONALITY Marsh's supermarket sales are subject to some seasonal fluctuation, as are other retail food chains. Traditionally, higher sales occur during the third quarter holiday season, and lower sales occur in the warm weather months of the second quarter. Convenience store sales traditionally peak in the summer months.\nEMPLOYEES The Company has approximately 11,300 employees, of whom approximately 6,800 are employed on a part-time basis. All employees are non-union, with the exception of the approximately 150 supermarket distribution facility employees who are unionized under two three-year collective bargaining agreements which extend to May, 1997. The Company considers its employee relations to be excellent.\nREGULATORY MATTERS As a retailer of alcoholic beverages and gasoline, the Company is subject to federal, state and local statutes, ordinances and regulations concerning the storage and sale of these products. Current environmental laws and regulations require the removal or abandonment of underground storage tanks (UST's) at 26 Village Pantry locations prior to December, 1998. Earlier removal or abandonment would be required in the event any of these UST's fail any leak detection test, which the Company performs at least annually. All UST's at these 26 locations passed the most recent leak detection tests in December 1993, which results were consistent with data from the Company's established petroleum product inventory control program.\nIn addition to the 26 sites, the Company is aware of the existence of petroleum contamination at nine other Village Pantry locations and has commenced remediation at each of these sites. The cost of remediation may vary significantly depending on the extent, source and location of the contamination, geological and hydrological conditions and other factors. The cost to remove or abandon the remaining UST's at these nine locations and to remediate the unknown contamination has been estimated at approximately $870,000. The Company has charged this amount to earnings.\nThe Company currently estimates the maximum aggregate cost remaining to be incurred in connection with compliance to existing environmental laws and regulations applicable to owners and operators of UST's will not exceed approximately $2.0 million through December 1998. This estimate of accrued or potential compliance costs does not consider any potential recovery the Company may receive from either the State of Indiana Underground Storage Tank Excess Liability Fund, which reimburses owners and operators of UST's for a portion of the costs incurred in connection with the remediation of soil and groundwater contamination, or from third parties which may be responsible for all or part of the contamination at one of the nine locations referenced above.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES\nSubstantially all leases have one to four renewal options for periods of two to five years each. The majority of leases provide for payment of property taxes, maintenance and insurance by the Company. In addition, the Company is obligated under leases for 18 closed stores, of which 11 were subleased at April 2, 1994.\nThe non-perishable grocery products warehouse in Indianapolis is leased with an initial lease term expiring in 2000 and options available through 2014. The facility, constructed in 1969, is located on a 44 acre site and has a total of 409,000 square feet, of which 382,000 are utilized for grocery warehousing operations. The remainder consists of a catering commissary and office space.\nA 128,000 square foot refrigerated perishable products handling facility in Yorktown, Indiana, serves as the distribution center for meat, produce and delicatessen items. The leased facility was completed in 1981.\nMarsh owns an additional 388,000 square foot facility in Yorktown. Approximately 180,000 square feet of this facility is used for the non-food warehouse operation, approximately 21,000 square feet is used by the retail maintenance department, and an additional 55,000 square feet of warehouse space is leased to third parties. The portion of this facility formerly utilized for the corporate offices currently is vacant.\nThe Company leases a 172,000 square foot warehouse in Indianapolis for storage of forward purchases of merchandise and seasonal items.\nThe 160,000 square foot corporate headquarters in Indianapolis is owned by the Company. This facility was completed and occupied in May 1991.\nCSDC owns a 187,000 square foot warehouse and distribution facility in Richmond, Indiana.\nOne supermarket and two warehouses (considered owned for purposes of the foregoing analysis) are leased under equity lease arrangements pursuant to which ownership is transferred to Marsh at the expiration of the lease term.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nThere are no pending legal proceedings to which Marsh is a party which are material to its business, financial condition or results of operations or which would otherwise be required to be disclosed under this item.\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 April 2, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nInformation required by Item 10 with respect to the executive officers of the Registrant is set forth below. Each officer has been elected for a term to expire in August, 1994, or upon election of his successor by the Board of Directors.\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nInformation on Common Stock and Shareholder Matters on pages 15 and 34 of the annual report to shareholders for the year ended April 2, 1994, is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 SELECTED FINANCIAL DATA\nSelected Financial Data on page 14 of the annual report to shareholders for the year ended April 2, 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 16 through 19 of the annual report to shareholders for the year ended April 2, 1994, is incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements on pages 21 to 33 of the annual report to shareholders for the year ended April 2, 1994, are incorporated herein by reference.\nQuarterly Financial Data on page 15 of the annual report to shareholders for the year ended April 2, 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\nIn accordance with Instruction G(3), except as indicated in the following sentence, the information called for by ITEMS 10, 11, 12 and 13 is incorporated by reference from the Registrant's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after April 2, 1994, the end of the fiscal year covered by this report. As permitted by instruction G(3) the information on executive officers called for by ITEM 10","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) (1) The following consolidated financial statements of Marsh Supermarkets, Inc. and subsidiaries, included in the annual report to shareholders for the year ended April 2, 1994, are incorporated by reference in Item 8.\nConsolidated Balance Sheets as of April 2, 1994 and March 27, 1993.\nConsolidated Statements of Income for each of the three years in the period ended April 2, 1994.\nConsolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended April 2, 1994.\nConsolidated Statements of Cash Flows for each of the three years in the period ended April 2, 1994.\nNotes to Consolidated Financial Statements - April 2, 1994.\n(2) The following consolidated financial statement schedules of Marsh Supermarkets, Inc. and subsidiaries are included in Item 14(d):\nSchedule II - Amounts Receivable from Related Parties, 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 IX - Short-term Borrowings Schedule X - Supplementary Income Statement Information\nNote: All 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(b) Reports on Form 8-K: There were no reports on Form 8-K filed by the Registrant during the fourth quarter of its fiscal year ended April 2, 1994.\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. 2-74859 (filed December 2, 1981), 33-33427 (filed February 12, 1990), 33-43817 (filed November 7, 1991), 33-56630 (filed December 31, 1992), 33-56624 (filed December 31, 1992) and 33-56626 (filed December 31, 1992).\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as 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 report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMARSH SUPERMARKETS, INC.\nJune 24, 1994 By: \/s\/ Don E. Marsh --------------------------- Don E. Marsh, 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.\nJune 24, 1994 \/s\/ Don E. Marsh ------------------------------------- Don E. Marsh, President, Chief Executive Officer and Director\nJune 24, 1994 \/s\/ Douglas W. Dougherty ------------------------------------- Douglas W. Dougherty, Chief Financial Officer\nJune 24, 1994 \/s\/ Michael D. Castleberry ------------------------------------- Michael D. Castleberry, Director-Corporate Accounting\nJune 24, 1994 \/s\/ C. Alan Marsh ------------------------------------- C. Alan Marsh, Senior Vice President Corporate Development and Director\nJune 24, 1994 \/s\/ Garnet R. Marsh ------------------------------------- Garnet R. Marsh, Director\nJune 24, 1994 \/s\/ William L. Marsh ------------------------------------- William L. Marsh, Vice President - General Manager, Property Management and Director\nJune 24, 1994 \/s\/ Jack E. Buckles ------------------------------------- Jack E. Buckles, Director\nJune 24, 1994 \/s\/ Charles R. Clark ------------------------------------- Charles R. Clark, Director\nJune 24, 1994 \/s\/ Stephen M. Huse ------------------------------------- Stephen M. Huse, Director\nJune 24, 1994 \/s\/ James K. Risk, III ------------------------------------- James K. Risk, III, Director\nJune 24, 1994 \/s\/ K. Clay Smith ------------------------------------- K. Clay Smith, Director\nMARSH SUPERMARKETS, INC., AND SUBSIDIARIES\nMARSH SUPERMARKETS, INC. AND SUBSIDIARIES\nMARSH SUPERMARKETS, INC. AND SUBSIDIARIES\nMARSH SUPERMARKETS, INC. AND SUBSIDIARIES\nMARSH SUPERMARKETS, INC. AND SUBSIDIARIES","section_15":""}
{"filename":"807877_1994.txt","cik":"807877","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nBayou Steel Corporation (the \"Company\") is a leading producer of light structural steel products. The Company owns and operates a steel minimill strategically located on the Mississippi River in LaPlace, Louisiana, 35 miles northwest of New Orleans. The minimill, constructed at a cost of $243 million in 1981, is one of the most modern facilities in the world in its product line and utilizes state-of-the-art equipment and technology. The Company produces a variety of shapes, including angles, flats, channels, standard beams and wide flange beams. The shapes produced by the Company have a wide range of commercial and industrial applications, including the construction and manufacturing of petrochemical plants, barges and light ships, railcars, trucks and trailers, rack systems, tunnel and mine support products, joists, sign and guardrail posts for highways, power and radio transmission towers, and bridges. The Company sells its products to over 600 customers, most of which are steel service centers, in 41 states, Canada, Mexico and overseas. The Company also sells excess billets (which have not been rolled into shapes) on a worldwide basis to other steel producers for their own rolling or forging applications. In fiscal 1994, the Company sold 446,572 tons of shapes and 35,503 tons of billets.\nThe term \"minimill\" refers to a relatively low-cost steel production facility which uses steel scrap, rather than iron ore, as its basic raw material. In general, minimills recycle scrap using electric arc furnaces, continuous casters and rolling mills. The Company's minimill, which was owned and operated by Voest-Alpine A.G. until it was purchased by the Company in September 1986, includes a Krupp computer-controlled, electric arc furnace utilizing water- cooled sidewalls and roofs, two Voest-Alpine four-strand continuous casters, a computer supervised, Italimpianti reheat furnace and a 15-stand Danieli rolling mill (a second Krupp furnace is currently not in operation, but is available for additional production).\nIn August 1988, the Company completed an initial public offering of its Class A Common Stock, which shares are traded on the American Stock Exchange. The Company was incorporated under the laws of the State of Louisiana in 1979 and was reincorporated in Delaware in 1988 in connection with its public offering.\nIn March 1993, following the expiration of its existing labor contract, the United Steelworkers of America Local 9121 (the \"Union\") initiated a strike against the Company which continues to date.\nThe address of the Company's principal place of business is River Road, P.O. Box 5000, LaPlace, Louisiana 70069 and its telephone number is (504) 652-4900.\nMANUFACTURING PROCESS AND FACILITIES\nIn its production process, the Company uses steel scrap which is received by barge, rail, and truck, and then stored in a scrap receiving yard. The scrap is transported to the Company's melt shop by rail car or truck and loaded into its furnace. The steel scrap is melted with electricity in a 75-ton capacity electric arc furnace which heats the scrap to approximately 3100\/o\/F. During the scrap melting and refining process, impurities are removed from the molten steel. After the scrap reaches a molten state, it is poured from the furnace into ladles, where adjustments of alloying elements and carbon are made to obtain the desired chemistry. The ladles of steel are then transported to one of two four-strand continuous casters in which the molten steel is solidified in water-cooled molds. The casters produce long strands of steel which are cut by torch into billets and moved to a cooling bed and marked for identification. After cooling, the billets are transferred to the rolling mill for further processing. In the rolling mill, the billets are reheated in a walking beam furnace with recuperative burners. Once the billets are heated to approximately 2000\/o\/F, they are rolled through up to fifteen mill stands which mold the billets into the dimensions and sizes of the finished products. The heated finished shapes are placed on a cooling bed and then straightened and cut into the appropriate customer lengths. The shapes are bundled into 2 1\/2- to 5-ton stacks and placed in a climate controlled warehouse where they are subsequently shipped to the Company's stocking locations via barge, or to customers directly via truck, rail, or barge.\nThe Company is currently able, using only one of its two furnaces, to produce more billets than it can consume in its rolling mill. Prior to 1991, the Company operated both of its furnaces and produced a much greater tonnage of billets for sale in the billet market than it currently produces. The Company discontinued this practice in 1990 due to declining margins on such products and has been operating only one of its two furnaces since then. The Company believes that it could restart its other furnace with an expenditure of less than $1 million. As a result, the Company believes that it has significant additional capacity to produce more billets if conditions in the worldwide billet market improve or if the Company obtains additional rolling mill capacity. However, above certain environmental permit levels of approximately 780,000 tons, additional capital, ranging up to approximately $10 million depending on volume and design, would be required to maintain environmental compliance.\nPRODUCTS\nFinished Steel. The Company produces a variety of light structural steel products (including angles, flats, channels, standard beams and wide-flange beams) that are collectively referred to as \"shapes.\" The Company produces and sells shapes in the forms of equal leg angles (2\"x 2\" through 6\"x 6\"), unequal leg angles (4\"x 3\" through 7\"x 4\"), channels (3\" through 8\"), flats (3\" through 8\"), standard beams (3\" through 6\"), and wide flange beams (4\" through 8\"). The shapes produced by the Company have a wide range of commercial and industrial applications, including the construction and manufacturing of petrochemical plants, barges and light ships, railcars, trucks and trailers, rack systems, tunnel and mine support products, joists, sign and guardrail posts for highways, power and radio transmission towers, and bridges.\nThe Company's shapes are produced to various national specifications, such as those set by the American Society for Testing and Materials (\"ASTM\"). In addition, the Company is one of a few minimills that is approved by the American Bureau of Shipping (\"ABS\") and certified for nuclear applications. The Company's products are also certified for state highway and bridge structures.\nThe Company's shape products are distinguishable from bar mill products which include hot rolled bars, cold finished bars and reinforcing bars. The manufacture of light structural steel products is generally more labor intensive and technically demanding than the manufacture of steel bar mill products.\nSemi-finished Steel. The Company sells its excess billets on a worldwide basis to other steel producers for their own rolling or forging applications. The billets are sold both domestically and worldwide through supply contracts or on an occasional and selective basis. During fiscal 1994, the Company produced in excess of 25 grades and 4 sizes (130 mm to 200 mm square or rectangle) of billets.\nCUSTOMERS\nThe Company has over 600 customers in 41 states, Canada, Mexico and overseas. The majority of the Company's shape products (approximately 77% in fiscal 1994) are sold to steel service centers, while the remainder are sold to original equipment manufacturers (approximately 15% in fiscal 1994) and export customers (approximately 8% in fiscal 1994). Steel service centers purchase nearly 30% of all carbon industrial steel products produced in the United States. Steel service centers warehouse steel products from various minimills and integrated mills and sell combinations of products from different mills to their customers. Some steel service centers also provide additional labor intensive value added services such as fabricating, cutting or selling steel by the piece rather than by the bundle.\nIn fiscal 1994, the Company's top ten customers accounted for approximately 36% of total sales, and no one customer accounted for more than 8% of total sales. The Company believes that it is not dependent on any customer and that it could, over time, replace lost sales attributable to any one customer.\nDISTRIBUTION\nThe Company's steelmaking facility, which includes a deep-water dock, is strategically located on the Mississippi River, which the Company believes gives it transportation cost advantages because it can ship its product by barge, the least costly method of transportation in the steel industry. Furthermore, the Company operates three inventory\nstocking warehouses in Chicago, Tulsa and Pittsburgh, which supplement its operations in Louisiana. These facilities, each of which includes an inland waterway dock, enable the Company to significantly increase its marketing territory by providing storage capacity for its finished products in three additional markets and by allowing the Company to meet customer demand far from its minimill facility on a timely basis. The Company believes that the location of its minimill on the Mississippi River, and its network of inland waterway warehouses, enable it to access markets for its products that would otherwise be unavailable to the Company.\nThe Company's deep-water dock at its Louisiana manufacturing facility on the Mississippi River enables the Company to load vessels or ocean-going barges for overseas shipments, giving the Company low cost access to overseas markets. Since the minimill is only 35 miles from the Port of New Orleans, smaller quantities of shapes or billets can be shipped overseas on cargo ships from that port. In addition, the Company makes rail shipments to some customers, primarily those on the West Coast and in Mexico. Relative to its domestic competitors, the Company believes it has a freight cost advantage over land-locked minimills in serving the export market. This advantage permits the Company to compete with foreign minimills in certain export markets.\nThe Company believes that the elimination of current duties in Canada and Mexico as a result of the passage of the North American Free Trade Agreement (\"NAFTA\") will increase the competitiveness of the Company's products compared to locally produced products in such countries. During fiscal 1994, 1993, and 1992, 7.6%, 2.9%, and 3.4% respectively, of the Company's tons shipped were exported to Canada and Mexico. There can be no assurance, however, that there will be an increase in the Company's shipments to Canada and Mexico as a result of the passage of NAFTA.\nMARKETS AND SALES\nAccording to the American Iron and Steel Institute, the domestic market demand for all structural steel shape products in 1992 was 5.1 million tons. The Company estimates that its share of the total domestic shapes market was approximately 8% in 1992. The Company believes that its share of the light structural steel shapes market (the primary market in which the Company competes) is much higher, and that it is one of the five largest producers in this market of light structural steel shapes in the U.S.\nThe Company's shape products are sold domestically and in Canada, Mexico and overseas on the basis of price, availability, quality and service. The Company maintains a real-time computer information system, which tracks prices offered by competitors, as well as freight rates from its customers to both the Company's stocking locations and the nearest competitive facilities. In addition, the Company maintains a full product assortment at its stocking locations to ensure availability of its product and operates on a predetermined production schedule that is provided to customers to assist customers in scheduling their purchases.\nAlthough sales of shapes tend to be slower during the winter months due to the impact of winter weather on construction and transportation, and during the late summer due to planned plant shutdowns of end-users, seasonality has not been a material factor in the Company's business. The Company's backlog of unfilled cancelable purchase orders for shapes, which typically are filled in approximately three months, totaled $41.3 million as of September 30, 1994 as compared to $24.3 million as of September 30, 1993. As of October 31, 1994, the Company's backlog totaled $46.2 million.\nThe level of billet sales to third parties is dependent on the Company's internal billet requirements and worldwide market conditions, which may vary greatly from year to year. In the past three fiscal years, shipments of billets to third parties have ranged from 8% to 13% of the Company's total tonnage sales. The Company is currently able, using only one of its two furnaces, to produce more billets than it can consume in its rolling mill. Prior to 1990, the Company operated both of its furnaces and produced a much greater tonnage of billets for sale in the billet market than it currently produces. The Company discontinued this practice in 1990 in response to a decision by foreign governments to resume the practice of heavily subsidizing their steel-making industries. This decision precipitated a sharp decline in worldwide billet prices, as foreign steel-making companies produced more billets for export. Due to current margins, the Company has chosen to sell its excess billets through supply contracts or on an occasional and selective basis. If the market for billets were to improve, the Company could increase its billet production by restarting its idled second furnace.\nSTRATEGY\nThe Company's principal operating strategy is to improve operating results by continuing to reduce costs, including labor costs per ton, and increasing sales of higher margin shape products. In addition, the Company has committed to implement a $9.2 million capital expenditure program to reduce its production costs and increase its melt shop and rolling mill capacity by the end of fiscal 1995. The Company may also consider strategic acquisitions which complement or expand the Company's current operations, such as businesses engaged in the metals field or recycling operations.\nOperating Efficiencies. The Company has lowered its labor cost per ton by $13 since fiscal 1992 and has lowered its labor costs per ton by $5 since fiscal 1993. The Company believes that it can continue to lower its labor costs per ton from fiscal 1994 levels by increasing productivity and shipments, reducing overtime, and implementing a productivity incentive plan. In addition, the Company's proposed labor agreement with the Union would further reduce labor costs per ton.\nThe Company continues to be committed to developing a high performance work culture. Through extensive training and individual development efforts, the Company will further reinforce its basic values of employee improvement, teamwork, and increased individual accountability. The Company believes that the workforce, through this program, will have an impact in achieving operational and productivity improvements. The program does not involve the terms and conditions of the workplace and is therefore not subject to the collective bargaining process. The Company has begun implementing the program with its supervisory personnel.\nCapital Improvements. From fiscal 1987 through fiscal 1994, the Company spent an aggregate of approximately $51 million on capital projects. Most of these expenditures were directed toward establishing its stocking location distribution system, establishing a controlled warehouse environment to minimize surface rust, extending its product line by adding equipment to roll wide-flange beams and complying with changing environmental regulations.\nIn addition to normal maintenance programs, the Company is implementing a $9.2 million capital expenditure program to reduce its production and operating costs and increase its melt shop and rolling mill capacity. The principal elements of this program are (i) an automobile shredder to enable the Company to shred car bodies on-site and reduce scrap costs, (ii) modification of the furnace shell and tapping hole to increase furnace capacity and reduce consumption of materials, (iii) a steel straightener to improve production capacity in the rolling mill, (iv) an off-line sawing system and conveyor to further improve production capacity in the rolling mill and (v) a shipping bay rail spur to reduce the handling of finished products. The Company believes that these capital projects, when fully implemented, would result in annual operating savings of approximately $3.3 million.\nEach of the projects in the capital expenditure program is described briefly, including project costs and estimated savings (excluding depreciation and additional interest expense)\nAutomobile Shredder. Mississippi River Recycling (\"MRR\"), a business division of the Company, will operate the automobile shredder, at a site adjacent to the LaPlace minimill. This new enterprise will process car bodies and sheet material into shredded material ready for the melting process, thereby providing shredded scrap at a lower cost than the Company currently procures such scrap. MRR will sell by-product non-ferrous metals to outside companies. In addition, the Company believes that the automobile shredder would produce scrap of a consistently higher quality than purchased shredded scrap. The Company believes that local preparation of scrap would enhance the efficiency of the dock in handling finished goods since fewer shipments of scrap by barge would arrive. The Company estimates that the purchase and installation of the local shredder would require $4.2 million of capital expenditures. The estimated annual cost savings will be approximately $1.7 million based on recent market prices for shredded material. Estimated savings will vary depending on fluctuations in the market price for scrap.\nFurnace Modification. The modification of the furnace shell and tapping hole will increase productivity by reducing tap time and increasing heat size. In addition, the modification will result in lower consumption of power, electrodes, and refractory material. The Company estimates that the modification of the furnace would require $0.8 million of capital expenditures. The estimated annual cost savings will be at least $0.4 million.\nSteel Straightener. The new steel straightener would contain enhanced features which would allow it to operate more rapidly, thereby eliminating the bottleneck caused by the existing straightener in the rolling mill. (The old straightener will be retained as an in-line back-up.) The new steel straightener, together with the off-line sawing system and conveyor, would expand the capacity of the rolling mill by improving the productivity on certain products. Additionally, it would permit the production of light bar shape products (2\"x2\" angles), which historically are products with a strong demand, but which the Company previously dropped from its production schedule due to lower productivity. The Company estimates that the purchase and installation of the steel straightener would require $1.9 million of capital expenditures. The estimated annual cost savings relating to the steel straightener will be approximately $0.6 million.\nOff-Line Sawing System and Conveyor. The proposed off-line sawing system would allow the rolling mill to operate more rapidly by removing the bottleneck that currently exists when shape products are cut into lengths less than 40 feet. The off-line sawing system will include a conveyor to move shapes from the last rolling mill operation to the shipping bays. The off-line sawing system and conveyor, together with the steel straightener, would expand the capacity of the rolling mill and permit the production of light bar shape products. The Company estimates that the purchase and installation of the off- line sawing system and conveyor would require $1.5 million of capital expenditures. The estimated annual cost savings relating to the off-line sawing system and conveyor will be approximately $0.4 million.\nShipping Bay Rail Spur. The proposed rail spur in the shipping bay would move finished products from the Company's warehouse to the rail lines adjacent to the minimill without loading and unloading such products to and from trucks. The Company believes that its labor costs and operating and capital costs of mobile equipment would be reduced by installation of the shipping bay rail spur, as well as reduce damage to its finished products. The Company estimates that the installation of the shipping bay rail spur would require $0.8 million of capital expenditures. The estimated annual costs savings will be approximately $0.2 million.\nSince the estimated operating cost savings from the Company's expected operating efficiencies and planned capital improvements are based upon a number of assumptions, estimated operating cost savings are not necessarily indicative of the Company's expected financial performance and increases in the cost of raw materials and other conversion costs may offset any operating cost savings to cause actual results to vary significantly. In addition, although the Company believes its assumptions with respect to its planned capital expenditure program to be reasonable, there can be no assurance that the estimated production cost savings of the Company's capital expenditure program will actually be achieved, sufficient demand for structural steel products will exist for the additional capacity, or other difficulties will not be encountered in completing the capital expenditure program, or that the projects can be installed or constructed at the estimated prices.\nAcquisition Program and Tax Benefits. The Company may, from time to time, seek strategic acquisitions in order to accelerate its growth, focusing on businesses which complement or expand the Company's current operations, such as businesses in the metals field or involving recycling operations. The Company is not presently engaged in negotiations with respect to any acquisition. As of September 30, 1994, the Company had approximately $319 million of regular net operating loss carryforwards which could be used to offset taxable earnings of the Company, including the earnings of acquired entities, subject to certain limitations imposed by the Internal Revenue Code of 1986, as amended (the \"Tax Code\"). See the Notes to the Financial Statements.\nCOMPETITION\nThe Company's location on the Mississippi River, as well as its stocking locations in three additional regions of the country, provide it with access to vast markets in the eastern, midwestern, southern, and central portions of the United States. As a result, the Company competes in the shape market with several major domestic minimills in each of these regions. Depending on the region and product, the Company competes with, among others, Nucor Corporation, Structural Metals, Inc., North Star Steel Co., Northwestern Steel and Wire Company, and Lake Ontario Steel Corporation. The Company does not currently compete with minimill flat rolled or rebar products, nor does it compete with any domestic integrated steel producers.\nForeign steel producers historically have not competed significantly with the Company in the domestic market for shape sales due to higher freight costs in the relatively low priced shape market. Foreign competition could increase, however, as a result of changes in currency exchange rates and increased steel subsidies by foreign governments.\nThe Company sells its excess billets on a supply contract or on an occasional and selective basis. Since most steel companies produce billets, the Company competes with steel companies, both domestic and foreign, that may also have an excess billet supply at any particular time.\nRAW MATERIALS\nThe Company's major raw material is steel scrap, which is generated principally from industrial, automotive, demolition, railroad and other scrap sources and is primarily purchased directly by the Company in the open market through a large number of steel scrap dealers. The Company is able to efficiently transport scrap from suppliers throughout the inland waterway system and through the Gulf of Mexico, permitting it to take advantage of scrap purchasing opportunities far from its minimill, and to protect itself from supply imbalances that develop from time to time in specific local markets. In addition, unlike many other minimills, the Company, through its own scrap purchasing staff, buys scrap directly from scrap dealers and contractors rather than through brokers. The Company believes that its enhanced knowledge of scrap market conditions gained by being directly involved in scrap procurement on a daily basis, coupled with management's long experience in metals recycling markets, gives the Company a competitive advantage. The Company does not currently depend upon any single supplier for its scrap. The Company, on average, maintains a 25-day inventory of steel scrap.\nThe Company has initiated a program of buying directly from local scrap dealers and small peddlers for cash. Through this program, the Company has procured approximately 20% of its scrap at prices lower than those of large scrap dealers. In addition, the Company is procuring an automobile shredder which will be located at a site adjacent to the plant. Mississippi River Recycling (\"MRR\"), a new division of the Company, will operate the automobile shredder. See \"Business - Strategy\" for a description of the automobile shredder. It is the Company's intention to expand MRR's business activities to processing other types of unprepared scrap which could be used by the Company or sold to other consumers of prepared scrap metal, generating additional revenues.\nThe cost of steel scrap is subject to market forces, including demand by other steel producers. The cost of steel scrap to the Company can vary significantly, and product prices generally cannot be adjusted in the short-term to recover large increases in steel scrap costs. Over longer periods of time, however, product prices and steel scrap prices have tended to move in the same direction.\nThe long-term demand for steel scrap and its importance to the domestic steel industry may be expected to increase as steel makers continue to expand steel scrap-based electric arc furnace capacity. For the foreseeable future, however, the Company believes that supplies of steel scrap will continue to be available in sufficient quantities at competitive prices. In addition, a number of technologies exist for the processing of iron ore into forms which may be substituted for steel scrap in electric arc furnace-based steelmaking. Such forms include direct-reduced iron, iron carbide and hot-briquetted iron. While such forms may not be cost competitive with steel scrap at present, a sustained increase in the price of steel scrap could result in increased implementation of these alternative technologies.\nIn addition to steel scrap, the Company consumes smaller quantities of additives, alloys and flux (\"AAF\"). The Company does not currently depend upon a single supplier for its AAF requirements.\nThe Company has not experienced any shortages or significant delays in delivery of these materials. The Company believes that an adequate supply of raw materials will continue to be available.\nENERGY\nThe Company's manufacturing process consumes large amounts of electrical energy. The Company purchases its electrical service needs from Louisiana Power and Light (\"LPL\") pursuant to a contract originally executed in 1980 and extended in 1991 for a five year period. The base contract is supplemented to provide lower cost off-peak power and known maximums in higher cost firm demand power. In addition, the Company receives discounted peak\npower rates in return for LPL's right to periodically curtail service during periods of peak demand. These curtailments are generally limited to a few hours and during the last several years have had negligible impact on operations. Although the supplemental contract with LPL expires February 1, 1996, the Company has no reason to believe that this contract will not be renewed upon substantially similar terms. To a lesser extent, the Company's manufacturing facility consumes quantities of natural gas via two separate pipelines serving the facility. The Company purchases its natural gas on a month-to-month basis from a variety of suppliers. Due to the effect of a fuel adjustment provision in the contract with LPL and price increases in natural gas, the Company's energy expense increased by $0.5 million in fiscal 1994 compared to fiscal 1993. Historically, the Company has been adequately supplied with electricity and natural gas and does not anticipate any curtailment in its operations resulting from energy shortages.\nThe Company believes that its utility rates are very competitive in the domestic minimill steel industry. As one of LPL's largest customers, the Company has been able to obtain competitive rates from LPL.\nENVIRONMENTAL MATTERS\nThe Company is subject to various Federal, state and local laws and regulations, including, among others, the Clean Air Act, the 1990 amendments to the Clean Air Act (the \"1990 Amendments\"), the Resource Conservation and Recovery Act, the Clean Water Act and the Louisiana Environmental Quality Act, and the regulations promulgated in connection therewith, concerning the discharge of contaminants which may be emitted into the air and discharged into the waterways, and the disposal of solid and\/or hazardous waste such as electric arc furnace dust.\nIn the event of a release or discharge of a hazardous substance to certain environmental media, the Company could be responsible for the costs of remediating the contamination caused by such a release or discharge. In the last six years, the only environmental penalty assessed to the Company was a fine in the amount of $43,000 levied in 1989 in conjunction with a Hazardous Waste Compliance Order issued by the Louisiana Department of Environmental Quality for alleged violations of the hazardous waste management regulations. At this time, the Company believes it is in compliance in all material respects with applicable environmental requirements. The Company has a full-time compliance manager who is responsible for monitoring the Company's procedures for compliance with such rules and regulations. The Company does not anticipate any substantial increase in its costs for environmental remediation or that such costs will have a material adverse effect on the Company's competitive position, operations or financial condition.\nThe Company plans to close two storm-water retention ponds at the LaPlace minimill. The Company has tested the effluents running into and out of the ponds. These tests confirm there is little potential for contamination. Based on this preliminary analysis, the Company does not believe that future clean up costs, if any, will be material. The Company has proposed a sampling plan to the Louisiana Department of Environmental Quality (the \"LDEQ\") to analyze the contents of the pond sediments. The results of such sampling could indicate a greater level of contaminants than suggested by the Company's limited testing. In such case, the costs of clean up could be higher than the Company now believes. Until such sampling is completed, however, it is impossible to estimate such costs.\nThe Company's minimill is classified, in the same manner as similar steel mills in the industry, as generating hazardous waste due to the production of dust that contains lead, cadmium and chromium. The Resource Conservation and Recovery Act regulates the management of such emission dust from electric arc furnaces. The Company currently collects the dust resulting from its melting operation through an emissions control system and manages it through an approved waste recycling firm. The dust management costs were approximately $1.5 million in both fiscal 1993 and 1994, and are estimated to be approximately $1.8 million for fiscal 1995. The increase in cost is due primarily to increases in recycling costs and to a lesser degree, increased steel production. In fiscal 1990, a small quantity of dust containing very low concentrations of radioactive material inadvertently entered the scrap stream on one occasion. All of the dust containing such material was captured by the emissions control system and is being held pending a decision as to its appropriate disposal. The Company has estimated that the ultimate cost of disposal of such dust will be approximately $500,000. There are at least five other steel mills in the United States storing such radioactive dust.\nThe Company's future expenditures for installation of environmental control facilities are difficult to predict. Environmental legislation, regulations and related administrative policies are constantly changing. Environmental issues are also subject to differing interpretations by the regulated community, the regulating authorities and the courts. Consequently, it is difficult to forecast expenditures needed to comply with future regulations, such as those forthcoming as a result of the 1990 Amendments. Specific air regulations and requirements applicable to the Company have yet to be promulgated under the authority of the 1990 Amendments. Therefore, at this time, the Company cannot estimate those costs associated with compliance and the effect the upcoming regulations will have on the Company's competitive position, operations or financial condition. In fiscal 1995, the Company intends to spend approximately $650,000 on various environmental capital projects, including those related to the 1990 Amendments.\nIn fiscal 1993, as part of a corporate campaign announced in August 1993 (see \"Business - Strike and Impact Upon the Company\"), the Union engaged a consulting company which conducted what was characterized as an environmental audit of the Company's facilities. The Union's consultant did not visit the minimill, speak with any officer of the Company or review any corporate records. The Union consultant's report stated that it was based on a review of the LDEQ's files and the Company's written operating procedures. The report also stated that the consulting company interviewed Union members employed by the Company. Based on this review, the Union consultant issued a report which stated that its purpose was to identify areas of concern regarding the Company's environmental compliance. The report alleges that the Company, among other things, impermissibly manages hazardous waste (including incineration of flue dust without a permit, operation of a waste pile to manage hazardous wastes without a permit, long-term storage of mixed waste without a permit, and improper training of personnel in waste management), bypasses its air emissions control systems (by venting flue dust directly into the atmosphere in violation of its air permit and releasing fugitive emissions greatly in excess of the level of emissions permitted through its control systems), violates its wastewater discharge permit (by discharging hazardous waste into ponds at its facility) and violates various reporting requirements (with respect to releases of hazardous substances by failing to report the amount of hazardous waste being treated on- site). The Company believes that the Union has submitted this report to the LDEQ, the Louisiana Board of Commerce and Industry (\"LBCI\"), and to other government agencies.\nThe Company believes the Union consultant's allegations are without merit and were made to further the efforts of the Union in the strike. The Company's minimill is subject to regular inspections by the LDEQ. At the request of the LBCI in connection with the Company's most recent tax abatement renewal, LDEQ issued a letter dated February 7, 1994 stating that there were no environmental enforcement actions outstanding against the Company. Subsequent to the issuance of the letter, the Company was inspected numerous times by the LDEQ's offices of Air and Radiation Protection, Solid and Hazardous Waste, and Water Resources. No penalties have been received or are expected as a result of these inspections.\nOn June 14, 1994, LDEQ asked Region 6 of the United States Environmental Protection Agency (EPA) to conduct a multi-media investigation at the LaPlace, Louisiana facility due to the serious nature of the Union's allegations and its lack of resources to conduct such a review. The EPA, accompanied by LDEQ, conducted a multi-media inspection, i.e. air, water, and land, in June 1994. The results of this investigation have not been received. Analytical results from soil and waste samples, obtained by the EPA and submitted to the Company, do not indicate the mismanagement of waste as alleged by the Union. It is possible that the Company may be subject to fines as a result of this inspection; however, the Company does not expect any such fines to have a material adverse affect on the Company's operations. The Company knows of no environmental issues that would require any material adjustment in its contingent liabilities.\nSAFETY AND HEALTH MATTERS\nThe Company is subject to various regulations and standards promulgated under the Occupational Safety and Health Act, which are administered by the Occupational Safety and Health Administration (\"OSHA\"). These regulations and standards are minimum requirements for employee protection and health. It is the Company's policy to meet or exceed these minimum requirements in all of the Company's safety and health policies, programs and procedures.\nDuring fiscal 1994, the Company settled an outstanding OSHA citation issued to the Leetsdale, Pennsylvania stocking location. The final settlement amount was $19,000. All of the agreed upon hazards and recordkeeping issues are being abated. Prior to this citation, the Company has been assessed $7,000 in fines by OSHA over seven years.\nAs part of the Union's corporate campaign, a complaint containing over 150 allegations was submitted by the Union to OSHA. These complaints have apparently been based upon allegations regarding working conditions in the plant alleged by some of the striking Union members who have not been in the plant in nearly 1 1\/2 years. As a result, an inspection was conducted at the LaPlace, Louisiana facility in October and November of 1994 by OSHA. The results of this inspection have not been received. The Company expects that some citations may be issued as a result of this politically driven inspection. Due to its wide discretion in assessing proposed civil penalties, OSHA may initially propose fines which are material in nature but which may be reduced through negotiation in informal proceedings with OSHA or after independent administrative or judicial review. The Company has accrued a loss contingency for its estimate of the ultimate liability arising from these inspections as of September 30, 1994. This estimate is based upon the Company's observations of the items identified by OSHA, the items observed by OSHA, a review of the Union's complaint, expert's experience in handling OSHA citations, the ability to negotiate reductions in proposed fines in informal proceedings with OSHA, and the access to independent administrative or judicial review, if any. The Company does not believe any such fines will be material in nature.\nThe Company knows of no other safety or health issues that would require any material adjustment in its liabilities.\nSTRIKE AND IMPACT UPON THE COMPANY\nGeneral. The Company's six-year labor contract with the Union expired on February 28, 1993. On March 21, 1993, after three short contract extensions, the Union initiated a strike by its 337 bargaining unit employees after the parties failed to reach agreement on a new labor contract due to differences on economic issues. Initially, the Company had to curtail its operations (for six weeks the Company operated at 50% capacity), which resulted in reduced production, higher per ton conversion costs and lost sales, all of which adversely affected the Company's profitability, particularly in the early weeks of the strike.\nDuring its negotiations with the Union, the Company developed a strategic contingency plan to maintain continued operation of the plant in the event of a work stoppage. As a result of such planning, the Company was able to avoid complete suspension of operations by operating the minimill with fewer workers and by utilizing a combination of temporary replacement workers, Union employees who returned to work and salaried employees. As a result of such measures, the Company is currently operating at full capacity and since October 1993 overall production and productivity have exceeded pre-strike levels.\nFor fiscal year 1993, the Company incurred approximately $3.2 million in out- of-pocket costs for security, legal matters and other services related to the strike ($2.5 million of which was incurred during the first three months of the strike). For fiscal year 1994, the Company incurred $1.0 million in similar out- of-pocket costs. During the last six months of fiscal year 1994, these costs averaged $60,000 per month. Although uncertainties inherent in the strike generally make it impossible to predict the duration or ultimate cost of the strike to the Company, the Company expects that future strike-related costs will not exceed $100,000 per month.\nInjunction. The Company obtained an injunction from a Louisiana state court on April 1, 1993 imposing restrictions on the number of picketers and regulating conduct on the picket line. As a result of violations of the injunction, the Company has obtained numerous contempt orders against the violators, as well as additional injunctive relief to further regulate picketing activity. As a result of assault and battery charges filed by the Company, several striking Union members have been sentenced to serve time in jail or to do community service work; the local Union itself has twice been sentenced to do community service work. Access to the minimill has been generally unimpaired since the injunction was issued (with the exception of a court imposed 90-second per vehicle waiting time) and the Company has been allowed by the court to open additional gates to its facility. The injunctive relief permitted the Company to significantly reduce its out-of-pocket expenses for security and housing of temporary replacement workers.\nUnfair Labor Practice Charge. In connection with the strike, the Union filed unfair labor practice charges against the Company with the New Orleans regional office of the National Labor Relations Board (the \"NLRB\"), which included 22 specific allegations. In late January 1994, the Regional Director of the NLRB informed the Company that it had sufficient grounds to issue a complaint against the Company and order a trial with respect to eight of these allegations. In order to avoid a lengthy and expensive trial on these issues, the Company agreed to negotiate a settlement agreement with the NLRB. The settlement agreement does not contain an admission by the Company that it engaged in any unfair labor practices. The settlement agreement requires the Company to post a notice stating that it will not engage in any of the actions specified in the eight allegations. The other 14 allegations were to be dismissed. The Union has appealed the dismissal. The approval of the settlement agreement will not become effective until completion of the appeals process relating to the dismissal of such allegations. However, even if the appeal were successful and a trial were ordered, the Company does not believe that the ultimate outcome would have a material affect on the Company's operations.\nThe settlement agreement does not cover two separate charges filed on January 14, 1994 and March 22, 1994, respectively. These outstanding charges include allegations that the Company bargained in bad faith by failing to provide certain employee safety and health documents and denying the Union access to the minimill and by placing return-to-work conditions without bargaining. The Union is seeking a finding that the Company negotiated in bad faith which, under the National Labor Relations Act (the \"NLRA\"), could convert the strike from an \"economic\" strike to an \"unfair labor practice\" strike. If the Company were found to have engaged in an \"unfair labor practice\" strike, the Company would be precluded from hiring permanent replacement workers. If the Company were to hire permanent replacement workers or declare an impasse prior to the time of such decision, the NLRB could reverse such actions. Furthermore, if the strike was deemed an \"unfair labor practice\" strike and the Company refused to re-employ striking workers who made an unconditional offer to return to work, the Company could be subject to exposure for back-pay. The Company believes that it possesses meritorious defenses to such unfair labor practice charges. An adverse decision by the NLRB on the outstanding charges or a successful appeal by the Union of the dismissed charges could delay and impair the Company's labor initiatives because the Company would be unable to implement all or part of its last proposed labor agreement until it returned to the bargaining process and remedied the unfair labor practices, and until such time as either an agreement with the Union was ratified or impasse in the bargaining process was reached.\nThe Company does not expect that an adverse decision by the NLRB on the outstanding charges or a successful appeal by the Union of the dismissed charges would have a material long-term effect on the Company. Since the strike began, the Company has permitted any striking employee who wished to return to his job upon the terms of the expired contract the opportunity to do so (and the temporary replacement workers have been operating under the terms of the expired contract). Since the Company has not replaced any of the striking workers with permanent replacement employees and has not implemented any of its proposed contract terms, a return of striking workers would have no material financial effect on the Company's operations, although it could disrupt operations for a time.\nUnemployment Compensation. Striking employees filed claims for unemployment compensation at the beginning of the strike. The State of Louisiana paid some unemployment benefits to the striking employees. The Company appealed the decision; the administrative judge disqualified the striking employees from receiving benefits. On October 25, 1994, the Louisiana 5th Circuit Court of Appeals affirmed the order of the 14th Judicial District Court which upheld the administrative judge's decision that striking employees are not eligible for unemployment benefits. The opinion stated: \"In this case, the claimants refused to accept an extension of the expiring contract. An extension would have allowed them to continue working as they had the prior six year period, while negotiations of a new contract continued. Rather, the claimants elected to strike.\" The Union has appealed the decision to the Louisiana State Supreme Court.\nStatus of Negotiations. Union and Company representatives have continued to hold negotiating meetings since March 21, 1993 in attempts to reach a resolution of the outstanding issues. The Company made a contract proposal to the Union on March 11, 1994 which was overwhelmingly rejected by the Union even though the Union leadership had previously indicated that it would support the proposal. No negotiating meetings have been held since March 1994. The NLRA provides that a company, in the absence of unfair labor practices in connection with the negotiations, may implement all or individual parts of its last labor agreement proposal in the event that the bargaining process reaches impasse. The determination of impasse is strictly dependent on the facts of each individual case. The Company has not made a determination that it is at an impasse and any such determination would be subject to review by the NLRB. If the Company were to implement its last proposed labor agreement and the NLRB were to subsequently find that the Company had engaged in unfair labor practices, the Company would be liable to\nmake the employees economically whole with respect to those labor agreement provisions that adversely affected such workers since the Company could not have been at impasse if it were found to have bargained in bad faith.\nBased on the Union's June 14, 1994 letter proposal to the Company, the Company and the Union currently remain apart on many issues with respect to the proposed labor contract. The Union has led the Company to believe that the following issues, among others, are significant in reaching agreement:\nHealth Benefits. The Company has proposed a point-of-service managed health care plan which would require employees to contribute $12.00 per week to the plan for family coverage. In addition, any future increases in the cost of the plan would be shared equally by the Company and employees. The Union's last proposal requires employees to contribute only $10.00 per week and that employees bear responsibility for only $.69 per week in future increases in the cost of the plan over a six year contract.\nIncentive Plan. The Company has proposed an incentive plan and profit sharing plan for its employees as the primary basis for increases in compensation, the components of which would be subject to change at the discretion of the Company. The Union is proposing that these plans be subject to the grievance and arbitration procedure under the contract (and therefore not subject to amendment at the Company's discretion).\nContract Services. The Company has proposed a provision granting the Company the right to utilize contract labor and outside contractors, although no employee directly affected would be terminated or suffer a loss of pay rate as a result of using contract labor. The Union is seeking a more restrictive provision limiting the Company's ability to utilize such contractors.\nBargaining Unit Work. The Company has proposed reduced limitations on non- bargaining unit employees, primarily supervisors, from performing bargaining unit work. The Union's proposal maintains past restrictions contained in the expired contract, in addition to more severe penalties in the event of future violations.\nUnion Representatives. The Company and the Union disagree as to which party should be responsible for the compensation of union representatives for the performance of Union duties during Company hours.\nPicket Line Misconduct. The Company maintains that it has a right to subject picketers who have engaged in picket line misconduct (meeting the criteria established by the NLRB as behavior not protected by the NLRA) to disciplinary action, including termination of employment. The Union demands that all striking employees, even those who have engaged in such misconduct, be returned to their positions at the cessation of the strike.\nRelease From Liability. The Company maintains that it has a right to pursue any legal remedies against the Union to recover damages. The Union demands that both the Company and Union sign mutual releases of claims against the other.\nCorporate Campaign. In August 1993, the Union announced a corporate campaign designed to bring pressure on the Company from individuals and institutions with direct financial or other interests in the Company. Although plant operations continue, the potential impact of such a campaign, including the financial impact, is difficult to assess at this time. Although the corporate campaign is directed at many areas, the Company believes the following areas are significant and are typical of union tactics in other corporate campaigns.\nEnvironment. See \"Business- Environment\" for description of the Company's environmental matters.\nSafety and Health. See \"Business - Safety and Health\" for a description of the Company's safety and health matters.\nRefinancing. In March 1994, the Company sold $75 million of 10.25% First Mortgage Notes due 2001 (the \"10.25% Notes\"). The Union interrupted a meeting with potential investors and mailed information to potential investors and regulatory groups. The Company believes this harassment resulted in a more costly offering in terms of out of pocket expenses and in a higher interest rate on the 10.25% Notes.\nGovernance. On October 19, 1994, the Union, which own 5 shares of the Company's 12,884,607 outstanding shares, brought two legal actions against the Company in Delaware state court seeking to enforce certain alleged shareholder rights. The first lawsuit sought to compel the Company to turn over to the Union the Company's list of stockholders, ostensibly for the purpose of soliciting proxies regarding six advisory resolutions to be proposed by the Union for voting at the next annual meeting. The second lawsuit sought to compel the Company to fix a date for its annual meeting. The Company believed that the Union was not entitled to the shareholder list because it did not have a \"proper purpose\" under Delaware law. Specifically the Company believes the Union's actions were for the sole purpose of bringing pressure on the Company to accept the Union's collective bargaining demands. During pre-trial discovery, the Union dismissed its lawsuit seeking the shareholder list. On the eve of trial, the Union also dismissed its action seeking to compel an annual meeting. The Company has agreed to hold an annual meeting on January 26, 1995, in New York City. It is anticipated that the Union will speak at the annual meeting on its unfair labor practice charges pending before the National Labor Relations Board, issues of corporate governance, and other matters the Union has raised as part of its publicly-announced corporate campaign to discredit the Company and management.\nEMPLOYEES\nAs of September 30, 1992, the Company had 491 employees, of whom 153 were salaried office, supervisory, and sales personnel, and 338 were hourly employees. 20 salaried non-exempt employees and 329 hourly employees were covered by a collective bargaining contract which expired on February 28, 1993 between the Company and the Union. There has been no agreement on a new contract. The employees covered by this expired contract are on strike. In addition, 9 hourly employees at the Pittsburgh stocking location are covered by a collective bargaining contract which expired on July 31, 1994 between the Company and the Union. The Company and the Union agreed to a new five year contract covering these nine positions. The contract calls for wage increases and the move to a managed health care program. As of September 30, 1994, the Company had 428 non-striking employees, of whom 142 were salaried office, supervisory, and sales personnel, and 286 were hourly employees. As of September 30, 1994, the Company had utilized 197 temporary replacement workers to perform certain of the services of striking workers. Of the 337 bargaining unit employees as of the date of the strike, 101 have returned to work of which 90 are still working, an additional 21 have resigned, and 215 remain on strike as of November 21, 1994.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal operating properties are listed in the table below. The Company believes that its properties and warehouse facilities are suitable and adequate to meet its needs and that the size of its warehouse facilities is sufficient to store the level of inventory necessary to support its level of distribution.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSee \"Business--Strike and Impact Upon the Company\" for a description of the NLRB proceedings, \"Business - Environmental Matters\" for a description of environmental issues and \"Business - Safety and Health Matters\" for a description of safety and health issues. The Company is not involved in any pending legal proceedings which involve claims for damages exceeding 10% of its current assets. The Company is not a party to any material pending litigation which, if decided adversely, would have a significant impact on the business, income, assets or operation of the Company, and the Company is not aware of any material threatened litigation which might involve 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 fiscal year ended September 30, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S CLASS A COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nMarket Information and Stock Price\nThe principal market in which the Class A Common Stock of the Company is traded is the American Stock Exchange (AMEX) under the symbol BYX. The approximate number of stockholders of record on October 31, 1994 was 430. The stock has been trading since July 27, 1988. The closing price per share on November 30, 1994 was $3.3125. The following tables set forth the high and low closing prices for the periods indicated.\nThere is no public trading market for the Class B Common Stock and the Class C Common Stock.\nDividends\nThe Company is restricted from paying dividends on its capital stock under the terms of its tax abatement agreement with the State of Louisiana, which expires in September 1995. Further, the Company's ability to pay dividends is subject to restrictive covenants under both the Indenture pursuant to which the Company's 10 1\/4% First Mortgage Notes due 2001 (the \"10 1\/4% Notes\") were issued and the Company's line of credit. At such time as the Company is permitted to pay dividends, the Board of Directors will determine whether such action would be appropriate based on the Company's results of operations, financial condition, capital requirements, and other circumstances.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSet forth below is summary financial information for the Company since 1988.\nSUMMARY FINANCIAL INFORMATION (DOLLARS IN THOUSANDS, EXCEPT RATIO AND PER TON DATA)\n- - -------------- (1) In fiscal 1991 the Company decided to reduce its melting capacity by discontinuing the operation of one of its two electric furnaces and ceasing the practice of exporting large quantities of billets. In prior years, billet sales contributed small margins; however, the margins on billets sales virtually disappeared as a result of worldwide market conditions in late 1990. The Company believes its decision to stop producing large quantities of billets for export resulted in a decline in sales of approximately $40 million. (2) In fiscal 1993, Non-Production Strike Expenses includes $3.2 million in expenses for security, lodging, damages, legal matters, and other services related to the strike. (3) In fiscal 1990, Miscellaneous includes income in connection with a favorable settlement of a lawsuit for $1.3 million. (4) In fiscal 1988, income applicable to common shares after accretion and dividends accrued on preferred stock was $19.8 million. (5) In fiscal 1994, the Company refinanced its long-term debt. The extraordinary loss includes prepayment penalties, interest during the defeasance period, and the write-off of the unamortized portion of deferred financing cost.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nBayou Steel Corporation reported net income of $4.4 million before an extraordinary loss in fiscal 1994 compared to a net loss of $6.7 million before an extraordinary gain in fiscal 1993. The $11.1 million improvement in the Company's results was due to several factors. First, shape shipments increased by 10.7%. Second, metal margin, the difference between shape selling price and raw material (\"scrap\") cost, increased by 6.2%. Third, conversion cost, the cost to convert raw material into shapes decreased by 9.4%. And fourth, out-of-pocket strike expenses decreased by $2.2 million.\nThe Company reported a net loss of $6.7 million before an extraordinary gain in fiscal 1993 compared to a net loss of $1.4 million in fiscal 1992. The 1993 loss was primarily caused by the strike and by sharp increases in scrap costs. The strike adversely affected the Company in four ways. First, the Company incurred significant out-of-pocket expenses for security, legal, and other services related to the strike. Second, a reduction in production during the initial phases of the strike resulted in higher fixed costs per ton produced during that period. Third, the impact of training new employees affected productivity and led to higher consumption of materials for several months. And fourth, reduced production during the early weeks of the strike resulted in lost sales due to reduced inventory levels. The increases in scrap costs during the year was only partially offset by increases in selling prices, resulting in reduced metal margins.\nThe extraordinary loss of $5.5 million in fiscal 1994 was caused by the prepayment of the 14.75% Senior Secured Notes (the \"14.75% Notes\"). The loss includes prepayment penalties, interest during the defeasance period, and the write-off of the unamortized portion of deferred financing cost. This debt was replaced with $75 million of 10.25% First Mortgage Notes Due 2001 (the \"10.25% Notes\"). This refinancing transaction not only improved cash flow by changing the timing on principal payments but also provided the Company with cash to undertake a $9.2 million capital improvements program directed toward cost reduction. The extraordinary gain of $0.6 million in fiscal 1993 was the result of purchasing some of the outstanding 14.75% Notes at a discount.\nThe following table sets forth the shipment and sales data for the fiscal years indicated.\nSALES\nNet sales increased by $25 million or 18.2% in fiscal 1994 compared to fiscal 1993 due to an increase in shape shipments and selling prices. The increase was partially offset by fewer tons of billets shipped in fiscal 1994. Net sales increased by $16 million or 13.6% in fiscal 1993 compared to fiscal 1992 due to an increase in shipments and selling prices for both billets and shapes.\nShapes. In 1994, the 43,298 ton or 10.7% increase in shape shipments was attributable to an improvement in the economy and the Company's improved product mix and availability. In 1993, shipments were adversely affected by the lack of availability and mix of product resulting from a reduced production schedule caused by the strike. Export shape shipments in fiscal 1994 were 8.2% of shape shipments as compared to 11.1% of shape shipments for fiscal 1993. The $37 per ton or 12.3% increase in shape prices in 1994 compared to 1993 was in response to continued escalation in scrap prices and strong domestic demand. The shape price increases, toward the end of the fiscal 1994, surpassed the scrap price increases resulting in improved margins compared to fiscal 1993. Because of the strong domestic demand, the Company was able to further improve the net selling price by reducing competitive allowances. The Company anticipates modest growth in the economy in fiscal 1995 which should result in increased\nsales due to increased demand. The Company hopes to continue to optimize its product mix to remain competitive and maintain market share.\nIn 1993, the 30,331 ton or 8.1% improvement in domestic shape shipments was mainly due to an improving economy and the Company's efforts to recapture market share which had been lost in prior years due to the presence of excessive surface rust on the Company's products. The improvement would have been greater if the Company had not lost some sales due to the temporary disruption in shipments out of LaPlace and the stocking locations and the curtailed production due to the strike. Export shape shipments in fiscal 1993 were 11.1% of shape shipments as compared to 9.7% for the previous year. Even though there were extreme pressures on prices in the form of rebates and discounting, which the Company matched to stay competitive, the average selling price for the Company's shape products rose approximately $4 per ton in fiscal 1993. The increases in prices were primarily in response to sharp increases in raw material costs; however, the price increases only partially offset the raw material increases.\nBillets. In fiscal 1994, billet shipments decreased mainly due to fewer billets available for shipment. More billets were required by the rolling mill due to higher shape production levels which resulted in less billets available to sell. The selling price for billets increased in fiscal 1994 due to increased raw material costs. In fiscal 1995, the Company will continue to ship billets on a supply contract or on an occasional and selective basis to domestic and export customers when inventory levels and market demand make it beneficial.\nIn fiscal 1993, the Company increased billet shipments by 86% as compared to fiscal 1992. The average selling price of billets also improved over the same period due to an increase in domestic shipments, which carry a higher selling price than export shipments, and increasing raw material prices, which were passed on to billet customers.\nCOST OF SALES\nCost of sales was 89.7% of sales in fiscal 1994 compared to 94.1% in fiscal 1993 and 91.1% in fiscal 1992. The decrease in cost of sales in fiscal 1994 was due to shape selling prices increasing more than the scrap price increases. Also, contributing to the improvement in cost of sales was increases in productivity and reductions in conversion costs (the cost of converting raw materials into shapes). The significant increase in fiscal 1993 compared to fiscal 1992 was due to both higher scrap costs, which were not completely offset by selling prices, and higher conversion costs, which were caused by the curtailment of operations during the initial phases of the strike and higher purchase prices for electricity, natural gas and electrodes. Cost of sales has been favorably impacted in fiscal 1994, 1993, and 1992 by approximately $1 million due to a contract with the State of Louisiana to abate state franchise and sales taxes. This agreement expires at the end of the second fiscal quarter of 1995.\nThe major component of cost of sales is scrap. The volatility of the scrap markets was evident during fiscal 1994 and 1993. Scrap costs increased an average of 14.6% in fiscal 1993 compared to fiscal 1992. In 1993, scrap cost per ton increased $10 more than the increase in the shape selling prices, reducing margins. For 1993, the average metal margin was 4.0% below the average metal margin in 1992. In 1994, the scrap costs increased an average of 24% compared to 1993. In 1994, selling prices increased $11 per ton more than the increases in the scrap prices, increasing margins. The average metal margin was 6.2% higher in 1994 compared to 1993. Scrap costs may increase in fiscal 1995, as scrap market prices began a rising trend in late fiscal 1994.\nAnother significant portion of cost of sales is conversion cost, which includes labor, energy, maintenance material, and supplies used to convert raw materials into billets and billets into shapes. Conversion cost per ton, which include fixed and variable costs, increased 3.0% in fiscal 1993 compared to fiscal 1992, but decreased by 9.4% in fiscal 1994 compared to fiscal 1993. Cost of sales in 1994 reflected the termination of the refund program with the power company which favorably impacted cost of sales by $0.6 million in both fiscal 1993 and 1992.\nThe 3.0% increase in per ton conversion cost in 1993 was due to the strike and increased energy costs. The inability to operate at full capacity during the initial phases of the strike resulted in reduced production and a higher level of fixed cost per ton than comparable periods. Conversion cost per ton also increased due to overtime wages paid to workers as a result of reduced staffing and training new employees during this period of the strike. Compared to fiscal 1992, the price of the fuel adjustment component of power increased 28% and the price of natural gas and electrodes increased 32% and 9%, respectively, further increasing conversion costs. Increased consumption of certain\nsupplies and materials, particularly as new employees were trained to replace striking employees, also contributed to higher per ton conversion cost. The Company has been operating at full capacity since July 1993.\nThe 9.4% decrease in conversion costs in fiscal 1994 was due to improvements in production and productivity compared to fiscal 1993. The current work force has been trained and gaining experience; consequently, production tons, productivity and cost have improved. Production and productivity have exceeded pre-strike levels which reduced fixed cost per ton. The melt shop and the rolling mill have set several production records in fiscal 1994. The records were achieved despite training replacement workers which currently represent 67% of the workers. Also, variable cost per ton decreased due to more efficient consumption of supplies. Man-hours per ton have been reduced by .57 or 21% since 1992. Labor cost per ton has been reduced by $13 since 1992. The Company's goal is to further reduce labor cost per ton through increased shipments, increased productivity, and reduction in overtime.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general and administrative expenses were relatively stable for fiscal 1993 and 1992. However, selling, general and administrative expenses decreased in fiscal 1994 due to reductions in collection expenses and labor costs.\nNON-PRODUCTION STRIKE EXPENSES\nIn fiscal 1993, the Company incurred $3.2 million ($2.5 million of which was incurred during the first three months of the strike) of non-production strike expenses, such as legal, security, and other services during the strike. In fiscal 1994, the Company's strike-related expenses averaged approximately $83,000 per month. Future strike-related costs should not exceed $100,000 per month. See \"Business-Strike and Impact Upon the Company.\"\nINTEREST EXPENSE & MISCELLANEOUS\nInterest expense decreased in fiscal 1993 compared to fiscal 1992 due to the Company purchasing $11.1 million of its 14.75% Notes in fiscal 1993. Interest expense decreased in fiscal 1994 compared to 1993 primarily due to the purchase of $6.5 million of the 14.75% Notes in late 1993. During the first half of fiscal 1994, the Company accrued interest on $48.9 million of the 14.75% Notes, and as of March 1994, the Company accrued interest on $75 million of the 10.25% Notes; in addition, the Company borrowed an average of $2.4 million under its revolving line of credit at a weighted average interest rate of 5.2%. In fiscal 1993, the Company accrued interest on $55.4 million of its 14.75% Notes on a weighted outstanding basis. In fiscal 1992, the Company accrued interest on $60 million of its 14.75% Notes. The Company expects interest expense to be approximately the same in fiscal 1995 as in fiscal 1994.\nInterest income decreased in fiscal 1993 compared to fiscal 1992 due to both less attractive investment options and having less cash to invest following its purchase of some of the 14.75% Notes on the open market. Interest income increased in fiscal 1994 compared to fiscal 1993 due to investing excess cash from the sale of the $75 million 10.25% Notes. Also, interest rates improved in fiscal 1994.\nMiscellaneous income and expenses have been relatively the same for fiscal 1992, 1993 and decreased in fiscal 1994. The 1994 decrease was due to a lower allowance for doubtful accounts as compared to 1992 and 1993.\nNET INCOME\/LOSS BEFORE EXTRAORDINARY ITEMS\nThe Company's results before extraordinary items improved by $11.1 million in fiscal 1994 compared to fiscal 1993. The primary reasons for the improvement are increased shipments and margins, lower conversion cost per ton, and lower strike-related costs. The unfavorable results in fiscal 1993 compared to fiscal 1992 are due to the strike, lower metal margin and higher prices for energy.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company ended fiscal 1994 in a sound liquidity position with $8.9 million of cash and with current assets exceeding current liabilities by a ratio of 4.2 to 1.0. Working capital increased by $32.8 million to $65.2 million in fiscal 1994. The increase in working capital was due to the increases in cash from the sale of the 10.25% Notes, the replenishment of inventory, reductions in accounts payable, the repayment of the short-term debt under the Company's credit facility and the repayment of the 14.75% Notes which avoided the need for a required $9.0 million principal payment.\nNet cash used in operations was $1.9 million due to the replenishment of the inventory depleted during the strike and reductions in accounts payable. The Company expects finished goods inventory to remain essentially the same for fiscal year 1995. Significant changes in the scrap prices without a corresponding change in the selling price could have a substantial effect on the Company's results and liquidity.\nCapital expenditures amounted to $2.8 million in fiscal 1994. The Company has committed to implement a $9.2 million capital modernization program directed towards cost reduction. These projects include the processing of unprepared scrap metal into material used by the electric furnace and the reduction of processing costs in both the melt shop and the rolling mill. As of the end of fiscal 1994, the Company spent approximately $1.0 million of the $9.2 million commitment.\nCash from financing activities of $13.0 million was due to the cash generated from the 10.25% Notes issued net of retirement of the 14.75% Notes, the repayment of borrowings under the line of credit, and all refinancing costs.\nIn fiscal 1994, the Company entered into an amendment and restatement of its credit facility, which is a three-year line of credit that permits loans to be made to the Company, on a secured basis, of up to $30 million. There have been no borrowings under the credit facility since March 1994. Interest rates under the credit facility are prime plus 1% or LIBOR plus 2% at the Company's option. The Company's credit facility contains certain covenants, such as an Interest Expense Coverage Ratio, which become increasingly more restrictive over time. The Interest Expense Coverage Ratio covenant was 1.25 to 1.00 for the quarter ending September 30, 1994 and increases to 1.80 to 1.00 for the four quarters ending September 30, 1995. The Company's Interest Expense Coverage Ratio for the quarter ended September 30, 1994 was 3.08 to 1.00. In the event of a default under the credit facility, the Company would seek a waiver of the covenant or otherwise renegotiate the terms under the credit facility. The Company does not anticipate any difficulty in obtaining another secured line of credit upon the expiration of the current revolving line of credit in November of 1996.\nAll of the $75 million 10.25% Notes are classified as long-term debt. There are no principal payments due on the 10.25% Notes until maturity in 2001. The Company believes that current cash balances, internally generated funds, the credit facility and additional purchase money mortgages are adequate to meet the foreseeable short-term and long-term liquidity needs. The Company currently intends to refinance the 10.25% on or before the maturity date in 2001. The Indenture contains a covenant which restricts the Company's ability to incur additional indebtedness. Under the Indenture, the Company may not incur additional indebtedness unless its Interest Expense Coverage Ratio for the trailing 12 months, would be greater than 2.00 to 1.00 after giving effect to such incurrence. As of September 30, 1994, the Interest Expense Coverage Ratio was 2.28 to 1.00. If additional funds are required to accomplish long-term expansion of its production facility or significant acquisitions, the Company believes funding can be obtained from a secondary equity offering or additional indebtedness.\nThere are no financial obligations with respect to post-employment or post- retirement benefits.\nOTHER COMMENTS\nENVIRONMENTAL MATTERS\nSee \"Business--Environmental Matters\" for a description of the Company's environmental matters.\nSAFETY AND HEALTH MATTERS\nSee \"Business--Safety and Health Matters\" for a description of the Company's safety and health matters.\nSTRIKE\nSee \"Business--Strike and Impact Upon the Company\" for a description of the strike.\nINFLATION\nThe Company is subject to increases in the cost of energy, supplies, salaries and benefits, additives, alloy and scrap due to inflation. Shape prices are influenced by supply, which varies with steel mill capacity and utilization, and market demand.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nBAYOU STEEL CORPORATION\nBALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of these balance sheeets.\nBAYOU STEEL CORPORATION\nSTATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these balance sheeets.\nBAYOU STEEL CORPORATION\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these balance sheeets.\nBAYOU STEEL CORPORATION\nSTATEMENTS OF CHANGES IN EQUITY\nThe accompanying notes are an integral part of these balance sheeets.\nBAYOU STEEL CORPORATION\nNOTES TO FINANCIAL STATEMENTS\nSEPTEMBER 30, 1994 AND 1993\n1. OWNERSHIP:\nBayou Steel Corporation (of LaPlace) was incorporated in Louisiana in 1979. On September 5, 1986, Bayou Steel Acquisition Corporation (BSAC) acquired substantially all of the capital stock of Bayou Steel Corporation (of LaPlace) from the former stockholders (the Acquisition) for $75,343,000. Simultaneously with the Acquisition, BSAC merged into Bayou Steel Corporation (of LaPlace) (the Company) with the Company being the surviving corporation. The Company reincorporated as a Delaware corporation on July 19, 1988 and changed its name from Bayou Steel Corporation (of LaPlace) to Bayou Steel Corporation on August 3, 1988.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nINVENTORIES\nInventories are carried at the lower of cost (last-in, first-out) or market except mill rolls which are stated at cost (specific identification) and operating supplies and other which are stated at average cost.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment acquired as part of the acquisition in 1986 was recorded based on the purchase price. Betterments and improvements on property, plant and equipment are capitalized at cost. Interest during construction of significant additions is capitalized. Repairs and maintenance are expensed as incurred. Depreciation is provided on the units-of-production method for machinery and equipment and on the straight-line method for buildings over an estimated useful life of 30 years.\nSTATEMENT OF CASH FLOWS\nThe Company considers investments purchased with an original maturity of generally three months or less to be cash equivalents.\nCash payments for interest and Federal income taxes during the three years ended September 30, were as follows:\nINCOME TAXES\nThe Company adopted the provisions of Financial Accounting Standards Board Statement No. 109 \"Accounting for Income Taxes\" (\"FAS 109\") effective October 1, 1993. As permitted under FAS 109, the Company has elected not to restate the financial statements of prior years. There was no impact on income for the fiscal year ended September 30, 1994 or any prior years.\nBAYOU STEEL CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(CONTINUED)\nCREDIT RISK\nThe Company extends credit to its customers primarily on 30 day terms and encourages discounting. The Company believes that the credit risk is minimal due to the ongoing review of its customers' financial conditions, the Company's sizeable customer base and the geographical dispersion of the customer base. On some occasions, particularly large export shipments, the Company requires letters of credit. Historically, credit losses have not been significant. Also, the Company invests its excess cash in high-quality short-term financial instruments.\nOPERATING LEASE COMMITMENTS\nThe Company has no significant operating lease commitments that would be considered material to the financial statement presentation.\n3. INVENTORIES:\nInventories, as of September 30, 1994 and 1993 consisted of the following:\nThere was an increment in the last-in, first-out (\"LIFO\") inventories in fiscal 1994. In fiscal 1993, decrements in the LIFO inventories had the effect of decreasing net loss by $124,000 or $0.01 per share. At September 30, 1994 and 1993, the first-in, first-out (\"FIFO\") inventories were $41.3 million and $32.3 million, respectively. A lower of cost or market evaluation of the carrying value of inventory was done at the end of each fiscal year. For all years presented, market value was in excess of the carrying value of the LIFO and FIFO inventories.\n4. PROPERTY, PLANT AND EQUIPMENT:\nCapital expenditures totaled $2.7 million in fiscal 1994 and $3.2 million in fiscal 1993 and 1992. As of September 30, 1994, the estimated costs to complete authorized projects under construction or contract amounted to $8.2 million.\nThe Company capitalized interest of $69,000, $115,000, and $107,000 during the years ended September 30, 1994, 1993, and 1992, respectively, related to qualifying assets under construction.\nDepreciation expense during the years ended September 30, 1994, 1993, and 1992 was allocated as follows:\nBAYOU STEEL CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(CONTINUED)\n5. OTHER ASSETS:\nOther assets consist of financing costs associated with the issuance of long- term debt and the Company's revolving line of credit (see Notes 6 and 7) which are being amortized over the lives of the related debt. During fiscal 1994, the Company wrote off $953,000 of other assets related to the 14.75% Senior Secured Notes and the previously existing revolving line of credit. The Company also capitalized $3,783,000 of deferred financing costs related to the 10.25% First Mortgage Notes and the amended and restated revolving line of credit during fiscal 1994. Amortization expense was approximately $553,000, $458,000 and $332,000 for the years ended September 30, 1994, 1993, and 1992, respectively.\n6. LONG-TERM DEBT:\nLong-term debt of the Company as of September 30, 1994 and 1993 included the following:\nThe 10.25% First Mortgage Notes (the \"10.25% Notes\") are secured by a first priority security interest granted by the Company, subject to certain exceptions, in substantially all unencumbered existing and future real and personal property, fixtures, machinery and equipment (including certain operating equipment classified as inventory) and the proceeds thereof, whether existing or hereafter acquired. A purchase money facility relating to the Tulsa stocking location is secured by the stocking location facility.\nThe 10.25% Notes bear interest at the nominal rate of 10.25% per annum payable semi-annually on each March 1 and September 1, commencing September 1, 1994.\nThe 10.25% Notes will be redeemable, in whole or in part, at any time on and after March 1, 1998, initially at 103.33% of the principal amount, plus accrued interest to the date of redemption, and declining ratably to par on March 1, 2000. There are no principal payments due on the 10.25% Notes until maturity in 2001. The market value of the 10.25% Notes on September 30, 1994 was $69.8 million.\nOn March 3, 1994, the Company redeemed $39.9 million of the 14.75% Senior Secured Notes at a price of 110 in connection with the issuance of the 10.25% Notes. Call premiums of $3.9 million, write-offs of unamortized finance costs of $1.0 million, and interest of $0.6 million related to this redemption are included in the extraordinary loss recorded in the Statement of Operations as of September 30, 1994. There was no tax effect related to this transaction.\nAs of September 30, 1994 and 1993, the Company accrued interest at a rate of 10.25% and 14.75%, respectively.\nDuring fiscal 1993, the Company purchased $11.1 million of the 14.75% Senior Secured Notes at a net discount. The result of these purchases at a net discount, reduced by the write-off of the related unamortized deferred finance cost, has been reflected in the Statement of Operations as of September 30, 1993 as an extraordinary gain. There was no tax effect related to this transaction.\nBAYOU STEEL CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(CONTINUED)\n7. SHORT-TERM BORROWING ARRANGEMENT:\nOn November 23, 1993, the Company entered into an amendment and restatement of its revolving line of credit agreement which will be used for general corporate purposes. The terms of the amended and restated agreement call for available borrowings up to $30 million including outstanding letters of credit. Based on these criteria, the amount available as of September 30, 1994 was $26.3 million. The agreement is secured by inventory and accounts receivable at interest rates of prime plus 1% or LIBOR plus 2%. The terms of the loan agreement impose certain restrictions on the Company, the most significant of which require the Company to maintain a minimum interest coverage ratio, limit the incurrence of certain indebtedness and restrict various payments. There were no borrowings under the line of credit as of September 30, 1994 and the only borrowing for fiscal 1993 of $4,000,000 occurred on September 15, 1993 and remained outstanding at a rate of 3.75% through September 30, 1993. The maximum amount outstanding during fiscal 1994 was $7,900,000. The average borrowings were $2,402,000 at a weighted average interest rate of 5.2% as of September 30, 1994.\n8. INCOME TAXES:\nThe Company is subject to United States Federal income taxes. The primary difference between book and tax reporting of income relates to the allocation of the carrying cost of property, plant and equipment to operations due to (a) different depreciation methods used for tax and financial reporting purposes, (b) a writedown of the carrying value of property, plant and equipment to estimated net realizable value recorded for financial reporting purposes in prior years, and (c) the sale of tax benefits discussed below.\nIn 1981, the Company entered into lease agreements with an unrelated corporation whereby certain tax benefits were transferred to the unrelated corporation as allowed under the provisions of the Economic Recovery Tax Act of 1981. These agreements, the last of which will expire in late 1996, include various covenants not to dispose of the property covered by the agreement and indemnification of the unrelated corporation by the former majority stockholder against any losses which might result from a breach of the Company's warranties and covenants, including those related to the Federal income tax implications of the transaction. In 1986, the Company agreed to require any purchaser of the property subject to such Mortgage to take the property subject to such agreements and to ensure that any disposition of the property upon a foreclosure of the Mortgage would not constitute a \"disqualifying event\" within the meaning of the regulations promulgated under Section 168(f)(8) of the Internal Revenue Code as in effect prior to the enactment of the Tax Equity and Fiscal Responsibility Act of 1982. The result of this and other related agreements may be to limit the marketability of the property upon a foreclosure of the Mortgage. The Company will recognize interest income of $4.1 million and rent expense of $26.1 million for tax reporting purposes in fiscal years 1995 through 1997 based upon the foregoing agreements.\nAs of September 30, 1994, for tax purposes, the Company had net operating loss carryforwards (\"NOLs\") of approximately $319.0 million and $292.9 million available to offset against regular tax and alternative minimum tax, respectively. Due to the fact that book and tax losses were generated in 1994, 1993 and 1992, there was no provision for income taxes in any of these years.\nThe NOLs will expire in varying amounts through fiscal 2009. A substantial portion of the available NOLs, approximately $203 million, expires by fiscal 2000. In addition, the Company has $22.0 million of future tax benefits attributable to its tax benefit lease which expires in 1996 and which may, to the extent of taxable income in the year such tax benefit is produced, be utilized prior to the NOLs. Even though management believes the Company will be profitable in the future and will be able to utilize a portion of the NOLs, management does not believe that it is likely that all of the NOLs will be utilized. The Company adopted the provisions of Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"), effective October 1, 1993. FAS 109 required recognition of future tax benefits, subject to a valuation allowance based on the likelihood of realizing such benefits. Deferred tax assets of approximately $122 million (NOLs, future tax benefits attributable to its tax benefit lease, and other temporary timing differences multiplied by the federal income tax rate) and deferred tax liabilities of approximately $8 million (basis differences between tax and book plant, property, and equipment multiplied by the\nBAYOU STEEL CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(CONTINUED)\nfederal income tax rate) were recorded in fiscal 1994. However, in recording these deferred assets, FAS 109 required the Company to determine whether it is \"more-likely-than-not\" that the Company will realize such benefits and that all negative and positive evidence be considered (with more weight given to evidence that is \"objective and verifiable\") in making the determination. FAS 109 indicated that \"forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years\"; therefore, the Company determined that it was required by the provisions of FAS 109 to establish a valuation allowance of $114 million for all of the recorded net deferred tax assets. In view of the fact that this determination was based primarily on historical losses with no regard for the impact of proposed capital expenditures and business plans, future favorable adjustments to the valuation allowance may be required if and when circumstances change. Adoption of FAS 109 had no impact on income for financial reporting or tax purposes for fiscal 1994 or prior years.\nThe Company and an individual controlling the current majority stockholder agreed to indemnify the former majority stockholder for any payments required to be made to the unrelated corporation caused by the Company's failure to comply with the foregoing agreements. The former stockholder retains ownership of the Company's Class C Common Stock which carries certain limited voting rights including the holders' right to prevent certain transactions (liquidation and certain mergers) which could result in liability to the former majority stockholder under its indemnification to the unrelated corporation. The Company's Class B Common Stock carries these same voting rights.\n9. COMMITMENTS AND CONTINGENCIES:\nSTRIKE\nOn March 21, 1993, the United Steelworkers of America Local 9121 (the \"Union\") initiated a strike against the Company. Negotiations on a new contract have continued, but differences have thus far precluded an agreement. The Company cannot predict the impact that a new collective bargaining contract will have on the Company's results. However, the Company believes a new contract will not have a negative material effect on the Company's results. Also, the Union has filed charges with the National Labor Relations Board alleging that the Company has violated the National Labor Relations Act relating to its bargaining conduct. The Company believes it has meritorious defenses to these charges and has responded timely to all of these allegations and believes that it has negotiated in good faith with the Union. An unfavorable decision by the National Labor Relations Board, however, should not materially affect the Company. In addition, the Union has initiated an inspection of the Company's facilities and records by the Environmental Protection Agency (the \"EPA\"), which was completed in June, 1994, and the Occupational & Safety Health Administration (the \"OSHA\"), which was completed in November, 1994. The results of these inspections have not been received. It is possible that the Company may be subject to fines as a result of the EPA or OSHA inspections. Due to its wide discretion in assessing proposed civil penalties, OSHA may initially propose fines which are material in nature but which may be reduced through negotiation in informal proceedings with OSHA or after independent administrative or judicial review. The Company has accrued a loss contingency for its estimate of the ultimate liability arising from these inspections as of September 30, 1994. This estimate is based on the Company's observations of the items identified by EPA and OSHA, expert's experience in handling OSHA citations, the ability to negotiate reductions in proposed fines in informal proceedings with OSHA, and access to independent administrative or judicial review, if any. As a result, the Company does not expect any such fines to have a material adverse financial affect on the Company.\nENVIRONMENTAL\nThe Company is subject to various Federal, state and local laws and regulations concerning the discharge of contaminants which may be emitted into the air, discharged into waterways, and the disposal of solids and\/or hazardous wastes such as electric arc furnace dust. In addition, in the event of a release of a hazardous substance generated by the Company, the Company could be potentially responsible for the remediation of contamination associated with such a release. In the past, the Company's operations in some respects have not met all of the\nBAYOU STEEL CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(CONTINUED)\napplicable standards promulgated pursuant to such laws and regulations. At this time, the Company believes that it is in compliance in all material respects with applicable environmental requirements and that the cost of such continuing compliance will not have a material adverse effect on the Company's competitive position, operations or financial condition, or cause a material increase in currently anticipated capital expenditures. The Company currently has no mandated expenditures to address previously contaminated sites and does not anticipate any infrequent or non-recurring clean-up expenditures. Also, the Company is not designated as a Potential Responsible Party (\"PRP\") under the Superfund legislation. At September 30, 1994, the Company has accrued a loss contingency for environmental matters.\nOTHER\nThe Company does not provide any post-employment or post-retirement benefits to its employees other than those described in Note 11.\nThere are various claims and legal proceedings arising in the ordinary course of business pending against or involving the Company wherein monetary damages are sought. It is management's opinion that the Company's liability, if any, under such claims or proceedings would not materially affect its financial position.\n10. STOCK OPTION PLAN\nThe Board of Directors and the Stockholders approved the 1991 Employees Stock Option Plan (the \"1991 Plan\") for the purpose of attracting and retaining key employees.\nOn September 21, 1994, the Board of Directors granted 115,000 incentive stock options to purchase Class A Common Stock, exercisable at the market price on that date of $4.375, to key employees. The options are exercisable in five equal annual installments commencing on September 21, 1995. As of September 30, 1994, no options were exercised or exercisable and 485,000 shares were available for grant under the 1991 Plan. The Company recorded no compensation expense related to the 1991 Plan during fiscal 1994.\nA summary of activity relating to stock options is as follows:\n11. EMPLOYEE RETIREMENT PLANS:\nEffective October 1, 1991, the Company implemented two defined benefit retirement plans (the \"Plan(s)\"), one for employees covered by the contracts with the United Steelworkers of America (\"hourly employees\") and one for substantially all other employees (\"salaried employees\"). The Plan for the hourly employees provides benefits of stated amounts for a specified period of service. The Plan for the salaried employees provides benefits based on employees' years of service and average compensation for a specified period of time before retirement. The Company follows the funding requirements under the Employee Retirement Income Security Act of 1974 (\"ERISA\"). The net\nBAYOU STEEL CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(CONTINUED)\npension cost for both non-contributory Company sponsored pension plans consists of the following components for fiscal year 1994 and 1993:\nThe actuarial present value of future benefit obligations:\nThe primary actuarial assumptions used in determining the above benefit obligation amounts were established on the September 30, 1994 and 1993 measurement dates and include a discount rate of 7.5% per annum on valuing liabilities; long-term expected rate of return on assets of 9% per annum; salary increases of 5% per annum for salaried employees; and an inflation rate of 5% per annum.\nIn addition, the Company recognized expenses of $50,000 in each of fiscal 1994, 1993, and 1992 in connection with a defined contribution plan to which non-bargaining employees contribute and the Company makes matching contributions based on employees contribution.\n12. MAJOR CUSTOMERS:\nNo single customer accounts for 10% or more of the total sales for the years ended September 30, 1994, 1993, and 1992.\n13. RELATED PARTY TRANSACTIONS:\nSERVICE AGREEMENT WITH RELATED PARTIES\nThe Company and related parties controlled by a stockholder entered into a Service Agreement dated September 5, 1986 (the Service Agreement), pursuant to which the related parties provide certain assistance and services (research and development, industrial and labor relations, engineering, legal, etc.) to the Company for a fee. Costs charged for these services were approximately $64,000 for the year ended September 30, 1994, $87,000 for the year ended September 30, 1993, and $107,000 for the year ended September 30, 1992. The Service Agreement was terminated as of September 30, 1994.\nBAYOU STEEL CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(CONTINUED)\nOTHER AGREEMENTS WITH STOCKHOLDERS\nThe Company entered into an agreement on May 28, 1987 with a stockholder to provide certain investment banking services to the Company on a competitive, first refusal basis until September 4, 1996. Although services were provided, no obligations were incurred in fiscal years 1994 and 1993.\n14. COMMON STOCK:\nIncome per common share is based on the average number of common shares outstanding of 12,884,607 for the years ended September 30, 1994, 1993, and 1992, respectively. There was no impact on income per share as a result of the stock options granted in September, 1994 (see Note 10).\nOther than for voting rights, all classes of Common Stock have similar rights. With respect to voting rights, Class B Common Stock has 60% and Class A and Class C Common Stock have 40% of the votes except for special voting rights for Class B and Class C Common Stock on liquidation and certain mergers (see Note 8). The Company's ability to pay dividends is subject to restrictive covenants under both the Indenture pursuant to which the Company's 10.25% Notes were issued and the Company's line of credit (see Notes 6 and 7).\n15. MISCELLANEOUS:\nMiscellaneous income\/(expense) as of September 30, 1994, 1993, and 1992 included the following:\n16. QUARTERLY FINANCIAL DATA (UNAUDITED):\nBAYOU STEEL CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(CONTINUED)\n* Amount has been restated to conform with the 3rd and 4th quarter's 10-Q presentation of strike-related expenses.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Bayou Steel Corporation:\nWe have audited the accompanying balance sheets of Bayou Steel Corporation (a Delaware corporation) as of September 30, 1994 and 1993, and the related statements of operations, cash flows, and changes in equity for the years ended September 30, 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 auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 Bayou Steel Corporation as of September 30, 1994 and 1993 and the results of its operations and its cash flows for the years ended September 30, 1994, 1993, and 1992 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nNew Orleans, Louisiana November 18, 1994\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\nInformation regarding Directors and Executive Officers is incorporated by reference to the \"Directors\" section of the Company's Proxy Statement for the 1995 Annual Meeting of Shareholders.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding executive compensation is incorporated by reference to the \"Executive Compensation\" section of the Company's Proxy Statement for the 1995 Annual Meeting of Shareholders.\nITEM 12.","section_12":"ITEM 12. OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity Ownership of Certain Beneficial Owners\nThe beneficial ownership of the Company's Common Stock as of October 31, 1994, by persons, other than directors and officers, known to the Company to be beneficial owners of more than 5% of the outstanding Common Stock is incorporated by reference to the \"Voting Securities and Security Ownership\" section of the Company's Proxy Statement for the 1995 Annual Meeting of Shareholders.\nSecurity Ownership of Management and Directors\nThe beneficial ownership of the Company's Common Stock of all Directors and Officers is incorporated by reference to the \"Board of Directors\" section of the Company's Proxy Statement for the 1995 Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAdditional information regarding certain relationships and related transactions is incorporated by reference to the \"Agreement Concerning Change in Control\" and \"Service Agreement\" and \"Agreements with Allen & Company Incorporated\" and \"Agreements with MMG Patricof & Co.\" sections of the Company's Proxy Statement for the 1995 Annual Meeting of Shareholders and to the \"Notes to Financial Statements\" section of the 1994 Annual Report.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nSchedules not listed above are omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements submitted.\n(B) REPORTS ON FORM 8-K\nNo reports on Form 8-K were required to be filed by the Registrant during the year ended September 30, 1994.\nLIST OF EXHIBITS\nNUMBER EXHIBIT - - ------ -------\n3.1 Second Restated Certificate of Incorporation of the Company (incorporated by reference herein to Post-Effective Amendment No. 1 to Registration Statement on Form S-1 (No. 33-10745)).\n3.2 By-laws of the Company (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-10745)).\n4.1 Specimen Certificate for Class A Common Stock (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-10745)).\n4.1A Form of Indenture (including form of First Mortgage Note) between the Company and First National Bank of Commerce as trustee (the \"Trustee\") (incorporated herein by reference to Amendment No. 4 to Registration Statement on Form S-1 (No 33-72-486)).\n4.2 Form of Mortgage granted by the Company and Subsidiary Guarantors to the Trustee (Louisiana) (incorporated herein by reference to Amendment No. 1 to Registration Statement on Form S-1 (No. 33-72486)).\n4.3 Form of Mortgage, Assignment of Rents and Leases and Security Agreement from the Company to the Trustee (Non-Louisiana) (incorporated herein by reference to Amendment No. 1 to Registration Statement on Form S-1 (No. 33-72486)).\n4.4 Form of Mortgage, Assignment of Rents and Leases and Security Agreement from Subsidiary Guarantors to the Trustee (Non-Louisiana) (incorporated herein by reference to Amendment No. 1 to this Registration Statement on Form S-1 (No. 33-72486)).\n4.5 Form of Security Agreement between the Company and the Trustee (incorporated herein by reference to Amendment No. 1 to Registration Statement on Form S-1 (No 33-72486)).\n4.6 Form of Subsidiary Security Agreement between Subsidiary Guarantors and the Trustee (incorporated herein by reference to Amendment No. 1 to Registration Statement on Form S-1 (No. 33-72486)).\n4.7 Form of Intercreditor Agreement between the Trustee and Chemical Bank, as agent under the Credit Agreement (incorporated herein by reference to Amendment No. 1 to Registration Statement on Form S-1 (No. 33-72486)).\n4.8 Form of Subsidiary Guarantee between each recourse subsidiary of the Company and the Trustee (incorporated herein by reference to Amendment No. 1 to Registration Statement on Form S-1 (No 33-72486)).\n4.9 Form of Release of Federal Income Tax Ownership and Agreement between the Trustee and the Company, Voest-Alpine A.G. and Howard M. Meyers (incorporated by reference to Amendment No. 1 to Registration Statement on Form S-1 (No. 33-72486)).\n4.21 Stock Purchase Agreement dated August 28, 1986, between BSAC and the purchasers of the Company's Class A Common Stock and Preferred Stock (incorporated herein by reference to Post-Effective Amendment No. 1 to Registration Statement on Form S-1 (No. 33-10745)).\n4.22 Stock Purchase Agreement dated August 28, 1986, between BSAC and RSR, the sole purchaser of the Company's Class B Common Stock (incorporate herein by reference to Registration Statement on Form S-1 (No. 33-22603)).\n4.23 Stock Purchase Agreement dated August 28, 1986, between BSAC and Allen & Company, Incorporated (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-22603)).\n4.24 Agreement between the Company and the holders of Preferred Stock dated as of July 26, 1988 (incorporated herein by reference to Post-Effective Amendment No. 1 to Registration Statement on Form S-1 (No. 33-10745)).\n10.1 Employment Letter dated July 26, 1988, between Howard M. Meyers and the Company (incorporated herein by reference to Post-Effective Amendment No. 1 to Registration Statement on Form S-1 (No. 33-10745)).\n10.2 (i) Agreement dated November 11, 1981, between Amoco Tax Leasing I Corporation (\"Amoco\") and the Company, (ii) letter dated December 7, 1981 from Voest-Alpine A.G. (\"VA\") and Voest-Alpine International Corporation (\"VAIC\") to Amoco, and (iii) letter dated November 11, 1981 from VAIC, Honen Investissements SARL, Barzel Investissements SARL, Anku Foundation, Raphaely Steel Investments, N.V., Landotal Properties, Inc., Canota Investments, Ltd., S.A. and Beruga Establishment and VA to Amoco (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-10745)).\nNUMBER EXHIBIT - - ------ -------\n10.4 Service Agreement dated September 5, 1986, between the Company and RSR Corporation and the assignment by RSR Corporation of a portion of its interest in the Service Agreement to RSR Holding Corp., now known as Quexco Incorporated (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-10745)).\n10.5 Letter Agreement dated May 28, 1987 between the Company and Allen & Company Incorporated relating to investment banking services (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-10745)).\n10.6 Agreement dated June 20, 1991 among the Company, MMG Patricof & Co., Inc., and MMG Placement Corp. relating to investment banking services (incorporated herein by reference to Post-Effective Amendment No. 4 to Registration Statement on Form S-1 (No. 33-10745)).\n10.8 Warehouse (Stocking Location) Leases. (i) Leetsdale, Pennsylvania (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-10745)). (ii) Catoosa, Oklahoma (incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989).\n10.9 Tax Abatement Agreement dated July 10, 1985 between the Company and the Louisiana Board of Commerce and Industry (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-22603)).\n10.10 Tax Abatement Renewal Agreement dated August 22, 1990 between the Company and the State of Louisiana Board of Commerce and Industry (incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1989).\n10.11 Credit Agreement dated as of June 28, 1989, as amended and restated through November 23, 1993, among the Company, the Lenders named therein, and Chemical Bank, as agent (the \"Credit Agreement\") (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-72486)).\n10.12 Security Agreement dated as of June 28, 1989, as amended and restated through November 23, 1993, among the Company, the Lenders named in the Credit Agreement, and Chemical Bank, as agent (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-72486)).\n10.13 Intercreditor Agreement dated as of November 23, 1993 between First National Bank of Commerce and Chemical Bank as agent under the Credit Agreement (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-72486)).\n10.15 First Amendment dated as of November 22, 1993 to the Loan Agreement dated as of January 9, 1991 between the Company and Hibernia National Bank (incorporated herein by reference to Registration Statement on Form S-1 (No. 72486)).\n10.17 First Amendment dated as of November 22, 1993 to Mortgage, Security Agreement and Financing Statement dated as of January 9, 1991 by the Company in favor of Hibernia National Bank (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-72486)).\n10.18 Intercreditor Agreement dated as of November 23, 1993 between Chemical Bank and Hibernia National Bank (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-72486)).\n10.19 Security Agreement dated as of November 22, 1993 between the Company and Hibernia National Bank (incorporated herein by reference to Registration Statement on Form S-1 (No. 33-72486)).\n10.21 Incentive Compensation Plan for Key Employees dated March 3, 1988 (incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended September 30, 1991).\n10.22 1991 Employees' Stock Option Plan dated April 18, 1991 with technical amendments (incorporated herein by reference to Post-Effective Amendment No. 4 to Registration Statement on Form S-1 (No. 33-10745)).\n10.23 Pension Plan for Bargained Employees and the Employees Retirement Plan (incorporated herein by reference to Post-Effective Amendment No. 5 to the Company's Registration Statement on Form S-1 (No. 33-10745)).\n10.24 Amendment among the Company, Bayou Scrap Corporation River Road Realty Corporation, the Lenders named in the Credit Agreement and Chemical Bank, as agent (incorporated herein by reference to Amendment No. 4 to Registration Statement on Form S-1 (No. 33-72486)).\nNUMBER EXHIBIT - - ------ -------\n18.1 Letter from Arthur Andersen & Co. regarding change in accounting method from first-in, first-out (FIFO) to last-in, first-out (LIFO) method of accounting for inventories (incorporated herein by reference to the Annual Report on Form 10-K for the year ended September 30, 1989).\n18.2 Letter from Arthur Andersen & Co. regarding change in method of accounting for interest from the effective interest method to another acceptable method (incorporated herein by reference to the Annual Report on Form 10-K for the year ended September 30, 1990).\n27.0 Financial Data Schedule filed herewith.\nSCHEDULE V--PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993, AND 1992\nSCHEDULE VI--ACCUMULATED DEPRECIATION\nFOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993, AND 1992\nSCHEDULE VIII VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993, AND 1992\n- - ---------- (1) Write-off of uncollectible accounts.\nSCHEDULE X--SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993, AND 1992\n- - -------- (1) Represents amortization of costs associated with the issuance of the Senior Secured Notes entered into on September 5, 1986 and the line of credit entered into on June 28, 1989.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Bayou Steel Corporation\nWe have audited, in accordance with generally accepted auditing standards, the financial statements included in Bayou Steel Corporation's annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated November 18, 1994. 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 above 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 LLP\nNew Orleans, Louisiana November 18, 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.\nBayou Steel Corporation\nBy \/s\/ Howard M. Meyers -------------------------- Howard M. Meyers Chairman of the Board and Chief Executive Officer\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 on the date indicated.","section_15":""}
{"filename":"92195_1994.txt","cik":"92195","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nSouthern Indiana Gas and Electric Company (Company) is an operating public utility incorporated June 10, 1912, under the laws of the State of Indiana, engaged in the generation, transmission, distribution and sale of electric energy and the purchase of natural gas and its transportation, distribution and sale in a service area which covers ten counties in southwestern Indiana. The Company has three active wholly-owned nonutility subsidiaries, Southern Indiana Properties, Inc., Southern Indiana Minerals, Inc., and Energy Systems Group, Inc., and one wholly-owned utility subsidiary, Lincoln Natural Gas Company, Inc. (See Note 1 (a) of the Notes To Consolidated Financial Statements, page 31, for further discussion.)\nElectric service is supplied directly to Evansville and 74 other cities, towns and communities, and adjacent rural areas. Wholesale electric service is supplied to an additional nine communities. At December 31, 1994, the Company served 118,992 electric customers and was also obligated to provide for firm power commitments to the City of Jasper, Indiana and to maintain spinning reserve margin requirements under an agreement with the East Central Area Reliability Group (ECAR).\nAt December 31, 1994, the Company supplied gas service to 102,929 customers in Evansville and 64 other nearby communities and their environs. Since 1986, the Company has purchased its natural gas supply requirements from numerous suppliers. During 1994, twenty-one suppliers were used. Until November 1993, Texas Gas Transmission Corporation (TGTC) was the Company's primary contract supplier. In November 1993, TGTC restructured its services so that its gas supplies are sold separately from its interstate transportation services. The Company assumed full responsibility for the purchase of all its natural gas supplies. (See subsequent reference under \"Gas Business\" to the restructuring of interstate pipelines.) During 1994, twenty-two of the Company's major gas customers took advantage of the Company's gas transportation program to procure a portion of their gas supply needs from suppliers other than the Company.\nThe principal industries served by the Company include polycarbonate resin (Lexan) and plastic products, aluminum smelting and recycling, aluminum sheet products, appliance manufacturing, pharmaceutical and nutritional products, automotive glass, gasoline and oil products, and coal mining.\nThe only property the Company owns outside of Indiana is approximately eight miles of 138,000 volt electric transmission line which is located in Kentucky and which interconnects with Louisville Gas and Electric Company's transmission system at Cloverport, Kentucky. The original cost of the property is less than $425,000. The Company does not distribute any electric energy in Kentucky.\nLINES OF BUSINESS\nThe percentages of operating revenues and operating income before income taxes attributable to the electric and gas operations of the Company for the five years ended December 31, 1994, were as follows:\nReference is made to Note 12 of the Notes To Consolidated Financial Statements, page 41, for Segments of Business Data.\nELECTRIC BUSINESS\nThe Company supplies electric service to 118,996 customers, including 104,049 residential, 14,741 commercial, 179 industrial, 23 public street and highway lighting and four municipal customers.\nThe Company's installed generating capacity as of December 31, 1994 was rated at 1,238,000 kilowatts (Kw). Coal-fired generating units provide 1,023,000 Kw of capacity and gas or oil-fired turbines used for peaking or emergency conditions provide 215,000 Kw.\nIn addition, the Company has interconnections with Louisville Gas and Electric Company, CINergy Services, Inc., Indianapolis Power & Light Company, Hoosier Energy Rural Electric Cooperative, Inc., Big Rivers Electric Corporation, Wabash Valley Power Association, and the City of Jasper, providing an ability to simultaneously interchange approximately 750,000 Kw.\nRecord-breaking peak conditions occurred on July 28, 1993, when the Company's system summer peak load reached 1,012,700 Kw . The 1993 peak was 2.2% greater than the 1994 system summer peak load of 990,800 Kw (the second highest summer peak in Company history) established July 20, 1994. The Company's total load obligation for each of the years 1990 through 1994 at the time of the system summer peak, and the related capacity margin, are presented below. The Company's other load obligations at the time of the peak included firm power commitments to the City of Jasper, Indiana and the Company's reserve margin requirements under the ECAR agreement.\nThe all-time record system winter peak load of 772,000 Kw occurred during the 1993-1994 season on January 19, 1994, and was slightly greater than the previous record winter season system peak reached on December 22, 1989 of 771,900 Kw.\nThe Company, primarily as agent of Alcoa Generating Corporation (AGC), operates the Warrick Generating Station, a coal-fired steam electric plant which interconnects with the Company's system and provides power for the Aluminum Company of America's Warrick Operations, which includes aluminum smelting and fabricating facilities. Of the four turbine generators at the plant, Warrick Units 1, 2 and 3, with a capacity of 144,000 Kw each, are owned by AGC. Warrick Unit 4, with a rated capacity of 270,000 Kw, is owned by the Company and AGC as tenants in common, each having shared equally in the cost of construction and sharing equally in the cost of operation and in the output.\nThe Company (a summer peaking utility) has an agreement with Hoosier Energy Rural Electric Cooperative, Inc. (Hoosier Energy) for the sale of firm peaking power to Hoosier Energy during the annual winter heating season (November 15-March 15). The contract made available 100 Mw during the 1994-1995 winter season, and allows for a possible increase to 250 Mw by November 15, 1998. The contract will terminate March 15, 2000.\nElectric generation for 1994 was fueled by coal (99.5%) and natural gas (0.5%). Oil was used only to light fires and stabilize flames in the coal-fired boilers and for testing of gas\/oil fired peaking units.\nHistorically, coal for the Company's Culley Generating Station and Warrick Unit 4 has been purchased from operators of nearby Indiana strip mines pursuant to long-term contracts. During 1991, the Company pursued negotiations for new contracts with these mine operators and while doing so, purchased coal from the respective operators under interim\nagreements. In October 1992, the Company finalized a new supply agreement effective through 1995 and retroactive to 1991, with one of the operators under which coal is supplied to both locations. Included in the agreement was a provision whereby the contract could be reopened by the Company for modification of certain coal specifications. In early 1993, the Company reopened the contract for such modifications. Effective July 1, 1993, the Company bought out the remainder of its contractual obligations with the supplier, enabling the Company to acquire lower priced spot market coal. The Company estimates the savings in coal costs during the 1991-1995 period, net of the total buy out costs, will approximate $58 million. The net savings are being passed back to the Company's electric customers through the fuel adjustment clause. The coal supplier retained the right of first refusal to supply Warrick Unit 4 and the Culley plant during the years 1996-2000. (See \"Rate and Regulatory Matters\" of Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION, page 16, for further discussion of the contract buy out.) The Indiana coal used in these plants is blended by the vendor and delivered to the plants to meet specifications set in conformance with the requirements of the Indiana State Implementation Plan for sulfur dioxide issued under Federal laws regulating air quality (Clean Air Act). Approximately 1,372,000 tons of coal were used during 1994 in the generation of electricity at the Culley Station and Warrick Unit 4. Culley Units 2 and 3 were recently equipped with flue gas desulfurization equipment as part of the Company's Clean Air Act Compliance Plan. (See \"Environmental Matters\", page 7, for further discussion.) For supplying the A. B. Brown Generating Station, the Company has a contested agreement, possibly extending to 1998, with an area producer. (See Item 3, LEGAL PROCEEDINGS, page 10, for discussion of litigation with this producer regarding the coal supply agreement.) The amount of coal burned at A. B. Brown Generating Station during 1994 was approximately 1,160,000 tons. Both units at the generating station are equipped with flue gas desulfurization equipment so that coal with a higher sulfur content can be used. There are substantial coal reserves in the southern Indiana area. The average cost of coal consumed in generating electrical energy for the years 1990 through 1994 was as follows:\nThe Broadway Turbine Units 1 and 2, Northeast Gas Turbines and A. B. Brown Gas Turbine, when used for peaking, reserve or emergency purposes, use natural gas for fuel. Number 2 fuel oil can also be used in the Broadway Turbine Units and the Brown Gas Turbine.\nAll metered electric rates contain a provision for adjustment in charges for electric energy to reflect changes in the cost of fuel and the net energy cost of purchased power through the operation of a fuel adjustment clause unless certain criteria contained in the regulations are not met. The principal restriction to recovery of fuel cost increases is that such recovery is not allowed to the extent that operating income for the twelve month period provided in the fuel cost adjustment filing exceeds the operating income authorized by the Indiana Utility Regulatory Commission (IURC) in the latest general rate case of the Company. During 1992-1994, this restriction did not affect the Company. As prescribed by order of the IURC, the adjustment factor is calculated based on the estimated cost of fuel and the net energy cost of purchased power in a designated future quarter. The order also provides that any over- or underrecovery caused by variances between estimated and actual cost in a given quarter will be included in the second succeeding quarter's adjustment factor. This continuous reconciliation of estimated incremental fuel costs billed with actual incremental fuel costs incurred closely matches revenues to expenses.\n(See \"Rate and Regulatory Matters\" in Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION, page 16, for discussion of the Company's general adjustments in electric rates.) The Company participates in research and development in which the primary goal is cost savings through the use of new technologies. This is accomplished, in part, through the efforts of the Electric Power Research Institute (EPRI). In 1994,\nthe Company paid $829,000 to EPRI to help fund research and development programs such as advanced clean coal burning technology.\nThe Company is participating with 14 other electric utility companies through Ohio Valley Electric Corporation (OVEC) in arrangements with the United States Department of Energy (DOE), to supply the power requirements of the DOE plant near Portsmouth, Ohio. The sponsoring companies are entitled to receive from OVEC, and are obligated to pay for the right to receive, any available power in excess of the DOE contract demand. The proceeds from the sale of power by OVEC are designed to be sufficient to meet all of its costs and to provide for a return on its common stock. During 1994, the Company's participation in the OVEC arrangements was 1.5%.\nThe Company participates with 32 other utilities and other affiliated groups located in eight states comprising the east central area of the United States, in the East Central Area Reliability group, the purpose of which is to strengthen the area's electric power supply reliability.\nGAS BUSINESS\nThe Company supplies natural gas service to 102,929 customers, including 93,719 residential, 8,980 commercial, 226 industrial and four public authority customers, through 2,644 miles of gas transmission and distribution lines.\nThe Company owns and operates three underground gas storage fields with an estimated ready delivery from storage of 3.9 million Dth of gas. Natural gas purchased from the Company's suppliers is injected into these storage fields during periods of light demand which are typically periods of lower prices. The injected gas is then available to supplement the contracted volumes during periods of peak requirements. It is estimated that approximately 119,000 Dth of gas per day can be withdrawn from the three storage fields during peak demand periods on the system.\nThe gas procurement practices of the Company and several of its major customers have been altered significantly during the past eight years as a result of changes in the natural gas industry. In 1985 and prior years, the Company purchased nearly its entire gas requirements from Texas Gas Transmission Corporation (TGTC) compared to 1994 when a total of 24 suppliers sold gas to the Company. In total, the Company purchased 15,554,557 Dth in 1994. In November 1993, TGTC restructured its services so that its gas supplies are sold separately from its interstate transportation services. The Company assumed full responsibility for the purchase of all its natural gas supplies. (See subsequent reference under \"Gas Business\" to the restructuring of interstate pipelines.)\nDuring 1994, twenty-two of the Company's major gas customers took advantage of the Company's gas transportation program to procure a portion of their gas supply needs from suppliers other than the Company. A total of 11,584,538 Dth was transported for these major customers in 1994 compared to 11,370,542 Dth transported in 1993. The Company received fees for the use of its facilities in transporting such gas, allowing it to offset a portion of the loss of its customary sales margin with respect to these customers.\n(See \"Rate and Regulatory Matters\" in Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION, page 16, for discussion of the Company's general adjustment in gas rates and for discussion of the FERC Order No. 636 which requires interstate pipelines to restructure their services so that gas supplies will be sold separately from interstate transportation services.)\nThe all-time record send out occurred during the 1989- 1990 winter season on December 22, 1989, when 223,489 Dth of gas were delivered to the Company's customers. Of this amount, 89,614 Dth was purchased, 104,358 Dth was taken out of the Company's three underground storage fields, and 29,517 Dth was transported to customers under transportation agreements. The 1993-1994 winter season peak day send out was 189,717 Dth on February 17, 1993.\nThe average cost per Dth of gas purchased by the Company during the past five calendar years was as follows: 1990, $2.84; 1991, $2.71; 1992, $2.77; 1993, $2.85; and 1994, $2.54.\nThe State of Indiana has established procedures which result in the Company passing on to its customers the changes in the cost of gas sold unless certain criteria contained in the regulations are not met. The principal restriction to recovery of\ngas cost increases is that such recovery is not allowed to the extent that operating income for the twelve month period provided the gas cost adjustment filing exceeds the operating income authorized by the IURC in the latest general rate case of the Company. During 1992-1994, this restriction did not affect the Company. Additionally, these procedures provide for scheduled quarterly filings and IURC hearings to establish the amount of price adjustments for a designated future quarter. The procedures also provide for inclusion in a later quarter of any variances between estimated and actual costs of gas sold in a given quarter. This reconciliation process with regard to changes in the cost of gas sold closely matches revenues to expenses. The Company's rate structure does not include a weather normalization-type clause whereby a utility would be authorized to recover the gross margin on sales established in its last general rate case, regardless of actual weather patterns.\nNatural gas research is supported by the Company through the Gas Research Institute in cooperation with the American Gas Association. Since passage of the Natural Gas Act of 1978, a major effort has gone into promoting gas exploration by both conventional and unconventional sources. Efforts continue through various projects to extract gas from tight gas sands, shale and coal. Research is also directed toward the areas of conservation, safety and the environment.\nOn December 23, 1993, the Company entered into a definitive agreement to acquire Lincoln Natural Gas Company, Inc. (LNG), a small gas distribution company serving approximately 1,300 customers contiguous to the eastern boundary of the Company's gas service territory. On June 30, 1994, the Company completed its acquisition of LNG after receiving the necessary regulatory and shareholder approvals. The applicable financial data in this filing has been restated to reflect this acquisition, except where noted. (See Note 1, of the Notes to Consolidated Financial Statements, page 31, for further discussion of this acquisition.)\nNONUTILITY SUBSIDIARIES\nIn addition to its wholly-owned utility subsidiary, LNG, the Company has three active wholly-owned nonutility subsidiaries. Southern Indiana Properties, Inc., formed in 1986, invests principally in partnerships (primarily real estate), leveraged leases and marketable securities. Energy Systems Group, Inc., incorporated in April 1994, provides equipment and related design services to industrial and commercial customers. Southern Indiana Minerals, Inc., incorporated in May 1994, processes and markets coal combustion by-products. (See Note 1 of the Notes to Consolidated Financial Statements, page 31, for further discussion.)\nPERSONNEL\nThe Company's network of gas and electric operations directly involves 780 employees with an additional 182 employed at Alcoa's Warrick Power Plant. Alcoa reimburses the Company for the entire cost of the payroll and associated benefits at the Warrick Plant, with the exception of one-half of the payroll costs and benefits allocated to Warrick Unit 4, which is jointly owned by the Company and Alcoa. The total payroll and benefits for Company employees in 1994 (including all Warrick Plant employees) were $47.5 million, including $5 million of accrued postretirement benefits other than pensions which the Company is deferring as a regulatory asset until inclusion in rates. (See Note 1 of the Notes To Consolidated Financial Statements, pages 31- 36, for further discussion of the new financial accounting standard requiring recognition of these costs effective January 1, 1993 and related regulatory treatment.) In 1993, total payroll and benefits were $46.1 million.\nOn July 1, 1994, the Company signed a new four-year contract with Local 702 of the International Brotherhood of Electrical Workers. The contract provides for annual wage increases of 3.5%, 3.5%, 3.75% and 4.0%. Improvements in productivity, work practices and the pension plan are also included, along with initiatives to increase labor\/management cooperation. Additionally, the Company's Hoosier Division signed a five-year labor contract with Local 135 of the Teamsters, Chauffeurs, Warehousemen and Helpers. The contract provides for annual wage increases of 3.5%, 3.5%, 3.75%, 4.0% and 4.0%. Also included are improvements in health care coverage costs and pension benefits.\nCONSTRUCTION PROGRAM AND FINANCING\nA total of $84,751,000 was spent in 1994 on the Company's construction program, of which $65,949,000 was for the electric system, $9,315,000 for the gas system, $5,368,000 for common utility plant facilities, and $4,119,000 for the Demand Side Management (DSM) Program. (See \"Demand Side Management\" in Item 7, MANAGEMENT'S DISCUSSION AND\nANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, page 21.) Major construction project expenditures in 1994 included $36.4 million to substantially complete the estimated $103 million (including Allowance for Funds It Used During Construction) Culley Unit 2 and 3 scrubber project. (See \"Clean Air Act\" in Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, page 20.) The Culley scrubber project was completed and declared commercially in service on February 1, 1995.\nOther than an $11 million increase in short-term debt, no financing activity occurred during 1994.\nFor 1995, construction expenditures are presently estimated to be $40.3 million which includes $6.8 million for DSM programs. Expenditures in the power production area are expected to total $8.4 million. The balance of the 1995 construction program consists of $14.3 million for additions and improvements to other electric system facilities, $7.9 million of additions and improvements to the gas system and $2.9 million for miscellaneous common utility plant buildings, fixtures and equipment.\nIn keeping with the Company's objective to bring new facilities on line as needed, the construction program and amount of scheduled expenditures are reviewed periodically to factor in load growth projections, system planning requirements, environmental compliance and other considerations. As a result of this program of periodic review, construction expenditures may change in the future from the program as presented herein.\nCurrently it is estimated that construction expenditures will total about $230 million for the years 1995-1999 as follows: 1995 - $40 million; 1996 - $49 million; 1997 - $58 million; 1998 - $44 million; and 1999 - $39 million. This construction program reflects approximately $47 million for the Company's DSM programs; however, as discussed in \"Demand Side Management\" of Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION, page 21, the anticipated changes in the electric industry may require changes to the level of future DSM expenditures. While the Company expects the majority of the construction requirements and an estimated $90 million of required debt redemptions to be provided by internally generated funds, external financing requirements of $55-70 million are anticipated.\nThe aforementioned amounts relating to the Company's construction program are in all cases inclusive of Allowance for Funds Used During Construction.\nREGULATION\nOperating as a public utility under the laws of Indiana, the Company is subject to regulation by the Indiana Utility Regulatory Commission as to its rates, services, accounts, depreciation, issuance of securities, acquisitions and sale of utility properties or securities, and in other respects as provided by the laws of Indiana.\nIn addition, the Company is subject to regulation by the Federal Energy Regulatory Commission with respect to the classification of accounts, rates for its sales for resale, interconnection agreements with other utilities, and acquisitions and sale of certain utility properties as provided by the laws of the United States.\nSee \"Electric Business\" and \"Gas Business\" for further discussion regarding regulatory matters.\nThe Company is subject to regulations issued pursuant to federal and state laws, pertaining to air and water pollution control. The economic impact of compliance with these laws and regulations is substantial, as discussed in detail under \"Environmental Matters.\" The Company is also subject to multiple regulations issued by both federal and state commissions under the Federal Public Utility Regulatory Policies Act of 1978.\nAs a result of the Company's ownership of LNG and 33% of Community Natural Gas Company, the Company is a \"Holding Company\" as such term is defined under the Public Utility Holding Company Act of 1935 (the 1935 Act). The Company is exempt from all provisions of the 1935 Act except for the provisions of Section 9(A)(2), which pertains to acquisitions of other utilities.\nOn December 20, 1994, the Company's Board of Directors authorized the steps required for a corporate reorganization\nin which a holding company would become the parent of the Company. (See \"Holding Company\" of Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION, page 18, for further discussion of the proposed reorganization.)\nCOMPETITION\nThe Company does not presently compete for retail electric or gas customers with the other utilities within its assigned service areas. As a result of changes brought about by the National Energy Policy Act of 1992, the Company may be required to compete (or have the opportunity to compete) with other utilities and wholesale generators for sales of electricity to existing wholesale customers of the Company and other potential wholesale customers. (See subsequent reference to discussion of this recent legislation.) The Company currently competes with other utilities in connection with intersystem bulk power rates.\nSome of the Company's customers have, or in the future could acquire, access to energy sources other than those available through the Company. (See \"Gas Business\", page 4, for discussion of gas transportation.) Although federal statute allows for bypass of a local distribution (gas utility) company, Indiana law disallows bypass in most cases and the Company would likely litigate such an attempt in the Indiana courts. Additionally, the Company's geographical location in the corner of the state, surrounded on two sides by rivers, limits customers' ability to bypass the Company. There is also increasing interest in research on the development of sources of energy other than those in general use. Such competition from other energy sources has not been a material factor to the Company in the past. The Company is unable, however, to predict the extent of competition in the future or its potential effect on the Company's operations.\nAs part of its efforts to develop a National Energy Strategy, Congress has amended the Public Utility Holding Company Act and the Federal Power Act by enacting the National Energy Policy Act of 1992 (the Act), which will affect the traditional structure of the electric utility industry. (Refer to \"National Energy Policy Act of 1992\" in Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION, page 19, for discussion of the major changes in the electric industry effected by the Act.)\nENVIRONMENTAL MATTERS\nThe Company is currently investigating the possible existence of facilities once owned and operated by the Company, its predecessors, previous landowners, or former affiliates of the Company utilized for the manufacture of gas. Refer to \"Environmental Matters\" in Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION, page 19 , for discussion of the Company's actions regarding the investigation.\nThe Company is subject to federal, state and local regulations with respect to environmental matters, principally air, solid waste and water quality. Pursuant to environmental regulations, the Company is required to obtain operating permits for the electric generating plants which it owns or operates and construction permits for any new plants which it might propose to build. Regulations concerning air quality establish standards with respect to both ambient air quality and emissions from the Company's facilities, including particulate matter, sulfur dioxide and nitrogen oxides. Regulations concerning water quality establish standards relating to intake and discharge of water from the Company's facilities, including water used for cooling purposes in electric generating facilities. Because of the scope and complexity of these regulations, the Company is unable to predict the ultimate effect of such regulations on its future operations, nor is it possible to predict what other regulations may be adopted in the future. The Company intends to comply with all applicable valid governmental regulations, but will contest any regulation it deems to be unreasonable or impossible to comply with or which is otherwise invalid.\nThe implementation of federal and state regulations designed to protect the environment, including those hereinafter referred to, involves or may involve review, certification or issuance of permits by federal and state agencies. Compliance with such regulations may limit or prevent certain operations or substantially increase the cost of operation of existing and future generating installations, as well as seriously delay or increase the cost of future construction. Such compliance may also require substantial investments above those amounts stated under \"Construction Program and Financing\", page 5.\nAll existing Company electric generation facilities have operating permits from the Indiana Air Board or other agencies having jurisdiction. In order to secure approval for these permits, the Company has installed electrostatic precipitators on all coal-fired units and is operating flue gas desulfurization (FGD) units to remove sulfur dioxide from the flue gas at its A. B. Brown\nUnits 1 and 2 generating facilities. The FGD units at the Brown Station remove most of the sulfur dioxide from the flue gas emissions by way of a scrubbing process, thereby allowing the Company to burn high sulfur southern Indiana coal at the station.\nIn October 1990, the U.S. Congress adopted major revisions to the Federal Clean Air Act. The revisions impose significant restrictions on future emissions of sulfur dioxide (SO2) and nitrogen oxide (NOX) from coal- burning electric generating facilities, including those owned and operated by the Company. The legislation severely affects electric utilities, especially those in the Midwest. Two of the Company's principal coal-fired facilities (A. B. Brown Units 1 and 2, totaling 500 megawatts of capacity) are presently equipped with sulfur dioxide removal equipment (scrubbers) and were not severely affected by the new legislation. However, 523 megawatts of the Company's coal- fired generating capacity were significantly impacted by the lower emission requirements. The Company was required to reduce total emissions from Culley Unit 3 (250 megawatts), Warrick Unit 4 (135 megawatts) and Culley Unit 2 (92 megawatts) by approximately 50% to 2.5 lb\/MMBTU by January 1995 (Phase I) and to 1.2 lb\/MMBTU by January 2000 (Phase II). The Company met the Phase I emission requirements by January 1995 with the implemention of its Clean Air Act Compliance Plan which includes equipping Culley Units 2 and 3 with a sulfur dioxide scrubber, among other provisions. Unit 1 at Culley Station (46 megawatts) is also subject to the 1.2 lb\/MMBTU restriction by January 2000. The legislation included various incentives to promote the installation of scrubbers on units affected by the 1995 deadline. Current regulatory policy allows for the recovery through rates of all authorized and approved pollution control expenditures.\n(Refer to \"Clean Air Act\" in Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION, page 20, for discussion of the Company's Clean Air Act Compliance Plan, which was filed with the IURC on January 3, 1992 and approved October 14, 1992, and the associated estimated costs. Refer also to \"Construction Program and Financing\", page 5, for further discussion of the Company's Culley scrubber project.)\nOn April 1, 1994 , the EPA (Region V) issued the Company a Notice of Violation regarding the exceedance of quarterly opacity limitations at the Company's Culley Generating Station for six quarterly periods during 1992- 1993. The Company met with the EPA in May 1994 to present the Company's voluntary opacity limitation compliance plan (Compliance Plan), which is designed to eliminate future exceedances, and which had already been implemented by the Company. The EPA has since contacted the Company and accepted the Compliance Plan. The EPA is developing an Agreed Order based on the accepted Compliance Plan and subsequent operational performance of the units. A civil penalty may be levied on the Company by the EPA, but the amount, if any, of such penalty is not known at this time.\nUnder the Federal Clean Air Act (the Act), states are authorized to adopt implementation plans to fulfill the requirements of the Act. The Indiana Department of Environmental Management (IDEM), which administers the Indiana State Implementation Plan, issued to the Company on October 11, 1994 a Notice of Violation (NOV) regarding exceedance of quarterly opacity limitations for the first quarter of 1994 at the Company's Culley Generating Station. The Company subsequently consented to an Agreed Order and a civil penalty of $30,000. As previously discussed, actions had already been taken by the Company to correct compliance deficiencies with the opacity limitations before the NOV was issued.\nIn connection with the use of sulfur dioxide removal equipment at the A. B. Brown Generating Station, the Company operates a solid waste landfill for the disposal of approximately 200,000 tons of residue per year from the scrubbing process. Renewal of the landfill operating permit was granted in March 1992 by the Indiana Department of Environmental Management (IDEM). The permit expires in January 1997. Additionally, IDEM granted the Company's request for modification (expansion) of the landfill, issuing the construction permit in March 1992.\nUnder the Federal Water Pollution Control Act of 1972 and Indiana law and regulations, the Company is required to obtain permits to discharge effluents from its existing generating stations into the navigable waterways of the United States. The State of Indiana has received authorization from the EPA to administer the Federal discharge permits program in Indiana. Variances from effluent limitations may be granted by permit on a plant-by- plant basis where the utility can establish the limitations are not necessary to assure the protection of aquatic life and wildlife in and on the body of water into which the discharge is to be made. The Company has been granted National Pollution Discharge Elimination System (NPDES) permits covering miscellaneous waste water and thermal discharges for all its generating facilities to which the NPDES is applicable, namely the Culley Station, A. B. Brown Station, Broadway Station (gas turbines) and Warrick Unit 4. Such discharge permits are limited in time and must be renewed at five-year intervals. During 1994, the Company submitted renewal applications for\nthese permits. The existing permits will remain in effect until action is taken by IDEM on the renewal applications. At present, there are no known enforcement proceedings concerning water quality pending or threatened against the Company.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company are elected at the annual organization meeting of the Board of Directors, held immediately after the annual meeting of stockholders, and serve until the next such organization meeting, unless the Board of Directors shall otherwise determine, or unless a resignation is submitted.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's installed generating capacity as of December 31, 1994 was rated at 1,238,000 Kw. The Company's coal-fired generating facilities are: the Brown Station with 500,000 Kw of capacity, located in Posey County about eight miles east of Mt. Vernon, Indiana; the Culley Station with 388,000 Kw of capacity, and Warrick Unit 4 with 135,000 Kw of capacity. Both the Culley and Warrick Stations are located in Warrick County near Yankeetown, Indiana. The Company's gas-fired turbine peaking units are: the 80,000 Kw Brown Gas Turbine located at the Brown Station; two Broadway Gas Turbines located in Evansville, Vanderburgh County, Indiana, with a combined capacity of 115,000 Kw; and, two Northeast Gas Turbines located northeast of Evansville in Vanderburgh County, Indiana with a combined capacity of 20,000 Kw. The Brown and Broadway turbines are also equipped to burn oil. Total capacity of the Company's five gas turbines is 215,000 Kw and are generally used only for reserve, peaking or emergency purposes due to the higher per unit cost of generation.\nThe Company's transmission system consists of 798 circuit miles of 138,000 and 69,000 volt lines. The transmission system also includes 26 substations with an installed capacity of 3,870,349 kilovolt amperes (Kva). The electric distribution system includes 3,175 pole miles of lower voltage overhead lines and 186 trench miles of conduit containing 1,046 miles of\nunderground distribution cable. The distribution system also includes 87 distribution substations with an installed capacity of 1,493,422 Kva and 45,644 distribution transformers with an installed capacity of 1,805,318 Kva.\nThe Company owns and operates three underground gas storage fields with an estimated ready delivery from storage capability of 3.9 million Dth of gas. The Oliver Field, in service since 1954, is located in Posey County, Indiana, about 13 miles west of Evansville. The Midway Field is located in Spencer County, Indiana, about 20 miles east of Evansville near Richland, Indiana, and was placed in service in December 1966. The third field is the Monroe City Field, located in Knox County, about 10 miles east of Vincennes, Indiana. The field was placed in service in 1958.\nThe Company's gas transmission system includes 324 miles of transmission mains, and the gas distribution system includes 2,320 miles of distribution mains.\nThe Company's properties, excluding those of its subsidiaries, are subject to the lien of the First Mortgage Indenture dated as of April 1, 1932 between the Company and Bankers Trust Company, New York, as Trustee, as supplemented by various supplemental indentures, all of which are exhibits to this report and collectively referred to as the \"Mortgage\".\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nOn January 27, 1993, a coal supplier filed a complaint in the Federal District Court for the Southern District of Indiana alleging that the Company breached a coal supply contract between the Company and that supplier. The Company had notified the supplier that it would not require any delivery of coal under the contract for at least some part of 1993. The supplier claims that this action violates certain minimum purchase requirements imposed by the contract, and asked the court to require specific performance of the contract by the Company and for unspecified monetary damages. The complaint alleges that the Company is obligated to purchase coal at a minimum rate of 50,000 tons per month under the contract and in any event to purchase all of the coal consumed at the Company's A. B. Brown generating plant below 1,000,000 tons per year. The contested contract may run until December 31, 1998. The Company filed counterclaims and disputes that its actions have violated the terms of the contract. On March 26, 1993, the Company and the coal supplier agreed to resume coal shipments but with the invoiced price per ton substantially lower than the contract price and subject to final outcome of the litigation. (Refer to \"Rate and Regulatory Matters\" in Item 7, MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION, page 16 of this report, for discussion of the pricing of this coal to inventory and the associated ratemaking treatment.) On June 6, 1993, the coal supplier won a summary judgement to require the Company to take a minimum of 600,000 tons annually, more or less in equal weekly shipments. The Company maintains that shipments from the supplier do not conform to the agreed upon coal specifications in the contract. This litigation came to trial conclusion based upon summary judgment motions in June 1994. The U. S. District Court found in favor of the Company regarding required coal quality specification and, in the earlier summary judgment, found in favor of the coal supplier regarding alleged minimum annual tonnage requirements. Damages of $1,442,000 were awarded to the coal supplier. Both parties have initiated appeal procedures and expect the case to be heard by the Court of Appeals in mid-1995 with a decision from that court later in 1995. The parties are also considering mediation. Since the litigation arose due to the Company's efforts to reduce fuel costs, management believes that any related costs should be recoverable through the regulatory ratemaking process.\nThere are no other pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the registrant is a party.\nNo material legal proceedings were terminated during the fourth quarter of 1994.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.\nNone\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS\nThe principal market on which the registrant's common stock (Common Stock) is traded is the New York Stock Exchange, Inc. where the Common Stock is listed. The high and low sales prices for the stock as reported in the consolidated transaction reporting system for each quarterly period during the two most recent fiscal years are:\nAs of February 10, 1995 there were 9,332 holders of record of Common Stock.\nDividends declared and paid per share of Common Stock during the past two years were:\nThe quarterly dividend on Common Stock was increased to 42-1\/4 cents per share in January 1995, payable March 20, 1995.\nThe payment of cash dividends on Common Stock is, in effect, restricted by the Mortgage to accumulated surplus, available for distribution to the Common Stock, earned subsequent to December 31, 1947, subject to reduction if amounts deducted from earnings for current repairs and maintenance and provisions for renewals, replacements and depreciation of all the property of the Company are less than amounts specified in the Mortgage. See Section 1.02 of the Supplemental Indenture dated as of July 1, 1948, as supplemented. No amount was restricted against cash dividends on Common Stock as of December 31, 1994, under this restriction.\nThe payment of cash dividends on Common Stock is, in effect, restricted by the Amended Articles of Incorporation to accumulated surplus, available for distribution to the Common Stock, earned subsequent to December 31, 1935. The Amended Articles of Incorporation require that, immediately after such dividends, there shall remain to the credit of earned surplus an amount at least equal to two times the annual dividend requirements on all then outstanding Preferred Stock, No Par Value. See Art. VI, Terms of Capital Stock, General Provisions (B). The amount restricted against cash dividends on Common Stock at December 31, 1994 under this restriction was $2,209,642, leaving $215,823,713 unrestricted for the payment of dividends. In addition, the Amended Articles of Incorporation provide that surplus otherwise available for the payment of dividends on Common Stock shall be restricted to the extent that such surplus is included in a calculation required to permit the Company to issue, sell or dispose of preferred stock or other stock senior to the Common Stock (Art. VI, Terms of Capital Stock, General Provisions (E)).\nAn order of the Securities and Exchange Commission dated October 12, 1944 under the Public Utility Holding Company Act of 1935 in effect restricts the payment of cash dividends on Common Stock to 75% of net income available for distribution to the Common Stock, earned subsequent to December 31, 1943, if the percentage of Common Stock equity to total capitalization and surplus, as defined, is less than 25%. At December 31, 1994, such ratio amounted to approximately 48%.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION.\nEarnings per share of $2.53 in 1994 were the highest in Company history, exceeding 1993 earnings of $2.44, the previous all-time high. Earnings in 1992 were $2.25.\nThe record earnings reflected improved gas and electric margins resulting from recent rate adjustments, greater sales to the Company's commercial and industrial electric customers, and increased allowance for funds used during construction resulting from the Company's expanded construction program. Expected increases in maintenance and nonfuel-related operating expenses and a decline in sales to gas customers partially offset the impact of the higher margins.\nAt its December 1994 meeting, the Board of Directors authorized the actions necessary for a corporate reorganization in which a yet to be formed holding company would become the parent of the Company. Assuming the Company obtains shareholder approval at its March 1995 annual meeting and receives the required authorizations from federal regulatory agencies, the reorganization should be completed by late 1995 (see \"Holding Company\").\nAt its January 1995 meeting, the Board of Directors declared a dividend increase to common shareholders, marking the thirty-sixth consecutive year of dividend growth. Payable in March 1995, the Company's new quarterly dividend is 42-1\/4 cents per share, increasing the indicated annual rate to $1.69 per share.\nELECTRIC OPERATIONS. The table below compares changes in operating revenues, operating expenses and electric sales between 1994 and 1993, and between 1993 and 1992, in summary form.\nThe Company's implementation of the first and second steps of a three-step increase in its base electric rates (see \"Rate and Regulatory Matters\"), effective October 1, 1993 and June 29, 1994, respectively, and greater sales to the Company's commercial and industrial customers were the primary reasons for the 1% ($2.5 million) increase in electric operating revenues. Lower per unit fuel costs recovered in customer rates and lower average unit revenues from sales to nonsystem electric customers partially offset the impact of increased base rates and greater sales. In 1993, operating revenues rose 6.3% ($15.3 million) on higher weather-related sales to retail customers.\nSystem revenues rose an estimated $3.7 million due to the effect of two increases in base electric rates. Effective October 1, 1993, the Company implemented the first step (about 1% of retail revenues, or $1.8 million on an annual basis) of a three-step increase in its base electric rates to recover the cost of complying with the Clean Air Act Amendments of 1990 (see \"Rate and Regulatory Matters\"). Effective June 29, 1994, the second step (about 2.3% of retail revenues, or $4.2 million on an annual basis) of the increase was implemented.\nDespite milder winter and summer temperatures, when heating and cooling degree days were lower than in 1993 by 10% and 8%, respectively, commercial sales rose 2.4% on increased local economic activity. Residential sales declined about 1%. Due to continued growth in manufacturing activity, sales to the Company's industrial customers rose 3.2% following a 5.7% increase in 1993. Total system sales were up 1.8% over 1993. System sales in 1993 exceeded 1992 sales by 7.6% due to much warmer summer temperatures.\nDuring 1994, the Company's electric customer base grew by 829, totaling 118,992 at year end.\nSystem revenues declined approximately $2.3 million in 1994 due to recovery of lower unit fuel costs following a $2.7 million increase in 1993 from the recovery of higher unit fuel costs. Changes in the cost of fuel for electric generation and purchased power are reflected in customer rates through commission-approved fuel cost adjustments.\nSince 1987, the Company has provided electric energy to Alcoa Generating Corporation (AGC), a wholly-owned subsidiary of Alcoa (a wholesale customer), for one of its six potlines. Due to market conditions in the aluminum industry, Alcoa shut down the oldest of the six potlines at the Warrick County manufacturing operation in July 1993. The Company estimates that the decline in electric sales related to the potline for 1993 represented approximately $4.8 million in nonsystem revenues and approximately $.8 million in operating income compared to the prior year. During 1994, revenue related to the reduced sales to AGC declined an additional $8.2 million with a corresponding $1.4 million additional decline in operating income. A portion of the decline in operating income was offset by increased sales to other nonsystem customers made possible by the reduced commitment to AGC. Total nonsystem sales were 3.2% higher than 1993, due primarily to the requirements of one nonassociated utility during the first quarter of 1994. Most sales to nonsystem customers, including AGC, are on an \"as available\" basis under interchange agreements which provide for significantly lower margins than sales to system customers.\nMilder summer temperatures and the peak-shaving effect of the Company's demand side management programs resulted in a 1994 peak load obligation of 1,068 megawatts, 2.9% lower than the all-time peak of 1,100 megawatts reached on July 28, 1993, despite the increased demand by industrial customers. The Company's total generating capacity at the time of the 1994 peak was 1,238 megawatts, representing a 14% capacity margin.\nAlthough electric generation increased 7.2% as a result of the increased sales and fewer purchases of electricity from other utilities, fuel for electric generation, the most significant electric operating cost, rose only 2.8% due to lower coal costs and improved plant efficiencies. In 1994, the Company experienced more favorable volume-related pricing with its remaining long-term contract supplier and took advantage of generally lower spot market coal prices. The Company continues to pursue further reductions in coal prices as a key component of its strategy to remain a low- cost provider of electricity (see \"Rate and Regulatory Matters\"). The 1993 fuel costs were comparable to 1992; in each year, a decline in generation offset slightly higher costs of coal consumed.\nThe Company reduced its purchases of electricity from other utilities by 41% compared to the previous year due to lower energy requirements and internally generated electricity being more favorably priced compared to that available from other utilities. Purchased electric energy costs in 1993 were 220% higher than in 1992 due to greater energy requirements of the Company and the availability of lower- priced power from other utilities.\nBecause the Company is undecided whether it will seek recovery of 1993 and 1994 demand side management expenditures and postretirement benefits other than pensions allocable to firm wholesale customers, about $2.5 million of these costs were expensed. As a result of these expenses, increased employee benefit costs, higher operating costs at the A. B. Brown scrubber due to increased generation at that plant and consulting and legal expenditures related to on- going coal contract negotiations and litigation (see \"Rate and Regulatory Matters\"), other operation expenditures increased 23.6% ($7.1 million) during the current year, after an 8.2% rise in 1993.\nExpected increases in production plant maintenance activity were the primary reason for the 14.9% ($3.6 million) rise in electric maintenance expense. In addition to normal maintenance project expenditures, the Company performed a scheduled major turbine generator overhaul on Culley Unit 2, performed significant repairs to one of the Company's gas turbine peaking units and incurred greater maintenance costs on the A. B. Brown scrubber facilities due to the plant's significantly greater generation. Electric maintenance expenditures in 1993 rose 20% over 1992, when such costs were down $4.5 million. Depreciation and amortization expense increased about 3% in 1994, following a 2% increase in 1993, reflecting normal additions to utility plant.\nWhile inflation has a significant impact on the replacement cost of the Company's facilities, only the historical cost of electric and gas plant investment is recoverable in revenues as depreciation under the ratemaking principles followed by the Indiana Utility Regulatory Commission (IURC), under whose regulatory jurisdiction the Company is subject. With the exception of adjustments for changes in fuel and gas costs and margin on sales lost under the Company's demand side management programs (see \"Demand Side Management\"), the Company's electric and gas rates remain unchanged until a rate application is filed and a general rate order is issued by the IURC.\nFederal and state income tax expense was lower during 1994 due to the decrease in pretax income. Income tax expense rose $1.9 million in 1993, the result of higher pretax income and the provision of additional federal income tax expense to reflect higher tax rates enacted under the Omnibus Budget Reconciliation Act of 1993. The $3.2 million decrease in taxes other than income taxes during the current year reflects adjustments to prior years' provisions for property taxes related to the favorable outcome of a property tax appeal.\nGAS OPERATIONS. The following table compares changes in operating revenues, operating expenses and gas sold and transported between 1994 and 1993, and between 1993 and 1992, in summary form.\nFewer sales of natural gas and lower gas costs recovered through retail rates more than offset the impact on gas operating revenues of the second step (about 4% of gas revenues, or $2.75 million on an annual basis) of the Company's two-step increase in its base gas rates, effective August 1, 1994 (see \"Rate and Regulatory Matters\"). The overall decline in 1994 gas revenues was 2.8%.\nA 32% decline in industrial sales during 1994 was the primary reason for an 8.5% drop in the Company's gas sales. Residential and commercial customer sales also declined, 4.7% and 4.8%, respectively, due to the milder winter temperatures. Industrial sales were down due to increased transportation activity of certain large customers; total deliveries to industrial customers under the Company's sales and transportation tariffs declined 3.9% primarily due to the lower production levels of Alcoa, one of the Company's largest industrial customers (see \"Electric Operations\"). In 1993, residential and commercial sales were up 12.8% and 10.3%, respectively, due to colder winter weather, and industrial sales and transportation volumes increased 6.4% on greater manufacturing activity of several of the Company's largest customers.\nOn June 30, 1994, the Company completed its acquisition of Lincoln Natural Gas Company, Inc. (LNG), a small gas distribution company serving approximately 1,300 customers contiguous to the eastern boundary of the Company's gas service territory. (See Note 1 of the Notes to Consolidated Financial Statements for further discussion.) In addition to the LNG customers, 1,200 new gas customers were added to the Company's system, raising the year end total to 102,929.\nThe recovery of lower unit gas costs through retail rates in 1994 lowered revenues approximately $1 million following a $2.7 million increase in revenues related to the recovery of higher unit costs in the prior year. During the past several years, the market for purchase of natural gas supply has been very volatile with the average price ranging from the low of $1.34 per Dth in February 1992 to the peak of $2.58 per Dth in May 1993 and then declining to $1.38 per Dth in October 1994. The volatility of the market reflects the general tightening of the balance between available supply and demand after several years of excess supply, and more recently, the effect of the further deregulation of the gas pipeline industry (see \"Rate and Regulatory Matters\"). Changes in the cost of gas sold are passed on to customers through IURC-approved gas cost adjustments.\nCost of gas sold, the major component of gas operating expenses, declined 17.5% ($9 million) in 1994 to $42.3 million, following a 9.9% ($4.6 million) increase in 1993. The lower costs in 1994 reflected a 10.6% decrease in deliveries to customers and a 7.9% decline in the average unit cost of gas delivered to customers. The higher cost of gas sold in 1993 was due to increased deliveries to customers and higher unit costs.\nAlthough the Company's former primary pipeline supplier, Texas Gas Transmission Corporation (TGTC), implemented revised tariffs November 1, 1993 to reflect certain changes required by Federal Energy Regulatory Commission (FERC) Order No. 636, the Company's 1994 and 1993 purchased gas costs were relatively unaffected by the new tariffs. As of November 1, 1993, TGTC ceased to be a supplier of natural gas to the Company, and the Company assumed full responsibility for the purchase of all its natural gas supplies. (See \"Rate and Regulatory Matters\" for further discussion of FERC Order No. 636 and of the impact on future purchased gas costs and procurement practices of the Company.)\nFollowing a 31% increase in 1993, other operation and maintenance expenses were 8.1% ($1.1 million) greater than the prior year due primarily to expenses associated with an accelerated program of relocating gas customer meters outside of customer premises to aid in future operating efficiencies, greater employee-related benefit costs and increases in various other operating expenses.\nAlthough the Company has continued to invest in gas plant due to new business requirements and improvements to the distribution system, depreciation expense in 1994 declined, reflecting the impact of a full year of lower depreciation rates implemented during 1993 as a result of the Company's gas rate case. Depreciation expense in 1993 was relatively unchanged from 1992 because lower depreciation rates were only in effect during five months of 1993.\nThe significant increase in income tax expense resulted from higher pretax gas income in 1994; income tax expense in 1993 was comparable to 1992.\nOTHER INCOME AND INTEREST CHARGES.\nOther income was $1.1 million greater during 1994 due to increased allowance for equity funds used during construction, resulting primarily from the continued construction of the Company's new sulfur dioxide scrubber (see \"Clean Air Act\" ). Higher other income in 1993, up $2.5 million, also resulted from increased allowance for equity funds used during construction related to the scrubber project.\nInterest expense during the current year and during 1993 was relatively unchanged. Increased interest expense on short- term debt during 1994 was offset by additional interest capitalized due to the increased construction program.\nRATE AND REGULATORY MATTERS.\nAs described in Note 1 of the Notes to Consolidated Financial Statements, the Company complies with the provisions of Financial Accounting Standard (FAS) 71, \"Accounting for the Effects of Certain Types of Regulation\" that allows certain costs incurred by the Company that have been, or are expected to be, approved by regulatory authorities for recovery through rates, to be deferred as regulatory assets until recovered by the Company. In the event the Company determines that it no longer meets the criteria for following FAS 71, the accounting impact to the Company would be an extraordinary noncash charge to operations of an amount that could be material. Criteria that could give rise to the discontinuance of FAS 71 include (1) increasing competition that restricts the Company's ability to establish prices to recover specific costs, and (2) a significant change in the manner in which rates are set by regulators from cost-based regulation to another form of regulation. The Company periodically reviews these criteria to ensure the continuing application of FAS 71 is appropriate.\nIn November 1992, the Company petitioned the IURC requesting a general increase in gas rates, the first such adjustment since 1982. On July 21, 1993, the IURC approved an overall increase of approximately 8%, or $5.5 million in revenues, in the Company's base gas rates. The increase was implemented in two equal steps of approximately 4% on August 1, 1993 and August 1, 1994. In addition to seeking relief for rising operating and maintenance costs and substantial investment in utility plant over the past decade, the Company sought to restructure its tariffs, make available additional services and \"unbundle\" existing services to better serve its gas customers and strategically position itself to address the changes brought about by the continued deregulation of the natural gas industry.\nOn May 24, 1993, the Company petitioned the IURC for an adjustment in its base electric rates representing the first step in the recovery of the financing costs on its investment through March 31, 1993 in the Clean Air Act Compliance project being constructed at the Culley Generating Station. The majority of the costs are for the installation of a sulfur dioxide scrubber on Culley Units 2 and 3. (See \"Clean Air Act\" for further discussion of the project and previous approval of ratemaking treatment of the incurred costs.) On September 15, 1993, the IURC granted the Company's request for a 1% revenue increase, approximately $1.8 million on an annual basis, which took effect October 1, 1993. The Company petitioned the IURC on March 1, 1994 for recovery of financing costs related to the scrubber construction costs incurred from April 1, 1993 through January 31, 1994, and was granted a 2.3% increase, approximately $4.2 million on an annual basis, in base electric retail rates. This second step of the increase was effective June 29, 1994. On December 22, 1993, the Company petitioned the IURC for the third of the three planned general electric rate increases related to its Clean Air Act Compliance project. The final adjustment is necessary to cover financing costs related to the balance of the project construction expenditures, costs related to the operation of the scrubber, certain nonscrubber-related operating costs such as additional costs incurred for postretirement benefits other than pensions beginning in 1993 and the recovery of demand side management program expenditures (see \"Demand Side Management\"). The Company filed its case-in- chief on May 16, 1994 supporting a $12.4 million, 5.7% retail rate increase. On October 1, 1994, the Office of the Utility Consumer Counselor (UCC) filed its case-in-chief. On rebuttal, the Company reduced its request to $10.5 million reflecting a stipulated agreement with the UCC on depreciation rates and a reduction in the final estimated cost of the Clean Air Act Compliance project. The estimated impact of the UCC's recommendation is a $1.7 million, .7%, decrease in retail revenues. The major differences between the Company's request and the UCC's proposal are the requested rate of return on equity, the recovery of the additional cost of postretirement benefits other than pensions, the \"fair value\" of rate base investment and the appropriate level of operation and maintenance expenses to be included in cost of service. All hearings have been completed and the Company is awaiting the final rate order, anticipated in early 1995. The Company cannot predict what action the IURC may take with respect to this proposed rate increase.\nOver the past several years, the Company has been actively involved in intensive contract negotiations and legal actions to reduce its coal costs and thereby lower its electric rates. During 1992, the Company was successful in negotiating a new coal supply contract with one of its major coal suppliers. The new agreement, effective through 1995, was retroactive to 1991. Included in the agreement was a provision whereby the contract could be reopened by the Company for modification of certain coal specifications. In early 1993, the Company reopened the contract for such modifications. In response, the coal supplier elected to terminate the contract enabling the Company to buy out the remainder of its contractual obligations and acquire lower- priced spot market coal. The cost of the contract buyout in 1993, which was based on estimated tons of coal to be consumed during the agreement period, and related legal and consulting services, totaled approximately $18 million. In 1994, the Company incurred additional buyout costs of $.8 million. No additional buyout costs are anticipated for the remainder of the agreement period. On September 22, 1993, the IURC approved the Company's request to amortize all buyout costs to coal inventory during the period July 1, 1993 through December 31, 1995 and to recover such costs through the fuel adjustment clause beginning February 1994. The Company estimates the total savings in coal costs during the 1991-1995 period resulting from the renegotiation and subsequent buyout, net of the total buyout costs, will approximate $58 million. The net savings are being passed back to the Company's electric customers through the fuel adjustment clause.\nThe Company is currently in litigation with another coal supplier. Under the terms of the original contract, the Company was allegedly obligated to take 600,000 tons of coal annually. In early 1993, the Company informed the supplier that it would not require shipments under the contract until later in 1993. On March 26, 1993, the Company and the supplier agreed to resume coal shipments under the terms of a letter agreement which is effective until final resolution of the current litigation. Under the letter agreement, the invoiced price per ton would be substantially lower than the contract price. As approved by the IURC, the Company has charged the full contract price to coal inventory for recovery through the fuel adjustment clause. The difference between the contract price and the invoice price , $22 million at December 31, 1994, has been deposited in an escrow account and will be paid to either the Company's ratepayers or its coal supplier upon resolution of the litigation. The Company also maintains that shipments from the supplier do not conform to the agreed upon coal specifications in the contract. This litigation came to trial conclusion based upon summary judgment motions in June 1994. The U.S. District Court found in favor of the Company regarding required coal quality specifications and, in an earlier summary judgment, found in favor of the coal supplier regarding alleged minimum annual tonnage requirements. Both parties have initiated appeal procedures and expect the case to be heard by the Court of Appeals in mid-1995 with a decision from that court later in 1995. The parties are also considering mediation. Since the litigation arose due to the Company's efforts to reduce fuel costs, management believes that any related costs should be recoverable through the regulatory ratemaking process.\nIn late 1993, in a further effort to reduce coal costs, the Company and the supplier entered into an additional letter agreement, effective January 1, 1994, and continuing until the litigation is resolved, whereby the Company will purchase an additional 50,000 tons monthly above the alleged base requirements at a market-competitive price. The price under this agreement is not subject to revision regardless of the outcome of the litigation.\nIn April 1992, the Federal Energy Regulatory Commission (FERC) issued Order No. 636 (the Order) which required interstate pipelines to restructure their services. In August 1992, the FERC issued Order No. 636-A which substantially reaffirmed the content of the original Order. Under the Order, the stated purpose of which is to improve the competitive structure of the natural gas pipeline industry, existing pipeline sales service was \"unbundled\" so that gas supplies are sold separately from interstate transportation services. Customers, such as the Company and ultimately its gas customers, could benefit from enhanced access to competitively priced gas supplies as well as from more flexible transportation services. Conversely, customer costs could rise because the Order requires pipelines to implement new rate design methods which shift additional demand-related costs to firm customers; additionally, the FERC has authorized the pipelines to seek recovery of certain \"transition\" costs associated with restructuring from their customers.\nOn November 2, 1992, the Company's major pipeline supplier, Texas Gas Transmission Corporation (TGTC), filed a recovery implementation plan with the FERC as part of its revised compliance filing regarding the Order. On October 1, 1993, the FERC accepted, subject to certain conditions, the TGTC recovery implementation plan (the Plan). The Plan, which addresses numerous issues related to the implementation of the requirements of the Order, became effective November 1, 1993. Under new TGTC transportation tariffs, which reflect the Plan's provisions, the Company will incur additional annual demand-related charges which will be partially offset by lower volume-related transportation costs. TGTC has estimated that the Company's allocation of transition costs will total approximately $5.2 million, to be incurred over a three-year period ending the first quarter of 1997, and has filed and received approval for recovery of $3 million of these costs. During 1994, the Company was billed $1.3 million of these transition costs, $.4 million of which it deferred pending authorization by the IURC of recovery of such costs. The Company has also recognized an additional $1.7 million of these costs which have not yet been billed. Since authorization for recovery of transition costs was recently granted by the IURC to other Indiana utilities, the Company does not expect the Order to have a detrimental effect on its financial condition or results of operations.\nHOLDING COMPANY.\nOn December 20, 1994, the Company's Board of Directors authorized the steps required for a corporate reorganization in which a yet to be formed holding company would become the parent of the Company. Three of the Company's four subsidiaries are expected to also become subsidiaries of the new holding company. The Company will seek shareholder approval at the Company's March 28, 1995 annual meeting. In addition to shareholder approval, approval by the Federal Energy Regulatory Commission and the Securities and Exchange Commission is required.\nThe reorganization is in response to the changes created in the electric industry by the Energy Policy Act of 1992 and the need to respond quickly to the more competitive business environment. The new structure will enable the Company to better define and separate its regulated and nonregulated businesses.\nIf the Company receives the required shareholder and regulatory approvals, the outstanding shares of Company common stock would be exchanged on a one-for-one basis for shares of common stock of the new holding company. All of the Company's debt securities and all of its outstanding shares of preferred stock would remain securities of the Company and be unaffected.\nIf the necessary approvals are received when expected, the Company anticipates the reorganization could be completed by late 1995. ENVIRONMENTAL MATTERS.\nIn 1993, the Company expensed $.5 million of anticipated cost of performing preliminary and comprehensive investigations of the possible existence of facilities once owned and operated by the Company, its predecessors, previous landowners or former affiliates of the Company, utilized for the manufacture of gas.\nThese facilities would have been operated from the 1850's through the early 1950's under industry standards then in effect. However, due to current environmental regulations, the Company and other responsible parties may be required to take remedial action if certain materials are found at the sites of these former facilities.\nThe Company completed its initial investigation in early 1994 and identified the existence and general location of four sites. Although the results of preliminary assessments of the sites indicated no contamination was present, the Company elected to conduct more comprehensive testing of the sites to provide conclusive evidence that no such contamination exists. Comprehensive testing of three of the sites was initiated in late 1994; the Company expects to initiate testing of the fourth site in 1995. Testing of one site has been completed with no evidence of contamination present, and testing of the remaining sites should be completed in 1995. No additional costs for testing are anticipated at this time.\nThe Company has notified all known insurance carriers providing coverage during the probable period of operation of these facilities of potential claims for coverage of environmental costs. The Company has not, however, recorded any receivables representing future recovery from insurance carriers. Additionally, the Company is attempting to identify all potentially responsible parties for each site. The Company has not been named a potentially responsible party by the Environmental Protection Agency (EPA) for any of these sites.\nThe Company does not presently anticipate seeking recovery of these investigation costs from its ratepayers. If, however, the specific site investigations indicate that significant remedial action is required, the Company will seek recovery of all related costs in excess of amounts recovered from other potentially responsible parties or insurance carriers through rates.\nAlthough the IURC has not yet ruled on a pending request for rate recovery by another Indiana utility of such environmental costs, the IURC did grant that utility authority to utilize deferred accounting for such costs until the IURC rules on the request.\nNATIONAL ENERGY POLICY ACT OF 1992.\nKey provisions of the National Energy Policy Act of 1992 (the Act) are expected to cause some of the most significant changes in the history of the electric industry. The primary purpose of the electric provisions is to increase competition in electric generation by enabling virtually nonregulated entities, such as exempt wholesale generators, to develop power plants, and by providing the FERC authority to require a utility to provide transmission services, including the expansion of the utility's transmission facilities necessary to provide such services, to any entity generating electricity. Although the FERC may not order retail wheeling (the transmission of electricity directly to an ultimate consumer) it may order wheeling of electricity generated by an exempt wholesale generator or another utility to a wholesale customer of a regulated utility.\nThe changes brought about by the Act may require, or provide opportunities for, the Company to compete with other utilities and wholesale generators for sales to existing wholesale customers of the Company and other potential wholesale customers. The Company has long-term contracts with its wholesale customers which mitigate the opportunity for other generators to provide service to them.\nMany observers of the electric utility industry, including major credit rating agencies, certain financial analysts and some industry executives, have expressed an opinion that retail wheeling to large retail customers and other elements of a more competitive business environment will occur in the electric utility industry, similar to developments in the telecommunications and natural gas industries. Although there has been much discussion of the subject during the past year, most notably in California where the state regulatory commission staff proposed a plan to implement retail wheeling, the timing of these projected developments is uncertain. In addition, the FERC has adopted a position, generically and on a case-by-case basis, that it will pursue a more competitive, less regulated, electric utility industry.\nAlthough the Company is uncertain of the final outcome of these developments, it is committed to pursuing, and is moving rapidly to implement, its corporate strategy of positioning itself as a low-cost energy producer and the provider of high quality service to its retail as well as wholesale customers. The Company already has some of the lowest per-unit administrative, operation and maintenance costs in the industry, and is continuing its efforts to further reduce its coal costs.\nCLEAN AIR ACT.\nTo meet the Phase I requirements of the Clean Air Act Amendments of 1990 and nearly all of the Phase II requirements, the Company's Clean Air Act Compliance Plan (the Compliance Plan), which was developed as a least-cost approach to compliance, proposed the installation of a single scrubber at the Culley Generating Station to serve both Culley Unit 2 (92 MW) and Culley Unit 3 (250 MW) and the installation of state of the art low NOx burners on these two units. In October 1992, the IURC approved a stipulation and settlement agreement between the Company and intervenors essentially approving the Compliance Plan.\nConstruction of the facilities, originally projected to cost approximately $115 million including the related allowance for funds used during construction, began during 1992. This project, which is on schedule and under budget, will total approximately $103 million. Under the settlement agreement, the maximum capital cost of the compliance plan to be recovered from ratepayers is capped at approximately $107 million, plus any related allowance for funds used during construction. The estimated annual cost to operate and maintain the facilities, including the cost of chemicals to be used in the process, is approximately $4.3 million.\nBy installing a scrubber, the Company was entitled to apply to the federal EPA for extra allowances, called \"extension allowances\". The Company will receive about 88,500 extension allowances, which it has sold to another party under a confidential agreement. As part of the IURC- approved stipulation and agreement, the Company agreed to credit approximately $2.5 million per year for the period 1995 through 1999 to retail customers to reduce the rate impact of the Compliance Plan.\nWith the addition of the scrubber, the Company expects to exceed the minimum compliance requirements of Phase I of the Clean Air Act and have available unused allowances, called \"overcompliance allowances\", for sale to others. Proceeds from sales of overcompliance allowances will also be passed through to customers.\nThe scrubbing process utilized by the Culley scrubber produces a salable by-product, gypsum, a substance commonly used in wallboard and other products. In December 1993, the Company finalized negotiations for the sale of an estimated 150,000 to 200,000 tons annually of gypsum to a major manufacturer of wallboard. This scrubber has been operating in a start-up \"test\" mode for several months, and by early January 1995, the Company had shipped several barge loads of gypsum to the manufacturer. The agreement will enable the Company to reduce certain operating costs with the proceeds from the sale of the gypsum, further mitigating the rate impact of the Compliance Plan.\nThe rate impact related to the Compliance Plan, estimated to be 7-8%, is being phased in over a three-year period beginning in October 1993 (see \"Rate and Regulatory Matters\" for further discussion).\nDEMAND SIDE MANAGEMENT.\nIn October 1991, the IURC issued an order approving expenditures by the Company for development and implementation of demand side management (DSM) programs. The primary purpose of the DSM programs is to reduce the demand on the Company's generating capacity at the time of system peak requirements, thereby postponing or avoiding the addition of generating capacity. Thus, the order of the IURC provided that the accounting and ratemaking treatment of DSM program expenditures should generally parallel the treatment of construction of new generating facilities.\nMost of the DSM program expenditures are being capitalized per the IURC order and will be amortized over a 15-year period beginning at the time the Company reflects such costs in its rates. The Company is requesting recovery of these costs in its general electric rate increase request filed December 22, 1993 (see \"Rate and Regulatory Matters\"). In addition to the recovery of DSM program costs through base rate adjustments, the Company is collecting, through a quarterly rate adjustment mechanism, most of the margin on sales lost due to the implementation of DSM programs.\nAccording to projections included in the Company's latest update of its Integrated Resource Plan (IRP), approved by the IURC on September 7, 1994, the Company expects to incur costs of approximately $54 million on DSM programs during the 1995-1999 period. The projections indicate that by 1999, approximately 118 megawatts of capacity are expected to have been postponed or eliminated due to these programs. While the latest projections of DSM expenditures are an estimated $201 million through the year 2012, they are estimated to result in incremental savings of approximately $160 million to ratepayers by deferring the need for approximately 166 megawatts of new generating capacity. However, due to the anticipated changes in the electric industry precipitated by the National Energy Policy Act of 1992, the projected DSM programs, related costs and associated results are subject to change.\nIn addition to the utilization of DSM programs, the 1993 IRP forecasts the need for 125 megawatts of base-load generating capacity in the early 21st century to meet the future electricity needs of the Company's customers.\nLIQUIDITY AND CAPITAL RESOURCES.\nThe Company experienced record earnings per share during 1994, and financial performance continued to be solid. Internally generated cash provided 58.8% of the Company's construction and DSM program expenditures, despite the requirements of the Culley scrubber project. Earnings continued to be of high quality, of which 12.8% represented allowance for funds used during construction. The ratio of earnings to fixed charges (SEC method) was 3.7:1, the embedded cost of long-term debt is approximately 6.6%, and the Company's long-term debt continues to be rated AA by major credit rating agencies.\nThe Company has access to outside capital markets and to internal sources of funds that together should provide sufficient resources to meet capital requirements. The Company does not anticipate any changes that would materially alter its current liquidity.\nOther than an $11 million increase in short-term debt, no financing activity occurred during 1994, in contrast to 1993 when the Company called $84.5 million of its first mortgage bonds, at a premium, and refunded them with two $45 million issues. In addition, the Company retired $20 million of its maturing first mortgage bonds with a $20 million issue due 2025. To provide financing for a portion of the Culley scrubber project, the Company issued two series of adjustable rate first mortgage bonds totaling $45 million in May 1993 in connection with the sale of Warrick County, Indiana environmental improvement bonds.\nDuring the five-year period 1995-1999, the Company anticipates that a total of $90 million of debt securities will be redeemed.\nConstruction expenditures, including $4.1 million for DSM programs, totaled $84.8 million during 1994, compared to the $80.2 million expended in 1993. As discussed in \"Clean Air Act\", construction of the new scrubber continued in 1994, requiring $36.4 million. The remainder of the 1994 construction expenditures consisted of the normal replacements and improvements to gas and electric facilities and of the construction of a $3.7 million vehicle maintenance facility located at the Company's Norman P. Wagner Operations Center.\nAt this time, the Company expects that construction requirements for the years 1995-1999 will total approximately $230 million, including approximately $47 million of capitalized expenditures to develop and implement DSM programs; however, as discussed previously in \"Demand Side Management\", the anticipated changes in the electric industry may require changes to the level of future DSM expenditures. While the Company expects the majority of the construction program and debt redemption requirements to be provided by internally generated funds, external financing requirements of $55-70 million are anticipated.\nAt year end, the Company had $22.1 million in short-term borrowings, leaving unused lines of credit and trust demand note arrangements totaling $13 million.\nThe Company is confident that its long-term financial objectives, which include maintaining a capital structure near 45-50% long-term debt, 3-7% preferred stock and 43-48% common equity, will continue to be met, while providing for future construction and other capital requirements. Item 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE SHAREHOLDERS OF SOUTHERN INDIANA GAS AND ELECTRIC COMPANY:\nWe have audited the consolidated balance sheets and consolidated statements of capitalization of SOUTHERN INDIANA GAS AND ELECTRIC COMPANY (an Indiana corporation) AND SUBSIDIARIES 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 and the supplemental schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and supplemental 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 Southern Indiana Gas and Electric 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 1, effective January 1, 1993, the Company 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 schedule listed under Item 8 (3) 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 supplemental 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 January 23, 1995\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) 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 Southern Indiana Properties, Inc., Southern Indiana Minerals, Inc., Energy Systems Group, Inc. and Lincoln Natural Gas Company, Inc. All significant intercompany transactions and balances have been eliminated. Southern Indiana Properties, Inc. invests principally in partnerships (primarily in real estate), leveraged leases and marketable securities. Energy Systems Group, Inc., incorporated in April 1994, provides equipment and related design services to industrial and commercial customers. Southern Indiana Minerals, Inc., incorporated in May 1994, processes and markets coal combustion by-products. The operating results of these subsidiaries are included in \"Other, net\" in the Consolidated Statements of Income. On June 30, 1994, the Company completed the acquisition of Lincoln Natural Gas Company, Inc. (LNG), a small gas distribution company with approximately 1,300 customers contiguous to the eastern boundary of the Company's gas service territory. The Company issued 49,399 shares of its common stock for all common stock of LNG. This transaction was accounted for as a pooling of interests. Prior period financial statements have been restated to reflect this merger and to conform to current period presentation.\n(b) REGULATION\nThe Indiana Utility Regulatory Commission (IURC) has jurisdiction over all investor-owned gas and electric utilities in Indiana. The Federal Energy Regulatory Commission (FERC) has jurisdiction over those investor-owned utilities that make wholesale energy sales. These agencies regulate the Company's utility business operations, rates, accounts, depreciation allowances, services, security issues and the sale and acquisition of properties. The financial statements of the Company are based on generally accepted accounting principles, which give recognition to the ratemaking and accounting practices of these agencies.\n(c) REGULATORY ASSETS\nThe Company is subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71 \"Accounting for the Effects of Certain Types of Regulation.\" Regulatory assets represent probable future revenues to the Company associated with certain incurred costs which will be recovered from customers through the ratemaking process. Because of the expected favorable regulatory treatment, the following regulatory assets are reflected in the Consolidated Balance Sheets as of December 31:\n(d) CONCENTRATION OF CREDIT RISK\nThe Company's customer receivables from gas and electric sales and gas transportation services are primarily derived from a broadly diversified base of residential, commercial and industrial customers located in a southwestern region of Indiana. The Company serves 118,992 electric customers in the city of Evansville and 74 other communities and serves 102,929 gas customers in the city of Evansville and 64 other communities. The Company continually reviews customers' creditworthiness and requests deposits or refunds deposits based on that review. See Note 3 of Notes to Consolidated Financial Statements for a discussion of receivables related to its leveraged lease investments.\n(e) UTILITY PLANT\nUtility plant is stated at the historical original cost of construction. Such cost includes payroll-related costs such as taxes, pensions and other fringe benefits, general and administrative costs and an allowance for the cost of funds used during construction (AFUDC), which represents the estimated debt and equity cost of funds capitalized as a cost of construction. While capitalized AFUDC does not represent a current source of cash, it does represent a basis for future cash revenues through depreciation and return allowances. The weighted average AFUDC rate (before income tax) used by the Company was 9.5% in 1994, 10.5% in 1993 and 11.5% in 1992.\n(f) DEPRECIATION\nDepreciation of utility plant is provided using the straight-line method over the estimated service lives of the depreciable plant. Provisions for depreciation, expressed as an annual percentage of the cost of average depreciable plant in service, were as follows:\n(g) INCOME TAXES\nEffective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" The standard did not have a material impact on results of operations, cash flow or financial position. The Company utilizes the liability method of accounting for income taxes, providing deferred taxes on temporary differences. Investment tax credits have been deferred and are amortized through credits to income over the lives of the related property. The components of the net deferred income tax liability at December 31 are as follows:\nOf the $3,309,000 increase in the net deferred income tax liability from December 31, 1993 to December 31, 1994, $234,000 is due to current year deferred federal and state income tax expense and the remaining $3,075,000 increase is primarily a result of the change in the net regulatory assets and liabilities. The components of current and deferred income tax expense for the years ended December 31 are as follows:\nThe components of deferred federal and state income tax expense for the years ended December 31 are as follows:\nA reconciliation of the statutory tax rates to the Company's effective income tax rate for the years ended December 31 is as follows:\n(h) PENSION BENEFITS\nThe Company has trusteed, noncontributory defined benefit plans which cover eligible full-time regular employees. The plans provide retirement benefits based on years of service and the employee's highest 60 consecutive months' compensation during the last 120 months of employment. The funding policy of the Company is to contribute amounts to the plans equal to at least the minimum funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA) but not in excess of the maximum deductible for federal income tax purposes. The plans' assets as of December 31, 1994 consist of investments in interest-bearing obligations and common stocks of 52% and 48%, respectively. The components of net pension cost related to these plans for the years ended December 31 are as follows:\nPart of the pension cost is charged to construction and other accounts. The funded status of the trusteed retirement plans at December 31 is as follows:\nThe projected benefit obligation at December 31, 1993 was determined using an assumed discount rate of 7%. Due to the increase in yields on high quality fixed income investments, a discount rate of 8% was used to determine the projected benefit obligation at December 31, 1994. For both periods, the long-term rate of compensation increases was assumed to be 5%, and the long-term rate of return on plan assets was assumed to be 8%. The transitional asset is being recognized over approximately 15, 18 and 14 years for the Salaried, Hourly and Hoosier plans, respectively. In addition to the trusteed pension plans discussed above, the Company provides supplemental pension benefits to certain current and former officers under nonqualified and nonfunded plans. In 1994, the Company charged $1,978,000 to pension expense representing the projected value of these future benefits earned as of December 31, 1994, but not yet recognized. Future annual service cost related to these benefits will be approximately $150,000.\n(i) POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company provides certain postretirement health care and life insurance benefits for retired employees and their dependents through fully insured plans. Retired employees are eligible for lifetime medical and life insurance coverage if they retire on or after attainment of age 55, regardless of length of service. Their spouses are eligible for medical coverage until age 65. Prior to 1993, the cost of retiree health care and life insurance benefits was recognized as insurance premiums were paid, which was consistent with ratemaking practices. The costs for retirees totaled $670,000 in 1992. Effective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires the expected cost of these benefits be recognized during the employees' years of service. As authorized by the Indiana Utility Regulatory Commission in a December 30, 1992 generic ruling, the Company is deferring as a regulatory asset the additional SFAS No. 106 costs accrued over the costs of benefits actually paid after date of adoption, but prior to inclusion in rates. The components of the net periodic other postretirement benefit cost for the years ended December 31 are as follows:\nThe net periodic cost determined under the new standard includes the amortization of the discounted present value of the obligation at the adoption date, $29,400,000, over a 20- year period. Because the Company is undecided whether it will seek recovery of 1993 and 1994 postretirement benefits other than pensions allocable to firm wholesale customers, $372,000 of these costs, which had previously been deferred as regulatory assets, were expensed in 1994. Reconciliation of the accumulated postretirement benefit obligation to the accrued liability for postretirement benefits as of December 31 is as follows:\nThe assumptions used to develop the accumulated postretirement benefit obligation at December 31, 1993 included a discount rate of 7.25% and a health care cost trend rate of 13.5% in 1994 declining to 5.5% in 2008. Due to the increase in yields on high quality fixed income investments, a discount rate of 8.25% was used to determine the accumulated postretirement benefit obligation at December 31, 1994. All other actuarial assumptions remained unchanged at year end. The estimated cost of these future benefits could be significantly affected by future changes in health care costs, work force demographics, interest rates or plan changes. A 1% increase in the assumed health care cost trend rate each year would increase the aggregate service and interest costs for 1994 by $750,000 and the accumulated postretirement benefit obligation by $5,800,000. The Company anticipates that beginning in 1995, postretirement benefits costs other than pensions will be funded as recognized, through a Voluntary Employee Benefit Association (VEBA) trust.\n(j) POSTEMPLOYMENT BENEFITS\nIn November 1992, the Financial Accounting Standards Board issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires the Company to accrue the estimated cost of benefits provided to former or inactive employees after employment but before retirement. The Company adopted SFAS No. 112 on January 1, 1994. The adoption of the new standard did not affect financial position or results of operations.\n(k) CASH FLOW INFORMATION\nFor the purposes of the Consolidated Balance Sheets and the Consolidated Statements of Cash Flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. The Company, during 1994, 1993 and 1992, paid interest (net of amounts capitalized) of $18,053,000, $18,359,000 and $17,890,000, respectively, and income taxes of $15,447,000, $10,248,000 and $14,291,000, respectively. The Company is involved in several partnerships which are partially financed by partnership obligations amounting to $12,881,000 and $16,730,000 at December 31, 1994 and 1993, respectively.\n(l) INVENTORIES\nThe Company accounts for its inventories under the average cost method except for gas in underground storage which is accounted for under two inventory methods: the average cost method for the Company's Hoosier Division (formerly Hoosier Gas Corporation) and the last-in, first- out (LIFO) method for all other gas in storage. Inventories at December 31 are as follows:\nBased on the December 1994 price of gas purchased, the cost of replacing the current portion of gas in underground storage exceeded the amount stated on a LIFO basis by approximately $11,000,000 at December 31, 1994. (m) OPERATING REVENUES AND FUEL COSTS\nRevenues include all gas and electric service billed during the year except as discussed below. All metered gas rates contain a gas cost adjustment clause which allows for adjustment in charges for changes in the cost of purchased gas. As ordered by the IURC, the calculation of the adjustment factor is based on the estimated cost of gas in a future quarter. The order also provides that any under- or overrecovery caused by variances between estimated and actual cost in a given quarter, as well as refunds from its pipeline suppliers, will be included in adjustment factors of four future quarters beginning with the second succeeding quarter's adjustment factor. All metered electric rates contain a fuel adjustment clause which allows for adjustment in charges for electric energy to reflect changes in the cost of fuel and the net energy cost of purchased power. As ordered by the IURC, the calculation of the adjustment factor is based on the estimated cost of fuel and the net energy cost of purchased power in a future quarter. The order also provides that any under- or overrecovery caused by variances between estimated and actual cost in a given quarter will be included in the second succeeding quarter's adjustment factor. The Company also collects through a quarterly rate adjustment mechanism, the margin on electric sales lost due to the implementation of demand side management programs. Reference is made to \"Demand Side Management\" in Management's Discussion and Analysis of Operations and Financial Condition for further discussion. The Company records monthly any under- or overrecovery as an asset or liability, respectively, until such time as it is billed or refunded to its customers. The IURC reviews for approval the adjustment clauses on a quarterly basis. The cost of gas sold is charged to operating expense as delivered to customers and the cost of fuel for electric generation is charged to operating expense when consumed.\n(2) RATE AND REGULATORY MATTERS\nOn July 21, 1993, the IURC approved an overall increase of approximately 8%, or $5.5 million in revenues, in the Company's base gas rates. The increase was implemented in two equal steps. The first step of the rate adjustment, approximately 4%, took place August 1, 1993; the second step of the rate adjustment took place on August 1, 1994. On May 24, 1993, the Company petitioned the IURC for an adjustment in its base electric rates representing the first step in the recovery of the financing costs on its investment through March 31, 1993 in the Clean Air Act Compliance (CAAC) project presently being constructed at the Culley Generating Station. The majority of the costs are for the installation of a sulfur dioxide scrubber on Culley Units 2 and 3. On September 15, 1993, the IURC granted the Company's request for a 1% revenue increase, approximately $1.8 million on an annual basis, which took effect October 1, 1993. The Company petitioned the IURC on March 1, 1994 for recovery of financing costs related to scrubber construction expenditures incurred from April 1, 1993 through January 31, 1994, and was granted a 2.3% increase, approximately $4.2 million on an annual basis, in base electric retail rates effective June 29, 1994. On December 22, 1993, the Company petitioned the IURC for the third of three planned general electric rate increases related to its CAAC project. The final adjustment is necessary to cover financing costs related to the balance of the project construction expenditures, costs related to the operation of the scrubber, certain nonscrubber-related operating costs such as additional costs incurred for postretirement benefits other than pensions beginning in 1993, and the recovery of demand side management program expenditures. The Company filed its case-in-chief on May 16, 1994 supporting a $12.4 million, 5.7% retail rate increase. On October 1, 1994, the Office of the Utility Consumer Counselor (UCC) filed its case-in-chief. On rebuttal, the Company reduced its request to $10.5 million reflecting a stipulated agreement with the UCC on depreciation rates and a reduction in the final estimated cost of the Clean Air Compliance project. The estimated impact of the UCC's recommendation is a $1.7 million, .7%, decrease in retail revenues. The major differences between the Company's request and the UCC's proposal are the requested rate of return on equity, the recovery of the additional cost of postretirement benefits other than pensions, the fair value of ratebase investment, and the appropriate level of operation and maintenance expenses to be included in cost of service. All hearings have been completed and the Company is awaiting the final rate order, anticipated in early 1995. The Company cannot predict what action the IURC may take with respect to this proposed rate increase. In April 1992, the Federal Energy Regulatory Commission (FERC) issued Order No. 636 (the Order) which required interstate pipelines to restructure their services. In August 1992, the FERC issued Order No. 636-A which substantially reaffirmed the content of the original Order. On November 2, 1992, the Company's major pipeline, Texas Gas Transmission Corporation (TGTC), filed a recovery implementation plan with the FERC as part of its revised compliance filing regarding the Order. On October 1, 1993, the FERC accepted, subject to certain conditions, the TGTC recovery implementation plan. Under the new TGTC transportation tariffs, which became effective November 1, 1993, the Company will incur additional annual demand-related charges which will be partially offset by lower volume-related transportation costs. TGTC has estimated that the Company's allocation of transition costs will total approximately $5.2 million, to be incurred over a three-year period ending the first quarter of 1997, and has filed and received approval for recovery of $3 million of these costs. During 1994, the Company was billed $1,285,000 of these transition costs, $445,000 of which it deferred pending authorization by the IURC of recovery of such costs. The Company has also recognized an additional $1.7 million of these costs, which have not yet been billed. Since authorization for the recovery of transition costs was recently granted by the IURC to other Indiana utilities, the Company does not expect the Order to have a detrimental effect on its financial condition or results of operations. Over the past several years, the Company has been involved in contract negotiations and legal actions to reduce its coal costs. During 1992, the Company successfully negotiated a new coal supply contract with a major supplier which was retroactive to 1991 and effective through 1995. In 1993, the Company exercised a provision of the agreement which allowed the Company to reopen the contract for the modification of certain coal specifications. In response, the coal supplier elected to terminate the contract enabling the Company to buy out the remainder of its contractual obligations and acquire lower priced spot market coal. The cost of the contract buyout in 1993, which was based on estimated tons of coal to be consumed during the agreement period, and related legal and consulting services, totaled approximately $18 million. In 1994, the Company incurred additional buyout costs of $.8 million. No additional buyout costs are anticipated for the remainder of the agreement period. On September 22, 1993, the IURC approved the Company's request to amortize all buyout costs to coal inventory during the period July 1, 1993 through December 31, 1995 and to recover such costs through the fuel adjustment clause beginning February 1994. As of December 31, 1994, $7,685,000 of settlement costs paid to date had not yet been amortized to coal inventory. The Company is currently in litigation with another coal supplier. Under the terms of the contract, the Company was allegedly obligated to take 600,000 tons of coal annually. In early 1993, the Company informed the supplier that it would not require shipments under the contract until later in 1993. On March 26, 1993, the Company and the supplier agreed to resume coal shipments under the terms of a letter agreement which is effective until final resolution of the current litigation. Under the letter agreement the invoiced price per ton would be substantially lower than the contract price. As approved by the IURC, the Company has charged the full contract price to coal inventory for recovery through the fuel adjustment clause. The difference between the contract price and the invoice price, $22,018,000 at December 31, 1994, has been deposited in an escrow account with an offsetting accrued liability which will be paid to either the Company's ratepayers or its coal supplier upon resolution of the litigation. The Company also maintains that shipments from the supplier do not conform to the agreed upon coal specifications in the contract. This litigation came to trial conclusion based upon summary judgment motions in June 1994. The U.S. District Court found in favor of the Company regarding required coal quality specifications and, in an earlier summary judgement, found in favor of the coal supplier regarding alleged minimum annual tonnage requirements. Both parties have initiated appeal procedures and expect the case to be heard by the Court of Appeals in mid-1995 with a decision from that court later in 1995. The parties are also considering mediation. Since the litigation arose due to the Company's efforts to reduce fuel costs, management believes that any related costs should be recoverable through the regulatory ratemaking process. In late 1993, in a further effort to reduce coal costs, the Company and the supplier entered into an additional letter agreement, effective January 1, 1994, and continuing until the litigation is resolved, whereby the Company will purchase an additional 50,000 tons monthly above the alleged base requirements at a market-competitive price. The price under this agreement is not subject to revision regardless of the outcome of the litigation. Reference is made to \"Rate and Regulatory Matters\" in Management's Discussion and Analysis of Operations and Financial Condition for further discussion of these matters.\n(3) LEVERAGED LEASES\nSouthern Indiana Properties, Inc. is a lessor in four leveraged lease agreements under which an office building, a part of a reservoir, an interest in a paper mill and passenger railroad cars are leased to third parties. The economic lives and lease terms vary with the leases. The total equipment and facilities cost was approximately $101,200,000 at December 31, 1994 and 1993, respectively. The cost of the equipment and facilities was partially financed by nonrecourse debt provided by lenders, who have been granted an assignment of rentals due under the leases and a security interest in the leased property, which they accepted as their sole remedy in the event of default by the lessee. Such debt amounted to approximately $77,900,000 and $78,700,000 at December 31, 1994 and 1993, respectively. The Company's net investment in leveraged leases at those dates was $6,169,000 and $8,184,000, respectively, as shown:\n(4) SHORT-TERM FINANCING\nThe Company has trust demand note arrangements totaling $17,000,000 with several banks, of which $13,000,000 was utilized at December 31, 1994. Funds are also borrowed periodically from banks on a short-term basis, made available through lines of credit. These available lines of credit totaled $18,000,000 at December 31, 1994 of which $9,000,000 was utilized at that date.\n(5) LONG-TERM DEBT\nThe annual sinking fund requirement of the Company's first mortgage bonds is 1% of the greatest amount of bonds outstanding under the Mortgage Indenture. This requirement may be satisfied by certification to the Trustee of unfunded property additions in the prescribed amount as provided in the Mortgage Indenture. The Company intends to meet the 1995 sinking fund requirement by this means and, accordingly, the sinking fund requirement for 1995 is excluded from current liabilities on the balance sheet. At December 31, 1994, $163,063,000 of the Company's utility plant remained unfunded under the Company's Mortgage Indenture. Several of the Company's partnership investments have been financed through obligations with such partnerships. Additionally, the Company's investments in leveraged leases have been partially financed through notes payable to banks. Of the amount of first mortgage bonds, notes payable, and partnership obligations outstanding at December 31, 1994, the following amounts mature in the five years subsequent to 1994: 1995 - $11,178,000; 1996 - $12,340,000; 1997 - $2,712,000; 1998 - $16,617,000; and 1999 - $47,074,000. In addition, $31,500,000 of adjustable rate pollution control series first mortgage bonds could, at the election of the bondholder, be tendered to the Company in May 1995. If the Company's agent is unable to remarket any bonds tendered at that time, the Company would be required to obtain additional funds for payment to bondholders. For financial statement presentation purposes those bonds subject to tender in 1995 are shown as current liabilities. First mortgage bonds, notes payable and partnership obligations outstanding and classified as long-term at December 31 are as follows:\n(6) CUMULATIVE PREFERRED STOCK\nThe amount payable in the event of involuntary liquidation of each series of the $100 par value preferred stock is $100 per share, plus accrued dividends. The nonredeemable preferred stock is callable at the option of the Company as follows: 4.8% Series at $110 per share, plus accrued dividends; and 4.75% Series at $101 per share, plus accrued dividends.\n(7) CUMULATIVE REDEEMABLE PREFERRED STOCK\nOn December 8, 1992, the Company issued $7,500,000 of its Cumulative Redeemable Preferred Stock to replace a like amount of 8.75% of Cumulative Preferred Stock. The new series has an interest rate of 6.50% and is redeemable at $100 per share on December 1, 2002. In the event of involuntary liquidation of this series of $100 par value preferred stock, the amount payable is $100 per share, plus accrued dividends.\n(8) CUMULATIVE SPECIAL PREFERRED STOCK\nThe Cumulative Special Preferred Stock contains a provision which allows the stock to be tendered on any of its dividend payment dates. On April 1, 1992, the Company repurchased 850 shares of the Cumulative Special Preferred Stock at a cost of $85,000 as a result of a tender within the provision of the issuance.\n(9) COMMITMENTS AND CONTINGENCIES\nThe Company presently estimates that approximately $40,000,000 will be expended for construction purposes in 1995, including those amounts applicable to the Company's demand side management (DSM) programs. Commitments for the 1995 construction program are approximately $21,000,000 at December 31, 1994. Reference is made to \"Demand Side Management\" in Management's Discussion and Analysis of Operations and Financial Condition for discussion of the implementation of the Company's DSM programs. In 1993, the Company expensed $500,000 for the anticipated cost of performing preliminary and comprehensive investigations of the possible existence of facilities once owned and operated by the Company, its predecessors, previous landowners or former affiliates of the Company utilized for the manufacture of gas. The Company completed its initial investigations in early 1994 and identified the existence and general location of four sites at which contamination may be present. The Company completed its preliminary assessments of all four sites in 1994. Although the results of the preliminary assessments of the sites indicated no contamination was present, the Company elected to conduct more comprehensive testing to provide conclusive evidence that no such contamination exists. Comprehensive testing of three of the sites was initiated in late 1994; the Company expects to initiate testing of the fourth site in 1995. Testing of one site has been completed with no evidence of contamination present, and testing of the remaining sites should be completed in 1995. No additional costs for testing are anticipated at this time. The Company is attempting to identify all potentially responsible parties for each site. The Company has not been named a potentially responsible party by the Environmental Protection Agency for any of these sites. The Company does not presently anticipate seeking recovery of these investigation costs from its ratepayers. If the specific site investigations indicate that significant remedial action is required, the Company will seek recovery of all related costs in excess of amounts recovered from other potentially responsible parties or insurance carriers through rates. Although the IURC has not yet ruled on a pending request for rate recovery by another Indiana utility of such environmental costs, the IURC did grant that utility authority to utilize deferred accounting for such costs until the IURC rules on the request.\n(10) COMMON STOCK\nSince 1986, the Board of Directors of the Company authorized the repurchase of up to $25,000,000 of the Corporation's common stock. As of December 31, 1994, the Company had accumulated 1,110,177 common shares with an associated cost of $24,540,000 under this plan. On January 21, 1992, the Board of Directors of the Company approved a four-for-three common stock split effective March 30, 1992. The stock split was authorized by the IURC on March 18, 1992. Average common shares outstanding, earnings per share of common stock and dividends per share of common stock as shown in the accompanying financial statements have been adjusted to reflect the split. Shares issued during 1992 as a result of the stock split were 3,923,706. On June 30, 1994, the Company completed its acquisition of Lincoln Natural Gas Company, Inc. (LNG). The Company issued 49,399 shares of common stock for all common stock of LNG. Average common shares outstanding, earnings per share of common stock and dividends per share of common stock as shown in the accompanying financial statements have been restated to reflect the issued shares. No shares of common stock were issued during 1993. After obtaining stockholder approval at the Company's 1994 Annual Stockholders Meeting, the Company established a common stock option plan for key management employees of the Company. During 1994, 153,666 options were granted to participants, of which 76,996 options are exercisable one year after the grant date. Since the impact of the outstanding options on earnings per share is antidilutive, only primary earnings per share have been presented. Each outstanding share of the Company's stock contains a right which entitles registered holders to purchase from the Company one one-hundredth of a share of a new series of the Company's Redeemable Preferred Stock, no par value, designated as Series 1986 Preferred Stock, at an initial price of $120.00 (Purchase Price) subject to adjustment. The rights will not be exercisable until a party acquires beneficial ownership of 20% of the Company's common shares or makes a tender offer for at least 30% of its common shares. The rights expire October 15, 1996. If not exercisable, the rights in whole may be redeemed by the Company at a price of $.01 per right at any time prior to their expiration. If at any time after the rights become exercisable and are not redeemed and the Company is involved in a merger or other business combination transaction, proper provision shall be made to entitle a holder of a right to buy common stock of the acquiring company having a value of two times such Purchase Price.\n(11) OWNERSHIP OF WARRICK UNIT 4\nThe Company and Alcoa Generating Corporation (AGC), a subsidiary of Aluminum Company of America, own the 270 MW Unit 4 at the Warrick Power Plant as tenants in common. Construction of the unit was completed in 1970. The cost of constructing this unit was shared equally by AGC and the Company, with each providing its own financing for its share of the cost. The Company's share of the cost of this unit at December 31, 1994 is $30,914,000 with accumulated depreciation totaling $19,045,000. AGC and the Company also share equally in the cost of operation and output of the unit. The Company's share of operating costs is included in operating expenses in the Consolidated Statements of Income.\n(12) SEGMENTS OF BUSINESS\nThe Company is primarily a public utility operating company engaged in distributing electricity and natural gas. The reportable items for electric and gas departments for the years ended December 31 are as follows:\n(13) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe company adopted in 1994 SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires accounting for certain investment in debt or equity securities at either amortized cost or fair value. Of the $5,444,000 of temporary investments, $2,990,000 are available-for-sale securities and $200,000 are held-to- maturity securities. Nonutility property and other includes of held-to-maturity securities, which are valued at amortized cost. The unrealized loss, net of tax, of $106,000 on these investments is recorded as a separate component of shareholders' equity. The carrying amount and estimated fair values of the Company's financial instruments at December 31 are as follows:\nAt December 31, 1994, the carrying amounts of the Company's debt relating to utility operations exceeded fair market value by $14,000,000. Fair value of long-term debt at December 31, 1993 exceeded carrying amounts by $20,400,000. Anticipated regulatory treatment of the excess or deficiency of fair value over carrying amounts of the Company's long-term debt, if in fact settled at amounts approximating those above, would dictate that these amounts be used to reduce or increase the Company's rates over a prescribed amortization period. Accordingly, any settlement would not result in a material impact on the Company's financial position or results of operations. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\nCASH AND TEMPORARY INVESTMENTS\nThe carrying amount is based on fair value or amortized cost. The fair value was determined based on current market values.\nNONUTILITY PROPERTY AND OTHER\nIncluded in Nonutility property are held-to-maturity debt securities. Held-to-maturity debt securities are valued at amortized cost, which approximates fair value.\nLONG-TERM DEBT\nThe fair value of the Company's long-term debt was estimated based on the current quoted market rate of utilities with a comparable debt rating. Nonutility long- term debt was valued based upon the most recent debt financing.\nPARTNERSHIP OBLIGATIONS\nThe fair value of the Company's partnership obligations was estimated based on the current quoted market rate of comparable debt.\nREDEEMABLE PREFERRED STOCK\nFair value of the Company's redeemable preferred stock was estimated based on the current quoted market of utilities with a comparable debt rating.\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\n(a) Identification of Directors\nThe information required by this item is included in the Company's Proxy Statement, definitive copies of which were filed with the Commission pursuant to Regulation 14A.\n(b) Identification of Executive Officers\nThe information required by this item is included in Part I, Item 1. - BUSINESS on page 9, to which reference is hereby made.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION AND TRANSACTIONS\nThe information required by this item is included in the Company's Proxy Statement, definitive copies of which were filed with the Commission pursuant to Regulation 14A.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is included in the Company's Proxy Statement, definitive copies of which were filed with the Commission pursuant to Regulation 14A.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is included in the Company's Proxy Statement, definitive copies of which were filed with the Commission 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) The financial statements, including supporting schedules, are listed in the Index to Financial Statements, page 23, (a) 2) filed as part of this report.\n(a) 3) Exhibits:\nEX-2(a)Merger Agreement - Plan of Reorganization and Agreement of Merger, by and among: Southern Indiana Gas and Electric Company; Southern Indiana Group, Inc.; Horizon Investments, Inc.; and MPM Investment Corporation, dated August 27, 1987. (Physically filed and designated as Exhibit A in Form S-4 Registration Statement filed November 12, 1987, File No. 33-18475.)\nEX-3(a)Amended Articles of Incorporation as amended March 26, 1985. (Physically filed and designated in Form 10-K, for the fiscal year 1985, File No. 1-3553, as Exhibit 3-A.) Articles of Amendment of the Amended Articles of Incorporation, dated March 24, 1987. (Physically filed and designated in Form 10-K for the fiscal year 1987, File No. 1-3553, as Exhibit 3-A.) Articles of Amendment of the Amended Articles of Incorporation, dated November 27, 1992. (Physically filed and designated in Form 10-K for the fiscal year 1992, File No. 1-3553, as Exhibit 3-A).\nEX-3(b)By-Laws as amended through December 18, 1990. (Physically filed in Form 10-K for the fiscal year 1990, File No. 1-3553, as Exhibit 3-B.) By-Laws as amended through September 22, 1993. (Physically filed and designated in Form 10-K for the fiscal year 1993, File No. 1-3553, as EX-3 (b).)\nEX-4(a)*Mortgage and Deed of Trust dated as of April 1, 1932 between the Company and Bankers Trust Company, as Trustee, and Supplemental Indentures thereto dated August 31, 1936, October 1, 1937, March 22, 1939, July 1, 1948, June 1, 1949, October 1, 1949, January 1, 1951, April 1, 1954, March 1, 1957, October 1, 1965, September 1, 1966, August 1, 1968, May 1, 1970, August 1, 1971, April 1, 1972, October 1, 1973, April 1, 1975, January 15, 1977, April 1, 1978, June 4, 1981, January 20, 1983, November 1, 1983, March 1, 1984, June 1, 1984, November 1, 1984, July 1, 1985, November 1, 1985, June 1, 1986. (Physically filed and designated in Registration No. 2-2536 as Exhibits B-1 and B- 2; in Post-effective Amendment No. 1 to Registration No. 2- 62032 as Exhibit (b)(4)(ii), in Registration No. 2-88923 as Exhibit 4(b)(2), in Form 8-K, File No. 1-3553, dated June 1, 1984 as Exhibit (4), File No. 1-3553, dated March 24, 1986 as Exhibit 4-A, in Form 8-K, File No. 1-3553, dated June 3, 1986 as Exhibit (4).) July 1, 1985 and November 1, 1985 (Physically filed and designated in Form 10-K, for the fiscal year 1985, File No. 1-3553, as Exhibit 4-A.) November 15, 1986 and January 15, 1987. (Physically filed and designated in Form 10-K, for the fiscal year 1986, File No. 1-3553, as Exhibit 4-A.) December 15, 1987. (Physically filed and designated in Form 10-K, for the fiscal year 1987, File No. 1-3553, as Exhibit 4-A.) December 13, 1990. (Physically filed and designated in Form 10-K, for the fiscal year 1990, File No. 1-3553, as Exhibit 4-A.) April 1, 1993. (Physically filed and designated in Form 8-K, dated April 13, 1993, File 1-3553, as Exhibit 4.) June 1, 1993 (Physically filed and designated in Form 8-K, dated June 14, 1993, File 1-3553, as Exhibit 4.) May 1, 1993. (Physically filed and designated in Form 10-K, for the fiscal year 1993, File No. 1-3553, as Exhibit 4(a).)\nEX-10.1 Agreement, dated, January 30, 1968, for Unit No. 4 at the Warrick Power Plant of Alcoa Generating Corporation (\"Alcoa\"), between Alcoa and the Company. (Physically filed and designated in Registration No. 2-29653 as Exhibit 4(d)-A.)\nEX-10.2 Letter of Agreement, dated June 1, 1971, and Letter Agreement, dated June 26, 1969, between Alcoa and the Company. (Physically filed and designated in Registration No. 2-41209 as Exhibit 4(e)-2.)\n*Pursuant to paragraph (b)(4)(iii)(a) of Item 601 of Regulation S-K, the Company agrees to furnish to the Commission on request any instrument with respect to long- term debt if the total amount of securities authorized thereunder does not exceed 10% of the total assets of the Company, and has therefore not filed such documents as exhibits to this Form 10-K.\nItem 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (Continued)\nEX-10.3 Letter Agreement, dated April 9, 1973, and Agreement dated April 30, 1973, between Alcoa and the Company. (Physically filed and designated in Registration No. 2-53005 as Exhibit 4(e)-4.)\nEX-10.4 Electric Power Agreement (the \"Power Agreement\"), dated May 28, 1971, between Alcoa and the Company. (Physically filed and designated in Registration No. 2-41209 as Exhibit 4(e)-1.)\nEX-10.5 Second Supplement, dated as of July 10, 1975, to the Power Agreement and Letter Agreement dated April 30, 1973 - First Supplement. (Physically filed and designated in Form 12-K for the fiscal year 1975, File No. 1-3553, as Exhibit 1(e).)\nEX-10.6 Third Supplement, dated as of May 26, 1978, to the Power Agreement. (Physically filed and designated in Form 10-K for the fiscal year 1978 as Exhibit A-1.)\nEX-10.7 Letter Agreement dated August 22, 1978 between the Company and Alcoa, which amends Agreement for Sale in an Emergency of Electrical Power and Energy Generation by Alcoa and the Company dated June 26, 1979. (Physically filed and designated in Form 10-K for the fiscal year 1978, File No. 1-3553, as Exhibit A-2.)\nEX-10.8 Fifth Supplement, dated as of December 13, 1978, to the Power Agreement. (Physically filed and designated in Form 10-K for the fiscal year 1979, File No. 1-3553, as Exhibit A-3.)\nEX-10.9 Sixth Supplement, dated as of July 1, 1979, to the Power Agreement. (Physically filed and designated in Form 10-K for the fiscal year 1979, File No. 1-3553, as Exhibit A-5.)\nEX-10.10 Seventh Supplement, dated as of October 1, 1979, to the Power Agreement. (Physically filed and designated in Form 10-K for the fiscal year 1979, File No. 1-3553, as Exhibit A-6.)\nEX-10.11 Eighth Supplement, dated as of June 1, 1980 to the Electric Power Agreement, dated May 28, 1971, between Alcoa and the Company. (Physically filed and designated in Form 10-K for the fiscal year 1980, File No. 1-3553, as Exhibit (20)-1.)\nEX-10.12* Agreement dated May 6, 1991 between the Company and Ronald G. Reherman for consulting services and supplemental pension and disability benefits. (Physically filed and designated in Form 10-K for the fiscal year 1992, File No. 1-3553, as Exhibit 10-A-12.)\nEX-10.13* Agreement dated July 22, 1986 between the Company and A. E. Goebel regarding continuation of employment. (Physically filed and designated in Form 10-K for the fiscal year 1992, File No. 1-3553, as Exhibit 10-A- 13.)\nEX-10.14* Agreement dated July 25, 1986 between the Company and Ronald G. Reherman regarding continuation of employment. (Physically filed and designated in Form 10-K for the fiscal year 1992, File No. 1-3553, as Exhibit 10-A- 14.)\nEX-10.15* Agreement dated July 22, 1986 between the Company and James A. Van Meter regarding continuation of employment. (Physically filed and designated in Form 10-K for the fiscal year 1992, File No. 1-3553, as Exhibit 10-A- 15.)\nEX-10.16* Agreement dated February 22, 1989 between the Company and J. Gordon Hurst regarding continuation of employment. (Physically filed and designated in Form 10-K for the fiscal year 1992, File No. 1-3553 as Exhibit 10-A- 16.)\nEX-10.17* Summary description of the Company's nonqualified Supplemental Retirement Plan (Physically filed and designated in Form 10-K for the fiscal year 1992, File No. 1-3553, as Exhibit 10-A-17.)\n* Filed pursuant to paragraph (b)(10)(iii)(A) of Item 601 of Regulation S-K. Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (Continued)\nEX-10.18* Supplemental Post Retirement Death Benefits Plan, dated October 10, 1984. (Physically filed and designated in Form 10-K for the fiscal year 1992, File No. 1-3553, as Exhibit 10-A-18.)\nEX-10.19* Summary description of the Company's Corporate Performance Incentive Plan. (Physically filed and designated in Form 10-K for the fiscal year 1992, File No. 1-3553, as Exhibit 10-A-19.)\nEX-10.20* Company's Corporate Performance Incentive Plan as amended for the plan year beginning January 1, 1994. (Physically filed and designated in Form 10-K for the fiscal year 1993, File No. 1-3553, as Exhibit 10-A-20.)\nEX-12 Computation of Ratio of Earnings to Fixed Charges\nEX-21 Subsidiaries of the Registrant\nEX-24 Power of Attorney\n* Filed pursuant to paragraph (b)(10)(iii)(A) of Item 601 of Regulation S-K.\n(b) Reports on Form 8-K\nNo Form 8-K reports were filed by the Company during the fourth quarter of 1994.\nSCHEDULE II\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 SOUTHERN INDIANA GAS AND ELECTRIC COMPANY By R. G. Reherman, Chairman, President and Chief Executive Officer\nBY \/s\/R. G. Reherman\nPursuant to the requirements of the 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.\nSIGECO 10-K","section_15":""}
{"filename":"713676_1994.txt","cik":"713676","year":"1994","section_1":"ITEM 1 - -BUSINESS\nINTRODUCTION\nPNC Bank Corp. (\"Corporation\") is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (\"Act\"). The Corporation was incorporated under Pennsylvania law in 1983 with the consolidation of Pittsburgh National Corporation and Provident National Corporation. Since 1983, the Corporation has diversified its geographical presence and product capabilities through numerous strategic acquisitions and the formation of various non-banking subsidiaries. At December 31, 1993, the Corporation operated 9 banking subsidiaries (\"Banks\") in Pennsylvania, Kentucky, Ohio, Delaware, Massachusetts and Indiana and 78 non-banking subsidiaries. The Corporation's total assets and total shareholders' equity were $62.1 billion and $4.3 billion, respectively. Based on 1993 year-end assets, the Corporation was the 10th largest bank holding company in the nation as reported by the American Banker. The Corporation employs approximately 21,100 people on a full-time equivalent basis.\nIn 1993, the Corporation's strategic focus was on refining the line-of-business organizational structure; strategic growth through acquisitions and continued investment in targeted businesses; managing the revenue and expense relationship associated with the Corporation's mature businesses; and marketing the Corporation under a new unified identity with an emphasis on customer satisfaction.\nOn November 30, 1993, the Corporation consummated its acquisition of the Sears Mortgage Banking Group, which consisted primarily of Sears Mortgage Corporation, Sears Mortgage Securities Corporation and Sears Savings Bank. Upon consummation, Sears Savings Bank was converted to a national banking association and renamed PNC Mortgage Bank, National Association (\"PNC Mortgage\"), and the other acquired entities became wholly-owned subsidiaries of PNC Mortgage. With this acquisition, the Corporation added consumer assets of $7.6 billion; a mortgage servicing portfolio approximating $27 billion, including $21 billion serviced for others; and a national residential mortgage production network consisting of 117 locations in 33 states. Other acquisitions during the year are described under Item 7 of this Form 10-K.\nThe Corporation delivers a full range of banking products and services to its customers through four lines of business: Corporate Banking, Retail Banking, Investment Management and Trust, and Investment Banking. For the most part, these products and services are distributed through the Corporation's retail banking and mortgage origination office networks or its wholesale banking offices in certain major metropolitan areas located in the U.S.\nCorporate Banking provides financing, liquidity and cash management, and financial services to businesses and government entities. Corporate Banking's focus is on serving customers by developing and delivering products and services specific to their needs. Certain market studies indicate that this line of business has established one of the largest market shares among middle market companies in the Corporation's primary markets, which include Delaware, Indiana, Kentucky, New Jersey, Ohio and Pennsylvania. In addition, Corporate Banking maintains banking relationships with many of the largest companies in the U.S. and is a major provider of cash management services.\nRetail Banking provides lending, deposit, investment, payment systems access, and other financial services to consumers and small businesses. Such services are primarily provided through the Corporation's 550 banking offices located in Pennsylvania, Kentucky, Ohio, Delaware and Indiana. Certain retail products, including residential mortgages, student loans and credit cards, are centrally managed to enhance the Corporation's ability to provide high quality, low cost products. The primary focus of Retail Banking is on enhancing sales and service levels by pursuing acquisitions and consolidating certain operations. Retail Banking serves more than two million households and more than 70,000 small businesses, operates one of the largest student lending businesses in the U.S. and maintains a mortgage origination network with offices in 33 states.\nInvestment Management and Trust provides investment advice, asset management, and administrative and custodial services to individuals, institutions and mutual funds. Additionally, economic and investment research services are sold to more than 230 institutions, including brokerage firms, insurance companies, pension funds and other banks. At December 31, 1993, the market value of trust assets under administration totaled $193 billion, with discretionary authority over $57 billion. According to published rankings, the Corporation ranks as the largest bank manager of mutual funds, one of the largest bank trustees for individuals, the fourth-largest institutional money fund manager and the seventh-largest bank money manager in the nation.\nInvestment Banking includes the asset\/liability management function of the Corporation as well as underwriting, brokerage and direct investment services. Full-service retail brokerage services are provided in selected offices within the Retail Banking office network through PNC Brokerage Corp and PNC Securities Corp. In addition, securities underwriting services are provided by PNC Securities Corp which ranks as one of the largest bank underwriters of revenue bonds for the health care industry and colleges and universities. Private equity placements for middle market and smaller companies to finance growth or ownership transition are provided by PNC Capital Corp, PNC Venture Corp and PNC Equity Management Corp.\nFor additional line of business information, see pages 27 through 30 of the Annual Report to Shareholders, which are incorporated herein by reference.\nSubsidiary Banks\nInformation as of December 31, 1993 for the Corporation's five largest Banks is set forth below.\nCREDIT RISK MANAGEMENT\nFor a description of the Corporation's credit risk management activities, information concerning the distribution of the loan portfolio and a discussion and analysis of risk elements in the loan portfolio see pages 31-35 of the Annual Report to Shareholders, incorporated herein by reference.\nFor additional information regarding the Corporation's business, see Items 7 and 8 of this Annual Report on Form 10-K.\nSUPERVISION AND REGULATION\nBank Holding Companies\nAs a registered holding company, the Corporation is regulated under the Act and is subject to supervision and regular inspection by the Board of Governors of the Federal Reserve System (\"Federal Reserve Board\"). The Act requires, among other things, the prior approval of the Federal Reserve Board in any case where the Corporation proposes to (i) acquire all or substantially all of the assets of any bank, (ii) acquire direct or indirect ownership or control of more than 5 percent of the voting shares of any bank or (iii) merge or consolidate with any other bank holding company.\nBank holding companies and their subsidiary banks are also subject to the provisions of the Community Reinvestment Act of 1977, as amended (\"CRA\"). Under the terms of the CRA, each subsidiary bank's record in meeting the credit needs of the community served by that bank, including low- and moderate-income neighborhoods is annually assessed by that bank's primary regulatory\nauthority. When a bank holding company applies for approval to acquire a bank or other bank holding company, the Federal Reserve Board will review the assessment of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application. The federal banking agencies have issued a notice of proposed rulemaking that would replace the current CRA assessment system with a new evaluation system that would primarily rate institutions based on their actual lending activity in the community. Under the current proposal, each institution would be evaluated based on the degree to which it is providing loans, branches and other services and investments to low- and moderate-income areas.\nThe Act prohibits the Federal Reserve Board from approving a bank holding company's application to acquire a bank or bank holding company located outside the state in which the operations of its banking subsidiaries are principally conducted, unless such acquisition is specifically authorized by statute of the state in which the bank or bank holding company to be acquired is located. Pennsylvania law permits bank holding companies located in any state to acquire Pennsylvania banks and bank holding companies, provided that the home state of the acquiring company has enacted \"reciprocal\" legislation. In this context, reciprocal legislation is generally defined as legislation that expressly authorizes Pennsylvania bank holding companies to acquire banks or bank holding companies located in another state on terms and conditions substantially no more restrictive than those applicable to such an acquisition in Pennsylvania by a bank holding company located in the other state.\nUnder the Act, the Corporation is prohibited, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of any class of voting shares of any non-banking corporation. Further, the Corporation may not engage in any business other than managing and controlling banks or furnishing certain specified services to subsidiaries, and may not acquire voting control of non-banking corporations except those corporations engaged in businesses or furnishing services which the Federal Reserve Board deems to be so closely related to banking as \"to be a proper incident thereto\". The Federal Reserve Board has determined that a number of activities meet this standard and include: making and servicing loans; performing certain fiduciary functions; leasing real and personal property; underwriting and dealing in government obligations and certain money market instruments; underwriting and dealing, to a limited extent, in corporate debt obligations and other securities that banks may not deal in; providing foreign exchange advisory and transactional services; and owning, controlling or operating a savings association, if the savings association engages only in deposit-taking activities and lending and other activities that are permissible for bank holding companies. The Board, from time to time, may revise the list of permitted activities.\nUnder Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to each of its subsidiary banks and to commit resources, including capital funds during periods of financial stress, to support each such bank. Although this \"source of strength\" policy has been challenged in litigation, the Federal Reserve Board continues to take the position that it has the authority to enforce it. Consistent with its \"source of strength\" policy for subsidiary banks, the Federal Reserve Board has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common shareholders has been sufficient to fund fully the dividends, and the prospective rate of earnings retention appears to be consistent with the company's capital needs, asset quality and overall financial condition.\nSubsidiary Banks\nThe Banks are subject to supervision and examination by applicable federal and state banking agencies, including the Office of the Comptroller of the Currency (\"Comptroller\") in the case of subsidiaries that are national banks. All of the Banks are insured by, and therefore subject to regulations of, the Federal Deposit Insurance Corporation (\"FDIC\"), and are also subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be 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. Numerous consumer laws and regulations also affect the operations of the Banks including, among others, disclosure requirements, antidiscrimination provisions, and substantative contractual limitations with respect to deposit accounts. The banking agencies, together with the Departments of Justice and Housing and Urban Development, have announced that they intend to enforce more rigorously compliance with community reinvestment, antidiscrimination and other fair lending laws and regulations. In 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.\nThe parent company's principal assets are its loans and advances to, and investments in, its Banks and other subsidiaries. Dividends from the Corporation's Banks constitute the principal source of income to the parent company. The Banks are subject to various statutory restrictions on their ability to pay dividends to the Corporation. Under such restrictions, the amount available for payment of dividends to the Corporation by the Banks was $942.8 million at December 31, 1993. In addition, the Comptroller and the FDIC, in the case of national bank subsidiaries, and the FDIC or the Federal Reserve Board, in the case of state bank subsidiaries, have authority to prohibit any such Bank from engaging in an unsafe or unsound practice in conducting its business. The payment of dividends, depending upon the financial condition of the Bank in question, could be deemed to constitute such an unsafe or unsound practice, and the regulatory agencies have indicated their view that it generally would be an unsafe and unsound practice to pay dividends except out of current operating earnings. The ability of the Banks to pay dividends in the future is presently, and could be further, influenced, among other things, by applicable capital guidelines or by bank regulatory and supervisory policies.\nThe ability of the Banks to make funds available to the parent company is also subject to restrictions imposed by federal law. For a discussion of these restrictions see \"Regulatory Matters\" on pages 56-57 of the Annual Report to Shareholders, incorporated herein by reference.\nThe Banks are also subject to the \"cross-guarantee\" provisions of federal law which provide that if one depository institution subsidiary of a multi-bank holding company fails or requires FDIC assistance, the FDIC may assess a commonly controlled depository institution for the actual or estimated losses suffered by the FDIC. Such liability could have a material adverse effect upon the financial condition of any assessed bank and its parent company. While the FDIC's claim is junior to the claims of depositors, holders of secured liabilities, general creditors and subordinated creditors, it is superior to the claims of shareholders and affiliates.\nThe amount of FDIC assessments paid by individual insured depository institutions is based on their relative risk as measured by regulatory capital ratios and certain other factors. Under this system, in establishing the insurance premium assessment for each bank, the FDIC will take into consideration the probability that the deposit insurance fund will incur a loss with respect to an institution, and will charge an institution with perceived higher inherent risks a higher insurance premium. The FDIC will also consider the different categories and concentrations of assets and liabilities of the institution, the revenue needs of the deposit insurance fund, and any other factors the FDIC deems relevant. Current regulations provide for a minimum assessment of 23 cents per $100 of eligible deposits. A significant increase in the assessment rate or a special additional assessment with respect to insured deposits could have an adverse impact on the results of operations and capital levels of the Banks or the Corporation.\nThe federal banking agencies possess broad powers to take corrective action as deemed appropriate for an insured depository institution and its holding companies. The extent of these powers depends upon whether the institution in question is considered \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" or \"critically undercapitalized.\" At December 31, 1993, all of the Banks exceeded the required ratios for classification as well capitalized. Generally, as an institution is deemed to be less well capitalized, the scope and severity of the agencies' powers increase. The agencies' corrective powers can include, among other things, requiring an insured financial institution to adopt a capital restoration plan which cannot be approved unless guaranteed by the institution's parent holding company; placing limits on asset growth and restrictions on activities; placing restrictions on transactions with affiliates; restricting the interest rate the institution may pay on deposits; prohibiting the institution from accepting deposits from correspondent banks; prohibiting the payment of principal or interest on subordinated debt; prohibiting the holding company from making capital distributions without prior regulatory approval; and, ultimately, appointing a receiver for the institution. Business activities may also be influenced by an institution's capital classification. For instance, only a \"well capitalized\" depository institution may accept brokered deposits without prior regulatory approval and only an \"adequately capitalized\" depository institution may accept brokered deposits with prior regulatory approval. For a discussion of the current capital levels of the Corporation, see \"Capital\" on page 37 of the Annual Report to Shareholders, incorporated herein by reference.\nNon-bank Subsidiaries\nAll of the non-bank subsidiaries of the Corporation are subject to regulatory restrictions imposed by the Federal Reserve Board and other federal or state regulatory agencies. For example, two subsidiaries of the Corporation are registered broker-dealers. The activities of these companies are monitored by the Comptroller in one instance and the Federal Reserve Board in the other instance and both are subject to rules and regulations promulgated by the Securities and Exchange Commission, the National Association of Securities Dealers, Inc., the Municipal Securities Rulemaking Board, the Securities Investors Protection Corporation and various state securities commissions. Several other non-bank affiliates of the Corporation are registered investment advisors and are subject to the regulations of the Securities and Exchange Commission and may be subject to one or more state securities commissions. Additionally, certain of these investment advisors are subsidiaries of national banks and are subject to supervision by the Comptroller. Other non-bank subsidiaries of the Corporation are regulated under federal and\/or state mortgage lending, insurance and consumer laws, among others.\nGOVERNMENTAL POLICIES\nThe operations of financial institutions may be affected by legislative changes. For example, Congress is presently considering various administration proposals, including proposals to consolidate the bank regulatory agencies, to authorize interstate branching and to amend various consumer protection laws. In addition, Congress is considering various issues relating to the separation of banking and commerce including, for example, banks' mutual fund activities. Financial institutions' operations also may be affected by the policies of various regulatory authorities. In particular, bank holding companies and their subsidiaries are affected by the credit policies of the Federal Reserve Board. An important function of the Federal Reserve Board is to regulate the national supply of bank credit. Among the instruments of monetary policy used by the Federal Reserve Board to implement its objectives are: open market operations in U.S. Government securities; changes in the discount rate on bank borrowings; and changes in reserve requirements on bank deposits.\nThese instruments of monetary policy are used in varying combinations to influence the overall level of bank loans, investments and deposits, the interest rates charged on loans and paid for deposits, the price of the dollar in foreign exchange markets, and the level of inflation. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banking institutions in the past and are expected to continue to do so in the future. It is not possible to predict the nature of future changes in monetary and fiscal policies, or the effect that they may have on the Corporation's business and earnings.\nCOMPETITION\nBank holding companies and their subsidiaries are subject to intense competition from various financial institutions and other companies or firms that engage in similar activities. The Banks compete for deposits with other commercial banks, savings banks, savings and loan associations, insurance companies, credit unions and issuers of commercial paper and other securities, such as shares in money market funds. In making loans, the Banks compete with other commercial banks, savings banks, savings and loan associations, consumer finance companies, credit unions, leasing companies and other lenders. In addition, PNC Securities Corp, PNC Brokerage Corp, PNC Capital Corp, PNC Venture Corp and PNC Equity Management Corp compete with commercial banks, investment banking firms, insurance companies and venture capital firms. In providing trust and money management services, the Corporation competes with other large commercial banks, trust companies, brokerage houses, mutual fund managers and insurance companies. Many such competitors have substantial resources and operations which are national or international in scope.\nThe Corporation and its subsidiaries compete not only with financial institutions based in the states in which the Banks are located, but also with a number of large out-of-state and foreign banks, bank holding companies and other financial institutions which have an established market presence in each state. Some of the financial institutions operating in these markets are engaged in local, regional, national and international operations and have more assets and personnel than the Corporation.\nEXECUTIVE OFFICERS\nInformation concerning each executive officer of the Corporation as of February 28, 1994 is set forth below. Each executive officer held the position indicated or another senior executive position with the same entity or one of its affiliates or a predecessor corporation for the past five years, except: Mr. Caldwell whose principal occupation prior to 1990 was Executive Vice President and Manager of the Trust Division of Harris Trust and Savings Bank, Chicago; Mr. Haunschild whose principal occupation prior to 1990 was Partner in the Pittsburgh Office of Ernst & Young; and Ms. Pudlin whose principal occupation prior to 1989 was Partner in the Philadelphia law firm of Ballard Spahr Andrews & Ingersoll.\nSTATISTICAL DISCLOSURES BY BANK HOLDING COMPANIES\nThe statistical information contained on pages 63-72 of the Annual Report to Shareholders is incorporated herein by reference.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - -PROPERTIES\nThe executive and administrative offices of the Corporation and PNC Bank, National Association (\"PNC Bank, N.A.\") are located in One PNC Plaza, located at Fifth Avenue and Wood Street, Pittsburgh, Pennsylvania. This thirty-story structure is owned by PNC Bank, N.A. The Corporation and PNC Bank, N.A. occupy the entire building. In January 1993, PNC Bank, N.A. purchased a thirty-four story structure adjacent to One PNC Plaza, now known as Two PNC Plaza, that contains additional office space. PNC Bank, N.A. also owns a recently-constructed data processing and telecommunications center located in a suburb of Pittsburgh.\nThe Corporation's subsidiaries own or lease numerous other premises for use in conducting banking and non-banking activities. The facilities owned or occupied under lease by the Corporation's subsidiaries are considered by management to be adequate. Neither the location of any particular office nor the unexpired term of any lease is deemed material to the business of the Corporation.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nOn December 13, 1993, the United States District Court for the Western District of Pennsylvania dismissed with prejudice the previously reported consolidated federal securities law class action lawsuit commenced in April 1990 against the Corporation and certain present and former directors and executive officers and the previously reported shareholders' derivative suit against such individuals. The dismissal was entered pursuant to a settlement agreement approved by the court. The cost of settlement was covered by insurance and existing litigation reserves.\nIn January 1992, a lawsuit was filed against PNC National Bank (\"PNCNB\"), a national bank subsidiary of the Corporation located in Wilmington Delaware, alleging that PNCNB violated Pennsylvania statutes in connection with certain fees charged on credit cards issued by PNCNB. The lawsuit is brought on behalf of a purported class of resident individuals of Pennsylvania who have contracted for, been charged, had reserved, or have paid these fees, and seeks, among other things, unquantified compensatory and triple damages and injunctive relief. In March 1992, PNCNB filed an answer to the amended complaint, denying liability and raising several affirmative defenses, and in January 1993, PNCNB filed a motion for judgment on the pleadings seeking dismissal of the suit. The lawsuit was filed in the Court of Common Pleas of Allegheny County and has been removed to the United States District Court for the Western District of Pennsylvania. PNCNB is vigorously defending the lawsuit. The impact of the final disposition of this litigation on the Corporation cannot be assessed at the present time. The lawsuit is one of several brought against a number of banks, challenging whether a credit card issuing bank can impose various types of fees allowed by the state where the issuer is located on cardholders residing in other states that allegedly limit or prohibit those fees.\nThe Corporation, in the normal course of business, is subject to various other pending and threatened lawsuits in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate that the ultimate aggregate liability, if any, arising out of such other lawsuits will have a material adverse effect on the Corporation's financial position.\nAt the present time, management is not in a position to determine whether any pending or threatened litigation will have a material adverse effect on the Corporation's results of operations in any future reporting period.\nPART II\nITEM 5","section_4":"","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Corporation's common stock is listed on the New York Stock Exchange and is traded under the symbol \"PNC\". At the close of business on February 28, 1994, there were 43,456 shareholders of record.\nHolders of common stock are entitled to receive dividends when declared by the Board of Directors out of funds legally available therefor. The Board of Directors may not pay or set apart dividends on the common stock until dividends for all past dividend periods on any series of outstanding preferred stock have been paid or declared and set apart for payment. The Board presently intends to continue the policy of paying quarterly cash dividends. However, the amount of any future dividends will depend upon earnings, the financial condition of the Corporation and other factors including applicable government regulations and policies. The ability to maintain dividends at current levels is affected by the level of core earnings, economic conditions, credit quality, regulatory policies, capital needs, growth objectives, the ability of the Banks and non-bank subsidiaries to upstream dividends to the parent company and other relevant factors. See further discussion concerning dividend restrictions under Item 1 of this Form 10-K and in \"Regulatory Matters\" on pages 56-57 of the Annual Report to Shareholders, which is incorporated herein by reference.\nAdditional information relating to the common stock under the caption \"Stock Prices\/Dividends Declared\" on page 80 of the Annual Report to Shareholders is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\n\"Selected Consolidated Financial Data\" on page 61 of the 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\"Corporate Financial Review 1993 versus 1992\" and \"Management's Discussion and Analysis 1992 Versus 1991\" on pages 24-37 and 73-76, respectively, of the Annual Report to Shareholders are incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe \"Report of Independent Auditors,\" \"Consolidated Financial Statements\" and \"Selected Quarterly Financial Data\" on pages 38, 39-60 and 62, respectively, of the Annual Report to Shareholders 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\nInformation relating to the principal occupations of directors of the Corporation, their ages, directorships in other companies, and respective terms of office under the heading \"Election of Directors - Information Concerning Nominees\" in the definitive proxy statement of the Corporation for the annual meeting of shareholders to be held on April 26, 1994 (\"Proxy Statement\") is incorporated herein by reference. Information regarding timely filing of initial reports of ownership and reports of changes in ownership of any equity securities of the Corporation under the heading \"Certain Reports\" in the Proxy Statement is incorporated herein by reference.\nInformation regarding executive officers of the Corporation is included in Part I of this Form 10-K.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nInformation regarding compensation of directors and executive officers under the headings \"Election of Directors - Compensation of Directors\" and \"Compensation of Executive Officers\" in the Proxy Statement is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding the beneficial ownership of the equity securities of the Corporation by each director and nominee for director, each of the five highest compensated executive officers and all directors and executive officers of the Corporation as a group under the heading \"Security Ownership of Certain Beneficial Owners and Management - Security Ownership of Directors and Executive Officers\" in the Proxy Statement is incorporated herein by reference. Information regarding ownership of the equity securities of the Corporation by certain other beneficial owners under the heading \"Security Ownership of Certain Beneficial Owners and Management - Security Ownership of Certain Beneficial Owners\" in the Proxy Statement is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding transactions and relationships with certain directors and executive officers of the Corporation and their associates under the heading \"Compensation of Executive Officers - Compensation Committee Interlocks and Insider Participation\" 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\nThe following consolidated financial statements and report of independent auditors of the Corporation, included in the Annual Report to Shareholders at the page indicated, are incorporated herein by reference.\nFINANCIAL STATEMENT SCHEDULES\nNot applicable.\nREPORTS ON FORM 8-K\nA Current Report on Form 8-K (\"Current Report\") dated as of November 19, 1993 was filed on December 7, 1993 pursuant to Items 2 and 5 to report: (i) completion of the acquisition of Sears Mortgage Corporation, Sears Mortgage Securities Corporation and Sears Savings Bank, FSB, and (ii) completion of the acquisition of Gateway Fed Corporation.\nAlso, a Current Report dated as of January 19, 1994 was filed on January 26, 1994 pursuant to Item 5 to report: (i) the Corporation's consolidated financial results for the three months and twelve months ended December 31, 1993, and (ii) completion of the acquisition of United Federal Bancorp, Inc.\nNo pro forma financial statements were required to be filed with either such Current Report.\nEXHIBITS\nThe exhibits listed on the Exhibit Index on pages 15-16 of this Form 10-K are filed herewith or are incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, PNC Bank Corp. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPNC BANK CORP.\nBy \/s\/ Thomas H. O'Brien ------------------------------ Thomas H. O'Brien Chairman and Chief Executive Officer\nDate: March 16, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of PNC Bank Corp. and in the capacities and on the dates indicated:\nEXHIBIT INDEX\n3.1 Articles of Incorporation of the Corporation as amended, filed herewith.\n3.2 By-Laws of the Corporation, as amended, filed herewith.\n4.1 Instruments defining the rights of holders of long-term debt of the Corporation and its subsidiaries are not filed as Exhibits because the amount of debt under each instrument is less than 10 percent of the consolidated assets of the Corporation. The Corporation undertakes to file these instruments with the Commission upon request.\n4.2 Designation of Series: $1.80 Cumulative Convertible Preferred Stock -- Series A, incorporated herein as part of Exhibit 3.1.\n4.3 Designation of Series: $1.80 Cumulative Convertible Preferred Stock -- Series B, incorporated herein as part of Exhibit 3.1.\n4.4 Designation of Series: $1.60 Cumulative Convertible Preferred Stock -- Series C, incorporated herein as part of Exhibit 3.1.\n4.5 Designation of Series: $1.80 Cumulative Convertible Preferred Stock -- Series D, incorporated herein as part of Exhibit 3.1.\n10.1 Supplemental Executive Retirement Income and Disability Plan of the Corporation, incorporated herein by reference to Exhibit 10.2 of the Annual Report on Form 10-K for the year ended December 31, 1990 (\"1990 Form 10-K\").\n10.2 Supplemental Executive Life Insurance and Spouse's Benefit Plan of the Corporation, incorporated herein by reference to Exhibit 10.3 of the 1990 Form 10-K.\n10.3 Description of the Corporation's Senior Executive Compensation Plan, incorporated herein by reference to Exhibit 10.4 of the Annual Report on Form 10-K for the year ended December 31, 1992 (\"1992 Form 10-K\").\n10.4 1992 Long-Term Incentive Award Plan of the Corporation, incorporated herein by reference to Exhibit 4.3 of the Registration Statement on Form S-8 at File No. 33-54960.\n10.5 1992 Director Share Incentive Plan, incorporated herein by reference to Exhibit 10.6 of the 1992 Form 10-K.\n11 Calculation of Primary and Fully Diluted Earnings Per Share, filed herewith.\n12.1 Computation of Ratio of Earnings to Fixed Charges, filed herewith.\n12.2 Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends, filed herewith.\n13 Annual Report to Shareholders for the year ended December 31, 1993, filed herewith. Such Annual Report, except for those portions thereof that are expressly incorporated by reference herein, is furnished for information of the Securities and Exchange Commission only and is not deemed to be \"filed\" as part of this Form 10-K.\n21 Major Subsidiaries of the Corporation, filed herewith.\n23 Consent of Ernst & Young, independent auditors for the Corporation, filed herewith.\n24 Power of Attorney of certain directors of the Corporation, filed herewith.","section_15":""}
{"filename":"105096_1994.txt","cik":"105096","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Company believes that it is one of the leading suppliers of plumbing products to the home repair and remodeling market in the United States. The Company conducts its business primarily through its wholly-owned subsidiaries Barnett Inc. (\"Barnett\"), and Waxman Consumer Products Group Inc. (\"Consumer Products\"). The Company distributes plumbing, electrical and hardware products, in both packaged and bulk form, to over 47,000 customers in the United States, including do-it-yourself (\"D-I-Y\") retailers, mass merchandisers, smaller independent retailers and plumbing and electrical repair and remodeling contractors. The Company's consolidated net sales from continuing operations were $215.1 million in fiscal 1994.\nThe Company's domestic business is conducted primarily through Barnett and Consumer Products. Through their nationwide network of warehouses and distribution centers, Barnett and Consumer Products provide their customers with a single source for an extensive line of competitively priced quality products. The Company's strategy of being a low-cost supplier is facilitated by its purchase of a significant portion of its products from low-cost foreign sources. Barnett's marketing strategy is directed predominantly to repair and remodeling contractors and independent retailers, as compared to Consumer Products' strategy of focusing on mass merchandisers and larger Do-It-Yourself (\"D-I-Y\") retailers.\nBased on management's experience and knowledge of the industry, the Company believes that Barnett is the only national mail order and telemarketing operation distributing plumbing, electrical and hardware products in the United States. Barnett's marketing strategy is comprised of frequent catalog and promotional mailings, supported by 24-hour telemarketing operations. Barnett has averaged 15% net sales growth per annum during the period from fiscal 1992 through fiscal 1994 as a result of (i) the expansion of its warehouse network to increase its market penetration, (ii) the introduction of new product offerings and (iii) the introduction of an additional catalog targeted at a new customer base. Barnett's net sales were $95.2 million in fiscal 1994.\nConsumer Products markets and distributes its products to a wide variety of retailers, primarily national and regional warehouse home centers, home improvement centers and mass merchandisers. An integral element of Consumer Products' marketing strategy of serving as a single source supplier is offering mass merchandisers and D-I-Y retailers innovative comprehensive marketing and merchandising programs designed to improve their profitability, efficiently manage shelf space, reduce inventory levels and maximize floor stock turnover. Consumer Products' customers currently include national retailers such as Kmart, Builders Square, Sears, Home Depot and Wal-Mart, as well as large regional D-I-Y retailers. According to the most recent rankings of the largest D-I-Y retailers published by National Home Center News, an industry trade publication, Consumer Products' customers include 16 of the 25 largest D-I-Y retailers in the United States. Management believes that Consumer Products is the only supplier\nto the D-I-Y market that carries a complete line of plumbing, electrical and floor protective hardware products, in both package and bulk form. Consumer Products' net sales were $70.7 million in fiscal 1994 and have remained generally consistent since fiscal 1992.\nThe Company, through its smaller operations, also distributes a full line of security hardware products and copper tubing, brass fittings and other related products. Net sales from these other operations were $47.7 million in fiscal 1994.\nBUSINESS STRATEGY\nThe Company's business strategy is designed to capitalize on the growth prospects for Barnett and Consumer Products. The Company's current strategy includes the following elements:\no Expansion of Barnett. Since its acquisition in 1984, Barnett's net sales and operating income have grown at compound annual growth rates of 11.7% and 13.2%, respectively, as a result of (i) the expansion of its warehouse network, (ii) the introduction of new product offerings and (iii) the introduction in January 1992 of an additional catalog targeted at a new customer base. The Company intends to continue to expand Barnett's national warehouse network and expects to open as many as four new warehouses during each of the next several fiscal years. Barnett expects to fund this expansion using cash flow from operations and\/or available borrowing under its secured revolving credit facility. Barnett also intends to continue expanding its product offerings, allowing its customers to utilize its catalogs as a means of one-stop shopping for many of their needs. In an effort to further increase profitability, Barnett is also increasing the number of higher margin product offerings bearing its proprietary trade names and trademarks.\no Enhance Competitive Position of Consumer Products. During the past 24 months, Consumer Products has restructured its sales and marketing functions in order to better serve the needs of its existing and potential customers. Consumer Products restructured its sales department by defining formal regions of the country for which regional sales managers would have responsibility. Prior to the restructuring, sales managers had responsibility for specific customers without regard to location. In addition, as part of the restructuring, in fiscal 1993 a marketing department was established separate and apart from the sales department. The marketing department is staffed with product managers who are responsible for identifying new product programs. The restructuring of the sales and marketing departments is complete at this time. Consumer Products' strategy is to achieve consistent growth by expanding its business with existing customers and by developing new products and new customers. In order to increase business with existing customers, Consumer Products is focusing on developing strategic alliances with its customers. Consumer Products seeks to (i) introduce new products within existing categories, as well as new product categories, (ii) improve customer service, (iii) introduce full service marketing programs and (iv) achieve higher profitability for both the retailer and Consumer Products. Management believes that Consumer Products is well positioned to benefit from the trend among many large retailers to consolidate their purchases among fewer vendors.\nCORPORATE RESTRUCTURING AND REORGANIZATION\nOn May 20, 1994, the Company issued Series A 12.75% Senior Secured Deferred Coupon Notes Due 2004 having an initial accreted value of $50 million (the \"Deferred Coupon Notes\") together with warrants (the \"Warrants\") to purchase 2.95 million shares of common stock, par value $.01 per share, of the Company (\"Common Stock\") in exchange for $50 million aggregate principal amount of the Company's outstanding 13.75% Senior\nSubordinated Notes due June 1, 1999 (the \"Senior Subordinated Notes\") pursuant to a private exchange offer (the \"Private Exchange Offer\") which was a part of a series of interrelated transactions (the \"Reorganization\"). In addition to the Private Exchange Offer, the components of the Reorganization included (i) the solicitation of the consents of the holders of the Senior Subordinated Notes to certain waivers of and the adoption of certain amendments to the indenture governing the Senior Subordinated Notes (the \"Senior Subordinated Consent Solicitation\"), (ii) the establishment of a $55 million revolving credit facility (the \"Domestic Credit Facility\") and a $15 million term loan (the \"Domestic Term Loan\"); and together with the Domestic Credit Facility, (the \"Debt Financing\"), (iii) the solicitation of the consents of the holders of the Company's 12.25% Fixed Rate and Floating Rate Senior Secured Notes due September 1, 1998 (Senior Secured Notes\") to certain waivers of and the adoption of certain amendments to the indenture governing the Senior Secured Notes (the 12.25% Consent Solicitation\") and (iv) the repayment of the borrowings under the Company's then existing domestic revolving credit facilities (including $27.6 million under the Company's then existing working capital credit facility and $1.2 million under the $5.0 million revolving credit facility of Barnett (the \"Barnett Financing\").\nDuring fiscal 1994, the Company restructured (the \"Corporate Restructuring\") its domestic operations such that the Company is now a holding company whose only material assets are the capital stock of its subsidiaries. As part of the Corporate Restructuring, the Company formed (a) Waxman USA Inc. (\"Waxman USA\") as a holding company for the subsidiaries that comprise and support the Company's domestic operations, (b) Waxman Consumer Products Group Inc. (\"Consumer Products\"), a wholly owned subsidiary of Waxman USA, to own and operate Consumer Products Group Division, and (c) WOC Inc. (\"WOC\"), a wholly owned subsidiary of Waxman USA, to own and operate Waxman USA's domestic subsidiaries, other than Barnett Inc. (\"Barnett\") and Consumer Products. On May 20, 1994, the Company completed the Corporate Restructuring by (i) contributing the capital stock of Barnett to Waxman USA, (ii) contributing the assets and liabilities of the Consumer Products Group Division to Consumer Products, (iii) contributing the assets and liabilities of its Madison Equipment Division to WOC, (iv) contributing the assets and liabilities of its Medal Distributing Division to WOC, (v) merging U.S. Lock Corporation (\"U. S. Lock\") and LeRan Copper & Brass, Inc. (\"LeRan\"), each a wholly owned subsidiary of the Company, into WOC, (vi) contributing the capital stock of TWI, International, Inc. (\"TWI\") to Waxman USA and (vii) contributing the capital stock of Western American Manufacturing, Inc. (\"WAMI\") to TWI. The Operating Companies consist of Barnett, Consumer Products and WOC. This restructuring was accounted for based upon each entities historical carrying amounts with no impact on the accompanying consolidated financial statements.\nDISCONTINUED OPERATIONS - IDEAL\nEffective March 31, 1994, the Company adopted a plan to dispose of its Canadian subsidiary, Ideal Plumbing Group, Inc. (\"Ideal\"). Unlike the Company's U.S. operations which supply products to customers in the home repair and remodeling market through mass retailers, Ideal primarily served customers in the Canadian new construction market through independent contractors. Accordingly, Ideal is reported as a discontinued operation and the consolidated financial statements have been reclassified to report separately Ideal's net assets and results of operations. Prior period consolidated financial statements have been reclassified to the current period presentation.\nAt the time the plan of disposition was adopted, the Company expected that the disposition would be accomplished through a sale of the business to a group which included members of Ideal's management. Such transaction would have required the consent of Ideal's Canadian banks as borrowings under its bank credit agreements were collateralized by all of the assets and capital stock of Ideal. The bank considered the management group's acquisition proposal, however the proposal was subsequently rejected. On May 5, 1994, without advance notice, the bank filed an involuntary bankruptcy petition against Ideal citing defaults under the bank credit agreements (borrowings under these agreements are non-recourse to Waxman Industries, Inc.). The Company has not contested the bank's efforts to effect the orderly disposition of\nIdeal. On May 30, 1994, Ideal was declared bankrupt by the Canadian courts and, as a result, the Company's ownership and control of Ideal effectively ceased on such date. Upon petition of Ideal's Canadian lenders, a trustee was appointed to liquidate the assets of Ideal. The Company has been advised that Ideal is no longer operating and the liquidation process is continuing at the present time. The Company has no liability to the creditors of Ideal as a result of Ideal's bankruptcy. The estimated loss on disposal totaled $38.3 million, without tax benefits, and represents a complete write-off of the Company's investment in Ideal. See Note 2 to Notes to Consolidated Financial Statements.\nBARNETT\nBarnett markets over 10,000 products to more than 33,000 active customers through comprehensive quarterly catalogs, supplemented by monthly promotional flyers and supported by telemarketing operations. Barnett services its customers, who are primarily plumbing and electrical contractors serving the repair and remodeling markets, and independent retailers, through its growing, nationwide network of 28 mail order warehouses. Barnett also distributes a specialized quarterly catalog of maintenance products (also supplemented by monthly promotional flyers) that is directed only to customers responsible for the maintenance of hotels, motels, office buildings, health care facilities and apartment complexes. The Company believes that this marketing strategy effectively positions Barnett to continue to expand its customer base and increase sales to existing customers. In fiscal 1994, Barnett's largest customer accounted for less than 2% of the Company's continuing operations' net sales and its top-ten customers accounted for less than 6% of the Company's continuing operations' net sales. Barnett's average sale is $240. Barnett's net sales were $95.2 million in fiscal 1994.\nBarnett was acquired by the Company in 1984. Since the acquisition, Barnett has increased its number of warehouses from three to 28 and the number of items in its catalog from 2,000 to 10,000. During this period, the number of active accounts serviced by Barnett increased from 6,000 to over 33,000. Barnett has added nine warehouses during the last three full fiscal years including two warehouses in fiscal 1994. Barnett plans to open up to four warehouses annually for the next several years. Barnett has been able to maintain its overall operating margins throughout its expansion.\nBased on management's experience and knowledge of the industry, the Company believes, in the absence of any applicable statistics, that Barnett is the only national mail order and telemarketing operation distributing plumbing, electrical and hardware products in the United States. The Company believes that Barnett has significant advantages over its regional and national competitors. Due to its size and volume of purchases, Barnett is able to obtain purchase terms which are more favorable than those available to its competition, enabling it to offer prices which are generally lower than those available from its competitors. In addition to Barnett's competitive pricing strategy, by offering over 10,000 products, Barnett is able to provide its customers with a single source of supply for many of their needs.\nMarketing and Distribution\nBarnett markets its products nationwide principally through regular catalog and promotional mailings to existing and potential customers, supported by telemarketing operations providing 24-hour, toll-free ordering and an expanding network of 28 warehouses allowing for delivery to customers generally within one day of the receipt of an order. The telemarketing operations are utilized to make telephonic sales presentations to certain potential customers only after these customers have received written promotional materials. Barnett's telemarketing operations are centralized in Jacksonville, Florida.\nCatalogs\nBarnett's in-house art department produces the design and layout for its catalogs and promotional mailings, including the quarterly catalog, the monthly promotional flyers and Barnett's catalog of maintenance products. Barnett's catalogs are indexed and illustrated, provide simplified pricing and highlight new product offerings.\nBarnett mails its principal catalog, containing plumbing, electrical and hardware products, to over 33,000 active customers, including hardware and building supply stores, lumberyards and plumbing, electrical repair and remodeling contractors. The quarterly catalog is supplemented by monthly promotional flyers mailed to approximately 180,000 active and potential customers. In January 1992, Barnett introduced a new catalog of maintenance products designed to appeal to customers responsible for the maintenance of hotels, motels, healthcare facilities, office buildings and apartment complexes. Since the maintenance catalog was introduced in 1992, Barnett has added approximately 6,000 new maintenance accounts.\nBarnett makes its initial contact with potential customers primarily through promotional flyers. Barnett obtains the names of prospective customers through the rental of mailing lists from outside marketing information services and other sources. Barnett uses sophisticated proprietary information systems to analyze the results of individual catalog and promotional flyer mailings and uses the information derived from these mailings to target future mailings. Barnett updates its mailing lists frequently to delete inactive customers.\nTelemarketing\nBarnett's telemarketing operations have been designed to make ordering its products as convenient and efficient as possible. Barnett offers its customers a nationwide toll-free telephone number which accepts orders on a 24-hour basis. Calls are handled by members of Barnett's well-trained staff of 47 telemarketers who utilize Barnett's proprietary, on-line order processing system. This system provides the telemarketing staff with access to information about products, pricing and promotions which enables them to better serve the customer. Barnett's telemarketing staff handles approximately 1,600 incoming calls per day.\nAfter an order is received, a computer credit check is performed and if credit is approved, the order is transmitted to the warehouse located nearest the customer and is shipped within 24 hours.\nIn addition to receiving incoming calls, Barnett's telemarketing operations are also utilized to make telephonic sales presentations to potential customers who have received promotional flyers from Barnett. Also, for several months prior to the opening of new mail order warehouses, Barnett utilizes its telemarketing operations to generate awareness of Barnett, its product offerings and the upcoming opening of new mail order warehouses located near the target customers.\nBarnett's telemarketing operations and information systems provide its management with current market information such as customer purchasing patterns and purchases, competitive pricing data, and potential new products. This information allows Barnett to quickly react to and capitalize on business opportunities.\nWarehouses\nBarnett currently has four warehouses in Texas, three in Florida and two in each of Pennsylvania, New York and California. The remaining 15 warehouses are dispersed among an equal number of states. Barnett's warehouses are located in areas meeting certain criteria for overall population and potential customers. Typical warehouses have approximately 15,000 to 18,000 square feet of space of which up to 600 square feet are devoted to over-the-counter sales. Barnett has initiated a program to enlarge product displays in the counter area of the warehouses in order to display the breadth of its expanding product line.\nBarnett's experience indicates that customers prefer to order from local suppliers and that many local tradespeople prefer to pick up their orders in person rather than to have them delivered. Therefore, Barnett intends to continue the expansion of its warehouse network in order to reduce the distance between it and the customer. For the year ended June 30, 1994, approximately 24% of Barnett's net sales were picked up by Barnett's customers.\nThe factors considered in site selection include the number of prospective customers in the local target area, the existing sales volume in such area and the availability and cost of warehouse space, as well as other demographic information. From its experience in opening 25 new warehouses since its acquisition by the Company, Barnett has gained substantial expertise in warehouse site selection, negotiating leases, reconfiguring space to suit its needs, and stocking and opening new warehouses. The average investment required to open a warehouse is approximately $500,000, including approximately $250,000 for inventory.\nProducts\nBarnett markets an extensive line of over 10,000 plumbing, electrical and hardware products, many of which are sold under its proprietary trade names and trademarks. This extensive line of products allows Barnett to serve as a single source supplier for many of its customers. Over the past two years, Barnett has added approximately 1,400 new products, including a new line of builders' hardware and light bulbs. Many of these products are higher margin products bearing Barnett's proprietary trade names and trademarks. Barnett tracks sales of new products the first year they are offered and new products that fail to meet specified sales criteria are discontinued. Barnett believes that its customers respond favorably to the introduction of new product lines in areas that allow the customers to realize additional cost savings and to utilize Barnett's catalogs as a means of one-stop shopping for many of their needs.\nIn an effort to further increase profitability and to further enhance Barnett's reputation as a leading supplier of plumbing, electrical and hardware products, Barnett is presently increasing the number of its higher margin product offerings bearing its proprietary trade names and trademarks. Proprietary products offer customers high quality, lower cost alternatives to the brand name products Barnett also sells. Barnett's catalogs and monthly promotional flyers emphasize the comparative value of such items. Barnett's products are generally covered by a one year warranty, and returns (which require prior authorization from Barnett) have historically been immaterial in amount.\nThe following is a discussion of Barnett's principal product groups:\nPlumbing Products. Barnett's plumbing products include faucets and faucet parts, sinks, disposals, vanities and cabinets, tub and shower accessories, and toilets and toilet tank repair items. Barnett's plumbing products are sold under its proprietary trademarks Premier(TM) and Regent(TM). Barnett also sells branded products of leading plumbing manufacturers.\nElectrical Products. Barnett's electrical products include such items as light bulbs, light fixtures, circuit panels and breakers, switches and receptacles, wiring devices, chimes and bells, telephone and audio\/video accessories and various appliance repair items. Certain of Barnett's electrical products are sold under its own proprietary trademarks, such as Premier(TM) light bulbs, and the proprietary trademarks of leading manufacturers of electrical supplies.\nHardware Products. Barnett sells a broad range of hardware products, including hand tools and power tools, patio and closet door repair accessories, window hardware, paint supplies, fasteners, safety equipment, cleaning supplies and garden hoses and sprinklers.\nCONSUMER PRODUCTS\nConsumer Products markets and distributes approximately 9,000 products to a wide variety of retailers, primarily D-I-Y warehouse home centers, home improvement centers, mass merchandisers, hardware stores and lumberyards. Representative of Consumer Products' large national retailers are Kmart, Builders Square, Sears, Home Depot and Wal-Mart. Representative of Consumer Products' large regional D-I-Y retailers are Channel Home Centers and Fred Meyer Inc. According to rankings of the largest D-I-Y retailers published in National Home Center News, an industry trade publication, Consumer Products' customers include 16 of the 25 largest D-I-Y retailers in the United States. Consumer Products works closely with its customers to develop comprehensive marketing and merchandising programs designed to improve their profitability, efficiently manage shelf space, reduce inventory levels and maximize floor stock turnover. Management believes that Consumer Products is the only supplier to the D-I-Y market that carries a complete line of plumbing, electrical and floor protective hardware products, in both packaged and bulk form. Consumer Products also offers certain of its customers the option of private label programs. The Company believes that Consumer Products will benefit from the continued growth of the D-I-Y market which, according to Do-It-Yourself Retailing, an industry trade publication, is expected to expand at a compound annual rate of 8% over the next three years as well as from the expected growth of existing customers, several of which have announced expansion plans.\nIn fiscal 1994, K-Mart and its subsidiary Builder's Square, accounted for approximately 13% of the Company's continuing operations' net sales. No other customer was responsible for more than 2% of the Company's continuing operations' net sales in fiscal 1994. Consumer Products' top ten customers accounted for approximately 25% of the Company's continuing operations' net sales in fiscal 1994.\nDuring the 1980's, Consumer Products significantly expanded its business through a combination of internal growth and strategic acquisitions. The Company's acquisition strategy focused on businesses which marketed similar or complementary product lines to customers or markets not previously served or through channels not previously utilized by the Company. In recent years, Consumer Products has integrated the acquired businesses to enhance the Company's purchasing power, improving operating efficiencies and enabling Consumer Products to cross-sell a broader range of products to a larger customer base. These improvements have enabled Consumer Products to withstand financial downturns suffered by several important regional retailers to whom Consumer Products sells its products and to significantly increase its sales to several national retailers. Consumer Products' net sales were $70.7 million in fiscal 1994.\nIn recent years, the rapid growth of large mass merchandisers and D-I-Y retailers has contributed to a significant consolidation of the United States retail industry and the formation of large, dominant, product specific and multi-category retailers. These retailers demand suppliers who can offer a broad range of quality products and can provide strong marketing and merchandising support. Due to the consolidation in the D-I-Y retail industry, a substantial portion of Consumer Products' net sales are generated by a small number of customers. During the past 24 months, Consumer Products has restructured its sales and marketing functions in order to better position itself to meet the demands of the retailers. Management believes that its strategy of developing new products and forming strategic alliances with its customers will enable Consumer Products to effectively compete and achieve consistent growth. Consumer Products supplies products to its customers pursuant to individual purchase orders and has no long-term written contracts with its customers.\nMarketing and Distribution\nConsumer Products' marketing strategy includes offering mass merchandisers and D-I-Y retailers a comprehensive merchandising program which includes design, layout and setup of selling areas. Sales and service personnel assist the retailer in determining the proper product mix in addition to designing department layouts to effectively display products and optimally utilize available floor and shelf space. Consumer\nProducts supplies point-of-purchase displays for both bulk and packaged products, including color-coded product category signs and color-coordinated bin labels to help identify products, and backup tags to signify products that require reordering. Consumer Products also offers certain of its customers the option of private label programs for their plumbing and floor care products. In-house design, assembly and packaging capabilities enable Consumer Products to react quickly and effectively to service its customers' changing needs. In addition, Consumer Products' products are packaged and designed for ease of use, with \"how to\" instructions included to simplify installation, even for the uninitiated D-I-Y consumer.\nConsumer Products' sales and service representatives visit stores regularly to take reorders and recommend program improvements. These representatives also file reports with Consumer Products, enabling it to stay abreast of changing consumer demand and identify developing trends. In order to support its customers' \"just-in-time\" requirements, Consumer Products has significantly improved its EDI capabilities, so as to reduce their inventory levels and increase returns on investment.\nConsumer Products operates and distributes its products through four strategically located distribution facilities in Cleveland, Ohio, Lancaster, Pennsylvania, Dallas, Texas and Reno, Nevada.\nProducts\nThe following is a discussion of the principal product groups:\nPlumbing Products. Consumer Products' plumbing products include valves and fittings, rubber products, repair kits and tubular products such as traps and elbows. Many of Consumer Products' plumbing products are sold under the proprietary trade names Plumbcraft(R), PlumbKing(R), Plumbline(TM) and KF(R). In addition, Consumer Products offers certain of its customers the option of private label programs. Consumer Products also offers proprietary lines of faucets under the trade name Premier(R), as well as a line of shower and bath accessories under the proprietary trade name Spray Sensations(TM).\nElectrical Products. Consumer Products' electrical products include items such as plugs, adapters, outlets, wire, circuit breakers and various tools and test equipment. Consumer Products sells many of its electrical products under the proprietary trade name Electracraft(R). Consumer Products also sells a line of outdoor weatherproof electrical products, a full line of ceiling fan accessories, a line of telephone accessories and connecting devices, a line of audio and video accessories and lamp and light fixture replacement parts and replacement glassware.\nFloor Protective Hardware Products. Consumer Products' floor protective hardware products include casters, doorstops and other floor, furniture and wall protective items. Consumer Products markets a complete line of floor protective hardware products under the proprietary trade name KF(R) and also under private labels.\nOTHER OPERATIONS\nThe Company has several other operations, which are conducted through WOC Inc. and TWI International Inc. These operations, which in the aggregate generated net sales in fiscal 1994 of $47.7 million, accounted for approximately 22.1% of the net sales from the Company's continuing operations during the period. The most significant of these operations are U.S. Lock, a supplier of security hardware products, and LeRan Copper & Brass (\"LeRan\"), a supplier of copper tubing and specialty plumbing products. U. S. Lock and LeRan, as well as Madison Equipment and Medal Distributing, are operated as separate divisions of WOC. TWI includes the foreign sourcing and packaging operations which support the Company's continuing operations.\nU.S. Lock\nU.S. Lock, which was acquired by the Company in 1988, carries a full line of security hardware products, including locksets, door closers and locksmith tools. Many of these products are sold under the U.S. Lock(R) and Legend(TM) trademarks. U.S. Lock markets and distributes its products primarily to locksmiths through a telemarketing\nsales team. U.S. Lock's telemarketing effort is supplemented with a catalog that is mailed annually to 6,000 existing customers and promotional flyers. Since its acquisition by the Company, U.S. Lock has increased its number of warehouses from one to four, three of which are shared with Barnett. Shared facilities allow the Company to realize additional efficiencies by consolidating space requirements and reducing personnel costs.\nLeRan\nLeRan, which was acquired by the Company in 1985, is a supplier of copper tubing and fittings, brass valves and fittings, malleable fittings and related products. Its customers include liquid petroleum gas dealers, lumberyards, plumbing and mechanical contractors and D-I-Y retailers. LeRan markets its products primarily through salesmen and outside service representative organizations. These efforts are supported by a catalog, which is mailed semiannually to 7,000 existing customers, monthly promotional flyers and a telemarketing program. LeRan currently services its customers from four regional warehouses, two of which are shared with Barnett.\nOther\nWOC's other operations also include its Madison Equipment division, a supplier of electrical products, and its Medal Distributing division, a supplier of hardware products.\nPURCHASING, PACKAGING AND ASSEMBLY\nProducts bearing the Company's proprietary trade names and trademarks are assembled and packaged in its Taiwan, Mainland China and Mexico facilities. The products packaged in Taiwan and China are purchased locally in bulk and, after assembly and packaging, are shipped to the Company's various distribution centers in the United States. The Company also outsources the packaging of certain products. For the year ended June 30, 1994, products purchased overseas, primarily from Taiwan, accounted for approximately 27.2% of the total product purchases made by the Company's continuing operations.\nTWI, through its subsidiaries, operates the Taiwan and Mainland China facilities, which assemble and package plumbing and electrical products. In addition, the facility in Mainland China manufactures and packages plastic floor protective hardware. The Company believes that these facilities give it competitive advantages, in terms of cost and flexibility in sourcing. Both labor and physical plant costs are significantly below those in the United States.\nDuring fiscal 1991, the Company purchased Western American Manufacturing Inc. (\"WAMI\"), a small manufacturer of plumbing pipe nipples in Tijuana, Mexico. Pipe nipples are short lengths of pipe from 1\/2 of an inch to 6 feet long, threaded at each end. As a result of this acquisition, the Company is vertically integrated in the manufacture and distribution of pipe nipples. Since the acquisition, in order to take advantage of lower labor costs, the Company has relocated certain of its United States packaging operations to TWI's WAMI subsidiary in Mexico.\nSubstantially all of the other products purchased by the Company are manufactured for it by third parties. The Company estimates that it purchases products and materials from over approximately 1,300 suppliers and is not dependent on any single unaffiliated supplier for any of its requirements.\nThe following table sets forth the approximate percentage of net sales attributable to the Company's principal products groups:\nIMPORT RESTRICTIONS\nUnder current United States government regulations, all products manufactured offshore are subject to import restrictions. The Company currently imports goods from Mexico under the preferential import regulations commonly known as '807' and as direct imports from China and Taiwan. The '807' arrangement permits an importer who purchases raw materials in the United States and then ships the raw materials to an offshore factory for assembly, to reimport the goods, without quota restriction and to pay a duty only on the value added in the offshore factory.\nWhere the Company chooses to directly import goods purchased outside of the United States, the Company may be subject to import quota restrictions, depending on the country in which assembly takes place. These restrictions may limit the amount of goods of a particular category that a country may export to the United States. If the Company cannot obtain the necessary quota, the Company will not be able to import the goods into the United States. Export visas for the goods purchased offshore by the Company are readily available.\nThe above arrangements, both 807 and quota restrictions, may be superseded by more favorable regulations with respect to Mexico under the North American Free Trade Agreement (\"NAFTA\"), or may be limited by revision or cancelled at any time by the United States government. The Company does not believe that its relative competitive position will be adversely affected by NAFTA. As a result of the passage of NAFTA, it is expected that importation from Mexico will become more competitive in the near future relative to importation from other exporting countries.\nCOMPETITION\nThe Company faces significant competition from different competitors within each of its product lines, although it has no competitor offering the range of products in all of the product lines that the Company offers. The Company believes that its buying power, extensive inventory, emphasis on customer service and merchandising programs have contributed to its ability to compete successfully in its various markets. In the areas of electrical and hardware supplies, the Company faces significant competition from smaller companies which specialize in particular types of products and larger companies which manufacture their own products and have greater financial resources than the Company. Barnett competes principally with local distributors of plumbing, electrical and hardware products. The Company believes that competition in sales to both mail order customers and retailers is primarily based on price, product quality and selection, as well as customer service, which includes speed of responses for mail order customers and packaging and merchandising for retailers.\nEMPLOYEES\nAs of June 30, 1994, the Company employed 1,211 persons, 273 of whom were clerical and administrative personnel, 190 of whom were sales service representatives and 748 of whom were either production or warehouse personnel. Approximately 8% of the Company's employees are represented by collective bargaining units. The Company considers its relations with its employees, including those represented by collective bargaining units, to be satisfactory.\nTRADEMARKS\nSeveral of the trademarks and trade names used by the Company are considered to have significant value in its business. See \"Business - Barnett - - - Products,\" \"Consumer Products - Products\" and \"Other Operations\".\nENVIRONMENTAL REGULATIONS\nThe Company is subject to certain federal, state and local environmental laws and regulations. The Company believes that it is in material compliance with such laws and regulations applicable to it. To the extent any subsidiaries of Waxman Industries are\nnot in compliance with such laws and regulations, Waxman Industries, as well as such subsidiaries, may be liable for such non-compliance. However, in any event, the Company is not aware of any such liabilities which could have a material adverse effect on it or any of its subsidiaries.\nSEASONALITY\nThe Company's sales are generally consistent throughout its fiscal year.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table sets forth, as of June 30, 1994, certain information with respect to the Company's principal physical properties:\nIn addition to the properties shown in the table, the Company owns 2 warehouses and leases 36 warehouses ranging in size from 6,000 to 50,000 square feet (of these properties, Barnett leases 26 warehouses and Consumer Products leases two warehouses).\nThe Company believes that its facilities are suitable for its operations and provide the Company with adequate productive capacity.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is subject to various legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of any ultimate liability with respect to these actions will not materially affect the financial statements of the Company.\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.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following is a list of the executive officers of the Company and a brief description of their business experience during the past five years. Each executive officer will hold office until his successor is chosen and qualified.\nMelvin Waxman, age 60, was elected Co-Chief Executive Officer in May 1988. Mr. Waxman has been the Chief Executive Officer of the Company since July 1970, and has been a director of the Company since 1962. Mr. Waxman has been Chairman of the Board since August 1976. Melvin Waxman and Armond Waxman are brothers.\nArmond Waxman, age 55, was elected Co-Chief Executive Officer in May 1988. Mr. Waxman has been the President and Treasurer of the Company since August 1976. Mr. Waxman has been a director of the Company since 1962 and was Chief Operating Officer of the Company from August 1976 to May 1988. Armond Waxman and Melvin Waxman are brothers.\nJohn S. Peters, age 46, was elected to the position of Senior Vice President--Operations in April 1988, after serving as Vice President--Operations of the Company since February 1985. Prior to that, Mr. Peters had been Vice President--Personnel\/Administration of the Company since February 1979.\nWilliam R. Pray, age 47, was elected Senior Vice President in February 1991, and is also President of Barnett, a position he has held since 1987. He joined Barnett in 1979 as Vice President of Sales and Marketing.\nLaurence S. Waxman, age 37, was elected Senior Vice President in November 1993 and is also President of Waxman Consumer Products Group, Inc., a position he has held since 1988. Mr. Waxman joined the Company in 1981. He is the son of Melvin Waxman.\nNeal R. Restivo, age 34, was elected Vice President, Finance and Chief Financial Officer of the Company in November 1993, after serving as Vice President, Corporate Controller since November 1990, and as Corporate Controller of the Company since November 1989. From August 1982 until November 1989, he was employed by the public accounting firm of Arthur Andersen LLP, where he was an Audit Manager since 1988.\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 is listed on the New York Stock Exchange (\"NYSE\") under the symbol \"WAX\". The Company's Class B Common Stock does not trade in the public market due to restricted transferability. However, the Class B Common Stock may be converted into Common Stock on a share-for-share basis at any time.\nThe following table sets forth the high and low closing quotations as reported by the NYSE for fiscal years 1994 and 1993.\nHOLDERS OF RECORD\nOn September 12, 1994, there were 1,092 holders of record of the Company's Common Stock and 144 holders of record of the Company's Class B Common Stock.\nDIVIDENDS\nThe Company declared no dividends in fiscal 1994. Restrictions contained in the Company's debt instruments currently prohibit the declaration and payment of any cash dividends.\n(1) The information above and on the preceding page reflects the acquisitions of Western American Manufacturing in November 1990, and U.S. Lock Corporation in July 1988, the plumbing and floor care businesses of The Stanley Works in May 1988, Madison Equipment Company in March 1988, H. Belanger Plumbing Accesories, Ltd. in July 1987, Keystone Franklin, Inc. in December 1986, Select-Line Industries, Inc. in April 1986, Leran Copper & Brass, Inc. in November 1985 and Barnett Brass & Copper, Inc. in July 1984. Discontinued operations data relates to Ideal which was acquired in May 1989 and accounted for as a purchase. All per share amounts have been adjusted to reflect a three-for-two stock split effective July 1, 1988.\n(2) See Note 4 to the Notes to Consolidated Financial Statements for a further discussion of the extraordinary charge for fiscal 1992 and fiscal 1994. The fiscal 1990 extraordinary charge related to the repurchase of the Company's Convertible Debentures.\n(3) See Note 3 to the Notes to Consolidated Financial Statements.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe Company operates in a single business segment-the distribution of plumbing, electrical and hardware products. The Company's business is conducted primarily through Barnett and Consumer Products.\nEffective March 31, 1994, the Company adopted a plan to dispose of its Canadian subsidiary, Ideal. Unlike the Company's U.S. operations which supply products to customers in the home repair and remodeling market through mass retailers, Ideal primarily served customers in the Canadian new construction market through independent contractors. The decision to dispose of Ideal was prompted by a number of factors which had adversely affected Ideal's results of operations and resulted in severe liquidity problems which jeopardized Ideal's ability to continue conducting its operations. At the time the plan of disposition was adopted, the Company expected that the disposition would be accomplished through a sale of the business to a group of investors which included members of Ideal's management. Such transaction would have required the consent of Ideal's Canadian banks as borrowings under its bank credit agreements were collateralized by all of the assets and capital stock of Ideal. The bank considered the management group's acquisition proposal; however, the proposal was subsequently rejected. On May 5, 1994, without advance notice, Ideal's Canadian bank filed an involuntary bankruptcy petition against Ideal citing defaults under the bank credit agreements (borrowings under these agreements are non-recourse to Waxman Industries). The Company has not contested the bank's efforts to effect the orderly disposition of Ideal. On May 30, 1994, Ideal was declared bankrupt by the Canadian court and, as a result, the Company's ownership and control of Ideal effectively ceased on such date. The estimated loss on disposal totaled $38.3 million, without tax benefits, and represents a complete write-off of the Company's investment in Ideal. See Note 2 to Notes to Consolidated Financial Statements.\nFor financial reporting purposes, Ideal is reported as a discontinued operation and the Company's consolidated financial statements have been reclassified to report separately Ideal's net assets and results of operations. Prior period consolidated financial statements have been reclassified to conform to the current period presentation.\nRESULTS OF OPERATIONS\nThe following tables set forth certain items reflected in the Company's Consolidated Statements of Income expressed as a percentage of net sales:\nFISCAL 1994 VERSUS FISCAL 1993\nNet sales\nThe Company's net sales from continuing operations for fiscal 1994 totaled $215.1 million compared with $204.8 million in fiscal 1993, an increase of 5.0%. The Company's net sales were adversely affected by the sale of H. Belanger Plumbing Accessories (\"Belanger\") in October 1993. Belanger's net sales for fiscal 1994 totaled $1.5 million compared with $6.3 million in fiscal 1993. Net sales increased 7.6% after excluding the impact of Belanger. The net sales increase is primarily the result of the continued growth of Barnett. Barnett's net sales increased $12.3 million or 14.9%, from $82.9 million in fiscal 1993 to $95.2 million in fiscal 1994. Sales of new products accounted for $7.2 million of the increase. The remainder of Barnett's increase was the result of opening additional mail order warehouses, as well as the growth of Barnett's existing customer base. Barnett opened two additional warehouses during fiscal 1994, increasing the total number of warehouses to 28. Also contributing to the overall increase in net sales from continuing operations was increased net sales from Consumer Products. Consumer Products net sales increased $3.2 million or 4.8%, from $67.5 million in fiscal 1993 to $70.7 million in fiscal 1994. The increase in Consumer Products' net sales is primarily the result of the sale of additional existing product lines to several of its existing customers. Management believes that the change in the continuing operation's net sales is primarily the result of changes in volume.\nGross Profit\nThe Company's gross profit increased from 33.0% in fiscal 1993 to 34.9% in fiscal 1994. The increase in the Company's gross margin is primarily a result of improved margins at Barnett. Barnett's gross margin has been favorably impacted by increased sales of higher margin proprietary branded products. Also contributing to the increase in gross margins were improved gross margins at Consumer Products. Consumer Products' margin increased as a result of proportionately higher sales of higher margin packaged products during the latter part of fiscal 1994. Overall, the Company's gross margins were favorably impacted by an increase in the percentage of products purchased from foreign sources. Such products typically generate higher gross margins than products purchased domestically. The sale of Belanger had no significant effect on gross margin. Excluding the impact of Belanger, gross margin would have been 32.9% in fiscal 1993 as compared to 34.9% in fiscal 1994.\nOperating Expenses\nThe Company's operating expenses increased 1.4% for fiscal 1994 from $56.1 million in fiscal 1993 to $56.9 in fiscal 1994. As discussed below, prior year operating expenses included approximately $1.2 million of additional amortization expense relating to an accounting change. Excluding the impact of this additional amortization as well as the sale of Belanger, operating expenses increased 6.9% from $52.7 million in fiscal 1993 to $56.4 million in fiscal 1994. This increase was due primarily to higher operating expenses at Barnett. Barnett's operating expenses increased approximately $2.8 million. The majority of the increase in Barnett's operating expenses related to increased warehouse and selling and advertising costs. The increases in warehouse and selling and advertising costs were $0.7 million and $1.1 million, respectively. These increases primarily related to the opening of new mail order warehouses and increased promotional activity during fiscal 1994. Consumer Products' operating expenses increased approximately $0.5 million or 2.9% between years.\nRestructuring and Other Non-Recurring Charges\nAs discussed below, the Company recorded a $6.8 million restructuring charge during fiscal 1993.\nOperating Income\nThe Company's operating income totaled $18.2 million or 8.5% of net sales in fiscal 1994 compared to $4.7 million or 2.3% of net sales in fiscal 1993. Fiscal 1993 operating income included a $6.8 million restructuring charge, as well as $1.2 million of additional amortization expense relating to an accounting change. The impact of the sale of Belanger on operating income was not significant.\nInterest Expense\nThe Company's interest expense totaled $21.3 million in fiscal 1994 compared to $20.4 in fiscal 1993. Average borrowings increased from $159.1 million in fiscal 1993 to $172.2 million in fiscal 1994. The increase in average borrowings outstanding is due to increased working capital needs relating to the growth of the Company's operations as well as the impact of the additional debt incurred to fund repurchase premiums, fees and expenses relating to the Company's recent debt restructuring. The weighted average interest rate decreased from 12.9% in fiscal 1993 to 12.4% in fiscal 1994. The decrease in the weighted average interest rate results from proportionally higher borrowings under the Company's revolving credit facilities during fiscal 1994. Revolving credit facility borrowings bear lower interest rates than the Company's other indebtedness. As a result of the debt restructuring, cash interest expense will be reduced by approximately $6.9 million annually for five years. The reduction in cash interest requirements will be offset in part by the $11.0 million of additional indebtedness incurred as part of the Reorganization. The Company's weighted average interest rate is expected to increase by approximately 0.5% as a result of the completion of the Reorganization. See \"Liquidity and Capital Resources\".\nIncome Taxes\nIn accordance with the provisions of SFAS 109, the Company is unable to benefit losses in the current year. The Company has $59.6 million of available domestic net operating loss carryforwards which expire through 2009, the benefit of which has been reduced 100% by a valuation allowance. This includes amounts relating to the disposition of Ideal. The Company will continue to evaluate the valuation allowance and to the extent that the Company is able to recognize tax benefits in the future, such recognition will favorably affect future results of operations.\nThe provision for income taxes for both fiscal years 1993 and 1994 represent state and foreign taxes.\nLoss from Continuing Operations\nThe Company's loss from continuing operations totaled $3.5 million in fiscal 1994 compared to $15.9 million in fiscal 1993.\nDiscontinued Operations\nThe Company's net loss from discontinued operations totaled $3.2 in fiscal 1994, compared to $11.2 million in fiscal 1993. The Company also recognized a loss on the disposal of Ideal of approximately $38.3 million in the fiscal 1994 third quarter.\nExtraordinary Charge\nThe Company recognized a $6.8 million extraordinary charge, without tax benefit in fiscal 1994. Approximately, $6.6 million of the extraordinary charge relates to the refinancing of the $50 million of Senior Subordinated Notes as well as borrowings under the domestic bank credit facilities. The extraordinary charge included the fees paid upon the exchange of the Senior Subordinated Notes along with the accelerated amortization of unamortized debt discount and issuance costs. The remainder of the extraordinary charge results from the Company's repurchase of $1.9 million of its 9.5% Convertible Subordinated Debentures due 2007 (\"Convertible Debentures\") pursuant to a mandatory repurchase obligation. As a result of the repurchase, the Company recorded an extraordinary charge of $.2 million which primarily represents the accelerated amortization of unamortized debt discount and issuance costs.\nAs noted in \"Liquidity and Capital Resources,\" commencing in September 1996, the Company is required to make certain substantial sinking fund payments with respect to its Senior Secured Notes. In order to eliminate and\/or satisfy such sinking fund obligations, and to decrease the Company's high degree of leverage, the Company will have to obtain a significant infusion of funds either through additional debt refinancing transactions or the sale of equity and\/or assets. Although the Company is currently exploring its various alternatives, it has not yet committed to any specific course of action or transaction. The Company expects that additional extraordinary charges will be incurred if additional debt refinancing transactions occur. There can, however, be no assurances with respect to the timing and magnitude of any such extraordinary charges.\nNet Loss\nThe Company's net loss (including those relating to Ideal) for fiscal 1994 totaled $51.9 million compared with a net loss of $29.2 million in fiscal 1993. The fiscal 1993 net loss includes a $2.1 million charge for the cumulative effect of a change in accounting for warehouse and catalog costs, which was made during the fourth quarter of fiscal 1993 and was applied retroactively to July 1, 1992.\nFISCAL 1993 VERSUS FISCAL 1992\nNet sales\nThe Company's net sales from continuing operations for fiscal 1993 totaled $204.8 million compared with $197.7 million in fiscal 1992, an increase of 3.6%. Barnett's net sales increased 14.9% from $72.1 million in fiscal 1992 to $82.9 million in fiscal 1993. New product introductions accounted for $5.6 million of this increase. In addition, the new catalog of maintenance products introduced in January 1992 generated approximately $2.2 million in incremental sales. The remainder of Barnett's increase was the result of the opening of additional mail order warehouses, as well as the growth of Barnett's existing customer base. Barnett opened three additional mail order warehouses during fiscal 1993, increasing the total number of warehouses to 26. The increase from Barnett was offset, in part, by lower net sales from Consumer Products. Consumer Products' net sales totaled $67.5 million in fiscal 1993 compared with $70.0 million in fiscal 1992, a decrease of 3.6%. Management believes that the change in the domestic operations' net sales is primarily the result of changes in volume.\nGross Profit\nThe Company's gross margin was 33.0% in fiscal 1993 compared with 35.7% in fiscal 1992. Barnett's gross margin declined approximately one-half of one percentage point and Consumer Products' gross margin declined approximately four percentage points. The majority of Consumer Products' decline in margin is attributable to proportionately lower sales of higher margin packaged products as well as competitive pressures within its markets relating to the pricing of new business. Consumer Products' margins continued to decline during the first part of fiscal 1994, however it improved during the latter part of that year.\nOperating Expenses\nThe Company's operating expenses totaled $56.1 million or 27.4% of net sales, in fiscal 1993 compared with $51.8 million, or 26.2% of net sales, in fiscal 1992, an increase of $4.3 million, or 8.2%. Approximately $1.2 million of this increase relates to accelerated amortization of certain warehouse start-up and catalog costs during fiscal 1993 to conform with prevailing industry practice. This change was made during the fourth quarter and was applied retroactively to July 1, 1992. The effect of this change on fiscal 1993 results was to increase amortization expense by $1.2 million. This increase is primarily the result of the introduction of a new catalog, and in management's opinion, was not indicative of the expected impact of accelerated amortization on future operating results. The cumulative effect of this change on prior years totaled $2.1 million and is reported separately in the income statement, without tax benefit, as a change in accounting. Excluding the impact of this item, operating expenses were up 6.7% primarily due to increases at Barnett. Barnett's operating expenses (excluding the accelerated amortization) increased approximately $2.1 million or 13.4% which is less than Barnett's 14.9% increase in net sales between the years. Approximately $1.3 million of Barnett's increase in operating expenses is related to the opening of new mail order warehouses. Consumer Products' operating expenses increased approximately $0.4 million between years.\nRestructuring and Other Non-Recurring Charges\nIn fiscal 1993, the Company recorded $6.8 million of restructuring and other nonrecurring charges. In fiscal 1992, the Company recorded $3.9 million of restructuring and other nonrecurring charges.\nThe fiscal 1993 restructuring charge consisted of $4.6 million related to the expected losses in connection with the disposal of three small operating units. The decision to dispose of the three entities was based in part on the Company's strategy to refocus and build on its core businesses in the U.S. (i.e., Consumer Products and Barnett). The Company completed the sale of one of these operating units in October 1993. The Company was unable to come to terms with the prospective buyer of the other two entities and the consummation of a sale of these businesses is not expected to occur in the foreseeable future, if at all. The remainder of the restructuring charge included $1.6 million of costs incurred to consolidate administrative functions and transfer two of Consumer Products' domestic packaging facilities to Mexico. These costs principally consist of lease and severance termination costs of $0.5 million, relocation costs, including payroll and freight costs of $0.5 million and a write-off of fixed assets of $0.1 million. The relocation to Mexico was done in order to take advantage of that country's lower labor costs which are expected to benefit the Company annually through increased margins. No additional cash disbursements relating to the $1.6 million restructuring charge are expected. The remaining $0.6 million related to the Company's decision not to proceed with the securities offering of Barnett in fiscal 1993.\nThe fiscal 1992 restructuring charge consisted of a $3.9 million capital loss realized upon the sale of the Company's portfolio of debt securities.\nOperating Income\nThe Company's operating income totaled $4.7 million in fiscal 1993 compared with $14.9 million in fiscal 1992, a decrease of 68.5%. Fiscal year 1993 results were negatively impacted by the $6.8 million restructuring charge described above, and the $1.2 million of accelerated amortization described above. The remainder of the decrease was primarily attributable to a $2.5 million decline of Consumer Products' gross margin.\nInterest Expense\nThe Company's net interest expense totaled $20.4 million for fiscal year 1993 compared with $20.0 million for fiscal year 1992, an increase of 1.7%. Average borrowings outstanding totaled $159.1 million in fiscal 1993, as compared with $159.7 million in fiscal 1992. Weighted average borrowings in fiscal 1992 included amounts which the Company borrowed under a domestic term loan which were invested in highly liquid short-term securities and used for working capital purposes until the Company obtained its revolving credit facility in September 1991. Excluding the impact of these borrowings, average borrowings for fiscal 1992 were $156.4 million. The weighted average interest rate for fiscal year 1993 was 12.9% compared with 13.2% in the prior year.\nLoss from Continuing Operations\nThe Company's fiscal 1993 loss from continuing operations totaled $15.9 million compared with a loss of $4.4 million in fiscal 1992.\nDiscontinued Operations\nThe Company's fiscal 1993 net loss from discontinued operations totaled $11.2 million compared with net income of $1.1 million in fiscal 1992.\nNet Income (Loss)\nThe Company's fiscal 1993 net loss totaled $29.2 million and included a $2.1 million charge for the cumulative effect of the change in accounting discussed above. The net loss for fiscal 1992 was $4.4 million and included a $1.2 million extraordinary charge for the early repayment of debt. The Company was not able to benefit any of its fiscal 1993 losses for tax purposes.\nLIQUIDITY AND CAPITAL RESOURCES\nOn May 20, 1994, the Company completed a debt restructuring which was undertaken to modify the Company's capital structure to facilitate the growth of its domestic businesses by reducing cash interest expense and increasing the Company's liquidity.\nAs part of the restructuring, the Company exchanged $50 million of its Senior Subordinated Notes for $50 million initial accreted value of Deferred Coupon Notes. Approximately $48.8 million of the Senior Subordinated Notes remain outstanding. The Deferred Coupon Notes have no cash interest requirements until June, 1, 1999. As a result of the exchange, the Company's cash interest requirements have been reduced by approximately $6.9 million annually for five years. The reduction in cash interest requirements will be offset, in part, by the $11.0 million of additional indebtedness incurred as part of the debt restructuring. In addition, the $50 million of Senior Subordinated Notes exchanged satisfy the Company's mandatory redemption requirements with respect to such issue and, as a result, the $20 million mandatory redemption payments due on June 1, 1996 and l997 have been satisfied and the mandatory redemption payment due on June 1, 1998 has been reduced to $8.8 million. The Company is, however, required to make two mandatory redemption payments of $17.0 million on each of September 1, 1996 and September 1, 1997 with respect to the Senior Secured Notes.\nAs part of the restructuring, the Operating Companies entered into a $55 million, four-year, secured credit facility with an affiliate of Citibank, N.A., as agent for certain financial institutions. The Domestic Credit Facility, which has an initial term of three years, will be extended for an additional year if the Senior Secured Notes have been repaid on or before March 1997. The Domestic Credit Facility is subject to borrowing base formulas. The Domestic Credit Facility prohibits dividends and distributions by the Operating Companies except in certain limited instances. The Domestic Credit Facility contains customary negative, affirmative and financial covenants and conditions. At June 30, 1994, availability under the Domestic Credit Facility totaled approximately $10 million.\nAs part of the restructuring, the Operating Companies also entered into a $15.0 million three-year term loan with Citibank, N.A., as agent. A one-time fee of 1.0% of the principal amount outstanding under the Domestic Term Loan will be payable if such loan is not repaid by November 20, 1994. Principal payments of the Domestic Term Loan of $1.0 million each will be required quarterly commencing in March 1995. The Domestic Term Loan will be required to be prepaid if Waxman USA completes a financing sufficient to retire the Subordinated Notes, the Senior Secured Notes and the Domestic Term Loan. The Domestic Term Loan contains negative, affirmative and financial covenants, conditions and events of default substantially the same as those under the Domestic Credit Facility.\nSee Note 6 to Consolidated Financial Statements for a more complete discussion of the new Domestic Credit Facility and Domestic Term Loan.\nThe Company does not have any commitments to make substantial capital expenditures. However, the Company does expect to open up to 4 Barnett warehouses over the next twelve months. The average cash cost to open a Barnett warehouse is approximately $0.5 million, including approximately $250,000 for inventory and approximately $250,000 for fixed assets, leasehold improvements and startup costs.\nThe Company expects to incur approximately $0.5 million of costs relating to the disposition of Ideal, of which approximately $0.1 million has been incurred as of June 30, 1994.\nThe Company currently has no significant principal repayment requirements. Commencing March 1995, the Company will be required to make quarterly principal payments of $1.0 million under its Domestic Term Loan. However, the Company is required to make mandatory sinking fund payments of $17.0 million relating to its Senior Secured Notes on each of September 1, 1996 and 1997. The Company is also required to make a mandatory sinking fund payment of $8.8 million relating to its Senior Subordinated Notes on June 1, 1998.\nAs a result of the issuance of the Deferred Coupon Notes, which reduces cash interest requirements by approximately $6.9 million annually until June 1, 1999, the Company believes that funds generated from operations along with funds available under the Company's revolving credit facility will be sufficient to satisfy the Company's liquidity requirements (including the Domestic Term Loan principal payments) until September 1996, the date the first sinking fund payment is due. In order to eliminate and\/or satisfy such sinking fund obligations, and to decrease the Company's high degree of leverage, the Company will have to obtain a significant infusion of funds either through additional debt refinancing transactions or the sale of equity and\/or assets. Although the Company is currently exploring its various alternatives, it has not yet committed to any specific course of action or transaction.\nDISCUSSION OF CASH FLOWS\nThe Company's continuing operations used $6.2 million of cash flow for operations primarily as a result of the $10.1 million increase in inventories. Inventory levels were up in response to the higher sales levels achieved during fiscal 1994. In addition, the Company began building inventories during the fourth quarter of fiscal 1994 relating to new business commitments which Consumer Products obtained from several of its largest customers. The opening orders of such additional business will be shipped primarily during the first quarter of fiscal 1995. Cash flow used for investments totaled $1.6 million in fiscal 1994. During October 1993, the Company generated approximately $3.0 million of cash from the sale of Belanger. The proceeds from the sale were offset by $3.4 million of capital expenditures and a $1.3 million increase in other assets. Cash flow provided by financing activities totaled $17.4 million. Additional borrowings under the Company's revolving credit facilities along with the proceeds from the Domestic Term Loan were offset, in part, by $1.9 million used to satisfy a mandatory repurchase requirement relating to the Convertible Debentures and $13.9 million of repurchase premiums, fees and expenses relating to the Reorganization.\nIMPACT OF NEW ACCOUNTING STANDARDS\nIn February 1992, the Financial Accounting Standards Board (the FASB) issued SFAS No. 109, \"Accounting for Income Taxes.\" The Company adopted SFAS No. 109 during the first quarter of its fiscal year ending June 30, 1994. SFAS No. 109 requires the Company to recognize income tax benefits for loss carryforwards which have not previously been recorded. The tax benefits recognized must be reduced by a valuation allowance in certain circumstances. The Company did not recognize a benefit and such adoption did not have a material impact on its results of operations or financial position. However, to the extent that the Company is able to recognize tax benefits in the future, such recognition will favorably effect future results of operations. The FASB has also issued SFAS No. 106, \"Employers' Accounting for Postretirement Benefits other than Pensions\" and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" The Company does not currently maintain any postretirement or postemployment benefit plans or programs which would be subject to such accounting standards.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n(Begins on Following Page)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of Waxman Industries, Inc.:\nWe have audited the accompanying consolidated balance sheets of Waxman Industries, Inc. (a Delaware corporation) and Subsidiaries (the Company) as of June 30, 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 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 financial statements referred to above present fairly, in all material respects, the financial position of Waxman Industries, Inc. and Subsidiaries as of June 30, 1994 and 1993, and the 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.\nAs explained in Note 3 to the consolidated financial statements, effective July 1, 1992, the Company changed its method of accounting for certain warehousing and catalog costs.\nArthur Andersen LLP\nCleveland, Ohio, August 23, 1994.\nWAXMAN INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED JUNE 30, 1994, 1993 AND 1992\n(IN THOUSANDS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nA. Consolidation and Basis of Presentation\nThe financial statements include the accounts of Waxman Industries, Inc. and its wholly-owned subsidiaries (the Company). All significant intercompany transactions and balances are eliminated in consolidation. Certain fiscal 1993 and 1992 amounts have been reclassified to conform with the fiscal 1994 presentation, including a restatement to reflect the discontinued operations discussed in Note 2.\nThe Company operates in a single business segment - the distribution of plumbing, electrical and hardware products. Substantially all of the Company's business is conducted in the United States.\nDuring fiscal 1994, the Company restructured (the \"Corporate Restructuring\") its domestic operations such that the Company is now a holding company whose only material assets are the capital stock of its subsidiaries. As part of the Corporate Restructuring, the Company formed (a) Waxman USA Inc. (\"Waxman USA\") as a holding company for the subsidiaries that comprise and support the Company's domestic operations, (b) Waxman Consumer Products Group Inc. (\"Consumer Products\"), a wholly owned subsidiary of Waxman USA, to own and operate Consumer Products Group Division, and (c) WOC Inc. (\"WOC\"), a wholly owned subsidiary of Waxman USA, to own and operate Waxman USA's domestic subsidiaries, other than Barnett Inc. (\"Barnett\") and Consumer Products. On May 20, 1994, the Company completed the Corporate Restructuring by (i) contributing the capital stock of Barnett to Waxman USA, (ii) contributing the assets and liabilities of the Consumer Products Group Division to Consumer Products, (iii) contributing the assets and liabilities of its Madison Equipment Division to WOC, (iv) contributing the assets and liabilities of its Medal Distributing Division to WOC, (v) merging U.S. Lock Corporation (\"U. S. Lock\") and LeRan Copper & Brass, Inc. (\"LeRan\"), each a wholly owned subsidiary of the Company, into WOC, (vi) contributing the capital stock of TWI, International, Inc. (\"TWI\") to Waxman USA and (vii) contributing the capital stock of Western American Manufacturing, Inc. (\"WAMI\") to TWI. The \"Operating Companies\" consist of Barnett, Consumer Products and WOC. This restructuring was accounted for based upon each entities' historical carrying amounts with no impact on the accompanying consolidated financial statements.\nB. Restricted Cash Balances\nIn accordance with the terms of its Domestic Credit Facility (See Note 6), all of the Operating Companies' available cash is pledged to the lenders and is required to be used to pay down borrowings under the facility.\nC. Accounts Receivable\nAccounts receivable are presented net of allowances for doubtful accounts of $1,353 and $1,352 at June 30, 1994 and 1993, respectively. Bad debt expense totaled $617 in fiscal 1994, $695 in fiscal 1993 and $562 in fiscal 1992.\nThe Company sells plumbing, electrical and hardware products throughout the United States to do-it-yourself retailers, mass merchandisers, smaller independent retailers and plumbing, electrical repair and remodeling contractors. The Company performs ongoing credit evaluations of its customers' financial condition. In fiscal years 1994, 1993 and 1992, the Company's largest customer accounted for approximately 13%, 12% and 11% of its net sales, respectively. The Company's ten largest customers accounted for approximately 25% of net sales in fiscal 1994, 23% in fiscal 1993 and 22% in fiscal 1992 and approximately 28% and 26% of accounts receivable at June 30, 1994 and 1993, respectively.\nD. Inventories\nAt June 30, 1994 and 1993, inventories, consisting primarily of finished goods, are carried at the lower of first-in, first-out (FIFO) cost or market. The Company regularly evaluates its inventory carrying value, with appropriate consideration given to any excess, slow-moving and\/or nonsalable inventories.\nE. Property and Equipment\nProperty and equipment is stated at cost. For financial reporting purposes, buildings and equipment are depreciated on a straight-line basis over their estimated useful lives at annual depreciation rates ranging from 2 1\/2% to 30%. For income tax\npurposes, accelerated methods generally are used. Depreciation expense totaled $2,738 in fiscal 1994, $2,690 in fiscal 1993 and $2,665 in fiscal 1992.\nF. Cost of Businesses in Excess of Net Assets Acquired\nCost of businesses in excess of the fair market value of net assets acquired is being amortized primarily over 40 years, using the straight-line method. Management has evaluated its accounting for goodwill, considering such factors as historical profitability and current operating cash flows and believes that the asset is realizable and the amortization period is appropriate. Goodwill amortization expense totaled $724 in fiscal 1994, $725 in fiscal 1993 and $756 in fiscal 1992. The accumulated amortization of goodwill at June 30, 1994 and 1993 was $4,469 and $3,745, respectively.\nG. Per Share Data\nPrimary earnings per share have been computed based on the weighted average number of shares and share equivalents outstanding which totaled 11,674 in fiscal 1994, 11,662 in fiscal 1993 and 9,794 in fiscal 1992. Share equivalents include the Company's common stock purchase warrants (see Notes 7 and 8). The conversion of the Convertible Debentures was not assumed in computing fully diluted earnings per share for fiscal 1994, fiscal 1993 and fiscal 1992 as the effect would be anti-dilutive.\nH. Foreign Currency Translation\nAll balance sheet accounts of foreign subsidiaries are translated at the exchange rate as of the end of the fiscal year. Income statement items are translated at the average currency exchange rates during the fiscal year. The resulting translation adjustment is recorded as a component of stockholders' equity. Foreign currency transaction gains or losses are included in the income statement as incurred and such net gains totaled $17 in fiscal 1994, $80 in fiscal 1993 and $73 in fiscal 1992.\nI. Impact of New Accounting Standards\nThe Company adopted SFAS No. 109 during 1994 (see Note 5). The FASB has also issued SFAS No. 106, \"Employers' Accounting for Postretirement Benefits other than Pensions\" and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" The Company does not currently maintain any postretirement or postemployment benefit plans or programs which would be subject to such accounting standards.\nJ. Debt\nThe Company made interest payments of $20,523 in fiscal 1994, $19,540 in fiscal 1993 and $18,858 in fiscal 1992. Accrued liabilities in the accompanying consolidated balance sheets include accrued interest of $2,101 and $2,609 at June 30, 1994 and 1993, respectively. Other assets in the accompanying consolidated balance sheets include deferred financing costs of $10,284 and $3,935 at June 30, 1994 and 1993, respectively.\nNo quoted market prices are available for any of the Company's debt as the debt is not actively traded. Management, however, believes the carrying values of its bank loans approximate their fair values as they bear interest based upon the banks' prime lending rates. It was not practical to determine the fair value of the Company's Senior Secured Notes, Deferred Coupon Notes, Convertible Debentures and Senior Subordinated Notes because of the inability to determine fair value without incurring excessive costs.\n2. DISCONTINUED OPERATIONS - IDEAL\nEffective March 31, 1994, the Company adopted a plan to dispose of its Canadian subsidiary, Ideal Plumbing Group, Inc. (Ideal). Unlike the Company's U.S. operations, which supply products to customers in the home repair and remodeling market through mass retailers, Ideal primarily serves customers in the Canadian new construction market through independent contractors. Accordingly, Ideal is reported as a discontinued operation and the consolidated financial statements have been reclassified to report separately Ideal's net assets and results of operations.\nAt the time the plan of disposition was adopted, the Company expected that the disposition would be accomplished through a sale of the business to a group which included members of Ideal's management. Such transaction would have required the consent of Ideal's Canadian bank as borrowings under its bank credit agreements were collateralized by all of the assets and capital stock of Ideal. The bank considered the management group's acquisition proposal, however, the proposal was subsequently rejected. On May 5, 1994, without advance notice, the bank filed an involuntary bankruptcy petition against Ideal citing defaults under the bank credit agreements (Borrowings under these agreements are non-recourse to Waxman Industries, Inc.). On May 30, 1994, Ideal was declared bankrupt by the Canadian courts and, as a result, the Company's ownership and control of Ideal effectively ceased on such date. The Canadian court appointed a trustee to liquidate the assets of Ideal. The Company has been advised that Ideal is no longer operating and the liquidation process is continuing at the present time. The Company has no liability to the creditors of Ideal as a result of Ideal's bankruptcy.\nThe estimated loss on disposal, which was recorded by the Company in its consolidated financial statements as of March 31, 1994, totaled $38.3 million, without tax benefit, and represents a complete write-off of the Company's investment in Ideal. The loss included the estimated loss on disposal, a provision for anticipated operating losses until disposal and provisions for other estimated costs to be incurred in connection with the disposal, as well as a $6.4 million foreign currency exchange loss which results from the elimination of the currency translation adjustments relating to Ideal. In accordance with SFAS No. 109. \"Accounting for Income Taxes\", any tax benefits relating to the loss on disposal have been reduced 100% by a valuation allowance. The Company will continue to evaluate the valuation allowance and to the extent it is determined that such allowance is no longer required, the tax benefit of such loss on disposal will be recognized in the future.\nNet assets of the discontinued operation at June 30, 1993 consisted of working capital of $29,879, net plant, property and equipment of $15,171, other assets of $40,561 and bank debt of $56,455 without any allowance for the estimated loss on disposal.\nSummary operating results of the discontinued operation for the periods presented are as follows:\n3. CHANGE IN ACCOUNTING:\nDuring fiscal 1993, the Company accelerated its amortization of certain warehouse start-up costs and catalog costs. This change was applied retroactively to July 1, 1992. The Company had historically amortized such costs over a period not to exceed five years which, in management's opinion, represented the period over which economic benefits were received. The acceleration of amortization was made to conform with prevailing industry practice. By accelerating amortization, certain costs associated with the opening of new warehouse operations are amortized over a period of twelve months commencing the month in which the warehouse opens. Costs associated with the development and introduction of new catalogs are amortized over the life of the catalog, not to exceed a period of one year.\nThe cumulative effect of this change on prior years totaled $2,110 or $.18 per share, and is reported separately in the fiscal 1993 consolidated income statement, without tax benefit. The additional effect of the change in fiscal 1993 was to\nincrease both the loss from continuing operations before extraordinary charge and cumulative effect of accounting change and the net loss by $1,191.\nThe following pro forma information reflects the Company's results for fiscal 1992 as if the change had been retroactively applied:\n4. RESTRUCTURING, NONRECURRING AND EXTRAORDINARY CHARGES:\nA. Extraordinary Charges\nDuring fiscal 1994, the Company recognized a $6.6 million extraordinary charge, without tax benefit, as a result of the refinancing of $50 million of Senior Subordinated Notes as well as borrowings under the domestic bank credit facilities. The extraordinary charge included the fees paid upon the refinancing of the Senior Subordinated Notes along with the accelerated amortization of unamortized debt discount and issuance costs.\nAlso during fiscal 1994, the Company purchased $1.9 million of its Convertible Debentures pursuant to a mandatory repurchase obligation. As a result of the repurchase, the Company recorded an extraordinary charge of $.2 million, without tax benefit, which primarily represents the accelerated amortization of unamortized debt discount and issuance costs.\nDuring fiscal 1992, the Company repurchased certain debt securities in open market purchases. As a result, the Company incurred an extraordinary charge which totaled $1,186 (net of applicable income tax benefit of $611) and included the market premium paid along with the accelerated amortization of unamortized debt discount and issuance costs.\nB. Restructuring and Non-Recurring Charges\nDuring fiscal 1993, as a result of certain actions taken as part of its strategy to refocus and build its existing core businesses in the U.S., the Company recorded a $6,762 restructuring charge. The provision for restructuring charge included an estimate of the loss to be incurred upon the sale of three businesses, including anticipated operating results through the projected disposal dates, and the write-off of intangible assets. Below is a summary of the components comprising the restructuring charges as of June 30, 1993:\nEstimated loss on disposal of businesses $4,600 Relocation and consolidation costs 1,544 Other 618 ----- $6,762 ===== The disposal of businesses included three operating entities in which the Company had entered into letters of intent with prospective buyers.\nDuring October 1993, the Company completed the sale of one of its Canadian operations, H. Belanger Plumbing Accessories, Ltd. (Belanger). The Company sold all of the capital stock of Belanger for approximately U.S. $3 million in cash and a U.S. $0.3 million promissory note. The promissory note, which matures on October 14, 1996, provides for three equal consecutive annual payments. Interest is payable annually at a rate of 7%. The loss on the sale of Belanger was approximately $3 million. Net assets held for sale at June 30, 1993, included in the accompanying consolidated balance sheets is comprised primarily of working capital items and fixed assets of Belanger, net of the reserve for the estimated loss on disposal.\nThe Company was unable to come to terms with the prospective buyer of the other two entities. At the present time, the Company is not engaged in any other negotiations with respect to the sale of these entities. As such, the consummation of a sale of these businesses is not expected to occur in the foreseeable future, if at\nall. As a result, the individual assets and liabilities of these businesses have been reclassified on the accompanying consolidated balance sheets. The Company evaluated the net realizable value of the carrying value of the assets previously held for sale in accordance with its normal ongoing policy regarding impairment and concluded that no further writedown of the net carrying value of the assets was required in excess of the reserve previously established. Therefore, the reversal of the accrued loss on disposal includes $1.4 million for the writedown of assets to net realizable value and $.2 million for fees and expenses associated with the transaction.\nDuring fiscal 1992, the Company recorded a $3.9 million nonrecurring charge which represents a capital loss realized upon the sale of the Company's portfolio of debt securities.\n5. INCOME TAXES:\nThe Company adopted SFAS NO. 109 during the first quarter of fiscal 1994. SFAS 109 requires the Company to recognize income tax benefits for loss carryforwards which have not previously been recorded. The tax benefits recognized must be reduced by a valuation allowance in certain circumstances. Upon the adoption of SFAS 109, the benefit of the Company's net operating loss carryforwards was reduced 100% by a valuation allowance. The benefit of the fiscal 1994 net operating loss has also been reduced 100% by a valuation allowance. The adoption of SFAS 109 in fiscal 1994 had no material impact on the accompanying consolidated financial statements. However, to the extent that the Company is able to recognize tax benefits in the future, such recognition will favorably effect future results of operations.\nThe components of income (loss) from continuing operations before income taxes, extraordinary charges and cumulative effect of change in accounting are as follows:\nThe following table reconciles the U.S. statutory rate to the Company's effective tax rate:\nAt June 30, 1994, the Company had $59,598 available domestic net operating loss carryforwards for income tax purposes which expire through 2009. For financial reporting purposes, the benefit of these net operating loss carryforwards has been reduced 100% by a valuation allowance in accordance with the provisions of SFAS No. 109.\nAt June 30, 1994, the Company had recorded deferred tax liabilities of $3,218 and deferred tax assets (excluding the net operating loss carryforwards discussed above) of $2,663. For financial reporting purposes, previously recorded deferred income tax liabilities were reduced in fiscal 1993 by the tax benefit of the fiscal 1992 net operating loss which could not be carried back to prior years. In fiscal 1992 and fiscal 1993, the Company was able to carryback domestic net operating losses to prior years which resulted in refunds of previously paid taxes. Refunds received totaled $2,462 in fiscal 1993 and $435 in fiscal 1994.\nThe Company made income tax payments of $556 in fiscal 1994, $926 in fiscal 1993 and $1,358 in fiscal 1992.\n6. LONG TERM DEBT:\nLong term debt at June 30, 1994 and 1993 consisted of the following:\nOn May 20, 1994, the Operating Companies entered into a new $55 million secured credit facility with an affiliate of Citibank, N.A., as agent, which includes a $20 million letter of credit subfacility. The secured credit facility, which has an initial term of three years, will be extended for an additional year if the Senior Secured Notes have been repaid on or before March 1997. The secured credit facility is subject to borrowing base formulas. Interest is based, at the Company's option, on either (i) the prime rate of Citibank, N.A. plus 1.5%, or (ii) LIBOR plus 3.0%. These rates will be increased by 0.5% until such time as the term loan, discussed below, has been repaid in full. The weighted average interest rate on borrowings outstanding under the credit facility was 8.5% during fiscal 1994. The Company is required to pay a commitment fee of 0.5% per annum on the unused commitment. The secured credit facility is secured by the accounts receivable, inventory, certain general intangibles\nand unencumbered fixed assets of the Operating Companies and 65% of the capital stock of one subsidiary of TWI. The agreement requires that Waxman USA maintain certain leverage, fixed charge coverage, net worth, capital expenditures and EBITDA to total cash interest ratios. All financial covenants are based solely on the results of operations of Waxman USA. The Company was in compliance with all covenants at June 30, 1994.\nThe Operating Companies also entered into a $15.0 million three-year term loan with Citibank, N.A., as agent. The term loan bears interest at a rate per annum equal to 1.5% over the interest rate under the secured credit facility and is secured by a junior lien on the collateral under the secured credit facility. A one-time fee of 1.0% of the principal amount outstanding under the term loan will be payable if the loan is not repaid by November 20, 1994. Principal payments on the domestic term loan of $1.0 million each will be required quarterly commencing in March 1995. The term loan's financial covenants are identical to the covenants contained in the secured credit facility and are based solely on the results of operations of Waxman USA.\nThe initial borrowings under the secured credit facility along with proceeds from the term loan were used to repay all borrowings under the Company's existing domestic bank credit facilities as well as fees and expenses associated with the issuance of the Company's Deferred Coupon Notes (See Note 8). The $55 million secured credit facility, the $15 million term loan and the issuance of the Deferred Coupon Notes were part of a financial restructuring (the Restructuring).\nIn May 1994, the $30 million secured domestic revolving credit facility was terminated by the Company, and borrowings thereunder were refinanced using proceeds as discussed above. The weighted average interest rate on borrowings outstanding under the $30 million secured domestic revolving credit facility was 6.2% during fiscal 1994.\n7. SENIOR SECURED NOTES\nIn September 1991, the Company completed a private placement of $50 million of 7-year Senior Secured Notes (the Senior Secured Notes), including detachable warrants to purchase 1 million shares of the Company's common stock (the Warrants). At the time of issuance, the Senior Secured Notes included $42.5 million of 12.25% fixed rate notes and $7.5 million of floating rate notes with interest at 300 basis points over the 90 day LIBOR rate. The Senior Secured Notes are redeemable in whole or in part, at the option of the Company, after September 1, 1993 at a price of 107.35% for the fixed rate notes and 103% for the floating rate notes. The redemption prices decrease annually to 100% of the principal amounts at September 1, 1996. Annual mandatory redemption payments of $14.45 million for the fixed rate notes, and $2.55 million for the floating rate notes are due on September 1, 1996 and September 1, 1997 and are calculated to retire 68% of the principal amount of the Senior Secured Notes prior to maturity. The Senior Secured Notes, which are secured by a pledge of all of the outstanding stock of the Company's wholly-owned subsidiaries, Barnett, Consumer Products and WOC, are senior in right of payment to all subordinated indebtedness and pari passu with all other senior indebtedness of the Company.\nThe Warrants are exercisable through September 1, 1996, at a price of $4.60 per share. A portion of the proceeds of the private placement was allocated to the Warrants and, as a result, paid-in capital increased by $1 million in fiscal year 1992. The related $1 million reduction in the recorded principal amount of the Senior Secured Notes is being amortized as interest expense over the life of the Senior Secured Notes.\nDuring June 1992, the Company repurchased $10,850 principal amount of the fixed rate notes in open market purchases.\nThe Senior Secured Note indenture contains various covenants, including dividend restrictions and minimum operating cash flow requirements. The operating cash flow covenant requires a minimum ratio of operating cash flow to interest expense of 1.1 to 1.0 (the Company's actual ratio for fiscal 1994 was approximately 1.2 to 1.0). For purposes of calculating this ratio, operating cash flow is calculated based on the results of continuing operations only and interest expense excludes any non-cash interest relating to the Company's Deferred Coupon Notes.\nDuring November 1993 and May 1994, the Company completed solicitations of consents from the holders of the Senior Secured Notes which, among other things, amended the net worth and certain other financial covenants and permitted the completion of the Company's Restructuring and eliminated any prospective defaults resulting from the adverse results and events relating to the Company's discontinued Canadian operations.\n8. SENIOR SECURED DEFERRED COUPON NOTES\nOn May 20, 1994, the Company exchanged $50 million of its Senior Subordinated Notes for $50 million initial accreted value of 12.75% Senior Secured Deferred Coupon Notes due 2004 (the Deferred Coupon Notes) along with detachable warrants to purchase 2.95 million shares of the Company's common stock. The Deferred Coupon Notes have no cash interest requirements until 1999. Thereafter interest on the Deferred Coupon Notes will accrue at a rate of 12.75% and will be payable in cash semi-annually on June 1 and December 1. The Deferred Coupon Notes are redeemable, in whole or in part, at the option of the Company, after June 1, 1999 at 106.375% of accreted value, which decreases annually to 100% at the maturity date. The Deferred Coupon Notes are secured by a pledge of the capital stock of Waxman USA. Substantially all of the assets of Waxman USA are pledged under the Restructuring. The Deferred Coupon Notes rank senior in right of payment to all existing and future subordinated indebtedness of the Company and rank pari passu in right of payment with all other existing or future unsubordinated indebtedness of the Company. The Deferred Coupon Notes contain certain covenants which, among other things, limit additional indebtedness, the payment of dividends and any restricted payments.\nThe warrants are exercisable through June 1, 2004, at a price of $2.45 per share. A portion of the initial accreted value of the Deferred Coupon Notes was allocated to the warrants and as a result paid in capital increased by $2.5 million and the related $2.5 million reduction in the recorded initial accreted value of the Deferred Coupon Notes is being amortized as interest expense over the life of the Deferred Coupon Notes.\n9. SENIOR SUBORDINATED NOTES\nIn June 1989, the Company issued $100 million principal amount of 13.75% Senior Subordinated Notes (Senior Subordinated Notes) due June 1, 1999. The Senior Subordinated Notes are redeemable in whole or in part, at the option of the Company, after June 1, 1994 at a price of 105.156% which decreases annually to 100% of the principal amount at the maturity date. Annual mandatory redemption payments of $20 million commencing June 1, 1996 are calculated to retire 60% of the issue prior to maturity. In case of a change in control, the noteholders have the right to require the Company to repurchase the Senior Subordinated Notes at established redemption prices. The Senior Subordinated Notes, which are unsecured, are subordinate in right of payment to all senior debt and are senior in right of payment to the Company's Convertible Debentures. Under the terms of the Senior Subordinated Note indenture, the Company may not incur additional indebtedness which is subordinate to senior debt and senior to the Senior Subordinated Notes. Additionally, the indenture agreement contains various other covenants, including dividend restrictions and minimum net worth requirements.\nAs discussed in Note 8, during 1994, the Company exchanged $50 million principal amount of the Senior Subordinated Notes for a like amount of Deferred Coupon Notes. The $50 million of Senior Subordinated Notes exchanged satisfy the Company's mandatory redemption requirements with respect to such issue and, as a result the $20 million mandatory redemption payments due on June 1, 1996 and 1997 have been satisfied and the mandatory redemption payment due on June 1, 1998 has been reduced to $8.8 million.\nDuring fiscal 1992, the Company repurchased $1,250 principal amount of the Senior Subordinated Notes in an open market purchase.\nDuring November 1993 and May 1994, the Company completed a solicitation of consents from the holders of the Senior Subordinated Notes which, among other things, amended the net worth and certain other financial covenants and permitted the completion of the Company's Restructuring and eliminated any prospective defaults resulting from the adverse results and events relating to the Company's discontinued Canadian operations.\n10. CONVERTIBLE SUBORDINATED DEBENTURES\nIn March 1987, the Company issued $25 million principal amount of Convertible Subordinated Debentures (the Convertible Debentures) due March 15, 2007. The Convertible Debentures, which are unsecured, may be converted at any time prior to maturity, unless previously redeemed, into shares of the Company's common stock at a conversion price of $3.25 per share.\nDuring fiscal 1990, the Company called $12.5 million principal amount of the Convertible Debentures for redemption and subsequently $6.5 million principal amount\nwas converted into 683 shares of common stock and the remaining $6.0 million principal amount was redeemed at the call price of 105%.\nDuring fiscal years 1990 and 1992, the Company also purchased $9.7 million and $.8 million, respectively, of the principal amount of the Convertible Debentures in open market purchases at prices which approximated the par value of the Convertible Debentures.\nIn June 1994, the Company purchased $1.9 million of the Convertible Debentures pursuant to a mandatory repurchase obligation.\n11. STOCKHOLDERS' EQUITY:\nIn March 1994, the Company contributed 50 shares of its common stock to the profit sharing retirement plan in lieu of a cash contribution. The total fair market value of the common stock at the date of contribution was approximately $132.\nIn May 1992, the Company completed a public offering of 2,199 shares of common stock at a price of $5.00 per share. The net proceeds from the offering, after deducting all associated costs, were $9,785.\nEach share of common stock entitles the holder to one vote, while each share of Class B common stock entitles the holder to ten votes. Cash dividends on the Class B common stock may not exceed those on the common stock. Due to restricted transferability there is no trading market for the Class B common stock. However, the Class B common stock may be converted, at the stockholder's option, into common stock on a share-for-share basis at any time without cost to the stockholder.\nStockholders' equity includes cumulative currency translation adjustments of ($600) and ($4,651) at June 30, 1994 and 1993, respectively. A foreign currency exchange loss of $6.4 million, which resulted from the elimination of the currency translation adjustments relating to Ideal, was realized as part of the loss on disposal of Ideal. See Note 2.\n12. STOCK OPTIONS:\nStock Option Plan\nEffective July 1, 1992, the Company's stockholders approved the 1992 Non-Qualified and Incentive Stock Option Plan (the 1992 Stock Option Plan) which replaced the then existing stock option plan (the 1982 Plan) which terminated by its terms on April 30, 1992. The 1992 Stock Option Plan authorized the issuance of an aggregate of 1.1 million shares of common stock as incentive stock options to officers and key employees of the Company or its subsidiaries. During fiscal 1994, the Board of Directors of the Company approved an amendment to the 1992 Stock Option Plan which would increase the number of shares subject to the 1992 Stock Option Plan to 1.5 million shares. Such amendment is subject to stockholder approval, which the Company intends to seek at its next annual meeting of stockholders. Under the terms of the 1992 Stock Option Plan, all options granted are at an option price not less than the market value at the date of grant and may be exercised for a period not exceeding 10 years from the date of grant.\nDuring fiscal 1994, options exercisable to purchase an aggregate of 1,250 shares were issued under the 1992 Stock Option Plan at exercise prices of $2.25 to $3.88 per share, and options exercisable to purchase 1,046 shares with exercise prices of $2.38 to $5.00 per share were cancelled. At June 30, 1994, options for 1,194 shares were outstanding, of which none were exercisable. Of the options granted in fiscal 1994, options to purchase an aggregate of 200 shares are subject to stockholder approval to the amendment to the 1992 Stock Option Plan. At June 30, 1993, there were options for 990 shares outstanding under the 1992 Stock Option Plan.\nAlso during fiscal 1994, options for 271 shares under the 1982 Plan with exercise prices of $4.75 to $6.00 per share were cancelled. At June 30, 1994, there were no options outstanding under the 1982 Plan. At June 30, 1993, there were options for 271 shares outstanding under the 1982 Plan.\nOther Stock Options\nIn fiscal 1994, the Board of Directors of the Company adopted the 1994 Non-Employee Directors Stock Option Plan pursuant to which each current non-employee director of the Company was granted an option to purchase an aggregate of 20 shares of the Company's Common Stock at an exercise price of $2.25 per share and each future non-employee director of\nthe Company would be granted, on the date such person becomes a non-employee director of the Company, an option to purchase an aggregate of 20 shares of Common Stock at anexercise price equal to the fair market value of the Common Stock at the date of grant. The grant of such options is subject to stockholder approval, which the Company intends to seek at its next annual meeting of stockholders. In addition, during fiscal 1994, the Company granted a consultant to the Company an option to purchase an aggregate of 10 shares of Common Stock at an exercis price of $2.25 per share. At June 30, 1994, options to purchase a total of 70 shares were outstanding under the non-qualified options, of which none were exercisable. During fiscal year 1994, options to purchase 170 shares with exercise prices of $4.25 to $6.00 per share were cancelled.\n13. LEASE COMMITMENTS:\nThe Company leases certain of its warehouse and office facilities and equipment under operating lease agreements which expire at various dates through 2003.\nFuture minimum rental payments are as follows: $3,856 in 1995, $3,254 in 1996, $3,016 in 1997, $2,361 in 1998, $1,850 in 1999 and $2,595 after 1999, with a cumulative total of $16,932.\nTotal rent expense charged to operations was $3,951 in 1994, $3,758 in 1993 and $3,398 in 1992.\n14. PROFIT SHARING PLAN:\nThe Company has a trusteed profit sharing retirement plan for employees of certain of its divisions and subsidiaries. In fiscal 1989, the plan was amended to qualify under Section 401(K) of the Internal Revenue Code. Company contributions are determined by the Board of Directors. The charges to operations for Company contributions totaled $132 in fiscal 1993 and $123 in fiscal 1992.\n15. CONTINGENCIES:\nThe Company is subject to various legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of any ultimate liability with respect to these actions will not materially affect the Company's financial statements.\nSUPPLEMENTARY FINANCIAL INFORMATION\nQuarterly Results of Operations:\nThe following is a summary of the unaudited quarterly results of operations for the fiscal years ended June 30, 1994 and 1993 (in thousands, except per share amounts):\nPART III\nPart III, except for certain information relating to Executive Officers included in Part I, Item 4A, is omitted inasmuch as the Company intends to file with the Securities and Exchange Commission within 120 days of the close of its fiscal year ended June 30, 1994 a definitive proxy statement pursuant to Regulation 14A of the Securities Exchange Act of 1934.\nPART IV\nITEM 14.","section_9":"","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) (1) The following consolidated financial statements are included in Part II, Item 8:\nReport of Independent Public Accountants\nBalance Sheets--June 30, 1994 and 1993\nStatements of Income--For the Years Ended June 30, 1994, 1993, and 1992\nStatements of Stockholders' Equity--For the Years Ended June 30, 1994, 1993 and 1992.\nStatements of Cash Flows--For the Years Ended June 30, 1994, 1993 and 1992.\nNotes to Financial Statements For the Years Ended June 30, 1994, 1993 and 1992.\nSupplementary Financial Information\n(a) (2) 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 including notes thereto.\n(a) (3) Exhibits\n3.1* Certificate of Incorporation of the Company dated October 27, 1989 (Exhibit 3(a) to the Company's Form S-8 filed December 4, 1989, File No. 0-5888, incorporated herein by reference).\n3.2* By-laws of the Company. (Exhibit 3.2 to Annual Report on Form 10-K for the year ended June 30, 1990, File No. 0-5888, incorporated herein by reference.)\n4.1* Indenture dated as of June 1, 1989 (the \"Ameritrust Indenture\") between the Company and Ameritrust Company National Association (Exhibit 4.1 to Annual Report on Form 10-K for the year ended June 30, 1989, File No. 0-5888, incorporated herein by reference).\n4.2* Form of the Company's 13 3\/4% Senior Subordinated Note due June 1, 1999 (Exhibit 4.2 to Annual Report on Form 10-K for the year ended June 30, 1989, File No. 0-5888, incorporated herein by reference).\n4.3* First Supplemental Indenture to the Ameritrust Indenture dated November 29, 1989. (Exhibit 4.2 to Annual Report on Form 10-K for the year ended June 30, 1990, File No. 0-5888, incorporated herein by reference.)\n4.4* Second Supplemental Indenture to the Ameritrust Indenture dated November 23, 1993 (Exhibit 4.3 to Waxman Industries, Inc.'s Form S-2 filed July 8, 1994, incorporated herein by reference).\n4.5* Third Supplemental Indenture to the Ameritrust Indenture dated May 20, 1994 (Exhibit 4.4 to Waxman Industries, Inc.'s Form S-2 filed July 8, 1994, incorporated herein by reference).\n4.6* Indenture , dated as of May 20, 1994, by and between Waxman Industries, Inc. and The Huntington National Bank, as Trustee, with respect to the Deferred Coupon Notes, including the form of Deferred Coupon Notes (Exhibit 4.1 to Waxman Industries, Inc.'s Form S-4 filed June 20, 1994, incorporated herein by reference).\n4.7* Warrant Agreement, dated as of May 20, 1994, by and between Waxman Industries, Inc. and The Huntington National Bank, as Warrant Agent (Exhibit 4.2 to Waxman Industries, Inc.'s Form S-4 filed June 20, 1994, incorporated herein by reference).\n4.8* Warrant Certificate (Exhibit 4.3 to Waxman Industries, Inc.'s Form S-4 filed June 20, 1994, incorporated herein by reference).\n4.9* Securities Purchase Agreement for Notes and Warrants dated as of September 17, 1991, among the Company and each of the Purchasers referred to therein. (Exhibit 4.4 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n4.10* Indenture dated as of September 1, 1991 (the \"US Trust Indenture\"), between the Company and United States Trust Company of New York. (Exhibit 4.5 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n4.11* Form of the Company's Floating Rate Senior Secured Notes due September 1, 1998. (Exhibit 4.6 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n4.12* Form of the Company's 12.25% Fixed Rate Senior Secured Notes due September 1, 1998. (Exhibit 4.7 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n4.13* First Supplemental Indenture to the US Trust Indenture dated November 15, 1993 (Exhibit 4.8 to Waxman Industries, Inc.'s Form S-2 filed July 8, 1994, incorporated herein by reference).\n4.14* Second Supplemental Indenture to the US Trust Indenture dated March 25, 1994 (Exhibit 4.9 to Waxman Industries, Inc.'s Form S-2 filed July 8, 1994, incorporated herein by reference).\n4.15* Third Supplemental Indenture to the US Trust Indenture dated May 20, 1994 (Exhibit 4.10 to Waxman Industries, Inc.'s Form S-2 filed July 8, 1994, incorporated herein by reference).\n4.16* Warrant Agreement dated as of September 17, 1991, between the Company and United States Trust Company of New York. (Exhibit 4.8 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n4.17* Form of the Company's Common Stock Purchase Warrant Certificate. (Exhibit 4.9 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n4.18* Registration Rights Agreement for Senior Notes, Warrants and Warrant Shares dated as of September 17, 1991, among the Company and each of the Purchasers signatory thereto. (Exhibit 4.10 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n4.19* Pledge Agreement dated as of September 17, 1991, among the Company, United States Trust Company of New York and each of the Purchasers signatory thereto. (Exhibit 4.11 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n4.20* Operating Credit Agreement dated as of April 20, 1989 between Bank of Montreal and Waxman Acquisition, Inc. (Exhibit 10.9 to Annual Report on Form 10-K for the year ended June 30, 1989, File No. 0-5888, incorporated herein by reference).\n4.21* Amending Agreement of Operating Credit Agreement dated as of July 1, 1990 between Bank of Montreal and Ideal Plumbing Group Inc. (Exhibit 4.10 to Annual Report on Form 10-K for the year ended June 30, 1990, File No. 0-5888, incorporated herein by reference).\n4.22* Amended and Restated Operating Credit Agreement dated as of July 22, 1991 between Bank of Montreal and Ideal Plumbing Group Inc. (Exhibit 4.15 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n4.23* Amended and Restated Credit Agreement dated as of April 1, 1993 between Waxman Industries, Inc. and the Banks Named Therein and National City Bank as Agent (Exhibit 4.15 to Annual Report on Form 10-K for the year ended June 30, 1993, File No. 0-5888, incorporated herein by reference).\n4.24* Amendment dated as of October 1, 1993 to Amended and Restated Credit Agreement dated as of April 1, 1993 between Waxman Industries, Inc. and the Banks Named Therein and National City Bank as Agent (Exhibit 4.16 to Annual Report on Form 10-K for the year ended June 30, 1993, File No. 0-5888, incorporated herein by reference).\n4.25* Credit Agreement dated as of May 20, 1994 among Waxman USA, Inc., Barnett Inc., Waxman Consumer Products Group Inc. and WOC Inc., the Lenders and Issuers party thereto and Citicorp USA, Inc., as Agent and certain exhibits thereto (Exhibit 10.8 to Waxman Industries, Inc.'s Form S-4 filed June 20, 1994, incorporated herein by reference).\n4.26* Term Loan Credit Agreement dated as of May 20, 1994 among Waxman USA, Inc., Barnett Inc., Waxman Consumer Products Group, Inc. and WOC Inc., the Lenders and Issuers party thereto and Citibank, N.A., as Agent (Exhibit 10.9 to Waxman Industries, Inc.'s Form S-4 filed June 20, 1994, incorporated herein by reference.).\n10.1* Lease between the Company as Lessee and Aurora Investment Co. as Lessor dated June 30, 1992 (Exhibit 10.1 to Annual Report on Form 10-K for the year ended June 30, 1992, File No. 0-5888, incorporated herein by reference).\n10.2* Policy Statement (revised as of June 1, 1980) regarding the Company's Profit Incentive Plan (Exhibit 10(c)-1 to Annual Report on Form 10-K for the year ended June 30, 1984, File No. 0-5888, incorporated herein by reference).\n10.3* Employment Contract dated June 18, 1990 between the Company and William R. Pray. (Exhibit 10.4 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n10.4* Form of Stock Option Agreement between the Company and its Directors. (Exhibit 10.5 to Annual Report on Form 10-K for the year ended June 30, 1991, File No. 0-5888, incorporated herein by reference).\n10.5* Employment Contract dated January 1, 1992 between the Company and John S. Peters (Exhibit 10.6 to Annual Report on Form 10-K for the year ended June 30, 1992, File No. 0-5888, incorporated herein by reference).\n10.6* Tax Sharing Agreement dated May 20, 1994 among Waxman Industries, Waxman USA, Barnett Inc., Waxman Consumer Products Group Inc., WOC Inc. and Western American Manufacturing, Inc. (Exhibit 10.6 to Waxman Industries, Inc.'s Form S-4 filed June 20, 1994, incorporated herein by reference).\n10.7* 1992 Non-Qualified and Incentive Stock Option Plan of Waxman Industries, Inc., adopted as of July 1, 1992 (Exhibit 10.7 to Annual Report of Form 10-K for the year ended June 30, 1993, File No. 0-5888, incorporated herein by reference).\n10.8* Intercorporate Agreement dated May 20, 1994 among Waxman Industries, Waxman USA, Barnett Inc., Waxman Consumer Products Group Inc., WOC Inc. and Western American Manufacturing, Inc. (Exhibit 10.7 to Waxman Industries, Inc.'s Form S-4).\n10.9* Employee Stock Purchase Plan of Waxman Industries, Inc., adopted on September 1, 1992 (Exhibit 10.8 to Annual Report on Form 10-K for the year ended June 30, 1993, File No. 0-5888, incorporated herein by reference).\n18.1* Letter Regarding Change in Accounting Principles (Exhibit 18.1 to Annual Report on Form 10-K for the year ended June 30, 1993, File No. 0-5888, incorporated herein by reference).\n21.1* Subsidiaries (Exhibit 21.1 to Waxman Industries, Inc.'s Form S-4 filed June 20, 1994, incorporated herein by reference)\n23 Consent of Arthur Andersen LLP\n27 Financial Data Schedule\n* Incorporated herein by reference as indicated.\n(b) REPORTS ON FORM 8-K\nThere are no reports on Form 8-K for the three months ended June 30, 1994.\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 its behalf by the undersigned, thereunto duly authorized.\nWAXMAN INDUSTRIES, INC.\nSeptember 26, 1994 By: \/s\/ Armond Waxman ------------------------------- Armond Waxman President and Co-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.\nSeptember 26, 1994 By: \/s\/ Melvin Waxman ------------------------------- Melvin Waxman Chairman of the Board, Co-Chief Executive Officer and Director\nSeptember 26, 1994 By: \/s\/ Armond Waxman ------------------------------- Armond Waxman President, Co-Chief Executive Officer and Director\nSeptember 26, 1994 By: \/s\/ Neal R. Restivo ------------------------------- Neal R. Restivo Vice President, Finance and Chief Financial Officer and Chief Accounting Officer\nSeptember 26, 1994 By: \/s\/ Samuel J. Krasney ------------------------------- Samuel J. Krasney, Director\nSeptember 26, 1994 By: \/s\/ Judy Robins ------------------------------- Judy Robins, Director\nSeptember 26, 1994 By: \/s\/ Irving Z. Friedman ------------------------------- Irving Z. Friedman, Director","section_15":""}
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{"filename":"84557_1994.txt","cik":"84557","year":"1994","section_1":"ITEM 1. BUSINESS\nThe following are discussed under the general heading of \"Business\". Reference is made to the various other Items as applicable.\nGENERAL\nIncorporated in 1904 in the State of New York, the Company supplies electric and gas service wholly within that State. It produces and distributes electricity and distributes gas in parts of nine counties centering about the City of Rochester. At December 31, 1994 the Company had 2,075 employees.\nThe Company's service area has a population of approximately one million and is well diversified among residential, commercial and industrial consumers. In addition to the City of Rochester, which is the third largest city and a major industrial center in New York State, it includes a substantial suburban area with commercial growth and a large and prosperous farming area. A majority of the industrial firms in the Company's service area manufacture consumer goods. Many of the Company's industrial customers are nationally known, such as Xerox Corporation, Eastman Kodak Company, General Motors Corporation, and Bausch & Lomb Incorporated.\nEnergyline Corporation, a wholly owned subsidiary, was formed by the Company as a gas pipeline corporation to fund the Company's investment in the Empire State Pipeline. The Company has invested a net amount of approximately $10 million in Energyline as of December 31, 1994.\nThe business of the Company is seasonal. With respect to electricity, winter peak loads are attained due to spaceheating sales and shorter daylight hours and summer peak loads are reached due to the use of air-conditioning and other cooling equipment. With respect to gas, the greatest sales occur in the winter months due to spaceheating usage.\nIn each of the communities in which it renders service, the Company, with minor exceptions, holds the necessary municipal franchises, none of which contains burdensome restrictions. The franchises are non-exclusive, and are either unlimited as to time or run for terms of years. The Company anticipates renewing franchises as they expire on a basis substantially the same as at present.\nInformation concerning revenues, operating profits and identifiable assets for significant industry segments is set forth in Note 4 of the Notes to the Company's financial statements under Item 8. Information relating to the principal classes of service from which electric and gas revenues are derived and other operating data are included herein under \"Operating Statistics\". A discussion of the causes of significant changes in revenues is presented in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations. Percentages of the Company's operating revenues derived from electric and gas operations for each of the last three years are as follows:\nFINANCING AND CAPITAL REQUIREMENTS PROGRAM\nA discussion of the Company's capital requirements and the resources available to meet such requirements may be found in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations. In addition to those issues discussed in Item 7, the sale of additional securities depends on regulatory approval and the Company's ability to meet certain requirements contained in its mortgage and Restated Certificate of Incorporation.\nUnder the New York State Public Service Law, the Company is required to secure authorization from the Public Service Commission of the State of New York (PSC) prior to issuance of any stock or any debt having a maturity of more than one year.\nThe Company's First Mortgage Bonds are issued under a General Mortgage dated September 1, 1918, between the Company and Bankers Trust Company, as Trustee, which has been amended and supplemented by thirty-nine supplemental indentures. Before additional First Mortgage Bonds are issued, the following financial requirements must be satisfied:\n(a) The First Mortgage prohibits the issuance of additional First Mortgage Bonds unless earnings (as defined) for a period of twelve months ending not earlier than sixty days prior to the issue date of the additional bonds are at least 2.00 times the annual interest charges on First Mortgage Bonds, both those outstanding and those proposed to be outstanding. The ratio under this test for the twelve months ended December 31, 1994 was 5.28.\n(b) The First Mortgage also provides that, if additional First Mortgage Bonds are being issued on the basis of property additions (as defined), the principal amount of the bonds may not exceed 60% of available property additions. As of December 31, 1994 the amount of additional First Mortgage Bonds which could be issued on that basis was approximately $356,674,000. In addition to issuance on the basis of property additions, First Mortgage Bonds may be issued on the basis of 100% of the principal amount of other First Mortgage Bonds which have been redeemed, paid at maturity, or otherwise reacquired by the Company. As of December 31, 1994, the Company could issue $194,334,000 of Bonds against Bonds that have matured or been redeemed.\nThe Company's Restated Certificate of Incorporation (Charter) provides that, without consent by two-thirds of the votes entitled to be cast by the preferred stockholders, the Company may not issue additional preferred stock unless in a 12-month period within the preceding 15 months: (a) net earnings applicable to payment of dividends on preferred stock, after taxes, have been at least 2.00 times the annual dividend requirements on preferred stock, including the shares both outstanding and proposed to be issued, and (b) net earnings available for interest on indebtedness, after taxes, have been at least 1.50 times the annual interest requirements on indebtedness and annual dividend requirements on preferred stock, including the shares both outstanding and proposed to be issued. For the twelve months ended December 31, 1994, the coverage ratio under (b) above (the more restrictive provision) was 2.13.\nAt December 31, 1994 the Company had $51.6 million of short-term debt outstanding consisting of $32.0 million of unsecured short-term debt and $19.6 million of secured short-term debt.\nThe Company's Charter provides that unsecured debt may not exceed 15% of the Company's total capitalization (excluding unsecured debt). At December 31, 1994, including the $32 million of unsecured debt already outstanding, the Company was able to issue $69.5 million of unsecured debt under this provision. The Company has unsecured short-term credit facilities totaling $72 million.\nThe Company has a $90 million revolving credit agreement which expires December 31,1997. In order to be able to use its revolving credit agreement, the Company created a subordinate mortgage which secures borrowings under its revolving credit agreement that might otherwise be restricted by this provision of the Company's Charter. The subordinate mortgage provides that the aggregate principal amount of bonds outstanding under the First Mortgage together with all borrowings under the revolving credit agreement will not exceed 70% of available property additions. At December 31, 1994, this provision would not restrict borrowings under the revolving credit agreement.\nThe Company has a loan and security agreement with a domestic bank providing for up to $20 million of short-term debt. Borrowings under this agreement, which extends to December 31, 1995, are secured by a lien on the Company's accounts receivable.\nThe Company has a $30 million credit agreement with a domestic bank until May 31, 1995 to provide funds for the Company's transition cost liability pursuant to Federal Energy Regulatory Commission Order No. 636. Borrowings under this agreement, which are secured by the Company's accounts receivable, totaled $18.7 million (recorded as a deferred credit on the Balance Sheet) at December 31, 1994.\nThe Company's Charter does not contain any financial tests for the issuance of preference or common stock.\nThe Company's securities ratings at December 31, 1994 were:\nThe securities ratings set forth in the table are subject to revision and\/or withdrawal at any time by the respective rating organizations and should not be considered a recommendation to buy, sell or hold securities of the Company.\nREGULATORY MATTERS\nThe Company is subject to regulation by the PSC under New York statutes, by the Federal Energy Regulatory Commission (FERC) as a licensee and public utility under the Federal Power Act and by the Nuclear Regulatory Commission (NRC) as a licensee of nuclear facilities.\nThe National Energy Policy Act (Energy Act), signed into law in 1992 is the most comprehensive energy bill in more than a decade and impacts virtually every sector of the U.S. energy industry. Major provisions of the Energy Act, as they relate to the Company, include energy efficiency, promoting competition in the electric power industry at the wholesale level, streamlining of federal licensing of nuclear power plants, encouraging development and production of coal resources and ensuring that a new class of independent power producers established under the bill as well as qualified facilities and other electric utilities can achieve access to utility-owned transmission lines upon payment of appropriate prices. Under the Energy Act, FERC may order utilities to provide wholesale transmission services for others only if, among other things, the order meets certain requirements as to cost recovery and fairness of rates. This law prohibits FERC from ordering retail wheeling, which is power to be transmitted directly to a customer from a supplier other than the customer's local utility. The law, however, does not prevent state regulatory commissions from allowing or ordering intrastate retail wheeling; and, New York State is currently considering the issue of retail wheeling through various studies and hearings. The Company believes this Act could lead to enhanced competition among the Company and other service providers in the electric industry.\nIn April 1992 FERC issued Order No. 636 with the intention of fostering competition in the gas supply industry and improving access of customers to gas supply sources. In essence, FERC Order No. 636 requires interstate natural gas companies to offer customers \"unbundled\", or separate, sales and transportation services. FERC Order 636 offers an opportunity for the Company and other gas utilities to negotiate directly with gas producers for supplies of natural gas. With the unbundling of services, primary responsibility for reliable natural gas supply has shifted from interstate pipeline companies to local distribution companies, such as the Company. Since 1988 the Company has endeavored to diversify both its natural gas supply sources and the pipelines on which that supply is delivered to the Company's distribution system. With the unbundling of services as required under FERC Order 636 and the commencement of Empire State Pipeline operation, the Company has successfully achieved those goals, which should enhance its competitive position.\nOn December 19, 1994, the PSC instituted a proceeding to review the Company's practices regarding acquisition of pipeline capacity, the costs of capacity and the Company's recovery of those costs. Pending conclusion of the proceeding, the PSC directed the Company to recover FERC Order No. 636 transition costs over a five-year period and all other unrecovered gas costs over 18 months. This proceeding follows an announcement made by the Company last fall that it expected purchased gas expense to be higher during the 1994-95 heating season. See the Notes to Financial Statements, Note 10 under the heading \"Gas Cost Recovery\" and Note 1 under the heading \"Rates and Revenue\" for further information related to this proceeding and for information related to the discontinuing of the weather normalization adjustment from January-May 1995 and its estimated impact on 1995 earnings.\nIn 1988 the PSC ordered New York utilities to submit proposals to implement a competitive bidding procedure for new electric generation. In response to this requirement, the Company filed with the PSC (and thereafter amended such filings as required by the PSC) its proposed request for proposals (RFP) for the bidding of capacity additions and certain demand side management (DSM) measures. On September 11, 1990, the Company issued an RFP to purchase 70,000 kilowatts (Kw) of capacity or capacity savings. Of this total resource block, 20,000 Kw was set aside for DSM projects implemented within the Company's service territory while the remaining 50,000 Kw could be filled either by some form of generation directly interconnected to the electric system within or outside the Company's service territory or by additional DSM projects. The Company expressed a strong preference for peaking capacity in the RFP. The Company announced the successful bids in October 1991. Contract negotiations have been completed with three successful bidders of DSM projects resulting in contracts to supply 20.6 MW of capacity savings to be phased-in over the 1993-1996 period.\nA joint New York State utility analysis completed in late August 1991 concluded that capacity reserves on a statewide basis would exceed required levels until after the long-range planning period, or through and beyond the year 2007. Based on this analysis, the Company determined that its remaining needs could be more economically met through spot market purchases of capacity more closely tailored to its year-to-year\nrequirements than by a long-term supply commitment. As a result, no contracts were offered to sponsors of supply-side proposals. On September 1, 1993 the Company issued an RFP for 3 MW of summer peak capacity savings at one of its facilities. Four proposals were received on October 20, 1993. A contract was executed on December 1, 1993. This project is expected to be completed in 1996.\nThe Company is subject to regulation of rates, service, and sale of securities, among other matters, by the PSC. On August 24, 1993 the PSC issued an order approving a settlement agreement (1993 Rate Agreement) among the Company, PSC Staff and other interested parties. This agreement resolved the Company's rate case proceedings initiated in July 1992 and determines the Company's rates from July 1, 1993 through June 30, 1996. The 1993 Rate Agreement includes certain incentive arrangements providing for both rewards and penalties. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations under the heading \"Regulatory Matters\" for a summary of recent PSC rate decisions, a summary of the 1993 Rate Agreement and a discussion of the incentive arrangements including a discussion of the risks and rewards available to the Company under the 1993 Rate Agreement.\nIn July 1993 the Company requested approval from the PSC for a new flexible pricing tariff for major industrial and commercial electric customers. A settlement in this matter was approved by the PSC in March 1994. This tariff allows the Company to negotiate competitive electric rates at discount prices to compete with alternative power sources, such as customer-owned generation facilities. Under the terms of the settlement, the Company will absorb 30 percent of any net revenues lost as a result of such discounts through June 1996, while the remainder may be recovered from other customers. The portion recoverable after June 1996 is expected to be determined in a future Company rate proceeding. The Company has negotiated long-term electric supply contracts with three of it's large industrial and commercial electric customers at discounted rates. It intends to pursue negotiations with other large customers as the need and opportunity arise. The Company has not experienced any customer loss due to competitive alternative arrangements.\nCOMPETITION\nThe Company is operating in an increasingly competitive environment. In its electric business, this environment includes a federal trend toward deregulation and a state trend toward incentive regulation. The passage of the National Energy Policy Act of 1992 (Energy Act) has accelerated these competitive challenges by promoting competition in the electric power industry at the wholesale level, and ensuring that a new class of independent power producers established under the Energy Act, as well as qualified facilities and other electric utilities, can achieve access to utility-owned transmission facilities upon payment of appropriate prices. Competition in the Company's gas business was accelerated with the passage in April 1992 of the FERC's Order No. 636. In essence, FERC Order 636 requires interstate natural gas companies to offer customers \"unbundled\", or separately-priced sale and transportation services. The PSC has been conducting proceedings to investigate various issues regarding the emerging competitive environment\nin the electric and gas business in New York State. See Item 7 - Managements Discussion and Analysis of Financial Condition and Results of Operations under the heading \"Competition\" for information on the competitive challenges the Company faces in it's electric and gas business and how it proposes to respond to those challenges.\nELECTRIC OPERATIONS\nThe total net generating capacity of the Company's electric system is 1,225,000 Kw. In addition the Company purchases 120,000 Kw of firm power under contract and 35,000 Kw of non-contractual peaking power from the Power Authority, 150,000 Kw of a 1,000,000 Kw pumped storage plant owned by the Power Authority in Schoharie County, New York, 50,000 Kw of firm power from the Power Authority's 821,000 Kw FitzPatrick Nuclear Power Plant near Oswego, New York and 20,000 Kw of firm power from Hydro-Quebec purchased through the Power Authority. The Company's net peak load of 1,374,000 Kw occurred on July 21, 1994.\nThe percentages of electricity actually generated and purchased for the years 1990-1994 are as follows:\nThe Company, six other New York utilities and the Power Authority are members of the New York Power Pool. The primary purposes of the Power Pool are to coordinate inter-utility sales of bulk power, long range planning of generation and transmission facilities, and inter- utility operating and emergency procedures in order to better assure reliable, adequate and economic electric service throughout the State. By agreement with the other members of the New York Power Pool, the Company is required to maintain a reserve generating capacity equal to at least 18% of its forecasted peak load. The Company expects to have reserve margins, which include purchased energy under long term firm contractual arrangements, of 23%, 24% and 24%, for the years 1995, 1996 and 1997, respectively.\nThe Company's five major generating facilities are two nuclear units, the Ginna Nuclear Plant and the Company's 14% share of Nine Mile Point Nuclear Plant Unit No. 2 (Nine Mile Two), and three fossil fuel generating stations, the Russell and Beebee Stations and the Company's 24% share of Oswego Unit Six. In terms of capacity these comprise 38%, 12%, 21%, 7% and 16%, respectively, of the Company's current electric generating system.\nNine Mile Two, a nuclear generating unit in Oswego County, New York\nwith a capability of 1,080 megawatts (Mw), was completed and entered commercial service in Spring 1988. Niagara Mohawk Power Corporation (Niagara) is operating the Unit on behalf of all owners pursuant to a full power operating license which the NRC issued on July 2, 1987 for a 40-year term beginning October 31, 1986. Under arrangements dating from September 1975, ownership, output and cost of the project are shared by the Company (14%), Niagara (41%) Long Island Lighting Company (18%), New York State Electric & Gas Corporation (18%) and Central Hudson Gas & Electric Corporation (9%). Under the operating Agreement, Niagara serves as operator of Nine Mile Two, but all five cotenant owners shared certain policy, budget and managerial oversight functions. The base term of the Operating Agreement is 24 months from its effective date, with automatic extension, unless terminated by written notice of one or more of the cotenant owners to the other cotenant owners; such termination becomes effective six months from the receipt of any such notice of termination by all the cotenant owners receiving such notice.\nThe Company has four licensed hydroelectric generating stations with an aggregate capability of 47 megawatts. Although applications for renewal of those licenses were timely made in 1991, the FERC was unable to complete processing of many such applications by the December 31, 1993 license expiration. The Company and many other hydro project owners are thus operating under FERC annual licenses that essentially extend the terms of the old licenses year-to-year until processing of new ones can be completed. The Company is currently participating in negotiations with the New York State Department of Environmental Conservation (NYSDEC) and other parties to receive favorable Water Quality Certifications from the NYSDEC. The outcome of the process, as well as decisions on what environmental conditions FERC will impose in new licenses for the stations, will determine the content of state water quality certifications issued by the NYSDEC. The United States Supreme Court earlier this year decided a case brought by the State of Washington (Tacoma Case) which held that the various States had broad authority to impose non-water quality conditions in their certifications. The NYSDEC holds the view that this is the governing law in the State of New York, and has drafted new provisions accordingly. If the negotiations are unsuccessful, the Company will resume it's litigation in a NYSDEC administrative proceeding initially brought by the Company to challenge the 1992 certifications. This is anticipated to happen in the first quarter of 1995. Overly stringent environmental conditions or other governmental requirements could nullify or greatly impair the economic viability of one or more of the Company's hydro stations and could even compel it to abandon efforts to relicense the affected station or stations. If, however, conditions in the renewal licenses for these stations can be limited to those proposed by FERC Staff in its evaluation, the Company believes that it can continue to operate the stations economically.\nThe Company's Ginna Nuclear Plant, which has been in commercial operation since July 1, 1970, provides 470 Mw of the Company's electric generating capacity. In August 1991 the NRC approved the Company's application for amendment to extend the Ginna Nuclear Plant facility operating license expiration date from April 25, 2006 to September 18, 2009.\nPreparation for replacement of the two steam generators at the Ginna Nuclear Plant began in 1993 and will continue until the replacement in 1996. Steam generator fabrication is well underway. All major components for the steam generators have been ordered and most have been delivered. Major sub-assemblies are now being fabricated. Engineering for the installation is underway and will be completed well before the scheduled installation. Cost of the replacement is estimated to be $115 million, about $40 million for the steam generators, about $50 million for the installation and the remainder for Company engineering, radiation protection, plant support and other services. In 1994 the Company spent approximately $16 million for the replacement project. The installation contractor, Bechtel Power Corporation, has established a presence at the Ginna site and 1995 activities will include a number of in-containment modifications during the normal refueling outage in preparation for the 1996 replacement. Following the 1995 outage, support facilities will be constructed in preparation for the spring 1996 replacement.\nThe gross and net book cost of the Ginna Plant as of December 31, 1994 are $484 million and $258 million, respectively. From time to time the NRC issues directives requiring all or a certain group of reactor licensees to perform analyses as to their ability to meet specified criteria, guidelines or operating objectives and where necessary to modify facilities, systems or procedures to conform thereto. Typically, these directives are premised on the NRC's obligation to protect the public health and safety. The Company is reviewing several such directives and is in the process of implementing a variety of modifications based on these directives and resulting analyses. Additional analyses and modifications can be expected. Expenditures, including AFUDC, at the Ginna Plant (including the cost of these modifications and $30.0 million in 1995 and $48.5 million in 1996 for steam generator replacement as discussed above) are estimated to be $47.8 million, $61.3 million and $6.5 million for the years 1995, 1996 and 1997, respectively, and are included in the capital expenditure amounts presented under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations.\nSee Item 8, Note 10 - Commitments and Other Matters, \"Nuclear- Related Matters\", for a discussion relating to nuclear insurance including information on coverages and maximum assessments.\nGAS OPERATIONS\nThe total daily capacity of the Company's gas system, reflecting the maximum demand which the transmission system can accept without a deficiency, is 5,625,000 Therms (one Therm is equivalent to 1,000,000 British Thermal Units). On January 19, 1994, the Company experienced its maximum daily throughput of approximately 4,735,690 Therms.\nAs a result of the implementation of FERC Order 636, and the commencement of operation of the Empire State Pipeline (Empire), the Company now purchases all of its required gas supply from numerous producers and marketers under contracts containing varying terms and\nconditions. The Company anticipates no problem with obtaining reliable, competitively priced natural gas in the future. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations under the captions \"Energy Supply and Costs - Gas\" for a discussion of that topic and \"Capital Requirements and Gas Operations\" for a discussion of Empire.\nThe Company continues to provide new and additional gas service. Of 235,313 residential gas spaceheating customers at December 31, 1994, 3,376 were added during 1994, and 30% of those were conversions from other fuels.\nApproximately 26% of the gas delivered to customers by the Company during 1994 was purchased directly by commercial, industrial and municipal customers from brokers, producers and pipelines. The Company provided the transportation of gas on its system to these customers' premises.\nFUEL SUPPLY\nNUCLEAR\nGenerally, the nuclear fuel cycle consists of the following: (1) the procurement of uranium concentrate (yellowcake), (2) the conversion of uranium concentrate to uranium hexafluoride, (3) the enrichment of the uranium hexafluoride, (4) the fabrication of fuel assemblies, (5) the utilization of the nuclear fuel in generating station reactors and (6) the appropriate storage or disposition of spent fuel and radioactive wastes. Arrangements for nuclear fuel materials and services for the Ginna Plant and Nine Mile Two have been made to permit operation of the units through the years indicated:\n(1) Information was supplied by Niagara Mohawk Power Corporation.\n(2) Arrangements have been made for procuring the majority of the uranium and conversion requirements through 2000, leaving the remaining portion of the requirements uncommitted.\n(3) A contract is in place with flexibility to supply from 20 to 80 percent of the annual Ginna uranium requirements. A second contract is in place to supply about 20% of the annual requirements for 1995. The remaining requirements are uncommitted.\n(4) Seventy percent of the conversion requirements have been procured through 1997.\n(5) Thirty years from 1984 or life of reactor, whichever is less. See\nthe following discussion.\nThe Company has a contract with United States Enrichment Corporation (USEC) formerly with the federal Department of Energy (DOE) for nuclear fuel enrichment services which assures provision of 70% of the Ginna Plant's requirements throughout its service life or 30 years, whichever is less. For further information concerning this contract see Item 8, Note 10 under the heading \"Nuclear Fuel Enrichment Services\".\nThe Company is pursuing arrangements for the supply of uranium requirements and related services beyond those years for which arrangements have been made as shown above. The prices and terms of any such arrangements cannot be predicted at this time.\nThe average annual cost of nuclear fuel per million BTU used for electric generation for the last five years is as follows:\nThere are presently no facilities in operation in the United States available for the reprocessing of spent nuclear fuel from utility companies. In the Company's determination of nuclear fuel costs it has taken into account that nuclear fuel would not be reprocessed and has provided for disposal costs in accordance with the Nuclear Waste Policy Act discussed below. The Company has completed a conceptual study of alternatives to increase the capacity for the interim storage of spent nuclear fuel at the Ginna Plant. The preferred alternative, based on cost and safety criteria, is to install high-capacity spent fuel racks in the existing area of the spent fuel pool. The additional storage capacity, scheduled to be implemented prior to September 2000, would allow interim storage of all spent fuel discharged from the Ginna Plant through the end of it's Operating License in the year 2009.\nThe cost of nuclear fuel and estimated permanent storage costs of spent nuclear fuel are charged to operating expense on the basis of the thermal output of the reactor. These costs are charged to customers through the fuel cost adjustment clause and base rates.\nThe Nuclear Waste Policy Act (Act) of 1982, as amended, requires the DOE to establish a nuclear waste disposal site and to take title to nuclear waste. A permanent DOE high level nuclear waste repository is not expected to be operational before the year 2010. The DOE is pursuing efforts to establish a monitored retrievable interim storage facility which may allow it to take title to and possession of nuclear waste prior to the establishment of a permanent repository. The Act provides for a determination of the fees collectible by the DOE for the disposal of nuclear fuel irradiated prior to April 7, 1983 and for three payment options. The option of a single payment to be made at any time prior to the first delivery of fuel to the DOE was selected in June 1985. The Company estimates the fees, including accrued interest, owed to the DOE to be $70.9 million at December 31, 1994. The Company is allowed by the\nPSC to recover these costs in rates. The estimated fees are classified as a long term liability and interest is accrued at the three-month Treasury bill rate, adjusted quarterly. The Act also requires the DOE to provide for the disposal of nuclear fuel irradiated after April 6, 1983, for a charge of one mill ($.001) per Kwh of nuclear energy generated and sold. This charge is currently being collected from customers and paid to the DOE pursuant to PSC authorization. The Company expects to utilize on-site storage for all spent or retired fuel assemblies until an interim or permanent nuclear disposal facility is operational.\nDecommissioning costs (costs to take the plant out of service in the future) for the Ginna Plant are estimated to be approximately $163.0 million, and those for the Company's 14% share of Nine Mile Two are estimated to be approximately $37.1 million (January 1994 dollars). Through December 31, 1994, the Company has accrued and recovered in rates $70.1 million for this purpose and is currently accruing for decommissioning costs at a rate of approximately $8.9 million per year based on the use of a combination of internal and external sinking funds.\nSee Note 10 of the Notes to Financial Statements under Item 8 for additional information regarding nuclear plant decommissioning and DOE uranium enrichment facility decontamination and decommissioning.\nCOAL\nThe Company's present annual coal requirement is approximately 560,000 tons. In 1994 approximately 95% of its requirements were purchased under contract and the balance on the open market. The Company is meeting its requirements during early 1995 through contract purchases. Normally, the Company maintains a reserve supply of coal ranging from a 30 to a 60 day supply at maximum burn rates.\nThe sulfur content of the coal utilized in the Company's existing coal-fired facilities ranges from 1.0 to 1.9 pounds per million BTU. Under existing New York State regulations, the Company's coal-fired facilities may not burn coal which exceeds 2.5 pounds per million BTU, which averages more than 1.9 pounds per million BTU over a three-month period or which averages more than 1.7 pounds per million BTU over a 12-month period.\nThe average annual delivered cost of coal used for electric generation was as follows:\nOIL\nThe Company's present annual requirement at Company-operated facilities is estimated at 800,000 gallons of #2 fuel oil. The Company currently intends to meet this requirement through competitively bid\ncontracts.\nENVIRONMENTAL QUALITY CONTROL\nOperations at the Company's facilities are subject to various Federal, state and local environmental standards. To assure the Company's compliance with these requirements, the Company expended approximately $2.9 million on a variety of projects and facility additions during 1994.\nThe most significant environmental control measures affecting Company operations involve the regulation of the quality of fuel burned in utility boilers, the evaluation to determine ambient air quality standards, the imposition of emission limitations on discharges into the air and effluent limitations and pretreatment standards on liquid discharges, the evaluation to determine water quality objectives for water bodies into which Company facilities discharge, the regulation of toxic substances and the disposal of solid wastes.\nThe Company is monitoring a public concern tending to associate health effects with electromagnetic fields from power lines. Together with other New York utilities, the Company funded some of the earliest governmentally-directed research on the question and it continues, with other electric utilities nationwide, to underwrite a broad program of industry-sponsored research in this area. The Company also participated with other New York utilities in compiling information on the state's existing high voltage lines in an initiative which served as a basis for PSC adoption of field limits applicable to the construction of new high voltage lines. The Company has no definitive plans to construct new high voltage lines for its system, but, in connection with Clean Air Act compliance and planning of generation resources, it is considering possible transmission reinforcements; at least one option could require such construction. On request, the Company performs surveys of electromagnetic fields on customer premises. None of its lines have been found to exceed the State field limits applicable to new construction.\nThe Federal Low Level Radioactive Waste Policy Act (Act), as amended in 1985, provides for states to join compacts or individually develop their own low level radioactive waste disposal sites. The portion of the Act that requires a state which fails to provide access to a licensed disposal site by 1996 to take title to such waste was declared unconstitutional by the United States Supreme Court on June 19, 1992, but the court upheld other provisions of the Act enabling sited states to increase charges on shipments from non-sited states and ultimately to refuse such shipments altogether. The Company can provide no assurance as to what disposal arrangements, if any, New York will have in place. The State has not passed legislation that would designate a site for the disposal of low level radioactive waste. In 1990, then Governor Cuomo certified a plan that requires all nuclear power plants in New York State to store their low level radioactive waste on site from January 1, 1993, until the end of 1995. The Company has extended it's interim storage capacity at the Ginna Plant from December 31, 1995 through mid-1999. Efforts will be pursued to extend storage capacity beyond mid-1999, if necessary, at this plant. A low level radioactive waste management and contingency plan is currently ongoing to provide assurance that Nine Mile\nTwo will be properly prepared to handle interim storage of low level radioactive waste for the next ten years.\nThe Company has wastewater discharge permits from NYSDEC for its Ginna, Beebee, and Russell Stations, which were renewed in July, 1992, February, 1994, and June 1994, respectively. These permits are each effective for a period of five years. Consistent with these permits, no significant changes to the wastewater discharge treatment systems are currently required, nor anticipated.\nThe Company believes that additional expenditures and costs made necessary by environmental regulations will be fully allowable for ratemaking purposes. Expenditures for meeting various Federal, State and local environmental standards are estimated to be $2.2 million for the year 1995, $2.8 million for the year 1996 and $22.6 million for the year 1997. These expenditures are included under Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, in the table entitled \"Capital Requirements\".\nSee Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations and Item 8, Note 10 - Commitments and Other Matters, with respect to other environmental matters.\nRESEARCH AND DEVELOPMENT\nThe Company's research activities are designed to improve existing energy technologies and to develop new technologies for the production, distribution, utilization and conservation of energy while preserving environmental quality. Research and development expenditures in 1994, 1993 and 1992 were $7.3 million, $8.3 million, and $7.4 million respectively. These expenditures represent the Company's contribution to research administered by Electric Power Research Institute and Empire State Electric Energy Research Corporation, the Company's share of research related to Nine Mile Two, an assessment for state government sponsored research by the New York State Energy Research and Development Authority, as well as internal research projects.\n* Method for determining daily capacity, based on current network analysis, reflects the maximum demand which the transmission systems can accept without a deficiency.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nELECTRIC PROPERTIES\nThe net capability of the Company's electric generating plants in operation as of December 31, 1994, the net generation of each plant for the year ended December 31, 1994, and the year each plant was placed in service are as set forth below:\nELECTRIC GENERATING PLANTS\n(1) Represents 24% share of jointly-owned facility. (2) Represents 14% share of jointly-owned facility. (3) Owned and operated by the Power Authority.\nThe Company owns 147 distribution substations having an aggregate rated transformer capacity of approximately 2,091,104 Kva, of which 138, having an aggregate rated capacity of 1,911,938 Kva, were located on lands owned in fee, and 9 of\nwhich, having an aggregate rated capacity of 179,166 Kva, were located on land under easements, leases or license agreements. The Company also has 75,486 line transformers with a capacity of 2,973,933 Kva. The Company also owns 24 transmission substations having an aggregate rated capacity of approximately 3,052,017 Kva of which 23, having an aggregate rated capacity of approximately 2,977,350 Kva, were located on land owned in fee and 1, having a rated capacity of 74,667 Kva, was located on land under easements. The Company's transmission system consists of approximately 707 wire miles of overhead lines and 399 wire miles of underground lines. The distribution system consists of approximately 16,181 wire miles of overhead lines, approximately 3,580 wire miles of underground lines and 345,988 installed meters. The electric transmission and distribution system is entirely interconnected and, in the central portion of the City of Rochester, is underground. The electric system of the Company is directly interconnected with other electric utility systems in New York and indirectly interconnected with most of the electric utility systems in the United States and Canada. (See Item 1 -Business, \"Electric Operations\".)\nGAS PROPERTIES\nThe gas distribution systems consists of 4,172 miles of gas mains and 284,006 installed meters. (See Item 1 - Business, \"Gas Operations\".)\nOTHER PROPERTIES\nThe Company owns a ten-story office building centrally located in Rochester and other structures and property. The Company also leases a 153,000 square foot Customer Service Center in Rochester.\nThe Company has good title in fee, with minor exceptions, to its principal plants and important units, except rights of way and flowage rights, subject to restrictions, reservations, rights of way, leases, easements, covenants, contracts, similar encumbrances and minor defects of a character common to properties of the size and nature of those of the Company. The electric and gas transmission and distribution lines and mains are located in part in or upon public streets and highways and in part on private property, either pursuant to easements granted by the apparent owner containing in some instances removal and relocation provisions and time limitations, or without easements but without objection of the owners. The First Mortgage securing the Company's outstanding bonds is a first lien on substantially all the property owned by the Company (except cash and accounts receivable). A mortgage securing the Company's revolving credit agreement is also a lien on substantially all the property owned by the Company (except cash and accounts receivable) subject and subordinate to the lien of the First Mortgage. The Company has a credit agreement with a domestic bank under which short term borrowings are secured by the Company's accounts receivable.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSee Item 8, Note 10 - Commitments and Other Matters and Item 7, under the heading entitled \"Projected Capital and other Requirements\".\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.\nITEM 4 - A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe term of office of each officer extends to the meeting of the Board of Directors following the next annual meeting of shareholders and until his or her successor is elected and qualifies.\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCOMMON STOCK AND DIVIDENDS\nTAX STATUS OF CASH DIVIDENDS\nCash dividends paid in 1994, 1993 and 1992 were 100 percent taxable for Federal income tax purposes.\nDIVIDEND POLICY\nThe Company has paid cash dividends quarterly on its Common Stock without interruption since it became publicly held in 1949. The Company believes that future dividend payments will need to be evaluated in the context of maintaining the financial strength necessary to operate in a more competitive and uncertain business environment. This will require consideration, among other things, of a dividend payout ratio that is lower over time, reevaluating assets and managing greater fluctuation in revenues. While the Company does not presently expect the impact of these factors to affect the Company's ability to pay the current dividend, future dividends may be affected. The Company's Certificate of Incorporation provides for the payment of dividends on Common Stock out of the surplus net profits (retained earnings) of the Company.\nQuarterly dividends on Common Stock are generally paid on the twenty-fifth day of January, April, July and October. In January 1995, the Company paid a cash dividend of $.45 per share on its Common Stock, up $.01 from the prior quarterly dividend payment of $.44. The January 1995 dividend payment is equivalent to $1.80 on an annual basis.\nCOMMON STOCK TRADING\nShares of the Company's Common Stock are traded on the New York Stock Exchange under the symbol \"RGS\".\nItem 6.","section_6":"Item 6. Selected Financial Data\n(a) Includes Company's long term liability to the Department of Energy (DOE) for nuclear waste disposal. Excludes DOE long term liability for uranium enrichment decommissioning and amounts due or redeemable within one year.\n(b) Rate of return on average common equity excludes the effects of retirement enhancement programs recognized by the Company in 1994 and 1993.\n(c) Excludes disallowed Nine Mile Two plant costs written off in 1989.\n(d) The recognition by the Company in 1991 of a fuel procurement audit approved by the New York State Public Service Commission (PSC) has been excluded from 1991 coverages. Likewise, recognition by the Company in 1992 of disallowed ice storm costs as approved by the PSC has been excluded from 1992 coverages. Coverages for 1994 and 1993 exclude the effects of retirement enhancement programs recognized by the Company during each year and certain gas purchase undercharges written off in 1994 and 1993.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following is Management's assessment of significant factors which affect the Company's financial condition and operating results.\nEARNINGS SUMMARY\nOperating earnings have improved due to modest rate relief and lower interest expense, coupled with cost control efforts by the Company and savings resulting from work force reduction programs in 1993 and 1994.\nPresented below is a table which summarizes the Company's Common Stock earnings on a per-share basis. Non-recurring items and their effect on earnings per share have been identified. Earnings per share as reported in 1994 fell below 1993 levels, reflecting one-time charges for work force reduction programs completed during the past year. A total of 572 persons, or about 22 percent of the work force elected to participate in one of three programs offered in 1993 and 1994. Of that total, 399 were participants in the most recent program completed on October 1, 1994. The overall after-tax savings of the program are estimated to be about $61 million through 1998. The latest program resulted in a one-time charge in September 1994 of $33.7 million, or $.59 per share, net of tax. The 1993 writeoffs totaled $8.2 million or $.15 per share for the earlier programs.\nIn addition to the cost of the work force reduction programs, earnings as reported include a charge of $.01 per share in 1994 and $.04 per share in 1993 for unrecoverable gas costs.\nExcluding the impact of non-recurring items, earnings per share for 1994 and 1993 were up despite the effect of the issuance of additional Common Stock in each year. Future earnings will be affected, in part, by the Company's success in controlling operating and capital costs within the levels targeted under the terms of the 1993 Rate Agreement (see Regulatory Matters), as well as achieving certain incentive goals established in that Agreement. Furthermore, a decision in early 1995 by the Company to discontinue operation of a weather normalization clause under certain circumstances through May 1995 is expected to have an impact on 1995 earnings as discussed under Operating Revenues and Sales. The impact of developing competition in the energy marketplace may also affect future earnings.\nEARNINGS PER SHARE - SUMMARY\nDIVIDEND POLICY\nIn December 1993 the Company announced a quarterly dividend increase from $.43 to $.44 per share of Common Stock payable in January 1994. Subsequently, in December 1994 the Company announced a new quarterly dividend rate of $.45 per share payable in January 1995. The Company's Certificate of Incorporation (Charter) provides for the payment of dividends on Common Stock out of the surplus net profits (retained earnings) of the Company. The Company believes that future dividend payments will need to be evaluated in the context of maintaining the financial strength necessary to operate in a more competitive and uncertain business environment. This will require consideration, among other things, of a dividend payout ratio that is lower over time, reevaluating assets and managing greater fluctuation in revenues. While the Company does not presently expect the impact of these factors to affect the Company's ability to pay the current dividend, future dividends may be affected.\nCOMPETITION\nOVERVIEW. The Company is operating in a rapidly developing competitive marketplace for electric and gas service. In its electric business, this competitive environment includes a Federal trend toward deregulation and a state trend toward incentive regulation. The passage of the National Energy Policy Act of 1992 (Energy Act) has accelerated these competitive challenges by promoting competition in the electric power industry at the wholesale level, and ensuring that a new class of independent power producers established under the Energy Act, as well as qualified facilities and other electric utilities, can achieve access to utility-owned transmission facilities upon payment of appropriate prices. Competition in the Company's gas\nbusiness was accelerated with the passage of the Federal Energy Regulatory Commission's (FERC) Order No. 636. In essence, FERC Order 636 requires interstate natural gas pipeline companies to offer customers \"unbundled\", or separately-priced, sale and transportation services.\nELECTRIC UTILITY COMPETITION. Cost pressures on major customers, excess electric capacity in the region, and new technology have created incentives for major customers to investigate different electric supply options. Initially, those options will include various forms of self generation, but may eventually include customer access to the transmission system in order to purchase electricity from suppliers other than the Company.\nIn New York State, the Public Service Commission (PSC) has encouraged competition by requiring utilities to purchase power from non-utility generating companies at prices in excess of the utilities' internal cost of production, has established various incentive mechanisms in rate proceedings to provide lower cost energy, and has authorized flexible pricing for certain large customers who have \"realistic competitive alternatives\".\nPhase I of a PSC proceeding to address various issues related to increasing competition in the New York State electric energy markets was completed in the summer of 1994. The PSC approved flexible rate discounts for non-residential electric customers who have competitive alternatives and adopted specific guidelines for such rates. The PSC noted that flexible rates being offered by the Company should serve as one of the models for other utilities within the State. Phase II of this proceeding is currently underway with an objective to identify regulatory and ratemaking practices that will assist in a transition to a more competitive electric energy market, including investigating the establishment of an efficient wholesale competitive market, and various issues relating to retail competition. In a Notice issued in December 1994 inviting comments on proposed principles to guide the transition to competition, the PSC set forth nine general principles as follows. First, competition is endorsed, especially at the wholesale level. Second, service affordability must be maintained. Third, research programs, environmental protection, energy efficiency and fuel diversity must be preserved. Fourth, safety and reliability must not be jeopardized. Fifth, new industry structures should provide increased choice for customers, consumer protection, efficiency incentives and flexibility to accommodate individual utilities. Sixth, more competition should lead to less regulation. Seventh, the current vertically integrated industry is incompatible with effective competition. Eighth, utilities that cooperate in the furthering of these principles should have a reasonable opportunity to recover their costs. Ninth, changes in the industry should result in rising income levels.\nWhile the Company is in agreement with the spirit underlying most of the principles described above, their\nimplementation could subsequently alter the nature and magnitude of the business risks faced by the Company. This is especially true of any change resulting from the seventh principle. In general, the Company believes market-based solutions to the challenges facing this industry will ultimately result in the greatest shareholder value, and it will continue to work to implement such solutions. The Company cannot predict when Phase II will be completed or the final outcome of this proceeding.\nGAS UTILITY COMPETITION. Competition in the Company's gas business has existed for some time, as larger customers have had the option of obtaining their own gas supply and transporting it through the Company's distribution system. FERC Order 636 enables the Company and other gas utilities to negotiate directly with gas producers for supplies of natural gas. With the unbundling of services, primary responsibility for reliable natural gas has shifted from interstate pipeline companies to local distribution companies, such as the Company.\nIn October 1993 the PSC initiated a proceeding to address issues involving the restructuring of gas utility services to respond to competition. In December 1994, the PSC issued an order which established regulatory policies and guidelines for natural gas distributors. The requirements of the order having the greatest impact on the Company are as follows. First, the Company must offer its customers unbundled access to upstream facilities such as storage and transportation capacity on the interstate pipelines with which the Company does business. Second, the Company may offer to package an individual supply of gas to an individual customer in cases where that would lower the Company's overall cost of supplying gas. Third, the Company must offer an aggregation program whereby individual customers could join together in a pool for the purpose of purchasing gas from a supplier; in such cases the Company would still provide the service of distributing the gas on the Company's system. Fourth, the PSC allow the full recovery of the transition costs resulting from FERC Order 636, and require that a share of these costs be borne by firm transportation customers. Fifth, the PSC will institute a future proceeding to consider incentive-based gas cost recovery mechanisms, a departure from the full flow- through mechanism in place today. Lastly, the PSC will institute a separate proceeding to bring about programs ensuring that all customers have access to a basic, affordable gas service. The Company is reviewing these policies and, at the present time, is unable to predict their impact.\nCOMPETITION AND THE COMPANY'S PROSPECTIVE FINANCIAL POSITION. The stock of New York utilities, including the Company, has dropped during the past year reflecting, in part, investor concern over the impact of the competitive and regulatory changes which have occurred. Some critics have suggested that certain New York State utilities should write down certain regulatory or generating assets as a result of these changes. The Company has deferred certain costs and is recognizing them as expenses when they are reflected in rates and\nrecovered from customers as permitted by Statement of Financial Accounting Standard No. 71 (SFAS-71). These costs are shown as Regulatory Assets on the Company's Balance Sheet and a discussion and summarization of such Regulatory Assets is presented in Note 10 of the Notes to Financial Statements. Deferral of these costs is appropriate while the Company's rates are regulated under a cost-of-service approach. In a purely competitive pricing approach, such costs might not have been incurred or deferred. Accordingly, if the Company's rate setting were changed from a cost-of-service approach and it was no longer allowed to defer these costs under SFAS-71, certain of these assets may not be fully recoverable. In addition, stranded assets (or other costs) arise when investments are made in facilities or costs are incurred to service customers and such costs may not be fully recoverable in rates. Examples include purchase power contracts (i.e. the Kamine\/Besicorp Allegany L.P. contract, see Projected Capital and Other Requirements) or uneconomic generating assets. Excluding the Kamine\/Besicorp Allegany L.P. contract, estimates of stranded asset costs are highly sensitive to the competitive wholesale market price assumed in the estimation for electricity. The amount of stranded assets at December 31, 1994 cannot be determined at this time, but could be significant. While the Company currently believes that its regulatory and stranded assets are probable of recovery in rates, industry trends have moved more toward competition, and in a purely competitive environment, it is not clear to what extent, if any, writeoffs of such assets may occur.\nTHE COMPANY'S RESPONSE. The growing pace of competition in the energy industry has been a primary focus of management over the past three years. The Company accepts the challenges of this new environment and is working to anticipate the impact of increased competition. Its business strategy for one year and in summary for five years, focuses on improving cost-effective service while reducing expenses and maintaining a competitive return for the shareholder. The Company is engaged in a continuous process improvement program to find opportunities for improved service and efficiency. It has implemented three work force reduction programs during 1993 and 1994 which have had, and will continue to have, a favorable impact on reducing operating costs, while still enabling the Company to deliver safe, quality service. Also, the Company in August 1994 streamlined its internal organization by combining 14 division- sized functions into three functional areas as part of an ongoing effort to provide customers with the best possible service at the lowest possible price.\nThe Company is operating under a three-year rate settlement which includes caps on rate increases that approximate or are less than projected inflation, contains incentive programs that tie performance to earnings and stabilizes revenue through revenue adjustment mechanisms. By settlement with the PSC and others, the Company has a competitive rate tariff that allows negotiated rates with larger industrial and commercial customers\nthat have competitive electric supply options. Furthermore, the Company has proposed for PSC approval two new flexible pricing tariffs to encourage economic development and new business growth in our service territory.\nThe Company has responded to the changes in the gas business by positioning itself to obtain greater access to both U.S. and Canadian natural gas supplies and storage, so that it can take advantage of the unbundling of services that results from FERC Order 636. A major element of this strategy went into place in 1993 with the start-up of the Empire State Pipeline. The Company is engaged in various aspects of capacity release and is investigating other options available to mitigate its costs and increase earnings in the new gas business environment.\nThe Company is evaluating all the factors which impact the rates it charges its customers and therefore its competitive position, both with respect to industrial and commercial customers as well as residential customers. In that regard, it is reviewing its regulatory assets (costs which have been deferred for collection in future rates) and generating facilities for their impact on the Company's rate structure. The Company's workforce reduction programs, efforts to control fixed and operational costs and decisions to delay any collection of incentives earned under the 1993 Rate Agreement (see Regulatory Matters) all relate to a focus on trying to maintain a rate structure which has long-term benefits for the competitive presence of the Company in the industry. The Company is reviewing its financing strategies as they relate to debt and equity structures, the cost of these structures including the dividend program and their impact on the Company's rate structure. All of these evaluations are in the context of the new competitive environment and the ability of the Company to shift from a fully regulated to a more competitive and growth- oriented organization.\nIn addition to strategies aimed at creating a competitive rate structure, the Company is reviewing strategies which may enhance it's ability to respond to competitive forces and regulatory change. These strategies may include business partnerships or combinations with other companies, internal restructuring involving a separation of some or all of its wholesale and retail businesses, and acquisitions of related businesses. No assurance can be given that any of these potential strategies will be pursued or the corresponding results on the financial condition or competitive position of the Company.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring 1994 cash flow from operations, together with proceeds from external financing activity (see Consolidated Statement of Cash Flows), provided the funds for construction expenditures, the retirement of long-term debt and short- term borrowings and the retirement and refinancing of Preferred Stock.\nCapital requirements during 1995 are anticipated to be satisfied primarily from the use of internally generated funds.\nPROJECTED CAPITAL AND OTHER REQUIREMENTS\nThe Company's capital requirements relate primarily to expenditures for electric generation, transmission and distribution facilities and gas mains and services as well as the repayment of existing debt. Construction programs of the Company focus on the need to serve new customers, to provide for the replacement of obsolete or inefficient utility property and to modify facilities consistent with the most current environmental and safety regulations. The Company has no current plans to install additional baseload generation.\nUnder Federal and New York State laws and regulations, the Company is required to purchase the electrical output of unregulated cogeneration facilities which meet certain criteria (Qualifying Facilities). With the exception of one contract which the Company was compelled by regulators to enter into with Kamine\/Besicorp Allegany L.P. (Kamine) for approximately 55 megawatts of capacity, the Company has no other long-term obligations to purchase energy from Qualifying Facilities.\nUnder State law and regulatory requirements in effect at the time the contract with Kamine was negotiated, the Company was required to pay Kamine a price for power that is substantially greater than the Company's own cost of production and other purchases. Since that time, the State law mandating a minimum price higher than the Company's own costs has been repealed and PSC estimates of future prices on which the contract was based have declined dramatically.\nIn September 1994 the Company filed a lawsuit against Kamine seeking to void its contract for the forced purchase of unneeded electricity at above- market prices which would result in substantial cost increases for the Company's customers. The Company estimates that Kamine will owe the Company $400 million by the midpoint of the contract term and if the contract extends to its full 25- year term, the total amount of such overpayments (plus interest) could reach approximately $700 million. Alternatively, the Company sought relief to ensure that its customers would pay no more for the Kamine power than they would pay for power from the Company's other sources of electricity. Kamine answered the Company's complaint, seeking to force the Company to take and pay for power at the above-market rates and claiming damages in an unspecified amount alleged to have been caused by the Company's conduct. The Company is unable to predict the ultimate outcome of this litigation. The Company began receiving test generation from the Kamine facility during the last quarter of 1994. In late December 1994, the Company announced it would no longer be accepting electric power from this facility because it is the Company's position, in addition to other beliefs, that the Kamine facility is no longer a \"Qualifying Facility\" as specified under Federal regulations.\nOn January 27, 1995 Kamine initiated a lawsuit against the Company in Federal District Court for the Western District of New York for alleged anti- trust violations by the Company that are based on the same issues that are raised by the Company's New York State Court lawsuit. The Kamine lawsuit seeks injunctive relief similar to that requested in Kamine's answer to the Company's lawsuit in New York State Court and damages of $420 million. The Company intends to vigorously defend against this lawsuit, but is unable to predict the outcome at this time.\nThe Company's most current Integrated Resource Plan (IRP) explores options for complying with the 1990 Clean Air Act Amendments. The IRP is part of an ongoing planning process to examine options for the future with regard to generating resources and alternative methods of meeting electric capacity requirements. Activities are currently under way to:\n- Modify Units 2, 3, and 4 at Russell Station and Unit 12 at Beebee Station, all coal-fired facilities, to meet Federal Environmental Protection Agency standards and Clean Air Act requirements,\n- Explore possible partnerships with certain large customers to use alternative generation or existing generation to mutual benefit,\n- Use demand side management programs to reduce the need for generating capacity, and\n- Replace the two steam generators at the Ginna Nuclear Plant.\nReplacement of the two steam generators at the Ginna Nuclear Plant is expected to be completed in 1996. Much of the preliminary preparation is being done during the normal annual refueling and maintenance outages. The Company anticipates that the 1996 outage for refueling and final replacement will take about 70 days. Cost of the replacement is estimated at $115 million; about $40 million for the units, about $50 million for installation and the remainder for engineering and other services. As discussed under Regulatory Matters, a three- year rate settlement establishes a mechanism to share variances from the estimated $115 million cost between customers and the Company.\nThe Company's capital expenditures program is under continuous review and will be revised depending upon the progress of construction projects, customer demand for energy, rate relief, government mandates and other factors. In addition to its projected construction requirements, the Company may consider, as conditions warrant, the redemption or refinancing of certain long- term securities.\nCAPITAL REQUIREMENTS AND ELECTRIC OPERATIONS. Electric production plant expenditures in 1994 included $31 million of expenditures made at the Company's Ginna Nuclear Plant, of which $16 million was incurred for preparation to replace the steam generators. The Company spent $15 million on this project in 1993. In addition, nuclear fuel expenditures of $11 million were incurred at Ginna during 1994. A refueling outage at Ginna normally occurs annually for a period of approximately 40 to 50 days. Refueling is expected to take place on an 18-month cycle once the new steam generators are installed.\nExclusive of fuel costs, the Company's 14 percent share of electric production plant expenditures at the Nine Mile Two nuclear facility totaled $5 million in 1994. Expenditures of $5 million during 1994 were also made for the Company's share of nuclear fuel at Nine Mile Two. On October 2, 1993 Nine Mile Two was taken out of service for a scheduled refueling outage and resumed full operation on December 3, 1993. The next refueling outage for Nine Mile Two is scheduled for April 1995.\nElectric transmission and distribution expenditures, as presented in the Capital Requirements table, totaled $26 million in 1994, of which $24 million was for the upgrading of electric distribution facilities to meet the energy requirements of new and existing customers.\nCAPITAL REQUIREMENTS AND GAS OPERATIONS. The Empire State Pipeline (Empire), an intrastate natural gas pipeline subject to PSC regulation between Grand Island and Syracuse, New York commenced operation in November 1993. Empire provides capacity for up to 50 percent of the Company's gas requirements. The Company is participating as an equity owner of Empire, along with subsidiaries of Coastal Corporation and Westcoast Energy Inc. The PSC authorized the Company to invest up to $20 million in Empire. The Company's share of ownership in Empire will depend upon final project costs and method of financing selected by Empire. In June 1993 Empire secured a $150 million credit agreement, the proceeds of which were used to finance approximately 75 percent of the total construction cost and initial operating expenses. At December 31, 1994 the Company had invested a net amount of $10.3 million in Energyline and was committed to provide a guarantee for $9.7 million of the borrowings under the credit agreement.\nReplacement of older cast iron mains with longer-lasting and less expensive plastic and coated steel pipe, the relocation of gas mains for highway improvement, and the installation of gas services for new load resulted in gas property construction requirements of $20 million in 1994.\nENVIRONMENTAL ISSUES\nGENERAL. The production and delivery of energy are necessarily accompanied by the release of by-products subject to environmental controls. In recognition of the Company's responsibility to preserve the quality of the air, water, and land it shares with the community it serves, the Company has\ntaken a variety of measures (e.g., self-auditing, recycling and waste minimization, training of employees in hazardous waste management) to reduce the potential for adverse environmental effects from its energy operations and, specifically, to manage and appropriately dispose of wastes currently being generated. The Company, nevertheless, has been contacted, along with numerous others, concerning wastes shipped off-site to licensed treatment, storage and disposal sites where authorities have later questioned the handling of such wastes. The Company typically seeks to cooperate with those authorities and with other site users to develop cleanup programs and to fairly allocate the associated costs. (See Note 10 of the Notes to Financial Statements.)\nFEDERAL CLEAN AIR ACT AMENDMENTS. The Company is developing strategies responsive to the Federal Clean Air Act Amendments of 1990 (Amendments). The Amendments will primarily affect air emissions from the Company's fossil-fueled electric generating facilities. The Company is in the process of identifying the optimum mix of control measures that will allow the fossil fuel based portion of the generation system to fully comply with applicable regulatory requirements. Although work is continuing, not all compliance control measures have been determined. A range of capital costs between $20 million and $30 million has been estimated for the implementation of several potential scenarios which would enable the Company to meet the foreseeable NOx and sulphur dioxide requirements of the Amendments. These capital costs would be incurred between 1996 and 2000. The Company estimates that it could also incur up to $2.1 million of additional annual operating expenses, excluding fuel, to comply with the Amendments. The Company anticipates that the costs incurred to comply with the Amendments will be recoverable through rates based on previous rate recovery of environmental costs required by governmental authorities.\nREDEMPTION OF SECURITIES\nDiscretionary redemption of securities totaled $24.5 million during 1994. A $16 million first mortgage bond maturity and $11.3 million of sinking fund obligations were also a part of the Company's capital requirements in 1994.\nCapital requirements in 1993 included a $75 million first mortgage bond maturity, $17 million of sinking fund obligations, and discretionary first mortgage bond redemptions of $120 million.\nCAPITAL REQUIREMENTS - SUMMARY\nThe Company's capital program is designed to maintain reliable and safe electric and natural gas service, to improve the Company's competitive position, and to meet future customer service requirements. Capital requirements for the three-year period 1992 to 1994 and the current estimate of capital requirements through 1997 are summarized in the Capital Requirements table.\n* Excludes prospective refinancings.\nFINANCING AND CAPITAL STRUCTURE\nCapital requirements in 1994 were satisfied primarily by a combination of internally generated funds and short-term borrowings and the Company foresees modest near-term financing requirements. With an increasingly competitive environment, the Company believes maintaining a high degree of financial flexibility is critical. In this regard, the Company's long-term objective is to control capital expenditures, to move to a less leveraged capital structure and to increase the common equity percentage of capitalization toward the 50 percent range.\nThe Company is utilizing its credit agreements to meet any interim external financing needs prior to issuing any long-term securities. As financial market conditions warrant, the Company may, from time to time, issue securities to permit the early redemption of higher-cost senior securities. The Company's financing program is under continuous review and may be revised depending upon the level of construction, financial market conditions, and other factors.\nFINANCING. Under provisions of the Company's Charter, the Company may not issue unsecured debt if immediately after such issuance the total amount of unsecured debt outstanding would exceed 15 percent of the Company's total secured indebtedness, capital, and surplus without the approval of at least a majority of the holders of outstanding Preferred Stock. At December 31, 1994, including the $32.0 million of unsecured indebtedness already outstanding as discussed in the following paragraph, the Company was able to issue $37.5 million of additional unsecured debt under this provision.\nShort-term credit is available from certain banks pursuant to a $90 million revolving credit agreement which continues until December 31, 1997 and may be extended annually. Borrowings under this agreement are secured by a subordinate mortgage on substantially all of the Company's property except cash and accounts receivable. In addition, the Company entered into a Loan and Security Agreement to provide for borrowing up to $30 million for the exclusive purpose of financing FERC Order 636 transition costs (see Energy Supply and Costs-Gas) and up to $20 million as needed from time to time for other working capital needs. Borrowings under this agreement, which can be renewed annually, are secured by a lien on the Company's accounts receivable. The Company also has unsecured lines of credit totaling $72 million with several other banks. Funds available pursuant to these lines of credit are at the discretion of the respective banks. At December 31, 1994 the Company had short-term borrowings outstanding of $51.6 million, consisting of $32.0 million of unsecured short- term debt and $19.6 million of secured short-term debt. In addition, borrowings of $18.7 million associated with FERC Order 636 transition costs (recorded on the Balance Sheet as a deferred credit) were outstanding at December 31, 1994.\nIn March 1994 the Company redeemed 180,000 shares of its 8.25% Preferred Stock, Series R, representing all of the outstanding shares of this series. At the Company's option, 120,000 of these shares were redeemed prior to their normal sinking fund redemption date. Later that month, the Company issued 250,000 shares of 6.60% Preferred Stock, Series V.\nDuring 1994 approximately 644,000 new shares of Common Stock were sold through the Company's Automatic Dividend Reinvestment and Stock Purchase Plan (ADR Plan), providing $14.8 million to help finance its capital expenditures program. New shares issued in 1994 and 1993 through the ADR Plan were purchased from the Company at a market price above the book value per share at the time of purchase.\nCAPITAL STRUCTURE. The Company's retained earnings at December 31, 1994 were $74.6 million, a decrease of approximately $0.5 million compared with a year earlier. Retained earnings were reduced by approximately $21.9 million in September 1994 resulting from the charge for a workforce reduction program, as discussed under the heading Earnings Summary. Common equity (including retained earnings) comprised 44.5 percent of the\nCompany's capitalization at December 31, 1994, with the balance being comprised of 7.3 percent preferred equity and 48.2 percent long-term debt. As presented, these percentages are based on the Company's capitalization inclusive of its long-term liability to the United States Department of Energy (DOE) for nuclear waste disposal as explained in Note 10 of the Notes to Financial Statements. To improve its capital structure, the Company currently anticipates the issuance of new shares of Common Stock, primarily through the Company's ADR Plan. The Company is reviewing its financing strategies as they relate to debt and equity structures in the context of the new competitive environment and the ability of the Company to shift from a fully regulated to a more competitive organization.\nREGULATORY MATTERS\nNEW YORK STATE PUBLIC SERVICE COMMISSION (PSC). The Company is subject to PSC regulation of rates, service, and sale of securities, among other matters. On August 24, 1993 the PSC issued an order approving a settlement agreement (1993 Rate Agreement) among the Company, PSC Staff and other interested parties. The 1993 Rate Agreement will determine the Company's rates through June 30, 1996 and includes certain incentive arrangements providing for both rewards and penalties. The 1993 Rate Agreement amounts are based on an allowed return on common equity of 11.50% through June 30, 1996. Earnings between 8.50% and 14.50% will be absorbed\/retained by the Company. Earnings above 14.50% will be refunded to the customers. If, but not unless, earnings fall below 8.50%, or cash interest coverage falls below 2.2 times, the Company can petition the PSC for relief.\nIn the first quarter of 1994 the Company filed with the PSC certain adjustments required under various clauses of the 1993 Rate Agreement and new rates were subsequently approved and became effective for the rate year beginning July 1, 1994 (Year 2 under the Agreement). These new rates primarily reflect adjustments for higher property taxes, a Federal tax rate increase, and variations in electric sales between actual and projected levels offset, in part, by operating and maintenance expense savings achieved in Year 1 under the 1993 Rate Agreement.\nA summary of recent PSC rate decisions is presented in the table titled Rate Increases. The amounts presented in this table do not include any variations from the estimated cost of fuel included in base rates which are or may be collected\/refunded through the Company's fuel clause provisions (see Operating Revenues and Sales).\n* See under heading Regulatory Matters for additional details. Amounts for 1995 are subject to certain adjustments to be filed with the PSC by the Company in March 1995.\nThe 1993 Rate Agreement includes:\n- Incentive mechanisms that have the potential to either increase or reduce earnings from 5 to 110 basis points each, depending on the Company's ability to meet a variety of prescribed targets in the areas of electric fuel costs, demand side management, service quality, and integrated resource management (relative electric production efficiency). During the rate year ending June 30, 1995, these incentives have the potential to affect earnings by approximately $12 million.\n- Mechanisms for sharing costs between customers and shareholders for operation and maintenance expense variations. In general, these variances are shared 50% by customers and 50% by the Company, unless those costs are directly manageable by the Company, in which case there is no sharing and such costs are to be absorbed\/retained by the Company.\n- Mechanisms for sharing variances between forecasted and actual electric capital expenditures related to production and transmission facilities. The Company will retain the savings for cost of money and depreciation on underspending variances. If there is an overspending variance, the Company will write off 50% of the net cumulative amount of the variance.\n- Sharing mechanism regarding the replacement of the Ginna Nuclear Plant steam generators. A graduated sharing percentage is applied for up to $15 million of variances, plus or minus, from the forecasted cost of $115 million. Variances above $130 million or below $100 million are absorbed by the Company. Replacement of the steam generators was made subject to a final prudency review by the PSC.\n- An Electric Revenue Adjustment Mechanism (ERAM) designed to stabilize electric revenues by eliminating the impact of variations in electric sales. A gas weather normalization clause previously in place was retained.\nTo the extent incentive and sharing mechanisms apply, the negotiated base revenue increase shown in the table titled Rate Increases may be adjusted up or down in Year 3. Negotiated electric base rate increases could be reduced to zero or increased up to an additional 1.6% in Year 3 and 1.8% in the following year. Negotiated gas base rate increases could also be reduced to zero or increased up to an additional 1.6% in Year 3, and 1.8% in the following year, exclusive of the impact of Empire going into service.\nContained in the rate order for Year 2 is recognition of $9.6 million related to the Company's performance in Year 1, recovery of which the Company has delayed for future consideration. The $9.6 million is comprised of the following:\n- $1.9 million for ERAM,\n- $6.7 million for an Integrated Resource Management Incentive or relative electric production efficiency, and\n- $1.0 million for a Service Quality Incentive.\nIn electing to delay for possible future recovery those incentive amounts for which it was entitled, the Company gave consideration to the current and future competitive environment and its objective for minimizing price impacts on the customer while protecting earnings for shareholders.\nThe Company obtained PSC approval for a new flexible pricing tariff for major industrial and commercial electric customers in a settlement approved by the PSC in March 1994. This tariff allows the Company to negotiate competitive electric rates at discount prices to compete with alternative power sources, such as customer-owned generation facilities. Under the terms of the settlement, the Company will absorb 30 percent of any net revenues lost as a result of such discounts through June 1996, while the remainder may be recovered from other customers.\nThe portion recoverable after June 1996 is expected to be determined in a future Company rate proceeding. Under these tariff provisions, the Company has negotiated long-term electric supply contracts with three of its large industrial and commercial electric customers at discounted rates. It intends to pursue negotiations with other large customers as the need and opportunity arise. The Company has not experienced any customer loss due to competitive alternative arrangements.\nThe PSC Staff is currently reviewing the Company's application for the recovery of certain deferred gas costs as discussed under the heading Energy Supply and Cost - Gas.\nThe PSC has been conducting proceedings to investigate various issues regarding the emerging competitive environment in the electric and gas business in New York State, as noted under the heading Competition.\nThe Company became aware during 1993 that it did not account properly for certain gas purchases for the period August 1990 - August 1992 resulting in undercharges to gas customers of approximately $7.5 million. Of the total undercharges, $2.3 million had previously been expensed and $5.2 million had been deferred on the Company's Balance Sheet. In March 1994, the PSC approved a December 1993 settlement among the Company, PSC Staff and another party providing for the recovery in rates of $2.6 million over three years. The Company wrote off $2.0 million of the undercharges as of December 31, 1993, reducing 1993 earnings by four cents per share, net of tax. In April 1994 the Company wrote off an additional $0.6 million reducing 1994 earnings by approximately one cent per share, net of tax. Due to rate increase limitations established for Year 2 of the rate settlement, the Company is precluded from recovering the undercharges until Year 3, which begins July 1, 1995.\nIn June 1992 the PSC allowed the Company to defer and recover through rates over a period of ten years approximately $21.3 million of non-capital incremental storm-damage repair costs incurred as a result of a March 1991 ice storm. The PSC has permitted the unamortized balance of these allowed costs to be included in rate base. Rate recovery of an additional $8.2 million of non- capital storm-damage costs incurred by the Company was denied by the PSC and the Company accordingly recorded in the second quarter of 1992 a charge to earnings in the amount of $8.2 million, equivalent to approximately $.15 per share, net of tax.\nRESULTS OF OPERATIONS\nThe following financial review identifies the causes of significant changes in the amounts of revenues and expenses, comparing 1994 to 1993 and 1993 to 1992. The Notes to Financial Statements contain additional information.\nOPERATING REVENUES AND SALES\nCompared with a year earlier, operating revenues rose\nfive percent in 1994 following a six percent increase in 1993. Operating revenues in 1994 were pushed higher by gains in retail customer electric and gas revenues, while revenues from the sale of electric energy to other utilities were basically unchanged from a year earlier. Customer revenue increases in 1994 resulted primarily from rate relief and recovery of higher fuel costs. Details of the revenue changes are presented in the Operating Revenues table. As presented in this table, the base cost of fuel has been excluded from customer consumption and is included under fuel costs, revenue taxes are included as a part of other revenues, and unbilled revenues are included in each caption as appropriate.\nChanges in FUEL AND PURCHASED POWER COST REVENUES normally have been earnings neutral in the past. The Company, however, does have fuel clause provisions which currently provide that customers and shareholders will share, generally on a 50%\/50% basis subject to certain incentive limits, the benefits and detriments realized from actual electric fuel costs, generation mix, sales of gas to dual- fuel customers and sales of electricity to other utilities compared with PSC- approved forecast, or base rate, amounts. As a result of these sharing arrangements, discussed further in Note 1 of the Notes to Financial Statements, pretax earnings were increased by $4.4 million in 1993 and $3.9 million in 1994, primarily reflecting actual experience in both electric fuel costs and generation mix compared with rate assumptions. Deferred costs associated with the DOE's assessment for future uranium enrichment decontamination and certain transition costs incurred by the Company's gas supply pipeline companies and billed to the Company are being recovered through the Company's fuel adjustment clauses.\nThe effect of WEATHER variations on operating revenues is most measurable in the Gas Department, where revenues from\nspaceheating customers comprise about 85 to 90 percent of total gas operating revenues. Variation in weather conditions can also have a meaningful impact on the volume of gas delivered and the revenues derived from the transportation of customer-owned gas since a substantial portion of these gas deliveries is ultimately used for spaceheating. Weather in the Company's service area during 1993 was colder than normal, in contrast to 1994 which was warmer than normal, despite record-setting cold weather in January 1994. Overall, weather during 1994 was 4.9 percent warmer than 1993 on a calendar-month heating degree day basis. Warmer than normal summer weather during 1994 and 1993 boosted electric energy sales to meet the demand for air conditioning usage. The decoupling, or separation, of sales level fluctuations from revenue through the ERAM provisions, discussed under Regulatory Matters, and a gas normalization weather clause (see following paragraph) may mitigate the effect of abnormal weather conditions on earnings.\nRetail customers who use gas for spaceheating are subject to a WEATHER NORMALIZATION ADJUSTMENT to reflect the impact of variations from normal weather on a billing cycle month basis for the months of October through May, inclusive. The weather normalization adjustment for a billing cycle applies only if the actual heating degree days are lower than 97.5 percent or higher than 102.5 percent of the normal heating degree days. Weather normalization adjustments lowered gas revenues in 1994 and 1993 by approximately $1.25 million and $1.2 million respectively. Adjustments will continue through June 1996 in accordance with the 1993 Rate Agreement for weather which is colder than normal. However, beginning in January 1995 and continuing until May 1995, the Company elected to discontinue the operation of this clause in circumstances where the weather is warmer than normal because of the unusually mild weather that has been experienced in its service territory and the adverse effects on customer bills. The earnings impact of this decision in 1995 will range between $3.5 and $8.7 million depending on the duration of mild weather for the heating season.\nCompared with a year earlier, KILOWATT-HOUR SALES OF ENERGY TO RETAIL CUSTOMERS were nearly flat in 1994, after climbing about one percent in 1993. Electric demand for air conditioning usage had a significant impact on such sales in each of these years. During 1993 and 1994, an increase in combined sales to residential and commercial customers more than offset a decline in sales to industrial customers, which occurred as a result, in part, of a decline in local manufacturing employment. The Company had a net gain of over 2,600 new electric customers during 1994, including nearly 350 new commercial customers.\nFluctuations in revenues from ELECTRIC SALES TO OTHER UTILITIES are generally related to the Company's customer energy requirements, New York Power Pool energy market and transmission conditions and the availability of electric generation from Company facilities. Such revenues in 1993 and 1994 reflect the sale of energy at a lower average rate per megawatt hour, a\nresult, in part, of competition and greater availability of energy. With the possibility of more open access to transmission services as provided for under the Energy Act, the Company is examining alternative markets and procedures to meet what it believes will be increased competition for the sale of electric energy to other utilities.\nThe TRANSPORTATION OF GAS FOR LARGE-VOLUME CUSTOMERS who are able to purchase natural gas from sources other than the Company remains an important component of the Company's marketing mix. Company facilities are used to distribute this gas, which amounted to 13.6 million dekatherms in 1994 and 12.4 million dekatherms in 1993. These purchases have caused decreases in customer revenues, with offsetting decreases in purchased gas expenses, but in general do not adversely affect earnings because transportation customers are billed at rates which, except for the cost of buying and transporting gas to our city gate, approximate the rates charged the Company's other gas service customers. Gas supplies transported in this manner are not included in Company therm sales, depressing reported gas sales to non-residential customers.\nTHERMS OF GAS SOLD AND TRANSPORTED COMBINED, including unbilled sales, were down about two percent in 1994, after being nearly flat in 1993. These changes reflect, primarily, the effect of weather variations on therm sales to customers with spaceheating. If adjusted for normal weather conditions, residential gas sales would have increased about 0.6 percent in 1994 over 1993, while nonresidential sales, including gas transported, would have increased approximately 1.9 percent in 1994. The average use per residential gas customer, when adjusted for normal weather conditions, was slightly down in 1994, following a modest decrease in 1993.\nFluctuations in \"OTHER\" CUSTOMER REVENUES shown in the Operating Revenues table for both comparison periods are largely the result of revenue taxes, deferred fuel costs, and miscellaneous revenues.\nOPERATING EXPENSES\nCompared with the prior year, operating expenses were up $44.0 million in 1994 after increasing $40.2 million in 1993. These increases were driven by higher gas purchased for resale costs in each comparison period. The increases in operating expenses were mitigated by the Company's continuing efforts to curtail increases in maintenance and other operation expenses. Operating expenses are summarized in the table titled Operating Expenses.\nOPERATING EXPENSES\n- --------------------------------------------------------------------------------\nINCREASE OR (DECREASE) FROM PRIOR YEAR\n(Thousands of Dollars) 1994 1993\nENERGY COSTS - ELECTRIC. For both comparison periods, an electric generation mix favoring less expensive nuclear fuel, compared with the cost of coal or oil, resulted in fuel expenses not increasing at the same rate as electric generation. The average cost of coal and nuclear fuel decreased in 1994 over 1993.\nThe Company purchases electric power to supplement its own generation when needed to meet load or reserve requirements, and when such power is available at a cost lower than the Company's production cost. For both comparison periods, the increase in purchased electricity expense was primarily caused by an increase in kilowatt-hours purchased. Average rates for purchased electricity declined in 1994 and in 1993.\nENERGY SUPPLY AND COSTS - GAS. As a result of the implementation of FERC Order 636, and the commencement of operation of Empire, the Company now purchases all of its required gas supply directly from numerous producers and marketers under contracts containing varying terms and conditions. The Company holds firm transportation capacity on ten major pipelines, giving the Company access to the major gas-producing regions of North America. In addition to firm pipeline capacity, the Company also has obtained contracts for firm storage capacity on the CNG Transmission Corporation (CNG) system (10.4 billion cubic feet) and on the ANR Pipeline system (6.4 billion cubic feet) which are used to help satisfy its customers' winter demand requirements.\nThe Company acquires gas supply and transportation capacity based on its requirements to meet peak loads which generally occur in the winter months. With Empire going on-line, the Company's gas supply and transportation capacity have also\nbeen enhanced and increased. The Company expects to have excess gas and transportation capacity at various times throughout the year which it will attempt to sell separately or bundled as a package to customers outside the Company's franchise area. The Company is also able to mitigate transportation costs via the capacity release market. To what extent the Company can successfully achieve the assignment or sale of any excess gas and\/or transportation capacity, or at what price, cannot be determined at the present time.\nAs a result of the restructuring of the gas transportation industry by FERC and related decisions, there will be a number of changes in this aspect of the Company's business over the next several years. These changes will require the Company to pay a share of certain transition costs incurred by the pipelines as a result of the FERC-ordered industry restructuring. Although the final amounts of such transition costs are subject to continuing negotiations with several pipelines and ongoing pipeline filings requiring FERC approval, the Company expects such costs to range between $44 and $52 million. A substantial portion of such costs will be on the CNG system of which approximately $27 million was billed to the Company in December 1993 and subsequently paid by the Company. The Company has entered into a $30 million credit agreement with a domestic bank to provide funds for the Company's transition cost liability to CNG. At December 31, 1994 the Company had $18.7 million of borrowings outstanding under the credit agreement. The Company has begun collecting those costs through the Gas Clause Adjustment in its rates.\nIt was primarily an increase in average purchased gas rates that pushed up the cost of gas purchased for resale for both comparison periods. These higher rates reflect, in part, increased demand charges and newly assessable gas service restructuring charges as a result of FERC Order 636. In contrast to 1993, a decrease in the volume of gas purchased for resale helped to mitigate the overall increase in purchased gas expense in 1994.\nA reconciliation of gas costs incurred and gas costs billed to customers is done annually, as of August 31, and the excess or deficiency is refunded to or recovered from customers during a subsequent period. In October 1994 the Company submitted to the PSC its annual reconciliation providing for recovery of $24 million of deferred gas costs, which was substantially higher than in previous years due to the factors mentioned above.\nThe Staff of the PSC has reviewed the Company's application for recovery of these deferred costs and various other parties requested that the PSC conduct hearings to determine whether and on what terms the deferral should be recovered. On December 19, 1994 the PSC instituted a proceeding to review the Company's practices regarding acquisition of pipeline capacity, the deferred costs of the capacity and the Company's recovery of those costs. The costs included in the\ndeferral have ordinarily been recovered in the past and the Company believes that they should be recovered in this instance; however, it is possible that with respect to these costs, the PSC may not recognize all of them in rates. If that were to occur, the Company would be compelled to discontinue deferring and recovering costs above the allowed amount, and would recognize the disallowed costs as they were incurred as a charge against earnings. In addition, in a more adverse decision, the PSC could order the Company to refund a portion of such costs previously collected from ratepayers. Pending the conclusion of the proceeding, the PSC directed the Company to recover FERC Order 636 transition costs over a five-year period and all other unrecovered gas costs over 18 months.\nAs an interim measure, on February 1, 1995, the PSC directed the Company to remove from existing rates $16 million of gas revenues representing a portion of the costs attributable to excess capacity over the remaining term of the contracts. Prospective capacity release credits obtained by the Company are to be used to offset such amounts. These deferred costs are subject to recovery by the Company from customers, with interest, to the extent the Company's actions are found prudent.\nThe Company cannot predict to what extent the deferred costs described above would be recoverable in rates.\nThe Company's purchased gas expense charged to customers will be higher during the 1994-95 heating season for the reasons described above.\nOPERATING EXPENSES, EXCLUDING FUEL. After rising approximately $8.8 million in 1993, the growth in other operation expenses remained flat in 1994, a direct result of the Company's cost control efforts and workforce reduction programs. For 1994, higher costs for the Company's demand side management program, claims, and uncollectibles were offset by lower payroll and employee welfare costs due to employee reductions and reduced expenses for contractors and consultants. The change in other operation expenses for the 1993 comparison period reflects primarily increased payroll costs and demand side management expenses partially offset by lower fire and liability insurance costs, transportation, materials and supplies, and legal expense.\nStatement of Financial Accounting Standards 112 (SFAS-112), \"Employees' Accounting for Postemployment Benefits\", was adopted by the Company during the first quarter of 1994. SFAS-112 requires the Company to recognize the obligation to provide postemployment benefits to former or inactive employees after employment but before retirement. The additional postemployment obligation at the time of the accounting change was approximately $11 million and is being deferred on the Balance Sheet. The Company anticipates filing with the PSC for recovery of the incremental expenses as the result of the adoption of SFAS-112.\nStatement of Financial Accounting Standards 115 (SFAS-115), \"Accounting for Certain Investments in Debt and\nEquity Securities\" was also adopted by the Company in the first quarter of 1994 and requires that debt and equity securities not held to maturity or held for trading purposes be recorded at fair value with unrealized gains and losses excluded from earnings and recorded as a separate component of shareholders' equity. The Company's accounting policy, as prescribed by the PSC, with respect to its nuclear decommissioning trusts is to reflect the trusts' assets at market value and reflect unrealized gains and losses as a change in the corresponding accrued decommissioning liability.\nLower maintenance expense in both comparison periods reflects reduced payroll and contractor costs.\nDespite an increase in depreciable plant in both comparison periods, depreciation declined moderately in 1993 due mainly to a decrease in the depreciation and accrued decommissioning expenses related to the Ginna Nuclear Plant because of a three-year extension of its operating license. For the 1994 comparison period, the higher depreciation expense reflects the increase in depreciable plant.\nTAXES CHARGED TO OPERATING EXPENSES. The increase in local, state and other taxes in both comparison periods resulted primarily from an increase in revenues combined with increased property tax rates and generally higher property assessments. The 1994 comparison period also reflects certain assessments for prior years' taxes.\nDuring the first quarter of 1993, the Company adopted SFAS-109 entitled \"Accounting for Income Taxes\" issued by the FASB in February 1992. The Company's adoption of SFAS-109 did not have a material effect on the Company's results of operations although since then, reflection of a deferred tax liability, together with a corresponding regulatory asset, caused total assets and liabilities to increase significantly. See Note 2 of the Notes to Financial Statements for further discussion of SFAS-109 and an analysis of Federal income taxes.\nIn August 1993 the Revenue Reconciliation Act of 1993 (1993 Tax Act) was signed into law. Among other provisions, the 1993 Tax Act provides for a Federal corporate income tax rate of 35% (previously 34%) retroactive to January 1, 1993. In 1993, the Company adjusted it's tax reserve balances to reflect this new rate. Such adjustment had no material effect on the Company's financial condition or results of operations.\nOTHER STATEMENT OF INCOME ITEMS\nVariations in non-operating Federal income tax reflect mainly accounting adjustments related to retirement enhancement programs (see Earnings Summary), regulatory disallowances, and employee performance incentive programs (discussed below in this section).\nRecorded under the caption Other Income and Deductions is the recognition of retirement enhancement programs designed to reduce overall labor costs which were implemented by the Company\nduring the third and fourth quarters of 1993 and the third quarter of 1994. These programs are discussed under Earnings Summary.\nRecorded under the caption Regulatory Disallowances is the recognition of the 1992 PSC order related to a March 1991 ice storm, and a 1993 settlement with the PSC, as supplemented in 1994, regarding certain gas purchase undercharges, each discussed under the heading New York State Public Service Commission.\nOther Income in 1992 includes $3.5 million of proceeds received in settlement of lawsuits filed against certain contractors involved in the construction of the Nine Mile Two nuclear plant. Other--Net Income and Deductions for 1993 and 1994 results mainly from the recognition of employee performance incentive programs in each of those years. These programs recognize employees' achievements in meeting corporate goals and reducing expenses. For the 1994 comparison period, Other--Net Income and Deductions also reflects higher miscellaneous interest revenues.\nBoth mandatory and optional redemptions of certain higher-cost first mortgage bonds have helped to reduce long-term debt interest expense over the three-year period 1992-1994. The average short-term debt outstanding decreased in 1993 and 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nA. Financial Statements\nReport of Independent Accountants\nConsolidated Statements of Income and Retained Earnings for each of the three years ended December 31, 1994.\nConsolidated Balance sheets at December 31, 1994 and 1993.\nConsolidated Statement of Cash Flows for each of the three years ended December 31, 1994.\nNotes to Consolidated Financial Statements.\nFinancial Statement Schedules -\nThe following Financial Statement Schedule is submitted as part of Item 14, Exhibits, Financial Statement Schedules and Reports on Form 8-K, of this Report. (All other Financial Statement Schedules are omitted because they are not applicable, or the required information appears in the Financial Statements or the Notes thereto.)\nSchedule II - Valuation and Qualifying Accounts\nB. Supplementary Data\nInterim Financial Data.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and Board of Directors of Rochester Gas and Electric Corporation\nIn our opinion, the consolidated financial statements listed under Item 8A in the index appearing on the preceding page present fairly, in all material respects, the financial position of Rochester Gas and Electric 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 1 to the financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" in 1994.\nPRICE WATERHOUSE LLP\nRochester, New York January 20, 1995 (except for Note 10, as to which the date is February 1, 1995)\nConsolidated Statement of Retained Earnings\nThe accompanying notes are an integral part of the financial statements.\n* Reclassified for comparative purposes. The accompanying notes are an integral part of the financial statements.\n* Reclassified for comparative purposes. The accompanying notes are an integral part of the financial statements.\nThe accompanying notes are an integral part of the financial statements.\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF ACCOUNTING PRINCIPLES\nGENERAL. The Company is subject to regulation by the Public Service Commission of the State of New York (PSC) under New York statutes and by the Federal Energy Regulatory Commission (FERC) as a licensee and public utility under the Federal Power Act. The Company's accounting policies conform to generally accepted accounting principles as applied to New York State public utilities giving effect to the ratemaking and accounting practices and policies of the PSC.\nEnergyline Corporation, which is a wholly-owned subsidiary, was incorporated in July 1992. Energyline was formed as a gas pipeline corporation to fund the Company's investment in the Empire State Pipeline project. On November 1, 1993 Empire commenced service. The Company has authority to invest up to $20 million in Empire. In June 1993 Empire secured a $150 million credit agreement, the proceeds of which are to finance approximately 75% of the total construction cost and initial operating expenses. Energyline is obligated to pay its 20% share of the balance outstanding subject to a maximum commitment of $9.7 million under the credit agreement. Excluding the loan commitment, at December 31, 1994 the Company had invested a net amount of $10.3 million in Energyline.\nPRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries Roxdel and Energyline. All intercompany balances and transactions have been eliminated.\nA description of the Company's principal accounting policies follows.\nRATES AND REVENUE. Revenue is recorded on the basis of meters read. In addition, the Company records an estimate of unbilled revenue for service rendered subsequent to the meter-read date through the end of the accounting period.\nTariffs for electric and gas service include fuel cost adjustment clauses which adjust the rates monthly to reflect changes in the actual average cost of fuels. The electric fuel adjustment provides that ratepayers and the Company will share the effects of any variation from forecast monthly unit fuel costs on a 50%\/50% basis up to a $5.6 million cumulative annual gain or loss to the Company. Thereafter, 100% of additional fuel clause adjustment amounts are assigned to customers. The electric fuel cost adjustment also provides that any variation from forecast margins below $7.1 million or above $8.5 million on sales to electric utilities be shared with retail customers on a 50%\/50% basis.\nIn addition, there is a similar 50%\/50% sharing process of variances from forecasted margins derived from sales and the\ntransportation of privately owned gas to large customers that can use alternate fuels.\nUnder the Company's Electric Revenue Assurance Mechanism (ERAM), which was established in the 1993 multi-year rate settlement, any variations between actual margins and the established targets may be recovered from or returned to customers. Beginning July 1994 through December 31, 1994, $7.3 million was recoverable from customers. The company is not currently recognizing ERAM amounts as part of income. The ultimate recognition, if any, will be determined based on a filing with the PSC during 1995.\nRetail customers who use gas for spaceheating are subject to a weather normalization adjustment to reflect the impact of variations from normal weather on a billing month basis for the months of October through May, inclusive. The weather normalization adjustment for a billing cycle applies only if the actual heating degree days are lower than 97.5% or higher than 102.5% of the normal heating degree days. Weather normalization adjustments lowered gas revenues in 1994 and 1993 by approximately $1.25 million and $1.2 million respectively. Adjustments will continue through June 1996 in accordance with the 1993 multi- year rate settlement agreement for weather which is colder than normal (also see Note 10).\nThe Company practices fuel cost deferral accounting as described above. A reconciliation of recoverable gas costs with gas revenues is done annually as of August 31, and the excess or deficiency is refunded to or recovered from the customers during a subsequent period.\nUTILITY PLANT, DEPRECIATION AND AMORTIZATION. The cost of additions to utility plant and replacement of retirement units of property is capitalized. Cost includes labor, material, and similar items, as well as indirect charges such as engineering and supervision, and is recorded at original cost. The Company capitalizes an Allowance for Funds Used During Construction approximately equivalent to the cost of capital devoted to plant under construction that is not included in its rate base. Replacement of minor items of property is included in maintenance expenses. Costs of depreciable units of plant retired are eliminated from utility plant accounts, and such costs, plus removal expenses, less salvage, are charged to the accumulated depreciation reserve.\nDepreciation in the financial statements is provided on a straight- line basis at rates based on the estimated useful lives of property, which have resulted in provisions of 2.9% per annum of average depreciable property in 1994, 1993, and 1992.\nFERC ORDER 636. Under this order, gas supply and pipeline companies are allowed to pass restructuring and transition costs associated with the implementation of the order on to their customers. The Company, as a customer, has estimated total costs to range between $44 and $52 million which will be paid to its suppliers. A regulatory asset and related deferred credit have been established on the balance sheet to account for these estimated costs. Approximately $33.7 million of these costs were paid to various suppliers, of which $15 million has been included in purchased gas costs (see Note 10).\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION. The Company capitalizes an Allowance for Funds Used During Construction (AFUDC) based upon the cost of borrowed funds for construction purposes, and a reasonable rate upon the Company's other funds when so used. AFUDC is segregated into two components and classified in the Consolidated Statement of Income as Allowance for Borrowed Funds Used During Construction, an offset to Interest Charges, and Allowance for Other Funds used During Construction, a part of Other Income.\nThe rates approved by the PSC for purposes of computing AFUDC ranged from 3.9% to 7.1% during the three-year period ended December 31, 1994.\nThe Company did not accrue AFUDC on a portion of its investment in Nine Mile Two for which a cash return was allowed. Amounts were accumulated in deferred debit and credit accounts equal to the amount of AFUDC which was no longer accrued. The balance in the deferred credit account was intended to reduce future cash revenue requirements over a period substantially shorter than the life of Nine Mile Two, and the balance in the deferred debit account would then be collected from customers over a longer period of time. The current balances of $19.2 million are expected to remain on the Company's books for future application by the PSC as a rate moderator.\nFEDERAL INCOME TAX. Statement of Financial Accounting Standards (SFAS) 109, Accounting for Income Taxes, was adopted by the Company during the first quarter of 1993 (see Note 2).\nRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS. The Company provides certain health care and life insurance benefits for retired employees and health care coverage for surviving spouses of retirees. Substantially all of the Company's employees may become eligible for these benefits if they reach retirement age while working for the Company. These and similar benefits for active employees are provided through insurance policies whose premiums are based upon the experience of benefits actually paid.\nIn December 1990, the Financial Accounting Standards Board issued SFAS-106 entitled \"Accounting for Postretirement Benefits Other than Pensions\" effective for fiscal years beginning after December 15, 1992. Among other things, SFAS- 106 requires accrual accounting by employers for postretirement benefits other than pensions reflecting currently earned benefits. The Company adopted this accounting practice in 1992.\nIn September 1993, the PSC issued a \"Statement of Policy Concerning the Accounting and Ratemaking Treatment for Pensions and Postretirement\nBenefits Other Than Pensions\". The Statement's provisions require, among other things, ten-year amortization of actuarial gains and losses and deferral of differences between actual costs and rate allowances.\nPOSTEMPLOYMENT BENEFITS. SFAS-112, \"Employers ' Accounting for Postemployment Benefits\", was adopted by the Company during the first quarter of 1994. SFAS- 112 requires the Company to recognize the obligation to provide postemployment benefits to former or inactive employees after employment but before retirement. The additional postemployment obligation at the time of the accounting change was approximately $11 million and is being deferred on the balance sheet.\nINVESTMENTS IN DEBT AND EQUITY SECURITIES. SFAS-115, \"Accounting for Certain Investments in Debt and Equity Securities\" was adopted by the Company in the first quarter 1994 and requires that debt and equity securities not held to maturity or held for trading purposes be recorded at fair value with unrealized gains and losses excluded from earnings and recorded as a separate component of shareholders' equity. The Company's accounting policy, as prescribed by the PSC, with respect to its nuclear decommissioning trusts is to reflect the trusts' assets at market value and reflect unrealized gains and losses as a change in the corresponding accrued decommissioning liability.\nEARNINGS PER SHARE. Earnings applicable to each share of common stock are based on the weighted average number of shares outstanding during the respective years.\nNOTE 2. FEDERAL INCOME TAXES\nThe provision for Federal income taxes is distributed between operating expense and other income based upon the treatment of the various components of the provision in the rate-making process. The following is a summary of income tax expense for the three most recent years.\nThe following is a reconciliation of the difference between the amount of Federal income tax expense reported in the Consolidated Statement of Income and the amount computed by multiplying the income by the statutory tax rate.\nA summary of the components of the net deferred tax liability is as follows:\nThe Company adopted SFAS-109 \"Accounting for Income Taxes\" in 1993. SFAS-109 requires that a deferred tax liability must be recognized on the balance sheet for tax differences previously flowed through to customers. Substantially all of these flow-through adjustments relate to property plant and equipment and related investment tax credits and will be amortized consistent with the depreciation of these accounts. The net amount of the additional liability at December 31, 1993 and 1994 was $241 million and $206 million, respectively. In conjunction with the recognition of this liability, a corresponding regulatory asset was also recognized.\nSFAS-109 also requires that a deferred tax liability or asset be adjusted in the period of enactment for the effect of changes in tax laws or rates. During 1993 the statutory income tax rate was increased one percent to 35%. This resulted in increases of $.6 million and $1.3 million for current and deferred tax liabilities, respectively. There was no earnings impact since the effects of the tax change have been deferred for future recovery.\nAs of December 31, 1994, the regulatory asset recognized by the Company as a result of adopting SFAS-109 is attributed to $184 million in depreciation, $21 million to property taxes, $18 million of deferred finance charges - Nine Mile Two and $3 million of Miscellaneous items offset by $18 million attributed to investment tax credits and $2 million to revenue taxes.\nNote 3. Pension Plan and Other Retirement Benefits\nThe Company has a defined benefit pension plan covering substantially all of its employees. The benefits are based on years of service and the employee's compensation during the last three years of employment. The Company's funding policy is to contribute annually an amount consistent with the requirements of the Employee Retirement Income Security Act and the Internal Revenue Code. These contributions are intended to provide for benefits attributed to service to date and for those expected to be earned in the future.\nThe plan's funded status and amounts recognized on the Company's balance sheet are as follows:\n* Actuarial present value ** Includes $43.3 million pension plan curtailment charge. *** Includes $9.2 million pension plan curtailment charge.\nDuring 1994, the Company offered to its employees a Temporary Retirement Enhancement Program (TREP 3). A total of 399 employees elected to participate in TREP 3 resulting in a net curtailment charge of $43.3 million including $71.1 million cost of the enhanced benefit offset by a curtailment gain of $27.8 million. In connection with the curtailment, the Company revalued the projected benefit obligation as of September 30, 1994 utilizing the then current discount rate of 8.25%.\nThe projected benefit obligation at December 31, 1994, September 30, 1994 and December 31, 1993 assumed discount rates of 8.50%, 8.25%, and 7.25%, respectively and long-term rate of increase in future compensation levels of 6.00%. The assumed long-term rate of return on plan assets was 8.50%. The unrecognized net obligation is being amortized over 15 years beginning January 1986.\nIn September 1993, the PSC issued a \"Statement of Policy Concerning the Accounting and Ratemaking Treatment for Pensions and Postretirement Benefits Other than Pensions\" (Statement). The 1994 and 1993 pension cost reflects adoption of the Statement's provisions which, among other things, requires ten- year amortization of actuarial gains and losses and deferral of differences between actual costs and rate allowances.\nIn addition to providing pension benefits, the Company provides certain health care and life insurance benefits to retired employees and health care coverage for surviving spouses of retirees. Substantially all of the Company's employees are eligible provided that they retire as employees of the Company. In 1994, the health care benefit consisted of a contribution of up to $193 per month towards the cost of a group health policy provided by the Company. The life insurance benefit consists of a Basic Group Life benefit, covering substantially all employees, providing a death benefit equal to one-half of the retiree's final pay. In addition, certain employees and retirees, employed by the Company at December 31, 1982, are entitled to a Special Group Life benefit providing a death benefit equal to the employee's December 31, 1982 pay.\nThe Company adopted SFAS-106, \"Accounting for Postretirement Benefits Other than Pensions\" as of January 1, 1992 for financial accounting purposes. Subsequently, with the issuance of the Statement referenced above, the Company's application of SFAS-106 will extend to ratemaking purposes as well. The Company has elected to amortize the unrecognized, unfunded Accumulated Postretirement Benefit Obligation at January 1, 1992 over twenty years as provided by SFAS-106. The Company intends to continue funding these benefits as the benefit becomes due.\nThe plans' funded status reconciled with the Company's balance sheet is as follows:\nThe Accumulated Postretirement Benefit Obligation at December 31, 1994 and 1993 assumed discount rates of 8.50% and 7.25%, respectively and long-term rate of increase in future compensation levels of 6 percent.\nNote 4. Departmental Financial Information\nThe Company's records are maintained by operating departments, in accordance with PSC accounting policies, giving effect to the rate-making process. The following is the operating data for each of the Company's departments, and no interdepartmental adjustments are required to arrive at the operating data included in the Consolidated Statement of Income.\n(a) Excludes cash, unamortized debt expense and other common items.\nNOTE 5. JOINTLY-OWNED FACILITIES\nThe following table sets forth the jointly-owned electric generating facilities in which the Company is participating. Both Oswego Unit No. 6 and Nine Mile Point Nuclear Plant Unit No. 2 have been constructed and are operated by Niagara Mohawk Power Corporation. Each participant must provide its own financing for any additions to the facilities. The Company's share of direct expenses associated with these two units is included in the appropriate operating expenses in the Consolidated Statement of Income. Various modifications will be made throughout the lives of these plants to increase operating efficiency or reliability, and to satisfy changing environmental and safety regulations.\nThe Plant in Service and Accumulated Provision for Depreciation balances for Nine Mile Point Nuclear Unit No. 2 shown above include disallowed costs of $374.3 million. Such costs, net of income tax effects, were previously written off in 1987 and 1989.\nNOTE 6. LONG TERM DEBT\n(a) The Series EE, Series OO, Series RR and Series SS First Mortgage Bonds equal the principal amount of and provide for all payments of principal, premium and interest corresponding to the Pollution Control Revenue Bonds, Series A, Series C, and Pollution Control Refunding Revenue Bonds, Series 1992 A, Series 1992 B (Rochester Gas and Electric Corporation Projects), respectively, issued by the New York State Energy Research and Development Authority through a participation agreement with the Company. Payment of the principal of, and interest on the Series 1992 A and Series 1992 B Bonds are guaranteed under a Bond Insurance Policy by Municipal Bond Investors Assurance Corporation. The Series EE Bonds are subject to a mandatory sinking fund beginning August 1, 2000 and each August 1 thereafter. Nine annual deposits aggregating $3.2 million will be made to the sinking fund, with the balance of $6.8 million principal amount of the bonds becoming due August 1, 2009.\n(b) The Series QQ First Mortgage Bonds and the 7%, 7.15%, 7.13% and 6.375% medium-term notes described below are generally not redeemable prior to maturity.\n(c) In 1993 the Company issued $200 million under a medium-term note program entitled \"First Mortgage Bonds, Designated Secured Medium-Term Notes, Series A\" with maturities that range from seven years to thirty years.\nThe First Mortgage provides security for the bonds through a first lien on substantially all the property owned by the Company (except cash and accounts receivable).\nSinking and improvement fund requirements aggregate $333,540 per annum under the First Mortgage, excluding mandatory sinking funds of individual series. Such requirements may be met by certification of additional property or by depositing cash with the Trustee. The 1993 and 1994 requirements were met by certification of additional property.\nOn February 15, 1994 the Company redeemed $2.75 million principal amount of its First Mortgage 10.95% Bonds, Series FF, pursuant to a sinking fund provision. On June 15, 1994 the Company redeemed all of its outstanding $15 million principal amount of First Mortgage 13 7\/8% Bonds, Series JJ, due June 15, 1999. Of the $15 million total, $2.5 million was redeemed through a mandatory sinking fund provision, and the remaining $12.5 million was redeemed at the Company's option.\nThere are no sinking fund requirements for the next five years. Bond maturities for the next five years are:\n(d) The $51.7 million Promissory Note was issued in connection with NYSERDA's Floating Rate Monthly Demand Pollution Control Revenue Bonds (Rochester Gas and Electric Corporation Project), Series 1984. This obligation is supported by an irrevocable Letter of Credit expiring October 15, 1997. The interest rate on this note for each monthly interest payment period will be based on the evaluation of the yields of short term tax-exempt securities at par having the same credit rating as said Series 1984 Bonds. The average interest rate was 2.82% for 1994, 2.19% for 1993 and 2.74% for 1992. The interest rate will be adjusted monthly unless converted to a fixed rate.\n(e) The $40.2 million Promissory Note was issued in connection with NYSERDA's Adjustable Rate Pollution Control Revenue Bonds (Rochester Gas and Electric Corporation Project), Series 1985. This obligation is supported by an irrevocable Letter of Credit expiring November 30, 1997. The annual interest rate was adjusted to 3.10% effective November 15, 1992, to 2.75% effective November 15, 1993 and to 4.40% effective November 15, 1994. The interest rate will be adjusted annually unless converted to a fixed rate.\nThe Company is obligated to make payments of principal, premium and interest on each Promissory Note which correspond to the payments of principal, premium, if any, and interest on certain Pollution Control Revenue Bonds issued by the New York State Energy Research and Development Authority (NYSERDA) as described above. These obligations are supported by certain Bank Letters of Credit discussed above. Any amounts advanced under such Letters of Credit must be repaid, with interest, by the Company.\nBased on an estimated borrowing rate at year-end 1994 of 8.62% for long term debt with similar terms and average maturities (13 years), the fair value of the Company's long term debt outstanding (including Promissory Notes as described above) is approximately $667 million at December 31, 1994.\nBased on an estimated borrowing rate at year-end 1993 of 6.68% for long term debt with similar terms and average maturities (14 years), the fair value of the Company's long term debt outstanding (including Promissory Notes as described above) is approximately $816 million at December 31, 1993.\nNOTE 7. PREFERRED AND PREFERENCE STOCK\n* See below for mandatory redemption requirements\nNo shares of preferred or preference stock are reserved for employees, or for options, warrants, conversions, or other rights.\nA. Preferred Stock, not subject to mandatory redemption:\n# May be redeemed at any time at the option of the Company on 30 days minimum notice, plus accrued dividends in all cases.\nB. Preferred Stock, subject to mandatory redemption:\n+ Thereafter at $100.00\nMandatory Redemption Provisions - -------------------------------\nIn the event the Company should be in arrears in the sinking fund requirement, the Company may not redeem or pay dividends on any stock subordinate to the Preferred Stock.\nSERIES R. The Company redeemed the remaining 180,000 shares on March 1, 1994 at - --------- $100 per share. Capital stock expense of $1.4 million was charged against retained earnings in connection with the redemption of the Series R Preferred Stock in 1994.\nSERIES S, SERIES T, SERIES U. All of the shares are subject to redemption - ----------------------------- pursuant to mandatory sinking funds on September 1, 1997 in the case of Series S, September 1, 1998 in the case of Series T and September 1, 1999 in the case of Series U; in each case at $100 per share.\nSERIES V. The Series V is subject to a mandatory sinking fund sufficient to - --------- redeem on each March 1 beginning in 2004 to and including 2008, 12,500 shares at $100 per share and on March 1, 2009, the balance of the outstanding shares. The Company has the option to redeem up to an additional 12,500 shares on the same terms and dates as applicable to the mandatory sinking fund.\nBased on an estimated dividend rate at year-end 1994 of 7.50% for Preferred Stock, subject to mandatory redemption, with similar terms and average maturities (8.65 years), the fair value of the Company's Preferred Stock, subject to mandatory redemption, is approximately $54 million at December 31, 1994.\nBased on an estimated dividend rate at year-end 1993 of 5.25% for Preferred Stock, subject to mandatory redemption, with similar terms and average maturities (3.25 years), the fair value of the Company's Preferred Stock, subject to mandatory redemption, is approximately $53 million at December 31, 1993.\nNote 8. Common Stock\nAt December 31, 1994, there were 50,000,000 shares of $5 par value Common Stock authorized, of which 37,669,963 were outstanding. No shares of Common Stock are reserved for options, warrants, conversions, or other rights. There were 549,135 shares of Common Stock reserved and unissued for shareholders under the Automatic Dividend Reinvestment and Stock Purchase Plan and 138,870 shares reserved and unissued for employees under the RG&E Savings Plus Plan.\nCapital stock expense increased in 1992 and 1993 primarily due to expenses associated with the public sale of Common Stock. Redemption of the Company's 8.25% Preferred Stock, Series R, decreased capital stock expense by $0.9 million in 1993 and $1.4 million in 1994.\nCOMMON STOCK\nNOTE 9. SHORT TERM DEBT\nAt December 31, 1994 and December 31, 1993, the Company had short term debt outstanding of $51.6 million and $68.1 million, respectively. The weighted average interest rate on short term debt outstanding at year end 1994 was 6.01% and was 4.50% for borrowings during the year. For 1993, the weighted average interest rate on short term debt outstanding at year end was 3.46% and was 3.48% for borrowings during the year.\nThe Company has a $90 million revolving credit agreement for a term of three years. In November of 1994 the Company was granted a one-year extension of the commitment termination date to December 31, 1997. Commitment fees related to this facility amounted to $169,000 per year in 1994, 1993, and 1992.\nThe Company's Charter provides that unsecured debt may not exceed 15 percent of the Company's total capitalization (excluding unsecured debt). As of December 31, 1994, the Company would be able to incur $37.5 million of additional unsecured debt under this provision. In order to be able to use its revolving credit agreement, the Company has created a subordinate mortgage which secures borrowings under its revolving credit agreement that might otherwise be restricted by this provision of the Company's Charter.\nThe Company has entered into a Loan and Security Agreement to provide for borrowings up to $30 million for the exclusive purpose of financing Federal Energy Regulatory Commission (FERC) Order 636 transition costs(636 Notes) and up to $20 million as needed from time to time for other working capital needs (Secured Notes). Borrowings under this agreement, which can be renewed annually, are secured by a lien on the Company's accounts receivable. Additional unsecured lines of credit totaling $72 million (Unsecured Notes) are also available from several other banks, at their discretion.\nAt December 31, 1994, borrowings outstanding were $18.7 million of 636 Notes (recorded on the Balance Sheet as a deferred credit), $19.6 million of Secured Notes, and $32.0 million of Unsecured Notes.\nNOTE 10. COMMITMENTS AND OTHER MATTERS\nCAPITAL EXPENDITURES.\nThe Company's 1995 construction expenditures program is currently estimated at $132 million, including $30 million related to replacement of the steam generators at the Ginna Nuclear Plant. The Company has entered into certain commitments for purchase of materials and equipment in connection with that program.\nNUCLEAR-RELATED MATTERS.\nDECOMMISSIONING TRUST. The Company is collecting in its electric rates amounts for the eventual decommissioning of its Ginna Plant and for its 14% share of the decommissioning of Nine Mile Two. The operating licenses for these plants expire in 2009 and 2026, respectively.\nUnder accounting procedures approved by the PSC, the Company has collected approximately $70.1 million through December 31, 1994. In connection with the Company's rate settlement completed in August 1993, the PSC approved the collection during the rate year ending June 30, 1995 of an aggregate $8.9 million for decommissioning, covering both nuclear units. The amount allowed in rates is based on estimated ultimate decommissioning costs of $163.0 million for Ginna and $37.1 million for the Company's 14% share of Nine Mile Two (January 1994 dollars). This estimate is based principally on the application of a Nuclear Regulatory Commission (NRC) formula to determine minimum funding with an additional allowance for removal of non-contaminated structures. Site specific studies of the anticipated costs of actual decommissioning are required to be submitted to the NRC at least five years prior to the expiration of the license. The Company believes that decommissioning costs are likely to exceed these estimates but is unable to predict the costs at this time. The Company currently anticipates performing a site specific cost analysis of decommissioning at Ginna during 1995.\nThe NRC requires reactor licensees to submit funding plans that establish minimum NRC external funding levels for reactor decommissioning. The Company's plan, filed in 1990, consists of an external decommissioning trust fund covering both its Ginna Plant and its Nine Mile Two share. The Company is depositing in an external decommissioning trust the amount of the NRC minimum funding requirement only. Since 1990, the Company has contributed $45.7 million to this fund and, including investment returns, the fund has a balance of $49.0 million as of December 31, 1994. The amount attributed to the allowance for removal of non-contaminated structures is being held in an internal reserve. The internal reserve balance as of December 31, 1994 is $24.4 million.\nThe Company is aware of recent NRC activities related to upward revisions to the required minimum funding levels. These activities, primarily focused on disposition of low level radioactive\nwaste, may require the Company to increase funding. The Company continues to monitor these activities but cannot predict what regulatory actions the NRC may ultimately take.\nThe Staff of the Securities and Exchange Commission and the Financial Accounting Standards Board are currently studying the recognition, measurement and classification of decommissioning costs for nuclear generating stations in the financial statements of electric utilities. If current accounting practices for such costs were changed, the annual provisions for decommissioning costs would increase, the estimated cost for decommissioning could be reclassified as a liability rather than as accumulated depreciation and trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense. If annual decommissioning costs increased, the Company would defer the effects of such costs pending disposition by the Public Service Commission.\nURANIUM ENRICHMENT DECONTAMINATION AND DECOMMISSIONING FUND. As part of the National Energy Act (Energy Act) issued in October 1992, utilities with nuclear generating facilities are assessed an annual fee payable over 15 years to pay for the decommissioning of Federally owned uranium enrichment facilities. The assessments for Ginna and Nine Mile Two are estimated to total $22.1 million, excluding inflation and interest. The first installment of $1.6 million was paid in 1993. The Company made the second of 15 payments for this purpose in April 1994, remitting approximately $1.4 million. The third of 15 payments (approximately $1.5 million) was made in October 1994. A liability has been recognized on the financial statements along with a corresponding regulatory asset. For the two facilities the Company's liability at December 31, 1994 is $18.5 million ($16.9 million as a long-term liability and $1.6 million as a current liability). In October 1993, the Company began recovery of this deferral through its fuel adjustment clause. The Company believes that the full amount of the assessment will be recoverable in rates as described in the Energy Act.\nNUCLEAR FUEL DISPOSAL COSTS. The Nuclear Waste Policy Act (Nuclear Waste Act) of 1982, as amended, requires the United States Department of Energy (DOE) to establish a nuclear waste disposal site and to take title to nuclear waste. A permanent DOE high-level nuclear waste repository is not expected to be operational before the year 2010. The DOE is pursuing efforts to establish a monitored retrievable interim storage facility which may allow it to take title to and possession of nuclear waste prior to the establishment of a permanent repository. The Act provides for a determination of the fees collectible by the DOE for the disposal of nuclear fuel irradiated prior to April 7, 1983 and for three payment options. The option of a single payment to be made at any time prior to the first delivery of fuel to the DOE was selected by the Company in June 1985. The Company estimates the fees, including accrued interest, owed to the DOE to be $70.9 million at December 31, 1994. The Company is allowed by the PSC to recover these costs in rates. The estimated fees are classified as a long-term liability and interest is accrued at the current three-month Treasury bill rate, adjusted\nquarterly. The Act also requires the DOE to provide for the disposal of nuclear fuel irradiated after April 6, 1983, for a charge of one mill ($.001) per KWH of nuclear energy generated and sold. This charge is currently being collected from customers and paid to the DOE pursuant to PSC authorization. The Company expects to utilize on-site storage for all spent or retired nuclear fuel assemblies until an interim or permanent nuclear disposal facility is operational.\nSPENT NUCLEAR FUEL LITIGATION. The Nuclear Waste Act obligates the DOE to accept for disposal spent nuclear fuel (\"SNF\") starting in 1998. Since the mid-1980s the Company and other nuclear plant owners and operators have paid substantial fees to the DOE for the disposal of SNF. DOE has indicated that it may not be in a position to accept SNF in 1998. On June 20, 1994, Northern States Power Company and other owners and operators of nuclear power plants filed suit against DOE and the U.S. in the U.S. Court of Appeals for the District of Columbia Circuit asking for a declaration that DOE is not acting in accordance with law, seeking orders directing DOE to submit to the Court a description of and progress reports on a program to begin acceptance of SNF by 1998, and requesting other relief at appropriate times including an order allowing petitioners to pay fees into an escrow fund rather than to DOE. The Company has joined Northern States and the other petitioners in this litigation. On September 9, 1994, the DOE responded to the petition by filing a motion to dismiss stating that (1) the petition was premature, (2) it has taken no \"final\" action that would be subject to review and (3) any injury suffered as a result of its failure to begin spent fuel acceptance in 1998 is too speculative. On September 30, 1994, the petitioners filed their opposition to the DOE's motion. On October 14, 1994, DOE filed its reply to the petitioners' opposition.\nNUCLEAR FUEL ENRICHMENT SERVICES. The Company has a contract with the United States Enrichment Corporation (USEC), formerly part of the DOE, for nuclear fuel enrichment services which assures provision for 70% of the Ginna Nuclear Plant's requirements throughout its service life or 30 years, whichever is less. No payment obligation accrues unless such enrichment services are needed. Annually, the Company is permitted to decline USEC-furnished enrichment for a future year upon giving ten years' notice. Consistent with that provision, the Company has terminated its commitment to USEC for the years 2000, 2001 and 2002. The USEC waived, for an interim period, the obligation to give ten years' notice for 2003 and 2004. The Company has secured the remaining 30% of its Ginna requirements for the reload years 1994 through 1995 under different arrangements with USEC. The Company plans to meet its enrichment requirements for years beyond those already committed by making further arrangements with USEC or by contracting with third parties. Negotiations are underway with Urenco, a European enrichment facility to fill all or part of the unfilled enrichment services through 2002. The estimated cost of enrichment services utilized for the next seven years (priced at the most current rates) is expected to be $6 million in 1995 and ranges from $10 million to $13 million every 18 months thereafter.\nINSURANCE PROGRAM. The Price-Anderson Act establishes a Federal program insuring against public liability in the event of a nuclear accident at a licensed U.S. reactor. Under the program, claims would first be met by insurance which licensees are required to carry in the maximum amount available (currently $200 million). If claims exceed that amount, licensees are subject to a retrospective assessment up to $79.3 million per licensed facility for each nuclear incident, payable at a rate not to exceed $10 million per year. Those assessments are subject to periodic inflation-indexing and a surcharge for New York State premium taxes. The Company's interests in two nuclear units could thus expose it to a potential liability for each accident of $90.4 million through retrospective assessments of $11.4 million per year in the event of a sufficiently serious nuclear accident at its own or another U.S. commercial nuclear reactor.\nClaims alleging radiation-induced injuries to workers at nuclear reactor sites are covered under a separate, industry-wide insurance program. That program contains a retrospective premium assessment feature whereby participants in the program can be assessed to pay incurred losses that exceed the program's reserves. Under the plan as currently established, the Company could be assessed a maximum of $3.1 million over the life of the insurance coverage.\nThe Company is a member of Nuclear Electric Insurance Limited, which provides insurance coverage for the cost of replacement power during certain prolonged accidental outages of nuclear generating units and coverage for property losses in excess of $500 million at nuclear generating units. If an insuring program's losses exceeded its other resources available to pay claims, the Company could be subject to maximum assessments in any one policy year of approximately $5.0 million and $19.5 million in the event of losses under the replacement power and property damage coverages, respectively.\nNON-UTILITY GENERATING CONTRACT. Under Federal and New York State laws and regulations, the Company is required to purchase the electrical output of unregulated cogeneration facilities which meet certain criteria (Qualifying Facilities). With the exception of one contract which the Company was compelled by regulators to enter into with Kamine\/Besicorp Allegany L.P. (Kamine) for approximately 55 megawatts of capacity, the Company has no other long-term obligations to purchase energy from Qualifying Facilities.\nUnder State law and regulatory requirements in effect at the time the contract with Kamine was negotiated, the Company was required to pay Kamine a price for power that is substantially greater than the Company's own cost of production and other purchases. Since that time the State law mandating a minimum price higher than the Company's own costs has been repealed and PSC estimates of future prices on which the contract was based have declined dramatically.\nIn September 1994, the Company filed a lawsuit against Kamine seeking to void its contract for the forced purchase of unneeded electricity at above- market prices which would result in substantial cost increases for the Company's customers. The Company estimates that Kamine will owe the Company $400 million by the midpoint of the contract term and if the contract extends to its full 25 year term, the total amount of such overpayments (plus interest) could reach approximately $700 million. Alternatively, the Company sought relief to ensure that its customers would pay no more for the Kamine power than they would pay for power from the Company's other sources of electricity. Kamine answered the Company's complaint, seeking to force the Company to take and pay for power at the above-market rates and claiming damages in an unspecified amount alleged to have been caused by the Company's conduct. The Company is unable to predict the ultimate outcome of this litigation. The Company began receiving test generation from the Kamine facility during the last quarter of 1994. In late December 1994, the Company announced it would no longer be accepting electric power from this facility because it is the Company's position, in addition to other beliefs, that the Kamine facility is no longer a \"Qualifying Facility\" as specified under Federal regulations.\nOn January 27, 1995, Kamine initiated a lawsuit against the Company in Federal District Court for the Western District of New York for alleged anti- trust violations by the Company that are based on the same issues that are raised by the Company's New York State Court lawsuit. The Kamine lawsuit seeks injunctive relief similar to that requested in Kamine's answer to the Company's lawsuit in New York State Court and damages of $420 million. The Company intends to vigorously defend against this lawsuit, but is unable to predict the outcome at this time.\nENVIRONMENTAL MATTERS.\nThe following table lists various sites where past waste handling and disposal has or may have occurred that are discussed below:\n* orders on consent signed.\nCOMPANY-OWNED WASTE SITE ACTIVITIES. As part of its commitment to environmental excellence, the Company is conducting proactive Site Investigation and\/or Remediation (SIR) efforts at six Company-owned sites where past waste handling and disposal may have occurred. Remediation activities at three of these sites are in various stages of planning or completion and the Company is conducting a program to restore, as necessary to meet environmental standards, the other three sites. The Company anticipates spending $10 million over the next five years on SIR initiatives. Approximately $4.5 million has been provided for in rates through June 1996 ($1.5 million annually) for recovery of SIR costs. To the extent actual expenditures differ from this amount, they will be deferred for future disposition and recovery as authorized by the PSC.\nThe Company owns, and was the prior owner or operator of, a number of locations within the vicinity of the Lower Falls of the Genesee River, which had been identified by the New York State Department of Environmental Conservation (NYSDEC). The preceding paragraph includes references to Company owned property in this vicinity. In mid-1991, NYSDEC advised the Company that it had delisted the Lower Falls site, i.e., removed it from its Registry of Inactive Hazardous Waste Disposal Sites. The effect of delisting is to terminate the Company's status as a potentially responsible party for the Lower Falls site, to discontinue the pending NYSDEC review of a joint Company\/City of Rochester proposal for a limited further investigation of the Lower Falls, to defer the prospect of remedial action and perhaps to end any Company sharing of the cost thereof. However, NYSDEC also stated its intention to consider listing individual manufactured gas plant sites within the larger, original site once the State of New York adopts new Federal hazardous waste criteria. These manufactured gas plant sites make up three of the six sites referenced in the previous paragraph. There is at least some material at one of the individual manufactured gas plant sites that could trigger relisting. The Company is unable to predict what further listing action NYSDEC may take.\nAs already mentioned, the Company and its predecessors formerly owned and operated three manufactured gas facilities within the Lower Falls area. In September 1991, the Company initiated a study of\nsubsurface conditions in the vicinity of retired facilities at its West Station manufactured gas property and has since commenced the removal of soils containing hazardous substances in order to minimize any potential long-term exposure risks. Cleanup efforts have been temporarily suspended while the Company investigates more cost effective remedial technologies. The Company has obtained a research permit (including an air permit) in order to evaluate the burning of material from its West Station property in a coal-fired boiler as a possible disposal strategy. At the second of the three manufactured gas plant sites known as East Station, an interim remedial action was undertaken in late 1993. Groundwater monitoring wells were also installed to assess the quality of the groundwater at this location. The Company has informed the NYSDEC of the results of the samples taken. These results may indicate that some further action may be required.\nAt the third Lower Falls area property owned by the Company (Front Street) where gas manufacturing took place, a boring placed in Fall 1988 for a sewer system project showed a layer containing a black viscous material. The study of the layer found that some of the soil and ground water on-site had been adversely impacted by the hazardous substance constituents of the black viscous material, but evidence was inadequate to determine whether the material or its constituents had migrated off-site. The matter was reported to the NYSDEC and, in September 1990, the Company also provided the agency with a risk assessment for its review. That assessment concluded that the findings warranted no agency action and that site conditions posed no significant threat to the environment. Although NYSDEC could require the Company to undertake further investigation and\/or remediation, the agency has taken no action since the report's submittal. The Company is formulating plans for long term management of the site.\nAnother property owned by the Company where gas manufacturing took place is located in Canandaigua, New York. No residues of the former gas production operations have been discovered there, although investigative work has been limited to date.\nOn another portion of the Company's property in the Lower Falls (Brewer Street), and elsewhere in the general area, the County of Monroe has installed and operates sewer lines. During sewer installation, the County constructed over Company property certain retention ponds which reportedly received from the sewer construction area certain fossil-fuel-based materials (\"the materials\") found there. In July 1989, the Company received a letter from the County asserting that activities of the Company left the County unable to effect a regulatorily-approved closure of the retention pond area. The County's letter takes the position that it intends to seek reimbursement for its additional costs incurred with respect to the materials once the NYSDEC identifies the generator thereof and that any further cleanup action which the NYSDEC may require at the retention pond site is the Company's responsibility. In the course of discussions over this matter, the County has claimed, without offering any evidence, that the Company was the original generator of the materials. It asserts that it will hold\nthe Company liable for all County costs -- presently estimated at $1.5 million - - - associated both with the materials' excavation, treatment and disposal and with effecting a regulatorily-approved closure of the retention pond area. The Company could incur costs as yet undetermined if it were to be found liable for such closure and materials handling, although provisions of an existing easement afford the Company rights which may serve to offset all or a portion of any such County claim. To date, the Company has agreed to pay a 20% share of the County's most recent investigation of this area, which commenced in September 1993 and which is estimated to cost no more than $150,000, but no commitment has been made toward any remedial measures which may be recommended by the investigation.\nIn the letter announcing the delisting of the Lower Falls site, NYSDEC indicated an intention to pursue appropriate closure of the County's former retention pond area, suggesting that it will be evaluated separately to determine whether it meets the criteria of an inactive hazardous waste disposal site. The Company is unable to assess what implications the NYSDEC letter may have for the County's claim against it.\nMonitoring wells installed at another Company facility (Brooks Avenue) in 1989 revealed that an undetermined amount of leaded gasoline had reached the groundwater. The Company has continued to monitor free product levels in the wells, and has begun a modest free product recovery project, reports on both of which are routinely furnished to the NYSDEC. Free product levels in the wells have declined. In December 1994, the NYSDEC granted a permit for the storage of hazardous wastes at this location. Conditions of the permit require additional investigation and corrective action of the hazardous constituents at the site. It is estimated that such investigations may cost approximately $100,000. The cost of corrective actions cannot be determined until investigations are completed.\nSUPERFUND AND OTHER SITES. The Company has been or may be associated as a potentially responsible party (PRP) at seven sites not owned by it, but for which the Company has been identified as a PRP. The Company has signed orders on consent for five of these sites and recorded estimated liabilities totaling approximately $0.8 million.\nIn August 1990, the Company was notified of the existence of a Federal Superfund site located in Syracuse, NY, known as the Quanta Resources Site. The Federal Environmental Protection Agency (EPA) has included the Company in its list of approximately 25 PRPs at the site, but no data has been produced showing that any of its wastes were delivered to the site. In return for its release from liability for that phase, the Company has joined other PRPs in agreeing to divide among them, utilizing a two-tier structure, EPA's cost of a contractor- performed removal action intended to stabilize the site and has signed a consent order to that effect. The Company, in the lower tier of PRPs, paid its $27,500 share of such cost. Although the NYSDEC has not yet made an assessment for certain response and investigation costs it has\nincurred at the site, nor is there as yet any information on which to determine the cost to design and conduct at the site any remedial measures which Federal or state authorities may require, the Company does not expect its costs to exceed $250,000.\nOn May 21, 1993, the Company was notified by NYSDEC that it was considered a PRP for the Frontier Chemical Pendleton Superfund Site located in Pendleton, NY. The Company has signed, along with other participating parties, an Administrative Order on Consent with NYSDEC. The Order on Consent obligates the parties to implement a work plan and remediate the site. The PRPs have negotiated a work plan for site remediation and have retained a consulting firm to implement the work plan. Preliminary estimates indicate site remediation will be between $6 and $8 million. The Company is participating with the group to allocate costs among the PRPs. In April 1994, the Company recorded an estimated liability of $0.7 million for site remediation based on preliminary allocation. Subsequent work has indicated that total is likely to be lower when final.\nThe Company is involved in the investigation and cleanup of the Maxey Flats Nuclear Disposal Site in Morehead, Kentucky and has signed various consent orders to that effect. The Company has contributed to a study of the site and estimates that its share of the cost of investigation and remediation would approximate $205,000.\nThe Company has been named as a PRP at three other sites and has been associated with another site for which the Company's share of total projected costs is not expected to exceed $120,000. Actual Company expenditures for these sites are dependent upon the total cost of investigation and remediation and the ultimate determination of the Company's share of responsibility for such costs as well as the financial viability of other identified responsible parties since clean-up obligations are joint and several.\nFEDERAL CLEAN AIR ACT AMENDMENTS. The Company is developing strategies responsive to the Federal Clean Air Act Amendments of 1990 (Amendments). The Amendments will primarily affect air emissions from the Company's fossil-fueled electric generating facilities. The Company is in the process of identifying the optimum mix of control measures that will allow the fossil-fuel-based portion of the generation system to fully comply with applicable regulatory requirements. Although work is continuing, not all compliance control measures have been determined. A range of capital costs between $20 million and $30 million has been estimated for the implementation of several potential scenarios which would enable the Company to meet the foreseeable NOx and sulphur dioxide requirements of the Amendments. These capital costs would be incurred between 1996 and 2000. The Company estimates that it could also incur up to $2.1 million of additional annual operating expenses, excluding fuel, to comply with the Amendments. The Company anticipates that the costs incurred to comply with the Amendments will be recoverable through rates based on previous rate recovery of environmental costs required by governmental authorities.\nGAS COST RECOVERY.\nAs a result of the restructuring of the gas transportation industry by the Federal Energy Regulatory Commission (FERC) pursuant to Order No. 636 and related decisions, there will be a number of changes in this aspect of the Company's business over the next several years. These changes will require the Company to pay a share of certain transition costs incurred by the pipelines as a result of the FERC-ordered industry restructuring. Although the final amounts of such transition costs are subject to continuing negotiations with several pipelines and ongoing pipeline filings requiring FERC approval, the Company expects such costs to range between $44 and $52 million. A substantial portion of such costs will be on the CNG Transmission Corporation (CNG) system of which approximately $27 million was billed to the Company on December 3, 1993 and subsequently paid by the Company. The Company has entered into a $30 million credit agreement with a domestic bank to provide funds for the Company's transition cost liability to CNG. At December 31, 1994 the Company had $18.7 million of borrowings outstanding under the credit agreement. The Company has begun collecting those costs through the Gas Clause Adjustment (GCA) in its rates.\nThe Company is committed to transportation capacity on the Empire State Pipeline (Empire) which commenced operation in November 1993, as well as to upstream pipeline transportation and storage services. The Company also has contractual obligations with CNG and upstream pipelines whereby the Company is subject to charges for transportation and storage services for a period extending to the year 2001. The combined CNG and Empire transportation capacity exceeds the Company's current requirements. This temporary excess has occurred largely due to the Company's initiatives to diversify its supply of gas and the industry changes and increasing competition resulting from the implementation of FERC Order 636.\nUnder FERC rules, the Company may transfer its excess transportation capacity in the market. The Company is attempting to do that, whenever possible. The Company also entered into a marketing agreement with CNG, pursuant to which CNG will assist the Company in obtaining permanent replacement customers for the transportation capacity the Company will not require. While CNG has already secured letters of intent for a substantial portion of such capacity and has ordered compressors and other related equipment associated with the planned modifications to CNG's pipeline, whether and to what extent CNG and\/or the Company can successfully negotiate the assignment of the excess capacity, or at what price, cannot be determined at the present time. The ability of CNG to market this capacity may depend on FERC approval of rolled-in (rather than incremental) rate treatment for the CNG new facility costs necessary to serve the letter of intent customers. Several CNG customers have protested CNG's proposed rolled-in rate treatment, arguing that such costs should be borne as incremental by the letter of intent customers. The FERC has issued a preliminary determination on non-environmental issues in which they\nconcluded that it would be in the public interest to authorize construction and operation of the proposed facilities. Subsequent to the protests filed in response to the proposed rolled-in rate treatment of the facility costs, the Company entered into an amended and restated marketing agreement with CNG. As a result of this agreement and the negotiations surrounding its implementation, CNG is prepared to file a settlement agreement with the FERC, reflecting certain changes in the facilities and their cost. The impact of the changes on rates is favorable to the approval of rolled-in treatment of the facility costs. As a result, the Company anticipates that there will not be significant objection to the settlement, however, the timing of the FERC decision on the settlement and with respect to environmental issues cannot be determined at the present time and that decision is necessary to implement the permanent assignment of the excess capacity. The Company has also exercised its option to postpone for one year the commencement of certain Empire-related transportation service that was scheduled for November 1994. The Company will continue to pursue other options for the release of the capacity.\nA reconciliation of gas costs incurred and gas costs billed to customers is done annually, as of August 31, and the excess or deficiency is refunded to or recovered from customers during a subsequent period. In October 1994, the Company submitted to the PSC its annual GCA reconciliation providing for recovery of $24 million of deferred gas costs, which was substantially higher than in previous years principally due to factors mentioned above.\nThe Staff of the PSC has reviewed the Company's application for recovery of deferred costs and the Consumer Protection Board, along with certain individuals or groups of ratepayers, has requested that the PSC conduct hearings to determine whether and on what terms the deferral should be recovered. On December 19, 1994, the PSC instituted a proceeding to review the Company's practices regarding acquisition of pipeline capacity, the deferred costs of the capacity and the Company's recovery of those costs. The costs included in the deferral have ordinarily been recovered in the past and the Company believes that they should be recovered in this instance; however, it is possible that with respect to these costs, the PSC may not recognize all of them in rates. If that were to occur, the Company would be compelled to discontinue deferring and recovering costs above the allowed amount, and would recognize the disallowed costs as they were incurred as a charge against earnings. In addition, in a more adverse decision, the PSC could order the Company to refund a portion of such costs previously collected from ratepayers. Pending conclusion of the proceeding, the PSC directed the Company to recover Order 636 transition costs over a five-year period and all other unrecovered gas costs over 18 months.\nAs an interim measure, on February 1, 1995 the PSC directed the Company to remove from existing rates $16 million of gas revenues representing a portion of the costs attributable to excess capacity over the remaining term of the contracts. Prospective capacity release credits obtained by the Company are to be used to offset such amounts.\nThese deferred costs are subject to recovery by the Company from customers, with interest, to the extent the Company's actions are found prudent.\nThe Company cannot predict to what extent the deferred costs described above would be recoverable in rates.\nThe Company's purchased gas expense charged to customers will be higher during the 1994-95 heating season for the reasons described above. In addition, beginning in January 1995 and continuing until May 1995, the Company elected to discontinue the operation of its weather normalization clause (see Note 1) in circumstances where the weather is warmer than normal because of the unusually mild weather that has been experienced in its service territory and the adverse effects on customer bills. The earnings impact of this decision in 1995 will range between $3.5 and $8.7 million depending on the duration of mild weather for the heating season.\nGAS PURCHASE UNDERCHARGES.\nThe Company became aware during 1993 that it did not account properly for certain gas purchases for the period August 1990 - August 1992 resulting in undercharges to gas customers of approximately $7.5 million. Of the total undercharges, $2.3 million had previously been expensed and $5.2 million had been deferred on the Company's balance sheet. In March 1994, the PSC approved a December 1993 settlement among the Company, PSC Staff and another party providing for the recovery in rates of $2.6 million over three years. The Company wrote off $2.0 million of the undercharges as of December 31, 1993, reducing 1993 earnings by four cents per share, net of tax. In April 1994, the Company wrote off an additional $0.6 million reducing 1994 earnings by approximately one cent per share, net of tax. Due to rate increase limitations established for the second year of the rate settlement, the Company is precluded from recovering the undercharges until the third year of the rate settlement, which begins July 1, 1995.\nASSERTION OF TAX LIABILITY.\nThe Company's Federal income tax returns for 1987 and 1988 have been examined by the Internal Revenue Service (IRS) which has proposed adjustments of approximately $29 million.\nThe adjustments at issue generally pertain to the characterization and treatment of events and relationships at the Nine Mile Two project and to the appropriate tax treatment of investments made and expenses incurred at the project by the Company and the other co-tenants. A principal issue is the year in which the plant was placed in service.\nThe Company has filed a protest of the IRS adjustments to its 1987-88 tax liability and the appeals officers have indicated a decision may be forthcoming on the service year issue in 1995. The Company\nbelieves it has sound bases for its protest, but cannot predict the outcome thereof. Generally, the Company would expect to receive rate relief to the extent it was unsuccessful in its protest except for that part of the IRS assessment stemming from the Nine Mile Two disallowed costs, although no such assurance can be given.\nThe IRS has also completed in 1994 its audit of the Company's Federal income tax returns for 1989 and 1990, which has resulted in a proposed refund of $600,000. Since this refund arises from the contentious issues from the prior audit, the Company has filed a protest with the IRS.\nREGULATORY AND STRANDED ASSETS.\nCertain costs are deferred and recognized as expenses when they are reflected in rates and recovered from customers as permitted by Statement of Financial Accounting Standard No. 71, \"Accounting of the Effects of Certain Types of Regulation\". These costs are shown as Regulatory Assets. Such costs arise from the traditional cost-of-service rate setting approach where all prudently incurred costs are recoverable through rates. Deferral of these costs is appropriate while the Company's rates are regulated under a cost-of-service approach.\nIn a purely competitive pricing approach, such costs might not have been incurred or deferred. Accordingly, if the Company's rate setting were changed from a cost-of-service approach and it was no longer allowed to defer these costs under SFAS 71, certain of these assets may not be fully recoverable.\nBelow is a summarization of the Regulatory Assets as of December 31, 1994.\n- Income Taxes: This amount represents the unrecovered portion of tax benefits from accelerated depreciation and other timing differences which were used to reduce tax expense in past years. The recovery of this deferral is anticipated when the effect of the past deductions reverses in future years.\n- Deferred Ice Storm Charges: These costs result from the non-capital storm damage repair costs following the March 1991 ice storm.\n- Uranium Enrichment Decommissioning Deferral: This amount is mandated to be paid to DOE over the next 13 years. The Energy Policy Act of 1992 requires utilities to contribute such amounts based on the amount of uranium enriched by DOE for each utility.\n- FERC 636 Transition Costs: These costs are payable to gas supply and pipeline companies which are passing various restructuring and other transition costs on to the Company, as ordered by FERC.\n- Demand Side Management Costs Deferred: These costs are Demand Side Management costs which relate to programs initiated to increase efficiency with which electricity is used.\n- Deferred Fuel Costs - Gas: These costs are recoverable over future years and arise from an annual reconciliation of gas revenues and costs (as described in Note 1).\nStranded assets (or other costs) arise when investments are made in facilities or costs are incurred to serve customers and such costs may not be fully recoverable in rates. Examples include purchase power contracts (i.e., the Kamine contract) or uneconomic generating assets.\nExcluding the Kamine contract described above, estimates of stranded asset costs are highly sensitive to the competitive wholesale price assumed in the estimation for electricity. The amount of stranded assets at December 31, 1994, cannot be determined at this time but could be significant.\nWhile the Company currently believes that its regulatory and stranded assets are probable of recovery in rates, industry trends have moved more toward competition, and in a purely competitive environment, it is not clear to what extent, if any, writeoffs of such assets may occur.\nInterim Financial Data\nIn the opinion of the Company, the following quarterly information includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results of operations for such periods. The variations in operations reported on a quarterly basis are a result of the seasonal nature of the Company's business and the availability of surplus electricity.\n* Includes recognition of $21.9 million net-of-tax pension plan curtailment ** Includes recognition of $1.9 million net-of-tax pension plan curtailment *** Includes recognition of $3.4 million net-of-tax pension plan curtailment **** Includes recognition of $5.4 million net-of-tax ice storm disallowance\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants and Financial Disclosure.\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by Item 10 of Form 10-K relating to directors who are nominees for election as directors at the Company's Annual Meeting of Shareholders to be held on April 18, 1995, will be set forth under the heading \"Election of Directors\" in the Company's Definitive Proxy Statement for such Annual Meeting of Shareholders.\nThe information required by Item 10 of Form 10-K with respect to executive officers is, pursuant to instruction 3 of paragraph (b) of Item 401 of Regulation S-K, set forth in Part I as Item 4 - A of this Form 10-K under the heading \"Executive Officers of the Registrant\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 of Form 10-K will be set forth under the headings \"Report of the Committee on Management on Executive Compensation\", \"Executive Compensation\" and \"Pension Plan Table\" in the Company's Definitive Proxy Statement for the Annual Meeting of Shareholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by Item 12 of Form 10-K will be set forth under the headings \"General\" and \"Security Ownership of Management\" in the Company's Definitive Proxy Statement for the Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 of Form 10-K will be set forth under the heading \"Election of Directors\" in the Company's Definitive Proxy Statement for the Annual Meeting of Shareholders.\nPursuant to General Instruction G(3) to Form 10-K, Items 10 through 13 have not been answered because, within 120 days after the close of its fiscal year, the Registrant will file with the Commission a definitive proxy statement pursuant to Regulation 14A which involves the election of directors. Registrant's definitive proxy statement dated March 6, 1995 will be filed with the Securities and Exchange Commission prior to April 30, 1995. The information required in Items 10 through 13 under the headings set forth above is incorporated by reference herein by this reference thereto. Except as specifically referenced herein the proxy statement in connection with the annual meeting of shareholders to be held April 18, 1995 is not deemed to be filed as part of this Report.\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 shown under Item 8 of this Report.\nReport of Independent Accountants\nConsolidated Statements of Income and Retained Earnings for each of the three years ended December 31, 1994\nConsolidated Balance Sheets at December 31, 1994 and 1993\nConsolidated Statement of Cash Flows for each of the three years ended December 31, 1994\nNotes to Consolidated Financial Statements\n(a) 2. Financial Statement Schedules - Included in Item 14 herein:\nFor each of the three years ended December 31, 1994\nSchedule II - Valuation and Qualifying Accounts\n(a) 3. Exhibits - See List of Exhibits\n(b) Reports on Form 8-K:\nThe Company filed a Form 8-K, dated February 10, 1995 reporting under Item 5. Other Events, information relating to gas cost recovery and also cogeneration contract litigation.\nROCHESTER GAS AND ELECTRIC CORPORATION\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(THOUSANDS OF DOLLARS)\nFOR THE YEAR ENDED DECEMBER 31, 1992\nFOR THE YEAR ENDED DECEMBER 31, 1993\nFOR THE YEAR ENDED DECEMBER 31, 1994\nBeginning in 1992 the Company no longer charges uncollectible expenses through the uncollectible reserve. The total amount written off directly to expense in 1992 was $5,116, in 1993 was $6,241 and in 1994 was $9,000.\nLIST OF EXHIBITS\nExhibit 3-1* - Restated Certificate of Incorporation of Rochester Gas and Electric Corporation under Section 807 of the Business Corporation Law filed with the Secretary of State of the State of New York on June 23, 1992. (Filed in Registration No. 33-49805 as Exhibit 4-5 in July 1993)\nExhibit 3-2* - Certificate of Amendment of the Certificate of Incorporation of Rochester Gas and Electric Corporation Under Section 805 of the Business Corporation Law filed with the Secretary of State of the State of New York on March 18, 1994. (Filed as Exhibit 4 in May 1994 on Form 10-Q for the quarter ended March 31, 1994, SEC File No. 1-672.)\nExhibit 3-3* - By-Laws of the Company, as amended to date. (Filed as Exhibit 3-2 in February 1994 on Form 10-K for the year ended December 31, 1993, SEC File No. 1-672-2)\nExhibit 4-1* - Restated Certificate of Incorporation of Rochester Gas and Electric Corporation under Section 807 of the Business Corporation Law filed with the Secretary of State of the State of New York on June 23, 1992. (Filed in Registration No. 33-49805 as Exhibit 4-5 in July 1993)\nExhibit 4-2* - Certificate of Amendment of the Certificate of Incorporation of Rochester Gas and Electric Corporation Under Section 805 of the Business Corporation Law filed with the Secretary of State of the State of New York on March 18, 1994. (Filed as Exhibit 4 in May 1994 on Form 10-Q for the quarter ended March 31, 1994, SEC File No. 1-672.)\nExhibit 4-3* - By-Laws of the Company, as amended to date. (Filed as Exhibit 3-2 in February 1994 on Form 10-K for the year ended December 31, 1993, SEC File No. 1-672-2)\nExhibit 4-4* - General Mortgage to Bankers Trust Company, as Trustee, dated September 1, 1918, and supplements thereto, dated March 1, 1921, October 23, 1928, August 1, 1932 and May 1, 1940. (Filed as Exhibit 4-2 in February 1991 on Form 10-K for the year ended December 31, 1990, SEC File No. 1-672-2)\nExhibit 4-5* - Supplemental Indenture, dated as of March 1, 1983 between the Company and Bankers Trust Company, as Trustee (Filed as Exhibit 4-1 on\nForm 8-K dated July 15, 1993, SEC File No. 1- 672)\nExhibit 10-1* - Basic Agreement dated as of September 22, 1975 among the Company, Niagara Mohawk Power Corporation, Long Island Lighting Company, New York State Electric & Gas Corporation and Central Hudson Gas & Electric Corporation. (Filed in Registration No. 2-54547, as Exhibit 5-P in October 1975.)\nExhibit 10-2* - Letter amendment modifying Basic Agreement dated September 22, 1975 among the Company, Central Hudson Gas & Electric Corporation, Orange and Rockland Utilities, Inc. and Niagara Mohawk Power Corporation. (Filed in Registration No. 2-56351, as Exhibit 5-R in June 1976.)\nExhibit 10-3 - Agreement dated September 25, 1984 between the Company and the United States Department of Energy, as amended to date.\nExhibit 10-4* - Agreement dated February 5, 1980 between the Company and the Power Authority of the State of New York. (Filed as Exhibit 10-10 in February 1990 on Form 10-K for the year ended December 31, 1989, SEC File No. 1-672-2)\nExhibit 10-5* - Agreement dated March 9, 1990 between the Company and Mellon Bank, N.A. (Filed as Exhibit 10-1 in May 1990 on Form 10-Q for the quarter ended March 31, 1990, SEC File No. 1-672)\nExhibit 10-6* - Basic Agreement dated September 22, 1975 as amended and supplemented between the Company and Niagara Mohawk Power Corporation. (Filed as Exhibit 10-11 in February 1993 on Form 10-K for the year ended December 31, 1992, SEC File No. 1-672-2)\nExhibit 10-7* - Operating Agreement effective January 1, 1993 among the owners of the Nine Mile Point Nuclear Plant Unit No. 2. (Filed as Exhibit 10-12 in February 1993 on Form 10-K for the year ended December 31, 1992, SEC File No. 1-672-2)\n(A) Exhibit 10-8* - Rochester Gas and Electric Corporation Deferred Compensation Plan. (Filed as Exhibit 10-14 in February 1994 on Form 10-K for the year ended December 31, 1993, SEC File No. 1-672-2)\n(A) Exhibit 10-9 - Rochester Gas and Electric Corporation Executive Incentive Plan, Restatement of January 1, 1994.\n(A) Exhibit 10-10 - Rochester Gas and Electric Corporation Long Term Incentive Plan, Restatement of January 1, 1994.\nExhibit 23 - Consent of Price Waterhouse, independent accountants\nExhibit 27 - Financial Date Schedule, pursuant to Item 601(c) of Regulation S-K.\n* Incorporated by reference. (A) Denotes executive compensation plans and arrangements.\nThe Company agrees to furnish to the Commission, upon request, a copy of all agreements or instruments defining the rights of holders of debt which do not exceed 10% of the total assets with respect to each issue, including the Supplemental Indentures under the General Mortgage and credit agreements in connection with promissory notes as set forth in Note 6 of the Notes to Financial Statements.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nROCHESTER GAS AND ELECTRIC CORPORATION\nBy \/s\/ ROGER W. KOBER ------------------------------------- (Roger W. Kober) (Chairman of the Board, President and Chief Executive Officer)\nDate: February 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 in the capacities and on the dates indicated.\nSignature Title Date\nPrincipal Executive Officer:\n\/s\/ ROGER W. KOBER Chairman of the Board, February 16, 1995 - ------------------------------ (Roger W. Kober) President and Chief Executive Officer\nPrincipal Financial Officer:\n\/s\/ THOMAS S. RICHARDS Senior Vice President, February 16, 1995 - ------------------------------ (Thomas S. Richards) Corporate Services and General Counsel\nPrincipal Accounting Officer:\n\/s\/ DANIEL J. BAIER Controller February 16, 1995 - ------------------------------ (Daniel J. Baier)\nSIGNATURE TITLE DATE\nDIRECTORS:\nWILLIAM BALDERSTON III Director February 16, 1995 - ---------------------------------- (William Balderston III)\nANGELO J. CHIARELLA Director February 16, 1995 - ---------------------------------- (Angelo J. Chiarella)\nALLAN E. DUGAN Director February 16, 1995 - --------------------------------- (Allan E. Dugan)\nWILLIAM F. FOWBLE Director February 16, 1995 - ---------------------------------- (William F. Fowble)\nJAY T. HOLMES Director February 16, 1995 - ---------------------------------- (Jay T. Holmes)\nROGER W. KOBER Director February 16, 1995 - ---------------------------------- (Roger W. Kober)\nDAVID K. LANIAK Director February 16, 1995 - ---------------------------------- (David K. Laniak)\nTHEODORE L. LEVINSON Director February 16, 1995 - ---------------------------------- (Theodore L. Levinson)\nCONSTANCE M. MITCHELL Director February 16, 1995 - ---------------------------------- (Constance M. Mitchell)\nCORNELIUS J. MURPHY Director February 16, 1995 - ---------------------------------- (Cornelius J. Murphy)\nARTHUR M. RICHARDSON Director February 16, 1995 - ---------------------------------- (Arthur M. Richardson)\nM. RICHARD ROSE Director February 16, 1995 - ---------------------------------- (M. Richard Rose)","section_15":""}
{"filename":"36068_1994.txt","cik":"36068","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3: LEGAL PROCEEDINGS\nNote 16 to the Consolidated Financial Statements, included in this Report under Item 8, is hereby incorporated in this Item 3 by reference.\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 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 Corporation's Common Stock is traded on the National Association of Securities Dealers Automated Quotation National Market System (the \"NASDAQ National Market System\") under the symbol FATN. At the close of business on February 9, 1995, there were approximately 9,260 holders of record of the Corporation's common stock. The following table sets out the quarterly high and low sales prices of the Corporation's common stock. The dividends declared during each quarter for the last two years are also shown. In the fourth quarter of 1994, the Corporation declared a dividend of $.25 per share, an increase of 19%.\nSTOCK PRICES\nSee SUPERVISION AND REGULATION, PAYMENT OF DIVIDENDS. See also, notes 8 and 16 to the Corporation's Consolidated Financial Statements, included in this Report under Item 8, which are incorporated herein by reference.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nThe table \"Selected Financial Data\" on page 45 hereof is incorporated in this Item 6 by reference.\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nThe following is Management's discussion and analysis of First American Corporation's results of operations and financial condition for 1994. It should be read in conjunction with the consolidated financial statements and accompanying notes and other data included herein. Tables referred to in this discussion may be found on pages 45 to 54.\nOVERVIEW\nNet income for 1994 was $90.7 million, or $3.48 per share, compared with $101.8 million, or $3.93 per share, in 1993. Net income for 1994 was increased by a $6.1 million negative provision for loan losses, net of tax, or $.24 per share, and reduced by $6.0 million of losses, net of tax, or $.23 per share, in the fourth quarter on sales of securities available for sale. Net income for 1993 was increased by a $28.6 million negative provision for loan losses, net of tax, or $1.10 per share, and reduced by a $6.5 million charitable contribution, net of tax, or $.25 per share, and the $.1 million cumulative effect of changes in accounting principles. With these transactions excluded in both years, net income increased 13% to $90.6 million in 1994, or $3.47 per share, versus $79.8 million in 1993, or $3.08 per share.\nReturn on average assets (ROA) and return on average equity (ROE) were 1.25% and 15.23%, respectively, during 1994.\nNet interest income on a taxable equivalent basis increased 4% during 1994 to $283.1 million due primarily to loan growth. Average loans increased 17% from 1993 (14% excluding acquisitions).\nAsset quality improved during 1994, marking the fourth straight year of improvement. Nonperforming assets equaled $21.1 million, or .43% of total loans and foreclosed properties at December 31, 1994. This is down 48% from $40.5 million, or .93% of total loans and foreclosed properties a year earlier. First American recorded net loan recoveries of $2.7 million during 1994, compared to net loan charge-offs of $6.3 million during 1993. In light of these and other factors, the Company's allowance for possible loan losses methodology produced a negative $10.0 million (pre-tax) provision for loan losses in 1994 in order to maintain the allowance for loan losses at an appropriate level.\n[GRAPH 1 - See Appendix]\nNET INCOME (LOSS) PER SHARE\n[GRAPH 2- See Appendix]\nRETURN ON AVERAGE EQUITY\n[GRAPH 3 - See Appendix]\nRETURN ON AVERAGE ASSETS\n[GRAPH 4- See Appendix]\nNET INTEREST INCOME\nExcluding the $9.7 million (pre-tax) losses on sales of securities available for sale recorded in the fourth quarter of 1994, non-interest income rose 10% to $94.6 million. Excluding the $10.0 million (pre-tax) charitable contribution in 1993, non-interest expense rose only 2% to $229.6 million. With these transactions excluded, the operating efficiency ratio improved from 63.2% in 1993 to 60.8% in 1994.\nDividends paid in 1994 increased 60% to $.88 per share compared to $.55 per share in 1993. The Board of Directors voted to increase the quarterly cash dividend from $.21 per share to $.25 per share during the fourth quarter of 1994 based on First American's capital position and financial performance.\nIn December 1994, the Board of Directors authorized the repurchase of up to 800,000 shares of First American common stock to fund the Company's various employee benefit plans and potential future acquisitions.\nIn February 1995, First American signed a definitive merger agreement under which all of the outstanding shares of Heritage Federal Bancshares, Inc. (Heritage Federal) will be exchanged for approximately $89 million of First American common stock. Heritage Federal, a savings bank with $521.5 million in assets at December 31, 1994, is headquartered in Kingsport, Tennessee and operates 13 offices primarily in the East Tennessee areas of Tri-Cities, Anderson County and Roane County. The merger is expected to be completed during the fourth quarter of 1995, subject to approval by regulatory authorities and a vote of Heritage Federal shareholders.\nTABLE 1 presents selected financial data for First American for the past five years. A more detailed discussion and analysis of the 1994 results of operations and financial condition follows.\nRESULTS OF OPERATIONS\nNET INTEREST INCOME\nNet interest income is First American's largest source of income and was $283.1 million in 1994 on a taxable equivalent basis. This is up $11.6 million, or 4%, from $271.5 million in 1993. Net interest income is the difference between total interest income earned on loans, securities and other earning assets and total interest expense incurred on deposits and other interest-bearing liabilities. Throughout this discussion, tax-exempt interest income has been adjusted to a fully taxable equivalent basis in order to be comparable to interest income which is subject to Federal income tax. This adjustment has been calculated using a Federal income tax rate of 35%, adjusted for applicable non-deductible interest expense (for tax purposes) to purchase or carry tax-exempt obligations.\nInterest income, interest expense and net interest income are all impacted by fluctuations in the volume and mix of earning assets and interest-bearing liabilities and the corresponding interest yields and costs. TABLE 2 highlights the effect that changes in volume, mix and rates had on net interest income from 1993 to 1994 and 1992 to 1993. TABLE 3 presents detailed average balance sheets, taxable equivalent interest income, interest expense, and corresponding yields and rates for the past five years.\nInterest income was $475.5 million in 1994, an increase of $36.2 million, or 8%, from 1993. Of the $36.2 million increase, $31.2 million was due to a higher volume of earning assets (primarily loans) and $5.0 million resulted from an increase in average yields.\nFirst American's two primary types of earning assets are securities and loans. During 1994, average earning assets rose $439.4 million, or 7%, to $6.62 billion. Average loans increased $672.3 million, or 17%, to $4.54 billion and average total securities declined $143.2 million, or 7%, to $1.98 billion. Changes in average balances and other pertinent items are discussed in more detail under the captions \"Securities\" and \"Loans.\"\nThe average yield on earning assets rose seven basis points to 7.18%. The average yield on loans increased ten basis points to 7.74%, which reflects a higher interest rate environment in 1994 compared to 1993. The average yield on total securities dropped 41 basis points in 1994 to 6.07% from 6.48% during 1993. This drop in yield during the rising interest rate environment in 1994 reflects the fact that a portion of the Company's securities portfolio contains fixed rate securities which do not reprice upon a change in external interest rates. Thus, an increase in external interest rates does not affect fixed rate securities until those securities mature or are sold. Downward pressure on the Company's average securities yield during 1994 resulted from the fact that many of the fixed rate securities maturing throughout 1994 and in the latter part of 1993 were purchased during 1990 and 1991 when average rates were higher than average rates in effect during 1994 and the latter part of 1993.\nInterest expense increased $24.6 million, or 15%, to $192.4 million in 1994. Of the $24.6 million increase, $13.7 million was due to higher average rates paid on interest-bearing funds and $10.9 million resulted from increased volumes of interest-bearing liabilities.\nDuring 1994, average interest-bearing liabilities grew $330.3 million, or 7%, to $5.40 billion. Average interest-bearing deposits grew $182.4 million, or 4%, to $4.57 billion, average short-term borrowings increased $103.5 million, or 16%, to $740.4 million and average long-term debt increased $44.4 million, or 86%, to $95.9 million. Changes in average balances and other relevant information are discussed in more detail under the captions \"Deposits\" and \"Other Borrowed Funds.\"\nThe average cost of interest-bearing funds in 1994 rose 25 basis points to 3.56%. As a reflection of the higher interest rate environment during 1994, the average rate on interest-bearing deposits increased ten basis points to 3.45% and the average rate on short-term borrowings rose 116 basis points to 3.85%. The 87 basis point decline in the average rate on long-term debt to 6.61% reflects the January 1994 repayment of $13.6 million of debentures with a rate of 7 5\/8% and the 1994 addition of long-term debt at rates lower than those in effect when long-term debt agreements were entered into in previous years.\nNational and international interest rates significantly impact the market rates First American charges on loans, earns on investment securities, and pays on interest-bearing liabilities. The average national prime lending rate and certain longer-term market indices directly impact market rates charged on new or adjustable rate loans. Yields on many of the Company's newly purchased debt securities are affected by treasury security yields. Rates paid on interest-bearing liabilities are primarily impacted by changes in the Federal funds rate, LIBOR (London Interbank Offering Rate) and certain longer-term indices.\nDuring periods of increasing rates like 1994, First American's yields on earning assets and rates paid on interest-bearing liabilities will generally rise. The increase will not be precisely the same size nor will it occur at the same time as increases in external indices. This is because some of First American's earning assets and interest-bearing liabilities do not reprice immediately or at the same time upon a change in external rates. Competitive factors also impact yields on earning assets and rates paid on interest-bearing liabilities. The following chart compares selected average interest rates for 1994 and 1993 and rates in effect on December 31, 1994 and 1993.\nNet interest income increased primarily as a result of the increase in the volume of earning assets partially offset by a lower net interest spread. Net interest spread is the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. First American's net interest spread decreased from 3.80% in 1993 to 3.62% in 1994. This 18 basis point decline reflects the 25 basis\npoint increase in the rates paid on interest-bearing liabilities which exceeded the seven basis point increase in yields on earning assets.\nAs the Company's net interest spread declined, the net interest margin, which is net interest income expressed as a percentage of average earning assets, decreased 12 basis points to 4.27% in 1994 from 4.39% in 1993. The net interest margin declined less than the net interest spread due to the increase in net non-interest funding. Net non-interest funding represents the excess of non-interest-bearing liabilities (such as demand deposits and shareholders' equity) over non-earning assets (such as cash and other assets).\nManagement anticipates net interest income will increase in 1995 due to expected growth in earning assets (primarily loans). However, we also anticipate that the net interest margin may decline in 1995 as external interest rates are expected to increase. This may cause the average rates on interest-bearing liabilities to increase initially at a faster pace than the Company's ability to increase average yields on interest-earning assets since, in aggregate, the former tends to reprice more rapidly than the latter. This topic is also addressed under the caption \"Interest Rate Sensitivity.\"\nManagement continues to concentrate on improving the mix of earning assets, increasing the ratio of earning assets to total assets, and managing interest rate sensitivity. Various techniques are used to assist in managing the Company's interest rate sensitivity and are discussed under the caption \"Asset\/Liability Management.\"\nPROVISION FOR LOAN LOSSES\nThis topic is addressed under the caption \"Allowance and Provision for Possible Loan Losses.\"\nNON-INTEREST INCOME\nNon-interest income of $84.9 million in 1994 declined $.9 million, or 1%, from 1993. This decline is due in large part to losses on securities available for sale of $10.0 million during 1994 compared to losses of $2.0 million in 1993. Virtually all of the 1994 losses occurred during the fourth quarter when $85 million of securities available for sale were sold at a $9.7 million loss. The securities sold had the longest maturities and were the most depreciated in value in the available for sale category. The proceeds were invested in higher yielding securities with shorter maturities, which improved First American's overall interest rate sensitivity. The sale did not impact total shareholders' equity since the unrealized net losses on those securities had been previously recorded as a reduction in total shareholders' equity under Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\"\nNon-interest income, excluding net securities losses totalled $94.9 million for 1994, an increase of $7.0 million (8%) from $87.9 million in 1993. This increase is primarily attributable to increases in service charges on deposit accounts ($3.0 million, an 8% increase); \"other income\" ($3.9 million, an 18% increase); and commissions and fees on fiduciary activities ($.8 million, a 5% increase). The increase in service charges on deposit accounts is primarily due to 8% growth in the number of retail deposit accounts. The increase in \"other income\" consists primarily of $2.6 million of increases from vendor incentives and insurance commissions. These increases in non-interest income were partially offset by a decline in investment services income ($.9 million, a 12% decrease) attributable to a decrease in the sale of investment products.\nManagement currently expects non-interest income to increase in 1995, as generating more fee income from existing products and developing new sources of fee income are two of our primary objectives over the next several years.\nNON-INTEREST EXPENSE\nNon-interest expense decreased $6.3 million, or 3%, during 1994 to $229.6 million. The decline was primarily due to a $10.0 million charitable contribution in 1993 to First American Foundation, a not-for-profit private foundation formed to facilitate the Company's charitable contributions. There was no similar contribution in 1994. Also contributing to the decrease in non-interest expense was a $3.3 million decrease in net foreclosed properties expense. Exclusive of the 1993 charitable contribution, 1994 non-interest expenses increased $3.7 million, or 2%.\nFirst American's two recent acquisitions, which were recorded under the purchase method of accounting, resulted in a $4.2 million increase in non-interest expense. First American National Bank of Kentucky (FANBKY), acquired October 1, 1993, produced $1.2 million of non-interest expense in the three months it was owned during 1993 and $4.5 million in 1994, an increase of $3.3 million. First Fidelity Savings Bank, F.S.B. (First Fidelity), acquired April 1, 1994, generated $.9 million of non-interest expense for the nine months in 1994 it was part of First American. Exclusive of the non-interest expense of the two acquisitions and the 1993 charitable contribution, non-interest expense was $224.2 million in 1994 compared to $224.5 million in 1993. The acquisitions are described in NOTE 10 to the consolidated financial statements.\nSalaries and employee benefits increased $12.7 million, or 11%, for the year ended December 31, 1994. Salaries expense increased $12.6 million, or 13%, in 1994, reflecting merit increases, higher incentive compensation, and additional employees. The number of full-time equivalent employees increased 4% from 3,138 at December 31, 1993, to 3,273 at December 31, 1994, primarily due to the transfer of certain software programming functions to First American that were previously\noutsourced and the acquisition of First Fidelity. Though the October 1, 1993, acquisition of FANBKY did not cause the number of employees to increase from year-end 1993 to year-end 1994, it did result in a $1.2 million increase in salaries and employee benefits since it was part of First American for only three months during 1993 compared to a full year in 1994. Included within salaries expense, incentive compensation increased $1.6 million as a result of higher corporate and individual performances and an increase in the number of employees covered by incentive programs.\nSystems and processing expense declined $5.1 million following the amendment in March 1994 to First American's agreement with an outside vendor that provides data processing and telecommunications services. The agreement was amended to transfer certain software programming functions to the Company. This amendment resulted in cost reductions in systems and processing expense and increases in other non-interest expense categories, such as salaries and benefits, which increased due to hiring approximately 50 additional computer systems personnel.\nNet foreclosed properties expense decreased $3.3 million in 1994 ($5.7 million of net foreclosed properties income in 1994 versus income of $2.4 million in 1993). First American recorded net gains on disposals of foreclosed properties and in-substance foreclosures amounting to $6.4 million in 1994, as compared to $3.8 million in 1993. Operating costs associated with foreclosed properties declined from $1.4 million during 1993 to $.7 million in 1994, as the level of foreclosed properties decreased.\nFirst American's operating efficiency ratio, which represents the ratio of operating expenses to taxable equivalent net interest income plus non-interest income, improved to 60.8% in 1994 (exclusive of the impact on non- interest income of the $9.7 million of losses on securities available for sale realized in the fourth quarter of 1994). The 1993 operating efficiency ratio was 63.2% (exclusive of the impact on non-interest expense of the $10 million Foundation contribution). Management continues to emphasize expense control as a means to improve efficiency and profitability. Our near-term objective is to improve the operating efficiency ratio to less than 59% for 1996.\n[GRAPH 5 - See Appendix]\nOPERATING EFFICIENCY RATIO\nINCOME TAXES\nIncome tax expense was $54.1 million in 1994, which resulted in an effective tax rate of 37.4% of pre-tax income. Income tax expense for 1993 was $57.4 million which produced an effective tax rate of 36.0%. The lower effective tax rate in 1993 was primarily attributable to a $1.8 million benefit resulting from the Omnibus Budget Reconciliation Act of 1993 which became effective January 1, 1993. For additional information on income taxes of the Company and the status of Internal Revenue Service examinations, see NOTE 12 to the consolidated financial statements.\nASSET\/LIABILITY MANAGEMENT\nINTEREST RATE SENSITIVITY\nThe purpose of managing First American's interest rate sensitivity is to maintain growth in net interest income while limiting exposure to the potentially adverse effects of changes in interest rates. Through this process, Management seeks to maximize net interest income within liquidity, capital, and interest rate risk constraints. Asset\/liability management is the responsibility of the Asset\/Liability Committee, which is comprised of senior executives of First American. The Committee regularly reviews First American's balance sheet, net interest income performance, and forecasts of net interest income under numerous alternative simulated interest rate environments. The objective of the review is to identify risks and opportunities relative to balance sheet and margin strategies. Additionally, the Committee formulates and monitors compliance with policies and guidelines.\nAn important tool used in this process is the earnings simulation model. The model captures earning assets, interest-bearing liabilities and off-balance-sheet financial instruments and combines the various factors affecting interest rate sensitivity into an earnings projection that incorporates the Asset\/Liability Committee's forecast of the most likely interest rate environment for the next 12 months. Interest rate sensitivity is determined by assessing the impact on net interest income of multiple rising and falling interest rate scenarios. The model is updated at least monthly and more often as considered necessary.\nManagement's asset\/liability objective is to manage the interest sensitivity position so that net income will not be impacted more than 5% for changes in interest rates within 150 basis points of the Committee's most likely interest rate forecast over the next 12 months. A 5% impact on net income corresponds approximately to a 2.5% impact on net interest income. Throughout 1994, First American operated within this guideline. At December 31, 1994, the Asset\/Liability Committee's assessment of the most likely interest rate scenario included a 100 basis point increase in the prime rate during the next 12 months from 8.5% at December 31, 1994, to 9.5% at December 31, 1995. This scenario also assumes that interest-\nbearing deposit costs in aggregate will rise by a like amount in 1995. Management's objective is expected to be met even if the prime rate is 150 basis points higher or lower than forecast.\nAnother measure of interest rate sensitivity is the \"static gap\" approach, which compares the volume of assets to the volume of liabilities subject to repricing over a series of future time periods. TABLE 4 presents First American's interest rate sensitivity at December 31, 1994 and 1993, and reflects that First American is positioned more favorably for a lower interest rate environment than for a higher interest rate environment. At December 31, 1994, the net of interest-earning assets and interest-bearing liabilities repricing in a one-year period as a percent of earning assets was a cumulative net liability sensitivity of 10.9%. In other words, based on the December 31, 1994, balance sheet, the amount of liabilities repricing in 1995 in excess of the amount of assets repricing in 1995, together with the effect of related off-balance-sheet activities, was $767.4 million, or 10.9% of all earning assets. This compares with a cumulative one-year repricing net liability sensitivity of $1,020.8 million, or 15.6%, at year-end 1993.\nFor interest rate sensitivity purposes, First American classifies savings, NOW, and money market deposits, which in aggregate amount to $2.77 billion, as immediately rate-sensitive since none of these deposits carry contractual rate guarantees or early withdrawal penalties. The classification of savings and NOW accounts as immediately rate-sensitive is a conservative approach in measuring maximum interest rate sensitivity since, based on past experience, rates paid on NOW and regular savings balances ($1.18 billion at December 31, 1994) have generally not been immediately interest rate sensitive. If NOW and regular savings accounts are not considered interest-sensitive, the cumulative one-year repricing gap at December 31, 1994, would be net asset sensitive by $413.8 million, or 5.9% of earning assets.\nDERIVATIVES\nGenerally, a derivatives transaction is a bilateral contract or payments exchange agreement whose value derives from the value of an underlying asset or underlying reference rate or index. First American has utilized off-balance-sheet derivative products for a number of years in managing its interest rate sensitivity. The use of non-complex, non-leveraged derivative products has reduced the Company's exposure to changes in the interest rate environment. By using derivatives, such as interest rate swaps and futures contracts, to alter the nature of (hedge) specific assets or liabilities on the balance sheet (for example, to change a variable to a fixed rate obligation), the derivative products offset fluctuations in net interest income from the otherwise unhedged position. In other words, if net interest income from the otherwise unhedged position changes (increases or decreases) by a given amount, the derivative product should produce close to the opposite result, making the combined amount (otherwise unhedged position impact plus the derivative product position\nimpact) essentially unchanged. Derivative products have enabled First American to improve its balance between interest-sensitive assets and interest-sensitive liabilities by managing interest rate sensitivity, while continuing to meet the credit and deposit needs of customers.\nFirst American uses derivatives to reduce the negative effect of certain interest rate changes. In aggregate, many of First American's securities and loans with fixed rates may be funded with variable rate money market deposits. Consequently, net interest income can be negatively affected if short-term interest rates rise quickly. To reduce this exposure, the Company has entered into interest rate swaps on which the Company pays a fixed rate and receives a variable rate tied to three-month LIBOR. Thus, these swaps act to \"fix\" the rates paid on a portion of the money market account balances for the period of time covered by the swaps, which in turn reduces the potential negative impact on net interest income of rising interest rates. NOTE 15 to the consolidated financial statements presents the derivative financial instruments outstanding at December 31, 1994 and 1993.\nAt December 31, 1994, First American had interest rate and basis swaps with notional values totalling $1.7 billion with net positive fair values (unrealized net pre-tax gains) of $17.9 million. Notional amounts are key elements of derivative financial instrument agreements. However, notional amounts do not represent the amounts exchanged by the parties to derivatives and do not measure First American's exposure to credit or market risks. The amounts exchanged are based on the notional amounts and the other terms of the underlying derivative agreements. At December 31, 1993, the Company had interest rate and basis swaps with notional values totalling $1.1 billion and futures contracts with notional values of $.3 billion. These derivatives had a total of $3.0 million of net negative fair values (unrealized net pre-tax losses) at December 31, 1993.\nAs First American's individual derivative contracts approach maturity, they may be terminated and replaced with derivatives with longer maturities which offer more interest rate risk protection. NOTE 15 to the consolidated financial statements presents the deferred gains related to terminated derivative contracts. These deferred gains totalled $6.1 million at December 31, 1994, and $.1 million at December 31, 1993. Deferred gains and losses on off-balance-sheet derivative activities are recognized as interest income or interest expense over the original covered periods. Of the $6.1 million of deferred gains at December 31, 1994, $4.6 million will be recognized in net interest income during 1995 and $1.5 million will be recognized in 1996.\nNet interest income for the year ended December 31, 1994, included derivative products net expense of $4.3 million, consisting of $1.4 million in additional interest income on loans, $.7 million reduction in interest income on securities, $4.6 million in additional interest expense on money market deposits and $.4 million in additional\ninterest expense on long-term debt. This compares to $8.3 million of derivatives products net expense in 1993 which consisted almost entirely of additional interest expense on money market deposits.\nThis net expense represents the net of all income and expenses related to derivatives. For example, when First American enters into an interest rate swap linked to money market deposits, it initially pays a fixed rate that is higher than the variable rate it receives. The net difference is a component of derivative products expense. If the index rate, which is generally 3-month LIBOR, increases, the out-of-pocket cost of the contract declines while the fair value of the contract increases. If First American terminates its position in the contract prior to maturity as part of its strategy in managing interest rate risk, any gain or loss is deferred and amortized. The amortization of deferred gains and losses is also a component of derivative products income or expense. The reduction in derivative products net expense from 1993 to 1994 resulted primarily from rising rates in 1994.\nAll derivatives activity is conducted under close Management and Board of Directors supervision and according to detailed policies and procedures governing these activities. Policy prohibits the use of leveraged and complex derivatives. The Board also sets limitations on the total notional amount of derivatives contracts that may be outstanding at any time.\nOff-balance-sheet derivative activities give rise to credit risk when interest rate changes move in the Company's favor. In such cases, First American relies on the ability of the counterparts to off-balance-sheet derivative contracts to make contractual payments over the remaining lives of the contracts. Credit risk exposure due to off-balance-sheet derivative activities is closely monitored, and counterparts to these contracts are selected on the basis of their credit worthiness, as well as their market-making ability. As of December 31, 1994, all outstanding derivative transactions were with counterparts with credit ratings of A-2 or better. Enforceable bilateral netting contracts between First American and its counterparts allow for the netting of gains and losses in determining net credit exposure. First American's net credit exposure on outstanding derivatives was $18.3 million on December 31, 1994. Given the credit standing of the counterparts to the derivative contracts, Management believes that this credit exposure is reasonable in light of its objectives.\nFINANCIAL CONDITION\nSECURITIES\nSecurities generated 25% of total taxable equivalent interest income for the year ended December 31, 1994. In addition to producing interest income, the securities portfolio satisfies pledging requirements on deposits and is an important component of asset\/liability, interest rate sensitivity and liquidity management, which\nare discussed in more detail under the captions \"Asset\/Liability Management\" and \"Liquidity.\"\nFirst American's total securities portfolio of $2,150.0 million at December 31, 1994, consisted of $664.7 million of securities available for sale (market value) and $1,485.3 million of securities held to maturity (amortized cost). This compares to a total securities portfolio of $2,050.8 million at December 31, 1993, which consisted of $1,392.9 million of securities available for sale and $657.8 million of securities held to maturity. The $827.5 million increase in securities held to maturity and $728.2 million decrease in securities available for sale reflect the 1994 transfer of $203.8 million of securities from the classification of available for sale to held to maturity, which is discussed in more detail at NOTE 3 to the consolidated financial statements. Additionally, Management determined that it had the intent and ability to hold to maturity $802.0 million of securities purchased during 1994, which exceeded the maturities of $177.8 million of held to maturity securities. Also during 1994, sales and maturities of available for sale securities exceeded purchases of those securities by $466.8 million.\nAlthough total securities increased $99.2 million, or 5%, to $2.15 billion at December 31, 1994, total average securities declined $143.2 million, or 7%, to $1.98 billion during 1994. The decline in total average securities reflects the funding of new loans, as well as differences in the timing of maturities, sales, and purchases of securities in 1994 compared to 1993. The average yield of total securities in 1994 was 6.07%, down from 6.48% in 1993, as securities maturing in both years bore higher yields than yields on reinvestment securities despite generally rising interest rates throughout 1994.\nThe average estimated maturity of the total securities portfolio was 4.2 years at December 31, 1994 (3.8 years for securities held to maturity and 5.0 years for securities available for sale), compared with 4.9 years at year-end 1993 (4.4 years for securities held to maturity and 5.1 years for securities available for sale). The expected maturity for government and corporate securities is the stated maturity, and the expected maturity for mortgage-backed securities is based on current estimates of average maturities, which include prepayment assumptions. The average repricing life of the total securities portfolio was 2.3 years at December 31, 1994 (2.7 years for securities held to maturity and 1.4 years for securities available for sale). TABLE 5 presents the estimated average maturity and weighted average yields for securities held to maturity and securities available for sale at December 31, 1994.\nAll mortgage-backed securities classified as U.S. Government agencies and corporations were issued or guaranteed by the Government National Mortgage Association (Ginnie Mae), the Federal National Mortgage Association (Fannie Mae), or the Federal Home Loan Mortgage Corporation (Freddie Mac). Essentially all other mortgage-backed securities consisted of Planned Amortization Class (PAC)\ncollateralized mortgage obligations (CMOs), which were purchased because of their high credit quality and relatively certain average lives. On December 31, 1994, mortgage-backed security holdings included $289.0 million of floating rate mortgage-backed securities, of which $125.3 million were classified as held to maturity and $163.7 million were classified as available for sale. At year-end 1994, over 99.8% of the Company's debt securities were investment grade with the remaining .2% unrated.\nLOANS\nLoans represent First American's largest component of earning assets, producing 74% of interest income for the year ended December 31, 1994. During 1994, average loans increased $672.3 million, or 17%, to $4.54 billion. Excluding acquisitions, average loans increased 14%.\nThe increase in average loan volume is a reflection of positive economic conditions in Tennessee and selected markets in adjacent states and the success of First American's marketing efforts. During 1994, the U.S. economy continued to post gains, while the southeastern states outperformed the national averages. During this same time, the Tennessee economy led the southeast in a number of economic categories. Additionally, the Company's marketing efforts contributed to increased lending in certain target areas. Management currently expects loan growth to continue in 1995, although at a slower pace than 1994.\nThe average yield on loans was 7.74% during 1994 as compared to 7.64% during 1993. TABLE 3 contains average loan balances and TABLE 12 presents end of period loan balances by category for the past five years. TABLE 6 presents the maturities of loans, exclusive of consumer loans, outstanding at December 31, 1994.\nAverage commercial loans increased $262.7 million, or 15%, to $2.03 billion during 1994 from $1.77 billion during 1993. During 1994 and 1993, commercial loans averaged 45% and 46% of total loans, respectively.\nThe increase in the average balances of commercial loans occurred over a broad range of industry categories. The continued strong performance in the Tennessee and southeastern economies were important catalysts for First American's commercial loan growth. Also contributing were marketing campaigns aimed at the small business market (revenues under $10 million) and the middle market (revenues of $10 million to $100 million). As an example, during 1994 First American launched a small business equipment loan promotion guaranteeing 20-minute credit decisions. This was made possible by the 1993 re-engineering of the small business lending underwriting process. Efforts like these contributed to First American becoming a market leader in the state of Tennessee in the small business and middle markets.\n[GRAPH 6 - See Appendix]\nLOANS, NET OF DISCOUNT AND FEES\nConsumer loans, which consist of consumer amortizing mortgages and other consumer loans, averaged $2.10 billion during 1994, as compared with $1.69 billion during 1993, an increase of $403.5 million, or 24%. Total average consumer loans were 46% of total loans at December 31, 1994, compared with 44% at year-end 1993.\nAverage consumer amortizing mortgages, which consist principally of residential mortgages, increased $309.9 million, or 40%, during 1994. Exclusive of acquisitions, average consumer amortizing mortgages increased 25%. This increase results primarily from increases in new and existing home sales in First American's markets.\nAverage other consumer loans increased $93.6 million, or 10%, in 1994, primarily due to an $84.2 million increase in average automobile installment loans. Average other consumer loans did not increase as much as some of the Company's peers in part because Management made a decision not to match the low pricing that developed during 1994 in certain consumer loan markets such as indirect auto lending. In addition, First American does not have a credit card portfolio, which is a product generating consumer loan growth for many of its peers.\nCommercial real estate loans, which include real estate construction and real estate commercial mortgages, averaged $415.7 million during 1994, compared with $409.5 million during 1993. There have been, and continue to be, selective opportunities for commercial real estate lending in First American's markets. However, commercial real estate lending is not a high priority market for First American. Average total commercial real estate loans represented 9% of total loans at December 31, 1994, compared with 10% at December 31, 1993.\nEssentially all of First American's loans are to borrowers residing in or doing business in Tennessee and selected markets in adjacent states. First American seeks to exercise prudent risk management in lending, including diversification by loan category and by industry segment, as well as by identification of credit risks. The Company's lending activities are performed by relationship managers organized by broad industry classification. Based on Standard Industrial Classification (SIC) codes, there were no industry concentrations within the commercial loan category in excess of 10% of total loans, at December 31, 1994 and 1993.\nFirst American's ten largest outstanding loan relationships at December 31, 1994, amounted to $210.4 million, or 4% of total loans, compared to $225.7 million, or 5% of total loans, at year-end 1993. At December 31, 1994 and 1993, First American had no loans classified as highly leveraged transactions, as defined by banking regulations. First American had $.6 million international loans outstanding at December 31, 1994, and essentially no such loans at December 31, 1993.\nNOTE 15 to the consolidated financial statements discusses off-balance-sheet loan commitments and risks.\nALLOWANCE AND PROVISION FOR POSSIBLE LOAN LOSSES\nManagement's policy is to maintain the allowance for possible loan losses at a level which is adequate to absorb estimated loan losses inherent in the loan portfolio. The provision for loan losses is a charge (credit) to earnings necessary, after loan charge-offs and recoveries, to maintain the allowance at an appropriate level. The level of the allowance is determined on a quarterly basis using procedures which include assessments of: (1) individual criticized and classified credits, other significant credits, and non-criticized\/classified commercial and commercial real estate credits to estimate loss probability; (2) various consumer loan categories to estimate loss probabilities based primarily on historical loss experience; (3) unfunded commitments; and (4) various other factors, such as changes in credit concentrations, loan mix, and economic conditions which may not be specifically quantified in the loan analysis process. Determining the appropriate level of the allowance and the amount of the provision for loan losses involves uncertainties and matters of judgment and therefore cannot be determined with precision.\nIn order to maintain the allowance at an appropriate level during 1994, the methodology generally described above produced no provision for loan losses in each of the first three quarters of 1994 and a $10 million negative provision in the fourth quarter of 1994. This compares to a $42 million negative provision reported in 1993. The primary factors resulting in the negative $10 million provision for 1994 were the continued improvement in asset quality as discussed under the caption \"Asset Quality\" and favorable net loan charge-off experience.\nDuring the years ended December 31, 1994 and 1993, total loan charge-offs were $15.3 million and $26.6 million, respectively, while total recoveries amounted to $18.0 million and $20.3 million, respectively, resulting in net recoveries of $2.7 million in 1994 and net charge-offs of $6.3 million in 1993. The ratio of net recoveries to average loans was .06% in 1994 compared to a ratio of net charge-offs to average loans of .16% in 1993.\nFuture provisions for loan losses depend on such factors as asset quality, net loan charge-offs, loan growth and other criteria discussed above. The appropriate level of the allowance for possible loan losses and the corresponding provision will continue to be determined quarterly based on the allowance assessment methodology. Management currently does not anticipate that there will be any significant provision for possible loan losses in 1995.\nThe allowance for possible loan losses was $127.1 million at December 31, 1994, as compared to $134.1 million at December 31, 1993. The $7.0 million\ndecline in the allowance during 1994 reflects the $10.0 million negative provision for loan losses and $2.7 million of net loan recoveries. The total allowance for possible loan losses represented 2.61% of net loans at December 31, 1994, compared to 3.09% at December 31, 1993.\n[GRAPH 7 - See Appendix]\nALLOWANCE TO NET LOANS\n[GRAPH 8 - See Appendix]\nNET CHARGE-OFF (RECOVERY) RATIO\nThe allowance for possible loan losses is comprised of an allocated portion and an unallocated, or general, portion. The allocated portion is maintained to cover estimated losses applicable to specific segments of the loan portfolio. The unallocated portion is maintained to absorb losses which probably exist as of the evaluation date but are not identified by the more objective processes used for the allocated portion of the allowance for loan losses due to risk of error or imprecision. While the total allowance consists of an allocated portion and an unallocated portion, these terms are primarily used to describe a process. Both portions of the allowance are available to provide for inherent loss in the entire portfolio.\nTABLE 7 presents a five-year recap of the activity in the allowance for possible loan losses. The table also contains the year-end allocation of the allowance for possible loan losses among the various loan portfolios and the unallocated portion of the allowance for each of the past five years.\nASSET QUALITY\nNonperforming assets, which include non-accrual and restructured loans and foreclosed properties, continued to decline during 1994. Nonperforming assets decreased 48% during 1994 to $21.1 million at December 31, 1994. This decline follows a 54% drop in 1993, a 37% decrease in 1992 and a 32% decline in 1991. Over the last four years, nonperforming assets have decreased 90%, or $188.6 million from $209.7 million at December 31, 1990, to $21.1 million at December 31, 1994. The ratio of nonperforming assets to total loans and foreclosed properties was .43% at December 31, 1994, compared with .93% a year earlier. The improvement in asset quality resulted from the continuation of efforts to improve asset quality and collect the full balance due on nonperforming assets, as well as from a reduction in the level of loans criticized or classified by First American's internal loan grading and review process. Management continues to focus on strengthening the credit culture by improving portfolio management concepts in the area of credit and industry concentrations, by refining credit risk rating systems, and maintaining a disciplined adherence to existing credit policies and procedures.\nTABLE 8 summarizes changes in nonperforming assets for each of the past five years and presents the composition of the nonperforming asset balance at the end of each year.\nOther potential problem loans consist of loans that are currently not considered nonperforming but on which information about possible credit problems has caused Management to doubt the ability of the borrowers to comply fully with present repayment terms. At December 31, 1994, loans totalling $75.1 million, while not considered nonperforming, were classified under the Company's internal loan grading system as substandard or worse. This was essentially the same level as a year ago.\nDepending on the economy and other factors, these loans and others which may not be presently identified could become nonperforming assets in the future.\n[GRAPH 9 - See Appendix]\nNONPERFORMING ASSETS TO LOANS AND FORECLOSED PROPERTIES\nDEPOSITS\nTotal deposits, First American's largest source of funding, averaged $5.73 billion during 1994, compared with $5.51 billion during 1993, an increase of $220.3 million, or 4%. Exclusive of acquisitions, average deposits increased 1% during 1994, primarily due to the success of First American's money market deposit account, the First American Investment Reserve (\"FAIR\") account. This account combines many features common among money market mutual funds including a minimum balance requirement of $1,000 and a competitive rate. FAIR account balances averaged $1.43 billion in 1994, up $108.1 million, or 8%, from 1993. The FAIR account is key to marketing and liquidity strategies in that it satisfies a known customer need while providing First American a stable core source of funding at rates favorable to many alternative sources of funding. On December 31, 1994, FAIR account balances outstanding were $1.54 billion and the interest rate paid was 4.60%.\nFirst American's core deposit base, which represents total deposits excluding certificates of deposit $100,000 and over and foreign deposits, averaged $5.33 billion, or 93% of total deposits, during 1994, as compared with $5.14 billion, or 93% of total deposits, during 1993. Core deposits provide a stable, low-cost source of funds for the Company.\nTABLE 9 details maturities of certificates of deposits $100,000 and over at December 31, 1994 and 1993.\nOTHER BORROWED FUNDS\nIn addition to deposits, other sources of funding utilized by First American include short-term borrowings and long-term debt. Total short-term borrowings include Federal funds purchased from correspondent banks, securities sold under agreements to repurchase (repurchase agreements), and other short-term borrowings, principally funds due to the U.S. Treasury Department in tax and loan accounts.\nFederal funds purchased and securities sold under repurchase agreements averaged $681.2 million during 1994, a 16% increase over the previous year. The average rate paid on Federal funds purchased and securities sold under repurchase agreements for 1994 was 3.80%, 116 basis points more than the 2.64% average rate paid in 1993. The net funds purchased position (Federal funds purchased and repurchase agreements less Federal funds sold and securities purchased under agreements to resell) at year-end 1994 was $829.0 million, up from $520.0 million at year-end 1993.\nOther short-term borrowings averaged $59.2 million during 1994 compared with $49.8 million during 1993. The average rate paid on other short-term\nborrowings was 4.51% in 1994, an increase of 132 basis points from 3.19% in 1993.\n[GRAPH 10 - See Appendix]\nCORE DEPOSITS\nLong-term debt averaged $95.9 million during 1994 compared to $51.5 million during 1993. During 1994 long-term debt increased $186.1 million to $252.1 million as of December 31, 1994, due to two borrowings of $100 million each from the Federal Home Loan Bank. Each borrowing has a maturity of three years and interest which is payable and reprices monthly based on LIBOR. At December 31, 1994, the borrowings had an average interest rate of 6.08%.\nOn January 31, 1994, First American redeemed the remaining balance of $13.6 million of its 7 5\/8% debentures due in 2002. These debentures were redeemed at a price of 101.22% of par.\nThe average rate paid on long-term borrowings was 6.61% in 1994 compared to 7.48% in 1993. The long-term debt to equity ratio was 40.9% at December 31, 1994, compared to 11.3% at December 31, 1993, which is reflective of the additional debt issued during 1994.\nCAPITAL POSITION\nTotal shareholders' equity amounted to $616.7 million, or 7.95% of total assets, at December 31, 1994, compared to $581.7 million, or 8.09% of total assets at December 31, 1993. The $35.0 million increase in total shareholders' equity resulted principally from $67.7 million of earnings retention ($90.7 million of net income less $23.0 million of dividends). The impact of earnings retention was reduced by the $35.4 million change in net unrealized gains and losses on securities available for sale, net of tax. The Consolidated Statements of Changes in Shareholders' Equity details the changes in shareholders' equity during 1994, and NOTES 1 AND 3 to the consolidated financial statements provide further information regarding unrealized gains and losses on available for sale securities.\nDuring 1994, First American paid dividends of $.88 per share, up 60% from $.55 per share during 1993. The dividend payout ratio was 25% during 1994 versus 14% during 1993. The Board of Directors voted to increase the quarterly cash dividend from $.21 per share to $.25 per share during the fourth quarter of 1994 based on First American's capital position and financial performance.\nThe Federal Reserve Board and the OCC risk-based capital guidelines and regulations for bank holding companies and national banks require minimum levels of capital based upon applying various risk ratings to defined categories of assets and to certain off-balance-sheet items. Under the risk-based capital requirements, total capital consists of Tier I capital (essentially realized common equity less intangible assets) and Tier II capital (essentially qualifying long-term debt and a portion of the allowance for possible loan losses). Assets by type, or category, are assigned risk-weights of 0% to 100%, depending on regulatory assigned levels of credit risk associated with such assets. Off-balance-sheet items are considered in the calculation\nof risk-adjusted assets through conversion factors established by regulators. These items are assigned the same risk-weighting as on-balance-sheet items and are included in total risk-adjusted assets.\n[GRAPH 11 - See Appendix]\nAVERAGE EQUITY TO AVERAGE ASSETS\nAt December 31, 1994, these regulations required bank holding companies and national banks to maintain certain minimum capital ratios. As of December 31, 1994, the Company, its principal subsidiary, First American National Bank (FANB), and FANBKY all had ratios which exceeded the regulatory requirements to be classified as \"well capitalized,\" the highest regulatory capital rating. TABLE 10 summarizes risk-based capital and related ratios for the Company and FANB.\nIn December 1994, the Board of Directors authorized the repurchase of up to 800,000 shares of First American's common stock. It is anticipated that stock repurchases will be made in the open market or in privately negotiated transactions from time to time during 1995, subject to market conditions and regulatory guidelines. Following these purchases, the Company is expected to continue to exceed all applicable regulatory capital requirements. It is anticipated that the repurchased shares will be used to fund First American's various employee benefit plans and potential future acquisitions.\nLIQUIDITY\nLiquidity management involves maintaining sufficient cash levels (including the ability to access markets to raise additional cash) to fund operations and to meet the requirements of borrowers, depositors, and creditors. Higher levels of liquidity bear higher corresponding costs, measured in terms of lower yields on short-term, more liquid earning assets, and higher interest expense involved in extending liability maturities. Liquid assets include cash and cash equivalents (less Federal Reserve Bank reserve requirements discussed at NOTE 2 to the consolidated financial statements), money market instruments, and securities that mature within one year. At December 31, 1994, the carrying value of First American's liquid assets amounted to $832.5 million, or 12% of earning assets, which compares with $702.1 million, or 11%, at December 31, 1993.\nIn addition, First American has securities available for sale maturing after one year which can be sold to meet liquidity needs. The market value of securities available for sale which mature after one year was $329.7 million at December 31, 1994. Since held to maturity securities are purchased with the intent to hold them to maturity, such securities are generally a source of liquidity only to the extent interest and principal payments are received thereon. NOTES 1 AND 3 to the consolidated financial statements discuss accounting for securities in further detail. Decisions to purchase securities or sell available for sale securities are based on current and expected economic and financial conditions, including the interest rate environment and loan demand, and other on-and off-balance-sheet positions. Maturity of securities is also discussed under the caption \"Securities.\"\nLiquidity is reinforced by maintaining a relatively stable funding base, which is achieved by diversifying funding sources, extending the contractual maturity of\nliabilities, and limiting corporate reliance on volatile short-term purchased funds. First American's strategy is to fund assets to the maximum extent possible with core deposits, which provide a sizable source of relatively stable and low-cost funds. Core deposits totalled $5.45 billion, or 70% of total assets at December 31, 1994, compared with $5.36 billion, or 75%, at December 31, 1993.\nShort-term funding needs can arise from declines in deposits or other funding sources, drawdowns of loan commitments, and requests for new loans. Relationships with a stable and growing customer base and a network of about 300 downstream correspondent banks routinely supply some of these funds. Additional funds, if needed, can be raised from national money markets. Short-term funding sources, comprised of non-core deposits and other interest-bearing liabilities totalled $1.35 billion, or 17% of total assets, at December 31, 1994, compared to $1.09 billion, or 15%, at December 31, 1993.\nShareholders' equity and long-term debt also contribute to liquidity by reducing the need to continually rely on short-term purchased funds. At December 31, 1994, the ratio of equity to assets was 7.95% compared to 8.09% at December 31, 1993. At the end of 1994, long-term debt totalled 3% of total assets and 41% of total shareholders' equity versus 1% of total assets and 11% of total shareholders' equity at December 31, 1993.\nDuring the first quarter of 1993, First American filed a shelf registration statement with the Securities and Exchange Commission to issue $100 million of subordinated debt securities. The Company issued $50 million of subordinated notes under the shelf registration statement during second quarter 1993. The remaining $50 million shelf registration is available for future needs.\nAn additional source of liquidity is the Company's three-year $50 million revolving credit agreement which will expire March 31, 1997. First American had no borrowings outstanding under this agreement during 1994.\nManagement believes First American has sufficient liquidity to meet all reasonable borrower, depositor, and creditor needs in the present economic environment.\nIMPACT OF INFLATION\nFirst American's asset and liability structure is substantially different from that of an industrial company in that most of its assets and liabilities are monetary in nature. Management believes the impact of inflation on financial results depends upon the Company's ability to react to changes in interest rates and, by such reaction, reduce the inflationary impact on performance. Interest rates do not necessarily move in the same direction, or at the same magnitude, as the prices of\nother goods and services. As discussed previously, Management seeks to manage the relationship between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.\nEARNINGS PERFORMANCE FOR 1993 VERSUS 1992\nThe previous discussion has concentrated on First American's 1994 results of operations and financial condition. The following discussion recaps the Company's results of operations for 1993 compared to 1992.\nNet income for 1993 was $101.8 million or $3.93 per share as compared with $42.0 million or $1.74 per share for 1992. The earnings improvement was primarily attributable to a $42.0 million negative provision for loan losses in 1993 compared to a $38.5 million charge in 1992, an $80.5 million decrease in the provision for loan losses. Net income for 1993 also included a $15.7 million increase in taxable equivalent net interest income, an $11.1 million improvement in non-interest income, and a $7.5 million increase in non-interest expense.\nThe negative provision for loan losses resulted primarily from continued improvement in asset quality as evidenced by a 64% decrease in nonperforming loans to $21.7 million at December 31, 1993, from $60.3 million at year-end 1992 and an 84% decline in net charge-offs to $6.3 million in 1993 from $38.4 million in 1992.\nThe 6% increase in 1993 net interest income (computed on a taxable equivalent basis) to $271.5 million was primarily due to an increase in average earning assets and a slightly improved net interest margin. Average earning assets increased 5% to $6.18 billion in 1993 from $5.90 billion in 1992, while the net interest margin on earning assets increased 5 basis points to 4.39%. During 1993, First American had a higher volume of interest-bearing liabilities repricing at a lower interest rate than earning assets repricing; thus, net interest income benefited from declining interest rates. The net interest spread increased 10 basis points to 3.80% in 1993 from 3.70% in 1992. The net interest margin and spread improvements in 1993 generally reflect a lower interest rate environment for First American.\nThe 15% improvement in non-interest income in 1993 was due primarily to increased fee income resulting from new products and services introduced in 1993. Approximately 55% of the increase was due to additional investment services income related to sales of annuities, mutual funds and other investment products.\nThe $7.5 million, or 3%, increase in non-interest expense in 1993 resulted primarily from a $10.0 million charitable contribution made during the fourth quarter of 1993 to First American Foundation. Non-interest expense in 1993 also included an $8.1 increase in salaries and employee benefits and a $13.1 million decline in net foreclosed properties expense. Exclusive of the contribution, non-interest expense\ndecreased $2.5 million or 1%. The operating ratio improved to 63.2% in 1993 (exclusive of the Foundation contribution) from 69.1% in 1992.\nIncome tax expense was $57.4 million in 1993, an increase of $39.9 million over the 1992 income tax expense of $17.5 million. The major factor for the increase was the increase in the Company's income before income tax expense.\nTABLE 1: SELECTED FINANCIAL DATA: 1990-1994\n* Adjusted to a taxable equivalent basis based on the statutory Federal income tax rates, adjusted for applicable state income taxes net of the related Federal tax benefit. ** Ratio of operating expenses to taxable equivalent net interest income plus non-interest income. For 1994, calculation excludes $9.7 million of losses in the fourth quarter on sales of securities available for sale. For 1993, calculation excludes the $10.0 million Foundation contribution. For 1990, calculation excludes the $34.3 million gain on sale of credit card receivables. N\/A Information not considered meaningful.\nTABLE 2: RATE-VOLUME RECAP\n* Amounts are adjusted to a fully taxable basis, based on the statutory Federal income tax rates, adjusted for applicable state income taxes net of the related Federal tax benefit. The effect of volume changes is computed by multiplying the change in volume by the prior year rate. The effect of rate changes is computed by multiplying the change in rate by the prior year volume. Rate\/volume changes are computed by multiplying the change in volume by the change in rate and are included in the effect on income of rate changes.\nTABLE 3: CONSOLIDATED AVERAGE BALANCE SHEETS AND TAXABLE EQUIVALENT INCOME\/EXPENSE AND YIELDS\/RATES\n* Loan fees and amortization of net deferred loan fees (costs), which are considered an integral part of the lending function and are included in yields and related interest categories, amounted to $4.4 million in 1994, $2.2 million in 1993, $(.8) million in 1992, $(2.7) million in 1991, and $(.3) million in 1990. Yields\/rates and income\/expense amounts are presented on a fully taxable equivalent basis based on the statutory Federal income tax rates adjusted for applicable state income taxes net of the related Federal tax benefit; related interest income includes taxable equivalent adjustments of $3.4 million in 1994, $4.0 million in 1993, $4.2 million in 1992, $6.6 million in 1991, and $11.1 million in 1990. Non-accrual and restructured loans are included in average loans and average earning assets. Consequently, yields on these items are lower than they would have been if these loans had earned at their contractual rates of interest.\nN\/A Information not considered meaningful.\nTABLE 4: INTEREST RATE SENSITIVITY ANALYSIS\nEach column includes earning assets and interest-bearing liabilities that are estimated to mature or reprice within the respective time frame. All floating rate balance sheet items are included as \"within three months\" regardless of maturity. Non-earning assets (cash and due from banks, premises and equipment, foreclosed properties, and other assets), non-interest-bearing liabilities (demand deposits and other liabilities) and shareholders' equity are considered to be non-interest-sensitive for purposes of this presentation and thus are not included in the above table.\nIn the table, all NOW, money market, and savings accounts are reflected as interest-sensitive within three months. NOW accounts, savings, and certain money market accounts are not totally interest-sensitive in all interest rate environments. If NOW and regular savings accounts were not considered interest-sensitive, the one year cumulative net asset interest-sensitive gap position and percent of earning assets would be $413.8 million and 5.87%, respectively, for 1994 as compared to a net asset interest-sensitive gap position and percent of earning assets of $201.0 million and 3.07%, respectively, for 1993.\nTABLE 5: SECURITY PORTFOLIO ANALYSIS\n* Yields presented on a taxable equivalent basis, based on the statutory Federal income tax rate, adjusted for applicable state income taxes net of the related Federal tax benefit. ** Securities held to maturity were reported on the balance sheet at amortized cost and securities available for sale were reported on the balance sheet at market value for a combined total of $2,150.0 million.\nTABLE 6: MATURITIES OF LOANS, EXCLUSIVE OF CONSUMER LOANS\nTABLE 7: ALLOWANCE FOR POSSIBLE LOAN LOSSES\nTABLE 9: CERTIFICATES OF DEPOSIT $100,000 AND OVER\nTABLE 10: RISK-BASED CAPITAL AND RELATED RATIOS\n* Risk-based capital ratios were computed using realized equity (total shareholders' equity exclusive of net unrealized gains (losses) on securities available for sale, net of tax) and exclude the 7 5\/8% debentures redeemed January 31, 1994.\nTABLE 11: QUARTERLY FINANCIAL DATA\n* Adjusted to a taxable equivalent basis based on the statutory Federal income tax rates, adjusted for applicable state income taxes net of the related Federal tax benefit.\nTABLE 12: CONSOLIDATED YEAR-END BALANCE SHEETS\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and schedule listed in Item 14(a)(1) and (2) are included in this Report beginning on Page 65 and are incorporated in this Item 8 by reference. The table \"Quarterly Financial Data\" on page 53 hereof, \"Consolidated Year-End Balance Sheets\" on page 54 hereof, and \"Consolidated Average Balance Sheets and Taxable Equivalent Income\/Expense and Yields\/Rates\" on pages 47-48 hereof are incorporated in this Item 8 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\nExecutive Officers of the Registrant\nThe following is a list of the Corporation's executive officers, their ages and their positions and offices during the last five years (listed alphabetically).\nThe additional information required by Item 405 of Regulation S-K is contained in the Corporation's Notice of 1995 Annual Meeting of Shareholders and Proxy Statement (the \"1995 Proxy Statement\") filed with the Securities and Exchange Commission within 120 days of the Corporation's year-end pursuant to Regulation 14A. Such information appears in the sections entitled \"Election of Directors\" and \"Reports of Beneficial Ownership\" in the 1995 Proxy Statement and is incorporated herein by reference.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION\nThis information appears in the sections entitled \"Executive Compensation\", \"Human Resources Committee Interlocks and Insider Participation\", \"Compensation of Directors\" and \"Retirement Plans\" in the 1995 Proxy Statement, and is incorporated herein by reference.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information appears in the section entitled \"Security Ownership of Certain Beneficial Owners and Management\" in the 1995 Proxy Statement, and is incorporated herein by reference.\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis information appears in the sections entitled \"Certain Transactions\" and \"Human Resources Committee Interlocks and Insider Participation\" in the 1995 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 part of this Report:\n1. Financial Statements\nThe Report of KPMG Peat Marwick LLP, Independent Certified Public Accountants\nConsolidated Income Statements of First American Corporation and Subsidiaries for the three years ended December 31, 1994, 1993, and 1992\nConsolidated Balance Sheets of First American Corporation and Subsidiaries at December 31, 1994 and\nConsolidated Statements of Changes in Shareholders' Equity of First American Corporation and Subsidiaries for the three years ended December 31, 1994, 1993, and 1992\nConsolidated Statements of Cash Flows of First American Corporation and Subsidiaries for the three years ended December 31, 1994, 1993, and 1992\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nAll schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or the notes thereto.\nThe following reports and consents are submitted herewith:\nAccountants' Consent by KPMG Peat Marwick LLP -- Exhibit 23\n3. Exhibits\nExhibit Number Description ------- -----------\n2 Agreement and Plan of Merger dated February 21, 1995 by and between First American Corporation and Heritage Bancshares, Inc. (previously filed as Exhibit 2 to Current Report on Form 8-K filed February 23, 1995 and incorporated herein by reference).\n3.1 Restated Charter (previously filed as Exhibit 1 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991, and incorporated herein by reference).\n3.2 By-Laws of the Corporation currently in effect as amended April 21, 1994 included on page 102 hereof.\n4.1 The Corporation agrees to provide the SEC, upon request, copies of instruments defining the rights of holders of long-term debt of the Corporation, and all of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed with the SEC.\n4.2 Rights Agreement, dated December 14, 1988, between First American Corporation and First American Trust Company, N.A. (previously filed as Exhibit 1 to a Current Report on Form 8-K dated December 14, 1988, and incorporated herein by reference).\n4.3(a) Indenture, dated as of December 15, 1972, between First Amtenn Corporation and the Chase Manhattan Bank, National Association, as Trustee (previously filed as Exhibit 4(b) to Registration Statement No. 2-46447 and incorporated herein by reference).\n4.3(b) Indenture, dated as of April 22, 1993, between First American Corporation and Chemical Bank, as Trustee (previously filed as Exhibit 4.1 to Registration Statement No. 33-59844 and incorporated herein by reference).\n4.3(c) Supplemental Indenture, dated as of April 22, 1993, between First American Corporation and Chemical Bank, as Trustee (previously filed as Exhibit 4.2 to Registration Statement No. 33-59844 and incorporated herein by reference).\n10.3(a) First American STAR Award Plan (previously filed as Exhibit 10.03(b) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1986 and incorporated herein by reference).\n10.3(b) First American Corporation 1991 Employee Stock Incentive Plan (previously filed as part of the Corporation's Notice of Annual Meeting and Proxy Statement dated March 18, 1991 for the annual meeting of shareholders held April 18, 1991 and incorporated herein by reference).\n10.3(c) 1993 Non-Employee Director Stock Option Plan (previously filed as part of the Corporation's Notice of Annual Meeting and Proxy Statement dated March 18, 1993 for the annual meeting of shareholders held April 15, 1993 and incorporated herein by reference).\n10.3(d) Consulting Agreement (previously filed as Exhibit 10.3(a) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference) with James F. Smith dated January 1, 1993.\n10.3(e) First American Corporation 1992 Executive Early Retirement Program (previously filed as Exhibit 10.4(a) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).\n10.3(f) First American Corporation Directors' Deferred Compensation Plan (previously filed as Exhibit 19.1 to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).\n10.3(g) First American Corporation Supplemental Executive Retirement Program dated as of January 1, 1989 (previously filed as Exhibit 19.2 to the Corporation's Annual\nReport on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).\n10.3(h) Form of Deferred Compensation Agreement approved by the Human Resources Committee of the Board of Directors of the Corporation on December 16, 1993 (previously filed as Exhibit 10.3(h) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference) and entered into by the Corporation and John Boyle and Dennis Bottorff, as amended and restated and included on page 125 hereof.\n10.3(i) Restated and Amended First American Corporation First Incentive Reward Savings Thrift Plan (previously filed as Exhibit 4 to Registration Statement No. 33-57385 filed January 20, 1995 and incorporated herein by reference).\n11 Calculation of earnings per share is included in note 1 to the consolidated financial statements contained herein on page 73 and incorporated herein by reference.\n13 First American Corporation's Annual Report to Shareholders for the fiscal year ended December 31, 1994. Such report, except for the portions included herein, is furnished for the information of the Securities and Exchange Commission and is not \"filed\" as part of this Report.\n21 List of Subsidiaries included on page 130 hereof.\n23 Consent of KPMG Peat Marwick LLP, independent accountants included on page 131 hereof.\n27 Financial Data Schedule included herewith.\nUpon written or oral request, a copy of the above exhibits will be furnished at cost.\n(b) No reports on Form 8-K were filed during the last quarter of 1994.\nFIRST AMERICAN CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nINDEPENDENT AUDITORS' REPORT.\nThe Board of Directors and Shareholders First American Corporation:\nWe have audited the accompanying consolidated balance sheets of First American Corporation and subsidiaries 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 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 First American 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.\nAs discussed in note 13 to the consolidated financial statements, the Corporation adopted in 1993 the provisions of the Financial Accounting Standards Board's Statements of Financial Accounting Standards No. 109, Accounting for Income Taxes; No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions; No. 112, Employers' Accounting for Postemployment Benefits; and No. 115, Accounting for Certain Investments in Debt and Equity Securities.\n\/s\/ KPMG Peat Marwick LLP ------------------------- KPMG Peat Marwick LLP\nNashville, Tennessee January 20, 1995\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.\n- -------------------------------------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe consolidated financial statements of First American Corporation have been prepared in conformity with generally accepted accounting principles including general practices of the banking industry. The following is a summary of the more significant accounting policies of the Corporation.\nCONSOLIDATION\nThe consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiaries, including its principal subsidiary First American National Bank, as well as First American National Bank of Kentucky and First American Trust Company, N.A. All significant intercompany accounts and transactions have been eliminated in consolidation.\nSECURITIES\nEffective December 31, 1993, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 115 requires investments in equity securities that have a readily determinable fair value and investments in debt securities to be classified into three categories, as follows: held to maturity debt securities, trading securities, and securities available for sale.\nUnder SFAS No. 115, classification of a debt security as held to maturity is based on the Corporation's positive intent and ability to hold such security to maturity. Securities held to maturity are stated at cost adjusted for amortization of premiums and accretion of discounts, unless there is a decline in value which is considered to be other than temporary, in which case the cost basis of such security is written down to market and the amount of the write-down is included in earnings.\nSecurities that are bought and held principally for the purpose of selling them in the near term are classified as trading account securities, which are valued at market with unrealized gains and losses included in earnings. Gains or losses on sales and adjustments to market value of trading account securities are included in non-interest income in the consolidated income statements.\nSecurities classified as available for sale, which are reported at market value with unrealized gains and losses excluded from earnings and reported, net of tax, in a separate component of shareholders' equity, include all securities not classified as trading account securities or securities held to maturity. These include securities used\nas part of the Corporation's asset\/liability strategy which may be sold in response to changes in interest rates, prepayment risk, the need or desire to increase capital, and other similar factors. Gains or losses on sale of securities available for sale are recognized at the time of sale, based upon specific identification of the security sold, and are included in non-interest income in the consolidated income statements.\nDERIVATIVE FINANCIAL INSTRUMENTS\nThe Corporation enters into interest rate swap, forward interest rate swap, and basis swap transactions (swaps), as well as futures contracts, in connection with its asset\/liability management program in managing interest rate exposure arising out of non-trading assets and liabilities. The impact of swaps is accrued based on expected settlement payments and is recorded as an adjustment to interest income and expense, in the period in which it accrues and in the category appropriate to the related asset or liability, over the life of the related agreements. The related amount receivable from or payable to the swap counterpart is included in other liabilities or assets in the consolidated balance sheets. Realized and unrealized gains and losses on futures contracts which are designated as effective hedges of interest rate exposure arising out of non-trading assets and liabilities are deferred and recognized as interest income or interest expense, in the category appropriate to the related asset or liability, over the covered periods or lives of the hedged assets or liabilities. Gains or losses on early terminations of derivative financial instruments that modify the underlying characteristics of specified assets or liabilities are deferred and amortized as an adjustment to the yield of the related assets or liabilities over the remaining covered period.\nOn a limited basis, the Corporation also enters into interest rate swap agreements, as well as interest rate cap and floor agreements, with customers desiring protection from possible adverse future fluctuations in interest rates. As an intermediary, the Corporation generally maintains a portfolio of matched offsetting interest rate contract agreements. At the inception of such agreements, the portion of the compensation related to credit risk and ongoing servicing, if any, is deferred and taken into income over the term of the agreements.\nLOANS\nLoans are stated at the principal amount outstanding. Unearned discount, deferred loan fees net of loan acquisition costs, and the allowance for possible loan losses are shown as reductions of loans. Loan origination and commitment fees and certain loan related costs are being deferred and the net amount amortized as an adjustment of the related loan's yield over the contractual life of the loan. Unearned discount represents the unamortized amount of finance charges, principally related to certain installment loans. Interest income on loans is generally computed on the outstanding loan balance. Interest income on installment loans which have unearned discounts is recognized primarily by the sum-of-the-month's digits method.\nInterest income is generally accrued on all loans. Commercial loans are placed on non-accrual status when doubt as to timely collection of principal or interest exists, or when principal or interest is past due 90 days or more unless such loans are well-secured and in the process of collection. The decision to place a loan on non-accrual status is based on an evaluation of the borrower's financial condition, collateral, liquidation value, and other factors that affect the borrower's ability to pay. Generally, at the time a loan is placed on a non-accrual status, all interest accrued and uncollected on the loan in the current fiscal year is reversed from income, and all interest accrued and uncollected from the prior year is charged off against the allowance for possible loan losses. Thereafter, interest on non-accrual loans is recognized in interest income only to the extent that cash is received and future collection of principal is not in doubt. If the collectibility of outstanding principal is doubtful, such interest received is applied as a reduction of principal. A non-accrual loan may be restored to an accruing status when principal and interest are no longer past due and unpaid and future collection of principal and interest on a timely basis is not in doubt. Generally, consumer loans on which interest or principal is past due more than 120 days are charged off.\nALLOWANCE FOR POSSIBLE LOAN LOSSES\nThe provision for loan losses represents a charge (credit) to earnings necessary, after loan charge-offs and recoveries, to maintain the allowance for possible loan losses at an appropriate level which is adequate to absorb estimated losses inherent in the loan portfolio. Such estimated losses arise primarily from the loan portfolio but may also be derived from other sources, including commitments to extend credit and standby letters of credit. The level of the allowance for possible loan losses is determined on a quarterly basis using procedures which include: (1) an evaluation of individual criticized and classified credits as determined by internal reviews, of other significant credits, and of non-criticized\/classified commercial and commercial real estate credits, to determine estimates of loss probability; (2) an evaluation of various consumer loan categories to determine an estimation of loss on such loans based primarily on historical loss experience of the category; (3) a review of unfunded commitments; and (4) an assessment of various other factors, such as changes in credit concentrations, loan mix, and economic conditions which may not be specifically quantified in the loan analysis process.\nThe allowance for possible loan losses consists of an allocated portion and an unallocated, or general, portion. The allocated portion is maintained to cover estimated losses applicable to specific segments of the loan portfolio. The unallocated portion is maintained to absorb losses which probably exist as of the evaluation date but are not identified by the more objective processes used for the allocated portion of the allowance for loan losses due to risk of error or imprecision. While the total allowance consists of an allocated portion and an unallocated portion, these terms are primarily used to describe a process. Both portions of the allowance are available to provide for inherent loss in the entire portfolio.\nThe allowance for possible loan losses is increased (decreased) by provisions for loan losses charged (credited) to expense and is reduced (increased) by loans charged off net of recoveries on loans previously charged off. The provision for loan losses is based on management's determination of the amount of the allowance necessary to provide for estimated loan losses based on its evaluation of the loan portfolio. Determining the appropriate level of the allowance and the amount of the provision for loan losses involves uncertainties and matters of judgment and therefore cannot be determined with precision.\nFORECLOSED PROPERTIES\nForeclosed properties include property acquired through foreclosure and in-substance foreclosures. In-substance foreclosed properties are those properties where the borrower retains title but has little or no remaining equity in the property considering its fair value; where repayment can only be expected to come from the operation or sale of the property; and where the borrower has effectively abandoned control of the property or it is doubtful that the borrower will be able to rebuild equity in the property. Foreclosed properties are valued at the lower of cost or fair value minus estimated costs to sell. The fair value of the assets is the amount that the Corporation could reasonably expect to receive for them in a current sale between a willing buyer and a willing seller, that is, other than in a forced or liquidation sale. Cost includes loan principal, accrued interest, foreclosure expense, and expenditures for subsequent improvements. The excess of cost over fair value minus estimated costs to sell at the time of foreclosure is charged to the allowance for possible loan losses. Subsequent write-downs to fair value minus estimated costs to sell are included in foreclosed properties expense.\nDEPRECIATION AND AMORTIZATION\nPremises and equipment is stated at cost less accumulated depreciation and amortization, which is computed principally on the straight-line method based on the estimated useful lives of the respective assets.\nFor acquisitions accounted for as purchases, the net assets have been adjusted to their fair values as of the respective acquisition dates. The value of core deposit rights and the excess of the purchase price of subsidiaries over net assets acquired are being amortized on a straight-line basis over periods ranging from ten to twenty years. Core deposit rights and the excess of the purchase price of subsidiaries over net assets acquired, net of amounts amortized, are included in other assets in the consolidated balance sheets.\nThe carrying value of the excess of the purchase price of subsidiaries over net assets acquired (goodwill) will be reviewed if the facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the undiscounted cash flows of an entity acquired over the remaining amortization period, the Corporation's carrying value of the goodwill will be reduced by the estimated shortfall of cash flows.\nEMPLOYEE BENEFIT PLANS\nThe Corporation provides a variety of benefit plans to eligible employees. Retirement plan expense is accrued each year, and plan funding represents at least the minimum amount required by the Employee Retirement Income Security Act of 1974, as amended. Differences between expense and funded amounts are carried in other assets or other liabilities. Beginning in 1993, the Corporation recognizes postretirement benefits other than pensions on an accrual basis, and effective December 31, 1993, other postemployment benefits are also recognized on an accrual basis. The Corporation also makes contributions to an employee thrift and profit-sharing plan based on employee contributions and performance levels of the Corporation.\nINCOME TAXES\nThe Corporation files a consolidated Federal income tax return, except for its credit life insurance subsidiary, which files a separate return. Effective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" which requires a change from the deferred method of accounting under Accounting Principles Bulletin No. 11 to the asset and liability method of accounting for income taxes. Under SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are reduced by a valuation allowance, if necessary, to an amount that more likely than not will be realized.\nEARNINGS PER COMMON SHARE\nEarnings per common share amounts are computed by dividing net income by the weighted average number of common shares outstanding during each year.\nRECLASSIFICATIONS\nCertain prior year amounts have been reclassified to conform with current year presentation.\nNOTE 2: CASH AND DUE FROM BANKS\nThe Corporation's bank subsidiaries are required to maintain reserves, in the form of cash and balances with the Federal Reserve Bank, against its deposit liabilities. Approximately $161.5 million and $171.8 million of the cash and due from banks balance at December 31, 1994 and 1993, respectively, represented reserves maintained in order to meet Federal Reserve requirements.\nNOTE 3: SECURITIES\nSECURITIES HELD TO MATURITY\nThe amortized cost, gross unrealized gains, gross unrealized losses, and approximate market values of securities held to maturity at December 31, 1994 and 1993, are presented in the following table:\nIncluded in U.S. Treasury and other U.S. Government agencies and corporations securities held to maturity were agency-issued mortgage-backed securities amounting to $1,035.4 million ($983.1 million market value) at December 31, 1994 and $480.5 million ($492.3 million market value) at December 31, 1993. Mortgage-backed securities included in other debt securities amounted to $156.2 million ($145.6 million market value) at December 31, 1994 and $6.9 million ($7.2 million market value) at December 31, 1993.\nSECURITIES AVAILABLE FOR SALE\nThe amortized cost, gross unrealized gains, gross unrealized losses, and approximate market values of securities available for sale at December 31, 1994 and 1993, are presented in the following table:\nIncluded in U.S. Treasury and other U.S. Government agencies and corporations securities available for sale were agency-issued mortgage-backed securities amounting to $326.8 million ($306.3 million market value) at December 31, 1994 and $992.7 million ($1,016.8 million market value) at December 31, 1993.\nEffective December 31, 1993, the Corporation adopted SFAS No. 115 which requires investments in equity securities that have a readily determinable fair value and investments in debt securities to be classified into three categories, as follows: held to maturity debt securities, trading securities, and available for sale securities. In conjunction with the adoption of SFAS No. 115 on December 31, 1993, the Corporation reclassified $368.6 million of securities to the available for sale classification from the former investment, now held to maturity, category. At that date, unrealized appreciation on total securities available for sale amounted to $36.1 million, resulting in an increase in shareholders' equity of $22.0 million, net of taxes. There was no impact on the Corporation's consolidated net income as a result of the adoption of SFAS No. 115.\nIncluded within total securities classified as available for sale at December 31, 1993, were $203.8 million of securities classified as such due to regulatory restrictions even though the Corporation had the intent and ability to hold such securities to maturity. Upon a regulatory revision in 1994, which allowed those securities to be classified as held to maturity, the Corporation transferred such securities from available for sale to held to maturity. At the time of transfer, the securities had an unrealized loss of $1.0 million ($.6 million net of taxes). In accordance with SFAS No. 115, such unrealized loss was retained as a component of shareholders' equity and is being amortized over the remaining lives of the securities.\nNet realized losses from the sale of securities available for sale for the years ended December 31, 1994, 1993, and 1992, amounted to $10.0 million, $2.0 million, and $3.0 million, respectively. Gross realized gains and losses on such sales were as follows:\nTOTAL SECURITIES\nThe amortized cost and approximate market values of debt securities at December 31, 1994, by average estimated maturity are shown below. The expected maturity for governmental and corporate securities is the stated maturity, and the\nexpected maturity for mortgage-backed securities and other asset-backed securities is based on current estimates of average maturities.\nAt December 31, 1994 and 1993, the Corporation held securities with amortized cost amounting to $484.6 million and $503.7 million, respectively, which were issued or guaranteed by the Federal National Mortgage Association and $714.1 million and $856.1 million, respectively, which were issued or guaranteed by the Federal Home Loan Mortgage Corporation.\nSecurities carried in the consolidated balance sheets at approximately $1,627.0 million and $1,310.0 million at December 31, 1994 and 1993, respectively, were pledged to secure public and trust deposits and for other purposes as required or permitted by law.\nNOTE 4: LOANS AND ALLOWANCE FOR POSSIBLE LOAN LOSSES\nThe Corporation's bank subsidiaries make commercial, consumer, and real estate loans to its customers, located principally within the Corporation's primary market, which consists of Tennessee and selected markets in adjacent states. Although the bank subsidiaries have a diversified loan portfolio, a substantial portion of their debtors' ability to honor their contracts is dependent upon economic conditions in the Corporation's primary market.\nLoans are either secured or unsecured based on the type of loan and the financial condition of the borrower. The loans are generally expected to be repaid from cash flow or proceeds from the sale of selected assets of the borrower; however, the Corporation is exposed to risk of loss on loans due to the borrower's difficulties, which may arise from any number of factors including problems within the respective industry or economic conditions, including those within the Corporation's primary market.\nTransactions in the allowance for possible loan losses were as follows:\nNet charge-offs (recoveries) by major loan categories were as follows:\nAt December 31, 1994 and 1993, loans on a non-accrual status amounted to $11.5 million and $21.7 million, respectively. Interest income not recognized on non-accrual loans was approximately $.3 million in 1994, $1.1 million in 1993, and $3.6 million in 1992. Interest income recognized on a cash basis on non-accrual loans was $.8 million, $1.2 million, and $1.0 million for the same respective periods.\nDirectors and executive officers (and their associates, including companies in which they hold ten percent or more ownership) of the Corporation and its significant subsidiary, First American National Bank, had loans outstanding with the Corporation and its subsidiaries of $11.7 million and $5.7 million at December 31, 1994 and 1993, respectively. During 1994, $39.5 million of new loans or advances on existing loans were made to such related persons and repayments from such persons totalled $33.5 million. The Corporation believes that such loans were made on substantially the same terms, including interest and collateral, as those prevailing at the time for comparable transactions with other borrowers and did not involve more than the normal risk of collectibility or present other unfavorable features at the time such loans were made.\nDuring 1993, the Financial Accounting Standards Board issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan.\" SFAS No. 114 was amended in 1994 by SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" These pronouncements, which will be adopted prospectively by the Corporation on January 1, 1995, require that impaired loans be measured at the present value of expected future cash flows discounted at the loan's effective interest rate, at the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. The Corporation's financial position and results of operations will not be materially impacted upon the adoption of SFAS No. 114 and No. 118.\nNOTE 5: PREMISES AND EQUIPMENT AND LEASE COMMITMENTS\nPremises and equipment is summarized as follows:\nDepreciation and amortization expense of premises and equipment for 1994, 1993, and 1992 was $14.1 million, $13.8 million and $12.3 million, respectively.\nNon-cancelable minimum operating lease commitments for real property amount to $8.8 million for 1995; $8.6 million for 1996; $8.2 million for 1997; $7.7 million for 1998; $7.4 million for 1999; and $38.5 million thereafter. In the normal course of business, management expects that leases will be renewed or replaced by other leases. Rent expense, net of rental income on bank premises, for 1994, 1993, and 1992 was $4.4 million, $3.5 million, and $4.1 million, respectively. Rental income on bank premises for 1994, 1993, and 1992 was $3.8 million, $4.0 million, and $3.8 million, respectively.\nThe Corporation has a data processing outsourcing agreement expiring in 2001 that has an average annual base expense, as amended in 1994, of $8.5 million. Total annual fees vary with cost of living adjustments and changes in services provided by the vendor, which services depend upon the Corporation's volume of business and system needs. The related expense is included in systems and processing expense in the consolidated income statements.\nNOTE 6: INTANGIBLE ASSETS\nTotal intangible assets representing core deposit rights and excess of purchase price of subsidiaries over net assets acquired amounted to $25.6 million and $26.0 million at December 31, 1994 and 1993, respectively, and are included in other assets on the consolidated balance sheets. Amortization expense of intangible assets was $3.4 million, $2.5 million, and $2.4 million, in 1994, 1993, and 1992, respectively.\nNOTE 7: SHORT-TERM BORROWINGS\nShort-term borrowings are issued on normal banking terms and consisted of the following:\nAt December 31, 1994 and 1993, Federal funds purchased and securities sold under agreements to repurchase included Federal funds purchases of $25.0 million (due within three months) and $55.0 million (due within five months), respectively. Other short-term borrowings is essentially composed of U.S. Treasury tax and loan accounts.\nThe following table presents information regarding Federal funds purchased and securities sold under agreements to repurchase.\nNOTE 8: LONG-TERM DEBT\nLong-term debt consisted of the following:\nAt December 31, 1994, advances from the Federal Home Loan Bank were $201.2 million which consisted of $1.2 million maturing September 28, 2007, at an interest rate of 3.891%, and $200.0 million maturing in 1997 with the interest rate tied to one-month LIBOR. These advances are collateralized by a blanket pledge of 1-4 family mortgage loans.\nDuring the first quarter of 1993, the Corporation filed a shelf registration statement with the Securities and Exchange Commission to issue $100.0 million of subordinated debt securities. The Corporation issued $50.0 million of subordinated notes under the shelf registration statement during second quarter 1993. The notes are non-callable.\nOn January 31, 1994, the Corporation redeemed the remaining balance of approximately $13.6 million of its 7 5\/8% debentures due in 2002, at a price of 101.22% of par.\nThe Corporation owns a parking garage which was financed through an Industrial Revenue Bond due April 1, 1997. Indebtedness at December 31, 1994 and 1993, totalled $1.1 million and $1.4 million, respectively. Sinking fund requirements of this debt amount to $.3 million for 1995 and $.4 million for 1996; the balance of $.4 million is due in 1997. The interest rate on these bonds is 5.9% for the remaining life of the bonds.\nDuring 1994, the Corporation entered into a three-year unsecured revolving credit agreement which provides for loans up to $50.0 million. Under the terms of the agreement, which expires in March 1997, the Corporation pays a fee for the availability of these funds computed at the rate of 1\/4 of 1% per annum on the commitment. Interest to be paid on the outstanding balances will be computed based\non the prime interest rate of the lending banks, Eurodollar rates, or adjusted certificate of deposit rates, as selected by the Corporation. The Corporation had no revolving credit borrowings outstanding at December 31, 1994 or 1993.\nThe terms of these agreements provide for, among other things, restrictions on payment of cash dividends and purchases, redemptions, and retirement of capital shares. Under the Corporation's most restrictive debt covenant, approximately $88.6 million of retained earnings was available to pay dividends as of December 31, 1994.\nNOTE 9: EMPLOYEE BENEFITS\nRETIREMENT PLAN\nThe Corporation and its subsidiaries participate in a non-contributory retirement plan with death and disability benefits covering substantially all employees with one or more years of service. The benefits are based on years of service and average monthly earnings of a participant for the 60 consecutive months which produce the highest average earnings.\nThe following table sets forth the plan's funded status and amounts recognized in the Corporation's consolidated balance sheets at December 31, 1994 and 1993:\nNet pension expense included the following components:\nAs of January 1, 1994, the Corporation elected to change its method of measuring the market-related value of plan assets from utilizing a calculation based on 50% book value plus 50% fair market value to utilization of 100% fair market value. The change had the effect of decreasing 1994 net periodic pension expense by $1.6 million.\nThe following table presents assumptions used in determining the actuarial present value of the projected benefit obligation for the pension plan:\nSUPPLEMENTAL RETIREMENT PLAN\nThe Corporation has a supplemental retirement plan which provides supplemental retirement benefits to certain executives of the Corporation. The expense was $.2 million in 1994, $.1 million in 1993, and $.7 million in 1992. The higher level of expense in 1992 was due to early retirements. Benefit payments from the plan are made from general assets of the Corporation. 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 in 1994 were 8.0% and 4.5%, respectively, and in 1993 were 7.5% and 4.5%, respectively.\nOTHER POSTRETIREMENT BENEFITS\nIn addition to pension benefits, the Corporation and its subsidiaries have defined postretirement benefit plans that provide medical insurance and death benefits for retirees and eligible dependents. Because the death benefit plan is not significant, it is combined with the health care plan for disclosure purposes.\nEffective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires the cost of postretirement benefits other than pensions to be recognized on an accrual basis as employees perform services to earn such benefits. The Corporation's previous practice, like most companies, was to expense such costs on a pay-as-you-go basis. The Corporation recognized this change during 1993 as a cumulative effect of a change in accounting principle, resulting in a one-time non-cash charge of $17.5 million before taxes ($11.6 million after taxes). This charge represents the discounted present value of expected future retiree medical and death benefits attributed to employees' service rendered prior to 1993. See note 13.\nThe status of the plans at December 31, 1994 and 1993, was as follows:\nThe components of net periodic expense for postretirement benefits in 1994 and 1993 were as follows:\nThe Corporation continues to fund medical and death benefit costs principally on a pay-as-you-go basis. Postretirement benefit expense for 1992, which was recorded on a cash basis, has not been restated and was $.6 million.\nFor measurement purposes, an 11.00% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1994, declining gradually to 5.5% per year by 2011 and remaining at that level thereafter. The discount rate used to determine the accumulated postretirement benefit obligation was 8.0% in 1994 and 7.5% in 1993, and the assumed long-term rate of compensation increase was 4.5% in 1994 and 1993.\nThe health care cost trend rate assumption has a significant effect on the accumulated postretirement benefit obligation and net periodic benefit costs. A 1% increase in the trend rate for health care costs would have increased the accumulated postretirement benefit obligation by $1.5 million as of December 31, 1994, and the net periodic expense (service cost and interest cost) would have increased by $.1 million for 1994.\nPOSTEMPLOYMENT BENEFITS\nEffective December 31, 1993, the Corporation adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires employers to recognize a liability for postemployment benefits under certain circumstances. The Corporation's short-term and long-term disability benefits, survivor income benefits, and certain other benefits are governed by this statement. The Corporation recognized this item during the fourth quarter of 1993 as a cumulative effect of a change in accounting principle, resulting in a one-time non-cash charge of $2.0 million before taxes ($1.3 million after taxes). Prior to this date, postemployment benefit expenses were recognized on a pay-as-you-go basis. See note 13.\nOTHER EMPLOYEE BENEFITS\nThe Corporation has executive incentive compensation plans covering certain officers and other key employees of the Corporation. The plans provide for incentives based on the attainment of annual and long-term performance goals. Executive incentive compensation plans also include stock option programs, which provide for the granting of statutory incentive stock options and non-statutory options to key employees. Additionally, the Corporation has a stock option plan for non-employee directors. As of December 31, 1994, the Corporation had 2,889,961 shares of common stock reserved for issuance under these plans.\nDuring 1991 through 1994, the Corporation has issued 131,400 shares of restricted common stock to certain executive officers. The restrictions lapse within 15 years; however, if certain performance criteria are met, restrictions will lapse earlier. The amount recorded for the restricted stock issued is based on the market value of the Corporation's common stock on the award dates and is shown as deferred compensation in the consolidated statements of changes in shareholders' equity. Such compensation expense is recognized over a 3- to 15-year period.\nStock options granted under option programs have been at 85% to 133% of the market price on the day of grant. Each stock option is for one share of common stock. Some options are exercisable immediately, while some options are exercisable over a period of time and may be exercisable earlier if certain performance criteria are met. All options expire within a ten-year period from the date of grant. The market price of the Corporation's stock was $26.88 at December 31, 1994.\nThe following table presents a summary of stock option and restricted stock activity:\nThe Corporation has a combination savings thrift and profit-sharing plan (\"FIRST Plan\") available to substantially all full-time employees. In connection with the plan, 1,285,000 shares of the Corporation's common stock have been reserved for issuance. At year-end 1994, 1,279,000 of these shares had been issued. During 1994, 1993, and 1992, 149,360 shares, 94,193 shares, and 3,538 shares, respectively, were purchased in the open market for the FIRST Plan. During 1992, 62,961 shares were issued by the Corporation in connection with the FIRST Plan (none in 1994 or 1993). The plan is funded by employee and employer contributions. The Corporation's annual contribution to the plan is based upon the amount of basic contributions of participants, participants' compensation, and the achievement of\ncertain corporate performance standards and may be made in the form of cash or the Corporation's common stock with a market value equal to the cash contribution amount. Total plan expense in 1994, 1993, and 1992 was $3.4 million, $2.9 million, and $1.2 million, respectively. During 1994, 1993, and 1992, the Corporation matched participating employees' qualifying contributions by 100%, 100%, and 50%, respectively.\nNOTE 10: ACQUISITIONS AND SALES\nOn April 1, 1994, the Corporation consummated its purchase of all of the outstanding shares of Fidelity Crossville Corporation (FCC), the parent company of First Fidelity Savings Bank, F.S.B. (First Fidelity) located in Crossville, Tennessee, for $6.5 million. First Fidelity was a Federal stock savings bank with offices in Crossville and Fairfield Glade, Tennessee with total assets of $48.7 million on March 31, 1994. In conjunction with the acquisition, First Fidelity was merged into First American National Bank and First Fidelity's two offices became branches of First American National Bank. The acquisition was accounted for using the purchase method. Accordingly, the purchase price was allocated to assets acquired and liabilities assumed based on their estimated fair values. The purchase price in excess of the fair value of net assets acquired of $3.1 million is being amortized on a straight-line basis over 10 years. First Fidelity's results of operations have been included in the Corporation's consolidated income statement since the date of acquisition.\nOn October 1, 1993, the Corporation acquired all of the outstanding shares of First American National Bank of Kentucky (FANBKY), formerly known as First Federal Savings and Loan Association of Bowling Green, a $219.0 million national bank headquartered in Bowling Green, Kentucky, for $27.5 million. This transaction was accounted for as a purchase. All financial data after the acquisition date has been adjusted to reflect the purchase and, consistent with the purchase method of accounting, the results of operations of FANBKY are included in the Corporation's consolidated income statement beginning October 1, 1993. Total fair value of net assets of FANBKY on the acquisition date was approximately $19.1 million. The excess of the purchase price over the fair value of the net assets acquired was $8.4 million at the acquisition date and is being amortized over 10 years. FANBKY operates three branches in Warren and Simpson Counties in southern Kentucky.\nNOTE 11: FIRST AMERICAN FOUNDATION\nThe Corporation's non-interest expenses for 1993 included a $10.0 million charitable contribution to First American Foundation, a not-for-profit private foundation formed in 1993 to facilitate the Corporation's charitable contributions.\nNOTE 12: INCOME TAXES\nThe components of income tax expense (benefit) for the years ended December 31 were:\nThe 1992 total income tax expense for financial reporting purposes included the benefit from utilization of tax credit carryforwards amounting to $5.6 million (general business credit carryforwards of $4.9 million and alternative minimum tax credits of $.7 million).\nCurrent Federal income tax expense includes the utilization of alternative minimum tax credits amounting to $3.4 million in 1992.\nThe following table presents a reconciliation of the provision for income taxes as shown in the consolidated income statements with that which would be computed by applying the statutory Federal income tax rates of 35% for 1994 and 1993, and 34% for 1992 to income before income tax expense and the cumulative effect of changes in accounting principles.\nEffective January 1, 1993, the Corporation prospectively adopted SFAS No. 109, which required a change from the deferred method (an income statement approach) of accounting for income taxes under Accounting Principles Bulletin No. 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The cumulative effect of the adoption of SFAS No. 109 was a $12.8 million benefit. See note 13.\nSFAS No. 109 requires that the tax benefit of deductible temporary differences be recorded as an asset to the extent that management assesses the utilization of such temporary differences to be \"more likely than not.\" In accordance with SFAS No. 109, the realization of tax benefits of deductible temporary differences depends on whether the Corporation has sufficient taxable income within the carryback and carryforward period permitted by the tax law to allow for utilization of the deductible amounts. As of January 1, 1993, the Corporation had net deductible temporary differences of $165.5 million. For state purposes, Tennessee law does not permit carrybacks and thus a valuation allowance was established for the portion of the net deductible temporary differences for which realization was uncertain. A valuation allowance of $3.9 million was established (as of January 1, 1993).\nThe net change in the valuation allowance for 1994 was a decrease of $1.3 million. In 1993, the net change in the valuation allowance was a decrease of $2.6 million; consisting of an increase related to the adoption of SFAS No. 106 (accounting for postretirement benefits) of $1.1 million, an increase related to the adoption of SFAS 112 (accounting for postemployment benefits) of $.1 million, and a decrease of $3.8 million related to continuing operations.\nAccumulated deferred taxes aggregated net assets of $50.1 million at December 31, 1994 and $38.2 million at December 31, 1993, and are included in other assets on the consolidated balance sheets. Management believes that it is more likely than not that the deferred tax assets, net of the valuation allowance (if any), will be realized. The tax effects of temporary differences that give rise to the significant portions of deferred tax assets and deferred tax liabilities at December 31, 1994 and 1993, are as follows:\nThe tax effects of timing differences that give rise to significant portions of deferred tax expense (benefit) for the year ended December 31, 1992 are as follows:\nDuring 1994, the Corporation and the Internal Revenue Service (IRS) reached a settlement agreement related to the IRS's examination of the Corporation's 1989 and 1990 consolidated Federal income tax returns. Such settlement had no material impact on the Corporation's consolidated financial statements.\nNOTE 13: CHANGES IN ACCOUNTING PRINCIPLES\nThe cumulative effect of changes in accounting principles reflected in the 1993 consolidated income statement relates to the Corporation's 1993 adoption of Statements of Financial Accounting Standards (SFAS), as follows:\nSFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and No. 112, \"Employers' Accounting for Postemployment Benefits,\" are discussed in note 9 (employee benefits), and SFAS No. 109, \"Accounting for Income Taxes,\" is addressed in note 12 (income taxes). See note 3 for a discussion regarding the impact to the 1993 consolidated financial statements resulting from the December 31, 1993, adoption of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\"\nNOTE 14: COMMON STOCK\nIn December 1994, the Board of Directors authorized the repurchase of up to 800,000 shares of the Corporation's common stock. It is anticipated that stock repurchases will be made in the open market or in privately negotiated transactions from time to time during 1995, subject to market conditions and regulatory guidelines. Following these purchases, the Corporation expects to continue to exceed all applicable regulatory capital requirements. It is anticipated that the repurchased\nshares will be used to fund the Corporation's various employee benefit plans and potential future acquisitions.\nOn September 30, 1992, the Corporation completed an underwritten public offering of its common stock at $21.25 per share, resulting in the issuance of 2,012,500 shares. A $40.8 million addition to shareholders' equity in 1992 resulted from the offering.\nNOTE 15: OFF-BALANCE-SHEET AND DERIVATIVE FINANCIAL INSTRUMENTS\nIn the normal course of business, the Corporation is a party to financial transactions which have off-balance-sheet risk. Such transactions arise in meeting customers' financing needs and from the Corporation's activities in reducing its own exposure to fluctuations in interest rates. Off-balance-sheet items involving customers consist primarily of commitments to extend credit and letters of credit, which generally have fixed expiration dates. These instruments may involve, to varying degrees, elements of credit and interest rate risk. To evaluate credit risk, the Corporation uses the same credit policies in making commitments and conditional obligations on these instruments as it does for instruments reflected on the balance sheet. Collateral obtained, if any, varies but may include deposits held in financial institutions; U.S. Treasury securities or other marketable securities; income-producing commercial properties; accounts receivable; property, plant, and equipment; and inventory. The Corporation's exposure to credit risk under commitments to extend credit and letters of credit is the contractual (notional) amount of the instruments. Interest rate swap transactions and futures contracts may have credit and interest rate risk significantly less than the contractual amount.\nCOMMITMENTS\nCommitments to extend secured or unsecured credit are contractual agreements to lend money providing there is no violation of any condition. Commitments 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. At year-end 1994 and 1993, respectively, the Corporation had $1.9 billion and $1.3 billion of unfunded commitments to extend credit. Of these amounts, unfunded commitments for borrowers with loans on non-accrual status were $.5 million at December 31, 1994, and $5.3 million at December 31, 1993.\nStandby letters of credit are commitments issued by the Corporation to guarantee the performance of a customer to a third party. As of December 31, 1994 and 1993, the Corporation had standby letters of credit issued amounting to approximately $188.8 million and $135.4 million, respectively. The Corporation also had commercial letters of credit of $54.2 million and $56.1 million at December 31, 1994 and 1993, respectively. Commercial letters of credit are conditional\ncommitments issued by the Corporation to facilitate trade for corporate customers. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.\nThe Corporation contracts to buy and sell foreign exchange in order to meet the financing needs of its customers and to hedge its own exposure against market risk. At December 31, 1994 and 1993, the Corporation had $26.2 million and $12.7 million, respectively, of foreign exchange forward contracts, which is the sum of customers' contracts with the Corporation and the Corporation's offsetting contracts to minimize its exposure.\nDERIVATIVES\nThe Corporation's principal objective in holding or issuing derivative financial instruments for purposes other than trading is the management of interest rate exposure arising out of nontrading assets and liabilities. The Corporation's earnings are subject to risk of interest rate fluctuations to the extent that interest-earning assets and interest-bearing liabilities mature or reprice at different times or in differing amounts. Asset\/liability management activities are aimed at maximizing net interest income within liquidity, capital and interest rate risk constraints established by management. The Corporation's objective is that net income will not be impacted more than 5% from results simulated for the interest rate environment that the Corporation considers most likely, assuming that interest rates do not vary more than 150 basis points from the most likely scenario within the next 12 months.\nTo achieve its risk management objective, the Corporation uses a combination of derivative financial instruments, particularly interest rate swaps and futures contracts. The instruments utilized are noted in the following table along with their notional amounts and fair values at year-end 1994 and 1993.\n(1) Fixed rate. (2) Variable rate which reprices quarterly based on 3-month LIBOR except for $25 million which reprices every 6 months based on 6-month LIBOR. (3) Variable rate which reprices quarterly based on 3-month LIBOR. (4) Forward swap periods begin in June 1995 for $200 million and December 1995 for $450 million. The rates to be paid are fixed and were set at the inception of the contracts. Variable rates are based on 3-month LIBOR but are currently unknown since they will not be established until the affected periods begin. (5) Variable rate which reprices quarterly based on 5-year constant maturity Treasury rate less a constant spread. (6) Represents $300 million short position of Eurodollar futures contracts which in aggregate simulated a $100 million 9-month interest rate swap.\nNotional amounts are key elements of derivative financial instrument agreements. However, notional amounts do not represent the amounts exchanged by the parties to derivatives and do not measure the Corporation's exposure to credit or market risks. The amounts exchanged are based on the notional amounts and the other terms of the underlying derivative agreements. The Corporation's credit exposure at the reporting date from derivative financial instruments is represented by the fair value of instruments with a positive fair value at that date and is presented above along with the notional amounts of the instruments. Credit risk disclosures, however, relate to accounting losses that would be recognized if counterparts failed completely to perform their obligations.\nThe risk that counterparts to derivative financial instruments might default on their obligations is monitored on an ongoing basis. To manage the level of credit risk, the Corporation reviews the credit standing of its counterparts and enters into master netting agreements whenever possible, and when appropriate, obtains collateral. Master netting agreements incorporate rights of setoff that provide for the net settlement of subject contracts with the same counterparts in the event of default.\nInterest rate swap contracts are primarily used to convert certain deposits and long-term debt to fixed interest rates or to convert certain groups of customer loans to fixed rates. The Corporation's net credit exposure with interest rate swap counterparts totalled $18.3 million at December 31, 1994, and $.5 million at December 31, 1993.\nThe table below summarizes, by notional amounts, the activity for each major category of derivative financial instruments.\nThe table below presents the deferred gains, included in other liabilities on the consolidated balance sheets, related to terminated derivative financial instruments at December 31, 1994 and 1993.\n(1) $4,645 will be amortized into income during 1995 and $1,516 will be amortized during 1996. (2) Amortized into income during 1994.\nNOTE 16: LEGAL AND REGULATORY MATTERS\nThe extent to which dividends may be paid to the Corporation from its subsidiaries is governed by applicable laws and regulations. For the Corporation's national bank subsidiaries, the approval of the OCC is required if dividends declared in any year exceed net profits for that year (as defined under the National Bank Act) combined with the retained net profits of the two preceding years. In addition, a national bank may not pay a dividend, make any other capital distribution, or pay management fees if such payment would cause it to fail to satisfy certain minimum capital requirements. In accordance with the most restrictive of these restrictions, at December 31, 1994, FANB and FANBKY had $167.6 million and $1.3 million, respectively, available for distribution as dividends to the Corporation. For the trust company bank subsidiary, approximately $1.4 million was available for distribution as dividends to the Corporation as of December 31, 1994.\nThe Corporation and seven other financial institutions are defendants in a class action lawsuit brought in the Circuit Court of Shelby County, Tennessee. The lawsuit alleges antitrust, unconscionability, usury, and contract claims arising out of the defendant's returned check charges. The asserted plaintiff class consists of depositors who have been charged returned check or overdraft fees. The plaintiffs are requesting compensatory and punitive damages of $25.0 million against each defendant. The antitrust, unconscionability, and usury claims were previously dismissed, and in December 1993, the Circuit Court granted the defendants' motion for summary judgment and dismissed the remaining claim. The plaintiffs have appealed. In addition, an antitrust lawsuit alleging a price fixing conspiracy has been filed by the plaintiffs against the Corporation and eight other financial institutions in the U.S. District Court for the Western District of Tennessee. In March 1994, the District Court granted the defendants' motion for summary judgment dismissing the action. The plaintiffs have also appealed in this lawsuit. Management believes these suits are without merit and, based upon information currently known and on advice of counsel, that they will not have a material adverse effect on the Corporation's consolidated financial statements.\nAlso, there are from time to time other legal proceedings pending against the Corporation and its subsidiaries. In the opinion of management and counsel, liabilities, if any, arising from such proceedings presently pending would not have a material adverse effect on the consolidated financial statements of the Corporation.\nNOTE 17: FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards (SFAS) No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of fair value information about financial instruments for both on- and off-balance-sheet assets and liabilities for which it is practicable to estimate fair value. The techniques used for this valuation are significantly affected by the assumptions used, including the amount and timing of future cash flows and the discount rate. Such estimates involve uncertainties and matters of judgment and therefore cannot be determined with precision. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets. Accordingly, the aggregate fair value amounts presented are not meant to represent the underlying value of the Corporation.\nThe estimated fair values for the Corporation's off-balance-sheet financial instruments are summarized as follows:\nThe following methods and assumptions were used in estimating the fair value disclosures for financial instruments.\nCash and short-term investments -- The carrying amounts reported in the balance sheet approximate fair values since such instruments mature within 90 days or less and present no anticipated credit concerns.\nSecurities held to maturity, securities available for sale, and trading account securities -- Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.\nLoans -- For variable loans that reprice frequently, fair values are based on carrying values. The fair values for certain homogeneous categories of loans, such as residential mortgages, are estimated using quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair values for other loans are estimated by discounting estimated future cash flows using the current rates at which similar loans would be made to borrowers with similar credit risk and for similar maturities.\nDeposits -- The fair value of deposits with no stated maturity, such as demand deposits, NOW accounts, money market accounts, and regular savings accounts, is equal to the amount payable on demand at the reporting date. The fair value of certificates of deposits and other fixed maturity time deposits is estimated using the rates currently offered for deposits of similar remaining maturities. Any foreign deposits are valued at the carrying value due to the frequency with which rates for such deposits are adjusted to a market rate.\nShort-term borrowings -- Fair value is estimated to equal the carrying amount since these instruments have a relatively short maturity.\nLong-term debt -- Rates for long-term debt with similar terms and remaining maturities are used to estimate fair value of existing debt.\nOff-balance-sheet instruments -- The fair value of commitments to extend credit is based on unamortized deferred loan fees and costs. For letters of credit, fair value is estimated using fees currently charged to enter into similar agreements with similar maturities. The fair value of the Corporation's outstanding futures contracts is based on quoted market prices, and the estimated fair value of interest rate swaps is based on estimated costs to settle the obligations with the counterparts at the reporting date.\nNOTE 18: PARENT COMPANY FINANCIAL INFORMATION\nCondensed financial information for First American Corporation (Parent Company only) was as follows:\nCONDENSED BALANCE SHEETS\nCONDENSED INCOME STATEMENTS\nCONDENSED STATEMENTS OF CASH FLOWS\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 AMERICAN CORPORATION (Registrant)\nBY: \/s\/ DENNIS C. BOTTORFF ----------------------------- DENNIS C. BOTTORFF, CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER\nDate: March 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.\n\/s\/ William O. McCoy ----------------------- -------------------- SAMUEL E. BEALL, II WILLIAM O. MCCOY Director Director Dated: Dated: March 16, 1995\n\/s\/ Earnest W. Deavenport, Jr. \/s\/ Dale W. Polley ------------------------------ ------------------ EARNEST W. DEAVENPORT, JR. DALE W. POLLEY Director Director Dated: March 16, 1995 Dated: March 16, 1995\n\/s\/ Reginald D. Dickson \/s\/ Dr. Roscoe R. Robinson ----------------------- -------------------------- REGINALD D. DICKSON DR. ROSCOE R. ROBINSON Director Director Dated: March 16, 1995 Dated: March 16, 1995\n\/s\/ T. Scott Fillebrown, Jr. \/s\/ James F. Smith, Jr. ---------------------------- ----------------------- T. SCOTT FILLEBROWN, JR. JAMES F. SMITH, JR. Director Director Dated: March 16, 1995 Dated: March 16, 1995\n\/s\/ James A. Haslam, II \/s\/ Cal Turner, Jr. ----------------------- ------------------- JAMES A. HASLAM, II CAL TURNER, JR. Director Director Dated: March 16, 1995 Dated: March 16, 1995\n\/s\/ Martha R. Ingram \/s\/ Ted H. Welch -------------------- ---------------- MARTHA R. INGRAM TED H. WELCH Director Director Dated: March 16, 1995 Dated: March 16, 1995\n\/s\/ Walter G. Knestrick \/s\/ David K. Wilson ----------------------- ------------------- WALTER G. KNESTRICK DAVID K. WILSON Director Director Dated: March 16, 1995 Dated: March 16, 1995\n\/s\/ Gene C. Koonce \/s\/ Toby S. Wilt ------------------ ---------------- GENE C. KOONCE TOBY S. WILT Director Director Dated: March 16, 1995 Dated: March 16, 1995\n\/s\/ James R. Martin \/s\/ William S. Wire ------------------- ------------------- JAMES R. MARTIN WILLIAM S. WIRE Director Director Dated: March 16, 1995 Dated: March 16, 1995\n\/s\/ Robert A. McCabe, Jr. ------------------------ ROBERT A. MCCABE, JR. Director Dated: March 16, 1995\nFor purposes of EDGAR filing for 12\/31\/94 Form 10-K:\nAPPENDIX TO ELECTRONIC FORMAT DOCUMENT\nGraph #1: In the Overview section of Management's Discussion and Analysis, this bar graph depicts the Company's net income (loss) per share for 1990 through 1994. For 1994, this graph also depicts the Company's 1994 earnings per share based on earnings exclusive of negative loan loss provision and available for sale securities losses realized in the fourth quarter of 1994. For 1993, this graph also depicts the Company's 1993 based on earnings exclusive of negative loan loss provisions in the last three quarters of 1993 and charitable contribution to First American Foundation in the fourth quarter of 1993. This graph appears in the paper format version of the document and not in this electronic filing.\nGraph #2: In the Overview section of Management's Discussion and Analysis, this bar graph depicts the Company's return on average equity for 1990 through 1994. For 1994, this graph also depicts the Company's 1994 return on average equity based on earnings exclusive of negative loan loss provision and available for sale securities losses realized in the fourth quarter of 1994. For 1993, this graph also depicts the Company's 1993 return on average equity based on earnings exclusive of negative loan loss provisions in the last three quarters of 1993 and charitable contribution to First American Foundation in the fourth quarter of 1993. This graph appears in the paper format version of the document and not in this electronic filing.\nGraph #3: In the Overview section of Management's Discussion and Analysis, this bar graph depicts the Company's return on average assets for 1990 through 1994. For 1994, this graph also depicts the Company's 1994 return on average assets based on earnings exclusive of negative loan loss provision and available for sale securities losses realized in the fourth quarter of 1994. For 1993, this graph also depicts the Company's 1993 return on average assets based on earnings exclusive of negative loan loss provisions in the last three quarters of 1993 and charitable contribution to First American Foundation in the fourth quarter of 1993. This graph appears in the paper format version of the document and not in this electronic filing.\nGraph #4: In the Net Interest Income section of Management's Discussion and Analysis, this bar graph depicts the Company's net interest income (taxable equivalent basis) for 1990 through 1994. This graph appears in the paper format version of the document and not in this electronic filing.\nGraph #5: In the Non-Interest Expense section of Management's Discussion and Analysis, this bar graph depicts the Company's operating efficiency ratio for 1990 through 1994. For 1994, the ratio excludes available for sale securities losses realized in the fourth quarter of 1994. For 1993, the ratio excludes the charitable contribution to First American Foundation. For 1990, the ratio excludes the gain on the sale of credit card receivables. This graph appears in the paper format version of the document and not in this electronic filing.\nGraph #6: In the Loans section of Management's Discussion and Analysis, this bar graph depicts the Company's loans, net of discount and fees, at year-end 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.\nGraph #7: In the Allowance and Provision for Possible Loan Losses section of Management's Discussion and Analysis, this bar graph depicts the Company's allowance to net loans at year-end 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.\nGraph #8: In the Allowance and Provision for Possible Loan Losses section of Management's Discussion and Analysis, this bar graph depicts the Company's net charge-offs (recoveries) to average loans for 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.\nGraph #9: In the Asset Quality section of Management's Discussion and Analysis, this bar graph depicts the Company's nonperforming assets to loans and foreclosed properties at year-end 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.\nGraph #10: In the Deposits section of Management's Discussion and Analysis, this bar graph depicts the Company's core deposits at year-end 1990 through 1994. This graph appears in the paper format version of the document and is not in this electronic filing.\nGraph #11: In the Capital Position section of Management's Discussion and Analysis, this bar graph depicts the Company's average equity to average assets for 1990 through 1994. This graph appears in the paper format version of the document and not in this electronic filing.\nEXHIBIT INDEX\nNUMBER NAME PAGE - ------ ---- ----\nExhibit 3.2 By-laws of the Corporation 102\nExhibit 10.3(h) Amended Salary Deferral Agreement 125\nExhibit 21 List of Subsidiaries 130\nExhibit 23 Accountants' Consent 131\nExhibit 27 Financial Data Schedule","section_15":""}
{"filename":"310377_1994.txt","cik":"310377","year":"1994","section_1":"ITEM 1: BUSINESS\nGENERAL\nHBO & Company (the Company or HBOC), a Delaware corporation incorporated in 1974, is a healthcare information solutions company that provides a comprehensive range of computer-based information systems and services to healthcare enterprises - hospitals, integrated delivery networks and managed care organizations. The Company designs, sells and services information systems for a variety of applications within healthcare organizations. It also sells, installs and services local, metropolitan and wide area networks (LANs, MANs and WANs) and provides a range of value-added services through network communications technology. In addition, HBOC provides outsourcing services under contract management agreements whereby it staffs, manages and operates data centers, information systems organizations and even business offices of healthcare institutions of all sizes and structures.\nThe Company's primary market for its products and services consists of approximately 3,000 acute-care hospitals (and affiliated organizations) in the above-100 bed range in the United States. Through hospital affiliates, HBOC is marketing new products to the total healthcare enterprise including ambulatory care, physician offices and managed care providers. Through its subsidiary HBO & Company Canada Ltd., HBOC provides products and services in Canada, where there are approximately 500 hospitals having 100 or more beds. Through its subsidiary HBO & Company (UK) Limited, the Company services the United Kingdom, where there are approximately 300 hospitals having 100 or more beds. Experts estimate that in 1994 the industry spent more than $4 billion in the United States and more than $.5 billion in Canada and the United Kingdom on information systems, services and computer hardware. HBOC products are sold in other parts of the world through agreements with third parties.\nHBOC's products and services are offered through a companywide sales organization and business units that have responsibility for research and development and customer services. These business units include Pathways 2000, STAR, Series 3000\/4000, HealthQuest\/Series 5000, Outsourcing Services Group, Connect Technology Group, Amherst Product Group, Serving Software Group and, as of February 1995, Advanced Laboratory Group.\nIn June 1994, HBOC acquired IBAX Healthcare Systems (IBAX), a partnership of subsidiaries of Baxter Healthcare Corporation (Baxter) and International Business Machines Corporation (IBM). With this acquisition, HBOC added the Series 3000, 4000 and 5000 lines of \"core\" hospital transaction systems. Series 3000 and 4000 run on IBM AS\/400 hardware, and the Series 5000 line runs on IBM mainframe equipment.\nThe Serving Software Group was formed with the September 1994 acquisition of Serving Software, Inc., a Minneapolis-based provider of resource scheduling and management software. Serving Software's newest product, which is client\/server-based, has become a member of HBOC's Pathways 2000 family of enterprisewide information systems solutions.\nIn December 1994, HBOC acquired Care 2000, Inc., a small Atlanta-based firm specializing in case management methodologies.\nSubsequent to year-end 1994 and prior to the filing of this form 10-K, HBOC acquired Advanced Laboratory Systems, Inc., a Eugene, Oregon-based developer of laboratory software for the healthcare and commercial marketplace.\nHBOC's RISC\/UNIX-based STAR family of products and the Series 3000 and 4000 products serve organizations ranging in size from 100-bed institutions to those with multiple facilities that generally prefer to keep in-house data processing staff to a minimum. Customers of IBM mainframe-based\nHealthQuest and Series 5000 software and services are primarily large, complex healthcare organizations with in-house data processing departments staffed with their own systems professionals. In addition, throughout 1994 HBOC continued development and rollout of its Pathways 2000 family of products, which serves the needs of today's burgeoning healthcare alliances.\nTo support the connectivity needs of hospitals and their affiliates, the Connect Technology Group (CTG) provides total network installation and support. In addition, CTG offers comprehensive value-added network information services that extend local and metropolitan area networks outside of the hospital to include payers, vendors, financial institutions and Internet. All together, HBOC's networking solutions provide customers with a complete network solution for electronic access throughout a provider enterprise.\nHBOC's Amherst Product Group (APG) provides its industry-leading decision support products to many healthcare settings, including multifacility, corporate and university environments. APG also offers an enterprise information system to assist healthcare executives in critical strategic decision-making. Both APG systems are being transitioned to an open systems, client\/server-based architecture.\nThe Outsourcing Services Group provides resources for formulating and delivering complete solutions for information technology and business office management. In June 1994, HBOC signed an agreement with Unisys Corporation that allowed HBOC to acquire the Unisys PRN (Professional Resource Network) product line and related Charlotte, North Carolina operations. The Charlotte office, which is managed by the Outsourcing Services Group, provides ongoing customer service and support for some 60 PRN customers in the United States and Canada.\nHBO & Company also provides a host of software and networking products and services to the global healthcare marketplace outside the United States. In 1994, HBOC increased its presence in the United Kingdom when it contracted with the North East Thames Regional Health Authority to transfer the assets and 90-person staff of a full-service computer center to HBOC. The initial contract brought in 37 outsourcing agreements.\nAs of December 31, 1994, the Company and its subsidiaries had 2,383 employees.\nTECHNOLOGY STRATEGY\nHBO & Company's product technology strategy reflects the needs of community-based health networks that are emerging as a result of the healthcare reform movement. In particular, these networks will require information systems that are highly flexible and quickly adaptable and that can serve the information access needs of a broad range of users.\nThe Company's strategy also builds on the direction proposed in the 1992 report from the Institute of Medicine (IOM) for developing the computer-based patient record. This strategy, which consists of the following six major components, guides HBOC's product development direction.\nFoundation Products -- Many of HBO & Company's products are portable to a variety of hardware platforms to protect a healthcare organization's hardware investments and enable it to benefit from price\/performance advances. For example, HBOC offers a full range of its products on RISC (Reduced Instruction Set Computing) hardware using the UNIX operating system, which has very attractive price\/performance characteristics.\nWorkstations -- Workstation technology, via PCs, provides enhanced productivity and appeal for system users by giving them access to graphics, image processing, voice processing, multiple technologies and sophisticated user interfaces.\nSpecialized Processors -- Specialized processors, utilizing client\/server technology, provide organizations with improved processing and storage for large volumes of data and specific applications, including imaging and document processing.\nNetworks -- LANs, MANs and WANs provide faster and more effective pathways to distribute the wider variety of data, images and recorded voice needed by image processing and client\/server applications.\nTechnology Standards -- HBO & Company products can be interconnected with other vendors' products through the use of industry-accepted standards for hardware connectivity and communications protocols, including Health Level Seven (HL7). These standards speed the healthcare organization's assimilation of new technologies and advanced third-party products, while insulating the Company's products from obsolescence.\nSoftware Engineering -- HBOC's product developers use state-of-the-art application development tools, such as program generators, artificial intelligence and expert systems, which decrease development time and lower the cost of new products.\nPRODUCT PORTFOLIO\nHBO & Company's offering of products and services is based on a strategic mix of applications and technologies that support today's dramatic restructuring of the healthcare delivery system, backed by implementation, support and outsourcing services. This \"portfolio\" of products is organized into three areas: infrastructure, enterprise management and improved clinical practice, as reflected in the following table. - --------------------------------------------------------------------------------\nProduct Portfolio - --------------------------------------------------------------------------------\nINFRASTRUCTURE\n-Pathways Interface Manager\n-Pathways Health Network Server\n-Pathways Health Network Management\n-Network technologies and services\nENTERPRISE MANAGEMENT\n-Pathways Healthcare Scheduling\n-Pathways Managed Care\n-Pathways Contract Management\n-QUANTUM enterprise information system\nIMPROVED CLINICAL PRACTICE\n-STAR hospital information systems\n-Series hospital information systems\n-HealthQuest hospital information systems\n-TRENDSTAR decision support\n-Pathways Care Manager\n-Pathways Clinical Workstation - --------------------------------------------------------------------------------\nIn addition to the above applications, HBO & Company offers software manufactured by a host of industry-leading business partners. Among these is Software Technologies Corporation (STC) of Arcadia, California, which had been an IBAX Healthcare Systems partner. Under the terms of a new partnership agreement entered into in the third quarter of 1994, HBOC is licensing STC's Datagate interface engine for use in its Pathways Interface Manager product.\nJust after the close of the third quarter, HBOC announced the formation of a strategic alliance with Scientific Data Management, Inc. (SDM), a Detroit-area physician practice management company. This alliance, which gives HBOC the exclusive right to market the SDM product to its customer and prospect base, is a first step toward building a comprehensive ambulatory care offering.\nInstallation and implementation services are provided for purchasers of all HBOC software products to assist with the smooth introduction of or transition to those products. HBOC also provides software maintenance and enhancement services, as well as custom programming and system modifications to meet special client requirements. Equipment maintenance services are provided through HBOC's various hardware partners.\nAs of December 31, 1994, the Company had 590 active users of patient care systems, 600 active users of clinical\/departmental systems, 837 active users of financial systems, 639 active users of decision support systems and 55 active users of enterprise information systems. In addition, as of December 31, 1994, HBOC had 129 LAN, MAN and WAN customers.\nINFRASTRUCTURE\nHBOC's wide array of networking and database applications provides the key elements for integrating and uniting providers across the continuum of care. In bringing the enterprise together, these solutions establish the basis for a lifelong patient record.\nPATHWAYS INTERFACE MANAGER\nPathways Interface Manager, which is offered with Pathways Health Network Server or as a separate product, reduces the burden of maintaining the large number of interfaces needed to consolidate disparate organizational systems. Pathways Interface Manager provides a mechanism that converts data from one application to a format that is readable by many other applications. It also manages and consolidates traffic on the network and maintains a repository of information about network transactions and performance.\nPATHWAYS HEALTH NETWORK SERVER\nHBO & Company's Pathways Health Network Server (HNS) is a relational database that functions as a central repository for patient transactions by integrating diverse clinical, financial and administrative data elements into meaningful and accessible information on patient episodes. Other Company products, such as Pathways Clinical Workstation, Pathways Health Network Management and Pathways Managed Care, build on top of HNS to provide business functionality that spans the healthcare enterprise.\nPATHWAYS HEALTH NETWORK MANAGEMENT\nThe Pathways Health Network Management system supports the current trend toward health delivery networks. These networks encompass all providers of healthcare and wellness services, as well as an enrolled population that may or may not actually be patients. The product is a common, enterprisewide (and potentially communitywide) patient\/customer\/enrollee management system that allows organizations to collect and disseminate information about individuals to and from diverse providers over time.\nNETWORK TECHNOLOGIES AND SERVICES\nThe Connect Technology Group offers full design, installation, consulting, and hardware and software support capabilities for local, metropolitan and wide area networks, as well as value-added network services. These services are provided to a wide range of HBOC customers, from large multifacility healthcare groups to small community hospitals. These organizations may have any number of other Company products -- on both minicomputer and mainframe platforms -- or none at all.\nLANs, MANs and WANs provide connectivity from terminals and PCs to multiple host processors and shared resources. LANs and MANs are data communications networks spanning a limited geographical area, while WANs may span several cities, states or even countries. Communication\nnetworking through the use of LANs, MANs and WANs assists hospitals in maximizing existing investments in products and services while integrating new and emerging technologies that guarantee a path for multimedia and multifacility expansion.\nHBOC's Value-Added Network (VAN) helps customers reduce networking costs, improve customer support, and enhance productivity, end-user services and physician access. Specific services offered through the VAN include electronic data interchange, Internet, electronic funds transfer, payer access and electronic customer support.\nENTERPRISE MANAGEMENT\nHBOC's scheduling system, managed care solutions and QUANTUM enterprise information system provide the critical business functionality necessary to manage today's emerging health networks.\nPATHWAYS HEALTHCARE SCHEDULING\nHBOC's newest client\/server-based Pathways 2000 product provides caregivers with a tool that assists them in delivering high-quality patient care while managing costs by optimizing resource utilization and increasing productivity. Pathways Healthcare Scheduling is a patient-focused scheduling and resource management system that enables caregivers to transform an assortment of procedures into a coordinated treatment plan and then assign the appropriate resources for just the amount of time needed to carry out that plan.\nPATHWAYS MANAGED CARE\nPathways Managed Care helps organizations manage the variety of contractual arrangements that exist among providers, payers and patients. It also assists in performing related business activities such as tracking membership and processing encounters, in performing such clinical managed care activities as utilization management, and in managing benefit plans and the business activities that support benefits services such as premium billing and claims adjudication. These applications are designed to meet the information needs of a full range of managed care players -- providers, insurers, government agencies, employers, administrators, Health Maintenance Organizations and the like --and can be combined or changed to create \"new\" functionality that quickly delivers solutions to changing business needs.\nPATHWAYS CONTRACT MANAGEMENT\nFor some organizations, the first step toward managing care is managing the many and varied contracts they hold with payers. Pathways Contract Management offers a focused range of applications that monitor and manage multiple varied contracts for providers with significant managed care volumes. The product is interfaced to HBOC's patient accounting systems and the TRENDSTAR decision support system to provide a functionally rich set of contract management tools.\nQUANTUM\nHBOC's Amherst Product Group also offers the QUANTUM enterprise information system for both the minicomputer and mainframe markets. QUANTUM presents data collected from transaction and decision support systems in graphical formats and at a level of detail required to assist executives in their critical decision-making. The system offers a broad, encompassing view of the healthcare enterprise, one that spans organizational and system boundaries.\nIMPROVED CLINICAL PRACTICE\nHBO & Company's hospital-based \"core\" transaction and decision support systems, along with its new client\/server, clinician-focused tools, help streamline care to elevate the health status of patients over the continuum of care.\nSTAR, SERIES AND HEALTHQUEST\nHBOC offers its core hospital information systems on a variety of hardware platforms. The STAR family of products operates with open systems architecture on RISC-based hardware from Data\nGeneral Corporation, Hewlett-Packard Company, Digital Equipment Corporation and IBM Corporation. Series 3000 products operate on IBM AS\/400 and RISC System\/6000 hardware, and Series 4000 runs on the IBM AS\/400. The HealthQuest and Series 5000 products are IBM mainframe-based.\nPatient Care -- Patient care information systems are offered through HBOC's STAR, HealthQuest and Series patient care applications. Using these systems, vital patient information is entered, maintained, tracked and disseminated throughout the healthcare institution. The systems include applications for patient processing, patient and resource scheduling, order management and medical records.\nClinical\/Departmental -- HBOC markets departmental information systems for laboratory, radiology and pharmacy departments. These individual application systems may be sold separately or as a part of the comprehensive STAR or Series product families.\nLaboratory -- Laboratory applications are offered through HBOC's STAR Laboratory system, which interconnects all areas of the hospital laboratory. When interfaced with a patient care information system (such as STAR Patient Care), patient data inquiry is available and redundant data entry is eliminated. Subdepartments such as chemistry, hematology and microbiology are offered as lab-specific modules.\nRadiology -- HBOC's STAR and Series 4000 and 5000 radiology management systems allow for the scheduling of patients, procedures and radiology resources. Radiological results are reported back into the system and communicated to the appropriate area. Film history, film tracking and film indexing are also provided.\nPharmacy -- Pharmacy applications are available through STAR and all the Series product lines. These applications provide for the administrative and clinical needs of the hospital pharmacy by capturing information for the filling, refilling, distribution and administration of medications.\nFinancial -- HBOC offers a comprehensive set of patient accounting and general accounting applications through all its core product lines. These integrated, flexible applications retain extensive account detail online for the entire life of an account, accumulating data on inpatient, outpatient and physician activity regardless of account status. In addition, the HealthQuest Receivables Workstation is available to HealthQuest Patient Accounting customers to enhance their collections productivity via online workfiles and to improve the look and feel of the system by capitalizing on PC technology. HBOC is also developing a receivables workstation in conjunction with a future release of STAR Financials. The workstation will provide enhanced navigation, expanded access and improved productivity.\nTRENDSTAR\nHBOC is the market leader in decision support information systems for healthcare organizations. While offered on a minicomputer platform, the TRENDSTAR decision support products provided by the Amherst Product Group are sold into both the minicomputer and mainframe markets -- as part of the Company's network of products or as a stand-alone system.\nTraditionally, most decision support system users have been chief financial, operations and information officers. However, there is a growing emphasis on improving clinical processes and achieving the optimal application of medical resources. Increasingly, managed care, medicine, nursing, quality improvement and department managers are finding TRENDSTAR's wide range of clinical management tools critical to optimizing the quality, appropriateness and cost-effectiveness of patient care.\nTRENDSTAR helps an organization implement programs for clinical practice evaluation, clinical pathways development, outcomes analysis and benchmarking. By bringing clinical and financial information together, the system provides the means for understanding the financial impact of clinical decisions. The TRENDSTAR family also includes the Marketing Systems Library (MSL), which helps hospitals in market analysis and strategic planning.\nThe TRENDSTAR Contract Payment Advisor product provides a tool for dealing with a number of managed care issues through contract modeling and claims payment monitoring capabilities.\nPATHWAYS CARE MANAGER\nAs HBOC's single product solution for caregivers, Pathways Care Manager is the result of a partnership with CliniCom Inc., a leading provider of clinical information systems. Through that alliance, HBOC has integrated its patient care products with core application software from CliniCom to provide a multidisciplinary system for clinicians that provides comprehensive care planning, flowsheet charting and case management functions at either the nursing station or the point of care.\nPATHWAYS CLINICAL WORKSTATION\nHBOC's Pathways Clinical Workstation provides the clinical solution necessary for managing today's emerging population-based health delivery networks. Using HBOC's central data repository (Pathways Health Network Server), Pathways Clinical Workstation provides the integrated clinical information necessary for the computer-based patient record. Pathways Clinical Workstation assimilates clinical data into meaningful information for multiple user communities, including clinicians, healthcare managers, case managers, and physicians and other caregivers. HBOC is developing the workstation in phases, building toward the complete capabilities of a multimedia workstation.\nINTERNATIONAL OFFERINGS\nMost of the Pathways 2000, STAR and TRENDSTAR products in HBOC's product portfolio are offered internationally, and Series 4000 products are also sold in Canada. In addition, products added to the HBOC product line with the acquisition of Data-Med Computer Services in December 1993 are available in the United Kingdom. In most cases, the applications offered internationally have been customized or developed to meet the particular needs of the country in which they are implemented.\nOUTSOURCING SERVICES GROUP\nHBOC has been in the outsourcing business in the United States for more than 20 years and now offers outsourcing services in the United Kingdom as well. With the change and uncertainty engendered by healthcare reform and the resulting economic pressures, information systems outsourcing is becoming increasingly popular in the United States. Outsourcing services go beyond managing hospital data processing operations (traditionally known as facilities management) to encompass strategic management services in information systems planning, receivables management, business office administration and major system conversions.\nSOURCES OF REVENUE\nInformation regarding sources of revenue is included in the table \"Revenue from Continuing Operations by Business Unit\" on page 17 of the Company's Annual Report to Stockholders for the year ended December 31, 1994 (the Annual Report), and under the caption \"Revenue Recognition\" in Note 1 of \"Notes to Consolidated Financial Statements\" on page 23 of the Annual Report, a copy of which is included as an exhibit to this Form 10-K and is incorporated herein by reference.\nBACKLOG\nInformation regarding backlog as of December 31, 1994, is included in the \"Financial Review\" section under the caption \"Results of Operations\" on pages 14 and 15 of the Annual Report, a copy of which is included as an exhibit to this Form 10-K and is incorporated herein by reference.\nRESEARCH AND DEVELOPMENT\nThe Company's product development effort applies advanced computer technology and installation methodologies to specific information processing needs of hospitals. The Company believes a substantial and sustained commitment to such research and development is important to the long-term success of the business.\nInvestment in software development, including both research and development expense as well as capitalized software, has increased as the Company has addressed new software applications and\nenhanced existing products for installed systems. The Company expensed $28,928,000 (9% of revenue) for research and development activities during 1994, as compared to $23,428,000 (9% of revenue) and $20,096,000 (9% of revenue) during 1993 and 1992. The Company capitalized 25%, 24% and 23% of its research and development expenditures in 1994, 1993 and 1992.\nInformation regarding research and development is included in the table \"Research and Development Summary\" on page 15 of the Annual Report, in the \"Financial Review\" section under the caption \"Results of Operations\" on pages 14 and 15 of the Annual Report and under the caption \"Capitalized Software\" in Note 1 of \"Notes to Consolidated Financial Statements\" on pages 23 and 24 of the Annual Report, a copy of which is included as an exhibit to this Form 10-K and is incorporated herein by reference.\nThe technical concepts and codes embodied in the Company's computer programs and program documentation are not protected by patents or copyrights but constitute trade secrets that are proprietary to the Company. The Company and its subsidiaries are the owners of various trademarks and service marks, including the federally registered trademarks or service marks \"MEDPRO,\" \"IFAS,\" \"CLINPRO,\" \"MEDIPAC,\" \"CML,\" \"COSTREP,\" \"TRENDSTAR,\" \"TRENDSERVE,\" \"TRENDPAC I,\" \"BUDGET+,\" \"CLINIPAC,\" \"CLINSTAR,\" \"HOSTS,\" \"HSL,\" \"PARAGON,\" \"HEALTHQUEST,\" \"QUANTUM,\" \"ERS\" and the triangular design that forms the Company logo, but such registration provides limited protection as to the trademark or service mark.\nCOMPETITION\nHBO & Company experiences substantial competition from many firms, including other computer services firms, consulting firms, shared service vendors, certain hospitals and hospital groups, and hardware vendors. Competition varies in size from small to large companies, in geographical coverage, and in scope and breadth of products and services offered.\nAlthough some of the Company's competitors are larger than the Company, the Company believes that few competitors offer a comparable range of healthcare information systems and services that compare favorably with respect to all of the competitive criteria.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES\nThe Company's principal administrative and research offices are located at 301 and 303 Perimeter Center North, Atlanta, Georgia. The offices consist of approximately 226,000 square feet of space under a lease which expires in 1999. The rental expense for these offices totaled approximately $3,939,000 for 1994.\nThe Company also owns three buildings and leases space in 30 buildings throughout the United States, Canada and the United Kingdom primarily for sales and customer service offices. Information regarding the Company's leases is included in Note 2 of \"Notes to Consolidated Financial Statements\" on page 24 of the Annual Report, a copy of which is included as an exhibit to this Form 10-K and is incorporated herein by reference.\nInformation regarding the Company's principal offices is included on the back cover of the Annual Report, a copy of which is included as an exhibit to this Form 10-K and is incorporated herein by reference.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS\nInformation regarding Legal Proceedings is included in Note 9 of \"Notes to Consolidated Financial Statements\" on page 27 of the Annual Report, a copy of which is included as an exhibit to this Form 10-K and is incorporated herein by reference.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the quarter ended December 31, 1994, there were no matters submitted 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 Company's common stock is traded on The Nasdaq Stock Market's National Market under the symbol HBOC. Information regarding the high and low closing prices, the number of holders of the Company's common stock and dividends is presented under the caption \"Common Stock Data\" on page 27 of the Annual Report, a copy of which is included as an exhibit to this Form 10-K, and is incorporated herein by reference.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nThe information included under the caption \"Five-Year Selected Financial Information\" on page 13 of the Annual Report, a copy of which is included as an exhibit to this Form 10-K, 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 included in the \"Financial Review\" and \"Revenue from Continuing Operations by Business Unit\" sections on pages 14 through 17 of the Annual Report, a copy of which is included as an exhibit to this Form 10-K, is incorporated herein by reference.\nITEM 8:","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information included on pages 18 through 27 of the Annual Report, a copy of which is included as an exhibit to this Form 10-K, under the captions \"Condensed Consolidated Quarterly Statements of Income,\" \"Consolidated Statements of Income,\" \"Consolidated Balance Sheets,\" \"Consolidated Statements of Stockholders' Equity,\" \"Consolidated Statements of Cash Flows\" and \"Notes to Consolidated Financial Statements\" is incorporated herein by reference.\nITEM 9:","section_9":"ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nThe Company has neither changed its independent public accountants nor had any disagreements on accounting and financial disclosures with such accountants.\nPART III\nITEM 10:","section_9A":"","section_9B":"","section_10":"ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information regarding the executive officers of the Company as of March 1, 1995. Additional information regarding the Board of Directors is included in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, under the caption \"Election of Directors,\" which is incorporated herein by reference.\nCharles W. McCall has served as a Director, President and Chief Executive Officer of the Company since 1991. Prior to joining the Company, he served as President and Chief Executive Officer of CompuServe, Inc., a wholly owned subsidiary of H&R Block, from 1985 to 1991. Mr. McCall is also a Director of SYMIX Systems, Inc., EIS International, Inc., West Point Stevens Inc. and XcelleNet, Inc.\nMichael W. McCarty has served as Executive Vice President - Sales since 1992. Prior to joining the Company, Mr. McCarty served as Executive Vice President of Sales and Marketing for Liebert Corporation from 1985 through 1992.\nJames A. Gilbert has served as Vice President and General Counsel since joining the Company in 1988. He has served as Secretary since 1992.\nJay P. Gilbertson has served as Vice President - Finance, Chief Financial Officer, Treasurer, Chief Accounting Officer and Assistant Secretary since 1993. In 1992, Mr. Gilbertson served as Vice President - Controller and Chief Accounting Officer. From 1988 through 1991, he served in a financial management capacity at Medical Systems Support, Inc., HBOC's hardware maintenance subsidiary sold in 1991.\nMichael L. Kappel has served as Vice President - Pathways 2000 since 1994. During 1993 and 1994, he served as Vice President - Research and Development. From 1991 through 1993, Mr. Kappel served as Vice President - Product Planning and Development. From 1989 through 1991, he served as Executive Director - Research and Technology for the Company.\nRussell G. Overton has served as Senior Vice President - Business Development since 1992. From 1989 through 1991, he served as Vice President - Business Development for HealthQuest Ltd. (a wholly owned subsidiary of HBO & Company).\nGlenn N. Rosenkoetter has served as Senior Vice President since 1992. Mr. Rosenkoetter is responsible for the Amherst Product Group, Serving Software Group and HBO & Company (UK) operations. During 1991 and 1992, Mr. Rosenkoetter served as Senior Vice President - Marketing and Business Development for HBO & Company of Georgia (a wholly owned subsidiary of HBO & Company). Prior to 1991, he served as Vice President - National Sales for HBO & Company of Georgia.\nDavid A. Schenk has served as Senior Vice President - Connect Technology Group and Outsourcing Services Group since 1994. From 1990 to 1994, he served as Vice President of the Connect Technology Group.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION\nThe Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, contains under the captions \"Compensation of Directors,\" \"Executive Compensation,\" and \"Approval of the HBO & Company Chief Executive Officer Incentive Plan,\" information relating to executive compensation for the year ended December 31, 1994, all of which are incorporated herein by reference.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, contains under the caption \"Security Ownership of Certain Beneficial Owners and Management\" information relating to security ownership of beneficial owners and management, which is incorporated herein by reference.\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information contained in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, under the caption \"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\nThe following documents are filed as part of this report:\n(a) 1. Financial Statements\nThe Annual Report contains the following information on pages 18 through 27: \"Condensed Consolidated Quarterly Statements of Income,\" \"Consolidated Statements of Income,\" \"Consolidated Balance Sheets,\" \"Consolidated Statements of Stockholders' Equity,\" \"Consolidated Statements of Cash Flows\" and \"Notes to Consolidated Financial Statements.\" The report of Arthur Andersen LLP on these financial statements is on page 28 of the Annual Report. These financial statements and the report of Arthur Andersen LLP are incorporated herein by reference.\n(a) 2. Financial Statement Schedules\nSchedules not listed have been omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto.\n(a) 3. Exhibits\nThe following exhibits filed with the Securities and Exchange Commission are incorporated by reference as shown below. Items marked with an asterisk, \"*,\" relate to management contracts or compensatory plans or 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.\nHBO & COMPANY\nBy: \/s\/ CHARLES W. MCCALL -------------------------------------- Charles W. McCall PRESIDENT AND CHIEF EXECUTIVE OFFICER\nDate: March 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.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"760775_1994.txt","cik":"760775","year":"1994","section_1":"Item 1. BUSINESS.\nGeneral\nWLR Foods, Inc. (WLR Foods or the Company) is a fully-integrated poultry processing company involved in the production, further processing and marketing of turkey and chicken products, and the distribution of poultry and meat products. In addition, WLR Foods manufactures ice for retail distribution and is a provider of public refrigerated warehousing services.\nWLR Foods markets more than 250 branded, as well as private label, commodity and value-added poultry and related products to selected retail, food service and institutional markets, primarily in the mid-Atlantic and northeastern regions of the United States and, to a lesser extent, the upper Midwest and California. WLR Foods exports to more than 40 countries, with particular customer strength in the Far East, the Caribbean and United States military installations.\nWLR Foods is the combination of three poultry companies, Wampler Foods, Inc., Horace W. Longacre, Inc. and Rockingham Poultry Marketing Cooperative Incorporated, all of which had their beginnings prior to 1945. Wampler Foods, Inc. and Horace W. Longacre, Inc. were combined in 1985, and Rockingham Poultry Marketing Cooperative Incorporated was acquired in 1988. Prior to their consolidation on December 31, 1993, the Company operated its poultry business through two major subsidiaries, Wampler- Longacre Turkey, Inc. (Wampler-Longacre Turkey) and Wampler- Longacre Chicken, Inc. (Wampler-Longacre Chicken).\nIn April 1990, the Company acquired Cassco Ice & Cold Storage, Inc. (Cassco), a public refrigerated warehouse and ice manufacturing and distribution business. WLR Foods also owns 65% of May Supply Company, Inc. (May Supply), a wholesale distributor of plumbing supplies and equipment. In May 1993, WLR Foods acquired assets of two ice manufacturing and distribution companies located in the greater Washington, D.C. area and in Richmond, Virginia. These two operations have been integrated into Cassco.\nOn November 27, 1992, WLR Foods acquired Round Hill Foods, Inc. and affiliated companies (Round Hill), located in New Oxford, Pennsylvania. Round Hill is engaged in turkey production, processing and marketing.\nOn January 1, 1994, Wampler-Longacre Turkey and Wampler-Longacre Chicken were merged into a single poultry company under the name Wampler-Longacre, Inc. (Wampler-Longacre). As a part of this consolidation, Round Hill was also merged into Wampler-Longacre.\nPoultry Production\nWLR Foods controls the breeding, hatching, grow-out and processing of its turkeys and chickens. For fiscal 1994, WLR Foods produced approximately 386 million pounds of dressed turkey and 517 million pounds of dressed chicken.\nWLR Foods purchases breeder stock turkey eggs which it hatches and places with growers who supply labor and housing to produce breeder flocks. These breeder flocks produce eggs that are taken to the company-owned turkey hatchery for incubation and hatching into poults. In its chicken operations, WLR Foods purchases breeder flock chicks and places them with growers who supply labor and housing to raise the birds. The birds are then moved to breeder farms where they begin providing eggs. When laid, eggs are transported to company-owned hatcheries. Once hatched, day-old poults and chicks are inspected and vaccinated against common poultry diseases. In total, WLR Foods contracts with 146 breeder growers who grow most of WLR Foods' turkey, and all of WLR Foods' chicken, breeder flocks.\nAfter hatching and vaccination, poults and chicks are transported to one of WLR Foods' approximately 630 contract growers located in Virginia, West Virginia, Pennsylvania and Maryland who supply labor and housing to raise the turkeys and chickens to maturity. WLR Foods supplies feed primarily from company-owned feed mills and provides grower support through WLR Foods' technicians and veterinarians.\nGrow-out and breeder farms provide WLR Foods with more than 38 million square feet of growing facilities. These farms typically are grower-owned, operate under contract with WLR Foods, and provide facilities, utilities and labor. Contract growers are compensated on a cost-based formula and several incentive-based formulas. Approximately 80% of WLR Foods' turkeys and 100% of its chickens are raised by contract growers, with the balance grown by independent growers and company-owned farms. WLR Foods strives to maintain good contract grower relationships and believes the availability of contract growers is sufficient for anticipated needs.\nAn important factor in the grow-out of poultry is the rate at which poultry converts feed into body weight. The Company purchases its primary feed ingredients on the open market. These ingredients consist primarily of corn and soybean meal and represent approximately 66% of WLR Foods' total cost to grow turkeys and chickens and approximately 32% of its cost of sales for fiscal 1994. Because the quality and composition of feed is critical to the feed conversion rate, WLR Foods formulates and produces a majority of its own feed at one of its three feed mills. WLR Foods has annual feed manufacturing capacity in excess of 1 million tons and anticipates no difficulty in meeting the Company's feed requirements in the future.\nOnce the turkeys and chickens reach processing weight, they are transported in WLR Foods' trucks to one of its six processing plants. These plants utilize modern, highly automated equipment to process and package the turkeys and chickens for sale or preparation for further processing. WLR Foods further processes bulk poultry by adding value beyond deponing and skinning, such\nas slicing, grinding, marinating, spicing and cooking to produce delicatessen products, frankfurters, meat salads, ground turkey and chicken and food service products.\nDistribution, Public Refrigerated Warehousing, Ice and Other\nWLR Foods' distribution business, with its warehousing and transportation equipment, includes fresh poultry, beef, and other meat products purchased from third parties for resale and is conducted within a radius of approximately 75 miles of WLR Foods' further processing facility in Franconia, Pennsylvania. In fiscal 1994, Cassco sold 21.8 million eight-pound equivalent bags of retail ice, making it one of the largest ice manufacturers in the mid-Atlantic region. In addition, Cassco operates public refrigerated warehouses at four locations. WLR Foods' protein conversion plants convert the nonedible by-products of its poultry processing plants into feed ingredients, with the balance sold to pet food manufacturers.\nThe following table sets out sales revenues from WLR Foods' products for the last three fiscal years.\nFiscal 1994 Fiscal 1993 Fiscal 1992 (Dollars in Millions)\nChicken, fresh and frozen $287.5 $238.2 $202.8 Turkey, fresh and frozen 171.4 123.7 90.9 Further processed 152.1 147.7 123.4 Distribution 82.4 80.0 73.7 Other 33.9 27.1 23.7 Total Net Sales $727.3 $616.7 $514.5\nCompetition\nPoultry production requires continuous growing and processing, with limited storage, making the poultry industry highly competitive. WLR Foods markets its products in competition with larger and smaller poultry companies on the basis of price, quality and service, with WLR Foods' greatest competition coming from four or five of the country's larger poultry producers and processors. The pricing of poultry products is so competitive that any company with a cost advantage is in a favorable competitive position. Seasonal increases in production and customer buying patterns contribute to fluctuations in prices which are controlled more by supply and demand than by cost of production. WLR Foods primarily markets its products in the highly competitive northeastern section of the United States.\nIn June 1994 WLR Foods was ranked as the ninth largest in poultry processing\/further processing according to Meat & Poultry Magazine. WLR Foods was the fourth largest American turkey producer according to Turkey World magazine's December 1993 issue. WLR Foods was cited as the 14th largest chicken producer in the December 1993 issue of Broiler Industry magazine.\nSeasonality\nIn general, WLR Foods consistently produces and sells its products throughout the year. Highest demand for poultry is in May, June, July, November and December. The early summer months have strong demand for chicken and further processed products and November and December are high demand months for turkey products. The highest demand for ice is during the period from mid-May to mid-September.\nTrademarks and Patents\nWampler-Longacre markets its products under the trademarks WAMPLER LONGACRE and design, LONGACRE FAMILY and design, TRIM FREE and chicken in heart design, MOUNTAIN MAID, SALADFEST, SALT WATCHERS, TENDERLINGS and TURKEY WITH A TWIST, all of which are federally registered trademarks. Wampler-Longacre also markets under the trademark CHEF'S QUALITY, which has a pending federal application. Wampler-Longacre markets its export and foreign military sales under the ROCKINGHAM trademark. Products are also sold under the GENUINE SHENVALLEY VIRGINIA POULTRY mark.\nCassco distributes its products under the federally registered trademark CASSCO.\nWampler-Longacre holds a patent for pasteurized salads.\nGovernment Contracts\nWLR Foods' government contracts are a small segment of its total sales, consisting of bids on particular products for delivery at specified locations. Contracts are generally bid, and the product is delivered, within a one- to two-month period. These contracts include both chicken and turkey products and can involve further processed products. WLR Foods had approximately $0.9 million of governmental contracts outstanding as of July 2, 1994, compared to approximately $1.8 million outstanding as of July 3, 1993.\nForeign Sales\nWLR Foods' foreign sales constituted approximately 7% of its total annual sales in fiscal 1994, compared to 6% for fiscal year 1993 and 5% for fiscal year 1992. Wampler-Longacre has a full- time staffed foreign sales office which coordinates foreign sales efforts on behalf of WLR Foods. Foreign sales originate from that office and use independent brokers as needed. Sales are made in over 40 countries.\nTransportation\nTransportation logistics, including the availability of transportation equipment and the efficiency of transportation systems, are key elements in the raising of poultry, transporting feed to the contract growers and outside purchasers, transporting\npoultry to the processing plants, and transporting products to customers. WLR Foods has contracts with two railroad companies for the delivery of feed ingredients to WLR Foods' feedmills.\nWLR Foods' primary marketing area is the northeastern, central and eastern United States, and delivery of the Company's products are generally made by truck. WLR Foods maintains a fleet of refrigerated trucks and uses them, along with refrigerated common carrier and customer-owned vehicles, to deliver its product. Export products are loaded in refrigerated containers and shipped overseas.\nRaw Materials\nWLR Foods' largest cost is for basic feed ingredients, namely corn and soybean meal. Feed costs represented approximately 32% of the Company's total cost of sales in fiscal year ended July 2, 1994.\nFeed grains are commodities subject to volatile price changes caused by weather, size of harvest, transportation and storage cost and the agricultural policies of the United States and foreign governments. Although WLR Foods can, and sometimes does, purchase grain in the forward markets, it cannot completely eliminate the potential adverse effect of grain price increases.\nEnvironmental and Other Regulatory Compliance\nWLR Foods' facilities and operations are subject to the regulatory jurisdiction of various federal agencies, including the federal Food and Drug Administration, Department of Agriculture, Environmental Protection Agency, Occupational Safety and Health Administration, and corresponding state agencies in Virginia, West Virginia and Pennsylvania.\nWampler-Longacre currently holds two environmental permits for its Hinton turkey processing facility: an air permit which regulates certain combustion equipment to comply with the Clean Air Act and a water permit which regulates the treatment of processing wastewater to comply with the Clean Water Act. Wampler-Longacre has one environmental permit for its Harrisonburg turkey processing facility which requires it to pre- treat its processing wastewater to meet certain effluent standards before discharging it into the regional sewer. Wampler-Longacre currently has six environmental permits for its Franconia turkey processing facility: two water permits, issued by the Pennsylvania Department of Environmental Resources, for the treatment of processing wastewater to comply with the Clean Water Act, three air permits to regulate the operation of certain combustion and incineration equipment, and one municipal waste permit for the disposal of incinerator ash. Wampler-Longacre's turkey processing facility in New Oxford, Pennsylvania, holds one environmental permit (air permit) which regulates combustion equipment. Wampler-Longacre also holds one environmental permit (air permit) for its Harrisonburg feedmill issued primarily for the control and abatement of dust.\nWampler-Longacre holds two permits for its Timberville chicken processing and rendering facility: a water permit to regulate the discharge of processing wastewater and an air permit to regulate the operation of its new protein conversion facility, as well as certain combustion equipment. Wampler-Longacre has one permit for its Alma\/Stanley chicken processing facility: a water permit to regulate the discharge of processing wastewater to meet the standards of the Clean Water Act. Additionally, there are three permits for Wampler-Longacre's chicken processing and rendering facility in Moorefield, West Virginia: a water permit to regulate the discharge of processing wastewater, an air permit to regulate the operation of the company's new protein conversion facility, and a sludge management permit regulating the land application in West Virginia of certain wastewater biosolids generated at the Moorefield wastewater treatment works. Finally, Wampler-Longacre holds one environmental permit (air permit) for its Broadway and Moorefield feedmills which were issued primarily for the control and abatement of dust.\nWLR Foods, on behalf of its Virginia chicken and turkey processing facilities, filed for issuance of a Virginia Pollution Abatement (VPA) permit regulating the land application in Virginia of certain wastewater biosolids generated by the facilities' Virginia wastewater treatment systems. The VPA permit will replace Wampler-Longacre's No-Discharge certificate which formerly regulated the land application of the facilities' wastewater sludges in Virginia and will supersede an Interim Sludge Management Plan under which Wampler-Longacre has managed certain wastewater biosolids generated from its Virginia facilities.\nManagement has taken steps to ensure that those facilities regulated by new stormwater regulations have made the necessary group, individual, or general permit applications in accordance with the federal deadlines.\nManagement believes that all facilities and operations are currently in compliance with environmental and regulatory standards. Compliance has not had a materially adverse effect upon WLR Foods' earnings or competitive position in the past, and it is not anticipated to have a material adverse effect in the future.\nEmployees\nWLR Foods employed approximately 6,800 persons as of July 2, 1994, none of whom were covered by a collective bargaining agreement.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.\nWLR Foods' six poultry processing facilities and one further processing plant are located in Virginia, West Virginia and Pennsylvania and have a total slaughter capacity of approximately 460,000 turkeys per week and 3.1 million chickens per week. WLR Foods owns and operates three feed mills with a production capacity in excess of one million tons of finished feed per year; a turkey hatchery with a production capacity of approximately 335,000 poults per week and two chicken hatcheries with a\nproduction capacity of approximately 3.2 million chicks per week; freezer and cold storage for finished products with approximately 5.2 million cubic feet of capacity; and two protein conversion plants with a total production capacity of 4,500 tons of raw product weekly. The diversity, number and geographic proximity of its processing and support facilities provide WLR Foods with operating flexibility and enable it to alter the size and mix of poultry processed among the various facilities, as market conditions change.\nCassco operates public refrigerated facilities at four locations with approximately 7.0 million cubic feet. These facilities are located close to major food processors in the mid- Atlantic region, as well as WLR Foods' own processing plants. Cassco also operates six ice manufacturing facilities in Virginia and West Virginia with a capacity of approximately 1,000 tons per day.\nFrom fiscal 1988 through the end of fiscal 1994, WLR Foods has spent over $152 million (excluding capital leases) for replacement and productivity improvements, acquisitions and expansion of facilities and protein conversion plant construction. WLR Foods owns virtually all of its manufacturing and production equipment which is in good repair and is updated periodically. Replacement parts and service for the equipment are readily available, which allows for timely processing of the Company's products.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nOn February 6, 1994, WLR Foods filed suit in the United States District Court for the Western District of Virginia against Tyson Foods, Inc. (Tyson), seeking, among other things, (1) a declaratory judgment as to the validity of the Company's Shareholder Protection Rights Plan, and (2) a declaratory judgment as to the constitutionality of Article 14, Virginia Code Sections 13.1-725 et seq. (Virginia Affiliated Transactions Statute), and Article 14.1, Virginia Code Sections 13.1-728 et seq. (Virginia Control Share Acquisitions Statute), of the Virginia Stock Corporation Act under the Virginia and United States Constitutions.\nIn response, on February 25, 1994, Tyson, joined later by its wholly-owned subsidiary WLR Acquisition Corp., filed counterclaims against the Company and all its directors, except Peter A.W. Green, seeking, among other things, to invalidate the Company's Shareholder Protection Rights Plan and certain severance agreements, and a declaratory judgment that the Virginia Affiliated Transactions Statute, the Virginia Control Share Acquisitions Statute and other Virginia statutes, facially and as applied, are unconstitutional under the United States Constitution.\nTyson's counterclaims also sought a declaratory judgment that four of the Company's directors who resigned as employees of the Company in February 1994 were not disinterested shareholders, and therefore were ineligible to vote their shares at a Special Meeting of the Shareholders held on May 21, 1994, and that the Company's directors breached their fiduciary duties in taking certain actions described in Tyson's counterclaims. Tyson filed motions for preliminary relief as to the directors' eligibility to vote and as to the constitutionality of the several Virginia statutes, which motions for relief were denied by the District Court on June 22, 1994 and August 7, 1994, respectively.\nTrial for any remaining issues was scheduled for September 12-15, 1994; however, those trial dates have been released. The District Court will issue a final judgment in the litigation based on the written record, as supplemented.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nOn March 9, 1994, Tyson Foods, Inc., through its wholly- owned subsidiary, WLR Acquisition Corp., commenced a tender offer to purchase all the outstanding shares of WLR Foods for $30 per share. The Board of Directors of WLR Foods determined that the offer was inadequate and recommended that the Company's shareholders not tender their shares to Tyson Foods, Inc. This position is detailed in the Company's Schedule 14d-9 filed with the Securities and Exchange Commission on March 14, 1994, as amended.\nTo further their takeover efforts, on April 14, 1994 Tyson Foods, Inc. requested a special meeting of WLR Foods' shareholders under the Virginia Control Share Acquisitions Statute.\nA special meeting of the Company's shareholders was held on May 21, 1994 for the sole purpose of considering a proposal of Tyson to grant it and its associates voting rights for shares of the Company's stock they have acquired or may acquire in connection with their offer to buy the Company.\nOn March 9, 1994, Tyson commenced an unsolicited public tender offer to purchase all outstanding shares of the Company's stock for $30 per share. Among the conditions of Tyson's offer was a requirement that it receive voting rights under Virginia's Control Share Acquisitions Statute for all shares acquired by Tyson and its affiliates. Under the Control Share Statute, any shares acquired in a control share acquisition or prior to a control share acquisition and pursuant to a plan to make a control share acquisition, have no voting rights unless voting rights are granted by a resolution approved by a majority of disinterested shares. A control share acquisition is the direct or indirect acquisition (other than certain excepted acquisitions which are not relevant here) of shares of the Company that, when added to all other shares beneficially owned by the acquiror, would entitle the acquiror to vote 20% or more of the Company's shares.\nAt the May 21, 1994 special meeting, the Company's shareholders defeated Tyson's proposal to grant it voting rights for its control share acquisition. At the meeting, 3,152,830 votes were cast in favor of Tyson's proposal, and 5,977,118 votes were cast against the proposal. There were 53,547 abstentions, and 1,603,800 votes were either withheld or were broker non- votes.\nTyson Foods, Inc. terminated its tender offer on August 5, 1994.\nExecutive Officers of the Registrant\nThe following information is given regarding WLR Foods' executive officers.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nPublic trading of shares of WLR Foods' common stock commenced on May 10, 1988. The stock was included in NASDAQ as of September 12, 1988, and was included in NASDAQ\/National Market System as of March 7, 1989. The range of high and low bid information for the stock, as well as information regarding dividends declared by WLR Foods, for each full quarterly period within the two most recent fiscal years is incorporated by reference to Note 13 to the Registrant's Consolidated Financial Statements in the Annual Report, attached hereto as Exhibit 13.3. As of September 27, 1994, the approximate number of shareholders of record was 2,461.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA.\nSelected financial data for each of the fiscal years in the five- year period ended July 2, 1994 is incorporated by reference to the table entitled \"Five Year Financial Highlights\" in the Annual Report, attached hereto as Exhibit 13.1. A summary of significant accounting policies and business acquisitions and dispositions is incorporated by reference to Notes 1 and 2 to the Registrant's Consolidated Financial Statements in the Annual Report, attached hereto as Exhibit 13.3.\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 to that section in the Annual Report, attached hereto as Exhibit 13.2.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by this Item, except for the required financial statement schedules, is incorporated by reference to the Consolidated Financial Statements and Notes thereto into the Annual Report, attached hereto as Exhibit 13.3. The required financial statement schedules are included on pages 19-22 of this report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere were no changes in or disagreements with accountants on accounting and financial disclosure during WLR Foods' two most recent fiscal years or any subsequent interim period.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS OF THE REGISTRANT.\nInformation concerning WLR Foods' directors is incorporated by reference to the Proxy Statement.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nInformation concerning executive compensation is incorporated by reference to the Proxy Statement.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN PERSONS.\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.\nInformation concerning certain relationships and related transactions 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.\n(a) Financial Statements, Schedules and Exhibits (AR designates Annual Report)\nFinancial Statements Location\nConsolidated Statements of Earnings - Fiscal years ended AR July 2, 1994, July 3, 1993 and June 27, 1992\nConsolidated Balance Sheets - July 2, 1994 and July 3, 1993 AR\nConsolidated Statements of Shareholders' Equity - Fiscal years AR ended July 2, 1994, July 3, 1993 and June 27, 1992\nConsolidated Statements of Cash Flows - Fiscal years ended AR July 2, 1994, July 3, 1993 and June 27, 1992\nNotes to Consolidated Financial Statements - Fiscal years AR ended July 2, 1994, July 3, 1993 and June 27, 1992\nIndependent Auditors Report AR\nFinancial Statement Schedules\nIndependent Auditors' Report on Schedules Page 18\nSchedule V - Property, Plant and Equipment Page 19\nSchedule VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment Page 20\nSchedule VIII - Valuation and Qualifying Accounts Page 21\nSchedule X - Supplementary Income Statement Information Page 22\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the fourth quarter of fiscal 1994 that ended on July 2, 1994.\n(c) Exhibits\n3.1 Articles of Incorporation of the Registrant incorporated by reference to Exhibit 3 on Form 8-K filed with the Securities and Exchange Commission on January 31, 1992\n3.2 Bylaws of the Registrant incorporated by reference to Exhibit 3 of Form 8-K filed with the Securities and Exchange Commission on February 15, 1994\n4.1 Specimen Stock Certificate incorporated by reference to Exhibit 4 of Form 10-K filed with the Securities and Exchange Commission on September 27, 1990\n4.2 Loan Agreement incorporated by reference to Exhibit 4.2 of Form 10-K filed with the Securities and Exchange Commission on September 27, 1991\n4.3 Floating Rate Note incorporated by reference to Exhibit 4.3 of Form 10-K filed with the Securities and Exchange Commission on September 27, 1991\n4.4 Note Agreement incorporated by reference to Exhibit 4.4 of Form 10-K filed with the Securities and Exchange Commission on September 27, 1991\n4.5 Loan Agreement dated June 1, 1994\n4.6 Promissory Note dated July 20, 1994\n4.7 Shareholder Protection Rights Agreement, dated as of February 4, 1994, which includes as Exhibit A the forms of Rights Certificate and Election to Exercise and as Exhibit B the Form of Certificate of Designation and Terms of the Participating Preferred Stock incorporated by reference to Exhibit 1 of Form 8-A filed with the Securities and Exchange Commission on September 30,\n10.1 Employment Agreement dated July 4, 1993 between the Registrant and James L. Keeler (Deferred Compensation Agreement attached thereto as Exhibit A) incorporated by reference to Exhibit 10.6 of Form 10-K filed with the Securities and Exchange Commission on September 30,\n10.2 Executive Cash Bonus Program incorporated by reference to Exhibit 10.7 of Form 10-K filed with the Securities and Exchange Commission on September 30, 1993\n10.3 Long-Term Incentive Plan, as amended, incorporated by reference to Exhibit 28 of Post-Effective Amendment Number One to Form S-8 (No. 33-27037) filed with the Securities and Exchange Commission on November 18, 1992\n10.4 Amendment to Employment Agreement dated February 4, 1994 between the Registrant and James L. Keeler incorporated by reference to Exhibit 10.2 of Form 8-K filed with the Securities and Exchange Commission on February 15, 1994\n10.5 Amendment to Deferred Compensation Agreement dated February 4, 1994 between the Registrant and James L. Keeler incorporated by reference to Exhibit 10.3 of the Form 8-K filed with the Securities and Exchange Commission on February 15, 1994\n10.6 Severance Agreement dated February 4, 1994 between the Registrant and James L. Keeler incorporated by reference to Form 10-Q\/A filed with the Securities and Exchange Commission on February 23, 1994\n10.7 Severance Agreement dated February 4, 1994 between the Registrant and Delbert L. Seitz incorporated by reference to Form 10-Q\/A filed with the Securities and Exchange Commission on February 23, 1994\n10.8 Severance Agreement dated February 4, 1994 between the Registrant and James L. Mason incorporated by reference to Form 10-Q\/A filed with the Securities and Exchange Commission on February 23, 1994\n10.9 Severance Agreement dated February 4, 1994 between the Registrant and John J. Broaddus incorporated by reference to Form 10-Q\/A filed with the Securities and Exchange Commission on February 23, 1994\n10.10 Severance Agreement dated February 4, 1994 between the Registrant and V. Eugene Misner incorporated by reference to Form 10-Q\/A filed with the Securities and Exchange Commission on February 23, 1994\n10.11 Deferred Compensation Agreement dated February 4, 1994 between the Registrant and Charles W. Wampler, Jr. incorporated by reference to Form 10-Q\/A filed with the Securities and Exchange Commission on February 23, 1994\n10.12 Deferred Compensation Agreement dated February 4, 1994 between the Registrant and Herman D. Mason incorporated by reference to Form 10-Q\/A filed with the Securities and Exchange Commission on February 23, 1994\n10.13 Deferred Compensation Agreement dated February 4, 1994 between the Registrant and George E. Bryan incorporated by reference to Form 10-Q\/A filed with the Securities and Exchange Commission on February 23, 1994\n10.14 Deferred Compensation Agreement dated February 4, 1994 between the Registrant and William D. Wampler incorporated by reference to Form 10-Q\/A filed with the Securities and Exchange Commission on February 23, 1994\n13.1 Financial Highlights, from the Registrant's Annual Report to Shareholders for the fiscal year ended July 2, 1994\n13.2 Management's Discussion and Analysis, from the Registrant's Annual Report to Shareholders for the fiscal year ended July 2, 1994\n13.3 Consolidated Financial Statements and Notes to Consolidated Financial Statements, from the Registrant's Annual Report to Shareholders for the fiscal year ended July 2, 1994\n13.4 Independent Auditors' Report on Consolidated Financial Statements, from the Registrant's Annual Report to Shareholders for the fiscal year ended July 2, 1994\n21 List of Subsidiaries of the Registrant\n22 Excerpts from the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on October 29, 1994\n23 Consent of Independent Certified Public Accountants\n24 Power of Attorney\n27 Financial Data Schedule\nSchedules not included in this Item have been omitted because they are either not applicable or the information is included in the Consolidated Financial Statements or notes thereto.\n[The remainder of this page is 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.\nWLR Foods, Inc.\nBy:__\/s\/ James L. Keeler______________ Its President & Chief Executive Officer\nDate: September _30_, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n____\/s\/ James L. Keeler____________ President & Chief Executive Officer\nDate: September _30_, 1994\n__\/s\/ Delbert L. Seitz___________ Chief Financial Officer\nDate: September 30, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities on September 30, 1993.\nSignature Title\n______________________________ Director George E. Bryan*\n______________________________ Director Charles L. Campbell*\n______________________________ Director Stephen W. Custer*\n______________________________ Director Calvin G. Germroth*\n______________________________ Director William H. Groseclose*\n______________________________ Director J. Craig Hott*\n______________________________ Director James L. Keeler\n______________________________ Director Herman D. Mason*\n______________________________ Director Charles W. Wampler, Jr.*\n______________________________ Director William D. Wampler*\n______________________________ Director Peter A.W. Green*\n*By _\/s\/ Delbert L. Seitz______________ Delbert L. Seitz, attorney-in-fact\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES\nThe Board of Directors and Shareholders WLR Foods, Inc.:\nUnder date of August 17, 1994, except Note 14 which is as of August 29, 1994, we reported on the consolidated balance sheets of WLR Foods, Inc. and subsidiaries as of July 2, 1994 and July 3, 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 July 2, 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 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.\nKPMG PEAT MARWICK LLP\nRichmond, Virginia August 17, 1994","section_15":""}
{"filename":"882239_1994.txt","cik":"882239","year":"1994","section_1":"ITEM 1. BUSINESS\nEach of the Grantor Trusts, (the \"Trusts\"), listed below, was formed by GMAC Auto Receivables Corporation (the \"Seller\") by selling and assigning the receivables and the security interests in the vehicles financed thereby to The First National Bank of Chicago, as Trustee, in exchange for Class A certificates representing an undivided ownership interest that ranges between approximately 91% and 93.5% in each Trust, which were remarketed to the public, and Class B certificates representing an undivided ownership interest that ranges between approximately 6.5% and 9% in each Trust, which were not offered to the public and initially were held by the Seller. The right of the Class B certificateholders to receive distribution of the receivables is subordinated to the rights of the Class A certificateholders.\nGRANTOR TRUST -------------\nGMAC 1991-B GMAC 1991-C GMAC 1992-A GMAC 1992-C GMAC 1992-D GMAC 1992-E GMAC 1992-F GMAC 1993-A GMAC 1993-B GMAC 1994-A _____________________\nPART II.\nITEM 7.","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nEach of the Grantor Trusts, listed in the table as shown below, was formed by GMAC Auto Receivables Corporation (the \"Seller\") pursuant to a Pooling and Servicing Agreement between the Seller and The First National Bank of Chicago, as Trustee. Each Trust acquired retail finance receivables from the Seller in the aggregate amount as shown below in exchange for certificates representing undivided ownership interests in each Trust. Each Trust's property includes a pool of retail instalment sale contracts secured by automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby.\nThe certificates for each of the following Trusts consist of two classes, entitled \"Asset-Backed Certificates, Class A\" and \"Asset-Backed Certificates, Class B\". The Class A Certificates represent in the aggregate an undivided ownership interest that ranges between approximately 91% and 93.5% of the Trusts and the Class B Certificates represent in the aggregate an undivided ownership interest that ranges between approximately 6.5% and 9% of the Trusts. Only the Class A Certificates have been remarketed to the public. The Class B Certificates have not been offered to the public and initially are being held by the Seller. The rights of the Class B Certificateholder to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A Certificateholders.\nOriginal Aggregate Amount ----------------------------------- Date of Pooling Retail Asset-Backed Certificates Grantor and Servicing Finance ------------------------- Trust Agreement Receivables Class A Class B ------- ----------------- ----------- -------- ------- (In millions of dollars)\nGMAC 1991-B September 17, 1991 1,007.4 916.7 90.7\nGMAC 1991-C December 16, 1991 1,326.4 1,207.0 119.4\nGMAC 1992-A January 30, 1992 2,001.4 1,851.3 150.1\nGMAC 1992-C March 26, 1992 1,100.3 1,012.3 88.0\nGMAC 1992-D June 4, 1992 1,647.6 1,499.3 148.3\nGMAC 1992-E August 20, 1992 1,578.0 1,436.0 142.0\nGMAC 1992-F September 29, 1992 1,644.6 1,496.6 148.0\nGMAC 1993-A March 24, 1993 1,403.0 1,297.8 105.2\nGMAC 1993-B September 16, 1993 1,450.6 1,341.8 108.8\nGMAC 1994-A June 28, 1994 1,151.9 1,077.0 74.9\nII-1\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (concluded)\nGeneral Motors Acceptance Corporation, the originator of the retail receivables, continues to service the receivables for each of the aforementioned Grantor Trusts and receives compensation and fees for such services. Investors receive monthly payments of the pro rata portion of principal and interest for each Trust as the receivables are liquidated.\n------------------------\nII-2\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCROSS REFERENCE SHEET\nExhibit No. Caption Page ----------- ---------------------------------------------- ------\n-- GMAC 1991-B Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-4 Data for the Year Ended December 31, 1994.\n-- GMAC 1991-C Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-9 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-A Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-14 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-C Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-19 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-D Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-24 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-E Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-29 Data for the Year Ended December 31, 1994.\n-- GMAC 1992-F Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-34 Data for the Year Ended December 31, 1994.\n-- GMAC 1993-A Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-39 Data for the Year Ended December 31, 1994\n-- GMAC 1993-B Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-44 Data for the Year Ended December 31, 1994.\n-- GMAC 1994-A Grantor Trust, Independent Auditors' Report, Financial Statements and Selected Quarterly II-49 Data for the period from June 28, 1994 to December 31, 1994.\n27.1 Financial Data Schedule for GMAC 1991-B Grantor Trust (for SEC electronic filing purposes only). --\n27.2 Financial Data Schedule for GMAC 1991-C Grantor Trust (for SEC electronic filing purposes only). --\n27.3 Financial Data Schedule for GMAC 1992-A Grantor Trust (for SEC electronic filing purposes only). --\n27.4 Financial Data Schedule for GMAC 1992-C Grantor Trust (for SEC electronic filing purposes only). --\n27.5 Financial Data Schedule for GMAC 1992-D Grantor Trust (for SEC electronic filing purposes only). --\n27.6 Financial Data Schedule for GMAC 1992-E Grantor Trust (for SEC electronic filing purposes only). --\n27.7 Financial Data Schedule for GMAC 1992-F Grantor Trust (for SEC electronic filing purposes only). --\n27.8 Financial Data Schedule for GMAC 1993-A, 1993-B and 1994-A Grantor Trusts (for SEC electronic -- filing purposes only). II-3\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1991-B Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1991-B Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1991-B Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the three years in the period ended December 31, 1994, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-4\nGMAC 1991-B GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) ................... 124.0 306.4 ------- -------\nTOTAL ASSETS ........................... 124.0 306.4 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ...................... 124.0 306.4 ------- -------\nTOTAL LIABILITIES ...................... 124.0 306.4 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-5\nGMAC 1991-B GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 182.4 276.3 340.7\nAllocable to Interest ............... 14.5 30.4 51.5 ------ ------ ------ Distributable Income ................... 196.9 306.7 392.2 ====== ====== ======\nIncome Distributed ..................... 196.9 306.7 392.2 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-6\nGMAC 1991-B GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1991-B Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn September 17, 1991, GMAC 1991-B Grantor Trust acquired retail finance receivables aggregating approximately $1,007.4 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing October 15, 1991. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 6.75% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-7\nGMAC 1991-B GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 53.0 4.9 57.9\nSecond quarter ..................... 50.1 3.9 54.0\nThird quarter ...................... 42.5 3.2 45.7\nFourth quarter ..................... 36.8 2.5 39.3 --------- -------- ----- Total ......................... 182.4 14.5 196.9 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 72.7 9.4 82.1\nSecond quarter ..................... 74.8 8.2 83.0\nThird quarter ...................... 68.3 7.0 75.3\nFourth quarter ..................... 60.5 5.8 66.3 --------- -------- ----- Total ......................... 276.3 30.4 306.7 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 87.1 15.1 102.2\nSecond quarter ..................... 89.5 13.6 103.1\nThird quarter ...................... 84.9 12.1 97.0\nFourth quarter ..................... 79.2 10.7 89.9 --------- -------- ----- Total ......................... 340.7 51.5 392.2 ========= ======== =====\nII-8\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1991-C Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1991-C Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1991-C Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the three years in the period ended December 31, 1994, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-9\nGMAC 1991-C GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) ................... 228.7 496.0 ------- -------\nTOTAL ASSETS ........................... 228.7 496.0 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ...................... 228.7 496.0 ------- -------\nTOTAL LIABILITIES ...................... 228.7 496.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-10\nGMAC 1991-C GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 267.3 378.5 451.8\nAllocable to Interest ............... 20.7 39.7 63.3 ------ ------ ------ Distributable Income ................... 288.0 418.2 515.1 ====== ====== ======\nIncome Distributed ..................... 288.0 418.2 515.1 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-11\nGMAC 1991-C GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1991-C Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn December 16, 1991, GMAC 1991-C Grantor Trust acquired retail finance receivables aggregating approximately $1,326.4 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing January 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.70% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-12\nGMAC 1991-C GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 75.2 6.7 81.9\nSecond quarter ..................... 74.0 5.6 79.6\nThird quarter ...................... 63.9 4.6 68.5\nFourth quarter ..................... 54.2 3.8 58.0 --------- -------- ----- Total ......................... 267.3 20.7 288.0 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 96.7 12.0 108.7\nSecond quarter ..................... 101.1 10.6 111.7\nThird quarter ...................... 95.2 9.2 104.4\nFourth quarter ..................... 85.5 7.9 93.4 --------- -------- ----- Total ......................... 378.5 39.7 418.2 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 120.6 18.3 138.9\nSecond quarter ..................... 115.3 16.6 131.9\nThird quarter ...................... 109.9 15.0 124.9\nFourth quarter ..................... 106.0 13.4 119.4 --------- -------- ----- Total ......................... 451.8 63.3 515.1 ========= ======== =====\nII-13\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-A Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-A Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period January 30, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-A Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period January 30, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-14\nGMAC 1992-A GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 89.4 370.7 ------- -------\nTOTAL ASSETS ...................................... 89.4 370.7 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 89.4 370.7 ------- -------\nTOTAL LIABILITIES ................................. 89.4 370.7 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-15\nGMAC 1992-A GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period January 30, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------- ------- ------- $ $ $ Distributable Income\nAllocable to Principal ............... 281.3 681.7 948.9\nAllocable to Interest ............... 11.0 35.4 72.0 ------- ------- ------- Distributable Income ................... 292.3 717.1 1,020.9 ======= ======= =======\nIncome Distributed ..................... 292.3 717.1 1,020.9 ======= ======= =======\nReference should be made to the Notes to Financial Statements.\nII-16\nGMAC 1992-A GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-A Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn January 30, 1992, GMAC 1992-A Grantor Trust acquired retail finance receivables aggregating approximately $2,001.4 million from the Seller in exchange for certificates representing undivided ownership interests of 92.5% for the Class A certificates and 7.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing February 18, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.05% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-17\nGMAC 1992-A GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 98.2 4.2 102.4\nSecond quarter ..................... 81.3 3.1 84.4\nThird quarter ...................... 60.0 2.2 62.2\nFourth quarter ..................... 41.8 1.5 43.3 --------- -------- ----- Total ......................... 281.3 11.0 292.3 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 206.9 12.4 219.3\nSecond quarter ..................... 192.5 9.8 202.3\nThird quarter ...................... 157.7 7.5 165.2\nFourth quarter ..................... 124.6 5.7 130.3 --------- -------- ----- Total ......................... 681.7 35.4 717.1 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 171.8 16.5 188.3\nSecond quarter ..................... 278.3 21.9 300.2\nThird quarter ...................... 263.6 18.4 282.0\nFourth quarter ..................... 235.2 15.2 250.4 --------- -------- ------- Total ......................... 948.9 72.0 1,020.9 ========= ======== =======\nII-18\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-C Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-C Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period March 26, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-C Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period March 26, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-19\nGMAC 1992-C GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 80.0 311.3 ------- -------\nTOTAL ASSETS ...................................... 80.0 311.3 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) .................................. 80.0 311.3 ------- -------\nTOTAL LIABILITIES ................................. 80.0 311.3 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-20\nGMAC 1992-C GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period March 26, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 231.3 405.0 384.0\nAllocable to Interest ............... 11.1 31.0 41.2 ------ ------ ------ Distributable Income ................... 242.4 436.0 425.2 ====== ====== ======\nIncome Distributed ..................... 242.4 436.0 425.2 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-21\nGMAC 1992-C GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-C Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn March 26, 1992, GMAC 1992-C Grantor Trust acquired retail finance receivables aggregating approximately $1,100.3 million from the Seller in exchange for certificates representing undivided ownership interests of 92% for the Class A certificates and 8% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing April 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.95% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-22\nGMAC 1992-C GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 76.0 4.3 80.3\nSecond quarter ..................... 68.1 3.1 71.2\nThird quarter ...................... 51.0 2.2 53.2\nFourth quarter ..................... 36.2 1.5 37.7 --------- -------- ----- Total ......................... 231.3 11.1 242.4 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 109.2 10.1 119.3\nSecond quarter ..................... 109.3 8.5 117.8\nThird quarter ...................... 99.7 6.9 106.6\nFourth quarter ..................... 86.8 5.5 92.3 --------- -------- ----- Total ......................... 405.0 31.0 436.0 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nSecond quarter ..................... 133.1 15.7 148.8\nThird quarter ...................... 129.8 13.7 143.5\nFourth quarter ..................... 121.1 11.8 132.9 --------- -------- ----- Total ......................... 384.0 41.2 425.2 ========= ======== =====\nII-23\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-D Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-D Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period June 4, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-D Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period June 4, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\/ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-24\nGMAC 1992-D GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------\n1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 300.7 702.0 ------- -------\nTOTAL ASSETS ...................................... 300.7 702.0 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 300.7 702.0 ------- -------\nTOTAL LIABILITIES ................................. 300.7 702.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-25\nGMAC 1992-D GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period June 4, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 401.3 568.4 377.2\nAllocable to Interest ............... 28.0 55.4 48.0 ------ ------ ------ Distributable Income ................... 429.3 623.8 425.2 ====== ====== ======\nIncome Distributed ..................... 429.3 623.8 425.2 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-26\nGMAC 1992-D GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-D Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn June 4, 1992, GMAC 1992-D Grantor Trust acquired retail finance receivables aggregating approximately $1,647.6 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing June 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 5.55% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-27\nGMAC 1992-D GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 113.3 9.2 122.5\nSecond quarter ..................... 108.5 7.7 116.2\nThird quarter ...................... 95.9 6.2 102.1\nFourth quarter ..................... 83.6 4.9 88.5 --------- -------- ----- Total ......................... 401.3 28.0 429.3 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 148.6 16.9 165.5\nSecond quarter ..................... 153.3 14.8 168.1\nThird quarter ...................... 140.7 12.8 153.5\nFourth quarter ..................... 125.8 10.9 136.7 --------- -------- ----- Total ......................... 568.4 55.4 623.8 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nSecond quarter ..................... 50.7 7.6 58.3\nThird quarter ...................... 166.9 21.4 188.3\nFourth quarter ..................... 159.6 19.0 178.6 --------- -------- ----- Total ......................... 377.2 48.0 425.2 ========= ======== =====\nII-28\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-E Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-E Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period August 20, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-E Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period August 20, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-29\nGMAC 1992-E GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, --------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 478.4 885.4 ------- -------\nTOTAL ASSETS ...................................... 478.4 885.4 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 478.4 885.4 ------- -------\nTOTAL LIABILITIES ................................. 478.4 885.4 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-30\nGMAC 1992-E GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period August 20, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 407.0 512.6 180.0\nAllocable to Interest ............... 32.6 55.1 23.9 ------ ------ ------ Distributable Income ................... 439.6 567.7 203.9 ====== ====== ======\nIncome Distributed ..................... 439.6 567.7 203.9 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-31\nGMAC 1992-E GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-E Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn August 20, 1992, GMAC 1992-E Grantor Trust acquired retail finance receivables aggregating approximately $1,578.0 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing September 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.75% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-32\nGMAC 1992-E GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 110.6 10.1 120.7\nSecond quarter ..................... 110.9 8.7 119.6\nThird quarter ...................... 97.9 7.5 105.4\nFourth quarter ..................... 87.6 6.3 93.9 --------- -------- ----- Total ......................... 407.0 32.6 439.6 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 128.3 16.1 144.4\nSecond quarter ..................... 134.8 14.5 149.3\nThird quarter ...................... 129.0 13.0 142.0\nFourth quarter ..................... 120.5 11.5 132.0 --------- -------- ----- Total ......................... 512.6 55.1 567.7 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nThird quarter ...................... 46.1 6.2 52.3\nFourth quarter ..................... 133.9 17.7 151.6 --------- -------- ----- Total ......................... 180.0 23.9 203.9 ========= ======== =====\nII-33\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1992-F Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1992-F Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for each of the two years in the period ended December 31, 1994 and the period September 29, 1992 (inception) through December 31, 1992. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1992-F Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for each of the two years in the period ended December 31, 1994 and the period September 29, 1992 (inception) through December 31, 1992, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-34\nGMAC 1992-F GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, -------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 442.6 908.7 ------- -------\nTOTAL ASSETS ...................................... 442.6 908.7 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 442.6 908.7 ------- -------\nTOTAL LIABILITIES ................................. 442.6 908.7 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-35\nGMAC 1992-F GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994, 1993 and the period September 29, 1992 (inception) through December 31, 1992 (in millions of dollars)\n1994 1993 1992 ------ ------ ------ $ $ $ Distributable Income\nAllocable to Principal ............... 466.1 584.1 151.8\nAllocable to Interest ............... 30.6 55.0 17.9 ------ ------ ------ Distributable Income ................... 496.7 639.1 169.7 ====== ====== ======\nIncome Distributed ..................... 496.7 639.1 169.7 ====== ====== ======\nReference should be made to the Notes to Financial Statements.\nII-36\nGMAC 1992-F GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1992-F Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn September 29, 1992, GMAC 1992-F Grantor Trust acquired retail finance receivables aggregating approximately $1,644.6 million from the Seller in exchange for certificates representing undivided ownership interests of 91% for the Class A certificates and 9% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing October 15, 1992. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.50% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-37\nGMAC 1992-F GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 129.5 9.7 139.2\nSecond quarter ..................... 124.8 8.3 133.1\nThird quarter ...................... 112.8 6.9 119.7\nFourth quarter ..................... 99.0 5.7 104.7 --------- -------- ----- Total ......................... 466.1 30.6 496.7 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 146.9 16.2 163.1\nSecond quarter ..................... 151.2 14.6 165.8\nThird quarter ...................... 147.3 12.9 160.2\nFourth quarter ..................... 138.7 11.3 150.0 --------- -------- ----- Total ......................... 584.1 55.0 639.1 ========= ======== =====\n1992 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFourth quarter ..................... 151.8 17.9 169.7 ========= ======== =====\nII-38\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1993-A Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1993-A Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the year ended December 31, 1994 and the period March 24, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1993-A Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for the year ended December 31, 1994 and the period March 24, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-39\nGMAC 1993-A GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, --------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 379.4 845.9 ------- -------\nTOTAL ASSETS ...................................... 379.4 845.9 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 379.4 845.9 ------- -------\nTOTAL LIABILITIES ................................. 379.4 845.9 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-40\nGMAC 1993-A GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the year ended December 31, 1994 and the period March 24, 1993 (inception) through December 31, 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 466.5 557.0\nAllocable to Interest ...................... 25.2 35.6 -------- -------- Distributable Income .......................... 491.7 592.6 ======== ========\nIncome Distributed ............................ 491.7 592.6 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-41\nGMAC 1993-A GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1993-A Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn March 24, 1993, GMAC 1993-A Grantor Trust acquired retail finance receivables aggregating approximately $1,403.0 million from the Seller in exchange for certificates representing undivided ownership interests of 92.5% for the Class A certificates and 7.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing April 15, 1993. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.15% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-42\nGMAC 1993-A GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 144.3 8.3 152.6\nSecond quarter ..................... 127.0 6.8 133.8\nThird quarter ...................... 106.4 5.6 112.0\nFourth quarter ..................... 88.8 4.5 93.3 --------- -------- ----- Total ......................... 466.5 25.2 491.7 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nSecond quarter ..................... 196.7 13.9 210.6\nThird quarter ...................... 194.4 11.8 206.2\nFourth quarter ..................... 165.9 9.9 175.8 --------- -------- ----- Total ......................... 557.0 35.6 592.6 ========= ======== =====\nII-43\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1993-B Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1993-B Grantor Trust as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the year ended December 31, 1994 and the period September 16, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1993-B Grantor Trust at December 31, 1994 and 1993, and its distributable income and distributions for the year ended December 31, 1994 and the period September 16, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\/ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-44\nGMAC 1993-B GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ---------------------\n1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) .............................. 679.2 1,269.0 ------- -------\nTOTAL ASSETS ...................................... 679.2 1,269.0 ======= =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 679.2 1,269.0 ------- -------\nTOTAL LIABILITIES ................................. 679.2 1,269.0 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-45\nGMAC 1993-B GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the year ended December 31, 1994 and the period September 16, 1993 (inception) through December 31, 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 589.8 181.6\nAllocable to Interest ...................... 39.0 13.9 -------- -------- Distributable Income .......................... 628.8 195.5 ======== ========\nIncome Distributed ............................ 628.8 195.5 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-46\nGMAC 1993-B GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1993-B Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn September 16, 1993, GMAC 1993-B Grantor Trust acquired retail finance receivables aggregating approximately $1,450.6 million from the Seller in exchange for certificates representing undivided ownership interests of 92.5% for the Class A certificates and 7.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing October 15, 1993. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 4.00% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-47\nGMAC 1993-B GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 173.9 12.1 186.0\nSecond quarter ..................... 158.1 10.4 168.5\nThird quarter ...................... 137.8 8.9 146.7\nFourth quarter ..................... 120.0 7.6 127.6 --------- -------- ----- Total ......................... 589.8 39.0 628.8 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFourth quarter ..................... 181.6 13.9 195.5 ========= ======== =====\nII-48\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe GMAC 1994-A Grantor Trust, its Certificateholders, GMAC Auto Receivables Corporation, and The First National Bank of Chicago, Trustee:\nWe have audited the accompanying Statement of Assets and Liabilities of the GMAC 1994-A Grantor Trust as of December 31, 1994 and the related Statement of Distributable Income for the period June 28, 1994 (inception) through December 31, 1994. These financial statements are the responsibility of the Trust'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.\nAs described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets and liabilities of the GMAC 1994-A Grantor Trust at December 31, 1994 and its distributable income and distributions for the period June 28, 1994 (inception) through December 31, 1994, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------- Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-49\nGMAC 1994-A GRANTOR TRUST\nSTATEMENT OF ASSETS AND LIABILITIES (in millions of dollars)\nDecember 31, ------------ ASSETS $\nReceivables (Note 2) .............................. 901.8 -------\nTOTAL ASSETS ...................................... 901.8 =======\nLIABILITIES\nAsset-Backed Certificates (Notes 2 and 3) ................................. 901.8 -------\nTOTAL LIABILITIES ................................. 901.8 =======\nReference should be made to the Notes to Financial Statements.\nII-50\nGMAC 1994-A GRANTOR TRUST (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the period June 28, 1994 (inception) through December 31, 1994 (in millions of dollars)\n----- $ Distributable Income\nAllocable to Principal ..................... 250.1\nAllocable to Interest ..................... 33.0 ----- Distributable Income ......................... 283.1 =====\nIncome Distributed ........................... 283.1 =====\nReference should be made to the Notes to Financial Statements.\nII-51\nGMAC 1994-A GRANTOR TRUST (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of the GMAC 1994-A Grantor Trust (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to certificateholders are recognized when paid rather than when the obligation is incurred. Certain expenses of the Trust are paid by GMAC Auto Receivables Corporation (the \"Seller\").\nNOTE 2. SALE OF CERTIFICATES\nOn June 28, 1994, GMAC 1994-A Grantor Trust acquired retail finance receivables aggregating approximately $1,151.9 million from the Seller in exchange for certificates representing undivided ownership interests of 93.5% for the Class A certificates and 6.5% for the Class B certificates in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, and security interests in the vehicles financed thereby. The Seller has the option to repurchase the remaining receivables as of the last day of any month on or after which the principal balance declines below 10% of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPrincipal (including prepayments) and interest are passed through and distributed pro rata to Class A and Class B certificateholders on each distribution date commencing July 15, 1994. Principal consists of payments on the receivables that are allocable to repayment of the amount sold as determined on a constant interest rate basis (the \"actuarial method\"). Interest is passed through and distributed to Class A certificateholders at one-twelfth of the pass through rate of 6.30% per annum. Interest consists of payments on the receivables that are allocable to finance charges, using the actuarial method, net of fees and expenses. The rights of the Class B certificateholders to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. A distribution date is the 15th day of each month (or, if such 15th day is not a business day, the next following business day).\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each certificateholder will be treated as the owner of a pro rata undivided interest in each of the receivables in the Trust.\nII-52\nGMAC 1994-A GRANTOR TRUST (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nThird quarter ...................... 125.0 17.5 142.5\nFourth quarter ..................... 125.1 15.5 140.6 --------- -------- ----- Total ......................... 250.1 33.0 283.1 ========= ======== =====\nII-53\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) FINANCIAL STATEMENTS.\nIncluded in Part II, Item 8, of Form 10-K.\n(a) (2) FINANCIAL STATEMENT SCHEDULES.\nAll schedules have been omitted because they are not applicable or because the information called for is shown in the financial statements or notes thereto.\n(a) (3) EXHIBITS (Included in Part II of this report).\n-- GMAC 1991-B Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1991-C Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-A Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-C Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-D Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-E Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1992-F Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1993-A Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1993-B Grantor Trust Financial Statements for the Year Ended December 31, 1994.\n-- GMAC 1994-A Grantor Trust Financial Statements for the period June 28, 1994 through December 31, 1994.\n-- Financial Data Schedule for GMAC 1991-B Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1991-C Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-A Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-C Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-D Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-E Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1992-F Grantor Trust (for SEC electronic filing purposes only).\n-- Financial Data Schedule for GMAC 1993-A, 1993-B and 1994-A Grantor Trusts (for SEC electronic filing purposes only).\nIV-1\n(b) REPORTS ON FORM 8-K.\nNo current reports on Form 8-K have been filed by any of the above-mentioned Grantor Trusts during the fourth quarter ended December 31, 1994.\nITEMS 2, 3, 4, 5, 6, 9, 10, 11, 12 and 13 are not applicable and have been omitted.\nIV-2\nSIGNATURE\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Trustee has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nGMAC 1991-B GRANTOR TRUST GMAC 1991-C GRANTOR TRUST GMAC 1992-A GRANTOR TRUST GMAC 1992-C GRANTOR TRUST GMAC 1992-D GRANTOR TRUST GMAC 1992-E GRANTOR TRUST GMAC 1992-F GRANTOR TRUST GMAC 1993-A GRANTOR TRUST GMAC 1993-B GRANTOR TRUST GMAC 1994-A GRANTOR TRUST\nThe First National Bank of Chicago (Trustee)\ns\/ Steven M. Wagner ---------------------------------- (Steven M. Wagner, Vice President)\nDate: March 29, 1995 --------------\nIV-3","section_15":""}
{"filename":"812128_1994.txt","cik":"812128","year":"1994","section_1":"Item 1. Business\n(a) GENERAL DEVELOPMENT OF THE REGISTRANT'S BUSINESS\nSanderson Farms, Inc. was incorporated in Mississippi in 1955. The Registrant is a fully-integrated poultry processing company engaged in the production, processing, marketing and distribution of fresh and frozen chicken products. In addition, through its wholly-owned subsidiary, Sanderson Farms, Inc. (Foods Division), the Registrant is engaged in the processing, marketing and distribution of processed and prepared food items. The Registrant sells ice pack, chill pack and frozen chicken, in whole, cut-up and boneless form, primarily under the Miss Goldy brand name to retailers, distributors, and fast food operators principally in the southeastern, southwestern and western United States. During its fiscal year ended October 31, 1994, the Registrant processed 162.1 million chickens, or approximately 522.8 million dressed pounds. According to 1994 industry statistics, the Registrant was the 15th largest processor of dressed chickens in the United States based on estimated average weekly processing. The Registrant's chicken operations presently encompass four hatcheries, three feed mills, five processing plants and one by-products plant. The Registrant has contracts with operators of approximately 403 grow-out farms that provide it with sufficient housing capacity for its current operations. The Registrant also has contracts with operators of 161 breeder farms. The Registrant sells over 100 processed and prepared food items nationally and regionally, primarily to distributors, national food service accounts, retailers and club stores. These food items include frozen entrees, such as chicken and dumplings, lasagna, seafood gumbo, and shrimp creole and specialty products, such as chicken patties and corn dogs. The Registrant also sells a retail entree line of six different two-pound frozen entrees including chicken primavera, lasagna with meat, seafood gumbo and mexican casserole with beef. This product line is designed as a convenient, quality product for the family. Since the Registrant completed the initial public offering of its common stock through the sale of 1,150,000 shares to an underwriting syndicate managed by Smith Barney, Harris Upham & Co. Incorporated and Morgan Keegan & Co. Inc. in May 1987, the Registrant has significantly expanded its operations to increase production capacity, product lines and marketing flexibility. Through 1993, this expansion included the expansion of the Registrant's Hammond, Louisiana processing facility, the construction of new waste water\nfacilities at the Hammond, Louisiana and Hazlehurst, Mississippi processing facilities, the addition of second shifts at the Hammond, Louisiana, Laurel, Mississippi and Hazlehurst, Mississippi processing facilities, expansion of freezer and production capacity at its prepared foods facility in Jackson, Mississippi, the expansion of freezer capacity at its Laurel, Mississippi, Hammond, Louisiana and Collins, Mississippi processing facilities, and the addition of deboning capabilities at four of the registrant's five poultry processing facilities. In addition, since 1987, the Registrant completed the expansion and renovation of the hatchery at its Hazlehurst, Mississippi production facilities, and completed the renovation and expansion of its Collins, Mississippi by-products facility, allowing for the elimination of a smaller by-products facility at the Laurel, Mississippi plant. During 1993, the Registrant began operations at its Pike County, Mississippi, production and processing facilities. These facilities include a hatchery, a feed mill, a processing plant, a waste water treatment facility and a water treatment facility. The Registrant continued its expansion during fiscal 1994. In January 1994, the Registrant began operations of a second processing line at its Pike County, Mississippi processing facility, which increased the Registrant's processing capacity by 325,000 birds per week to approximately 3,200,000 birds per week. In addition to expanding the Pike County processing facilities to include a second line, the Registrant expanded its Collins, Mississippi processing plant in early fiscal 1994 to allow for the deboning of product. The Registrant also began operations of a second shift on one of two processing lines at its Collins, Mississippi processing plant during June 1994. The new shift reached its processing capacity during the fourth quarter of fiscal 1994, and increased the number of birds the Company is processing to approximately 3,475,000 birds per week. Capital expenditures for fiscal 1994 were funded by working capital and borrowings under a revolving credit agreement. Effective July 28, 1994, the Registrant amended its revolving credit agreement to, among other things, increase the revolving credit available to the Registrant thereunder to $70.0 million from $60.0 million. The Registrant anticipates that capital expenditures for fiscal 1995 will be funded by internally generated working capital and borrowings under the revolving credit agreement. The Registrant currently has additional processing capacity available to it through the double shifting of its Pike County, Mississippi processing facility and the second line at its Collins, Mississippi processing facility. In addition, the Registrant continually evaluates internal and external expansion opportunities to continue its growth in poultry and\/or related food products.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nNot applicable.\n(c) NARRATIVE DESCRIPTION OF BUSINESS\nREGISTRANT'S BUSINESS\nGeneral\nThe Registrant is engaged in the production, processing, marketing and distribution of fresh and frozen chicken and the preparation, processing, marketing and distribution of processed and prepared food items. The Registrant sells chill pack, ice pack and frozen chicken, both whole and cut-up, primarily under the Miss Goldy brand name to retailers, distributors and fast food operators principally in the southeastern, southwestern and western United States. During its fiscal year ended October 31, 1994, the Registrant processed approximately 162.1 million chickens, or approximately 522.8 million dressed pounds. In addition, the purchased and further processed 52.3 million pounds of poultry products during fiscal 1994. According to 1994 industry statistics, the Registrant was the 15th largest\nprocessor of dressed chicken in the United States based on estimated average weekly processing. The Registrant conducts its chicken operations through Sanderson Farms, Inc. (Production Division) and Sanderson Farms, Inc. (Processing Division), both of which are wholly-owned subsidiaries of the Sanderson Farms, Inc. Sanderson Farms, Inc. (Production Division), which has facilities in Laurel, Collins, Hazlehurst and Pike County, Mississippi, is engaged in the production of chickens to the broiler stage. Sanderson Farms, Inc. (Processing Division), which has facilities in Laurel, Collins, Hazlehurst and Pike County, Mississippi, and Hammond, Louisiana, is engaged in the processing, sale and distribution of chickens. The Registrant conducts its processed and prepared foods business through its wholly-owned subsidiary, Sanderson Farms, Inc. (Foods Division), which has a facility in Jackson, Mississippi. The Foods Division is engaged in the processing, marketing and distribution of over 100 processed and prepared food items, which it sells nationally and regionally, principally to distributors, national food service accounts, retailers and club stores. Products\nThe Registrant has the ability to produce a wide range of processed chicken products and processed and prepared food items thereby allowing it to take advantage of marketing opportunities as they arise. Processed chicken is first saleable as an ice packed whole chicken. The Registrant adds value to its ice packed whole chickens by removing the giblets, weighing, packaging and labelling the product to specific customer requirements and cutting the product based on customer specifications. The additional processing steps of giblet removal, close tolerance weighing and cutting increase the value of the product to the customer over whole chickens by reducing customer handling and cutting labor and capital costs, reducing the shrinkage associated with cutting, and ensuring consistently sized portions. With respect to chill pack products, additional value can be achieved by deep chilling and packaging whole chickens in bags or combinations of fresh chicken parts in various sized individual trays under the Registrant's brand name, which then may be weighed and prepriced, based on each customer's needs. The chill pack process increases the value of the product by extending shelf life, reducing customer weighing and packaging labor, and providing the customer with a wide variety of products with uniform, well designed packaging, all of which enhance the customer's ability to merchandise chicken products. To satisfy some customers' merchandising needs, the Registrant quick freezes the chicken product, which adds value by meeting the customers' handling, storage, distribution and marketing needs and by permitting shipment of product overseas where transportation time may be as long as 25 days. Value added products usually generate higher sale prices per pound, exhibit less finished price volatility and generally result in higher and more consistent profit margins over the long-term than non-value added product forms. Selling fresh chickens as a prepackaged brand name product has been a significant step in the development of the value added, higher margin consumer business. The Registrant evaluates daily the potential profitability of all product lines and attempts to maximize its profits on a short-term basis by making strategic changes in its product mix to meet customer demand. The following table sets forth, for the periods indicated, the contribution, as a percentage of net sales of chicken products, of value added and non-value added chicken products.\n(1) Vacuum pack poultry products have been restated in 1993 and included in 1994 as fresh bulk pack, which includes ice pack and vacuum pack products. The vacuum pack products were classified as chill pack products in the 1993 Form 10-K.\n(2) Consists of sales of poultry products that the Registrant purchases from other poultry processors for resale, as necessary, to meet customer demand.\nSales and Marketing\nThe Registrant's chicken products are sold primarily to retailers (including national and regional supermarket chains and local supermarkets), distributors and fast food operators located principally in the southeastern, southwestern and western United States. The Registrant also sells its chicken products to governmental agencies and to customers who resell the products outside of the continental United States. This wide range of customers, together with the Registrant's broad product mix, provides the Registrant with flexibility in responding to changing market conditions in its effort to maximize profits. This flexibility also assists the Registrant in its efforts to reduce its exposure to market volatility. Sales and distribution of the Registrant's chicken products are conducted primarily by sales personnel at the Registrants general corporate offices in Laurel, Mississippi and by customer service representatives at each of its five processing complexes and through independent food brokers. Each complex has individual on-site distribution centers and uses the Registrant's truck fleet, as well as contract carriers, for distribution of its products. Generally, the Registrant prices its chicken products based upon weekly market prices reported by the United States Department of Agriculture. Consistent with the industry, the Registrant's profitability is impacted by such market prices, which may fluctuate substantially and exhibit cyclical characteristics. The Registrant adds a markup to base prices, which depends upon value added, volume, product mix and other factors. While base prices may change weekly, the Registrant's markup is generally negotiated from time to time with the Registrant's customers. The Registrant's sales are generally made on an as-ordered basis, and the Registrant maintains no long-term sales contracts with its customers. The Registrant uses television, radio and newspaper advertising, coupon promotion, point of purchase material and other marketing techniques to develop consumer awareness of and brand recognition for its Miss Goldy products. The Registrant has achieved a high level of public awareness and acceptance of its products through television advertising featuring a celebrity as the Registrant's spokesperson. Brand awareness is an important element of the Registrant's marketing philosophy, and it intends to continue brand name merchandising of its products. The Registrant's processed and prepared food items are sold nationally and regionally, primarily to distributors, national food service accounts, retailers and club stores. Sales of such products are handled by independent food brokers located throughout the United States, primarily in the southeast and southwest United States, and by sales personnel of the Registrant. Processed and prepared food items are distributed from the Registrant's plant in Jackson, Mississippi, through arrangements with contract carriers.\nProduction and Facilities\nGeneral. The Registrant is a vertically-integrated producer of fresh and frozen chicken products, controlling the production of hatching eggs, hatching, feed manufacturing, growing, processing and packaging of its product lines.\nBreeding and Hatching. The Registrant maintains its own breeder flocks for the production of hatching eggs. The Registrant's breeder flocks are acquired as one-day old chicks (known as pullets or cockerels) from primary breeding companies that specialize in the production of genetically designed breeder stock. As of October 31, 1994, the Registrant maintained contracts with 40 pullet farm operators for the grow-out of pullets (growing the pullet to the point at which it is capable of egg production, which takes approximately six months). Thereafter, the mature breeder flocks are transported by Registrant vehicles to breeder farms that are maintained, as of October 31, 1994, by 121 independent contractors under the Registrant's supervision. Eggs produced by independent contract breeders are transported to Registrant's hatcheries in Registrant vehicles. During the beginning of fiscal year 1994, the Registrant supplemented the production of hatching eggs by outside purchases of eggs for a period of twelve weeks, to support the second processing line at the Pike County processing facility. The Registrant owns and operates four hatcheries located in Mississippi where eggs are incubated and hatched in a process requiring 21 days. Once hatched, the day-old chicks are vaccinated against common poultry diseases and are transported by Registrant vehicles to independent contract grow-out farms. As of November 1994, the Registrant's hatcheries were capable of producing an aggregate of approximately 3.6 million chicks per week.\nGrow-out. The Registrant places it chicks on 403 grow-out farms, as of October 31, 1994, located in Mississippi and Louisiana where broilers are grown to an age of approximately six to seven weeks. The farms provide the Registrant with sufficient housing capacity for its operations, and are typically family-owned farms which are operated under contract with the Registrant. The farm owners provide facilities, utilities and labor; the Registrant supplies the day-old chicks, feed and veterinary and technical services. The farm owner is compensated pursuant to an incentive formula designed to promote production cost efficiency.\nHistorically, the Registrant has been able to accommodate expansion in grow-out facilities through additional contract arrangements with independent growers.\nFeed Mills. An important factor in the grow-out of chickens is the rate at which chickens convert feed into body weight. The Registrant purchases on the open market the primary feed ingredients, including corn and soybean meal, which historically have been the largest cost components of the Registrant's total feed costs. The quality and composition of the feed is critical to the conversion rate, and accordingly, the Registrant formulates and produces its own feed. As of October 31, 1994, the Registrant operated three feed mills, all of which are located in Mississippi. The Registrant's annual feed requirements for fiscal 1994 were approximately 752,000 tons, and it has the capacity to produce approximately 904,800 tons of finished feed annually under current configurations. Feed grains are commodities subject to volatile price changes caused by weather, size of harvest, transportation and storage costs and the agricultural policies of the United States and foreign governments. On October 31, 1994, the Registrant had approximately 401,000 bushels of corn storage capacity at its feed mills, which was sufficient to store all of its weekly requirements for corn. The Registrant purchases its corn and other feed supplies at current prices from suppliers and, to a limited extent, direct from farmers. Feed grains are available from an adequate number of sources. Although the Registrant has not experienced and does not anticipate problems in securing adequate supplies of feed grains, price fluctuations of feed grains can be expected to have a direct and material effect upon the Registrant's profitability. Although the Registrant sometimes purchases grains in forward markets, it cannot eliminate the potentially adverse affect of grain price increases.\nProcessing. Once the chicks reach processing weight, they are transported to the Registrant's processing plants. These plants use modern, highly automated equipment to process and package the chickens. The Registrant's Pike County, Mississippi processing plant, which currently operates two processing lines on a single shift basis, is currently processing approximately 650,000 chickens per week. The Registrant's Collins, Mississippi processing plant, which is currently operating one of its two lines on a double shift basis and one line on a single shift basis, is currently processing approximately 950,000 chickens per week. The Registrant's Laurel and Hazlehurst, Mississippi and Hammond, Louisiana processing plants currently operate on a double shift basis, and have the capacity to process an aggregate of approximately 1,875,000 chickens per week. The Registrant also has the capabilities to produce deboned product at all its processing facilities. At October 31, 1994, four of these deboning facilities were operating on a double shift basis and the fifth was operating on a single shift basis, resulting in a combined capacity to process approximately 2.9 million pounds of product per week at all deboning facilities.\nSanderson Farms, Inc. (Foods Division). The facilities of Sanderson Farms, Inc. (Foods Division) are located in Jackson, Mississippi in a plant with approximately 75,000 square feet of refrigerated manufacturing and storage space. The plant uses highly automated equipment to prepare, process and freeze food items. The Registrant could increase significantly its production of processed and prepared food items without incurring significant capital expenditures or delays.\nExecutive Offices; Other Facilities. The Registrant's corporate offices are located in Laurel, Mississippi. As of October 31, 1994, the Registrant operated one by-products plant, and five automotive maintenance shops which service approximately 308 Registrant over-the-road and farm vehicles. In addition, the Registrant has one child care facility located near its Collins, Mississippi, processing plant currently serving over 200 children.\nQuality Control\nThe Registrant believes that quality control is important to its business and conducts quality control activities throughout all aspects of its operations. The Registrant believes these activities are beneficial to efficient production and in assuring its customers wholesome, high quality products. From the corporate offices, the Director of Technical Services supervises the operation of a modern, well-equipped laboratory which, among other things, monitors sanitation at the hatcheries, quality and purity of the Registrant's feed ingredients and feed, the health of the Registrant's breeder flocks and broilers, and conducts microbiological tests of live chickens, facilities and finished products. The Registrant conducts on-site quality control activities at each of the five processing plants and the processed and prepared food plant.\nRegulation\nThe Registrant's facilities and operations are subject to regulation by various federal and state agencies, including, but not limited to, the federal Food and Drug Administration (\"F.D.A.\"), the United States Department of Agriculture (\"U.S.D.A.\"), the Environmental Protection Agency, the Occupational Safety and Health Administration and corresponding state agencies. The Registrant's chicken processing plants are subject to continuous on-site inspection by the U.S.D.A. The Sanderson Farms, Inc. (Foods Division) processing plant operates under the U.S.D.A.'s Total Quality Control Program which is a strict self-inspection plan written in cooperation with and monitored by the U.S.D.A. The F.D.A. inspects the production of the Registrant's feed mills. Compliance with existing regulations has not had a material adverse effect upon the Registrant's earnings or competitive position in the past and is not anticipated to have a materially adverse effect in the future. Management believes that the Registrant is in substantial compliance with existing laws and regulations relating to the operation of its facilities and does not know of any major capital expenditures necessary to comply with such statutes and regulations. The Registrant takes extensive precautions to ensure that its flocks are healthy and that its processing plants and other facilities operate in a healthy and environmentally sound manner. Events beyond the control of the Registrant, however, such as an outbreak of disease in its flocks or the adoption by governmental agencies of more stringent regulations, could materially and adversely affect its operations.\nCompetition\nThe Registrant is subject to significant competition from regional and national firms in all markets in which it competes. Some of the Registrant's competitors have greater financial and marketing resources than the Registrant. The primary methods of competition are price, product quality, number of products offered, brand awareness and customer service. The Registrant has emphasized product quality and brand awareness through its advertising strategy. See \"Business - Sales and Marketing\". Although poultry is relatively inexpensive in comparison with other meats, the Registrant competes indirectly with the producers of other meats and fish, since changes in the relative prices of these foods may alter consumer buying patterns.\nSources of Supply\nDuring fiscal 1994, the Registrant purchased its pullets and its cockerels from three major breeders. The Registrant has found the genetic cross of the breeds supplied by these companies to produce chickens most suitable to the Registrant's purposes. The Registrant has no written contracts with these breeders for the supply of breeder stock. Other sources of breeder stock are available, and the Registrant continually evaluates these sources of supply. Should breeder stock from its present suppliers not be available for any reason, the Registrant believes that it could obtain adequate breeder stock from other suppliers. During fiscal 1994, the Registrant purchased approximately 1.3% of its hatching egg requirements from an outside source to supplement the Registrant's hatching egg production. Purchases from this supplier were discontinued during the first quarter of fiscal 1994 as sufficient breeder operators were under contract to support the Registrant's operations. Other major raw materials used by the Registrant include feed grains, cooking ingredients and packaging materials. The Registrant purchases these materials from a number of different vendors and believes that its sources of supply are adequate for its present needs. The Registrant does not anticipate any difficulty in obtaining these materials in the future.\nSeasonality\nThe demand for the Registrant's chicken products generally is greatest during the spring and summer months and lowest during the winter months. Trademarks\nThe Registrant has registered with the United States Patent and Trademark Office the trademark Miss Goldy which it uses in connection with the distribution of its premium grade chill pack products. The Registrant considers the protection of this trademark to be important to its marketing efforts due to consumer awareness of and loyalty to the Miss Goldy label. The Registrant also has registered with the United States Patent and Trademark Office six other trademarks which are used in connection with the distribution of chicken and other products and for other competitive purposes. The Registrant has registered with the United States Patent and Trademark Office the trademark Sanderson Farms which it uses in connection with the distribution of its prepared foods and two pound frozen entree products. The Registrant, over the years, has developed important non-public proprietary information regarding product related matters. While the Registrant has internal safeguards and procedures to protect the confidentiality of such information, it does not generally seek patent protection for its technology.\nEmployees and Labor Relations\nAs of October 31, 1994, the Registrant had 4,854 employees, including 668 salaried and 4,186 hourly employees. A collective bargaining agreement, which expired on November 30, 1994, with the United Food and Commercial Workers International Union covering 483 hourly employees who work at the Registrant's processing plant in Hammond, Louisiana, was renegotiated and signed by the union and the Registrant effective November 6, 1994. This agreement will expire on November 30, 1998. The collective bargaining agreement has a grievance procedure and no strike-no lockout clauses that should assist in maintaining stable labor relations at the Hammond plant. On June 30, 1994, an election was held by the National Labor Relations Board at the Registrant's Collins, Mississippi processing plant as a result of a petition filed by the Laborer's International Union of North America Local 693 seeking recognition as the exclusive collective bargaining representative of certain employees at that plant. The results of the election were inconclusive, with 430 votes cast in favor of union representation, 413 votes cast against union representation, and 29 votes not opened or counted because of challenges to their eligibility. On July 7, 1994, the Registrant filed its objections with the National Labor Relations Board asking that Board to count the ballots challenged by the union and to set aside the election as a result of improper election activity on the part of the union. A hearing on these objections and the challenged ballots was ordered, and was concluded on August 16, 1994. On October 9, 1994, the hearing officer issued his report and recommendation to the National Labor Relations Board that the Registrant's objectives and challenges be dismissed and that the appropriate certification of the union be issued. On November 15, 1994, the Registrant filed its exceptions to the hearing officer's report and recommendation, and the matter is now pending before the National Labor Relations Board. On December 14, 1994, the National Labor Relations Board scheduled an election at the Registrant's Hazlehurst, Mississippi processing plant as a result of a petition filed by the Laborer's International Union of North America Local 693 seeking recognition as the exclusive collective bargaining representative of certain employees at that plant. The election is scheduled for January 27, 1995.\n(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nThe Registrant engages in no material foreign operations, and no material portion of its revenues was derived from customers in foreign countries.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Registrant owns substantially all of its major operating facilities with the following exceptions: one processing plant and feed mill complex is leased on an annual renewal basis through 2063 with an option to purchase at a nominal amount, at the end of the lease term. One processing plant complex is leased under four leases, three of which are renewable annually through 2061, 2063, 2075 and 2073, respectively. Certain infrastructure improvements associated with a processing plant are leased under a lease which expires in 2012 and is thereafter renewable annually through 2091. All of the foregoing leases are capital leases. There are no material encumbrances on the major operating facilities owned by the Registrant, except that the plant of Sanderson Farms, Inc. (Foods Division) is encumbered by a mortgage which collateralizes a note with an outstanding principal balance of $1,609,208 on December 31, 1994, which bears interest at the rate of 5% per annum and is payable in equal annual installments through 2009. In addition, under the terms of the revolving credit agreement obtained July 29, 1992, and under the $20 million long-term fixed rate loan obtained in February, 1993, the Registrant may not pledge any additional assets as collateral other than fixed assets up to 15% of its tangible assets. Management believes that the Company's facilities are suitable for its current purposes, and believes that current renovations and expansions will enhance present operations and allow for future internal growth.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no material pending legal proceedings, other than routine litigation incidental to the Registrant's business, to which the Registrant is a party or of which its property is the subject, and no such proceedings are known by the Registrant to be contemplated by governmental authorities.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matters were submitted to a vote of the Registrant's security holders, through the solicitation of proxies or otherwise, during the fourth quarter of the Fiscal Year.\n(1) Joe Frank Sanderson, a founder of the Registrant, has served as Chairman of the Board for more than five years. Prior to November 1, 1989, Mr. Sanderson also served as Chief Executive Officer and Treasurer of the Registrant.\n(2) Joe F. Sanderson, Jr. has served as President and Chief Executive Officer of the Registrant since November 1, 1989. From January 1984, to November 1989, Mr. Sanderson served as Vice-President, Processing and Marketing of the Registrant.\n(3) D. Michael Cockrell became Treasurer and Chief Financial Officer of the Registrant effective November 1, 1993. Prior to that time, for more than five years, Mr. Cockrell was a member and shareholder of the Jackson, Mississippi law firm of Wise Carter Child & Caraway, Professional Association.\n(4) James A. Grimes became Secretary of the Registrant effective November 1, 1993. Mr. Grimes also serves as Chief Accounting Officer, which position he has held since 1985.\nExecutive officers of the Company serve at the pleasure of the Board of Directors. There are no understandings or agreements relating to any person's service or prospective service as an executive officer of the Registrant. Joe F. Sanderson, Jr. is the son of Joe Frank Sanderson. Joe Frank Sanderson and Joe F. Sanderson, Jr. are also Directors of the Registrant.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nThe Company's common stock is traded on the NASDAQ National Market System under the symbol SAFM. The number of stockholders as of December 31, 1994, was 606.\nThe following table shows quarterly cash dividends and quarterly high and low prices for the common stock for the past two fiscal years. National Market quotations are based on actual sales prices.\nOn December 30, 1994, the closing sales price for the common stock was $22.25 per share.\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\nThe Company's poultry operations are integrated through its control of all functions relative to the production of its chicken products, including hatching egg production, hatching, feed manufacturing, raising chickens to marketable age (\"grow out\"), processing, and marketing. Consistent with the industry, its profitability is substantially impacted by the market price for finished product and feed grains, both of which may fluctuate substantially and exhibit cyclical characteristics typically associated with commodity markets. Other costs, excluding feed, related to the profitability of its poultry operations, including hatching egg production, hatching, growing, and processing cost, are responsive to efficient cost containment programs and management practices. Over the past three fiscal years, these other production costs have averaged approximately 60% of the Company's total production costs.\nThe Company believes that value-added products are subject to less price volatility and generate higher, more consistent profit margins than whole chickens ice packed and shipped in bulk form. To reduce its exposure to market cyclicality that has historically characterized commodity chicken sales, the Company has increasingly concentrated on the production and marketing of value-added product lines with emphasis on product quality, customer service, and brand recognition. The Company adds value to its poultry products by performing one or more processing steps beyond the stage where the whole chicken is first saleable as a finished product, such as cutting, deep chilling, packaging and labelling the product. The Company believes that one of its major strengths is its ability to change its product mix to meet customer demands.\nThe Company's processed and prepared foods product line includes over 100 institutional and consumer packaged food items which it sells nationally and regionally, primarily to distributors, food service establishments and retailers. A majority of the prepared food items are made to the specifications of food service users.\nOn February 24, 1994, the Company announced plans to add a second shift to one of two processing lines at its Collins, Mississippi processing plant. The new shift began operations during June 1994 and reached its processing capacity during the fourth quarter of fiscal 1994. This additional shift increased the number of birds the Company is processing to approximately 3,475,000 birds per week.\nPoultry prices per pound, as measured by the Georgia dock price, fluctuated during the three years ended October 31, 1994 as follows:\nMarket prices, as measured by the Georgia dock price, have decreased from October 31, 1994 through the Thanksgiving holiday to $.5125 per pound. Market prices have remained stable at $.5125 per pound from Thanksgiving through the Christmas season.\nDuring fiscal 1993, the poultry industry experienced a favorable finished product environment and an overall decline in feed grain prices. These factors, together with the Company's expansion, favorably impacted income from operations. During fiscal 1994, as in fiscal 1993, the poultry industry experienced higher prices for poultry products as compared to the previous fiscal year. However, the positive effect of improved prices of poultry products was partially offset by higher costs of feed grains. Although feed costs were higher overall for fiscal 1994 than for fiscal 1993, they declined significantly during the last months of fiscal 1994. The Company is unable to predict how long current conditions will continue or to what extent cyclical pressures will affect operations.\nRESULTS OF OPERATIONS:\nFiscal 1994 Compared to Fiscal 1993\nNet sales for the year ended October 31, 1994, increased to $371.5 million, an increase of $102.4 million, or 38.1%. The increase in net sales resulted from a 35.2% increase in the total pounds of products sold and a 2.1% increase in the average sale price of products. Net sales of poultry products sold increased $100.0 million, or 45.8%, when compared to fiscal 1993. The increase in the net sales of poultry products was due to an increase in the pounds of poultry products sold of 38.3% and an increase in the average net sales price of poultry products of 5.5%. Net sales of prepared food products increased $2.4 million, or 4.7%. The pounds of prepared food products sold increased 3.2% as the average sale price of prepared food products increased 1.5% during fiscal 1994 as compared to fiscal 1993.\nCost of sales for fiscal 1994 increased approximately $94.6 million, or 40.3%, as compared to fiscal 1993. Cost of sales of poultry products sold increased $92.6 million, or 46.1%, during fiscal 1994 as compared to fiscal 1993. The increase in cost of sales for fiscal 1994 as compared to fiscal 1993, resulted primarily from the increased pounds of poultry products sold and an increase in the overall costs of feed grains. A simple average of the corn and soybean meal cash market prices reflected an increase of 10.4% and a decrease of 3.5%, respectively, during fiscal 1994 as compared to the previous fiscal year. Cost of sales of prepared food products increased $2.0 million, or 6.1%, during the year ended October 31, 1994 as compared to the year ended October 31, 1993.\nSelling, general and administrative expenses in fiscal 1994 increased $.4 million, or 3.1%, as compared to fiscal 1993. Measured as a percentage of net sales, selling, general and administrative expenses for fiscal 1994 were 3.8% as compared to 5.1% during fiscal 1993.\nInterest expense increased approximately $1.6 million during fiscal 1994 as compared to fiscal 1993. The increase in interest expense is due primarily to higher interest rates and reflects interest incurred on borrowed funds for the financing of the Pike County complex and other major construction projects for the entire year of fiscal 1994.\nThe Company's effective tax rate increased in fiscal 1994 to approximately 37.7% as compared to approximately 37.1% in fiscal 1993. The increase is primarily due to higher earnings in fiscal 1994 as compared to fiscal 1993, which resulted in tax calculations using higher tax rates.\nFiscal 1993 Compared to Fiscal 1992\nFor the year ended October 31, 1993, net sales increased $59.0 million or 28.1% as compared to the year ended October 31, 1992. The increase in net sales resulted from a 24.4% increase in the total pounds of products sold and a 3.0% increase in the average sale price of products sold during fiscal 1993 as compared to fiscal 1992. Net sales of poultry products sold increased $53.6 million, or 32.5%, when compared to fiscal 1992. The increase in net sales of poultry during fiscal 1993 as compared to fiscal 1992 is a result of an increase in the pounds of poultry products sold and an increase in the average sale price of poultry products of 26.2% and 5.0%, respectively. Net sales of prepared food products increased $5.4 million, or 11.9%. The pounds of prepared food products sold increased 7.9% as the average sale price of prepared food products increased 3.7%.\nCost of sales for fiscal 1993 increased approximately $45.8 million, or 24.2%, over the prior fiscal year. Of the increase, approximately $42.6 million was associated with poultry products and was due primarily to the increase in pounds of poultry products sold. A simple average of the corn and soy meal cash market prices reflected a decrease of 6.3% and an increase of 4.1%, respectively, when compared to fiscal 1992. Cost of sales of prepared food products sold increased $3.2 million, or 10.4%, during fiscal 1993 as compared to fiscal 1992, primarily as a result of an increase in the pounds of prepared food products sold.\nSelling, general and administrative expenses in fiscal 1993 increased $.5 million, or 3.6%, as compared to fiscal 1992. Selling, general and administrative expenses for fiscal 1993 were 5.1% of net sales as compared to 6.2% of net sales in fiscal 1992.\nInterest expense increased approximately $1.9 million during fiscal 1993 as compared to fiscal 1992. Interest costs of $.4 million and $.3 million were capitalized as a result of additional borrowings incurred in connection with the construction of the Pike County, Mississippi complex and other major construction projects in fiscal 1993 and 1992, respectively. Interest income decreased approximately $.2 million during fiscal 1993 as compared to fiscal 1992 as a result of reduced amounts available for investments and lower interest rates.\nThe Company's effective tax rate increased in fiscal 1993 to approximately 37.1% as compared to approximately 36.0% in fiscal 1992. The increase is primarily due to reduced tax-free interest income as a percentage of net income before taxes. The effect of the retroactive tax rate increase incorporated into the Revenue Reconciliation Act of 1993 was insignificant.\nLIQUIDITY AND CAPITAL RESOURCES\nOn October 31, 1994, the Company's working capital totaled $45.8 million and its current ratio was 5.6 to 1, as compared to working capital of $42.5 million and a current ratio of 6.6 to 1 at October 31, 1993. During fiscal 1994, the Company expended $22.4 million on planned capital projects and $4.0 million to reduce the outstanding debt under its revolving credit agreement. During the third quarter of fiscal 1994, the credit agreement was amended to, among other things, increase the revolving credit available to the Company thereunder to $70.0 million from $60.0 million. The same group of banks that were parties to the original revolving credit agreement were parties to the amendment.\nThe Company's capital budget for fiscal 1995 is approximately $23.2 million. The original capital budget for fiscal 1994 was approximately $21.6 million, which was increased to approximately $26.7 million due to the addition of items not approved at the beginning of fiscal 1994 pending justification, field trial and alternate costing. Included in the fiscal 1995 budget is approximately $3.9 million relating to fiscal 1994 budget items that were not completed or started in fiscal 1994. Also included in the fiscal 1995 budget are renovations to offices at three processing facilities and other major capital projects for changes and additions to existing processing facilities to allow better product flow and product mix for more market flexibility.\nThe Company anticipates that the capital expenditures for fiscal 1995 will be funded by working capital and additional borrowings under its $70.0 million revolving credit agreement.\nSanderson Farms, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Significant Accounting Policies Principles of Consolidation: The consolidated financial statements include the accounts of Sanderson Farms, Inc. (the \"Company\") and its wholly-owned subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation.\nTemporary Cash Investments: Temporary cash investments are stated at cost which approximates market. Included are investment agreements for securities purchased under agreements to resell with a maturity of one day.\nAccounts Receivable: The Company sells fresh and frozen chicken and other prepared food items to retailers, distributors and fast food operators in the southern, southwestern and western United States. Management periodically performs credit evaluations of its customers' financial condition and generally does not require collateral. Credit losses have consistently been within management's expectations.\nInventories: Processed food and poultry inventories and inventories of feed, egg, medication and packaging supplies are stated at the lower of cost (first- in, first-out method) or market.\nLive poultry inventories of broilers are stated at the lower of cost or market and breeders at cost less accumulated amortization. The costs associated with breeders are accumulated up to the production stage and amortized over the productive lives using the straight-line method.\nProperty, Plant and Equipment: Property, plant and equipment is stated at cost. Depreciation of property, plant and equipment is provided by the straight-line and units of production methods over the estimated useful lives.\nIncome Taxes: Deferred income taxes relate principally to cash basis temporary differences and depreciation expense accounted for differently for financial and income tax purposes. Effective November 1, 1988, the Company could no longer use cash basis accounting for its farming subsidiary because of tax law changes. The taxes on the cash basis temporary differences as of that date will not be payable under current tax laws provided there are no changes in ownership control and future annual revenues of the farming subsidiary exceed 1988 revenues. Management does not anticipate the payment of such taxes related to these cash bases timing differences during fiscal 1995. (See Note 4).\nEffective October 31, 1993, the Company adopted Statement of Financial Accounting Standard No. 109, \"Accounting for Income Taxes.\" The effect of adopting the statement was insignificant on the Company's financial position and operations.\nEarnings Per Share: Earnings per share are based upon the weighted average number of shares outstanding during each year. The weighted average shares outstanding were 9,075,427 in 1994, 1993 and 1992.\n2. Inventories Inventories consisted of the following:\n3. Long-term Credit Facilities and Debt Long-term debt consisted of the following:\nThe Company has a $70.0 million ($40.0 million available at October 31, 1994) revolving credit agreement with four banks. The revolver extends to 1997, when the outstanding borrowings may be converted to a term loan payable in equal semiannual installments over four years. Borrowings are at prime or below and may be prepaid without penalty. A commitment fee of .375% is payable quarterly on the unused portion of the revolver. Covenants related to the revolving credit and the term loan agreements include requirements for maintenance of minimum consolidated net working capital, tangible net worth, debt to total capitalization and current ratio. The agreements also establish limits on dividends, assets that can be pledged and capital expenditures.\nProperty, plant and equipment with a carrying value of approximately $7,941,000 is pledged as collateral to a note payable and the capital lease obligation.\nInterest costs of $0, $416,000 and $250,000 were capitalized in 1994, 1993 and 1992, respectively.\nThe aggregate annual maturities of long-term debt at October 31, 1994 are as follows (in thousands):\nSignificant components of the Company's deferred tax assets and liabilities at were as follows (in thousands):\nDeferred tax assets (included in prepaid expenses):\nThe differences between the consolidated effective income tax rate and the federal statutory rate were as follows:\n5. Employee Benefit Plans\nThe Company has a defined contribution profit sharing plan that covers all employees and an employee stock ownership plan that is restricted to salaried employees. As of October 31, 1994, the Company is waiting to receive approval from the Internal Revenue Service to merge the employee profit sharing plan into the employee stock ownership plan. Annual contributions are made at the discretion of the Board of Directors. Total contributions to the profit sharing plan were $1,200,000 in 1994, $750,000 in 1993 and $350,000 in 1992.\nUnder the Company's Stock Option Plan, 500,000 shares of Common Stock have been reserved for grant to key management personnel. Options to purchase an aggregate of 30,000 shares at $16 per share and 57,000 shares at $16.50 are outstanding at October 31, 1994. Options to purchase 6,000 shares were exercisable at October 31, 1994.\n6. Shareholder Rights Agreement\nOn April 21, 1989, the shareholders of the Company approved a shareholders rights agreement (the \"Agreement\") under which one share purchase right (\"right\") was declared as a dividend for each share of the Company's Common Stock outstanding on May 31, 1989. The rights do not become exercisable and certificates for the rights will not be issued until ten business days after a person or group acquires or announces a tender offer for the beneficial ownership of 20% or more of the Company's Common Stock. Special rules set forth in the Agreement apply to determine beneficial ownership for members of the Sanderson family. Under these rules, such a member will not be considered to beneficially own certain shares of Common Stock, the economic benefit of which is received by any member of the Sanderson family, and certain shares of Common Stock acquired pursuant to profit sharing plans of the Company.\nThe exercise price of a right has been established at $53. Once exercisable, each right would entitle the holder to purchase one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $100 per share. The rights may be redeemed by the Board of Directors at $.01 per right prior to an acquisition, through open market purchases, a tender offer or otherwise, of the beneficial ownership of 20% or more of the Company's Common Stock, or by two-thirds of the Directors who are not the acquirer, or an affiliate of the acquirer, prior to the acquisition of 50% or more of the Company's Common Stock by such acquirer. The rights expire on April 21, 1999.\n7. Other Matters\nOne customer accounted for 10.4% and 11.6% of consolidated sales for the years ended October 31, 1993 and 1992. No customer accounted for more than 10% of consolidated sales for the year ended October 31, 1994. Export sales were less than 10% of consolidated sales in each year presented.\nThe effects of adopting in 1994 FASB Statement No. 106 \"Employers' Accounting for Postretirment Benefits other than Pension\" was insignificant to the Company's financial position and operation for the year ended October 31, 1994. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.\nNot applicable.\nPART III\nItem 10. Directors and Executive Officers of the Registrant.\nAs required by General Instruction G(3) to Form 10-K, reference is made to the information concerning the Directors of the Registrant and the nominees for election as Directors appearing in the Registrant's definitive proxy statement filed or to be filed with the Commission pursuant to Rule 14a-6(c). Such information is incorporated herein by reference to the definitive proxy statement. Information concerning the executive officers of the Registrant is set forth in Item 4A of Part I of this Annual Report.\nItem 11. Executive Compensation.\nAs required by General Instruction G(3) to Form 10-K, reference is made to the information concerning remuneration of Directors and executive officers of the Registrant appearing in the Registrant's definitive proxy statement filed or to be filed with the Commission pursuant to Rule 14a-6(c). Such information is incorporated herein by reference to the definitive proxy statement.\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nAs required by General Instruction G(3) to Form 10-K, reference is made to the information concerning beneficial ownership of the Registrant's Common Stock, which is the only class of the Registrant's voting securities, appearing in the Registrant's definitive proxy statement filed or to be filed with the Commission pursuant to Rule 14a-6(c). Such information is incorporated herein by reference to the definitive proxy statement.\nItem 13. Certain Relationships and Related Transactions.\nNot applicable.\nPART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a)1. FINANCIAL STATEMENTS:\nThe following consolidated financial statements of the Registrant are 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":"6281_1994.txt","cik":"6281","year":"1994","section_1":"ITEM 1. BUSINESS\nAnalog Devices, Inc. (\"Analog\" or the \"Company\") designs, manufactures and markets a broad line of high-performance linear, mixed-signal and digital integrated circuits (\"ICs\") that address a wide range of real-world signal processing applications. The Company's principal products include special-purpose linear and mixed-signal ICs (\"SPLICs\"), digital signal processing ICs (\"DSP ICs\") and general-purpose, standard-function linear and mixed-signal ICs (\"SLICs\"). The Company also manufactures and markets devices using assembled product technology, the largest portion of which are hybrid ICs, which combine unpackaged IC chips and other chip-level components in a single package.\nNearly all of the Company's products are components, which are typically incorporated by original equipment manufacturers (OEMs) in a wide range of equipment and systems for use in computer, telecommunication, industrial, instrumentation, military\/aerospace and high-performance consumer electronics applications. The Company sells its products worldwide; approximately 44% of the Company's fiscal 1994 net sales were made to customers in North America, while most of the balance was to customers in Western Europe and the Far East.\nINDUSTRY OVERVIEW\nReal-world phenomena, such as temperature, pressure, sound, images, speed, acceleration, position and rotation angle, are inherently analog in nature, consisting of continuously varying information. This information can be detected and measured using analog sensors, which represent real-world phenomena by generating continuously varying voltages and currents. The signals from these sensors are initially processed using analog methods, e.g., amplification, filtering and shaping. They are then usually converted to digital form for input to a microprocessor, which is used to manipulate, store or display the information. In many cases the signals are further processed after conversion to digital form using a technology called \"digital signal processing.\" In addition, digital signals are frequently converted to analog form to provide signals for analog display, sound, or control functions. These manipulations and transformations are collectively known as \"real-world signal processing.\"\nSignificant advances in semiconductor technology over the past ten to fifteen years have led to substantial increases in the performance and functionality of ICs used for signal processing applications. Key among these advances is the ability to create VLSI (Very Large Scale Integration) mixed-signal ICs that contain both high-performance analog circuitry and large amounts of high- density digital circuitry. The analog circuitry portion of the IC is used for manipulating real-world signals while still in analog form and for converting analog signals into digital form (or vice versa), and the digital portion is used for further processing analog signals subsequent to their conversion to digital form. The ICs resulting from these advances are used as components in equipment and systems to achieve more effective interaction with natural phenomena and the human senses.\nTRENDS IN THE COMPANY'S BUSINESS\nAnalog has long been a leader in the development, production and marketing of linear and mixed-signal ICs, particularly technology-driven, high-performance, general-purpose, standard-function ICs (or SLICs). Building on its core technical competencies, Analog believes that it is a leading worldwide supplier of data converters and operational amplifiers and that data converters and operational amplifiers collectively account for approximately half of the semiconductor industry's total SLIC sales. SLICs are sold to a very large customer base for a wide variety of applications. Early markets for these products were primarily manufacturers of equipment and systems for the industrial, instrumentation and military\/aerospace markets, and these markets still account for a significant part of the Company's business.\nAs linear IC technology has evolved within the industry, it has been employed to develop market-driven, special-purpose linear and mixed-signal ICs (or SPLICs) tailored to specific high-volume applications. Early-generation SPLICs were generally low-performance devices for applications in automotive, computer, consumer and certain communications applications. These devices were subject to commodity-like pricing pressures, and the Company therefore chose initially not to compete in this area. However, the emerging demand for the highest levels of performance in many high-volume applications has provided the Company an opportunity to leverage its expertise by diversifying into SPLICs and DSP ICs for selected applications in these market segments. Products for such applications must also have a high level of functionality (i.e., many functions on one chip) to satisfy OEMs' requirements for low cost per function.\nOver the past four years, Analog has been engaged in a transition from being primarily a supplier of SLICs (and to a lesser extent, assembled products) serving a very fragmented market to a company whose strategy is to balance its traditionally stable, profitable SLIC business with the growth opportunities available for SPLICs and DSP ICs, which are typically sold in high volume to a relatively small number of customers. Toward this end, the Company has refocused much of its direct sales force and marketing resources on the needs of SPLIC and DSP IC customers and moved a significant portion of its traditional SLIC business into the distribution sales channel to better serve the fragmented customer base characteristic of the instrumentation, industrial and military\/aerospace markets.\nPRINCIPAL PRODUCTS\nThe Company operates predominantly in one industry segment: the design, manufacture and marketing of a broad line of high-performance linear, mixed-signal and digital integrated circuits that address a wide range of real-world signal processing applications. Analog's products can be divided into three classifications: standard-function linear and mixed-signal ICs (SLICs); special-purpose linear and mixed-signal ICs (SPLICs) and digital signal processing ICs (DSP ICs); and assembled products.\nA substantial portion of the Company's products are proprietary (available only from Analog), while equivalents to most of its other products are available from a limited number of other suppliers. Many of the Company's products tend to be less price sensitive than other types of ICs, such as DRAM (Dynamic Random Access Memory) ICs, primarily because there are fewer suppliers and because OEMs, in many cases, after qualifying one manufacturer's high-performance linear or mixed-signal IC for a specific application, are reluctant to switch manufacturers due to the risk of degradation in the performance of their product and\/or the effort required to qualify additional suppliers.\nThe following table sets forth the approximate percentage of revenue attributable to each of the Company's product groups for the past three fiscal years:\nSLICS\nSLICs have been the foundation of the Company's business for more than 20 years, and the Company expects that they will continue to be its core products for much of the 1990s. Analog believes that it is currently one of the world's largest suppliers of SLIC products. The Company's SLIC products are primarily high-performance, single-function devices. The majority of the Company's SLIC revenue is attributable to data converters (analog-to-digital and digital-to-analog) and amplifiers. Other products within this category with significant sales are analog signal-processing devices (such as analog multipliers), voltage references and comparators. The Company is currently expanding its SLIC product offerings in areas where it traditionally has had limited focus, principally interface circuits and power management ICs. It is also expanding its SLIC product line to include a much larger number of products designed to operate from single-supply 3- or 5-volt power sources to better meet the needs of customers designing portable, battery-operated equipment.\nAnalog's SLIC products tend to be general purpose in nature, which allows customers to incorporate them in a wide variety of equipment and systems. Analog's product portfolio includes several hundred SLICs, any one of which can have as many as several hundred customers. The Company's SLIC customers include both OEMs and customers who build equipment for their own use. Historically, most SLICs have been purchased by OEMs which serve the industrial and military\/aerospace markets, but they are now also being used for applications in personal computers (PCs), peripheral equipment used with PCs and computers, and commercial and consumer communications equipment.\nDesign engineers employed by the Company's OEM customers typically select SLIC products based on information in the Company's catalogs, datasheets and other promotional materials. By using standard, high-performance, readily available, off-the-shelf components in their designs, Analog's customers can reduce the time required to develop and bring new products to market. Given the high cost of developing customized ICs, SLICs usually provide the most cost- effective solutions for low- to medium-volume applications. In addition, combinations of SLICs connected together on a printed circuit board can provide functionality that cannot currently be implemented with a single-chip device.\nSPLICS AND DSP ICS\nSPLICs and DSP ICs, which are collectively referred to as system-level ICs, are multi-function devices that feature high levels of functional integration on a single chip. Most SPLICs are mixed-signal devices (some of which include DSP capability) and the balance are linear-only devices. SPLICs are almost always designed to the requirements of a specific application, and the design process often includes significant input from one or more potential key customers. Market demand for SPLICs is driven by the benefits that result from using one of these devices rather than a combination of SLICs and other ICs. These benefits include higher performance, lower cost per function, smaller size, lower weight, fewer parts, decreased power consumption, easier design-ins and faster time to market. These benefits are becoming more important to the Company's OEM customers as they increase their focus on high-performance, small, lightweight products, many of which are battery powered. Many of the products they are designing could not be developed without these types of ICs.\nThe Company's DSP ICs are designed to efficiently execute specialized programs (algorithms) associated with processing real-time, real-world data. The Company's fixed-point and floating-point DSP ICs share a common architecture and code compatibility, which allows system designers to make cost, performance and time-to-market trade-offs. By reducing the manufacturing cost of its fixed- point DSP ICs, the Company has been able to reduce the selling prices of these devices, which has made it possible to incorporate them in mass-market products such as PCs and modems. Analog's DSP ICs are supported with specialized applications and easy-to-use, low-cost design tools, which reduce product development cost and time to market. The Company's DSP IC revenue growth has been aided by the availability of analog and mixed-signal \"front-end\" ICs such as data converters from the Company.\nThe Company's DSP IC revenues are derived from both digital-only devices and mixed-signal ICs that include a DSP core along with data conversion and analog signal processing circuitry. Demand for system-level ICs that incorporate both DSP functionality and sophisticated mixed-signal capability is expected to increase as customers continue to demand as much functionality as possible from a single chip.\nASSEMBLED PRODUCTS\nThe Company's assembled products consist primarily of hybrid products (devices with several IC chips mounted and wired together on a substrate) and modules (ICs and other components soldered to a small printed circuit board, which is mounted inside a small plastic case). These are primarily older products, which include devices such as amplifiers and data converters used in data acquisition applications. Revenue from this product group began declining in fiscal 1989, due in part to the deliberate obsolescence of certain products (in conjunction with a manufacturing consolidation program implemented by the Company) and their replacement with newer- generation ICs from the Company. Assembled products revenue is expected to continue declining at a moderate rate. However, given the proprietary nature of the majority of the products in this line, the Company expects that these products will continue providing a positive contribution to cash flow and profits.\nPRINCIPAL MARKET AND APPLICATIONS\nThe Company's principal market is comprised of original equipment manufacturers (OEMs) that incorporate the Company's products in equipment, instruments and systems sold to end users for a wide variety of applications, including computers and computer peripherals; communications equipment; engineering, medical and scientific instruments; industrial automation equipment; military\/aerospace equipment; and high-end consumer electronics products. The Company's growth has been aided both by the expansion of the markets represented by these end-use applications and by the increasing use of computer technology in the equipment and systems offered for sale in these markets.\nAnalog believes that for fiscal 1994 its 20 largest customers accounted for approximately 27% of the Company's net sales. The largest single customer represented less than 5% of net sales. Sales of the Company's products are not highly seasonal.\nListed below are some of the characteristics of each of the Company's major served markets:\nINSTRUMENTATION--includes manufacturers of engineering, medical and scientific instruments. These products are usually designed using the highest performance SLICs available, where the end product must be substantially more accurate than the equipment or phenomena it is expected to measure, and where production volumes generally do not warrant custom or application-specific ICs. The Company's products sold into this market usually have long product life cycles.\nINDUSTRIAL AUTOMATION--includes data acquisition systems, automatic process control systems, robotics, environmental control systems and automatic test equipment (ATE). These products generally require ICs that offer performance greater than that available from commodity-level ICs, but generally do not have production volumes that warrant custom or application-specific ICs. Combinations of SLICs are therefore usually employed to achieve the necessary functionality (ATE being an exception, where the high level of electronic circuitry required per tester has created opportunities for SPLICs). ICs sold into this market tend to have long product life cycles.\nMILITARY\/AEROSPACE--includes the military, commercial avionics and space markets, all of which require high-performance ICs that meet rigorous environmental and reliability specifications. Nearly all of the Company's SLICs can be supplied in versions that meet the requirements of MIL-STD-883C, Class B, and many can be supplied to Class S, an even more stringent specification that governs ICs used for spaceflight applications. Most of the Company's products sold into this market are derived from standard commercial grade ICs, although the Company sometimes develops products expressly for military\/aerospace applications.\nCOMPUTERS AND COMPUTER PERIPHERALS--includes high-performance personal computers, workstations and peripheral devices such as hard disk drives. The Company currently supplies a variety of ICs used in this market for functions such as graphic displays; interfaces between PCs and peripherals such as modems and printers; power and battery management; processing analog signals from a hard disk drive's read head and positioning the read head over a hard disk drive platter; and providing enhanced sound input and output capability for business and entertainment applications. This market is characterized by rapidly developing technology.\nCOMMUNICATIONS--includes data and fax modems, digital cellular telephones and portable, wireless communications equipment. The need for ever higher speed, coupled with more reliable, more bandwidth-efficient communications is creating increasing demand for systems that include both digital and analog signal processing capability. Demand for signal processing ICs for this market is also being driven by the equipment manufacturers' need for components that enable them to develop cost-effective products that feature high performance, small size, low weight and minimal power consumption.\nCONSUMER ELECTRONICS--The emergence of high-performance consumer products, such as compact disc players, digital VCRs, digital audio tape equipment and digital camcorders, has led to the need for high-performance SPLICs with a high level of functionality. Although the Company's revenue from this market is not currently significant, the Company expects to supply ICs for sophisticated products used by consumers for computing, communications and entertainment applications, and believes that many of these applications will involve digital signal processing.\nIn addition to the above markets, Analog is pursuing the automotive market. Although this market has historically been served with low-cost, low-performance ICs, demand has developed for higher performance devices for a wide range of applications. In response, Analog is developing products specifically for the automotive market. The Company began shipments of its first automotive product, a micromachined IC employed as a crash sensor in airbag systems, in 1993. In 1994 the Company began shipments of this device to Delco for airbag systems in several 1995 model-year General Motors \"W body\" cars, including the Pontiac Grand Prix, Oldsmobile Cutlass and Buick Century. Revenues from this device were not significant in 1994, but are expected to increase substantially beginning in 1995.\nNEW PRODUCTS\nAnalog's revenue growth is driven by a continuing flow of new products. More than 40% of the Company's orders in fiscal 1994 were for products introduced within the preceding five years. Among the key new products introduced and\/or first actively marketed in 1994 were:\nSHARC 32-BIT, FLOATING-POINT DSP--A high-performance 32-bit, floating-point digital signal processor (DSP), with 40 MIPS (millions of instructions\/second) capability. It is available in two versions: the ADSP-21060 with 4 Mb of on-board static memory and the ADSP-21062 with 2 Mb. This device achieved a broad range of design-ins during 1994, and is well suited for applications such as digital mobile radio base stations, speech processing, graphics and imaging systems and high-performance arcade games.\nADSP-2171 HIGH-PERFORMANCE 16-BIT, FIXED-POINT DSP--Analog's highest-performance fixed-point DSP. Because of its low power, high MIPS and added functionality, this device is particularly well suited for handling speech coding requirements for digital radio communications. It is also well suited for PC applications for processing real-time signals such as those used in voice, audio and telephone applications.\nAD899 COMPLETE READ CHANNEL--A fully integrated read-channel IC for hard disk drives. It replaces multiple-chip solutions with a single device that significantly reduces power and space requirements, as well as overall function cost, while supporting data transfer rates of up to 32 Mbits per second.\nAD8001 HIGH-SPEED, LOW-POWER AMPLIFIER--A very fast general-purpose operational amplifier. It provides operation at 800 MHz while consuming only 50 mW of power. The AD8001 is well suited for use as an A\/D converter driver, in numerous video applications, and in the RF (radio frequency) section of receivers.\nAD1845\/46 STEREO CODECS--Third-generation 16-bit codec ICs that provide low-cost, single-chip audio solution for business audio and multimedia applications for both computer motherboard and add-in card implementations. Both devices are compatible with the Windows Sound System (a trademark of Microsoft Corp.). The AD1846 provides a parallel computer interface, while the AD1845 has an asynchronous interface and includes sample rate conversion technology, which permits audio signals digitized at different sample rates to be used in the same system.\nAD20MSP815 PERSONAL SOUNDCOMM CHIPSET--A five-chip chipset for implementing many popular PC functions, including 14.4 Kbps fax and data modem capability, industry-standard 16-bit audio capability, and telephone functions such as answering machine and speaker phone capability. The chipset consists of a DSP IC, a stereo audio codec IC, a complete, high-performance analog front-end and two custom logic chips. A complete design guide is also available that greatly simplifies the customer's design-in task.\nADM663\/666 VOLTAGE REGULATORS--Five-volt regulators used for power management in end products such as communications equipment and computers. These products are representative of Analog's increased focus on ICs designed expressly for power management applications.\nAD835 MULTIPLIER AND AD831 MIXER --These two analog ICs are used as building blocks for RF (radio frequency) front-ends in receivers. They are among the first parts introduced by Analog aimed specifically at RF front-end applications for products such as digital mobile radio base stations and handsets, RF modems, and communications and aircraft receivers.\nAD420 4-20 mA D\/A CONVERTER--A serial-input 16-bit digital-to-analog converter used to generate a 4-to-20 mA analog output signal that is proportional to its digital input signal. It provides a high-precision, fully integrated, low-cost, single-chip solution for generating the industry-standard control loop signals required in industrial automation systems.\nLOW VOLTAGE, LOW POWER ICs--During 1994 Analog Devices introduced a substantial number of ICs designed to operate from single-supply 3- and 5-volt power sources. Some of these products represent new functionality, while many are lower-voltage, lower-power versions of existing products. They are much better suited for many emerging computer and communication applications in battery-powered portable products where power consumption is a primary concern. Products in this catergory included amplifiers, data converters and DSPs.\nRESEARCH AND DEVELOPMENT\nThe markets served by Analog are characterized by rapid technological changes and advances. Accordingly, the Company makes substantial investments in the design and development of new products and processes, and for significant improvement of existing products and processes. Analog spent $106.9 million during fiscal 1994 for the design, development and improvement of new and existing products and processes, compared to $94.1 million during fiscal 1993 and $88.2 million during 1992.\nIn fiscal 1994, approximately half of the Company's R&D expenditures were devoted to the design and development of SPLICs and DSP ICs, and the development and improvement of processes used for these products. The Company believes that it will be able to leverage its core technological competencies and leadership position in linear and DSP technology to design and develop a wide range of highly integrated, high-performance, cost-effective mixed-signal SPLICs, many of which will include DSP capability. At the same time, however, the Company expects to continue developing new and improved SLIC products to increase its share of the SLIC market.\nAs of December 1, 1994, the Company owned 262 U.S. patents and had 91 patent applications on file with the United States patent office. The Company believes that while its patents may provide some advantage, its competitive position is largely determined by such factors as the knowledge, ability and experience of the Company's personnel, new product development, market recognition and ongoing marketing efforts, customer service and technical support.\nSALES CHANNELS\nAnalog sells its products in both North America and internationally through a direct sales force, third-party distributors and independent sales representatives. Approximately 44% of fiscal 1994 revenue was derived from customers in North America. As of December 1, 1994, the Company had 17 sales offices in the United States, and its third-party distribution channel consisted of nine national and regional third-party distributors and several independent sales representatives with numerous locations throughout the U.S. and Canada.\nApproximately 26% of the Company's fiscal 1994 revenue was derived from sales to customers in Europe; 17% to customers in Japan; and 13% to customers in other international markets. As of December 1, 1994, the Company had direct sales offices in Austria, Belgium, Denmark, France, Germany, Hong Kong, India, Israel, Italy, Japan, Korea, The Netherlands, Sweden, Switzerland, Taiwan and the United Kingdom. The Company also had sales representatives and\/or distributors in approximately 25 countries outside North America, including countries where the Company also has direct sales offices.\nApproximately one-third of Analog's fiscal 1994 revenue was derived from sales made through distributors. The Company's distributors typically maintain an inventory of Analog products. Some of these distributors also sell products competitive with the Company's products, including those for which the Company is an alternate source. Sales to distributors are made under agreements which provide protection to the distributors for their inventory of Company products against price reductions and products that are slow-moving or have been discontinued by the Company. These agreements generally contain a provision for the return of the products to the Company in the event the relationship with the distributor is terminated.\nSales to North American distributors are not recognized until the products are resold by distributors to their customers. Sales made to distributors outside North America are recognized upon shipment to the distributor, but the Company provides specific reserves for possible returns and allowances.\nThe Company's worldwide sales efforts are supported by an extensive promotional program that includes editorial coverage and paid advertising in trade publications; direct mail programs; promotional brochures; technical seminars; and participation in trade shows. The Company publishes and distributes full-length databooks, short-form catalogs, applications guides, technical handbooks and detailed data sheets for individual products. The Company also maintains a staff of application engineers who aid customers in incorporating Analog's products into their products during their product development cycles.\nPRODUCTION AND RAW MATERIALS\nMonolithic integrated circuit components are manufactured in a sequence of production steps that include wafer fabrication, wafer testing, cutting the wafer into individual \"chips\" (or dice), assembly of the dice into packages and electrical testing of the devices in final packaged form. The raw materials used to manufacture these devices include silicon wafers, processing chemicals (including liquefied gases), precious metals, ceramic packages and plastic used for plastic packaging.\nIn addition to using industry-standard bipolar and CMOS wafer fabrication processes, Analog employs a number of Company-developed proprietary processes specifically tailored for use in fabricating high-performance linear and mixed-signal SLICs and SPLICs.\nAnalog's IC products are fabricated both at the Company's production facilities and by third-party wafer fabricators. Assuming that the Company can continue to maintain favorable relationships with its third-party wafer fabricators, it intends to continue using such suppliers for meeting most of its needs for wafers that can be fabricated using industry-standard digital processes. The Company intends to meet most of its needs for wafers fabricated with linear and mixed-signal processes with wafers fabricated at the Company's production facilities.\nHybrid products are manufactured by mounting and connecting together several integrated circuit chips in a single package. Some of the chips used in the Company's hybrids are manufactured by the Company and some are purchased from outside suppliers. The production process for modular components, subsystems and systems consists primarily of assembly, packaging and testing. Some of the Company's assembled products are assembled and tested within the Company's U.S. manufacturing facilities, while others are assembled and tested at Company-owned facilities outside the United States or by subcontractors, principally in the Far East.\nIn general, the Company uses standard supplies and components in the manufacture of its products and most are available from a number of suppliers. Certain items are made to the Company's specifications and are available from a limited number of suppliers. However, the Company believes that, if necessary, alternative sources of supply for these items could be developed, and that any delays in obtaining alternative sources would be temporary and would not have a material adverse effect on the Company's business.\nWORKING CAPITAL REQUIREMENTS\nThe Company manufactures and sells a wide variety of products, a significant portion of which are standard products delivered from inventory on a current basis. As a result, the Company generally maintains finished goods inventories sufficient to meet customer delivery requirements within a short time following receipt of an order.\nBACKLOG\nThe Company defines its backlog at any point in time as those orders for which customers have requested shipment within the next 13 weeks. The quantities of the Company's products to be delivered and their delivery schedules, as covered by customer purchase orders, are frequently revised by customers to reflect changes in their needs. As is customary in the semiconductor industry, most such orders can be canceled or deliveries delayed by the customer without significant penalty.\nBacklog at the end of fiscal 1994 was approximately $152.8 million; it was approximately $127.1 million at the end of the prior fiscal year. In the past, backlog at the end of one quarter has typically represented about 60% to 70% of the next quarter's sales. For example, the backlog at the end of the third quarter of fiscal 1994 was approximately $140.1 million; sales for the fourth quarter of fiscal 1994 were $203.3 million. Standard products, which are typically delivered from current inventory, usually account for much of the difference between one quarter's ending backlog and the next quarter's sales.\nAgreements between the Company and its third-party stocking distributors provide price protection for the distributors and certain rights of return for merchandise unsold by the distributors; as a result, sales to domestic distributors are not recognized until the products are resold by the distributors to their customers. For these reasons, and the previously mentioned ability of customers to cancel orders or delay deliveries without significant penalty, the Company believes that its backlog is not necessarily a reliable indicator of future revenue.\nGOVERNMENT CONTRACTS\nThe Company estimates that approximately 15% of its total worldwide revenue is attributable to sales to the U.S. government and government contractors and subcontractors. Analog's government contract-related business is predominantly in the form of negotiated, firm fixed-priced subcontracts. All such contracts and subcontracts contain standard provisions related to termination at the election of the United States government. The Company expects that the U.S. government's intention to further reduce U.S. military spending will result in a continuing gradual reduction in the percentage of the Company's total sales going to governmental users and contractors.\nCOMPETITION\nAnalog competes with a large number of semiconductor companies in markets that are highly competitive. The Company believes it is one of the largest suppliers of high-performance linear and mixed-signal signal-processing components. These types of products fall into both the SLIC and SPLIC product categories. Competitors for the Company's linear and mixed-signal products include Brooktree Corp., Burr-Brown Corp., Cirrus Logic Inc., Exar Corp., Harris Corp., Linear Technology Corp., Maxim Integrated Products, Inc., National Semiconductor Corp., Sierra Semiconductor Corp., Siliconix Inc., Silicon Systems (a subsidiary of TDK Corp), Texas Instruments, Inc. and others.\nSales of DSP ICs represent a growing percentage of the Company's total sales. Analog's competitors for DSP ICs include AT&T, Integrated Device Technology, Inc., Motorola Semiconductor Products and Texas Instruments, Inc.\nMany other companies offer components that compete with Analog's products; some also offer other electronic products, and some have financial resources substantially larger than Analog's. Also, some formerly independent competitors have been purchased by larger companies (which in some cases may be viewed as a means by which the acquiring company gains in-house capability). However, to the Company's knowledge, no manufacturer competes with Analog across all of the product types offered by the Company in its signal-processing components product line.\nAnalog believes that competitive performance in the marketplace for real-world signal-processing components depends upon several factors, including product price, technical innovation, product quality and reliability, range of products, customer service and technical support. Analog believes its aggressive technical innovation emphasizing product performance and reliability, supported by its commitment to strong customer service and technical support, will allow the Company to continue to compete successfully in its chosen markets against both foreign and domestic semiconductor manufacturers.\nENVIRONMENT\nAnalog's manufacturing facilities are subject to numerous environmental laws and regulations, particularly with respect to industrial waste and emissions. Compliance with these laws and regulations has not had a material impact on the Company's capital expenditures, earnings or competitive position.\nEMPLOYEES\nAs of October 29, 1994, the Company employed approximately 5,400 persons. The Company believes that relations with its employees are good.\nINTERNATIONAL OPERATIONS\nAnalog has direct sales offices in 16 countries outside the United States. In addition, the Company has manufacturing facilities in Ireland, Japan, the Philippines and Taiwan. The Company also has arrangements with subcontractors, principally in the Far East, for the wafer fabrication, assembly and testing of certain products. The majority of Analog's international sales in the past fiscal year were made through its direct international sales offices while the balance, approximately one-third of the total, were made through distributors.\nA significant portion of Analog's revenues and operating profits are derived from international operations, and the Company is therefore subject to the economic and political risks inherent in international operations generally, including expropriation, air transportation disruptions, currency controls and changes in currency exchange rates, tax and tariff rates and freight rates. The Company has taken steps it deems prudent in its international operations to diversify and otherwise insure and protect against these risks. Financial information concerning domestic and international operations appears in Notes 1(f), 1(g) and 2 in the Notes to Consolidated Financial Statements included as part of this report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters is located in Norwood, Massachusetts. Manufacturing and other operations are carried on in several locations worldwide. The following tables provide certain information as to the Company's principal general offices and manufacturing facilities:\nIn addition to the principal leased properties listed above, the Company also leases sales offices and other premises at 24 locations in the United States and 26 locations overseas under operating lease agreements. These leases expire at various dates through the year 2010.\nSee Note 5 - \"Lease Commitments\" in the Notes to Consolidated Financial Statements for information concerning the Company's obligations under all operating and capital leases.\nThe Company believes that its existing and planned facilities are adequate and suitable for the manufacture and sale of its products, and have sufficient productive capacity to meet its current and anticipated requirements. In addition, the Company anticipates no difficulty in retaining occupancy of any of its manufacturing, office or sales facilities through lease renewals prior to expiration or through month-to-month occupancy, or in replacing them with equivalent facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTEXAS INSTRUMENTS LITIGATION\nThe Company is a defendant in a lawsuit brought by Texas Instruments, Inc. (\"TI\") on July 9, 1990 in the United States District Court for the Western District of Texas (Dallas Division). The complaint alleges that certain plastic encapsulation processes conducted by the Company's subsidiaries in Ireland and the Philippines infringe two TI patents (both of which had expired by August 1994) and seeks an injunction and unspecified damages. The alleged infringement of one of these patents was also the subject matter of a proceeding brought by TI against the Company before the International Trade Commission (the \"ITC\") on July 9, 1990 seeking an injunction preventing the Company from importing allegedly infringing products into the United States.\nFollowing a hearing in May 1991, the ITC upheld the validity of the TI patent, determined that certain types of encapsulation processes practiced by the Company's subsidiaries infringed the TI patent and found that alternative encapsulation processes used by the Company's subsidiaries did not infringe the TI patent. The ITC also determined that, upon the merger of Precision Monolithics, Inc. (\"PMI\") into the Company in November 1990, the Company acquired the benefit of a license from TI to PMI for the TI patent. Pursuant to such license, the Company obtained what it believed was the right to import annually up to $94 million of integrated circuits using the patented encapsulation process. The decision of the ITC was upheld on appeal by the United States Court of Appeals for the Federal Circuit. Even if the Company's ability to utilize the full amount of the PMI license is upheld by the District Court, TI could seek damages for sales of allegedly infringing products between February 1989 and the November 1990 merger with PMI.\nOn January 10, 1994, the ITC brought an enforcement proceeding against the Company alleging that the Company had violated the ITC's cease and desist order of February 1992, as modified in July 1993. The ITC is seeking substantial penalties against the Company for these alleged violations. The Company has denied that it violated either of these orders. An initial hearing in this proceeding is scheduled to begin on February 13, 1995.\nOn June 19, 1992, the Company commenced a lawsuit in the United States District Court for the District of Massachusetts alleging that certain TI digital signal processors infringed a patent owned by the Company. TI has filed counterclaims in this action alleging that certain of the Company's products infringe four TI patents relating to digital signal processing and electrostatic discharge protection in integrated circuits. In its counterclaim, TI seeks an injunction against the Company from violating the TI patents and unspecified damages. The Company has denied the essential allegations in the TI counterclaims. A trial in this case is currently scheduled for June 1995.\nMAXIM LITIGATION\nThe Company is a defendant in a suit brought by Maxim Integrated Products, Inc. (\"Maxim\") on November 11, 1992 in the United States District Court for the Northern District of California. The complaint alleges violations of federal antitrust law and pendant state claims in connection with distribution arrangements between the Company and certain distributors. Maxim alleged that a number of these distributors ceased doing business with Maxim as a result of the distribution arrangements between the distributors and the Company. Maxim claims that those agreements have improperly restricted its access to channels by which it distributes its products. Maxim seeks, among other things, injunctive relief and actual, consequential and punitive damages. In a pre-trial submission dated August 31, 1994, Maxim asserted actual and consequential damages in the amount of $14.1 million. It also claims restitution and punitive damages in an unspecified amount. Under applicable law, Maxim would receive three times the amount of any actual damages suffered as a result of any antitrust violation.\nOn September 7, 1994, the Northern District of California ruled in favor of the Company on a summary judgment motion, dismissing all of Maxim's claim for lack of evidence. Maxim has appealed this ruling to the Ninth Circuit Court of Appeals, which has ordered that briefing of the appeal be concluded by March 7, 1995.\nFor additional information concerning the above described lawsuits and the potential impact of such suits upon the Company's financial condition and results of operations, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nOTHER\nThe Company has also received and made inquiries with regard to other possible patent infringement claims. These inquiries have been referred to counsel and are in various stages of discussion. If any infringements are determined to exist, the Company may seek or extend licenses or settlements. In addition, from time to time as a normal incidence of the nature of the Company's business, various claims, charges and litigation are asserted or commenced against the Company arising from or related to contractual relations, personal injury, environmental matters and product liability. While the Company cannot accurately predict the ultimate outcome of these other matters, at this time management believes that the likelihood of an outcome resulting in a material adverse effect on the Company's consolidated financial position, trends in results of operations or cash flows is remote.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Company's security holders during the last quarter of the fiscal year ended October 29, 1994.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following table sets forth (i) the name and age of each present executive officer of the Company; (ii) the position(s) presently held by each person named; and (iii) the principal occupations held by each person named for at least the past five years.\nPART 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 New York Stock Exchange under the symbol ADI. The table below sets forth the high and low prices of the Common Stock during the two most recent fiscal years.\nOn November 30, 1994, the Company's Board of Directors authorized a three-for-two stock split effected in the form of a 50% stock dividend distributed on January 4, 1995 to stockholders of record December 12, 1994. All stock prices in the table above have been restated to reflect the split.\nThe Company's $60,000,000 credit agreement restricts the aggregate of all cash dividend payments declared or made subsequent to October 29, 1994 to an amount not exceeding $85,147,000 plus 50% of the consolidated net income of the Company for the period from October 30, 1994 through the end of the Company's then most recent fiscal quarter. Although prior credit agreements may not have restricted the payment of dividends, the Company has never paid any cash dividends on its Common Stock.\nThe approximate number of holders of record of the Company's Common Stock at December 30, 1994 was 4,417. This number does not include shareholders for whom shares are held in a \"nominee\" or \"street\" name.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nFISCAL 1994 COMPARED TO FISCAL 1993\nNet sales of $773.5 million for fiscal 1994 increased 16% from net sales of $666.3 million for fiscal 1993. The sales increase was due principally to higher sales volumes of both standard linear IC and system-level IC products which together grew approximately 20% year-over-year to comprise approximately 90% of total sales for fiscal 1994.\nStandard linear IC sales rose $54.3 million or approximately 14% to $455.3 million in fiscal 1994. This increase was primarily due to the combination of increased penetration of the distribution channel coupled with well accepted new product offerings. As a percentage of total sales, standard linear products accounted for 59% in fiscal 1994 compared to 60% in fiscal 1993.\nSales of system-level IC products grew $59.6 million or approximately 34% to $234.6 million in fiscal 1994. This growth was attributable largely to increased demand for applications in personal computers and wireless communications products, and the Company's broader participation in these growing markets.\nSales of assembled products declined approximately 7% from fiscal 1993 to fiscal 1994 and as a percentage of total sales decreased from 14% to 11% over the same period. Despite the revenue declines in assembled products over the past few years and lower gross margins associated with these products, this product grouping remained profitable in 1994.\nSales to North American customers increased 18% over 1993 levels to $343.9 million with much of this increase coming from the distributor channel as sales through North American distributors increased 36% from the prior year. Sales to international customers grew 15% led by sales increases of approximately 27% and 35% in Japan and Southeast Asia, respectively. Sales growth in Japan was mainly attributable to increased demand for standard linear IC products, aided in part by the translation of yen-denominated sales to a weaker average U.S. dollar. The sales increase in Southeast Asia represented continued strength in sales of personal computer products. European sales of $197.9 million for fiscal 1994 were flat compared to the prior year due to weaker European industrial economies as compared to fiscal 1993. Sales growth in Europe resumed in the fourth quarter of fiscal 1994, growing again after weakness in the first nine months of the year as the European economy showed improvement, particularly Germany. As a percentage of total net sales, North American and international sales remained at 44% and 56%, respectively, which are comparable to fiscal 1993.\nGross margin improved to 49.0% of sales for fiscal 1994 compared to 47.3% for fiscal 1993. This increase resulted principally from a significant improvement in gross margin for system-level IC products as variable manufacturing costs declined and fixed costs were allocated over greater production volumes. Gross margin for the Company's standard linear IC products remained at a high level and gross margin on all IC products, which include both standard linear and system-level ICs, was approximately 50% of sales. Overall gross margin for fiscal 1995 will depend primarily on the gross margin from system-level IC products and the relative mix of sales between standard linear and system-level ICs. During fiscal 1995, the Company does not anticipate overall gross margin to improve at the same rate of improvement as achieved in fiscal 1994.\nResearch and development expenses for fiscal 1994 increased 13.6% from fiscal 1993 as the Company continued to invest in new product development. As a percentage of sales, R&D expenses were 13.8% compared to 14.1% for the prior year. R&D expenses for fiscal 1995 are expected to increase approximately 15% to 20% over fiscal 1994 levels as the Company expands its investments in communications, digital signal processing and micromachining technology.\nSelling, marketing, general and administrative (SMG&A) expenses grew 7.4% compared to fiscal 1993, increasing at a lower rate than sales. As a result, SMG&A as a percentage of sales decreased to 22.0% for fiscal 1994 from 23.8% for fiscal 1993. The increase in SMG&A expenses related mostly to increased strategic advertising and marketing expenses associated with many new product launches and additional incentive expense associated with the Company's improved performance.\nIn total, operating expenses were reduced to 35.8% of sales, down from 37.9% one year ago, consistent with the Company's emphasis on maintaining tight control over all costs in order to gain better operating leverage on increases in revenues. A key factor in controlling operating expenses has been holding worldwide employment relatively flat at levels approximately equal to that of 1990, while revenues have grown significantly since that time.\nOperating income reached 13.2% of sales for fiscal 1994, an increase of nearly four percentage points from 9.4% of sales for fiscal 1993. This performance gain reflected the higher sales level, improvement in gross margin as a percent of sales and a slower rate of expense growth versus sales.\nNonoperating expenses decreased $2.3 million, benefiting from increased interest income on a higher level of invested cash as net interest expense was reduced from $5.8 million in fiscal 1993 to $2.0 million in fiscal 1994. Due to the funding of fiscal 1995 planned capital expenditures with cash on hand and expected operating cash flows, the Company expects interest income to decline in fiscal 1995.\nThe effective income tax rate increased to 23% in fiscal 1994 from 20% in fiscal 1993 due to a shift in the mix of worldwide income. In the first quarter of fiscal 1994, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (FAS 109). The impact of adopting FAS 109 was not material to the Company's consolidated financial statements. See Note 1(k), \"Income Taxes,\" in the Notes to Consolidated Financial Statements for information concerning the adoption of FAS 109.\nThe growth in sales, improved operating performance and lower nonoperating expenses resulted in a 68% rise in net income to $74.5 million or 9.6% of sales compared to $44.5 million or 6.7% of sales in fiscal 1993.\nThe Company has not yet adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" and Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Adoption of these statements which is required in fiscal year 1995 is not expected to have a material impact on the Company's consolidated financial statements.\nThe impact of inflation on the Company's business during the past three years has not been significant.\nFISCAL 1993 COMPARED TO FISCAL 1992\nNet sales rose 17% to $666.3 million for fiscal 1993, compared to fiscal 1992 sales of $567.3 million. Sales growth in fiscal 1993 was principally attributable to increased sales volumes. Overall market demand for integrated circuits remained strong throughout fiscal 1993, with the Company benefiting from this demand both in its broad-based, standard-function linear IC business and in its application specific, system-level IC business. Total IC sales, including both standard linear IC and system-level IC products, increased $113 million or 24% in fiscal 1993 to comprise 87% of total sales. Sales of assembled products declined approximately 14% in fiscal 1993.\nSales of standard linear IC products increased $38 million or approximately 10% in fiscal 1993. As a percentage of sales, standard linear IC products accounted for 60% in fiscal 1993 compared to 64% in fiscal 1992. Increased distribution sales, which represented approximately 40% of total standard linear IC sales, and new product offerings led to much of the growth in sales of standard linear IC products.\nSales of system-level ICs grew by more than 70% to $175 million, or 26% of total sales. This growth was fueled by increasing success in fast growing sectors of the communications and computer markets in fiscal 1993.\nAssembled product sales declined by $14 million or approximately 14% in fiscal 1993. Assembled products continued to decline as a percentage of total revenues as well, falling to 14% of total sales in fiscal 1993. Despite the 14% decline in revenues of assembled products, this product grouping was profitable for fiscal 1993.\nSales in North America grew approximately 8% over the prior year to $292.1 million. The distributor channel in North America was a major contributor to this growth with sales through distributors increasing approximately 24% in fiscal 1993. Sales to all international customers increased 26% with sales in Europe, Japan and export sales to Southeast Asia increasing 17%, 20% and 74%, respectively. Much of the sales growth in Southeast Asia resulted from design-ins achieved in the U.S. and Western Europe for applications in personal computers. Sales growth in Europe was fueled largely by strong sales of system-level ICs used in the GSM digital cellular phone network. Demand showed renewed strength in Japan from the depressed levels in fiscal 1992 with the fiscal 1993 sales increase mainly attributable to increased\nsales of standard linear IC products. A weaker average dollar exchange rate year-to-year also contributed to some of the Japanese sales improvement. As a percentage of total net sales, North American sales decreased from 47% in fiscal 1992 to 44% in fiscal 1993 and international sales increased from 53% in fiscal 1992 to 56% in fiscal 1993. This shift reflected a significant increase in sales to customers in Southeast Asia.\nGross margin improved slightly to 47.3% of sales in fiscal 1993 from 46.8% in fiscal 1992 due to continued control of manufacturing costs.\nR&D expenses for fiscal 1993 grew approximately 7% over the prior year but as a percentage of sales decreased to 14.1%, down from 15.5% of sales for fiscal 1992. This improvement was the result of continuing efforts to focus R&D on the most promising opportunities where the Company can build a sustainable competitive advantage and earn high return factors.\nSMG&A expenses grew 5% in absolute dollars in fiscal 1993, increasing at a much lower rate than sales. As a result, the SMG&A to sales ratio declined from 26.7% for fiscal 1992 to 23.8% for fiscal 1993. The 5% growth in SMG&A expenses principally reflected normal increases for salaries and benefits and increased incentive expense associated with the Company's performance.\nOperating income for fiscal 1993 was $62.7 million or 9.4% of sales, more than double the $26.2 million or 4.6% of sales for fiscal 1992. The significant improvement in operating income was the result of increased sales, improved gross margin performance and tight operating expense controls which allowed the Company to gain strong operating leverage on increased revenues.\nInterest expense for fiscal 1993 increased to $7.2 million from $6.0 million in fiscal 1992. This increase resulted from a higher level of total borrowings in fiscal 1993 which included the issuance of $80 million of long-term debt during the year. Interest expense net of interest income was $5.8 million for fiscal 1993 compared to $5.1 million for fiscal 1992 as the increased interest expense on a higher level of debt was offset to some degree by interest income earned on a higher level of invested cash resulting from increased cash flows from operations combined with the excess proceeds from the $80 million offering.\nThe effective income tax rate decreased slightly to 20% in fiscal 1993 from 21% in fiscal 1992. The tax provisions for both fiscal 1993 and fiscal 1992 were driven largely by the high proportion of income earned by the Company's Irish operation for which earnings are taxed at a lower rate.\nNet income was $44.5 million, or three times the $14.9 million earned in fiscal 1992. As a percentage of sales, net income was 6.7% in fiscal 1993 versus 2.6% in fiscal 1992.\nLIQUIDITY AND CAPITAL RESOURCES\nAt October 29, 1994, cash and cash equivalents and short-term investments totaled $181.8 million, an increase of $101.1 million from $80.7 million at the end of fiscal 1993. Increased cash and cash equivalents and short-term investments resulted from a significant improvement in cash provided from operations compared to fiscal 1993. During fiscal 1994, the Company invested $72.7 million in short-term investments including commercial paper, certificates of deposit and bankers' acceptances with maturities greater than three months and less than one year.\nCash provided by operating activities was $183.3 million or 23.7% of sales for fiscal 1994 compared to $89.5 million or 13.4% of sales for fiscal 1993. The increase in operating cash flows in fiscal 1994 was mainly attributable to higher net income together with a decrease in inventories and an increase in accounts payable, which were offset in part by growth in accounts receivable.\nAccounts receivable of $162.3 million at the end of fiscal 1994 increased $16.7 million or 11.4% from $145.7 million at the end of fiscal 1993. The primary factors contributing to the increase in accounts receivable were the 14% growth in fourth quarter sales between the two years and the translation of local currency denominated receivables to a weaker U.S. dollar, particularly in Japan. These increases were offset in part by improved collection of receivables. Despite the increase in accounts receivable in dollars year-to-year, accounts receivable as a percentage of annualized fourth quarter sales decreased slightly to 20.0% at the end of fiscal 1994 compared to 20.3% at the end of fiscal 1993.\nInventories declined $19.7 million during fiscal 1994 to $130.7 million. As a percentage of annualized fourth quarter sales, inventories were reduced from 21.0% to 16.1% which the Company believes is an appropriate level.\nThe increase in accounts payable compared to fiscal 1993 primarily reflected fourth quarter fiscal 1994 expenditures associated with the expansion of the Company's Irish facility as described below.\nNet additions to property, plant and equipment of $90.9 million in fiscal 1994 were funded with internally generated cash flow from operations. Nearly half of these expenditures occurred in the fourth quarter as expansion of the Company's wafer fabrication facilities in Limerick, Ireland commenced. This expansion will include the addition of 6-inch submicron wafer fabrication capability intended primarily to meet the future demands associated with the Company's growth. Capital expenditures for fiscal 1995 are currently expected to be approximately $150 million, including approximately $65 million of capital expenditures associated with the Limerick wafer fabrication expansion. The Company expects to finance its planned fiscal 1995 capital additions with cash, cash equivalents and short-term investments on hand, coupled with internally generated cash flow from operations.\nAt October 29, 1994, substantially all of the Company's lines of credit were unused, including its four-year, $60 million credit facility. In the first quarter of fiscal 1995, the Company's 7.18%, $20.0 million loan matured. Upon maturity, this loan was repaid in full with cash and cash equivalents on hand.\nThe Company believes that its strong financial condition, existing sources of liquidity, available capital resources and cash expected to be generated from operations leave it well positioned to obtain the funds required to meet its current and future business requirements.\nLITIGATION\nAs set forth in \"Business-Legal Proceedings,\" the Company is engaged in patent infringement litigation with Texas Instruments, Inc. (\"TI\") and antitrust litigation with Maxim Integrated Products, Inc. (\"Maxim\"). See Item 3, \"Business - Legal Proceedings\" for additional information concerning these lawsuits.\nIf it is determined that the Company has violated the cease and desist order entered by the ITC in February 1992, as modified in July 1993, the ITC could seek to impose penalties of up to $100,000 per day or equal to twice the value of the goods determined to be sold in violation of the order. If, in the district court action, it is found that certain plastic encapsulation processes used by the Company infringe TI's patents or that the Company did not obtain from PMI valid license rights to import up to $94 million annually of circuits using TI's patented process, the court could award TI substantial damages. Even if the district court upholds the validity of the PMI license, if it finds infringement by the Company, TI could seek damages for sales of allegedly infringing products between February 1989 and the November 1990 merger with PMI.\nThe dismissal of Maxim's claims has been appealed. The Company believes it has meritorious defenses to Maxim's antitrust allegations and intends to vigorously defend the suit. If the dismissal is overturned on appeal and Maxim's claims are upheld in a subsequent trial on the merits, in addition to potential damage awards the Company may be required to modify its relationships with its distributors.\nAlthough the Company believes it should prevail in the matters described above, the Company is unable to determine their ultimate outcome or estimate the ultimate amount of liability, if any, at this time. An adverse resolution of these matters could have a material adverse effect on the Company's consolidated financial position or on its consolidated results of operations or cash flows in the period in which the matters are resolved.\nFACTORS AFFECTING FUTURE RESULTS\nThe Company's future results remain difficult to predict and may be affected by a number of factors including business conditions within the semiconductor industry and the world economies as a whole, competitive pressures and cyclical market patterns. In addition, the Company's revenue growth is driven by a continuing flow of new products; more than 40% of the orders received by the Company in fiscal 1994 were for products introduced within the preceding five years. The success of many of these products and the Company's growth opportunities are dependent on successful penetration of new high volume computer, communication, and automotive segments of the electronics market where the Company has less experience and competition is substantial. No assurance can be given that new products can be developed, or if developed, will be successful; that market demand or customer acceptance will be realized; that demand if achieved will be sustained; that competitors will not force prices to an unacceptably low level or take market share from the Company;\nor that the Company can achieve or maintain profits in these markets. Also, some of the customers in these markets are less well established which could subject the Company to increased credit risk. Because of these and other factors, past financial performance should not be considered an indicator of future performance. Investors should not use historical trends to anticipate future results and should be aware that the Company's stock price frequently experiences significant volatility.\nANALOG DEVICES, INC.\nANNUAL REPORT ON FORM 10-K\nYEAR ENDED OCTOBER 29, 1994\nITEM 8","section_7A":"","section_8":"ITEM 8\nFINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL INFORMATION\nANALOG DEVICES, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Analog Devices, Inc.\nWe have audited the accompanying consolidated balance sheets of Analog Devices, Inc. as of October 29, 1994, October 30, 1993 and October 31, 1992, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended October 29, 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 Analog Devices, Inc. at October 29, 1994, October 30, 1993 and October 31, 1992, and the consolidated results of its operations and its cash flows for each of the three years in the period ended October 29, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 6 to the consolidated financial statements, claims and actions have been brought against Analog Devices, Inc. and the ultimate outcome of these claims and actions cannot presently be determined. Accordingly, no provision for any liability, if any, that may result has been made in the financial statements.\nERNST & YOUNG LLP\nBoston, Massachusetts November 29, 1994\nANALOG DEVICES, INC. CONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes.\nSee accompanying notes.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED OCTOBER 29, 1994, OCTOBER 30, 1993 AND OCTOBER 31, 1992 (ALL TABULAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. PRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and all of its wholly owned subsidiaries. All intercompany balances and transactions are eliminated. The Company's fiscal year ends on the Saturday closest to the last day in October. Fiscal years 1994, 1993 and 1992 were each 52-week years.\nB. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS\nCash and cash equivalents are highly liquid investments with a maturity of three months or less at the time of acquisition. Cash and cash equivalents are stated at cost which approximates fair value.\nShort-term investments consist of commercial paper, certificates of deposit and bankers' acceptances with maturities greater than three months and less than one year at the time of acquisition. The short-term investments are stated at cost which approximates fair value due to the short maturity of these instruments.\nThe Company is required to adopt Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" (FAS 115) in fiscal 1995. Adoption of FAS 115 is not expected to have a material impact on the Company's consolidated financial statements.\nA director of the Company is also a director of a raw material supplier. Total purchases from this supplier approximated $28,435,000 in 1994, $37,990,000 in 1993 and $21,984,000 in 1992. Accounts payable to this supplier at October 29, 1994, October 30, 1993 and October 31, 1992 approximated $1,090,000, $3,639,000 and $3,655,000, respectively. Another director of the Company was also a director of a raw material supplier through June 1993. Total purchases from this supplier approximated $1,510,000 in 1993 and $5,216,000 in 1992. Accounts payable to this supplier at October 31, 1992 approximated $397,000. The Company believes that the terms of these purchases were comparable to those available from other suppliers.\nD. PROPERTY, PLANT AND EQUIPMENT\nThe straight-line method of depreciation is used for all classes of assets for financial statement purposes; both straight-line and accelerated methods are used for income tax purposes. Capitalized leases and leasehold improvements are amortized based upon the lesser of the term of the lease or the useful life of the asset. Depreciation and amortization are based on the following useful lives:\nBuildings & Building Equipment Up to 25 years Machinery & Equipment 3-10 years Office Equipment 3-8 years\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nTotal depreciation and amortization of property, plant and equipment was $59,240,000, $57,732,000 and $52,858,000 in 1994, 1993 and 1992, respectively.\nE. INTANGIBLE ASSETS\nIntangible assets at October 29, 1994 consist of goodwill, patents and other intangibles. Goodwill is being amortized on a straight-line basis over a fifteen-year period. Patents and other intangibles are being amortized on a straight-line basis over their estimated economic lives which range from four to fifteen years. Amortization expense for all intangible assets was $2,044,000, $2,081,000 and $2,092,000 in 1994, 1993 and 1992, respectively. Accumulated amortization for all intangible assets was $8,636,000, $6,657,000 and $4,706,000 at October 29, 1994, October 30, 1993 and October 31, 1992, respectively.\nF. TRANSLATION OF FOREIGN CURRENCIES\nThe functional currency for the Company's foreign sales operations is the applicable local currency. Gains and losses resulting from translation of these foreign currencies into U.S. dollars are accumulated in a separate component of stockholders' equity. Transaction gains and losses are included in income currently, including those at the Company's principal foreign manufacturing operations where the functional currency is the U.S. dollar.\nG. FOREIGN CURRENCY INSTRUMENTS AND INTEREST RATE AGREEMENTS\nThe Company enters into forward foreign exchange contracts, foreign currency option contracts and currency swap agreements to offset certain operational and balance sheet exposures from changes in foreign currency exchange rates. Such exposures result from the portion of the Company's operations, assets and liabilities that are denominated in currencies other than the U.S. dollar. These foreign exchange contract, option and swap transactions are entered into to support normal recurring purchases, product sales and financing transactions, and accordingly, are not speculative in nature.\nForward foreign exchange contracts are utilized to manage the risk associated with currency fluctuations on certain firm purchase commitments, firm sales commitments and certain non-U.S. dollar denominated asset and liability positions. The forward foreign exchange contracts that relate to firm purchase and sales commitments are designated as effective hedges of firm foreign currency commitments, and accordingly, the gains and losses on these contracts are deferred and included in the measurement of the related foreign currency transaction. Gains and losses on forward foreign exchange contracts designated to hedge foreign currency assets and liabilities are recognized in income as the exchange rates change and offset the foreign currency gains and losses on the related transactions. The face amounts of forward foreign exchange contracts outstanding at October 29, 1994, October 30, 1993 and October 31, 1992 were $136.4 million, $107.9 million and $107.4 million, respectively. Forward foreign exchange contracts outstanding at October 29, 1994 have maturities of up to 14 months.\nThe Company also may periodically purchase foreign currency option contracts to hedge certain probable anticipated, but not firmly committed, foreign currency transactions related to the sale of product during the ensuing twelve months. These foreign currency option contracts are designated as effective hedges of such transactions, and accordingly, the costs and any gains associated with these option contracts are deferred and included in the measurement of the related foreign currency transaction. When the dollar strengthens significantly against the foreign currencies, the decline in value of future foreign currency cash flows is partially offset by the gains in the value of purchased currency options designated as hedges. Conversely, when the dollar weakens, the increase in the value of future foreign currency cash flows is reduced only by the premium paid to acquire the options. The face amounts of foreign currency option contracts outstanding at October 29, 1994, October 30, 1993 and October 31, 1992 were $28.6 million, $29.0 million and $27.3 million, respectively. Purchased foreign currency options outstanding at October 29, 1994 have maturities of up to 6 months.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCurrency swap agreements are utilized to hedge the net investment in certain foreign subsidiaries. Realized and unrealized gains and losses on such agreements related to the net foreign investment being hedged are recognized in the cumulative translation adjustment component of stockholders' equity. The face amount of currency swap agreements outstanding at October 29, 1994 was $10.0 million. Currency swap agreements outstanding at October 29, 1994 have maturities of up to one year.\nThe Company enters into interest rate swap and cap agreements to partially modify the interest characteristics of its financing arrangements from a fixed to a floating rate basis. These agreements involve the receipt of fixed rate amounts in exchange for floating rate interest payments over the life of the agreement without an exchange of the underlying principal amounts. The differential to be paid or received is accrued as interest rates change and recognized as an adjustment to interest expense related to the financing arrangement. The related amount payable to or receivable from counterparties is included in liabilities or assets. The notional principal amounts of interest rate swap and cap agreements outstanding at October 29, 1994 and October 30, 1993 were $50.5 million and $40.0 million, respectively. Interest rate swap and cap agreements outstanding at October 29, 1994 have maturities of up to 12 years.\nThe cash requirements of the above-described foreign currency instruments and interest rate swap and cap agreements approximate their fair value. Cash flows associated with these financial instruments are classified consistent with the cash flows from the transactions being hedged.\nThe foreign currency instruments and interest rate swap and cap agreements involve, to a varying degree, elements of market and interest rate risk not recognized in the consolidated financial statements. While the contract or notional amounts are often used to express the volume of the above-described instruments, the amounts potentially subject to credit risk are generally limited to the amounts, if any, by which the counterparties' obligations under the agreements exceed the obligations of the Company to the counterparties. The Company controls credit risk through credit approvals, limits and monitoring procedures including the use of high credit quality counterparties.\nH. CONCENTRATIONS OF CREDIT RISK\nFinancial instruments which potentially subject the Company to concentrations of credit risk consist principally of investments and trade accounts receivable.\nThe Company maintains cash, cash equivalents and short-term investments with high credit quality financial institutions and monitors the amount of credit exposure to any one financial institution.\nThe Company sells its products to distributors and original equipment manufacturers involved in a variety of industries including industrial automation, instrumentation, military\/aerospace, and to an increasing degree, computers and peripherals, telecommunications and high performance consumer electronics. The Company has adopted credit policies and standards to accommodate growth into these markets. The Company believes that any risk of accounting loss with respect to trade accounts receivable is limited due to the diversity of its products, end customers and geographic sales areas. The Company performs continuing credit evaluations of its customers financial condition and although the Company generally does not require collateral, letters of credit may be required from its customers in certain circumstances. Due to the Company's credit evaluation and collection process, bad debt losses have been insignificant.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nI. FAIR VALUE OF FINANCIAL INSTRUMENTS\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, \"Disclosures About Fair Value of Financial Instruments.\"\nThe following estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment 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.\nThe following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:\nCash, cash equivalents and short-term investments -The carrying amounts of these items are a reasonable estimate of their fair value due to the short term to maturity and readily available market for these types of investments.\nShort-term borrowings-The carrying amounts of these variable-rate borrowings approximate fair value due to the short period of time to maturity.\nLong-term debt-The fair value of long-term debt is estimated based on current interest rates available to the Company for debt instruments with similar terms, degree of risk and remaining maturities.\nInterest rate swap and cap agreements-The fair value of interest rate swap and cap agreements are obtained from dealer quotes. These values represent the estimated amount the Company would receive or pay to terminate the agreements taking into consideration current interest rates.\nForward foreign currency exchange contacts-The estimated fair value of forward foreign currency exchange contracts is based on the estimated amount at which they could be settled based on market exchange rates.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nForeign currency option contracts and currency swap agreement-The fair values of foreign currency option contracts and currency swap agreement are obtained from dealer quotes. These values represent the estimated amount the Company would receive or pay to terminate the agreements.\nJ. REVENUE RECOGNITION\nRevenue from product sales to end users is recognized upon shipment. A portion of the Company's sales are made to domestic distributors under agreements allowing for price protection and certain rights of return on merchandise unsold by the distributors. Because of the uncertainty associated with pricing concessions and future returns, the Company defers recognition of such sales and related gross margin until the merchandise is sold by the distributors. For sales to international distributors, the Company recognizes the sale upon shipment to the distributor, but provides specific reserves for possible returns and allowances.\nK. INCOME TAXES\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (FAS 109). FAS 109 requires a change from the deferred method of accounting for income taxes under APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of FAS 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 FAS 109, the effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.\nEffective October 31, 1993 the Company adopted FAS 109. The adoption of FAS 109 was not material to the consolidated financial statements. As permitted by FAS 109, prior years' financial statements have not been restated.\nPursuant to the deferred method under APB Opinion 11, which was applied at October 30, 1993 and in prior fiscal 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 calculation. Under the deferred method, deferred taxes are not adjusted for subsequent changes in tax rates.\nL. STOCK SPLIT\nOn November 30, 1994, the Company's Board of Directors authorized a three-for-two stock split effected in the form of a 50% stock dividend distributed on January 4, 1995 to stockholders of record December 12, 1994. The split was accomplished through the issuance of common stock and the reissuance of treasury stock. All references to share and per share amounts have been restated to reflect the split.\nM. EARNINGS PER SHARE OF COMMON STOCK\nPrimary earnings per common share are computed based on the weighted average number of common shares outstanding during the year, adjusted for incremental shares assumed issued for dilutive common stock equivalents. Fully diluted earnings per share do not differ materially from primary earnings per share.\nN. RECLASSIFICATIONS\nCertain amounts reported in previous years have been reclassified to conform to the 1994 presentation.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n2. INDUSTRY AND GEOGRAPHIC SEGMENT INFORMATION\nINDUSTRY\nThe Company operates predominantly in one industry segment: the design, manufacture and marketing of a broad line of high-performance linear, mixed-signal and digital integrated circuits that address a wide range of real-world signal processing applications.\nGEOGRAPHIC INFORMATION\nThe Company operates in three major geographic areas. information on the Company's geographic operations is set forth in the table below. the predominant countries comprising European operations are England, France, Germany and Ireland. The predominant country comprising Asian operations is Japan. For segment reporting purposes, sales generated by North American operations in the table include export sales of $96,700,000, $71,542,000 and $41,010,000 in 1994, 1993 and 1992, respectively; sales generated by European operations include export sales of $1,267,000 in 1992. Transfers between geographic areas are based on market comparables and are consistent with prevailing tax regulations. Operating income reflects the allocation of corporate expenses of $19,718,000, $17,174,000 and $14,901,000 in 1994, 1993 and 1992, respectively, to the appropriate geographic area based upon their beneficial and causal relationship to each area. Corporate identifiable assets consist of cash equivalents, short-term investments and intangible assets.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n4. DEBT AND CREDIT FACILITIES\n6 5\/8% NOTES\nON March 11, 1993, the Company completed a public offering of $80 million of seven-year 6 5\/8% notes due March 1, 2000 with semiannual interest payments on March 1 and September 1. The net proceeds of the offering were approximately $79 million after payment of the underwriting discounts and expenses of the offering which were deferred and are being amortized to interest expense over the term of the Notes. Approximately $60.0 million of the net proceeds was used to repay in full outstanding U.S. dollar borrowings under the Company's revolving credit agreement. Simultaneous with the sale of the Notes, the Company entered into an interest rate swap and cap agreement for the term of the Notes having a notional principal amount of $40 million whereby the effective net interest rate on $40 million of the Notes will be the six-month libor rate (up to a maximum of 7%) plus 1.4%. For the year ended October 29, 1994, the net effective interest rate on $40 million of the Notes was 6.6% after giving effect to the interest rate swap agreement.\nFIXED RATE TERM LOAN\nThe Company has an unsecured, three-year term loan with a bank in the amount of $20,000,000 at a fixed interest rate of 7.18% per annum. Under this agreement, the Company is generally subject to the same financial covenants as are contained in the Revolving Credit Agreement described below. The Company was in compliance with all covenants under this agreement at October 29, 1994. This loan was repaid in full at maturity on November 14, 1994.\nREVOLVING CREDIT AGREEMENT AND LINES OF CREDIT\nThe Company has a revolving credit agreement with several banks which commits them to lend up to $60,000,000. The terms of the credit agreement provide that interest on U.S. dollar borrowings may not exceed the greater of the prime rate or the federal funds rate plus .50%. Under this agreement, the Company also has the option to borrow both U.S. dollars and foreign currencies at interest rates tied to various money market instruments, customarily below the prime rate. Under the credit agreement, the Company is currently required to pay fees of .05 of 1% per annum on the unused portion of the lending commitment and .15 of 1% per annum on the total amount of the committed facility. All borrowings under the credit agreement are due no later than September 8, 1998. Borrowing from banks not participating in the agreement is permitted as long as the Company maintains certain required financial ratios. The credit agreement requires the Company to maintain stated minimum net worth and current ratio levels, plus a stated maximum ratio of total liabilities to net worth. In addition, the credit agreement restricts the aggregate of all cash dividend payments declared or made subsequent to October 29, 1994 to an amount not exceeding $85,147,000 plus 50% of the consolidated net income of the Company for the period from October 30, 1994 through the end of the Company's then most recent fiscal quarter. At October 29, 1994, the Company was in compliance with all covenants under the credit agreement. There are no compensating balance requirements under the credit agreement. In addition to the credit agreement, the Company also has various unsecured, uncommitted money market lines of credit with its credit agreement and other banks which provide for short-term borrowings.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe weighted average interest rates of U.S. dollar borrowings under the credit agreement and the uncommitted money market lines of credit were 4.0% and 4.3% during 1993 and 1992, respectively. The weighted average interest rate of U.S. dollar borrowings under the credit agreement and the uncommitted money market lines of credit was 4.1% at October 31, 1992. There were no variable rate U.S. dollar borrowings under the credit agreement or the uncommitted money market lines of credit during 1994 nor were there any such borrowings outstanding at October 29, 1994 or October 30, 1993. The weighted average interest rates of foreign currency borrowings under foreign lines of credit were 8.7%, 10.9% and 12.4% during 1994, 1993 and 1992, respectively. The weighted average interest rates of foreign currency borrowings were 7.4%, 11.8% and 11.7% at October 29, 1994, October 30, 1993 and October 31, 1992, respectively. There were $2.9 million of foreign currency borrowings outstanding at October 29, 1994, which were at prevailing money market rates for the respective currencies. Borrowings under the Company's credit agreement and lines of credit are generally due within six months. In 1992, however, a portion of these borrowings were classified as long-term debt based on the Company's intention to refinance a portion of these borrowings on a long-term basis and the ability to refinance these borrowings under the credit agreement.\nAggregate principal payments on long-term debt and short-term borrowings for the following fiscal years are: 1995-$22.9 million; 2000-$80.0 million.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n5. LEASE COMMITMENTS\nThe Company leases certain of its facilities and equipment under various operating and capital leases which expire at various dates through 2010. The lease agreements frequently include renewal and purchase provisions and require the Company to pay taxes, insurance and maintenance costs.\nTotal rental expense under operating leases was $9,985,000, $8,853,000 and $9,268,000 in 1994, 1993 and 1992, respectively.\n6. COMMITMENTS AND CONTINGENCIES\nThe Company is a defendant in a lawsuit brought by Texas Instruments, Incorporated (TI) claiming damages for the Company's alleged infringement of certain patents related to plastic encapsulation of semiconductor devices. The lawsuit relates to sales of plastic encapsulated products sold between February 1989 and August 1994 when the patents expired. In January 1994, the International Trade Commission (ITC) brought an enforcement proceeding against the Company alleging that the Company had violated the terms of the Commission's February 1992 cease and desist order (as modified in July 1993) relating to the importation of plastic encapsulated products into the United States from the Company's foreign subsidiaries. If the Company is found to be in violation of the orders, it may be subject to substantial penalties. The Company has denied the essential allegations in the complaints and believes that it has meritorious defenses in each of these actions which it intends to vigorously pursue. The Company also has a lawsuit pending against TI in which the Company alleges that TI infringed one of its patents relating to digital signal processing products, and TI has filed counterclaims.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Company is a defendant in a lawsuit brought by Maxim Integrated Products, Inc. (\"Maxim\") seeking an injunction against, and claiming damages for, alleged antitrust violations and unfair competition in connection with distribution arrangements between the Company and certain distributors. Maxim alleged that certain distributors ceased doing business with Maxim as a result of the distribution arrangements between the distributors and the Company, resulting in an improper restriction to Maxim's access to channels by which it distributes its products. Maxim asserted actual and consequential damages in the amount of $14.1 million and unspecified claims for restitution and punitive damages. Under applicable law, Maxim would receive three times the amount of any actual damages suffered as a result of any antitrust violation. On September 7, 1994, Maxim's claim was dismissed for lack of evidence. Maxim has appealed this ruling and briefing of the appeal is scheduled to be concluded by March 7, 1995.\nAlthough the Company believes it should prevail in the matters described in the previous two paragraphs, the Company is unable to determine their ultimate outcome or estimate the ultimate amount of liability, if any, at this time. An adverse resolution of these matters could have a material adverse effect on the Company's consolidated financial position or on its consolidated results of operations or cash flows in the period in which the matters are resolved.\nFrom time to time as a normal incidence of the nature of the Company's business, various claims, charges and litigation are asserted or commenced against the Company arising from or related to contractual relations, personal injury, environmental matters and product liability. The Company has also received and made inquiries with regard to other possible patent infringement claims. These inquiries have been referred to counsel and are in various stages of discussion. If any infringements are determined to exist, the Company may seek or extend licenses or settlements. While the Company cannot accurately predict the ultimate outcome of the matters referred to in this paragraph, at this time management believes that the likelihood of an outcome resulting in a material adverse effect on the Company's consolidated financial position, trends in results of operations or cash flows is remote.\nThe Company's wholly owned manufacturing facility in the Republic of Ireland has received operating and capital grants. A liability to repay up to $19.2 million of the grants received by the Company would arise in the unlikely event the Company should liquidate its Irish operation prior to the commitment periods noted in the grant agreements which expire at various dates through 1999.\nUnder the terms of the lease agreement related to the Company's headquarters facility in Norwood, Massachusetts, the Company has agreed to assume the note related to the property in the case of default by the lessor. Assumption of the note, which was $10.5 million at October 29, 1994, would entitle the Company to a first lien on the property. In addition, the Company may be subject to an incremental rent payment if the Company were to either default on the lease or not exercise its option to extend the lease at the end of the current fifteen-year term. This payment would be the present value of the balance of the lessor's debt related to the property in excess of $6.5 million at the end of the current lease term. As of October 29, 1994, the Company's unrecorded financial risk of loss under this agreement was $1.5 million in the unlikely event of default.\n7. STOCKHOLDERS' EQUITY\nCOMMON STOCK\nIn December 1994, the Board of Directors authorized an amendment to the Company's Articles of Organization to increase the authorized number of shares of common stock from 150,000,000 to 300,000,000 subject to stockholder approval in March 1995.\nSTOCK PLANS\nThe 1988 Stock Option Plan provides for the issuance of nonstatutory and incentive stock options to purchase up to 10,350,000 shares of common stock. Under this plan, options may be granted to key employees of the Company and its subsidiaries at a price not less than 100% of the fair market value of the underlying stock on the date of grant. The Company's 1980 Stock Option Plan was terminated upon adoption of the 1988 Stock Option Plan; however, options to purchase common stock remain outstanding under this plan.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nUnder the 1992 Director Option Plan, each nonemployee director receives nonstatutory options to purchase 15,000 shares of common stock at an exercise price equal to the fair market value on the date of grant. A total of 150,000 shares of common stock may be issued under this plan. In December 1994, the Board of Directors authorized the 1994 Director Option Plan under which each nonemployee director will receive options to purchase 5,250 shares of common stock annually at an exercise price equal to the fair market value on the date of grant. These options vest ratably over a three-year period. A total of 200,000 shares of common stock are reserved for issuance under the plan which is subject to stockholder approval in March 1995. Upon adoption of the 1994 Director Option Plan by the stockholders, no additional options will be granted under the 1992 Director Option Plan.\nWhile the Company may grant options to employees which become exercisable at different times or within different periods, the Company has generally granted options which are exercisable in annual installments of 33.3% each during the third, fourth and fifth years after the date of grant.\nThe Company has a stock purchase plan that allows eligible employees to purchase, through payroll deductions, shares of the Company's common stock at 85% of the fair market value at specified dates. Employees purchased 523,800 shares in 1994 (754,500 and 513,500 in 1993 and 1992, respectively) for $6.0 million ($4.2 million and $2.8 million in 1993 and 1992, respectively). At October 29, 1994, 1,422,000 common shares remained available for issuance under the plan.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nUnder the 1991 Restricted Stock Plan, a maximum of 1,050,000 shares of common stock may be awarded by the Company to key employees for nominal consideration. This plan succeeded the Company's 1978 Restricted Stock Plan which provided for the issuance of up to 3,686,400 shares of common stock. Shares awarded from both plans are restricted as to transfer, usually for a period of five years and, under certain conditions, may be subject to repurchase by the Company at the original purchase price per share. Shares awarded under the Company's restricted stock plans, net of cancellations, for 1994, 1993 and 1992 were 243,000, 21,000 and 231,000, respectively. The fair market value of the shares at the date of award was accounted for as deferred compensation and is being amortized over the restricted period. During 1994, 1993 and 1992, $1,851,000, $1,716,000 and $1,887,000, respectively, of such compensation was charged to expense. At October 29, 1994, there were 275,250 shares of common stock available for issuance under the 1991 Restricted Stock Plan.\nWARRANTS\nIn 1990, the Company issued warrants for the purchase of 1,500,000 shares of common stock. Each warrant entitles the holder to purchase one share of the Company's common stock at an exercise price of $8 per share, subject to certain adjustments, anytime prior to the expiration of the warrants on August 7, 1997. At October 29, 1994, all of the warrants were outstanding.\nAs of October 29, 1994, a total of 13,365,000 common shares were reserved for issuance under the company's stock plans and warrant agreement.\nPREFERRED STOCK\nThe Company has 500,000 authorized shares of $1.00 par value Preferred Stock. The Board of Directors is authorized to fix designations, relative rights, preferences and limitations on the preferred stock at the time of issuance. The Company had previously authorized 35,000 shares of such Preferred Stock as Series A Convertible Preferred Stock, of which 28,066 shares were sold in prior years. As of June 14, 1990, all of these shares had been fully converted to common stock.\nCOMMON STOCK PURCHASE RIGHTS\nIn 1988, the Board of Directors adopted a Shareholder Rights Plan which provides for a dividend distribution of one common stock purchase right for each share of common stock outstanding on February 12, 1988. Under certain circumstances, each right entitles the holder to purchase from the Company one share of common stock at an exercise price of $40 per share.\nThe rights are not exercisable and cannot be transferred separately from the common stock until ten days after a person acquires 20% or more or makes a tender offer for 30% or more of the Company's common stock. If, after the rights become exercisable, (i) any person becomes the owner of 20% or more of the Company's common stock, or (ii) the Company is the surviving entity in a merger with a 20% or more stockholder, or (iii) a 20% or more stockholder engages in certain \"self-dealing\" transactions with the Company, each right not owned by such person will entitle its holder to purchase, at the right's exercise price, common stock having a value of two times the exercise price of the right. In addition, if the Company is either (i) acquired in a merger or other business combination in which the Company is not the surviving entity, or (ii) sells or transfers 50% or more of its assets or earning power to another party, each right will entitle its holder to purchase, upon exercise, common stock of the acquiring Company having a value equal to two times the exercise price of the right.\nThe rights expire on February 12, 1998 but may be redeemed by the Company for $.0133 per right at any time prior to the tenth day following a person's acquisition of 20% or more of the Company's common stock. So long as the rights are not separately transferable, the Company will issue one right with each new share of common stock issued.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n8. RETIREMENT PLANS\nThe Company and its subsidiaries have various savings and retirement plans covering substantially all employees. The Company maintains defined contribution plans for the benefit of its eligible United States employees. These plans provide for Company contributions of up to 5% of each participant's total eligible compensation. In addition, the Company contributes an amount equal to each participant's contribution, if any, up to a maximum of 2% of each participant's total eligible compensation. The Company also has various defined benefit pension and other retirement plans for certain foreign employees that are consistent with local statutes and practices. The total expense related to all of the Company's retirement plans in 1994, 1993 and 1992 was $12.6 million, $11.9 million and $10.9 million, respectively, which primarily consists of costs related to domestic defined contribution plans. Also included in total expense is pension expense related to foreign defined benefit plans of $2.5 million for 1994, $3.0 million for 1993 and $2.8 million for 1992. Summary data related to these foreign plans at October 29, 1994 is as follows: accumulated benefit obligation, substantially vested, of $18.4 million; projected benefit obligation of $31.0 million; plan assets at fair value of $28.5 million; discount rates ranging from 5.5% to 15%; compensation increase rates ranging from 4.5% to 12% and expected rate of return on assets ranging from 5% to 15%.\nIn November 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (FAS 112), which will become effective during fiscal year 1995. FAS 112 requires that postemployment benefits, primarily salary continuation and insurance continuation, be accrued for at the time the benefit is earned by the employee. Adoption of FAS 112 is not expected to have a material impact on the Company's consolidated financial statements.\nThe valuation allowance at the beginning of fiscal 1994 was $14,300. The net change in the valuation allowance for the year ended October 29, 1994 was a decrease of $4,265 from the utilization of general business and foreign tax credits. The valuation allowance as of October 29, 1994 relates primarily to capital loss carryovers and tax credits.\nANALOG DEVICES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Company's practice is to reinvest indefinitely the earnings of certain international subsidiaries. Applicable U.S. Federal and state income taxes, net of related foreign tax credits, are provided only on amounts planned to be remitted. Accordingly, no U.S. Federal and state income taxes have been provided for approximately $221,893,000 of unremitted earnings of international subsidiaries.\nANALOG DEVICES, INC. SUPPLEMENTARY FINANCIAL INFORMATION (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\nThe response to this item is contained in part under the caption \"EXECUTIVE OFFICERS OF THE COMPANY\" in Part I hereof, and the remainder is contained in the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on March 14, 1995 (the \"1995 Proxy Statement\") under the caption \"Election of Directors\" and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe response to this item is contained in the Company's 1995 Proxy Statement under the captions \"Directors' Compensation,\" \"Executive Compensation\", \"Severance and Other Agreements\" and \"Approval of the 1994 Director Option Plan,\" and is incorporated herein by reference. Information relating to a delinquent filing of a Form 4 by an executive officer of the Company is contained in the Company's 1995 Proxy Statement under the caption \"Delinquent Filing of Forms 4.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe response to this item is contained in the Company's 1995 Proxy Statement under the caption \"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 response to this item is contained in the Company's 1995 Proxy Statement under the caption \"Transactions with Directors,\" 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 consolidated financial statements are included in Item 8:\n- Consolidated Statements of Income for the years ended October 29, 1994, October 30, 1993 and October 31, 1992 - Consolidated Balance Sheets as of October 29, 1994, October 30, 1993 and October 31, 1992 - Consolidated Statements of Stockholders' Equity for the years ended October 29, 1994, October 30, 1993 and October 31, 1992 - Consolidated Statements of Cash Flows for the years ended October 29, 1994, October 30, 1993 and October 31, 1992\n(A) 2. FINANCIAL STATEMENT SCHEDULES\nNo Financial Statement Schedules have been presented since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.\n(A) 3. LISTING OF EXHIBITS\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nANALOG DEVICES, INC. (Registrant)\nBy: \/s\/ Ray Stata By: \/s\/ Joseph E. McDonough ----------------------------- --------------------------- Ray Stata Joseph E. McDonough Chairman of the Board and Vice President-Finance Chief Executive Officer and Chief Financial Officer (Principal Executive Officer) (Principal Financial and Accounting Officer)\nDate: January 24, 1995 Date: January 24, 1995 ---------------------------- ------------------------","section_15":""}
{"filename":"54045_1994.txt","cik":"54045","year":"1994","section_1":"ITEM 1. BUSINESS\n1(a) GENERAL DEVELOPMENT OF BUSINESS\nJoslyn Corporation, an Illinois corporation (together with its subsidiaries, the \"Registrant\") is a holding company formed in 1988 in connection with a share exchange with its principal operating subsidiary, Joslyn Manufacturing Co. Joslyn Manufacturing Co., founded by Marcellus L. Joslyn, was incorporated in Illinois on December 6, 1902 as the Independent Arm and Pin Co.\nThe Registrant is a holding company for a number of subsidiaries which are engaged primarily in the manufacturing and supplying of electrical hardware, apparatus, protective equipment, air pressurization and dehydration products, and services used in the construction and maintenance of transmission and distribution facilities to electric power and telephone companies. The Registrant's subsidiaries also manufacture and supply vacuum switchgear and electrical controls to commercial and industrial markets as well as protective equipment, connector backshells, and air and gas dehydration systems to aerospace and defense companies.\nThe Registrant has eleven wholly owned operating subsidiaries.\n* JOSLYN MANUFACTURING CO., a Delaware corporation, manufactures and supplies electrical hardware, apparatus, and protective equipment used in the construction and maintenance of electric power transmission and distribution facilities and telephone and cable television communication lines.\n* JOSLYN CLARK CONTROLS, INC., a Delaware corporation, manufactures electrical controls, fire pump controllers, general purpose contactors and starters for industrial and commercial markets.\n* JOSLYN CANADA INC., organized under the laws of the Province of Ontario, Canada, supplies electrical apparatus and protective equipment, high-voltage vacuum and sulfur hexaflouride (SF-6) switching equipment for commercial, heavy industrial and electrical utility markets within Canada.\n* JOSLYN HI-VOLTAGE CORPORATION, a Delaware corporation, manufactures and supplies high-voltage vacuum and air switching equipment for commercial, heavy industrial and electrical utility markets.\n* JOSLYN ELECTRONIC SYSTEMS CORPORATION, a Delaware corporation, manufactures and supplies electric power equipment, electronic protection equipment, and field test equipment designed and produced primarily for the telecommunications, industrial, aerospace and defense industries.\n* JOSLYN POWER PRODUCTS CORPORATION, a Delaware corporation, manufactures and supplies sulfur hexaflouride (SF-6) fuses and medium voltage switchgear for commercial, industrial and electrical utility markets.\n* JOSLYN JENNINGS CORPORATION, a Delaware corporation, manufactures and supplies vacuum capacitors for aerospace and defense markets and vacuum interrupters for industrial,commercial and electrical utility markets.\n* JOSLYN RESEARCH AND DEVELOPMENT CORPORATION, a Delaware corporation, conducts research and product development jointly with other Joslyn subsidiaries.\n* ADK PRESSURE EQUIPMENT CORPORATION, a Delaware corporation, manufactures and distributes air dehydrators and associated equipment to provide and monitor pressurized dry air. Most products are used to prevent moisture intrusion in telephone cables, antenna lines and wave guides and are sold to telephone markets worldwide.\n* THE SUNBANK FAMILY OF COMPANIES, INC., a California holding corporation, and its two subsidiaries, JOSLYN SUNBANK CORPORATION and AIR-DRY CORPORATION OF AMERICA, Delaware corporations, supply custom designed electrical connector accessories and flexible conduits, multi-conductor cable and air and gas dehydration systems for aerospace and defense markets.\n* JOSLYN FOREIGN SALES CORPORATION, organized under the laws of the Virgin Islands of the United States, exports the Registrant's products throughout the world.\n1(b) FINANCIAL INFORMATION ABOUT BUSINESS SEGMENTS\nNote 12, Segment of Business Reporting, on page 26 of the Annual Report is incorporated herein by reference.\n1(c) NARRATIVE DESCRIPTION OF BUSINESS\nThe Registrant's business is composed of two business segments: Utility Line Products and Electrical Switches and Controls. The products and services of Registrant's subsidiaries have been grouped as business segments in a manner consistent with the types of markets existing for the products and services.\nUTILITY LINE PRODUCTS\n(a) PRINCIPAL PRODUCTS AND SERVICES\nThe Registrant designs and manufactures construction and maintenance materials and electric power protection equipment principally for electric power distribution and overhead telecommunications and cable television communication lines. These products are manufactured from metal, polymers, fiberglass, engineered materials and porcelain and include hardware, earth anchors, power surge arresters, cable termination devices and other products. Sales of these materials and products by Registrant's subsidiaries are made directly to ultimate users, distributors for resale to ultimate users, contractors, and to original equipment manufacturers by a direct sales force of approximately twenty people. In addition, independent sales agents are used for selective international and domestic markets. Distribution is made directly from manufacturing plants or through a network of distribution centers operated by Registrant's subsidiaries.\n(b) RAW MATERIALS\nMaterials used in the manufacture of the products of this segment are basic commodities, primarily various types of steel, polymer, zinc, zinc oxide powder and components which are readily available and are purchased by Registrant's subsidiaries from numerous sources, none of which is material to the business in this segment as a whole.\n(c) PATENTS, LICENSES AND TRADEMARKS\nThe Registrant does not consider that the business of the Utility Line Products segment is dependent to a material extent upon patent protection, although certain features of the products of this segment are protected by patents and trademarks. Licensing of these products to others plays no material role in the Registrant's earnings.\n(d) SEASONAL ASPECTS OF BUSINESS\nAlthough the level of business of the Utility Line Products segment varies modestly throughout the year, the business of this segment is not seasonal.\n(e) CUSTOMERS\nThe business of this segment is not dependent upon any single customer or a few customers, the loss of which would have a material adverse effect on this segment as a whole.\n(f) BACKLOG ORDERS\nThe Registrant does not believe information related to backlog orders to be material to the understanding of the business of this segment.\n(g) RENEGOTIATION OF PROFITS\nThe business of the Utility Line Products segment is not subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government.\n(h) COMPETITION\nThere are several competitors in every product line of this segment resulting in strong competition. Because of the range of products manufactured by Registrant's subsidiaries, it is difficult to determine accurately its overall competitive position in these lines. The Registrant believes, however, that it is one of the principal suppliers of transmission, distribution and communication hardware, electric power surge arresters and terminating devices in the United States and Canada.\nSome of the products manufactured by this segment, however, are commodity products with respect to which the Registrant experiences competition with directly competing products. The Registrant competes on the basis of its service, product quality, marketing technique and price and believes that its ability in these areas permits it to compete effectively.\nELECTRICAL SWITCHES AND CONTROLS\n(a) PRINCIPAL PRODUCTS AND SERVICES\nElectric power and electronic protection equipment and switchgear are designed and produced primarily for use by the telecommunications, industrial, aerospace, defense, and electric utility industries. These products include a variety of specialty devices that protect, control, monitor, test or perform\nswitching functions for users of electric power. The Registrant's defense products include electrical flexible conduits, vacuum capacitors, air and gas dehydration systems and specialty products. Such products are primarily sold by Registrant's subsidiaries own sales force directly to end users or to original equipment manufacturers, although some sales are made to distributors for resale.\n(b) RAW MATERIALS\nMaterials used in the manufacture of the products of the Electrical Switches and Controls segment are basic commodities and components which are readily available and are purchased by Registrant's subsidiaries from numerous sources, none of which is material to the business of this segment as a whole.\n(c) PATENTS, LICENSES AND TRADEMARKS\nThe Registrant does not consider that the business of the Electrical Switches and Controls segment is dependent to a material extent upon patent protection, although certain features of the products of the segment are protected by patents and trademarks. Licensing of these products to others is not material to the Registrant's earnings.\nThe Registrant has obtained licenses to utilize various patents in some of the lines of business of this segment. However, no product manufactured by the Electrical Switches and Controls segment under licenses from others makes a significant contribution to sales or earnings.\n(d) SEASONAL ASPECTS OF BUSINESS\nAlthough the level of the business of the Electrical Switches and Controls segment varies modestly throughout the year, the business of this segment is not seasonal.\n(e) CUSTOMER\nThe business of this segment is not dependent upon any single customer or a few customers, the loss of which would have a material adverse effect on the segment as a whole.\n(f) BACKLOG ORDERS\nThe Registrant does not believe information related to backlog orders to be material to the understanding of the business of this segment.\n(g) RENEGOTIATION OF PROFITS\nThe business of the Electrical Switches and Controls segment is not subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government.\n(h) COMPETITION\nThere are several competitors in most product lines of this segment resulting in competition. Because of the range of products manufactured by the Registrant's subsidiaries, it is difficult to determine accurately its overall competitive position in these lines.\nSome of the electrical products manufactured by this segment are high technology products with respect to which Registrant's subsidiaries experience competition with products utilizing competing technology. The Registrant competes on the basis of its advanced technology, services, product quality, marketing technique and price and believes that its ability in these areas permits it to compete effectively.\nEFFECT OF ENVIRONMENTAL PROTECTION\nCompliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has had no material adverse impact upon capital expenditures, earnings and the competitive position of the Registrant and its subsidiaries, except to the extent as described in Item 3, \"Legal Proceeding.\" The Registrant regularly makes provision in its budgeted capital expenditures for environmental control facilities; however, for the current fiscal year ending December 31, 1994, the Registrant has not incurred any capital expenditures, and for future periods, the Registrant has not planned any capital expenditures for environmental control facilities which are expected to be material to current operations. See also Item 3, \"Legal Proceeding.\"\nNUMBER OF EMPLOYEES\nAs of March 1, 1995, the Registrant had approximately 1,975 employees.\n1(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nNote 12, Segment of Business Reporting, on page 26 of the Annual Report is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES \t\t\t\t\t\t\t\t EXPIRATION \t\t\t\t\t\t\t\t OF TERM PLANT OR FACILITY AND LOCATION GENERAL CHARACTER IF LEASED\n(a) CORPORATE HEADQUARTERS\nAllen County, Indiana Undeveloped Property Sold 3\/9\/95\nBonner County, Idaho Undeveloped Property\nChicago, Illinois Office 4\/30\/05\nGoleta, California Undeveloped Property\nSanta Maria, California Undeveloped Property\n(b) UTILITY LINE PRODUCTS\nBirmingham, Alabama Distribution Center\nBrooklyn Center, Minnesota Undeveloped Property\nChicago, Illinois Manufacturing Plant and \t\t\t\t\t Distribution Center\nChicago, Illinois Manufacturing Plant\nFranklin Park, Illinois Office, Manufacturing \t\t\t\t\t Plant\nFranklin Park, Illinois Undeveloped Property\nRichmond, Virginia Distribution Center and 9\/1\/96 \t\t\t\t\t Sales Office\nVernon, California Distribution Center 10\/31\/97\n(c) ELECTRICAL SWITCHES AND CONTROLS\nAlsip, Illinois Manufacturing Plant\nCleveland, Ohio (116th Street) Manufacturing Plant\nCleveland, Ohio (Harvard Avenue) Manufacturing Plant\nGoleta, California Manufacturing Plant\nLachine, Quebec Manufacturing Plant \t\t\t\t\t and Office 12\/31\/96\nLancaster, South Carolina Manufacturing Plant\nMaui, Hawaii Investment Property\nMoorpark, California Manufacturing Plant 1\/31\/98\nPaso Robles, California Manufacturing Plant 1\/31\/98\nSan Jose, California Manufacturing Plant\nSpokane, Washington Manufacturing Plant 9\/30\/95\nSomerset, New Jersey Distribution Center and \t\t\t\t\t Sales Office 4\/30\/97\nWoodstock, Illinois Office, Manufacturing \t\t\t\t\t Plant and Test Facility\nThe Registrant believes that its properties are in good condition and are adequate to meet its current and reasonably anticipated needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nRegistrant's subsidiary, Joslyn Manufacturing Co., (the Company) previously operated wood treating facilities that chemically preserved utility poles, pilings and railroad ties. Environmental reserves for estimated remedial actions and clean-up costs for known sites either currently under investigation or not known to be under investigation pursuant to environmental laws and regulations has been made. Note 6, Environmental Matters, on page 23 of the Annual Report is incorporated herein by reference.\nJoslyn Manufacturing Co. executed a Consent Order effective May 30, 1985, with the Minnesota Pollution Control Agency pertaining to a former wood treating facility located in Brooklyn Center, Minnesota. The Consent Order binds the Company to undertake soil and groundwater investigation and clean-up of the site. The Company is currently performing its obligations under the Consent Order and is continuing the clean-up of the site. The Company has completed a significant portion of the clean-up at the site.\nThe Louisiana Department of Environmental Quality issued administrative orders against potentially responsible parties, including Joslyn Manufacturing Co., to perform a clean-up at a former wood treating facility located in Bossier City, Louisiana. The Company has complied with the administrative order and has unilaterally implemented the remedial action plan substantially remediating the site. Additional offsite soil remediation may be required. The Company has begun preliminary investigation of offsite areas. The site has been proposed for listing on the National Priorities List by the U.S. Environmental Protection Agency. The Company is opposing the proposed listing. The Company unsuccessfully appealed adverse decisions against other potentially responsible parties as well as its insurance carrier for allocation, contribution and indemnification for remediation efforts which have been or will be performed by the Company. Those cases are now concluded without recoveries.\nThe Company is a defendant in a purported class action lawsuit entitled, Johnson et al. v. Lincoln Creosote Co. Inc. filed with the 26th Judicial Court for Bossier Parish, Louisiana, No. 70481 on February 23, 1987. Plaintiffs are seeking damages allegedly sustained from the disposal of materials on the former wood treating site previously owned and operated by the Company prior to 1970 and located in Bossier City, Louisiana. The damages sought are unspecified. The Court held a hearing for the purpose of determining class\ncertification and issued a ruling favorable to the Company by narrowing and defining the geographic area of the class and excluding non-cancerous, non- life threatening injuries from the class litigation. However, after an appeal by the plaintiffs, the judge modified its prior ruling to allow all personal injury claims within the defined geographic area upon proof of causation and injury. The Company has tendered the defense of the suit to its insurance carrier.\nOn November 20, 1986, the Illinois Environmental Protection Agency issued an Immediate Removal Order for Company's former wood treating facility in Franklin Park, Illinois. In compliance with that Order, Registrant has completed a significant portion of the clean-up at the site. As a result of successful litigation, all future expenditures will be the responsibility of the Company's insurance carrier.\nIn 1990, the Company entered into a Consent Order with the current property owner and the Oregon Department of Environmental Quality pertaining to a former wood treating facility located in Portland, Oregon. The Consent Order requires an investigation of the site which was completed in 1994. The implementation of a remedy is scheduled to begin in 1995. The Company has entered into a cost sharing agreement with the current owner whose share is 27%.\nThe Company has been named as a third party defendant in a suit filed on September 11, 1992 entitled UNITED STATES OF AMERICA, ET AL. V. SCA SERVICES OF INDIANA V. OMNISOURCE CORP.,-29, U.S. District Court Northern District Indiana (Ft. Wayne Division). The suit seeks contribution for the remediation of the Ft. Wayne Reduction Superfund Site. The Company is one of over 65 potentially responsible parties. The Company is defending the suit.\nThe Company was initially notified in July, 1994 by the U.S. Environmental Protection Agency that it is a potentially responsible party (PRP) at a former wood treating site known as Rab Valley located in Panama, Oklahoma. The Company sold the site in 1955, after operating it for 16 years. Although one prior and three subsequent owners have operated a wood treating facility at the site, it initially appears that the Company may be the only significant financially viable PRP and the Company's insurance coverage during such period may be minimal. The Company believes that approximately 20% of the remediation costs at the Oklahoma site will be expended over the next couple of years and that most of the remediation will take place during a period five to ten years from now. Determining the Company's ultimate cost associated with remediating sites is subject to many variables, including the availability of economical remediation technologies, the volume of contaminated soil, contributions from other PRPs, insurance recoveries and changes in applicable laws and regulations. The Company's investigation of the Oklahoma site is still in the preliminary stages. The estimated costs were prepared by the Company's environmental consultants based on the limited data about the Oklahoma site that is currently available, the Company's experience with nearly completed clean-ups and recent action by USEPA at other sites. This estimate assumes\nthat the Company will be allowed to apply the remediation technologies at the Oklahoma site that it has applied elsewhere. Certain of such technologies are among the least expensive of various alternatives. If technologies other than those assumed to be available are utilized at the Oklahoma site, or if the volume of contaminated soil at that site is significantly greater than that suggested by preliminary data, remediation costs could more than double.\nThe Registrant received a complaint entitled JANCO V. SUNBANK ELECTRONICS, INC. in January 1995, alleging contribution for contamination present in the groundwater aquifer beneath the City of Burbank, California. Numerous potentially responsible parties (PRP) are involved in litigation with the lead PRP, Lockheed Corporation, to allocate costs associated with the remediation. An investigation into the extent of contribution and participation in costs sharing by Sunbank has been initiated. Sunbank is a wholly-owned subsidiary of the Registrant and the activities alleged against Sunbank apparently occurred in a 10-year period between 1971 and 1981, prior to the Registrant's acquisition of Sunbank in 1988. Preliminary indications are that Sunbank is a DE MINIMIS PRP.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nListed below are the names, titles, offices, positions and ages of all executive officers of the Registrant. There are no family relationships between them. The officers' terms in office expire on April 26, 1995, the date of the meeting of the Board of Directors, which is held immediately before the 1995 Annual Meeting of Shareholders.\nLAWRENCE G. WOLSKI Director, Acting Chief Executive Officer \t\t\t\t and Executive Vice President - Age 50\nExperience\n\t1993 Elected Executive Vice President 1987 Elected Senior Vice President\nGEORGE W. DIEHL Vice President, Power Switching and Controls \t\t\t\t\t\t\tGroup - Age 55\nExperience\n1991 Appointed Vice President; Elected President \t\t\tand Chief Operating Officer, Joslyn Hi-Voltage Corporation 1988 General Manager, Joslyn Hi-Voltage Corporation\nDANIEL DUMONT Vice President - Age 47\nExperience\n1990 Appointed Vice President; Elected President and \t\t\t\tChief Operating Officer, Joslyn Canada Inc. 1987 General Manager, Joslyn Canada Inc.\nWAYNE M. KOPROWSKI Vice President, General Counsel and Secretary - \t\t\t\tAge 48\nExperience\n1990 Elected Vice President\nSTEVEN L. THUNANDER Vice President - Age 44\nExperience\n1988 Appointed Vice President; Elected President \t\t\t\tand Chief Operating Officer, \t\t\t\tJoslyn Manufacturing Co.\n\t\t\t\t\t\t\t\tPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND \t RELATED SECURITY STOCKHOLDER MATTERS\nInformation regarding the price of Registrant's common stock, dividend payments and numbers of shareholders is included in Common Stock Prices and Dividends on page 14 of the Annual Report which is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data, which is included in the Five Year Comparative Financial Data on page 14 of the Annual Report, is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND \t RESULTS OF OPERATIONS\nManagement's Discussion and Analysis of Financial Condition and Results of Operations on pages 12 through 13 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 in the Annual Report, are incorporated herein by reference:\nANNUAL REPORT PAGE NO. \t\t\t\t\t\t _____________\nConsolidated Statement of Income for the Years Ended December 31, 1994, 1993 and 1992 15\nConsolidated Balance Sheet -- December 31, 1994 and 1993 16\nConsolidated Statement of Shareholders' Equity for the Years Ended December 31, 1994, 1993 and 1992 17\nConsolidated Statement of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 18\nNotes to Consolidated Financial Statements 19-27\nReport of Independent Public Accountants 27\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING \t AND FINANCIAL DISCLOSURE\nNone.\n\t\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(a) Information regarding directors of the Registrant required by this Item 10 is contained under the caption \"Nominees For Election As Director\" on pages 2 and 3 of the Proxy Statement, and is incorporated herein by reference.\n(b) Information regarding executive officers of the Registrant required by this Item 10 is included on pages 11 and 12 in Part I of this Report pursuant to General Instructions G of Form 10-K. in Part I of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation concerning executive compensation required by this Item 11 is contained under the following captions in the Proxy Statement, and is incorporated herein by reference:\nPROXY STATEMENT PAGE NO. \t\t\t __________\nCompensation of Directors 6 Summary Compensation Table 7 Stock Option\/SAR Grants in 1994 8 Defined Benefit Pension Plan 9 Employment and Severance Agreements 9-10\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND \t MANAGEMENT\nThe information required by this Item 12 is contained in the Proxy Statement under the captions \"Principal Holders of Voting Securities\" on page 5 and \"Security Ownership of Management on March 1, 1995\" on page 4 and is incorporated herein by reference.\n\t\t\t\t\t PART IV\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. Financial Statements \t\t \t\t\tIncluded in Part II of this report: \t\t \t\t \t Consolidated Statement of Income for the years ended \t\t\t December 31, 1994, 1993 and 1992 \t\t \t\t \t Consolidated Balance Sheet as of December 31, 1994 and 1993 \t\t \t\t \t Consolidated Statement of Shareholders' Equity for the years \t\t ended December 31, 1994, 1993 and 1992 \t\t \t\t \t Consolidated Statement of Cash Flows for the years ended \t\t\t December 31, 1994, 1993 and 1992 \t\t \t\t \t Notes to Consolidated Financial Statements\n\t 3. Exhibits\n\t\t The exhibits filed in response to Item 601 of Regulation \t\t\t S-K and Item 14(c) of Form 10-K are listed in the Exhibit \t\t\t Index on page 18. Management contracts or compensatory \t\t\t plans or arrangements are identified in the Exhibit Index \t\t\t by \"+\".\n(b) Reports on Form 8-K\n\t Two reports on Form 8-K were filed during the fourth quarter \t\t of the period ended December 31, 1994.\n\t Registrant filed a Form 8-K on September 20, 1994, regarding\n\t 1. an anticipated 4th Quarter environmental charge; \t\t 2. changes in the severance arrangements and benefit plans; and \t\t 3. amended and restated By-Laws.\n\t The Registrant also filed a Form 8-K on October 19, 1994, regarding \t a third quarter net loss as a result of a $35 million charge for \t increase environmental reserves.\nPursuant to the requirements of Section 13 or 15(d) of the 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 30, 1995\n\t\t\t\t\t\t\t\t\t JOSLYN CORPORATION\n\t\t\t\t\t\t\t\t\t By:\/s\/ Lawrence G. Wolski ______________________ Acting 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\/William E. Bendix Chairman of the Board March 30, 1995 _______________________ William E. Bendix\n\/s\/Lawrence G. Wolski Acting Chief Executive _________________________ Officer, Director March 30, 1995 Lawrence G. Wolski\n\/s\/John H. Deininger Director March 30, 1995 _______________________ John H. Deininger\n\/s\/Donald B. Hamister Director March 30, 1995 _______________________ Donald B. Hamister\n\/s\/Richard C. Osborne Director March 30, 1995 _______________________ Richard C. Osborne\n\/s\/ Raymond E. Micheletti Director March 30, 1995 _________________________ Raymond E. Micheletti\n\/s\/ Raymond G. Bjorseth Chief Accounting Officer March 30, 1995 _________________________ Raymond G. Bjorseth\n\t\t\t\t\t\t\tEXHIBIT INDEX\n\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t Page\n3(i) Articles of Incorporation (Exhibit D to Registrant's Form S-4 Registration Statement filed March 17, 1988)*\n3(ii) By-Laws, as amended and restated (Exhibit 3 to Registrant's Form 8-A filed September 20, 1994)*\n4 (a) Rights Agreement with the First National Bank of Chicago dated February 10, 1988 \t (Exhibit 4 to Registrant's 1987 Form 10-K)*\n\t (b) Amendment dated September 2, 1994 to Rights \t Agreement Exhibit 2A to Form 8-A\/A filed \t September 9, 1994)*\n10 Material Contracts\n\t(a) Form of Employment Agreement with Mr. Wolski \t (Exhibit 10(c) to Registrant's 1991 Form 10-K)*+\n(b) Form of Severance Agreement with Mr. Wolski \t (Exhibit 10.1 to Form 8-K filed September 20, 1994)*+\n(c) Form of Severance Agreement with Messrs. Diehl and \t Koprowski (Exhibits 10.2 and 10.3 to Form 8-K filed \t\t September 20,1994)*+\n(d) Severance Policy for Corporate Managers \t \t (Exhibit 10.4 to Form 8-K filed September 20, 1994)*+\n\t(e) Joslyn Corporation Executive Management Incentive Plan \t (Exhibit 10(c) to Registrant's 1980 Form 10-K)*+\n(f) Amendment to Executive Management Plan \t \t (Exhibit 10.6 to Form 8-K filed September 20, 1994)*+\n(g) Joslyn Corporation Parity Compensation Plan \t (Exhibit 10(c) to Registrant's 1989 Form 10-K)*+\n(h) Amendment to Parity Compensation Plan \t\t (Exhibit 10.7 to Form 8-K filed September 20, 1994)*+\n(i) Joslyn Mfg. and Supply Co. Employee Stock Benefit Plan, \t\t as amended (Exhibit A to Registrant's Proxy Statement \t\t dated March 25, 1983)*+\n(j) Joslyn Corporation Stock Option Plan (Exhibit A to \t Registrant's Proxy Statement dated \t March 28, 1989)*+\n13 Portions of the Annual Report for the year ended December 31,1994 incorporated by reference 20 - 47\n21 Subsidiaries of the Registrant 48\n24 Consent of Independent Public Accountants dated and manually signed 49\n27 Financial Data Schedule 50\n99 Proxy Statement dated March 28, 1995 51 - 75\n_______________ * Incorporated by reference + Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"909298_1994.txt","cik":"909298","year":"1994","section_1":"ITEM 1\nBUSINESS\nMid-Atlantic Realty Trust was incorporated June 29, 1993 and commenced operations effective with the completion of its initial public share offering on September 11, 1993. Mid-Atlantic Realty Trust is the successor to the operations of BTR Realty, Inc. (the predecessor to Mid-Atlantic Realty Trust), and qualifies as a real estate investment trust, \"REIT\", for Federal income tax purposes. As used herein, the term \"MART\" refers to Mid-Atlantic Realty Trust, the term \"Company\" refers to MART and its subsidiaries, the successor company, and \"BTR\" refers to BTR Realty, Inc. and its subsidiaries, the predecessor to the Company.\nThe Company is a fully integrated, self managed real estate investment trust which owns, leases, develops, redevelops and manages its retail shopping center facilities and commercial properties. The Company's primary objective is to manage the properties for long-term cash flow growth. The Company's principal strategies are to grow the portfolio through the selective acquisition of additional properties in the Mid-Atlantic region, redeveloping or developing retail properties on a selective basis, and, when appropriate, divesting through sale or exchange of non-strategic properties.\nThe Company's financial strategy is to continue to refocus the portfolio through the selective acquisition of retail properties utilizing (1) proceeds from divestitures, (2) issuance of equity or debt securities, when appropriate, and (3) arranging bank or other borrowings for short term needs. The Company intends to maintain the conservative ratio of secured debt to total estimated property value below 50%.\nThe Company has an equity interest in twenty two operating shopping centers, sixteen of which are wholly-owned by the Company, and six others in which the Company has an interest ranging from 50% to 80%, as well as other commercial properties. The operating properties have a gross leasable area of approximately 3,022,000 square feet, of which approximately 94% was leased at December 31, 1994. Total gross leasable area includes 2,786,000 square feet of established operating properties, of which approximately 97% was leased at December 31, 1994 and approximately 236,000 square feet of a shopping center acquired in October, 1993, currently under redevelopment, of which 64% was leased at December 31, 1994. Of these properties, approximately 83% of the gross leasable area is in the states of Maryland, New York and Virginia, 11% in Arizona and 6% in other states. The Company also owns one land parcel being developed into a shopping center and has 8 undeveloped parcels of commercial and residential zoned land totaling approximately 173 acres and varying in size from 3 to 56 acres.\nThe business of the Company is not materially affected by seasonal factors. Although construction may be affected to some extent by inclement weather conditions, usually during winter months, property sales and revenue from income producing properties held for investment are usually not so affected.\nThe commercial real estate development and investment industry is subject to widespread competition for desirable sites, tenants and favorable financing. The industry is extremely fragmented and there are no principal methods of competition. However, the ability to compete is dependent in part upon the ability to find and complete appropriate real estate investments in a timely manner. While many competitors have fewer assets and financial resources than the Company, there are many competitors with greater financial resources competing for similar business activities. Accordingly, it is not possible to estimate the Company's position in the industry. In addition, certain of the Company's real estate projects are near unimproved sites that could be developed commercially and would provide further competition to the Company. The management of the Company believes, however, that the Company competes favorably in the industry due to the quality of its developments, its ability to take advantage of opportunities as they arise, its access to capital, and its reputation in the industry.\nThe Company has 45 full time employees and believes that its relationship with its employees is good.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2\nPROPERTIES\nThe following schedule describes the Company's commercial and residential properties as of December 31, 1994:\nI. SHOPPING CENTERS A. In Operation (1) Percentage of Type of land Area in Leasable Percentage Principal Lease ownership ownership acres square feet leased tenants expirations Name and Location\nHarford Mall 100% Fee(2) 38.0 557,000(3) 99% Hecht's, 1995-2008 U.S. Route 1 Montgomery Ward, Bel Air Woolworth\nPatriots Plaza 50% Long-term 6.1 39,000 92% Denny's, 1995-2005 Ritchie Highway of lease (4) Dunkin Donuts Anne Arundel County Partnership\nRolling Road Plaza 100% Fee 6.5 63,000 100% Fair Lanes, 1995-2009 Rolling Road Firestone Baltimore County\nRosedale Plaza 100% Fee 9.2 73,000 86% Valu Food, 1995-1999 Rite Aid Chesaco and Weyburn Avenue Baltimore County\nShoppes at Easton 100% Fee 13.9 113,000 99% Giant Food, 1997-2024 Route 50 Fashion Bug Easton\nWilkens Beltway Plaza 75% Fee 7.1 65,000 100% Giant Food, 1995-2014 Wilkens Avenue of Partnership Provident Bank, Baltimore County Radio Shack, Carrollton Bank\nYork Road Plaza 100% Fee 7.5 52,000 100% Giant Food, 1995-2000 York Road Firestone Baltimore County\nVIRGINIA PROPERTIES: Burke Town Plaza 100% Long-term 12.6 114,000 100% Safeway, 1995-2002 Old Keene Mill Road lease(5) CVS Drugs Burke\nSkyline Village 100% Fee 14.6 127,000 100% Sears, 1995-2009 US Route 33 Richfood Harrisonburg\nSmoketown Plaza 60% Fee 27.0 176,000 98% Shoppers Food 1995-2011 Davis Ford and of Partnership Warehouse, CVS Drugs, Smoketown Roads Frank's Nursery & Crafts Prince William County\nSpotsylvania Crossing 80% Fee 11.2 142,000 100% K-Mart, CVS 1996-2007 Route 3 & Bragg Road of Partnership Drugs Fredericksburg\nITEM 2. Properties (Continued)\nI. SHOPPING CENTERS (continued) A. In Operation (continued)\nPercentage of Type of land Area in Leasable Percentage Principal Lease ownership ownership acres square feet leased tenants expirations VIRGINIA PROPERTIES (continued):\nSudley Towne Plaza 100% Fee 9.6 108,000 96% Burlington Coat 1995-2009 Route 234 & Sudley Manor Dr. Factory, CVS Manassas Drug Store\nARIZONA PROPERTIES:\nDobson-Guadalupe 100% Fee 3.2 22,000 84% Nevada Bob's 1995-2001 Shopping Center Dobson & Guadalupe Roads Mesa\nFair Lanes Chandler 50% Fee 1.1 10,000 100% No principal Plaza of Partnership tenants selected Arizona & Warner Roads Chandler\nFair Lanes Union 50% Fee 5.9 17,000 88% No principal 1995-1999 Hills Plaza of Partnership tenants selected Union Hills Drive Phoenix\nGateway Park 100% Fee 10.5 82,000 98% Bashas', 1995-2011 Page Corral West\nMcRay Plaza 100% Fee 4.9 35,000 100% Mountainside 1996-2004 McClintock & Ray Roads Fitness Chandler\nPark Sedona 100% Fee 11.4 99,000 99% Safeway, 1995-2011 Highway 89 A Payless Drug Store Sedona\nPlaza Del Rio 100% Fee 11.8 60,000 100% Payless Drug 1995-2009 16th Street and Avenue B Store Yuma\nNEW YORK PROPERTIES: Colonie Plaza 100% Fee 18.7 140,000 98% Price Chopper, 1995-2010 Central Avenue RX Place, Colonie Paper Cutter\nColumbia Plaza 100% Fee 16.0 117,000 98% Price Chopper, 1995-2008 Columbia Turnpike Ben Franklin East Greenbush\nB. Under Development\nMARYLAND PROPERTIES: Timonium Mall 100% Long-term 12.9 236,000 64% Caldor, 2001-2011 York & Ridgely Roads lease (6) Circuit City Timonium\n(1) Shopping centers in operation are subject to mortgage financing aggregating $50,086,463 at December 31, 1994. (2) Subject to the following long-term ground leases: (i) 150,000 square feet on 10 acres for Montgomery Ward's department store, (ii) 10,200 square feet on one acre for Montgomery Ward's auto accessory store. The Harford Mall property is subject to a mortgage principal balance at December 31, 1994 of $19,821,030. The Harford Mall mortgage has an interest rate of 9.78%, a 30 year amortization, with a 10 year balloon payment of $18,148,848 due at the maturity date of July, 2003. The mortgage's prepayment provision prohibits prepayment until June, 1997, after which the penalty is the greater of 1% of the outstanding principal balance or yield maintenance. (3) Includes 302,000 square feet occupied by department stores. (4) Remaining term of 13 years plus two 10 year options. (5) Remaining term of 37 years plus three 15 year renewal options. (6) Remaining term of 22 years plus five 10 year options.\nITEM 2. Properties (Continued)\nII. OFFICE BUILDINGS\nA. In Operation (7)\nPercentage of Type of land Area in Leasable Percentage Principal Lease ownership ownership acres square feet leased tenants expirations\nGateway International I 100% Fee 7.0 84,000 91% Browning Ferris, 1995-2003 Elkridge Landing & Daughters of Charity Winterson Roads Health System, Anne Arundel County US Healthcare, Tandem Computers\nGateway International II 100% Fee 15.5 119,000 90% Digital Equip. 1995-2004 Elkridge Landing & Corporation, Winterson Roads Price Waterhouse, Anne Arundel County MART, AT&T, American Express\nPatriots Plaza 50% Long-term 0.5 28,000 24% No principal 1996-2004 Office Building of Partnership lease (8) tenants selected Ritchie Highway Anne Arundel County\nWilkens Beltway Plaza 75% Fee 3.9 53,000 100% Ryder Truck 1995-2000 Office Park of Partnership Rental Inc., Freestate Buildings I, II & III Health, Prudential Wilkens Avenue and Maiden Choice Lane Health System Baltimore County\nIII. OTHER DEVELOPED PROPERTIES\nA. In Operation Leasable Per- Principal Name and Percentage of Type of land Area in square centage Lease Location ownership ownership acres Improvements feet leased tenants expirations\nMARYLAND PROPERTIES:\nThe Business Center at 100% Fee 5.4 One-story 27,000 96% No principal 1995-1998 Harford Mall Warehouse tenants selected Harford County\nClinton Property 100% Long-term 2.9Bowling Center 29,000 100%Fair Lanes 1995-1996 Prince George's lease (9) and Bank County\nSouthwest Property 100% Fee (10) 3.2 One-story 25,000 100% Shell Oil, 1995-1999 Anne Arundel Office Building, One-story Carrier\/Otis County Warehouse and Gas Station Potomac Air Gas\nWaldorf Property 100% Fee 3.6 Bowling Center 30,000 100%Fair Lanes, 1997-1998 Waldorf and Tire Center Firestone\nILLINOIS PROPERTIES: Illinois Properties 100% 2 parcels 5.0 2 Bowling 71,000 100% Fair Lanes 1995-1998 Chicago in fee Centers\nTEXAS PROPERTIES: Regal Center (11) 100% Fee 6.0 One-story 109,000 93% Berger Allied 1995-1997 Dallas Warehouse\n(7) Office buildings in operation are subject to mortgage financing aggregating $3,164,677 as of December 31, 1994. (8) Remaining term of 13 years plus two 10 year options. (9) Remaining term of 32 years plus a 45 year renewal option. (10) Ground Lease was purchased by BTR Realty, Inc. in August, 1993. (11) Regal Center was sold on February 17, 1995 for $1,800,480, generating a loss on the sale of approximately $370,000.\nITEM 2. Properties (Continued)\nIV. DEVELOPMENT OPERATIONS Leasable Per- Principal Name and Percentage of Type of land Area in square centage Lease Location ownership ownership acres Improvements feet leased tenants expirations\nOwings Mills 100% Fee 12.5 Neighborhood 125,000 76% Giant 1998-2020 New Town Village Shopping Center Food Lakeside Blvd. Owings Mills\nV. UNDEVELOPED PROPERTIES\nPercentage of Type of land Area in Name and Location ownership ownership acres Zoning MARYLAND PROPERTIES: Dorsey Property 100% Fee 19.4 Commercial Anne Arundel County\nGateway International III 100% Fee 6.5 Commercial Anne Arundel County\nHarford Property 100% Fee 3.0 Light Industrial (Adjacent to Harford Mall) Harford County\nNorth East Property 100% Fee 56.0 Commercial\/ North East Residential\nNorthwood Industrial Park 67% Fee 24.4 Industrial Salisbury of Partnership\nPulaski Property 100% Fee 3.0 Industrial Baltimore County\nNORTH CAROLINA PROPERTIES: Burlington Commerce Park(12)100% Fee 46.8 Commercial Burlington\nHillsborough Crossing 100% Fee 13.9 Commercial Hillsborough\n(12) Lot #10, 1.2 Acres, at Burlington Commerce Park was sold on January 6, 1995 for $40,000.\nManagement believes the Company's properties are adequately covered by insurance.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\nIn the ordinary course of business, the Company is involved in legal proceedings. However, there are no material legal proceedings presently pending against 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 Stock And Related Stockholder Matters\nMART's common shares of beneficial interest, par value $.01 per share, (\"shares\"), are listed on the American Stock Exchange (symbol: MRR), which reports high, low and last sales prices. The table below lists high and low sales prices for MART for the periods indicated.\n1994 High Low First Quarter 10 3\/8 8 1\/2 Second Quarter 9 3\/4 8 7\/8 Third Quarter 9 1\/4 8 1\/2 Fourth Quarter 9 1\/4 7 3\/8\n1993 High Low September 11 (Inception) - September 30 10 3\/4 10 1\/4 Fourth Quarter 11 9\nCash dividends paid to holders of MART's shares during the periods indicated are as follows:\n1994 Cash Dividend Paid First Quarter $0.21 Second Quarter $0.21 Third Quarter $0.21 Fourth Quarter $0.22 Total 1994 $0.85\n1993 Cash Dividend Paid Fourth Quarter $0.05\nOn February 14, 1995, MART declared a quarterly cash dividend of $.22 per share payable March 15, 1995 to shareholders of record February 28, 1995.\nThe number of holders of record of the MART shares as of February 16, 1995 was 1,292. ITEM 6","section_6":"ITEM 6\nSELECTED FINANCIAL DATA\nThe following table sets forth the consolidated financial data for the Company and should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report. The table consists of the Consolidated Financial Statements of Mid-Atlantic Realty Trust as of December 31, 1994 and December 31, 1993, and for the year ended December 31, 1993 and for the period September 11, 1993 (commencement of operations) through December 31, 1993, and also includes the Consolidated Financial Statements of BTR Realty, Inc. as of December 31, 1992, 1991, 1990 and for the periods January 1, 1993 through September 10, 1993, and for the years ended December 31, 1992, 1991, and 1990. Mid-Atlantic Realty Trust, a Real Estate Investment Trust, was merged with BTR Realty, Inc. on September 11, 1993. The consolidated financial data of BTR, the predecessor company, are presented for comparative purposes.\nMid-Atlantic Realty Trust || ----------------------------------------------|| Year ended September 11, 1993 to || December 31, 1994 December 31, 1993 || || Revenues $22,848,881 6,576,684 || ============== ============ || Net Earnings (Loss) || Before Cumulative || Effect of Change In || Accounting Principle and || Extraordinary Item $2,916,286 467,474 || Cumulative Effect of Change || In Accounting Principle - - || -------------- ------------ || Net Earnings (Loss) Before || Extraordinary Item 2,916,286 467,474 || Extraordinary Item - - || -------------- ------------ || Net Earnings (Loss) $2,916,286 467,474 || ============== ============ || || Net Earnings (Loss) Per || Share Before Cumulative || Effect of Change In || Accounting Principle || and Extraordinary Item $0.46 0.07 || Cumulative Effect of Change || In Accounting Principle - - || ------------- ------------ || Net Earnings (Loss) Per || Share Before || Extraordinary Item $0.46 0.07 || Extraordinary Item - - || ------------- ------------ || Net Earnings (Loss) || Per Share $0.46 0.07 || ============= ============ || || Weighted Average Shares || Outstanding, || Including Common || Share Equivalents (1) 6,291,407 6,291,407 || ============= ============ || || Total Assets $162,842,567 148,563,052 || ============= ============ || Indebtedness: || Total mortgages, convertible || debentures, construction || loans and notes payable $133,390,553 116,494,372 || ============= ============ || || Net cash provided by || (used in) operating || activities $7,766,044 3,479,346 || ============= ============ || || Cash Dividends || Paid Per Share $0.85 0.05 || ============= ============ ||\nBTR Realty, Inc. ------------------------------------------------ January 1, 1993 to September 10, Years ended December 31, 1993 1992 1991 1990\nRevenues 15,912,211 22,655,133 22,779,812 20,366,006\nNet Earnings (Loss) Before Cumulative Effect of Change In Accounting Principle and Extraordinary Item (2,057,106) (1,118,957) (4,688,646) (6,374,172) Cumulative Effect of Change In Accounting Principle - 1,286,000 - - ------------------------------------------------ Net Earnings (Loss) Before Extraordinary Item (2,057,106) 167,043 (4,688,646) (6,374,172) Extraordinary Item (548,323) - - - ------------------------------------------------ Net Earnings (Loss) (2,605,429) 167,043 (4,688,646) (6,374,172) ================================================\nNet Earnings (Loss) Per Share Before Cumulative Effect of Change In Accounting Principle and Extraordinary Item (0.24) (0.13) (0.55) (0.74)\nCumulative Effect of Change In Accounting Principle - 0.15 - - ------------------------------------------------ Net Earnings (Loss) Per Share Before Extraordinary Item (0.24) 0.02 (0.55) (0.74) Extraordinary Item (0.06) - - - ------------------------------------------------ Net Earnings (Loss) Per Share (0.30) 0.02 (0.55) (0.74) ================================================\nWeighted Average Shares Outstanding, Including Common Share Equivalents (1) 8,512,718 8,503,916 8,527,036 8,600,395 ================================================\nTotal Assets 147,869,512 153,212,133 159,879,954 166,319,506 ================================================\nIndebtedness: Total mortgages, convertible debentures, construction loans and notes payable 150,666,971 149,168,632 153,024,838 151,677,634 ================================================\nNet cash provided by (used in) operating activities 4,129,635 1,249,138 (961,065) 1,091,144 ================================================ Cash Dividends Paid Per Share 0.58 - - 0.08 ================================================\n(1) In September, 1993, MART issued 3,450,000 shares in its initial public offering, and as part of the merger, exchanged for every 3 shares of BTR, 1 share of MART totaling approximately 8,526,000 shares of BTR for approximately 2,842,000 shares of MART.\nContinued\nITEM 6 - SELECTED FINANCIAL DATA - CONTINUED\nPro Forma Data The following sets forth summary financial data on a pro forma basis. Management believes the following data should be used as a supplement to the historical statements of operations. The data should be read in conjunction with the historical financial statements and the Notes thereto for MART included in Item 8. The pro forma financial data is unaudited and is not necessarily indicative of the results which actually would have occurred if the transactions had been consummated at January 1, 1992, nor does it purport to represent the financial position and results of operations for future periods. The following assumes the MART public offering took place on January 1, 1992.\nSummary Pro Forma Financial Data In thousands, except per share data\nYears ended December 31, 1994 1993 1992 ACTUAL PRO FORMA\nRevenues $22,849 20,777 20,051\nEarnings $2,916 1,217 494 Earnings per share $0.46 0.19 0.08\nFunds from operations (FFO)(1): Primary $6,797 6,034 5,398 Fully diluted $11,400 10,609 9,973\nWeighted average number of shares outstanding: Primary 6,291 6,291 6,291 Fully diluted 12,005 12,005 12,005\n(1) Funds from operations as defined by the National Association of Real Estate Investment Trusts, Inc. (NAREIT) -funds from operations means net income (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. The presentation of funds from operations is not normally included in financial statements prepared in accordance with generally accepted accounting principles (GAAP).\nQUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe unaudited combined quarterly results of operations for MART for 1994 are summarized as follows:\nQuarter ended 1994 March 31, June 30, September 30, December 31, Revenues $5,556,016 5,868,272 5,444,666 5,979,927\nNet earnings $ 700,334 750,505 317,461 1,147,986 =================================================\nNet earnings per share $0.11 0.12 0.05 0.18 =================================================\nThe unaudited combined quarterly results of operations for MART and BTR for 1993 are summarized as follows:\nQuarter ended >--1\/1\/93(BTR)-9\/10\/93---<>9\/11\/93-(MART)12\/31\/93< 1993 March 31, June 30, September 30, December 31, Revenues $5,267,903 5,710,208 6,024,780 5,486,004\n(Loss) earnings before extraordinary item ($383,355)(1,154,053) (481,077) 428,853 Extraordinary item - early extinguishment of debt - - (548,323) - -------------------------------------------------- Net (loss) earnings ($383,355)(1,154,053) (1,029,400) 428,853 ==================================================\n(Loss) earnings per share before extraordinary item ($0.05) (0.13) (0.05) 0.06 Extraordinary item - early extinguishment of debt - - (0.06) - ------------------------------------------------- Net (loss) earnings per share ($0.05) (0.13) (0.11) 0.06 =================================================\nQuarterly results are influenced by a number of factors including timing of settlements of property sales, completion of operating projects, write-offs of unrecoverable development costs, and tax benefits.\nITEM 7","section_7":"ITEM 7\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR COMPANY) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion compares the Company's operations for the year ended December 31, 1994, with the year ended December 31, 1993, which includes the summation of the Company's and BTR's results of operations. The discussion also compares the operations for the year ended December 31, 1993, which includes the summation of the Company's and BTR's results of operations, with the operations of BTR for the year ended December 31, 1992.\nComparison of 1994 to 1993\nRental revenues increased by $1,209,000, or 6%, to $21,891,000 for the year ended December 31, 1994 from $20,682,000 for the year ended December 31, 1993. Net increases in occupancy and CPI rental rates resulted in rental increases of approximately $1,125,000. Additionally, two acquisitions, Timonium Mall in October, 1993 and Easton Shoppes in September, 1994, contributed to rental increases of $600,000 and $374,000, respectively. The rental increases were offset by a $732,000 loss of rental attributable to operating properties sold or discontinued in 1993, a $74,000 loss of rental attributable to the redevelopment of York Road Plaza in 1994, and $84,000 in other net rental decreases.\nSales of residential property decreased by $1,032,000 due to the discontinuation and final sellout of BTR's residential assets in July, 1993.\nGains on sales of properties held for sale increased by $50,000 to $81,000 in 1994 from $31,000 in 1993 due to higher profit margins on properties sold in 1994.\nOther income increased by $133,000 to $877,000 in 1994 from $744,000 in 1993 primarily as a result of $424,000 in interest income increases from partners' notes receivables added in September, 1993, and increases due to a $166,000 loss included in BTR's other income in September, 1993 related to a provision for losses on notes receivable. The increases were offset by decreases due to a $210,000 decrease in income from a lease termination payment recorded as other income in December, 1993 and $247,000 in net decreases primarily related to higher tenant lease cancellation charges & fees in 1993.\nAs a result of the above changes, total revenues increased by $360,000 to $22,849,000 in 1994 from $22,489,000 in 1993.\nInterest expense decreased by $2,011,000 to $10,343,000 in 1994 from $12,354,000 in 1993 primarily due to the payoff in September, 1993 of higher fixed rate mortgage debt which was replaced by the sale of lower interest convertible subordinated debentures and the sale of common shares. Approximately $1,839,000 in interest expense decreases can be attributable to the payoff of mortgage debt and replacement with debentures and common shares. A decrease in interest expense of $409,000 can be attributable to the discontinuation of operations in September, 1993 of a residential operating property sold in February, 1994. Other net decreases of $100,000 in interest expense are generally related to projects terminated in 1993 and principal paydowns. Additionally, the interest expense decreases were offset by increases from the two new acquisitions, Timonium Mall in October, 1993 and Easton Shoppes in September, 1994, which contributed to interest increases of $106,000 and $231,000, respectively.\nDepreciation and amortization increased by $347,000 to $5,083,000 in 1994 from $4,736,000 in 1993, primarily due to the following increases: amortization of debentures sold in September, 1993, $204,000, new acquisitions - Timonium, $99,000, and Easton, $57,000, new tenant improvements Gateway I and II, $64,000, and new redevelopment, Rolling Road Plaza $28,000. The increases were offset by a $111,000 decrease in depreciation expense due to the discontinuation of operations in September, 1993 of a residential property sold in February, 1994.\n(Continued)\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR COMPANY) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nComparison of 1994 to 1993 - Continued\nOperating expenses decreased by $417,000 to $3,337,000 in 1994 from $3,754,000 in 1993, primarily due to the discontinuation in September, 1993 of a residential operating property sold in February, 1994 which decreased operating expenses by $321,000. In addition, operating expense decreased $117,000 as a result of the sale of certain projects, Harbour Island and Plantation Bowl, which were sold in July, 1993 and January, 1994, respectively. Some operating expense decreases were due to projects with additional occupancy in 1994, which included Columbia Plaza, $68,000, Sedona, $57,000, and McRay, $49,000. Other projects had operating decreases due to various gross expense decreases, such as Burke Town, $43,000 (primarily legal fees decreased) and York Road Plaza $28,000 (primarily real estate taxes decreased). These major decreases in operating expenses were offset by increases in operating expenses primarily related to the new acquisition of Timonium of $173,000 and additional legal fees related to the Smoketown Plaza project of $101,000.\nCost of residential property sold decreased by $1,008,000 due to the discontinuation of the residential sales in July, 1993.\nGeneral and administrative expenses increased by $397,000 to $1,751,000 in 1994 from $1,354,000 in 1993 due to an increase of $120,000 in payroll expenses which was due to the adoption, in 1994, of an incentive based compensation plan. In addition, payroll expenses increased by $158,000 primarily due to fewer payroll costs capitalized in 1994. Other increases in general and administrative expenses were related to additional shareholder related costs of $52,000, an increase in 401K Plan expense of $45,000 due to a one time downward expense adjustment in December, 1993, and various other net increases totaling $104,000. The increases were offset by decreases in general and administrative expenses related to lower outside professional fees of $33,000 and a decrease of $49,000 in stock compensation expense.\nUnrecoverable development costs decreased by $1,279,000 due to write- downs in 1993 to net realizable value of two residential properties under contract of sale pursuant to a divestiture plan and the write-down in 1993 to net realizable value of a property held for sale.\nMinority interest expense increased by $539,000 to $541,000 in 1994 from $2,000 in 1993 generally due to higher earnings in minority interest ventures.\nEarnings from operations increased by $3,792,000 to $1,794,000 in 1994 from a loss from operations of $1,998,000 in 1993. At September 10, 1993, BTR recorded an extraordinary loss of $548,000 due to an early extinguishment of debt. A net income tax benefit of $408,000 was recognized by BTR for the period January 1 to September 10, 1993. The 1993 extraordinary item and income tax benefit for the combined year ended December 31, 1993, offset the loss from operations for the period resulting in a $2,138,000 net loss for the combined year ended 1993 for BTR and the Company. For the year ended December 31, 1994, the Company recorded a gain on the sales of operating properties of $1,122,000, and, when combined with the earnings from operations for the period, resulted in net earnings of $2,916,000 for the year ended December 31, 1994.\n(Continued)\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR COMPANY) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nComparison of 1993 to 1992\nRental revenues increased by $465,000, or 2%, to $20,682,000 for the year ended December 31, 1993 from $20,217,000 for the year ended December 31, 1992. Net increases in occupancy and CPI rental rates resulted in rental increases of approximately $1,255,000, and the acquisition of Timonium Mall contributed to a rental increase of $149,000, which were offset by a $433,000 loss of rental attributable to operating properties sold in 1992 or discontinued in 1993, a $450,000 loss of rental due to vacancies and reserves, and other rental changes.\nSales of residential property in BTR decreased by $89,000 to $1,032,000 in 1993 from $1,121,000 in 1992 due to the discontinuation and final sellout of residential assets in July, 1993.\nGains on properties held for sale decreased in BTR by $250,000 to $31,000 in 1993 from $281,000 in 1992 due to higher profit margins on properties sold in 1992.\nOther income decreased by $292,000 to $744,000 in 1993 from $1,036,000 in 1992 primarily as a result of income of $329,000 from the sale of development rights and $119,000 of income from bankruptcy settlement in 1992 and a $166,000 loss included in BTR's other income in September, 1993 related to a provision for losses on notes receivable. The decreases were offset by increases due to a $210,000 increase in income from a lease termination payment in December, 1993 and $187,000 in interest income increases from partners notes receivables added in September, 1993, as well as other minimal changes in other income.\nAs a result of the above changes total revenues decreased by $166,000 to $22,489,000 in 1993 from $22,655,000 in 1992.\nInterest expense decreased by $1,678,000 to $12,354,000 in 1993 from $14,032,000 in 1992 primarily due to the payoff in September, 1993 of higher fixed rate mortgage debt which was replaced by the sale of lower interest convertible subordinated debentures and the sale of common shares, as well as a decrease in interest expense attributable to the refinancing in 1992 and discontinuation of operations in 1993 of a residential operating property and to favorable reduction in interest rates. Approximately $1,155,000 in interest expense decreases for the period September 10, 1993 through December 31, 1993 can be attributable to the payoff of mortgage debt and replacement with debentures and common shares. A decrease in interest cost of $304,000 can be attributable to the refinancing in 1992 and discontinuation of operations in September, 1993 of a residential operating property sold in February, 1994.\nDepreciation and amortization decreased by $42,000 to $4,736,000 in 1993 from $4,778,000 in 1992, primarily due to the sale in 1992 of two operating properties and the discontinuation in September, 1993 of the residential operating property sold in February, 1994.\nOperating expenses decreased by $232,000 to $3,754,000 in 1993 from $3,986,000 in 1992, primarily due to the sale in 1992 of two operating properties and the discontinuation in September, 1993 of the residential operating property sold in February, 1994.\nCost of residential property sold decreased by $60,000 to $1,008,000 in 1993 from $1,068,000 in 1992 due to the discontinuation of the residential sales in July, 1993.\nGeneral and administrative expenses increased by $131,000 to $1,354,000 in 1993 from $1,223,000 in 1992 due to an increase in insurance expense of $35,000 and an increase of $318,000 in stock compensation expense resulting from a $269,000 adjustment to accrued expense in 1992, due to a decrease in the value of BTR stock. The increases were offset by a decrease in professional fees of $36,000, a decrease in net payroll costs of $107,000, a decrease of $50,000 in 401K Plan expenses and changes in other categories.\nUnrecoverable development costs increased by $1,017,000 in BTR to $1,279,000 in 1993 from $262,000 in 1992 due to write-downs to net realizable value of two residential properties under contract of sale pursuant to a divestiture plan and the write-down in 1993 to net realizable value of a property held for sale.\n(Continued)\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR COMPANY) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nComparison of 1993 to 1992 - Continued\nMinority interest decreased by $158,000 to an expense of $2,000 in 1993 from a benefit of $156,000 in 1992 generally due to lower losses in minority interest ventures.\nLoss from operations decreased by $540,000 to $1,998,000 in 1993 from $2,538,000 in 1992. At January 1, 1992, BTR recognized the positive, cumulative effect of a change in accounting for income taxes of $1,286,000. At September 10, 1993, BTR recorded an extraordinary loss of $548,000 due to an early extinguishment of debt. A net income tax benefit of $408,000 and $127,000 was recognized by BTR for the periods ended 1993 and 1992, respectively. The 1992 accounting change, combined with a 1992 $48,000 loss on the sale of operating properties, a $1,340,000 gain on fire damage in 1992, the 1993 extraordinary item and income tax benefits for both periods, offset the loss from operations for the periods, resulting in net earnings of $167,000 for the year ended 1992 and a $2,138,000 net loss for the combined year ended 1993 for BTR and the Company.\nCash Flow comparison\nThe following discussion compares the statements of cash flows of the Company for the year ended December 31, 1994 with the statements of cash flows for the year ended December 31, 1993, which includes the summation of the Company's and BTR's cash flows. The discussion also compares the statements of cash flows for the year ended December 31, 1993, which includes the summation of the Company's and BTR's cash flows, with the statements of cash flows of BTR for the year ended December 31, 1992.\nCash Flow comparison of 1994 to 1993\nNet cash flow provided by operating activities increased by $157,000, to $7,766,000 for the year ended December 31, 1994 from $7,609,000 for the year ended December 31, 1993. The change in net cash flow provided by operating activities was due primarily to the factors described in the comparison of operating results above. The level of net cash provided by operating activities was also affected by timing in the payment of operating liabilities and the receipt of revenues from rental operations.\nNet cash flow used in investing activities increased by $13,680,000, to $19,630,000 from $5,950,000. The increase was primarily a result of the following: acquisitions and additions to properties which resulted in an increase of $14,644,000 (primarily the Shoppes at Easton acquisition in September, 1994), a decrease in cash flow used in investing activities related to an increase in proceeds from sales of properties of $1,617,000 (primarily due to sales of land held for sale and operating properties in 1994), and an increase of $653,000 related to an increase in payments to minority partners in 1994.\nNet cash flow provided by or used in financing activities increased by $12,591,000, to net cash provided by financing activities of $11,521,000 from net cash used in financing activities of $1,070,000. The increase was primarily three major net cash increases: (1) $18,369,000 in cash increases due to net additions to notes payable primarily in 1994 for the acquisition of the Shoppes at Easton in September, 1994 and the land for the new Owings Mills New Town shopping center under development purchased in December, 1994, (2) net reductions in 1993 in construction loans payable, and mortgages payable of $84,560,000, (3) 1993 additions to deferred debenture costs of $3,063,000. The increases were offset by a decrease in cash flow provided by financing activities resulting from the net cash flow provided by the net proceeds in 1993 from the sale of debentures and common shares of $93,453,000. Other net increases for the period totaled $52,000.\n(Continued)\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR COMPANY) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nCash Flow comparison - Continued\nCash Flow comparison of 1993 to 1992\nNet cash flow provided by operating activities increased by $6,360,000, to $7,609,000 for the year ended December 31, 1993 from $1,249,000 for the year ended December 31, 1992. Net cash flow increased generally due to the following: An increase in operating liabilities of $4,634,000 primarily consisting of $1,394,000 in 1993 accrued interest expense on newly issued debentures (See Note K), an increase of $1,865,000 due to a reduction in deferred income tax liability for 1993 and 1992 (See Note L), and the balance of the increase, $1,375,000, was primarily a decrease in 1992 in accounts payable and accrued expenses primarily due to a reduction in 1992 development activity. Other net cash flow increases of $2,626,000 were due to two non-recurring events in 1992, a cumulative effect of change in accounting principle, and a gain on fire damage of an operating property. Another major increase in net cash flow was due to $1,017,000 in unrecoverable development cost increases (described above). The increases were offset by a decrease in net earnings of $2,305,000 (described above) and other changes in net cash flow.\nNet cash flow used in or provided by investing activities decreased by $8,532,000, to net cash used in investing activities of $5,950,000 from net cash provided by investing activities of $2,582,000. The decrease was primarily a result of the following: an additions to properties increase of $4,586,000 (primarily the Timonium Mall purchase in October, 1993). A reduction in proceeds from sales of properties of $3,150,000 (primarily due to more sales of land held for sale and residential property in 1992), and a reduction due to the transfer or sale of investments in 1992 of $626,000.\nNet cash flow used in financing activities decreased by $2,861,000, to $1,070,000 from $3,931,000. The decrease was primarily due to the net cash flow provided by the net proceeds from the sale of debentures and common shares of $93,453,000 offset by 3 major net cash uses: (1) net reductions in construction loans payable, and mortgages payable of $82,387,000, (2) dividends paid in 1993 of $5,259,000, and (3) 1993 additions to deferred debenture costs of $3,063,000.\nLiquidity and Capital Resources\nHistorically, BTR's principal source of capital consisted of acquisition and development loans, with recourse to the borrower, which funded land and construction costs. As development projects were completed, acquisition and development loans were replaced with permanent mortgages which typically bore higher rates of interest but were secured by the project only, with no recourse to the borrower. BTR also utilized bank lines and internal funds for equity in its real estate projects, replacing such sources with permanent financing when rates and terms were deemed favorable. BTR had paid its shareholders a modest dividend, retaining excess cash flows to invest in additional projects. In 1990, the dividend was discontinued and cash flows in excess of operating requirements were used for paying or curtailing outstanding debt, primarily bank lines and construction and acquisition loans. BTR improved its liquidity in September, 1993 with the conversion into MART. The initial public share and debenture offering on September 10, 1993 replaced higher fixed rate mortgage debt with lower interest convertible subordinated debentures and the sale of common shares.\nIn order to qualify as a REIT for Federal income tax purposes, MART is required to pay dividends to its shareholders of at least 95% of its REIT taxable income. MART intends to pay these dividends from operating cash flows which have increased due to the reduction in debt service resulting from the repayment of indebtedness with the proceeds of the offering, and from future growth in rental revenues and other sources, such as the leasing of currently vacant space and development of undeveloped parcels. While MART intends to distribute to its shareholders a substantial portion of its cash flows from operating activities, MART also intends to retain or reserve such amounts as it considers necessary from time to time for the acquisition or development of new properties as suitable opportunities arise and for the expansion and renovation of its shopping centers. Also, MART currently has and will continue to maintain a line of credit of at least $35,000,000 from a commercial bank (See Footnote I).\nThe Company anticipates material commitments for capital expenditures to include, in the next two years, the redevelopment or development of five Baltimore area projects at an estimated cost between $14 and $25 million. The Company expects to fund the development projects and other capital expenditures with (i) available net cash flows from operating activities, (ii) if necessary, construction loan financing, (iii) if necessary, long term mortgage financing on unencumbered operating properties, and (iv) if necessary, the use of its $35,000,000 line of credit from a commercial bank (See Footnote I).\n22 (Continued)\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR COMPANY) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nLiquidity and Capital Resources - Continued\nIt is management's intention that MART continually have access to the capital resources necessary to expand and develop its business. Management cannot practically quantify MART's 1995 cash requirements, but, expects to meet its short-term liquidity requirements generally through available net cash flow provided by operations and short-term borrowings. To meet its long-term liquidity requirements, MART intends to obtain funds through additional equity offerings or long-term debt financing in a manner consistent with its intention to operate with a conservative debt capitalization policy. MART anticipates that the cash flow available from operations, together with cash from borrowings, will be sufficient to meet the capital and liquidity needs of MART in both the short and long term.\nChanges in Accounting Principles\nEffective April 1, 1994 the Company adopted a new accounting treatment regarding lease cancellation fees received from tenants who want to discontinue their remaining lease term obligations. Prior to April 1, 1994, the lease termination payments for major tenants were recognized as other income in the period when the termination agreement was executed. Under the new treatment, the entire amount of the cancellation or termination fee on the date of the lease termination is deferred and then amortized into income on a straight-line basis over the remaining original lease term as minimum rent. The Company believes that this change is preferable since it provides a better matching of revenues and expenses. During 1994, approximately $687,000 of termination fees were deferred, and $56,000 was amortized.\nEffective January 1, 1995 the Company changed its accounting treatment for percentage rent. Percentage rent revenues are based on store sales for certain periods and are charged according to a percentage over a breakpoint amount of sales for the period according to the lease agreement. During the year ended December 31, 1994 and previously, percentage rent was recognized as rental revenues in the period when the actual percentage rent was billed and received. The new method will recognize percentage rent as rental revenues in the period when the actual percentage rent is earned. The Company will begin on January 1, 1995 estimating the percentage rent earned from major tenants and record the amounts monthly as receivable. The cumulative effect of this change on January 1, 1995, was approximately $675,000.\nInflation\nThe majority of all of the leases at the shopping center properties contain provisions which may entitle MART to receive percentage rents based on the tenants' gross sales. Such percentage rents ameliorate the risk to MART of the adverse effects of inflation. Percentage rent received by BTR and MART remained stable in the year ended December 31, 1994 compared to the year ended December 31, 1993. If a recession were to begin and continue for a prolonged time, funds from operations could decline as some tenants may have trouble meeting their lease obligations. Most of the leases at the properties require the tenants to pay a substantial share of operating expenses, such as real estate taxes, insurance and common area maintenance costs, and thereby reduce MART's exposure to increased costs. In addition, many of the leases at the properties are for terms of less than 10 years, which may enable MART to seek increased rents upon renewal of existing leases if rents are below the then-existing market value.\nStock Repurchase Plan\nOn February 14, 1995 the MART Board of Trustees approved a stock repurchase plan. Under this plan, MART may, from time to time, repurchase shares of its common stock either in the open market or in privately negotiated transactions upon such prices and other terms as the Company deems appropriate. The aggregate number of shares authorized for repurchase will not exceed 5% of the number of shares currently outstanding, or approximately 310,000.\nITEM 8","section_7A":"","section_8":"ITEM 8\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES, & BTR REALTY, INC. & SUBSIDIARIES (PREDECESSOR COMPANY) Financial Statements: Independent auditors' report ......................25\nConsolidated Balance Sheets - as of December 31, 1994 and 1993 ................26\nConsolidated Statements of Operations - For the Year ended December 31, 1994 and the Periods ended December 31, 1993 and September 10, 1993 and for the Year ended December 31, 1992 ...27\nConsolidated Statements of Shareholders' Equity - For the Year ended December 31, 1994 and the Periods ended December 31, 1993 and September 10, 1993 and for the Year ended December 31, 1992 ...............................28\nConsolidated Statements of Cash Flows - For the Year ended December 31, 1994 and the Periods ended December 31, 1993 and September 10, 1993 and for the Year ended December 31, 1992 ...29\nNotes to Consolidated Financial Statements ........31\nExhibits, Financial Statement Schedule, and Reports on Form 8-K are included in Part IV - Item 14.\nSchedule:\nSchedule VI - Real Estate and Accumulated Depreciation ..................................42\nINDEPENDENT AUDITORS' REPORT\nBoard of Trustees and Shareholders Mid-Atlantic Realty Trust :\nWe have audited the accompanying consolidated balance sheets of Mid-Atlantic Realty Trust and subsidiaries as of December 31, 1994 and 1993 and the related consolidated statements of operations, shareholders' equity and cash flows for the year ended December 31, 1994, and the period ended December 31, 1993 and the consolidated statements of operations, shareholders' equity and cash flows of BTR Realty, Inc. and subsidiaries for the period ended September 10, 1993 and for the year ended December 31, 1992. In connection with our audits of the consolidated financial statements, we have also 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 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 Mid-Atlantic Realty Trust and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for the year ended December 31, 1994, and for the period ended December 31, 1993 and the results of BTR Realty, Inc. and subsidiaries' operations and their cash flows for the period ended September 10, 1993 and for the year ended December 31, 1992, 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.\nAs discussed in note A to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1992 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Also, as discussed in note A, the Company changed its method of accounting for lease termination payments in 1994.\nKPMG PEAT MARWICK LLP\nBaltimore, Maryland February 16, 1995\nMID-ATLANTIC REALTY TRUST & SUBSIDIARIES\nConsolidated Balance Sheets\nAs of December 31, 1994 1993\nASSETS Properties: Operating properties (Notes C and D)............$ 140,062,761 127,713,850 Development operations (Note E)................... 6,354,947 2,128,434 Property held for development or sale ....... 8,630,465 9,169,232 ------------- ------------- 155,048,173 139,011,516\nCash and cash equivalents .... 344,522 687,108 Notes and accounts receivable - tenants and other (Note F).......... 1,688,194 2,357,791 Due from joint venture partners ................... 1,937,019 1,701,708 Prepaid expenses and deposits. 402,283 403,075 Refundable income taxes ...... - 24,045 Net assets of properties to be sold (Note G) ........... - 449,219 Deferred financing costs (Note H) ................... 3,422,376 3,928,590 ------------- ------------- $ 162,842,567 148,563,052 ============= =============\nLIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Notes payable (Note I).......$ 20,139,413 2,800,000 Accounts payable and accrued expenses (Note J).......... 3,534,277 4,377,411 Mortgages payable (Note D) .. 53,251,140 53,694,372 Convertible subordinated debentures (Note K)........ 60,000,000 60,000,000 Deferred income ............. 730,466 133,468 Minority interest in consolidated joint ventures 330,893 250,432 Income taxes currently payable - state (Note L).......... - 19,581 ------------- ------------- 137,986,189 121,275,264\nCommitments (Notes M & O) Shareholders' Equity (Note N): Preferred shares of beneficial interest, $.01 par value, authorized 2,000,000 shares, issued and outstanding, none .......... - - Common shares of beneficial interest, $.01 par value, authorized 100,000,000, issued and outstanding, 6,291,407...... 62,914 62,914 Additional paid-in capital .. 42,602,505 42,602,505 Accumulated deficit ......... (17,809,041) (15,377,631) ------------- ------------- 24,856,378 27,287,788 ------------- ------------- $ 162,842,567 148,563,052 ============= =============\nSee accompanying notes to consolidated financial statements.\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) Consolidated Statements of Operations\nMid-Atlantic Realty Trust || BTR Realty, Inc. Year Ended September 11 to||January 1 to Year Ended December 31, December 31, ||September 10, December 31, 1994 1993 || 1993 1992 || REVENUES: || Rentals ........$ 21,890,446 6,061,175 || 14,620,418 20,217,251 Gain on sales of || properties held || for sale, net 81,313 - || 31,501 281,511 Sales of residential || property ..... - - || 1,032,000 1,120,750 Other (Note P) 877,122 515,509 || 228,292 1,035,621 ------------ ----------- ||------------ ------------ 22,848,881 6,576,684 || 15,912,211 22,655,133 ------------ ----------- ||------------ ------------ COSTS AND EXPENSES: || Interest ....... 10,342,725 3,076,060 || 9,278,198 14,032,352 Depreciation and || amortization of property || and improvements 5,083,384 1,502,449 || 3,233,530 4,778,432 Operating ...... 3,336,415 1,104,193 || 2,649,341 3,985,439 General and || administrative 1,751,101 300,625 || 1,053,295 1,223,319 Cost of residential || property sold . - - || 1,008,475 1,067,806 Unrecoverable || development costs - - || 1,278,817 262,147 ------------ ----------- ||------------ ------------ 20,513,625 5,983,327 || 18,501,656 25,349,495 ------------ ----------- ||------------ ------------ EARNINGS (LOSS) FROM || OPERATIONS BEFORE || MINORITY INTEREST 2,335,256 593,357 || (2,589,445) (2,694,362) Minority interest || (expense) benefit (540,744) (125,883) || 124,129 156,460 ------------ ----------- ||------------ ------------ EARNINGS (LOSS) FROM || OPERATIONS ..... 1,794,512 467,474 || (2,465,316) (2,537,902) Gain on Fire || Damage ......... - - || - 1,340,000 Gain (loss) on || sales of operating || properties 1,121,774 - || - (47,573) ------------ ----------- ||------------ ------------ EARNINGS (LOSS) BEFORE INCOME || TAXES, CUMULATIVE EFFECT OF || CHANGE IN ACCOUNTING || PRINCIPLE & EXTRAORDINARY || ITEM 2,916,286 467,474 || (2,465,316) (1,245,475) Income tax benefit, || net (Note L) .. - - || 408,210 126,518 ------------ ----------- ||------------ ------------ EARNINGS (LOSS) BEFORE || CUMULATIVE EFFECT OF || CHANGE IN ACCOUNTING || PRINCIPLE AND || EXTRAORDINARY || ITEM ........... 2,916,286 467,474 || (2,057,106) (1,118,957) Cumulative effect || of change in accounting || for income taxes - - || - 1,286,000 ------------ ----------- ||------------ ------------ EARNINGS (LOSS) || BEFORE EXTRAORDINARY || ITEM ........... 2,916,286 467,474 || (2,057,106) 167,043 Extraordinary item - || Loss on early || extinguishment || of debt ........ - - || (548,323) - ------------ ----------- ||------------ ------------ NET EARNINGS || (LOSS) .........$ 2,916,286 467,474 || (2,605,429) 167,043 ============ =========== ||============ ============ || Earnings (loss) per share || before cumulative effect || of change in accounting || principle and extraordinary || item ...........$ 0.46 0.07 || (0.24) (0.13) Cumulative effect of || change in accounting || principle - - || - 0.15 ------------ ----------- ||------------ ------------ Earnings (loss) per || share before extraordinary || item ............ 0.46 0.07 || (0.24) 0.02 Extraordinary item - || early extinguishment || of debt ........ - - || (0.06) - ------------ ----------- ||------------ ------------ NET EARNINGS (LOSS) || PER SHARE ......$ 0.46 0.07 || (0.30) 0.02 ============ =========== ||============ ============\nSee accompanying notes to consolidated financial statements.\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) Consolidated Statements of Shareholders' Equity Years ended December 31, 1994, 1993 and 1992\nRetained Additional Earnings Total Common Par Paid-in (Accumulated Shareholders' Shares Value Capital Deficit) Equity\nBTR REALTY, INC. BALANCE, January 1, 1992 8,503,916 $85,039 9,078,718 (8,147,270) 1,016,487\nNet earnings - - - 167,043 167,043 ----------- -------- ----------- ------------ ----------- BALANCE, December 31, 1992 8,503,916 85,039 9,078,718 (7,980,227) 1,183,530 ----------- -------- ----------- ------------ -----------\nStock issued through the exercise of options pursuant to the BTR stock compensation plan 78,286 783 224,475 - 225,258 Stock canceled for repayment of a note receivable from a former employee (56,554) (566) (176,485) - (177,051) Dividend Paid - $.58 per share - - - (4,944,879) (4,944,879) Net loss - - - (2,605,429) (2,605,429) ----------- -------- ----------- ------------ -----------\nBALANCE, September 10, 1993 8,525,648 85,256 9,126,708 (15,530,535) (6,318,571) ----------- -------- ----------- ------------ ----------- ========================================================================\nMID-ATLANTIC REALTY TRUST\nConversion of 3 shares of BTR for 1 share of MART (5,683,765) (56,837) 56,837 - - Acquisition of Fractional Shares (476) (5) (5,024) - (5,029) Initial sale of Common Shares of Beneficial Interest 3,450,000 34,500 33,423,984 - 33,458,484 Dividend Paid - $.05 per share - - - (314,570) (314,570) Net Earnings - - - 467,474 467,474\nBALANCE, December 31, 1993 6,291,407 62,914 42,602,505 (15,377,631) 27,287,788\nDividends Paid - $.85 per share - - - (5,347,696) (5,347,696) Net Earnings - - - 2,916,286 2,916,286 ----------- -------- ------------ ------------ -----------\nBALANCE, December 31, 1994 6,291,407 $62,914 42,602,505 (17,809,041) 24,856,378 =========== ======== ============ ============ ===========\nSee accompanying notes to consolidated financial statements.\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY)\nConsolidated Statements of Cash Flows\nMid-Atlantic Realty Trust || BTR Realty, Inc. Year Ended September 11 to||January 1 to Year Ended December 31, December 31, ||September 10, December 31, 1994 1993 || 1993 1992 || Cash flows from || operating activities: || Net earnings || (loss) $2,916,286 467,474 || (2,605,429) 167,043 Adjustments to reconcile || net earnings (loss) || to net cash provided || by operating activities: || Depreciation and || amortization 5,083,384 1,502,449 || 3,233,530 4,778,432 Minority interest || in earnings (loss), || net ......... 540,744 125,883 || (124,129) (156,460) (Gain) loss on sales || of operating || properties .(1,121,774) - || - 47,573 Gain on sales of || residential properties || and properties held || for sale, net (81,313) - || (7,976) (334,455) Unrecoverable || development || costs - - || 1,278,817 262,147 Loss on early || extinguishment || of debt - || capitalized .. - - || 273,308 - Deferred income || taxes benefit .. - - || (460,570) (118,000) Gain on fire damage of || operating || property - - || - (1,340,000) Cumulative effect of || change in accounting || principle ... - - || - (1,286,000) Stock compensation || plan accrual .. - - || - (268,900) Changes in operating || assets and liabilities: || Decrease in operating || assets .... 694,434 108,480 || 555,067 869,252 Increase (decrease) || in deferred rental || income ..... 610,678 (974,173) || 974,173 - (Decrease) increase || in operating || liabilities (876,395) 2,249,233 || 1,012,844 (1,371,494) ----------- ------------ || ----------- ----------- Total || adjust- || ments... 4,849,758 3,011,872 || 6,735,064 1,082,095 ----------- ------------ || ----------- ----------- NET CASH PROVIDED BY || OPERATING || ACTIVITIES 7,766,044 3,479,346 || 4,129,635 1,249,138 ----------- ------------ || ----------- ----------- || Cash flows from || investing activities: || Additions to || properties (22,197,577) (6,173,532) || (1,379,710) (2,967,398) Proceeds from || sales of || properties. 3,263,444 - || 1,646,748 4,796,907 (Payments to) || receipts from || minority partners, || net ....... (695,594) (213,756) || 170,224 147,839 Purchases of || investments.. - - || - (21,753) Transfer or sale of || investments.... - - || - 625,921 ----------- ------------ || ----------- ----------- NET CASH (USED IN) || PROVIDED BY || INVESTING || ACTIVITIES (19,629,727) (6,387,288) || 437,262 2,581,516 ------------ ----------- || ----------- -----------\n(CONTINUED)\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY)\nConsolidated Statements of Cash Flows - (Continued)\nMid-Atlantic Realty Trust || BTR Realty, Inc. Year Ended September 11 to||January 1 to Year Ended December 31, December 31, ||September 10, December 31, 1994 1993 || 1993 1992 || Cash flows from || financing activities: || Proceeds from || notes payable $39,456,366 3,100,000 || 90,832,649 7,044,500 Principal || payments on || on notes || payable (22,116,953) (87,486,651) || (7,475,452) (8,285,036) Proceeds from || mortgages payable - - || 2,682,600 1,076,444 Principal payments || on mortgages || payable ...... (443,232) (3,143,953) ||(46,709,513) (2,446,767) Proceeds from || construction || loans payable .. - - || - 1,087,244 Payments on || construction || loans payable .. - - ||(37,831,945) (2,332,591) Additions to deferred || finance costs - || other......... (27,388) (171,954) || (45,149) (33,807) Proceeds from sale || of convertible || debentures .. - 60,000,000 || - - Additions to deferred || finance costs - || debentures..... - (3,063,274) || - - Net proceeds from || sale of common || shares ....... - 33,453,455 || - - Sinking fund || payments - - || - (41,083) Stock issued - || options exercised || in compensation || plan ........ - - || 225,258 - Stock canceled - || employee note || payment ...... - - || (177,051) - Dividends paid .(5,347,696) (314,570) || (4,944,879) - ----------- ----------- || ----------- -------- - -- || NET CASH PROVIDED || BY (USED IN) || FINANCING || ACTIVITIES 11,521,097 2,373,053 || (3,443,482) (3,931,096) ----------- ----------- || ----------- ----------- NET (DECREASE) || INCREASE IN CASH || AND CASH || EQUIVALENTS (342,586) (534,889) || 1,123,415 (100,442)\nCASH AND CASH || EQUIVALENTS, || beginning of || period 687,108 1,221,997 || 98,582 199,024 ---------- ----------- || ----------- ----------- - - || CASH AND CASH || EQUIVALENTS, || end of period ... $344,522 687,108 || 1,221,997 98,582 =========== =========== || =========== =========== || Supplemental disclosures of || cash flow information: || Cash paid for: || Interest (net of amounts || capitalized) $10,404,859 1,659,428 || 9,218,811 14,009,774 Income taxes .. - 20,560 || 16,813 48,588 =========== =========== || =========== ============\nSupplemental schedule of noncash investing and financing activities:\nDuring 1994, $2,832,641 in assets were transferred from Development Operations to Operating Properties.\nAt December 31, 1993, MART recorded an asset on the balance sheet, Net assets of properties to be sold (Note G) of $449,219. The reclassification of the assets and liabilities consisted of the following; a decrease in operating properties of $6,505,807, a decrease in operating assets of $304,377, a decrease in deferred financing costs of $323,449, a decrease in operating liabilities of $42,419, and a decrease in mortgages payable of $6,641,995. Proceeds from sales of properties for the year ended December 31, 1994 included net proceeds of $504,820 from the sale, in February 1994, of net assets of properties to be sold which included proceeds of $7,146,815 reduced by the payoff of the mortgage payable of $6,641,995.\nOn September 10, 1993, BTR reported a loss on an early extinguishment of debt of $548,323. The loss included prepayment penalties and loan fee expenses amounting to $275,015, and a reduction of net amortized financing costs capitalized as costs of the related operating properties of $273,308.\nIn August, 1993, a former Officer of BTR surrendered 56,544 shares of BTR stock as full repayment of his note receivable.\nIn December, 1992, BTR reported a gain on sale of property that had fire damage. The effect of the $1,340,000 gain increased operating assets by the insurance recovery expected of $1,826,000 and decreased operating properties by $486,000. The decrease in operating assets ended September 10, 1993 includes a partial collection of the insurance recovery of $1,328,000.\nSee accompanying notes to consolidated financial statements.\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYears Ended December 31, 1994, 1993, 1992\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization\nMid-Atlantic Realty Trust, \"the Company\", was incorporated on June 29, 1993 and commenced operations effective with the completion of its initial public share offering on September 11, 1993. The Company is the successor to the operations of BTR Realty, Inc. (the predecessor to the company), \"BTR\". The Consolidated Financial Statements of BTR Realty, Inc. are presented for comparative purposes.\nPrinciples of Consolidation\nThe consolidated financial statements include all wholly-owned subsidiaries and majority-owned partnerships. Investments in unconsolidated joint ventures are carried on the equity method. All significant intercompany balances and transactions have been eliminated.\nThe Company owns 100% majority interests in corporate subsidiaries which are general managing partners as well as limited partners of several partnerships which have outside partners with 50% interests. Based upon the structure of the respective partnership management agreements the Company has control (as defined by the Statement of Financial Accounting Standards No. 94, \"Consolidation of All Majority- Owned Subsidiaries\", which describes the full consolidation method as preferable to the equity method where there is a 50% or less financial interest but control) over the 50% owned partnerships. The Company uses the full consolidation method to record the 50% owned partnerships.\nIn September, 1993, MART loaned to outside partners funds to cover their respective partner share of partnership mortgage paydowns using their respective equity interests in the partnerships as collateral for the notes receivable. The company eliminates the notes receivable against what is due from joint venture partners. The interest on the partner notes is recognized as interest income.\nRecognition Of Revenue From Property Sales\nThe sale of residential property and any resulting gain or loss on properties held for sale are recorded upon settlement. Properties held for sale are primarily outparcels of operating properties or undeveloped commercial land.\nNet Earnings (Loss) Per Share\nEarnings (loss) per share are computed by dividing net earnings (loss) by the weighted average number of common shares and common share equivalent shares outstanding during each year. The effect on earnings per share assuming conversion of the convertible subordinated debentures would be anti-dilutive.\nCapitalization Policy and Net Realizable Value\nAcquisition costs, interest and other carrying costs, as well as construction and start-up costs of commercial property are capitalized and charged to related undeveloped land, construction in progress or deferred costs. In addition, costs incurred in the financing and leasing of shopping centers and other commercial properties are deferred until the project is completed and are then amortized over the term of the related mortgage or lease. Management ceases to capitalize or defer these costs when the carrying value equals the net realizable value of the property or costs are unlikely to be recoverable. Net realizable value is determined primarily by the application of the principles of valuation of operating properties. The basis for determining the value of operating properties is the lower of historical cost or the net realizable value. The net realizable value of operating properties is based on the present value of each property's anticipated net cash flow, before debt service payments, calculated using prevailing industry discount and capitalization rates. Anticipated net cash flow is based upon an analysis of the history and future of the property, existing and prospective tenant leases, occupancy rates, and estimated operating expenses. The discount factor, capitalization rates or reversion rates used to arrive at the net realizable value of each property are based on the risk associated with the property as well as the prevailing rates at the end of the reporting period. Risk variations reflect differences in quality, age, location and market conditions of each property.\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\nProperties\nOperating properties and property held for development or sale are carried at the lower of historical cost or, where appropriate, an amount not to exceed estimated net realizable value. Depreciation of buildings and leaseholds is provided using the straight-line method over the estimated useful lives or lease terms of the properties. Improvements for tenants are amortized on a straight- line basis over the terms of the related tenant leases. Expenditures for normal maintenance and repairs are charged against income as incurred.\nChanges in Accounting Principles\nEffective April 1, 1994 the Company adopted a new accounting treatment regarding lease cancellation fees received from tenants who want to discontinue their remaining lease term obligations. Prior to April 1, 1994, the lease termination payments for major tenants were recognized as other income in the period when the termination agreement was executed. Under the new treatment, the entire amount of the cancellation or termination fee on the date of the lease termination is deferred and then amortized into income on a straight-line basis over the remaining original lease term as minimum rent. The Company believes that this change is preferable since it provides a better matching of revenues and expenses. During 1994, approximately $687,000 of termination fees were deferred, and $56,000 was amortized.\nEffective January 1, 1995 the Company changed its accounting treatment for percentage rent. Percentage rent revenues are based on store sales for certain periods and are charged according to a percentage over a breakpoint amount of sales for the period according to the lease agreement. During the year ended December 31, 1994 and previously, percentage rent was recognized as rental revenues in the period when the actual percentage rent was billed and received. The new method will recognize percentage rent as rental revenues in the period when the actual percentage rent is earned. The Company will begin on January 1, 1995 estimating the percentage rent earned from major tenants and record the amounts monthly as receivable. The cumulative effect of this change on January 1, 1995 was approximately $675,000.\nIncome Taxes\nThe Company has elected to qualify, and intends to continue to qualify as a real estate investment trust, \"REIT\", pursuant to the Internal Revenue Code Sections 856 through 860, as amended. In general, under such Code provisions a trust which, in any taxable year, meets certain requirements and distributes to its shareholders at least 95% of its REIT taxable income will not be subject to Federal income tax to the extent of the income which it distributes.\nEffective January 1, 1992, BTR adopted Statement of Financial Accounting Standards No. 109,\"Accounting for Income Taxes\", (Statement 109), which requires an asset and liability method of accounting for income taxes. The Company reported the cumulative effect of that change in the method of accounting for income taxes in the consolidated statement of operations for 1992. The Company continues to apply the standard which did not have a material effect on the year ended December 31, 1994 and the period September 11 through December 31, 1993.\nCash and Cash Equivalents\nAll highly liquid unrestricted investments with original maturities of three months or less are considered cash equivalents for purposes of the statements of cash flows.\nDeferred Finance Costs\nCosts associated with the issuance of debt are capitalized and recorded as deferred finance costs and amortized on a straight-line basis, which is not materially different from the interest method, over the term of the related debt.\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nB. PUBLIC OFFERINGS\nOn September 11, 1993, the Company completed a public offering of 3,450,000 common shares of beneficial interest at $10.50 per share and $60,000,000 in convertible subordinated debentures at 7.625%. Net proceeds from these offerings totaled approximately $90,390,000.\nC. OPERATING PROPERTIES\nOperating properties consist of the following: December 31, 1994 1993 Land $17,993,243 15,781,566 Land improvements 21,123,172 19,819,368 Buildings 107,030,436 95,771,668 Improvements for tenants 6,013,294 5,280,554 Development costs on completed projects 16,577,892 16,739,579 Furniture, fixtures and equipment 2,181,109 2,177,423 Deferred lease costs 5,592,584 4,794,044 ------------ ----------- 176,511,730 160,364,202 Less accumulated depreciation and amortization 36,448,969 32,650,352 ------------ ----------- $140,062,761 127,713,850 ============ ===========\nD. PROPERTIES AND RELATED ACCUMULATED DEPRECIATION AND AMORTIZATION AND MORTGAGES PAYABLE\nA summary of all of the Company's properties and related mortgages payable at December 31, 1994 follows:\nAccumulated Cost of Depreciation Classi- Mortgages Initial Subsequent Total and fication Payable Cost Improvements Cost Amortization Net Cost\nShopping centers $50,086,463 117,544,194 20,116,163 137,660,357 28,634,598 109,025,759 Bowling centers - 2,866,998 64,383 2,931,381 1,320,174 1,611,207 Office buildings 3,164,677 26,415,163 3,230,125 29,645,288 4,709,584 24,935,704 Other rental properties - 4,782,560 919,046 5,701,606 1,387,953 4,313,653 Other property - 573,098 - 573,098 396,660 176,438 ------------------------------------------------------------ - ------------ Operating proper- ties 53,251,140 152,182,013 24,329,717 176,511,730 36,448,969 140,062,761 Development operations - 6,354,947 - 6,354,947 - 6,354,947 Property held for development or sale - 8,630,465 - 8,630,465 - 8,630,465 -------------------------------------------------------------- - ----------- $53,251,140 167,167,425 24,329,717 191,497,142 36,448,969 155,048,173=========================================================== ===========\nMortgages payable aggregating $53,251,140 at December 31, 1994 bear interest at 9.54% to 11.75% and mature in installments through 2003. Aggregate annual principal payments applicable to mortgages payable for the five years subsequent to December 31, 1994 are:\n1995 $ 7,197,969 1996 5,835,477 1997 5,241,874 1998 14,045,689 1999 253,258 Thereafter 20,676,873 ===========\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nE. DEVELOPMENT OPERATIONS Development operations consist of the following:\nDecember 31, 1994 1993 Land $5,072,696 - Construction in progress 953,456 1,749,886 Pre-construction costs 328,795 378,548 ---------- --------- $6,354,947 2,128,434 ========== =========\nDevelopment operations are transferred to operating property costs when a project is completed, at which time depreciation and amortization commences.\nF. NOTES AND ACCOUNTS RECEIVABLE\nIncluded in notes and accounts receivable at December 31, 1994 are significant concentrations of amounts due from tenants in two primary geographical areas: the mid-Atlantic region of the United States and Arizona. Although improved for 1994 and 1993, the economic condition of the Arizona real estate market has been weak as evidenced by increased vacancies in the Company's projects, particularly in the Phoenix market. The Company's accounts receivable at December 31, 1994 included $673,000 and $379,000 due from tenants in the mid-Atlantic region and Arizona, respectively. Management believes adequate provision has been made for the Company's credit risk for all receivables.\nG. NET ASSETS OF PROPERTIES TO BE SOLD\nNet assets of properties to be sold consist of net assets and liabilities (only liabilities assumed by the purchasers) of an operating property, Orchard Landing, under contract for sale at December 31, 1993. MART sold its partnership interest in this property on February 1, 1994 for $7.2 million. The property was part of a divestiture plan to facilitate the merger of BTR and MART. On September 10, 1993 BTR decided to sell this property and discontinue reporting operating results in its consolidated statement of operations. The amount of losses from the discontinued segment was de-minimus.\nThe remaining assets and liabilities reported on the balance sheet at December 31, 1993 consists of:\nOperating property $6,505,807 Cash 268,879 Accounts receivable 10,404 Prepaid expenses and deposits 25,094 Deferred financing costs 323,449 --------- Total assets 7,133,633 ---------- Tenant accounts payable 42,419 Mortgage payable 6,641,995 ---------- Total liabilities (assumed by purchaser) 6,684,414 ---------- Net assets $449,219 ==========\nH. DEFERRED FINANCING COSTS As of December 31, Deferred financing costs 1994 1993 consist of the following: Deferred costs related to the debentures $3,063,274 3,063,274 Deferred costs of new line of credit 198,972 171,584 Deferred financing costs capitalized related to operating properties 1,720,827 1,720,827 ----------- ----------- 4,983,073 4,955,685 Less accumulated amortization (1,560,697) (1,027,095) ----------- ----------- Deferred financing costs $3,422,376 3,928,590 =========== ===========\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nI. NOTES PAYABLE Notes payable consist of the following: As of December 31, 1994 1993 Line of credit 20,100,000 2,800,000 Notes payable, bearing interest at 8.71% 39,413 - ---------- --------- 20,139,413 2,800,000 ========== =========\nAt December 31, 1994, the Company has amended the existing agreement with its primary bank for an additional $10,000,000 to its $25,000,000 secured line of credit. This amendment also provides that as long as the Company is in compliance with all loan covenants, the loan maturity date, which at December 31, 1994 was December 31, 1997, will be extended one year automatically each year. Under the amended agreement, the Bank must give the Company two years notice should it decide to terminate the loan. Availability under the agreement is determined by the amount of collateral provided. At December 31, 1994, $35,000,000 was fully collateralized. The line bears interest at the prime rate. However, the Company has the option to fix the rate at LIBOR plus 1.125% under certain circumstances. A stand-by fee is required by the bank for any unused portion of the line. The agreement contains covenants which provide for the maintenance of specified debt service ratios and minimum levels of net worth, and other requirements, among which is the requirement that the Company maintain its status as a REIT, and other normal conditions consistent with bank lines of credit.\nAt December 31, 1994, the unused line of credit available to the Company, subject to compliance with all terms and conditions of the agreement and net of outstanding letters of credit of $715,500, was $14,184,500. The maximum level of borrowings under the line of credit was $20,100,000, $4,633,130 and $4,663,000 in 1994, 1993 and 1992, respectively. The average amounts of borrowings were approximately $6,131,000, $1,888,000, and $3,566,000, with weighted average interest approximating 6.5%, 5.6%, and 6.3%, in 1994, 1993 and 1992, respectively.\nAggregate annual principal maturities of notes payable subsequent to December 31, 1994 are as follows:\n1995 $ 9,270 1996 9,270 1997 20,109,270 1998 9,270 1999 2,333 ==========\nJ. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\nAccounts payable and accrued expenses consist of the following:\nDecember 31, 1994 1993 Trade accounts payable 1,195,143 1,289,204 Retainage on construction in progress 61,117 146,774 Accrued debenture interest expense 1,334,375 1,394,435 Accrued expenses 943,642 1,546,998 --------- --------- 3,534,277 4,377,411 ========= =========\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nK. CONVERTIBLE SUBORDINATED DEBENTURES\nEffective September 11, 1993 the Company issued $60,000,000 of convertible subordinated debentures at 7.625% scheduled to mature in September, 2003. Interest on the debentures is paid semi-annually on March 15 and September 15. The debentures are convertible, unless previously redeemed, at any time prior to maturity into common shares of beneficial interest of the Company at $10.50 per share, subject to certain adjustments. As of December 31, 1994 no debentures have been converted. Costs associated with the issuance of the debentures were approximately $3,063,000 and are being amortized through 2003. The debentures are redeemable by the Company at any time on or after September 15, 1996, or at any time for certain reasons intended to protect the Company's REIT status, at 100% of the principal amount thereof, together with accrued interest. The debentures are subordinate to all mortgages payable.\nL. INCOME TAXES\nAs discussed in Note A, the Company plans to maintain its status as a REIT, and be taxed under Sections 856-860 of the Internal Revenue Code of 1986, as amended. In general terms, under such Code provisions a trust or corporation which, in any taxable year, meets certain requirements and distributes to its shareholders at least 95% of its taxable income will not be subject to Federal income tax to the extent of the income which it distributes.\nA REIT will generally not be subject to federal income taxation for the portion of its income that qualifies as REIT taxable income to the extent that it distributes at least 95 percent of its taxable income to its shareholders and complies with certain other requirements. Accordingly, no provision has been made for federal income taxes for the Company and certain of its subsidiaries in the accompanying consolidated financial statements. At December 31, 1994, the income tax basis of the Company's assets was approximately $151,000,000 and liabilities was approximately $ 137,000,000.\nAs discussed, BTR adopted Statement 109, as of January 1, 1992. The cumulative effect at January 1, 1992 of this change in accounting for income taxes was to increase net earnings for 1992 by $1,286,000 or $.15 per share. The effect of the change in 1992, excluding the change in accounting principle, was not material.\nThe income taxes benefit, net, in BTR, for the period January 1, 1993 through September 10, 1993 included a currently payable income tax expense of $52,360, offset by a deferred income tax benefit of $460,570, including the balance of deferred income taxes payable of $466,570 in BTR which was recognized as an income tax benefit. It was determined by BTR that it was more likely than not that there would be no payment in the future of any deferred tax temporary differences due to the expected merger with the Company. This was in accordance with Statement 109 adopted by BTR as of January 1, 1992.\nThe net benefit for income taxes consists of the following:\nJan. 1, 1993 thru Year ended September 10, December 31, 1993 1992\nCurrent taxes: Federal $ - - State 52,360 (8,518) ----------------------------- 52,360 (8,518) -----------------------------\nDeferred: Federal 118,430 (265,000) State (579,000) 147,000 ----------------------------- (460,570) (118,000) ----------------------------- $ (408,210) (126,518) =============================\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nM. COMMITMENTS\nLease Commitments Minimum rental commitments for operating land leases as of December 31, 1994 are as follows:\n1995 $220,000 1996 222,000 1997 222,000 1998 222,000 1999 222,000 Thereafter 4,908,000 =========\nCertain of the leases contain renewal or purchase options. All of the leases require the Company to pay real estate taxes. Total annual minimum lease payments amounted to $219,000 in 1994, $176,000 in 1993 and $164,000 in 1992.\nN. SHAREHOLDERS' EQUITY AND STOCK COMPENSATION PLAN\nPreferred Shares At its inception on September 11, 1993, Mid-Atlantic Realty Trust authorized 2,000,000 preferred shares of beneficial interest at a par value of $.01 per share. At December 31, 1994, none of these shares were issued and outstanding.\nBTR Stock Compensation Plan Under the BTR Executive Stock Compensation Plan, certain officers had been awarded shares of BTR's stock to be issued at a rate of 20% of the shares awarded for each year of continued employment. A charge was made to general and administrative expense at the time of such awards.\nDuring 1992, BTR adjusted the recorded value of the awarded but unissued shares to reflect the downward movement in the market value of the BTR's stock from the measurement date of the awards, resulting in a reduction of general and administrative expenses of approximately $269,000. In 1993, the 78,286 remaining shares were exercised and issued prior to the merger on September 11, 1993. For the period January 1, 1993 through September 10, 1993, BTR recorded general and administrative expenses of approximately $49,000 representing the increase in recorded value of the awarded shares of BTR stock.\nMART Incentive Stock Option Plan MART has an Omnibus Share Plan, \"Plan\", under which Trustees, officers and employees may be granted awards of stock options, stock appreciation rights, performance shares and restricted stock. The purpose of the Plan is to provide equity-based incentive compensation based on long-term appreciation in value of MART's shares and to promote the interests of MART and its shareholders by encouraging greater management ownership of MART's shares. Pursuant to the Plan, the Company authorized on February 1, 1994 the availability of 300,000 shares for the Plan. At February 1, 1994, trustees, officers and key employees were granted 256,000 option shares at an option price of $10.50 per share with 89,333 shares vesting February 1, 1994 and 83,333 vesting in 1995 & 1996. The closing price of MART shares at December 31, 1994 was $8.25 per share. No options were exercised during the year ended December 31, 1994 and based on the market value of MART shares, the options, if converted, would be anti-dilutive producing fewer weighted average shares for the year ended December 31, 1994.\nAcquisition of Outstanding Shares On February 14, 1995 the MART Board of Trustees approved a stock repurchase plan which authorizes the repurchase of up to approximately 310,000 shares.\nIn 1993, BTR retired 56,544 shares of BTR stock held as collateral for a note receivable from a former officer of the Company.\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nO. LEASES\nThe Company owns shopping centers and other commercial property which are leased, generally on a long-term basis. All leases are classified as operating leases. Future minimum lease payments receivable under noncancelable operating leases are as follows:\n1995 $19,590,863 1996 17,897,043 1997 15,273,182 1998 12,272,911 1999 10,229,882 Thereafter 63,868,068 ===========\nThe minimum future lease payments do not include contingent rentals which may be paid under certain leases on the basis of a percentage of sales in excess of stipulated amounts. Contingent rentals amounted to $1,206,000 in 1994, $1,259,000 in 1993 and $1,235,000 in 1992.\nP. OTHER INCOME\nOther income consists of the following: MART BTR Realty, Inc. Year ended Sept. 11 thru Jan. 1, thru Year ended Dec. 31, Dec. 31, Sept. 10, Dec. 31, 1994 1993 1993 1992\nInterest and dividends $727,249 266,141 93,312 262,069 Miscellaneous 149,873 249,368 134,980 439,285 Sale of development rights - - - 334,267 ----------------------------------------------- $877,122 515,509 228,292 1,035,621 ===============================================\nQ. FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\" (Statement 107) requires the Company to disclose estimated fair values for certain on- and off-balance sheet financial instruments. Fair value estimates, methods, and assumptions are set forth below for the Company's financial instruments as of December 31, 1994 and 1993.\nCash and Cash Equivalents The carrying amount for cash and cash equivalents approximates fair value due to the short maturity of these instruments.\nNotes and Accounts Receivable The carrying amount for notes and accounts receivable approximates fair value due to the short maturity of these instruments.\nNotes Payable The carrying amount for the line of credit approximates fair value due to its adjustable interest rate.\nMortgages Payable\nThe fair value of mortgages payable was based on the discounted value of contractual cash flows. The discount rate for mortgages payable was estimated using the rate currently offered for borrowings of similar remaining maturities. The carrying amount and estimated fair value of mortgages payable at December 31, 1994 was $53,251,140 and $53,641,000 respectively, and at December 31, 1993 was $53,694,372 and $58,071,000, respectively.\nConvertible Subordinated Debentures The fair value of convertible subordinated debentures was based on the discounted value of contractual cash flows. The discount rate for convertible subordinated debentures was estimated using the rate currently offered for borrowings of similar remaining maturities. The carrying amount and estimated fair value of convertible subordinated debentures at December 31, 1994 was $60,000,000 and $52,119,000 respectively, and at December 31, 1993 was $60,000,000 and $58,522,000, respectively.\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 with respect to the identity and business experience of the directors of MART and their remuneration, in the definitive proxy statement (to be filed pursuant to Regulation 14A) with respect to the election of directors at the 1994 annual meeting of stockholders, is incorporated herein by reference.\nThe Executive Officers of MART are as follows: Position and Name Age Business Experience\nLeRoy E. Hoffberger 69 Chairman of the Board of MART since September, 1993.Director of BTR from 1963 to September 1993.President of CPC, Inc., President and Director of Keystone Realty Co., Vice President and director of MP Commercial Inc., Director of the following public mutual funds - New York Venture Fund, Venture Income (+) Plus, Venture Muni (+) Plus, and the Retirement Planning Funds of America. President and director of the Hoffberger Foundation, Vice President and director of Hoffberger Family Fund\nF. Patrick Hughes 47 President, Principal Executive Officer, and CEO of MART since 1993. President of BTR from November, 1990 to September, 1993. Senior Vice President BTR from May, 1989 to November, 1990. Vice President, Controller and Secretary of BTR for more than five years.\nPaul F. Robinson 41 Vice President of MART since September, 1993. Vice President of BTR from May, 1992 to September, 1993. Secretary and General Counsel of MART since September, 1993. Secretary and General Counsel of BTR from May 1989 to September, 1993; General Counsel since August, 1985.\nEugene T. Grady 46 Treasurer of MART since September, 1993. Treasurer of BTR since May, 1989.\nPaul G. Bollinger 35 Controller and Principal Financial Officer of MART since September, 1993. Controller of BTR since June, 1992. Assistant Treasurer & Assistant Secretary since May, 1992 Principal Financial Officer of Financial Associates of Maryland, (BTR Related Residential development partnership), for more than five years\nEach executive officer is elected for a term expiring at the next regular annual meeting of the Board of Directors of the Company or until his successor is duly elected and qualified.\nITEM 11","section_11":"ITEM 11 Executive Compensation\nThe information required by this item is incorporated by reference from the Registrant's Proxy Statement filed with respect to the 1995 annual meeting of stockholders. ITEM 12","section_12":"ITEM 12 Security Ownership of Certain Beneficial Owners and Management\nThe information required by this item is incorporated by reference from the Registrant's Proxy Statement filed with respect to the 1995 annual meeting of stockholders.\nITEM 13","section_13":"ITEM 13 Certain Relationships and Related Transactions The information required by this item is incorporated by reference from the Registrant's Proxy Statement filed with respect to the 1995 annual meeting of stockholders.\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 Mid-Atlantic Realty Trust and Subsidiaries and BTR Realty, Inc. (Predecessor Company) are included in Part II Item 8: Independent auditors' report Consolidated balance sheets at December 31, 1994 and 1993 Consolidated statements of operations for the year ended December 31, 1994 for the periods ended December 31, 1993 and September 10, 1993 and the year ended December 31, 1992 Consolidated statements of shareholders' equity for year ended December 31, 1994 for the periods ended December 31, 1993 and September 10, 1993 and the year ended December 31, 1992 Consolidated statements of cash flows for the year ended December 31, 1994 for the periods ended December 31, 1993 and September 10, 1993 and the year ended December 31, 1992 Notes to consolidated financial statements (a) 2. Financial Statement Schedule Schedule VI - Real estate and accumulated depreciation and amortization All other schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financial statements or notes thereto. (a) 3. Exhibits Exhibit No. 3. Articles of Incorporation and by-laws. None. 4. Instrument Defining the Right of Shareholders. None. 9. Voting Trust Agreement. None. 11. Computations of net earnings per common share. See Summary of Significant Accounting Policies under Notes to Financial Statements appearing on page 31 of this report. 12. Statement re: computation of ratios. Not applicable. 13. Annual Report to Shareholders. Not applicable.\nITEM 14 - (Continued) EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n18. Letter regarding change in accounting principles. See Summary of Significant Accounting Policies under Notes to Financial Statements appearing on page 31 and 32 of this report and letter from KPMG Peat Marwick LLP. 19. Previously unfiled documents. Not applicable. 21. List of subsidiaries of registrant. Filed herewith 23. Published report regarding matters submitted to vote of security holders. Not applicable. 24. Consents of experts and counsel. Not applicable. 25. Power of Attorney. Not applicable. 27. Financial Data Schedule. Filed thru EDGAR 28. Additional exhibits. Not applicable.\n(b) Reports on Form 8-K. None.\nSchedule VI - Real Estate and Accumulated Depreciation MID-ATLANTIC REALTY TRUST AND SUBSIDIARIES Cost capitalized subsequent Year ended Initial cost to Company to acquisition December 31, 1994 Mortgages Buildings and Description Payable Land Improvements Improvements Shopping Centers Harford Mall $19,821,030 158,085 8,457,331 12,027,287 Easton Shoppes, Inc. - 2,600,000 10,379,069 Smoketown Plaza - 516,312 10,095,077 622,540 Park Sedona - 2,376,739 8,590,146 232,741 Colonie Plaza 5,497,128 1,137,567 7,755,095 572,837 Columbia Plaza 4,970,228 999,739 6,887,711 1,445,476 Spotsylvania Crossing - 1,544,314 6,600,616 268,225 Skyline Village 5,569,526 555,295 6,240,003 914,776 Page Plaza - 464,375 5,777,369 119,705 Plaza Del Rio - 1,291,324 3,938,734 382,813 Sudley Town Plaza - 789,881 3,736,837 445,857 Burke Town Plaza 7,262,534 - 2,936,134 1,691,996 Rosedale Plaza 1,906,018 1,024,712 3,217,926 299,037 Wilkens Avenue 5,059,999 - 3,601,891 337,436 Timonium Shopping Ctr - - 4,031,809 246,212 York Road Plaza - 1,243,860 2,102,575 170,369 Patriots Plaza (A) - - 1,709,846 482,321 McRay Plaza - 1,182,596 2,565,290 284,739 Rolling Road Plaza (B) - 338,791 1,632,268 1,997,587 Union Hills Plaza - 274,920 679,863 138,031 Dobson-Guadalupe - 69,146 791,347 89,268 Chandler Plaza - 160,671 565,298 64,310 ---------------------------------------------------- 50,086,463 16,728,327 102,292,235 22,833,563 Office Buildings Gateway II - 364,982 12,376,977 1,204,111 Gateway I - 82,396 8,271,751 1,373,259 Patriots Plaza - - 1,522,943 239,890 Wilkens Office II 1,946,154 - 1,644,370 141,706 Wilkens Office I 1,218,523 - 1,383,102 229,433 Wilkens Office III - - 768,642 41,726 ----------------------------------------------------- 3,164,677 447,378 25,967,785 3,230,125 Bowling Centers Freestate - 307,656 1,279,278 22,793 Waldorf - 243,139 579,161 5,690 Clinton - - 457,764 35,900 ----------------------------------------------------- - 550,795 2,316,203 64,383\n(Continued)\nSchedule VI - Real Estate and Accumulated Depreciation MID-ATLANTIC REALTY TRUST AND SUBSIDIARIES\nCost capitalized subsequent Amount at which carried Year ended to acquisition at close of period December 31, 1994 Carrying Costs Land Buildings and Total Description Land Improvements Improvements Shopping Centers Harford Mall 158,085 20,484,618 20,642,703 Easton Shoppes, Inc. 2,600,000 10,379,069 12,979,069 Smoketown Plaza 516,312 10,717,617 11,233,929 Park Sedona (309,000) (1,095,141) 2,067,739 7,727,746 9,795,485 Colonie Plaza 1,137,567 8,327,932 9,465,499 Columbia Plaza 999,739 8,333,187 9,332,926 Spotsylvania Crossing 1,544,314 6,868,841 8,413,155 Skyline Village 555,295 7,154,779 7,710,074 Page Plaza 464,375 5,897,074 6,361,449 Plaza Del Rio 1,291,324 4,321,547 5,612,871 Sudley Town Plaza 789,881 4,182,694 4,972,575 Burke Town Plaza - 4,628,130 4,628,130 Rosedale Plaza 1,024,712 3,516,963 4,541,675 Wilkens Avenue 475,481 475,481 3,939,327 4,414,808 Timonium Shopping Ctr - 4,278,021 4,278,021 York Road Plaza 1,243,860 2,272,944 3,516,804 Patriots Plaza (A) - 2,192,167 2,192,167 McRay Plaza (679,840) (1,397,337) 502,756 1,452,692 1,955,448 Rolling Road Plaza (B) (837,931) 338,791 2,791,924 3,130,715 Union Hills Plaza 274,920 817,894 1,092,814 Dobson-Guadalupe 69,146 880,615 949,761 Chandler Plaza (86,450) (263,550) 74,221 366,058 440,279 -------------------------------------------------------- (599,809) (3,593,959)16,128,518 121,531,839137,660,357\nOffice Buildings Gateway II 364,982 13,581,088 13,946,070 Gateway I 82,396 9,645,010 9,727,406 Patriots Plaza - 1,762,833 1,762,833 Wilkens Office II - 1,786,076 1,786,076 Wilkens Office I - 1,612,535 1,612,535 Wilkens Office III - 810,368 810,368 ---------------------------------------------------------- - - 447,378 29,197,910 29,645,288 Bowling Centers Freestate 307,656 1,302,071 1,609,727 Waldorf 243,139 584,851 827,990 Clinton - 493,664 493,664 ---------------------------------------------------------- - - 550,795 2,380,586 2,931,381\n(Continued)\nSchedule VI - Real Estate and Accumulated Depreciation MID-ATLANTIC REALTY TRUST AND SUBSIDIARIES\nLife on which Year ended depreciation on December 31, 1994 latest income Accumulated Date of Date statement is Description Depreciation Construction Acquired computed Shopping Centers Harford Mall 9,094,042 12\/73 5-50 yrs. Easton Shoppes, Inc. 57,618 9\/94 5-50 yrs. Smoketown Plaza 2,285,058 4\/87 5-50 yrs. Park Sedona 816,801 11\/90 5-50 yrs. Colonie Plaza 1,740,904 12\/87 5-50 yrs. Columbia Plaza 1,568,587 6\/88 5-50 yrs. Spotsylvania Crossing 1,569,597 5\/87 5-50 yrs. Skyline Village 1,403,267 5\/88 5-50 yrs. Page Plaza 559,127 8\/91 5-50 yrs. Plaza Del Rio 574,815 2\/89 5-50 yrs. Sudley Town Plaza 1,156,252 7\/84 5-50 yrs. Burke Town Plaza 1,707,113 7\/79-7\/82 5-50 yrs. Rosedale Plaza 450,680 10\/89 5-50 yrs. Wilkens Avenue 1,301,922 5\/81 5-50 yrs. Timonium Shopping Ctr 137,734 10\/93 5-50 yrs. York Road Plaza 1,378,772 11\/85 5-50 yrs. Patriots Plaza (A) 831,328 6\/84 5-50 yrs. McRay Plaza 252,268 6\/89 5-50 yrs. Rolling Road Plaza (B) 966,345 6\/73 5-50 yrs. Union Hills Plaza 304,780 11\/83 5-50 yrs. Dobson-Guadalupe 296,651 9\/85 5-50 yrs. Chandler Plaza 180,937 3\/84 5-50 yrs. -------------- 28,634,598 Office Buildings Gateway II 1,395,534 7\/89 5-50 yrs. Gateway I 1,932,085 4\/87 5-50 yrs. Patriots Plaza 464,579 8\/85 5-50 yrs. Wilkens Office II 355,713 1\/87 5-50 yrs. Wilkens Office I 470,634 1\/85 5-50 yrs. Wilkens Office III 91,039 1\/91 5-50 yrs. ----------------- 4,709,584 Bowling Centers Freestate 871,924 3\/78 5-50 yrs. Waldorf 207,114 3\/79 5-50 yrs. Clinton 241,136 8\/71 5-50 yrs. ------------------ 1,320,174\nSchedule VI - Real Estate and Accumulated Depreciation MID-ATLANTIC REALTY TRUST AND SUBSIDIARIES Cost capitalized subsequent Year ended Initial cost to Company to acquisition December 31, 1994 Mortgages Buildings and Description Payable Land Improvements Improvements (Continued)\nOther Rental Properties Regal Row - 416,606 2,192,259 212,846 Business Center - 395,536 1,190,692 59,403 Southwest - - 283,039 596,738 Waldorf Firestone - 9,261 161,543 4,910 Ocean City - - 133,624 - ------------------------------------------------------- - 821,403 3,961,157 873,897\nDevelopment Operations - 5,072,696 1,282,251 -\nProperty Held - 8,630,465 - -\nOther Property - - 573,098 - ------------------------------------------------------- $53,251,140 32,251,064 136,392,729 27,001,968 =======================================================\n(Continued)\nSchedule VI - Real Estate and Accumulated Depreciation MID-ATLANTIC REALTY TRUST AND SUBSIDIARIES\nCost capitalized subsequent Amount at which carried Year ended to acquisition at close of period December 31, 1994 Carrying Costs Land Buildings and Total Description Land Improvements Improvements (Continued)\nOther Rental Properties Regal Row 416,606 2,405,105 2,821,711 Business Center 395,536 1,250,095 1,645,631 Southwest 45,149 45,149 879,777 924,926 Waldorf Firestone 9,261 166,453 175,714 Ocean City - 133,624 133,624 -------------------------------------------------------- 45,149 866,552 4,835,054 5,701,606\nDevelopment Operations - - 5,072,696 1,282,251 6,354,947\nProperty Held - - 8,630,465 - 8,630,465\nOther Property - - - 573,098 573,098 -------------------------------------------------------- (554,660)(3,593,959) 31,696,404 159,800,738 191,497,142 ========================================================\n(Continued)\nSchedule VI - Real Estate and Accumulated Depreciation MID-ATLANTIC REALTY TRUST AND SUBSIDIARIES\nLife on which Year ended depreciation on December 31, 1994 latest income Accumulated Date of Date statement is Description Depreciation Construction Acquired computed (Continued)\nOther Rental Properties Regal Row 725,244 7\/84 5-45 yrs. Business Center 131,664 4\/90 5-50 yrs. Southwest 421,051 4\/68 5-50 yrs. Waldorf Firestone 57,658 9\/78 5-50 yrs. Ocean City 52,336 12\/87 5-50 yrs. ------------- 1,387,953\nDevelopment Operations - 91-94\nProperty Held - 7\/73-12\/94\nOther Property 396,660 9\/82-12\/94 3-10 yrs. ------------- 36,448,969 =============\n(A) The mortgage payable of $2,585,984 is owed by the owner Southdale LP to Southdale Mortgage Inc., a wholly owned subsidiary of MART and is eliminated in consolidation. (B) This property was damaged by fire in December, 1992 producing a net reduction in value of $486,000, which is included in Cost capitalized subsequent to acquisition, Carrying Costs - Improvements, $837,931 was deducted, and Accumulated depreciation was adjusted for $351,931.\nMID-ATLANTIC REALTY TRUST (COMPANY) & BTR REALTY, INC. (PREDECESSOR TO THE COMPANY) SCHEDULE VI - REAL ESTATE AND ACCUMULATED DEPRECIATION - Continued\n(1) The changes in total cost of properties for the three years ended December 31, 1994 are as follows: Years ended December 31, 1994 1993 1992 Balance beginning of year $171,661,868 174,593,579 177,052,733 Additions during year: Acquisitions 18,051,765 4,076,958 285,234 Improvements 2,159,354 5,308,235 2,199,913 Development operations 1,986,458 1,448,303 571,759 ----------------------------------------- 22,197,577 10,833,496 3,056,906 Deductions during year: Write-downs to net realizable value (2)(a) - (1,318,314) (742,147) Cost of real estate sold (2,304,214) (1,637,772) (4,655,851) Transfers (4) - (9,416,190) (33,807) Retirements and disposals (58,089) (1,392,931) (84,255) ------------------------------------------ (2,362,303) (13,765,207) (5,516,060) ------------------------------------------ Balance end of year $191,497,142 171,661,868 174,593,579 ==========================================\n(2) Write-downs to net realizable value are reported in the statement of operations as follows: Year ended BTR Realty, Inc. January 1 thru December 31, Sep. 10, 1993 1992 Gain on Fire Damage (Note F) $ - 486,000 Under Costs and Expenses: Unrecoverable development costs 1,278,817 256,147 -------------------------------- $ 1,278,817 742,147 ================================ (a) In the period 1\/1\/93 thru 9\/10\/93 BTR reduced total cost of properties by $1,318,314 and reduced related accumulated depreciation by $39,497 resulting in a net write-down of $1,278,817.\n(3) The changes in accumulated depreciation for the three years ended December 31, 1994 are as follows:\nYears ended December 31, 1994 1993 1992 Balance beginning of year ($32,650,352) (29,168,658) (24,909,903) Depreciation and amortization (4,549,782) (4,735,979) (4,778,432) Transfers (4) - 96,041 290,378 Retirements and disposals 751,165 1,158,244 229,299 ------------------------------------------ Balance end of year ($36,448,969) (32,650,352) (29,168,658) ==========================================\n(4) Transfers include assets originally in operating properties reclassified on the balance sheet to the following:\nYears ended December 31, 1993 1992 Total Cost Net assets of properties to be sold ($7,030,232) - Deferred financing costs (2,385,958) (33,807) --------------------------- (9,416,190) (33,807) Accumulated Depreciation Net assets of properties to be sold $524,425 - Deferred financing costs: - Reclassification of asset (765,192) - - Reclassification of amortization 336,808 290,378 --------------------------- $96,041 290,378 --------------------------- Net transfers ($9,320,149) 256,571 =========================== (5) The aggregate basis of properties for Federal income tax purposes is approximately $143,000,000 at December 31, 1994. (6) See Item 2 for geographic location of properties. (7) Freestate includes 2 bowling centers in Illinois.\nEXHIBIT 21. PARENT AND SUBSIDIARIES OF REGISTRANT\nThe subsidiaries of MART are listed below. All are engaged in the ownership and\/or development of commercial or residential real estate in the United States. All are included in the consolidated financial statements filed as part of this Annual Report.\nState of Incorporation Name or Formation Interest CORPORATIONS:\nBTR Arkor, Inc. Maryland 100% BTR Atlanta Daycare, Inc. Maryland 100% BTR Business Center, Inc. Maryland 100% BTR Chandler, Inc. Maryland 100% BTR Delmar, Inc. Maryland 100% BTR East Greenbush, Inc. Maryland 100% BTR Fallston, Inc. Maryland 100% BTR Fallston Corner, Inc. Maryland 100% BTR Fallston Management, Inc. Maryland 100% BTR Financial, Inc. Maryland 100% BTR Free State Bowls, Inc. Maryland 100% BTR Gateway, Inc. Maryland 100% BTR Hillside, Inc. Maryland 100% BTR Holdings, Inc. (Formerly Diamond Alley, Inc.) Maryland 100% BTR Ironfield, Inc. Maryland 100% BTR Manassas, Inc. Maryland 100% BTR Marigot, Inc. Maryland 100% BTR Marina, Inc. Maryland 100% BTR McClintock, Inc. Maryland 100% BTR New Ridge, Inc. Maryland 100% BTR Northwood Properties, Inc. Maryland 100% BTR Odenton Properties, Inc. Maryland 100% BTR Park Sedona, Inc. Maryland 100% BTR Ray Road, Inc. Maryland 100% BTR Real Estate Enterprises, Inc. Maryland 100% BTR Rockburn, Inc. Maryland 100% BTR Salisbury, Inc. Maryland 100% BTR Southdale, Inc. Maryland 100% BTR Union Hills, Inc. Maryland 100% BTR Waldorf Development Corporation Maryland 100% BTR Waldorf Tire, Inc. Maryland 100% BTR Yuma, Inc. Maryland 100%\n(Continued)\nEXHIBIT 21. PARENT AND SUBSIDIARIES OF REGISTRANT - (Continued)\nState of Name Incorporation CORPORATIONS:(Continued) or Formation Interest\nBurke Town Plaza, Inc. Maryland 100% Burlington Commerce Park, Inc. Maryland 100% Christiansburg Plaza, Inc. Maryland 100% Clinton Development Company, Inc. Maryland 100% Cobleskill Plaza, Inc. Maryland 100% Colonie Plaza, Inc. Maryland 100% Columbia Plaza, Inc. Maryland 100% Commonwealth Plaza, Inc. Maryland 100% Concourse Realty Management, Inc. Maryland 100% Cypress Square, Inc. Maryland 100% Davis Ford Properties, Inc. Maryland 100% Essanwy, Inc. Maryland 100% Easton Shoppes, Inc. Maryland 100% Fredericksburg Plaza, Inc. Maryland 100% Greenbush Residential, Inc. Maryland 100% Greencastle Plaza, Inc. Maryland 100% Hampstead Plaza, Inc. Maryland 100% Harrisonburg Plaza, Inc. Maryland 100% Kingsbrook Funding, Inc. Maryland 100% Kingston Crossing, Inc. Maryland 100% Lynchburg Plaza, Inc. Maryland 100% MART Acquisition, Inc. Maryland 100% Madison Plaza, Inc. Maryland 100% Millers Plaza, Inc. Maryland 100% New Town Village, Inc. Maryland 100% North East Station, Inc. Maryland 100% Orchard Landing Apartments, Inc. Maryland 100% Orchard Landing Limited, Inc. Maryland 100% Page Plaza Associates, Inc. Maryland 100% Park Sedona, Inc. Maryland 100% Parkway Pond, Inc. Maryland 100% Ridgewood Funding, Inc. Maryland 100% Rolling Road Plaza, Inc. Maryland 100% Rosedale Partners, Inc. Maryland 100% Rosedale Plaza, Inc. Maryland 100% Route 642 Properties, Inc. Maryland 100% Scotia Crossing, Inc. Maryland 100% Senate Properties, Inc. Maryland 100% Southdale Mortgage Inc. Maryland 100% Southwest Development Properties, Inc. Maryland 100% Timonium Shopping Center, Inc. Maryland 100% Tempe Auto Center, Inc. Maryland 100% Wake Plaza, Inc. Maryland 100% Wyaness, Inc. Maryland 100%\n(Continued)\nEXHIBIT 21. PARENT AND SUBSIDIARIES OF REGISTRANT - (Continued)\nThe following are partnerships in which Mid-Atlantic Realty Trust, BTR Realty, Inc. or Financial Associates of Maryland have partnership interests:\nState of Incorporation Name or Formation Interest Arizona & Warner Limited Partnership Maryland 50% BBG Joint Venture Maryland 60% BBG Properties Limited Partnership Maryland 60% Cypress Square Limited Partnership Maryland 55% Fredericksburg Plaza Limited Partnership Maryland 80% Gateway International Limited Partnership Maryland 100% Harbour Island Associates Maryland 100% Hillside at Seminary Joint Venture Maryland 100% Kensington Associates Maryland 75% North Greenbrier Limited Partnership Maryland 100% Northwood Limited Partnership Maryland 67% Ridgewood Associates Maryland 100% Rockburn Associates Maryland 100% Rosedale Plaza Limited Partnership Maryland 100% Route 642 Limited Partnership Maryland 60% Scotia Associates Limited Partnership Maryland 50% Southdale Limited Partnership Maryland 50% Union Hills Limited Partnership Maryland 50% Wyaness Associates Maryland 100%\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.\nMID-ATLANTIC REALTY TRUST\nDate 3\/13\/95 \/s\/s F. Patrick Hughes F. Patrick Hughes, President\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated:\nDate: 3\/15\/95 \/s\/s LeRoy E. Hoffberger LeRoy E. Hoffberger, Chairman\nDate: 3\/13\/95 \/s\/s F. Patrick Hughes F. Patrick Hughes, Trustee, Principal Executive Officer\nDate: 3\/13\/95 \/s\/s Paul G. Bollinger Paul G. Bollinger, Controller, Principal Financial Officer\nDate: 3\/13\/95 \/s\/s Eugene T. Grady Eugene T. Grady, Treasurer\nDate: Robert A. Frank, Trustee\nDate: 3\/15\/95 \/s\/s Marc P. Blum Marc P. Blum, Trustee\nDate: 3\/15\/95 \/s\/s M. Ronald Lipman M. Ronald Lipman, Trustee\nDate: 3\/14\/95 \/s\/s Stanley J. Moss, Esquire Stanley J. Moss, Esquire, Trustee\nDate: 3\/15\/95 \/s\/s Daniel S. Stone Daniel S. Stone, Trustee\nDate: David F. Benson, Trustee","section_15":""}
{"filename":"351238_1994.txt","cik":"351238","year":"1994","section_1":"ITEM 1 - BUSINESS\nTHE COMPANY AND THE BANK\nThe San Francisco Company (the \"Company\"), formerly the Bank of San Francisco Company Holding Company, a Delaware corporation, is a one-bank holding company, registered under the Bank Holding Company Act of 1956, for Bank of San Francisco (the \"Bank\"), a California state chartered bank organized in 1978 whose deposits are insured by the Federal Deposit Insurance Corporation (the \"FDIC\"), subject to applicable limits. The Company was organized in California in 1981 and reincorporated in Delaware in 1988. The Bank, which the Company acquired through a reorganization in 1982, is the only direct subsidiary of the Company and accounts for over 99% of the consolidated assets of the Company. The Bank delivers its services from its headquarters building, Bank of San Francisco Building, at 550 Montgomery Street (at Clay Street), San Francisco, California 94111, and its phone number is (415) 781-7810.\nThe Company's Class A Common Stock, par value $0.01 per share (the \"Class A Common Stock\"), is listed on the American Stock Exchange (the \"AMEX\"). The closing price for the Class A Common Stock on April 12, 1995 was $4.50.\nThe Bank currently specializes in providing private banking and trust and investment management services for individuals, as well as business banking for such individuals, their businesses and other businesses, primarily in the San Francisco banking market. See \"-- Private and Business Banking.\" In addition, the Bank provides specialized services related to homeowners associations (see \"-- Association Bank Services\") and brokerage services (see \"-- Stock Option Services\"). In the future, the Bank intends to establish specialized banking services for the Asian private banking market for individuals who require private banking services both in Asia and the United States.\nIn October 1994, James E. Gilleran was appointed Chairman and Chief Executive Officer of the Company and the Bank. Mr. Gilleran had been serving as the California Superintendent of Banks since 1989 and was the Managing Partner for the San Francisco office of KPMG Peat Marwick LLP from 1977 to 1987.\nDuring the period from 1991 through 1994, the Company suffered an aggregate of $74.6 million in losses, primarily as a result of defaulted loans secured by real estate and losses on direct real estate development activities. The Company and the Bank succeeded in avoiding insolvency during this period only through the injection of a total of $52.0 million of new capital by the Company's controlling stockholder, Mr. Putra Masagung. These losses nevertheless caused impairments of capital and the breach of various regulatory requirements that have led to the issuance of orders by both state and federal bank regulatory authorities imposing restrictions and requirements on both the Bank's (the \"Orders\") and the Company's (the \"Agreement\") business activities and requiring the timely resolution of problem assets. See \"-- Regulatory Agreements and Orders.\"\nIn response to continuing operating losses and regulatory oversight, the Company has revised its business strategy to return the Company and Bank to profitability. The Company's goal for 1995 is to return to profitability within the current fiscal year. The following are actions the Company is taking to achieve its objective:\n- Capital On April 20, 1995, Mr. Masagung committed to contribute an additional $3.8 million to the Company, expected by April 24, 1995. The Company intends to contribute $4.2 million to the Bank upon receipt of Mr. Masagung's investment. The Company is attempting to raise a minimum of $6.3 million of additional capital.\n- Non-performing assets The Company intends to reduce non-performing assets to no more than 50% of capital (after capital restoration plans) by the end of 1995.\n- Deposit and Loan Growth The Company has initiated a core deposit incentive program, selective marketing programs, and is identifying and pursuing new sources of core deposits. The funds, if any,\nprovided by core deposit growth will be used to fund loan growth. The concentration risks in the existing loan portfolio are expected to be reduced through selective renewals and new loan fundings.\n- Cost Reductions In addition to the actions mentioned previously, the Company's actions include staff reductions, reduced occupancy expense through the leasing of unoccupied space, settlement of litigation matters to reduce professional fees, and re-engineering operations to improve efficiency and effectiveness. The Company and Bank will continue to consider the purchase of limited partnership interests in the Bank of San Francisco Building Company (BSFBC) as a means of reducing future occupancy costs.\nThe Company's objectives involve two simple goals; returning the Company and the Bank to profitability and increasing shareholder value. Considerable progress has been made in improving operational routines and controls. However, given the Bank's financial condition, its ability to achieve profitability and improve its regulatory ratios in 1995 is dependent on the Company raising additional capital and executing the sale of a majority of the Bank's non-performing assets.\nPRIVATE AND BUSINESS BANKING\nPrivate and Business Banking at the Bank combines highly personalized service with an array of products to meet the complex needs of its primary clients -- executives, professionals and high net worth or high income individuals and the private and closely held businesses with which such individuals are associated. The Bank has specialized in private banking since it began operations in 1979. In the San Francisco area, the Bank's focus on serving the needs of its clients has led it to offer a range of services, including general credit and depository services and specialized corporate escrow services and, to a lesser extent, asset management and trust services.\nThe Bank seeks to concentrate on establishing relationships with private and closely held businesses and their owners and operators. In particular, the Bank seeks relationships with individuals whose financial needs require customized banking programs. At December 31, 1994 and 1993, Private and Business Banking managed approximately $67.0 million and $80.4 million in deposits, representing approximately 45.5% and 38.3% of the Bank's total deposits, respectively. At December 31, 1994 and 1993, Private and Business Banking managed approximately $72.7 million and $108.0 million in loans, representing approximately 67.5% and 72.4% of the Bank's total loans, respectively.\nThe Bank places a high degree of importance on providing exceptional client service. To facilitate providing such a high degree of service, the Bank has recruited highly experienced banking professionals who understand and can meet the needs of the Bank's target market. The Bank assigns its professionals to serve small groups of personal clients rather than periodically reassigning such professionals to different areas or shifting them into administrative positions. The Bank seeks to enable its clients to have confidence that their private bankers understand their financial situations and are accessible when needed.\nThe Bank also places a high degree of importance on responding quickly to its clients' needs. Each client relationship is supported, not only by an individual banking officer, but also by a team familiar with each client's needs and situation, so that the client is aware that another Bank employee other than the primary banking officer is familiar with and is able to respond to such client's needs.\nThe Company's primary goals and related action steps for the Private and Business Banking Department over the next year involve:\n- Deposit growth Private Banking will concentrate on deposit growth in the Bank's \"primary\" marketing area and aggressively increase new relationships through selling quality service. The focus will be small privately held companies and their owners, and professionals. Every effort will be made to promote merchant and transaction services to those prospects. The initial focus will be calling on existing clients, and the identification and calling on prospective clients.\n- Loan concentrations One overall goal in 1995 is to improve the risk ratings and industry concentrations of the portfolio. Private Banking will focus on a broader diversification and reduce real estate related loans. Also, the Bank will selectively concentrate on investment management, law and accounting firms, and other professional companies as well as the personal accounts of the owners and senior partners\nassociated with these organizations. The Bank will strive to obtain the customer's entire banking relationship rather than being a transaction bank.\nNorthern California has a highly diversified economic base, including high technology electronic manufacturing, scientific research, real estate construction, retail and wholesale trade and transportation. Much of the diversity in the economic base is attributable to the service sector, including finance, accounting, insurance, communications, law, consulting and tourism. While many of the Bank's loans have been and continue to be collateralized by real estate, and a significant portion of the Bank's clients' net worth has historically consisted of real estate holdings, the Bank's deposit and lending relationships have not been concentrated among borrowers within a specific trade, service or industrial activity.\nTRUST SERVICES\nThe Bank was granted trust powers in late 1989, and beginning in 1990, began to combine the personalized services of private banking with comprehensive investment management services. In addition to acting as investment advisor, the Bank offers its clients individual securities management, cash management, trustee services, including bill paying and budget evaluation, and employee benefits services including Individual Retirement Accounts (IRAs). The Bank can handle the administration of probates and trusts, and cash management for foundations. At December 31, 1994 and 1993, trust services were being provided on assets totaling $26.5 million and $25.7 million, respectively. Trust has never achieved the size (and, therefore, fee income) necessary to cover its direct costs. As a result, for 1995, the Company has elected to scale back the Trust business. During 1995, a concerted effort will be made to increase the profitability of existing relationships and to re-engineer internal processes and work flows.\nESCROW SERVICES\nBegun in 1989, the Corporate Escrow Services Department (\"Escrow\") provides a service for all non-real estate escrows, including the temporary deposit and investment of funds, deposit of securities, personal property and other assets by attorneys, business brokers and clients for business transactions, disputes, life care facilities, and court actions. Escrow has always made a modest contribution to operating profit and provides a modest amount of deposits to fund other business activities. At December 31, 1994 and 1993, Escrow managed approximately $6.6 million and $9.2 million in deposits, representing approximately 4.5% and 4.4% of the Bank's total deposits, respectively. Escrow's primary goals and related action steps over the next year involve:\n- Increasing fee income and deposits by increasing business development calls, mailings, and advertisements to targeted markets, companies and individuals.\n- Better integrating with the Bank's other business units by participating in joint marketing calls with other Bank staff and identification of joint target clients.\n- Cross sell the Bank's other businesses by participating in a cross-referral program with Trust, Private and Business Banking, Association Bank Services, and Stock Option Lending.\nSTOCK OPTION SERVICES\nBegun in 1984, Stock Option Services provides a range of brokerage services combined with a program to facilitate the exercise of stock options by employees of publicly held companies. The stock option exercise program offers employees the means to exercise, hold or sell their option shares at a minimum cost.\nIn this program, the Bank makes loans to holders of stock options of publicly traded companies for the purpose of enabling them to exercise their options and sell the stock thus acquired. The Bank works with stock transfer and employee benefits officers to coordinate the payment of the option exercise price to the company granting such options, the provision for the payment of taxes related to the exercise of such options, the issuance and subsequent sale of the underlying stock and the distribution of the net sale proceeds. At December 31, 1994 and 1993, the total amount of the Bank's stock option loans outstanding was $2.1 million and $1.7 million,\nrespectively. Such amounts can vary substantially based upon the timing of the exercise of stock options as well as market conditions.\nHistorically, approximately 35% of Stock Option Services' clients have generated over 90% of the fee income of Stock Option Services. These clients are the focus of Stock Option Services' customer service activities; however, this concentration of fee income and service activities exposes the Bank to the possibility of losing certain important clients. For example, certain clients moved their accounts to a competitor in late 1993 after the Bank employees responsible for those accounts were hired by that competitor. This concentration of accounts also leaves the Bank vulnerable to losing a large source of fee income with the departure of a few clients. Management considers the fee income produced by this activity to be highly volatile, and there can be no guarantee that income levels from the activity can be maintained at current levels.\nStock Option Services is a substantially self-funding activity with associated deposit balances closely tracking outstanding loan balances. Because Stock Option Services' deposits are primarily non-interest bearing demand deposit accounts, the Bank benefits from them by reducing its cost of funds. Management believes that most of these clients are in industries that continue to present growth opportunities. Accordingly, stock option programs should represent a continuing component of such clients' overall compensation programs. In addition, management believes that the current client base should represent referral sources for future business development activities for other Bank products and services. As the Bank and the Company expand the Private Banking business, the executives who utilize their company's stock option program with the Bank are natural prospects for other services.\nStock Option Services initiatives include:\n- Expanding services to existing clients Through focused calling programs on each client and by maintaining service quality.\n- Develop new company relationships The development of a prospect database, an action plan for initial contact and follow-up contacts, and sales and marketing literature are primary action steps completed by a newly hired manager. The Plan includes the development of a marketing program for discount brokerage services.\n- Improving systems Review stock option reporting systems and interactive voice response products for possible purchase and linkage with client company relationships.\n- Cross sell the Bank's other businesses Participate in a cross-referral program with Private and Business Banking. Determine feasibility of \"discount brokerage\" concept for Private Banking customers and prospects.\nASSOCIATION BANK SERVICES\nEstablished in 1987, Association Bank Services operates throughout California and is a major provider of deposit and financial management services to homeowner and community associations in the State. The Bank offers deposit accounts for operating funds and reserves, loans, assessment collection services and investment services to homeowner and community associations. In addition, the Bank offers lockbox and courier services, expedited deposit processing and special handling of accounts to simplify banking operations. Deposits from homeowner and community associations are a key component of the Bank's core deposit base. At December 31, 1994 and 1993, the Association Bank Services Division accounted for approximately $3.1 million and $848,000 in loans, representing approximately 2.9% and .6% of the Bank's total loans, respectively.\nAt December 31, 1994 and 1993, the Association Bank Services accounted for approximately $41.6 million and $45.1 million in deposits, representing approximately 28.3% and 21.5% of the Bank's total deposits, respectively. A substantial portion of the Association Bank Services deposits are held in individual accounts that are 100% covered by FDIC insurance. The Bank also offers a certificate of deposit placement service (CD Placement) designed to invest a customer's funds in other insured financial institutions up to a maximum of\n$100,000 per institution (for which the Bank is paid a fee based on the average CD Placement investments outstanding).\nAlthough a substantial portion of the individual Association Bank Services deposit accounts are fully insured, a small number of \"account managers\" control significant numbers of such individual accounts, thus concentrating control of such deposits in the discretionary authority of a few individuals. Accordingly, a decision by several such account managers to withdraw their business from the Bank could have a significant impact on the Bank's core deposits, and thus on the Bank's liquidity. Association Banking Services' primary goals and related action steps over the next year involve:\n- Maintain existing clients by continuing to provide the service level and specialized services in addition to new products.\n- Evaluate the profitability of existing products by working with clients to ensure that they understand the cost of the services that they receive, and by cross-selling other Bank services to increase the service value that they receive.\n- Expand market share by increasing in state and out of state business. Presently, the Bank's primary market of Association Bank Service deposits are in California. Through direct marketing, Association Bank Services is targeting a significant increase in market share within the state. Selective marketing tests in Colorado in 1994 have provided new clients and broadened the Bank's exposure for prospective clients in the Colorado market.\n- Loan growth by continuing direct marketing to attorneys, CPA's, and management companies that specialize in the association industry. These provide an excellent source of prospective lending clients and, potentially, deposit customers.\n- Expand the automation of services by automating the lockbox processing and integrating ACH services, the Bank will be able to provide a more cost effective product. A new product that will be introduced in 1995 is for associations to collect assessment dues by credit card.\nREAL ESTATE INVESTMENT AND DEVELOPMENT ACTIVITIES\nManagement has withdrawn the Bank from all real estate development activities. From 1985 through 1992, the Bank was engaged in commercial and residential real estate development through Bank of San Francisco Real Estate Investors (\"BSFRI\"), a wholly-owned subsidiary of the Bank. Then-applicable regulations and practices of the FDIC and the Federal Reserve Board permitted state-chartered bank subsidiaries of bank holding companies to engage in real estate investment activities if such activities were permitted under state law (as was the case in California). The Bank's approval for engaging in real estate investment and development activities was suspended after November 1991 pursuant to the terms of a Memorandum of Understanding with the FDIC and the State Banking Department (the \"MOU\"), and the Bank agreed to discontinue its real estate investment activities not later than December 1993. In addition, under FDICIA (see \"--Regulation and Supervision -- Federal Deposit Insurance Corporation Improvement Act of 1991\"), the Bank is no longer permitted to engage in real estate development activities and must dispose of assets acquired for such purposes by December 19, 1996. See \"-- Regulation and Supervision.\" As required by FDICIA, the Bank has filed an application to continue the orderly divestiture of its real estate investments until December 19, 1996. The Bank was granted until December 31, 1994 to effect an orderly divestiture of its real estate investments. Although complete divesture was not achieved, the FDIC has not taken enforcement actions against the Bank (see \"PROBLEM ASSET PORTFOLIO\"). The Bank intends to file another application with the FDIC to allow for an orderly liquidation by December 31, 1995.\nBSFRI's activities were substantially cut back after 1989. During 1994, BSFRI sold one property. BSFRI sold no properties in 1993. At December 31, 1994 and 1993, real estate investment totaled $682,000 and $1.5 million, or approximately 0.4% and 0.6%, respectively, of the Company's total assets, excluding real estate accounted for as Bank premises (which totaled at such dates $1.7 million and $2.2 million, respectively).\nLENDING ACTIVITIES\nHistorically, the Bank concentrated its lending activities in commercial and financial loans, in real estate construction and development loans and real estate mortgage loans made primarily to individuals and businesses in the San Francisco area and, for a brief period, in the Sacramento area. The Bank also provides financing for the exercise of employee stock options. The Bank has offered credit for private or closely held businesses ranging from $250,000 to $2.5 million and credit to high net worth and high income individuals ranging from $150,000 to $1.5 million. In conjunction with the Bank's Plan to reduce concentration risks in the loan portfolio, the Bank has elected to reduce the loans it offers to no more than $1.0 million. The Bank has no foreign loans. Renewal of existing loans in excess of $500,000 requires the approval of the Loan and Investment Committee of the Board.\nAt December 31, 1994 and 1993, the Bank had net loans outstanding of $99.5 million and $141.1 million, respectively, which represented approximately 67.6% and 67.2% of the Bank's total deposits at those dates and approximately 63.5% and 61.1% of the total assets of the Company. During 1994, the Bank originated $30.5 million of new loans, compared with $87.8 million of new loans during 1993. The interest rates charged on the Bank's loans have varied with the degree of risk, maturity and amount of the loans and have been subject to competitive pressures, money market rates, funds availability and governmental regulations. Approximately 93.2% of the Bank's loans have interest rates that either adjust with the Bank's prime rate or mature within 90 days.\nAs of December 31, 1994 and 1993, approximately 70.9% and 66.7%, respectively, of the Bank's loans were secured by real estate. While these percentages indicate an increase, total loans secured by real estate actually declined to $75.5 million as of December 31, 1994 from $99.9 million as of December 31, 1993. A loan may be secured by real estate even though the purpose of the loan is not to facilitate the purchase or development of real estate and even though the principal source of repayment is not the sale of the real estate serving as collateral. However, in accordance with the terms of the Orders the Bank has agreed to diversify its risk by reducing the Bank's exposure to real estate lending and investment. See \"-- Regulation and Supervision.\"\nLENDING POLICIES AND PROCEDURES\nThe Bank's lending policies are established by the Bank's senior management and approved by the Board of Directors of the Bank and its Loan Committee. The Bank is required by regulation to limit its maximum outstanding balance to any one borrower to 25% of capital on secured loans and to 15% of capital on unsecured loans. Secured loans are defined as loans secured by a first deed of trust or possessory collateral. The Bank has established its own internal limits on the outstanding balance of loans to a maximum of $1.0 million. Any renewal of existing loans for over $1.0 million requires the approval of the Loan and Investment Committee of the Board. All loans require the approval of two officers. All loans in excess of $100,000 must be approved by the Bank's Loan Committee, chaired by the Chief Credit Officer and comprised of the Bank's Chief Executive Officer and other senior officers not related to the lending function. The Loan and Investment Committee also must review all extensions of credit in which the Bank's total lending exposure equals or exceeds $500,000.\nThe Bank assesses the lending risks, economic conditions and other relevant factors related to the quality of the Bank's loan portfolio in order to identify possible credit quality risks. The Bank relies primarily on its own internal credit review staff, which is independent of the lending divisions, to evaluate the loan portfolio. The Credit Administration Department reviews all new and renewed credits in excess of $250,000 on a continuous basis and reports the results of its findings to the Audit Committee of the Bank's Board of Directors. Results of reviews by the Credit Administration Department as well as examination of the loan portfolio by state and federal regulators are also considered by management in determining the level of the allowance for loan losses. In addition, the allowance for loan losses is reviewed and measured against the analysis of individual credits when the potential for loss exceeds amounts assigned to assets of similar risk classifications because of collateral values, payment history or economic conditions.\nWhen a borrower fails to make a required payment on a loan, the loan is classified as delinquent. If the delinquency is not cured, workout procedures are generally commenced. If workout proceedings are not successful, collection procedures, which may include collection demands, negotiated restructures, foreclosures and suits for collection, are initiated. In general, loans are placed on non-accrual status after being contractually delinquent for more than 90 days, or earlier, if management believes full collection of future principal and interest on a timely\nbasis is unlikely. When a loan is placed on non-accrual status, all interest accrued but not received is charged against interest income. During the period in which a loan is on non-accrual status, any payment received may be used to reduce the outstanding loan balance. A non-accrual loan is restored to an accrual basis when principal and interest payments are being paid currently and full payment of principal and interest is expected. Loans that are well secured and in the process of collection remain on accrual status.\nThe Bank may restructure loans as a result of a borrower's inability to service the obligation under the original terms of the loan agreement. Restructures are executed only when the Bank expects to realize more from a restructured loan than from allowing the loan to be foreclosed or seeking other forms of collection.\nCREDIT QUALITY\nIn its lending operations, the Bank continues to take steps to strengthen its credit management practices and to improve the overall quality of the loan portfolio. Such steps include instituting more stringent underwriting standards and restricting lending to small businesses, corporations and individuals for cash flow, inventory funding and other investments. As a result of the decline in California real property values and the desire to reduce concentrations of real estate loans, the Bank has substantially eliminated its origination of land acquisition and development loans other than lending to community redevelopment projects and funding outstanding commitments. See \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Valuation Allowances.\"\nCOMPOSITION OF LOAN PORTFOLIO\nThe composition of the Bank's loan portfolio at December 31 is summarized as follows:\nThe following table presents the loan portfolio at December 31, 1994 based upon various contractually scheduled principal payments allocated to maturity categories. This table does not reflect anticipated prepayment of loans.\nLoans due in one year or more include $8.6 million with fixed interest rates and $37.2 million with floating or adjustable rates based on prime rate.\nCommercial and Financial Loans. The Bank offers a variety of commercial and financial lending services, including revolving lines of credit, working capital loans, letters of credit and loans to facilitate the exercise of stock\noptions. These loans are typically secured by cash deposits, accounts receivable, equipment, inventories, investments, real estate and securities. The Bank's commercial and financial loans typically bear a floating rate of interest based on the prime rate. The Bank's commercial and financial loans are primarily in principal amounts of at least $100,000 and generally have terms of one year or less. As of December 31, 1994 and 1993, the Bank had commercial and financial loans outstanding of $83.1 million and $109.0 million constituting approximately 78.1% and 77.2% of the Bank's gross loans, respectively. As of December 31, 1994, approximately 61.0% of the Bank's gross commercial and financial loans were scheduled to mature within one year. During 1994, no single commercial client accounted for more than 4.3% of the Bank's outstanding loan financings.\nIn underwriting commercial and financial loans, the Bank focuses on the net worth, income, liquidity and cash flows of the borrower or borrowers and, in the case of secured loans, the value of the collateral. The Bank's borrowers who secure their loans typically use personal or business real estate in the San Francisco area as collateral. As of December 31, 1994 and 1993, approximately 50.0% and 49.2%, respectively, of the Bank's total commercial and financial loans were secured by real estate.\nAt December 31, 1994 and 1993, the total amount of the Bank's stock option loans outstanding was $2.1 million and $1.7 million, respectively. See \"-- Stock Option Services.\"\nConstruction Lending and Real Estate Mortgage Lending. Historically, the Bank has made loans to finance the construction of commercial, industrial and residential properties and to finance land development. The Bank's real estate construction loans typically have had maturities of less than two years, have had a floating rate of interest based on the Bank's prime lending rate, have been secured by deeds of trust and usually have not exceeded 70% of the appraised value of the property at origination. Bank policy generally limits real estate construction loans to 75% of the appraised value of the property after development. From time to time, the Bank sought participants to share in the funding of real estate construction loans. At December 31, 1994 and 1993, real estate construction and mortgage loans constituted approximately 21.9% and 27.1%, respectively, of the Bank's gross loans outstanding. In 1993, management decided to reduce the Bank's real estate construction lending activities in order to help further diversify the Bank's loan portfolio. Accordingly, gross real estate construction loans outstanding as a percentage of gross loans outstanding fell to 8.5% at December 31, 1994 from 9.4% at December 31, 1993.\nThe Bank's real estate mortgage loans typically are secured by first or second deeds of trust on either commercial or residential property, and have original maturities of three years or more. Such loans have been non-revolving and generally have had maturities that do not exceed ten years. Repayment terms generally include principal amortization over a negotiated term, with balloon principal payments due upon maturity of the loans. The typical purpose of these loans is the acquisition of real property securing the loan. The primary sources of repayment have been the properties' cash flow in the case of commercial real estate loans and the borrower's cash flow in the case of residential real estate. The secondary source of repayment is the sale of the real property securing the loan. Real estate mortgage loans accounted for approximately 13.4% and 17.7% of the Bank's gross loans outstanding as of December 31, 1994 and 1993, respectively.\nFrom 1990 through 1991, the Bank had a Residential Lending Division whose objective was to originate residential and multi-family mortgage loans through a network of retail, wholesale and correspondent sources for resale in the secondary market for residential loans. During the third quarter of 1991, as a result of the Division's marginally profitable operations, management decided to substantially reduce the Bank's residential lending activities and began winding down the operations of the Residential Lending Division. In the fourth quarter of 1991, the Bank sold its mortgage servicing portfolio of approximately $21.0 million at a profit. The Bank has retained $5.5 million in residential loans in its portfolio, which it has determined will be held to maturity. At December 31, 1994 and 1993, residential mortgage loans accounted for $4.2 million and $5.5 million, or 4.0% and 3.8% of gross loans outstanding, respectively.\nPROBLEM ASSET PORTFOLIO\nThe Bank's problem assets portfolio consists of non-performing loans, real estate held after foreclosure or in substance foreclosure on assets securing loans (\"other real estate owned\" or \"OREO\"), real estate with an impaired value that was originally acquired by the Bank for its own development and loans that are performing but otherwise have undesirable characteristics (as a result, for instance, of impaired collateral or adverse developments\nwith respect to the borrower's ability to service the loan out of the cash flow of the securing property). As a result of the Bank's real estate lending and the deteriorated economic condition of the California real estate markets, a significant number of loans and investments made by the Bank from 1985 through 1992 have subsequently proven difficult or impossible to recover without incurring losses. As of December 31, 1994, the Bank had $9.4 million in problem loans and $10.7 million in other problem assets (OREO and real estate investments).\nIn 1994, the Bank reduced its problem asset portfolio by $36.7 million, from $56.8 million to $20.1 million, in accordance with the requirements of the Orders (See \"-- Regulatory Agreement and Orders\"), through resolutions, charge offs and improvements in loan quality. Of the $20.1 million of problem assets in the Bank's portfolio at December 31, 1994, loans and properties classified by the Bank as other real estate owned comprised 49.8% of the total value of the problem asset portfolio and 46.8% was held on a non-accrual basis. Based upon information currently available, Management believes that the Bank has made sufficient provision to its allowance for possible loan losses and specific reserves to absorb expected losses that might result from the Bank's current strategies to resolve the problem assets.\nPresently, the Bank's strategy includes the reduction of problem assets through individual workout plans. Management expects that such sales would not be likely to entail further write downs of the problem assets sold. There can be no assurance, however, that the Bank or the Company will be able to liquidate, resolve or otherwise dispose of any problem assets, or that any liquidation, resolution or disposal of such assets will be made at acceptable values or without the incurrence of additional losses to the Bank or the Company.\nThe Bank maintains a Special Assets Department to monitor and attempt to resolve the problem asset portfolio with the objective of maximizing value. The Special Assets Department is currently staffed with four full-time-equivalency positions. As a result of the reduction in the number of problem assets, the staffing level for the management of problem assets can be reduced and the Special Assets Department will be absorbed into the Credit Administration Department. Individual workout plans have been developed for certain assets managed by the Special Assets Department, and a tracking system to monitor compliance with these plans has also been established.\nCORRESPONDENT BANKS\nThe Bank has correspondent relationships with twelve banks for the purpose of check clearing, selling federal funds, buying and selling investment securities, the safekeeping of investment portfolio and related record keeping, stock registration and stock transfer services, credit card issuance and servicing, and issuance of letters of credit.\nEMPLOYEES\nAt December 31, 1994 the Company, primarily through the Bank, employed 83 persons, consisting of 76 full-time and 7 part-time employees.\nCOMPETITION\nThe banking business in California, and specifically the market area served by the Bank, is highly competitive. The Bank competes for loans and deposits with other commercial banks, including some of the country's and the world's largest banks, savings and loan associations, finance companies, money market funds, brokerage houses, credit unions and non-financial institutions. By virtue of their larger amounts of capital, many of the financial institutions with which the Bank competes have significantly greater lending limits than the Bank and perform certain functions, including corporate trust services and international banking services, which are not presently offered directly by the Bank although such functions may be offered indirectly by the Bank through correspondent institutions. In addition, certain regulatory restrictions which have been imposed on the Bank by\nfederal and state regulators may prohibit the Bank from engaging in certain activities and place the Bank at a competitive disadvantage to other financial institutions.\nThe Bank's strategy for meeting its competition has been to concentrate on discrete segments of the market for financial services, particularly small to medium-sized businesses and their owners, professionals, corporate executives, affluent individuals, and homeowners and community associations, by offering specialized and personalized banking services to such clients. In addition, the Bank offers a range of brokerage services to employees of publicly held companies and Private and Business Banking clients where it competes with other brokerage firms, including some of the country's largest brokerage firms.\nFrom time to time, legislation has been and continues to be proposed or enacted which has the effect of increasing the cost of doing business for banks, limiting the permissible activities of banks, or affecting the competitive balance between banks and other financial institutions or between large banks and small banks. It is difficult to predict the competitive impact that these and other changes in legislation may have in the future on commercial banking in general or on the business of the Bank in particular.\nREGULATORY AGREEMENT AND ORDERS\nCAPITAL ORDERS\nOn March 24, 1995, the SBD issued an order for the Bank to increase its capital. The capital order requires that the Bank increase its capital by $4.2 million on or before April 10, 1995 and by a minimum of $10.5 million (including the first installment of $4.2 million) on or before June 30, 1995. The second installment must be at least equal to the amount of capital necessary to increase the shareholder's equity to not less than 7.0% of total tangible assets as of February 28, 1995. No assurances were given that the SBD would refrain from taking action against the Bank until the deadlines specified have passed. On April 20, 1995, the Company received a commitment from its major shareholder to contribute an additional $3.8 million in capital, expected by April 24, 1995. The Company intends to contribute $4.2 million in capital to the Bank upon receipt of Mr. Masagung's investment to meet the first installment required by the SBD Capital order.\nOn March 28, 1995, the FDIC issued a Notification of Capital Category (\"Notification\") in accordance with its Prompt Corrective Action regulations. The FDIC has determined that the Bank is Critically Undercapitalized. On the date of the Notification the Bank became subject to certain mandatory requirements including submission of a capital restoration plan and restrictions on asset growth, acquisitions, new activities, new branches, payment of dividends or making any other capital distribution, management fees, and senior executive compensation. Prior to the Notification, the Bank was subject to the Orders which included these limitations. In addition, immediately upon receiving notice, the Bank must obtain FDIC's prior written approval before entering into any material transaction other than in the usual course of business, extending any credit for any highly leveraged transactions, as defined by regulation, amending the Bank's charter or bylaws, except to the extent necessary to carry out any other requirement of any law, regulation, or order, making any change in accounting methods, engaging in any covered transaction as defined in section 23A(b) of the Federal Reserve Act, paying excessive compensation or bonuses, paying interest on new or renewed liabilities at a rate that would increase the Bank's weighted average cost of funds to a level significantly exceeding the prevailing rates of interest on insured deposits in the Bank's normal market area, and making any principal or interest payment on subordinated debt.\nFEDERAL RESERVE BOARD WRITTEN AGREEMENT\nAs a result of the Federal Reserve Bank of San Francisco's (the \"FRB\") examination of the Company as of June 30, 1991, the FRB on April 20, 1992 issued a letter (the \"Directive\") prohibiting the Company, without the FRB's prior approval, from (i) paying any cash dividends to its stockholders, (ii) incurring any new debt or increasing existing debt, (iii) repurchasing any outstanding stock of the Company or (iv) acquiring or entering into an agreement to acquire any entities or portfolios. The Company has been notified that it is in a \"troubled condition\" for purposes of Section 914 of the Financial Institutions Recovery, Reform and Enforcement Act (\"FIRREA\").\nOn December 16, 1994, the Company and the FRB entered into a Written Agreement (the \"Agreement\") that supersedes the previous directive dated April 20, 1992. The Agreement prohibits the Company, without prior approval of the FRB, from: (a) paying any cash dividends to its shareholders; (b) directly or indirectly, acquiring or selling any interest in any entity, line of business, problem or other assets; (c) executing any new employment,\nservice, or severance contracts, or renewing or modifying any existing contracts with any executive officer; (d) engaging in any transactions with the Bank that exceeds an aggregate of $20,000 per month; (e) engaging in any cash expenditures with any individual or entity that exceeds $25,000 per month; (f) increasing fees paid to any directors for attendance at board or committee meetings, or paying any bonuses to any executive officers; (g) incurring any new debt or increasing existing debt; and (h) repurchasing any outstanding stock of the Company. The Company is required to submit a progress report to the FRB on a quarterly basis.\nThe Company was also required to submit to the FRB an acceptable written plan to improve and maintain an adequate capital position, a comprehensive business plan concerning current and proposed business activities, a comprehensive operating budget for the Bank and the consolidated Company. In addition, the Board of Directors was required to submit an acceptable written plan designed to enhance their supervision of the operations and management of the consolidated organization. The Company has filed all of the required submissions with the FRB in accordance with the Agreement.\nCEASE AND DESIST ORDERS\nOn August 18, 1993, the Bank, without admitting or denying any alleged charges, stipulated to Cease and Desist Orders (the \"Orders\") issued by the FDIC and the California State Banking Department (the \"SBD\") that became effective August 29, 1993 (the \"Orders Effective Date\"). The Orders directed, among other things, that the Bank: (a) achieve and maintain a 7% leverage capital ratio on and after September 30, 1993; (b) pay no dividends without the prior written consent of the FDIC and the California Superintendent of Banks (the \"Superintendent\"); (c) reduce the $88.6 million in assets classified \"Substandard\" or \"Doubtful\" as of November 30, 1992 (the date of the most recent full-scope FDIC and SBD Report of Examination of the Bank), to no more than $40.0 million by September 30, 1994; (d) have and retain management whose qualifications and experience are commensurate with their duties and responsibilities to operate the Bank in a safe and sound manner, notify the FDIC and the Superintendent at least 30 days prior to adding or replacing any new director or senior executive officer and comply with certain restrictions in compensation of senior executive officers; (e) maintain an adequate reserve for loan losses; (f) not extend additional credit to, or for the benefit of, any borrower who had a previous loan from the Bank that was charged off or classified \"Loss\" in whole or in part; (g) develop and implement a plan to reduce its concentrations of construction and development loans; (h) not increase the amount of its brokered deposits above the amount outstanding on the Orders Effective Date ($20.0 million) and submit a written plan for eliminating reliance on brokered deposits; (i) revise or adopt, and implement, certain plans and policies to reduce the Bank's concentration of construction and land development loans, reduce the Bank's dependency on brokered deposits and out of area deposits, and to improve internal routines and controls; (j) reduce the Bank's volatile liability dependency ratio to not more than 15% by March 31, 1994; (k) eliminate or correct all violations of law set out in the most recent Report of Examination, and take all necessary steps to ensure future compliance with all applicable laws and regulations; and (l) establish a committee of three independent directors to monitor compliance with the Orders and report to the FDIC and the Superintendent on a quarterly basis.\nAs of December 31, 1994, the Bank failed to meet the capital requirements of the Orders and other industry wide requirements (see \"-- Regulation and Supervision -- Federal Deposit Insurance Corporation Improvement Act -- Prompt Corrective Action\") including the failure to meet the 7% leverage capital ratio imposed by the Orders. This failure occurred because the continued operating losses primarily related to problem assets.\nOn April 20,1995, the Company received a commitment from its major shareholder to contribute an additional $3.8 million in capital, expected by April 24, 1995. The Company intends to contribute $4.2 million in capital to the Bank upon receipt of Mr. Masagung's investment. Giving effect to the April 1995 capital commitments as of December 31, 1994, the Company and the Bank would not have been in compliance with all regulatory capital requirements including the Impaired Capital. The Company is attempting to raise a minimum of $6.3 million of additional capital in order to comply with all regulatory capital requirements except the Impaired Capital as discussed under \"-- Capital Impairment Orders\".\nThe Bank believes that the findings of the FDIC and SBD at their recent examination which began January 30, 1995 will be that the Bank is not in compliance with substantial requirements of the Orders. However, no Report of Examination has been received from the FDIC and the SBD as a result of their recent examination of the Bank. Management believes that the FDIC and SBD will find that the Bank is not in compliance with: (a) having and maintaining management whose qualifications and experience are commensurate with their duties and\nresponsibilities to operate the Bank in a safe and sound manner; (b) the implementation of a plan to reduce concentrations; (c) the submission of an acceptable plan for the elimination of the reliance on brokered deposits; (d) the reduction of the volatile liabilities dependency ratio to at or below 15%, and; (e) the correction of all violations of law as set out in the previous examination. In addition, because of its asset quality, operating losses, volatile liability dependency and liquidity constraints, the Bank is potentially subject to further regulatory sanctions that are generally applicable to banks that are critically undercapitalized.\nIn response to the Orders and the failure of the Bank to meet industry wide capital requirements, management submitted a 1995 Business and Profit Plan (Plan) on February 14, 1995 to the FDIC and the SBD for approval. It is expected that the Plan will be have to be updated to give effect for the delay in capital. Management believes that the Bank will be able to take the actions contemplated by such Plan, subject to the general requirement that the Bank return to profitability and be operated safely and soundly. A number of the restrictions imposed by the Orders will remain in effect until the Orders can be officially lifted. Although management anticipates the FDIC and the SBD will lift the Orders once the Bank demonstrates full compliance with the Orders, and the Bank's problem assets are resolved and it is deemed to be operating is a safe and sound manner, no assurance can be given as to when all conditions precedent to the lifting of the Orders will be fulfilled. The Company also is subject to certain restrictions imposed by the FRB pursuant to the Agreement that may prevent the Company from taking steps to establish new businesses (or new subsidiaries) at the Company level until similar conditions precedent are fulfilled.\nCAPITAL IMPAIRMENT ORDERS\nThe California Financial Code (the \"Financial Code\") requires the Superintendent to order any bank whose contributed capital is impaired to correct such impairment within 60 days of the date of his or her order. Under Section 134(b) of the Financial Code, the \"contributed capital,\" defined as all shareholders' equity other than retained earnings, of a bank is deemed to be impaired whenever such bank has deficit retained earnings in an amount exceeding 40% of such contributed capital. Under Section 662 of the Financial Code, the Superintendent has the authority, in his or her discretion, to take certain appropriate regulatory action with respect to a bank having impaired contributed capital, including possible seizure of such bank's assets. A bank that has deficit retained earnings may, subject to the approval of its shareholders and of the Superintendent, readjust its accounts in a quasi-reorganization, which may include eliminating its deficit retained earnings, under Section 663 of the Financial Code. However, a bank that is not able to effect such a quasi-reorganization or otherwise to correct an impairment of its contributed capital within 60 days of an order to do so from the Superintendent must levy and collect an assessment on its common shares pursuant to Section 423 of the California Corporations Code.\nA bank must levy such an assessment within 60 days of the Superintendent's order; the assessment becomes a lien upon the shares assessed from the time of service or publication of such notice of assessment. Within 60 days of the date on which the assessment becomes delinquent, a bank subject to the Superintendent's order must sell or cause to be sold to the highest bidder for cash as many shares of each delinquent holder of the assessed shares as may be necessary to pay the assessment and charges thereon.\nAs of December 31, 1994, the Bank had contributed capital of $66.2 million and deficit retained earnings of $64.6 million, or approximately 97.6% of contributed capital, within the meaning of Section 134(b) of the Financial Code. Thus, under Section 134(b) of the Financial Code, the Bank's contributed capital was impaired as of that date in the approximate amount of $38.1 million. The Superintendent issued orders, most recently on February 1, 1995, to the Bank to correct the impairment of its contributed capital within 60 days. The Bank has not complied with these orders. As the sole shareholder of the Bank, the Company (not the Company's shareholders) will receive any notices of assessment issued by the Bank. The Bank is in violation of this California law requiring it to assess the shares of the Bank (which are all held by the Company) in order to correct the impairment of the bank's capital.\nThe Bank's capital impairment may be corrected through earnings, by raising additional capital or by a quasireorganization, subject to the approval of the SBD, in which the Bank's deficit retained earnings would be reduced or eliminated by a corresponding reduction in the Bank's contributed capital. The Bank is addressing the possibility of obtaining approval of a quasi-reorganization with the SBD. If the SBD refuses to grant permission for such a quasi-reorganization, as of December 31, 1994, the Bank would have been required to raise $95.2 million in new capital in order to correct its impaired contributed capital (because the ratio of deficit retained earnings to contributed capital may not exceed 40%, $2.50 of new capital must be raised for every dollar of\nimpairment). In response to the February 1, 1995 order requiring the Bank to correct its impaired capital within 60 days, the Bank notified the SBD in writing that it did not believe it will be in a position to comply with the order within 60 days, and requested the SBD's cooperation as the Company implements its Plan, and as the Company continues to consider the requirements for a quasireorganization. It is the policy of the Superintendent not to grant a quasi-reorganization unless a Bank can establish that (a) it has adequate capital, (b) the problems that created past losses and the impairment of capital have been corrected and (c) it is currently operating on a profitable basis and will continue to do so in the future.\nNo assurance can be given that the Bank's capital condition will not deteriorate further as a result of operating losses prior to a quasi-reorganization. In addition, because a quasi-reorganization requires that the Bank reflect its assets and liabilities at market value at the time of the reorganization, the Bank's capital could be further impacted from its present level as a result of such an adjustment in the market value of the Bank's assets and liabilities. Finally, there can be no assurance that, following a correction of the Bank's capital impairment, whether through a quasi-reorganization or an infusion of sufficient capital, the Bank's capital position will not continue to erode through future operating losses. As long as the Bank's contributed capital is impaired, the Superintendent is authorized to take possession of the property and business of the Bank, or to order the Bank to comply with the legal requirement and levy an assessment on the shares of the Bank held by the Company sufficient to correct the impairment. As the Company is the sole shareholder of the Bank, the assessment would be made on the Company. The Company does not have the funds to satisfy such an assessment. Management believes, however, that the Superintendent has never exercised his bank takeover powers under Section 134 solely on the basis that a bank's capital is impaired under the standards set forth in Section 134.\nIn order to permit a quasi-reorganization of a bank's capital, the SBD requires, among other things, that a bank demonstrate that it is adequately capitalized and that it is capable of operating profitably. Management believes, although it cannot assure, that the Bank will be able to so demonstrate at such time as the Bank's problem assets are substantially resolved and additional capital is received, that it will then be possible for the Bank to effect a quasi-reorganization. Management also believes that the Bank will have high leverage and risk-based capital ratios if current capital raising efforts are successful, it is unlikely that the Superintendent would seek to take action solely on the basis of impaired capital under the Section 134 definition. There can be no assurance, however, that other circumstances such as insufficient liquidity (See \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity\") or further operating issues will not arise that would provide incentive to the Superintendent to utilize the powers granted by Section 134.\nREGULATION AND SUPERVISION\nBank holding companies and banks are subject to extensive supervision and regulation. The following summaries of certain statutes and regulations affecting banks and bank holding companies do not purport to be complete. Such summaries are qualified in their entirety by reference to such statutes and regulations.\nTHE COMPANY\nThe Company, as a bank holding company, is subject to regulation under the Bank Holding Company Act of 1956, as amended (the \"Holding Company Act\"), and is registered with and subject to the supervision of the FRB. It is the policy of the FRB that each bank holding company serve as a source of financial and managerial strength to its subsidiary banks and not conduct its operations in an unsafe or unsound manner.\nThe Holding Company Act generally restricts the Company from engaging in any business other than managing or controlling banks or furnishing services to its subsidiaries. Among the exceptions to such restrictions are certain activities which, in the opinion of the FRB, are so closely related to banking or to managing or controlling banks as to be a proper incident to banking. The Company also is generally prohibited from acquiring direct or indirect ownership or control of more than 5% of any class of voting shares of any company unless that company is engaged in activities permissible for bank holding companies and the Company receives the prior approval of the FRB.\nThe Company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or provision of services. For example, with certain\nexceptions, the Bank is not permitted to condition an extension of credit on a customer obtaining other services provided by it or the Company, or on a promise by the customer not to obtain other services from a competitor. In addition, applicable federal law imposes certain restrictions on transactions between the Bank and its affiliates. As an affiliate of the Bank, the Company is subject, with certain exceptions, to the provisions of federal law imposing limitations on, and requiring collateral for, loans by the Bank to any affiliate.\nThe Holding Company Act also requires the Company to obtain the prior approval of the FRB before acquiring all or substantially all of the assets of any bank or ownership or control of the voting shares of any bank if, after giving effect to such acquisition, the Company would own or control, directly or indirectly, more than 5% of any class of voting shares of such bank.\nFinally, the Company is subject to restrictions on its operations imposed by the Agreement. See \"-- Regulatory Agreement and Orders -- Federal Reserve Board Written Agreement.\"\nTHE BANK\nThe Bank is a California state-chartered bank and is subject to regulation, supervision and periodic examination by the SBD and the FDIC. The Bank is not a member of the Federal Reserve System, but is nevertheless subject to certain regulations of the FRB. The Bank's deposits are insured by the FDIC to the maximum amount permitted by law, which is currently $100,000 per depositor in most cases.\nThe regulations of state and federal bank regulatory agencies govern most aspects of the Bank's business and operations, including but not limited to, the scope of its business, its investments, its reserves against deposits, the timing of the availability of deposited funds, the payment of dividends, potential expansion, including real estate development activities, and the maximum rates of interest allowed on certain deposits.\nThe Bank is subject to regulatory and operating restrictions pursuant to several orders and a notification issued by the FDIC and SBD. These orders and restrictions are discussed in full in \"Regulatory Agreement and Orders\".\nCHANGE IN BANK CONTROL\nThe Holding Company Act and the Change in Bank Control Act of 1978, as amended (the \"Change in Control Act\"), together with regulations of the FRB, require that, depending on the particular circumstances, either FRB approval must be obtained or notice must be furnished to the FRB and not disapproved prior to any person or company acquiring \"control\" of a bank holding company, such as the Company, subject to exemptions for certain transactions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the company has registered securities under Section 12 of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), or no other person will own a greater percentage of that class of voting securities immediately after the transaction. Generally, similar rules on the acquisition of control apply to the Bank under California banking law and the Change in Control Act. Finally, the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the \"Hart-Scott Act\"), together with regulations of the Federal Trade Commission, may require certain filings to be made with the Federal Trade Commission and the United States Department of Justice, and certain waiting periods to expire, prior to consummation of an acquisition of a bank holding company's voting securities.\nCAPITAL ADEQUACY REQUIREMENTS\nThe Company is subject to the FRB's capital guidelines for bank holding companies while the Bank is subject to the FDIC's regulations governing capital adequacy for nonmember banks and to similar rules under California banking law. As noted below, the Federal banking agencies have solicited comments on a proposed regulation which would impose additional capital requirements on banks based on the interest rate risk inherent in a bank's portfolio.\nThe FRB has established a minimum leverage ratio of 3% Tier 1 capital1\/ to total assets for bank holding companies that have received the highest composite regulatory rating (a regulatory measurement of capital, assets, management, earnings and liquidity) and that are not anticipating or experiencing any significant growth. All other institutions will be required to maintain a leverage ratio of at least 100 to 200 basis points above the 3% minimum.\nFRB regulations require bank holding companies to maintain a minimum ratio of qualifying total capital to risk-weighted assets of 8.00%. Risk-based capital ratios are calculated with reference to risk-weighted assets, including both on and off-balance sheet exposures, which are multiplied by certain risk weights assigned by the FRB to those assets. At least one-half of the qualifying capital must be in the form of Tier 1 capital.\nIn certain circumstances, the FRB may determine that the capital ratios for a bank holding company must be maintained at levels which are higher than the minimum levels required by the guidelines. A bank holding company which does not achieve and maintain the required capital levels may be issued a capital directive by the FRB to ensure the maintenance of required capital levels.\nThe Bank failed to meet its regulatory capital requirements at March 31, 1993 and December 31, 1994 and, therefore, was required to file a Capital Restoration Plan pursuant to the \"prompt corrective action\" system imposed by the FDIC under FDICIA. The Bank failed to comply with the Capital Restoration Plan filed in 1993. A revised Capital Restoration Plan, the Plan, was filed on March 15, 1995 and has yet to be approved by the FDIC. As a condition of FDIC approval of the Bank's previous Capital Restoration Plan, the Company agreed to guarantee that the Bank will comply with the Capital Restoration Plan. The Company guaranteed that the Bank would comply with the Capital Restoration Plan until the Bank met its minimum capital requirements on average during each of four consecutive calendar quarters. The Company's liability under the guarantee is limited to the lesser of 5% of the Bank's total assets at the time it became under capitalized or an amount which is necessary (or would have been necessary) to bring the Bank into compliance with all of its capital requirements as of the time it fails to comply with its capital restoration plan. The Bank's capital is also impaired under California law, permitting the Superintendent to take possession of the Bank unless its capital impairment is cured through contribution of additional capital by the Company to the Bank or through a quasi-reorganization of the Bank. See \"-- Regulatory Agreement and Orders -- Capital Impairment Order.\"\nThe FDIC has established risk-based and leverage capital regulations for state nonmember banks which are similar to the FRB's capital guidelines for bank holding companies. In addition to these capital requirements, the Orders require the Bank to meet an individual minimum capital requirement after September 30, 1993 of 7% for Tier 1 capital to total average assets (leverage ratio). The Bank's leverage capital ratio was 0.9% as of December 31, 1994. See \"-- Regulatory Agreement and Orders.\"\nOn April 20, 1995, the Company's major shareholder committed to contribute $3.8 million in capital, expected by April 24, 1995. The Company intends to contribute $4.2 million in capital to the Bank upon receipt of Mr. Masagung's investment. Giving effect to the April 1995 capital commitment as of December 31, 1994, the Company and the Bank would not have been in compliance with all regulatory capital requirements including the Impaired Capital. The Company is attempting to raise a minimum of $6.3 million of additional capital in order to comply with all regulatory capital requirements except the Impaired Capital as discussed under \"-- Capital Impairment Orders\". See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital\".\n- - --------------------------------- 1\/ Tier 1 capital is generally defined as the sum of the core capital elements less goodwill and certain intangibles. The following items are defined as core capital elements: (i) common stockholders' equity; (ii) qualifying noncumulative perpetual preferred stock; and (iii) minority interests in the equity accounts of consolidated subsidiaries.\nPAYMENT OF DIVIDENDS\nSince April 20, 1992, the FRB has prohibited the Company from paying any cash dividends to its shareholders without prior FRB approval. The ability of the Company to pay dividends in the future will depend in large part on the Company's ability to satisfy the concerns of the FRB as set forth in the Agreement regarding the financial performance of the Company, and the ability of the Bank to make dividend payments to the Company. The Bank's ability to make dividend payments is dependent upon the ability of the Bank to return to profitability, to satisfy the regulatory concerns expressed in the Orders, and the ability of the Bank to cure its capital impairment or obtain approval from the SBD to conduct a quasi-reorganization to reduce or eliminate the Bank's deficit retained earnings. See \"-- Regulatory Agreement and Orders -- Capital Impairment Order.\"\nIn addition, any future payment of dividends by the Bank is subject to meeting the state law requirement that amount of funds available for a cash dividend shall be the lesser of retained earnings of the bank or the bank's net income for its last three fiscal years (less the amount of any distributions to shareholders made during such period). If the above test is not met, cash dividends may be paid with the prior approval of the SBD, in an amount not exceeding greatest of the bank's retained earnings, net income for its last fiscal year, or the amount of its net income for its current fiscal year. The Bank is not presently permitted to pay any dividends to the Company because it has sustained net losses throughout the period 1991 through 1994. As a result of these losses, the Bank had deficit retained earnings of $64.6 million as of December 31, 1994 and currently the Bank's capital is impaired in the amount of $38.1 million, giving the Superintendent the power to take possession of the Bank in the event its capital impairment is not cured. See \"-- Regulatory Agreement and Orders -- Capital Impairment Orders.\"\nAccordingly, any future payment of cash dividends will depend upon the Bank correcting its capital impairment, meeting applicable capital requirements, maintaining an adequate allowance for loan and lease losses, satisfying the terms of the Orders outstanding against it, its ability to conduct profitable operations and other factors.\nFEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991\nGeneral\nFDICIA primarily addresses the safety and soundness of the deposit insurance fund, supervision of and accounting by insured depository institutions and prompt corrective action by the federal bank regulatory agencies for troubled institutions. FDICIA gives the FDIC, in its capacity as federal insurer of deposits, broad authority to promulgate regulations to assure the viability of the deposit insurance fund including regulations concerning safety and soundness standards. FDICIA also places restrictions on the activities of state-chartered institutions and on institutions failing to meet minimum capital standards and provides enhanced enforcement authority for the federal banking agencies. FDICIA has strengthened FRB regulations regarding insider transactions.\nPrompt Corrective Action\nFDICIA amended the Federal Deposit Insurance Act (the \"FDIA\") to establish a format for closer monitoring of insured depository institutions and to enable prompt corrective action by regulators when an institution begins to experience difficulty. The general thrust of these provisions is to impose greater scrutiny and more restrictions on institutions as their requirements for additional capitalization increases.\nFDICIA establishes five capital categories for insured depository institutions: (a) Well Capitalized;2\/ (b) Adequately Capitalized;3\/ (c) Undercapitalized;4\/ (d) Significantly Undercapitalized;5\/ and (e) Critically Undercapitalized.6\/ All insured institutions (i.e., the Bank) are barred from making capital distributions or paying management fees to a controlling person (i.e., the Company) if to do so would cause the institution to fall into any of the three undercapitalized categories.\nUndercapitalized institutions are subject to several mandatory supervisory actions, including increased monitoring and periodic review of the institution's efforts to restore its capital, submitting an acceptable capital restoration plan, restricted asset growth, and limits on acquisitions, new branches or new lines of business. A parent holding company of an undercapitalized bank is expected to guarantee that the bank will comply with the bank's capital restoration plan until the bank has been adequately capitalized, on the average, for four (4) consecutive quarters. Such guarantee is limited to the lesser of 5% of the bank's total assets at the time it became undercapitalized or the amount necessary to bring the bank into full capital compliance.\nSignificantly undercapitalized institutions and undercapitalized institutions that fail to submit and implement adequate capital restoration plans are subject to the mandatory provisions applicable to undercapitalized institutions and, in addition, may be required to: sell additional capital, including voting shares; restrict transactions with affiliates; restrict interest rates paid on deposits; restrict asset growth or reduce total assets; terminate, reduce or alter any risky activities; elect new directors and install new management; cease accepting deposits from correspondent depository institutions; or divest or liquidate certain subsidiaries. A bank holding company may be required to divest itself of any affiliate of the institution (other than another insured depository institution) under certain conditions. Critically undercapitalized institutions face even more severe restrictions. See \"-- Regulatory Agreement and Orders -- Capital Orders.\"\nIn addition, significantly undercapitalized institutions will be prohibited from paying any bonus or raise to a senior executive officer without prior agency approval. No such approval will be granted to an institution which is required to but has failed to submit an acceptable capital restoration plan.\nCritically undercapitalized institutions are required to enter into a written agreement with the SBD with the FDIC as a party to the agreement to increase Tier I leverage capital to such level as the FDIC deems appropriate or the institution may be subject to termination of insurance action by the FDIC. The written agreement would require the immediate efforts by the institution to acquire the required capital.\nFDICIA also provides that if a well or adequately capitalized or undercapitalized institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice, its capital category may be downgraded to achieve a higher level of regulatory scrutiny and prompt corrective action. FDICIA restricts the solicitation and acceptance of and interest rates payable on brokered deposits by insured depository institutions that are not well capitalized and has added new bases for which a conservator or receiver may be appointed for undercapitalized and\n- - ----------------------------- 2\/ Well Capitalized means a financial institution with a total risk-based ratio of 10% or more, a Tier 1 risk-based ratio of 6% or more and a leverage ratio of 5% or more, so long as 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.\n3\/ Adequately Capitalized means a total risk-based ratio of 8% or more, a Tier 1 risk-based ratio of 4% or more and a leverage ratio of 4% or more (3% or more if the institution has received the highest composite rating in its most recent report of examination) and does not meet the definition of a Well Capitalized institution.\n4\/ Undercapitalized means a financial institution with a total risk-based ratio of less than 8%, a Tier 1 risk-based ratio of less than 4% or a leverage ratio of less than 4%.\n5\/ Significantly Undercapitalized means a financial institution with a total risk-based ratio of less than 6%, a Tier 1 risk-based ratio of less than 3% or a leverage ratio of less than 3%.\n6\/ Critically Undercapitalized means a financial institution with a ratio of tangible equity to total assets that is equal to or less than 2%.\ncritically undercapitalized institutions and under certain other circumstances not relating to capital levels. Finally, FDICIA establishes a risk-based assessment system for calculating a depository institution's semiannual deposit insurance premium under which institutions pay premiums based upon their capital classification and supervisory risk.\nBrokered Deposits\nFDICIA restricts the acceptance of brokered deposits by insured depository institutions that are not well capitalized. It also places restrictions on the interest rate payable on brokered deposits and the solicitation of such deposits. An undercapitalized institution will not be allowed to solicit brokered deposits by offering rates of interest that are significantly higher than the prevailing rates of interest on insured deposits in the particular institution's normal market areas or in the market area in which such deposits would otherwise be accepted.\nThe FDIC has promulgated final regulations with respect to the ability of insured depository institutions in each of the new capitalization categories to accept brokered deposits. Under the regulations, undercapitalized institutions are prohibited from accepting funds obtained directly or indirectly though a deposit broker. Adequately capitalized institutions may accept brokered deposits only if a waiver is first obtained from the FDIC. Well capitalized institutions are permitted by the regulations to accept brokered funds without restriction. For purposes of the brokered deposit regulation the FDIC has stated that the term \"well capitalized\" means an institution whose leverage and risk-based capital ratios are at least one to two percentage points higher than those currently required by applicable regulations, and which has not been notified that it is in a troubled condition.\nIn addition to the above restrictions on acceptance of brokered deposits, FDICIA provides that no pass-through deposit insurance will be provided to employee benefit plan deposits accepted by an institution which is ineligible to accept brokered deposits under applicable law and regulations.\nUnder the Order, the Bank is required to submit a written plan to the FDIC for eliminating its reliance on brokered deposits, and to provide the Regional Director of the FDIC and the SBD with monthly written reports outlining the Bank's progress under the plan. The FDIC had granted the Bank permission to renew brokered deposits through September 1995, provided that the Bank continued to meet the definition of an adequately capitalized institution. At December 31, 1994, the Bank did not meet the definition of an adequately capitalized institution. The brokered deposit waiver was suspended on January 30, 1995. At December 31, 1994, the Bank had brokered deposits of $19.7 million. These brokered deposits have various maturity dates. However, they cannot be extended without further regulatory approval which cannot be granted if the Bank's capital ratios remain below the minimum requirements.\nConservatorship and Receivership\nFDICIA adds grounds to the previously existing list of reasons for appointing a conservator or receiver for an insured depository institution including: (a) substantial dissipation of assets or earnings due to an unsafe or unsound practice or any violation of law or regulation; (b) existence of an unsafe or unsound condition; (c) any willful violation of a cease and desist order; (d) any concealment of assets, records, books or papers from any federal or state bank regulatory agency; (e) likely inability of the institution to meet obligations in the normal course of business; (f) losses threatening capital; (g) the institution becomes undercapitalized where certain factors are present suggesting the institution may not become adequately capitalized; or (h) the institution is critically undercapitalized or otherwise has substantially insufficient capital. The FDIC's March 28, 1995 Notification of Capital Category included a determination that the Bank is critically under capitalized thus making the Bank eligible for conservatorship or receivership.\nFIRREA provides other grounds upon which a receiver or conservator may be appointed for a state bank. These other grounds include \"having substantially insufficient capital,\" incurrence or likely incurrence of losses that will deplete all or substantially all of a bank's capital with no reasonable prospect for that capital to be replenished without federal assistance, or a violation of law or regulation which is likely to weaken the condition of the institution.\nDeposit Insurance Premiums\nAs of January 1, 1993, the FDIC charges higher deposit insurance premiums on banks which pose greater risks to the deposit insurance fund. Under the rule, a bank is required to pay an annual insurance premium ranging from 0.23% to 0.31% for domestic deposits, depending upon the bank's risk classification. A bank's risk classification is determined by the FDIC according to the bank's capital ratios and the FDIC's evaluation of the bank based upon federal and state supervisory examinations and other relevant information. Under the classification system, the FDIC has assigned the Bank its highest risk classification and set the Bank's deposit insurance premium at 0.31%.\nRestrictions on Insured State Bank Activities and Investments\nRecently enacted FDIC regulations generally prohibit an insured state bank from directly engaging as principal in any activity that is not permissible for a national bank, and also prohibit majority-owned subsidiaries of an insured state bank from engaging in any activity that is not permissible for a subsidiary of a national bank, unless the bank meets and continues to meet applicable minimum capital standards and the FDIC determines that the conduct of the activity by the bank and\/or its majority-owned subsidiary will not pose a significant risk to the deposit insurance funds.\nIf consent to engage in the activity is denied, the bank is required to cease the activity not later than one year from the denial. However, the FDIC may condition or restrict the conduct of any impermissible activity during this phase-out period. If the activities of a subsidiary are denied consent by the FDIC, the bank is required to divest its interest in the subsidiary as quickly as prudently possible, but in no event later than December 19, 1996. Alternatively, the bank may discontinue the impermissible activity, but this must be effected within one year of the date of denial.\nThese new regulations also impose new restrictions on real estate investments, requiring that undercapitalized banks with subsidiaries holding impermissible equity investments in real estate cease the activity as soon as practicable, but no later than June 8, 1994, and divest the subsidiary or the real estate investments owned by the subsidiary as soon as practicable, but in no event later than December 19, 1996. State banks also must obtain the prior consent of the FDIC before making real estate loans other than in compliance with guidelines established for national banks. The Bank has conducted real estate investment activities through its subsidiary BSFRI. As required by FDICIA, the Bank has filed an application to continue the orderly divestiture of its real estate investments until December 19, 1996. The Bank was granted until December 31, 1994 to effect on orderly divestiture of its real estate investments. The FDIC has not taken enforcement action against the Bank with respect to such divestiture. The Bank intends to file another application to continue the orderly divestiture by December 31, 1995.\nProposed Standards on Safety and Soundness\nPursuant to the requirements of FDICIA, recently proposed FDIC and FRB regulations provide new standards for safety and soundness applicable to banks and bank holding companies. The proposed regulations establish managerial, operational, asset quality and earnings standards for state nonmember banks as well as bank holding companies, i.e., requiring banks and bank holding companies to maintain a ratio of classified assets to total capital and ineligible allowances no greater than 1.25% of risk weighted assets, and to maintain minimum earnings sufficient to absorb losses without impairing capital. A bank's \"minimum earnings\" are deemed sufficient if the bank's earnings during its last four quarters would be sufficient for the bank to maintain compliance with its minimum capital requirements for the next four quarters. Due to the Bank's operating losses during each quarter of 1994, the Bank will not be in compliance with this regulation if adopted. In addition, the proposed safety and soundness standards would prohibit excessive compensation or compensation which could lead to material financial loss for the bank or bank holding company.\nThese regulations are subject to change; therefore, the ultimate impact on the Company and the Bank of final regulation in this area cannot be predicted at this time.\nExtensions of Credit to Insiders and Transactions with Affiliates\nThe Federal Reserve Act and FRB regulations, which are applicable to state nonmember banks under regulations of the FDIC, place limitations and conditions on loans or extensions of credit to: a bank's or bank holding company's executive officers, directors and principal shareholders (i.e., in most cases, those persons who own, control or have power to vote more than 10% of any class of voting securities); any company controlled by any such executive officer, director or shareholder; or any political or campaign committee controlled by such executive officer, director or principal shareholder.\nLoans extended to any of the above persons must comply with loans-to-one-borrower limits, require prior full board approval when aggregate extensions of credit to such person exceed specified amounts, 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 non-insiders, and must not involve more than the normal risk of repayment or present other unfavorable features. Regulation O also prohibits a bank from paying an overdraft on an account of an executive officer or director, except pursuant to a written pre-authorized interest-bearing extension of credit plan that specifies a method of repayment or a written pre-authorized transfer of funds from another account of the officer or director at the bank.\nThe provisions of Regulation O summarized above reflect substantial strengthening as a result of the adoption of FDICIA. FDICIA also resulted in an amendment to Regulation O which provides that the aggregate limit on extensions of credit to all insiders of a bank as a group cannot exceed the bank's unimpaired capital and unimpaired surplus. An exception to this limitation is provided, until February 18, 1994, for banks with less than $100.0 million in deposits. The aggregate limit applicable to such banks is two times the bank's unimpaired capital and unimpaired surplus, provided the bank meets or exceeds all applicable capital requirements.\nGovernment Monetary Policy\nThe earnings of the Bank and, therefore, the earnings of the Company, are and will be affected by the policies of regulatory authorities, including the FRB. An important function of the FRB is to regulate the national supply of bank credit. Among the instruments used to implement these objectives are open market operations in U.S. Government securities, changes in reserve requirements against bank deposits, and changes in the discount rate which banks pay on advances from the Federal Reserve System. These instruments 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 on loans or interest rates paid for 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. The effect, if any, of such policies upon the future business earnings of the Company and the Bank cannot be predicted.\nRECENT FEDERAL AND STATE LEGISLATION\nFEDERAL\nIn late September 1994, two major pieces of financial services legislation were signed into law.\nThe Riegle Community Development and Regulatory Improvement Act of 1994 seeks to facilitate securitization of small business loans, reduce bank's paperwork and regulatory burden, streamline anti-money laundering rules, and toughen flood insurance compliance.\nSmall Business Capital Formation Small business access to capital is encouraged by Title II of the ACT, which seeks to remove impediments in existing law to the securitization of small business loans and leases. The Small Business Loan Securitization and Secondary Market Enhancement Act of 1994 creates a secondary market framework for small business related securities, with the goal of stimulating the flow of funds to small businesses.\nPaperwork Reduction and Regulatory Improvement Title III of the Act of 1994 provides a number of initiatives to lessen the regulatory burden placed upon banks and other depository institutions. Title III also affects a number of the consumer compliance laws by allowing streamlined disclosures for radio advertising\nof consumer leases, providing consumers with information necessary to challenge an \"adverse characterization\" due to a credit reporting agency report and by clarifying the disclosure requirements under the Real Estate Settlement Procedures Act regarding the transfer of serviced mortgaged loans.\nMoney Laundering Title IV addressed reform of Currency Transaction Reports to increase their usefulness to the Federal Government and to various law enforcement agencies in combating money laundering. The measure also calls for improvement in the identification of money laundering schemes, better controls over negotiable instruments drawn on foreign banks by making them subject to reporting, and uniform licensing and registration of check cashing and money transmitting businesses, which are often used to facilitate illegal currency transactions.\nFlood Insurance Title V, the \"National Flood Insurance Reform Act of 1994\" reforms the financial condition of the National Flood Insurance Program (NFIP). This legislation requires improved compliance with the mandatory purchase requirements of the NFIP by bank lenders and secondary market purchasers.\nThe Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 liberalizes both interstate banking by way of bank subsidiaries and provides for phased-in direct interstate branch banking.\nMergers and Acquisitions Specifically, Title I of the Interstate Banking Act allows adequately capitalized and managed bank holding companies to acquire banks in any state starting one year after enactment. Another important provision allows interstate merger transactions beginning June 1, 1997. 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. Through interstate merger transactions, banks will be able to acquire branches of out-of-State banks by converting their offices into branches of the resulting bank. The Act provides that it will be the exclusive means for bank holding companies to obtain interstate branches.\nProtecting key provisions of State law, the Act provides that required conditions and commitments made relating to interstate mergers that predate the Act's affective date will remain in force. After the Act becomes effective, State taxation, community reinvestment, antitrust, deposit concentration caps and minimum age provisions will be honored unless preempted. In this regard, Congress intended that the Act does not alter time-tested preemption rules. Moreover, the Act expressly states that neither current federal law, nor the Act's amendments provide authority to preempt State law dealing with homestead protection.\nBranching and Community Guidelines Banks may establish and operate a \"de novo branch\" in any State that \"opts-in\" to de novo branching. Foreign banks are allowed to operate branches, either de novo or by merger. These branches can operate to the same extent that the establishment and operation of such branches would be permitted if the foreign bank were a national bank or State bank. Interstate banks proposing to close any branch in low-or moderate income areas are now required to provide notice to customers of the proposed closing.\nTitle I also requires each Federal banking agency to prescribe uniform regulations including guidelines ensuring that interstate branches operated by out-of-State banks are reasonably helping to meet the credit need of communities where they operate. These agencies are required to conduct evaluations of overall Community Reinvestment Act performance of institutions with interstate branches. New procedural requirements are also required of the Federal banking agencies pertaining to agency preemption opinion letters and interpretive rules in connection with community reinvestment, consumer protection, fair lending and establishment of intrastate branches.\nRevival of Statute of Limitations Title II, among other things, permits in certain circumstances, the FDIC or Resolution Trust Corporation, acting as conservator or receiver of a failed depository institution to \"revive\" tort claims that had expired under a State statute of limitations within five years of the appointment of a receiver or conservator.\nState\nAs a California state-chartered bank, the Bank is subject to the California banking laws and to regulation, supervision and periodic examination by the SBD.\nThe California banking laws, among other matters, regulate: (a) the process of issuance of a banking permit, including the application for, term of and surrender or revocation of the permit; (b) the conduct of the banking business, including banking days, banking offices, preservation and disposal of records, borrowing by the bank and pledges of assets; (c) accounts, including types of deposit accounts and claims made thereon; (d) reserves, including forms, computations, limitations and exemptions; (e) loans, including limitations on obligations to the bank by borrowers in general and by the bank's officers, directors and employees; (e) mergers, consolidations and conversions of banks, including changes in control of banks; and (f) liquidation and dissolution of banks.\nOther\nVarious other legislation, including proposals to overhaul the bank regulatory system and to limit the investments that a depository institution may make with insured funds, is introduced into Congress from time to time. The Company cannot determine the ultimate effect that any potential legislation, if enacted, would have upon the financial condition or operations of the Company or the Bank.\nRECENT REGULATIONS AND GUIDELINES\nInterest Rate Risk\nAs required by FDICIA, the federal banking agencies have solicited comments on a proposed method of incorporating an interest rate risk component into the current risk-based capital guidelines, with the goal of ensuring that institutions with high levels of interest rate risk have sufficient capital to cover their exposure. Interest rate risk is the risk that changes in market interest rates might adversely affect a bank's financial condition. Under the proposal, interest rate risk exposures would be quantified by weighing assets, liabilities and off-balance sheet items by risk factors which approximate sensitivity to interest rate fluctuations. Institutions identified as having an interest rate risk exposure greater than a defined threshold would be required to allocate additional capital to support this higher risk. Higher individual capital allocations could be required by the bank regulators based on supervisory concerns.\nAs the federal banking agencies have solicited comments on this proposal but have not yet proposed regulations to implement any interest rate risk component into the risk-based capital guidelines, the ultimate impact on the Company and the Bank of final regulation in this area cannot be predicted at this time.\nState Bank Sales of Nondeposit Investments\nSecurities activities of state non-member banks, as well as their subsidiaries and affiliates, are governed by FDIC regulations. The FDIC has taken the position that bank sales of alternative investment products, such as mutual funds and annuities, raise substantial bank safety and soundness concerns involving consumer confusion over the nature of the products offered, and the potential for mismanagement of sales programs for such investments which could expose a bank to liability under the anti-fraud provisions of federal securities laws.\nAccordingly, the FDIC has issued guidelines to state non-member banks which recommend, among other things, establishing a compliance and audit program to monitor the bank's mutual funds sales activities and compliance with applicable federal securities laws, providing full disclosure to customers about the risks of such investments (including the possibility of loss of principal investment), conducting securities activities of bank subsidiaries or affiliates in separate and distinct locations, and prohibiting bank employees involved in deposit-taking activities from selling investment products or from giving investment advice.\nBanks are also required to establish qualitative standards for the selection and marketing of the investments offered by the bank and maintain appropriate documentation regarding suitability of investments recommended to bank customers.\nTAXATION\nThe effective tax rates (benefit) for the years ended December 31, 1994, 1993 and 1992, were 0.4%, 1.7% and (1.7)%, respectively. For each of the years ended December 31, 1994, 1993 and 1992, the federal statutory tax rate applicable to the Company was 34%. The tax benefits reported in 1992 are attributable to the Company's\nability to carryback net operating losses for 1992 against net operating income from prior periods. Because the Company has utilized all of its ability to carryback net operating losses, much of the 1994, 1993 and 1992 losses, and future losses, if any, must be carried forward to offset future net operating income. In addition, the actual benefit rate may be less than the current statutory rate due to tax differentials and the alternative minimum tax. As of December 31, 1994, the Company has net operating loss carryforwards for federal tax purposes of approximately $39.0 million which expire in 2007 and onwards, and for California tax purposes of approximately $24.0 million, which expire in 1997, 1998, and 1999. The Company has rehabilitation tax credit carryforwards for federal tax purposes of approximately $250,000, which expires in 2004 and 2005. In addition, the Company has minimum tax credits of approximately $230,000 which have no expiration. Utilization of the net operating loss carryforwards, and rehabilitation and minimum tax credit carryforwards may be limited on an annual basis under current tax law due to the change in ownership in 1992 and a possible change in ownership in future years.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe following table sets forth certain information concerning the Bank's significant real property lease commitments:\nThe Bank has a long term lease on 550 Montgomery Street, an 89,000 square foot, historically significant office building on Clay and Montgomery Streets in San Francisco's Financial District. The building serves as the administrative and banking headquarters of the Company and the Bank. The Bank leases 75,488 square feet and the remainder is subleased to third parties. During 1994, the Bank began subleasing some of its space. Additional space will be made available for sublease in 1995.\nThe lease on 550 Montgomery Street is currently held by Bank of San Francisco Building Company (BSFBC), a California limited partnership in which the Bank and BSFRI have 34.5% and 2.5% partnership interests, respectively. At December 31, 1994, the Bank's and BSFRI's investment in BSFBC totaled $1.6 million and $120,000, respectively. The Bank's lease agreement may be renegotiated or the Bank may acquire additional shares of BSFBC. The impact of such activities is not presently determinable.\nAs a result of moving the Bank's headquarters to 550 Montgomery Street, the Bank subleased its facilities at 351 California Street to an unrelated third party who is presently in default with respect to $60,000 in past due rent. The lease and subleases expire on June 30, 1995.\nThe net rental expense and occupancy expenses for all leases of premises were approximately $2.1 million for each of the two years ended December 31, 1994 and 1993.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nLITIGATION\nBecause of the nature of its business, the Company and its subsidiaries, including the Bank, are from time-to-time, a party to legal actions. At December 31, 1994, the Company and\/or the Bank are defendants in certain lawsuits for which the damages sought are substantial as described below.\nPresently, the Bank is involved in several lawsuits. In the first lawsuit, BSFRI is named as a defendant and has been served with a cross-complaint for indemnity in a deficiency judgement with respect to a first deed of trust on a property owned by a limited partnership. The plaintiff under the cross compliant is seeking damages in the amount of $5.0 million, and unspecified punitive damages. BSFRI was once a limited partner in the partnership\nbut became a secured lender of the partnership under a second deed of trust, at which time BSFRI was given a release from any liability. The Bank believes it has meritorious defenses to the cross-claim and will contest any allocation of liability to it if defendants are found liable for any deficiency.\nIn the second lawsuit, the Bank has been named a defendant in an action brought in Florida by the institutional purchaser of a block of loans from the Bank, alleging failure of the Bank to properly perform a credit check for one of the loans. The plaintiff is seeking approximately $155,000 it allegedly lost when the loan defaulted. The Bank is defending the matter vigorously and believes it has meritorious defenses. In addition, the Bank has been threatened with arbitration proceedings by another institutional purchaser in connection with a $750,000 principal amount loan purchased from the Bank on the sale of its former Sacramento branch. The institutional purchaser contends that the Bank breached the sale agreement by failing to notify the purchaser of the downgrading of the loan and the release of certain collateral. The Bank denies that it has breached the sale agreement.\nThe Bank is currently involved in two lawsuits which were brought by former employees of the Bank; one former employee has alleged discrimination and wrongful termination. The other former employee alleges wrongful termination. The former employees have sought unspecified damages.\nThe Bank has denied these allegations and is vigorously defending these proceedings. The disposition of these proceedings could have a material adverse effect on the Company's financial position or results of operation, however, management cannot predict the specific outcome of these actions. Accordingly, the accompanying financial statements do not include any adjustments that might result from the outcome of the uncertainties.\nThe Bank has reached settlement or potential settlement in numerous other litigation or potential litigation matters. In some instances the Bank has agreed to make certain payments. As a result of the settlement or potential settlement of certain lawsuits, the Company established a litigation reserve of $536,500 as of December 31, 1994.\nThe Company and the Bank intend to pursue their rights under an indemnification agreement with Mr. Donald R. Stephens, a former Chairman of the Board and Chief Executive Officer of the Company who resigned in 1993, pursuant to which Mr. Stephens is required to provide indemnification in respect of certain expenses related to actions brought by a former employee.\nThe jury ruled in favor of the Bank on another lawsuit where the plaintiffs were seeking compensatory damages in an amount of $6.0 million, and unspecified punitive damages. The plaintiffs were claiming breach of an alleged joint venture agreement, and of other duties owed to the plaintiffs, arising from the Bank's foreclosure on a series of loans made to the plaintiffs by the Bank in connection with the development of an 800 acre parcel of land.\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.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MARKET\nMARKET INFORMATION\nThe Company's Class A Common Stock is listed on the American Stock Exchange under the symbol \"SFH.\" The closing sale price for the Class A Shares on the American Stock Exchange on April 12, 1995 was $4.50. The following table sets forth the high and low closing sale prices for the Class A Shares on the American Stock Exchange for each calendar quarter during 1993 and 1994.\nThe Series B Preferred Shares had been listed on the American Stock Exchange since their issuance in October 1988. In March 1990, the Company received approval from the Securities and Exchange Commission to delist the Series B Preferred Shares, pursuant to Rule 12d2-2(d), under the Securities Exchange Act of 1934, as amended. The Series A and Series C Preferred Shares have never been listed on any exchange or traded in any other public market, and none were outstanding at December 31, 1994.\nThe closing sales prices for the Class A Common Shares have been adjusted to reflect the effect of the 1 for 20 reverse stock split that occurred on May 23, 1994.\nHOLDERS\nAs of December 31, 1994, the number of holders of record of the Company's Class A Shares and Series B Preferred Shares was 423 and 14, respectively, which management believes is in each case substantially less than the number of beneficial owners whose shares are held in nominee names.\nDIVIDENDS\nThe Company is subject to dividend restrictions under the Delaware General Corporation Law and regulations and policies of the FRB. The Company's Series B Preferred Shares participate equally, share for share, in cash dividends paid on the Class A Shares in addition to receiving the cash dividends to which they are entitled. The Board of Directors suspended the dividend on the Class A Shares and the Series B Preferred Shares.\nThe payment of cash dividends by the Bank to the Company is subject to certain regulatory restrictions set forth in the California Financial Code. The Bank and the Company have amended the Certificate of Determinations of Rights, Preferences, Privileges and Restrictions of the 8% Series B Convertible Preferred Stock issued by the Bank to the Company to provide that dividends on the Bank's 8% Series B Convertible Preferred Stock shall be cumulative from year to year. The Bank's Board of Directors has decided to suspend future payment of dividends on the Preferred Stock to the Company, and the FRB Directive prohibits the Company from paying any dividends without the prior approval of the FRB. See \"-- Regulatory Directives and Orders\" for a discussion of these restrictions.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe following table sets forth certain selected consolidated financial data of the Company at and for the years ended December 31:\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nThe Company recorded a net loss of $33.0 million for the year ended December 31, 1994, following net losses of $10.3 million and $22.2 million for the years 1993 and 1992, respectively. These net losses were principally due to the high level of the provision for loan and real estate owned losses, and declines in net interest income during each of 1994, 1993 and 1992. In addition, the Company's non-interest expense reached extremely high levels at 263.9%, 96.1% and 105.0% of total revenues for the years 1994, 1993 and 1992, respectively.\nThe Company's provision for loan losses and the increase in the loan loss allowance as a percentage of outstanding loans reflects management's concern over the decline in the credit quality of the Bank's loan portfolio, regulatory examinations, and the high level of net loan charge-offs during the period 1992 through 1994. Although the Company's provision for loan losses increased to $3.8 million in 1994, from $3.6 million in 1993 and declined from $9.8 million in 1992, the allowance for loan losses as a percentage of loans grew from 3.6% in 1992 to 6.2% in 1994. The Company's net loan charge-offs, primarily associated with unsecured commercial loans, loans secured by real estate, and loans to facilitate the development of real estate, amounted to $5.3 million in 1994 as compared to $3.9 million in 1993, and $9.8 million in 1992.\nThe Company's net interest income was reduced to $7.8 million in 1994 from $10.7 million in 1993, a 27.5% decline, following a 14.7% decline in net interest income in 1993 from $12.6 million in 1992. These declines in net interest income were principally due to a reduction in average earning assets from $286.0 million in 1992 to $234.8 million in 1993, a 17.9% decline, and a further reduction to $152.9 million in 1994, a decline of 34.9%.\nThe Company's non-interest expenses were largely driven by expenses associated with managing its high level of non-earning assets (average non-earning assets were 22.3% of total average assets in 1994, 19.6% in 1993 and 20.1% in 1992) in addition to litigation settlements and reserve, legal, accounting and consulting expenses related to the Company's loan collection and recapitalization efforts. These costs comprised 40.9% of the Company's non-interest expense in 1992, declining to 29.6% in 1993 and comprised 66.1% of non-interest expense during 1994. In 1994, the Bank provided an additional provision for the decline in the fair value of other real estate owned properties to reflect the fair value less selling expenses.\nAt December 31, 1994, total assets and deposits of $156.8 million and $147.1 million, respectively, had declined 32.1% and 30.0%, respectively, from amounts reported at December 31, 1993. Loans, net of deferred loan fees, were $106.1 million, a decrease of 28.9% from the amount reported at December 31, 1993. At December 31, 1993, total assets, deposits and net loans were $231.0 million, $210.1 million and $149.2 million, respectively, a decline of 27.6%, 26.5% and 36.6%, respectively, from amounts reported at the close of 1992. The declines in assets and loans during 1992, 1993 and 1994 reflect the condition of the Bank and the general economic conditions in Northern California and more particularly the depressed value of real estate collateral in the San Francisco Bay Area from which the repayment of a substantial portion of the Company's loans are based. The declines followed substantial operating losses of the Company, beginning in 1991 and continuing through 1994. These operating losses were the major cause of the Company's failure to meet its capital adequacy requirements causing it to reduce its assets in order to meet regulatory capital adequacy requirements and the resulting Written Agreement, MOU and Orders which generally require the Bank to reduce its classified assets, concentration of real estate related credits, volatile liability dependence, and maintain its liquidity and increase its capital. See \"-- Regulatory Written Agreement and Orders\" for a full description of the Written Agreement and the Orders.\nIn response to the significant problems experienced by the Company during the period from 1991 through 1994 the Company restructured its management team and has analyzed several different business strategies. The 1995 Business and Profit Plan contemplates three specific measures; 1) the raising of an additional $15.0 million in capital, 2) the sale of the remaining non-performing assets through several means, and 3) returning the Company to profitability through focusing on the Private Banking concept. The previous business plan contemplated several measures, including without limitation, raising additional capital, eliminating problem assets, commencing new lines of business, hiring additional personnel for such new lines of business, and establishing a new relationship with\nStrategic Alliance Partners. Because of the delay in raising enough capital to significantly reduce problem assets the Company has not been able to execute its expansion plans involving new lines of business. If the Company is successful in raising sufficient capital and disposing of a substantial portion of its problem assets, of which no assurance can be given, implementation of the international components of the business plan may become feasible in future years. To the extent that the Company can return to profitability in the future, recent financial trends experienced by the Company may not be indicative of future trends; however, due to the numerous factors affecting the successful implementation of the 1995 Business and Profit Plan, many of which are beyond the control of the Company, no prediction can be made with respect to the nature or extent of future financial trends.\nRESULTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nNET INTEREST INCOME\nYields Earned and Rates Paid\nOne of the fundamental measures of the Bank's results of operations is net interest income. Net interest income is the difference between the combined yield earned on interest earning assets and the combined rate paid on interest bearing liabilities. Net interest income is also dependent on whether the balance of interest earning assets equals, exceeds or is less than the balance of interest bearing liabilities. If an excess in the balance of interest bearing liabilities over interest earning assets exists, then the positive interest rate spread between yields earned and rates paid may need to be increased in order to achieve a positive net interest position.\nThe following table presents the consolidated average balance sheets of the Company, together with the total dollar amounts of interest income and expense, and weighted average interest rates for each of the years in the three year period ended December 31, 1994. Where possible, the average balances are calculated on a daily average basis. When this information is not available, average balances are calculated on a monthly basis.\n- - ----------------- (1) Non-performing loans have been included in the average loan balances. Interest income is included on non-accrual loans only to the extent to which cash payments have been received and full principal repayment is probable.\nThe dollar amount of interest income and interest expense fluctuates depending on changes in the respective interest rates and on changes in the respective amounts (volume) of the Bank's earning assets and interest bearing liabilities. For each category of interest earning asset and interest bearing liability, information is provided in the following table for changes attributable to (i) changes due to volume (change in average balance multiplied by prior year's rate), and (ii) changes in rate (changes in rates multiplied by prior year's average balances). Changes attributable to the combined impact of volumes and rates have been allocated pro-rata to each category.\nThe Company's interest income decreased during the three year period ended December 31, 1994 due mainly to a 38.7% decrease in average loans. The decrease in the loan portfolio primarily resulted from a decision to reduce the size of the Company's assets to comply with regulatory capital requirements, and loan repayments. The weighted average yield on loans increased in 1994 after declines since 1991 primarily due to the Bank's prime rate increase from 6.0% at December 31, 1993 to 8.5% at December 31, 1994. During the two year period prior to 1994 the Bank's prime rate declined from an average of 6.3% 1992 and to 6.0% in 1993.\nInterest income and dividends on investment securities was $1.4 million in 1994 compared to $1.5 million in 1993. Although average portfolio balances were $31.9 million in 1994 compared to $37.4 million in 1993, average portfolio yields were 4.4% in 1994 compared to 4.0% in 1993. Interest income on investment securities was $1.5 million in 1993 compared to $2.2 million in 1992. Average portfolio balances were $37.4 million in 1993 compared to $37.1 million in 1992, and average portfolio yields were 4.0% in 1993 compared to 5.9% in 1992. The higher average yields in 1994 reflect the overall increase in market interest rates and higher average yield realized from reinvestment.\nInterest expense for 1994 was $4.9 million, a decrease of $2.6 million, or 34.5% during 1994, as compared to 1993. This decrease was primarily attributable to a decrease in average interest bearing liabilities of $81.4 million to $145.5 million, or 35.9%, as compared to 1993, partially offset by a slight increase in average interest rates. The average cost of deposits and borrowings for 1994 was 3.3% as compared to 3.3% for 1993. Interest expense for 1993 was $7.4 million, a decrease of $3.9 million, or 34.3% during 1993, as compared to 1992. This decrease was primarily attributable to a decrease in average interest bearing liabilities of $69.3 million to $226.9 million, or 23.4%, as compared to 1992, and to a decline in average interest rates. The average cost of deposits and borrowings for 1993 was 3.3% as compared to 3.8% for 1992.\nInterest expense for 1992 was $11.3 million, a decrease of $7.9 million, or 41.3% during 1992, as compared to 1991. This decrease was primarily attributable to a decrease in average interest bearing liabilities of approximately $49.7 million, or a 14.5% decrease, from 1991, and to a decline in short term interest rates. The average cost of deposits and borrowings for 1992 was 3.8% as compared to 5.6% for 1991.\nPROVISION FOR LOAN LOSSES\nDuring 1994, 1993, and 1992, the Bank provided $3.8 million, $3.6 million and $9.8 million, respectively, to its allowance for loan losses. Net charge offs recorded for 1994, 1993 and 1992 were $5.3 million, $3.9 million, and $9.8 million, respectively. The increase in the loan loss provision in 1994 as a percentage of average loans to 3.1% from 1.8% in 1993 was required as a result of the increase in charge offs in 1994 compared to 1993 and reflects management's assessment that higher loan loss allocation on loans with specific weaknesses was required. The substantial loan loss provision made in 1992 reflects management's assessment of the decline in the credit quality in the Bank's loan portfolio and the impact of declining economic conditions in California and particularly the real estate values which served as collateral for many of the Bank's loans. The Company's loan loss provisions were largely loan loss reserves allocated to specific classified and non-performing loans. See \"-- Allowance for Loan Losses\" herein.\nSummary of Loan Loss Experience\nNet loan charge-offs for the years ended December 31, 1994, 1993 and 1992 were $5.3 million, $3.9 million, and $9.8 million, respectively. As a percentage of average total loans, net loan charge-offs were 4.4%, 2.0% and 3.9% for 1994, 1993, and 1992, respectively.\nIn 1994, loan losses from the deterioration in borrowers' financial condition and the value of collateral securing loans occurred as a result of the recession in California. A summary of significant charge-off activity during 1994 is as follows:\n- - - Unsecured loans charged off totaled $306,000 comprised of two loans.\n- - - The charge-offs related to commercial and financial loans totaled $3.0 million and were comprised of 14 loans. The single largest charge-off was $529,000. This loan is secured by a limited partnership interest. The loan was classified as non-accrual in the first quarter 1994 and a partial charge-off was recorded in the third quarter of 1994 and the remaining balance was charged off in the fourth quarter of 1994.\n- - - The charge-offs related to real estate construction loans totaled $630,300 and were comprised of two loans. The loans were secured by a first deed of trust on land under development located in Northern California. The largest charge-off on these loans related to a restructuring which provided for a discount for a partial payoff.\n- - - The charge-offs related to real estate mortgage loans totaled $2.6 million and were comprised of 13 loans. The single largest charge-off was $1.0 million. This loan was secured by a first deed of trust on land zoned for single family development property and the purpose of the loan was for the purchase of real estate. The loan was a loan to facilitate the sale of real estate foreclosure which was placed on non-accrual during the third quarter of 1994 and the charge-off recorded during the fourth quarter reflected a deterioration in the collateral value based on updated appraisal information.\nIn 1993, loan losses from the deterioration in borrowers' financial condition and the value of collateral securing loans occurred as a result of the recession in California. A summary of significant charge-off activity during 1993 is as follows:\n- - - Unsecured loans charged off totaled $290,200 and was comprised of five loans. The single largest charge-off was $174,400.\n- - - The charge-offs related to commercial and financial loans totaled $2.1 million and were comprised of 19 loans. The single largest charge-off was $600,000. The purpose of this loan was for working capital and to acquire partnership interest in two limited partnerships. This loan is secured by UCC filings and securities agreements on various partnerships and trusts. The loan was classified as non-accrual in the second quarter 1993 and a partial charge-off was recorded in the third quarter of 1993.\n- - - The charge-offs related to real estate construction loans totaled $137,300 and were comprised of two related loans. The related loans were secured by a first deed of trust on land under development located in Northern California. This property was classified as non-accrual during the third quarter of 1992 and transferred to in-\nsubstance foreclosure during the fourth quarter of 1993 when an updated appraisal indicated that the borrower's equity in the property had deteriorated.\n- - - The charge-offs related to real estate mortgage loans totaled $1.1 million and were comprised of six loans. The single largest charge-off was $761,800. This loan was secured by a fourth deed of trust on commercial property and the purpose of the loan was for real estate investment. The loan was classified as non-accrual during the second quarter of 1993 and the charge-off recorded during the fourth quarter reflected a deterioration in the collateral value and a weakness in the guarantors' financial condition.\n. The charge-offs related to the sale of the Sacramento Regional Office totaled $402,000. This charge-off was incurred as a result of selling $28.0 million in loans at the Bank's carrying value, less an allocated allowance.\nNON-INTEREST INCOME\nNon-interest income decreased $2.3 million or 53.3% in 1994 as compared to 1993, primarily as a result of a decrease in brokerage fee income related to the exercise of stock options of $1.3 million, a decrease in income from limited partnership of $527,000 as a result of the decline in the limited partnerships earnings resulting primarily from deferred maintenance costs, and a decline in service charge and fee revenue and all other income of $514,000 related to trust management fees, referral fees on CD Placement, and deposit products and services because of lower transaction volumes and lower average deposit balance outstanding, lower levels of assets under management through trust services, and an increase in the loss on sale of securities.\nNon-interest income increased $129,000 or 3.0% in 1993 as compared to 1992, primarily as a result of an increase in brokerage fee income related to the exercise of stock options of $586,000 and a decrease in service charges and fee revenue and all other income of $781,000 related to trust management fees, escrow fees, referral fee on CD Placement, and deposit products and services because of lower transaction volumes and lower average deposit balance outstanding, and lower levels of assets under management through trust services.\nThe following table provides a detail of non-interest income for the years ended December 31:\nNON-INTEREST EXPENSE\nFor the year ended December 31, 1994, non-interest expense increased $17.3 million, or 79.3%, from the year ended December 31, 1993. The increase was attributed primarily to higher a level of costs related to real estate asset, a higher level of litigation settlement and provision charges, and a higher professional costs for legal and consulting costs related to the Company's litigation matters, and the requirement for special services related to addressing the Company's financial condition.\nFor the year ended December 31, 1993, non-interest expenses decreased $8.0 million, or 26.5%, from the year ended December 31, 1992. The reduction was attributed primarily to lower compensation related expenses, a lower level of costs related to asset and credit quality, and lower level of legal and consulting costs related to the Company's loan collection and recapitalization efforts.\nThe following table provides a detail of non-interest expense for the years ended December 31:\nThe decrease in compensation related expenses of $1.0 million in 1994 to $7.3 million, or 12.0% from the 1993 level, resulted from lower staffing levels, partially offset by higher incentive compensation paid and severance related costs. The decrease in compensation related expenses of $1.5 million in 1993 to $8.3 million, or 15.6% from the 1992 level, resulted from lower staffing levels, and lower levels of other benefits for executive officers, partially offset by an increase in incentive compensation primarily related to work performed related to reductions in problem assets. The compensation expense included performance-based incentives of $755,000, $526,000, and $920,000 for 1994, 1993 and 1992, respectively.\nThe Company's expenses for professional services were $3.1 million in 1994 compared to $2.3 million and $3.4 million in 1993 and 1992, respectively. The Company includes in professional fees the costs of legal, accounting, and management consulting services. Professional service expenses increased in 1994 as a result of the continuing activities related to recapitalization, consulting services related to the new lines of business, and the increase in professional services required to manage the resolution of classified and non-performing assets during that year. In 1994, the Company incurred additional professions service costs related to the analysis and preliminary activities required to establish various international business strategies. Professional service costs decreased in 1993 by $1.1 million compared to 1992 as a result of lower costs related to the Company's loan collection and recapitalization efforts. Professional service expenses were high in 1992 as a result of the substantial activities undertaken by the Company to complete its 1992 recapitalization, and the increase in professional services required to manage the resolution of classified and non-performing assets during that year.\nThe increase of $15.0 million in net cost of real estate operations related to asset and credit quality from $4.1 million in 1993 to $19.1 million in 1994 reflects continued deterioration in the value of the real estate collateral. The decrease of $4.6 million in net cost of real estate operations related to asset and credit quality from $8.7 million in 1992 to $4.1 million in 1993 reflects lower levels of classified assets and lower levels of loans migrating to classified or non-performing status because of the stabilization of borrowers' financial conditions and the quality of the underlying collateral on loans.\nThe decline of $463,000 in 1994 other operating costs to $1.4 million from $1.9 million in 1993 and the $620,000 decrease in 1993 other operating expenses from $2.5 million in 1992 resulted primarily from cost reduction initiatives in miscellaneous expenses and customer related service expenses.\nIn 1994, the Bank recorded loss provisions totaling $16.5 million for 18 other real estate owned assets compared to $3.3 million in 1993 on 15 properties, an increase of 400.0%. In addition to the provisions, the Bank recognized $73,300 in losses on the sale of two real estate properties acquired in settlement of loans in 1994 compared to $712,000 on 11 properties in 1993. The Bank recognized recoveries and gains on sale of other real estate owned totaling $253,000 million on three properties in 1994 compared to $1.7 million in 1993 on four properties.\nIn 1993, the Bank recorded loss provisions totaling $3.3 million for 15 other real estate owned assets compared to $5.5 million in 1992 on 17 properties, an improvement of 40.0%. In addition to the provisions, the Bank recognized $712,000 in losses on the sale of 11 real estate properties acquired in settlement of loans in 1993 compared to $467,000 on five properties in 1992. The Bank recognized recoveries and gains on sale of other real estate owned totaling $1.7 million on four properties in 1993 compared to $1.0 million in 1992 on five properties.\nThe Bank recorded a loss provision of $513,500 for three real estate investment property compared to $250,000 in 1993 on one property, an increase of 88.0%. The Bank did not recognized a loss on the sale of real estate investment in 1994 compared to a loss of $54,000 on one real estate investment in 1993. The Bank recognized gains on sale of real estate investments totaling $10,000 in 1994 on one property. No gains were recognized in 1993.\nThe Bank recorded a loss provision of $250,000 for one real estate investment property compared to $662,000 in 1992 on three properties, an improvement of 62.2%. In addition to the provisions, the Bank recognized a loss of $54,000 on the sale of one real estate investment in 1992 compared to none in 1993. The Bank recognized gains on sale of real estate investments totaling $749,000 in 1992 on two properties. No gains were recognized in 1993.\nFINANCIAL CONDITION\nTOTAL ASSETS\nWith the recurring operating losses during 1994, 1993 and 1992 and the failure of the Company and the Bank to consistently meet its regulatory capital requirements, management of the Company implemented a strategy of reducing the Company's total assets in order to more easily meet its regulatory capital ratios and an aggressive loan work-out program to reduce the level of the real estate related and other problem loans. As a result, the Company's assets decreased 32.1% in 1994 from $231.0 million at December 31, 1993 to $156.8 million at December 31, 1994.\nCASH AND CASH EQUIVALENTS\nThe Bank maintains cash and cash equivalents, such as federal funds sold, at levels management believes are sufficient to meet the liquidity needs of its deposit customers. At December 31, 1994 the Company's cash and cash equivalents were $28.6 million or 19.5% of total deposits and 94.7% of non-interest bearing deposits. At December 31, 1993 the Company's cash and cash equivalents were $25.8 million or 12.3% of total deposits and 74.1% of non-interest bearing deposits. See also \"Liquidity\" herein for a further discussion of the Bank's other sources of liquid assets.\nINVESTMENT ACTIVITIES\nThe Bank maintains a securities portfolio consisting of United States Government and Federal agency securities, collateralized mortgage obligations, investments in certificates of deposits at other financial institutions, and mutual funds. The balance of the investment securities maintained by the Bank in excess of the requirement of applicable regulations and the Orders reflect management's objective of ensuring compliance with liquidity requirements. Most securities are held in safekeeping by an independent custodian.\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt & Equity Securities.\" 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 securities, trading securities, and available-for-sale securities. Held-to-maturity securities are those securities the Bank has the intent and ability to hold to maturity and are carried at amortized cost. Trading securities are those securities that are bought and held principally for the purpose of selling in the near term and are reported at fair value, with unrealized gains or losses included in current earnings. Available-for-sale securities are those securities that do not fall into the other two categories and are reported at fair value, with unrealized gains or losses reported as a separate component of shareholders' equity. This Statement is effective for\nfiscal years beginning after December 15, 1993, however, earlier implementation is permitted. The Bank elected to implement SFAS No. 115 effective as of December 31, 1993.\nThe Bank determines the classification of all securities at the time of acquisition. In classifying securities as being heldto-maturity, trading, or available-for-sale, the Bank considers its collateral needs, asset\/liability management strategies, liquidity needs, interest rate sensitivity and other factors in determining its intent and ability to hold the securities to maturity.\nInvestment securities held-to-maturity include United States Treasury and Federal agency securities, investments in certificates of deposit, and an equity investment in Federal Home Loan Bank of San Francisco (FHLB) membership stock. The objectives of these investments are to increase portfolio yield, and to provide collateral to pledge for federal, state and local government deposits and other borrowing facilities. The investments held-to-maturity have an average term to maturity of four months and 20 months at December 31, 1994 and 1993, respectively. The investments held-to-maturity are carried at amortized cost. At December 31, 1994 and 1993, the investment securities held-to-maturity portfolio includes $7.9 million and $3.1 million in fixed rate investments, and $1.3 and $3.3 million in adjustable-rate investments, respectively. During 1994, the Bank reclassified certain collateralized mortgage obligations to the available-for-sale category as a result of a change in the strategy regarding the investment in these types of securities.\nInvestment securities available-for-sale may include United States Treasury and Federal agency securities, mutual funds, and collateralized mortgage obligations. These securities are typically used to supplement the Bank's liquidity portfolio with the objective of increasing yield. Investment securities available-for-sale are accounted for at fair value. Unrealized gains and losses are recorded as an adjustment to equity and are not reflected in the current earnings of the Bank. 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 and 1993, the Bank held $2.2 million and $14.9 million classified as investments available-for-sale, respectively. At December 31, 1994 and 1993, $4,000 and $60,000 was charged against equity to reflect the market value adjustment to the securities available-for-sale, respectively.\nThe table below sets forth certain information regarding the carrying values and market values and the weighted average yields of the Bank's investment securities portfolio by maturity at December 31, 1994:\nNo investment securities had a maturity of more than five years at December 31, 1994. The FHLB stock have no term to maturity.\nIn October 1994, Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) no. 119, Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments. The provisions of SFAS No. 119 are effective for the Company and the Bank as of December 31, 1995. SFAS No. 119 required disclosure about derivative financial instruments -- futures, forwards, swap and option contracts, and other financial instruments with similar characteristics. As of December 31, 1994, the Company and the Bank had no derivative financial instruments that would be subject to such disclosure.\nLOANS\nDuring 1994, the Company reduced its total loans by $43.3 million from $149.7 million at December 31, 1993. The reduction in total loans resulted primarily from a strategic decision to reduce concentrations in real estate and\/or real estate related loans and to reduce the total loan portfolio to improve the liquidity position of the Bank through loan repayments. In addition, loans were reduced by charge-offs of $6.6 million.\nIn addition, the increase in classified loans from $22.9 million at December 31, 1993 to $25.0 million at December 31, 1994 was the result of redefining the criteria for all classified assets based on comments from the FDIC examiners. During 1994, there were $14.7 million in newly classified loans, of which $12.2 million were reclassified in the first quarter of 1994 based on FDIC examiners comments, whereas in 1993, there were $4.4 million in newly classified loans. For a description of the composition of the loan portfolio and a description based upon various contractually scheduled repayments, see \"BUSINESS -- The Company and the Bank -Lending Activities -- Composition of Loan Portfolio.\"\nCLASSIFIED ASSETS\nFederal regulations require banks to review their assets on a regular basis and to classify them if any weaknesses are noted. Banks must maintain adequate allowances for assets classified as \"Substandard\" or \"Doubtful\" and to immediately write off those assets classified as \"Loss\". The Bank has a comprehensive process for classifying assets and asset reviews are performed on a periodic basis. In addition to identifying adversely classified assets, the Bank identifies certain assets as \"Special Mention\", which do not currently expose the Bank to a sufficient degree of risk to warrant a more adverse classification but do possess credit deficiencies or potential weaknesses deserving management's close attention. Assets that do not possess credit deficiencies are not classified and are labeled \"Pass\". The Bank stratifies its loan portfolio based on collateral type concentrations and delinquency trends. The objective of the review process is to identify any trends and determine the levels of loss exposure to the Bank that would require an adjustment to the valuation allowance.\nClassified assets include non-accrual loans, other real estate owned, real estate investments and performing loans that exhibit credit quality weaknesses. Certain loans identified as in-substance foreclosed are included in other real estate owned. The table below outlines the Bank's classified assets as of December 31, 1994 and 1993:\nThe Bank is required by the Orders to reduce its classified assets, as defined by the Orders, to no more than $60.0 million by December 31, 1993, no more than $50.0 million by March 31, 1994 and no more than $40.0 million by September 30, 1994. At December 31, 1994, the Bank had $20.8 million in such assets. However, no assurance can be given that the regulatory authorities will not establish additional requirements on the Bank to reduce its classified assets.\nFurther declination in the regional real estate market could increase the amount of the Bank's non-performing assets and, in addition, could have an adverse effect on the Bank's efforts to collect its non-performing loans or otherwise liquidate its non-performing assets on terms favorable to the Bank. Accordingly, there can be no assurance that the Bank will not experience additional increases in the amount of its non-performing assets or experience significant additional losses in attempting to collect the non-performing loans or otherwise liquidate the non-performing assets which are presently reflected on the Bank's statement of financial condition. Moreover, the Bank has been incurring substantial asset-carrying expenses, such as the expenses of maintaining and operating properties included among the Bank's other real estate owned classification, and the Bank may continue to incur assetcarrying expenses in connection with such loans and assets until its non-performing loans and assets are collected or liquidated.\nNON-PERFORMING ASSETS\nWhen a borrower fails to make a required payment on a loan, the loan is classified as delinquent. If the delinquency is not cured, workout procedures are generally commenced and the loan is transferred to the Bank's Special Assets Department. If workout proceedings are not successful, collection procedures, which may include collection demands, negotiated restructures, foreclosures, suits for collection and borrower bankruptcy, are initiated. In general, loans are placed on non-accrual status after being contractually delinquent for more than 90 days, or earlier if management believes full collection of future principal and interest on a timely basis is unlikely. When a loan is placed on non-accrual status, all interest accrued but not received is charged against interest income. During the period in which a loan is on non-accrual status, any payment received may be used to reduce the outstanding loan balance. A non-accrual loan is restored to an accrual basis when principal and interest payments are paid current and full payment of principal and interest is expected. Loans that are well secured and in the process of collection remain on accrual status.\nThe Bank may restructure loans as a result of a borrower's inability to service the obligation under the original terms of the loan agreement. Restructures are executed only when the Bank expects to realize more from a restructured loan rather than allowing it to go into foreclosure or other form of collection.\nAt December 31, 1994 and 1993, other real estate owned, including in-substance foreclosed loans, were $10.0 million and $32.4 million, respectively. In-substance foreclosed loans are those in which the borrower has little or no equity in the collateral based on its fair value, the borrower has effectively abandoned control of the collateral so that many of the risks and rewards of ownership have been passed to the lender, and repayment of the loan can only be expected from the operation or sale of the collateral. At December 31, 1994 and 1993, in-substance foreclosed loans were $4.6 million and $19.1 million, respectively. As of December 31, 1994 and 1993, all other real estate owned and real estate investments were classified.\nNon-performing assets include non-accrual loans, in-substance foreclosed assets and real estate foreclosures. Non-performing assets were $19.4 million at the end of 1994, down 55.4% from $43.5 million in 1993. Loans past due 90 days or more and accruing are included in the schedule of non-performing assets.\nThe following table provides information on all non-performing assets at December 31:\nIn addition to the loans disclosed in the foregoing table, the Bank had approximately $3.3 million in loans on December 31, 1994 that were between 31 and 89 days delinquent. In the opinion of management, these loans have a greater than ordinary risk that the borrowers may not be able to perform under the terms of their contractual arrangements. Approximately $2.7 million of these loans are secured by first or subordinate deeds of trust on real estate.\nAt December 31, 1994, the Bank had two loans totaling $22,000 that were less than 90 days delinquent and on non-accrual status. The performance history of these loans demonstrated that the borrower may not be able to perform under the terms of the contractual arrangements. As of December 31, 1994, the Bank had three loans totaling $940,000 that were more than 90 days delinquent with accrued interest income that was included in income. These loans were in the process of renewal, and were renewed and interest and principal were paid current during the first quarter of 1995.\nThe following table provides a stratification of non-performing assets, which includes non-accrual loans and other real estate owned, by collateral type as of December 31, 1994 and 1993.\nAt December 31, 1994, substantially all of the non-performing assets are real estate or loans secured by real estate located in Northern California. Raw land consists of land acquired for the purpose of future residential or commercial development. The Bank had no non-performing assets secured by subordinate deeds of trust as of December 31, 1994.\nRestructured loans totaled $6.3 million and $2.0 at December 31, 1994 and 1993, respectively. For the years ended December 31, 1994 and 1993, interest income foregone on restructured loans was $18,000 and $166,000, respectively.\nVALUATION ALLOWANCES\nThe Bank charges current earnings with provisions for estimated losses on loans receivable, other real estate owned, and real estate investments. The provisions take into consideration specifically identified problem loans, the financial condition of the borrowers, the fair value of the collateral, recourse to guarantors, and other factors.\nIn 1993, the FASB issued SFAS No. 114 \"Accounting by Creditors for Impairment of a Loan\". This Statement required that impaired loans be measured based on the present value of expected future cash flows discounted at the effective rate of the loan's observable market price or the fair market value of the collateral if the loan is collateral dependent. This Statement applies to financial statements for fiscal years beginning after December 31, 1994. In October 1994, the FASB issued SFAS No. 118 \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures\". SFAS No. 118 amends SFAS No. 114 to allow a creditor to use existing methods for recognizing interest income on an impaired loan. SFAS No. 118 is effective concurrent with the effective date of SFAS No. 114. The Company elected not to implement SFAS No. 114 and 118 for the period ended December 31, 1994. It has been determined that the effect of SFAS No. 114 and 118 on the Company's financial statements would not have been material had the Company implemented SFAS No. 114 and 118 as of December 31, 1994.\nAllowance for Loan Losses\nPrior to 1991, the Bank's method of analyzing the adequacy of its allowance for loan losses generally relied on the application of historic loan loss ratios and specific allocations of loss allowances based on specific credit reviews. In 1991, the Bank revised its methodology because of deterioration in the credit quality of the loan portfolio, resulting from weakness in the economy and the oversupply of properties similar to the properties collateralizing many of the Bank's loans. The Bank has continued to refine the allowance methodology to ensure that all known risks, trends, and facts are utilized in determining the adequacy of the allowance for loan losses.\nFair value of the underlying collateral is based on current market conditions, appraisals, and estimated sales values of similar properties, less an estimated discount for selling and other expenses. In addition, the Bank establishes a specific loss allowance based on the asset classification and credit quality grade. This specific loss allowance is utilized to ensure that allowances are allocated based on the credit quality grading to capture inherent risks. In addition, the Bank carries an \"unallocated\" loan loss allowance to provide for losses that may occur in the future in loans that are not presently classified, based on present economic conditions, trends, and related uncertainties.\nThe following table summarizes the loan loss experience of the Bank for the years ended December 31:\nThe following table provides an allocation of the allowance for loan losses by collateral type at December 31:\n(1) Percent refers to the percent of loans in each category to total loans.\nAllowance for Losses on Other Real Estate Owned\nReal estate acquired through foreclosure and in-substance foreclosed loans are recorded at fair value at the time of transfer to OREO. In 1992, the Bank adopted a policy in which the Bank periodically obtains either an appraisal or market valuation analysis on all other real estate owned. If the valuation analysis indicates a decline in the market value of the property, a specific loss allowance is established. The Bank provides a charge against current earnings for estimated losses on foreclosed property when the carrying value of the property exceeds its fair value net of estimated selling expenses. Fair value is based on current market conditions, appraisals, and estimated sales values of similar properties, net of an estimated discount for selling and other expenses.\nThe following table summarizes the other real estate owned loss experience of the Bank for the periods shown:\nThe Bank recorded gains on sale of other real estate owned totaling $253,000 in 1994 and $1.7 million in 1993. The gains in 1993 were related to four properties. The Bank recorded losses on sale of other real estate owned totaling $73,000 in 1994 and $712,000 in 1993. The losses in 1994 were related to two properties and in 1993 were related to 11 properties. The OREO properties are shown net of allowance for losses.\nDuring 1993, the Bank transferred a loan with a carrying value of $1.6 million collateralized by commercial real estate to in-substance foreclosure. The collateral securing this loan requires seismic upgrading and may be located on property containing hazardous materials. During 1994, the asset was charged off.\nAllowance for Losses on Real Estate Investments\nReal estate investments are recorded at the lower of cost or fair value. Periodically, the Bank obtains either an appraisal or market valuation analysis on all real estate investments. If the valuation analysis indicates a decline in the market value of the property subsequent to the date of acquisition, a specific loss allowance is established. The Bank provides a charge against current earnings for estimated losses on real estate investments when the carrying value of the property exceeds its fair value less estimated selling expenses. Fair value is based on current market conditions, appraisals, and estimated sales values of similar properties, less an estimated discount for selling and other expenses.\nThe following table summarizes the real estate investments loss experience of the Bank for the years ended December 31:\nDEPOSITS\nThe Bank had total deposits of $147.1 million and $210.1 million at December 31, 1994 and 1993, respectively. As of December 31, 1994, deposits consisted of demand deposits totaling $30.3 million, money market accounts totaling $25.3 million, savings and NOW accounts totaling $43.4 million and time deposits totaling\n$48.2 million. As of December 31, 1994, the Bank had a total of 4,554 deposit accounts consisting of 1,132 demand deposit accounts with an average balance of approximately $27,000 each, 864 money market accounts with an average balance of approximately $29,000 each, approximately 1,829 savings and NOW accounts with an average balance of approximately $24,000 each and 729 time accounts with an average balance of approximately $66,000. The Bank's deposits and, correspondingly, its liquidity, are largely dependent upon four sources of funds: deposits acquired through its Association Bank Services function, brokered placement of certificates of deposit, and deposits solicited through the Bank's money desk. These sources of deposits comprised 46.8% of the Bank's total deposits at December 31, 1994.\nCertificates of deposit having a balance of at least $100,000 (including brokered placements of certificates of deposit) represented approximately 7.0% of the Bank's total deposits as of December 31, 1994 compared to 24.8% as of December 31, 1993. As of December 31, 1994, 68.7% of the Bank's certificates of deposit of at least $100,000 mature in 90 days or less, 27.4% between 91 days and one year and 3.9% greater than a year. The aggregate average maturity of all of the Bank's certificates of deposit of at least $100,000 was four months as of December 31, 1994, and the aggregate amount of all such certificates of deposit as of December 31, 1994 was $10.2 million. Concentrations of large certificates of deposit and certain money market deposits have been classified by bank regulatory authorities as volatile liabilities associated with certain risks, including the risks of reduced liquidity if a bank is unable to retain such deposits and reduced margins if its interest costs are increased by a bank in order to retain such deposits. See \"-- Regulation and Supervision.\" As a result of the Orders the Bank was required to submit a plan to the FDIC and SBD to reduce its dependence on volatile liabilities.\nDeposits from homeowner and community associations are a key component of the Bank's core deposit base. See \"Association Bank Services\". At December 31, 1994 and 1993, the Association Bank Services function accounted for $34.5 million and $45.1 million in deposits, representing approximately 23.4% and 21.5% of the Bank's total deposits, respectively. During 1994, Association Bank Service customer deposits declined 23.5% from a year earlier. In August 1993, the manager and much of the staff of the Association Bank Services function left the Bank to join a competitor, whose services have been actively marketed to the Bank's customer base. Since March 31, 1994, there has not been a significant decline in Association Bank Service customer deposits as a result of the change in management, but there can be no assurance that the Bank will be able to continue to stem the loss of such deposits.\nAt December 31, 1994 and 1993, the Bank had brokered deposits totaling $19.8 million or 13.5% and $20.0 million or 9.5% of total deposits, respectively. During 1994, the Bank's agreement with a major retail brokerage firm for the placement of certificates of deposits was cancelled. The Bank repaid the $20.0 million in deposits from the major retail brokerage firm in September 1994 and established other sources of brokered deposits through other intermediaries. In addition, as a result of a regulatory examination in 1994 certain money market accounts totaling approximately $7.2 million as of December 31, 1994, were reclassified as brokered deposits. Most of these deposits have been on deposit with the Bank since 1989.\nAt December 31, 1994 and 1993, the Bank's brokered deposits were approximately 12.5% and 8.7% of the Bank's total assets, respectively. During 1994 and 1993 brokered deposits averaged $24.9 million and $36.3 million, respectively, with high and low balances for 1994 of $27.0 million and $11.1 million, respectively. Such brokered certificates of deposit have a remaining weighted average term to maturity of approximately six months The Bank's brokered deposit waiver was suspended on January 30, 1995 by the FDIC. As a result of the suspension of the brokered deposit waiver the Bank will not be able to renew these brokered deposits.\nIn March 1993, the Bank initiated a money desk for the purpose of attracting additional deposits. These deposits are gathered principally from other financial institutions and municipalities outside of the Bank's market area. As of December 31, 1994 and 1993, the Bank had outstanding money desk deposits of $14.9 million or 9.6% of total Bank's assets and $41.5 million or 19.8% of Bank's total deposits. During 1994, the money desk deposits averaged $28.4 million, with a high balance of $41.5 million. As of December 31, 1994, money desk deposits had a remaining weighted average maturity of approximately seven months. In response to the suspension of the brokered deposit waiver, the Bank has reactivated its money desk deposit program for the purpose of replacing the maturing brokered deposits.\nThe Bank's ability to accept brokered placements of certificates of deposit was restricted in the first quarter of 1992 under FDICIA and FDIC regulations that prohibit adequately capitalized banks from accepting or renewing\nsuch deposits. As of December 31, 1994, the Bank was accepting brokered deposits pursuant to a waiver of such prohibition received in September 1994 with a term of one year. As required by the Orders, the Bank has submitted a plan to the FDIC and the SBD to eliminate reliance on brokered deposits and to reduce its dependency on out of area deposits and volatile liabilities. During the first quarter of 1995, the Bank's risk-based capital ratio declined to below the minimum regulatory requirement of 8.0% which caused the FDIC to suspend the Bank's brokered deposit waiver. No assurance can be given that brokered deposits, in the near future, can be replaced with other core deposits. See -- \"Regulatory Agreement and Orders\" and \"Regulation and Supervision\".\nThe following table sets forth the maturities, as of December 31, 1994, of the Bank's interest-bearing deposits and other interest-bearing liabilities:\nOTHER BORROWINGS\nThe Bank's other borrowings at December 31, 1994 totaled $4.1 million, as compared to $1.3 million at December 31, 1993. The Bank's other borrowing facilities include advances from the FHLB and reverse repurchase agreements.\nThe Bank's short term line of credit with the Federal Reserve Bank of San Francisco (Federal Reserve Bank) was cancelled effective April 3, 1995. However, the Bank has an overdraft line with the Federal Reserve Bank of $1.1 million secured by loans in the Bank's portfolio. The Bank's short term line of credit with the FHLB of up to $5.5 million is secured by pledged loans. At December 31, 1994 and 1993, the Bank had no borrowings outstanding with the FHLB or Federal Reserve Bank. During 1994 and 1993, the Bank did not borrow at the discount window at the Federal Reserve Bank. In the first quarter of 1995, the Bank activated its FHLB borrowing as a result of liquidity concerns related to the decline in core deposits since December 31, 1994.\nASSET AND LIABILITY MANAGEMENT\nBanking is a business which depends on rate differentials. In general, the difference between the interest rate paid by the Bank on its deposits and its other borrowing and the interest rate received by the Bank on loans extended to its customers and securities held in the Bank's portfolio comprise the major portion of the Bank's earnings. These rates are highly sensitive to many factors which are beyond the control of the Bank. Accordingly, the earnings and growth of the Bank are subject to the influence of domestic economic conditions, including inflation, recession and unemployment.\nThe most important component of the Bank's earnings is the difference between the rates earned on its assets as compared to the rates paid on its liabilities. The difference between the amount of assets and the amount of liabilities which are subject to interest rate risk is referred to as the \"gap.\" The gap represents the risk and the opportunity inherent in mismatching asset and liability interest rate changes. If more assets than liabilities are interest rate sensitive at a given time in a rising interest rate environment, net interest income increases. In a declining interest rate environment with the same \"gap\", net interest income decreases. If more liabilities change rates than assets, the same scenarios produce the opposite effects.\nThe Bank's risk management policies are established by the ALCO. The ALCO meets semi-monthly to formulate the Bank's strategies. The basic responsibilities of the ALCO include the management of interest rate risk, liquidity, funding, and asset and liability products. The Bank's approach is to measure interest rate risk, assess and determine if the risk level is acceptable and to develop strategies to either reduce excessive risk or recognize the trade-offs between risk and return.\nThe following table shows the repricing opportunities for the Bank's interest-earning assets and interest-bearing liabilities at December 31, 1994:\n(1) Excludes non-accrual loans.\nThe maturity\/rate sensitivity analysis is a static view of the balance sheet with assets and liabilities grouped into certain defined time periods, and thus only partially depicts the dynamics of the Bank's sensitivity to interest rate changes. Such an analysis does not fully describe the complexity of relationships between product features and pricing, market rates and future management of the balance sheet mix. As a result, assets and liabilities indicated as repricing within the same period may in fact reprice at different times and different rates. The Company's net interest margins on average earnings assets for the years ended December 31, 1994, 1993 and 1992, were 5.1%, 4.6% and 4.5%, respectively.\nLIQUIDITY\nIn 1994 and 1993, the Company's principal source of liquidity has been new capital from the issuance of its capital stock. Generally, the Bank has various sources of liquidity including core deposits, money desk deposits, other borrowings, loan participations and sales, loan repayments, and the sale of problem assets. The Bank's access to all of these sources of liquidity is limited as a result of the failure to meet capital requirements, its level of classified assets, continued operating losses, and contractual maturities of performing loans or the inability of borrowers to repay loans according to the contractual terms. In addition, the Bank's brokered deposit waiver was suspended on January 30, 1995 disallowing the Bank from renewing existing and accepting new brokered deposits.\nLiquidity is the Bank's ability to meet the present and future needs of its clients for loans and deposit withdrawals. The Bank's liquidity generally decreases as a result of increases in the Bank's loans and other assets, and fluctuations in the maturities of deposits in the Bank can have a significant effect on the Bank's liquidity. The sources of the Bank's liquidity include deposits, other liquid assets and short-term borrowings. The most important source of these assets are core deposits. Core deposits are defined as all deposits from its customer base except time deposits of $100,000 or greater and all deposits identified as volatile. At December 31, 1994, the Bank's core\ndeposits were $101.2 million, representing a 12.8% decrease from core deposits of $116.0 million at December 31, 1993, which in turn represents a 49.1% decrease from core deposits of $228.0 million at December 31, 1992. The Bank's liquid assets, which includes cash and short term investments, at December 31, 1994 totaled $40.1 million, a decrease of 15.0% from $47.1 million at December 31, 1993. The Bank currently has an overdraft line with the Federal Reserve Bank of up to $1.1 million secured by loans in the Bank's portfolio. As of December 31, 1994, the Bank had pledged loans and securities enabling the Bank to borrow up to $5.5 million from the Federal Home Loan Bank of San Francisco, and the Bank had not drawn on this line of credit.\nThe Bank's ability to generate liquidity through deposits from homeowner and community associations, $34.5 million or 23.4% of deposits at December 31, 1994, had become the subject of intense competition during 1993. During 1994, these deposits declined $4.9 million or 12.4% from December 31, 1993. In addition, out of area deposits solicited through the Bank's money desk, $14.9 million or 10.0% of deposits at December 31, 1994 are the subject of an Order requiring the Bank to reduce its reliance on such deposits. During 1994, the Bank reduced these deposits by $26.6 million or 64.0% since December 31, 1993.\nThe Bank's ability to generate liquidity through acceptance of brokered placements of certificates of deposit was restricted in the first quarter of 1992 under FDICIA and new FDIC regulations that prohibit undercapitalized banks from accepting or renewing such brokered deposits and prohibit adequately capitalized institutions from accepting or renewing such deposits unless such institutions obtain a waiver of such prohibition from the FDIC. Under the Orders, the Bank was required to submit a written plan to the FDIC and the SBD for eliminating its reliance on brokered deposits, and to provide the Regional Director of the FDIC and the Superintendent with monthly reports outlining the Bank's progress under such plan. The FDIC had granted the Bank a one-year waiver expiring in September 1995 to permit renewal of brokered deposits, provided that the Bank continues to meet the definition of an adequately capitalized institution. If the Bank fails to meet the definition of an adequately capitalized institution or fails to demonstrate substantial progress towards elimination of dependency on brokered deposits, the Bank may be unable to obtain an extension of such waiver. During the first quarter of 1995, the Bank's brokered deposit waiver was suspended as a result of the failure to meet the minimum risk-based capital requirement. See \"-- Regulation and Supervision.\"\nDuring 1994, the Bank had a plan to reduce its reliance on volatile liabilities which included certain actions including the hiring of a liability manager to work with Private and Business Banking officers in the development and marketing of core deposit programs, a new local area certificate of deposit product was rolled-out in early February, 1994, and the Bank's international strategy with deposits expected to exceed loans by a ratio of 2:1. As a result of the Bank's capital position, management determined that the implementation of these measures was not advisable. The Bank's present strategy focuses on the stabilization of the existing core deposit portfolio and the selective non-renewal of transaction type loans. The proceeds from loan pay offs will be used to fund the maturity of volatile liabilities.\nAlthough management believes that the Bank's ability to eliminate its brokered deposits, and reduce its reliance on out of area and volatile liabilities can be accomplished through local deposit marketing efforts following a recapitalization of the Bank, the success of which cannot be assured, and because brokered deposits and out of area deposits presently comprise over 23.5% of the Bank's total deposits, it is not expected that, in the near future, these deposits can be replaced with core deposits. Nor can any assurance be given that the Bank will be able to successfully implement its plans, find alternate sources of deposits and avoid violation of the Orders. See \"-- Regulatory Directives and Orders.\"\nCAPITAL\nShareholders' equity totaled $2.1 million at December 31, 1994, a decrease of $15.4 million from $17.5 million at December 31, 1993. During the period from 1991 through 1994, the Company suffered an aggregate of $74.6 million in losses, primarily as a result of defaulted loans secured by real estate and losses on direct real estate development activities. The Company and the Bank succeeded in avoiding insolvency during this period only through the injection of a total of $52.0 million in new capital as of December 31, 1994. The Company's majority shareholder committed to an additional capital contribution of $3.8 million, expected by April 24, 1995. The Company intends to raise a minimum of $6.3 million of additional capital in 1995.\nPursuant to federal law, the Company is subject to the Federal Reserve Board's capital guidelines of the FRB and the Bank is subject to the FDIC's regulations governing capital adequacy for banks that are not members (\"non-member banks\") of the Federal Reserve System. As a result of the Bank's failure to meet its minimum regulatory and Orders capital requirements at December 31, 1994, the Bank filed the Plan in compliance with \"Prompt Corrective Action\" imposed by FDICIA. It is expected that the Plan will be acceptable to the FDIC and the SBD after the receipt of additional capital. The Plan supersedes previously filed plans under the \"Prompt Corrective Action\" regulations. In addition, in 1993 the Company agreed to guarantee that the Bank will comply with the previously filed capital restoration plan until the Bank has met its minimum capital requirements on average during each of four consecutive calendar quarters. The Company's liability under the guarantee is limited to the lesser of 5% of the Bank's total assets at the time it became undercapitalized, $15.3 million or an amount necessary (or that would have been necessary) to bring the Bank into compliance with all of its capital requirements as of the time it fails to comply with the Restoration Plan. The Company currently does not have sufficient funds to satisfy the guarantee, and would be in default thereunder if called upon to do so. See \"-- Supervision and Regulation\" for further information concerning FDICIA's \"Prompt Corrective Action\" system.\nUnder California law, if a bank's deficit retained earnings exceed 40% of its contributed capital, its capital is deemed to be impaired, and the bank is required to levy an assessment on its shares to correct the impairment. The SBD has issued eight Impairment Orders to the Bank, most recently dated February 1, 1995. At December 31, 1994, the Bank had contributed capital of $66.2 million and deficit retained earnings of $64.6 million resulting in a $38.1 million capital impairment. See \"-- Regulatory Directives and Orders -- Capital Impairment Order\" for more discussion on the Bank's impairment of capital.\nOn July 13, 1992, the Company had completed (i) the sale to the Company's controlling stockholder of 280,000 shares of Class A Common Stock (the \"Class A Shares\") at $50.00 per share and warrants which will enable the Company's controlling stockholder to acquire 1.0408 additional Class A Shares at $50.0 per share for every Class A Share issued by the Company for an aggregate purchase price of $14,000,000, under an Amended Stock Purchase Agreement dated April 10, 1992. As a consequence of the acquisition of the 280,000 Class A Shares by the Company's controlling stockholder on July 13, 1992, a change of control of the Company was effected.\nOn October 29, 1992, the Company entered into an agreement which was subsequently amended on November 20, 1992 (as amended, the \"October 29 Letter Agreement\") with the Company's controlling stockholder whereby it was agreed that the Company's controlling stockholder would purchase up to 600,000 shares of Series C Preferred Share at a price of $20.00 per share, completed by a specified date and the Company would grant to the Company's controlling stockholder an option (the \"Series C Preferred Stock Option\") to purchase up to an additional 400,000 Series C Preferred Shares at a price of $20.00 per share, exercisable in whole or in part at any time before a specified date. The Company's controlling stockholder acquired 300,000 shares as of December 31, 1992, 300,000 shares on February 26, 1993, 200,000 shares on August 27, and 100,000 shares on September 30, 1993, of Series C Preferred Stock.\nOn May 23, 1994, the holder of the Company's Series C Preferred Stock converted each share of his Preferred Stock into 40 shares of Class A Common Stock and 40 warrants, with each warrant granting the right to purchase an additional share of Class A Common Stock, exercisable at $0.50 per share (before the reverse split). The warrants have not been exercised. In addition to the conversion, the Company effected a 1-for-20 reverse stock split of the Company's Class A Common Stock and changed the authorized number of shares to 40,000,000. As a result of the reverse stock split, the Company repurchased the fractional shares which totaled 119 new shares. No Series C Preferred Shares were outstanding at December 31, 1994.\nOn July 25, 1994, the Company issued 3,521,126 shares of Class A Common Stock, and warrants to purchase an additional 3,521,126 shares with an exercise price for each share of $10.00 to its principal stockholder in its first closing of a private stock offering for $20.0 million in capital. The price per unit was $5.68. Each unit sold under the private placement includes a Risk Protection Right (RPR). Under the RPR, additional Class A Common Stock will be issued to the holder of each RPR if a net loss is incurred on certain specified assets or as the result of losses, incurred related to certain litigation actions. The RPR will effectuate this risk allocation by compensating the holder with additional shares of Class A Common Stock (Adjustment Shares) up to a maximum number of shares per RPR without the payment of additional consideration. This compensation will be effected through periodic distributions of Adjustment Shares. Adjustment Shares will be issued to compensate for net losses, net charge-offs and expenses on certain specified assets (Specified Assets) and the lawsuit that was settled for $2.0 million during July 1994 up\nto a cumulative amount of $16.0 million. The maximum number of shares to be issued is 9,723,000. As a result of the losses incurred in 1994, the maximum number of Adjustment Shares would have been issued at December 31, 1994 as a result of the losses incurred in 1994.\nThe total cost of this capital raising was $2.4 million for a net capital contribution of $17.6 million. On July 27, 1994 and December 31, 1994, the Company contributed net capital of $13.5 million and $3.5 million, respectively, to the Bank.\nWith the conversion and the issuance of the Adjustment Shares, and if the controlling stockholder exercised all of the Warrants, then the Company's controlling stockholder would receive an additional 1,800,000 Class A Common Shares and would own approximately 99.2% of the total number of issued and outstanding common shares.\nMr. Kaharudin Latief of Jakarta, Indonesia is presently in the process of providing notice to the FRB and applying to the SBD for approval to acquire shares of the Class A Common Stock. If and when regulatory clearance is received, Mr. Latief plans to acquire from the Company's controlling stockholder 600,000 shares of Class A Common Stock and Warrants through cancellation of an unsecured, personal loan in the amount of $6.0 million which Mr. Latief previously extended to the Company's controlling stockholder. The Company's controlling stockholder used the proceeds of this loan to acquire 300,000 shares of the Series C Preferred Stock from the Company. If Mr. Latief consummates this transaction, the Company's stockholders, Mr. Latief would hold 600,000 shares of Class A Common Stock and 600,000 Warrants with an exercise price of $10.00 per share. Mr. Latief's ownership percentage including Warrants would be 5.8% and the Company's controlling stockholder's new common ownership would decline to approximately 93.4%.\nThe Company and the Bank are subject to general regulations issued by the FRB, FDIC, and SBD which require maintenance of a certain level of capital and the Bank is under specific capital requirements as a result of the Orders. As of December 31, 1994, the Company was not in compliance with all minimum capital requirements and the Bank was not in compliance with all minimum capital requirements including the minimum leverage ratio of 7.0% mandated by the Orders.\nThe following table reflects both the Company's and the Bank's capital ratios with respect to minimum capital requirements in effect as of December 31, 1994.\nOn April 20, 1995, the Company's majority shareholder committed to contributing $3.8 million in capital, expected by April 24, 1995. The Company intends to contribute $4.2 million of capital to the Bank upon receipt of the $3.8 million. The following table reflects both the Company's and Bank's capital ratios with respect to minimum capital requirements in effect as of December 31, 1994 giving effect to the capital raised in April of 1995.\nCertain reclassification were made in the prior years' financial statements to conform to the current year presentation.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nREPORT OF INDEPENDENT ACCOUNTANTS\nThe Board of Directors and Shareholders of The San Francisco Company:\nWe have audited the accompanying consolidated statements of financial condition of The San Francisco Company and subsidiaries (the Company) as of December 31, 1994 and 1993 and the related consolidated statements of operations, changes in shareholders' 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 report on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our report.\nIn our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company 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.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in note 2 to the consolidated financial statements, the Company's recurring losses from operations; noncompliance of the Bank of San Francisco (the Bank) with the Orders to Cease and Desist issued jointly by the Federal Deposit Insurance Corporation (the FDIC) and the California State Banking Department (the SBD); the Bank's noncompliance with the Impairment Orders issued by the SBD; the Bank's designation as a critically undercapitalized institution by the FDIC and the restrictions imposed by the prompt corrective action provisions of Federal Deposit Insurance Corporation Improvement Act of 1991; and the uncertainty relating to the potential unfavorable outcome of pending litigation discussed in note 17 to the consolidated financial statements, raise substantial doubt about the Company's ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent on many factors, including obtaining additional capital contributions, increasing and maintaining its capital ratios, achieving profitable operations and obtaining full compliance with the Cease and Desist and Impairment Orders. Management's plans in regard to these matters are described in note 2 to the consolidated financial statements. The accompanying consolidated financial statements do not included any adjustments that might result from the outcome of these uncertainties.\nBecause of the significance of the uncertainties discussed above, we are unable to express, and we do not express, an opinion on the accompanying 1994 consolidated financial statements.\nKPMG Peat Marwick LLP\nApril 4, 1995, except as to note 3, which is as of April 20, 1995 San Francisco, California\nTHE SAN FRANCISCO COMPANY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 1994 AND 1993\nThe accompanying notes are an integral part of the consolidated financial statements.\nTHE SAN FRANCISCO COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of the consolidated financial statements.\nTHE SAN FRANCISCO COMPANY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of the consolidated financial statements.\nSAN FRANCISCO COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of the consolidated financial statements. (continued)\nTHE SAN FRANCISCO COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (continued)\nThe accompanying notes are an integral part of the consolidated financial statements.\nTHE SAN FRANCISCO COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1994 AND 1993\nNote 1: Statement of Accounting Policies\nOrganization\nThe San Francisco Company (Company) formerly the Bank of San Francisco Company Holding Company is a Delaware corporation and a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company was organized in 1981 under the laws of the State of California. In July 1988, the Company changed its state of incorporation from California to Delaware by means of a merger of the Company into a newly formed wholly owned Delaware subsidiary. Bank of San Francisco (Bank), a state chartered bank, was organized as a California banking corporation in 1978 and became a wholly owned subsidiary of the Company through a reorganization in 1982.\nThe Bank and Bank of San Francisco Realty Investors (BSFRI) acquired partnership interests of 34.5% and 2.5%, respectively, in Bank of San Francisco Building Company (BSFBC), a California limited partnership which holds the leasehold interest in the Company's headquarters building located at 550 Montgomery Street, San Francisco, California. The Company accounts for its investment in BSFBC using the equity method.\nPrinciples of Consolidation\nThe accompanying financial statements include the accounts of the Company, the Bank, and the Bank's wholly owned subsidiary, BSFRI, formerly BSF Equities. All material intercompany transactions have been eliminated in consolidation.\nOther ventures and partnerships in which the Company or any of its subsidiaries have a significant ownership interest are accounted for by the equity method. These investments are recorded as real estate investments, and gains or losses upon disposition of these investments are recorded in gain\/loss on sale of real estate.\nCash and Cash Equivalents and Statements of Cash Flows\nCash equivalents are defined as short-term, highly liquid investments both readily convertible to known amounts of cash and so near maturity that there is insignificant risk of changes in value because of changes in interest rates. Generally, only investments with maturities of three months or less at the time of purchase qualify as cash equivalents. Cash and cash equivalents include cash and due from banks, time deposits with other financial institutions, and Federal funds sold.\nThe Bank is required to maintain non-interest bearing cash reserves equal to a percentage of certain deposits. In 1994 and 1993, the average reserve balances outstanding were $2.8 million and $5.7 million, respectively. Generally, the Bank does not maintain compensating balance arrangements.\nInvestment Securities\nAt December 31, 1993, the Company adopted Statement of Financial Accounting Standards \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS No. 115) which requires the classification of debt and equity securities into one of three categories; held-to-maturity, trading, or available-for-sale. The investments classified as held-to-maturity are carried at amortized cost because management has both the intent and ability to hold these investments to maturity. Investments classified as available-for-sale are carried at fair value with any unrealized gains and loss included as a separate component of shareholders' (deficit)\/equity.\nInvestment securities include both debt and equity securities. At December 31, 1994, Bank maintained two securities portfolios; investment securities held-to-maturity, and debt and equity securities available-for-sale. Investment securities held-to-maturity are carried at amortized cost and discounts or premiums are accreted or amortized to income over the expected term of the investment based on prepayment assumptions. Discounts or\npremiums are adjusted periodically to reflect actual prepayment experience. The gain or loss on all investment securities sold is determined based on the specific identification method. The estimated fair value is based on market price.\nLoans Receivable\nLoans are stated at the principal amount outstanding, net of the allowance for loan losses, deferred fees and unearned discount, if any. The Bank holds loans receivable primarily for investment purposes. A significant portion of the Bank's loan portfolio is comprised of adjustable rate loans.\nInterest on loans is calculated using the simple interest method on the daily balances of the principal amount outstanding. The accrual of interest is discontinued and any accrued and unpaid interest is charged against current income when the payment of principal or interest is 90 days past due, unless the amount is well-secured and in the process of collection. Subsequent interest payments on loans in non-accruing status are recorded as a reduction of the loan balance. Interest payments received on loans for which the future collection of the recorded principal is probable are recognized as interest income.\nLease financing receivables, net of unearned income, are included in loans. Unearned income and residual values related to lease financing receivables are recognized in income over the life of the lease under a method that yields an approximately level rate of return on the unrecovered lease investment.\nLoan Fees\nThe Bank charges nonrefundable fees for originating loans. Loan origination fees, net of the direct costs of underwriting and closing the loans, are deferred and amortized to interest income using the interest method. Unamortized net fees and costs on loans sold or paid in full are recognized as income. Other loan fees and charges, which represent income from delinquent payment charges, and miscellaneous loan services, are recognized as interest income when collected.\nAllowance for Loan Losses\nThe Company records a provision for estimated losses on loans receivable considering both specifically identified problem loans and credit risks not specifically identified in the loan portfolio. The allowance for loan losses takes into consideration numerous factors including the financial condition of the borrowers, the fair value of the collateral prior to the anticipated date of sale, delinquency trends, collateral concentrations and past loss experience.\nLosses are recognized as charges to the allowance when the loan is considered uncollectible or at the time of foreclosure. Recoveries on loans receivable previously charged off are credited to allowance for loan losses.\nPremises and Equipment\nPremises and equipment are stated at historical cost less accumulated depreciation and amortization. Depreciation on furniture, fixtures and equipment is computed on the straight-line method over the estimated useful life of each type of asset. Estimated useful lives are from three to seven years. Leasehold improvements are amortized over the term of the applicable lease or their estimated useful life, whichever is shorter.\nReal Estate Investments\nThe Company, through BSFRI, has acquired property for development and sale and has made investments in joint ventures and partnerships. Real estate acquired for development and sale is recorded at the lower of cost (adjusted for subsequent development costs) or fair value net of estimated selling costs. Interest costs are capitalized when properties are in the development stage. Investments in real estate joint ventures and partnerships are reported using the equity method of accounting.\nOther Real Estate Owned\nOther real estate owned (OREO) includes loans receivable that have either been repossessed in settlement of debt (foreclosures) or substantially repossessed (\"in-substance foreclosures\"). In-substance foreclosures occur when the market value of the collateral is less than the legal obligation of the borrower and the Bank expects the payment of the loan to come only from sale of the collateral. At the date of transfer, OREO is recorded at fair value net of estimated selling costs.\nThe Company provides a charge against current earnings for estimated losses on foreclosed property when the carrying value of the property exceeds its fair value net of estimated selling expenses. The Bank obtains an appraisal or market valuation analysis on all other real estate owned periodically. If the periodic valuation indicates a decline in the fair value below recorded carrying value, an allowance for OREO losses is established. Fair value is based on current market conditions, appraisals, and estimated sales values of similar properties, net of estimated selling and other expenses.\nOther Assets\nOther assets include equipment owned by the Bank and leased to third parties under an operating lease which is stated at cost less accumulated depreciation. Depreciation is computed using a straight-line method over five years.\nIncome Taxes\nPrior to 1987, the Company filed consolidated Federal income and combined California franchise tax returns, using the cash method of accounting. Beginning in 1987, as required by the Tax Reform Act of 1986, the Company filed consolidated tax returns using the accrual method of accounting.\nEffective January 1, 1993, the Company changed its method of accounting for income taxes to adopt Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109). Under the asset and liability method prescribed by SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences of differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases (temporary differences). Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period of enactment.\nUnder SFAS No. 109, deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards, and then a valuation allowance is established to reduce that deferred tax asset if it is \"more likely than not\" that the related tax benefits will not be realized. The adoption of SFAS No. 109 did not have a material impact on the Company's January 1, 1993 net deferred tax asset. Additionally, the adoption of this accounting method did not have a material impact on tax expense and net income for 1994 and 1993.\nNon-Interest Income\nFees for other customer services represent fees earned for the brokerage of certificates of deposit and commissions earned in connection with the Bank's stock option lending program and other banking services. Fees for services are recorded as income when the services are performed.\nLoss per Share\nLoss per share is calculated using the weighted average number of common shares outstanding divided into net loss. The conversion of the Series C Preferred Shares and warrants are included in the calculations of loss per share for 1994 effective from the date of conversion.\nRecent Accounting Pronouncements\nIn October 1994, Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) no. 119, Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments. The provisions of SFAS No. 119 are effective for the Company and the Bank as of December 31, 1995. SFAS No. 119 required disclosure about derivative financial instruments -- futures, forwards, swap and option contracts, and other financial instruments with similar characteristics. As of December 31, 1994, the Company and the Bank had no derivative financial instruments that would be subject to such disclosure.\nIn 1993, the FASB issued SFAS No. 114 \"Accounting by Creditors for Impairment of a Loan\". This Statement required that impaired loans be measured based on the present value of expected future cash flows discounted at the effective rate of the loan's observable market price or the fair market value of the collateral if the loan is collateral dependent. This Statement applies to financial statements for fiscal years beginning after December 31, 1994. In October 1994, the FASB issued SFAS No. 118 \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures\". SFAS No. 118 amends SFAS No. 114 to allow a creditor to use existing methods for recognizing interest income on an impaired loan. SFAS No. 118 is effective concurrent with the effective date of SFAS No. 114. The Company elected not to implement SFAS No. 114 and 118 for the period ended December 31, 1994. It has been determined that the effect of SFAS No. 114 and 118 on the Company's financial statements would not have been material had the Company implemented SFAS No. 114 and 118 as of December 31, 1994.\nReclassifications\nCertain reclassifications have been made in the prior years' consolidated financial statements to conform to current year presentation.\nNote 2: Regulatory Orders and Going Concern Considerations\nThe Company\nOn December 16, 1994, the Company and the Federal Reserve Bank of San Francisco (FRB) entered into a Written Agreement (the \"Agreement\") that supersedes the previous directive dated April 20, 1992. The Agreement prohibits the Company, without prior approval of the FRB, from: (a) paying any cash dividends to its shareholders; (b) directly or indirectly, acquiring or selling any interest in any entity, line of business, problem or other assets; (c) executing any new employment, service, or severance contracts, or renewing or modifying any existing contracts with any executive officer; (d) engaging in any transactions with the Bank that exceeds an aggregate of $20,000 per month; (e) engaging in any cash expenditures with any individual or entity that exceeds $25,000 per month; (f) increasing fees paid to any directors for attendance at board or committee meetings, or paying any bonuses to any executive officers; (g) incurring any new debt or increasing existing debt; and (h) repurchasing any outstanding stock of the Company. The Company is required to submit a progress report to the FRB on a quarterly basis.\nThe Company was also required to submit to the FRB an acceptable written plan to improve and maintain adequate capital position, a comprehensive business plan concerning current and proposed business activities, a comprehensive operating budget at the Bank and the consolidated organization. In addition, the Board of Directors was required to submit an acceptable written plan designed to enhance their supervision of the operations and management of the consolidated organization. The Company has filed all of the required submissions with the FRB in accordance with the Agreement.\nThe Bank\nCapital Orders\nOn March 24, 1995, the State Banking Department (SBD) issued an order for the Bank to increase its level of capital. The capital order requires that the Bank increase its capital by $4.2 million on or before April 10, 1995 and by a minimum of $10.5 million (including the first installment of $4.2 million) on or before June 30, 1995. The second installment must be at least equal to the amount of capital necessary to increase the shareholder's equity to not less than 7.0% of total tangible assets as of February 28, 1995. No assurances were given that the SBD would refrain from taking action against the Bank until the deadlines specified have passed.\nOn March 28, 1995, the Federal Deposit Insurance Corporations (FDIC) issued a Notification of Capital Category (\"Notification\") in accordance with Prompt Corrective Action regulations. The FDIC has determined that the Bank is Critically Undercapitalized. On the date of the Notification the Bank became subject to certain mandatory requirements including submission of a capital restorations plan and restrictions on asset growth, acquisitions, new activities, new branches, payment of dividends or making any other capital distribution, management fees, and senior executive compensation. Prior to the Notification, the Bank was subject to the Orders to Cease and Desist (Orders), as described below, which included these limitations. In addition, immediately upon receiving notice, the Bank must obtain FDIC's prior written approval before entering into any material transaction other than in the usual course of business, extending any credit for any highly leveraged transactions, as defined by regulation, amending the Bank's charter or bylaws, except to the extent necessary to carry out any other requirement of any law, regulation, or order, making any change in accounting methods, engaging in any covered transaction as defined in section 23A(b) of the Federal Reserve Act, pay excessive compensation or bonuses, paying interest on new or renewed liabilities at a rate that would increase the Bank's weighted average cost of funds to a level significantly exceeding the prevailing rates of interest on insured deposits in the Bank's normal market area, and making any principal or interest payment on subordinated debt.\nOrders to Cease and Desist\nOn August 18, 1993, the Bank stipulated to Orders to Cease and Desist (Orders) issued jointly by the FDIC and the SBD, whereby the Bank agreed to correct alleged unsafe and unsound practices disclosed in the FDIC and SBD Reports of Examination as of November 30, 1992. The Orders supersede the Memorandum of Understanding that the Bank had been operating under since November 15, 1991. As a result of the Orders, the Bank is classified as a \"troubled institution\" by the FDIC.\nThe Orders, which became effective on August 29, 1993, require that the Bank: (a) achieve and maintain a 7% leverage capital ratio on and after September 30, 1993; (b) pay no dividends without the prior written consent of the FDIC and the California Superintendent of Banks (the \"Superintendent\"); (c) reduce the $88.6 million in assets classified \"Substandard\" or \"Doubtful\" as of November 30, 1992 (the date of the most recent full-scope FDIC and SBD Report of Examination of the Bank), to no more than $40.0 million by August 31, 1994; (d) have and retain management whose qualifications and experience are commensurate with their duties and responsibilities to operate the Bank in a safe and sound manner, notify the FDIC and the Superintendent at least 30 days prior to adding or replacing any new director or senior executive officer and comply with certain restrictions in compensation of senior executive officers; (e) maintain an adequate reserve for loan losses; (f) not extend additional credit to, or for the benefit of, any borrower who had a previous loan from the Bank that was charged off or classified \"Loss\" in whole or in part; (g) develop and implement a plan to reduce its concentrations of construction and development loans; (h) not increase the amount of its brokered deposits above the amount outstanding on the Orders Effective Date ($20.0 million) and submit a written plan for eliminating reliance on brokered deposits; (i) revise or adopt, and implement, certain plans and policies to reduce the Bank's concentration of construction and land development loans, reduce the Bank's dependency on brokered deposits and out of area deposits, and to improve internal routines and controls; (j) reduce the Bank's volatile liability dependency ratio to not more than 15% by March 31, 1994; (k) eliminate or correct all violations of law set out in the most recent Report of Examination, and take all necessary steps to ensure future compliance with all applicable laws and regulations; and (l) establish a committee of three independent directors to monitor compliance with the Orders and report to the FDIC and the Superintendent on a quarterly basis.\nFailure to comply with the above Orders could result in the termination of the Bank's federal deposit insurance, imposition of civil money penalties against the Bank or other responsible parties, or possession of the Bank's property and business and ultimate liquidation thereof by the SBD.\nAs of December 31, 1994, the Bank failed to meet industry-wide capital requirements and to meet the 7% leverage capital ratio imposed by the Orders primarily because of the continued losses incurred as a result of problem assets. As to the other requirements of the Orders and the Restoration Plan, the Bank believes that the findings of the FDIC and SBD at its recent examination which began January 30, 1995 will be that the Bank is not in compliance with substantial requirements of the Orders including the SBD's order requiring the Bank to correct its capital impairment. However, no Report of Examination has been received from the FDIC and the SBD as a result of their recent examination of the Bank. In addition, because of its asset quality, continued operating losses, volatile liability dependency and liquidity problems, the Bank is potentially subject to further regulatory sanctions that are generally applicable to banks that are critically undercapitalized.\nIn response to the Orders and Prompt Correction Action regulations, management has submitted a 1995 Business and Profit Plan to the FDIC and the SBD for approval. It is expected that the business plan will be acceptable to the FDIC and the SBD after the receipt of additional capital. Management believes that the Bank will be able to take the actions contemplated by such plan without need for further FDIC approval, subject to the general requirement that the Bank return to profitability and be operated safely and soundly. A number of the restrictions imposed by the Orders will remain in effect until the Orders are officially lifted. Although management anticipates the FDIC and the SBD will lift the Orders if the Bank's problem assets are fully resolved, no assurance can be given as to when all conditions precedent to the lifting of the Orders will be fulfilled. The Company also is subject to certain restrictions imposed by the FRB pursuant to the Agreement that may prevent the Company from taking steps to establish new businesses (or new subsidiaries) at the Company level until similar conditions precedent are fulfilled.\nPrompt Corrective Action\nThe Bank's failure to meet minimum regulatory requirements as of December 31, 1994, resulted in the imposition of operating restrictions pursuant to the prompt corrective action provisions of FDIC Improvement Act (FDICIA). In accordance with FDICIA, the Bank submitted a capital restoration plan (Plan) for meeting regulatory capital requirements. The Plan has not been approved. In addition, in 1993 the Company agreed to guarantee that the Bank will comply with the previously filed capital restoration plan until the Bank has met its minimum capital requirements on average during each of four consecutive calendar quarters. The Company agreed to guarantee the Bank's performance under the Plan for up to five percent (5%) of the Bank's assets or the amount needed to bring the Bank into compliance. The Company's guarantee will remain in effect until the Bank maintains compliance with the minimum capital ratio requirements for four consecutive calendar quarters.\nFailure to maintain minimum capital requirements or to implement the Plan can result in the imposition of additional restrictions upon the Bank's activities including increased supervision and ultimately regulatory takeover.\nImpairment Orders\nUnder California law, if a bank's deficit retained earnings exceed 40% of its contributed capital, its capital is deemed to be impaired, and the bank is required to levy an assessment on its shares to correct the impairment. The SBD has issued six impairment orders to the Bank, with the most recent dated February 1, 1995 (the \"Impairment Orders\"). At December 31, 1994, the Bank had contributed capital of $66.2 million and deficit retained earnings of $64.6 million.\nThe Impairment Orders require the Bank to correct the impairment within 60 days by levying an assessment on the Company as the Bank's sole shareholder. The Bank has not levied an assessment against its shares nor has it otherwise corrected the impairment, and, therefore, is in violation of this law. In addition, the SBD has specifically reserved the right to take such other action as the Superintendent may deem appropriate or necessary, which may include taking possession of the Bank's property and business, including ultimately liquidating the business and affairs of the Bank.\nThe Company plans to correct the Bank's capital impairment by requesting the SBD to approve a quasi-reorganization of the Bank. In a quasi-reorganization, the Bank's retained deficit would be reduced or eliminated by netting the retained deficit against contributed capital. Management believes that approval for such a quasi-reorganization would only be granted by the SBD upon the Bank raising sufficient additional capital for the Bank to sustain profitable operations and meet all of its regulatory capital requirements in the future. Should the SBD deny approval for a quasi-reorganization of the Bank, the Bank would be required to raise additional new capital of $95.2 million, to cure the capital impairment at December 31, 1994. Any operating losses thereafter would further impair the Bank's capital and give rise to further capital assessments.\nNo assurance can be given that the Bank's capital condition will not deteriorate further prior to any such quasi-reorganization as a result of operating losses. In addition, because a quasi-reorganization requires that the Bank adjust its assets and liabilities to market value at the time of the reorganization, the Bank's capital could be further reduced from its present level. Finally, there can be no assurance given that, following a correction of the Bank's capital impairment, whether through a quasireorganization or an infusion of sufficient capital, the Bank's capital position will not continue to erode through future operating losses.\nGoing Concern Considerations\nDuring the period 1991 through 1994, the Company suffered an aggregate of $74.6 million in losses, primarily as a result of defaulted loans secured by real estate and losses on direct real estate development activities. The Company and the Bank succeeded in avoiding insolvency during this period only through the injection of a total of $52.0 million of new capital by the Company's controlling stockholder. The Company's and the Bank's recurring losses from operations, noncompliance with minimum regulatory capital requirements, the negative capital position, the Bank's designation as a critically undercapitalized institution by the FDIC, and the Bank's noncompliance with the Orders and Impairment Order raise substantial doubt about the Company's ability to continue as a going concern.\nThe ability of the Company to continue as a going concern is dependent upon many factors, including increasing and maintaining its capital ratios, obtaining additional capital contributions and returning the Company to profitable operations. In response to these problems, the Company and the Bank have developed a business strategy and capital plan to raise new capital and return the Company and the Bank to profitability. The Company intends to raise additional capital in 1995 and contribute that capital to the Bank. If the Company does not succeed in raising new capital, termination of the Bank's FDIC insurance is likely.\nNote 3: Subsequent Event -- Capital Contribution\nIn April 1995, the Company received a commitment from its majority shareholder for $3.8 million in capital, expected by April 24, 1995. The Company intends to contribute a total of $4.2 million in capital to the Bank upon receipt of the $3.8 million. The following table reflects both the Company's and Bank's capital ratios with respect to minimum capital requirements in effect as of December 31, 1994 giving effect to the capital commitment.\nNote 4: Investment Securities Held-to-Maturity\nThe carrying and estimated market values of investment securities held-to-maturity at December 31 are as follows:\nAt December 31, 1994 and 1993, $2.5 million and $2.1 million, respectively, of securities were pledged as collateral for treasury, tax, loan deposits, public agency, bankruptcy and trust deposits. At December 31, 1994 and 1993, the Company had no securities sold under agreements to repurchase.\nThe average yield on investments securities was 4.6% and 3.6% at December 31, 1994 and 1993, respectively. U.S. Treasury and agency securities held by the Company have maturities of less than one year. The FHLB stock has no stated maturity.\nDuring 1994, the Bank reclassified collateralized mortgage obligations with an amortized cost of $2.3 million to the availablefor-sale investment category as a result of a change in the strategy regarding the investment in these types of securities. The Bank recorded a loss of $14,000 on the transfer of securities to the available-for-sale category.\nNote 5: Investment Securities Available-for-Sale\nThe carrying and estimated market values of investment securities available-for-sale at December 31 are as follows:\nFor 1994 and 1993, the Bank included an unrealized loss of $4,000 and $60,000 as a separate component of stockholders' equity. U.S. Treasury and agency securities and CMO held by the Company have maturities of less than one year. The maturity on the CMO is estimated based on the prepayment experience of similar investment securities.\nThe proceeds from sales of securities available for sale were $19.4 million at December 31, 1994. During 1994, the Bank recorded no gains, and losses of $265,000 were realized.\nNote 6: Loans Receivable\nThe Bank's loan portfolios at December 31 are summarized as follows:\nAt December 31, 1994 and 1993, non-accrual loans totaled $9.4 million and $11.1 million, respectively, and loans past due 90 days or more and still accruing totaled $940,000 and $182,000, respectively. For the years ended December 31, 1994, 1993 and 1992, interest income foregone on non-accrual loans was $918,000, $797,000, and $713,000, respectively. Restructured loans totaled $6.3 million and $2.0 million at December 31, 1994 and 1993, respectively. For the years ended December 31, 1994, 1993 and 1992, interest income foregone on restructured loans were $18,000, $166,000 and zero, respectively.\nThere were $9.4 million of fixed rate loans at December 31, 1994 with a weighted average yield of 7.1%. Total fixed rate loans, most of which mature in more than five years, comprised approximately 8.8% of the Bank's loan portfolio at December 31, 1994.\nThe Company makes commercial and financial loans secured by real estate, which are principally located in Northern California. At December 31, 1994 loans secured by deeds of trust on property located in these areas represented 65.4% of the Bank's loans. The primary source of repayment of commercial and financial loans is the borrower's or property's debt service capacity while the secondary source of repayment is the underlying real estate collateral.\nAt December 31, 1994, 8.5% of the Bank's loan portfolio was composed of loans secured by properties that were under construction or contract for construction.\nNote 7. Allowance for Loan Losses\nChanges in the Company's allowance for loan losses for the years ended December 31 were as follows:\nNote 8: Other Real Estate Owned\nOther real estate owned (including in-substance foreclosures) at December 31 consist of the following:\nAt December 31, 1994 and 1993, other real estate owned included $4.6 million and $19.1 million, respectively, of in-substance foreclosed loans. For both December 31, 1994 and 1993, other real estate owned was comprised of 18 properties, with the largest single property totaling $3.5 million.\nThe following table summarizes the other real estate owned loss experience of the Bank for the periods shown:\nNote 9: Real Estate Investments\nReal estate investments at December 31 consist of the following:\nAt December 31, 1994 and 1993, real estate investments included two residential development properties, one commercial land available for development, and the general and limited partnership investments in BSFBC. In 1994 and 1993, the Bank had losses of $264,000 and earnings of $263,000, respectively from BSFBC.\nNote 10: Premises and Equipment\nPremises and equipment at December 31 consist of the following:\nThe amount of depreciation and amortization included in non-interest expense was $660,000, $770,000, and $990,000 in 1994, 1993 and 1992, respectively. Total rental expense net of sublease income and other occupancy expenses for the Company premises were $2.1 million in 1994, 1993 and 1992.\nAt December 31, 1994, the approximate future minimum rental payments under non-cancelable operating leases, with remaining terms ranging from six months to twenty-three years, for the Company's premises are as follows:\nLease payments are subject to rent adjustments every five years to reflect changes in the consumer price index with a minimum increase of 20%. During 1994, 1993 and 1992, the Company received $169,000, $59,000 and $30,000 of sublease income, respectively. The total future minimum rent payments to be received under noncancellable operating subleases at December 31, 1994 were approximately $354,000. These payments are not reflected in the above table.\nNote 11: Deposits\nDeposit balances by deposit programs offered by the Bank at December 31 are as follows:\nTotal deposit balances averaged $172.9 million and $264.7 million during 1994 and 1993, respectively, with average interest rates of 2.7% and 2.6%, respectively. The weighted average stated rates on deposits as of December 31, 1994 and 1993 was 2.9% and 3.0%, respectively.\nDomestic time deposits in amounts of $100,000 or more by time remaining to maturity at December 31 are as follows:\nInterest expense on time deposits in amounts of $100,000 or more was $935,000, $2.0 million and $1.8 million in 1994, 1993, and 1992, respectively. Time deposit accounts in amounts of $100,000 or more averaged $24.5 million and $54.7 million during 1994 and 1993, respectively, with weighted average rates of 3.8% and 3.7%, respectively. The weighted average stated interest rate on such deposits at December 31, 1994 and 1993 was 4.4% and 3.3%, respectively.\nBrokered deposits totaled $19.7 million and $20.0 million, and money desk deposits totaled $15.1 million and $41.5 million at December 31, 1994 and 1993, respectively.\nNote 12: Other Borrowings\nOther borrowings at December 31 are as follows:\nThe terms of the borrowings outstanding at December 31, 1994 provide for the repayment of $4.1 million in 1995. The securities pledged under the agreement to resell are held in safe keeping by an unrelated third party.\nThe Bank has an approved FHLB line of credit, of which $5.5 million was available at December 31, 1994, based on the collateral pledged. At December 31, 1994 and 1993, $11.4 million and $6.4 million of loans and securities are pledged as collateral against other borrowings. The Bank is required to hold FHLB stock as a condition for maintaining its line of credit.\nThe Bank's other borrowings included senior liens of other real estate owned. The rates and terms of these borrowings vary. As of December 31, 1994, there was no outstanding balance in real estate owned securing the senior liens.\nNote 13: Income Taxes\nThe provision (benefit) for Federal and state income taxes consists of:\nThe provision for state taxes for 1994, 1993 and 1992 consists of the minimum amount of franchise taxes due.\nIn 1992, during which period the Company accounted for income taxes under the deferred method as described in APB Opinion No. 11, deferred taxes arose from timing differences in the recognition of revenues and expenses for tax and financial reporting purposes. The tax effects of the principal items resulting in deferred tax expense (benefit) were the difference between:\nThe tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 1994 and 1993 are presented below:\nThe Bank provided a valuation allowance for deferred tax assets as the utilization of the net operating loss carryforwards and rehabilitation and minimum tax credit carryforwards may be limited on an annual basis under current tax law due to the change in ownership in 1992 and possible changes in ownership in future years.\nThe total tax provision (benefit) differs from the statutory Federal rates for the reasons shown in the following table:\nAt December 31, 1994 and 1993, there is no deferred income tax receivable.\nThe tax benefits reported in 1992 were attributable to the Company's ability to carryback net operating losses for 1992 against net operating income of prior periods. Because the Company has utilized all of its ability to carryback net operating losses, much of the 1994, 1993, and 1992 losses, and future losses, if any, must be carried forward to offset future net operating income. In addition, the actual benefit rate may be less than the current statutory rate due to tax differentials and the alternative minimum tax. As of December 31, 1994, the Company has net operating loss carryforwards for federal tax purposes of approximately $39.0 million which expire in 2007 and onwards, and for California tax purposes of approximately $24.0 million, which expire in 1997, 1998, and 1999. The Company has rehabilitation tax credits carryforwards for federal tax purposes of approximately $250,000, which expire in 2004 and 2005. In addition, the Company has minimum tax credits of approximately $230,000 which have no expiration.\nNote 14: Shareholders' Equity (See Note 2: Impairment Orders)\nThe capital infusion by the Company's controlling stockholder in 1994, 1993 and 1992 was $20.0 million, $12.0 million and $20.0 million, respectively. The capital for 1994 was raised from the issuance of 3,521,126 shares of Class A common stock at $5.68 per share. The capital for 1993 and 1992 was raised from the issuance of shares of Series C Perpetual Preferred Shares (Series C Preferred Shares) at twenty dollars ($20.00) per share. The Series C Preferred Shares were converted in to Class A Common shares in 1994.\nDescription of Capital Stock\nThe authorized capital stock of the Company consists of 40,000,000 Class A Shares, par value $0.01 per share and 2,500,000 shares of preferred stock, par value $0.01 per share, of which 437,500 are designated as Series B Preferred Shares. The remainder are not designated.\nIn accordance with the Agreement and the Orders, the Company and the Bank are prohibited from paying dividends without the prior written consent or approval of the FDIC, the Superintendent of Banks and the Federal Reserve Bank of San Francisco.\nOn July 25, 1994, the Company issued 3,521,126 shares of Class A Common Stock, and warrants to purchase an additional 3,521,126 shares with an exercise price for each share of $10.00 to its principal shareholder in its closing of a private stock offering for $20.0 million in capital. The price per unit was $5.68. Each unit sold under the private placement includes a Risk Protection Right (RPR). Under the RPR, additional Class A Common Stock will be issued to the holder of each RPR if a net loss is incurred on certain specified assets or as the result of losses, incurred related to certain litigation actions. The RPR will effectuate this risk allocation by compensating the holder with additional shares of Class A Common Stock (Adjustment Shares) up to a maximum number of shares per RPR without the payment of additional consideration. This compensation will be effected through periodic distributions of Adjustment Shares. Adjustment Shares will be issued to compensate for net Losses, net charge-offs and expenses on certain specified assets (Specified Assets) and the lawsuit that was settled for $2.0 million during July 1994 up to a cumulative amount of $16.0 million. The maximum number of Class A Common shares to be issued is 9,723,000. As a result of the losses incurred in 1994, the maximum number of Adjustment Shares would have been issued at December 31, 1994 as a result of the losses incurred in 1994.\nDescription of Class A Common Stock\nAs of December 31, 1994 there were 5,766,008 Class A Shares outstanding out of a total of 40,000,000 shares authorized. During 1994, the Shareholders of Company approved to reclassification of all Class B Common Stock as and into class A Common Stock. The Series B Preferred Shares, which were convertible into shares of the Class B Common Stock at the option of the holders thereof are now convertible to Class A Common Stock. The reclassification is not deemed by the Company to alter or change any of the relative powers, preferences or special rights of the holders of the Class B Preferred Stock.\nDividends\nSubject to the rights and preferences of any preferred stock outstanding, each Class A Share Common Stock is entitled to receive dividends if, as and when declared by the Board of Directors of the Company. Subject to the rights of the Series B Preferred Shares and the Series C Preferred Shares, dividends must be paid on the Class A Shares Common Stock, together with the Series B Preferred Shares and the Series C Preferred Shares, at any time that dividends are paid on either. Any dividend so declared and payable in cash, capital stock of the Company or other property will be paid equally, share for share, on the Class A Common Stock, Series B Preferred Shares, Series C Preferred Shares and on any other participating series of preferred stock issued in the future; provided, however, that the Company may issue dividends consisting solely of its Class A Shares on the Class A Shares of Common Stock.\nLiquidation Rights\nIn the event of the liquidation, dissolution or winding up of the Company, holders of the Class A Common Stock are entitled to share equally, share for share, in the assets available for distribution, subject to the liquidation\npreferences of the Series B Preferred Shares and Series C Preferred Shares and the rights of any other class or series of preferred stock then outstanding.\nDescription of Preferred Stock\nThe Board of Directors of the Company is authorized by the Certificate of Incorporation to provide for the issuance of one or more series of preferred stock. The Board of Directors has the power to fix various terms with respect to each such series, including voting powers, designations, preferences, dividend rates, conversion and exchange provisions, redemption provisions, and the amounts which holders are entitled to receive upon any liquidation, dissolution, or winding up of the Company. To date the Board of Directors has authorized only the issuance of the Series B Preferred Shares and the Series C Preferred Shares. Pursuant to the Amended Stock Purchase Agreement, the Company's Certificate of Incorporation and Bylaws were amended to provide that additional securities, including additional shares of any class of preferred stock, can be issued only if unanimously approved by the Board of Directors or by stockholders holding a majority of the voting power of the Company.\nVoting Rights\nHolders of Class A Common Stock (when and if issued) are entitled to one vote per share. Except as described below, holders of Class A vote together with holders of the Company's Series B Preferred Shares and Series C Preferred Shares, on all matters including the election of directors. The Board of Directors is presently authorized to have 14 members. The Board of Directors is a classified Board with staggered terms providing for a maximum of three classes of directors, which are as nearly equal in number as possible, and with one class elected each year for a maximum term of three years. Holders of Class A Common Stock are not entitled to vote cumulatively for the election of directors.\nThe holders of Class A Common Stock are entitled to vote as separate classes on any modification to the rights of either class of stock and as otherwise required by law. As part of the transactions contemplated by the Amended Stock Purchase Agreement, the stockholders of the Company eliminated multiple voting rights of the Series B Preferred Shares.\nDescription of Series B Preferred Stock\nThe Company issued the Series B Preferred Shares during 1988. As of December 31, 1994, there were 16,291 Series B Preferred Shares outstanding.\nDividends\nHolders of the Series B Preferred Shares are entitled to receive, when funds of the Company are legally available for payment, an annual cash dividend of Fifty-Six Cents ($0.56) per share, payable quarterly in January, April, July and October of each year. Dividends on the Series B Preferred Shares are cumulative.\nPayment of dividends on the Series B Preferred Shares shall be junior to payment of dividends at the stated rate of all other series of preferred stock that the Company may issue in the future and that are designated senior to the Series B Preferred Shares. Dividends on the Series B Preferred Shares will be declared and paid or set apart for payment in full for all previous dividend periods (i) before the payment or setting apart of any funds or assets for the payment of any dividends on the Class A Common Stock or any other class of stock, except preferred stock ranking on a parity with or senior to the Series B Preferred Shares, and (ii) before any purchase or other acquisition for value of any Class A Common Stock or any future class of stock except preferred stock ranking on a parity with or senior to the Series B Preferred Shares; provided, however, that the Company may issue dividends consisting of its Class A Shares on the Class A Shares.\nAfter payment of dividends at the stated rate on all series of preferred stock that the Company may issue in the future and that are designated senior to the Series B Preferred Shares and on any other preferred stock of the Company that is on a parity with the Series B Preferred Shares, and payment of dividends at the stated rate on the Series B Preferred Shares, holders of the Series B Preferred Shares will participate pro rata with the holders of Class A Common Stock and Series C Preferred Shares, on the basis of number of shares owned, in all other dividends by the Company to its stockholders, except that, as noted above, the Company may issue dividends consisting solely of its Class A Shares on the Class A Shares.\nLiquidation Rights\nIn the event of any liquidation, dissolution, receivership, bankruptcy, or winding up of the Company, voluntarily or involuntarily, the holders of the Series B Preferred Shares are entitled to receive the sum of Seven Dollars ($7.00) per share, plus any accrued and unpaid dividends thereon, before any distributions will be made to the holders of the Class A Common Stock or any other class of stock junior in preference upon liquidation, but after or concurrent with distributions to be made at the stated rate on preferred stock of any series ranking on a parity with or senior in preference upon liquidation to the Series B Preferred Shares, and will be entitled to no other distribution.\nConversion\nThe holders of Series B Preferred Shares are entitled at any time to convert their Series B Preferred Shares into Class A Common Stock of the Company at the conversion ratio of one Series B Preferred Share convertible into one-tenth of one share of Class A Common Stock, upon payment of a conversion fee of Seven Dollars ($7.00) per share, subject to adjustment under certain conditions.\nPrior to the reclassification of the Class B Common Stock, the Amended Stock Purchase Agreement required that at least 90% of the Series B Preferred Shares be converted into Class A Shares on a share-for-share basis. Holders of 408,865 Series B Preferred Shares so converted on July 13, 1992, and a total of 420,909 Series B Preferred Shares had been so converted as of December 31, 1992. Three hundred shares converted during 1994. The remaining shares outstanding at December 31, 1994 are 16,291.\nVoting Rights\nThe holders of the Series B Preferred Shares are entitled to one vote per Series B Preferred Share on all matters on which shareholders are entitled to vote. Holders of the Series B Preferred Shares have full voting rights and powers equal to the voting rights and powers of the holders of the Class A Common Stock. Holders of the Series B Preferred Shares are entitled to vote generally for the election of directors and vote with the holders of the Class A Common Stock and Series C Preferred Shares as a single class, except that the holders of the Series B Preferred Shares are entitled to vote as a class on any modification to the rights of the Series B Preferred Shares and otherwise as required by law.\nDescription of Stock Option Plans\nPrior to 1994, the Company had various stock option plans which provided for the issuance of up to 20,000 Class A Common Shares. The stock option plans expired by their terms in January 1992 except that options granted prior to that date remain in effect and exercisable during the term of the options. Generally, options were granted at a price not less than the fair market value of the stock at the date of grant, were exercisable in increments of 40%\nafter two years after the date of the grant and 20% each year thereafter, and expire ten years after the date of the grant.\nOutstanding stock options for the purchase of 50 shares exercisable at $100.00, 1,423 shares exercisable at $80.00 and 600 shares exercisable at $72.50 were outstanding at December 31, 1994.\nDuring 1994, the Company's shareholders approved two new stock option plans; the 1993 Executive Stock Option Plan (\"Executive Plan\") and the 1993 Non-employee Directors Stock Option Plan (\"Director Plan\").\nExecutive Plan\nOptions under the Executive Plan may be granted to key employees and consultants of the Company and its subsidiaries. The Executive Plan will cover a total of 1,100,000 shares of Class A Common Stock. The number of shares granted is subject to adjustment to prevent dilution. The exercise price of options must be at least the fair market value of the shares of the Company's Class A Common Stock as of the date the option is granted. As of December 31, 1994, shares granted under the Executive Plan total 188,022 with an average exercise price of $10.00. None of the options have been exercised.\nThe executive employment agreement for certain officers provide that certain officers shall be granted options to acquire shares of Class A Common Stock under the Executive Plan equal to 8% of the fully-diluted shares of the Company's Class A Common Stock, with additional shares to be issued in the future to maintain the 8% ratio. The effective dates of the initial grant of options for certain officers are September 30, 1993 and October 1, 1994. Based on the current capitalization of the Company, certain officers received options to purchase 501,392 shares of the Company, as of December 31, 1994.\nDirector Plan\nOptions under the Directors' Plan may be granted to non-executive directors of the Company and its subsidiaries. The Directors' Plan will cover a total of 50,000 shares of Class A Common Stock. The number of shares granted is subject to adjustment to prevent dilution. The exercise price of options must be at least the fair market value of the shares of the Company's Class A Common Stock as of the date the option is granted. As of April 1, 1994, shares granted under the Directors' Plan total 12,500 with an average exercise price of $30.00. Each non-employee director serving on each subsequent April 1 shall automatically be granted additional options to acquire up to 1,250 shares of Class A Common Stock. None of the options have been exercised.\nNote 15: Regulation\nIn accordance with FIRREA, the FRB and the FDIC established capital regulations requiring the Company and Bank to maintain minimum: (i) tier 1 capital equal to 4% of total assets, as defined; (ii) tier 1 capital equal to 4% of risk-weighted assets; and (iii) total capital, as defined, equal to 8% of risk-weighted assets, as defined.\nThe following table sets forth the Company's and the Bank's capital ratios compared to minimum capital requirements as of December 31, 1994 and the requirements contained in the Orders:\nThe FDICIA requires each federal banking agency to implement prompt corrective actions for institutions that it regulates. In response to this requirement, the FDIC adopted final rules, effective for December 19, 1992, based upon FDICIA's five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under FDICIA, the FDIC is required to take supervisory action against financial institutions that are not deemed either well capitalized or adequately capitalized. The rules generally provide that a bank is adequately capitalized if its total risk-based capital ratio is 8% or greater, its Tier 1 capital to risk based assets is 4% or greater, its leverage ratio is 4% or greater, and the financial institution is not subject to a capital directive. See \"Note 3. Subsequent Event -- Capital Contribution\".\nThe Bank's failure to meet minimum regulatory requirements as of December 31, 1994, resulted in the imposition of operating restrictions pursuant to the prompt corrective action provisions of FDIC Improvement Act (FDICIA). See Note 2: Regulatory Orders and Going Concern Considerations.\nNote 16: Employee Benefit Plans\nEmployee Stock Ownership Plan\nThe Company has established an Employee Stock Ownership Plan (\"ESOP\") for the benefit of its employees. During 1985, the ESOP borrowed $500,000 from a third party financial institution at a floating rate based upon 90% of the institution's current prime rate. Repayment of the principal occurred in seven annual installments of $71,000 through June 30, 1992 and was completed as scheduled. The proceeds from this borrowing, which was not guaranteed by the Company, were used to purchase 5,208 Class A Shares at a price of $160.00 per share. During 1988, the ESOP established a loan for $650,000 from a third party financial institution at a floating rate based upon 95% of the current prime rate. At December 31, 1988, the ESOP had drawn $325,000 from this loan. Repayment of the principal is scheduled in quarterly payments of $23,000 through March 31, 1995. Payment on this loan started in the fourth quarter of 1988. The proceeds from the borrowing were used to purchase 1,429 shares of the Company's Series B Preferred Shares at a price of $140.00 per share, and to purchase the Company's Class A Shares throughout 1988. The stock purchased is pledged as collateral for the loan. During 1989, the ESOP drew the remaining $325,000 from this loan. The proceeds from the borrowing were used to purchase 2,500 shares of the Company's Class A Shares at a price of $100.00 per share. During 1994 and 1993, the ESOP did not purchase any shares of the Company's stock.\nThe Company has determined that its contribution to the ESOP will be sufficient to cover the yearly debt service on the ESOP's borrowings. At December 31, 1994, the Company had provided a total of approximately $1.9 million in contributions to the ESOP since its inception in 1985. During 1994, 1993 and 1992, the Company contributed $130,000, $120,000, and $240,000, respectively, to the ESOP.\nEmployee Stock Purchase Plan\nThe Company's Board of Directors adopted an Employee Stock Purchase Plan (\"ESPP\") for the benefit of substantially all employees in March 1990, which was approved by the Company's stockholders in July 1990.\nA total of 1,250 shares of the Company's Class A Shares have been made available for purchase under the Plan, and a total of 1,250 shares of Class A Shares have been made available for matching awards under the Plan. The purchase price of the shares available under the Plan is the lesser of (i) 85% of the fair market value of such\nshares on the first day of the purchase period, or (ii) 85% of the fair market value of such shares on the last day of such purchase period.\nAt December 31, 1994, the Company had outstanding 364 Class A Shares under the ESPP, approximately 2.0% of which represented matching shares. At December 31, 1993, the Company had outstanding 429 Class A Shares under the ESPP. The Company's Board of Directors suspended this Plan as of December 31, 1991.\nEmployee 401K Plan\nThe Company provides a 401k plan for its employees. The Company provides matching contributions up to 2% of the employees qualifying earnings. During 1994, 1993, and 1992, the Company included $42,000, $81,000 and $90,000, respectively in non-interest expense in order to recognize contributions to the 401k Plan.\nNote 17: Commitments and Contingencies\nLending and Letter of Credit Commitments\nIn the normal course of its business, the Bank has entered into various commitments to extend credit which are not reflected in the consolidated financial statements. Over 90% of such commitments consist of the undisbursed balance on personal and commercial lines of credit and of undisbursed funds on construction and development loans. At December 31, 1994 and 1993, the Bank had outstanding loan commitments, which are primarily adjustable rates, totaling approximately $16.3 million and $29.6 million, respectively. In addition, the Bank had outstanding letters of credit, which represent guarantees of obligations of Bank customers, totaling $10.4 million and $12.1 million at December 31, 1994 and 1993, respectively. The actual liquidity needs or the credit risk that the Company will experience will be lower than the contractual amount of commitments to extend credit because a significant portion of these commitments is expected to expire without being drawn upon. The Bank's outstanding loan commitments are made using the same underwriting standards as comparable outstanding loans. The credit risk associated with these commitments is considered in management's determination of the allowance for loan losses.\nLitigation\nBecause of the nature of its business, the Company and its subsidiaries, including the Bank, are from time-to-time, a party to legal actions. At December 31, 1994, the Company and\/or the Bank are defendants in certain lawsuits for which the damages sought are substantial as described below.\nPresently, the Bank is involved in several lawsuits. In the first lawsuit, BSFRI is named as a defendant and has been served with a cross-complaint for indemnity in a deficiency judgement with respect to a first deed of trust on a property owned by a limited partnership. The plaintiff under the cross complaint is seeking damages in the amount of $5.0 million, and unspecified punitive damages. BSFRI was once a limited partner in the partnership but became a secured lender of the partnership under a second deed of trust, at which time BSFRI was given a release for any liability. The Bank believes it has meritorious defenses to the cross-claim and will contest any allocation of liability to it if defendants are found liable for any deficiency.\nIn the second lawsuit, the Bank has been named a defendant in an action brought in Florida by the institutional purchaser of a block of loans from the Bank, alleging failure of the Bank to properly perform a credit check for one of the loans. The plaintiff is seeking approximately $155,000 it allegedly lost when the loan defaulted. The Bank is defending the matter vigorously and believes it has meritorious defenses. In addition, the Bank has been threatened with arbitration proceedings by another institutional purchaser in connection with a $750,000 principal amount loan purchased from the Bank on the sale of its former Sacramento branch. The institutional purchaser contends that the Bank breached the sale agreement by failing to notify the purchaser of the downgrading of the loan and the release of certain collateral. The Bank denies that it has breached the sale agreement.\nThe Bank is currently involved in two lawsuits which were brought by former employees of the Bank; one former employee has alleged discrimination and wrongful termination. The other former employee alleges wrongful termination. The former employees have sought unspecified damages.\nThe Bank has denied these allegations and is vigorously defending these proceedings. The disposition of these proceedings could have a material adverse effect on the Company's financial position or results of operation, however, management cannot predict the specific outcome of these actions. Accordingly, the accompanying financial statements do not include any adjustments that might result from the outcome of the uncertainties.\nThe Bank has reached settlement or potential settlement in numerous other litigation or potential litigation matters. In some instances the Bank has agreed to make certain payments. As a result of the settlement or potential settlement of certain lawsuits, the Company established a litigation reserve of $536,500 as of December 31, 1994.\nThe Company and the Bank intend to pursue their rights under an indemnification agreement with Mr. Donald R. Stephens, a former Chairman of the Board and Chief Executive Officer of the Company who resigned in 1993, pursuant to which Mr. Stephens is required to provide indemnification in respect of certain expenses related to actions brought by a former employee.\nThe jury ruled in favor of the Bank on another lawsuit where the plaintiffs were seeking compensatory damages in an amount of $6.0 million, and unspecified punitive damages. The plaintiffs were claiming breach of an alleged joint venture agreement, and of other duties owed to the plaintiffs, arising from the Bank's foreclosure on a series of loans made to the plaintiffs by the Bank in connection with the development of an 800 acre parcel of land.\nOther Contingencies\nDuring 1993, the Bank transferred a loan with a carrying value of $1.6 million collateralized by commercial real estate to in-substance foreclosure. The collateral securing this loan requires seismic upgrading and may be located on property containing hazardous materials. During 1994, the asset was charged off.\nNote 18: Related Party Transactions\nIn the ordinary course of business, the Bank makes loans to directors, officers, shareholders and their associates on substantially the same terms, including interest rates and collateral, as in comparable loan transactions with unaffiliated persons, and such loans do not involve more than the normal risk of collection. The following table sets forth the activity related to loans to directors, officers and principal shareholders and their associates for the year ended December 31, 1994:\nThe Company accounts for its investment in BSFBC, a California limited partnership, using the equity method. Condensed statements of financial condition and operations of BSFBC at December 31 are as follows:\nCONDENSED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)\nCONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)\nThe Bank's and BSFRI's equity in the operating results of BSFBC in 1994, 1993 and 1992 was approximately a loss of $264,000, and earnings of $263,000, $202,000, respectively. Such income is included in the Bank's other income in the Company's Consolidated Financial Statements.\nNote 19: Fair Value of Financial Instruments\nThe following disclosures of the estimated fair value of financial instruments are made in accordance with the requirements of Statement of Financial Accounting Standards No. 107 \"Disclosures about Fair Value of Financial Instruments\" (SFAS No. 107). The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgement is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount 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.\nThe carrying amount and estimated fair values of the Company's financial instruments at December 31 are as follows:\nThe following methods and assumptions were used to estimate the fair value of each major classification of financial instruments at December 31, 1994 and 1993:\nCASH AND CASH EQUIVALENTS: Current carrying amounts approximate estimated fair value.\nTIME DEPOSITS WITH OTHER FINANCIAL INSTITUTIONS: Due to the short term nature of time deposits with other financial institutions (original maturities of 90 days or less), current carrying amounts approximate market.\nINVESTMENT SECURITIES HELD-TO-MATURITY AND AVAILABLE-FOR-SALE: For securities held-to-maturity and available-for-sale, current market prices were used to determine fair value.\nLOANS RECEIVABLE: The carrying amount of loans is net of unearned fee income and the reserve for possible losses. To estimate fair value of the Company's loans, primarily adjustable rate, commercial and real estate secured loans, each loan collateral type is segmented into categories based on fixed or adjustable interest rate terms, maturity, estimated credit risk, and accrual status. The fair value of loans is calculated by discounting cash flows expected to be received through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Bank's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending factors.\nDEPOSIT LIABILITIES: The fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings and NOW accounts, and money market and checking accounts, is equal to the amount payable on demand as of December 31, 1994. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.\nBORROWED FUNDS: Due to the terms of these borrowings, current carrying amounts approximate estimated fair value. A total of $4.0 million matures in January 1995.\nOFF BALANCE SHEET INSTRUMENTS: The estimated fair value of off balance sheet instruments, principally letters of credit and loan commitments, is approximately the face value of commitment fees collected.\nNote 20: The San Francisco Company\nCondensed statements of financial condition and operations of The San Francisco Company at December 31 are as follows:\nCONDENSED STATEMENTS OF FINANCIAL CONDITION\nCONDENSED STATEMENTS OF OPERATIONS\nCONDENSED STATEMENTS OF CASH FLOWS\nNote 21: Quarterly Information (Unaudited)\nThe following table sets forth the condensed operating results of the Company for each quarter of the two year periods ending December 31, 1994, and is qualified in its entirety by the more detailed information and financial statements contained elsewhere in 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 information required by this Item will be furnished in the Company's definitive Proxy Statement and is incorporated herein by reference.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe information required by this Item will be furnished in the Company's definitive 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 will be furnished in the Company's definitive Proxy Statement and is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item will be furnished in the Company's definitive Proxy Statement and is incorporated herein by reference.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. List of documents filed as a part of the report.\nThe following financial statements are included in Item 8 of this report:\nReport of Independent Public Accountants;\nConsolidated Balance Sheets at December 31, 1994 and 1993;\nConsolidated 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 Flow for the years ended December 31, 1994, 1993 and 1992;\nNotes to Consolidated Financial Statements.\n2. 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 the Consolidated Financial Statements or the notes thereto.\n3. List of Exhibits (numbered in accordance with Item 601 of Regulation S-K):\nExhibit 3.1 Certificate of Incorporation of Bank of San Francisco (Delaware) Holding Company, dated June 23, 1988 (1)\nExhibit 3.2 Agreement and Plan of Merger of Bank of San Francisco (Delaware) Holding Company, a Delaware corporation and Bank of San Francisco Company Holding Company, a California Corporation, dated June 24, 1988 (1)\nExhibit 3.3 Certificate of Amendment of the Certificate of Incorporation of Bank of San Francisco Company Holding Company, dated May 22, 1989 (1)\nExhibit 3.4 Certificate of Amendment of the Certificate of Incorporation of Bank of San Francisco Company Holding Company, dated September 21, 1989 (1)\nExhibit 3.5 Bylaws of Bank of San Francisco (Delaware) Holding Company, dated June 23, 1988 (1)\nExhibit 3.6 First Amendment to Bylaws of Bank of San Francisco Company Holding Company, dated July 19, 1989 (1)\nExhibit 3.7 Second Amendment to Bylaws of Bank of San Francisco Company Holding Company, dated June 6, 1990 (1)\nExhibit 3.8 Certificate of Amendment of the Certificate of Incorporation of Bank of San Francisco Company Holding Company, dated May 23, 1994 (10)\nExhibit 3.9 Amended and Restated Certificate of Incorporation of The San Francisco Company, dated May 23, 1994 (10)\nExhibit 4.1 Certificate of Designations of Rights, Preferences, Privileges and Restrictions of 8% Series B Convertible Preferred Stock of Bank of San Francisco Company Holding Company, dated July 28, 1988 (1)\nExhibit 4.2 Amended Certificate of Designations of Rights, Preferences, Privileges and Restrictions of 7% Series B Convertible Preferred Stock of Bank of San Francisco Company Holding Company, dated October 7, 1988 (1)\nExhibit 4.3 Certificate of Correction of Certificate of Incorporation, dated June 18, 1990 (1)\nExhibit 10.1 Sales agreement dated October 23, 1986 between Bank of San Francisco Realty Investors (BSFRI) and Bank of America with respect to the lease on 550 Montgomery Street, San Francisco, California (2)\nExhibit 10.2 Lease dated November 1, 1960 between The Lurie Company and Bank of America, with respect to premises at 550 Montgomery Street (2)\nExhibit 10.3 Consent to Assignment of Lease, dated October 8, 1986, between The Lurie Company and Bank of San Francisco and Bank of San Francisco Realty Investors, with respect to premises at 550 Montgomery Street (2)\nExhibit 10.4 Assignment of Lease, dated October 17, 1986, by Bank of America to Bank of San Francisco and Bank of San Francisco Realty Investors, with respect to premises at 550 Montgomery Street (2)\nExhibit 10.5 Nominee Agreement between Bank of San Francisco Realty Investors and 550 Partners, with respect to premises at 550 Montgomery Street (2)\nExhibit 10.6 Partnership Agreement, dated October 23, 1986, by and among Bank of San Francisco, Bank of San Francisco Realty Investors, and D.R. Stephens Separate Property Trust, with respect to 550 Montgomery Street (2)\nExhibit 10.7 Lease dated May 1, 1987, between Bank of San Francisco Building Company and Bank of San Francisco with respect to premises at 550 Montgomery Street, San Francisco, California (Bank Space and Office Space Leases) (3)\nExhibit 10.8 Bank of San Francisco Company Holding Company Employee Stock Ownership Plan, restated and amended as of January 1, 1989 (1)\nExhibit 10.9 Agreement dated January 17, 1990 between Bank of San Francisco and Rogers, Casey & Associates, Inc. with respect to investment consulting services (1)\nExhibit 10.10 Employee Stock Purchase Plan (4)\nExhibit 10.11 Letter Agreement with the Board of Governors of the Federal Reserve Board, dated April 21, 1989 (1)\nExhibit 10.12 Escrow Agreement dated December 31, 1990 between Bank of San Francisco Company Holding Company and Bank of San Francisco with respect to the Employee Stock Purchase Plan (5)\nExhibit 10.13 Bank of San Francisco Company Holding Company 401(k) Profit Sharing Plan (5)\nExhibit 10.14 Amended and Restated Indemnification Agreements dated October 29, 1991 between Bank of San Francisco Company Holding Company and each director and executive officer of the Company (7)\nExhibit 10.15 Indemnification Agreement dated November 25, 1991 between Bank of San Francisco and each director and executive officer of the Bank (8)\nExhibit 10.16 Stock Purchase Agreement dated as of April 10, 1992 between Bank of San Francisco Company Holding and Peninsula Holdings (9)\nExhibit 10.17 First amendment to Stock Purchase Agreement dated May 14, 1992 between Bank of San Francisco Company Holding Company and Putra Masagung (9)\nExhibit 10.18 Second amendment to Stock Purchase Agreement dated June 18, 1992 between Bank of San Francisco Company Holding Company and Putra Masagung (9)\nExhibit 10.19 Agreement Respecting Assignment, Assumption, Consent and Amendments dated as of May 8, 1992 among Bank of San Francisco Company Holding Company, Peninsula Holdings and Putra Masagung (10)\nExhibit 10.20 Subscription Agreement dated as of October 29, 1992 between Bank of San Francisco Holding Company and Putra Masagung (10)\nExhibit 10.21 First Amendment of Bank Space and Office Space lease, dated July 8, 1992 between Bank of San Francisco and Bank of San Francisco Building Company, with respect to premises at 550 Montgomery Street, San Francisco, California (10)\nExhibit 10.22 Employment Agreements dated October 1, 1994 between Mr. Gilleran and The San Francisco Company and the Bank of San Francisco. *\nExhibit 10.23 The San Francisco Company 1993 Executive Stock Option Plan (11)\nExhibit 10.24 The San Francisco Company 1993 Non-Employee Directors Stock Option Plan (11)\nExhibit 21 Subsidiaries of registrant (6)\nExhibit 27 Financial Data Schedule *\n--------------------------- Footnotes to List of Exhibits:\n* Indicates filed herewith.\n(1) Incorporated by reference from the exhibits included with the Registrant's Form S-2 Registration Statement (Registration No. 33-34985), previously filed with the Commission.\n(2) Incorporated by reference from exhibits included in the Company's Annual Report on Form 10-K for the year ended December 31, 1986, previously filed with the Commission.\n(3) Incorporated by reference from exhibits included with the Company's Annual Report on Form 10-K for the year ended December 31, 1987, previously filed with the Commission.\n(4) Incorporated by reference from exhibits included with the Company's Form S-8 Registration Statement (Registration No. 33-35649), previously filed with the Commission.\n(5) Incorporated by reference from exhibits included with the Company's Annual Report on Form 10-K for the year ended December 31, 1990, previously filed with the Commission.\n(6) Incorporated by reference from exhibits included with the Company's Annual report on Form 10-K for the year ended December 31, 1990, previously filed with the Commission.\n(7) Identical agreements have been signed by each executive officer and director of the Company.\n(8) Identical agreements have been signed by each executive officer and director of the Bank.\n(9) Incorporated by reference from exhibits included with the Company's Proxy Statement for the Special Meeting of Stockholders' held on June 25, 1992, previously filed with the Commission.\n(10) Incorporated by reference from exhibits included with the Company's Annual report on Form 10-K for the year ended December 31, 1992, previously filed with the Commission.\n(11) Incorporated by reference from exhibits included with the Company's Proxy Statement for the Special Meeting of Stockholders' held on May 23, 1994, previously filed with the Commission.\n(b) Reports on Form 8-K filed in the fourth quarter of 1994:\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.\nTHE SAN FRANCISCO COMPANY\nBy: \/s\/ James E. Gilleran ---------------------------- James E. Gilleran Chairman of the Board and Chief Executive Officer\nDate: April 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 in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/ James E. Gilleran Chairman of the Board and April 20, 1995 - - ------------------------- -------------- James E. Gilleran Chief Executive Officer (Principal Executive Officer)\n\/s\/ Steven R. Champion Director April 20, 1995 - - ------------------------- -------------- Steven R. Champion\n\/s\/ Donna Miller Casey Director April 20, 1995 - - ------------------------- -------------- Donna Miller Casey\n\/s\/ David R. Holbrooke Director April 20, 1995 - - ------------------------- -------------- David R. Holbrooke, M.D.\n\/s\/ Willard D. Sharpe Director April 20, 1995 - - ------------------------- -------------- Willard D. Sharpe\n\/s\/ Gordon B. Swanson Director April 20, 1995 - - ------------------------- -------------- Gordon B. Swanson\n\/s\/ Kent D. Price Director April 20, 1995 - - ------------------------- -------------- Kent D. Price\n\/s\/ Nicholas Unkovic Director April 20, 1995 - - ------------------------- -------------- Nicholas Unkovic\nEXHIBIT INDEX\nExhibit 10.22 Employment Agreement dated October 1, 1994 between Mr. Gilleran and The San Francisco Company and the Bank of San Francisco.\nExhibit 27 Financial Data Schedule.","section_15":""}
{"filename":"833088_1994.txt","cik":"833088","year":"1994","section_1":"Item 1. Business.\nIntroduction\nGeneral\nTIS Mortgage Investment Company, a Maryland corporation (the \"Company\" or the \"Registrant\" which, unless otherwise indicated refers to the Company and its subsidiary, TIS Mortgage Acceptance Corporation, a Delaware corporation (\"TISMAC\")), was incorporated on May 11, 1988. The Company seeks to generate income for distribution to its stockholders primarily through acquisition of Structured Securities (as hereinafter defined) and direct fee ownership of real estate. The Company may also acquire Mortgage Loans (as hereinafter defined). \"Structured Securities\" include (i) residual interests (\"Residual Interests\"), principal only bonds (\"PO Bonds\") and interest only bonds (\"IO Bonds\") in collateralized mortgage obligations (\"CMOs\"), which entitle the Company to certain cash flows from collateral pledged to secure such securities; (ii) \"Mortgage Certificates,\" which include securities collateralized by or representing equity interests in mortgage loans secured by first liens on single family residences, multiple family residences or commercial real estate (\"Mortgage Loans\"): (iii) CMOs; and (iv) \"Commercial Securitizations,\" which include debt obligations which are issued in multiple classes and are funded as to the payment of interest and principal by a specific group of Mortgage Loans on multiple family or commercial real estate, accounts and other collateral. As used herein, the term \"Mortgage Assets\" includes Structured Securities and Mortgage Loans, and the term \"Mortgage Instruments\" includes Mortgage Certificates and Mortgage Loans.\nThe Company may experience losses on Residual Interests during periods of high prepayment rates on mortgages, which occurred in 1992 and 1993. Although Commercial Securitizations reduce the Company's exposure to risk of loss from high prepayment rates on Residual Interests, they are susceptible to the risk of loss on foreclosures. Monthly cash flows on the Company's assets are comprised of both interest income and a partial return of principal.\nThe Company's investment policy is controlled by its Board of Directors (the \"Board of Directors\"). The By-Laws of the Company require that a majority of the members of the Board of Directors must be persons who (i) are not \"Affiliates\" of TIS Financial Services, Inc., a Delaware corporation, (the \"Manager\"), as that term is defined in the By-Laws, or Affiliates of persons who are Affiliates of the Manager and (ii) are not employed by, or receiving any compensation (except for serving as a director) from, the Company (\"Unaffiliated Directors\").\nThe Company has entered into an agreement (the \"Management Agreement\") with the Manager to manage the Company's day-to-day operations, subject to the supervision of the Board of Directors. The Manager will continue to attempt to obtain for the Company mortgage loans and other real estate- related investments meeting the investment criteria and policies set by the Board of Directors, advise the Company with respect to various aspects of its business and administer the Company's day-to-day operations, including cash flow management. For additional information concerning the management of the Company, see \"Management of Operations - The Management Agreement\" below.\nThe Company intends, for all taxable years since inception, to qualify for the tax treatment accorded to real estate investment trusts (\"REITs\") under the Internal Revenue Code of 1986, as amended, (the \"Code\") and to make quarterly distributions to its stockholders which, in the aggregate, annually will equal at least 95% of its real estate investment trust taxable income (as defined in Section 857(b)(2) of the Code) (hereafter \"REIT Taxable Income\"). As a result, the Company expects that, with limited exceptions, its REIT Taxable Income distributed to its stockholders will not be subject to Federal income tax at the corporate level. See \"Federal Income Tax Considerations\" below.\nSee Item 7 below, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for additional information on the general development of the Company's business. See \"Risk Factors\" below for a discussion of certain risks to which holders of the Company's Common Stock may be subject.\nThe Company normally borrows funds to purchase and carry assets expecting that the cost of such borrowings will be less than the net cash flow on the assets purchased with such funds.\nThe Company, on the one hand, and the Manager and its affiliates, on the other hand, may enter into a number of relationships other than those governed by the Management Agreement, some of which may give rise to conflicts of interest between the Manager and its affiliates and the Company.\nBecause taxable income may exceed cash flow from certain mortgage- related assets in the early years after such an asset is created, the Company may realize taxable income in excess of its net cash flow in a taxable year. Since the Company must distribute substantially all of its net taxable income annually in order to maintain its status as a REIT, the Company might, in such circumstances, have to borrow funds to enable it to make such distributions. In evaluating Mortgage Assets for purchase, the Company considers the effect of any excess of taxable income over projected cash receipts of net cash flows. For the fiscal year ended December 31, 1994, the Company's taxable income did not exceed the cash flows from Mortgage Assets.\nPrimary Business Activity\nThe Company has, in prior years, primarily invested in the Residual Interests of single-family CMOs, which are a series of fixed rate or variable rate bonds with a wide range of maturities. CMOs are typically issued in series, which generally consist of serially maturing classes ratably secured by a single pool of Mortgage Instruments. Generally, principal payments received on the Mortgage Instruments securing a series of CMOs, including prepayments on such Mortgage Instruments, are applied to principal payments on one or more classes of the CMOs of such series on each principal payment date for such CMOs. Scheduled payments of principal and interest on the Mortgage Instruments and other collateral securing a series of CMOs are intended to be sufficient to make timely payments of interest on such CMOs and to retire each class of such CMO by its stated maturity. The Company may also purchase Residual Interests in real estate mortgage investment conduits (\"REMICs\").\nThe Company has determined to make a substantial portion of its future investments in multifamily residential properties. On December 29, 1994 the Company entered into a definitive agreement to acquire four multifamily housing properties in California's Central Valley. These properties consist of 539 units together with 9.75 acres of unimproved land slated for development of an additional 126 units. The properties will be purchased in a series of closings occurring between mid-January and mid-September 1995. The aggregate purchase price for the properties will be $29,275,000, including existing debt to be assumed by the Company.\nThe Company has also determined that certain future investments would also be made in Commercial Securitizations. Commercial Securitizations are multi-class issuances of debt securities which are funded as to the payment of interest and principal by a specific group of mortgage loans on multifamily residences or other commercial property. Generally, a Commercial Securitization will consist of some senior debt securities rated investment grade, \"AAA\", \"AA\" and \"A\" and other lower-rated \"BBB\" and \"BB\" bonds, and unrated bonds. Generally the credit quality of any bond relates to the subordination level of the bond or its priority to receive principal and interest from the mortgage collateral. A First Loss security is the most subordinated class of a multi-class issuance of debt securities and is the first to bear the risk of default on the underlying collateral. To the extent that the Commercial Securitization is a REMIC, there will be a residual interest investment involved. Since many of the Commercial Securitizations are backed by mortgage loans which have prepayment penalty or lock-out provisions, the risk of loss from prepayments may be significantly less than securitizations backed by single-family loans. On the other hand, since there are generally fewer loans involved in the securitization and since the loans usually do not have any guarantee of payment of principal, the risk of loss on foreclosure is much greater. Therefore, the credit quality of the underlying loans is a primary consideration in the risk and reward evaluation of the asset.\nThe Company also invests in PO Bonds and some of the IO Bonds of single-family CMOs. Single-family CMOs are collateralized by residential mortgages, most often in the form of mortgage-backed securities or certificates, and the bond interest and principal payments, as well as administrative costs, are covered by the interest and principal payments of the underlying mortgages. The mortgage collateral underlying the single- family CMOs in the Company's portfolio of Residual Interests, PO Bonds and some of the IO Bonds are mortgage-backed certificates issued by the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). Some of the IO Bonds are backed by single-family loans which are not included in mortgage-backed certificates issued by these agencies.\nIn most CMOs, there are excess cash flows after bond payments and administrative expenses. The excess cash flows, called residuals, arise primarily from the difference between the interest received from the mortgage obligations and the interest paid on the bonds. These CMO residuals have been the primary focus of the Company. However, beginning in the last quarter of 1991, the Company began to invest in other parts of the CMO such as PO Bonds, IO Bonds and inverse IO Bonds.\nMonthly cash flows on the Company's Mortgage Assets have two components: income from the investment and a partial return of investment principal. The investment income forms the basis for payment of expenses and dividends paid to shareholders, and the return of principal portion is reinvested in other mortgage-related assets. In most cases cash flows and income tend to be higher in early periods of ownership and lower in the later periods. It will be necessary for the Company to utilize the principal which is repaid to reduce debt or to acquire new assets. The rate of return on such new assets may be lower than the rate of return on the repaid assets.\nResidual Interests. Because of almost infinite differences in composition and structure, each individual CMO, and thus Residual Interest, is unique. Nonetheless, there are generally two very broad categories of CMO residuals. \"Bullish\" residuals are associated with CMOs partially composed of variable rate bonds. The yields on bullish residuals tend to increase when short-term interest rates decline, and decrease when short- term rates rise. Although the mortgage collateral on bullish residuals provides a fixed interest rate, the interest payable on the variable bonds declines as short-term rates decline, thus increasing the amount of cash flow to the residual. Correspondingly, higher short-term interest rates will make variable rate bonds more expensive and thus the spread will narrow.\nResidual Interests with only fixed rate CMO bonds, on the other hand, fall into a category called \"Bearish\" residuals. The yields on bearish residuals tend to increase when long-term interest rates rise, and decrease when long-term rates decline. The interest spread on bearish residuals is not impacted by changes in interest rates. However, in an environment of rising interest rates, the pace of mortgage prepayments slows and the positive spread remains in effect for a longer period of time. Falling interest rates provide consumers with incentives to refinance, prepaying the original mortgage and, overall, this tends to reduce the amount of time the positive spread is outstanding.\nCMO cash flows, and therefore residual income and value, are significantly affected by changes in short-term interest rates and mortgage prepayment rates. The Company diversifies its portfolio by investing in both Residual Interests of CMOs having fixed rate and variable rate bond classes. This balance helps to provide total portfolio yield protection whether interest rates rise or fall. The Company has selected bullish residuals which use indices with different sensitivities to interest rate changes.\nPO Bonds. A PO Bond is a bond which passes through only the principal portion of a mortgage-backed security. All such bonds are created by stripping the coupon interest from the underlying mortgages to create the PO Bond and an associated IO Bond. PO Bonds can represent the principal from an entire pool of mortgages, or they can be tranches within a CMO. PO Bonds are sold at a deep discount to face value. They pay no periodic coupon interest. Principal is returned in the form of scheduled amortization and prepayments. Ultimately, the entire face amount of a PO Bond is repaid to the investor.\nBecause there is no coupon, the financial performance of a PO Bond is extremely sensitive to mortgage prepayment rates. Higher prepayments lead to a more rapid return of principal and a higher yield. Because faster prepayments are usually associated with lower market interest rates, the price of a PO Bond is further enhanced by the lower discount rate. Conversely, lower prepayments lead to a slower return of principal and a lower yield. However, since PO Bonds are sold at a discount to their face value, and the total face value is ultimately received, the total yield on a PO Bond cannot drop below zero if it is held to maturity.\nIO Bonds. IO Bonds pass through a specified interest portion of a mortgage-backed security. The interest due on an IO Bond is calculated by multiplying this interest rate times the outstanding balance of the underlying mortgage pools. As the balances of the underlying mortgages decline to zero, payments on the IO Bond also decline to zero. Usually the interest rate applied to the underlying mortgages is fixed. If the interest rate is variable, it is called a Floating Rate IO Bond. If the variable rate of interest is inversely related to an index, it is called an Inverse IO Bond. A regular IO Bond is similar to a Bearish Residual Interest, in general its yield will increase as interest rates increase and decrease an interest rates decline. An Inverse IO Bond is similar to a Bullish Residual Interest. In general, its yield will decrease as interest rates increase and increase as interest rates decline. If prepayments increase significantly over the level at which the IO Bond was purchased, it is possible to receive less cash flow over the life of the asset than was initially invested.\nRisk Factors\nOwnership of the Company's Common Stock is subject to certain risks. The Company's earnings from its acquisitions of multifamily residential properties will depend upon maintaining rental income that exceeds the Company's interest and other costs. Rental income, in turn, will depend upon the rental market, rates of occupancy and defaults by tenants. Long- term profits will depend upon an appreciation in the value of the properties. Profits from Commercial Securitizations will depend upon proven credit evaluation of underlying loans as well as factors which affect real estate in general including, but not limited to, interest rates at the time the underlying properties are refinanced. The ability of the Company to generate income from the cash flows relating to Structured Securities, or to minimize losses, will depend, in large part, upon the ability of the Company to acquire suitable Structured Securities, respond to fluctuations in market interest rates, and utilize appropriate strategies.\nThe amount of income that may be generated from Structured Securities is dependent upon the rate of principal prepayments on the underlying mortgages. Lower rates of prepayments means a longer life for Residual Interests and IO Bonds and thus higher income. Similarly, faster rates of prepayments mean a shorter life and lower income. The rate of prepayments on mortgages is influenced by a variety of economic, geographic, social and other factors, but probably the most important factor is the level of prevailing mortgage rates. In general, prepayments of mortgage loans are faster during periods of substantially declining interest rates and slower during periods of substantially increasing interest rates.\nThe income from Residual Interests in CMOs which include one or more bond classes which bear interest based on specified margins in relation to either the London Interbank Offered Rate for Eurodollars on U.S. dollar deposits (\"LIBOR\") or on the Eleventh District Cost of Funds Index (\"COFI\"), and income on Inverse IO Bonds which bear an interest rate which is inversely related to LIBOR, may fluctuate widely depending upon changes in the LIBOR or COFI rates, which affect the amount of interest payable on such LIBOR or COFI bonds and on Inverse IO Bonds. In general, income on these Residual Interests and Inverse IO Bonds will decrease when LIBOR or COFI rates increase, and will increase when LIBOR or COFI rates decrease. Income on these Residual Interests and Inverse IO Bonds will also be affected by the relationship between changes in these rates and prepayments on mortgages. Under certain extended high interest rate periods or in the event of extremely high prepayment rates on mortgages, the return on a Residual Interest, on an IO Bond or on an Inverse IO Bond could be zero or negative and may require the Company to effect significant reductions in the carrying value of these assets. Such reductions are recorded as operating losses in the year in which the reduction is taken.\nThe Company only purchases Residual Interests, IO Bonds and PO Bonds of CMOs if the Structured Securities relating to such CMOs are rated in one of the two highest categories by a nationally recognized rating agency. Certain Residual Interests, IO and PO Bonds themselves are rated. The risks of ownership of such assets, however, will be substantially the same as those associated with ownership of unrated Residual Interests, IO and PO Bonds because the rating would not address the possibility that the Company might have a lower than anticipated yield or, in the case of Residual Interests and IO Bonds, fail to recover its initial investment.\nA substantial portion of the Company's assets directly or indirectly consists of Mortgage Instruments pledged to secure debt securities and, accordingly, would not be available to stockholders in the event of liquidation of the Company. In purchasing Mortgage Assets and in issuing debt securities, the Company competes with investment banking firms, savings and loan associations, banks, mortgage bankers, insurance companies, federal agencies and other entities, many of which have greater financial resources than the Company.\nTo the extent the Company acquires Commercial Securitizations or other interests in real estate, the Company will be subject to varying degrees of risk incident to the ownership of real estate. There are many factors which can impact upon the performance of real estate including economic events or governmental regulations which are out of the control of the Company, all of which can impact upon real estate assets whose values are supporting the Mortgage Loans.\nThe Company may acquire non-rated investments in Commercial Securitizations, including first loss positions and other subordinated positions, which are entitled to receive repayment of principal only after all required principal payments have been made to more senior instruments in the Securitization. A first loss security is the most subordinated class of a multi-class issuance of debt securities and is the first to bear the risk of default on the underlying collateral. These investments are generally less marketable than other classes and are illiquid assets.\nThe Company is subject to potential conflicts of interest arising from its relationship with its Manager. Transactions which present potential conflicts of interest will be approved by the Board of Directors, including a majority of the Unaffiliated Directors, or will be carried out in accordance with guidelines which the Board has adopted. In the latter case, the specific transactions generally will not be subject to the approval of the Board of Directors.\nIn order to maintain its status as a REIT, the Company is required to comply with certain restrictions imposed by the Code with respect to the nature of its assets and income, which could prevent it from making investments or from making dispositions of investments otherwise considered desirable. The REIT provisions of the Code require the Company to distribute substantially all of its net taxable income on an annual basis. If the Company should not qualify as a REIT in any tax year, it would be taxed as a regular domestic corporation, and distributions to the Company's stockholders would not be deductible by the Company in computing its taxable income. Any resulting tax liability could be substantial and would reduce the amount of cash available for distributions to stockholders. Further, the failure of the Company to be treated as a REIT for any one year would disqualify the Company from being treated as a REIT for four subsequent years.\nBecause of these and other factors, future distributions to stockholders cannot be predicted. The Company has the right, but not the obligation, to refrain from making distributions to stockholders until the tax loss carryforward is fully utilized. It is likely that the market price of the shares of the Company's Common Stock would be affected by any decline in the spread between the Company's net yield on its assets and prevailing interest rates.\nAcquisition and Disposition of Mortgage Assets\nThe Company purchases Mortgage Assets from investment banking firms and other mortgage suppliers, some of which may be affiliates of the Manager. The Company does not intend to purchase assets that would disqualify it as a REIT or subject it to regulation as an investment company under the Investment Company Act of 1940.\nThe Company is not in the business of trading its Mortgage Assets. However, from time to time the Company may sell an asset as part of the Company's ongoing effort to adjust its portfolio composition to reflect changes in economic conditions. In the fourth quarter of 1989, the Company sold a Residual Interest it had acquired in 1988. In 1992, the Company sold for a total of $6,008,000 both of the PO Bonds it had acquired in 1991. There have been no other dispositions of Mortgage Assets since the Company's inception. See Item 7 below, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Item 8 below, \"Financial Statements and Supplementary Data\" for further details.\nDuring 1992 the Company reinvested approximately $30,760,000. Of this amount, $22,557,000 was invested in IO Bonds and the remaining $8,203,000 was invested in an Inverse IO Bond. In 1993 the Company reinvested $4,069,000 in inverse IO bonds and $340,000 in equity residuals. In 1994 the Company purchased two Commercial Securitizations for $1,232,000. See Item 7 below, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Item 8 below, \"Financial Statements and Supplementary Data\" for details on assets acquired. The funds for reinvestment came from cash balances, borrowings, proceeds from the sale of PO Bonds and principal returned to the Company from its investments.\nBased on current projections of return of investment from its portfolio, the Company expects to generate cash flows of $450,000 to $700,000 after expenses in each month of 1995. These cash flows will be used to acquire assets or reduce borrowings. Although the Company continually reviews Mortgage Assets available for purchase, the Company will acquire additional Mortgage Assets only when they are believed to complement the current portfolio.\nOn May 31, 1990, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus for a uniform method of accounting for Residual Interests in CMOs (Issue 89-4). The consensus, among other things, required Residual Interests to be classified either as \"equity\" (and be accounted for under the Equity Method) or as \"nonequity\" (and be accounted for under a level yield method referred to as the Prospective Method). The methods described in Issue 89-4 are essentially the same as those used by the Company until December 31, 1993. As of December 31, 1993 the Company adopted the accounting method for impairment of mortgage-backed derivative investments prescribed by FASB Statement No. 115 and presented its 1993 and 1994 financial statements in accordance therewith. See Item 7 below, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Item 8 below, \"Financial Statements and Supplementary Data\" for information as to the effect of adoption of this change in accounting method. Fair Value of Residual Interests and IO Bonds\nIn General - Substantially all income to the Company is currently derived from the cash flows on the Company's Residual Interests, IO Bonds and PO Bonds. The fair value of these assets is the net present value of the projected future cash flows. The amount of cash flows that may be generated from these assets is uncertain and may be subject to wide variations depending primarily upon the rate and timing of prepayments on the underlying mortgage collateral and, for Residual Interests with variable rate Bond Classes and IO Bonds with variable interest rates, changes in LIBOR and COFI. The following information sets forth assumptions used to calculate the projected cash flows on the Company's Nonequity Residual Interests and IO Bonds, and the resulting net present value of these assets, at December 31, 1994 based on various assumptions and discount factors.\nAssumptions - For purposes of the presentations on the following tables, the Nonequity Residual Interests have been separated into two groups: Residual Interests in CMOs with fixed rate Bond Classes and Residual Interests in CMOs with one or more COFI Bond Classes. The IO Bonds have been separated into two groups: IO Bonds with a fixed interest rate and Inverse IO Bonds. For purposes of projecting future cash flows, the Company has used the following one-month LIBOR and 11th District COFI rates:\nPrincipal payments on mortgage loans may be in the form of scheduled amortization or prepayments (for this purpose, \"prepayments\" include principal prepayments and liquidations due to default or other dispositions). The prepayment assumptions used herein are based on an assumed rate of prepayment each month of the unpaid principal balance on a pool of mortgage loans. A 100% prepayment assumption assumes prepayment rates of 0.2% per annum of the then outstanding principal balance of such mortgage loans in the first month of the life of such mortgage and an additional 0.2% per annum in each month thereafter (for example, 0.4% per annum in the second month) until the 30th month. Beginning with the 30th month and in each month thereafter during the life of such mortgage loans, 100% prepayment assumption assumes a constant prepayment rate of 6% per annum.\nThe prepayment assumptions used in Case III to estimate the fair value of the Company's Nonequity Residual Interests and IO Bonds are the Bloomberg Financial Markets (\"Bloomberg\") Dealer Prepayment Estimates Average as estimated by several dealers in mortgage-related assets and compiled by Bloomberg as of January 3, 1995. Bloomberg has obtained this information from sources it believes to be reliable but has not verified such information and assumes no responsibility for the accuracy of such information. The prepayment assumptions used in Case I reflect a decline in short-term interest rates accompanied by a decline in mortgage loan interest rates. The prepayment assumptions used in Case II (which also are used in Case III) reflect a decline in short-term rates not accompanied by a decline in mortgage loan interest rates. The prepayment assumptions used in Case IV (which also are used in Case V) reflect an increase in mortgage loan interest rates not accompanied by an increase in short-term interest rates. The prepayment assumptions used in Case V reflect an increase in short-term interest rates accompanied by an increase in mortgage loan interest rates. The table below shows the prepayment assumptions used to project cash flows in order to calculate the present value of the Company's Nonequity Residual Interests and IO Bonds:\nPresent Value of Projected Cash Flows - The tables which follow set forth the present value at December 31, 1994 of the projected cash flows discounted at the indicated discounted rates subject to the assumptions described above. For example, if cash flows are projected using the assumptions in Case III and Nonequity Residuals Interests in CMOs with fixed rate Bond Classes are discounted at 14% and the Nonequity Residual Interests in CMOs with variable rate Bond Classes are discounted at 18%, the present value of the projected cash flows of the Company's Nonequity Residual Interests would equal approximately $8,675,000. This is the Company's estimate of the fair value of these assets. In addition, if cash flows on the Company's regular IO Bonds are discounted at 14% and the cash flows on its Inverse IO Bonds are discounted at 30%, the present value of the projected cash flows on the IO Bonds would equal $9,558,000. This represents a decrease of $236,000 from the $9,794,000 book value of these assets. The difference of $236,000 is the difference between the present value of cash flows and the actual market values as of December 31, 1994 of FNMA SMBS Trust 7 Class 2 IO and FNMA SMBS Trust 4 Class 2 IO. The book value is the Company's estimate of the fair value of these IO Bonds. There will be differences between the projected cash flows used to calculate the present value of these assets and the actual cash flows received by the Company, and such differences may be material.\nAcquisition of Mortgage Instruments\nThe Company has the power to purchase Mortgage Instruments from mortgage suppliers. Mortgage Instruments may be acquired subject to the liability represented by Structured Securities. In addition, Mortgage Instruments may be acquired with the intention of arranging for the subsequent issuance of Structured Securities secured thereby. Through December 31, 1994, the Company had not purchased Mortgage Instruments.\nMortgage Certificates may consist of GNMA Certificates, FHLMC Certificates, FNMA Certificates and other Mortgage Certificates. Mortgage Loans may be originated by various lenders throughout the United States. Originators may include savings and loan associations, banks, mortgage bankers and other mortgage lenders. There are no limits upon the geographic concentration of Mortgage Loans which the Company can acquire.\nThe Company has the power to enter into commitments to purchase Mortgage Loans but has not done so. Such commitments would obligate the Company to purchase Mortgage Loans and the holder to sell such Mortgage Loans at a future date for a specific period of time at an established price, in a specific aggregate principal amount and bearing a specified interest rate. However, all loans would be fully funded prior to their acquisition by the Company. Following the issuance of commitments, the Company would be exposed to risks of interest rate fluctuations.\nIssuance of Structured Securities\nIn June of 1989, the wholly-owned subsidiary of the Company issued a series of CMOs. See \"Formation of Subsidiary\" below. The Company has not issued, and it has no present plans to issue, any other Structured Securities. The following paragraphs describe certain types of Structured Securities that the Company might issue if permitted and warranted by future circumstances.\nCMOs. To the extent consistent with its objective of generating income from the net cash flows on its Mortgage Assets, the Company may issue, itself or through one or more Affiliated Issuers, various series of CMOs secured by collateral which may include Mortgage Instruments, debt service funds and reserve funds, insurance policies, servicing agreements and a master servicing agreement\nOther Mortgage-Backed Securities. Mortgage pass-through certificates representing undivided interests in pools of Mortgage Loans formed by the Company could be utilized as a vehicle for raising funds. The issuance of mortgage pass-through certificates would be undertaken, however, only if the Board of Directors received an opinion of counsel or other satisfactory evidence that the issuance and sale of such securities would not cause the Company to fail to qualify for treatment as a REIT under the Code and that the income, if any, realized by the Company in connection with the issuance, sale, and holding of such securities would not constitute income from a prohibited transaction under the Code.\nCommercial Securitizations. The general structure of these securities would be in what is normally called a senior\/subordinated structure consisting of some senior debt securities rated investment grade, \"AAA,\" \"AA\" and \"A\" and other lower-rated \"BBB\" and \"BB\" bonds, and unrated bonds. Generally the credit quality of any of these bonds relates to the subordination level of the bond or its priority to receive principal and interest from the mortgage collateral. Any such securitizations would be issued as REMIC Securities which would also involve a Residual Interest. The Company might or might not retain an investment in any of the bonds or the Residual Interest, however the Company would likely retain a first loss security from the issuance. The first loss bond is the most subordinated class of the multi-class issuance and is the first to bear the risk of default on the underlying collateral. Since there are generally fewer loans involved in the securitization and since the loans usually do not have any guarantee of payment of principal, the risk of loss on foreclosure is much greater. The Company believes that careful credit underwriting would help manage credit risk, although there can be no assurances in this regard.\nThe Company may also acquire fee interest in or acquire or originate Mortgage Loans on commercial real estate which, among other things, may be used as collateral for future securitizations.\nMaster Servicing. In the event that an affiliated issuer issued a series of Structured Securities secured by Mortgage Instruments owned or financed by the Company (other than Mortgage Certificates issued or guaranteed by a governmental entity), the Company or such Affiliated Issuer generally would be required to enter into a master servicing agreement (the \"Master Servicing Agreement\") with respect to such series of Structured Securities with an entity acceptable to the rating agency that is rating such series of Structured Securities (the \"Master Servicer\"). The Master Servicer would receive for a series of Structured Securities a monthly administrative services fee which would be in an amount negotiated between the Company and the Master Servicer.\nCosts. Various expenses would be incurred in connection with issuances of Structured Securities, including legal and accounting fees, printing expenses, underwriters' compensation or other sales commissions, and expenses of registration or qualification under state and federal securities laws. If the Company did not issue the Structured Securities through a subsidiary or trust established by it, it is anticipated that the Company would not pay such costs directly, but would pay to the Affiliated Issuer an amount which would include such costs as well as any applicable fees.\nThe possible strategy described above of issuing Structured Securities would be based upon the Company's current assessment of the demand for these securities, the cost of issuing the securities, the relative strength of issuers and other market participants active in such securities, rating agency requirements and other factors affecting the structure, cost, rating and benefits of such securities relative to each other and to other investment alternatives. The market for Structured Securities, and CMOs in particular, has developed rapidly within the past few years and continues to generate new structures, issuers, buyers and products. Developments in the market that affect the factors mentioned or that change the Company's assessment of the market for such securities may cause the Company to revise the financing strategy described herein. Any such revision in strategy would require the approval of the Board of Directors of the Company, including a majority of the Unaffiliated Directors.\nCapital Resources\nWhen feasible the Company may seek to increase the amount of funds available for its activities through various types of debt financing. The Company would seek to obtain lines of credit from independent financial institutions. The Company would also seek to raise funds through agreements pursuant to which the Company would sell Mortgage Assets for cash and simultaneously agree to repurchase them at a specified date for the same amount of cash plus an interest component (\"Reverse Repurchase Agreements\"), and through the issuance of commercial paper and other debt securities, other forms of borrowings and the issuance of additional equity securities. Short-term indebtedness would be expected to bear interest at variable rates.\nAs of December 31, 1993 the Company had total borrowings of $11,745,000. Of this amount, $696,000 was under a repurchase agreement with Kidder, Peabody & Co. and $11,049,000 under a repurchase agreement with Bear, Stearns & Co., Inc. As of December 31, 1994 the Company's borrowings were solely under a repurchase agreement with Bear, Stearns & Co. and were reduced to $8,325,000. The debt is collateralized by some of the Company's Residual Interests and IO Bonds. The weighted average interest rate on such borrowings at December 31, 1994 was 6.9776%.\nIn connection with the agreement to acquire four multifamily housing projects in California's Central Valley, the Company intends to incur mortgage obligations secured by such properties. Any other indebtedness incurred by the Company may be secured by the assets of the Company, including its Mortgage Assets.\nThe Company's By-Laws provide that it may not incur indebtedness if, after giving effect to the incurrence thereof, the Company's aggregate indebtedness (other than liability represented by Structured Securities and any loans between the Company and its trusts or corporate subsidiaries), secured and unsecured, would exceed 100% of the Company's average invested assets in the preceding calendar quarter, as calculated in accordance with generally accepted accounting principles, unless approved by a majority of the Unaffiliated Directors.\nThe Company has 100,000,000 authorized shares of Common Stock. The Company may increase its capital resources by making additional offerings of Common Stock. Such offerings may result in a reduction of the net tangible book value per outstanding share and a reduction in the market price of the Company's Common Stock. The Company is unable to estimate the amount, timing or nature of such future sales of its Common Stock as such sales will depend on general market conditions and other factors.\nOn December 5, 1991 the Board of Directors approved a Dividend Reinvestment and Share Purchase Plan which became effective on January 2, 1992. The Plan provides, at the Company's option, for shares purchased under the Plan to either be issued by the Company, or be purchased on the open market. The Plan prospectus provides for up to 1,000,000 new shares to be issued. To the extent new shares are issued, the Company's capital would be increased. During 1992, 5,780 shares were issued under the Plan resulting in an increase to capital of $39,000. No new shares were issued under the Plan in 1993 or 1994 as all required shares were purchased in the open market.\nOperating Restrictions\nThe Company intends to conduct its business so as not to become regulated as an investment company under the Investment Company Act of 1940 (the \"1940 Act\"). Accordingly, the Company does not expect to be subject to the provisions of the 1940 Act, including those that prohibit certain transactions among affiliated parties. The 1940 Act exempts entities that are primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. Under current interpretations of the staff of the Securities and Exchange Commission, in order to qualify for this exemption, the Company must maintain at least 55% of its assets directly in Mortgage Loans, certain Mortgage Certificates and certain other qualifying interests in real estate. The Company's ownership of Residual Interests may therefore be limited by the 1940 Act. In addition, certain Mortgage Certificates may be treated as securities separate from the underlying Mortgage Loans and, thus, may not qualify as \"mortgages and other liens on and interests in real estate\" for purposes of the 55% requirement, unless such Mortgage Certificates represent all the certificates issued with respect to an underlying pool of mortgages. The Company's investment policies prohibit it from making any investments that would cause the Company to be an investment company within the meaning of the 1940 Act.\nAlthough the Company has no present intention to seek modification of its operating policies described herein, a majority of the Unaffiliated Directors may in the future conclude that it would be advantageous for the Company to do so and may modify such operating policies accordingly, without the consent of the stockholders.\nOther Operating Strategies\nThe Company has the power to originate Mortgage Loans, retain or purchase servicing or excess servicing rights or engage in other similar activities, but only to the extent consistent with its qualification as a REIT. The Company does not currently engage, nor does it expect to engage, in any such activities.\nThe Company also has the power to acquire equity interests in improved real property. At December 31, 1994, the Company did not own real property; however, it has acquired in 1995 and intends to acquire additional multifamily properties in the Western states with the approval of a majority of the Unaffiliated Directors. Acquisition of real property will be incremental to the ownership of mortgage securities. Real property acquisitions will be opportunistic and will occur from time to time only when the potential for appreciation in value together with current cash flow yield provides a total return equal to the Company's investment in mortgage securities.\nTo the extent consistent with the Company's qualification as a REIT, the Company has the power to hedge Mortgage Assets it might hold to seek to protect the value of such assets from interest rate fluctuations. Generally, hedging is a technique used either to increase the liquidity or decrease the risk of an asset by guaranteeing, wholly or partially, the price at which the asset may be disposed of prior to its maturity. Certain of the tests that the Company must satisfy to qualify as a REIT, however, may significantly limit the Company's ability to hedge. See \"Federal Income Tax Considerations\" below. In times of volatile interest rates, the Company may be prevented from hedging its Mortgage Assets. The Company currently has no hedging agreements in place or plans to hedge.\nFormation of Subsidiary\nOn October 21, 1988 TISMAC was incorporated for the purpose of issuing CMOs directly. TISMAC is a wholly-owned subsidiary of the Company. On June 29, 1989, TISMAC issued $199,400,000 original aggregate principal amount of its Collateralized Mortgage Obligations, Series 1989-1, Classes A- F. All of the Bond Classes in the CMO have 10% bond coupons and mature serially from March 2016 through July 1, 2019. The bonds are secured by $200,000,000 of GNMA I collateral with a stated pass through rate of 10%. The assets of TISMAC are not available to pay creditors of the Company. The Company has undertaken to indemnify certain parties who have contracted with TISMAC against certain losses which they might sustain in carrying out their obligations.\nCompetition\nIn purchasing Mortgage Assets and in issuing Structured Securities, the Company competes with investment banking firms, savings and loan associations, banks, mortgage bankers, insurance companies, other lenders, GNMA, FHLMC and FNMA and other entities purchasing Residual Interests, Mortgage Instruments and issuing Structured Securities, virtually all of which have significantly greater financial resources than the Company. Additionally, Structured Securities which the Company might seek to issue face competition from other investment opportunities available to prospective purchasers.\nEmployees\nThe Company currently has no full time salaried employees who are employed directly by the Company. However, the Company reimburses the Manager for employment expenses of personnel performing certain functions as specified in the Management Agreement. The Manager currently employs seven employees who perform these specified functions on behalf of the Company. See \"Management of Operations - Expenses\".\nManagement of Operations\nThe Management Agreement\nThe Company has entered into a Management Agreement with the Manager which is renewable annually. In June 1994 the Board of Directors renewed the Management Agreement through June 30, 1995. In March 1995 the Board of Directors authorized a committee composed of four Unaffiliated Directors to consider proposed revisions to the Management Agreement in light of the Company's acquisition of multifamily residential properties and recent waivers by the Unaffiliated Directors of the requirement in the Management Agreement that the Manager reimburse the Company for Excess Expenses (as defined below; see \"Expenses\"). The Management Agreement may be terminated by the Company without cause at any time upon 60 days written notice by a majority vote of its Unaffiliated Directors or by a vote of the holders of a majority of the outstanding shares of Common Stock and by the Manager upon 60 days written notice.\nUnder the Management Agreement the Manager, in accordance with criteria established by the Company's Board of Directors, including a majority of the Unaffiliated Directors, arranges for the acquisition of mortgage-related assets for the Company, arranges for the acquisition, management and financing of real estate, arranges for the issuance and administration of Structured Securities, monitors the performance of the foregoing and provides certain administrative and overall managerial services necessary for the operation of the Company. For performing these services, the Manager receives (i) a base management fee, payable quarterly, in an amount equal to 3\/8 of 1% per annum of the Company's Average Invested Assets and (ii) incentive compensation, payable quarterly, in an amount equal to 25% of the amount by which the Company's annualized Return on Equity for the quarter exceeds the Ten Year U.S. Treasury Rate for the quarter plus one percentage point.\nIn order to compensate the Manager for certain administrative functions that the Manager performs with respect to each Residual Interest which is projected to have cash flows in excess of $40,000 in the following year purchased by the Company for which neither the Manager nor an Affiliate acts as bond administrator, the Company pays the Manager a fee equal to $10,000 for each year or fraction thereof that the Company holds such Residual Interest. The Company also pays the Manager certain bond issuance and administration fees when it acts in the capacity of bond administrator in connection with the issuance and administration of Structured Securities issued by or on behalf of the Company. Such fees are comparable to those that the Company would pay unrelated entities.\nExpenses\nThe Company reimburses the Manager for certain expenses incurred by the Manager on the Company's behalf, including rent, telephone, utilities, office furniture, equipment and machinery, computers, and computer services, as well as expenses relating to accounting, bookkeeping and related administrative functions (including the employment expenses of any persons performing these functions), and fees and expenses of agents and employees employed directly by the Company or by the Manager at the Company's expense.\nUnless waived by the Unaffiliated Directors, the Management Agreement provides that the Manager shall reimburse the Company, up to the extent of the base management fee, to the extent that certain of such expenses exceed the greater of 2% of the average invested assets of the Company or 25% of the Company's Net Income for the year (\"Excess Expenses\"). The Company experienced Excess Expenses in 1993 and 1994, and the Unaffiliated Directors waived the reimbursements that would otherwise have been required by the Management Agreement.\nExcept as set forth above, the Manager is required to pay employment expenses of its personnel, rent, telephone, utilities, other office expenses, certain travel and miscellaneous administrative expenses of the Manager and, if the Manager or an affiliate of the Manager serves as bond administrator for a series of Structured Securities issued by or on behalf of the Company, all expenses incurred by the Manager in performing administrative services in connection with the issuance and administration of such series of Structured Securities.\nIf the Company participates in programs operated by the Manager for the pricing and acquisition of Mortgage Loans, the Company will pay the Manager a fixed expense allowance in an amount which shall be determined by a majority of the Unaffiliated Directors, and which shall be subject to adjustment every six months upon approval by a majority of such Unaffiliated Directors. The amount of such allowance would not be subject to the expense limitation described above. Federal Income Tax Considerations\nGeneral\nIf the Company satisfies certain tests with respect to the nature of its income, assets, management, share ownership and the amount of its distributions, and elects to be so treated, it will qualify as a real estate investment trust (\"REIT\") for federal income tax purposes. The Company satisfied such tests and elected to be treated as a REIT on its tax return for the year ended December 31, 1988. The Company has satisfied such tests in all subsequent years and intends to satisfy this test in future years. As a REIT, the Company generally will not be subject to tax at the corporate level on its net income to the extent that it distributes cash in the amount of such net income to its stockholders. See \"Taxation of the Company.\" Generally, those distributions will constitute dividends to the stockholders and will be taxable as ordinary income to the extent of the Company's earnings and profits. It is expected that distributions made by the Company will be made out of earnings and profits.\nThe failure of the Company to be treated as a REIT for any taxable year would materially and adversely affect the stockholders since the Company would be taxed as a corporation. Accordingly, the taxable income of the Company (computed without any deduction for distributions to stockholders) would be taxed to the Company at corporate rates (currently up to 35%), and the Company would be subject to any applicable minimum tax. Additionally, dividends to the stockholders would be treated as ordinary income to the extent of the Company's earnings and profits. As a result of the \"double taxation\" (i.e. taxation at the corporate level and subsequently at the stockholder level when earnings are distributed) the dividends to the stockholders would decrease substantially, because a large portion of the cash otherwise available for distribution to stockholders would be used to pay taxes. Further, the failure of the Company to be treated as a REIT for any one year would disqualify the Company from being treated as a REIT for four subsequent years.\nQualification of the Company as a REIT\nGeneral\nIn order to qualify as a REIT for federal income tax purposes, the Company must elect to be so treated and must satisfy certain tests with respect to the sources of its income, the nature and diversification of its assets, the amount of its distributions, and the ownership of the Company. The following is a discussion of those tests.\nSources of Income\nThe Company must satisfy three separate income tests for each taxable year with respect to which it intends to qualify as a REIT: (i) the 75% income test, (ii) the 95% income test, and (iii) the 30% income test. Under the first test, at least 75% of the Company's gross income for the taxable year must be derived from certain qualifying real estate related sources. Income that qualifies under the 75% test includes (a) interest on obligations secured by mortgages on real property or on interests in real property (including, generally, income from regular and residual interests in REMICs), (b) dividends from other REITs, and (c) gain from the sale or other disposition of real property (including interests in real property and interests in mortgages on real property) that is not \"dealer property\" (i.e. property that is stock in trade, inventory, or property held primarily for sale to customers in the ordinary course of business), (d) income from the operation, and gain from the sale, of property acquired at or in lieu of a foreclosure of a mortgage (\"foreclosure property\") , (e) commitment fees related to mortgage loans, and (f) income attributable to the temporary investment of the Company's capital proceeds (excluding amounts received pursuant to a dividend reinvestment program) in stock or debt instruments, if such income is received or accrued during the one-year period beginning on the date of receipt of the capital proceeds (\"qualified temporary investment income\").\nIn addition to meeting the 75% income test, at least 95% of the Company's gross income for the taxable year must be derived from items of income that either qualify under the 75% test or are from certain other types of passive investments. This is referred to as the 95% income test. Income that satisfies the 95% income test includes income from dividends, interest and gains from the sale or disposition of stock or other securities, other than stock or other securities that are dealer property.\nFinally, the 30% income test requires that the Company derive less than 30% of its gross income for the taxable year from the sale or other disposition of (1) real property, including interests in real property and interests in mortgages on real property, held for less than four years, other than foreclosure property or property involuntarily converted through destruction, condemnation or similar events, (2) stock or securities held for less than one year, and (3) property in \"prohibited transactions.\" A prohibited transaction is a sale or other disposition of property that is stock in trade, inventory, or property held for sale to customers in the ordinary course of business, other than foreclosure property or a real estate asset held for at least four years, if certain other conditions are satisfied.\nIf the Company inadvertently fails to satisfy either the 75% income test or the 95% income test, or both, and if the Company's failure to satisfy either or both tests is due to reasonable cause and not willful neglect, the Company may avoid loss of REIT status by satisfying certain reporting requirements and paying a tax generally equal to 100% of any excess nonqualifying income. There is no comparable safeguard that could protect against REIT disqualification as result of the Company's failure to satisfy the 30% income test.\nThe Company anticipates that its gross income will continue to consist principally of interest and gains on Mortgage Assets and income from short- term reinvestments. The composition and sources of the Company's income allowed the Company to satisfy the income tests for all fiscal years through December 31, 1994 and should allow the Company to satisfy the income tests during each year of its existence. If, however, the Company causes issuances of interests in REMICs or issuances of certificates representing certain equity interests in Mortgage Instruments (such as pass- through certificates), the Company could recognize income or gain that, if excessive, could result in the Company's failure to meet the 30% income test or, if from transactions in which the Company is deemed to be a dealer, could be subject to the 100% tax on prohibited transactions. See \"Taxation of the Company\" below. This effectively limits both the Company's ability to issue REMIC securities directly or through wholly owned subsidiaries and its ability to issue such securities indirectly through issuance of Funding Notes to Affiliated Issuers. See \"Issuance of Structured Securities - CMOs.\" Further, certain short-term reinvestments may generate qualifying income for purposes of the 95% income test but nonqualifying income for purposes of the 75% income test, and certain hedging transactions could give rise to income that, if excessive, could result in the Company's disqualification as a REIT for failing to satisfy the 30% income test. In addition, income from Structured Securities which do not represent equity interests in Mortgage Loans and with respect to which a REMIC election has not been made (e.g. CMOs) may not qualify under the 75% income test. The Company intends to monitor its reinvestments and hedging transactions closely to avoid disqualification as a REIT.\nNature and Diversification of Assets\nAt the end of each quarter of the Company's taxable year, at least 75% of the value of the Company's assets must be cash and cash items (including receivables), \"government securities\" and \"real estate assets.\" Real estate assets include real property, Mortgage Loans, Mortgage Certificates, equity interest in other REITs, any stock or debt instrument for so long as the income therefrom is qualified temporary investment income (as described below) and, subject to certain limitations, interests in REMICs. Structured Securities that do not represent equity interests in Mortgage Loans and with respect to which a REMIC election has not been made may not qualify as real estate assets. The balance of the Company's assets may be invested without restriction, except that holdings of the securities of any non-governmental issuer (other than a REIT or qualified REIT subsidiary) may not exceed 5% of the value of the Company's assets or 10% of the outstanding voting securities of that issuer. Securities that are qualifying assets for purposes of the 75% asset test will not be treated as securities for purposes of the 5% and 10% asset tests.\nIf a REIT receives \"new capital,\" stock or debt instruments purchased with such new capital are treated as real estate assets for purposes of the 75% asset test (described above) during the one-year period beginning on the date the REIT receives such new capital. New capital is defined as any amount received by a REIT in exchange for its stock (other than amounts received pursuant to a dividend reinvestment plan) or received in a public offering of its debt obligations having maturities of at least five years.\nThe Company anticipates that its assets will continue to consist principally of (i) ownership interests in Mortgage Assets (including undivided ownership interests in Mortgage Instruments), (ii) interests in REMICs, (iii) interests in real estate, (iv) interests in other REITs, (v) stock or debt instruments that generate qualified temporary investment income, (vi) cash and (vii) certain short-term investments and reinvestments. The Company believes that such asset holdings will allow it to satisfy the assets tests necessary to qualify as a REIT, and the Company intends to monitor its activities to attempt to assure satisfaction of such tests.\nIf the Company fails to satisfy the 75% asset test at the end of any quarter of its taxable year as a result of its acquisition of securities or other property during that quarter, the failure can be cured by a disposition of sufficient nonqualifying assets within 30 days after the close of that quarter. The Company intends to maintain adequate records of the value of its assets and take such action as may be required to cure any failure to satisfy the 75% asset test within 30 days after the close of any quarter. The Company may not be able to cure any failure to satisfy the 75% asset test, however, if assets that the Company believes are qualifying assets for purposes of the 75% asset test are later determined to be nonqualifying assets.\nREITs are permitted to hold assets in wholly owned subsidiaries (\"Qualified REIT Subsidiaries\"). A subsidiary of a REIT is a Qualified REIT Subsidiary if 100% of its stock is owned by the REIT at all times during the period such subsidiary is in existence. A Qualified REIT Subsidiary is not treated as a separate corporate entity for federal income tax purposes, but rather, together with its parent REIT, is treated as a single taxpayer. Accordingly, all of the assets, liabilities and items of income, deduction and credit of a Qualified REIT Subsidiary are treated as the assets, liabilities, and items of income, deduction and credit of the parent REIT for federal income tax purposes and, in particular, for purposes of satisfying the applicable Code provisions for qualification as a REIT. The Company's wholly owned subsidiary, TISMAC, is a Qualified REIT Subsidiary.\nDistributions\nThe Company must distribute as dividends to its stockholders for each taxable year an amount at least equal to (i) 95% of its \"REIT taxable income\" as defined below (determined before the deduction of dividends paid and excluding any net capital gain) plus (ii) 95% of the excess of its net income from foreclosure property over the tax imposed on such income by the Code, less (iii) any excess non-cash income (as determined under the Code).\nGenerally, a distribution must be made in the taxable year to which it relates. A portion of the required distribution, however, may be made in the following year (i) if the dividend is declared in October, November or December of any year, is payable to shareholders of record on a specified date in such a month, and is actually paid before February 1 of the following year; or (ii) if the dividend is declared before the date on which the Company's tax return for the taxable year is due to be filed (including extensions) and is paid on or before the first regular dividend payment date after such declaration. Further, if the Company fails to meet the 95% distribution requirement as a result of an adjustment to the Company's tax returns by the IRS, the Company may, if the deficiency is not due to fraud with intent to evade tax or a willful failure to file a timely tax return, retroactively cure the failure by paying a deficiency dividend (plus interest).\nThe Code imposes a non-deductible 4% excise tax on REITs to the extent that the \"distributed amount\" with respect to a particular calendar year is less than the sum of (i) 85% of the REITs taxable income (computed pursuant to Section 857(b)(2) of the Code, but before the dividends paid deduction and excluding capital gain or loss) for such calendar year, (ii) 95% of the REIT's capital gain net income (i.e. the excess of capital gains over capital losses) for such calendar year, and (iii) the excess, if any, of the \"grossed up required distribution\" (as defined in Section 4981(b)(3) of the Code) for the preceding calendar year over the distributed amount for such preceding year. For purposes of the excise tax provision, the \"distributed amount\" with respect to any calendar year is the sum of (i) the deduction for dividends paid during such calendar year (excluding dividends paid after the close of the taxable year under Section 858 of the Code but including dividends declared in October, November or December and paid in January, as described above), (ii) amounts on which the REIT is required to pay corporate tax and (iii) the excess, if any, of the distributed amount for the preceding year over the \"grossed up required distribution\" for such preceding taxable year. The Company paid excise tax of $38,051 for calendar year 1992, $2,009 for 1993 and $336 for 1994.\nThe Company intends to make distributions to its stockholders on a basis that will allow the Company to satisfy both the 95% distribution requirement and the excise tax distribution requirement. Certain factors inherent in the structure of certain mortgage-backed securities (particularly CMOs) and the federal income tax rules for calculating income of Mortgage Assets may cause the Company to realize taxable income in excess of net cash flows in certain years. The Company intends to monitor closely the interrelationship between its pre-distribution taxable income and its cash flow and intends to borrow funds or liquidate investments in order to overcome any cash flow shortfalls if necessary to satisfy the distribution requirement.\nOwnership of the Company\nShares of the Company's Common Stock must be beneficially owned by a minimum of 100 persons for at least 335 days in each full taxable year (or a proportionate part of any short taxable year) after the Company's first taxable year. Further, at no time during the second half of any taxable year after the Company's first taxable year may more than 50% of the Company's shares be owned, actually or constructively, by five or fewer individuals (including pension funds except under certain circumstances, and certain other types of tax exempt entities). The Company's Articles of Incorporation contain repurchase provisions and transfer restrictions designed to prevent violation of the latter requirement. To evidence compliance with these requirements, the Company is required to maintain records that disclose the actual ownership of its outstanding shares. Each year, in order to satisfy that requirement, the Company will demand written statements from record holders owning designated percentages of Common Stock disclosing, among other things, the identities of the actual owners of such shares.\nTaxation of the Company\nFor any taxable year in which the Company qualifies and elects to be treated as a REIT under the Code, the Company will be taxed at regular corporate rates (or, if less, at alternative rates in any taxable year in which the Company has an undistributed net capital gain) on its real estate investment trust taxable income (\"REIT Taxable Income\"). REIT Taxable Income is computed by making certain adjustments to a REIT's taxable income as computed for regular corporations. Significantly, dividends paid by a REIT to its stockholders with respect to a taxable year are deducted to the extent such dividends are not attributable to net income from foreclosure property. Thus, in any year in which the Company qualifies and elects to be treated as a REIT, it generally will not be subject to federal income tax on that portion of its taxable income that is distributed to its stockholders in or with respect to that year. In computing REIT Taxable Income, taxable income also is adjusted by (i) disallowing any corporate deduction for dividends received, (ii) disregarding any tax otherwise applicable as a result of a change of accounting period, (iii) excluding the net income from foreclosure property, (iv) deducting any tax resulting from the REIT's failure to satisfy either of the 75% of 95% income tests, and (v) excluding net income from prohibited transactions.\nRegardless of distributions to stockholders, the Company will be subject to a tax at the highest corporate rate on its net income from foreclosure property, a 100% tax on its net income from prohibited transactions, and a 100% tax on the greater of the amount by which it fails either the 75% income test or the 95% income test, less associated expenses, if the failure to satisfy either or both of such tests does not cause the REIT to fail to qualify as such. See \"Qualification of the Company as a REIT.\" In addition, as described above, the Company will be subject to a 4% excise tax for any taxable year in which, and on the amount by which, distributions made by the Company fail to equal or exceed a certain amount determined with reference to its REIT Taxable Income. See \"Qualification of the Company as a REIT - Distributions\" above. The Company is also subject to the alternative minimum tax, which is determined for REITs with reference to REIT Taxable Income as increased by tax preferences. The Company does not expect to have significant amounts of tax preference items. Accordingly, the Company anticipates that its federal tax liabilities, if any, will be minimal.\nCalifornia Franchise tax regulations regarding REIT qualification currently conform to Federal income tax regulations. There is no assurance that this will continue in the future and, if state regulations do not conform to Federal regulations in the future, there is a possibility that the Company might be liable for state income taxes.\nThe Company uses the calendar year both for tax and financial reporting purposes. Due to the differences between tax accounting rules and generally accepted accounting principles, the Company's REIT Taxable Income may vary from its net income for financial reporting purposes.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe principal executive offices of the Company and the Manager are located at 655 Montgomery Street, Suite 800, San Francisco, California 94111, telephone (415) 393-8000. The offices are leased for a period of three years, ending on February 28, 1996, by the Manager of the Company. The Manager is reimbursed by the Company for a portion of the rent based on the percentage of spaced used by personnel who provide accounting and administration services to the Company.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nAt March 15, 1995, there were no material pending legal proceedings (within the meaning of the Form 10-K instructions) to which the Company or its subsidiary is a party or to which any of their respective 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 the security holders of the Company during the fourth quarter of the fiscal year covered by this report. PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.\nThe Company's Common Stock is listed on both the New York Stock Exchange and the Pacific Stock Exchange under the symbol \"TIS.\" The high and low closing sales prices of shares of the Common Stock on the New York Stock Exchange for the periods indicated were as follows:\nOn March 15, 1995, the closing sales price of the shares of Common Stock on the New York Stock Exchange was $2.25. On that date the Company had outstanding 8,105,880 shares of Common Stock which were held by approximately 890 stockholders of record and the total number of beneficial shareholders was approximately 8,000.\nIn order to maintain its qualification as a REIT under the Code for any taxable year, the Company, among other things, must distribute as dividends to its stockholders an amount at least equal to (i) 95% of its REIT taxable income (determined before the deduction of dividends paid and excluding any net capital gain) plus (ii) 95% of the excess of its net income from foreclosure property over the tax imposed on such income by the Code less (iii) any excess non-cash income (as determined under the Code). The Company intends that the cash dividends paid each year to its stockholders will equal or exceed the Company's taxable income generated from operations. The following table details the dividends declared and\/or paid for the Company's two most recent fiscal years.\nThe Board of Directors, at its regular meeting on March 1, 1994, suspended the regular quarterly dividend payment for the first quarter of 1994. On September 7, 1994, a dividend of $0.02 per share was declared in order to minimize corporate income taxes payable by the Company. The actual amount and timing of future dividend payments will be at the discretion of the Board of Directors and will depend upon the financial condition of the Company in addition to the requirements of the Code.\nSubject to the distribution requirements to maintain REIT qualification, the Company intends, to the extent practicable, to utilize substantially all of the principal from repayments, sales and refinancings of the Company's Mortgage Assets to reduce debt or to acquire new assets. The Company may, however, under extraordinary circumstances, make a distribution of principal. Such distributions, if any, will be made at the discretion of the Company's Board of Directors.\nIt is anticipated that dividends generally will be taxable as ordinary income to stockholders of the Company (including, in some cases, stockholders that would otherwise be exempt from tax under the Code), although a portion of such dividends may be designated by the Company as capital gain or may constitute a return of capital. Such dividends received by stockholders of the Company will not be eligible for the dividends-received deduction so long as the Company qualifies as a REIT. The Company will furnish annually to each of its stockholders a statement setting forth distributions paid during the preceding year and their characterization as ordinary income, return of capital or capital gain.\nSubstantially all of the REIT Taxable Income of the Company is, and is expected to continue to be, derived from the Company's Mortgage Assets. Such income is increased by non-cash credits from, among other things, the accretion of market discount on the Mortgage Certificates pledged as collateral for bonds and is decreased by non-cash expenses, including, among other things, the amortization of the issuance costs of bonds, market premium on the Mortgage Certificates pledged as collateral for bonds and the accretion of original issue discount on certain bond classes of bonds. In certain instances, the REIT Taxable Income of the Company for federal income tax purposes may differ from its net income for financial reporting purposes principally as a result of the different methods used to determine the effect and timing of recognition of such non-cash credits and expenses.\nAs a result of the requirement that the Company distribute to its stockholders an amount equal to substantially all of its REIT Taxable Income in order to qualify as a REIT, the Company may be required to distribute a portion of its working capital to its stockholders or borrow funds to make required distributions in years in which on a tax basis the \"non-cash\" items of income (such as those resulting from the accretion of market discount on the assets owned by the Company) exceed the Company's \"non-cash\" expenses. In the event that the Company is unable to pay dividends equal to substantially all of its REIT Taxable Income, it will not continue to qualify as a REIT. Item 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data is qualified in its entirety by, and should be read in conjunction with, the financial statements and notes thereto appearing in sections of this Annual Report on Form 10-K. The data as of December 31, 1994, 1993 and 1992 and for the years ended December 31, 1994, 1993 and 1992 have been derived from the Company's financial statements which are included elsewhere in this Annual Report on Form 10-K.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe Company commenced operations on August 26, 1988 in connection with its initial public offering of 8,100,000 shares of Common Stock.\nInvestment Activities\nDuring 1994 the Company reinvested $1,232,000 in Commercial Securitizations and reduced its short-term borrowings by $3,420,000. In addition, the Company incurred costs of $395,000 related to the 1995 purchase of multifamily residential properties. At December 31, 1994, these costs are included in other assets. During 1993 the Company reinvested $4,069,000 in IO Bonds and $340,000 in Residual Interests and reduced its short-term borrowing by $6,212,000. The funds came from operating activities and the principal returned to the Company from its investments. The Company continually reviews the composition of its portfolio and analyzes potential investments as additions to the portfolio. The Company reinvests the principal portion of its cash flow as soon as it finds suitable investments. The following table illustrates the Company's cash receipts, disbursements and reinvestments for the last four years.\nThe Company decreased the level of reinvestments in 1994 over the two prior years because the cash flows from investments did not provide cash at prior year's levels. The Company increased the level of reinvestments substantially in 1992 over 1991 levels due to a combination of the following: (1) the higher prepayments did not reduce the 1992 cash flows but instead caused most of the $20,949,000 cash flows from investments to be considered a return of investment - therefore, the Company had more cash to reinvest, (2) the drop in short term rates, and the resulting difference between long and short term rates, made it prudent for the Company to be as fully invested in longer term assets as was practical, (3) the funds from the sale of PO Bonds were available for reinvestment and (4) the Company wanted to replace some of the assets which had been written down.\nFrom the middle of 1991 until mid-1993, the Company has reinvested its cash flows into PO and IO Bonds, including Inverse IO Bonds because issuers of CMOs were able to reallocate the economics formerly found only in Residual Interests to some of the other CMO tranches. In addition, most new Residual Interests were noneconomic and would not provide the investment attributes previously found in Residual Interests and now found in a variety of PO and IO Bonds. See \"Effect of Interest and Prepayment Rates on Net Income\" below for further detail on the investment characteristics of PO and IO Bonds as compared to Residual Interests.\nIn 1993 the Company purchased two Inverse IO Bonds for $4,069,000 and purchased for $340,000 all of the outstanding minority interest in an Equity Residual and minority interests in two other Equity Residuals.\nIn 1994 the Company purchased two commercial securitizations for $1,232,000. Based on current projections of return of investment from its portfolio, the Company expects to generate cash flows of $450,000 to $700,000 in each month of 1995 either for reinvestment or to be used to reduce borrowings. The Company continually reviews mortgage-related assets available for purchase and plans to acquire additional mortgage-related assets when they complement the current portfolio.\nAccounting Change\nIn May 1993 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 115 - Accounting for Certain Investments in Debt and Equity Securities (\"SFAS No. 115\"). SFAS No. 115 requires the Company to classify its investments into one of three categories: held-to-maturity, available-for-sale, or trading. Investments in debt securities shall be classified as held-to-maturity and measured at amortized cost only if the Company has the positive intent and ability to hold those securities to maturity.\nSFAS No. 115 requires investments in debt and equity securities that are classified as available-for-sale to be carried at fair value with any net unrealized gain or less excluded from earnings and reported as a separate component of shareholders' equity.\nFurthermore SFAS No. 115 requires that investments classified as held- to-maturity or available-for-sale be written down to fair value as a realized loss if the fair value of an investment is less than its carrying value and the decline is determined to be \"other than temporary\". The Emerging Issues Task Force (\"EITF\") of the FASB reached a consensus (EITF 93-18) in March 1994 as to the definition of \"other than temporary\". The EITF concluded that if the projected yield on the carrying value of an investment is less than a risk free rate, the decline in value is considered to be other than temporary and the investment is written down to its fair value as the new cost basis. The amount of the write down, if any, is included in current earnings (i.e. accounted for as a realized loss). Prior to SFAS No. 115 and EITF 93-18 the Company wrote down its Mortgage Assets only when the undiscounted future estimated cash flows were less than the carrying value in accordance with EITF 89-4.\nSFAS No. 115 became effective for years beginning after December 15, 1993; however an enterprise was permitted to apply this statement effective in the fourth quarter of 1993. Prior years' financial statements were not permitted to be restated. The Company elected to adopt SFAS No. 115 in the fourth quarter of 1993.\nThe Company is not in the business of trading its Mortgage Assets; however, from time to time the Company may sell an investment as part of its efforts to adjust its portfolio composition to reflect changes in economic conditions. As such, the Company does not meet the stringent requirements of SFAS No. 115 related to classifying its real estate investments as held-to-maturity and, therefore, has classified all of its real estate investments as available-for-sale.\nThe Company recognized a $9,879,000 charge to earnings in 1993 from the cumulative effect at December 31, 1993 of adopting the new standard for assets which meet the definition of other than temporary impairment. For assets which do not meet the definition of other than temporary impairment and for assets where the fair value exceeds amortized cost, the Company has recorded, as a cumulative effect of change in accounting for investments, a net unrealized gain of $1,351,000 as a separate component of equity as prescribed by SFAS No. 115 for assets classified as available-for-sale. Prior years' consolidated financial statements were not permitted to be restated.\nResults of Operations\nThe Company had net income of $2,537,000, or $0.31 per share, for the year ended December 31, 1994. For the year ended December 31, 1993 it had a net loss of $25,439,000, or $3.14 per share. The 1993 loss included $9,879,000, or $1.22 per share, as the cumulative effect of a change in accounting for real estate investments occasioned by the Company's decision to adopt SFAS No. 115 as of its fiscal year ended December 31, 1993. Additionally, the 1993 net loss included write-downs of Mortgage Assets of $12,388,000. This loss compares to a net loss for the year ended December 31, 1992 of $21,387,000, or $2.64 per share. The 1992 net loss included write-downs of mortgage assets of $25,047,000. The Company declared dividends totaling $162,000 for 1994, or $0.02 per share as compared with $1,621,000 for 1993, or $0.20 per share. 1992 dividends declared totaled $4,942,000, or $0.61 per share. The Company's first and second quarter 1992 dividends were based on the Company's best estimate of taxable income for 1992 at the time the dividends were declared. When it became apparent that the Company might have a taxable loss for the year, the dividend was lowered to $0.05 per share. The Company also anticipated a taxable loss for 1993 and retained its quarterly dividend policy of $0.05 per share throughout the year. The 1994 dividend of $0.02 per share was declared to minimize the Company's corporate income taxes.\n1994 Compared to 1993\nAs a result of the accounting change described above which adjusted the carrying value of the Company's Mortgage Assets to fair value, 1994 operating results were likely to be favorable in most stable interest rate environments. As shown in the Net Interest Income Analysis below, the average yield from residual interests and IO bonds was 35.65% and 18.77%, respectively.\nNet interest margin (interest income from Mortgage Certificates net of interest expense on CMOs) improved to a net interest expense of $689,000 in 1994 from net interest expense of $1,450,000 in 1993 as shown in the following table.\n(In thousands) 1994 1993 Change\nInterest Income from $17,518 $33,160 ($15,642 Mortgage Certificates ) Amortization of Market 780 3,713 (2,933) Discount Net Interest Income 18,298 36,873 (18,575)\nInterest Expense on CMOs 17,528 33,302 (15,774) Amortization of Original 1,459 5,021 (3,562) Issue Discount Net Interest Expense 18,987 38,323 (19,336)\nNet Interest Margin ($ ($ $ 689) 1,450) 761\nNet interest margin continues to be negative because of the retirement of some of the lower coupon bonds leaving primarily bonds which bear an interest rate equal to or close to the mortgage rate.\nInterest expense on repurchase agreements decreased from $568,000 in 1993 to $509,000 in 1994. This the result of a decrease in the average amount of debt outstanding from $15,234,000 in 1993 to $9,854,000 in 1994. However, this was reduction offset by an increase in the weighted average interest rate from 3.70% in 1993 to 5.10% in 1994. Management and residual interest administration fees declined in 1994 because of the lower level of average invested assets which arose from the 1993 write downs of Mortgage Assets. In 1994 the Company incurred management fees of $121,000 and residual interest administration fees of $100,000 as compared to fees of $179,000 and $110,000, respectively, in 1993. General and administrative expense declined from $1,430,000 in 1993 to $1,229,000 in 1994 because costs of stockholder communications and the capitalization in 1994 of certain consulting fees.\n1993 Compared to 1992\nThe increases in both actual mortgage prepayments and the forecasted level of future prepayments which gave rise to substantial write downs of Mortgage Assets commencing in mid-1992 continued throughout 1993. As a result, the Company sustained a net loss before the cumulative effect of the change in accounting for real estate investments of $15,560,000 or $1.92 per share. This compares to a net loss of $21,387,000 or $2.64 per share in 1992. Write downs in 1993 totaled $12,388,000 as compared to $25,047,000 in 1992. The carrying values of these assets were adjusted so that their book values at the end of each quarter equaled the sum of their projected future cash flows based on an assumed continuation of the high prepayment speeds. The projected increase in future prepayments shortened the anticipated future life of the investments and therefore reduced their existing values. The higher prepayments also caused lower income on some of the Company's Mortgage Assets which did not require downward adjustments.\nNet interest margin (interest income from Mortgage Certificates net of interest expense on CMOs) declined from $1,590,000 in 1992 to a net interest expense of $1,450,000 in 1993 because of the retirement of some of the lower coupon bonds leaving primarily bonds which carried an interest rate equal to or close to the mortgage rate. Net interest margin was also adversely impacted by changes in non-cash expenses related to the mortgages and bonds such as an increase in total amortization of bond issuance costs and discount on Mortgage Certificates and CMOs from $1,566,000 in 1992 to $3,016,000 in 1993.\nInterest expense on repurchase agreements decreased from $781,000 in 1992 to $568,000 in 1993 because of the lower average interest rate in 1993 as well as the decreased level of short-term borrowings. Management and residual interest administration fees declined in 1993 because of the decreased level of average invested assets arising from the write downs of mortgage-related assets. In 1993 the Company incurred management fees of $179,000 and residual interest administration fees of $110,000 as compared to management fees of $276,000 and residual interest administration fees of $100,000 in 1992. General and administrative expense in 1993 was $431,000 greater than in 1992 because of increased accounting fees related to tax matters, the employment of outside consultants to aid in the development of future investment strategies for the Company, increased franchise and excise taxes and increases in overhead expenses.\nOutlook\nBecause mortgage interest rates increased in 1994, the high level of prepayments experienced in 1992 and 1993 subsided. As a result, most of the Company's Mortgage Assets yielded income in 1994 approximately equal to the amounts projected at the end of 1993. If mortgage interest rates remain stable or increase, the Company will continue to show profits on these assets. If mortgage rates decline sufficiently to cause prepayments to increase, the Company will again have write downs on certain of its single family Mortgage Assets.\nThe Company has determined that it will direct its future investments to multifamily residential properties and Commercial Securitizations. On December 29, 1994 the Company entered into a definitive agreement to acquire four multifamily housing properties in California's Central Valley. These properties consist of 539 units together with 9.75 acres of unimproved land slated for development of an additional 126 units. The properties will be purchased in a series of closings occurring between mid- January and mid-September, 1995. The aggregate purchase price for the properties will be $29,275,000, including existing debt to be assumed by the Company. During the second and fourth quarters of 1994, the Company acquired subordinate interests in Commercial Securitizations for $1,232,000.\nThe Company has generated significant tax loss carryforwards from losses experienced over the last several years. The Company has continued to generate cash flows from its Mortgage Assets and it is expected that in the future, to a large degree, these cash flows will represent a return of investment principal to the Company and not taxable income required to be distributed as dividends to stockholders. The Company has been seeking suitable real estate assets and Commercial Securitizations which would generate cash flows for additional reinvestment. Should these activities be successful, the Company would be in a tax position to continue to use cash flows to rebuild its investment portfolio prior to resuming taxable dividend payments.\nEffect of Interest and Prepayment Rates on Net Income\nThe Company's income from its investments in Residual Interests is attributable to its share of the Residual Cash Flow. \"Residual Cash Flow\" is the difference between (i) the cash flow from the collateral pledged to secure a CMO together with reinvestment income and (ii) the amount required for debt service payments on the CMO bonds together with related administrative expenses. Residual Cash Flow results from the positive interest rate spread between the collateral pledged to secure a CMO and the outstanding CMO bonds of the CMO, and other factors inherent in the CMO structure.\nIncome from Residual Cash Flow on an individual Residual Interest is highest in the earlier years of a CMO since the CMO bonds having earlier stated maturities generally have lower interest rates. Such income will decline (and eventually terminate) over the life of the CMO since (i) progressively higher interest rates on later maturing CMO bonds reduce the positive spread between the weighted average interest rate on the CMO bonds and the weighted average pass-through rate on the collateral and (ii) the administrative expenses of the CMO as a percentage of the spread will increase as the outstanding principal balance of the collateral declines.\nThe amount of income that may be generated from the Company's ownership in Residual Interests is dependent upon the rate of principal prepayments on Mortgage Loans which underlie the CMO bonds. Lower rates of prepayment mean a longer life for the Residual Interest and thus higher income. Similarly, faster rates of prepayment mean a shorter life for the Residual Interest and lower income. The rate of principal payments on mortgage loans is influenced by a variety of economic, geographic, social and other factors, but probably the most important factor is the level of prevailing mortgage rates. In general, if prevailing mortgage interest rates rise significantly above the interest rates on the collateral pledged to secure the CMOs, such collateral is likely to experience lower prepayment rates and hence the Residual would have higher income. Conversely, if mortgage interest rates fall significantly, prepayments increase and income from the Residual Interests would be less.\nA PO Bond is a bond which passes through only the principal portion of a mortgage-backed security. PO Bonds are created by splitting the principal cash flows from the coupon interest on a CMO Bond to create the PO Bond and an associated IO Bond. PO Bonds are sold at a deep discount to face value. They pay no periodic coupon interest. Principal is returned in the form of scheduled amortization and mortgage prepayments. Ultimately, the entire face amount of a PO Bond is repaid to the investor. Because there is no coupon, the income performance of a PO Bond is extremely sensitive to prepayments. Higher prepayments lead to a more rapid return of principal and a higher yield and lower prepayments lead to a slower return of principal and a lower yield. However, since a PO Bond is sold at a discount to its face value, and the total face value is ultimately received, the total yield on a PO Bond cannot drop below zero.\nIO Bonds pass through a specified interest portion of a CMO. The interest due on an IO Bond is calculated by multiplying this interest rate times the outstanding balance of the underlying mortgage pools. As the balance of the underlying mortgages decline to zero, payments on the IO Bond also decline to zero. Usually the interest on the underlying mortgages is fixed. If the interest rate is variable, it is called a Floating Rate IO Bond. If the variable rate of interest is inversely related to an index, it is called an Inverse IO Bond. A regular IO Bond is similar to a fixed rate Residual Interest, in that its yield will generally increase as interest rates increase and decrease as interest rates decline. An Inverse IO is similar to a LIBOR or COFI indexed Residual. In general its yield will decrease as interest rates increase and increase as interest rates decline.\nThe Company's income from Residual Interests in CMOs which includes one or more LIBOR or COFI Bond Classes and from Inverse IO Bonds may fluctuate widely depending upon changes in the LIBOR or COFI rates, which will affect the amount of interest payable on such LIBOR or COFI bonds and on the Inverse IO Bond. The Company's income also will be affected by the relationship between changes in these rates and mortgage prepayments. As a result of 1994 return of principal and interest earnings, the composition of the Company's Structured Securities was approximately 23% fixed rate, 24% COFI, 31% IO Bonds and 22% inverse IO bonds. As a result of 1993 reinvestments, write downs, and return of principal, the composition of the Company's Structured Securities was approximately 31% fixed rate, 19% COFI, 19% IO Bonds and 31% Inverse IO Bonds at December 31, 1993. Because of this balance, the cash flow characteristics of the Company's Structured Securities are intended to complement each other in a way that, to some extent, hedges the portfolio internally. The goals are to avoid undue future interest rate risk and to obtain greater ability to produce steady cash flow levels.\nUnder certain extended high interest rate periods or in the event of extremely high prepayment rates on the Collateral, the return on the Company's investment in a Residual Interest or IO Bond could be significantly reduced. In the event that the projected return on Structured Securities falls below a risk free rate, the Company would be required to write down the asset to a fair value.\nLiquidity and Capital Resources\nThe Company uses its cash flow to provide working capital to pay its expenses and debt service, acquire other assets and, at the discretion of the Board of Directors, to pay dividends to its shareholders. In 1994 the Company generated cash flow from its operations of $7,914,000 as compared to $4,342,000 in 1993, whereas in 1992 the Company used $5,934,000 of cash to support operations.\nAt December 31, 1994 the Company had outstanding borrowings with one investment banking firm under repurchase agreements totaling $8,325,000. All of the borrowing had initial terms of one month, are renewed on a month- to-month basis and have a floating rate of interest which is tied to the one month LIBOR rate. The weighted average interest rate of these borrowings at that date was 6.9776%. At December 31, 1993 the Company had outstanding borrowings with two investment banking firms under repurchase agreements. At that date the Company owed $11,745,000. The weighted average interest rate of these borrowings was 3.65%. At December 31, 1994, the Company had no other borrowings or committed lines of credit.\nManagement of the Company believes that the cash flow from operations and availability of repurchase agreements are sufficient to enable the Company to meet its current and anticipated future liquidity requirements including payment of dividends to its shareholders, which must equal at least 95% of the Company's taxable income in order for the Company to qualify as a REIT.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nTIS Mortgage Investment Company and Subsidiary\nReport of Independent Public Accountants ........................... 35\nConsolidated Balance Sheets - December 31, 1994 and 1993 ........... 36\nConsolidated Statements of Operations for the years ended December 31, 1994, 1993 and 1992 ................................ 37\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1994, 1993 and 1992 .................... 38\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 ................................ 39\nNotes to the Consolidated Financial Statements ..................... 40\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and Board of Directors of TIS Mortgage Investment Company:\nWe have audited the accompanying consolidated balance sheets of TIS Mortgage Investment Company (a Maryland corporation) and Subsidiary 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. 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 TIS Mortgage Investment Company 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 2, in 1993 the Company changed its method of accounting for its investments to adopt the provisions of Statement of Financial Accounting Standards No. 115 - Accounting for Certain Investments in Debt and Equity Securities.\nSan Francisco, California, March 21, 1995\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\n1. The Company\nTIS Mortgage Investment Company (the \"Company\") was incorporated on May 11, 1988. At incorporation 100 shares of the Company's Common Stock were issued to TIS Financial Services, Inc., formerly Thrift Investment Services (the \"Manager\") at $10 per share. During the period from the Company's incorporation until August 26, 1988, the Company's activities consisted solely of preparations for its initial public offering. On August 26, 1988, the Company completed its initial public offering of 7,600,000 shares of Common Stock at a price to the public of $10 per share and commenced operations. On October 11, 1988, as part of the initial public offering, the Company issued an additional 500,000 shares of its Common Stock at $10 per share in connection with the exercise of an over- allotment option by the underwriters. In 1992, 5,780 shares were issued under the Company's Dividend Reinvestment and Share Purchase Plan (the \"Plan\"). No additional shares were issued in 1993 or 1994 as shares required for the Plan were purchased on the open market.\n2. Summary of Significant Accounting Policies\nOverall Methods of Accounting - On May 31, 1990, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus (Issue 89-4) for a uniform method of accounting for Residual Interests in collateralized mortgage obligations (\"CMOs\"). The consensus, among other things, required Residual Interests to be classified either as \"equity\" (and be accounted for under the Equity Method) or as \"nonequity\" (and be accounted for under a level yield method referred to as the Prospective Method). The methods described in Issue 89-4 are essentially the same as those used by the Company.\nAccounting Change - On December 31, 1993 the Company adopted Financial Accounting Standards Board Standard No. 115 (\"SFAS 115\") - Accounting for Certain Investments in Debt and Equity Securities. In accordance with this new Standard, the Company is required to classify its investments as either trading investments, available-for-sale investments or held-to-maturity investments. The Company is not in the business of trading its real estate investments, however, from time to time the Company may sell an investment as part of its efforts to adjust its portfolio composition to reflect changes in economic conditions. Therefore, the Company has classified all its real estate related investments as available-for-sale investments, carried at fair value in the financial statements. Unrealized holding gains and losses for available-for-sale investments are excluded from earnings and reported as a net amount in shareholders' equity until realized.\nAll of the Company's investments are subject to write down whenever the yield on the projected cash flows is less than a risk free rate. If the yield on the projected cash flows is less than a risk free rate, the decline in value is considered to be \"other than temporary\" and the investment is written down to its fair value as the new cost basis. The amount of the write down is included in the Company's current earnings (i.e. accounted for as a realized loss). The Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus (EITF 93-18) as to the definition of \"other than temporary\" impairment. The Company's accounting policy is consistent with this consensus.\nFor purposes of applying the impairment provisions of SFAS No. 115, the Company considers its investment in each of its Equity Residuals to be a net cash flow investment (net of CMO Bond interest payments and related CMO Bond administrative expenses). The Company measures other than temporary impairment by comparing the yield on the projected net cash flows from the Equity Residual, (i.e. Mortgage Certificates net of discounts and CMO Bond Liabilities) to a risk free rate. If the yield on the projected cash flows from the Equity Residual is less than a risk free rate, the Company records a reserve to reduce the carrying value to fair value. The fair value is calculated using the forecasted net cash flows discounted at a risk adjusted rate. The risk adjusted rate is determined by the Company using established market transactions for securities having similar characteristics and backed by collateral of similar rate and term.\nThe Company recognized a $9,879,000 charge to earnings in 1993 from the cumulative effect at December 31, 1993 of adopting the new standard for assets which meet the definition of other than temporary impairment. For assets which do not meet the definition of other than temporary impairment and for assets where the fair value exceeds amortized cost, the Company has recorded, as a cumulative effect of change in accounting for investments, a net unrealized gain of $1,351,000 directly to equity as prescribed by SFAS No. 115 for assets classified as available-for-sale. Prior years' consolidated financial statements were not permitted to be restated.\nThe change in accounting principle significantly reduced the amortized cost of many of the Company's CMO Ownership Interests. As a result, it was anticipated that there would be earnings from these assets in future periods. However, faster prepayment speeds and lower estimates of cash flow from call rights may cause the fair value of CMO Ownership Interests and Acquired CMO Classes to decline further and may require additional write downs in the future.\nPrinciples of Consolidation - The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, TISMAC. The assets of TISMAC are not available to pay creditors of the Company. The Company has undertaken to indemnify certain parties who have contracted with TISMAC against certain losses which they might sustain in carrying out their obligations. In addition, under generally accepted accounting principles, the Company consolidates assets and liabilities of Owner Trust Residuals when over 50% equity interest in the trust is held by the Company. The portion of equity interest of each such Owner Trust Residual not owned by the Company is accounted for as minority interest.\nMortgage Certificates and CMOs - Mortgage certificates and CMO bonds of consolidated Owner Trusts are carried at their outstanding principal balance plus or minus any premium or discount, respectively.\nAmortization of Premiums and Discounts - Premiums and discounts related to mortgage certificates and CMOs are amortized to income using the interest method over the stated maturity of the mortgage certificates or CMOs.\nResidual Interests and Interest Only (IO) Bonds - Residual Interests held in bond form and Corporate Real Estate Mortgage Investment Conduit (\"REMIC\") Residual Interests, regardless of percentage ownership, are Nonequity Residual Interests and, along with IO Bonds, are accounted for under the Prospective method. Under this method, assets are carried at book value and income is amortized over their estimated lives based on a method which provides a constant yield. At the end of each quarter, the yield over the remaining life of the asset is recalculated based on expected future cash flows using current interest rates and mortgage prepayment speeds. This new yield is then used to calculate the subsequent quarter's financial statement income.\nRestricted Cash - Restricted cash represents the cash balances of CMOs in which the Company holds a Residual Interest and whose assets and liabilities are consolidated with those of the Company. This cash is not available to the Company or its creditors.\nIncome Taxes - The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended. As a REIT, the Company must distribute at least 95% of its taxable income to its shareholders. No provision has been made for income taxes in the accompanying consolidated financial statements as the Company is not subject to federal income taxes. The loss reported in the accompanying financial statements may be greater or less than the taxable loss because some income and expense items are reported in different periods for income tax purposes. Over the life of a Residual Interest or IO Bond, total taxable income will equal total financial statement income. However, the timing of income recognition may differ between the two from year to year.\nNet Income (Loss) Per Share - Net income (loss) per share is based upon the weighted average number of shares of Common Stock outstanding for 1994, 1993, and 1992, respectively.\nStatement of Cash Flows - For purposes of the statement of cash flows, the Company considers only highly liquid debt instruments with original maturities of three months or less to be cash equivalents.\n3. Taxation of Dividends Declared\nThe dividends paid by the Company of $0.02, $0.25 and $0.56 per share in the years 1994, 1993 and 1992, respectively, were fully taxable as ordinary income.\nUnder the Internal Revenue Code of 1986, a dividend declared by a REIT in December of a calendar year, which is payable to shareholders of record as of a specified date in December, will be deemed to have been paid by the Company and received by the shareholders on that record date if the dividend is actually paid before February 1st of the following calendar year. Therefore, the $0.34 dividend declared in December 1991 to shareholders of record at December 31, 1991 and paid in January 1992 was taxable income in 1991. However, since the $0.05 dividend declared in December 1992 and paid in January 1993 had a record date of January 4, 1993, it is considered 1993 income and its taxability is based on the REIT's 1993 taxable income. The Company's dividends are not eligible for the dividends-received deduction for corporations.\nAll of the 1994, 1993 and 1992 dividends paid are considered \"excess inclusion\" income. Excess inclusion income is attributable to Residual Interests for which an election has been made to be treated as a REMIC for federal income tax purposes. The portion of the Company's dividends determined to be excess inclusion income is taxable to certain otherwise tax-exempt shareholders as unrelated business income. Except for certain entities such as savings and loan associations, the portion of the dividend considered excess inclusion income may not be offset by any deductions or losses, including net operating losses.\n4. Residual Interests\nGeneral - Each CMO in which the Company has purchased a Residual Interest was rated at the time of its issuance \"AAA\" by Standard & Poor's Corporation or \"Aaa\" by Moody's Investors Service, Inc. Each such CMO is comprised of one or more classes of bonds (each, a \"Bond Class\") and was issued pursuant to an Indenture between the CMO issuer and a specified trustee. Each CMO is structured so that the principal and interest payments received from the collateral pledged to secure such CMO, together with reinvestment income thereon, will be sufficient, irrespective of the rate of prepayments on the collateral, to make timely payments of interest on each Bond Class, to begin the payment of principal on each Bond Class not later than its \"first mandatory principal date\" and to retire each Bond Class not later than its \"stated maturity.\"\nInterest on Bond Classes is payable on specified payment dates (quarterly or monthly), except with respect to \"compound interest bonds\" on which interest accrues and is added to the principal amount thereof on each payment date until the conditions set forth in the related Indenture have been satisfied, and with respect to \"principal only bonds\" which do not bear interest at a stated rate. Each other Bond Class provides for payment of interest at a fixed or variable rate for the life of such Bond Class. The interest rate on variable rate Bond Classes resets monthly based on specified margins in relation to LIBOR or COFI.\nPrincipal payments on Bond Classes are made on specified payment dates (quarterly or monthly) or in full at maturity in accordance with the terms of the related Indenture. Generally, payments of principal are allocated to the earlier maturing Bond Classes until such Bond Classes are paid in full. Payments of principal on certain Bond Classes occur pursuant to a specified repayment schedule or formula (to the extent funds are available therefore), regardless of which other Bond Classes are outstanding.\nResidual Interests are classified as either equity or nonequity. Presented on the following table is a schedule of the Nonequity Residual Interests and the Prospective Yield at December 31, 1994.\nSecuritized Residuals and Corporate REMIC Residual Interests - Both Residual Interests held in bond form and Corporate REMIC Residual Certificates are Nonequity Residual Interests and are accounted for under the Prospective Method as described in Footnote 2. Certain characteristics of the CMO Bonds in the Company's Residual Interests held in these forms are on the following tables:\nEquity Residual Interests - The Company holds interests in two Owner Trust Residuals. It also holds the Residual Interest in TISMAC 1989-1, the CMO issued by the Company's wholly-owned subsidiary. Although the underlying CMOs in these Residual Interests are not liabilities of the Company, under the requirements of generally accepted accounting principles, the Company consolidates assets and liabilities of TISMAC 1989- 1 and the Owner Trust Residuals when over 50% equity interest in the trust is held by the Company. Under the underlying bond indentures, the Company would never be required to pay more than the outstanding principal balance to retire the CMO Bonds. Therefore, the carrying value of these CMO Bonds are reasonable estimates of their fair value to the Company. Certain characteristics of the CMO Bonds in the Equity Residual Interests in which the Company holds an interest are set forth below:\nCMO Collateral - The table below sets forth certain characteristics of the mortgage collateral pledged to secure each CMO in which the Company holds a Residual Interest.\n5. Interest Only (IO) Bonds\nIO Bonds include both regular IO Bonds and Inverse IO Bonds. No IO Bonds were purchased in 1994; however, during 1993, the Company invested $4,069,000 in IO Bonds; in 1992 the Company invested $30,760,000 in IO Bonds. Presented below is a schedule of the Company's IO Bonds and the Prospective yield at December 31, 1994.\nCertain characteristics of the Company's IO Bonds are on the following table:\n6. Fair Value of Equity Residuals and Mortgage Certificates\nFor purposes of determining fair value of the Company's investment in Equity Residuals in applying SFAS No. 115, the Company uses the cash flows from Mortgage Certificates, net of CMO Bond interest expenses and related trustee expenses. The Company includes in its net cash flows an assumption of redemption of the Series at the earliest available stated redemption date with an assumed sale of the Mortgage Certificates at a current market price. These cash flows are discounted at a fair value rate of 14%. The following table gives the pertinent fair value assumptions used in forecasting the cash flows as of December 31, 1994:\nFor purposes of SFAS No. 107, the Company is required to disclose the fair value of its Mortgage Certificates. Information with respect to the fair value of the mortgage certificates collateralizing the CMO Bonds is presented in the table below as of December 31, 1994. The Company is not able to sell the mortgage collateral, and therefore realize any gain, until the CMO Bonds which are collateralized by the mortgages mature or are called in accordance with the underlying bond indenture.\n7. Fair Value of Nonequity Residual Interests and IO Bonds\nGeneral - Substantially all income to the Company is derived from the cash flows from the Company's Residual Interests and IO Bonds. The fair value of a Residual Interest and an IO Bond is the net present value of the projected future cash flows. The amount of cash flows that may be generated from the Company's Residual Interests and IO Bonds are uncertain and may be subject to wide variations depending primarily upon the rate and timing of prepayments on the mortgage collateral and, for Residual Interests with variable rate Bond Classes and Inverse IO Bonds, changes in LIBOR and COFI. The following information sets forth assumptions used to calculate the projected cash flows on the Company's Residual Interests and IO Bonds, and the present value of these assets at December 31, 1994 based on various assumptions and discount factors.\nAssumptions - For purposes of the presentations below, the Nonequity Residual Interests have been separated into two groups: Residual Interests in CMOs with fixed rate Bond Classes and Residual Interests in CMOs with one or more LIBOR or COFI Bond Classes still outstanding. The IO Bonds have been separated into two groups: regular IO Bonds and Inverse IO Bonds. For purposes of projecting future cash flows, the following December 31, 1994 one-month LIBOR rate and the 11th District COFI rate for October which was released in December 1994 are used:\nPrincipal payments on mortgage loans may be in the form of scheduled amortization or prepayments (for this purpose, \"prepayments\" includes principal prepayments and liquidations due to default or other dispositions). The prepayment assumptions used herein are based on an assumed rate of prepayment each month of the unpaid principal balance on a pool of mortgage loans. A 100% prepayment assumption assumes prepayment rates of 0.2% per annum of the then outstanding principal balance of such mortgage loans in the first month of the life of such mortgage loans and an additional 0.2% per annum in each month thereafter (for example, 0.4% per annum in the second month) until the 30th month. Beginning with the 30th month and in each month thereafter during the life of such mortgage loans, a 100% prepayment assumption assumes a constant prepayment rate of 6% per annum.\nThe prepayment assumptions used to estimate the fair value of the Company's Nonequity Residual Interests and IO Bonds are the Bloomberg Financial Markets (\"Bloomberg\") Dealer Prepayment Estimates Average as estimated by several dealers in mortgage-related assets and compiled by Bloomberg as of January 3, 1995. Bloomberg has obtained this information from sources it believes to be reliable but has not verified such information and assumes no responsibility for the accuracy of such information. The following are the prepayment assumptions used to project cash flows in order to calculate the present value of Nonequity Residual Interests and IO Bonds:\nNeither the interest rates nor the prepayment assumptions used herein purports to be a historical description of interest rates or prepayment experiences or a prediction of future interest rates or prepayments of any pool of mortgage loans. The fair value of these assets can vary dramatically depending on future interest rates, prepayment speeds and the discount factor used.\nPresent Value of Projected Cash Flows - The tables which follow set forth the present value at December 31, 1994 of the projected cash flows discounted at the indicated discounted rates subject to the assumptions described above. For example, if cash flows are projected using the Bloomberg Financial Markets (\"Bloomberg\") Dealer Prepayment Estimates Average, as estimated by several dealers in mortgage-related assets and compiled by Bloomberg as of January 3, 1995, and Nonequity Residual Interests in CMOs with fixed rate Bond Classes are discounted at 14%, and the Nonequity Residual Interests in CMOs with variable rate Bond Classes are discounted at 18%, the present value of the projected cash flows of the Company's Nonequity Residual Interests would equal approximately $8,675,000. This is the Company's estimate of the fair value of these assets. In addition, if cash flows on the Company's regular IO Bonds are discounted at 14% and the cash flows on its Inverse IO Bonds are discounted at 30%, the present value of the projected cash flows on the IO Bonds would equal $9,558,000. This represents a decrease of $236,000 from the $9,794,000 book value of these assets. The difference of $236,000 is the difference between the present value of cash flows and the actual market values as of December 31, 1994 of FNMA SMBS Trust 7 Class 2 IO and FNMA SMBS Trust 4 Class 2 IO. The book value is the Company's estimate of the fair value of these IO Bonds. There will be differences between the projected cash flows used to calculate the present value of these assets and the actual cash flows received by the Company, and such differences may be material.\n8. Short Term Debt\nShort term debt is debt due within 360 days after the end of the year. At December 31, 1994 the Company owed $8,325,000 under one repurchase agreement. All of the borrowings had initial terms of one month, are renewed on a month-to-month basis and have a floating rate of interest which is tied to the one month LIBOR rate. The weighted average interest rate of such borrowings at December 31, 1994 was 6.9776%. At December 31, 1993 short-term borrowings totaled $11,745,000 and had a weighted average interest rate of 3.652%. The Company has no committed lines of credit.\n9. Related Party Transactions\nThe Company has entered into an agreement (the \"Management Agreement\") with the Manager which is renewable annually. In June 1994 the Board of Directors renewed the Management Agreement through June 30, 1995 and it is thereafter renewable annually.\nThe Manager advises the Company on various facets of its business and manages its operations, subject to supervision by the Company's Board of Directors. For performing these services, the Manager receives a base management fee of 3\/8 of 1% per annum of the Company's average invested assets and an incentive management fee equal to 25% of the amount by which the Company's annualized return on equity, calculated based on taxable income, exceeds the ten-year U.S. Treasury rate plus 1%. Management fees of $121,000, $179,000 and $276,000 were earned in 1994, 1993 and 1992, respectively. Within two months of the applicable year end, $32,000 of the 1994 fees, $31,000 of the 1993 fees and $59,000 of the 1992 fees were paid. In order to compensate the Manager for certain administrative functions that the Manager performs with respect to each Residual Interest purchased by the Company, for which neither the Manager nor an affiliate acts as bond administrator, the Company pays the Manager a fee equal to $10,000 per annum for each Residual Interest. A total of $100,000 of these Residual Interest Administration fees were earned by the Manager and paid in 1994 as compared to $110,000 in 1993 and $100,000 in 1992. For 1994, 1993 and 1992, the Manager did not charge a Residual Interest Administration Fee on those Residual Interests for which it projected total 1995, 1994 and 1993 income of less that $40,000. In addition, the Manager is reimbursed for certain direct expenses incurred on behalf of the Company. At December 31, 1994 and 1993, all of these reimbursable expenses were paid to the Manager. At December 31, 1992, $29,000 of these reimbursable expenses were due to the Manager. This amount was paid within one month after the applicable year end.\n10. Wholly-Owned Subsidiary\nOn October 21, 1988 TISMAC, the wholly-owned Subsidiary of the Company, was incorporated for the purpose of issuing CMOs directly. At incorporation 100 shares of TISMAC's common stock were issued to the Company for $100. The assets of the Subsidiary are not available to pay creditors of the Company. The Company has undertaken to indemnify certain parties who have contracted with the Subsidiary against certain losses which they might sustain in carrying out their obligations.\n11 . Other Fair Value Disclosure\nThe Company has the following other financial instruments: cash and cash equivalents, accrued interest and accounts receivable, accounts payable and accrued liabilities, accrued interest payable, short term debt and dividends payable. The carrying amounts of these instruments are reasonable estimates of their fair value due to their short term nature.\n13. Acquisition of Multifamily residential property.\nOn December 29, 1994 the Company entered into a definitive agreement to acquire four multifamily housing properties in California's Central Valley. These properties consist of 539 units together with 9.75 acres of unimproved land slated for development of an additional 126 units. The properties will be purchased in a series of closings occurring between mid- January and mid-September 1995. The aggregate purchase price for the properties will be $29,275,000, including existing debt to be assumed by the Company. The purchase of the first two properties occurred in January and February 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. Information about Directors and Executive Officers of the Registrant.\nInformation required to be set forth hereunder has been omitted and will be incorporated by reference, when filed, to the company's Proxy Statement for its 1995 Annual Meeting of Stockholders to be held on June 7, 1995.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation required to be set forth hereunder has been omitted and will be incorporated by reference, when filed, to the company's Proxy Statement for its 1995 Annual Meeting of Stockholders to be held on June 7, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation required to be set forth hereunder has been omitted and will be incorporated by reference, when filed, to the company's Proxy Statement for its 1995 Annual Meeting of Stockholders to be held on June 7, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation required to be set forth hereunder has been omitted and will be incorporated by reference, when filed, to the company's Proxy Statement for its 1995 Annual Meeting of Stockholders to be held on June 7, 1995.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements and Reports on Form 8-K.\n(a) Documents filed as part of this report:\nConsolidated financial statements of the Company - al listed in the \"Index to Financial Statements\" included in Part II, Item 8 of this Form 10-K\nAll financial statement schedules not included have been omitted because of the absence of conditions under which they are required or because the information is given in the consolidated financial statements and notes included in Part II, Item 8 of this Form 10-K. (3) Exhibits:\nNumber Exhibit ------ ------- 3(a) Amended Articles of Incorporation of the Registrant* 3(b) Amended Bylaws of the Registrant 4(a) Specimen Certificate representing $.001 par value Common Stock* 4(b) Dividend Reinvestment and Share Purchase Plan** 10(b) Management Agreement between the Registrant and TIS Financial Services, Inc. ***** 10(c) Bonus Program*** 10(d) Custody Agreement between Registrant and Mellon Bank N.A.**** 10(e) Transfer Agency Agreement between Registrant and Mellon Securities Trust Company**** 10(f) Reverse Repurchase Agreement between Registrant and Kidder, Peabody & Co.**** 10(g) Reverse Repurchase Agreement between Registrant and The First Boston Corporation**** 10(h) Reverse Repurchase Agreement between Registrant and Bear, Stearns Securities Corp.***** 10(i) Reverse Repurchase Agreement between Registrant and Shearson Lehman Brothers***** 22 Subsidiaries of the Registrant***** 24 Consent of Arthur Andersen LLP --------------------------------------------------------------------------- ___________________________________ * Incorporated herein by reference to Registrant's Registration Statement on Form S-11 (No. 33-22182) declared effective August 19, 1988.\n** Incorporated herein by reference to Pre-Effective Amendment No. 1 to Registrant's Registration Statement on Form S-3 (No. 33-44526) filed with the Securities and Exchange Commission on December 30, 1991.\n*** Incorporated herein by reference to Registrant's Annual Report on Form 10-K (File No. 1-10004) filed with the Securities and Exchange Commission on April 2, 1990.\n**** Incorporated herein by reference to Registrant's Annual Report on Form 10-K (File No. 1-10004) filed with the Securities and Exchange Commission on March 30, 1992.\n***** Incorporated herein by reference to Registrant's Annual Report on Form 10-K (File No. 1-10004) filed with the Securities and Exchange Commission on March 30, 1993.\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.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTIS MORTGAGE INVESTMENT COMPANY\nDate: March 24, 1995 By: \/s\/ Lorraine O. Legg -------------- ---------------------- Lorraine O. Legg, Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/ Lorraine O. Legg Director, President and March 24, 1995 ----------------------- Principal Executive Officer Lorraine O. Legg\n\/s\/ John E. Castello Executive Vice President March 24, 1995 ----------------------- (Principal Financial Officer) John E. Castello\n\/s\/ Michael J. Stone Controller March 24, 1995 ----------------------- Michael J. Stone\n\/s\/ Patricia M. Howe Director, March 24, 1995 ----------------------- Chairman of the Board Patricia M. Howe\n\/s\/ John D. Boyce Director March 24, 1995 ----------------------- John D. Boyce\n\/s\/ Robert H. Edelstein Director March 24, 1995 ----------------------- Robert H. Edelstein\n\/s\/ Douglas B. Fletcher Director March 24, 1995 ----------------------- Douglas B. Fletcher\n\/s\/ Robert W. Ledoux Director March 24, 1995 ----------------------- Robert W. Ledoux\n\/s\/ Harvie M. Merrill Director March 24, 1995 ----------------------- Harvie M. Merrill\n\/s\/ Will M. Storey Director March 24, 1995 ----------------------- Will M. Storey","section_15":""}
{"filename":"88255_1994.txt","cik":"88255","year":"1994","section_1":"Item 1. Business.\nSears Roebuck Acceptance Corp. (\"SRAC\") is a wholly-owned subsidiary of Sears, Roebuck and Co. (\"Sears\"). SRAC raises funds primarily from the direct placement of commercial paper with corporate and institutional investors and through intermediate-term loans. SRAC uses borrowing proceeds to acquire short-term notes of Sears and purchase outstanding customer receivable balances from Sears. Sears uses the funds obtained from SRAC for general funding purposes.\nIn 1994, SRAC borrowed $845 million of intermediate-term loans having original maturities between two and five years. In March 1995, SRAC filed a registration statement with the Securities and Exchange Commission for the registration of debt securities.\nSRAC's income is derived primarily from the earnings on its investment in the notes and receivable balances of Sears. The interest rate on Sears notes is presently calculated so that SRAC maintains an earnings to fixed charge ratio of at least 1.25 times. The yield on the investment in Sears notes is related to SRAC's borrowing costs and, as a result, SRAC's earnings fluctuate in response to movements in interest rates and changes in Sears short-term borrowing requirements.\nIn January 1995, Moody's Investors Service raised its ratings on SRAC's Commercial Paper (to P-1 from P-2). Other ratings for SRAC's commercial paper are from Fitch Investors Service, Duff-1 from Duff and Phelps Credit Rating Co. and A-2 from Standard & Poor's.\nIn 1994, SRAC took steps to bring its liquidity support and capital resources into alignment with projected funding requirements. SRAC's credit facilities, which totalled $4.2 billion at the end of 1993, were replaced with a syndicated credit agreement totalling $4.5 billion, a syndicated minority bank credit agreement totalling $32 million and $600 million of uniform credit agreements with individual banks.\nSRAC continues to be a very strongly capitalized company, with an equity position of $1.2 billion. The company's debt-to-equity ratio was 5.0:1 at the end of 1994 compared to 2.6:1 at the end of 1993.\nPursuant to the syndicated credit agreements between SRAC and various banks (detailed below in Item 8 \"Notes to Financial Statements, note 5\"), the agreement between SRAC and Sears concerning SRAC's investment in Sears notes may not be amended, waived, terminated or modified (except that SRAC's fixed charge coverage ratio may be reduced to 1.15) without the approval of such banks.\nFrom time to time, SRAC acts as placement agent for Sears Credit Corp. A, Sears Credit Corp. B, Sears Credit Corp. I and Sears Credit Corp. II (collectively \"SCC\"), which are wholly-owned subsidiaries of Sears that issue asset-backed commercial paper (\"ABCP\"). The ABCP is secured by investor certificates acquired by SCC, which represent undivided interests in a trust. The trust holds receivables arising in selected accounts under Sears open-end credit plans, all payments received on the receivables including related finance charges, and deposits in certain accounts of the trust. At February 28, 1995, SRAC had 11 employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nNone.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nNone.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\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 SRAC's common stock. As of February 28, 1995, Sears owned all outstanding shares of SRAC's common stock. The Board of Directors of SRAC declared a $1.7 billion dividend on December 20, 1993 to Sears, payable on December 30, 1993. The Board also approved payment to Sears on December 30, 1993 of $330.2 million out of capital in excess of par value; such payment is characterized as a dividend under the Delaware General Corporation Law. Payments for these transactions were effected by reducing SRAC's investment in the notes of Sears by approximately $2.0 billion. SRAC does not intend to pay any cash or other dividends on its common stock in the foreseeable future.\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.\nFinancial Condition\nSRAC's investment in Sears notes increased to over $6.8 billion at year-end 1994, from $3.4 billion at the end of 1993, due to increased funding requirements by Sears. In response to Sears increased funding requirements, total commercial paper outstandings increased from $2.5 billion at the beginning of the year to $4.9 billion at the close of 1994. SRAC also borrowed $845 million under 15 privately-placed variable rate intermediate-term loans with original maturities from two to five years. At the end of 1994, SRAC maintained a very strong equity position of $1.2 billion, with a debt-to-equity ratio of 5.0:1.\nSRAC had investments in highly liquid short-term securities of $100.7 million at the end of 1994, as part of its liability management program. In 1994, SRAC took steps to bring its liquidity support into alignment with projected funding requirements. SRAC's credit facilities, which totalled $4.2 billion at the end of 1993, were replaced with a syndicated credit agreement totalling $4.5 billion, a syndicated minority bank credit agreement for $32 million and $600 million in uniform credit agreements with individual banks.\nIn March 1995, SRAC filed a registration statement with the Securities and Exchange Commission for the registration of debt securities.\nResults of Operations\nUnder an agreement with Sears, SRAC is presently guaranteed a rate on the notes of Sears providing a ratio of earnings to fixed charges of at least 1.25 times. SRAC's total revenues of $282.7 million declined $54.8 million, or 16%, compared to $337.5 million in 1993, primarily due to a decrease in the average Customer Receivable Balances purchased from Sears during 1994. In 1994, SRAC's average cost of short-term funds increased 90 basis points to 4.57% from 3.67% in 1993. Average outstanding short- term debt of $3,739.7 million declined $581 million compared to $4,320.7 million in 1993. The 13% decrease in average outstanding debt during 1994, resulted in a $17.6 million, or 7%, decrease in interest and related expenses to $218.5 million in 1994 from $236.1 million in 1993. In 1994, SRAC purchased receivables from Sears with recourse, thereby not requiring a loss provision, compared to the receivables purchased in 1993 without recourse which required a loss provision of $33.8 million. As a result, total expenses decreased $56.3 million, or 20%, to $220.4 million from $276.7 million in 1993 and SRAC's 1994 net income increased $.7 million, or 2%, to $40.2 million from net income of $39.5 million in 1993. In 1993, SRAC's net income decreased 63% from $108.1 million in 1992, primarily due to a reduction in the Sears notes during 1993.\nThe financial information appearing in this annual report on Form 10-K is presented in historical dollars which do not reflect the decline in purchasing power that results from inflation. As is the case for most financial companies, substantially all of SRAC's assets and liabilities are monetary in nature. Interest rates on SRAC's combined investment in Sears notes (set to provide a fixed charge coverage of at least 1.25 times) and customer receivable balances help insulate SRAC from the effects of inflation-based interest rate increases.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nSEARS ROEBUCK ACCEPTANCE CORP. STATEMENTS OF INCOME Year Ended December 31, millions 1994 1993 1992 ------- ------- ------- Revenues -------- Earnings on notes of Sears $257.9 $209.1 $508.4 Earnings on receivable balances purchased from Sears (Note 3) 6.2 105.4 125.3 Earnings on invested cash 18.4 22.6 61.9 Other revenues 0.2 0.4 0.9 ------- ------- ------- Total revenues 282.7 337.5 696.5\nExpenses -------- Interest and amortization of debt discount and expense 218.5 236.1 482.8 Provision for credit losses -- 33.8 44.9 Operating expenses 1.9 6.8 4.6 ------- ------- ------- Total expenses 220.4 276.7 532.3 ------- ------- ------- Income before income taxes 62.3 60.8 164.2 Income taxes (Note 2) 22.1 21.3 56.1 ------- ------- ------- Net Income $40.2 $39.5 $108.1 ------- ------- ------- Ratio of earnings to fixed charges 1.29 1.26 1.34\nSee notes to financial statements.\nSEARS ROEBUCK ACCEPTANCE CORP. STATEMENTS OF FINANCIAL POSITION December 31, millions 1994 1993 --------- --------- Assets ------ Notes of Sears $6,842.5 $3,403.9 Customer receivable balances purchased from Sears (Note 3) 81.5 88.0 Cash and invested cash 102.1 650.7 Other assets 5.1 3.2 --------- --------- Total assets $7,031.2 $4,145.8 --------- --------- Liabilities ----------- Commercial paper (net of unamortized discount of $22.3 and $5.1) $4,912.9 $2,475.0 Agreements with bank trust departments 87.4 139.8 Zero coupon note - 379.8 Intermediate-term loans 845.0 - Accrued interest and other liabilities 8.2 10.7 Deferred federal income taxes - 3.0 --------- --------- Total liabilities 5,853.5 3,008.3 --------- --------- Stockholder's Equity -------------------- Capital stock, par value $100 per share 500,000 shares authorized 350,000 shares issued and outstanding 35.0 35.0 Capital in excess of par value - - Retained income 1,142.7 1,102.5 --------- --------- Total stockholder's equity 1,177.7 1,137.5 --------- --------- Total liabilities and stockholder's equity $7,031.2 $4,145.8 --------- --------- See notes to financial statements.\nSEARS ROEBUCK ACCEPTANCE CORP. STATEMENTS OF STOCKHOLDER'S EQUITY\nYear Ended December 31, millions 1994 1993 1992 -------- -------- -------- Capital stock $35.0 $35.0 $35.0 -------- -------- -------- Capital in excess of par value Beginning of year - $330.2 $330.2 Return of capital paid to Sears* - (330.2) - -------- -------- -------- End of year $- $- $330.2 -------- -------- -------- Retained income Beginning of year $1,102.5 $2,763.0 $2,654.9 Net income 40.2 39.5 108.1 Dividend paid to Sears - (1,700.0) - -------- -------- -------- End of year $1,142.7 $1,102.5 $2,763.0 -------- -------- -------- Total stockholder's equity $1,177.7 $1,137.5 $3,128.2 -------- -------- --------\n* characterized as a dividend under Delaware General Corporation Law.\nSee notes to financial statements.\nSEARS ROEBUCK ACCEPTANCE CORP. STATEMENTS OF CASH FLOWS Year Ended December 31, millions 1994 1993 1992 -------- -------- -------- Cash Flows From Operating Activities ------------------------------------ Net income $40.2 $39.5 $108.1 Adjustments to reconcile net income to net cash provided by operating activities Earnings amortization on Retail Customer Receivable Balances discount - (125.9) (149.2) Provision for credit losses - 33.8 44.9 Depreciation, amortization and other noncash items 20.9 58.7 55.3 Decrease in deferred federal income taxes (3.0) (7.1) (5.9) Increase in other assets (2.6) (2.5) (1.0) Decrease in other liabilities (2.5) (20.9) (5.4) -------- -------- -------- Net cash provided by (used in) operating activities 53.0 (24.4) 46.8\nCash Flows From Investing Activities ------------------------------------ (Increase) decrease in notes of Sears (3,438.6) 5,059.5 1,720.9 Decrease in receivable balances purchased from Sears 6.5 967.5 183.7 -------- -------- -------- Net cash (used in) provided by investing activities (3,432.1) 6,027.0 1,904.6\nCash Flows From Financing Activities ------------------------------------ Increase (decrease) in commercial paper, primarily 90 days or less 2,437.9 (6,040.3) (1,690.5) Decrease in agreements with bank trust departments (52.4) (258.1) (112.2) Payments for redemption of zero coupon and variable interest notes (400.0) - (604.0) Proceeds from issuance of intermediate-term loans 845.0 - - -------- -------- -------- Net cash provided by (used in) financing activities 2,830.5 (6,298.4) (2,406.7) -------- -------- -------- Net decrease in cash and invested cash (548.6) (295.8) (455.3) Cash and invested cash, beginning of year 650.7 946.5 1,401.8 -------- -------- -------- Cash and invested cash, end of year $102.1 $650.7 $946.5 -------- -------- -------- Supplemental Disclosure of Cash Flow Information Cash paid during the year Interest $231.1 $200.5 $444.1 Income taxes 21.7 37.1 61.0 See notes to financial statements. NOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nSears Roebuck Acceptance Corp. (\"SRAC\"), a wholly-owned subsidiary of Sears, Roebuck and Co. (\"Sears\"), is principally engaged in the business of acquiring short-term notes of Sears and purchasing outstanding customer receivable balances from Sears, using proceeds from its short-term borrowing programs (primarily the direct placement of commercial paper) and intermediate-term loans.\nUnder the letter agreement between SRAC and Sears, the interest rate on the Sears notes is presently calculated so that SRAC maintains an earnings to fixed charge ratio of at least 1.25 times.\nCash and invested cash is defined to include all highly liquid investments with maturities of three months or less. In 1993 a $2.0 billion dividend and return of capital paid to Sears was effected through a reduction in SRAC's investment in Sears notes, a noncash transaction.\nCustomer receivables purchased from Sears are either purchased at a discount and then amortized using the interest method, or purchased at par and are interest-bearing.\nThe zero coupon note issued to Sears Overseas Finance N.V. (\"SOFNV\"), a wholly-owned international finance subsidiary of Sears, was amortized using the interest method. Other debt discount and issue expenses are amortized on a straight-line basis over the terms of the related obligation.\nThe results of operations of SRAC are included in the consolidated federal income tax return of Sears. Tax liabilities and benefits are allocated as generated by SRAC, whether or not such benefits would be currently available on a separate return basis.\nEffective January 1, 1992, SRAC adopted Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions,\" and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" The adoption of the standards did not have a material impact on the financial statements of SRAC, and will have no effect on the future cash flows of the Company.\n2. FEDERAL INCOME TAXES\nYear Ended December 31, millions 1994 1993 1992 ------- ------- ------- Current $25.5 $28.4 $62.0 Deferred (3.4) (7.1) (5.9) ------- ------- ------- Financial statement income tax provision $22.1 $21.3 $56.1 ------- ------- ------- Effective income tax rates 35% 35% 34%\n3. CUSTOMER RECEIVABLE BALANCES\nSRAC has purchased two types of customer receivable balances (\"CRB\") from Sears, merchant (\"MCRB\") and retail (\"RCRB\"). MCRB are purchased with recourse at par, with SRAC earning interest on the receivables. RCRB (excluding related finance charges) were purchased without recourse and at a discount (which included an allowance for uncollectible accounts).\nMCRB are made up of credit accounts Sears has established with merchants and contractors for bulk purchases from Sears. The MCRB's are predominately paid within 30 days. RCRB were made up of accounts under Sears open-end credit plans related to the purchase of goods and services at Sears. In administering sold receivables, Sears utilizes procedures with respect to collections, charge-offs and other matters identical to those employed in administering account balances which had not been purchased by SRAC. The MCRB purchased were negotiated between related parties; accordingly, the fair value of this instrument is not provided.\nIn December 1993, SRAC sold to Sears the entire outstanding RCRB at net book value of $847.6 million. SRAC received the collections and accepted the net charge-offs (collectively referred to as liquidations) related to the RCRB and paid Sears a fee for administering the accounts. The administrative fee paid to Sears in 1993 was $20.5 million.\nEach month, SRAC purchases the balance increases in the MCRB accounts attributable to additional credit sales and receives the collections related to the previously purchased balances. Sears will pay interest to SRAC on the balances in these accounts at a rate equivalent to the prime rate.\n4. BORROWINGS\nSRAC obtains funds through the direct placement of commercial paper (issued in maturities of one to 270 days) and borrowings under agreements with bank trust departments and private institutions (intermediate-term loans). Selected details of SRAC's borrowings are shown below. Weighted interest rates are based on the actual number of days in the year and borrowings net of unamortized discount.\nThe short-term and\/or variable interest rate nature of substantially all of SRAC's financial instruments (both assets and liabilities) causes their carrying value to approximate fair value. The terms of the loan agreement with SOFNV was negotiated between related parties; accordingly, the fair value of this instrument is not provided. December 31, millions 1994 1993 -------- -------- Commercial paper outstanding $4,935.2 $2,480.1 Less: Unamortized discount 22.3 5.1 -------- -------- Commercial paper outstanding (net) 4,912.9 2,475.0 Agreements with bank trust departments 87.4 139.8 Intermediate-term loans 845.0 - Zero coupon, $400 million face value loan agreement with SOFNV due May 26, 1994 - 379.8 -------- -------- Total borrowings $5,845.3 $2,994.6 -------- -------- Commercial Paper and Agreements with Bank Trust Departments Average and Maximum Balances During the Year\n1994 1993 ------------------- ------------------- Maximum Maximum millions Average (month-end) Average (month-end) ------------------- ------------------- Commercial paper $3,615.3 $4,912.9 $3,812.1 $ 7,271.1 Agreements with bank trust dept. 124.4 142.2 401.8 499.1 ------------------- ------------------- Weighted Interest Rates 1994 1993 ------------------- ------------------- millions Average Year-End Average Year-End ------------------- ------------------- Commercial paper 4.58% 5.82% 3.64% 3.51% Agreements with bank trust dept. 4.38% 6.06% 3.38% 3.30% ------------------- -------------------\nUnder the terms of a 1986 agreement, Sears agreed to make all payments required to be made by SRAC to SOFNV in accordance with certain loan agreements between SRAC and SOFNV. SRAC remains liable to SOFNV for such loan agreements, which total $302 million as of December 31, 1994.\nSRAC's intermediate-term loans were as follows at December 31, 1994:\nTerm (millions) ------------------------------------------------------------------- Two year loans expiring in 1996 $200 Three year loans expiring in 1997 320 Five year loans expiring in 1999 325 ------------------------------------------------------------------- Total loans $845 ===================================================================\nThe rates on most of these variable rate intermediate-term loans are set periodically at Libor plus a set basis point spread. The average rate on the intermediate-term loans in 1994 was 5.41%.\n5. CREDIT FACILITIES AS OF DECEMBER 31, 1994\nContractual Credit Facilities:\nExpiration Date (millions) -------------------------------------------------------------------- June 1999 $4,500 September 1995 200 October 1995 32 December 1995 400 ------------------------------------------------------------------- Total credit facilities $5,132 ===================================================================\nCommitment fees are paid on the unused portions of the above credit facilities. The annualized fees at December 31, 1994 on these lines were $6.1 million.\n6. LETTER OF CREDIT COMMITMENTS\nSRAC issues letters of credit at Sears request to facilitate Sears purchase of goods from foreign suppliers. At December 31, 1994, letters of credit totaling $119.0 million were outstanding. SRAC has no liabilities with respect to this program other than the obligation to pay drafts under the letters of credit which, if not reimbursed by Sears on the day of the disbursement, are automatically converted into demand borrowings by Sears from SRAC. To date, all SRAC disbursements have been reimbursed on a same- day basis.\nSRAC issues standby letters of credit on behalf of its affiliate, Western Auto Supply Company (\"Western Auto\"), which are used by Western Auto to secure its obligation to repurchase any defaulted accounts receivable sold to a financial institution. At December 31, 1994, a $49.0 million standby letter of credit was outstanding.\n7. QUARTERLY FINANCIAL DATA (UNAUDITED)\nFor the quarter ended March 31, June 30, September 30, December 31, 1994 1993 1994 1993 1994 1993 1994 1993 ------------- ------------ ------------- ------------ Operating Results (millions) Combined earnings from Sears notes and CRB $47.6 $123.7 $53.9 $73.6 $72.3 $63.4 $90.3 $87.6 Total Revenues 51.1 133.2 57.1 79.0 76.3 67.0 98.2 92.1\nInterest & related expenses 40.3 96.7 45.2 54.7 55.0 44.9 78.0 39.8 Total expenses 41.1 107.7 45.7 65.0 55.8 55.7 77.8 48.3 Income before income taxes 10.0 25.5 11.4 14.0 20.5 11.3 20.4 10.0\nNet income 6.4 16.8 7.3 9.3 13.1 6.6 13.4 6.8\nRatio of earnings to fixed charges 1.25 1.26 1.25 1.26 1.37 1.25 1.26 1.25\nAverages (billions) Earning assets* $4.5 $11.3 $4.8 $7.4 $5.4 $6.2 $6.7 $6.6 Short-term debt 3.0 7.8 3.2 3.9 4.0 2.7 4.7 3.0 Cost of short-term debt 3.45% 3.98% 4.11% 3.57% 4.68% 3.31% 5.45% 3.33%\n* Notes and receivable balances of Sears and invested cash.\nCertain reclassifications have been made to the quarterly data from the classification used in reporting such data in Form 10-Q, which primarily relate to the presentation of the provision for credit losses.\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 applicable.\nItem 11.","section_11":"Item 11. Executive Compensation.\nNot applicable.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nNot applicable.\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 a part of this report:\n1. An \"Index to Financial Statements\" has been filed as a part of this report on page S-1 hereof.\n2. No financial statement schedules are included herein because they are not required or because the information is contained in the financial statements and notes thereto, as noted in the \"Index to Financial Statements\" filed as part of this report.\n3. An \"Exhibit Index\" has been filed as part of this report beginning on page E-1 hereof.\n(b) Reports on Form 8-K: There were no reports filed on Form 8-K 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.\nSEARS ROEBUCK ACCEPTANCE CORP. (Registrant)\nBy Stephen D. Carp* Vice President, Finance and Assistant Secretary\nMarch 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 date indicated.\nSignature Title Date\nKeith E. Trost Director and President ) (Principal Executive ) Officer) ) ) ) Stephen D. Carp* Vice President, Finance ) March 27, 1995 and Assistant Secretary ) (Principal Financial and ) Accounting Officer) ) ) ) James A. Blanda* Director ) ) ) James D. Constantine* Director ) ) ) Alan J. Lacy* Director ) ) ) Alice M. Peterson* Director ) ) ) Larry R. Raymond* Director ) ) ) George F. Slook* Director )\n*By \\s\\ Stephen D. Carp Individually and as Attorney-in-Fact\nSEARS ROEBUCK ACCEPTANCE CORP.\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nPAGE\nSTATEMENTS OF INCOME 5\nSTATEMENTS OF FINANCIAL POSITION 6\nSTATEMENTS OF STOCKHOLDER'S EQUITY 7\nSTATEMENTS OF CASH FLOWS 8\nNOTES TO FINANCIAL STATEMENTS 9-13\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS S-2\nS-1\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Stockholder and Board of Directors of Sears Roebuck Acceptance Corp.:\nWe have audited the accompanying Statements of Financial Position of Sears Roebuck Acceptance Corp. (a wholly-owned subsidiary of Sears, Roebuck and Co.) as of December 31, 1994 and 1993, and the related Statements of Income, Stockholder's 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 financial statements present fairly, in all material respects, the financial position of Sears Roebuck Acceptance Corp. 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.\nDeloitte & Touche LLP Philadelphia, Pennsylvania January 26, 1995\nS-2\nEXHIBIT INDEX\n3(a) Certificate of Incorporation of the Registrant, as in effect at November 13, 1987 [Incorporated by reference to Exhibit 28(c) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1987*].\n3(b) By-laws of the Registrant, as in effect at March 24, 1995.**\n4(a)(1) Form of Series A-B Note [Incorporated by reference to Exhibit 4(a)(1) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1982*].\n4(a)(2) Form of letter agreement relating to Series A-B Note [Incorporated by reference to Exhibit 4(a)(2) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1982*].\n4(b) $4,500,000,000 Credit Agreement dated as of June 7, 1994 among SRAC, the Banks listed therein and Morgan Guaranty Trust Company of New York, as Agent [Incorporated by reference on Form 8-K of the Registrant for June 7, 1994*]\n4(c) Form of Sears Roebuck Acceptance Corp. Investment Note Agreement. [Incorporated by reference to Exhibit 4(c) to Annual Report on Form 10-K of the Registrant for the year ended December 31, 1992*]\n4(d) The Registrant hereby agrees to furnish the Commission, upon request, with each instrument defining the rights of holders of long-term debt of the Registrant with respect to which the total amount of securities authorized does not exceed 10% of the total assets of the Registrant.\n10(a) Letter Agreement dated as of October 17, 1991 between Sears Roebuck Acceptance Corp. and Sears, Roebuck and Co. [Incorporated by reference to Exhibit 10 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991*].\n________________________________ * SEC File No. 1-4040. ** Filed herewith.\nE-1 EXHIBIT INDEX (cont'd)\n10(b) Letter Agreement dated as of September 2, 1986 between Sears Roebuck Acceptance Corp. and Sears, Roebuck and Co. [Incorporated by reference to Exhibit 10 to the Registrant's Current Report on Form 8-K dated September 2, 1986*].\n10(c)(1) Agreement to Issue Letters of Credit dated December 3, 1985 between Sears, Roebuck and Co. and Sears Roebuck Acceptance Corp. [Incorporated by reference to Exhibit 10(i)(1) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987*].\n10(c)(2) Letter Agreement dated March 11, 1986 amending Agreement to issue Letters of Credit dated December 3, 1985 [Incorporated by reference to Exhibit 10(i)(2) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987*].\n10(c)(3) Letter Agreement dated November 26, 1986 amending Agreement to Issue Letters of Credit dated December 3, 1985 [Incorporated by reference to Exhibit 10(i)(3) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987*].\n12 Calculation of ratio of earnings to fixed charges.**\n24 Power of attorney.**\n________________________________ * SEC File No. 1-4040. ** Filed herewith.\nE-2\nExhibit 12\nSEARS ROEBUCK ACCEPTANCE CORP.\nCALCULATION OF RATIO OF EARNINGS TO FIXED CHARGES\nYear Ended December 31, 1994 1993 1992 (dollars in millions)\nINCOME BEFORE INCOME TAXES $ 62.3 $ 60.8 $ 164.2\nPLUS FIXED CHARGES: Interest 190.5 177.6 427.6 Amortization of debt discount and expense 28.0 58.5 55.2 ------- ------- -------\nTOTAL FIXED CHARGES 218.5 236.1 482.8 ------- ------- -------\nEARNINGS BEFORE INCOME TAXES AND FIXED CHARGES $ 280.8 $ 296.9 $ 647.0 ======= ======= =======\nRATIO OF EARNINGS TO FIXED CHARGES 1.29 1.26 1.34\nExhibit 24\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each of the undersigned, being a director or officer, or both, of SEARS ROEBUCK ACCEPTANCE CORP., a Delaware corporation (the \"Corporation\"), does hereby constitute and appoint JAMES A. BLANDA, RICHARD F. KOTZ, KEITH E. TROST, GEORGE F. SLOOK, STEPHEN D. CARP and NANCY HOUGHTON-LYNCH, with full power to each of them to act alone, as the true and lawful attorneys and agents of the undersigned, with full power of substitution and resubstitution to each of said attorneys, to execute, file and deliver any and all instruments and to do any and all acts and things which said to attorneys and agents, or any of them, deem advisable to enable the Corporation to comply with the Securities Exchange Act of 1934, as amended, and any requirements of the Securities and Exchange Commission in respect thereto, relating to annual reports on Form 10-K, including specifically, but without limitation of the general authority hereby granted, the power and authority to sign his name in the name and on behalf of the Corporation or as director or officer, or both, of the Corporation, as indicated below opposite his signature, to annual reports on Form 10-K or any amendment or papers supplemental thereto; and each of the undersigned does hereby fully ratify and confirm all that said attorneys and agents, or any of them, or the substitute of any of them, shall do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, each of the undersigned has subscribed these presents, as of this 24th day of March, 1995.\nNAME TITLE\n\/s\/ Keith E. Trost Director and President (Principal Executive Officer)\n\/s\/ Stephen D. Carp Vice President, Finance and Assistant Secretary (Principal Financial and Accounting Officer)\n\/s\/ James A. Blanda Director\n\/s\/ James D. Constantine Director\n\/s\/ Alan J. Lacy Director\n\/s\/ Alice M. Peterson Director\n\/s\/ Larry R. Raymond Director\n\/s\/ George F. Slook Director","section_15":""}
{"filename":"790406_1994.txt","cik":"790406","year":"1994","section_1":"ITEM 1. BUSINESS (A) GENERAL DEVELOPMENT OF BUSINESS\nMerrill Corporation provides a full range of typesetting, printing, document reproduction, distribution and marketing communication services to financial, legal, insurance and corporate markets. The Company is headquartered in St. Paul, Minnesota and has 16 full service offices in major financial centers across the United States and in Canada, as well as 5 regional printing plants, and printing and distribution operations in St. Cloud, Minnesota.\nOn June 1, 1993, the Company completed the acquisition of the common stock of Torrie Enterprises, Ltd., operators of Atwell Fleming Printing Company, a financial and corporate printing company, in Toronto and Montreal.\nOn December 31, 1993, the Company acquired the business of May Printing Company for approximately $25 million. This business, which is conducted through a wholly owned subsidiary, May Printing Company, Inc. (\"May Printing\"), provides demand printing and distribution services designed to promote the corporate identity of large, national clients with multiple franchisees, members, divisions or affiliated organizations.\nThe Company, which is a Minnesota corporation, was organized in 1968 under the name \"K.F. Merrill Company.\" The Company's executive offices are located at One Merrill Circle, Energy Park, St. Paul, Minnesota 55108. Its telephone number is (612) 646-4501. Unless the context otherwise requires, the terms \"Merrill Corporation\" or the \"Company\" include its subsidiaries, Merrill\/New York Company, Merrill Custom Communications, Inc., Merrill\/Magnus Publishing Corporation, Merrill Corporation, Canada, and May Printing Company, Inc.\n(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nSince its inception, the Company's revenues, operating profits and assets have been attributable to one business segment -- providing document typesetting, printing, reproduction, distribution and marketing communication services for the financial, legal, insurance and corporate markets. Financial information about this segment is contained on pages 24 to 33 of the Company's 1994 Annual Report, which information is incorporated herein by reference.\n(C) NARRATIVE DESCRIPTION OF BUSINESS\nThe Company's services can be divided into three categories: financial, corporate, and commercial and other services.\nIn its financial printing business, the Company applies advanced computer and telecommunications technology to the production and distribution of time-sensitive, transactional financial documents, such as registration statements, prospectuses and other printed materials related to corporate financings and acquisitions. The Company's corporate printing business involves typesetting and printing of corporate documents which are prepared annually or at regular intervals, such as annual and quarterly reports and proxy materials for companies, and registration statements for unit investment trusts and mutual funds. In its commercial printing business, the Company typesets price catalogs, directories, insurance industry annual reports, sample ballots and technical manuals from electronic information supplied by customers and provides printing services for customers desiring time-sensitive or other high levels of service. The Company's May Printing subsidiary provides demand printing and distribution services designed to promote the corporate identity of large, national clients with multiple franchisees, members, divisions or affiliated organizations. The Company's document reproduction and imaging businesses provide photocopying and imaging services to law firms and corporate customers. These services include dedicated office photocopying or imaging services, for which the Company provides on-site equipment, employees and management, and custom photocopying or imaging of projects requiring time-sensitivity or other special services. The Company also provides custom marketing communication services to corporate customers.\nThe following table sets forth the percentage of revenue attributable to each of the Company's categories of service for each of the past three fiscal years:\nFINANCIAL AND CORPORATE SERVICES\nGENERAL\nIn its financial printing business, the Company typesets, prints and distributes financial documents. These include documents which are used for specific financing transactions, such as registration statements and prospectuses filed with the Securities and Exchange Commission (the \"SEC\"), tender offer materials and merger documents, official statements for municipal securities, offering circulars, and other documents related to corporate financings, acquisitions and mergers, restructurings and bankruptcy reorganizations.\nThe Company's corporate printing business involves typesetting, printing and distribution of corporate documents which are prepared annually or at regular intervals. These include annual and interim reports to shareholders, proxy materials, certificates for stocks, bonds and other securities, and periodic reports filed with the SEC. The Company includes in this category registration statements and other documents for unit investment trusts and mutual funds which are regularly produced at periodic intervals.\nThe Company's financial and corporate document business is service oriented. The production of financial and corporate documents requires rapid typesetting and printing services, available 24 hours a day and tailored to the exacting demands of the Company's customers. Financial and corporate documents are usually prepared and edited by numerous parties involved in a transaction, including corporate executives, investment bankers, attorneys and accountants. Each document typically goes through numerous proof cycles, and at each cycle the document is typeset, duplicated and distributed to the parties. Individual participants are frequently located in different cities, often requiring proofs to be delivered simultaneously to different parts of the country.\nJust prior to the completion of a financial or corporate document, a drafting group generally will meet at one of the Company's service facilities where conference rooms and other amenities are maintained for customer use. Accommodating the needs of its customers \"in-house\" is the most time-critical service that the Company provides, and requires, among other things, the accurate and rapid turnaround of the edited pages and expert knowledge of the documents and filing requirements of the SEC. After final changes have been made, the Company is usually required to quickly prepare copies of the document (including any exhibits) for filing with the SEC. The document is then printed, collated, bound and distributed in booklet form.\n\"HUB AND SPOKE\" NETWORK\nBy using advanced computer and telecommunications technology, the Company has created a \"hub and spoke\" network linking its central computerized production facility in St. Paul, Minnesota with its 16 full-service facilities.\nThe Company's central computerized production facility (the \"hub\") is located in St. Paul, Minnesota, and its 16 full service facilities (the \"spokes\") are located in New York City, Boston, Newark, Washington, D.C., Atlanta, Chicago, Minneapolis\/St. Paul, Dallas, Denver, Seattle, San Francisco, Palo Alto, downtown Los Angeles, West Los Angeles, Montreal and Toronto, with sales offices in Baltimore, Cleveland and Houston. The Company receives information directly from its customers in various forms, including typed or handwritten pages, magnetic recording media, such as word-\nprocessing disks or computer tapes, and by direct telecommunication with its clients' word processing equipment. This information is transmitted by facsimile or direct electronic connection to the Company's central production facility for processing into a typeset document.\nCENTRAL COMPUTERIZED PRODUCTION FACILITY. The Company has integrated multiple systems with communications technology and proprietary software in its central production facility. This facility consists of multiple computers, communication controllers, text entry and editing stations, laser typesetting equipment, as well as a number of special purpose computer subsystems for data conversion and information management. Each critical piece of equipment in the system has at least one secondary or back-up device to protect against interruptions should any piece of equipment temporarily fail. This computer equipment has been integrated by the Company to create a document production environment which is designed to have a high level of performance, data protection and system reliability.\nThe concentration of equipment and typesetting personnel in a central facility has been a key Company strategy to reduce overhead and labor expense, implement more effective training programs and more efficiently use its management resources. The Company believes that this strategy has enabled it to benefit more quickly from new technologies that have decreased costs and improved the quality of its service, since new technologies and methods, when implemented in the central facility, immediately benefit all service facilities. The Company also believes that this concentration of personnel and equipment at the hub, and the linking of service facilities to the hub, enables it to respond quickly to fluctuating demand for typesetting services in each of its service facilities across the country by efficiently allocating its typesetting resources when and where they are needed.\nNATIONAL COMMUNICATIONS NETWORK. The Company has established a dedicated telecommunications network, connecting each of its service facilities with the hub, which permits typeset documents and production control information to be electronically transmitted to each of its service facilities. The network consists of \"tie\" lines connecting each of the Company's service facilities with the hub, data switching and multiplexing equipment, and the necessary software to manage and control the communications. Designed to operate continuously, the network is highly efficient and reliable, and contains secondary or back-up service for each portion of the network to minimize the possibility of an interruption in service.\nSERVICE FACILITIES. Each service facility is staffed with sales, administrative, customer service, production, duplication and distribution personnel. The service facilities all have conference rooms with support staff, office equipment and amenities to give the Company's customers a comfortable work environment in which to meet, write and revise their documents. Each service facility has the necessary photo imaging equipment to produce documents with high image quality, using the electronic information received from the hub. This enables the Company to transmit completed documents to one or more service facilities for distribution within minutes of completion.\nMERRILLLINK-TM-. The Company has developed the MerrillLink system that connects the hub to locations outside of its service facilities through the use of portable printing devices. These printing devices, usually placed in the customer's office or at the Company's sales offices, allow the Company to edit typeset pages and provide proof distribution to remote locations throughout the world. MerrillLink lets the Company service transactional work in locations where a smaller market does not justify the cost of a full service facility and where rapid turnaround distribution is needed.\nINTERNATIONAL SERVICE. The Company and Burrups, Ltd., a London based financial printing company, jointly market worldwide their communications and production facilities and services. The objective of this arrangement is to work together to provide customers with integrated document typesetting, printing and distribution services wherever the document originates or needs to be delivered. Besides London, Burrups has full service facilities in Luxembourg, Paris, Seoul and Tokyo. In addition, the Company has established relationships with financial printing companies in the Czech Republic, Italy, Hong Kong, New Zealand, Australia, Mexico, Argentina and Brazil which have agreed to work as service facilities for the Company on an \"as needed\" basis. The Company has made\nsoftware and hardware modifications in order to successfully establish electronic communications between its production hub and the service facilities overseas. With this electronic connection as well as the MerrillLink system, the Company is able to transmit high-quality typeset documents for printing and distribution in Europe, the Pacific Rim and South America without the time delays and costs incurred by conventional air shipment. As a result of the acquisition of Atwell Fleming Printing Company, the Company is able to offer its financial and corporate services in Canada through its full service facilities in Toronto and Montreal.\nTHE JOB CONTROL SYSTEM. The Company coordinates the activities of its service facilities through a proprietary Job Control System (\"JCS\"). This system tracks each document from the time it is initially received by the Company at a service facility through completion of production and billing. The JCS is used as a national production control system with each service facility being \"on-line\" to the system through the Company's communications network. Information can be sent to and retrieved from the JCS by any service facility, and can be immediately read by the hub to aid in the rapid and accurate completion of each document. Each service facility can also immediately send instructions to another service facility using this system. During the production phase of a document, the JCS assigns job numbers and keeps track of specific information about the document, such as dates and the times at which proofs are due, style and job specifications, messages regarding the job and last-minute changes. Distribution of drafts is a critical task in the preparation of financial documents, and the JCS simplifies this task by keeping a current address list for each job and history of the distribution and method of delivery for each proof of the document. The Company also uses the production information collected in the JCS to assist in the pricing of its services.\nEDGAR\nThe SEC has established a program for the electronic filing of documents under the federal securities laws, entitled Electronic Data Gathering Analysis and Retrieval (\"EDGAR\"). This program requires participants or their agents to file disclosure information with the SEC in an electronic format rather than by the traditional paper filing package. This electronic format, usually in ASCII, includes additional submission information and coding \"tags\" within the document for aid in the SEC's analysis of the document and retrieval by the public. This electronic format is generally delivered by direct telecommunications, but may be delivered on magnetic computer tape or by diskette. EDGAR allows registrants to file and the public to retrieve disclosure information electronically.\nThe SEC began the development of EDGAR with a pilot program in 1984. Through a phase-in schedule, the SEC has assigned one of ten dates by which all public companies must start filing disclosure documents through the EDGAR operational system, which began April 26, 1993. Through December 1993, there have been 3,380 companies required to file through EDGAR. All publicly-held companies are expected to be required to file disclosure documents through EDGAR by May 1996, according to the phase-in schedule.\nThe Company has been highly involved in all stages of development of EDGAR since the start of the pilot program. The Company has written proprietary software that enables it to quickly prepare and file the electronic version of financial and corporate documents through a dedicated data line directly to the SEC's computers. In addition, the Company has spent considerable time training its staff to coordinate the preparation of these EDGAR filings. The Company also keeps current and future participants informed of EDGAR developments by publishing quarterly Merrill's EDGAR Advisor-TM-, a newsletter for distribution to lawyers, corporate executives and other interested parties, and by conducting seminars throughout the country to inform current and future participants about EDGAR. The Company has a toll-free telephone information line for its customer's questions regarding EDGAR and also distributes EDGAR rules, forms and reference materials.\nThe Company has experienced an increased demand for EDGAR filing services for financial as well as corporate categories of services. The Company converts word processing and other computer formats to the EDGAR format for SEC form types and exhibit documents, and assembles these\ndocuments for electronic filing with the SEC. The Company believes that the operational EDGAR system will continue to increase the demand for the time-sensitive services of the Company, since many filing companies will use outside services to meet EDGAR filing requirements. With the experience and expertise gained since the start of the pilot program, the Company believes it has developed the procedures and skills necessary to handle the increased volume of EDGAR filings as more companies are required to file electronically.\nCOMMERCIAL AND OTHER SERVICES\nGENERAL\nAs part of its commercial and other services, the Company provides document reproduction services for projects that are time-sensitive or otherwise require special service, such as photocopying business records or other documents for large litigation matters. The Company will produce the photocopies at its service facilities or locate photocopying equipment and personnel at the customer's office. Document reproduction services require rapid turnaround and availability 24 hours a day. The Company's document reproduction customers typically have several boxes of documents which may be in file folders, stapled or on varying sizes of paper. The Company will take apart, photocopy and reassemble the original documents and copies as instructed by the customer. The Company also provides sequential numbering and binding services for these documents, if requested. Photocopying projects range from single copies of short documents to the more complicated copying jobs described above. The Company also offers comprehensive office photocopying, typesetting and mailroom facility management services to its customers. These services involve providing for all of a customer's needs for that department, including on-site equipment, employees and management of the operation. The Company uses its service facilities in connection with its document reproduction services. Each service facility is equipped with sophisticated photocopying equipment. The Company is able to make more efficient use of this equipment by performing project photocopying during times when the equipment would otherwise be idle.\nThe Company's Imaging Services Group captures data from its customers' paper documents and creates a digital picture of each page. The customer may then store large quantities of documents on CD-ROM (Compact disk -- read only memory), rather than on paper in boxes or file cabinets. Retrieval of the documents may be accessed simply by one user with a personal computer, or simultaneously by multiple users at multiple sites. The Company disassembles the customers' documents, captures the image, and reassembles the original documents. The Company may also create for the customer text files using Optical Character Recognition (\"OCR\") processing for full text retrieval systems. The Company also performs document management services such as barcoding, document coding, and services to assist with database development, programming, data management and conversions. The Company also consults with the customer regarding its hardware, software and network needs for development of an imaging system. Imaging projects can take from one day to several months to complete. The Company may provide imaging services at its service facilities, or provide on-site equipment, employees and management at the customer's location.\nThe Company also typesets, prints and distributes commercial and other documents, including price catalogs, directories, sample ballots, legal briefs, business and college educational materials, annual reports for the insurance industry and technical manuals, often produced using electronic information supplied by its clients. Through its Merrill Custom Communications, Inc. subsidiary, the Company provides custom marketing communications and publishing services, primarily marketed to financial services companies, media organizations, retailers and the health care industry. The types of custom publications the Company produces include magazines, tabloids, newsletters, booklets and catalogs used by its customers for their marketing purposes. The Company, generally pursuant to an annual contract, works with customers in the design and editorial content of these publications, typesets and prints the publications, then assists the customer in locating a target mailing list and mails the publications. The Company also has an insurance printing group which typesets and prints annual reports submitted to various governmental regulatory agencies by the insurance industry. The Company's commercial typesetting business provides turnkey document services, including camera,\npre-press and printing services for one-or multi-color publications. The Company believes that offering high levels of service is a competitive advantage in certain niches of the commercial printing business. These commercial printing projects, like financial and corporate printing, require a high level of attention to detail, quick turnaround times and responsive customer service.\nMAY PRINTING\nOn December 31, 1993, the Company acquired the business of May Printing Company. May Printing provides demand printing and distribution services designed to support the corporate identity of large, national clients with multiple franchisees, members, divisions or affiliated organizations (\"member organizations\").\nMay Printing is authorized by its national clients to develop and produce custom printed products such as business cards, stationary and collateral support print materials with a uniform appearance for the client's member organizations. Working with each national account client, May Printing prepares a catalog to merchandise these custom printed products, along with other promotional merchandise produced by third parties. May Printing distributes each client-specific catalog to the national client's member organizations.\nIn marketing its national account printed products, May Printing develops direct relationships with each of the individual member organizations, which are independently owned and operated and make their own print purchasing decisions. May Printing uses a sophisticated order entry system, supported by a large inbound telemarketing staff, to receive and process orders. After reviewing a catalog, a member organization can place an order by mail, fax or toll free May Printing telephone number. A May Printing customer service representative processing the order will have access to the customer's purchase history (if an existing customer) and can suggest reordering certain items, cross-sell complementary items or alert the customer to current specials. May Printing accepts major credit cards and payment is typically made upon placing the order.\nMay Printing produces large quantities of printed materials for each national client, which it warehouses pending receipt of an order for the product. May Printing can produce multi-color, highly technical, commercial quality printed materials. Products ordered from a catalog typically require additional \"personalizing\" for the ordering member organization, after which they are checked for quality, packaged and shipped. Promotional merchandise (point of purchase, advertising specialty, premiums and incentives) included in a catalog that are produced by third parties are generally shipped directly by the manufacturer to the ordering member organization. May Printing uses a sophisticated materials handling system with automated handling, order consolidation and shipping. Most orders are filled within four days of receipt.\nThe demand printing and distribution services provided by May Printing benefit both the national account client and the member organizations. The national account client benefits from May Printing's centralized production and fulfillment by controlling the use of its trademarks and facilitating the economies of mass production for its membership while the ultimate consumer of May Printing's services, the member organization, receives quality products, fast delivery and prices that the Company believes are competitive with prices charged by local print shops.\nIn addition to working with national accounts, May Printing provides general commercial printing services. The commercial printing services that May provides help keep it current with printing industry trends and enhance overall printing quality. May Printing's customers are located in all 50 states and Canada, with limited shipments to Mexico, Puerto Rico, Australia\/New Zealand, France and England.\nPRINTING SERVICES\nThe demand for financial printing services, like that for typesetting, fluctuates significantly. In order to adequately meet this fluctuating demand, financial printing companies have typically invested in printing presses and employed a complete printing workforce in or near each of the markets they serve. The Company meets this fluctuating demand by owning presses only in those markets\nwhere it has an adequate amount of recurring business and identifying in these and the other markets it serves several printers capable of meeting a portion of the Company's production needs on an \"as required\" basis.\nThe Company currently operates printing plants in Minneapolis\/St. Paul, Los Angeles, Chicago, Dallas, and New Jersey, markets in which the Company has found it advantageous to acquire printing presses to service a portion of its recurring corporate and commercial business. Corporate and commercial printing is generally both more predictable in volume and less time-sensitive in nature than financial printing. Because the Company only owns presses in those markets in which its corporate and commercial printing business requires presses, the Company is able to adequately utilize these printing presses for its recurring corporate and commercial work while retaining the flexibility to use the presses for financial printing. May Printing also operates a printing plant in St. Cloud, Minnesota, for its specialized printing services. See \"Business -- Commercial and Other Services -- May Printing\" above.\nThe Company uses associated printers when it needs additional capacity in markets where the Company does not own presses or where special printing equipment is needed. The Company generally selects associated printers on a job-by-job basis, based upon considerations of price, availability and suitability of press equipment.\nMARKETING AND CUSTOMERS\nThe Company markets its services nationwide through a direct sales organization operating from full service facilities located in New York City, Boston, Newark, Washington, D.C., Atlanta, Minneapolis\/St. Paul, Chicago, Dallas, Denver, San Francisco, Palo Alto, Los Angeles, Seattle, Toronto and Montreal, sales offices in Baltimore, Cleveland and Houston, and its custom communications facility located in Eden Prairie, Minnesota. The services provided by May Printing are marketed through a direct sales organization operating from May Printing's principal facility in St. Cloud, Minnesota, and sales offices in Minneapolis\/St. Paul, Los Angeles and San Francisco.\nThe Company markets its financial and corporate document production services to executives or corporations whose securities are publicly traded, or are planned to be publicly traded, corporate finance underwriters, municipal bond underwriters, attorneys and others who require fast and accurate typesetting. The Company markets its commercial printing services primarily to corporations, associations, insurance companies and legal, institutional and governmental publishers, and markets its document reproduction services primarily to lawyers, paralegal and law office administrators, as well as to the legal departments of corporations. The Company markets its custom publication services to financial service companies (such as banks, credit unions and insurance companies), television and radio stations and networks, trade associations, manufacturers and the health care and vacation travel industries. May Printing markets its demand printing and distribution services to large, national clients with multiple franchisees, members, divisions or affiliated organizations. The Company markets all of these services through personal contacts with customers, corporate advertising, promotional programs and direct mail.\nAs of April 15, 1994, the Company employed 101 full-time salespeople to market its typesetting, printing, publishing, imaging and document reproduction services and 20 full-time employees to market the services provided by May Printing. The Company's salespersons solicit business from existing and prospective customers and, together with the customer service representatives, act as coordinators between the customer and the Company's production personnel, and provide advice and assistance to customers.\nCOMPETITION\nThe Company competes with a number of other companies in the financial printing industry, including regional firms, two principal nationwide competitors, Bowne & Co., Inc. and R.R. Donnelley & Sons Company, and international printing firms. Both Bowne and Donnelley have been in business longer, have greater financial resources and revenues than the Company, and are major\ncompetitors in most of the Company's financial and corporate printing markets. In its commercial printing business, the Company competes for complex computer intensive and large-run typesetting work with a number of other computer typesetting firms, and medium-run printing work with a number of commercial web press printers. In its document reproduction and imaging services businesses, the Company competes with two nationwide service companies, Xerox Corporation and Pitney Bowes, litigation support services vendors, and a large number of photocopying and imaging shops, including privately owned shops as well as franchise operations. The Company competes in its custom communications business with marketing service firms, including advertising agencies, custom publication printers, direct mail firms, and television, radio, newspapers, magazine and other media organizations. In the insurance printing business, the Company competes with other national and regional printers, including Bowne. In the May Printing business, the Company believes that its primary competitors are local print shops. Competition in the Company's printing businesses is intense, and is based principally on service, price, speed, accuracy, technological capability and established relationships. The Company believes that it competes favorably with its competitors.\nEMPLOYEES\nAs of April 1, 1994, the Company had 1,577 full-time employees and 41 part-time employees. None of the Company's employees are covered by a collective bargaining agreement. The Company considers its employee relations to be good.\nThe Company's senior management and certain technical personnel have substantial experience and expertise in the financial printing industry. The Company considers the retention of these employees to be important to its continued success. The Company competes intensively with others in the industry to attract and retain qualified sales personnel. However, the Company believes that it is able to provide employment incentives sufficient to minimize the loss of key sales producers and to attract new sales personnel capable of producing significant amounts of business should the need or opportunity arise. Many sales personnel are under employment contracts of varying terms with the Company.\n(D) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nSubstantially all of the Company's revenue, operating profit and identifiable assets are attributable to the United States.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases all of its facilities, other than the principal facility of May Printing, which it owns. The Company's principal production and administrative office facility, located in St. Paul, includes 47,000 square feet of space and is leased, together with the associated land, from the Port Authority of the City of St. Paul. The terms of the Company's agreements with the Port Authority are contained in a facilities lease and land lease, both dated October 1, 1985, which require the Company to pay rents to the Port Authority in the amounts of $24,069 per month and $3,431 per month, respectively, for a term expiring on November 30, 2005. Each lease grants the Company the option to purchase the property at the end of the term, or earlier. Under the facilities lease, the Company may purchase the building for $254,500 at the end of the lease term or after ten years if the Company pays the remaining principal and interest on the bonds outstanding at the time of exercise of the options. The land may be purchased for $167,140 at the end of the lease term or $334,280 at the end of ten years.\nThe Company owns May Printing's principal production, administrative and warehousing facility. This facility, which is located in St. Cloud, Minnesota, includes approximately 122,900 square feet of space.\nThe Company also leases other office and warehouse space in the Minneapolis\/St. Paul metropolitan area, service facilities in each of its other fifteen cities and sales offices in three other cities, with\nspace ranging from 120 square feet to 77,000 square feet. These leases have expiration dates ranging from September 1994 to December 1998 under which the Company makes monthly payments aggregating approximately $239,000, including rental fees, real estate and taxes and operating expense.\nThe Company makes a continuing effort to keep all of its properties and facilities modern, efficient and adequate for its operating needs, through the acquisition, disposition, expansion and improvement of such properties and facilities. As a result, the Company believes that its properties and facilities are, on an aggregate basis, fully utilized and adequate for the conduct of its business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending or threatened legal, governmental, administrative or other proceedings to which the Company or 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 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 April 26, 1994 are as follows:\nExecutive officers of the Company are elected by the Board of Directors and serve for one-year terms, commencing with their election at the first meeting of the Board of Directors immediately following the annual meeting of shareholders and continuing until the next such meeting of the Board of Directors. Appointed officers serve at the discretion of the President and Chief Executive Officer. There are no family relationships between or among any of the executive officers or directors of the Company. Except as indicated below, there has been no change in position of any of the executive officers during the past five years.\nMs. Iserman was appointed Vice President -- Client Services Development in June, 1993. She had served as Vice President -- Production since July 1986.\nMr. Machov has been General Counsel of the Company since January 1987. He was elected to the office of Secretary in February 1990 and Vice President in May 1993.\nMr. Sippl joined the Company in November 1989 as Vice President. Prior to joining the Company, Mr. Sippl was President of Chicago Cutlery Corporation, a manufacturer of quality cutlery, from May 1986 to October 1989.\nMs. Larkin joined the Company in April 1993 as Manager of Human Resources and was appointed Vice President -- Human Resources in December 1993. From February 1987 to March 1993, Ms. Larkin was Employee Relations Manager for The Gillette Company, a manufacturer of personal care products.\nMs. Shay served as Manager of Training and Development from March 1993 to December 1993 when she was appointed Vice President -- Training and Development. From July 1989 to March 1993, she was Manager of Customer Service for the Company's St. Paul operations, and also served as a Customer Service Supervisor from November 1988 to July 1989.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information under the caption \"Quarterly Stock Price Comparison\" on page 23 of the Company's 1994 Annual Report is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe financial information in the table on page 35 of the Company's 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 Financial Condition and Results of Operations\" on pages 20 to 23 of the Company's 1994 Annual Report is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's Consolidated Financial Statements on pages 24 to 33 (including the unaudited information set forth under the caption \"Quarterly Financial Data\" on page 33) and the Report of its Independent Accountants on page 34 of the Company's 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\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(a) DIRECTORS OF THE REGISTRANT.\nThe information under the captions \"Election of Directors -- Information About Nominees\" and \"Other Information About Nominees\" on page 5 of the Company's 1994 Proxy Statement is incorporated herein by reference.\n(b) EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation concerning Executive Officers of the Company is included in this Report under Item 4A, \"Executive Officers of the Registrant.\"\n(c) COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.\nThe information under the caption \"Security Ownership of Certain Beneficial Owners and Management\" on pages 3 and 4 of the Company's 1994 Proxy Statement is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information under the captions \"Election of Directors -- Directors' Compensation\" on page 6 and \"Executive Compensation\" on pages 9 to 13, (excluding the \"Comparative Stock Performance\" graph on page 11), of the Company's 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 \"Security Ownership of Certain Beneficial Owners and Management\" on pages 3 and 4, and \"Election of Directors -- Information About Nominees\" on page 5 of the Company's 1994 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial statements:\nThe following Financial Statements are incorporated herein by reference from the pages indicated in the Company's 1994 Annual Report:\nConsolidated Balance Sheets as of January 31, 1994 and 1993 -- page 24.\nConsolidated Statements of Operations for the years ended January 31, 1994, 1993 and 1992 -- page 25.\nConsolidated Statements of Cash Flows for the years ended January 31, 1994, 1993 and 1992 -- page 26.\nConsolidated Statements of Changes in Shareholders' Equity for the years ended January 31, 1994, 1993 and 1992 -- page 27.\nNotes to Consolidated Financial Statements -- pages 28-33.\nReport of Independent Accountants -- page 34.\n2. Financial statement schedules:\nThe following supplemental schedules and accountants' report thereon are included herein and should be read in conjunction with the consolidated financial statements referred to above (page numbers refer to pages in this Report):\nAll other schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.\n3. Exhibits:\nThe exhibits to this Report are listed in the Exhibit Index on pages 22 and 23 herein.\nA copy of any of these exhibits will be furnished at a reasonable cost to any person who was a shareholder of the Company as of April 1, 1994, upon receipt from any such person of a written request for any such exhibit. Such request should be sent to Merrill Corporation, One Merrill Circle, St. Paul, Minnesota 55108, Attention: Secretary.\nThe following is a list of each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K:\nA. Employment Agreement between John Castro and the Company (incorporated by reference to Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 1989 (File No. 0-14082)).\nB. Amendment to Employment Agreement between John Castro and the Company (filed herewith).\nC. Employment Agreement between Rick R. Atterbury and the Company (incorporated by reference to Exhibit 10.2 to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1991 (File No. 0-14082)).\nD. Amendment to Employment Agreement between Rick R. Atterbury and the Company (filed herewith).\nE. 1987 Omnibus Stock Plan, as amended (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1991 (File No. 0-14082)).\nF. 1993 Incentive Stock Plan (incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1993 (File No. 0-14082)).\nG. Option Agreement between Ronald N. Hoge and the Company (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 1993 (File No. 0-14082)).\n(b) REPORTS ON FORM 8-K:\nA Form 8-K, dated December 31, 1993, was filed during the fourth quarter of the fiscal year ended January 31, 1994 covering Items 2 and 7. Financial statements of May Printing Company (consisting of balance sheets as of September 30, 1993 and December 31, 1992 and the related statements of operations, stockholders' equity and cash flows for the nine month period ended September 30, 1993 and for the year ended December 31, 1992 respectively, including the accountants' reports thereon), and unaudited condensed consolidated pro forma financial statements (consisting of a balance sheet as of October 31, 1993 and statements of operations for the nine month period ended October 31, 1993 and for the year ended January 31, 1993) were included in the Form 8-K\/A.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nOur report on the consolidated financial statements of Merrill Corporation has been incorporated by reference in this Form 10-K from page 34 of the 1994 Annual Report to Shareholders of Merrill Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in Item 14(a)2 of this Form 10-K.\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\nSt. Paul, Minnesota March 22, 1994\nSCHEDULE II MERRILL CORPORATION\nAMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES\nFOR THE YEARS ENDED JANUARY 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nADDITIONAL INFORMATION\n- -------------------------- * Currently under renegotiation with expectation of payment over approximately 5 years.\nSCHEDULE V MERRILL CORPORATION\nPROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED JANUARY 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nSee page 28 of the Annual Report incorporated by reference in this Form 10K for information regarding property, plant and equipment accounting policies.\nSCHEDULE VI MERRILL CORPORATION\nACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED JANUARY 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nSee page 28 of the Annual Report incorporated by reference in this Form 10K for information regarding property, plant and equipment accounting policies.\nSCHEDULE VIII\nMERRILL CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED JANUARY 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nSCHEDULE IX\nMERRILL CORPORATION\nSHORT-TERM BORROWINGS\nFOR THE YEARS ENDED JANUARY 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nSCHEDULE X\nMERRILL CORPORATION\nSUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED JANUARY 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPursuant to 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.\nMERRILL CORPORATION EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K\nFOR FISCAL YEAR ENDED JANUARY 31, 1993","section_15":""}
{"filename":"51200_1994.txt","cik":"51200","year":"1994","section_1":"ITEM 1. BUSINESS --------\nA. OVERVIEW. Great Dane Holdings Inc. (\"Holdings\" or the \"Company\") is a holding company and its business is conducted by its operating subsidiaries. Through Great Dane Trailers, Inc. (\"Great Dane\"), the Company is one of the largest manufacturer of truck trailers and intermodal containers and chassis in the United States. In addition, through Checker Motors Corporation (\"Motors\"), the Company is one of the leading independent manufacturers of sheet metal stampings for automotive components and subassemblies for sale to North American original equipment manufacturers (\"OEMs\"). The Company's other operations consist of its vehicular operations, primarily its subsidiary, Yellow Cab Company (\"Yellow Cab\"), which is currently the largest owner of taxicabs and provider of taxi-related services in Chicago, Illinois, and its insurance operation, American Country Insurance Company (\"Country\"), which underwrites property and casualty insurance.\nThe Company was incorporated in 1959 under the laws of the State of Florida and subsequently changed its name to International Controls Corp. On January 1, 1989, the Company's continuing operations consisted solely of Great Dane's truck trailer manufacturing operations. On January 11, 1989, the Company acquired all of the outstanding capital stock of Motors. Immediately following the acquisition of Motors by the Company, Checker Holding Corp. (\"Holding\"), a privately-held company owned by substantially all of the former shareholders of Motors, acquired all of the outstanding capital stock of the Company (the \"Holding Buyout\"). Subsequently, Holding was merged into the Company. The Holding Buyout has been accounted for as if Motors acquired the Company (a \"reverse acquisition\"), since there was no significant change in control of Motors. On October 19, 1994, the Company changed its name to Great Dane Holdings Inc. and reincorporated in the State of Delaware through a merger into a newly incorporated wholly-owned subsidiary.\nAs of January 17, 1995, pursuant to a Plan of Reorganization (the \"Plan\"), all of the assets (subject to the liabilities) of Checker Motors Co., L.P. (\"Checker L.P.\" or \"the Partnership\"), a Delaware limited partnership in which Motors was the general partner, were distributed to Motors, which contributed substantially all of such assets (subject to the liabilities), except for the stock of Country, to three newly formed, wholly- owned subsidiaries, Yellow Cab, Chicago AutoWerks Inc. (\"Chicago AutoWerks\") and CMC Kalamazoo Inc. (\"CMC Kalamazoo). In accordance with the Plan, Motors was simultaneously reincorporated in Delaware through a merger with its wholly-owned subsidiary organized solely for that purpose.\nB. INFORMATION CONCERNING INDUSTRY SEGMENTS. Certain financial data with respect to Registrant's industry segments appear in Note L of Notes to Consolidated Financial Statements and are incorporated herein by reference.\nAs of December 31, 1994, the Company employed a total of 5,784 people. The chart below details the number of persons employed as of that date in each of the Company's industry segments:\nC. NARRATIVE DESCRIPTION OF BUSINESS.\nTRUCK TRAILER MANUFACTURING.\nGreat Dane designs, manufactures and distributes a full line of truck trailers and containers and chassis. In 1994, Great Dane, one of the largest manufacturers of truck trailers and intermodal containers and chassis in the United States, accounted for approximately 13% of the new truck trailer market, 11.5% of the new van market, 11.5% of the new platform trailer market, 38.4% of the new refrigerated van (\"reefer\") market and 18.8% of the market for intermodal containers and chassis.\nThe national truck trailer market is fragmented and competitive due to the relative ease of entrance (with the exception of the higher technology refrigerated trailers). There are approximately 180 companies in the truck trailer manufacturing industry. In 1994, the two largest companies, Great Dane and Wabash National Corporation, accounted for approximately 24% of the market and the ten largest companies accounted for approximately 66% of sales. The basis of competition in the truck trailer industry is quality, durability, price, warranties, service and relationships.\nPRODUCTS\nGENERAL. Great Dane's principal products include vans, reefers, platform trailers and intermodal containers and chassis. Great Dane's trailers and intermodal containers are manufactured in sizes ranging from 28 to 57 feet. In addition to this standard line of products, its flexible assembly operations enable Great Dane to customize products for its customers at premium prices.\nVANS. Vans are used primarily for the transportation of dry freight. Great Dane manufactures four primary types: sheet and post, aluminum plate, ThermaCube and Fiberglass Reinforced Plastic Plywood. Great Dane sells vans primarily to for-hire truckload carriers, private carriers and leasing companies.\nREEFERS. Great Dane's reefers are specialized products. The Company believes that it is the only company to offer more than one type of reefer. Great Dane currently manufactures three types of reefers.\nPLATFORM TRAILERS. Platform trailers are flatbeds or open deck trailers. Great Dane offers a full line of platform trailers, consisting of drop frame, extendible, curtainside and straight frame trailers. Drop frame\nflatbeds are designed for heavy duty hauling where low deck heights are required. Extendible flatbeds are used for self-supporting loads (e.g., pre- stressed concrete). Curtainside flatbeds are used where side loading and cover is required. The primary customers for Great Dane's platform trailers are for-hire material haulers, which would include steel haulers, pre- stressed concrete carriers and builders.\nINTERMODAL CONTAINERS AND CHASSIS. In conjunction with the growth of intermodal container transportation, Great Dane's engineers developed a specialized container (which can be double stacked during rail transport) and chassis that allow a trucking company to haul containerized loads which are similar in size and weight to those carried on conventional over-the-road trailers. These containers use either aluminum plate or the ThermaCube technology, which is Great Dane's composite wall construction, to offer greater inside width, higher cubic capacity and greater strength than can be obtained by conventional sheet and post construction. Further, these containers are 500 to 1,000 pounds lighter and the chassis are 1,000 to 1,500 pounds lighter than products now in use with similar carrying capacities. The Company believes that it is one of the two largest U. S. manufacturers of intermodal containers and chassis and the only domestic producer of reefer containers.\nMARKETING, DISTRIBUTION AND SALES\nGENERAL. Great Dane's business includes aftermarket parts and accessories sales, used trailer sales and retail services (including repair and maintenance) which enable it to be a full-service provider. The parts and service operations have historically been a stable source of higher margin business.\nGreat Dane sells replacement parts and accessories through 51 full- line dealers, 17 parts-only dealers and 17 Great Dane-owned branch operations. Dealers and branches sell parts either over-the-counter or through their respective retail services.\nTo be competitive in the sale of new trailers, it is often necessary to accept used trailers in trade. Great Dane's larger retail branches employ individuals who are responsible for trade-in appraisals and selling used trailers. Great Dane believes that its nationwide distribution system provides it with superior used trailer marketing capabilities.\nGreat Dane owns and operates 17 full-service retail branches, which provide repair and maintenance services. These retail branches also provide warranty support to Great Dane's customers.\nMANUFACTURING AND OPERATIONS\nMANUFACTURING. Great Dane has four manufacturing facilities, located in Savannah, Georgia; Memphis, Tennessee; Wayne, Nebraska; and Brazil, Indiana, and, in December 1994, acquired property and buildings in Terre Haute, Indiana, for an additional manufacturing facility which is expected to commence manufacturing in April 1995. Certain of Great Dane's\nmanufacturing operations include flexible assembly lines that allow Great Dane to customize its products in a cost-efficient manner.\nRESEARCH AND DEVELOPMENT. Great Dane makes extensive use of computer-aided design (\"CAD\") technology to support production engineering. Great Dane's use of CAD technology accelerates the development of product innovations and manufacturing efficiencies. Great Dane's new products must meet strict quality and durability standards and must pass strenuous road test procedures. Great Dane believes that it is the only trailer manufacturer with on-site road simulation testing capability.\nGreat Dane has developed a new proprietary floor for its ThermaCube and certain Classic reefers which will eliminate wood components, thereby increasing the life of the floor, increasing the capacity of the reefer, simplifying the manufacturing process and reducing the cost to manufacture the reefer. Great Dane is also developing and testing a new line of ultra- lightweight flatbeds intended to increase its market share.\nSUPPLIES AND RAW MATERIALS. Purchased materials represent approximately 80% of direct cost of goods sold and are purchased on a centralized basis in order to achieve economies of scale. Great Dane purchases a variety of raw materials and sub-assemblies from various vendors with short-term contracts. Aluminum, wood, tires, steel and refrigeration units account for a significant portion of material costs. Great Dane has not experienced major shortages in these materials, but prices may fluctuate. However, Great Dane attempts to minimize purchased material price fluctuations by utilizing just- in-time inventory systems, thereby coordinating the purchase of certain materials with customer orders.\nPATENTS, LICENSES AND TRADEMARKS\nThe Company believes its \"Great Dane\" trademark, which identifies all of its products, to be of value and to contribute significantly to the wide acceptance of its products.\nBACKLOG\nTruck trailer and container backlog was approximately $515 million at December 31, 1994, and $365 million at December 31, 1993. The increase in backlog is principally attributed to increased orders for truck trailers.\nAUTOMOTIVE PRODUCTS OPERATIONS.\nThrough South Charleston Stamping & Manufacturing Company (\"SCSM\") and CMC Kalamazoo, Motors develops, designs, engineers and manufactures a broad range of sheet metal automotive components and subassemblies, including tailgates, fenders, doors, roofs and hoods for sale to North American OEMs. The majority of Automotive Products' Operations revenues are derived from complex, value-added products, primarily assemblies containing multiple stamped parts and various welded or fastened components.\nMANUFACTURING\nUnlike certain of its smaller competitors, the Automotive Products Operations have the equipment and versatility to produce a wide variety of automotive stamping products, carrying out substantially all phases of a project. Their principal products include tailgate and liftgate assemblies, door assemblies, hood assemblies, fender assemblies, wheelhouses, pillars, back panels, floor panels, deck lids, body side panels, roof outer panels and related parts.\nThe major portion of tooling design, build and prototype for the Automotive Products Operations is performed by selected suppliers under close supervision.\nMARKETING AND CUSTOMERS\nThe Automotive Products Operations focuses on the higher-growth light truck, sport utility vehicle and van segments of the market and currently supplies products primarily for GM which has, historically, accounted for more than 95% of this segment's revenues. At the present time, Motors is supplying parts on the following light truck\/sport utility and minivan vehicles: Suburban, Crew Cab, M Van (Astro and Safari), CK Pickup Truck, CK Sport Side Pickup and Tahoe\/Yukon. The automotive segment also supplies parts for GM's service organization. Motors is also currently supplying parts to Freightliner Corp. (Class 6 and 7 Truck), Saturn Corporation (station wagon), Ford Motor Co. (Cougar) and Toyota (Camry and Avalon). In addition, SCSM was awarded an eight-year contract with Mercedes-Benz to produce the majority of the stamped parts for its new sports utility vehicle. Mercedes-Benz is providing the funding necessary for the tooling to produce these parts.\nShipments of customer orders from both SCSM and CMC Kalamazoo are made on a daily or weekly basis as required by the customer. GM provides an estimated 13-week shipping forecast which is used for material and fabrication planning purposes. Nevertheless, changes in production by the customer may be reflected in increases or decreases of these forecasts.\nCMC Kalamazoo and SCSM are committed to customer satisfaction by producing parts and providing the necessary support systems to assure conformity to customer requirements. As evidence of success in these areas, SCSM has been awarded GM's \"Mark of Excellence\" Award, and the GM Q.S.P. (quality, service, price) award for being GM's worldwide Supplier of the Year 1993 for major sheet metal stampings. In addition, SCSM has been awarded ISO 9000 Certification by the International Standards Organization (ISO 9002).\nThe fabrication business is highly competitive and Motors competes with numerous other industrial manufacturers, as well as with the in-house capabilities of its customers (i.e., GM). The failure to obtain future orders from GM could have a material adverse impact on the Automotive Products operations despite the fact that the Company is expanding its customer base. The automotive products industry is experiencing increased pricing pressure from GM which is continuing its aggressive measures to reduce its operating costs, including obtaining significant price reductions from suppliers. Although opportunities for new business may arise as a result of GM's pressure on other suppliers and, while the Company believes\nthat it has adequately provided for any price reductions which may result from discussions with GM in near-term financial plans, future earnings of the automotive products operations may be materially adversely affected by additional price reductions requested or required by GM.\nVEHICULAR OPERATIONS.\nYellow Cab is the largest taxicab fleet owner in the City of Chicago (\"Chicago\") and, as of January 1, 1995, owned 2,271 or 41% of the 5,500 taxicab licenses (\"licenses\" or \"medallions\") available in Chicago. Yellow Cab's primary business is the leasing of its medallions and vehicles to independent taxi operators. Through its subsidiary, Chicago AutoWerks, the Company also provides a variety of other services to taxi drivers and non- affiliated medallion holders, including insurance coverage through Country and repair and maintenance services.\nTHE OWNER-OPERATOR AND DAILY LEASE PROGRAMS\nPursuant to Yellow Cab's owner-operator program, an independent, non- employee taxi operator leases from Yellow Cab a license and vehicle, with an option to purchase the vehicle beginning at the end of the second year. During the lease term (generally five years), Yellow Cab receives a weekly lease payment for the vehicle as well as a weekly fee to cover the use of Yellow Cab's license and other services provided by Yellow Cab and its affiliates, including use of its colors and trade name, liability insurance coverage, radio dispatch, repair and maintenance. Most operators also purchase the required collision insurance from Country. See \"Business-- Insurance Operations.\" The daily lease program, which allows drivers to lease a medallion and a vehicle for 12 hours, 24 hours, or for a weekend, has been used largely as a source and training operation for new owner-operators.\nMAINTENANCE, REPAIR AND PARTS SALES\nChicago AutoWerks provides preventive and other maintenance services, primarily to Yellow Cab and non-affiliated taxi drivers, and also, as a licensed full-line auto repair shop, to the public. Chicago AutoWerks maintains a body shop at which major repairs can be made. As an authorized Chevrolet and Ford warrantor, Chicago AutoWerks also repairs those manufacturers' vehicles that are under warranty and invoices the manufacturers directly.\nChicago AutoWerks serves the dispatching needs of Yellow Cab and non- affiliated drivers, maintains the radio in their taxicabs and supplies the emergency radio services they required. Chicago AutoWerks also sells automotive parts.\nTHE MEDALLIONS\nIn order to retain its licenses, the Company must comply with the regulations of Chapter 9-112 of the Municipal Code of Chicago (governing public passenger vehicles), including the payment of annual taxicab license fees, currently $500 per vehicle.\nPursuant to a 1988 agreement with the City of Chicago to settle various lawsuits, Yellow Cab is required to relinquish to the City of Chicago and not\nrenew 100 taxicab licenses on January 1 of each year through 1997 (the \"Agreement\"). In addition, the Agreement limits to 100 per year the number of new licenses that the City of Chicago may add to the total medallions outstanding through 1997, bringing the total number of available licenses to a maximum of 5,700 on December 31, 1997. At the required surrender rates, assuming no additional medallions are sold by Yellow Cab, Yellow Cab would hold approximately 2,070 medallions after January 1, 1997, or approximately 36% of the maximum total then-to-be outstanding. There is no limit on the number of medallions Chicago may issue after December 31, 1997.\nThe scheduled decline in the number of licenses allowed to be held by Yellow Cab pursuant to the Agreement has had, and will continue to have, a negative effect on the revenue-generating capability of the taxi leasing operations. Yellow Cab has been able to offset these declines to some extent through increases in the average lease rates charged to its customers, as well as through increases in other services provided by Chicago AutoWerks. At the same time, as the number of medallions held by Yellow Cab declines, Yellow Cab will require fewer new vehicles to support its taxi leasing operations and, consequently, a lower level of capital spending.\nThe Agreement has also had the effect of allowing the Company to purchase and sell licenses in the open market for the first time since 1982. Recent sales of these licenses have been recorded at prices of approximately $37,500 per medallion, and the prices realized by Yellow Cab have been consistent with the prices realized in license sales by other, non- affiliated, medallion holders. Although the value of Yellow Cab's fleet of vehicles is reflected on the Company's balance sheet, the significant value of its medallions is not.\nAlthough Yellow Cab is the largest provider of taxicab related services in Chicago, it faces competition from a number of other medallion owners who lease medallions and vehicles to independent operators. Yellow Cab management believes that even the most significant of these competitors owns only approximately 150 to 200 medallions, although each competitor operates under a variety of individual cab service names and logos. There are also many associations in the City, the largest of which is the Checker Taxi Association, an unaffiliated association, which compete with Yellow Cab in the delivery of taxicab related services to medallion owners and their agents.\nLIABILITY INSURANCE\nYellow Cab currently maintains liability insurance coverage for losses of up to $350,000 per occurrence, as well as an \"excess layer\" of coverage for losses over $600,000 and up to $29,000,000. The initial $350,000 layer of insurance is issued by Country. See \"Business--Insurance Operations.\" During several periods in the past, Yellow Cab did not maintain the level of coverage that Yellow Cab currently maintains for any losses over $350,000 per occurrence. As a result, there are currently outstanding claims against Yellow Cab for which it is not fully covered by third-party insurance. Yellow Cab maintains balance sheet reserves totalling $2.2 million at December 31, 1994, for these claims. Management believes that these reserves will be sufficient to cover its outstanding claims.\nREGULATORY\nYellow Cab's operations are regulated extensively by the Department of Consumer Services of the City of Chicago which regulates Chicago taxicab operations with regard to certain requirements including vehicle maintenance, insurance and inspections, among others. The City Council of Chicago has authority for setting taxicab rates of fare. Effective December 1, 1993, lessors had the right to increase, until May 1, 1994, the rates paid by lessee drivers by not more than 2.8% of the lease rate in effect on December 1, 1993. After May 1, 1994, lessors may not charge more than the rates prescribed by the Commissioner (which, in certain categories, are less than the rates currently charged by Yellow Cab) without the consent of the City of Chicago. The rates in effect on May 1, 1994, including the 2.8% increase, may remain in effect pending a petition and appeal for a higher rate. Yellow Cab increased its rates by the maximum allowed 2.8% prior to May 1, 1994, and has filed, in a timely manner, a petition to increase its rates still further. Yellow Cab intends to pursue that proposal to final hearing.\nINSURANCE OPERATIONS. Country underwrites property and casualty insurance, including taxicab insurance, workers' compensation and other commercial and personal lines. During 1994, 75% of Country's total premium revenue was attributable to non-affiliated property\/casualty lines, primarily workers' compensation, commercial automobile and commercial multiple peril. The remainder of Country's premium revenues was attributable to affiliated taxi liability and collision insurance in the State of Illinois and workers' compensation insurance in the States of Illinois and Michigan. Country is currently rated \"A\" by A. M. Best.\nCountry is one of the few voluntary providers of taxi liability insurance in the industry. Most insurers which have previously written taxi insurance coverage on a voluntary basis experienced poor underwriting results and have withdrawn from the business. Management believes that Country's longstanding relationship with Yellow has provided it with a stable market for this type of coverage and has enabled it to develop a comprehensive understanding of the business and to assess more properly the associated risk.\nThe taxicab liability coverage which Country writes carries a $350,000 limit of liability for each driver. In addition, Country makes collision insurance available to licensees and owner-operators at premium rates which are favorable relative to the rates charged by competitors for equivalent coverage. Country also writes full lines of commercial and personal property and casualty insurance for risks located in the City of Chicago and the surrounding metropolitan area. With the exception of a specialty public transportation program (excluding limousines), which program policies are reinsured for amounts above $350,000, all non-affiliate policies are reinsured for amounts above $150,000.\nCountry is domiciled in the State of Illinois and is a licensed carrier in Michigan, as well as being admitted as an excess and surplus lines carrier in 33 other states. Country is also applying for licenses in other states, such as Wisconsin, Indiana and Iowa. To the best of management's knowledge, Country is in compliance with all applicable statutory requirements and regulations.\nLABOR RELATIONS. Approximately 322 employees in the Company's automotive products operations, 315 in the Company's truck trailer manufacturing operations and 60 in the Company's vehicular operations are covered by collective bargaining agreements. During 1993, Motors entered into a new contract with the Allied Industrial Workers of America, AFL-CIO, Local 682 in Kalamazoo--currently known as Local Union No. 7682 of the United Paperworkers International Union, AFL-CIO--which expires in May 1996. Motors is party to a contract with D.U.O.C. Local 777, a division of National Production Workers of Chicago and Vicinity, Local 777 which expires in November 1995. During February 1993, Great Dane Trailers, Tennessee, Inc., a subsidiary of Great Dane, negotiated a new contract (expiring in January 1996) with Talbot Lodge No. 61 of the International Association of Machinists and Aerospace Workers. In general, the Company believes its relationship with its employees to be satisfactory. Although there have been attempts to unionize various of the Company's divisions in the past few years, including SCSM and the Great Dane plant in Brazil, Indiana, such attempts have, to date, been unsuccessful.\nCOMPLIANCE WITH ENVIRONMENTAL PROTECTION PROVISIONS. The Company believes that future 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, will have no material effect upon the capital expenditures, earnings and competitive position of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe Company currently maintains its principal executive offices at Motors' facility in Kalamazoo, Michigan.\nThe location and general description of the principal properties owned or leased by the Company are as follows:\nThe principal facilities owned by the Company and its subsidiaries are considered by the Company to be well maintained, in good condition and suitable for their intended use.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nEXECUTIVE LIFE LITIGATION. By order of the Superior Court of Los Angeles County (the \"California Court\"), on April 11, 1991, Case No. B5-006- 912 (the \"California Order\"), the California State Insurance Commissioner was appointed Conservator for Executive Life Insurance Company (\"ELIC\"), a limited partner in the Partnership. By letter dated May 20, 1991, Motors and the Partnership advised ELIC and the Conservator that the appointment of the Conservator pursuant to the California Order constituted an \"Event of Default\" under the Partnership Agreement, and that, therefore, ELIC's rights under the Partnership Agreement and interest in the Partnership were altered. More specifically, Motors and the Partnership asserted that ELIC's rights, as of April 11, 1991, were limited to the right to receive a payout of its capital account, calculated as of that date, in quarterly installments over approximately a 23-year period. On June 28, 1991, the Conservator notified Motors and the Partnership that he did not accept that position set forth in the May 20 letter and that, in his view, ELIC's status as a limited partner had not been altered. In March 1992, Motors and the Partnership were added as parties to the Order which sought damages from them in an unspecified amount for, among other things, their alleged \"forfeiture\" of ELIC's interest, breach of fiduciary duties, interference with the conservatorship proceedings and waste of conservatorship assets. In this litigation, each of Motors, the Partnership and the Conservator was also seeking, among other things, a declaration of its rights under the Partnership Agreement.\nOn May 26, 1994, the California Court approved a settlement of this litigation. Pursuant to the Settlement Agreement, on December 22, 1994, Motors redeemed ELIC's interest in the Partnership for $37.0 million (the \"Minority Interest Redemption\") and the litigation was thereafter dismissed with prejudice. Under certain circumstances, if all or substantially all of the assets of the Partnership are sold within five years of the consummation of the Minority Interest Redemption, ELIC may be entitled to receive a payment equal to the positive difference between (x) the distribution ELIC would have received upon liquidation of the Partnership as a result of such transaction, calculated in accordance with the provisions of the Partnership Agreement as if it had continued to hold its partnership interest, and (y) the future value of $37.0 million calculated at 15% per annum from the date of the Minority Interest Redemption to the date of such transaction. The Company has guaranteed the obligations of its subsidiaries under the Settlement Agreement.\nCERTAIN ENVIRONMENTAL MATTERS. Within the past five years, Great Dane and Motors have entered into certain decrees with federal and state governments relating to the cleanup of waste materials. The aggregate obligations of Great Dane and Motors pursuant to these consent decrees are not material.\nIn May 1988, Holdings sold all of the stock of its subsidiaries, Datron Systems, Inc., and All American Industries, Inc., and in connection therewith agreed to indemnify the purchasers for, among other things, certain potential environmental liabilities. The purchaser has put Holdings on notice of certain alleged environmental and other matters for which it intends to seek indemnification as costs are incurred. Holdings does not believe that its bligations, if any, to pay these claims will be material.\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 There is no market for Registrant's common stock; all issued and outstanding common stock is owned of record by David R. Markin, Martin L. Solomon, Allan R. Tessler and Wilmer J. Thomas, Jr.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA Summarized below is selected financial data for the years 1990 through 1994. The extraordinary items in all years relate to the gain or loss on the repurchase of indebtedness. The accounting changes represent the cumulative effect of changes in accounting principles as a result of adopting, as of January 1, 1993, the provisions of Statement of Financial Accounting Standard (\"SFAS\") No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions,\" and SFAS No. 109, \"Accounting for Income Taxes\" (see Notes H and J of the Notes to Consolidated Financial Statements). Per share amounts for all of the years are based on 1,000 shares.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES.\nAvailable cash and cash equivalents, cash flow generated from operations ($25.2 million, $30.7 million and $56.4 million for the years ended December 31, 1992, 1993 and 1994, respectively), proceeds from borrowings and proceeds from disposal of assets have provided sufficient liquidity and capital resources for the Company to conduct its operations during each of these years.\nFrom the time that present management assumed control of the Company in January 1989, it has been continually reassessing the Company's financial condition and prospects. The Company was hampered in its efforts to achieve a refinancing of its debt in recent years, in part because of litigation with the Boeing Company which was settled in December 1993 and in part because of litigation with the Conservator of ELIC, a limited partner in the Partnership. A settlement with ELIC, agreed to in principle in early 1994, was consummated in December 1994 (see \"Item 3 - -LEGAL PROCEEDINGS\").\nIn February 1994, the Company filed a Registration Statement on Form S-1 with the Securities and Exchange Commission in connection with an overall refinancing of the Company's outstanding indebtedness. On August 10, 1994, the Company announced that, due to market conditions, it had postponed the proposed refinancing and would not complete the transaction on the terms described in its registration statement.\nCertain costs were incurred in connection with the refinancing efforts which would have been capitalized and amortized over the life of the new loans. Because this refinancing was not completed, those costs, which totaled approximately $3.5 million (pre-tax), were expensed against income in the quarter ended September 30, 1994.\nOn November 23, 1994, the Company filed a Registration Statement on Form S-1 with the Securities and Exchange Commission in connection with an initial public offering (\"IPO\") of the Company's common stock. The Company is registering 6,555,000 shares of common stock (including 855,000 shares which the underwriters have the right to purchase to cover over-allotments) (in each case, giving effect to a 16,800 to 1 split of the common stock to be effected prior to consummation of the IPO). It is currently estimated that the initial public offering price will be between $13 and $15 per share. All of the net proceeds are intended to be used to redeem approximately $72 million of the Company's 12-3\/4% Senior Subordinated Debentures, due 2001, which will be sufficient to satisfy all remaining sinking fund payments on this indebtedness. If successfully completed, the principal effect of the IPO will be to reduce the cash flow necessary from its subsidiaries to meet the Company's obligations. Any excess proceeds from the IPO as a result of sale of the over-allotment will be utilized to retire additional debentures or for working capital.\nThe Company is a holding company and is, therefore, dependent on cash flow from its subsidiaries in order to meet its obligations. The Company's operating subsidiaries are required, pursuant to financing agreements with third parties, to meet certain covenants, which may have the effect of\nlimiting cash available to the Company. The operating subsidiaries' plans indicate that sufficient funds are anticipated to be available to the Company to meet its short-term obligations.\nIn December 1994, the Company purchased ELIC's interest in the Partnership for $37 million. $30 million of this payment was provided by a subsidiary through borrowings on its revolving credit facility and the balance was paid from available cash.\nIn January 1995, Motors and its subsidiaries finalized a refinancing with a bank whereby Motors entered into a loan agreement providing for a $45 million term loan and a $20 million revolving credit facility. The funds from the term loan were used to repay approximately $27 million of bank debt including the Partnership term loan, the equipment term loan and the notes payable to the bank, provide $15 million to the Company to retire a portion of certain notes outstanding to the Company's shareholders and pay fees and expenses. Availability under the revolving credit facility is based on the amount of eligible trade accounts receivable and inventory, and may be used for working capital needs, as well as for general corporate purposes.\nThe new term loan requires twenty quarterly principal payments of approximately $2.3 million, commencing June 30, 1995, plus interest at either the bank's prime rate plus 1.25% (subject to reductions of up to 0.5% upon the occurrence of certain events) or a selected Eurodollar contract rate plus 300 basis points (subject to reductions of up to 50 basis points upon the occurrence of certain events). The new term loan is secured by substantially all of Motors's assets including the stock of the Insurance Subsidiary. The new term loan agreement requires Motors to, among other things, comply with certain financial covenants, limits additions to and sales of Motors' fixed assets and limits additional borrowings by Motors.\nIn February 1995, Great Dane Trailers amended its loan and security agreement. Pursuant to the amended agreement, the Lenders have loaned $28 million as a term loan and have agreed to provide, at any given time, up to $150 million (less amounts then outstanding as a term loan) as a revolving credit facility (subject to availability based on the amount of eligible trade accounts receivable and inventory) to be used as working capital by Great Dane and for general corporate purposes. The term loan is subject to further increases as final collateral appraisals are completed and as equipment for the new facility in Terre Haute is purchased. The Company believes that the term loan will be increased to between $33 million and $38 million. The initial term loan proceeds, which were drawn immediately upon closing, were used, together with drawings under the revolver, to repay approximately $17 million of bank debt, provide $15 million to the Company to retire the balance of the shareholder notes and pay fees and expenses. The term loan requires monthly principal payments of $0.3 million plus interest on the unpaid principal amount of the loan in arrears at a rate equal to 1% above the prime rate of interest charged from time to time by Bank of America or a rate equal to 2.5% above a selected Eurodollar contract rate with the unpaid principal balance due five years after the closing date. The loans are secured by substantially all of the assets of Great Dane and its subsidiaries. The Agreement requires Great Dane to, among other things, comply with certain financial covenants, and limits the amount of loans and transfers to the Company, limits additions to and sales of Great Dane's fixed assets and limits additional Great Dane borrowings.\nThe refinancing of the Motors and Great Dane bank debt, as well as the expansion of each of these entities' availabilities under their respective credit facilities, improves the Company's liquidity.\nEffective January 1, 1994, the Company adopted the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" In accordance with this statement, prior period financial statements have not been restated to reflect the change in accounting principle. The opening balance of shareholders' deficit was decreased by $1.4 million (net of $0.8 million in deferred income taxes) to reflect the net unrealized holding gains on securities classified as available-for-sale previously carried at amortized cost or lower of cost of market. The adoption of this SFAS has not adversely affected liquidity and capital resources.\nPurchases of property, plant and equipment have averaged approximately $18.6 million per year over the past three years and have been funded principally by cash flow generated from operations, as well as proceeds from disposal of assets. Purchases of property, plant and equipment for 1995 are anticipated to be approximately $38.3 million and are expected to be funded principally by cash flow generated from operations and borrowings.\nGeneral Motors Corporation (\"GM\"), a major customer of the Company's automotive products segment, is resorting to many measures, including obtaining significant price reductions from its suppliers, in an effort to reduce its operating costs. Automotive products segment management believes that it has adequately provided in its financial plans for any price reductions which may result from its current discussions with GM. However, price reductions in excess of those anticipated could have a material adverse effect on the automotive products operations.\nRESULTS OF OPERATIONS.\n1994 COMPARED TO 1993:\nRevenues increased $187.2 million and gross profit increased $36.7 million during the year ended December 31, 1994, as compared to the same period of 1993. The higher revenues are principally attributed to higher Trailer Manufacturing revenues ($147.2 million), primarily associated with a higher volume of sales within the segment. Automotive Products revenues increased $29.6 million during the year ended December 31, 1994, as compared to the same period in 1993. General increases in volumes to accommodate automotive customers' demands and additional jobs were the principal reasons for the revenue increases.\nThe Company's operating profit (gross profit less selling, general and administrative expenses) increased $28.3 million in 1994 compared to 1993. This increase is attributed to an increase of Trailer Manufacturing operating profits ($26.2 million) which is principally due to higher volumes of sales and higher margins, and an increase of Automotive Products operating profits ($4.3 million) principally due to higher sales and higher margins. These increases in operating profits were offset by higher corporate costs due principally to the refinancing which was not completed ($3.5 million).\nSales, general and administrative (\"SG&A\") expenses were $8.4 million higher in 1994 as compared to 1993, but as a percentage of sales, SG&A was 0.8 percentage points lower in 1994 as compared to 1993.\nDuring the year ended December 31, 1994, a $0.6 million charge was recorded to reflect a minority equity in SCSM.\nIncome tax expense is higher for financial statement purposes than would be computed if the statutory rate were used because of state income taxes, as well as the impact of the reporting of certain income and expense items in the financial statements which are not taxable or deductible for income tax purposes.\nNet income was $24.3 million for the year ended December 31, 1994, as compared to a $43.3 million net loss for the prior year. The improvement in net income is attributed to the reasons mentioned above, as well as a one- time charge ($46.6 million) incurred for the implementation of SFAS Nos. 106 and 109 which was recorded in the first quarter of 1993.\n1993 COMPARED TO 1992:\nDuring 1993, revenues increased $192.6 million and gross profit increased $24.7 million as compared to 1992. The Truck Trailer Manufacturing and the Automotive Products segment operations benefited from increased demand for their products. Truck Trailer Manufacturing revenues increased by $175.5 million as compared to 1992, primarily due to the sale of containers and chassis which were introduced in late 1992 and sold principally to one customer, and a higher volume of truck trailer sales. Automotive Products revenues increased $15.3 million as compared to 1992. Increased production of the General Motors Blazer and Suburban models and crew cab products and other general increases in volumes to accommodate automotive customers' demands are the principle reasons for the increase. Vehicular Operations revenues increased $1.5 million in 1993 as compared to 1992. The increase was attributed to lease rate increases obtained in 1993 to cover certain Vehicular Operations cost increases. The revenue increase was somewhat offset by the impact of tendering medallions to the City of Chicago.\nThe factors impacting sales, as discussed previously, had the effect of increasing the Company's 1993 operating profit by $18.4 million as compared to 1992. Truck Trailer Manufacturing operating profit increased by $14.8 million as compared to 1992. This increase is principally due to higher volumes, partly offset by SG&A expenses. Higher volumes were also the principal reason for an increase of $3.7 million of Automotive Products operating profits as compared to 1992.\nS G & A expenses were $6.3 million higher in 1993 as compared to 1992, but as a percentage of sales, S G & A expense is 1.7 percentage points lower in 1993 as compared to 1992.\nOther expenses decreased $5.5 million in 1993 as compared to 1992. The decrease in expense resulted primarily from $1.4 million income from the settlement of a dispute in 1993 and $2.8 million income from sales of taxi medallions in 1993.\nOn February 8, 1989, the Boeing Company (\"Boeing\") filed a lawsuit naming the Company, together with three prior subsidiaries of the Company, as defendants in Case No. CV89-199MA, United States District Court for the District of Oregon. In that lawsuit, Boeing sought damages and declaratory relief for past and future costs resulting from alleged groundwater contamination at a location in Gresham, Oregon, where the three prior subsidiaries of the Company formerly conducted business operations. On December 22, 1993, the Company entered into a settlement with Boeing, settling all claims asserted by Boeing in the lawsuit. Pursuant to the settlement terms, the Company will pay Boeing $12.5 million over the course of five years, at least $5 million of which has been committed by certain insurance carriers in the form of cash or irrevocable letters of credit. Accordingly, the Company recorded a $7.5 million special charge during 1993 to provide for the cost associated with this legal proceeding. In accordance with the settlement agreement, Boeing's claims against the Company and the three former subsidiaries have been dismissed and Boeing has released and indemnified the Company with respect to certain claims.\nNet loss was $43.3 million for the year ended December 31, 1993, as compared to a $7.6 million net loss for the year ended December 31, 1992. The fluctuations in net loss between the years are attributed to the reasons discussed above, as well as the one-time charge ($46.6 million) incurred for the implementation of SFAS Nos. 106 and 109 which was recorded in 1993.\nIMPACT OF INFLATION\nRecently, due to competitive market conditions, the Company has been unable to factor all cost increases into selling prices for its products and services. The Company does not believe that the impact of inflation affects the Company any more than it affects the Company's competitors.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nRegistrant's response to this item is incorporated herein by reference to the consolidated financial statements and consolidated financial statement schedules, and the report thereon of independent auditors, listed in Item 14(a)1 and 2 and appearing after the signature page to 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 THE REGISTRANT\nDavid R. Markin, age 64, President and Chief Executive Officer of the Company since January 11, 1989, has been President and Chief Executive Officer of Motors since 1970. Mr. Markin serves on the Boards of Directors of Jackpot Enterprises, Inc., an operator of gaming machines, Enhance Financial Services Group Inc., a reinsurance company, and Data Broadcasting Corporation, a provider of market data services to the investment community.\nAllan R. Tessler, age 58, Chairman of the Board of Holdings since January 11, 1989, is also Chairman of the Boards of Directors of International Financial Group, Inc., a merchant banking firm (\"IFG\"), Enhance Financial Services Group Inc., a reinsurance company, Allis-Chalmers Corporation, a manufacturer of miscellaneous fabricated textile products (\"Allis-Chalmers\"), and Jackpot Enterprises, Inc., an operator of gaming machines, and has been Chief Executive Officer of IFG since 1987 and of Allis-Chalmers since 1994. Mr. Tessler serves on the Board of Directors of The Limited, Inc., a manufacturer and retailer of apparel. Mr. Tessler is also an attorney and from 1976 through 1988, he was a member of the Executive Committee of the law firm of Shea & Gould; from 1989 through March 1, 1993, he was of counsel to that firm. Beginning in 1990, Mr. Tessler and another person were retained by Infotechnology, Inc. and Financial News Network Inc. as a restructuring team and to serve as Co-Chief Executive Officers during the restructuring of those companies. As part of the plan implemented by the restructuring team, those companies were placed in bankruptcy, from which they emerged in 1992 as Data Broadcasting Corporation, a provider of market data services to the investment community. Mr. Tessler continues to serve as Co-Chairman of the Board and Co-Chief Executive Officer of the restructured company.\nMartin L. Solomon, age 58, Vice Chairman and Secretary of the Company since January 11, 1989, is a private investor. Mr. Solomon was employed as a securities and portfolio analyst at Steinhardt Partners, an investment firm, from 1985 through 1987. From 1988 through September 1990, he was the Managing Partner and Director at Value Equity Associates I, Limited Partnership, an investment firm. Mr. Solomon serves on the Board of Directors of XTRA Corporation, a truck leasing company.\nWilmer J. Thomas, Jr., age 68, Vice Chairman of the Company since January 11, 1989, is a private investor. Mr. Thomas served as Treasurer of the Company from January 1989 to January 1994. Mr. Thomas serves on the Boards of Directors of Moore Medical Corp., a pharmaceutical and surgical supply company, and Oak Hills Sportswear Corp., a clothing company.\nThe executive officers of the Registrant, in addition to Messrs. Markin, Tessler, Solomon and Thomas, are:\nJay H. Harris, age 58, has been Executive Vice President and Chief Operating Officer of the Company for more than the past five years and a Vice President of Motors since 1991. Mr. Harris was a director of the Company from 1978 until January 11, 1989.\nMarlan R. Smith, age 51, has been Treasurer of the Company since January 1994 and Vice President and Treasurer of Motors since March 1988. Prior to being elected Treasurer of the Company, he served as Assistant Treasurer since January 1989.\nKevin J. Hanley, age 39, has been Controller of the Company since January 1994 and Secretary and Controller of Motors since December 1989.\nWillard R. Hildebrand, age 55, was elected as President and Chief Executive Officer of Great Dane effective January 1, 1992. Mr. Hildebrand had served as President and Chief Operating Officer of Fiatallis North America, Inc., a manufacturer of heavy construction and agricultural equipment, for more than five years prior thereto.\nLarry D. Temple, age 48, has been Group Vice President of Motors since September 1989. Mr. Temple served as Vice President of Manufacturing from 1988 to 1989.\nJohn T. Wise, age 49, has been President of SCSM since July 1992. He was Vice President - General Manager from 1989 to 1992.\nJeffrey M. Feldman, age 44, has been President of Yellow Cab since 1983.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCOMPENSATION\nThe following table sets forth the 1994 annual compensation for the Company's Chief Executive Officer and the five highest paid executive officers, as well as the total compensation paid to each individual for the Company's two previous fiscal years:\nCOMPENSATION PURSUANT TO PLANS\nGREAT DANE PENSION AND EXCESS BENEFIT PLANS\nGreat Dane has in effect a defined benefit employee pension plan entitled Retirement Plan For Great Dane Trailers, Inc. (the \"Retirement Plan\") covering substantially all of its employees. Pension benefits are subject to limitations imposed by the Internal Revenue Code of 1986, as amended (the \"Code\"), and the Employee Retirement Income Security Act of 1974, as amended, with respect to the annual amount of benefits provided by employer contributions. Effective January 1, 1994, Great Dane adopted the Supplemental Retirement Income Plan (the \"Great Dane Excess Benefit Plan\") for officers of Holdings who are participants in the Checker Motors Pension Plan and officers of Great Dane, in each case whose annual compensation exceeds $150,000. The Great Dane Excess Benefit Plan provides benefits which cannot be provided under the Retirement Plan because of the $150,000 compensation limit under the Code. Considered compensation under the Great Dane Excess Benefit Plan is limited to $235,840 (adjusted for inflation) per year. The benefits under the Great Dane Excess Benefit Plan are not funded and will be paid from Great Dane's general assets.\nEffective as of July 1, 1988, the assets and the liabilities attributable to active and former employees under the Amended and Restated International Controls Corp. Pension Plan as of June 30, 1988 were transferred to the Retirement Plan and Holdings adopted the Retirement Plan for the benefit of its employees. With respect to benefits accruing after June 30, 1984, to a participant who was a participant under the Amended and Restated International Controls Corp. Pension Plan as of June 30, 1988, the following table shows the estimated annual benefits payable upon retirement at age 65 under the plan to specified average annual compensation and years of benefit service classifications. The following amounts would be reduced by a Social Security offset:\nFor Mr. Hildebrand, the following are credited years of service under the Retirement Plan and 1994 salary covered by the Retirement Plan:\nExpected 1994 Salary Credited Credited Covered by Years of Years of Retirement Service Service at 65 Plan --------- ------------- ---------- Willard R. Hildebrand 4 14 $150,000\nMr. Harris has an aggregate of 24 years of benefit service under the Retirement Plan (8 years) and the Amended and Restated International Controls Corp. Pension Plan (16 years) and will receive benefits of approximately $74,000 per year at age 65.\nMOTORS PENSION AND EXCESS BENEFIT PLANS\nMotors maintains a defined benefit employee pension plan entitled Checker Motors Pension Plan (the \"Pension Plan\") covering substantially all of its non-union employees of Motors and its subsidiaries other than SCSM, and, effective January 1, 1992, the employees of the Company.\nMotors, as the successor in interest to the Partnership, also maintains the Checker Motors Co., L.P. Excess Benefit Retirement Plan (the \"Partnership Excess Benefit Plan\"). The Partnership Excess Benefit Plan provides benefits which cannot be provided under the Retirement Plan because of the $150,000 compensation limit under the Code. At the present time, David R. Markin and Jeffrey M. Feldman are the only individuals named above who would receive benefits under the Partnership Excess Benefit Plan. Considered compensation under the Partnership Excess Benefit Plan is limited to $300,000. The benefits under the Partnership Excess Benefit Plan are not funded and will be paid from Motors' general assets.\nSet forth below are the estimated annual benefits for participants in the Pension Plan (including benefits payable under the Partnership Excess Benefit Plan) who have been employed by Motors for the indicated number of years prior to retirement, assuming retirement at age 65 in 1994:\nThe above benefit projections were prepared on the assumption that the participant made participant contributions to the Pension Plan for all years in which he was eligible to contribute, and that Social Security covered compensation is $1,893.\nFor those executive officers named above, the following are credited years of service under the Pension Plan and Excess Benefit Plans and 1994 salary covered by the Pension Plan:\nSALARY CONTINUATION PLAN\nMotors entered into Stated Benefit Salary Continuation Agreements (the \"Agreements\") with certain officers and employees (the \"Salary Plan\") pursuant to which such participants will receive benefits upon attaining age 65 (or their beneficiaries will receive benefits upon their death prior to or within 120 months after such executives or employees attain age 65).\nFor those executive officers named above, the following table sets forth the benefits payable pursuant to the Salary Plan:\n1994 OPTION PLAN\nOn November 16, 1994, the Board of Directors adopted the 1994 Option Plan, subject to approval by the Compensation Committee (the composition of which committee is described below) and by the stockholders at the first annual meeting of stockholders after the consummation of the IPO. The 1994 Option Plan provides for the granting of incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the \"Code\") to employees of the Company and for the granting of nonstatutory\nstock options and stock appreciation rights (\"Rights\") to employees, consultants, non-employee directors and other persons providing goods or services to the Company. Under the 1994 Option Plan, a total of 1,680,000 shares of Common Stock (after giving effect to a 16,800 to 1 stock split to be effectuated prior to the consummation of the IPO) have been reserved for issuance. The maximum number of shares of Common Stock with respect to which options or Rights may be granted during the life of the 1994 Option Plan to any employee cannot exceed 400,000. On January 25, 1995, the Board of Directors granted nonstatutory options under the 1994 Option Plan to certain employees to purchase 174,500 shares of Common Stock at 50% of the IPO price. The grants are subject to the consummation of the IPO, approval of the 1994 Option Plan by the Compensation Committee and the stockholders and ratification of the grants by the Compensation Committee. The options will be exercisable for five years commencing one year from the date on which the IPO is consummated.\nThe 1994 Option Plan will be administered by the Compensation Committee which, when constituted, will consist of persons who are \"disinterested persons\" within the meaning of Rule 16(b) promulgated under the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"). The Compensation Committee will have the power, subject to the terms of the 1994 Option Plan, to determine the recipients and terms of any options or Rights granted, including the exercise price, number of shares subject to the option or Rights and the exercisability thereof. Options and Rights granted under the 1994 Option Plan may not be transferred except by will or the laws of descent and distribution and, during the lifetime of the optionee, may be exercised only by such optionee or such optionee's guardian or legal representative. If an optionee's employment or other relationship with the Company terminates for any reason, the employee's options and Rights shall immediately terminate, except that: (i) upon termination of employment due to disability or retirement, an optionee may generally exercise options or Rights that have not expired on such date for a period of two years after the date of termination of employment; and (ii) upon termination of employment as a result of death, or in the event of the employee's death within the periods described in (i), above, an optionee's legal representative may generally exercise options or Rights that have not expired on such date for a period of 12 months after the date of death. Options granted to non-employee directors, consultants and other persons providing goods and services to the Company will be subject to such terms as the Compensation Committee shall determine.\nThe exercise price of all incentive stock options granted under the 1994 Option Plan must be at least equal to the fair market value of the shares of Common Stock subject to the option on the date the option is granted. The exercise price of all nonstatutory stock options granted under the 1994 Option Plan is to be determined by the Compensation Committee but cannot be less than the minimum required to comply with any applicable law, rule or regulation. The term of options granted under the 1994 Option Plan may not exceed 10 years. Notwithstanding the above, incentive stock options granted to an employee that owns more than 10% of the voting power of all classes of stock of the Company must have an exercise price at least equal to 110% of the fair market value of the stock subject to the option on the date the option is granted and must have a term that does not exceed five years.\nOptions may be exercised either in cash or with Common Stock having a fair market value equal to the exercise price of the option on the date the option is exercised.\nEach option and Right granted under the 1994 Option Plan is exercisable in whole or in part at any time, or from time to time, as determined by the Compensation Committee, provided that the election to exercise an option or a Right is made in accordance with applicable federal and state laws and regulations, and, unless the optionee dies or becomes disabled, the option or Right cannot be exercised during the first six months of the option period. An option is vested and becomes immediately exercisable if: any person within the meaning of Sections 13(d) and 14(d) of the Exchange Act, other than the Company or the current stockholders of the Company, becomes the beneficial owner, within the meaning of Rule 13d-3 of the Exchange Act, of 75% or more of the Company's outstanding voting securities, unless such ownership has been approved by the Board of Directors of the Company; the first day on which shares of Common Stock are purchased pursuant to a tender offer or exchange offer, unless the offer is made by the Company or approved by its Board of Directors; the stockholders of the Company have approved an agreement to merge or consolidate with or into another corporation (and the Company is not the survivor of the merger or consolidation), or an agreement to sell or otherwise dispose of all or substantially all of the Company's assets (which includes a plan of liquidation), unless the Board of Directors has resolved that options do not automatically vest; or during any period of two consecutive years, individuals who at the beginning of the period constituted a majority of the Board of Directors cease to constitute a majority thereof, unless the election or the nomination for the election by the Company's stockholders of each new director was approved by a vote of at least a majority of the directors then still in office who were directors at the beginning of the period. In addition, the Compensation Committee has the authority at any time or from time to time to accelerate the vesting of any individual option and to permit any option not yet exercisable to become immediately exercisable.\nUnless terminated sooner, the 1994 Option Plan will terminate 10 years from the Effective Date. The Board of Directors has authority to amend or terminate the 1994 Option Plan, provided no such action may impair the rights of the holder of any outstanding option or Rights.\nNo Right can be exercised by an optionee unless the Company has been subject to the reporting requirements of Section 12 of the Exchange Act for at least one year prior to the date of exercise and has filed all reports and statements required to be filed during that period, and the Company on a regular basis releases for publication quarterly and annual summary statements of sales and earnings. No Common Stock can be delivered by the Company pursuant to the exercise of an option or a Right until qualified for delivery under applicable securities laws and regulations, as determined by the Compensation Committee, until the Common Stock is listed on each securities exchange on which the Common Stock may then be listed, and until the exercise price of the option is received by the Company either in cash or in Common Stock.\nCOMPENSATION OF DIRECTORS\nThe directors did not receive any fees for their services as directors in 1994. See \"Compensation Committee Interlocks and Insider Participation.\"\nEMPLOYMENT AGREEMENTS\nMotors, as a successor to the Partnership, is party to an Amended and Restated Employment Agreement dated as of November 1, 1985, as further amended, with David R. Markin pursuant to which Mr. Markin is to serve as President, Chief Executive Officer and Chief Operating Officer of the Partnership until April 30, 1996, subject to extension (the \"Termination Date\"), at a minimum salary of $600,000 per annum, together with the payment of certain insurance premiums, the value of which have been included in the Summary Compensation Table above. The beneficiaries of these insurance policies are designated by Mr. Markin. Mr. Markin continues to be eligible to participate in profit sharing, pension or other bonus plans of the Motors. Pursuant to the Amended and Restated Employment Agreement, in the event of Mr. Markin's death, the Company shall pay Mr. Markin's estate the compensation which would otherwise be payable to him for the period ending on the last day of the month in which death occurs. In addition, Motors shall pay to Mr. Markin's beneficiaries deferred compensation from the date of his death through the Termination Date in an annual amount equal to one-third of his base salary at the date of his death. In the event of termination of the Amended and Restated Employment Agreement for any reason other than cause, disability or death, Mr. Markin shall continue to serve as a consultant to Motors for a period of five years, for which he shall receive additional compensation in the amount of $50,000 per annum. Motors has agreed to indemnify Mr. Markin from certain liabilities arising out of his service to Motors, except for liabilities resulting from his gross negligence or willful misconduct. Effective January 1, 1994, Mr. Markin and the Company memorialized in writing their agreement, pursuant to which Mr. Markin has been compensated by the Company since January 11, 1989, on substantially the same terms as are set forth above.\nThe Company entered into an employment agreement as of July 1, 1992, with Jay H. Harris pursuant to which Mr. Harris serves as Executive Vice President and Chief Operating Officer of the Company until June 30, 1995, subject to extension or earlier termination, at a minimum salary of $350,000 per annum, an incentive bonus to be determined by the Board of Directors, and such other fringe benefits and plans as are available to other executives of the Company. Upon the happening of certain events, including a change in control (as defined therein) of the Company or retirement after June 30, 1994, Mr. Harris is entitled to compensation in an amount equal to the greater of (a) five percent of the increase in the Company's retained earnings, subject to certain adjustments, during the period commencing on March 31, 1992, and ending on the last day of the month preceding the event which triggers the payment (the \"Termination Payment\") and (b) 2.99 times his then base salary. If Mr. Harris were to die or become disabled, he or his estate would receive the greater of (a) one year's base compensation or (b) the Termination Payment. Payments in either case would be made over a period of time, the length of which would be dependent on the amount due to Mr. Harris. Mr. Harris has agreed to serve as a consultant to the Company during the first year after termination for no compensation beyond his expenses incurred in connection with rendering such services. The Company has agreed\nto indemnify Mr. Harris to the full extent allowed by law. Motors has guaranteed the Company's obligations. Mr. Harris' current salary is $500,000.\nYellow Cab is party to an Amended and Restated Employment Agreement dated as of June 1, 1992, with Jeffrey Feldman pursuant to which Mr. Feldman serves as President of Yellow Cab until February 1, 1996, subject to extension (the \"Termination Date\"), at a minimum salary of $200,000 per annum, together with certain insurance premiums, the value of which have been included in the Summary Compensation Table above. The beneficiaries of these insurance policies are designated by Mr. Feldman. Mr. Feldman is eligible to participate in profit sharing, pension or other bonus plans implemented by Yellow Cab or Motors. Pursuant to the Amended and Restated Employment Agreement, in the event of Mr. Feldman's death, Yellow Cab shall pay Mr. Feldman's estate the amount of compensation which would otherwise be payable to him for the period ending on the last day of the month in which death occurs. In addition, Yellow Cab shall pay to Mr. Feldman's estate deferred compensation from the date of his death to the Termination Date in an annual amount equal to one-third of his base salary at the date of his death. In the event of the termination of the Amended and Restated Employment Agreement for any reason other than cause, disability or death, Mr. Feldman shall continue to serve as a consultant to Yellow Cab for a period of five years (if terminated by Mr. Feldman) or seven years if terminated by Yellow Cab, for which he shall receive compensation in the amount of $75,000 per annum. Yellow Cab has agreed to indemnify Mr. Feldman from certain liabilities arising out of his service to Yellow Cab, except for liabilities resulting from his gross negligence or willful misconduct.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company has had no separate compensation committee or other committee providing equivalent functions. Each of Messrs. Markin, Solomon, Tessler and Thomas is an executive officer of Holdings and participates, as a director, in the deliberations concerning executive officer compensation. During 1994, Mr. Markin served on the compensation committee of Enhance Financial Services Group Inc. and Data Broadcasting Corporation and Mr. Tessler served as an executive officer of each of these companies.\nAs of December 31, 1994, Country holds $0.6 million principal amount of 7% Notes due December 1, 1996, issued by Enhance Financial Services Group Inc. Mr. Markin is a director of and served on the compensation committee of that company.\nDuring 1994, the Company used, on a month-to-month basis, an airplane owned by a corporation of which Mr. Tessler is the sole shareholder. The Company paid $90,000 per month for such use.\nEach of Messrs. Markin, Solomon, Tessler and Thomas provides consulting services to Yellow Cab and each received for such services $10,000 per month\nin 1994. Messrs. Solomon, Tessler and Thomas also provide consulting services (a) to Motors for which they each received monthly fees of $5,000 and (b) to Country for which they each received monthly fees of approximately $18,300 in 1994. Mr. Markin serves as a consultant to Chicago AutoWerks for which he received monthly fees of approximately $1,200, and to Country, for which he received monthly fees of approximately $4,600 in 1994. Upon consummation of the IPO, these fees will be reduced to a fee of $50,000 per year for each of Messrs. Markin, Solomon, Tessler and Thomas, in payment for consulting services to Country.\nOn September 24, 1992, American Country Financial Services Corp. (\"AFSC\"), a subsidiary of Country, purchased from The Mid City National Bank of Chicago the promissory note dated July 30, 1992, made by Checker Services, Inc., formerly King Cars, Inc. (\"Services\"), in the principal amount of $381,500 plus accrued interest in the amount of $3,560. The note, which was renewed several times, had outstanding principal and accrued interest as of September 30, 1994, of approximately $430,000 and matured in December 1994. Until October 1994 when Checker Taxi Association purchased 45% of Services for $250,500 (which amount was used by Services to pay accrued interest and to reduce the principal amount of the note), Services was owned by Messrs. Markin, Solomon, Tessler, Thomas and Feldman. The balance of the note (except for $57,309 which was forgiven) was paid prior to December 31, 1994. Services is a party to an agreement dated December 15, 1992, with Yellow Cab pursuant to which Yellow Cab purchases from Services display frames for installation in its taxicabs and Services furnishes Yellow Cab advertising copy for insertion into the frames. Services receives such advertising copy as an agent in Chicago for an unrelated company which is in the business of selling and arranging for local and national advertising. Of the revenues generated from such advertising, 30% will be retained by Services and the balance will be delivered to Yellow Cab until such time as Yellow Cab has recovered costs advanced by it for the installation of advertising frames in 500 of its taxicabs (approximately $78,000). The terms of Yellow Cab are the same or more favorable than those offered by Services to unrelated third parties.\nEach of Messrs. Markin, Solomon, Tessler and Thomas received from Holdings interest payments of $790,428 in 1994 pursuant to the terms of the senior notes held by them (see Note F of the Notes to Consolidated Financial Statements - December 31, 1994).\nJeffrey M. Feldman is the nephew of David R. Markin.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Common Stock, which is the only class of stock of the Company, is owned as follows:\nThe address of each of the shareholders is c\/o Great Dane Holdings Inc., 2016 North Pitcher Street, Kalamazoo, Michigan 49007.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\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\n(a) 1 and 2. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES:\nThe following consolidated financial statements and consolidated financial statement schedules of Great Dane Holdings Inc. and subsidiaries and the report thereon of independent auditors are filed as part of this Annual Report on Form 10-K and are incorporated by reference in Item 8:\nA. Report of Independent Auditors.\nB. Consolidated Financial Statements.\nConsolidated Balance Sheets as of December 31, 1993 and 1994.\nConsolidated Statements of Shareholders' Deficit for the years ended December 31, 1992, 1993 and 1994.\nConsolidated Statements of Operations for the years ended December 31, 1992, 1993 and 1994.\nConsolidated Statements of Cash Flows for the years ended December 31, 1992, 1993 and 1994.\nNotes to Consolidated Financial Statements - December 31, 1994.\nC. Consolidated Financial Statement Schedules.\nSchedule III - Condensed Financial Information of Registrant\nSchedule VIII - Valuation and Qualifying Accounts\nSchedule XIV - Supplemental Information Concerning Property- Casualty Insurance Operations\nSee the accompanying Index to Financial Statements and Financial Statement Schedules Covered by Report of Independent Auditors appearing after the signature page to this Annual Report on Form 10-K.\n3. See the accompanying Index to Exhibits which precedes the Exhibits filed with this Annual Report on Form 10-K.\n(b) REPORTS ON FORM 8-K:\nNone\n(c) EXHIBITS:\nSee the accompanying Index to Exhibits which precedes the Exhibits filed with this Annual Report on Form 10-K.\n(d) FINANCIAL STATEMENT SCHEDULES REQUIRED BY REGULATION S-X:\nSee the accompanying Index to Financial Statements and Financial Statement Schedules Covered by Report of Independent Auditors which appears after the signature page 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, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFebruary 15, 1995 GREAT DANE HOLDINGS, INC.\nBy: \/s\/ David R. Markin ------------------------------------------ David R. Markin 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, including at least a majority of the members of its Board of Directors, on behalf of Registrant and in the capacities and on the dates indicated.\n\/s\/ Allan R. Tessler Chairman of the Board February 15, 1995 - -------------------------- Allan R. Tessler\n\/s\/ David R. Markin President, Chief Executive February 15, 1995 - -------------------------- Officer and Director David R. Markin\n\/s\/ Jay H. Harris Executive Vice President February 15, 1995 - -------------------------- and Chief Operating Officer Jay H. Harris\n\/s\/ Marlan R. Smith Treasurer (Principal February 15, 1995 - -------------------------- Financial Officer and Marlan R. Smith Principal Accounting Officer)\n\/s\/ Martin L. Solomon Vice Chairman of the Board February 15, 1995 - -------------------------- and Secretary Martin L. Solomon\nVice Chairman of the Board - -------------------------- Wilmer J. Thomas, Jr.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES COVERED BY REPORT OF INDEPENDENT AUDITORS\nThe following consolidated financial statements of Great Dane Holdings Inc. and subsidiaries are submitted herewith in response to Item 8:\nPage ----\n- - Report of Independent Auditors\n- - Consolidated Balance Sheets as of December 31, 1993 and 1994\n- - Consolidated Statements of Shareholders' Deficit for the Years Ended December 31, 1992, 1993 and 1994\n- - Consolidated Statements of Operations for the Years Ended December 31, 1992, 1993 and 1994\n- - Consolidated Statements of Cash Flows for the Years Ended December 31, 1992, 1993 and 1994\n- - Notes to Consolidated Financial Statements--December 31, 1994\nThe following consolidated financial statement schedules of Great Dane Holdings Inc. and subsidiaries are submitted herewith in response to Item 14(d):\nSchedule III - Condensed Financial Information of Registrant S-1\nSchedule VIII - Valuation and Qualifying Accounts S-4\nSchedule XIV - Supplemental Information Concerning Property- Casualty Insurance Operations S-6\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.\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors Great Dane Holdings Inc.\nWe have audited the accompanying consolidated balance sheets of Great Dane Holdings Inc. and subsidiaries as of December 31, 1993 and 1994, and the related consolidated statements of operations, shareholders' 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.\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 Great Dane Holdings Inc. and subsidiaries at 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. 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\nKalamazoo, Michigan February 14, 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 GREAT DANE HOLDINGS INC. AND SUBSIDIARIES December 31, 1994\nNOTE A--ORGANIZATION\nOn October 19, 1994, International Controls Corp. (\"ICC\") changed its name and its jurisdiction of incorporation through a merger into its wholly- owned subsidiary, Great Dane Holdings Inc. (the \"Company\"), a Delaware corporation. Each of the outstanding shares of common stock of ICC was converted into a pro rata portion of 1,000 shares of common stock, $1 par value per share, of the Company. As a result of the above, the Company has 3,000 shares of $1 par value common stock authorized and 1,000 shares issued and outstanding. All share and per share data and affected amounts have been adjusted to reflect these changes as though they had occurred at the beginning of the earliest period presented. On November 16, 1994, the Company's Board of Directors approved a resolution, subject to shareholder approval, to be effective prior to the consummation of an initial public offering, increasing the number of authorized shares of common stock to 50 million, reducing the par value to $0.01 per common share and splitting the shares 16,800 for 1. This resolution also authorized 5 million shares of $1 par value preferred stock.\nThe Company has two operating subsidiaries, Great Dane Trailers, Inc. (\"Great Dane\") and Checker Motors Corporation (\"Motors\"). During 1989, the Company purchased all of the common stock of Motors, the general partner of Checker Motors Co., L.P. (the \"Partnership), a Delaware limited partnership (the \"Motors acquisition\").\nImmediately after the Motors acquisition, substantially all of Motors' former shareholders purchased, through Checker Holding Corp. (\"Holding\"), all of the outstanding common stock of the Company (the \"Holding buyout\"). Holding was created solely for the purpose of acquiring the stock of the Company and was subsequently merged into the Company. The Holding buyout has been accounted for as if Motors acquired the Company (a \"reverse acquisition\"), since there was no significant change in control of Motors.\nUnder generally accepted accounting principles for reverse acquisitions, the net assets of Motors acquired in the Motors acquisition cannot be revalued to estimated fair value. Accordingly, the $127.7 million excess of the amount paid over the historical book value of Motors net assets has been accounted for as a separate component reducing shareholders' equity and is not subject to amortization. The fair value of Motors net assets, as estimated by management, is significantly greater than historical book value, but no appraisal of fair value is available.\nNOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of Great Dane Holdings Inc. and its subsidiaries, including the Partnership and the Partnership's wholly-owned subsidiaries, including American Country Insurance Company (\"Insurance Subsidiary\"). All significant intercompany accounts and transactions have been eliminated.\nCASH EQUIVALENTS: The Company considers all highly liquid investments, other than Insurance Subsidiary investments, with a maturity of three months or less when purchased to be cash equivalents.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued. . .\nINVENTORIES: Inventories are stated at the lower of cost or market. The cost of inventories is determined principally on the last-in, first-out (\"LIFO\") method.\nPROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are stated at cost. Depreciation is provided based on the assets' estimated useful lives, principally by the straight-line method.\nEstimated depreciable lives are as follows:\nINTANGIBLE ASSETS: Intangible assets, principally cost in excess of net assets acquired and a trademark, are being amortized on the straight-line basis over periods of 5 to 40 years.\nCUSTOMER DEPOSITS: Substantially all customer deposits represent advanced payments from a customer in connection with tooling production for this customer.\nMINORITY INTEREST: Minority interest represents the limited partner's allocable share of the Partnership's net assets (see Notes G and I) and the share of net assets of South Charleston Stamping & Manufacturing Company (\"SCSM\") allocable to the minority interest holder.\nREVENUE RECOGNITION: Revenues from sales of trailers that are manufactured in response to customers' orders are recorded when such products are completed and invoiced. Rental income from vehicle leases is recognized as earned. Vehicles are generally leased on a daily or weekly basis to unaffiliated operators. Insurance Subsidiary premiums are recognized as income ratably over the period covered by the policies. Unearned premium reserves are calculated on the monthly pro-rata basis. Realized gains and losses on investments are determined on a specific identification basis and are included in the determination of net income.\nDEBT ISSUE EXPENSE: Expenses incurred in connection with the issuance of debt are capitalized and amortized as interest expense over the life of the debt.\nLOSSES AND LOSS ADJUSTMENT EXPENSES: The Insurance Subsidiary's liability for unpaid losses and loss adjustment expenses represents an estimate of the ultimate net costs of all losses which are unpaid at the balance sheet dates, and is determined using case-basis evaluations and statistical analysis. These estimates are continually reviewed and any adjustments which become necessary are included in current operations. Since the liability is based on estimates, the ultimate settlement of losses and the related loss adjustment expenses may vary from the amounts included in the consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued. . .\nRECLASSIFICATION: Certain 1993 amounts have been reclassified to conform to the 1994 classifications.\nNOTE C--INVENTORIES\nInventories are summarized below (dollars in thousands):\nInventories would not differ materially if the first-in, first-out costing method were used for inventories costed by the LIFO method.\nNOTE D--PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are summarized below (dollars in thousands):\nNOTE E--INVESTMENTS\nEffective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" In accordance with this statement, prior period financial statements have not been restated to reflect the change in accounting principle. The opening balance of\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE E--INVESTMENTS--Continued. . .\nshareholders' deficit was decreased by $1.4 million (net of $0.8 million in deferred income taxes) to reflect the net unrealized holding gains on securities classified as available-for-sale previously carried at amortized cost or lower of cost or market.\nInsurance company management evaluated the investment portfolio and, based on the Insurance Subsidiary's ability and intent, has classified securities between the held-to-maturity and available-for-sale categories. Held-to- maturity securities are stated at amortized cost. Debt securities not classified as held-to-maturity and marketable equity securities are classified as available-for-sale. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported as a separate component of shareholders' deficit.\nFollowing is a summary of held-to-maturity and available-for-sale securities of the Insurance Subsidiary, which are generally reserved for Insurance Subsidiary operations, as of December 31, 1994:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE E--INVESTMENTS--Continued. . .\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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE E--INVESTMENTS--Continued. . .\nThe proceeds from sales of available-for-sale securities was $2.8 million for the year ended December 31, 1994. No gross gains or gross losses were realized on those sales during the year ended December 31, 1994.\nBonds with an amortized cost of $2.3 million at December 31, 1994, were on deposit to meet certain regulatory requirements.\nNOTE F--BORROWINGS\nLong-term debt is summarized below (dollars in thousands) (see Note O):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE F--BORROWINGS--Continued. . .\nInterest on the $132 million face value of 12-3\/4% Senior Subordinated Debentures is payable semiannually at the stated rate. The recorded debt discount is being amortized as interest expense over the expected life of the debentures using an imputed interest rate of approximately 15% compounded semiannually. Under the terms of the debentures, the Company's payment of dividends is limited to, among other things, 50% of consolidated net income subsequent to June 30, 1986, plus $12 million. At December 31, 1994, the Company was restricted from paying a dividend. The debentures are redeemable at the option of the Company in whole or in part at a decreasing premium. The debentures are subject to redemptions through a sinking fund whereby the Company is required to make five annual sinking fund payments of $18 million commencing August 1, 1996, with the final payment due August 1, 2001.\nInterest on the $61 million face value of 14-1\/2% Subordinated Discount Debentures is payable semiannually at the stated rate. The recorded debt discount is being amortized as interest expense over the expected life of the debentures using an imputed interest rate of approximately 16.7% compounded semiannually. The 14-1\/2% debentures are subject to redemption through a sinking fund whereby the Company is required to redeem, at their face value, on January 1 in each of the years 1997 through 2005, 7-1\/2% of the principal amount of the debentures outstanding on January 1, 1997. The balance of debentures are due January 1, 2006. The debentures are callable any time at their face value and are subordinated to all present or future indebtedness of the Company not expressly subordinated to, or on a parity with, the debentures.\nThe notes payable to shareholders, which were paid off in February 1995 (see Note O), bore interest payable quarterly in arrears at an annual rate equal to the prime rate of a New York bank (8.5% at December 31, 1994) plus 3-1\/2%.\nIn March 1990, Great Dane entered into a five year loan and security agreement (\"Agreement\") with certain banks. The Agreement made available to Great Dane a $33 million five-year term loan and a $47 million revolving credit line. In 1993, the maximum revolving credit line was increased to $65 million. The amount available under the revolving credit line is based upon the amount of Great Dane's eligible trade accounts receivable and inventory as defined in the Agreement. The additional amount available under the revolving credit line under the borrowing base terms of the Agreement totaled $30.2 million at December 31, 1994. The term loan is payable in equal monthly installments of $0.34 million plus interest at the bank's prime interest rate (8.5% at December 31, 1994) plus 1-1\/2%, with the balance due in March 1995. The revolving credit line is due in 1995 and requires interest payments at the bank's prime rate (8.5% at December 31, 1994) plus 1-1\/2%. In February 1995, Great Dane entered into an amended and restated loan and security agreement with certain banks (See Note O). Accordingly, since these obligations have been refinanced on a long-term basis, the amounts have been classified as long-term debt as of December 31, 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE F--BORROWINGS--Continued. . .\nAll borrowings under the Agreement are fully secured by substantially all of the Great Dane assets. The Agreement requires Great Dane to, among other things, comply with certain financial covenants, and limits the amount of loans and transfers to the Company, limits additions to and sales of Great Dane's fixed assets and limits additional Great Dane borrowings. Under the most restrictive covenant, no additional transfers of funds to the Company are available until after December 31, 1994.\nDuring 1992, the Partnership entered into a Loan and Guaranty Agreement with a bank pursuant to which the bank provided a $30 million term loan to the Partnership. The term loan requires twenty quarterly principal payments of $1.5 million, plus interest at the bank's prime rate (8.5% at December 31, 1994) plus 1-1\/4%, which payments commenced December 31, 1992. The term loan is secured by substantially all of the Partnership's assets, excluding the stock of the Insurance Subsidiary. The term loan agreement, which is guaranteed by Motors, requires Motors to, among other things, comply with certain financial covenants and limits additional loans to Motors.\nThe equipment term loan requires quarterly payments of $0.5 million plus interest at the bank's prime rate (8.5% at December 31, 1994) plus 1-1\/4%. The obligation is secured by certain machinery and equipment with a net carrying amount of $5.9 million at December 31, 1994.\nIn connection with the Partnership term loan and the equipment term loan, Motors is required to comply with certain financial covenants.\nThe economic development term loan, which is guaranteed by Motors, is payable by SCSM to the West Virginia Economic Development Authority, and requires monthly payments of $0.1 million, including interest at 5% with the unpaid balance due 2008. The interest rate will be adjusted in April 1998 and 2003, so as to remain equal to 75% of the base rate, as defined, plus 1\/2%. The loan is secured by certain machinery and equipment with a net carrying amount of $22.5 million at December 31, 1994.\nMaturities of long-term debt for the four years subsequent to 1995, after giving effect to the payoff of the notes payable to shareholders and to the refinancing of Great Dane and Motors debt, are as follows: $14.2 million in 1996, $32.2 million in 1997, $32.2 million in 1998 and $29.0 million in 1999.\nInterest paid totaled $42.4 million in 1992, $39.8 million in 1993 and $38.5 million in 1994.\nSCSM has a line of credit with a bank totaling $7.5 million at December 31, 1994. Borrowing under the line ($5.0 million at December 31, 1994) bears interest at the bank's prime rate (8.5% at December 31, 1994) plus 1%.\nThe Partnership has $3.8 million available under a line of credit with a bank. Borrowings under the line ($0 at December 31, 1994) bear interest at the bank's prime rate (8.5% at December 31, 1994) plus 1%.\nThe weighted average interest rate on short-term borrowings outstanding as of December 31, 1993 and 1994 was 7.25% and 9.75% respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE G--COMMITMENTS AND CONTINGENCIES\nOn February 8, 1989, the Boeing Company (\"Boeing\") filed a lawsuit naming the Company, together with three prior subsidiaries of the Company, as defendants in Case No. CV89-119MA, United States District Court for the District of Oregon. In that lawsuit, Boeing sought damages and declaratory relief for past and future costs resulting from alleged groundwater contamination at a location in Gresham, Oregon, where the three prior subsidiaries of the Company formerly conducted business operations. On December 22, 1993, the Company entered into a settlement with Boeing, settling all claims asserted by Boeing in the lawsuit. Pursuant to the settlement terms, the Company will pay Boeing $12.5 million over the course of five years, at least $5 million of which has been committed by certain insurance companies in the form of cash or irrevocable letters of credit. In accordance with the settlement agreement, Boeing's claims against the Company and the three former subsidiaries have been dismissed with prejudice and Boeing has released and indemnified the Company with respect to certain claims. Accordingly, a $7.5 million special charge was recorded in 1993, to provide for the cost associated with this legal proceeding.\nOn March 4, 1992, Motors received notice that the Insurance Commissioner of the State of California, as Conservator and Rehabilitator of ELIC, a limited partner of the Partnership, had filed an Amendment to the Application for Order of Conservation filed in Superior Court of the State of California for the County of Los Angeles. The amendment seeks to add to the Order, dated April 11, 1991, Motors, the Partnership and Checker Holding Corp. III, a limited partner of the Partnership. The amendment alleges that the action by Motors invoking provisions of the Partnership Agreement that alter ELIC's rights in the Partnership upon the occurrence of certain events is improper and constitutes an impermissible forfeiture of ELIC's interest in the Partnership and a breach of fiduciary duty to ELIC. The amendment seeks (a) a declaration of the rights of the parties in the Partnership and (b) damages in an unspecified amount. The Partnership believes that it has meritorious defenses to the claims of ELIC. On April 15, 1994, the Company and the Conservator entered into a letter agreement pursuant to which the Company agreed to purchase ELIC's interest in the Partnership for $37 million. On May 26, 1994, the California Court approved a settlement of this litigation. Pursuant to the Settlement Agreement, on December 22, 1994, Motors redeemed ELIC's interest in the Partnership for $37.0 million (the \"Minority Interest Redemption\") and the litigation was thereafter dismissed with prejudice. Under certain circumstances, if all or substantially all of the assets of the Partnership are sold within five years of the consummation of the Minority Interest Redemption, ELIC may be entitled to receive a payment equal to the positive difference between (x) the distribution ELIC would have received upon liquidation of the Partnership as a result of such transaction, calculated in accordance with the provisions of the Partnership Agreement as if it had continued to hold its partnership interest, and (y) the future value of $37.0 million calculated at 15% per annum from the date of the Minority Interest Redemption to the date of such transaction.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE G--COMMITMENTS AND CONTINGENCIES--Continued. . .\nIn 1988, Great Dane entered into an operating agreement with the purchaser of a previously wholly-owned finance company (\"Finance\"). Under the terms of the agreement, the purchaser is given the opportunity to finance certain sales of Great Dane. The 1988 operating agreement requires that Great Dane, among other things, (i) not finance the sale of its products for the first eight years and (ii) maintain a minimum net worth as defined in the agreement. In addition, under this operating agreement, Great Dane is liable to the purchaser for 50% of losses incurred in connection with the realization of certain new receivables financed by the purchaser subsequent to the sale of Finance subject to certain maximums. Failure to comply with these requirements of the agreement would result in Great Dane having to repay the purchaser varying amounts reducing to $5 million during the year ending September 8, 1996. At December 31, 1994, Great Dane was in compliance with the provisions of the operating agreement.\nIn addition, at December 31, 1994, Great Dane Trailers has guaranteed the realization of receivables of approximately $0.6 million in connection with the sale of Finance and is partially responsible for the realization of new receivables of approximately $156.9 million financed by the purchaser under the operating agreement subject to certain maximums. In addition to Great Dane's guarantee, these receivables are also collateralized by a security interest in the respective trailers originally sold by Great Dane. A loss reserve of $3.1 million, for potential losses that may be incurred on the ultimate realization of these receivables, is included in other accrued and other non-current liabilities in the December 31, 1994, consolidated balance sheet.\nTo secure certain obligations, the Company and its subsidiaries had outstanding letters of credit aggregating approximately $3.4 million at December 31, 1994, which letters of credit were fully secured by cash deposits included in other assets in the consolidated balance sheets. In addition, Great Dane has standby letters of credit aggregating approximately $7.6 million and the Partnership has standby letters of credit aggregating approximately $1.2 million outstanding at December 31, 1994.\nThe Company and certain of its subsidiaries have employment agreements with three officers of the Company that provide for minimum annual compensation of approximately $1.8 million. The contracts expire on various dates from June 1995 to February 1997.\nThe Company and its subsidiaries lease real estate and equipment. Certain leases are renewable and provide for monthly rentals, real estate taxes and other operating expenses. The Company believes that, in the normal course of business, leases that expire will be renewed or replaced by other leases. Rental expense under operating leases was approximately $3.8 million in 1992, $4.8 million in 1993, and $5.5 million in 1994. Minimum rental obligations for all noncancelable operating leases at December 31, 1994 are as follows: $3.0 million in 1995, $2.8 million in 1996, $2.6 million in 1997, $2.5 million in 1998, $2.4 million in 1999, and $14.6 million thereafter.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE G--COMMITMENTS AND CONTINGENCIES--Continued. . .\nManagement believes that none of the above legal actions, guarantees or commitments will have a material adverse effect on the Company's consolidated financial position.\nNOTE H--RETIREMENT PLANS\nThe Company and its subsidiaries have defined benefit pension plans applicable to substantially all employees. The contributions to these plans are based on computations by independent actuarial consultants. The Company's general funding policy is to contribute amounts required to maintain funding standards in accordance with the Employee Retirement Income Security Act. Employees' benefits are based on years of service and the employees' final average earnings, as defined by the plans.\nNet periodic pension cost includes the following components (dollars in thousands):\nGains and losses and prior service cost are amortized over periods ranging from seven to fifteen years. Other assumptions used in the calculation of the actuarial present value of the projected benefit obligation were as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE H--RETIREMENT PLANS--Continued. . .\nThe following table sets forth the plans' funded status and amounts recognized in the Company's consolidated balance sheets (dollars in thousands):\nRelative positions and undertakings in multiemployer pension plans covering certain of the Partnership's employees are not presently determinable. Expenses related to multiemployer pension plans totaled $0.2 million, $0.2 million and $0.3 million for the years ended December 31, 1992, 1993 and 1994, respectively.\nExpense related to defined contribution plans, which is based on a stipulated contribution for hours worked or employee contributions, approximated $0.3 million in 1992, $0.5 million in 1993 and $0.5 million in 1994.\nThe Company and its subsidiaries provide postretirement health care and life insurance benefits to eligible retired employees. The Company's policy is to fund the cost of medical benefits as paid. Prior to 1993, the Company recognized expense in the year the benefits were provided. The amount charged to expense for these benefits was approximately $2.5 million in 1992. Effective January 1, 1993, the Company adopted SFAS No.106, \"Employers Accounting for Postretirement Benefits Other Than Pensions.\" This statement requires the accrual of the cost of providing postretirement\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE H--RETIREMENT PLANS--Continued. . .\nbenefits, including medical and life insurance coverage, during the active service period of the employee. The Company recorded a charge of $29.7 million (net of taxes of $16.5 million), or $29,762 per share, during 1993 to reflect the cumulative effect of this change in accounting principle.\nThe following table sets forth the plan's funded status reconciled with amounts recognized in the Company's consolidated balance sheets (in thousands):\nNet periodic postretirement benefit cost includes the following components (in thousands):\nThe health care cost trend rate as of December 31, 1994, ranges from 12.6% down to 5.5% over the next 20 years and remains level thereafter. The\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE H--RETIREMENT PLANS--Continued. . .\nhealth care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1994, by $2.9 million. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.5% and 8.0% at December 31, 1993 and 1994, respectively.\nThe effect of adopting SFAS No. 106 decreased 1993 pre-tax income by $2.0 million as compared to 1992.\nNOTE I--MINORITY EQUITY\nOn April 11, 1991, ELIC was placed in conservatorship. In accordance with the provisions of the Partnership Agreement, the Partnership continues, but ELIC's interest in the Partnership and rights under the Partnership Agreement are limited to the right to receive the balance of its capital account as calculated and on the terms set forth in the Partnership Agreement. On December 22, 1994, the Company purchased ELIC's interest in the Partnership for $37 million.\nMinority equity for the year ended December 31, 1994, represents the minority interest holder's allocable share of SCSM's net income for the period.\nNOTE J--INCOME TAXES\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" As permitted under the new rules, prior years financial statements have not been restated. The Company recorded a charge of $16.9 million, or $16,864 per share, during 1993 to reflect the cumulative effect of this change in accounting principle. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.\nSignificant components of the Company's deferred tax assets and liabilities as of December 31, 1993 and 1994 are as follows (dollars in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE J--INCOME TAXES--Continued. . .\nThe components of income tax expense are as follows (dollars in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE J--INCOME TAXES--Continued. . .\nThe components of the deferred tax benefit are as follows (dollars in thousands):\nIncome tax expense differs from the amount computed by applying the statutory federal income tax rate to income (loss) before income taxes. The reasons for these differences are as follows (dollars in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE J--INCOME TAXES--Continued. . .\nIncome taxes paid totaled $3.9 million in 1992, $13.4 million in 1993 and $24.5 million in 1994.\nNOTE K--RELATED PARTY TRANSACTIONS\nThe Company leases an airplane owned by a corporation of which a director is the sole shareholder. Lease expenses totaled $0.7 million each year in 1992 and 1993 and $1.1 million in 1994.\nNOTE L--INDUSTRY SEGMENT INFORMATION\nThe Company operates in four principal segments:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE L--INDUSTRY SEGMENT INFORMATION--Continued. . .\nTRAILER MANUFACTURING SEGMENT--Manufacturing and distribution of highway truck trailers.\nAUTOMOTIVE PRODUCTS SEGMENT--Manufacturing metal stampings and assemblies and coordination of related tooling production for motor vehicle manufacturers.\nVEHICULAR OPERATIONS SEGMENT--Leasing taxicabs.\nINSURANCE OPERATIONS SEGMENT--Providing property and casualty insurance coverage to the Partnership and to outside parties.\nTrailer Manufacturing segment sales to J. B. Hunt totaled approximately $50.0 million in 1992, $92.3 million in 1993 and $85.3 million in 1994.\nAutomotive product net sales to General Motors Corporation totaled approximately $109.1 million in 1992, $121.5 million in 1993 and $145.9 million in 1994 (includes accounts receivable of $8.9 million, $8.9 million and $13.0 million at December 31, 1992, 1993 and 1994, respectively).\nIndustry segment data is summarized as follows (dollars in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE M--FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used by the Company in estimating the fair value of financial instruments:\nCASH AND CASH EQUIVALENTS: The carrying amount reported in the balance sheet for cash and cash equivalents approximates its fair value.\nINDEBTEDNESS: The carrying amounts of the Company's notes payable to shareholders, Great Dane term loan payable, Great Dane revolving credit line, Partnership term loan payable, equipment term loan, economic development term loan and line of credit approximate their fair value. The fair values of the Company's 12-3\/4% Senior Subordinated Debentures and 14- 1\/2% Subordinated Discount Debentures are based on quoted market prices. The fair values of the Company's other indebtedness is estimated using discounted cash flow analyses based on current market rates.\nThe carrying amount and fair value of the Company's indebtedness at December 31, 1994, are as follows (dollars in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE O--SUBSEQUENT EVENTS\nIn January 1995, Motors and its subsidiaries finalized a refinancing with a bank whereby Motors entered into a loan agreement providing for a $45 million term loan and a $20 million revolving credit facility. The funds from the term loan were used to repay approximately $27 million of bank debt including the Partnership term loan, the equipment term loan and the notes payable to the bank, provide $15 million to the Company to retire a portion of certain notes outstanding to the Company's shareholders and pay fees and expenses. Availability under the revolving credit facility is based on the amount of eligible trade accounts receivable and inventory and may be used for working capital needs, as well as for general corporate purposes.\nThe new term loan requires twenty quarterly principal payments of approximately $2.3 million, commencing June 30, 1995, plus interest at either the bank's prime rate plus 1.25% (subject to reductions of up to 0.5% upon the occurrence of certain events) or a selected Eurodollar contract rate plus 300 basis points (subject to reductions of up to 50 basis points upon the occurrence of certain events). The new term loan is secured by substantially all of Motors' assets including the stock of the Insurance Subsidiary. The new term loan agreement requires Motors to, among other things, comply with certain financial covenants, limits additions to and sales of Motors' fixed assets and limits additional borrowings by Motors.\nIn February 1995, Great Dane Trailers amended its loan and security agreement. Pursuant to the amended agreement, the Lenders have loaned $28 million as a term loan and have agreed to provide, at any given time, up to $150 million (less amounts then outstanding as a term loan) as a revolving credit facility (subject to availability based on the amount of eligible trade accounts receivable and inventory) to be used as working capital by Great Dane and for general corporate purposes. The initial term loan proceeds, which were drawn immediately upon closing, were used, together with drawings under the revolver, to repay approximately $17 million of bank debt, provide $15 million to the Company to retire the balance of the shareholder notes and pay fees and expenses. The term loan requires monthly principal payments of $0.3 million plus interest on the unpaid principal amount of the loan in arrears at a rate equal to 1% above the prime rate of interest charged from time to time by Bank of America or a rate equal to 2.5% above a selected Eurodollar contract rate with the unpaid principal balance due five years after the closing date. The loans are secured by substantially all of the assets of Great Dane and its subsidiaries. The Agreement requires Great Dane to, among other things, comply with certain financial covenants, and limits the amount of loans and transfers to the Company, limits additions to and sales of Great Dane's fixed assets and limits additional Great Dane borrowings.\nIn January 1995, Motors liquidated the Partnership.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED GREAT DANE HOLDINGS INC. AND SUBSIDIARIES\nNOTE O--SUBSEQUENT EVENTS--Continued. . .\nOn November 23, 1994, the Company filed a Registration Statement on Form S- 1 with the Securities and Exchange Commission in connection with an initial public offering (\"IPO\") of the Company's common stock. The Company is registering 6,555,000 shares of common stock (including 855,000 shares which the underwriters have the right to purchase to cover over-allotments) (in each case, giving effect to a 16,800 to 1 split of the common stock to be effected upon consummation of the IPO). It is currently estimated that the initial public offering price will be between $13 and $15 per share. All of the net proceeds are intended to be used to redeem approximately $72 million of the Company's 12-3\/4% Senior Subordinated Debentures, due 2001, which will be sufficient to satisfy all remaining sinking fund payments on this indebtedness.\nS-1\nS-2\nS-3\nThe Registrant's subsidiaries declared dividends totaling $120.9 million in 1992, $22 million in 1993 and $15 million in 1994. These dividends were declared to offset certain intercompany account balances at the respective dates.\nS-4\nS-5\nS-6\nE-1 INDEX TO EXHIBITS\nThe following Exhibits required by Item 601 of Regulation S-K (and numbered in conformity therewith) are filed herewith or incorporated by reference herein:\n3.1 - Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to Registration Statement No. 033- 56595 filed with the Securities and Exchange Commission on November 23, 1994 (the \"1994 S-1\").\n3.2 - Bylaws of the Company (incorporated herein by reference to Exhibit 3.2 to the 1994 S-1).\n4.1 - Form of Indenture between the Company and First Fidelity Bank, National Association, New Jersey, as trustee (\"First Fidelity\") relating to the 12-3\/4% Senior Subordinated Debentures due August 1, 2001, of International Controls Corp (\"ICC\") (incorporated herein by reference to Exhibit 4.1 to Registration Statement No. 33-7212 filed with the Securities and Exchange Commission on July 15, 1986).\n4.2 - First Supplemental Indenture, dated as of October 19, 1994, among ICC, the Company and First Fidelity relating to the 12-3\/4% Senior Subordinated Debentures due August 1, 2001 (incorporated herein by reference to Exhibit 4.2 to the 1994 S-1).\n4.3 - Form of Indenture between the Company and Midlantic National Bank, as trustee (\"Midlantic\"), relating to the 14-1\/2% Sub-\nordinated Discount Debentures due January 1, 2006, of ICC (incorporated herein by reference to Exhibit 4.1 to Registration Statement No. 33-1788 filed with the Securities and Exchange Commission on November 26, 1985).\n4.4 - First Supplemental Indenture, dated October 19, 1994, among ICC, the Company and Midlantic relating to the 14-1\/2% Subordinated Discount Debentures due January 1, 2006 (incorporated herein by reference to Exhibit 4.4 to the 1994 S-1).\n4.5 - Agreement to furnish additional documents upon request by the Securities and Exchange Commission (incorporated herein by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 (the \"1989 10-K\").\n10.1 - Amended and Restated Employment Agreement, dated as of November 1, 1985, between Motors and David R. Markin (\"Markin Employment Agreement\") (incorporated herein by reference to Exhibit 10.18 to the 1989 10-K).\n10.2 - Amendment, dated as of March 4, 1992, to Markin Employment Agreement (incorporated herein by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (the \"1991 10-K\")).\nE-2 10.3 - Extension, dated July 12, 1993, of Amended and Restated Employ-\nment Agreement between Motors and David R. Markin (incorporated herein by reference to Exhibit 10.6 of the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (the \"1993 10-K\").\n10.4 - Amended and Restated Employment Agreement, dated as of June 1, 1992, between Yellow Cab and Jeffrey Feldman (incorporated herein by reference to Exhibit 28.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992 (the \"June 1992 10- Q\")).\n10.5 - Form of Stated Benefit Salary Continuation Agreement (incorpo-\nrated herein by reference to Exhibit 10.21 to the 1989 10-K).\n10.6 - Employment Agreement, dated as of July 1, 1992, between the Company and Jay H. Harris (incorporated herein by reference to Exhibit 28.1 to the June 1992 10-Q).\n10.7 - Amendment, dated April 6, 1994, to Harris Employment Agreement (incorporated herein by reference to Exhibit 10.10 to the 1994 S- 1).\n10.8 - Lease, dated December 1, 1988, between SCSM and Park Corporation (incorporated herein by reference to Exhibit 10.25 to the 1989 10-K).\n10.9 - Assumption Agreement, dated as of August 1, 1989, by and between Motors and the West Virginia Economic Development Authority (incorporated herein by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990).\n10.10 - Agreement, dated as of September 1, 1991, between Yellow Cab Company and Jerry E. Feldman (incorporated herein by reference to Exhibit 10.12 to the 1991 10-K).\n10.11 - Form of Checker Motors Corporation Excess Benefit Retirement Plan, effective January 1, 1983 (incorporated herein by reference to Exhibit 19.9 to the 1991 10-K).\n10.12 - Amended and Restated License Agreement, dated December 30, 1992, between Motors and Checker Taxi Association, Inc. (incorporated herein by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31 1992 (the \"1992 10-K\")).\n10.13 - Employment Agreement, dated as of January 1, 1994, between the Company and David R. Markin (incorporated herein by reference to Exhibit 10.36 to the 1994 S-1).\n10.14 - Great Dane Holdings Inc. 1994 Stock Option Plan.*\n10.16 - Settlement Agreement, dated as of June 21, 1994, among John Garamendi, as Insurance Commissioner of the State of California,\nE-3\nBase Assets Trust, the Partnership, Motors, Checker Holding Corp.III and Holdings (incorporated herein by reference to Exhibit 10.38 to the 1994 S-1).\n10.17 - Form of Indemnification Agreement (incorporated herein by reference to Exhibit 10.39 to the 1994 S-1).\n10.18 - Sale, Installation and Technical Assistance Agreement, dated November 14, 1983, between Graaff KG and Great Dane Trailers, Inc. (incorporated herein by reference to Exhibit 10.40 to the 1994 S-1).\n10.19 - Form of Great Dane Trailers, Inc., Supplemental Retirement Income Plan, effective January 1, 1994 (incorporated herein by reference to Exhibit 10.41 to the 1994 S-1).\n10.20 - Amended and Restated Operating Agreement, dated as of August 31, 1988, between Associates Commercial Corporation (as successor to Great Dane Finance Company) and Great Dane Trailers, Inc. (the \"Associates Agreement\") (incorporated herein by reference to Exhibit 10.43 to the 1994 S-1).\n10.21 - Amendment, dated February 7, 1994, to the Associates Agreement (incorporated herein by reference to Exhibit 10.44 to the 1994 S- 1).\n10.22 - Amendment, dated May 18, 1994, to the Associates Agreement (incorporated herein by reference to Exhibit 10.45 to the 1994 S- 1).\n10.23 - Loan Agreement, dated as of January 26, 1995, by and among Motors, Yellow Cab, Chicago AutoWerks, CMC Kalamazoo, SCSM, the Lenders named therein and NBD Bank, as Agent (\"NBD\").*\n10.24 - Pledge Agreement and Irrevocable Proxy, dated as of January 26, 1995, given by Motors to NBD.*\n10.25 - Security Agreement, dated as of January 26, 1995, made by Motors, Yellow Cab, Chicago AutoWerks and CMC Kalamazoo to NBD.*\n10.26 - Amended and Restated Loan and Security Agreement, dated as of February 14, 1995, among Great Dane Trailers, Inc., Great Dane Los Angeles, Inc., and Great Dane Trailers Tennessee, Inc., the financial institutions named therein, and BankAmerica Business Credit, Inc., as Agent (\"BABC\").*\n10.27 - Amended and Restated Pledge Agreement, dated as of February 14, 1995, made by Great Dane Trailers, Inc., in favor of BABC.*\n10.28 - Amended and Restated Agreement Regarding Stock and Other Matters, dated as of February 14, 1995, between the Company and BABC.*\n21.1 - Subsidiaries of the Company.*\n27.1 - Financial Data Schedule.*\nE-4 28.1 - Schedule P of Annual Statements provided by Country to Illinois Regulatory Authorities (filed under cover of Form SE filed with the Securities and Exchange Commission on February 17, 1995).\n________________ *Filed herewith.","section_15":""}
{"filename":"79209_1994.txt","cik":"79209","year":"1994","section_1":"ITEM 1. BUSINESS.\nPLY GEM Industries, Inc., a Delaware corporation (\"PLY GEM\", hereinafter with its subsidiaries referred to collectively as the \"Company\"), was originally incorporated in 1946 in New York and reincorporated in Delaware in 1987. The Company is a national manufacturer and distributor of a wide range of specialty products for the home improvement industry. The Company believes that it is among the nation's largest manufacturers of wood windows, vinyl siding and accessories, and vinyl windows, and one of the major suppliers of specialty wood and other related products. Each of the Company's ten wholly-owned subsidiaries and its one division have achieved a leading market position within their respective niches of the home improvement industry.\nThe home improvement industry includes products designed for all remodeling, repair and alteration of residential structures whether the work is performed by the homeowner (the \"do-it-yourselfer\" or \"D-I-Y\"), or by a professional contractor. Home improvement products, which in some cases are also used in new construction applications, are sold either through retailers or specialty wholesale distributors that in turn sell to retailers, contractors and builders. The success of the recently introduced warehouse home center format, such as that utilized by Home Depot, continues to change the traditional way in which home improvement products are sold.\nThe Company's primary objective is to become the supplier of choice to the home improvement industry for high margin specialty products. The Company believes that it is uniquely positioned to provide products and services to the major home center retailers, which the Company believes is the fastest growing segment of the home improvement industry.\nThe Company's products are distributed through an extensive network which includes major retail home center chains, specialty home remodeling distributors, lumber and building products wholesalers, professional contractors and Company operated distribution centers. The products are marketed throughout the United States and Canada through Company sales personnel and independent representatives.\nDuring 1994, the Company announced a restructuring program which is intended to strengthen the Company's core businesses, improve long-term profitability and enhance shareholder value. These actions are part of the Company's continuing effort to identify opportunities to improve its cost structure. The Company's restructuring program provides for a wide range of targeted initiatives including delayering the organization, consolidation and closure of selected regional distribution and manufacturing facilities, abandonment of certain information systems and other actions including lease termination expenses. Implementation of certain of these initiatives has already begun, while others are planned to be completed during 1995.\nThe Company operates predominantly in one business segment -- Home Improvement Products. Prior to 1992, the Company reported in two industry segments, Home Improvement Products and Home Products. The operations of the latter segment, consisting of manufacturing and distribution of disposable paper vacuum cleaner bags, have become less significant over the past several years and as a result the Home Products operations are not material to an understanding of the Company's business taken as a whole.\nBUSINESSES OF THE COMPANY\nThe Company operates in four primary business groups: Windows, Doors and Siding; Specialty Wood Products; Distribution; and Home Products. Set forth below are the operating entities within each group and the year in which the entity was acquired by the Company. Ply*Gem Manufacturing is a division of the Company and constitutes the Company's original business.\nWINDOWS, DOORS AND SIDING\nSNE Enterprises, Inc.: SNE is a major manufacturer of wood windows, competing with companies such as Andersen, Marvin and Pella. The Company believes that it is the second largest supplier of wood windows to the major home center retailers.\nSNE manufactures a full line of wood and vinyl windows and patio doors, glass and polycarbonate skylights, and wooden interior bifold doors and shutters. Its products are sold primarily under the Crestline (R) and Vetter (R) brand names and include double hung, casement, sliding and awning windows as well as hinged and sliding patio doors. SNE recently introduced a window that offers the maintenance free and insulating benefits of a solid vinyl window yet has a wood interior that can be painted or stained. SNE's windows are available primed or with an exterior cladding of either aluminum or vinyl. They are available in both custom and stock sizes, and are sold through an extensive network of home centers, lumber and building materials retailers, and specialized value added distributors. SNE's products are marketed to both the home improvement and new construction markets.\nThe market for wood windows is highly competitive. SNE differentiates itself from its competition by pursuing a dual brand strategy, having a distribution base in both the remodeling and new construction markets, extensive custom design and manufacturing capabilities, and a superior field service and support network. The Company believes that SNE will continue to grow as its existing products gain brand recognition from cooperative and other advertising programs with its retail customers, and as it introduces new products.\nVariform, Inc.: Variform is a producer of vinyl siding in the United States and a leading supplier to the major home center retailers. Its vinyl siding, soffit and accessories are produced in a variety of patterns and colors, including woodgrains. Vinyl siding is used in both remodeling and new construction applications and has captured an increasing share of the market for exterior siding materials (which primarily includes wood, aluminum and masonry) due to its ease of installation, durability and low maintenance requirements.\nVinyl siding is sold to either specialized wholesale distributors who in turn sell directly to remodeling contractors (one-step distribution), or to building materials distributors who sell to home centers and lumberyards who, in turn, sell to remodeling contractors (two-step distribution). While Variform sells through both channels of distribution, it focuses on the two-step market, where management believes it is the dominant supplier to the major home center retailers and retail lumber yards, primarily through private label programs with building materials distributors. The Company believes that Variform is able to compete on\nfavorable terms as a result of its broad distribution coverage, high quality innovative products, and production efficiency. Additionally, Variform is strongest in the retail segment of the market, which continues to grow at a rate that is faster than the overall market, as warehouse retailers continue to take business away from the traditional one-step market by offering remodeling contractors a \"one-stop-shop\" for all of their home improvement material needs.\nGreat Lakes Window, Inc.: Great Lakes is a manufacturer of high quality, energy efficient, maintenance free vinyl windows. Its products include double hung, casement, sliding and awning windows, as well as hinged and sliding patio doors. Great Lakes offers a wide selection of products, including a variety of exterior colors and interior woodgrains, several different grille patterns and a wide assortment of glass options. Great Lakes products are primarily used in replacement applications, where windows and patio doors are manufactured for a specific order on a custom size basis. During 1994, Great Lakes introduced a new vinyl window line to penetrate the new construction market which will be sold primarily through two-step distribution.\nGreat Lakes sells its products through its highly trained sales force. It sells its products to specialty window distributors who in turn sell to remodeling contractors, and direct to large remodeling companies. The Company believes that Great Lakes is able to compete successfully due to the breadth and quality of its product offering and its merchandising support. In addition, Great Lakes has been the forerunner in introducing new designs to the industry. Great Lakes' innovative locking system, interior woodgrains and its use of various glass treatments are a few examples of innovations that distinguish Great Lakes from its competition. Great Lakes expects to continue to develop new designs and features for its products in the future.\nRichwood Building Products, Inc.: Richwood is a manufacturer of siding accessories to the remodeling and new construction markets. Siding accessories include blocks, which allow for the flush mounting of items like light fixtures to the exterior of a home, and gable vents. Their products are sold through a network of manufacturers representatives and directly to home centers, lumberyards and wholesale distributors of building materials, electrical and plumbing products. Richwood is the only manufacturer of siding accessories to offer a color selection that matches the colors offered by most, if not all, major manufacturers of vinyl siding in the United States and Canada.\nSPECIALTY WOOD PRODUCTS\nHoover Treated Wood Products, Inc.: Hoover is a manufacturer of pressure treated wood products, selling to home center chains, lumberyards and building material retailers and wholesalers. Its products include lumber and plywood which have been treated for fire retardancy and for protection against moisture and insect infestation.\nSagebrush Sales, Inc.: Sagebrush is a manufacturer and distributor of specialty lumber and building products serving the home improvement and building materials market in the Southwest.\nPly*Gem Manufacturing is a manufacturer and distributor of decorative wall coverings. Its products include decorator paneling, planking and tileboard for the home improvement market. Ply*Gem Manufacturing also distributes a complete line of imported ceramic, porcelain and marble floor tile marketed through home centers and lumberyards.\nContinental Wood Preservers, Inc.: Continental is a Midwestern manufacturer of pressure treated wood products for home improvement retailers and lumberyards in the Midwest.\nWhile the specialty wood products industry is very competitive, the Company believes it is able to compete effectively by providing superior customer service, outstanding quality and, wherever possible, proprietary products. The companies within the group focus on high margin, niche markets within the broader defined wood products industry which tends to be commodity driven. Its products are sold through home center retailers and wholesalers of building materials. The Company believes that growth in this segment of its business will result from continued expansion of its share of the home center market.\nDISTRIBUTION\nAllied Plywood Corporation: Allied is a national distributor of a broad range of high end specialty wood and wood related products, including hardwood plywood, melamine and other laminated board products, hardwood lumber, solid surface materials and cabinet hardware. It is also a major importer of Russian wood products, through its affiliate, Russian Wood Express Inc. (\"Russian Wood\"). Allied's customers are industrial woodworkers, including cabinet manufacturers, architectural millworkers, and manufacturers of store fixtures, furniture, signs and exhibits. Allied sells its products through an extensive network of eleven company operated warehouse facilities and utilizes numerous public warehouses located primarily in the East. A hub and spoke distribution network was recently established at Allied to serve its six Northeast distribution centers. This operation, which allows a central warehouse to serve a broad region, now handles approximately 60% of the material sold in the Northeast and has improved inventory turns. Sales are generated by a well trained and experienced sales force.\nAllied differentiates itself from its competitors, which primarily include local independent distributors, by its superior customer service, geographic coverage and breadth of product line. As a result, it has become a preferred distributor of many products, selling them on an exclusive, or limited exclusive, basis.\nThe Company believes that Allied's future growth will be from the introduction of new products, expansion of its customer base and the development of further opportunities through Russian Wood. Allied recently began to penetrate the retail home center market with some of its products and, the Company believes, will increase its sales to that industry segment.\nGoldenberg Group, Inc.: Goldenberg is a West Coast distributor and manufacturer of furniture components, laminates and board products to furniture manufacturers and other original equipment manufacturers, building material retailers and wholesalers.\nHOME PRODUCTS\nStudley Products, Inc.: Studley is a manufacturer of disposable paper vacuum cleaner bags. In addition, it sells related floor care products. Studley's products are sold to manufacturers of vacuum cleaners, mass merchandisers and other retailers and recently to the retail home center market.\nEven though the market is very competitive Studley is able to compete on the basis of its technical expertise in the design and manufacture of its products, and in its use of high performance materials. Studley introduced an innovative new vacuum cleaner bag that is able to capture pollen and other allergy causing bacteria through the use of high performance materials. The continued introduction of new products and the fact that many consumers are now likely to own more than one vacuum cleaner are expected to provide opportunities for future growth.\nPRODUCTION AND FACILITIES\nThe Windows, Doors and Siding group operates ten manufacturing and warehouse facilities in the United States and one in Canada. Vinyl siding is produced by an extrusion process which forms siding through various dies from certain resin compounds, primarily polyvinyl chloride. Siding accessories are manufactured through an injection molding process using proprietary mold designs. Insulated vinyl framed replacement windows are manufactured, using a patented process, from insulated glass and vinyl extrusions. The manufacturing process of wood windows and patio doors involves cutting and shaping of components that are assembled with high speed tools. In 1994, SNE closed three window assembly and distribution facilities and consolidated these operations into its main manufacturing facility in Mosinee, Wisconsin. This action plus the addition of new automated production equipment, will effectively double the manufacturing capacity of SNE and lead to improved service to its customers.\nThe Specialty Woods Products group operates eight production and warehouse facilities in the United States. The treatment process of wood products generally involves vacuum pressure impregnation of chemicals into the wood in an enclosed vessel to ensure thorough penetration to meet industry and\ngovernment standards. Some of the wood is kiln dried after treatment to remove moisture imparted during the pressure impregnation process, providing a clean, dry and easily handled product. The Company's high-speed laminating production facilities afford flexibility in laminating paper and vinyl to various substrate materials. Specialty lumber products, including siding, decking and paneling are manufactured by the Company in two facilities with a combined annual production capacity in excess of 100 million board feet.\nThe Distribution group operates thirteen distribution centers and utilizes numerous public warehouses located in various major port cities. It also operates two manufacturing facilities.\nDisposable paper vacuum cleaner bags are manufactured at one facility in the United States and one in Canada. Disposable paper vacuum cleaner bags are manufactured on highly automated equipment, the major part of which was designed and built by the Company. The Company is continuously engaged in designing vacuum cleaner bags for new vacuum cleaner models.\nRAW MATERIALS\nThe principal raw materials used in the manufacture of the Company's products are polyvinyl chloride, polypropylene, glass, vinyl extrusions, particle board, fiberboard, plywood, various species of lumber such as pine, spruce, luaun, hemlock and fir, various chemicals, filter paper, and paper.\nThe Company purchases its raw materials from a large number of domestic and international sources. The Company believes that there are alternative sources of supply in the event of its inability to purchase from its present suppliers.\nSEASONALITY\nThe Company's home improvement business is seasonal, particularly in the Northeast and Midwest regions of the United States where inclement weather during the winter months usually reduces the level of activity in both the home improvement and new construction markets. The Company's lowest sales levels usually occur during the first and fourth quarters. Since a high percentage of the Company's manufacturing overhead and operating expenses are relatively fixed throughout the year, operating income tends to be lower in quarters with lower sales. Inventory and borrowings to satisfy working capital requirements are usually at their highest level during the second and third quarters.\nBACKLOG\nIn general, the Company does not produce against a backlog of firm orders; production is geared primarily to the level of incoming orders and to projections of future demand. Significant inventories of finished goods, work- in-process and raw materials are maintained to meet delivery requirements of customers.\nHoover and Continental maintain a backlog of firm orders to be filled in an amount representing approximately 5% of its annual sales. Distribution consists of warehouse operations where orders are filled from stock and where there is no significant backlog.\nEMPLOYEES\nAt December 31, 1994 approximately 4,200 persons were employed by the Company. Approximately 1,500 of such employees are covered by collective bargaining agreements which expire at various times over the next five years. Although the Company had two work stoppages of short duration during 1994, neither had a material adverse effect on the Company's operations and the Company considers its relations with its employees to be good. Under the Company's restructuring program, the Company expects to reduce its work force through 1995 by approximately 600 positions. Approximately 150 positions were eliminated under the program during 1994.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Windows, Doors and Siding group operates ten manufacturing and warehouse facilities in the United States and one in Canada ranging in size from approximately 20,000 square feet to 660,000 square feet. Of these facilities, six are owned, and five are leased under net leases that expire at various dates through 2017. The group's manufacturing facilities operated at ranges of approximately 75% to 90% of capacity during 1994.\nThe Specialty Woods group has eight manufacturing and warehouse facilities in the United States ranging in size from approximately 20,000 square feet to 215,000 square feet. Of these facilities, six are owned, and two are leased under net leases that expire in 1996. The group's manufacturing facilities operated at ranges of approximately 60% to 70% of capacity during 1994.\nThe Distribution group operates thirteen distribution centers ranging in size from approximately 16,000 square feet to 177,000 square feet and two manufacturing facilities of approximately 38,000 square feet and 91,000 square feet. Two facilities are owned, and thirteen are leased under leases that expire at various dates through 2003. Goldenberg's two manufacturing facilities operated at approximately 80% of capacity during 1994.\nHome Products has one manufacturing facility (approximately 160,000 square feet) in the United States and one (approximately 39,000 square feet) in Canada. These facilities are leased by the Company under leases that expire in 2007. The facilities operated at ranges of approximately 60% to 65% of capacity during 1994.\nThe Company's building, machinery and equipment have been generally well maintained, are in good operating condition and are adequate for current and future production requirements.\nThe Company's executive offices are located at 777 Third Avenue, New York, New York and consist of approximately 14,700 square feet of office space which is leased through 1999.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nHoover, a wholly-owned subsidiary of Ply Gem, is a defendant, along with many other parties, in a number of commercial lawsuits, including a purported class action on behalf of certain Maryland homeowners, alleging property damage caused by alleged defects in certain pressure treated interior wood products it produced and sold through August, 1988. Sales of this product constituted less than 3% of the total sales of Ply Gem and its subsidiaries on a consolidated basis during the period January 1, 1984 through December 31, 1990. Ply Gem is also a defendant in many of these suits. The number of lawsuits pending as of December 31, 1994, as well as the number of lawsuits filed in 1993 and 1994 has declined significantly from earlier periods.\nMany of the suits and claims have been settled. In those suits that remain pending, direct defense costs are being paid by either insurance carriers, under reservations of rights agreements, or out of insurance proceeds. Two actions have proceeded to trial against Hoover and resulted in jury verdicts against it. In one of these actions, judgment was entered in Hoover's favor by the court after a jury verdict against it and the plaintiff's petition to appeal the judgment entered in Hoover's favor was denied. Hoover is appealing the other judgment and believes that it has meritorious grounds for overturning it in whole or in part.\nHoover and the Company are engaged in litigation with their insurers regarding coverage for these lawsuits and claims. Hoover has settled its coverage claims with a majority of its insurers and is negotiating settlements with others. Hoover and the Company believe they have meritorious claims for coverage from their remaining unsettled insurers and are seeking declaratory judgments confirming such coverage. The proceeds from settled insurance claims, along with the proceeds from a settlement of claims by Hoover against certain suppliers of materials used by it in the production of treated wood, are available for the settlement of the underlying property damage actions, including the jury verdict now on appeal. The Company believes that Hoover's remaining coverage disputes will be resolved within the next two years on a satisfactory basis and a sufficient amount of additional coverage will be available to Hoover. In reaching this belief, it has analyzed Hoover's insurance coverage, considered its history of successful settlements with primary and excess insurers and consulted with counsel.\nHoover and the Company are vigorously defending the underlying lawsuits which cannot be resolved on a reasonable basis and believe that they have meritorious defenses to those suits including, in the case of the Company, the defense that it has been improperly joined, as it did not manufacture or market the Hoover products at issue, and is not legally liable for the damage allegedly caused by them.\nIn evaluating the effect of the lawsuits, a number of factors have been considered, including: the number and exposure posed by the pending lawsuits; the significant decline in the number of lawsuits filed in 1993 and to date; the availability of various legal defenses, including statutes of limitations; the existence of settlement protocols; an agreement indemnifying Hoover as to certain past and future claims; and Hoover's experience to date in settling with its insurance companies and the likely availability of proceeds from additional insurance. Based on its evaluation, the Company believes that the ultimate resolution of the lawsuits and the insurance claims will not have a material adverse effect upon the financial position 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 1994.\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 been listed on the New York Stock Exchange since December 1, 1994. Prior to that date, the stock traded on the American Stock Exchange. The following table sets forth, for the periods indicated, the high and low market prices for the Company's Common Stock and dividends paid.\nThe Company has paid cash dividends on its Common Stock since 1976 and presently pays quarterly dividends at the annual rate of $.12 per share.\nThe Company's revolving credit facility has limitations on the annual amounts of the Company's dividends. Under the most restrictive provision, at December 31, 1994, approximately $2,900,000 was available for the payment of dividends in 1995.\nThe number of holders of record of the Company's Common Stock as of March 13, 1995 was approximately 2,700.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe selected financial data presented below as of the dates and for the periods indicated are derived from the consolidated financial statements of the Company. The selected financial data should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and the Company's consolidated financial statements and notes thereto.\n-------- (1) Results include a nonrecurring pretax charge of $41.0 million and $4.2 million in 1994 and 1990, respectively related to employee severance, facility consolidations and closures and asset writedowns.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nINTRODUCTION\nThis discussion summarizes the significant factors affecting the consolidated operating results and financial condition of the Company during the three-year period ended December 31, 1994. It should be read in conjunction with the financial statements and notes thereto.\nAs more fully described in Note 2 to the consolidated financial statements, the Company recorded a nonrecurring charge of $41.0 million ($25.7 million after tax) during 1994. The nonrecurring charge consists of $29.1 million related to a restructuring program and $11.9 million related to unusual items primarily consisting of the write-offs of certain intangible assets and discontinued products and costs associated with the Company's business process redesign. Approximately $17 million of the charge is for noncash asset write- offs.\nThe Company's restructuring program is intended to strengthen the Company's core businesses, improve long-term profitability and enhance shareholder value. These actions are part of the Company's continuing effort to identify opportunities to improve its cost structure. The Company's restructuring program provides for a wide range of targeted initiatives including delayering the organization, consolidation and closure of selected regional distribution and manufacturing facilities, abandonment of certain information systems and other actions including lease termination expenses. Implementation of certain of these initiatives has already begun, while others are planned to be completed during 1995. The restructuring includes an expected reduction in workforce of approximately 600 positions. As of December 31, 1994, approximately 150 positions have been eliminated. The restructuring actions and the unusual charge are expected to result in annualized pretax savings of approximately $13 million upon full implementation. There can be no assurance, however, that the Company will realize these savings.\nFurthermore, the Company expects to exit certain lower margin businesses during 1995. The estimated annual net sales associated with these discontinued products is approximately $25 million. The effect of these lost revenues on 1995 net income is not expected to be significant.\nNET SALES\nNet sales for the year ended December 31, 1994 were $796.4 million which represents a 10.2% increase over 1993 net sales of $722.7 million. The Company continues to improve its position in the retail channel of the home improvement market as evidenced by a 34% increase in sales to this market. The 1994 sales growth was driven by the Company's Windows, Doors and Siding subsidiaries which experienced a 14% increase in sales. Increased market penetration and new products helped fuel this growth. Of the total net sales increase in 1994, approximately 6% is attributable to increases in unit volume and the remainder to increases in average selling prices.\nStrong sales in the Company's Windows, Doors and Siding group, and improved sales of the Company's Distribution business, resulted in a 16% increase in net sales for the year 1993 when compared to 1992. Approximately 10% of the increase was attributable to unit volume growth and 6% due to increases in average selling prices.\nGROSS PROFIT\nGross profit, expressed as a percentage of net sales, was 19.3% in 1994, compared with 19.1% in 1993 and 20.7% in 1992. Although the price of PVC resin and glass, which are used in the manufacturing of siding and windows, increased significantly during 1994, improved labor productivity, overall lower conversion costs and the absence of new plant start-up costs, which were incurred in 1993, offset these increases and were primarily responsible for the improvement in gross profit during 1994. Higher raw material costs (particularly wood and resin), competitive pricing pressures, costs of introducing new products and the aforementioned new plant start-up costs accounted for most of the decline in gross profit experienced in 1993 as compared to 1992.\nThe Company's results of operations are affected by fluctuations in the market prices of wood products used as raw materials in its various manufacturing operations. Over the years, the Company has experienced significant fluctuations in the cost of wood products from primary suppliers. A variety of factors over which the Company has no control, including environmental regulations, weather, economic conditions and natural disasters, impact the cost of wood products. The Company anticipates that these fluctuations will continue in the future. Although the Company attempts to increase sales prices of its products in response to higher wood products costs, such sales prices often lag behind the escalation of the cost of raw materials in question. While the Company intends to increase prices in a timely manner to cover further increases in the cost of wood products, its ability to do so may be limited by competitive or other factors.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general and administrative expenses, as a percentage of net sales, decreased to 14.2% in 1994 as compared to 14.8% in 1993 and 16.3% in 1992. In general, the improvement reflects the efforts by the Company to manage expense growth relative to revenue growth and the implementation of cost containment programs.\nSpecifically, the decrease in 1994 is primarily attributable to a lower provision for bad debts, certain administrative and functional consolidations and work force reductions, partially offset by employment costs associated with the creation of new positions in purchasing, executive management, information systems, total quality management and marketing. Economies resulting from the absorption of fixed expenses over a larger sales base also attributed somewhat to the improvement in 1994 and were primarily responsible for the improvement in 1993.\nINCOME FROM OPERATIONS\nIncome from operations, excluding the $41.0 million nonrecurring charge described previously, increased 30% to $41.1 million in 1994 from $31.6 million in 1993. Income from operations was $27.4 million in 1992. The improvements are due to the factors discussed above.\nAMORTIZATION OF GOODWILL AND OTHER INTANGIBLES\nAmortization of goodwill and other intangibles was $4.2 million, $4.7 million and $4.8 million in 1994, 1993 and 1992, respectively. The decrease in amortization in 1994 of $0.5 million, when compared to 1993, is attributable to the write-off of certain intangible assets as described in Note 2 to the consolidated financial statements.\nINTEREST EXPENSE\nInterest expense was $7.5 million in 1994 compared to $10.1 million in 1993 and $9.6 million in 1992. Lower interest expense in 1994 resulted from the conversion of the Company's 10% Convertible Subordinated Debentures (\"Debentures\") into common stock during March 1994, partially offset by higher average debt balances and higher interest rates experienced during the year. The slight increase in interest expense during 1993 as compared to 1992 is due primarily to higher borrowing levels during 1993.\nOTHER INCOME (EXPENSE)\nOther income (expense) primarily includes the costs associated with the sale of accounts receivables program, partially offset in 1993 by a gain resulting from an involuntary conversion of property.\nINCOME TAXES\nThe effective income tax rate (benefit in 1994) was 28.6% in 1994, 44.8% in 1993 and 44.6% in 1992. The lower tax rate in 1994 is due to the proportionately higher amount of non-deductible goodwill amortization in 1994 as compared to the loss before taxes than in 1993 and certain state tax benefits related to the nonrecurring charge which, in accordance with the criteria set forth in Financial Accounting Standards Board Statement No. 109, were not recognized. Excluding the effect of the nonrecurring charges, the effective tax rate in 1994 was 41%.\nThe effective income tax rate in 1993 and 1992 was approximately the same. During 1993, the federal statutory rate was increased by 1% retroactive to January 1, 1993. This rate increase in 1993 was offset by a proportionately lower amount of non-deductible goodwill amortization in 1993 as compared to income before taxes than in 1992.\nNET INCOME\nNet income, before the nonrecurring charge, increased 77% to $17.2 million in 1994 from $9.7 million in 1993. Net income was $6.3 million in 1992. The factors cited above were responsible for the improved results of the Company.\nLIQUIDITY AND CAPITAL RESOURCES\nIn February 1994, the Company entered into a five-year revolving credit facility with a syndicate of banks which provides available financing of up to $200 million. Initial borrowings were used to repay the Company's previous bank credit facilities. The new credit facility provides the Company with financing at competitive prices, strengthens the balance sheet by extending debt maturities to 1999 and makes available additional resources to fund the Company's growth programs. Approximately $92 million was available under this facility at December 31, 1994. See Note 8 to the consolidated financial statements for additional information on the new credit facility.\nAs more fully described in Note 8 to the consolidated financial statements, in March 1994 holders of the Company's Debentures converted a total principal amount of approximately $50 million into 2,751,328 shares of the Company's common stock. As a result, the Company's net worth was increased by approximately $49.1 million after the costs of the conversion; in addition, the Company will save $5 million of annual interest expense.\nThe sale of accounts receivable program, which is a $50 million facility, resulted in the sale of $40.0 million of accounts receivables at December 31, 1994 compared to $20.0 million at the end of 1993.\nThe table below summarizes the Company's cash flow from operating, investing and financing activities as reflected in the Consolidated Statement of Cash Flows.\nOPERATING ACTIVITIES\nCash flow provided from operations was $48.9 million, an increase of $44.2 million compared to $4.7 million provided in 1993. Although the Company reported a net loss of $8.5 million for 1994, such loss was the result of nonrecurring charges of $41.0 million. Approximately 60% of the nonrecurring charge will require cash outlays of which approximately $5.2 was spent as of the end of 1994.\nThe increase in cash from operations resulted primarily from improved operating results (before nonrecurring charges), implementation of inventory reduction programs resulting primarily from discontinued sales of lower margin products and proceeds from the Company's accounts receivable program more fully discussed in Note 3 to the consolidated financial statements. Cash generated from operations was used to fund capital expenditures, repurchase Company shares and reduce bank debt.\nThe Company's working capital requirements for inventory and accounts receivable are impacted by changes in raw material costs, the availability of raw materials, growth of the Company's business and seasonality. As a result, such requirements may fluctuate significantly.\nINVESTING ACTIVITIES\nInvesting activities of the Company during the discussion periods primarily consist of acquisition of property, plant and equipment and the receipt and use of funds held for construction.\nCapital expenditures were $23.0 million in 1994 compared to $20.5 million in 1993 and $17.1 million in 1992. Most of the outlays in 1994 were for machinery and equipment used to expand capacity and improve productivity. Approximately $4.3 million was incurred in connection with the design and development of the Company's new information systems.\nFunds Held for Construction relate to proceeds and usage of cash from the industrial development revenue obligations which were used to finance plant expansions in prior years.\nCapital expenditures provide a basis for future growth. The Company has a formalized review procedure for all capital spending. The acceptability of a capital project is based on many factors, including its discounted cash flow, return on investment and projected payback period. Management expects that 1995 capital expenditures will approximate 1994 levels.\nFINANCING ACTIVITIES\nIn the fourth quarter of 1994, the Board of Directors authorized the repurchase of up to 1 million shares of the Company's common stock. Aggregate repurchases for the year approximated 641,000 shares with a total purchase price of $12.2 million. The Company is expected to continue its buy-back program during 1995 as determined by market conditions.\nDuring 1994, the Company reduced bank debt by $15.8 million. In addition, the Company received approximately $6.5 million from the exercise of employee stock options.\nBALANCE SHEET ANALYSIS\nThe capitalization of the Company (long-term debt plus stockholders' equity) was $248.3 million at December 31, 1994. The ratio of debt to capitalization was 35% at December 31, 1994, which reflects the conversion of the Company's Debentures. This is substantially improved from such ratio at December 31, 1993 which was 54%.\nThe Company's working capital was $110.5 million at December 31, 1994 compared to $137.4 million at December 31, 1993. The current ratio was 2.5 at December 31, 1994, compared to 3.2 at December 31, 1993. The decrease in working capital and the current ratio was the result of a decrease in current assets of $13.2 million from December 31, 1993 to December 31, 1994 and an increase in current liabilities of $13.8 million during the same period. The decrease in current assets at December 31, 1994 compared to December 31, 1993 resulted primarily from lower inventories due to the implementation of inventory reduction programs and lower accounts receivable as a result of additional sales under the Company's accounts receivable program, offset by higher deferred taxes resulting from the tax benefits associated with the nonrecurring charge. Such benefits are deductible for income tax purposes in years when the assets are disposed of or expenditures incurred. The increase in current liabilities from December 31, 1993 to December 31, 1994 was due primarily to the restructuring accrual.\nThe increase in other assets and other liabilities resulted primarily from the adoption of Financial Accounting Standards Board Interpretation No. 39 which became effective January 1, 1994 and is more fully described in Note 12 to the consolidated financial statements.\nLong-term debt at December 31, 1994 was $79.5 million compared $142.9 million at December 31, 1993. Conversion of the Company's Debentures and the additional proceeds of the Company's accounts receivable program used to repay long-term debt were primarily responsible for the decline.\nThe Company will continue to have cash requirements to support working capital needs, pay interest, fund the restructuring program and fund capital expenditures. In order to meet these cash requirements, the Company intends to use internally generated funds and, if necessary, borrowings from the new credit facility. Management believes cash generated from these sources will be adequate to meet the Company's cash requirements over the next 12 months.\nSEASONAL NATURE OF BUSINESS\nThe home improvement business is seasonal, particularly in the Northeast and Midwest regions of the United States where inclement weather during the winter months usually reduces the level of building and remodeling activity in both the home improvement and new construction markets. The Company's lowest sales levels usually occur during the first and fourth quarters. Since a high percentage of the Company's manufacturing overhead and operating expenses are relatively fixed throughout the year, operating income tends to be lower in quarters with lower sales. Inventory and borrowings to satisfy working capital requirements are usually at their highest level during the second and third quarters.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS (THE INDEX TO CONSOLIDATED FINANCIAL STATEMENTS IS INCORPORATED BY REFERENCE IN ITEM 14(A) OF PART IV OF THIS FORM 10-K)\n(ART)\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors and Stockholders Ply Gem Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of Ply Gem Industries, Inc. and Subsidiaries (the \"Company\") 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 conduct our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 Ply Gem Industries, Inc. and Subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nGRANT THORNTON LLP\nNew York, New York February 24, 1995\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these statements.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these statements.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nTHREE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of these statements.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these statements.\nPLY GEM INDUSTRIES, INC. 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 Ply Gem Industries, Inc. and its wholly-owned subsidiaries after eliminating all significant intercompany accounts and transactions. Certain prior year items have been reclassified to conform to the 1994 presentation.\nCash and Cash Equivalents\nCash and cash equivalents include cash on hand and temporary investments having a maturity of three months or less.\nMarketable Securities\nMarketable securities are carried at fair value. The fair value of these securities is estimated based on current market prices and management's estimates.\nInventories\nInventories are stated at the lower of cost or market. Cost is determined on the first-in, first-out (FIFO) method.\nProperty, Plant and Equipment\nOwned property, plant and equipment are depreciated, generally on a straight- line basis over their estimated useful lives. Leasehold improvements are amortized on a straight-line basis over their respective lives or the terms of the applicable leases, including expected renewal options, whichever is shorter. Accelerated depreciation methods are used for tax purposes. Capitalized leases are amortized on a straight-line basis over the terms of the leases or their economic useful lives.\nIntangible Assets\n(a) Patents and Trademarks\nPurchased patents and trademarks are recorded at appraised value at time of acquisition and are being amortized on a straight-line basis over their estimated remaining economic lives; thirteen to sixteen years for patents and thirty years for trademarks.\n(b) Other Intangibles\nCost in excess of net assets acquired is being amortized from twenty to thirty years on a straight-line basis. On a periodic basis, the Company estimates the future undiscounted cash flows of the businesses to which goodwill relates in order to ensure that the carrying value of such goodwill has not been impaired. Other purchased intangibles are being amortized on a straight-line basis generally from ten to thirty-nine years.\nIncome Taxes\nDeferred income tax liabilities and assets reflect the tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes and net operating loss carryforwards. Deferred income tax assets, such as benefits related to net operating loss carryforwards, are recognized to the extent that such benefits are more likely than not to be realized.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nFair Value of Financial Instruments\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:\n(a) Cash and Cash Equivalents\nThe carrying amount approximates fair value because of the short maturity of those instruments.\n(b) Long-Term Debt\nThe carrying amount approximates fair value, as the debt carries variable interest rates.\nEarnings (Loss) Per Share\nEarnings (loss) per share of common stock is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding. Stock options have been excluded from the calculation in 1994 as their effect would be anti-dilutive. Earnings per share is calculated using the modified treasury stock method, which limits the assumed purchase of treasury shares to 20% of the outstanding common shares. The assumed conversion of the Company's 10% Convertible Subordinated Debentures (\"Debentures\") was not used in 1993 and 1992 because the result would be anti-dilutive.\nNOTE 2 -- NONRECURRING CHARGES\nDuring 1994, the Company recorded nonrecurring charges of $41.0 million ($25.7 million after tax), of which $4.7 million ($3.2 million after tax) was recorded in the fourth quarter. The charges consist of approximately $29.1 million related to a restructuring program designed to improve profitability and $11.9 million for unusual items primarily consisting of the write down of certain intangible assets and discontinued products and costs associated with the Company's business process redesign.\nThe Company began working on the proposed restructuring program during the fiscal 1994 second quarter. The restructuring charge consists of several components including: severance and related costs in connection with the planned reduction of approximately 15% of the Company's workforce or approximately 600 salaried and hourly jobs, consolidation and closure of selected regional distribution and manufacturing facilities, the abandonment of certain information systems and other actions including lease termination expenses and transaction costs to execute the restructuring program. It is anticipated that these actions will be implemented over the next twelve months and the Company expects to realize annualized pretax savings of approximately $13 million upon full implementation. However, there can be no assurance that the Company will realize these savings.\nThe status of the components of the restructuring provision at the end of the year was:\n-------- * The following amounts are included in the consolidated balance sheet at December 31, 1994 under the captions: \"accrued restructuring\" ($13.4 million), \"other liabilities\" ($4.1 million), \"property, plant and equipment\" (reduction of $2.0 million), \"inventory\" (reduction of $1.5 million), \"accounts receivable\" (reduction of $.8 million) and various other asset accounts (reduction of $.5 million).\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 3 -- ACCOUNTS RECEIVABLE\nThe Company has a program which currently allows for the sale of up to $50 million of undivided fractional interests in a designated pool of eligible accounts receivable to a financial institution with limited recourse. The program expires in January 1998 with options to extend the agreement to January 2000. At December 31, 1994, the Company sold $40 million of receivables under this program compared to $20 million at December 31, 1993. Program costs of $1,892,000, $1,495,000 and $1,502,000 are included in other income (expense) for 1994, 1993 and 1992, respectively.\nNOTE 4 -- INVENTORIES\nThe classification of inventories at the end of each year was as follows:\nNOTE 5 -- PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at the end of each year consisted of the following:\nNOTE 6 -- INTANGIBLE AND OTHER ASSETS\nThe accumulated amortization of cost in excess of net assets acquired and other intangible assets is $25,990,000 at December 31, 1994 and $26,136,000 at December 31, 1993.\nOther assets at December 31, 1994 include notes receivable from an executive officer of $5,400,000 ($6,340,000 at December 31, 1993) and $3,250,000. The $5,400,000 notes have an average interest rate of 7.1% and are due in approximately equal annual installments through 2003. Under the terms of the notes, principal and interest are forgiven upon the attainment of at least a 20% improvement in net income, as defined, versus the prior year or at the discretion of the Board of Directors. Accordingly, the annual installments for 1994 and 1993 were forgiven. Furthermore, under the terms of the officer's employment agreement, the loan shall be forgiven upon the occurrence of a change in control of the Company or permanent disability of the officer. The $3,500,000 note has an interest rate which is the higher of the Company's average bank borrowing rate or the applicable Federal rate in effect for such period. The note is payable in annual installments of $250,000 with the final payment due December 31, 1998.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 7 -- SUPPLEMENTAL CASH FLOW INFORMATION\nSupplemental cash flow information for the years ended December 31 is as follows:\nNoncash financing activities involve the issuance of common stock upon conversion of $49,963,000 of the Company's Debentures in 1994.\nNOTE 8 -- LONG-TERM DEBT\nThe composition of long-term debt at the end of each year was as follows:\nThe Company has a revolving credit facility with a syndicate of banks, which provides financing of up to $200 million through February 1999. Interest on borrowings are at varying rates based, at the Company's option, on the London Interbank Offered Rate (LIBOR) or the bank's prime rate. The Company pays an annual fee of .375% on the facility amount. The average weighted interest rate on these loans for the year 1994 was 5.9%. The credit facility includes customary covenants, including covenants limiting the Company's ability to pledge assets or incur liens on assets and financial covenants requiring among other things, the Company to maintain a specified leverage ratio, fixed charge ratio and tangible net worth levels. In addition, the amount of annual dividends the Company can pay is limited based on a formula. At December 31, 1994 $2,900,000 was available for payments of dividends in 1995. Borrowings under this credit facility are collateralized by the common stock of the Company's principal subsidiaries.\nDuring 1994, holders of the Company's Debentures converted a total principal amount of $49,963,000 into 2,751,328 shares of the Company's common stock. As a result of this transaction, the total principal amount converted was credited to common stock at par and paid-in-capital, net of unamortized expenses of the original debt issue and transaction costs and offset by the accrued interest from the last payment date to the conversion date. The remaining $37,000 of the original $50 million face amount was redeemed by the Company.\nThe Company has purchased $60 million of interest rate caps, which has the effect of limiting the Company's exposure to high interest rates. These caps mature over various periods through October 1996 and have cap rates ranging from 6.5% to 8.5%.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nFuture maturities of long-term debt, for the years 1996 through 1999, are: 1996-$401,000; 1997-$421,000; 1998-$446,000; and 1999-$71,976,000.\nThe net book value of property, plant and equipment pledged as collateral under mortgages and industrial revenue bonds approximated $7,780,000 at December 31, 1994.\nNOTE 9 -- INCOME TAXES\nThe income tax provision (benefit) for the years ended December 31 consisted of the following:\nThe significant components of the Company's deferred tax assets and liabilities as of December 31, 1994 and 1993 are as follows:\nAs of December 31, 1994, the Company has deferred tax assets largely attributable to the 1994 nonrecurring charge (see Note 2) and other accrued expenses. These items are expected to reverse when paid and are therefore likely to be realized.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nPrior to the adoption of Financial Accounting Standards Board Statement No. 109, the deferred tax provision was comprised as follows:\nThe actual income tax provision (benefit) varies from the Federal statutory rate applied to consolidated pretax income (loss) as follows:\nNOTE 10 -- RETIREMENT PLANS\nThe Company provides retirement benefits to certain of its salaried and hourly employees through non-contributory defined benefit pension plans. The benefits provided are primarily based upon length of service and compensation, as defined. The Company funds the plans in amounts as actuarially determined and to the extent deductible for federal income tax purposes. The Company's pension plan assets consist of marketable securities including stocks, bonds and U.S. government securities and insurance company contracts.\nThe components of pension expense are as follows:\nAssumptions used in the computation of net pension expense are as follows:\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The reconciliation of the funded status of the plans at year end follows:\nThe Company maintains a discretionary profit sharing plan with a voluntary 401(k) option for certain of its salaried and hourly employees who vest after meeting certain minimum age and service requirements. Profit sharing plan expense, including the Company's 401(k) match, is comprised as follows:\nNOTE 11 -- STOCK OPTION PLANS\nThe Company's Executive Incentive Stock Option Plan provides for the granting of options to key employees to purchase up to 2,037,500 shares of common stock. Option prices must be 100% of fair market value at date of grant except for an employee who owns in excess of 10% of the common stock outstanding, in which case the exercise price is 110% of the fair market value at date of grant. Options are exercisable in full or in part after one year from the date of grant and expire within ten years (within five years for an employee owning in excess of 10% of the outstanding common stock). Shares acquired must be held for one year.\nThe Senior Executive Stock Option Plan (\"the Senior Plan\") authorizes the granting of either incentive or non-qualified stock options only to executives of businesses acquired by the Company or to newly employed executives. The Senior Plan provides for 750,000 shares of the Company's common stock to be reserved for such issuance.\nThe 1989 Employee Incentive Stock Plan (\"the 1989 Plan\") authorizes the granting of incentive and non-qualified stock options and awards of restricted stock and is made available to executives and key employees of the Company. As in the Senior Plan, option terms and holding and exercise periods may vary except that no option may be exercised more than ten years after date of grant. Stock awarded under the Plan will be subject to restrictions as to sale or transfer. These restrictions may lapse or be waived based on performance, period of service or other factors. The 1989 Plan provides for 3,500,000 shares of the Company's common stock to be reserved for issuance.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe 1994 Incentive Stock Plan (\"the 1994 Plan\") authorizes the granting of incentive and non-qualified stock options and awards of restricted stock. The terms and conditions of the 1994 Plan are similar to those as described above. The 1994 Plan provides for 2,250,000 shares reserved for such issuance.\nAt December 31, 1994, approximately 1,862,000 shares were available for future grant.\nIn 1991, the Company granted 250,000 shares of restricted stock to an executive officer of the Company. The restrictions on these shares will be released at the rate of 25,000 shares per year upon the attainment of certain performance goals and the continued employment of the officer. The restrictions will be lifted in the event of a change in control of the Company. The unamortized restricted stock resulting from this stock award has been deducted from stockholders' equity and is being amortized over ten years at the fair market value on the dates the restrictions are released.\nIn 1994, the Company granted 175,000 shares of restricted stock to an executive officer of the Company. The shares will be released at the rate of 43,750 per year upon the attainment of certain performance goals and the continued employment of the officer. Compensation expense is charged to the income statement at the fair market value on the dates the restrictions are released.\nFor the three years ended December 31, 1994, option activity was as follows:\nNOTE 12 -- COMMITMENTS AND CONTINGENCIES\nLEASES\nThe Company leases certain of its manufacturing, distribution and office facilities as well as some transportation and manufacturing equipment under noncancellable leases expiring at various dates through\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) the year 2017. Certain real estate leases contain escalation clauses and generally provide for payment of various occupancy costs. Minimum future lease obligations on noncancellable leases in effect at December 31, 1994 are as follows:\nRental expense for operating leases amounted to approximately $21,036,000 in 1994, $21,224,000 in 1993, and $20,146,000 in 1992.\nHOOVER TREATED WOOD PRODUCTS, INC. (\"HOOVER\")\nHoover Treated Wood Products, Inc. (\"Hoover\"), a wholly-owned subsidiary of the Company is a defendant, along with many other parties, in a number of commercial lawsuits, including a purported class action on behalf of certain Maryland homeowners, alleging property damage caused by alleged defects in certain pressure treated interior wood products. Hoover has not manufactured or sold these products since August 1988. The Company is also a defendant in some of these suits. The number of lawsuits pending, as of December 31, 1994, as well as the number of lawsuits filed in 1993 and 1994, have declined significantly from earlier periods.\nMany of the suits and claims have been settled. In those suits that remain pending, direct defense costs are being paid by either insurance carriers, under reservations of rights agreements, or out of insurance proceeds. Two actions have proceeded to trial against Hoover and resulted in jury verdicts against it. In one of these actions, judgment was entered in Hoover's favor by the court after a jury verdict against it and the plaintiff's petition to appeal the judgment entered in Hoover's favor was denied. Hoover is appealing the other judgment and believes that it has meritorious grounds for overturning it in whole or in part.\nHoover and the Company are engaged in litigation with their insurers regarding coverage for these lawsuits and claims. Hoover has settled its coverage claims with a majority of its insurers and is negotiating settlements with others. Hoover and the Company believe they have meritorious claims for coverage from their remaining unsettled insurers and are seeking declaratory judgments confirming such coverage. The proceeds from settled insurance claims, along with the proceeds from a settlement of claims by Hoover against certain suppliers of materials used by it in the production of treated wood, are available for the settlement of the underlying property damage actions, including the jury verdict now on appeal. The Company believes that Hoover's remaining coverage disputes will be resolved within the next two years on a satisfactory basis and a sufficient amount of additional coverage will be available to Hoover. In reaching this belief, it has analyzed Hoover's insurance coverage, considered its history of successful settlements with primary and excess insurers and consulted with counsel.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nHoover and the Company are vigorously defending the underlying lawsuits which cannot be resolved on a reasonable basis and believe that they have meritorious defenses to those suits including, in the case of the Company, the defense that it has been improperly joined, as it did not manufacture or market the Hoover products at issue, and is not legally liable for the damage allegedly caused by them.\nIn accordance with the provisions of Financial Accounting Standards Board Interpretation No. 39, which became effective on January 1, 1994, Hoover has recorded a receivable at December 31, 1994 (included in other assets) for $12.1 million for the estimated proceeds and recoveries related to insurance matters discussed above and recorded an accrual for the same amount (included in other liabilities) for its estimated cost to resolve those matters not presently covered by existing settlements with insurance carriers and suppliers. In estimating both this liability, which Hoover expects to discharge over the next four years, and its anticipated additional insurance recoveries, Hoover and the Company have considered a number of factors including: the number and exposure posed by the pending lawsuits; the significant decline in the number of lawsuits filed in 1993 and to date; the availability of various legal defenses, including statutes of limitations; the existence of settlement protocols; an agreement indemnifying Hoover as to certain past and future claims; and Hoover's experience to date in settling with its insurance companies and the likely availability of proceeds from additional insurance. Based on its evaluation, the Company believes that the ultimate resolution of the lawsuits and the insurance claims will not have a material adverse effect upon the financial position of the Company.\nEXECUTIVE COMPENSATION\nIn the event of a change in control of the Company, as defined, senior management, except for the chairman, have the right to receive payments upon termination of employment or resignation within one year. Such payments are to be 2.75 times average annual compensation, as defined, plus in some cases 2.75 times the difference between the market and exercise price of any unexercised stock options. At December 31, 1994, the maximum amount payable, applicable to thirteen individuals, would be approximately $14 million.\nLETTERS OF CREDIT\nAt December 31, 1994 $18,811,000 of letters of credit issued by the Company's banks were outstanding, principally in connection with certain financing transactions.\nOTHER\nThe Company and its subsidiaries are subject to legal actions from time to time which have arisen in the ordinary course of its business. In the opinion of management, the resolution of these claims will not materially affect the financial position of the Company.\nNOTE 13 -- INDUSTRY SEGMENT\nThe Company operates predominantly in one business segment. Operations in the Home Improvement Products business consist of the manufacture and sale of vinyl siding, wood and vinyl-framed windows and patio doors, prefinished decorative plywood and solid wood paneling, furniture components, various pressure-treated wood products and the purchase and resale of a variety of other products for the home improvement markets. One customer accounted for 14.2%, 12.2% and 11.2% of the Company's net sales for the years ended December 31, 1994, 1993 and 1992, respectively.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)\nNOTE 14 -- QUARTERLY RESULTS (UNAUDITED)\n-------- (1) After nonrecurring charges of $36.3 million in the third quarter and $4.7 million in the fourth quarter. See Note 2 to the consolidated financial statements.\nEarnings (loss) per share calculations for each of the quarters presented are based on the weighted average number of shares and common equivalent shares outstanding during such periods. The sum of the quarters may not necessarily be equal to the full year earnings per share amounts.\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 is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on May 11, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on May 11, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on May 11, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on May 11, 1995.\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:\nThe list of consolidated financial statements is set forth in Part II, Item 8 of this Form 10-K and such Index to Consolidated Financial Statements is incorporated herein by reference.\n(a)(2) Financial Statement Schedules:\nThe financial statement schedules that are required by Part II, Item 8 of this Form 10-K, will be filed by amendment.\n(a)(3) Exhibits:\n(b) Reports on Form 8-K\nOn October 18, 1994, the Company reported on a restructuring plan to improve profitability.\nOn November 4, 1994, the Company reported on an amendment to its By-laws.\nOn November 23, 1994, the Company reported on a plan for the Company to purchase up to 1,000,000 shares of its common stock in the open market.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nPly Gem Industries, Inc. (Registrant)\n\/s\/ Jeffrey S. Silverman By: _________________________________ JEFFREY S. SILVERMAN, CHAIRMAN (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\n\/s\/ Jeffrey S. Silverman Chairman, Chief March 31, 1995 ------------------------------------- Executive Officer JEFFREY S. SILVERMAN (Principal Executive Officer) and Director\n\/s\/ Herbert P. Dooskin Executive Vice March 31, 1995 ------------------------------------- President HERBERT P. DOOSKIN (Principal Financial Officer) and Director\n\/s\/ Jerome Baum Controller March 31, 1995 ------------------------------------- JEROME BAUM\n\/s\/ Albert Hersh Director March 31, 1995 ------------------------------------- ALBERT HERSH\n\/s\/ Elihu H. Modlin Director March 31, 1995 ------------------------------------- ELIHU H. MODLIN\n\/s\/ Joseph Goldenberg Director March 31, 1995 ------------------------------------- JOSEPH GOLDENBERG","section_15":""}
{"filename":"824430_1994.txt","cik":"824430","year":"1994","section_1":"ITEM 1. DESCRIPTION OF BUSINESS.\n(1) The Company. Xanthic Enterprises, Inc. was incorporated in Colorado on October 27, 1986 and has not yet commenced operations. The primary activity of the Company will involve seeking merger or acquisition candidates.\n(2) Plan of Operations. The Company plans to seek merger or acquisition candidates.\n(3) Employees. At the present time the Company has no employees other than its officers. The officers devote as much time as they deem appropriate to the Company's business. The officers are not paid salary or expenses.\n(4) Administrative Offices. The Company maintains its executive offices at 8833 Sunset.Blvd., Suite 200, West Hollywood, CA 90069 pursuant to an oral lease agreement with David G. Lilly, a shareholder of the Company on a month to month basis. No rent is paid for this office at this time.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns no properties, plans or other real estate, and has no Letters of Intent to purchase or acquire any property.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nOn November 2, 1991 the State of Oregon issued a cease and desist order ordering the Company to cease and desist issuing unregistered securities in the State of Oregon. The proceeding was based on the distribution of shares and warrants to Oregon shareholders (registered by way of a S-18 registration statement) pursuant to the agreement for such distribution between the Company and Automated Services, Inc.\nOn April 2, 1992 the State of Oregon issued a final order to cease and desist violating any provision of Oregon Securities Law. Xanthic was denied the use of any statutory exemption provided in ORS 59.022 and ORS 59.035. Xanthic, Mark Lilly and Glenn DeCicco were assessed civil penalties of $750.00 each for violating ORS 59.055 and ORS 59.132(2). Directors Mark Lilly and Glenn DeCicco were ordered to cease and desist violating any provision of ORS Chapter 59. Neither the Company nor the Directors appealed.\nThe Company has been advised that the effect of the Oregon ruling was to\ninvalidate the issuance and distribution of the registered shares and warrants to residents of Oregon until such time as said securities are registered pursuant to the provisions of the Oregon Securities Law.\nThe number of shares affected by the ruling is estimated to be 188,000 shares owned by approximately 650 residents of Oregon. The 188,000 shares represent approximately 3.4% of the issued and outstanding shares of Xanthic.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to the shareholders during the year 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nThere is no established public trading market for the common shares of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThis information is omitted as allowed by General Instruction 1 of Form 10-K as the information is adequately reflected in the certified financial statements as set forth in Item 8.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\n(1) LIQUIDITY. The Company has no cash assets and no liquidity.\n(2) CAPITAL RESOURCES. The Company has no capital resources.\n(3) RESULTS OF OPERATIONS. The Company has not operated during the past fiscal year and there are no results of operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAttached are audited financial statements for the Company as of December 31, 1994.\nXANTHIC ENTERPRISES, INC.\n(A DEVELOPMENT STAGE COMPANY)\nFINANCIAL STATEMENTS\nDECEMBER 31, 1994 AND 1993\nCONTENTS\nPAGE\nAUDITOR'S REVIEW REPORT.................................................... 6\nFINANCIAL STATEMENTS:\nBALANCE SHEET............................................................ 7\nSTATEMENTS OF OPERATION.................................................. 8\nSTATEMENT OF STOCKHOLDERS' EQUITY........................................ 9\nSTATEMENTS OF CASH FLOWS................................................. 10\nNOTES TO FINANCIAL STATEMENTS............................................11-12\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF XANTHIC ENTERPRISES, INC.:\nWe have audited the accompanying balance sheets of Xanthic Enterprises, Inc. (a development stage company) as of December 31, 1994 and 1993, and the related statements of operations, stockholders' equity (deficit), and cash flows for the years then ended and for the period from October 27, 1986 (inception), to 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 Xanthic Enterprises, Inc. as of December 31, 1994, and 1993, and the results of its operations and cash flows for the years then ended and from October 27, 1986 (inception), to December 31, 1994 in conformity with generally accepted accounting principles.\nHarlan & Boettger, CPA's San Diego, California February 17, 1997\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) BALANCE SHEETS\nThe accompanying notes are an integral part of these financial statements.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF OPERATIONS\nThe accompanying notes are an integral part of these financial statements.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)\nThe accompanying notes are an integral part of these financial statements.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) STATEMENT OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1994\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nORGANIZATION\nXanthic Enterprises, Inc., a Colorado corporation, was incorporated October 27, 1986, and since its inception, the Company has been in the development stage. The Company's primary intended activity is to engage in all aspects of review and evaluation of private companies, partnerships, or sole proprietorships for the purpose of completing mergers or acquisitions with the Company, and to engage in mergers acquisitions with any or all varieties of private entities.\nThe Company has had no operations since its inception except for expenses related to maintaining the corporate status.\nBASIS OF ACCOUNTING\nThe Company's policy is to use the accrual method of accounting and to prepare and present financial statements which conform to generally accepted accounting principles. 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 reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.\nB. ACCOUNTS PAYABLE:\nAccounts payable at December 31, 1994 represents amounts due the Company's stock transfer agency, AST.\nC. CAPITAL STOCK\nThe Company is authorized to issue 50,000,000 shares of common stock, with a par value of $.0001 per share.\nIn May, 1989 the Company became obligated to distribute shares and warrants to the shareholders of ASI pursuant to the S-18 registration statement. The Company distributed 313,826 shares of stock and 627,652 warrants pursuant to the agreement with ASI. The shares and warrants were delivered at various dates between May of 1989 and February of 1990. This distribution included 313,826 shares of common stock and one (1) Class A Warrant and one (1) Class B Warrant with each share of stock distributed. Each warrant allowed the holder to acquire an additional share of common stock as follows: The Class A Warrant had an exercise price of $0.75 per share and an expiration date of April 30, 1990. The Class B Warrant had an exercise price of $1.50 per share and an expiration date of April 30, 1992. No warrants were exercised.\nXANTHIC ENTERPRISES, INC. (A DEVELOPMENT STAGE COMPANY) NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1994 (CONTINUED)\nD. LITIGATION:\nOn November 2, 1991 the State of Oregon issued a cease and desist order ordering the Company to cease and desist issuing unregistered securities in the State of Oregon. The proceedings was based on the distribution of shares and warrants to Oregon shareholders (registered by way of a S-18 registration statement) pursuant to the agreements for such distribution between the Company and Automated Services, Inc.\nOn April 2, 1992 the State or Oregon issued a final order to cease and desist violating any provision of Oregon Securities Law. Xanthic was denied the use of any statutory exemption provided in ORS 59.022 and ORS 59.035. Xanthic, Mark Lilly and Glenn DeCicco were assessed civil penalties of $750.00 each for violating ORS 59.055 and ORS 59.132(2). Directors Mark Lilly and Glenn DeCicco were ordered to cease and desist violating any provision of ORS Chapter 59. Neither the Company nor the Directors appealed.\nThe Company has been advised that the effect of the Oregon ruling was to invalidate the issuance and distribution of the registered shares and warrants to residents of Oregon until such time as said securities are registered pursuant to the provisions of the Oregon Securities Law. The number of shares affected by the ruling is estimated to be 188,000 shares owned by approximately 650 residents at Oregon. The 188,000 shares represent approximately 3.4% of the issued and outstanding shares of the Company.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nThere is no disagreement with any prior accountant.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nMark A. Lilly, President and a Director. Mr. Lilly, age 31, has been President of Xanthic since inception. During 1988 he was President of NinHao Enterprises, Inc., a Colorado corporation. NinHo Enterprises is now inactive. Mr. Lilly was an Assistant Health Planner for the Alameda Health Consortium from February 1987 to May, 1988. Since May, 1988 Mr. Lilly has been self employed as a free lance computer programer.\nGlenn DeCicco, Vice-President, Secretary and a Director. Mr. DeCicco, age 34, was a Senior Vice President of Nin Hao Enterprises during 1988 and was President of Land and Water Real Estate Company, an inactive development stage real estate consultation company formed in 1987. Land and Water Real Estate Company has no assets, income or employees.\nJohn D. Lilly, Vice-President and Director. Mr. Lilly, age 28, is a freelance software consultant and technical writer.\nJohn Lilly and Mark Lilly are brothers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nDuring the past year the Company did not compensate any officer or director. The Company has no plans to compensate any officer or director at the present time.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n*The total number of shares owned by officers and directors is 2,534,500.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNot Applicable.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES.\nThe Company incorporates by reference the exhibits filed with its registration statement and the amendments thereto. There have been no 8-K filings during the past year. Attached under Item 8 are audited financial statements for the Company as of December 31, 1994.\nSIGNATURE\nIn accordance with Section 12 of the Securities Exchange Act of 1934, this registrant caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.\nXANTHIC ENTERPRISES, INC.\nDated: 4\/2\/97 --------------------------------\nBy: \/s\/ Mark A. Lilly ----------------------------------- Mark A. Lilly, President, Director and Chief Financial Officer\nDated: 4\/2\/97 --------------------------------\nBy: \/s\/ Glenn DeCicco --------------------------------- Glenn DeCicco, Vice-President and Director","section_15":""}
{"filename":"315213_1994.txt","cik":"315213","year":"1994","section_1":"ITEM 1. BUSINESS\nRobert Half International Inc. is the world's largest specialized provider of temporary and permanent personnel in the fields of accounting and finance. Its divisions include ACCOUNTEMPS-Registered Trademark- and ROBERT HALF-Registered Trademark-, providers of temporary and permanent personnel, respectively, in the fields of accounting and finance. The Company, utilizing its experience as a specialized provider of temporary and permanent personnel, has expanded into additional specialty fields. In December 1991, the Company formed OFFICETEAM-Registered Trademark- to provide skilled temporary administrative and office personnel. In 1992, the Company acquired THE AFFILIATES-Registered Trademark-, which focuses on placing temporary and permanent employees in paralegal, legal administrative and other legal support positions. In addition, the Company recently established RHI CONSULTING-SM- to concentrate on providing temporary information technology professionals in positions ranging from PC\/LAN technician to system design and application programmer.\nThe Company's business was originally founded in 1948. Prior to 1986, the Company was primarily a franchisor of ACCOUNTEMPS and ROBERT HALF offices. Beginning in 1986, the Company and its current management embarked on a strategy of acquiring franchised locations and other local or regional independent providers of specialized temporary service personnel. The Company has acquired all but five of the ACCOUNTEMPS and ROBERT HALF franchises in 45 separate transactions, and has acquired 14 other local or regional providers of specialized temporary service personnel. Since 1986, the Company has significantly expanded operations at many of the acquired locations and has opened over 50 new locations. The Company believes that direct ownership of offices allows it to better monitor and protect the image of the ACCOUNTEMPS and ROBERT HALF names, promotes a more consistent and higher level of quality and service throughout its network of offices and improves profitability by centralizing many of its administrative functions. The Company currently has more than 180 offices in 36 states and five foreign countries and placed approximately 85,000 employees on temporary assignment with clients in 1994.\nACCOUNTEMPS\nThe ACCOUNTEMPS temporary services division offers customers a reliable and economical means of dealing with uneven or peak work loads for accounting, tax and finance personnel caused by such predictable events as vacations, taking inventories, tax work, month-end activities and special projects and such unpredictable events as illness and emergencies. Businesses increasingly view the use of temporary employees as a means of controlling personnel costs and converting such costs from fixed to variable. The cost and inconvenience to clients of hiring and firing permanent employees are eliminated by the use of ACCOUNTEMPS temporaries. The temporary workers are employees of ACCOUNTEMPS and are paid by ACCOUNTEMPS only when working on customer assignments. The customer pays a fixed rate only for hours worked.\nACCOUNTEMPS clients may fill their permanent employment needs by using an ACCOUNTEMPS employee on a trial basis and, if so desired, \"converting\" the temporary position to a permanent position. The client typically pays a one-time fee for such conversions.\nThe ACCOUNTEMPS business accounted for 75% of the Company's revenue in 1993 and 66% of the Company's revenue in 1994.\nOFFICETEAM\nThe Company's OFFICETEAM division, which commenced operations in 1991, places temporary and permanent office and administrative personnel, ranging from word processors to office managers, from over 125 locations in the United States. OFFICETEAM operates in much the same fashion as the ACCOUNTEMPS and ROBERT HALF divisions. The OFFICETEAM business accounted for 14% of the Company's revenue in 1993 and 19% of the Company's revenue in 1994.\nROBERT HALF\nThe Company offers permanent placement services through its office network under the name ROBERT HALF. The Company's ROBERT HALF division specializes in placing accounting, financial, tax and banking personnel. Fees for successful permanent placements are paid only by the employer and are generally a percentage of the new employee's annual compensation. No fee for permanent placement services is charged to employment candidates.\nThe ROBERT HALF business accounted for 9% of the Company's revenue in 1993 and 1994.\nOTHER ACTIVITIES\nIn 1992, the Company acquired THE AFFILIATES, a small operation involving only a limited number of offices, which places temporary and permanent employees in paralegal, legal administrative and legal secretarial positions. The legal profession's requirements (the need for confidentiality, accuracy and reliability, a strong drive toward cost-effectiveness, and frequent peak workload periods) are similar to the demands of the clients of the ACCOUNTEMPS division.\nThe Company recently established its RHI CONSULTING division, which specializes in providing information technology professionals ranging from PC\/LAN technician to system design and application programmer.\nMARKETING AND RECRUITING\nThe Company markets its services to clients as well as employment candidates. Local marketing and recruiting are generally conducted by each office or related group of offices. Advertising directed to clients and employment candidates consists primarily of yellow pages advertisements, classified advertisements and radio. Direct marketing through mail and telephone solicitation also constitutes a significant portion of the Company's total advertising. National advertising conducted by the Company consists primarily of print advertisements in national newspapers, magazines and certain trade journals. Joint marketing arrangements have been entered into with Lotus Development Corporation, WordPerfect Corporation, Peachtree Software, Inc., and Computer Associates International, Inc. and typically provide for cooperative advertising, joint mailings and similar promotional activities. The Company also actively seeks endorsements and affiliations with professional organizations in the business management, office administration and professional secretarial fields. The Company also conducts public relations activities designed to enhance public recognition of the Company and its services. Local employees are encouraged to be active in civic organizations and industry trade groups.\nThe Company owns many trademarks, service marks and tradenames, including the ROBERT HALF-Registered Trademark-, ACCOUNTEMPS-Registered Trademark-, OFFICETEAM-Registered Trademark-, THE AFFILIATES-Registered Trademark- and RHI CONSULTING-SM- marks, which are registered in the United States and in a number of foreign countries.\nORGANIZATION\nManagement of the Company's operations is coordinated from its headquarters in Menlo Park, California. The Company's headquarters provides support and centralized services to its offices in the administrative, marketing, accounting, training and legal areas, particularly as it relates to the standardization of the operating procedures of its offices. The Company has more than 180 offices in 36 states and five foreign countries. Office managers are responsible for most activities of their offices, including sales, local advertising and marketing and recruitment.\nCOMPETITION\nThe Company faces competition in its efforts to attract clients as well as high-quality specialized employment candidates. The temporary and permanent placement businesses are highly competitive, with a number of firms offering services similar to those provided by the Company on a national, regional or local basis. In many areas the local companies are the strongest competitors. The most significant competitive factors in the temporary and permanent placement businesses are price and the reliability of service, both of which are often a function of the availability and quality of personnel.\nThe Company believes it derives a competitive advantage from its long experience with and commitment to the specialized employment market, its national presence, and its various marketing activities.\nEMPLOYEES\nThe Company has approximately 1,600 full-time staff employees. The Company's offices placed approximately 85,000 employees on temporary assignments with clients during 1994. Temporary employees placed by the Company are the Company's employees for all purposes while they are working on assignments. The Company pays the related costs of employment, such as workers' compensation insurance, state and federal unemployment taxes, social security and certain fringe benefits. The Company provides voluntary health insurance coverage to interested temporary employees.\nOTHER INFORMATION\nThe Company's current business constitutes a single business segment. (See Item 8. Financial Statements and Supplementary Data for financial information about the Company.)\nThe Company is not dependent upon a single customer or a limited number of customers. The Company's operations are generally more active in the first and fourth quarters of a calendar year. Order backlog is not a material aspect of the Company's business and no material portion of the Company's business is subject to government contracts. The Company does not have any material expenditures for research and development. Compliance with federal, state or local environmental protection laws has no material effect on the capital expenditures, earnings or competitive position of the Company.\nInformation about foreign operations is contained in Note N of Notes to Consolidated Financial Statements in Item 8. The Company does not have export sales.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's headquarters is located in Menlo Park, California. Placement activities are conducted through more than 180 offices located in the United States, Canada, the United Kingdom, Belgium, France and the Netherlands. All of the offices are leased.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not a party to any material pending legal proceedings other than routine litigation incidental to its business.\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 the fiscal year covered by this report.\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 under the symbol \"RHI\". On February 28, 1995, there were approximately 1,400 holders of record of the Common Stock.\nFollowing is a list by fiscal quarters of the sales prices of the stock as quoted on the New York Stock Exchange, adjusted, as appropriate, to reflect the two-for-one stock split effected in the form of a stock dividend in August 1994:\nNo cash dividends were paid in 1994 or 1993. The Company, as it deems appropriate, may continue to retain all earnings for use in its business or may consider paying a dividend in the future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFollowing is a table of selected financial data of the Company of the last five years:\nAll shares and per share amounts have been restated to retroactively reflect the two-for-one stock split effected in the form of a stock dividend in August 1994.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1994\nTemporary services revenues increased 46% during 1994 and 40% during 1993, including the revenues generated from the Company's OfficeTeam division, which was started in 1991 to provide highly-skilled office and administrative personnel. Permanent placement revenues increased 47% during the year ended December 31, 1994 and 30% during the year ended December 31, 1993. The revenue comparisons reflect continued improvement in the demand for the Company's services.\nGross margin dollars increased 47% during the year ended December 31, 1994 compared to 33% for the year ended December 31, 1993. Gross margin amounts equaled 39% of revenue in 1994 and 1993. In 1992, gross margin equaled 40% of revenue. The percentage decline relative to 1992 related primarily to the lower mix of the higher permanent placement gross margins and higher unemployment insurance costs associated with the temporary services divisions.\nSelling, general and administrative expenses were approximately $122 million during 1994 compared to $88 million in 1993 and $72 million in 1992. Selling, general and administrative expenses as a percentage of revenues were 27% in 1994, compared to 29% in 1993 and 33% in 1992. The percentage declines were attributable to revenue growth coupled with the Company's continued cost containment.\nAmortization of intangible assets increased from 1992 to 1994 due to the acquisitions in each of those years of additional personnel services operations.\nInterest expense for the years ended December 31, 1994 and 1993 decreased 61% and 7%, respectively, over the comparable prior periods due primarily to the conversion of the Convertible Subordinated Debentures in the fourth quarter of 1993 and the reduction in outstanding indebtedness.\nThe provision for income taxes was 42% in 1994, as compared to 46% in 1993 and 45% in 1992. The decrease in 1994 is the result of a smaller percentage of non-deductible intangible expenses relative to income. The 1993 increase reflects the effect of the 1% increase in the federal corporate income tax rate as a result of the 1993 Tax Act. Because of the increase in pre-tax book income, the effect of the non-deductible intangible amortization on the effective tax rate was reduced in 1993 as compared to 1992. The Financial Accounting Standards Board issued a new standard on accounting for income taxes, which the Company adopted, as required, on January 1, 1993. The cumulative effect of the adoption of the accounting method prescribed by the new standard was not material.\nLIQUIDITY AND CAPITAL RESOURCES\nThe change in the Company's liquidity during the past three years is the net effect of funds generated by operations and the funds used for the personnel services acquisitions, principal payments on outstanding notes payable, and the securities repurchase program.\nIn November 1994, the Company issued 633,555 shares of its common stock. The net proceeds from the sale of shares were approximately $12.6 million. The Company used the proceeds for repayment of the borrowings under the Company's revolving credit agreement.\nOn December 10, 1993, substantially all of its outstanding convertible subordinated debentures were converted into common stock of the Company. See Note E to the Consolidated Financial Statements.\nThe Company's working capital requirements consist primarily of the financing of accounts receivable. While there can be no assurances in this regard, the Company expects that internally generated cash plus the bank revolving line of credit will be sufficient to support the working capital needs of the Company's offices, the Company's fixed payments and other long-term obligations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nROBERT HALF INTERNATIONAL INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\nAll share and per share amounts have been restated to retroactively reflect the two-for-one stock split effected in the form of a stock dividend in August 1994.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nROBERT HALF INTERNATIONAL INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nAll share and per share amounts have been restated to retroactively reflect the two-for-one stock split effected in the form of a stock dividend in August 1994.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nROBERT HALF INTERNATIONAL INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)\nAll share and per share amounts have been restated to retroactively reflect the two-for-one stock split effected in the form of a stock dividend in August 1994.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nROBERT HALF INTERNATIONAL INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION. The Consolidated Financial Statements include the accounts of Robert Half International Inc. (the \"Company\") and its subsidiaries, all of which are wholly-owned. The Company is a Delaware corporation. All significant intercompany balances have been eliminated. Certain reclassifications have been made to the 1993 and 1992 financial statements to conform to the 1994 presentation.\nREVENUE RECOGNITION. Temporary services revenues are recognized when the services are rendered by the Company's temporary employees. Permanent placement revenues are recognized when employment candidates accept offers of permanent employment. Allowances are established to estimate losses due to placed candidates not remaining in employment for the Company's guarantee period, typically 90 days.\nFOREIGN CURRENCY TRANSLATION. Foreign income statement items are translated at the monthly average exchange rates prevailing during the period. Foreign balance sheets are translated at the current exchange rates at the end of the period, and the related translation adjustments are recorded as part of Stockholders' Equity. Gains and losses resulting from foreign currency transactions are included in the Consolidated Statements of Income.\nCASH AND CASH EQUIVALENTS. For purposes of the Consolidated Statements of Cash Flows, the Company classifies all highly liquid investments with an original maturity of three months or less as cash equivalents.\nINTANGIBLE ASSETS. Intangible assets represent the cost of acquired companies in excess of the fair market value of their net tangible assets at acquisition date, and are being amortized on a straight-line basis over a period of 40 years. The carrying value of intangible assets is periodically reviewed by the Company and impairments are recognized when the expected future operating cash flows derived from such intangible assets is less than their carrying value. Based upon its most recent analysis, the Company believes that no material impairment of intangible assets exists at December 31, 1994.\nINCOME TAXES. Effective January 1, 1993, the Company adopted Financial Accounting Standards No. 109, Accounting for Income Taxes (FAS 109). Under FAS 109, deferred taxes are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. As permitted under the provisions of FAS 109, the Company elected not to restate prior years and has determined that the cumulative effect of implementation was immaterial.\nNOTE B -- ACQUISITIONS In July 1986, the Company acquired all of the outstanding stock of Robert Half Incorporated, the franchisor of the Accountemps and Robert Half operations. Subsequently, in 59 separate transactions the Company acquired all of the outstanding stock of certain corporations operating Accountemps and Robert Half franchised offices in the United States, the United Kingdom and Canada as well as other personnel services businesses. The Company has paid approximately $192 million in cash, stock, notes and other indebtedness in these acquisitions, excluding transaction costs and cash acquired.\nThese acquisitions were accounted for as purchases, and the excess of cost over the fair market value of the net tangible assets acquired is being amortized over 40 years using the straight-line method. Results of operations of the acquired companies are included in the Consolidated Statements of Income from the dates of acquisition. The acquisitions made during 1994 and 1993 had no material pro forma impact on the results of operations.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE C -- NOTES PAYABLE AND OTHER INDEBTEDNESS The Company issued promissory notes as well as other forms of indebtedness in connection with certain acquisitions. These are due in varying installments, carry varying interest rates and in aggregate amounted to $4,214,000 at December 31, 1994, and $2,440,000 at December 31, 1993. At December 31, 1994, $1.8 million of the notes was secured by a standby letter of credit (see Note D). The following table shows the schedule of maturities for notes payable and other indebtedness at December 31, 1994 (in thousands):\nAt December 31, 1994, all of the notes carried fixed rates of interest ranging from 4.1% to 13.3%. The weighted average interest rate for the above was approximately 8.2%, 11.1% and 8.5% for the years ended December 31, 1994, 1993 and 1992, respectively.\nAs part of a Restructuring in 1987, a newly formed corporation, BF Enterprises, Inc., assumed the obligation for certain subordinated debentures issued by a predecessor of the Company. At December 31, 1994, the Company remains contingently liable for $3.6 million of these subordinated debentures, payment of $3.4 million of which has been provided for by the issuance of letters of credit to the trustee for the debentures by BF Enterprises, Inc. Additionally, pursuant to a pledge and security agreement entered into at the time of Restructuring, BF Enterprises, Inc., has agreed to pledge to the Company collateral (consisting of real estate, marketable securities and bank letters of credit) if the net worth of BF Enterprises, Inc., falls below certain minimum levels.\nNOTE D -- BANK LOAN (REVOLVING CREDIT) The bank loan is an unsecured credit facility which provides a line of credit of up to $80,000,000, which is available to fund the Company's general business and working capital needs, including acquisitions and the purchase of the Company's common stock, and to cover the issuance of debt support standby letters of credit up to $15,000,000.\nAs of December 31, 1994, the Company had no borrowings on the line of credit outstanding and had used $3,358,000 in debt support standby letters of credit. There is a commitment fee on the unused portion of the entire credit facility of .25%. The loan is subject to certain financial covenants which also affect the interest rates charged.\nThe credit facility has the following scheduled reduction in availability (in thousands):\nThe final maturity date for the credit facility is August 31, 2000.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE D -- BANK LOAN (REVOLVING CREDIT) (CONTINUED) As of December 31, 1993, the Company had borrowed $30,300,000 on the line of credit and had used $2,780,000 in debt support standby letters of credit. Of the $30,300,000 outstanding loan balance at December 31, 1993, $29,000,000 carried an interest rate tied to Eurodollar rates plus 1.25% and the remaining balance of $1,300,000 carried an interest rate at prime.\nNOTE E -- CONVERTIBLE SUBORDINATED DEBENTURES On August 6, 1987, the Company issued $74,750,000 of 7.25% Convertible Subordinated Debentures (the \"Convertible Debentures\"). Prior to 1993, all but $22,745,000 of the Convertible Debentures were repurchased by the Company pursuant to its repurchase program (see Note F). The Convertible Debentures were unsecured obligations of the Company with an original maturity date of August 1, 2012. Interest was payable semi-annually as of February 1 and August 1 of each year to the registered holders as of the preceding January 15 and July 15, respectively. The Convertible Debentures were redeemable at the Company's option at any time on or after August 1, 1990, at declining redemption prices.\nIn December 1993, the Company called for redemption all of its then outstanding Convertible Debentures. Holders of $22,440,000 in principal amount elected to convert their debentures into 2.04 million shares of common stock at the conversion price of $11.00 per share. The remaining $305,000 in principal amount of Convertible Debentures was redeemed at 102.9% of the principal amount plus accrued interest.\nNOTE F -- STOCKHOLDERS' EQUITY On June 27, 1994, the stockholders of the Company voted to amend the certificate of incorporation to increase the number of authorized shares of the Company's common stock from 30,000,000 to 100,000,000 shares and the number of authorized shares of the Company's preferred stock from 500,000 to 5,000,000. The stockholders of the Company also authorized a reduction in par value from $1 per share to $.001 per share on both classes of shares.\nIn August 1994, the Company effected a two-for-one stock split in the form of a stock dividend. All share and per share amounts have been restated to retroactively reflect the two-for-one stock split.\nIn November 1994, the Company issued 633,555 shares of its common stock at a price of $21.25 per share. The net proceeds from the sale of shares (after deducting issuance costs of approximately $355,000 and a 4% underwriter's discount) were approximately $12.6 million.\nNOTE G -- INCOME TAXES The provisions for income taxes for the three years ended December 31, 1994, consisted of the following (in thousands):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE G -- INCOME TAXES (CONTINUED) The income taxes shown above varied from the statutory federal income tax rates for these periods as follows:\nThe deferred portion of the tax provisions consisted of the following (in thousands):\nDuring the fourth quarter of 1992, the Company recorded a one-time benefit of $400,000 for the resolution of certain tax accounting issues related to previous acquisitions.\nThe deferred income tax liability shown on the balance sheet is comprised of the following (in thousands):\nNo valuation allowances against deferred tax assets were required for the years ended December 31, 1994 and 1993.\nThe components of the net deferred income tax liability at December 31, 1994 and 1993, were as follows (in thousands):\nNOTE H -- EMPLOYEE BENEFIT PLANS Under a retirement plan covering one current and one former executive officer of the Company, monthly benefits are payable equal to 25% of the participant's base compensation as defined, increased by an inflation formula. The plan was amended effective May 31, 1992, to provide a fixed supplemental benefit for the current employee during the first 15 years after retirement. The current employee forfeited long-term incentive awards of equal value in exchange for this amendment. The plan was also amended effective May 21, 1991, for the current employee to increase the percentage of\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE H -- EMPLOYEE BENEFIT PLANS (CONTINUED) base compensation to 30% increasing thereafter by 3% for each year of service beyond the age of 50, up to a maximum of 66%. During 1993, the Company changed its discount rate assumption from 8% to 6%. The effect of both plan amendments and the discount rate change are being amortized over the employee's expected future service period (initially 15 years) and will increase after-tax expense by approximately $76,000 per year. The employee can require the Company to discharge its liability at defined intervals by purchasing annuities. At December 31, 1992, a liability of $1,124,000 was established to cover the estimated unfunded cost of these benefits. This amount was increased to $1,721,000 at December 31, 1993, and at December 31, 1994, is $1,827,000. Pre-tax pension costs for these plans were $232,000, $188,000, and $131,000 for the years ended December 31, 1994, 1993 and 1992, respectively. These charges were computed using certain assumptions regarding salary increases, retirement age and life expectancy.\nNOTE I -- COMMITMENTS Rental expense, primarily for office premises, amounted to $9,183,000, $8,457,000 and $8,042,000 for the years ended December 31, 1994, 1993 and 1992, respectively. The approximate minimum rental commitments for 1995 and thereafter under non-cancelable leases in effect at December 31, 1994, are as follows (in thousands):\nNOTE J -- STOCK PLANS Under various stock plans, officers, employees and outside directors may receive grants of restricted stock or options to purchase common stock. Grants are made at the discretion of the Compensation Committee of the Board of Directors. Grants usually vest over four years.\nOptions granted under the plans have exercise prices ranging from 85% to 100% of the fair market value of the Company's common stock at the date of grant, consist of both incentive stock options and nonstatutory stock options under the Internal Revenue Code, and generally have a term of ten years.\nRecipients of restricted stock do not pay any cash consideration to the Company for the shares, have the right to vote all shares subject to such grant, and receive all dividends with respect to such shares, whether or not the shares have vested.\nAs of December 31, 1994 the total number of available grants under the plans (consisting of either restricted stock or options) was 340,227.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE J -- STOCK PLANS (CONTINUED) The following table reflects activity under all stock plans from January 1, 1992 through December 31, 1994 and the exercise prices:\nAs of December 31, 1994, an aggregate of 1,235,574 options to purchase common stock were vested.\nNOTE K -- PREFERRED SHARE PURCHASE RIGHTS Pursuant to the Company's stockholder rights agreement, each share of common stock carries one right to purchase one two-hundredth of a share of preferred stock. The rights become exercisable in certain limited circumstances involving a potential business combination transaction or an acquisition of shares of the Company and are exercisable at a price of $32.50 per right, subject to adjustment. Following certain other events after the rights become exercisable, each right entitles its holder to purchase for $32.50 an amount of common stock of the Company, or, in certain circumstances, securities of the acquiror, having a then-current market value of twice the exercise price of the right. The rights are redeemable and may be amended at the Company's option before they become exercisable. Until a right is exercised, the holder of a right has no rights as a stockholder of the Company. The rights expire on July 23, 2000.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE L -- INCOME PER SHARE Income per fully diluted share has been computed using the weighted average number of shares of fully diluted common stock and common stock equivalents outstanding during each period (28,484,000, 25,260,000 and 24,007,000 shares for the years ending December 31, 1994, 1993 and 1992, respectively). An assumed conversion of the Convertible Debentures was not dilutive to income per share in 1993 (see Note E) or 1992.\nNOTE M -- QUARTERLY FINANCIAL DATA (UNAUDITED) The following tabulation shows certain quarterly financial data for 1994 and 1993 (in thousands, except per share amounts):\nNOTE N -- SEGMENT REPORTING Information about the Company's operations in different geographic locations for each of the three years in the period ended December 31, 1994, is shown below. The Company's areas of operations outside of the United States include Canada, the United Kingdom, Belgium, France and the Netherlands. Revenues represent total net revenues from the respective geographic areas. Operating income is net revenues less operating costs and expenses pertaining to specific geographic areas. Foreign operating income reflects charges for U.S. management fees and amortization of intangibles of $956,000, $917,000 and $854,000 for the years ended December 31, 1994, 1993 and 1992, respectively. Domestic operating income reflects charges for amortization of intangibles of $4,137,000,\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE N -- SEGMENT REPORTING (CONTINUED) $3,841,000 and $3,606,000 for the years ended December 31, 1994, 1993 and 1992, respectively. Identifiable assets are those assets used in the geographic areas and are after elimination of intercompany balances.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE STOCKHOLDERS AND THE BOARD OF DIRECTORS OF ROBERT HALF INTERNATIONAL INC.:\nWe have audited the accompanying consolidated statements of financial position of Robert Half International Inc. (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 Robert Half International 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\nSan Francisco, California January 24, 1995\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThe information required by Items 10 through 13 of Part III is incorporated by reference from the registrant's Proxy Statement, under the captions \"NOMINATION AND ELECTION OF DIRECTORS,\" \"BENEFICIAL STOCK OWNERSHIP,\" \"COMPENSATION OF DIRECTORS,\" \"COMPENSATION OF EXECUTIVE OFFICERS\" AND \"COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION AND CERTAIN TRANSACTIONS,\" which Proxy Statement will be mailed to stockholders in connection with the registrant's annual meeting of stockholders which is scheduled to be held in May 1995.\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 following consolidated financial statements of the Company and its subsidiaries are included in Item 8 of this report:\nConsolidated statements of financial position at 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.\nReport of independent public accountants.\nSelected quarterly financial data for the years ended December 31, 1994 and 1993 are set forth in Note M - Quarterly Financial Data (Unaudited) included in Item 8 of this report.\n2. FINANCIAL STATEMENT SCHEDULES\nSchedules I through V have been omitted as they are not applicable.\n3. EXHIBITS\n(b) Reports on Form 8-K\nThe Registrant filed the following report on Form 8-K during the fiscal quarter ending 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.\nROBERT HALF INTERNATIONAL INC. (Registrant)\nDate: March 8, 1995 By: \/S\/ M. KEITH WADDELL\n----------------------------------- M. Keith Waddell Senior Vice President, Chief Financial Officer and Treasurer (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.","section_15":""}
{"filename":"313867_1994.txt","cik":"313867","year":"1994","section_1":"ITEM 1. Business\nIntroduction\nTriad Systems Corporation is a leading provider of business and information management solutions for the automotive aftermarket and the hardgoods industry. Triad offers new and existing customers a variety of proprietary database products with periodic updates, software and hardware products, financing and ongoing support services.\nTriad's installed base provides significant recurring revenues, accounting for 72% of its annual revenues in fiscal 1994. In the year ended September 30, 1994, 33% of Triad's total revenues were from service and support agreements, 24% from sales of hardware and software upgrades and add-ons to existing customers and 15% from subscription fees for Triad's proprietary database products. Triad's principal strategy is to increase its installed base by offering its database, hardware and software products in its two key markets, by penetrating adjacent segments of those markets and by geographic expansion.\nMarkets\nThe Company's markets consist of numerous independent businesses which require management of large quantities of data. These businesses are increasingly seeking information management products and services targeted to their specific industries. Triad is providing a growing family of database products and information management services to existing and new customers in response to these market demands. See \"BUSINESS-Information Services.\" Triad continues to provide cost-effective software and hardware products for these markets.\nAutomotive Aftermarket. The automotive aftermarket consists of four principal levels of distribution: manufacturers, warehouse distributors, wholesalers (\"jobbers\") and retailers and auto repair shops (\"service dealers\"). Manufacturers distribute automotive parts through warehouse distributors to jobbers and retailers, who stock and sell the automobile parts used by service dealers and consumers.\nAs of September 30, 1994, the Company had approximately 10,000 Automotive Division customers, spanning small-to large-sized jobbers. Historically, the Company's Automotive Division has sold integrated business systems primarily to jobbers. Triad's large installed base of jobber customers provides a source of recurring revenue through sales of applications software packages, peripherals, hardware upgrades, information services, supplies and customer support services. The new Triad Prism is initially targeted at upgrade opportunities for our existing customer base. Due to the high level of automation in the traditional jobber market and the lower per-unit cost of systems being sold to smaller non-automated jobbers, the Company does not anticipate significant growth in revenues from system sales in the domestic jobber market.\nThe Company has developed new products and approaches to expand its customer base in adjacent markets. The Company typically offers its software products and databases in conjunction with system sales, and also markets selected software products and databases separately from its hardware products. Triad has gained access to several leading retail chains, as well as jobbers with competing systems, with these products. Further, the Company has reached retail chains, service dealers and small jobbers through products such as the LaserCat and ServiceCat workstations and software and database products. See \"BUSINESS-Triad Hardware Systems and Software Products\" and \" - - - -Information Services.\" The ServiceCat product, Triad Service System and Triad ServiceWriter are directed to the automotive repair market of approximately 185,000 potential customers.\nTo expand its market presence, Triad intends to pursue strategic acquisitions in its markets as opportunities arise.\nTriad markets its Automotive Division products in the United States, United Kingdom, Ireland, Canada and Puerto Rico. See \"BUSINESS-Marketing and Sales.\" The Company's strategy is to expand its customer base through the development and marketing of database products for the automotive parts aftermarket in the United States, United Kingdom and selected European Community countries. See \"BUSINESS-Information Services.\"\nTriad markets systems to the warehouse distributor segment of the automotive parts aftermarket. In February 1994, the Company introduced The Paperless Warehouse and the UNIX-based Warehouse System to provide new levels of efficiency and productivity in automotive parts warehouses. Approximately 70 mid-range and large warehouse distributors have installed the company's systems, and 180 smaller warehouse distributors and larger jobbers have purchased the Company's Series 14 system or its predecessor, the Series 12 system, equipped with specialized applications software designed for the needs of the warehouse operations. The Triad Information System is designed for large multiple-location customers who require single-system solutions. See \"BUSINESS-Triad Hardware Systems and Software Products.\"\nHardgoods Industry. Triad's Hardgoods Division offers integrated business systems to approximately 47,000 hardware stores and home centers, lumber\/building supplies stores and paint and decorating retailers with annual sales of between $250,000 and $100 million. At September 30, 1994, the Company had more than 3,500 customers in these markets.\nHardgoods distribution chains have a much lower level of automation than the automotive parts aftermarket. The Company believes that independent hardgoods dealers are increasingly recognizing the advantages of automation as they face increased competition. Hardgoods trade journals have strongly favored automation, and major hardgoods wholesalers and cooperatives strongly endorse automation to their members. Approximately half of the top 60 hardware distributors endorse Triad products and services, along with five of the seven leading lumber and building materials groups. In addition, Triad has developed and maintains strong relationships with the four major hardgoods cooperatives. See \"BUSINESS-Marketing and Sales.\"\nTechnological advancements in Triad's interactive UNIX-based Eagle and Eagle LS systems allow for product offerings suitable for hardgoods and building materials chains with up to 30 stores and $100 million in annual sales. See \"BUSINESS-Triad Hardware Systems and Software Products.\"\nInformation Services\nTriad provides its proprietary databases to its customers in return for a license fee and monthly subscription fees entitling customers to periodic updates. These database products generate recurring revenues for Triad through the monthly subscription fees and differentiate the Company's products from those of its competitors, contributing to new system sales. The Company cur- rently offers four unique databases to its Automotive Division customers and has a database catalog product for hardgoods distribution chains affiliated with Cotter & Company (True Value).\nElectronic Catalog. Triad's Electronic Catalog product provides nearly 16.5 million automobile parts applications. This database virtually eliminates the time-consuming and cumbersome use of printed catalogs and is designed to increase productivity and accuracy in parts selection and handling. Proprietary software on Triad's jobber systems integrates information from the Electronic Catalog and the Telepricing databases so that for a given auto- motive repair, such as a tune-up, all parts required are identified, along with updated prices and inventory levels. Additional prompts enable the jobber to recommend related parts that the customer may need in addition to the parts requested. Triad charges a monthly subscription fee for the Electronic Catalog database and provides the customer with periodic updates. At September 30, 1994, approximately 3,400 customers had licensed the Electronic Catalog database and it was used at more than 29,000 automotive counter positions.\nTelepricing. The Telepricing service provides automatic price updates for automotive parts following a manufacturer's price change, eliminating a customer's need to input this data manually. Telepricing service customers pay an initial license fee and a monthly subscription fee for this updating service. This database had more than 3,000 subscribers at September 30, 1994.\nLaborGuide Database. The LaborGuide database automates the estimation of labor hours for car repairs and is based on labor estimating data from Mitchell International, Inc. There were more than 1,600 customers paying monthly fees for this database at September 30, 1994. This database is targeted to approximately 185,000 service dealers in the United States and permits users to comply more easily with regulations in many states that require written estimates of repair costs. During fiscal 1994, Triad added a new dimension to the automotive repair industry's most comprehensive database with its introduction of Major Service Intervals for domestic automobiles. The data includes detailed labor time and parts recommendations as defined by the automobile manufacturer, enabling subscribers to schedule regular maintenance appointments for their customers.\nLaserGuide. The LaserGuide database is a reconfiguration of Electronic Catalog and allows a jobber to determine which automobiles (by make and year) the identified automotive parts will fit. The database also assists the jobber in making decisions on inventory levels. There were approximately 300 cust- omers using this database at September 30, 1994.\nWorkstation Products. Triad offers several products which are designed to make its proprietary databases available in a cost-effective manner to businesses with or without Triad systems. These products, including the LaserCat and ServiceCat, make Triad's proprietary database products available through CD-ROM technology and are designed to operate as stand-alone terminals or integrated as terminals in Triad systems or many competitors' systems. See \"BUSINESS-Triad Hardware Systems and Software Products.\" The Company's Information Services Division also markets the software and database products to new customers separately from Triad's hardware systems.\nDatabases for Retailers. Triad markets its database products to large automotive retail chains (i.e., Goodyear, Western Auto, Kmart and Sears) with multiple national or regional sites. These chains use a variety of hardware platforms and applications software on their systems. Triad's proprietary databases are integrated into these systems. Triad's applications software may, but need not, be included in these packages.\nDatabases for Manufacturers. Triad markets database services utilizing Triad's database products to auto parts manufacturers. In addition to the full Telepricing database, manufacturers may select only certain categories of parts, or may choose the Competitive Analysis service, which compares price levels and number of applications to a competitor's product line. Triad's new transaction analysis services, MarketPACE for the Automotive aftermarket and VISTA for the Hardgoods industry, reports product movement information based on point of sale (POS) data collected at the independent retail levels in the respective markets. MarketPACE services supply comprehensive POS information and inventory analysis providing the decision support tools required to increase sales, boost productivity, improve distribution and enhance customer service for warehouses and auto parts stores. VISTA information services provide product manufacturers with ongoing measurement of brand and item movement with major product classifications using POS business analysis data from independent hardware stores, home centers and lumber and building materials outlets. Information provided by the MarketPACE and VISTA services provide manufacturers with insight into how a given product or brand performs against its competitors and the market in general.\nDatabases for International Markets. Triad established a wholly-owned subsidiary in Longford, Ireland, to create, maintain and distribute database products for automotive business management systems marketed by Triad and third parties in the United Kingdom and Ireland and subsequently for third party systems marketed in selected European Community nations. This project is supported, in part, by grants from the Industrial Development Authority of Ireland (\"IDA\"), subject to maintaining minimum capitalization and employment levels for the subsidiary. The facility began distributing database products in 1993 and its Electronic Catalog product is marketed in the United Kingdom and Ireland. Triad also markets automotive database products in Canada and Puerto Rico and is in the process of developing a product for the French market to be introduced in late 1995.\nCotter & Company Database. Triad introduced the Cotter & Company database product as a catalog of products available from the Cotter & Company (True Value) cooperative warehouses. The database is marketed both to Cotter affiliates and to independent outlets and outlets affiliated with other cooperatives. See \"BUSINESS-Triad Hardware Systems and Software Products.\"\nTriad Hardware Systems and Software Products\nTriad's applications software and business computer systems, together with its database products, provide comprehensive business solutions targeted to its two key markets. The Company provides a different set of standard applications programs for each market that include user options allowing the selective structuring of applications files and reports to meet customers' specific requirements. These software products also allow Triad customers to access the Company's proprietary databases. See \"BUSINESS-Information Services.\"\nSystems developed for each specific market are generally field-upgradable to meet customers' future growth needs. Hardware components include central processing units (CPUs), disk drives, video display terminals, CD-ROM storage devices, point of sale terminals, communication devices, printers and other peripherals. Triad's systems also have communication capabilities allowing users to exchange purchase orders and pricing and inventory information with suppliers and, in some cases, customers.\nAutomotive Aftermarket. Since the first phase of the Triad Prism platform introduced in 1993, more than 500 Triad Prism systems have been installed. Triad Prism is a powerful UNIX-based system featuring Intel Pentium and other processors. Triad Prism was created specifically for the automotive parts distributor, and it employs a \"management-by-exception\" capability that is intuitive and efficient. Triad's Series 11, Series 12 and Series 14 product lines, and the Triad Prism track inventory, perform point of sale functions such as invoicing, billing and other accounting functions. Smaller warehouse distributors also use these systems with applications software designed to serve their particular information management requirements. Triad's systems also use a microcomputer manufactured by Triad with a proprietary operating system. The systems also enable customers to use the Electronic Catalog database and Triad's other automotive database products. See \"BUSINESS- Information Services.\"\nThe Company also markets the TelePart terminal to its jobber customers, who generally place the terminal on-site with their service dealer customers. The TelePart terminal allows service dealers to electronically order parts by communicating directly with that jobber's Triad system equipped with the Electronic Catalog product. At September 30, 1994, Triad had installed more than 2,400 TelePart terminals.\nIn May 1994, Triad introduced Triad ServiceWriter, the latest addition to its growing family of affordable information management solutions. Triad ServiceWriter blends Triad's unique databases of 2 million parts, detailed labor estimates and recommended vehicle service intervals with the latest in workstation technology and easy-to-use, pull-down windows. Triad ServiceWriter also creates printed work estimates, automated work orders and maintains individual vehicle records and histories, enabling users to notify customers of required preventive maintenance and create other special promotions to generate higher volumes. Utilizing Triad's unique TelePart feature, Triad ServiceWriter electronically orders required parts, speeding and increasing the accuracy of the ordering process. Triad ServiceWriter can also be integrated with other Triad services, including Triad's new Service Accounting and ServiceTech for the latest in technical bulletins and other repair infor- mation. ServiceWriter can also be expanded to include inventory management, point of sale and general accounting applications.\nThe ServiceCat workstation is marketed to the service dealer segment of the automotive parts aftermarket. The ServiceCat product includes the Electronic Catalog and LaborGuide databases and TelePart software. It permits service dealers to estimate the cost of an entire repair job, including parts and labor, for customers which is mandatory in several states. See \"BUSINESS-Information Services.\" Triad's Information Services Division also markets the ServiceCat software and databases separately from the workstation.\nThe Company also markets various terminals and workstations which provide access to Triad's proprietary databases. Triad's LaserCat product is marketed to customers requiring the complete Electronic Catalog database product, regardless of whether they own a Triad jobber system, a competitor's system or are not automated. The LaserCat product is an independent PC-based workstation using CD-ROM technology to provide access to Triad's Electronic Catalog database product, resulting in recurring revenues from monthly subscription fees. See \"BUSINESS-Information Services.\" LaserCat workstations function as stand-alone units and also can be integrated as a terminal with any Triad Jobber System or with numerous competitors' jobber systems. Approx- imately 8,000 LaserCat workstations had been sold as of September 30, 1994. Triad's Information Services Division also markets the LaserCat software and databases separately from the workstation. See \"BUSINESS-Information Services.\"\nTriad's warehouse systems have the potential for a larger number of application enhancements and offers increased processor speed to serve businesses with high transaction volumes. The enhanced database management features allow the user flexibility in information retrieval. The Paperless Warehouse from Triad eliminates manual entry of parts-related information and enables warehouse operators to update inventory records, dramatically changing the way warehouses manage the flow of parts. This product enables employees to utilize hand-held computers equipped with bar-code scanners and radio transmitters to perform every warehouse task from receiving to stocking and from order picking to shipping, transmitting the data to the host Triad computer. Triad's UNIX-based Warehouse System merges the latest UNIX\/RISC technology to provide users with total warehouse management capabilities and gives users a powerful relational database to access any information they require.\nHardgoods Industry. Triad hardgoods systems automate inventory control, point of sale functions (such as invoicing and billing), payroll, accounting and purchase orders to affiliated cooperatives and distributors.\nThe UNIX-based Intel 486\/Pentium driven Eagle series of systems is designed for mid- to large sized hardgoods dealers. These systems have greater power and functionality and therefore have expanded access to larger hardgoods dealers. Existing Triad customers are able to upgrade to an Eagle system and utilize the newly incorporated technological advancements. More than 1,750 Eagle systems, including upgrades and new systems, have been sold as of September 30, 1994.\nThe Company's Eagle LS blends the power and flexibility of Triad's UNIX-based business and information management system with applications and features created to meet the unique needs of lumber and building materials operations. The Eagle LS system efficiently manages the flow of a typical transaction, including estimating, ordering and inventory management, shipping, invoicing and tracking accounts receivable. The system's compre- hensive features enable retailers to serve a wide range of customers, from building contractors to the do-it-yourself customer.\nThe LaserStation product includes the Cotter and Company database product, is designed as a stand-alone unit and may also be integrated as part of a Triad hardgoods system.\nBusiness Products. Triad markets a wide line of business products to the automotive aftermarket and hardgoods industry through catalogs and telemarketing services.\nCustomer Support and Services\nThe Company's Customer Support Services organization, representing approximately 32% of the Company's full-time employees at September 30, 1994, provides service, training and support to Triad's domestic and international customers. System support agreements are a significant source of recurring revenue for Triad. Triad system owners are principally small business proprietors without the internal staffing or expertise to train users or to maintain computer systems on a consistent basis. These customers require a high level of service, training and support. Management believes its service organization represents a major competitive advantage.\nHardware Maintenance and Software Support. Triad provides a limited 90-day warranty on its systems. Triad also offers a variety of post-sale support programs through its system support agreements, including preventive and remedial maintenance, hardware engineering modifications and daily system operating support by phone. Triad's customers can call the Company's AdviceLine service on a toll-free network, which gives them access to trained personnel able to perform on-line diagnostics or to field engineers if on-site service is necessary.\nQuick Assist, introduced in October 1994, is an automated service that connects customers directly with an Advice Line representative for high-priority assistance. It provides an alternative to customers who, due to the urgency of their support need, do not want to wait for a return call.\nVirtually all new system customers enter into system support agreements at the time of acquisition and most retain such service agreements as long as they own the system. Monthly domestic fees vary with system size.\nTriad also provides support for approximately 450 dental customers with systems previously marketed by Triad and provides support to other businesses under third party maintenance agreements.\nAt September 30, 1994, the Company had 189 field engineers and managers, and 68 customer education representatives (CERs) and managers in 120 domestic and 15 foreign field service offices.\nCustomer Training. Customer training is offered in the Company's facilities, including 40 education centers nationwide. The Company also provides on-site training for new and existing customers. In addition to training in system operations and software enhancements, Triad offers seminars and workshops to assist customers in understanding the capabilities of their systems.\nPre-Delivery Services and Installation. Triad's sales representatives provide a number of pre-delivery services to Triad's customers, including a cost-justification analysis, visits to current Triad users, site planning and preparation, training for management and employees and installation planning. Triad's Zapstart product pre-loads an individual automotive customer's inven- tory, pricing and parts applications data into its Triad system upon installation, saving customers significant data-entry time. The Company also offers hardware retailers a similar capability to preload inventory files provided by certain cooperatives or distributors.\nMarketing and Sales\nThe Company markets its automotive and hardgoods products and services through a 275-person direct sales organization operating from 120 domestic and 15 foreign sales and support offices as of September 30, 1994.\nThe Company's systems are marketed through direct sales calls and by system demonstrations in customer facilities or in Company sales offices. Sales prospects are generated by telemarketing, customer referrals, trade publication advertising and trade show demonstrations. Triad's national accounts sales force solicits endorsements and other marketing arrangements with regional and national associations, distributors and cooperatives.\nIn addition, the Company markets its unique database products directly by telemarketing and direct sales, or indirectly through value-added resellers, to jobbers, service dealers and hardgoods distribution chains. Triad reaches potential customers who do not own Triad computer systems by marketing its database information products through value-added resellers who offer other systems or products in Triad's markets.\nThe Company began marketing certain products and services in the automotive aftermarket of the United Kingdom and Canada in the early 1980s. Marketing efforts were expanded to Ireland through the United Kingdom subsidiary in 1989. Sales in foreign countries are generally priced in local currencies and are therefore subject to currency exchange fluctuations.\nFor the years ended September 30, 1992, 1993 and 1994, no customer other than Triad Systems Financial Corporation (\"Triad Financial\"), accounted for 10% or more of Triad's revenues, and no end user accounted for more than 10% of Triad's revenues. Historically, the Company's business has been seasonal, with the Company generally experiencing a decline in revenues in the first quarter of each year from the final quarter of the preceding year, with revenues usually building as the year progresses.\nTriad Systems Financial Corporation\nTriad formed Triad Systems Financial Corporation in August 1978 to provide lease financing to the Company's customers. Leases are full-payout, noncancellable leases with terms from two to six years. Triad Financial provided lease financing for approximately 61% of domestic business systems sales in the year ended September 30, 1994.\nThe Company believes that its ability to offer lease financing to its customers through Triad Financial shortens the sales cycle and provides a competitive advantage in marketing Triad products. From its inception through September 30, 1994, Triad Financial purchased and leased $488 million of Triad equipment, including $39.6 million during fiscal 1994. Triad Financial provides lease financing and administration services to independent third parties in the markets that Triad serves, and since that time has financed $35.5 million under these programs, including $11.4 million in 1994. It is actively pursuing additional third party opportunities.\nTriad Financial discounts most of its lease receivables on either a full or limited recourse basis to banks and lending institutions under discounting agreements. Under the agreements, Triad Financial is contingently liable for losses in the event of lessee nonpayment for discounted leases. The contin- gent liability for losses was $19.4 million at September 30, 1994. The discounting agreements provide for limited recourse of up to 10% or full recourse at 100% of discounted proceeds, depending on the credit risk associated with specific leases. At September 30, 1994, the Company had $26 million invested in its lease portfolio and, if needed, maintains discounting lines to sufficiently liquidate the principal of this investment into cash.\nThe discounting agreements contain restrictive covenants that must be maintained in order to discount, the most restrictive requiring that both Triad and Triad Financial be profitable every quarter. Under the terms of an operating and support agreement with Triad Financial, the Company is obligated, if required, to make equity contributions or subordinated loans to enable Triad Financial to fulfill its obligations under the equipment financing agreements.\nProduct Development\nTriad's newest products are based on open systems design architecture. This allows the use of latest technology hardware and industry standard software for rapid development of products and services. Triad typically bundles its application software with industry standard operating systems and hardware platforms. Triad uses its system integration expertise to deliver reliable systems with the appropriate performance and scalability for future enhancements. The open design environment allows the Company to focus its development efforts on applications that provide business solutions for each segment of its markets. During 1992, 1993 and 1994, Triad's respective product development expenditures including capitalized costs were $10.8 million, $10.9 million and $11.2 million.\nThe Company capitalized $3.3 million, $2.8 million and $3.1 million of software development costs in 1992, 1993 and 1994, respectively. Amortization of capitalized software costs begins when the products are available for general release to customers. Costs are amortized over the expected product lives and are calculated using the greater of the straight-line method, generally three or five years, or a cost per unit sold basis.\nAt September 30, 1994, the Company employed 119 persons in product development. Separate teams of Company analysts and programmers are dedicated to each of the Company's markets. Common hardware and operating system expertise provides support to each market-oriented development team. In addition, Triad uses industry-specific advisory councils, representing a cross-section of its customers, to review its development plans and give advice on software applications features and priorities as they relate to their automation needs.\nManufacturing\nTriad's Manufacturing operation consists primarily of systems integra- tion, including third party hardware and software with the Company's application software. Triad assembles and tests systems or peripherals from standard components and third party subassemblies at the Livermore facility. In addition, Triad provides manufacturing and test services for third party companies to optimize capacity and material planning operations.\nPurchased parts and standard assemblies normally account for approximately 95% of hardware overhead cost, with subassembly, assembly and test costs representing the balance. The Company had 52 manufacturing employees at September 30, 1994. Standard systems are typically shipped in the same quarter the orders are received. The backlog of orders is not a signi- ficant factor in understanding the Company's business.\nMost of the components and peripherals used in the Company's systems are available from a number of different suppliers, although the Company generally purchases such major items as peripherals from a single source of supply. The Company believes that alternative sources could be developed, if required, without significant disruption or delay of shipments.\nProduct Protection\nTriad regards its software and databases as proprietary and attempts to protect them with copyrights, trade secret law and internal nondisclosure safeguards, as well as restrictions on disclosure and transferability that are incorporated into its license agreements. Despite these restrictions, it may be possible for competitors or users to copy aspects of the Company's products or to obtain information which the Company regards as trade secrets.\nTriad has obtained software licenses from several sources covering operating systems and applications programs used in its minicomputer and microcomputer systems and planned for future products. The Company is not aware that the manufacture and sale of its current hardware, software and database products requires any licenses from others not already secured.\nTriad holds one patent, has two patents pending and may seek additional patent protection related to new hardware or software products as appropriate.\nCompetition\nTriad experiences competition for its applications software and database products from a variety of firms, ranging from small, independent applications software producers to partnerships of software producers and computer systems manufacturers (e.g., IBM and Digital Equipment Corp.). Some of Triad's competitors customize general-purpose business management software and market it for use on industry-standard hardware. The Company also faces competition in both the automotive and hardgoods segments from distributors and coop- eratives that market computer systems to their members. Competition for the Company's higher-priced warehouse systems comes from both customers developing their own systems in-house, and from large, well-established businesses that offer general-purpose business computers and custom programming. Entry into the markets for the Company's products is not unusually difficult, and new competition is expected.\nThe Company believes that the key competitive factors in each of the Company's markets are information management capability, product features and functions, quality and quantity of data, price, ease of use, reliability, quality of technical support and customer service and features and functions. The Company believes that it competes favorably with respect to these factors.\nLitigation\nThe Company is involved in litigation arising in the ordinary course of business and in litigation to protect its proprietary rights. Triad is party to various legal proceedings, primarily in connection with deficiencies from customer-financed leases for products and services and related contract defenses such as breach of warranty. Alleged damages vary widely and some actions involve claims against the Company for damages, including punitive damages. In the opinion of management, after consultation with legal counsel, these matters will be resolved without material adverse effect on the Company's results of operations or financial position.\nEmployees\nAt September 30, 1994, Triad had 1,449 full-time employees. Persons with programming skills and experience are in great demand in the information management industry. The loss of a substantial number of these personnel, or an inability in the future to obtain sufficient additional qualified person- nel, would have an adverse effect on the Company's business. The Company considers its employee relations good and is not party to any collective bargaining agreements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe Company owns substantially all of its real property and the equipment used in its business. Corporate headquarters is located on a portion of its Livermore, California properties. Operations are consolidated in three buildings aggregating 220,000 square feet. Title to the headquarters buildings and the land on which they sit is held by a wholly owned subsidiary of the Company, which leases the premises to the Company for approximately $209,000 per month. The property and the lease are pledged as security on a 15-year term loan made by an insurance company to the subsidiary in the principal amount of $15.5 million with an initial interest rate of 9 7\/8% that may be adjusted at the option of the lender in 1998.\nAt September 30, 1994, the Company was leasing sales and service space in 120 cities in the United States and 15 foreign sites.\nIn 1984 the Company purchased Triad Park, an aggregate of 398 contiguous acres in the City of Livermore, for a total purchase price of $15.8 million. The Company subsequently reconveyed approximately 10 acres of Triad Park to the sellers under the terms of the original purchase agreement. Since 1984, the Company has also conveyed approximately 12.8 acres to Livermore for roadways which Triad developed in Triad Park. A portion of Triad Park consisting of 110 acres is zoned \"open space\" and currently may not be developed under an agreement with the City of Livermore.\nThe Company sold an aggregate of 39.6 acres of Triad Park from fiscal years 1987 through 1994 for $8.5 million and intends to market 166 acres of Triad Park for resale during the next several years. Approximately 50 acres of property have been rezoned for retail use, and the balance of the property is zoned for industrial and research and development purposes. As part of this rezoning process, the Company entered into an agreement with the City of Livermore canceling the former development agreement for the Triad Park and eliminating any further obligations by the Triad Park owners, including Triad, to construct or participate in any assessment district to fund construction of two freeway interchanges and a water storage facility. However, all future construction in the Triad Park will require payment to the City of its current traffic impact fees required in connection with issuance of building permits.\nImprovements are financed through municipal bonds. Two series of municipal bonds were sold by an assessment district from November 1985 through September 1988 to finance $11.5 million in improvements. A community facilities district was formed in 1990 that replaced the function of the assessment district under which $2.4 million in improvements were financed in September 1990. The community facilities district is authorized to finance a total of $17 million in bonds to provide funds to pay costs of the acquisition and construction of certain public facilities and services related to Triad Park. In 1993, the assessment district debt was refinanced to take advantage of lower interest rates.\nThe liens of the assessment district and community facilities district securing those bonds is segregated on a pro rata basis among all developable parcels of Triad Park and thus, except with respect to parcels retained by Triad for its own use, will be assumed by buyers of individual parcels.\nPrincipal and interest payments are required to be made by Triad (or by subsequent purchasers of parcels of Triad Park) as additional bonds up to the $17 million authorized are sold. With respect to $11.2 million in assessments outstanding, the Company made $903,000 in interest payments on the bonds in fiscal 1992, $1,033,000 in fiscal 1993 and $864,000 in fiscal 1994.\nThe Company intends to sell those portions of the Livermore acreage which are in excess of the Company's long-term facilities requirements. The Company's ability to market this property is dependent upon interest rates, general economic and market conditions, the prospective purchaser's ability to develop the property and the purchaser's ability to obtain a variety of governmental approvals, none of which is assured and all of which are subject to objections from the public. Economic conditions continue to impact the real estate market in Livermore, and throughout California, which has resulted in reduced real estate activity.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nSee \"Item 1 - Litigation.\"\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders\nThe Company did not submit any matters to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Stock and Related Security \t Holder Matters\nThere is incorporated by reference the information under the caption \"Market for Triad Stock\" on page 25 of the Annual Report.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThere is incorporated by reference the information under the caption \"Selected Financial Data\" on the inside cover of the Annual Report.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and \t Results of Operations\nThere is incorporated by reference the information under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 8 through 11 of the Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThere is incorporated by reference the financial statements and the notes thereto which appear on pages 12 to 22 of the Annual Report.\nITEM 9.","section_9":"ITEM 9. Disagreements on Accounting and Financial Disclosure\nNot applicable.\n\t\t\t PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors, Executive Officers and Operating Management of the \t Registrant\nThe Company's Directors, Executive Officers and Operating Management as of December 15, 1994 are as follows:","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"703645_1994.txt","cik":"703645","year":"1994","section_1":"ITEM 1.\nGENERAL. The Company was incorporated in Delaware in 1982 for the purpose of operating family oriented restaurants and entertainment centers. By 1988, the Company had concluded that enhanced growth required a change in the Company's business focus from the operation of the restaurants to the building of an industrial corporation. As a result, the Company acquired Aerosol Systems, Inc. (\"ASI\"), effective December 31, 1988, for an aggregate purchase price of approximately $40,000,000, of which approximately $14,750,000 was paid for stock and approximately $25,250,000 worth of liabilities were assumed. Further, the Company disposed of the restaurants October 31, 1991. ASI was merged into the Company on December 30, 1992.\nThe Company's principal executive offices are located at 9100 Valley View Road, Macedonia, Ohio 44056; telephone (216) 468-1380. Unless the context otherwise indicates, the term \"Company\" refers to Specialty Chemical Resources, Inc.\nOn February 26, 1992, the Company effected a 1-for-14 reverse stock split, whereby each share of the Common Stock of the Company outstanding immediately prior to the reverse split was converted into 1\/14 of a share of the Common Stock. Unless otherwise indicated, the information in this Report is adjusted to reflect the 1-for-14 reverse stock split.\nBUSINESS. The Company is a leading custom formulator and packager of specialty chemical products, primarily for the automotive service and industrial maintenance markets. The Company specializes in developing, formulating and packaging new products for customers which do not have the expertise or volume to maintain captive research and development departments and manufacturing operations. The Company produces and sells over 1200 \"proprietary\" chemical formulations, substantially all of which are packaged in aerosol containers. In 1994, the Company sold approximately 37 million units. These proprietary formulations represent know-how of the Company developed through the skill and experience of its employees. These proprietary formulations are not patented. Approximately 83% of the Company's sales are of its proprietary products sold under the brand names of the Company's customers. The Company's products include cleaners, sealants, gasket components, lubricants, waxes, adhesives, paints, coatings, degreasers, polishes, anti-statics and tire inflators. Substantially all of the Company's products are used by professionals in commercial applications. In addition, the Company produces and sells its own branded products under the Taylor Made Products (TMP) and Aerosol Maintenance Products (AMP) names. Approximately 10% of the Company's sales are of its TMP products and approximately 7% of sales are of the Company's AMP products.\nThe Company acts as an extension of its customers' marketing, research and development, procurement, production and quality control departments. It provides a wide range of services including: aerosol product design and concept origination; chemical formulation; container\nPage 2 of 60\nselection; marketing program development; labeling; filling and packaging; component and raw materials purchasing; vendor verification; regulatory compliance; inventory control and overall program management. As such, the Company differentiates itself from contract packagers, which fill aerosol cans for a fee but do not provide the same range of services. The Company believes that it is one of three companies providing such a wide range of services in the Company's product markets.\nThe Company's customers are principally distribution companies. The Company sells to approximately 350 core accounts with no single customer accounting for 10% of the Company's sales. The Company provides customers with prompt shipment, normally within four weeks after receipt of order, and will accept short production run orders (as few as 100 cases), thereby reducing the inventory requirements of its customers. Approximately 85% of the Company's aggregate sales are to customers in the automotive service and the industrial maintenance markets. Other markets served by the Company include janitorial and sanitation, high tech electronic and electrical manufacturing, and art and crafts. Less than 6% of the Company's sales are to chain store merchandisers. The Company believes, based on its experience with its customers and its knowledge of its industry, that it is the only custom packager in its principal markets that provides this wide range of services, and on a routine basis will produce as few as 100 cases of a product and offers delivery within four weeks.\nThe Company relies heavily on its pre-sale consultation and ongoing involvement with customers to establish long-term relationships. Its specialized equipment permits it to meet the varied needs of its customers. The Company's strong technical capabilities, proprietary products and formulations, manufacturing expertise and customer support are key elements in the Company's operating strategy.\nIn December, 1992, the Company experienced a non-chemical fire at its Macedonia, Ohio facility. Machinery and equipment were damaged affecting the Company's production capabilities. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nPRODUCT DEVELOPMENT PROCESS. The product development process typically takes six to nine months from new product concept origination to completion. Existing formulations may also serve as the basis for new products, in which case the product development process may be substantially accelerated.\nThe Company's product development activities typically originate through the identification by the Company's sales or research and development personnel of a perceived product need for its customers and its potential customers. The Company also develops products by utilizing technology developed by third parties. After the product\nPage 3 of 60\nconcept is originated, the Company develops the formula and manufactures samples of the product. The Company's sales staff then demonstrates the product for its customers, who field test the product through end-users. Concurrently, the Company conducts product stability tests in its laboratories. The Company makes any necessary adjustments resulting from customer and end-user comments. These adjustments may include changes in formulation, valve, spray pattern and propellant chemistry. Then, the Company, with customer input, designs the label, both for the aerosol cans and for the carton in which it is packaged. The Company's package and container design services include artistic design, writing of product instructions, product name creation and regulatory compliance, if necessary. Alternatively, the product concept origination may be initiated by the customer with the product development activity continuing in substantially the same way from that point forward.\nPRODUCTS. Aerosol containers are a convenient, effective and efficient way to deliver thousands of products. The containers, 2.9 billion of which were sold in the United States in 1993, are generally made of steel or aluminum and can be recycled. Since 1978, when the use of chlorofluorocarbons (\"CFC's\") as propellant was discontinued in the United States, the Company's aerosol products generally have used compressed gases, such as carbon dioxide and nitrogen and liquified gases, such as propane and butane, as propellants. The Company's aerosol containers range from 4 ounces to 24 ounces in capacity. The Company combines its chemical formulation, an appropriate propellant, dip tube, valve, actuator, cap and the aerosol container to produce the final product.\nProducts developed by the Company for the automotive service and industrial maintenance markets include cleaners, degreasers, lubricants and paints. The Company has also developed specialized products for the automotive service market, such as its patented non- flammable tire inflator, carburetor, brake and choke cleaners, gasket and trim adhesives, undercoatings, silicones, belt dressings, fabric protectors, and the Company's patented automobile fuel injection system cleaner, a specially formulated cleaner and a patented propellant system. Specialized products for the industrial maintenance market include molybdenum lubricants, food-grade lubricants and cleaners, release agents and protectors for injection and cast molding applications.\nPage 4 of 60\nIn 1991 the Company introduced its environmentally responsive, water-carried (as opposed to solvent-carried), aerosol products under the program name of SmartLine. TM Products using this system significantly reduce solvent release. Additionally, these products meet the National Fire Prevention Agency's most stringent fire prevention and storage standards for aerosol products. Products using this technology include a range of cleaners, degreasers and lubricants produced for the Company's principal markets.\nThe Company has developed a number of products using barrier packages. In a typical aerosol, the propellant and product are mixed and released from the can as a foam or spray. In a barrier package, the product is separated from the propellant by a liner (a can within a can) and only the product, and not the propellant, is released. This is important with products that cannot be mixed with a propellant, such as room temperature vulcanizing silicones (RTV's), or products which are too viscous to be propelled through a standard aerosol, such as caulking compounds.\nThe Company also produces its own brand name products through its Taylor Made Products Division (TMP), which are sold principally to the automotive do-it-yourself market through chain store merchandisers. The products include, cleaners, lubricants and degreasers. In addition, the Company produces its own brand name products through its Aerosol Maintenance Products Division (AMP). These products are sold principally to janitorial and sanitation supply distributors and include cleaning compounds and disinfectants.\nMARKETING AND DISTRIBUTION. The Company's marketing and sales activities are carried out by eight full-time salaried salespersons, except for sales of the Company's brand name products, which are marketed and sold by 21 manufacturer's representative agencies. The Company's customers are distributors of a broad range of products to the automotive service and industrial maintenance markets. The Company's efforts to obtain sales involve detailed pre-production and ongoing involvement with a customer. The Company seeks to develop long-term customer relationships. More than 71% of the Company's current sales volume is attributable to customers who have been with the Company for more than 10 years. The Company's active core customers number more than 350, with no single customer accounting for 10% of the Company's net sales. Substantially all of the Company's customers are located in the eastern two-thirds of the United States.\nRESEARCH AND DEVELOPMENT. The Company's research and development activities are directed toward aerosol product development and improvement, product screening and custom applications designed to meet the specific requirements of its customers. The Company's research and development activities involve both the formulation of proprietary chemical compounds and the development of associated aerosol delivery systems. The Company works with its customers to develop new products and to modify existing products for them. It also seeks to develop new, proprietary products such as its patented fuel injection system cleaner, water-carried aerosol products, and patented tire inflators. The Company's technical activities are carried out by four chemists and 11 laboratory technicians. The Company holds several registered trademarks and patents.\nPage 5 of 60\nMANUFACTURING. The Company currently has two manufacturing facilities, one in Macedonia, Ohio and the other in Twinsburg, Ohio. Upon completion of its restructuring plan, the Company will have consolidated its two manufacturing facilities into the Macedonia facility (see Management's Discussion and Analysis and Note I to Financial Statements). The expanded facility will contain six production lines. Each line will have different characteristics, providing the Company with flexibility to accommodate the short production runs required for many customized products, the longer high speed production runs, and the specialized barrier packaging production. In addition, the Company will be able to package its products in one gallon cans, five gallon pails, and fifty-five gallon drums.\nIn 1994, the Company sold approximately 37 million units. The handling of large volumes of liquid propellants requires that the manufacturing area be compartmentalized, permitting the isolation of each step in the production process. Control systems automatically shut down operation if safety limits are exceeded. Raw materials are stored within the plant, while propellants and solvents are stored in above- ground tanks outside the plant. The raw materials are moved as needed to the mixing area and the product is piped into a separate filling area where cans are filled. The cans are then conveyed into propellant charging rooms, two lines per room, where the propellant is loaded and the cans are crimped (sealed) automatically. After leaving the propellant charging room, the cans are coded and run through a hot water test tank to test for leaking and container integrity at elevated temperatures. In cases where the can label has not been preprinted, a label is applied. The cans are coded, then packed and palletized for shipment or, in some cases, stored in the warehouse on racks for order picking.\nThe Company purchases its raw materials and components such as metal cans, chemicals, solvents, propellants, labels and other supplies from a broad range of suppliers. The Company is not experiencing any difficulty in obtaining adequate supplies of raw materials or purchased components and does not anticipate any such difficulty in the foreseeable future.\nThe Company generally produces against firm commitment purchase orders and usually ships within 4 weeks from date of order. Accordingly, backlog is not material to the Company's business and is not indicative of future sales.\nCOMPETITION. The aerosol industry is highly fragmented geographically,along product lines and by production capacity. Within these areas, the industry is highly competitive. Although many companies perform some of the individual operations and services carried out by the Company, and some of its competitors have greater financial and other resources, the Company believes it has few competitors that offer the same type of technical assistance, product formulation and packaging. Further, the Company's competitors do not routinely offer to produce as few as 100 cases of product and to deliver products within four weeks. These services are provided by the Company. Most of the Company's customers do not have their own aerosol research or production facilities. Because of the highly specialized nature of the Company's business, price, while important, is not normally the principal competitive factor. The Company believes that the principal competitive factors in the industry are quality of product and the product's ease of use by its end-user.\nPage 6 of 60\nEMPLOYEES. As of January 31, 1995, the Company employed approximately 222 people on a full-time basis, of whom 82 are salaried and the remainder are hourly. All of the Company's hourly employees are represented by two collective bargaining units with collective bargaining agreements. One expired in November 1994, the other expires in February 1997. The Company considers its relationship with its employees to be good. There have not been any work stoppages or slowdowns due to labor related problems.\nIn December, 1994 the Company and its employees substantially agreed on the fundamental terms of a new collective bargaining agreement to replace the one which expired in November, 1994. However, a binding collective bargaining agreement has not been executed. The Company expects to enter into a new collective bargaining agreement in 1995.\nENVIRONMENTAL MATTERS. The Company's manufacturing facilities are subject to extensive environmental laws and regulations concerning, among other things, emissions to the air, discharges to the land, surface, subsurface strata and water, and the generation, handling, storage, transportation, treatment and disposal of waste and materials, and are also subject to other federal, state and local laws and regulations regarding health and safety matters. Management believes that the Company's business, operations and facilities are being operated in substantial compliance in all material respects with applicable environmental and health and safety laws and regulations. As a result, compliance with existing federal, state and local environmental laws is not expected to have a material effect upon the earnings or competitive position of the Company. However, management of the Company cannot predict the effect, if any, of environmental laws that may be enacted in the future. Capital expenditures for environmental control facilities for the next two fiscal years (exclusive of expenses that are expected to be substantially reimbursed) are not expected to be material. See \"Legal Proceedings\". Such costs, if any, should comprise a part of normal purchases of new or replacement equipment or facilities.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPROPERTY. The Company's Macedonia and Twinsburg production facilities are leased. The 72,820 square feet Macedonia facility lease expires in 1997; the lease on 33,600 square feet Twinsburg plant will be maintained on a month to month basis until the facility is abandoned in accordance ith the Company's Restructuring Plan (see Management's Discussion and Analysis and Note I to Financial Statements). Under a lease amendment dated July 25, 1994, upon completion of certain leasehold improvements, the term of the Macedonia lease will be extended through the year 2005, with four (4) five-year unilateral options to extend the lease through the year 2025. The Company leases 8,000 square feet of space for its executive offices, which are located adjacent to the Macedonia plant. The lease expires in 1996. The Company also currently leases a warehouse in Macedonia, Ohio for the storage and distribution of its manufactured finished goods. This lease is currently maintained on a month to month basis. Negotiations are ongoing to establish a long term lease on this property.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLEGAL PROCEEDINGS. The Company is currently involved in litigation and investigations pertaining to environmental concerns which preceded the Company's acquisition of ASI, which is now operated as a division of the Company.\nPage 7 of 60\nWith respect to the environmental concerns at its Macedonia plant, in 1990 ASI entered into a Consent Order with the State of Ohio. ASI was required to submit a closure plan to address contamination identified at the property. ASI submitted the closure plan as required. In December 1991, ASI received a Notice of Deficiency with respect to the proposed closure plan from the Ohio EPA requesting that ASI address the deficiencies within 30 days (which it did) and that certain additional testing be undertaken by ASI. Ohio EPA also requested, in the event the remedial measures in the proposed closure plan are not successful within a two-year period, that at that time ASI provide supplemental or alternative measures to clean up the remaining contamination.\nOn May 17, 1994, the Ohio EPA approved the revised closure plan which included unilateral modifications as deemed necessary by the Ohio EPA. On June 17, 1994, the Company appealed the Ohio EPA's action on the grounds that the unilateral modifications were unreasonable and unlawful. On January 6, 1995, the Company and the State of Ohio entered into a settlement agreement. The Company anticipates that, under this agreement, the Ohio EPA will issue a supplemental closure plan approval letter that will establish certain deadlines and further identify the scope of certain tasks. Upon issuance of the supplemental closure plan approval letter by the Ohio EPA, the Company will withdraw its appeal and the litigation will be terminated.\nTechnical consultants to the Company have estimated the cost of implementing the proposed closure plan to be approximately $670,000, substantially all of which will be paid by former owners of the Company from funds that have been deposited in a trust account with Ohio EPA for that purpose. As of December 31, 1994, the trust contained approximately $786,000. Additionally, there is approximately $227,000 available to the Company in an environmental escrow established by the former owners of the Company (the \"Environmental Escrow\"). The Environmental Escrow requires the Company to participate in 38% of the costs incurred. The terms of the trust have no such participation requirement. If the remediation techniques proposed in the closure plan are not successful, or if supplemental or alternative technologies are required to be used, then the Company may incur costs in excess of the amounts in such trust and in the \"Environmental Escrow\". The Company believes, based on discussions with technical consultants, that the cost of the additional testing requested by Ohio EPA will be approximately $120,000 and that the cost of the supplemental or alternative clean up measures, if determined to be necessary, will not exceed $2,000,000.\nOther than the environmental matters discussed above, the Company is involved only in claims, legal actions and complaints arising in the ordinary course of its business. In the opinion of management, the outcome of such matters will not have a material adverse effect on the financial position or results of operations of the Company.\nPage 8 of 60\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 ------------------\nSet forth below is certain information concerning the Executive Officers of the Company. Officers of the Company are elected annually by the Board of Directors of the Company, and serve at the pleasure of the Board of Directors that elects them.\nMr. Edwin M. Roth has been a Director and President of the Company and Chairman of the Board of Directors of the Company since its formation in June 1982. Mr. Roth was Chief Executive Officer of ASI from the time of its acquisition in December 1988 until its merger into the Company in December 1992. Mr. Roth is the father of Mr. Corey B. Roth.\nMr. Corey B. Roth has been Vice President of the Company since June 1982, a Director since October 1984 and Asst. Secretary since June, 1992. Mr. Roth served as Treasurer from November 1987 until January 30, 1990 and has again served in that capacity since June, 1992. Mr. Roth served as secretary from October 1984 until June 1992. Mr. Roth was Vice President of Administration of ASI from April 1989 until December 1992. Mr. Roth is the son of Mr. Edwin M. Roth.\nMr. John H. Ehlert joined the Company in 1990. He has been Vice President of the Company since April 1992. Mr. Ehlert was President of ASI from April 1992 until December 1992. In December of 1992, he was named President of the Aerosol Systems Division.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nFrom March 21, 1989 to August 1, 1991, the Company's Common Stock was listed on the Interdealer Quotation System of NASDAQ (\"NASDAQ System\") under the symbol \"MMNT\". From August 1, 1991 to February 27, 1992, the Common Stock was eligible for trading in the over-the-counter market. On February 27, 1992 the Common Stock was listed on the American Stock Exchange (\"AMEX\") under the symbol \"CHM\".\nPage 9 of 60\nDuring 1994, the closing sales prices on AMEX ranged from $2.88 to $7.25. During 1993, the closing sales prices on AMEX ranged from $5.75 to $7.50. The following table sets forth the high and low sale prices by quarter for 1994 and 1993.\nAs of February 10, 1995, the closing price for the Common Stock on AMEX was $3.94. As of February 10, 1995, there were 625 holders of record of Common Stock.\nThe Company has not paid cash dividends on its Common Stock and intends to follow a policy of retaining earnings in order to finance the continued growth and development of its business. Payment of dividends will be within the discretion of the Company's Board of Directors and will depend, among other factors, on earnings, capital requirements, and the operating and financial condition of the Company. The terms of outstanding loans to the Company currently prohibit the Company from paying cash dividends to its stockholders in any fiscal year in excess of 20% of the Company's net income for such fiscal year.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data for the fiscal years 1990 through 1994 are derived from the Company's audited financial statements. All financial data have been restated to reflect the discontinued restaurant operations and the adoption of Financial Accounting Standards Board (FASB) Statement 109, \"Accounting for Income Taxes\". This information should be read in conjunction with the Company's Financial Statements and Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations, each of which is included elsewhere in this Report.\nPage 10 of 60\n(1) A plan was adopted, effective April 1, 1991, to dispose of the Company's restaurant operations and on October 31, 1991, the Company completed disposition of the restaurants. All financial data have been restated to reflect the restaurant operations, as a discontinued business.\n(2) All financial data have been restated to reflect the adoption of FASB Statement 109.\n(3) At December 31, 1994, the Company had approximately $6,615,000 ofnet operating loss carryforwards available for federal income tax purposes. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Income Taxes and Net Operating Loss Carryforwards\" regarding limitations on the usage of these carryforwards.\n(4) Common Stock data are restated to reflect a one for fourteen reverse stock split effective on February 26, 1992.\n(5) The supplemental earnings per share is computed assuming the public stock offering had been effective on January 1, 1992 (See Note J to Financial Statements).\n(6) Includes long-term obligations (less current maturities), subordinated note payable and common stock warrants of ASI subject to put options, which were exchanged for Company warrants in 1992 in conjunction with the common stock offering. See Notes C, D and E to Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL. This discussion should be read in conjunction with the information contained in the Financial Statements and Notes thereto of the Company contained elsewhere in this Report.\nIn December, 1992, the Company experienced a non-chemical fire at its Macedonia, Ohio facility. The fire has adversely effected production capabilities, which adverse effect continued through 1993 and into 1994. Since the first quarter of 1994, the Company's Macedonia facility has been fully operational.\nAll financial data have been restated to reflect the adoption of FASB Statement 109.\nPage 12 of 60\nRESULTS OF OPERATIONS\nThe following table sets forth, for the periods indicated, the percentage of net sales of certain items included in the Company's Statement of Operations.\nFISCAL YEAR ENDED DECEMBER 31, 1994 AS COMPARED TO 1993\nNet sales of $44,931,000 for the year ended December 31, 1994 were $2,341,000 or 5.1% below the prior year. The decrease is due to softness in the markets for the Company's automotive and industrial maintenance products in the early part of the year and production inefficiencies as a result of fire related replacement equipment and operating procedures in the latter half of the year.\nCost of goods sold for the year ended December 31, 1994 increased by $1,078,000 or 2.9% as compared to the prior year. As a percentage of net sales, cost of goods increased form 78.1% to 84.7%. This increase is due to production inefficiencies associated with the functioning of new equipment throughout 1994, coupled with a reduction in sales dollars for the year ended December 31, 1994 as compared to the same period in 1993.\nSelling, general, and administrative expenses increased from $6,327,000 for the year ended December 31, 1993 to $6,995,000 for the year ended December 31, 1994. As a percentage of net sales these expenses were 13.4% for the year ended December 31, 1993 and 15.6% for the year ended December 31, 1994. The increase was due principally to higher freight changes as well as increased charges for medical insurance, professional fees and commissions related to the sale of branded products.\nInterest expense and amortization of debt issuance expense for the year ended December 31, 1994 was 1.2% of net sales versus 1.1% for the comparable period in the prior year. Interest expense was $560,000 for the year ended December 31, 1994, an increase of $29,000, from the year ended December 31, 1993.\nIn the fourth quarter of 1994, the Company's Board of Directors approved a plan to reduce the Company's cost structure and to improve operations through the consolidation of facilities and reductions in the number of employees. The Plan provides for the Company to accrue $941,000 of restructuring charges which are comprised of the following: $168,000 related to the abandonment of lease-hold improvements and lease termination costs; $457,000 for the abandonment of certain property and equipment; $254,000 related to the discontinuation of a product line and $62,000 for employee termination benefits. During 1994, the Company also expended approximately $13,000 for employee termination benefits under the Plan. The Company anticipates the Restructuring Plan will be completed by August 1995.\nPage 13 of 60\nDuring 1993 and 1994, in conjunction with the fire, the Company incurred an aggregate extraordinary loss of $3,801,000 which is comprised of $2,208,000, representing the write-off of the net book value of the machinery and equipment destroyed by the fire, and $1,593,000 of expenses related to restoration, property damage and unreimbursed expenditures by the Company. Additionally, the Company recognized an aggregate extraordinary gain of $5,888,000 related to the insurance replacement value of machinery and equipment. For financial reporting, the Company recorded, based upon the above transactions, an extraordinary loss of $1,338,000 ($884,000 net of tax benefits) for the year ended December 31, 1993 and an extraordinary gain of $3,245,000 ($2,265,000 net of taxes) for the year ended December 31, 1994.\nFISCAL YEAR ENDED DECEMBER 31, 1993 AS COMPARED TO 1992\nNet sales of $47,362,000 for the year ended December 31, 1993 were $565,000, or 1.2% below the prior year. The December, 1992 fire adversely effected the Company's production capacity throughout 1993. These adverse effects were reflected in three successive quarters of reduced sales in 1993 as compared to the same periods in 1992. Net sales in the fourth quarter of 1993 were $13,138,000, and increase of $2,560,000, or 24.2%, when compared to the fourth quarter of 1992. This increase is due to restored production capacity during the fourth quarter of 1993 versus reduced sales during the fourth quarter of 1992 resulting from the fire.\nCost of goods sold for the year ended December 31, 1993 decreased by $1,160,000 or 3.0% as compared to the prior year, caused by decreased sales. Cost of goods sold decreased as a percentage of net sales from 79.6% to 78.1% for the year ended December 31, 1993 as compared to the same period in the prior year. This decrease is primarily due to the Company's sales mix being weighted towards higher margin products in 1993 period, as well as fourth quarter 1992 expenses related the December, 1992 fire. Cost of goods sold as a percentage of net sales for the three months ended December 31, 1993 decreased from 80.6% to 78.1% as compared to the same period in the prior year. The decrease was caused by fourth quarter 1992 expenses related to the December, 1992 fire.\nSelling, general, and administrative expenses increased from $6,128,000 for the year ended December 31, 1992 to $6,327,000 for the year ended December 31, 1993. As a percentage of net sales these expenses were 12.8% for the year ended December 31, 1992 and 13.4% for the year ended December 31, 1993. The increase was due principally to salaries for additional staff totalling $168,000 as well as other administrative expenses related to the December, 1992 fire not covered by insurance.\nInterest expense and amortization of debt issuance expense for the year ended December 31, 1993 was 1.1% of net sales versus 2.3% for the comparable period in the prior year. Interest expense was $531,000 for the year ended December 31, 1993, a decrease of $520,000, or 49.5%, from the year ended December 31, 1992. This decrease principally resulted from the repayment of substantially all of the company's long-term debt with the proceeds of the public offering in February 1992.\nDuring 1993, the Company recorded an extraordinary charge in the amount of $884,000 (net of a tax benefit of $455,000). The extraordinary charge reflects the loss on property damaged and expenses incurred as a result of the 1992 fire, net of proceeds recognized from the insurance carrier through December 31, 1993.\nPage 14 of 60\nDuring the year 1992, the Company incurred an extraordinary charge of $714,000 related to write-offs, consisting of deferred financing costs of $915,000 and original issue discount of $184,000 (net of income taxes of $385,000), applicable to indebtedness that was repaid during the first quarter of 1992 with the proceeds of the public offering.\nINCOME TAXES AND NET OPERATING LOSS CARRYFORWARDS\nThe income tax provision of $320,000 for the year ended December 31, 1994 consists of $1,040,000 of current federal income taxes and $720,000 of deferred federal income taxes. The income tax provision of $489,000 for the year ended December 31, 1993 consisted of $29,000 of current federal alternative minimum tax and local taxes and $460,000 of deferred federal income tax. The income tax provision of $775,000 for the year ended December 31, 1992 consisted principally of current federal income tax. The Company recognized $2,664,000, $248,000, and $309,000 of tax benefits from the utilization of net operating loss carryforwards (\"NOLs\") for book purposes during the years ended December 31, 1994, 1993 and 1992 respectively. See Note J to Financial Statements.\nAs of December 31, 1994, the Company's NOLs were approximately $6,615,000. The NOLs arose primarily from the operations of the Company prior to the acquisition of ASI. Except as discussed below, and subject to limitations of the Internal Revenue Code of 1986, as amended (the \"Code\"), the NOLs should be available to offset future income of the Company. Use of the NOLs to reduce future taxable income may subject the Company to an alternative minimum tax.\nSection 382 of the Code limits the amount of a corporation's taxable income which can be offset by NOLs arising prior to an \"ownership change\". An ownership change occurs when, for example, shares comprising more than 50 percent of a corporation's stock are sold to new public shareholders. As a result of the public offering in February 1992 and the ownership change that occurred in connection therewith, the limitation on the utilization of the NOLs imposed by Section 382 of the Code will apply. Under the limitation, the amount of the Company's taxable income that each year can be offset by NOLs attributable to periods before the ownership change cannot exceed the product of (i) the fair market value of the stock of the Company immediately prior to the ownership change and (ii) the long-term tax-exempt rate prescribed by the IRS. The limitation imposed by the change in ownership may result in the Company paying income taxes in excess of the amount payable in the absence of a change in ownership.\nLIQUIDITY AND CAPITAL RESOURCES\nAs of December 31, 1994, the Company's ratio of current assets to current liabilities was 1.83 to 1 and the quick ratio (cash, cash equivalents, and accounts receivable, divided by current liabilities) was .90 to 1. As of December 31, 1993, the Company's ratio of current assets to current liabilities was 2.42 to 1 and the quick ratio (described above) was 1.57 to 1. The decrease in liquidity is due primarily to losses from operations during 1994 and reduction in Receivables - other, a result of proceeds received from the insurance company, used to pay off a portion of long term debt and purchase additional new equipment.\nDuring the twelve months ended December 31, 1994, the Company incurred $560,000 in interest expense and made interest payments totaling $556,000. Accrued interest at December 31, 1994, was $62,000.\nPage 15 of 60 The Company, as borrower, is a party to a credit agreement (the Credit Agreement\") that provides for a $10,000,000 revolving line of credit at an interest rate equal to the prime rate or the London Inter-Bank Offered Rate (LIBOR), at the Company's election. The Credit Agreement, entered into on March 30, 1992 and expiring on May 31, 1996, is a facility that allows for borrowings based upon a formula comprised of inventory, accounts receivable and fixed assets, less an environmental compliance reserve, if any. No compliance reserve has been required.\nUnder the terms of the Credit Agreement, the Company is required to comply with various covenants, the most restrictive of which relate to restrictions on distributions from the Company to its stockholders, maintenance of certain financial ratios and levels of tangible net worth and limits on capital expenditures. As a result of the foregoing, as of December 31, 1994, approximately $5,500,000 was unused and available under the Credit Agreement. On January 4, 1994, the Company entered into a 90 day $1,500,000 note at an interest rate equal to the prime rate with its senior lender to fund operations until insurance proceeds become available. On June 24, 1994, the note was repaid in full with a portion of the proceeds received from the Company's insurance carrier as final settlement of all claims relating to the December, 1992 fire.\nThe Company spent $16,385,000 for property damage, cleanup, and business interruption costs during the year ended December 31, 1993 that were related to the December 1992 fire; $7,300,000 of which were reimbursed in 1993 and $8,400,000 were reimbursed in 1994 with insurance proceeds as final settlement. The Company expects to spend an aggregate of approximately $2,300,000 on capital improvements during 1995. Such expenditures are expected to be funded from cash generated by operations and\/or borrowings under the Credit Agreement.\nNet cash provided by operating activities was $1,735,000 for 1994, as compared to $5,032,000 for 1993 and $1,908,000 for 1992. Net capital expenditures were $612,000, $6,084,000, and $513,000 respectively, for the three years 1994, 1993 and 1992. The decreased cash flow in 1994 compared to 1993 is due to 1992 year end accounts payable balance being abnormally low from the substantial reduction of purchasing as a result of the December 1992 fire. Growth of accounts payable during 1993, as operations were recommenced, created a significant cash source.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPage 16 of 60\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; REPORTS ON FORM 8-K\nThe Index to Financial Statements and Financial Statement Schedules is listed below.\nThe Company filed no reports on Form 8 - K during the quarter ending December 31, 1994.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nPg No. -----\nReport of Independent Certified Public Accountants...............\nBalance Sheets December 31, 1994 and 1993.............................. &\nStatements of Operations December 31, 1994, 1993 and 1992..............................\nStatements of Stockholders' Equity December 31, 1994, 1993, and 1992.............................\nStatements of Cash Flows December 31, 1994, 1993, and 1992....................... &\nNotes to Financial Statements............................. -\nReport of Independent Certified Public Accountants on Schedules.................................................\nSchedule II - Valuation and Qualifying Accounts December 31, 1994, 1993 and 1992................\nPage 17 of 60 SIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, this 29th day of March, 1995.\nSPECIALTY CHEMICAL RESOURCES, INC.\nBy:\/s\/ EDWIN M. ROTH --------------------------------- Edwin M. Roth, Chairman of the Board and President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed by the following persons in the capacities, on the date indicated. This Report may be signed in multiple counterparts, all of which taken together shall constitute one document.\nPage 18 of 60\nIndex to Exhibits\nExhibit Page Number ------ Number ------\n3.01 The Amended and Restated Bylaws of the Company were filed as Exhibit 3.03 to the Company's Form S-1 Registra- tion Statement (Registration No. 2-78134) and are incorp- orated herein by reference....................................\n3.02 The Restated Certificate of Incorporation of the Company was filed as an exhibit to Company's Second Modified Plan of Reorganization which was filed as Exhibit 2.1 to the Company's Current Report on Form 8-K dated December 9, 1986, and is incorporated herein by reference.................\n3.03 Amendment, effective December 12, 1991, to the Company's Restated Certificate of Incorporation was filed as Exhibit 3.03 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 and is incorporated herein by reference..................\n3.04 Amendment, effective February 26, 1992, to the Company's Restated Certificate of Incorporation was filed as Exhibit 3.04 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 and is incorporated herein by reference..................\n4.01 Credit Agreement, dated as of March 30, 1992, between ASI and National City Bank was filed as Exhibit 4(a) to the Company's Current Report on Form 8-K dated April 8, 1992, and is incorporated herein by reference...........................................\n4.02 Guaranty, dated as of March 30, 1992, executed by the Company for National City Bank was filed as Exhibit 4(b) to the Company's current Report on Form 8-K dated April 8, 1992, and is incorporated herein by reference.......................\n4.03 Amendment to Credit Agreement, dated as of March 5, 1993, between the Company and National City Bank was filed as exhibit 4.03 to the company's Annual Report on Form 10 - K for the year ended December 31, 1992 and is incorporated herein by reference..................\n4.04 Specimen Stock Certificate of the Company was filed as Exhibit 4.5 to the Company's Registration Statement on Form S-2, File No. 33-43092, and is incorporated herein by reference.......................\n4.05 $1,500,000 Time Commercial Note dated January 4, 1994 between the Company and National City Bank was filed as Exhibit 4.05 on the Company's Annual Report on Form 10-K for the year ended December 31, 1993 and is incorporated by reference herein..................\n4.06 Extension Agreement dated as of November 15, 1993 by and between the Company and National City Bank was filed as Exhibit 4.06 on the Company's Annual Report on Form 10-K for the year ended December 31, 1993 and is incorporated by reference herein..................\n4.07 Extension Agreement dated as of December 2, 1994 by\/and between the Company and National City Bank............................\n-Ex 1-\nExhibit Page Number ------ Number ------\n10.01 Lease between ASI and 9150 Group, dated September 30, 1977 and amended January 1, 1989 was filed as Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended January 1, 1989 and is incorporated herein by reference.......\n10.02 Lease between ASI and 9150 Group, dated September 25, 1977 and amended January 1, 1989, was filed as Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended January 1, 1989 and is incorporated herein by reference...............\n10.03 1989 Non-Qualified and Incentive Stock Option Plan of the Company was filed as Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended January 1, 1989 and is incorporated herein by reference..............................\n10.04 Form of option agreement pursuant to 1989 Incentive Stock Option Plan of the Company was filed as Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended January 1, 1989 and is incorporated herein by reference.......\n10.05 1989 Outside Directors' Stock Option Plan of the Company was filed as Exhibit 10.5 to the Company's Registration Statement on Form S-2, File No. 33-43092 and is incorporated by reference herein........................................................\n10.06 First Amendment to 1989 Non-Qualified and Incentive Stock Option Plan of the Company, adopted October 3, 1991, was filed as Exhibit 10.12 to the Company's Registration Statement on Form S-2, File No. 33-43092 and is incorporated by reference herein...............\n10.07 Second Amendment to 1989 Non-Qualified and Incentive Stock Option Plan of the Company, dated February 26, 1992, was filed as Exhibit 10.12 to the Company's Registration Statement on Form S-2, File No. 33-43092 and is incorporated by reference herein...............................\n10.08 First Amendment to 1989 Outside Directors' Stock Option Plan of the Company, adopted October 3, 1991, was filed as 10.9 to the Company's Registration Statement on Form S-2, File No. 33-43092 and is incorporated by reference herein...............................\n10.9 Second Amendment to the 1989 Outside Directors' Stock Option Plan, dated February 26, 1992, was filed as Exhibit 10.13 to the Company's Registration Statement on Form S-2, File No. 33-43092 and is incorporated by reference herein...............................\n10.10 Agreement between ASI and Teamsters Local Union No. 416, dated November 17, 1993 and effective as of August 15, 1993 was filed as Exhibit 10.10 on the Company's Annual Report on Form 10-K for the year ended December 31, 1993 and is incorporated by reference herein...............\n-Ex 2-\nExhibit Page Number ------ Number ------\n10.11 Agreement between ASI and Teamsters Local Union No. 416, dated January 12, 1992, and effective as of December 23, 1991 was filed as Exhibit 10.11 to the Company's Registration Statement on Form S-2, File No. 33-43092 and is incorporated by reference herein........................................................\n10.12 Lease between ASI and Dutton Company, dated October 7, 1987 as amended May 4, 1989, was filed as Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 2-78134, and is incorporated herein by reference...........................................\n10.13 Lease amendment between Specialty Chemical Resourses, Inc. (assignee of ASI) and the 9150 Group dated July 25, 1994......\n23 Independent Auditor's Report..................................\n27 Financial Data Schedule.......................................\n-Ex 3- EXHIBIT 23\nINDEPENDENT AUDITORS' REPORT\nStockholders of SPECIALTY CHEMICAL RESOURCES, INC.\nWe have audited the accompanying balance sheets of Specialty Chemical Resources, Inc. as of December 31, 1994 and 1993, and the related statements of earnings, 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 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 Specialty Chemical Resources, 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.\nGRANT THORNTON LLP\nCleveland, Ohio February 8, 1995\nThe accompanying notes are an integral part of these statements.\nThe accompanying notes are an integral part of these statements.\nThe accompanying notes are an integral part of these statements.\nThe accompanying notes are an integral part of these statements.\n(CONTINUED ON NEXT PAGE)\nThe accompanying notes are an integral part of these statements.\nThe accompanying notes are an integral part of these statements.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS\nDecember 31, 1994, 1993 and 1992\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nSpecialty Chemical Resources, Inc. (SCR, Inc.) formulates, blends, and packages pressurized specialty chemical products for sale to marketers, distributors, and retailers. Its largest markets are the automotive aftermarket and industrial\/maintenance.\nA summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows.\nINVENTORIES -----------\nInventories are stated at the lower of cost or market. Cost is determined by the last-in, first-out (LIFO) method for raw materials and the first-in, first-out (FIFO) method for finished goods.\nPROPERTY AND EQUIPMENT ----------------------\nDepreciation is provided for in amounts sufficient to relate the costs of depreciable assets to operations over their estimated service lives on a straight-line basis. Leasehold improvements are amortized on a straight-line basis over the lease term or the service lives of the improvements, whichever is shorter.\nINTANGIBLES -----------\nIn conjunction with the repayment of debt from the proceeds of the public offering (see note H), the Company recorded an extraordinary charge of $915,451 (net of $321,000 of taxes) for the year ended December 31, 1992, to write off the remaining balance of the unamortized debt issuance expense related to the senior and subordinated debt (see notes C and D).\nGoodwill, resulting from the excess of the purchase price over the fair value of net assets acquired is being amortized over 40 years. The Company evaluates potential impairment of goodwill on the basis of whether goodwill is recoverable from the projected undiscounted profit from operations before goodwill amortization of the related assets. Purchased product formulations are being amortized on a straight-line basis over 10 years, and all research and development costs are being expensed as incurred.\nAccumulated amortization for intangibles amounted to $5,102,000 and $4,227,000 for the years ended December 31, 1994 and 1993, respectively.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- CONTINUED\nINCOME TAXES ------------\nThe Company accounts for income taxes under the Financial Accounting Standards Board Statement 109, which requires an asset and liability approach to accounting for income taxes. The asset and liability method requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between tax bases and financial reporting bases of assets and liabilities.\nSTATEMENTS OF CASH FLOWS ------------------------\nFor purposes of the statements of cash flows, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\nCash payments for interest amounted to $556,000, $512,000 and $1,346,000 in the years ended December 31, 1994, 1993 and 1992, respectively. Cash payments for income taxes amounted to $228,000, $1,216,000 and $74,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE B - INVENTORIES\nHad the Company historically followed the FIFO cost method for raw material inventories, the net earnings for the years ended December 31, 1994, 1993 and 1992 would have been increased by approximately $8,000, $37,000 and $98,000, respectively.\nNOTE C - LONG-TERM OBLIGATIONS\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE C - LONG-TERM OBLIGATIONS -- CONTINUED\nOn January 12, 1989, the Company entered into a loan and security agreement with a bank which provided a credit facility of up to $22,000,000 comprised of a revolving credit agreement and two term loans, one for $10,000,000 and one for $2,000,000. During the year ended December 31, 1992, in conjunction with the proceeds from the public offering as described in note H, SCR, Inc. retired the obligation.\nIn March 1992, the Company entered into a revolving credit agreement with a bank. The revolver provides for maximum borrowings of $10,000,000 through May 31, 1996 with any amounts then outstanding payable in full at that date. In certain circumstances, the maximum borrowings under the agreement are reduced pursuant to a formula based upon the amount of SCR, Inc.'s receivables, inventory and fixed assets. In addition, the lender can reduce the maximum borrowings under the revolver by establishing an environmental compliance reserve in certain circumstances. No compliance reserves have been required as of December 31, 1994. Borrowings are collateralized by substantially all of the Company's assets and interest is payable monthly at the lender's prime rate (8-1\/2% at December 31, 1994).\nUnder the terms of the revolver, SCR, Inc. is required to comply with various covenants, the most restrictive of which relate to restrictions on dividends, maintenance of certain financial ratios and levels of net worth and limits on capital expenditures.\nNOTE D - SUBORDINATED NOTE PAYABLE\nDuring 1989, the Company entered into an agreement to sell to a bank (Subordinated Noteholder) a $13,000,000 note which was subordinate to the senior debt described above. During 1992, in conjunction with the proceeds from the public offering, SCR, Inc. retired the subordinated note and recorded an extraordinary charge of $184,001 (net of $64,000 of taxes) to write-off the unamortized portion of the original issue discount related to this debt.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE E - COMMON STOCK WARRANTS\nIn connection with the subordination agreement, the Subordinated Noteholder was granted warrants to acquire 168,555 shares of the Company's common stock at an exercise price of $.14 per share pursuant to a Warrant Purchase Agreement. During 1993, the subordinated noteholder, upon the exercise of its warrants, was issued 164,635 shares. The value of the remaining shares, in conjunction with the warrants, was used to offset the $.14 per share exercise price.\nNOTE F - COMMITMENTS AND CONTINGENCIES\nThe Company's operations are conducted in leased facilities under noncancellable operating leases which expire at various dates through 1997. Certain of the leases, all of which relate to the manufacturing facilities, can be extended at the option of the Company to the year 2009.\nThe following table details scheduled minimum rental payments.\nRent expense for the years ended December 31, 1994, 1993 and 1992 was approximately $606,000, $545,000 and $485,000, respectively.\nThe Company is currently involved in litigation and investigations pertaining to environmental concerns by the State of Ohio in connection with several potential problems at its Macedonia, Ohio manufacturing plant.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE F - COMMITMENTS AND CONTINGENCIES -- CONTINUED\nWith respect to the environmental concerns at its Macedonia plant, in 1990 the Company entered into a Consent Order with the State of Ohio. The Company was required to submit to the Ohio Environmental Protection Agency (Ohio EPA), a closure plan to address contamination identified at the property. The Company submitted the closure plan as required. Ohio EPA also requested, in the event the remedial measures in the proposed closure plan are not successful within a two-year period, that at that time the Company provide supplemental or alternative measures to clean up the remaining contamination.\nOn May 17, 1994, the Ohio EPA approved the revised closure plan which included unilateral modifications as deemed necessary by the Ohio EPA. On June 17, 1994, the Company appealed the Ohio EPA's action on the grounds that the unilateral modifications were unreasonable and unlawful. On January 6, 1995, the Company and the State of Ohio entered into a settlement agreement. The Company anticipates that, under this agreement, the Ohio EPA will issue a supplemental closure plan approval letter that will establish certain deadlines and further identify the scope of certain tasks. Upon issuance of the supplemental closure plan approval letter by the Ohio EPA, the Company will withdraw its appeal and the litigation will be terminated.\nTechnical consultants to the Company have estimated the cost of implementing the proposed closure plan to be approximately $670,000, substantially all of which will be paid by former owners of the Company from funds that have been deposited in a trust account with Ohio EPA for that purpose. As of December 31, 1994, the trust contained approximately $786,000. Additionally, there is approximately $227,000 available to the Company in an environmental escrow established by the former owners of the Company (the \"Environmental Escrow\"). The Environmental Escrow requires the Company to participate in 38% of the costs incurred. The terms of the trust have no such participation requirement. If the remediation techniques proposed in the closure plan are not successful, or if supplemental or alternative technologies are required to be used, then the Company may incur costs in excess of the amounts in such trust and in the \"Environmental Escrow\". The Company believes, based on discussions with technical consultants, that the cost of the additional testing requested by Ohio EPA will be approximately $120,000 and that the cost of the supplemental or alternative clean up measures, if determined to be necessary, will not exceed $2,000,000.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE G - EMPLOYEE BENEFIT PLANS\nThe Company has a defined contribution 401(k) profit-sharing plan (the Plan) covering certain salaried employees with one year of credited service. The Company's profit-sharing contributions are at the discretion of the Board of Directors and are credited to each participant's account based on a percentage of gross compensation subject to a maximum contribution for each participant. The Company is also required under the 401(k) provisions to match employee contributions equal to 50% of each such participant's deferred compensation up to a maximum of 4% of the participant's annual compensation. Contributions by the Company under the 401(k) provisions for 1994, 1993 and 1992 were approximately $35,400, $32,900 and $26,400, respectively. The Company did not make any profit-sharing contributions to the Plan for the years ended December 31, 1994, 1993 and 1992.\nThe Company has a Retirement Savings Trust and Plan covering full-time hourly employees who have completed six months of service. The Company's contributions are made on an annual basis and are credited to each participant's account at an amount equal to 10 cents per hour of compensation (maximum of 48 hours per week). In addition, qualified employees are eligible to make voluntary contributions to the Retirement Savings Trust and Plan which are fully vested and nonforfeitable. Contributions by the Company for the years ended December 31, 1994, 1993 and 1992 approximated $36,700, $14,000 and $21,300, respectively.\nNOTE H - STOCKHOLDERS' EQUITY\nThe Board of Directors and the stockholders of the Company approved an amendment to the Company's Certificate of Incorporation to authorize 13,000,000 shares of common stock, $.10 par value, and 2,000,000 shares of preferred stock, $.01 par value. The amendment was effective February 26, 1992. The Board of Directors and the stockholders also approved a 1-for-14 reverse common stock split. The reverse common stock split was also effective February 26, 1992. All share and per share data contained in these financial statements are presented giving effect to the reverse stock split.\nOn February 27, 1992, the Company's Registration Statement filed with the Securities and Exchange Commission for the sale of 2,760,000 shares of the Company's common stock was declared effective. The offering resulted in net proceeds to the Company of $24,470,000 which was net of $3,130,000 for underwriters' commissions and offering expenses. The purpose of the offering was to repay a substantial portion of the Company's long-term debt. During January 1994, the Company's Registration Statement, filed with the SEC for the registration of the shares issued in connection with the warrants exercised, was declared effective (see note E).\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE H - STOCKHOLDERS' EQUITY -- CONTINUED\nThe Company has a Nonqualified and Incentive Stock Option Plan (the Plan) under which 650,000 shares of common stock have been reserved. The Plan provides for grants to officers and key employees of the Company of both nonqualified and incentive stock options. The exercise price for options granted under the Plan must be at least equal to fair market value of the shares on the date of grant. The Plan will terminate in January 1999 but will not affect any outstanding options previously granted. Such options granted may be exercised after one year from the date of grant for not more than one-third of the shares originally subject to the option and an additional one-third for each of the two years thereafter. The options granted under the Plan expire five years from the date of grant.\nThe Company also has an Outside Directors' Stock Option Plan (Directors' Plan) under which 150,000 shares of common stock have been reserved. Under the Directors' Plan, each outside director will be granted an option to purchase 10,000 shares of common stock and an additional option to purchase 5,000 shares of common stock every two years thereafter as long as the individual remains on the Company's Board of Directors and remains an \"outside\" director. The exercise price for options granted shall be the fair market value of the shares on the date of grant. Directors vest in their options in 25% annual increments commencing one year after the date of grant. Options granted, to the extent the director has vested, shall be exercisable for a term of ten years from the date of grant. In addition, the Directors' Plan calls for the exercising of options by directors upon their termination and by their beneficiaries upon their death for a designated period of time. The Directors' Plan will terminate in January 1999 but will not affect any outstanding options previously granted.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE H - STOCKHOLDERS' EQUITY -- CONTINUED\nAs of December 31, 1994, no incentive stock options have been granted.\nNOTE I - RESTRUCTURING CHARGES\nIn the fourth quarter of 1994, the Company's Board of Directors approved a plan to reduce the Company's cost structure and to improve operations through the consolidation of facilities and reductions in the number of employees.\nThe Plan provides for the Company to accrue $941,000 of restructuring charges which are comprised of the following: $168,000 related to the abandonment of leasehold improvements and lease termination costs; $457,000 for the abandonment of certain property and equipment; $254,000 related to the discontinuation of a product line and $62,000 for employee termination benefits. During 1994, the Company has also expended approximately $13,000 for employee termination benefits under the Plan. The Company anticipates the Restructuring Plan will be completed by August 1995.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE J - INCOME TAXES\nAs of December 31, 1994, the Company had approximately $6,615,000 of net operating loss and $51,000 of investment tax credit carryforwards. However, due to the change in percentage ownership related to the public stock offering, the Company has an annual limitation of approximately $850,000 in the utilization of its net operating loss and investment tax credit carryforwards. In addition, due to the realization of built in gains related to the fire, approximately $2,500,000 of the carryforwards may be utilized beyond the annual limitation to offset future taxable income. The net operating loss carryforward and investment tax credit carryforwards, to the extent unused, will expire as follows:\nThe above-mentioned carryforwards gave rise to a deferred tax asset of approximately $2.6 million at December 31, 1994 which is an increase of $.5 million over the previous year. Due to the uncertainty of the ultimate realization of the deferred tax asset, a valuation allowance for the entire amount was recorded annually by the Company.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE J - INCOME TAXES -- CONTINUED\nThe provision for income taxes is different from that which would be obtained by applying the statutory federal income tax rate due to amortization of goodwill and the utilization of net operating loss carryforwards.\nThe income tax provision of $320,000 for the year ended December 31, 1994 consists principally of $1,040,000 of current federal income taxes and $720,000 of deferred tax benefits. The income tax provision of $489,000 for the year ended December 31, 1993 consisted of $29,000 of current federal alternative minimum taxes and local taxes and $460,000 of deferred federal income tax. The income tax provision of $775,000 for the year ended December 31, 1992 consisted principally of current federal income tax.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE K - EARNINGS (LOSS) PER SHARE OF COMMON STOCK\nNet earnings (loss) per share of common stock has been computed based upon the weighted average number of common shares and common share equivalents outstanding for each year as follows: 3,935,431 for the year ended December 31, 1994, 3,946,167 for the year ended December 31, 1993 and 3,443,027 for the year ended December 31, 1992. Common share equivalents include dilutive employee stock options and the shares exercisable under the common stock warrants (less the number of treasury shares assumed to be repurchased).\nThe Company's supplementary earnings per share for the year ended December 31, 1992 from continuing operations would have been $.34 per share assuming the Public Stock Offering had been effective on January 1, 1992 (see note H). Under this assumption, the Company's interest expense and amortization of deferred financing costs and original issue discount would have been reduced by $369,000, net of applicable taxes. The Company would also have had 3,908,929 weighted average common shares and common share equivalents outstanding for the year ended December 31, 1992.\nNOTE L - INSURANCE CLAIM\nOn December 13, 1992, a portion of the Macedonia, Ohio plant, machinery and equipment, and inventory was damaged by a non-chemical fire. The Company carried (and continues to carry) replacement cost insurance and business interruption insurance and had notified the insurance company. The Company had incurred various expenditures related to the repair and restoration of the fire damaged property as well as business interruption costs. The replacement cost portion of the claim for property and restoration costs has been settled with the insurance company for approximately $7.6 million, of which approximately $5.8 million was received during 1993 and an additional $1.8 million was received during 1994. The business interruption portion of the claim for reimbursement of expenses incurred and lost sales experienced was settled with the insurance company for approximately $8.1 million, of which $1.5 million was received during 1993 and an additional $6.6 million was received during 1994.\nSpecialty Chemical Resources, Inc.\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDecember 31, 1994, 1993 and 1992\nNOTE L - INSURANCE CLAIM -- CONTINUED\nThe Receivables - other in the amount of $4,308,000 as reported on the December 31, 1993 balance sheet was due from the insurance company related to the fire claim. This amount was paid in full during 1994 as part of the overall proceeds received as discussed above.\nDuring 1993 and 1994, in conjunction with the fire, the Company incurred an aggregate extraordinary loss of $3,801,000 which is comprised of $2,208,000, the write-off of the net book value of the machinery and equipment destroyed by the fire, and $1,593,000 of expenses related to restoration, property damage and unreimbursed expenditures by the Company. Additionally, the Company recognized an aggregate extraordinary gain of $5,888,000 related to the insurance replacement value of machinery and equipment. For financial reporting, the Company recorded, based upon the above transactions, an extraordinary loss of $1,338,000 ($884,000 net of tax benefits) for the year ended December 31, 1993 and an extraordinary gain of $3,425,000 ($2,265,000 net of taxes) for the year ended December 31, 1994.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULES\nStockholders of SPECIALTY CHEMICAL RESOURCES, INC.\nIn connection with our audit of the financial statements of Specialty Chemical Resources, Inc. referred to in our report dated February 8, 1995, we have also audited Schedule II for each of the three years in the period ended December 31, 1994. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein.\nGRANT THORNTON LLP\nCleveland, Ohio February 8, 1995","section_15":""}
{"filename":"57183_1994.txt","cik":"57183","year":"1994","section_1":"Item 1. Business\nLaclede Gas Company is a public utility engaged in the retail distribution and transportation of natural gas. The Company, which is subject to the jurisdiction of the Missouri Public Service Commission, serves the City of St. Louis, St. Louis County, the City of St. Charles, and parts of St. Charles County, the town of Arnold, and parts of Franklin, Jefferson, St. Francois, Ste. Genevieve, Iron, Madison and Butler Counties, all in Missouri. As an adjunct to its gas distribution and transportation business, the Company operates underground natural gas storage fields and is engaged in the transportation and storage of liquid propane. The Company has engaged in exploration for and development of natural gas on a utility and non-utility basis. The Company has also made investments in other non- utility businesses as part of a diversification program.\nNATURAL GAS SUPPLY\nFederal Energy Regulatory Commission (FERC) Order 636 requires interstate natural gas pipeline companies to offer unbundled, or separate, gas transportation and storage services and to discontinue their bundled merchant sales operation, which included gas acquisition as well as related storage and transportation service.\nIn December 1992, the Mississippi River Transmission Corporation (MRT), Laclede's principal supplier at that time, filed its initial restructuring plan, which after careful analysis, Laclede concluded was unacceptable. The two companies were unable to develop an acceptable restructuring plan that would meet the requirements of Order 636 and provide Laclede with the long- term gas supply assurances provided by Laclede's previous contract with MRT. As as result, the long-term supply contract between Laclede and MRT was terminated on November 1, 1993.\nTo replace the MRT contract, the two companies have entered into an agency agreement in which Laclede is responsible for acquiring its own gas supplies and making transportation and storage arrangements to get such supplies to MRT's pipeline system. MRT, as Laclede's agent, is responsible for administering, much as it historically has done, the various functions (such as scheduling day-to-day gas supply and transportation, and managing storage requirements, all in accord with Laclede's needs) for deliveries to Laclede in a manner that will achieve for Laclede maximum operational efficiency and economy. MRT has agreed to advise and assist Laclede in locating sources of gas and helping to negotiate purchases from these sources. On November 1, 1993, the new agency relationship and unbundled pipeline services went into effect.\nThe Company's supply agreements applicable to Missouri Pipeline Company were structured in a manner that is more compatible with Order 636 and need not be terminated in order to reconcile it with that Order.\nGas for producing areas is transported through interstate \"upstream\" pipelines into the pipeline systems of Mississippi River Transmission Corporation (MRT) and Missouri Pipeline Company (MPC) for delivery to Laclede's service area. Under FERC Order 636, Laclede was allocated a part of such upstream firm transportation pipeline capacity, which connects MRT's system to the gas production basins and off-shore platforms, as well as a share of MRT's underground gas storage capacity. Most of such storage capacity is located in northern Louisiana. Wherever possible, Laclede negotiated revisions or reformed the gas transportation agreements MRT\nformerly had with the three primary transporters of gas into MRT's pipeline system. The new arrangements increased Laclede's operational flexibility as compared to MRT's purchasing the transportation services and also provided reduced unit costs. Laclede also has been able to release firm transportation capacity to other gas users when it was not required for use by the Company's own customers. This resulted in reducing Laclede's overall gas costs during 1994 by almost $3.1 million.\nIn order to meet its gas supply requirements in the restructured environment of the interstate natural gas pipeline industry, Laclede put in place last year arrangements to purchase gas directly from producers and marketers. In making such arrangements Laclede has had the twofold objectives of: (1) insuring that the gas supplies it acquires are dependable and will be delivered when needed; and (2) insofar as is compatible with that dependability, that the gas purchased will be reasonably and economically priced.\nConsonant with those intertwined objectives Laclede acquired its purchased gas supplies from three different producing basins - Mid-Continent, Gulf Coast and offshore - and also concentrated its firm purchases of gas with major suppliers which own or have large natural gas reserves available to them. Long-term agreements were negotiated in 1994 between Laclede and subsidiaries of two of the ten largest gas producers in the United States - Amoco and Arco. The Amoco agreement involves the reformation of two existing MRT agreements with Amoco to better suit Laclede's requirements and to involve Amoco in a long-term commitment to the St. Louis market.\nThe Arco agreement will provide significant firm long-term gas supplies to Laclede and its customers with an initial term extending to 1999. While reliablity of supply is Laclede's first gas supply imperative, the Company's arrangements also have met the second objective of being reasonably priced insofar as is consistent with obtaining long-term, firm commitments from suppliers.\nDuring fiscal 1994, Laclede Gas Company purchased natural gas from a diverse group of 32 suppliers to meet its current market and storage injection requirements. Natural gas purchased by Laclede and delivered to St. Louis through the MRT system during fiscal 1994 totalled 80.8 billion cubic feet, including 5.1 Bcf purchased directly from MRT in October 1993 before Order 636 was implemented. Purchases through the MPC system during fiscal 1994 totalled 12.5 Bcf, all of which was purchased pursuant to the Company's long-term firm supply contract with ESCO Energy, Inc. The long- term ESCO agreement provides for the delivery and purchase of up to 55,000 MMBtu of gas per day through the various MPC interconnects in St. Charles and Franklin counties.\nIt must be pointed out that the FERC-ordered new supply system has only been effective for the past year and that the past winter was warmer than normal, not only in Laclede's service area but in most areas of the country. The new system has not been tested on severely cold days over a long and protracted cold winter, and Laclede's management has some concern about how well this FERC ordered system will perform for the gas industry under such weather conditions. This concern underlies the Company's insistence on supply reliability as being the most important requirement of its gas supply portfolio.\nThe peak day sendout of 1,113,000 MMBtu occurred on Tuesday, January 18, 1994, when the average temperature was -1 degree Fahrenheit. This peak day sendout was met by using 632,000 MMBtu of gas purchased and transported using the MRT system, 301,000 MMBtu of gas withdrawn from Laclede's storage facilities, 84,000 MMBtu of propane, 60,000 MMBtu of gas purchased under the Company's long-term gas supply contract with ESCO Energy, Inc., and 36,000 MMBtu of gas not owned by the Company that was transported for Laclede customers. Temperatures during the heating season on average were 3% warmer than fiscal 1993 and 1% warmer than normal. The Company sold and transported 1,070.1 million therms of gas this year, a decrease of 10.0 million therms from fiscal 1993.\nUNDERGROUND NATURAL GAS STORAGE\nThe Company has entered into a firm storage service agreement with MRT for approximately 23.5 billion cubic feet of allocated storage capacity on MRT's system located primarily in Unionville, Louisiana. MRT's tariffs provide for injections into the allocated storage capacity between May 16 through November 15. The Company must withdraw all but 2.3 Bcf during the November 16 through May 15 period.\nThe Company supplements flowing pipeline gas with natural gas withdrawn from its underground storage fields located in St. Louis and St. Charles Counties. The fields are designed under normal operations to provide 357,000 MMBtu of natural gas withdrawals on a peak day, and annual withdrawals of approximately 5,500,000 MMBtu based on the inventory level which the Company plans to maintain.\nPROPANE SUPPLY\nLaclede Pipeline Company, a wholly owned subsidiary, owns and operates a propane pipeline which connects the parent company's 800,000-barrel (approximately 33,000,000 gallons) propane storage facilities in St. Louis County, Missouri, to propane supply terminal facilities located at Wood River and Cahokia, Illinois. Liquid propane gas is transported through this pipeline for delivery to the parent company for storage, to be ultimately vaporized and used during those periods of operation when the natural gas supply has to be supplemented to meet the peak demands of the distribution system. The Company's contract with Phillips Petroleum Company provides for delivery of up to 35 million gallons of propane annually through March 31, 1999, and year to year thereafter unless terminated by either party.\nEXPLORATION AND DEVELOPMENT\nThe Company's exploration and development activities are segregated into two distinct functions: utility and non-utility. Under the utility program, the Company has participated in drilling 96 wells over its twenty-three year span with 52 of the wells being commercially productive. Since 1981, this program has been limited to development activities. Capital expenditures in recent years have not been significant, amounting to $10,000 in 1994, $84,000 in 1993 and $50,000 in 1992, for the utility program.\nBeginning in 1981, the Company continued its search for gas and oil discoveries through Laclede Energy Resources, Inc. (LER), a wholly owned, non-utility subsidiary, which is the general partner in LIMA RESOURCES ASSOCIATES, a limited partnership in which Laclede Energy Resources, Inc. holds a 39.6% interest. LIMA has four limited partners, three of which are subsidiaries of gas transportation and\/or distribution companies, each holding an interest of 19.8%. The remaining limited partner, a stock brokerage firm, has a 1.0% interest.\nLaclede's non-utility exploratory drilling program to date has involved participation in drilling a total of 92 wells. Fifty of these wells were successfully completed after testing commercial quantities of hydrocarbon reserves. Forty-two wells were plugged and abandoned. The investment in the program changed only slightly during 1994, 1993 and 1992. Presently, Laclede is not actively seeking new gas and oil exploration discoveries through LIMA, or otherwise.\nREGULATORY MATTERS\nThe implementation of unbundled services on MRT's system, pursuant to FERC Order 636, necessitated a change in Laclede's Purchased Gas Adjustment Clause (PGA). Accordingly, on October 1, 1993, Laclede filed a revised PGA clause with the Missouri Public Service Commission (MoPSC) to enable the Company to continue to flow through to its customers any increases or decreases in the Company's cost of purchased gas. The MoPSC approved such filing on October 29, 1993.\nThe Company is currently involved in a proceeding before the MoPSC regarding the operation of PGA clauses. The Company expects that its operation of the PGA clause will be reviewed in the context of the changed environment in which the Company and other local distributors are required to buy their gas from unregulated producers and marketers instead of from the formerly regulated interstate pipelines.\nThe cost of buying natural gas at the wellhead and the associated cost of transporting it to the St. Louis area account for about 60% of Laclede's total operating costs. Thus, the Commission's proceeding concerning the PGA clause is of vital importance for the future. Laclede is doing everything possible to see to it that any modifications in the PGA will not restrict the Company's ability to promptly adjust rates to reflect changes in wholesale gas costs.\nThe new system, with its requirement that local distributors obtain their own gas supplies and arrange for all required storage and pipeline transportation services, imposes a much greater degree of risk and responsibiltiy upon the gas distributor and relieves the interstate gas pipeline company of a similar risk and responsibility. Laclede believes that regulatory commissions throughout the nation should take into account this change in risk in setting the permissible rate of return allowed to the gas distribution companies which they regulate.\nAs previously reported, MRT asked the FERC in October 1992 to approve higher rates for its bundled gas sales service, as well as for the use of its separate gas transportation and gas storage services. In April 1993, MRT was able to put the proposed new rates into effect, subject to refund to the extent not fully approved by the FERC. Then, in July 1994, the FERC approved a settlement that eliminated virtually all of MRT's proposed rate increase and brought Laclede refunds of almost $10 million, which the Company had paid MRT while the higher rates were in effect. These refunds are being passed through to Laclede's customers.\nThe settlement also resolved a dispute over MRT's transition costs involved in the FERC-ordered restructuring of the gas pipeline industry. With Laclede and other gas distributors now purchasing their gas supplies directly from producers and marketers, MRT has had to buy out certain long- term gas supply contracts that the pipeline company entered into when it had an obligation to provide Laclede and its other customers with their supplies\nof gas. In order to carry out the restructuring without loss to the pipeline companies, the FERC is allowing them to recover from their customers the costs of their contract buyouts. As part of the July 1994 rate case settlement, MRT agreed not to seek recovery from Laclede and its other customers of about 11% of the amount originally proposed to cover its gas supply transition costs.\nIn June 1994, Laclede's persistent efforts to resolve a long-standing dispute with United Gas Pipe Line Company (United), the former leading supplier of gas to MRT, resulted in a settlement, which brought Laclede and its customers refunds of $8 million. The case, which had been pending for years before FERC and the U.S. Court of Appeals in Washington, D.C., began when Laclede sought refunds arising out of a 1985 United rate case and certain questionable gas accounting practices of United. The refunds were paid to Laclede by the successor corporation of United, the Koch Gateway Pipeline Company.\nIn January 1994, Laclede filed new rates with the MoPSC seeking a general rate increase of $27.1 million annually. The Commission suspended those rates from becoming effective and entered into a rate case investigation and hearings thereon. In July 1994, a settlement was reached among the Commission Staff, Laclede and the other parties who had intervened in the rate case. This settlement was approved by the MoPSC on August 23, 1994. Under the settlement, Laclede was permitted to file rates to become effective September 1, 1994, which are designed to increase the Company's revenues by $12.2 million annually. Laclede accepted the settlement believing the lower amount preferable to further litigation and delays in obtaining the much-needed rate relief. A major part of the increase was a $1.50 per month increase in the Company's customer charge, a flat monthly charge applicable to the bills of all customers. This will make the major portion of the increase granted the Company less subject to the impact of higher gas rates on low-income customers, many of whom live in poorly insulated houses.\nOTHER PERTINENT MATTERS\nThe business of the Company is subject to a seasonal fluctuation with the peak period occurring in the winter season.\n*****\nAs of September 30, 1994, the Company had 2,151 employees, which includes 2 part-time employees. *****\nThe Company has a labor agreement with Locals 5-6 and 5-194 of the Oil, Chemical and Atomic Workers International, two unions which represent most of the Company's employees. On June 28, 1994, Company and Union representatives signed a new three-year labor agreement replacing the prior agreement which was to expire July 31, 1994. The new contract extends through July 31, 1997. The settlement provides for wage increases of 3.5% in the first year, 3.25% the second year, and 3.25% the third year. Other employee benefit improvements will be effected during the three-year term.\n*****\nThe Company's business has monopoly characteristics in that it is the only distributor of natural gas within its (franchised) service area. The principal competition is the local electric company. Other competitors in Laclede's service area include two major suppliers of fuel oil, a major supplier of coal, numerous suppliers of liquefied petroleum gas in outlying areas, and in a portion of downtown St. Louis, a district steam system. Gas for househeating, certain other household uses, and commercial and industrial space heating is now being sold by Laclede at prices generally lower than are charged for competitive fuels and other energy forms. Coal is competitive as a fuel source for very large boiler plant loads, but environmental concerns have forestalled any significant market inroads. Oil and propane can be used to fuel boiler loads and certain direct-fired process applications, but these fuels vary widely in price throughout the year, thus limiting the competitiveness of these fuels. In certain cases, district steam has been competitive with gas for downtown area heating users. In the past five years, Laclede has converted 53 steam customers representing approximately 2.1 million annual therms.\nLaclede's residential, commercial, and small industrial markets, representing 90% of sales, remain committed to gas. The Company knows of no reason why natural gas should not continue generally to have a price advantage over electricity and other forms of energy in the foreseeable future. The Company's exposure to price competition is not presently a substantial factor and exists primarily in the large industrial and commercial boiler fuel market where coal is the competing form of energy.\nLaclede offers gas transportation service to its large user industrial and commercial customers. The tariff approved for that type of service produces a margin similar to that which Laclede would have received under its regular sales rates. The availability of gas transportation service and favorable spot market prices for natural gas during certain times of the year may offer additional competitive advantages to Laclede and new opportunities for cogeneration and large tonnage air conditioning applications.\n*****\nThe Company is subject to various laws and regulations relating to the environment, which thus far have not had a material effect on the Company's financial position and results of operations. Prior to the widespread availability of natural gas, the Company operated various manufactured gas plants, the last of which was closed in 1961. The process for manufacturing gas produced by-products and residuals, including hydrocarbons such as lamp black and coal tar. Certain remnants of these residuals are typically found at former gas manufacturing sites. The United States Environmental Protection Agency (EPA) has been engaged in a survey of a large number of former manufactured gas plant sites across the nation.\nIn this regard, the Company and the EPA have determined that manufactured gas residuals are present at one of the former manufactured gas plant sites operated by the Company. While no conclusion has been reached as to the extent of any remedial action that will be required, the Company and the EPA have entered into an Administrative Order on Consent (AOC), effective March 31, 1994, with regard to this site. The AOC provides for the Company to conduct certain investigative activities (i.e., a removal site evaluation and an engineering evaluation cost analysis), and to reimburse the EPA for response costs under the AOC. The AOC requires only investigations and does not cover any removal action. If remedial action is necessary, then a\nsubsequent order will cover such action. Based on currently available information, management believes that the costs of the foregoing investigations, response costs of the EPA in overseeing such investigations, and other associated legal and engineering consulting costs are likely to approximate $380,000. At September 30, 1994, $135,000 has been paid and a liability of $245,000 remains to cover future payments.\nThe Company is presently unable to evaluate and quantify further the scope or cost of any environmental response activity. However, the Company has notified its insurers that the Company intends to seek reimbursement from them of its investigation, remediation, clean-up and defense costs in regard to the foregoing. In addition to pursuing insurance proceeds to the extent feasible, the Company also plans to seek recovery, if practicable, from any other potentially responsible parties.\nAn environmental cost deferral procedure was established by the Missouri Public Service Commission in the Company's recent rate case, effective September 1, 1994, for use by the Company in applying for appropriate rate recovery of various investigation, remediation and other costs to be incurred by the Company in connection with former manufactured gas plant sites. The authorization to begin deferring such costs shall only be triggered to the extent that the cumulative liability incurred by the Company during the deferral period is not offset by the cumulative costs of $250,000 per year reflected in the Company's current rates. In the event the cumulative liability incurred by the Company for such costs during the deferral period is less than the cumulative amount of such annualized costs reflected in the rates approved in the settlement, then the Company shall refund the difference. The above authorization will become null and void if the Company does not file for a general rate increase by September 1, 1996, and, in any event, the recovery of costs deferred thereunder is subject to challenge in future rate cases.\n*****\nAt the Annual Meeting held on January 27, 1994, the Company's share owners approved an amendment which increased the authorized common stock to 50,000,000 shares with a new par value of $1.00 per share and reclassified the par value of the outstanding common stock from $2.00 to $1.00 per share. These changes were approved in connection with a 2-for-1 stock split authorized by the Board of Directors which became effective February 11, 1994.\nShare owners approved an amendment to the Company's Dividend Reinvestment Plan at the January 27, 1994 meeting to permit cash purchases of common stock through the Plan, with a minimum purchase of $100 per calendar quarter up to a maximum purchase of $30,000 per calendar year. The amendement also provides for the issuance of common shares by the Company to provide shares purchased under the Plan. The Company filed a Registration Statement for the Plan with the Securities and Exchange Commission on February 22, 1994. During fiscal 1994, 83,561 shares were issued under the Company's Dividend Reinvestment and Stock Purchase Plan.\n*****\nCustomers and revenues contributed by each class of customers for the last three fiscal years are as follows:\n*****\nThe Company has, or in one instance is seeking renewal of, franchises having initial terms varying from five years to indefinite duration. All of the franchises are free from unduly burdensome restrictions. The foregoing are adequate for the conduct of its public utility business in the State of Missouri as now conducted.\n*****\nLaclede Investment Corporation, a wholly owned subsidiary, invests in other enterprises and has made loans to several joint ventures engaged in real estate development.\nLaclede Energy Resources, Inc., a wholly owned subsidiary of Laclede Investment, engaged in the exploration and development of oil and gas properties on a non-utility basis. Exploration and development projects were conducted through LIMA RESOURCES ASSOCIATES, a limited partnership. As general partner, Laclede Energy Resources has a 39.6% interest in LIMA. Laclede Energy is not presently actively seeking new gas and oil exploration discoveries through LIMA, or otherwise.\nLaclede Gas Family Services, Inc., a wholly owned subsidiary of Laclede Energy Resources, Inc., is a registered insurance agency in the State of Missouri. It is currently promoting the sale of supplemental hospital- ization, accident, supplemental medicare and life insurance by Life Insurance Company of North America, Washington National Insurance Company and Fidelity Security Life Insurance Company.\nLaclede Development Company, a wholly owned subsidiary, is engaged in participation in real estate development, primarily through joint ventures. In December 1987, Laclede Development made an investment of $5.8 million in a 10.25%, 16-year convertible debenture issued by Germania Bank, a St. Louis-based federal savings institution. The debenture permitted conversion into 577,000 common shares of Germania stock at $10 per share. On June 22, 1990, government regulators placed Germania Bank in conservatorship, and appointed the Resolution Trust Corporation (RTC) as Conservator for the Bank. The Company recorded, in fiscal 1990, a provision for the possible write-off of this investment. In September 1992, Laclede learned that a former senior executive of Germania Bank had pleaded guilty to participating in a criminal conspiracy to defraud former bank investors, including Laclede. On September 18, 1992, Laclede filed a lawsuit in the U. S. District Court for the Eastern District of Missouri against the executive and against the RTC, as Receiver for Germania, alleging that Germania engaged in fraud, negligent misrepresentation, breach of contract, and violation of securities law by establishing inadequate loan loss reserves and withholding information in this regard from Laclede, and that the RTC had knowledge of the actionable wrong-doing but did not disclose to Laclede its existence, nature, extent or substance. On November 19, 1992, criminal indictments were issued in Missouri and Illinois charging fraud by certain additional former Germania senior executives, and, based upon such indictments, Laclede promptly amended its lawsuit to name such additional persons as defendants. On November 10, 1993, the jury in the Illinois criminal trial found the two senior executives who were indicted in Illinois guilty on all charges. Laclede Development's civil suit was transferred to the U.S. District Court for the Southern District of Illinois. The RTC and other defendants have vigorously contested Laclede's civil suit.\nLaclede Venture Corp., a wholly owned subsidiary of Laclede Development Company has a 28.5% interest in the LBP Partnership, a general partnership. LBP was engaged in research and development of light beam profiling technology for the production of portrait sculpture and for use in other applications. After conducting market testing, LBP decided to cease its efforts to exploit the portrait sculpture application of this technology. A third party has been licensed to look into the possibility of further development of the technology for non-portrait sculpture applications, but LBP is not presently earning or receiving any compensation from any such licensing or development.\nThe lines of business which constitute the non-utility activities of the corporate family are not considered significant as defined.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal utility properties of Laclede consist of approximately 7,352 miles of gas main and related service pipes, meters and regulators. Other physical properties include regional office buildings and holder stations. Extensive underground gas storage facilities and equipment are located in an area in North St. Louis County extending under the Missouri River into St. Charles County. Substantially all of the Company's utility plant is subject to the liens of its mortgage.\nAll of the utility properties of Laclede are held in fee or by easement or under lease agreements. The principal lease agreements include underground storage rights which are of indefinite duration and the general office building. The current lease on the general office building extends through February 2000 with options to renew for up to 20 additional years.\nLaclede Gas Company jointly owns oil and gas properties in Texas, Oklahoma and Louisiana.\nThe non-utility properties of Laclede do not constitute a significant portion of the properties of the Company.\nItem 3.","section_3":"Item 3. Legal Proceedings\nFor a discussion of environmental matters, see Part I, Item 1, Business, Other Pertinent Matters.\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.\nEXECUTIVE OFFICERS OF REGISTRANT Name, Age, and Position with Company Appointed (1)\nR. C. Jaudes, Age 60 Chairman, President and Chief Executive Officer January 27, 1994 President and Chief Executive Officer August 1, 1991 President and Chief Operating Officer October 1, 1990 Executive Vice President - Operations and Marketing July 1, 1989\nH. Elliott, Jr., Age 61 Senior Vice President - Administrative Services January 23, 1992 Vice President - Administration January 27, 1977\nD. L. Godiner, Age 61 Senior Vice President - General Counsel and Secretary January 24, 1991 Vice President - General Counsel and Secretary September 1, 1990 Vice President and General Counsel January 22, 1981\nR. J. Carroll, Age 57 Senior Vice President - Finance and Chief Financial Officer January 27, 1994 Vice President - Finance and Chief Financial Officer January 23, 1992 Vice President and Controller January 24, 1991 Assistant Vice President - Accounting January 28, 1988\nJ. G. Hofer, Age 57 Vice President - Operations July 1, 1992 (Superintendent of Operations) July 1, 1991 (Chief Engineer - Director of Support Services) February 1, 1991 (Superintendent - Engineering and Support Services) April 1, 1988\nR. M. Lee, Age 53 Senior Vice President - Marketing January 27, 1994 Vice President - Marketing January 22, 1987\nM. E. McMillian, Age 48 Vice President - Human Resources September 22, 1983\nG. T. McNeive, Age 52 Vice President - Associate General Counsel January 27, 1994 Assistant Vice President - Associate General Counsel September 1, 1992 (Associate General Counsel) August 1, 1986\nJ. Moten, Jr., Age 53 Vice President - Community Relations January 27, 1994 (Director of Community Affairs\/Conservation) November 1, 1986\nK. J. Neises, Age 53 Senior Vice President - Federal Regulatory Affairs January 27, 1994 Vice President - Federal Regulatory Affairs October 27, 1988\nP. J. Palumbo, Age 49 Vice President - Industrial Relations September 1, 1992 (Director of Industrial Relations) (2) January 7, 1991\nD. H. Yaeger, Age 45 Senior Vice President - Operations, Gas Supply and Technical Services January 27, 1994 Vice President - Operations, Gas Supply and Technical Services September 1, 1992 Vice President - Planning (3) December 1, 1990\nV. O. Steinberg, Age 56 Vice President - Treasurer and Assistant Secretary January 27, 1994 Treasurer and Assistant Secretary September 1, 1990 Assistant Secretary-Treasurer September 28, 1978\n( ) Indicates a non-officer position. (1) Officers of Laclede Gas Company are normally reappointed at the Annual Meeting of the Board of Directors in January of each year \"to serve for the ensuing year and until their successors are elected and qualify\". (2) Mr. Palumbo served as Senior Vice President - Resource Management at Peabody Development Company from 1985 through 1990. (3) Mr. Yaeger served as Executive Vice President of Arkla Energy Marketing company from April 1990 through November 1990; and prior to that he was employed at Mississippi River Transmission Corporation as its Vice President - Marketing from September 1982 to July 1986; Senior Vice President - Marketing from July 1986 to April 1988; and Executive Vice President from April 1988 through April 1990.\nPart II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Share Owner Matters\nThe Company's common stock is listed on the New York Stock Exchange and the Chicago Stock Exchange. At September 30, 1994, there were 11,564 holders of record of the Company's common stock.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\nEarnings applicable to common stock for the fiscal year ended September 30, 1994 were $22.1 million, compared with $25.1 million for 1993 and $18.2 million for 1992. Earnings per share of common stock based on average shares outstanding were $1.42 in 1994, compared with $1.61 in 1993 and $1.17 in 1992, restated to reflect the 2-for-1 stock split effective February 11, 1994. The $.19 per share decrease in fiscal 1994 (from fiscal 1993) was primarily due to increases in the costs of doing business and decreased sales volumes arising from warmer weather. These decreases were partially offset by the one-month benefit of a general rate increase effective September 1, 1994, designed to increase revenues by $12.2 million on an annual basis. The $.44 per share increase in earnings in fiscal 1993 (over fiscal 1992) was principally due to higher sales arising from colder weather. Increases in the costs of doing business were essentially offset by the benefit of the Company's general rate increase, which was placed in effect September 1, 1992. Weather in the metropolitan St. Louis area was 1% warmer than normal in 1994, 2% colder than normal in 1993, and 15% warmer than normal in 1992.\nUtility operating revenues for fiscal year 1994 increased $20.0 million, or 4.0%, above fiscal 1993, and 1993 increased $85.7 million, or 20.5%, above fiscal 1992. The 1994 increase was due to higher wholesale gas costs of $21.3 million (which are passed on to customers in accordance with the Purchased Gas Adjustment Clause) and increased revenues arising from the general rate increase effective September 1, 1994 of $.9 million. These increases were partially offset by lower therms sold and transported (principally due to the warmer weather) and other variations netting to $2.2 million. The 1993 increase in revenues, compared with 1992, was largely due to higher therms sold (reflecting the significantly colder weather) and minor factors totalling $34.1 million, higher PGA levels of $38.4 million, and increased revenues arising from the general rate increase effective September 1, 1992 of $13.2 million. Therms sold and transported for 1994 were 1,070.1 million compared with 1,080.1 million in 1993 and 971.5 million in 1992.\nUtility operating expenses increased $22.7 million, or 4.9%, in fiscal 1994, and 1993 increased $77.4 million, or 20.0%, above fiscal 1992. Natural and propane gas expense increased $17.5 million in 1994 reflecting higher natural gas prices, partially offset by reduced volumes required for sendout. In 1993, natural and propane gas expense increased $55.5 million due to increased volumes purchased for sendout and higher natural gas prices. Other operation and maintenance expenses increased $5.5 million, or 5.7%, in 1994 mainly due to increased pension expense of $5.9 million, reflecting the effect of recognition in fiscal 1993 of gains arising from significant lump-sum settlements (no such gains were recognized during fiscal 1994) coupled with higher net pension costs this fiscal year. This increase was partially offset by several changes netting to a $.4 million reduction in expense. These include a lower provision for uncollectibles, reduced group insurance expenses, and other reductions in expense; the benefits of which were largely offset by increased expense resulting from the adoption of Statement of Financial Accounting Standard (SFAS) No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions\",\nincreased maintenance requirements, and higher contract wage rates. In 1993, other operation and maintenance expenses increased 9.9% reflecting increased group insurance charges, higher distribution and maintenance charges, increased wage rates, and other increases in the costs of doing business. Depreciation and amortization expense increased 3.4% in 1994 and 3.7% in 1993 primarily as a result of additional depreciable property. Taxes, other than income taxes, increased 3.8% in 1994 principally due to higher gross receipts taxes (reflecting increased revenues). In 1993, taxes, other than income taxes, increased 16.2% primarily due to higher gross receipts taxes and increased property taxes. The variations in income tax expense are mainly due to changes in income, and as a result of tax adjustments recorded in 1993 related to prior years.\nMiscellaneous income and income deductions (net of applicable income tax expense) in 1994 were essentially the same as 1993, while 1993 was $.8 million lower than 1992 reflecting lower interest income on temporary cash investments.\nInterest expense increased by 1.1% in fiscal 1994 primarily due to increased short-term debt, largely offset by reduced interest on long-term debt (reflecting the benefit of redemptions of First Mortgage Bonds totalling $51.7 million in fiscal 1993 and $12.0 million in fiscal 1994, partially offset by the effect of the issuance of $40 million of 7-1\/2% First Mortgage Bonds in November 1992 and $25 million of 6-1\/4% First Mortgage Bonds in May 1993). The fiscal 1993 increase in interest expense was primarily due to the aforementioned First Mortgage Bond issues, partially offset by the effect of redemptions in 1992 and 1993.\nOn June 28, 1994, Company and Union representatives signed a new three-year labor agreement replacing the prior agreement which was to expire July 31, 1994. The new contract extends through July 31, 1997. The settlement resulted in wage increases of 3.5% in the first year, 3.25% the second year, and 3.25% the third year. Other employee benefit improvements will be effected during the three-year term.\nOn January 14, 1994, the Company filed a request with the Missouri Public Service Commission (MoPSC) seeking a general rate increase of $27.1 million annually. This filing culminated in a settlement, approved by the MoPSC on August 22, 1994, providing the Company an annual increase in revenues of $12.2 million effective September 1, 1994. The Company's last general rate increase was effective on September 1, 1992, and amounted to $13.5 million per year.\nAccounting Changes\nThe Company implemented SFAS No. 109, \"Accounting for Income Taxes\", effective October 1, 1993, without restating previously issued financial statements. SFAS No. 109 prescribes the liability method of accounting for income taxes, which required the Company to recognize additional deferred tax assets and liabilities for certain temporary differences and to adjust deferred tax accounts for changes in income tax rates.\nSFAS No. 109 had no effect on the Company's cash flows or results of operations due to the effect of rate regulation. Substantially all of the adjustments required by SFAS No. 109 were recorded to deferred tax balance\nsheet accounts, with offsetting adjustments to regulatory assets and liabilities. At October 1, 1993 the cumulative effect of adopting SFAS No. 109 was an increase in net deferred tax liabilities of $30.2 million, and recognition of a regulatory asset of $30.2 million.\nIn the first quarter of fiscal year 1994, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions (OPEB)\". In its 1992 rate case, the Company was authorized by the MoPSC to recover OPEB on a pay-as-you-go basis and to defer the difference as a regulatory asset. However, a regulatory asset was not recorded since it did not meet the more stringent accounting criteria subsequently established in the 1993 Emerging Issues Task Force consensus. In July 1994, a new state law was enacted which requires SFAS No. 106 accrued costs to be recognized for ratemaking purposes provided that such costs are funded through an independent, external funding mechanism. The approved settlement of the Company's 1994 rate case included recovery of such costs, effective September 1, 1994. The Company is in the process of establishing funding mechanisms which comply with the new law and the terms of the settlement.\nIn November 1992, the FASB issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\", which will require the Company to accrue the estimated future cost of providing postemployment benefits to former or inactive employees after employment but before retirement. Adoption of SFAS No. 112 is required in fiscal year 1995. The Company does not expect the adoption of SFAS No. 112 to have a material effect on the Company's financial position or results of operations.\nInflation\nThe accompanying Financial Statements reflect the historical costs of events and transactions, regardless of the purchasing power of the dollar at the time. Due to the capital intensive nature of the Company's business, the most significant impact of inflation is on the Company's depreciation of utility plant. Rate regulation to which the Company is subject allows recovery through its rates of only the historical cost of utility plant as depreciation. While no plans exist to undertake other than normal replacements of plant in service, the Company believes that any higher costs experienced upon replacement of existing facilities would be recovered through the normal regulatory process.\nLiquidity and Capital Resources\nCash flow from operations, net of dividend payments, has generally provided the principal liquidity to meet operating requirements and to fund a significant portion of the Company's construction program. Any remaining funding requirement for construction or for other needs has been provided by long-term and short-term financing. The issuance of long-term financing is dependent on management's evaluation of need, financial market conditions, and other factors. Short-term financing is used to meet seasonal cash requirements and\/or to defer long-term financing until market conditions are favorable.\nShort-term borrowing requirements typically peak during colder months, principally because of required payments for natural gas made in advance of\nthe receipt of cash from our customers for the sale of that gas. Such short-term cash requirements have traditionally been met through the sale of commercial paper supported by lines of credit with banks. In January 1994, the Company renewed its primary line of bank credit under which it may borrow up to $40 million prior to January 31, 1995, with renewal of any loans outstanding on that date permitted up to June 30, 1995. This primary line of credit contained short-term step-up provisions providing an additional $15 million of credit to January 27, 1994 and an additional $5 million to February 28, 1994 which helped cover peak requirements during those two months. The Company anticipates renewal of this primary line of $40 million in January 1995. Additionally, beginning October 18, 1993, the Company obtained a supplemental line of credit varying from $20 million to $40 million through October 17, 1994 and $70 million from October 18, 1994 to March 1, 1995. Thus, at this writing, the total line of credit for the 1994-1995 heating season is $110 million, compared with a maximum of $95 million during the 1993-1994 heating season. The Company anticipates that the supplemental line will be reduced after March 1, 1995, since seasonal cash needs typically decline significantly at the end of the heating season. Short-term borrowings outstanding at September 30, 1994 were $53.5 million.\nOn April 13, 1993, the Company filed a Registration Statement with the Securities and Exchange Commission (SEC) in connection with the sale of up to $100 million of First Mortgage Bonds. The Registration Statement was approved by the SEC and became effective for a two-year period commencing April 21, 1993. The Company issued $25 million of First Mortgage Bonds in May 1993 (the proceeds of which were used to redeem outstanding higher cost debt) and has $75 million remaining related to this Registration Statement. In a further effort to take advantage of lower interest rates, the Company also redeemed $12 million of 7-1\/2% First Mortgage Bonds in November 1993. These bonds were originally scheduled to mature in 1997. The amounts, timing, and types of future financings issued by the Company will depend on cash requirements, market conditions, and other factors.\nAt the Annual Meeting held on January 27, 1994, the Company's share owners approved an amendment which increased the authorized common stock to 50,000,000 shares with a new par value of $1.00 per share and reclassified the par value of the outstanding common stock from $2.00 to $1.00 per share. These changes were approved in connection with a 2-for-1 stock split authorized by the Board of Directors which became effective February 11, 1994.\nShare owners approved an amendment to the Company's Dividend Reinvestment Plan at the January 27, 1994 meeting to permit cash purchases of common stock through the Plan and the issuance by the Company of common stock under the Plan. The Company filed a Registration Statement for the Plan with the Securities and Exchange Commission on February 22, 1994. The Missouri Public Service Commission granted the necessary approvals of the stock split and Plan amendments by order dated January 4, 1994. During the last two quarters of fiscal 1994, 83,561 shares were issued under the Company's Dividend Reinvestment and Stock Purchase Plan. Total shares outstanding were 15,670,023 at September 30, 1994.\nConstruction expenditures for utility purposes were $39.2 million in fiscal 1994 compared with $40.9 million in fiscal 1993 and $44.7 million in fiscal 1992. Fiscal 1992 expenditures were abnormally high compared to other years mainly due to completion of construction of a 26-mile transmission line from Washington, Missouri to Ellisville, Missouri.\nThe Company is subject to various laws and regulations relating to the environment, which thus far have not had a material effect on the Company's financial position and results of operations. Prior to the widespread availability of natural gas, the Company operated various manufactured gas plants, the last of which was closed in 1961. The process for manufacturing gas produced by-products and residuals, including hydrocarbons such as lamp black and coal tar. Certain remnants of these residuals are typically found at former gas manufacturing sites. The United States Environmental Protection Agency (EPA) has been engaged in a survey of a large number of former manufactured gas plant sites across the nation.\nIn this regard, the Company and the EPA have determined that manufactured gas residuals are present at one of the former manufactured gas plant sites operated by the Company. While no conclusion has been reached as to the extent of any remedial action that will be required, the Company and the EPA have entered into an Administrative Order on Consent (AOC), effective March 31, 1994, with regard to this site. The AOC provides for the Company to conduct certain investigative activities (i.e., a removal site evaluation and an engineering evaluation cost analysis), and to reimburse the EPA for response costs under the AOC. The AOC requires only investigations and does not cover any removal action. If remedial action is necessary, then a subsequent order will cover such action. Based on currently available information, management believes that the costs of the foregoing investigations, response costs of the EPA in overseeing such investigations, and other associated legal and engineering consulting costs are likely to approximate $380,000. At September 30, 1994, $135,000 has been paid and a liability of $245,000 remains to cover future payments.\nThe Company is presently unable to evaluate and quantify further the scope or cost of any environmental response activity. However, the Company has notified its insurers that the Company intends to seek reimbursement from them of its investigation, remediation, clean-up and defense costs in regard to the foregoing. In addition to pursuing insurance proceeds to the extent feasible, the Company also plans to seek recovery, if practicable, from any other potentially responsible parties.\nAn environmental cost deferral procedure was established by the Missouri Public Service Commission in the Company's recent rate case, effective September 1, 1994, for use by the Company in applying for appropriate rate recovery of various investigation, remediation and other costs to be incurred by the Company in connection with former manufactured gas plant sites. The authorization to begin deferring such costs shall only be triggered to the extent that the cumulative liability incurred by the Company during the deferral period is not offset by the cumulative costs of $250,000 per year reflected in the Company's current rates. In the event the cumulative liability incurred by the Company for such costs during the deferral period is less than the cumulative amount of such annualized costs reflected in the rates approved in the settlement, then the Company shall refund the difference. The above authorization will become null and void if the Company does not file for a general rate increase by September 1, 1996, and, in any event, the recovery of costs deferred thereunder is subject to challenge in future rate cases.\nOn April 8, 1992, the Federal Energy Regulatory Commission (FERC) issued Order No. 636 which adopted its final rule to restructure the Nation's natural gas pipelines and the services they provide. Under the final rule,\nthe FERC is requiring natural gas pipelines to offer unbundled, or separate, transportation and storage services and to eliminate their bundled merchant sales and transportation service under which gas was sold to local distribution companies at the city gate. The Company's long-term gas supply contract with Mississippi River Transmission Corporation (MRT) was terminated on November 1, 1993, and replaced with an agency agreement. Under such new agreement, the Company will acquire its own gas supplies and MRT will administer all functions necessary to deliver the gas to the Company. Pursuant to this new arrangement, the Company has entered into long-term and short-term gas supply arrangements with more than 17 suppliers, so as to provide adequate supplies for the foreseeable future. The Company's PGA Clause has been revised to continue to flow through to its customers increases and decreases in the Company's cost of purchased gas, as such costs are incurred under the new Order No. 636 supply arrangements.\nCapitalization at September 30, 1994, excluding current redemption requirements of long-term debt, consisted of 55.5% common stock equity, .6% preferred stock and 43.9% long-term debt. The Company's outstanding First Mortgage Bonds are rated AA- by Fitch, Aa3 by Moody's, and AA- by Standard & Poor's.\nThe Company's ratio of earnings before taxes to interest charges was 3.1 for 1994, 3.5 for 1993 and 2.7 for 1992.\nIt is management's view that the Company has adequate access to capital markets and will have sufficient capital resources both internal and external to meet anticipated capital requirements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINDEPENDENT AUDITORS' REPORT\nWe have audited the accompanying consolidated balance sheets and statements of consolidated capitalization of Laclede Gas Company and its subsidiary companies as of September 30, 1994 and 1993, and the related statements of consolidated income, retained earnings, 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 Part IV, 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 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 Laclede Gas Company and its subsidiary companies as of 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 Notes 1 and 2 to the consolidated financial statements, effective October 1, 1993, Laclede Gas Company and its subsidiary companies changed their method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109 and changed their method of accounting for postretirement benefits other than pensions to conform with Statement of Financial Accounting Standards No. 106.\nDeloitte & Touche LLP St. Louis, Missouri November 17, 1994\nMANAGEMENT REPORT\nManagement is responsible for the preparation, presentation and integrity of the consolidated financial statements and other financial information in this report. The statements were prepared in conformity with generally accepted accounting principles and include amounts that are based on management's best estimates and judgments. In the opinion of management, the financial statements fairly reflect the Company's financial position, results of operations and cash flows.\nThe Company maintains internal accounting systems and related administrative controls that are designed to provide reasonable assurance, on a cost effective basis, that transactions are executed in accordance with management's authorization, that consolidated financial statements are prepared in conformity with generally accepted accounting principles, and that the Company's assets are properly accounted for and safeguarded. The Company's Internal Audit Department, which has unrestricted access to all levels of Company management, monitors compliance with established controls and procedures.\nDeloitte and Touche LLP, the Company's independent auditors, whose report is contained herein, are responsible for auditing the Corporation's financial statements in accordance with generally accepted auditing standards. Such standards include obtaining an understanding of the internal control structure in order to design the audit of the financial statements.\nThe Audit Committee of the Board of Directors, which consists of six outside directors, meets periodically with management, the internal auditor, and the independent auditors to review the manner in which they are performing their responsibilities. Both the internal auditor and the independent auditors periodically meet alone with the Audit Committee and have access to the Audit Committee at any time.\nRobert C. Jaudes - ------------------------------------- Chairman of the Board, President and Chief Executive Officer\nRobert J. Carroll - ----------------------------------- Senior Vice President- Finance and Chief Financial Officer\nItem 8. Financial Statements and Supplementary Data\nNOTES TO FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\nBasis of Consolidation - The consolidated financial statements include the accounts of the Laclede Gas Company and its subsidiary companies (Company). The net operating results of the Company's non-utility subsidiaries, all of which are wholly owned, are included under the caption \"Miscellaneous Income and Income Deductions - Net\" in the Statements of Consolidated Income. Revenues from non-utility subsidiaries are insignificant. All appropriate intercompany transactions have been eliminated.\nSystem of Accounts - The accounts of the Company are maintained in accordance with the uniform system of accounts prescribed by the Missouri Public Service Commission (MoPSC), which system substantially conforms to that prescribed by the Federal Energy Regulatory Commission.\nUtility Plant, Depreciation and Amortization - Utility plant is stated at original cost. The cost of additions to utility plant includes contracted work, direct labor and materials, allocable overheads, and an allowance for funds used during construction. The costs of units of property retired, replaced, or renewed are removed from utility plant and such costs, plus removal costs, less salvage are charged to accumulated depreciation. Maintenance and repairs of property and replacement and renewal of items determined to be less than units of property are charged to operating expenses. Utility plant, excluding exploration and development, is depreciated on the straight-line basis at rates based on estimated service lives of the various classes of property. Annual depreciation in 1994, 1993 and 1992 averaged approximately 2.8% of the original cost of depreciable property. In August 1994, the MoPSC approved a settlement agreement which authorized a net increase in depreciation rates for the Company effective on September 1, 1994.\nGas Stored Underground - Inventory of gas in storage is priced on a last-in, first-out (LIFO) basis. The replacement cost of gas stored underground for current use at September 30, 1994 was less than the LIFO cost by $8,437,000, and at September 30, 1993, exceeded the LIFO cost by $3,354,000. The inventory carrying value has not been reduced to market prices because, pursuant to the Company's Purchased Gas Adjustment Clause, actual gas costs are recovered in customer rates.\nOil & Gas Exploration and Development - The Company uses the full cost method of accounting for utility exploration and development costs as ordered by the Missouri Public Service Commission. Under the full cost method, all exploration and development costs of productive and non- productive wells are capitalized. Such costs are charged to expense based on oil and gas produced in relation to total estimated recoverable reserves. Depreciation and amortization charges amounted to $812,000 in 1994, $1,213,000 in 1993 and $1,125,000 in 1992.\nOperating Revenues - The Company records revenues from gas sales and transportation service on the accrual basis which includes estimated amounts for gas delivered, where applicable, but not yet billed.\nPurchased Gas Adjustments and Deferred Account - Pursuant to the provisions of the Company's Purchased Gas Adjustment (PGA) Clause, increases or decreases in gas costs are passed on to its customers. The difference between actual costs incurred and costs recovered through the application of the PGA is reflected as a deferred charge or credit until September 30, at which time the balance is classified as a current asset or liability and is recovered from or credited to customers over an annual period commencing in November. The balance in the current account is amortized as amounts are reflected in customer billings.\nIncome Taxes - The Company has elected, for tax purposes only, various accelerated depreciation provisions of the Internal Revenue Code. In addition, intangible drilling and unsuccessful exploration costs, and certain other costs are expensed currently for tax purposes while being deferred for book purposes. The provision for current income taxes reflects the tax treatment of these items. The Company adopted Statement of Financial Accounting Standard (SFAS) No. 109, \"Accounting for Income Taxes\" effective October 1, 1993. SFAS No. 109 requires the establishment of deferred tax liabilities and assets, as measured by enacted tax rates, for the net tax effects of all temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes, and the amounts used for income tax purposes. Substantially all of the adjustments required by SFAS No. 109 were recorded to deferred tax balance sheet accounts, with the corresponding adjustments to regulatory assets and liabilities. At October 1, 1993, the cumulative effect of adopting SFAS No. 109 was an increase in net deferred tax liabilities of $30,200,000, and recognition of a regulatory asset of $30,200,000. The adoption of this standard did not have an impact on the Company's cash flows or results of operations due to the effect of rate regulation. In 1993 and 1992, the Company accounted for income taxes in accordance with the provisions of Accounting Principles Board Opinion No. 11. The benefit of investment tax credits utilized prior to 1986 has been deferred and is being amortized over the useful life of the related property for financial statement purposes.\nCash and Cash Equivalents - For the purpose of the statements of cash flows, the Company considers all highly liquid debt instruments purchased, which generally have a maturity of three months or less, to be cash equivalents. Such instruments are carried at cost, which approximates market value.\nReclassification - Certain prior-year amounts have been reclassified to conform to current-year presentation.\n2. Pension Plans and Other Postemployment Benefits\nThe Company has non-contributory defined benefit, trusteed forms of pension plans covering substantially all employees over the age of twenty-one. Benefits are based on years of service and the employee's compensation during the last three years of employment. The Company's funding policy is to contribute an amount not less than the minimum required by government funding standards, nor more than the maximum deductible amount for federal income tax purposes. Plan assets consist primarily of corporate and U.S. government obligations. Pension costs in 1994, 1993 and 1992 amounted to $1,895,000, $50,000 and $812,000, respectively, including amounts charged to construction.\nThe net pension costs (credits) include the following components:\nThe variance in net pension cost is primarily attributable to actuarial and investment experience.\nThe following table sets forth the funded status of the plans and amounts recognized in the Company's consolidated balance sheet at September 30:\nThe projected benefit obligation, which is based on a June 30 measurement date, was determined using a weighted-average discount rate of 8.25% for 1994 and 7.5% for 1993, and a weighted-average rate of future compensation of 5.0% for 1994 and 4.5% for 1993. The expected long-term rate of return on plan assets was 8.25% for 1994 and 9.0% for 1993.\nPursuant to the provisions of the Company's pension plans, pension obligations may be settled by lump-sum cash payments. Significant settlements in 1993 and 1992 resulted in pre-tax gains of approximately $4,355,000 and $3,514,000, respectively. No such gains were recognized in 1994. The cost of the Company's defined contribution plans, which cover substantially all employees, amounted to $1,706,000, $1,595,000 and $1,122,000 for the years 1994, 1993 and 1992, respectively. The Company provides life insurance benefits to all employees after retirement and medical insurance is available after early retirement until age 65. In the first quarter of fiscal year 1994, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions (OPEB)\". Under the provisions of SFAS No. 106, the future cost of providing these postretirement benefits is recognized as an expense and a liability during the employees' service periods. As permitted by SFAS No. 106, the liability for any unfunded accumulated postretirement benefit obligations existing at October 1, 1993 is being recognized as a transition obligation and amortized over 20 years. Prior to the adoption of SFAS No. 106, life insurance costs were accrued systematically in order to provide for future payments. The cost of medical insurance, net of payments by the retirant, was recognized as claims were paid. Postretirement benefit costs in 1994, 1993 and 1992 amounted to approximately $6,063,000, $4,300,000 and $4,100,000, respectively, including amounts charged to construction.\nThe 1994 net postretirement benefit cost consisted of the following components:\nThe following table sets forth the funded status of the plans and amounts recognized in the Company's consolidated balance sheet at September 30:\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 10% for 1994, and gradually decreases each successive year until it reaches 5% in 1998. A one percent increase in the assumed health care cost trend rate for each year would increase accumulated postretirement benefit costs as of September 30, 1994 by $1,900,000 and the sum of the service cost and interest cost by approximately $384,000. The weighted-average discount rate and weighted- average rate of future compensation used in determining the accumulated postretirement benefit obligation was 8.25% and 5.0%, respectively. In its 1992 rate case, the Company was authorized by the MoPSC to recover OPEBs on a pay-as-you-go basis and to defer, as a regulatory asset, the difference between the accrued costs calculated under the provisions of SFAS No. 106 and the actual pay-as-you-go costs. However, in January 1993, the Emerging Issues Task Force (EITF) reached a consensus requiring more stringent accounting criteria necessary to record a regulatory asset. The 1992 MoPSC authorization was not in conformity with the 1993 EITF consensus; therefore, a regulatory asset was not recorded to reflect rate recovery of these costs on a pay-as-you-go basis. However, in July 1994, a new state law was enacted which requires SFAS No. 106 accrued costs to be recognized for ratemaking purposes provided that such costs are funded through an independent, external funding mechanism. The approved settlement of the Company's 1994 rate case included recovery of such costs, effective on September 1, 1994. The Company is in the process of establishing funding mechanisms which comply with the new law and the terms of the settlement. The 1994 rate case settlement also provided for the deferral, net of any applicable tax effects, of the difference between the costs funded by the Company to its external OPEB funding mechanisms and $6,100,000 of annualized OPEB costs included in rates. Any such deferrals will be reflected in rates established in the next general rate case proceeding. In November 1992, the FASB issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\", which will require the Company to accrue the estimated future cost of providing postemployment benefits to former or inactive employees after employment but before retirement. Adoption of SFAS No. 112 is required in fiscal year 1995. The Company does not expect the adoption of SFAS No. 112 to have a material effect on the Company's financial position or results of operations.\n3. Common Stock and Paid-in Capital\nAt the Annual Meeting held on January 27, 1994, the Company's share owners approved an amendment which increased the authorized Common Stock to 50,000,000 shares with a new par value of $1.00 per share and reclassified the par value of the outstanding Common Stock from $2.00 to $1.00 per share. These changes were approved in connection with a 2-for-1 stock split authorized by the Board of Directors effective February 11, 1994. As a result, common share and per share amounts in the consolidated financial statements have been retroactively adjusted to reflect the stock split. Share owners approved an amendment to the Company's Dividend Reinvestment Plan at the January 27, 1994 meeting to permit cash purchases of common stock through the Plan, with a minimum purchase of $100 per calendar quarter up to a maximum purchase of $30,000 per calendar year. The amendment also provides for the issuance of common shares by the Company to provide shares purchased under the Plan. The Company filed a Registration Statement for the Plan with the Securities and Exchange Commission on February 22, 1994. During fiscal 1994, 83,561 shares were issued under the Company's Dividend Reinvestment and Stock Purchase Plan. At September 30, 1994, a total of 15,670,023 shares were outstanding.\nOn March 27, 1986, the Company declared a dividend of one Common Share Purchase Right for each outstanding share of common stock as of May 1, 1986. The rights expire on May 1, 1996, and may be redeemed by the Company for five cents each at any time before they become exercisable. The rights will not be exercisable or transferable apart from the common stock, until ten days after a person or group acquires or obtains the right to acquire 20% or more of the common stock, or commences or announces its intention to commence a tender or exchange offer for 30% or more of the common stock. Each right entitles its holder to buy one share of common stock at an exercise price of $50. In certain circumstances, each right will entitle the holder to purchase one share of common stock at one-third of the market price, or to purchase, at the exercise price, common stock of an acquiring entity having a value equal to twice the exercise price. A total of 15,670,023 rights were outstanding at September 30, 1994. Paid-in capital increased $1,852,000 in 1994, reflecting the issuance of common stock under the Dividend Reinvestment Plan. There were no changes in paid-in capital in 1993 or 1992.\n4. Redeemable Preferred Stock\nThe preferred stock, which is non-voting except in certain circumstances, may be redeemed at the option of the Board of Directors. The redemption price is equal to par of $25.00 a share. During 1994, 1993 and 1992 no shares of preferred stock were reacquired. Any default in a sinking fund payment must be cured before the Company may pay dividends on or acquire any common stock. There are no sinking fund requirements on preferred stock for the five years subsequent to September 30, 1994.\n5. Long-Term Debt\nThere are no maturities or sinking fund requirements on long-term debt for the five years subsequent to September 30, 1994. Substantially all of the Company's utility plant is subject to the liens of its mortgage. The Company's mortgage contains provisions which restrict retained earnings from declaration or payment of cash dividends. As of September 30, 1994, approximately $164,300,000 of consolidated retained earnings was free from such restrictions. In November 1993, the Company redeemed approximately $12 million (a portion of which was current) of First Mortgage Bonds, 7-1\/2% Series, due March 15, 1997 at a cost of $12,100,000.\n6. Fair Value of Financial Instruments\nThe carrying amounts and estimated fair values of the Company's financial instruments at September 30, 1994, are as follows:\nThe carrying amounts for cash and cash equivalents and short-term debt approximate fair value due to the short maturity of these investments. Fair value of long-term debt and preferred stock is estimated based on market prices for similar issues.\n7. Income Taxes\nNet provisions for income taxes were charged during the years ended September 30, 1994, 1993 and 1992 as shown on the Schedule of Income Taxes. Deferred tax expense results from timing differences in the recognition of revenue and expense for tax and book purposes in 1993 and 1992 and the change in temporary tax differences in 1994. The sources of these differences and the related tax effect of each are indicated below:\nThe effective income tax rate varied from the federal statutory income tax rate for each year due to the following:\nThe significant items comprising the Company's net deferred tax liability recognized in the consolidated balance sheet as of September 30, 1994 are as follows:\nThe net deferred tax liability is presented in the consolidated balance sheet as current assets of $3,717,000, and deferred credits and other liabilities of $76,662,000.\n8. Notes Payable and Credit Agreements\nThe Company has a primary line of bank credit which permits borrowing of up to $40 million at any time before January 31, 1995. Such borrowings are on a 90-day basis, renewable from time to time, with no note maturing beyond June 30, 1995. The borrowings may be repaid at any time without penalty. The Company anticipates renewal of this primary line of $40 million in January 1995. Additionally, beginning October 18, 1993, the Company obtained a supplemental line of credit varying from $20 million to $40 million through October 17, 1994 and $70 million from October 18, 1994 to March 1, 1995. Thus, at this writing, the total line of credit for the 1994-1995 heating season is $110 million, compared with a maximum of $95 million during the 1993-1994 heating season. The Company anticipates that the supplemental line will be reduced after March 1, 1995, since seasonal cash needs typically decline at the end of the heating season. Alternatively, the Company has an agreement for the issuance of commercial paper which is supported by the bank loan lines of credit. During fiscal year 1994, the Company's short-term borrowing requirements were met by the sale of commercial paper. As of September 30, 1994, the Company had $53.5 million in commercial paper outstanding at an average interest rate of 4.9%.\n9. Commitments and Contingencies\nThe Company estimates fiscal year 1995 utility construction expenditures at $39,300,000. The lease agreement covering the Company's general office space extends through February 2000. The aggregate rental expense for fiscal year 1994 was $770,000. Annual minimum rental payments for years subsequent to September 30, 1994 are $770,000 per year. The lease agreement provides for an annual rent escalation which is not determinable as of the balance sheet date but such escalations have historically been relatively minor. The Company has other rental arrangements which provide for minimum rental payments that are relatively minor. The Company has entered into various contracts which in the aggregate require it to pay approximately $92 million on an annual basis, at present rate levels, for the reservation of gas supplies and pipeline transmission and storage capacity. These costs are recovered from customers in accordance with the Purchased Gas Adjustment Clause of the Company's tariff. The contracts have various expiration dates ranging from 1995 to 2000. A consolidated subsidiary is a general partner in an unconsolidated partnership which invests in real estate partnerships. The subsidiary and third parties are jointly and severally liable for the payment of mortgage loans in the aggregate outstanding amount of approximately $11.9 million incurred in connection with various real estate ventures. The Company has no reason to believe that the other principal liable parties will not be able to meet their proportionate share of these obligations. The Company further believes that the asset values of the real estate properties are sufficient to support these mortgage loans. The Company is subject to various laws and regulations relating to the environment, which thus far have not had a material effect on the Company's financial position and results of operations. Prior to the widespread availability of natural gas, the Company operated various manufactured gas plants, the last of which was closed in 1961. The process for manufacturing gas produced by-products and residuals, including hydrocarbons such as lamp black and coal tar. Certain remnants of these residuals are typically found at former gas manufacturing sites. The United States Environmental Protection Agency (EPA) has been engaged in a survey of a large number of former manufactured gas plant sites across the nation. In this regard, the Company and the EPA have determined that manufactured gas residuals are present at one of the former manufactured gas plant sites operated by the Company. While no conclusion has been reached as to the extent of any remedial action that will be required, the Company and the EPA have entered into an Administrative Order on Consent (AOC), effective March 31, 1994, with regard to this site. The AOC provides for the Company to conduct certain investigative activities (i.e., a removal site evaluation and an engineering evaluation cost analysis), and to reimburse the EPA for response costs under the AOC. The AOC requires only investigations and does not cover any removal action. If remedial action is necessary, then a subsequent order will cover such action. Based on currently available information, management believes that the costs of the foregoing investigations, response costs of the EPA in overseeing such investigations, and other associated legal and engineering consulting costs, are likely to approximate $380,000. At September 30, 1994, $135,000 has been paid and a liability of $245,000 remains to cover future payments. The Company is presently unable to evaluate and quantify further the scope or cost of any environmental response activity. The Company has notified its insurers that the Company intends to seek reimbursement from them of its investigation, remediation, clean-up and defense costs in regard\nto the foregoing. In addition to pursuing insurance proceeds to the extent feasible, the Company also plans to seek recovery, if practicable, from any other potentially responsible parties. An environmental cost deferral procedure was established by the Missouri Public Service Commission in the Company's recent rate case, effective September 1, 1994, for use by the Company in applying for appropriate rate recovery of various investigation, remediation and other costs to be incurred by the Company in connection with former manufactured gas plant sites. The authorization to begin deferring such costs shall only be triggered to the extent that the cumulative liability incurred by the Company during the deferral period is not offset by the cumulative costs of $250,000 per year reflected in the Company's current rates. In the event the cumulative liability incurred by the Company for such costs during the deferral period is less than the cumulative amount of such annualized costs reflected in the rates approved in the settlement, then the Company shall refund the difference. The above authorization will become null and void if the Company does not file for a general rate increase by September 1, 1996, and, in any event, the recovery of costs deferred thereunder is subject to challenge in future rate cases. The Company is involved in litigation, claims, and investigations arising in the normal course of business. While the results of such litigation cannot be predicted with certainty, management, after discussion with counsel, believes the final outcome will not have a material adverse effect on the consolidated financial position and results of operations reflected in the financial statements presented herein.\n10. Interim Financial Information (Unaudited)\nIn the opinion of the Company, the quarterly information presented in the Schedule of Interim Financial Information for fiscal years 1994 and 1993 includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results of operations for such periods. Variations in operations reported on a quarterly basis reflect the seasonal nature of the Company's business.\nItem 9.","section_9":"Item 9. Changes in and Disagreements on Accounting and Financial Disclosure\nThere have been no disagreements on accounting and financial disclosure with the Company's outside auditors which are required to be disclosed.\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information concerning directors required by this item is set forth on pages 3 through 7 in the Company's proxy statement dated December 27, 1994 and is incorporated herein by reference.\nThe information concerning executive officers required by this item is reported in Part I of this Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this item is set forth on pages 9 through 18 in the Company's proxy statement dated December 27, 1994 and is incorporated herein by reference but the information under the captions \"Compensation Committee Report Regarding Compensation\" and \"Performance Graph\" on pages 14 through 17 of such proxy statement is expressly NOT incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation required by this item is set forth on page 8 in the Company's proxy statement dated December 27, 1994 and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThere were no transactions required to be disclosed pursuant to this item.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. Consolidated Financial Statements: 1994 10-K Page\nFor Years Ended September 30, 1994, 1993, and 1992: Statements of Income 25 Statements of Retained Earnings 26 Statements of Cash Flows 30 Schedule of Income Taxes 31 As of September 30, 1994 & 1993: Balance Sheets 27-28 Statements of Capitalization 29 For Years Ended 1994 & 1993: Schedules of Interim Financial Information 32 Notes to Financial Statements 33-42 Independent Auditors' Report 23 Management Report 24\n2. Supplemental Schedules\nV - Property, Plant and Equipment 48-50 VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment 51-53 VII - Gurantees of Securities of Other Issuers 54 VIII - Reserves 55 IX - Short-Term Borrowings 56 X - Supplementary Income Statement Information 57\nSchedules not included have been omitted because they are not applicable or the required data has been included in the financial statements or notes to financial statements.\n3. Exhibits\nIncorporated herein by reference to Index to Exhibits, page 58.\n(b) During the last quarter of fiscal year 1994, no reports on Form 8-K were required to be filed by the Company.\n(c) Management contracts and compensatory plans or arrangements listed in the Index to Exhibits required to be filed as exhibits to this form pursuant to Item 14(c) of this report:\nExhibit No. Description\n10.01 - Incentive Compensation Plan of the Company. 10.01a - Amendment adopted by the Board of Directors on July 26, 1990 to the Incentive Compensation Plan. 10.01b - Amendments adopted by the Board of Directors on August 23, 1990 to the Incentive Compensation Plan. 10.02 - Senior Officers' Life Insurance Program of the Company. 10.02a - Certified copy of resolutions of the Company's Board of Directors adopted on June 27, 1991 amending the Senior Officers' Life Insurance Program. 10.02b - Certified copy of resolutions of the Company's Board of Directors adopted on January 28, 1993 amending the Senior Officers' Life Insurance Program. 10.03 - Employees' Retirement Plan of Laclede Gas Company - Management Employees, effective as of July 1, 1990, as amended. 10.03a - Amendment to the Employees' Retirement Plan of Laclede Gas Company - Management Employ- ees adopted by the Board of Directors on September 27, 1990. 10.03b - Amendments, dated December 12, 1990 to the Employees' Retirement Plan of Laclede Gas Company - Management Employees. 10.03c - Amendment to the Employees' Retirement Plan of Laclede Gas Company - Management Employees dated January 10, 1994. 10.03d - Amendments to the Employees' Retirement Plan of Laclede Gas Company - Management Employees dated July 29, 1994. 10.04 - Laclede Gas Company Supplemental Retirement Benefit Plan, as amended and restated effec- tive July 25, 1991. 10.05 - Laclede Gas Company Salary Deferral Savings Plan, as amended through February 27, 1992. 10.05a - Amendment to the Company's Salary Deferral Savings Plan, effective January 31, 1992, adopted by the Board of Directors on August 27, 1992. 10.05b - Amendment to the Company's Salary Deferral Savings Plan dated January 10, 1994. 10.05c - Amendments to the Company's Salary Deferral Savings Plan, dated July 29, 1994. 10.05d - Amendments to the Company's Salary Deferral Savings Plan effective August 1, 1994 adopted by the Board of Directors on August 25, 1994.\n10.05e - Amendments to the Company's Salary Deferral Savings Plan dated September 27, 1994. 10.06 - Laclede Gas Company Deferred Compensation Plan for Non-Employee Directors dated March 26, 1981. 10.06a - First Amendment to the Company's Deferred Compensation Plan for Non-Employee Directors, adopted by the Board of Directors on July 26, 1990. 10.06b - Amendment to the Company's Deferred Com- pensation Plan for Non-Employee Directors, adopted by the Board of Directors on August 27, 1992. 10.08 - The Retirement Plan for Non-Employee Direc- tors of Laclede Gas Company dated January 24, 1985. 10.08a - First Amendment to Retirement Plan for the Company's Non-Employee Directors, adopted by the Board of Directors on July 26, 1990. 10.08b - Amendments to the Retirement Plan for Non- Employee Directors, adopted by the Board of Directors on January 23, 1992. 10.09 - Salient Features of the Laclede Gas Company Deferred Income Plan for Directors and Selected Executives, including amendments adopted by the Board of Directors on July 26, 1990. 10.09a - Amendment to the Company's Deferred Income Plan for Directors and Selected Executives, adopted by the Board of Directors on August 27, 1992. 10.10 - Form of Indemnification Agreement between the Company and its Directors and Officers. 10.11 - Laclede Gas Company Management Continuity Protection Plan, as amended, effective at the close of business on January 27, 1994, by the Board of Directors. 10.12 - Laclede Gas Company Restricted Stock Plan for Non-Employee Directors, effective as of January 25, 1990. 10.14 - Salient Features of the Laclede Gas Company Deferred Income Plan II for Directors and Selected Executives adopted by the Board of Directors on September 23, 1993.\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.\nLACLEDE GAS COMPANY\nDecember 15, 1994 By Robert J. Carroll Robert J. Carroll 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.\nDate Signature Title\n12\/15\/94 Robert C. Jaudes Chairman of the Board, Robert C. Jaudes President and Chief Executive Officer (Principal Executive Officer)\n12\/15\/94 Robert J. Carroll Senior Vice President - Robert J. Carroll Finance and Chief Financial Officer (Principal Financial and Accounting Officer)\n12\/15\/94 Andrew B. Craig, III Director Andrew B. Craig, III\n12\/15\/94 Henry Givens, Jr. Director Henry Givens, Jr.\n12\/15\/94 James L. Hoagland Director James L. Hoagland\n12\/15\/94 C. Ray Holman Director C. Ray Holman\n12\/15\/94 Mary Ann Krey Director Mary Ann Krey\n12\/15\/94 William E. Nasser Director William E. Nasser\n-------------- Director Boyd F. Schenk\n12\/15\/94 Robert P. Stupp Director Robert P. Stupp\n12\/15\/94 H. Edwin Trusheim Director H. Edwin Trusheim\nINDEX TO EXHIBITS -----------------\nSequentially Exhibit Numbered No. Pages - ------- ------------\n3.01(i)* - Articles of Incorporation, as of February 11, 1994; filed as Exhibit 4(a) to the Company's Form S-3 Registration Statement No. 33-52357. 3.01(ii)* - By-Laws of the Company, as amended on October 1, 1990; filed as Exhibit 3.01 to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 3.01(ii)a* - Certified copy of resolutions of the Company's Board of Directors adopted on November 21, 1991 amending Article IV, Section 1 of the Company's By-Laws, effective January 22, 1992; filed as Exhibit 3.01a to the Company's 10-K for the fiscal year ended September 30, 1991 (File No. 1-1822). 4.01* - Mortgage and Deed of Trust, dated as of February 1, 1945; filed as Exhibit 7-A to Registration Statement No. 2-5586. 4.02* - Fourteenth Supplemental Indenture, dated as of October 26, 1976; filed on June 26, 1979 as Exhibit b-4 to Registration State- ment No. 2-64857. 4.03* - Seventeenth Supplemental Indenture, dated as of May 15, 1988; filed as Exhibit 28(a) to the Registration Statement No. 33-38413. 4.04* - Eighteenth Supplemental Indenture, dated as of November 15, 1989; filed as Exhibit 28(b) to the Registration Statement No. 33-38413. 4.05* - Nineteenth Supplemental Indenture, dated as of May 15, 1991; filed on May 16, 1991 as Exhibit 4.01 to the Company's Form 8-K (File No. 1-1822). 4.06* - Twentieth Supplemental Indenture, dated as of November 1, 1992; filed on November 4, 1992 as Exhibit 4.01 to the Company's Form 8-K (File No. 1-1822). 4.07* - Twenty-First Supplemental Indenture, dated as of May 1, 1993; filed on May 13, 1993 as Exhibit 4.01 to the Company's Form 8-K (File No. 1-1822).\n* Incorporated herein by reference and made a part hereof.\nINDEX TO EXHIBITS -----------------\nSequentially Exhibit Numbered No. Pages - ------- ------------\n4.08* - Laclede Gas Company Board of Directors' Resolution dated August 28, 1986 which generally provides that the Board may delegate its authority in the adoption of certain employee benefit plan amendments to certain designated Executive Officers; filed as Exhibit 4.12 to the Company's 10-K for the fiscal year ended September 30, 1991 (File No. 1-1822). 4.08a* - Laclede Gas Company Board of Directors' Resolutions dated August 25, 1988, which generally provide for certain amendments to the Company's Wage Deferral Savings Plan and Salary Deferral Savings Plan and that certain Officers are authorized to execute such amendments; filed as Exhibit 4.12g to the Company's 10-K for the fiscal year ended September 30, 1988 (File No. 1-1822). 4.09* - Laclede Gas Company Wage Deferral Savings Plan, incorporating amendments through December 12, 1990; filed as Exhibit 4.13 to the Company's 10-K for the fiscal year ended September 30, 1991 (File No. 1-1822). 4.09a* - Amendments to the Company's Wage Deferral and Salary Deferral Savings Plans, effective May 1, 1992, adopted by the Board of Directors on February 27, 1992; filed as Exhibit 4.13 to the Company's 10-Q for the fiscal quarter ended March 31, 1992 (File No. 1-1822). 4.09b* - Amendment to the Company's Wage Deferral Savings Plan, effective August 1, 1992, adopted by the Board of Directors on August 27, 1992; filed as Exhibit 4.13b to the Company's 10-K for the fiscal year ended September 30, 1992 (File No. 1-1822). 4.09c - Amendments to the Company's Wage Deferral 66 Savings Plan dated July 29, 1994. 4.09d - Amendments to the Company's Wage Deferral 76 Savings Plan effective August 1, 1994 and adopted by the Board of Directors August 25, 1994.\n* Incorporated herein by reference and made a part hereof.\nINDEX TO EXHIBITS -----------------\nSequentially Exhibit Numbered No. Pages - ------- ------------\n4.10* - Missouri Natural Gas Division of the Laclede Gas Company Dual Savings Plan incorporat- ing amendments through December 12, 1990; filed as Exhibit 4.01 to the Company's 10-Q for the fiscal quarter ended December 31, 1990 (File No. 1-1822). 4.10a* - Amendment to the Missouri Natural Gas Division of Laclede Gas Company Dual Savings Plan effective April 11, 1993, adopted by the Board of Directors on August 26, 1993; filed as Exhibit 4.10a to the Company's 10-K for the fiscal year ended September 30, 1993 (File No. 1-1822). 4.10b - Amendments to the Missouri Natural Gas 79 Division of Laclede Gas Company Dual Savings Plan dated July 29, 1994. 4.11* - Rights Agreement dated as of April 17, 1986; filed on April 18, 1986 as Exhibit 1 to the Company's Form 8-A (File No. 1-1822). 10.01* - Incentive Compensation Plan of the Company, as amended; filed as Exhibit 10.03 to the Company's 10-K for the fiscal year ended September 30, 1989. 10.01a* - Amendment adopted by the Board of Directors on July 26, 1990 to the Incentive Compensation Plan; filed as Exhibit 10.02a to the Com- pany's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.01b* - Amendments adopted by the Board of Directors on August 23, 1990 to the Incentive Compensation Plan; filed as Exhibit 10.02b to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.02* - Senior Officers' Life Insurance Program of the Company, as amended; filed as Exhi- bit 10.03 to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.02a* - Certified copy of resolutions of the Company's Board of Directors adopted on June 27, 1991 amending the Senior Officers' Life Insurance Program; filed as Exhibit 10.01 to the Company's 10-Q for the fiscal quarter ended June 30, 1991 (File No. 1-1822).\n* Incorporated herein by reference and made a part hereof.\nINDEX TO EXHIBITS -----------------\nSequentially Exhibit Numbered No. Pages - ------- ------------\n10.02b* - Certified copy of resolutions of the Company's Board of Directors adopted on January 28, 1993 amending the Senior Officers' Life Insurance Program; filed as Exhibit 10.03 to the Company's 10-Q for the fiscal quarter ended March 31, 1993 (File No. 1-1822). 10.03* - Employees' Retirement Plan of Laclede Gas Company - Management Employees, effective as of July 1, 1990, as amended; filed as Exhibit 10.01 to the Company's 10-Q for the fiscal quarter ended June 30, 1990 (File No. 1-1822). 10.03a* - Amendment to the Employees' Retirement Plan of Laclede Gas Company - Management Employ- ees adopted by the Board of Directors on September 27, 1990; filed as Exhibit 10.04a to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.03b* - Amendments, dated December 12, 1990 to the Employees' Retirement Plan of Laclede Gas Company - Management Employees; filed as Exhibit 10.04b to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.03c* - Amendment to the Employees' Retirement Plan of Laclede Gas Company - Management Employees dated January 10, 1994; filed as Exhibit 10.01 to the Company's 10-Q for the fiscal quarter ended December 31, 1993 (File No. 1-1822). 10.03d - Amendments to the Employees' Retirement Plan 84 of Laclede Gas Company - Management Employees dated July 29, 1994. 10.04* - Laclede Gas Company Supplemental Retirement Benefit Plan, as amended and restated effec- tive July 25, 1991; filed as Exhibit 10.05 to the Company's 10-K for the fiscal year ended September 30, 1991 (File No. 1-1822). 10.04a* - Trust Agreement with Boatmen's Trust Company, dated September 4, 1990; filed as Exhibit 10.05c to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822).\n* Incorporated herein by reference and made a part hereof.\nINDEX TO EXHIBITS -----------------\nSequentially Exhibit Numbered No. Pages - ------- ------------\n10.04b* - First Amendment to Laclede Gas Company Trust Agreement dated as of September 4, 1990, adopted by the Board of Directors on September 23, 1993; filed as Exhibit 10.05(b) to the Company's 10-K for the fiscal year ended September 30, 1993 (File No. 1-1822). 10.05* - Laclede Gas Company Salary Deferral Savings Plan, as amended through February 27, 1992; filed as Exhibit 10.08 to the Company's 10-Q for the fiscal quarter ended March 31, 1992 (File No. 1-1822). 10.05a* - Amendment to the Company's Salary Deferral Savings Plan, effective January 31, 1992, adopted by the Board of Directors on August 27, 1992; filed as Exhibit 10.08a to the Company's Form 10-K for the fiscal year ended September 30, 1992 (File No. 1-1822). 10.05b* - Amendment to the Company's Salary Deferral Savings Plan dated January 10, 1994; filed as Exhibit 10.02 to the Company's 10-Q for the fiscal quarter ended December 31, 1993 (File No. 1-1822). 10.05c - Amendments to the Company's Salary Deferral 86 Savings Plan, dated July 29, 1994. 10.05d - Amendments to the Company's Salary Deferral 89 Savings Plan effective August 1, 1994 adopted by the Board of Directors on August 25, 1994. 10.05e - Amendments to the Company's Salary Deferral 92 Savings Plan dated September 27, 1994. 10.06* - Laclede Gas Company Deferred Compensation Plan for Non-Employee Directors dated March 26, 1981; filed as Exhibit 10.12 to the Company's 10-K for the fiscal year ended September 30, 1989 (File No. 1-1822). 10.06a* - First Amendment to the Company's Deferred Compensation Plan for Non-Employee Directors, adopted by the Board of Directors on July 26, 1990; filed as Exhibit 10.09a to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.06b* - Amendment to the Company's Deferred Com- pensation Plan for Non-Employee Directors, adopted by the Board of Directors on August 27, 1992; filed as Exhibit 10.09b to the Company's Form 10-K for the fiscal year ended September 30, 1992 (File No. 1-1822).\n* Incorporated herein by reference and made a part hereof.\nINDEX TO EXHIBITS -----------------\nSequentially Exhibit Numbered No. Pages - ------- ------------\n10.07* - Agency Agreement Between Laclede Gas Company and Mississippi River Transmission Corporation dated August 26, 1993; filed as Exhibit 10.10 to the Company's 10-K for the fiscal year ended September 30, 1993 (File No. 1-1822). 10.07a* - Propane sales contract between Phillips 66 Company and Laclede Pipeline Company, dated February 2, 1989; filed as Exhibit 10.10d to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.07b* - Amendment, dated August 6, 1992, to Propane Sales Contract between the Company and Phillips 66 Company; filed as Exhibit 10.10c to the Company's Form 10-K for the fiscal year ended September 30, 1992 (File No. 1-1822). 10.07c* - Gas Purchase and Sales Agreement effective November 1, 1990 between the Company and ESCO Energy, Inc. and its affiliated companies; filed as Exhibit 10.10d to the Company's 10-K for the fiscal year ended September 30, 1991 (File No. 1-1822). 10.08* - The Retirement Plan for Non-Employee Direc- tors of Laclede Gas Company dated January 24, 1985; filed as Exhibit 10.01 to the Company's 10-Q for the fiscal quarter ended March 31, 1990 (File No. 1-1822). 10.08a* - First Amendment to Retirement Plan for the Company's Non-Employee Directors, adopted by the Board of Directors on July 26, 1990; filed as Exhibit 10.11a to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.08b* - Amendments to the Retirement Plan for Non- Employee Directors, adopted by the Board of Directors on January 23, 1992; filed as Exhibit 10.11 to the Company's 10-Q for the fiscal quarter ended March 31, 1992 (File No. 1-1822). 10.09* - Salient Features of the Laclede Gas Company Deferred Income Plan for Directors and Selected Executives, including amendments adopted by the Board of Directors on July 26, 1990; filed as Exhibit 10.12 to the Company's 10-K for the fiscal year ended September 30, 1991 (File No. 1-1822).\n* Incorporated herein by reference and made a part hereof.\nINDEX TO EXHIBITS -----------------\nSequentially Exhibit Numbered No. Pages - ------- ------------\n10.09a* - Amendment to the Company's Deferred Income Plan for Directors and Selected Executives, adopted by the Board of Directors on August 27, 1992; filed as Exhibit 10.12a to the Company's Form 10-K for the fiscal year ended September 30, 1992 (File No. 1-1822). 10.10* - Form of Indemnification Agreement between the Company and its Directors and Officers; filed as Exhibit 10.13 to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.11* - Laclede Gas Company Management Continuity Protection Plan, as amended, effective at the close of business on January 27, 1994, by the Board of Directors; filed as Exhibit 10.1 to the Company's 10-Q for the fiscal quarter ended March 31, 1994 (File No. 1-1822). 10.12* - Laclede Gas Company Restricted Stock Plan for Non-Employee Directors, effective as of January 25, 1990; filed as Exhibit 10.03 to the Company's 10-Q for the fiscal quarter ended March 31, 1990 (File No. 1-1822). 10.13* - Laclede Gas Company Trust Agreement with Boatmen's Trust Company, dated December 7, 1989; filed as Exhibit 10.16 to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.13a* - First Amendment to Laclede Gas Company Trust Agreement, adopted by the Board of Directors on July 26, 1990; filed as Exhibit 10.16a to the Company's 10-K for the fiscal year ended September 30, 1990 (File No. 1-1822). 10.13b* - Second Amendment to Laclede Gas Company Trust Agreement dated as of December 7, 1989, adopted by the Board of Directors on September 23, 1993; filed as Exhibit 10.16b to the Company's 10-K for the fiscal year ended September 30, 1993 (File No. 1-1822). 10.14* - Salient Features of the Laclede Gas Company Deferred Income Plan II for Directors and Selected Executives adopted by the Board of Directors on September 23, 1993; filed as Exhibit 10.17 to the Company's 10-K for the fiscal year ended September 30, 1993 (File No. 1-1822).\n* Incorporated herein by reference and made a part hereof.\nINDEX TO EXHIBITS -----------------\nSequentially Exhibit Numbered No. Pages - ------- ------------\n10.15* - January 19, 1994 line of credit agreement with Mercantile Bank of St. Louis, N.A.; filed as Exhibit 10.2 to the Company's 10-Q for the fiscal quarter ended March 31, 1994 (File No. 1-1822). 10.16* - January 10, 1994 line of credit agreement with The Boatmen's National Bank of St. Louis; filed as Exhibit 10.3 to the Company's 10-Q for the fiscal quarter ended March 31, 1994 (File No. 1-1822). 10.17* - January 20, 1994 line of credit agreement with Commerce Bank of St. Louis, N.A.; filed as Exhibit 10.4 to the Company's 10-Q for the fiscal quarter ended March 31, 1994 (File No. 1-1822). 10.18* - January 10, 1994 line of credit agreement with Chemical Bank; filed as Exhibit 10.5 to the Company's 10-Q for the fiscal quarter ended March 31, 1994 (File No. 1-1822). 10.19* - October 18, 1993 line of credit agreement with Chemical Bank, The Boatmen's National Bank of St. Louis and Mercantile Bank, N.A.; filed as Exhibit 10.6 to the Company's 10-Q for the quarter ended March 31, 1994 (File No. 1-1822). 10.19a* - Amendment and Extension dated April 18, 1994 of Line of Credit Agreement dated October 18, 1993 among Laclede Gas Company, Chemical Bank, The Boatmen's National Bank of St. Louis and Mercantile Bank of St. Louis National Association; filed as Exhibit 10 to the Company's 10-Q for the quarter ended June 30, 1994 (File No. 1-1822). 10.19b - Amendment and Further Extension dated 97 August 18, 1994 of Line of Credit Agreement dated October 18, 1993 among Laclede Gas Company, Chemical Bank, The Boatmen's National Bank of St. Louis and Mercantile Bank of St. Louis National Association. 12 - Ratio of Earnings to Fixed Charges. 100 22 - Subsidiaries of the Registrant. 101 24 - Consent of Independent Public Accountants. 102 27 - Financial Data Schedule UT 103\n* Incorporated herein by reference and made a part hereof.","section_15":""}
{"filename":"743475_1994.txt","cik":"743475","year":"1994","section_1":"Item 1. Business.\nThe Turner Corporation (the \"Company\") is a holding company that is engaged together with its subsidiaries in general building construction and construction management in the United States and abroad and in real estate investment in the United States. The Turner Corporation establishes general policy direction, coordination and planning, and provides cash management, internal accounting control and other management services for its operating subsidiaries.\nDue to economic conditions generally, and to factors specifically affecting the commercial real estate market, beginning in 1989, there was a significant slowdown in commercial construction. In an effort to minimize the effects of this slowdown, during the last several years, the company's construction subsidiaries increased their focus on manufacturing, municipal, institutional, public, justice and amusement (i.e., hospital, university, aviation, aquariums, arenas and similar) projects. Approximately 70% in dollar value of the contracts awarded to the construction subsidiaries in 1994 were in these areas.\nDuring 1993, plans were developed to significantly reduce the company's future operating costs and expenses and to improve productivity. This restructuring program principally involved a reduction in the number of staff, plus the consolidation of offices and facilities and the reorganization of support functions. This program was implemented and substantially completed in 1994. Its final phase is expected to be completed in 1995. While a portion of the benefits of restructuring were realized in 1994, the full benefits are expected to be realized in 1995 and thereafter.\nDuring the early 1980's, the Company acquired and developed a number of properties. In 1987, the Company decided to discontinue its new development activities and began trying to dispose of the properties it owned.\nDuring 1994, the Company sold one developed real estate property, two land parcels and a number of condominium units for $7.5 million which was essentially the carrying amount of the properties on the company's books. While the Company continues to seek purchasers for its real estate properties, it is unlikely it will be able to dispose of its properties in their entirety until there are more stable market conditions in the areas in which the company's properties are located.\nIn addition to its property sales, during 1994 the Company sold its master lease and development rights at the Rickenbacker Air Industrial Park for $1.8 million.\nFinancial information about the registrant's operations in its construction and real estate segments appear in the consolidated financial statements and in footnote 15 on page 34 in Part II, Item 8 of this report.\nAt December 31, 1994, The Turner Corporation and subsidiaries employed approximately 2,500 staff employees, of which 1,400 held supervisory positions and 1,100 held non-supervisory positions. Construction Business\nThe Turner Corporation's construction business is conducted by a number of construction subsidiaries (together, \"Turner Construction\"). Turner Construction is engaged primarily in the construction of commercial and multi-family residential buildings, manufacturing and research facilities, hospitals, correctional facilities, stadiums and other entertainment facilities, airports and other structures. It also has a division which does interior work, such as building-out office space. Turner Construction normally does not build roads, dams, or similar infrastructure elements. Turner Construction primarily acts as a general building contractor or as a construction manager. However, Turner Construction also sometimes acts as a consultant to owners and others.\nAlthough Turner Construction is a nationwide (and to a lesser extent, worldwide) construction firm, Turner Construction attempts to compete locally in major cities of the United States through essentially self-contained regional offices and partially self-contained branch offices. Its objective is to be a major builder in each city or region in which it has an office.\nThe Turner Corporation's principal construction subsidiary is Turner Construction Company. Universal Construction Co., Inc., The Lathrop Company Inc., and Turner Caribe Inc., wholly-owned subsidiary companies of The Turner Corporation or Turner Construction Company, are also engaged in construction activities in the United States principally in the Southeast, Midwest and the Caribbean Islands.\nWhen it acts as a general building contractor, Turner Construction normally undertakes to construct a project and is paid the entire price for the completed project. Most aspects of the construction, however, are performed by subcontractors who are paid by Turner Construction. The functions actually performed by Turner Construction are the planning and scheduling of a construction project, the procurement of materials, the marshaling of the manpower required for the project, the awarding of subcontracts and the direction and management of the construction operation. During 1994, 1993, and 1992 general building contracting activities represented 81%, 75%, and 83%, respectively, of Turner Construction's value of work completed.\nTurner Construction makes extensive use of specialty contractors (such as structural steel contractors, electrical contractors and plumbing contractors) as subcontractors in the performance of its construction contracts. The extent to which work is performed by workmen on its own payroll varies with the location of a particular project and is largely dependent on the availability of experienced subcontractors in a particular area. Work performed by Turner Construction is generally limited to temporary facilities, foundation, concrete, masonry and carpentry work.\nIn its performance of construction management services, Turner Construction, for a fee, monitors and coordinates the progress of the work done by specialty contractors who are employed directly by the owner to build the project. During 1994, 1993 and 1992 management construction services and consulting represented 19%, 25% and 17%, respectively, of Turner Construction's value of work completed. Construction management contracts involve less risk than do projects in which Turner Construction is a general building contractor. However, the profit from construction management contracts can be substantially less than that which Turner Construction can earn when it acts as a general building contractor.\nConstruction contracts include lump sum or fixed price contracts, cost-plus fixed fee contracts and variations thereof including cost- plus guaranteed total contracts. The majority of Turner Construction's business involves negotiated contracts. The remainder of its contracts are secured by competitive bidding.\nThe Company is a partner with Karl Steiner Holding AG (\"Steiner\") of Switzerland in a joint venture by the name of Turner Steiner International SA, which renders general building construction and construction consulting services outside Turner Construction's and Steiner's respective home markets.\nIn South America, Turner Construction Company is a partner with Birmann SA of Brazil in a joint venture by the name of Turner Birmann Construction Management Do Brazil SA. The purpose of the joint venture is to provide construction management and consulting services to clients in Brazil and other South American markets.\nThe Company is also a partner with EMCON in a joint venture by the name of ET Environmental Corporation which provides environmental engineering, general building construction, and construction management services on environmental projects throughout the United States.\nThe United States building construction industry is intensely competitive and Turner Construction Company and the other domestic construction subsidiaries compete with other major contractors as well as with small contractors. Competition in the industry takes on a number of forms, including fee levels, quality of service and degree of risk assumption. Construction companies can expand their operations rapidly and each large population center generally has a number of medium-sized building contractors accustomed to undertaking all but the largest and most complicated projects. Through its organizational structure of permanently established decentralized branch offices and subsidiaries, Turner Construction competes directly with those locally based contractors. Year-to-year operations may be adversely affected by general economic conditions which are unfavorable for business and industry. Exact statistical data is not available for determining the relative size of construction companies, however, based on the contract value of construction contracts received in 1994 and published industry data, Turner Construction believes that it is one of the largest building contractors operating principally within the United States.\nA portion of the Company's construction activity is performed under payment and performance bonds obtained through bonding capacity from its sureties. Projects requiring surety bonds are usually either publicly funded or private projects, which often require FHA - type mortgage insurance. While the Company's sureties limit the amount of new payment and performance bonds available, this limitation did not restrict the Company's ability to secure new work. There could be certain circumstances, however, when this limitation could influence the Company's selection of prospective projects to pursue.\nAt December 31, 1994, the anticipated earnings associated with backlog from work to be completed under construction, construction management and construction consulting contracts and under awards believed to be firm but not yet confirmed by signed formal contracts was $92.6 million. The anticipated earnings from work to be completed on contracts and awards at December 31, 1993 was $91.8 million. Approximately 44% of the December 31, 1994 earnings backlog from construction contracts relates to work expected to be performed during 1996 and beyond. The backlog is important to long-range planning and continuity of work for the company's permanent staff. However, anticipated earnings from construction contracts cannot and should not be used as the basis of predictions with respect to future operating results. The anticipated value of work to be completed under construction, construction management and construction consulting contracts and under awards believed to be firm but not yet confirmed by signed formal contracts was $4.55 billion at December 31, 1994. The anticipated value of work to be completed on contracts and awards at December 31, 1993 was $4.66 billion. Approximately 48% of the December 31, 1994 construction backlog is expected to be completed during 1996 and beyond.\nValue of construction completed represents the cost of work put in place and materials fabricated during the year and related earnings pursuant to construction and construction management contracts, together with fees and reimbursed expenses from consulting contracts. It is essentially a measure of construction activity during the year rather than \"sales\" or \"revenues\" in the sense that those terms are used in other industries.\nBecause of the varying proportion of construction, construction management and construction consulting work, the impact of inflation on the value of construction completed, changes in anticipated earnings from construction contracts and anticipated value of work completed will not necessarily be correlative.\nAt December 31, 1994, Turner Construction employed approximately 2,400 staff employees, of whom about 1,200 were executives, project managers, superintendents, engineers, purchasing agents, estimators, senior accountants and other supervisory personnel. In addition, Turner Construction employs foremen and building craftsmen for construction work which has not been subcontracted to specialty contractors. During 1994, approximately 2,300 foremen and building craftsmen were employed at various times.\nReal Estate.\nThe Company's subsidiaries involved in real estate operations are Rickenbacker Holdings, Inc. (\"RHI\"), and Turner Development Corporation and subsidiaries (\"TDC\"). The Company also has certain other real estate holdings, either directly or through joint venture interests, which are currently being marketed. These holdings relate to residential condominium developments in Boston and Puerto Rico.\nFrom 1980 to 1987, TDC engaged in real estate development in the United States, principally in Florida, Georgia, Illinois, Michigan and Virginia. TDC developed and marketed office buildings and other commercial and residential properties, principally in metropolitan suburban areas.\nTDC essentially discontinued new development activity in 1987. It is attempting to sell land parcels previously held for development as well as certain developed projects. At December 31, 1994, TDC owned properties in seven states.\nTDC's development projects were financed principally by construction and mortgage loans. TDC is attempting to market projects to institutional and other investors in commercial real estate. In connection with sales of projects, TDC may be required to guarantee levels of occupancy and rentals for limited periods.\nTurner Medical Building Services (\"TMBS\") is engaged in project consulting and development services for ancillary medical and other health care facilities. Its principal clients are hospitals, physician group practice clinics, nursing home and life care sponsors. TMBS provides management of architectural and construction services. TMBS subcontracts the design and construction of its projects. At December 31, 1994, TDC (including Turner Medical Building Services) had 3 employees, of whom 2 were management, and marketing personnel.\nRHI owns and leases an air cargo distribution facility located at the Rickenbacker Air Industrial Park in Columbus, Ohio. In 1994, the Company sold its master lease and development rights to the 1600 acre air industrial park adjacent to the distribution facility. In addition, the Company has renegotiated a lease with the existing lessee extending the maturity date from 1996 to 2010.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company's executive offices and offices of subsidiary companies are located in leased facilities in commercial office buildings, except for Universal Construction Co., Inc., which owns a small office building in which its offices are located. The Company's corporate headquarters and New York branch office occupy 100,000 square feet of space which is leased until 2005. Rental expense for this space during 1994 was $2.14 million. Each construction project has temporary field offices.\nTurner Construction operates three equipment and storage yards, located in Newark, New Jersey, Cincinnati, Ohio and St. Louis, Missouri for the storage and repair of its construction tools and equipment. Turner Construction owns the Ohio storage and repair yards and leases the New Jersey and Missouri facilities. Universal Construction Co., Inc., owns a yard, while The Lathrop Company, Inc., leases yards for the storage and repair of construction equipment.\nTurner Construction leases major construction equipment such as hoists, cranes and personnel lifts from equipment suppliers for use on particular projects and generally owns only small tools and other miscellaneous equipment; Universal Construction Co., Inc., and The Lathrop Company, Inc. each own construction equipment, earth-moving equipment and small tools.\nTDC holds as an investment a wholly-owned apartment complex which it had previously developed, located in Orlando, Florida (200 units). This property is encumbered by a mortgage note payable.\nRHI owns certain buildings and air cargo handling equipment at the Rickenbacker Air Industrial Air Park in Columbus, Ohio, which collateralize related revenue bonds.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nSince 1990, the Company and a joint venture including Prudential Insurance Company of America, have been engaged in a litigation in the Circuit Court of Cook County, Illinois in which the Company is seeking an unpaid portion of the cost of constructing the Prudential Plaza 2 Tower in Chicago and Prudential is seeking damages for alleged construction delays. The Company believes it fully performed its obligations with regard to the Prudential Tower. If it were determined that there were impermissible construction delays, the Company might have resulting claims against others. The Company is a defendant in various litigations incident to its business. In some instances the amounts sought are very substantial, including some which are proceeding to trial involving substantial claims and counterclaims, and certain parties are withholding significant amounts included in construction receivables pending the outcome of the litigation. Although the outcome of the litigation cannot be predicted with certainty, in the opinion of management based on the facts known at this time, the resolution of such litigation is not anticipated to have a material adverse effect on the financial position or results of operations of the Company.\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 Equity and Related Stockholder Matters.\nThe Turner Corporation common stock is listed on the American Stock Exchange under the symbol TUR.\nQuarterly Stock Information\n1994 High Low Close First $9.50 $7.375 $8.375 Second 9.00 8.00 8.375 Third 9.625 8.375 8.75 Fourth 8.875 7.25 8.25\n1993 High Low Close First $11.750 $7.375 $11.50 Second 12.875 11.00 12.50 Third 13.00 9.625 9.875 Fourth 10.50 6.75 7.875\nNo dividends were declared or paid in 1994 or 1993. As of March 20, 1995, there were approximately 3,517 record holders of the registrant's common stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe Turner Corporation and Subsidiaries FIVE-YEAR SUMMARY OF FINANCIAL INFORMATION (in thousands, except share amounts)\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition\nResults of Operations 1994 vs. 1993 The Company reported net income of $3.7 million or $0.35 per common share compared to a net loss of $6.2 million in 1993 or $1.55 per common share. The most significant factors contributing to this change were improvements in real estate operations, reductions in operating and general and administrative expenses and the recognition of income tax benefits resulting from both operations and excess tax reserves. In addition, 1993's results included pretax charges of $8.5 million for restructuring costs and $6.0 million for real estate valuation adjustments. Results for 1994 include a pretax restructuring credit of $1.1 million which represents excess restructuring reserves.\nGross earnings declined 8 percent from 1993 to $54.6 million primarily due to losses on construction projects in the Caribbean of $7.7 million and a decline in the value of construction completed. These reductions were offset by an improvement in real estate operations.\nGeneral and administrative expenses decreased 10 percent primarily due to savings from restructuring steps taken, as well as a leveling off of the start-up costs of the Company's \"Total Quality Management\" program. 1994's results are more fully described in the discussion that follows.\nConstruction: Earnings from construction contracts declined 19 percent from 1993 to $54.9 million. While a portion of that can be attributed to a 5 percent decline in construction completed, the majority was the result of the $7.7 million loss incurred by the Company's Caribbean operations in the U.S. Virgin Islands and Puerto Rico. These losses stemmed from overruns on lump sum contracts begun in prior years and substantially completed in 1994.\nIn recent years construction management contracts have figured more significantly in the mix of the Company's value of construction completed. In 1994 construction management projects amounted to 19 percent of the value of construction completed compared to 25 percent in 1993 and 17 percent in 1992. Construction management contracts normally involve lower risk than other types of contracts; they also typically carry lower fees. The significant proportion of construction management contracts has, therefore, contributed to the decline in the profitability ratio (construction earnings divided by value of construction completed).\nThe value of new contracts secured in 1994 was $2.69 billion, essentially unchanged from 1993. Although the expected growth in the Company's traditional markets did take place, the flat sales numbers reflect the fact that the Company's penetration in fact declined in the face of intense competition. Construction management contract sales in 1994 declined in favor of more traditional general contracting projects reversing the trends previously noted.\nAccording to F.W. Dodge, the Company's traditional non-residential building markets for 1994 grew by 12 percent over 1993. Projections are that these markets will continue to grow in 1995, and the Company should be in a position to take advantage of that growth.\nThe Company's sureties limit the annual amount of new payment and performance bonds available to the Company. This limitation did not restrict the Company's ability to secure new business in 1994; however, there could be circumstances in which it could influence the Company's selection of prospective projects.\nAt the end of 1994, the anticipated earnings associated with backlog from work to be completed under contracts and awards believed to be firm were $92.6 million_essentially unchanged from 1993. The backlog in terms of value of construction to be completed declined 2 percent from 1993 to $4.55 billion. The decline in backlog volume is a result of the cancellation in 1994 of certain projects that had been secured in 1993 and in prior years. The unchanged earnings backlog does represent, however, an improvement in the profitability ratio of the construction backlog when compared to prior years. In support of this, fees on contracts secured in 1994 were slightly higher, on average, than fees on contracts secured in 1993, which is a continuation of the trend begun in 1993.\nApproximately 44 percent of the earnings backlog and 48 percent of the value of construction backlog relates to work to be performed in 1996 and beyond. Estimated earnings from construction backlog cannot and should not be used as a basis for predicting future net income.\nReal Estate: Losses from real estate operations amounted to $277,000 in 1994 compared to $8.1 million in 1993. Included in the 1993 losses was a $6.0 million valuation provision set up as additional reserves against asset values in relation to their carrying value. During 1994, the Company sold one developed property, two land parcels and certain condominium units, all at their approximate carrying value.\nThe majority of 1994's excess of real estate sales over the cost of sales comes from the sale of lease rights at the Company's Rickenbacker facility. Rental income and direct operating costs declined by 8 percent and 13 percent, respectively, due to sales of properties in 1993 and 1994.\nThe Company's real estate portfolio is carried at estimated net realizable value or at cost, as applicable. Management believes that the timing of future sales will depend upon achieving reasonable values under more stable market conditions which the Company believes will be within the next few years for developed properties and a more prolonged period for undeveloped land parcels. Until conditions in the real estate market improve to the point that will permit the Company to conduct real estate transactions, the Company will continue to review the asset values of the properties in relation to prospective net realizable value and make adjustments as necessary. During 1994, the Company sold its master lease and development rights to the 1,600-acre Rickenbacker Air Industrial Park for $1.8 million. In addition, the Company as lessor, successfully renegotiated a lease for a 66-acre site, with the existing lessee, extending the maturity date from 1996 to 2010. As a result of these transactions, the operations of the Rickenbacker facility should not have any future adverse effect on the Company's cash flow.\nOperating and General and Administrative Expenses:\nRestructuring credits and charges - in the fourth quarter of 1993 the Company recorded an $8.5 million provision for restructuring. The provision included estimated expenses required to implement the Company's plan to consolidate certain support functions and scale down operations in shrinking geographic markets. During 1994, the Company charged $6.5 million of expenditures against the reserve which included severance, benefits and other incentives associated with staff reductions, the costs of the consolidation of offices and facilities resulting from down-sizing operations in shrinking geographic markets, and the reorganization of certain support functions. Approximately $897,000 of the reserve remains in accrued liabilities at December 31, 1994, representing the balance of the charges to be funded in 1995. The remainder of the unused reserve of $1.1 million was credited to income in 1994.\nThe benefits of the restructuring efforts taken in 1994 are reflected in the 11 percent reduction in operating and general and administrative expenses to $53.4 million from $59.8 million in 1993 (exclusive of the restructuring credits and charges). Management believes that the full benefit of the restructuring efforts will be realized in 1995 and thereafter.\nOther Income: In 1994 the Company recorded other losses of $1.9 million compared to $870,000 in 1993. A major part of the loss is attributable to the absorption, on a pretax basis, of the cumulative foreign translation adjustment relating to the planned liquidation of one of the Company's inactive foreign subsidiaries. Cumulative translation adjustments had previously been charged directly to stockholders' equity net of tax.\nThe Company's investment in Turner Steiner International SA resulted in a $1.7 million loss to the Company in 1994 compared to a $3.0 million loss in 1993. This foreign joint venture has secured work in Europe, the Middle East and Asia- Pacific markets and is expected to break-even in 1995.\n1994 losses were partially offset by interest and dividend income and other foreign investments.\nIncome Taxes: The net tax benefit for 1994 amounted to $3.2 million and is due primarily to the benefits derived from losses incurred in Puerto Rico as well as the reversal of excess reserves resulting from the planned liquidation of one of the Company's inactive foreign subsidiaries.\nThe Company has recorded $18.4 million of deferred tax assets having resulted principally from net operating loss and tax credit carryforwards. Management believes that no valuation allowance is required for these assets due to the future reversals of existing taxable temporary differences primarily related to the Company's pension plan.\nFourth Quarter 1994 Compared to Third Quarter 1994: Results for the fourth quarter amounted to net income of $698,000 or $0.05 per common share compared to net income of $896,000 or $0.08 per common share recorded in the third quarter.\nFourth quarter construction operations reported value of construction completed of $711 million and operating income of $4.8 million compared to $659 million and $3.4 million, respectively, in the third quarter. The improvement is attributable to the change in construction activity and the increase in productivity as a result of the restructuring program.\nReal estate reported operating losses of $23,000 in the fourth quarter compared to $1.5 million in the third quarter. This improvement is attributable to reduced direct operating costs due to the sale of properties as well as a reduction in operating expenses as a result of the restructuring steps taken in previous quarters.\nThe excess restructuring reserve of $1.1 million was credited to income in the fourth quarter.\nExclusive of the restructuring credit, general and administrative expenses increased 56 percent to $5.3 million in the fourth quarter from $3.4 million in the third quarter. These changes are primarily attributable to the payment of certain incentive benefits which are typically charged to the fourth quarter and the growth in interest expense from slightly increased borrowings and higher interest rates.\nThe Company recorded a $1.2 million charge to other income representing the recognition of the cumulative foreign translation adjustment which had previously been charged directly to stockholders' equity. In addition, the Company released tax reserves in the fourth quarter that had been held pending the planned liquidation of an inactive foreign subsidiary.\nResults of Operations 1993 vs. 1992 The Company reported a net loss of $6.2 million in 1993 or $1.55 per common share compared to net income of $4.0 million in 1992 or $0.50 per common share. This change was primarily attributable to provisions for restructuring charges in 1993 of $5.6 million and real estate valuation adjustments in 1993 of $4.0 million, both net of tax. In addition, 1992's net income included a non- recurring extraordinary gain of $316,000 from the extinguishment of debt and a gain of $1.5 million due to the cumulative effect of an accounting change, both net of tax.\n1993 gross earnings declined 9.4 percent from 1992 to $59.4 million primarily due to a decline in construction earnings and an increase in the real estate loss due to the valuation adjustments noted above.\nGeneral and administrative expenses increased 26 percent primarily due to increased interest costs associated with corporate credit facilities and costs incurred in implementing the Company's \"Total Quality Management\" program.\nFinancial Condition: In total, the Company recorded an increase in cash and cash equivalents in 1994 of $29.3 million.\nOperating activities provided positive cash flow of $7.8 million primarily as a result of domestic construction profitability and reduced overhead expenditures. Cash expended to fund the restructuring program amounted to $6.5 million in 1994 and was provided by operations. The remaining balance of the restructuring charge amounts to $897,000 and will be expended in early 1995.\nCash flows from investing activities amounted to $17.4 million and were due primarily to sales of marketable securities and the three real estate properties noted earlier. $5.0 million was also returned to the Company from its investment in a Boston condominium project from unit sales. The remainder of this project is expected to be substantially sold in 1995.\nCash flows from financing activities amounted to $4.1 million which represents the excess of borrowings over debt paydowns during the year. In the fourth quarter of 1994, the Company sold $39.5 million of Senior Notes in a private placement to institutional investors, including the Company's pension plan which participated to the extent of $9.5 million. Proceeds from the sale were used to paydown short-term borrowings under the Company's revolving credit facility. The revolving credit facility remains available to the Company.\nManagement believes the Company's cash flows from construction backlog, its $40 million revolving credit facility and amounts available from overnight credit facilities will be sufficient to support the Company's operations. Debt maturing in 1995 will be paid from funds generated from operations or will be refinanced prior to its actual maturity date.\nFair Value of Financial Instruments: As described in Note 16 to the financial statements, certain financial instruments have fair values which differ from their carrying amounts. The difference in the values related to Notes Payable reflect current favorable interest rates and terms, given the underlying value of the loan collateral.\nInflation: Inflation and changing prices during the current fiscal year have not significantly affected the major markets in which the Company conducts its business. Domestically, prices have remained relatively stable. In view of the moderate rate of inflation, its impact on the Company's business has not been significant.\nImpairment of Loans: In May of 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\", which was amended in October 1994 by Statement of Financial Accounting Standards No. 118.\nThese statements require that a loan be recognized as 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. Impairments would be recognized by creating valuation allowances with corresponding charges to bad debt expense. The statements are effective for fiscal years beginning after December 15, 1994, and are to be initially applied as of the beginning of an enterprise's fiscal year.\nThe Company will adopt the standard at the beginning of 1995, and management believes that the impact will not be material to the financial statements.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nPage No. Financial Statements: Report of Independent Public Accountants 14 Consolidated Balance Sheets - as of December 31, 1994 and 1993 15 Consolidated Statements of Operations - for the years ended December 31, 1994, 1993 and 1992 16 Consolidated Statements of Stockholders' Equity - for the years ended December 31, 1994, 1993 and 1992 17 Consolidated Statements of Cash Flows - for the years ended December 31, 1994, 1993 and 1992 18 Notes to Consolidated Financial Statements 19-36 Responsibilities for Financial Reporting 37\nReport of Independent Public Accountants\nTo The Turner Corporation:\nWe have audited the accompanying consolidated balance sheets of The Turner Corporation (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.\nAs further discussed in Note 4 to the consolidated financial statements, the Company has significant interests in real estate properties which are carried at the lower of cost or estimated net realizable value. The financial statements do not purport to present the Company's entire portfolio of real estate interests at their current market value or liquidation value, which may be less than the carrying amounts presented. The Company's management presently intends to hold these real estate interests until they can be sold for prices which they believe reflect reasonable values under more stable market conditions. Given the current market for land, management expects to hold the undeveloped land parcels for a prolonged period of time.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Turner 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 further discussed in Note 10 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for postretirement benefits other than pensions. As also discussed in Note 10 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for amortizing unrecognized pension actuarial gains and losses for the defined benefit pension plan.\nNew York, New York ARTHUR ANDERSEN LLP March 7, 1995\nThe Turner Corporation and Subsidiaries Consolidated Balance Sheets (in thousands, except share amounts)\nAs of December 31, 1994 1993 Assets Cash and cash equivalents $ 54,756 $ 25,485 Marketable securities 4,251 13,046 Construction receivable: (Note 3) Due on contracts including retainage 356,160 314,435 Estimated unbilled construction costs and related earnings 70,733 80,572 Real estate (Note 4) 106,300 119,892 Property and equipment, net (Note 5) 17,490 17,725 Prepaid pension cost (Note 10) 64,259 63,207 Other assets 31,140 29,844 Total assets $705,089 $664,206 Liabilities Construction accounts payable: Trade $276,391 $239,156 Due on completion of contracts 118,959 117,647 Accrued estimated work completed 67,196 78,495 Notes payable and convertible debenture (Note 6) 106,879 102,365 Deferred income taxes (Note 7) 12,731 13,708 Other liabilities 63,717 58,152 Total liabilities 645,873 609,523 Commitments and contingencies (Note 13)\nStockholders' Equity (Note 12) Preferred stock, $1 par value (2,000,000 shares authorized): Series C 8.5% cumulative convertible (9,000 shares issued and outstanding; $9,000 9 9 liquidation preference) Series B cumulative convertible (850,000 shares issued; 848,956 and 849,011 outstanding) 849 849 Common stock, $1 par value (20,000,000 shares authorized, 5,200 5,135 5,199,941 and 5,134,778 issued) Paid in capital 37,778 37,280 Net unrealized loss on marketable (276) - securities Cumulative foreign translation - (787) adjustment Retained earnings 26,656 24,834 70,216 67,320 Less: Loan to Employee Stock Ownership Plan (Note 11) (10,468) (12,105) Treasury stock, at cost (53,489 common shares) (532) (532) Total stockholders' equity 59,216 54,683 Total liabilities and stockholders' equity $705,089 $664,206 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nThe Turner Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share amounts) For the years ended December 31, 1994 1993 1992\nValue of construction completed (see below) $ 2,638,579 $ 2,768,379 $ 2,644,794 Earnings from construction contracts $ 54,892 $ 67,434 $ 73,118 Losses from real estate operations (see below) (277) (8,069) (7,603) Gross earnings 54,615 59,365 65,515 Operating expenses - construction 36,450 40,156 41,160 Operating expenses - real estate 1,997 3,053 4,143 General and administrative expenses 14,969 16,555 13,107 Restructuring charges (credits) (Note 2) (1,145) 8,500 - Income (loss) from operations 2,344 (8,899) 7,105 Other income (loss), net (Note 14) (1,854) (870) (2,903) Income (loss) before income taxes 490 (9,769) 4,202 Income tax provision (benefit): (Note 7) Current (2,329) 252 405 Deferred (831) (3,816) 1,567 Total income tax provision (benefit) (3,160) (3,564) 1,972 Income (loss) before extraordinary gain and cumulative effect of accounting change 3,650 (6,205) 2,230 Extraordinary gain, net of tax (Note 6) - - 316 Cumulative effect of accounting change, net of tax (Note 10) - - 1,454 Net income (loss) $ 3,650 $ (6,205) $ 4,000\nPrimary earnings (loss) per common share: Before extraordinary gain and cumulative effect of accounting change $ 0.35 $ (1.55) $ 0.15 Extraordinary gain - - 0.06 Cumulative effect of accounting change - - 0.29 Net income (loss) per common share $ 0.35 $ (1.55) $ 0.50 Fully diluted earnings (loss) per common share: Before extraordinary gain and cumulative effect of accounting change $ 0.30 (a) $ 0.15 Extraordinary gain - - 0.05 Cumulative effect of accounting change - - 0.25 Net income (loss) per common share $ 0.30 (a) $ 0.45 Weighted average common and common equivalent shares outstanding Primary 5,186,879 5,186,442 5,074,943 Fully diluted 6,035,835 (a) 5,924,437\nValue of construction completed consists of the following: Revenue from construction contracts: Construction costs incurred by the company $1,835,010 $1,848,800 $1,993,749 Company's share of joint venture 253,080 160,021 134,280 construction costs Earnings from construction contracts (including joint venture earnings of $5,153, $3,253 and $3,785 54,892 67,434 73,118 for 1994, 1993 and 1992, respectively) Total revenue from construction contracts 2,142,982 2,076,255 2,201,147 Construction costs incurred by owners in connection with work under construction management and similar contracts 495,597 692,124 443,647 Value of construction completed 2,638,579 2,768,379 2,644,794\nLosses from real estate operations consist of the following: Real estate sales $ 9,279 $ 23,537 $ 252 Cost of sales (7,600) (23,571) (252) Rental and other income 12,416 13,497 15,026 Direct operating costs (8,776) (10,054) (14,879) Depreciation and amortization expense (5,596) (5,460) (5,930) Write-downs and reserves - (6,018) (1,820) Losses from real estate operations $ (277) $ (8,069)$ (7,603) The accompanying Notes to Consolidated (a) Antidilutive Financial Statements are an integral part of these statements.\nThe Turner Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except share amounts) For the years ended December 31, 1994 1993 1992 Shares Amount Shares Amount Shares Amount Convertible preferred stock, Series C Balance at beginning of year 9,000 $9 9,000 $9 - $- Preferred stock issued - - - - 9,000 9 Balance at end of year 9,000 9 9,000 9 9,000 9 Convertible preferred stock, Series B Balance at beginning of year 849,011 849 849,494 849 850,000 850 Preferred stock retired (55) - (483) - (506) (1) Balance at end of year 848,956 849 849,011 849 849,494 849 Common stock Balance at beginning of year 5,134,778 5,135 5,070,535 5,071 4,980,088 4,980 Common stock issued 65,163 65 64,243 64 90,447 91 Balance at end of year 5,199,941 5,200 5,134,778 5,135 5,070,535 5,071 Paid in capital Balance at beginning of year 37,280 36,699 26,997 Excess of proceeds over par value of Series C preferred stock issued - - 8,991 Excess of proceeds over par value of common stock issued 498 575 695 Excess of proceeds over cost of treasury stock issued - 6 16 Balance at end of year 37,778 37,280 36,699 Net unrealized loss on marketable securities Balance at beginning of year - - - Net unrealized loss for the year (276) - - Balance at end of year (276) - - Cumulative foreign translation adjustment Balance at beginning of year (787) (783) (1,088) Change in cumulative translation adjustments during the year 787 (4) 305 Balance at end of year - (787) (783) Retained earnings Balance at beginning of year 24,834 32,869 30,306 Net income (loss) for the year 3,650 (6,205) 4,000 Cash dividends on Series C preferred stock,$85.00, $85.00 $38.00 per share (765) (765) (342) Cash dividends on Series B preferred stock, $2.16 per share (1,833) (1,835) (1,835) Tax benefits on Series B preferred stock dividends 770 770 740 Balance at end of year 26,656 24,834 32,869 Loan to Employee Stock Ownership Plan (ESOP) Balance at beginning of year (12,105) (13,668) (15,260) Repayment from loan to ESOP 1,637 1,563 1,592 Balance at end of year (10,468) (12,105) (13,668) Treasury stock Balance at beginning of year 53,489 (532) 22,647 (325) 25,965 (382) Purchase of treasury stock - - 32,900 (240) - - Treasury stock issued - - (2,058) 33 (3,318) 57 Balance at end of year 53,489 (532) 53,489 (532) 22,647 (325) Total stockholders' equity $59,216 $54,683 $60,721\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements. The Turner Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, except share amounts) For the years ended December 31, 1994 1993 1992 Cash flows from operating activities: Net income (loss) 3,650 (6,205) 4,000 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Restructuring charges (credits) (1,145) 8,500 - (Gain) loss on sale of real (1,679) - - estate sales Cumulative foreign translation 1,193 34 - charge Write-downs and reserves - 6,018 1,820 Extraordinary gain - - (571) Cumulative effect of accounting change - - (2,423) Equity in affiliates' net loss 1,915 3,027 3,928 Depreciation and amortization 9,366 9,824 11,043 Net periodic pension credit (1,052) (9,674) (9,549) Provision (benefit) for deferred (831) (3,816) 2,536 income taxes Changes in operating assets and liabilities: Decrease (increase) in (31,886) 27,703 23,757 construction receivables Increase (decrease) in 27,248 (32,110) (25,857) construction accounts payable Decrease in restructuring (6,458) - - reserve Decrease (increase) in other 7,484 4,780 (7,207) assets and liabilities, net Net cash provided by 7,805 8,081 1,477 operating activities Cash flows from investing activities: Purchases of marketable securities - (25,913) (13,613) Proceeds from sale of marketable 8,389 26,480 - securities Distributions from joint ventures 5,000 - - Investments in joint ventures (900) (8,137) (3,180) Purchases of property and equipment (3,569) (4,610) (4,373) Proceeds from sale of property 1,916 4,162 591 and equipment Proceeds from sale of real estate net 7,049 17,465 - Increase in real estate (3,423) (3,911) (2,468) Repayments on notes receivable 2,888 416 474 Net cash provided by (used in) 17,350 5,952 (22,569) investing activities Cash flows from financing activities: Common stock issued 563 639 786 Convertible preferred stock issued - - 15,000 Cash dividends to preferred stock- (2,598) (2,600) (2,177) holders Repayments from loan to ESOP 1,637 1,563 1,592 Proceeds from borrowings 80,497 62,963 42,386 Payments on borrowings (75,983) (89,217) (34,321) Cash used for debt restructuring - - (1,201) Funding of joint venture borrowings - - (5,034) Proceeds from issuance of - 39 73 treasury stock Purchases of treasury stock - (240) - Net cash provided by (used in) 4,116 (26,853) 17,104 financing activities Net increase (decrease) in cash and 29,271 (12,820) (3,988) cash equivalents Cash and cash equivalents at 25,485 38,305 42,293 beginning of year Cash and cash equivalents at end of year $54,756 $25,485 $38,305 Noncash financing activities: Mortgage note assumed by the buyer in connection with the sale of real estate $ - $ 4,426 $ - Series D convertible preferred stock exchanged for a convertible debenture - - 6,000 Note payable forgiven related to the air industrial park - - 2,500 Noncash investing activities: Net unrealized loss on marketable securities 276 - - Note provided upon the sale of certain assets and liabilities of a construction subsidiary - 1,577 - Notes provided upon the sale of real estate 1,849 1,185 - The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nTHE TURNER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share amounts)\n1. Summary of Significant Accounting Policies\nPrinciples of Consolidation: The consolidated financial statements include the accounts of The Turner Corporation and Subsidiaries and their proportionate interest in the accounts of construction joint ventures (the Company). The Company also has investments in affiliates and in real estate joint ventures, which are accounted for under the equity or cost method, as appropriate. All significant intercompany transactions and balances are eliminated. Certain prior year balances have been reclassified in the consolidated financial statements in order to provide a presentation consistent with the current year.\nConstruction Operations: The Company determines construction earnings under the percentage of completion method. Under this method, the Company recognizes as earnings that portion of the total earnings anticipated from a contract which the value of the work completed bears to the estimated total value of the work covered by the contract. As the Company's construction contracts generally extend over more than one year, revisions in costs and earnings estimates during the course of the work are reflected in the year in which the facts which require the revision become known. When a loss is forecasted for a contract, the full amount of the anticipated loss is recognized in the period in which it is determined that a loss will occur. Claims are included in earnings from construction contracts at an amount based on the related contract costs when realization is probable and the amount can be reliably estimated.\nThe Company continuously reviews estimated earnings from construction contracts and makes necessary adjustments based on current evaluations of the indicated outcome. In 1994 and 1993, the Company wrote down certain construction receivables and claims deemed unrecoverable.\nUnder certain contracts, owners of buildings make payments directly to suppliers and subcontractors for all or for portions of work covered by the contract. The Company considers such costs in determining contract percentage of completion and reports such amounts in the value of construction completed.\nReal Estate Operations: Rental income, including fixed minimum rents and additional rents, under operating leases with tenants is generally recognized on a contractual basis.\nProfit on sales of real estate is recognized in full when the profit is determinable, an adequate down payment has been received, collectability of the sales price is reasonably assured and the earnings process is substantially complete. If the sales transaction does not meet these criteria, all profit or a portion thereof is deferred until such criteria are met.\nThe real estate properties which are held for investment are carried at cost less accumulated depreciation and are assessed periodically for impairment based on the sum of undiscounted estimated future cash flows. All other real estate properties and investments in real estate joint ventures are carried at the lower of cost or estimated net realizable value (Note 4). Depreciation and Amortization: The Company calculates depreciation on property and equipment, and on real estate primarily on the straight-line method. Estimated useful lives are as follows: buildings and improvements, 20-40 years; office machines and furniture, 5-10 years; and equipment, 10 years. Leasehold improvements (the Company as lessee) to property used in Company operations are amortized on a straight-line basis over the lease terms. Tenant improvements (the Company as lessor) on real estate properties are amortized on a straight-line basis over the term of the lease. Maintenance and repairs are expensed currently, except that expenditures for betterments are capitalized.\nIn connection with the renegotiated lease of certain facilities at the Rickenbacker Air Industrial Park, effective January 1, 1995, the Company revised the estimated depreciable life of the facilities to coincide with the new lease term.\nCash: The Company considers all investments purchased with maturities of 90 days or less to be cash equivalents. The Company's other liabilities include approximately $36,800 and $26,400 net payable to banks for checks drawn but not cleared as of December 31, 1994 and 1993, respectively.\nMarketable Securities: On January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" In accordance with the provisions of SFAS No. 115, marketable securities which consist primarily of equity and bond mutual funds are classified as available-for-sale and are reported in the Balance Sheet at fair value as of December 31, 1994. Prior to that date, marketable securities were carried at the lower of cost or market at the Balance Sheet date.\nUnrealized gains and losses in 1994 are reported as a separate component of stockholders' equity. In prior periods, net unrealized losses were charged to expense. The effect of the adoption of the Standard was not material to the financial statements.\nLoans Receivable: Effective January 1, 1995, the Company will adopt SFAS No. 114 \"Accounting by Creditors for Impairment of a Loan\" which was amended by SFAS No. 118. These statements require that a loan be recognized as 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. Impairments would be recognized by creating valuation allowances with corresponding charges to bad debt expense. Management believes the impact of the standards upon adoption will not be material to the financial statements.\nIncome Taxes: Prior to January 1, 1993, deferred income tax expenses or benefits were recorded to reflect the tax consequences of timing differences between the recording of income and expenses for financial reporting purposes and for purposes of filing income tax returns in effect when the difference arose.\nEffective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" Under SFAS No. 109, deferred assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or benefits are based on the changes in the asset or liability from period to period. The adoption of the standard was not material to the financial statements.\nThe Company does not provide for U.S. Federal income taxes on undistributed earnings of foreign subsidiaries since it is the Company's intention to permanently reinvest those earnings outside the United States.\nForeign Currency Translation: Assets and liabilities of operations that represent an investment in a foreign country are translated into U.S. dollars at exchange rates in effect at year-end, while revenues and expenses are translated at average exchange rates prevailing during the year. The resulting translation gains and losses are accumulated as a separate component of stockholders' equity. Foreign exchange transaction gains and losses are included in results of operations during the periods in which they arise.\nEarnings Per Common Share: Primary earnings per common share is based on net income less preferred stock dividends (net of tax benefits relating to Series B preferred stock) divided by the weighted average number of common and common equivalent shares outstanding. Fully diluted earnings per common share is further adjusted to reflect the assumed conversion of convertible preferred stock and the convertible debenture, and the elimination of the preferred stock dividends and interest expense on the convertible debenture, net of applicable income taxes, if such conversions are dilutive.\n2. Restructuring Charges\nDuring 1993, plans were developed to significantly reduce the Company's future operating costs and expenses and to improve productivity. This restructuring program principally involved a reduction in the number of staff, plus the consolidation of offices and facilities and the reorganization of support functions. The results of operations for 1993 included $8,500 of pretax charges ($5,600 net of tax benefits, or $1.08 per share) related to this program. The charges included provisions for severance pay, incentive programs relating to employee terminations, costs related to the consolidation of offices and other reorganization costs. This program was implemented in 1994 and was substantially completed by the end of the year. During 1994, $6,458 was charged to the reserve and $897 remains in accrued liabilities at December 31, 1994. The balance of the unused reserve of $1,145 was credited to income in the fourth quarter of 1994.\n3. Construction Receivables\nDue on contracts included $116,856 of retainage at December 31, 1994. It is expected that approximately 86% of such retainage will be collected by December 31, 1995. At December 31, 1993, retainage was $106,665. Construction receivables include estimated net claims. The settlement of the claims depends on individual circumstances, accordingly, the timing of the collection will vary and may extend beyond one year. Those claims, primarily due to owner-caused delays, incomplete specifications or similar reasons, amounted to $8,600 and $10,800 at December 31, 1994 and 1993, respectively.\n4. Real Estate\nThe Company owns a portfolio of real estate, either directly or through joint venture interests, that includes commercial office properties, mixed-use warehouse\/service properties, residential properties, undeveloped land, and certain buildings and hangars located at an air industrial park. The properties are located throughout the United States, but primarily in the Southeast and Great Lakes regions. Accumulated depreciation at December 31, 1994 and 1993 was $34,639 and $32,037, respectively.\nGiven the current real estate market, the Company has determined that its interests in commercial office, mixed-use and residential condominium properties, and undeveloped land parcels will be available for sale when they can be sold for prices which the Company believes reflect the reasonable value of the properties under more stable market conditions. Management expects to dispose of its interests in commercial office, mixed-use and residential condominium properties for those prices generally within the next few years. Based on management's intended holding period, the Company's interests in certain developed properties are carried at their estimated fair value. Given the current market for undeveloped land parcels, management anticipates a prolonged period before land values recover. Due to the relatively low holding costs of the Company's undeveloped land parcels, the Company intends to and has the ability to hold the properties for a prolonged period of time in order to achieve more reasonable prices upon disposition. The carrying amounts of the Company's interests in these developed properties were $45,934 and $57,692, and in the undeveloped land parcels were $30,458 and $31,076 at December 31, 1994 and 1993, respectively. These real estate interests are carried at the lower of cost or estimated net realizable value. The net realizable values reflect the Company's estimates of the net sales proceeds less anticipated capital expenditures through the estimated date of sale and disposal costs, which have not been discounted to net present value.\nThe Company estimates the net realizable values by evaluating and making assumptions about future events with respect to the property, market conditions and anticipated investor rates of return. The net realizable values reflect each disposition based on the Company's current intended holding period, and do not represent liquidation values. Judgments regarding future events are not subject to precise quantification or verification and may change from time to time as economic and market factors, and the Company's evaluation of them, change and the effects of such changes may be significant.\nThe Company actively monitors market conditions and reviews, on a quarterly basis, the net realizable values of its real estate interests and reduces carrying amounts when required. On a periodic basis, generally not exceeding two to three years, the Company has independent appraisals performed for significant real estate interests for the purpose of assisting management in determining their fair value and the appropriate timing of disposition. In connection with the Company's review of the carrying amounts of its real estate interests, additional write- downs and reserves of $6,018 were recorded for the year ended December 31, 1993.\n5. Property and Equipment\nProperty and equipment as of December 31, 1994 and 1993 consisted of:\n1994 1993 Buildings and $14,063 $12,633 improvements Office machines and 17,000 16,610 furniture Equipment 16,470 16,508 Total 47,533 45,751 Less: accumulated depreciation and amortization (30,043)(28,026) Net $17,490 $17,725 6. Notes Payable and Convertible Debenture\nNotes payable and convertible debenture as of December 31, 1994 and 1993 consisted of the following:\n1994 1993 Senior Notes $ 39,500 $ - Land and building 24,845 31,877 mortgages Revenue bonds 18,400 20,500 Employee Stock 11,100 12,800 Ownership Plan Revolving credit - 24,000 facility Convertible 6,000 6,000 debenture Other 7,034 7,188 Total $ 106,879 $ 102,365\nSenior Notes: On December 21, 1994, the Company sold $39,500 of Senior Notes in a private placement to institutional investors, including the Company's pension plan (Note 10). Proceeds of the Notes were used to paydown short-term borrowings under the revolving credit facility. The Notes bear interest at a fixed rate of 11.74% and mature in even principal amounts on the third through seventh anniversary dates of the Notes. The Note Purchase Agreement contains various covenants, the most restrictive of which is a fixed-charge coverage requirement.\nLand and Building Mortgages: Variable rate mortgages bear interest at rates of LIBOR plus 2.25% or prime plus 0.5% and mature in varying installments through 1999. The weighted average interest rate for 1994 and 1993 was approximately 7.47% and 6.64%, respectively. In connection with a variable rate building mortgage, in 1994, the Company entered into an interest rate swap agreement with a bank for a notional amount equal to the underlying mortgage ($9,562 at December 31, 1994). The swap agreement provides for a fixed interest rate of 6.96% through January 27, 1998. Fixed rate mortgages of $5,163 bear interest at 7% or 9.375% and are due in varying installments through 2001.\nRevenue Bonds: Adjustable rate revenue refunding bonds collateralized by properties at the air industrial park mature in varying installments through 2010. The bonds bear interest at a weekly variable rate. The weighted average interest rate for 1994 and 1993 was approximately 2.89% and 2.46%, respectively. The bonds are supported by a letter of credit for which the Company pays 1.50% per annum. The Company entered into an interest rate swap agreement with a bank for a $15,000 notional amount providing for a fixed interest rate of 4.13% through December 15, 1996.\nMulti-family facility revenue bonds collateralized by a residential property were retired in 1993 upon disposition of the property. The bonds bore interest at a weekly variable rate. The weighted average interest rate for 1993 was approximately 3.32%.\nExtinguishment of Debt: In December 1992, the Company restructured certain debt relating to the air industrial park. The previously outstanding revenue bonds, which carried a fixed interest rate of 8.75% were redeemed at 102% of par value. In addition, $2,500 of other debt was forgiven. Proceeds for the redemption were primarily provided by a series of adjustable rate revenue refunding bonds issued in November 1992. The transaction resulted in a net extraordinary gain of $316. Employee Stock Ownership Plan (ESOP): This loan was used to fund the Company's loan to the ESOP and is payable in varying installments through 1999. Interest is payable quarterly at a variable rate equal to 83% of the prime rate or a percentage of LIBOR, at the Company's option. The loan is collateralized by first mortgages on certain real estate properties and letters of credit. The loan allows for collateral substitution and upon disposition of such properties may require additional collateral to maintain loan-to-value relationships. The weighted average interest rate for 1994 and 1993 was approximately 4.56% and 3.44%, respectively. The loan agreement contains various covenants, including the maintenance of a minimum amount of stockholders' equity and debt coverage ratio. At December 31, 1994, the minimum stockholders' equity required was $54,000 and increases by $4,000 annually to $74,000 in 1999.\nRevolving Credit Facility: The Company has an unsecured $40,000 revolving credit facility maturing in 1996, the proceeds of which are being used for general corporate purposes. The current facility permits the Company to choose between various interest rate options. The weighted average interest rate for 1994 and 1993 was approximately 6.84% and 5.97%, respectively. The Company pays a commitment fee at an annual rate of 0.5% on the unused portion of the facility. The facility contains various covenants, the most restrictive of which is a fixed-charge coverage requirement.\nConvertible Debenture: In July 1992, the Company issued a $6,000 8.5% convertible debenture which matures in 1997. The Company may not prepay the principal balance prior to its maturity. At the option of the holder, the debenture is convertible into 6,000 shares of Series D 8.5% convertible preferred stock of the Company. The holder must convert the full debenture principal balance at the time of conversion. The Series D stock is ultimately convertible into 600,000 shares of the Company's common stock and carries terms similar to the Series C stock of the Company, except as to the election of directors (Note 12).\nOther: This amount includes a bank loan for the purpose of financing improvements to the Company's corporate offices which had an outstanding balance of $3,000 and $5,000 at December 31, 1994 and 1993, respectively. The principal is payable in semi-annual installments through 1995. The loan bears interest at LIBOR plus 0.25%. The weighted average interest rate for 1994 and 1993, including associated letter of credit fees, was approximately 7.74% and 4.85%, respectively.\nThe Company maintains overnight credit facilities with various banks at varying rates. The Company had available $10,500 of which $2,400 was outstanding at December 31, 1994. The facilities are subject to periodic renewal from the banks and certain facilities carry annual commitment fees ranging from 0.375% to 0.5%. During 1994 and 1993, the weighted average interest rates were 7.59% and 6.31%, respectively.\nAggregate maturities of notes due are as follows:\n1995 1996 1997 1998 1999 Thereafter $11,9888 $3,288 $22,971 $20,190 $11,926 $36,516\nInterest cost, which approximates amounts paid, for the years ended December 31, 1994, 1993 and 1992 was $7,923, $7,427 and $8,124, respectively.\nAt December 31, 1994, the carrying value of the real estate that was pledged as collateral for notes payable was $68,629. 7. Income Taxes\nThe components of the income tax provision (benefit) are as follows:\n1994 1993 1992 Current: Federal $ (2,924) $ - $ - Foreign 59 145 196 State & Local 536 107 464 (2,329) 252 660\nDeferred:\nFederal 1,659 (4,027) 2,099 Foreign (2,482) - - State & Local (8) 211 437 (831) (3,816) 2,536 Total $ (3,160) $(3,564) $ 3,196\nThe income tax provision (benefit) above consists of the following components:\n1994 1993 1992 Operations $ (3,160) $ (3,564) $ 1,972 Extraordinary gain - - 255 Accounting change - - 969 $ (3,160) $ (3,564) $ 3,196\nIn the Statement of Operations for the year ended December 31, 1992, the extraordinary gain and the cumulative effect of the accounting change are shown net of the related tax provision.\nDeferred income taxes result from temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The source of these differences and tax effect of each at December 31, 1994 and 1993 and for the year ended December 31, 1992 are as follows:\nDeferred Income Tax Provision (Benefit) for Liability (Asset) Deferred Income Taxes\n1994 1993 1992 Construction earnings $ 656 $ 556 $ (314) Pension plans 24,629 24,287 4,216 Depreciation 5,857 5,572 (156) Real estate properties (2,736) (2,362) 159 Net operating loss benefits (11,163) (7,375) (1,886) Restructuring charges (239) (2,890) - Alternative minimum tax credit carryforward (2,451) (2,451) - Jobs credit carryforward (75) (75) - Deferred compensation plan (611) (787) (100) Contributions carryover (1,056) (848) (231) Other (80) 81 848 $ 12,731 $ 13,708 $ 2,536\nThe Company has recorded $18,411 of deferred tax assets having resulted principally from net operating loss and tax credit carryforwards. Management believes that no valuation allowance is required for these assets due to the future reversals of existing taxable temporary differences primarily related to the Company's defined benefit pension plan.\nA comparison of the Federal statutory rate with the company's effective tax rate is as follows:\n1994 1993 1992\nStatutory Federal income 34.0 % (34.0) % 34.0 % tax rate (benefit) State and local taxes, 86.6 % 2.2 % 8.3 % net of Federal benefit Effective foreign tax (489.3) % (3.0) % 0.7 % rate Reserve reversals (355.2) % -- -- Other 79.0 % (1.7) % 1.4 % Effective tax rate (644.9) % (36.5) % 44.4 % (benefit)\nIncome taxes paid (refunded) were $(455), $73 and $(3,397) for 1994, 1993, and 1992, respectively.\nFor Federal income tax purposes, the company has available at December 31, 1994 a net operating loss carryforward of $26,422 which is available to offset future taxable income and expires from 2006 through 2009, and an alternative minimum tax credit carryforward of $2,451 which can be carried forward indefinitely.\nThe unrecognized deferred tax liability related to cumulative undistributed earnings of foreign subsidiaries which were permanently reinvested was $164 at December 31, 1994.\n8. Incentive Compensation Plans\nThe Company sponsors two incentive compensation plans. The Executive Incentive Compensation Plan (EICP) authorizes payments of awards to executive officers and other designated employees of the Company in the form of cash and common stock of the Company, which may be deferred in part at the election of the recipient. The committee that administers the plan determines the particular recipients who are to receive awards and the amounts of their respective awards. The amounts charged to expense in 1994, 1993 and 1992 aggregated $849, $39, and $1,092, respectively.\nThe staff Incentive Compensation Plan (ICP) authorizes payment of awards in the form of cash and common stock of the Company to certain salaried employees who are not participants in the Company's EICP. All awards are deferred for a period of five years and are paid out in cash and common stock over a six-year period thereafter. Recipients must remain in the continuous employment of the Company up to the distribution date in order to receive the award. The amounts charged to expense in 1994, 1993 and 1992 aggregated $134, $116 and $78, respectively.\nThe Company plans to liquidate the ICP during the first quarter of 1995. The liquidation of the plan will be done through issuance of 21,379 shares of the Company's common stock to the current participants of the program. Each share will be valued at $7.919, which is the average market price of the Company's common stock over the last 20 business days of December, 1994. The total gross value of the liquidation is $283. 9. Stock Options\nThe Company has incentive stock option plans adopted in 1986 and 1992 which provide for the granting of options to officers and designated employees of the Company to purchase shares of the common stock of the Company at a price not less than the market value of the common stock on the date the option is granted. In addition, an incentive plan adopted in 1981 has been terminated and no new options can be granted under this plan, although unexercised options remain outstanding.\nOptions are exercisable in whole or in part from one to ten years from the date of the grant at the discretion of the stock option committee. Options granted under each plan may not exceed 400,000 shares. No charges to income arise in connection with the plans.\nOption plan transactions during 1994 and 1993 are summarized in the following table:\nPrice Range 1994 1993 Per Share Outstanding January 1 759,788 645,328 $8.00 - 27.50\nGranted 99,000 135,500 7.75 - 8.56 Exercised - (800) 8.50 Canceled (114,360) (20,240) 7.75 - 27.50\nOutstanding December 31 744,428 759,788 7.75 - 27.50\nExercisable at December 31 617,449 636,568 8.00 - 27.50\nOptions available for grant at January 1 277,530 405,290\nOptions available for grant at December 31 247,390 277,530\n10. Employee Benefit Plans\nDefined Benefit Pension Plan: The Company has a noncontributory defined benefit pension plan which covers salaried employees who meet minimum age and length of service requirements.\nOn March 31, 1991, the Company curtailed its defined benefit pension plan such that benefits do not accrue to plan participants for future years of service under the benefit formula. Benefits earned prior to the curtailment were based on members' years of service and averaged final salary.\nEffective January 1, 1994, the Company amended the defined benefit pension plan to add a cash balance plan feature, to provide benefits to plan participants that were previously provided under the defined contribution retirement plan. Past benefits earned by plan participants prior to curtailment are not changed and benefits earned by participants for future service are provided under a different benefit formula. New participants will earn benefits only under the revised formula. The new benefit formula provides for credits into notional individual account balances based upon salary and years of service. Management anticipates that the cash balance plan will significantly reduce the net periodic pension credit recognized in future years, and result in a reduction of the prepaid pension asset. The projected unit credit actuarial method is used to determine the recognition of net periodic pension expense and to determine funding requirements. The Company will continue to fund the plan as required.\nThe Company amortizes unrecognized prior service costs on a straight-line basis over a period not exceeding the average life expectancy of retirees.\nEffective January 1, 1992, the Company changed the method for amortizing unrecognized pension actuarial gains and losses, under which the full amount of the net actuarial gain or loss in the year is being amortized over a period not exceeding the average life expectancy of employees. The effect of the change in accounting method for the year ended December 31, 1992 related to the 1992 pension expense was to increase net income by $641, net of tax, or $0.12 per share on primary earnings per share and $0.10 per share on fully diluted earnings per share.\nPlan assets consist primarily of pooled equity, debt and short-term investment funds, a pooled real estate equity fund, 675,000 shares of the Company's common stock and $9,500 of the Company's Senior Notes (Note 6).\nThe table below sets forth the funded status of the defined benefit pension plan and the amounts recognized in the Company's financial statements at December 31, 1994 and 1993 and for the years then ended:\n1994 1993 Actuarial present value of benefit obligations: Vested benefits $ 100,201 $ 81,843 Accumulated benefit obligation 104,602 86,670 Projected benefit obligation 104,602 86,670 Plan assets at fair value 154,918 163,099\nPlan assets in excess of projected benefit obligation 50,316 76,429 Unrecognized prior service cost 8,832 1,825 Unrecognized net loss (gain) 9,514 (9,763) Remaining unrecognized net asset being recognized over 15 years (4,403) (5,284)\nPrepaid pension cost $ 64,259 $ 63,207\nComponents of net periodic pension credit: Service cost $ 7,910 $ - Interest cost on projected benefit obligation 7,651 6,829 Actual return on plan assets 1,370 (15,646) Net amortization and deferral (17,983) (857)\nNet periodic pension credit $ (1,052) $ (9,674)\nThe assumptions used in measuring the actuarial value of projected benefit obligations and determining the net periodic pension credit were:\n1994 1993 Weighted average discount rate 8.25% 8.25% Rate of compensation increase - cash balance feature 6.8% N\/A Weighted average expected long-term rate of return on plan assets 9.96% 10.00%\nDefined Contribution Pension Plans From April 1, 1991 to December 31, 1993, the Company sponsored a defined contribution retirement plan covering salaried employees who met minimum age and length of service requirements. Contributions were based on salaries and length of service. The Company also sponsors a Section 401(k) tax deferred savings plan which covers salaried employees who meet minimum age and length of service requirements. Matching contributions are based on employee contributions and are limited to one-half of the first 3% of the employee's compensation. Effective January 1, 1994, the defined contribution retirement plan was merged into the Section 401(k) tax deferred savings plan. No additional contributions will be made to the defined contribution retirement plan. Benefits earned under the Section 401(k) tax deferred savings plan remain unchanged. The aggregate amount charged to expense for these plans was $1,653 and $6,933 in 1994 and 1993, respectively.\nPostretirement Benefit Plan Employees retiring from the Company and eligible for an immediate benefit from the retirement plans (generally age 55 with 15 years of service) are eligible to continue their current medical insurance coverage into retirement. The medical benefits continue to be subject to the deductibles, copayment provisions and other limitations. Retirees pay for a portion of the total cost of their medical insurance and starting with 1993 retirements, the portion of the total cost will be dependent on the individual's total Company service at retirement. The medical plans of the Company are funded on a pay-as-you-go basis.\nEffective January 1, 1993, the Company adopted SFAS No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which mandates the accrual of postretirement health benefits during the years that employees render service. The following table sets forth the funded status of the plan and the amounts recognized in the Company's financial statements at December 31, 1994 and 1993 and for the years then ended: 1994 1993 Actuarial present value of accumulated postretirement benefit obligation: Retirees $14,023 $16,162 Fully eligible active plan participants 1,569 1,371 Other active plan participants 3,590 4,788 Accumulated unfunded postretirement benefit obligation 19,182 22,321 Remaining unrecognized transition obligation being recognized over 20 years (17,829) (18,820) Unrecognized net gain (loss) 2,183 (1,744) Accrued postretirement benefit obligation $ 3,536 $ 1,757\nNet periodic postretirement benefit cost includes the following components: Service cost $ 336 $ 286 Interest cost 1,652 1,612 Amortization of unrecognized transition obligation 991 991 Net periodic postretirement benefit cost $ 2,979 $ 2,889\nImpact of one percent increase in healthcare trend rate: Aggregate impact on annual service cost and interest cost $ 106 $ 120 Increase in accumulated postretirement benefit obligation $ 1,186 $ 1,619\nThe accumulated postretirement benefit obligation was computed using an assumed weighted average discount rate of 8.5% in 1994 and 7.5% in 1993. The healthcare cost trend rate was assumed to be 12% in 1994 decreasing by 1% a year to 6% in 2000 and 5.5% in 2001 and beyond.\nEffective January 1, 1994, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" This statement mandates the accrual of all types of postemployment benefits provided to former or inactive employees, their beneficiaries and covered dependents after employment but before retirement. The effect of the adoption of the standard was not material to the financial statements.\n11. Employee Stock Ownership Plan\nThe Company has a leveraged Employee Stock Ownership Plan (ESOP) for salaried employees who meet minimum age and length of service requirements. To fund the ESOP, the Company originally borrowed $18,092. Proceeds of this borrowing were loaned to the ESOP, which purchased 850,000 shares of Series B convertible preferred stock.\nEligible employees are allocated the Series B stock over the term of the ten-year ESOP loan. The allocated shares vest after five years of service.\nThe Series B stock is callable, in whole or in part, at the option of the Company at any time after July 1, 1994, at a price per share expressed as a percentage of the issue price of $21.29. At the Company's option, the call may be satisfied by common shares, cash or a combination thereof. The call price is 112% in 1995 and decreases to 100% in 1999 and for years thereafter. The trustee may, at any time, convert each share of Series B stock into one share of common stock.\nPrior to the retirement of the ESOP debt, employees can only redeem their vested preferred shares upon death or age 70 1\/2. Once the debt is retired, shares can be redeemed at retirement, termination or death. The redemption value is established at the end of each year by an independent appraiser. The latest appraised value dated March 7, 1995 was $17 per preferred share. At the Company's option, redemption by an employee may be satisfied by common shares, cash or a combination thereof.\nThe preferred stockholders are entitled to identical voting rights as the holders of common shares.\nThe loan to the ESOP is on the same terms as the Company's bank loan. The ESOP will repay the loan (plus interest) with proceeds from the quarterly dividends paid on the Series B stock and contributions from the Company. All contributions to the ESOP in excess of dividends are treated as compensation expense.\nCompensation expense and interest income for the years ended December 31, 1994, 1993 and 1992 were:\n1994 1993 1992 Compensation expense $412 $340 $215 Interest income $546 $509 $627\nThe interest income earned by the Company on the ESOP loan offsets the interest expense incurred on the original borrowing, with no impact on the results of operations.\n12. Stockholders' Equity\nOn July 20, 1992, the Company sold Karl Steiner Holding AG (Steiner) 9,000 shares of Series C 8.5% convertible preferred stock and 6,000 shares of Series D 8.5% convertible preferred stock for a total of $15,000. On July 22, 1992, the Series D stock was exchanged for an 8.5% convertible debenture due in 1997 in the principal amount of $6,000 (Note 6).\nThe Series C stock is convertible into 1,000,000 shares of common stock or can be exchanged for 9,000 shares of Series E 8.5% convertible preferred stock (which is substantially identical to the Series C stock, except as to transferability and election of directors). The debenture is convertible into 6,000 shares of Series D stock, which is convertible into 600,000 shares of common stock. The Series C stock has, and the Series D and Series E stock will have a liquidation preference of $1,000 per share and a cumulative dividend preference of $85 per share per year. At their option, the holders of the Series C, Series D and Series E stock will have the right to convert either the full amount or a partial percentage into common stock. While the Series C stockholders own securities constituting (after conversion) more than 10 percent of the Company's outstanding common stock, on a fully diluted basis, the Series C stockholders have the right to elect, as a class, between one and three directors, depending on the percentage of the outstanding stock owned. Holders of Series D and Series E stock, and Series C stock (except when they are entitled to elect at least one director as a class), vote on an as- converted basis as though they held common stock. Holders of Series C or Series D stock also have the right to elect a director if the Company is six quarters or more in arrears in paying dividends.\nIn connection with the purchase of the Company's securities by Steiner, the Company executed an agreement providing the Company and Steiner with certain rights, obligations and options which terminate on June 30, 2002, unless extended.\nUnder this agreement, Steiner has the right of first refusal in some instances with regard to sales by the Company of more than five percent of its stock. In addition, if the Company issues additional stock or convertible or exchangeable securities, Steiner will have the option in some instances to purchase similar securities to the extent necessary to maintain its percentage ownership.\nIf the Company issues, in a transaction or related series of transactions, common stock or convertible or exchangeable securities totaling at least 15% of the Company's outstanding common stock, on a fully diluted basis, the Series C stock will be redeemable during a 30-day period at its liquidation preference plus accrued or accumulated dividends, unless the holders of two- thirds of the Series C stock approve the transaction.\nThe Company has a right of first refusal with regard to sales or transfers of the Company's securities owned by Steiner constituting more than five percent of the Company's outstanding common stock, on a fully diluted basis. In addition, the Company has the option to repurchase the Company's securities owned by Steiner, upon a change in control in the ownership of Steiner.\nIf after December 31, 1994, the price of the Company's common stock is below $7 for at least 20 consecutive trading days (or if the agreement is not extended), Steiner may require the Company either to find a buyer (which may be the Company) for all of Steiner's holdings (or all its holdings except the debenture or Series D stock), or to sell Steiner additional common stock equal to Steiner's existing holdings on an as-converted basis, at a price selected by Steiner which is not higher than 115% of the market price of the Company's common stock. The Company will not decide until it knows the terms on which it is to find a buyer for Steiner's holdings or to sell Steiner additional common stock, which of the two options it would elect.\n13. Commitments and Contingencies\nThe Company (as lessee) leases office space under operating leases having remaining non-cancelable lease terms in excess of one year. Rental expense for the years ended December 31, 1994, 1993 and 1992 amounted to $9,254, $9,779 and $10,103, respectively. Future minimum rental payments are as follows:\n1995 1996 1997 1998 1999 Thereafter $8,597 $7,740 $6,604 $5,599 $5,079 $15,652\nThe Company (as lessor) has operating leases with tenants that provide for fixed minimum rent and reimbursement of a portion of operating costs. Additional rents for reimbursements included in rental income amounted to $373, $390, and $447 for 1994, 1993 and 1992, respectively. Tenant leases on commercial office and mixed-use properties have terms of up to ten years, and leases on residential properties generally have terms of one year or less. Minimum future rental revenue from non-cancelable leases in effect at December 31, 1994 are as follows:\n1995 1996 1997 1998 1999 Thereafter $8,199 $5,405 $4,198 $3,147 $2,553 $17,499\nThe Company has jointly and severally guaranteed completion of an $93,300 construction contract which was entered into by Turner Steiner International SA in which the Company has a 50% interest. The Company has guaranteed $2,750 of a $5,000 letter of credit facility and $275 of a $500 line of credit facility of Turner Steiner International SA.\nIn connection with the sale of certain assets and liabilities of a construction subsidiary, the Company agreed to guaranty or otherwise indemnify their surety up to $15,000 in obtaining bonds in excess of $45,000 through December 31, 1997.\nThe Company owns certain buildings, hangars and equipment and is the ground lessee on the underlying land located at an air industrial park. The Company has leased to a tenant the buildings, hangars, equipment and land with a term of 15 years expiring in 2010. Rental income under this lease represented 37%, 33% and 30% of total rental income for 1994, 1993 and 1992, respectively.\nThe Company is a defendant in various litigations incident to its business. In some instances the amounts sought are very substantial, including some which are proceeding to trial involving substantial claims and counterclaims, and certain parties are withholding significant amounts included in construction receivables pending the outcome of the litigation. Although the outcome of litigation cannot be predicted with certainty, in the opinion of management based on the facts known at this time, the resolution of such litigation is not anticipated to have a material adverse effect on the financial position or results of operations of the Company.\n14. Other Income, net\nThe major components of Other Income, net are as follows:\n1994 1993 1992 Interest and dividend income $ 1,074 $ 1,036 $ 1,035 Investment income (loss) (79) 861 - Equity in affiliates'net loss (1,915) (3,027) (3,928) Cumulative foreign translation reversal (1,193) - - Other 259 260 (10) $ (1,854) $ (870) $(2,903)\nEquity in affiliates' net loss includes losses from Turner Steiner International SA of $1,730, $3,027 and $1,726 for the years 1994, 1993 and 1992, respectively. 15. Business Segments\nThe Consolidated Statements of Operations provide segment information regarding revenues and operating expenses. Certain other financial data of the Company's business segments (construction and real estate) are presented below:\n1994 1993 1992 Identifiable assets at year end:\nConstruction $502,498 $ 448,524 $ 483,245 Real estate 116,007 128,597 143,792 General corporate 86,584 87,085 99,521 $705,089 $ 664,206 $ 726,558\nDepreciation and amortization expense:\nConstruction $ 2,522 $ 3,034 $ 3,706 Real estate 5,644 5,460 5,930 General corporate 1,200 1,330 1,407 $9,366 $ 9,824 $ 11,043\nInterest expense:\nConstruction $ 82 $ 65 $ 94 Real estate 3,586 4,252 6,528 General corporate 4,255 3,110 1,502 $ 7,923 $ 7,427 $ 8,124\n16. 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:\nCash and Cash Equivalents: The carrying amount of cash and cash equivalents approximates fair value due to the short-term maturity of these amounts.\nMarketable Securities: The fair value of marketable securities is based on quoted market prices for such investments. At December 31, 1994 and 1993, the fair value approximates the carrying amount.\nConstruction Receivables and Construction Payables: The carrying amount of construction receivables and construction payables approximate fair value as these amounts generally are due or payable within the Company's operating cycle.\nNotes Payable:\nThe fair value of notes payable secured by real estate properties is estimated based on discounting the future cash flows at the Company's year-end risk-adjusted incremental borrowing rate for a similar debt instrument, given the underlying value of the loan collateral.\nThe fair value of unsecured notes payable is estimated based on the Company's year-end, risk- adjusted incremental borrowing rate for similar liabilities.\nAt December 31, 1994 and 1993, the fair value of notes payable was $99,064 and $95,021, respectively.\nConvertible Debenture: The fair value of the convertible debenture is estimated based on the greater of the Company's risk-adjusted incremental borrowing rate for a similar debt instrument, or the value of the debt assuming conversion at the year-end stock price, which would reflect the probability of conversion by the debt holder. At December 31, 1994 and 1993, the fair value was $5,700.\nESOP Loan Receivable: The fair value of the loan receivable from the ESOP is estimated based on the fair value of the Company's borrowing to fund the ESOP. At December 31, 1994 and 1993, the fair value was $10,714 and $12,255, respectively.\nInterest Rate Swap Agreements: The Company uses unleveraged interest rate swaps to provide fixed interest rates for selected periods of time on certain outstanding loans (Note 6). Cash settlements on the swaps occur monthly and are recorded as an adjustment to interest expense. The fair value of the interest rate swap agreements is estimated based on the discounted value of the difference between the fixed payments on the swap and the payments that would be required at current market fixed rates for a similar financial instrument. The fair value of the interest rate swap asset was $869 at December 31, 1994. The fair value of the interest rate swap liability was $286 at December 31, 1993.\n17. Quarterly Financial Information (Unaudited)\n1994 Quarter Ended March 31 June 30 September 30 December 31 Value of construction completed $592,390 $676,629 $658,849 $710,711 Gross earnings $ 14,729 $ 15,209 $ 10,752 $ 13,925 Income (loss) before income taxes 1,122 1,651 (1,837) (446)(a) Net income 1,059 997 896(b) 698(b) Primary earnings per common share (c) 0.12 0.10 0.08 0.05 Fully diluted earnings per common share (c) 0.10 0.09 0.07 0.04\n1993 Quarter Ended March 31 June 30 September 30 December 31 Value of construction completed $580,941 $737,080 $735,223 $715,135 Gross earnings $ 15,758 $ 14,936 $ 16,952 $ 11,719 Income (loss) before income taxes 1,704 1,280 1,816 (14,569)(d) Net income (loss) 946 909 911 (8,971) Primary earnings (loss) per common share (c) 0.09 0.09 0.09 (1.83) Fully diluted earnings per common share (c) 0.08 0.07 0.07 (e)\n(a) Includes restructuring credits of $1,145. (b) Includes income tax benefits resulting from operations and excess tax reserves. (c) The quarterly per share amounts are computed independently of annual amounts. (d) Includes restructuring charges of $8,500 and real estate write-downs and reserves of $5,188. (e) Antidilutive.\nResponsibilities for Financial Reporting:\nThe management of The Turner Corporation and Subsidiaries has the responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The financial statements were prepared in accordance with generally accepted accounting principles applied on a consistent basis and are not misstated due to material fraud or error. The financial statements include amounts that are based on management's best estimates and judgments. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the financial statements.\nThe fair presentation of the Company's financial position, results of operations and cash flows are reported on by the independent public accountants, Arthur Andersen LLP (see Report of Independent Public Accountants) for each of the three years in the period ended December 31, 1994. Their report emphasizes that the Company has significant interests in real estate properties, the carrying amounts of which are based on management's present intent to hold these properties until market conditions improve to the extent necessary to achieve reasonable prices upon disposition. Management has made available to Arthur Andersen LLP all of the Company's financial records and related data, as well as the minutes of stockholders' and directors' meetings. Furthermore, management believes that all representations made to Arthur Andersen LLP during its audit were valid and appropriate.\nTo fulfill the responsibility for the reporting of financial results, management maintains a system of accounting and internal controls. Management has operational and financial personnel perform procedures to provide assurance of compliance with controls and policies. In addition, based upon management's assessments of risk, operational, financial and special reviews are performed by contracted auditors to monitor the effectiveness of selected controls. Management seeks to assure the quality of financial reporting by careful selection and training of supervisory and management personnel, by organization structures that provide an appropriate division of responsibility, and by communication of accounting and business policies and procedures throughout the Company. Management believes the internal accounting controls in use provide reasonable assurance that the Company's assets are safeguarded, that transactions are executed in accordance with management's authorizations, and that the financial records are reliable for the purpose of preparing financial statements. In addition, the Company has distributed a statement of its policies for conducting business affairs in a lawful and ethical manner and receives reports of compliance annually.\nThe Board of Directors, through the Audit Committee of the Board, meets separately and jointly with management, the contracted auditors and the independent public accountants on a periodic basis to assure itself that each is carrying out its responsibilities.\nItem 9.","section_9":"Item 9. Change 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 with respect to the directors and nominees for directors which will appear in the registrant's definitive proxy statement to be filed with the Securities and Exchange Commission prior to April 30, 1995, is incorporated herein by reference.\nExecutive Officers of the Registrant.\nServed as an Officer in the Capacity Name Age Office Indicated Since Alfred T. McNeill 58 Chairman of the Board, Chairman since 3\/1\/89. Chief Executive Officer and Director Harold J. Parmelee 57 President and Director President since 5\/11\/90. Joseph V. Vumbacco 49 Executive Vice President Executive Vice President and General Counsel since November 11, 1994 David J. Smith 54 Senior Vice President and 1\/1\/94. Chief Financial Officer Ralph W. Johnson 58 Senior Vice President 6\/11\/93. Donald R. Kerstetter 64 Senior Vice President 6\/11\/93. Richard H. Esau, Jr. 60 Vice President 6\/11\/93. Francis C. O'Connor 52 Vice President 11\/1\/92. Sara J. Gozo 31 Vice President, Secretary and Associate General Counsel 10\/24\/94. Donald G. Sleeman 40 Vice President and Treasurer Treasurer since 1\/15\/92. Anthony C. Breu 47 Vice President and Controller Controller since 6\/1\/88.\nEach executive officer holds office at the pleasure of the Board of Directors.\nEach of the executive officers listed above is an employee of The Turner Corporation or Turner Construction Company and has been an employee of these companies or other construction subsidiaries in an executive, managerial or engineering capacity for the past five years except for Mr. Smith and Ms. Gozo. From 1983 to 1993 Mr. Smith served as Vice President and Treasurer of Mack Trucks, Inc., a subsidiary of Renault. From 1976 to 1983 Mr. Smith held various executive financial positions within the Renault organization. From 1989 to 1993, Ms. Gozo practiced construction law at Shea & Gould, and until October 1994, at Thelen, Marrin, Johnson & Bridges.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information which will appear under the caption \"Remuneration of Executive Officers\" in the registrant's definitive proxy statement to be filed with the Securities and Exchange Commission prior to April 30, 1995, is incorporated herein by reference. Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information under the caption \"Election of Directors\" in the registrant's definitive proxy statement to be filed with the Securities and Exchange Commission prior to April 30, 1995 with respect to the ownership by certain beneficial owners and management of the registrant's stock is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information under the caption \"Election of Directors\" in the registrant's definitive proxy statement to be filed with the Securities and Exchange Commission prior to April 30, 1995 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.\na) Documents filed as part of this report (including documents incorporated herein by reference):\n1. Financial Statements: Page No. - Report of Independent Public Accountants 14 - Consolidated Balance Sheets - as of December 31, 1994 and 1993 15 - Consolidated Statements of Operations - for the years ended December 31, 1994, 1993 and 1992 16 - Consolidated Statements of Stockholders' Equity - for the years ended December 31, 1994, 1993 and 1992 17 - Consolidated Statements of Cash Flows - for the years ended December 31, 1994, 1993 and 1992 18 - Notes to Consolidated Financial Statements 19-36 - Responsibilities for Financial Reporting 37\n2. Consent of Independent Public Accountants 45\nIndividual financial statements of the registrant and financial statement schedules not included above are omitted since they are either not required or not applicable or the information has been presented in the notes to consolidated financial statements.\n3. Exhibits\nExhibit No. Description\n3(a)(i) Certificate of Incorporated herein by Incorporation, as reference to Exhibit 3 to the amended to 7\/10\/89. Registration Statement on Form S-14 of The Turner Corporation, No. 2- 90235.\n3(a)(ii) Amendment dated, 5\/19\/86 Incorporated herein 3(a)(iii) Amendment dated, 9\/12\/88 by reference to Exhibit 3(a) 3(a)(iv) Amendment dated, 7\/10\/89 to the Company's 1989 Annual Report on Form 10-K. Exhibit No. Description\n3(b) By-Laws, as amended Incorporated herein by reference to 6\/11\/93. to Exhibit 3(b) to the Company's 1993 Annual Report on Form 10-K\n3(c)(i) Certificate of Designations Incorporated herein relating to Series C 8-1\/2% by reference to Exhibit Convertible Preference Stock. 2 to the Company's Form 8-K dated July 20, 1992.\n3(c)(ii) Certificate of Designations Incorporated herein relating to Series D 8-1\/2% by reference to Convertible Preference Stock. Exhibit 3 to the Company's Form 8-K dated July 20, 1992.\n3(c)(iii) Certificate of Designations Incorporated herein by relating to Series E 8-1\/2% reference to Exhibit 4 to Convertible Preference Stock. the Company's Form 8-K dated July 20, 1992.\n4(a) Shareholders Rights Incorporated herein by Agreement. reference to the Registration Statement on Form 8-A dated September 9, 1988.\n4(b) Agreement regarding Security Incorporated herein Holder's Rights, Obligations by reference to and Options. Exhibit 5 to the Company's Form 8-K dated July 20, 1992.\n10(c)(i)The Company's Executive Incorporated herein Incentive Compensation by reference to Plan. Exhibit 10.3 to the Registration Statement on Form S-14 of The Turner Corporation, No. 2-90235.\n10(c)(ii)The Company's 1981 Stock Incorporated herein by Option Plan, as amended. reference to Exhibit 10(c)(v) 1988 Annual Report on Form 10-K.\n10(c)(iii)The Company's 1986 Incorporated herein by reference Stock Option Plan, to Exhibit 10(c)(vii) to the as amended as amended. Company's 1988 Annual Report on Form 10-K.\n10(c)(iv)The Company's 1992 Stock Incorporated herein by reference to the Option Plan. Registration Statement on Form S-8.\n10(c)(v) The Company's Incentive Incorporated herein Compensation Plan. by reference to Exhibit 10(c)(v) to the Company's 1983 Annual Report on Form 10-K.\nExhibit No.Description\n10(c)(vi) The Company's Retirement Incorporated herein by reference Benefit Equalization Plan, to Exhibit 10(c)(vi) to the Company's amended and restated as of 1992 Annual Report 1\/22\/92. on Form 10-K.\n10(c)(vii) The Company's Defined Incorporated herein by reference Contribution Retirement to Exhibit 10(c)(vii) to the Company's Equalization Plan. 1992 Annual Report on Form 10-K\n10(c)(viii)The Company's Supplemental Incorporated herein by reference Executive Defined Benefit to Exhibit 10(c)(viii) to the Company's Retirement Plan. 1992 Annual Report on Form 10-K.\n10(c)(ix) The Company's Supplemental Incorporated herein by reference Executive Defined Contribution to Exhibit 10(c)(ix) to the Company's Retirement Plan. 1992 Annual Report on Form 10-K.\n10(c)(x) Tax Deferred Savings Incorporated herein by reference to Income Plan amended and Exhibit 10(c)(ix) to the Company's restated as of 1\/1\/89. 1991 Annual Report on Form 10-K.\n10(c)(xi) Option Exchange and Incorporated herein by reference to Stock Purchase Plan. Registration Statement on Form S-8, File No. 33-33867.\n10(c)(xii)Employees' Retirement Incorporated herein by reference to Plan - Restated as of Exhibit 10(c)(vii) to the Company's 1\/1\/87. 1991 Annual Report on Form 10-K.\n10(c)(xiii)Employees' Retirement Incorporated herein by reference Income Plan as of 4\/1\/91. to Exhibit 10(c)(viii) to the Company's 1991 Annual Report on Form 10-K. 10(c)(xiv)Director's Retirement Plan\n10(d) Asset Purchase Agreement Incorporated herein by reference dated 6\/3\/92, between to Exhibit 10(d) to the Company's Turner Steiner International 1992 Annual Report on Form 10-K. S.A. and Turner International Industries, Inc., and Turner International Industries (U.K.) Ltd.\n10(e) Joint Venture and Shareholders Incorporated herein by reference Agreement dated 6\/3\/92 between to Exhibit 10(e) to the Company's The Turner Corporation and Karl 1992 Annual Report on Form 10-K. Steiner Holding AG.\n10(f) Purchase Agreement dated Incorporated herein by reference June 3, 1992 between Karl to Exhibit 1 to the Company's Steiner Holding AG and The Form 8-K dated July 20, 1992. Turner Corporation. Exhibit No.Description\n10(g)(i) The Company's Revolving Incorporated herein by reference Credit Facility dated as of to Exhibit 10(g)(i) to the Company's 12\/30\/92. 1993 Annual Report on Form 10-K.\n10(g)(ii)Amendment No. 1 to Incorporated herein by reference Credit Agreement dated to Exhibit 10(g)(ii) to the Company's as of 12\/31\/93. 1993 Annual Report on Form 10-K.\n10(h) Form of Change of Control Agree- Incorporated herein by reference ment between The Turner Corp- to Exhibit 10(h) to the Company's oration and Messrs. McNeill, 1993 Annual Report on Form 10-K. Parmelee, Smith and Vumbacco, respectively, Chairman, President, Chief Financial Officer and General Counsel dated July 1, 1993.\n10(i) Form of Change of Control Incorporated herein by reference Agreement with 56 other to Exhibit 10(i) to the Company's officers of parent or 1993 Annual Report on Form 10-K. subsidaries dated July 1, 1993.\n10(j) Note Purchase Agreement 11.74% Senior Notes Due 2001 dated as of December 1, 1994.\n11 Computation of earnings per share.\n21 Subsidiaries of the Registrant.\n27 Financial Data Schedules. 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.\nTHE TURNER CORPORATION\nRegistrant\nDate: March 10, 1995 By: A. T. McNeill A. T. McNeill Chairman of the Board, Chief Executive Officer and 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.\nName Capacity Date\nH. Baumann - Steiner Director March 10, 1995 (H. Baumann-Steiner)\nW. G. Ehlers Director March 10, 1995 (W. G. Ehlers)\nA. G. Fieger Director March 10, 1995 (A. G. Fieger)\nE. T. Gravette, Jr. Director March 10, 1995 (E. T. Gravette, Jr.)\nL. Lomo Director March 10, 1995 (L. Lomo)\nA. T. McNeill Chairman of the Board, March 10, 1995 (A. T. McNeill) Chief Executive Officer and Director Name Capacity Date\nC. H. Moore, Jr Director March 10, 1995 (C. H. Moore, Jr.)\nH. J. Parmelee President and Director March 10, 1995 (H. J. Parmelee)\nD. J. Smith Senior Vice President March 10, 1995 (D. J. Smith) and Chief Financial Officer\nP. K. Steiner Director March 10, 1995 (P. K. Steiner)\nG. A. Walker Director March 10, 1995 (G. A. Walker)\nJ. O. Whitney Director March 10, 1995 (J. O. Whitney)\nF. W. Zuckerman Director March 10, 1995 (F. W. Zuckerman)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our report dated March 7, 1995 included in this Form 10-K, into the Company's previously filed Registration Statements on Form S-8 (File Nos. 2-64509 and 33-33867).\nARTHUR ANDERSEN LLP\nNew York, New York March 30, 1995\nEXHIBIT INDEX\nExhibit No. Description\n3(a)(i) Certificate of Incorporated herein by Incorporation, as reference to Exhibit 3 to the amended to 7\/10\/89. Registration Statement on Form S-14 of The Turner Corporation, No. 2- 90235.\n3(a)(ii) Amendment dated, 5\/19\/86 Incorporated herein 3(a)(iii) Amendment dated, 9\/12\/88 by reference to Exhibit 3(a) 3(a)(iv) Amendment dated, 7\/10\/89 to the Company's 1989 Annual Report on Form 10-K.\n3(b) By-Laws, as amended Incorporated herein by reference to 6\/11\/93. to Exhibit 3(b) to the Company's 1993 Annual Report on Form 10-K\n3(c)(i) Certificate of Designations Incorporated herein relating to Series C 8-1\/2% by reference to Exhibit Convertible Preference Stock.2 to the Company's Form 8-K dated July 20, 1992.\n3(c)(ii) Certificate of Designations Incorporated herein relating to Series D 8-1\/2% by reference to Convertible Preference Stock.Exhibit 3 to the Company's Form 8-K dated July 20, 1992.\n3(c)(iii)Certificate of Designations Incorporated herein by relating to Series E 8-1\/2% reference to Exhibit 4 to Convertible Preference Stock.the Company's Form 8-K dated July 20, 1992.\n4(a) Shareholders Rights Incorporated herein by Agreement. reference to the Registration Statement on Form 8-A dated September 9, 1988.\n4(b) Agreement regarding Security Incorporated herein Holder's Rights, Obligations by reference to and Options. Exhibit 5 to the Company's Form 8-K dated July 20, 1992.\n10(c)(i)The Company's Executive Incorporated herein Incentive Compensation by reference to Plan. Exhibit 10.3 to the Registration Statement on Form S-14 of The Turner Corporation, No. 2-90235. Exhibit No.Description\n10(c)(ii)The Company's 1981 Stock Incorporated herein by reference Option Plan, as amended. to Exhibit 10(c)(v) to the Company's 1988 Annual Report on Form 10-K.\n10(c)(iii)The Company's 1986 Incorporated herein by reference Stock Option Plan, to Exhibit 10(c)(vii) to the as amended as amended. Company's 1988 Annual Report on Form 10-K.\n10(c)(iv)The Company's 1992 Stock Incorporated herein by reference to the Option Plan. Registration Statement on Form S-8.\n10(c)(v) The Company's Incentive Incorporated herein Compensation Plan. by reference to Exhibit 10(c)(v) to the Company's 1983 Annual Report on Form 10-K.\n10(c)(vi)The Company's Retirement Incorporated herein by reference Benefit Equalization Plan, to Exhibit 10(c)(vi) to the Company's amended and restated as of 1992 Annual Report 1\/22\/92. on Form 10-K.\n10(c)(vii)The Company's Defined Incorporated herein by reference Contribution Retirement to Exhibit 10(c)(vii) to the Company's Equalization Plan. 1992 Annual Report on Form 10-K\n10(c)(viii)The Company's Supplemental Incorporated herein by reference Executive Defined Benefit to Exhibit 10(c)(viii) to the Company's Retirement Plan. 1992 Annual Report on Form 10-K.\n10(c)(ix) The Company's Supplemental Incorporated herein by reference Executive Defined Contri- to Exhibit 10(c)(ix) to the Company's bution Retirement Plan. 1992 Annual Report on Form 10-K.\n10(c)(x) Tax Deferred Savings Incorporated herein by reference to Income Plan amended and Exhibit 10(c)(ix) to the Company's restated as of 1\/1\/89. 1991 Annual Report on Form 10-K.\n10(c)(xi) Option Exchange and Incorporated herein by reference to Stock Purchase Plan. Registration Statement on Form S-8, File No. 33-33867.\n10(c)(xii) Employees' Retirement Incorporated herein by reference to Plan - Restated as of Exhibit 10(c)(vii) to the Company's 1\/1\/87. 1991 Annual Report on Form 10-K.\n10(c)(xiii)Employees' Retirement Incorporated herein by reference Income Plan as of 4\/1\/91. to Exhibit 10(c)(viii) to the Company's 1991 Annual Report on Form 10-K.\n10(c)(xiv)Director's Retirement Plan\nExhibit No. Description\n10(d) Asset Purchase Agreement Incorporated herein by reference dated 6\/3\/92, between to Exhibit 10(d) to the Company's Turner Steiner International 1992 Annual Report on Form 10-K. S.A. and Turner International Industries, Inc., and Turner International Industries (U.K.) Ltd.\n10(e) Joint Venture and Shareholders Incorporated herein by reference Agreement dated 6\/3\/92 between to Exhibit 10(e) to the Company's The Turner Corporation and Karl 1992 Annual Report on Form 10-K. Steiner Holding AG.\n10(f) Purchase Agreement dated Incorporated herein by reference June 3, 1992 between Karl to Exhibit 1 to the Company's Steiner Holding AG and The Form 8-K dated July 20, 1992. Turner Corporation.\n10(g)(i)The Company's Revolving Incorporated herein by reference Credit Facility dated as of to Exhibit 10(g)(i) to the Company's 12\/30\/92. 1993 Annual Report on Form 10-K.\n10(g)(ii) Amendment No. 1 to Incorporated herein by reference Credit Agreement dated to Exhibit 10(g)(ii) to the Company's as of 12\/31\/93. 1993 Annual Report on Form 10-K.\n10(h) Form of Change of Control Agree- Incorporated herein by reference ment between The Turner Corp- to Exhibit 10(h) to the Company's oration and Messrs. McNeill, 1993 Annual Report on Form 10-K. Parmelee, Smith and Vumbacco, respectively, Chairman, President, Chief Financial Officer and General Counsel dated July 1, 1993.\n10(i) Form of Change of Control Incorporated herein by reference Agreement with 56 other to Exhibit 10(i) to the Company's officers of parent or 1993 Annual Report on Form 10-K. subsidiaries dated July 1, 1993.\n10(j) Note Purchase Agreement 11.74% Senior Notes Due 2001 dated as of December 1, 1994.\n11 Computation of earnings per share.\n21 Subsidiaries of the Registrant.\n27 Financial Data Schedules.","section_15":""}
{"filename":"28412_1994.txt","cik":"28412","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nComerica Incorporated (\"Comerica\" or the \"Corporation\") is a registered bank holding company incorporated under the laws of the State of Delaware, headquartered in Detroit, Michigan, and was formed in 1973 to acquire the outstanding common stock of Comerica Bank (formerly Comerica Bank-Detroit), a Michigan banking corporation (\"Comerica Bank\"). As of December 31, 1994, Comerica owned directly or indirectly all the outstanding common stock (except for directors' qualifying shares, where applicable) of seven banking and forty-nine non-banking subsidiaries. At December 31, 1994, Comerica had total assets of approximately $33.4 billion, total deposits of approximately $22.4 billion, total loans (net of unearned income) of approximately $22.2 billion, and shareholders' equity of approximately $2.4 billion. At December 31, 1994, Comerica was the second largest bank holding company headquartered in Michigan in terms of both total assets and total deposits.\nBUSINESS STRATEGY\nComerica's business strategy focuses on five core businesses in four geographic markets. Those businesses are corporate banking, consumer banking, private banking, institutional trust and investment management, and international finance and trade services. Corporate banking incorporates highly specialized units servicing a full range of company sizes with both credit and non-credit products. Consumer banking provides deposit, credit and fee-based products to individuals needing financial services but whose income or wealth do not make them prospects for private banking services. Private banking is oriented to servicing the financial needs of the affluent market as defined by individual net income or wealth. Institutional trust and investment management activities involve providing companies, municipalities and other entities a wide spectrum of investment management products and trust products such as master trust, master custody, and corporate trust services, as well as administering and serving as trustee for employee benefit plans. International finance and trade services offer importers and exporters trade financing, letters of credit,\nFORM 10-K: COMERICA INCORPORATED AND SUBSIDIARIES\nforeign exchange and international customhouse brokerage and freight forwarding products. The core businesses are tailored to each of Comerica's four primary geographic markets: the Midwest (currently Michigan and Illinois), Texas, California and Florida. The Midwest is the only market in which all five core businesses are currently pursued. In California and Texas the primary focus is on corporate banking and private banking activities. In Florida the primary focus is on private banking.\nACQUISITIONS AND JOINT VENTURE\nOn September 8, 1993, Comerica, Pacific Western Bancshares, Inc., a Delaware Corporation and bank holding company (\"PAC WEST\"), Pacific Western Bank, a California state chartered bank and wholly owned subsidiary of PAC WEST (\"PWB\"), and Comerica California Incorporated, a California corporation, bank holding company and wholly owned subsidiary of the Corporation (\"COM CAL\"), entered into an Agreement and Plan of Reorganization and Merger providing for, among other things, the merger of COM CAL into PAC WEST with PAC WEST being the surviving corporation under the charter and bylaws of COM CAL and the name \"Comerica California Incorporated.\" The merger of COM CAL into PAC WEST was completed on March 30, 1994 and was accounted for as a purchase. PAC WEST shareholders received common stock of the Corporation valued at approximately $121 million. At December 31, 1993, PAC WEST had assets of approximately $1 billion. PWB merged into Comerica Bank-California on June 30, 1994. On April 4, 1994, Comerica, Michigan National Corporation, a Michigan corporation and a bank holding company (\"MNC\"), Lockwood Banc Group, Inc., a Michigan corporation, wholly owned subsidiary of MNC and a registered bank holding company (\"Lockwood\") and Lockwood National Bank of Houston, a national banking association and wholly owned subsidiary of Lockwood (\"LNB\") entered into a Stock Purchase Agreement whereby Comerica purchased from MNC all of the issued and outstanding stock of Lockwood and LNB. The purchase was completed on August 4, 1994 for a purchase price of approximately $44 million in cash. At June 30, 1994, Lockwood had assets of approximately $318 million. Comerica contributed the stock of LNB to Comerica Texas Incorporated its wholly owned bank holding company in Texas. LNB merged into Comerica Bank-Texas on December 16, 1994. On October 4, 1994, Comerica, University Bank & Trust Company, a California bank (\"UBT\") and Comerica Interim Incorporated, a California corporation and wholly owned subsidiary of Comerica (\"Interim\") entered into an Agreement and Plan of Reorganization and Merger providing for, among other things, the merger of UBT into Interim with UBT being the surviving corporation. Subsequent to the merger of UBT into Interim, UBT may, at the Corporation's election, be merged into a subsidiary of the Corporation. UBT shareholders will receive approximately 2.7 million shares of Comerica common stock. The transaction is subject to regulatory approval and is expected to be completed in the spring of 1995. As of December 31, 1994, UBT had total assets of approximately $460 million. On November, 2, 1994, Comerica and Munder Capital Management, Inc., a Delaware corporation and registered investment adviser located in the Detroit, Michigan metropolitan area (\"Munder\"), entered into a Joint Venture Agreement providing for the combination of the investment advisory businesses of Munder and two investment advisory subsidiaries of Comerica: Woodbridge Capital Management, Inc. (\"Woodbridge\") and World Asset Management, Inc. (\"World\"). As of December 31, 1994, the joint venture became effective with the formation of a partnership, Munder Capital Management, that succeeded to the investment advisory businesses of Munder, Woodbridge, and World. Munder now holds a majority interest in Munder Capital Management, and Comerica holds a minority interest.\nSUPERVISION AND REGULATION\nBanks, bank holding companies and financial institutions are highly regulated at both the state and federal level. As a bank holding company, Comerica is subject to supervision and regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended (the \"Act\"). Under the Act, the Corporation is prohibited, with certain exceptions, from acquiring or retaining direct or indirect ownership or control of voting shares of any company which is not a bank or bank holding company and from engaging in activities other than those of banking or of managing or controlling banks, other than subsidiary companies and activities which the Federal Reserve Board determines to be so closely related to the business of banking as to be a proper incident thereto. Comerica Bank is chartered by the State of Michigan and is supervised and regulated by the Financial Institutions Bureau of the State of Michigan. Comerica Bank-Texas is chartered by the State of Texas and is supervised and regulated by the Texas Department of Banking. Comerica Bank-Midwest, N.A. and Comerica Bank-Ann Arbor, N.A. are chartered under federal law and subject to supervision and regulation by the Office of the Comptroller of the Currency. Comerica Bank-California is chartered and regulated by the State of California. Comerica Bank & Trust, FSB is chartered under federal law and subject to supervision and regulation by the Office of Thrift Supervision. Comerica Bank-Illinois is chartered by the State of Illinois and is regulated by the State of Illinois Commissioner of Banks and Trust Companies. Comerica Bank, Comerica Bank-Illinois, Comerica\nFORM 10-K: COMERICA INCORPORATED AND SUBSIDIARIES\nBank-Midwest, N.A. and Comerica Bank-Ann Arbor, N.A. are members of the Federal Reserve System. State member banks are also regulated by the Federal Reserve Bank and state non-member banks are also regulated by the Federal Deposit Insurance Corporation. The deposits of all the banks, except for Comerica Bank & Trust, FSB, are insured by the Bank Insurance Fund (the \"BIF\") of the Federal Deposit Insurance Corporation to the extent provided by law. The deposits of Comerica Bank & Trust, FSB, are insured by the Savings Association Insurance Fund to the extent provided by law. Comerica is a legal entity separate and distinct from its banking and other subsidiaries. Most of Comerica's revenues result from dividends paid to it by its bank subsidiaries. There are statutory and regulatory requirements applicable to the payment of dividends by subsidiary banks to Comerica as well as by Comerica to its shareholders.\nINTERSTATE BANKING AND BRANCHING\nOn September 29, 1994, the Riegle\/Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Act\") was signed into law. This 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 acquiror on a consolidated basis would control more than 10 percent of the total deposits nationwide or would control more than 30 percent 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 the 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. Branching 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. Interstate branching is also subject to a 30 percent statewide deposit concentration limit on a consolidated basis, and a 10 percent nationwide deposit concentration limit. The laws of the host state regarding community reinvestment, fair lending, consumer protection (including usury limits) and establishment of branches shall apply to the interstate branches. De 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 initial acquisition of a bank in the host state other than the deposit concentration limits. Effective 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 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 conditions, insured saving associations which were affiliated with banks as of June 1, 1994, may act as agents for such banks. An affiliate bank or saving association may not conduct any activity as an agent which such institution is prohibited from conducting as principal. If 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. To 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.\nFORM 10-K: COMERICA INCORPORATED AND SUBSIDIARIES\nWhen the interstate banking provisions become effective in one year, Comerica will have enhanced opportunities to acquire banks in any state subject to approval by the appropriate federal and state regulatory agencies. When the interstate branching provisions become effective in June 1997, Comerica will have the opportunity to consolidate its affiliate banks to create one legal entity with branches in more than one state should management decide to do so, or to establish branches in different states, subject to any state opt-out provisions. The agency authority permitting Comerica affiliate banks to act as agents for each other in accepting deposits or servicing loans should make it more convenient for customers of one Comerica bank to transact their banking business at a Comerica affiliate in another state provided that operations are in place to facilitate these out of state transactions.\nDIVIDENDS\nEach state bank subsidiary that is a member of the Federal Reserve System and each national banking association is required by federal law to obtain the prior approval of the Federal Reserve Board or the Office of the Comptroller of the Currency, as the case may be, for the declaration and payment of dividends if the total of all dividends declared by the board of directors of such bank in any year will exceed the total of (i) such bank's net profits (as defined and interpreted by regulation) for that year plus (ii) the retained net profits (as defined and interpreted by regulation) for the preceding two years, less any required transfers to surplus. In addition, these banks may only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined by regulation). Under the foregoing dividend restrictions, at January 1, 1995 Comerica's subsidiary banks, without obtaining governmental approvals, could declare aggregate dividends of approximately $153 million from retained net profits of the preceding two years, plus an amount approximately equal to the net profits (as measured under current regulations), if any, earned for the period from January 1, 1995 through the date of declaration. Dividends paid to Comerica by its subsidiary banks amounted to $293 million in 1994 and $311 million in 1993.\nFIRREA\nRecent banking legislation, including the Financial Institutions Reform and Recovery and Enforcement Act of 1989 (\"FIRREA\") and the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), has broadened the regulatory powers of the federal bank regulatory agencies. Under FIRREA, a depository institution insured by the Federal Deposit Insurance Corporation (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 any 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.\nFDICIA\nIn December 1991, FDICIA was enacted, substantially revising the bank regulatory and funding provisions of the Federal Deposit Insurance Act and making revisions to several other federal banking statutes. Among other things, FDICIA requires the federal banking agencies to take \"prompt corrective action\" in respect of depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" and \"critically undercapitalized.\" A depository institution's capital tier will depend upon where its capital levels are in relation to various relevant capital measures, which will include a risk-based capital measure and a leverage ratio capital measure, and certain other factors. Regulations establishing the specific capital tiers provide that, for an institution to be well capitalized it must have a total risk-based capital ratio of at least 10 percent, a Tier 1 risk-based capital ratio of at least 6 percent, a Tier 1 leverage ratio of at least 5 percent, 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 percent, a Tier 1 risk-based capital ratio of at least 4 percent, and a Tier 1 leverage ratio of at least 4 percent (and in some cases 3 percent). Under these regulations, the banking subsidiaries of Comerica would be considered to be well capitalized as of December 31, 1994. FDICIA 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\nFORM 10-K: COMERICA INCORPORATED AND SUBSIDIARIES\nsubject to growth limitations and are required to submit a capital restoration 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. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company under the guaranty is limited to the lesser of (i) an amount equal to 5 percent of the depository institution's total assets at the time it became undercapitalized, and (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. 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 institutions are subject to the appointment of a receiver or conservator. Under FDICIA, the FDIC is permitted to provide financial assistance to an insured bank before appointment of a conservator or receiver only if (i) such assistance would be the least costly method of meeting the FDIC's insurance obligations, (ii) grounds for appointment of a conservator or a receiver exist or are likely to exist, (iii) it is unlikely that the bank can meet all capital standards without assistance and (iv) the bank's management has been competent, has complied with applicable laws, regulations, rules and supervisory directives and has not engaged in any insider dealing, speculative practice or other abusive activity. FDICIA directs that each federal banking agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares and other standards as they deem appropriate. Because such standards have been proposed but not yet finalized, management is unable to assess their impact. FDICIA also contains a variety of other provisions that may affect the operations of depository institutions including new reporting requirements, regulatory standards for real estate lending, \"truth in savings\" provisions, the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch and a prohibition on the acceptance or renewal of brokered deposits by depository institutions that are not well capitalized or are adequately capitalized and have not received a waiver from the FDIC. Under regulations relating to the brokered deposit prohibition, Comerica Bank is well capitalized and may accept brokered deposits without restriction.\nFDIC INSURANCE ASSESSMENTS\nComerica's subsidiary banks are subject to FDIC deposit insurance assessments. 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 upon the assessment category into which the insured institution is placed. Based on the current FDIC proposal, it is probable that such assessments will decrease in the future. Any decrease in assessments could have a positive impact on Comerica's results of operations.\nCOMPETITION\nBanking is a highly competitive business. The Michigan banking subsidiary of the Corporation competes primarily with Detroit and outstate Michigan banks for loans, deposits and trust accounts. Through its offices in Arizona, California, Colorado, Florida, Indiana, Illinois, Ohio and Texas, Comerica competes with other financial institutions for various types of loans. Through its Florida subsidiary, Comerica competes with many companies, including financial institutions, for trust business. At year-end 1994, Comerica Incorporated was the second largest bank holding company located in Michigan in terms of total assets and deposits. Based on the Interstate Act as described above, the Corporation believes that the level of competition in all geographic markets will increase in the future. Comerica's banking subsidiaries also face competition from other financial intermediaries, including savings and loan associations, consumer finance companies, leasing companies and credit unions.\nEMPLOYEES\nAs of December 31, 1994, Comerica and its subsidiaries had 11,239 full-time and 2,259 part-time employees.\nFORM 10-K: COMERICA INCORPORATED AND SUBSIDIARIES\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe executive offices of the Corporation are located in the Comerica Tower at Detroit Center in Detroit, Michigan. Comerica and its subsidiaries occupies 15 floors of the building, which it leases through Comerica Bank from an unaffiliated third party. This lease extends through January 2007. As of December 31, 1994, Comerica Bank operated 310 offices within the State of Michigan, of which 228 were owned and 82 were leased. Seven other banking affiliates operate 146 offices in California, Florida, Illinois and Texas. The affiliates own 58 of their offices and lease 88 offices. One banking affiliate also operates from leased space in Toledo, Ohio. In addition, the Corporation owns an operations and check processing center in Livonia, Michigan, a ten-story building in the central business district of Detroit that houses certain departments of the Corporation and Comerica Bank, and a four-story building in Auburn Hills, Michigan, that houses a mortgage subsidiary of Comerica Bank and certain other departments of the Corporation and Comerica Bank. In 1983, Comerica entered into a sale\/leaseback agreement with an unaffiliated party covering an operations center which was built in Auburn Hills, Michigan, and now is occupied by various departments of the Corporation and Comerica Bank.\nITEM 5.","section_3":"","section_4":"","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of Comerica Incorporated is traded on the New York Stock Exchange (NYSE Trading Symbol: CMA). At January 31, 1995, there were approximately 16,472 holders of the Corporation's common stock. Quarterly cash dividends were declared during 1994 and 1993 totaling $1.24 and $1.07 per common share per year, respectively. The following table sets forth, for the periods indicated, the high and low sale prices per share of the Corporation's common stock as reported on the NYSE Composite Transactions Tape for all quarters of 1994 and 1993. All of the prices are adjusted for the January 4, 1993 two-for-one stock split.\n* Dividend yield is calculated by annualizing the quarterly dividend per share and dividing by an average of the high and low price in the quarter.\nFORM 10-K CROSS-REFERENCE INDEX: COMERICA INCORPORATED AND SUBSIDIARIES\nCertain information required to be included in Form 10-K is also included in the 1994 Annual Report to Shareholders or in the 1995 Proxy Statement used in connection with the 1995 annual meeting of shareholders to be held on May 19, 1995. The following cross-reference index shows the page location in the 1994 Annual Report or the section of the 1995 Proxy Statement of only that information which is to be incorporated by referenced into Form 10-K. All other sections of the 1994 Annual Report or the 1995 Proxy Statement are not required in Form 10-K and should not be considered a part thereof.\nFORM 10-K CROSS-REFERENCE INDEX: COMERICA INCORPORATED AND SUBSIDIARIES\n* This copy of the 1994 Annual Report and Form 10-K does not include any exhibits. Copies of the listed exhibits will be furnished to shareholders upon request. Requests should be directed to Comerica Incorporated, Corporate Secretary, 500 Woodward Avenue, Detroit, Michigan 48226-3391.\n** Incorporated by reference from Registrant's Annual Report on Form 10-K for the year ended December 31, 1987--Commission File Number 0-7269.\n*** Incorporated by reference from Registrant's Annual Report on Form 10-K for the year ended December 31, 1991--Commission File Number 0-7269.\n**** Incorporated by reference from Registrant's Annual Report on Form 10-K for the year ended December 31, 1992--Commission File Number 0-7269.\n***** Incorporated by reference from Registrant's Annual Report on Form 10-K for the year ended December 31, 1989--Commission File Number 0-7269.\n****** Incorporated by reference from Registrant's Annual Report on Form 10-K for the year ended December 31, 1993--Commission File Number 0-7269.\nFORM 10-K: COMERICA INCORPORATED AND SUBSIDIARIES\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 in the City of Detroit, State of Michigan on the 17th day of March, 1995.\nCOMERICA INCORPORATED\nEugene A. Miller Eugene A. Miller Chairman and Chief Executive Officer\nPaul H. Martzowka Paul H. Martzowka Executive Vice President and Chief Financial Officer\nArthur W. Hermann Arthur W. Hermann Senior Vice President and Controller (Chief Accounting Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated on March 17, 1995.\nBY DIRECTORS\nE. Paul Casey\nJames F. Cordes\nJ. Philip DiNapoli\nMax M. Fisher\nJohn D. Lewis\nPatricia Shontz Longe, Ph.D.\nWayne B. Lyon\nGerald V. MacDonald\nEugene A. Miller\nMichael T. Monahan\nAlfred A. Piergallini\nAlan E. Schwartz\nHoward F. Sims\nEXHIBIT INDEX","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":"823870_1994.txt","cik":"823870","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nFirst Fidelity Bancorporation (the \"Company\" or \"First Fidelity\") is a bank holding company which was organized as a corporation under New Jersey law in 1987. On February 29, 1988, the Company became the successor to and the holder of all of the capital stock of First Fidelity Incorporated (\"FFI\"), a New Jersey bank holding company, and Fidelcor, Inc., a Pennsylvania bank holding company.\nThe Company has a centralized organizational structure, with uniform policies and procedures. Functions such as asset and liability management, corporate operations and systems, credit policy, audit, legal services, employee hiring and benefits and financial planning are conducted at the holding company level, while day-to-day banking activities are managed by the Company's two bank subsidiaries (collectively, the \"Subsidiary Banks\"). Important management decisions are addressed at bi-weekly meetings of the Office of the Chairman of the Company, chaired by Anthony P. Terracciano, Chairman of the Board of Directors, Chief Executive Officer and President of the Company, and including Wolfgang Schoellkopf, Vice Chairman and Chief Financial Officer of the Company, Peter C. Palmieri, Vice Chairman and Chief Credit Officer of the Company, Leslie E. Goodman, Senior Executive Vice President of the Company, Roland K. Bullard II, Senior Executive Vice President of the Company and Donald C. Parcells, Senior Executive Vice President of the Company.\nAs of December 31, 1994, the Subsidiary Banks operated a general banking business from 701 full-service offices located in New Jersey, eastern Pennsylvania, Connecticut, Maryland and southern New York State. The Subsidiary Banks also have offices in London, the Cayman Islands and New York City. As of December 31, 1994, the Company and its subsidiaries employed approximately 12,000 persons on a full-time basis. For information with respect to contemplated branch consolidations and personnel reductions, see \"Business -- 1995 Cost Reduction Program\".\nRECENT TRANSACTIONS\nDuring 1994, the Company entered into a variety of transactions which, in the aggregate, were significant to its business, operations and structure, including the following:\n(i) ACQUISITIONS. During 1994, the Company expanded its branch network into Maryland, significantly strengthened its presence in New York, and filled in gaps in its branch network in Pennsylvania and Connecticut. In addition, the Company announced that it had entered into agreements to acquire a banking institution in Wilmington, Delaware. This acquisition is expected to be consummated in the first quarter of 1995. The transactions are summarized below:\nCOMPLETED ACQUISITIONS\na. On January 31, 1994, the Company completed its acquisition for $41.9 million in cash of Greenwich Financial Corporation and its subsidiary, Greenwich Federal Savings and Loan Association (\"Greenwich Federal\"), which had $410 million in assets and seven branches. Greenwich Federal operated in the Greenwich\/Stamford area of Fairfield County, Connecticut.\nb. On March 25, 1994, the Company acquired BankVest Inc. and its two branch and $99 million in assets subsidiary First Peoples National Bank of Edwardsville, Pennsylvania, for $19.7 million in cash.\nc. On May 12, 1994, the Company completed the acquisition of The Savings Bank of Rockland County, of Spring Valley, New York, an organization with $184 million in assets, for $5.9 million in cash.\nd. On June 10, 1994, the Company acquired four branches ($62 million in deposits) of the John Hanson Federal Savings Bank from the Resolution Trust Corporation. These branches were acquired by First Fidelity Bank, FSB, a newly formed thrift subsidiary of the Company having its headquarters in Beltsville, Maryland.\ne. On August 20, 1994, the Company completed the acquisition of First Inter-Bancorp Inc., Fishkill, New York, for $56 million in cash. First Inter-Bancorp's subsidiary, Mid-Hudson Savings Bank, with $504 million in assets and sixteen branches, was merged into First Fidelity Bank, N.A., New York.\nf. On November 18, 1994, First Fidelity Bank, N.A. acquired two branches, located in Brodheadsville and Effort, in Monroe County Pennsylvania, from PNC Bank, N.A.\ng. On November 29, 1994, First Fidelity completed the acquisition of Baltimore Bancorp. Baltimore Bancorp had assets of $2.1 billion and deposits of $1.7 billion at closing. Baltimore Bancorp's forty one branch banking subsidiary, The Bank of Baltimore, was merged into First Fidelity Bank, N.A.\nh. On January 20, 1995, First Fidelity Bank, N.A. acquired the deposits and deposit-related loans of the Katonah branch (Westchester County, New York) of Emigrant Savings Bank.\nPENDING ACQUISITIONS\na. On July 22, 1994, First Fidelity entered into a definitive agreement to acquire First State Bank, a state-chartered commercial bank with assets of $32.2 million and two offices located in Wilmington, Delaware. Subject to receipt of all applicable regulatory approvals, the acquisition is expected to close by the end of the first quarter of 1995.\nb. On February 7, 1995, the Company announced that First Fidelity Bank, N.A. had entered into an agreement to acquire the 24 branches and $1.1 billion in deposits in Maryland of Household Bank, FSB for a premium of $76.1 million.\n(ii) INTERNAL CONSOLIDATION. In 1994, the Company, through a series of mergers and head office relocations, combined its New Jersey, Pennsylvania, New York and Maryland banking operations under a single national bank headquartered in Elkton, Maryland and now known as First Fidelity Bank, N.A. In addition, on January 20, 1995, Union Trust Company, which conducts the Company's Connecticut banking business, changed its name to First Fidelity Bank.\n(iii) CAPITAL MARKETS ACTIVITIES. On February 2, 1994, the Company issued $200 million of floating rate senior notes due August 2, 1996.\n(iv) COMMON STOCK REPURCHASE PROGRAM. On October 21, 1993, the Company's Board of Directors (the \"Board\") authorized the acquisition of up to 2% of First Fidelity's outstanding Common Stock in any calendar year, through open market or privately-negotiated transactions. On March 7, 1994, the Board authorized the acquisition of up to an additional 1,300,000 shares of Common Stock in 1994, and on October 20, 1994, the Board authorized the acquisition of an additional 2,000,000 shares of Common Stock. During 1994, the Company repurchased 3,795,700 shares of its Common Stock, at an average price of $44.77 per share. Pursuant to such Board authorizations, entering 1995, the Company had remaining authority to repurchase approximately 2.7 million shares of its Common Stock during 1995. The Company is entering the market from time to time to repurchase these shares. Banco Santander, S.A. (together with its wholly-owned subsidiary, FFB Participacoes e Servieos, S.A., Funchal, Portugal, the current owner of the shares, \"Santander\"), which at the end of 1994 owned 24.8% of First Fidelity's outstanding voting stock, has received regulatory approval to increase such ownership to 30%. It will purchase stock in the open market. In 1994, the Company also continued its program of purchasing its Common Stock, through an independent agent, for issuances under its dividend reinvestment plan and stock option plans. See Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Capital\".\n(v) DIVIDEND INCREASES. The Board increased the regular dividend on the Company's Common Stock on January 20, 1994 from $.37 to $.42 per share. On October 17, 1994, the Board further increased the regular dividend from $.42 to $.50 per share.\nRELATIONSHIP WITH BANCO SANTANDER\nDuring 1994, the Company issued 4,752,500 shares of its Common Stock to Santander, pursuant to the terms of the Investment Agreement (the \"Investment Agreement\"), dated as of March 18, 1991, between Santander and the Company. Of such shares, 2,376,250 were issued on March 29, 1994 and 2,376,250 were issued on June 14, 1994 pursuant to Santander's exercise of all of its remaining Warrants to purchase up to 9,505,000 shares of Common Stock at $25.50 per share.\nAt December 31, 1994, Santander held certain acquisition gross up rights to acquire $45.9 million (remaining from the original $100 million amount under the Investment Agreement) in value of Common Stock (or other equity securities of First Fidelity). By its terms, the Investment Agreement and Santander's rights to exercise its acquisition gross up rights terminate on December 27, 1995.\nThe Investment Agreement also provides Santander with gross up rights in the event that First Fidelity issues equity (other than pursuant to an employee benefit plan or upon conversion of convertible securities) in order to insure that Santander maintains the same proportional interest in any class of outstanding equity. These gross up rights give Santander the right to acquire such equity securities on the same terms (including price) as the terms on which the equity being issued by the Company is issued to third parties. Such rights also terminate December 27, 1995.\nSantander has received regulatory approval to increase its holdings of the Company's stock to 30% by open market purchases of the stock.\n1995 COST REDUCTION PROGRAM\nThe Company is implementing a 1995 cost reduction program which involves the accelerated integration of recent acquisitions, consolidation of the branch system from 710 offices to 670 offices, reduction of internal paper work requirements, rationalization of work flow and processes, and reductions in staff.\nFull-time equivalent employment, which totaled about 13,100 at December 31, 1994, will be reduced by about 7.7% during the course of 1995 through this program and as a result of the integration of The Bank of Baltimore. While a significant part of the staff reduction will be accomplished through attrition, the program will require approximately $5 million in related charges in 1995. The goal of the program is to offset virtually all of the former Bank of Baltimore's expense base.\nBUSINESS OF FIRST FIDELITY'S SUBSIDIARIES\nBANK SUBSIDIARIES\nFirst Fidelity's Subsidiary Banks consist of First Fidelity Bank, N.A. (\"FFB-NA\") and First Fidelity Bank (\"FFB-CT\") (a Connecticut-chartered commercial bank). First Fidelity's Subsidiary Banks operate primarily in New Jersey, eastern Pennsylvania, southern New York, Maryland and Connecticut. This marketplace is characterized by a diversified industry base (including a number of well-known, large companies as well as many successful smaller and mid-sized businesses), four key ports on the East Coast (Baltimore, Philadelphia, New York\/Newark and New Haven\/New London) and a well-educated work force.\nFirst Fidelity, through its Subsidiary Banks, offers a broad range of lending, depository and related financial services to individual consumers, businesses and governmental units. Commercial lending services provided by the Subsidiary Banks include short and medium term loans, revolving credit arrangements, lines of credit, asset-based lending, equipment leasing, real estate construction loans and mortgage loans. Consumer banking services include various types of deposit accounts, secured and unsecured loans, consumer installment loans, mortgage banking services, mortgage loans, automobile leasing and other consumer-oriented services.\nThe Subsidiary Banks offer a wide range of money-market services. They underwrite and distribute general obligations of municipal, county and state governments and agencies. In their respective money-center activities, the Subsidiary Banks deal in U.S. Treasury and U.S. Government agency securities, certificates of deposit, foreign exchange, commercial paper, bankers' acceptances, Federal funds and repurchase agreements.\nFiduciary services are available through the Subsidiary Banks and include trustee services for corporate and municipal securities issuers and investment management and advisory services to individuals, corporations, organizations and other institutional investors. The Subsidiary Banks act as investment adviser to and provide management services for a number of mutual funds, including several proprietary funds of First Fidelity designed primarily for trust customers and corporate and retail banking customers of the Subsidiary Banks. The Subsidiary Banks administer, in a fiduciary capacity, pensions, personal trusts and estates. They also act as transfer agent, registrar, paying agent and in other corporate agency capacities.\nThe Subsidiary Banks offer international banking services through their domestic offices, correspondent banks, and foreign offices. The Subsidiary Banks' foreign banking and international activities presently consist primarily of short-term trade-related financing and the extension of credit to foreign banks and governments and foreign and multinational companies.\nFirst Fidelity Bank, N.A. and Bankers Trust Company of New York, each own fifty percent of Global Processing Alliance, Inc., which provides check-processing and related services to depository institutions including its owners.\nNONBANK SUBSIDIARIES\nThe Company has several nonbank subsidiaries, including entities which provide insurance brokerage services, community development assistance, securities brokerage services, mortgage banking and consumer leasing.\nCOMMITMENTS AND LINES OF CREDIT\nThe Subsidiary Banks are obligated under standby and commercial letters of credit on behalf of customers. In addition, the Subsidiary Banks issue lines of credit to customers, generally for periods of up to one year and usually in connection with the provision of working capital for borrowers. For further information regarding such obligations, see Part II, Item 8, \"Financial Statements and Supplementary Data -- Note 16 of the Notes to Consolidated Financial Statements\".\nCOMPETITION\nThe Company and its subsidiaries face vigorous competition from a number of sources, including other bank holding companies and commercial banks, consumer finance companies, thrift institutions, other financial institutions and financial intermediaries. In addition to commercial banks, federal and state savings and loan associations, savings banks, credit unions and industrial savings banks actively compete to provide a wide variety of banking services. Mortgage banking firms, real estate investment trusts, finance companies, insurance companies, leasing companies, brokerage and factoring companies, financial affiliates of industrial companies and government agencies provide additional competition for loans and for many other financial services. The Subsidiary Banks also currently compete for interest-bearing funds with a number of other financial intermediaries, including brokerage firms and mutual funds, which offer a diverse range of investment alternatives.\nFirst Fidelity's competition is not limited to financial institutions based in New Jersey, Pennsylvania, Connecticut, Maryland and New York. A number of large out-of-state and foreign banks, bank holding companies, consumer finance companies and other financial institutions have an established market presence in New Jersey, Pennsylvania, Connecticut, Maryland and southern New York State. Many of the financial institutions operating in First Fidelity's market area engage in local, regional, national and international operations and some of such institutions are larger than the Company.\nSUPERVISION AND REGULATION\nGENERAL\nThe Company, Northeast Bancorp Inc. (\"Northeast\") and FFI are bank holding companies within the meaning of the Bank Holding Company Act of 1956, as amended (the \"Act\"), and are registered as such with the Federal Reserve Board. As bank holding companies, the Company and FFI also are subject to regulation by the New Jersey Department of Banking (the \"New Jersey Department\"), and the Company and Northeast are subject to regulation by the Connecticut Department of Banking (the \"Connecticut Department\").\nFFB-NA is a national bank subject to the regulation and supervision of, and regular examination by, the Office of the Comptroller of the Currency (the \"OCC\"), as well as regulation by the Federal Deposit Insurance Corporation (the \"FDIC\") and the Federal Reserve Board. FFB-CT is subject to the regulation and supervision of, and regular examination by, the FDIC and the Connecticut Department.\nBank holding companies and banks are extensively regulated under both federal and state law. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. A change in applicable law or regulation could have a material effect on the business and prospects of the Subsidiary Banks and the Company.\nGOVERNMENT REGULATION\nEach of First Fidelity, FFI and Northeast is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the Act. Annual and other periodic reports also are required to be filed with the New Jersey Department and the Connecticut Department. In addition, the Federal Reserve Board makes examinations of bank holding companies and their subsidiaries. The Act requires each bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire substantially all of the assets of any bank, or before it may acquire, directly or indirectly, ownership or control of any voting shares of any company, including a bank, if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting shares of such company. See \"Acquisitions -- Interstate Banking\".\nCapital adequacy guidelines may impede a bank holding company's ability to consummate acquisitions involving consideration with a cash component. For a description of certain applicable guidelines, see \"Capital\", \"FDICIA\" and Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Asset and Liability Management\" and \"-- Capital\".\nUnder Federal Reserve Board policy, the Company is expected to act as a source of strength to each Subsidiary Bank and to commit resources to support each Subsidiary Bank. Such support may be required at times when, absent such Federal Reserve Board policy, the Company would not otherwise provide it. In addition, any capital loans by the Company or any subsidiary to any of the Subsidiary Banks would be subordinate in right of payment to deposits and to certain other indebtedness of such Subsidiary Bank.\nThe Act also restricts the types of businesses and operations in which a bank holding company and its subsidiaries may engage. Generally, permissible activities are limited to banking and activities found by the Federal Reserve Board to be so closely related to banking as to be a proper incident thereto.\nThe operations of the Subsidiary Banks are subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be made and the types of services which may be offered and restrictions on the ability to acquire deposits under certain circumstances. Various consumer laws and regulations also affect the operations of the Subsidiary Banks.\nApproval of the OCC is required for branching by FFB-NA and for bank mergers in which the continuing bank is a national bank. Approval of the Office of Thrift Supervision is required in connection with certain acquisitions of thrift institutions as well as for establishment of a de novo federal savings bank. In addition, approval of the relevant state banking authorities and the FDIC is required in connection with certain fundamental corporate changes involving state-chartered banks (such as FFB-CT) or other banking entities.\nFederal law provides for the enforcement of any pro rata assessment of stockholders of a national bank to cover impairment of capital stock by sale, to the extent necessary, of the stock of any assessed stockholder failing to pay the assessment. FFI, as stockholder of FFB-NA, is subject to such provisions.\nACQUISITIONS -- INTERSTATE BANKING\nFirst Fidelity is continually evaluating acquisition opportunities and frequently conducts due diligence activities in connection with possible acquisitions. Acquisitions that may be under consideration at any time include, without limitation, acquisitions of banking organizations and thrift or savings type associations or their assets or liabilities or acquisitions of other financial services companies or their assets or liabilities. Depository organizations targeted by First Fidelity for acquisition would generally be based in markets in which the Company presently operates or in markets in proximity to one of the Company's then existing markets. First Fidelity contemplates that any such acquisitions would be financed through a combination of working capital and issuances of equity and debt securities.\nFederal law currently precludes the Federal Reserve Board from approving the acquisition by a bank holding company of the voting shares of, or substantially all the assets of, any bank (or its holding company) located in a state\nother than that in which the acquiring bank holding company's banking subsidiaries conducted their principal operations on the date such company became a bank holding company unless such acquisition is specifically authorized by the laws of the state in which the bank to be acquired is located. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Act\") authorizes bank holding companies to engage in interstate acquisitions of banks, without geographic limitations, beginning September 29, 1995.\nThe Interstate Act permits (i) adequately managed bank holding companies to engage in interstate acquisitions of banks beginning September 29, 1995, (ii) interstate branching through interstate bank mergers and acquisitions beginning June 1, 1997 (subject to the ability of states to permit such mergers and acquisitions earlier or to prohibit them) and (iii) other interstate branching through the establishment of de novo branches if authorized by state law.\nDIVIDEND RESTRICTIONS\nThe Company is a legal entity separate and distinct from the Subsidiary Banks and its nonbank subsidiaries. Virtually all of the revenue of the Company available for payment of dividends on its capital stock will result from amounts paid to the Company by FFI and Northeast from dividends received from their respective Subsidiary Bank. All such dividends are subject to various limitations imposed by federal and state laws and by regulations and policies adopted by federal and state regulatory agencies.\nFFB-NA as a national bank is required by federal law to obtain the approval of the OCC for the payment of dividends if the total of all dividends declared by the Board of Directors of such bank in any year will exceed the total of such bank's net profits (as defined and interpreted by regulation) for that year and the retained net profits (as defined) for the preceding two years, less any required transfers to surplus. National banks can only pay dividends to the extent that retained net profits (including the portion transferred to surplus) exceed bad debts (as defined).\nIn addition, payment of dividends by a Subsidiary Bank will be prohibited under the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") in the event such Subsidiary Bank would become \"undercapitalized\" under the guidelines described below as a result of such distribution. Connecticut banking statutes provide that Connecticut-chartered banks may pay dividends only out of \"net profits\", defined as the remainder of earnings from current operations, and limited in amount per year to the total of net profits for that year combined with retained net profits of the preceding two years.\nUnder the above-mentioned restrictions, in 1995 the Subsidiary Banks, without affirmative governmental approvals, could declare aggregate dividends of approximately $131 million plus an amount approximately equal to the net profits (as measured under current regulations), if any, earned by the Subsidiary Banks for the period from January 1, 1995 through the date of declaration less dividends previously paid in 1995, subject to the limitations described elsewhere herein. See Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Asset and Liability Management\" and \"-- Capital\".\nIf, in the opinion of the applicable regulatory authority, a bank or bank holding company under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank or bank holding company, could include the payment of dividends), such authority may require that such bank or bank holding company cease and desist from such practice, or require the bank or bank holding company to limit dividends in the future. In addition, the Federal Reserve Board, the OCC and the FDIC have issued policy statements which provide that insured banks and bank holding companies should generally only pay dividends out of current operating earnings. Finally, as described elsewhere herein, the regulatory authorities have established guidelines and under FDICIA have adopted regulations (and may in the future adopt additional regulations) with respect to the maintenance of appropriate levels of capital by a bank or bank holding company under their jurisdiction. Compliance with the standards set forth in such policy statements, guidelines and regulations could limit the amount of dividends which the Company and its bank and bank holding company affiliates may pay. In addition, the Company and its Subsidiary Banks discuss overall capital adequacy, including the payment of dividends, on at least a quarterly basis with their respective appropriate Federal regulatory authorities.\nBORROWINGS BY THE COMPANY\nFederal law prevents the Company and certain of its affiliates (with certain exceptions), including FFI and Northeast, from borrowing from the Subsidiary Banks, unless such borrowings are secured by specified amounts and types of collateral. Additionally, such secured loans to any one affiliate are generally limited to 10% of each such\nSubsidiary Bank's capital and surplus and, in the aggregate with respect to the Company and all of such affiliates, to 20% of each such Subsidiary Bank's capital and surplus. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.\nCAPITAL\nThe Federal Reserve Board measures capital adequacy for bank holding companies on the basis of a risk-based capital framework and a leverage ratio. The minimum ratio of total risk-based capital to risk-adjusted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. At least half of the total capital must be common equity and qualifying perpetual preferred stock, less goodwill (\"Tier I capital\"). The remainder (\"Tier II capital\") may consist of mandatory convertible debt securities, a designated amount of qualifying subordinated debt, other preferred stock and a portion of the reserve for possible credit losses.\nIn addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These guidelines currently provide for a minimum leverage ratio (Tier I capital to quarterly average total assets less goodwill and certain intangibles) of 3% for bank holding companies that meet certain criteria, including that they maintain the highest regulatory rating. All other bank holding companies are required to maintain a leverage ratio of 3% plus an additional cushion of at least 1 to 2 percentage points. The Federal Reserve Board has not advised First Fidelity of any specific minimum leverage ratio under these guidelines which would be applicable to First Fidelity. The guidelines also indicate that, when appropriate, including when a bank holding company is undertaking expansion, engaging in new activities or otherwise facing unusual or abnormal risk, the Federal Reserve Board will consider a \"tangible Tier I leverage ratio\" (deducting all intangibles) in making an overall assessment of capital adequacy. Failure to satisfy regulators that a bank holding company will comply fully with capital adequacy guidelines upon consummation of an acquisition may impede the ability of a bank holding company to consummate such acquisition, particularly if the acquisition involves payment of consideration other than common stock. In many cases, the regulatory agencies will not approve acquisitions by bank holding companies and banks unless their capital ratios are well above regulatory minimums.\nIn 1993, the Federal Reserve Board adopted changes to the risk-based capital and leverage ratio calculations which require that most intangibles, including core deposit intangibles and goodwill (but excluding qualifying purchased credit card relationships and purchased mortgage servicing rights), be deducted for the purpose of calculating Tier I and total capital. Under the rule, bank holding companies are permitted to include certain identifiable intangible assets, such as core deposit intangibles, in calculating capital to the extent that such intangibles were acquired prior to February 19, 1992. See Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Asset and Liability Management\" and \"-- Capital\".\nThe Company's Subsidiary Banks are subject to capital requirements which generally are similar to those affecting the Company. As described below under \"FDICIA\", the federal banking agencies have established certain minimum levels of capital which are consistent with statutory requirements. As of December 31, 1994, 1993 and 1992, the Company and the Subsidiary Banks had capital in excess of all regulatory minimums.\nThe Federal Reserve Board, the FDIC and the OCC have adopted a rule to implement the requirement under FDICIA that risk-based capital standards take account of interest rate risk. The rule focuses on institutions having relatively high levels of measured interest rate risk, and considers the effect that changing interest rates would have upon the value of an institution's assets, liabilities, and off balance-sheet positions. First Fidelity's risk profile (as defined) is such that the rule has no impact on the capital ratios or operations of the Company and its Subsidiary Banks.\nFDICIA\nUpon its enactment in December 1991, FDICIA substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made revisions to several other federal banking statutes.\nAmong other things, FDICIA requires the federal banking agencies to take \"prompt corrective action\" in respect of depository institutions that do not meet minimum capital requirements in order to minimize losses to the FDIC. FDICIA establishes five capital classifications: \"well capitalized\", \"adequately capitalized\", \"undercapitalized\", \"significantly undercapitalized\" and \"critically undercapitalized\" and imposes significant restrictions on the operations\nof a bank that is not at least adequately capitalized. A depository institution's capital classification depends upon its capital levels in relation to various relevant capital measures, which include a risk-based capital measure, a leverage ratio capital measure and certain other factors.\nA depository institution is considered well capitalized if it significantly exceeds the minimum level required by regulation for each relevant capital measure, adequately capitalized if it meets each such measure, undercapitalized if it fails to meet any such measure, significantly undercapitalized if it is significantly below any such measure and critically undercapitalized if it fails to meet any critical capital level set forth in the regulations. The critical capital level is a level of tangible equity equal to not less than 2% of total assets and not more than 65% of the minimum leverage ratio at levels prescribed by regulation (except to the extent that 2% would be higher than such 65% level). An institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating or is deemed to be in an unsafe or unsound condition or to be engaging in unsafe or unsound practices. Under applicable regulations, for an institution to be well capitalized it must have a total risk-based capital ratio of at least 10%, a Tier I risk-based capital ratio of at least 6% and a Tier I leverage ratio of at least 5% and not be subject to any specific capital order or directive. As of December 31, 1994, both of the Company's Subsidiary Banks were \"well capitalized\" as defined under FDICIA. See Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition -- Asset and Liability Management\" and \"-- Capital\".\nFDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and prohibitions on the payment of interest rates on deposits in excess of 75 basis points above the average market yields for comparable deposits. In addition, such institutions must submit a capital restoration plan which is acceptable to applicable federal banking agencies and which must include a guarantee from the parent holding company that the institution will comply with such plan.\nSignificantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets or to cease accepting deposits from correspondent banks and restrictions on senior executive compensation and on inter-affiliate transactions. Critically undercapitalized institutions are subject to a number of additional restrictions, including the appointment of a receiver or conservator.\nRegulations promulgated under FDICIA also require that an institution monitor its capital levels closely and notify its appropriate federal banking regulators within 15 days of any material events that affect the capital position of the institution. FDICIA also contains a variety of other provisions that affect the operations of the Company, including certain reporting requirements, regulatory standards and guidelines for real estate lending, \"truth in savings\" provisions, the requirement that a depository institution give 90 days prior notice to customers and regulatory authorities before closing any branch, certain restrictions on investments and activities of state-chartered insured banks and their subsidiaries, limitations on credit exposure between banks, restrictions on loans to a bank's insiders, guidelines governing regulatory examinations and a prohibition on the acceptance or renewal of brokered deposits by depository institutions that are not well capitalized or are adequately capitalized and have not received a waiver from the FDIC.\nFDICIA directs that each federal banking agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and quality, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares (if feasible) and such other standards as the agency deems appropriate.\nFinally, FDICIA limits the discretion of the FDIC with respect to deposit insurance coverage by requiring that, except in very limited circumstances, the FDIC's course of action in resolving a problem bank must constitute the \"least costly resolution\" for the Bank Insurance Fund (\"BIF\") or the Savings Association Insurance Fund (\"SAIF\"), as the case may be. The FDIC has interpreted this standard as requiring it not to protect deposits exceeding the $100,000 insurance limit in more situations than was previously the case. In addition, FDICIA prohibits payments by the FDIC on uninsured deposits in foreign branches of U.S. banks, and severely limits the \"too\nbig to fail\" doctrine under which the FDIC formerly protected deposits exceeding the $100,000 insurance limit in certain failed banking institutions.\nFIRREA\nUnder the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (\"FIRREA\"), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. \"Default\" is defined generally as the appointment of a conservator or receiver and \"in danger of default\" is defined generally as the existence of certain conditions indicating that a \"default\" is likely to occur in the absence of regulatory assistance. FIRREA and the Crime Control Act of 1990 expand the enforcement powers available to federal banking regulators, including providing greater flexibility to impose enforcement action, expanding the category of persons dealing with a bank who are subject to enforcement action, and increasing the potential civil and criminal penalties. In addition, in the event of a holding company insolvency, the Crime Control Act of 1990 affords a priority in respect of capital commitments made by the holding company on behalf of its Subsidiary Banks. The consummation of the Investment Agreement with Santander caused the FDIC-insured depository institutions controlled by Santander and the FDIC-insured depository institutions controlled by the Company to become commonly controlled for FIRREA purposes, and would have subjected these institutions to the foregoing provisions were it not for the grant of an exemption from liability by the FDIC which was granted effective December 27, 1991. A condition to effectiveness of such exemption is a requirement that Santander not control 25% or more of the voting securities of the Company. Santander currently owns more than 25% of the Company's voting securities and, therefore, the exemption has lapsed. See also \"FDICIA\".\nANNUAL INSURANCE ASSESSMENTS\nUnder FIRREA, the Federal Savings and Loan Insurance Corporation, which insured savings and loan associations and federal savings banks, was replaced by the SAIF, which is administered by the FDIC. A separate fund, the BIF, which was essentially a continuation of the FDIC's then existing fund, was established for banks and state savings banks. The Subsidiary Banks generally are subject to deposit insurance assessments by BIF. As a result, however, of the Company's acquisition of various branches and deposits of SAIF-insured depository institutions, a portion of the Company's deposit base is subject to deposit insurance assessment by SAIF.\nThe FDIC has developed a risk-based assessment system, under which the assessment rate for an insured depository institution varies according to its level of risk. An institution's risk category is based upon whether the institution is well capitalized, adequately capitalized or less than adequately capitalized and the institution's \"supervisory subgroups\": Subgroup A, B or C. Subgroup A institutions are financially sound institutions with a few minor weaknesses; Subgroup B institutions are institutions that demonstrate weaknesses which, if not corrected, could result in significant deterioration; and Subgroup C institutions are institutions for which there is a substantial probability that the FDIC will suffer a loss in connection with the institution unless effective action is taken to correct the areas of weakness. Based on its capital and supervisory subgroups, each BIF or SAIF member institution is assigned an annual FDIC assessment rate per $100 of insured deposits varying between 0.23% per annum (for well capitalized Subgroup A institutions) and 0.31% per annum (for undercapitalized Subgroup C institutions). Well capitalized Subgroup B and Subgroup C institutions will be assigned assessment rates per $100 of insured deposits of 0.26% per annum and 0.29% per annum, respectively. As of December 31, 1994, the Subsidiary Banks were well capitalized.\nThe FDIC has proposed a reduction in the BIF insurance assessment for well capitalized Subgroup A banks to 0.04% per annum. A significant decrease in the assessment could have a positive impact on the Company's results of operations.\nDEPOSITOR PREFERENCE STATUTE\nLegislation has been enacted providing that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the \"liquidation or other resolution\" of such an institution by any receiver.\nOTHER MATTERS\nFirst Fidelity's Common Stock, preferred stock, par value $1.00 per share (the \"Preferred Stock\"), and Preferred Share Purchase Rights are registered under the Securities Exchange Act of 1934. As a result, the Company and such securities are subject to the Securities and Exchange Commission's rules regarding, among other things, the filing of public reports, the solicitation of proxies, the disclosure of beneficial ownership of certain securities, short swing profits and the conduct of tender offers.\nEFFECT OF GOVERNMENTAL POLICIES\nThe earnings of the Subsidiary Banks and, therefore, of the Company are affected not only by domestic and foreign economic conditions, but also by the monetary and fiscal policies of the United States and its agencies (particularly the Federal Reserve Board), foreign governments and other official agencies. The Federal Reserve Board can and does implement national monetary policy, such as the curbing of inflation and combating of recession, by its open market operations in United States Government securities, control of the discount rate applicable to borrowings and the establishment of reserve requirements against deposits and certain liabilities of depository institutions. The actions of the Federal Reserve Board influence the level of loans, investments and deposits and also affect interest rates charged on loans or paid on deposits. The nature and impact of future changes in monetary and fiscal policies are not predictable.\nFrom time to time, various proposals are made in the United States Congress and the New Jersey, Pennsylvania, New York, Maryland and Connecticut legislatures and before various regulatory authorities which would alter the powers of different types of banking organizations or remove restrictions on such organizations and which would change the existing regulatory framework for banks, bank holding companies and other financial institutions. It is impossible to predict whether any of such proposals will be adopted and the impact, if any, of such adoption on the business of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1994, the Company had 852 properties, of which 415 were owned (including 35 on leased land) and 437 were leased. The owned properties aggregate approximately 4.7 million square feet. The leased properties aggregate approximately 2.8 million square feet and, in 1994, required (with the 35 land leases) approximately $28.3 million in rental payments.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party (as plaintiff or defendant) to a number of lawsuits. While any litigation carries an element of uncertainty, management is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the financial condition or results of operations of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth the name and age (as of December 31, 1994) of each current executive officer of the Company, the positions and offices with the Company and its subsidiaries presently held by each such officer and a brief account of the business experience of each such officer for the past five years. Each officer is appointed by the Company's Board of Directors to serve for a term of one year. Unless otherwise noted, each officer has held the position indicated for at least five years.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nFirst Fidelity's Common Stock is listed on the New York Stock Exchange. The following table sets forth the high and low sales prices of the Common Stock, as reported in the consolidated transaction reporting system, and the dividends declared thereon, for the periods indicated below:\nFederal and state laws and regulations contain restrictions on the ability of the Company, the Subsidiary Banks and the Company's intermediate bank holding companies to pay dividends. For information regarding restrictions on dividends, see Part I, Item 1, \"Business -- Supervision and Regulation -- Dividend Restrictions\" and Part II, Item 8, \"Financial Statements and Supplementary Data -- Note 12 of the Notes to Consolidated Financial Statements\".\nAs of December 31, 1994 the Company had approximately 29,900 holders of record of its Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data should be read in conjunction with First Fidelity's Consolidated Financial Statements and the accompanying notes presented elsewhere herein.\n- --------------- (1) Anti-dilutive in 1990. (2) As a result of a change in the schedule of Common Stock dividend declaration dates in 1990, the fourth quarter of 1990 regular common dividend was declared on January 17, 1991, payable on February 8, 1991, to stockholders of record on January 28, 1991. (3) Net income (loss). (4) Net income (loss) applicable to Common Stock. (5) Not statistically meaningful in 1990.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and accompanying notes appearing later in this document. When necessary, reclassifications have been made to prior years' data throughout the following discussion and analysis for purposes of comparability with 1994 data.\nSUMMARY\nFirst Fidelity's net income for the year ended December 31, 1994 was $451.1 million, or $5.21 per common share on a primary basis and $5.11 per common share on a fully-diluted basis. These results compare to net income of $398.8 million, or $4.66 per common share on a primary basis and $4.58 per common share on a fully-diluted basis for 1993. The Company's 1993 net income reflects the cumulative effect of changes in accounting principles, which increased net income $2.4 million, or $.03 per common share on both a primary and fully-diluted basis. The Company's net income in 1992 was $313.7 million, or $3.89 per common share on a primary basis and $3.77 per common share on a fully-diluted basis. The 13.1% improvement in 1994 net income over 1993 reflects a lower provision for possible credit losses, increased net interest income, and higher non-interest income, partially offset by higher non-interest expense, and an increased provision for income taxes.\nReturn on average stockholders' equity was 16.08% in 1994, compared to 16.19% in 1993 and 15.18% in 1992. Return on average assets was 1.34% in 1994 compared to 1.27% in 1993 and 1.06% in 1992.\nTotal non-performing assets decreased 34% to $328.9 million at December 31, 1994, from $494.7 million at December 31, 1993, due to continuing workout and collection efforts, including payments and charge-offs, a strengthening economy, and a reduced volume of loans migrating to non-performing status. The ratio of non-performing loans to total loans declined from 1.77% at December 31, 1993 to .99% at December 31, 1994. The significant decline in non-performing loans was primarily responsible for the ratio of the reserve to non-performing loans increasing to 253% at December 31, 1994 from 159% at December 31, 1993.\nThe Company continued to pursue its strategy of acquiring banks and bank branches located in its market area and in contiguous markets. During 1994, the Company expanded its branch network in Connecticut with the acquisition of Greenwich Financial Corporation and enhanced its New York and Pennsylvania presence through the acquisitions of First Inter-Bancorp, The Savings Bank of Rockland County, and BankVest, Inc. The Company acquired Baltimore Bancorp (\"Baltimore\"), with assets of $2.1 billion and deposits of $1.7 billion, on November 29, 1994 for $347.6 million. The acquisition was accounted for as a purchase, and is reflected in the Company's Consolidated Statement of Condition at December 31, 1994, but had no significant impact on the Company's 1994 earnings.\nDuring 1994, the Company also entered into an agreement to acquire the two branch First State Bank in Wilmington, Delaware, for approximately $7 million in cash. Subject to the receipt of regulatory and shareholder approval, the acquisition is expected to close in the first quarter of 1995. At December 31, 1994, this bank reported $26.7 million in deposits and $32.2 million of total assets.\nIn February, 1995, First Fidelity entered into an agreement to acquire the 24 Maryland branches of Household Bank, FSB, including $1.1 billion in deposits at December 31, 1994, for approximately $76 million in cash. Subject to regulatory approval, the acquisition is expected to close in the second quarter of 1995.\nEach of the recent and pending acquisitions described above is expected to have an additive effect on earnings per share within 18 months of its consummation, assuming the absence of significant adverse economic conditions. These acquisitions are not expected to have a material adverse impact on liquidity. See Part I, Item 1, \"Business -- Recent Transactions -- Acquisitions\".\nRESULTS OF OPERATIONS\nNET INTEREST INCOME\nNet interest income, the largest component of First Fidelity's operating income, was $1,433 million in 1994 and $1,387 million in 1993, on a taxable equivalent basis. The 1994 increase was primarily due to a higher level of average earning assets, partially offset by the decline in the Company's net interest margin from 4.86% in 1993 to 4.70% in 1994. The increase in average earning assets was largely due to acquisitions and increases in the adjustable rate mortgage and auto lease portfolios. The decline in the net interest margin was primarily due to refinancings of higher rate loans at lower rates, maturing higher yielding assets being replaced by lower yielding assets, an increase in short-term borrowings, cash outlays for acquisitions and for the purchase of First Fidelity's Common Stock, and deposit run-off, partially offset by a decrease in average rates associated with core deposits.\nEarning assets averaged $30.3 billion in 1994, which was $1.9 billion, or 7%, above the 1993 level. The increase primarily resulted from a $1.9 billion or 26% increase in average mortgage loans, a $1.1 billion or 16% increase in average securities, and a $488.1 million or 9% increase in average installment loans, partially offset by a $971.6 million or 65% decrease in average time deposits with banks, a $483.8 million or 95% decrease in average federal funds sold and securities purchased under agreements to resell and a $42.7 million or 1% decrease in average commercial loans. The increase in average mortgage and installment loans was largely the result of 1994 acquisitions and the growth of the mortgage and auto leasing portfolios.\nFor 1994, average core deposits, comprised of demand deposits, savings and NOW accounts, money market deposits and consumer certificates of deposit, increased 3% over the prior year level (as a result of 1994 acquisitions, as well as the full year effect of acquisitions completed in 1993) to $26.8 billion, and funded 88% of average earning assets. In comparison, average core deposits were $25.9 billion and funded 91% of average earning assets during 1993. The 1994 increase consisted of higher levels of savings and NOW account deposits, demand deposits, and money market deposits, partially offset by lower levels of consumer certificates of deposit. The higher average deposit balances reflect the impact of acquisitions, partially offset by deposit run-off, which, the Company believes, resulted primarily from a shift by consumers to alternative market instruments and deposit attrition associated with acquisitions.\nThe Company relied primarily on the increase in core deposits and short-term borrowings to fund its increased asset base. Short-term borrowings, primarily federal funds purchased, securities sold under repurchase agreements and commercial paper, averaged $1.8 billion in 1994 compared to $1.2 billion in 1993. The Company also increased its average long-term debt from $591.4 million in 1993 to $795.5 million in 1994, primarily through the issuance of $200 million of floating rate senior notes in February, 1994. During 1994, average deposits in overseas offices increased by $121.9 million, while average corporate certificates of deposits decreased by $72.1 million.\nInterest income also benefited from the decline in non-performing assets during 1994. Total non-performing assets declined 34%, or $165.8 million to $328.9 million at December 31, 1994, compared to $494.7 million at December 31, 1993. Non-accruing and restructured loans were $219.6 million and $17.3 million, respectively, at December 31, 1994 as compared to $365.0 million and $13.9 million, respectively, at December 31, 1993.\nFirst Fidelity's net interest margin percentage may decline moderately in 1995, largely due to: recent acquisitions, which historically have reduced the margin while adding to net interest income; the use of investable funds for anticipated Common Stock buybacks; projected loan growth funded by short-term borrowings; an expected higher interest rate environment; and the full year effect of an investment in corporate owned life insurance and the outsourcing of official checks, both of which reduce investable funds while increasing non-interest income.\nThe following table reflects the components of net interest income, setting forth, for each of the three years in the period ended December 31, 1994, (i) average assets, liabilities and stockholders' equity, (ii) interest income earned on earning assets and interest expense paid on interest-bearing liabilities, (iii) average rates earned on earning assets and average rates paid on interest-bearing liabilities, (iv) the Company's net interest income\/spread (i.e., the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities) and (v) the net interest margin.\nNET INTEREST INCOME SUMMARY\n- ---------------\n(1) In this table and in other data presented herein on a taxable equivalent basis, income that is exempt from federal income taxes or taxed at a preferential rate, such as interest on state and municipal securities, has been adjusted to a taxable equivalent basis using a federal income tax rate of 35% for 1994 and 1993 and 34% for 1992.\n(2) Includes non-performing loans. The effect of including such loans is to reduce the average rate earned on the Company's loans.\n(3) Includes Collateralized Mortgage Obligations.\nThe following table demonstrates the relative impact on net interest income of changes in the volume of earning assets and interest-bearing liabilities and changes in rates earned and paid by the Company on such assets and liabilities. For purposes of constructing this table, earning asset averages include non-performing loans.\nNET INTEREST INCOME CHANGES DUE TO VOLUME AND RATE(1)\n- --------------- (1) Changes in interest income and interest expense attributable to changes in both volume and rate have been allocated equally to changes due to volume and changes due to rate.\n1994 VS. 1993: The table above indicates an increase in taxable equivalent net interest income of $45.2 million, reflecting an increase due to volume changes of $119.7 million and a decrease due to rate changes of $74.5 million. The increase in net interest income for 1994 was primarily due to the higher levels of earning assets as a result of acquisitions. Earning assets averaged $30.3 billion in 1994, $1.9 billion or 7% above the 1993 level. The volume- related change resulted from increased average balances for consumer loans, primarily mortgage and installment loans. An increase in taxable securities was partially offset by reductions in time deposits with banks, money market instruments and tax-exempt securities. Average total loans increased, resulting in an increase to net interest income, which was offset, in part, by the costs associated with the higher level of deposits and short-term borrowings used to fund such loans. Average core deposits increased 3% over the 1993 level (as a result of acquisitions) to $26.8 billion, and funded 88% of average earning assets. The increase consisted of $1.0 billion in savings and NOW accounts, $342.7 million in demand deposits, and $100.6 million in money market deposits, partly offset by a $602.4 million decrease in consumer certificates of deposit. The rate-related change was primarily attributable to a decline in the spread between rates earned on assets and the average cost of interest-bearing liabilities, as rates earned on assets declined, while rates on interest-bearing liabilities remained relatively unchanged.\n1993 VS. 1992: Net interest income on a taxable equivalent basis totalled $1,387 million and $1,248 million in 1993 and 1992, respectively. The increase in net interest income for 1993 was primarily due to higher levels of earning assets as a result of acquisitions, along with a wider spread between the rates earned on assets and the average cost of interest-bearing liabilities, which reflected the declining rate environment that prevailed early in 1993. Earning assets averaged $28.4 billion in 1993, $1.4 billion or 5% above the 1992 level. The volume-related change resulted from increased average balances for consumer loans, primarily mortgage loans. An increase in taxable securities was more than offset by reductions in time deposits with banks, other types of securities and money market instruments. Average total loans increased, resulting in an increase to net interest income, which was offset, in part, by the costs\nassociated with the higher level of deposits used to fund such loans. Average core deposits increased nearly 8% over the 1992 level (as a result of acquisitions) to $25.9 billion and funded 91% of average earning assets. The increase consisted of $1.6 billion in savings and NOW accounts and $.5 billion in demand deposits, partly offset by a $.2 billion decrease in consumer certificates of deposit.\nNON-INTEREST INCOME\nMAJOR COMPONENTS OF NON-INTEREST INCOME\nThe Company's core business operations generate various types of non-interest income, such as service charges on deposit accounts, trust income, and other service charges, commissions and fees. In addition, non-interest income is derived from other sources, such as gains on the sale of assets, which may vary significantly in type and amount from period to period. For 1994, total non-interest income increased $33.4 million, or 9%, to $416.9 million from $383.5 million in 1993.\nTrust income increased from $104.5 million in 1993 to $105.9 million for 1994. Trust income associated with employee benefit plan administration increased primarily as a result of a successful marketing campaign. This was partially offset by a decline in personal and corporate trust income, attributable to the bond market decline, which adversely affected performance fees, as well as a reduced volume of new securities issues in the increasing interest rate environment.\nService charges on deposit accounts and other service charges, commissions and fees accounted for 60% of total non-interest income in 1994. Service charges on deposit accounts decreased 5% in 1994, from $152.3 million in 1993 to $145.1 million. An increase in customers' average deposit balances and an increase in commercial customers' compensating balances, as well as larger earnings credits associated with such balances in the higher interest rate environment, contributed to the decrease.\nOther service charges, commissions and fees of $105.7 million were 23% higher than in the prior year, primarily as a result of commission income earned on branch-based annuity and mutual fund sales, increased revenue from credit card merchant services and various other business-related fees.\nNet securities transactions were $17.7 million in 1994, compared to $7.0 million in 1993. Other income amounted to $32.5 million in 1994, compared to $17.0 million in 1993. The increase in other income resulted primarily from net gains on the sale of various assets and income related to venture capital investments.\nPRIOR YEARS: Non-interest income of $383.5 million in 1993 increased $51.1 million, or 15%, from 1992. Trust income increased from $86.4 million in 1992 to $104.5 million in 1993, primarily as a result of the Northeast acquisition and trust marketing campaigns. Primarily as a result of additional deposit accounts attributable to acquisitions, as well as changes in the service fee structure, service charges on deposits increased 9% in 1993, to $152.3 million, from $139.3 million in 1992. Other service charges, commissions and fees increased by 12% to $85.7 million from 1992 to 1993, primarily due to increased customer relationships resulting from acquisitions. Net securities transactions increased from $4.8 million in 1992 to $7.0 million in 1993. Other income increased from $8.8 million in 1992 to $17.0 million in 1993, primarily due to the inclusion in 1993 income of $7.8 million in gains on the sale of various assets.\nNON-INTEREST EXPENSE\nMAJOR COMPONENTS OF NON-INTEREST EXPENSE\nNon-interest expense was $1,069.6 million for the year, $54.9 million, or 5%, above the 1993 level. The increase resulted primarily from the incremental operating expenses associated with acquisitions completed in 1993 and 1994.\nProductivity continued to benefit from the progressing integration of banks acquired in 1993 and 1994. In addition, First Fidelity has undertaken a Company-wide effort to reduce expenses. The Company is also reviewing its branch network, with the goal of optimizing customer convenience while maximizing the network's cost-effectiveness. Management intends to continue its productivity and expense reduction programs in 1995 and subsequent years. See Part I, Item 1, \"Business -- 1995 Cost Reduction Program.\"\nIn July, 1993, First Fidelity and Bankers Trust Company formed a bank service corporation, Global Processing Alliance, Inc. (\"GPA\") which provides check-processing and related services, and is 50%-owned by each company. In January, 1994, GPA became operational and as a result, First Fidelity's check-processing expenses, which were previously reflected in several expense categories, are now reported in \"other expenses\" in the Consolidated Statement of Income.\nSalaries and benefits expense totaled $485.5 million in 1994 compared with $468.1 million in 1993. The $17.4 million, or 4% increase from the prior year, primarily reflects the additional personnel expenses associated with acquisitions completed in 1994 and the full year impact of acquisitions completed in 1993, partially offset by the GPA reclassification noted above. At December 31, 1994 and 1993, the Company had approximately 12,000 full-time employees, compared to approximately 10,600 at the end of 1992. Although the Company added staff in connection with acquisitions, such additions were offset by staff reductions arising from the consolidations of certain support and operating departments and branches, as well as staff transfers related to the GPA reclassification noted above.\nOccupancy expense, which includes the costs of leasing office space and branches and the expenses associated with owning and maintaining such facilities, increased $1.9 million, or 2% in 1994, due primarily to acquisitions in 1994 and 1993 and severe weather conditions early in 1994, partially offset by the effect of branch consolidations and the GPA reclassification mentioned above. Equipment expense decreased $2.2 million, or 5%, primarily due to operating efficiencies, branch consolidations and the effect of the GPA reclassification, partially offset by acquisitions.\nFDIC premium expense was $63.9 million in 1994 compared to $63.2 million in 1993. The increase reflects the impact of a higher level of deposits resulting from 1994 and 1993 acquisitions. Deposit insurance assessment rates are expected to decline in 1995. See Part I, Item 1, \"Business -- Supervision and Regulation -- FDICIA\" and \"-- Annual Insurance Assessments\".\nCommunication expense decreased 26%, from $33.5 million in 1993 to $24.7 million for 1994. The decrease was primarily due to cost control measures which reduced postage and telephone expenses. Communication expense is expected to rise in 1995, reflecting the increase in U.S. postal rates.\nThe amortization expense related to intangibles increased $10.7 million, or 35%, to $41.5 million for 1994. The increase was related to intangibles generated in conjunction with recent acquisitions, but reflects only one month of amortization associated with the Baltimore acquisition, which occurred on November 29, 1994.\nExpenses incurred in connection with other real estate owned (\"OREO\") were $12.3 million in 1994 compared to $28.4 million in 1993. Such expenses relate primarily to OREO provisions necessitated by property write-downs resulting from declines in OREO property appraisal values, as well as expenses associated with the operation of such properties. The $16.1 million decrease during 1994 resulted primarily from a lower OREO provision, which was attributable to a lower level of charge-offs, reflecting an improvement in the real estate market.\nOther expenses decreased $9.1 million, or 5%, from $185.9 million in 1993 to $176.8 million in 1994. The reduction in other expenses reflects the impact of the ongoing productivity program, partially offset by expenses associated with acquisitions.\nPRIOR YEARS: Non-interest expense totaled $1,014.7 million for 1993, which was $97.9 million, or 11%, above the 1992 level. This increase resulted primarily from the incremental operating expenses associated with acquisitions completed in 1992 and 1993 and higher FDIC expense. In addition, during 1993, Statement of Financial Accounting Standards (\"SFAS\") 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" was adopted, resulting in higher ongoing expenses, and a one-time cumulative effect adjustment of $53.3 million.\nSalaries and benefits expense totaled $468.1 million in 1993 compared with $408.8 million in 1992. The $59.2 million, or 15%, increase from the prior year's level reflected additional staff expenses associated with acquisitions completed in 1992 and 1993. Occupancy expense increased $5.5 million, or 5%, in 1993, due primarily to acquisitions in 1992 and 1993, partially offset by the effect of branch consolidations. Equipment expense increased $2.6 million, or 6%, primarily due to acquisitions. FDIC premium expense totaled $63.2 million in 1993 compared to $56.2 million in 1992; a higher level of deposits due to acquisitions resulted in the increase. Amortization of intangibles increased $8.0 million or 35%, to $30.8 million in 1993. The increase was related to intangibles generated in conjunction with several acquisitions, primarily The Howard Savings Bank in late 1992. Total OREO expenses were $28.4 million in 1993 compared to $29.9 million in 1992, reflecting property write-downs related to valuation adjustments resulting from declines in OREO property appraisal values and write-downs due to transfers of OREO to the \"assets held for sale\" classification. Other expenses increased $15.6 million, to $185.9 million in 1993. The overall increase was primarily due to acquisitions.\nINCOME TAX EXPENSE\nIncome tax expense was $221.4 million for the year, a $43.4 million increase from the $178.0 million reported in 1993, reflecting a higher level of pretax income, combined with a lower level of tax-exempt income. The effective tax rates for the years ended December 31, 1994 and 1993 were 33% and 31%, respectively. For information regarding alternative minimum tax credit carryforwards, see Item 8, \"Financial Statements and Supplementary Data -- Note 15 of the Notes to Consolidated Financial Statements\".\nPRIOR YEARS: Income tax expense for 1993 was $178.0 million, compared to $82.4 million for 1992, primarily reflecting the increase in the effective tax rate from 21% in 1992 to 31% in 1993, and a higher level of pretax earnings. During the first quarter of 1993, the Company recognized a one-time cumulative effect benefit and a related deferred tax asset of $63.1 million due to the adoption of SFAS 109, \"Accounting for Income Taxes\". SFAS 109 required realizable future tax benefits (primarily related to the reserve for possible credit losses, alternative minimum tax credit carryforwards, and accrued postretirement benefits) to be recorded as the cumulative effect of a change in accounting principle at the adoption date.\nFINANCIAL CONDITION\nASSET AND LIABILITY MANAGEMENT\nThe major objectives of the Company's asset and liability management process are to (i) manage exposure to changes in the interest rate environment to achieve an interest rate sensitivity position within reasonable ranges, (ii) ensure adequate liquidity and funding, (iii) maintain a strong capital base, and (iv) maximize net interest income opportunities. Members of the Asset and Liability Management Committee meet weekly to develop balance sheet and product pricing strategies affecting the future level of net interest income, liquidity and capital. Factors that are considered in asset and liability management include forecasts of the balance sheet mix, the economic environment and anticipated direction of interest rates, and the Company's earnings sensitivity to changes in these rates.\nINTEREST RATE SENSITIVITY\nThe Company analyzes its interest sensitivity position to manage the risk associated with interest rate movements through the use of \"gap analysis\" and \"income simulation\". Interest rate risk arises from mismatches in the repricing of assets and liabilities within a given time period. Gap analysis is an approach used to quantify these differences. A \"positive\" gap results when the amount of assets maturing or repricing within a given time period exceeds that of liabilities maturing or repricing. A \"negative\" gap results when liabilities maturing or repricing exceed such assets.\nWhile gap analysis is a general indicator of the potential effect that changing interest rates may have on net interest income, the gap itself does not present a comprehensive view of interest rate sensitivity. First, changes in the general level of interest rates do not affect all categories of assets and liabilities equally or simultaneously. Second, assumptions must be made to construct a gap table. One quarter of money market deposits, for example, which have no contractual maturity, are assigned a repricing interval of 180-365 days with the remainder in the 91-180 day interval. Management can influence the actual repricing of these deposits independent of the gap assumption. Third, the gap table represents a one-day position and cannot incorporate a changing mix of assets and liabilities over time as interest rates change.\nFor these reasons, the Company primarily uses \"simulation\" techniques to project future net interest income streams, incorporating the current \"gap\" position, the forecasted balance sheet mix, and the anticipated spread relationships between market rates and bank products, under a variety of interest rate scenarios. As of December 31, 1994, the Company's interest sensitivity was modestly liability sensitive, but interest rate increases or decreases of 200 basis points would not be expected to have a significant impact on the Company's net interest income.\nINTEREST RATE GAP\nThe following table illustrates First Fidelity's interest rate gap position as of December 31, 1994. At that date, the Company had a cumulative negative gap on a one-year basis of $2,380 million, or 6.6% of total assets. This was slightly smaller than on December 31, 1993, when the cumulative negative gap was $2,392 million, or 7.1% of total assets.\nINTEREST RATE GAPS AS OF DECEMBER 31, 1994\n- --------------- (1) Trading account securities and federal funds sold and securities purchased under agreements to resell.\n(2) The interest rate sensitivity of mortgage-backed securities is presented based upon estimated cash flows, maturities and\/or repricings, and includes Collateralized Mortgage Obligations.\n(3) The amount shown as \"Nonsensitive\" is that portion which, based upon average balances, is considered stable and not sensitive to changes in interest rates. The Company's historical experience has been that total demand deposit account balances exhibit minimal movement with changes in interest rates. Accordingly, a large percentage of the Company's demand deposit account balances are considered \"Nonsensitive\", with the remainder classified as \"1 to 90\" days.\nDERIVATIVES\nFirst Fidelity uses certain off balance-sheet instruments to assist in managing its interest rate sensitivity. Such instruments, known generically as \"derivatives\", may be purchased through over-the-counter markets, on standard exchanges, or through privately structured transactions. Derivatives take many forms, including swaps, futures, forward contracts and cap agreements. The Company enters into these instruments for the purpose of asset and liability management, to accommodate customer needs and, to a limited extent, in connection with its trading activities.\nAn interest rate \"swap\" is an agreement whereby two parties exchange, at specified intervals, interest payment streams calculated on an agreed-upon \"notional amount\", over a specified period of time. Typically, one of the payment streams is based upon a fixed interest rate, and the other payment stream is based upon a floating interest rate. Almost all of First Fidelity's swap agreements are structured so that it receives a fixed interest rate and pays a floating interest rate (a \"fixed interest rate swap\"). As a practical matter, such payments are made \"net\", usually on a quarterly or semiannual basis.\n\"Futures\" contracts may take many forms, but for First Fidelity, they generally are used to ensure that the Company will be able to invest a \"notional\" amount of funds at an agreed-upon interest rate for a specified period of time into the future.\nForeign exchange contracts are used to ensure that a certain exchange rate between two currencies will be available at some future point, or over an agreed-upon time period. The Company is party to foreign exchange forward and futures contracts. First Fidelity's foreign exchange contracts are used primarily to accommodate its commercial customers, who could be adversely affected by changes in exchange rates. It enables customers to \"lock in\" their foreign currency-denominated transactions in U.S. dollars. First Fidelity also holds some such contracts in its trading account.\n\"Forwards\", or forward delivery contracts, are agreements to buy or sell a financial instrument at a specified future date for an agreed-upon price. First Fidelity makes limited use of such contracts. At December 31, 1994, the Company's outstanding contracts involved the future delivery of investment securities (which it already holds) at specified prices, to accommodate customer needs.\nInterest rate caps are used to guarantee to a customer a specified maximum interest rate \"cap\" on an agreed-upon notional value, in exchange for a premium payment. If market interest rates exceed the specified cap rate, the interest differential, applied to the notional value, will be paid to the \"cap\" customer. First Fidelity generally enters into these agreements to meet customer needs, in connection with variable rate loans.\nThe Company uses a majority of its derivatives portfolio to help manage interest rate risk by \"hedging\" on balance sheet positions. When a derivative is used in connection with an on-balance sheet position, the interest income or expense associated with the balance sheet position is combined with the effects of the related derivative instrument. To a much lesser extent, the Company also uses derivatives as trading instruments, which are carried in the trading account. Such instruments are marked to market on a daily basis, with the effect flowing directly to trading account revenue.\nThe Company's aggregate derivative positions used for asset\/liability management purposes are shown in the following table.\nDERIVATIVES USED FOR ASSET-LIABILITY MANAGEMENT PURPOSES AS OF DECEMBER 31, 1994\nAs of December 31, 1994, the Company employed a total of $5.0 billion (notional value) of swaps (including $2.3 billion of indexed amortizing swaps), with an average remaining life of approximately two years, to help manage its interest rate sensitivity. At December 31, 1994, approximately $3.3 billion of fixed interest rate swaps were used to adjust the Company's sensitivity to floating rate loans, and an additional $1.7 billion of fixed interest rate swaps were used to transform consumer certificates of deposit and long-term debt into floating rate instruments having equivalent maturities. These positions compare with a total of $4.3 billion (notional value) of swaps used for similar purposes as of December 31, 1993.\nAt December 31, 1994, the Company also employed a series of sequential 90 day futures contracts with an aggregate notional value of $800 million to help manage its interest rate risk. Such contracts are used to \"lock in\" future interest rates as a means of hedging a portion of the Company's variable rate securities portfolio. As of December 31, 1993, the Company held similar contracts with an aggregate notional value of $750 million.\nThe following table sets forth information, based on notional values, regarding First Fidelity's asset-liability management-related derivatives activity:\n- --------------- (1) Receive fixed interest rates and pay floating interest rates.\nInterest rate swaps and futures positions contributed $82.0 million to net interest income in 1994, down $60.0 million from 1993, and compared to total net interest income on a tax-equivalent basis of $1,432.6 million in 1994. The decline in such income reflects the effect of rising interest rates on fixed rate swaps and futures contracts. Should interest rates remain the same or continue to increase, net interest income from interest rate swaps and futures positions will continue to decline, and will have a net negative impact on net interest income and net interest margin in 1995. However, the net interest income associated with the on-balance sheet assets and liabilities hedged by such contracts should continue to increase. This is the converse of what occurred in 1992 and 1993, as interest rates declined.\nThe \"market value\" of a derivative contract is the amount which the Company would pay or receive in exchange for termination of that contract. At December 31, 1994, First Fidelity would have had to pay $205.2 million to terminate all of its interest rate swaps. Of that amount, $146.4 million is associated with indexed amortizing swaps, which have extended from their original maturity of one year to their maximum maturity of three years, and have a remaining average maturity of 2.1 years. At December 31, 1994, First Fidelity's futures contracts, if terminated, would have reflected a loss of $2.4 million.\nThe Company may terminate derivative contracts which were used to \"hedge\" the cash flows associated with on-balance sheet assets or liabilities. Realized gains and losses on terminated hedge contracts are deferred and amortized to interest income or expense over the interest rate risk period of the related hedged asset or liability. The Company terminated $2.3 billion of futures contracts and $680 million of swap contracts (notional amounts) during 1994. As a practical matter, futures contracts are generally terminated within a month of their maturity date. The swap contracts terminated during 1994 would have had remaining contractual lives ranging from three weeks to five months at December 31, 1994. During 1994, $4.7 million of net deferred gains were recognized as income, of which $4.6 million was attributable to terminated futures contracts and $.1 million was associated with terminated swaps. At December 31, 1994, First Fidelity had $.7 million of net unamortized deferred gains from terminated hedge contracts, which will be amortized into interest income during 1995.\nThe Company from time to time also enters into derivative contracts, including interest rate swaps and interest rate cap agreements, to accommodate customer needs. As of December 31, 1994, the Company had sold $83.5 million (notional amount) of interest rate swap contracts and $42.0 million (notional amount) of interest rate caps to its customers. Because offsetting interest rate swaps and caps having identical notional amounts were purchased almost simultaneously, such positions present no market value risk and are not reflected in the derivatives table above.\nTo a much lesser extent, the Company also uses derivatives as part of its trading activity. All such positions are marked to market regularly and carried in the Company's trading account, and such activity is strictly monitored by management through the use of trading limits. At December 31, 1994, derivatives held for trading purposes included $375.4 million of foreign exchange contracts and $176.2 million of futures contracts. First Fidelity's foreign exchange contracts consisted of forward contracts of $329.1 million and $46.3 million of spot and futures contracts. Of the $176.2 million of futures contracts held at December 31, 1994, $175.0 million were eurodollar futures contracts, and the remaining $1.2 million were treasury and municipal futures contracts.\nDerivative instruments are subject to the same type of credit and market risk as other financial instruments, and are monitored and controlled in accordance with the Company's credit and risk management policies. The Company has not experienced a credit loss associated with any derivative instruments.\nFor additional information regarding derivatives, see Notes 16 and 17 to the Consolidated Financial Statements in Item 8, \"Financial Statements and Supplementary Data\".\nLIQUIDITY AND FUNDING\nFirst Fidelity manages its liquidity in order to maximize earnings opportunities and to ensure that the cash flow needs of the Company are met in a cost-efficient manner. First Fidelity's Asset and Liability Management Committee is responsible for formulating investment policies and monitoring liquidity.\nDuring 1994, the Company's total assets increased by $2.5 billion, primarily through acquisitions and increases in its mortgage and auto lease portfolios. This growth was funded mainly by increases in short-term borrowings of $1.1 billion, deposits of $.8 billion, and long-term debt of $.2 billion. Deposits and other funding sources acquired through bank acquisitions have enhanced the Company's overall liquidity by funding loans and investments and offsetting deposit outflows. The core deposits to total loans ratio was a favorable 117% at December 31, 1994.\nThe Company has other potential sources of liquidity, such as its securities available for sale portfolio, which increased significantly during 1994. First Fidelity's ability to enter into repurchase agreements, using investment securities as collateral, provides an additional source of liquidity.\nIn managing liquidity, the Company takes into account the various legal limitations affecting the extent to which banks may pay dividends to their parent companies or otherwise supply funds to certain affiliates (See Item 1, \"Supervision and Regulation-Dividend Restrictions\" for further information). During 1994, the Company paid dividends of $163.0 million to shareholders.\nManagement believes that First Fidelity's liquidity position continues to be more than adequate, based upon its levels of cash, cash equivalents and core deposits, the stability of its other funding sources and the support provided by its capital base.\nCASH FLOWS\nCash and cash equivalents (cash and due from banks, interest-bearing time deposits, federal funds sold and securities purchased under agreements to resell) are the Company's most liquid assets. At December 31, 1994, cash and cash equivalents totaled $2.2 billion, a decrease of $657.8 million from December 31, 1993. Financing activities absorbed $887.8 million in cash and cash equivalents. This was primarily due to: a decline in core deposits; the purchase of treasury stock; and the payment of dividends, partially offset by an increase in short-term borrowings as well as an increase in deposits in overseas offices. The Company believes that the decrease in deposits reflects the industrywide shift by consumers to alternative market instruments. During 1994, long-term debt increased by $200.0 million. Cash and cash equivalents of $544.1 million were used in investing activities, including net disbursements of $678.0 million for lending activities and $307.1 million associated with acquisitions, partially offset by net cash proceeds of $490.6 million received from securities. Operating activities provided $774.1 million of cash and cash equivalents for the year.\nThe following table presents certain information regarding the major components of short-term borrowings for each of the years presented:\nSHORT-TERM BORROWINGS\nAt December 31, 1994, corporate certificates of deposit and other time deposits in amounts of $100,000 and over issued by domestic offices matured as follows:\nDOMESTIC TIME DEPOSITS $100,000 AND OVER\nSubstantially all of the Company's deposits in overseas offices of $733.1 million were interest-bearing time deposits in denominations of $100,000 and over.\nCAPITAL\nThe maintenance of appropriate levels of capital is a management priority. Overall capital adequacy and dividend policy are monitored on an ongoing basis by management and reviewed quarterly by the Company's Board of Directors. Management discusses the Company's capital plans with the Board of Directors frequently. First Fidelity's principal capital planning goals are to provide an attractive return to stockholders while maintaining the capital levels of the Company and the Subsidiary Banks above the bank regulatory agencies' \"well capitalized\" level (as defined below), thus providing a sufficient base for future growth.\nThe following tables present information regarding the Company's risk-based capital at December 31, 1994, 1993 and 1992, and selected overall capital ratios.\nCAPITAL ANALYSIS\nCAPITAL RATIOS\nThe Federal Reserve Board measures capital adequacy for bank holding companies on the basis of a risk-based capital framework and a leverage ratio. FDICIA established a capital-based supervisory system of prompt corrective action for all depository institutions. The bank regulatory agencies' \"implementing rule\" under FDICIA defines \"well capitalized\" institutions (the highest possible rating) as those whose capital ratios equal or exceed all of the following: Tier I Risk-Based Ratio, 6.0%; Total Risk-Based Ratio, 10.0%; and Tier I Leverage Ratio, 5.0%. At December 31, 1994, the Company and all of its Subsidiary Banks reported capital ratios in excess of these \"well capitalized\" standards.\nThe decline in the Company's Tier I and Total Risk-Based Capital Ratios in 1994 was primarily attributable to the Baltimore acquisition, including the effect of the associated goodwill. The Company's Tier I Leverage Ratio declined compared to 1993, primarily as a result of the increase in quarterly total average assets and higher goodwill related to acquisitions.\nFor a discussion of regulatory capital requirements affecting the Company and its Subsidiary Banks, see Part I, Item 1, \"Business -- Supervision and Regulation -- Capital\" and \"-- FDICIA\".\nChanges in stockholders' equity during the twelve months ended December 31, 1994 and 1993 were comprised of the following:\nDuring 1993, the Board authorized the Company to acquire 2% of its Common Stock in each calendar year, to be used for general corporate purposes. On March 7, 1994, the Board authorized the acquisition by the Company of up to an additional 1.3 million shares of its outstanding Common Stock during 1994, and on October 20, 1994, the Board authorized the purchase of an additional 2.0 million shares of Common Stock during the remainder of 1994 and\/or in subsequent periods. Pursuant to the foregoing, the Company repurchased 3.8 million shares (of the 4.9 million shares authorized) of its Common Stock during 1994, at an average price of $44.77 per share. First Fidelity repurchased 250 thousand of such shares from Santander during 1994 at market prices. Under the October 20, 1994 Board authorization, 1.1 million additional shares may be repurchased in 1995 or subsequent years, for general corporate purposes. In addition, the Company made open market purchases of its Common Stock during 1994, through an independent agent, for issuance under its dividend reinvestment plan and stock option plans. At December 31, 1994, the Company held 1,020,282 shares of its Common Stock, both to fund such plans and for general corporate purposes.\nPursuant to its Investment Agreement with the Company, Santander applied for and received, early in 1995, regulatory approval to acquire up to 30% of First Fidelity's voting stock. Santander held 24.8% of the Company's voting stock at December 31, 1994.\nSECURITIES\nGENERAL\nThe Company's securities portfolios are comprised of U.S. government and federal agency securities, tax-exempt issues of states and municipalities, and equity and other securities. The portfolios generate substantial interest income and provide liquidity. The decline in the market value of the investment portfolio is generally attributable to the increase in the overall interest rate environment during 1994.\nDebt and equity securities are classified as: (a) securities held to maturity based on management's intent and the Company's ability to hold them to maturity, (b) trading securities that are bought and held principally for the purpose of selling them in the near term, and (c) securities available for sale.\nManagement determines the appropriate classification of securities at the time of purchase. Securities classified as available for sale include securities that may be sold in response to changes in interest rates, changes in prepayment risks, the need to increase regulatory capital or other similar requirements. Such securities generally are of high quality (treasuries, government agencies, etc.), with relatively short maturities (weighted average time to maturity of 1.4 years at December 31, 1994, based on projected cash flows or time to repricing for variable rate securities). The Company does not necessarily intend to sell such securities, but has classified them as \"available for sale\" to provide it with flexibility to respond to unforeseen changes in the economic environment. Given the relatively short-term nature of the portfolio and its generally high credit quality, management expects to realize all of its investment upon the maturity of such instruments, and thus believes that any market value impairment is temporary in nature.\nMortgage-backed securities are generally high-quality securities issued by a governmental agency or corporation, or by private issuers. Such securities generally consist of pools of residential mortgages with similar interest rates and similar maturities. Payments to investors include both interest and return of principal.\nAt December 31, 1994, the Company held a total of $4.4 billion of mortgage-backed securities, including $2.8 billion in its securities held to maturity portfolio and $1.6 billion classified as securities available for sale. The mortgage-backed portfolio consisted of fixed interest rate securities of $2.8 billion, and floating rate securities of $1.6 billion ($1.1 billion of the floating rate securities were one-year adjustable rate mortgages and $.5 billion were collateralized mortgage obligations). The weighted average life of the Company's mortgage-backed securities was 1.8 years, based on projected cash flows or time to repricing for variable rate securities. Such securities are generally made up of well-protected, highly predictable \"planned amortization classes\" or well-seasoned \"mortgage participation certificates\", having limited maturity variability. To illustrate, as of December 31, 1994, an interest rate increase of 300 basis points would be expected to extend the weighted average life of the mortgage-backed securities portfolio from 1.8 years to approximately 2.5 years, while a decline in interest rates of 300 basis points would reduce such weighted average life to approximately 1.2 years.\nStructured notes of various types comprise a small portion of the Company's securities portfolios. At December 31, 1994, the Company held $93.7 million (book value) of structured notes, compared to $2.0 million at December 31, 1993. The increase was attributable to 1994 acquisitions. Most of the Company's structured notes are held in its \"securities available for sale\" portfolio. First Fidelity's structured notes at December 31, 1994 were comprised of step-up bonds ($35.9 million), dual index notes ($32.0 million), deleveraged bonds ($13.5 million), indexed amortizing notes ($9.4 million), and single index notes ($2.9 million). At December 31, 1994, a net unrealized loss of $2.3 million was associated with the Company's structured notes.\nThe adoption of SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities\", had no effect on the Company's net income or liquidity for 1994 or 1993. Total stockholders' equity was reduced by $75.2 million, net of taxes, at December 31, 1994 as a result of net unrealized losses on securities available for sale. At December 31, 1993, total stockholders' equity was increased by $27.3 million, net of taxes, as a result of net unrealized gains on securities available for sale.\nSECURITIES HELD TO MATURITY\nAt December 31, 1994, securities held to maturity are comprised of debt obligations with a weighted average yield of 6.45% and a remaining weighted average life of 2.9 years, based on projected cash flows or time to repricing for variable rate securities. Gross unrealized gains and losses in the securities held to maturity portfolio at December 31, 1994 were as follows:\nAt December 31, 1994, the securities held to maturity portfolio totaled $4.2 billion, a decrease of $1.1 billion from December 31, 1993.\nSECURITIES AVAILABLE FOR SALE\nAt December 31, 1994, securities available for sale were primarily U.S. Treasury and federal agency securities having a weighted average yield of 5.94% and a remaining weighted average life of 1.4 years, based on projected cash\nflows or repricing for variable rate securities. Gross unrealized gains and losses in the securities available for sale portfolio at December 31, 1994 were as follows:\nThe net unrealized losses were reported as a separate component of stockholders' equity, net of tax effect, at December 31, 1994. Bank regulatory authorities have determined that such net gains and losses should be ignored for purposes of determining regulatory capital. Securities available for sale totaled $3.8 billion at December 31, 1994 and $2.7 billion at December 31, 1993.\nProceeds from sales of securities available for sale during 1994 were $969.8 million. Gains of $19.5 million and losses of $1.8 million were realized on these sales. In 1993, the sale of debt securities available for sale resulted in realized gains of $7.5 million and realized losses of $642 thousand. Proceeds from these sales were $458.3 million.\nMATURITIES\nThe following tables set forth certain information regarding First Fidelity's securities held to maturity and securities available for sale.\nSECURITIES HELD TO MATURITY -- BOOK VALUE AND MATURITY DISTRIBUTION(1)\n- ---------------\n(1) For 1992, these securities were classified as securities at amortized cost.\n(2) Maturities of mortgage-backed securities are estimated based on projected cash flows, assuming no change in the current interest rate environment.\nSECURITIES AVAILABLE FOR SALE -- FAIR VALUE AND MATURITY DISTRIBUTION\n- ---------------\n(1) Maturities of mortgaged-backed securities are estimated based on projected cash flows, assuming no change in the current interest rate environment.\n(2) Consists entirely of equity securities.\nLOAN PORTFOLIO\nDetails regarding the Company's loan portfolio are presented below:\nLOANS OUTSTANDING\nLOANS OUTSTANDING -- MATURITY DISTRIBUTION(1)\n- ---------------\n(1) Excludes mortgage, installment and leasing loans.\nThe economy in First Fidelity's primary marketplace (New Jersey, eastern Pennsylvania, Connecticut, southern New York and Maryland) is broad-based and diverse. The Company's loan portfolio reflects this diversity. Consumer loans constituted 55%, 50% and 49% of total loans at December 31, 1994, 1993 and 1992, respectively. The remainder of the portfolio is predominantly domestic commercial loans and commercial real estate loans. Commercial lending activities are focused primarily on lending to middle market and small business corporate borrowers engaged in a variety of industries. Foreign loans are an insignificant portion of total loans.\nThe Company's total loans grew in 1994 by $2.4 billion, to $23.8 billion, primarily as a result of acquisitions. In addition, demand for certain types of consumer loans in the Company's primary market area increased slightly during 1994. The Company's commercial and financial loans decreased $311.6 million during the year, primarily as a result of a significant decrease in commercial and financial loans with lower than average interest rate spreads. Commercial mortgages increased by $587.6 million, or 17%.\nContinued expansion of the consumer loan portfolio is an important objective for First Fidelity. Residential mortgage loans increased 24% to $6.0 billion at December 31, 1994, primarily as a result of acquisitions and growth in adjustable rate mortgage originations. Installment loans increased $579.7 million, or 12%. Home equity loans rose 7% to $1.6 billion at December 31, 1994. Automobile leases increased by 59% to $1.7 billion at December 31, 1994. The growth in consumer loans reflects the Company's marketing efforts.\nFOREIGN ASSETS\nFirst Fidelity's foreign loan portfolio was $110.5 million, $112.4 million and $117.0 million at December 31, 1994, 1993 and 1992, respectively. At December 31, 1994, the Company had no outstandings to any single foreign country in excess of .75% of total assets. At December 31, 1993, the Company had such outstandings of $333 million, or 1% of total assets, with United Kingdom banks. At December 31, 1992, the Company had such outstandings of $509 million, or 2% of total assets, with French banks and $476 million, or 2% of total assets, with United Kingdom banks.\nASSET QUALITY\nThe Company seeks to manage credit risk through diversification of the loan portfolio and the application of policies and procedures designed to foster sound underwriting and credit monitoring practices. However, as in any banking organization, the level of credit risk is dependent in part upon local and national economic conditions that are beyond the Company's control. The chief credit officer is charged with monitoring asset quality, establishing credit policies and procedures, seeking the consistent application of these policies and procedures across the organization, and adjusting policies as appropriate for changes in market conditions.\nFirst Fidelity's loan portfolio is diversified by industry of borrower and type of loan, with limits on the size of loan to any single borrower. At December 31, 1994 and 1993, domestic commercial and financial loans represented 25% and 30% of the loan portfolio, respectively; residential mortgages represented 25% and 23%, respectively; installment loans were 22% in both years; commercial mortgages represented 17% and 16%, respectively; the leasing\nportfolio (consisting of equipment and automobile leases) represented 9% and 6%, respectively; construction loans were 1% and 2%, respectively; and foreign loans represented 1% in both years.\nThe risk profile of the loan portfolio is impacted by many external trends and conditions. Among the more important economic factors which tend to reduce or increase the risk profile of the loan portfolio are changes in regional or local real estate values, employment levels and personal income levels. Changes in property and income tax rates, interest rates, governmental actions such as spending cutbacks, and real estate market conditions are also important determinants of the risk inherent in lending by the Company.\nThe lending risk associated with commercial mortgage, real estate\/construction, commercial and financial loans, and equipment leasing is also influenced by factors such as the specific borrower's financial condition, the demand for office space, and the long-term success of companies which operate in the Company's primary marketplace.\nCertain of the Company's asset quality ratios are set forth below:\nASSET QUALITY RATIOS\n- --------------- (a) Non-performing loans and non-performing assets and ratios exclude loans classified as contractually past due 90 days or more but still accruing, assets subject to FDIC loss-sharing provisions, and assets classified as held for sale, which are included in other assets.\nThe ratios for \"Non-performing loans\/loans\" and \"Non-performing assets\/loans and other real estate owned\" continued to improve during 1994, reflecting the Company's continuing workout and collection efforts, which result in payments and charge-offs. In addition, the Company experienced a decreased volume of loans migrating to non-performing status during 1994 and 1993, compared with 1990 through 1992.\nThe commercial loan portfolio is monitored continuously, primarily by the review of risk ratings assigned to each commercial loan, which take into consideration both the borrower's fundamental condition and the specifics of each loan. These risk ratings provide the principal basis for managerial and accounting actions. It is the responsibility of lending groups to monitor these loans and to make adjustments as appropriate to the risk ratings. In addition, such loans are periodically examined by the Company's credit audit department, which is structured to be independent of both the lending and the credit policy and administration functions. The status of individual loans, portfolio segments, and the entire portfolio are monitored by credit policy officers and senior management on a continuous basis. This process is designed to assist the Company in taking appropriate corrective actions as early as possible.\nA quarterly reporting and review process is in place to monitor those credits that have been identified as problematic or vulnerable in order to develop a corrective action program, to assess the Company's progress in working toward a solution, and to assist in determining an appropriate reserve for possible credit losses. A separate loan workout unit becomes involved in credits that have been identified as problematic. The Company's loan review procedures are designed to reduce both non-performing assets and loan losses; however, such assets and losses are an inevitable consequence of a banking organization's provision of credit to its customers. The levels of such assets and losses are dependent in part on economic, legislative and regulatory factors that are beyond the Company's control.\nFor commercial loans, mortgage loans and leases, the necessity for charge-offs is determined on a case-by-case basis. Installment loans and credit card receivables are generally charged-off when principal or interest payments are in arrears for more than 120 and 180 days, respectively, except where the loan is well-secured and in the process of collection.\nCommercial real estate lending is an integral part of the Company's middle market lending business, and continues to be an important commercial credit product for First Fidelity. Commercial real estate loans (commercial mortgages and construction loans) comprised 18% of total loans at December 31, 1994 and 1993. First Fidelity's real estate lending policies are designed to take into consideration the cyclical nature of the real estate business and to define acceptable transactions specifically in terms of the borrower, collateral, documentation, loan structure and product.\nIn addition to internal processes, lending procedures and the loan portfolio are examined by bank regulatory agencies as part of their supervisory activities. For First Fidelity, the most comprehensive of these is the examination by the OCC. Examinations by regulators are performed periodically. The Company's independent auditors also review the loan portfolio and lending procedures during their annual audit of the Company's financial statements.\nSEGREGATED ASSETS\nOn October 2, 1992, in accordance with the agreement to acquire selected assets and liabilities of The Howard Savings Bank (\"Howard\"), the Company entered into a loss-sharing arrangement with the FDIC. The Howard non-performing commercial mortgages, commercial real estate\/construction loans and commercial and financial loans (\"shared-loss loans\"), and any such Howard performing shared-loss loans that become non-performing through October 2, 1997, are considered \"segregated assets\", and are included in the \"other assets\" caption of the Consolidated Statements of Condition. Such segregated assets include non-accrual loans, foreclosed properties and in-substance foreclosures, net of a reserve for segregated assets, but exclude acquired consumer loans. Under the terms of the loss-sharing arrangement, the FDIC reimburses the Company for 80% of net charge-offs and reimbursable expenses associated with such shared-loss loans for a five year period. Under the terms of the loss-sharing arrangement, First Fidelity is obligated to pay the FDIC 80% of net recoveries on such assets during years six and seven after the acquisition. At the end of the seven year period, the FDIC is obligated to provide additional reimbursement to First Fidelity for losses so that, subject to certain conditions, First Fidelity bears only 5% of total losses with respect to such segregated assets over $130 million of net losses and associated expenses.\nIn addition to non-performing shared-loss loans reported as segregated assets, performing loans potentially subject to the loss-sharing arrangement with the FDIC at December 31, 1994 and 1993, totaled $274.4 million and $351.3 million, respectively.\nAt December 31, 1994, segregated assets were $68.3 million, net of a $4.3 million reserve, compared to $247.9 million, net of a $6.5 million reserve at December 31, 1993. The reserve established by First Fidelity in 1992 with respect to its 20% loss exposure on the segregated assets was $25.0 million. First Fidelity's share of charge-offs on segregated assets was $2.5 million in 1994, $10.6 million in 1993 and $8.8 million in 1992. Related recoveries in 1994 and 1993 were $1.3 million and $855 thousand, respectively.\nASSETS HELD FOR SALE\nAssets held for sale declined to $69.3 million at December 31, 1994, from $88.4 million at December 31, 1993, despite $58.3 million of gross additions related to 1994 acquisitions, including $34.3 million related to the Baltimore acquisition. In 1993, First Fidelity determined that it would pursue an accelerated disposition approach on certain non-performing assets. Accordingly, the Company classified $91.0 million of assets as \"held for sale\", net of $48.8 million in write-downs taken to record such assets at their estimated near-term disposition values. Late in 1993, the Company classified an additional $44.7 million of assets as \"held for sale\", related primarily to the Peoples acquisition. The Company anticipates that substantially all such assets will be sold within 18 months of their reclassification.\nPROVISION AND RESERVE FOR POSSIBLE CREDIT LOSSES\nThe levels of the provision and reserve for possible credit losses are based on management's ongoing assessment of the Company's credit exposure and consideration of a number of relevant variables. These variables include prevailing and anticipated domestic and international economic conditions, assigned risk ratings on credit exposures, the diversification and size of the loan portfolio, the results of the most recent regulatory examinations available to the Company, the current and projected financial status and creditworthiness of borrowers, certain off balance sheet credit risks, the nature and level of non-performing assets and loans that have been identified as potential problems, the\nadequacy of collateral, past and expected loss experience, and other factors deemed relevant by management. The Company's risk rating system and the quarterly reporting process for problem and vulnerable credits are utilized by management in determining the adequacy of the Company's reserve for possible credit losses.\nThe following table sets forth information regarding the Company's provision and reserve for possible credit losses and charge-off experience:\nRECONCILIATION OF RESERVE FOR POSSIBLE CREDIT LOSSES\n- --------------- (1) As a result of a significant decrease in the level of foreign assets and substantial recoveries in its foreign portfolio, management made the indicated reallocations from the reserve for foreign loans to the general reserve, in years prior to 1994. In 1994, charge-offs and management's assessment of a small number of foreign loans resulted in an increase in the foreign provision.\nThe continued decline in the provision for possible credit losses from 1991 through 1994 reflects management's evaluation of the adequacy of the level of the reserve for possible credit losses in light of, among other factors, improved asset quality trends, generally improving economic conditions, the continued decline in non-performing loans and lower levels of charge-offs. The reduction of the provision for possible credit losses contributed to the improvement in the Company's net income in each of the last three years.\nKey asset quality reserve ratios increased steadily over the three years ended December 31, 1994. The ratio of the reserve for possible credit losses to non-performing loans was 121% for 1992, 159% for 1993 and 253% for 1994. The reserve for possible credit losses to non-performing assets ratio was 88% for 1992, 122% for 1993 and\n182% for 1994. These ratios exclude loans classified as contractually past due 90 days or more but still accruing, assets subject to FDIC loss-sharing provisions, and assets classified as held for sale.\nThe reserve for possible credit losses was $599.3 million at December 31, 1994, and represented 2.52% of total loans, compared to $602.2 million and 2.82% of total loans at December 31, 1993. The Company believes that it has maintained the reserve for possible credit losses at an adequate level, although ultimately, the level of credit losses is dependent in part upon factors outside of management's control which may not be presently foreseeable. Management believes that it has remained sensitive to the evolving economic situation and its potential impact on asset quality and the reserve for possible credit losses. If the economic environment deteriorates, management may find it appropriate to increase the reserve for possible credit losses. In addition, regulatory agencies periodically review the level of the Company's reserve for possible credit losses. Such agencies could require the Company to increase or decrease the level of the reserve based on their interpretation of data available to them at the time of their examination.\nThe Company regards the reserve as a general reserve which is available to absorb losses from all loans. However, for the purpose of complying with disclosure requirements of the Securities and Exchange Commission, the table below presents an allocation of the reserve among various loan categories and sets forth the percentage of loans in each category to total loans. The allocation of the reserve as shown in the table should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions.\nALLOCATION OF RESERVE FOR POSSIBLE CREDIT LOSSES\nCHARGE-OFFS\nFirst Fidelity's gross charge-offs in 1994 totaled $159.8 million, a decline of 44% from $283.6 million in 1993. The 1993 charge-offs included $42.8 million in connection with transfers to \"assets held for sale\". Charge-offs in 1993 were down 4% from $295.3 million in 1992. The current charge-off level reflects improvement in the business climate, which affects both business and consumers, and greater stability in the regional real estate market.\nReal estate-related charge-offs were $32.6 million in 1994, compared to $118.3 million in 1993. The decrease in 1994 was primarily the result of a reduced amount of charge-offs in connection with transfers to \"assets held for sale\", compared to 1993.\nCharge-offs of commercial and financial loans, excluding those related to commercial real estate loans, were $73.3 million, representing a $27.5 million decrease from 1993. Charge-offs unrelated to real estate were not concentrated in any industry, type of loan or type of borrower.\nInstallment loan charge-offs of $39.0 million were down $8.7 million from 1993, reflecting lower charge-offs in credit cards and other types of installment loans. Leasing charge-offs were $7.3 million in 1994, compared to $16.3 million in 1993. Foreign charge-offs were $7.6 million and $.5 million in 1994 and 1993, respectively.\nRECOVERIES\nRecoveries on charged-off commercial and financial loans were $18.4 million in 1994, compared to $15.8 million in the prior year. Real estate-related recoveries were $4.3 million in 1994 and $6.3 million in 1993. Installment loan recoveries were $13.9 million in 1994, compared to $17.8 million a year earlier. Recoveries on leasing and foreign loans were $3.6 million and $.6 million, respectively, in 1994, compared to $4.9 million and $1.0 million, respectively, in 1993.\nNON-PERFORMING ASSETS\nNon-performing assets include those loans that are not accruing interest (non-accruing loans), loans that have been renegotiated due to a weakening in the financial position of the borrower (restructured loans) and OREO, which consists of real estate acquired upon foreclosure and in-substance foreclosures.\nThe following table sets forth information regarding non-performing assets and accruing contractually past due loans.\nNON-PERFORMING ASSETS AND CONTRACTUALLY PAST DUE LOANS\n- ---------------\n(a) Non-performing assets exclude loans classified as contractually past due 90 days or more and still accruing, segregated shared-loss assets of $72.6 million in 1994, $254.4 million in 1993 and $310.0 million in 1992, and assets held for sale of $69.3 million in 1994 and $88.4 million in 1993.\n(b) Accruing loans past due 90 days or more.\nInterest income is not accrued on loans where interest or principal is 90 days or more past due, unless the loans are adequately secured and in the process of collection. Additionally, interest is not accrued on loans where management has determined that the borrowers may be unable to meet future contractual principal and\/or interest obligations, even though interest and principal payments may be current. When a loan is placed on non-accrual status, interest accruals cease and past due interest is reversed and charged against current income. Any interest payments subsequently received are credited to either principal or interest income, depending upon the financial condition of the borrower. Interest income is not accrued until the financial condition and payment record of the borrower once again\nwarrant it. Interest on loans that have been restructured is accrued according to the restructured terms once regularity of payment is established and management has determined that the borrower is able to meet all recorded obligations.\nNon-performing assets were $328.9 million at December 31, 1994, compared to $494.7 million at December 31, 1993. The decline reflects the Company's continuing workout and collection efforts and a lower volume of loans migrating to non-performing status. Non-performing real estate loans declined $89.7 million. The level of non-accruing domestic commercial loans decreased $59.3 million from December 31, 1993 to December 31, 1994. Restructured loans were $17.2 million at December 31, 1994, compared to $13.9 million at December 31, 1993.\nPayments recognized as interest income on loans that were classified as non-accruing and restructured as of year-end totaled $3.3 million in 1994. Had payments on year-end non-accruing and restructured loans been made at the original contracted amounts and due dates, the Company would have recorded additional interest income of approximately $19.2 million in 1994.\nPrior to transferring a real estate loan to OREO, it is written-down to the lower of cost or fair value. This write-down is charged to the reserve for possible credit losses. Subsequently, OREO is carried at the lower of fair value less estimated cost to sell or carrying value. An OREO reserve is maintained at a level sufficient to absorb unidentified declines in the fair value of all OREO properties between periodic appraisals, and for estimated selling costs. The following table sets forth information regarding the Company's reserve for OREO:\nAt December 31, 1994, loans that were 90 days or more past due but still accruing interest totaled $131.5 million (including $128.3 million of consumer loans), compared to $141.5 million at December 31, 1993, a decrease of $10.0 million, or 7%. The decrease was primarily the result of continuing workout and collection efforts, as well as an improving economy. Management's determination regarding the accrual of interest on these loans is based on the availability and sufficiency of collateral and the status of collection efforts. In the present environment, certain of such loans could become non-performing assets and\/or result in charge-offs in the future.\nDuring 1994, SFAS 114, \"Accounting by Creditors for Impairment of a Loan\" and SFAS 118, \"Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures\", were issued. Under SFAS 114 and SFAS 118, \"impaired\" loans must be measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, or, as a practical expedient, at the loan's observable market price, or the fair value of the collateral if the loan is collateral-dependent. Management is continuing to develop First Fidelity's approach to implementing SFAS 114 and SFAS 118, and does not expect that the adoption of these standards, which is required beginning in 1995, will have a material effect on the Company's financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n(a) The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the following pages:\n(b) The following supplementary data is set forth in this Annual Report on Form 10-K on the following pages:\n[KPMG Peat Marwick LLP LOGO]\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors First Fidelity Bancorporation\nWe have audited the accompanying consolidated statements of condition of First Fidelity Bancorporation and subsidiaries as of December 31, 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 First Fidelity Bancorporation's management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Fidelity Bancorporation and subsidiaries as of December 31, 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 2 to the consolidated financial statements, First Fidelity Bancorporation changed its methods of accounting for income taxes, postretirement benefits other than pensions, postemployment benefits, and certain investments in debt and equity securities in 1993.\n\/s\/ KPMG Peat Marwick LLP\nJanuary 18, 1995, New York, New York\nMember Firm of \/ \/ \/ \/ \/ Klynveld Peat Marwick Goerdeler\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes to consolidated financial statements.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nCONSOLIDATED STATEMENTS OF CONDITION\nSee accompanying notes to consolidated financial statements.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. ACCOUNTING POLICIES\nThe Consolidated Financial Statements of First Fidelity Bancorporation and Subsidiaries (collectively, the \"Company\" or \"First Fidelity\") have been prepared in conformity with generally accepted accounting principles and reporting practices applied in the banking industry. The consolidated financial statements include the accounts of First Fidelity Bancorporation and its subsidiaries, all of which are directly or indirectly wholly-owned. Significant intercompany balances and transactions have been eliminated in consolidation. The Company also presents herein condensed parent company only financial information regarding First Fidelity Bancorporation (the \"Parent Company\"). Prior period amounts are reclassified when necessary to conform with the current year's presentation. The following is a summary of significant accounting policies:\nSECURITIES HELD TO MATURITY: Securities are classified as securities held to maturity based on management's intent and the Company's ability to hold them to maturity. Such securities are stated at cost, adjusted for unamortized purchase premiums and discounts. Purchase premiums and discounts are amortized over the life of the related security using a method which approximates the effective interest method.\nTRADING ACCOUNT SECURITIES: Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading account securities, which are carried at market value. Realized gains and losses and gains and losses from marking the portfolio to market value are included in trading revenue.\nSECURITIES AVAILABLE FOR SALE: Securities not classified as securities held to maturity or trading account securities are classified as securities available for sale, and are stated at fair value. Unrealized gains and losses are excluded from earnings, and are reported as a separate component of stockholders' equity, net of taxes. Such securities include those that may be sold in response to changes in interest rates, changes in prepayment risk or other factors.\nNet securities transactions included in non-interest income consist of realized gains and losses on the sale of securities. Gains or losses on sale are recorded on the completed transaction basis and are computed under the identified certificate method.\nLOANS: Loans are stated net of unearned income. Unearned income is recognized over the lives of the respective loans, principally on the effective interest method.\nIncome from direct financing leases is recorded over the life of the lease under the financing method of accounting, except for leveraged lease transactions. Income from leveraged lease transactions is recognized using a method which yields a level rate of return in relation to the Company's net investment in the lease. The investment includes the sum of aggregate rentals receivable and the estimated residual value of leased equipment, less deferred income and third party debt on leveraged leases.\nInterest income is not accrued on loans where interest or principal is 90 days or more past due, unless the loans are adequately secured and in the process of collection, or on loans where management has determined that the borrowers may be unable to meet contractual principal and\/or interest obligations. When a loan is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Non-accrual loans are generally not returned to accruing status until principal and interest payments have been brought current and full collectibility is reasonably assured. Interest on loans that have been restructured is recognized according to the revised terms.\nLoan origination and commitment fees and certain related costs are deferred and amortized as an adjustment of loan yield in a manner which approximates the effective interest method.\nRESERVE FOR POSSIBLE CREDIT LOSSES: The level of the reserve for possible credit losses is based on management's ongoing assessment of the Company's credit exposure, in consideration of a number of relevant variables. These variables include prevailing and anticipated domestic and international economic conditions, assigned risk ratings, the diversification and size of the loan portfolio, the results of the most recent regulatory examinations available to the Company, the current and projected financial status and creditworthiness of borrowers, various off balance-sheet credit risks, the nature and level of non-performing assets and loans that\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nhave been identified as potential problems, the adequacy of collateral, past and expected loss experience and other factors deemed relevant by management.\nMORTGAGE BANKING ACTIVITIES: Mortgage loans held for sale are valued at the lower of aggregate cost or market, as determined by outstanding commitments from investors or current investor yield requirements. Gains or losses resulting from sales are recognized on a settlement date basis. Purchased mortgage servicing rights (\"PMSRs\") are capitalized at their initial purchase price, not to exceed net future servicing income at the time of acquisition. Excess mortgage servicing rights (\"EMSRs\") occur when mortgage loans are sold with servicing retained and the net servicing fee rate exceeds the normal servicing fee. Servicing fee income is recognized as received. The costs of acquiring rights to service loans is capitalized and amortized in relation to the estimated period of net servicing revenues. The carrying value of PMSRs and EMSRs is periodically evaluated on a disaggregated basis. Write-downs are recorded when and to the extent that the carrying amount exceeds estimated future net servicing income. Mortgage loans held for sale, PMSRs and EMSRs are included in other assets.\nFINANCIAL INSTRUMENTS: A financial instrument is defined as cash, evidence of ownership in an entity, or a contract that imposes an obligation on one entity and conveys a right to another for the exchange of cash or other financial instruments. In addition to the financial instruments shown in the Consolidated Statement of Condition, the Company enters into interest rate swaps, futures, caps and floors, primarily to manage interest rate exposure, and also enters into firm commitments to extend credit.\nHEDGES: In order to qualify for hedge accounting treatment, the item being hedged must expose the Company to interest rate risk. Interest rate swaps, futures, caps and floors which reduce the Company's exposure to interest rate risk associated with identifiable assets, liabilities, firm commitments or anticipated transactions are designated as hedges. Gains or losses on contracts designated as hedges are deferred and amortized to interest income or expense over the interest rate risk period of the related hedged asset, liability, firm commitment or anticipated transaction. The net settlement amount to be received or paid on contracts designated as hedges is accrued over the life of the contract and recognized as interest income or expense, respectively.\nTRADING POSITIONS: Financial instruments not qualifying for hedge accounting treatment and those used for trading purposes are carried at market value, and realized and unrealized gains and losses are included in trading revenue.\nFOREIGN CURRENCY TRANSLATION AND EXCHANGE CONTRACTS: Assets and liabilities of overseas offices are translated at current rates of exchange. Related income and expenses are translated at average rates of exchange in effect during the year. All foreign exchange positions are valued daily at prevailing market rates. Exchange adjustments, including unrealized gains or losses on unsettled forward contracts, are included in trading revenue.\nOTHER REAL ESTATE OWNED: Real estate acquired in partial or full satisfaction of loans and loans meeting the criteria of \"in-substance foreclosures\" are classified as Other Real Estate Owned (\"OREO\"). Prior to transferring a real estate loan to OREO (due to actual or in-substance foreclosure) it is written down to the lower of cost or fair value. This write down is charged to the reserve for possible credit losses. Subsequently, OREO is carried at the lower of fair value less estimated costs to sell or carrying value.\nPREMISES AND EQUIPMENT: Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method. Buildings and equipment are depreciated over their estimated useful lives. Leasehold improvements are amortized over the lesser of the term of the respective lease or the estimated useful life of the improvement.\nINCOME TAXES: The Company adopted Statement of Financial Accounting Standards (\"SFAS\") 109, \"Accounting for Income Taxes\", in 1993. Deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as operating loss and tax credit carryforwards. Deferred tax\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nassets are recognized for future deductible temporary differences and tax loss and credit carryforwards if their realization is \"more likely than not\". Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nUnder Accounting Principles Board Opinion No. 11, which was applied by the Company in 1992 and prior years, deferred income taxes were recognized for income and expense items that were reported in different years for financial reporting purposes and income tax purposes, using the tax rate applicable in the year of the calculation. Under that method, deferred taxes were not adjusted for subsequent changes in tax rates.\nThe Parent Company's income taxes, as reflected in the Parent Company's Statement of Income, represent the taxes allocated to the Parent Company on the basis of its contribution to consolidated income.\nRETIREMENT BENEFITS: The Company maintains self-administered, non-contributory defined benefit pension plans covering all employees who qualify as to age and length of service. Plan expense is based on actuarial computations of current and future benefits for employees and is included in salaries and benefits expense. In addition, the Company provides health care and life insurance benefits for qualifying employees. The related expense is based upon actuarial calculations and is recognized during the period over which such benefits are earned. Prior to 1993, the Company recognized health care and life insurance expenses on an \"as paid\" basis.\nEARNINGS PER SHARE: Primary earnings per share is based on the weighted average number of common shares outstanding during each period, including the assumed exercise of dilutive stock options and warrants, using the treasury stock method. Primary earnings per share also reflects provisions for dividend requirements on all outstanding shares of the Company's Preferred Stock.\nFully diluted earnings per share is based on the weighted average number of common shares outstanding during each period, including the assumed conversion of convertible preferred stock into common stock and the assumed exercise of dilutive stock options and warrants, using the treasury stock method. Fully diluted earnings per share also reflects provisions for dividend requirements on non-convertible preferred stock.\nSTATEMENT OF CASH FLOWS: For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing time deposits, federal funds sold and securities purchased under agreements to resell, none having an original maturity of more than three months.\nEXCESS OF COST OVER NET ASSETS ACQUIRED: The excess of cost over the fair value of acquired net assets is included in other assets and is being amortized using the straight-line method over the estimated period of benefit.\nNOTE 2. CHANGES IN ACCOUNTING PRINCIPLES\nDuring 1993, First Fidelity changed its method of accounting for: (a) postretirement benefits other than pensions, as required by SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", (b) income taxes, as required by SFAS 109, \"Accounting for Income Taxes\", (c) postemployment benefits, as prescribed in SFAS 112, \"Employers' Accounting for Postemployment Benefits\" and (d) securities, as prescribed in SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities\".\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe cumulative effect of changes in accounting principles, net of tax effect, in the Company's 1993 Consolidated Statement of Income consists of the following:\nThe major components of the deferred tax asset that resulted from the adoption of SFAS 109 related to temporary differences created by the reserve for possible credit losses, alternative minimum tax credit carryforwards, and accrued postretirement benefits.\nSFAS 106 requires accrual, during an employee's active years of service, of the expected costs of providing postretirement benefits (principally health care) to employees and their beneficiaries and dependents. Through 1992, First Fidelity, like most other companies, recognized this expense on an \"as paid\" basis.\nSFAS 112 requires employers to recognize any obligation to provide postemployment (as differentiated from postretirement) benefits (salary continuation, outplacement services, etc.) by accruing the estimated liability through a charge to expense.\nThe adoption of SFAS 115 had no effect on the Company's net income. The unrealized gain or loss on securities available for sale is reported as a separate component of stockholders' equity, net of tax effect.\nNOTE 3. PRINCIPAL ACQUISITIONS\nOn November 29, 1994, First Fidelity acquired Baltimore Bancorp (\"Baltimore\") and its affiliates for $348 million in cash. Baltimore had $2.1 billion in assets and $1.7 billion in deposits at closing. This acquisition generated $225.8 million of goodwill, which is being amortized over the period of expected benefit.\nOn August 20, 1994, the Company acquired $504 million in assets and assumed $450 million in deposits of First Inter-Bancorp, Inc. (\"Mid-Hudson\") and its subsidiary for $56 million in cash. On May 12, 1994, First Fidelity acquired $184 million in assets and assumed $174 million in deposits of The Savings Bank of Rockland County (\"Rockland\") for $5.9 million in cash.\nOn March 25, 1994, the Company acquired BankVest, Inc. (\"BankVest\") and its subsidiary for $19.7 million in cash. BankVest had $99 million in assets and $84 million in deposits at closing. On January 31, 1994, First Fidelity acquired $410 million in assets and assumed $251 million in deposits of Greenwich Financial Corporation (\"Greenwich\") and its subsidiary for $41.9 million in cash.\nOn December 30, 1993, the Company acquired Peoples Westchester Savings Bank (\"Peoples\"), for a combination of cash and Common Stock with an aggregate value of $234.9 million. At closing, Peoples had approximately $1.7 billion in assets and $1.5 billion in deposits. Substantially all of the 2,442,083 shares of Common Stock issued to Peoples stockholders in the acquisition came from Treasury Stock, all of which was acquired by First Fidelity late in 1993 through open market purchases.\nOn August 11, 1993, First Fidelity acquired Village Financial Services, Ltd. (\"Village\") and its subsidiary, Village Bank, for $40.0 million in cash and $26.8 million of First Fidelity Common Stock. Village had $736 million in assets and $489 million in deposits at closing. In connection with the acquisition, the Company issued 893,956 shares of First Fidelity Common Stock to Banco Santander, S.A. (\"Santander\") representing the exercise by\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSantander of gross up rights (\"the Acquisition Gross Up Rights\") pursuant to the Investment Agreement, dated as of March 18, 1991 (the \"Investment Agreement\") between the Company and Santander.\nIn May 1993, the Company acquired Northeast Bancorp. Inc. (\"Northeast\") and its subsidiaries, which had $2.5 billion in assets and $2.5 billion in liabilities, for $27.2 million in an exchange of common stock. In connection with the acquisition, the Company also issued 3,284,207 shares of its Common Stock to Santander, representing the exercise by Santander of warrants (\"Warrants\") to purchase 2,376,250 shares and Acquisition Gross Up Rights to purchase an additional 907,957 shares, under the Investment Agreement.\nAll 1994 and 1993 acquisitions were accounted for as purchases and, accordingly, the results of operations of such acquisitions have been included in the Company's consolidated financial statements from their respective closing dates.\nThe following required unaudited pro forma financial information presents the combined historical results of operations of First Fidelity, Northeast, Village, Peoples, Greenwich, BankVest, Rockland, Mid-Hudson and Baltimore (the \"companies\") as if the acquisitions had all occurred as of January 1, 1993. The results reflect purchase accounting adjustments, but do not include certain non-recurring charges and credits directly attributable to such acquisitions. The pro forma financial information does not necessarily reflect the results of operations that would have been achieved had the companies actually combined at such dates.\nCOMBINED CONDENSED CONSOLIDATED PRO FORMA STATEMENTS OF INCOME (UNAUDITED)\nNOTE 4. CASH AND DUE FROM BANKS\nThe Company's banking subsidiaries are required to maintain reserve balances with Federal Reserve Banks. These balances totaled $458 million at December 31, 1994 and averaged $348 million for the year then ended.\nNOTE 5. SECURITIES HELD TO MATURITY AND SECURITIES AVAILABLE FOR SALE\nThe Company's investment securities are classified as either \"held to maturity\" or \"available for sale\". Securities are classified as securities held to maturity based on management's intent and the Company's ability to hold them to maturity. Securities not classified as securities held to maturity or trading account securities are classified as securities available for sale.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nInvestment securities aggregating approximately $2.5 billion at December 31, 1994 and $2.6 billion at December 31, 1993 were pledged, either under repurchase agreements or to secure public deposits.\nSECURITIES HELD TO MATURITY\nSecurities held to maturity, stated at amortized cost, the related fair value, and the unrealized gains and losses for the portfolio were as follows at December 31, 1994 and 1993:\nFederal agency securities consisted almost entirely of mortgage-backed securities (which included collateralized mortgage obligations and pass-through certificates) at December 31, 1994 and 1993. Other securities also included mortgage-backed securities, with book values of $577.9 million and $442.8 million and market values of $541.6 million and $443.1 million at December 31, 1994 and 1993, respectively.\nProceeds from sales of debt securities held as investments in 1992 were $134.5 million. Gains of $7.7 million and losses of $67 thousand were realized on such sales in 1992.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSECURITIES AVAILABLE FOR SALE\nSecurities available for sale, stated at fair value, and the unrealized gains and losses for the portfolio were as follows at December 31, 1994 and 1993:\nProceeds from the sale of securities available for sale during 1994 were $969.8 million. Gains of $19.5 million and losses of $1.8 million were realized on these sales. In 1993, proceeds from such sales were $458.3 million, resulting in realized gains of $7.5 million and realized losses of $642 thousand.\nMATURITIES\nExpected maturities of debt securities were as follows at December 31, 1994 (maturities of mortgage-backed securities and collateralized mortgage obligations are based upon estimated cash flows, assuming no change in the current interest rate environment):\nSECURITIES HELD TO MATURITY:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSECURITIES AVAILABLE FOR SALE:\nNOTE 6. LOANS\nLoans at December 31, 1994 and 1993 consisted of the following:\nIncluded in loans at December 31, 1994 and 1993 were $274.4 million and $351.3 million, respectively, of shared-loss loans acquired from The Howard Savings Bank (\"Howard\") in a 1992 Federal Deposit Insurance Corporation (\"FDIC\") - -assisted transaction. Under the terms of the agreement with the FDIC, such loans are subject to FDIC reimbursement for certain losses if they become non-performing before October 2, 1997. When such assets become non-performing, they are reclassified as \"segregated assets\" (see Note 9).\nNon-accruing loans at December 31, 1994 and 1993 totaled $219.6 million and $365.0 million, respectively. Restructured loans totaled $17.2 million and $13.9 million at December 31, 1994 and 1993, respectively. Interest recognized as income on loans that were classified as non-accruing and restructured as of year-end totaled $3.3 million in 1994, $3.1 million in 1993 and $2.4 million in 1992. Had payments on year-end non-accruing and restructured loans been made at the original contracted amounts and due dates, the Company would have recorded additional interest income of approximately $19.2 million in 1994, $30.1 million in 1993 and $47.8 million in 1992.\nDuring 1993, $78.5 million of non-accruing loans were transferred to the \"Assets Held for Sale\" portfolio (see Note 9).\nDuring 1994, SFAS 114, \"Accounting by Creditors for Impairment of a Loan\" and SFAS 118, \"Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures\", were issued. Under SFAS 114 and SFAS 118, \"impaired\" loans must be measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral-dependent. Management is continuing to develop First Fidelity's approach to implementing SFAS 114 and SFAS 118, and does not expect that the adoption of these standards, which is required beginning in 1995, will have a material effect on the Company's financial statements.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 7. RESERVE FOR POSSIBLE CREDIT LOSSES\nChanges in the reserve for possible credit losses for 1994, 1993 and 1992 are shown below:\nNOTE 8. PREMISES AND EQUIPMENT\nPremises and equipment at December 31, 1994 and 1993 consisted of the following:\nDepreciation and amortization expenses for 1994, 1993 and 1992 were $44.6 million, $46.6 million and $47.9 million, respectively.\nNOTE 9. OTHER ASSETS\nSEGREGATED ASSETS\nSegregated assets consist of Howard shared-loss loans acquired October 2, 1992 (\"Bank Closing\") that were or have since become classified as restructured, non-accrual or OREO. Such assets at December 31, 1994 were $68.3 million, net of a $4.3 million reserve. The Company's share of charge-offs on such assets was $2.5 million in 1994, while recoveries were $1.3 million. Segregated assets at December 31, 1993 were $247.9 million, net of a $6.5 million reserve. The Company's share of charge-offs was $10.6 million in 1993, and recoveries were $855 thousand.\nThe FDIC pays the Company 80 percent of all net charge-offs on acquired shared-loss loans, during the five-year period that commenced with Bank Closing. Charge-offs eligible for FDIC reimbursement include accrued interest as of October 2, 1992 and up to 90 days of additional accrued interest. Subsequent to the charge-off of a shared-loss loan, the FDIC also reimburses First Fidelity for 80 percent of the aggregate amount of certain actual direct expenses incurred on such loans, on a prospective basis.\nAt the end of the seven year period after Bank Closing, the FDIC is obligated to provide additional reimbursement to First Fidelity for losses so that, subject to certain conditions, First Fidelity bears only 5% of total losses over $130 million with respect to such segregated assets.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nINTANGIBLE ASSETS\nUnamortized goodwill and identified intangibles were $787.5 million and $458.3 million at December 31, 1994 and 1993, respectively. These amounts relate primarily to intangible assets having original terms of up to 20 years, and are being amortized over the remaining term of expected benefit, which approximates 17 years on a weighted-average basis. The amortization expense related to goodwill and identified intangibles was $43.2 million, $31.7 million and $23.0 million for 1994, 1993 and 1992, respectively.\nOTHER REAL ESTATE OWNED\nOREO consisted of foreclosed property of $94.9 million and \"in-substance foreclosures\" of $3.9 million, less a $6.8 million reserve, as of December 31, 1994. At December 31, 1993, OREO consisted of foreclosed property of $103.3 million and \"in-substance foreclosures\" of $19.2 million, less a $6.6 million reserve. During 1993, $46.9 million of OREO (net of market value adjustments of $6.6 million taken against the OREO reserve) was transferred to the \"Assets Held for Sale\" portfolio (see below).\nChanges in the OREO reserve for 1994, 1993 and 1992 are shown below:\nMORTGAGE BANKING ACTIVITIES\nAt December 31, 1994, mortgage loans held for sale and outstanding commitments to sell mortgage loans were $39.9 million and $26.7 million, respectively. Aggregate net gains on the sale of mortgage loans held for sale were $264 thousand for 1994. The Company did not capitalize any purchased mortgage servicing rights (\"PMSRs\") during 1994. The Company capitalized excess mortgage servicing rights (\"EMSRs\") of $174 thousand during 1994. Total PMSRs and EMSRs as of December 31, 1994, virtually all of which were acquired in the Baltimore transaction, were $49.5 million and $2.0 million, respectively. Amortization of PMSRs and EMSRs was $1.2 million and $42 thousand, respectively, for 1994. Mortgage loans serviced for others totaled $4.7 billion at December 31, 1994.\nASSETS HELD FOR SALE\nAssets held for sale, excluding those related to mortgage banking activities, totaled $69.3 million and $88.4 million at December 31, 1994 and 1993, respectively. Such assets consisted of $29.2 million and $64.6 million, respectively, of non-performing loans and $40.1 million and $23.8 million, respectively, of OREO. At December 31, 1994, assets held for sale consisted primarily of loans and OREO related to recent acquisitions. Such assets are carried at the lower of adjusted cost or fair value.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 10. SHORT-TERM BORROWINGS\nShort-term borrowings at December 31, 1994 and 1993 consisted of the following:\nNOTE 11. LONG-TERM DEBT\nLong-term debt at December 31, 1994 and 1993 consisted of the following:\nThe floating rate senior notes bear interest at .10% per annum above the London Interbank Offered Rate (\"LIBOR\") for three-month eurodollar deposits (5.74% at December 31, 1994). Such notes are direct, unsecured, senior obligations of First Fidelity Bancorporation and may not be redeemed prior to maturity.\nThe 6.80% and 9 5\/8% subordinated notes, the 8 1\/2% subordinated capital notes and the floating rate subordinated notes due 1997 qualify as Tier II capital for regulatory purposes, subject to certain limitations.\nThe 6.80%, 9 5\/8% and 9 3\/4% subordinated notes are not redeemable prior to maturity and are subordinated in right of payment to all senior indebtedness of the Parent Company. Interest on the notes is payable semi-annually on various dates each year.\nThe 8 1\/2% subordinated capital notes are not redeemable prior to maturity and are subordinated to all indebtedness for borrowed money. At maturity, these notes are payable either in whole or in part in cash from the proceeds of the sale of Common Stock, perpetual preferred stock or other securities qualifying as primary capital securities designated for such purpose, or in whole or in part by the exchange of such securities having a market value equal to the principal amount of the notes to be so exchanged. If the Company determines that the notes do not constitute \"primary capital\" or if the notes cease being treated as \"primary capital\" by the Federal Reserve Board, the Company will not exchange the notes for securities at maturity but instead will pay cash at 100% of the principal amount, plus accrued interest.\nThe floating rate subordinated note is a capital note bearing interest at 1\/4 of 1% per annum above LIBOR for three-month eurodollar deposits. It is repayable using any combination of cash and certain nonvoting securities. Under certain circumstances, the Company may be obligated to repurchase the note prior to maturity using proceeds of a\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nsecondary offering of certain nonvoting securities. The note is redeemable prior to maturity at 100% of principal plus accrued interest if the Federal Reserve Board determines that the note will not be treated as \"primary capital\" and in certain other limited circumstances.\nThe aggregate amounts of maturities for long-term debt as of December 31, 1994 are as follows:\nNOTE 12. STOCKHOLDERS' EQUITY\nPreferred Stock at December 31, 1994 and 1993 consisted of the following:\nThe Series B Convertible Preferred Stock bears a cumulative annual dividend of $2.15 per share, votes as a single class with the Common Stock (each share of Series B Convertible Preferred Stock being entitled to .39 votes, subject to adjustment in certain events), has a liquidation preference of $25 per share, is redeemable in whole or in part at the Company's option at $25 per share plus accrued but unpaid dividends to the redemption date, and is convertible at any time at the option of the holder into .7801 of a share of Common Stock, subject to adjustment in the event of a merger, stock split, etc. Holders of Series B Convertible Preferred Stock are also entitled to vote as a class in certain limited circumstances.\nThe Series D Adjustable Rate Cumulative Preferred Stock is non-voting, subject to certain limited exceptions, has a liquidation preference of $100 per share, is redeemable in whole or in part at the option of the Company at a redemption price of $100 per share plus accrued but unpaid dividends to the redemption date, and cannot be converted into any other class of capital stock. It bears cumulative dividends at a rate (the \"applicable rate\") equal to .75% less than the highest of the three month U.S. Treasury Bill rate, the U.S. Treasury ten year constant maturity rate or the U.S. Treasury twenty year constant maturity rate (as defined), adjusted quarterly; however, in no event will the applicable rate be less than 6 1\/4% or more than 12 3\/4% per annum. For the quarter beginning January 1, 1995, the rate is 7.40%.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Series F 10.64% Cumulative Preferred Stock (the \"Series F Preferred Stock\") is non-voting, subject to certain limitations, and is not convertible into any other class of capital stock. The 75,000 outstanding shares of Series F Preferred Stock were issued in the form of 3,000,000 depositary shares, each of which represents a one-fortieth interest in a share of Series F Preferred Stock. Each depositary share bears a cumulative annual dividend of $2.66, has a liquidation preference of $25.00 and is redeemable in whole or part at the Company's option on or after July 1, 1996 at $25.00.\nCHANGES IN NUMBER OF SHARES OUTSTANDING\nChanges in the number of shares of Common Stock outstanding during 1993 and 1994 were comprised of the following:\nPursuant to its Investment Agreement with the Company, Santander applied for and received, early in 1995, regulatory approval to acquire up to 30% of First Fidelity's voting stock. Santander held 24.8% of the Company's voting stock at December 31, 1994. During 1994, Santander exercised the final two tranches of its Warrants, pursuant to the Investment Agreement.\nAs of December 31, 1994, Santander retained Acquisition Gross Up Rights to acquire $45.9 million (remaining from the original $100 million amount under the Investment Agreement) in value of Common Stock (or other equity securities of First Fidelity). By its terms, the Investment Agreement and Santander's rights to exercise its Acquisition Gross Up Rights terminate on December 27, 1995.\nTREASURY STOCK\nUnder various programs, the Company's Board of Directors authorized the purchase of up to 4.9 million and 2.4 million shares of First Fidelity's outstanding Common Stock in 1994 and 1993, respectively, to be used for general corporate purposes, including acquisitions. The Company acquired 3.8 million and 2.4 million shares of such stock in 1994 and 1993, respectively.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAt December 31, 1994, the Company held 1,020,282 shares of Treasury Stock to be used for general corporate purposes, including acquisitions, and to fund certain benefit plans. At December 31, 1993, the Company held 36,714 shares of Treasury Stock to be issued under the dividend reinvestment and stock option plans.\nSHARE PURCHASE RIGHTS PLAN\nThe Company has in effect a preferred share purchase rights plan. The rights plan provides that each share of Common Stock has attached to it a right (each, a \"Right\", together, the \"Rights\") to purchase one one-hundredth of a share of Series E Junior Participating Preferred Stock, par value $1.00 per share (the \"Series E Preferred Stock\") at a price of $185 per one one-hundredth of a share of Series E Preferred Stock, subject to adjustment. In general, if a person or group (other than the Company, its subsidiaries, certain affiliates or any of the Company's employee benefit plans) acquires 10% or more of the Company's Common Stock (a \"10% Holder\"), stockholders (other than such 10% Holder) may exercise their Rights to purchase Common Stock having a market value equal to twice the exercise price of the Rights. If the Company is acquired in a merger, the Rights may be exercised to purchase common shares of the acquiring company at a similar discount. At any time after a person or group becomes a 10% Holder but prior to the acquisition by such 10% Holder of 50% or more of the outstanding Common Stock, First Fidelity's Board may elect to exchange the Rights (other than Rights owned by such 10% Holder which become void) for Common Stock or Series E Preferred Stock, at an exchange ratio of one share of Common Stock or one one-hundredth of a share of Series E Preferred Stock, per Right, subject to adjustment. The rights plan is designed to protect stockholders in the event of unsolicited offers or attempts to acquire the Company.\nCAPITAL\nThe Parent Company and the Subsidiary Banks are required by various regulatory agencies to maintain minimum levels of capital. At December 31, 1994, the Company and its Subsidiary Banks exceeded all such minimum capital requirements.\nDIVIDENDS DECLARED\nDuring 1994, dividends declared with respect to the Company's Common Stock, Series B Convertible Preferred Stock, Series D Adjustable Rate Cumulative Preferred Stock and per depositary share with respect to the Series F Preferred Stock were $1.76, $2.15, $6.70, and $2.66, respectively.\nDIVIDEND REINVESTMENT PLAN\nAt December 31, 1994, the Company had reserved 461,693 shares of its Common Stock for issuance under the Company's dividend reinvestment plan.\nDIVIDEND RESTRICTIONS\nDividends payable by the Company, its bank holding company subsidiaries and its banking subsidiaries are subject to various limitations imposed by statutes, regulations and policies adopted by bank regulatory agencies. Under current regulations regarding dividend availability, the Company's bank subsidiaries, without prior approval of bank regulators, may declare dividends to the respective holding companies totaling approximately $131 million plus additional amounts equal to the net profits earned by the Company's bank subsidiaries for the period from January 1, 1995 through the date of declaration, less dividends declared during that period.\nNOTE 13. BENEFIT PLANS\nPENSION PLANS\nThe Company maintains self-administered, non-contributory defined benefit pension plans covering all employees who qualify as to age and length of service. Benefits are based on years of credited service and highest average compensation (as defined). Qualified plans are funded in accordance with statutory and regulatory guidelines.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPension expense (benefit) for the years ended December 31, 1994, 1993 and 1992, for all qualified and unqualified plans, aggregated $3,414,000, $(130,000) and $(937,000), respectively.\nThe following table sets forth the plans' funded status and amounts recognized in the Company's consolidated financial statements at December 31, 1994 and 1993:\nNet pension expense (benefit) for 1994, 1993 and 1992 included the following components:\nThe weighted average discount rate assumed in determining the actuarial present value of the projected benefit obligation was 8.75% at December 31, 1994 and 7.5% at December 31, 1993. The assumed rate of increase in future compensation levels was 4.0% at December 31, 1994 and 1993. The long-term expected rate of return on\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nassets was 9.75% in 1994 and 1993. The change in the weighted average discount rate to 8.75% resulted in a decrease in the actuarial present value of the projected benefit obligation of approximately $40.4 million.\nPOSTRETIREMENT BENEFITS\nThe Company sponsors postretirement benefit plans which provide medical and life insurance coverage to employees, depending upon the employee's status (currently retired or still employed), length of service, age at retirement and other factors.\nThe plans have no assets. The following table sets forth the plans' accumulated postretirement benefit obligation as of December 31, 1994 and 1993, which represents the liability for accrued postretirement benefit cost:\nThe net periodic postretirement benefit cost for 1994 and 1993 includes the following:\nFor 1994, the future health care cost trend rate is projected to be 12.5% for participants under 65 and 10% for participants over 65. These rates are assumed to trend downward to 5.5% for participants under 65 and 5% for participants over 65 by the year 2008, and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by 1% in each year would increase the accumulated postretirement benefit obligation as of January 1, 1994 by $8.5 million (8%) and the aggregate of the service and interest cost components of net periodic retirement benefit cost for the year 1994 by $.7 million (9%). The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8.75% for 1994 and 7.5% for 1993. The change in the weighted average discount rate from 7.5% resulted in a decrease in the actuarial present value of the postretirement benefit obligation of approximately $11.6 million.\nThe Company's accumulated postretirement benefit obligation under SFAS 106 of approximately $81 million was recognized in the first quarter of 1993 by a one-time cumulative effect adjustment of $53.3 million, net of tax effect. In 1992, the cost of providing postretirement benefits was recognized as such benefits were paid, and totaled $5.8 million.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nPOSTEMPLOYMENT BENEFITS\nThe Company's accumulated postemployment benefit obligation under SFAS 112 of $11.3 million was recognized in the first quarter of 1993 by a one-time cumulative effect adjustment of $7.4 million, net of tax effect. Annual postemployment benefit expense on an accrual basis was approximately $2.6 million for 1994 and $900 thousand for 1993, exclusive of the one-time adjustment, as compared to approximately $2 million in 1992 under the previous method.\nSAVINGS PLANS\nThe Company maintains a savings plan under Section 401(k) of the Internal Revenue Code, which covers substantially all full-time employees after one year of continuous employment. Under the plan, employee contributions are partially matched by the Company. Such matching becomes vested when the employee reaches three years of credited service. Total savings plan expense was $13.2 million, $12.0 million and $10.7 million for 1994, 1993 and 1992, respectively.\nSTOCK OPTION PLANS\nThe Company maintains stock option plans, pursuant to which an aggregate of 9,775,454 shares of Common Stock have been authorized for issuance to certain key employees of the Company and its subsidiaries. The options granted under these plans are, in general, exercisable not earlier than one year after the date of grant, at a price equal to the fair market value of the Common Stock on the date of grant, and expire not more than ten years after the date of grant. There are also options outstanding under other plans, pursuant to which no further options may be granted. Vesting with respect to certain options granted to certain senior executive officers may be accelerated. In addition, the Company assumed certain stock options related to acquisitions during 1993.\nThe Company also maintains an employee stock purchase plan, under the terms of which 1,760,000 shares of Common Stock have been authorized for issuance. The plan's purchase period begins on July 1 and ends June 30 of the following year, during which options to purchase stock are offered to employees once a year. No individual employee may exercise options under the employee stock purchase plan to acquire stock in any one year in excess of 10% of base compensation, or $20,000, whichever is less. The option price equals 90% of the market price of the Common Stock on the last day of the purchase period. The aggregate number of shares to be purchased in any given offering, which cannot be greater than 250,000, is determined by the amount contributed by the employees and the market price as of the last day of the purchase period.\nChanges in total options outstanding during 1994, 1993 and 1992 are as follows:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCertain of the options assumed in the course of 1993 acquisitions (55,368 shares at the end of 1994 and 64,831 shares at December 31, 1993), when translated at the applicable exchange rate for First Fidelity Common Stock, resulted in an option price as high as $797. In order to provide more meaningful disclosure, such prices and shares have been omitted from the tabular presentation above.\nNOTE 14. OTHER EXPENSE\nThe components of other expense were as follows:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 15. INCOME TAXES\nIncome tax expense was comprised of the following:\nThe components of deferred income tax expense attributable to income from continuing operations for the years ended December 31, 1994 and 1993 were as follows:\nThe components of deferred income tax for the year ended December 31, 1992, under accounting rules then in effect, were as follows:\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1994 and 1993 were as follows:\nManagement has determined that, based upon its assessment of recoverable taxes and projected levels of pretax income, realization of the deferred tax asset is more likely than not. Included in the table above is the effect of certain temporary differences for which no deferred tax expense or benefit was recognized. Such items consisted primarily of unrealized gains and losses on certain investments in debt and equity securities accounted for under SFAS 115, as well as book and tax basis differences relating to business combinations accounted for under the purchase method of accounting.\nThe total tax expense for 1994, 1993 and 1992 resulted in effective tax rates which differed from the applicable U.S. federal income tax rate. A reconciliation follows:\nAt December 31, 1994, for income tax purposes, the Company had alternative minimum tax credit carryforwards of approximately $12.5 million available to offset future income tax to the extent that it exceeds alternative minimum tax. These credits have an unlimited life. The Company had capital loss carryforwards at December 31, 1994 of $2.9 million, which are available to offset future capital gains. Such carryforwards expire on December 31, 1997, if not utilized by that date.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nNOTE 16. FINANCIAL INSTRUMENTS\nFINANCIAL INSTRUMENTS WITH OFF BALANCE-SHEET RISK\nThe Company is a party to various financial instruments acquired in the normal course of business to manage its exposure to changes in interest and foreign exchange rates and to meet the financing needs of its customers. Except for foreign exchange contracts, the contract or notional amounts of such instruments are not included in the Consolidated Statements of Condition at December 31, 1994 and 1993. The Company's involvement in such financial instruments at December 31, 1994 and 1993 is summarized as follows:\nThe amounts above indicate gross positions and have not been reduced by offsetting positions, but are reflected net of participations to other financial institutions.\nThe Company uses the same credit policies in extending commitments, letters of credit and financial guarantees as it does for financial instruments recorded on the Consolidated Statements of Condition. First Fidelity seeks to control its exposure to loss from these agreements through credit approval processes and monitoring procedures. Letters of credit and commitments to extend credit are generally issued for one year or less and may involve a commitment fee. The total commitment amounts do not necessarily represent future cash disbursements, as many commitments expire without being drawn upon. In connection with extending such commitments, the Company may require collateral, which may include cash, accounts receivable, securities, real or personal property, or other assets, in circumstances where it would not generally make an unsecured loan. For those commitments which require collateral, the value of the collateral generally equals or exceeds the amount of the commitment. Total standby letters of credit are shown net of $39.8 million and $22.4 million participated to other financial institutions at December 31, 1994 and 1993, respectively.\nThe Company enters into derivative instruments primarily to hedge the interest rate risk associated with its various assets and liabilities and to meet the needs of its customers. Such hedge instruments generally take the form of interest rate swaps and futures contracts. In part through the use of these instruments, the Company strives to be essentially insensitive to changes in interest rates within reasonable ranges (i.e., plus or minus 200 basis points). Such instruments are subject to the same type of credit and market risk as other financial instruments, and are monitored and controlled in accordance with the Company's credit and risk management policies. To a much lesser extent, First Fidelity utilizes foreign exchange and futures contracts for trading purposes; such contracts are carried at market value in the trading account.\nAs of December 31, 1994, the Company had $5.0 billion (notional amount) of interest rate swap contracts, which were structured such that the Company receives a fixed rate and pays a floating interest rate. Of the $5.0 billion swap agreements (which includes $2.3 billion of indexed amortizing swaps), $3.3 billion were used to hedge variable\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nrate loans and $1.7 billion were used to transform equivalent maturity fixed rate certificates of deposit and long-term debt into floating rate instruments. At December 31, 1994, the Company's interest rate swaps had an average remaining time to maturity of approximately 2 years. Such swaps do not extend beyond 5 years (except for those swaps associated with the Company's long-term debt). The Company's indexed amortizing swaps are \"receive fixed\" swaps, which have extended from their original maturity of one year to their maximum maturity of three years, such that they mature in early 1997. The risk of loss associated with interest rate swaps is primarily attributable to counterparty default and movements in interest rates. Credit risk is limited to any amounts receivable, and generally does not constitute more than a small fraction of the notional amounts presented above.\nThe Company had $976.2 million (notional amount) of interest rate futures contracts as of December 31, 1994. Of this total, $800 million are used to hedge variable rate securities, and are structured sequentially over the first nine months of 1995. The remaining $176.2 million of futures contracts are held for trading purposes, and consist of $175.0 million of eurodollar futures and $1.2 million of treasury and municipal futures contracts. The eurodollar futures are marked to market and settled daily, and have a maximum duration of 90 days. During 1994, such eurodollar futures contracts averaged $58 million, with the Company's outstandings fluctuating between zero and $250 million. Realized gains associated with futures contracts held for trading purposes totalled $275 thousand for 1994. The risk associated with such futures positions arises primarily from movements in interest rates.\nThe Company accounts for its derivative contracts qualifying for \"hedge\" accounting treatment in a manner consistent with the related on-balance sheet asset or liability. Cash flows associated with such instruments are included in net interest income over the lives of the associated assets or liabilities (on an accrual basis). In the event of termination of a contract qualifying for \"hedge\" accounting treatment, the resulting gain or loss is deferred and amortized over the interest rate risk period of the associated financial instrument.\nDuring 1994, $4.7 million of net deferred gains associated with terminated contracts qualifying for \"hedge\" accounting treatment were recognized in income, of which $4.6 million was attributable to futures contracts and $.1 million was associated with $680 million (notional amount) of terminated interest rate swap contracts. The remaining $1.7 million of net deferred gains associated with the 1994 swap terminations and the $980 thousand of net deferred losses on futures contracts will be amortized into net interest income early in 1995.\nThe Company's forward contracts of $99.7 million at December 31, 1994, were comprised of commitments to sell treasury securities at future dates for specified prices. Such contracts have an average remaining maturity of approximately 2 years at December 31, 1994.\nThe interest rate swap and cap agreements designated in the table above as \"customer contracts\" are used solely to accommodate customer needs. At December 31, 1994, the Company had outstanding $83.5 million (notional amount) of interest rate swap contracts and $42.0 million (notional amount) of interest rate caps to its customers. Offsetting positions with identical maturities and notional amounts were purchased almost simultaneously, such that mark-to-market gains offset losses on such contracts.\nAt December 31, 1994, the Company's foreign exchange portfolio consisted of $329.1 million of foreign exchange forward contracts, as well as foreign exchange spot and futures contracts which totaled $46.3 million. The average balance of such contracts were approximately $302 million and $250 million, respectively, for 1994. The Company's foreign exchange forward contracts have an average maturity of approximately 6 months; however, some contracts extend for up to two years. Foreign exchange spot contracts require settlement to occur within two business days of the contract date. The Company's foreign exchange futures contracts have an average maturity of approximately 3 months at December 31, 1994. The Company's foreign exchange portfolio is marked to market on a daily basis. These contracts are reflected in the table above at their December 31, 1994 market value. All realized and unrealized gains and losses were included in trading revenue. Net trading gains on foreign exchange forward, futures and spot contracts were $3.7 million for 1994.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCONCENTRATIONS OF CREDIT RISK OF FINANCIAL INSTRUMENTS\nThe Company extends credit in the normal course of business to its customers, the majority of whom operate or reside within the New Jersey, eastern Pennsylvania,Connecticut, Maryland and the southern New York business areas. The ability of its customers to meet contractual obligations is, to some extent, dependent upon the economic conditions existing in this region.\nIn addition, the Company had credit extensions (on and off balance-sheet) to certain groups which represented 5% or more of total credit extensions, at December 31, 1994 and 1993, respectively, as follows: consumers (including residential mortgages), 40% and 38%; U.S. government and agencies, 16% in both years; commercial mortgages and commercial real estate, 11% in both years; and depository institutions, 5% and 10%.\nNOTE 17. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company is required to disclose certain information about so-called \"fair values\" of financial instruments, as defined in SFAS 107.\nLIMITATIONS: Estimates of \"fair value\" are made at a specific point in time, based upon, where available, relevant market prices and information about the financial instrument. Such estimates do not include any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. For a substantial portion of the Company's financial instruments, no quoted market exists. Therefore, estimates of \"fair value\" are necessarily based on a number of significant assumptions (many of which involve events outside the control of management). Such assumptions include assessments of current economic conditions, perceived risks associated with these financial instruments and their counterparties, future expected loss experience and other factors. Given the uncertainties surrounding these assumptions, the reported \"fair values\" represent estimates only and, therefore, cannot be compared to the historical accounting model. Use of different assumptions or methodologies are likely to result in significantly different \"fair value\" estimates.\nThe estimated \"fair values\" presented neither include nor give effect to the values associated with the Company's banking, trust or other businesses, existing customer relationships, extensive branch banking network, property, equipment, goodwill or certain tax implications related to unrealized gains or losses. Also, the \"fair value\" of non-interest bearing demand deposits, savings and NOW accounts and money market deposit accounts is required to be reported as equal to the carrying amount because these deposits have no stated maturity. Obviously, this approach to estimating \"fair value\" excludes the significant benefit that results from the low-cost funding provided by such deposit liabilities, as compared to alternative sources of funding.\nThe following methods and assumptions were used to estimate the \"fair value\" of each major classification of financial instruments at December 31, 1994 and 1993:\nCASH, SHORT-TERM INVESTMENTS, AND CUSTOMERS' ACCEPTANCE LIABILITY: Current carrying amounts approximate estimated \"fair value\".\nSECURITIES: Current quoted market prices were used to determine \"fair value\".\nLOANS: The \"fair value\" of residential mortgages was estimated based upon recent market prices of securitized receivables, adjusted for differences in loan characteristics. The \"fair value\" of certain installment loans (e.g., bankcard receivables) was estimated based upon recent market prices of sales of similar receivables. The \"fair value\" of non-accruing and restructured loans which are secured by real estate was estimated considering recent external appraisals of the underlying collateral and other factors. The \"fair value\" of all other loans was estimated using a method which approximates the effect of discounting the estimated future cash flows over the expected repayment periods using rates which consider credit risk, servicing costs and other relevant factors.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nDEPOSITS WITH NO STATED MATURITY AND SHORT-TERM TIME DEPOSITS: Under the terms of SFAS 107, such deposits must be reported as having a \"fair value\" equal to their carrying amount. However, the economic value of a low-cost deposit base which averaged $18.6 billion in 1994 is significant, particularly in a high and rising interest rate environment, as occurred in 1994.\nOTHER CONSUMER TIME DEPOSITS: \"Fair value\" was estimated by discounting the contractual cash flows using current market rates offered in the Company's market area for deposits with comparable terms and maturities.\nSHORT-TERM BORROWINGS AND ACCEPTANCES OUTSTANDING: Current carrying amounts approximate estimated \"fair value\".\nLONG-TERM DEBT: Current quoted market prices were used to estimate \"fair value\".\nCOMMITMENTS TO EXTEND CREDIT AND LETTERS OF CREDIT: The majority of the Company's commitments to extend credit and letters of credit carry current market interest rates if converted to loans. Because commitments to extend credit and letters of credit are generally unassignable by either the Company or the borrower, they only have value to the Company and the borrower. The estimated \"fair value\" approximates the recorded deferred fee amounts.\nThe carrying amounts and estimated \"fair values\" of the Company's financial instruments were as follows at December 31, 1994 and 1993:\n- --------------- (A) Disclosure of the \"fair value\" of lease receivables is not required and has not been included above. The carrying amount of Net loans excludes $2.1 billion and $1.4 billion of lease receivables, $249 million and $183 million of related unearned income and allocated reserves of $22 million and $29 million at December 31, 1994 and 1993, respectively. The reserve for lease receivables has been allocated only to present the information above on a comparable basis. Additionally, the Company continues to pursue its contractual claims on loans which have been charged-off. The \"fair value\" of such contractual claims was not included in the estimate of \"fair value\".\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nOTHER OFF BALANCE-SHEET INSTRUMENTS: The Company uses interest rate swaps and futures contracts to help manage its interest rate sensitivity. Such financial instruments are used in conjunction with on-balance sheet items (loans, deposits and long-term debt) to help achieve targeted interest rate spreads over specified time periods, and should be viewed in that context. Under SFAS 107, certain of the \"hedged\" on-balance sheet categories (i.e., certain deposits) may not be presented at their estimated \"fair value\", but must be shown in the above table at their liquidation (\"book\") value. For SFAS 107 purposes, however, the \"fair value\" of derivative contracts used to hedge such items must be disclosed without regard to the \"fair value\" of the hedged balance sheet item. The estimated amounts that the Company would receive or pay, based upon current market rates or prices, to terminate such agreements was used as an approximation of \"fair value\". The \"fair value\" of customer contracts and the related offsetting contracts equal their carrying value. The \"fair value\" of interest rate swaps used for asset\/liability management purposes was a \"loss\" of $205 million at December 31, 1994 and a \"gain\" of $115 million at the end of 1993. The \"fair value\" of First Fidelity's futures contracts aggregated a $2 million \"loss\" at the end of 1994 and a $3 million \"gain\" as of December 31, 1993.\nNOTE 18. OTHER COMMITMENTS AND CONTINGENCIES\nLEGAL PROCEEDINGS\nThe Company is a party (as plaintiff or defendant) to a number of lawsuits. While any litigation carries an element of uncertainty, management is of the opinion that the liability, if any, resulting from these actions will not have a material effect on the liquidity, financial condition or results of operations of the Company.\nOPERATING LEASES\nAt December 31, 1994, the Company was obligated under non-cancelable operating leases for certain premises and equipment. Minimum future rental expenses under these leases are as follows:\nTotal rental expense under cancelable and non-cancelable operating leases for 1994, 1993 and 1992 was $33.4 million, $36.4 million and $44.3 million, respectively.\nLONG-TERM SERVICE CONTRACT\nIn September, 1990, the Company entered into a service contract, under which an outside servicer provides certain data processing services, manages the Company's data center operations and is integrating various application systems to produce unified Company-wide operating systems. The cost of the services is determined by volume considerations and an inflation factor, in addition to an agreed base rate.\nNOTE 19. RELATED PARTY TRANSACTIONS\nAt December 31, 1994 and 1993, the Company had balances with Santander, typical of and consistent with a correspondent banking relationship in the normal course of business. In addition, First Fidelity repurchased 250 thousand shares of its Common Stock from Santander during 1994, at market prices, which averaged $44.43.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company also purchased from Santander 3,063,297 shares of the capital stock of Banco Espanol de Credito, S.A. (\"Banesto\"), which represents approximately 0.5% of Banesto's outstanding capital stock, for approximately $18.1 million.\nLoans to directors, executive officers and their associates, which are made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others, approximated $423 million at December 31, 1994 and $154 million at December 31, 1993. During 1994, there were increases of approximately $310 million and loan repayments of approximately $41 million on such loans.\nNOTE 20. CONDENSED FINANCIAL INFORMATION OF FIRST FIDELITY BANCORPORATION (PARENT COMPANY ONLY)\nCONDENSED BALANCE SHEETS (PARENT COMPANY ONLY)\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCONDENSED STATEMENTS OF INCOME (PARENT COMPANY ONLY)\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nCONDENSED STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY)\nREGULATORY RESTRICTIONS\nThe Federal Reserve Act limits extensions of credit that can be made from the Company's bank subsidiaries to any affiliate (with certain exceptions), including the Parent Company. Loans to any one affiliate may not exceed 10% of a bank subsidiary's capital and surplus, and loans to all affiliates may not exceed 20% of such bank subsidiary's capital and surplus. Additionally, such loans must be collateralized and must have terms comparable to those with unaffiliated companies.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nSUPPLEMENTARY DATA\nSUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\n- ---------------\n(A) Non-interest income less net securities transactions.\n(B) Net income.\n(C) Net income applicable to Common Stock.\nFIRST FIDELITY BANCORPORATION (AND SUBSIDIARIES)\nSUPPLEMENTARY DATA\nCOMPUTATION OF EARNINGS PER SHARE\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS OF THE REGISTRANT\nThe Company responds to this item by incorporating by reference the material responsive to such item in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Company responds to this item by incorporating by reference the material responsive to such item in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders, provided, however, that such incorporation by reference shall not be deemed to specifically incorporate by reference the information referred to in Item 402(a)(8) of Securities and Exchange Commission Regulation S-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Company responds to this item by incorporating by reference the material responsive to such item in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company responds to this item by incorporating by reference the material responsive to such item in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The financial statements listed on the index set forth in Item 8 of this Annual Report on Form 10-K are filed as part of this Annual Report.\nFinancial statement schedules are not required under the related instructions of the Securities and Exchange Commission or are inapplicable and, therefore, have been omitted.\n(b) The following exhibits are incorporated by reference herein or annexed to this Annual Report:\n(c) Current Reports on Form 8-K during the quarter ended December 31, 1994.\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, THIS 16TH DAY OF FEBRUARY, 1995.\nFIRST FIDELITY BANCORPORATION\nBy: \/s\/ ANTHONY P. TERRACCIANO -------------------------------------- Anthony P. Terracciano Chairman, President and Chief Executive Officer\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nEXHIBIT INDEX","section_15":""}
{"filename":"70538_1994.txt","cik":"70538","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Registrant is neither a party to nor is its property subject to any material pending legal proceedings.\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 information required by this item is included on the inside back cover of the company's annual report for the year ended August 31, 1994, under the caption \"Common Share Prices and Dividends per Share\" and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this item is included on pages 36 and 37 of the company's annual report for the year ended August 31, 1994, under the caption \"Ten-Year Financial Summary\" and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information required by this item is included on pages 34 and 35 of the company's annual report for the year ended August 31, 1994, under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" 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 included on pages 25 through 33 of the company's annual report for the year ended August 31, 1994, under the captions \"Consolidated Balance Sheets,\" \"Consolidated Statements of Income,\" Consolidated Statements of Stockholders' Equity,\" \"Consolidated Statements of Cash Flows,\" \"Notes to Consolidated Financial Statements,\" and \"Report of Independent Public Accountants\" and is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nITEM 11.","section_9A":"","section_9B":"","section_10":"","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is included on pages 6 through 13 under the captions \"Compensation of Directors,\" \"Other Information Concerning the Board and its Committees,\" \"Compensation Committee Interlocks and Insider Participation,\" \"Summary Compensation Table,\" \"Option Grants in Last Fiscal Year,\" \"Aggregated Option Exercises and Fiscal Year-End Option Values,\" \"Other Agreements,\" and \"Pension and Supplemental Retirement Benefits\" of the company's proxy statement for the annual meeting of stockholders to be held January 4, 1995, filed with the Commission pursuant to Regulation 14A, and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is included on page 5 under the caption \"Beneficial Ownership of the Corporation's Securities\" of the company's proxy statement for the annual meeting of stockholders to be held January 4, 1995, filed with the Commission pursuant to Regulation 14A, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is included on page 5 under the caption \"Certain Transactions\" of the company's proxy statement for the annual meeting of stockholders to be held January 4, 1995, filed with the Commission pursuant to Regulation 14A, and is incorporated herein by reference.\nAny of schedules I through XIV not listed above have been omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto.\nITEM 14.","section_14":"ITEM 14. (Continued) 3. Exhibits filed with this report\nITEM 14. (Continued)\nITEM 14. (Continued)\n(b) No reports on Form 8-K were filed for the three months ended August 31, 1994.\n(c) Exhibits 2, 9, 12, 18, 22, and 28 have been omitted because they are not applicable.\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.\nNATIONAL SERVICE INDUSTRIES, INC.\nDate: November 18, 1994 By: \/s\/ Kenyon W. Murphy Kenyon W. Murphy Secretary and Assistant Counsel\nPursuant to the requirements of the 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 \/s\/ David Levy Attorney-in-Fact David Levy\nArthur Andersen LLP\nAtlanta, Georgia\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo National Service Industries, Inc.:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in NATIONAL SERVICE INDUSTRIES, INC. and subsidiaries' annual report to stockholders incorporated by reference in this Form 10-K and have issued our report thereon dated October 20, 1994. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in Item 14 in this Form 10-K are the responsibility of the Company's management and are presented for the purpose of complying with the Securities and Exchange Commission's rules and are not part of the 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 LLP ARTHUR ANDERSEN LLP\nOctober 20, 1994\nINDEX TO EXHIBITS","section_15":""}
{"filename":"71344_1994.txt","cik":"71344","year":"1994","section_1":"Item 1. BUSINESS\nGeneral -------\nNew England Telephone and Telegraph Company (the \"Company\") was incorporated in 1883 under the laws of the State of New York, has its principal executive offices at 125 High Street, Boston, Massachusetts 02110 (telephone number 617-743-9800) and is engaged primarily in providing telecommunications services in Maine, Massachusetts, New Hampshire, Rhode Island and Vermont. The Company is a wholly-owned subsidiary of NYNEX Corporation (\"NYNEX\").\nTelecommunications Services ---------------------------\nThe Company is engaged primarily in providing two types of telecommunications services, exchange telecommunications and exchange access, in Maine, Massachusetts, New Hampshire, Rhode Island and Vermont.\nExchange telecommunications service is the transmission of telecommunications among customers located within geographical areas (local access and transport areas or \"LATAs\"). These LATAs are generally centered on a city or other identifiable community of interest and, subject to certain exceptions, each LATA marks an area within which a former Bell System local exchange company (\"LEC\") operating within such territory may provide telecommunications services (see \"Operations Under the Modification of Final Judgment\" below). Exchange telecommunications service may include long distance service as well as local service within LATAs. Examples of exchange telecommunications services include switched local residential and business services, long distance service, private line voice and data services, Wide Area Telecommunications Service (\"WATS\") and Centrex services.\nExchange access service refers to the link provided by LECs between a customer's premises and the transmission facilities of other telecommunications carriers, generally interLATA carriers. Examples of exchange access services include switched access and special access services.\nCertain billing and collection services are performed by the Company for other carriers, primarily AT&T Corp. (\"AT&T\"), and certain information providers that elect to subscribe to these services rather than perform such services themselves. Effective January 1, 1987, such billing and collection services were detariffed on an interstate basis and are offered to interexchange carriers under contract. In 1994, approximately 1% of operating revenues was derived from such billing and collection services. In 1990, the Company and AT&T signed a six-year contract extending the Company's role as an AT&T long distance billing and collection agent. The agreement allows AT&T the flexibility of gradually assuming certain administrative and billing functions performed by the Company. The contract expires on December 31, 1995.\nThere are six LATAs that comprise the area served by the Company and they are referred to as follows: Eastern Massachusetts, Western Massachusetts, Maine, New Hampshire, Rhode Island and Vermont.\nThe following table sets forth for the Company the approximate number of network access lines in service at the end of each year:\nSizable areas and many localities within the territories served by the Company are served by nonaffiliated telephone companies that had approximately 215,000 network access lines in service in those territories on December 31, 1994. The Company does not furnish local service in the areas and localities served by such companies.\nFor the year ending December 31, 1994, approximately 93% of the total operating revenues of the Company was derived from telecommunications services, of which one customer, AT&T, accounted for approximately 14%, primarily in network access and other revenues. The remaining approximately 7% of total operating revenues was from other sources, primarily licensing fees for telephone directories and inside wire related charges.\nTelesector Resources Group, Inc. -------------------------------\nTelesector Resources Group, Inc. (\"Telesector Resources\") is a wholly-owned subsidiary of the Company and New York Telephone Company (\"New York Telephone\"), also a wholly-owned subsidiary of NYNEX. In 1990, NYNEX Materiel Enterprises Company was transferred from NYNEX to the Company and to New York Telephone (collectively, the \"Telephone Companies\") and then merged into another jointly owned subsidiary, NYNEX Service Company, which was renamed Telesector Resources. The Company has a 33 1\/3% ownership in Telesector Resources and shares voting rights equally with the other owner, New York Telephone.\nThe Telephone Companies have consolidated all or part of many regional service and support functions into Telesector Resources. Regional service functions are interstate access services, operator services, public communications, sales, market area services, corporate services, information services, labor relations, engineering\/construction and business planning. Support functions are quality and process re-engineering, marketing, technology and planning, public relations, legal and human resources. In addition, Telesector Resources provides various procurement, procurement support and materials management services to the Telephone Companies, on a nonexclusive basis. These services include product evaluation, contracting, purchasing, materials management and disposition, warehousing, transportation, and equipment repair management. Under a reciprocal services agreement, the Company provides certain administrative and other services for Telesector Resources.\nEach of the seven regional holding companies (\"RHCs\") formed in connection with the AT&T divestiture owns an equal interest in Bell Communications Research, Inc. (\"Bellcore\") (see \"Operations Under the Modification of Final Judgment\" below). Bellcore furnishes to the LECs, including the Company, and certain of their subsidiaries technical and support services (that include research and development) relating to exchange telecommunications and exchange access services that can be provided more efficiently on a centralized basis. Bellcore serves as a central point of contact for coordinating the efforts of NYNEX and the other RHCs in meeting the national security and emergency preparedness requirements of the federal government.\nCertain Affiliated Business Operations --------------------------------------\nNYNEX Information Resources Company -----------------------------------\nThe Company has agreements with NYNEX Information Resources Company (\"Information Resources\"), a wholly-owned subsidiary of NYNEX, pursuant to which Information Resources pays a fee to the Company for the right to produce, publish and distribute alphabetical (White Pages) and classified (Yellow Pages) directories for the Company.\nBusiness Restructuring ----------------------\nDuring 1994, the Company reached new agreements with the Communications Workers of America (\"CWA\") and the International Brotherhood of Electrical Workers (\"IBEW\") which provided for retirement incentives (see \"Employee Relations\" below). The Company also announced retirement incentives for its management employees. These incentives are intended to provide a voluntary means to implement substantially all of the planned work force reductions of approximately 6,300 employees by the end of 1996. Much of the cost will be funded by the NYNEX pension plans. In 1994, the Company recorded $168.1 million of pretax charges ($111.2 million after-tax) primarily for the incremental cost of pension enhancements and associated postretirement medical costs for 1,580 employees who left the Company under the retirement incentives and for the Company's allocation from Telesector Resources for its pension enhancements.\nIn 1993, the Company recorded $619 million in pretax charges ($376 million after-tax) for business restructuring. These charges resulted from a comprehensive analysis of operations and work processes, resulting in a strategy to redesign them to improve efficiency and customer service, to adjust quickly to accelerating change, to implement work force reductions, and to produce cost savings necessary for the Company to operate in an increasingly competitive environment.\nCapital Expenditures --------------------\nThe Company meets the expanding needs for telecommunications services by making capital expenditures to upgrade and extend the existing telecommunications network, including new construction, optical fiber and modernization. Capital expenditures (excluding the equity component of allowance for funds used during construction and additions under capital\nleases) for 1990 through 1994 are set forth below:\nOperations Under the Modification of Final Judgment ---------------------------------------------------\nThe operations of NYNEX and its subsidiaries in all industry segments are subject to the requirements of a consent decree known as the \"Modification of Final Judgment\" (\"MFJ\"). The MFJ arose out of an antitrust action brought by the United States Department of Justice (\"DOJ\") against AT&T. In August 1982, the United States District Court for the District of Columbia (the \"MFJ Court\") approved the MFJ as in the public interest. In February 1983, the United States Supreme Court affirmed the MFJ Court's action. Pursuant to the MFJ, AT&T divested its 22 wholly-owned LECs, including the Telephone Companies, distributed them to the RHCs, and distributed the stock of the RHCs to AT&T's stockholders on January 1, 1984.\nAs initially approved, the MFJ restricted the RHCs, including NYNEX and its subsidiaries, including the Company, to the provision of exchange telecommunications service, exchange access and information access services, the provision (but not manufacture) of customer premises equipment (\"CPE\") and the publishing of printed directory advertising. Although some restrictions placed on RHC operations have been removed or modified since entry of the MFJ, the RHCs are still required to seek MFJ Court approval in order to provide interLATA telecommunications services, to manufacture or provide telecommunications products and to manufacture CPE. Also, the Company is still required to offer to all interexchange carriers and information service providers exchange access and information access, at certain locations, which are equal in quality, type and price to that provided to AT&T and its affiliates (\"Equal Access\"). Included in capital expenditures for the period 1990 through 1993 are costs in connection with the requirement to provide Equal Access (see \"Capital Expenditures\" above).\nMFJ Court approval to engage in any of the prohibited activities is normally predicated upon a showing to the MFJ Court that there is no substantial possibility that an RHC could use its monopoly power to impede competition in the market it seeks to enter. The MFJ Court has established procedures for dealing with requests by an RHC to enter new businesses. Such requests must first be submitted to the DOJ for its review. After DOJ review, the RHC seeks approval directly from the MFJ Court. The MFJ Court will consider the recommendation of the DOJ in deciding whether a specific request should be granted.\nIn July 1991, the MFJ Court lifted the MFJ restriction on the provision of the content of information services by the RHCs and LECs, including NYNEX and the Telephone Companies. In May 1993, the United States Court of Appeals for the District of Columbia Circuit affirmed that decision. The Court of Appeals decision allows the RHCs and LECs, including NYNEX and the Telephone\nCompanies, to create and own the content of the information they transmit over the telephone lines and to provide data processing services to customers. In November 1993, the United States Supreme Court declined to review the Court of Appeals decision.\nRegulated Services ------------------\nIntrastate communications services offered by the Company are under the jurisdiction of state public utility commissions (see \"State Regulatory Matters\" below), and interstate communications services are under the jurisdiction of the Federal Communications Commission (\"FCC\") (see \"Federal Regulatory Matters\" below). In addition, state and federal regulators review various transactions between the Company and the other subsidiaries of NYNEX.\nState Regulatory Matters ------------------------\nSet forth below is a description of certain intrastate regulatory proceedings with respect to changes in rates and revenues\/1\/. -\nThe net annual intrastate revenue reduction ordered for the Company, comprised of both reductions in rates and one-time credits to customers, was approximately $13.5 million, $6.2 million and $9.0 million for 1994, 1993, and 1992, respectively.\nMaine -----\nOn May 10, 1994, the Maine Public Utilities Commission (\"MPUC\") commenced a proceeding to explore alternatives to traditional rate of return regulation for the Company. In an Order dated August 18, 1994, the MPUC consolidated this proceeding with an earnings investigation commenced in response to a ratepayer complaint. In testimony filed October 3, 1994, and amended January 13, 1995, the Company maintained that it was not earning above its authorized rate of return and identified a potential revenue requirement of approximately $12 million under a traditional rate of return methodology. Accordingly, the Company argued that current rates represent the appropriate starting point for any alternative regulation plan. The MPUC Staff and the Office of the Public Advocate each filed testimony on December 13, 1994 contesting the Company's analysis. The MPUC Staff concluded that current rates produced nearly $40 million in overearnings, while the Public Advocate estimated overearnings at $65 million. Both argued for a revenue reduction prior to the initiation of any incentive regulation plan. Hearings on this consolidated proceeding were held in February 1995, with a decision expected from the MPUC in May 1995.\n---------- \/1\/ The term \"rates\" is synonymous with prices. When changes in rates are - referred to in the aggregate, the reference is to the aggregate effect of individual price changes multiplied by the volumes of services, assuming no change in volume as a result of the price changes. The term \"revenues\", on the other hand, refers to the aggregate effect of prices multiplied by volumes of service, with effect given to the change in volume as a result of any price changes.\nMassachusetts -------------\nOn January 6, 1995, the MDPU opened an investigation concerning intraLATA and local exchange competition in Massachusetts. The MDPU indicated that among the matters it intends to address are collocation, interconnection of networks, intraLATA toll presubscription, telephone number assignment and portability and universal service funding. The Company and other parties submitted their comments on the scope of the proceeding in February 1995. Decisions in this proceeding could have a significant impact on the Company's revenues.\nRhode Island ------------\nOn October 25, 1994, the RIPUC initiated a proceeding with respect to competition. In an order dated February 26, 1995, the RIPUC stated that it will consider numerous issues including intraLATA presubscription, telephone number assignment and portability, interconnection of networks and collocation.\nIn a separate proceeding, the RIPUC considered proposals from the Rhode Island Division of Public Utilities and Carriers and various interexchange carriers with respect to the Company's intrastate access charges, including a proposal to freeze the Company's annual carrier common line revenues based on the most recent available amount. On November 18, 1994, the RIPUC decided to take no action to alter rates or rate structure at this time.\nVermont -------\nIn February 1995, the Company and other parties submitted to the Vermont Public Service Board (\"VPSB\") their comments on the proposed order of procedure in the VPSB's proceeding on competition. The proceeding will address issues such as open network architecture, interconnection, unbundling, intraLATA toll presubscription, telephone number assignment and portability and universal service policy.\nSee also discussion of State Regulatory Matters in Part II, Management's Discussion and Analysis of Results of Operations, which is incorporated herein by reference.\nFederal Regulatory Matters --------------------------\nInterstate Access Charges -------------------------\nInterstate access charges are tariff charges filed with the FCC that compensate LECs, including the Company, for services that allow carriers and other customers to originate and terminate interstate telecommunications traffic on the LECs' local distribution networks. Such charges recover the LECs' access-related costs allocated to the interstate jurisdiction (\"Interstate Costs\") under the FCC's jurisdictional cost allocation rules.\nWith respect to the provision of access to the switched network, separate charges are applied to end users (\"End User Common Line Charges\") and to interexchange carriers (\"switched access\"). End User Common Line Charges recover, through a fixed charge, a portion of the Interstate Costs of the line connecting an end user's premises with the LEC's central office. The LECs recover their remaining Interstate Costs through mileage and usage sensitive charges to the interexchange carriers.\nIn June 1994, the FCC completed a review of the performance of LECs during the initial period of price cap regulation. The Telephone Companies filed comments advocating price cap and access reform to keep pace with the intensifying competitive environment. Among other things, the Telephone Companies recommended increased pricing flexibility, elimination of sharing and low end adjustment mechanisms, and reduction of the productivity factor. An FCC decision is pending.\nOn March 3, 1995, the FCC released Orders to Show Cause to each of the LECs, including the Telephone Companies, resulting from an audit of the costs that the LECs reported to the National Exchange Carrier Association (\"NECA\") for Common Line Pooling purposes for 1988 and the first quarter of 1989. The audit report cites each of the LECs for alleged violations of the FCC's accounting rules and reporting errors which, as to the Telephone Companies, were calculated to total $37.8 million in respect of all interstate costs for the period. Some of the alleged errors would have the effect of understating the Telephone Companies' revenue requirement; the net effect, therefore, is an alleged revenue requirement overstatement of $19.8 million. That estimate is considered preliminary, however, because the auditors did not have sufficient information for several items to reach final conclusions.\nThe Order requires the Telephone Companies to show cause why the FCC should not (1) issue a Notice of Apparent Liability for Forfeiture for violations of the FCC's accounting rules; (2) require the Telephone Companies to adjust their price cap indexes; and (3) require the Telephone Companies to improve their internal processes to bring them into compliance. The Telephone Companies must respond to the Order by May 2, 1995.\nOn December 15, 1993, the Telephone Companies filed a petition with the FCC for a waiver to implement the Universal Service Preservation Plan (\"USPP\") in order to compete more effectively with alternative providers of local telephone service. The USPP would reduce the Switched Access rate for multiline business users in zones of high traffic density by approximately 40 percent and would shift most of the revenues lost from this rate reduction to flat, per-line charges applicable to all access lines. Overall annual access revenues would be reduced by $25 million.\nOther Federal Matters ---------------------\nIn August 1992, the FCC determined that the LECs may provide video dialtone service, a common carrier platform for transporting and switching video programming from programmers to subscribers, and that neither the LEC providing video dialtone nor its programmer-customers require a local cable franchise.\nOn October 20, 1994, the FCC announced that it had adopted a decision responding to petitions for reconsideration of its 1992 order establishing the rules and regulatory framework governing telephone company provision of video dialtone. The FCC generally affirmed its rules for video dialtone, with some clarifications and modifications. The FCC affirmed the common carrier nature of the video dialtone platform, indicated that the video dialtone platform will be subject to dual federal\/state regulation, stated that cost allocation issues will be resolved in the tariff process and relaxed in certain respects its telephone company\/cable non-ownership affiliation rules.\nOn February 7, 1995, the FCC adopted an order granting the Company authorization to begin construction of advanced video dialtone network facilities in portions of Massachusetts and Rhode Island. The facilities, which are planned to pass 334,000 households in Massachusetts and 63,000 households in Rhode Island, will be used to provide video dialtone service as an alternative to cable service by early 1996.\nSee also discussion of Federal Regulatory Matters in Part II, Management's Discussion and Analysis of Results of Operations, which is incorporated herein by reference.\n---------------------------------\nThe outcome of all refund matters as well as the time frame within which each will be resolved, is not presently determinable. As of December 31, 1994, the aggregate amount of revenues that was estimated to be subject to possible refund from all regulatory proceedings was approximately $21.4 million, plus related interest.\n---------------------------------\nCompetition -----------\nAdvances in technology, as well as regulatory and court decisions, are expanding the types of communications products and services available in the market, as well as the number of alternatives to the telecommunications services provided by the Company. Various business alliances and other undertakings were announced or consummated in the telecommunications industry in 1994 which indicate an intensifying level of competition, especially with respect to the operations of the Company. AT&T acquired, through a merger, McCaw Cellular Communications Inc. (\"McCaw\"), which operates in a number of areas within NYNEX's region in the Northeast. U S WEST Inc. (\"U S WEST\") holds a major interest in Time Warner Entertainment Co. L.P., which includes Time Warner Cable and has announced an agreement to acquire Cablevision Systems Corp. (\"Cablevision\"). Time Warner Cable has extensive operations in the Northeast. Cablevision, which operates in Boston plans to construct a fiber-optic network to deliver telecommunications and video services. MCI Communications Corp. (\"MCI\") plans to spend $2 billion to establish local fiber-optic networks in 20 major cities, including Boston offering a way to bypass the local exchange carrier, including the Company, and connect directly to MCI's long-distance network. MCI has acquired Digital Equipment Corporation's fiber optic network in New England. In certain markets in New England, the Company faces significant competition from alternative service providers with substantial resources. The Company has allowed alternative service providers to place transmission equipment in its central offices, under an arrangement known as collocation. The Company also faces increasing competition in Centrex services, long distance, WATS, billing and collection services, pay telephones, and various other services.\nEmployee Relations ------------------\nThe Company had approximately 20,000 employees at December 31, 1994. Approximately 13,700 employees are represented by unions. Of those so represented, approximately 99% are represented by the IBEW and approximately 1% by the CWA, both of which are affiliated with the AFL-CIO.\nIn 1994, collective bargaining agreements between the Company, the CWA and the IBEW were extended until August 8, 1998. These agreements were scheduled to expire on August 5, 1995. Basic wages will increase approximately 14.5%, including a 4.0% increase in August 1994, and a pension enhancement is provided to encourage early retirement. Wages will increase 4.0%, 3.5% and 3.0% in August 1995, 1996 and 1997, respectively. There may be a cost-of-living adjustment in 1997, and employees may receive added compensation for meeting service standards (in March 1996, 1997 and 1998) and for enrollment into a managed care network (in 1996 and 1997).\nFor the CWA, the effective date of their agreements and the initial wage increase was April 3, 1994.\nThe effective date of the agreement with the IBEW was August 5, 1994, and the initial wage increase was effective on August 7, 1994.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe properties of the Company do not lend themselves to simple description by character and location of principal units.\nAt December 31, 1994, the gross book value of telephone plant was $12.1 billion, consisting principally of telephone plant and equipment (89%). Other classifications include: land, land improvements and buildings (7%); furniture and other equipment (3%); and plant under construction and other (1%).\nSubstantially all of the Company's central office equipment is located in buildings owned by the Company situated on land that it owns. Many administrative offices, garages and business offices are in rented quarters.\nAs part of the Company's 1993 restructuring associated with re-engineering the way service is delivered to customers (see \"Business Restructuring\" above), the Company intends to consolidate work centers by the end of 1996 to build larger work teams in fewer locations.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nContingent Liabilities Agreement --------------------------------\nThe Plan of Reorganization, which was approved by the MFJ Court in August 1983 in connection with the AT&T divestiture, provides for the recognition and payment of liabilities that are attributable to predivestiture events (including transactions to implement divestiture), but that do not become certain until after divestiture. These contingent liabilities relate principally to predivestiture litigation and other claims against AT&T, its affiliates and the LECs with respect to the environment, rates, taxes, contracts and torts (including business torts, such as alleged violations of the antitrust laws).\nWith respect to such liabilities, AT&T and the LECs will share the costs of any judgment or other determination of liability entered by a court or administrative agency against any of them, whether or not a given entity is a party to the proceeding and regardless of whether an entity is dismissed from the proceeding by virtue of settlement or otherwise. Other costs to be shared would include the costs of defending the claim (including attorneys' fees and\ncourt costs) and the cost of interest or penalties with respect to any such judgment or determination. With certain exceptions, responsibility for such contingent liabilities will generally be divided among AT&T and the LECs on the basis of their relative net investment as of the effective date of divestiture. Under this general rule of allocation, the Company pays approximately 3.5% of any judgment or determination of liability.\nIn January 1995, NYNEX and the other RHCs agreed to terminate the sharing arrangement among the LECs with respect to predivestiture contingent liabilities for certain matters. AT&T did not enter into the agreement and, accordingly, the sharing arrangement remains in effect with respect to AT&T's predivestiture liabilities and with respect to AT&T's share of LEC predivestiture liabilities.\nLitigation ----------\nOn October 28, 1994, a lawsuit was filed in Vermont state court by a ratepayer group seeking an additional refund by the Company, with respect to 1993 and 1994 revenues, of up to $54 million. The Company and other defendants filed motions to dismiss the complaint, and on December 30, 1994, the Court dismissed the lawsuit in its entirety.\nIn January 1990, Wegoland Ltd. and Howard Weiner filed an action in the United States District Court for the Southern District of New York on behalf of the telephone ratepayers of the Telephone Companies alleging violations of the Racketeer Influenced and Corrupt Organizations Act and various state laws. A substantially identical case was filed by Donna Roazen in March 1990. The defendants in these cases were NYNEX, certain of its subsidiaries, including the Company, and certain present and former officers of those companies. Plaintiffs alleged that the Telephone Companies had been charged inflated prices in transactions with their affiliates and that those prices were unlawfully reflected in the Telephone Companies' regulated rates. In November 1992, the District Court granted defendants' motions to dismiss these actions with prejudice. The United States Court of Appeals for the Second Circuit affirmed the dismissal on May 20, 1994. No further appeal was taken.\n---------------------------------\nWhile counsel cannot give assurance as to the outcome of any of these matters, in the opinion of Management based upon the advice of counsel, the ultimate resolution of these matters in future periods is not expected to have a material effect on the Company's financial position or annual operating results but could have a material effect on quarterly operating results.\n---------------------------------\nOn November 15, 1993, NYNEX and the Company filed suit in the United States District Court for the District of Maine seeking an order declaring that section 533(b) of the Cable Communications Policy Act of 1984 is unconstitutional and permanently enjoining the United States from enforcing section 533(b) against NYNEX. Section 533(b) prohibits NYNEX from providing video programming to subscribers in areas where the Telephone Companies provide service. On December 8, 1994, the court issued an opinion and order declaring that section 533(b) is unconstitutional and stating that it will enjoin the enforcement of section 533(b) against NYNEX and its subsidiaries within the NYNEX service area. The Department of Justice has appealed.\nPART II ITEM 6. SELECTED FINANCIAL DATA\nThe results for 1994 include $168 million of pretax charges ($111 million after-tax) for pension enhancements for employees who elected to leave the Company during the year under retirement incentives (see Management's Discussion and Analysis of Results of Operations). The results for 1993 reflect the effects of pretax charges of $619 million ($376 million after- tax) for business restructuring, primarily related to efforts to redesign operations and incremental costs associated with work force reductions (see Management's Discussion and Analysis of Results of Operations). The results for 1991 reflect the effects of pretax charges of $193 million ($122 million after-tax) for operational restructuring related to force reduction programs.\n+ Excludes additions under capital lease obligations and the equity component of allowance for funds used during construction. ++ For the purpose of this ratio: (i) earnings have been calculated by adding Interest expense and the estimated interest portion of rentals to Earnings before Income taxes and cumulative effect of change in accounting principle; and (ii) fixed charges are comprised of Interest expense and the estimated interest portion of rentals.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS\nThe following Management's Narrative Analysis of Results of Operations is provided pursuant to General Instruction J(2) to Form 10-K.\nBusiness Restructuring ----------------------\nPURPOSE OF RESTRUCTURING Externally, rapid changes in technology and regulation are opening New England Telephone and Telegraph Company's (the \"Company\") markets to competitors (see State and Federal Regulatory Matters). As there are more communications alternatives available to customers, and their expectations for better quality and service at lower prices are rising, it is possible that competitors can serve parts of the Company's market at lower costs. Business restructuring resulted from a comprehensive analysis of operations and work processes, resulting in a strategy to redesign them to improve efficiency and customer service, to adjust quickly to accelerating change, to implement work force reductions, and to produce cost savings necessary for the Company to operate in an increasingly competitive environment.\n1993 RESTRUCTURING CHARGES As a result of the planned business restructuring, 1993 results include pretax charges of approximately $619 million ($376 million after-tax) comprised of $395 million in employee termination costs, $83 million of process re-engineering charges, and $141 million for the Company's allocation of Telesector Resources Group, Inc. (\"Telesector Resources\") business restructuring charges.\nEmployee Termination Costs: In 1993, approximately $201 million of pretax charges was recorded for employee severance payments and approximately $194 million of pretax charges was recorded for postretirement medical costs (total after-tax charges of $240 million) for the work force reductions. The severance charges included salary, payroll taxes, and outplacement costs to be paid under provisions of the Company's force management plan for management employees and terms of collective bargaining agreements for nonmanagement employees. At December 31, 1993, the expected work force reductions by year were as follows:\nProcess Re-engineering: Approximately $83 million of the 1993 charges ($51 million after-tax) consists of costs associated with re-engineering the way service is delivered to customers, including operating the Company and New York Telephone Company (\"New York Telephone\") (collectively, the \"Telephone Companies\") as a single enterprise under the \"NYNEX\" brand. During the period 1994 through 1996, NYNEX Corporation (\"NYNEX\") intends to decentralize the provision of residence and business customer service throughout the region, create regional businesses to focus on unique markets,\nand centralize numerous operations and support functions. Included in this amount are:\nSystems redesign is the cost of developing new systems, processes and procedures to realize operational efficiencies and enable the Company to reduce work force levels. Commencing in 1994, certain specific new systems development initiatives were begun to facilitate implementation of process re-engineering initiatives. These projects consist of radical changes in the applications and systems supporting business functions. The redesign of these business functions is an integral part of the restructuring plan, and all the costs associated with these projects are incremental to ongoing operations. Specifically, only software purchases and external contractor expenses, which are normally expensed in accordance with Company policy, were included in the 1993 restructuring charges for the following business processes:\nCustomer contact represents the direct interface with the customer to provide sales, billing inquiry and repair service scheduling on the first contact, eliminating the number of handoffs that presently exist. New processes will allow customers to define the way they want to do business with the Company. Customer operations focuses on network monitoring and surveillance, trouble testing, dispatch control, and proactive repair with reliability as a critical source of competitive advantage.\nWork center consolidation costs are incremental costs associated with establishing work teams in fewer locations to take advantage of lower force levels and system efficiencies, such as lease termination costs from the date premises are vacated, moving property to new locations and other consolidation costs. Branding includes the costs to develop a single \"NYNEX\" brand identity associated with the restructured business operations. Relocation costs are required to move personnel to different locations due to work center consolidations and include employee home sale and purchase expenses, moving expenses, travel and lodging expenses, and other costs based on the Company's relocation guidelines and the provisions of collective bargaining agreements. Training costs are for training nonmanagement employees on newly-designed, cross-functional job positions and re-engineered systems created as part of the restructuring plan and include tuition, out of pocket course development and administrative costs, facilities charges, and related travel and lodging. This training reflects broadening of job skills that will permit one employee to perform tasks formerly performed by several employees. Re-engineering implementation costs are incremental costs to complete the various re- engineering initiatives.\nCosts Allocated from Telesector Resources: Approximately $141 million of restructuring charges ($86 million after-tax) was allocated to the Company from Telesector Resources, primarily related to its force reduction and re- engineering programs. The following items were included in these charges:\n* 1994 includes $17 million of severance amounts associated with the balance of the 1991 restructuring reserve at December 31, 1993.\n1994 ADDITIONAL CHARGES During 1994, the Company reached new agreements with the Communications Workers of America (\"CWA\") and the International Brotherhood of Electrical Workers (\"IBEW\") (see \"Collective Bargaining Agreements\" below) which provided for retirement incentives. The Company also announced retirement incentives for its management employees. The retirement incentives credit employees with an additional six years toward both their age and their length of service for the purpose of determining pension eligibility and benefits. The management and nonmanagement incentives are intended to provide a voluntary means to implement a portion of the planned work force reductions of approximately 6,300 employees by the end of 1996. Postretirement medical costs will be increased on a per employee basis, because these incentives resulted in more individuals qualifying for lifetime medical coverage than under the 1993 force reduction plan. Other retiree costs include vacation buyout and outplacement costs.\nThe retirement incentives will be offered at different times through 1996 according to local force requirements and are expected to generate additional charges over that period of time as employees elect to leave the business, under retirement incentives rather than under the 1993 force reduction plan. Much of the cost of the retirement incentives will be funded by NYNEX's pension plans. In 1994, $168.1 million of pretax charges ($111.2 million after-tax) was recorded, primarily for the incremental cost of retirement incentives for 1,580 employees who left the Company and for the Company's allocation from Telesector Resources for its retirement incentives.\nThe components of the $168.1 million pretax charges are $84.4 million ($57.0 million after-tax) for pension enhancements, $47.6 million ($32.3 million after tax) for associated postretirement medical costs and $36.1 million ($21.9 million after-tax) allocated to the Company from Telesector Resources for its retirement incentives and related postretirement medical costs.\nCURRENT STATUS OF BUSINESS RESTRUCTURING Employee Reductions: Due to additional time required to negotiate with the CWA and IBEW, the number of employees leaving the Company during 1994 was less\nthan originally planned, reflecting a delay, but not a decrease, in the total number of employees expected to leave. The actual number of work force reductions in 1994 and the revised expectation for 1995 and 1996 are as follows:\n* Includes 145 management employees who transferred from the Company to Telesector Resources and subsequently left in 1994 under the pension enhancements.\nAdvances in technology and streamlined processes are expected to make it possible for a smaller work force to maintain the same size network. As a result, force reductions will continue in areas where redesigned processes can meet customer service requirements with fewer people. The analysis of operations and work processes resulted in recommendations for specific process and system changes, and force reductions were identified as a result. This, in turn, will enable the Company to reduce expenses.\nThe reserves established for severance in 1993 have been, and will continue to be, primarily transferred to the pension liability on a per employee basis as a result of employees' leaving under the retirement incentives as opposed to severance provisions of the 1993 force reduction plan. The severance reserves utilized and the application of the postretirement medical liability established in 1993 for those employees are detailed in the 1994 column below under \"Retirement Incentives.\" Assuming that employees will continue to leave under the retirement incentives, the expected utilization of severance reserves and the application of the postretirement medical liability established in 1993 have been revised from the expectations previously reported under the 1993 force reduction plan as follows:\n* The revised expected utilization for severance reserves and the application of the postretirement medical liability per year is based on 1994 actual experience for the year and, therefore, updates the amounts disclosed during 1994 in the Quarterly Reports on Form 10-Q.\n** The severance reduction amount is comprised of $62 million of severance reserves transferred to the pension liability on a per employee basis and $6 million utilized for other retiree costs. In addition, the severance and postretirement medical reductions include $12 million and $5 million, respectively, which was transferred from the Company to Telesector Resources to cover the severance and postretirement medical costs associated with approximately 145 employees who transferred from the Company to Telesector Resources and subsequently left in 1994 under the pension enhancements.\nProcess Re-engineering: The actual 1994 utilization of reserves with revised expected utilization for 1995 and 1996 is as follows:\nSystems redesign: During 1994, it was determined that systems redesign would require a larger than anticipated upfront effort to fully integrate interfaces between various systems to permit development of multi-tasking capabilities. A higher degree of complexity and additional functionality required by real time, interactive systems contributed to the increase. The actual utilization in 1994 and the revised expected utilization in 1995 and 1996 of the systems redesign reserves are as follows:\nWork center consolidation was delayed in 1994 because of additional time required to negotiate agreements with the CWA and the IBEW. Until agreements were reached (see Collective Bargaining Agreements below), the movement of employees could not begin. Branding will require additional time to complete. The 1994 reduction in the reserve for branding includes approximately $6 million to reflect a revised estimate of 1994 branding costs. Relocation of employees has been significantly revised due to the increase in work centers and terms of the union agreements. Training was delayed due to the timing of the union agreements and the higher degree of complexity of the systems redesign; total expected costs were decreased due to the planned use of more in-house training. Re-engineering implementation cost more than expected because of an expanded work effort for the initiatives and the related retention of outside consultants.\nCosts allocated from Telesector Resources: The actual 1994 utilization of reserves with revised expected utilization for 1995 and 1996 is as follows:\n* 1994 includes $17 million of severance amounts associated with the balance of the 1991 restructuring reserve at December 31, 1993.\nCost Savings During the third and fourth quarters of 1994, the Company began to realize significant expense savings associated with force reductions. The Company experienced a $22 million reduction in wages as a result of approximately 1,580 employees leaving primarily under retirement incentives. In addition, there was a $16 million reduction in costs allocated from Telesector Resources as a result of expense savings associated with its force reductions.\nCollective Bargaining Agreements --------------------------------\nOn March 24, 1994, an agreement was reached with the CWA to extend through August 8, 1998 the collective bargaining agreement that was to expire on August 5, 1995. The agreement was ratified in May 1994. A similar agreement was reached with and ratified by the IBEW in August 1994. Under the terms of the new agreements, there will be basic wage increases of 10.5% during the life of the agreements. The wage rates will increase 4.0%, 3.5%, and 3.0% in August 1995, 1996 and 1997, respectively. In 1997, there may also be a cost-of-living adjustment. The agreements also provide for retirement incentives, a commitment to no layoffs or loss of wages as a result of Company-initiated \"process change\", an enhanced educational program and incentives to improve service quality.\nState Regulatory Matters ------------------------\nMassachusetts On April 14, 1994, the Company filed comprehensive tariff ------------- provisions with the Massachusetts Department of Public Utilities (\"MDPU\") as part of an Alternative Regulatory Plan to govern the Company's Massachusetts intrastate operations. The Company's filing proposes the following: (1) regulation of the Company for a period of ten years from the date of MDPU approval under a price framework; (2) pricing rules that limit the Company's ability to increase both overall average prices and specific rate elements, including a ceiling on the weighted average price of all tariffed services based on a formula of inflation minus a productivity factor plus or minus exogenous changes; (3) no earnings restriction; (4) a cap on the monthly rates for residence services until August 2001; (5) an increase of $2.50 monthly in the credit on exchange services for Lifeline customers; (6) investment commitments for the public telecommunications network, including commencing the deployment of a broadband network in Massachusetts; (7) quality of service commitments; (8) rate reductions for switched access services; and (9) a new streamlined standard of regulation governing the review of tariff filings. On May 24, 1994, the MDPU ruled that the Company's filing would be treated as a petition for alternative regulation and, consequently, the MDPU's review is not subject to the statutory suspension period. Hearings concerning the Company's filing concluded in November 1994, and final briefs were submitted in January 1995. A decision by the MDPU is pending.\nIn June 1990, the MDPU issued an order in Phase III of a proceeding that culminated a five-year investigation into the Company's rates, costs and revenues. The order calls for the gradual restructuring of local and long distance rates within the state, with the objective of moving prices for services closer to the costs of providing them. This is accomplished through an annual transitional filing of new rates by the Company. At the time the rates are established, revenue neutrality is maintained. The Company's first, second and third transitional filings became effective on November 15, 1991,\nJanuary 15, 1993, and April 14, 1994, respectively (see Operating Revenues below). On June 14, 1994, the MDPU granted the Company's motion to defer further transitional filings pending the outcome of the alternative regulation proceeding.\nNew Hampshire On June 30, 1994, the New Hampshire Public Utilities Commission ------------- (\"NHPUC\") approved the Company's proposed toll rate reduction targeted at small and medium volume usage customers, effective August 5, 1994. The annual revenue effect of the toll rate reduction is estimated to be approximately $7.1 million. Effective with billing periods on and after June 15, 1994, the Company was granted authority to impose a late payment charge on overdue residence and business customer balances, with an annual revenue effect of $2.5 million. The NHPUC previously approved, effective January 31, 1994, a Company-requested toll rate reduction targeted at high and medium volume usage customers, with an annual revenue effect of $3.5 million.\nRhode Island In August 1992, the Rhode Island Public Utilities Commission ------------ (\"RIPUC\") approved a Price Regulation Trial (\"PRT\") that provides the Company with significantly increased pricing and earnings freedom through 1995 and calls for specific investment and service-quality commitments by the Company. As a part of the PRT, the Company makes an annual filing, with overall price increases capped by a formula indexing Rhode Island prices to the Gross National Product Price Index, adjusted for productivity and exogenous factors. The PRT allows the Company to continue moving the prices of its services closer to the costs of providing them. The Company's 1993 filing, effective January 15, 1994, resulted in an overall revenue reduction of approximately $3.2 million for 1994, resulting from decreases in long distance revenues partially offset by increases in local service revenues. The Company's most recent annual filing became effective January 15, 1995. The filing effects an overall revenue reduction of approximately $445,000 for 1995 with numerous price adjustments. Under the PRT the Company must apply a one-time credit to customers' bills of 50% of any earnings between 12.25% and 19.25% return on equity and 100% of any earnings in excess of 19.25% return on equity. On March 1, 1995, the Company filed with the RIPUC a statement of its 1994 Rhode Island intrastate earnings, proposing no 1994 shared earnings credit.\nVermont On February 6, 1995, the Vermont Public Service Board (\"VPSB\"), on ------- motions for reconsideration, amended its earlier order in the Company's Price Regulation Plan proceeding to remove additional pricing restrictions and to permit the Company to modify or exit the Price Regulation Plan during its term. As with the VPSB's earlier order, the proposed changes would not restrict the Company's earnings during the four-year term of the plan but would impose a higher productivity factor and a narrow definition of exogenous costs in the price regulation formula, and additional quality of service standards. On March 8, 1995, the Company notified the VPSB of its rejection of the VPSB's proposed changes and that, accordingly, the Company would continue under rate of return regulation.\nIn the related proceeding to examine the Company's level of earnings, on February 6, 1995, the VPSB issued an order, on motions for reconsideration of its October 5, 1994 order, recalculating certain aspects of the required annual revenue reduction, the net effect of which remained approximately $15 million. The reduction is retroactive to December 29, 1993, the date the VPSB opened the proceeding. Among the adjustments ordered was a reversal of\nthe VPSB's previous position on depreciation rates and the approval of stipulated depreciation parameters, with the result that the adjustment previously taken by the Company in response to the VPSB's October 5th order must be reversed and reserves adjusted to conform with the February 6th order. In 1994, the Company reduced local operating revenues by approximately $15 million for subsequent refunds to Vermont customers for the period from December 29, 1993 through December 31, 1994 (see Operating Revenues and Operating Expenses below). A date for refunds to customers will be set once the VPSB completes supplemental hearings on rate reduction design issues. On March 6, 1995, the Company filed an appeal of certain portions of the VPSB's February 6 order with the Vermont Supreme Court.\nFederal Regulatory Matters --------------------------\nEffective January 1, 1991, the Federal Communications Commission (\"FCC\") adopted incentive regulation in the form of price caps with respect to interstate services provided by the Company. Price caps focus on local exchange carriers' (\"LECs\") prices rather than costs and set maximum limits on prices LECs can charge for their services. These limits are subject to adjustment each year to reflect inflation, a productivity factor and certain other cost changes. Under FCC price cap regulation, the Company may earn a return on equity up to approximately 15%. Above that level, earnings are subject to equal sharing with ratepayers until they reach an effective cap on interstate return on equity of approximately 18.7%.\nIn 1992, the Telephone Companies implemented a plan to unify their interstate access rates which, including the effect of the Company's annual price cap tariff filings, resulted in a decrease in the Company's interstate access revenues of approximately $4 million during the tariff period ending June 30, 1992, an increase of approximately $88 million during the tariff period ending July 1, 1993, a decrease of approximately $25 million during the tariff period ending June 30, 1994 and will result in a decrease of approximately $0.3 million during the tariff period ending June 30, 1995. The Telephone Companies implemented a phase-in payment plan in 1992 and 1993 in order to avoid sudden changes in each of the Telephone Company's earnings resulting from the unified rate structure. A substantial portion of the increase in the Company's access revenues during those tariff periods was offset by the payment plan. With unification of interstate rates, the Telephone Companies report one unified interstate rate of return to the FCC, which will be the basis for determining any possible refund obligations due to overearnings as well as any need to increase interstate rates due to underearnings under the price cap plan.\nTariff revisions were filed by the Telephone Companies with the FCC on September 1, 1994 and amended on December 19, 1994, to amend price cap indexes to reflect additional exogenous costs resulting from the implementation of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"OPEB\"). The filing as amended reflected $42 million of costs already accrued, increased annual costs of $21 million and increased rates of $2.2 million. The filing follows a July 12, 1994 decision of the Court of Appeals overturning the FCC's prior order denying exogenous treatment of additional OPEB costs. On December 29, 1994, the FCC's Common Carrier Bureau (the \"Bureau\") issued an order allowing the proposed rates to go into effect December 30, 1994, subject to an\ninvestigation and accounting order. Commencing December 30, 1994, the Telephone Companies began collecting these revenues, subject to possible refund pending resolution of the Bureau's investigation.\nFollowing the FCC's adoption of physical collocation rules in September 1992 and 1993, the Company filed Special Access Expanded Interconnection tariffs in February 1993 and Switched Transport Expanded Interconnection tariffs in November 1993. On June 10, 1994, the United States Court of Appeals for the District of Columbia Circuit overturned the FCC's physical collocation rules. On July 25, 1994, the FCC adopted rules making physical collocation optional but requiring virtual collocation where physical collocation is not offered. The Company decided to continue offering physical collocation.\nOperating Revenues ------------------\nOperating revenues for the year ended December 31, 1994 increased $132.0 million, or 3.2%, over the same period last year. The increase in total operating revenues is comprised of the following:\nLocal service revenues are earned from the provision of local exchange, local private line and local public network services. Local service revenues increased $84.9 million due principally to: (1) increased customer demand of approximately $64 million, evidenced by growth in access lines and growth in sales of calling features such as caller identification, call waiting and touch- tone services, (2) a net increase of approximately $23 million in local service rates primarily attributable to the implementation of the third transitional filing of a restructuring of Massachusetts rates effective April 14, 1994, (3) a $4 million increase in local directory assistance revenues resulting from the recognition of previously deferred revenues pursuant to a regulatory agreement with the State of Massachusetts to offset expenses to enhance E911 systems, (4) a $9 million increase primarily due to the 1994 recognition of revenues deferred in 1993 that were in excess of the required one-time credit to customers' bills pursuant to the Rhode Island price regulation trial for 1993 and (5) a $15 million decrease resulting from a deferral of revenues in 1994 for subsequent refund to Vermont customers as required by an October 1994 VPSB order. (See State Regulatory Matters above.)\nLong distance revenues are earned from the provision of services beyond the local service area, but within the local access and transport area (\"LATA\"), and include public and private network switching. Long distance revenues decreased $21.7 million due principally to: (1) a $25 million decrease in long distance rates primarily attributable to the implementation of the third transitional filing of a restructuring of Massachusetts rates effective April 14, 1994, (2) an $8 million decrease resulting from reductions in New Hampshire long distance rates, (3) a $5 million decrease due to reductions in Rhode Island long distance rates attributable to the Price Regulation\nTrial, (4) a $4 million increase in long distance directory assistance revenues resulting from the recognition of previously deferred revenues pursuant to a regulatory agreement with the State of Massachusetts to offset expenses to enhance E911 systems and (5) a net increase of approximately $12 million resulting from increased message toll service usage partially offset by decreases in private line revenues and wide area telecommunications revenues primarily due to increased competition and customer shifts to lower priced services offered by the Company. (See State Regulatory Matters above.)\nNetwork access revenues are earned from the provision of exchange access services primarily to interexchange carriers. Network access revenues increased $51.7 million due principally to a $58 million increase in switched access revenues partially offset by a $6 million decrease in special access revenues. Switched access revenues increased as a result of a $68 million increase in network demand and an $8 million increase due to revenue adjustments which included $3 million for the 1994 recognition of revenues previously deferred for postretirement medical costs. These increases were partially offset by a net decrease of approximately $18 million primarily attributable to interstate rate decreases. The decline in special access revenues was due principally to decreased demand of approximately $3 million resulting from increased competition and customer shifts to lower priced services offered by the Company and a reduction in interstate rates of approximately $2 million. (See Federal Regulatory Matters above.)\nOther revenues are earned from the provision of products and services other than Local service, Long distance and Network access. Other revenues increased $17.1 million due principally to an $11 million increase in revenues related to the directory licensing agreement with NYNEX Information Resources Company resulting from higher estimated pretax earnings from the directories published pursuant to the agreement and to a $6 million increase in revenues from inside wire related charges and voice messaging services.\nOperating Expenses ------------------\nOperating expenses decreased $463.5 million, or 12.3%, from 1993. The decrease in total operating expenses is comprised of the following:\nDepreciation and amortization increased $39.9 million due principally to a $33 million increase due to revised intrastate depreciation rates in Massachusetts effective July 1993 and a $31 million increase associated with\nincreased depreciable plant investment. These increases were partially offset by the reversal of $15 million which represents an adjustment of prior year estimates for cost of removal (net of salvage) for electromechanical switching equipment in Massachusetts, Maine and Rhode Island and a decrease of $9 million resulting from implementation of revised intrastate depreciation rates in Vermont in September 1994 retroactive to January 1, 1994 (see State Regulatory Matters above).\nTaxes other than income taxes, which include gross receipts taxes, property taxes and other non-income based taxes, decreased $20.5 million principally due to the reversal in 1994 of a 1993 accrual of $9 million as a result of unasserted municipal assessments and a $2 million net decrease in Massachusetts property taxes.\nBusiness restructuring charges recorded during 1994 consisted of incremental costs related to pension enhancements (see Business Restructuring above).\nBusiness restructuring charges recorded in the fourth quarter of 1993 consisted of incremental costs associated with work force reductions, re-engineering, and costs related to consolidation of work locations (see Business Restructuring above). Employee related costs, which consist primarily of wages, payroll taxes and employee benefits, decreased $36.5 million. The decrease was principally due to a $19 million net decrease in benefit expenses primarily attributable to: (1) a $29 million decrease attributable to the elimination of an assumed benefit improvement and greater than anticipated return on pension assets, (2) a $10 million decrease resulting from an accrual in 1993 for a supplemental executive retirement plan, (3) a $12 million increase resulting from the amortization of deferred pension costs pursuant to an intrastate regulatory plan, (4) a $3 million net increase in medical costs primarily attributable to an $11 million increase in medical costs for retirees principally due to the requirements of the collective bargaining agreements and other medical plan amendments partially offset by an $8 million decrease in medical costs for active employees due principally to a reduction in the work force attributable to the Company's force reduction program and the transfer of employees to Telesector Resources, and (5) a $3 million increase in sickness disability costs. Wages and payroll taxes decreased a net $18 million principally due to a reduction in the work force attributable to the Company's force reduction program and the transfer of approximately 400 employees to Telesector Resources as part of the single enterprise organization partially offset by increases in salary and wage rates. (see Other operating expenses below).\nOther operating expenses, which consist primarily of contracted and centralized services, rent and other general and administrative costs, increased $4.3 million. The increase was principally due to: (1) a $14 million net increase in charges from affiliated companies primarily attributable to the increase in Telesector Resources' contracted and centralized services, the transfer of approximately 400 employees from the Company to Telesector Resources (see Employee related costs above) and increases in salaries and wage rates, partially offset by decreases due to Telesector Resources' force reduction program, (2) a $7 million increase in right-to-use fees resulting from increased software purchases, (3) a $7 million increase resulting from capitalization in 1993 of certain 1992\nengineering charges, (4) an $8 million increase in sales commissions due to increased commission rates and promotion of new products, (5) a $7 million increase in the Provision for uncollectible revenues and (6) a $4 million increase in contract engineering due to an increase in generic switch conversions and installation of software enhancements. These increases were partially offset by: (1) a $13 million decrease in the loss associated with bad debt expense realized pursuant to the provision of the billing and collection contract primarily with AT&T Corp., (2) an $11 million decrease due to the completion of equal access amortization in 1993, (3) an $8 million decrease resulting from an adjustment of prior years' group medical costs (4) a $7 million decrease in advertising expense due to addition of advertising programs in 1993 for new products including voice messaging and caller identification services and (5) a $5 million decrease due to the Company's contractual share of a predivestiture AT&T liability recorded in 1993.\nOther Income (Expense) - Net ----------------------------\nOther income (expense) - net increased $67.8 million over the same period last year due principally to a $55 million increase resulting from completion in 1993 of the transition plan with New York Telephone to phase in the earnings impact of the unified tariff access rate structure and to a $24 million increase due to higher expense in 1993 for the interstate portion of call premiums and other charges associated with the refinancing of long-term debt. These increases were partially offset by a $12 million decrease due to interest received in 1993 on refunds of Massachusetts taxes.\nInterest Expense ----------------\nInterest expense decreased $12.0 million from the same period last year primarily due to a decrease in average interest rates resulting from long-term debt refinancings in 1993.\nIncome Taxes ------------\nIncome taxes increased $307.3 million from the same period last year principally due to an increase in taxable income and a lower level of excess deferred tax reversals due primarily to a 1993 one-time benefit of $23 million representing adjustments of prior year estimates of depreciation on capitalized overheads and of the reversal of excess deferred taxes, using the average rate assumption method, which had been deferred at a rate higher than the current statutory rate.\nFinancing ---------\nAt December 31, 1994, the Company had $500 million of unissued, unsecured debt securities registered with the Securities and Exchange Commission.\nItem 8. FINANCIAL STATEMENTS\nReport of Management --------------------\nManagement of New England Telephone and Telegraph Company (the \"Company\") has the responsibility for preparing the accompanying financial statements and for their integrity and objectivity. The financial statements were prepared in accordance with generally accepted accounting principles and, in Management's opinion, are fairly presented. The financial statements include amounts that are based on Management's best estimates and judgments. Management also prepared the other information in this report and is responsible for its accuracy and consistency with the financial statements.\nThe financial statements have been audited by Coopers & Lybrand L.L.P. (\"Coopers & Lybrand\"), independent accountants, whose appointment was approved by the Company's Board of Directors. Management has made available to Coopers & Lybrand all of the Company's financial records and related data, as well as the minutes of share owner's and directors' meetings. Furthermore, Management believes that all representations made to Coopers & Lybrand during its audit were valid and appropriate.\nManagement of the Company has established and maintains an internal control structure that is designed to provide reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, and the prevention and detection of fraudulent financial reporting. The concept of reasonable assurance recognizes that the cost of the internal control structure should not exceed the benefits to be derived. The internal control structure provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees with significant roles in the financial reporting process. Management monitors the internal control structure for compliance, considers recommendations for improvement from both the internal auditors and Coopers & Lybrand and updates such policies and procedures as necessary. Monitoring includes an internal auditing function to independently assess the effectiveness of the internal controls and recommend possible improvements thereto. Management believes that the internal control structure of the Company is adequate to accomplish the objectives discussed herein.\nThe Audit Committee of the Board of Directors, which is comprised of directors who are not employees, meets periodically with Management, the internal auditors and Coopers & Lybrand to review the manner in which they are performing their responsibilities and to discuss matters relating to auditing, internal controls and financial reporting. Both the internal auditors and Coopers & Lybrand periodically meet privately with the Audit Committee and have access to the Audit Committee at any time.\nManagement also recognizes its responsibility for conducting Company activities under the highest standards of personal and corporate conduct. This responsibility is accomplished by fostering a strong ethical climate as characterized in the NYNEX Code of Business Conduct, which is publicized throughout the Company. The Code of Conduct addresses, among other things, standards of personal conduct, potential conflicts of interest, compliance with all domestic and foreign laws, accountability for Company property and the confidentiality of proprietary information.\nRichard A. Jalkut President and Chief Executive Officer\nMel Meskin Vice President - Finance and Treasurer\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Share Owner and Board of Directors of New England Telephone and Telegraph Company:\nWe have audited the financial statements and financial statement schedule of New England Telephone and Telegraph Company listed in Item 14(a) (1) and (2) 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 financial position of New England Telephone and Telegraph 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. 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 A and D to the financial statements, the Company changed its methods of accounting for income taxes, postretirement benefits other than pensions and postemployment benefits in 1993.\nCoopers & Lybrand L.L.P.\nBoston, Massachusetts February 8, 1995\nNEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY STATEMENTS OF INCOME AND RETAINED EARNINGS ------------------------------------------ Dollars In Millions\nSee accompanying notes to financial statements.\nNEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY BALANCE SHEETS -------------- Dollars In Millions\nSee accompanying notes to financial statements.\nNEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY BALANCE SHEETS -------------- Dollars In Millions\nSee accompanying notes to financial statements.\nNEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY STATEMENTS OF CASH FLOWS ------------------------ Dollars In Millions\nSee accompanying notes to financial statements.\nNOTES TO FINANCIAL STATEMENTS\n(A) Accounting Policies\nBasis of Presentation ---------------------\nNew England Telephone and Telegraph Company (the \"Company\") is a wholly-owned subsidiary of NYNEX Corporation (\"NYNEX\") and primarily provides exchange telecommunications and exchange access services. The financial statements for 1993 and 1992 have been reclassified to conform to the current year's format.\nThe financial statements have been prepared in accordance with generally accepted accounting principles, including the application of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (\"Statement No. 71\"), to the effects of rate actions by the Federal Communications Commission (the \"FCC\") and certain state regulatory commissions for the Company. The rate actions of regulators can provide reasonable assurance of the existence of an asset, reduce or eliminate the value of an asset, impose a liability, or eliminate a previously imposed liability on a regulated enterprise. The Company applies Statement No. 71 instead of any conflicting provisions of accounting standards in other authoritative pronouncements. The effects of Statement No. 71 are reflected in the financial statements and material effects, where practicable to determine, are detailed in this Note and the individual Notes to Financial Statements related to the specific financial statement line items.\nThe major components of non-plant regulatory net assets (liabilities) at December 31, 1994 and 1993 are as follows:\nThe Company has a 33 1\/3% ownership interest in Telesector Resources Group, Inc. (\"Telesector Resources\") and shares voting rights equally with the other owner, New York Telephone Company (\"New York Telephone\") which is a wholly-owned subsidiary of NYNEX. The Company uses the equity method of accounting for its investment in Telesector Resources.\nCash ----\nThe Company's cash management policy is to make funds available in banks when checks are presented. At December 31, 1994 and 1993, the Company had recorded in Accounts payable - Trade and other checks outstanding but not presented for payment of $69.4 and $33.0 million, respectively.\nInventory ---------\nInventory, consisting of materials and supplies, is carried principally at average cost.\nTelephone Plant ---------------\nTelephone plant is stated at its original cost.\nWhen depreciable plant is disposed of, the carrying amount, salvage, and the cost to remove such plant are charged to accumulated depreciation.\nDepreciation rates used by the Company are prescribed by the FCC and by the various state commissions (the \"commissions\") for interstate operations and for intrastate operations, respectively. All rates are calculated on a straight- line basis using the concept of \"remaining life.\" The represcription process requires the Company to perform a detailed study using actual and estimated factors to develop future life expectancy of telephone plant investments, including technological evolution, competition, asset utilization, modernization plans and regulatory commitments. Both the Company and the commissions' staffs submit factors deemed appropriate to permit asset recovery. The commissions select the one they believe to be the most appropriate from among these alternatives. Utilizing these factors, new depreciation rates are set to enable the Company to recover costs of plant additions as well as to permit the prospective recovery of deficiencies in existing depreciation reserve balances as a result of shorter asset lives to be utilized on a going forward basis. The represcription process occurs on a triennial basis and includes the commissions and the Company. Once new depreciation rates are set, the commissions may take rate actions to permit the Company to recover costs if deemed necessary. In 1993, revised interstate depreciation rates were approved by the FCC. Revised intrastate depreciation rates were effective November 1, 1992 for Rhode Island, January 1, 1993 for New Hampshire, July 1, 1993 for Massachusetts and January 1, 1994 for Vermont. The application of the interstate and intrastate rates resulted in average effective composite rates of 7.5%, 7.3% and 7.4% for 1994, 1993 and 1992, respectively.\nThe quantification of the difference between recorded depreciation and depreciation that would have been recorded in accordance with generally accepted accounting principles for an entity not subject to the provisions of Statement No. 71 cannot be precisely estimated at this time, but is expected to be between $1.0 and $1.5 billion.\nRegulatory authorities in Maine, Massachusetts, New Hampshire and Rhode Island allow the Company to capitalize interest, including an allowance on share owner's equity, as a cost of constructing certain telephone plant and as income, included in Other income (expense) - net. Such income will be realized over the service life of the plant as the resulting higher depreciation expense is recovered through the rate-making process. In Vermont, telephone plant under construction is included in the rate base, thereby eliminating the need for any interest accrual mechanism. The FCC requires the same method as Vermont for short-term telephone plant under construction, while long-term plant under construction accrues interest under FCC procedures.\nComputer Software Costs -----------------------\nThe Company capitalizes initial right-to-use fees for central office switching equipment, including initial operating system and initial application software costs. For non-central office equipment, only the initial operating system software is capitalized. Subsequent additions, modifications, or upgrades of initial software programs, whether operating or application packages, are expensed. This accounting treatment conforms to the rules set forth by the FCC.\nRefinancing Charges -------------------\nThe Company defers the intrastate portion of call premiums and other charges associated with the redemption of long-term debt and expenses the interstate portion of these charges, as required by the state commissions and the FCC, respectively. The deferred amounts are amortized over periods stipulated by the state commissions. Prior to January 1, 1988, these charges were deferred and amortized for both intrastate and interstate purposes.\nIncome Taxes ------------\nNYNEX and its subsidiaries, including the Company, file a consolidated Federal income tax return. The Company's provision for federal income taxes currently payable is allocated in accordance with its contribution to the consolidated group's taxable income and tax credits.\nDeferred income taxes are provided to reflect the effect of temporary differences in the recognition of revenue and expenses for financial reporting and income tax purposes.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"Statement No. 109\"), which superseded Statement of Financial Accounting Standards No. 96, \"Accounting for Income Taxes.\" The effect of implementing Statement No. 109 on the Company's financial position and results of operations was not significant. Statement No. 109 requires that deferred tax assets and liabilities be measured based on the enacted tax rates that will be in effect in the years in which temporary differences are expected to reverse. However, for the Company, the treatment of excess deferred taxes resulting from the reduction of federal tax rates in prior years is subject to federal income tax and regulatory rules.\nDeferred income tax provisions of the Company are based on amounts recognized for rate-making purposes. The Company recognizes a deferred tax liability and establishes a corresponding regulatory asset for tax benefits previously flowed through to ratepayers. The major temporary difference that gave rise to the net deferred tax liability is depreciation, which for income tax purposes is determined based on accelerated methods and shorter lives.\nStatement No. 71 requires the Company to reflect the additional deferred income taxes as regulatory assets to the extent that they will be recovered in the rate-making process. In accordance with the normalization provisions under federal tax law, the Company reverses excess deferred taxes relating to depreciation of regulated assets over the regulatory lives of those assets.\nFor other excess deferred taxes, the commissions generally allow amortization of excess deferred taxes over the reversal period of the temporary difference giving rise to the deferred taxes.\nOn August 10, 1993, the Revenue Reconciliation Act of 1993 was signed into law, and the statutory corporate federal income tax rate increased to 35% from 34%, retroactive to January 1, 1993. In accordance with Statement No. 109, the Company adjusted its current and deferred income tax balances to reflect the tax rate change. The Company reflected the additional deferred income taxes arising from the tax rate increase primarily as increases to the regulatory asset and decreases to the regulatory liability.\nThe Tax Reform Act of 1986 repealed the investment tax credit (\"ITC\"), effective January 1, 1986. As required by tax law, ITC for the Company was deferred and is amortized as a reduction to tax expense over the estimated service lives of the related assets giving rise to the credits.\n(B) Receivables - Affiliates\nAt December 31, 1992, the Company had advances to NYNEX of $82.0 million included in Receivables-Affiliates which was principally due to the investment by NYNEX of a portion of the proceeds from the long-term debt issued by the Company on December 9, 1992. On January 19, 1993, these proceeds were used for the redemption of $175 million of the Company's Thirty-Nine Year 8 5\/8% Debentures, due September 1, 2009.\n(C) Income Taxes\nThe components of income tax expense (benefit) are as follows:\n* Does not include the deferred tax benefit of $14.1 million associated with the Cumulative effect of change in accounting for postemployment benefits.\nThe increase in 1994 deferred tax expense was due principally to the partial reversal of temporary differences associated with the Company's 1993 restructuring charges (see Note (P)).\nIn 1993, the total tax benefit includes $23.1 million representing a one-time benefit from adjustments of prior year estimates of depreciation on capitalized overheads and of the reversal of excess deferred taxes. The total deferred tax benefit includes $187.7 million due to the Company's restructuring charges (see Note (P)). Additional 1993 decreases resulted from\nthe adoption of a new accounting standard related to postretirement benefits (see Note (D)).\nA reconciliation between federal income tax expense (benefit) computed at the statutory rate and the Company's effective tax expense (benefit) is as follows:\n* Does not include the deferred tax benefit of $14.1 million associated with the Cumulative effect of change in accounting for postemployment benefits.\nTemporary differences for which deferred income taxes have not been provided by the Company are represented principally by \"c\" above. Only taxes currently payable on these temporary differences are recognized in the rate-making process.\nThe components of current and long-term deferred tax assets and liabilities at December 31, 1994 and 1993 are as follows:\nAt December 31, 1994 and 1993, the Company recorded approximately $209.7 and $223.4 million, respectively, in deferred taxes representing the cumulative amount of income taxes on temporary differences that were previously flowed through to ratepayers. The Company recorded a corresponding regulatory asset in deferred charges for these items, representing amounts that will be recovered through the rate-making process. These deferrals have been increased for the tax effect of future revenue requirements and will be amortized over the lives of the related depreciable assets concurrently with their recovery in rates.\nThe Company recorded a regulatory liability at December 31, 1994 and 1993 of approximately $225.4 and $246.3 million, respectively, in Other long-term liabilities and deferred credits and Accounts payable - Trade and other. A substantial portion of the regulatory liability relates to the reduction in the statutory federal income tax rate in 1986 and unamortized ITC. These liabilities have been increased for the tax effect of future revenue requirements.\n(D) Employee Benefits\nPensions --------\nSubstantially all of the Company's employees are covered by one of two NYNEX noncontributory defined benefit pension plans (the \"Plans\"). Benefits for management employees are based on a modified career average pay plan, while benefits for nonmanagement employees are based on a nonpay-related plan. Contributions are made, to the extent deductible under the provisions of the Internal Revenue Code, to an irrevocable trust for the sole benefit of pension plan participants.\nTotal pension (benefit)\/cost for 1994, 1993 and 1992 was $(87.0), $(51.0) and $2.2 million, respectively, of which $1.5 million was deferred in 1992 as a result of state regulatory decisions that required pension expense to be equivalent to amounts contributed to the Plans. Deferral of pension cost was\ndiscontinued in 1993, and the Company has implemented a plan to recover deferred pension costs through the rate-making process (see Postretirement Benefits Other Than Pensions below). The pension benefit for 1994 and 1993 includes the effect of plan amendments and changes in actuarial assumptions for the discount rate and future compensation levels. At December 31, 1994 and 1993, the Company had recorded $335.4 and $276.7 million, respectively, in Other long-term liabilities and deferred credits representing the Company's pension liability.\nThe assumptions used to determine the projected benefit obligation at December 31, 1994 and 1993 include a discount rate of 8.5% and 7.5%, respectively, and an increase in future compensation levels of 4.5% in both years for management employees and 4.0% in both years for nonmanagement employees. The expected long-term rate of return on pension plan assets used to calculate pension expense was 8.9% in 1994, 1993 and 1992. Periodically, the Plans have been amended to increase the level of plan benefits. The actuarial projections included herein anticipate plan improvements in the future.\nAs a result of planned work force reductions, the Company incurred additional pension costs of $145.9 million, comprised of a charge for special termination benefits of $215.9 million and a curtailment gain of $70.0 million, in 1994 due to employees leaving under retirement incentives. These pension costs were partially offset by 1993 severance reserves of $61.5 million which were transferred to the pension liability.\nIn 1992 and 1993, management employees who left the Company under the Force Management Plan could elect to receive their pension benefit in a lump sum distribution, or as a monthly annuity beginning when they left the Company. The 1992 reduction in the number of management employees and the lump sum option were accounted for as a curtailment and a settlement, respectively, and reduced pension costs by $13.0 million in 1992, of which $3.8 million was recognized as a reduction to expense and $9.2 million was deferred. There was no reduction in the number of management employees under the Force Management Plan in 1993.\nPostretirement Benefits Other Than Pensions -------------------------------------------\nThe Company provides certain health care and life insurance benefits for retired employees and their families. Substantially all of the Company's employees may become eligible for these benefits if they reach pension eligibility while working for the Company.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"Statement No. 106\"). Statement No. 106 changed the practice of accounting for postretirement benefits from recognizing costs as benefits are paid to accruing the expected cost of providing these benefits during an employee's working life. The Company is recognizing the transition obligation for retired employees and the earned portion for active employees over a 20-year period. The cost of health care benefits and group life insurance was determined using the unit credit cost actuarial method. The net postretirement benefit cost for 1994 and 1993 for the Company was $157.1 and $143.0 million, respectively.\nThe Company participates in the NYNEX benefit plans, and the structure of the plans is such that certain disclosures required by Statement No. 106 cannot be presented for the Company on an individual basis. A comparison of the actuarial present value of the accumulated postretirement benefit obligation with the fair value of plan assets, the components of the net postretirement benefit cost, and the reconciliation of the funded status of the plans with the amount recorded on the balance sheet are provided on a consolidated basis in the Annual Report for the year ended December 31, 1994 filed by NYNEX.\nThe actuarial assumptions used to determine the December 31, 1994 and 1993 obligations for postretirement benefit plans under Statement No. 106 include the following: discount rate of 8.5% and 7.5%, respectively; weighted average expected long-term rate of return on plan assets of 8.4% in both years; weighted average salary growth rate of 4.2% in both years; medical cost trend rate of 12.6% grading down to 4.5% in 2008 and 14.3% grading down to 4.5% in 2008, respectively; and dental cost trend rate of 4.5% grading down to 3.0% in 2002 and 5.0% grading down to 3.0% in 2002, respectively.\nAs a result of planned work force reductions, the Company recorded an additional $193.9 million of postretirement benefit cost in 1993 accounted for as a curtailment. In 1994, under work force reduction retirement incentives, the Company incurred additional postretirement benefit costs of $84.8 million, comprised of a curtailment loss of $66.4 million and a charge for special termination benefits of $18.4 million. These postretirement benefit costs were partially offset by $37.2 million which was previously accrued for in 1993.\nTotal costs of providing benefits for retired employees and their families was $63.7 million in 1992.\nWith respect to interstate treatment, on July 12, 1994, the U.S. Court of Appeals for the District of Columbia Circuit overturned the FCC's January 1993 order denying exogenous treatment of additional costs recognized under Statement No. 106. Tariff revisions were filed by the Company and New York Telephone (collectively the \"Telephone Companies\") with the FCC on September 1, 1994, and amended on December 19, 1994, to amend price cap indices to reflect additional exogenous costs recognized under Statement No. 106. The filing as amended reflected, for the Telephone Companies, $42 million of costs already accrued, increased annual costs of $21 million and increased rates of $2.2 million. On December 29, 1994, the FCC's Common Carrier Bureau (the \"Bureau\") issued an order allowing the proposed rates to go into effect December 30, 1994, subject to an investigation and an accounting order. Commencing December 30, 1994, the Company began collecting these revenues, subject to possible refund pending resolution of the Bureau's investigation.\nWith respect to intrastate treatment, in 1993, the Company implemented an accounting plan as previously discussed with the regulatory commissions in each of the states in which it operates for regulatory accounting and rate-making treatment. The plan provided for: (1) immediate adoption of both Statement No. 106 and Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions\" (\"Statement No. 87\") on a revenue requirement neutral basis, (2) amortization of existing deferred pension costs within a ten-year period and (3) discontinuance of additional deferrals of Statement No. 106 and Statement No. 87 costs. In December 1994, the Company amortized $12.1 million of deferred pension costs according to this accounting plan. Approval of the\nplan is still pending in the State of Rhode Island.\nNYNEX established two separate Voluntary Employees' Beneficiary Association Trusts (\"VEBA Trusts\"), one for management and the other for nonmanagement, to begin prefunding postretirement health care benefits. At December 31, 1992, NYNEX had transferred a portion of excess pensions assets, totaling $486 million, to health care benefit accounts within the pension plans and then contributed those assets to the VEBA Trusts. No additional contributions were made in 1993 and 1994. The assets in the VEBA Trusts consist primarily of equity securities and fixed income securities. Additional contributions to the VEBA Trusts are evaluated and determined by NYNEX management.\nPostemployment Benefits -----------------------\nThe Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"Statement No. 112\") in the fourth quarter of 1993, retroactive to January 1, 1993. Statement No. 112 applies to postemployment benefits, including workers' compensation, disability plans and disability pensions, provided to former or inactive employees, their beneficiaries, and covered dependents after employment but before retirement. Statement No. 112 changed the Company's method of accounting from recognizing costs as benefits are paid to accruing the expected costs of providing these benefits. The initial effect of adopting Statement No. 112 was reported as a cumulative effect of a change in accounting principle and resulted in a one- time, non-cash charge of $39.1 million ($25.0 million after-tax). In 1994, the effect of Statement No. 112 did not result in periodic expense materially different from the expense recognized under the prior method.\n(E) Telephone Plant - Net\nThe components of Telephone plant-net are as follows:\n(F) Long-term Debt\nInterest rates and maturities on long-term debt outstanding are as follows:\nIn 1997 and 1998, $175 and $100 million, respectively, of the Notes will mature. In 1999, $100 million of the Notes and $45 million of the Debentures will mature.\nThe Company's Debentures, except for its Forty Year 7 7\/8% Debentures, due November 15, 2029, and its Forty Year 9% Debentures, due August 1, 2031, are callable five years after the issue date, upon thirty days' notice, at the option of the Company. The Company's Forty Year 7 7\/8% Debentures, due November 15, 2029, are repayable on November 15, 1996, in whole or in part, at the option of the holder, and its Forty Year 9% Debentures, due August 1, 2031, are callable ten years after issue date upon thirty days' notice by the Company.\nAt December 3l, l994, the Company had $500.0 million of unissued, unsecured debt securities registered with the Securities and Exchange Commission.\n(G) Fair Value of Financial Instruments\nThe estimated fair value of Long-term debt is based on quoted market prices. Estimated fair values of financial instruments, where different than the carrying amounts, are as follows:\n(H) Short-term Debt\nShort-term debt and related weighted average interest rates are as follows:\n# Computed by dividing the aggregate related interest expense by the average daily face amount of advances. + Computed by dividing the sum of the aggregate principal amounts outstanding each day during the year by the total number of calendar days in the year.\nInterest expense on advances from NYNEX was $5.9, $4.2 and $0.9 million in 1994, 1993 and 1992, respectively.\n(I) Lease Commitments\nThe Company leases certain facilities and equipment used in its operations. Rental expense was $68.3, $68.5 and $74.5 million for 1994, 1993 and 1992, respectively. At December 31, 1994, the minimum lease commitments under noncancelable operating and capital leases for the periods shown are as follows:\n(J) Transactions with AT&T Corp.\nIn 1994, 1993 and 1992, AT&T Corp. (\"AT&T\") provided approximately 14%, 15% and 15%, respectively, of the Company's total operating revenues, primarily Network access revenues and Other revenues from billing and collection services performed under contract by the Company for AT&T. In connection with such services, the Company purchases the related receivables, with recourse, up to a contractual limit.\n(K) Transactions with Affiliates\nThe Company and other NYNEX subsidiaries receive corporate governance and ownership services such as securities administration, investor relations, certain tax support and human resources planning services from NYNEX. The costs of these services are allocated to the Company and the other NYNEX subsidiaries through intercompany billings. NYNEX performs a semi-annual study to identify on whose behalf functions of corporate departments are being performed. Directly charged costs apply exclusively to one subsidiary and are charged only to that subsidiary. Directly attributable costs apply to more than one subsidiary and are allocated based on usage, specific work plans, and relative size (composite of employees and assets) of the applicable subsidiaries. Indirectly attributable and unattributable costs for services performed on behalf of all subsidiaries are allocated based on the relative size of the subsidiaries. For 1994, 1993 and 1992, the Company recorded allocated costs of $21.2, $51.9 and $48.5 million, respectively, in connection with these services. The reduction of allocated costs in 1994 is due to the transfer of approximately 540 employees from NYNEX to Telesector Resources associated with re-engineering the way service is delivered to customers, including operating as a single enterprise under the \"NYNEX\" brand.\nTelesector Resources performs data processing and related services and materials management services on a centralized basis on behalf of the Telephone Companies. Prior to 1993, the costs of these services were allocated to the Telephone Companies based on an annual study which identified on whose behalf functions were being performed. Since 1993, costs are allocated based on identification of detailed work functions that are approved and documented within Telesector Resources' planning and budgeting process. Costs are directly assigned, directly attributed or indirectly attributed based on the analysis of the work function. In 1994, 1993 and 1992, the Company recorded charges from Telesector Resources of $718.0, $670.3 and $590.3 million, respectively, for data processing services and materials related charges, including both materials management services (such as procurement support, warehousing and transportation costs) and the Company's purchase of materials (including items charged to plant accounts). The total materials related charges to the Company in 1994, 1993 and 1992 were approximately $242.7, $255.4 and $240.3 million, respectively. Telesector Resources acts as a purchasing agent for the Company for directly shipped materials and supplies. During 1994, 1993 and 1992, total agency purchases by Telesector Resources amounted to $132.1, $123.6 and $120.6 million, respectively. In addition, in 1994 and 1993, approximately $36.1 and $140.8 million, respectively, of restructuring charges ($21.9 and $85.5 million after- tax) was allocated to the Company from Telesector Resources, primarily related to its force reduction and re-engineering programs. The increase in overall allocated costs in 1994 is due to the transfer of\napproximately 400, 540 and 565 employees from the Company, NYNEX and New York Telephone, respectively, to Telesector Resources associated with re-engineering the way service is delivered to customers, including operating as a single enterprise under the \"NYNEX\" brand.\nTelesector Resources owns a one-seventh interest in Bell Communications Research, Inc. (\"Bellcore\"). Bellcore furnishes technical and support services relating to exchange telecommunications and exchange access services, a portion of which is research and development. For 1994, 1993 and 1992, the Company recorded charges of $39.8, $42.1 and $42.7 million, respectively, for services provided by Bellcore.\nIn 1992, the FCC permitted the Telephone Companies to unify their interstate access rates. As a result of the unified rate structure, the Company experienced an interstate rate increase and New York Telephone experienced an offsetting interstate rate decrease. The Telephone Companies implemented a phase-in payment plan (\"transition plan\") in order to avoid sudden changes in each of the Telephone Company's earnings resulting from the unified rate structure. The transition plan was completed in 1993. In 1993 and 1992, the Company made transition payments of $55 million and $18 million, respectively, to New York Telephone.\nThe Company has an agreement with NYNEX Information Resources Company (\"Information Resources\") pursuant to which Information Resources pays a fee to the Company for the use of the Company's name in soliciting directory advertising and in publishing and distributing directories. For the years ended December 31, 1994, 1993 and 1992, licensing fees, included in Other revenues, amounted to $167.8, $156.7 and $159.0 million, respectively.\n(L) Taxes Other Than Income Taxes\nTaxes other than income taxes consist of:\n(M) Supplemental Cash Flow Information\nThe following information is provided in accordance with Statement of Financial Accounting Standards No. 95, \"Statement of Cash Flows\":\n(N) Revenues Subject to Possible Refund\nSeveral regulatory matters, primarily involving the rates and charges for the provision of certain interstate access and other related services, may possibly require the refund of a portion of the revenues collected in the current and prior periods. As of December 31, 1994, the aggregate amount of such revenues that was estimated to be subject to possible refund was approximately $21.4 million, plus related interest. The outcome of each pending matter, as well as the time frame within which each will be resolved, is not presently determinable.\n(O) Litigation and Other Contingencies\nVarious other legal actions and regulatory proceedings are pending that may affect the Company, including matters involving Racketeer Influenced and Corrupt Organizations Act, antitrust, tort, contract and tax deficiency claims. While counsel cannot give assurance as to the outcome of any of these matters, in the opinion of Management based upon the advice of counsel, the ultimate resolution of these matters in future periods is not expected to have a material effect on the Company's financial position or annual operating results but could have a material effect on quarterly operating results.\n(P) Business Restructuring\nIn 1994, the Company recorded approximately $168 million of pretax charges primarily for the cost of pension enhancements for approximately 1,580 employees who elected to leave the Company under retirement incentives and for the Company's allocation from Telesector Resources for its pension enhancements. The components of the $168 million pretax charges are as follows: $84 million for pension enhancements, $48 million for associated postretirement medical benefits, $19 million for charges allocated to the Company from Telesector Resources for its pension enhancements and $17 million for its associated postretirement medical benefits. The 1994 restructuring charges of $168 million were included in the Income Statements in Other operating expenses.\nIn the fourth quarter of 1993, approximately $619 million of pretax business restructuring charges was recorded, primarily related to efforts to redesign operations and work force reductions. These charges included: $395 million for severance and postretirement medical costs for employees leaving the Company through 1996; $83 million for re-engineering service delivery; and $141 million of restructuring charges allocated to the Company from Telesector Resources. The restructuring charges were included in the Income Statements as follows: Maintenance and support - $78 million; Marketing and customer services - $77 million; and Other expense - $464 million.\nSUPPLEMENTARY INFORMATION\nQuarterly Financial Information (Unaudited)\nAll adjustments (consisting only of normal recurring accruals) necessary for a fair statement of income for each period have been included in the following table.\nResults for the second, third and fourth quarters of 1994 include $54.3, $6.7 and $107.1 million, respectively, of pretax charges for pension enhancements, which were reflected in operating expenses. The after-tax effect of these charges was $34.7, $4.5 and $72.0 million in the second, third and fourth quarters, respectively. See the section entitled \"Business Restructuring\" included in Management's Discussion and Analysis of Results of Operations and Note (P) \"Business Restructuring\" for further discussion of these charges.\nResults for the fourth quarter of 1994 include $23.9 million of pretax credits to pension and medical expense associated with plan amendments and favorable plan experience which was reflected in operating expenses. The after-tax effect of these benefits was an increase in net income of $14.9 million, of which $3.7 million was applicable to the fourth quarter.\nResults for the first quarter of 1993 include the adoption of Statement No. 112 (see Note (D), \"Employee Benefits\", for further discussion). Results for the third quarter of 1993 reflect the effect of the increase in the statutory corporate federal income tax rate (see Note (A), \"Accounting Policies - Income Taxes\", for further discussion). Results for the fourth quarter of 1993 reflect the effects of $619 million of pretax charges for business restructuring, including re-engineering operations and force reductions, which were reflected in operating expenses. The after-tax effect of these charges was a reduction in net income of approximately $376 million. See the section entitled \"Business Restructuring\" included in Management's Discussion and Analysis of Results of Operations and Note (P), \"Business Restructuring\", for further discussion of these charges.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nDuring 1994 and 1993, the Company did not change its auditors.\nPART IV\nITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this Annual Report on Form 10-K. -----------------------------------------------------------\nPages in This Annual Report On Form 10-K ---------------- (1) Financial Statements filed as part of this report are listed in the Table of Contents on page 2 and contained in Item 8 herein.\n(2) Financial Statement Schedule. The following ---------------------------- financial statement schedule of the Registrant is included herein in response to Item 14:\nII - Valuation and Qualifying Accounts... 51\nFinancial statement schedules other than that listed above have been omitted because the required information is contained in the financial statements and notes thereto or because such schedules are not required or applicable.\n(3) Exhibits. Exhibits identified in parentheses below, on file -------- with the SEC, are incorporated herein by reference as exhibits hereto.\nExhibit Number -------\n(3)a Restated Certificate of Incorporation of the Company dated August 19, 1988 (Exhibit No. (19)ii to the Registrant's filing on Form SE dated May 2, 1989, File No. 1-1150).\n(3)b By-Laws of the Company as amended April 18, 1989 (Exhibit No. (3)b to the Registrant's filing on Form SE, dated May 2, 1989, File No. 1-1150).\n(4) No instrument which defines the rights of holders of long-term debt of the Company is filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation, the Company hereby agrees to furnish a copy of any such instrument to the SEC upon request.\n(10)(ii)(B)1 Directory License Agreement between New England Telephone and Telegraph Company and NYNEX Information Resources Company dated as of January 1, 1991 (Exhibit No. (10)(ii)(B)4 to the Registrant's filing on Form SE, dated March 26, 1991, File No. 1-1150).\nExhibit Number -------\n(10)(ii)(B)2 Service Agreement concerning provision by Telesector Resources Group, Inc. to New England Telephone and Telegraph Company of numerous services, including (i) purchasing, materials handling, inspection, distribution, storage and similar services and (ii) technical, regulatory, government relations, marketing operational support and similar services, dated March 31, 1992 (Exhibit No. (19)(i)1 to the Registrant's filing on Form SE, dated March 23, 1993, File No. 1-1150.\n(23) Consent of Independent Accountants.\n(24) Powers of attorney.\n(b) Reports on Form 8-K. -------------------\nThe Company's Current Report on Form 8-K, date of report December 8, 1994 and filed December 22, 1994, reporting on Item 5.","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":"276477_1994.txt","cik":"276477","year":"1994","section_1":"Item 1. Business\nGeneral\nThe Hillhaven Corporation, a Nevada corporation (\"Hillhaven\", the \"Registrant\" or the \"Company\"), operates nursing centers, pharmacies and retirement housing communities. Hillhaven was incorporated in May 1989 by National Medical Enterprises, Inc. (together with its subsidiaries, \"NME\") in anticipation of a spin-off by NME of substantially all of its domestic long term care operations in a dividend distribution of Hillhaven common stock to NME shareholders that was effected in January 1990 (the \"Spin-off\"). As part of the Spin-off, Hillhaven and NME entered into certain agreements which included the leasing of initially 115 nursing centers and four retirement housing communities adjacent thereto, the borrowing of certain sums of money and the managing of certain nursing centers located on NME hospital campuses. These relationships are discussed in more detail under \"Certain Transactions\" in the Proxy Statement for the Company's 1994 Annual Meeting of Stockholders.\nBased upon the number of beds in service and net operating revenues, Hillhaven is the second largest long term care provider in the United States and believes that it is one of the leading providers of Alzheimer's care. At May 31, 1994, the Company operated 288 nursing centers (of which 194 were owned, 78 were leased and 16 were managed for others) with 36,249 licensed beds. The nursing centers are located in 33 states and range in capacity from 42 to 692 beds. For the year ended May 31, 1994, average nursing center occupancy was 93.4%. Pharmacy operations are conducted through the Company's subsidiary, Medisave Pharmacies, Inc. (\"Medisave\"), which, as of May 31, 1994, consisted of 40 institutional pharmacies and 32 retail pharmacies located in 19 states. The Company also operates 19 retirement housing communities containing an aggregate of 2,622 apartment units located in 14 states.\nThe Company provides a wide range of diversified health care services, including long term care and subacute medical and rehabilitation services, such as wound care, oncology treatment, brain injury care, stroke therapy and orthopedic therapy. Subacute medical and rehabilitation services are offered at all of the Company's nursing centers and are the fastest growing component of the Company's nursing center operations, constituting approximately 24.7% of nursing center net operating revenues in fiscal 1994, 19.4% in fiscal 1993 and 13.6% in fiscal 1992. Hillhaven believes that it is also one of the largest providers of physical, occupational and speech therapies in the United States. In addition, the Company currently provides long term care to residents of the Company's nursing centers with Alzheimer's disease through 61 Alzheimer's care units with 1,870 beds. The Company does not presently maintain designated beds for specialty care services, other than for Alzheimer's care, where the patients benefit from segregated facilities. The Company's experience has been that subacute medical and rehabilitation services, particularly rehabilitation, can be\neffectively and successfully integrated into its standard nursing center operations at the majority of its centers, in most cases with little physical reconfiguration of or modification to the facilities.\nNursing center net operating revenues, comprised primarily of net patient revenues, accounted for 85.5% and 84.9% of Hillhaven's total net operating revenues for fiscal 1994 and 1993, respectively. In fiscal 1994, the Company derived 50.2% of its net patient revenues from Medicaid, 26.8% from private pay and other sources and 23.0% from Medicare. In fiscal 1993, the comparable figures were 54.8%, 26.8% and 18.4%, respectively. Pharmacy operations accounted for 12.2% and 13.1% of Hillhaven's total net operating revenues for fiscal 1994 and 1993, respectively. In fiscal 1994, institutional pharmacy operations constituted approximately 76% of Medisave's total net operating revenues, compared to 63% in fiscal 1993. Retirement housing operations represented 2.3% and 2.0% of Hillhaven's total net operating revenues for fiscal 1994 and 1993, respectively. Under segment reporting criteria, Hillhaven believes its only material business segment is \"health care,\" which contributed substantially all of the Company's net operating revenues and substantially all of its operating profits for fiscal 1994.\nThe Recapitalization\nSince the Spin-off, it has been management's intention to improve Hillhaven's balance sheet (in particular, its debt-to- equity ratio) and to gradually decrease the extent of the relationship between Hillhaven and NME. To this end, prior to September 1993, the Company had purchased all but 23 of the 115 nursing centers originally leased from NME, had restructured its leases relating to the NME-owned nursing centers to eliminate contingent rent provisions and to fix the purchase option prices, had repaid $96.8 million of the $145.9 million principal amount of notes issued by Hillhaven to NME at the time of the Spin-off, had issued $35 million of its 8-1\/4% cumulative nonvoting Series C Preferred Stock (the \"Series C Preferred Stock\") to NME and used the proceeds to repay higher cost debt and had reduced the amount of obligations guaranteed by NME, for which the Company pays a guarantee fee, to $699.0 million at May 31, 1993.\nOn September 2, 1993, Hillhaven substantially completed a recapitalization plan (the \"Recapitalization\") which improved its balance sheet, extended maturities of outstanding indebtedness, increased operating flexibility through the acquisition of previously leased facilities, fixed the interest rates on a portion of its previously floating rate indebtedness and also reduced the extent of the relationship between the Company and NME.\nThrough the Recapitalization, the Company's relationship with NME was modified by (i) the purchase of the remaining 23 facilities leased from NME (the \"Leased Facilities\") for $111.8 million, (ii) the repayment of all existing debt to NME in the aggregate principal amount of $147.2 million, (iii) the release\nof NME guarantees on approximately $400 million of debt, (iv) the limitation of the annual fee payable to NME in connection with the maintenance of the remaining guarantees to 2% of the remaining amount guaranteed and (v) the amendment of existing agreements to eliminate obligations of NME to provide additional financing to the Company.\nThe Recapitalization was financed through (i) the issuance to NME of $120 million of a newly created series of payable-in- kind preferred stock (the \"Series D Preferred Stock\"), (ii) the incurrence by First Healthcare Corporation, the Company's principal operating subsidiary (\"FHC\"), of a $175 million five- year term loan under a secured credit facility with a syndicate of banks (the \"Bank Term Loan\"), (iii) the issuance of $175 million of 10-1\/8% Senior Subordinated Notes due 2001 (the \"Offering\"), (iv) the borrowing of $30 million under an accounts receivable-backed credit facility (the \"Accounts Receivable Financing\") and (v) the use of approximately $39 million of cash.\nThe Recapitalization included a $100 million letter of credit facility to be used to provide credit enhancement for and replace NME guarantees on the Company's industrial revenue bonds, and an $85 million revolving bank line of credit. In February 1994, the letter of credit facility was reduced to $90 million. The availability of the revolving line of credit allows the Company to maintain lower cash balances and may facilitate repayments of higher-rate debt or provide cash for investment or other corporate purposes.\nFollowing the Recapitalization, NME has continued to be a substantial shareholder of the Company, but is no longer a lessor to or creditor of the Company. NME has continued as a guarantor of certain leases and a significantly reduced portion of the Company's debt. In the short term, the removal of NME as a guarantor of certain of the Company's indebtedness has caused the Company to incur debt at higher interest rates than may have been available previously. However, this cost has been balanced by the reduction of guarantee fees paid to NME and the replacement of $120 million of indebtedness with the Series D Preferred Stock. In addition, the Company has benefited by capping at 2% NME's guarantee fee, which otherwise would have escalated to 3%. New funds are anticipated to be obtained at rates which the Company believes will be lower than the rates which it would have otherwise obtained on financing provided by NME.\nThe Recapitalization is discussed in more detail under \"Certain Transactions\" in the Proxy Statement for the Company's 1994 Annual Meeting of Stockholders.\nIndustry Trends\nThe Company believes that several industry trends will contribute to growth opportunities. These trends include an aging population, the increasing shift of patients from acute care and rehabilitation hospitals to nursing centers due to the nationwide emphasis on health care cost containment, the health care system reform proposals being considered by the federal and\nstate governments and others, the growth in demand for long term care services and centers currently exceeding the growth in supply and the increasing complexity of and more burdensome operating standards for the delivery of pharmaceutical products and services to nursing centers and other institutions.\nAging Population. People over the age of 65 are the primary users of long term care. Based on U.S. Census Bureau data, this segment of the population in the United States has grown from approximately 25 million in 1980 to approximately 31 million in 1990. This age group is expected to increase to approximately 35 million by the year 2000. The fastest growing segment of the United States population is the over-85 age group, which is expected to increase from approximately 3.4 million in 1991 to approximately 4.6 million in 2000. Advances in medical technology have increased life expectancies; as a result, an increasing number of elderly patients require a high level of care not historically available outside an acute care hospital.\nEarlier Hospital Discharge to Nursing Centers. Based on reports in health care industry journals, in recent years, average lengths of stay in hospitals have been decreasing, in part as a result of governmental and private pay sources attempting to control health care costs by adopting reimbursement strategies that encourage earlier discharge from hospitals. Many patients leaving hospitals require skilled nursing care and rehabilitation services of the type that the Company provides.\nHealth Care System Reforms. In an effort to combat increasing health care costs, governmental entities and insurance companies are considering ways to contain costs, including adjusting Medicaid eligibility requirements and encouraging patients to obtain treatment from lower cost providers. The Company believes that, as a low cost provider of subacute medical and rehabilitation services, it is well-positioned to benefit from these reforms.\nNursing Center Supply\/Demand Imbalance. Based on reports in long term care industry journals, while demand for nursing center beds has increased in recent years, the supply has remained relatively unchanged. Construction and expansion of nursing centers is regulated in most states, and the ability to obtain financing for these activities in the past was adversely affected by lending limitations imposed by the financial institutions industry.\nIncreasing Complexity of Institutional Pharmaceutical Requirements. The Company believes that the implementation of the Omnibus Budget Reconciliation Act of 1987 (\"OBRA\") in October 1990 has further increased the demand for the Company's pharmaceutical services. Nursing centers are responsible for complying with more stringent standards of care established by OBRA, which include planning, monitoring and reporting the progress of prescription drug therapy. Based on reports in long term care industry journals, nursing center administrators and directors of nursing now seek sophisticated and experienced pharmacies with trained consultant pharmacists and computerized\ndocumentation programs to help ensure regulatory compliance. Retail pharmacies, which generally lack the breadth of service and do not focus on the special requirements of nursing centers, are being replaced with institutional pharmacies that can more effectively serve this market.\nBusiness Strategy\nOperating Strategy\nThe Company's operating strategy is designed to take advantage of several important industry trends, a number of which are favorable, and includes expanding higher revenue specialty care services, increasing private pay and Medicare census, maintaining high occupancy levels and expanding Medisave's institutional pharmacy operations.\nExpansion of Specialty Care Services. Hillhaven intends to continue to expand its specialty care programs and services. These services generally produce higher revenues than do routine nursing care services and serve to differentiate the Company's facilities from others in a given market. The Company intends to expand its subacute medical and rehabilitation services, which include wound care, oncology treatment, brain injury care, stroke therapy and orthopedic therapy. The expansion of these services is designed to increase private pay and Medicare revenues which are higher than reimbursement rates for traditional long term care services.\nIncreasing Private Pay and Medicare Census. Hillhaven is also working to increase private pay and Medicare census by further developing and maintaining relationships with traditional referral sources and by entering into contracts with private insurance companies to provide subacute medical and rehabilitation services to their insureds. Increasing the number of managed care patients in the Company's nursing centers is an increasingly important component of the Company's marketing strategy. Hillhaven's subacute medical and rehabilitation services offer a less expensive alternative to hospital care for patients who need specialized nursing care but do not require many of the other services provided in an acute care hospital. As of May 31, 1994, the Company was operating under 139 such managed health care contracts.\nMaintaining High Occupancy Levels. The Company believes in maintaining high occupancy levels in existing facilities through (i) an enhanced emphasis on local marketing efforts in which nursing center employees are charged with actively marketing their services within the community, (ii) broadening the scope and character of services provided in each nursing center and (iii) favorable demographic trends. The Company believes that maintaining high occupancy levels enables it to realize greater economies of scale. In fiscal 1994, Hillhaven had an average occupancy in its ongoing nursing centers of 93.4%. However, certain facilities, particularly in the western states, have lower occupancy rates, and management's strategy is to increase occupancy levels in the nursing centers in these states.\nExpansion of Institutional Pharmacy Business. The Company is a leading provider of comprehensive pharmacy services to nursing centers and their patients. Medisave has a growth strategy which includes (i) continued penetration of existing markets, (ii) expansion into selected new markets and (iii) increasing infusion and enteral therapy revenues by targeting specific health care providers.\nFinancial Strategy\nThe Company's financial strategy is designed to increase the equity base of the Company over time and to provide flexibility to capitalize on attractive business opportunities. The key elements of this financial strategy include reducing or refinancing indebtedness, purchasing leased nursing centers and divesting nursing centers that do not perform satisfactorily.\nReducing or Refinancing Indebtedness. The Company's plan to reduce or refinance indebtedness is designed to improve the Company's debt-to-equity ratio, reduce the overall interest rates on indebtedness (including guarantee fees) and extend the maturities and amortization of the Company's indebtedness.\nPurchasing Leased Nursing Centers. Since the Spin-off, Hillhaven has purchased 136 of the 239 nursing centers that were leased at that time. The acquisition of the Leased Facilities completed the Company's purchase of all of the 115 facilities previously leased from NME. The Company generally considers ownership of nursing centers preferable to leasing, both in the short term and in the long term, because it provides increased operating flexibility and the opportunity to benefit from future real estate appreciation.\nConclusion of the Disposition Program. On December 5, 1991, Hillhaven announced a restructuring plan designed to improve its long-term financial strength and operating performance by disposing of underperforming nursing centers, restructuring facility leases with NME and selling $35 million of Series C Preferred Stock to NME in order to prepay indebtedness owed to NME. The plan involved the sale or sublease of 82 nursing centers, which disposition was intended to allow the Company to concentrate on markets and services that offer higher profits, as well as to realize reductions in overhead costs. As of November 30, 1993, the Company had completed the disposition of 50 of these nursing centers, as well as three retirement housing facilities which, prior to March 1, 1992, had been recorded as discontinued operations. During the second quarter of fiscal 1994, the Company reviewed its asset disposition program and, because of improvements in reimbursement rates and results of operations, decided not to pursue the sale of the remaining nursing homes and a retirement housing facility, but instead reinstated these facilities as ongoing operations. On December 31, 1993, the Company completed the sale of 13 additional nursing centers, nine of which had previously been held for disposition.\nNursing Centers\nHillhaven's nursing center operations provide skilled nursing, residential and rehabilitative care in 288 nursing centers in 33 states. At May 31, 1994, Hillhaven owned 194 and leased 78 nursing centers. These nursing centers had a total of 34,162 licensed beds, with individual nursing center capacities ranging from 42 to 692 beds. In addition, seven nursing centers are managed for partnerships or joint ventures in which Hillhaven has an equity interest and nine nursing centers are managed for NME and other third parties for management fees usually based upon a percentage of nursing center revenues.\nHillhaven is a leading provider of rehabilitation services, including physical, occupational and speech therapies. Rehabilitation services are provided in all of the Company's nursing centers. The majority of patients in rehabilitation programs stay for eight weeks or less. Patients in rehabilitation programs generally provide for higher revenues than other nursing center patients because they use a higher level of ancillary services. In addition, management believes that Hillhaven is one of the leading providers of care for patients with Alzheimer's disease. At May 31, 1994, the Company offered treatment in approximately 1,870 beds in 61 nursing centers for patients suffering from Alzheimer's disease. Many of these patients reside in separate units within the nursing centers and are cared for by teams of professionals specializing in the unique problems experienced by Alzheimer's patients.\nMarketing\nThe factors which affect consumers' selection of a nursing center vary from community to community and include competition and a provider's relationships with local referral sources. Competition creates the standards against which nursing centers in a given market are judged by various referral sources, which include physicians, hospital discharge planners, community organizations and families. Therefore, Hillhaven's marketing efforts are conducted at the local market level by the nursing center administrators, admissions coordinators and others. Nursing center personnel are assisted in carrying out their marketing strategies by regional marketing staffs. The Company's marketing efforts are directed toward improving the payor mix at the nursing centers by increasing the census of private pay patients, patients covered by managed care contracts and Medicare patients. To this end, the Company is working to educate the various referral sources about the value of Hillhaven's nursing centers as an attractive lower cost alternative to acute care and rehabilitation hospitals for subacute medical care and specialty services.\nOperations\nEach nursing center is managed by a state licensed administrator who is supported by other professional personnel, including a director of nursing, staff development professional (responsible for employee training), activities director,\nbusiness office manager and, in general, physical, occupational and speech therapists. The directors of nursing are state licensed nurses who supervise nursing staffs which include registered nurses, licensed practical nurses and nursing assistants. Staff size and composition vary depending on the size and occupancy of each nursing center and on the level of care provided by the nursing center. The nursing centers contract with physicians who serve as medical directors and serve on quality assurance committees.\nThe nursing centers are supported by regional staff in the areas of nursing, dietary and rehabilitation services, maintenance, human resources, marketing and financial services. In addition, corporate staff in Tacoma, Washington provide other services in the areas of marketing assistance, human resource management, state and federal reimbursement, state licensing and certification, legal, finance and accounting support. Financial control is maintained principally through fiscal and accounting policies established at the corporate level for use at the nursing centers.\nQuality of care is monitored and enhanced by quality assurance committees, regional quality assurance teams and family satisfaction surveys. The quality assurance committees oversee patient health care needs and resident and staff safety. Additionally, physicians serve on the quality assurance committees as medical directors and advise on health care policies and practices. Regional consultants visit each nursing center periodically to review practices and recommend improvements where necessary in the level of care provided and to assure compliance with requirements under applicable Medicare and Medicaid regulations. Surveys of residents' families are conducted from time to time in which the families are asked to rate various aspects of service and the physical condition of the nursing centers. These surveys are reviewed by nursing center administrators to help ensure quality care.\nHillhaven provides training programs for nursing center administrators, managers, nurses and nursing assistants. These programs are designed to provide career opportunities for employees and to maintain high levels of quality patient care.\nApproximately 99% of the nursing centers are currently certified to receive benefits provided under Medicare and Medicaid programs. Medicare is a federal health insurance program primarily for the elderly. Medicaid is a joint federal\/state program providing medical assistance to the indigent. A nursing center's qualification to participate in such programs depends upon many factors, including, among other things, accommodations, equipment, services, safety, personnel, physical environmental and adequate policies and procedures.\nOccupancy Level\nThe following table sets forth for the periods indicated data with respect to numbers of owned or leased nursing centers operated by Hillhaven, numbers of beds and occupancy levels. (Data with respect to facilities managed by the Company for partnership and joint ventures in which the Company has an equity interest and for third parties are not included. See \"Facilities.\")\nSources of Revenues\nNet patient care revenues are derived principally from Medicare and Medicaid programs and from private pay patients. Consistent with the nursing home industry generally, changes in the mix of Hillhaven's patient population among these three categories significantly affect the profitability of Hillhaven's operations. Although the level of cost reimbursement for Medicare patients generally produces the most revenue per patient day, profitability is reduced by the costs associated with the higher level of nursing care and other services required by such patients. The Company believes that private pay patients generally constitute the most profitable and Medicaid patients generally constitute the least profitable category.\nThe table below sets forth certain data for the periods shown with respect to the payor mix of owned or leased nursing centers that were operated by Hillhaven. (Data with respect to facilities managed by the Company for partnerships and joint ventures in which the Company has an equity interest and for third parties are not included. See \"Facilities.\")\nBoth governmental and private third-party payors have employed cost containment measures designed to limit payments\nmade to health care providers such as the Company. Those measures include the adoption of initial and continuing recipient eligibility criteria which may limit payment for services, the adoption of coverage criteria which limit the services that will be reimbursed and the establishment of payment ceilings which set the maximum reimbursement that a provider may receive for services. Furthermore, government reimbursement programs are subject to statutory and regulatory changes, retroactive rate adjustments, administrative rulings and government funding restrictions, all of which may materially increase or decrease the rate of program payments to the Company for its services. There can be no assurance that payments under governmental and private third-party payor programs will remain at levels comparable to present levels or will be sufficient to cover the costs allocable to patients eligible for reimbursement pursuant to such programs. In addition, there can be no assurance that facilities owned, leased or managed by the Company, or the provision of services and supplies by the Company, will meet the requirements for participation in such programs. The Company could be adversely affected by the continuing efforts of governmental and private third-party payors to contain the amount of reimbursement for health care services. In an attempt to limit the federal budget deficit, there have been, and the Company expects that there will continue to be, a number of proposals to limit Medicare and Medicaid reimbursement for health care services.\nMedicare\nThe Medicare Part A program provides reimbursement for extended care services furnished to Medicare beneficiaries who are admitted to skilled nursing centers after at least a three- day stay in an acute care hospital. Covered services include supervised nursing care, room and board, social services, physical and occupational therapies, pharmaceuticals, supplies and other necessary services provided by skilled nursing centers.\nUnder the Medicare program, skilled nursing center reimbursement is based upon actual costs incurred as reported by each nursing center at the end of each annual reporting period. Revenues under this program are subject to audit and retroactive adjustment. Provisions for estimated third-party payor settlements are provided for in the period the related services are rendered and are adjusted as final settlements are determined. To date, these settlements have not resulted in material adjustments to earnings.\nMedicaid\nMedicaid is a state-administered program financed by state funds and matching federal funds. The program provides for medical assistance to the indigent and certain other eligible persons. Although administered under broad federal regulations, states are given flexibility to construct programs and payment methods consistent with their individual goals. These programs, therefore, differ from state to state in many respects.\nFederal law requires Medicaid programs to pay rates that are reasonable and adequate to meet the costs incurred by an\nefficiently and economically operated nursing center providing quality care and services in conformity with all applicable laws and regulations. However, despite these federal requirements, disagreements frequently arise between nursing centers and states regarding the adequacy of Medicaid payments. In addition, the Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy by the state agencies and certain government funding limitations, all of which may materially increase or decrease the level of program payments to nursing centers operated by Hillhaven. Management believes that, at present, the payments under these programs are not sufficient on an overall basis to cover the costs of serving residents participating in these programs. Furthermore, OBRA mandates an increased emphasis on ensuring quality patient care, which has resulted in additional expenditures by nursing centers.\nThere can be no assurance that the payments under these state programs will remain at levels comparable to current levels or, in the future, will be sufficient to cover the costs incurred in serving residents participating in such programs. Hillhaven provides to eligible individuals Medicaid-covered services consisting of nursing care, room and board and social services. In addition, states may at their option cover other services such as physical, occupational and speech therapies and pharmaceuticals.\nPrivate Payment and Medicare Patients\nHillhaven seeks private payment and Medicare patients and has specific marketing and referral programs aimed at enhancing its private census. In particular, the Company has implemented a strategy to increase the number of managed care patients. Private payment patients typically have financial resources (including insurance coverage) to pay for their monthly services and therefore do not rely on Medicaid for support. Private payment billings are sent monthly, with any collection efforts handled primarily through the nursing centers. Patients either pay directly or funds are received from family members, insurance companies, health maintenance organizations or other private third-party payors.\nCompetition\nHillhaven's nursing centers compete on a local and regional basis with other long term care providers. Hillhaven's competitive position varies from nursing center to nursing center within the various communities served. Hillhaven believes that the quality care provided, reputation, location and physical appearance of its nursing centers and, in the case of private patients, the rates or charges for services are significant competitive factors. There is limited, if any, price competition with respect to Medicare and Medicaid patients, since revenues received for services provided to such patients are strictly controlled and based on fixed rates or cost reimbursement principles.\nThe long term care industry is divided into a variety of competitive areas which market similar services. These competitors include nursing centers, hospitals, extended care\ncenters, retirement housing facilities and communities, home health agencies and similar institutions. The industry includes government-owned, church-owned, secular not-for-profit and for- profit institutions.\nFacilities\nThe following table lists, by state, the number of nursing centers operated by the Company for its own account as of May 31, 1994. Sixteen nursing centers, accounting for 2,087 beds, managed at that date for partnerships and joint ventures in which the Company has an equity interest and for others are not included in the table.\nIn addition to its interests in nursing centers, as described above, as of May 31, 1994, Hillhaven had 50% interests in seven partnerships and joint ventures that own nursing centers managed by Hillhaven with an aggregate of 772 beds in five states. Hillhaven also manages nine nursing centers owned by NME and other third parties. These nursing centers are managed by Hillhaven for varying management fees. The aggregate net operating revenues received in connection with the management of these facilities was $5.7 million in fiscal 1994 and $5.5 million in fiscal 1993.\nPharmacies\nThrough Medisave, the Company provides institutional and retail pharmacy services. As of May 31, 1994, Medisave operated 40 institutional pharmacies and 32 retail pharmacies in 19 states. In fiscal 1994, Medisave's net operating revenues were $176.2 million, representing 12.2% of the Company's net operating revenues. Medisave's net operating revenues of $179.3 million accounted for 13.1% of Hillhaven's net operating revenues in fiscal 1993, compared to 12.0% in fiscal 1992.\nThe institutional pharmacy division focuses on providing a full array of pharmacy services to approximately 400 nursing centers and specialized care centers. Institutional pharmacy sales encompass a wide variety of products including prescription medication, prosthetics, respiratory and infusion services and enteral therapies. In addition, Medisave provides a variety of pharmaceutical consulting services designed to assist nursing centers in program administration. The disposition of 50 nursing centers as part of the restructuring announced in December 1991 has not had a material adverse effect on the results of operations of the institutional pharmacy division. Institutional pharmacy operations accounted for approximately 76% of total pharmacy revenues and approximately 90% of Medisave's operating profits in fiscal 1994. In fiscal 1993, the comparable figures were 63% and 80%, respectively.\nMedisave's retail pharmacy operations consist of discount retail pharmacy and optical stores in leased facilities. In 1993 and 1994, the Company terminated leases of 36 retail outlets in Wal-Mart stores. The leases of the remaining 14 Wal-Mart outlets were terminated in the 1995 first quarter. The termination of these leases is not expected to have a material effect on pharmacy operating income. Retail operations accounted for approximately 24% of Medisave's total pharmacy revenues and approximately 10% of its operating profits in fiscal 1994. In fiscal 1993, the comparable figures were 37% and 20%, respectively.\nThe following table lists by state the number of pharmacies operated by Medisave as of May 31, 1994.\nRetirement Housing Communities\nHillhaven's retirement housing operations consist of 19 retirement housing communities. These centers include 2,622 apartment units and are located in 14 states. Of the total number of retirement housing centers, 14 are owned by Hillhaven, one is leased by Hillhaven and four are owned by partnerships in which Hillhaven has an equity interest. Retirement housing operations represented approximately 2.3%, 2.0% and 1.7% of Hillhaven's total net operating revenues for fiscal 1994, 1993 and 1992, respectively.\nRetirement housing communities serve more independent and self-sufficient residents than do the nursing centers. A retirement housing community consists of studio, one-bedroom and two-bedroom apartment units. Residents typically receive weekly housekeeping and linen service, local transportation, 24-hour emergency call system and daily food service.\nResidents are responsible for monthly fees which typically are paid by the resident or the resident's family members. Retirement housing operations do not presently qualify for reimbursement under Medicare, Medicaid or Veterans Administration health care programs because they do not offer the levels of care required under such programs. Monthly fees paid by residents are based upon the resident's apartment size, the number of meals the resident elects to purchase and the level of personal care required by the resident.\nThe following table lists, by state, the number of retirement housing communities operated by the Company as of May 31, 1994.\nGovernment Regulation\nThe federal government and all states in which the Company operates regulate various aspects of the Company's business. In particular, the development and operation of long term care facilities and retirement communities and the provision of health care services are subject to federal, state and local laws relating to the adequacy of medical care, distribution of pharmaceuticals, equipment, personnel, operating policies, fire prevention, rate-setting and compliance with building codes and environmental laws. Long term care facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with various standards, their continued licensing under state law, certification under the Medicare and Medicaid programs and continued participation in the Veterans Administration program. Retirement communities and their owners are subject to periodic inspection by governmental authorities to assure compliance with various standards including standards relating to the financial condition of the owners of such communities. The failure to obtain or renew any required regulatory approvals or licenses could adversely affect the Company's operations.\nEffective October 1, 1990, OBRA increased the enforcement powers of state and federal certification agencies. Additional sanctions were authorized to correct noncompliance with regulatory requirements, including fines, temporary suspension of admission of new patients to nursing centers and, in extreme circumstances, decertification from participation in the Medicare or Medicaid programs.\nNursing centers managed and operated by Hillhaven are licensed either on an annual or bi-annual basis and certified annually for participation in Medicare and\/or Medicaid by the respective states through various regulatory agencies which determine compliance with federal, state and local laws. These legal requirements relate to the quality of the nursing care provided, the qualifications of the administrative personnel and nursing staff, the adequacy of the physical plant and equipment and continuing compliance with the laws and regulations governing the operation of nursing centers. Hillhaven endeavors to comply with federal, state and local regulatory requirements for the maintenance and operation of its nursing centers. From time to time Hillhaven's nursing centers receive statements of deficiencies from regulatory agencies. In response, Hillhaven implements plans of correction with respect to these nursing centers to address the alleged deficiencies. Hillhaven believes that its nursing centers are in material compliance with all applicable regulations or laws.\nIn certain circumstances, federal law mandates that conviction of certain abusive or fraudulent behavior with respect to one health care facility may subject other facilities under common control or ownership to disqualification for participation in Medicare and Medicaid programs. In addition, some state regulations provide that all facilities under common control or ownership within a state are subject to delicensure if any one or more of such facilities is delicensed.\nIn addition to license requirements, many states in which Hillhaven operates have statutes that require a Certificate of Need to be obtained prior to the construction of a new nursing center, the addition of new beds or services or the incurring of certain capital expenditures. Certain states also require regulatory approval prior to certain changes in ownership of a nursing center. A total of eight states in which Hillhaven operates have eliminated their Certificate of Need programs and a number of other states are considering alternatives to their Certificate of Need programs. To the extent that Certificates of Need or other similar approvals are required for expansion of Company operations, either through facility acquisitions or expansion or provision of new services or other changes, such expansion could be adversely affected by the failure or inability to obtain the necessary approvals, changes in the standards applicable to such approvals or possible delays and expenses associated with obtaining such approvals.\nPharmaceutical operations are subject to regulation by the various states in which the Company conducts its business as well as by the federal government. The Company's pharmacies are regulated under the Food, Drug and Cosmetic Act and the Prescription Drug Marketing Act, which are administered by the United States Food and Drug Administration. Under the Comprehensive Drug Abuse Prevention and Control Act of 1970, which is administered by the United States Drug Enforcement Administration (\"DEA\"), dispensers of controlled substances must register with the DEA, file reports of inventories and transactions and provide adequate security measures. Failure to comply with such requirements could result in civil or criminal penalties.\nThe Company is also subject to federal and state laws which govern financial and other arrangements between health care providers. These laws often prohibit certain direct and indirect payments or fee-splitting arrangements between health care providers that are designed to induce or encourage the referral of patients to, or the recommendation of, a particular provider for medical products and services. Such laws include the anti- kickback provisions of the federal Medicare and Medicaid Patients and Program Protection Act of 1987. These provisions prohibit, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for the referral of Medicare and Medicaid patients. In addition, some states restrict certain business relationships between physicians and pharmacies, and many states prohibit business corporations from providing, or holding themselves out as a provider of, medical care. Possible sanctions for violation of any of these restrictions or prohibitions include loss of licensure or eligibility to participate in reimbursement programs as well as civil and criminal penalties. These laws vary from state to state and have seldom been interpreted by the courts or regulatory agencies.\nInsurance Coverage and Availability\nThe Company has liability insurance policies providing insurance coverage which it believes to be adequate. There can be no assurance, however, that claims in excess of the Company's insurance coverage or claims not covered by the Company's coverage will not be asserted against the Company. In addition, the Company's insurance policies must be renewed annually. Although the Company has obtained various insurance coverages at a reasonable cost in the past, there can be no assurance that it will be able to do so in the future. Although the Company has had access to other insurance options, through May 31, 1994, substantially all of the professional and general liability risks of Hillhaven were insured by a company that is wholly-owned by NME because it offered more competitive rates. All matters arising after May 31, 1994 will be insured through the Company's newly formed captive insurance company, Cornerstone Insurance Company.\nOther Real Property\nThe Company owns unimproved real property with a book value of approximately $11.4 million at May 31, 1994.\nEmployees\nAs of May 31, 1994, Hillhaven employed approximately 38,100 individuals, of whom approximately 25,600 full-time and 9,800 part-time employees work at Hillhaven's nursing centers, approximately 850 employees work at the corporate and regional offices, approximately 1,350 employees work in Hillhaven's pharmacy operations and approximately 500 employees work in the retirement housing communities. Among its professional staff, Hillhaven employs approximately 2,900 registered nurses, 4,800 licensed practical nurses and 2,600 licensed therapists. Hillhaven has 22 collective bargaining agreements covering approximately 4,500 employees. The Company believes that its relations with its employees are good.\nExecutive Officers of the Registrant\nSet forth below are the names, ages, titles and present and past positions of the persons who are executive officers of Hillhaven.\nName and Age Position and Experience\nBruce L. Busby (50) Chief Executive Officer and Chairman of the Board. Mr. Busby has been a director and the Chief Executive Officer of the Company since April 1991 and Chairman of the Company since September 1993. Before joining the Company, Mr. Busby served NME as Chief Executive Officer and President of the Venture Development Group from April 1988 to March 1991, Chairman and Chief Executive Officer of the Long Term Care Group from August 1986 to March 1988 and President of the Retail Services Group from June 1986 to November 1987.\nChristopher J. Marker (51) President. Mr. Marker has been a director and the President of the Company since December 1989. He served as President of the Company's predecessor, an NME subsidiary, from April 1988 to January 1990. Prior to that, Mr. Marker was Executive Vice President of Westin Hotels and Resorts from January 1984 to March 1988.\nName and Age Position and Experience\nJeffrey M. McKain (43) Executive Vice President. Mr. McKain has served Hillhaven as Executive Vice President since January 1992 and as Senior Vice President from April 1991 to January 1992. He served as Senior Vice President, Operations of First Healthcare Corporation, a wholly-owned subsidiary of the Company, from April 1990 to April 1991 and as Vice President of Operations of FHC from January 1986 to March 1990.\nRobert F. Pacquer (49) Senior Vice President and Chief Financial Officer. Mr. Pacquer has served the Company as Senior Vice President and Chief Financial Officer since December 1989 and as Treasurer from that date to March 1992. He served as Senior Vice President and Chief Financial Officer of the Company's predecessor from October 1986 to January 1990.\nRichard P. Adcock (39) Senior Vice President, Secretary and General Counsel. Mr. Adcock has served the Company as Senior Vice President since December 1989 and as Vice President, Secretary and General Counsel since May 1989. He served as Vice President, Secretary and General Counsel of the Company's predecessor from May 1987 to January 1990.\nKris Scoumperdis (50) Senior Vice President. Mr. Scoumperdis has served the Company as Senior Vice President since February 1991 and as Vice President from March 1990 to January 1991. Before joining the Company he served as Vice President, Human Resources of the Frank Russell Company, a pension asset consulting firm, from November 1988 to March 1990, and as Vice President, Human Resources and Support Services of Good Samaritan, Inc., a health care company, from November 1984 to October 1988.\nName and Age Position and Experience\nCarl Napoli (56) Chief Executive Officer, President and Chief Operating Officer of Medisave. Mr. Napoli has served as Chief Executive Officer of Medisave Pharmacies, Inc. since July 19, 1994, as President and Chief Operating Officer since May 1992, and he previously served as Executive Vice President of Operations from September 1984 to May 1992.\nEdward L. Hiller (63) Vice President\/Acquisitions of Medisave. Mr. Hiller has served as Vice President\/Acquisitions of Medisave since July 19, 1994. Mr. Hiller served as Chief Executive Officer of Medisave Pharmacies, Inc. from April 1992 to July 19, 1994 and as President from July 1975 to March 1992.\nRobert K. Schneider (46) Vice President and Treasurer. Mr. Schneider has served as Vice President and Treasurer since April 1992 and as Vice President, Treasury from August 1990 to April 1992. Before joining Hillhaven, he served as a Vice President and Manager of Seafirst Bank from September 1985 to August 1990.\nMichael B. Weitz (44) Vice President of Finance. Mr. Weitz has served as Vice President of Finance and principal accounting officer since April 1992 and as Vice President, Finance from June 1991 to April 1992. From November 1990 to May 1991, he was a self-employed independent certified public accountant. From June 1989 to October 1990, he served as Vice President of Finance and Treasurer of Chemical Processors, Inc., an environmental company.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe response to this item is included in Item 1.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are no material legal proceedings pending to which the Registrant is a party, or to which any of its property is subject, nor is such litigation threatened, 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\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended May 31, 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nAt May 31, 1994, there were approximately 8,700 holders of record of the Company's common stock. Approximately 33,300 additional stockholders held shares under beneficial ownership in nominee name or within clearing house positions of brokerage firms and banks. The Company's common stock has been listed and traded on the New York Stock Exchange since November 2, 1993 and was previously listed and traded on the American Stock Exchange under the symbol \"HIL.\" The stock prices below are the high and low sales prices as reported on the composite tape as adjusted to reflect a one-for-five reverse stock split.\nThe Company has not paid a common dividend and does not anticipate declaring a common dividend in the near future.\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 (Dollars in thousands)\nThe following material should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements of the Company and the related notes thereto. All references in this section to years are to fiscal years of the Company ended May 31 of such year.\nSignificant Events\nIn the 1994 second quarter, Hillhaven completed a recapitalization plan which improved its balance sheet and modified its relationship with National Medical Enterprises, Inc. (NME).\nA one-for-five reverse split of the Company's common stock was effected in the 1994 second quarter.\nAlso in the second quarter, the Company completed its facility disposition program and recorded a $21,904 pretax restructuring credit.\nIn 1994, Hillhaven realized earnings of $57,463, compared to $39,079 in 1993 and a net loss of $78,792 in 1992. The 1992 loss included a $90,000 pretax restructuring charge, as described below.\nThe Recapitalization\nOn September 2, 1993, Hillhaven substantially completed a recapitalization plan (the \"Recapitalization\") which improved the Company's balance sheet, extended the maturities of outstanding indebtedness, increased operating flexibility through the acquisition of leased facilities, fixed the interest rate on a portion of its previously floating rate indebtedness and also modified the relationship between Hillhaven and NME.\nThe Company's relationship with NME was modified by (i) the purchase of the remaining 23 nursing centers leased from NME for $111,800, (ii) the repayment of all existing debt to NME in the aggregate principal amount of $147,202, (iii) the release of NME guarantees on approximately $400,000 of debt, (iv) the limitation of the annual fee payable to NME to 2% of the remaining amount guaranteed and (v) the amendment of existing agreements to eliminate obligations of NME to provide additional financing to the Company. The Recapitalization was financed through (i) the issuance to NME of $120,000 of payable-in-kind Series D Preferred Stock, (ii) the incurrence of a $175,000 five-year term loan under a secured credit facility with a syndicate of banks (the \"Bank Term Loan\"), (iii) the issuance of $175,000 of 10-1\/8% Senior Subordinated Notes due 2001, (iv) borrowings of $30,000\nunder an accounts receivable-backed credit facility and (v) the use of approximately $39,000 of cash. Hillhaven refinanced third-party debt in the aggregate amount of $266,737 with proceeds from the Recapitalization. At May 31, 1994, the Bank Term Loan had a balance of $165,000 bearing interest at 6.1%.\nThe Recapitalization included a $100,000 letter of credit facility to be used to provide credit enhancement for and replace NME guarantees on the Company's industrial revenue bonds, and an $85,000 revolving bank line of credit. In February 1994, the letter of credit facility was reduced to $90,000. The availability of the revolving line of credit allows the Company to maintain lower cash balances and may facilitate repayments of higher-rate debt or provide cash for investment or other corporate purposes. At May 31, 1994, letters of credit outstanding under the letter of credit facility totalled $69,418 and the revolving bank line of credit had an outstanding balance of $8,000.\nConclusion of the Disposition Program\nOn December 5, 1991, Hillhaven announced a restructuring plan designed to improve its long-term financial strength and operating performance by disposing of underperforming nursing centers, restructuring facility leases with NME and selling $35,000 of Series C Preferred Stock to NME in order to prepay indebtedness owed to NME. The plan involved the sale or sublease of 82 nursing centers, which disposition was intended to allow the Company to concentrate on markets and services that offer higher profits, as well as to realize reductions in overhead costs. A pretax restructuring charge of $90,000 was recorded in the 1992 second quarter ended November 30, 1991, which included provisions for estimated losses on the disposition of the 82 nursing centers, operating losses of these centers during an estimated two-year disposition period and other related costs.\nAs of November 30, 1993, the Company had completed the disposition of 50 of these nursing centers, as well as three retirement housing facilities which, prior to March 1, 1992, had been recorded as discontinued operations. During the 1994 second quarter, the Company reviewed its asset disposition program. Because of improvements in reimbursement rates and results of operations, the Company decided not to pursue the sale of the remaining nursing centers and a retirement housing facility. In addition, several parcels of land which had been held for development have been reclassified to other noncurrent assets.\nAccrued loss reserves remaining at September 1, 1993 amounted to $54,550. Revenues and expenses related to the 32 nursing centers and other properties previously held for disposition have been reclassified to ongoing operations in the consolidated statements of operations for all periods presented. See Note 2 of Notes to Consolidated Financial Statements. Net assets of these facilities, less adjustments to asset carrying values and remaining accrued restructuring costs aggregating $32,646, have been reclassified from net assets held for disposition to appropriate balance sheet accounts.\nOn December 31, 1993, the Company sold 13 nursing centers, nine of which had previously been held for disposition. The sale resulted in a gain of $5,102, which is included in net operating revenues.\nResults of Operations\nNet operating revenues were $1,448,734 in 1994, $1,362,830 in 1993 and $1,304,126 in 1992. Net operating revenues for 1993 and 1992 are not directly comparable because revenues and expenses of the 50 nursing centers disposed of in connection with the December 1991 restructuring have been excluded from results of operations for periods after November 1991. Operating income before property-related expenses (which are comprised of rent, depreciation and amortization, interest and guarantee fees) and restructuring items was $213,082 in 1994 (14.7% of net operating revenues), an increase of approximately 8.6% from $196,223 in 1993 (14.4% of net operating revenues), which in turn represented an increase of 14.2% from $171,841 in 1992 (13.2% of net operating revenues). Net income (loss) was $57,463, $39,079 and $(78,792) in 1994, 1993 and 1992, respectively. Net income for 1994 includes the $21,904 pretax restructuring credit. The net loss in 1992 was due largely to the $90,000 pretax restructuring charge.\nThe following table identifies the Company's sources of net operating revenues.\nNursing center net operating revenues, comprised primarily of patient revenues, increased 7.1% in 1994 to $1,239,317 and 2.7% in 1993 to $1,156,766 from $1,126,094 in 1992. These increases were due to the increases in revenues per patient day, offset in part by the disposition of nursing centers.\nPatient revenues are affected by changes in Medicare and Medicaid reimbursement rates, private pay and other rates charged by Hillhaven, occupancy levels, the nature of services provided and the payor mix. Data for nursing center operations with respect to sources of net patient revenues and patient mix by payor type are set forth below. Included in private and other revenues are per diem amounts received from managed care contracts.\nIn 1994 and 1993, Hillhaven received rate increases from Medicare and Medicaid and increased its private pay rates.\nThe Company is continuing its strategy of improving its quality mix of private pay and Medicare patients by expanding its subacute medical and rehabilitation programs and services. These higher revenue services include physical, occupational, speech and respiratory therapy and subacute care services, such as stroke therapy and wound care. The Company has increased the number of managed care contracts it maintains with insurance companies and other payors to provide subacute medical and rehabilitation care to their insureds, offering a less expensive alternative to acute care hospitals. The average daily number of managed care patients in Hillhaven's nursing centers, including long term care patients, was approximately 435 in 1994 compared to 211 in 1993 and 29 in 1992.\nNet operating revenues from pharmacy operations decreased to $176,178 in 1994 from $179,299 in 1993 and increased from $156,107 in 1992. Pharmacy operations produced operating income before property-related expenses of $25,366 in 1994 (14.4% of net operating revenues), an increase of approximately 8.3% from $23,419 (13.1% of net operating revenues) in 1993, which in turn represented an increase of approximately 5.0% from $22,307 (14.3% of net operating revenues) in 1992. The decrease in revenues in 1994 is the result of the disposition of 61 marginally performing retail outlets in 1994 and late 1993. Institutional revenues, accounting for approximately 76% of pharmacy net operating revenues in 1994, versus 63% in 1993 and 55% in 1992, increased by 17.9% and 31.9% to $133,988 and $113,676 in 1994 and 1993, respectively, from $86,189 in 1992. The growing contribution from institutional operations reflects the Company's increasing focus on the nursing center market, the disposition of retail outlets and continuing pricing pressure in the retail operations. The increase in institutional revenues\nis due to an increase in the number of nursing center beds serviced and higher sales volumes per bed. The increase in per bed sales reflects the Company's strategy of aggressively marketing higher margin ancillary products and services, such as respiratory and intravenous therapies and enteral and urological supplies.\nIn 1993 and 1994, the Company terminated leases of 36 retail outlets in Wal-Mart stores. The leases of the remaining 14 Wal- Mart outlets were terminated in the 1995 first quarter. The termination of these leases is not expected to have a material effect on pharmacy operating income.\nNet operating revenues from retirement housing operations increased to $33,239 in 1994 from $26,765 in 1993 and $21,926 in 1992. These increases were primarily due to improvements in occupancy, which averaged 96.1% in 1994 compared to 92.0% in 1993 and 85.5% in 1992.\nOperating and administrative expenses of the Company's nursing centers increased by 7.1% in 1994 to $1,062,442 and by 1.3% in 1993 to $992,149 from $979,633 in 1992. These increases were attributable primarily to the expansion of subacute and medical rehabilitation services, offset in part by the disposition of nursing centers. Labor and related benefits, which represented approximately 77% of nursing center operating and administrative expenses in 1994, increased by 7.2% in 1994 to $820,065 and by 1.8% in 1993 to $765,276. These increases were the result of general wage rate increases, as well as an increase in the number of therapists and nurses in the Company's nursing centers to accommodate the increase in the number of medically complex patients. Increases in labor and benefit costs in 1994 and 1993 were mitigated by the reduced use of higher-cost contract nurses and favorable results of workers' compensation loss experience as actuarially computed.\nThe increases in the non-labor components of operating and administrative expenses, including ancillary supplies, reflect the higher costs associated with caring for higher acuity patients.\nCombined interest and guarantee fee expense decreased by 11.7% to $59,215 in 1994 due to the refinancing of certain of the Company's indebtedness. See \"The Recapitalization.\" Property- related costs in 1993 were impacted by the purchase of previously leased nursing centers, related increases in debt (discussed below) and the restructuring of the NME leases. As a result of the restructuring of the terms of the NME leases, these leases were recorded as capital leases beginning in December 1991. This increased both property and long-term debt by the aggregate fixed option price of $299,500. Primarily as a result of these transactions, total interest, depreciation and amortization and guarantee fees increased in 1993 by $13,163 and rent expense decreased in 1993 by $14,607.\nInterest income is earned from notes receivable and invested cash. Interest income decreased by 14.8% in 1994 to $13,635 due to lower balances of invested cash and notes receivable.\nInterest income increased by 24.9% to $16,006 in 1993 as a result of an increase of $36,338 in notes receivable arising from the sale of nursing centers.\nAs a result of the refinancing of certain of the Company's industrial revenue bond issues, extraordinary charges of $1,062 and $565 (net of income taxes) were reported in 1994 and 1993, respectively, due to the write-off of previously capitalized financing costs.\nEffective June 1, 1992, Hillhaven adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). Adoption of SFAS 109 resulted in a charge of $1,103 to the 1993 statement of operations. Including the impact of this charge, the effect of the adoption of SFAS 109 in 1993 was a reduction of net income tax expense and an increase in net income of $7,710 as compared to amounts that would have been reported under APB Opinion No. 11. See Note 7 of Notes to Consolidated Financial Statements. The Company has recorded net deferred tax assets of $18,023 at May 31, 1994, the realization of which is dependent upon future pretax earnings.\nStatement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" (SFAS 114), establishes standards to determine in what circumstances a creditor should measure impairment based on either the present value of expected future cash flows related to the loan, the market price of the loan or the fair value of the underlying collateral. SFAS 114 relates to the Company's portfolio of notes receivable. The Company anticipates that the adoption of SFAS 114 on the required application date of June 1, 1995 will not have a material adverse impact on Hillhaven's financial position or results of operations.\nCash Flows and Financial Condition\nHillhaven believes that it will generate sufficient cash to fund operations and meet its debt and lease obligations for the current fiscal year. Cash provided by operations in 1994 totalled $73,526 compared to $65,459 in 1993 and $54,545 in 1992. These increases are due primarily to higher pretax earnings. Working capital at May 31, 1994 amounted to $36,147 compared to $77,870 and $58,951 at May 31, 1993 and 1992, respectively. The decrease in working capital in 1994 is due primarily to a decrease in cash and an increase in the current portion of long-term debt resulting from the Recapitalization. At May 31, 1994, Hillhaven had available $117,000 under short- and long-term revolving lines of credit which allows the Company to maintain lower levels of cash.\nNet cash used in investing activities amounted to $7,777 in 1994 compared to $901 in 1993 and $54,660 in 1992. In connection with the Recapitalization, the Company expended $14,816 for financing costs. On December 31, 1993, Hillhaven completed the sale of 13 nursing centers and received cash for the $15,594 aggregate sales price.\nIn 1993, Hillhaven purchased 62 nursing centers previously leased from NME for an aggregate purchase price of $179,890. The purchase was financed with the proceeds from the sale of $74,750 of 7-3\/4% Convertible Subordinated Debentures due 2002 (the \"Debentures\"), the assumption of underlying debt amounting to $4,825 and NME financing in the amount of $92,256, with the balance settled in cash. The Company also acquired seven previously leased nursing centers from third parties in 1993 for an aggregate purchase price of $26,791. These transactions were partially financed by the assumption of underlying debt and borrowings aggregating $15,095, with the balance settled in cash. During this same period, the Company disposed of 47 nursing centers and a retirement housing facility for an aggregate sales price of $59,355. Hillhaven provided financing for $36,338 of the total sales price and received cash for the balance. In 1992, the Company acquired 24 previously leased nursing centers, of which 20 were purchased from NME, for an aggregate purchase price of $108,951. These transactions were partially financed by the assumption of underlying debt and additional borrowings aggregating $76,212.\nIn 1994, capital expenditures for routine replacements and refurbishment of facilities and capital additions amounted to $43,568 compared to $30,526 in 1993 and $30,597 in 1992. The increase in 1994 is due primarily to the expansion of certain nursing centers to accommodate the growth in subacute and medical rehabilitation programs. Capital expenditures of approximately $50,000 are budgeted for 1995, the majority of which are anticipated to be funded from cash flow from operations.\nNet cash used in financing activities totalled $89,364 in 1994, $37,331 in 1993 and $16,310 in 1992. See \"The Recapitalization.\" In 1993, the Company sold the Debentures, the proceeds of which were used to purchase certain facilities leased from NME which had escalating rent provisions. In 1992, Hillhaven sold its 8-1\/4% Series C Preferred Stock in the amount of $35,000 to NME to repay debt to NME bearing interest at 10%. The Company repaid an additional $61,800 owed to NME with the proceeds from its 1991 Performance Investment Plan.\nIn April 1994, the Company replaced the financing for its accounts receivable-backed liquidity facility with a revolving bank line of credit and increased the facility from $30,000 to $40,000. At May 31, 1994, there were no borrowings outstanding under this credit facility.\nOn February 28, 1994, NME exercised its warrants to purchase 6,000,000 shares of Hillhaven common stock. NME tendered shares of the Company's payable-in-kind Series D Preferred Stock in payment of the $63,300 purchase price. At May 31, 1994, NME owned approximately 32.7% of the Company's outstanding common stock.\nLegislative Action\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 (\"OBRA-93\") was enacted. OBRA-93 contains certain provisions which impact Hillhaven's Medicare reimbursement. For cost report periods beginning after October 1, 1993, a return on equity has been eliminated as a reimbursable item. For federal fiscal years 1994 and 1995, there will be no increases in the limits on reimbursable costs. The Company has and will continue to file for exceptions based on its costs to care for higher acuity patients. Hillhaven expects to offset much of these revenue reductions by containing operating cost increases and increasing the number of patients under managed care contracts. In addition, other provisions in OBRA-93 will benefit Hillhaven, such as the extension of the targeted jobs tax credit. Management believes that the provisions of OBRA-93, in the aggregate, will not have a material adverse impact on the future operations of the Company.\nOn October 27, 1993, President Clinton submitted the American Health Security Act of 1993 (the \"Health Security Act\") to Congress for consideration. The Health Security Act, which is designed to guarantee health coverage to all United States citizens and legal residents and to create regional alliances to negotiate contracts with qualified health plans, is currently being studied by the relevant Congressional committees. At the same time, numerous other health care reform proposals have been introduced by members of the House of Representatives and the Senate. These proposals range from the formation of a single payor system to the creation of health plan purchasing cooperatives to pool the purchasing power of individuals and employees of small businesses, or the formation of purchasing groups to negotiate contracts with health plans and offer them to individuals. These proposals also differ on the treatment of long term care services. Health care reform legislation may or may not be enacted; whether or not any such effect will be beneficial or adverse to the Company cannot be determined at this time.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFinancial Statements are contained on pages through of this report and are incorporated hereby 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 concerning the directors of the Registrant is included on pages 2, 3 and 19 of the definitive Proxy Statement for the Registrant's 1994 Annual Meeting of Stockholders. The required information is hereby incorporated by reference. Similar information regarding executive officers of the Registrant is set forth in Item 1.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe response to this item is included on pages 8 through 15 and 19 through 23 of the definitive Proxy Statement for the Registrant's 1994 Annual Meeting of Stockholders. The required information is hereby incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe response to this item is included on pages 4, 5 and 25 of the definitive Proxy Statement for the Registrant's 1994 Annual Meeting of Stockholders. The required information is hereby incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe response to this item is included on pages 15 through 19 of the definitive Proxy Statement for the Registrant's 1993 Annual Meeting of Stockholders. The required information is hereby incorporated by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Documents filed as part of this report:\n1. Financial Statements. Page\nIndependent Auditors' Report\nConsolidated Balance Sheets -- As of May 31, 1994 and 1993\nConsolidated Statements of Operations -- Years Ended May 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows -- Years Ended May 31, 1994, 1993 and 1992\nConsolidated Statements of Changes in Stockholders' Equity -- Years Ended May 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nQuarterly Financial Summary\n2. Financial Statement Schedules.\nSchedule V Property and Equipment S-1\nSchedule VI Accumulated Depreciation and S-5 Amortization of Property and Equipment\nSchedule VIII Valuation and Qualifying S-6 Accounts\nSchedule X Supplementary Income S-8 Statement Information\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.\n3. Exhibits\nExhibit No. Item\/Document\n(3) Articles of Incorporation and By-Laws\n3.01 Amended and Restated Articles of Incorporation of Hillhaven (Incorporated by reference to Exhibit J to Exhibit 2 to the document referred to in Note 1 below)\n3.02 Amended and Restated By-Laws of Hillhaven\n(4) Instruments Defining the Rights of Security Holders\n4.01 Amended and Restated Articles of Incorporation of Hillhaven (See Exhibit 3.01)\n4.02 Amended and Restated By-Laws of Hillhaven (See Exhibit 3.02)\n4.03 Form of Common Stock Certificate of Hillhaven (Incorporated by reference to Exhibit 4.3 to the document referred to in Note 1 below)\n4.04 Warrant and Registration Rights Agreement among Hillhaven, NME and Manufacturers Hanover Trust Company of California, dated as of January 31, 1990 (Incorporated by reference to Exhibit 4.4 to the document referred to in Note 1 below)\n4.05 Rights Agreement between Hillhaven and Manufacturers Hanover Trust Company of California, dated as of January 31, 1990 (Incorporated by reference to Exhibit 4.6 to the document referred to Note 1 below)\n4.06 Form of Rights Certificate (Incorporated by reference to Exhibit A to Exhibit 4.6 to the document referred to in Note 1 below)\n4.07 Agreement concerning purchase by NME Properties Corp., of Series C Preferred Stock of Hillhaven and prepayment by First Healthcare Corporation of indebtedness to NME Properties Corp. dated at or prior to 11:59 p.m. on November 30, 1991 between NME, NME Properties Corp., Hillhaven and First Healthcare Corporation (Incorporated by reference to Exhibit 4(a) to the document referred to in Note 2 below)\n4.08 Certificate of Designation, Preferences and Rights of Series C Preferred Stock of Hillhaven (Incorporated by reference to Exhibit 4(b) to the document referred to in Note 2 below)\nExhibit No. Item\/Document\n4.09 Certificate of First Amendment to Certificate of Designation, Preferences and Rights of Series C Preferred Stock of The Hillhaven Corporation (Incorporated by reference to Exhibit 4(b) to the document referred to in Note 9 below)\n4.10 Form of Indenture between Hillhaven and Bankers Trust Company, as Trustee with respect to the 7-3\/4% Convertible Subordinated Debentures Due 2002 (Incorporated by reference to Exhibit 4.14 to the document referred to in Note 4 below)\n4.11 Form of 7-3\/4% Convertible Subordinated Debenture Due 2002 (Incorporated by reference to Exhibit 4.15 to the document referred to in Note 4 below)\n4.12 Form of Indenture between Hillhaven and State Street Bank and Trust Company, as Trustee with respect to the 10-1\/8% Senior Subordinated Notes due 2001 (Incorporated by reference to Exhibit 4.01 to the document referred to in Note 5 below)\n4.13 Form of 10-1\/8% Senior Subordinated Note due 2001 (Incorporated by reference to Exhibit 4.02 to the document referred to in Note 5 below)\n4.14 Agreement Concerning Purchase by NME Properties Corp. and Certain Subsidiaries of Series D Preferred Stock of The Hillhaven Corporation, dated as of September 1, 1993 among Hillhaven, First Healthcare Corporation, NME, NME Properties Corp. and certain subsidiaries of NME Properties Corp.\n4.15 Certificate of Designation, Preferences and Rights of Series D Preferred Stock of The Hillhaven Corporation (Incorporated by reference to Exhibit 4(a) to the document referred to in Note 9 below)\n4.16 Certificate Concerning Reverse Stock Split of The Hillhaven Corporation (Incorporated by reference to Exhibit 4(c) to the document referred to in Note 9 below)\n4.17 Credit Agreement dated as of September 2, 1993, between First Healthcare Corporation, as lender, and Hillhaven PIP Funding I, Inc., as borrower (Incorporated by reference to Exhibit 4.07 to the document referred to in Note 8 below)\nExhibit No. Item\/Document\n4.18 The Hillhaven Corporation 1991 Performance Investment Plan (Incorporated by reference to Exhibit 10.24 to the document referred to in Note 1 below)\n4.19 Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stock (Incorporated by reference to Exhibit 4.03 to the document referred to in Note 8 below)\n4.20 Form of Indenture between Hillhaven and Chemical Bank, as Trustee with respect to the Convertible Debentures due May 29, 1999 (Incorporated by reference to Exhibit 4.01 to the document referred to in Note 8 below)\n4.21 Form of Convertible Debenture due May 29, 1999 (Incorporated by reference to Exhibit 4.02 to the document referred to in Note 8 below)\n(10) Material Contracts\n10.01 Services Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.2 to the document referred to in Note 1 below)\n10.02 Tax Sharing Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.3 to the document referred to in Note 1 below)\n10.03 Government Programs Agreement between Hillhaven and NME, dated January 31, 1990 (Incorporated by reference to Exhibit 10.4 to the document referred to in Note 1 below)\n10.04 Insurance Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.5 to the document referred to in Note 1 below)\n*10.05 Employee and Employee Benefits Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.6 to the document referred to in Note 1 below)\n*10.06 Resignation Agreement and General Release between Hillhaven and Richard K. Eamer, dated as of September 15, 1993\n*10.07 Employment Agreement between Hillhaven and Leonard Cohen, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.21 to the document referred to in Note 1 below)\nExhibit No. Item\/Document\n*10.08 Amendment No. One to Employment Agreement between Hillhaven and Leonard Cohen, dated as of May 31, 1994\n*10.09 Severance Agreement among Hillhaven, NME and Christopher J. Marker, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.23 to the document referred to in Note 1 below)\n*10.10 Severance Agreement between Hillhaven and Christopher J. Marker, dated as of May 24, 1994\n*10.11 Form of Severance Agreement between Hillhaven and certain of its officers\n10.12 Form of Indemnification Agreement between Hillhaven and certain of its executive officers (Incorporated by reference to Exhibit 4.8 to the document referred to in Note 1 below)\n*10.13 Hillhaven Directors' Stock Option Plan (Incorporated by reference to Exhibit 10.18 to the document referred to in Note 1 below)\n*10.14 The Hillhaven Corporation Board of Directors Retirement Plan\n*10.15 Hillhaven Deferred Savings Plan (Incorporated by reference to Exhibit 10.11 to the document referred to in Note 1 below)\n*10.16 Hillhaven 1990 Stock Incentive Plan (Incorporated by reference to Exhibit 10.12 to the document referred to in Note 1 below)\n*10.17 Hillhaven Annual Incentive Plan (Incorporated by reference to Exhibit 10.13 to the document referred to in Note 1 below)\n*10.18 Hillhaven Long Term Incentive Plan (Incorporated by reference to Exhibit 10.14 to the document referred to in Note 1 below)\n*10.19 Hillhaven Deferred Compensation Master Plan (Incorporated by reference to Exhibit 10.15 to the document referred to in Note 1 below)\n*10.20 Hillhaven Senior Management Deferred Compensation Plan (Incorporated by reference to Exhibit 10.16 to the document referred to in Note 1 below)\nExhibit No. Item\/Document\n*10.21 First Restatement of the Hillhaven Supplemental Executive Retirement Plan\n*10.22 Hillhaven Individual Retirement Annuity Plan (Incorporated by reference to Exhibit 10.19 to the document referred to in Note 1 below)\n10.23 Form of Assignment and Assumption of Lease Agreement between Hillhaven and certain subsidiaries, on the one hand, and NME and certain subsidiaries on the other hand, together with the related Guaranty by Hillhaven, dated on or prior to January 31, 1990 (Incorporated by reference to Exhibit 10.7 to the document referred to in Note 1 below)\n10.24 Form of Management Agreement between First Healthcare Corporation and certain NME subsidiaries, dated on or prior to January 31, 1990 (Incorporated by reference to Exhibit 10.10 to the document referred to in Note 1 below)\n10.25 Reorganization and Distribution Agreement between Hillhaven and NME, dated as of January 8, 1990, as amended on January 30, 1990 (Incorporated by reference to Exhibit 2.01 to the document referred to in Note 1 below)\n10.26 Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.8 to the document referred to in Note 1 below)\n10.27 First Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of October 30, 1990\n10.28 First Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of May 30, 1991 (Incorporated by reference to Exhibit 10.45 to the document referred to in Note 3 below)\n10.29 Second Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of October 2, 1991 (Incorporated by reference to Exhibit 10.46 to the document referred to in Note 3 below)\nExhibit No. Item\/Document\n10.30 Third Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of April 1, 1992 (Incorporated by reference to Exhibit 10.47 to the document referred to in Note 3 below)\n10.31 Fourth Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of November 12, 1992 (Incorporated by reference to Exhibit 10.13 to the document referred to in Note 6 below)\n10.32 Fifth Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of February 19, 1993 (Incorporated by reference to Exhibit 10.14 to the document referred to in Note 6 below)\n10.33 Sixth Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of May 28, 1993 (Incorporated by reference to Exhibit 10.15 to the document referred to in Note 6 below)\n10.34 Seventh Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of May 28, 1993\n10.35 Eighth Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of September 2, 1993\n10.36 Amended and Restated Loan Agreement among Hillhaven, New Pond Village Associates and BayBank of Boston, N.A., dated as of August 25, 1989 and effective November 1, 1991 (Incorporated by reference to Exhibit 10.52 to the document referred to in Note 3 below)\n10.37 Facility Purchase and Sale Agreements, each dated as of February 12, 1992, between First Healthcare Corporation and Zevco Enterprises, Inc. for the four nursing centers in Houston, Texas (Incorporated by reference to Exhibit 10.41 to the document referred to in Note 3 below)\n10.38 Facility Agreement among First Healthcare Corporation and Certain Limited Partnerships, dated as of April 23, 1992 relating to the sale of 32 nursing centers (Incorporated by reference to Exhibit 10.42 to the document referred to in Note 3 below)\nExhibit No. Item\/Document\n10.39 First Amendment to Facility Agreement among First Healthcare Corporation and Certain Limited Partnerships, dated as of July 31, 1992 relating to the sale of 32 nursing centers (Incorporated by reference to Exhibit 10.43 to the document referred to in Note 3 below)\n10.40 Letter Agreement dated July 14, 1992, concerning acquisition by Hillhaven from NME of 26 nursing centers and two adjacent retirement housing communities (Incorporated by reference to Exhibit 10.49 to the document referred to in Note 3 below)\n10.41 Letter Agreement dated August 4, 1992, between Hillhaven and NME, amending the July 14, 1992 letter agreement concerning acquisition by Hillhaven from NME of 26 nursing centers and two adjacent retirement communities (Incorporated by reference to Exhibit 10.50 to the document referred to in Note 3 below)\n10.42 Letter Agreement dated October 14, 1992, between Hillhaven and NME, amending the July 14, 1992 letter concerning acquisition by Hillhaven from NME of 34 nursing centers and two adjacent retirement housing communities (Incorporated by reference to Exhibit 10.58 to the document referred to in Note 6 below)\n10.43 Purchase and Sale Agreement and Escrow Instructions between First Healthcare Corporation and certain NME subsidiaries, dated as of November 4, 1992 relating to the acquisition of 24 nursing centers (Incorporated by reference to Exhibit 10.59 to the document referred to in Note 6 below)\n10.44 Purchase and Sale Agreement and Escrow Instructions between First Healthcare Corporation and certain NME subsidiaries, dated as of February 1, 1993, relating to the acquisition of 17 nursing centers (Incorporated by reference to Exhibit 10.60 to the document referred to in Note 6 below)\n10.45 Facility Purchase and Sale Agreement, each dated April 1, 1993, between First Healthcare Corporation and Zevco Enterprises, Inc., an Illinois corporation, relating to the sale of 13 nursing centers (Incorporated by reference to Exhibit 10.61 to the document referred to in Note 6 below)\nExhibit No. Item\/Document\n10.46 Purchase and Sale Agreement and Escrow Instructions between First Healthcare Corporation and certain NME subsidiaries, dated as of May 20, 1993 relating to the acquisition of 11 nursing centers (Incorporated by reference to Exhibit 10.62 to the document referred to in Note 6 below)\n10.47 Letter of Intent dated June 22, 1993 between Hillhaven and NME (Incorporated by reference to Exhibit 10.63 to the document referred to in Note 6 below)\n10.48 Credit Agreement dated as of September 1, 1993 among First Healthcare Corporation, The Hillhaven Corporation, the Banks referred to therein, the LC Issuing Banks referred to therein, Morgan Guaranty Trust Company of New York, Chemical Bank and J. P. Morgan Delaware (Incorporated by reference to Exhibit B to the document referred to in Note 7 below)\n10.49 Amendment No. 1 to Credit Agreement, dated as of October 12, 1993, among First Healthcare Corporation, The Hillhaven Corporation, the Banks referred to therein, the LC Issuing Banks referred to therein, Morgan Guaranty Trust Company of New York, Chemical Bank and J. P. Morgan Delaware\n10.50 Amendment No. 2 to Credit Agreement, dated as of December 30, 1993, among First Healthcare Corporation, The Hillhaven Corporation, the Banks referred to therein, the LC Issuing Banks referred to therein, Morgan Guaranty Trust Company of New York, Chemical Bank and J. P. Morgan Delaware\n10.51 Amendment No. 3 to Credit Agreement, dated as of May 27, 1994, among First Healthcare Corporation, The Hillhaven Corporation, the Banks referred to therein, the LC Issuing Banks referred to therein, Morgan Guaranty Trust Company of New York, Chemical Bank and J. P. Morgan Delaware\n10.52 Agreement and Waiver, dated as of September 2, 1993, by and among Hillhaven, First Healthcare Corporation, NME and certain NME subsidiaries\nExhibit No. Item\/Document\n10.53 Novation Agreement among Hillhaven Funding Corporation, Banque Indosuez, New York Branch, Banque Nationale de Paris, San Francisco Agency, Bank of America National Trust and Savings Association and Seattle-First National Bank, dated as of April 29, 1994\n10.54 Amended and Restated Master Sale and Servicing Agreement among Hillhaven Funding Corporation, Hillhaven and certain Hillhaven subsidiaries, dated as of April 29, 1994\n10.55 Amended and Restated Liquidity Agreement between Hillhaven Funding Corporation, Bank of America National Trust and Savings Association and Seattle-First National Bank dated as of April 29, 1994\n(11) Computation of Per Share Earnings\n11.01 Statement re: Computation of Per Share Earnings\n(21) Subsidiaries\n21.01 Subsidiaries of the Registrant\n(23) Consent of Experts and Counsel\n23.01 Consent of Independent Accountants, KPMG Peat Marwick LLP\nNote Reference Document\n1. Quarterly Report on Form 10-Q for the quarter ended November 30, 1989, as amended. 2. Quarterly Report on Form 10-Q for the quarter ended November 30, 1991, as amended. 3. Annual Report on Form 10-K for the year ended May 31, 1992, as amended. 4. Registration Statement on Form S-1 (File No. 33-48755). 5. Registration Statement on Form S-3 (File No. 33-65718). 6. Annual Report on Form 10-K for the year ended May 31, 1993. 7. Current Report on Form 8-K dated September 2, 1993. 8. Registration Statement on Form S-3 (File No. 33-50833). 9. Quarterly Report on Form 10-Q for the quarter ended November 30, 1993.\n___________________\n* Management contracts and compensatory plans or arrangements required to be filed as an Exhibit to comply with Item 14(a)(3).\n(b) Reports filed on Form 8-K:\nNone\nPursuant to the requirements of Section 13 or 15(d) of the 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 HILLHAVEN CORPORATION\nBy: \/s\/ Bruce L. Busby Bruce L. Busby Chief Executive Officer\nDate: August 17, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ Bruce L. Busby Chief Executive August 17, 1994 Bruce L. Busby Officer, Chairman of the Board and Director\n\/s\/ Robert F. Pacquer Senior Vice President August 17, 1994 Robert F. Pacquer and Chief Financial Officer (principal financial officer) \/s\/ Michael B. Weitz Michael B. Weitz Vice President and August 17, 1994 Principal Accounting Officer\n\/s\/ Christopher J. Marker President and August 17, 1994 Christopher J. Marker Director\n\/s\/ Maris Andersons Director August 17, 1994 Maris Andersons\n\/s\/ Walter F. Beran Director August 17, 1994 Walter F. Beran\n\/s\/ Leonard Cohen Director August 17, 1994 Leonard Cohen\n\/s\/ Peter de Wetter Director August 17, 1994 Peter de Wetter\n\/s\/ Dinah Nemeroff Director August 17, 1994 Dinah Nemeroff\n\/s\/ Jack O. Vance Director August 17, 1994 Jack O. Vance\nIndependent Auditors' Report\nThe Board of Directors and Stockholders The Hillhaven Corporation:\nWe have audited the accompanying consolidated balance sheets of The Hillhaven Corporation and subsidiaries (Hillhaven) as of May 31, 1994 and 1993, and the related consolidated statements of operations, cash flows and changes in stockholders' equity for each of the years in the three-year period ended May 31, 1994. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the index on page 34 of this annual report. These consolidated financial statements and financial statement schedules are the responsibility of the management of Hillhaven. 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 aforementioned consolidated financial statements present fairly, in all material respects, the financial position of The Hillhaven Corporation and subsidiaries as of May 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 May 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 7 to the consolidated financial statements, effective June 1, 1992 the Company changed its method of providing for income taxes by adopting Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\nKPMG PEAT MARWICK LLP\nSeattle, Washington July 8, 1994\nThe Hillhaven Corporation And Subsidiaries\nNotes To Consolidated Financial Statements (Dollars in thousands, except per share amounts)\n1. Significant Accounting Policies\nBasis of Presentation. The consolidated financial statements include the accounts of The Hillhaven Corporation and its wholly- owned subsidiaries (\"Hillhaven\" or the \"Company\"). Significant intercompany transactions and balances have been eliminated.\nThe Company completed its facility disposition program in the quarter ended November 30, 1993 (Note 2). Revenues and expenses related to facilities remaining at the end of the disposition period have been reclassified to ongoing operations in the consolidated statements of operations for periods after December 1, 1991. In addition, certain other reclassifications of prior years' amounts have been made to conform to 1994 classifications.\nNet Operating Revenues. Revenues are recognized when services are provided and products are delivered.\nNet operating revenues consist primarily of patient care revenues which are reported at the net amounts realizable from residents, third-party payors and others for services provided. A provision for estimated uncollectible patient accounts and notes receivable is included in operating and administrative expenses and was $8,094, $4,029 and $5,962 for the years ended May 31, 1994, 1993 and 1992, respectively.\nApproximately 73%, 73% and 72% of net patient care revenues for the years ended May 31, 1994, 1993 and 1992, respectively, are from participation of the nursing centers in Medicare and Medicaid programs. Revenues under these programs are subject to audit and retroactive adjustment. Provisions for estimated third-party payor settlements are provided in the period the related services are rendered and are adjusted as final settlements are determined. Accounts receivable from Medicare and Medicaid amounted to $16,189 and $64,022, respectively, at May 31, 1994, and $15,520 and $63,006, respectively, at May 31, 1993.\nNet operating revenues also include revenues from pharmacy operations of $176,178, $179,299 and $156,107 for the years ended May 31, 1994, 1993 and 1992, respectively.\nInventories. Inventories, which are stated at the lower of cost (first-in, first-out) or market, are comprised of the following:\nProperty and Equipment. Owned land, buildings, leasehold improvements and equipment are stated at cost. Capitalized leases are stated at the lower of the present value of minimum lease payments or fair value at the inception of the lease. Depreciation and amortization are computed using the straight- line method over the useful lives of the assets, estimated as follows: buildings, 20-45 years; leasehold improvements and certain capitalized leases, over the lesser of the estimated useful life or the lease term; and equipment, 5-10 years.\nFair Value of Financial Instruments. Statement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments\", requires that Hillhaven disclose estimated fair values for its financial instruments. The estimated fair values have been determined by the Company using available market information and appropriate valuation methodologies. Because no market exists for a significant portion of Hillhaven's financial instruments, considerable judgment is necessarily required in interpreting the data to develop the estimates of fair value. The use of different market assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nThe carrying amounts of cash equivalents, accounts receivable and accounts payable approximate fair value because of the short maturity of these instruments. The fair value estimates for notes receivable (Note 3) and long-term debt (Note 6) are based on information available to the Company as of May 31, 1994.\nIntangible Assets. Costs incurred in obtaining long-term financing are amortized over the terms of the related indebtedness, primarily using the straight-line method. Costs related to the acquisition of leases are amortized using the straight-line method over the lease term.\nHillhaven recorded extraordinary charges of $1,543 ($1,062 net of tax) and $743 ($565 net of tax) for the years ended May 31, 1994 and 1993, respectively, primarily in connection with the early retirement of industrial revenue bonds which were refinanced.\nIncome (Loss) Per Share. Primary income (loss) per share is calculated by dividing net income (loss), after deducting dividends on preferred stock, by the weighted average number of common shares and equivalents outstanding for the period. Common stock equivalents are stock purchase warrants and employee stock\noptions. Fully diluted income per share further assumes conversion of the Company's convertible debentures. Conversion of the debentures was not assumed for the 1993 calculation because the exercise prices of the debentures exceeded the market price at May 31, 1993. Common stock equivalents were not included in the 1992 calculation of loss per share as their effect was anti-dilutive. All share and per share data have been restated for a one-for-five reverse stock split effective November 1, 1993.\nCash Equivalents. Highly liquid investments with maturities of three months or less at the date of acquisition are considered cash equivalents. Interest earned on these investments amounted to $1,027, $911 and $1,024 for the years ended May 31, 1994, 1993 and 1992, respectively.\n2. Restructuring Plan\nOn December 5, 1991, Hillhaven announced a restructuring plan designed to improve its long-term financial strength and operating performance. The plan included the disposition of 82 nursing centers over an estimated 24-month period. In the second quarter of fiscal 1992, the Company recorded a $90,000 pretax charge, comprised of $25,700 for the projected losses from operations of the 82 nursing centers during the disposition period and $64,300 for estimated losses from the dispositions. Also as part of the restructuring, Hillhaven exercised options to purchase nine nursing centers leased from National Medical Enterprises, Inc. (NME), modified terms of the remaining leases with NME and sold preferred stock to NME in the amount of $35,000, the proceeds of which were used to prepay debt owed to NME (Note 8).\nAs of November 30, 1993, the Company had completed the disposition of 50 of these nursing centers, as well as three retirement housing facilities which, prior to March 1, 1992, had been recorded as discontinued operations. During the three months ended November 30, 1993, the Company reviewed its asset disposition program. Because of improvements in reimbursement rates and results of operations, the Company decided not to pursue the sales of the remaining nursing centers and a retirement housing facility. In addition, several parcels of land which had been held for development have been reclassified to other noncurrent assets. Assets related to the Company's restructuring program were as follows:\nAccrued loss reserves remaining at the date of reinstatement were comprised of $17,668 for losses from operations and $36,882 for estimated future losses on sale. Pretax losses charged to the reserve were as follows:\nRevenues and expenses related to the 32 nursing centers and other properties previously held for disposition have been reclassified to ongoing operations in the consolidated statements of operations for all periods presented. Total revenues and expenses of these facilities were as follows:\nNet assets of these facilities as of September 1, 1993, less adjustments to asset carrying values and remaining accrued restructuring costs aggregating $32,646, have been reclassified from net assets held for disposition to appropriate balance sheet accounts.\nOn December 31, 1993, Hillhaven completed the sale of 13 nursing centers for an aggregate sales price of $15,594. Nine of these nursing centers had previously been held for disposition. The sale resulted in a gain of $5,102, which is included in net operating revenues.\n3. Notes Receivable\nNotes receivable consist primarily of notes originated upon the sale of nursing centers to third parties. Generally the notes receivable are secured by mortgages and deeds of trust on the properties sold. Notes receivable, net of the allowance for doubtful accounts, totalled $87,921 and $115,978 as of May 31, 1994 and 1993, respectively.\nThe aggregate estimated fair value of notes receivable was $91,084 and $114,855 at May 31, 1994 and 1993, respectively. The fair value of performing notes is calculated by discounting the projected cash flows using estimated market discount rates that reflect the credit and interest rate risk inherent in the notes and using specific borrower information. Fair values for nonperforming notes (notes delinquent more than 90 days) and notes with no set maturity are determined based on individual circumstances and are valued net of specific reserves.\n4. Investments In Unconsolidated Partnerships\nHillhaven has ownership interests ranging from 35% to 50% in a number of unconsolidated general and limited partnerships. These investments are accounted for by the equity method and are included in other noncurrent assets. All of these partnerships own or lease real and personal property and operate nursing centers or retirement housing communities. Combined summarized unaudited financial information for these partnerships is as follows:\nHillhaven manages seven nursing centers and one retirement housing community for partnerships in which the Company has an equity interest. Management fees earned are usually based upon a percentage of revenues, ranging from 5% to 9%.\n5. Property And Equipment\nProperty and equipment at May 31 is comprised of the following:\nProperty and equipment includes buildings acquired under capital leases of $1,997 at May 31, 1994. At May 31, 1993, capitalized lease assets were comprised of: land, $11,105; buildings, $119,056; and equipment, $7,236. Related accumulated depreciation and amortization amounted to $1,776 and $9,401 at May 31, 1994 and 1993, respectively.\n6. Long-Term Debt\nThe Recapitalization. In September 1993, Hillhaven completed a recapitalization plan (the \"Recapitalization\") which included the modification of the Company's relationship with NME (Note 8) to (i) purchase 23 nursing centers leased from NME for a purchase price of $111,800, (ii) repay all existing debt to NME in the aggregate principal amount of $147,202, (iii) release NME guarantees on approximately $400,000 of debt, (iv) limit the annual fee payable to NME to 2% of the remaining amount guaranteed and (v) amend existing agreements to eliminate obligations of NME to provide additional financing to the\nCompany. The Recapitalization was financed through (i) the issuance to NME of $120,000 of payable-in-kind Series D Preferred Stock, (ii) the incurrence of a $175,000 term loan under a secured credit facility with a syndicate of banks, (iii) the issuance of $175,000 of 10-1\/8% Senior Subordinated Notes due 2001, (iv) borrowings of $30,000 under an accounts receivable- backed credit facility and (v) the use of approximately $39,000 of cash.\nLong-term debt at May 31 is comprised of the following:\nHillhaven participates in a $40,000 accounts receivable-backed credit facility whereby eligible Medicaid receivables of selected nursing centers are sold to a wholly-owned subsidiary of Hillhaven, formed specifically for the purpose of such transactions. The purchase of receivables by the subsidiary may be financed by a bank line of credit with interest payable at either LIBOR plus 3\/4% or the lenders' cost of funds. At May 31, 1994, the subsidiary had total assets of approximately $65,378, which cannot be used to satisfy claims against Hillhaven or any of its subsidiaries.\nCertain loan agreements have, among other requirements, restrictions on cash dividends, investments and borrowings and require maintenance of specified operating ratios, levels of working capital and net worth. Management believes that Hillhaven is in compliance with all material covenants. There are no compensating balance requirements for any of the credit lines or borrowings.\nFuture maturities of long-term debt are as follows:\nThe fair value of the Company's long-term borrowings at May 31, 1994 and 1993, excluding capitalized lease obligations, is estimated to be $638,751 and $702,317 based on quoted market prices or by discounting future cash flows at current rates offered to the Company for debt of comparable types and maturities.\n7. Income Taxes\nEffective June 1, 1992, Hillhaven adopted Statement of Financial Accounting Standards No. 109 , \"Accounting for Income Taxes\" (\"SFAS 109\"). The implementation of SFAS 109 changes the Company's method of accounting for income taxes from the deferred method of APB Opinion No. 11 (\"APB 11\") to an asset and liability approach. 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.\nDeferred 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.\nPursuant to the deferred method under APB 11, which was applied in fiscal 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. Under the deferred method, deferred taxes were not adjusted for subsequent changes in tax rates.\nAdoption of SFAS 109 resulted in a charge of $1,103 to the 1993 statement of operations as the cumulative effect of a change in accounting principle. Including the impact of this charge, the effect on the year ended May 31, 1993 of the adoption of SFAS 109 was a reduction of net income tax expense and an increase in net income of $7,710 as compared to amounts that would have been reported under APB 11.\nIncome tax (expense) benefit on income (loss) from operations before income taxes, reinstatement of discontinued operations, extraordinary charge and cumulative effect of accounting change consists of the following amounts:\nAn analysis of Hillhaven's effective income tax rate is as follows:\nUnder APB 11, deferred income tax (expense) benefits were created by timing differences in the recognition of revenues and expenses for tax and financial statement purposes. Deferred income tax (expense) benefit for the year ended May 31, 1992 was comprised of the following:\nThe tax effects of temporary differences that give rise to significant portions of the federal and state deferred tax assets (liabilities) are comprised of the following:\nThe decrease in the valuation allowance for deferred tax assets of $1,090 was attributable to taxable income earned in the year ended May 31, 1994 and, to a lesser extent, an increase in the estimate of future income to be earned. For the Company to realize its net deferred tax assets, it must continue to achieve future pretax earnings. Although the Company believes such pretax earnings will be achieved, a lack of earnings could result in an increased provision for income taxes.\nAs of May 31, 1994, Hillhaven had $5,296 of targeted jobs tax credits which expire between May 31, 2006 and May 31, 2009.\nThe Tax Reform Act of 1986 enacted an alternative minimum tax system for corporations. The alternative minimum tax is assessed at a rate of 20% on Hillhaven's alternative minimum taxable income. Alternative minimum taxable income is determined by making statutory adjustments to the Company's regular taxable income. For the years ended May 31, 1994 and 1993, utilization of regular tax credits was limited by alternative minimum tax expense of $11,043 and $5,400, respectively. For the years ended May 31, 1994, 1993 and 1992, regular income tax expense (before utilization of tax credits) exceeded the alternative minimum tax expense and resulted in the utilization of tax credits of $6,780, $915, and $123, respectively.\n8. Transactions with NME\nLending and Related Agreements. In connection with the spin-off from NME in January 1990 (the \"Spin-off\"), Hillhaven entered into certain financial arrangements with its former parent company. Hillhaven issued unsecured notes to NME in the aggregate amount of $145,859. The Company used the proceeds from the sale of both the 8-1\/4% Series C Preferred Stock to NME and the PIP Debentures to repay $96,800 of these notes (Notes 2 and 6). As of May 31, 1993, one of the notes had been paid in full, and the outstanding indebtedness on the remaining note was $49,059. NME also provided mortgage financing to Hillhaven on certain nursing centers purchased by the Company from NME. At May 31, 1993, $98,156 was outstanding under these arrangements. In fiscal 1994, Hillhaven repaid all of the NME notes in the aggregate principal amount of $147,202 with proceeds from the Recapitalization. The Company also repaid debt which was guaranteed by NME in the aggregate amount of $266,737 (Note 6).\nInterest expense on NME notes totalled $3,696, $7,061 and $12,345 for the years ended May 31, 1994, 1993 and 1992.\nGuarantee Reimbursement Agreement. NME and Hillhaven entered into a guarantee reimbursement agreement providing for the payment by Hillhaven of a fee in consideration of NME's guarantee of certain Hillhaven obligations. At May 31, 1994 and 1993, an aggregate total of approximately $279,000 and $699,000, respectively, of long-term debt (Note 6), leases (Note 9) and contingent liabilities (Note 11) were subject to this agreement. In addition, NME guarantees $7,057 of Hillhaven debt and leases for which Hillhaven is not charged a guarantee fee.\nInsurance. Through May 31, 1994, substantially all of the professional and general liability risks of Hillhaven were insured by an insurance company which is owned by NME. Such insurance expense amounted to $7,627, $7,344 and $6,025 for the years ended May 31, 1994, 1993 and 1992, respectively. Beginning June 1, 1994, Hillhaven obtained separate coverage for its professional and general liability exposure.\nLeases. At the time of the Spin-off, Hillhaven leased 115 nursing centers from NME. During the three years ended May 31, 1993, the Company purchased 92 of the leased nursing centers for an aggregate purchase price of $346,900. At May 31, 1993, Hillhaven leased 23 nursing centers from NME which were recorded as capital leases at the aggregate purchase option price of $135,400. As part of the Recapitalization (Note 6), the Company purchased the remaining 23 nursing centers leased from NME for an aggregate purchase price of $111,800. Interest expense on the NME leases for the years ended May 31, 1994 and 1993 and the six months ended May 31, 1992 amounted to $3,401, $19,889 and $12,825, respectively. Rent expense on NME leases for the six months ended November 30, 1991 amounted to $15,117.\nHillhaven is leasing certain nursing centers from Health Care Property Partners, a joint venture in which NME has a minority interest. Lease payments to this joint venture amounted to $9,923, $9,699 and $9,507 for the years ended May 31, 1994, 1993 and 1992, respectively.\nEquity Ownership. On November 30, 1991, NME purchased 35,000 shares of Hillhaven's 8-1\/4% cumulative nonvoting Series C Preferred Stock. The proceeds, $35,000, were used to reduce notes payable to NME. NME is entitled to a cumulative dividend, payable quarterly, at the annual rate of 8-1\/4% of the $35,000 liquidation value. The Series C Preferred Stock is redeemable at the option of the Company at any time, in whole or in part.\nIn connection with the Recapitalization, Hillhaven issued to NME $120,000 of cumulative nonvoting payable-in-kind Series D Preferred Stock. On February 28, 1994, NME tendered shares of the Series D Preferred Stock in the amount of $63,300 in order to exercise its warrants to purchase 6,000,000 shares of Hillhaven common stock.\nNME is entitled to receive cumulative quarterly dividends on the Series D Preferred Stock at an annual rate of 6-1\/2% of the liquidation value which, as of May 31, 1994, was $60,546. The dividends are payable in additional shares of Series D Preferred Stock, compounded annually, until September 1998, when the dividends will be paid in cash. The Company may, at its option, redeem the Series D Preferred Stock at any time, in whole or in part, subject to restrictions included in certain loan agreements.\nManagement Agreement. Hillhaven provides management, consulting and advisory services in connection with the operation of seven nursing centers owned or leased by NME or its subsidiaries. In return for such services, Hillhaven receives a management fee and is reimbursed for certain costs and expenses. Hillhaven earned $2,543, $2,440 and $2,300 for such services during fiscal 1994, 1993 and 1992, respectively. Management fees receivable from NME amounted to $610 at May 31, 1994 and $545 at May 31, 1993.\n9. Leases\nAs of May 31, 1994, Hillhaven leases 122 nursing centers, 78 of which are operated by the Company. Most lease agreements cover periods from 10 to 20 years and contain renewal options of 5 to 40 years. Hillhaven's pharmacy outlets are leased under terms generally ranging from three to five years with three-year renewal options.\nMinimum lease payments under noncancelable leases and related sublease income are as follows:\nRent expense under operating leases is as follows:\n10. Benefit Plans\nHillhaven's 1990 Stock Incentive Plan (the \"1990 Plan\") provides for incentive stock option, nonqualified stock option, restricted stock, stock appreciation right and cash bonus awards to certain executive officers and other key employees of Hillhaven. Incentive stock options are granted at an exercise price equal to the fair market value of the shares on the date of grant, and nonqualified stock options are granted at an exercise price of not less than 50% of fair market value on the date of grant. Restricted shares are issued at no cost to the employee, and restrictions on such shares generally lapse over five years from the date of the award as long as the employee continues to be employed by Hillhaven.\nIn addition, Hillhaven has replaced its long-term cash bonus plan with performance share awards (\"Performance Shares\") under the 1990 Plan. The Compensation Committee of the Board of Directors identified key management employees who are eligible to receive Performance Shares. Performance Shares represent potential rights to receive common stock based upon the Company achieving specified financial targets over a three-year period. Subject to the Compensation Committee's sole discretion to award all or any\nportion of the Performance Shares, participants may receive shares of common stock based upon actual performance in relation to the financial targets.\nThe fair market value on the date of award of restricted shares and the excess of the fair market value of the Hillhaven shares on the date of grant of nonqualified stock options over the exercise price represents compensation which is deferred and charged to operations as the forfeiture restrictions lapse and as the nonqualified options vest. An estimate of the fair market value of Performance Shares expected to be awarded also represents compensation and is deferred and charged to operations over a three-year period. Unearned compensation is recorded as a deduction from stockholders' equity. No stock appreciation rights or cash bonuses have been awarded under the 1990 Plan. At May 31, 1994, there were 2,401,629 shares of common stock available under the 1990 Plan for future awards.\nHillhaven also has a Directors' Stock Option Plan for directors who are not employees of Hillhaven and are not eligible to participate in the 1990 Plan. Nonstatutory options to purchase 2,000 shares of common stock are granted each year to each qualified director at the fair market value of the shares on the date of grant.\nInformation regarding stock option plans follows:\nShares of common stock issued in the last three fiscal years in connection with employee and director compensation and benefit plans were 97,785 in 1994, 135,079 in 1993 and 134,345 in 1992. Restricted shares forfeited and retired in the last three fiscal years were 16,000 in 1994, 39,670 in 1993 and 37,915 in 1992.\nHillhaven maintains defined contribution retirement plans covering substantially all full-time employees, whereby employee contributions to the plans are matched by Hillhaven up to certain limits. Defined contribution pension expense totalled $3,938, $4,556 and $3,812 for the years ended May 31, 1994, 1993 and 1992, respectively.\nHillhaven also maintains supplemental retirement plans covering outside directors, executive officers and certain other management employees under which benefits are determined based primarily upon the participants' compensation and length of service to the Company. Expense under these plans amounted to $730, $262 and $393 for the years ended May 31, 1994, 1993 and 1992, respectively. Accrued benefits under the plans amounted to $2,518 and $1,829 at May 31, 1994 and 1993, respectively, and are included in other long-term liabilities.\n11. Commitments And Contingencies\nHillhaven is contingently liable at May 31, 1994 for $34,099 primarily as a guarantor of indebtedness of partnerships in which Hillhaven has an ownership interest (Note 4) or with which it has a management agreement. It is not practicable to estimate the fair value of these off-balance sheet obligations. NME has guaranteed $16,421 of these obligations for which Hillhaven has agreed to indemnify NME under the terms of the Guarantee Reimbursement Agreement (Note 8).\nThe Company maintains insurance coverage for its workers compensation exposure. The estimated liability for retrospective workers compensation premiums (included in other accrued liabilities and other long-term liabilities) is based on actuarially projected estimates discounted at an 8.4% average rate to their present value, which amounted to $8,619 at May 31, 1994 and $16,805 at May 31, 1993.\nHillhaven is subject to various claims and lawsuits in the ordinary course of business which are covered by insurance or adequately provided for in Hillhaven's financial statements. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on Hillhaven's financial condition.\n12. Statements of Cash Flows\nSupplemental disclosures of cash flow information are as follows:\n[FN]\n(1) 1992 additions include the purchase of 24 previously leased nursing centers and one retirement housing facility: land, $7,420; buildings, $95,088; and equipment, $7,397. Total consideration for the purchase included debt totaling $76,212. Additions also include the capitalization of 76 leases: land, $28,983; buildings, $251,031; and equipment, $19,486, as part of the restructuring transaction as described in Note 2 of Notes to Consolidated Financial Statements.\n(2) a. Reclassification to net assets held for disposition as part of restructuring transaction: land, $(8,473); buildings $(83,467); leasehold improvements, $(10,963); equipment, $(26,820); and construction in progress, $(261). The restructuring is described in Note 2 of Notes to Consolidated Financial Statements\nReinstatement of discontinued operations: land, $11,309; building, $74,437; leasehold improvements, $127; and equipment, $5,818.\nConsolidation of previously unconsolidated investee: land, $1, building, $5,611; and equipment, $561. Adjustment to basis of retirement housing property: land $(24); building, $(1,315); and equipment, $(35).\nb. Reclassification to other property and equipment accounts.\nc. Purchase of nursing centers, previously recorded as capitalized leases: land $17,303; buildings $131,095; and equipment $11,902. Adjustment to building ($1,486) in connection with purchase of partnership interests.\nReclassification to other property and equipment accounts.\nd. Purchase of 23 nursing centers and two retirement housing facilities previously recorded as capitalized leases: land, $11,105; buildings, $117,059; and equipment, $7,236. Discount on purchase of nursing centers, previously recorded as capitalized leases: land, $(197); buildings, $(22,880); and equipment, $(523). Reclassification of leasehold improvements to buildings in connection with the acquisition of previously leased nursing centers, $4,048.\nConsolidation of a previously unconsolidated investee: land, $989; buildings, $7,874; and equipment, $396.\n[FN]\nEffect of reinstatement of assets held for disposition: land, $6,876; buildings, $47,042; leasehold improvements, $1,061; equipment, $12,722; and construction in progress, $347.\nReclassification to other property and equipment accounts.\nThe annual provision for depreciation and amortization is computed using the straight-line method over the following useful lives: 20 to 45 years for buildings and improvements, 5 to 10 years for equipment and the lesser of the estimated useful life or the lease term for leasehold improvements and certain capital leases.\n[FN]\n(1) Write-off of accounts and notes receivable.\n(2) Effect of reinstatement of discontinued operations.\n(3) Elimination of loss reserve upon reinstatement of discontinued operations.\n(4) Operating losses related to nursing centers and retirement housing facilities held for disposition were charged to the reserve. See Note 2 of Notes to Consolidated Financial Statements.\n(5) Provision related to nursing centers and retirement housing facilities held for disposition was charged to the reserve for loss on assets held for disposition.\n(6) Elimination of loss reserve upon reinstatement of assets held for disposition.\nINDEX TO EXHIBITS\nExhibit No. Item\/Document\n(3) Articles of Incorporation and By-Laws\n3.01 Amended and Restated Articles of Incorporation of Hillhaven (Incorporated by reference to Exhibit J to Exhibit 2 to the document referred to in Note 1 below)\n3.02 Amended and Restated By-Laws of Hillhaven\n(4) Instruments Defining the Rights of Security Holders\n4.01 Amended and Restated Articles of Incorporation of Hillhaven (See Exhibit 3.01)\n4.02 Amended and Restated By-Laws of Hillhaven (See Exhibit 3.02)\n4.03 Form of Common Stock Certificate of Hillhaven (Incorporated by reference to Exhibit 4.3 to the document referred to in Note 1 below)\n4.04 Warrant and Registration Rights Agreement among Hillhaven, NME and Manufacturers Hanover Trust Company of California, dated as of January 31, 1990 (Incorporated by reference to Exhibit 4.4 to the document referred to in Note 1 below)\n4.05 Rights Agreement between Hillhaven and Manufacturers Hanover Trust Company of California, dated as of January 31, 1990 (Incorporated by reference to Exhibit 4.6 to the document referred to Note 1 below)\n4.06 Form of Rights Certificate (Incorporated by reference to Exhibit A to Exhibit 4.6 to the document referred to in Note 1 below)\n4.07 Agreement concerning purchase by NME Properties Corp., of Series C Preferred Stock of Hillhaven and prepayment by First Healthcare Corporation of indebtedness to NME Properties Corp. dated at or prior to 11:59 p.m. on November 30, 1991 between NME, NME Properties Corp., Hillhaven and First Healthcare Corporation (Incorporated by reference to Exhibit 4(a) to the document referred to in Note 2 below)\n4.08 Certificate of Designation, Preferences and Rights of Series C Preferred Stock of Hillhaven (Incorporated by reference to Exhibit 4(b) to the document referred to in Note 2 below)\nExhibit No. Item\/Document\n4.09 Certificate of First Amendment to Certificate of Designation, Preferences and Rights of Series C Preferred Stock of The Hillhaven Corporation (Incorporated by reference to Exhibit 4(b) to the document referred to in Note 9 below)\n4.10 Form of Indenture between Hillhaven and Bankers Trust Company, as Trustee with respect to the 7-3\/4% Convertible Subordinated Debentures Due 2002 (Incorporated by reference to Exhibit 4.14 to the document referred to in Note 4 below)\n4.11 Form of 7-3\/4% Convertible Subordinated Debenture Due 2002 (Incorporated by reference to Exhibit 4.15 to the document referred to in Note 4 below)\n4.12 Form of Indenture between Hillhaven and State Street Bank and Trust Company, as Trustee with respect to the 10-1\/8% Senior Subordinated Notes due 2001 (Incorporated by reference to Exhibit 4.01 to the document referred to in Note 5 below)\n4.13 Form of 10-1\/8% Senior Subordinated Note due 2001 (Incorporated by reference to Exhibit 4.02 to the document referred to in Note 5 below)\n4.14 Agreement Concerning Purchase by NME Properties Corp. and Certain Subsidiaries of Series D Preferred Stock of The Hillhaven Corporation, dated as of September 1, 1993 among Hillhaven, First Healthcare Corporation, NME, NME Properties Corp. and certain subsidiaries of NME Properties Corp.\n4.15 Certificate of Designation, Preferences and Rights of Series D Preferred Stock of The Hillhaven Corporation (Incorporated by reference to Exhibit 4(a) to the document referred to in Note 9 below)\n4.16 Certificate Concerning Reverse Stock Split of The Hillhaven Corporation (Incorporated by reference to Exhibit 4(c) to the document referred to in Note 9 below)\n4.17 Credit Agreement dated as of September 2, 1993, between First Healthcare Corporation, as lender, and Hillhaven PIP Funding I, Inc., as borrower (Incorporated by reference to Exhibit 4.07 to the document referred to in Note 8 below)\nExhibit No. Item\/Document\n4.18 The Hillhaven Corporation 1991 Performance Investment Plan (Incorporated by reference to Exhibit 10.24 to the document referred to in Note 1 below)\n4.19 Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stock (Incorporated by reference to Exhibit 4.03 to the document referred to in Note 8 below)\n4.20 Form of Indenture between Hillhaven and Chemical Bank, as Trustee with respect to the Convertible Debentures due May 29, 1999 (Incorporated by reference to Exhibit 4.01 to the document referred to in Note 8 below)\n4.21 Form of Convertible Debenture due May 29, 1999 (Incorporated by reference to Exhibit 4.02 to the document referred to in Note 8 below)\n(10) Material Contracts\n10.01 Services Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.2 to the document referred to in Note 1 below)\n10.02 Tax Sharing Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.3 to the document referred to in Note 1 below)\n10.03 Government Programs Agreement between Hillhaven and NME, dated January 31, 1990 (Incorporated by reference to Exhibit 10.4 to the document referred to in Note 1 below)\n10.04 Insurance Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.5 to the document referred to in Note 1 below)\n*10.05 Employee and Employee Benefits Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.6 to the document referred to in Note 1 below)\n*10.06 Resignation Agreement and General Release between Hillhaven and Richard K. Eamer, dated as of September 15, 1993\n*10.07 Employment Agreement between Hillhaven and Leonard Cohen, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.21 to the document referred to in Note 1 below)\nExhibit No. Item\/Document\n*10.08 Amendment No. One to Employment Agreement between Hillhaven and Leonard Cohen, dated as of May 31, 1994\n*10.09 Severance Agreement among Hillhaven, NME and Christopher J. Marker, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.23 to the document referred to in Note 1 below)\n*10.10 Severance Agreement between Hillhaven and Christopher J. Marker, dated as of May 24, 1994\n*10.11 Form of Severance Agreement between Hillhaven and certain of its officers\n10.12 Form of Indemnification Agreement between Hillhaven and certain of its executive officers (Incorporated by reference to Exhibit 4.8 to the document referred to in Note 1 below)\n*10.13 Hillhaven Directors' Stock Option Plan (Incorporated by reference to Exhibit 10.18 to the document referred to in Note 1 below)\n*10.14 The Hillhaven Corporation Board of Directors Retirement Plan\n*10.15 Hillhaven Deferred Savings Plan (Incorporated by reference to Exhibit 10.11 to the document referred to in Note 1 below)\n*10.16 Hillhaven 1990 Stock Incentive Plan (Incorporated by reference to Exhibit 10.12 to the document referred to in Note 1 below)\n*10.17 Hillhaven Annual Incentive Plan (Incorporated by reference to Exhibit 10.13 to the document referred to in Note 1 below)\n*10.18 Hillhaven Long Term Incentive Plan (Incorporated by reference to Exhibit 10.14 to the document referred to in Note 1 below)\n*10.19 Hillhaven Deferred Compensation Master Plan (Incorporated by reference to Exhibit 10.15 to the document referred to in Note 1 below)\n*10.20 Hillhaven Senior Management Deferred Compensation Plan (Incorporated by reference to Exhibit 10.16 to the document referred to in Note 1 below)\nExhibit No. Item\/Document\n*10.21 First Restatement of the Hillhaven Supplemental Executive Retirement Plan\n*10.22 Hillhaven Individual Retirement Annuity Plan (Incorporated by reference to Exhibit 10.19 to the document referred to in Note 1 below)\n10.23 Form of Assignment and Assumption of Lease Agreement between Hillhaven and certain subsidiaries, on the one hand, and NME and certain subsidiaries on the other hand, together with the related Guaranty by Hillhaven, dated on or prior to January 31, 1990 (Incorporated by reference to Exhibit 10.7 to the document referred to in Note 1 below)\n10.24 Form of Management Agreement between First Healthcare Corporation and certain NME subsidiaries, dated on or prior to January 31, 1990 (Incorporated by reference to Exhibit 10.10 to the document referred to in Note 1 below)\n10.25 Reorganization and Distribution Agreement between Hillhaven and NME, dated as of January 8, 1990, as amended on January 30, 1990 (Incorporated by reference to Exhibit 2.01 to the document referred to in Note 1 below)\n10.26 Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of January 31, 1990 (Incorporated by reference to Exhibit 10.8 to the document referred to in Note 1 below)\n10.27 First Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of October 30, 1990\n10.28 First Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of May 30, 1991 (Incorporated by reference to Exhibit 10.45 to the document referred to in Note 3 below)\n10.29 Second Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of October 2, 1991 (Incorporated by reference to Exhibit 10.46 to the document referred to in Note 3 below)\nExhibit No. Item\/Document\n10.30 Third Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of April 1, 1992 (Incorporated by reference to Exhibit 10.47 to the document referred to in Note 3 below)\n10.31 Fourth Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of November 12, 1992 (Incorporated by reference to Exhibit 10.13 to the document referred to in Note 6 below)\n10.32 Fifth Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of February 19, 1993 (Incorporated by reference to Exhibit 10.14 to the document referred to in Note 6 below)\n10.33 Sixth Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of May 28, 1993 (Incorporated by reference to Exhibit 10.15 to the document referred to in Note 6 below)\n10.34 Seventh Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of May 28, 1993\n10.35 Eighth Amendment to Guarantee Reimbursement Agreement between Hillhaven and NME, dated as of September 2, 1993\n10.36 Amended and Restated Loan Agreement among Hillhaven, New Pond Village Associates and BayBank of Boston, N.A., dated as of August 25, 1989 and effective November 1, 1991 (Incorporated by reference to Exhibit 10.52 to the document referred to in Note 3 below)\n10.37 Facility Purchase and Sale Agreements, each dated as of February 12, 1992, between First Healthcare Corporation and Zevco Enterprises, Inc. for the four nursing centers in Houston, Texas (Incorporated by reference to Exhibit 10.41 to the document referred to in Note 3 below)\n10.38 Facility Agreement among First Healthcare Corporation and Certain Limited Partnerships, dated as of April 23, 1992 relating to the sale of 32 nursing centers (Incorporated by reference to Exhibit 10.42 to the document referred to in Note 3 below)\nExhibit No. Item\/Document\n10.39 First Amendment to Facility Agreement among First Healthcare Corporation and Certain Limited Partnerships, dated as of July 31, 1992 relating to the sale of 32 nursing centers (Incorporated by reference to Exhibit 10.43 to the document referred to in Note 3 below)\n10.40 Letter Agreement dated July 14, 1992, concerning acquisition by Hillhaven from NME of 26 nursing centers and two adjacent retirement housing communities (Incorporated by reference to Exhibit 10.49 to the document referred to in Note 3 below)\n10.41 Letter Agreement dated August 4, 1992, between Hillhaven and NME, amending the July 14, 1992 letter agreement concerning acquisition by Hillhaven from NME of 26 nursing centers and two adjacent retirement communities (Incorporated by reference to Exhibit 10.50 to the document referred to in Note 3 below)\n10.42 Letter Agreement dated October 14, 1992, between Hillhaven and NME, amending the July 14, 1992 letter concerning acquisition by Hillhaven from NME of 34 nursing centers and two adjacent retirement housing communities (Incorporated by reference to Exhibit 10.58 to the document referred to in Note 6 below)\n10.43 Purchase and Sale Agreement and Escrow Instructions between First Healthcare Corporation and certain NME subsidiaries, dated as of November 4, 1992 relating to the acquisition of 24 nursing centers (Incorporated by reference to Exhibit 10.59 to the document referred to in Note 6 below)\n10.44 Purchase and Sale Agreement and Escrow Instructions between First Healthcare Corporation and certain NME subsidiaries, dated as of February 1, 1993, relating to the acquisition of 17 nursing centers (Incorporated by reference to Exhibit 10.60 to the document referred to in Note 6 below)\n10.45 Facility Purchase and Sale Agreement, each dated April 1, 1993, between First Healthcare Corporation and Zevco Enterprises, Inc., an Illinois corporation, relating to the sale of 13 nursing centers (Incorporated by reference to Exhibit 10.61 to the document referred to in Note 6 below)\nExhibit No. Item\/Document\n10.46 Purchase and Sale Agreement and Escrow Instructions between First Healthcare Corporation and certain NME subsidiaries, dated as of May 20, 1993 relating to the acquisition of 11 nursing centers (Incorporated by reference to Exhibit 10.62 to the document referred to in Note 6 below)\n10.47 Letter of Intent dated June 22, 1993 between Hillhaven and NME (Incorporated by reference to Exhibit 10.63 to the document referred to in Note 6 below)\n10.48 Credit Agreement dated as of September 1, 1993 among First Healthcare Corporation, The Hillhaven Corporation, the Banks referred to therein, the LC Issuing Banks referred to therein, Morgan Guaranty Trust Company of New York, Chemical Bank and J. P. Morgan Delaware (Incorporated by reference to Exhibit B to the document referred to in Note 7 below)\n10.49 Amendment No. 1 to Credit Agreement, dated as of October 12, 1993, among First Healthcare Corporation, The Hillhaven Corporation, the Banks referred to therein, the LC Issuing Banks referred to therein, Morgan Guaranty Trust Company of New York, Chemical Bank and J. P. Morgan Delaware\n10.50 Amendment No. 2 to Credit Agreement, dated as of December 30, 1993, among First Healthcare Corporation, The Hillhaven Corporation, the Banks referred to therein, the LC Issuing Banks referred to therein, Morgan Guaranty Trust Company of New York, Chemical Bank and J. P. Morgan Delaware\n10.51 Amendment No. 3 to Credit Agreement, dated as of May 27, 1994, among First Healthcare Corporation, The Hillhaven Corporation, the Banks referred to therein, the LC Issuing Banks referred to therein, Morgan Guaranty Trust Company of New York, Chemical Bank and J. P. Morgan Delaware\n10.52 Agreement and Waiver, dated as of September 2, 1993, by and among Hillhaven, First Healthcare Corporation, NME and certain NME subsidiaries\nExhibit No. Item\/Document\n10.53 Novation Agreement among Hillhaven Funding Corporation, Banque Indosuez, New York Branch, Banque Nationale de Paris, San Francisco Agency, Bank of America National Trust and Savings Association and Seattle-First National Bank, dated as of April 29, 1994\n10.54 Amended and Restated Master Sale and Servicing Agreement among Hillhaven Funding Corporation, Hillhaven and certain Hillhaven subsidiaries, dated as of April 29, 1994\n10.55 Amended and Restated Liquidity Agreement between Hillhaven Funding Corporation, Bank of America National Trust and Savings Association and Seattle-First National Bank dated as of April 29, 1994\n(11) Computation of Per Share Earnings\n11.01 Statement re: Computation of Per Share Earnings\n(21) Subsidiaries\n21.01 Subsidiaries of the Registrant\n(23) Consent of Experts and Counsel\n23.01 Consent of Independent Accountants, KPMG Peat Marwick LLP\nNote Reference Document\n1. Quarterly Report on Form 10-Q for the quarter ended November 30, 1989, as amended. 2. Quarterly Report on Form 10-Q for the quarter ended November 30, 1991, as amended. 3. Annual Report on Form 10-K for the year ended May 31, 1992, as amended. 4. Registration Statement on Form S-1 (File No. 33-48755). 5. Registration Statement on Form S-3 (File No. 33-65718). 6. Annual Report on Form 10-K for the year ended May 31, 1993. 7. Current Report on Form 8-K dated September 2, 1993. 8. Registration Statement on Form S-3 (File No. 33-50833). 9. Quarterly Report on Form 10-Q for the quarter ended November 30, 1993.\n___________________\n* Management contracts and compensatory plans or arrangements required to be filed as an Exhibit to comply with Item 14(a)(3).","section_15":""}
{"filename":"704886_1994.txt","cik":"704886","year":"1994","section_1":"ITEM 1. BUSINESS. ------------------\nBUSINESS OF THE COMPANY\nCalifornia Commercial Bankshares (the \"Company\") is a bank holding company, incorporated under the laws of the State of California on June 16, 1982, and is registered under the Bank Holding Company Act of 1956, as amended. The Company's primary purpose is to be a bank holding company for its wholly-owned subsidiary, National Bank of Southern California, a national banking association organized under the laws of the United States (the \"Bank\"). At December 31, 1994, the Company had total assets of $301 million and total shareholders' equity of $20 million.\nOn January 10, 1983, the Company purchased 450,000 shares of the Bank's common stock, which constituted all of the issued and outstanding capital stock of the Bank. The Bank's charter was granted by the Comptroller of the Currency (the \"Comptroller\") on January 10, 1983, and the Bank began operations as a full- service commercial bank on that date.\nDuring 1985, the Company activated another subsidiary, Venture Partners, Inc., a California corporation incorporated on March 11, 1983 (\"Venture\"), to act as an intermediary for tax deferred exchanges, a service function for the escrow department of the Bank.\nThe Company has no other subsidiaries or affiliated businesses other than the Bank and Venture. The Company's executive offices are located at 4100 Newport Place, Newport Beach, California 92660. Telephone number 714-497-9380\nBUSINESS OF THE BANK\nThe Bank's accounts are insured by the Federal Deposit Insurance Corporation (\"FDIC\") and it is a member of the Federal Reserve System. In addition to its headquarters office in Newport Beach, California, the Bank presently operates three branches located in Santa Ana, El Toro and Orange, California. At December 31, 1994, the Bank had total assets of $300 million, gross loans and leases of $202 million, total deposits of $278 million and total shareholders' equity of $21 million.\nThe Bank is engaged in substantially all of the services customarily conducted by independent commercial banks in California including checking, savings and time deposit accounts, commercial, interim construction, personal, home improvement, mortgage, automobile and other installment and term loans, leasing, traveler's checks, safe deposit boxes, collection services, night depository facilities, wire transfers and automatic teller machines.\nSee distribution of assets, liabilities and shareholders' equity; interest rates and interest differential at pages 19, 20 and 21.\nLOANS AND LEASES ----------------\nThe aggregate balances of loans and leases, excluding deferred fees, outstanding at the indicated dates are shown in the following table according to the type of loan. All loans are domestic loans.\nThe declining balance of loans from 1991 through 1994 reflects the continued recession in the local economy, a reduction in the demand for loans and the Bank's commitment of its financial and human resources to identifying and collecting problem loans and leases and to disposing of other real estate owned obtained through foreclosure.\nThe Bank concentrates its lending activities in three principal areas:\n(1) REAL ESTATE LOANS Real estate loans are comprised of construction loans, miniperm loans collateralized by first or junior trust deeds on specific properties and equity lines of credit. The properties collateralizing real estate loans are principally located in the Bank's primary market area of Orange County and contiguous communities. The construction loans are comprised of loans on residential and income producing properties, generally have terms less than two years and typically bear an interest rate that floats with prime. The miniperm loans finance the purchase and\/or ownership of income producing properties. Miniperm loans generally are made on a thirty year amortization schedule with a lump sum, balloon payment due in 1-5 years. Equity lines of credit are revolving lines of credit collateralized by junior trust deeds on real properties. They bear a rate of interest that floats with prime and have maturities of five to seven years. The Bank also makes a small number of loans on 1-4 family residential properties and 5 or more unit residential properties. From time to time, the Bank purchases participation interests in loans made by other institutions. These loans are subject to the same underwriting criteria and approval processes as loans made directly by the Bank. During 1994, the Bank purchased $381,000 of participations in real estate loans from other institutions. At December 31, 1994, the Bank had $1,685,000 outstanding in real estate participation loans purchased from other institutions.\n(2) COMMERCIAL LOANS Commercial loans are granted to finance operations or for specific purposes, such as to finance the purchase of equipment. Since cash flows from operations are generally the primary source of repayment, the Bank's policies provide specific guidelines regarding required debt coverage and other important financial ratios. Lines of credit are made to businesses or individuals based on the financial strength and integrity of the borrower, are generally collateralized by inventory and accounts receivable, but may be uncollateralized, and generally have a maturity of one year or less. They generally bear an interest rate that floats with prime. Commercial term loans are typically made to finance the acquisition of fixed assets, refinance short term debt originally used to purchase fixed assets or, in rare cases, to finance purchases of businesses. Commercial term loans generally have a term of from one to five years. Commercial term loans may be collateralized by the asset being acquired or other available assets.\n(3) CONSUMER LOANS Consumer loans include personal loans, auto loans, boat loans, home improvement loans, equipment loans, revolving lines of credit and other loans typically made by banks to individual borrowers. The Bank also makes leases on new and used automobiles. These leases may be closed-end or commercial leases, have a term of one to five years and bear interest at a fixed rate.\nThe following tables show the amount of loans (excluding mortgages of 1-4 family residences, installment loans and leases) of the Bank outstanding as of December 31, 1994 which, based on remaining scheduled repayments of principal, (1) are due in the period indicated and (2) for the amounts due after one year, are fixed rate or floating rate.\nThe prime rate with which the interest rate floats may be the prime rate of a specific money center bank, the prime rate posted in the Wall Street Journal or the Bank's own posted prime rate. The Bank's prime rate is set by Bank management. The Bank's prime rate at December 31, 1994 was 10%.\nThere are no concentrations of loans exceeding 10% of total loans which were not otherwise disclosed as a category of loans in the above table.\nCLASSIFIED ASSETS AND NONPERFORMING ASSETS. The Company maintains an internal ------------------------------------------- loan review program. All loans are categorized into one of the five following groups: Pass loans: loans that contain strong credit quality and ability to repay. Special mention loans: loans that have an identified weakness which requires correction to protect the Bank (not considered a classified loan). Substandard loans: loans that exhibit some weakness and require immediate attention to correct the deficiency. Doubtful loans: loans that exhibit a significant weakness and whose full collection is improbable. Loss loans: Loans that are charged off upon identification of being loss loans. The following table shows the amounts of special mention loans, classified loans (substandard or doubtful) and the amount of other real estate owned as of the dates indicated (see ITEM 1. BUSINESS, BUSINESS OF THE BANK, ALLOWANCE FOR LOAN ---------------- ------------------ AND LEASE LOSSES): ----------------\nSpecial mention loans, classified loans and other real estate owned decreased significantly in 1993 as compared to 1992. Although the economy remained weak, the balances decreased as the Bank increased the staffing levels of personnel dedicated to problem loan identification and workout and the disposal of other real estate owned. The sustained weak economy in 1994 continued to affect borrower cash flows and real estate values keeping these balances at the same level as the previous year.\nIt is generally the Company's policy to discontinue the accrual of interest on a loan when any installment payment of interest or principal is 90 days or more past due, when management otherwise determines the collectibility of the interest or principal on the loan is unlikely or when the loan is deemed to be a potential foreclosure. Accrued but unpaid interest on loans placed on nonaccrual status is generally reversed from income. In certain cases where the value of the collateral is sufficiently in excess of the balance of principal and interest owing, the Bank may continue to accrue interest or may not reverse accrued but not paid interest from income.\nThe following table shows the aggregate amount and percentage of the portfolio of delinquent loans and nonaccrual loans as of December 31, 1994:\nThe following table sets forth information regarding the Company's nonperforming assets at December 31, 1994:\nALLOWANCE FOR LOAN AND LEASE LOSSES The allowance for loan and lease losses is ----------------------------------- based on an analysis of the portfolio and reflects an amount which, in management's opinion, is adequate to provide for potential losses after giving consideration to the portfolio, current economic conditions, past loss experience and other pertinent factors. Management and the internal credit review function monitor delinquency reports, new loans, renewals and reports of on-site inspections to identify credits requiring special attention. Annual examinations of the loan portfolio are also performed by an independent, third party credit review professional.\nOn a quarterly basis, senior management, in conjunction with the board of directors, reviews the adequacy of the allowance for loan and lease losses. Loan officers prepare Special Asset Credit Reports (\"SAC reports\") for each loan on the special asset report. SAC reports include all pertinent details about the loan, a write-up of current status, steps being taken to correct any problems, a detailed workout plan and recommendations as to classification of the loans as pass, special mention, substandard, doubtful or loss (see ITEM 1. ------- BUSINESS, BUSINESS OF THE BANK, CLASSIFIED ASSETS AND NONPERFORMING ASSETS) and -------- ------------------------------------------ specific allocation of the Allowance for Loan and Lease Losses. Management approves and informs the credit review function of loan classifications. Loans classified as loss are charged against the Allowance for Loan and Lease Losses. Specific allowances are established for loans designated by management. Quarterly, the credit review function is responsible for preparing a historical migration analysis of loans as part of the determination of the required balance of the Allowance for Loan and Lease Losses. The migration analysis tracks charged off loans to their original classifications and assigns a risk factor to each loan in the portfolio based upon classifications of such loans as pass, special mention, substandard or doubtful. The amount of the general portion of the allowance is determined by multiplying the aggregate principal balance of loans in each category by the specified percentage. The amount of the required general portion of the allowance is added to the specific allowances previously established to form the total balance of the allowance. The amount of the allowance is based upon management's evaluation of this analysis and other factors, including adequacy of collateral, economic conditions, collateral value trends, nonperforming asset data, delinquencies and other material.\nManagement utilizes its best judgement in providing for possible loan losses and establishing the allowance for loan and lease losses. However, the allowance is an estimate which is inherently uncertain and depends on the outcome of future events. Adverse economic conditions and a declining real estate market in California have adversely affected certain borrowers' ability to repay loans. A continuation of these conditions or a further decline in the California economy could result in further deterioration in the quality of the loan portfolio and could require increased provisions for loan and lease losses that cannot reasonably be predicted at this date. In October 1993, the greater southern California area was ravaged by a series of fires which destroyed thousands of acres and caused millions of dollars in lost property. Although a significant portion of the fires occurred in the Bank's service area, the Bank incurred no losses directly attributable to the fires. In January 1994, a severe earthquake occurred in the San Fernando Valley of Los Angeles, causing over 50 deaths, destroying property valued in the billions of dollars, causing major impediments to Southern California transportation networks and affecting the business community. Damage in the Bank's service area was relatively minimal and, after\ncontacting customers and investigating its potential exposure, the Bank is not aware of any of its borrowers who were directly affected by the earthquake.\nSince the calculation of the adequacy of the allowance for credit losses is based largely on loan classification categories and not only whether a loan is performing or nonperforming, changes in the amount of nonperforming loans will not necessarily be reflected in corresponding changes in the ratio of the allowance for loan and lease losses to nonperforming loans. The following table shows the ratios of the allowance for loan and lease losses to total loans and the balance of the allowance for loan and lease losses to nonperforming loans as of December 31:\nSUMMARY OF LOAN LOSS EXPERIENCE The following table summarizes loan and lease ------------------------------- balances of the Bank at December 31, 1994, 1993, 1992, 1991 and 1990 changes in the allowance for possible loan losses arising from loans charged off, additions to the allowance for loan and lease losses which have been charged to expense and the ratio of net charge-offs during the periods to average loans and leases:\n(1) See the table below for summary of the amounts of loans and leases charged off and recoveries of loans and leases previously charged off.\nThe allowance for loan and lease losses has been allocated between the following categories of loans and leases according to the amount deemed adequate to provide for the possibility of losses being incurred at the dates indicated:\nSFAS 114 which becomes effective after December 31, 1994 requires creditors to measure impairment of a loan based on the present value of expected future cash flows discounted at the loans effective interest rate. If the measure of the impaired loan is less than the recorded investment in the loan, a creditor will recognize an impairment by creating a valuation allowance with a corresponding charge to bad debt expense. This statement also applies to restructured loans. As of December 31, 1994, the Company had written down all its nonperforming loans to the current collateral value or had established specific reserves that the management believes, are more than adequate to cover future exposure.\nINVESTMENT PORTFOLIO\nThe following table sets forth the book value and estimated fair value of investment securities available for sale as of December 31, 1994 and investment securities of the Company as of December 31, 1993 and 1992:\nAs of January 1, 1994 the Bank had classified all its Debt Securities as \"Available for Sale.\"\nAs of December 31, 1994 the Bank had no derivatives.\nThe Bank had invested $1,000,000 in a bond issued by a Sanitation district in the County of Orange. The district invested the funds in the Orange County Pool Fund which declared bankruptcy. The Bank has placed that bond on a nonaccrual basis. The Bond is due to mature in May of 1995.\nThe following table sets forth the maturities of investment securities of the Company at December 31, 1994 and the weighted average yields of such securities (calculated available for sale on the basis of the cost and effective yields weighted for the scheduled maturity of each security):\nAs of December 31, 1994 the Company had no derivatives.\nDEPOSITS --------\nThe Bank's major source of funds for lending and other investment purposes is deposits. In addition to deposits, the Bank derives funds from principal and interest repayments on loans, maturities and sales of investment securities, and Federal funds sold.\nThe Bank's deposit strategy has been to emphasize business deposits, through its four branch offices and by a network of couriers employed by the Bank. From time to time retail deposits and time certificates of deposits have also been gathered through listings in various national publications. Business demand deposits earn credits for collected balances against which the Bank charges fees for various products and services used by the customer. In some cases, the Bank pays for data processing fees for business customers with significant excess balances. The Bank has five business customers each of which maintains demand deposit balances in excess of 1% of total deposits. The balances in these accounts averaged an aggregate of $38.7 million and $47.7 million during 1994 and 1993, respectively, and totalled an aggregate of $37.3 million and $49.0 million, or 13.4% and 16.4% of total deposits, respectively, at December 31, 1994 and 1993.\nGuidelines by federal regulatory agencies specify that time certificates of deposit may be considered to be brokered if the rate on the deposit exceeds 75 basis points over (i) the average rate paid locally for certificates of deposit of similar maturities or (ii) 120% of the rate for treasury bills and notes of similar maturities. Time certificates of deposit generated through publication of rates in national publications totaled an aggregate of $5,444,000 at December 31, 1994.\nAs of December 31, 1994, the Bank had no brokered deposits. Under the prompt corrective action provisions of FDICIA, the Bank must obtain prior approval from the FDIC in order to acquire or roll over brokered time certificates of deposit.\nOn January 31, 1994, the Bank completed the acquisition of approximately $12.5 million in deposits from a local Bank that decided to no longer be an insured depository institution. The Bank paid no premium for these demand, savings and time deposits and has retained most of the core deposits acquired.\nThe following table shows the average daily amount of deposits and average interest rates paid for the periods indicated:\nThe following table shows the maturities and repricing data of time certificates of deposit of $100,000 or more at December 31, 1994:\nBORROWING ARRANGEMENTS\nIn December 1988, the Company obtained a $3,000,000 term loan from another financial institution for the purpose of providing additional capital to the Bank. The Credit Agreement for this loan was amended pursuant to a Second Amendment to the credit agreement dated August 25, 1994. The loan, as amended, bears interest at a fluctuating rate per annum equal to .75% in excess of the lender's reference rate (8.50% at December 31, 1994). Interest is payable monthly on the unpaid principal balance of the loan. Principal is to be repaid on January 1, 1997. The Second Amendment waives all financial covenants relating to the term loan. At December 31, 1994 and 1993, $2,351,000 remained outstanding on the loan. The Second Amendment is supported by a Support Agreement between a shareholder of the Company and the Company whereby the shareholder has guaranteed the payment of the loan.\nTo compensate the shareholder for signing the Support Agreement, the Company signed a Holding Company Support Agreement whereby the Company: (1) has paid the shareholder a standby fee of $23,500, (2) will pay a standby fee equal to one percent of the unpaid principal amount of the term loan on each anniversary date of the closing date of the Holding Company Support Agreement and (3) will issue to the shareholder on or prior to March 31, 1997 warrants to purchase 25,000 shares of common stock of the Company at an exercise price per share equal to 80% of the book value per share of the Company on December 31, 1996.\nThe Bank maintains two lines of credit with outside financial institutions for the purpose of purchasing Federal funds. The lines of credit bear interest at a floating rate and provide for borrowing up to $8,000,000 and $2,000,000, respectively. At December 31, 1994 and 1993, no amounts were outstanding on these lines of credit.\nUnder an agreement with the Federal Home Loan Bank, the Bank may obtain an extension of credit of up to 5% of total assets collateralized by real estate loans. At December 31, 1994, the Bank had pledged loans amounting to $5,387,000 and had available credit of $2,694,000 based on 50% of the outstanding balance of pledged loans. No amounts were outstanding on this line of credit at December 31, 1994 and 1993.\nLIQUIDITY AND INTEREST RATE SENSITIVITY\nThe following table shows the components of the Company's liquidity at the dates indicated:\nThe principal sources of asset liquidity are balances due from banks, Federal funds sold and short term investment securities. Secondary sources of liquidity are loan repayments, maturing investments, and loans and investments that can be used as collateral for other borrowings. The majority of the Company's loans are short term and if paid in accordance with their terms, provide continuous additional cash inflow. The following chart shows the distribution of loans by their maturities and ratio to total loans and total assets as of December 31, 1994:\nLiability-based liquidity includes interest bearing and noninterest-bearing deposits, largely from local businesses and professionals, time deposits from financial institutions throughout the United States and obtained through listings in national publications and Federal funds\npurchased. From time to time the Bank has used brokered deposits as an additional source of funds; however, under conditions of its formal\nagreement (see ITEM 1. BUSINESS, SUPERVISION AND REGULATION, FORMAL AGREEMENT) ---------------- ---------------- and regulations issued by the Federal banking agencies (see ITEM 1. BUSINESS, ---------------- SUPERVISION AND REGULATION, FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ------------------------------------------------- ACT OF 1991, OTHER ITEMS, PASS THROUGH FDIC INSURANCE PROVISIONS), the Bank is ----------- currently precluded from accepting or rolling over brokered deposits.\nThe Company maintains an Interest Rate Risk simulation model which enables management to measure the Bank's Interest Rate Risk (IRR) exposure using various assumptions and interest rate scenarios, and to incorporate alternative strategies for the reduction of IRR exposure. The Bank measures its IRR using several methods to provide a comprehensive view of its IRR from various perspectives. These methods include analysis of repricing and maturity mismatches, or gaps, between assets and liabilities, and analysis of the size and sources of basis risk.\nGap analysis measures the difference between financial assets and financial liabilities scheduled and expected to mature or reprice within a specified time period. The gap is positive when repricing and maturing assets exceed repricing and maturing liabilities, where as the gap is negative when repricing and maturing liabilities exceed repricing and maturing assets. A positive or negative cumulative gap indicates in a general way how the Bank's net interest income should respond to interest rate fluctuations. A positive cumulative gap for a period generally means that rising interest rates would be reflected sooner in financial assets than in financial liabilities, thereby increasing net interest income over that period. A negative cumulative gap for a period would produce an increase in net interest income over that period if interest rates declined.\nThe following maturity and interest rate sensitivity analysis summarizes the asset and liability balances of the Company at December 31, 1994 on the basis of rate adjustments due to occur within the periods indicated:\nREPRICING OPPORTUNITIES\nAs of December 31, 1994 the Company had a positive gap of $94,713,000 with a cumulative positive gap of $48,603,000 over one year period. The Board of Directors has established limits on total net interest income exposure for a one year time horizon based on 1% rate change. While the gap analysis is a useful asset\/liability management tool, it does not fully assess IRR. Gap analysis does not address the effects of customer options (such as early withdrawal of time deposits, withdrawal of deposits with no stated maturity, and options to prepay loans) and Bank strategies (such as delaying increases in interest rates paid on certain interest-bearing demand and money market deposit accounts) on the Bank's net interest income. In addition, the gap analysis assumes no changes in the spread relationships between market rates on interest-sensitive financial instruments (basis risk), or in yield curve relationships. Therefore, a gap analysis is only one tool with which to analyze IRR, and must be reviewed in conjunction with other asset\/liability management reports.\nINTEREST RATES AND INTEREST RATE DIFFERENTIAL. The following tables set forth ---------------------------------------------- the average amounts outstanding for major categories of interest earning assets, interest bearing liabilities, the average interest rates earned thereon and interest income\/expenses for the Bank as of and for the years ended:\n(1) Average loans and leases include non-performing loans and leases, however, income does not include foregone interest. In addition, loan fees have not been included in interest income and in calculating the rate realized on loans and leases.\n(2) Average Assets and Average Equity do not include unrealized gains or losses on Investment Securities.\n(1) Average loans and leases include non-performing loans and leases, however, income does not include foregone interest. In addition, loan fees have not been included in interest income and in calculating the rate realized on loans and leases.\nINTEREST EARNED AND INTEREST INCURRED RESULTING FROM CHANGES IN VOLUME AND -------------------------------------------------------------------------- CHANGES IN RATES. The following table sets forth, for the periods indicated, a ----------------- summary of the changes in interest earned and interest incurred resulting from changes in volume and changes in rates:\nIn calculating interest rates and volumes and related changes, non-performing loans and leases have been included in loans and leases volumes; however, foregone interest has been excluded. In addition, loan fees were not included in interest income in calculating the rate realized on loans.\nCOMPETITION\nThe banking business in California generally, and in the Bank's service area in particular, is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major banks which have many offices operating throughout wide geographic areas. In addition, there are numerous other independent commercial banks within the Bank's primary service areas.\nThe primary factors in competing for deposits are interest rates, personalized services, quality and range of financial services, convenience of office locations and banking hours. The Bank competes for deposits and loans principally with banks, savings and loan associations, thrift and loan associations, credit unions, mortgage companies, insurance companies, other lending institutions, money market and mutual funds and other investment alternatives. Competition for loans comes primarily from other commercial banks, savings institutions, mortgage banking firms, credit unions and other financial intermediaries. Among the advantages that some of these institutions have over the Bank is their ability to undertake extensive advertising campaigns and to allocate their investment assets to areas of highest yield and demand. Many of the major commercial banks operating in the Bank's service area offer certain other services which are not offered directly by the Bank, such as trust, investment and international banking services, and by virtue of their greater total capitalization, such banks have substantially higher lending limits than the Bank. In competing for deposits, the Bank is subject to certain limitations not applicable to non-bank financial institutions.\nSUPERVISION AND REGULATION\nTHE COMPANY -----------\nThe Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the \"Act\"), 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 Act. The Federal Reserve Board may also make examinations of the Company and each of its subsidiaries. The costs of any examination by the Federal Reserve Bank are paid by the Company.\nThe Federal Reserve Board has significant supervisory and regulatory authority over the Company and its subsidiaries. The Federal Reserve Board requires the Company to maintain certain levels of capital (see ITEM 1. BUSINESS, SUPERVISION ---------------- AND REGULATION, CAPITAL ADEQUACY GUIDELINES). The Federal Reserve Board also --------------------------- has the authority to take enforcement action against any bank holding company that commits any unsafe or unsound practice, or violates certain laws, regulations or conditions imposed by the Federal Reserve Board in writing (see\nITEM 1. BUSINESS, SUPERVISION AND REGULATION, FEDERAL DEPOSIT INSURANCE ---------------- -------------------------- CORPORATION IMPROVEMENT ACT OF 1991 AND FORMAL AGREEMENT). --------------------------------------------------------\nThe Act requires prior approval of the Federal Reserve Board for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than five percent of the voting shares, or substantially all the assets, of any bank or for merger or consolidations by a bank holding company with any other bank holding company. The Act also prohibits the acquisition by a bank holding company or any of its subsidiaries of voting shares or substantially all the assets of any bank 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 bank to be acquired is located expressly authorizes such an acquisition. (See ITEM 1. BUSINESS, SUPERVISION AND REGULATION, MEMORANDUM ---------------- ---------- OF UNDERSTANDING). ----------------\nWith certain limited exceptions, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking, managing or controlling banks or furnishing services to or performing services for its authorized subsidiaries. A bank holding company may, however, engage or acquire an interest in a company that engages in activities which the Federal Reserve Board has determined to be closely related to banking or managing or controlling banks or properly incident thereto. In making such a determination, the Federal Reserve Board is required to consider whether the performance of such activities can reasonably be expected to increase competition, or produce 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. The Federal Reserve Board is also empowered to differentiate between activities commenced de-novo and activities commenced by acquisition, in whole or in part, of a going concern.\nAdditional statutory provisions prohibit a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, a subsidiary bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the concentration for any of the foregoing on the condition that: (i) the customer must obtain or provide some additional credit, property or service from, or to, such bank other than a loan, discount, deposit or trust service; (ii) the customer must obtain or provide some additional credit, property or service from or to the Company or any other subsidiary of the Company; (iii) the customer may not obtain some other credit, property or service from competitors, except under reasonable requirements to assure the soundness of credit extended.\nThe Federal Reserve Board generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded through borrowing or other arrangements that might adversely affect a bank holding company's financial position. The Federal Reserve Board's policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition.\nTransactions between the Company and its subsidiaries are subject to a number of other restrictions. Federal Reserve Board policies forbid the payment by bank subsidiaries of management fees which are unreasonable in amount or exceed the fair market value of the services rendered (or, if no market exists, actual costs plus a reasonable profit). Nor is the holding company allowed to transfer to the Bank any nonperforming loans or other assets.\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), Regulation D (Reserves), Regulation E (Electronic Funds Transfer Act), Regulation F (Interbank Liabilities), Regulation Z (Truth in Lending), 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 has liability under various statutes and regulations applicable to property owners, generally including statutes and regulations relating to the environmental condition of the property.\nTHE BANK --------\nThe Bank is a national banking association whose deposits are insured by the Bank Insurance Fund (\"BIF\") as administered by the FDIC, up to the maximum legal limits of the FDIC ($100,000), and is subject to regulation, supervision, and regular examination by the Comptroller. The Bank is a member of the Federal Reserve System, and as such is subject to certain provisions of the Federal Reserve Board. The Bank is also subject to applicable provisions of California law, insofar as they do not conflict with, or are not preempted by, federal law. The regulations of these various agencies govern most aspects of the Bank's business, including reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowing, dividends, and locations of branch offices. California law exempts banks from the California usury laws.\nLEGISLATIVE AND REGULATORY CHANGES ----------------------------------\nOver the past few years the volume and complexity of banking regulations and the intensity of the regulatory examination process have increased dramatically. Banking institutions are subject to closer scrutiny today than ever before. This increased scrutiny is designed to reduce the number of failing institutions and to require immediate corrective actions by troubled institutions. Many of the recent statutory changes have been directed at giving the various bank regulatory agencies increased enforcement powers to take \"prompt corrective actions\" (see ITEM 1. BUSINESS, SUPERVISION AND REGULATION, FEDERAL DEPOSIT ---------------- ---------------- INSURANCE CORPORATION IMPROVEMENT ACT OF 1991) when an insured financial --------------------------------------------- institution's capital falls below certain levels. In addition, more stringent capital requirements have been imposed to provide more protection against potential losses. Premiums for deposit insurance have increased to record levels and are now based upon risk evaluations. While the Company and the Bank have not directly measured the full impact and cost of compliance with these new requirements, such compliance represents an ever increasing expense for the Company and the Bank and requires a significant amount of staff and officer time.\nDIVIDEND LIMITATIONS --------------------\nOn January 1, 1991, the Comptroller changed the interpretations of the dividend regulations to simplify the calculation of a bank's dividend paying capacity and make them more consistent with generally accepted accounting principles. The dividend limit is based on retained \"net profits\" for the current year plus the two previous years, less any required transfers to surplus or a fund for the retirement of preferred stock. \"Net profits\" are defined as the net income as reported in the bank's call report with no adjustments. The Formal Agreement also prohibits the payment of any cash dividends by the Bank without the prior written consent of the Comptroller or by the Company without prior notice to the Federal Reserve Bank of San Francisco (see ITEM 1. BUSINESS, SUPERVISION AND ---------------- REGULATIONS, FORMAL AGREEMENT AND MEMORANDUM OF UNDERSTANDING). In addition, a ---------------- --------------------------- national bank may not pay any dividends or make other capital distributions if the capital distribution would cause the national bank to be undercapitalized, with the exception of repurchases or redemptions of the national bank's shares that are made in connection with the issuance of additional shares, or that will impair the national bank's financial condition.\nFEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991. -------------------------------------------------------------\nOn December 19, 1991, the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") was enacted. Set forth below is a brief discussion of certain portions of this law and implementing regulations that have been adopted or proposed by the Federal Reserve Board, Comptroller and the FDIC (collectively, the \"federal banking agencies\").\nBIF RECAPITALIZATION. FDICIA provides the FDIC with three additional sources of funds to protect deposits insured by the BIF administered by the FDIC. The FDIC is authorized to borrow up to $30 billion from the U.S. Treasury; borrow from the Federal Financing Bank up to 90% of the fair market value of the assets of institutions acquired by the FDIC as receiver; and borrow from financial intermediaries that are members of the BIF. Any borrowing not repaid by asset sales are to be repaid through insurance premiums assessed to member institutions. Such premiums must be sufficient to repay any borrowed funds within 15 years and provide insurance fund reserves of $1.25 for each $100 of insured deposits.\nIMPROVED EXAMINATIONS. All insured depository institutions must undergo a full-scope, on-site examination by their appropriate federal banking agency at least once every 12 months. A transition period allows for examination of certain well capitalized and well managed institutions every 18 months until December 31, 1993. 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.\nSTANDARDS FOR SAFETY AND SOUNDNESS. FDICIA requires the federal banking agencies to prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating to internal control, loan documentation, credit underwriting, interest rate exposure and asset growth. Standards must also be prescribed for classified loans, earnings and the ratio of market value to book value for publicly traded shares. FDICIA also requires the federal banking agencies to issue uniform regulations prescribing standards for real estate lending that are to consider such factors as the risk to the deposit insurance fund, the need for safe and sound operation of insured depository institutions and the availability of credit.\nFurther, FDICIA requires the federal banking agencies to establish standards prohibiting compensation, fees and benefit arrangements that are excessive or could lead to financial loss. Under proposed regulations implementing the safety and soundness standards, a national bank must maintain a ratio of classified assets to total capital and ineligible allowances that is no greater than 1.0. A minimum earnings standard is also included in the proposed regulation requiring earnings sufficient to absorb losses with impairing capital. Earnings would be sufficient under the proposed regulation if the institution meets applicable capital requirements and would remain in capital compliance if its net income or loss over the last four quarters of earnings continue over the next four quarters of earnings. A national bank that fails to meet either of these standards must submit a compliance plan.\nIn December 1992, the federal banking agencies issued final regulations prescribing uniform guidelines for real estate lending. The regulations, which became effective March 19, 1993, require insured depository institutions to adopt written policies establishing standards, consistent with such guidelines, for extensions of credit collateralized by real estate. The policies must address loan portfolio management, underwriting standards and loan-to-value limits that do not exceed the supervisory limits prescribed by the regulations.\nIn December 1993, pursuant to the mandate of FDICIA, the federal banking agencies issued an interagency policy statement regarding the allowance for loan and lease losses(\"ALLL\"). Insured depository institutions are required to maintain a level of ALLL that is adequate to absorb \"estimated credit losses\" associated with the loan and lease portfolio, including all binding commitments to lend. \"Estimated credit losses\" are defined as an estimate of the current amount of the loan and lease portfolio that is not likely to be collected given the facts and circumstances as of the evaluation date. These estimated credit losses should meet the criteria for accrual of a loss contingency set forth in generally accepted accounting principles as stated in Statement on Financial Accounting Standards No. 5 (\"SFAS 5\"). The policy statement describes the responsibility of the board of directors and management to maintain the ALLL at an adequate level and prescribes that the ALLL should be no less than the sum of the following items:\n(1) For loans and leases classified substandard or doubtful,whether analyzed and provided individually or as part of pools, all estimated credit losses over the remaining effective lives of these loans.\n(2) For components of the loan and lease portfolio not classified, all estimated credit losses over the upcoming 12 months.\n(3) Amounts for estimated losses from transfer risk on international loans.\nThe board of directors and management are also responsible to ensure:\n(1) the institution has an effective loan review system;\n(2) loans or portions of loans are promptly charged off if determined uncollectible; and\n(3) the process for determining an adequate level for the ALLL is based on a comprehensive, adequately documented and consistently applied analysis of the loan and lease portfolio.\nThe policy statement describes components of the portfolio which should be reviewed and factors to consider in the estimation of credit losses. Furthermore, the policy statement specifies the steps which will be followed by examiners of the federal banking agencies in examining the adequacy of the ALLL for individual institutions. These steps include analyzing an institution's policies, practices and historical credit loss experience, and a further check of the reasonableness of management's methodology by comparing the reported ALLL (after deduction of all loans, or portions thereof, classified as loss) against the sum of the following amounts:\n(1) 50 percent of the portfolio that is classified doubtful;\n(2) 15 percent of the portfolio that is classified substandard; and\n(3) for the portions of the portfolio that have not been classified (including those loans designated special mention), estimated credit losses over the upcoming twelve months given the facts and circumstances as of the evaluation date (based on the institutions's average annual rate of net charge-offs experienced over the previous two or three years on similar loans, adjusted for current conditions and trends).\nThe policy statement cautions that \"the amount is neither a 'floor' nor a 'safe harbor' level for an institution's ALLL. However, examiners will view a shortfall relative to this amount as indicating a need to more closely review management's analysis to determine whether it is reasonable and supported by the weight of available evidence, and that all relevant factors have been appropriately considered.\" The Bank's ALLL is less than that which would be established under the policy statement guidelines.\nPROMPT CORRECTIVE REGULATORY ACTION. FDICIA requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions that fall below one or more prescribed minimum capital ratios. The purpose of this law is to resolve the problems of insured depository institutions at the least possible long-term cost to the appropriate deposit insurance fund.\nThe law required each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized (significantly exceeding the required minimum capital requirements), adequately capitalized (meeting the required capital requirements), undercapitalized (failing to meet any one of the capital requirements), significantly undercapitalized (significantly below any one capital requirement) and critically undercapitalized (failing to meet all capital requirements).\nIn September 1992, the federal banking agencies issued uniform final regulations implementing the prompt corrective action provisions of FDICIA. Under the regulations, an insured depository institution will be deemed to be:\n. \"well capitalized\" if it (i) has total risk-based capital of 10% or greater, Tier 1 risk-based capital of 6% or greater and a leverage capital ratio of 5% or greater and (ii) is not subject to an order, written agreement capital directive or prompt corrective action directive to meet and maintain a specific capital level of any capital measure;\n. \"adequately capitalized\" if it has total risk-based capital of 8% or greater, Tier 1 risk-based capital of 4% or greater and a leverage capital ratio of 4% or greater (or a leverage ratio of 3% or greater if the institution is rated composite 1 under the applicable regulatory rating system in its most recent report of examination);\n. \"undercapitalized\" if it has total risk-based capital that is less than 8%, Tier 1 risk-based capital that is less than 5% or a leverage capital ratio that is less than 4% (or a leverage capital ratio that is less than 3% if the institution is rated composite 1 under the applicable regulatory rating system in its most recent report of examination);\n. \"significantly undercapitalized\" if it has a total risk-based capital that is less than 6%, Tier 1 risk-based capital that is less than 3% or a leverage capital ratio that is less than 3%; and\n. \"critically undercapitalized \" if it has a ratio of tangible equity to total assets that is equal to or less than 2%.\nAn institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized or undercapitalized may be reclassified to the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, (i) determines that the institution is in an unsafe or unsound condition or (ii) deems the institution to be engaging in an unsafe or unsound practice and not to have corrected the deficiency. At each successive lower capital category, an insured depository institution is subject to more restrictions and federal banking agencies are given less flexibility in deciding to deal with it.\nThe law prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transactions the institutions would be undercapitalized. If an insured depository institution is undercapitalized, it will be closely monitored by the appropriate federal banking agency, subject to asset growth restrictions and required to obtain prior regulatory approval for acquisitions, branching and engaging in new lines of business. Any undercapitalized depository institution must submit an acceptable capital restoration plan to the appropriate federal banking agency 45 days after becoming undercapitalized. The appropriate federal banking agency cannot accept a capital plan unless, among other things, it determines that the plan (1) specifies the steps the institution will take to become adequately capitalized on an average basis during each of four consecutive calendar quarters and must otherwise provide adequate assurances of performance. The aggregate liability of such guarantee is limited to the lesser of (a) an amount equal to 5% of the depository institutions's total assets at the time the institution became undercapitalized or (b) the amount which is necessary to bring the institution into compliance with all capital standards applicable to such institution as of the time the institution fails to comply with its capital restoration plan. Finally, the appropriate federal banking agency may impose any of the additional restrictions or sanctions that it may impose on significantly undercapitalized institutions if it determines that such action will further the purpose of the prompt corrective provisions.\nAn insured depository institution that is significantly undercapitalized, or is undercapitalized and fails to submit, or in a material respect to implement, an acceptable capital restoration plan, is subject to additional restrictions and sanctions. These include, among other things: (1) a forced sale of the voting shares to raise capital or, if grounds exist for appointment of a receiver or conservator, a forced merger; (ii) restrictions on transactions with affiliates; (iii) further limitations on interest rates paid on deposits; (iv) further restrictions on growth or required shrinkage; (v) modification or termination of specified activities; (vi) replacement of directors or senior executive officers, subject to certain grandfather provisions for those elected prior to enactment of FDICIA; (vii) prohibitions on the receipt of deposits from correspondent institutions; (viii) restrictions on capital distributions by the holding companies of such institutions; (ix) required divestiture of subsidiaries by the institution; or (x) other restrictions as determined by the appropriate federal banking agency.\nAlthough the appropriate federal banking agency has discretion to determine which of the foregoing restrictions or sanctions it will seek to impose, it is required to force a sale of voting shares or merger, impose restrictions on affiliate transactions and impose restrictions on rates paid on deposits unless it determines that such actions would not further the purpose of the prompt corrective action provisions. In addition, without the prior written approval of the appropriate federal banking agency, a significantly undercapitalized institution may not pay any bonus to its senior executive officers or provide compensation to any of them at a rate that exceeds such officer's average rate of base compensation during the 12 calendar months preceding the month in which the institution became undercapitalized.\nFurther restrictions and sanctions are required to be imposed on insured depository institutions that are critically undercapitalized. For example, a critically undercapitalized institution generally would be prohibited from engaging in any material transaction other than in the ordinary course of business without prior regulatory approval and could not, with certain exceptions, make any payment of principal or interest on its subordinated debt beginning 60 days after becoming critically undercapitalized. Most importantly, however, except under limited circumstances, the appropriate federal banking agency, not later than 270 days after an insured depository institution becomes critically undercapitalized, is required to appoint a conservator or receiver for the institution. The board of directors of an insured depository institution would not be liable to the institution's shareholders or creditors for consenting in good faith to the appointment of a receiver or conservator or to an acquisition or merger as required by the regulator.\nAs of December 31, 1994, the Bank had a total risk-based capital of 12.07%, a Tier 1 risk-based capital ratio of 10.82% and a leverage capital ratio of 7.47%. Based solely upon these ratios, the Bank would be deemed to be well capitalized as of December 31, 1994; however, because the Bank is subject to a written agreement with the Comptroller and the Company with the Federal Reserve Bank, the Bank and the Company are deemed to be adequately capitalized. ( see ITEM 1. ------- BUSINESS, SUPERVISION AND REGULATION, FEDERAL DEPOSIT INSURANCE CORPORATION -------- ------------------------------------- IMPROVEMENT ACT OF 1991, FORMAL AGREEMENT AND MEMORANDUM OF UNDERSTANDING). In ----------------------- addition, under the prompt corrective action provision of FDICIA, a subsequent reduction in the Bank's capital could cause it to fall within a lower capital category and subject it to the mandatory and discretionary sanctions applicable to the category.\nOTHER ITEMS. FDICIA also, among other things, (i) limits the percentage of interest paid on brokered deposits and limits the unrestricted use of such deposits to only those institutions that are well capitalized; (ii) requires the FDIC to charge insurance premiums based on the risk profile of each institution; (iii) eliminates \"pass through\" deposit insurance for certain employee benefit accounts unless the depository institution is well capitalized or, under certain circumstances, adequately capitalized; (iv) prohibits insured state chartered banks from engaging\nas principal in any type of activity that is not permissible for a national bank unless the FDIC permits such activity and the bank meets all of its regulatory capital requirements; (v) directs the appropriate federal banking agency to determine the amount of readily marketable purchased mortgage servicing rights that may be included in calculating such institutions' tangible, core and risk- based capital; and (vi) provides that, subject to certain limitations, any federal savings association may acquire or be acquired by any insured depository institution.\nBROKERED DEPOSITS. FDICIA prohibits \"undercapitalized\" institutions from accepting funds obtained, directly or indirectly, by or through a deposits broker. Undercapitalized institutions also are prohibited from soliciting deposits by offering rates of interest that are significantly higher than the prevailing rates of interest on insured deposits in the institutions's normal market areas, or in the market area in which the deposits would otherwise be accepted.\n\"Adequately capitalized\" institutions may accept brokered funds only if they first obtain a waiver granted the FDIC. Adequately capitalized institutions that solicit brokered deposits pursuant to a waiver granted by the FDIC may pay a rate of interest on brokered funds that significantly exceeds the rate paid on deposits of similar maturity in the institution's normal market area or the \"national rate\" paid on deposits of comparable maturity for deposits accepted outside the institution's normal market area. The term \"deposit broker\" also includes any insured depository institution, or employee thereof, that solicits deposits by offering rates of interest that are significantly higher than the prevailing rates of interest offered by other insured depository institutions having the same type of charter in the offering institution's normal market area. The effect of this definition, and the other limits on brokered deposits, is to preclude an institution that is only \"adequately capitalized\" from offering rates of interest that are significantly more than local or national rates.\nPASS THROUGH FDIC INSURANCE PROVISIONS. As of December 19, 1992, pro rata, or \"pass through\" deposit insurance is available for deposits attributable to participants in or beneficiaries of certain employee benefit plans, only if the institution in which the deposits are placed is permitted to accept brokered deposits or qualifies for a second exception. Under the brokered deposits exception, deposit insurance \"passes through\" to the participants or beneficiaries (i.e., with coverage up to $100,000 per person) only if the institution is well capitalized, or if the institution was adequately capitalized with a waiver from the FDIC that allowed it to accept brokered deposits. In the latter case, at the time the deposit was made the depositor must receive a written statement from the institution that the deposit was eligible for insurance coverage on a \"pass through\" basis. The second exception is available for deposits placed in an institution that meets each applicable capital standard set forth by the institution's appropriate Federal banking agency. The exception is also subject to the requirement that the depositor be given written notice, at the time the deposit is made that the deposit is entitled to insurance or a pass-through basis. The Bank has obtained a waiver from the FDIC under the first exception category.\nRISK-BASED DEPOSIT INSURANCE PREMIUMS. As required by FDICIA, the FDIC adopted a transitional risk-based assessment system for deposit insurance premiums which became effective January 1, 1993. Under the transitional regulations, insured depository institutions are required to pay insurance premiums within a range of 23 cents per $100 of deposits to 31 cents per $100 of deposits depending on their risk classification. To determine the risk-based assessment for each institution, the FDIC will categorize an institution as well-capitalized, adequately capitalized or undercapitalized based on its capital ratios. 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% leverage capital ratio. An adequately capitalized institution will have at least an 8% total risk-based capital ratio, a 4% Tier 1 risk-based capital ratio and a 4% leverage capital ratio. An undercapitalized institution will be one that does no meet either of the above definitions. The FDIC will also assign each institution to one of three subgroups based upon review by the institutions's primary federal or state regulator, statistical analyses of financial statements and other information relevant to evaluating the risk posed by the institution. As a result, the assessment rates within each of three capital categories will be as follows (expressed as cents per $100 of deposits):\nThe transitional rules have now been made permanent. In February 1995 the FDIC proposed to amend the schedule from a current range of 23 to 31 to 4 to 31. The Bank currently pays deposit insurance to the FDIC at the rate of 29 cents per $100 of deposits.\nFORMAL AGREEMENT ----------------\nAn on-site examination of the Bank was conducted by the Comptroller as of July 31, 1991. As a result of that examination, the Comptroller requested the Bank to take certain actions to improve the condition of the Bank, and the Bank agreed, pursuant to a formal agreement entered into with the Comptroller on April 8, 1992 (the \"Formal Agreement\"), to take such actions.\nUnder the terms of the Formal Agreement, the Bank agreed to (a) conduct studies of various parts of its operations and develop written action plans and policies designed to address any issues raised by those studies, (b) develop and implement a program designed to reduce the Bank's level of criticized assets, (c) implement an effective and ongoing loan review system, (d) establish a program for maintaining an adequate allowance for loan and lease losses, (e) develop and implement a program to improve the Bank's loan administration, (f) update the Bank's real estate appraisal program and procedures, (g) develop a program for the management of the Bank's other real estate owned (OREO), (h) develop a capital program and maintain total capital at least equal to 9% of risk-weighted assets, and Tier 1 capital at least equal to 6% of actual adjusted total assets, (i) maintain liquidity at a level sufficient to sustain the Bank's operations, and (j) develop a program for Board supervision over the Bank's management team. The Formal Agreement also prohibits the payment of any cash dividends by the Bank without the prior written consent of the Comptroller.\nThe Comptroller conducted another examination of the Bank as of July 31, 1992. As a result of that examination, the Comptroller requested, and on November 27, 1992, management and the Board of Directors of the Bank agreed to certain commitments to take specific actions to assure compliance with the Formal Agreement. The Comptroller conducted its annual examinations as of August 31, 1993 and September 30, 1994. The Bank was found to be in full, substantial or partial compliance with all terms and commitments under the Formal Agreement. Management believes the Bank is now in substantial compliance with all the terms of the Formal Agreement.\nMEMORANDUM OF UNDERSTANDING ---------------------------\nOn May 27, 1993, the Company executed a Memorandum of Understanding (\"memorandum\") with the Federal Reserve Bank of San Francisco (the \"Fed\") in which the Company agreed to submit a summary of actions to improve conditions in the Bank, not declare cash dividends without prior notice to the Fed, and obtain prior approval of changes in Directors or executive officers. Management of the Company believes the Company is in substantial compliance with the Memorandum.\nCAPITAL ADEQUACY GUIDELINES ---------------------------\nThe Federal Reserve Board, FDIC and Comptroller have issued guidelines to implement the new risk-based capital requirements. The guidelines are intended to establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations, takes off-balance sheet items into account in assessing capital adequacy and minimizes disincentives to holding liquid, low-risk assets. Under these guidelines, assets and credit equivalent amounts of off-balance sheet items, such as letters of credit and outstanding loan commitments, are assigned to one of several risk categories, which range from 0% for risk-free assets, such as cash and certain U.S. government securities, to 100% for relatively high-risk assets, such as loans and investments in fixed assets, premises and other real estate owned.\nThe guidelines included a transition period for implementing the risk-based capital requirements to allow banking organizations, among other things, to raise additional capital, if necessary, or restructure their asset mix to achieve compliance. The transition period, which was in effect through the end of 1992, required an institution to maintain a minimum ratio of qualifying total capital to risk-weighted assets of 7.25%, of which at least 3.6% was required to consist of Tier 1 capital. On and after December 31, 1992, the guidelines require a minimum ratio of qualifying total capital to risk-weighted assets of 8%, of which at least 4% must consist of Tier 1 Capital. Higher risk-based ratios are required to be considered well capitalized under the prompt corrective action provisions of FDICIA (see ITEM 1. BUSINESS, SUPERVISION AND ---------------- REGULATION, FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991, ------------------------------------------------------------- PROMPT CORRECTIVE ACTION).\nA banking organization's qualifying capital consists of two components: Tier 1 capital (core capital) and Tier 2 capital (supplementary capital). Tier 1 capital consists primarily of common stock, related surplus and retained earnings, qualifying noncumulative perpetual preferred stock (plus, for bank holding companies, qualifying cumulative perpetual preferred stock an amount to 25% of Tier 1 capital) and minority interests in the equity accounts of consolidated subsidiaries. Intangibles, such as goodwill, are generally deducted from Tier 1 capital; however, purchased mortgage servicing rights and purchased credit card relationships may be included, subject to certain limitations. At least 50% of the banking organization's total regulatory capital must consist of Tier 1 capital.\nTier 2 capital may consist of (i) the allowance for loan and lease losses in an amount up to 1.25% of risk-weighted assets; (ii) cumulative perpetual preferred stock and long-term preferred stock (which for bank holding companies must have an original maturity of 20 years or more) and related surplus; (iii) hybrid capital instruments (with characteristics of both debt and equity), perpetual debt and mandatory convertible debt securities; and (iv) eligible term subordinated debt and intermediate-term preferred stock with an original maturity of five years or more, including related surplus, in an amount up to 50% of Tier 1 capital. The inclusion of the foregoing elements of Tier 2 capital is subject to certain requirements and limitations of the federal banking authorities.\nThe federal banking authorities have also adopted a minimum ratio of Tier 1 capital to average total assets of 3% for the highest rated banks. This risk- based leverage capital ratio is only a minimum and applies only to the highest rated banks. Institutions experiencing or anticipating significant growth or those with other than minimum risk profiles are expected to maintain capital well above the minimum level. Furthermore, higher leverage capital ratios are required to be considered well capitalized or adequately capitalized under the prompt corrective action provisions of FDICIA (see ITEM 1. BUSINESS, SUPERVISION ---------------- AND REGULATION, FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991, ------------------------------------------------------------- PROMPT CORRECTIVE ACTION). Thus, the effective minimum risk-based leverage ratio, for all practical purposes, is at least 4% or 5%.\nThe federal banking authorities have issued a joint advance notice of proposed rule making, in accordance with FDICIA, seeking public comment of methods to take account of interest rate risk, concentrations of credit risk and the risks of nontraditional activities in calculating risk-based capital. Although the notice does not contain any agency proposals relating to concentration of credit risk and risks of nontraditional activities, the notice includes a general framework for taking account of interest rate risk. Under that framework, institutions with interest rate risk exposure in excess of a certain threshold would be required to hold capital proportionate to that excess risk. Exposures would be measured in terms of the change in the present value of an institution's assets minus the change in the present value of its liabilities and off-balance sheet positions for an assumed 100 basis point parallel shift in interest rate markets.\nThe federal banking agencies recently issued a statement advising that, for regulatory purposes, federally supervised banks and savings associations should report deferred tax assets in accordance with Statement of Financial Accounting Standards Board No. 109 (\"SFAS No. 109\") beginning in 1993, although earlier application was permitted subject to certain limitations. However, the federal banking agencies have advised that they will place a limit on the amount of deferred tax assets that is allowable in computing an institutions's regulatory capital. Deferred tax assets that can be realized from taxes paid in prior carry back years and from the future reversal of temporary differences would generally not be limited. Deferred tax assets that can only be realized through future taxable earnings, including the implementation of a tax planning strategy, would be limited to regulatory capital purposes to the lesser of (i) the amount that can be realized within one year of the quarter-end report date or (ii) 10% of Tier 1 Capital. The amount of deferred taxes in excess of this limit, if any, would be deducted from Tier 1 Capital and total assets in regulatory capital calculations. The federal banking agencies have notified institutions that their capital rules will be amended to reflect this change. The Company has adopted SFAS No. 109 effective January 1, 1993. As a result of the provisions of SFAS No. 109 the Company has established an allowance of $837,000 against its tax asset of $2,452,000 as of December 31, 1994.\nCOMMUNITY REINVESTMENT ACT --------------------------\nThe Community Reinvestment Act (\"CRA\") requires each national bank, as well as other lenders, to identify the communities served by the national bank's offices and to identify the types of credit the national bank is prepared to extend to such communities. The CRA also requires the Comptroller to assess the performance of the national 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.\nIn connection with its assessment of CRA performance, the Comptroller assigns a rating of \"outstanding,\" \"satisfactory,\" \"needs to improve\" or \"substantial noncompliance.\" Based on an examination conducted during May of 1993, the Bank was rated Outstanding. The last examination was conducted in February of 1995 and the Bank expects to maintain the same rating.\nACCOUNTING PRONOUNCEMENTS\nIn May 1993, the Financial Accounting Standards Board (\"FASB\") issued Statement on Financial Accounting Standards No. 114 (\"SFAS 114\"), \"Accounting by Creditors for Impairment of a Loan\" as amended by SFAS 118, \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures\". Under the provisions of 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. SFAS 114, as amended, requires creditors to measure impairment of a loan based on the present value of expected future cash flows discounted at the loan's effective interest rate. If the measure of the impaired loan is less than the recorded investment in the loan, a creditor will recognize an impairment by creating a valuation allowance with a corresponding charge to bad debt expense. This statement also applies to restructured loans and eliminates the requirement to classify loans that are in-substance foreclosures as foreclosed assets except for loans where the creditor has physical possession of the underlying collateral, but not legal title. SFAS 114 must be adopted by the Company January 1, 1995. The Company does not believe adoption of this statement will have a material impact on its results of operations or financial position.\nIn October 1994, the FASB issued SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments\" (\"SFAS No. 119\"). SFAS No. 119 requires entities that hold or issue derivative financial instruments for trading purposes to disclose related average fair value and net trading gains or losses. For entities that hold or issue derivative financial instruments for purposes other than trading, it requires disclosure about those purposes and about how the instruments are reported in financial statements. For entities that hold or issue derivative financial instruments and account for them as hedges of anticipated transactions, it requires disclosure about the anticipated transactions, the classes of derivative financial instruments used to hedge those transactions, the amounts of hedging gains and losses deferred, and the transactions or other events that result in recognition of the deferred gains or losses in earnings, SFAS No. 119 also encourages the disclosure of quantitative information about market risks of derivative financial instruments, and also of other assets and liabilities, that is consistent with the way the entity manages or adjusts risks and that is useful for comparing the results of applying the entity's strategies to its objectives for holding or issuing the derivative financial instruments. SFAS No. 119 applies to financial statements issued for fiscal years ending after December 15, 1994. The Company does not anticipate that the implementation of SFAS No. 119 will have a material impact on its results of operations or financial position.\nEMPLOYEES ----------\nThe Bank currently employs approximately 174 persons in varying capacities. The Company does not have any full-time employees at this time. (See ITEM 11. --------- EXECUTIVE COMPENSATION, for further information). -----------------------\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. --------------------\nOn December 29, 1982, the Company entered into a sublease (the \"Sublease\") for the premises covering approximately 5,735 square feet on the ground floor of a building located at 3951 South Coast Plaza Drive, Santa Ana, California 92704. The Sublease the (\"old Sublease\") had an initial term of 10 years, which expired on January 31, 1993. The Sublease was amended effective February 1, 1993 for a term of 24 months, terminating on January 31, 1995. It has further been amended to expire on January 31, 1998. The rent for the premises at the end of the term of the old Sublease was $2.61 per square foot per month. The rent under the terms of the \"new Sublease\" is $1.38 per square foot per month. The Company has assigned the Sublease to the Bank for the purpose of conducting banking operations on the premises. The Company does not independently occupy any part of the premises.\nOn May 4, 1988 the Bank entered into a lease expiring June 30, 2000 for the branch located at 22831 Lake Forest Drive, El Toro, California. The El Toro premises consist of approximately 6,672 square feet and the current monthly rent is $1.64 per square foot.\nOn September 19, 1989 the Bank entered into a lease expiring September 18, 1993 for the Service Center located at 17252 Armstrong, Suite H, Irvine, California. These premises consist of approximately 7,900 square feet. On August 26, 1994, the Company revised and extended the lease for a period of twelve months, expiring September 17, 1995, at the current monthly rent of $.67 per square foot.\nOn October 4, 1989 the Bank entered into a lease expiring December 31, 1999 for the Orange regional office located at 625 The City Drive, Orange, California. These premises consist of approximately 8,257 square feet and the current monthly rent is $2.01 per square foot.\nOn November 29, 1991 the Bank entered into a lease for a branch facility, commercial loan department and escrow division space covering approximately 14,866 square feet on the ground floor and 14,103 square feet for its headquarters office on the ninth floor of a building located at 4100 Newport Place, Newport Beach, California 92660. The Lease has an initial term of 10 years. The current rent for the premises is $1.57 per square foot per month on the ground floor and $1.55 per square foot per month for the ninth floor. Pursuant to the Lease, the Bank has an option to lease additional space on the ninth floor. The Bank is using the ground floor for banking operations and is using the ninth floor for administrative offices.\nAll of the premises leased by the Company are used by the Bank and there are no immediate plans to utilize any of the leased premises for any other purpose.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. ---------------------------\nFrom time to time, the Company or the Bank is a party to claims and legal proceedings arising in the ordinary course of business. Management of the Company evaluates the Company's or Bank's exposure to the cases individually and in the aggregate and provides for potential losses on such litigation if the amount of the loss is determinable and if the\nincurrence of the loss is probable. Because of the uncertainties and possible costs related to legal proceedings, the Bank has accrued $143,000 for potential future damages and legal fees. After taking into consideration information furnished by counsel to the Company and the Bank as to the current status of various remaining claims and legal proceedings to which the Company or the Bank is a party, management of the Company and the Bank believe that the ultimate aggregate liability represented thereby, if any, will not have a material adverse effect on the Company's consolidated financial statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. -------------------------------------------------------------\nNo matter was submitted to security holders during the fourth quarter of the fiscal year ended December 31, 1994.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER -------------------------------------------------------------------------- MATTERS. --------\nAs of January 31, 1995, there were approximately 306 shareholders of record of the Company's common stock. No shares of the Company's preferred stock have been issued or are outstanding.\nAlthough there are at least four broker\/dealers purporting to make a market in the Company's common stock, there is limited trading activity in the Company's common stock. No cash dividends have been paid on shares of the Company's common stock since the formation of the Company, and the Company presently has no intention to pay cash dividends in the foreseeable future.\nThe following table lists high and low bid prices of the Company's Common Stock in the over the counter market. Prices represent quotations by dealers making a market in the stock and reflect inter-dealer prices without adjustments for mark-ups, mark-downs or commissions and may not necessarily represent actual transactions. Trading in the Company's common stock is limited in volume and may not be a reliable indicator of its market value.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. ---------------------------------\nThe following table should be read in conjunction with, and is qualified in its entirety by, the Company's Consolidated Financial Statements and the notes thereto contained in Item 8 of this Form 10-K.\n*1 ADJUSTED FOR STOCK SPLITS IN 1990\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND -------------------------------------------------------------------------- FINANCIAL CONDITION. --------------------\nThe purpose of this discussion is to provide additional information about the Company's financial condition and results of operations which is not otherwise apparent from the consolidated financial statements included in this annual report. Since the banking subsidiary represents most of the Company's activity and investment, the following discussion relates primarily to the financial condition and operations of the Bank. It should be read in conjunction with the consolidated financial statements of the Company and the notes thereto contained in Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS. ------------------------------\nCalifornia Commercial Bankshares and Subsidiaries\nIndex to Consolidated Financial Statements\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES ----------------\nConsolidated Financial Statements for the Years Ended December 31, 1994, 1993 and 1992 and Independent Auditors' Report\nINDEPENDENT AUDITORS' REPORT\nTO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF CALIFORNIA COMMERCIAL BANKSHARES:\nWe have audited the accompanying consolidated balance sheets of California Commercial Bankshares (the 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. 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 California Commercial Bankshares 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 2 to the consolidated financial statements, in 1994 the Bank changed its method of accounting for investment securities.\nFEBRUARY 9, 1995 LOS ANGELES, CALIFORNIA\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nCONSOLIDATED BALANCE SHEETS, DECEMBER 31, 1994 AND 1993\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nCONSOLIDATED BALANCE SHEETS, DECEMBER 31, 1994 AND 1993\nSee notes to consolidated financial statements.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nCONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee notes to consolidated financial statements.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES ------------------------------------------------- CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 -------------------------------------------------------------------------------\n------------------------------------------------------------------------------- See notes to consolidated financial statements.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee notes to consolidated financial statements.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nSee notes to consolidated financial statements.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES ------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 --------------------------------------------------------------------------------\n1. GENERAL\nCalifornia Commercial Bankshares (the \"Company\") was incorporated on June 16, 1982 for the purpose of becoming a bank holding company. National Bank of Southern California (the \"Bank\") commenced operations as a wholly-owned subsidiary of the Company on January 10, 1983.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION - The consolidated financial statements include the accounts of ------------- the Company, the Bank and Venture Partners, Inc. All significant intercompany balances and transactions have been eliminated.\nCONSOLIDATED STATEMENTS OF CASH FLOWS - Cash and cash equivalents for the ------------------------------------- purpose of the consolidated statements of cash flows are defined as cash and due from banks and Federal funds sold.\nINVESTMENT SECURITIES - The Bank adopted Statement of Financial Accounting --------------------- Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, as of January 1, 1994. SFAS No. 115 requires the classification of investments in debt and equity securities into three categories: held to maturity, trading, and available for sale. Debt securities that the Bank has the positive intent and ability to hold to maturity are classified as held to maturity securities 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. The Bank has no trading securities. Debt and equity securities not classified as either held to maturity securities or trading securities are 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 equity, net of deferred taxes. As of January 1, 1994, the cumulative effect of the adoption of the new statement was not material.\nThe Bank designates investment securities as held to maturity or available for sale upon acquisition. Gain or loss on the sales of investment securities is determined on the specific identification method. Premiums and discounts on investment securities are amortized or accreted using the interest method over the expected lives of the related securities.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES ------------------------------------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nLOANS AND INVESTMENT IN LEASES - Loans and leases are carried at principal ------------------------------ amounts outstanding, net of deferred net loan origination fees, unearned lease income and the allowance for loan and lease losses.\nNonaccrual loans are those for which management has discontinued accrual of interest because (i) there exists reasonable doubt as to the full and timely collection of either principal or interest or (ii) such loans have become contractually past due ninety days with respect to principal or interest. Interest accruals may be continued for loans that have become contractually past due ninety days when such loans are well secured and in the process of collection and, accordingly, management has determined such loans to be fully collectible as to both principal and interest.\nFor this purpose, loans are considered well secured if they are collateralized by property having a realizable value in excess of the amount of principal and accrued interest outstanding or are guaranteed by a financially capable party. Loans are considered to be in the process of collection if collection of the loan is proceeding so that management reasonably expects repayment of the loan or its restoration to a current status in the near future.\nWhen a loan is placed on nonaccrual status, all interest previously accrued but uncollected is reversed against current period operating results. Income on such loans is then recognized only to the extent that cash is received and where the ultimate collection of the carrying amount of the loan is probable, after giving consideration to borrowers' current financial condition, historical repayment performance and other factors. Accrual of interest is resumed only when (i) principal and interest are brought fully current and (ii) such loans are either considered, in management's judgement, to be fully collectible or otherwise become well secured and in the process of collection.\nTroubled debt restructured loans are those for which the Company has, for reasons related to borrowers' financial difficulties, granted concessions to borrowers (including reductions of either interest or principal) that it would not otherwise consider, whether or not such loans are secured or guaranteed by others.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nTroubled debt restructuring involving only a modification of terms is accounted for prospectively from the time of restructuring. Accordingly, no gain or loss is recorded at the time of such restructuring unless the recorded investment in such loans exceeds the total future cash receipts specified by the new loan terms.\nLOAN ORIGINATION FEES - Loan origination fees, net of certain related direct --------------------- incremental loan origination costs, are deferred and amortized to income over the term of the loans using the effective interest method.\nALLOWANCE FOR LOAN AND LEASE LOSSES - The allowance for loan and lease losses is ----------------------------------- based on an analysis of the loan and lease portfolio and reflects an amount which, in management's judgment, is adequate to provide for potential loan and lease losses after giving consideration to the loan and lease portfolio, current economic conditions, past loan and lease loss experience and other factors that deserve current recognition in estimating loan and lease losses. While management uses the best information available to provide for possible losses, future adjustments to the allowance may be necessary due to economic, operating, regulatory or other conditions that may be beyond the Company's control.\nIn each reporting period, the allowance for loan and lease losses is increased by provisions for losses charged against operations in that period and recoveries of loans and leases previously charged off, and is reduced by charge- offs of loans and leases recognized in that period.\nOTHER REAL ESTATE OWNED - Other real estate owned, which represents real estate ----------------------- acquired in settlement of loans, is carried at fair value less estimated selling costs. Any subsequent operating expenses or income, reduction in estimated fair values, or gains or losses on disposition of such properties are charged or credited to current operations.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nPROPERTY - Property is stated at cost less accumulated depreciation and -------- amortization. Depreciation and amortization are computed using the straight- line basis over the estimated useful lives of the related assets (estimated to be one to five years) or, if shorter, the term of the lease in the case of leasehold improvements.\nINCOME TAXES - In January 1993, the Company adopted Statement of Financial ------------ Accounting Standards No. 109, \"Accounting for Income Taxes.\" The Company had adopted the provisions of SFAS No. 96, \"Accounting for Income Taxes,\" for fiscal 1992. Under SFAS No. 109, deferred income taxes are recognized for the tax consequences in future years of differences between the tax basis 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. The 1992 consolidated financial statements were not restated for the accounting change. The cumulative effect of adoption of the new standard was not material.\nNET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE - Net income (loss) per -------------------------------------------------------- common and common equivalent share is based on the weighted average number of common and common equivalent shares (stock options) outstanding during the year.\nRECLASSIFICATION - Certain items in the previous years' consolidated financial ---------------- statements have been reclassified to conform to the current year presentation.\n3. CASH AND DUE FROM BANKS\nThe Bank is required to meet statutory reserve requirements. In part, the Bank meets these requirements by maintaining a balance in a noninterest-bearing account at a Federal Reserve Bank. During 1994 and 1993, the average balance in this account was approximately $6,480,000 and $5,889,000, respectively.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued) ________________________________________________________________\n4. INVESTMENT SECURITIES\nBook value and market value of investment securities (in thousands of dollars) are summarized as of December 31 as follows:\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued) ________________________________________________________________\nThe maturity distribution for investment securities available for sale at December 31, 1994 is as follows (in thousands of dollars):\nProceeds from sales of investment securities available for sale were $49,229,000 for the year ended December 31, 1994. Gross realized gains were $12,000 and gross realized losses were $6,000 from sales of investment securities available for sale for the year ended December 31, 1994.\nProceeds from sales of investment securities was $9,163,000 for the year ended December 31, 1992. Gross realized gains from the sales of investment securities were $119,000 and gross realized losses from the sales of investment securities were $5,000 for the year ended December 31, 1992.\nThe carrying value of investment securities pledged as required or permitted by law amounted to $4,040,000 and $3,072,000 at December 31, 1994 and 1993, respectively.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued) ________________________________________________________________\n5. LOANS AND INVESTMENT IN LEASES\nThe loan portfolio and net investment in direct financing leases (in thousands of dollars) at December 31 is summarized as follows:\nThe Bank grants loans to customers throughout its primary market area of Southern California. The Bank makes loans to borrowers from a number of different industries, the largest of which, including undisbursed amounts, are as follows at December 31 (in thousands of dollars) (see Note 11):\nLoans in the commercial loan portfolio are collateralized primarily by accounts receivable and inventory.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nThe allowance for loan and lease losses is an estimate involving both subjective and objective factors and its measurement is inherently uncertain, pending the outcome of future events.\nManagement's determination of the adequacy of the allowance is based on an evaluation of the loan and lease portfolio, previous loan and lease loss experience, current economic conditions, volume, growth and composition of the loan and lease portfolio, the value of collateral and other relevant factors. The ongoing economic downturn in Southern California continued to have an adverse impact on the credit risk profile and performance of the Bank's loan and lease portfolio in 1994. Management believes the level of the allowance as of December 31, 1994 and 1993 is adequate to absorb losses inherent in the loan and lease portfolio; however, additional deterioration of the economy in the Bank's lending area could result in levels of loan and lease losses that could not be reasonably predicted at that date.\nA summary of the changes in the allowance for loan and lease losses (in thousands of dollars) for the years ended December 31 follows:\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nLoans and leases on which the accrual of interest has been discontinued amounted to $14,771,000 and $18,068,000 at December 31, 1994 and 1993, respectively. If interest on those loans and leases had continued to accrue, the additional income would have been $968,000 and $1,169,000 in 1994 and 1993, respectively.\nThe Bank has pledged real estate loans amounting to $5,387,000 as collateral for a line of credit with the Federal Home Loan Bank (Note 7).\n6. PROPERTY\nProperty (in thousands of dollars) at December 31 is summarized as follows:\n7. BORROWING ARRANGEMENTS\nIn December 1988, the Company obtained a $3,000,000 term loan from another financial institution for the purpose of providing additional capital to the Bank. The credit agreement for this loan was amended pursuant to a Second Amendment to the credit agreement dated August 25, 1994. The loan, as amended, bears interest at a fluctuating rate per annum equal to .75% in excess of the lender's reference rate (8.50% at December 31, 1994). Interest is payable monthly on the unpaid principal balance of the loan. Principal is to be repaid on January 1, 1997. The Second Amendment waives all financial covenants relating to the term loan. At December 31, 1994 and 1993, $2,351,000 remained outstanding on the loan.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nThe Second Amendment is supported by a Support Agreement between a shareholder of the Company and the Company, whereby the shareholder has guaranteed the payment of the loan.\nTo compensate the shareholder for signing the Support Agreement, the Company signed a Holding Company Support Agreement whereby the Company: (1) has paid the shareholder a standby fee of $23,500, (2) will pay a standby fee equal to one percent of the unpaid principal amount of the term loan on each anniversary date of the closing date of the Holding Company Support Agreement (3) will issue to the shareholder on or prior to March 31, 1997 warrants to purchase 25,000 shares of common stock of the Company at an exercise price per share equal to 80% of the book value per share of the Company on December 31, 1996.\nThe Bank maintains two lines of credit with outside financial institutions for the purpose of purchasing Federal funds. The lines of credit bear interest at a floating rate and provide for borrowing up to $8,000,000 and $2,000,000, respectively. At December 31, 1994 and 1993, no amounts were outstanding on these lines of credit.\nUnder an agreement with the Federal Home Loan Bank, the Bank may obtain an extension of credit of up to 5% of total assets collateralized by real estate loans. At December 31, 1994, the Bank had pledged loans amounting to $5,387,000 and had available credit of $2,694,000 based on 50% of the outstanding balance of pledged loans. No amounts were outstanding on this line of credit at December 31, 1994 and 1993.\n8. EMPLOYEE BENEFIT PLANS\nThe Company has a stock option plan that permits the granting of options to directors, officers and employees to purchase, at the fair market value of the common stock on the date of grant, up to 750,000 shares of the Company's common stock. The outstanding options become exercisable over a period of ten years.\nA summary of stock option transactions for each of the three years in the period ended December 31 is as follows:\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nAt December 31, 1994, options for 227,646 shares were exercisable.\nDuring the year ended December 31, 1993 and 1992, 96,050 and 172,500 options were exercised and paid for with cash of $189,000 and 18,050 shares of common stock previously outstanding and $316,000 and 41,500 shares of common stock previously outstanding. No options were exercised during 1994.\nThe Company also has stock option plans it uses as a means of compensating directors for services performed. During the years ended December 31, 1994, 1993 and 1992 no options were granted, exercised or cancelled. At December 31, 1994, options for 16,000 shares were outstanding and exercisable.\nThe Company maintains a stock bonus plan that covers substantially all Company employees. The plan provides for the issuance to participating employees of share units in the plan, which entitles participants to distributions primarily of common stock of the Company. Contributions to the plan are held in trust and invested in common stock of the Company (which is purchased from third parties) or other investments under the terms of the plan agreement. Contributions are determined based on management's discretion. The Company's contributions for 1994 and 1993 were $5,000 and $51,000, respectively. There were no contributions in 1992.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nThe Bank has a defined contribution plan, which meets the requirements of Section 401(k) of the Internal Revenue Code and covers substantially all employees. The Bank's contributions are determined as a percentage of each participant's contribution. The amounts contributed to the plan by the Bank were $88,000, $81,000 and $77,000 for 1994, 1993 and 1992, respectively.\nIn 1987, the Company purchased cost recovery life insurance with aggregate death benefits in the amount of $2,473,000 on the lives of the senior management participants. The Company is the sole owner and beneficiary of such policies, which were purchased to fund the Company's obligation under separate deferred compensation arrangements. The cash surrender values and obligation under deferred compensation agreements at December 31, 1994 and 1993 of $1,167,000 and $1,104,000, respectively, and $189,000 and $201,000, respectively, have been included in other assets and in other liabilities, respectively, in the accompanying consolidated balance sheets.\n9. RELATED PARTY TRANSACTIONS\nIn the ordinary course of business, the Bank has granted loans to certain directors, executive officers and the businesses with which they are associated. All such loans and commitments to loans were made under terms that are consistent with the Bank's normal lending policies.\nThe following is an analysis of the activity of all such loans for the years ended December 31:\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) -------------------------------------------------------------------------------\n10. INCOME TAXES\nIncome tax expense (benefit) for the years ended December 31 is as follows:\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued) ________________________________________________________________\nIncome tax expense (benefit) for the years ended December 31 (in thousands of dollars) varies from the amounts computed by applying the statutory Federal income tax rate as a result of the following factors:\nThe following tables show the components of the provision for deferred income taxes as of December 31, 1992:\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES ________________________________________\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nThe Company has recorded net deferred tax assets as of December 31 consisting principally of the following:\nDeferred tax assets arising from deductible temporary differences are expected to reverse in the years indicated above.\nIn the event the future consequences of differences between financial accounting bases and the tax bases of the Company's assets and liabilities result in a deferred tax asset, SFAS 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred asset is recorded when it is more likely than not that some portion or all of the deferred asset will not be recognized.\nAt December 31, 1994, the Company has a California state net loss carryforward of $1,007,000 which expires primarily in 1998.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\n11. COMMITMENTS AND OTHER MATTERS\nOPERATING LEASES - At December 31, 1994, the Company and the Bank were obligated under various noncancelable lease agreements, classified as operating leases, primarily for the rental of office space. Certain leases for office space contain provisions for renewal options of one or two five-year periods. Minimum future rental payments under these lease agreements are summarized as follows:\nTotal rental expense was $1,072,000, $1,173,000 and $1,022,000 in 1994, 1993 and 1992, respectively.\nThe 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 include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank's exposure to credit loss in the event of nonperformance by the other party to commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. At December 31, 1994 and 1993, the Bank had primarily variable rate commitments to extend credit of $47,920,000, and $37,267,000, respectively, and obligations under standby letters of credit of $1,629,000 and $1,550,000, respectively.\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\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nfuture cash requirements. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.\nThe Bank uses the same credit policies in making commitments and conditional obligations as it does for extending loan facilities to customers. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment or real estate.\n12. LEGAL PROCEEDINGS\nFrom time to time, the Company or the Bank is a party to claims and legal proceedings arising in the ordinary course of business. Management of the Company evaluates the Company's or Bank's exposure to the cases individually and in the aggregate and provides for potential losses on such litigation if the amount of the loss is determinable and if the incurrence of the loss is probable. After taking into consideration information furnished by counsel to the Company or the Bank as to the current status of various claims and legal proceedings to which the Company or the Bank is a party, management of the Company or the Bank believes that the ultimate aggregate liability represented thereby, if any, will not have a material adverse effect on the Company's consolidated financial statements.\n13. RISK-BASED CAPITAL STANDARDS AND OTHER REGULATORY MATTERS\nOn April 8, 1992, the Bank executed a Formal Agreement (the \"Agreement\") with the Office of the Comptroller of the Currency (the \"Comptroller\") in which the Bank agreed to take specific action with respect to classified assets and the allowance for loan and lease losses, maintain specific minimum capital levels, obtain prior approval of changes in Directors and executive officers, strengthen controls over loan administration and real estate loan appraisals, improve liquidity management, submit a three-year capital program and obtain prior written approval from the Comptroller before dividends may be declared. Management believes that the Bank is in substantial compliance with all terms of the Agreement.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nOn May 27, 1993, the Company executed a Memorandum of Understanding (the \"memorandum\") with the Federal Reserve Bank of San Francisco (the \"Fed\") under which the Company submitted a summary plan of action to improve conditions in the Bank, cannot declare cash dividends without prior notice to the Fed, and must obtain prior approval of changes in Directors or executive officers. Management of the Company believes the Company is in substantial compliance with the terms of the memorandum.\nRisk-based capital guidelines require that the Company and the Bank maintain a minimum total capital of 8% of risk-weighted assets. Further, at least 4% of the required capital must be \"core\" (Tier 1) capital. Leverage capital guidelines require, generally, that the Company and the Bank maintain a minimum ratio of (Tier 1) capital to total assets of 4%. The Agreement requires the Bank to maintain a minimum ratio of total capital to risk-weighted assets of 9% and a minimum ratio of core capital to adjusted total assets of 6%. At December 31, 1994, the Company's total capital to risk-weighted assets and core capital to risk weighted assets were 11.24% and 10.00%, respectively. At December 31, 1994, the Bank's total capital to risk-weighted assets and core capital to risk weighted assets were 12.07% and 10.82%, respectively. At December 31, 1994, the Company's and the Bank's leverage ratios were 6.97% and 7.47%, respectively. At December 31, 1994, the Bank was in compliance with the capital requirements set forth in the Agreement.\nUnder Federal and California laws and regulations, the Company and the Bank are subject to restrictions related to the payment of dividends and the transfer of funds from the Bank to the Company through intercompany loans and advances.\n14. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY\nBalance sheets as of December 31:\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nLiabilities and Shareholders' Equity ------------------------------------\nStatements of operations for the years ended December 31:\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES _________________________________________________\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\n15. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS\nIn accordance with Statement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments,\" a summary of the estimated fair value of the Company's consolidated financial instruments as of December 31, 1994 and 1993 is presented below. The estimated fair value amounts have been determined by management using available market information and appropriate valuation methodologies. However, assumptions are necessary to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different assumptions and\/or estimation methodologies may have a material effect on the estimated fair value amounts.\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nThe carrying value of cash and due from banks, Federal funds sold, savings and demand deposits, note payable and commitments is a reasonable estimate of the fair value. The fair value of investment securities is based on quoted market prices.\nThe fair value of loans and investment in leases is estimated by discounting the 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. The fair value of classified loans with a carrying value of approximately $38,956,000 and $43,470,000 as of December 31, 1994 and 1993, respectively, was not estimated because it is not practical to reasonably assess the credit adjustment that would be applied in the market place for such loans. These classified loans, which are primarily real estate or construction loans, have a weighted average interest rate ranging from 9.50% to 13.50% and from 7.79% to 11.50% as of December 31, 1994 and 1993, respectively, and are due at various dates through the year 2017.\nThe fair value of time deposit accounts is the amount payable on demand at December 31, 1994. The fair value of term deposit accounts is estimated using the rates currently offered for deposits of similar remaining maturities.\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 factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these consolidated financial statements since that date and, therefore, current estimates of fair value may differ significantly from amounts presented herein.\n16. ACCOUNTING PRONOUNCEMENTS\nIn May 1993, the Financial Accounting Standards Board (\"FASB\") issued Statement on Financial Accounting Standards No. 114 (\"SFAS 114\"), \"Accounting by Creditors for Impairment of a Loan\" as amended by SFAS 118, \"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures\". Under the provisions of 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\nCALIFORNIA COMMERCIAL BANKSHARES AND SUBSIDIARIES -------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED) --------------------------------------------------------------------------------\nof the loan agreement. SFAS 114, as amended, requires creditors to measure impairment of a loan based on the present value of expected future cash flows discounted at the loan's effective interest rate. If the measure of the impaired loan is less than the recorded investment in the loan, a creditor will recognize an impairment by creating a valuation allowance with a corresponding charge to bad debt expense. This statement also applies to restructured loans and eliminates the requirement to classify loans that are in-substance foreclosures as foreclosed assets except for loans where the creditor has physical possession of the underlying collateral, but not legal title. SFAS 114 must be adopted by the Company January 1, 1995. The Company does not believe adoption of this statement will have a material impact on its results of operations or financial position.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING 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 lists information regarding all directors and executive officers of the Company.\nPHILLIP L. BUSH, 58 years of age, has been a Director and Secretary of the Company since 1982. Mr. Bush has been a practicing attorney with the firm of Bush, Bush and Larsen, in Fountain Valley, California since 1967. Mr. Bush's practice is primarily litigation of personal injury matters. He also has practiced in the areas of real estate development and syndication, and business enterprise organization and formation.\nMICHAEL J. GERTNER, 55 years of age, has been a Director of the Company since 1982. Mr. Gertner is a partner in the law firm of Michael Avey Gertner, a professional corporation in Newport Beach, California. He is licensed to practice law in both California and New York. Mr. Gertner is also a Certified Public Accountant and specializes in the areas of taxation, estate planning and estate administration.\nJAMES W. HAMILTON, 62 years of age, has been a Director of the Company since 1982. Mr. Hamilton is Senior Counsel to the law firm of Paul, Hastings, Janofsky & Walker of which he has been a partner from 1965 until 1993. His office is in the firm's Costa Mesa facility. He specializes in securities and corporate law.\nFARRELL G. HINKLE, DDS, MSD, 52 years of age, has been a Director of the Company since 1982. Dr. Hinkle is an Orthodontist with offices in Newport Beach and Santa Ana. He has been practicing Orthodontics since 1973. He has a degree in Mathematics and graduated from the UCLA School of Dentistry as a Regents Scholar in 1971. He also earned a Certificate in Orthodontics and a Masters Degree from the University of Washington in 1973.\nWILLIAM H. JACOBY, 56 years of age, has been a Director, and the President and Chief Executive Officer of the Company since 1982 and is also Chairman of the Board and Chief Executive Officer of the Bank. Mr. Jacoby began his banking career in 1960 with First Interstate Bank of California. In 1979 Mr. Jacoby joined Westlands Bank and served in various positions until joining the Company in June 1982 during its organizational period.\nROBERT L. MCKAY, 64 years of age, is a private investor in Orange County, California, where he oversees his investments in Venture Capital for business and real estate. From 1966 to 1981 Mr. McKay was President of Taco Bell, Inc.\nMARK H. STUENKEL, 42 years of age, is, and since November 1982 has been, Exectutive Vice President of the Company. He is, and since December 1988 has been President of the Bank. He was previously Executive Vice President of the Bank since 1982. Mr. Stuenkel was made a Director of the Company in 1987. He started his banking career in 1974 and prior to joining the Bank held various positions with Security Pacific National Bank.\nDANNIE M. HAYES, 53 years of age, is, and also has been since May 1993, Executive Vice Presient and Senior Credit Officer of the Bank. Mr. Hayes began his banking career in 1963 and prior to joining the Company held various senior positions with Security Pacific National Bank and City National Bank.\nABDUL S. MEMON, 49 years of age, is, and since 1983 has been, Chief Financial Officer and Assistant Secretary of the Company and Senior Vice President, Cashier, Controller and Assistant Secretary of the Bank. Mr. Memon began his banking career in 1973 and prior to joining the Company held various senior positions with Westlands Bank.\nEffective February 1991, the director's fee paid to non-employee Directors has been $1,000 per meeting attended and the fee for attending committee meetings has been $375 per meeting attended. No fee is paid to employee directors.\nIn lieu of the usual cash director's fee paid to the non-employee Directors, certain non-employee directors (who elect to participate) entered into discounted stock option agreements granting such directors the right to purchase all or a part of an aggregate of 900 shares of the Company's Common Stock at an exercise price equal to the sum of $1.00 per share plus an adjustment for Board of Directors' meetings which were missed by the non-employee Directors throughout 1991. The exercise price to be paid for the shares and the number of shares subject to option were based upon fair market value of the Company's Common Stock as determined by the Board of Directors on the date of grant as compared with the cash fees the directors would otherwise receive. The purpose of granting the discounted stock options to the non-employee directors is to conserve the Bank's cash for utilization in its business and to provide an opportunity for the directors to increase their personal interest in the Company's long-term success and profitability. Mr. Hinkle, a non-employee director, participated in the plan during 1991. None of the non-employee directors participated in the plan since 1992.\nThere is no family relationship between any of the officers or directors of the Company and no legal proceedings have been brought against officers with respect to the performance of their duties for the Bank.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. ---------------------------------\n(A) SUMMARY COMPENSATION TABLE\nThe following Summary Compensation Table sets forth information for the fiscal year ended December 31, 1994 concerning all plan and non-plan compensation awarded to, earned by, or paid to (i) the Company's Chief Executive Officer (\"CEO\") at the end of such fiscal year, regardless of compensation level, and (ii) the Company's four most highly compensated executive officers other than the CEO who were serving as executive officers at the end of such fiscal year and whose compensation exceeded $100,000, if any.\nSUMMARY COMPENSATION TABLE --------------------------\n---------------------- # - Number of units $ - Dollar amount\n* Includes vacation pay of $9,000. ** Amounts reported represent Company's matching contribution to the 401-K Plan. None of the named officers had other annual compensation in excess of $50,000 or 10% of the total annual salary and bonus reported for any of the last three fiscal years.\nThe following letter footnotes contain information which relate to the corresponding lettered columns in the above table:\n(c) The dollar value of base salary (cash and non-cash) earned by the named executive officer.\n(d) The dollar value of bonus (cash and non-cash) earned by the named executive officer during the fiscal year covered, even if deferred at the election of the executive officer.\n(e) The dollar value of other annual compensation not properly categorized as salary or bonus; including (i) perquisites and other personal benefits, securities or property unless the aggregate amount of such compensation is the lesser of either $50,000 or 10% of the total annual salary and bonus reported for the named executive officer in columns (c) and (d); (ii) above-market or preferential earnings on restricted stock, options, stock appreciation rights (\"SARs\") or deferred compensation paid during the fiscal year or payable during that period but deferred at the election of the named executive officer, (iii) earnings on long-term incentive plan(\"LTIP\") compensation paid during the fiscal year or payable during that period but deferred at the election of the named executive officer; (iv) amounts reimbursed during the fiscal year for the payment of taxes; and (v) the dollar value of the difference between the price paid by a named executive officer for any security of the Company or its subsidiaries purchased from the Company or its\nsubsidiaries (through deferral of salary or bonus, or otherwise), and the fair market value of such security at the date of purchase, unless that discount is available generally, either to all security holders or to all salaried employees of the company.\n(b) STOCK OPTIONS AND STOCK APPRECIATION RIGHTS TABLES -------------------------------------------------------\nOption\/SAR Grants in Last Fiscal Year\nThe following table discloses grants of stock options and stock appreciation rights (\"SARs\") to the named executive officers during the year ended December 31, 1994. Multiple grants are aggregated only if they have the same terms, such as exercise price and expiration dates. The table also discloses information related to the potential realizable value of the awards at assumed annual rates of stock price appreciation (5% and 10%) compounded annually over the option\/SAR term.\nOPTIONS\/SAR GRANTS FOR THE YEAR ENDED DECEMBER 31, 1994 -------------------------------------------------------\n* As an alternative to disclosing the potential realizable value, the registrant may opt to disclose the fair value of the option\/SAR at the grant date using a financial formula such as the Black-Scholes model (or some other method as long as the methodology and significant assumptions are disclosed).\nAggregated Option\/SAR Exercises in Last Fiscal Year and FY-End option\/SAR Values\nThe following table describes the aggregate option\/SAR exercised during fiscal year ended December 31, 1994 and unexercised options\/SARs for each named executive officer at the end of such fiscal year:\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION\/SAR VALUES ----------------------------\nDuring the fiscal year ended December 31, 1994, the Company did not reprice any options or SARs held by a named executive officer or otherwise reduce the terms of exercise. No options or SARs held by any executive officer over the last ten years have been repriced or modified.\n(C) LONG-TERM INCENTIVE PLAN ('LTIP\") AWARDS TABLE ---------------------------------------------------\nThe following table describes awards to the named executive officers under long- term incentive plans (\"LTIP\") during the fiscal year ended December 31, 1994, of items such as phantom stock, restricted stock units, dividend equivlants, and performance shares or units. The disclosures encompass plans that are \"stock- based\" where the benefits are a function of market price movements, as well as plans prescribing performance criteria other than or in addition to market price. For the latter type of plan, the table discloses the estimated payouts realizable in relation to the performance targets (threshold, target, and maximum).\nLONG-TERM INCENTIVE PLANS - AWARDS IN LAST FISCAL YEAR ------------------------------------------------------\n(D) DEFINED BENEFIT OR ACTUARIAL PLAN DISCLOSURE -------------------------------------------------\nAlthough the Company has no defined benefit plan or actuarial plan, the Company has entered into certain executive salary continuation agreements with Messrs. Jacoby, Stuenkel and Memon. Please see \"(F) Employment Contracts and Termination of Employment and Change-in Control Arrangements\".\n(E) COMPENSATION OF DIRECTORS ------------------------------\nSince February 1991, the director's fee paid to non-employee directors of the Bank has been $1,000 per board meeting attended and $375 per Committee meeting attended. The total amounts of director's fees paid and accrued by the Bank during the fiscal years ended December 31, 1994, 1993 and 1992 were $130,000, $147,000 and $166,000, respectively. No director's fees are paid by the Company.\n(F) EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN CONTROL ----------------------------------------------------------------------------- ARRANGEMENTS ------------\nIn 1988, the Bank entered into Executive Salary Continuation Agreements with Messrs. Jacoby, Stuenkel and Memon. Pursuant to the agreements, each executive receives benefits upon his retirement or upon termination of service with the Bank prior to retirement unless such executive's employment with the Bank is terminated prior to retirement either (i) voluntarily by the executive other than for \"Good Reason\" (as defined in the agreements) or (ii) by the Bank for \"Cause\" (also defined in the agreements), in which case no benefits or payments are paid pursuant to the agreements. The agreements also provide each executive with benefits (to the extent such benefits are vested at the time) if his employment is terminated by the Bank prior to the executive's retirement for any reason other than the executives's death, disability, for Cause or is terminated by the executive for Good Reason. With the exception of Mr. Jacoby whose benefits vest at the rate of ten percent (10%) per year for each year of employment that he has been employed by the Bank, benefits vest under the agreements at the rate of ten percent (10%) per year for each year that the executive has been employed by the Bank commencing as of January 1, 1988, up to a maximum of 100%.\nUnder the agreements, the executives shall receive the following yearly sums for a period of fifteen (15) years after either their retirement from the Bank or upon their death: Mr. Jacoby, $70,000; Mr. Stuenkel, $55,000; and Mr. Memon, $20,000. If one of the executives' employment with the Bank is terminated because of disability prior to retirement, such executive (or his\/her Estate) shall be entitled to receive the above benefits upon retirement or death or in lieu thereof, to elect to receive a disability benefit in an amount equal to the present value of such executive's retirement benefits under the agreement.\nEach agreement also has provisions which become effective upon the occurrence of a \"Change in Control\" (as defined therein) of the Company or the Bank. In such event, the agreements become employment agreements with three-year terms for Mr. Jacoby and Mr. Stuenkel and employment agreements with eighteen month terms for Mr. Memon. The agreements also provide for the executives' compensation to increase annually. The executives shall also continue to receive all non-cash forms of compensation and benefits which they received prior to the Change in Control for such three year term. Under the agreements, a Change in Control is deemed to have occurred if (a) any person (other than the Company's directors as of the date of the agreements) becomes the beneficial owner of more than 40% of the Company's outstanding Common Stock (exclusive of shares held in the Company's treasury or by the Company's subsidiaries) which such stock shall have been acquired after the date of the agreements pursuant to a tender offer, exchange offer or series of purchases or other acquisitions, or any combination of such transactions; (b) there is a change in the Company's or the Bank's Board of Directors at any time within two years after any tender offer, exchange offer, merger, consolidation, sale of assets or contested election or any combination of those transactions (the \"transaction\") so that persons who are directors of the Company or the Bank immediately before the first transaction cease to constitute a majority of the Board of Directors of the Company or the Bank any corporation which may be the successor to the Company of the Bank in any such transaction; or (c) the Company sells, transfers or otherwise disposes of substantially all of its assets and properties including the stock of the Bank or the Company shall cause the Bank to sell, transfer or otherwise dispose of substantially all of the Bank's assets and properties.\nIf after a Change in Control one of the executives shall either terminate his\/her employment for a Good Reason or be terminated by the Bank for any reason other than Cause, then the Bank shall pay such executive the cash compensation during his\/her remaining term (but in the case of Messrs. Jacoby and Stuenkel such payments shall not be less than two times the executives' annual cash compensation and in the case of Mr. Memon, not less than one times the executives' annual cash compensation). Moreover, all employee benefits plans and programs in which the executives are entitled to participate shall continue for the remainder of the executives' terms and the executives shall continue to receive the retirement, death and disability benefits under the agreements.\nDISCOUNTED STOCK OPTION AGREEMENT\nIn January 1988, the Company granted William H. Jacoby an option to purchase 1,980 shares of the Company's Common Stock pursuant to a Discounted Stock Option Agreement. The option was granted to Mr. Jacoby in consideration of his past performance as an officer of the Company. The option to purchase shares granted to Mr. Jacoby was intended to be the equivalent at its inception to a $24,500 bonus. As a result, the option price to be paid upon exercise for the shares is only $1.00; such price being determined by the difference between the exercise price and the fair market value of the Company's Common Stock as determined by the Board of Directors on the date of grant. Subject to the conditions set forth in the Agreement, the option may be exercised in whole or in part at any time.\nSTOCK OPTION PLAN\nThe Company had a Stock Option Plan (the \"Plan\") for its directors, officers and full time employees. The Company's Board of Directors administered the Plan and decide to whom and upon what terms options shall be granted. Subject to adjustment by reason of stock splits or similar capital adjustments, the plan provided for the granting of nonstatutory stock options as well as incentive stock options to purchase an aggregate of 750,000 shares of the Company's Common Stock. The purpose of the Plan was to compensate certain of the organizers of the Company and the Bank, and to provide incentives to key employees to remain in the employ of the Company and the Bank.\nOptions were not transferable under the Plan other than by will or by the laws of descent and distribution and during the participant's lifetime were exercisable only by the participant. The option price per share for options granted under the Plan had to be at least 100% of the fair market value of the Common Stock on the date any such options were granted, except that in the case of a shareholder owning more than 10% of the total combined voting power of all classes of the outstanding stock of the Company, the option price for incentive stock options had to be a least 110% of the fair market value on the date of grant. Upon expiration or termination of any outstanding options, shares remaining unexercised became available for grant under the Plan.\nAs of December 31, 1994, options to purchase 229,446 shares of Common Stock were outstanding at prices ranging from $4.33 to $13.00 per share. No options were exercised during 1994.\nSTOCK BONUS PLAN\nEffective January 1, 1986, the Company adopted a Stock Bonus Plan (the \"Stock Bonus Plan\") and established a related trust. Subject to certain eligibility requirements for time of service, all of the Company's employees participate in the Stock Bonus Plan. The Stock Bonus Plan is a tax-credit employee stock ownership plan and is administered by the Board of Directors or the Chief Executive Officer. The amount of the Company's contributions of cash or securities of the Company to the Stock Bonus Plan is determined by the Board of Directors (or the Chief Executive Officer). Subject to certain limitations, such contributions are allocated to each participant's account in proportion to such participant's compensation earned during the applicable Stock Bonus Plan year. Allocations to a participant's account vest in accordance with the schedules set forth in the Stock Bonus Plan. Distributions to participants are made at participants' death, retirement, disability, or termination of employment. Participants are not permitted to make voluntary contributions to the Stock Bonus Plan and the Stock Bonus Plan may not make loans to participants. Any cash amounts contributed to the Stock Bonus Plan will be used primarily to purchase securities issued by the Company. The Company contributed $15,000 to the Stock Bonus Plan for 1994. Of such allocations Mr. Jacoby, Mr. Stuenkel and Mr. Hayes received less than $1,000 each.\n401-K PLAN\nEffective February 1, 1989 the Company established a 401-K Plan which enables employees to defer a portion of their wages tax free subject to limitations established by the Internal Revenue Service. All the employees at the completion of certain eligibility requirements for time of service can elect to participate in the plan. Under the plan, the Company may make matching contributions to the plan up to stated limits. Such contributions are determined by the Board of Directors at the beginning of the year. The vesting of such contributions to the employees is based on the time of service since the effective date of the plan.\n(G) ADDITIONAL INFORMATION WITH RESPECT TO COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION DECISION.\nNot Applicable.\n(H) BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION.\nIt is the duty of the Compensation Committee to administer the Company's compensation program and various incentive plans, including its stock option plan and its annual bonus plan. In addition, the Committee reviews compensation levels of members of management, evaluates the performance of management, considers management succession and related matters. The Committee reviews with the Board in detail all aspects of compensation for senior officers.\nThe Committee has reviewed the compensation for each of the five highest paid officers for 1994 and has reported to the Board that in the Committee's opinion, the compensation of all officers is reasonable in view of the Company's consolidated performance and the contribution of those officers to that performance. In doing so, the Committee takes into account how compensation compares to compensation paid by competing companies as well as the Company's performance and economic conditions in the Company's service area. Members of the Committee also review compensation surveys provided by the State Banking Department and others.\nOfficers' individual salaries for 1994, were established relative to the mid point for salaries paid to officers of comparable companies, taking into consideration the length of service in the position and other factors. The performance award under the incentive plan took into consideration the Company's performance and the individual's performance and impact in a turnaround of the Company's financial results despite a very difficult year in banking and the Southern California economy.\nThe Company has an Officer Incentive Program to motivate and compensate officers for their individual performance as well as to encourage a spirit of cooperation and teamwork to achieve the maximum performance for the Company as a whole. The Incentive Program is established prior to the beginning of each year by the Board of Directors after it reviews a recommendation from the Compensation Committee. The Directors establish a goal for pretax income for the Company at the start of the year based upon their evaluation of the local economy, a desired performance goal, and any special circumstances that effect projected income. Officers participating in the Incentive Program are those officers who are expected to have a direct impact upon the net income of the Bank. Additionally each officer is assigned a specific goal such as the amount of deposits, loans, or other requirements of their position. A determination is then made by the committee at the end of the year regarding whether the Bank has met its threshold goal and whether the individuals have met their specific goals. An Incentive award is then granted to officers who have met their goal based upon their level of performance combined with that of the Bank. The Incentive Plan for executive officers was based primarily on the goal of achieving specific net income and asset quality goals. The established goals were achieved and resulted in the award of an incentive payment of $22,000 to Mr. Jacoby, $16,000 to Mr. Stuenkel and $5,000 to Mr. Hayes for the year ended December 31, 1994.\nDuring 1994, there were no stock option grants to any of the senior officers of the Company.\nNo member of the Committee is a former or current officer or employee of the Company or any of its subsidiaries.\nThis report was completed by the Compensation Committee as of January 15, 1995. The members of the Compensation Committee filing this report are Phillip L. Bush, Michael J. Gertner, James W. Hamilton and Robert L. McKay.\n(I) PERFORMANCE GRAPH.\nThe performance graph below compares the five-year cumulative total return on the Company's Common Stock, assuming reinvestment of dividends, with the total returns on the Standard & Poor's 500 Stock Composite Index (S&P 500) and the Montgomery Securities' Western Bank Monitor (Southern California Proxy), a peer ------------------------------------------------ group index compiled by Montgomery Securities, consisting of the Company and the following other southern California banks: ValliCorp, Mid-State Bank, Santa Barbara Bancorp, CU Bancorp, Foothill Independent, City National Corporation, GBC Bancorp, Imperial Bancorp, Santa Monica Bank, Home Interstate Bancorp, Landmark Bancorp, CVB Financial Corp, Eldorado Bancorp, Riverside National Bank and Peninsula Bank of San Diego. The Company selected the Western Bank Monitor -------------------- (Southern California Proxy) because it provides a representative sample of --------------------------- southern California community banks. This index should be available on a continuing basis.\nPlease see the graph on the following page.\nCalifornia Commerical Stock Price Performance\n[PLOT POINTS TO COME]\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. -------------------------------------------------------------------------\nThe shares of the Company's Common Stock constitute the only class of voting securities of the Company. As of March 13, 1995 there were 2,425,000 shares of common stock outstanding and entitled to vote. As of March 13, 1995, there were approximately 306 shareholders of record.\nSet forth in the table on the following page is certain information regarding persons who according to the Company's records own more than five percent of the voting securities of the Company as of March 13, 1995, each director of the Company and all directors and officers of the Company as a group.\nITEM 12. (CONTINUED)\n(1) Except as otherwise indicated, each of the persons named in the table has sole power to vote and dispose of his shares of the Company's Common Stock, subject to community property laws where applicable.\n(2) Includes 15,000 shares of the Company's Common Stock which may be purchased on the exercise of stock options.\n(3) Includes 18,447 shares of the Company's Common Stock which may be purchased on the exercise of stock options.\n(4) Includes 4,347 shares of the Company's Common Stock which may be purchased on the exercise of stock options.\n(5) Includes 34,455 shares of the Company's Common Stock which may be purchased on the exercise of stock options.\n(6) Includes 38,250 shares of the Company's Common Stock which may be purchased on the exercise of stock options.\n(7) Includes an aggregate of 205,446 shares of the Company's Common Stock which may be purchased on the exercise of stock options.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. ---------------------------------------------------------\nThe Bank has had, and expects to have in the future, banking transactions in the ordinary course of its business with directors, principal shareholders and their associates on the same terms, including interest rates and collateral securing loans, as those prevailing at the time for comparable transactions with unaffiliated persons, and which do not involve more than a normal risk of collectibility, nor present other unfavorable features.\nPlease refer to Note 7 (Borrowing Arrangements) of Item 8 (Financial Statements) regarding the Support Agreement between and director\/shareholder, Robert L. McKay, and the Company, and the related compensations paid currently or which will be paid in the future by 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.\nFinancial statements and schedules of the registrant are listed in the index to Consolidated Financial Statements contained under Part II Item 8. Financial Statements and Supplementary Data of this report.\n(2) FINANCIAL STATEMENT SCHEDULES.\nAll Financial statement schedules are omitted either because the conditions under which they are required are not applicable or because the information is included in the Financial Statements.\n(3) EXHIBITS:\n(3) (A) Articles of Incorporation of California Commercial Bankshares as amended. (Incorporated by reference from Company's Form 10-K filed on March 31, 1990).\n(3) (B) By-Laws of California Commercial Bankshares, as amended. (Incorporated by reference from the Company's Form 10- K filed on March 31, 1989.)\n(10) (A) Office Sublease between First California Associates and the Company (Incorporated by reference from the Company's Form 10-K filed on March 31, 1983).\n(10) (B) Form of Incentive Stock Option Agreement (Incorporated by reference from the Company's Form 10-K filed on March 31, 1983).\n(10) (C) Form of Non-Statutory Stock Option Agreement (Incorporated by reference from the Company's Form 10-K filed on March 31, 1983).\n(10) (D) First Amendments to Sublease between First California Associates and the Bank (Incorporated by reference from the Company's Form 10-K filed on March 31, 1984).\n(10) (E) The Company's Stock Bonus Plan (Incorporated by reference from the Company's Form 10-K filed on March 31, 1986).\n(10) (F) Amendments to Office Sublease between First California Associates and the Company (Incorporated by reference from the Company's Form 10-K filed March 31, 1986).\n(10) (G) Form of Discounted Stock Option Agreement (Incorporated by reference from the Company's Form 10-K filed March 31, 1987).\n(10) (H) Executive Salary Continuation Agreement between National Bank of Southern California and William H. Jacoby. (Incorporated by reference from the Company's Form 10-K filed March 31, 1989).\n(10) (I) Executive Salary Continuation Agreements between National Bank of Southern California and Mark H. Stuenkel. (Incorporated by reference from the Company's Form 10-K filed March 31, 1987).\n(10) (J) Executive Salary Continuation Agreement between National Bank of Southern California and Abdul S. Memon. (Incorporated by reference from the Company's Form 10-K filed March 31, 1987).\n(10) (K) Executive Salary Continuation Agreement between National Bank of Southern California and Barbara J. Morales. (Incorporated by reference from the Company's Form 10-K filed March 31, 1987).\n(10) (L) 401-K Plan. (Incorporated by reference from the Company's Form 10-K filed March 31, 1989).\n(10) (M) Lease for the premises on branch located at 22831 Lake Forest Drive, El Toro, Ca. (Incorporated by reference from the Company's Form 10-K filed March 31, 1989).\n(10) (N) Lease for the premises on branch located at 625 The City Drive, Orange, Ca. (Incorporated by reference from Company's Form 10-K filed on March 31, 1990).\n(10) (O) Lease for the property on branch located at 17252 Armstrong Ave., Irvine, Ca. (Incorporated by reference from Company's Form 10-K filed on March 31, 1990).\n(10) (P) 1982 Stock Option Plan, as amended. (Incorporated by reference from Company form 10-K filed on March 31, 1991).\n(10) (Q) Lease for the property located at 4100 Newport Place, Newport Beach, Ca. (Incorporated by reference from Company's Form 10-K filed on March 31, 1992).\n(10) (r) Credit Agreement dated 12\/21\/1988 with Security Pacific National Bank. (Incroporated by reference from Company's Form 10-K filed on March 31, 1994).\n(10) (s) First amendment to Credit Agreement dated March 1993 with Bank of America National Trust & Savings Association. (Incorporated by reference from Company's Form 10-K filed on March 31, 1994).\n(10) (t) Second amendment to Credit Agreement dated August 24, 1994 with Bank of America National Trust & Savings Association.\n(10) (u) Support Agreement dated September 27, 1994 with Robert L. McKay.\n(10) (v) Holding Company Support Agreement dated October 1, 1994 with Robert L. McKay.\n(22) Subsidiaries of the Company\n(24) Independent Auditors' Consent.\n(27) Financial Data Schedule.\n(b) Reports on Form 8-K. No report on Form 8-K were filed by the Company during the last quarter of 1992.\n(c) Exhibits Filed.\nThe following exhibits are filed with this 10-K\n(10) (t) Second amendment to Credit Agreement dated August 24, 1994 with Bank of America National Trust & Savings Association.\n(10) (u) Support Agreement dated September 27, 1994 with Robert L. McKay.\n(10) (v) Holding Company Support Agreement dated October 1, 1994 with Robert L. McKay.\n(22) Subsidiaries of the Company.\n(24) Independent Auditors' Consent.\n(27) Financial Data Schedule.\n(d) Financial Statement Schedules.\nPlease see paragraph (a)(2) above in this Item 14.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCALIFORNIA COMMERCIAL BANKSHARES\nBY: William H. Jacoby MARCH 24, 1994 ----------------------------- WILLIAM H. JACOBY 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:\nPhillip L. Bush MARCH 24, 1994 ---------------------------------- PHILLIP L. BUSH DIRECTOR\/SECRETARY\nMichael J. Gertner MARCH 24, 1994 ---------------------------------- MICHAEL J. GERTNER DIRECTOR\/TREASURER\nJames W. Hamilton MARCH 24, 1994 ---------------------------------- JAMES W. HAMILTON DIRECTOR\nFarrell G. Hinkle MARCH 24, 1994 ---------------------------------- FARRELL G. HINKLE DIRECTOR\nWilliam H. Jacoby MARCH 24, 1994 ---------------------------------- WILLIAM H. JACOBY DIRECTOR\/PRESIDENT, C.E.O.\nRobert L. McKay MARCH 24, 1994 ---------------------------------- ROBERT L. MCKAY DIRECTOR\/CHAIRMAN OF THE BOARD\nMark H. Stuenkel MARCH 24, 1994 --------------------------------- MARK H. STUENKEL EXECUTIVE VICE PRESIDENT\nAbdul S. Memon MARCH 24, 1994 ---------------------------------- ABDUL S. MEMON PRINCIPAL FINANCIAL & ACCOUNTING OFFICER\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.\nFour copies of the following will be furnished to the Securities and Exchange Commission when sent to the registrant's security holders:\n(1) Registrant's annual report to security holders covering the registrant's last fiscal year; and (2) the registrant's proxy statement and the form of proxy which will be sent to the registrant's security holders with respect to the next annual meeting of security holders.\nNo such reports or proxy materials have yet been sent to the registrant's security holders.\nCALIFORNIA COMMERCIAL BANKSHARES\nEXHIBIT INDEX","section_15":""}
{"filename":"106040_1994.txt","cik":"106040","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nWestern Digital Corporation (the \"Company\" or \"Western Digital\") designs, manufactures and sells small form factor Winchester disk drives for the mid-to high-end personal computer (\"PC\") market. The Company is one of the five largest independent manufacturers of these drives. The Company's principal drive products are 3.5-inch form factor disk drives with storage capacities from 210 megabytes (\"MBs\") to 1 gigabyte (\"GB\") including the Caviar AC31000, a 1 GB drive, which began initial volume shipments in June 1994.\nThe disk drive market is highly cyclical and is characterized by significant price erosion over the life of a product, periodic rapid price declines due to industry over-capacity or other competitive factors, technological changes, changing market requirements and requirements for significant expenditures for product development. The Company's disk drive strategy in response to these conditions is to achieve time-to-market leadership with new product introductions while minimizing its fixed cost structure and maximizing the utilization of its assets. The Company implements this strategy, in part, by capitalizing on its expertise in control and communication electronics to deliver greater storage capacity per disk from components widely available in the commercial market, such as disks and heads, and to provide a high degree of commonality of component parts among its disk drive products.\nThe Company also designs, manufactures and sells an array of microcomputer products (\"MCP\") consisting of integrated circuits (\"ICs\") and board products which perform or enhance graphics and input\/output (\"I\/O\") functions in PCs and other computer systems. The Company's MCP strategy is to bring to market superior graphical user interface and I\/O control products through its applications knowledge and integrated circuit design capability.\nThe Company sells its products through its worldwide direct sales force primarily to PC manufacturers, and, to a lesser extent, resellers and distributors. The Company's direct sales organization is structured so that each customer is served by a single sales team which markets the Company's entire product line. The Company's OEM (original equipment manufacturer) customers include AST Research, AT&T, Dell Computer, Gateway 2000, IBM, NEC, Siemens-Nixdorf, Toshiba and Zenith Data Systems.\nIn December 1993, the Company sold its Irvine, California silicon wafer fabrication facility and certain other tangible assets to the Semiconductor Products Sector of Motorola, Inc. (\"Motorola\") for approximately $111.0 million plus certain other considerations, including the assumption by Motorola of equipment leases and certain other liabilities associated with the facility. Approximately $95.0 million of the proceeds from the sale were used to reduce bank indebtedness. Concurrent with the sale, the Company entered into a supply contract with Motorola under which Motorola will supply silicon wafers to Western Digital for at least two years. The Company has entered into various other silicon wafer supply agreements since the sale of the facility and anticipates that it will enter into additional supply arrangements with other companies in the future. During the fourth quarter of fiscal 1994, the Company initiated plans to convert its wholly-owned facility in Malaysia from an IC assembly and test facility to a disk drive manufacturing facility. The conversion of the facility is expected to be complete and operational by the second quarter of fiscal 1995. The Company has obtained independent contractors to supply finished ICs that were previously supplied by the Company's Malaysia facility. However, a disruption in the supply of wafers or finished ICs for any reason could have a material adverse impact on the Company -- see \"Manufacturing\".\nThe Company's principal executive offices are located at 8105 Irvine Center Drive, Irvine, California 92718, and its telephone number is (714) 932-5000. Unless otherwise indicated, references herein to specific years correspond to the Company's fiscal years ending June 30.\n---\nMARKETS\nThe Company sells its disk drive products primarily to manufacturers of mid-to high-performance desktop and notebook PCs and to selected resellers and distributors. The market for the Company's products is characterized by short product life cycles and a continuing demand for increasingly cost-effective, high-performance products. In addition, the disk drive market has in recent years experienced periods of extraordinary competitive price discounting which produced significant operating losses for a number of competitors in this market, including Western Digital.\nThe rapid increase in PC performance and storage requirements and the need for PC manufacturers to differentiate their products have increased the demand for higher capacity products. At the same time, intense price competition among PC manufacturers requires that disk drive suppliers also meet aggressive cost targets in order to become high-volume suppliers. The market for PC disk drives is segmented by type of computer (sub-notebook, notebook, desktop), form factor (1.8-inch, 2.5-inch, 3.5-inch) and storage capacity (currently 80 MBs to 1 GB). The segment of the PC market currently generating the largest requirements for disk drives is the mid-to high-performance desktop segment which uses 3.5-inch drives ranging in capacity from 170 MBs to 1 GB. In addition, the Company anticipates that the market for notebook and sub-notebook PCs will accelerate as technological advancements increase their functionality and as user acceptance expands.\nThe Company sells its MCP products to manufacturers of high-performance PCs and high-performance disk drives. This market is characterized by rapid new product introduction and an increasing demand for higher performance, lower cost ICs. The Company also sells its graphics and sound add-in boards in the retail market to PC end-users under its Paradise brand name.\nPRODUCTS\nThe following table sets forth the Company's consolidated revenues by major product area for each of the periods indicated (in millions):\n- - --------------------------------------------------------------------------------\n(1) In October 1991, the Company sold its Local Area Network (\"LAN\") business. See Note 1 to the consolidated financial statements.\nIn general, the unit price for a given product in all of the Company's markets decreases over time as increases in industry supply and cost reductions occur. Cost reductions are primarily achieved as volume efficiencies are realized, component cost reductions are achieved, experience is gained in manufacturing the product and design enhancements are made. Competitive pressures and customer expectations result in these cost improvements being passed along as reductions in selling prices. At times, the rate of general price decline is accelerated when some competitors lower prices to absorb excess capacity, liquidate excess inventories and\/or to gain market share. The disk drive industry has experienced all of these effects on pricing in the periods covered in the above table.\n---\nDISK DRIVE PRODUCTS\nTECHNOLOGY. Winchester disk drives are used to record, store and retrieve digital data. They are faster than floppy disk, tape and optical disk drives and cost less than semiconductor memory. To date, substantially all of the Company's disk drives use the Enhanced IDE (integrated drive electronics) interface.\nCommonly quoted measures of disk drive performance are storage capacity, average seek time (the average time to move the heads from one track to another), data transfer rate (the rate at which data are transferred between the drive and the host computer) and spindle rotational speed.\nPRODUCT OFFERINGS. The Company's current line of disk drive products consists of the Caviar family of low profile drives which includes 1-inch high, 3.5-inch form factor models for desktop applications and 2.5-inch form factor models for portable computer applications. Each of these drives features CacheFlow, the Company's proprietary adaptive disk caching system which significantly enhances the drive's read\/write performance as measured by the rate at which it can deliver data to or receive it from the computer. An additional common feature is the Company's proprietary drive control and communication electronic circuitry called Architecture II, which spans the Company's entire 3.5-inch Caviar product line. Architecture II features Enhanced IDE technology, which provides the desktop marketplace the key attributes of the SCSI (small computer systems interface) interface while retaining the focus on ease-of-use, compatibility and overall lower cost of connection advantages, all of which are the traditional strengths of IDE. The Company believes that the commonality of control and communication electronics featured in all of the Caviar disk drives facilitates customer qualification of successive product models, reduces risk of inventory obsolescence and allows the Company to place larger orders for components resulting in reduced component cost.\nThe following table summarizes certain design and performance characteristics and specifications of the Company's current disk drive products:\n* Features Enhanced IDE (EIDE) technology, improving the performance of the standard IDE interface. DISK DRIVE PRODUCTS FOR DESKTOP PCS\nThe Caviar AC2340 was the industry's first 3.5-inch, two-platter 340 MB drive and is targeted at high-performance 486-based machines. Customers for the Caviar AC2340 include AST Research, AT&T, Dell Computer, Gateway 2000, IBM, NEC and Zenith Data Systems.\n---\nThe Caviar AC2250 has the same storage density per platter as the AC2340 but utilizes only three drive heads instead of four. This drive is targeted at high-performance 486-based machines. Customers for the AC2250 include AST Research, AT&T, Dell Computer, Gateway 2000 and IBM.\nThe Caviar AC2420 was the industry's first 3.5-inch, two-platter 420 MB drive and is targeted at high-performance 486-based machines. Customers for the Caviar AC2420 include AT&T, Fountain Technologies and Zenith Data Systems.\nThe Caviar AC1210 was the industry's first 3.5-inch, single-platter 210 MB drive. This drive is targeted at high-performance 486-based machines. Customers for the AC1210 include AST Research, AT&T, Gateway 2000, IBM and Zenith Data Systems.\nThe Caviar AC1270 was the industry's first single-platter 270 MB drive and is targeted at high-performance 486-based machines. Customers for the AC1270 include AST Research, AT&T, Dell Computer, Gateway 2000 and NEC.\nThe Caviar AC2540 was the industry's first 3.5-inch, two-platter 540 MB drive and is targeted at high-end Pentium and Power PC-based machines and high-performance 486-based machines. Customers for the AC2540 include AST Research, AT&T, Dell Computer, Gateway 2000 and NEC.\nThe Caviar AC2700 was the industry's first 3.5-inch, two-platter 700 MB drive and is targeted at high-end Pentium and Power PC-based machines and high-performance 486-based machines. Customers of the AC2700 include AST Research and Packard Bell.\nThe Caviar AC31000 was the industry's first 3.5-inch, three-platter Enhanced IDE drive in a 1 GB capacity. This drive is targeted at high-end Pentium and Power PC-based machines and high-performance 486-based machines. Customers for the AC31000 include Dell Computer, Gateway 2000, NEC-Japan and Siemens-Nixdorf. DISK DRIVE PRODUCTS FOR PORTABLE PCS\nThe Caviar Lite AL2170, a 2.5-inch, 15mm high drive, was designed to address the requirements of the growing notebook market which demands an increased capacity, low power, low profile storage solution. IBM is a customer for the Caviar Lite AL2170.\nThe Caviar Lite AL2200, a 2.5-inch, 15mm high drive, was also designed to address the requirements of the growing notebook market. Customers for the AL2200 include AST Research, AT&T and IBM. MICROCOMPUTER PRODUCTS\nGRAPHICS PRODUCTS. The Company supplies a family of RocketCHIP brand name graphics ICs and Paradise brand name add-in cards to the desktop and portable PC markets. Graphics ICs and Paradise add-in cards provide enhanced video graphics array (\"Super VGA\") functionality. These products allow major enhancements in display resolution and color depth quality and incorporate a Windows acceleration feature, which provides faster display of icons and other graphics features in the Windows operating system without the need for new PC hardware.\nIn November 1993, the Company introduced RocketCHIP WD24A, the industry's first single-chip Super VGA LCD video graphics controller to offer hardware Windows acceleration features and true 32-bit VESA VL-Bus interface to portable PC environments. This device provides a fully integrated solution including RAMDAC and programmable dual-frequency clock generator. As with all of its VGA IC's, the Company's portable graphics display products emphasize hardware capability with all VGA software and hardware standards and with all previous graphics standards.\nIn February 1994, the Company began volume shipments of the Paradise 16-DSP (digital signal processor) sound card, which is the Company's first multimedia-related product from Paradise. The Paradise 16-DSP\n---\nsound card provides high-performance, programmable digital signal processing and also supports future revolutionary functions such as DSP-based voice recognition and DSP-based sound effects.\nI\/O PRODUCTS. The Company supplies control electronics to certain manufacturers of high-performance, high-capacity disk drives and other storage peripherals utilizing the SCSI bus interface. These manufacturers of SCSI disk, tape and optical drives utilize the Company's storage control chipsets for their logic and control electronics.\nSALES AND DISTRIBUTION\nThe Company sells its products primarily to PC manufacturers, and, to a lesser extent, resellers and distributors through its worldwide direct sales force. The Company's direct sales organization is structured so that each customer is served by a single sales team. Each sales team is responsible for marketing the Company's entire product line and providing timely feedback to engineering regarding customers' new product requirements. This promotes early identification of and response to the customer's full range of product needs. Later, in the production stage, the team focus enables the Company to provide timely product delivery and effective service. Many of the Company's OEM customers purchase both disk drives and MCP products from the Company. These customers include AST Research, AT&T, Dell Computer, Gateway 2000, IBM, NEC, Siemens-Nixdorf, Toshiba and Zenith Data Systems. While Western Digital believes its relationships with key customers are very good, the concentration of sales to a relatively small number of major customers presents a business risk that loss of one or more accounts could adversely affect the Company's operating results. During 1994, sales to Gateway 2000 and IBM each accounted for approximately 12% of revenues. During 1993, sales to Gateway 2000 and IBM accounted for approximately 13% and 11% of revenues, respectively. During 1992, sales to Gateway 2000 accounted for approximately 10% of revenues.\nThe Company also sells its products through its direct sales force to selected resellers, which include major distributors, mass merchandisers and value-added resellers. In accordance with standard industry practice, the Company's reseller agreements provide for price protection for unsold inventories which the resellers may have at the time of changes in published price lists and, under certain circumstances, stock rotation for slow moving items. These agreements may be terminated by either party upon written notice and, in the event of termination, the Company may be obligated to repurchase such inventories.\nWestern Digital maintains sales offices and technical support in the United States, Europe and Asia. The Company's international sales, which include sales to foreign subsidiaries of U.S. companies, represented 44%, 43% and 40% of revenues for 1994, 1993 and 1992, respectively. Sales to international customers may be subject to certain risks not normally encountered in domestic operations including exposure to tariffs and various trade regulations.\nRESEARCH AND DEVELOPMENT\nThe Company devotes substantial resources to research and development in order to develop new products and improve existing products. The Company also focuses its engineering efforts to coordinate its product design and manufacturing processes in order to bring its products to market in a cost-effective and timely manner. The Company's research and development expenses totaled $112.8 million in 1994, $101.6 million in 1993 and $89.6 million in 1992.\nThe market for the Company's products is subject to rapid technological change and short product life cycles. To remain competitive, the Company must anticipate the needs of the market and successfully develop and introduce new products in a timely fashion. Before volume shipments of the Caviar AC2200 in March 1992, the Company was less successful than its competitors in developing new products and bringing them to market in a timely manner. If not carefully planned and executed, the introduction of new products may adversely affect sales of existing products and increase risk of inventory obsolescence. In addition, new products typically have lower initial manufacturing yields and higher initial component costs than more mature products. No assurance can be given that the Company will be able to successfully complete the\n---\ndesign and introduction of new products, manufacture the products at acceptable yields and costs, effectively manage product transitions or obtain significant orders for these products.\nMANUFACTURING\nThe Company's disk drives are assembled in its plant in Singapore. The Singapore plant has complete responsibility for all disk drives in volume production including manufacturing engineering, purchasing, inventory management, assembly, test, quality assurance and shipping of finished units. The Company purchases most of the standard mechanical components and micro controllers for its disk drives from external suppliers, although the Company does manufacture a substantial portion of the media for its disk drives in its Santa Clara, California facility.\nDuring the fourth quarter of 1994, the Company initiated plans to convert its wholly-owned facility in Malaysia from an IC assembly and test facility to a disk drive manufacturing facility. It is intended that the Malaysia facility will manufacture the Company's more mature disk drive products. The conversion of the facility is expected to be complete and operational by the second quarter of 1995. The cost of converting the Malaysia facility to a drives manufacturing plant is not expected to be material to the financial position of the Company.\nThe Company experiences fluctuations in manufacturing yields which can materially affect the Company's operations, particularly in the start-up phase of new products or new manufacturing processes. With the continued pressures to shorten the time required to introduce new products, the Company must accelerate production learning curves to shorten the time to achieve acceptable manufacturing yields and costs. No assurance can be given that the Company's operations will not be adversely affected by these fluctuations or that it can shorten its new product development cycles or manufacturing learning curves sufficiently to achieve these objectives in the future.\nAs a result of the sale of its wafer fabrication facility in December 1993 and conversion of its Malaysia IC assembly and test facility to a disk drive manufacturing plant, the Company has entered into various agreements with multiple vendors to purchase fabricated wafers and has also obtained independent contractors to supply finished ICs that were previously supplied by the Company's Malaysia facility. However, a disruption in the supply of wafers or finished ICs for any reason could have a material adverse impact on the Company.\nThe Company has manufacturing facilities located in Singapore, Malaysia and Korea and is therefore subject to certain foreign manufacturing risks such as changes in government policies, high employee turn-over, political risk, transportation delays, tariffs, fluctuations in foreign exchange rates and import, export, exchange and tax controls. To date, exposure to such risks has not had a material effect on the Company's business, consolidated financial position or results of operations.\nMATERIALS AND SUPPLIES\nThe principal components used in the manufacture of the Company's disk drives are read\/write heads (both thin film and MIG) and related headstack assemblies, media, micro controllers, spindle motors and mechanical parts used in the head-disk assembly. The principal materials used in the manufacture of the Company's semiconductor circuits are silicon wafers, chemicals and gases used in the wafer fabrication process and plastic packages used in the assembly process. The Company also uses standard semiconductor components such as logic, memory and microprocessor devices obtained from other manufacturers, as well as proprietary semiconductor circuits manufactured for the Company, and a wide variety of other parts including connectors, cables and switches.\nA number of the components used by the Company are available from a single or limited number of outside suppliers. Some of these materials may periodically be in short supply and the Company has, on occasion, experienced temporary delays or increased costs in obtaining these materials. An extended shortage of required materials and supplies could have an adverse effect upon the revenue and earnings of the Company. In addition, the Company must allow for significant lead times when procuring certain materials and\n---\nsupplies. The Company has more than one available source of supply for most of its required materials. Where there is only one source of supply, the Company believes that a second source could be obtained within a reasonable period of time. However, no assurance can be given that the Company's results of operations will not be adversely affected until a new source can be located.\nThe Company purchases substantially all of its thin film head requirements for disk drives from Read-Rite Corporation. The Company also uses MIG heads for certain products which are supplied by several vendors. Any significant disruption in the supply of these components would have an adverse effect on the Company's results of operations.\nIn December 1993, the Company sold its Irvine, California silicon wafer fabrication facility -- see \"General.\" From 1990 until the sale, the Company manufactured silicon wafers in the Irvine facility. The Company also buys wafers fabricated by other companies. Since the sale of the wafer fabrication facility, the Company has obtained various outside sources to manufacture its semiconductor wafer requirements. The Company has also obtained independent contractors to supply finished ICs that were previously supplied by the Company's Malaysia facility. However, a disruption in the supply of wafers or finished ICs for any reason could have a material adverse impact on the Company.\nCOMPETITION\nThe PC industry is intensely competitive and is characterized by significant price erosion over the life of a product, periodic rapid price declines due to industry over-capacity or other competitive factors, technological changes, changing market requirements, occasional shortages of materials, dependence upon a limited number of vendors for certain components, dependence upon highly skilled engineering and other personnel and significant expenditures for product development. The disk drive market in particular has been subject to recurring periods of severe price competition. Certain of the Company's competitors have greater financial and other resources and broader product lines than the Company with which to compete in this environment.\nThe Company believes that proprietary disk drive, semiconductor, and board-level design technology, close technical relationships with key OEM customers and vendors, diverse product lines, competitive pricing, adequate capital resources and worldwide low cost\/high volume manufacturing capabilities are key factors for successfully competing in its market areas. The Company's principal competitors in the disk drive industry are Conner Peripherals, Maxtor, Quantum and Seagate Technology, and large computer manufacturers such as IBM that manufacture drives for use in their own products and for sale to others. In other market areas the Company competes with a variety of companies including Adaptec, Chips and Technologies, Cirrus Logic, Intel, LSI Logic, S3 Incorporated, Tseng Labs and VLSI Technology.\nThe Company also competes with companies offering products based on alternative data storage and retrieval technologies. Technological advances in magnetic, optical, flash or other technologies, could result in the introduction of competitive products with performance superior to and prices lower than the Company's products, which could adversely affect the Company's results of operations.\nBACKLOG\nAt June 30, 1994, the Company's backlog, consisting of orders scheduled for delivery within the next twelve months, aggregated approximately $223.1 million, compared with a backlog at June 30, 1993 which aggregated approximately $40.0 million. Historically, a substantial portion of the Company's orders have been for shipments within 30 to 60 days of the placement of the order. The Company's sales are made under contracts and purchase orders which, under industry practice, may be canceled at any time, subject to payment of certain costs, or modified by customers to provide for delivery at a later date. Therefore, backlog information as of the end of a particular period is not necessarily indicative of future levels of the Company's revenue and profit.\n---\nPATENTS AND LICENSES\nAlthough the Company owns numerous patents and has many patent applications in process, the Company believes that the successful manufacture and marketing of its products generally depends more upon the experience, technical know-how and creative ability of its personnel rather than upon ownership of patents.\nThe Company pays royalties under several patent licensing agreements which require periodic payments. From time to time, the Company receives claims of alleged patent infringement from patent holders which typically contain an offer to grant the Company a license. It is the Company's policy to evaluate each claim and, if appropriate, to enter into licensing arrangements. Although patent holders commonly offer such licenses, no assurance can be given that licenses will be offered, or that the terms of any offered license will be acceptable to the Company. No assurance can be given that failure to obtain a license would not adversely affect the Company's business, consolidated financial position or results of operations -- see \"Legal Proceedings\".\nEMPLOYEES\nAs of June 30, 1994, the Company employed a total of 6,593 full-time employees, of whom 529 were engaged in engineering, 431 in sales and administration and 594 in manufacturing in the United States. The Company employed 728 employees at its manufacturing facility in Malaysia, 4,007 at its disk drive manufacturing facility in Singapore, 163 at its board-level subsystems facility in Korea and 141 at its international sales offices.\nMany of the Company's employees are highly skilled, and the Company's continued success depends in part upon the ability to attract and retain such employees. In an effort to attract and retain such employees, the Company continues to offer employee benefit programs which it believes are at least equivalent to those offered by its competitors. Despite these programs, the Company has, along with most of its competitors, experienced difficulty at times in hiring and retaining certain skilled personnel. In critical areas, the Company has utilized consultants and contract personnel to fill these needs until full-time employees could be recruited. The Company has never experienced a work stoppage, none of its domestic employees are represented by a labor organization and the Company considers its employee relations to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's headquarters are located in a 358,000 square foot building in Irvine, California. This building houses management, research and development, administrative and sales personnel and is leased to the Company pursuant to an agreement expiring in June 2000. The Company's disk drive manufacturing facilities are located in Singapore in several buildings totaling approximately 278,000 square feet. These buildings are leased to the Company pursuant to several agreements expiring from August 1995 through October 1996. The Company also owns a 83,500 square foot facility in Kuala Lumpur, Malaysia which is in the process of being converted into a disk drive manufacturing facility (see \"Manufacturing\"), and owns a facility in Seoul, Korea designed for board-level assembly of disk drive components which consists of approximately 33,800 square feet. In addition, the Company leases office space in Mountain View and San Jose, California for research and development activities, and in Santa Clara, California for media processing activities.\nThe Company also leases office space in various other locations throughout the world primarily for sales and technical support. The Company's present facilities are adequate for its current needs, although the process of upgrading its facilities to meet technological and market requirements is expected to continue.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company was sued in September 1991, in the United States District Court for the Central District of California by Amstrad plc, a British computer maker. The suit alleged that disk drives furnished to Amstrad in 1988 and 1989 were defective. Amstrad claimed damages of approximately $3.0 million for asserted losses\n---\nin out-of-pocket expenses, $38.0 million in lost profits and $100.0 million for injury to Amstrad's reputation and loss of goodwill. The Company filed a counterclaim against Amstrad. This federal action was dismissed without prejudice and Amstrad has filed a similar complaint in Orange County, California Superior Court, but raised the claim for damages to $186.0 million. The Company again filed a counterclaim for $3.0 million in actual damages plus exemplary damages in an unspecified amount and intends to vigorously defend itself against the Amstrad claims.\nThe Company was sued in March 1993 in the United States District Court for the Northern District of California by Conner Peripherals, Inc. (\"Conner\"). The suit alleges that the Company infringes five Conner patents and seeks damages (including treble damages) in an unspecified amount and injunctive relief. Conner moved for a preliminary injunction to enjoin the Company from using three of the patents in certain of the Company's disk drive products. The court denied that motion. If Conner were to prevail in its claims, the Company could be enjoined from using any of the Conner patents found to be valid and infringed that are the subject of this action as well as held liable for past infringement damages. The amount of such damages, if any, could be material. The Company believes that it has meritorious defenses to all of Conner's claims and intends to vigorously defend itself against the Conner lawsuit. The Company has also filed a suit alleging that Conner infringes two of the Company's patents.\nThe Company has received a claim of alleged patent infringement from Rodime PLC (\"Rodime\") under one of Rodime's U.S. patents which relates to 3.5-inch disk drives. Rodime has offered to grant the Company a royalty bearing license under that and other Rodime patents. Based on the opinion of patent counsel, the Company believes that the broad claims of the Rodime patent, if scrutinized in court, will not withstand an attack on validity, and believes that the Company has not infringed any valid claim of the Rodime patent. If Rodime were to commence litigation against the Company on this patent, and if Rodime were to prevail on its claim, the Company could be held liable for damages for past infringement. The amount of such damages, if any, is uncertain but could be material.\nThe Company currently has a cross-license with IBM Corporation (\"IBM\") which became effective January 1, 1990. Pursuant to this agreement, the Company has licensed IBM under certain Western Digital patents for the life of such patents, and has obtained from IBM a patent license which expires December 31, 1994 covering certain Western Digital products. Although the license granted to Western Digital extends to certain components within Western Digital disk drives, disk drives as such are not expressly covered. In calendar 1993, IBM initiated further discussion with the Company for the purpose of determining whether the Company's disk drives are covered by specified IBM patents. The Company is currently reviewing these patents. Based on its prior dealings with IBM, the Company expects to work toward a supplemental agreement with IBM which will address the disk drive issues and extend the term of the license, with the goal of reaching agreement prior to the expiration of the term of the current license agreement. This supplemental agreement, if finalized, may involve payment of higher royalties to IBM than are presently paid. No assurance can be given that such an agreement can be reached upon terms acceptable to the Company. Failure to reach an acceptable agreement could have a material adverse impact on the Company's business.\nThe Company is also subject to certain other legal proceedings and claims arising in connection with its business. There can be no assurance that litigation will not be commenced on one or more of these or possible other future such claims, or that, if commenced, all such litigation would be resolved without any material adverse effect on the Company's business, consolidated financial position or results of operations.\nIt is management's opinion, however, that none of these claims will have a material adverse effect on the Company's business, consolidated financial position or results of operations. The costs of defending such litigation can be substantial, regardless of outcome.\nThe Company was sued in July 1991 in the United States District Court for the Central District of California in a purported class action securities lawsuit. In June 1994, the court approved a settlement of this case whereby eligible class members will share, on a claims made basis, up to $6.75 million, comprised of $3.5 million in cash and the balance in shares of the Company's common stock. The Company's insurance\n---\ncarrier has agreed to contribute up to $2.6 million in cash toward the settlement. At June 30, 1994, the Company has provided for its estimate of claims to be made under the settlement.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nInapplicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages and positions of all the executive officers of the Company as of September 1994 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.\nMessrs. Erickson, Nussbaum, Schafer and Williams and Ms. Braun have been employed by the Company for more than five years and have served in various executive capacities with the Company before being appointed to their present positions.\nMr. Haggerty joined the Company as President in June 1992 and has been a director since January 1993. He assumed the additional positions of Chairman and Chief Executive Officer on June 30, 1993. Prior to joining the Company, he spent his 28-year business career in various positions at IBM. In 1987, he became IBM's Vice President of worldwide operations for the AS\/400. He then served as Vice President\/General Manager, low-end mass-storage products responsible for operations in the United States, Japan and the United Kingdom. Immediately prior to joining the Company, he held the position of Vice President of IBM's worldwide OEM storage marketing.\nMr. Hendrickson joined the Company in March 1994. Prior to joining the Company, he served as Vice President, Operations and Quality and member of the Board of Directors of Overland Data Corporation, Inc. from 1993 to 1994. From 1990 to 1993, he served as President of Archive Corporation's Archive Technology Division. During 1989, he served as President of Genicom Corporation's Printer Products Division.\nMr. Mercer joined the Company in October 1991 and served in various executive capacities with the Company before being appointed to his present position in August 1993. Prior to joining the Company, he served as Senior Vice President and Chief Financial Officer of Businessland, Inc. from 1990 to 1991. From 1983 to 1990, he served in various executive capacities with LSI Logic Corporation.\nMr. Hughes joined the Company in July 1993 as Vice President, Human Resources before becoming an elected officer of the Company in July 1994. Prior to joining the Company, he served as Director of Human Resources of Quantum Corporation from 1992 to 1993. From 1990 to 1992, he served in various capacities with Western Digital, including acting Vice President, Human Resources. From 1986 to 1990, Mr. Hughes served as a compensation benefits consultant with Hewitt Associates.\n---\n------------------ PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITIES AND RELATED SHAREHOLDER MATTERS\nWestern Digital's common stock is listed on the New York Stock Exchange (\"NYSE\"). The approximate number of holders of record of common stock of the Company as of September 1, 1994 was 4,360.\nThe Company has not paid any cash dividends on its common stock and does not intend to pay any cash dividends in the foreseeable future.\nThe high and low closing prices of the Company's common stock, as reported by the NYSE, for each quarter of 1994 and 1993 are as follows:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nWESTERN DIGITAL CORPORATION\nFINANCIAL HIGHLIGHTS (in thousands, except per share and employee data)\n(1) For the year ended June 30, 1994, fully diluted earnings per share were $1.70. For all other periods presented fully diluted earnings (loss) per share approximated primary earnings (loss) per share.\n---\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nWestern Digital operates in an extremely competitive industry subject to short product life cycles, dependence upon a limited number of suppliers for certain component parts, dependence upon highly skilled engineering and other personnel and significant expenditures for product development. The disk drive market in particular has been subject to recurring periods of severe price competition. During the fourth quarter of 1993, revenues and gross profits declined significantly due to severe competitive pricing pressures across all 3.5-inch drive capacity price points, resulting in the Company reporting a loss in the fourth quarter of 1993 and well as for the year, and for the first quarter of 1994.\nThe Company's engineering strategy has been focused toward the production of higher capacity-per-platter, cost-competitive disk drives, and as a result, during 1994, the Company continued to introduce higher-capacity disk drives, increase factory utilization and improve manufacturing efficiencies, which reduced per unit manufacturing costs and also obtained lower component costs from suppliers. These factors, along with stabilizing industry conditions, contributed to the Company reporting net income of $73.1 million in 1994, as compared with net losses of $25.1 million and $72.9 million for 1993 and 1992, respectively.\nDuring 1994, the Company significantly strengthened its balance sheet through cash flows from operations, proceeds from the sale of the Company's wafer fabrication facility and common stock offering and retirement of all bank debt ($143.3 million) outstanding at June 30, 1993. Cash and cash equivalents totaled $243.5 million at the end of 1994 versus $33.8 million at the end of 1993. In addition, during 1994, the Company entered into an $85.0 million accounts receivable facility with certain financial institutions, consisting of a $50.0 million three-year arrangement and a $35.0 million one-year committed arrangement. This facility is intended to serve as a source of working capital as may be needed from time to time and replaces credit facilities secured by substantially all of the Company's assets.\nUnless otherwise indicated, references herein to specific years and quarters are to the Company's fiscal years ending June 30 and to fiscal quarters.\nRESULTS OF OPERATIONS\nCOMPARISON OF 1994, 1993 AND 1992\nThe Company reported net income for 1994 of $73.1 million compared with net losses of $25.1 and $72.9 million for 1993 and 1992, respectively. The improved operating results since 1992 are directly related to increased revenues and improved gross profit margins. The Company's revenues increased 26% and 31% in 1994 and 1993, respectively, while gross profit margins improved from 11.8% in 1992 to 14.9% in 1993 and 20.6% in 1994.\nRevenue for drive products totaled $1.4 billion in 1994, an increase of $333.0 million, or 32% as compared with the prior year. A 56% increase in the volume of drive units shipped year-to-year and a shift in product mix to higher-capacity drives contributed to this increase in revenue. The average MB per drive shipped in 1994 increased significantly to 298 MBs per drive from 186 MBs per drive in 1993. The positive impact of these factors on revenue was partially offset by a seven percent decline in disk drive average selling prices (\"ASPs\") from 1993 to 1994. If the disk drive industry is subjected to another period of severe pricing competition such as occurred in the latter half of 1993 and first part of 1994, revenue and gross profit may be adversely impacted in future quarters.\nRevenue for MCP totaled $160.0 million in 1994, a decrease of $18.0 million, or 10% from 1993, primarily due to a decrease in graphics product revenue as a result of decreased sales in desktop graphics. During the fourth quarter of 1994, MCP reported its first profitable quarter in more than three years. This performance was driven by strength in the input\/output product line and the Company's strong position in portable\n---\ngraphics accelerator chips, as well as continued fixed cost reductions associated with the Company's transition to a fabless business model.\nRevenue for drive products totaled $1.0 billion in 1993, an increase of $379.0 million, or 57% as compared with 1992. Unit shipments increased 63% year-to-year with the majority of the increase occurring in the first nine months of 1993, as the mix of units shipped continued to shift to newer, higher-performance, higher-capacity drives. In 1993 the average MB per drive shipped nearly doubled to 186 MBs per drive from 98 MBs per drive in 1992. The increase in drive shipments and shift in product mix was partially offset by a 14% year-to-year decline in ASPs across all 3.5-inch drive capacity price points as a result of severe competitive pricing pressures in the disk drive industry beginning in March 1993.\nMCP revenue decreased $35.0 million, or 16% from 1992 to 1993, with the majority of the decrease occurring in the systems solutions product line. Unit shipments of systems solutions products decreased approximately 26% from 1992 to 1993, while the ASPs decreased 53% year over year primarily as a result of the transition away from board level products to ICs with lower ASPs.\nDisk drive gross margin for 1994 and 1993 increased approximately four and seven percentage points, respectively to 19.1% in 1994 from 15.3% in 1993 and from 8.2% in 1992. Beginning in the latter half of 1992, disk drive sales began to contribute to gross profits as increased demand for the Company's newer, higher-capacity products resulted in higher sales volume and ASPs and increased factory utilization, which reduced per unit manufacturing costs and improved gross margins. Gross margins from disk drives continued to increase from the second half of 1992 to the first half of 1993 as unit shipments of the Company's higher-capacity drives increased while ASPs remained steady. Beginning in March 1993, however, gross margins declined significantly as ASPs for all 3.5-inch drive capacity price points decreased sequentially during the last two quarters of 1993 as a result of severe competitive pricing pressures in the disk drive industry.\nDuring 1994 the Company's gross margins increased sequentially through the third quarter as a result of increases in unit shipments which reduced per unit production costs, lower component costs and a favorable product mix which more than offset the decline in ASPs. Gross margin in the fourth quarter was essentially flat with the immediately preceding quarter. There can be no assurance that the Company will be able to sustain the current gross margin levels due to the cyclical nature of the disk drive industry and the Company's dependence on new product introductions.\nMCP gross margin increased approximately 21 percentage points to 33.7% in 1994 from 12.5% in 1993 as the Company began to realize the cost benefits of selling its wafer fabrication facility (see Note 3 to the consolidated financial statements) and thereby reducing manufacturing costs. Gross margin from MCP, excluding the LAN business, decreased approximately eight percentage points to 12.5% in 1993 from 20.2% in 1992 as a result of the planned transition away from board-level systems solutions products, which contributed to higher gross margins in 1992 than the Company's product offerings in 1993. The decrease in gross margins in 1993 was partially offset by the sequential increase in gross margins experienced in the latter half of 1993 as a result of manufacturing efficiencies which reduced per unit manufacturing costs.\nResearch and development expense (\"R&D\") in 1994 increased approximately $11.2 million, or 11% as compared with the prior year and increased approximately $12.0 million, or 13% from 1992 to 1993. These increases were primarily attributable to planned expenditures to support new product introductions. During 1994 and 1993, R&D expenditures were primarily focused on the development of new disk drive products whereas in 1992, the Company's R&D resources were approximately equally allocated between the development of new disk drives and MCPs, including semiconductor processes and licensing support.\nSelling, general and administrative expenses (\"SG&A\") in 1994 increased $22.8 million, or 25% from the prior year as a result of increases in selling, marketing, and other related expenses in support of higher revenue levels and provisions made for the Company's pay-for-performance plans. SG&A expense increased approximately $2.5 million, or 3% from 1992 to 1993 primarily as a result of increased selling and marketing expenses and certain reserves for executive severance.\n---\nNet interest expense decreased $9.3 million in 1994 due to significant reductions in debt outstanding. Net interest expense decreased $5.1 million in 1993 as a result of lower market interest rates and lower levels of debt outstanding.\nIn 1992, the Company recorded a gain of $15.8 million from the sale of its LAN business for a cash payment of $33.0 million. The buyer acquired specific tangible and intangible assets, assumed certain liabilities, and received certain licenses from Western Digital for specific LAN applications of more broadly based Western Digital technology. Western Digital agreed not to manufacture or distribute similar products for a period of up to six years.\nThe provision for income taxes in 1994 and 1992 consist primarily of taxes associated with certain of the Company's foreign subsidiaries which had taxable income. The Company's effective tax rate of 15% recorded in 1994 results primarily from the earnings of certain subsidiaries which are taxed at substantially lower tax rates as compared with United States statutory rates (see Note 6 to the consolidated financial statements).\nLIQUIDITY AND CAPITAL RESOURCES\nAt June 30, 1994, the Company had $243.5 million in cash and cash equivalents as compared with $33.8 million at June 30, 1993. During 1994, the Company generated $178.8 million in cash flows from operations and $73.3 million in net proceeds from the sale of 7,618,711 shares of common stock in February 1994. Cash flows from operations, along with approximately $95.0 million of the proceeds from the sale of the Company's wafer fabrication facility were used to reduce long-term debt by $146.3 million and to fund capital expenditures of $16.3 million. Capital expenditures were incurred primarily for increased disk drive manufacturing and wafer testing capacity. The Company anticipates that capital expenditures in 1995 will be approximately $60.0 million and will relate to increased disk drive manufacturing capacity. The Company believes that its current cash position and its anticipated future cash flow from operations are sufficient to meet all currently planned capital expenditures and sustain operations during the next fiscal year.\nDuring 1994, the Company entered into an $85.0 million accounts receivable facility with certain financial institutions. The facility consists of a $50.0 million three-year arrangement at Eurodollar or reference rates of the participating banks and a $35.0 million one-year committed arrangement at a rate approximating commercial paper rates. This new facility is intended to serve as a source of working capital as may be needed from time to time and replaces credit facilities secured by substantially all of the Company's assets.\nNotwithstanding the significant improvements in financial position realized over the past year, the ability of the Company to sustain its improved working capital management and to continue operating profitably is dependent upon a number of factors including competitive conditions in the marketplace, general economic conditions, the efficiency of the Company's manufacturing operations, procurement of fabricated wafers and finished ICs from outside suppliers and the timely development and introduction of new products which address market needs.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nInformation required by this Item is listed on page and is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nInapplicable.\n---\n------------------ PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThere is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1994 Annual Meeting of Shareholders which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended June 30, 1994 and the information from the section entitled \"Executive Officers of the Registrant\" following Part I, Item 4 of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThere is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1994 Annual Meeting of Shareholders which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended June 30, 1994. Western Digital 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, 10.2, 10.3, 10.10, 10.11, 10.12, 10.14, 10.21, 10.28 and 10.29 to this Report.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThere is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1994 Annual Meeting of Shareholders which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended June 30, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere is incorporated herein by reference the information required by this Item included in the Company's Proxy Statement for the 1994 Annual Meeting of Shareholders which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended June 30, 1994.\n---\n------------------ PART 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:\n(1) Financial Statements\nThe financial statements listed in the accompanying Index to Consolidated Financial Statements and Schedules on page are filed as part of this Report and incorporated herein by reference.\n(2) Financial Statement Schedules\nThe financial statement schedules listed in the accompanying Index to Consolidated Financial Statements and Schedules on page are filed as part of this Report and incorporated herein by reference.\n(3) Exhibits\n---\n---\n* New exhibit filed with this Report. ** Compensation plan, contract or arrangement required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.\n(1) Incorporated by reference to the Registrant's Annual Report on Form 10-K (File No. 1-8703) as filed with the Securities and Exchange Commission on September 28, 1992.\n(2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (File No. 1-8703) as filed with the Securities and Exchange Commission on May 9, 1994.\n(3) Incorporated by reference to Registrant's Amendment No. 1 to Form S-1 (No. 33-54968) as filed with the Securities and Exchange Commission on January 5, 1993.\n(4) Incorporated by reference to the Registrant's Current Report on Form 8-K (File No. 1-8703) as filed with the Securities and Exchange Commission on January 5, 1994.\n(5) Subject to confidentiality order dated November 24, 1992.\n(6) Subject to confidentiality order dated November 21, 1988.\n(7) Incorporated by reference to Amendment No. 2 to Registrant's Registration Statement on Form S-1 (No. 33-54968) as filed with the Securities and Exchange Commission on January 26, 1993.\n(8) Incorporated by reference to Registrant's Registration Statement on Form S-8 (No. 33-51725) as filed with the Securities and Exchange Commission on December 28, 1993.\n(9) Confidental treatment requested.\n(B) Reports on Form 8-K\nNone.\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.\nWESTERN DIGITAL CORPORATION\nBy: SCOTT MERCER ------------------------------- D. Scott Mercer Executive Vice President, Chief Financial and Administrative Officer Dated: September 21, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on September 21, 1994.\n---\nEXHIBIT 11\nWESTERN DIGITAL CORPORATION COMPUTATION OF PER SHARE EARNINGS (in thousands, except per share amounts)\n---\nEXHIBIT 21\nWESTERN DIGITAL CORPORATION SUBSIDIARIES OF THE COMPANY\n* represents inactive subsidiaries of the Company\n---\nEXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS\nThe Board of Directors Western Digital Corporation:\nWe consent to the incorporation by reference in the Registration Statements (Nos. 2-76179, 2-97365, 2-72672, 33-9853, 33-11777, 33-15771, 33-60166, 33-60168 and 33-51725) on Form S-8 of Western Digital Corporation of our report dated July 19, 1994, relating to the consolidated balance sheets of Western Digital Corporation as of June 30, 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 June 30, 1994, and all related schedules, which report appears in the June 30, 1994 Annual Report on Form 10-K of Western Digital Corporation.\nKPMG PEAT MARWICK LLP Orange County, California September 21, 1994\n---\nWESTERN DIGITAL CORPORATION SEC FORM 10-K, ITEMS 8, 14(A) AND 14(D) Index to Consolidated Financial Statements and Schedules\nAll other schedules are omitted as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.\nSeparate financial statements of the Registrant have been omitted as the Registrant is primarily an operating company and its subsidiaries are wholly-owned and do not have minority equity interests and\/or indebtedness to any person other than the Registrant in amounts which together exceed 5% of the total consolidated assets as shown by the most recent year-end consolidated balance sheet.\n-----\nWESTERN DIGITAL CORPORATION INDEPENDENT AUDITORS' REPORT\nThe Board of Directors Western Digital Corporation:\nWe have audited the consolidated financial statements of Western Digital Corporation 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 Western Digital Corporation as of June 30, 1994 and 1993, and the results of its operations and its cash flows for each of the years in the three-year 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 consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK LLP\nOrange County, California July 19, 1994\n-----\nWESTERN DIGITAL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)\nThe accompanying notes are an integral part of these financial statements.\n-----\nWESTERN DIGITAL CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts)\nLIABILITIES AND SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\n-----\nWESTERN DIGITAL CORPORATION\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands)\nThe accompanying notes are an integral part of these financial statements.\n-----\nWESTERN DIGITAL CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)\nThe accompanying notes are an integral part of these financial statements.\n-----\nWESTERN DIGITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES\nWestern Digital Corporation (\"Western Digital\" or the \"Company\") has prepared its financial statements in accordance with generally accepted accounting principles and has adopted accounting policies and practices which are generally accepted in the industry in which it operates. Following are the Company's significant accounting policies:\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The accounts of foreign subsidiaries have been translated using the U.S. dollar as the functional currency. As such, all material foreign exchange gains or losses resulting from remeasurement of these accounts are reflected in the results of operations. Approximately $.8 million and $1.6 million of foreign exchange losses were included in the results of operations for 1994 and 1993, respectively. Foreign exchange losses were not material for 1992. Monetary and non-monetary asset and liability accounts have been translated at the exchange rate in effect at each year end and historical rates, respectively. Operating statement accounts have been translated at average monthly exchange rates.\nCASH EQUIVALENTS\nAll highly liquid investments purchased with an original maturity of three months or less are considered cash equivalents. Cash equivalents are stated at cost which approximates market.\nCONCENTRATION OF CREDIT RISK\nThe Company designs, manufactures and sells small form factor Winchester disk drives and microcomputer products to personal computer manufacturers and resellers throughout the world. The Company performs ongoing credit evaluations of its customers' financial condition and generally requires no collateral. The Company maintains reserves for potential credit losses and such losses have historically been within management's expectations. The Company also has cash equivalent investment policies that limit the amount of credit exposure to any one financial institution and restrict placement of these investments in financial institutions evaluated as highly credit-worthy.\nINVENTORY VALUATION\nInventories are valued at the lower of cost or net realizable value. Cost is on a first-in, first-out basis for raw materials and is computed on a currently adjusted standard basis (which approximates first-in, first-out) for work in process and finished goods.\nDEPRECIATION AND AMORTIZATION\nThe cost of property and equipment is depreciated over the estimated useful lives of the respective assets. Depreciation is computed on a straight-line basis for financial reporting purposes and on an accelerated basis for income tax purposes. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or the related lease terms. Goodwill and purchased technology are capitalized at cost and amortized on a straight-line basis over their estimated lives which are fifteen and five to fifteen years, respectively.\nREVENUE RECOGNITION\nThe Company has agreements with its resellers to provide price protection for inventories held by the resellers at the time of published list price reductions and, under certain circumstances, stock rotation for slow-moving items. These agreements may be terminated upon written notice by either party. In the event of termination, the Company may be obligated to repurchase a certain portion of the resellers' inventory. The\n-----\nCompany recognizes revenue at time of shipment and records a reserve for price adjustments and estimated sales returns.\nINCOME TAXES\nThe Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes.\" SFAS 109 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 (\"NOL\") carryforwards. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and reflected in the financial statements in the period of enactment.\nPER SHARE INFORMATION\nPrimary earnings per share amounts are based upon the weighted average number of shares and dilutive common stock equivalents for each period presented. Fully diluted earnings per share additionally reflect dilutive shares assumed to be issued upon conversion of the Company's convertible subordinated debentures.\nLoss per share amounts are based upon the weighted average number of shares of common stock outstanding during the period. Common stock equivalents are not included in the computation because their effect would be antidilutive.\nSALE OF LAN BUSINESS\nIn October 1991, the Company sold its Local Area Network (\"LAN\") business under an asset purchase agreement for a cash payment of approximately $33.0 million. Through this transaction the buyer acquired specific tangible and intangible assets, assumed certain liabilities and received appropriate licenses from Western Digital for specific LAN applications of more broadly based Western Digital technology. Further, Western Digital agreed not to manufacture or distribute similar products for a period of up to six years. In 1992 LAN business revenue totaled $30.4 million and costs and expenses totaled $24.3 million. In addition, the Company sold its remaining inventory in 1992 to the purchaser of the LAN business for approximately $18.0 million.\nRECLASSIFICATIONS\nCertain prior years' amounts have been reclassified to conform to the current year presentation.\nNOTE 2 -- SUPPLEMENTAL FINANCIAL STATEMENT DATA\n- - --------------------------------------------------------------------------------\n-----\n- - -------------------------------------------------------------------------------- NOTE 3 -- SALE OF WAFER FABRICATION FACILITY\nIn December 1993, the Company sold its Irvine, California silicon wafer fabrication facility and certain tangible assets to the Semiconductor Products Sector of Motorola, Inc. (\"Motorola\") for approximately $111.0 million plus certain other considerations, including the assumption by Motorola of equipment leases and certain other liabilities associated with the facility. The gain on the sale of the facility is not material to the financial position or results of operations of the Company. Approximately $95.0 million of the proceeds from the sale were used to reduce bank indebtedness (see Note 4). Concurrent with the sale, the Company entered into a supply contract with Motorola under which Motorola will supply silicon wafers to Western Digital until at least December 1995.\nNOTE 4 -- DEBT\nSENIOR DEBT\nDuring 1993, the Company and its lenders entered into amendments to two existing secured credit facilities which enabled Western Digital to borrow up to $143.3 million as of June 30, 1993. In 1994, the Company repaid all outstanding indebtedness under these facilities with cash flows from operations and proceeds of approximately $95.0 million from the sale of the Company's wafer fabrication facility (see Note 3). Upon repayment of the indebtedness, these two credit facilities were terminated. While these facilities were utilized by the Company, the lenders periodically waived compliance with certain financial covenants.\nDuring 1994, the Company entered into an $85.0 million accounts receivable facility with certain financial institutions. The facility consists of a $50.0 million three-year arrangement at Eurodollar or reference rates of the participating banks and a $35.0 million one-year committed arrangement at a rate approximating commercial paper rates. This new facility is intended to serve as a source of working capital as may be needed from time to time and replaces credit facilities secured by substantially all of the Company's assets. The accounts receivable facility requires the Company to maintain certain financial ratios. As of June 30, 1994, there were no borrowings under this facility.\nSUBORDINATED DEBT\nThe 9% debentures, due 2014, are subordinated to all senior debt, are convertible into the Company's common stock at a conversion price of $14.45 per share and, subject to certain conditions, are redeemable by the Company. Annual sinking fund requirements of $3.5 million commence June 1, 1999. During 1994, approximately $.4 million of convertible debentures were converted into 24,496 shares of the Company's\n-----\ncommon stock. The fair market value of outstanding debentures, based on the quoted market price at June 30, 1994, was approximately $61.9 million.\nNOTE 5 -- COMMITMENTS AND CONTINGENT LIABILITIES\nPATENTS AND LICENSES\nAlthough the Company owns numerous patents and has many patent applications in process, the Company believes that the successful manufacture and marketing of its products generally depends more upon the experience, technical know-how and creative ability of its personnel rather than upon ownership of patents.\nThe Company pays royalties under several patent licensing agreements which require periodic payments. From time to time, the Company receives claims of alleged patent infringement from patent holders which typically contain an offer to grant the Company a license.\nFOREIGN EXCHANGE CONTRACTS\nThe Company enters into short-term, forward exchange contracts to hedge the impact of foreign currency fluctuations on certain assets and liabilities denominated in foreign currencies. At June 30, 1994 and 1993, the Company had outstanding $30.5 and $14.1 million, respectively of forward exchange contracts with commercial banks. These contracts generally have maturity dates that do not exceed three months. The total amount of these contracts is offset by the underlying assets and liabilities denominated in foreign currencies. The realized and unrealized gains and losses on these contracts are included in the results of operations in the year in which the exchange rates change, and are not material for all periods presented. At June 30, 1994 and 1993, the carrying value of the foreign currency contracts approximated their fair value.\nOPERATING LEASES\nThe Company leases certain facilities and equipment under long-term, non-cancelable operating leases which expire at various dates through 2000. Rental expense under these leases, including month-to-month rentals, was $26.5, $29.5 and $27.7 million in 1994, 1993, and 1992, respectively.\nFuture minimum rental payments under non-cancelable operating leases as of June 30, 1994 are:\nLEGAL CLAIMS\nThe Company was sued in September 1991, in the United States District Court for the Central District of California by Amstrad plc, a British computer maker. The suit alleged that disk drives furnished to Amstrad in 1988 and 1989 were defective. Amstrad claimed damages of approximately $3.0 million for asserted losses in out-of-pocket expenses, $38.0 million in lost profits and $100.0 million for injury to Amstrad's reputation and loss of goodwill. The Company filed a counterclaim against Amstrad. This federal action was dismissed without prejudice and Amstrad has filed a similar complaint in Orange County, California Superior Court, but raised the claim for damages to $186.0 million. The Company again filed a counterclaim for $3.0 million in actual damages plus exemplary damages in an unspecified amount and intends to vigorously defend itself against the Amstrad claims.\nThe Company was sued in March 1993 in the United States District Court for the Northern District of California by Conner Peripherals, Inc. (\"Conner\"). The suit alleges that the Company infringes five Conner patents and seeks damages (including treble damages) in an unspecified amount and injunctive relief. Conner moved for a preliminary injunction to enjoin the Company from using three of the patents in certain\n-----\nof the Company's disk drive products. The court denied that motion. If Conner were to prevail in its claims, the Company could be enjoined from using any of the Conner patents found to be valid and infringed that are the subject of this action as well as held liable for past infringement damages. The amount of such damages, if any, could be material. The Company believes that it has meritorious defenses to all of Conner's claims and intends to vigorously defend itself against the Conner lawsuit. The Company has also filed a suit alleging that Conner infringes two of the Company's patents.\nThe Company has received a claim of alleged patent infringement from Rodime PLC (\"Rodime\") under one of Rodime's U.S. patents which relates to 3.5-inch disk drives. Rodime has offered to grant the Company a royalty bearing license under that and other Rodime patents. Based on the opinion of patent counsel, the Company believes that the broad claims of the Rodime patent, if scrutinized in court, will not withstand an attack on validity, and believes that the Company has not infringed any valid claim of the Rodime patent. If Rodime were to commence litigation against the Company on this patent, and if Rodime were to prevail on its claim, the Company could be held liable for damages for past infringement. The amount of such damages, if any, is uncertain but could be material.\nThe Company currently has a cross-license with IBM Corporation (\"IBM\") which became effective January 1, 1990. Pursuant to this agreement, the Company has licensed IBM under certain Western Digital patents for the life of such patents, and has obtained from IBM a patent license which expires December 31, 1994 covering certain Western Digital products. Although the license granted to Western Digital extends to certain components within Western Digital disk drives, disk drives as such are not expressly covered. In calendar 1993, IBM initiated further discussion with the Company for the purpose of determining whether the Company's disk drives are covered by specified IBM patents. The Company is currently reviewing these patents. Based on its prior dealings with IBM, the Company expects to work toward a supplemental agreement with IBM which will address the disk drive issues and extend the term of the license, with the goal of reaching agreement prior to the expiration of the term of the current license agreement. This supplemental agreement, if finalized, may involve payment of higher royalties to IBM than are presently paid. No assurance can be given that such an agreement can be reached upon terms acceptable to the Company. Failure to reach an acceptable agreement could have a material adverse impact on the Company's business.\nThe Company is also subject to certain other legal proceedings and claims arising in connection with its business. There can be no assurance that litigation will not be commenced on one or more of these or possible other future such claims, or that, if commenced, all such litigation would be resolved without any material adverse effect on the Company's business, consolidated financial position or results of operations.\nIt is management's opinion, however, that none of these claims will have a material adverse effect on the Company's business, consolidated financial position or results of operations. The costs of defending such litigation can be substantial, regardless of outcome.\nThe Company was sued in July 1991 in the United States District Court for the Central District of California in a purported class action securities lawsuit. In June 1994, the court approved a settlement of this case whereby eligible class members will share, on a claims made basis, up to $6.75 million, comprised of $3.5 million in cash and the balance in shares of the Company's common stock. The Company's insurance carrier has agreed to contribute up to $2.6 million in cash toward the settlement. At June 30, 1994, the Company has provided for its estimate of claims to be made under the settlement.\n-----\nNOTE 6 -- INCOME TAXES\nThe domestic and international components of income (loss) before income taxes are as follows:\nThe components of the provision for income taxes are as follows:\nTemporary differences and carryforwards which give rise to a significant portion of deferred tax assets and liabilities at June 30, 1994 and 1993 are as follows:\n-----\nThe valuation allowance for deferred tax assets as of July 1, 1992 was $61.8 million. The net change in the total valuation allowance for the years ended June 30, 1994 and 1993 was an increase of $14.8 and $18.4 million, respectively.\nReconciliation of the United States Federal statutory rate to the Company's effective tax rate is as follows:\nCertain income of selected subsidiaries is taxed at substantially lower income tax rates as compared with local statutory rates. The lower rates reduced income taxes and increased net earnings by approximately $27.4 million ($.60 per share, fully diluted) and $8.6 million ($.27 per share, fully diluted) in 1994 and 1993, respectively. The lower rates did not affect income taxes paid or net loss in 1992. These lower rates expire periodically through 2000.\nAt June 30, 1994, the Company had Federal NOL carryforwards of $162.3 million and tax credit carryforwards of $16.2 million which expire in 1995 through 2009.\nNet undistributed earnings from international subsidiaries at June 30, 1994 were approximately $87.3 million. The net undistributed earnings are intended to finance local operating requirements. Accordingly, an additional United States tax provision has not been made.\nNOTE 7 -- SHAREHOLDERS' EQUITY\nThe following table summarizes all shares of common stock reserved for issuance as of June 30, 1994 (in thousands):\nCOMMON STOCK OFFERINGS\nIn February 1993, the Company issued 5,750,000 shares of its common stock in a public common stock offering. Proceeds from the offering, net of commissions and other related expenses totaling $3.6 million, were $42.4 million. The proceeds were used to reduce the Company's outstanding indebtedness.\nIn February 1994, the Company issued 7,618,711 shares of its common stock in a public common stock offering. Proceeds from the offering, net of commissions and other related expenses totaling $4.2 million, were $73.3 million. The proceeds were used for working capital and other general corporate purposes.\nSTOCK OPTION PLANS\nWestern Digital's Employee Stock Option Plan (\"Employee Plan\") is administered by the Board of Directors who determine the vesting provisions, the form of payment for the shares and all other terms of the options. Terms of the Employee Plan require that the exercise price of options be not less than the fair market value at the date of\n-----\ngrant. Options granted vest 25% one year from the date of grant and in twelve quarterly increments thereafter. As of June 30, 1994, 1,137,144 options were exercisable and 862,541 options were available for grant. Participants in the Employee Plan are permitted to finance the exercise of options with stock purchased previously. The following table summarizes activity under the Employee Plan (in thousands, except per share amounts):\nIn 1985, the Company's directors approved the Stock Option Plan for Non-Employee Directors (\"Director Plan\") and reserved 800,000 shares for issuance thereafter. The Director Plan provides for initial option grants to new directors of 20,000 shares per director and additional grants of up to 30,000 options per director following the exercise of the initial options. As of June 30, 1994, 120,000 options were exercisable and 488,188 options were available for grant. The following table summarizes activity under the Director Plan (in thousands, except per share amounts):\nSTOCK PURCHASE WARRANTS\nIn November 1991 and July 1993, in connection with amending its then existing two secured credit facilities, the Company issued warrants to the participating banks that ultimately entitled the holders to purchase an aggregate of 1,125,000 shares of common stock at an average price of $1.08 per share. In February 1994, the banks exercised all warrants outstanding and the related shares of common stock were subsequently sold by the banks in conjunction with the Company's public common stock offering. The Company received exercise price payments from the warrant holders aggregating approximately $1.2 million. The\n-----\nshares issued and proceeds received from the exercise of the warrants have been included in the shares issued and proceeds received from the February 1994 common stock offering.\nSTOCK PURCHASE RIGHTS\nIn 1989, the Company implemented a plan to protect stockholders' rights in the event of a proposed takeover of the Company. Under the plan, each share of the Company's outstanding common stock carries one Right to Purchase Series \"A\" Junior Participating Preferred Stock (\"the Right\"). The Right enables the holder, under certain circumstances, to purchase common stock of Western Digital or of the acquiring company at a substantially discounted price ten days after a person or group publicly announces it has acquired or has tendered an offer for 15% or more of the Company's outstanding common stock. The Rights are redeemable by the Company at $.01 per Right and expire in 1999.\nEMPLOYEE STOCK PURCHASE PLAN\nDuring 1994, the Board of Directors adopted, and stockholders subsequently approved, an employee stock purchase plan in accordance with Section 423 of the Internal Revenue Code whereby 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. Approximately 1.8 million shares of common stock have been reserved for issuance under this plan. As of June 30, 1994, no shares have been issued under this plan.\nPROFIT SHARING PLAN\nEffective July 1, 1991, the Company adopted an annual Profit Sharing Plan covering eligible domestic employees. During 1994, 1993 and 1992, the Company authorized 8% of pre-tax profits to be allocated to the participants. Payments to participants of the Profit Sharing Plan were $7.4 and $1.2 million in 1994 and 1993, respectively. No such payments were made under the Profit Sharing Plan in 1992.\nNOTE 8 -- BUSINESS SEGMENT AND INTERNATIONAL OPERATIONS\nWestern Digital operates in one industry segment--the design, manufacture and marketing of disk drives, integrated circuits and graphics enhancement boards to the personal computer industry. During 1994 and 1993, two customers accounted for approximately 24% of the Company's revenues. During 1992, one customer accounted for 10% of revenues.\nThe Company's operations outside the United States include manufacturing facilities in Singapore, Malaysia and Korea as well as sales offices throughout the world.\nThe following table summarizes operations by entities located within the indicated geographic areas for the past three years (in millions). United States revenues to unaffiliated customers include export sales, principally to Asia, of $300.0, $237.7 and $228.4 million in 1994, 1993, and 1992, respectively.\n-----\nTransfers between geographic areas are accounted for at prices comparable to normal sales through outside distributors. General and corporate expenses of $43.6, $32.7 and $31.1 million in 1994, 1993 and 1992, respectively, have been excluded in determining operating income (loss) by geographic region.\n-----\nWESTERN DIGITAL CORPORATION UNAUDITED QUARTERLY INFORMATION (in thousands, except per share amounts)\n- - --------------------------------------------------------------------------------\n(1) During the third and fourth quarter of 1994, fully diluted earnings per share were $.61 and $.75, respectively. During the second quarter of 1993, fully diluted earnings per share were $.21. For all other periods presented, fully diluted earnings (loss) per share approximated primary earnings (loss) per share.\n-----\nWESTERN DIGITAL CORPORATION\nSCHEDULE II -- CONSOLIDATED AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES (in thousands)\n- - --------------------------------------------------------------------------------\n(1) In October 1989, the Company made a $336 non-interest bearing loan to Roger W. Johnson, formerly Chairman and Chief Executive Officer, in connection with his exercise of stock options and payment of related income taxes. Pursuant to the terms of the Chief Executive Officer Severance Agreement, the indebtedness was forgiven upon Mr. Johnson's resignation as Chairman and Chief Executive Officer on June 30, 1993.\nIn June 1993, the Company made a $500 non-interest bearing loan to Mr. Johnson. If Mr. Johnson becomes an affiliate of, an employee of, or performs work for a competitor within four years, the loan is to accelerate and accrue interest from the date made and be due and payable immediately upon Mr. Johnson establishing the relationship. In any event, the loan is to be repaid at the end of a four-year term.\n(2) The Company has made several loans to John M. Markovich, formerly Vice President and Treasurer, to provide personal financial assistance. Mr. Markovich terminated his employment with the Company in June 1992. Loans aggregating $30 bear interest at 10%. The remaining loans are interest free.\n(3) The Company has made several loans to Marc H. Nussbaum, Senior Vice President, Engineering, to provide personal financial assistance. These notes bore interest at 10% per annum. During 1994, the notes were paid in full by Mr. Nussbaum.\n-----\nWESTERN DIGITAL CORPORATION\nSCHEDULES V AND VI -- CONSOLIDATED PROPERTY AND EQUIPMENT AND RELATED ACCUMULATED DEPRECIATION (in thousands)\nCost of property and equipment and the related depreciation and amortization are summarized as follows:\n-----\nWESTERN DIGITAL CORPORATION\nSCHEDULE VIII -- CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (in thousands)\nWESTERN DIGITAL CORPORATION\nSCHEDULE X -- SUPPLEMENTARY CONSOLIDATED INCOME STATEMENT INFORMATION (in thousands)\n** Less than one percent of revenues\n-----\nINDEX TO EXHIBITS\n- - ---------------\n* New exhibit filed with this Report. ** Compensation plan, contract or arrangement required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.\n(1) Incorporated by reference to the Registrant's Annual Report on Form 10-K (File No. 1-8703) as filed with the Securities and Exchange Commission on September 28, 1992.\n(2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q (File No. 1-8703) as filed with the Securities and Exchange Commission on May 9, 1994.\n(3) Incorporated by reference to Registrant's Amendment No. 1 to Form S-1 (No. 33-54968) as filed with the Securities and Exchange Commission on January 5, 1993.\n(4) Incorporated by reference to the Registrant's Current Report on Form 8-K (File No. 1-8703) as filed with the Securities and Exchange Commission on January 5, 1994.\n(5) Subject to confidentiality order dated November 24, 1992.\n(6) Subject to confidentiality order dated November 21, 1988.\n(7) Incorporated by reference to Amendment No. 2 to Registrant's Registration Statement on Form S-1 (No. 33-54968) as filed with the Securities and Exchange Commission on January 26, 1993.\n(8) Incorporated by reference to Registrant's Registration Statement on Form S-8 (No. 33-51725) as filed with the Securities and Exchange Commission on December 28, 1993.\n(9) Confidental treatment requested.","section_15":""}
{"filename":"49573_1994.txt","cik":"49573","year":"1994","section_1":"Item 1. BUSINESS. GENERAL\nWhitman Corporation (\"Whitman\") is engaged in three distinct businesses: Pepsi-Cola and other non-alcoholic beverage products, Midas automotive services, and Hussmann refrigeration systems and equipment. Prior to 1968, Whitman's only substantial business was the Illinois Central Railroad. Between 1968 and 1986, Whitman effected a series of acquisitions aimed at diversifying beyond the railroad business, including Pepsi-Cola General Bottlers in 1970 and Midas in 1972. In 1978, Pet Incorporated, together with its subsidiary Hussmann, was acquired as a part of this diversification program. In 1987, Whitman began a program of strategic restructuring designed to transform itself into an enterprise more focused on consumer goods and services. In 1988, Whitman sold its Pneumo Abex Corporation aerospace and defense subsidiary, and in January, 1989, Whitman spun off its railroad operations to its shareholders. On April 1, 1991, Whitman spun off its Pet subsidiary (excluding its Hussmann subsidiary) to its shareholders. After the Pet spin-off, the principal operating companies of Whitman were Pepsi-Cola General Bottlers, Inc. (\"Pepsi General\"), Midas International Corporation (\"Midas\") and Hussmann Corporation (\"Hussmann\").\nPEPSI GENERAL\nPepsi General produces and distributes soft drinks and non-alcoholic beverages, under exclusive franchises, in 12 states in the Midwestern United States - a market of approximately 25 million people. It is the largest independent Pepsi bottler in the U.S., accounting for about 12 percent of all Pepsi-Cola products sold in the U.S. Pepsi General products outsell all other brands in all of its major U.S. markets. In August, 1994, Pepsi General sold its first case of Pepsi outside the U.S. in a newly franchised area in Northern and Western Poland. This market, when fully developed, will serve approximately 16 million people. In 1994, approximately 87 percent of Pepsi General's volume was from Pepsi-Cola products, including: Pepsi, Diet Pepsi, Caffeine Free Pepsi, Caffeine Free Diet Pepsi, Wild Cherry Pepsi, Mountain Dew, Diet Mountain Dew, Slice and All-Sport. Other brands, including Dr Pepper, Seven-Up, Hawaiian Punch, Dad's Root Beer, Canada Dry, A & W Root Beer, Ocean Spray, Lipton's Tea and others account for the remaining 13 percent. Diet products account for slightly more than 27 percent of total cases sold. Approximately three- quarters of all cases sold are in cans and 24 percent are in non-returnable bottles. Volume growth in the soft drink industry has historically come from the supermarket sector, where competition is intense. Recently, Pepsi General's focus has been to obtain more of its growth from higher margin distribution channels such as convenience stores, gas stations, vending machines and food service providers. The majority of Pepsi General's products are distributed by route sales people to retail outlets by truck. Currently, Pepsi General operates more than 1,200 routes. For several years, Pepsi General has been expanding its bulk distribution system for larger customers, Pepsi Express, in efforts to improve delivery productivity. In addition, Pepsi General has pioneered the use of hand-held computers for route sales people. This system enables Pepsi General to process sales and orders more efficiently, allows for better inventory and discount controls, and enables sales personnel to handle a wider range of products more efficiently. Pepsi General owns, leases or sells the vending machines which dispense its soft drink products in factories, offices, schools, stores, gasoline stations and other locations. Pepsi General's business is seasonal and weather conditions have a significant effect on sales. One of Pepsi General's long-term strategic goals is to transform itself from a carbonated soft drink company to a total beverage company and to continue to grow faster than the industry. In 1994, Pepsi General continued to expand its product line by adding new product lines such as new lemonades and bottled waters; however, most of the new product effort was spent on other products introduced in recent years such as Lipton Tea, Ocean Spray, All Sport, Wild Cherry Pepsi, and Caffeine Free Mountain Dew products. Sales of these products increased approximately 50% in 1994. In January, 1994, Pepsi General acquired the Waterloo, Iowa franchise, which increased case sales by 1.2 percent. Pepsi General's franchises grant it the exclusive right to produce and sell the products and use the related trade names and trademarks in the franchised territories. The franchises require Pepsi General, among other things, to purchase its concentrate requirements solely from the franchisor, at prices established by the franchisor, and to promote diligently the sale and distribution of the franchised products. Packaging materials (bottles, bottle caps, cans, cartons, cases) are obtained from manufacturers approved by the franchisor and other items are purchased in the general market. Domestic franchises are for an indefinite term and are subject to termination upon failure to comply with the provisions of the franchise agreement. Competition among soft drinks of all kinds, and particularly in the principal cola drink market (approximately 65 percent of all soft drinks sold in the U.S. are colas), is intense and focuses on price to retail outlets. Despite fluctuations in the price of high fructose corn sweetener and materials used in soft drink packaging, Pepsi General has not experienced difficulty in obtaining such items. As the result of an agreement entered into in 1987, Pepsi General is 80% owned by Whitman and 20% owned by a subsidiary of PepsiCo, Inc. (\"PepsiCo\"), which is the franchisor of Pepsi-Cola products. While Pepsi General manages all phases of its operations, including pricing of its products, PepsiCo and Pepsi General exchange production, marketing, and distribution information. In 1994, PepsiCo granted Pepsi General a franchise for the distribution of Pepsi-Cola products in the western and northern areas of Poland for an initial term of 15 years. Pepsi General anticipates an investment of as much as $100 million over the next 5-8 years in Poland, and will in the near term incur losses in Poland as this new venture is developed.\nMIDAS\nMidas provides automotive exhaust, brake and suspension services through 2,575 franchised and company-owned Midas shops in the United States, Canada, France, Belgium, Austria, Switzerland, Spain, Italy, Australia, New Zealand, Panama, Mexico, Honduras and the Bahamas. Domestic manufacturing plants produce approximately 1,800 different types of mufflers and 2,750 types of exhaust and tail pipes to service approximately 1,200 makes and models of automobiles. The principal source of Midas' revenue is derived from its network of franchised and company-owned and operated retail shops. Midas collects an initial franchise fee and receives yearly royalties based upon the franchisee's gross revenues. In addition, Midas generates revenues from the sale of its manufactured mufflers and tubing; the resale of purchased parts, primarily brakes, shocks and front-end alignment components to its franchisees; and rental real estate revenues from franchisees related to the leasing of Midas shops. An important part of Midas' marketing program is its warranty of mufflers, brakes, and shocks. Midas also sells its manufactured exhaust system parts under other brand names to automotive parts distributors, jobbers and automobile accessory stores and its fabricated tube bending equipment to jobbers and retail installers. The raw materials and supplies used in Midas products are purchased from many suppliers and the company is not dependent upon any single source for any of its raw materials or supplies. Competition in the automotive replacement parts business is intensive at both the wholesale and retail levels. Service and convenience, price and warranties are the primary competitive factors. Competition includes automotive service centers of the retail chain stores, muffler shops, automotive dealers, gasoline stations and independent repair shops.\nHUSSMANN\nHussmann produces merchandising and refrigeration systems for the world's food industry. Products include refrigerated display cases, commercial\/industrial refrigeration systems, storage coolers, bottle coolers, walk-in coolers, and HVAC equipment. Hussmann is the market leader in North America, and has substantial operations in the United Kingdom. The supermarket equipment industry in the United States, Hussmann's core business, represents an $800 million market. The United States customer base is comprised of approximately 13,000 independent and 18,000 chain-owned supermarkets, plus over 52,000 other grocery stores. Every year, approximately 4,000 stores purchase refrigeration equipment for either new store openings or remodelings. Historically, Hussmann's supermarket business has been divided approximately equally between new store activity and the remodeling of existing stores. In 1994, about 45 percent of such business was in new store openings, and 55 percent remodelings. The convenience store\/specialty equipment industry in the U.S. represents a market of over $300 million per year, serving approximately 71,000 stores. Hussmann maintains separate sales and manufacturing operations for this industry. North American commercial\/industrial refrigeration represents a market of nearly $500 million. Hussmann manufactures unit coolers, condensing units, and air-cooled condenser products for this market. Mexico is Hussmann's second largest profit center. It has two manufacturing operations, and uses both a direct sales force and a network of 150 independent dealers and distributors to bring its products to the Mexican market. A large portion of Mexico's business is in equipment for the soft drink and brewery industries. Hussmann's Canadian operations consist of two manufacturing plants and a network of company-owned branches and independent distributors. In the United Kingdom, Hussmann has a manufacturing plant located in Glasgow, Scotland, and a network of sales, service, and installation depots located throughout the country. Hussmann also has a 50% interest in Capital Metalwork Ltd., a manufacturer of specialty refrigerated cases. Hussmann's branch service and distribution network in the United Kingdom is at least twice the size of its nearest competitor. In the Far East, Hussmann has a joint venture with a distributor in Singapore which sells, services, and distributes Hussmann products throughout the Southern Pacific Rim region. In December, 1994, Hussmann established a joint venture with the Luoyang Refrigeration Machinery Factory, China's leading producer of refrigeration systems and food display cases. Hussmann's initial investment will be approximately $5.5 million. It is expected that the joint venture will begin production of cases designed by Hussmann in the Spring of 1995. Hussmann also has distributor agreements in Japan, Taiwan, New Zealand, Korea, Argentina, Columbia, El Salvador and Costa Rica and licensees in Thailand and New Zealand. In 1993, Hussmann introduced PROTOCOLTM, a unique refrigeration system which is CFC and HCFC free, and less expensive to install and operate than conventional systems. Hussmann had exclusive use of the PROTOCOL compressor technology through 1994; however, the loss of exclusivity is not expected to significantly affect Hussmann's business in 1995 or thereafter. One of Hussmann's greatest strengths is its research and development center, where the PROTOCOL system was developed. It is the only R&D center of its kind in the industry. It allows Hussmann to work closely with chemical companies and compressor, valve and controls manufacturers to create the new generations of cases and systems. The dollar amount of firm backlog at December 31, 1994 was $136.2 million, compared with $146.9 million in 1993. Substantially all such backlog is expected to be filled within one year. Hussmann products are marketed internationally by both company sales personnel and independent distributors. The principal competitive factors in the sale of Hussmann products are price, variety, quality and technology, particularly energy conservation. The raw materials and supplies used in Hussmann products are purchased from many suppliers and Hussmann is not dependent upon any single source for any of its raw materials or supplies.\nEMPLOYEES\nWhitman employed 15,271 persons worldwide as of December 31, 1994. Whitman regards its employee relations as generally satisfactory.\nENVIRONMENTAL MATTERS\nWhitman maintains a continuous program to facilitate compliance with federal, state and local laws and regulations relating to the discharge or emission of materials into, and other laws and regulations relating to the protection of, the environment. The capital costs of such compliance, including the costs of the modification of existing plants and the installation of new manufacturing processes incorporating pollution control technology, are not material. Hussmann, together with numerous other defendants, has been named as a potentially responsible party (\"PRP\") in two state actions under the provisions of the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\") involving off-site waste disposal. Hussmann is also involved in several other, principally off-site, proceedings. None of these matters is expected to involve any significant expense to Hussmann. Pepsi General is a de minimus participant at seven off-site locations. Midas has been named a PRP at one Superfund site where its participation is also expected to be at the de minimus level, and is also involved in certain removal and remedial activities relating to underground storage tanks which are not anticipated to result in significant expense to Midas. Under the agreement pursuant to which Whitman sold Pneumo Abex Corporation in 1988 and a subsequent settlement agreement entered into with Pneumo Abex in September, 1991, Whitman has assumed indemnification obligations for certain environmental liabilities of Pneumo Abex, net of any insurance recoveries. Pneumo Abex is subject to a number of federal, state and local environmental cleanup proceedings, including proceedings under CERCLA at off-site locations involving other major corporations which have also been named as PRP's. Pneumo Abex is also subject to private claims and several lawsuits for remediation of properties currently or previously owned by Pneumo Abex, and Whitman is subject to two such suits. There is significant uncertainty in assessing the total cost of remediating a given site and in determining any individual party's share in that cost. This is due to the fact that the Pneumo Abex liabilities are at different stages in terms of their ultimate resolution, and any assessment and determination are inherently speculative during the early stages, depending upon a number of variables beyond the control of any party. Additionally, the settlement of governmental proceedings or private claims for remediation invariably involves negotiations within broad cost ranges of possible remediation alternatives. Furthermore, there are significant timing considerations in that a portion of the expense involved and any resulting obligation of Whitman to indemnify Pneumo Abex may not be incurred for a number of years. In 1992, the United States Environmental Protection Agency (\"EPA\") issued a Record of Decision (\"ROD\") under the provisions of CERCLA setting forth the scope of expected remedial action at a Pneumo Abex facility in Portsmouth, Virginia. On August 15, 1994, the EPA issued an Amended ROD revising certain remedial actions to be undertaken in areas of the Portsmouth site to be zoned commercial. The EPA has estimated that the cost of the revised remedial action necessary to comply with the Amended ROD will total $31.5 million. On December 19, 1994, Pneumo Abex, along with 20 other PRPs, received notice of liability under CERCLA and a request to negotiate a consent decree to undertake remedial action consistent with the Amended ROD. Whitman management remains optimistic that ongoing discussions with the EPA will result in a reduction in the total cost for implementation of the required remedial action, and that a portion of the remediation cost will be allocated to other PRPs, most of whom are financially viable, either through negotiations or as a result of a judicial determination in litigation initiated by Pneumo Abex and Whitman against several of the other PRPs. Management believes that potential insurance recoveries may defray a portion of the expenses involved in meeting Pneumo Abex environmental liabilities. On November 20, 1992, Jensen-Kelley Corporation, a Pneumo Abex subsidiary, Pneumo Abex and certain other of its affiliates, and Whitman and certain of its affiliates, filed a lawsuit against numerous insurance companies in the Superior Court of California, Los Angeles County, seeking damages and declaratory relief for insurance coverage and defense costs for environmental claims. Whitman is unable to predict the outcome of this litigation. In the opinion of management, Whitman believes that the eventual resolution of these claims and litigation, considering amounts accrued, but excluding potential insurance recoveries, will not have a material adverse effect on Whitman's financial condition.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES.\nPepsi General's facilities include six bottling plants, three combination bottling\/canning plants, three canning plants and 59 distribution warehouses, including, as of year-end 1994, one distribution facility in Poland. Approximately 16 percent of Pepsi General's production is from leased facilities. Midas operates four manufacturing plants in the United States, of which three are owned and one is leased. In addition, Midas maintains 13 warehouses in the United States and three warehouses in Canada, of which two are owned and 14 are leased. At December 31, 1994, Midas operated 125 Midas Muffler Shops in the United States, 32 Midas Muffler Shops in Canada and 189 Midas Muffler Shops in seven other foreign countries. Hussmann operates 9 owned and 8 leased manufacturing facilities in the United States, Canada, Mexico, and the United Kingdom. There are five owned and 42 leased branch facilities in the United States, Canada, Mexico, Hungary and the United Kingdom which sell, install and maintain Hussmann products. All facilities are adequately equipped and maintained and capacity is considered to be adequate for current needs. In addition, Whitman engages in a variety of industrial, commercial and residential real estate activities in the United States.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS.\nWhitman and its subsidiaries are defendants in numerous lawsuits, none of which will, in the opinion of Whitman's counsel, have a material adverse effect on Whitman s financial position. See also \"Environmental Matters\" in item 1.\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 common stock of the Company is listed on the New York, Chicago and Pacific stock exchanges. The table below sets forth the reported high and low sales prices as reported by THE WALL STREET JOURNAL for Whitman common stock and indicates the Whitman dividends for each quarterly period for the years 1994 and 1993. Common -------------------------- High Low Dividend 1994: ------- ------- -------- 1st quarter $ 17.000 $ 14.875 $ 0.075 2nd quarter 16.375 14.750 0.085 3rd quarter 18.000 15.375 0.085 4th quarter 17.250 15.250 0.085 1993: 1st quarter $ 15.375 $ 13.875 $ 0.065 2nd quarter 15.000 12.750 0.075 3rd quarter 15.500 13.250 0.075 4th quarter 17.000 14.875 0.075\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA.\nIncluded on page following 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 benefits of the Company's refinancing program became evident in 1994, as the Company reduced its net interest expense by $18.7 million to $64.7 million. The average interest rate on debt refinanced was reduced by approximately 300 basis points and total debt in 1994 was reduced by $26.3 million. This refinancing program not only contributed significantly to the Company's earnings performance for 1994, but also was a significant factor in the Company's strengthened financial condition. As a result of the improved earnings and cash flows, the Company's long-term debt-to-capital ratio improved to 48.8 percent at the end of 1994, compared with 52.1 percent at December 31, 1993, 55.3 percent at year-end 1992 and 64.0 percent at the time of the Pet spin-off in April, 1991. In addition, during 1994 the Company established a $300 million 5-year contractual revolving credit facility and increased its commercial paper program to $200 million. The Company has $188.6 million of debt, including $30 million of debt under its commercial paper program, that comes due in 1995. The Company expects to use a portion of its anticipated free cash flow to pay down debt during 1995 and to refinance the remainder under either its revolving credit facility, commercial paper program, or through the issuance of additional debt as market conditions warrant. In connection with this refinancing program, the Company issued $50.5 million of 8.1% 2-year notes and $100 million of 8-1\/4% 12-year notes on January 26, 1995 and February 16, 1995, respectively. The Company also continued to invest heavily in its future growth and in its efforts to improve its productivity and competitive position. Capital spending increased by 43.6 percent to $127.4 million in 1994, and is currently projected to increase in 1995 by an additional 10 percent or more. The Company believes that with its strong free cash flow, its outlook for continued earnings improvements, its existing and available lines of credit and with the potential for additional debt or equity offerings, it will have sufficient resources to fund its future growth, including funds for capital expenditures and possible acquisitions. The Company uses financial derivative instruments to manage its interest rate risk. The Company also has entered into foreign currency swap agreements to reduce the effect of foreign currency fluctuations on its foreign currency debts. A description of these transactions is discussed in Note 5 to the Consolidated Financial Statements. The effects of such transactions on the Company's results of operations and financial condition were not significant.\nOperating Results: 1994 compared with 1993\nSales and revenues increased by $129.1 million to $2,658.8 million in 1994, a 5.1 percent increase over the previous year. Pepsi General's revenues increased $76.5 million to $1,256.1 million, a 6.5 percent increase over 1993. Unit volume amounted to 169.7 million cases, a 5.8 percent increase over 1993. The increase in unit volume was principally in the core Pepsi brands, although relatively new products such as All-Sport, Lipton Teas and Ocean Spray also had significant volume increases. The average net selling price per case improved by approximately one percent during 1994, and primarily reflected favorable changes in brand, package and channel mix. Midas' revenues increased by $39.6 million, or 7.9 percent, to $543.2 million in 1994. Approximately 70 percent of the increase was from domestic operations, and reflected a relatively strong sales performance in its U.S. retail system. The increased retail sales in the U.S. included an approximate 3 percent increase in the number of jobs performed, as well as an improvement in the average revenue per job. Revenues in Europe increased by over 22 percent, and principally reflected an increase in the number of shops as well as improved revenues in France and Belgium. Hussmann's revenues increased by $13.0 million in 1994, or 1.5 percent, to $859.5 million, with the increased revenues being reported principally by the U.K. and Mexican operations. U.S. unit volume of refrigerated display and reach-in door cases increased by approximately one percent in 1994, but was offset by increasing competitive pressures which had an adverse effect upon pricing. Gross profit margins improved to 35.9 percent, modestly better than the gross profit margin of 35.8 percent in 1993. The margin improvement reflected the benefits of higher volumes and modest price increases at both Pepsi General and Midas, while Hussmann's gross profit margins declined, reflecting the adverse effects of increasingly competitive conditions, and a shift in product mix. Selling, general and administrative (S,G&A) expenses increased by 4.7 percent in 1994 to $609.8 million. The increase was less than the increase in revenues, and as a result, such expenses declined to 22.9 percent of sales, down from 23.0 percent in 1993. Increases at Pepsi General and Midas generally were in line with the increases in revenues, with Midas' increase also reflecting an increase in the number of company-owned shops, particularly in its international operations. Hussmann's S,G&A expenses declined by more than 6 percent, due, in part, to Hussmann's continuing cost containment programs. Amortization expense did not change significantly. As a result of the increase in sales and revenues, together with the improvement in gross profit margins and a reduction in S,G&A expenses as a percent of sales, operating income increased by $21.5 million, or 7.0 percent, to $326.8 million. The Company's operating margin, as a percent of sales, increased from 12.1 percent in 1993 to 12.3 percent in 1994. Pepsi General's operating income increased by 8.8 percent to a new record level of $185.5 million. The increase principally reflected the benefits of the higher case volume together with the modest increase in pricing. Costs were also favorably affected by lower aluminum can costs, offset in part by higher ingredient and packaging costs. Included in the operating results were $2.7 million of losses and expenses related to Pepsi General's new venture in Poland. Operating earnings at Midas increased by 12.1 percent, or $8.1 million, to $75.2 million. The increase in operating income was in Midas' U.S. operations, and principally resulted from higher royalty and rental revenues, higher product sales and improved earnings from company-owned shops. The increase in the U.S. operating results was partially offset by lower earnings from its foreign operations, principally in its Canadian operations, where wholesale and retail sales remained sluggish. Midas also provided for the closure of additional shops in Australia. Hussmann's operating earnings of $82.5 million were down $1.1 million from the record level established in 1993. The reduction in earnings primarily reflected the adverse effects of pricing pressures on profit margins in the U.S. and a shift in product mix to lower profit margin business in the U.K. and Mexico. Interest expense declined sharply from $96.2 million in 1993 to $71.1 million in 1994. The reduction reflected the effects of the Company's refinancing program, whereby approximately $530 million of debt has been refinanced over the past 2 years at an average interest cost which was approximately 300 basis points below the interest rate on the debt it replaced. In addition, the Company reduced its total debt levels by $26.3 million in 1994 and by $87.5 million since December 31, 1992. Interest income declined from $12.8 million in 1993 to $6.4 million in 1994. The reduction reflected a decline in investable funds during the latter part of 1993 and continuing into 1994. Other expense increased by $15.5 million to $25.2 million in 1994. The increase principally reflected losses from asset sales in 1994 compared with gains from asset sales in 1993, as well as additional expenses related to the Company's real estate and leasing operations.\n1993 compared with 1992\nSales and revenues increased by $141.7 million, or 5.9 percent, to $2,529.7 million in 1993. Pepsi General's revenues increased $68.4 million, or 6.2 percent, over 1992. The increase principally reflected higher case volume, up 4.4 percent, and included growth in not only the core Pepsi brands, but in new products, such as All Sport, Lipton Teas and Ocean Spray. The average net selling price per case improved by approximately one percent, with the remainder of the revenue increase principally reflecting improved product mix. Midas' revenues increased by $18.0 million to $503.6 million. Midas' domestic revenues were up 4 percent over those of 1992, in spite of a 52-week year in 1993 compared with a 53-week year in 1992, and principally reflected increased retail and wholesale sales during the latter part of 1993. Foreign revenues were up 3 percent over 1992 with growth in Europe being offset in part by lower revenues in Canada and Australia, which continued to experience recessionary conditions. Hussmann's revenues increased $55.3 million, or 7.0 percent, to $846.5 million, with the improvement principally reflecting the benefits of improved demand for Hussmann's products throughout the world. Gross profit margins improved for the third straight year after the spin- off of Pet, increasing from 35.3 percent in 1992 to 35.8 percent in 1993. This margin improvement reflected the benefits of lower ingredient costs, some modest price improvement and improved volumes at Pepsi General. The improvement was offset by modestly lower profit margins at Midas and Hussmann, where the inability to increase prices to offset increased costs depressed margins. Selling, general and administrative expenses increased 5.7 percent to $582.3 million, compared with a 5.9 percent increase in sales. As a result, such expenses declined modestly as a percentage of sales from 23.1 percent in 1992 to 23.0 percent in 1993. Such expenses increased at all subsidiaries, and generally reflected the effects of inflationary increases in costs, with the most significant increase being reported by Midas, where the increase reflected, among other items, an increase in the number of company-owned shops, particularly in Europe, as well as expenses associated with restructurings in the U.S. and shop closings in Australia. Amortization expense did not change significantly. As a result of the improved sales and revenues, as well as improved gross profit margins, operating income increased by $30.9 million, an 11.3 percent improvement, over 1992. Pepsi General's operating income increased by 22.7 percent to $170.5 million in 1993. The sharply improved results reflected the benefits of higher volume, due in part to more favorable weather conditions in 1993, lower ingredient and can costs and a modest improvement in pricing. Operating margins improved by 2 full percentage points to 14.5 percent. Midas' operating earnings in 1993 declined $6.0 million to $67.1 million. Midas' U.S. operating results were $2.8 million below 1992 and reflected, among other items, restructuring charges in the U.S., the continuing recessionary conditions in the Northeast and in Southern California, as well as the inability to raise prices to offset material and wage increases. Midas' foreign operations were down $3.2 million, principally in Australia and Canada, reflecting weak economic conditions in those countries plus the expenses associated with the closing of a number of shops in Australia, which more than offset improved results in Europe. Hussmann reported record earnings of $83.6 million, 8.9 percent over the previous record of $76.8 million in 1992. The improved performance reflected the benefits of improved volumes throughout their operations and the benefits of continued emphasis on cost controls. Interest expense declined by $1.5 million to $96.2 million. The reduction reflected the effects of lower interest rates. Average debt levels increased during 1993 as the Company issued debt in advance of repayments to take advantage of favorable market conditions. Interest income increased by $3.8 million to $12.8 million. The additional income was principally the result of higher levels of temporarily investable funds from proceeds of debt issued in advance of repayment requirements. Other expense declined by $5.4 million in 1993, with the reduction principally reflecting gains from asset sales.\nEnvironmental Matters\nThe Company is involved, directly or as a possible indemnitor, in a number of environmental proceedings and claims. The Company continues to actively investigate such matters in an attempt to evaluate the Company's exposure to each claim. In many instances, many other major corporations also have been identified as potentially responsible parties. As discussed in Note 11 to the Consolidated Financial Statements, the Company believes that it has made adequate provision for such potential liabilities, excluding consideration of possible insurance recoveries. However, it is not possible at this time to determine what the Company's ultimate liability on these claims may be.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee Index to Financial Information following signature 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.\nWhitman incorporates by reference the information contained under the caption \"Election of Directors\" in its definitive proxy statement dated March 22, 1995, filed pursuant to Section 14 (a) of the Securities Exchange Act of 1934, as amended.\nThe executive officers of Whitman and their ages as of March 1,1995 were as follows:\nAge Position ---- ---------- Bruce S. Chelberg 60 Chairman and Chief Executive Officer Thomas L. Bindley 51 Executive Vice President Frank T. Westover 56 Senior Vice President-Controller Lawrence J. Pilon 46 Senior Vice President-Human Resources Gerald A. McGuire 63 Corporate Vice President; President and Chief Executive Officer, Pepsi-Cola General Bottlers, Inc. John R. Moore 59 Corporate Vice President; President and Chief Executive Officer, Midas International Corporation J. Larry Vowell 54 Corporate Vice President; President and Chief Executive Officer, Hussmann Corporation Charles H. Connolly 60 Vice President-Corporate Affairs and Investor Relations William B. Moore 53 Vice President, Secretary and General Counsel\nExcept as described in the following paragraph or as incorporated by reference to the Registrant's definitive proxy statement, all the executive officers of Whitman have held positions which are the same or which involve substantially similar functions as indicated above during the past five years. Mr. Chelberg was elected Chairman and Chief Executive Officer in May, 1992. Prior to that, Mr. Chelberg served as Executive Vice President of the Company since 1985. Mr. Bindley joined Whitman Corporation as Executive Vice President in April, 1992. Prior to joining Whitman Corporation, Mr. Bindley served as Executive Vice President of Square D Corporation from August, 1986 through September, 1991. Mr. Pilon joined Whitman Corporation as Senior Vice President-Human Resources in February, 1994. Prior to joining Whitman Corporation, Mr. Pilon served as Vice President-Human Resources and Secretary of National Intergroup, Inc. from June, 1986 to January, 1994. Mr. Vowell was elected President and Chief Executive Officer of Hussmann Corporation in January, 1991. Prior to that, Mr. Vowell served as President and Chief Operating Officer of Hussmann U.S. operations since March, 1990; Senior Vice President and General Manager of Marketing from July, 1989; and President of the Convenience and Specialty Group from 1987.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nWhitman incorporates by reference the information contained under the caption \"Executive Compensation\" and the last two paragraphs under the caption \"General Information\" in its definitive proxy statement dated March 22, 1995, filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nWhitman incorporates by reference the information contained under the captions \"Principal Shareholders\" and \"Securities Ownership of Directors and Executive Officers\" in its definitive proxy statement dated March 22, 1995, filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNone.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) See Index to Financial Information and Exhibit Index.\n(b) Through December 31, 1994, no reports on Form 8-K were filed subsequent to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 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 the 22nd day of March, 1995.\nWHITMAN CORPORATION\nBy: \/s\/ FRANK T. WESTOVER ------------------------------- Frank T. Westover Senior Vice President-Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities indicated on the 22nd day of March, 1995.\nSignature Title --------- -----\n* Bruce S. Chelberg Chairman and Chief ------------------------- Executive Officer and Director BRUCE S. CHELBERG (principal executive officer)\n* Thomas L. Bindley Executive Vice President ------------------------- (principal financial officer) THOMAS L. BINDLEY\n\/s\/ FRANK T. WESTOVER Senior Vice President-Controller ------------------------- (principal accounting officer) FRANK T. WESTOVER\n* Richard G. Cline Director ------------------------- RICHARD G. CLINE\n* James W. Cozad Director *By: \/s\/ FRANK T. WESTOVER ------------------------- ---------------------- JAMES W. COZAD Frank T. Westover Attorney-in-Fact * Pierre S. du Pont Director March 22, 1995 ------------------------- PIERRE S. du PONT\n* Archie R. Dykes Director ------------------------- ARCHIE R. DYKES\nDirector ------------------------- HELEN GALLAND\n* Jarobin Gilbert, Jr. Director ------------------------- JAROBIN GILBERT, JR.\n* Victoria B. Jackson Director ------------------------- VICTORIA B. JACKSON\n* Donald P. Jacobs Director ------------------------- DONALD P. JACOBS\n* Charles S. Locke Director ------------------------- CHARLES S. LOCKE\nWHITMAN CORPORATION AND SUBSIDIARIES\n______________________\nFINANCIAL INFORMATION\nFOR INCLUSION IN ANNUAL REPORT ON FORM 10-K\nFISCAL YEAR ENDED DECEMBER 31, 1994\nWHITMAN CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL INFORMATION\nStatement of Financial Responsibility\nIndependent Auditors' Report\nConsolidated Statements of Income for the years ended December 31, 1994, 1993 and 1992\nConsolidated Balance Sheets at December 31, 1994 and December 31, 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\nSelected Financial Data\nFinancial Statement Schedules:\nFinancial statement schedules have been omitted because they are not applicable or the required information is shown in the financial statements or related notes.\nSTATEMENT OF FINANCIAL RESPONSIBILITY\nThe consolidated financial statements of Whitman Corporation and subsidiaries have been prepared by management which is responsible for their integrity and content. These statements have been prepared in accordance with generally accepted accounting principles and include amounts which reflect certain estimates and judgments by management. The Board of Directors, acting through the Audit Committee of the Board, has responsibility for determining that management fulfills its duties in connection with the preparation of these consolidated financial statements. The Audit Committee meets periodically and privately with the Independent Auditors and with the internal auditors to review matters relating to the quality of the financial reporting of the Company, the related internal controls and the scope and results of their audits. The Committee also meets with management and the internal audit staff to review the affairs of the Company. To meet management's responsibility for the fair and objective reporting of the results of operations and financial condition, the Company maintains systems of internal controls and procedures to provide reasonable assurance of the reliability of its accounting records. These systems include written policies and procedures, a substantial program of internal audit and the careful selection and training of its financial staff. The Company's Independent Auditors, KPMG Peat Marwick LLP, are engaged to audit the consolidated financial statements of the Company and to issue their report thereon. Their audit has been conducted in accordance with generally accepted auditing standards. Their report follows.\nINDEPENDENT AUDITORS' REPORT\nTHE BOARD OF DIRECTORS AND SHAREHOLDERS OF WHITMAN CORPORATION:\nWe have audited the accompanying consolidated balance sheets of Whitman 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. 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. We 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 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. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Whitman 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. As discussed in Note 6 to the Consolidated Financial Statements, effective January 1, 1993, the Company changed its method of accounting for postretirement benefits other than pensions.\nKPMG Peat Marwick LLP Chicago, Illinois January 16, 1995\nWhitman Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME\nFor the years ended December 31 (in millions) 1994 1993 1992 ------- ------- ------- Sales and revenues $2,658.8 $2,529.7 $2,388.0 Cost of goods sold 1,704.7 1,625.0 1,545.6 --------- --------- --------- Gross profit 954.1 904.7 842.4 Selling, general and administrative expenses 609.8 582.3 550.7 Amortization expense 17.5 17.1 17.3 --------- --------- --------- Operating income 326.8 305.3 274.4 Interest expense (71.1) (96.2) (97.7) Interest income 6.4 12.8 9.0 Other expense, net (25.2) (9.7) (15.1) Unrealized investment loss (24.2) -- -- --------- --------- --------- Income before income taxes 212.7 212.2 170.6 Income tax provision 88.1 90.7 68.5 --------- --------- --------- Income from continuing operations before minority interest 124.6 121.5 102.1 Minority interest 18.2 15.1 10.0 --------- --------- --------- Income from continuing operations 106.4 106.4 92.1 Loss from discontinued operations after taxes (Note 2) (3.2) -- -- Loss from dispositions of discontinued operations after taxes (Note 2) -- -- (32.3) Extraordinary loss on early debt retirement after taxes (Note 4) -- (4.2) -- Cumulative effect of change in accounting principle after taxes (Note 6) -- (24.0) -- --------- --------- --------- Net income $ 103.2 $ 78.2 $ 59.8 ========= ========= ========= Average number of common shares outstanding 106.2 107.5 107.2 ========= ========= ========= INCOME (LOSS) PER COMMON SHARE (IN DOLLARS): Continuing operations $ 1.00 $ 0.99 $ 0.86 Discontinued operations (0.03) -- (0.30) Extraordinary loss on early debt retirement -- (0.04) -- Cumulative effect of change in accounting principle -- (0.22) -- --------- --------- --------- Net income $ 0.97 $ 0.73 $ 0.56 ========= ========= ========= Cash dividends per common share $ 0.330 $ 0.290 $ 0.255 ========= ========= =========\nThe following notes are an integral part of these statements.\nWhitman Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS\nAs of December 31 (in millions) 1994 1993 ASSETS: ------ ------ Current assets: Cash and cash equivalents $ 71.3 $ 93.0 Receivables - net of allowance for doubtful accounts of $7.9 million in 1994 and $7.8 million in 1993 362.5 324.1 Inventories: Raw materials and supplies 73.8 67.6 Work in process 41.2 39.5 Finished goods 118.6 115.6 --------- --------- Total inventories 233.6 222.7 Other current assets 40.3 51.4 --------- --------- Total current assets 707.7 691.2 Investments 222.6 238.5 Property (at cost): Land 63.5 59.9 Buildings and improvements 308.4 298.1 Machinery and equipment 833.3 748.9 --------- --------- Total property 1,205.2 1,106.9 Accumulated depreciation and amortization (591.4) (534.1) --------- --------- Net property 613.8 572.8 Intangible assets, net of accumulated amortization of $123.6 million in 1994 and $106.7 million in 1993 524.3 525.9 Other assets 67.0 74.8 --------- --------- Total assets $ 2,135.4 $ 2,103.2 ========= =========\nThe following notes are an integral part of these statements.\nWhitman Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS\nAs of December 31 (in millions) 1994 1993 ------ ------ LIABILITIES AND SHAREHOLDERS' EQUITY: Current liabilities: Short-term debt, including current maturities of long-term debt $ 90.0 $ 90.0 Accounts and dividends payable 238.7 232.9 Income taxes payable 10.6 10.7 Accrued expenses: Salaries and wages 40.2 39.0 Interest 26.6 22.8 Other expenses 77.0 77.3 -------- -------- Total current liabilities 483.1 472.7 Long-term debt 723.0 749.3 Deferred income taxes 15.6 66.6 Other liabilities 154.9 124.7 Minority interest 206.2 172.9 Shareholders' equity: Common stock (no par, 250.0 million shares authorized; 105.0 million outstanding at December 31, 1994 and 107.1 million outstanding at December 31, 1993) 413.2 404.4 Retained income 239.9 172.4 Cumulative translation adjustment (51.8) (52.3) Unrealized investment gain 1.3 -- Treasury stock (50.0) (7.5) -------- -------- Total shareholders' equity 552.6 517.0 -------- -------- Total liabilities and shareholders' equity $2,135.4 $2,103.2 ======== ========\nThe following notes are an integral part of these statements.\nWhitman Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS\nFor the years ended December 31 (in millions) 1994 1993 1992 ------ ------ ------ CASH FLOWS FROM OPERATING ACTIVITIES: Income from continuing operations $ 106.4 $ 106.4 $ 92.1 Adjustments to reconcile to net cash provided by operating activities: Depreciation and amortization 98.0 95.5 93.5 Unrealized investment loss 24.2 -- -- Other 23.9 24.0 23.3 Changes in assets and liabilities, net of acquisitions and dispositions: (Increase) decrease in receivables (11.7) (43.2) 16.8 (Increase) decrease in inventories (10.3) (7.1) 3.7 Increase in payables 5.7 21.8 4.0 Net change in other assets and liabilities (24.6) 15.9 (26.4) ------- ------- ------- Net cash provided by continuing operations 211.6 213.3 207.0 Net cash used by discontinued operations (5.8) (29.8) (12.2) ------- ------- ------- Net cash provided by operating activities 205.8 183.5 194.8 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital investments (127.4) (88.7) (79.2) Proceeds from sales of property 18.2 14.3 12.0 Investment in joint ventures (4.5) -- -- Purchases of investments (168.8) (211.2) (121.4) Proceeds from the sale of investments 156.9 180.2 169.8 ------- ------- ------- Net cash used by investing activities (125.6) (105.4) (18.8) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings from (repayment of) bank lines of credit and commercial paper (41.1) 83.6 -- Proceeds from issuance of long-term debt 231.9 263.3 38.0 Repayment of long-term debt (221.1) (430.8) (159.1) Net increase (decrease) in short-term debt -- -- (2.2) Issuance of common stock 6.0 2.2 3.6 Treasury stock purchases (42.5) (3.9) -- Common dividends (34.8) (31.1) (27.3) ------- ------- ------- Net cash used in financing activities (101.6) (116.7) (147.0) ------- ------- ------- Effects of exchange rate changes on cash and cash equivalents (0.3) (0.9) (1.6) ------- ------- ------- Change in cash and cash equivalents (21.7) (39.5) 27.4 Cash and cash equivalents at beginning of year 93.0 132.5 105.1 ------- ------- ------- Cash and cash equivalents at end of year $ 71.3 $ 93.0 $ 132.5 ======= ======= =======\nThe following notes are an integral part of these statements.\nThe following notes are an integral part of these statements.\nWhitman Corporation and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNAFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of Whitman Corporation and all of its significant subsidiaries (the Company). CASH AND CASH EQUIVALENTS. Cash and cash equivalents consist of deposits with banks and financial institutions which are unrestricted as to withdrawal or use, and which have original maturities of three months or less. Inventories. Inventories are valued at the lower of cost (principally determined on the first-in, first-out or average methods) or net realizable value. INVESTMENTS. Investments include real estate held for sale, principally at Illinois Center, a large single location, mixed use development located on the Chicago lakefront. The investments in real estate are carried at cost which management believes is lower than net realizable value. When real estate is sold, the net proceeds are deducted from the carrying value. Also included are domestic and U.S. dollar-denominated foreign government securities and securities guaranteed by such governments or their agencies, bank obligations and corporate obligations (which are recorded at fair market value), as well as other miscellaneous investments. PROPERTY. Depreciation is computed on the straight-line method and includes depreciation for properties under capital leases. When property is sold or retired, cost and accumulated depreciation are eliminated from the accounts and gains or losses are recorded in income. Expenditures for maintenance and repairs are expensed as incurred. The approximate ranges of annual depreciation rates for major property classifications are as follows:\nBuildings 2% - 5% Machinery and equipment 5% - 33%\nINTANGIBLE ASSETS. Intangible assets primarily consist of the excess of cost over fair market value of tangible assets of acquired businesses, reflecting premiums paid for consumer franchises, brand names, trademarks, distribution systems, manufacturing know-how and other intangible assets. Such premiums generally are being amortized on straight-line bases over 40 years, with minor amounts being amortized over shorter periods. The Company evaluates such goodwill by reviewing past and, if necessary, projected future operating results and undiscounted cash flows from such operations. The Company does not believe there has been any material impairment of the carrying value of its goodwill. INCOME PER COMMON SHARE. Income per common share is based upon the weighted average number of common and common equivalent shares outstanding, assuming the exercise of stock options where dilutive. ADVERTISING. Advertising expenditures are expensed as incurred. REVENUE RECOGNITION. Revenue is recognized when title to a product is transferred to the customer or upon completion of a service. INTEREST RATE AND CURRENCY SWAPS. The Company enters into a variety of interest rate and currency swaps in its management of interest rate and foreign currency exposures. The differential to be paid or received is accrued as interest rates change and is recognized over the lives of the agreements. Realized and unrealized gains and losses on foreign currency transactions are recognized currently in other expense, net.\n2. DISCONTINUED OPERATIONS\nIn the fourth quarter of 1994, the Company recorded a $3.2 million after tax charge to discontinued operations. This charge was a result of an on- going evaluation of the Company's potential liabilities for environmental claims which principally relate to previously sold subsidiaries (see Note 11). As a result of additional claims, additional information and experience concerning possible remediation costs, as well as continuing legal, consulting and other related expenses, the Company provided approximately $30 million after taxes for additional estimated expenses relating to these potential environmental liabilities. The charge also reflected settlement of the Company's income tax audits for the years 1980-1987 with the Internal Revenue Service (I.R.S.), which included some large potential claims for issues related to previously discontinued operations. As a result of these settlements, the Company has restored to income amounts of tax accruals no longer deemed necessary. In the third quarter of 1993, the Company settled a lawsuit filed by the Middleby Corporation against the Company's Hussmann subsidiary for $19.5 million in cash and certain other concessions. The suit related to the 1989 sale of Hussmann's foodservice equipment operations. Provision for the lawsuit and related expenses (after taxes), along with additional income taxes and other expenses associated with previously discontinued operations, were recorded in 1992 as part of discontinued operations.\n3. PROVISION FOR INCOME TAXES\nThe income tax provision consisted of:\n(in millions) 1994 1993 1992 ------ ------ ------ Current: Federal $82.1 $63.1 $51.9 Foreign 16.3 14.0 13.3 State and local 13.6 10.6 8.9 ----- ----- ----- Total current 112.0 87.7 74.1 ===== ===== ===== Deferred: Federal (21.4) 3.2 (4.6) Foreign (1.6) 1.4 (1.4) State and local (0.9) (1.6) 0.4 Total deferred (23.9) 3.0 (5.6) ----- ----- ----- Income tax provision $88.1 $90.7 $68.5 ===== ===== =====\nThe items which gave rise to differences between the income tax provision in the income statements and the income tax computed at the United States statutory rate are summarized below:\n1994 1993 1992 ----------- ----------- ----------- (dollars in millions) Amount % Amount % Amount % ------ ---- ------ ---- ------ ---- Income tax expense computed at statutory rate $ 74.4 35.0 $ 74.3 35.0 $ 58.0 34.0 State income taxes, net of federal income tax benefit 8.3 3.9 5.9 2.8 6.1 3.6 Higher foreign effective tax rates 4.1 1.9 5.2 2.4 4.1 2.4 Goodwill amortization 5.1 2.4 4.7 2.2 4.5 2.6 Other items, net (3.8)(1.8) 0.6 0.3 (4.2)(2.4) ------ ---- ------ ---- ------ ---- Income tax provision $ 88.1 41.4 $ 90.7 42.7 $ 68.5 40.2 ====== ==== ====== ==== ====== ====\nPretax income from foreign operations amounted to $31.6 million, $30.7 million, and $25.4 million in 1994, 1993 and 1992, respectively. U.S. income taxes have not been provided on the undistributed income ($89.1 million) of the Company's foreign subsidiaries which currently is not intended to be remitted to the U.S. The I.R.S. has completed its examinations of the Company's Federal income tax returns through 1987. The IRS had proposed adjustments for the years 1980-1987 which would have substantially increased the Company's tax liability. The Company has settled all issues for these years, and accruals which were no longer required have been credited to income from continuing operations or to income from discontinued operations, as appropriate (see Note 2). The accruals which have been restored to income from continuing operations were reflected in \"other items, net\" in the table above. Deferred income taxes are created by \"temporary differences\" which exist between amounts of assets and liabilities recorded for financial reporting purposes and such amounts as measured by income tax regulations. These temporary differences, which gave rise to deferred tax assets and liabilities at December 31, are attributable to:\n(in millions) 1994 1993 ------ ------ Deferred tax assets: Provision for closed and sold businesses $ 39.9 $ 27.0 Lease transactions 19.3 20.8 Self-insurance provisions 16.3 19.3 Postretirement benefit accruals 12.4 12.2 Other 41.6 36.8 ------- ------- Total deferred tax assets 129.5 116.1 ------- ------- Deferred tax liabilities: Property, plant and equipment 68.2 70.8 Pensions 8.7 8.5 Intangibles 7.5 6.4 Other 48.6 72.9 ------- ------- Total deferred tax liabilities 133.0 158.6 ------- ------- Net deferred tax liability $ 3.5 $ 42.5 ======= ======= Net deferred tax liability (asset) included in: \"Other current assets\" $ (12.1) $ (24.1) \"Deferred income taxes\" 15.6 66.6 ------- ------- Net deferred tax liability $ 3.5 $ 42.5 ======= =======\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Statement No. 109 superseded existing accounting standards for income taxes, including Statement No. 96 which the Company adopted in 1988. Adoption of Statement No. 109 did not have any significant effect on the Company's financial position or results of operations. The increase in the statutory Federal income tax rate to 35 percent in 1993 did not have a significant effect on the deferred tax balances.\n4. DEBT\nDebt at December 31 consisted of the following:\n(in millions) 1994 1993 ------ ------ Whitman Corporation: 6.3% to 6.9% notes due 2000 and 2005 $ 136.5 $ 136.5 7.5% notes due 2003 125.0 125.0 6.5% notes due 2006 100.0 -- 7.5% notes due 2001 75.0 -- Notes due 1996, effective interest rate 5.7% 70.0 70.0 Notes due 1997, effective interest rate 5.6% 40.0 75.0 Term loan agreements and notes, due 1995 through 1999, effective interest rates 5.7% to 12.5% 104.9 109.9 Swiss franc bonds and notes due 1995, exchanged for U.S. dollar liabilities at 12.4% 50.0 96.7 Canadian notes due 1995, exchanged for U.S. dollar liabilities at 12.2% 38.1 38.1 Equipment notes due 1995 through 1996, 11.0% to 13.3% 7.0 15.4 Commercial paper and revolving credit borrowings due 1995, effective rates 6.4% to 6.5% 42.5 83.6 Whitman Finance Corporation, N.V.: Sinking fund zero coupon bonds due 1994, 14.3% -- 54.8 Retractable notes due 1994, 5.8% -- 5.3 Other Subsidiaries: Obligations under capital leases 17.7 19.4 Various 8.6 11.0 ------- ------- Total debt 815.3 840.7 Less: Amount due within one year 90.0 90.0 Unamortized discount 2.3 1.4 ------- ------- Total long-term debt $ 723.0 $ 749.3 ======= =======\nThe Company maintains a $200 million commercial paper program and had $30 million and $50 million of commercial paper outstanding under this program at December 31, 1994 and 1993, respectively. The Company also has a contractual revolving credit facility which permits it to borrow up to $300 million. The interest rates on the revolving credit facility may be floating or fixed and are based on domestic rates or the London Interbank Offered Rate (\"LIBOR\") at the option of the Company. This facility expires in 1999. There were borrowings of $12.5 million and $33.6 million under such commitments at December 31, 1994 and 1993, respectively. The fees payable on the unused portion of such commitments are not significant. At December 31, 1994, $287.5 million of the revolving credit facility remained unused and available to back the Company's commercial paper borrowings. The amounts of long-term debt (excluding commercial paper and revolving credit borrowings) maturing in 1996 through 1999, are: $102.4 million, $56.2 million, $3.4 million and $11.2 million, respectively. At December 31, 1994, $98.6 million of currently maturing notes have been classified as long-term because the Company has the intent and the ability (through its revolving credit facility) to refinance these obligations for more than one year. In September, 1993, the Company redeemed the entire issue of $95.8 million 7-1\/4% split currency bonds (effective interest rate of 12.6%), originally due September, 1997, for $101.9 million. After related expenses and fees, this early debt retirement resulted in an after tax loss of $4.2 million, or $0.04 per share. This loss is reported separately as an extraordinary loss in the Consolidated Statements of Income. Interest expense included $1.9 million, $2.1 million and $2.6 million for 1994, 1993 and 1992, respectively, relating to liabilities under capital lease agreements. Interest capitalized during periods of construction was not significant. At December 31, 1994, collateral of $57.3 million, consisting predominantly of equipment and real estate, was pledged under various long- term loan agreements. Certain of the Company's financing arrangements contain restrictions which, among other features, require maintenance of certain financial ratios. The Company is in compliance with these debt covenants.\n5. FINANCIAL INSTRUMENTS\nThe Company uses financial derivative instruments to manage its interest rate risk. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying notional amounts. The Company has entered into certain interest rate swap agreements with commercial and investment banks in which it pays a floating interest rate and receives a fixed interest rate. These contracts are summarized as follows:\nEffective Notional Effective Interest Amount Maturity Interest Rate Related Debt Issue: (in millions) of Swaps Rate Paid Received ---------- ---------- ---------- ---------- 7.5% notes due 2003 $ 125.0 1996 7.0% 5.2%\n6.5% notes due 2006 $ 40.0 1997 7.0% 5.2%\nThe Company's interest rate swap transactions (notional amounts) for 1993 and 1994 are summarized as follows (in millions): Pay Pay Fixed Variable -------- -------- Balance, January 1, 1993 $ 140.0 $ -- ------- ------- New contracts -- 135.0 Expired contracts (75.0) (10.0) ------- ------- Balance, December 31, 1993 65.0 125.0 ------- ------- New contracts -- 40.0 Expired contracts (65.0) -- ------- ------- Balance, December 31, 1994 $ -- $ 165.0 ======= =======\nWhitman's interest rate hedging programs increased the annual weighted average cost of debt from 8.7% to 9.0% in 1994, from 8.8% to 9.3% in 1993 and from 9.8% to 10.4% in 1992. Interest expense was increased by $2.1 million in 1994, $5.4 million in 1993 and $6.1 million in 1992 as a result of these hedging programs. The Company also has entered into foreign currency swap agreements to reduce the effect of changes in foreign exchange rates on its debt denominated in foreign currencies. Substantially all foreign currency denominated debt and interest payments have been hedged into U.S.dollars. Under the hedge agreements, the Company will repay the 138.2 million Swiss franc debt at an effective exchange rate of 2.764 Swiss francs per dollar ($50.0 million), compared to a December 30, 1994 exchange rate of 1.308 Swiss francs per dollar ($105.6 million) and will pay the 50 million Canadian dollar debt at an effective exchange rate of 1.312 Canadian dollars per U.S. dollar ($38.1 million), compared to a December 30, 1994 exchange rate of 1.403 Canadian dollars per U.S. dollar ($35.6 million). If the Company had left the interest payments payable in foreign currency (i.e., unhedged), then the Company's interest expense would have decreased by $0.3 million, $7.0 million and $7.0 million for 1994, 1993 and 1992, respectively. Consequently, this would have had no material effect on weighted average cost of borrowing in 1994, and would have lowered the weighted average cost of borrowing to 8.6% from 9.3% in 1993 and to 9.7% from 10.4% in 1992. At December 31, 1994, the Company had $303.1 million in floating rate debt exposure (including notional principal on interest rate swap contracts). Substantially all of this floating rate exposure is related to six month LIBOR rates. If the six month LIBOR increased by 50 basis points, the Company's 1994 interest expense would have increased by $1.4 million. In addition, the Company had $12.5 million in revolving credit facility borrowings and $30 million in commercial paper outstanding at December 31, 1994. The relevant indices for revolving credit and commercial paper borrowings are generally one month LIBOR and the commercial paper composite rate, respectively. If these rates increased by 50 basis points, the Company's 1994 interest expense would have increased by $0.3 million. As of the end of each of the last two years, the Company had no deferred gains or losses related to terminated interest rate swap contracts. The Company periodically monitors its financial instrument positions and the credit ratings of its counterparties and limits the amount of exposure with any one counterparty. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate and foreign currency swap agreements. The Company does not anticipate nonperformance by any of the counterparties. In 1992, Whitman Finance Corporation N.V. entered into a cross currency contract in order to hedge the cost of its split currency debt. In 1993, the Company terminated the contract, resulting in a $2.0 million gain. This gain was recognized in 1993 as the underlying debt to which it was assigned was called for redemption in 1993. The fair market value of the Company's debt as of December 31, 1994 was $827.1 million. The fair market value was based on quotes from financial institutions for instruments with similar characteristics and upon discounting future cash flows. The fair market value of the Company's derivative instruments, which was obtained by quotes from financial institutions for instruments with similar characteristics was $45.0 million as of December 31, 1994.\n6. PENSION AND OTHER POSTRETIREMENT PLANS\nCOMPANY-SPONSORED DEFINED BENEFIT PENSION PLANS. Substantially all of the Company's employees are covered under various defined benefit pension plans sponsored and funded by the Company. Plans covering salaried employees provide pension benefits based on years of service and employees' compensation during the five years preceding retirement. Plans covering hourly employees generally provide benefits of stated amounts for each year of service. Plan assets are invested primarily in common stocks, corporate bonds and government securities. Net periodic pension cost for 1994, 1993 and 1992 included the following components:\n(in millions) 1994 1993 1992 ------ ------ ------ Service cost - benefits earned during period $ 7.5 $ 7.7 $ 7.3 Interest cost on projected benefit obligation 16.4 16.4 16.3 Actual return on assets (6.3) (28.0) (20.6) Net amortization and deferral (12.2) 10.2 3.4 ----- ----- ----- Total net periodic pension cost $ 5.4 $ 6.3 $ 6.4 ===== ===== =====\nPension costs are funded in amounts not less than minimum levels required by regulation. The principal economic assumptions used in the determination of net periodic pension cost include the following:\n1994 1993 1992 ------ ------ ------ Discount rate 7.0% 7.5% 8.0% Expected long-term rate of return on assets 10.0% 10.0% 10.0% Rates of increase in compensation levels 4.5% 5.0% 5.5%\nThe following table reconciles the pension plans' funded status to the amounts recognized in the Company's balance sheets as of December 31, 1994 and 1993:\n1994 1993 ------------------------ ------------------------ Assets Accumulated Assets Accumulated Exceed Benefits Exceed Benefits Accumulated Exceed Accumulated Exceed (in millions) Benefits Assets Benefits Assets ---------- ---------- ---------- ---------- Actuarial present value of benefit obligation (measured as of September 30): Vested benefit obligation $(148.5) $ (33.2) $(152.3) $ (50.5) ======= ======= ======= ======= Accumulated benefit obligation (149.9) (34.8) (153.4) (52.6) ======= ======= ======= ======= Projected benefit obligation (175.5) (38.3) (177.5) (55.9) Plan assets at fair market value (measured as of September 30) 199.6 29.5 189.9 41.3 ------- ------- ------- ------- Plan assets in excess of (less than) projected benefit obligation 24.1 (8.8) 12.4 (14.6) ------- ------- ------- ------- Unrecognized net asset at transition to SFAS No. 87 (3.8) (0.1) (4.8) -- Unrecognized prior service cost 15.7 4.8 19.0 6.2 Unrecognized net loss (gain) (10.9) 1.0 (3.2) 7.4 Additional liability required to recognize minimum liability -- (2.9) -- (10.6) ------- ------- ------- ------- Prepaid (accrued) pension cost recognized on balance sheets $ 25.1 $ (6.0) $ 23.4 $ (11.6) ======= ======= ======= =======\nThe principal economic assumptions used in determining the above benefit obligations were: discount rates of 8.5 percent and 7.0 percent in 1994 and 1993, respectively, and rates of increase in future compensation levels of 6.0 percent and 4.5 percent, respectively.\nCOMPANY-SPONSORED DEFINED CONTRIBUTION PLANS. Substantially all U.S. salaried employees, certain U.S. hourly employees and certain Australian and Canadian employees participate in voluntary, contributory defined contribution plans to which the Company makes partial matching contributions. Company contributions to these plans amounted to $9.7 million, $8.1 million and $7.5 million in 1994, 1993 and 1992, respectively.\nMULTI-EMPLOYER PENSION PLANS. The Company's subsidiaries participate in a number of multi-employer pension plans which provide benefits to certain unionized employee groups of the Company. Amounts contributed to the plans totaled $4.8 million, $5.0 million and $5.3 million in 1994, 1993 and 1992, respectively.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, which among other items, required the Company to reflect in its financial statements estimates of future costs of medical and survivor benefits for certain retirees. Previously, the costs of the Company's retiree and survivor benefit programs were recognized in the financial statements on a cash accounting basis. The Company elected to recognize this change in accounting on the immediate recognition basis. The cumulative effect of adopting this change in accounting principle was an increase in accrued postretirement costs of $38.7 million, a decrease in deferred tax liabilities of $14.7 million and a decrease in net income of $24.0 million ($0.22 per share). The Company provides substantially all U.S. salaried employees who retired prior to July 1, 1989 and selected other employees in the U.S. and Canada with certain life and health care benefits. U.S. salaried employees retiring after July 1, 1989 generally are required to pay the full cost of these benefits. Eligibility for these benefits varies with the employee's classification prior to retirement. Benefits are provided through insurance contracts or welfare trust funds. The insurance plans generally are financed by monthly insurance premiums and are based upon the prior year's experience. Benefits paid from a welfare trust are financed by monthly deposits which approximate the amount of current claims and expenses. The Company has the right to modify or terminate these benefits. Net periodic cost of postretirement benefits other than pensions for 1994 and 1993 included the following components:\n(in millions) 1994 1993 ------ ------ Service cost-benefits earned during the period $0.3 $ 0.4 Interest cost on accumulated postretirement benefit obligation 2.2 2.9 Net amortization and deferral 0.4 -- ----- ----- Net periodic postretirement benefit cost $2.9 $ 3.3 ===== =====\nNet periodic postretirement benefit cost in 1992 was $2.8 million.\nThe principal economic assumptions used in the determination of net periodic cost of postretirement benefits other than pensions included the following: 1994 1993 -------------- -------------- Discount rate 7.0% 7.5%\nRate of increase in compensation levels 4.5% 5.0%\nRate of increase in the per capita cost of 10.3% in 1994 11.0% in 1993 covered health care decreasing gradually decreasing gradually benefits to 5.0% by the year 2006 to 5.5% by the year 2006\nThe Company's postretirement health care and life plans are not funded. The unfunded status of the plans as of December 31, 1994 and 1993 was as follows:\n(in millions) 1994 1993 ------ ------ Actuarial present value of accumulated postretirement benefit obligation: Retirees $22.1 $32.3 Fully eligible active plan participants 1.0 1.1 Other active plan participants 3.3 4.3 ------ ------ Total 26.4 37.7 ------ ------ Plan assets at fair market value -- -- Accumulated postretirement benefit obligation in excess of plan assets 26.4 37.7 Unrecognized net loss 12.9 1.1 Unrecognized prior service cost (0.2) 1.7 ------ ------ Accrued postretirement benefit cost $39.1 $40.5 ====== ======\nThe principal economic assumptions used in determining the above benefit obligations were as follows:\n1994 1993 -------------- -------------- Discount rate 8.5% 7.0%\nRate of increase in compensation levels 6.0% 4.5%\nRate of increase in the per capita cost of 9.9% in 1995 10.3% in 1994 covered health care decreasing gradually decreasing gradually benefits to 6.5% by the year 2006 to 5.0% by the year 2006\nIncreasing the assumed health care cost trend rate by 1 percentage point would have increased the accumulated postretirement benefit obligation at December 31, 1994 by $2.6 million and net periodic postretirement benefit cost for 1994 by $0.3 million.\nMULTI-EMPLOYER POSTRETIREMENT MEDICAL AND LIFE INSURANCE. The Company's subsidiaries participate in a number of multiemployer plans which provide health care and survivor benefits to unionized employees during their working lives and after retirement. Portions of the benefit contributions, which cannot be disaggregated, related to postretirement benefits for plan participants. Total amounts charged against income and contributed to the plans (including benefit coverage during their working lives) amounted to $5.5 million in 1994 and $5.4 million in 1993.\n7. LEASES\nAt December 31, 1994, annual minimum rental payments under capital and operating leases that have initial noncancellable terms in excess of one year were as follows: Capital Operating (in millions) Leases Leases ---------- ---------- 1995 $ 3.7 $ 51.2 1996 2.8 45.4 1997 2.4 39.6 1998 2.4 33.7 1999 2.3 26.9 Thereafter 18.6 123.0 ------- ------- Total minimum lease payments 32.2 $ 319.8 ======= Less imputed interest 14.5 ------- Present value of minimum lease payments $ 17.7 =======\nMinimum payments under operating leases have not been reduced by $134.7 million of sublease rental income which is due in the future under noncancellable subleases. Total rent expense applicable to operating leases amounted to $33.2 million, $29.0 million and $27.7 million in 1994, 1993 and 1992, respectively. These amounts have been reduced by sublease rental income of $21.4 million, $21.2 million and $21.6 million, respectively. A majority of the Company's leases provide that the Company pay taxes, maintenance, insurance and certain other operating expenses.\n8. STOCK OPTIONS AND SHARES RESERVED\nThe Company's Stock Incentive Plan (the \"Plan\"), originally approved by shareholders in 1982 and subsequently amended from time to time, provides for granting incentive stock options, nonqualified stock options, related stock appreciation rights (SARs), restricted stock awards, and performance awards or any combination of the foregoing. Incentive stock options and nonqualified stock options are exercisable during a ten-year period beginning six months to three years after the date of grant. Stock appreciation rights have been granted with respect to certain nonqualified and incentive stock options. Options are granted at fair market value at the date of grant.\nChanges in options outstanding are summarized as follows:\nOption Price Shares per Share ---------- ----------------- Balance, January 1, 1992 3,793,861 $5.062 - $15.474 ---------- ---------------- Granted 1,390,200 12.875 - 13.810 Exercised or surrendered for SARs (95,431) 5.062 - 11.750 Recaptured or terminated (53,702) 10.288 - 15.474 ---------- ---------------- Balance, December 31, 1992 5,034,928 6.937 - 15.474 ---------- ---------------- Granted 739,100 13.563 Exercised or surrendered for SARs (210,243) 8.440 - 14.453 Recaptured or terminated (18,618) 11.750 - 14.453 ---------- ---------------- Balance, December 31, 1993 5,545,167 6.937 - 15.474 ---------- ---------------- Granted 660,400 15.688 - 17.250 Exercised or surrendered for SARs (496,240) 10.288 - 15.875 Recaptured or terminated (5,134) 13.563 - 15.688 ---------- ---------------- Balance, December 31, 1994 5,704,193 $6.937 - $17.250 ========== ================\nAt December 31, 1994, 4,107,793 shares were exercisable and 6,524,910 shares were available for future grants. During 1994 and 1993, the Company granted 110,200 and 91,900 restricted shares of stock, respectively, to key members of management under the Plan. There were no grants of restricted stock in 1992. At December 31, 1994, there were 169,931 restricted shares of stock outstanding under the Plan. In addition to shares reserved for options, there were 1,248,214 shares of common stock reserved at December 31, 1994 for issuance pursuant to the Company's Retirement Savings Plan.\n9. SHAREHOLDER RIGHTS PLAN AND SECOND PREFERRED STOCK\nIn 1989, the Company adopted a Shareholder Rights Plan and declared a dividend of one preferred share purchase right (a \"Right\") for each outstanding share of common stock, without par value, of the Company. Each Right entitles the registered holder to purchase from the Company one one- hundredth of a share of Junior Participating Second Preferred Stock (Series 1), without par value, of the Company at a price of $120 per one one- hundredth of a share of such Second Preferred Stock, subject to adjustment. The Rights will become exercisable if someone buys 15 percent or more of the Company's common stock. In addition, if someone buys 15 percent or more of the Company's common stock, each right will entitle its holder (other than that buyer) to purchase a number of shares of the Company's common stock having a market value of twice the Right's $120 exercise price. If the Company is acquired in a merger, each Right will entitle its holder to purchase a number of the acquiring company's common shares having a market value at the time of twice the Right's exercise price. Prior to the acquisition of 15 percent or more of the Company's stock, the Rights can be redeemed by the Board of Directors for one cent per Right. The Company's Board of Directors also is authorized to reduce the threshold to 10 percent or increase it to not more than 20 percent. The Rights will expire on January 30, 1999. The Rights do not have voting or dividend rights, and until they become exercisable, have no dilutive effect on the per-share earnings of the Company. The Company has 10 million authorized shares of Second Preferred Stock. In January, 1989, the Company's Board of Directors designated 2.5 million shares of the Second Preferred Stock as Junior Participating Second Preferred Stock (Series 1) in conjunction with the Shareholder Rights Plan. There is no Second Preferred Stock issued or outstanding.\n10. SUPPLEMENTAL CASH FLOW INFORMATION\nNet cash provided by continuing operations reflects cash payments or cash receipts as follows:\n(in millions) 1994 1993 1992 ------ ------ ------ Interest paid $ 61.0 $ 82.0 $ 85.5 Interest received (6.8) (13.4) (8.4) Income taxes paid 115.4 75.2 57.2 Income tax refunds (8.6) -- --\n11. ENVIRONMENTAL AND OTHER CONTINGENCIES\nThe Company is subject to certain indemnification obligations under agreements with previously sold subsidiaries for potential environmental liabilities. There is significant uncertainty in assessing the Company's share of the potential liability for such claims. The assessment and determination for cleanup at the various sites involved is inherently speculative during the early stages, and the Company's share of such costs is subject to various factors, including possible insurance recoveries and the allocation of liabilities among many other potentially responsible and financially viable parties. Using the latest evaluations from outside advisors and consultants, the Company believes that its potential environmental liabilities, before possible insurance recoveries, range from $40 million to $60 million, or possibly more. As a result of this continuing evaluation of potential exposure for environmental liabilities, the Company has provided approximately $30 million after taxes in 1994 through a charge to discontinued operations (see Note 2). As of December 31, 1994, with the additional provision, the Company had $50 million accrued to cover these future potential liabilities. These estimated liabilities include expenses for the remediation of identified sites, payments to third parties for claims and expenses, and the expenses of on-going evaluation and litigation. The estimates are based upon current technology and remediation techniques, and do not take into consideration any inflationary trends upon such claims or expenses, nor do they reflect the possible benefits of continuing improvements in remediation methods. The accruals also do not provide for any claims for environmental liabilities or other potential issues which may be filed against the Company in the future. The Company also has other contingent liabilities from various pending claims and litigation on a number of matters, for which the ultimate liability for each claim, if any, cannot be determined. In the opinion of management, and based upon information currently available, the ultimate resolution of these claims and litigation, including potential environmental exposures, and considering amounts already accrued, will not have a material effect on the Company's financial condition. While additional claims and liabilities may develop and may result in additional charges to income, principally through discontinued operations, the Company does not believe that such charges, if any, would have a material effect upon the Company's financial condition.\nDepreciation and Capital amortization investments -------------------- -------------------- (in millions) 1994 1993 1992 1994 1993 1992 ------ ------ ------ ------ ------ ------ Pepsi General $ 53.7 $ 52.9 $ 52.0 $ 66.0 $ 45.0 $ 41.0 Midas 16.4 15.5 14.8 28.7 24.4 20.5 Hussmann 17.3 16.5 17.2 32.7 19.2 17.3 Eliminations & other 10.6 10.6 9.5 -- 0.1 0.4 ------ ------ ------ ------ ------ ------ Total before corporate administrative expenses $ 98.0 $ 95.5 $ 93.5 $127.4 $ 88.7 $ 79.2 ====== ====== ====== ====== ====== ======\nEquity in net income and net assets of the Company's foreign operations amounted to $16.7 million and $180.8 million, respectively, in 1994, $15.5 million and $157.2 million in 1993, and $13.6 million and $158.2 million in 1992. Operating income is exclusive of net interest expense, corporate administrative expenses, equity in net income of affiliates, other miscellaneous income and expense items, and income taxes. Other expense, net in 1994 includes a $24.2 million unrealized loss on investment in Northfield Laboratories Inc. (\"Northfield\"). Foreign currency gains or losses were not significant. Sales between operating segments and between geographical areas were not significant. Export sales, sales to any single customer and sales to domestic or foreign governments were each less than ten percent of consolidated sales and revenues. Corporate assets are principally cash or cash equivalents, investments, and furniture and fixtures.\n13. SELECTED QUARTERLY FINANCIAL DATA (unaudited)\n(in millions, except First Second Third Fourth Full per-share data) Quarter Quarter Quarter Quarter Year -------- -------- -------- -------- -------- 1994: From continuing operations: Sales $ 546.9 $ 673.5 $ 741.3 $ 697.1 $ 2,658.8 Gross profit 193.0 248.7 269.3 243.1 954.1 Income from continuing operations 9.8 35.8 29.0 31.8 106.4 Income per share: Continuing operations $ 0.09 $ 0.34 $ 0.27 $ 0.30 $ 1.00 Net income $ 0.09 $ 0.34 $ 0.27 $ 0.27 $ 0.97 1993: From continuing operations: Sales $ 522.5 $ 634.7 $ 703.7 $ 668.8 $ 2,529.7 Gross profit 183.0 233.7 255.5 232.5 904.7 Income from continuing operations 8.4 29.1 39.8 29.1 106.4 Income (loss) per share: Continuing operations $ 0.08 $ 0.27 $ 0.37 $ 0.27 $ 0.99 Net income (loss) $ (0.14) $ 0.27 $ 0.33 $ 0.27 $ 0.73\nAt the end of the third quarter of 1994, the Company adjusted its investment in Northfield to reflect the then current market value. The market value of the Northfield investment, based upon quoted market prices at that time, was lower than the purchase cost by $24.2 million. This unrealized loss, after reflecting deferred tax benefits of $8.7 million, resulted in a non-cash charge to income of $15.5 million, or $0.15 per share.\n14. SUBSEQUENT EVENT\nIn December, 1994, the Mexican peso was permitted to float against the U.S. dollar and other currencies, and as a result, the peso has been devalued from 3.4 pesos\/dollar as of November 30, 1994 (the date used for inclusion of Hussmann's Mexican operations in the consolidated financial statements of the Company) to approximately 5.4 pesos\/dollar as of January 16, 1995. This devaluation of the peso is expected to reduce Whitman's shareholders' equity by less than $20 million and will be reflected in the consolidated financial statements for the first quarter of 1995. In 1994, Hussmann's Mexican operations reported sales of approximately $100 million and operating income of approximately $20 million. While it is difficult to assess the effect on Hussmann's operating results for 1995, the devaluation of the peso may cause Hussmann-Mexico's competitive environment to improve, and may result in an incremental growth in revenues. It is not possible at this time to determine what effect the devaluation will have upon pricing or costs, but management believes the devaluation will not have a material adverse effect upon the Company's 1995 operating results.\n(A) 1994 includes a $24.2 million unrealized loss on investment in Northfield Laboratories Inc. (B) Included in the 1990 operating results were costs associated with a restructuring charge of $15.1 million at Pepsi General, $10.9 million at Midas, $10.5 million at Hussmann, and $134.3 million at the Whitman corporate office.\nWHITMAN CORPORATION AND SUBSIDIARIES\n______________________\nEXHIBITS\nFOR INCLUSION IN ANNUAL REPORT ON FORM 10-K\nFISCAL YEAR ENDED DECEMBER 31, 1994\nEXHIBIT INDEX\nExhibit No. Description of Exhibit - ------ ---------------------------------\n(3)a+ Certificate of Incorporation as Restated April 30, 1987, and subsequently amended through June 24, 1992. (3)b@ By-Laws, as Amended July 17, 1989. (4)# Indenture dated as of January 15, 1993, between Whitman Corporation and The First National Bank of Chicago, Trustee. The Registrant will furnish to the Securities and Exchange Commission, upon request, copies of the forms of the debt securities issued from time to time pursuant to the Indenture dated as of January 15, 1993. (10)a# **1982 Stock Option, Restricted Stock Award and Performance Award Plan (as amended through June 16, 1989). (10)b# **Amendment No. 2 to 1982 Stock Option, Restricted Stock Award and Performance Award Plan made as of September 1, 1992. (10)c# **Form of Nonqualified Stock Option Agreement. (10)d# **Amendment to 1982 Stock Option, Stock Award and Performance Award Plan made as of February 19, 1993. (10)e# **Form of Severance Compensation and Change in Control Agreement dated as of March 17, 1989. (10)f# **Form of Amendment to Severance Compensation and Change in Control Agreement dated July 1, 1992. (10)g# **Management Incentive Compensation Plan. (10)h# **Long Term Performance Compensation Program. (10)i **Whitman Corporation Executive Retirement Plan, as Amended and Restated Effective January 1, 1995. (10)j **Hussmann Corporation Executive Retirement Plan, as Amended and Restated Effective January 1, 1995. (10)k **Midas International Corporation Executive Retirement Plan, as Amended and Restated Effective January 1, 1995. (10)l **Pepsi-Cola General Bottlers, Inc. Executive Retirement Plan, as Amended and Restated Effective January 1, 1995. (10)m# **Deferred Compensation Plan for Directors, as Amended November 18, 1988. (10)n# **Director Emeritus Program, as amended through February 16, 1990. (10)o* **Form of Restricted Stock Award Agreement. (12) Statement of Calculation of Ratio of Earnings to Fixed Charges. (21) Subsidiaries of the Registrant. (23) Independent Auditors' Consent. (24) Powers of Attorney.\nExhibit Reference Explanations - ------------------------------ ** Exhibit constitutes a management contract or compensatory plan, contract or arrangement described under Item 601(b) (10) (iii) (A) of Regulation S-K. + Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 as Exhibit 3. @ Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 as Exhibit 3. # Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 under the indicated Exhibit number. * Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 as Exhibit (10)p","section_15":""}
{"filename":"753767_1994.txt","cik":"753767","year":"1994","section_1":"Item 1. Business.\nFar West Electric Energy Fund L.P., a Delaware limited partner-ship (the \"Partnership\"), was originally organized in September 1984 under the Uniform Limited Partnership Act of Utah as Far West Hydroelectric Fund, Ltd. On December 20, 1988, the Partnership changed its name to Far West Electric Energy Fund, L.P. and changed its domicile to Delaware.\nThe Partnership owns a geothermal power plant, (the \"Steamboat Springs Plant\") located in Nevada, and until recently, owned a hydroelectric plant located in Idaho (the \"Crystal Springs Plant\").\nThe Crystal Springs Plant was sold to Crystal Springs Hydroelectric, L.P., a Washington limited partnership pursuant to a Purchase and Sale Agreement dated February 28, 1995, which is attached hereto as Exhibit (10)(aai). Also attached as exhibits are the documents which are attached as exhibits to the Purchase and Sale Agreement and other related sale documents.\nThe sales price was $1,100,000 which was $895,063 less than the outstanding debt on the project. The general partner decided to accept that offer (at the urging of the Bank) rather than incur the potential expense of foreclosure and the substantial risk of a much larger deficiency judgment. All funds from the sale went to the Bank. In addition, a Third Extension and Modification Agreement was reached with the Bank pursuant to which the deficiency was reduced to an agreed upon amount of $537,000. Semi-annual interest payments are due thereon with the entire balance to be paid by March 15, 2000. If the balance is paid within three years, this deficiency will be reduced by $50,000 and if paid within two years the deficiency will be reduced by $100,000. The Third Extension and Modification Agreement is attached hereto as Exhibit (10) (aas). The $537,000 agreed upon deficiency was set forth in an Amended and Substituted Promissory Note which is attached hereto as Exhibit (10)(aat). See \"Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nSteamboat Springs thermal-hydroelectric plant.\nThe Steamboat Springs Plant is located ten miles south of Reno, Nevada on property leased from Sierra Pacific Power Company pursuant to a Geothermal Resource Lease in the Steamboat Known Geothermal Resource Area. The plant has gross capacity of approximately 6.5 megawatts and consists of seven separate modules, utilizing binary rankine cycle turbines.\nIn 1987 it was determined that to achieve the expected capacity and the performance requirements specified in the Steamboat Springs Plant's purchase contract, Ormat would have to install additional equipment and make some modifications to existing equipment. These corrections were made at no cost to the Partnership (although the down-time for modifications and testing adversely impacted revenues). The modifications and repairs were completed in the summer of 1988, and the Partnership was informed that the plant was performing near projected levels by the fall of 1988. However, during 1989 the plant produced approximately 36,000,000 kwh (about the same as 1988) which is substantially less than the 42,000,000 kwh which was the annual production for the plant, as modified, projected by Ormat and the 43,800,000 kwh called for by the Purchase Agreement.\nAfter reviewing the Steamboat Springs Plant performance with independent consultants, the General Partner concluded that the deficiencies in plant performance were attributable to both poor operating practices employed by Ormat, the former operator, and certain problems in plant design. Consequently, notice was given to Ormat that the Partnership believed that Ormat was in default under both its Operating and Purchase Agreements with the Partnership. The General Partner replaced Ormat as plant operator on October 11, 1990, and sought redress for plant deficiencies under the arbitration clause of the Purchase Agreement. Arbitration proceedings began October 29, 1990.\nThe claims of the petitioners as well as the counter claims of Ormat were numerous and complex, making it difficult to summarize the ruling of the Arbitration panel. However, in essence the panel denied the bulk of Petitioners' claims and Ormat's counter claims. Petitioners were awarded $175,000 for well field problems, and Ormat was awarded $254,000 for unpaid operating and warranty service, the payment of which had been withheld pending the completion of the Arbitration. The Parties have all complied with and satisfied the ruling of the Arbitrators, including payment of all awards. (See Part IV, Item 14, Exhibits, Form 10-K dated December 31, 1992.\nThe present operating agreement provides for SB Geo, Inc. (\"SB GEO\") to operate and maintain the plant for a period of 10 years. SB GEO is to operate the plant on a no profit basis (salaries and expenses) and will not pay any dividends or distributions to shareholders. In the long term this change to the new operator generally has brought increased power production and lower operating costs. However, because the Arbitration relieved Ormat from its warranty obligations, the Partnership has incurred increased cost associated with equipment repairs that otherwise would have beencovered by the Ormat warranty.\nIn October 1991, the Partnership assigned its 77% ownership interest and 1-A Enterprises assigned its 23% ownership in SB GEO to Messrs. Melchior and Quinn, who accepted the assignments and SB GEO's liabilities. According to an independent valuation firm, SB GEO had no value as of the transfer date due to its obligations and its cost basis operating status. Consequently, no gain or loss was recognized as a result of the assignment.\nOn October 23, 1992 Westinghouse Credit Corporation (\"WCC\") gave the Partnership a notice of default with regard to the long-term financing of the project for the Partnership allowing the reserve account to fall below its reserve requirement without adequate replenishment and because the Award of Arbitrators in the Ormat Arbitration exceeded $25,000. Since that date the parties have met in negotiations on several occasions and WCC has acknowledged that the parties are working together in good faith toward a resolution and that WCC has observed progress and anticipates further progress toward a mutually satisfactory resolution. The General Partner continues to believe that a resolution will be reached which will result in a cancellation of the default.\nCrystal Springs hydroelectric plant.\nThe Crystal Springs Plant is located ten miles west and seven miles north of Twin Falls, Idaho. Its leased site is located in Cedar Draw which flows into the Snake River Canyon. Its primary components consist of four horizontal Francis-type turbines with an installed total capacity of 2.88 megawatts. Until March 16, 1995, it was owned by the Partnership through Crystal Springs Hydroelectric Company (\"CSHC\"), a general partnership owned by the Partnership.\nThe Crystal Springs Plant was placed into operation during December, 1985, but did not generate significant revenues until the first quarter of 1986, primarily due to seasonal water shortage conditions. During the last quarter of 1987, the Partnership received information which suggests that the Crystal Springs Plant design was based on overly optimistic water flow assumptions and that it would not be able to consistently achieve projected average annual production figures. On July 7, 1988, the Partnership entered into a Purchase Option Agreement, effective October 1, 1987, with Bonneville Pacific Corp. (\"BPC\"), the company which sold the project to the Partnership. In conjunction therewith, as an accommodation, the Partnership signed refinancing loan documents (\"Loan\") with First Security Bank of Utah (\"Bank\").\nA Restated Operation and Maintenance Agreement (\"O&M Agreement\") entered into as of October 1, 1987, dated July 7, 1988, between CSHC and BPC, served to install BPC, or a representative of its choice, as the operator of the Crystal Springs Plant. This O&M Agreement also set forth BPC's duties as the operator. The terms of this O&M Agreement would run through September 30, 1997, unless terminated earlier, as provided in the O&M Agreement.\nUnder this O&M Agreement, BPC was responsible for the daily operation and maintenance of the plant, maintenance of accounting records, disbursements from available power revenues, supervision of employees interaction with power purchasers, and maintenance of the facility in a safe operating condition. In return, BPC was compensated a minimum of $20,000 per year; subject to increases by an amount equal to 10% of all profits between $0 and $20,000, plus 95% of all profits which exceed $20,000 per year.\nBPC accounted for revenues and expenses incurred by BPC inconnection with the operation and maintenance of the Crystal Springs Plant; CSHC was responsible for insurance expenses and property tax expenses. In view of the limited participation of CSHC in the operations, including profits and losses, as described elsewhere herein, operations of the project were not included in the financial statements for the years ended December 1990, 1991, or 1992. The net cost of the Crystal Springs Plant, related long-term debt and related depreciation, interest, insurance, and tax expenses were included in the financial statements of the Partnership. The debt service payments paid by the BPC were included as other income in the financial statements.\nOn December 5, 1991, BPC filed for protection under Chapter 11 of the United States Bankruptcy Laws and stopped making option payments to the Partnership and debt service payments to the Bank. This action terminated BPC's rights under the Purchase Option Agreement and the O&M Agreement. BPC's failure to make debt service payments to the Bank resulted in a default notice from the Bank.\nThe Partnership received such default notice from the Bank by letter dated February 3, 1992, maintaining that CSHC was in default of its loan obligations to the Bank.\nCSHC, the Partnership and Far West filed a complaint in the Third Judicial District Court for Salt Lake County, State of Utah, naming the Bank as defendant and seeking a declaratory judgment that plaintiffs were not obligated to perform the obligations under the Loan documents because they signed them merely as accommodation parties and seeking injunctive relief against the Bank, enjoining the Bank from naming any of the plaintiffs in litigation seeking money damages under the Loan documents.\nThe Bank subsequently filed a complaint in the District Court of the Fifth Judicial District of the State of Idaho seeking to foreclose on the real property security pursuant to the Mortgage.\nOn July 17, 1992, CSHC, the Partnership and its General Partners (\"Crystal Affiliates\") entered into an agreement with the Bank whereby the parties agreed to forbear from further action on both above complaints. Under such agreement CSHC agreed to pay to the Bank, on or before September 30, 1992, the sum of $1,800,000. Upon payment of this settlement sum the Bank was to release the parties from obligations under the Bank's loan documents.\nThat agreement expired prior to the Partnership's ability to refinance or sell the Crystal Springs Plant in order to pay the Bank the agreed upon $1,800,000 amount. The parties thereafter entered into a subsequent settlement agreement (\"Agreement\") effective December 31, 1992 which provided for dismissal of each of the two lawsuits and payment of the $1,800,000 to the Bank by December 1, 1993.\nIt also provided for a mutual waiver of claims between the parties (\"Mutual Release Agreement\") and in addition provided for a $50,000 line of credit for use in repair of certain items of equipment for the Crystal Springs Plant for startup of operations in 1993 (\"Repair Loan\"). The Partnership also agreed therein to exercise their best efforts to sell the Crystal Springs Plant on or before December 1, 1993, the proceeds to be used in satisfying the Repair Loan and the $1,800,000 payoff of the Loan to the Bank.\nThe Mutual Release Agreement also contemplated the execution by the Parties of an Extension and Modification Agreement with respect to the Loan which agreement was also entered into as of December 31, 1992 together with an Amendment to Mortgage and an Amendment to Security Agreement which amended the original Loan documents to provide for the issues resolved in the Mutual Release Agreement.\nIn addition, effective the first day of December, 1992, a new operator of the Project, Little Mac Power Services Co., was put in place through an Operation and Maintenance Agreement of that date. A restated Operation and Maintenance Agreement was entered into effective December 1, 1994.\nThe Partnership was unable to refinance or sell the Crystal Springs plant by December 1, 1993 in order to pay the Bank the agreed upon $1,800,000 amount. In order to extend the term of the loan for an additional nine (9) months, the parties thereafter entered into a Second Extension Agreement as of December 1, 1993. This agreement extended the date until September 1, 1994 for Crystal affiliates to be able to sell the Crystal Springs plant and use the proceeds to pay off the $1,800,000 agreed upon to the Bank.\nAs an incentive to enhance the flows of Cedar Draw Creek, to provide greater revenue from the plant, CSHC entered into an agreement dated March 8, 1993 to compensate the Twin Falls Canal Company (\"TFCC\") by paying TFCC a royalty of five percent of the energy revenue for each month. The general partner believes that this agreement was instrumental in producing increased water flows and revenues for the Crystal Springs Plant during 1993 and will result in increased water flows and revenues in future years. That agreement was attached to the December 31, 1993 Form 10-K as Exhibit (10) (aah).\nThe Crystal Springs Plant was sold as described in Item 1. above.\nRevenues from the 1-A thermal-hydroelectric plant\nThe 1-A geothermal plant (the \"1-A Plant\") is located adjacent to the Steamboat Springs Plant. The 1-A Plant consists of two separate modules, utilizing binary rankine cycle turbines with a combined net output of 1.8 megawatts.\nThe 1-A Plant was originally a Steamboat Springs expansion project, but was sold in 1988 to a general partnership entitled 1-A Enterprises which is owned 75% by Alan O. Melchior and Thomas A. Quinn, who were also General Partners of the Partnership and currently are officers and shareholders of Far West Capital. Use of the geothermal resource by the 1-A Plant has no adverse effect on the operation of the Partnership's Steamboat Springs Plant.\nIn a Second Amendment to Geothermal Resources Lease provision was made to accommodate the 1-A Plant on the Steamboat Springs Plant's lease. A Geothermal Resources Sublease was entered into granting rights and defining terms and conditions for the siting and operation of the 1-A Plant and setting forth a method of calculating royalty payments to be made to the Partnership. This Sublease was Revised and Restated on October 9, 1989.\nAs consideration for the sale of the 1-A Plant rights to 1-A Enterprises, the Partnership received a royalty interest in the net operating income of the 1-A Plant. Such royalties equal 10% in 1988 through 1992, 15% in 1993 through 1998, 40% in 1999 through 2010, and 45% in 2011, and thereafter. In addition, the Partnership is paid an amount equivalent to the net profit that would be realized by the Partnership if the 1-A Plant were bearing 150 KW of parasitic power load (power consumed by the Plant itself). The net profit equivalent is calculated as follows: 1,200,000 KWH x the rate at which power is sold to Sierra Pacific Power Company under the power purchase agreement applicable to the 1-A Plant, less any royalties, note payments, or net revenue interest or other expenses associated with or payable out of such additional revenues assuming that the 1-A Plant produced an additional 1,200,000 KWH per annum. In 1994 the Partnership earned $87,000.00 in royalty revenues from the 1-A Project and $57,000.00 in pumping charges.\nItem 3.","section_3":"Item 3. Legal Proceedings\nHealth Department\nSince its inception, the Partnership has operated the Steamboat plant under a variance granted by the Washoe County District Health Department (\"Health Department\") with respect to the release of pentane gas into the atmosphere. In 1991 the Health Department amended the original variance in an effort to require the Partnership to install more stringent pentane release safeguards. The Partnership notified the Health Department that the Partnership contested their authority to impose such additional safeguards but agreed to voluntarily comply with the new standards.\nAs a part of its effort to reduce pentane emissions at the Steamboat Springs Plant the Partnership recently installed a cryogenic pentane recovery system. The Health Department claimed that the Partnership installed this system after the deadline established under their amended variance and issued a notice of violation and fine of $15,000. Upon appeal to the Air Pollution Control Hearing Board the fine was reduced to $5,800. After further appeal of the notice of violation and fine to the Washoe County District Board of Health, the Board decided to hold the fine and citation in abeyance for 1 year. Since there were no further environmental infractions at the Steamboat Springs Plant, during this last year, the fine and citation were expunged.\nNevada Department of Transportation\nThe Department of Transportation of the State of Nevada (\"NDOT\") commenced action in the Second Judicial District Court of the State of Nevada in and for the County of Washoe against the Partnership and others to obtain, for highway purposes, ownership of approximately 2.79 acres of the property owned by Sierra Pacific Power Company (\"SPPC\") at the extreme north of the land upon which the Steamboat Springs Plant is located pursuant to the SPPC lease. The Partnership is defending the action insofar as is necessary to protect a stand-by injection well located on the lease in the proximity of the land being taken and a monitoring well in an adjacent area which is being taken. It is presently negotiating a settlement which will leave the stand-by injection well and the Partnership's rights in and use thereof intact and available. The Partnership will be required to construct a new monitoring well and will attempt to recover the cost thereof from the State. The Partnership is also attempting to obtain a portion of the $273,500 offered and deposited into Court by NDOT as compensation for the taking. SPPC is claiming all of such funds as the owner of the land. The Court has granted NDOT the right to possess and occupy the property while the amount of compensation to be finally awarded is being contested. WCC, the Partnership's principal creditor, has claimed that under the financing agreements with respect to the Steamboat Springs and 1-A Plants, all funds recovered from NDOT must be applied to reduce the principal balance of the loans outstanding.\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 Stock-holder Matters.\nNo market exists for the Partnership's Units. As of March 16, 1995, the 10,306 outstanding Units of the Partnership were held by 1,104 investors, including 530 units owned by the General Partner.\nNo cash distributions were made to the Limited Partners during the years ended December 31, 1989 through 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.\nLiquidity and Capital Resources\nThe sale of electricity to Sierra Pacific Power Company continues to be the Partnership's primary source of working capital. Power is sold pursuant to a long-term power contract (\"Power Purchase Agreement\") (see \"Item 1. Business\") which provides for purchase of all power produced by the Steamboat Springs Plant at a fixed rate. However, in December of 1996 the rate at which the plant will sell power goes from 7.17 cents per KW to short-term avoided cost (which presently is approximately 2.5 cents). The Partnership will not be able to continue to operate the plant selling power at that rate. The General Partner is attempting to renegotiate the rate at which power would be sold to Sierra Pacific Power Company during the second 10 years of the Power Purchase Agreement beginning in December of 1996. The Steamboat Springs Plant operating revenues have, in the past, provided cash balances to pay for operating expenses, including repairs and maintenance of the plant, during times of interrupted operations. However, in the event of failure of the Steamboat Springs geothermal resource, the Partnership would be unprotected from interruption of its revenues. Management believes that the likelihood of this event occurring is considered to be remote.\nAs shown in the financial statements for the year ended December 31, 1994, the Partnership's current liabilities exceed current assets by $ 9,191,000. Of this amount, $5,340,000 relates to the note default involving the Steamboat Springs Plant with WCC.\nThis is more fully described under \"Item 2. Properties\". Cumulative losses for the three-year period ended December 31, 1994 amounted to $541,000 before extraordinary items. The principal cause of these losses was due to expenses associated with poor plant performance and higher than expected operating and maintenance expenses due primarily to Ormat's refusal to honor its warranty obligations, litigation and administrative proceedings and unanticipated lower revenues. The General Partner is seeking to resolve the current liquidity concerns by taking steps to increase future production by improving maintenance and operation procedures and, if necessary, deferral of payment of general and administrative expenses to the General Partner. Partnership electric power revenue increased in 1993 by 34% over 1992 and by 12% over 1991. The general partner believes that 1994 revenues are representative of what can be expected in the future until the rate change becomes effective.\nWith the winding down of the Partnership's litigation and administrative proceedings, professional fees and general and administrative expenses charged by the General Partner decreased in 1994 by 45% from the preceding year, in 1993 by 49% from the preceding year and in 1992 by 33% from 1991. The General Partner also believes that these expenses will continue to stay at this lower level in 1995 because of the termination of such litigation and decreasing administrative costs.\nIn a report dated September 4, 1993 the General Partner reported to the Limited Partners on its efforts to restructure the business of the Partnership so as to be able to resume distributions to the Limited Partners. In summary the General Partner concluded that the Partnership would be unable to generate significant positive cash flow or resume distributions without the infusion of $1,000,000 to make capital improvements in the Steamboat Springs Plant and\/or buy out the Westinghouse loan and certain royalty interests at a discount. The Partnership does not have the financial resources to accomplish these goals. At present and in the foreseeable future the Partnership is generating taxable income without any cash distributions to pay the tax liabilities. Therefore, it appears to the General Partner that it may be advantageous to the Partnership to consider a sale of all the Partnership assets. At the present time the General Partner is attempting to sell the Partnership assets and will seek approval of the sale from the Limited Partners at such time as a serious offer is received.\nResults of Operations\nIn 1987 the Steamboat Springs Plant produced electric power and generated revenues at approximately 75% of expected operating levels. The production shortfall was primarily due to shutdowns required to effect certain equipment changes and modifications, and to operation of that plant at a lower level than expected. It was determined that to achieve the expected capacity and the performance requirements specified in the plant's purchase contract, the vendor\/operator would have to install additionalequipment and make some modifications to existing equipment. These corrections were made at no cost to the Partnership (although the down-time for modifications and testing impacted revenues). The modifications and repairs were completed in the summer of 1988, and the Partnership was informed by Ormat that the plant was performing at a level that would produce 42,000,000 KWH per year.\nThe Steamboat Springs Plant increased production of electric power from 32,797,000 KWH in 1987 to 36,142,000 KWH in 1988. Ormat, the vendor\/operator of the plant, installed additional equipment and made equipment modifications which increased the plant's capacity and performance. These additions and modifications were made at no additional cost to the Partnership.\nIn 1989 the Steamboat Springs Plant produced $2,564,000 in gross revenues which was $448,000 and $576,000 less than would have been received under the Ormat projected 42,000,000 and 43,800,000 kwh agreed to under the purchase agreement per year respectively. In 1990 the plant produced $2,765,000 in gross revenues which was an increase over 1989's revenues, but about $247,000 and $376,000 less than would have been received under the projected 42,000,000 and 43,800,000 kwh per year respectively. In 1991 the plant produced $2,791,000 in gross revenues which was $220,000 and $349,000 less than would have been received under the projected 42,000,000 and 43,800,000 kwh per year respectively. In 1992 the plant produced about $2,360,000 in gross revenues which was $651,400 and $780,460 less than would have been received under the projected 42,000,000 and 43,800,000 kwh per year respectively. The poor performance in 1992 was directly due to excessive equipment failures and breakdowns which resulted in plant downtime. In 1993 the Plant produced $2,625,000 in gross revenues which was an increase over 1992's revenues but about $386,391 and $515,451 less than would have been received under the projected 42,000,000 and 43,800,000 kwh per year respectively. This made 1993 a better than average year for revenues. In 1994 the revenues declined slightly and are more indicitave of what can be expected until the ratechange in 1996.\nThe following table shows the annual production for the Steamboat Springs Plant:\nYear $'s KWH 1987 $2,352,000 32,797,000 1988 $2,591,000 36,142,000 1989 $2,564,000 35,760,000 1990 $2,765,000 38,563,000 1991 $2,791,000 38,926,000 1992 $2,360,000 32,915,000 1993 $2,625,000 36,611,000 1994 $2,564,000 35,767,000\nThe Crystal Springs Plant produced power at approximately 51% of expected levels during 1987 and 1988, about 80%, 70%, 58% and 14% during 1989, 1990, 1991 and 1992, respectively, due chiefly to lower than normal precipitation in the Snake River Basin. In 1993 it produced a record 8,265,000 kwh for revenues of $537,000. This was a result of increased water flow resulting from greater precipitation and additional water released by the Twin Falls Canal Company as a result of the agreement with it. In 1994, due to the drought in southeastern Idaho, it was shut down for most of the year and produced 3,101,000 kwh for revenues of $163,000.00. SeeItem 2. Properties herein.\nThe 1-A Plant from which the Partnership receives royalties was put on line and began operations in December, 1988. That plant reached full scale production levels during the first quarter of 1989. The Partnership began to receive its 10% net operating royalty and pumping fee when the plant was accepted and commissioned during the first quarter of 1989. A total of $95,000, $94,000, $115,000, $102,000, $135,000 and $144,000 in royalties and pumping fees in the years ended December 31, 1989, 1990, 1991, 1992, 1993 and 1994 respectively, were earned by the Partnership from this plant. Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIndex to Financial Statements Page and Supplementary Data\nIndependent Auditors' Report 17\nBalance Sheets, December 31, 1994 and 1993 18\nStatements of Income, for the Years Ended December 31, 1994, 1993, and 1992 20\nStatements of Partners' Capital, for the Years Ended December 31, 1994, 1993, and 1992 21\nStatements of Cash Flows, for the Years ended December 31, 1994, 1993, and 1992 22\nNotes to Financial Statements 24\nSchedule I, Condensed Financial Information of Registrant (All Required Information Reported in Financial Statements and Notes to the Financial Statements)\nSchedule II, Valuation of Qualifying Accounts\n(All Required Information Reported in Note 2)\nINDEPENDENT AUDITOR'S REPORT\nGeneral Partner Far West Electric Energy Fund, L.P. Salt Lake City, Utah\nWe have audited the balance sheet of Far West Electric Energy Fund, L.P. as of December 31, 1994 and 1993, and the related statements of income, partners' capital and cash flows for the years 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, the financial statements referred to above present fairly, in all material respects, the financial position of Far West Electric Energy Fund, L.P. 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.\nRespectfully submitted,\n\/s\/ Robison, Hill & Co. Certified Public Accountants\nSalt Lake City, Utah March 7, 1995\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP BALANCE SHEETS DECEMBER 31, 1994 AND 1993\n1994 1993\nAssets\nUtility Plant: Plant in Service $18,716,000 $18,692,000 Equipment 335,000 220,000 Construction in Progress 118,000 118,000 Accumulated Depreciation (6,010,000) (5,367,000)\nNet Utility Plant 13,159,000 13,663,000\nRestricted Marketable Securities 1,145,000 1,102,000\nOther Assets 124,000 142,000\nCurrent Assets: Cash 278,000 280,000 Receivables - Trade 437,000 393,000 Receivables - Other 6,000 3,000 Receivable - Related Party 159,000 82,000 Prepaid Expenses 12,000 12,000\nTotal Current Assets 892,000 770,000\nTotal Assets $15,320,000 $15,677,000\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP BALANCE SHEETS DECEMBER 31, 1994 AND 1993 (Continued)\n1994 1993\nPartners' Capital and Liabilities\nPartners' Capital: Limited Partners $ 4,868,000 $ 4,796,000 General Partner (11,000) (12,000)\nTotal Partners' Capital 4,857,000 4,784,000\nContingencies (Note 9) - - Other Liabilities 150,000 150,000 Long-term Debt: Notes Payable - Related Party 230,000 268,000\nPartners' Capital and Long-Term Liabilities 5,237,000 5,202,000\nCurrent Liabilities: Current Portion - Long-term Debt 7,140,000 7,857,000 Note Payable - Related Party 1,043,000 956,000 Payable-Related Party 573,000 455,000\nAccrued Liabilities Operations 495,000 596,000 Royalties 220,000 186,000 Interest 612,000 425,000\nTotal Accrued Liabilities 1,327,000 1,207,000\nTotal Current Liabilities 10,083,000 10,475,000\nTotal Partners' Capital and Liabilities $15,320,000 $15,677,000\nSee accompanying notes to the financial statements.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP STATEMENTS OF INCOME\nFOR THE YEARS ENDED DECEMBER 31, 1994 1993 1992\nRevenues: Electric Power Revenues $ 2,728,000 $ 3,162,000 $ 2,360,000 Other Revenues 151,000 622,000 1,083,000\nTotal Revenues 2,879,000 3,784,000 3,443,000\nExpenses: Operations 1,779,000 2,163,000 2,014,000 General and Administrative: Professional Services 54,000 72,000 366,000 General Partners- Related Party 123,000 223,000 437,000\nTotal General and Administrative 177,000 295,000 803,000\nTotal Expenses 1,956,000 2,458,000 2,817,000\nIncome From Operations 923,000 1,326,000 626,000\nOther Income (Expense): Interest Income 52,000 38,000 56,000 Interest Expense (902,000) (806,000) (1,478,000) Write-down of Assets - - (345,000) Bad Debt Expense - (31,000) -\nNet Other Expense (850,000) (799,000) (1,767,000)\nNet Income (Loss) Before Extraordinary Item 73,000 527,000 (1,141,000)\nExtraordinary Item - Early Extinguishment of Debt - 175,000 1,794,000\nNet Income $ 73,000 $ 702,000 $ 653,000\nNet Income Per Limited Partnership Unit $ 7 $ 68 $ 63\nSee accompanying notes to the financial statements.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP STATEMENT OF PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1994, 1993, AND 1992\nSee accompanying notes to the financial statements.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994 1993 Cash Flows From Operating Activities:\nNet Income (Loss) $ 73,000 $ 702,000 $ 653,000 Adjustments to Net Income (Loss): Depreciation and Amortization 661,000 716,000 784,000 Write-down of Assets - - 345,000 Gain on Debt Restructure - (175,000) (1,794,000) (Increase) Decrease in Receivables (124,000) (59,000) 94,000 (Increase) Decrease in Prepaid Insurance - (9,000) 2,000 (Increase) Decrease in Other Assets 18,000 18,000 - Increase (Decrease) in Accrued Liabilities 120,000 (234,000) 188,000 Increase (Decrease) in Amount Due to General Partner 100,000 214,000 170,000\nTotal Adjustments 775,000 471,000 (211,000)\nNet Cash Provided by Operating Activities 848,000 1,173,000 442,000\nCash Flows From Investing Activities: Capital Expenditures (139,000) (222,000) (42,000)\nNet Cash Provided by (Used) in Investing Activities (139,000) (222,000) (42,000)\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (Continued)\nFOR THE YEARS ENDED DECEMBER 31, 1994 1993 Cash Flows From Financing Activities: Principal Payments on Long- term Debt $ (751,000) $(1,109,000) $ (947,000) Proceeds From the Issuance of Debt 83,000 171,000 350,000\nNet Cash Provided by (Used) in Financing Activities (668,000) (938,000) (597,000)\nIncrease (Decrease) in Cash, Restricted Cash and Cash Equivalents 41,000 13,000 (197,000)\nCash, Restricted Cash, and Cash Equivalents at Beginning of Year 1,382,000 1,369,000 1,566,000\nCash, Restricted Cash, and Cash Equivalents at End of Year $ 1,423,000 $ 1,382,000 $ 1,369,000\nSupplemental Disclosure of Cash Flow Information: Cash Paid During the Year For Interest $ 727,000 $ 755,000 $ 750,000\nNon-Cash Activities:\nThe Partnership reduced a contract payable for the year ended December 31, 1993 and 1992 by $13,000 and $187,000, respectively, and recognized income relating to option payments not made; see Note 6.\nAn extraordinary gain of $175,000 and $1,794,000 for the years ended December 31, 1993 and 1992, was recognized relating to the extinguishment and restructuring of debt and accrued interest; see Note 4.\nNotes payable and accrued interest were reduced and other income recognized for the year ended December 31, 1993 and 1992 in the amount of $424,000 and $387,000, respectively, relating to offsets allowed under the performance guaranty on the Steamboat Springs project; see Note 6.\nSee accompanying notes to the financial statements.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe following significant accounting policies are followed by Far West Electric Energy Fund, L.P. in preparing and presenting the financial statements, and are to assist the users in understanding the financial statements.\nOrganization Far West Electric Energy Fund, L.P., a Delaware limited partnership (the Partnership) was organized in 1985 to acquire and operate electric generating plants.\nUtility Plant and Equipment Utility plants and equipment are carried at cost or adjusted cost (see Note 2). Fixed assets are depreciated over their estimated useful life (utility plants - thirty years, equipment - five to ten years).\nCash Equivalents For purposes of the statement of cash flows, the Partnership's policy is that all investments with maturities of three months or less are considered cash equivalents.\nIncome Taxes No provision for income taxes has been made since the Partnership files partnership return under provisions for federal and state tax laws. The assets and liabilities of the Partnership for tax purposes are lower than the financial statements for 1994 by $11,154,000 and $2,208,000, for 1993 by $11,492,000 and $2,011,000, respectively.\nIncome Per Limited Partnership Unit The income before extraordinary item is calculated on the weighted average units outstanding during the year. The weighted average of units outstanding during 1994, 1993, and 1992 were 10,305.\nReclassifications\nCertain amounts in 1994 and 1993 have been reclassified to conform with financial statement presentations adopted in 1994.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 2 - UTILITY PLANT\nPlant in service consists of the following at December 31, 1994 and 1993: Estimated 1994 1993 Useful Lives Steamboat Springs Thermal Hydroelectric Power Plant $15,599,000 $15,597,000 30 Years\nExpansion Pipeline 400,000 400,000 5 to 7 Years\nCrystal Springs Hydroelectric Power Plant 4,738,000 4,716,000 30 Years\nValuation Allowance (2,021,000) (2,021,000)\n$18,716,000 $18,629,000\nThe valuation allowance relates to the Crystal Springs Hydroelectric Power Project. The valuation allowance is a result of the rights to a purchase option being waived and a decline in the value of the project.\nNOTE 3 - OTHER ASSETS\nOther assets consist of the following at December 31, 1994 and 1993:\n1994 1993\nLoan Origination Fees $183,000 $183,000 Organization Costs 65,000 65,000 Other Assets 35,000 35,000 Accumulated Amortization (159,000) (141,000)\nTotal Other Assets $124,000 $142,000\nThe loan origination fees are being amortized on a straight-line basis over the respective lives of the loans. Organization costs are amortized over a five year period on a straight-line basis. Amortization was $18,000, $18,000, $20,000 for the years ended December 31, 1994, 1993, and 1992, respectively.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 4 - LONG-TERM DEBT\nLong-term debt as of December 31, 1994 and 1993 consists of the following: 1994 1993 Note Payable to a corporation is in default as of 10\/23\/92 and is immediately due and payable. Note is secured by the Steamboat Springs Project and all associated rights. Interest rate is 11.5% $5,340,000 $6,035,000\nNote Payable to a bank is due and pay- able in full originally on December 1, 1994, extended to September 30, 1994 per a restructuring agreement, is in default. Interest is due in quarterly installments. Note is secured by Crystal Springs Project and associated rights. Interest rate is prime plus 2%, prime was 6% at year end (See Note 12 - Sub- sequent Events). 1,800,000 1,800,000\n7,140,000 7,857,000\nLess Current Installments Due 7,140,000 7,857,000\n$ - $ -\nThe Partnership is required to maintain an escrowed bank account as security under the terms of the note payable to a corporation with the note payable balance as of December 31, 1994 of $5,340,000. The reserve account was drawn down to $1,145,000 due to insufficient operating funds to meet principal and interest payments. The note is in default due to the reserve account being drawn below required amounts. The reserve includes the initial deposit of $1,000,000 and requires an additional $70,000 annually for the first seven years, interest income is also retained in the reserve account. Disbursements from the reserve account for principal and interest payments on the note are allowed to the extent that there are insufficient funds in the Partnership's operating accounts.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 4 - LONG-TERM DEBT (Continued)\nThe aggregate maturities of long-term debt for each of the five years subsequent to December 31, 1994 are as follows:\nYear Ending December 31,\n1995 $ 7,140,000 1996 - 1997 - 1998 - 1999 - Thereafter -\n$ 7,140,000\nA note payable to a corporation was extinguished in the amount of $175,000 in December 1993. The extinguishment was a result of negotiations to settle litigation on the performance guaranty. The principal note amount and related accrued interest are shown as an extraordinary item in the statement of operations for the year ended December 31, 1993.\nDuring December 1992, a note payable to a bank was restructured resulting in a reduction of principal amount, accrued interest, and a renegotiation of terms. The difference of the restructured principal and future cash payments and the amount previously due is shown as an extraordinary item in the statement of operations for the year ended December 31, 1992 in the amount of $1,794,000.\nInterest payments relating to the reduced note were offset to accrued interest payable. The total amount offset against accrued interest payable in 1994 was $26,000.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 5 - NOTE PAYABLE-RELATED PARTY\nThe Partnership had notes payable to related parties for the years ended December 31, 1994, and 1993 as follows:\n1994 1993\nNotes Payable to General Partner payable on demand, unsecured. Interest rate is 13% $1,005,000 $ 922,000\nNote Payable to 1-A Enterprises, a partnership, due in quarterly installments, including interest; commencing April 16, 1990, re- maining principal due January 16, 2000; unsecured. Interest rate is 11% 268,000 302,000\n1,273,000 1,224,000\nLess Current Installments Due 1,043,000 956,000\n$ 230,000 $ 268,000\nNOTE 6 - PURCHASE AND OPERATING AGREEMENTS\nSteamboat Springs Thermal Hydroelectric Power Plant (Steamboat Springs)\nUnder the terms of the Steamboat Springs purchase agreement (the Agreement), the Partnership is required to pay royalties aggregating 14.05 percent of annual gross revenues plus an annual lump sum of $50,000. For the years ended December 31, 1994, 1993, and 1992, royalty expense related to these commitments amounted to $410,000, $419,000, and $382,000, respectively.\nAs part of the Agreement, the original developer of Steamboat Springs (the Developer) guaranteed annual net operating revenues, as defined (Net Operating Revenues) of $2,000,000 for a period of ten years following the date of commissioning, March 31, 1987 (the Guarantee). In 1992, the debt and related performance guarantee with the original developer was extinguished. Pursuant to the Guarantee and included in other revenues in the statements of income for the years ended December 31, 1993, and 1992 are $424,000, and $387,000, respectively. Amounts due to the Partnership under the Guarantee are offset annually against a note\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 6 - PURCHASE AND OPERATING AGREEMENTS (Continued)\npayable to the Developer, and the corporation which subsequently sold the project to the Partnership. The note payable to the developer has been fully offset as of December 31, 1993.\nThe Partnership is also required to pay the Developer annual royalties equal to 50 percent of the first $100,000 over the guaranteed Net Operating Revenues and 75 percent of amounts in excess of the $100,000 each year for the first ten years following the date of commissioning. For years 11 through 20 after commissioning, the royalty equals 30 percent of Net Operating Revenues; principal debt service payments incurred to finance construction or operations are not deducted in determining the revised net operating revenues (Revised Net Operating Revenues). For years 21 inclusive and thereafter, the royalty is equal to 50 percent of Revised Net Operating Revenues. No royalties have been paid pursuant with this commitment.\nCrystal Springs Hydroelectric Company\nThe Partnership owns the entire beneficial interest of the partnership units of Crystal Springs Hydroelectric Company (an Idaho Limited Partnership) (the Company). The Company owns the Crystal Springs Hydroelectric Plant (the Project). The Company purchased the Project from its operator (the Operator). Under the terms of the original purchase agreement, the Company was required to pay the Operator royalties equaling 20 percent of gross annual revenues and the Operator received an option to purchase the Project from the Company 30 days prior to May 14, 2020 for $1. On July 7, 1988, effective October 1987, the Partnership issued the Operator a purchase option (the Option) to either purchase the Partnership's interest in the Project or Company. As consideration for the Option, the Operator waived rights to the previous purchase option, paid the Partnership cash of $150,000, forgave $998,000 in debt obligations, and agreed to make annual cash payments of $187,000 until the Option is exercised or expires. The quarterly option payment was not made for the period ending December 31, 1992, thereby waiving the option. Per the contract agreement option payments not made were offset against an original contract amount of $200,000, resulting in a reduction of $13,000, and $187,000 which is shown as miscellaneous income in the statements of income for the year ended December 31, 1993 and 1992, respectively. Previous option payments received by the Partnership had been recorded as deferred revenue.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 6 - PURCHASE AND OPERATING AGREEMENTS (Continued)\nPrior to December 1, 1992, the Company restated the operating agreement for the Project with the Operator effective October 1987.\nUnder the terms of the operating agreement, the Operator staffs and operates the Project, pays operating expenses (excluding insurance and taxes), and pays debt service payments related to the Project. In view of the limited participation of the Company in operations, including profits and losses, except as described elsewhere herein, operations of the Project are not included in the financial statements for the years ended December 31, 1992, and 1991. The net cost of the utility plant of the Project, related long-term debt and depreciation, interest, insurance, and tax expenses are included in the financial statements of the Partnership. For the year ended December 31, 1991, debt service payments from the Operator of $339,000, are included in other revenues. The Operator did not make any debt service payments in 1992.\nThe debt service was restructured in December 1992 and will beserviced out of revenues of the project. The restructuring agreement with the bank changed the terms of the note payable (see Note 4). Also, any excess cash flows from the Project are to be used by the bank to offset the prior reduction of debt. As a result of the restructuring agreement, the Partnership now oversees the Project. The revenues and expenses of the Project are reflected in the statement of operations for the year ended December 31, 1994.\nThe Partnership entered into an agreement, effective December 1, 1992 with Little Mac Power Services Co. for the operation and maintenance of the Crystal Springs Hydroelectric Project. Under the terms of the operating agreement, the operator staffs and operates the Project, pays operating expenses to maintain the highest available plant efficiency. The Partnership pays a monthly fee of $2,200 to cover salary, travel and expenses. An initial non-refundable start-up cost of $2,500 was paid at the time the agreement was executed. The monthly fee will increase by 4% annually if contract continues for longer than one year.\nUnder the terms of the Crystal Springs purchase agreement dated May 15, 1985, the Partnership is required to pay royalties aggregating 20 percent of gross revenue received from the sale of Hydroelectric Power of which 17 percent is subordinated to debt. An additional five percent is payable to Twin Falls Canal Company per an agreement dated March 8, 1993.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 7 - RELATED PARTY TRANSACTIONS\nUnder the terms of the Partnership agreement, the general partner is allowed various fees and reimbursements of expenses incurred to manage the Partnership. For each of the years in the three-year period ended December 31, 1994, the Partnership expensed the following amounts as cost reimbursements to the general partner:\n1994 1993 1992\nGeneral and Administrative Expenses $123,000 $223,000 $437,000\nIn addition, during the years ended December 31, 1993 and 1992, the Partnership paid $3,300 and $18,000 to a Utah partnership for private air transportation, in the ordinary course of business, in lieu of commercial airfare. The general partners are partners of the Utah Partnership.\nAs a term of the amended and restated Partnership agreement, the general partner is entitled to 5 percent of the limited partnership units (Units) as compensation.\nDuring 1988, the Partnership assigned their rights to build an expansion unit to Steamboat Springs to a Nevada general partnership. As consideration for the rights, the Nevada general partnership deeded the Partnership rights and title to piping and valves installed from Steamboat Springs to the expansion unit and agreed to pay the Partnership royalties equaling 10 percent of net operating income from the expansion for the years ended December 31, 1988 through 1992, 15 percent for 1993 through 1998, 40 percent for 1999 through 2010, 45 percent thereafter, and an annual pumping charge. Included in other revenues in the statement of operations for the years ended December 31, 1994, 1993 and 1992, are $144,000, $135,000, and $102,000, respectively related to this agreement. As of December 31, 1994 and 1993, two of the general partners held a 75 percent ownership in the Nevada general partnership.\nDuring 1991, the Partnership assigned its 77% ownership in SB Geo, Inc. a Utah Corporation, to two of the general partners. SB Geo, Inc. operates the Partnership's Steamboat Springs Thermal Hydroelectric Power Plant and a related expansion unit. At the time of the transfer, SB Geo, Inc. had no assets and operated on a cost reimbursement basis. No gain or loss was recognized as a result of the assignment.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 8 - MAJOR CUSTOMER\nThe Partnership has contracted with Sierra Pacific Power Company to sell electric energy from Steamboat Springs for a term of 20 years. The contract entitles the Partnership to a rate of 71.7 mills per kilowatt hour for the first 10 years and a variable amount related to the short-term cost of power to Sierra Pacific Power Company for the second 10 years. Sales to Sierra Pacific Power Company account for 100 percent of electric power sales. The Partnership is dependent upon this customer for the purchase of all electricity generated from this power plant.\nThe partnership has contracted with Idaho Power Company to sell electric energy from Crystal Springs for a term of 35 years. The contract entitles the Partnership to a base payment rate as determined by seasonal water flows plus an adjustable component pursuant to commission order. Sales to Idaho Power Company account for 100 percent of electric power sales. The Partnership is dependent upon this customer for purchase of all electricity generated from this power plant.\nNOTE 9 - LITIGATION\nOrmat Arbitration\nThe arbitrators have made their award regarding the lawsuitagainst Ormat alleging breach of contract on the Steamboat Springs project and Ormat's counter-suit regarding the cancellation of the operating agreement. The Partnership was awarded $188,000 in damages including a portion of the previously restricted cash. Ormat was awarded $255,000 for past fixed operating fees, which the majority had been held in an escrow account.\nSubsequent to the arbitrators award the Partnership and Ormat reached an additional agreement which cancels the note payable to Ormat which was previously offset by the performance guaranty. Bonneville Pacific Corporation Bankruptcy\nThe Partnership has filed a claim in the Chapter 11 filing of Bonneville Pacific Corporation. The claim relates to fraud claims and other transactions on the Crystal Springs project.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 9 - LITIGATION\nGeneral\nThe Partnership is involved in various other claims and legal actions arising in the ordinary course of business. In the opinionof the general partner, these matters will not have a material adverse effect on the Partnership's financial position.\nNOTE 10 - NOTE DEFAULTS\nThe Partnership received a notice of default as of 10\/23\/92 on a note to a bank. The balance as of December 31, 1994 and 1993 was $5,340,000, and $6,035,000, respectively. Under the terms of the note all principal and interest is immediately due and payable.\nThe note is secured by the Steamboat Springs project and related revenues and other assets.\nThe Partnership is in default on a note payable to a bank as of 9\/30\/94. The balance as of December 31, 1994 and 1993 was $1,800,000. Due to events occurring subsequent to December 31, 1994, this note will be reduced to $537,000 (see Note 12).\nNOTE 11 - LIQUIDITY\nAs shown in the accompanying financial statements for the year ended December 31, 1994, current liabilities exceeded current assets by $9,191,000. Of this amount $7,140,000 relates to the note defaults described in Note 10.\nNOTE 12 - SUBSEQUENT EVENTS\nSteamboat Springs Project\nThe Partnership is investigating the possibility of selling the Steamboat Springs Project. At this time, there has been no formal discussion.\nCrystal Springs Project\nThe Partnership signed an agreement dated February 28, 1995 to sell the Crystal Springs project. The assets to be sold are valued at $2,717,000 with accumulated depreciation of $1,245,000 for a basis of $1,472,000. Assets to be sold:\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 12 - SUBSEQUENT EVENTS (Continued)\nCrystal Plant $4,500,000 Additional costs 216,000 Valuation Allowance (see Note 2) (2,021,000) Unit Overhauls 22,000\n2,717,000\nLess: Accumulated Depreciation 1,245,000\n$1,472,000\nIn consideration for the assets sold; a note Payable to First Security Bank, which is secured by the assets, will be reduced by $1,263,000, interest payable of $133,000 will be made current, and royalties payable of $120,000 will be made current bringing total sales proceeds to $1,516,000. Total proceeds of $1,516,000 less basis of the assets of $1,472,000 provides for a gain on sale of $44,000.\nThe note payable will be amended as follows:\nUpon receipt of First Security (Lender) of a principle payment on the loan in the amount of $1,100,000, the note shall be modified to provide that the remaining principle balance owed shall be $537,000 and interest and costs on the loan shall be deemed current.\nIf the note is paid in full within two years after the payment of $1,100,000, the Lender will discount the amount of the principle due by $100,000 (requiring a principle payment of only $437,000), and if paid within three years, the Lender will discount the amount of the principle due by $50,000 (requiring a principle payment of only $487,000). There will be no discount if paid after the third anniversary.\nThe following pro forma balance sheet and statement of operations give effect to the above events as if they had occurred on January 1, 1994:\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP DECEMBER 31, 1994 NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 12 - SUBSEQUENT EVENTS (Continued)\nPRO FORMA BALANCE SHEETS As Reported Pro Forma in Adjustments Accompanying For Pro Forma Financial Subsequent Balance Statements Events Sheet ASSETS\nUtility Plant: Plant in Service $18,716,000 $(2,717,000) A $15,999,000 Equipment 335,000 - 335,000 Construction in Progress 118,000 - 118,000 Accumulated Depreciation (6,010,000) 1,245,000 A (4,765,000)\nNet Utility Plant 13,159,000 (1,472,000) 11,687,000\nRestricted Marketable Securities 1,145,000 - 1,145,000 Other Assets 124,000 - 124,000 Current Assets: Cash 278,000 - 278,000 Receivables - Trade 437,000 (1,000) B 436,000 Receivables - Other 6,000 - 6,000 Receivables - Related Party 159,000 - 159,000 Prepaid Insurance 12,000 (9,000) C 3,000\nTotal Current Assets 892,000 (10,000) 882,000\nTotal Assets $15,320,000 $(1,482,000) $13,838,000\nA - All assets of Crystal Spring Project are to be sold per sales agreement date February 28, 1995.\nB - Receivables attributable to Crystal Springs Project.\nC - Prepaid Insurance attributable to Crystal Springs Project.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP DECEMBER 31, 1994 NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 12 - SUBSEQUENT EVENTS (Continued)\nPRO FORMA BALANCE SHEETS\nAs Reported Pro Forma in Adjustments Accompanying For Pro Forma Financial Subsequent Balance Statements Events Sheet PARTNERS' CAPITAL & LIABILITIES\nPartners' Capital $ 4,857,000 $ 34,000 D $4,891,000 Other Liabilities 150,000 - 150,000 Long-term Debt: Notes Payable - Related Party 230,000 - 230,000\nPartners' Capital & Long-term Liabilities 5,237,000 34,000 5,271,000\nCurrent Liabilities: Current Portion - Long-term Debt 7,140,000 (1,263,000) E 5,877,000 Note Payable - Related Party 1,043,000 - 1,043,000 Payable - Related Party 573,000 - 573,000 Accrued Liabilities: Operations 495,000 - 495,000 Royalties 220,000 (120,000) F 100,000 Interest 612,000 (133,000) G 479,000\nTotal Current Liabilities 10,083,000 (1,516,000) 8,567,000\nTotal Partners' Capital and Liabilities $15,320,000 $(1,482,000) $13,838,000\nD - Net income from Crystal Springs project allocated to partners.\nE - Long-term debt attributable to Crystal Springs project.\nF - Royalties payable attributable to Crystal Springs project.\nG - Interest payable attributable to Crystal Springs project.\nFAR WEST ELECTRIC ENERGY FUND, L.P. A DELAWARE LIMITED PARTNERSHIP DECEMBER 31, 1994 NOTES TO FINANCIAL STATEMENTS (Continued)\nNOTE 12 - SUBSEQUENT EVENTS (Continued)\nPRO FORMA STATEMENT OF OPERATIONS\nAs Reported Pro Forma in Adjustments Accompanying For Pro Forma Financial Subsequent Statement of Statements Events Operations REVENUES Electric Power Sales $ 2,728,000 $ (163,000) H $2,565,000 Other Revenues 151,000 - 151,000\nTotal Revenues 2,879,000 (163,000) 2,716,000\nEXPENSES Interest 902,000 (95,000) I 807,000 Depreciation 643,000 (67,000) I 576,000 Royalty 451,000 (41,000) I 410,000 Professional Services 54,000 (25,000) I 29,000 Administrative Services - General Partner 123,000 (54,000) I 69,000 Amortization 18,000 - 18,000 Insurance 52,000 (18,000) I 34,000 Maintenance 436,000 (28,000) I 408,000 Taxes 47,000 (14,000) I 33,000 Other 80,000 (20,000) I 60,000\nTotal Expenses 2,806,000 (362,000) 2,444,000\nNet Income (Loss) Before Gain on Sale 73,000 199,000 272,000\nGain on Sale of Crystal Springs Project - 44,000 J 44,000\nNet Income (Loss) $ 73,000 $ 243,000 $ 316,000\nNet Income (Loss) Per Limited Partnership Unit $ 7 $ 24 $ 31\nH - Electric power sales attributable to Crystal Springs Project.\nI - Operating expenses attributable to Crystal Springs Project.\nJ - Gain on sale of Crystal Springs Project.\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 Registrant.\nThe Partnership has no executive officers. Its business affairs are managed by its General Partner, Far West Capital, and, until they resigned as General Partners effective January 1, 1995, the following individuals, who are also 90% shareholders of Far West Capital:\nALAN O. MELCHIOR, President and Director of Far West Capital, age 47. Mr. Melchior was a founder of Far West Capital, which was organized in May, 1983. He has been its President since its inception. From December, 1981 to May, 1983, he was an account executive with Westlake Securities, Inc., of Angora Hills, California. Mr. Melchior received a B.S. in business from Brigham Young University in 1971 and an M.B.A. degree from the University of Utah in 1974.\nTHOMAS A. QUINN, Vice President, General Counsel and Director of Far West Capital, age 59. Mr. Quinn was also a founder of Far West Capital. Since February, 1985, Mr. Quinn has been serving full-time in his capacities with Far West Capital. From 1968 to February, 1985, he was engaged in the private practice of law in Salt Lake City, Utah. He received a B.S. degree in political science from Brigham Young University in 1959, and a Juris Doctor, with honors, from George Washington University Law School in 1963.\nOn January 29, 1993, a Final Judgment of Permanent Injunction (\"Injunction\") was entered by the United States District Court, District of Utah, Central Division, restraining and enjoining the Partnership, Far West Capital, Inc. and Alan O. Melchior, previously a general partner until his resignation effective January 1, 1995, from violating provisions of the Securities Act of 1933. A copy of the Injunction is appended as an exhibit to Form 8-K dated January 29, 1993.\nThe action filed against the Partnership, Far West Capital, Inc., Alan O. Melchior, previously a General Partner until his resignation effective January 1, 1995, and others on December 7, 1992 by the Arizona Corporation Commission and reported in the December 31, 1992 Form 10-K and the December 31, 1993 Form 10-K has been settled pursuant to a cease and desist order without any expense to the Partnership. Item 11.","section_11":"Item 11. Executive Compensation.\nPursuant to the Amended and Restated Agreement of Limited Partnership of Far West Electric Energy Fund, L.P., as consideration for providing management services to the Partnership, the General Partner is entitled to the following compensation: (i) a one percent (1%) interest in the profits, losses, and net income of the Partnership; (ii) Units equal to five percent (5%) of the Units outstanding, to be increased proportionately if and as additional Units are issued in the future; (iii) if and when Units are listed for public trading, or the Limited Partners have received an amount equal to their capital contributions to the Partnership (reduced by the amount of tax credits allocated to the Limited Partners) together with a sum equal to a cumulative annual return of 8%, the General Partner shall receive additional Units equal to ten percent (10%) of the Units outstanding, and a total of 15% of any new Units issued. The General Partner may receive compensation in connection with the purchase of projects from the General Partner or its affiliates, and provision of services to the Partnership which are normally provided by outside consultants, provided any such payments are competitive with charges for similar projects or services.\nFollowing the reorganization of the Partnership in Delaware, Units equal to 5% of the Units outstanding were issued to the General Partner, together with a certificate evidencing a one percent (1%) General Partner's interest in the Partnership.\nThe Partnership has no employees and therefore relies on the personnel of Far West Capital and contracts with others to perform needed management operating and professional services. Far West Capital provides services on\nan hourly basis at rates competitive with third party sources.\nFar West Capital is also entitled to be reimbursed on a monthly basis for all direct expenses it incurs on behalf of the Partnership and for that portion of its administrative expenses allocable to the Partnership.\nFor the years ended December 31, 1994, December 31, 1993 and December 31, 1992 Far West Capital was entitled to receive $123,000, $223,000 and $437,000 respectively as reimbursement for allocable administrative costs and services\nrendered and direct expenses in connection with the above matters. During 1994 the Partnership paid $16,000 toward these amounts, leaving the amount of $573,000 still due to Far West Capital.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nSecurity Ownership of Certain Beneficial Owners\nThe Partnership is not aware of any beneficial owner of more than five percent interest in the Partnership other than the General Partner. The General Partner owns 5.14% of the Partnership in Limited Partnership Units and a 1% General Partner interest.\nSecurity Ownership of Management\nAs of March 16, 1995 the General Partner owns the following interest in the Partnership:\nName of Title of Class Beneficial Owner Ownership %\nLimited Partner- Far West Capital 530 5.14% ship Units Limited Partnership Units\nGeneral Partner Far West Capital Certificate Interest of General Partner's Interest 1%\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nGeneral Partner's Compensation and Reimbursement\nFar West Capital is entitled to receive certain compensation and reimbursement under the terms of the Amended and Restated Partnership Agreement. See \"Item 11. Executive Compensation\" as to amounts paid to the General Partner in 1994.\n1-A Expansion to the Steamboat Springs Plant\nIn 1988 the Partnership sold rights to develop the 1-A Expansion Project to the Steamboat Springs Project to an entity owned mostly by Alan O. Melchior and Thomas A. Quinn, officers and owners of the General Partner of the Partnership. For a discussion of the Partnership's interest in this Project, see \"Item 2. Properties -- Revenues from the 1-A thermal- hydroelectric Plant.\"\nAs consideration for the sale of the 1-A Plant rights to 1-A Enterprises, the Partnership received a royalty interest in the net operating income of the 1-A Plant. Such royalties equaled 15% in 1994. This amounted to $87,000 earned by the Partnership.\nIn addition the Partnership is paid an amount equivalent to the net profit that would be realized by the Partnership if the 1-A Plant were bearing 150 KW of parasitic power load (power consumed by the Plant itself). In 1994 this amounted to $57,000 received by the Partnership.\n$400,000 Loan\nSimultaneous with its January 17, 1990 loan to the Partnership, Westinghouse made a $3,000,000 non-recourse loan to 1-A Enterprises on the 1-A Plant on the same terms as the loan made to the Partnership but secured by the assets associated with the 1-A Plant. $400,000 of the loan on the 1-A Plant has been reloaned by 1-A Enterprises to the Partnership at 11% per annum for ten years on a non-recourse basis.\nAssignment of Ownership Interest in SB GEO\nIn October, 1991 the Partnership assigned its 77% ownership interest in SB GEO to Alan O. Melchior and Thomas A. Quinn, two of the officers and owners of the General Partner in exchange for their assuming all outstanding liabilities of SB GEO. See \"Item 2. Properties\" for further information.\nLoans From General Partner\nDuring the past 5 years the General Partner made unsecured loans to the Partnership to help the Partnership meet its financial obligations. The loans accrue interest at 13% and are payable upon demand. As of December 31, 1994, 1993 and 1992 loans from General Partners totaled $1,005,000, $922,000 and $751,000 respectively.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 10-K.\n(a) 1. The following financial statements are included in Part II, Item 8; Page\nIndependent Auditors' Report 17\nFinancial Statements:\nBalance Sheets, December 31, 1994 and 1993 18\nStatements of Operations, Years ended 20 December 31, 1994, 1993, and 1992\nStatements of Partners' Capital, Years ended 21 December 31, 1994, 1993, and 1992\nStatements of Cash Flows, Years ended 22 December 31, 1994, 1993, and 1992\nNotes to Financial Statements 24\n2. The following financial schedules for the period from January 1, 1993, to December 31, 1994, are submitted herewith.\nAll schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n3. Exhibits:\n(3) (a) Certificate and Agreement of Limited Partner- ship of Far West Electric Energy Fund, L.P. filed with the Delaware Secretary of State on December 20, 1988 (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(ab) filed with Form 10-K for the fiscal year ended December 31, 1988.)\n(b) Amendment to Certificate and Agreement of Limited Partnership of Far West Electric Energy Fund, L.P.\n(4) See Exhibit (3)(a) with respect to rights of Limited Partners.\n(10) (a) Purchase Agreement (Steamboat Springs-- formerly \"Sierra Pacific\"--Project). (Incorporated by reference to Exhibit 10(a) filed with Form 8 dated June 20, 1986.)\n(b) Offset Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(b) filed with Form 8, dated June 20, 1986.)\n(c) Agreement for the Purchase and Sale of Electricity (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(c) filed with Form 8 dated June 20, 1986.)\n(d) Memorandum of Lease, Assignment of Lease, and Purchase Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(d) filed with Form 8 dated June 20, 1986.)\n(e) Operating Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(e) filed with Form 8 dated June 20, 1986.)\n(f) Demand Note (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(f) filed with Form 8 dated June 20, 1986.)\n(g) Assignment and Security Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(g) filed with Form 8 dated June 20, 1986.)\n(h) Accommodation Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(h) filed with Form 8 dated June 20, 1986.)\n(i) Leasehold Trust Deed (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(i) filed with Form 8 dated June 20, 1986.)\n(j) Construction Loan Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(j) filed with Form 8 dated June 20, 1986.)\n(k) Consents to Assignment of Geothermal Resources Lease and Agreement for the Purchase and Sale of Electricity (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(k) filed with Form 8 dated June 20, 1986.)\n(l) Construction Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(l) filed with Form 8 dated June 20, 1986.)\n(m) Assignment of Construction Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(m) filed with Form 8 dated June 20, 1986.)\n(n) Promissory Note ($7.1 Million) (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(n) filed with Form 8 dated June 20, 1986.)\n(o) Purchase Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(o) filed with Form 8 dated June 20, 1986.)\n(p) Amendment to Agreement for Purchase and Sale of Electricity Between Far West Hydroelectric Fund, Ltd. and Sierra Pacific Power Company (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(p) filed with Form 10- K for the fiscal year ended December 31, 1986.)\n(q) Location and Occupancy Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(q) filed with Form 10-K for the fiscal year ended December 31, 1986.)\n(r) Insurance Policy (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(r) filed with Form 10-K for the fiscal year ended December 31, 1986.)\n(s) Insurance Policy (Crystal Springs Project). (Incorporated by reference to Exhibit 10(s) filed with Form 10-K for the fiscal year ended December 31, 1986.)\n(t) Certificate of Insurance (Crystal Springs Project). (Incorporated by reference to Exhibit 10(t) filed with Form 10-K for the fiscal year ended December 31, 1986.)\n(u) Memorandum of Agreement Regarding Crystal Springs Lease (Crystal Springs Project). (Incorporated by reference to Exhibit 6.(a)(1) filed with Form 10-Q for the quarter ended September 30, 1987.)\n(v) Steamboat Springs Geothermal Hydroelectric Plant Loan Agreement and Security Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 6.(a)(2) filed with Form 10-Q for the quarter ended September 30, 1987.)\n(w) Letter of Intent to Purchase Steamboat Springs 1-A Project (Steamboat Springs Project). (Incorporated by reference to Exhibit 6.(a)(1) filed with Form 10-Q for the quarter ended June 30, 1987.)\n(x) Restated Operation and Maintenance Agreement, Purchase Option Agreement, Promissory Note, Credit Agreement, Security Agreement, Mortgage, Assignment of Contract Rights, and Security Agreement, and Collateral Assignment of Water Rights (Steamboat Springs Project). (Incorporated by reference to Exhibits filed with Form 10-Q for the quarter ended June 30, 1988.)\n(y) Amendment to Steamboat Springs Geothermal Hydroelectric Plant Security Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit 6.(a)(1) filed with Form 10-Q for the quarter ended September 30, 1988.)\n(z) Agreement re Acquisition of 1-A Expansion to the Steamboat Nevada Geothermal Power Plant (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(w) filed with Form 10- K for the fiscal year ended December 31, 1987.)\n(aa) 1-A Assignment to the Partnership of Piping and Valves necessary to carry Geothermal fluids to and from the Steamboat Springs Geothermal power plants to the 1-A Expansion Facility, dated January 18, 1989 (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(ac) filed with Form 10-K for the fiscal year ended December 31, 1988.)\n(ab) Second Amendment to Geothermal Resources Lease between Sierra Pacific Power Company and Far West Hydroelectric Fund, Ltd., dated October 29, 1988 (Steamboat Springs Project). (Incor- porated by reference to Exhibit 10(ad) filed with Form 10-K for the fiscal year ended December 31, 1988.)\n(ac) Geothermal Resources Sublease between Far West Hydroelectric Fund, Ltd. and Far West Capital, Inc., dated October 28, 1988 (Steamboat Springs Project). (Incorporated by reference to Exhibit 10(ae) filed with Form 10-K for the fiscal year ended December 31, 1988.)\n(ad) Purchase Option Agreement between Crystal Springs Hydroelectric Company and BPC, dated July 7, 1988 (Crystal Springs Project). (Incorporated by reference to Exhibit 19(a) filed with Form 10-K for the fiscal year ended December 31, 1988.)\n(ae) Restated Operation and Maintenance Agreement between Crystal Springs Hydroelectric Company and BPC, dated July 7, 1988 (Crystal Springs Project). (Incorporated by reference to Exhibit 19(b) filed with Form 10-K for the fiscal year ended December 31, 1988.)\n(af) Term Loan Agreement with Westinghouse Credit Corporation dated December 28, 1989 (Steamboat Springs Project). Incorporated by reference to Exhibit 7.(c)(1) filed with Form 8-K dated January 17, 1990.)\n(ag) Note in the principal amount of $400,000 to 1- A Enterprises (Steamboat Springs Project). (Incorporated by reference to Exhibit 7.(c)(2) filed with Form 8-K dated January 17, 1990.)\n(ah) The following Exhibits relate to the Westinghouse Loan financing on the Steamboat Springs Project:\n1. Promissory Note.\n2. Leasehold Trust Deed and Security Agreement. 3. Security Agreement.\n4. Collateral Assignment.\n5. Financing Statement.\n6. Escrow Agreement.\n7. Escrow Instructions.\n8. Consent to Assignment and Agreement of Sierra Pacific Power Company.\n(Incorporated by reference to Exhibit (19) (ah) filed with Form 10-K for the fiscal year ended December 31, 1989.)\n(ai) Third Amendment to Geothermal Resources Lease (Steamboat Springs Project). (Incorporated by reference to Exhibit (10) (ai) filed with Form 10-K for the fiscal year ended December 31, 1989.)\n(aj) Amended Memorandum of Lease (Steamboat Springs Project). (Incorporated by reference to Exhibit 10-K for the fiscal year ended December 31, 1989.)\n(ak) Revised and Restated Geothermal Resources Sub- lease (Steamboat Springs Project). (Incorporated by reference to Exhibit (10) (ak) filed with Form 10-K for the fiscal year ended December 31, 1989.)\n(al) Memorandum of Revised and Restated Geothermal Resources Sublease (Steamboat Springs Project). (Incorporated by reference to Exhibit (10) (al) filed with Form 10-K for the fiscal year ended December 31, 1989.)\n(am) Amendment to Operating Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit (10) (am) filed with Form 10-K for the fiscal year ended December 31, 1989.)\n(an) Compromise Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit (10) (an) filed with Form 10-K for the fiscal year ended December 31, 1989.)\n(ao) Agreement Re Disputed Invoice and Interest Due Under Steamboat 1 Operating Agreement (Steamboat Springs Project). (Incorporated by reference to Exhibit (10) (ao) filed with Form 10-K for the fiscal year ended December 31, 1989.)\n(ap) Agreement for Services (Steamboat Springs). (Incorporated by reference to Exhibit 10 filed with Form 10-Q for the quarter ended June 10, 1990.)\n(aq) Revised Agreement for Services (Steamboat Springs). (Incorporated by reference to Exhibit 10 (a) filed with Form 10-Q for the quarter ended June 30, 1990.)\n(ar) Revised Operating Agreement (Steamboat Springs). (Incorporated by reference to Exhibit 10 (b) filed with Form 10-Q for the quarter ended June 31, 1990.)\n(as) Waiver Operating Agreement (Steamboat Springs). (Incorporated by reference to Exhibit 10(b) filed with Form 10-Q for the quarter ended June 30, 1990.)\n(at) First Amendment to collateral Assignment (Steamboat Springs). (Incorporated by reference to Exhibit (10) (qt) filed with Form 10-K for the fiscal year ended December 31, 1990.)\n(au) First Amendment to Security Agreement Steamamboat Springs). (Incorporated by reference to Exhibit (10) (au) filed with Form 10-K for the fiscal year ended December 31, 1990.)\n(av) Fifth Amendment to Escrow Agreement (Steamboat Springs). (Incorporated by reference to Exhibit (10) (av) filed with Form 10-K for the fiscal year ended December 31, 1990.)\n(aw) Assignment of Ownership (Steamboat Springs). (Incorporated by reference to Exhibit (10)(aw) filed with Form 10-K for the fiscal year ended December 31, 1991).\n(ax) Crystal Springs Agreement (Crystal Springs Project). (Incorporated by reference to Exhibit (10)(a) filed with Form 10-Q for the quarter ended June 30, 1992).\n(ay) Award of Arbitrators (Steamboat Springs Project). (Incorporated by reference to Exhibit (10)(a) filed with Form 10-Q for the quarter ended September 30, 1992).\n(az) Agreement (Crystal Springs Project). (Incorporated by reference to Exhibit (10) (a) filed with Form 10-K for the fiscal year ended December 31, 1992).\n(aaa) Mutual Release Agreement (Crystal Springs Project). (Incorporated by reference to Exhibit (10) (a) filed with Form 10-K for the fiscal year ended December 31, 1992).\n(aab) Extension and Modification Agreement (Crystal Springs Project). (Incorporated by reference to Exhibit (10) (a) filed with Form 10-K for the fiscal year ended December 31, 1992).\n(aac) Amendment to Mortgage (Crystal Springs Project). (Incorporated by reference to Exhibit (10) (a) filed with Form 10-K for the fiscal year ended December 31, 1992).\n(aad) Amendment to Security Agreement (Crystal Springs Project). (Incorporated by reference to Exhibit (10) (a) filed with Form 10-K for the fiscal year ended December 31, 1992).\n(aae) Operation and Maintenance Agreement (Crystal Springs Project). (Incorporated by reference to Exhibit (10) (a) filed with Form 10-K for the fiscal year ended December 31, 1992).\n(aaf) Mutual Satisfaction of Arbitration Award (Steamboat Springs Project). (Incorporated by reference to Exhibit (10) (a) filed with Form 10-K for the fiscal year ended December 31, 1992).\n(aag) Second Extension Agreement (Crystal Springs Project).\n(aah) Agreement (Crystal Springs Project).\n(aai) Purchase and Sale Agreement (Crystal Springs Project).\n(aaj) Bill of Sale (Crystal Springs Project).\n(aak) Release of All Claims (by Lessor) (Crystal Springs Project).\n(aal) Consent to Assignment (Crystal Springs Project).\n(aam) Consent and Agreement (Crystal Springs Project).\n(aan) Assignment of Interest (Crystal Springs Project).\n(aao) Certificate As To Fulfillment of Crystal Springs Hydroelectric Company (\"Seller\") and Obligations (Crystal Springs Project).\n(aap) Certificate As To Fulfillment of Crystal Springs Hydroelectric, L.P. (\"Purchaser\") Conditions (Crystal Springs Project).\n(aaq) Release of all claims (by Crystal Springs Hydroelectric Company) (Crystal Springs Project).\n(aar) Release of Security Agreement (Crystal Springs Project).\n(aas) Third Extension and Modification Agreement (Crystal Springs Project).\n(aat) Amended and Substituted Promissory Note (Crystal Springs Project).\n(23) (a) Consent of Independent Public Accountants (Robison Hill and Company).\nThe Partnership agrees to furnish to the Securities and Exchange Commission a copy of any long-term debt instrument or loan agreement that it may request.\n(b) No reports on Form 8-K were filed during the 4th Quarter of 1994.\n(c) The exhibits listed in Item 14(a)(3) are incorporated by reference.\n(d) No financial statement schedules required by this paragraph are required to be filed as a part of this form.\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 duly authorized persons.\nRegistrant: Far West Electric Energy Fund, L.P. By: Far West Capital, Inc., General Partner\nDATE: March 16, 1995 By: \/s\/ Alan O. Melchior, 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 and on the dates indicated.\nDATE: March 16, 1995 By: \/s\/ Alan O. Melchior, Director and Principal Financial Officer and\nPrincipal Executive Officer\nDATE: March 16, 1995 By: \/s\/ Thomas A. Quinn, Director\nDATE: March 16, 1995 By: \/s\/ Ronald E. Burch, Director\nDATE: March 16, 1995 By: \/s\/ Jody Rolfson Principal Accounting Officer","section_15":""}
{"filename":"80966_1994.txt","cik":"80966","year":"1994","section_1":"ITEM 1. BUSINESS\nThe principal businesses of PS Group, Inc. (the \"Company\") are aircraft leasing (conducted directly), fuel sales and distribution, and oil and gas production and development.\nIn March 1994 the Company sold its travel management business formerly conducted by its 85% owned subsidiary, USTravel Systems Inc. (USTravel). In August 1994 the Company adopted a plan to close-down or sell the major asset of Recontek, Inc. (Recontek), a metallic waste recycling plant in Newman, Illinois and, in December 1994, this plant was sold. Accordingly, travel management and metallic waste recycling are treated as discontinued operations.\nThe Company was incorporated in Delaware in 1972 (under the original name PSA, Inc.) as the successor to a California corporation originally incorporated in 1945. The Company has its principal executive offices at 4370 La Jolla Village Drive, Suite 1050, San Diego, California, 92122; telephone number (619) 546-5001.\nAs of December 31, 1994 the Company's corporate staff consisted of 9 full- time employees who conduct the Company's aircraft leasing operations as well as its executive and administrative activities.\nAIRCRAFT LEASING\nThe Company's aircraft investments consist of 21 wholly-owned and seven partially-owned jet aircraft. No additional aircraft have been acquired for lease since 1989, nor are any purchases currently contemplated. All of the Company's wholly-owned, leased aircraft have been pledged pursuant to various financing arrangements. In 1994 aircraft leasing contributed $35.6 million to the Company's consolidated operating revenues, or approximately 28% of total revenues from continuing operations.\nThe information reported herein relating to the Company's aircraft lessees was obtained from published media reports. The Company refers readers to public information regarding USAir, Continental and America West for further details relating to their financial condition.\nCurrently the Company has 16 aircraft on lease to USAir, Inc. (\"USAir\") under leases that expire at various times between 1998 and 2004. Six of the aircraft are McDonnell Douglas MD-80s and 10 are British Aerospace 146-200s. USAir contributed approximately 79% of the Company's aircraft lease revenues in 1994.\nThe Company owns and leases to Continental Airlines, Inc. (\"Continental\") one MD-80 aircraft and one Boeing 737-300 aircraft under leases that expire at the beginning of 2008 and has a one-third interest in seven Boeing 737-200 aircraft which are leased to Continental under leases that expire in 1996. The Company also owns and leases to America West Airlines, Inc. (\"America West\") one Boeing 737-300 aircraft under a lease that expires in 2006. Two Boeing 747-100 freighter aircraft formerly leased to Pan American World Airways (\"Pan Am\") are held for sale. Both 747s were converted from passenger to full freighter configuration following their return from Pan Am. See \"Recent Developments.\"\nTYPE OF AIRCRAFT LEASES. All of the Company's leases are net leases, which provide that the lessees bear the direct operating costs and the risk of physical loss of the aircraft, pay taxes, maintain the aircraft, indemnify the Company against any liability suffered as the result of any act or omission of the lessee, maintain casualty insurance in an amount equal to the specific amount set forth in the lease (which may be less than market value) and maintain liability insurance naming the Company as an additional insured. In general, substantially all obligations connected with the operation and maintenance of the leased aircraft are assumed by the lessee and minimal obligations are imposed upon the Company. The leases also typically provide that in those limited instances where the lessees have the voluntary right to terminate the lease, the lessee is obligated to pay the Company a stipulated sum which would retire any existing indebtedness relating to the aircraft and otherwise provide the Company with the same economic value it would have received had the lease continued.\nRECENT DEVELOPMENTS. During 1994 Continental significantly expanded their new low fare service called Continental Lite. This new service was not successful and was being scaled back in early 1995. Year-end 1994 results included a charge of about $400 million related to 42 aircraft Continental will phase out of its fleet (none of which are the Company's aircraft) plus charges for other cutbacks. Continental finished 1994 with approximately $400 million in cash, $110 million of which is restricted as to usage. In addition, new aircraft scheduled for delivery in 1996 and 1997 were delayed one year and Continental is also seeking to modify future debt payments. Continental, in comparison with many other carriers, has a lower cost structure. This lower cost structure should help sustain Continental as it is working to increase revenues while it reduces and redeploys part of its fleet. Until this redirection and cost reduction is successfully completed, there is uncertainty as to Continental's future. Due to Continental's financial condition, there is uncertainty as to whether the Company will recover its investment in aircraft leased to Continental.\nAmerica West completed its reorganization and emerged from bankruptcy in August 1994. As part of the reorganization, America West is partially owned by Continental. Both carriers are implementing various programs to cross feed passengers and reduce common costs. While both passenger levels and profits have recently declined, America West has been profitable for eight consecutive quarters and finished 1994 with total cash of $211 million, of which $29 million was restricted as to its usage. America West has a lower cost structure, which should assist in its efforts to solidify its long-term position in the marketplace.\nFollowing the cessation of operations by Pan Am on December 4, 1991, two 747-100 aircraft were returned to the Company in early 1992. At the time of return, both aircraft were in a passenger configuration, although each had been previously modified, at the US Government's expense, to be convertible into cargo configuration in case of a national emergency.\nIn February 1992 the Company committed to have the two ex-Pan Am 747s converted to full freighter status by The Boeing Company (\"Boeing\"). The Company also entered into an agreement with Boeing for the marketing of the aircraft. Conversion of both aircraft is now complete.\nUsed aircraft values continued to decrease during 1994. As a result the Company - which wrote-down the value of the two 747-100s at the end of 1991, 1992 and 1993 by approximately $5.8 million, $9.9 million, and $17 million, respectively, took a further write-down of those aircraft at the end of 1994 of approximately $7.2 million.\nUSAir leases 16 of the Company's aircraft - six MD-80 aircraft and ten BAe 146-200 aircraft. Since mid-1992 the BAe-146s have been out of service. USAir recorded additional loss reserves in 1994 against their 18 non-operating 146s (10 of which are leased from the Company).\n1994 was a very difficult year for USAir. Added low fare\/low cost competition from Continental (Continental Lite see above) and another new entrant into some of USAir's markets, two aircraft accidents with fatalities, which negatively impacted passenger levels, and a lack of progress in 1994 on reaching agreement with USAir's labor unions to reduce annual operating costs by $500 million all had significant impact on increasing USAir's losses in 1994. USAir recorded a net loss of $716 million in 1994 versus a 1993 loss of $375 million. To conserve cash during 1994, USAir suspended payment of preferred dividends and cancelled contracts to purchase new aircraft. The consolidated cash balance for USAir and its parent totalled $450 million at December 31, 1994. The projected cash balance of USAir at the end of the first quarter of 1995 is $200 million. USAir also announced the sale in February 1995 of 11 aircraft to be delivered in 1995, which will help reduce operating expenses. In March 1995, USAir announced a preliminary agreement with its pilots union as to a reported $190 million in annual expense savings for a five year period in exchange for \"financial returns and governance participation.\" While this is an important step in USAir's goal to achieve a total of $500 million in annual wage and benefit savings and while all of USAir's unions have expressed their commitment to finalize agreements to strengthen USAir, as of April 10, 1995 uncertainty remains as to USAir's future. If USAir fails in its attempt to reduce expenses and ceases to pay rent on some or all of the aircraft it leases from the Company, there will be a material adverse impact on the Company. Due to USAir's financial condition there is uncertainty as to whether the Company will recover its investment in aircraft leased to USAir.\nThe ultimate impact of the sale of the two 747 freighter aircraft, and the future prospects of USAir, Continental and America West on the Company are unknown. It is possible that the 747 freighter aircraft will be sold without further losses and that all of the current aircraft leases will remain with the existing carriers. On the other hand, (i) it is difficult to predict potential sales prices for the two 747 freighters (which may be less than current book value) and (ii) further economic deterioration of the Company's lessees could result in the return of some or all of the aircraft to the Company or the renegotiation of lease terms less favorable to the Company. If the aircraft were returned, the Company would be faced with a choice of maintaining control of the aircraft by continuing to make the scheduled debt payments or losing control of the aircraft to the lenders who would seek a buyer of the aircraft. Except for debt of $20.4 million on five BAe-146s and obligations of $25.9 million on the two 747 freighter aircraft, all other aircraft are encumbered by debt which is nonrecourse to the Company. If the lenders took control and sold the aircraft, the Company would likely lose most or all its equity. If, in the future, the Company has sufficient liquidity after a lessee defaulted and elected to pay the scheduled debt service to the lender(s), then the Company would be required to find purchasers or new lessees for the aircraft. To the extent that sales prices were less than the Company's carrying value or less favorable lease rates were obtained, the Company would be negatively affected.\nPS TRADING -- FUEL SALES AND DISTRIBUTION\nPS Trading, Inc. (PST), which is wholly-owned by the Company, is headquartered in Dallas and also has sales staff in California and Arizona. PST contributed $79.6 million to the Company's 1994 consolidated operating revenues or approximately 63% of total revenues from continuing operations.\nPST operations, which are characterized by large revenues and small operating margins, are composed of three separate divisions consisting of aviation fuel sales, wholesale fuel marketing and facility services.\nAVIATION FUEL SALES. From its formation in 1980 until 1991, PST's primary business focus was sales of aviation fuel to scheduled airlines. Large commercial airlines no longer dominate PST's aviation sales. Part of this decline was a result of PST's decision not to rebid large\ncontracts with de minimis margins and also the discontinuance of business with airlines who were experiencing financial adversity. In 1994 aviation fuel sales remained PST's largest revenue generator with a diversity of business from higher margin\/lower volume sales to corporate, charter and cargo operators along with limited sales to scheduled passenger air carriers. PST will continue to focus on this same business in 1995 with renewed emphasis on providing responsive, quality service at reasonable margins.\nWHOLESALE FUEL MARKETING. PST's growth segment in 1994 and area of emphasis for future growth is wholesale fuel marketing. Sales volumes of refined petroleum products (primarily diesel and gasoline) to commercial, military, municipal and reseller customers increased 31% over 1993. PST's customer base grew during 1994 in California, Arizona and Nevada, while new sales territories in New Mexico and Oregon were being developed. As planned, PST began shipping pipeline quantities of gasoline and diesel fuel to selected terminals in California and Arizona during the third quarter of 1994. These pipeline purchases have reduced PST's average cost of fuel and resulted in greater profitability and higher sales volumes. During 1995, PST's plan is to continue sales development in existing areas and to begin shipping via pipeline to Washington and Oregon. Much of 1995 will be devoted to expanding sales capabilities by employing additional sales representatives, improving customer support services, and continuing to develop a formal employee training program.\nFACILITY SERVICES. PST owns or leases limited fuel storage facilities or pipelines in several locations including San Francisco, Oakland and Los Angeles. During 1994 PST leased terminal storage capacity in San Diego, Sacramento, Stockton and Chico, California and Phoenix, Arizona. During 1995 PST plans on leasing additional storage capacity in Seattle, Portland, Albuquerque and Los Angeles.\nECONOMIC AND COMPETITIVE FACTORS AFFECTING PST. Virtually every refiner and reseller of refined petroleum products who sell in PST's market areas (including other large distributors and major oil companies) is a competitor or potential competitor of PST for the sale of its products. Many of these companies have greater financial resources and broader marketing capabilities than PST. In some instances competitors, especially refiners, may have lower costs for the refined petroleum products they sell and may thus be in a favorable position to offer product prices to PST's customers lower than those PST can offer.\nENVIRONMENTAL ISSUES. Since PST owns or leases fuel storage facilities or pipelines at several locations it is possible that future claims may be made against PST regarding potential soil and groundwater pollution. Currently no claim has been asserted. However, see \"Legal Proceedings\" for discussion of an order filed by the California Regional Water Quality Control Board, San Francisco Region. Typically PST operates at locations served by other companies including major airlines, oil companies and airports, most of which have greater financial resources and higher levels of operations at the locations served than the Company.\nEMPLOYEES. PST had 23 employees at December 31, 1994, none of whom are covered by union contracts.\nSTATEX - OIL AND GAS PRODUCTION AND DEVELOPMENT\nThe Company's oil and gas operations are conducted by Dallas-based Statex Petroleum, Inc. (Statex), which is currently wholly-owned. The Company repurchased the interest of the two managers of Statex during 1994. Statex's primary business activity is the application of secondary recovery processes to increase the productivity of producing properties which yield crude oil. Typically this involves injecting water into reservoirs which have been depleted of their natural pressure. Since 1991 Statex has augmented the water injection with polymers to increase\nthe recovery efficiencies. Statex concentrates its efforts in areas and reservoirs which have a proven history of economically attractive secondary recovery operations. Currently, the main focus is in North Texas.\nDuring 1994 Statex continued to improve the efficiency of its major property by reducing operating expenses, particularly power and repair costs. As a result of pricing and capital availability, major expansion projects were deferred. Consequently, at the end of 1994 gross production from the enhanced recovery projects averaged 1,225 barrels of oil per day versus 1,500 at the end of 1993. Statex will delay capital expenditures necessary to produce the proved, undeveloped reserves in Statex's primary Texas waterflood project until oil prices stabilize at $2 to $3 per barrel above year-end levels. Plans for 1995 call for extension of the major field by drilling two wells and a seismic survey to ascertain the potential of deeper reservoirs.\nThe following table sets forth, by states, well ownership and producing acreage as of December 31, 1994:\nThe following table sets forth, by states, undeveloped acreage ownership as of December 31, 1994:\nFor further information with respect to the oil and gas properties see Page 12 of the Company's 1994 Annual Report to Stockholders.\nThe following table sets forth information related to oil and gas production for the years ended December 31, 1994 and December 31, 1993:\nDuring 1994 no wells were drilled. In 1993 no exploratory wells were drilled and eight gross (7.1 net) development wells were drilled, all of which were producing.\nAs of December 31, 1994 and 1993 Statex was not participating in the drilling and\/or completion of any wells.\nStatex's operations are subject to all risks inherent in the exploration for and production of oil and gas, including blowouts, cratering and fires, which could result in damage to or destruction of oil and gas wells or formations, producing facilities or property, or could result in personal injury or loss of life. Such an event could result in substantial cost to Statex and could have a material adverse effect upon its financial condition if Statex is not fully insured against such risk. Statex carries substantial insurance coverage but may not be fully insured against such risks.\nREGULATION. Statex's operations are affected from time to time in varying degrees by political developments and federal and state laws and regulations. In particular, oil and gas production operations and returns are affected by tax and other laws relating to the petroleum industry, changes in such laws and constantly changing administrative regulations. In addition, oil and gas operations are subject to interruption or termination by governmental authorities for ecological and other considerations.\nAdditionally, in most, if not all, areas where Statex conducts activities, there are statutory provisions regulating the production of oil and gas. These provisions allow administrative agencies to promulgate rules in connection with the operation and production of both oil and gas wells, including the method of developing new fields, spacing of wells and the maximum daily production allowable for both oil and gas wells.\nECONOMIC AND COMPETITIVE FACTORS AFFECTING STATEX. Statex is engaged primarily in the production and sale of crude oil and natural gas directly from the well to remarketers. Statex has literally hundreds of competitors, most of which are larger and have greater resources than Statex. Oil and natural gas are fungible commodities and as such the prices Statex receives for its products are directly related to the open market price for such products at the time of sale. These prices generally fluctuate and are for the most part controlled by the laws of supply and demand. The price for oil is particularly driven by worldwide production and demand. Statex has virtually no control over the establishment of prices for its products.\nTo the extent there should be an oversupply of product and resulting lower prices, Statex's revenues would be negatively impacted.\nEMPLOYEES. Statex had eight employees as of December 31, 1994. None of the employees are covered by union contracts.\nFINANCIAL INFORMATION ABOUT BUSINESS SEGMENTS\nFor financial information about business segments, see Pages 6 through 13 of the Company's 1994 Annual Report to Stockholders, which information is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nEXECUTIVE OFFICES AND OTHER GROUND FACILITIES\nThe Company's executive offices and principal administrative offices are located at 4370 La Jolla Village Drive, Suite 1050, San Diego, California 92122. The Company leases its executive offices consisting of approximately 6,950 square feet for a period ending in 1998 with two five year options. Annual average base rent for the Company's executive offices is approximately $195,000.\nPST owns a building located at 17742 Preston Road, Dallas, Texas 75252. PST occupies approximately 8,000 square feet for use as its administrative offices.\nStatex leases approximately 5,000 square feet for executive offices at 1801 Royal Lane, Suite 110, Dallas, Texas 75229 at an approximate annual rental of $34,000, for a period ending in mid-1995 with a 5-year renewal option at 95% of current market rates. For information regarding Statex oil and gas properties see \"Business - Oil and Gas Production.\"\nThe Company believes that its present properties are adequate for its business in light of its current operations.\nFLIGHT EQUIPMENT\nThe aircraft owned by the Company as of March 31, 1995 are listed in the following table.\nNotes:\n(a) Six MD-80s are leased to USAir for terms expiring from 1998 to 2004. One is leased to Continental for a term expiring at the beginning of 2008. (b) These aircraft are all leased to USAir for terms expiring in 2000. (c) These aircraft are held for sale. They were formerly leased to Pan Am. (d) The Company owns a one-third interest in each of these aircraft. United States Airlease and Airlease, Ltd. each also own a one-third interest. All seven aircraft are leased to Continental for terms expiring in 1996. (e) One aircraft is leased to Continental for a term expiring at the beginning of 2008. One aircraft is leased to America West for a term expiring in 2006.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn 1992 three related lawsuits were filed against the Company, its directors and officers by stockholders in the United States District Court for the Southern District of California and a fourth lawsuit was filed in the United States District Court for the Central District of Illinois (the Illinois Case). All of the Southern District of California cases were consolidated into a single case\n(the California Case). Both the California Case and the Illinois Case were purported class actions alleging that the defendants made materially false and misleading statements in public statements in filings with the Securities and Exchange Commission and other reports, or omitted in such materials information necessary to make them not misleading, and that the defendants are therefore liable to the plaintiff class for declines in the price of the Company's common stock during a defined class period.\nIn the fall of 1992 the Company obtained dismissals of both the California Case and Illinois Case. In each instance, however, the court granted the plaintiffs leave to file an amended petition. In December 1992 the California case and the Illinois Case were consolidated in the Southern District of Illinois (the Consolidated Case). In March 1995 the Company reached an agreement in principle to settle for $5,000,000 all pending class action litigation. The Company continues to deny all claims in the litigation, and a substantial factor in the decision to settle was the substantial cost that would be incurred to litigate the matter through trial. The settlement was recommended by a disinterested special litigation committee of the Company's Board of Directors, with the advice of independent counsel.\nThe effectiveness of the settlement is subject to reaching a definitive agreement and certain other conditions, including the payment by USAir, Inc. of its rental payment obligations in the amount of $13,490,000 which were due by March 31st and April 3rd, 1995 for 15 aircraft leased by the Company to USAir. These payments were received on time. The settlement is also subject to approval by the federal court, which will review the fairness of the settlement. As required by the Federal Rules of Civil Procedure, notice of the settlement will be given to class members, describing the settlement and permitting class members to participate in, object to, or opt out of the settlement.\nThe Company, along with numerous other companies including major airlines, major oil companies and the owner of the San Francisco International Airport (most of which have greater financial resources than the Company), is under an order by the California Regional Water Quality Control Board, San Francisco Bay Region, to participate in the investigation, remediation and monitoring of actual or alleged soil and groundwater pollution at San Francisco International Airport. The Company and other potentially responsible parties have undertaken a joint compliance effort. No litigation is currently pending concerning this matter. The Company will vigorously defend against future claims, if any, in this matter.\nA subsidiary of the Company is the defendant in three complaints which fall under the Alaska Wage and Hour Act. The cases relate to three former employees who served as travel agents. The Company is vigorously defending these cases. While the amounts sought approximate $1 million, the Company believes the amount of ultimate liability will not have a materially adverse effect on the Company's financial condition.\nThe Company is a defendant in several other lawsuits related to the ordinary course of business, none of which are expected to have a materially adverse effect on the Company's financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nADDITIONAL ITEM. EXECUTIVE OFFICERS OF THE COMPANY\nThe following table sets forth the names, ages and certain additional information concerning the executive officers of the Company.\nThere are no family relationships between any of the Company's executive officers. Each of the Company's executive officers are elected annually and serve at the pleasure of the Board of Directors.\nPART II\nThe information required by Items 5, 6, 7 and 8 of this Part II are hereby incorporated by reference from pages 6 through 39 of the Company's 1994 Annual Report to Shareholders.\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Equity and Related Stockholder 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\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, is incorporated by reference from the Company's definitive Proxy Statement which will be filed with the Securities and Exchange Commission on or prior to April 14, 1995. Certain information concerning the Executive Officers of the Company is included in Part I, supra. See \"Additional Item. Executive Officers of the Company.\"\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. FINANCIAL STATEMENTS, EXHIBITS AND REPORTS ON FORM 8-K\n(a) Financial Statements and Exhibits\n1. Financial Statements: See Index to Financial Statements, Page. 2. Exhibits: See Index to Exhibits following Page.\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.\nDATED: April 12, 1995.\nPS GROUP, INC. (Registrant)\nBy: \/s\/ Lawrence A. Guske ------------------------------------- LAWRENCE A. GUSKE Vice President - Finance and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, the report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Each person whose signature appears below hereby authorizes Lawrence A. Guske and Johanna Unger, and each of them, as attorneys-in-fact, on his or her behalf, individually and in each capacity stated below, to sign and file any amendment to this Form 10-K Annual Report.\nPS GROUP, INC. [ITEM 14(A)]\nAll schedules and any pro-forma financial statements are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedules, or because the information required is included in the financial statements and notes thereto.\nThe consolidated statements of financial position of PS Group, Inc. at December 31, 1994 and 1993 and the related statements of operations, cash flows and stockholders' equity and the report of Ernst & Young LLP, independent auditors, are set forth on the pages indicated above in the Annual Report to Stockholders of PS Group, Inc. for the year ended December 31, 1994 and are incorporated herein by reference.\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report on Form 10-K of PS Group, Inc. of our report dated February 3, 1995 except for Note 4, as to which the date is April 3, 1995, included in the 1994 Annual Report to Stockholders of PS Group, Inc.\nWe also consent to the incorporation by reference in (i) the Registration Statement (Form S-8 No. 2-97926) pertaining to the Employee Incentive Stock Option Program and the Incentive Stock Option Plan of PS Group, Inc. and (ii) the Registration Statement (Form S-8, No. 33-45608) pertaining to the Recontek, Inc. 1987 Employment Stock Option Plan of our report referred to above, with respect to the consolidated financial statements of PS Group, Inc. incorporated by reference in the Annual Report (Form 10-K) for the year ended December 31, 1994 filed with the Securities and Exchange Commission.\n\/s\/ Ernst & Young LLP\nERNST & YOUNG LLP\nSan Diego, California April 12, 1995\nINDEX TO EXHIBITS\n(3)(i) Articles of Incorporation.\n(a) Restated Certificate of Incorporation. (Incorporated by reference to Exhibit (3)(a) to the Company's Current Report on Form 8-K dated November 18, 1986.) (b) Certificate of Amendment of Certificate of Incorporation. (Incorporated by reference to Exhibit (3)(b) to the Company's Current Report on Form 8-K dated November 18, 1986.) (c) Certificate of Amendment to Certificate of Incorporation dated May 24, 1990. (Incorporated by reference to Exhibit 3(c) to the Company's 1990 Annual Report on Form 10-K.) (d) Certificate of Amendment to Certificate of Incorporation dated June 12, 1992. (Incorporated by reference to Exhibit 3(d) to the Company's 1992 Annual Report on Form 10-K.)\n(3)(ii) Bylaws (as amended through March 24, 1995.)\n(4) Instruments defining the rights of security holders, including indentures:\n(a) Rights Agreement between the Company and Bank of America, N.T. & S.A. dated as of June 30, 1986. (Incorporated by reference to the Company's Current Report on Form 8-K dated July 14, 1986.) (b) Amendment dated September 15, 1988 to Rights Agreement between the Company and Bank of America. (Incorporated by reference to the Company's Current Report on Form 8-K dated September 12, 1988.) (c) Amendment dated September 16, 1990 to Rights Agreement between the Company and Bank of America. (Incorporated by reference to the Company's Current Report on Form 8-K dated September 16, 1990.) (d) Amendment dated December 14, 1990 to Rights Agreement between the Company and Bank of America. (Incorporated by reference to the Company's Current Report on Form 8-K dated December 14, 1990.)\n(10) Material contracts:\n(a) 1984 Stock Incentive Plan of PS Group, Inc. (Incorporated by reference to Exhibit (19)(a) to the Company's report on Form 10-Q for the quarter ended June 30, 1985.) (b) Amendment to 1984 Stock Incentive Plan for PS Group, Inc., as approved by the Stockholders May 21, 1987. (Incorporated by reference to Exhibit (10)(g) to the Company's 1987 Annual Report on Form 10-K.) (c) Form 1, Form 2, Form 3, and Form 4 of Option Agreement effective November 17, 1984. (Incorporated by reference to Exhibit (19)(h) to the Company's report on Form 10-Q for the quarter ended June 30, 1985.) (d) Retirement Plan for Corporate Officers of PSA, Inc. (now PS Group, Inc.) and Participating Subsidiaries effective March 12, 1984, amending and restating the Retirement Plan for Corporate Officers of Pacific Southwest Airlines. (e) Employment Agreement dated January 15, 1988 between the Company and Lawrence A. Guske. (Incorporated by reference to Exhibit 10(q) to the\nIndex-1\nCompany's 1988 Annual Report on Form 10-K.) This Agreement is substantially identical in all material respects to the Employment Agreement between the Company and Johanna Unger. (f) Amendment dated April 1, 1989 to Employment Agreement between the Company and Lawrence A. Guske. (Incorporated by reference to Exhibit 10(q) to the Company's 1989 Annual Report on Form 10-K.) This Amendment is substantially identical in all material respects to Amendment to Employment Agreement between the Company and Johanna Unger. (g) Agreement dated December 14, 1990 between Berkshire Hathaway Inc. (\"Berkshire\") and the Company relating to Berkshire's acquisition of the Company's Common Stock. (Incorporated by reference to Exhibit 10(v) to the Company's 1990 Annual Report on form 10-K.) (h) Form of Indemnification Agreement. (Incorporated by reference to Exhibit 10(w) to the Company's 1990 Annual Report on Form 10-K as filed on Form 8 Amendment thereto dated May 29, 1991.) (i) Arrangement for Pension benefit for Chairman of the Board of the Company. (Incorporated by reference to Exhibit 10(u) to the Company's 1992 Annual Report on Form 10-K.) (j) Amended and Restated Credit Agreement dated June 23, 1994 between the Company and Bank of America National Trust and Savings Association. (k) Letter agreement dated September 28, 1994 between George M. Shortley and PS Group, Inc. regarding the terms of his resignation effective October 1, 1994. (l) Letter agreement dated September 28, 1994 between Dennis C. O'Dell and PS Group, Inc. regarding the terms of his resignation effective October 1, 1994.\n(12) Computation of Ratios.\n(13) 1994 Annual Report to Stockholders.\n(21) Subsidiaries.\n(23) Consent of Independent Auditors (see page of Item 14(a) of this Form 10-K).\n(27) Financial Data Schedule\nEXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS\nMatters relating to executive compensation plans and arrangements can be found within the index to exhibits as follows: (10)(a), (10)(b), (10)(c), (10)(d), (10)(e), (10)(f), (10)(h), (10)(i), (10)(k) and (10)(l).\nALL EXHIBITS INCORPORATED BY REFERENCE ARE FILED IN PS GROUP, INC. DOCUMENTS COMMISSION FILE NUMBER 1-7141.\nIndex-2","section_15":""}
{"filename":"792987_1994.txt","cik":"792987","year":"1994","section_1":"Item 1. BUSINESS\nGeneral\n\tAstec designs, engineers, manufactures and markets equipment and components used primarily in road building and related construction activities. The Company's products are used in each phase of road building, from quarrying and crushing the aggregate to application of the road surface. The Company also manufactures certain equipment and components unrelated to road construction including trenching and excavating equipment, environmental remediation equipment, log loading and industrial heat transfer equipment. The Company holds over 100 United States and foreign patents, and has been responsible for many technological and engineering innovations in the industry. The Company currently manufactures over 125 different products which it markets both domestically and internationally. In addition to plant and equipment sales, the Company manufactures and sells replacement parts for equipment in each of its product lines. The distribution and sale of replacement parts is an integral part of the Company's business.\n\tThe Company's seven operating divisions and subsidiaries, each of which operates as an autonomous company, are: (i) the Astec division (effective January 1, 1995 Astec, Inc.), which manufactures a line of hot mix asphalt plants, soil purification and environmental remediation equipment and related components; (ii) Telsmith, Inc. which manufactures aggregate processing equipment for the production and classification of sand, gravel and crushed stone for road and other construction applications; (iii) Heatec, Inc. which manufactures thermal oil heaters, asphalt heaters and other heat transfer equipment used in the Company's asphalt mixing plants and in other industries; (iv) Roadtec, Inc., which manufactures milling machines used to recycle asphalt and concrete, asphalt paving equipment and material transfer vehicles; (v) Trencor, Inc. which manufactures chain and wheel trenching equipment, excavating equipment and log loaders; (vi) Wibau-Astec Maschinenfabrik GmbH, located in Germany, which represents Astec in international sales and manufactures and sells Wibau parts in Europe, Africa and the Middle East and Astec continuous mix plants in Europe and the Eastern bloc countries; (vii) Gibat Ohl Ingenieurgesellschaft fur Anlagentechnik mbH, located in Germany, which manufactures and sells batch asphalt plants, parts and controls in Europe and the Eastern bloc countries.\n\tThe Company's strategy is to become the high quality, low cost producer in each of its product lines while continuing to develop innovative new products for its customers. Management believes that this strategy will provide the Company with a competitive advantage in the marketplace and position it to capitalize on rebuilding the infrastructure in the United States and abroad.\nProducts\n\tThe Company operates in a single business segment. In 1994 it manufactured and marketed products in five principal categories: (i) hot mix asphalt plants, soil purification and environmental remediation equipment and related components; (ii) mobile construction equipment, including asphalt pavers from Roadtec, milling machines and material transfer vehicles and other auxiliary equipment; (iii) hot oil heaters, asphalt heaters and other heat transfer equipment; (iv) aggregates processing equipment; and (v) chain and wheel trenching and excavating equipment. The table following shows the Company's sales for each product category which accounted for 10% or more of consolidated revenue for the periods indicated.\n\tYears Ended December 31 1994 1993 1992 (in thousands) Asphalt plants and components $100,514 $88,116 $81,438 Aggregate processing equipment 38,823 40,108 33,298 Trenching and excavating equipment 25,867 16,535 14,803 Mobile construction equipment 30,291 22,120 14,660\nFinancial information in connection with the Company's international sales is included in Note 1 to \"Notes to Consolidated Financial Statements - Segment Information\", appearing at Page A-11 of this report.\nHot Mix Asphalt Plants\n\tThe Astec division designs, engineers, manufactures and markets a complete line of portable, stationary and relocatable hot mix asphalt plants and related components under the \"ASTEC\" trademark. An asphalt mixing plant typically consists of heating and storage equipment for liquid asphalt (manufactured by Heatec), cold feed bins for storing aggregates, a drum mixer for drying, heating and mixing, a baghouse composed of air filters and other pollution control devices, hot storage bins or silos for temporary storage of hot mix asphalt and a control house. The Company introduced the concept of plant portability in 1979. Its current generation of portable asphalt plants is marketed as the \"Six Pack\" and consists of six portable components which can be disassembled and moved to the construction site to reduce relocation expenses. Plant portability represents an industry innovation developed and successfully marketed by the Company.\n\tThe components in the Company's asphalt mixing plants are fully automated and use microprocessor based control systems for efficient operation. The plants are manufactured to meet or exceed federal and state clean air standards.\n\tThe Company has also developed specialized asphalt recycling equipment for use with its hot mix asphalt plants. Many of the existing Astec products are suited for blending, vaporizing, drying and incinerating contaminated products. As a result, the Astec division has developed a line of thermal purification equipment for the remediation of petroleum contaminated soil.\nMobile Construction Equipment\n\tRoadtec designs, engineers, manufactures and markets asphalt pavers, material transfer vehicles and milling machines. Roadtec engineers emphasize simplicity, productivity, versatility and accessibility in product design and use.\n\tAsphalt Pavers. Asphalt pavers are used in the application of hot mix asphalt to the road surface. Roadtec pavers have been designed to minimize maintenance costs while exceeding road surface smoothness requirements. A new effective and efficient paver has been introduced which must be used with the material transfer vehicle. Other additional new paver models have also been introduced in 1994.\n\tMaterial Transfer Vehicles. The \"Shuttle Buggy\" is a mobile, self-propelled material transfer vehicle which allows continuous paving by separating truck unloading from the paving process while remixing the asphalt surface material. A typical asphalt paver must stop paving to permit truck unloading of asphalt mix. By permitting continuous paving, the \"Shuttle Buggy\" allows the asphalt paver to produce a smoother road surface. Certain states are now requiring the use of the \"Shuttle Buggy\" on their jobs.\n\tMilling Machines. Roadtec milling machines are designed to remove old asphalt from the road surface before new asphalt mix is applied. They are manufactured with a simplified control system, wide conveyors, direct drives and a wide range of horsepower and cutting capabilities to provide versatility in product application. Additional models were introduced in 1994 to meet contractor needs.\nHeat Transfer Equipment\n\tHeatec designs, engineers, manufactures and markets a variety of heaters and heat transfer processing equipment under the \"HEATEC\" trade name for use in various industries including the asphalt industry.\n\tAsphalt Heating Equipment. Heatec manufactures a complete line of heating and liquid storage equipment for the asphalt paving industry. The equipment includes portable and stationary tank models with capacities up to 35,000 gallons each. Heaters are offered in both direct-fired and helical coil models.\n\tIndustrial Heating Equipment. Heatec builds a wide variety of industrial heaters to fit a broad range of applications, including equipment for emulsion plants, roofing material plants, refineries, chemical processing, rubber plants and the agribusiness. Heatec has the technical staff to custom design heating systems and has systems operating as large as 40,000,000 BTU's per hour.\nAggregates Processing Equipment\n\tTelsmith has served the quarry business since 1906. Telsmith designs, engineers, manufactures and markets a wide range of portable and stationary equipment for the production and classification of sand, gravel, and quarried stone for road and other construction applications. Telsmith's products include jaw, cone and impact crushers; several types of feeders which transport the aggregate from the storage site to the crushing equipment; vibrating screens to separate the aggregate into various mixes; and washing and conveying equipment. Telsmith markets its products individually and as complete systems, incorporating microprocessor based automated controls for the efficient operation of its equipment.\nTrenching and Excavating Equipment\n\tTrencor, Inc. designs, engineers, manufactures and markets chain and wheel trenching equipment, canal excavators, rock saws, road miners and log loading equipment. In August 1994, Trencor acquired the product line and related manufacturing rights, trademarks, patents, intellectual property and engineering designs of Capitol Trencher Corporation (\"CTC\"), also a manufacturer of trenching and excavation equipment. This purchase excluded the manufacturing plant and equipment operated by CTC. The acquisition of the CTC product line strengthens and broadens Trencor's position in the construction market. The fabrication of the CTC product line has been relocated to Trencor's new facility in Grapevine, Texas.\n\tChain Trenchers. Trencor chain trenching machines utilize a heavy duty chain (equipped with cutting teeth attached to steel plates) wrapped around a long moveable boom. These machines, with weights up to 400,000 pounds, are capable of cutting a trench up to eight feet wide and thirty feet deep through rock. Trencor also makes foundation trenchers used in areas where drilling and blasting are prohibited.\n\tWheel Trenchers. Trencor wheel trenching machines are used in pipeline excavation in soil and soft rock. The wheel trenchers weigh up to 390,000 pounds and have a trench capacity of up to seven feet in width and ten feet in depth.\n\tCanal Excavator. Trencor canal excavators are used to make finished and trimmed trapezoidal canal excavations within close tolerances. The canals are primarily used for irrigation systems.\n\tRock Saws. Trencor manufactures a rock saw which is utilized for laying water and gas lines, fiber optics cable, constructing highway drainage systems and for other applications.\n\tRoad Miners. Trencor manufactures four \"Road Miner\" models weighing up to 400,000 pounds with an attachment which allows it to cut a path up to twelve and a half feet wide and five feet deep on a single pass. The Road Miner has applications in the road construction industry and in mining and aggregates processing operations.\n\tLog Loaders. Trencor also manufactures several different models of log loaders. Its products include mobile\/truck mounted models, as well as track mounted and stationary models, each of which is used in harvesting and processing wood products. The equipment is sold under the Log-Hog name.\nManufacturing\n\tThe Company manufactures many of the component parts and related equipment for its products. In many cases, the Company designs, engineers and manufactures custom component parts and equipment to meet the particular needs of individual customers. Manufacturing operations during 1994 took place at seven separate locations. The Company's manufacturing operations consist primarily of fabricating steel components and the assembly and testing of its products to ensure quality control standards have been achieved.\nMarketing\n\tThe Company markets its products both domestically and internationally. The principal purchasers of the Company's products include highway and heavy equipment contractors, utility contractors, pipeline contractors, open mine operators, quarry operators and foreign and domestic governmental agencies. The Astec division (now Astec, Inc.) sells directly to its customers with domestic, soil remediation and international sales departments. Astec, Inc. also has a branch in Chino, California to service customers in the western United States. Telsmith products are sold through two leased branch locations in San Francisco, California and Sharon, Massachusetts, as well as through a combination of direct sales, domestic and international and dealer sales. Heatec, Roadtec and Trencor products are marketed through a combination of direct sales and dealer sales. Approximately 18 manufacturers' representatives sell Heatec products for applications in industries other than the asphalt industry with such sales comprising approximately 30% of Heatec's sales volume during 1994. Direct sales employees are paid salaries and are generally entitled to commissions after obtaining certain sales quotas. See \"Business - Properties\"\n\tThe Company's international sales efforts are decentralized with each division and subsidiary maintaining responsibility for its own international marketing efforts.\nGerman Subsidiaries\n\tEffective July 1, 1993, the Company entered into an agreement with Putzmeister-Werk Maschinenfabrik GmbH (\"Putzmeister\"), a company organized under the laws of the Federal Republic of Germany, to form a new German limited liability company, Wibau-Astec, to be jointly owned by the Company and Putzmeister (the \"Joint Venture\"). Wibau-Astec designs, engineers and manufactures asphalt plants, stabilization plants, asphalt and thermal heaters, hot storage systems and soil remediation equipment (including their respective parts and components) which it markets in Europe, Africa and the Middle East. Initially Putzmeister owned 50% of the Joint Venture and Astec owned 50%. In consideration for their respective interests in the Joint Venture, Putzmeister contributed the operating assets, other than real estate, and related liabilities of its asphalt plant manufacturing business located in Germany to the Joint Venture; and Astec contributed, among other things, an interest in the Company's technology related to asphalt plants, asphalt heating equipment and soil remediation equipment. In November 1994, Astec acquired the other 50% interest in Wibau-Astec, making it a wholly owned subsidiary of the Company.\nIn an unrelated transaction, Astec acquired Gibat Ohl Ingenieurgesellschaft fur Anlagentechnik mbH located in Hasselroth, Germany for cash and Astec stock in October 1994. Gibat Ohl is a manufacturer of asphalt batch plants and related equipment. The management of Gibat Ohl is composed of former Wibau employees who are very knowledgeable about the asphalt plant market. The completion of these acquisitions strengthens Astec's position in the European market.\nSeminars and Technical Bulletins\n\tThe Company periodically conducts technical and service seminars which are primarily for contractors, employees and owners of asphalt mixing plants. In 1994, approximately 200 representatives of contractors and owners of hot mix asphalt plants attended seminars held by the Company in Chattanooga, Tennessee. These seminars, which are taught by Company management and employees, cover a range of subjects including technological innovations in the hot mix asphalt business and other industry segments in which the Company manufactures products. \t \tIn addition to the seminars, the Company published a number of detailed technical bulletins covering various technological and business issues relating to the asphalt industry.\nPatents and Trademarks\n\tThe Company seeks to obtain patents to protect the novel features of its products. The Company and its subsidiaries hold 67 United States patents and 39 foreign patents. There are 24 United States and 16 foreign patent applications pending.\n\tThe Company and its subsidiaries have approximately 40 trademarks registered in the United States, including logos for Astec, Telsmith, Roadtec and Trencor, and the names ASTEC, TELSMITH, HEATEC, LOG HOG, ROADTEC and TRENCOR. Many of these trademarks are also registered in foreign countries, including Canada, Great Britain, Mexico, Australia and Japan.\n\tThe Company and its subsidiaries also license their technology to manufacturers.\nEngineering and Product Development\n\tThe Company dedicates substantial resources to its engineering and product development. At December 31, 1994, the Company and its subsidiaries had 143 individuals employed domestically full-time in engineering and design capacities.\nRaw Materials\n\tRaw materials used by the Company in the manufacture of its products include carbon steel and various types of alloy steel which are normally purchased from steel mills and other sources.\nSeasonality and Backlog\n\tThe Company's business is somewhat seasonal. The Company's sales tend to be stronger from January through June each year which is attributable largely to orders placed in the fourth quarter in anticipation of warmer summer months when most asphalt paving is done.\n\tAs of December 31, 1994, the Company had a backlog for delivery of products at certain dates in the future of approximately $50,500,000. At December 31, 1993 the total backlog was approximately $33,100,000. The Company's backlog is subject to some seasonality as noted above.\n\tThe Company's contracts reflected in the backlog are not, by their terms, subject to termination. Management believes that the Company is in substantial compliance with all manufacturing and delivery timetables relating to its products.\nCompetition\n\tThe Company faces strong competition in price, service and product performance in each product category. While the Company does not compete with any one manufacturer in all of its product lines, it competes as to certain products with both large publicly held companies with resources significantly greater than the Company and various smaller manufacturers. Hot mix asphalt plant competitors include CMI Corporation; Cedarapids, Inc., a division of Raytheon Company; and Gencor Industries, Inc. Paving equipment competitors include Caterpillar Paving Products Inc. (including the Company's former Barber-Greene product line), a subsidiary of Caterpillar Inc.; Blaw-Knox Construction Equipment Company, a subsidiary of Clark Equipment Co.; Ingersoll-Rand Company; and Cedarapids, Inc.\n\tThe market for the Company's heat transfer equipment is diverse because of the multiple applications for such equipment. Its principal competitor is Gencor\/Hyway Heat Systems. The Company's milling machine equipment competitors include Ingersoll-Rand Company; CMI Corporation; Cedarapids, Inc.; Caterpillar; and Wirtgen America, Inc. Aggregates processing equipment competitors include the Pioneer Division of Portec, Inc.; Nordberg, Inc.; Eagle Iron Works; Boliden Allis, a member of the Trelleborg Group; Cedarapids, Inc.; and other smaller manufacturers, both domestic and foreign. Competition for sales of trenching and excavating equipment includes Ditch Witch; J.I. Case; Vermeer and other smaller manufacturers in the small utility trencher market.\n\tAs a whole, imports do not constitute significant competition in the United States; however, in international sales, the Company generally competes with foreign manufacturers which may have a local presence in the market the Company is attempting to penetrate.\n\tAsphalt and concrete are generally considered competitive products as a surface choice for new roads and highways. A portion of the interstate highway system is paved in concrete, but a majority of all surfaced roads in the United States are paved with asphalt. Although concrete is used for some new road surfaces, asphalt is used for virtually all resurfacing, even the resurfacing of most concrete roads. Management does not believe that concrete, as a competitive surface choice, materially impacts the Company's business prospects.\nRegulation\n\tThe Company does not operate within a highly regulated industry. However, air pollution equipment manufactured by the Company principally for hot mix asphalt plants must comply with certain performance standards promulgated by the federal Environmental Protection Agency under the Clean Air Act applicable to \"new sources\" or new plants. Management believes that the Company's products meet all material requirements of such regulations and of applicable state pollution standards and environmental protection laws.\n\tIn addition, due to the size and weight of certain equipment, the Company and its customers sometimes confront conflicting state regulations on maximum weights transportable on highways and roads. This problem occurs most frequently in the movement of portable asphalt mixing plants. Also, some states have regulations governing the operation of asphalt mixing plants and most states have regulations relating to the accuracy of weights and measures which affect some of the control systems manufactured by the Company.\nEmployees\n\tAt December 31, 1994, the Company and its subsidiaries employed 1,531 persons, of which 1,045 were engaged in manufacturing operations, 176 in engineering and design functions and 310 in selling, administrative and management functions. Telsmith has a labor agreement expiring October 14, 1995. None of the Company's other employees are covered by a collective bargaining agreement. The Company considers its employee relations to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\n\tThe location, approximate square footage, acreage occupied and principal function of the properties owned or leased by the Company are set forth below:\n\tIn an effort to improve efficiency and consolidate manufacturing space, the Company consolidated all of Telsmith's manufacturing operations in an expanded Mequon facility. The expansion began in late 1993 and was completed in 1994. On February 18, 1994, Trencor, Inc. acquired facilities in Grapevine, Texas and has relocated its manufacturing and office operations to this location. Except as set forth above, management believes that each of the Company's facilities provide office or manufacturing space suitable for its current needs and considers the terms under which it leases facilities to be reasonable. Astec, Inc. is in the process of expanding its offices and manufacturing facilities. In 1995 its manufacturing space will increase by approximately 14,000 square feet. Existing facilities will undergo some remodeling also.\nItem 3.","section_3":"Item 3. Legal Proceedings\n\tDuring 1994, and in previous years, the Company and its former Barber-Greene subsidiary (now Telsmith, Inc.) were defendants in two patent infringement actions brought by Robert L. Mendenhall and CMI Corporation (\"CMI\"), a competitor, seeking monetary damages and an injunction to cease the alleged infringement.\n\tIn 1990, CMI was awarded damages of $4,457,000 and prejudgment interest of $2,838,000 or a total of $7,295,000 from Barber-Greene. During 1991, in a separate trial, CMI was awarded damages of $8,463,000, prejudgment interest of $5,309,000 and attorney's fees of $737,000 for a total of $14,509,000 from Astec; and Astec was awarded damages of $667,000 plus $391,000 of prejudgment interest or a total of $1,058,000 from CMI. The total damages and expenses awarded to CMI were $20,746,000, net of the $1,058,000 awarded to Astec. Both Astec and CMI appealed the judgments. In connection with its appeals, the Company was directed by the courts to pledge substantially all of its real property and to deposit funds in an escrow account to secure the judgments against the Company pending the outcome of appeals.\n\tOn June 9, 1994, the Company announced that the United States Court of Appeals for the Federal Circuit had reversed the lower court decision and did not remand to the lower court for further proceedings the judgments previously entered against Astec and its former Barber-Greene subsidiary in the Robert L. Mendenhall and CMI patent litigation. Those judgments had totaled approximately $22 million. The Federal Circuit Court ruled in favor of Astec because the allegedly infringing patents had been held invalid in a separate third party case. CMI asked the Federal Circuit to reconsider its decision and to have all of the Federal Circuit judges rehear the appeal. The Company responded to this request. On September 20, 1994, the Company announced that the United States Court of Appeals for the Federal Circuit denied the request from Mendenhall and CMI to reconsider its earlier reversal. With the issuance of this ruling, The Federal Circuit's review of this ongoing patent litigation ended.\n\tOn October 11, 1994, CMI Corporation and Robert L. Mendenhall filed a Petition of Writ Certiorari asking the U.S. Supreme Court to review the decision of the Federal Circuit Court of Appeals. The Company filed a response opposing the Petition and on November 28, 1994, the Supreme Court issued an Order denying the Petition thus bringing the patent litigation to an end.\n\tAs a result of the Supreme Court's refusal to grant certiorari, the Company received approximately $12.9 million which was being held in escrow pending the Company's appeal of the two judgments. In addition, on December 16, 1994, the Company received approximately $1.3 million from CMI in satisfaction of the judgment entered in favor of the Company on its counterclaim against CMI. The receipt of these funds effectively concluded the litigation between the Company and CMI and Robert L. Mendenhall which had been pending for a number of years. As a result, the Company has reversed its accrued liability for patent damages. The reversal of $13,870,000 in accrued patent damages and the receipt of $1,309,000 in patent damages from CMI total $15,179,000 and are shown net of accruals and related legal expenses in the Consolidated Statements of Income as Patent Suit Damages and Expenses (Net Recoveries and Accrual Adjustments).\n\tIn an unrelated case, the Company's Telsmith subsidiary is a defendant in a patent infringement action brought by Nordberg, Inc., a manufacturer of a competing line of rock crushing equipment, seeking monetary damages and an injunction to cease an alleged infringement of a patent on certain components used in the production of its rock crushing equipment. This case, being heard before the U.S. District Court for the Eastern District of Wisconsin, has been bifurcated into liability and damages phases. The liability phase was tried on January 11, 1993; however, no decision had been rendered by the Court. Because of the uncertainties inherent in the litigation process, the Company is unable to predict the ultimate outcome of this litigation.\n\tOn October 28, 1993, the Company was also named as a defendant in a patent infringement action brought by Gencor, Inc., a manufacturer of a competing line of asphalt plants, seeking monetary damages and an injunction to cease an alleged infringement of a patent on certain components used in the production of its asphalt plant product line. This case was filed in the U.S. District Court for the Middle District of Florida, Orlando Division, and is currently in the discovery phase. Management believes this case to be without merit and intends to vigorously defend this suit; however, due to the uncertainties inherent in the litigation process, the Company is unable to predict the ultimate outcome of this litigation.\n\tManagement has reviewed all claims and lawsuits and, upon the advice of counsel, has made provision for any estimable losses; however, the Company is unable to predict the ultimate outcome of the outstanding claims and lawsuits.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\n\tNone.\nExecutive Officers of the Registrant\n\tThe name, title, ages and business experience of the executive officers of the Company are listed below.\n\tJ. Don Brock has been President and a director of Astec since its incorporation in 1972 and assumed the additional position of Chairman of the Board in 1975. He was the Treasurer of the Company from 1972 until 1994. From 1969 to 1972, Dr. Brock was President of the Asphalt Division of CMI Corporation. Dr. Brock earned his Ph.D. degree in mechanical engineering from the Georgia Institute of Technology. Dr. Brock and Thomas R. Campbell, President of Roadtec, are first cousins. Dr. Brock is 56.\n\tAlbert E. Guth has been Chief Financial Officer of the Company since 1987, Senior Vice President since 1984, Secretary of the Company since 1972 and Treasurer since 1994. Mr. Guth, who has been a director since 1972, was the Vice President of the Company from 1972 until 1984. From 1969 to 1972, Mr. Guth was the Controller of the Asphalt Division of CMI Corporation. He is 55.\n\tF. McKamy Hall, a Certified Public Accountant, has served as Controller of the Company since May 1987. From 1985 to 1987, Mr. Hall was Vice President-Finance of Quadel Management Corporation, a company engaged in real estate management. He is 52.\n\tThomas R. Campbell has served as President of Roadtec, Inc. since 1988. From 1981 to 1988 he served as Operations Manager of Roadtec. Mr. Campbell and J. Don Brock, President of the Company, are first cousins. Mr. Campbell is 45.\n\tW. Norman Smith has served as the President of Astec, Inc. since December 1, 1994. He formerly served as President of Heatec, Inc. from 1977 to 1994. From 1972 to 1977, Mr. Smith was a Regional Sales Manager with the Company. From 1969 to 1972, Mr. Smith was an engineer with the Asphalt Division of CMI Corporation. Mr. Smith has also served as a director of the Company since 1972. He is 55.\n\tJerry F. Gilbert has served as President of Trencor, Inc. since 1981. From 1973 to 1980, Mr. Gilbert was self- employed in the real estate investment and insurance field. Mr. Gilbert has also served as a director of the Company since May, 1991. He is 49.\n\tRobert G. Stafford has served as President of Telsmith, Inc., formerly the Barber-Greene Company, since April 1991. Between January 1987 and January 1991, Mr. Stafford served as President of Telsmith, Inc., a subsidiary of Barber-Greene. From 1984 until the Company's acquisition of Barber-Greene in December 1986, Mr. Stafford was Vice President - Operations of Barber-Greene and General Manager of Telsmith. From 1979 to 1984 he served as Director-Engineering and Operations for Telsmith. He became a director of the Company in March 1988. He is 56.\n\tJames G. May has served as President of Heatec, Inc. since December 1, 1994. From 1983 until 1994 he served as Vice President of Engineering of Astec, Inc. He is 50.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Shareholder Matters\n\tThe Company's Common Stock is traded in the National Association of Securities Dealers Automated Quotation System (NASDAQ) National Market System under the symbol \"ASTE\". The Company has never paid any dividends on its Common Stock.\n\tThe high and low sales prices of the Company's Common Stock as reported on the NASDAQ National Market System for each quarter during the last two fiscal years, which have been restated to retroactively reflect the two-for-one stock split effected in the form of a dividend on August 12, 1993, were as follows:\n\tThe number of holders of record of the Company's Common Stock as of March 10,1995, was 821.\nItem 6.","section_6":"Item 6. Selected Financial Data\n\tSelected financial data appear on page A-1 of this Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\n\tManagement's discussion and analysis of financial condition and results of operations appears on pages A-2 to A-4 of this Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\n\tFinancial statements and supplementary financial information appear on pages A-5 to A-22 of this Report.\nItem 9.","section_9":"Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure \t \tNone required to be reported in this item.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\n\tInformation regarding the Company's directors included under the caption \"Election of Directors - Certain Information Concerning Nominees and Directors\" in the Company's definitive Proxy Statement to be delivered to the shareholders of the Company in connection with the Annual Meeting of Shareholders to be held on April 27, 1995 is incorporated herein by reference. Required information regarding the Company's executive officers is contained in Part I of this Report under the heading \"Executive Officers of the Registrant\". Information regarding compliance with Section 16(a) of the Exchange Act is included under \"Election of Directors - Section 16(a) Filing Requirements\" in the Company's definitive Proxy Statement which is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\n\tInformation included under the caption, \"Election of Directors - Executive Compensation\" in the Company's definitive Proxy Statement to be delivered to the shareholders of the Company in connection with the Annual Meeting of Shareholders to be held on April 27, 1995 is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n\tInformation included under the captions \"Election of Directors - Certain Information Concerning Nominees and Directors\", \"Election of Directors - Common Stock Ownership of Management\" and \"Election of Directors - Common Stock Ownership of Certain Beneficial Owners\" in the Company's definitive Proxy Statement to be delivered to the shareholders of the Company in connection with the Annual Meeting of Shareholders to be held on April 27, 1995 is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n\tIn September 1991, the Company's Chairman, its Senior Vice President, and the President of its Telsmith, Inc. subsidiary formed a general partnership which acquired 25% of the common stock of American Rock Products, Inc., an Ohio corporation engaged in the business of supplying crushed rock to concrete and asphalt producers in the southeastern Oklahoma area (\"Amrock\"). These individuals own interests in the partnership of 50%, 25% and 25%, respectively. In December 1992, the rock crushing business of Amrock was sold to a competitor, exclusive of two used rock crushing machines and certain other miscellaneous inventory and equipment.\n\tIn March 1994, Amrock sold two of these used rock crushing machines to Telsmith for $50,000 and $70,000, respectively. The purchase price for each of these machines was determined by the President of Telsmith based on his opinion of their fair market value at the time of purchase. Telsmith intends to market both rock crushing machines to its customers for sale in the ordinary course of business.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n\t(a)(1) The following financial statements and other information appear in Appendix \"A\" to this Report and are filed as a part hereof:\n\t\tSelected Consolidated Financial Data.\n\t\tManagement's Discussion and Analysis of Financial Condition and Results of Operations.\n\t\tReport of Independent Auditors.\n\t\tConsolidated Balance Sheets at December 31, 1994 and 1993.\n\tConsolidated Statements of Income for the Years Ended December 31, 1994, 1993 and 1992.\n\tConsolidated Statements of Shareholders' Equity for the Years Ended December 31, 1994, 1993 and 1992. \t \tConsolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992.\n\t\tNotes to Consolidated Financial Statements.\n\t (a)(2) Other than as described below, Financial Statement Schedules are not filed with this Report because the Schedules are either inapplicable or the required information is presented in the Financial Statements or Notes thereto. The following Schedules appear in Appendix \"A\" to this Report and are filed as a part hereof: \t \tReport of Independent Auditors.\n\t\tSchedule VIII - Valuation and Qualifying Accounts.\n\t (a)(3) The following Exhibits* are incorporated by reference into or are filed with this Report:\n\t 2.1\tShare Purchase and Transfer Agreement, dated October 13, 1994, between the Company and Wibau-Astec Maschinenfabrik GmbH (incorporated by reference to the Form 8-K effective November 7, 1994, File No. 0-14714).\n\t2.2\tShare Purchase and Transfer Agreement by and between the Company and Gibat Ohl Ingenieurgesellschaft fur Anlagentechnik mbH, dated as of October 5, 1994.\n\t3.1\tRestated Charter of the Company (incorporated by reference to the Company's Registration Statement on Form S-1, effective June 18, 1986, File No. 33-5348).\n\t3.2\tArticles of Amendment to the Restated Charter of the Company, effective September 12, 1988 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714). \t [FN] The Exhibits are numbered in accordance with Item 601 of Regulation S-K. Inapplicable Exhibits are not included in the list.\n\t3.3\tArticles of Amendment to the Restated Charter of the Company, effective June 8, 1989 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t3.4\tAmended and Restated Bylaws of the Company, adopted March 14, 1990 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t4.1\tTrust Indenture between City of Mequon and Firstar Trust Company, as Trustee, dated as of February 1, 1994 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-14714).\n\t4.2\tIndenture of Trust, dated April 1, 1994, by and between Grapevine Industrial Development Corporation and Bank One, Texas, NA, as Trustee.\n\t10.1\tAgreement, dated December 24, 1976, between the Company and Jemco International, Inc. (incorporated by reference to the Company's Registration Statement on Form S-1, effective June 18, 1986, File No. 33-5348).\n\t10.2\tSupplemental Agreement, dated December 30, 1982, between the Company and Jemco International, Inc. (incorporated by reference to Company's Registration Statement on Form S-1, effective June 18, 1986, File No. 33-5348).\n\t10.3\tRestated License and Trademark Agreement, dated March 25, 1988, between the Company and Barber-Greene Europa B.V. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.4\tLicense and Trademark Agreement, dated May 5, 1988, between the Company and BM Group PLC incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.5\t1986 Stock Option Plan of the Company (incorporated by reference to the Company's Registration Statement on Form S- 1, effective June 18, 1986, File No. 33-5348).\n\t10.6\tLoan Agreement, dated July 1, 1980, between the Company and the Industrial Development Board of the City of Chattanooga (incorporated by reference to the Company's Registration Statement on Form S-1, effective June 18, 1986, File No. 33-5348). \t\t \t \t10.7\tTrust Indenture, dated July 1, 1980, between the Industrial Development Board of the City of Chattanooga and Pioneer Bank (incorporated by reference to Company's Registration Statement on Form S-1, effective June 18, 1986, File No. 33-5348).\n\t10.8\tWarrant Agreement, dated as of December 29, 1986, between the Company and The Citizens and Southern National Bank, as Warrant Agent (incorporated by reference to the Company's Registration Statement on Form S-4, effective November 26, 1986, File No. 33-10403).\n\t10.9\tCredit Agreement, dated as of September 17, 1987, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987, File No. 0-14714).\n\t10.10\t\tAmendment No. One, dated January 4, 1988, to Credit Agreement, dated as of September 17, 1987, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987, File No. 0-14714).\n\t10.11\tAmendment No. Two, dated March 17, 1988, to Credit Agreement, dated as of September 17, 1987, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1987, File No. 0-14714).\n\t10.12\tAmendment, dated August 17, 1988, to Credit Agreement, dated as of September 17, 1987, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.13\tSecond Amendment, dated October 21, 1988, to Credit Agreement, dated as of September 17, 1987, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.14\tAmendment, dated as of January 19, 1989, to Credit Agreement, dated as of September 17, 1987, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.15\tConsent, Waiver and Release, dated as of January 31, 1989, to Credit Agreement, dated as of September 17, 1987, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.16\tWaiver, dated March 8, 1989, to Credit Agreement, dated as of September 17, 1987, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.17\tSenior Note Agreement, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.18\tSubordinated Note Agreement, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.19\tAmended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.20\tAmendment, dated as of March 26, 1990, to the Amended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.21\tConsent, Waiver and Release, dated as of November 1, 1989, to Amended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.22\tConsent, Waiver and Release, dated as of November 10, 1989, to Senior and Subordinated Note Agreements dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.23\tConsent, Waiver and Release, dated as of March 14, 1990, to Credit Agreement, dated as of September 17, 1987, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.24\tLease Agreement, dated as of July 1, 1974, between Barber-Greene Company and the City of Mequon, Wisconsin (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714). \t \t10.25\tLease Agreement, dated November 10, 1986, between Barber-Greene Company and Stephen P. and Sandra S. Davenport (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.26\tLease Agreement, dated as of March 31, 1988, between Telsmith, Inc. and AEW #79 Trust (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.27\tLease Agreement, dated June 20, 1988, between Barber-Greene Company and 8000 Cypress Parkway Corporation (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.28\tLease Agreement, dated February 1, 1989, between Barber-Greene Company and Lee Steinberg (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-14714).\n\t10.29\tLease Agreement, dated as of August 28, 1989, between Telsmith, Inc., and Pine Hill Developers (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.30\tLease Agreement, dated as of March 24, 1989, between the Company and Robert D. Ingersoll (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.31\tAssignment, dated as of February 5, 1990, of lease dated November 10, 1986, between Barber-Greene Company and Castro and Davenport (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.32\tSublease, dated as of December 29, 1989, of lease dated February 1, 1989, between Barber-Greene Company and Lee Steinberg (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-14714).\n\t10.33\tWaiver and Agreement, dated March 30, 1990, with respect to Senior and Subordinated Note Agreements, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-14714).\n\t10.34\tWaiver, dated August 24, 1990, with respect to Senior Note Agreement, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-14714).\n\t10.35\tWaiver, dated December 18, 1990, with respect to Senior and Subordinated Note Agreements, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-14714).\n\t10.36\tWaivers, dated October 18, 1990, with respect to Amended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and the First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-14714).\n\t10.37\tWaivers, dated December 20, 1990, with respect to Credit Agreement, dated as of April 27, 1989, between the Company and the First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-14714).\n\t10.38\tLease Agreement, dated as of March 1, 1991 between Astec Industries, Inc. and Carl M. Krueger (dba Krueger Instruments), (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-14714).\n\t10.39\tAsset Purchase Agreement by and between Caterpillar Paving Products Inc., Barber-Greene Company, and Astec Industries, Inc., dated December 17, 1990 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-14714).\n\t10.40\tWaiver, dated April 11, 1991, with respect to Amended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and the First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-14714).\n\t10.41\tWaiver, dated April 11, 1991, with respect to Senior and Subordinated Note Agreements, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-14714).\n\t10.42\tConsent and Waiver, dated April 17, 1991, with respect to the Amended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.43\tConsent and Waiver, dated April 17, 1991, with respect to the Senior and Subordinated Note Agreements, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.44\tConsent of Barber-Greene Company (now Telsmith, Inc.), Heatec, Inc., Roadtec, Inc., and Trencor Jetco, Inc., dated April 17, 1991, with respect to the (i) Amended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and The First National Bank of Chicago, and (ii) Senior and Subordinated Note Agreements, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.45\tCollateral Trust Indenture, dated as of March 1, 1991, between the Company, The First National Bank of Chicago, Principal Mutual Life Insurance Company and Citizens and Southern Trust Company (Georgia), N.A. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.46\tConsent, Waiver and Release of Security Interest by The First National Bank of Chicago (\"First Chicago\"), Principal Mutual Life Insurance Company (\"PMLIC\") and Citizens and Southern Trust Company (Georgia), N.A. (\"C&S\"), dated April 17, 1991, with respect to the (i) Amended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and First Chicago, (ii) Senior and Subordinated Note Agreements, dated as of January 31, 1989, between the Company and PMLIC, (iii) Collateral Trust Indenture, dated as of March 1, 1991, between the Company, First Chicago, PLMIC, and C&S, and (iv) certain collateral documents related thereto (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.47\tRelease of Security Interest by the Citizens and Southern Trust Company (Georgia), N.A., The First National Bank of Chicago (\"First Chicago\") and Principal Mutual Life Insurance Company (\"PMLIC\"), dated April 17, 1991, with respect to certain trademarks, trademark registrations, trademark applications and trademark licenses pledged as collateral under the Pledge and Security Agreement, dated as of March 26, 1990 between the Barber-Greene Company, Ameacon, Inc., Heatec, Inc., Roadtec, Inc., Trencor Jetco, Inc., Barber-Greene Overseas, Inc. and Telsmith, Inc., and First Chicago acting in its capacity as collateral agent for itself and PMLIC (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.48\tRelease of Security Interest by the Citizens and Southern Trust Company (Georgia), N.A., The First National Bank of Chicago (\"First Chicago\") and Principal Mutual Life Insurance Company (\"PMLIC\"), dated April 17, 1991, with respect to certain patents, patent applications and patent licenses pledged as collateral under the Pledge and Security Agreement, dated as of March 26, 1990 between the Barber-Greene Company, Ameacon, Inc., Heatec, Inc., Roadtec, Inc., Trencor Jetco, Inc., Barber-Greene Overseas, Inc. and Telsmith, Inc., and First Chicago acting in its capacity as collateral agent for itself and PMLIC (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.49\tBank response to requests for waivers for quarter ended 6\/30\/91 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.50\tWaiver, dated March 23, 1992, with respect to the Amended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.51\tFourth Amendment, dated March 23, 1992 between the Company and The First National Bank of Chicago, with respect to the Amended and Restated Credit Agreement, dated April 27, 1989 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.52\tWaiver, dated March 23, 1992, with respect to the Senior and Subordinated Note Agreements, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.53\tThird Amendment, dated March 23, 1992 between the Company and Principal Mutual Life Insurance Company, with respect to the Senior Note Agreement dated January 31, 1989 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.54\tThird Amendment, dated March 23, 1992 between the Company and Principal Mutual Life Insurance Company, with respect to the Subordinated Note Agreement dated January 31, 1989 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-14714).\n\t10.55\tConsent and Waiver, dated April 29, 1992, with respect to the Amended and Restated Credit Agreement, dated as of April 27, 1989, between the Company and The First National Bank of Chicago (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.56\tWaiver, dated April 29, 1992, with respect to the Senior and Subordinated Note Agreements, dated as of January 31, 1989, between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.57\tLicense Agreement, dated July 2, 1992, between Telsmith, Inc. and Gerlach Industries (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.58\tDeed of Trust from the Company to Milligan-Reynolds Guaranty Title Agency, Inc., Trustee, pledging certain property located in Hamilton County, Tennessee, recorded August 24, 1992 in Book 4029, Page 417 in the Office of the Register of Deeds of Hamilton County, Tennessee (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.59\tDeed of Trust from Heatec, Inc. to Milligan-Reynolds Guaranty Title Agency, Inc., Trustee, pledging certain property located in Hamilton County, Tennessee, recorded August 24, 1992 in Book 4029, Page 423 in the Office of the Register of Deeds of Hamilton County, Tennessee (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.60\tDeed of Trust from Roadtec, Inc. to Milligan-Reynolds Guaranty Title Agency, Inc., Trustee, pledging certain property located in Hamilton County, Tennessee, recorded August 24, 1992 in Book 4029, Page 428 in the Office of the Register of Deeds of Hamilton County, Tennessee (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.61\tDeed to Secure Debt from the Company to CMI Corporation pledging certain property located in Walker County, Georgia, recorded August 25, 1992 in deed Book 683, Page 506 in the Office of the Superior Court Clerk of Walker County, Georgia (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.62\tDeed of Trust from Trencor Jetco, Inc. to Craig Bishop, Trustee, pledging certain property located in Dallas County, Texas, recorded August 25, 1992 in Book 92166, Page 891 in the Office of the County Clerk of Dallas County, Texas (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.63\tMortgage from Telsmith, Inc. to CMI Corporation pledging certain property located in Ozaukee County, Wisconsin, recorded August 25, 1992 in Volume 768, Page 74 in the Office of the Register of Deeds of Ozaukee County, Wisconsin (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.64\tMortgage from Telsmith, Inc. to CMI Corporation pledging certain property located in Milwaukee County, Wisconsin, recorded August 25, 1992 in Reel 2850, image 427 in the Office of the Register of Deeds of Milwaukee County, Wisconsin (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.65\tFifth Amendment, dated December 31, 1992 between the Company and The First National Bank of Chicago, with respect to the Amended and Restated Credit Agreement, dated April 27, 1989 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.66\tLetter of Intent between the Company and Putzmeister-Werk, Maschinenfabrik GmbH dated December 12, 1992 in connection with the formation of WIBAU\/ASTEC GmbH (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, File No. 0-14714).\n\t10.67\tFirst Amendment to Note Agreement (for Senior Notes) dated April 1, 1991 between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Registration Statement on Form S- 2, effective June 8, 1993, as Exhibit 10.54, File No. 33-61952).\n\t10.68\tFirst Amendment to Note Agreement (for Subordinated Notes) dated April 11, 1991 between the Company and Principal Mutual Life Insurance Company (incorporated by reference to the Company's Registration Statement on Form S-2, effective June 8, 1993, as Exhibit 10.55, File No. 33-61952).\n\t10.69\tFourth Amendment, dated March 31, 1993 between the Company and Principal Mutual Life Insurance Company, with respect to the Amended and Restated Credit Agreement dated January 31, 1989 (incorporated by reference to the Company's Registration Statement on Form S-2, effective June 8, 1993, as Exhibit 10.56, File No. 33-61952).\n\t10.70\tSixth Amendment, dated March 31, 1993 between the Company and the First National Bank of Chicago, with respect to the Amended and Restated Credit Agreement, dated April 27, 1989 (incorporated by reference to the Company's Registration Statement on Form S-2, effective June 8, 1993, as Exhibit 10.57, File No. 33-61952).\n\t10.71\tConsent of Telsmith, Inc.; Heatec, Inc.; Roadtec, Inc.; and Trencor Jetco, Inc.; dated March 31, 1993, with respect to (i) the Fourth Amendment to Note Agreement; (ii) the Senior Guaranty; and (iii) the Security Documents (incorporated by reference to the Company's Registration Statement on Form S-2, effective June 8, 1993, as Exhibit 10.58, File No. 33-61952).\n\t10.72\tJoint Venture Agreement, dated June 6, 1993, between the Company and Putzmeister-Werk Maschinenfabrik GmbH (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-14714).\n\t10.73\tTechnology Contribution Agreement, dated July 12, 1993, between the Company and Wibau- Astec Maschinenfabrik GmbH (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-14714).\n\t10.74\tSeventh Amendment, dated January 21, 1994 between the Company and The First National Bank of Chicago, with respect to the Amended and Restated Credit Agreement, dated April 27, 1989 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-14714).\n\t10.75\tLoan Agreement between City of Mequon, Wisconsin and Telsmith, Inc. dated as of February 1, 1994 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-14714).\n\t10.76\tCredit Agreement by and between Telsmith, Inc. and M&I Marshall & Ilsley Bank, dated as of February 1, 1994 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-14714).\n\t10.77\tSecurity Agreement by and between Telsmith, Inc. and M&I Marshall & Ilsley Bank, dated as of February 1, 1994 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-14714).\n\t10.78\tMortgage and Security Agreement and Fixture Financing Statement by and between Telsmith, Inc. and M&I Marshall & Ilsley Bank, dated as of February 1, 1994 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-14714).\n\t10.79\tGuarantee of Astec Industries, Inc. in favor of M&I Ilsley Bank, dated as of February 1, 1994 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, File No. 0-14714).\n\t10.80\tGuarantee of Wibau-Astec Maschinenfabrik GmbH in favor of Dresdner Bank Aktiengensellschaft,dated as of December 22, 1993.\n\t10.81\tLetter of Guarantee of Wibau-Astec Maschinenfabrik GmbH in favor of Berliner Hondels - und Frankfurter Bank, dated as of December 22, 1993.\n\t10.82\tGuarantee of Wibau-Astec Maschinenfabrik GmbH in favor of Bayerische Vereinsbank, dated as of December 22, 1993.\n\t10.83\tLoan Agreement dated as of April 1,1994, between Grapevine Industrial Development Corporation and Trencor, Inc.\n\t10.84\tLetter of Credit Agreement, dated April 1, 1994, between The First National Bank of Chicago and Trencor, Inc.\n\t10.85\tGuaranty Agreement, dated April 1, 1994, between Astec Industries, Inc. and Bank One, Texas, NA, as Trustee.\n\t10.86\tAstec Guaranty, dated April 29, 1994, of debit of Trencor, Inc. in favor of The First National Bank of Chicago.\n\t10.87\tCredit Agreement, dated as of July 20, 1994, between the Company and The First National Bank of Chicago.\n\t10.88\tGuarantee of Wibau-Astec Maschinenfabrik GmbH in favor of Bayerische Vereinsbank, dated as of January 16, 1995.\n\t10.89\tWaiver for December 31, 1994, dated February 24, 1995 with respect to the First National Bank of Chicago Credit Agreement dated July 20, 1994.\n\t11.\tStatement Regarding Computation of Per Share Earnings.\n\t22.\tSubsidiaries of the Registrant.\n\t23.\tConsent of Independent Auditors\n\t(b)\tA report on Form 8-K was filed during the fourth quarter of 1994 in connection with the \t\tWibau-Astec Maschinenfabrik GmbH acquisition.\n\t(c)\tThe Exhibits to this Report are listed under Item 14(a)(3) above.\n\t(d)\tThe Financial Statement Schedules to this Report are listed under Item 14(a)(2) above.\nAPPENDIX \"A\" to ANNUAL REPORT ON FORM 10-K\nITEMS 8 and 14(a)(1) and (2), (c) and (d)\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nASTEC INDUSTRIES, INC.\nContents Page\nSelected Consolidated Financial Data\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nReport of Independent Auditors\nConsolidated Balance Sheets at December 31, 1994 and 1993\nConsolidated Statements of Income for the Years Ended December 31, 1994, 1993 and1992\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\nSchedule VIII - Valuation and Qualifying Accounts\nThe Company's common stock is traded on the National Association of Securities Dealers Automated Quotation System (NASDAQ) National Market System under the symbol ASTE. Prices shown are the high and low bid prices as announced by NASDAQ. The Company has never paid any dividends on its common stock.\nThe number of shareholders is approximately 900.\n[FN] 1 \tRestated to reflect paving equipment business of Barber-Greene as a discontinued operation.\n2 \tRestated to retroactively reflect the two-for-one stock split effected in the form of a dividend on August 12, 1993\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations, 1994 vs. 1993\nNet sales for 1994 increased $41,005,000 or approximately 23.7% compared to 1993. Of this increase, $10,133,000 is attributable to the acquisition of Gibat Ohl and the remaining 50% of Wibau-Astec. Excluding these acquisitions, sales increased $30,872,000 or 17.9%. International sales by domestic subsidiaries were 24.3% in 1994 and 17.2% in 1993. The increase in sales reflects the strength of our economy, the attitude of our customers toward the economy, expectations for infrastructure contracts and the quality, performance and competitiveness of our products as a result of many years of investment in research and development.\nThe gross profit margin for 1994 was 22.5% compared to 24.2% for 1993. Domestic operations gross profit margin for 1994 was 23.0% compared to 24.2% for 1993. Foreign operations gross profit margin was 11.4%. The domestic gross profit margin was negatively effected in 1994 for several reasons:\n1) Telsmith's consolidation of plant operations with many inefficiencies involved.\n2) Trencor's relocation to facilities in Grapevine, Texas from Grand Prairie, Texas.\n3) Inefficiencies related to the training of a significant number of new manufacturing employees at Trencor and training of replacements for retirees at Telsmith.\n4) Trencor's introduction of the Log Hog product line.\nOffsetting these negative factors were improved margins at Heatec and increased manufacturing efficiencies at Roadtec, both of which positively affected the gross profit margin.\nIn 1994, selling, general, and administrative expenses decreased to 14.6% of net sales from 16.6% in 1993. The increase in sales is the primary reason for the percentage reduction.\nResearch and development expenses declined from 1.7% of net sales in 1993 to 1.5% in 1994, again, primarily due to the increase in sales.\nIn October 1994, the decision by the United States Supreme Court to deny certiorari in connection with the appeal filed by CMI Corporation \"CMI\" brought to a successful end the Company's long-standing patent litigation with CMI. The Supreme Court's actions effectively denied CMI's request to appeal a lower court ruling that found that Astec did not have any liability for infringement of CMI patents and left intact damages payable by CMI to Astec. As a result, previously established liabilities of $13,870,000, payable by the Company, were reversed and patent damages of $1,309,000 were received from CMI. These amounts are shown in Consolidated Statements of Income as net recoveries and accrual adjustments of patent damages. See Contingencies and Note 9 to the Consolidated Financial Statements.\nBecause our joint venture, Wibau-Astec, continued to be unprofitable, it became apparent that major changes were necessary and we began a plan of restructuring. Restructuring costs of $1,500,000 related to Wibau-Astec are discussed in Note 12 to Consolidated Financial Statements. The anticipated effect of the restructuring plan is reflected in the pro forma summary included in Note 2.\nInterest expense for 1994 decreased to 0.3% of net sales from 1.0% in 1993. This is due to a decrease in overall interest expense combined with the increase in sales. Plant expansion and improvements were financed by industrial revenue bonds at favorable interest rates.\nOther income decreased by approximately $371,000 or 15.9% in 1994. As noted in the 1993 Management Discussion and Analysis, one international licensee that was not renewed for 1994 produced $665,000 in license fees in 1993.\nThe equity in loss of joint venture of $3,177,000 reflects 50% of the losses from the joint venture for the ten months prior to the purchase of the remaining 50% interest in Wibau-Astec.\nIncome tax expense for 1994 was $2,300,000 or approximately 8.9% of pre- tax income. The primary reasons for the variance from the normal corporate tax rate are the utilization of net operating loss carryforwards and establishment of a deferred tax benefit relative to net deductible temporary differences which could be recovered against future taxes or taxes previously paid. See Note 8 to Consolidated Financial Statements.\nIn the first quarter of 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\". At December 31, 1994, there were net deferred tax assets of approximately $14,799,000, which are comprised of temporary differences, the tax benefit of net operating loss and credit carryforwards and foreign net operating loss carryforwards. Temporary differences relate primarily to inventory reserves, warranty reserves and bad debt reserves. At December 31, 1994, a valuation allowance of approximately $10,070,000 was recorded. This valuation allowance offsets the deferred tax assets relative to net operating loss and credit carryforwards as well as foreign net operating loss carryforwards. Both the net operating loss and credit carryforwards are SRLY carryforwards and can be used to offset only the income of a certain subsidiary of the Company. As a result, the Company determined that a valuation allowance was necessary for these items as well as the foreign net operating loss carryforward, the utilization of which is uncertain.\nDue to the utilization of the majority of its credit carryforwards, the Company expects its tax rate for 1995 to approximate the normal corporate rate.\nThe backlog at December 31, 1994 was $50,465,000 compared to $33,100,000 at December 31, 1993, which represents a 52.4% increase. The increase is primarily due to the optimism of our customers about the strength of the economy and the performance and competitiveness of our products.\nResults of Operations, 1993 vs. 1992\nNet sales from continuing operations for 1993 increased $23,668,000, or approximately 15.9% compared to 1992. International sales declined from 21.9% of total company net sales in 1992 to 17.2% in 1993. Domestic sales increased by 22.9% in 1993 and 18% in 1992. The improved sales reflect the optimism of our customers with respect to both the continued improvement of the economy and the federal role in providing funding for the nation's surface transportation systems through 1997 with the passage of the Intermodal Surface Transportation Efficiency Act at the end of 1991.\nThe gross profit margin for 1993 was 24.2% compared to 22.9% for 1992. Pricing improved slightly in 1993, but the greatest impact on gross profit margins was the manufacturing efficiency achieved with improved volume.\nIn 1993, selling, general, and administrative expenses increased to 16.6% of net sales from 16.1% in 1992. Large increases were incurred for exhibition expense for the Conexpo show, legal expenses, international dealer commissions and profit sharing bonuses.\nResearch and development expenses as a percentage of sales remained constant at 1.7% of sales for both 1993 and 1992.\nPatent suit damages and expenses decreased by $192,000 compared to 1992 and were 0.2% of 1993 net sales compared to .4% in 1992. The patent suit damages and expenses relate to the patent suits by CMI against Astec and its former Barber-Greene subsidiary and the countersuit by Astec against CMI. See \"Contingencies\" and Note 9 to the Consolidated Financial Statements.\nInterest expense for 1993 decreased to 1.0% of net sales from 2.2% of net sales in 1992. This decrease was primarily the result of the Company's reduction of its debt by approximately $25,753,000 resulting primarily from funds generated by a secondary public stock offering of 1,195,000 shares of common stock, which raised approximately $27,000,000 for the Company. In connection with the prepayment of substantially all of its debt, the Company incurred approximately $545,000 in prepayment penalties and expenses.\nOther income in 1993 increased by approximately $370,000 or 16.6% over 1992. The increase is primarily due to increased license fee income which more than offset a nonrecurring refund of unemployment taxes in 1992. Increases in service income and the forfeiture of two customer deposits also contributed to the increase. One international licensee was not renewed for 1994 that produced approximately $665,000 of license fee income in 1993.\nThe equity in loss of joint venture of $720,000 reflects 50% of the loss from the Wibau-Astec joint venture in 1993. This loss reflects the continued European recession in 1993.\nDue to the existence of net operating loss carryforwards, income tax expense for 1993 consisted primarily of state income taxes, foreign income taxes and federal alternative minimum tax.\nLiquidity and Capital Resources\nWorking capital increased to $53,000,000 at December 31, 1994 from $40,767,000 at December 31, 1993. The Company's debt to equity ratio was .27 to 1 at December 31, 1994 and .0001 to 1 at December 31, 1993. The increase in 1994 reflects the utilization of industrial revenue bonds to expand and modernize plant facilities as well as debt assumed in connection with acquisitions.\nTotal short-term borrowings, including current maturities of long-term debt, were $8,573,000 at December 31, 1994 and $10,000 at December 31, 1993. Long-term debt, less current maturities was $16,155,000 at December 31, 1994 and zero at December 31, 1993.\nCapital expenditures of $21,886,000 were made in 1994 as compared to capital expenditures in 1993 of $8,767,000. The Company utilized industrial revenue bonds in the amount of $8,000,000 to finance the Grapevine, Texas (Trencor) project which included improvements to the existing facility as well as additions of new equipment. Industrial bonds were issued in February 1994 in the amount of $6,000,000 to assist in financing the Telsmith expansion at Mequon, Wisconsin.\nThe Company has a revolving credit loan agreement with The First National Bank of Chicago. The line of credit is $15,000,000. This credit facility expires June 30, 1997. At December 31, 1994, $2,655,000 of the line of credit was utilized. The credit line is unsecured. At December 31, 1994, the Company was in violation of the covenant relative to capital expenditures and has received a waiver for such violation.\nWibau-Astec has German bank lines of credit available totaling $11,253,669 (17,500,000 DM) of which $8,069,577 was outstanding at December 31, 1994. Gibat Ohl has a German bank line of credit available of $2,122,000 (3,300,000 DM), $2,925 of which was utilized at December 31, 1994.\nOn January 31, 1989, the Company placed $10,000,000 in Senior Notes and $10,000,000 in Senior Subordinated Notes with Principal Mutual Life Insurance Company. These notes were repaid during the second and third quarters of 1993 using cash received from the secondary public stock offering.\nFor additional information on current and long-term debt, see Note 6 to the Consolidated Financial Statements.\nContingencies\nSee Note 9 to Consolidated Financial Statements for information on certain pending litigation and contingent liabilities arising from recourse financing arrangements.\nEnvironmental Matters\nBased on information available from environmental consultants, the Company has no material reserve requirements for potential environmental liabilities.\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Astec Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of Astec Industries, 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Astec Industries, Inc. and subsidiaries 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.\nERNST & YOUNG LLP\nChattanooga, Tennessee February 18, 1995\n[FN] See notes to Consolidated Financial Statements.\n[FN] See notes to Consolidated Financial Statements.\n[FN] See notes to Consolidated Financial Statements.\n[FN] See notes to Consolidated Financial Statements.\n[FN] See notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\nBasis of Presentation The consolidated financial statements include the accounts of Astec Industries, Inc. and its subsidiaries. The Company's wholly-owned subsidiaries at December 31, 1994 are as follows: \tAstec, Inc.\t Heatec, Inc.\t Telsmith, Inc.\t Roadtec, Inc.\t Trencor, Inc. \tWibau-Astec Maschinenfabrik GmbH (Wibau-Astec) \tGibat Ohl Ingenieurgesellschaft fur Anlagentechnik (Gibat Ohl)\nAll significant intercompany transactions have been eliminated in consolidation.\nSegment Information - The Company operates in one industry segment. Its products are used predominately for road construction and for the manufacture and processing of construction aggregates. International sales by domestic subsidiaries were $52,031,000, $29,693,000, and $32,659,000, for the years ended December 31, 1994, 1993 and 1992, respectively. Net sales and net loss (including equity in loss of joint venture) of foreign operations for the year ended December 31, 1994, were $10,133,000 and $5,394,000, respectively. At December 31, assets of foreign subsidiaries were $23,953,000.\nCash Equivalents - The Company considers all highly liquid instruments purchased with a maturity of less than three months to be cash equivalents.\nInventories - Inventories excluding used equipment are stated at the lower of first-in, first-out cost or market. Used equipment inventories are stated on the specific unit cost method, which in the aggregate is less than market.\nProperty and Equipment - Property and equipment is stated at cost. Depreciation is computed generally on the straight-line method for financial reporting purposes at rates considered sufficient to amortize costs over estimated useful lives. Depreciation is computed generally on both accelerated and straight-line methods for tax reporting purposes. Maintenance and repairs are expensed as incurred.\nGoodwill - Goodwill represents the excess of cost over the fair value of net assets acquired. Goodwill amounts are being amortized using the straight-line method over twenty years. Additions to goodwill in 1994 reflect the purchase of the Capital Trencher product line, the Log Hog product line, the additional 50% of Wibau-Astec, and Gibat Ohl.\nProduct Warranty - The Company provides product warranties against defects in materials and workmanship for periods ranging from ninety days to one year following the date of sale. Estimated costs of product warranties are charged to cost of sales in the period of the sale.\nRevenue Recognition - A portion of the Company's equipment sales represents equipment produced in the Company's plants under short-term contracts for a specific customer project or equipment designed to meet a customer's specific requirements. Equipment revenues are recognized in compliance with the terms and conditions of each contract, which is ordinarily at the time the equipment is shipped. Certain contracts include terms and conditions through which the Company recognizes revenues upon completion of equipment production which is subsequently stored at the Company's plant at the customer's request. Revenue is recorded on such contracts upon the customer's assumption of title and all risks of ownership.\nCredit Risk - The Company sells products to a wide variety of customers. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains an allowance for doubtful accounts at a level which management believes is sufficient to cover potential credit losses. As of December 31, 1994 concentrations of credit risk with respect to trade receivables are limited due to the wide variety of customers.\nEarnings Per Share - Primary and fully diluted earnings per share are based on the weighted average number of common and common equivalent shares outstanding and include the potentially dilutive effects of the exercise of stock options in years where there are earnings. Fully diluted earnings per share are not presented for 1994 and 1993 since the dilution is not material. Earnings per share information has been restated to retroactively reflect the two-for-one stock split effected in the form of a dividend on August 12, 1993.\n2. Business Combinaions\nEffective July 1, 1993, the Company entered into a joint venture with Putzmeister-Werk Maschinenfabrik GmbH (Putzmeister) to form a new German limited liability company,Wibau-Astec Maschinenfabrik GmbH (Wibau-Astec). Wibau-Astec designed, engineered, manufactured and marketed asphalt plants, stabilization plants, asphalt and thermal heaters, hot storage systems and soil remediation equipment. Putzmeister and the Company each owned 50% of Wibau-Astec. On November 7, 1994, the Company acquired the remaining shares of Wibau-Astec from Putzmeister for $67,400. The acquisition was accounted for as a purchase effective November 7, 1994, and accordingly, the results of operations and accounts of Wibau-Astec subsequent to November 7, 1994 are included in the Company's consolidated financial statements. The purchase price was allocated to the net tangible assets of Wibau-Astec based on the estimated fair market values of the assets acquired. As required by the purchase method of accounting, the excess amount of the purchase price over the fair value of Wibau-Astec's net tangible assets was recorded as goodwill and is being amortized using the straight-line method over 20 years. Subsequent to the acquisition of Wibau-Astec, the Company undertook a plan to restructure Wibau-Astec's operations. See Note 12 - Restructuring Costs.\nEffective October 17, 1994, the Company acquired the operating assets and liabilities of Gibat Ohl Ingenieurgesellschaft fur Anlagentechnic (Gibat Ohl) in exchange for 193,357 shares of the Company's common stock and approximately $2,760,000 in cash. The acquisition was accounted for as a purchase effective October 17, 1994, and accordingly, the results of operations and accounts of Gibat Ohl subsequent to October 17, 1994 are included in the Company's consolidated financial statements. The purchase price of approximately $5,460,000 was allocated to the net tangible assets of Gibat Ohl based on the estimated fair market values of the assets acquired. The excess of the purchase price over the fair market value of Gibat Ohl's net tangible assets was recorded as goodwill and is being amortized using the straight-line method over 20 years.\nA summary of the net assets acquired is as follows:\nWibau-Astec \tGibat Ohl Current assets \t$\t4,938,766 \t$\t11,007,164 Property, plant and equipment \t412,193 \t300,657 Current liabilities\t (8,678,984) \t (10,029,223) Other liabilities\t (2,038,165) Goodwill\t 1,193,259 \t4,153,364 Net assets acquired excluding cash\t (4,172,931) \t 5,431,962 Cash\t 4,240,331 \t32,984 Net assets acquired \t$\t67,400 \t$\t5,464,946\nThe following unaudited pro forma summary presents the consolidated results of operations as if the acquisition of Wibau-Astec and Gibat Ohl had occurred at the beginning of each period presented. Pro forma adjustments have been made to reflect the restructuring of Wibau-Astec as described in Note 12. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results that would have occurred had the acquisition occurred at the beginning of the periods presented or of results which may occur in the future.\n\tYear Ended December 31, \t1994\t 1993 Net sales\t $\t223,887,000 \t$\t188,823,000 Income from operations\t 28,380,000 \t10,576,000 Net income\t 24,619,000 \t9,638,000\nPer common and common equivalent share: \tNet income\t $\t2.50 $\t1.11 \t\nPrior to its acquisition of the remaining 50% interest in Wibau-Astec, the Company's investment in Wibau-Astec was accounted for by the equity method. Accordingly, net income as presented in the Consolidated Statements of Income for 1994 and 1993 includes the Company's share of Wibau-Astec's losses for periods prior to the acquisition of $3,177,000 and $720,000, respectively.\n3. Inventories\nInventories consisted of the following: \t December 31, 1994 \t1993 Raw materials and parts\t $\t26,705,110 $\t18,418,839 Work-in-process\t 14,380,192 \t6,017,940 Finished goods\t 7,745,709 \t7,802,956 Used equipment\t 7,478,724 \t7,765,546 Total\t $\t56,309,735 $ 40,005,281\n4. Property and Equipment\nProperty and equipment consisted of the following: \tDecember 31, \t1994 \t1993 Land, land improvements, and buildings\t $\t26,676,486 \t $ 14,062,161 Equipment\t 37,497,348 \t27,955,598 Less accumulated depreciation \t(21,880,823) \t(18,437,672) Land, buildings, and equipment - net \t 42,293,011 \t23,580,087 Rental property: Equipment\t 1,703,608 \t1,703,608 Less accumulated depreciation \t (1,647,827) \t (1,624,680) Rental property - net \t55,781 \t78,928 Total\t $\t42,348,792 \t $\t23,659,015\n5. Leases\nThe Company leases certain land, buildings and equipment which are used in its operations. Total rental expense charged to operations under operating leases was approximately $615,000, $427,000 and $384,000 for the years ended December 31, 1994, 1993 and 1992 respectively.\nMinimum rental commitments for all noncancelable operating leases at December 31, 1994, are as follows: \t1995\t $ 718,000 \t1996\t 492,000 \t1997 \t246,000 \t1998 \t97,000 \t1999 and beyond\t189,000\nThe Company also leases equipment to customers under short-term contracts generally ranging from 2 months to 6 months. Rental income under such leases was $1,394,000, $1,719,000 and $2,470,000, for the years ended December 31, 1994, 1993 and 1992, respectively.\n6. Long-term Debt\nLong term debt consisted of the following: \t\t\t\t\t\t\t\t December 31, \t1994 1993 Revolving credit loan of \t$15,000,000 at December 31, 1994 \tand 1993, available through \tJune 30, 1997 at an interest rate of \tprime less a quarter, which was 8.25% and 6.0% \tat December 31, 1994 and 1993, respectively\t $\t2,655,000\nLoans payable in monthly installments \tmaturing at various dates through \t1995 at interest rates from 7.25% to 14.85%\t \t $\t9,520\nIndustrial Development Revenue Bonds \tpayable in semi-annual installments through \t2006 at weekly negotiated interest rates \t6,000,000 \t Industrial Development Revenue Bonds due in \t2009 at weekly negotiated interest rates \t8,000,000 \t Total long-term debt \t16,655,000 \t Less current maturities \t500,000 \t9,520 Long-term debt less \tcurrent maturities \t$\t16,155,000 \t$\t0\nOn January 31, 1989, the Company placed $10,000,000 in Senior Notes and $10,000,000 in Senior Subordinated Notes with Principal Mutual Life Insurance Company (\"Principal\"). The proceeds of the notes placed with Principal were applied to the outstanding revolving credit loan with The First National Bank of Chicago (\"FNBC\"). During 1993, both the Senior and Subordinated Notes with Principal were repaid in full. Related prepayment penalties and expenses are reflected on a separate line in the Consolidated Statements of Income.\nDuring 1994, the Company negotiated a new unsecured revolving loan agreement. The line of credit is $15,000,000 and expires June 30, 1997. At December 31, 1994, the Company was in violation of the covenant relative to capital expenditures and has received a waiver for such violation.\nThe aggregate of all maturities of long-term debt in each of the next five years is as follows: \t1995\t $ 500,000 \t1996\t 500,000 \t1997\t 3,155,000 \t1998\t 500,000 \t1999 and beyond\t 11,500,000\nFor 1994, the weighted average interest rate on short term borrowings, which include current maturities of Industrial Revenue Bonds and notes payable, were 3.46% and 8.75%, respectively.\n7. Retirement Benefits\nA former subsidiary of the Company, the Barber-Greene Company, had defined benefit pension plans (\"Barber-Greene Plans\") covering substantially all of its employees. Non-union benefits were frozen as of September 1, 1986, and certain union benefits were frozen as of October 31, 1986. The Company retained responsibility for the Barber-Greene Plans when it sold the Barber-Greene Company in 1991. Telsmith, Inc. also sponsors a defined benefit pension plan covering certain employees hired prior to October 14, 1987 who have chosen not to participate in the Company's 401(k) savings plan. The benefit is based on years of benefit service multiplied by a monthly benefit as specified in the plan. The Company's funding policy for its pension plans is to make the minimum annual contributions required by applicable regulations.\nDuring 1994, the Company made the decision to terminate the Barber- Greene Plans and purchased annuities to fund the benefits provided for in the plans. The Company has requested approval from the Internal Revenue Service to terminate the plans but has yet to receive such approval. As a result, no settlement of the plan will occur until 1995. The annuities purchased by the Company during 1994 are included in plan assets.\nA reconciliation of the funded status of the Plans, which is based on a valuation date of September 30, with amounts reported in the Company's consolidated balance sheets, is as follows:\n\t1994 \t1993 Actuarial present value of \tbenefit obligations: \tVested\t $\t40,574,462 \t$\t38,229,010 \tNonvested \t85,245 \t251,677 Accumulated benefit obligation\t $\t40,659,707 \t $\t38,480,687 Projected benefit obligation\t $\t40,659,707 \t$\t38,480,687 Plan assets at fair value\t 40,589,417 \t43,018,508 Projected benefit obligation in \texcess of (less than) plan assets \t70,290 (4,537,821) Unrecognized net gain\t 450,751 \t7,976,321 Prior service cost not \tyet recognized in net \tperiodic pension cost (320,665) \t (357,323) Pension liability in the \tconsolidated balance sheets \t$\t200,376 \t$\t3,081,177\nNet periodic pension cost for 1994, 1993, and 1992 included the following components: \t\tYear Ended December 31, \t 1994\t 1993\t 1992 Service cost - benefits earned \tduring the period\t $\t31,503 \t $\t26,873 \t $\t34,426 Interest cost on projected \tbenefit obligation\t 2,565,355 \t2,754,319 \t2,761,195 Actual return on plan assets \t2,148,873 \t 12,318,009 \t 833,167 Net amortization and deferral\t 5,405,871 \t9,345,175 \t 1,948,268 Net (income) expense\t $\t 660,140 \t$\t 191,642 \t$\t14,186\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 8.5% at September 30, 1994 and 7.0% at September 30, 1993. The expected long-term rate of return on assets was 9.0% for the years ending September 30, 1994 and 1993. Plan assets are primarily comprised of corporate equity and corporate and U.S. Treasury debt securities.\nIn 1987, the Company adopted deferred savings plans (Savings Plans) under Section 401 (k) of the Internal Revenue Code, under which substantially all employees of the Company and its subsidiaries are eligible. In 1991 the Savings Plans were consolidated and provide that the Company will match an amount equal to 50% of employee savings subject to certain limitations. The total expense for such matching was approximately $696,000, $567,000 and $485,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nIn addition to the retirement plans discussed above, the Company has an unfunded postretirement medical and life insurance plan covering employees of its Telsmith, Inc. subsidiary and retirees of its former Barber-Greene subsidiary. Effective January 1, 1993, the Company adopted SFAS No. 106, (Employers' Accounting for Postretirement Benefits Other than Pensions). The accumulated postretirement benefit obligation (APBO) at adoption was approximately $674,000 and is being amortized over twenty years.\nThe accumulated postretirement benefit obligation and the amount recognized in the Company's consolidated balance sheets, is as follows: \tDecember 31, \t 1994\t 1993 Accumulated postretirement \tbenefit obligation: \tRetirees\t $\t130,600 \t $ 207,500 \tActive employees\t 473,000 \t425,800 \t\t 603,600 \t633,300 Unamortized transition obligation\t 605,600 \t 639,300 Unrecognized net gain \t118,800 \t29,800 Accrued postretirement \tbenefit cost\t $\t116,800 \t$\t23,800\nNet periodic postretirement benefit cost included the following components: \tYear Ended December 31, \t1994 1993 Service cost\t $ 53,500 \t$\t53,500 Interest cost \t42,900 \t42,900 Amortization of transition \tobligation\t 33,700 \t33,700 Net expense\t $\t130,100 \t$\t130,100\nPostretirement benefit costs for 1992 were not material. A discount rate of 8.5% was used in calculating the APBO. The APBO assumes a 13.5% increase in per capita health care costs decreasing gradually to 5.8% for years 2012 and later. A 1% increase in the medical inflation rate would increase the APBO by approximately $26,800 and the expense by approximately $6,000.\n8. Income Taxes\nEffective January 1, 1993, the Company adopted SFAS No. 109. \"Accounting for Income Taxes\". Prior years' financial statements have not been restated nor was there any cumulative effect on income from the adoption of SFAS No. 109.\nFor financial reporting purposes, income before income taxes includes the following components: \t\t Year Ended December 31, \t 1994\t 1993\t 1992 United States\t $\t30,726,395 \t$\t9,474,455 \t$\t6,436,060 Foreign: \tLicense income\t 404,000 \t 1,018,000 \t \tEquity in loss of \t\tjoint venture\t (3,176,834) \t (720,000) \t \tLoss from foreign subsidiary\t (2,217,061) Income before \tincome taxes\t $\t25,736,500 \t$\t9,772,455 \t$ 6,436,060\nThe provision for income taxes consisted of the following: \t\tYear Ended December 31, \t1994 \t1993 \t1992 Current\t $\t7,029,419 \t $\t434,246 \t $\t421,807 Deferred (benefit) \t (4,729,293) Total provision for \tincome taxes\t $\t2,300,126 \t$\t434,246 \t$\t421,807\nA reconciliation of the provision for income taxes at the statutory rate to those provided is as follows: \t\tYear Ended December 31, \t 1994\t 199\t 1992 Tax at statutory rates\t $\t9,007,775 \t $\t3,322,635 \t$\t2,188,260 Effect of utilization \tof net operating loss \tcarryforwards net of \talternative minimum tax\t (3,008,000) \t (3,155,253) \t (1,921,766) Effect of utilization \tof alternative minimum \ttax credits\t (382,000) Benefit from foreign \tsales corporation\t (265,000) State taxes, net of federal \tincome tax benefit\t 212,000 \t115,271 \t155,313 Income taxes of \tother countries\t 27,000 \t151,593 \t Loss from foreign \toperations\t 2,636,000 Recognition of deferred \ttax asset\t (4,729,000) Reversal of prior temporary \tdifferences\t (1,937,000) Other items \t738,351 Income Taxes \t$\t2,300,126 \t$\t434,246 \t$\t421,807\nAt December 31, 1994, the Company had federal net operating loss carryforwards of approximately $3,800,000 for tax purposes, all of which are limited by consolidated return rules to use in offsetting only the taxable income of a subsidiary of the Company. The net operating loss carryforwards expire at various dates from 1997 through 2005. For financial reporting purposes, the federal net operating loss carryforwards approximate $11,600,000. At December 31, 1994, the Company had foreign net operating loss carryforwards of approximately $14,000,000 available to offset future income of Wibau-Astec.\nAt December 31, 1994, the Company had investment tax and other credit carryforwards of approximately $641,000 expiring at various dates principally from 1995 through 1999. Utilization of these credits will be limited to use in offsetting only the taxable income of a subsidiary of the Company.\nAs a result of utilizing the net operating loss carryforwards, net income from continuing operations increased by approximately $3,008,000, $3,155,000 and $1,922,000 and related per share amounts increased by approximately $.31, $.36 and $.26 for the years ended December 31, 1994, 1993 and 1992, respectively.\nAt December 31, 1994, the company had deferred tax assets of approximately $16,861,000, and deferred tax liabilities of approximately $2,062,000, related to temporary differences and tax loss and credit carryforwards. At December 31, 1994, a valuation allowance of approximately $10,070,000 was recorded. This valuation allowance offsets the deferred tax assets relative to net operating loss and credit carryforwards as well as foreign net operating loss carryforwards. Both the net operating loss and credit carryforwards are SRLY carryforwards and can be used to offset only the income of a certain subsidiary. Due to this, the Company determined that a valuation allowance was necessary for these items as well as the foreign net operating loss carryforward, the utilization of which is uncertain.\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes.\nSignificant components of the Company's deferred tax liabilities and assets are as follows: \t December 31, \t 1994\t 1993 Deferred tax assets: \tInventory reserves\t $\t1,753,000 \t$\t2,270,000 \tLegal reserves\t 100,000 \t487,000 \tPension expense\t 109,000 \t1,098,000 \tInvestment in foreign \t\tjoint venture\t 1,827,000 \t747,000 \tOther accrued expenses\t 3,002,000 \t2,703,000 \tAlternative minimum \t\ttax credits\t \t1,216,000 \tNet operating loss \t\tcarryforwards\t 1,344,000 \t4,216,000 \tForeign net operating \t\tloss carryforwards\t 8,085,000 \tOther credit carryforwards\t 641,000 \t760,000 Total deferred tax assets\t 16,861,000 \t13,497,000 Deferred tax liabilities: \tProperty and equipment \t2,062,000 \t1,742,000 Total deferred tax liabilities\t 2,062,000 \t1,742,000 Net deferred tax assets\t 14,799,000 \t11,755,000 Valuation allowance\t (10,070,000) \t (11,182,000) Deferred tax asset\t $\t4,729,000 \t$\t573,000\n9. Contingencies\nDuring 1994, and in previous years, the Company and its former Barber-Greene subsidiary (now Telsmith, Inc.) were defendants in two patent infringement actions brought by Robert L. Mendenhall and CMI Corporation (\"CMI\"), a competitor, seeking monetary damages and an injunction to cease the alleged infringement.\nIn 1990, CMI was awarded damages of $4,457,000 and prejudgment interest of $2,838,000 or a total of $7,295,000 from Barber-Greene. During 1991, in a separate trial, CMI was awarded damages of $8,463,000, prejudgment interest of $5,309,000 and attorney's fees of $737,000 for a total of $14,509,000 from Astec, and Astec was awarded damages of $667,000 plus $391,000 of prejudgment interest or a total of $1,058,000 from CMI. The total damages and expenses awarded to CMI were $20,746,000, net of the $1,058,000 awarded to Astec. Both Astec and CMI appealed the judgments. In connection with its appeals, the Company was directed by the courts to pledge substantially all of its real property and to deposit funds in an escrow account to secure the judgments against the Company pending the outcome of appeals.\nOn June 9, 1994, the Company announced that the United States Court of Appeals for the Federal Circuit had reversed the lower court decision and did not remand to the lower court for further proceedings the judgments previously entered against Astec and its former Barber-Greene subsidiary in the Robert L. Mendenhall and CMI patent litigation. Those judgments totaled approximately $22,000,000. The Federal Circuit Court ruled in favor of Astec because the allegedly infringing patents had been held invalid in a separate third party case. CMI asked the Federal Circuit to reconsider its decision and to have all of the Federal Circuit judges rehear the appeal. The Company responded to this request. On September 20, 1994, the Company announced that the United States Court of Appeals for the Federal Circuit denied the request from Mendenhall and CMI to reconsider its earlier reversal. With the issuance of this ruling, the Federal Circuit's review of this ongoing patent litigation ended.\nOn October 11, 1994, CMI and Robert L. Mendenhall filed a Petition of Writ Certiorari asking the U.S. Supreme Court to review the decision of the Federal Circuit Court of Appeals. The Company filed a response opposing the Petition and on November 28, 1994, the Supreme Court issued an Order denying the Petition thus bringing the patent litigation to an end.\nAs a result of the Supreme Court's refusal to grant certiorari, the Company received $12,917,000 which was being held in escrow pending the Company's appeal of the two judgments. In addition, on December 15, 1994, the Company received $1,309,000 from CMI in satisfaction of the judgment entered in favor of the Company on its counterclaim against CMI. The receipt of these funds effectively concluded the litigation between the Company and CMI and Robert L. Mendenhall which had been pending for a number of years. As a result, the Company has reversed its accrued liability for patent damages. The reversal of $13,870,000 in accrued patent damages and the receipt of $1,309,000 in patent damages from CMI total $15,179,000 and are included in the Consolidated Statements of Income as Patent suit damages and expenses net recoveries and accrual adjustments.\nIn an unrelated case, the Company's Telsmith subsidiary is a defendant in a patent infringement action brought by Nordberg, Inc., a manufacturer of a competing line of rock crushing equipment, seeking monetary damages and an injunction to cease an alleged infringement of a patent on certain components used in the production of its rock crushing equipment. This case, being heard before the U.S. District Court for the Eastern District of Wisconsin, has been bifurcated into liability and damages phases. The liability phase was tried on January 11, 1993; however, no decision has been rendered by the Court. Because of the uncertainties inherent in the litigation process, the Company is unable to predict the ultimate outcome of this litigation.\nOn October 28, 1993, the Company was also named as a defendant in a patent infringement action brought by Gencor, Inc., a manufacturer of a competing line of asphalt plants, seeking monetary damages and an injunction to cease an alleged infringement of a patent on certain components used in the production of its asphalt plant product line. This case was filed in the U.S. District Court for the Middle District of Florida, Orlando Division, and is currently in the discovery phase. Management believes this case to be without merit and intends to vigorously defend this suit; however, due to the uncertainties inherent in the litigation process, the Company is unable to predict the ultimate outcome of this litigation.\nManagement has reviewed all claims and lawsuits and, upon the advice of counsel, has made provision for any estimable losses; however, the Company is unable to predict the ultimate outcome of the outstanding claims and lawsuits.\nRecourse Customer Financing - Certain customers have financed purchases of the Company's products through arrangements in which the Company is contingently liable for customer debt aggregating approximately $13,800,000 and $13,700,000 at December 31, 1994 and 1993, respectively. These obligations average five years in duration and have minimal risk.\nOther - The Company is contingently liable for letters of credit of approximately $2,082,000 issued for bid bonds and performance bonds.\n10. Shareholders' Equity\nStock Options - The Company has reserved 300,000 shares of common stock under the 1986 Stock Option Plan and 500,000 shares of common stock under the 1992 Stock Option Plan for issuance upon exercise of nonqualified options, incentive options and stock appreciation rights to officers and employees of the Company and its subsidiaries at prices determined by the Board of Directors. At December 31, 1994, a total of 328,800 shares of common stock related to the 1992 Stock Option Plan are available for options to be granted.\nNonqualified options are exercisable at a price not less than 85% of the Board of Directors' determination of the fair market value of the Company's common stock on the date of the grant. Nonqualified options are exercisable starting one year from the date of grant and expire ten years after the date of grant. Incentive stock options granted by the Board of Directors must be exercisable at a price not less than 100% of the fair market value of the Company's common stock on the date of grant. Incentive stock options are exercisable immediately after the date of grant, except for certain officers of the Company, and expire ten years after the date of grant. Stock appreciation rights may be granted by the Board of Directors in conjunction with the grant of an incentive or nonqualified option. A stock appreciation right permits a grantee to receive payment in either cash or shares of the Company's common stock equal to the difference between the fair market value of the common stock and the exercise price for the related option.\nThe following is a summary of stock option information: \tNumber\t Option Price \t of Shares\t Range Per Share Outstanding, December 31, 1991\t 238,800 \t $ 1.375 - 4.675 Granted\t 140,000 \t 3.25 Expired\t (12,800) \t4.675 Exercised\t (109,000) \t1.375 - 4.675 Outstanding, December 31, 1992\t 257,000 \t1.375 - 4.675 Exercised\t (87,000) \t1.375 - 4.675 Outstanding, December 31, 1993\t 170,000 \t1.375 - 4.675 Granted\t 87,000 \t14.875 - 16.363 Exercised\t (13,000) \t1.375 - 3.25 Outstanding, December 31, 1994\t 244,000 \t$ 1.375 - 16.363\nOn July 29, 1993, the Company's Board of Directors approved a two-for-one split of the Company's common stock in the form of a 100% stock dividend for shareholders of record as of August 12, 1993. A total of 4,893,701 shares of common stock were issued in connection with the split. The stated par value of each share was not changed. A total of $978,740 was reclassified from additional paid-in capital to the Company's common stock account. All share and per share amounts for 1993 and prior years have been restated to retroactively reflect the stock split.\n11. Related Party Transactions\nIn September 1991, the Company's Chairman, its Senior Vice President, and the President of its Telsmith, Inc. subsidiary formed a general partnership which acquired 25% of the common stock of American Rock Products, Inc., an Ohio corporation engaged in the business of supplying crushed rock to concrete and asphalt producers in the southeastern Oklahoma area (\"Amrock\"). These individuals own interests in the partnership of 50%, 25% and 25%, respectively. In December 1992, the rock crushing business of Amrock was sold to a competitor, exclusive of two used rock crushing machines and certain other miscellaneous inventory and equipment.\nIn March 1994, Amrock sold two of these used rock crushing machines to Telsmith for $50,000 and $70,000, respectively. The purchase price for each of these machines was determined by the president of Telsmith based on his opinion of their fair market value at the time of purchase. Telsmith intends to market both rock crushing machines to its customers for sale in the ordinary course of business.\n12. Restructuring Costs\nIn the fourth quarter of 1994, the Company developed and implemented a plan to restructure the operations of Wibau-Astec. In connection with the restructuring, the Company accrued costs of $1,500,000 $1,250,000, net of tax, or $0.12 per share. The plan included, among other things, the cessation of manufacturing operations at Wibau-Astec along with related personnel reductions as well as personnel reductions in engineering and administration. Total personnel reductions were approximately 150. The plan was communicated to employees and severance notices given during the fourth quarter of 1994.\nAs of the end of 1994, the restructuring was substantially complete. Total costs incurred were for the write-down of certain assets to estimated fair market value, severance payments and lease termination expenses. Severance costs and exit costs incurred were approximately $1,137,000 and $363,000, respectively.\nWibau-Astec will sell Astec asphalt plants either manufactured in the United States or subcontracted in Europe. Wibau-Astec will continue to sell Wibau-Astec parts and service a large customer base and will utilize subcontractors as needed for parts and\/or manufacturing components in Europe.\n[FN]\n(1)\tUncollectible accounts written off, net of recoveries.\n(2)\tWarranty costs charged to the reserve.\n(3)\tRepresents reserve balances of subsidiaries acquired in 1994.\nSIGNATURES\n\tPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Astec Industries, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nASTEC INDUSTRIES, INC.\nBY: \t \/s\/ J. Don Brock\nJ. Don Brock, Chairman of the Board and President (Principal Executive Officer)\nBY: \t \/s\/ Albert E. Guth\nAlbert E. Guth, Senior Vice President Secretary and Treasurer (Principal Financial and Accounting Officer)\nDate: March 2, 1995\n\tPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by a majority of the Board of Directors of the Registrant on the dates indicated:\n\tSIGNATURE\tTITLE\tDATE\n\t\tChairman of the Board\tMarch 2, 1995 J. Don Brock\t\tand President\n\t\tSenior Vice President,\tMarch 2, 1995 Albert E. Guth\t\tSecretary, Treasurer \t\tand Director\n\t\tPresident - Astec, Inc.\tMarch 2, 1995 W. Norman Smith\t\tand Director\n\t\tPresident - Telsmith, Inc.\tMarch 2, 1995 Robert G. Stafford\t\tand Director\n\t\tPresident - Trencor, Inc.\tMarch 2, 1995 Jerry F. Gilbert\t\tand Director\n\tSIGNATURE\tTITLE\tDATE\n\t\tDirector\tMarch 2, 1995 E. D. Sloan, Jr.\n\t\tDirector\tMarch 2, 1995 James R. Spear\n\t\tDirector\tMarch 2, 1995 Joseph Martin, Jr.\n\t\tDirector\tMarch __, 1995 George C. Dillon\n\t\tDirector\tMarch 2, 1995 G.W. Jones\n\t\tDirector\tMarch 2, 1995 Daniel K. Frierson\nSIGNATURES\n\tPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Astec Industries, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nASTEC INDUSTRIES, INC.\nBY: \/s\/ J. Don Brock\t J. Don Brock, Chairman of the Board and President (Principal Executive Officer)\nBY: \/s\/ Albert E. Guth\t Albert E. Guth, Senior Vice President, Secretary and Treasurer(Principal Financial and Accounting Officer)\nDate: March 2, 1995\n\tPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by a majority of the Board of Directors of the Registrant on the dates indicated:\n\tSIGNATURE\tTITLE\tDATE\n\/s\/ J. Don Brock\t\tChairman of the Board \tMarch 2, 1995 J. Don Brock\t\tand President\n\/s\/ Albert E. Guth\t\tSenior Vice President,\tMarch 2, 1995 Albert E. Guth\t\tSecretary, Treasurer \t\tand Director\n\/s\/ W. Norman Smith\t\tPresident - Astec, Inc.\tMarch 2, 1995 W. Norman Smith\t\tand Director\n\/s\/ Robert G. Stafford\t\tPresident - Telsmith, Inc. March 2, 1995 Robert G. Stafford\t\tand Director\n\/s\/ Jerry F. Gilbert\t\tPresident - Trencor, Inc. March 2, 1995 Jerry F. Gilbert\t\tand Director\n\tSIGNATURE\tTITLE\tDATE\n\/s\/ E.D. Sloan Jr.\t\tDirector\tMarch 2, 1995 E.D. Sloan, Jr.\n\/s\/ James R. Spear\t\tDirector\tMarch 2, 1995 James R. Spear\n\/s\/ Joseph Martin, Jr.\t\tDirector\tMarch 2, 1995 Joseph Martin, Jr.\n\/s\/ George C. Dillon\t\tDirector\tMarch ,1995 George C. Dillon\n\/s\/ G.W. Jones\t\tDirector\tMarch 2, 1995 G.W. Jones\n\/s\/ Daniel K. Frierson\t\tDirector\tMarch 2, 1995 Daniel K. Frierson\nCommission File No. 0-14714\nSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549\nEXHIBITS FILED WITH ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1994\nASTEC INDUSTRIES, INC. 4101 Jerome Avenue Chattanooga, Tennessee 37407\nASTEC INDUSTRIES, INC. FORM 10-K INDEX TO EXHIBITS\nSequentially Exhibit Number Description Numbered Page\nExhibit 2.2 Share Purchase and Transfer Agreement by and between the Company and Gibat Ohl Ingenieurgesellschaft fur Anlagentechnik mbH, dated as of October 5, 1994.\nExhibit 4.2\t Indenture of Trust, dated April 1, 1994, by and between Grapevine Industrial Development Corporation and Bank One, Texas, NA, as Trustee.\nExhibit 10.80\t\t Guarantee of Wibau-Astec Maschinenfabrik GmbH in favor of Dresdner Bank Aktiengensellschaft, dated as of December 22, 1993.\nExhibit 10.81\t\t Letter of Guarantee of Wibau-Astec Maschinenfabrik GmbH in favor of Berliner Hondels - und Frankfurter Bank, dated as of December 22, 1993.\nExhibit 10.82\t\t Guarantee of Wibau-Astec Maschinenfabrik GmbH in favor of Bayerische Vereinsbank, dated as of December 22, 1993.\nExhibit 10.83 \t\tLoan Agreement dated as of April 1, 1994, between Grapevine Industrial Development Corporation and Trencor, Inc.\nExhibit 10.84\t\t Letter of Credit Agreement, dated April 1, 1994, between The First National Bank of Chicago and Trencor, Inc.\nExhibit 10.85\t\t Guaranty Agreement, dated April 1, 1994, between Astec Industries, Inc. and Bank One, Texas, NA, as Trustee.\nExhibit 10.86\t\t Astec Guaranty, dated April 29, 1994, of debit of Trencor, Inc. in favor of The First National Bank of Chicago.\nExhibit 10.87 \t\tCredit Agreement, dated as of July 20, 1994, between the Company and The First National Bank of Chicago.\nExhibit 10.88\t\t Guarantee of Wibau-Astec Maschinenfabrik GmbH in favor of Bayerische Vereinsbank, dated as of January 16, 1995.\nExhibit 10.89\t\t Waiver for December 31, 1994, dated February 24, 1995 with respect to the First National Bank of Chicago Credit Agreement dated July 29, 1994.\nExhibit 11\t Statement Regarding Computation of Per Share Earnings.\nExhibit 22\t Subsidiaries of the Registrant.\nExhibit 23\t Consent of Independent Auditors.\nFor a list of certain Exhibits not filed with this Report that are incorporated by reference into this Report, see Item 14(a)(3).","section_15":""}
{"filename":"34489_1994.txt","cik":"34489","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nUntil 1991 the business of Westminster Capital, Inc. (the \"Corporation\") primarily consisted of the operations of a subsidiary, FarWest Savings and Loan Association (the \"Association\").\nIn January 1991 the Resolution Trust Corporation (hereafter RTC) took possession of the Association as sole conservator pursuant to an order issued by the Office of Thrift Supervision (hereafter OTS). The conservatorship did not apply to the Corporation. Subsequently, the conservatorship was converted to a receivership under the control of the RTC. Pursuant to that receivership, the assets and liabilities of the Association have been liquidated, the Association's branches have been sold or closed and the Association has been effectively eliminated as a going concern. For this reason, operating results of the Association have not been included with those of the Corporation and will not be so included in the future.\nSince the RTC took possession of the Association, the Corporation has purchased and disposed of a controlling interest in a furniture rental company (see \"Furniture Rental Business\" below), increased its investment in, operated and sold an apartment house complex located in Las Vegas, Nevada (see \"Apartment House Business\" below), made several loans secured by real property mortgage loans (see \"Mortgage Lending\" below) and acquired an interest in a local telephone service company (see \"Telephone Company Investment\" below).\nThe Corporation is a Delaware corporation formed in 1959. The executive office of the Corporation is located at 9665 Wilshire Boulevard, Suite M-10, Beverly Hills, California 90212 and its telephone number is (310) 278-1930.\nFURNITURE RENTAL BUSINESS\nIn June 1992 the Corporation purchased all of the issued and outstanding shares of Class B Common Stock of Express Rental, Inc. (\"Express\"), a closely held corporation engaged in the business of renting furniture for residential and business purposes in Southern California. In connection with the stock purchase the Corporation also loaned Express $1,800,000. The shares of Class B Common Stock purchased by the Corporation constituted 50% of the equity of Express represented by all outstanding shares of common stock and gave the Corporation the right to elect a majority of the Express directors.\nIn June 1993 the Corporation sold its equity investment in Express for an amount equal to its cost ($200,000), payable $125,000 in cash and the balance pursuant to a promissory note payable in two years and secured by a pledge of all of the outstanding shares of Common Stock of Express. In connection with the sale of the Express stock, Express also repaid the outstanding principal balance and accrued interest under the loan which had been made by the Corporation. The Consolidated Statements of Operations for 1993 and 1992 reflect the income or loss for those periods in loss from discontinued operations.\nAPARTMENT HOUSE BUSINESS\nIn 1988 the Corporation invested in a real estate partnership which developed, owned and operated a 432 unit apartment project in a suburb of Las Vegas, Nevada. The investment was made through two wholly-owned subsidiaries. To stay foreclosure proceedings initiated by the construction lender, the partnership filed for protection under the Federal Bankruptcy Law in May\n1991. A plan of reorganization was subsequently confirmed which required the Corporation to advance to the partnership approximately $1 million to enable the partnership to pay various fees and satisfy miscellaneous claims. As part of the plan, the construction lender extended the maturity of the existing financing to October 31, 1993. The additional $1 million investment brought the Corporation's total equity investment in the partnership to $3.25 million.\nAs a result of the default by certain of the partners on obligations owed to a subsidiary of the Corporation, that subsidiary exercised its rights on default and acquired the interest of those partners. In October 1993 the apartment house project was sold for an aggregate purchase price of $18,050,000, which resulted in a pre-tax loss of $1,245,000 to the Corporation.\nMORTGAGE LENDING\nOn September 3, 1993 the Corporation purchased 70 mortgage loans for a purchase price of $375,000. The loans had an interest rate of 9% per annum and were secured by first mortgages on single family residences. The loans were sold to an unaffiliated party for $530,270, including accrued interest, on October 29, 1993.\nDuring the period from September 1993 through January 1994 the Corporation made four loans which aggregated approximately $6,560,000 and are secured by mortgages or deeds of trust on residential and commercial properties as well as notes secured by mortgages and deeds of trust on residential and commercial properties. As of December 31, 1994, the Corporation has received payments of $5,844,000 which reduced the outstanding balance to $716,000. These loans bear interest at rates ranging from 6.05% to 15.86% and are all payable within one year. The largest of these loans, involving approximately $5,200,000, was made in January 1994, bears interest at 10% and is secured by mortgages on a pool of motels and residential and commercial properties. In connection with the loans the Corporation will receive loan fees aggregating $1,150,000. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Past Due Loans.\"\nTELEPHONE COMPANY INVESTMENT\nThe Company acquired a limited partnership interest in Global Telecommunications Systems, LTD. (\"Global Telecommunications\") in October 1993 and had invested $390,000 in that partnership at December 31, 1993 to fund a telephone accessing network on two military bases. During 1994, the Company invested an additional $875,000 in Global Telecommunications, including $185,000 in the two ongoing projects and $690,000 in a network for two additional military bases. Under the Global Telecommunications partnership agreement the Company is entitled to 75% of the partnership distributions (which is proportional to its investment) until it receives a return of its investment plus a 10% per annum return thereon. Thereafter the Company is entitled to 60% of all distributions with respect to the first two projects and 67.5% of all distributions with respect to the last two projects. All four of the projects have been completed and were profitable during 1994. The consolidated financial statements include this investment on a consolidated basis.\nEMPLOYEES\nAs of December 31, 1994, the Corporation had four salaried employees, two of whom are executive officers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe executive office of the Corporation is located at 9665 Wilshire Boulevard, Suite M-10, Beverly Hills, California 90212, telephone (310) 278- 1930. The Corporation's executive office is leased for a five year term ending in 1997.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nDuring 1994, the Corporation received approximately $3.5 million in net proceeds from a settlement of claims asserted on behalf of the Corporation against Drexel Burnham Lambert Inc. (\"Drexel\"), Michael Milken (\"Milken\") and other related parties in an action filed in the Los Angeles County Superior Court in 1989. The action involved claims of various violations of federal and state securities laws by Drexel, Milken and the other parties. The $3.5 million represents an award of approximately $5.4 million, less court directed attorneys' fees of approximately $1.9 million. During 1993, the Corporation received approximately $16.8 million in net proceeds which represents an award of approximately $25.9 million, less court directed attorneys' fees of approximately $9.1 million.\nAlso in December 1993 the Los Angeles County Superior Court approved a settlement of derivative litigation brought on behalf of the Corporation against its officers, directors and certain other parties in 1989. The action, which was entitled GOLDMAN V. FARWEST FINANCIAL CORPORATION ET AL., alleged a broad ranging conspiracy to engage in certain investments and other activities to the detriment of the Corporation and for the personal gain of certain defendants. The Corporation agreed to settle the claims against the officers and directors of the Corporation and certain other parties by paying $1,500,000, of which $1,000,000 was to be paid by the Corporation's insurance carrier and the balance was to be paid by the Corporation. The Corporation had established a $1,000,000 reserve for this litigation in 1991. The terms of the settlement agreement state that the settling defendants vigorously deny any liability or wrongdoing and agree to the settlement to eliminate the burden and expense of further litigation. As a result of the settlement, all claims against the directors and officers of the Corporation have been dismissed. The terms of the settlement require that the Board of Directors of the Corporation establish an Investment Committee which will be required to approve the design and implementation and to monitor the use of internal controls designed and intended to prevent the purchase of unusually high risk securities by the Corporation and to promote sound securities investment practices by the Corporation. A majority of the members of the Committee are required to be outside directors. The Investment Committee has been established and consists of Barbara C. George, Dwight C. Baum and Keenan Behrle.\nOn April 15, 1994 the Corporation received notice from the RTC that the RTC had decided to commence an action against the Corporation and three of its present and former directors relating to transactions involving the association. On February 14, 1995 a Settlement Agreement and Release was entered into by and between the RTC and the Corporation and three of its present and former directors (\"Directors\"). The Settlement Agreement provides for payment of $4 million by the Corporation to the RTC, requires the RTC to cooperate with the Corporation in connection with the pending proceedings to recover tax payments made by the Corporation to the State of California, and releases all claims among the parties. The Settlement Agreement, which specifically acknowledges that the Corporation and Directors have consistently denied any liability to the RTC, was entered into for purposes of compromising the claims and avoiding the cost of a time consuming and potentially lengthy legal battle that would take management time, effort and resources. The $4 million settlement was provided for in the 1994 consolidated financial statements.\nA wholly-owned subsidiary of the Corporation is a party to litigation entitled BURES V. SILVER RIDGE APARTMENTS, LTD. filed in March 1993 and pending in the Eighth Judicial District Court of Clark County, Nevada. The case relates to the apartment house project described above under \"Business - Apartment House Business,\" which was sold in October 1993. The plaintiff, who is a creditor of a former general partner of the partnership that owned the apartment house project, alleges that he acquired a 69% interest in the partnership prior to the sale of the project as a result of judgment enforcement proceedings against the prior general partner. The prior general partner had given the Corporation's wholly-owned subsidiary a security interest in its partnership interest, that security interest was foreclosed and, as a result, the partnership interest was acquired by the Corporation's wholly-owned subsidiary. The Corporation believes that the judicial enforcement proceedings brought by the plaintiff were improper and had no legal effect on the ownership of the general partnership interest and that the security interest held by the Corporation's wholly-owned subsidiary was senior in priority to the interest claimed by the plaintiff, which means that the Corporation's wholly-owned subsidiary would own the general partnership interest in any event. The plaintiff is seeking an order declaring that he is the general partner of the partnership and entitled to possession of its property, and a judgment quieting title to general and limited partnership interests representing a 69% interest in the partnership and other relief determined by the court to be appropriate. The matter presently has no trial date in State District Court but may be recalendared in the near future. The Corporation believes that the claims asserted are without merit and intends to vigorously contest the case.\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 CORPORATION'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Corporation's Common Stock is traded on the Pacific Stock Exchange under the symbol \"WI.\" The following table sets forth the range of high and low sales prices for the Common Stock of the Corporation for the periods indicated, as reported by the Pacific Stock Exchange.\nHIGH LOW ---- --- ---- First Quarter 1 7\/16 1 1\/8 Second Quarter 1 1\/4 7\/8 Third Quarter 1 1\/8 7\/8 Fourth Quarter 1 3\/8 1 1\/4\n---- First Quarter 3\/4 5\/16 Second Quarter 3\/4 9\/16 Third Quarter 3\/4 9\/16 Fourth Quarter 2 11\/16\nThe Corporation had approximately 1,125 holders of record of its Common Stock as of December 31, 1994.\nThe Corporation has not paid cash dividends since 1989 and intends to retain all cash resulting from its business operations for future acquisitions and investments.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nBecause the Corporation does not have access to audited financial data with respect to the Association for any period subsequent to December 31, 1989, the financial data for the Association is omitted for 1990 and subsequent years. The RTC took possession of the Association on January 11, 1991.\nSELECTED FINANCIAL DATA (excluding the Association) (dollars in thousands except per share data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Corporation's financial statements for the years 1992 through 1994 do not include the operations or assets and liabilities of the Association because the Association was seized by the RTC on January 11, 1991. See \"Business - General\".\nAt December 31, 1994 the Corporation's principal assets consisted of cash and cash equivalents, investment securities available for sale, an investment in Global Telecommunications, a limited partnership engaged in constructing and operating local telephone services for military residential quarters (See \"Business - Telephone Company Investment\"), certain loans made by the Corporation and secured by mortgages, deeds of trust and mortgage loans (See \"Business - Mortgage Lending\").\nThe Corporation's major source of on-going income is limited to the interest earned on its cash and cash equivalent positions, interest on investment securities, interest on its loan portfolio and income from Global Telecommunications.\nRESULTS OF OPERATIONS\nRevenues for 1994 were $6,706,000 compared to $17,250,000 for 1993. The large decrease primarily resulted from a significant reduction in the amounts received from the Drexel, Milken litigation. See \"Legal Proceedings\". In 1994, the Corporation received $3,528,000 net of attorneys' fees as compared to $16,819,000, net of attorneys' fees in 1993.\nThe large decrease was partially offset by increases in interest and fees on loans of $437,000, interest on investment securities of $558,000, telephone system revenue of $1,088,000 and a $757,000 refund of litigation costs incurred in prior years. Interest income increased because of the investment of funds received in late 1993 from the same lawsuit settlement. Telephone system revenue, which consists entirely of billings for telephone charges, increased significantly due to the expanded operations of Global Telecommunications.\nRevenues for 1993 were $17,250,000, up substantially from the $319,000 for 1992 as a result of the $25,947,000 settlement received in the litigation pending against Drexel, Milken and others. This settlement amount was reduced by court-awarded attorneys' fees of $9,128,000 and the net amount received by the Corporation, $16,819,000 is reflected in the Corporation's Statement of Operations.\nThe income from the litigation settlement was partially offset by a pre-tax loss of approximately $1,245,000 on the October 1993 sale of the Las Vegas, Nevada apartment project described under \"Business - Apartment House Business.\" Additionally the Corporation realized a pretax gain of $150,000 on the sale of certain mortgage loans in 1993.\nRevenues for 1992 declined as compared to 1991 because of the reduction in prevailing interest rates and because the amounts invested were substantially lower in 1992. In addition, income in 1991 was higher as a result of the recognition of approximately $387,000 in interest on income tax refunds receivable and approximately $890,000 in gains on the sale of investments.\nTotal expenses for 1994 were $6,422,000 compared to $720,000 for 1993. The large increase was due to a $4,000,000 regulatory settlement in 1994 (See \"Legal Proceedings\"), an increase in telephone time charges of $508,000 and an increase of $1,194,000 in general and administrative expenses. Telephone time charges increased because of the expansion of Global Telecommunications in 1994.\nGeneral and administrative expenses for the years 1992 through 1994 consisted principally of legal fees incurred in defending litigation pending against the Corporation and its officers and directors (see \"Legal Proceedings\") as well as salaries, occupancy expense, accounting and related fees and other costs. The significant increase in general and administrative expenses for 1994 as compared to 1993 resulted from an increase in legal expenses of approximately $423,000 and increases in most expense categories. Legal expenses increased because of the RTC potential litigation which was settled in 1995. All other expense categories increased due to the significant increase in the Corporation's activities during 1994. The significant decrease in general and administrative expenses for 1993 as compared to 1992 and 1992 as compared to 1991 was primarily due to a reduction in legal costs.\nThe 1994 provision for income taxes primarily reflects a provision for unresolved tax issues. The 1993 provision primarily reflects a deferred provision for the settlement of the Drexel and Milken claims, offset by net operating loss carryforwards of the Corporation. The 1992 provision reflects a reduction in the value at which income tax refunds receivable are reflected as assets on the balance sheet as of the end of the year.\nThe loss from discontinued operations, net of tax, of $151,000 for 1992 reflects the loss incurred by Express for the seven months ended December 31, 1992 during which the Corporation owned a controlling interest in Express. The Corporation's investment in Express was sold in June 1993. See \"Business - Furniture Rental Business.\" This $151,000 loss for 1992 compares with a loss from discontinued operations for 1993 of $410,000, net of tax, which represents the loss from the Las Vegas apartment house complex and the Corporation's portion of Express's loss for that portion of 1993 before they were sold.\nIn the fourth quarter of 1994, the Corporation received the preliminary results provided by the Franchise Tax Board with respect to its refund claim for approximately $3.9 million (including accrued interest of $1.2 million). Those audit findings propose to deny the refund claim. The Corporation has filed a protest with the California Franchise Tax Board which sets forth its position with respect to the refund claims. While the Corporation remains convinced that it will eventually recover all or a substantial portion of its refund claim, in 1992 the Corporation established a valuation allowance of 50%, adjusting the carrying value of this asset to $1,954,000 at December 31, 1992, against the recovery of this refund to reflect the uncertainties attributable to the California Franchise Tax Board's position. Due to continuing uncertainties and the length of time it will take to resolve this matter, management recorded a provision for unresolved tax issues of $1,954,000 during 1994. The provision is included in liabilities and accrued expenses in the 1994 Consolidated Statement of Financial Condition and in the provision for income taxes in the 1994 Statement of Operations.\nPAST DUE LOANS\nOf the $716,000 of loans receivable outstanding at December 31, 1994, $613,000 are secured by mortgage loans on residential and commercial properties. These loans bear interest rates which range from 6.05% to 15.86% and all matured during 1994.\nIn addition to the past due principal of $613,000 at December 31, 1994, there was also past due accrued interest receivable of $206,000. There was also unrecognized past due loan fees at December 31, 1994 of $275,000. These loan fees will only be recognized in the consolidated financial statements on a cash basis after all principal and interest has been received.\nManagement believes that there is adequate collateral value to cover the past due principal balance and all past due interest. Accordingly, no allowance for loan losses has been established nor has the accrual of interest ceased. In January, 1995 the combined principal balance and past due accrued interest was reduced by approximately $200,000.\nLIQUIDITY\nThe principal changes in the Company's financial condition at December 31, 1994 as compared to December 31, 1993 are the increase in the accumulated deficit of $1,608,000 resulting from the net loss for the year ended December 31, 1994, an increase of $1,033,000 in telephone systems due to the increased investment by Global Telecommunications, Inc. and the significant decrease in cash and cash equivalents which was accompanied by a significant increase in the amount invested in short and intermediate term, municipal fixed income securities. Since these municipal securities have a weighted average maturity of approximately 10 months, the Company continues to maintain a very strong liquidity position.\nThe Company acquired a limited partnership interest in Global Telecommunications in October 1993 and had invested $390,000 in that partnership at December 31, 1993 to fund a telephone accessing network on two military bases. During 1994, the Company invested an additional $875,000 in Global Telecommunications, including $185,000 in the two ongoing projects and $690,000 in a network for two additional military bases. Under the Global Telecommunications partnership agreement the Company is entitled to 75% of the partnership distributions (which is proportional to its investment) until it receives a return of its investment plus a 10% per annum return thereon. Thereafter the Company is entitled to 60% of all distributions with respect to the first two projects and 67.5% of all distributions with respect to the last two projects. All four of the projects have been completed and were profitable during 1994. The consolidated financial statements include this investment on a consolidated basis.\nThe Company's financial position at December 31, 1994 remained strong. Shareholders' equity was $21,483,000 (as compared to $23,296,000 at December 31, 1993), and the Company had no debt, although it did have $3,099,000 in deferred income tax liabilities, and $6,350,000 in liabilities and accrued expenses. The deferred income tax liabilities primarily consist of tax provisions for the settlements received in connection with the Drexel and related litigation (partially offset by net operating loss carryfowards). Liabilities and accrued expenses increased significantly due to the $4,000,000 Settlement Agreement and Release entered into by and between the RTC, the Corporation and three of its present and former directors and the provison for unresolved tax issues of $1,954,000.\nThe Company continues to seek the acquisition of one or more businesses and anticipates the possibility of further investment in Global Telecommunications, although no assurances can be given that any such acquisitions or investments will be made or, if made, that they will be successful.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders Westminster Capital, Inc. Beverly Hills, California:\nWe have audited the accompanying consolidated statements of financial condition of Westminster Capital, Incorporated and subsidiaries (the \"Corporation\") 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 two-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. The consolidated financial statements of Westminster Capital, Incorporated and subsidiaries as of December 31, 1992 and for the year then ended, were audited by other auditors whose report thereon dated March 25, 1993, expressed an unqualified opinion on those statements.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Westminster Capital, Incorporated 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 two-year period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs discussed in note 2 of the notes to the consolidated financial statements, the Corporation adopted 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,\" on January 1, 1994.\n\/s\/ KPMG Peat Marwick\nLos Angeles, California March 17, 1995\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders Westminster Capital, Inc. Beverly Hills, California:\nWe have audited the accompanying consolidated statements of operations, shareholders' equity and cash flows of Westminster Capital, Incorporated and subsidiaries (formerly FarWest Financial Corporation ) (the \"Company\") for the year ended December 31, 1992. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our 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 consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of Westminster Capital, Incorporated and subsidiaries for the year ended December 31, 1992, in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP\nMarch 25, 1993\nWESTMINSTER CAPITAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION DECEMBER 31, 1994 AND 1993\nSee accompanying notes to consolidated financial statements.\nWESTMINSTER CAPITAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1994\nSee accompanying notes to consolidated financial statements\nWESTMINSTER CAPITAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE THREE YEARS ENDED DECEMBER 31, 1994\nSee accompanying notes to consolidated financial statements.\nWESTMINSTER CAPITAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE YEARS ENDED DECEMBER 31, 1994\nSee accompanying notes to consolidated financial statements.\nWESTMINSTER CAPITAL, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE YEARS ENDED DECEMBER 31, 1994 (See Independent Auditors' Report)\n1. BASIS OF PRESENTATION\nOn January 11, 1991, the Resolution Trust Corporation (the \"RTC\") took possession of FarWest Savings and Loan Association (the \"Association\") as sole conservator. Substantially all of the operations of the Corporation were discontinued in 1991. On February 15, 1991, the RTC was appointed receiver for the Association. Although the conservatorship with respect to the Association was imposed subsequent to December 31, 1990, from the date of the imposition of the conservatorship, Westminster Capital, Inc. (formerly FarWest Financial Corporation) (the \"Corporation\") has not had access to financial or other information regarding the Association's operations, including the Association's operations for the year ended December 31, 1990.\nOn June 5, 1992, the Corporation acquired 50% of the outstanding common stock of Express Rental, Inc. (\"Express\"), a company that rents office and residential furniture to individuals and businesses in Southern California. In February 1993, the Corporation announced its intent to dispose of Express. Accordingly, the consolidated statements of operations for 1993 and 1992 reflect the income or loss for those periods in loss from discontinued operations. In 1993, through the date of sale, the Corporation recorded pre-tax earnings from discontinued operations of $54,000 and also recorded a loss from discontinued operations for the seven months ended December 31, 1992 of $151,000.\nIn June 1993, the Corporation sold its equity investment in Express for an amount equal to its cost, $200,000. The Corporation received $125,000 in cash and the balance is payable pursuant to a note for $75,000. In addition, the Corporation received payment in full on a loan to Express upon the close of the sale. The note is secured by all of the outstanding shares of common stock of Express.\nThe Company acquired a limited partnership interest in Global Telecommunications in October 1993 and had invested $390,000 in that partnership at December 31, 1993 to fund a telephone accessing network on two military bases. During 1994, the Company invested an additional $875,000 in Global Telecommunications, including $185,000 in the two ongoing projects and $690,000 in a network for two additional military bases. Under the Global Telecommunications partnership agreement, the Company is entitled to 75% of the partnership distributions (which is proportional to its investment) until it receives a return of its investment plus a 10% per annum return thereon. Thereafter the Company is entitled to 60% of all distributions with respect to the first two projects and 67.5% of all distributions with respect to the last two projects. The consolidated financial statements include this investment on a consolidated basis.\nOn February 14, 1995 a Settlement Agreement and Release was entered into by and between the RTC , the Corporation, and three of its present and former directors (\"Directors\"). The Settlement Agreement provides for payment of $4 million by the Corporation to the RTC, requires the RTC to cooperate with the Corporation in connection with the pending proceedings to recover tax payments made by the Corporation to the State of California, and releases all claims among the parties. The $4 million settlement was provided for in the 1994 consolidated financial statements.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF ACCOUNTING AND CONSOLIDATION - The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries, FarWest Financial Insurance Agency, Silver Ridge Apartments, G.P., Inc. and Silver Ridge Apartments, L.P., Inc. FarWest Financial Insurance Agency has been inactive since 1991 and Silver Ridge Apartments G.P., Inc., and Silver Ridge Apartments L.P., Inc., have been inactive since 1993. The consolidated financial statements also include the accounts of Global Telecommunications, a limited partnership in which the Corporation has a 75% limited partnership interest. All material intercompany accounts and transactions have been eliminated. References to the Corporation may include one or more of its wholly owned subsidiaries.\nAt December 31, 1990, the Corporation's principal operating subsidiary was the Association. The Association previously represented substantially all of the consolidated assets, liabilities and operations of the consolidated entity. In January 1991, the RTC took possession of the Association (see Note 1). Accordingly, the accompanying consolidated financial statements do not include any of the accounts of the Association.\nCASH EQUIVALENTS - Cash equivalents are short-term, highly liquid investments that are both readily convertible to known amounts of cash and are so near maturity that no significant risk of changes in value exists because of changes in interest rates.\nINVESTMENT SECURITIES AVAILABLE FOR SALE - The Corporation adopted Statement of Financial Accounting Standards No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES (SFAS 115) at January 1, 1994. In accordance with SFAS 115, the Corporation classified its investment securities as held to maturity securities, trading securities and available for sale securities, as applicable. The Corporation did not hold any held to maturity securities or trading securities at December 31, 1994.\nInvestment securities available for sale are carried at market value. The Corporation classifies securities as available for sale when it determines that such securities may be sold at a future date or if there are foreseeable circumstances under which the Corporation would sell such securities.\nChanges in the market value of investment securities available for sale are included in shareholders' equity as unrealized holding gains or losses, net of the related tax effect. Unrealized losses, on available for sale securities reflecting a decline in value judged to be other than temporary, are charged to income in the Consolidated Statement of Operations. Realized gains or losses on available for sale securities are computed on a specific identification basis. Amortized premiums and accreted discounts are included in interest on investment securities available for sale and money market funds.\nTELEPHONE SYSTEMS - Telephone systems are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets which is seven years. Telephone system revenue is recognized on the accrual basis for charges incurred on a monthly basis.\nLOAN FEES - Nonrefundable loan fees associated with loans secured by trust deeds or mortgages are recognized on the cash basis after all principal payments and interest have been received.\nINCOME (LOSS) PER SHARE - Income (loss) per common share is computed using the weighted average number of common shares outstanding. Common stock equivalents have been excluded from the computation because the effect is anti-dilutive.\nINCOME TAX MATTERS - The Corporation joins with its subsidiaries in filing consolidated federal income and state franchise tax returns. In the tax returns, taxable income or loss is consolidated with the taxable income or loss of the subsidiaries. Prior to 1993, Federal and state income tax expense was provided based on Statement of Financial Accounting Standards No. 96.\nThe Corporation adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"SFAS 109\") as of January 1, 1993 and applied it retroactively to 1991. There was no impact on the Corporation's financial statements as a result of adoption. Under the asset and liability method of SFAS 109, income tax expense (benefit) is recognized by establishing deferred tax assets and liabilities for the estimated future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Under 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. The Corporation's evaluation of the realizability of deferred tax assets includes consideration of the amount and timing of future reversals of existing temporary differences.\nIn December 1991, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, (SFAS 107) which is effective for fiscal years ending after December 15, 1992 (December 15, 1995 in the case of entities with less than $150 million in total assets, such as the Corporation). SFAS 107 requires disclosure, either in the body of the financial statements or in the accompanying notes, the \"fair value\" of financial instruments for which it is \"practicable to estimate that value.\" SFAS No. 107 defines \"fair value\" as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Quoted market prices, if available, are deemed the best evidence of the fair value of such instruments. Management does not expect this pronouncement to have a material impact on the Consolidated Statements of Financial Condition and Results of Operations.\n3. INVESTMENT SECURITIES AVAILABLE FOR SALE\nInvestment securities available for sale consist entirely of State and Municipal obligations which are tax exempt for Federal income tax purposes. At December 31, 1994 and 1993 these securities are carried at market. The weighted average maturity of these securities is approximately ten months. The portfolio had a gross unrealized loss of $341,000 at December 31, 1994. During 1994, the Corporation sold $21,247,000 in investment securities which resulted in no realized gains or losses.\n4. LOANS RECEIVABLE\nThe composition of the Corporation's loans receivable at December 31, 1994 and 1993 is as follows (in thousands):\nThe loans secured by trust deeds or mortgages made by the Corporation are collateralized by residential and commercial properties. These properties are located throughout the United States,\nwith the primary concentration in Florida, Maine, Pennsylvania, New Jersey, Alabama and California. The Corporation's loans bear interest rates which range from 6.05% to 15.86% and all matured during 1994.\nIn addition to the past due principal of $613,000 at December 31, 1994, there was also past due accrued interest receivable of $206,000. There was also unrecognized past due loan fees at December 31, 1994 of $275,000. These loan fees will only be recognized in the consolidated financial statements on a cash basis after all principal and interest has been received.\nThese loans are secured by the aforementioned real properties and management believes that there is adequate collateral value to cover the past due principal balance and all past due interest. Accordingly, no allowance for loan losses has been established nor has the accrual of interest ceased. In January, 1995 both the principal balance and past due accrued interest were reduced by approximately $100,000.\nAs discussed in Note 1, the Corporation has a loan outstanding to the purchasers of Express. This loan is secured by all of the common stock of Express. Interest payments are based on a rate of one percent over the Reference Rate of Bank of America, and are payable quarterly. The loan will mature in 1995.\nDuring the third quarter of 1993, the Corporation purchased $375,000 of loans and recorded them as held for sale. The loans were subsequently sold during the fourth quarter of 1993. The Corporation recorded a gain on sale of loans of $150,000.\n5. TELEPHONE SYSTEMS, NET\nThe following is a summary of telephone systems, net at December 31, 1994 and 1993 ( in thousands):\nDepreciation expense of telephone systems was approximately $164,000 and $3,000 for the years ended December 31, 1994 and 1993, respectively.\n6. INVESTMENT IN REAL ESTATE\nThe investment in real estate represented the Corporation's investment in Silver Ridge Apartments Ltd. (\"Silver Ridge\"), a real estate partnership (the \"Partnership\") which was acquired in 1988. The Partnership owned a 432 unit apartment project in a suburb of Las Vegas, Nevada. The Corporation's investment was sold in October of 1993, resulting in a pre-tax loss on sale of $1,245,000, which is included in loss from discontinued operations. Additionally, during 1993, the Corporation recorded pre-tax earnings from discontinued operations of $506,000.\nSignificant financial statement information of Silver Ridge for the year ended December 31, 1992 consisted of a net loss from operations of $109,000 (unaudited), based on rental revenue of $1,354,000 (unaudited).\n7. INCOME TAXES\nThe Corporation made no income tax payments during 1994, 1993 or 1992, except for the minimum state franchise tax.\nThe provision (benefit) for income taxes for the years ended December 31, 1994, 1993, and 1992 includes the following ( in thousands):\nThe income tax provisions for 1994 and 1992 consist primarily of provisions for unresolved tax issues. The 1993 income tax provision is primarily composed of a deferred tax liability, related to a lawsuit settlement of $16,819,000. The 1993 income tax provision was reduced through the utilization of the Corporation's net operating loss carryforwards which consisted of $7,957,000 for federal income tax purposes and $3,970,000 for California Franchise Tax purposes. The Corporation's deferred tax receivables resulting from the utilization of net operating loss carryforwards are offset in future years by deferred tax payables. The Corporation's net operating loss carryforwards, expire at various dates through 2008 for Federal income tax purposes and through 1998 for state income tax purposes.\nThe income tax provision from continuing operations reflected an effective rate of 626%, 22%, and 213% for the years ended December 31, 1994, 1993, and 1992 on the earnings (loss) before income taxes, respectively. The income tax provision (benefit) differed from the amounts computed by applying the statutory Federal income tax rate of 34% for 1994, 1993, and 1992 to the income (loss) before income taxes for the following reasons (in thousands):\nIn the fourth quarter of 1994, the Corporation received preliminary results provided by the Franchise Tax Board with respect to its refund claim for approximately $3.9 million (including accrued interest of $1.2 million). Those audit findings propose to deny the refund claim. The Corporation has filed a protest with the California Franchise Tax Board which sets forth its position with respect to the refund claims. While the Corporation remains convinced that it will eventually recover all or a substantial portion of its refund claim, in 1992 the Corporation established a valuation allowance of 50%, adjusting the carrying value of this asset to $1,954,000 at December 31, 1992, against the recovery of this refund to reflect the uncertainties attributable to the California Franchise Tax Board's position. Due to continuing uncertainties and the length of time it will take to resolve this matter, management established a provison for unresolved tax issues of $1,954,000 during 1994. This provision is included in liabilities and accrued expenses in the Consolidated Statements of Financial Condition.\nAt December 31, 1994 and 1993 the Corporation had cumulative deferred taxes payable of $3,099,000 and $3,412,000, respectively. Tabulated below are the significant components of the net deferred tax liability at December 31, 1994 and 1993:\nIn evaluating the realizability of its deferred tax assets, management has considered the turnaround of deferred tax liabilities during the periods in which those temporary differences become deductible. Additionally, the Corporation has not considered income from future operations in evaluating realizability of its deferred tax assets.\n8. LAWSUIT SETTLEMENT\nDuring 1994, the Corporation received approximately $3.5 million in net proceeds from the settlement of claims asserted on behalf of the Corporation against Drexel Burnham Lambert, Inc. (\"Drexel\"), Michael Milken (\"Milken\") and other related parties. In 1993, the Corporation received approximately $16.8 million in net proceeds from the same settlement.\n9. COMMITMENTS AND CONTINGENCIES\nThe Corporation maintains two stock option plans: the 1986 Incentive Stock Option Plan and the 1986 Non-statutory Stock Option Plan (the \"Plans\"). An aggregate of one million shares of the Corporation's common stock may be issued under both Plans, provided that no more than 750,000 shares may be issued to directors.\nAt December 31, 1994, there were options outstanding for 195,000 shares of common stock which were granted in 1986 at an option price of $12.875 per share. All of these options were exercisable at December 31, 1994 and expire on October 21, 1996.\nDuring 1994, options were granted for 50,000 shares of common stock at $.875 per share, which was equal to the market price on the date of grant. The options are execisable in five equal annual installments commencing with the first anniversary of the grant date. None of these options were exercisable at December 31, 1994.\nNo options were exercised during the three year period ended December 31, 1994 and no options were granted during the two year period ended December 31, 1993.\nThe Corporation is a defendant in various lawsuits arising from the normal course of business. Management believes, based upon the opinion of legal counsel, that the ultimate resolution of the pending litigation will not have a material effect upon the financial condition of the Corporation.\n10. LEASE COMMITMENTS\nThe Corporation leases office space for its corporate offices under a non- cancelable operating lease. Minimum rental commitments under this lease are $67,720 for both of the years ending December 31, 1995 and 1996, and $55,138 for the year ending December 31, 1997. The Corporation recorded $73,364 in rent expense for the year ended December 31, 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nKPMG Peat Marwick was engaged by the Corporation to be its independent certified public accountants for 1993 in July 1993 and was selected by the Corporation's Board of Directors to continue to serve as the accountants for the Corporation for 1994. During the two fiscal years ended December 31, 1992 and 1991 and the subsequent interim period though July 16, 1993, there was a disagreement with Deloitte & Touche that arose in connection with their 1992 audit with respect to the ultimate collectability of an income tax refund claim pending with the State of California. After review of the matter with the Corporation's Board of Directors and Deloitte & Touche, the Corporation established a valuation allowance for the refund claim. This resolution\nwas satisfactory to Deloitte & Touche. The Corporation has authorized Deloitte & Touche to fully discuss the matter with KPMG Peat Marwick. No reportable events of the type described in subsection (v) of item 304 (a)(1) of Regulation S-K have arisen during the two fiscal years ended December 31, 1991 and 1992, and the subsequent interim period through July 16, 1993.\nThe audit report of Deloitte & Touche, dated March 25, 1993 on the consolidated statement of operations of Westminster Capital, Inc. and subsidiaries for the year ended December 31, 1992 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to audit scope or accounting principles.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE CORPORATION.\nIncorporated by reference to the Corporation's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders pursuant to instruction G(3) to Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference to the Corporation's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders pursuant to instruction G(3) to Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference to the Corporation's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders pursuant to instruction G(3) to Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference to the Corporation's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders pursuant to 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)(1) The following financial statements are included in Item 8:\nConsolidated Statements of Financial Condition as of December 31, 1994 and 1993 Consolidated Statements of Operations 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 Consolidated Financial Statements for the Three Years Ended December 31, 1994\n(a)(2) Financial Statement Schedules\nAll schedules are omitted as the required information is inapplicable or is presented in the consolidated financial statements or related notes.\n(b) Reports of Form 8-K\nNo reports were filed on Form 8-K during the fourth quarter of 1994.\nOn February 14, 1995 the Corporation filed a Current Report on Form 8-K reporting under Item 5 (Other Events) that a Settlement Agreement and Release was entered into by and between\nthe RTC and the Corporation and three of its present and former directors referred to in \"Legal Proceedings\"\n(c) Exhibits\nSee \"Index to Exhibits.\"\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWESTMINSTER CAPITAL, INC.\nMarch 24, 1995 By: \/s\/ William Belzberg -------------------- William Belzberg, Chairman of the Board and Chief Executive Officer\nBy: \/s\/ Philip J. Gitzinger ----------------------- Philip J. Gitzinger, Executive Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSIGNATURES CAPACITY DATE\n\/s\/William Belzberg Chairman of the Board March 24, 1995 -------------------- of Directors and William Belzberg Chief Executive Officer\n\/s\/Dwight C. Baum Director March 24, 1995 -------------------- Dwight C. Baum\n\/s\/Keenan Behrle Director March 24, 1995 -------------------- Keenan Behrle\n\/s\/Barbara C. George Director March 24, 1995 -------------------- Barbara C. George\n\/s\/Monty Hall Director March 24, 1995 -------------------- Monty Hall\n\/s\/Lester Ziffren Director March 24, 1995 -------------------- Lester Ziffren\nINDEX OF EXHIBITS\nEXHIBIT NO. SEQUENTIALLY NUMBERED DESCRIPTION\n3.1 Certificate of Incorporation of the Registrant as amended through July 12, 1992.\nCertificate of amendment of Certificate of Incorporation of the Registrant dated July 13, 1992.\n3.2 By-Laws of the Registrant as amended in their entirety effective March 25, 1994.\n10.1 Settlement Agreement and Release entered into by and between the Resolution Trust Corporation, the Registrant and three of the Registrant's present and former directors dated February 14, 1995.\n21 Subsidiaries of Registrant.\n27 Financial Data Schedule.","section_15":""}
{"filename":"764897_1994.txt","cik":"764897","year":"1994","section_1":"ITEM 1. DESCRIPTION OF BUSINESS\nGENERAL\nThe Registrant, Banyan Hotel Investment Fund (the \"Fund\"), was originally organized as a Massachusetts business trust pursuant to a Declaration of Trust filed March 19, 1985, under the name VMS Hotel Investment Trust and subsequently reorganized as a Delaware corporation on March 13, 1987, at which time the Fund's name was changed to VMS Hotel Investment Fund. The Fund began doing business under its present name following shareholder authorization to amend its Certificate of Incorporation to formally change its name to Banyan Hotel Investment Fund during the second quarter of 1991.\nOn September 13, 1985, the Fund commenced a public offering of up to 10,000,000 units pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933. Each unit consisted of two shares of common stock (\"shares\") at an offering price of $9.50 per share and one warrant entitling the holder to purchase one additional share at an initial exercise price of $9.50 per share. The shares and warrants were separated January 14, 1986. The warrants were exercisable for a five year period ending January 13, 1991, on which date all outstanding warrants were converted by the Fund into one-tenth of a share.\nThe public offering was terminated on December 16, 1985 and the final closing occurred on January 13, 1986, with 4,931,333 units sold. The Fund received gross proceeds of $98,462,751, net of volume discounts, from the sale of units of which $201,000 represented the sale of 10,050 units purchased by VMS Realty Partners. The shares of the Fund, which are registered with and listed on the American Stock Exchange, began trading on January 17, 1986.\nPRESENT BUSINESS OPERATIONS\nThe Fund was originally established to invest in mortgage loans, principally to entities affiliated with VMS Realty Partners which were collateralized by hotel and resort properties. Mortgage loans made by the Fund were for initial terms of three, five or seven years, and were pre-payable in whole at any time without prepayment penalty.\nOn January 28, 1992, the Board of Directors of the Fund authorized the preparation of a formal plan of liquidation which was subsequently adopted on April 7, 1992 (the \"Plan\"). The Plan contemplated the Fund liquidating its assets and distributing the proceeds to its shareholders. The Fund estimated that its liquidation value was between $.15 and $.20 per share. Since the adoption of the Plan, Management of the Fund completed the workout or liquidation of certain assets and considered alternatives to the announced plan of liquidation which could provide greater shareholder value, including a number of unsolicited proposals from various third parties. Based upon Management's review of these various proposals, the Board of Directors resolved that one proposal was in the best interest of the Fund and its shareholders because it allowed every shareholder an opportunity to sell his shares at an amount in excess of the projected liquidation value. The Board of Directors, by unanimous written consent dated June 15, 1994, authorized the Fund to execute and deliver a non-binding letter of intent with a Mr. Harvey Polly.\nOn August 3, 1994 the Fund entered into a Purchase Agreement (the \"Purchase Agreement\") with Mr. Polly providing, among other things, for an all cash tender offer, under which Mr. Polly agreed to offer to purchase 100% of the shares of common stock of the Fund for $0.35 per share. The Purchase Agreement was subsequently amended on November 4, 1994, December 19, 1994 and February 15, 1995. The Purchase Agreement provided, among other things, for the following events to occur at or before closing: (i) the resignation of the current officers and directors; (ii) the purchase by the Fund of \"run-off\" directors' and officers' liability insurance coverage for the current officers and directors; (iii) the termination of the employment contract of Leonard G. Levine and payment of the severance compensation associated therewith; (iv) the termination of the Administrative Services Agreement with Banyan Management Corp. and payment of the termination fee associated therewith; and (v) the assignment by the Fund of its ownership interest in Banyan Management Corp.\nOn February 15, 1995, a change in control of the Fund occurred pursuant to the closing of the sale of shares of common stock in the Fund to Mr. Polly pursuant to the Purchase Agreement. Mr. Polly's tender offer, which commenced on December 28, 1994, concluded on January 26, 1995, and resulted in the tender to Mr. Polly of 1,288,217 shares of common stock, or 12.5% of the Fund's then outstanding shares of common stock, for a cash price of $0.35 per share. Subsequent to the closing of the tender offer, the terms of the Purchase Agreement also required Mr. Polly to purchase from the Fund a number of shares sufficient to allow Mr. Polly to own, by virtue of the combination of the tender offer and the share purchase, not less than 3,335,000 and not more than 40% of the shares of common stock after giving effect to the shares issued in connection with the purchase. On February 15, 1995, per the Purchase Agreement, Mr. Polly purchased 2,047,766 newly issued shares of common stock of the Fund for a cash price of $0.22 per share. Upon the acquisition of the aforesaid shares from the Fund, when combined with the shares of common stock previously owned and acquired pursuant to the tender offer, Mr. Polly is the beneficial owner of 3,335,983 shares, or approximately 27% of the Fund's outstanding voting shares of common stock.\nAlthough the Fund currently does not satisfy certain American Stock Exchange (\"AMEX\") criteria for continued listing of its stock on the exchange, Mr. Polly is optimistic that AMEX will continue to defer consideration of delisting for the immediate future. There can be no assurance, however, that listing will be continued. Mr. Polly has indicated that he has no present intention of taking the Fund private, but he is contemplating, subject to shareholder approval, a 1 for 5 reverse stock split in the near future.\nUpon the closing of the sale of shares of common stock of the Fund on February 15, 1995, the Purchase Agreement provided for the resignation of the Fund's current Directors and Officers. Accordingly, all of the then current Directors and Officers resigned and were replaced with Mr. Polly's designees. Subsequent to the resignation of the Directors and Officers of the Fund, no further arrangements or understanding among the Fund or its new officers and directors existed. On February 15, 1995, Messrs. Leo Yarfitz, Morton I. Kalb, Willis G. Ryckman and Harvey Polly were appointed as new Directors of the Fund. In addition, the new Directors appointed Mr. Harvey Polly as President and Chief Executive Officer, Mr. Morton I. Kalb as Vice President and Chief Financial Officer, Ms. Celia Zisfein as Secretary and Mr. William L. Weiss as Assistant Secretary. Effective February 15, 1995, Mr. Polly's and the Fund's address of their principal executive office is One Penn Plaza, Suite 1531, New York, NY 10119.\nThe Fund currently owns a 50% limited partnership interest in the Santa Barbara Biltmore Resort and a loan collateralized by a third mortgage on the Omni Park Centre Hotel. Both the assets are illiquid due to the poor operating performance of these two hotels. While the Fund believes that the operations of both hotels may improve over time to the point that sale of these assets could result in a recovery of a portion of the Fund's investment, the timing and amount of such a recovery is difficult to predict. In the interim, the Fund has attempted to reduce the ongoing operating expenses of the Fund in order to maximize the net cash return to shareholders.\nBelow is a summary and current status for each of the Fund's remaining assets as of March 16, 1995.\nSANTA BARBARA BILTMORE\nThe Fund's 50% limited partnership interest in the Santa Barbara Biltmore Partnership was recorded by the Fund at its fair market value and is accounted for on the equity method. The Fund recorded $3,749,581 as its share of the operating loss of the Santa Barbara Biltmore Resort for 1992. The 1992 amount included an additional loss of $861,691 to reduce the December 31, 1992 carrying value of its interest in the Santa Barbara Biltmore to $506,695 which represented amounts due to the Fund under the settlement agreement from certain amounts held in escrow related to renovation work on the hotel which was completed in 1990. The Fund received this cash on February 3, 1993. The Fund did not record losses related to its interest in the Santa Barbara Biltmore during 1994 and 1993 since the carrying value of the partnership interest was reduced to zero as of December, 1992 and the Fund has no obligation to make additional capital contributions to, or to pay the liabilities of, the partnership.\nOMNI PARK CENTRE\nOn July 19, 1991 the Fund was served with a summons in a mortgage foreclosure action filed by Sheraton Holding Inc. (\"Sheraton\") in the Superior Court of New York, New York. Sheraton seeks to foreclose on its $54,000,000 first mortgage collateralized by the Omni Park Centre located in New York, New York. The Sheraton foreclosure action is based on monetary defaults by Park Centre Associates (the \"Borrower\"). The Fund holds a third mortgage loan on the Omni Park Centre in the original principal amount of $5,154,600 which is also in monetary default. On September 30, 1991 the Fund filed a counterclaim to the foreclosure action of Sheraton with the court. The second mortgage on the Omni Park property in the amount of approximately $5,600,000 is also in default and the holder of the mortgage has also filed a counterclaim to the foreclosure with the court.\nOn June 12, 1992, the Borrower filed for protection under the U.S. Bankruptcy Code. On June 30, 1992, an order was entered in the Bankruptcy Court between the Fund, Sheraton, the second mortgagee and the Borrower authorizing and restricting the use of cash collateral by the Borrower. The Fund recorded a provision for losses for the full amount of the loan which is considered in substantive foreclosure and will continue to monitor the foreclosure action.\nManagement currently considers it unlikely that the sale of the hotel in the near future will result in more than a nominal recovery of the Fund's mortgage loan.\nPrior to the February 15, 1995 acquisition of the Fund by Mr. Polly (as discussed above), the Fund had four employees who served as executive officers. Administrative and accounting services performed on behalf of the Fund were primarily provided by Banyan Management Corp. Please see Item 12, \"Certain Relationships and Related Transactions,\" and Note 5 of Notes to Consolidated Financial Statements.\nPrior to January 1, 1995, the Fund continued to be treated as a real estate investment trust (REIT) under Sections 856-860 of the Internal Revenue Code of 1986. However, management of the Fund intends to discontinue its REIT status.\nThe Fund reviews and monitors compliance with federal, state and local provisions which have been enacted or adopted regarding the discharge of material into the environment, or otherwise relating to the protection of the capital expenditures for environmental control facilities for the years ended December 31, 1994 and 1993.\nThe business of the Fund is not seasonal and the Fund does no foreign or export business. The Fund does not segregate revenue or assets by geographic region, and such presentation is not applicable and would not be material to an understanding of the Partnership's business taken as a whole.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY\nAs of December 31, 1994, the Fund owned a 50% partnership interest in the Santa Barbara Biltmore Hotel. In addition, see Note 3 of the Notes to Financial Statements for certain information pertaining to the property which collateralizes the Fund's mortgage loan to which the Fund has not acquired title.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Registrant is not aware of any material pending legal proceedings as of March 16, 1995 nor were any proceedings terminated during the quarter ended December 31, 1994.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Fund did not submit any matter to a vote of its security holders during the quarter ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe Fund's shares of common stock are traded on the American Stock Exchange (\"AMEX\") (Symbol - VHT). The range of high and low sales prices per share for each of the quarters in the years ended December 31, 1994 and 1993 are as follows:\nShare Price\nQuarter 1994 1993 1 High $0.344 $0.188 Low $0.156 $0.094\n2 High $0.438 $0.500 Low $0.250 $0.125\n3 High $0.500 $0.500 Low $0.281 $0.281 4 High $0.500 $0.438 Low $0.281 $0.188\nPrior to the acquisition of the Fund by Mr. Polly (See Item 1. Description of Business), the Fund had suspended distributions due to interruption in the Fund's cash flow resulting from defaults by borrowers on the Fund's mortgage loans, the modest size of the Fund's cash position, the uncertainty regarding the cash requirements for operating activities, and expected expenses to be incurred prior to disposition of the Fund's assets. No distributions were declared by the Fund in 1994 and 1993. Although the Fund currently does not satisfy certain AMEX criteria for continued listing of its stock on the exchange, Mr. Polly is optimistic that AMEX will continue to defer consideration of delisting for the immediate future. There can be no assurance, however, that listing will be continued. Mr. Polly has indicated that he has no present intention of taking the Fund private, but he is contemplating, subject to shareholder approval, a 1 for 5 reverse stock split in the near future.\nAt March 16, 1995, there were 2,632 record holders of shares of common stock.\nITEM 6.","section_6":"ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION\nGENERAL\nBanyan Hotel Investment Fund (the \"Fund\"), was formed to make mortgage loans to affiliates of VMS Realty Partners, (\"VMS\"), secured by hotel and resort properties. The Fund has been adversely affected as a result of the non-payment of amounts due from these borrowers on mortgage loans and notes receivable. As a result of these defaults, the Fund suspended the making of new loans (except for advances of additional funds under circumstances which it is deemed necessary to preserve the value of existing collateral) and suspended distributions to shareholders.\nIn early 1990, the Fund implemented a business plan focused on preservation of its assets and managing its properties acquired through foreclosure until they could be disposed of in an orderly manner (the \"Principal Recovery Plan\").\nOn January 28, 1992, the Board of Directors of the Fund authorized the preparation of a formal plan of liquidation which was subsequently adopted on April 7, 1992 (the \"Plan\"). The Plan contemplated the Fund liquidating its assets and distributing the proceeds to its shareholders. The Fund estimated that its liquidation value was between $.15 and $.20 per share. Since the adoption of the Plan, Management of the Fund completed the workout or liquidation of certain assets and considered alternatives to the announced plan of liquidation which could provide greater shareholder value, including a number of unsolicited proposals from various third parties. Based upon Management's review of these various proposals, the Board of Directors resolved that one proposal was in the best interest of the Fund and its shareholders because it allowed every shareholder an opportunity to sell his shares at an amount in excess of the projected liquidation value. The Board of Directors, by unanimous written consent dated June 15, 1994, authorized the Fund to execute and deliver a non-binding letter of intent with a Mr. Harvey Polly.\nOn August 3, 1994 the Fund entered into a Purchase Agreement (the \"Purchase Agreement\") with Mr. Polly providing, among other things, for an all cash tender offer, under which Mr. Polly agreed to offer to purchase 100% of the shares of common stock of the Fund for $0.35 per share. The Purchase Agreement was subsequently amended on November 4, 1994, December 19, 1994 and February 15, 1995. The Purchase Agreement provided, among other things, for the following events to occur at or before closing: (i) the resignation of the current officers and directors; (ii) the purchase by the Fund of \"run-off\" directors' and officers' liability insurance coverage for the current officers and directors; (iii) the termination of the employment contract of Leonard G. Levine and payment of the severance compensation associated therewith; (iv) the termination of the Administrative Services Agreement with Banyan Management Corp. and payment of the termination fee associated therewith; and (v) the assignment by the Fund of its ownership interest in Banyan Management Corp.\nOn February 15, 1995, a change in control of the Fund occurred pursuant to the closing of the sale of shares of common stock in the Fund to Mr. Polly pursuant to the Purchase Agreement. Mr. Polly's tender offer, which commenced on December 28, 1994, concluded on January 26, 1995, and resulted in the tender to Mr. Polly of 1,288,217 shares of common stock, or 12.5% of the Fund's then outstanding shares of common stock, for a cash price of $0.35 per share. Subsequent to the closing of the tender offer, the terms of the Purchase Agreement also required Mr. Polly to purchase from the Fund a number of shares sufficient to allow Mr. Polly to own, by virtue of the combination of the tender offer and the share purchase, not less than 3,335,000 and not more than 40% of the shares of common stock after giving effect to the shares issued in connection with the purchase. On February 15, 1995, per the Purchase Agreement, Mr. Polly purchased 2,047,766 newly issued shares of common stock of the Fund for a cash price of $0.22 per share. Upon the acquisition of the aforesaid shares from the Fund, when combined with the shares of common stock previously owned and acquired pursuant to the tender offer, Mr. Polly is the beneficial owner of 3,335,983 shares, or approximately 27% of the Fund's outstanding voting shares of common stock.\nUpon the closing of the sale of shares of common stock of the Fund on February 15, 1995, the Purchase Agreement provided for the resignation of the Fund's current Directors and Officers. Accordingly, all of the then current Directors and Officers resigned and were replaced with Mr. Polly's designees. Subsequent to the resignation of the Directors and Officers of the Fund, no further arrangements or understanding among the Fund or its new officers and directors existed. On February 15, 1995, Messrs. Leo Yarfitz, Morton I. Kalb, Willis Ryckman and Harvey Polly were appointed as new Directors of the Fund. In addition, the new Directors appointed Mr. Harvey Polly as President and Chief Executive Officer, Mr. Morton I. Kalb as Vice President and Chief Financial Officer, Ms. Celia Zisfein as Secretary and Mr. William L. Weiss as Assistant Secretary. Effective February 15, 1995, Mr. Polly's and the Fund's address of their principal executive office is One Penn Plaza, Suite 1531, New York, NY 10119.\nLIQUIDITY AND CAPITAL RESOURCES\nCash and cash equivalents consist of cash and short-term investments. The Fund's cash and cash equivalents balance at December 31, 1994 and 1993 was $275,161 and $2,443,797, respectively. This decrease in cash and cash equivalents is due primarily to the purchase of investment securities during 1994 with a carrying value of $1,907,531 as of December 31, 1994 and the payment of the Fund's operating expenses. Partially offsetting these payments was the receipt of $143,329, representing proceeds received by the Fund from an escrow account established in connection with the sale of the Silver Sands Motel (see discussion below for further details). In addition, the Fund received net proceeds of $90,693 from an escrow established as part of the class action settlement of the litigation captioned In re VMS Securities Litigation. The escrow was established to provide the directors of the Fund with monies to fund the cost of any litigation in which they may be named as defendants post settlement of the class action. Subsequently, the directors released the proceeds from the escrow, and the Fund purchased an insurance policy to cover the directors. During 1994, the Fund also received approximately $151,000 in interest income on its cash and cash equivalents and investment securities. On February 15, 1995, the purchase by Mr. Polly of 2,047,766 shares of common stock from the Fund resulted in cash proceeds of approximately $450,000 to the Fund.\nAt this time, there are no material commitments for capital expenditures. The Fund's cash and cash equivalents are sufficient to meet its needs for anticipated operating expenses. The Fund deems its liquidity to be adequate.\nAs of December 31, 1994 and 1993, the Fund's mortgage loan portfolio consisted of one loan, classified as loans in substantive foreclosure. The Fund has recorded a provision for losses on the loan representing its full carrying balance.\nEffective December 20, 1993, the Fund and the unaffiliated third party which purchased the Silver Sands Motel property from the Fund in October, 1991 (\"the Buyer\") jointly agreed to terminate an escrow established at the time of the sale to be used in connection with monitoring various environmental issues at the property. In anticipation of the final approval regarding the environmental issues by local authorities, the Fund and the Buyer determined that the necessary work was substantially complete and the escrow, which originally contained $327,000, was no longer required. After deducting the cost of the environmental work performed, the remaining balance of the escrow account was approximately $193,000 which had been classified by the Fund as an other asset. On January 10, 1994, the Fund paid the Buyer $50,000, representing the final settlement of the escrow. For the year ended December 31, 1993, the Fund recorded a gain on disposition of real estate of $143,329 representing its recovery from the escrow.\nOn November 18, 1993, in final settlement of guarantees of VMS Realty Partners of loans made by the Fund in prior years, the Fund received a cash distribution of $27,831 and an interest in a liquidating trust established for the benefit of the unsecured creditors of VMS. As of December 31, 1993, the Fund valued its interest at $4,939 representing its pro rata portion of the cash assets of the trust. During 1994 and 1993, the Fund has recorded $16,788 and $32,770, respectively, on its Statement of Income and Expenses as a recovery of the Provision for Losses on Mortgage Loans, Notes and Interest Receivable related to the distributions received from the liquidating trust. The $16,788 net recovery recorded in 1994 includes a $34,764 distribution received net of an estimated $13,037 due to the Class Action Settlement Fund representing the Fund's share of amounts due per the terms of the previously settled VMS Securities litigation.\nThe Fund's ultimate return of cash to its shareholders is dependent upon, among other things: (i) the activities undertaken by the Fund under Mr. Polly's direction; (ii) interest earned from the investment of cash and cash equivalents and investment securities; (iii) the Fund's ability to control its operating expenses; and (iv) possible recoveries from the Santa Barbara Biltmore Hotel, the Omni Park Loan and the liquidating trust, if any.\nRESULTS OF OPERATIONS\nTotal income for the years ended December 31, 1994, 1993 and 1992 was $138,603, $85,931 and $113,104, respectively. The increase in total income between 1994 and 1993 is the result of an increase in interest earned on the Fund's cash and cash equivalents and investment securities due to an increase in interest rates available on its cash and investment securities. Total income decreased between 1993 and 1992 as a result of decrease in interest income on short term investments attributable to the lower rates available during 1993 on investments of the Fund's cash and cash equivalents.\nOther operating expenses for the year ended December 31, 1994 decreased when compared to the same period in 1993 as a result of decreases in stockholder expenses, directors' fees, expenses and insurance, other professional fees, and general and administrative expenses. These decreases are due to the Fund's limited asset base and management's continued cost control efforts during 1994. Similarly, other operating expenses for the year ended December 31, 1993 decreased when compared to 1992 as a result of reductions in stockholder expenses, other professional fees and general and administrative expenses. These decreases reflect cost control efforts by management and the limited activity required during 1993 to maintain the Fund's remaining assets as a result of completion of the workout of most of the Fund's real estate assets and the replacement of outside consultants who formerly performed this work, with BMC personnel. Partially offsetting the decreases, directors' fees, expenses and insurance increased due to higher directors' and officers' insurance premiums in 1993.\nDuring 1994 and 1993, the Fund recorded net recoveries of losses on loans, notes and interest receivable of $16,788 and $32,770, respectively, as a result of cash received pursuant to the VMS Creditor Repayment Agreement as discussed above. During 1992, the Fund recognized a $2,606,600 provision for losses on loans, notes and interest receivable as a result of a provision recorded by the Fund regarding its interest in the Omni Park Centre. For 1994, the Fund recorded a $90,693 recovery of class action settlement costs and expenses representing the receipt of net escrow proceeds as discussed above in liquidity and capital resources. No class action settlement costs were recorded during 1993 and 1992 due to the completion of the settlement regarding the litigation captioned In re VMS Securities Litigation. During 1994 and 1993, the Fund did not record losses related to its interest in the Santa Barbara Biltmore since the carrying value of the partnership interest was reduced to zero as of December 31, 1992, and the Fund has no obligation to make additional capital contributions to, or pay the liabilities of, the partnership. For 1992, the Fund recorded $3,749,581 representing its share of the losses from its Santa Barbara Biltmore partnership interest.\nThe above changes for the year ended December 31, 1994, when compared to 1993 and 1992, resulted in a decrease in the net loss to $385,838 ($0.04 per share) from $488,081 ($0.05 per share) and $7,327,651 ($0.71 per share), respectively.\nITEM 7.","section_7":"ITEM 7. FINANCIAL STATEMENTS\nSee Index to Consolidated Financial Statements on Page of this Report for financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no changes in or disagreements with the accountant on any matter of accounting principles, practices or financial statement disclosure.\nPART III\nITEM 9.","section_9":"ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT\nPrior to the February 15, 1995 acquisition of the Fund by Mr. Polly (see Item 1. Description of Business), the following individuals were serving as directors and the executive officers of the Fund:\nNorman M. Gold Director Gerald L. Nudo Director Marvin A. Sotoloff Director Leonard G. Levine President Neil D. Hansen First Vice President Robert G. Higgins Vice President\/General Counsel Joel L. Teglia Acting Chief Financial Officer\nNORMAN M. GOLD, age 64, is a senior partner in the law firm of Altheimer & Gray and has actively practiced law for over 40 years, specializing in taxation, corporate and real estate law. Mr. Gold is a trustee of Banyan Short Term Income Trust, Banyan Strategic Realty Trust, and director of Banyan Management Corp. Mr. Gold is also a trustee of New Plan Realty Trust. Mr. Gold is a certified public accountant and a member of the Chicago and American Bar Associations.\nGERALD L. NUDO, age 45, is senior vice president of Mesirow Realty Finance, Inc., a subsidiary of Mesirow Financial Corp., a regional investment banking firm. From 1982 to 1990 Mr. Nudo was a principal and vice president of Capital Realty Services, Inc., a commercial real estate investment banking company. Mr. Nudo received his Bachelor of Science Degree from Northwestern University and his Masters Degree in Business Administration from the University of Chicago Graduate School of Business. Mr. Nudo is also a certified public accountant and a licensed real estate broker in Illinois. He is a trustee of Banyan Short Term Income Trust and a director of Banyan Strategic Land Fund II and Banyan Management Corp.\nMARVIN A. SOTOLOFF, age 51, is regional vice president of Premisys Marketing Services, Inc., effective July 1993. Premisys Marketing Services, a division of Premisys Real Estate Services, Inc., is a national real estate services firm involved in the leasing and management of office, retail and industrial properties. From 1979-1993, Mr. Sotoloff was executive vice presi- dent of The Palmer Group Ltd., a company involved in real estate brokerage, development and property management, concentrating on commercial real estate. He is a past president of the Chicago Office Leasing Brokers Association, a licensed real estate broker and a member of the Illinois and Pennsylvania Bar Associations. Mr. Sotoloff is a trustee of Banyan Strategic Realty Trust, Banyan Short Term Income Trust and director of Banyan Management Corp.\nLEONARD G. LEVINE, age 48, is president of Banyan Management Corp., Banyan Short Term Income Trust, Banyan Strategic Realty Trust, Banyan Strategic Land Fund II, Banyan Mortgage Investment Fund. Mr. Levine was employed by VMS Realty Partners from 1981 to 1989 before becoming president of the other Banyan Entities mentioned above. He received a B.S.\/B.A. Degree in Accounting from Roosevelt University in 1968 and a Masters Degree in Taxation from DePaul University in 1972. His areas of specialization include real estate syndications, estate planning and taxation of closely-held corporations. Mr. Levine is also a certified public accountant and a licensed real estate broker.\nNEIL D. HANSEN, age 48, is first vice president of Banyan Management Corp., Banyan Short Term Income Trust, Banyan Strategic Realty Trust, Banyan Strategic Land Fund II, and Banyan Mortgage Investment Fund. From 1988 through 1990 Mr. Hansen was senior vice president of Ruff Callaghan & Hemmeter Company, a real estate development firm, and executive vice president, secretary and treasurer of Resort Income Investors, Inc., an American Stock Exchange listed real estate investment trust. He received a B.S. Degree in Finance from the University of Illinois and a Master of Management Degree from Northwestern University. He is a certified public accountant.\nROBERT G. HIGGINS, age 43, is vice president\/general counsel of Banyan Management Corp., Banyan Short Term Income Trust, Banyan Strategic Realty Trust, Banyan Strategic Land Fund II, and Banyan Mortgage Investment Fund. From 1990 to 1992, Mr. Higgins was a contract partner at the law firm of Chapman and Cutler. From 1984 to 1990, Mr. Higgins was a partner at the law firm of Schwartz & Freeman. During these years, Mr. Higgins concentrated in the areas of real estate development, finance, acquisition, land use, sales, lending and syndications, and general corporate and business practice. Mr. Higgins is admitted to the bar in the States of Illinois, Minnesota and Texas. He received a B.A. Degree in Government from the University of Notre Dame and a J.D. Degree from Loyola University of Chicago.\nJOEL L. TEGLIA, age 33, is acting chief financial officer of Banyan Management Corp., Banyan Strategic Realty Trust, Banyan Mortgage Investment Fund, Banyan Short Term Income Trust and Banyan Strategic Land Fund II. Prior to assuming the responsibilities of his current position, Mr. Teglia was the Controller for Banyan Management Corp. From 1986 to 1990 Mr. Teglia held positions as Project Controller and Director of Finance and Budgeting at the Prime Group, Inc., an international real estate investment and development firm. He received a B.B.A. Degree in Accounting from the University of Notre Dame. Mr. Teglia is a certified public accountant.\nOn February 15, 1995, Norman M. Gold, Gerald L. Nudo and Marvin A. Sotoloff (the \"Directors\") submitted their respective resignations as Independent Directors of the Fund. Also on February 15, 1995, Leonard G. Levine, Neil D. Hansen, Robert G. Higgins and Joel L. Teglia (the \"Officers\") submitted their respective resignations as officers of the Fund. The resignations of the Directors and Officers, which were effective immediately, were submitted as a result of a change in control of the Fund pursuant to the closing of the February 15, 1995 sale of shares of stock in the Fund to Mr. Harvey Polly. See discussion in Item 1. Description of Business and Item 6. Management's Discussion and Analysis or Plan of Operation for details of this change in control.\nSubsequent to the February 15, 1995 acquisition of the Fund by Mr. Polly, the following individuals were appointed to serve as directors and the executive officers of the Fund:\nHarvey Polly Director, President and Chief Executive Officer Morton I. Kalb Director, Vice President and Chief Financial Officer Willis G. Ryckman Director Leo Yarfitz Director\nHARVEY POLLY, age 66, is a director and president and chief executive officer of the Fund. Mr. Polly also serves as the chief executive officer and a stockholder of H\/R Industries, Inc. H\/R Industries, Inc. is essentially a personal holding company which was formed in 1984 under the name Helena Rubinstein, Inc. and was engaged from 1984 until 1988 in various aspects of the cosmetics business. In 1988, the name of the corporation was changed to Elite Industries, Ltd., and in 1990 the name was changed to H\/R Industries, Inc. Mr. Polly has been involved in the railroad business for approximately 20 years. In 1973 he founded and became a major stockholder in Emons Industries, Inc., which was formed on the basis of the acquisition of the Maryland and Pennsylvania Railroad Company. Since the founding of Emons Industries, Mr. Polly has been involved in the railroad freight car business. Mr. Polly has been, since 1975, Chief Financial Officer and a stockholder of Railway Freight Car Services, Inc., which is involved in the railroad boxcar leasing business. In 1984 and 1985, Mr. Polly was Chairman of CAGY Industries, Inc., the publicly held holding company for the Columbus and Greenville Railway, the Chattooga & Chickamauga Railway and the Redmont Railway and was the largest stockholder with approximately 40% of the outstanding shares of common stock. Mr. Polly sold his shares and resigned from the Board effective February 16, 1995. Since 1988 he has served on the Board of Directors of the Delaware Otsego Corp., which is a publicly held corporation that operates the New York Susquehanna Railroad. In prior years, Mr. Polly was also a stockholder and heavily involved in the operations of the Louisiana Midland Railroad. He is also presently a stockholder and officer of SLF of Martin County, Inc., a real estate development company. From 1987 to 1990 he was a principal shareholder, Chief Executive Officer and Director of Hanover Bank of Florida, a publicly held corporation.\nMORTON I. KALB, age 61, is a director, vice president and chief financial officer of the Fund. Mr. Kalb has served as vice president of H\/R Industries, Inc., since July 1984. Mr. Kalb is also a certified public accountant.\nWILLIS G. RYCKMAN, age 50, is a director of the Fund. Mr. Ryckman has served as chairman of the Board of Directors of Tri-Tech Labs since August 1990. From December 1966 through August 1990, Mr. Ryckman was senior vice president of Manufacturers Hanover Trust Company.\nLEO YARFITZ, age 79, is a director of the Fund. Mr. Yarfitz has been a financial consultant with Sterling Management of Florida since June 1990. From October 1987 until October 1989, Mr. Yarfitz served as Chief Financial Officer of Hanover Bank of Florida. From October 1989 until December 1989, Mr. Yarfitz served as President of Hanover Bank of Florida.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. EXECUTIVE COMPENSATION\nA. DIRECTOR COMPENSATION\nPrior to February 15, 1995, the Independent Directors were paid an annual fee of $15,000, payable quarterly, plus $875 for each Board meeting, including meetings of the audit committee, attended in person and $250 an hour for each Board meeting, including meetings of the audit committee, attended via telephonic conference call. In addition, each Director was reimbursed for out- of-pocket expenses incurred in attending meetings of the Board. On February 15, 1995 a change in control of the Fund occurred pursuant to the closing of the sale of shares of common stock in the Fund to Mr. Harvey Polly. (See discussion in Item 1. Description of Business and Item 6. Management's Discussion and Analysis or Plan of Operation.) To date, no arrangements or decisions have been made with respect to payments to the new directors for their service on the Fund's Board of Directors.\nB. EXECUTIVE COMPENSATION\nCompensation paid to executive officers for the years ended December 31, 1994, 1993 and 1992 is as follows:\nAnnual Compensation\nOther Annual Compen- Year Salary Bonus(2) sation Leonard G. Levine, 1994 $41,554 $ 376 n\/a President & Chief 1993 $41,554 $30,633 n\/a Executive Officer (1) 1992 $41,554 $15,018 n\/a\nLong-Term Compensation Awards Payouts Restricted All Other Stock Options\/ LTIP Compen- Year Award(s) SARs (#) Payouts sation\nLeonard G. Levine, 1994 n\/a n\/a n\/a n\/a President & Chief 1993 n\/a n\/a n\/a n\/a Executive Officer (1) 1992 n\/a n\/a n\/a n\/a\n(1) No executive officer earned more than $100,000 in salary and bonus. (2) See incentive compensation program disclosure below.\nUntil February 15, 1995, Mr. Levine served as President of the Fund pursuant to an employment agreement entered into January 1, 1990. This agreement provided that Mr. Levine was to be employed through December 31, 1994 with automatic one year renewals unless either the Fund or Mr. Levine gave the other notice of termination before March 31 preceding the end of the current employment period.\nIn consideration of his employment, Mr. Levine received annual compensation from the Fund equal to $41,554 per year. In addition to his base salary, Mr. Levine could have been granted a bonus at the discretion of the Board of Directors of the Fund. Further, Mr. Levine was eligible to receive compensation under an incentive compensation program included in his contract. Mr. Levine's incentive compensation earnings were calculated based on the following four components: (i) 0.56% of the amount of the Fund's collateralized claims which were converted into cash; (ii) 1.35% of the amount of the Fund's unsecured claims which were converted into cash; (iii) the percentage increase in the Fund's market capitalization between January 1, 1990 and the end of each calendar year (0.25% of the first 10% increase, .50% of the next 10% increase and 1.00% of any increase in excess of 20%); and (iv) 0.1% of the amount of cash distributions to stockholder of the Fund. The total incentive compensation that Mr. Levine was permitted receive in any year (on a cumulative basis) from the Fund was subject to certain limitations. Any amounts in excess of these limits would have been deferred.\nPursuant to the terms of the August 3, 1994 agreement, as amended, between the Fund and Mr. Polly (see Item 1. Description of Business), on February 15, 1995, Mr. Levine resigned as President of the Fund. In accordance with the terms of his employment agreement, Mr. Levine was paid a total of $61,160 representing a severance payment equal to one year's salary, all incentive compensation earned through the date of his termination, and an amount equal to the full cost of continuing Mr. Levine's health benefits for one year.\nTo date, no arrangements or decisions have been made with respect to compensation to be paid to the Fund's new executive officers. The new Board of Directors will create a compensation committee which will recommend to the Board the compensation to be paid to the Fund's executive officers.\nITEM 11.","section_11":"ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of March 16, 1994, the following persons or entities were known by the Fund to be the beneficial owner of more than five percent (5%) of the outstanding shares of common stock of the Fund:\nName of Amount and Nature of Percent Title of Class Beneficial Owner Beneficial Ownership of Class\nShare of Common Mr. Harvey Polly 3,380,983 Shares 27% Stock, $.01 Par Value\nThe following table sets forth the ownership of shares owned directly or indirectly by the directors and principal officers of the Fund as of March 16, 1995:\nName of Amount and Nature of Percent Title of Class Beneficial Owner Beneficial Ownership of Class\nShare of Common Mr. Harvey Polly, 3,380,933 Shares 27% Stock, $.01 Par Director, Value President and Chief Executive Officer\nShares of Common Mr. Morton I. Kalb, 75,000 Shares 1% Stock, $.01 Par Director, Vice Value President and Chief Financial Officer Shares of Common Mr. Leo Yarfitz, 100,000 Shares 1% Stock, $.01 Par Director Value\nShares of Common All Directors and 3,555,983 Shares 29% Stock, $.01 Par Officers of the Value Fund, as a group (6 persons)\nITEM 12.","section_12":"ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAs a result of the acquisition of the Fund by Mr. Polly (See Item 1. Description of Business), the Administrative Services Agreement with Banyan Management Corp. was terminated on February 15, 1995. Banyan Management Corp. had performed certain administrative and accounting services on behalf of the Fund for which it was reimbursed at cost. Banyan Management Corp. is owned by the Banyan Funds for which it provides services. Prior to February 15, 1995, the Fund had been a stockholder of Banyan Management Corp. Mr. Levine is the president of Banyan Management Corp. for which he receives no compensation. Messrs. Hansen, Higgins and Teglia were employees of the Fund but are compensated by Banyan Management Corp., and their compensation was included in the administrative costs charged by Banyan Management Corp. to and reimbursed by the Fund. The directors\/trustees of all the Banyan Funds serve as directors of Banyan Management Corp. but receive no additional compensation. Prior to February 15, 1995, the Fund's directors had also served as directors of Banyan Management Corp. Administrative costs reimbursed by the Fund to Banyan Management Corp. for the year ended December 31, 1994, 1993 and 1992 totalled $96,917, $119,404 and $150,344, respectively. Banyan Management Corp. charges its operating expenses among the Banyan Funds for which it performs services and acts as a common paymaster for the Fund. As of December 31, 1994, the Fund had a net receivable from Banyan Management Corp. of $4,239.\nReference is made to Note 5 of the Notes to the Consolidated Financial Statements for the amount of administrative costs paid to, and a description of various transactions with Banyan Management Corp.\nITEM 13.","section_13":"ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1)(2) The financial statements indicated in Part II, Item 7, Financial Statements.\n(3) Exhibit (2) Plan of organization, reorganization, management, liquidation or succession; Exhibit (21) Subsidiaries of the Fund\nThe following exhibits are incorporated by reference from the Registrant's Registration Statement on Form S-11 (file number 2-96565), referencing the exhibit number used in such Registration Statement.\nExhibit Number Description\n(3)(a) Certificate of Incorporation (3)(b) By-Laws\n(b) No reports on Form 8-K were filed during the quarter ending December 31, 1994.\n(c) See Item 13(a)(3) above.\n(d) None.\nAn annual report will be sent to the shareholders subsequent to this filing and the Fund will furnish copies of such report to the Commission at that time.\nSIGNATURES\nPURSUANT to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.\nBANYAN HOTEL INVESTMENT FUND\nBy: \/s\/Harvey Polly Date: March 30, 1995 Harvey Polly, Director, President and Chief Executive Officer\nPURSUANT to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nBy: \/s\/Harvey Polly Date: March 30, 1995 Harvey Polly, Director, President and Chief Executive Officer\n\/s\/Morton I. Kalb Date: March 30, 1995 Morton I. Kalb, Director, Vice President and Chief Financial Officer\n\/s\/Willis Ryckman Date: March 30, 1995 Willis Ryckman, Director\n\/s\/Leo Yarfitz Date: March 30, 1995 Leo Yarfitz, Director\nEXHIBIT 21\nSUBSIDIARY OF BANYAN HOTEL INVESTMENT FUND\nName of subsidiary State of Organization\nBHF Merger Corp. Illinois\nBMC Santa Barbara Corp. Illinois\nBANYAN HOTEL INVESTMENT FUND INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPages\nReport of Independent Auditors\nConsolidated Balance Sheets as of December 31, 1994 and 1993\nConsolidated Statements of Income and Expenses 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 to\nAll 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 and notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nTo the Stockholders of Banyan Hotel Investment Fund\nWe have audited the accompanying consolidated balance sheets of Banyan Hotel Investment Fund as of December 31, 1994 and 1993, and the related consolidated statements of income and expenses, 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 Fund'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 Banyan Hotel Investment Fund 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.\nERNST & YOUNG LLP\nChicago, Illinois February 15, 1995\nBANYAN HOTEL INVESTMENT FUND CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993\n1994 1993 ASSETS Cash and Cash Equivalents $ 275,161 $ 2,443,797 Investment Securities 1,907,531 --- Interest Receivable on Cash and Cash Equivalents and Investment Securities 16,279 29,131 Mortgage Loans in Sub- stantive Foreclosure --- --- Prepaid Insurance 40,091 59,056 Net Investment in Liquidating Trust --- 4,939 Investment in Partnership --- --- Other Assets 31,461 235,483 ------------ ------------ Total Assets $ 2,270,523 $ 2,772,406 ============ ============\nLIABILITIES AND STOCKHOLDERS' EQUITY\nLiabilities Accounts Payable and Accrued Expenses $ 111,197 $ 162,104 ------------ ------------\nCommitments and Contingencies --- ---\nStockholders' Equity Shares of Common Stock $0.01 Par Value, 20,000,000 Shares Authorized, 10,355,799 Shares Issued 87,027,338 87,027,338 Accumulated Deficit (84,794,685) (84,408,847) Unrealized Losses on Investment Securities (65,138) --- Treasury Stock, At Cost, for 32,757 Shares of Common Stock (8,189) (8,189) ------------ ------------\nTotal Stockholders' Equity 2,159,326 2,610,302 ------------ ------------ Total Liabilities and Stockholders' Equity $ 2,270,523 $ 2,772,406 ============ ============ Book Value Per Share of Common Stock (10,323,042 $ 0.21 $ 0.25 Shares Outstanding) ============ ============\nThe accompanying notes are an integral part of the consolidated financial statements.\nBANYAN HOTEL INVESTMENT FUND CONSOLIDATED STATEMENTS OF INCOME AND EXPENSES FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1994 1993 1992 INCOME Interest Income on Cash and Cash Equivalents $ 18,305 $ 85,931 $ 113,104 Interest Income on Investment Securities 120,298 --- --- ----------- ----------- ----------- Total Income 138,603 85,931 113,104 ----------- ----------- ----------- EXPENSES (Recovery of) Provision for Losses on Mortgage Loans, Notes and Interest Receivable (16,788) (32,770) 2,606,600\nOther Expenses: Stockholder Expenses 76,620 92,298 134,087 Directors' Fees, Expenses and Insurance 260,670 300,428 280,681 Other Professional Fees 122,444 127,098 429,155 General and Administrative 172,188 230,287 240,651 ----------- ----------- ----------- Total Other Expenses 631,922 750,111 1,084,574 ----------- ----------- ----------- Recovery of Class Action Settlement Costs and Expenses (90,693) --- --- ----------- ----------- ----------- TOTAL EXPENSES 524,441 717,341 3,691,174 ----------- ----------- ----------- Operating Loss (385,838) (631,410) (3,578,070) Net Loss From Investment in Partnership --- --- (3,749,581) Gain on Disposition of Real Estate Held for Sale --- 143,329 --- ----------- ----------- ----------- Net Loss $ (385,838) $ (488,081) $(7,327,651) =========== =========== =========== Net Loss Per Share of Common Stock (Based on Weighted Average Number of Shares Outstanding of 10,323,042 for 1994 and 1993 and 10,324,388 for 1992) $ (0.04) $ (0.05) $ (0.71) =========== =========== ===========\nThe accompanying notes are an integral part of the consolidated financial statements.\nBANYAN HOTEL INVESTMENT FUND CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nUnrealized losses on Investment Shares of Common Stock Securities Shares Amount\nStockholders' Equity, (Deficit) December 31, 1991 10,355,799 $87,027,338 $ ---\nAcquisition of 32,757 Shares of Treasury Stock --- --- ---\nNet Loss for the Year Ended December 31, 1992 --- --- ---------- ------------ ------------\nStockholders' Equity (Deficit) December 31, 1992 10,355,799 87,027,338 ---\nNet Loss For The Year Ended December 31, 1993 --- --- --- ---------- ------------ ------------\nStockholders' Equity (Deficit) December 31, 1993 10,355,799 87,027,338 ---\nNet Loss For The Year Ended December 31, 1994 --- --- ---\nMarket Adjustment December 31, 1994 --- --- (65,138) ---------- ----------- ------------\nStockholders' Equity (Deficit) December 31, 1994 10,355,799 $ 87,027,338 $ (65,138) ========== ============ =============\nBANYAN HOTEL INVESTMENT FUND CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (CONTINUED)\nAccumulated Treasury Deficit Stock Total\nStockholders' Equity, (Deficit) December 31, 1991 $(76,593,115) $ --- $10,434,223 Acquisition of 32,757 Shares of Treasury Stock --- (8,189) (8,189)\nNet Loss for the Year Ended December 31, 1992 (7,327,651) --- (7,327,651) ------------ --------- -----------\nStockholders' Equity (Deficit) December 31, 1992 (83,920,766) (8,189) 3,098,383\nNet Loss For The Year Ended December 31, 1993 (488,081) --- (488,081) ------------ --------- -----------\nStockholders' Equity (Deficit) December 31, 1993 (84,408,847) (8,189) 2,610,302\nNet Loss For The Year Ended December 31, 1994 (385,838) --- (385,838)\nMarket Adjustment December 31, 1994 --- --- (65,138) ------------ --------- -----------\nStockholders' Equity (Deficit) December 31, 1994 $(84,794,685) $ (8,189) $ 2,159,326 ============= ========= ===========\nThe accompanying notes are an integral part of the consolidated financial statements.\nBANYAN HOTEL INVESTMENT FUND CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1994 1993 1992 CASH FLOWS FROM OPERATING ACTIVITIES:\nNET LOSS $ (385,838) $ (488,081) $(7,327,651)\nAdjustments to Reconcile Net Income (Loss) to Net Cash Used In Operating Activities: (Recovery of) Pro- vision for Losses on Mortgage Loans, Notes and Interest Receivable 4,939 (4,939) 2,606,600 Amortization of Pre- mium on Investment Securities 4,096 --- --- Gain On Dispositions of Real Estate Held For Sale --- (143,329) --- Net Loss From Oper- ations of Fore- closed Real Estate Held For Sale and Investment in Partnership --- --- 3,749,581 Net Change In: Interest Receivable on Cash and Cash Equivalents and Investment Securities 12,852 24,533 (26,128) Prepaid Insurance 18,965 55,219 (55,317) Other Assets 204,022 (11,163) 246,636 Accounts Payable and Accrued Expenses (50,907) (134,438) (2,806,203) ----------- ----------- ----------- Net Cash Used In Operating Activities (191,871) (702,198) (3,612,482) ----------- ----------- -----------\nCASH FLOWS FROM INVESTING ACTIVITIES: Purchase of Investment Securities (2,126,765) --- --- Proceeds from Maturity of Investment Securities 150,000 --- --- Recovery from Invest- ment in Partnership --- 506,695 ---\nPrincipal Collections on Mortgage Loans --- --- 4,735,493 ----------- ----------- ----------- Cash (Used In) Provided By Investing Activities (1,976,765) 506,695 4,735,493 ------------ ------------ ------------ CASH FLOWS USED IN FINANCING ACTIVITIES: Acquisition of Treasury Stock --- --- (8,189) ----------- ----------- ----------- Cash Used In Financing Activities --- --- (8,189) ----------- ----------- -----------\nNet (Decrease) Increase in Cash and Cash Equivalents (2,168,636) (195,503) 1,114,822\nCash and Cash Equi- valents at Beginning of Year 2,443,797 2,639,300 1,524,478 ----------- ----------- -----------\nCash and Cash Equi- valents at End of Year $ 275,161 $ 2,443,797 $ 2,639,300 =========== =========== ===========\nThe accompanying notes are an integral part of the consolidated financial statements.\nBANYAN HOTEL INVESTMENT FUND NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. BASIS OF PRESENTATION\nBanyan Hotel Investment Fund (the \"Fund\") was organized under the laws of the State of Massachusetts, pursuant to a Declaration of Trust filed March 19, 1985, and subsequently reorganized as a Delaware corporation on March 13, 1987.\nThe accompanying consolidated financial statements include the accounts of the Fund and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.\nB. INCOME TAXES\nFor the years ended December 31, 1994, 1993 and 1992, the Fund continued to be treated as a real estate investment trust (\"REIT\") under Internal Revenue Code Sections 856-860. In order to qualify, the Fund is required to distribute at least 95% of its taxable income to stockholders and meet asset and income tests as well as certain other requirements. However, if these requirements had not been met as of December 31, 1994, loss of REIT status would not significantly affect the Fund's current tax position.\nAs of December 31, 1994, the investment securities and the mortgage loan in substantive foreclosure have a basis of $1,972,669 and $5,154,000, respectively, for income tax purposes. In addition, unsecured notes receivable, which have a tax basis of $25,405, have not been accorded any value for financial reporting purposes.\nAs of December 31, 1994, the Fund had a net operating loss carry forward of approximately $74,000,000 which expires in 2005, 2006, 2007, 2008 and 2009. The utilization of the net operating losses may be subject to limitations contained in the Internal Revenue Code.\nC. INCOME (LOSS) PER SHARE\nFor 1992, a weighted average number of shares, 10,324,388 was used for calculating earnings per share due to the acquisition of 32,757 shares of Treasury Stock by the Fund on January 16, 1992. For 1994 and 1993, earnings per share was calculated using the 10,323,042 shares outstanding during the years.\nD. CASH AND CASH EQUIVALENTS\nThe Fund considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash and cash equivalents.\nE. INVESTMENT SECURITIES\nEffective January 1, 1994, the Fund adopted the provisions of Financial Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities. Accordingly, Investment Securities are classified as available for sale and carried at fair value, as determined by quoted market prices, with unrealized gains and losses reflected in the Statements of Shareholder Equity. Realized gains and losses are determined on a specific identification basis. The carrying value of investment securities is adjusted for amortization of premiums and discounts using a level yield method.\nF. RECLASSIFICATIONS\nCertain 1993 and 1992 amounts have been reclassified to conform to the 1994 financial statement presentation. These reclassifications have not changed 1993 or 1992 operating results.\n2. INVESTMENT SECURITIES\nThe Fund's investment securities portfolio at December 31, 1994 is as follows: Amortized Cost Net of Principal Paydowns Estimated Market Received Value at Dec. Title of Each Issue Dec. 31, 1994 31, 1994 (2) and Name of Issuer\nFederal National Mortgage Assn. (1) 8.00%, 1\/20\/94- 2\/25\/2005 $1,066,836 $1,042,125\nFederal National Mortgage Assn. (1) 5.00%, 1\/20\/94- 9\/25\/2011 905,833 865,406 ---------- ---------- $1,972,669 $1,907,531 ========== ==========\n(1) The Guaranteed REMIC Pass-Through Certificates are guaranteed as to timely payment of principal and interest by the Federal National Mortgage Association. The maturity of the principal of the above investment securities is dependent upon the repayment of the underlying U.S. Agency sponsored mortgages. The rate of repayment is dependent upon the current market level of interest rates on mortgage loans as it relates to the interest rates of the mortgages underlying each REMIC security. The expected maturity of these investment securities, under the market conditions as of the fourth quarter of 1994, is expected to be from February 25, 2005 to February 25, 2011. These expectations may change as interest rates on mortgage loans change.\n(2) The Fund has recorded a market adjustment of $65,138 representing unrealized losses on its investment securities based on current market values at December 31, 1994.\n3. MORTGAGE LOANS RECEIVABLE IN SUBSTANTIVE FORECLOSURE\nOMNI PARK CENTRE\nOn June 17, 1987, the Fund issued a $5,154,600 third mortgage loan to Park Centre Associates (the \"Borrower\") which was collateralized by the Omni Park Hotel (the \"Property\") located in New York, New York. On July 19, 1991 the Fund was served with a summons in a mortgage foreclosure action filed by Sheraton Holding Inc. (\"Sheraton\") in the Superior Court of New York, New York. Sheraton sought to foreclose on its $54,000,000 first mortgage collateralized by the Property. The Sheraton foreclosure action was based on monetary defaults by the Borrower. On September 30, 1991 the Fund filed a counterclaim to the Sheraton foreclosure action. In addition, the second mortgage on the property in the amount of approximately $5,600,000 is also in default and the holder of the mortgage has filed a counterclaim to the foreclosure with the court. On June 12, 1992, the Borrower filed for protection under the U.S. Bankruptcy Code. On June 30, 1992, an order was entered in the Bankruptcy Court between the Fund, Sheraton, the second mortgage holder and the Borrower authorizing and restricting the use of cash collateral by the Borrower. During 1992, the Fund recorded a provision for losses for the remaining carrying balance of the loan ($2,606,600) which is considered in substantive foreclosure.\nIn May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan (\"FAS 114\"). FAS 114 would require the Fund to reclassify Mortgage Loans in Substantive Foreclosure to Mortgage Loans Receivable with an appropriate allowance for loan losses determined based on consideration of the fair value of the collateral or discounted future cash flows to be received. The Fund does not anticipate any material impact to its financial statements and will adopt FAS 114, as required, effective January 1, 1995.\n4. INVESTMENT IN PARTNERSHIP\nIn 1991, in connection with a release from liability related to a loan made by the Fund, the Fund acquired a 50% interest in the partnership which owns the Santa Barbara Biltmore Resort. The 50% limited partnership interest in the Santa Barbara Biltmore Partnership was recorded by the Fund at its estimated fair market value of $5,769,000 and was accounted for on the equity method. This method resulted in the Fund recognizing a loss of $3,749,581 for the year ended December 31, 1992. The 1992 amount included an additional loss of $861,691 to reduce the investment's carrying value to $506,695, representing the amount due to the Fund from certain funds held in escrow. The $506,695 was received by the Fund on February 3, 1993 and was recorded by the Fund as a reduction in the investment carrying value. The Fund did not record losses related to its interest in the Santa Barbara Biltmore during 1994 and 1993 since the carrying value of the partnership interest was reduced to zero as of December, 1992, and the Fund has no obligation to make additional capital contributions to, or to pay the liabilities of, the partnership.\n5. TRANSACTIONS WITH AFFILIATES\nAdministrative costs, primarily salaries and general and administrative expenses, are reimbursed by the Fund to Banyan Management Corp. (\"BMC\"). Effective January 1, 1993, these costs are charged to each Banyan Fund based upon the actual number of hours spent by BMC personnel on matters related to that Fund. During 1992, these costs were allocated among the Banyan Funds 25% equally and 75% based on the percentage which each of the Banyan Fund's net book value, less cash and cash equivalents, represented of the total net book value less cash and cash equivalents, of all Banyan Funds. The Fund's costs for the year ended December 31, 1994 were $96,917 compared to $119,404 and $150,344 for 1993 and 1992, respectively.\nPrior to the February 15, 1995 acquisition of the Fund by Mr. Polly (see Note 10), as one of its administrative services, BMC served as the paying agent for general and administrative costs of the Fund. As part of providing this payment service, BMC maintained a bank account on behalf of the Fund. At December 31, 1994, the Fund had a net receivable from BMC of $4,239.\n6. INVESTMENT IN LIQUIDATING TRUST\nOn November 18, 1993, in final settlement of guarantees of VMS Realty Partners of loans made by the Fund in prior years, the Fund received a cash distribution of $27,831 and an interest in a liquidating trust established for the benefit of the unsecured creditors of VMS. As of December 31, 1993, the Fund valued its interest at $4,939 representing its pro rata portion of the cash assets of the trust. During 1994 and 1993, the Fund has recorded $16,788 and $32,770, respectively, on its Statement of Income and Expenses as a recovery of the Provision for Losses on Mortgage Loans, Notes and Interest Receivable related to the distributions received from the liquidating trust. The $16,788 net recovery recorded in 1994 includes the $34,764 distribution received net of an estimated $13,037 due to the Class Action Settlement Fund representing the Fund's share of amounts due per the terms of the previously settled VMS Securities litigation.\n7. TREASURY STOCK\nOn January 16, 1992 the Fund acquired 32,757 shares of its common stock for which were previously held by VMS Realty Partners for $8,189.\n8. RECOVERY OF CLASS ACTION SETTLEMENT COSTS AND EXPENSES\nOn January 25, 1994, the Fund received net proceeds of $90,693 relating to a recovery of payments previously made into an escrow established as part of the 1992 class action settlement of the VMS securities litigation. The escrow was established to provide the directors of the Fund with monies to fund the cost of any litigation in which they may be named as defendants post settlement of the class action. Subsequently, the directors released the proceeds from the escrow, and the Fund purchased an insurance policy to cover the directors.\n9. OTHER ASSETS AND GAIN ON DISPOSITION OF REAL ESTATE\nEffective December 20, 1993, the Fund and the unaffiliated third party which purchased the Silver Sands Motel property from the Fund in October, 1991 (\"the Buyer\") jointly agreed to terminate an escrow established at the time of the sale to be used in connection with monitoring various environmental issues at the property. In anticipation of the final approval regarding the environmental issues by local authorities, the Fund and the Buyer determined that the necessary work was substantially complete and the escrow, which originally contained $327,000, was no longer required. After deducting the cost of the environmental work performed, the remaining balance of the escrow account was approximately $193,000 which had been classified by the Fund as an other asset. On January 10, 1994, the Fund paid the Buyer $50,000, representing the final settlement of the escrow. For the year ended December 31, 1993, the Fund recorded a gain in disposition of real estate of $143,329 representing the amount of its recovery from the escrow.\n10. SUBSEQUENT EVENTS\nOn February 15, 1995, a change in control of the Fund occurred pursuant to the closing of the sale of shares of common stock in the Fund to Mr. Harvey Polly pursuant to a purchase agreement. Mr. Polly's tender offer, which commenced on December 28, 1994, concluded on January 26, 1995, and resulted in the tender to Mr. Polly of 1,288,217 shares of common stock, or 12.5% of the Fund's then outstanding shares of common stock, for a cash price of $0.35 per share. Subsequent to the closing of the tender offer, the terms of the purchase agreement also required Mr. Polly to purchase from the Fund a number of shares sufficient to allow Mr. Polly to own, by virtue of the combination of the tender offer and the share purchase, not less than 3,335,000 and not more than 40% of the shares of common stock after giving effect to the shares issued in connection with the purchase. On February 15, 1995, per the purchase agreement Mr. Polly purchased 2,047,766 newly issued shares of common stock of the Fund for a cash price of $0.22 per share. Upon the acquisition of the aforesaid shares from the Fund, when combined with the shares of common stock previously owned and acquired pursuant to the tender offer, Mr. Polly is the beneficial owner of 3,335,983 shares, or approximately 27% of the Fund's outstanding voting shares of common stock.","section_14":"","section_15":""}
{"filename":"74783_1994.txt","cik":"74783","year":"1994","section_1":"ITEM 1. BUSINESS\nCOMPANY STRATEGY\nAcceptance is engaged in the property and casualty insurance business concentrating on writing specialty coverages not generally emphasized by standard insurance carriers. The Company selects underwriting specialties within the property and casualty insurance industry that provide a diversified portfolio of products, with the goal of producing underwriting results better than the industry average.\nThe Company has expanded its business through internal growth and through acquisitions. The Company regularly explores opportunities, including through acquisition, where it believes it can achieve profitable results, often by taking advantage of capacity shortages or other dislocations in the market. The Company's most significant recent acquisition was its purchase in July 1993 of The Redland Group, Inc. (\"Redland\"), a leading writer of multi-peril crop insurance and of crop hail insurance.\nAcceptance's strategy is to develop perceived market opportunities by attracting and supporting underwriters and other managers with proven expertise who have dedicated their careers to understanding a particular segment of the insurance industry. The Company allocates its capital among its product lines depending on where it believes the best underwriting opportunities exist at any given time. In 1993, the Company expanded its General Agency segment by hiring four experienced executives who previously served a large national specialty insurer.\nThe Company underwrites its products through its five wholly-owned insurance company subsidiaries: (i) Acceptance Insurance Company (\"Acceptance Insurance\"), Acceptance Indemnity Insurance Company (\"Acceptance Indemnity\") and American Growers Insurance Company (\"American Growers\"), each domiciled in Nebraska; (ii) Redland Insurance Company (\"Redland Insurance\"), domiciled in Iowa; and (iii) Phoenix Indemnity Insurance Company (\"Phoenix Indemnity\"), domiciled in Arizona (the Company's insurance subsidiaries are collectively referred to herein as the \"Insurance Companies\"). Each of the Insurance Companies is rated A- (Excellent) by A.M. Best, with the exception of American Growers to which the A.M. Best rating system does not apply. A.M. Best bases its ratings upon factors that concern policyholders and agents, and not upon factors concerning investor protection.\nThe Company positions itself as both an admitted (licensed) and non-admitted (excess and surplus lines) carrier in order to afford the flexibility to operate through various distribution channels and react to different market conditions and opportunities. The Insurance Companies operate on an admitted carrier basis in 44 states and the District of Columbia and on a non-admitted carrier basis in 42 states, the District of Columbia and the Virgin Islands.\nThe Company seeks to structure reinsurance programs to reduce volatility in its business segments as well as to mitigate catastrophic or large loss exposure.\nINSURANCE SEGMENTS\nThe Company's principal business segments are:\nA. General Agency which includes specialty automobile, surplus lines liability and substandard property, and complex products and professional liability coverages. These business lines are marketed through the Company's general agency system which includes approximately 120 general agents.\nB. Rural America which includes crop insurance programs and property and casualty coverages for the rural marketplace. These business lines are marketed by over 9,000 independent insurance agents.\nC. Program, which includes transportation, focused workers' compensation and used automobile dealer programs. This business is marketed primarily through independent insurance agents.\nD. Non-Standard Automobile which provides coverages for private passenger automobiles and is written principally in the southwestern United States. This business is marketed through independent insurance agents.\nThe following table reflects the amount of net written premium for these four insurance segments for the periods set forth below.\n------------------------- (1) Premiums for Redland operations are included beginning July 1, 1993. Redland's operations include auto liability, crop hail, commercial multi-peril, fire and other allied lines and farmowners coverage, as well as Multi-Peril Crop Insurance.\n(2) For a discussion of the accounting treatment of MPCI premiums, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- General.\"\n- 2 -\nWith respect to the business written in the Company's four business segments, the following table sets forth the Company's gross written premium and net written premium by principal lines of business. Certain lines of business are written in more than one of the Company's business segments.\n------------------------- (1) Principally comprised of inland marine and surety coverages.\n(2) For MPCI, gross written premium consists of the aggregate amount of MPCI premiums paid by farmers, and does not include any related federal premium subsidies. For 1994, net written premium included in this table consists of the profit share of $17.0 million earned by the Company, net of $3.9 million in third party reinsurance costs. Since no MPCI profit share was earned in 1993, net premium written for MPCI shown for that year consists solely of the cost of third party reinsurance. For further discussion of the accounting treatment of MPCI premiums, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- General.\"\nThe increase in the Company's gross written premiums in 1994 compared to 1993 as shown in the table above was primarily the result of its acquisition of Redland, effective July 1, 1993. Redland's operations include auto liability, crop hail, commercial multi-peril, farmowners, fire and other allied lines, as well as MPCI. The increase in gross written premiums was also due in part to an increase in premiums in the General Agency segment, primarily in the general liability and commercial multi-peril lines, as a result of increased volume following the hiring in August 1993 of four experienced executives from another insurer. See \"-- General Agency\" below.\nThe principal factors behind the increase in net written premiums include the Company's retention of a higher proportion of its gross written premiums in several lines (principally auto liability and general liability) in 1993 as compared to 1992 as a result of improved capitalization of the Insurance Companies, which permitted them to cede less of their gross premiums written to reinsurers. In addition, the Company retained a higher proportion of its crop hail gross premiums written in 1994 than in 1993 due to substantial increases in the cost of third party reinsurance following unfavorable results from this business in 1993 and 1992.\nGENERAL AGENCY\nProducts. Specialty insurance coverages written by the General Agency segment include the following principal lines:\nSpecialty Automobile, including liability and physical damage coverages for local haulers of specialized freight, public livery and other classes of motor vehicles not normally underwritten by standard carriers.\nExcess and Surplus Lines Liability and Substandard Property Coverages, including general liability and commercial multi-peril coverages for small businesses which normally do not satisfy the underwriting criteria of standard carriers, such as small contractors, day care centers, automobile service centers and older apartment buildings, offices and motels.\nComplex General Liability Risks, including products and professional liability which primarily are written on a non-admitted basis and a substantial amount of which the Company reinsures.\nMarketing. General Agency business is written through a system of approximately 120 general agents who have received binding authority from the Company for specific lines of business. Insureds are generally small-to-medium sized businesses, and the Company provides agents with manuals which provide specific rules for quoting, binding and issuing insurance policies to these insureds. Risks that are too large or involve more complex coverages are submitted to the home office and quoted by the home office underwriters. The Company believes that a key to profitability in this division is in the choice of general agents within each geographic area. The Company seeks out general agents with top reputations and long standing relationships with independent insurance agents in a specific geographic area.\nGeneral agents are compensated primarily through commissions and to a lesser extent through a profit sharing plan based on the accident year experience of each agency, under which profits are paid out over a four-year period beginning in the year immediately following the accident year. The Company's agency agreements with its general agents may generally be terminated by either party without cause on 30 days' notice.\nIn August 1993, the Company expanded the General Agency segment by hiring four experienced executives who previously managed a division of a large national specialty property and casualty insurer which underwrote a substantial book of specialty insurance. This group brought significant underwriting expertise and agency contacts to the Company, especially in excess and surplus lines liability and substandard property coverages. Since joining the Company, this group has been responsible for the appointment of 28 new general agents and an increase in gross premiums written in these lines to approximately $65 million in 1994 from approximately $25 million in 1993.\nA subdivision within the General Agency segment consists of the complex general liability risks underwritten through Acceptance Risk Managers, Inc. (\"ARM\"), an independent general agent formed under Company sponsorship. This segment writes larger, long-tail risks, all of which are processed by ARM with respect to premium quotation, binding and policy issuance. ARM works with approximately 30 general agents who operate principally as wholesale intermediaries between the retail agent and ARM. These wholesalers, which do not have binding authority, tend to be well acquainted with the larger retail agencies which generally handle these types of risks, as well as the ways in which coverages can be structured to properly underwrite them.\nThe Company has structured its general agency relationship with ARM so that ARM's business incentives are consistent with the profitability goals of the Company. ARM is paid a flat fee on the first $10 million of gross premium it writes each year, and an additional variable fee equal to a percentage of gross premiums written in excess of the first $10 million, the percentage of which diminishes as premium volume increases. In addition, the Company has structured a profit sharing plan with ARM under which the first profit sharing adjustment in respect of an underwriting year is not paid until four years after the underwriting year\nhas begun, and includes reserves for losses and loss adjustment expenses, including those which have been incurred but not yet reported.\nIn 1994, the Company wrote through ARM gross written premiums of $42.6 million and net written premiums of $12.8 million. To reduce the potential volatility of ARM's long-tail business, the Company cedes 70% of this business to domestic reinsurers rated \"A\" or better by A.M. Best.\nAlthough ARM currently writes business exclusively for the Company, the Company's contract with ARM does not prohibit it from writing for other insurers and can be terminated by either party without cause upon one year's notice.\nRURAL AMERICA\nProducts. The Company's Rural America segment is comprised of its crop insurance programs and standard property and casualty coverages for the rural market.\nCrop Insurance. The two principal lines of the Company's crop insurance business are Multi-Peril Crop Insurance and crop hail insurance. Multi-Peril Crop Insurance is a federally-subsidized program established in 1980 under the Federal Crop Insurance Act which provides farmers who suffer insured crop damage during a growing season with funds needed to continue operating and plant crops for the next season. Under the MPCI program, private insurance companies, in conjunction with the federal government, offer farmers coverage against substantially all natural perils, including droughts, freezes, floods, tornados, insects, hail and other storm damage, excess rainfall, and plant diseases. Farmers purchase crop insurance, including MPCI, to meet risk management needs and are often encouraged or required to do so by their lenders. In 1994, approximately 811,000 MPCI policies were sold by private insurance companies to U.S. farmers, generating approximately $948 million in MPCI Premiums. For the year ended December 31, 1994, the Company was the third largest writer of MPCI business in the United States based on MPCI Premium with a market share of approximately 14%.\nThe size of the national MPCI market is poised to increase in 1995 due to recent changes in law. In response to the substantial costs incurred by the federal government under traditional disaster relief programs due to unprecedented flooding in 1993, in October 1994 Congress adopted significant reforms in the funding and structure of the MPCI program. Among other changes, the Reform Act now requires farmers for the first time to purchase MPCI coverage in order to be eligible for a number of other federally-sponsored farm benefits, including acreage set aside programs, in which farmers are paid to leave a portion of their land unplanted, and crop price supports. As a result, the federal Consolidated Farm Service Agency, which administers the MPCI program, has estimated that the number of acres insured under the MPCI program will increase substantially in 1995. However, there can be no assurance that such an increase will in fact occur or, if such an increase were to occur, that it would result in profitable growth for the Company.\nAlthough the Company writes MPCI business in 37 states, a significant portion (approximately 34% for 1994) of the business upon which the Company retains risk after federal reinsurance is written in Iowa and Nebraska. These states have historically had more consistent crop yields due in part to advantageous weather conditions and the high percentage of farm acres with irrigation systems. In addition, the two leading crops in these states are corn and soybeans, which the Company believes may be less likely to suffer losses than other, less hardy crops. The Company has crop yield history information on over 100,000 farms in the United States which it utilizes in its MPCI business.\nFor a more detailed description of the Company's MPCI business, see \"Business -- Multi-Peril Crop Insurance Program.\"\nIn addition to Multi-Peril Crop Insurance, the Company offers stand alone crop hail insurance, which insures growing crops against damage resulting from hail storms and which involves no federal participation. The Company generally sells crop hail insurance in conjunction with Multi-Peril Crop Insurance. Although both crop hail and MPCI provide insurance against hail damage, under crop hail coverages farmers can receive payments for hail damage which would not be severe enough to require a payment under an MPCI policy. The Company believes that offering crop hail insurance enables it to sell more MPCI policies than it\notherwise would. In addition to crop hail insurance, the Company also sells a small volume of insurance against crop damage from other specific named perils.\nOther Coverages. The Rural America segment also offers to rural agents a line of standard property and casualty coverages, e.g., farmowners, automobile and limited commercial coverages which are marketed to farmers and other customers in rural areas. The Company has found that many rural agencies experience difficulty in finding standard property and casualty coverages for their insureds because many larger insurance companies concentrate on high volume insurance agencies.\nMarketing. The Company markets its crop insurance through approximately 3,800 agencies employing over 7,600 independent agents primarily in the traditional grain belt of the Midwest. The Company believes its success in writing crop business is directly related to its investment in quality sales and service personnel, particularly because there is no price competition with respect to the MPCI product. The Company's agents, who are in many cases farmers themselves, often travel from farm to farm to discuss the benefits of crop insurance in informal, \"kitchen table\" conversations. A substantial number of agencies are equipped with laptop computers and proprietary software which agents use to make presentations to farmers to help them budget their insurance premium dollars and understand the relative benefits of purchasing different levels and combinations of MPCI and crop hail insurance policies. The Company has been an industry leader in the development of this type of marketing software, which permits the agent to directly transmit orders to the Company's on-line computer system and strengthens the relationship between the agent and the Company.\nThe Company markets its other Rural America coverages primarily through the same agents which market its crop insurance. The Company believes it can successfully underwrite this business because it focuses on smaller communities and outlying farms where certain losses tend to occur less frequently than in urban areas.\nRural America agents are primarily compensated based on a percentage of premiums produced. To a lesser degree, agents are also eligible for contingent commissions generally based upon their production volume and profitability.\nPROGRAM\nProducts. The two largest programs are trucking and workers' compensation. Other programs include insurance for temporary help agencies, greyhound race tracks and used car dealers. Trucking coverages include property and casualty coverages for long haul truckers and upper Midwest regional and national trucking companies hauling rural products. The workers' compensation program is based principally in Minnesota and focuses on larger companies, writing policies with minimum annual premiums of $50,000. The Company's workers' compensation strategy is to control voluntary and involuntary costs through the application of intensive claims management techniques which enable clients to improve their loss frequency experience over time.\nMarketing. The Program segment writes insurance generally through highly focused independent agents who specialize in one particular line of business. The Company's workers' compensation program is marketed directly to independent insurance agents who write larger insurance risks. Although the Company's long haul trucking business has historically been written through general agents, the Company generally finds that most of its long haul trucking business is received from a few highly specialized independent insurance agents. In 1991, the Company purchased Seaboard Underwriters, Inc., a national specialist in long haul trucking which also receives its business directly from specialized independent insurance agents. The Company believes that capitalizing on the expertise of specialized agents may provide more consistent results from this line of business. In 1993, with the acquisition of Redland, the Company combined all of its trucking-related business into the Program segment.\nWith respect to agents in the Program segment, commissions are the primary form of compensation. Profit sharing plans have been used sparingly to date, but competitive pressures may induce the Company to offer incentives to producers based on the profitability of their books of business.\nAdditionally, the Company also provides general agency functions for unaffiliated insurers primarily in the trucking business for which it receives commission income.\nNON-STANDARD AUTOMOBILE\nProducts. The Company writes non-standard private passenger automobile coverages principally in the southwestern United States. This product is designed for drivers who are unable to obtain coverage from standard carriers due to prior driving records, other underwriting criteria or market conditions. Such drivers normally are charged higher premium rates than the rates charged for preferred or standard risk drivers and are offered only basic limits of liability in order to meet state financial responsibility laws.\nMarketing. The Company's book of business was developed by a general agency, Statewide, over a period beginning in the mid-1960's. In 1988, the Company formed a joint venture with Statewide to write this book of business through Phoenix Indemnity, which was originally owned 80% by the Company and 20% by Statewide. In 1994, the Company purchased Statewide, thereby acquiring at the same time the remaining 20% of Phoenix Indemnity.\nThe Company currently writes this business through approximately 600 independent agents. The Company's agents in general do not specialize in non-standard automobile coverage and, therefore, the Company may be less likely to compete directly with specialized non-standard automobile companies. The Company's strategy in this segment is to write additional business when attractive opportunities arise; however, the Company is not actively seeking increased market share.\nWith respect to agents in the Non-Standard Automobile segment, commissions are the primary form of compensation. Profit sharing commissions have been used sparingly to date, but competitive pressures may induce the Company to offer incentives to producers based on the profitability of their books of business.\nMULTI-PERIL CROP INSURANCE PROGRAM\nDESCRIPTION OF MPCI PROGRAM\nMulti-Peril Crop Insurance is a federally-subsidized program which is designed to provide participating farmers who suffer insured crop damage with funds needed to continue operating and plant crops for the next growing season. All of the material terms of the MPCI program and of the participation of private insurers such as the Company in the program are set by the federal Consolidated Farm Service Agency (or \"CFSA\") under applicable law.\nMulti-Peril Crop Insurance provides coverage for insured crops against substantially all natural perils. Purchasing an MPCI policy permits a farmer to ensure that his crop yield for any growing season will be at least 50% to 75% (as selected by the farmer at the time of policy issuance) of his historic crop yield. If a farmer's crop yield for the year is greater than the yield coverage he selected, no payment is made to the farmer under the MPCI program. However, if a farmer's crop yield for the year is less than the yield coverage selected, MPCI entitles the farmer to a payment equal to the yield shortfall multiplied by 60% to 100% (as selected by the farmer at the time of policy issuance) of the price for such crop for that season as set by the CFSA.\nIn order to encourage farmers to participate in the MPCI program and thereby reduce dependence on traditional disaster relief measures, the Reform Act establishes a new minimum level of MPCI coverage (\"Basic Coverage\"), which farmers may purchase upon payment of a minimal fixed administrative fee instead of any premium. Basic Coverage insures 50% of historic crop yield at 60% of the CFSA-set crop price per bushel. Basic Coverage can be obtained from private insurers such as the Company or from USDA field offices.\nIn addition to Basic Coverage, MPCI policies that provide a greater level of protection than Basic Coverage are also offered (such policies, \"Buy-up Coverage\"). Most farmers purchasing MPCI historically have purchased at Buy-up Coverage levels, with the most frequently sold policy providing coverage for 65% of historic crop yield at 100% of the CFSA-set crop price per bushel. Buy-up Coverages require payment\nof a premium in an amount determined by formula set by the CFSA. Buy-up Coverage can only be purchased from private insurers. The Company focuses its marketing efforts on Buy-up Coverages, which have higher premiums and which the Company believes will continue to appeal to farmers who desire, or whose lenders encourage or require, revenue protection.\nThe number of MPCI policies written has historically tended to increase after a year, such as 1993, in which many natural disasters adversely affecting crops have occurred, and decrease following a year, such as 1994, in which favorable weather conditions prevail. Although management believes that this historical pattern will be significantly altered by the provisions of the Reform Act which now require farmers to purchase MPCI in order to receive certain other federal benefits, no assurance can be given as to the foregoing.\nREVENUES\nThe Company, like other private insurers participating in the MPCI program, generates revenues from the MPCI program in two ways. First, it markets, issues and administers policies, for which it receives administrative fees; and second, it participates in a profit sharing arrangement in which it receives from the government a portion of the aggregate profit, or pays a portion of the aggregate loss, in respect of the business it writes.\nPROFIT SHARING ARRANGEMENT\nThe Company's share of profit or loss on the MPCI business it writes is determined under a formula established by the CFSA. Under this formula, the primary factors that determine the Company's MPCI profit or loss share are (i) the gross premiums the Company is credited with having written; (ii) the amount of such credited premiums retained by the Company after ceding premiums to certain federal reinsurance pools; and (iii) the loss experience of the Company's insureds. The following discussion provides more detail about the implementation of this profit sharing formula.\nGross Premiums. For each year, the CFSA sets the formulas for determining premiums for different levels of Buy-up Coverage. Premiums are based on the type of crop, acreage planted, farm location, price per bushel for the insured crop as set by the CFSA for that year, and other factors. The federal government will generally subsidize a portion of the total premium set by the CFSA and require farmers to pay the remainder. Cash premiums received by the Company from farmers after the end of a growing season are promptly remitted to the federal government. Although applicable federal subsidies change from year to year, such subsidies will range up to approximately 42% of the Buy-up Coverage premium for 1995 depending on the crop insured and the level of Buy-up Coverage purchased. Federal premium subsidies are recorded on the Company's behalf by the government. For purposes of the profit sharing formula, the Company is credited with having written the full amount of premiums paid by farmers for Buy-up Coverages, plus the amount of any related federal premium subsidies (such total amount, its \"MPCI Premium\").\nAs previously noted, farmers are not required to pay any premium for Basic Coverage. However, for purposes of the profit sharing formula, the Company will be credited with an imputed premium (its \"MPCI Imputed Premium\") for all Basic Coverages it sells. The amount of such MPCI Imputed Premium credited is determined by formula. In general, such MPCI Imputed Premium will be less than 50% of the premium that would be payable for a Buy-up Coverage policy that insured 65% of historic crop yield at 100% of the CFSA-set crop price per bushel, historically the most frequently sold Buy-up Coverage.\nReinsurance Pools. Under the MPCI program, the Company must allocate its MPCI Premium or MPCI Imputed Premium in respect of a farm to one of three federal reinsurance pools, at its discretion. These pools provide private insurers with different levels of reinsurance protection from the CFSA on the business they have written. For insured farms allocated to the \"Commercial Pool,\" the Company generally retains 100% of the risk and the CFSA assumes none of the risk; for those allocated to the \"Developmental Pool,\" the Company generally retains 35% of the risk and the CFSA assumes 65%; and for those allocated to the \"Assigned Risk Pool,\" the Company retains 20% of the risk and the CFSA assumes 80%.\nAlthough the Company in general must agree to insure any eligible farm, it is not restricted in its decision to allocate a risk to any of the three pools, subject to a minimum aggregate retention of 35% of its MPCI Premiums and MPCI Imputed Premiums written. Based upon the production histories of each farm for which the Company writes MPCI policies, as well as other underwriting criteria, the Company assigns each farm to one of the pools. The Company has crop yield history information with respect to over 100,000 farms in the United States. Generally, farms or crops which, based on historical experience, location and other factors, appear to be less likely to suffer an insured loss, are placed in the Commercial Pool. Farms or crops which appear to be more likely to suffer a loss are placed in the Developmental Pool or Assigned Risk Pool. The Company has historically allocated the bulk of its insured risks to the Commercial Pool.\nThe Company's share of profit or loss depends in part on the aggregate amount of MPCI Premium and MPCI Imputed Premium on which the Company retains risk after allocating farms to the foregoing pools (its \"MPCI Retention\").\nLoss Experience of Insureds. The Company pays insured losses to farmers as they are incurred during the growing season, with the full amount of such payments reimbursed to the Company by the federal government within three business days. After a growing season ends, the aggregate loss experience of the Company's insureds in each state for risks allocated to each of the three reinsurance pools is determined. If, for all risks allocated to a particular pool in a particular state, the Company's share of losses incurred is less than its aggregate MPCI Retention, the Company shares in the gross amount of such profit according to a schedule set by the CFSA for each year. As an example, if the Company's MPCI Retention in respect of risks allocated to the Commercial Pool in Nebraska in 1995 was, for instance, $1 million, it would receive 94% of the first $350,000 of the gross amount of such profit, 65% of the next $100,000 of such gross profit, and 11% of any portion of the remaining $550,000 of such gross profit, for a maximum potential profit share to the Company on such $1 million of Nebraska Commercial Pool MPCI Retention of approximately $455,000, assuming no losses were incurred.\nA similar calculation would be performed if the Company's share of losses incurred were greater than its MPCI Retention to determine the Company's participation in such gross loss. The profit and loss sharing percentages and maximum potential gain or loss are different for profits and losses in each pool and are different for risks allocated to each of the three reinsurance pools. Private insurers will receive or pay the greatest percentage of profit or loss for risks allocated to the Commercial Pool.\nThe percentage split between private insurers and the federal government of any profit or loss which emerges from an MPCI Retention is set by the CFSA and generally is adjusted from year to year. For 1995 and 1996, the CFSA has increased the maximum potential profit share of private insurers for risks allocated to the Commercial Pool above the maximum potential profit share set for 1994, without increasing the maximum potential share of loss for risks allocated to that pool for 1995. This change increases the potential profitability of risks allocated to the Commercial Pool by private insurers. To illustrate, in the example relating to Nebraska above, in 1994 the Company would have received 92.5% of the first $150,000 of gross profit, 65% of the next $150,000 of gross profit, and 11% of the remaining $700,000 of gross profit, for a maximum potential profit share of approximately $313,000, assuming no losses were incurred. However, no assurance can be given that the profitability of the Company's MPCI business will increase in 1995, since such profitability is also affected by a number of other factors.\nTHIRD PARTY REINSURANCE\nIn order to reduce the Company's potential loss exposure under the MPCI program, the Company generally purchases stop loss reinsurance from other private insurers. The amount purchased varies yearly depending on market conditions and other factors. Such reinsurance would not eliminate the Company's potential liability in the event a reinsurer was unable to pay or losses exceeded the limits of the stop loss coverage. In addition, in 1993, 1992 and 1991 the Company also purchased certain pro rata reinsurance from third parties.\nADMINISTRATIVE PAYMENTS\nBuy-up Coverage. The Company receives an administrative payment from the CFSA for writing and administering Buy-up Coverage policies. These payments provide funds to compensate the Company for its expenses, including agents' commissions and the costs of administering policies and adjusting claims. In 1994, the administrative payments were set at 31% of the MPCI Premium. In 1995 and 1996, this payment has also been set at 31% of the MPCI Premium, but it is scheduled to be reduced to 29% in 1997, 28% in 1998, and 27.5% in 1999.\nBasic Coverage. Farmers are required to pay a minimal fixed administrative fee in order to obtain Basic Coverage. A portion of this fee is retained by the Company to defray the cost of administration, with the balance remitted to the government. The Company will also receive, from the CFSA, a separate minimal claims administration fee in respect of each Basic Coverage policy it writes. In general, administrative fees payable to the Company in respect of Basic Coverage are significantly lower than for Buy-up Coverage.\nREDLAND HISTORICAL RESULTS\nThe tables below provide supplemental unaudited GAAP financial information with respect to the historical results of Redland for the five year period ending December 31, 1994. Before its purchase by Acceptance effective July 1993, Redland operated as a private company with different objectives and requirements than those of the Company, particularly concerning expense levels and reinsurance programs.\nMULTI-PERIL CROP INSURANCE(1)\n------------------------- (1) Prior to 1992, the MPCI program only had one government-sponsored reinsurance pool, rather than the three reinsurance pools currently in place. Other changes over time in the MPCI program may affect the comparability of the results shown.\n(2) Represents profit (loss) share received from or payable to the federal government. Amounts exclude third party reinsurance expenses of $0.4 million, $2.1 million, $1.3 million, $1.2 million and $3.9 million in 1990, 1991, 1992, 1993 and 1994, respectively, which are included in \"Total Expenses\" shown in the \"Total Redland Operations\" table which follows, and exclude certain intercompany items for 1994.\n(3) Net of recoveries from third party reinsurance of $7.2 million.\nAs the table shows, Redland has recognized profit from its MPCI business in four of the last five years. The profits in each of 1994, 1991 and 1990 resulted primarily from favorable weather during the growing season in Redland's principal geographic regions. In 1993, excessive cloudy, wet and cold weather in those regions, together with severe flooding, resulted in a net loss. The 1993 net loss was mitigated by third party reinsurance coverage. Results in 1992 were adversely affected by severe hailstorms.\nCROP HAIL AND OTHER CROP INSURANCE\n-------------------------\n(1) Excluding underwriting and other expenses which are included in \"Total Expenses\" shown in the \"Total Redland Operations\" table which follows.\nRedland's crop hail and other crop results were adversely affected by significant hail damage suffered in 1994, 1993 and 1992. Crop hail results in those years were also impacted by significant price competition. The Company generally sells crop hail insurance in conjunction with MPCI and believes that offering crop hail insurance allows it to sell more MPCI policies than it otherwise would. The Company retained a higher proportion of its crop hail gross premiums written in 1994 than in 1993 due to substantial increases in the cost of third party reinsurance following the unfavorable results in 1993 and 1992.\nOTHER REDLAND P&C OPERATIONS\n-------------------------\n(1) Excluding underwriting and other expenses which are included in \"Total Expenses\" shown in the \"Total Redland Operations\" table which follows.\nOther Redland property and casualty lines include auto liability, auto physical damage, farmowners, commercial multi-peril lines, and fire and allied lines. Results in 1993 were adversely affected by a $3.0 million strengthening of reserves prior to Redland's acquisition by the Company in mid-1993.\nTOTAL REDLAND OPERATIONS\n-------------------------\n(1) Represents the totals of the amounts shown for \"Profit (Loss) Share\" in the \"Multi-Peril Crop Insurance\" table above, \"Underwriting Gain (Loss)\" in the \"Crop Hail and Other Crop Insurance\" table, and \"Underwriting Gain\" in the \"Other Redland P&C Operations\" table.\n(2) Net of federal reimbursements for the administration of MPCI policies.\n(3) Represents \"Total Underwriting Gain\" less \"Total Expenses.\"\nThe increase in Redland's expenses in 1994 over 1993 primarily resulted from the Company's increased retention in 1994 of its crop hail gross premiums written as described above, and consequently the receipt of an additional $3.8 million of ceding commissions from reinsurers of the Company's crop hail business in 1993 as compared to 1994. The remainder of the increase in expenses in 1994 was primarily the result of growth in premiums written.\nCOMBINED RATIOS\nThe statutory combined ratio, which reflects underwriting results before taking into account investment income, is a traditional measure of underwriting performance of a property and casualty insurer. A combined ratio of less than 100% indicates underwriting profitability whereas a combined ratio in excess of 100% indicates unprofitable underwriting. The following table reflects the loss ratios, expense ratios and combined ratios of the Company (separately stated to include and exclude MPCI and other crop insurance) and the property and casualty insurance industry, computed in accordance with SAP, for each of the years in the three-year period ending December 31, 1994.\n------------------------- (1) For information with respect to the effect of MPCI on the Company's historical combined ratios, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- General.\" 1993 data includes Redland for the entire calendar year.\n(2) Source: Best's Aggregates & Averages -- Property Casualty (1994 Edition). Ratios for 1994 are preliminary and are from Best's Review, Property-Casualty, January 1995 Edition.\nUNDERWRITING\nThe Company's underwriting staff is organized by specific lines of insurance. This enables the Company to take advantage of its underwriters' expertise and experience in underwriting a particular type of insurance risk on a consistent basis. In accepting risks, each underwriter is required to comply with risk parameters, retention limits and rates prescribed by the Company.\nGenerally, in order to deliver prompt service while ensuring consistent underwriting, the Company grants general agents the authority to sell and bind insurance coverages in accordance with detailed procedures and limitations established by the Company. The Company promptly reviews coverages bound by agents, decides whether the insurance is written in accordance with such procedures and limitations, and, subject to state law limits and policy terms, may cancel coverages that are not in compliance. Regulations of each state vary regarding cancellation of insurance policies and often depend upon whether they are written on an admitted or non-admitted basis. Additionally, the policies written by the Company provide that they may generally be canceled with 30 to 60 day notices, subject to state law limits.\nThe Company's underwriting staff attempts to visit general agents and independent agents not less than annually. Additionally, the Company provides seminars in certain lines of business for its general agents and independent agents to discuss, among other things, new procedures and policies, new coverages and new regulatory requirements.\nThe Company grants limited binding authority to certain independent agents in certain lines of business, and provides that all other agents submit all quotes to the Company's underwriting staff in order for such coverages to be bound. Each line of business has detailed procedures and limitations established by the Company. Business that is outside a general agent's or an independent agent's binding authority must be submitted to the Company's underwriting staff to obtain approval to bind such coverages.\nARM's operations are subject to contractual and operational controls designed to maintain proper underwriting standards. The authority of ARM to bind the Company is limited to specific types of insurance detailed in reinsurance treaties written for this business unit and is limited to risks under which the Company's ultimate net retention does not exceed $150,000. Further, the Company and each of the four reinsurers participating in this business periodically audit the underwriting operations of ARM, and each has conducted at least two audits during 1994.\nThe Company writes insurance in 44 states and the District of Columbia as an admitted carrier and in 42 states, the District of Columbia and the Virgin Islands as an approved non-admitted carrier. Non-admitted carriers normally are restricted to writing lines of business not regularly written in the standard admitted market, although they have greater freedom to design policy provisions and charge appropriate premiums on an unregulated basis. The Company generally seeks to have an insurance subsidiary licensed as an admitted carrier, as well as another insurance subsidiary operating as an approved non-admitted carrier, in each state in which it writes insurance in order to have the flexibility to offer insurance products in both the admitted as well as the non-admitted market. For the year ended December 31, 1994, the Company wrote 66% of its direct written premiums as an admitted carrier and 34% as a non-admitted carrier.\nCLAIMS\nThe Company's claims department administers all claims and directs all legal and adjustment aspects of the claims handling process. Independent adjusters are utilized regularly to assist in settling claims. The Company maintains an active approach to claims management which is designed to investigate claims as soon as practicable in order to manage and anticipate developments throughout the claims process.\nThe specialized nature of the Company's business segments requires specific skills to settle claims successfully, and accordingly the Company maintains a staff of experienced claim examiners. These claim examiners specialize in individual segments of the Company's business, which provides greater consistency and depth of experience in settling claims.\nLOSS AND LOSS ADJUSTMENT EXPENSE RESERVES\nThe Company maintains reserves for estimates of liability for reported losses, losses which have occurred but which have not yet been reported, and for the expenses of investigating, processing and settling claims under outstanding policies. Such reserves are estimates by the Company primarily based on Company and industry experience with the types of risks involved, knowledge of the circumstances surrounding individual claims, and Company and industry experience with respect to the probable number and nature of claims arising from losses not yet reported. The effects of inflation are implicitly reflected in these loss reserves through the industry data utilized in establishing such reserves. The Company does not discount its reserves to estimated present value for financial reporting purposes. The Company annually obtains an independent review of its loss reserving process and reserve estimates by a professional actuary as part of the annual audit of its financial statements.\nThe following table presents an analysis of the Company's reserves, reconciling beginning and ending reserve balances for the periods indicated:\nThe following table presents the development of balance sheet loss reserves from calendar years 1984 through 1994. The top line of the table shows the loss reserves at the balance sheet date for each of the indicated years. These amounts are the estimates of losses and loss adjustment expenses 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 the Company. The middle section of the table shows the cumulative amount paid with respect to previously recorded reserves as of the end of each succeeding year. The lower section of the table shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The \"Net cumulative redundancy (deficiency)\" caption represents the aggregate cumulative change in the estimates over all prior years. The Company computes the cumulative redundancy (deficiency) annually on a calendar year basis.\nThe establishment of reserves is an inherently uncertain process. The Company underwrites both property and casualty coverages in a number of specialty areas of business which may involve greater risks than standard property and casualty lines, including the risks associated with the absence of a long-term, reliable historical claims experience. These risk components may make more difficult the task of estimating reserves for losses, and cause the Company's underwriting results to fluctuate. Further, conditions and trends that have affected the development of loss reserves 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 information.\nThe Company adopted Statement of Financial Accounting Standards No. 113 (\"SFAS #113\"), \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts,\" effective January 1, 1993. The effect of the application of SFAS #113 resulted in the reclassification of amounts ceded to reinsurers, which amounts were previously reported as a reduction in unearned premium and unpaid losses and loss adjustment expenses, to assets on the consolidated balance sheet. The table below includes a reconciliation of net loss and loss adjustment expense reserves to amounts presented on the consolidated balance sheet after reclassifications related to the adoption of SFAS #113. The gross cumulative deficiency is presented for 1992 and 1993, the only years on the table for which the Company has restated amounts in accordance with SFAS #113.\n------------------------- (1) Cumulative deficiencies appearing in the Company's reserve estimates for years 1990 through 1993 principally resulted from adverse loss and loss adjustment expense development occurring in the 1990 and 1991 accident years in its general liability and commercial multi-peril lines of business, and to a lesser extent its workers' compensation and liquor liability lines. The actual experience of these lines differed from the historical patterns causing the deficiencies. The Company has reviewed and adjusted its reserving practices and actuarial techniques to adjust for these reserve deficiencies.\nFor further information about the Company's loss reserves, see \"Certain Investment Considerations -- Loss Reserves.\"\nREINSURANCE\nA significant component of the Company's business strategy involves the structuring of reinsurance tailored to the needs of its business lines. Insurance companies purchase reinsurance to spread risk on individual exposures, protect against catastrophic losses and increase their capacity to write insurance. Reinsurance involves an insurance company transferring, or ceding, all or a portion of its exposure on insurance to a reinsurer. The reinsurer assumes the exposure in return for a portion of the premium received by the insurance company. Reinsurance does not discharge the insurer from its obligations to its insured. If the reinsurer fails to meet its obligations, the ceding insurer remains liable to pay the insured, but the reinsurer is liable to the ceding insurer to the extent of the reinsured portion of any loss.\nThe Company limits its exposure under individual policies by purchasing excess of loss and quota share reinsurance from other insurance companies, as well as maintaining catastrophe reinsurance to protect against catastrophic occurrences where claims can arise under several policies from a single event, such as a hurricane, earthquake, wind storm, riot, tornado or other extraordinary event.\nThe Company generally retains the first $500,000 of risk under its casualty lines, ceding the next $2,500,000 to reinsurers; and 25% of the first $500,000 of risk under its property lines, ceding the other 75% to quota share reinsurers and the next $1,500,000 per risk to other reinsurers. The foregoing reinsurance coverage does not apply to business written through ARM, for which the Company maintains a separate 70% quota share treaty. To the extent that individual policies in any line exceed reinsurance treaty limits, it is the Company's customary policy to purchase reinsurance on a facultative (specific policy) basis.\nThe Company maintains catastrophe reinsurance for its casualty lines which provides coverages of $7 million in excess of $3 million of aggregate risk per occurrence, and for its property lines, which provides catastrophe coverage of 95% of $17,500,000 in excess of $2,500,000 per catastrophe.\nIn its Minnesota workers' compensation business, the Company buys catastrophe coverage on an unlimited basis from the Minnesota Workers Compensation Reinsurance Association in excess of $450,000 retention per occurrence. In other states the Company purchases $49.5 million of coverage in excess of $500,000 per occurrence and $9.5 million of coverage in excess of $500,000 per person through private insurers.\nThe Company reinsures its MPCI business with various federal reinsurance pools administered by the CFSA. Under the CFSA's reinsurance program, the Company may (at the Company's election) cede to the CFSA a portion of the Company's gross exposure under MPCI policies, ranging from 0% to 80% of such exposure. In 1994, the Company ceded to the CFSA an aggregate of 39.7% of such gross exposure. The Company's net exposure on MPCI business is further reduced by privately placed stop loss reinsurance purchased from private carriers. See \"Business -- Multi-Peril Crop Insurance Program.\"\nApproximately 50% of the Company's crop hail business is reinsured through quota share agreements, which is also supplemented by surplus and stop loss contracts purchased from private reinsurers. Surplus agreements generally limit the Company's quota share exposure to $1,500,000 per county or township. Stop loss reinsurance is purchased to cover 90% of net retained losses exceeding 90% up to 130% of retained premiums.\nReinsurance treaties are renegotiated and renewed annually by the Company, generally by March 31st. Although the Company may determine to make changes in its reinsurance facilities for the next renewal year, it is currently anticipated that its reinsurance program will remain substantially the same.\nThe Company seeks to mitigate exposure to adverse reinsurance pricing conditions and to credit risk by maintaining a diversity of reinsurers. The Company closely monitors the quality and performance of its reinsurers. At December 31, 1994, 94% of the Company's outstanding reinsurance recoverables were from\ndomestic reinsurance companies or the federal government, 98% of which was from domestic reinsurance companies rated A- (Excellent) or better by A.M. Best or from the federal government. The balance of the Company's reinsurance was primarily placed with major international reinsurers.\nThe following table sets forth the principal domestic reinsurers of the Company and their A.M. Best ratings, ranked in order of outstanding reinsurance recoverables at December 31, 1994.\nINVESTMENTS\nThe Company's investment policy is to maximize the after-tax yield of the portfolio while emphasizing the stability and preservation of the Company's capital base. Further, the portfolio is invested in types of securities and in an aggregate duration which reflect the nature of the Company's liabilities and expected liquidity needs. The Company manages its portfolio internally. Effective January 1, 1994, all of the Company's fixed maturity securities were classified as available for sale and carried at market value. At December 31, 1993, the fixed maturity securities which the Company classified as available for sale were carried at the lower of aggregate cost or market and the fixed maturity securities classified as held for investment were carried at cost. The investment portfolio at December 31, 1994 and December 31, 1993, consisted of the following:\n------------------------- (1) Due to the short-term nature of crop insurance, the Company must maintain short-term investments to fund amounts due. Historically, these short-term funds are highest in the Fall corresponding to the cash flow of the agricultural industry.\nThe following table sets forth, as of December 31, 1994, the composition of the Company's fixed maturity securities portfolio by time to maturity.\nThe following table sets forth, as of December 31, 1994, the ratings assigned to the Company's fixed maturity securities.\n------------------------- (1) Ratings are assigned by Moody's Investors Service, Inc. when available, with the remaining ratings assigned by Standard & Poor's Corporation.\nThe Company's investment results for the periods indicated are set forth below:\n------------------------- (1) Average investment portfolio represents the average of the beginning and ending investment portfolio (excluding real estate) computed on a quarterly basis.\nThe Company's collateral backed securities portfolio consists of mortgage-backed securities, all of which are collateralized mortgage obligations (\"CMOs\"). The following table sets forth as of December 31, 1994 the categories of the Company's CMOs, which at such date had an average life of approximately six years.\n------------------------- (1) Par value is the face amount of the underlying mortgage collateral. Any cost in excess of par value is a \"premium\" whereas cost lower than par value is a \"discount.\" The Company's aggregate CMO portfolio has been purchased at a discount.\n(2) Floating rate CMOs provide an increased interest rate when a specified index interest rate increases and a lower interest rate when such index rate decreases, while inverse floating rate CMOs provide a lower interest rate when the index rate increases and a higher rate when the index rate decreases. Generally, the Company's floating rate and inverse floating rate securities are tied to the one month LIBOR. The market values of the Company's floating rate and inverse floating rate CMOs are significantly impacted by various factors, including the outlook for future interest rate changes and such securities' relative liquidity under current market conditions. In certain cases, carrying values presented are determined by modeling techniques for securities not actively traded. See Note 1 to the Consolidated Financial Statements.\n(3) All of the CMO portfolio collateral is guaranteed by a government agency.\nThe yield characteristics of mortgage-backed securities differ from those of traditional fixed maturity securities. Interest and principal payments occur more frequently, often monthly, and mortgage-backed securities are subject to risks associated with variable prepayments. Prepayment rates are influenced by a number of factors which cannot be predicted with certainty, including the relative sensitivity of the underlying mortgages backing the assets to changes in interest rates, a variety of economic, geographic and other factors and the prepayment priority of the securities in the overall securitization structures.\nIn general, prepayments on the underlying mortgage loans, and the securities backed by these loans, increase when the level of prevailing interest rates decline significantly below the interest rates on such loans. Mortgage-backed securities purchased at a discount to par will experience an increase in yield when the underlying mortgages prepay faster than expected because the faster prepayment results in accelerated recognition of the discount as income. Those securities purchased at a premium that prepay faster than expected will incur a reduction in yield because the faster prepayment results in accelerated amortization of the premium. When declines in interest rates occur, the proceeds from the prepayment of mortgage-backed securities are likely to be reinvested at lower rates than the Company was earning on the prepaid securities.\nAs the level of prevailing interest rates increases, which occurred during 1994, prepayments on mortgage-backed securities decelerate as fewer underlying mortgages are refinanced. When this occurs, the average maturity and duration of the mortgage-backed securities increase, which decreases the yield on mortgage- backed securities purchased at a discount because the discount is realized as income at a slower rate and increases the yield on those purchased at a premium as a result of a decrease in annual amortization of the premium.\nREGULATION\nAs a general rule, an insurance company must be licensed to transact insurance business in each jurisdiction in which it operates, and almost all significant operations of a licensed insurer are subject to regulatory scrutiny. Licensed insurance companies are generally known as \"admitted\" insurers. Most states provide a limited exemption from licensing for insurers issuing insurance coverages that generally are not\navailable from admitted insurers. Their coverages are referred to as \"surplus lines\" insurance and these insurers as \"surplus lines\" or \"non-admitted\" companies.\nThe Company's admitted insurance businesses are subject to comprehensive, detailed regulation throughout the United States, under statutes which delegate regulatory, supervisory and administrative powers to state insurance commissioners. The primary purpose of such regulations and supervision is the protection of policyholders and claimants rather than stockholders or other investors. Depending on whether the insurance company is domiciled in the state and whether it is an admitted or non-admitted insurer, such authority may extend to such things as (i) periodic reporting of the insurer's financial condition; (ii) periodic financial examination; (iii) approval of rates and policy forms; (iv) loss reserve adequacy; (v) insurer solvency; (vi) the licensing of insurers and their agents; (vii) restrictions on the payment of dividends and other distributions; (viii) approval of changes in control; and (ix) the type and amount of permitted investments.\nThe Company also is subject to laws governing insurance holding companies in Nebraska, Iowa and Arizona, where the Insurance Companies are domiciled. These laws, among other things, require the Company to file periodic information with state regulatory authorities including information concerning its capital structure, ownership, financial condition and general business operations; regulate certain transactions between the Company, its affiliates and the Insurance Companies, including the amount of dividends and other distributions and the terms of surplus notes; and restrict the ability of any one person to acquire certain levels of the Company's voting securities without prior regulatory approval.\nThe insurance holding company laws of Nebraska, Iowa and Arizona limit dividends and other distributions from the Insurance Companies to the Company. Under Nebraska law, dividends or distributions may not be paid by an insurance company without prior regulatory approval, unless such dividend, together with any dividends paid within the preceding 12 months, does not exceed the lesser of (a) 10% of the policyholders' surplus of the insurer as of the preceding December 31 or (b) the insurer's net income, excluding realized capital gains, for the preceding calendar year, all as computed in accordance with SAP. In determining net income available for dividends in Nebraska, an insurer may carry forward net income from the second and third full calendar years preceding the date of determination, again excluding realized capital gains, less dividends paid in such prior calendar years. Under Iowa law, dividends or distributions may not be paid by an insurance company without prior regulatory approval, unless such dividend, together with any dividends paid within the preceding twelve months, does not exceed the greater of (a) 10% of the policyholders' surplus of the insurer as of the preceding December 31 or (b) the insurer's net income for the preceding calendar year, all as computed in accordance with SAP. Under Arizona law, dividends or distributions may not be paid by an insurance company without prior regulatory approval, unless such dividend, together with any dividends paid within the preceding twelve months, does not exceed the lesser of (a) 10% of the policyholders' surplus of the insurer as of the preceding December 31 or (b) the insurer's net investment income (including realized capital losses and excluding realized capital gains) for the preceding calendar year, all as computed in accordance with SAP.\nOther regulatory and business considerations may further limit the willingness of the Insurance Companies to pay dividends. For example, the impact of dividends on surplus could affect an insurer's competitive position, the amount of premiums that it can write and its ability to pay future dividends. Further, the insurance laws and regulations of Nebraska, Iowa and Arizona require that the statutory surplus of an insurance company domiciled therein, following any dividend or distribution by such company, be reasonable in relation to its outstanding liabilities and adequate for its financial needs. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nWhile the non-insurance company subsidiaries are not subject directly to the dividend and other distribution limitations, insurance holding company regulations govern the amount which a subsidiary within the holding company system may charge any of the Insurance Companies for services (e.g., agents' commissions).\nThe Company's MPCI program is federally regulated and supported by the federal government by means of premium subsidies to farmers, expense reimbursement and federal reinsurance pools for private insurers. Consequently, the MPCI program is subject to oversight by the legislative and executive branches of the\nfederal government, including the CFSA, a division of the USDA. The MPCI program regulations generally require compliance with federal guidelines with respect to underwriting, rating and claims administration. The Company is required to perform continuous internal audit procedures and is subject to audit by several federal government agencies.\nThe MPCI program has historically been subject to change by the federal government at least annually since its establishment in 1980, some of which changes have been significant. The most recent significant changes to the MPCI program came as a result of the passage by Congress of the Reform Act of 1994. See \"Business -- Multi-Peril Crop Insurance Program.\"\nCertain provisions of the Reform Act, if implemented by the CFSA, may increase competition among private insurers in the pricing of Buy-up Coverage. The Reform Act authorizes the CFSA to implement regulations permitting insurance companies to pass on to farmers in the form of reduced premiums certain cost efficiencies related to any excess expense reimbursement over the insurer's actual cost to administer the program, which could result in increased price competition. To date, the CFSA has not enacted regulations implementing these provisions.\nDuring the past several years, various regulatory and legislative bodies have adopted or proposed new laws or regulations to deal with the cyclical nature of the insurance industry, catastrophic events and insurance capacity and pricing. These regulations include (i) the creation of \"market assistance plans\" under which insurers are induced to provide certain coverages, (ii) restrictions on the ability of insurers to cancel certain policies in mid-term, (iii) advance notice requirements or limitations imposed for certain policy non-renewals and (iv) limitations upon or decreases in rates permitted to be charged.\nGovernmental regulators and the NAIC re-examine from time to time existing laws and regulations and their application to insurance companies. For example, the NAIC recently approved and recommended that states adopt and implement several regulatory initiatives designed to be used by regulators as an early warning tool to identify deteriorating or weakly capitalized insurance companies and to decrease the risk of insolvency of insurance companies. These initiatives include the implementation of the RBC standards for determining adequate levels of capital and surplus to support four areas of risk facing property and casualty insurers: (a) asset risk (default on fixed income assets and market decline), (b) credit risk (losses from unrecoverable reinsurance and inability to collect agents' balances and other receivables), (c) underwriting risk (premium pricing and reserve estimates), and (d) off-balance sheet\/growth risk (excessive premium growth and unreported liabilities). The RBC standards require regulators to analyze the ratio of an insurance company's total adjusted capital (defined as the total of its statutory capital and surplus, as adjusted) to its required RBC. Insurers having less statutory surplus than that required by the RBC formula will be subject to varying degrees of regulatory attention, from submission of a comprehensive plan to improve its capital position, to special examinations, to being placed under supervision.\nThe RBC formula provides a mechanism for the calculation of an insurance company's authorized control level RBC and its total adjusted capital. The formula sets forth the points at which a commissioner of insurance is authorized and expected to take regulatory action. The first level is known as the company action level RBC, which is set at twice the authorized control level RBC. The second level is the regulatory action level RBC, set at 1.5 times the authorized control level RBC. The third is the authorized control level RBC, and the fourth is the mandatory control level RBC, set at 70 percent of the authorized control level RBC.\nIf an insurance company's adjusted capital is higher than or equal to the regulatory action level RBC but below the company action level RBC, the insurance company must submit to its commissioner of insurance an RBC plan which shall contain, among other things, proposals for corrective action. If an insurance company's adjusted capital is higher than or equal to the authorized control level RBC but lower than the regulatory action level RBC, the commissioner of insurance shall perform any examination or analysis as deemed necessary of the insurer's business and operations and issue any appropriate corrective orders to address the insurance company's financial problems. If an insurer's adjusted capital is higher than or equal to the mandatory control level RBC but lower than the authorized control level RBC, the commissioner may place the insurer under regulatory control. If the insurance company's adjusted capital falls below the mandatory\ncontrol level RBC, the commissioner will be required to place the insurer under regulatory control. Of the states in which the Insurance Companies are domiciled, Nebraska is the first state to adopt, effective January 1, 1994, RBC rules into law, although the RBC results must be reported to the states in which the Insurance Companies do business. The Nebraska RBC statute is similar to the NAIC initiative set forth above. Management believes the implementation of RBC will not have a material adverse effect on the operations of the Insurance Companies, each of which has exceeded the RBC requirements for the 1994 year.\nThe NAIC has developed its Insurance Regulatory Information System (\"IRIS\") to assist state insurance departments in identifying significant changes in the operations of an insurance company, such as changes in its product mix, large reinsurance transactions, increases or decreases in premiums received and certain other changes in operations. Such changes may not result from any problems with an insurance company but merely indicate changes in certain ratios outside ranges defined as normal by the NAIC. When an insurance company has four or more ratios falling outside \"normal ranges,\" state regulators may investigate to determine the reasons for the variance and whether corrective action is warranted.\nFor the year ended December 31, 1993, Redland Insurance was outside the normal range specified by IRIS in six out of the twelve IRIS ratios for property and casualty insurers. The Company has taken action to improve certain of these ratio results, and, during 1994, the Company contributed a total of $24 million to the surplus of Redland Insurance, including the $18 million described below. As a result primarily of the foregoing IRIS results, the Iowa insurance regulatory authorities conducted a special examination of Redland Insurance for the year ended December 31, 1993. Since the results of this examination have not yet been disclosed to the Company, no assurance can be given that such examination will not result in regulatory action that could have an adverse impact on the business or results of operations of Redland Insurance.\nFor the year ended December 31, 1994, Redland Insurance was outside the normal range specified by IRIS in four out of the twelve IRIS ratios. Of these four ratios, the investment yield ratio was outside the normal range as a result of the high proportion of short-term investments held by Redland due to its short-term crop insurance business and the change in surplus ratio was outside the normal range due to surplus contributions to Redland Insurance from its parent company. Although the Company does not believe that these ratios will result in regulatory action having a material effect on the Company, there can be no assurance as to the foregoing.\nThe insurance laws of Michigan require non-domiciliary insurance companies that undergo a change of control to requalify for their certificates of authority to write insurance. On May 29, 1994, the Michigan Insurance Bureau (the \"Bureau\") revoked Redland Insurance's certificate of authority after it failed to requalify under such law following its acquisition by the Company. The Bureau cited as its reason concerns about Redland Insurance's capitalization, operating ratios and 1993 IRIS ratios. The Company has since improved the capitalization of Redland Insurance. Redland Insurance plans to seek requalification in Michigan in 1996. For 1994, gross premiums written by Redland in Michigan were $4.5 million, 90% of which consisted of MPCI and crop hail insurance. The Company does not believe that the action by Michigan will have a material adverse effect on the Company's financial condition and results of operations since management believes that the Company has been able to write through Acceptance Insurance substantially all of the Michigan business it would have written through Redland Insurance.\nOn August 29, 1994, after a review of the Company's six month financial statements, A.M. Best placed the current A- (Excellent) rating of three of the rated Insurance Companies under review, with negative implications, citing as the reason the Company's growth in written premiums without a corresponding growth in surplus. Subsequently, the Company increased the statutory surplus of Redland Insurance and Acceptance Insurance by an additional $18 million and $20 million, respectively, with the proceeds from the exercise of the Warrants. A.M. Best then affirmed the Insurance Companies' A- (Excellent) rating.\nThe eligibility of the Company's insurance subsidiaries to write insurance on a surplus lines basis in most jurisdictions is dependent on their compliance with certain financial standards, including the maintenance of a requisite level of capital and surplus and the establishment of certain statutory deposits. State surplus lines laws typically: (i) require the insurance producer placing the business to show that he or she was unable to\nplace the coverage with admitted insurers; (ii) establish minimum financial requirements for surplus lines insurers operating in the state; and (iii) require the insurance producer to obtain a special surplus lines license. In recent years, many jurisdictions have increased the minimum financial standards applicable to surplus lines eligibility.\nThe Insurance Companies also may be required under the solvency or guaranty laws of most states in which they are licensed to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insolvent or rehabilitated insurance companies. 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. Some state laws and regulations further require participation by the Insurance Companies in pools or funds to provide some types of insurance coverages which they would not ordinarily accept.\nIt is not possible to predict the future impact of changing state and federal regulation on the Company's operations, and there can be no assurance that existing insurance-related laws and regulations will not become more restrictive in the future or that laws and regulations enacted in the future will not be more restrictive than existing laws.\nEMPLOYEES\nAt March 15, 1995 the Company and its subsidiaries employed 17 salaried executives and 775 other personnel. Acceptance believes that relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe following table sets forth certain information regarding the principal properties of the Company.\n---------------------\n(1) The range of expiration dates for these leases is November 30, 2001 (Omaha), June 30, 1997 (Council Bluffs), February 1, 1996 (Burlington), February 21, 2000 (Phoenix), and December, 1998 (Scottsdale).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material legal proceedings pending involving the Company or any of its subsidiaries which require reporting pursuant to this Item.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1994.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Common Stock is listed and traded on the NYSE. The following table sets forth the high and low sales prices per share of Common Stock as reported on the NYSE Composite Tape for the fiscal quarters indicated.\nThe closing sales price of the Common Stock on March 29, 1995, as reported on the NYSE Composite Tape, was $15 per share. As of March 29, 1995, there were approximately 1,900 holders of record of the Common Stock.\nThe Company has not paid cash dividends to its stockholders during the periods indicated above and does not anticipate that it will pay cash dividends in the foreseeable future. The Revolving Credit Facility prohibits the payment of cash dividends to stockholders. See \"Business -- Regulation\" for a description of restrictions on payment of dividends to the Company from the Insurance Companies.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth certain selected consolidated financial data and should be read in conjunction with, and is qualified in its entirety by, the Consolidated Financial Statements and the notes thereto and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" appearing elsewhere herein. This selected consolidated financial data has been derived from the audited Consolidated Financial Statements of the Company and its subsidiaries. The information set forth below with respect to insurance operations does not present information for Acceptance Insurance's operations for periods prior to its acquisition by the Company in April 1990.\n------------------------- (1) For a discussion of the accounting treatment of the Company's MPCI business, the results of which are included in the periods indicated, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- General.\"\n(2) Effective September 1, 1990, the Company changed its fiscal year end from August 31 to December 31.\n(3) For further information with respect to amounts shown in these lines, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- General -- Effects of Non-Insurance Operations.\"\n(4) Operating profit was reduced in 1992 by the strengthening of reserves in the amount of approximately $2.1 million on two lines of insurance and $1.7 million of incurred losses relating to Hurricanes Andrew and Iniki. The strengthening of reserves and hurricane losses accounted for 4.8% of the loss ratio for 1992.\n(5) Results for 1994 and 1993 reflect the utilization of tax loss carryforwards and other temporary differences resulting from prior non-insurance operations.\n(6) Does not include amounts relating to discontinued operations recorded primarily in 1991. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- General -- Effects of Non-Insurance Operations.\"\n(7) Included in other income (expense), net and loss from continuing operations for the year ended December 31, 1991, is a non-cash charge of $15.3 million, or $4.49 per share, to reduce the Company's equity investment in real estate operations to estimated net realizable value, incurred as part of the restructuring of certain prior non-insurance operations.\n(8) Statutory data have been derived from the separate financial statements of the Insurance Companies prepared in accordance with SAP.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following discussion and analysis of financial condition and results of operations of the Company and its consolidated subsidiaries should be read in conjunction with the Company's Consolidated Financial Statements and the notes thereto included elsewhere herein.\nGENERAL\nINSURANCE OPERATIONS\nOver the past five years, premiums written in the Company's insurance operations have consistently increased, both as the result of acquisitions and through internal growth. The Company has reported operating profits in each quarter beginning with the third quarter of 1992, when the phasing out of its prior non-insurance operations was substantially completed. For information about the effects of these prior operations on the Company's financial results, see \"-- Effects of Non-Insurance Operations\" below.\nAlthough the property and casualty insurance industry in general has been experiencing soft market conditions for the past several years, the Company nonetheless has been able to increase premium volumes in recent periods while maintaining combined ratios better than the ratios of the industry as a whole. This growth has been the result of the Company's strategy of acquiring niche businesses and increasing premiums written in selected lines. The Company's most significant recent acquisition was its purchase in July 1993 of Redland, which provides MPCI, crop hail and other named peril crop insurance and certain standard property and casualty coverages to the rural market. Following its acquisition by the Company, Redland increased the volume of its MPCI Premium by 42% in 1994 over 1993. The Company was the third largest MPCI writer in the United States in 1994.\nMPCI is a government-sponsored program with accounting treatment which differs from more traditional property and casualty insurance lines. For income statement purposes under GAAP and under SAP, gross premiums written consist of the aggregate amount of MPCI premiums paid by farmers, and do not include any related federal premium subsidies. The Company's profit or loss from its MPCI business is determined after the crop season ends on the basis of a profit sharing formula established by law and the CFSA. For income statement purposes, any such profit share earned by the Company, net of the cost of third party reinsurance, is shown as net premiums written, which equals net premiums earned for MPCI business; however, any share of losses payable by the Company is charged to losses and loss adjustment expenses. All expense reimbursements received are credited to underwriting expenses. The foregoing are the principal entries that are made in respect of net premiums written, net premiums earned, losses paid and underwriting expenses. See \"Business -- Multi-Peril Crop Insurance Program.\"\nAs a result of this accounting treatment, the MPCI business may tend to affect comparisons of the Company's results and operating ratios for periods after the Redland acquisition with prior periods and affect comparisons of the Company's operating ratios with industry averages. For information about the Company's operating ratios excluding the results of its MPCI and other crop business, see \"Business -- Combined Ratios.\" Certain other characteristics of the Company's crop business also may affect comparisons, including: (i) the seasonal nature of the business whereby profits are generally recognized predominantly in the second half of the year; (ii) the short-term nature of crop business whereby losses are known within a short time period; and (iii) the limited amount of investment income associated with crop business. In addition, cash flows from such business differ from cash flows from certain more traditional lines. See \"-- Liquidity and Capital Resources\" below. The seasonal and short term nature of the Company's crop business, as well as the impact on such business of weather and other natural perils, may produce more volatility in the Company's operating results on a quarter to quarter or year to year basis than has historically been present in the operations of the Company.\nEFFECTS OF NON-INSURANCE OPERATIONS\nPrior to June 1992, the Company also was engaged in certain citrus and real estate businesses. These operations encountered difficulties beginning in 1990 and the Company commenced a restructuring in 1991. This restructuring was substantially completed by the third quarter of 1992, and since then the Company's insurance operations have been its sole business focus. The impact of these prior non-insurance operations and their restructuring and of certain related items in the Company's historical results of operations is described more fully below through an analysis of certain line items appearing in the \"Selected Consolidated Financial Data\" appearing elsewhere herein.\nNon-Insurance Revenues. Amounts shown as holding company interest income consisted of interest earned on investment assets held at the holding company level which were primarily acquired with a portion of the net proceeds of the Company's equity rights offering. Amounts shown as real estate revenues reflect income from prior real estate operations which were restructured in 1992 as described under \"Other Income (Expense), Net\" below.\nNon-Insurance Expenses. Included in holding company general and administrative expenses are directors' fees, legal and accounting expenses, shareholder-related costs including annual report, proxy and annual meeting expenses, New York Stock Exchange fees and similar expenses related to operation of the holding company. For consistency of presentation, the full amounts of these items have been included in non-insurance expenses for each of the periods shown.\nReal estate expenses relate to miscellaneous costs associated with the remaining real estate owned by the Company as well as costs from the Company's restructured real estate operations. All such real estate interests were contributed by the holding company to Acceptance Insurance prior to the third quarter of 1992.\nOther Income (Expense), Net. The Company owns an approximate 33% interest in Major Realty Corporation (\"Major Realty\"), a publicly-traded real estate company focusing on the ownership of land, principally in Florida (Nasdaq symbol: \"MAJR\"). The Company recorded a non-cash charge to continuing operations of $15.3 million for the year ended December 31, 1991, to reduce its equity investment in Major Realty to estimated net realizable value. At December 31, 1994, the carrying value of the Company's investment in Major Realty was $5.1 million. The Company continues to recognize its equity share of net operating losses recorded by Major Realty.\nIn 1991, the Company recognized an additional $2.5 million loss on the write-down of a real estate investment not owned by Major Realty. This investment has since been sold.\nPrior Citrus Operations. No effects from the discontinuation and sale of the Company's prior citrus operations are shown above since those effects were recorded as loss from discontinued operations for all relevant periods. The Company recorded a provision for the expected loss on disposal of its investment in the citrus operations of approximately $19.6 million, or $5.75 per share, in 1991 which is excluded from loss and loss per share from continuing operations. Upon the sale of such operations in 1992, the Company recognized an additional loss of approximately $0.1 million.\nCertain Tax Benefits. As a result of these prior non-insurance operations, the Company generated significant tax loss carryforwards and other temporary differences, all of which were used by the end of 1994. Utilization of these carryforwards and other temporary differences resulted in the Company recording a net income tax benefit of $3.4 million instead of any income tax expense in respect of its pretax net income in 1994, and no income tax expense in 1993 other than approximately $0.2 million representing applicable Alternative Minimum Tax amounts. The elimination of these tax benefits will result in an increase in taxes reported by the Company in its operations in future periods beginning in the first quarter of 1995.\nRESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nThe Company's net premiums earned increased 58.2% for the year ended December 31, 1994 to $202.7 million from $128.1 million in 1993. The principal components of this increase were an increase of $30.0 million and $14.4 million in earned premium in Redland's crop and standard property and casualty lines of business, respectively, following the acquisition of Redland in the third quarter of 1993, and an increase of $32.9 million in General Agency earned premium primarily resulting from the expansion of this segment following the hiring of four new managers in August 1993.\nIncluded in the $30.0 million increase in net earned premiums for crop business for 1994 was $17.0 million in profit sharing (before deducting the cost of third party reinsurance) earned on the Company's MPCI business, compared to no profit sharing earned for such business for 1993 when the Company recorded a loss share of $0.9 million (net of recoveries from third party reinsurers). Because of its accounting treatment, such 1993 loss share is not reflected as a reduction in net premiums earned but instead as an increase in the Company's losses and loss adjustment expenses for the 1993 period. The 1994 profit resulted primarily from increases in the Company's MPCI Premiums and MPCI Retention (as defined herein) after ceding risk to federal reinsurance pools, as well as the occurrence of fewer insured losses, as adverse weather conditions in 1993 gave way to favorable weather conditions in 1994.\nThe Company's net investment income increased 22.4% to $13.3 million in 1994 versus $10.8 million during the prior year. The average size of the investment portfolio increased from approximately $173 million during the year ended December 31, 1993 to approximately $220 million during 1994. This increase resulted primarily from internally-generated cash flows and the ownership of Redland for a full year. The investment yield decreased from 6.3% to 6.0% primarily as a result of Redland's portfolio generally being invested in short-term investments due to the nature of its business.\nNet realized capital gains were approximately $0.6 million for 1994 versus $2.3 million for 1993. The higher amount in 1993 resulted from the Company's decision to reposition its portfolio in a higher concentration of tax-exempt securities during 1993 when market values of the Company's fixed income securities in many cases exceeded cost due to lower prevailing interest rates.\nLosses and loss adjustment expenses increased to $143.0 million versus $92.8 million in 1993 or a 54.0% increase, consistent with the increase in net premiums earned. The 1994 results were affected by adverse loss and loss adjustment expense development of approximately $5.1 million, primarily from the Company's general liability and commercial multi-peril lines. This adverse development principally related to the 1990 and 1991 accident years, and to a lesser extent to the 1992 and 1993 years, when actual experience differed from historical patterns. In 1994 the Company reviewed and adjusted its reserving practices to adjust for these developments.\nThe Company's underwriting and other expenses increased 42.6% to $52.6 million in 1994 versus $36.9 million in 1993. The primary causes for this increase were the increase in premium volume, and to a lesser extent, the need to increase the staff and systems at the Insurance Companies in order to monitor the larger operations of the Company during 1994 and the expenses associated with the establishment of an office for General Agency business in Scottsdale, Arizona. Partially offsetting this increase was the full year impact of the Company's book of crop insurance, which typically has a lower expense ratio than most of the Company's other businesses.\nThe Company's interest expense for the year decreased 24.3% to $1.7 million versus $2.2 million in the prior year. This decrease in interest expense was principally caused by the retirement during 1993 of $16.5 million of higher interest rate debt issued in connection with the restructuring in 1992, which was partially offset by a $10.0 million increase in the outstanding debt of the Company during 1994.\nThe Company's net income benefitted from the recognition during the year ended December 31, 1994 of a deferred tax benefit of $9.5 million, which offset taxes that otherwise would have been accrued and resulted in a net income tax benefit of $3.4 million. This net income benefit resulted from the release of a valuation allowance established for a deferred tax asset upon the Company meeting the realizability tests for such asset under Statement of Financial Accounting Standards (\"SFAS\") #109, \"Accounting for Income Taxes\", adopted by the Company in January 1993.\nThe Company's net income increased 177.8% to $21.1 million for the year ended December 31, 1994 compared to $7.6 million for the year ended December 31, 1993 because of the factors discussed above.\nYEAR ENDED DECEMBER 31, 1993 COMPARED TO YEAR ENDED DECEMBER 31, 1992.\nNet premiums earned increased 61.8% to $128.1 million in 1993 from $79.2 million in 1992. The increase in premiums earned was due primarily to the Company's ability to retain more premiums as a result of increased capital from a portion of the $31.2 million proceeds of an offering of the Company's Common Stock completed in January 1993. The two business lines in which the increase in retentions was the most significant were the auto liability line, in which net premiums written increased $23.7 million, and the general liability line, in which net premiums written increased $11.7 million.\nRedland operations added $16.2 million to the Company's net premiums earned for 1993, consisting primarily of premiums from auto liability, auto physical damage and crop hail insurance, following the Redland acquisition in July of that year. The Company's MPCI business recorded a loss share of $0.9 million (net of recoveries from third party reinsurers) for 1993, and such loss is included in losses and loss adjustment expenses.\nThe Company's net investment income increased 31.9% to $10.8 million in 1993 from $8.2 million in 1992. This increase is attributable primarily to the increase in the size of the Company's investment portfolio from an average of $113 million during 1992 to an average of $173 million during 1993. This increase was principally a result of the investment of approximately $20 million of funds derived from the Company's Common Stock offering completed in January 1993, the Company's ability to retain more of its premiums written as a result of this additional capital, and approximately $21 million in additional investment assets acquired in the Redland acquisition. The impact of the increase in the average size of the investment portfolio was offset by a reduction in the average yield on the invested assets from 7.3% during 1992 to 6.3% during 1993. The reduction in the average yield primarily was due to the addition to the Company's portfolio of tax-exempt securities which in general have lower yields than equivalent taxable securities, the short term nature of Redland's portfolio, the amortization of premiums paid for certain of the Company's mortgage-backed securities caused by an acceleration in the rate of prepayments of the underlying mortgages, and a general decline in interest rates.\nThe Company's net realized capital gains increased to $2.3 million in 1993 from $1.0 million in the prior year. The increase in the net realized capital gains was primarily a result of sales related to the repositioning of\nthe Company's portfolio into a higher concentration in tax-exempt securities during the strong market for fixed income securities in 1993.\nLosses and loss adjustment expenses increased 54.6% to $92.8 million in 1993 from $60.0 million in the prior year, consistent with the increase in net premiums earned. Losses and loss adjustment expenses in 1993 were adversely impacted by the Company's MPCI results, which generated a net loss share of $0.9 million due primarily to losses resulting from adverse weather conditions in the 1993 growing season. The 1992 results were adversely affected by $1.7 million in losses from Hurricanes Andrew and Iniki as well as $2.1 million in reserve strengthening in the Company's workers' compensation and liquor liability lines.\nThe Company's underwriting and other expenses increased 56.9% to $36.9 million in 1993 from $23.5 million in the prior year, consistent with the increase in net premiums earned.\nThe Company's interest expense declined to $2.2 million during 1993 from $4.4 million in 1992 primarily due to a decrease in the average amount of outstanding debt as well as a reduction in the average interest rate. In May 1992, the Company completed the sale of its citrus operations permitting a $22 million principal amount reduction in bank debt, which accounted for approximately $1.1 million of the reduction in interest expense, and in January 1993, completed a Common Stock offering permitting the retirement of $9.5 million of higher interest rate notes issued in 1992, which accounted for approximately $800,000 of the reduction in interest expense.\nIncome taxes were approximately $200,000 in 1993 whereas none was recorded in 1992. The $200,000 recorded in 1993 represented applicable Alternative Minimum Tax amounts as no other tax was recorded in either year due to the availability of net operating loss carryforwards.\nThe Company's net income increased by $8.5 million from 1992 to 1993 as net income improved from a loss of $900,000 for the year ended December 31, 1992 to income of $7.6 million for the year ended December 31, 1993 because of the factors discussed above.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has included a discussion of the liquidity and capital resources requirements of the Company and the Insurance Companies.\nTHE COMPANY -- PARENT ONLY\nAs an insurance holding company, the Company's assets consist primarily of the capital stock of its subsidiaries, a surplus note issued by Acceptance Insurance and investment assets held at the holding company level. Following the Offering, the Company's primary sources of liquidity will be the receipt of dividends or other distributions from subsidiaries, interest payments on such surplus note (and any additional surplus note that Acceptance Insurance may issue), tax sharing payments from its subsidiaries and net investment income from, and proceeds from the sale of, holding company investments. The Company needs liquidity primarily to service debt, pay operating expenses and taxes and make investments in subsidiaries.\nThe three domiciliary states of the Insurance Companies limit the payment of dividends and other distributions by such companies. For example, under Nebraska law, dividends or distributions may not be paid by an insurance company unless such dividends, together with any dividends paid within the preceding 12 months, do not exceed the lesser of (a) 10% of the policyholders' surplus of the insurer as of the preceding December 31 or (b) the insurer's net income, excluding realized capital gains, for the preceding calendar year, both computed in accordance with statutory accounting principles applicable to insurance companies. In determining net income available for dividends in Nebraska, an insurer may carry forward net income, again excluding realized capital gains, from the second and third full calendar years preceding the date of determination, less dividends paid in such prior calendar years. See \"Business -- Regulation\" for a description of the dividend restrictions applicable to insurers domiciled in Iowa and Arizona. Under these laws, the maximum aggregate amount of dividend payments permitted to be made by the Insurance Companies in 1995 without prior regulatory approval will be approximately $6.0 million, none of which has been paid.\nThe Company currently holds a surplus note issued by Acceptance Insurance in the principal amount of $20 million, bearing interest at the rate of 9% per annum, payable quarterly. Although the principal of surplus notes issued by a Nebraska domiciled company such as Acceptance Insurance may not be repaid without the prior approval of the Nebraska insurance regulators, under current law, no prior approval is required for interest payments.\nThe maximum dividend permitted by law is not necessarily indicative of an insurer's actual ability to pay dividends or other distributions to a parent company, which may be constrained by business and regulatory considerations such as the impact of such payments on surplus and certain leverage and operating ratios, which could affect an insurer's competitive position, the amount of premiums that can be written and the ability to pay future dividends. Further, state insurance laws and regulations require that the statutory surplus of insurance companies following any dividend or distribution by such company be reasonable in relation to its outstanding liabilities and adequate for its financial needs.\nStatutory accounting practices differ in many respects from those governing the preparation of financial statements under generally accepted accounting principles. Accordingly, statutory operating results and statutory surplus may differ substantially from amounts reported in the GAAP basis financial statements for comparable items. Information as to statutory surplus and statutory net income for the Insurance Companies is included in the footnotes to the Consolidated Financial Statements of the Company included elsewhere herein.\nIn addition to dividends from the Insurance Companies, the Company also may receive distributions from its non-insurance subsidiaries which are engaged in agency, premium finance and claims service operations.\nThe Company is currently a party to a tax sharing agreement with its subsidiaries, under which such subsidiaries pay the Company amounts in general equal to the federal income tax that would be payable by such subsidiaries on a stand-alone basis. These tax payments may provide cash flow for the Company in the future.\nOn December 1, 1994, pursuant to a call by the Company to redeem certain outstanding Warrants, approximately 4.85 million of such Warrants were exercised to purchase shares of Common Stock, resulting in net proceeds to the Company of approximately $53.4 million. Of such amount, $18 million was contributed as surplus to Redland Insurance, $20 million was used to purchase the surplus note of Acceptance Insurance described above and thereby increase its surplus and the remainder was used for working capital and general corporate purposes.\nAt December 31, 1994, after receipt of the proceeds of exercise of the Warrants, approximately $9.4 million was held by the Company at the holding company level.\nThe Company is also a party to the Revolving Credit Facility with a group of bank lenders which is secured by substantially all of the Company's assets. The maximum amount that may be borrowed under the facility is $35 million. Interest is payable quarterly at a rate selected by the Company equal to either the prime rate or LIBOR plus a margin of 1% to 1.75% depending on the Company's debt-to-equity ratio. At December 31, 1994, the outstanding balance under the facility was $29 million, bearing interest at 7.375%. Borrowings under the facility were used to provide capital for the Insurance Companies and to repay other debt. The Revolving Credit Facility expires on March 31, 1998, and may be extended for an additional year with the consent of the lenders. The Company is currently discussing with its bank lenders an increase in the principal amount available under the Company's Revolving Credit Facility, although there can be no assurance that such an increase will occur.\nThe Company's history is one of continuing premium growth as a result both of acquisitions and other equity investments and of internal growth, and it intends to continue to pursue additional opportunities in the insurance business. Such growth requires capital, and as a result the Company may seek additional debt or equity financing in the future to provide capital for the Insurance Companies, to fund further acquisitions or for other purposes. There can be no assurance that the Insurance Companies will have access to sufficient capital in future periods to continue their growth and also satisfy the capital requirements of rating agencies and regulators.\nINSURANCE COMPANIES\nThe principal liquidity needs of the Insurance Companies are to fund losses and loss adjustment expense payments and to pay underwriting expenses, including commissions and other expenses. The available sources to fund these requirements are net premiums received and, to a lesser extent, cash flows from the Company's investment activities, which together have been adequate to meet such requirements on a timely basis. The Company monitors the cash flows of the Insurance Companies and attempts to maintain sufficient cash to meet current operating expenses, and to structure its investment portfolio at a duration which approximates the estimated cash requirements for the payment of loss and loss adjustment expenses.\nCash flows from the Company's MPCI and crop hail businesses differ in certain respects from cash flows associated with more traditional property and casualty lines. MPCI premiums are not received from farmers until the covered crops are harvested, and when received are promptly remitted by the Company in full to the government. Covered losses are paid by the Company during the growing season as incurred, with such expenditures reimbursed by the government within three business days. Policy acquisition and administration expenses are paid by the Company as incurred during the year. The Company periodically throughout the year receives a payment in reimbursement of its policy administration expenses.\nThe Company's profit or loss from its MPCI business is determined after the crop season ends on the basis of a profit sharing formula established by law and the CFSA. At such time, the Company receives a profit share in cash, with any amount in excess of 15% of its MPCI Retention in any year carried forward to future years, or it must pay its share of losses. The profit sharing formula takes into consideration the amount of federal premium subsidies credited to the Company in respect of the MPCI business it has written. These federal subsidies are non-cash items, which for 1994 ranged as high as 30% of MPCI Premiums for certain policies and for 1995 may range up to approximately 42% of such MPCI Premiums.\nIn the crop hail insurance business, premiums are generally not received until after the harvest, while losses and other expenses are paid throughout the year.\nCHANGES IN FINANCIAL CONDITION\nOn August 29, 1994, A.M. Best placed under review with negative implications the A- (Excellent) ratings of Acceptance Insurance, Acceptance Indemnity and Redland Insurance due to their rapid growth in premiums without a corresponding growth in surplus. Subsequently, the Company agreed to increase the\nstatutory capital of Redland Insurance and Acceptance Insurance by an additional $18 million and $20 million, respectively. A.M. Best then affirmed the A- (Excellent) ratings of Acceptance Insurance, Acceptance Indemnity and Redland Insurance.\nThe NAIC has released its proposed RBC formula for property and casualty insurance companies. The RBC initiative is designed to enhance the current regulatory framework for the evaluation of the capital adequacy of a property and casualty insurer. The formula requires an insurer to compute the amount of capital necessary to support four areas of risk facing property and casualty insurers: (a) asset risk (default on fixed income assets and market decline), (b) credit risk (losses from unrecoverable reinsurance and inability to collect agents' balances and other receivables), (c) underwriting risk (premium pricing and reserve estimates), and (d) off balance sheet\/growth risk (excessive premium growth and unreported liabilities). The Insurance Companies have reviewed and applied the proposed RBC formula for the 1994 year and have exceeded these requirements. Of the states in which the Insurance Companies are domiciled, Nebraska is the first state to adopt the RBC rules into law, although the RBC results must be reported to the states in which the Insurance Companies do business. See \"Business -- Regulation.\"\nThe Company's unrealized gain or loss on marketable equity securities and fixed maturities available for sale, net of tax, changed from a $66,000 gain as of December 31, 1993 to an approximate $13.7 million loss as of December 31, 1994. Such change was caused by the loss in value related to the general upward movement in interest rates. Although the Company believes that it has adequate sources of liquidity to avoid being required to realize any of the foregoing unrealized losses, there can be no assurance in this regard. See \"Recent Statements of Financial Accounting Standards\" below.\nCONSOLIDATED CASH FLOWS\nCash flows from operations for the year ended December 31, 1994 were a positive $42.7 million as compared to a positive $24.6 million for the 1993 year. The 1994 cash flows were positively impacted by premium growth in casualty lines of business and changes in the Company's reinsurance structure whereby the Company retained more of its business for its own account. Cash flows from financing activities for 1994 were positively impacted primarily by the exercise of the Warrants in December 1994, and to a lesser extent the restructuring of the Company's bank borrowings upon its entering into the Revolving Credit Facility in March 1994.\nINFLATION\nThe Company does not believe that inflation has had a material impact on its financial condition or results of operations.\nRECENT STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS\nOn January 1, 1994, the Company adopted SFAS #115, \"Accounting for Certain Investments in Debt and Equity Securities.\" In conjunction with the adoption of SFAS #115, the Company reclassified its debt and equity securities to meet the requirements of the statement. SFAS #115 requires investments in debt and equity securities to be classified at acquisition into one of three categories: held to maturity, available for sale, or trading.\nAt December 31, 1994, all debt and equity securities were classified as available for sale. Available for sale securities are stated at fair market value with the unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity. At December 31, 1994, the Company had an unrealized loss on these securities, net of taxes, of approximately $13.7 million. See \"Business -- Investments.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee Item 14 hereof and the Consolidated Financial Statements attached hereto.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere have been no disagreements with the Registrant's independent accountants of the nature calling for disclosure under Item 9.\nPART III. ITEM 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 Registrant's executive officers and directors will be set forth in the Company's 1995 Proxy Statement included as Exhibit 99.6 hereto and incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by Item 11 will be set forth in the Company's 1995 Proxy Statement included as Exhibit 99.6 hereto and incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by Item 12 will be set forth in the Company's 1995 Proxy Statement included as Exhibit 99.6 hereto and incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe Company beneficially owns 33.1% of the common stock of Major Realty Corporation (\"Major Realty\"). Messrs. Bielfield, Coon, McCarthy & Treadwell are directors of both the Company and Major Realty. George F. Valassis, beneficial owner of approximately 13% of the Company's common stock, owns beneficially approximately 9.8% of the Major Realty common stock. Mr. Valassis is the father of Doug T. Valassis, a director of the Company.\nDuring the fiscal year ended December 31, 1994, the Company employed McCarthy & Co., d\/b\/a Long View Capital Management, a wholly-owned subsidiary of McCarthy Group, Inc., to furnish investment advisory services to the Company and paid McCarthy & Co. $132,000 for such services. Michael R. McCarthy, a director of the Company, is Chairman and a principal shareholder of McCarthy Group, Inc.\nDuring the fiscal year ended December 31, 1994, the Company purchased from an unaffiliated insurer health insurance for its employees through Mammel & Associates, Inc., a third-party administrator, which receives certain commissions from the unaffiliated insurer. Mammel & Associated, Inc., is an 81% subsidiary of Redland & Associates, Inc. John P. Nelson, a director of the Company is Chairman of the Board and a principal shareholder of Redland & Associates, Inc.\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 Company's audited Consolidated Financial Statements for the years ended December 31, 1994 and 1993 consisting of the following:\nReports of Independent Accountants Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Cash Flows Consolidated Statements of Stockholders' Equity Notes to Consolidated Financial Statements\n2. Financial Statement Schedules SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE V. VALUATION ACCOUNTS\n3. The Exhibits filed herewith are set forth in the Exhibit Index attached hereto.\n(b) No Current Reports on Form 8-K have been filed during the last fiscal quarter of the period covered by this Report.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Acceptance Insurance Companies Inc.\nWe have audited the accompanying consolidated balance sheets of Acceptance Insurance Companies Inc. 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. 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, such consolidated financial statements present fairly, in all material respects, the financial position of Acceptance Insurance 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 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, in 1994 the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities.\nDELOITTE & TOUCHE LLP\nOmaha, Nebraska March 17, 1995\nACCEPTANCE INSURANCE COMPANIES INC.\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993 (IN THOUSANDS EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of the consolidated financial statements.\nACCEPTANCE INSURANCE COMPANIES INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of the consolidated financial statements.\nACCEPTANCE INSURANCE COMPANIES INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nThe accompanying notes are an integral part of the consolidated financial statements.\nACCEPTANCE INSURANCE COMPANIES INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nThe accompanying notes are an integral part of the consolidated financial statements.\nACCEPTANCE INSURANCE COMPANIES INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nDESCRIPTION OF OPERATIONS\nAcceptance Insurance Companies Inc. (the \"Company\") is primarily engaged in the specialty property and casualty insurance business through its wholly-owned subsidiaries, Acceptance Insurance Holdings Inc. (\"Acceptance\") and The Redland Group, Inc. (\"Redland\"), which the Company acquired on April 11, 1990 and August 13, 1993, respectively. The Company previously conducted citrus operations through its approximate 52% owned subsidiary, Orange-co, Inc. (\"Orange-co\"). In December 1991, the Company decided to sell its interest in Orange-co and in May 1992 its interest was sold. As a result, the Company's loss on its disposal of Orange-co is presented separately on the consolidated statements of operations.\nThe Company holds a 33% equity investment in Major Realty Corporation (\"Major Realty\"), a Florida based real estate company.\nPRINCIPLES OF CONSOLIDATION\nThe Company's consolidated financial statements include the accounts of its majority-owned subsidiaries. All significant intercompany transactions have been eliminated.\nINSURANCE ACCOUNTING\nGenerally, premiums are recognized as income ratably over the terms of the related policies. Crop insurance premiums are recognized based upon exposure to related insurance losses. Insurance costs are associated with premiums earned, resulting in the recognition of profits over the term of the policies. This association is accomplished through amortization of deferred policy acquisition costs and provisions for unearned premiums and loss reserves.\nThe liability for unearned premiums represents the portion of premiums written which relates to future periods and is calculated generally using the pro rata method. The Company also provides a liability for policy claims based on its review of individual claim cases and the estimated ultimate settlement amounts. This liability also includes estimates of claims incurred but not reported based on Company and industry paid and reported claim and settlement expense experience. Differences which arise between the ultimate liability for claims incurred and the liability established will be reflected in the statement of operations of future periods as additional claim information becomes available.\nCertain costs of acquiring new insurance business, principally commissions, premium taxes, and other underwriting expenses, have been deferred. Such costs are being amortized as related premiums are earned. Anticipated investment income is considered in evaluating recoverability of deferred acquisition costs.\nSTATEMENTS OF CASH FLOWS\nThe Company aggregates cash and short-term investments with maturity dates of three months or less from the date of purchase for purposes of reporting cash flows. As of December 31, 1994 and 1993, approximately $15,376,000 and $4,737,000 of short-term investments had maturity dates at acquisition of greater than three months.\nINVESTMENTS\nOn January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 (SFAS 115), Accounting for Certain Investments in Debt and Equity Securities. As a result of adoption of this statement, $2,912,000 was credited to stockholders' equity at January 1, 1994. In conjunction with the adoption of SFAS 115, the Company reclassified its investment in fixed maturity securities to meet the\nACCEPTANCE INSURANCE COMPANIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nrequirements of the statement. SFAS 115 requires investments in fixed maturity securities to be classified at acquisition into one of three categories: held-to-maturity, available-for-sale, or trading. Securities are classified as trading when they are bought and held principally for the purpose of selling them in the near future. Securities are classified as available-for-sale when the securities may be sold from time to time to effectively manage interest rate exposure and liquidity needs. Securities are classified as held-to-maturity securities when the Company has the positive intent and ability to hold these securities until maturity.\nSince adoption of SFAS 115, all debt and equity securities were classified as available-for-sale. Available-for-sale securities are stated at fair value with the unrealized gains and losses reported as a separate component of stockholders' equity, net of tax.\nMortgage loans are carried at the lower of their unpaid principal balance or their estimated net realizable value. Real estate is stated at the lower of cost or estimated net realizable value and is non-income producing.\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost, net of accumulated depreciation. Depreciation is recognized principally using the straight-line method over a period of five to ten years.\nEXCESS OF COST OVER ACQUIRED NET ASSETS\nThe excess of cost over equity in acquired net assets is being amortized principally using the straight-line method over periods not exceeding 40 years. Accumulated amortization approximated $3,299,000 and $2,185,000 at December 31, 1994 and 1993, respectively.\nRecoverability of this asset is evaluated periodically based on management's estimate of future undiscounted earnings of the businesses acquired.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nEstimated fair values of financial instruments have been determined by the Company, using available market information and valuation methodologies. However, 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 valuation methodologies or market assumptions may have an effect on the estimated fair value amounts presented.\nThe fair value of fixed maturity and equity securities disclosed in Note 4 to the financial statements are determined by the quoted market price or modeling techniques for asset-backed securities not actively traded. The book value of mortgage loans, short-term investments, other investments, cash, receivables, equity investment in Major Realty Corporation, accounts payable and borrowings approximate fair value.\nPER SHARE DATA\nPrimary and fully diluted earnings per share are based on weighted average shares outstanding of approximately 13.4 million and 13.6 million, respectively, for the year ended December 31, 1994; approximately 11.6 million and 11.9 million, respectively, for the year ended December 31, 1993; and approximately 3.4 million for the year ended December 31, 1992. Included in weighted average shares outstanding in 1994 and 1993 is the assumed conversion of all outstanding options and warrants utilizing the modified treasury stock method, since average outstanding options and warrants during those periods exceeded 20% of the outstanding stock. Under this method, appropriate adjustment to net income is made to reflect the assumed use of the proceeds of the conversion.\nACCEPTANCE INSURANCE COMPANIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nRECLASSIFICATIONS\nCertain prior period accounts have been reclassified to conform with current year presentation.\n2. COMMON STOCK ISSUED\nOn December 1, 1994, pursuant to a call by the Company to redeem certain outstanding warrants, approximately 4.85 million of such warrants were exercised to purchase shares of common stock, resulting in net proceeds to the Company of approximately $53.4 million.\nOn January 27, 1993, the Company completed a Common Stock Rights Offering to raise additional equity capital. The Rights Offering was fully subscribed resulting in the issuance of 3,992,480 units, at $8.00 per unit, consisting of one share of common stock and a warrant for the purchase of one share of common stock exercisable at $11.00. Net proceeds of approximately $31.2 million were used in part to retire $9.5 million of Secured Subordinated Notes (see Note 7).\nEffective April 15, 1993, the holder of a $7,000,000 Secured Subordinated Note of one of the Company's subsidiaries, which had been assumed by the Company, exchanged such note for 875,000 shares of common stock and warrants to purchase 875,000 additional shares of common stock. The shares of common stock and warrants were identical to the shares and warrants issued in the Company's Rights Offering.\n3. ACQUISITIONS\nOn March 31, 1994, the Company entered into an Agreement and Plan of Merger with Statewide Insurance Corporation (Statewide), the exclusive general agent for the Company's non-standard automobile insurance program underwritten by Phoenix Indemnity Insurance Company (Phoenix Indemnity), pursuant to which the Company acquired Statewide. Statewide owned 20% of the outstanding common stock of Phoenix Indemnity which was a previously 80% owned subsidiary of the Company. The acquisition was effective April 1, 1994 and was accounted for as a purchase.\nThe purchase price of approximately $3.1 million, comprised of approximately 266,000 shares of the Company's common stock, was allocated based upon the estimated fair market value of assets acquired and liabilities assumed. The purchase price in excess of the fair market value of the net assets acquired is being amortized using the straight-line method over 40 years.\nOn August 13, 1993, the Company acquired all of the outstanding common stock, warrants to purchase common stock, and preferred stock of Redland pursuant to an Exchange Agreement. Redland underwrites multi-peril crop, crop hail, specialty automobile, and farmowner insurance coverages. The acquisition of Redland was accounted for as a purchase transaction. The purchase price of approximately $15.4 million, comprised of 1,339,000 shares of the Company's common stock and acquisition related costs of $306,000, was allocated based upon the estimated fair market value of assets acquired and liabilities assumed. The purchase price in excess of the fair market value of the net assets acquired is being amortized using the straight-line method over 40 years.\nThe results of operations for Redland are included in the accompanying financial statements effective July 1, 1993. The purchase price does not reflect 240,000 shares issued by the Company and held in escrow pursuant to the Exchange Agreement, as a fund against which the Company may assert certain claims. The primary contingency under which claims may be asserted is the ultimate development of Redland's liability for losses and loss adjustment expenses. Upon resolution of contingencies related to the acquisition, such shares will be returned to the Company or released to former Redland stockholders.\nACCEPTANCE INSURANCE COMPANIES INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe pro forma financial data, which gives effect to the acquisition of Redland as though it had been completed January 1, 1993, for the year ended December 31, 1993, is as follows (in thousands, except per share data):\nThe pro forma financial data for the year ended December 31, 1993, is not necessarily indicative of the results had the Company actually acquired Redland on January 1, 1993, as the financial data includes $3.9 million of charges to earnings taken by Redland in the first and second quarters of 1993. The charges were comprised of a $900,000 write-down of a marketable equity security and a $3.0 million strengthening of reserves, both of which would have been adjusted to their fair market value on January 1, 1993, and thus would have been excluded from the 1993 results of operations.\n4. INVESTMENTS\nA summary of net investment income earned on the investment portfolio for the years ended December 31, 1994, 1993 and 1992 is as follows (in thousands):\nACCEPTANCE INSURANCE COMPANIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe amortized cost and related market values of fixed maturities in the accompanying balance sheets are as follows (in thousands):\nThe amortized cost and related market values of the fixed maturity securities as of December 31, 1994 are shown below by stated maturity dates. Actual maturities may differ from stated maturities because the borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nACCEPTANCE INSURANCE COMPANIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe Company's collateral backed securities portfolio consists of mortgage-backed securities, all of which are collateralized mortgage obligations (CMOs). The following table sets forth as of December 31, 1994 the categories of the Company's CMOs, which at such date had an average expected life of approximately six years.\n------------------------- (1) Par value is the face amount of the underlying mortgage collateral. Any cost in excess of par value is a \"premium\" whereas cost lower than par value is a \"discount\". The Company's aggregate CMO portfolio has been purchased at a discount.\n(2) Floating rate CMOs provide an increased interest rate when a specified index interest rate increases and a lower interest rate when such index rate decreases, while inverse floating rate CMOs provide a lower interest rate when the index increases and a higher rate when the index rate decreases. Generally, the Company's floating rate and inverse floating rate securities are tied to the one month LIBOR. The market values of the Company's floating rate and inverse rate CMOs are significantly impacted by various factors, including the outlook for future interest rate changes and such securities' relative liquidity under current market conditions.\n(3) All of the CMO portfolio collateral is guaranteed by a government agency.\nProceeds from sales of fixed maturity securities during the years ended December 31, 1994, 1993 and 1992 were approximately $21,729,000, $115,339,000 and $76,457,000, respectively. There were no sales of fixed maturity securities held for investment. Gross realized gains on sales of fixed maturity securities were approximately $55,000, $2,023,000 and $1,362,000, and gross realized losses on sales of fixed maturity securities were approximately $13,000, $17,000 and $85,000 during the years ended December 31, 1994, 1993 and 1992, respectively.\nAs required by insurance regulatory laws, certain bonds with an amortized cost of approximately $15,942,000 and short-term investments of approximately $376,000 at December 31, 1994 were deposited in trust with regulatory agencies.\n5. RECEIVABLES\nThe major components of receivables at December 31 are summarized as follows (in thousands):\nACCEPTANCE INSURANCE COMPANIES INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\n6. EQUITY INVESTMENT IN MAJOR REALTY CORPORATION\nAs of December 31, 1994 and 1993, the Company held an approximate 33% equity investment in Major Realty, a publicly traded real estate company engaged in the ownership and development of its undeveloped land in Orlando, Florida.\nAt December 31, 1994, the carrying value of the Company's investment in Major Realty approximated $5.1 million or $2.23 per share. Additionally at that date, Major Realty had a stockholders' equity of approximately $1,102,000 and the quoted market price of Major Realty was $2.00 per share. The Company expects to realize a minimum of its carrying value in Major Realty based on the estimated net realizable values of Major Realty's underlying assets. The Company's estimate of net realizable value is based upon several factors including estimates from Major Realty's management, asset appraisals and sales to date of Major Realty's assets. Commencing in 1992, the Company has not recognized its share of net gains realized by Major Realty on sales of real estate but continues to recognize its share of general and administrative expenses recorded by Major Realty.\nThe following summary financial data for Major Realty as of and for the years ended December 31, 1994 and 1993 was obtained from Major Realty's consolidated financial statements (in thousands):\n7. BANK BORROWINGS, TERM DEBT AND OTHER BORROWINGS AND NOTES PAYABLE TO AFFILIATES\nOn March 31, 1994, the Company amended its borrowing arrangements with its bank lenders providing a $35 million line of credit with interest payable quarterly at the prime rate or at LIBOR plus a margin of 1% to 1.75%, depending on the Company's debt to equity ratio. The line of credit will mature in four years and may be extended to five years by the bank lenders.\nACCEPTANCE INSURANCE COMPANIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe following information relates to the debt agreements in effect as of December 31 (in thousands):\nThe Company is considering raising additional debt capital. Use of the proceeds of any additional borrowing may include a contribution to capital of the insurance subsidiaries.\nAt December 31, 1994, the line of credit was collateralized by the Company's Acceptance and Redland common stock. Borrowings and interest on the line of credit averaged $20,852,000 and 6.3% during 1994. The line of credit contains covenants which do not permit the payment of dividends by the Company, require the Company to maintain certain operating and debt service coverage ratios, requires maintenance of specified levels of surplus and requires the Company to meet certain tests established by regulatory authorities.\nIn August 1993, Redland refinanced its existing notes payable to a bank with a $7,500,000 revolving promissory note. At December 31, 1993, $6,597,000 was outstanding under this agreement.\nThe Company issued $9.5 million of Secured Subordinated Notes to certain directors or stockholders in April 1992 through the exchange of previously issued secured and unsecured notes aggregating approximately $8.3 million and cash. Additionally, the Company issued to the holders of the Secured Subordinated Notes approximately 97,500 common stock warrants exercisable for five years at a price of $9.50 per share, of which 86,101 warrants remained outstanding at December 31, 1994. In January 1993, these notes were redeemed.\nCash payments for interest were approximately $1.5 million, $2.5 million and $4.2 million during the years ended December 31, 1994, 1993 and 1992, respectively.\n8. INCOME TAXES\nThe Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", effective January 1, 1993. The prospective application of SFAS No. 109 resulted in no effect upon net income for the year ended December 31, 1993.\nSFAS No. 109 requires that the Company recognize a net deferred tax asset or liability for all temporary differences and net operating loss carryforwards and a related valuation allowance account when realization of the asset is uncertain. A valuation allowance was recorded for the full amount of the deferred tax asset at December 31, 1993 because the Company had reported pre-tax losses from 1989 through 1992. Although the circumstances that generated these losses were not indicative of operating income, management was uncertain of future earnings.\nAs of December 31, 1994, the Company has reported ten consecutive quarters with pre-tax earnings and the Company has used all of its net operating loss carryforwards. Accordingly, management believes it is more likely than not that the Company will realize a portion of the deferred tax asset. The valuation allowance at\nACCEPTANCE INSURANCE COMPANIES INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nDecember 31, 1994 primarily relates to capital loss items whose realization is uncertain. The net deferred tax asset as of December 31, is as follows (in thousands):\nIncome taxes computed by applying statutory rates to income before income taxes are reconciled to the provision for income taxes set forth in the consolidated financial statements as follows (in thousands):\nThe Company recognized a current tax expense of approximately $167,000 for the year ended December 31, 1993 as a result of amounts due under alternative minimum taxable income provisions which limit net operating loss carryforwards.\nCash payments for income taxes were approximately $1,478,000 and $232,000 during the years ended December 31, 1994 and 1993.\nACCEPTANCE INSURANCE COMPANIES INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\n9. OPERATING LEASES\nThe Company leases office space and certain furniture and equipment under operating leases. Future minimum obligations under these operating leases are as follows (in thousands):\nRental expense totaled approximately $2,529,000, $1,169,000 and $1,014,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\n10. STOCK OPTIONS\nIn December 1992, stockholders approved an incentive stock option plan under which options granted to employees vest over the four years following the date of grant, options granted to non-employee directors are vested one year from the date of grant and all options terminate ten years from the date of grant. A maximum of 500,000 shares are available for the plan and 125,500 and 94,500 options were granted during 1994 and 1993, respectively.\nOn January 27, 1993, certain executive officers of the Company were awarded non-qualified options entitling these officers to purchase a total of 72,500 shares of the Company's Common Stock at market value on the date of grant of $8.75 per share, which are currently exercisable through January 27, 1998.\nIn connection with consulting agreements entered into in May 1991 with certain of its directors, the Company incurred approximately $100,000 of expense during the year ended December 31, 1992. Under the same agreements and in addition to the above, these directors received a total of 62,210 options to purchase Company common stock at a price of $10.25 per share which are exercisable through May 1996.\nChanges in stock options are as follows:\nAt December 31, 1994, 211,231 shares were exercisable under stock options.\nIn December 1992, stockholders approved an employee stock purchase plan whereby eligible employees will be given the opportunity to subscribe for the purchase of the Company's common stock for 85% of its fair\nACCEPTANCE INSURANCE COMPANIES INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nmarket value as defined. During 1994 and 1993, 19,722 and 12,639 shares were issued under this plan, respectively.\n11. RELATED PARTY TRANSACTIONS\nIncluded in real estate revenues for the year ended December 31, 1992, is fee income totaling approximately $1,522,000 for real estate advisory services provided by a subsidiary of the Company to Major Realty. Revenues for the year ended December 31, 1992 included a non-recurring fee of $925,000 associated with the settlement and termination of the advisory agreement in March 1992, effective January 1, 1992. As part of the termination and settlement agreement, Major Realty issued two promissory notes bearing interest at 12% aggregating $1,514,581 to the Company's subsidiary representing payment of all deferred fees and interest thereon and payment of the termination fee, substantially all of which has been paid at December 31, 1994. Four members of the Board of Directors of the Company also serve on the Board of Directors of Major Realty.\nThe Company contracts with a related party to administer health insurance benefits for its employees whereby the related party receives a commission fee from the insurance provider.\nThe Company made payments during 1994 totalling approximately $132,000 to a related party to provide investment related services.\n12. INSURANCE PREMIUMS AND CLAIMS\nInsurance premiums written and earned by the Company's insurance subsidiaries for the years ended December 31, 1994, 1993 and 1992 are as follows (in thousands):\nFive insurance agencies produced direct premiums written aggregating approximately 22%, 34% and 51% of total direct premiums during the years ended December 31, 1994, 1993 and 1992, respectively.\nACCEPTANCE INSURANCE COMPANIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe following table presents an analysis of the Company's reserves, reconciling beginning and ending reserve balances for the periods indicated (in thousands):\nInsurance loss and loss adjustment expenses have been reduced by recoveries recognized under reinsurance contracts of $145,451,000 and $216,246,000 for the years ended December 31, 1994 and 1993, respectively.\n13. REINSURANCE\nThe Company's insurance subsidiaries cede insurance to other companies under quota share, excess of loss and facultative treaties. The insurance subsidiaries also maintain catastrophe reinsurance to protect against catastrophic occurrences where claims can arise under numerous policies due to a single event. The reinsurance agreements are tailored to the various programs offered by the insurance subsidiaries. The largest amount retained in any one risk by the insurance subsidiaries during 1994 was $500,000. The methods used for recognizing income and expenses related to reinsurance contracts have been applied in a manner consistent with the recognition of income and expense on the underlying direct and assumed business (See Note 1).\nThree reinsurers, who have an A.M. Best rating of A- (Excellent) or better, accounted for approximately 30% of the reinsurance recoverables and prepaid reinsurance premiums at December 31, 1994. No other reinsurer, except for the Consolidated Farm Service Agency (sponsored by the United States Department of Agriculture) accounted for more than 5% of these balances.\n14. DIVIDEND RESTRICTIONS AND REGULATORY MATTERS\nDividends from the insurance subsidiaries of the Company are regulated by the state regulatory authorities of the states in which each subsidiary is domiciled. The laws of such states generally restrict dividends from insurance companies to parent companies to certain statutorily approved limits. As of December 31, 1994, the statutory limitations on dividends from insurance company subsidiaries to the Company without further insurance department approval were approximately $6.0 million.\nACCEPTANCE INSURANCE COMPANIES INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED\nThe Company's insurance subsidiaries reported to regulatory authorities surplus of approximately $126,272,000 and $73,910,000 at December 31, 1994 and 1993, respectively, and total statutory net income of $6,659,000, $682,000, and $1,304,000 for the years ended December 31, 1994, 1993, and 1992, respectively.\nThe statutory net income includes Redland insurance subsidiaries effective July 1, 1993.\n15. CONTINGENCIES\nThe Company is involved in various insurance related claims and other legal actions arising from the normal conduct of business. Management believes that the outcome of these proceedings will not have a material effect on the consolidated financial statements of the Company.\nA subsidiary of the Company has guaranteed debt of $775,000 relating to a real estate partnership in which the subsidiary has a limited partnership interest.\n16. INTERIM FINANCIAL INFORMATION (UNAUDITED)\n-------------------------\n(1) As a result of the acquisition of Redland in July 1993, the Company became significantly involved in crop insurance programs, including the federal Multi-Peril Crop Insurance program and the crop hail business. The Company's operating results from its crop program can vary substantially from quarter to quarter as a result of various factors, including timing and severity of losses from storms and other natural perils and crop production cycles. Therefore, the results for any quarter are not necessarily indicative of results for any future period. The results of the crop program business primarily are recognized in the second half of the calendar year.\n(2) Quarterly net income per share numbers do not add to the annual net income per share due to rounding.\nACCEPTANCE INSURANCE COMPANIES INC.\nSCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT DECEMBER 31, 1994 AND 1993 BALANCE SHEETS (PARENT COMPANY ONLY) (IN THOUSANDS)\nACCEPTANCE INSURANCE COMPANIES INC.\nSCHEDULE II - (CONTINUED) CONDENSED FINANCIAL INFORMATION OF REGISTRANT YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 STATEMENTS OF OPERATIONS (PARENT COMPANY ONLY) (IN THOUSANDS)\nACCEPTANCE INSURANCE COMPANIES INC.\nSCHEDULE II - (CONTINUED) CONDENSED FINANCIAL INFORMATION OF REGISTRANT YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 STATEMENTS OF CASH FLOWS (PARENT COMPANY ONLY) (IN THOUSANDS)\nACCEPTANCE INSURANCE COMPANIES INC.\nSCHEDULE II - (CONTINUED) CONDENSED FINANCIAL INFORMATION OF REGISTRANT YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 NOTES TO FINANCIAL STATEMENTS (PARENT COMPANY ONLY)\nThe condensed financial information of Acceptance Insurance Companies Inc. (the \"Company\") for the years ended December 31, 1994, 1993, and 1992 should be read in conjunction with the consolidated financial statements of the Company and the notes thereto incorporated elsewhere herein by reference.\nOn December 1, 1994, pursuant to a call by the Company to redeem certain outstanding warrants, approximately 4.85 million of such warrants were exercised to purchase shares of common stock, resulting in net proceeds to the Company of approximately $53.4 million.\nIn January 1993, the Company assumed a $7 million note from one of its subsidiaries. In April 1993, this note was exchanged for 875,000 shares of common stock and warrants to purchase common stock. (See Note 2 to the Consolidated Financial Statements.)\nOn March 31, 1994, the Company entered into an Agreement and Plan of Merger with Statewide Insurance Corporation (Statewide), the exclusive general agent for the Company's non-standard automobile insurance program underwritten by Phoenix Indemnity Insurance Company (Phoenix Indemnity), pursuant to which the Company acquired Statewide. Statewide owned 20% of the outstanding common stock of Phoenix Indemnity which was a previously 80% owned subsidiary of the Company. The acquisition was effective April 1, 1994 and was accounted for as a purchase.\nIn August 1993, the Company acquired Redland and the purchase price of $15.4 million was comprised of 1,339,000 shares of the Company's common stock and acquisition related costs of $306,000. (See Note 3 to the Consolidated Financial Statements.)\nThe Company aggregates cash and short-term investments with maturity dates of three months or less from the date of purchase for purposes of reporting cash flows. As of December 31, 1994, approximately $972,000 of short-term investments had maturity dates at acquisition of greater than three months.\nThe deferred tax benefit for the year ended December 31, 1994 is mainly comprised of $3.6 million of realized net operating loss carryforwards, which at December 31, 1993 had a valuation allowance for the same amount.\nCash payments for interest were $1,272,000, $1,019,000 and $1,960,000 during the years ended December 31, 1994, 1993 and 1992, respectively.\nACCEPTANCE INSURANCE COMPANIES INC.\nSCHEDULE V VALUATION ACCOUNTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS)\n(A) Includes allowance for doubtful accounts related to Redland of $663 at date of acquisition.\n(B) Includes $2,993 deductions related to Major Group which is a result of various write-offs and the conveyance of receivables to Term Sheet Creditors, in September 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.\nACCEPTANCE INSURANCE COMPANIES INC.\nBy \/s\/ Kenneth C. Coon Dated: March 23, 1995 ------------------------------------- Kenneth C. Coon Chairman and Chief Executive Officer\nBy \/s\/ Georgia M. Mace Dated: March 23, 1995 ------------------------------------- Georgia M. Mace Chief Financial Officer 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.\nDated: March 23, 1995 \/s\/ Jay A. Bielfield ------------------------------------ Jay A. Bielfield, Director\nDated: March 23, 1995 \/s\/ Kenneth C. Coon ------------------------------------ Kenneth C. Coon, Director\nDated: March 23, 1995 \/s\/ Edward W. Elliott, Jr. ------------------------------------ Edward W. Elliott, Jr., Director\nDated: March 23, 1995 \/s\/ Robert LeBuhn ------------------------------------ Robert LeBuhn, Director\nDated: March 23, 1995 \/s\/ Michael R. McCarthy ------------------------------------ Michael R. McCarthy, Director\nDated: March 23, 1995 \/s\/ John P. Nelson ------------------------------------ John P. Nelson, Director\nDated: March 23, 1995 \/s\/ R. L. Richards ------------------------------------ R. L. Richards, Director\nDated: March 23, 1995 \/s\/ David L. Treadwell ------------------------------------ David L. Treadwell, Director\nDated: March 23, 1995 \/s\/ Doug T. Valassis ------------------------------------ Doug T. Valassis, Director\nACCEPTANCE INSURANCE COMPANIES INC. ANNUAL REPORT ON FORM 10-K FISCAL YEAR ENDED DECEMBER 31, 1994\nEXHIBIT INDEX\nNUMBER EXHIBIT DESCRIPTION\n3.1 Restated Certificate of Incorporation of Acceptance Insurance Companies Inc. Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n3.2 Restated By-laws of Acceptance Insurance Companies Inc. Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n4.1 Form of Stock Certificate representing shares of Acceptance Insurance Companies Inc., Common Stock, $.40 par value. Incorporated by reference to Exhibit 4.1 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n10.1 Office Building Lease dated July 19, 1991, between State of California Public Employees' Retirement System and Acceptance Insurance Company. Incorporated by reference to Exhibit 10.7 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.2 Intercompany Federal Income Tax Allocation Agreement between Acceptance Insurance Holdings Inc. and its subsidiaries and Registrant dated April 12, 1990, and related agreements. Incorporated by reference to Exhibit 10i to Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1990.\n10.3 Employment Agreement dated February 19, 1990 between Acceptance Insurance Holdings Inc., Registrant and Kenneth C. Coon. Incorporated by reference to Exhibit 10.65 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10.4 Employment Agreement dated July 2, 1993, between Redland Insurance Group, Inc., and John P. Nelson. Incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated July 2, 1993.\n10.5 Employment Agreement dated July 2, 1993, between Redland Insurance Group, Inc., and Richard C. Gibson. Incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated July 2, 1993.\n11 Computation of Income (Loss) per share.\n21 Subsidiaries of the Registrant.\n23.1 Consent of Deloitte & Touche LLP.\n- 1 -\n23.2 Report on schedules of Deloitte & Touche LLP.\n27 Financial Data Schedule.\n28P Schedule P -- Analysis of Losses and Loss Expenses of Consolidated Annual Statement for the year 1993. Filed in paper format pursuant to S-T Regulation 311.\n99.1 Acceptance Insurance Companies Inc., 1992 Incentive Stock Option Plan effective as of December 22, 1992. Incorporated by reference to Exhibit 10.1 to Registrant's Registration Statement on Form S-1, Registration No. 33-53730.\n99.2 Acceptance Insurance Companies Inc., Employee Stock Purchase Plan, effective as of December 22, 1992. Incorporated by reference to Exhibit 10.2 to Registrant's Registration Statement on Form S-1, Registration No. 33-53730.\n99.3 Acceptance Insurance Companies Inc., Employee Stock Ownership and Tax Deferred Savings Plan as merged, amended and restated effective October 1, 1990. Incorporated by reference as Exhibit 10.4 to Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 1990.\n99.4 First Amendment to Acceptance Insurance Companies Inc. Employee Stock Ownership and Tax Deferred Savings Plan. Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n99.5 Second Amendment to Acceptance Insurance Companies Inc. Employee Stock Ownership and Tax Deferred Savings Plan. Incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n99.6 Proxy Statement for 1995 Annual Meeting of Shareholders filed on or prior to April 30, 1995.\n99.7 Acceptance Insurance Companies Inc. Amended 1992 Incentive Stock Option Plan. Incorporated by reference to Registrant's Proxy Statement for 1995 Annual Meeting of Shareholders filed on or prior to April 30, 1995.\n99.8 Acceptance Insurance Companies Inc. Amended Employee Stock Purchase Plan. Incorporated by reference to Registrant's Proxy Statement for 1995 Annual Meeting of Shareholders filed on or prior to April 30, 1995.\n- 2 -","section_15":""}
{"filename":"6260_1994.txt","cik":"6260","year":"1994","section_1":"ITEM 1. Business\nA. General\nAnacomp, Inc., (Anacomp or the Company) is a leading information management company which provides micrographics products and services, magnetics products and electronic image management systems to a broad range of customers worldwide. The Company's fiscal 1994 revenue was $ 593 million and operating income (continuing operations income before interest, other income and taxes) was $ 80 million. Approximately 29% of the Company's revenues are derived from international business.\nAnacomp was incorporated in Indiana in 1968. By 1986, Anacomp had become, through acquisitions and internal growth, the leading company in the Computer Output Microfilm (COM) data service center segment of the micrographics industry. COM is a process for transferring large volumes of information created by data processing directly from electronic form to microfilm. Microfilm is a cost-effective alternative to the use of paper or electronic files as a means of information storage and retrieval.\nIn 1987, Anacomp acquired the stock of DatagraphiX, Inc., the world's leading manufacturer of COM systems, from General Dynamics Corporation. The acquisition of DatagraphiX, which developed the first COM system in 1954, made Anacomp the world's leading provider of COM products and services by adding COM systems and maintenance to the Company's product line.\nIn 1988, the Company acquired Xidex Corporation, the leading manufacturer and distributor of duplicate microfilm (a consumable supply used in the COM process) and microfilm readers and reader\/printers. Xidex was also a manufacturer and marketer of computer tape products.\nIn the early 1990's, Anacomp, recognizing the evolution of technologies competing with COM, modified its strategic objective to becoming a provider of information and image management products and services. Today, in addition to being the world's largest provider of COM solutions for image and information management, Anacomp offers electronic image management products and services. These include writable\/erasable magneto-optical disks, CD-R (Compact Disk, Recordable) optical disks and CD-ROM (Compact Disk, Read Only Memory) optical disk storage systems. The Company is also a major manufacturer and distributor of computer tape products used by data processing operations. Additionally, Anacomp provides image and data conversion services whereby documents in human readable form are scanned and digitized for storage on any of the various electronic storage media.\nAnacomp's strategy is to provide customers a blend of COM and electronic storage media products and systems that will give them the most cost effective integrated data and image management storage and retrieval solution. B. The Information and Image Management Industry\nThe Information and Image Management (I & IM) industry consists of companies whose products and services store information in a compacted format. The trend toward increased emphasis on efficient management of information is driven by several factors. First, companies understand that effective information management is an important competitive advantage and allows them to better serve their customers. Second, the increasing amounts of data processing output and stored information have made cost-effective and flexible information management more important. Finally, information itself is coming to be viewed as a strategic corporate asset and managing this asset is therefore crucial.\nThe two major technologies applied in the I&IM industry are: (a) micrographics, which includes COM and source document micrographics and (b) electronic image management, which includes magnetic and optical technologies for both data and image storage and retrieval.\nMicrographics\nMicrographics is the conversion of information stored on paper or in electronic form to microfilm or microfiche. Anacomp's primary micrographics business is the sale of COM services, systems, and related maintenance and supplies.\nCOM is a sophisticated application of micrographics in which information is directly converted at high speed from magnetic or electronic forms to microfilm. COM systems, also known as COM recorders, create an image which is transferred to microfilm. During this process, the COM recorder organizes the information and inserts indexing, output formatting, titling and other retrieval aids tailored to specific customer applications.\nCOM recorders are data processing peripherals which record computer-generated data and graphics onto microfilm or microfiche at high speeds. COM was initially developed as an information management system that would reduce the cost and increase the speed of computer output by \"printing\" computer-generated data on microfilm. Since then, COM recorders have become a standard computer- output peripheral.\nCompared to paper, COM has a number of benefits. COM recorders can print reports substantially faster than typical impact printers and multiple copies can be made easily and economically on high-speed duplicators. COM has other important cost advantages as well. A COM recorder can print a 1,000 page report on just four 4\" by 6\" microfiche. Mailing COM reports represents a substantial cost savings over the shipment and handling of paper output. With correct indexing, retrieval of information is easier and faster with COM than with paper storage.\nAnacomp offers a complete line of micrographics services and products, including: (i) COM processing services provided to customers on an outsourcing contract basis; (ii) COM systems for users who perform their own data conversion to microfilm; (iii) maintenance services for COM and other micrographics equipment; (iv) source document microfilming services; and (v) consumable supplies used by micrographics systems. Anacomp also sells certain computer tape and other magnetic media products. Source document micrographics relates to the broad range of photographic, mechanical and other technologies necessary to convert hard copy images to microforms and then to store, retrieve, duplicate and reproduce such images. Applications of source document micrographics include the transferring of paper copy to a microform for more cost-effective storage.\nBy providing a full range of services, Anacomp can customize its offerings of products and services to meet the specific needs of any customer. Once a customer purchases a COM system from Anacomp, the Company has the opportunity to provide follow-up service, including maintenance and supplies, as well as to sell additional compatible hardware. Anacomp estimates that each dollar of COM system sales generates 36 cents of annual supply revenue and 14 cents of annual maintenance revenue.\nDespite the continual decline in the cost of magnetic and optical storage media and systems, micrographics technology is expected to retain significant cost and functional advantages which will keep it competitive in a wide range of applications beyond the year 2000. In addition, micrographics technology can complement other storage media systems to meet the information management needs of many companies.\nElectronic Data and Image Management\nElectronic data and image management is the application of various technologies, including magnetic media and optical disks, to the storage and retrieval of information and image data. Storage media include magnetic tape, magnetic disks, writable\/erasable magneto-optical disks, CD-R optical disks, and CD-ROM optical disks. Data that is created during data processing activities is directly written to the chosen media for later retrieval. Data and images that are in human readable documents are scanned and digitized in binary form and then recorded on the media of choice.\nElectronic storage and management of image data provides users with improved data retrieval access time and storage density as a trade off for increased cost versus other storage technologies such as COM.\nAnacomp's offerings in the electronic data and image management field include systems incorporating magneto optical disks for use in large, high output volume data centers, and CD-R storage systems intended for operations with only a few users. The Company is also a major manufacturer and distributor of magnetic storage media used by data processing operations, including open reel, 3480 cartridge and 3490 cartridge computer tape.\nAnacomp, through its Image Conversion Services Division, provides data and image conversion services where original source documents or other human readable forms and images are scanned, digitized and stored in binary form on any of a variety of magnetic or optical storage media. C. Description Of Business Units\nOverview\nThe table below sets forth Anacomp's revenues by product line for the years indicated:\nMicrographics Services\nThe Company operates 47 data service centers in the United States. Anacomp's data service centers, which generally operate 24 hours per day every day of the year, receive on a daily basis thousands of magnetic tapes from more than 8,000 customers. The data service centers then convert the information on these tapes to 16mm microfilm or to microfiche, which are 4\" x 6\" microfilm cards, each of which can store approximately 250 pages of computer output.\nFor the typical Anacomp data service center customer, an Anacomp salesperson identifies potential COM applications through a survey performed at the customer's site or observation of paper reports at a data processing location. For example, a bank may need to transfer a computerized record of all checking account activity to microfiche for distribution and use at various branch locations. The Anacomp salesperson obtains information regarding any specialized requirements, such as customer indexing, retrieval, rapid turnaround, conversion frequency or distribution, and relays this information to Anacomp's software programmers. The Anacomp data service center then creates a test sample for the customer. Once the test sample is approved by the customer, Anacomp establishes a regular schedule for gathering the customer's tapes for processing. The COM data service center creates, processes, duplicates, packages and returns the microfiche to the customer. Turnaround time ranges from two hours to 36 hours depending on customer needs.\nThrough its data service centers, Anacomp also offers CD-R data storage services. This offering is for customers who prefer their computer output stored on CD-R optical disks instead of microfiche. As with COM customers, Anacomp receives data on computer tape or via direct transmission and records the data on CD-Rs.\nThe data service center industry is highly fragmented with numerous small operations in each major geographic market. Due to the emphasis on prompt service, competition is primarily limited to data service centers within a 50- mile radius of a customer. Anacomp and First Image Management Company (First Image), a division of First Financial Management Corporation, are the two largest U.S. data service center organizations. The remainder of the market is served by numerous small, local data service centers.\nThe Company has been successful in acquiring data service centers located in markets attractive to Anacomp and consolidating these operations with its existing network where appropriate. Such acquisitions result in additional volumes being serviced by Anacomp's existing data service centers, thereby improving operating margins while maintaining competitive prices. Anacomp has acquired 24 data service centers or the related COM services customers and one microforms service center during the past three fiscal years.\nIn December 1993, Anacomp acquired two data service centers from First Image in markets where Anacomp provides COM services to separate customer bases. In January 1994, Anacomp acquired the COM services customers of 14 data service centers from National Business Systems. These were also in markets where Anacomp provides COM services. Consistent with past practices, all of these operations were incorporated into existing Anacomp data service centers (See Note 3 to the Consolidated Financial Statements). In September 1993, Anacomp, as part of a comprehensive agreement, sold two data service centers to First Image. These centers were in markets whose potential did not meet Anacomp's requirements.\nImage Conversion Services\nIn October 1994, Anacomp established Image Conversion Services as a separate division. Anacomp operates 11 image conversion centers which provide microforms services. Microforms services take two forms: the conversion of both active and archival paper documents to microfilm (source document microfilming), and the reproduction of large data bases, such as parts catalogs, on microfilm (micropublishing). Anacomp works closely with its customers to determine how best to convert records to microfilm or microfiche and to index them so that the information is easily accessed.\nThis division also provides a service to record data and\/or image management information onto CD-ROMs, CD-Rs, magneto optical disk, magnetic tape or other electronic storage media. The process involves taking a human readable document, usually an original source paper document, scanning and digitizing the data, and recording it on the chosen media for later retrieval.\nImage Conversion Services personnel are trained to work closely with Anacomp's COM sales force to identify COM customers who are potential users of image conversion services. Additionally, the Image Conversion Services sales force prospects for new business from non-Anacomp COM customers. Anacomp competes with EDS, customer in-house installations, and numerous small regional providers. COM Systems Anacomp is the world's leading manufacturer of COM systems, manufacturing and marketing a complete line of COM recorders, processors and duplicators, and related software.\nThe basic components of a COM recorder are relatively standard. An input section receives data directly from a computer, from magnetic tape or any other data storage device. The COM recorder interprets and converts the data performing certain functions such as film manipulation, output formatting, titling and index extraction. The data is converted into images and transferred directly onto film and the finished microfilm and duplicates are produced. Critical subassemblies for COM recorders and duplicators are manufactured, assembled and tested at the Company's facilities in Poway, California. Other components, such as tape drives, power supplies and frames are purchased from outside vendors. Multiple sources for these components exist.\nAnacomp supplies a complete line of COM recorders covering all feature possibilities, including wet or dry process technology, roll or cut fiche, medium to high speed, stand-alone or integrated film processors and duplicators, a PC-based operator control interface, and an electronic forms generation capability on its laser-based system. All of the Company's COM recorders are software compatible, which provides for customer transfer throughout the product line.\nIn 1990, Anacomp introduced the XFP 2000 COM system. The XFP 2000 represents the fourth generation of COM recorder technology. The XFP 2000 is the most significant technological advance in the COM industry in the last decade, permitting graphic as well as alphanumeric reproduction. The XFP 2000 is faster and more reliable than previous COM recorders. When coupled with the necessary software, the XFP 2000 can reproduce bit-mapped images and duplicate the output of laser printers of various manufacturers onto microfiche. This ability, which is not available in older generation COM recorders, allows applications such as signatures, logos and photographs to be output to microfiche.\nIn October 1991, Anacomp signed an agreement with Eastman Kodak to serve as the Original Equipment Manufacturer (OEM) for Kodak's new COM recorder. The six-year agreement calls for Anacomp to supply (subject to certain contractual cancellation rights) between 600 and 1,500 specially modified XFP 2000s to Kodak. Through September 1994, Kodak has purchased 149 XFPs under the agreement, 25 of which were purchased in fiscal 1994.\nIn October 1992, Anacomp and Xerox Corp. announced a joint effort to develop software that will enable the XFP 2000 to process and image Xerox high speed printing data streams. This effort will result in the XFP 2000 being able to output virtually all Xerox print data streams, including those containing fonts, forms, logos, signatures and other images on microfiche. This software is exected to be available during the first calendar quarter of 1995.\nIn November 1993, Anacomp and Pennant Systems, a division of IBM, announced a joint effort to develop software which will allow Anacomp's XFP 2000 to process and image IBM Advanced Function Presentation (AFP) formatted data. This program will result in the XFP 2000 being able to interpret AFP data streams, including, as with the Xerox program, those containing fonts, logos, signatures and other images on microfiche. This software is expected to be available during mid - 1995. The Company's primary competitors in the sale of COM systems are Kodak, Agfa- Gevaert and Micrographic Technology Corporation (MTC). Competition is based on such factors as price, product quality, product features and service. Anacomp has the largest installed base of COM systems of any company (approximately 58% of the machines in use) and accounts for approximately 70% of all new COM system sales (inclusive of OEM unit sales). Because changing from one manufacturer's COM system to another is difficult due to software conversion and operator training costs, Anacomp's large installed base is an important advantage. With an installed base that is more than twice as large as its nearest competitor and a technologically advanced family of new products, management believes that the Company has a strong competitive position in the replacement and add-on market.\nOptical Disk Systems\nIn November 1993, the Company announced an OEM agreement with IBM to produce an extended data storage product that bridges the gap between on-line storage and COM storage. The product, called XSTAR, features an OEM version of IBM's 3995 Optical Library Dataserver and will allow mainframe computer users to store and retrieve data through desktop terminals or PCs while also supporting storage via COM systems. XSTAR operates in IBM's MVS environment and provides up to 377 gigabytes of machine-readable storage, equivalent to more than 100 million pages. The system will support storage of data on mainframe magnetic disk, industry standard 5.25-inch single or double density optical disks as well as 3480\/3490 cartridge tape and COM. Anacomp received its first order in the fourth quarter of fiscal 1994 and has placed additional units with selected customers for evaluation and possible sale.\nIn April 1994, Anacomp announced a joint product development program with FileNet to develop a product known as VELLOS. As a document image storage and retrieval system, VELLOS is based on either CD-R optical disks, or writable\/erasable magneto-optical disks. It operates as a client\/server system in the Unix environment with retrieval options in Windows. The system is designed for small departmental multi-user applications. VELLOS is being marketed exclusively by Anacomp through its Image Conversion Services division, and Anacomp recorded its first sale in the fourth quarter of fiscal 1994.\nMaintenance Services\nAnacomp provides maintenance to 2,770 COM systems representing approximately 98% of its installed base (2,076 in the U.S. and 694 outside the U.S.) through over 900 service employees operating worldwide. Anacomp provides 24- hour service through a network of maintenance service centers and resident service representatives. The maintenance organization offers installation, ongoing maintenance and field technical support for existing and new products. As additional COM systems are sold, the Company is able to provide maintenance without adding maintenance centers or a significant number of personnel, thereby resulting in increased maintenance margins. In addition, the infrastructure is in place to compete for service contracts on other COM products or selected data processing products. Historically, each dollar of COM system sales has resulted in approximately 14 cents of annual maintenance revenue.\nHistorically, competition in maintenance has been limited as most customers tend to use the maintenance services of the vendor that installed their system. However, some customers choose to use in-house maintenance staffs. Thus, revenues are primarily a function of new COM system sales and the size of the installed base. Anacomp has the largest installed base in the industry.\nIn March 1992, Anacomp acquired the COM maintenance service operations of TRW, Inc. TRW was the last major third party provider of such services. These operations expanded the Company's maintenance service base and created new opportunities for COM system sales, COM data service back-up and supplies sales. The TRW operations were integrated into Anacomp's existing maintenance organization. As part of the September 1993 agreement between Anacomp and First Image, Anacomp became First Image's exclusive COM system maintenance provider in the United States.\nMicrographics Supplies\nAnacomp sells the most comprehensive line of micrographics supplies in the world, offering duplicate microfilms, chemicals for microfilm processing, original silver halide films, paper and toners for reader\/printers, micrographics lamps and bulbs, and other consumables. Anacomp's large installed base of COM systems provides the Company with a ready market for its consumable supplies although Anacomp also sells supplies outside of its COM systems base. Historically, every dollar of COM system revenue has generated approximately 36 cents of annual supply revenues. A majority of the supplies sold consist of duplicate microfilm and private label consumables incorporating proprietary chemistry and film developed specifically for Anacomp's COM systems and for which, in most cases, Anacomp is the sole supplier. Anacomp's duplicate microfilm market share is estimated to be 73% and its primary competitor is Rexham. Beginning in October 1994, Anacomp became the exclusive provider of duplicate microfilm to First Image.\nIn March 1992, Anacomp formed a strategic alliance with SKC Limited and SKC America, Inc. (collectively, SKC), member companies of the Sunkyong Group, a worldwide $22 billion Korean general trading company and manufacturer of petroleum-based products. In the first quarter of fiscal 1994, SKC purchased Anacomp's Sunnyvale, California, duplicate microfilm manufacturing facility. SKC now supplies Anacomp with substantial amounts of magnetic- base polyester and coated duplicate microfilm. SKC also provides Anacomp with a $25 million trade credit arrangement (See Note 4 to the Consolidated Financial Statements).\nReaders and Reader\/Printers\nAnacomp also designs, manufactures and markets a complete line of metal and plastic microfiche\/microfilm readers and reader\/printers. Readers are relatively simple, low-cost units (which sell for approximately $100 to $400 per unit) used to view microfilm. Reader\/printers, which allow users to print a paper copy of the microfilm or microfiche being viewed, sell for approximately $1,250 to $6,300 per unit.\nAnacomp is a supplier to Kodak, First Image and Bell & Howell for readers and reader\/printers. Anacomp's market share of the worldwide reader market is estimated to be 63% with the remainder of the market held by EyeCom and several small manufacturers, none of whom have more than 10% of the total unit shipments. Anacomp's share of the reader\/printer market is approximately 20%. In the reader\/printer market, Anacomp competes with Canon, Minolta and Infographics. In April 1993, the Company announced the introduction of the MicroImage Digital Scanner 300, a low-cost full-function workstation for digitizing and electronically processing micrographic images on demand. The device scans and digitizes micrographic images, allowing them to be viewed, edited or enhanced on a personal computer screen. The digitized image then can be sent electronically to a laser printer or fax machine, or distributed over an electronic network to another image-capable device. Anacomp has approximately 5% of the digital scanner market and competes with Kodak, 3M, Canon and Minolta.\nComputer Tape Products\nThe Company manufactures open reel tape as well as 3480 and 3490 computer tape cartridges used in large mainframe computers such as IBM, Amdahl, Unisys and NEC. It also manufactures a 1\/2\" tape cartridge for use with DEC computers. The market for open reel tape is comprised of data processing installations with large data storage needs. Demand for this product has been declining and is expected to continue this trend at a rate of 30% per year as 3480 and 3490 computer tape cartridges gain market share. The computer tape cartridge market continues to develop as IBM and DEC aggressively establish new standards. This process has resulted in the 3480 product being gradually replaced by 3490 computer tape cartridges. Demand for 3480 computer tape cartridges is expected to decline by approximately 8% per year while demand for 3490 computer tape cartridges is expected to grow by 35% per year. Anacomp has approximately 35% of the 3480 computer tape cartridge market and competes with 3M (with approximately 35% market share), BASF (with approximately 18% market share) and Memorex (approximately 10% market share). In the 3490 computer tape cartridge market, Anacomp has approximately 30% market share. Anacomp's competitors and their approximate respective market shares for 3490 computer tape cartridges are 3M (50%), BASF (15%) and Memorex (3%).\nNew installations as well as library conversions are the driving forces behind the growth in the 3490 computer tape cartridge market. Price competition in the computer tape cartridge market has resulted because of the large amount of manufacturing capacity installed by all producers. However, Anacomp's products consistently receive the highest possible quality ratings from independent rating agencies.\nIn May 1994, Anacomp acquired Graham Acquisition Corporation which manufactures open reel tape as well as 3480 and 3490 computer tape cartridges at its Graham, Texas facility (See Note 3 to the Consolidated Financial Statements). As a result of the acquisition, Anacomp now manufacturers over 95% of the world's supply of open reel tape. In October 1994, Anacomp announced that the 3480 and 3490 computer tape cartridge operations in the Omaha, Nebraska facility would be relocated to Graham, Texas to lower manufacturing costs of this product. International\nApproximately 29% of the Company's revenues are attributable to its international operations. Anacomp has wholly-owned operating subsidiaries in Germany, the United Kingdom, France, the Netherlands, Belgium, Italy, Finland, Sweden, Denmark, Norway, Canada, Brazil and Japan. The Company's international product and service offerings are virtually identical to those in the U.S. market, except that data service centers are not operated in foreign markets. The most significant markets are the United Kingdom (27% of fiscal 1994 international sales), Germany (18%), France (12%), Canada (6%) and the Benelux countries (5%). In countries where Anacomp does not have subsidiaries, it sells COM systems and supplies through dealers and agents. International sales in 1994 by product line include micrographics supplies (36%), COM systems (12%), maintenance (19%) and computer tape and other magnetics products (33%).\nCustomers in Western Europe and Canada are primarily in financial services, retailing, health care, COM data service centers, manufacturing and government agencies. Data service centers are the major customers for COM applications in emerging international markets.\nIn Europe, Anacomp has an estimated 70% market share in COM system sales, an approximate 50% share of the installed base of COM systems, an approximate 38% market share in maintenance and an approximate 33% market share in supplies.\nIn the Americas (excluding the United States) and Asia, Anacomp's approximate market shares are 63% in COM systems, 15% in maintenance and 39% in supplies. Anacomp has an approximate 51% share of the installed base of COM systems in these markets.\nAnacomp's international supplies market share is significantly below the U.S. level because these sales have historically been through dealers and agents. Anacomp's international subsidiaries are gradually taking over supplies sales from dealers and agents, enabling Anacomp to compete more effectively with other manufacturers, especially European manufacturers. Anacomp may establish subsidiaries in countries where it currently operates through distributors. Competition varies by country with no company in the world competing with Anacomp across all markets. For COM systems and maintenance, the Company primarily competes with MTC and Agfa-Gevaert in Germany and the United Kingdom; Agfa-Gevaert, MTC and Kodak in France; Kodak and Agfa-Gevaert in Italy and Northern Europe; and Kodak, NCR and Fuji in Japan. For supplies, the Company primarily competes with Kalle, Messerli and Rexham in Germany, the United Kingdom and France; Rexham and Kalle in Italy; Rexham and Messerli in Northern Europe; and Kodak and Fuji in Japan. D. Marketing and Customers\nThe Company has traditionally maintained separate sales forces for its data service centers, COM systems and maintenance services, micrographics supplies, computer tape products and international activities. In October 1994, Anacomp reorganized its domestic sales force. The data service centers, COM systems, and direct channel supplies sales organizations were merged and organized into two direct sales divisions covering the western and eastern sections of the United States. Each division contains 14 Area Business Units (ABU's) responsible for marketing COM services and COM systems and related supplies, and electronic image management systems in specific geographic areas of their division. The Maintenance Services division and the sales forces selling through indirect channels were left unchanged as independent operations. Additionally, the Company created Image Conversion Services as a separate division that offers microfilm, CD-R, CD- ROM and magnetic tape storage and retrieval solutions to customers. Sales force compensation is based on: (i) maintaining recurring sales volumes with existing customers, (ii) adding annual increments to these volumes and (iii) gross margin earned on sales.\nArea Business Units\nAnacomp's Area Business Units employ over 170 sales people, including managers, who are trained to sell the merits of COM to their customers' senior management and to identify individual data processing applications for which COM is the most appropriate output alternative. The salespeople work with the customer to determine the best alternative between out- sourcing to an Anacomp data service center and purchasing their own COM systems for in-house operation. The Anacomp salespeople also market COM system maintenance services, consumable supplies, readers and reader\/printers, source document micrographics products, and computer tape products. Anacomp salespeople are also trained to identify customer applications that are better suited for an optical disk storage solution and to assist such customers to design an information and image management system that provides the optimal mix of COM and optical storage solutions.\nPrincipal customers for the Company's COM systems include banks, insurance companies, financial service companies, retailers, healthcare providers, COM data service centers, manufacturers and government agencies. Anacomp has almost 900 active COM system customer sites. Principal customers for COM services are similar to COM system customers with the exception of COM data service centers. No single customer accounts for more than 10% of the Company's revenues.\nMaintenance\nAnacomp's Maintenance Services division is made up of 500 service engineers and managers, who provide geographic coverage through 10 districts in the United States.\nIndirect Supplies\nAnacomp's indirect supplies operation consists primarily of the sale of Anacomp manufactured products to dealers and distributors throughout the United States and includes the sale of consumable supplies, readers and reader\/printers. The indirect operation maintains a sales force of approximately 20 salespeople who provide geographic coverage throughout the United States.\nMagnetic Media Anacomp's magnetics operation consists primarily of the sale of Anacomp manufactured products to dealers and distributors throughout the United States and includes the sale of computer tape and flexible diskette products. The magnetics operation maintains a sales force of approximately 20 salespeople who provide geographic coverage throughout the United States.\nInternational\nInternational sales include micrographics products and services as well as certain data processing related products. The Company employs 70 direct salespeople in wholly-owned subsidiaries and has approximately 100 distributors in other countries. Approximately one-third of Anacomp's installed base of COM systems is outside of the United States.\nE. Engineering, Research and Development\nThe Company supports several engineering processes, including basic technological research, COM system and related software product development, and sustaining engineering support for existing customer installations. The engineering department is located in Poway, California and employs approximately 130 engineers and technicians. The operating costs associated with all engineering programs (including research and development) amounted to approximately $7.2 million in 1994, $7.9 million in 1993 and $8.3 million in 1992. The majority of these costs relate to the continued software development for the XFP 2000 COM recorder.\nManagement expects that its near-term engineering efforts will be concentrated on adding additional software capabilities to its COM recorders. Anacomp has intensified its development efforts aimed at providing optical disk based storage technology solutions and expects to continue to expand its efforts in this area over the next several years. The Company's primary focus will be to provide a technology bridge between COM and the newer optical disk technologies.\nAnacomp owns several patents and licenses covering certain aspects of its products and production processes. However, the Company believes that the patent protection is of lesser significance than the knowledge and experience of its management and personnel, and their abilities to develop and market the Company's products.\nF. Employees and Labor Relations\nAs of October 1994, Anacomp employed approximately 4,400 people who were engaged in management, sales and services, manufacturing, computer and micrographics operations. In October 1993, Anacomp employed approximately 4,200 people. G. Industry Segment and Foreign Operations\nAs discussed in Note 1 to the Consolidated Financial Statements, Anacomp operates in a single business segment - providing equipment, supplies and services for information management, including storage, processing and retrieval. Financial information concerning the Company's operations in different geographical areas is included in Note 15 to the Consolidated Financial Statements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAnacomp's principal administrative headquarters are located at 11550 North Meridian Street, Carmel, Indiana (a suburb of Indianapolis). Anacomp's micrographics manufacturing, engineering and product maintenance facilities are located primarily in Poway, California (outside San Diego). Anacomp's computer tape manufacturing and engineering facilities are located in Omaha, Nebraska, Graham, Texas, and Bryn Mawr, Wales. The following table indicates square footage:\nOther Facilities consist primarily of leased space from discontinued operations and property held for sale. Approximately 776,000 square feet of the Other Facilities have been sublet to others and an additional 21,000 square feet is vacant as of November 1994. Anacomp also leases standard office space for its sales and service centers in a variety of locations. Anacomp considers its facilities adequate for its present needs and does not believe that it would experience any difficulty in replacing any of its present facilities if any of its present agreements were terminated. Item 3.","section_3":"Item 3. Legal Proceedings\nAnacomp has been identified by the United States Environmental Protection Agency (EPA) and state governmental agencies (State) as a potentially responsible party pursuant to federal and\/or state law for the costs associated with the remediation undertaken or to be undertaken at various disposal sites located in the United States. At most of these sites, Anacomp is one of many parties identified by the EPA and\/or the State; at others, it is one of a small number of parties so identified. The liability for such remediation under federal law and, in some instances, state law is strict, joint and several where the alleged harm is indivisible. The actual liability, if any, of Anacomp at these sites cannot be precisely determined at this time, but the Company believes that any ultimate liability will not have a material adverse effect upon its financial position or results of operations because adequate liability estimates have been recorded in the Consolidated Balance Sheet.\nAnacomp also is involved in various claims and lawsuits incidental to its business and believes that the outcome of any of those matters will not have a material adverse effect on its consolidated financial position or results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted during the three months ended September 30, 1994, to a vote of Anacomp's security holders through the solicitation of proxies or otherwise.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages, positions with Anacomp and business background during the past five years of Anacomp's executive officers are as follows:\nLouis P. Ferrero, age 52, was elected Chairman of the Board and Chief Executive Officer on January 25, 1985, was elected to the Office of the Chairman of the Board and Chief Executive Officer on November 6, 1984, and was elected President of the Company in May 1984. Mr. Ferrero currently serves on the executive and nominating committees of the Board of Directors.\nWilliam C. Ater, age 54, was elected Vice President and Chief Administrative Officer in February 1988. From March 1981 to February 1988, Mr. Ater served as Vice President of Administration. He has served as Secretary since March 1985.\nK. Gordon Fife, age 49, was elected Vice President of Tax on October 1, 1985.\nHasso Jenss, age 51, was elected Vice President - European Micrographics on November 11, 1993. Prior to that, he served from October 1989 to October 1993 as Managing Director of Anacomp's German subsidiary.\nP. Lang Lowrey, age 41, was elected Vice President - Magnetics Group in November 1992. Prior to that, he served from October 1990 to October 1992 as Vice President - Worldwide Marketing Division. He was Vice President - MultiproduX Division from December 1987 through September 1990.\nThomas W. Murrel, age 54, was elected Vice President and General Manager of Poway Operations in January 1993. Prior to that, he served from February 1988 to December 1992 as Vice President - Maintenance Division. From June 1987 to February 1988, he served as Vice President - Product Service, DatagraphiX.\nJack R. O'Donnell, age 64, joined Anacomp in March 1992, as Executive Vice President, Treasurer and Chief Financial Officer. Prior to joining Anacomp, Mr. O'Donnell was an office managing partner with Arthur Andersen, an international public accounting firm.\nMichael H. Riley, Age 47, was elected Vice President, Product Development and Marketing on November 12, 1994. From January 1993 to November 1994, he served as Vice President, Product Planning and Marketing. Prior to that, he served from 1990 to 1992 as Vice President of Information Systems Marketing and from 1989 to 1990 as Director of Product Management.\nGary M. Roth, age 52, was elected Vice President, Americas Asia Division in November 1992. From October 1991 to October 1992, he served as Manager, LAAP\/Canada Operations. From October 1988 to October 1991, he served as Vice President - Data Systems Division. From July 1982 to October 1988, he served as Regional Vice President - COM Services Division.\nThomas R. Simmons, age 47, was elected Vice President, Direct Sales Division- East on November 12, 1994. He had served as Vice President - Information Systems Division since November 4, 1991. Prior to that, he served from 1987 to 1991 as Vice President - Micrographics Services Division.\nDonald L. Viles, age 48, was elected Vice President and Controller of Anacomp on October 1, 1985.\nMichael P. Wessner, age 34, was elected Vice President - Strategic Resellers Group on November 12, 1994. He had served as Vice President - Strategic Resellers Division since November 1992. Prior to that, from October 1991 to October 1992, he served as a Regional Vice President in the Strategic Resellers Division. From November 1988 to October 1991, he was a Regional Vice President in the MultiproduX Division. Mr. Wessner joined Anacomp in July 1985, and served as a supplies sales representative until October 1988.\nJ. Frederick Williams, age 52, was elected Vice President, Direct Sales Division-West on November 12, 1994. He had served as Vice President - Micrographics Services Division since November 4, 1991. From October 1988 through October 1991, he served as a Regional Vice President in the Micrographics Services Division. For the two years prior to that, he was Vice President - Commercial and Government Services Division. J. Mark Woods, age 52, was elected President and Chief Operating Officer in February, 1993. He had previously served as Executive Vice President and Chief Operating Officer since May 1989. From August 1988 through April 1989, he served as President of the Micrographics Group. He served as Executive Vice President and Chief Operating Officer from January 1985 to August 1988. In February 1988, Mr. Woods was elected a director of Anacomp. He currently serves on the nominating committee of the Board of Directors.\nEach of Anacomp's executive officers is elected for a term of one year and until their successors are chosen and qualified or until their death, resignation or removal. PART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nMarket, holder and dividend information concerning the Company's common stock appears on page A-1 of this Annual Report on Form 10-K.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected financial data appear on page A-1 of this Annual Report on Form 10-K.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nManagement's discussion and analysis of financial condition and results of operations appear on pages A-2 to A-7 of this Annual Report on Form 10-K.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFinancial statements and supplementary financial information appear on pages A-8 to A-35 of this Annual Report on Form 10-K.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures\nThere are no changes in or disagreements with accountants on accounting and financial disclosures.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors, Executive Officers, Promoters and Control Persons of the Registrant\nThe Company hereby incorporates by reference the information contained under the headings \"Election of Directors\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" from its definitive Proxy Statement to be delivered to the shareholders of the Company in connection with the 1995 Annual Meeting of Shareholders to be held January 27, 1995. Certain information relating to executive officers of the Company appears on pages 15, 16 and 17 hereof. Item 11.","section_11":"Item 11. Executive Compensation\nThe Company hereby incorporates by reference the information contained under the heading \"Executive Compensation\" from its definitive Proxy Statement to be delivered to the shareholders of the Company in connection with the 1995 Annual Meeting of Shareholders to be held January 27, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe Company hereby incorporates by reference the information contained under the heading \"Security Ownership of Management and Other Beneficial Owners\" from its definitive Proxy Statement to be delivered to the shareholders of the Company in connection with the 1995 Annual Meeting of Shareholders to be held on January 27, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThere are no relationships and related transactions that require disclosure.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) 1. The following financial statements and other information appear in Appendix A to this Annual Report on Form 10-K and are filed as a part hereof:\nSelected Financial Data. Market Price and Dividend Information. Management's Discussion and Analysis of Financial Condition and Results of Operations. Report of Independent Public Accountants. Consolidated Balance Sheets - September 30, 1994 and 1993. Consolidated Statements of Operations - Years Ended September 30, 1994, 1993, and 1992. Consolidated Statements of Cash Flows - Years Ended September 30, 1994, 1993, and 1992. Consolidated Statements of Stockholders' Equity - Years Ended September 30, 1994, 1993, and 1992. Notes to Consolidated Financial Statements.\n2. Other than as described below, Financial Statement Schedules are not filed with this Annual Report on Form 10-K because the Schedules are either inapplicable or the required information is represented in the financial statements or notes thereto. The following schedules appear in Appendix A to this Annual Report on Form 10-K and are filed as a part hereof:\nSchedule II - Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees Other than Related Parties.\nSchedule VIII - Valuation and Qualifying Accounts and Reserves.\n(b) Reports on Form 8-K:\nOn May 6, 1994, a Form 8-K was filed to report the acquisition of Graham Acquisition Corporation.\n(c) The following exhibits are filed with this Form 10-K or incorporated herein by reference to the document set forth next to the exhibit listed below. Previously unfiled documents are noted with an asterisk (*): (3) Articles of Incorporation and Bylaws: The Restated Articles of Incorporation of Anacomp amended effective January 30, 1992, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1992. The Bylaws of Anacomp, amended January 29, 1990, are incorporated by reference to Exhibit 3 (a) to Anacomp's Form 8-K dated January 31, 1990.\n(4) Instruments defining the rights of security holders, including indentures: (a) Indenture dated as of January 1, 1981, among Anacomp International N.V., Anacomp and The Chase Manhattan Bank, N.A., as trustee, relating to 9% Convertible Subordinated Debentures due 1996, incorporated by reference to Exhibit No. 4(c) to Anacomp's Annual Report on Form 10-K for its fiscal year ended June 30, 1981. Anacomp International N.V., Anacomp, The Chase Manhattan Bank, N.A., and J. Henry Schroder Bank & Trust Company mutually agreed to substitute J. Henry Schroder Bank & Trust Company as Trustee under said Indenture.\n(b) Indenture dated as of January 15, 1982, between Anacomp and American Fletcher National Bank & Trust Company, as Trustee, incorporated by reference to Exhibit (b) to Anacomp's Form S-16 Registration Statement (File No. 2-75650) dated January 20, 1982, relating to 13.875% Convertible Subordinated Debentures due January 15, 2002. Anacomp, American Fletcher National Bank & Trust Company and United States Trust Company of New York mutually agreed to substitute United States Trust Company of New York as Trustee under said Indenture. (c) Indenture dated as of October 24, 1990, between Anacomp and State Street Bank and Trust Company, as Trustee, for $224,900,000 fully accreted value ($215,904,000 aggregate principal amount) of 15% Senior Subordinated Notes due 2000. Incorporated by reference to Exhibit 4(a) to Anacomp's Form 8-K dated October 31, 1990.\n(d) Warrant Agreement dated as of October 24, 1990, between Anacomp and Manufacturers Hanover Trust Company as Warrant Agent. Incorporated by reference to Exhibit 4(f) to the October 31, 1990, Form 8-K.\n(e) Rights Agreement dated as of February 4, 1990, between Anacomp and Manufacturers Hanover Trust Company, as Rights Agent. Incorporated by reference to Exhibit 1 to Anacomp's Form 8-K dated February 6, 1990.\n(f) First Supplemental Indenture dated as of March 22, 1993, between Anacomp, Inc. and State Street Bank and Trust Company, as Trustee, relating to Anacomp's 15% Senior Subordinated Notes due 2000. Incorporated by reference to Anacomp's Annual Report on Form 10-K for its fiscal year ended September 30, 1993.\n(10) Material Contracts: (a) Employment Agreement between Anacomp and Louis P. Ferrero, effective October 1, 1992, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1992.\n(b) Employment Agreement between Anacomp and J. Mark Woods, effective October 1, 1990, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1990.\n(c) Second Amendment to Employment Agreement between Anacomp and P. Lang Lowrey III, effective September 30, 1992, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1992. Original Employment Agreement dated March 15, 1990, as amended on December 17, 1990, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1990.\n(d) Employment Agreement between Anacomp and Thomas R. Simmons, effective October 1, 1992. Incorporated by reference to Anacomp's Annual Report on Form 10-K for its fiscal year ended September 30, 1993.\n(e) Employment Agreement between Anacomp and Jack R. O'Donnell, effective March 1, 1992, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1992.\n(f) Letter Agreement between Anacomp, Inc. and Louis P. Ferrero, dated September 3, 1991, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1991.\n(g) Anacomp, Inc. Restricted Stock Bonus Plan, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1985.\n(h) Anacomp, Inc. Deferred Compensation Plan, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1985.\n(i) Anacomp, Inc. Stock Option Plan (1986), incorporated by reference to Anacomp's Proxy Statement dated February 3, 1986.\n(j) Anacomp, Inc. Stock Option Plan (1987), incorporated by reference to Anacomp's Proxy Statement dated January 5, 1987.\n(k) Anacomp, Inc. Stock Option Plan (1988), incorporated by reference to Anacomp's Proxy Statement dated January 12, 1988.\n(l) Anacomp, Inc. Stock Option Plan (1989), incorporated by reference to Anacomp's Proxy Statement dated January 13, 1989.\n(m) Anacomp, Inc. Deferred Stock Option Plan, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1988. (n) Anacomp, Inc. Executive Deferred Compensation Plan, incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1988.\n(o) Amended and Restated Master Agreement dated as of March 22, 1993 among Anacomp, Inc., the Multicurrency Borrowers, the Lenders, the Multicurrency Lenders, the Series A Purchasers, the Series B Purchasers, The First National Bank of Chicago, as Multicurrency Agent, and Citibank, N.A. as Agent, Administrative Agent and Collateral Agent. Incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1993.\n(p) Multicurrency Credit Agreement dated as of March 22, 1993, among Anacomp, Inc., Anacomp, S.A., Xidex S.A.R.L., Anacomp GmbH, Xidex GmbH, Anacomp Italia SRL, Anacomp A.B., Anacomp Holdings, Ltd., Anacomp Ltd., and Xidex Ltd. Incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1993.\n(q) Consent dated as of March 22, 1993, among Anacomp, Inc., the Lenders, the Series A Purchasers, the Series B Purchasers, and Citibank, N.A. as Collateral Agent. Incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1993.\n(r) Credit Agreement dated as of October 24, 1990, among Anacomp, the Lenders party thereto and Citibank, N.A. as Agent. Incorporated by reference to Exhibit 28(b) to the October 31, 1990, Form 8-K.\n(s) Series A Senior Note Purchase Agreement dated as of October 24, 1990, among Anacomp, the Series A Purchasers party thereto and Citibank, N.A. Incorporated by reference to Exhibit 28(c) to the October 31, 1990, Form 8-K.\n(t) Amendment to the Credit Agreement and Series A Senior Note Purchase Agreement (both dated as of October 24, 1990) dated February 21, 1992, among Anacomp, the Lenders party thereto and Citibank, N.A. as Agent. Incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1992.\n(u) Amendment No. 3 to Credit Agreement, dated as of March 22, 1993, among Anacomp, Inc., the Lenders, and Citibank, N.A., as Agent. Incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1993.\n(v) Amendment No. 2 to Series A Senior Note Purchase Agreement, dated as of March 22, 1993, among Anacomp, Inc., the Series A Purchasers and Citibank, N.A., as Administrative Agent. Incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1993. (w) Series B Senior Note Purchase Agreement dated as of October 24, 1990, among Anacomp and the Series B Purchasers party thereto. Incorporated by reference to Exhibit 28(d) to the October 31, 1990, Form 8-K.\n(x) Amendment No. 1 to Series B Senior Note Purchase Agreement, dated as of March 22, 1993, among Anacomp, Inc. and the Series B Purchasers. Incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1993.\n(y) Amended and Restated Master Supply Agreement dated October 8, 1993, among Anacomp, SKC America, Inc. and SKC Limited. Incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1993.\n(z) Consolidation Agreement dated October 8, 1993, between Anacomp, Inc. and SKC America, Inc. Incorporated by reference to Anacomp's Form 10-K Annual Report for the fiscal year ended September 30, 1993.\n(aa) Stock Purchase Agreement dated as of April 8, 1994 between Anacomp, Inc and Graham Acquisition Corporation. Incorporated by reference to Anacomp's Form 8-K dated May 6, 1994.\n(ab) *Amendment No. 1 to Amended and Restated Master Agreement dated as of July 1, 1994 among Anacomp, Inc., the Multicurrency Borrowers, the Lenders, the Multicurrency Lenders, the Series A Purchasers, the Series B Purchasers, the First National Bank of Chicago, as Multicurrency Agent, and Citibank, N.A. as Agent, Administrative Agent and Collateral Agent.\n(ac) *Amendment No. 2 to Amended and Restated Master Agreement dated as of December 2, 1994 among Anacomp, Inc., the Multicurrency Borrowers, the Lenders, the Multicurrency Lenders, the Series A Purchasers, the Series B Purchasers, the First National Bank of Chicago, as Multicurrency Agent, and Citibank, N.A. as Agent, Administrative Agent and Collateral Agent.\n(11)*Statement re: computation of per share earnings.\n(21)*Subsidiaries of the registrant.\n(23)*Consent of independent public accountants.\n(27)*Financial data schedule (Required for electronic filing only).\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.\nANACOMP, INC.\nBy: \/s\/ Louis P. Ferrero Louis P. Ferrero, Chairman of the Board and Chief Executive Officer December 7, 1994\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 on the dates indicated.\nDated: December 7, 1994 By: \/s\/ Louis P. Ferrero Louis P. Ferrero, Chairman of the Board and Chief Executive Officer\nDated: December 7, 1994 By: \/s\/ Jack R. O'Donnell Jack R. O'Donnell, Executive Vice President, Treasurer and Chief Financial Officer\nDated: December 7, 1994 By: \/s\/ Donald L. Viles Donald L. Viles, Vice President and Controller\nDated: December 7, 1994 By: \/s\/ J. Mark Woods J. Mark Woods, President, Chief Operating Officer and Director\nDated: December 7, 1994 By: \/s\/ Clark A. Johnson Clark A. Johnson, Director\nDated: December 7, 1994 By: \/s\/ Richard E. Neal Richard E. Neal, Director\nDated: December 7, 1994 By: \/s\/ Roger S. Palamara Roger S. Palamara, Director\nDated: December 7, 1994 By: \/s\/ Paul G. Roland Paul G. Roland, Director\nDated: December 7, 1994 By: \/s\/ Frederick W. Zuckerman Frederick W. Zuckerman, Director\nAPPENDIX A ANNUAL REPORT ON FORM 10-K ANACOMP, INC.\nCONTENTS\nANACOMP, INC., AND SUBSIDIARIES SELECTED FINANCIAL DATA\nThe following Selected Financial Data should be read in conjunction with Item 1 - Business of Part I and the Notes to the Consolidated Financial Statements.\nMARKET PRICE AND DIVIDEND INFORMATION\nAnacomp, Inc.'s common stock is traded on the New York and Chicago Stock Exchanges under the ticker symbol \"AAC.\"\nThe high and low closing prices (as reported by NYSE) for the Company's common stock for each quarter during the last two fiscal years were as follows:\nThe Company's borrowing agreements prohibit the payment of cash dividends on common shares.\nThe number of stockholders of record as of November 15, 1994, was 9,810. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGeneral\nAnacomp's fiscal 1994 revenues totalled $592.6 million compared to $590.2 million in fiscal 1993. As discussed below, Anacomp acquired Graham Acquisition Corporation (Graham), a manufacturer of computer tape cartridges and open reel tape, in early May 1994. The Graham acquisition contributed $22.4 million to 1994 revenues. Anacomp also acquired the COM services customer base of 14 data service centers from National Business Systems (NBS) in early January 1994 which contributed $9.1 million to 1994 revenues. Excluding the contributions from these two acquisitions, fiscal 1994 revenues decreased $29.1 million from fiscal 1993 principally due to decreased sales of COM systems, duplicate film, and retrieval devices.\nRevenues in 1993 were down $38.7 million compared to the prior year. The continued maturing of certain of Anacomp's computer tape products caused approximately one-half of the decline, with another quarter attributable to unfavorable currency fluctuations compared to the prior year. The balance is generally attributable to the continued weakness in the European economies.\nRevenues in 1992 were down $6.5 million from fiscal 1991's $635.4 million. Micrographics services, maintenance services, COM systems and computer tape products all enjoyed revenue increases ranging from 2-13% in 1992. Micrographics supplies revenues, however, decreased 8%, primarily reflecting a decline in film and chemistry sales, most of which occurred in the indirect channels.\nSelling, general and administrative costs in 1994 decreased $4.3 million , due in part to the receipt of insurance proceeds related to EPA liabilities. Selling, general and administrative costs in 1993 decreased $3.5 million primarily as a result of favorable settlements of certain facility lease obligations.\nOperating margins (continuing operations income before interest, other income, income taxes and extraordinary credits) as a percent of revenue were 13.4% in 1994 compared to 15% in 1993. Accordingly, operating income decreased $9.0 million in 1994. The decrease is largely attributable to a change in product mix as the relatively less profitable computer tape products represent a greater portion of total sales. Operating income decreased $11.7 million from 1992 to 1993, generally in proportion to the decline in revenues. Operating margins were 15.9% in 1992.\nOperating income decreased $5.2 million in 1992, in part due to the $6.4 million reduction in revenue. In addition, Anacomp completed two major factory consolidations during the third and fourth quarters in which its manufacturing operations in Hartford, Wisconsin, and its ten separate manufacturing facilities around San Diego county were relocated to a single site in Poway, California (outside San Diego). One-time costs associated with these moves totalled more than $3.2 million and are reflected in 1992's operating income. The table below sets forth Anacomp's revenues by product line for the years indicated:\nMicrographics Supplies, Readers and Reader\/Printers\nMicrographics supplies revenues decreased 8% in 1994, principally due to reduced demand for duplicate film and readers and reader\/printers. Duplicate film sales are expected to improve in 1995 with the addition of a U.S. data service center customer.\nDuring the fourth quarter of fiscal 1993, Anacomp introduced the Digital Scanner 300 (DS 300), a low-cost workstation for scanning and digitizing microfiche and microfilm images, which can then be viewed, edited, or enhanced on a personal computer screen. The DS 300 contributed $1 million of revenue in fiscal 1994, which was less than expected. However, each quarter's sales increased during the year and further increases are expected in fiscal 1995, as a result of product improvements and better identification of the user markets.\nMicrographics supplies revenues decreased from $237.3 million in 1992 to $223.1 million in 1993, a 6% decline. However, approximately 2% is attributable to currency fluctuations, and another 2% is attributable to the loss in mid - 1992 of the recently regained customer mentioned above. Micrographics supplies revenues declined 8.5% in 1992. Anacomp believes the decrease in 1992 resulted principally from the generally weak worldwide economic conditions.\nDuring 1992, Anacomp entered into a long-term supply agreement with SKC Limited and SKC America, Inc. (collectively, SKC), members of the Sunkyong Group of Korea (See Note 4 of the Consolidated Financial Statements). SKC was Anacomp's primary source for polyester, the basic raw material for duplicate microfilm and computer tape products. In the first quarter of fiscal 1994, SKC purchased Anacomp's Sunnyvale, California, duplicate microfilm manufacturing facility and became Anacomp's sole supplier of duplicate microfilm. In connection therewith, SKC invested several million dollars to consolidate and enhance the Sunnyvale facilities to improve both productivity and quality, the benefits of which are now enjoyed by Anacomp and its customers. Micrographics supplies operating profits were down in fiscal 1994 in proportion to the decline in revenue. In 1993, micrographics supplies operating margins were down 2-3%, due in part to currency fluctuations affecting both revenues and costs, as well as pricing competition in certain product lines. Micrographics supplies operating profits were down in fiscal 1992 in proportion to the decline in revenues, excluding approximately $2 million of costs associated with the factory relocation.\nMicrographics Services\nMicrographics services revenues, predominantly COM services through Anacomp's 47 U.S. data service centers, increased 5% in 1994, decreased 2% in 1993 and increased 6% in 1992, on volume increases of 10%, 13% and 14% in 1994, 1993,and 1992, respectively. As previously mentioned, the increase in fiscal 1994 is due to the acquisition of the COM services customer base of 14 data service centers from NBS. The revenue decline in 1993 is due to the absence of certain government contracts which expired in 1992 and were not replaced, as well as reduced prices. The volume growth is both from new customers and increased services to existing customers. Operating margins as a percent of revenue in 1994 were down approximately 2% as reductions in average selling prices exceeded reductions in production costs. In 1993 and 1992, reductions in operating costs kept margins steady in spite of price competition.\nMaintenance Services\nMaintenance revenues are derived principally from COM recorders and duplicators. Such revenues increased $3.1 million in 1994, decreased $4.8\nmillion in 1993, and increased $1.7 million in 1992. The improvement in 1994 is largely the result of the addition of a U.S. data service center company to Anacomp's customer base. Approximately one-half of the decline in 1993 is caused by currency fluctuations. The remainder is in part the result of the improved capacity and efficiency of the XFP 2000, which allows customers to produce more volume on fewer machines. Operating margins were modestly reduced in 1994 after remaining level in 1993 and 1992.\nCOM Systems\nCOM systems revenues were off 22% because of a decline in sales of XFP 2000 COM systems from 293 systems in 1993 to 187 systems in 1994. These results were partially due to reduced OEM shipments (25 systems in 1994 versus 67 in 1993). Introduction of the Xerox Compatibility Feature (XCF), which was released to beta sites in October 1994 and will be available in the first calendar quarter of 1995, should positively influence 1995 sales of XFP 2000 COM systems. XCF is the result of a two-year development effort between Anacomp and Xerox. The feature adds to Anacomp's XFP 2000 imaging platform the capability to process and image to microfilm Xerox high speed printing data streams.\nIn November 1993, Anacomp announced a joint effort with Pennant, the IBM Printing Systems Company, to integrate IBM's Advanced Function Presentation (AFP) capabilities with COM recorders. The availability is scheduled for spring 1995 and is expected to further bolster XFP 2000 sales.\nCOM systems revenues were up slightly in 1993 after consideration of currency effects. COM systems revenues grew over 7% in 1992, bolstered by sales of 212 XFP 2000 COM systems, an 84% increase over 1991's 115. Operating margins as a percent of revenue improved in 1994, in spite of reduced revenues, as a result of higher average selling prices. Operating margins in 1993 improved significantly both as a result of higher XFP volumes and from the benefits of the facility consolidations that took place in 1992.\nOperating margins in 1992 were essentially unchanged from the prior years, excluding costs associated with the San Diego facility consolidation. During the fourth quarter of fiscal 1992, Anacomp consolidated its San Diego-based manufacturing, engineering, maintenance and product marketing operations into a newly constructed facility in Poway, California, just outside San Diego. The move consolidated 10 different sites around San Diego county and involved approximately 1,000 employees. In connection with the move, Anacomp expensed approximately $1.2 million in the fourth quarter.\nIn early November 1993, Anacomp announced the signing of an OEM agreement with the IBM Storage Systems Division to produce an extended data storage product that bridges the gap between on-line data and long-term COM storage. Anacomp's XSTAR features an OEM version of IBM Storage Systems Division's 3995 Optical Library Dataserver and will allow mainframe computer users to store and retrieve data through desktop terminals or PCs while also supporting permanent storage via COM systems. Anacomp received its first order in the fourth quarter of fiscal 1994 and has placed additional units with selected customers for evaluation and possible sale.\nComputer Tape Products\nAnacomp's acquisition of Graham in May 1994 was the primary reason for a 53% increase in computer tape revenues over 1993. Graham manufactures computer tape cartridges and open reel tape at its facility in Graham, Texas. Anacomp will shift all of its U. S. production of those products from its Omaha, Nebraska plant to the Graham facility during the first half of fiscal 1995. The costs associated with this relocation will not be significant. The consolidation is expected to produce operating synergies.\nComputer tape revenues decreased $17.7 million in 1993. Almost half of the decrease is due to the completion of a one-time OEM arrangement which contributed $9.7 million in revenues in 1992 and only $1.1 million in 1993. In\naddition, Anacomp and its competitors experienced decreased demand for 3480 and TK 50-52 cartridges, as well as open reel tape, as these products continue to mature. Anacomp introduced in mid-1993 the high compression 3490E cartridge which contributed over $8 million of revenues in 1994.\nComputer tape revenues increased $7.7 million, or 13%, in 1992, primarily the result of the one-time OEM arrangement discussed above, which contributed an incremental $4.5 million. In addition, sales of 3480 cartridges increased 14%. The added revenues in 1994 increased operating profits and improved manufacturing efficiencies. The reduced revenues in 1993 resulted in a significant reduction in that year's operating profits. In 1992, operating profits also declined in spite of increased revenues, due principally to increased pricing pressures in the marketplace.\nOther Revenues\nOther revenues increased in 1994 and 1993 due to improved sales of flexible diskette products and media. The decline in 1992 was due to the maturing of certain of Anacomp's computer storage products. Interest\nThe reduction in interest expense in 1994 resulted from lower debt levels which was partly offset by the increase in short-term interest rates. Interest expense in 1993 and 1992 continued to decline as a result of debt repayments as well as reduced interest rates.\nOther Income (Expense)\nOther income (expense) is principally foreign exchange gains and losses incurred by the foreign subsidiaries.\nIncome Taxes\nIncome taxes as a percentage of income from continuing operations were 54% in 1994, 43% in 1993, and 44% in 1992. In 1994 and 1993, income tax expense was reduced $1.2 million and $3.7 million, respectively, as a result of favorable settlement and disposition of previously established tax reserves. In 1992, the effective tax rate was reduced by the receipt of $1.2 million in state tax refunds, and by the inclusion in income of certain foreign exchange gains which were not subject to tax.\nAs described in Note 10 to the accompanying financial statements, the effective tax rate is higher than the U.S. statutory rate due to amortization of goodwill not deductible for tax purposes, and generally higher foreign tax rates.\nThe Company adopted Financial Accounting Standards No. 109, Accounting for Income Taxes, in the first quarter of fiscal year 1994. The adoption resulted in a one-time increase to income of $8 million reflecting the cumulative effect on prior years of this accounting change. See Note 10 to the Consolidated Financial Statements for a further discussion of the effect on the Company's Financial Statements.\nDiscontinued Operations\nThe loss from discontinued operations represents the accretion of interest (net of taxes) on the present value of obligations recorded in prior years for unfavorable lease commitments and future lease costs discussed in Note 1 to the Consolidated Financial Statements.\nLiquidity and Capital Resources\nIn 1994, Anacomp continued to invest in data service center retooling, to make important acquisitions such as Graham and NBS, and to make significant investments in software including XCF and AFP. At the same time, short and long-term debt was reduced over $27 million. These requirements were met\nprimarily from operating cash flow. In addition, common stock was issued in each of the major acquisitions, inventory turnover rates were improved and certain data service center equipment was sold under sale\/leaseback arrangements which generated approximately $12 million during the year. As disclosed in the accompanying Consolidated Statements of Cash Flows, net cash provided by operating activities was $52.7 million for fiscal 1994 compared to $45.9 million for the prior year. Net cash used in investing activities increased $21.1 million primarily due to the Graham and NBS business acquisitions in the current year and the decline in proceeds from sale of assets. Net cash used in financing activities decreased $13.0 million due primarily to reduced debt fees and long-term debt payments.\nThe Company has experienced positive cash flow from operations for the last several years and anticipates positive cash flow will continue in the future. In addition, the debt agreements provide $70 million in revolving credit facilities, over $17 million of which was available at September 30, 1994. Anacomp believes the positive cash flow from operations, amounts available from sale\/leaseback of data service center equipment, and the availability of amounts under the revolving credit agreement will adequately fund operations, debt reductions and planned capital expenditures in fiscal 1995. In October 1994, Anacomp sold $19.3 million of data service center equipment of which $14.3 million of the proceeds were used to prepay debt. Anacomp believes that it could generate additional liquidity, if needed, through equity offerings, debt offerings or conversion of existing assets to cash. The revolving credit facilities expire in October, 1995. In connection with their extension or replacement, Anacomp intends to explore refinancing some or all of the remaining senior credit facilities.\nManagement does not believe that the effects of inflation will have a material impact on the Company. Neither is management aware of changes in prices of materials or other operating costs, or in the selling prices of Anacomp's products and services that will materially affect the Company.\nAccounting Pronouncements\nIn October 1994, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 119, which addresses the disclosure of derivative financial instruments and fair value of financial instruments. Adoption of this standard is required in fiscal 1995. The Company, based upon existing practices, does not expect adoption of FAS 119 to have a material adverse effect on its financial statements in the year of the adoption. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF ANACOMP, INC.:\nWe have audited the accompanying consolidated balance sheets of Anacomp, Inc. (an Indiana Corporation) and subsidiaries as of September 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 September 30, 1994. These financial statements and 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\nmanagement, 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 Anacomp, Inc. and subsidiaries as of 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.\nAs explained in Note 1 to the financial statements, effective October 1, 1993, 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. The schedules listed in Item 14(a) 2 are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the 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.\nIndianapolis, Indiana ARTHUR ANDERSEN LLP December 7, 1994 CONSOLIDATED BALANCE SHEETS Anacomp, Inc. and Subsidiaries\nSee notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF OPERATIONS Anacomp, Inc. and Subsidiaries\nSee notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS Anacomp, Inc. and Subsidiaries\n[CAPTION]\nSupplemental schedule of non-cash investing and financing activities:\nDuring 1994, 1993, and 1992 the Company acquired companies and rights to provide future services. In conjunction with these acquisitions, the purchase price consisted of the following:\nSee notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee notes to consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Anacomp, Inc. and Subsidiaries\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nConsolidation The consolidated financial statements include the accounts of Anacomp, Inc. (Anacomp or the Company) and its wholly-owned subsidiaries. Material intercompany transactions have been eliminated. Certain amounts in the prior year consolidated financial statements have been reclassified to conform to the current presentation.\nForeign Currency Translation Substantially all assets and liabilities of Anacomp's international operations are translated at the year-end exchange rates; income and expenses are translated at the average exchange rates prevailing during the year. Translation adjustments are accumulated in a separate section of stockholders' equity. Foreign currency transaction gains and losses are included in net income.\nSegment Reporting Anacomp operates in a single business segment - providing equipment, supplies and services for information management, including storage, processing and retrieval.\nRevenue Recognition Sales of products and services are recorded based on shipment of products or performance of services. Revenue from maintenance contracts is deferred and recognized in earnings on a pro rata basis over the period of the agreement. Revenues from the lease of equipment under sales-type leases are also recognized as shipments are made. Accordingly, the present value of all payments due under the lease contracts is recorded as revenue, cost of sales is charged with the book value of the equipment plus installation costs, and future interest income is deferred and recognized over the lease term.\nInventories Inventories are stated at the lower of cost or market, cost being determined by methods approximating the first-in, first-out basis.\nThe cost of the inventories is distributed as follows:\nProperty and Equipment Property and equipment are carried at cost. Depreciation and amortization of property and equipment are generally provided under the straight-line method\nfor financial reporting purposes over the shorter of the estimated useful lives or the lease terms. Tooling costs are amortized over the total estimated units of production, not to exceed three years. Research and Development The costs associated with research and development programs are expensed as incurred, and amounted to $2,973,000 in 1994, $2,525,000 in 1993, and $1,849,000 in 1992.\nIncluded in \"Other assets\" on the accompanying Consolidated Balance Sheets are unamortized deferred software costs of $19,745,000 and $14,134,000 as of September 30, 1994 and 1993, respectively. Deferred software costs are the capitalized costs of software products to be sold with COM systems in future periods. The unamortized costs are evaluated for impairment each year by determining net realizable value. Such costs are amortized under the straight- line method or over the estimated units of sale, not to exceed five years. See Note 12 for the amortization expense recorded during the past three years.\nIntangibles Excess of purchase price over net assets of businesses acquired is amortized primarily on the straight-line method over 40 years. Other intangibles represent the purchase of the rights to provide microfilm or maintenance services to certain customers and are being amortized on a straight-line basis over 10 years. The unamortized costs are evaluated for impairment each year by determining net realizable value. Balances are as follows:\nAt September 30, 1994, the aggregate amortization of intangibles by year through fiscal year 1999 are: 1995, $12,954,000; 1996, $12,627,000; 1997, $12,137,000; 1998, $11,586,000; and 1999, $10,998,000.\nAccrued Lease Reserves\nOther noncurrent liabilities include acquisition reserves established for unfavorable facility lease commitments, vacant facilities and related future lease costs. Total obligations recorded for these unfavorable lease commitments and future lease and related costs at their estimated present value were $12,460,000 and $19,402,000 at September 30, 1994 and 1993, respectively. The current portion of these obligations was $3,427,000 and $6,081,000 as of September 30, 1994 and 1993, respectively and is included in \"Other accrued liabilities\". The accretion recorded related to these obligations, net of tax effects, is included in \"Loss from discontinued operations\" in the Consolidated Statements of Operations.\nSale\/Leaseback Transactions\nAnacomp entered into sale\/leaseback transactions of $11,870,000 in 1994 and $9,858,000 in 1993 relating to COM systems installed in the data service centers. Part of the proceeds were treated as fixed asset sales and the remainder as sales of equipment. Revenues of $5,620,000 and $4,739,000 were recorded respectively. All profits were deferred and are being recognized over the applicable leaseback periods. In October 1994, Anacomp entered into additional sale\/leaseback transactions of $19,320,000 relating to COM systems installed in the data service centers. Income Taxes\nIn general, Anacomp's practice is to reinvest the earnings of its foreign subsidiaries in those operations and to repatriate these earnings only when it is advantageous to do so. It is expected that the amount of U.S. federal tax resulting from a repatriation will not be significant. Accordingly, deferred tax is not being recorded related to undistributed foreign earnings.\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (FAS 109). FAS 109 mandates the liability method for computing deferred income taxes and requires that the benefit of certain loss carryforwards be estimated and recorded as an asset unless it is \"more likely than not\" that the benefit will not be realized. Another principal difference is that changes in tax rates and laws will be reflected in income from continuing operations in the period such changes are enacted.\nAnacomp adopted FAS 109 in the first quarter of fiscal 1994. Under FAS 109, the Company has recorded a significant deferred tax asset to reflect the benefit of loss carryforwards that could not be recognized under prior accounting rules. The recording of this asset reduced goodwill and increased income as discussed in more detail in Note 10.\nConsolidated Statements of Cash Flows\nAnacomp considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. These temporary investments, primarily repurchase agreements and other overnight investments, are recorded at cost, which approximates market, and totalled $8,000,000, $14,000,000, and $8,000,000 at September 30, 1994, 1993 and 1992, respectively.\nNOTE 2. FAIR VALUES OF FINANCIAL INSTRUMENTS:\nStatement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of fair value information for certain financial instruments. The carrying amounts for trade receivables and payables are considered to be their fair values. The carrying amounts and fair values of the Company's other financial instruments at September 30, 1994, and 1993, are as follows:\nThe estimated fair values of Long-Term Debt and Redeemable Preferred Stock are based on quoted market values or discounted future cash flows using current interest rates.\nNOTE 3. ACQUISITIONS:\nDuring the three years ended September 30, 1994, Anacomp made the acquisitions set forth below, each of which has been accounted for as a purchase. The consolidated financial statements include the operating results of each business from the date of acquisition. Pro forma results of operations have not been presented because the effects of these acquisitions were not significant.\nFiscal 1994\nDuring fiscal 1994, Anacomp acquired 16 data service centers or the related customer base (all were incorporated with existing Anacomp service centers), a computer tape products company and the customer base of a micrographics supplies business. Total consideration for these acquisitions was $39,141,000 of which approximately $24,173,000 has been assigned to excess of purchase price over net assets of businesses acquired and other intangible assets. In connection with these acquisitions, Anacomp issued $17,201,000 of its common stock and increased debt and accrued liabilities by $4,290,000.\nNational Business Systems\nOne of the acquisitions included above was the purchase of the COM services customer base of 14 data service centers operated by National Business Systems (NBS). The acquisition was effective on January 3, 1994, and the acquisition cost consisted of the following (in thousands):\nAnacomp issued 1,973,000 common shares to the NBS shareholders using $3.75 per share. As part of the acquisition agreement, Anacomp agreed to provide stock price protection at the end of two years on those shares so designated by the NBS shareholders (1,128,000 of the shares issued are subject to this protection).\nOn January 3, 1996, Anacomp will recalculate the share price based on the average closing price of Anacomp stock for the 30 consecutive trading days ending on December 29, 1995. The revised price will be used to adjust the number of issued shares which are subject to the price protection. However, the revised price to be used for the revaluation will not be higher than 150% or lower than 50% of the original $3.75 per share price. If the per share price reached the 150% maximum, NBS shareholders would return 376,000 shares to Anacomp. If the per share price reached the 50% minimum, Anacomp would issue 1,128,000 additional shares to the NBS shareholders. The adjustment in the number of shares issued in connection with the NBS acquisition will not affect the recorded purchase price. Contingently issuable shares under the above arrangement are measured at each reporting period based on the market price of the Company's stock at the close of the period being reported on, and are considered in the computation of earnings per share.\nGraham Magnetics\nAnother of the acquisitions included above was the purchase of Graham Acquisition Corporation (Graham), a computer tape products company. The acquisition was effective on May 4, 1994, and the acquisition cost consisted of the following (in thousands):\nAnacomp issued 2,129,000 common shares to the Graham shareholders based on an agreed upon per share price. However, to determine the acquisition cost, the shares were valued at the market price on the date of closing.\nContingent consideration of $7,600,000 is payable in Anacomp common stock and will be based upon defined future earnings through September 1997. The contingent consideration will be computed based upon an agreed upon formula using a minimum stock price of $2.00 per share and will be issuable beginning in January 1995. The contingent consideration is not included in the acquisition cost total above but is recorded when the future earnings requirements have been met. The contingent consideration amount for fiscal 1994 is estimated to be approximately $144,000.\nAnacomp also issued 360,000 common shares to a Graham creditor at $3.57 per share to reduce the note payable to $4,240,000. The note is unsecured and bears interest at 10%. Principal payments of $345,000 plus accrued interest are payable quarterly beginning July 15, 1994. The note holder may at any time require Anacomp to prepay any amount of the note by issuing common stock. The shares of common stock to be issued will equal the prepayment amount divided by $3.57. The current outstanding note balance subject to prepayment was $3,895,000 at September 30, 1994.\nAnacomp has reserved 3,800,000 shares of authorized common stock for the contingent acquisition consideration and 1,091,000 shares of authorized common stock for the contingent prepayment of the note. Fiscal 1993\nDuring fiscal 1993, Anacomp acquired four micrographics service centers (all four were merged with existing Anacomp service centers) and certain assets of a microfilm reader maintenance services business for a total consideration of $4,434,000, of which approximately $1,904,000 has been assigned to excess of purchase price over net assets of businesses acquired and other intangible assets.\nFiscal 1992\nDuring fiscal 1992, Anacomp acquired four micrographics service centers and one microforms service center (all five were merged with existing Anacomp service centers) and certain selected assets of a computer output microfilm maintenance services business, for a total consideration of $9,602,000, of which approximately $6,356,000 has been assigned to excess of purchase price over net assets of businesses acquired and other intangible assets.\nNOTE 4. SKC AGREEMENT:\nIn March 1992, Anacomp entered into a ten-year supply agreement (the Supply Agreement) with SKC America, Inc., a New Jersey corporation (SKCA), and SKC Limited (SKCL), an affiliated corporation of SKCA organized pursuant to the laws of the Republic of Korea. SKCA and SKCL are collectively referred to as SKC. Pursuant to the Supply Agreement, Anacomp purchases substantially all of its requirements for magnetic-base polyester and coated duplicate microfilm from SKC.\nSKC is providing Anacomp with a $25 million trade credit arrangement which expires December 31, 2001. The trade credit arrangement may be terminated prior to the expiration in the event Anacomp restructures or refinances substantially all of its subordinated debt or in the event Anacomp breaches the Supply Agreement. The trade credit arrangement bears interest at 2.5% over the prime rate of The First National Bank of Boston (7.75% as of September 30, 1994).\nIn October 1993, the Supply Agreement was extended to December 2003 and amended to include finished microfilm products manufactured by SKC exclusively for Anacomp. Concurrent with the modification of the Supply Agreement, SKC purchased Anacomp's Sunnyvale, California, duplicate microfilm manufacturing operation for $900,000, payable over five years. At September 30, 1994, $720,000 is due from SKC. Costs of $3,392,000 associated with this Supply Agreement have been deferred and are being amortized over the life of the Supply Agreement. NOTE 5 PROPERTY AND EQUIPMENT:\nProperty and equipment consist of the following:\nNOTE 6. LONG-TERM RECEIVABLES:\nOther long-term receivables include $1,116,000 and $1,243,000 at September 30, 1994 and 1993, respectively, due from an officer.\nLease contracts receivable result from customer leases of products under agreements which qualify as sales-type leases. Annual future lease payments under sales-type leases are as follows:\nNOTE 7. LONG-TERM DEBT:\nOn March 26, 1993, the Company completed amendments to its Senior Credit Agreements and its 15% Senior Note Indenture. The provisions of these amendments include the elimination of the requirement for the Company to make Additional Amortization Payments as defined, allowance for the Company to use up to 50% of its annual Excess Cash Flow to repurchase subordinated debt and the creation of a Multicurrency Revolving Loan due in October 1995. The amendments also reduced the existing Revolving Loan from $50 million to $43 million at March 26, 1993 with a further reduction to $40 million on September 30, 1994 and provide for a final due date of October 1995. Additionally, the amendments provided for the Company to retain specified sale proceeds in connection with the sale\/leaseback of certain fixed assets and rescheduled the remaining amortization payments due on the Term Loan in a manner favorable to the Company.\nThe Revolving Loan carries an interest rate of 275 basis points over the one- , two-, three - or six-month reserve adjusted London Interbank Offered Rate (LIBOR), selected at the Company's option.\nThe Multicurrency Revolving Loan is available to the Company and certain of its foreign subsidiaries in U.S. Dollars, British Pounds, French Francs, German Marks, Italian Lira and Swedish Krona in an equivalent amount of $30 million, and carries an interest rate of 275 basis points over the one-, two-, three - or six-month reserve adjusted London Interbank Offered Rate (LIBOR) of the borrowed currency, selected at the Company's option. The Term Loans and Series A Senior Notes carry an interest rate of 275 basis points over the three-month LIBOR and have scheduled installment payments of $10.3 million in October 1994; $12.5 million in April 1995; $12.5 million in October 1995; and $8.5 million in April 1996.\nThe Series B Senior Notes carry an interest rate of 12.25% and require semi- annual installment payments commencing April 26, 1994, in amounts increasing from 10% to 16.67% of the original principal amount.\nIn addition to scheduled payments, the Company is required to make annual prepayments of the Revolving Loan, the Term Loans and Series A Senior and Series B Senior Notes (the Senior Debt) in amounts between 50% and 75% of the Company's Excess Cash Flow, as defined, depending on the amount of Excess Cash Flow used to repurchase subordinated debt per the provisions of the March 1993 Senior Debt Agreement amendments. Also, subject to certain exceptions, 100% of proceeds from the sale of assets must be applied to repayment of the Senior Debt.\nThe 15% Senior Subordinated Notes (the 15% Notes) were issued in 224,900 units of $1,000 and 30.351 detachable warrants to purchase Anacomp Common Stock at $1.873 per share. The 15% Notes are callable given 30 days notice beginning November 1995, at 107.5% of the fully accreted value, and declining to 100% of the fully accreted value by November 1998. Mandatory sinking fund payments of $72,000,000 are due November 1998, and November 1999. After the Term Loans and the Series A Senior Notes and Series B Senior Notes are fully repaid and cash collateralization of any remaining Revolving Credit Facility Commitment occurs, additional prepayments equal to 75% of Excess Cash Flow, as defined, are also required.\nThe Master Agreement, which covers the Term Loans, the Revolving Credit Commitments, and the Series A Senior Notes and Series B Senior Notes, gives the Senior Creditors a security interest in all of the assets of Anacomp; contains various limitations on advances and investments made by the Company; prohibits or restricts, without prior approval of the Senior Creditors, mergers, acquisitions, change of control, certain types of lease transactions, payment of dividends on Anacomp Common Stock, and voluntary payment in cash of any principal amount of Anacomp's subordinated debt; and contains certain other restrictive covenants related to net worth, cash flow, fixed charges, debt incurrence, capital expenditures and the current ratio. Subsequent to September 30, 1994, Anacomp completed an amendment to the Master Agreement lowering the Interest Coverage Ratio covenant for September 30, 1994, and all of fiscal year 1995. Based on information currently available, the Company is uncertain as to whether it will be able to satisfy certain of the restrictive covenants in place as of September 30, 1995. The Company believes that in connection with the replacement of the revolving credit facilities which expire in October 1995, these restrictive covenants will be modified or eliminated such that the Company expects to be in compliance with its covenants under the debt agreements in place at that time. The Master Agreement also provides for the availability of letters of credit in an amount up to $15,000,000. As of September 30, 1994, letters of credit for approximately $9,000,000 have been issued which reduce the amount of available revolver.\nIn conjunction with entering into the SKC Supply Agreement discussed in Note 4, Anacomp sought and received from its senior lenders certain amendments to its senior loan documents including certain financial covenant adjustments. The 15% Notes are subordinated to the payment in full of the principal and interest on all Senior indebtedness. The 15% Notes rank pari passu to the remaining 12.25% Notes and 8.25% Senior Subordinated Notes (if and when issued) discussed in Note 8. Additionally, they are senior to the outstanding 9% Convertible Subordinated Debentures due 1996 and the 13.875% Convertible Subordinated Debentures due 2002.\nThe 15% Note Indenture contains covenants relating to net worth, and limitations on restricted payments, liens, transactions with affiliates, incurrence of additional debt, asset sales, acquisitions, and change of control. The 15% Note holders will be granted a security interest in all of Anacomp's assets upon the repayment of all Senior Secured Indebtedness.\nThe 13.875% Convertible Subordinated Debentures require mandatory sinking fund payments of $3,750,000 annually commencing January 15, 1999, unless sufficient debentures have been converted or repurchased by Anacomp. The debentures are convertible into 1,327,542 shares of Anacomp Common Stock at a conversion price of $17.50 per common share, and allow optional redemption at a price of 100% at any time. Anacomp International, N.V. a wholly-owned Netherlands Antilles subsidiary, has issued the 9% Convertible Subordinated Debentures due January 15, 1996, guaranteed by Anacomp. The 9% debentures are convertible into 663,227 shares of Anacomp Common Stock at a conversion price of $15.80 per common share. In the event of certain changes affecting United States or Netherlands Antilles taxation, the interest rate will be increased for any taxes required to be withheld or, at Anacomp's option, all debentures outstanding may be redeemed at 100% of the principal amount plus accrued interest.\nThe maturities of long-term debt in each of the next five years and thereafter will be as follows:\nNOTE 8. REDEEMABLE PREFERRED STOCK:\nAnacomp issued in a private placement in 1987, 500,000 shares of 8.25% Cumulative Convertible Redeemable Exchangeable Preferred Stock (the Preferred Shares). Each Preferred Share has a preference value of $50 and is convertible into Anacomp common stock at a conversion price of $7.50. The redeemable preferred stock was recorded at fair value on the date of issuance less issue costs. The excess of the preference value over the carrying value is being accreted by periodic charges to retained earnings over the life of the issue.\nThe Preferred Shares may be redeemed by Anacomp at prices declining from 105.78% to 100% of preference value, or earlier if the price of Anacomp common stock remains at 160% of the conversion price for 20 of 30 consecutive trading days. On March 15, 2000 and 2001, Anacomp must redeem at the preference value 125,000 shares each year unless a sufficient number of shares has already been redeemed or converted. All remaining outstanding shares must be redeemed by March 1, 2002. At any dividend payment date after March 15, 1990, Anacomp may exchange the Preferred Shares for an equal face amount of 8.25% Senior Subordinated Notes due March 1, 2002 (the Exchange Debentures). Except for certain shareholder rights, the Exchange Debentures will carry terms similar to the Preferred Shares. There were no such exchanges as of September 30, 1994.\nNOTE 9. CAPITAL STOCK:\nShareholder Rights Plan\nThe Company has a Shareholder Rights Plan which was adopted by the Board of Directors on February 4, 1990. The Rights Plan provides that each share of the Company's common stock has associated with it a Common Stock Purchase Right. Each right entitles the registered holder to purchase from the Company one- tenth of a share of Anacomp common stock, par value $.01 per share, at a cash exercise price of $3.20 subject to adjustment.\nThe rights will be exercisable only if a person or group acquires beneficial ownership of 15% or more of the outstanding shares of common stock of Anacomp, or announces a tender or exchange offer upon consummation of which, such person or group would beneficially own 30% or more of the Company's common stock. If any person acquires 15% of Anacomp's common stock, the rights would entitle stockholders (other than the 15% acquiror) to purchase at $32 (as such price may be adjusted) a number of shares of Anacomp's common stock which would have a market value of $64 (as such amount may be adjusted). In the event that Anacomp is acquired in a merger or other business combination, the rights would entitle the stockholders (other than the acquiror) to purchase securities of the surviving company at a similar discount.\nAnacomp can redeem the rights at $.001 per right at any time until the tenth day following the announcement that a 15% ownership position has been acquired. Under certain circumstances set forth in the Rights Plan, the decision to redeem shall require the concurrence of a majority of the Continuing Directors (as such term is defined in the Rights Plan). The rights expire February 26, 2000.\nPreferred Stock Anacomp has authorized 1,000,000 shares of preferred stock, of which 500,000 shares of redeemable preferred stock were issued and outstanding at September 30, 1994 and 1993 (see Note 8).\nStock Option Plans Anacomp's stock option plans provide that the exercise price of the options be determined by the Board of Directors (the \"Board\"), and in no case be less than 100% of fair market value at the time of grant for qualified options, or less than the par value of the stock for non-qualified options. An option may be exercised subject to such restrictions as the Board may impose at the time the option is granted. In any event, each option shall terminate not later than 10 years after the date on which it is granted, except for certain non-qualified options which shall terminate not later than 20 years after the date on which granted.\nShares available for grant under the plans were 725,827 and 895,145 at September 30, 1994 and 1993, respectively. Options outstanding, of which 3,310,464 are exercisable as of September 30, 1994, are as follows:\nWarrants\nIn October 1990, Anacomp issued 6,825,940 warrants to holders of the 15% Senior Subordinated Notes. Each warrant entitles the holder to purchase one common share at a price of $1.873 and is exercisable through the date of expiration, November 11, 2000. Anacomp filed a shelf registration statement with respect to the warrants which became effective on February 25, 1991.\nRestricted Stock Bonus Plan In December 1984, Anacomp adopted a Restricted Stock Bonus Plan (the \"Plan\") allowing for the issuance of up to 2,800,000 shares of Anacomp common stock to certain employees as determined by the Compensation Committee of the Board. The purposes of the Plan are to assist Anacomp in retaining key employees, to provide additional motivation for those employees to continue their best efforts on behalf of Anacomp and to conserve cash. At September 30, 1994, 1,246,819 shares were issued and outstanding under the Plan. All issued and outstanding shares related to the plan were awarded from 1985 through 1988. All vesting in the shares was completed by September 30, 1988. No shares have been issued since 1988. Anacomp retained a right of first refusal to repurchase these shares at market value on the date of sale less 80% of market value on the date of grant.\nAt the time the shares were granted, they were recorded at 20% of the market value at the date of grant. This cost was amortized as compensation expense over the various vesting periods involved. When the stock is offered to the Company for resale in the marketplace, the Company will record the difference between the proceeds from the sale of the shares and the amount paid to the employee as paid in capital. Other Items Under an Employee Stock Purchase Plan, Anacomp may offer to sell common stock to its employees. Purchases of these shares are made by employee participants periodically at 85% of the market price on the date of offer or exercise, whichever is lower.\nAt September 30, 1994, approximately 23,900,000 shares of Anacomp common stock are reserved for exercise of stock options, conversion of convertible subordinated debentures, purchases by stock purchase plan participants, conversion of preferred stock, exercise of warrants, Graham acquisition agreement requirements and other corporate purposes.\nNOTE 10. INCOME TAXES:\nThe components of income from continuing operations before income taxes and extraordinary credits were:\nThe components of income tax expense after utilization of net operating loss carryforwards, the adjustment of the tax reserves and discontinued operations are summarized below:\nThe following is a reconciliation of the United States federal statutory rate to the rate used for the provision for income taxes:\nThe Company adopted FAS 109 in the first quarter of fiscal 1994 and recorded a deferred tax asset of $95 million representing the federal and state tax savings from net operating loss carryforwards (NOLs) and tax credits. The Company also recorded a valuation allowance of $60 million reducing the deferred tax asset to a net $35 million. Recognition of the deferred tax asset reduced goodwill by $27 million and provided a cumulative effect increase to income of $8 million. During 1994, the net deferred tax asset was reduced to $29 million, reflecting usage of the asset to reduce income taxes payable by $6 million. Future utilization, if any, of NOLs and tax credits for which a valuation allowance was provided, will further reduce goodwill up to $37 million, increase accrued income taxes up to $13 million and increase capital in excess of par value up to $7 million.\nThe components of deferred tax assets and liabilities at September 30, 1994 and October 1, 1993 are as follows:\nAt September 30, 1994, the Company has NOLs of approximately $200 million available to offset future taxable income. This amount will increase to $217 million as certain timing differences reverse in future periods. The Company also has tax credit carryforwards of $3 million available to reduce future tax liabilities, including $1 million of preacquisition tax credits. The NOLs expire commencing in 1995 ($2 million) with remaining amounts in various periods through 2007. The tax credit carryforwards expire substantially in 1997.\nDuring 1994 and 1993, the Company settled various income tax matters, including issues associated with the 1988 Xidex acquisition. Settlement of these issues and other considerations resulted in a favorable adjustment to federal and foreign tax reserves of $1.2 million and $3.7 million, respectively. The adjustments are reflected as a credit to the income tax expense from continuing operations.\nIn 1993 and 1992 the provisions for income taxes include amounts which are offset by the utilization of federal and foreign NOLs. The tax benefits from utilization of NOLs is reported as an extraordinary credit in the Consolidated Statements of Operations. The net tax provisions result from foreign and state income taxes which cannot be reduced by NOLs from prior years.\nIn addition to the cumulative effect adjustment on the statement of operations, the adoption of FAS 109 reduced goodwill amortization expense by $773,000 during 1994. Accordingly, income from continuing operations and net income increased by these same amounts. Earnings per common and common equivalent share increased by $.02.\nIf FAS 109 had been adopted beginning October 1, 1991, the following pro forma results would have been reported for the periods ended (in thousands except per share amounts):\nNOTE 11. COMMITMENTS AND CONTINGENCIES:\nAnacomp has commitments under long-term operating leases, principally for building space and data service center equipment. Lease terms generally cover periods from five to twelve years. The following summarizes the future minimum lease payments under all non-cancelable operating lease obligations, including the unfavorable lease commitments and vacant facilities discussed in Note 1, which extend beyond one year:\nThe total of future minimum rentals to be received under noncancellable subleases related to the above leases is $8,740,000. No material losses in excess of the liabilities recorded are expected in the future.\nIn October 1992, Anacomp and Xerox Corp. announced a joint effort to develop a Xerox Compatibility Feature (XCF) that will enable the XFP 2000 to process and image Xerox high speed printing data streams. This effort will result in the XFP 2000 being able to output virtually all Xerox print data streams, including those containing fonts, forms, logos, signatures and other images on microfiche. At September 30, 1994, $350,000 remains to be paid related to services to be performed.\nAnacomp also executed a software license agreement with Xerox to use the XCF. The agreement obligates Anacomp to pay Xerox $1,277,000 as a prepayment for 100 software license fees. The payment is due upon final acceptance of the XCF scheduled for January 1995.\nIn November 1993, Anacomp and Pennant Systems, a division of IBM, announced a joint effort to develop software which will allow Anacomp's XFP 2000 to process and image IBM Advanced Function Presentation (AFP) formatted data. This program will result in the XFP 2000 being able to interpret AFP data streams, including, as with the Xerox program, those containing fonts, logos, signatures and other images on microfiche. As consideration for the development of the AFP, Anacomp agreed to pay Pennant Systems a development fee of $6,500,000 payable quarterly from January 1994, through April 1995. At September 30, 1994 $5,250,000 remains to be paid; $2.5 million has been accrued; and $2.75 million relates to services to be performed.\nAnacomp also must pay Pennant Systems royalty payments for the licensed system installations over the next six years. The minimum royalty payments for years one through three are $1,500,000 per year and $1,000,000 per year for years four through six. In addition, Anacomp must pay Pennant Systems for ongoing system support which begins in December 1995 and continues for 10 years. The minimum system support payments over the 10 year period are $5,671,000.\nDuring 1994, the Company sold $5.9 million of lease receivables. Under the terms of the sales, the purchasers have recourse to the Company should the receivables prove to be uncollectible. The amount of the recourse at September 30, 1994 is $3.4 million.\nAnacomp also is involved in various claims and lawsuits incidental to its business and believes that the outcome of any of those matters will not have a material adverse effect on its consolidated financial position or results of operations.\nNOTE 12. SUPPLEMENTARY INCOME STATEMENT INFORMATION:\nNOTE 13. OTHER ACCRUED LIABILITIES:\nXidex was designated by the United States Environmental Protection Agency (EPA) as a potentially responsible party for investigatory and cleanup costs incurred by state and federal authorities involving locations included on a list of EPA's priority sites for investigation and remedial action under the federal Comprehensive Environmental Response, Compensation, and Liability Act. The EPA reserve noted above relates to its estimated liability for cleanup costs for the aforementioned locations and other sites. No material losses are expected in excess of the liabilities recorded above. NOTE 14. EARNINGS PER SHARE:\nThe computation of earnings per share is based upon the weighted average number of common shares outstanding during the period plus (in periods in which they have a dilutive effect) the effect of common shares contingently issuable, primarily from stock options, exercise of warrants and acquisitions. 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.\nThe weighted average number of common and common equivalent shares used to compute earnings per share is:\nNOTE 15. INTERNATIONAL OPERATIONS:\nAnacomp's international operations are conducted principally through subsidiaries, a substantial portion of whose operations are located in Western Europe. Information as to U.S. and international operations for the years ended September 30, 1994, 1993 and 1992 is as follows:\nNOTE 16. QUARTERLY FINANCIAL DATA (UNAUDITED):\n[1] In fiscal 1988, Anacomp provided Mr. Ferrero an interest-free loan of $1,800,000 due two years after the termination of Mr. Ferrero's employment with Anacomp. The Board of Directors awarded Mr. Ferrero a bonus of $500,000 in fiscal 1992 which was used to reduce the loan balance to $1,300,000. Mr. Ferrero is also required to use a portion of his annual bonus to repay the loan.\n[2] In March 1990, Anacomp made a non-recourse loan of $400,000 to Mr. Lowrey, then Vice President - Worldwide Marketing Division. The loan was stated to bear interest at 8% payable at the time the principal on the loan was repaid. The loan was repaid in December 1991, and all interest due was waived. SCHEDULE VIII\nANACOMP, INC. AND SUBSIDIARIES Valuation and Qualifying Accounts and Reserves (In thousands)\n[1] Estimate of deferred tax asset not expected to be realized upon adoption of FAS 109.\n[2] Reduction in available NOL.\n[3] Uncollectible accounts written off, net of recoveries. EXHIBIT INDEX","section_15":""}
{"filename":"277375_1994.txt","cik":"277375","year":"1994","section_1":"Item 1. Business\nGeneral\nDelta Natural Gas Company, Inc. (Delta or the Company) was incorporated in 1949 in the State of Kentucky. The Company is engaged in the distribution, transmission and production of natural gas in its service area in 17 counties in central and southeastern Kentucky. In addition to its corporate headquarters in Winchester, Delta has warehouse facilities in Corbin and Winchester and branch offices in Barbourville, Berea, Corbin, London, Manchester, Middlesboro, Nicholasville, Owingsville, Stanton, and Williamsburg, with which it serves approximately 32,000 residential, commercial, industrial and transportation customers. The four largest branch offices are Corbin, Nicholasville, Berea and Barbourville, where Delta serves approximately 5,800, 5,300, 3,400 and 3,100 customers, respectively.\nThe Company purchases and produces gas for distribution to its retail customers. Additionally, Delta transports gas produced in southeastern Kentucky to inter-connected pipelines and also transports gas for others to industrial customers. Delta owns and operates storage facilities and approximately 1,682 miles of natural gas gathering, transmission, distribution and service lines.\nDelta has four wholly-owned subsidiaries, Delta Resources, Inc. (Resources), Delgasco, Inc. (Delgasco), Deltran, Inc. (Deltran) and Enpro, Inc. (Enpro). Resources buys gas and resells it to industrial customers on Delta's system and to Delta for system supply. Delgasco buys gas and resells it to Resources and to customers not on Delta's system. Deltran was formed to engage in potential pipeline projects under consideration and is inactive. Enpro owns and operates existing production properties. Delta and its subsidiaries are managed by the same officers.\nGas Operations and Supply\nThe Company's revenues are affected by various factors, including rates billed to customers, the cost of natural gas, economic conditions in the areas that the Company serves, weather conditions and competition. Delta competes for customers and sales with alternate sources of energy, including electricity, coal, oil, propane and wood. Gas costs, which the Company is able to pass through to customers under its purchased gas adjustment clause, may affect Delta's competitive position or may cause customers to conserve, or, in the case of industrial customers, to use alternative energy sources. Also, the potential bypass of Delta's system by industrial customers and others is a competitive concern that Delta has and will continue to address. In recent years, regulatory changes at the federal level and changes in the participants in the natural gas industry have led to a national spot market for natural gas. The Company's marketing subsidiaries purchase gas and resell it to various industrial customers and others in competition with producers and marketers.\nDelta's retail sales are seasonal and temperature-sensitive as the majority of the gas sold by Delta is used for heating. This seasonality impacts Delta's liquidity position and its management of its working capital requirements during each 12 month period (see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\"). Currently, over 99% of Delta's customers are residential and commercial. Delta's remaining light industrial customers purchased approximately 7% of the total volume of gas sold by Delta at retail during 1994.\nRetail gas sales in 1994 were 4,334,000 thousand cubic feet (Mcf), as compared to 3,990,000 Mcf in 1993. Heating degree days for 1994 were approximately 105.8% of the thirty year average as compared with 99.2% in 1993. Sales volumes increased by 344,000 Mcf, or 8.6% in 1994 reflecting the colder weather in 1994 as compared to 1993. Also, the number of customers served increased by 796, or 2.5%, during 1994. Delta continued to convert customers to natural gas from other fuels. Also, much of Delta's service area continued to expand, resulting in growth opportunities for the Company. Industrial parks have been developed in certain areas and have resulted in new industrial customers, some of whom are on-system transportation customers.\nA total of $2,933,000 of transportation revenues was earned during 1994 as compared with $3,287,000 during 1993. Total volumes transported were 4,183,000 Mcf in 1994 as compared to 4,916,000 Mcf in 1993. As of June 30, 1994, Delta had 73 on-system transportation customers (industrial customers who purchase their gas from others) and 4 off-system transportation customers (deliveries made by Delta to other pipelines).\nTransportation revenues include $2,310,000 earned during 1994 and $2,451,000 earned during 1993 for transportation of 2,186,000 Mcf and 2,248,000 Mcf, respectively, on behalf of several on-system customers. Delta also transports volumes for off-system deliveries, which include deliveries for interconnected interstate pipeline systems. During 1994 and 1993, 1,997,000 Mcf and 2,668,000 Mcf, respectively, were transported for such off- system deliveries. The decline in off-system transportation in 1994 was primarily due to reduced shipments of gas on a 43 mile pipeline that Delta leased and began operating during 1989. The pipeline extends from Clay County to Madison County, where it interconnects with the interstate pipeline facilities of the Columbia Gulf Transmission Company. Delta's agreements to operate the line and transport gas through it had an initial term of three years and extend from year-to-year thereafter. Delta's off-system transportation volumes include 574,000 Mcf transported through this pipeline in 1993. This pipeline has been inactive since October, 1992. Also, some producers shipped gas to markets that did not require the use of Delta's system.\nSome producers in Delta's service area can access certain pipeline delivery systems other than Delta, which provides competition from others for transportation of such gas. Delta will continue to purchase or transport any natural gas available that is produced in reasonable proximity to its facilities.\nRecognizing competitive concerns, Delta will continue to maintain an active gas supply management program that emphasizes long-term reliability and the pursuit of cost effective sources of gas for its customers. Delta purchases gas supplies from interstate pipelines, intrastate suppliers and others. Delta has transportation and storage capacity available on certain interstate pipelines for deliveries of gas through those facilities. The Company presently anticipates an adequate gas supply for service to existing customers and to provide for growth.\nDelta receives a portion of its gas supply (including transportation gas purchased from others) from its interstate sources, Tennessee Gas Pipeline Company (Tennessee) and Columbia Gas Transmission Corporation (Columbia), which companies are subject to the Federal Energy Regulatory Commission (FERC) jurisdiction. A significant portion of Delta's supply comes from gas producers in southeastern Kentucky. Delta's subsidiary companies obtain supply from Kentucky producers and others.\nDuring 1992, the FERC ordered a major restructuring of interstate natural gas pipeline operations, services and rates during its Order 636 proceedings. It required that interstate pipelines provide transportation and storage services priced separately from sales of gas. The FERC provided for blanket sales for resale certificates authorizing interstate pipelines to sell gas at unregulated, market-based rates. Pipelines must provide a new no-notice firm service in addition to open-access transportation and storage services. The FERC provided for new capacity assignment mechanisms. Pipelines are required to design their transportation and storage rates using the straight-fixed-variable rate design methodology, which provides for recovery of less costs in the commodity, or unit, component of rates and correspondingly more costs in the demand, or fixed, component. Pipelines will be allowed to abandon sales and transportation service upon expiration or termination of contracts. The FERC established methods for the recovery of transition costs such as take-or-pay and contract reformation costs by pipelines.\nDelta was involved in restructuring proceedings with both Tennessee and Columbia. During 1994, Delta entered agreements for transportation and storage services with these two pipeline suppliers and began purchasing gas supplies from gas marketers. The FERC approved Tennessee's new rates and services effective September 1, 1993, and Columbia's new rates and services effective November 1, 1993.\nDelta's agreements with Tennessee expire in the year 2000 and thereafter will continue on a year-to-year basis until terminated by either party. During 1994, Tennessee discontinued sales of gas to Delta and other wholesale customers upon implementation of FERC Order 636. Delta's entitlements under those agreements were converted to firm transportation and storage rights on Tennessee, and Delta entered a three-year contract with a gas marketer to supply gas for those portions of Delta's system formerly served by Tennessee. The initial term of the contract extends through April, 1996, and such purchases are included in Delta's gas cost recovery filings (see \"Regulatory Matters\"). During 1994, Delta purchased approximately 530,000 Mcf from Tennessee, including the purchase of Delta's allocated portion of the gas in Tennessee's storage inventory as of September 1, 1993 as required by the FERC. Delta also purchased approximately 738,000 Mcf from the gas marketer.\nDelta's entitlements under agreements with Columbia were also converted to firm transportation and firm storage services upon implementation of Order 636 by Columbia. The agreements expire in the year 2008 and thereafter will continue on a year-to-year basis until terminated by either party. Delta contracted with a gas marketer to supply gas for those portions of Delta's system formerly served by Columbia. The initial term of the agreement with the gas marketer extends through April, 1996, and such purchases are included in Delta's gas cost recovery filings (see \"Regulatory Matters\"). During 1994, Delta purchased approximately 406,400 Mcf, from Columbia, including the purchase of Delta's allocated portion of the gas in Columbia's storage inventory as of November 1, 1993 as required by the FERC. Delta also purchased approximately 340,000 Mcf from the gas marketer.\nDuring July, 1991, Columbia and its parent company, Columbia Gas System Inc., filed for protection under Chapter 11 of the U.S. Bankruptcy Code due to problems related to above-market-price gas purchase contracts. The filing has not materially affected its service to Delta. Delta will continue to monitor Columbia's situation and take appropriate actions as required.\nDelta has a contract with The Wiser Oil Company (Wiser) to purchase natural gas from Wiser through 1999. Delta and Wiser annually determine the daily deliverability from Wiser and Wiser is committed to deliver that volume. Under this agreement, Wiser is obligated to deliver 11,000 Mcf per day to Delta. Delta purchased approximately 1,456,000 Mcf from Wiser during 1994.\nDelta has four contracts with Enpro to purchase all the natural gas produced from Enpro's wells on certain leases in Bell, Knox and Whitley Counties. These agreements remain in force so long as gas is produced in commercial quantities from the wells on the leases. Also, Delta purchases gas from Enpro which is produced from the Flat Lick Field in Knox County. Remaining proved, developed natural gas reserves are estimated at approximately 5.4 million Mcf. Delta purchased a total of approximately 242,000 Mcf from those properties during 1994. Enpro also produces oil from certain of these leases, but oil production has not been significant.\nDelta receives gas under agreements with various other marketers, brokers and local producers, most of which are priced as short-term, or spot- market, purchases. The combined volumes of gas purchased from these sources in 1994 was approximately 832,000 Mcf.\nResources and Delgasco purchase gas under agreements with various marketers, brokers and local producers, most of which are priced as short- term, or spot-market, purchases. The gas is resold to industrial customers on Delta's system, to Delta for system supply and to others. The combined volumes of gas purchased by Resources and Delgasco from these sources in 1994 was approximately 1,535,000 Mcf.\nAlthough there are competitors for the acquisition of supplies, Delta continues to seek additional new gas supplies from all available sources, including those in the proximity of its facilities in southeastern Kentucky. Also, Resources and Delgasco continue to pursue acquisitions of new gas supplies from local producers and others.\nAs an active participant in many areas of the natural gas industry, Delta plans to continue its efforts to expand its gas distribution system. Delta is considering acquisitions of other gas systems, some of which are contiguous to its existing service areas, as well as continued expansion within its existing service areas. The Company also anticipates continuing activity in gas production and transportation areas and plans to pursue and increase these activities wherever practicable. The Company will continue to consider the construction or acquisition of additional transmission, storage and gathering facilities to provide for increased transportation and enhanced supply and system flexibility.\nRegulatory Matters\nDelta is subject to the regulatory authority of the Public Service Commission of Kentucky (PSC) with respect to various aspects of its business, including rates and service to retail and transportation customers. Delta's last rate case was filed in 1990. Rates were implemented in May, 1991. Delta currently has no general rate case filed.\nOn January 29, 1993, the PSC established an administrative proceeding to investigate the reasonableness of current state regulatory practices, in particular purchased gas cost recovery mechanisms, in light of FERC Order 636. Delta is a party to this proceeding. Delta currently has a Gas Cost Recovery (GCR) clause, which provides for a dollar-tracker that matches revenues and gas costs and allows eventual full recovery of gas costs. This clause requires Delta to make quarterly filings with the PSC, but such procedure does not require a general rate case. The GCR mechanism provides for any over or under-recovery of purchased gas costs to be reflected in the rates charged to customers.\nIn an Order dated December 22, 1993, in its administrative proceeding, the PSC provided for pipeline transition costs and certain other components of gas supply costs to appropriately be recovered through regulated utilities' purchased gas recovery mechanisms. Delta's quarterly GCR filings include certain pipeline transition costs and various components of gas supply costs as a result of the FERC Order 636 restructuring. The PSC has approved such filings and Delta has implemented rates reflecting these increased costs. The administrative proceeding is a continuing docket wherein the PSC is considering and evaluating these and other issues relating to the FERC Order 636 restructuring. Delta will continue to be an active participant in this proceeding.\nIn addition to PSC regulation, Delta may obtain non-exclusive franchises from the cities and communities in which it operates authorizing it to place its facilities in the streets and public grounds. However, no utility may obtain a franchise until it has obtained from the PSC a certificate of convenience and necessity authorizing it to bid on the franchise. Delta holds unexpired franchises in five of the ten cities in which it maintains a branch office and in seven other communities it serves. In the other cities or communities, either Delta's franchises have expired, the communities do not have governmental organizations authorized to grant franchises, or the local governments have not required, or do not want to offer, a franchise. Delta will attempt to acquire or reacquire franchises wherever possible and feasible.\nWithout a franchise, a local government could require Delta to cease its occupation of the streets and public grounds or prohibit Delta from extending its facilities into any new area of that city or community. To date, the absence of a franchise has had no adverse effect on Delta's operations.\nCapital Expenditures\nCapital expenditures during fiscal 1994 were approximately $7.4 million and for fiscal 1995 are estimated at approximately $8.4 million. These include expenditures for system extensions and the replacement and improvement of existing transmission, distribution, gathering and general facilities.\nEmployees\nDelta employed a total of 174 full-time employees on June 30, 1994. Delta considers its relationship with its employees to be satisfactory.\nConsolidated Statistics\nFor the Years Ended June 30, 1994 1993 1992 1991 1990\nRetail Customers Served, End of Period Residential .............. 27,939 27,293 26,488 25,698 25,364 Commercial ............... 4,242 4,093 4,035 4,168 4,049 Industrial ............... 76 75 66 71 63\nTotal ................. 32,257 31,461 30,589 29,937 29,476\nOperating Revenues ($000) Residential sales ........ 16,597 14,578 13,945 12,453 12,792 Commercial sales ......... 9,663 8,269 7,651 6,294 6,581 Industrial sales ......... 1,671 1,383 1,188 1,299 1,656 On-system transportation . 2,310 2,451 2,348 2,351 2,039 Off-system transportation. 623 836 1,342 1,377 1,126 Subsidiary sales ......... 3,755 3,532 2,580 2,873 2,708 Other .................... 228 172 147 131 280\nTotal ................. 34,847 31,221 29,201 26,778 27,182\nSystem Throughput (Million Cu. Ft.) Residential sales ........ 2,511 2,341 2,202 2,049 2,195 Commercial sales ......... 1,506 1,368 1,235 1,115 1,214 Industrial sales ......... 316 281 229 248 327\nTotal retail sales .... 4,333 3,990 3,666 3,412 3,736\nOn-system transportation.. 2,186 2,248 2,061 1,993 1,518\nOff-system transportation. 1,997 2,668 4,580 4,903 4,087\nTotal ................. 8,516 8,906 10,307 10,308 9,341\nAverage Annual Consumption Per End of Period Residential Customer (Mcf) ............ 90 86 83 80 86 Lexington, Kentucky Degree Days Actual ................... 4,999 4,688 4,370 4,025 4,579 Percent of 30 year average (4,726) ................. 105.8 99.2 92.5 85.2 96.9\nAverage Revenue Per Mcf Sold at Retail ($) ............. 6.44 6.07 6.21 5.88 5.63\nAverage Gas Cost Per Mcf Sold at Retail ($) ............. 3.34 2.90 3.01 3.42 3.26\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nDelta owns the land and buildings containing its corporate headquarters in Winchester. The buildings house executive, administrative and technical staffs of Delta. In addition, Delta owns buildings used for branch operations in Barbourville, Berea, Corbin, London, Manchester, Middlesboro, Nicholasville, Stanton and Williamsburg and rents an office building in Owingsville for branch operations. Also, Delta owns a building in Laurel County used for training as well as equipment and materials storage.\nThe Company owns approximately 1,682 miles of natural gas field, transmission, distribution and service lines. These lines range in size up to eight inches in diameter. There are no significant encumbrances on this property.\nDelta owns the rights to any oil and gas underlying approximately 3,500 acres in Bell County. Portions of these properties are used by Delta for the storage of natural gas. The maximum capacity of the storage facilities is approximately 550,000 Mcf. These properties otherwise are currently non- producing, and no reserve studies have been completed on the properties.\nEnpro owns interests in certain oil and gas leases relating to approximately 11,000 acres located in Bell, Knox and Whitley Counties. There presently are 56 gas wells and 7 oil wells producing from these properties. Remaining proved, developed natural gas reserves are estimated at approximately 5.4 million Mcf. The gas production from these properties continues to be purchased by Delta for system supply, and such purchases amounted to approximately 242,000 Mcf during 1994. Oil production has not been significant.\nAlso, Enpro owns the oil and gas underlying approximately 11,500 additional acres in Bell, Clay and Knox Counties. These properties are currently non- producing, and no reserve studies have been completed on the properties. During 1994, Enpro entered an agreement with a producer covering approximately 14,000 acres of Enpro's undeveloped holdings. Under the terms of the agreement, the producer is to conduct exploration activities on the acreage. Enpro reserved the option to participate in wells drilled. Enpro also retained certain working and royalty interests in any production from wells to be drilled.\nItem 3.","section_3":"Item 3. Legal Proceedings\nDelta and its subsidiaries are not parties to any legal proceedings which are expected to have a materially adverse impact 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\nNo matter was submitted during the fourth quarter of 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nDelta has paid cash dividends on its common stock each year since 1964. While it is the intention of the Board of Directors to continue to declare dividends on a quarterly basis, the frequency and amount of future dividends will depend upon the Company's earnings, financial requirements and other relevant factors.\nDelta's common stock is traded in the National Association of Securities Dealers Automated Quotation (NASDAQ) National Market System. The accompanying table reflects the high and low sales prices during each quarter as reported by NASDAQ and the quarterly dividends declared per share.\nQuarter Range of Stock Dividends Prices ($) Per Share High Low ($)\n__________________________________________________________________\nFiscal 1994\nFirst 22 1\/4 18 3\/4 .275\nSecond 23 1\/2 21 .275\nThird 21 3\/4 19 .275\nFourth 20 1\/2 17 1\/4 .28\nFiscal 1993\nFirst 18 1\/2 15 1\/2 .27\nSecond 18 1\/2 17 1\/4 .27\nThird 19 1\/2 17 1\/4 .27\nFourt 19 1\/2 18 1\/2 .275 __________________________________________________________________\nThere were 2,258 record holders of Delta's common stock as of August 1, 1994.\nItem 6.","section_6":"Item 6. Selected Financial Data\nEnded June 30, 1994(a) 1993 1992 1991(b) 1990\nSummary of Operations ($)\nOperating revenues ........ 34,846,941 31,221,410 29,200,834 26,778,255 27,182,104\nOperating income .......... 4,850,673 4,791,816 4,586,323 3,039,045 2,920,238\nNet income ...... 2,671,001 2,620,664 2,453,813 1,162,582 1,195,512\nEarnings per common share .... 1.50 1.60 1.52 0.73 0.76\nDividends declared per common share .... 1.105 1.085 1.08 1.08 1.08\nAverage Number of Common Shares Outstanding ........ 1,775,068 1,635,945 1,612,437 1,586,235 1,563,588\nTotal Assets ($).... 61,932,480 55,129,912 50,478,014 47,816,330 44,243,819\nCapitalization ($)..\nCommon share- holders' equity . 22,164,791 17,501,045 16,227,158 15,147,551 15,369,126\nLong-term debt .. 24,500,000 19,596,401 20,187,826 21,473,431 12,231,202\nTotal capitalization .. 46,664,791 37,097,446 36,414,984 36,620,982 27,600,328\nShort-Term Debt ($) (c) ....... 2,705,000 7,729,000 4,029,000 2,616,000 7,632,800\nOther Items ($)\nCapital expenditures .... 7,374,747 6,289,508 5,074,483 5,213,319 6,275,866\nTotal plant ..... 77,882,135 71,187,860 66,032,217 61,757,666 57,421,951\n(a) During October, 1993, $15 million of debentures and 170,000 shares of Common Stock were sold, and the proceeds were used to repay short-term debt and to refinance certain long-term debt. (b) During May, 1991, $10 million of debentures were sold, and the proceeds were used to repay short-term debt. (c) Includes current portion of long-term debt.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nCapital expenditures for Delta for 1995 are expected to be approximately $8.4 million. Delta generates internally only a portion of the cash necessary for its capital expenditure requirements and finances the balance of its capital expenditures on an interim basis through the use of its borrowing capability under its short-term line of credit. The current line of credit is $15 million, of which approximately $2.7 million had been borrowed at June 30, 1994 at an interest rate of 5.5%. Delta had an average interest rate of 4.3% for 1994 on its line of credit. The current line of credit extends until November, 1994. Short-term borrowings are periodically repaid with the proceeds from the issuance of long-term debt and equity securities, as was done in October, 1993, when the net proceeds of approximately $17.8 million from the sale of $15 million of debentures and 170,000 shares of common stock were used to repay short-term debt and to refinance certain long-term debt. The amounts and types of future long-term debt and equity financings will depend upon the Company's capital needs and market conditions.\nDelta's sales are seasonal in nature, and the largest proportion of cash is received during the winter heating months when sales volumes increase considerably. During non-heating months, cash needs for operations and construction are partially met through short-term borrowings. Additionally, most construction activity takes place during the non-heating season because of more favorable weather conditions, thus increasing seasonal cash needs. The primary sources and uses of cash during the last three years are summarized below:\nSources(Uses) 1994 1993 1992\nProvided by operat- ing activities $ 6,172,019 $ 4,567,023 $ 6,370,685\nCapital expenditures $(7,374,747) $(6,289,508) $(5,074,483)\nIssuance of deben- tures, net $ 14,246,937 $ - $ -\nRepayment of long- term debt $(11,330,286) $(591,425) $ (787,605)\nNet short-term borrowings $ (3,765,000) $ 3,700,000 $ 915,000\nCommon stock dividends $ (1,972,368) $(1,775,411) $(1,741,661)\nIssuance of common stock, net $ 3,965,113 $ 428,634 $ 367,455\nCash provided by operating activities consists of net income and noncash items including depreciation, depletion, amortization and deferred income taxes. Additionally, changes in working capital are also included in cash provided by operating activities. The Company expects that internally generated cash, coupled with seasonal short-term borrowings, will continue to be sufficient to satisfy its operating, capital expenditure and dividend requirements over the next year.\nResults of Operations\nThe increase in operating revenues for 1994 of approximately $3,625,000 was due primarily to an increase in retail sales volumes of approximately 344,000 Mcf as a result of the colder winter weather in 1994 (105.8% of thirty year average weather compared to 99.2% for 1993), and an increase in customers served of 796, or 2.5%. The increase in operating revenues was partially offset by an approximately $212,000 decrease in transportation revenues for off-system customers resulting from decreased volumes of approximately 671,000 Mcf due primarily to reduced volumes shipped by others on a leased pipeline that has been inactive since October, 1992, and due to certain producers who shipped gas into markets that did not require the use of Delta's system.\nThe increase in operating revenues for 1993 of approximately $2,021,000 was due primarily to an increase in retail sales volumes of approximately 324,000 Mcf as a result of the colder winter weather in 1993 (99.2% of thirty year average weather as compared to 92.5% for 1992) and an increase in customers served of 872, or 2.9%. Contributing to the increase in operating revenues was an increase in Resources' revenues resulting from increased volumes and cost of gas for resale to on-system customers and an increase in transportation revenues resulting from increased volumes of approximately 187,000 Mcf transported for on-system customers. The increase in operating revenues was partially offset by an approximately $506,000 decrease in transportation revenues for off-system customers resulting from decreased volumes of approximately 1,912,000 Mcf due to reduced volumes shipped by others on a leased pipeline that has been inactive since October, 1992, and due to certain producers who shipped gas into markets that did not require the use of Delta's system.\nOperating Expenses\nThe increase in purchased gas expense of approximately $3,016,000 for 1994 was due primarily to an increase in the cost of gas for retail sales due to an increase in retail sales volumes.\nThe increase in purchased gas expense of approximately $1,669,000 for 1993 was due primarily to increases in the cost of gas purchased by Resources for resale to on-system customers. Contributing to the increase was an increase in the cost of gas for retail sales due to an increase in retail sales volumes.\nThe increases in depreciation expense during 1994 and 1993 of approximately $145,000 and $158,000, respectively, were due primarily to additional depreciable plant.\nThe increases in taxes other than income taxes during the periods of approximately $78,000 and $39,000 for 1994 and 1993, respectively, were primarily due to increased property taxes which resulted from increased plant, and to increased payroll taxes which resulted from increased wages and payroll tax rates.\nChanges in income taxes during the periods of approximately $34,100 and $102,000 for 1994 and 1993, respectively, were primarily due to changes in net income. The Omnibus Budget Reconciliation Act of 1993 did not result in additional income taxes for Delta. The Company adopted Statement of Financial Accounting Standard (SFAS) No. 109, \"Accounting for Income Taxes\", effective July 1, 1993, as required. SFAS No. 109, which replaces SFAS No. 96, adopts the liability method of accounting for income taxes, requiring deferred income tax assets and liabilities to be computed using tax rates that will be in effect when the book and tax temporary differences reverse. For regulated companies, the change in tax rates applied to accumulated deferred income taxes may not be immediately recognized in operating results because of ratemaking treatment. A regulatory liability has been established to recognize the future revenue requirement impact from these deferred taxes. As a result, the adoption of SFAS No. 109 did not have a material impact on the results of operations or financial position of the Company.\nStatement of Financial Accounting Standard (SFAS) No. 106, \"Employers' Accounting for Post-Retirement Benefits\", and SFAS No. 112, \"Employers' Accounting for Post-Employment Benefits\", did not affect the Company as Delta does not provide benefits for post-retirement or post-employment other than the pension plan for retired employees.\nInterest Charges\nThe decrease in long-term interest for 1993 of approximately $62,000 was due to less long-term debt outstanding during the period. The increase in other interest charges for 1993 of approximately $106,000 was due primarily to increased average short-term borrowings that were partially offset by lower interest rates for the period.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES PAGE\nManagement's Statement of Responsibility for Financial Reporting and Accounting 24\nReport of Independent Public Accountants 25\nConsolidated Statements of Income for the years ended June 30, 1994, 1993 and 1992 26\nConsolidated Statements of Cash Flows for the years ended June 30, 1994, 1993 and 1992 27\nConsolidated Balance Sheets as of June 30, 1994 and 1993 29\nConsolidated Statements of Changes in Shareholders' Equity for the years ended June 30, 1994, 1993 and 1992 31\nConsolidated Statements of Capitalization as of June 30, 1994 and 1993 32\nNotes to Consolidated Financial Statements 33\nSchedule II - Amounts Receivable from Related Parties and Underwriters, Promoters and Employees Other than Related Parties for the years ended June 30, 1994, 1993 and 1992 41\nSchedule V - Property, Plant and Equipment for the years ended June 30, 1994, 1993 and 1992 42\nSchedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment for the Years Ended June 30, 1994, 1993 and 1992 45\nSchedule VIII - Valuation and Qualifying Accounts for the years ended June 30, 1994, 1993 and 1992 48\nSchedule IX - Short-term Borrowings for the years ended June 30, 1994, 1993 and 1992 49\nSchedule X - Supplementary Income Statement Information for the years ended June 30, 1994, 1993 and 1992 50\nSchedules other than those listed above are omitted because they are not required, 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 None.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant Item 11.","section_11":"Item 11. Executive Compensation Item 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nRegistrant intends to file a definitive proxy statement with the Commission pursuant to Regulation 14A (17 CFR 240.14a) not later than 120 days after the close of the fiscal year. In accordance with General Instruction G(3) to Form 10-K, the information called for by Items 10, 11, 12 and 13 is incorporated herein by reference to the definitive proxy statement. Neither the report on Executive Compensation nor the performance graph included in the Company's definitive proxy statement shall be deemed 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, Schedules and Exhibits\n(1) - Financial Statements See Index at Item 8\n(2) - Financial Statement Schedules See Index at Item 8\n(3) - Exhibits\nExhibit No.\n3(a) - Delta's Amended and Restated Articles of Incorporation are incorporated herein by reference to Exhibit 3(a) to Delta's Form 10-Q for the period ended March 31, 1990.\n3(b) - Delta's By-Laws as amended August 19, 1993 are incorporated herein by reference to Exhibit 3(b) to Delta's Form 10-K for the year ended June 30, 1993.\n4(a) - The Indenture dated April 1, 1991 in respect of 9% Debentures due April 30, 2011, is incorporated herein by reference to Exhibit 4(e) to Delta's Form S-2 dated April 23, 1991.\n4(b) - The Indenture dated September 1, 1993 in respect of 6 5\/8% Debentures due October 1, 2023, is incorporated herein by reference to Exhibit 4(e) to Delta's Form S-2 dated September 2, 1993.\n10(a) - Certain of Delta's material natural gas supply contracts are incorporated herein by reference to Exhibit 10 to Delta's Form 10 for the year ended June 30, 1978 and by reference to Exhibits C and D to Delta's Form 10-K for the year ended June 30, 1980.\n10(b) - Gas Purchase Contract between Delta and Wiser is incorporated herein by reference to Exhibit 2(C) to Delta's Form 8-K dated February 9, 1981.\n10(c) - Assignment to Delta by Wiser of its Columbia Service Agreement, including a copy of said Service Agreement, is incorporated herein by reference to Exhibit 2(D) to Delta's Form 8-K dated February 9, 1981.\n10(d) - Contract between Tennessee and Delta for the sale of gas by Tennessee to Delta (amends earlier contract for Nicholasville and Wilmore Service Areas) is incorporated herein by reference to Exhibit 10(d) to Delta's Form 10-Q for the period ended September 30, 1990.\n10(e) - Contract between Tennessee and Delta for the sale of gas by Tennessee to Delta (amends earlier contract for Jeffersonville Service Area) is incorporated herein by reference to Exhibit 10(e) to Delta's Form 10-Q for the period ended September 30, 1990.\n10(f) - Contract between Tennessee and Delta for the sale of gas by Tennessee to Delta (amends earlier contract for Salt Lick Service Area) is incorporated herein by reference to Exhibit 10(f) to Delta's Form 10-Q for the period ended September 30, 1990.\n10(g) - Contract between Tennessee and Delta for the sale of gas by Tennessee to Delta (amends earlier contract for Berea Service Area) is incorporated herein by reference to Exhibit 10(g) to Delta's Form 10-Q for the period ended September 30, 1990.\n10(h) - Service Agreements between Columbia and Delta for the sale of gas by Columbia to Delta (amends earlier service agreements for Cumberland, Stanton and Owingsville service areas) are incorporated herein by reference to Exhibit 10(h) to Delta's Form 10-Q for the period ended September 30, 1990.\n10(i) - Amendment to Gas Purchase Contract between Delta and Wiser is incorporated herein by reference to Exhibit 10(c) to Delta's Form 10-Q for the period ended December 31, 1988.\n10(j) - Second amendment to Gas Purchase Contract between Delta and Wiser, dated August 20, 1993.\n10(k) - Employment agreements between Delta and three officers, those being Alan L. Heath, Jane W. Hylton, and Thomas A. Kohnle, are incorporated herein by reference to Exhibit 10(k) to Delta's Form 10-Q for the period ended December 31, 1985.\n10(l) - Employment agreements between Delta and two officers, those being John F. Hall and Robert C. Hazelrigg, are incorporated herein by reference to Exhibit 10(m) to Delta's Form 10-Q for the period ended December 31, 1988.\n10(m) - Employment agreement dated June 1, 1992 between Delta and Glenn R. Jennings, an officer, is incorporated herein by reference to Exhibit 10(l) to Delta's Form 10-K for the period ended June 30, 1992.\n12 - Computation of the Consolidated Ratio of Earnings to Fixed Charges.\n21 - Subsidiaries of the Registrant are incorporated herein by reference to Exhibit 22 to Delta's Form 10-K for the period ended June 30, 1986.\n24 - Consent of Independent Public Accountants.\n(b) Reports on 8-K.\nNo reports on Form 8-K were filed during the three months ended June 30, 1994. 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 the 26th day of August, 1994.\nDELTA NATURAL GAS COMPANY, INC.\nBy \/s\/Glenn R. Jennings Glenn R. Jennings, President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\n(i) Principal Executive Officer:\n\/s\/Glenn R. Jennings President, Chief August 26, 1994 (Glenn R. Jennings) Executive Officer and Director\n(ii) Principal Financial Officer:\n\/s\/John F. Hall Vice President - August 26, 1994 (John F. Hall) Regulatory Matters and Treasurer\n(iii) Principal Accounting Officer:\n\/s\/Thomas A. Kohnle Vice President - August 26, 1994 (Thomas A. Kohnle) Controller\n(iv) A Majority of the Board of Directors:\n\/s\/H. D. Peet Chairman of the August 26, 1994 (H. D. Peet) Board\n\/s\/Donald R. Crowe Director August 26, 1994 (Donald R. Crowe)\n\/s\/Billy Joe Hall Director August 26, 1994 (Billy Joe Hall)\n\/s\/Jane W. Hylton Vice President - August 26, 1994 (Jane W. Hylton) Human Resources, Secretary and Director\n\/s\/Virgil E. Scott Director August 26, 1994 (Virgil E. Scott)\n\/s\/Henry C. Thompson Director August 26, 1994 (Henry C. Thompson)\n\/s\/Arthur E. Walker, Jr. Director August 26, 1994 (Arthur E. Walker, Jr.)\n\/s\/Robert M. Watt III Director August 26, 1994 (Robert M. Watt III)\nManagement's Statement of Responsibility for Financial Reporting and Accounting\nManagement is responsible for the preparation, presentation and integrity of the financial statements and other financial information in this report. The statements, which were prepared in accordance with generally accepted accounting principles, include some amounts which are based on management's best estimates and judgments.\nThe Company maintains a system of accounting and internal controls which management believes provides reasonable assurance that the accounting records are reliable for purposes of preparing financial statements and that the assets are properly accounted for and protected.\nThe Board of Directors pursues its oversight role for these financial statements through its Audit Committee which consists of three outside directors. The Audit Committee meets periodically with management to review the work and monitor the discharge of their responsibilities. The Audit Committee also meets periodically with the Company's internal auditor as well as Arthur Andersen LLP, the independent auditors, who have full and free access to the Audit Committee, with or without management present, to discuss internal accounting control, auditing and financial reporting matters.\nReport of Independent Public Accountants\nTo the Board of Directors and Shareholders of Delta Natural Gas Company, Inc.:\nWe have audited the accompanying consolidated balance sheets and statements of capitalization of DELTA NATURAL GAS COMPANY, INC. (a Kentucky corporation) and subsidiary companies as of June 30, 1994 and 1993, and the related consolidated statements of income, cash flows and changes in shareholders' equity for each of the three years in the period ended June 30, 1994. These consolidated financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion of these consolidated financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Delta Natural Gas Company, Inc. and subsidiary companies as of June 30, 1994 and 1993, and the 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.\nAs discussed in Note 1 to the consolidated financial statements, effective July 1, 1993, 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 schedules listed in the Index to Consolidated Financial Statements and Schedules are presented for purposes of complying with the Securities and Exchange Commission 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\nLouisville, Kentucky\nAugust 12, 1994\nDelta Natural Gas Company, Inc. and Subsidiary Companies\nConsolidated Statements of Income For the Years Ended June 30, 1994 1993 1992\nOperating Revenues ............ $34,846,941 $31,221,410 $29,200,834\nOperating Expenses\nPurchased gas .............. $17,250,556 $14,234,258 $12,564,947 Operation and maintenance (Note 1) ................. 8,382,767 8,020,622 8,173,070\nDepreciation and depletion (Note 1) ................. 1,977,868 1,833,072 1,675,540\nTaxes other than income taxes .................... 875,477 797,942 759,354\nIncome taxes (Note 1) ...... 1,509,600 1,543,700 1,441,600\nTotal operating expenses. $29,996,268 $26,429,594 $24,614,511\nOperating Income .............. $ 4,850,673 $ 4,791,816 $ 4,586,323\nOther Income and Deductions, Net 34,987 39,681 34,087\nIncome Before Interest Charges. $ 4,885,660 $ 4,831,497 $ 4,620,410\nInterest Charges\nInterest on long-term debt.. $ 1,879,526 $ 1,875,901 $ 1,938,389\nOther interest ............. 243,729 258,405 152,728\nAmortization of debt expense 91,404 76,527 75,480\nTotal interest charges .. $ 2,214,659 $ 2,210,833 $ 2,166,597\nNet Income $ 2,671,001 $ 2,620,664 $ 2,453,813\nWeighted Average Number of Common Shares Outstanding ..... 1,775,068 1,635,945 1,612,437\nEarnings Per Common Share ..... $ 1.50 $ 1.60 $ 1.52\nDividends Declared Per Common Share ......................... $ 1.105 $ 1.085 $ 1.08\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nDelta Natural Gas Company, Inc. and Subsidiary Companies\nConsolidated Statements of Cash Flows\nFor the Years Ended June 30, 1994 1993 1992\nCash Flows From Operating Activities: Net income ...................... $ 2,671,001 $ 2,620,664 $ 2,453,813\nAdjustments to reconcile net income to net cash from operating activities: Depreciation, depletion and amortization ............... 2,069,013 1,922,102 1,751,020 Deferred income taxes and investment tax credits ..... 874,800 839,100 467,600 Other - net .................. 446,969 493,848 565,756\n(Increase) decrease in assets: Accounts receivable .......... 802,197 (707,605) 343,423 Unamortized debt expense and other ...................... - (1,616) (160,401) Materials and supplies ....... (229,275) 155,358 122,092 Prepayments .................. 25,701 8,096 (39,997) Other assets ................. (780) (93,948) (119,703)\nIncrease (decrease) in other liabilities: Accounts payable ............. 513,265 438,897 424,898 Refunds due customers ........ 358,270 37,226 (20,752) Accrued taxes ................ (34,543) (162,982) 297,368 Other current liabilities .... 38,675 16,435 (213,594) Advance (deferred) recovery of gas cost ................ (1,372,030) (993,136) 463,870 Advances for construction and other ...................... 8,756 (5,416) 35,292\nNet cash provided by operating activities .... $ 6,172,019 $ 4,567,023 $ 6,370,685\nCash Flows From Investing Activities: Capital expenditures ............ $(7,374,747) $(6,289,508) $(5,074,483)\nNet cash used in investing activities .............. $(7,374,747) $(6,289,508) $(5,074,483)\nDelta Natural Gas Company, Inc. and Subsidiary Companies\nConsolidated Statements of Cash Flows (continued)\nFor the Years Ended June 30, 1994 1993 1992\nCash Flows From Financing Activities: Dividends on common stock ....... $(1,972,368) $(1,775,411) $(1,741,661) Issuance of common stock,net .... 3,965,113 428,634 367,455 Issuance of debentures,net ...... 14,246,937 - - Repayment of long-term debt ..... (11,330,286) (591,425) (787,605) Increase (decrease) in notes payable ....................... (3,765,000) 3,700,000 915,000\nNet cash provided by (used in) financing activities $ 1,144,396 $ 1,761,798 $(1,246,811)\nNet Increase (Decrease) in Cash and Cash Equivalents ................... $ (58,332) $ 39,313 $ 49,391\nCash and Cash Equivalents, Beginning of Year .................. 214,879 175,566 126,175\nCash and Cash Equivalents, End of Year ........................ $ 156,547 $ 214,879 $ 175,566\nSupplemental Disclosures of Cash Flow Information:\nCash paid during the year for: Interest $ 2,141,705 $ 2,107,168 $ 2,154,055 Income taxes $ 715,000 $ 952,851 $ 867,382\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nDelta Natural Gas Company, Inc. and Subsidiary Companies\nConsolidated Balance Sheets\nAs of June 30, 1994 1993\nAssets Gas Utility Plant, at cost .............. $77,882,135 $71,187,860 Less - Accumulated provision for depreciation .......................... (22,862,469) (21,118,363)\nNet gas plant $55,019,666 $50,069,497\nCurrent Assets Cash and cash equivalents ............ $ 156,547 $ 214,879 Accounts receivable, less accumulated provisions for doubtful accounts of $131,324 and $208,182 in 1994 and 1993, respectively ................. 1,117,962 1,920,159 Gas in storage, at average cost ...... 352,572 364,508 Deferred Gas Costs (Note 1) .......... 1,471,342 99,312 Materials and supplies, at first-in, first-out cost ..................... 700,761 471,486 Prepayments .......................... 317,343 343,044\nTotal current assets $ 4,116,527 $ 3,413,388\nOther Assets Cash surrender value of officers' life insurance (face amount of $1,031,000 and $1,020,000 in 1994 and 1993, respectively) ...................... $ 269,029 $ 244,313 Note receivable from officer ......... 83,000 95,000 Unamortized debt expense and other (Note 5) ........................... 2,444,258 1,307,714\nTotal other assets $ 2,796,287 $ 1,647,027\nTotal assets $61,932,480 $55,129,912\nDelta Natural Gas Company, Inc. and Subsidiary Companies\nConsolidated Balance Sheets (continued)\nAs of June 30, 1994 1993\nLiabilities and Shareholders' Equity\nCapitalization (See Consolidated Statements of Capitalization) Common Shareholders' equity .......... $22,164,791 $17,501,045 Long-term debt (Note 5) .............. 24,500,000 19,596,401\nTotal capitalization .............. $46,664,791 $37,097,446\nCurrent Liabilities Notes payable (Note 4) ............... $ 2,705,000 $ 6,470,000 Current portion of long-term debt (Note 5) ........................... 500,000 1,259,000 Accounts payable ..................... 2,133,840 1,620,575 Accrued taxes ........................ 436,158 470,701 Refunds due customers ................ 396,065 37,795 Customers' deposits .................. 342,979 377,402 Accrued interest on debt ............. 427,338 445,788 Accrued vacation ..................... 454,362 420,675 Other accrued liabilities ............ 314,888 257,027\nTotal current liabilities $ 7,710,630 $11,358,963\nDeferred Credits and Other Deferred income taxes ................ $ 5,116,400 $ 5,482,600 Investment tax credits ............... 921,800 993,300 Regulatory liability (Note 1) ........ 1,312,500 - Advances for construction and other .. 206,359 197,603\nTotal deferred credits and other $ 7,557,059 $ 6,673,503\nCommitments and Contingencies (Note 6) ..\nTotal Liabilities and shareholders' equity ............ $61,932,480 $55,129,912\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nDelta Natural Gas Company, Inc. and Subsidiary Companies\nConsolidated Statements of Changes in Shareholders' Equity\nFor the Years Ended June 30, 1994 1993 1992\nCommon Shares Balance, beginning of year ............$ 1,648,485 $ 1,624,878 $ 1,600,033 $1.00 par value of 190,855, 23,607 and 24,845 shares issued in 1994, 1993 and 1992, respectively - Public issuance of common shares .. 170,000 - - Dividend reinvestment and stock purchase plan ................... 15,355 16,265 18,067 Employee stock purchase plan and other ........................... 5,500 7,342 6,778\nBalance, end of year ..................$ 1,839,340 $ 1,648,485 $ 1,624,878\nPremium on Common Shares Balance, beginning of year ............$15,562,427 $15,157,400 $14,814,790 Premium on issuance of common shares- Public issuance of common shares .. 3,570,000 - - Dividend reinvestment and stock purchase plan ................... 293,782 281,074 245,801 Employee stock purchase plan and other ........................... 106,700 123,953 96,809\nBalance, end of year ..................$19,532,909 $15,562,427 $15,157,400\nCapital Stock Expense Balance, beginning of year ............$(1,391,801) $(1,391,801) $(1,391,801) Public issuance of common shares (196,224) - - Balance, end of year ..................$(1,588,025) $(1,391,801) $(1,391,801)\nRetained Earnings Balance, beginning of year ............$ 1,681,934 $ 836,681 $ 124,529 Net income .......................... 2,671,001 2,620,664 2,453,813 Cash dividends declared on common shares - (See Consolidated Statements of Income for rates) ... (1,972,368) (1,775,411) (1,741,661)\nBalance, end of year ..................$ 2,380,567 $ 1,681,934 $ 836,681\nThe accompanying notes to consolidated financial statements are an integral part\nof these statements.\nDelta Natural Gas Company, Inc. and Subsidiary Companies\nConsolidated Statements of Capitalization\nAs of June 30, 1994 1993\nCommon Shareholders' Equity Common shares, par value $1.00 per share (Notes 2 and 3) Authorized - 6,000,000 shares - Issued and outstanding - 1,839,340 and 1,648,485 shares in 1994 and 1993, respectively ......... $ 1,839,340 $ 1,648,485 Premium on common shares ................ 19,532,909 15,562,427 Capital stock expense ................... (1,588,025) (1,391,801) Retained earnings (Note 5) .............. 2,380,567 1,681,934\nTotal common shareholders' equity .... $22,164,791 $17,501,045\nLong-Term Debt (Note 5) Debentures, 6 5\/8%, due 2023 $15,000,000 - Debentures, 9%, due 2011 ................ 10,000,000 $10,000,000 Debentures, 8 5\/8%, due 2007 ............ - 10,553,000 First mortgage loan payable to bank, at 9 1\/4%, due in monthly installments through 1997, secured by first mortgage on corporate office building . - 177,401 Sinking fund debentures, 9 1\/2% due in annual installments to 1996 ........... - 125,000\n$25,000,000 $20,855,401\nLess - Amounts due within one year, included in current liabilities ....... (500,000) (1,259,000)\nTotal long-term debt ................. $24,500,000 $19,596,401\nTotal capitalization .............. $46,664,791 $37,097,446\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nNotes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies:\n(a) Principles of Consolidation -- Delta Natural Gas Company, Inc. (Delta or the Company) has four wholly-owned subsidiaries. Delta Resources, Inc. (Resources) buys gas and resells it to industrial customers on Delta's system and to Delta for system supply. Delgasco, Inc. buys gas and resells it to Resources and to customers not on Delta's system. Deltran, Inc. was formed to engage in potential pipeline projects under consideration and is inactive. Enpro, Inc. owns and operates existing production properties. All subsidiaries of Delta are included in the consolidated financial statements. Intercompany balances and transactions have been eliminated.\n(b) Cash Equivalents -- For the purposes of the Consolidated Statements of Cash Flows, all temporary cash investments with a maturity of three months or less at the date of purchase are considered cash equivalents.\n(c) Depreciation -- The Company determines its provision for depreciation using the straight-line method and by the application of rates to various classes of utility plant. The rates are based upon the estimated service lives of the properties and were equivalent to composite rates of 2.7% of average depreciable plant.\n(d) Maintenance -- All expenditures for maintenance and repairs of units of property are charged to the appropriate maintenance expense accounts. A betterment or replacement of a unit of property is accounted for as an addition and retirement of utility plant. At the time of such a retirement, the accumulated provision for depreciation is charged with the original cost of the property retired and also for the net cost of removal.\n(e) Gas Cost Recovery -- Delta has a Gas Cost Recovery (GCR) clause that matches revenues and gas costs and provides eventual dollar-for-dollar recovery of all gas costs incurred. The Company expenses gas costs based on the amount of gas cost recovered through revenue. Any differences between actual gas costs and those estimated costs billed are deferred and reflected in the computation of future billings to customers using the GCR mechanism.\n(f) Revenue Recognition -- The Company records revenues as billed to its customers on a monthly meter reading cycle. At the end of each month, gas service which has been rendered from the latest date of each cycle meter reading to the month-end is unbilled.\n(g) Revenues and Customer Receivables -- The Company supplies natural gas to approximately 32,000 customers in central and southeastern Kentucky. Revenues and customer receivables arise primarily from sales of natural gas to customers and from transportation services for others. Provisions for doubtful accounts are recorded to reflect the expected net realizable value of accounts receivable.\n(h) Income Taxes -- The Company provides for income taxes on timing differences resulting from the use of alternative methods of income and expense recognition for financial and tax reporting purposes. The differences result primarily from the use of accelerated tax depreciation methods for certain properties versus the straight-line depreciation method for financial purposes, differences in recognition of purchased gas cost recoveries and certain other accruals which are not currently deductible for income tax purposes. Investment tax credits were deferred for certain periods prior to fiscal 1987 and are being amortized to income over the estimated useful lives of the applicable properties.\nThe Company adopted Statement of Financial Accounting Standard (SFAS) No. 109, \"Accounting for Income Taxes\", effective July 1, 1993, as required. SFAS No. 109, which replaces SFAS No. 96, adopts the liability method of accounting for income taxes, requiring deferred income tax assets and liabilities to be computed using tax rates that will be in effect when the book and tax temporary differences reverse. For regulated companies, the change in tax rates applied to accumulated deferred income taxes may not be immediately recognized in operating results because of ratemaking treatment. A regulatory liability has been established to recognize the future revenue requirement impact from these deferred taxes. As a result, the adoption of SFAS No. 109 did not have a material impact on the results of operations or financial position of the Company. The temporary differences which gave rise to the following net deferred tax liability at June 30, 1994 were as follows:\nDeferred Tax Assets Unamortized investment tax credit $ 363,600 Regulatory liabilities 517,700 Alternative minimum tax credits 667,200 Other 402,100\n$ 1,950,600\nDeferred Tax Liabilities Accelerated depreciation $(6,257,200) Deferred Gas Cost (580,400) Other (229,400)\n$(7,067,000)\nNet Accumulated Deferred Income Tax Liability $(5,116,400)\nThe components of the income tax provision are comprised of the following for the years ended June 30:\n1994 1993 1992 Components of income tax expense: Payable currently: Federal 306,300 $ 432,300 $ 968,300 State 100,800 121,900 260,100 Total 407,100 $ 554,200 $1,228,400\nDeferred to future years from: Use of accelerated depreciation 675,000 660,300 575,000 Deferred (advance) recovery of 541,200 418,000 (238,600) gas cost Amortization of investment tax credits, net (71,500) (71,800) (72,100) Other deferred tax effects, net (42,200) (17,000) (51,100) Income tax expense 1,509,600 $1,543,700 $1,441,600\nReconciliation of the statutory Federal income tax rate is shown in the table below:\n1994 1993 1992\nStatutory Federal income tax rate 34.0% 34.0% 34.0%\nState income taxes net of Federal benefit 5.2 5.2 5.2\nAmortization of investment tax credit (1.8) (1.7) (1.9)\nOther differences - net (.9) - - Effective Income Tax Rate 36.5% 37.5% 37.3%\n(2) Employee Benefit Plans:\n(a) Defined Benefit Retirement Plan - Delta has a trusteed, noncontributory, defined benefit pension plan covering all eligible employees. Retirement income is based on the number of years of service and annual rates of compensation. The Company makes annual contributions equal to the amounts necessary to adequately fund the plan. The funded status of the pension plan and the amounts recognized in the Company's consolidated balance sheets at June 30 were as follows:\n1994 1993 1992 Plan assets at fair value $5,251,296 $ 4,931,658 $4,357,255 Actuarial present value of benefit obligation: Vested benefits $4,114,517 $ 4,042,029 $3,335,604 Non-vested benefits 30,562 37,777 32,019 Accumulated benefit obligation $4,145,079 $ 4,079,806 $3,367,623 Additional amounts related to projected salary increases 1,734,413 1,881,303 1,528,180 Total projected benefit obligation $5,879,492 $ 5,961,109 $4,895,803 Projected benefit obligation in excess of plan assets $ (628,196) $(1,029,451) $ (538,548) Unrecognized net assets at date of initial application being amortized over 15 years (339,153) (381,547) (423,941) Unrecognized net loss 950,735 1,407,072 873,813 Accrued pension liability $ (16,614) $ (3,926) $ (88,676)\nThe assets of the plan consist primarily of common stock, bonds and certificates of deposit. Net pension costs for the years ended June 30 include the following:\n1994 1993 1992 Benefits earned during the year - service cost $ 455,097 $ 401,054 $ 339,359 Interest cost on projected benefit obligation 357,372 317,897 271,382 Actual return on plan assets (45,100) (356,971) (442,461) Net amortization and deferral (353,530) (24,856) 123,892 Net periodic pension cost $ 413,839 $ 337,124 $ 292,172\nThe weighted average discount rates and the assumed rates of increase in future compensation levels used in determining the actuarial present values of the projected benefit obligation at June 30, 1994, 1993 and 1992 were 6.0%, 6.5% and 7.0%, respectively (discount rates), and 4% (rates of increase). The expected long-term rates of return on plan assets were 8%.\nSFAS No. 106, \"Employers' Accounting for Post-Retirement Benefits\", and SFAS No. 112, \"Employers' Accounting for Post-Employment Benefits\", did not affect the Company as Delta does not provide benefits for post-retirement or post- employment other than the pension plan for retired employees.\n(b) Employee Savings Plan - The Company has an Employee Savings Plan (Savings Plan) under which eligible employees may elect to contribute any whole percentage between 2% and 15% of their annual compensation. The Company will match 50% of the employee's contribution up to a maximum Company contribution of 2% of the employee's annual compensation. For the years ended June 30, 1994, 1993 and 1992, Delta's Savings Plan expense was $106,863, $93,749 and $87,966, respectively.\n(c) Employee Stock Purchase Plan - The Company has an Employee Stock Purchase Plan (the Stock Plan) under which qualified permanent employees are eligible to participate. Under the terms of the Stock Plan, such employees can contribute on a monthly basis 1% of their annual salary level (as of July 1 of each year) to be used to purchase Delta's common stock. After June 30, the Company will issue Delta common stock, based upon the fiscal year contributions, using an average of the last sale price of Delta's stock as quoted in NASDAQ's national market system at the close of business for the last five business days in June, and will match those shares so purchased. Therefore, stock equivalent to $47,653 will be issued in July, 1994. The continuation and terms of the Stock Plan are subject to approval by Delta's Board of Directors on an annual basis.\n(3) Dividend Reinvestment and Stock Purchase Plan:\nThe Company's Dividend Reinvestment and Stock Purchase Plan (Reinvestment Plan) provides that shareholders of record can reinvest dividends and also make limited additional investments of up to $3,000 per quarter in shares of common stock of the Company. Shares purchased under the Reinvestment Plan are authorized but unissued shares of common stock of the Company, and 15,355 shares were issued in 1994. Delta reserved 200,000 shares under the Reinvestment Plan in 1989, and, as of June 30, 1994 there were 122,020 shares still available for issuance.\n(4) Notes Payable and Line of Credit:\nSubstantially all of the cash balances of Delta are maintained to compensate the respective banks for banking services and to obtain lines of credit; however, no specific amounts have been designated as compensating balances, and Delta has the right of withdrawal of such funds. At June 30, 1994, the line of credit was $15,000,000, of which $2,705,000 had been borrowed at an interest rate of 5.5%. The maximum amount borrowed during 1994 was $9,065,000. The interest on this line is either at the daily prime rate or is based upon certificate of deposit rates. The current line of credit expires on November 15, 1994.\n(5) Long-Term Debt:\nOn October 18, 1993, Delta issued $15,000,000 of 6 5\/8% Debentures that mature in October, 2023. Commencing in October, 1995, each holder may require redemption of up to $25,000 of the 6 5\/8% Debentures annually, subject to an annual aggregate limitation of $500,000. Such redemption will also be made on behalf of deceased holders within sixty days of notice, subject to the annual aggregate $500,000 limitation. The 6 5\/8% Debentures can be redeemed by the Company beginning in October, 1998 at a 5% premium, such premium declining ratably until it ceases in October, 2003. Restrictions under the indenture agreement covering the 6 5\/8% Debentures include, among other things, a restriction whereby dividend payments cannot be made unless consolidated shareholders' equity of the company exceeds $12 million. As of June 30, 1994, no retained earnings were restricted under the provisions of the indenture.\nOn May 1, 1991, Delta issued $10,000,000 of 9% Debentures that mature in April, 2011. Each holder may require redemption of up to $25,000 of the 9% Debentures annually, subject to an annual aggregate limitation of $500,000. Such redemption will also be made on behalf of deceased holders within sixty days of notice, subject to the annual aggregate $500,000 limitation. The 9% Debentures can be redeemed by the Company beginning in April, 1996 at a 5% premium, such premium declining ratably until it ceases in April, 2001. The Company may not assume any additional mortgage indebtedness in excess of $1 million without effectively securing the 9% Debentures equally to such additional indebtedness.\nDebt issuance expenses are deferred and amortized over the terms of the related debt. Call premium in 1994 of approximately $475,000 was deferred and will be amortized over the term of the related debt consistent with regulatory treatment.\n(6) Commitments and Contingencies:\nThe Company has entered into individual employment agreements with its six officers. The agreements expire or may be terminated at various times. The agreements provide for continuing monthly payments or lump sum payments and continuation of certain benefits over varying periods in the event employment is altered or terminated following certain changes in ownership of the Company.\n(7) Rates:\nReference is made to \"Regulatory Matters\" herein with respect to rate matters.\n(8) Quarterly Financial Data (Unaudited):\nEarnings Net (Loss) per Operating Operating Income Common Quarter Ended Revenues Income (Loss) Share(a)\nFiscal 1994\nSeptember 30 $ 3,585,499 $ 11,056 $ (542,285) $(.33) December 31 7,814,638 1,117,871 578,448 .32 March 31 16,494,674 3,270,274 2,713,563 1.48 June 30 6,952,130 451,472 (78,725) (.04)\nFiscal 1993\nSeptember 30 $ 3,466,378 $ 46,208 $ (475,979) $(.29) December 31 7,712,590 1,269,509 716,010 .44 March 31 13,479,132 2,786,379 2,228,909 1.40 June 30 6,563,310 689,720 151,724 .09\n______________________________________________________________\n(a) Quarterly earnings per share may not equal annual earnings per share due to changes in shares outstanding.\nSCHEDULE X\nDELTA NATURAL GAS COMPANY, INC. AND SUBSIDIARY COMPANIES\nSUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED JUNE 30, 1994, 1993 AND 1992\nColumn A Column B\nCharged to Income for the Year Ended June 30_________\n1994 1993 1992\nItem (a)\nMaintenance and Repairs $ 408,498 $436,455 $524,976\nProperty Taxes $ 408,361 $360,745 $356,061\n(a) Items omitted do not exceed one percent of total consoli- dated revenues as reported in the related consolidated statements of income or are reported separately in the consolidated financial statements.\nEXHIBIT INDEX\nExhibit 12 Computation of the Consolidated Ratio of Earnings to Fixed Charges\nExhibit 23 Consent of Independent Public Accountants\nExhibit 27 Financial Data Schedule","section_15":""}
{"filename":"746262_1994.txt","cik":"746262","year":"1994","section_1":"Item 1 - Business\nThe Registrant, John Hancock Properties Limited Partnership (the \"Partnership\"), is a Limited Partnership organized on May 17, 1984, under the provisions of the Massachusetts Uniform Limited Partnership Act. As of December 31, 1994, the partners in the Partnership consisted of a sole Managing General Partner, John Hancock Realty Equities, Inc. (the \"Managing General Partner\"), an Associate General Partner, JH Associates Limited Partnership (the \"Associate General Partner\") and 2,048 Limited Partners owning 21,954 Units of Limited Partnership Interests (the \"Units\"). The Managing General Partner is the general partner of the Associate General Partner. Two Broadway Associates III, an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated (\"Merrill Lynch\"), is the limited partner of the Associate General Partner. The Managing General Partner and the Associate General Partner are collectively referred to as the \"General Partners\". The initial capital of the Partnership was $6,000, representing capital contributions of $800 from the Managing General Partner, $200 from the Associate General Partner and $5,000 from the initial Limited Partner (a former director of the Managing General Partner). The Amended Agreement of Limited Partnership of the Partnership (the \"Partnership Agreement\") authorized the issuance of up to 35,000 Units at $1,000 per Unit. There have been no changes in the number of Units outstanding subsequent to the termination of the offering period.\nThe Units were offered and sold to the public during the period from September 21, 1984 to August 31, 1985 pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. The Partnership sold the Units for $1,000 per Unit. No established public market exists on which the Units may be traded.\nThe Partnership is engaged solely in the acquisition, operation and disposition of investment real estate. The latest date on which the Partnership is due to terminate is December 31, 2020, unless it is sooner terminated in accordance with the terms of the Partnership Agreement. It is expected that, in the ordinary course of the Partnership's business, the properties of the Partnership will be disposed of, and the Partnership terminated, before December 31, 2020. As initially stated in its Prospectus, it was expected that the Partnership would be dissolved upon the sale of its last remaining property, which at that time was expected to be within five to eight years following the date such property was acquired by the Partnership. As of December 31, 1994, and the date hereof, the Partnership has two properties remaining in its portfolio; one of the properties is currently listed for sale and the other property is expected to be listed for sale in 1995. Upon the sale of the last remaining property, the operations of the Partnership will terminate, and the Partnership will be dissolved, in accordance with the terms of the Partnership Agreement.\nThe Partnership's real estate investments have been subject to various risk factors including the fact that certain of the investments in its portfolio have not generated income sufficient to meet operating expenses and debt service, and to fund adequate reserves for repair, replacements and contingencies. The income received from the Partnership's properties have been affected by many factors, including fluctuations in occupancy rates and operating expenses and variations in rental rates, which in turn have been adversely affected by general economic conditions and local conditions, such as competitive over-building.\nItem 1 - Business (continued)\nSince its inception, the Partnership's liquidity has been adversely affected by declining income and the level of expenditures required to fund operating expenses. As a result, some of the properties in the Partnership's portfolio were unable to generate sufficient cash flow to meet both operating expenses and debt service obligations. Therefore, the Partnership has had to utilize funds from other sources in order to protect its investments and has had to dispose of certain properties at a loss. The Partnership has not generated any Distributable Cash from Operations, as defined in the Partnership Agreement, since its inception.\nOn February 28, 1985, the Partnership acquired the Delta Grove Apartments, a 65-unit garden apartment complex located in Eugene, Oregon. Given the cash flow constraints of the Partnership, the property's consistent and favorable income performance and the relative strength of the Eugene real estate market, the Partnership sold the Delta Grove Apartments on February 28, 1990 for a net sales price of $2,755,559 and retired the related mortgage indebtedness of $1,472,218. The Partnership received net cash proceeds of $1,283,341 from this sale. Of this amount, $852,913 was distributed to the Limited Partners on June 27, 1990. The remaining funds were used to retire outstanding debts and to pay operating expenses of the Partnership.\nOn December 17, 1985, the Partnership acquired 300 Ramsey Place, an office\/warehouse complex located in San Antonio, Texas. Subsequently, weakening market conditions in the San Antonio real estate market resulted in the property's inability to generate sufficient cash to meet both operating expenses and debt service obligations. In addition, the market value of the property was estimated to be less than the outstanding balance of the non-recourse mortgage. On November 7, 1990, the Partnership conveyed the Ramsey Place office\/warehouse to the mortgagee by a deed-in- lieu of foreclosure in exchange for a release of the outstanding indebtedness.\nOn August 9, 1984, the Partnership acquired the Waterford Apartments, a 256- unit garden apartment complex located in Little Rock, Arkansas. Subsequently, weakening market conditions in the Little Rock real estate market resulted in the property's inability to generate sufficient cash to meet both operating expenses and debt service requirements. During 1990, the Partnership was unable to make the requisite mortgage payments on the property, thereby placing the loan in default. In addition, the market value of the property was estimated to be less than the outstanding balance of the non-recourse mortgage. On August 9, 1991, the Partnership conveyed the Waterford Apartments to the mortgagee by a deed-in-lieu of foreclosure in exchange for a release of the outstanding indebtedness.\nOn September 24, 1984, the Partnership acquired the Huntington Park Apartments, a 212-unit garden apartment complex located in Tucson, Arizona. Subsequent to the Partnership's acquisition of the property, market conditions weakened in the Tucson real estate market and resulted in the property's inability to generate sufficient cash flow to meet both operating expenses and debt service requirements. During 1990, the Partnership was unable to make the requisite mortgage payments on the property, thereby placing the loan in default. In March 1992, the Partnership secured a reduced payoff amount from the mortgagee for the related mortgage indebtedness and accrued interest thereon from $5,525,028 to $3,800,000. On March 31, 1992, the Partnership sold the Huntington Park Apartments to a non-affiliated buyer for a net sales price of $4,072,442. The Partnership received net cash proceeds of $272,442 from the sale and extinguishment of the related mortgage indebtedness. These proceeds were used in 1992 to pay operating expenses of the Partnership.\nItem 1 - Business (continued)\nOn November 29, 1984, the Partnership acquired the Fisherman's Village Apartments, a 280-unit garden apartment complex located in Orlando, Florida. Real estate market conditions in the Orlando, Florida area have recovered from the overbuilding of multi-family residential units which occurred during the late 1980's and early 1990's. However, market conditions remain competitive due to new construction of multi-family housing units. Fisherman's Village Apartments was successful in increasing occupancy levels during 1993 through the use of leasing incentives and capital improvements made at the property. During 1994, Fisherman's Village Apartments reduced the level of leasing incentives offered as market conditions improved and occupancy stabilized. Due to current market conditions and the stabilized operations of the property, the Managing General Partner expects that the Fisherman's Village Apartments will be listed for sale during 1995. The full amount of the mortgage loan on the Fisherman's Village Apartments is due on November 1, 1995. At that time, a balloon payment equal to the entire outstanding principal balance and accrued but unpaid interest in the amount of $8,747,314 will be due. It is anticipated that the Partnership will obtain the funds to pay off the mortgage loan from the sale of the property. This property is also discussed in Items 2 and 7 of this Report and Note 5 to the Financial Statements included in Item 8 of this Report.\nOn February 28, 1985, the Partnership acquired the Northgreen Apartments, a 222-unit garden apartment complex located in Eugene, Oregon. Since early 1992, new apartment construction has declined in the Eugene, Oregon area, where the Northgreen Apartments are located, and absorption of vacant units has continued. With the gradual improvement in market conditions, the property has sustained a stabilized occupancy rate and improved its income and cash flow performance over recent years. Given these market conditions and the current income performance of the property, the Managing General Partner listed the Northgreen Apartments for sale during the second quarter of 1994. Efforts to sell Northgreen are discussed in Item 7 of this Report. This property is also discussed in Item 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties\nAs of December 31, 1994, the Partnership held the following two properties in its portfolio:\nThe Fisherman's Village Apartments ---------------------------------- On November 29, 1984, the Partnership purchased the Fisherman's Village Apartments, located in Orlando, Florida, from a non-affiliated seller. The property, completed in 1984, is located on approximately 24.4 acres of land and consists of 26 two-story stucco buildings containing 280 rental units, a clubhouse and an office. The average occupancy rate at the Fisherman's Village Apartments for the year ended December 31, 1994 was 94%. See Note 6 to the Financial Statements for a discussion of the status of the non- recourse mortgage indebtedness relating to this property.\nThe Northgreen Apartments ------------------------- On February 28, 1985, the Partnership purchased the Northgreen Apartments, located in Eugene, Oregon, from a non-affiliated seller. The property, completed in 1978, is located on 12.5 acres of land and consists of 22 two-story wood frame buildings containing a total of 222 rental units. The average occupancy rate at the Northgreen Apartments for the year ended December 31, 1994 was 96%. See Note 6 to the Financial Statements included in Item 8 of this Report for a discussion of the status of the non-recourse mortgage indebtedness relating to this property.\nBoth of these properties are further described in Item 7 of this Report.\nItem 3","section_3":"Item 3 - Legal Proceedings\nThere are no material pending legal proceedings, other than ordinary routine litigation incidental to the business of the Partnership, to which the Partnership is a party or to which any of its properties 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 of the Partnership during the fourth quarter of 1994.\nPart II\nItem 5","section_5":"Item 5 - Market for the Partnership's Securities and Related Security Holder Matters\n(a) Market Information\nThe Partnership's outstanding securities consist of 21,954 Units originally sold for $1,000 per Unit. The Units were offered and sold to the public during the period from September 21, 1984 to August 31, 1985. No established public market exists on which the Units may be traded. Consequently, holders of Units may not be able to liquidate their investments in the event of an emergency, or for any other reason. Additionally, the assignment or other transfer of Units would be subject to compliance with the minimum investment and suitability standards imposed by the Partnership or by applicable law, including state \"Blue Sky\" laws.\n(b) Number of Security Holders Number of Record holders Number of Units as of outstanding as of Title of Class December 31, 1994 December 31, 1994 -------------- ----------------- ----------------- Units of Limited Partnership Interests 2,048 21,954\n(c) Dividend History and Restrictions\nSince its inception, the Partnership has not generated any Distributable Cash from Operations, as defined in the Partnership Agreement. Unfavorable economic conditions, caused by excess supply and weak absorption in the real estate markets in which the Partnership has invested, have adversely affected the Partnership's income and cash flows. Based on current information, it is not anticipated that the Partnership will generate any Distributable Cash from Operations during 1995 and, accordingly, it is not anticipated that the Partnership will make any cash distributions from operations during that period. For a further discussion on the financial condition and results of operations of the Partnership, see Item 7 of this Report.\nItem 6","section_6":"Item 6 - Selected Financial Data\nThe following table sets forth selected financial information regarding the Partnership's financial position and operating results during the five year period ended December 31, 1994. This information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations, and the related Financial Statements and Notes thereto, which are included in Items 7 and 8, respectively, of this Report.\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nLiquidity and Capital Resources (continued) ------------------------------- As of December 31, 1993, the Partnership established a reserve against the entire outstanding balance of the note receivable relating to the unconditional guaranty obligation for operating deficits granted by the seller of the Waterford Apartments. The Managing General Partner believed, based on information obtained with respect to the obligor's financial condition, that it was probable that the Partnership would be unable to collect all amounts due from the obligor according to the contractual terms of the note. Accordingly, the Partnership established a provision against the entire outstanding balance of the note in the amount of $298,058. The provision has since been reduced by $13,903 as a result of payments made by the obligor. In June 1994, the obligor notified the Partnership that he would be unable to pay both the outstanding balance of the note upon its maturity on August 1, 1994 and the minimum monthly payments on the note. As of December 31, 1994, and as of the date hereof, the obligor is in default on the note for failure to pay the minimum required payments due since June 1, 1994 and for failure to pay the outstanding balance of the note, which was due on August 1, 1994. The Managing General Partner issued a default notice to the obligor and demand for payment and filed a complaint demanding full payment of the note. On December 7, 1994 the Partnership received a summary judgment in response to the complaint filed against the obligor in the amount of the note plus accrued interest thereon. As of the date hereof, the Partnership has not received payment from the obligor and the Managing General Partner continues to pursue collection of the judgment amount.\nDuring 1994, the Partnership made $186,647 of principal payments on its long-term mortgage debt. A balloon payment equal to the entire outstanding principal balance and all accrued but unpaid interest on the Fisherman's Village Apartments' mortgage loan in the amount of $8,747,314 will be due on November 1, 1995. It is anticipated that the Partnership will obtain the funds necessary to repay such amount at maturity through either a sale of the property or through short-term loans.\nReal estate market conditions in the Orlando, Florida area, where the Fisherman's Village Apartments are located, have recovered from the overbuilding of multi-family residential units which occurred during the late 1980's and early 1990's. However, real estate market conditions remain competitive due to the construction of new multi-family housing units. Fisherman's Village Apartments was successful in increasing occupancy levels during 1993 through the use of leasing incentives and capital improvements made during that year at the property. During 1994, Fisherman's Village Apartments reduced the level of leasing incentives offered as market conditions improved and occupancy stabilized. Due to current market conditions and the stabilized operations of the property, the Managing General Partner expects that the Fisherman's Village Apartments will be listed for sale during 1995.\nSince early 1992, new apartment construction has declined in the Eugene, Oregon area, where the Northgreen Apartments are located, and absorption of vacant units has continued. With the gradual improvement in market conditions in Eugene Oregon, the property has sustained a stabilized occupancy rate and improved its income performance over recent years. Given these market conditions and the current income performance of the property, the Managing General Partner listed the Northgreen Apartments for sale during the second quarter of 1994.\nItem 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nLiquidity and Capital Resources (continued) ------------------------------- On September 6, 1994, the Managing General Partner entered into a Purchase and Sale Agreement on behalf of the Partnership (the \"First Agreement\") for the sale of the Northgreen Apartments property to a non-affiliated buyer for a gross sales price of $8,950,000. However, the prospective buyer exercised its right to terminate the First Agreement and to terminate the proposed transaction prior to the scheduled date of sale. Accordingly, the Managing General Partner resumed its efforts to locate another buyer for the property.\nOn November 4, 1994, the Managing General Partner entered into a second Purchase and Sale Agreement on behalf of the Partnership (the \"Second Agreement\") for the sale of the Northgreen Apartments property to another non-affiliated buyer for a gross sales price of $8,950,000. However, the prospective buyer exercised its right to terminate the Second Agreement and to terminate the proposed transaction prior to the scheduled date of sale. Accordingly, the Managing General Partner resumed its efforts to locate another buyer for the property.\nEffective March 13, 1995, the Managing General Partner entered into a third Purchase and Sale Agreement on behalf of the Partnership (the \"Third Agreement\") for the sale of the Northgreen Apartments property to another non-affiliated buyer for a gross sales price of $9,200,000. The sale is subject to certain conditions which, if not satisfied prior to the scheduled date of sale, may result in the termination of the Third Agreement. If this potential transaction does not result in the sale of the property, then the Managing General Partner will resume its efforts to locate another buyer for the Northgreen Apartments.\nUpon the sale of the Partnership's last remaining property, the operations of the Partnership will terminate, and the Partnership will be dissolved, in accordance with the terms of the Partnership Agreement.\nDuring the second quarter of 1994, the Managing General Partner had the Fisherman's Village Apartments property independently appraised. Based upon the appraiser's investigation and analysis, the property's market value was estimated to be approximately $10,750,000, compared to the Partnership's cumulative investment in the property of approximately $13,463,000. The net book value of the Fisherman's Village Apartments property in the amount of $8,937,371 at December 31, 1994 was evaluated in comparison to the estimated future undiscounted cash flows and the independent appraisal and, based upon such evaluation, the Managing General Partner determined that no permanent impairment in value exists and that a write-down in value is not required as of December 31, 1994.\nThe Managing General Partner also evaluated the carrying value of the Northgreen Apartments as of December 31, 1994 by comparing it to the future undiscounted cash flows and a recent internal appraisal. Based on such evaluation, the Managing General Partner determined that no permanent impairment in value exists and that no write-down in value is required. The Managing General Partner will continue to conduct property valuations on an on-going basis, using internal or independent appraisals, in order to determine whether future write-downs, if any, are required.\nNo capital expenditures were made during 1994, and the Partnership does not anticipate incurring any significant capital expenditures during 1995.\nItem 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nResults of Operations --------------------- The net loss for the year ended December 31, 1994 was $43,962 as compared to a net loss of $667,686 in 1993 and a net loss of $834,469 in 1992. Included in the 1993 results is an allowance for the doubtful collection of the note receivable relating to the unconditional guaranty obligation granted by the seller of the Waterford Apartments in the amount of $298,058. Included in the 1992 results is a loss on the sale of the Huntington Park Apartments of $1,721,075 and an extraordinary gain on the extinguishment of the related mortgage indebtedness in the amount of $1,725,028.\nAverage occupancy for the Partnership's properties was as follows: Years ended December 31, 1994 1993 1992 ---- ---- ---- Fisherman's Village Apartments 94% 94% 89% Northgreen Apartments 96% 94% 95%\nRental income for the year ended December 31, 1994 increased by $152,727, or 5%, as compared to 1993 and $66,712, or 2%, as compared to 1992. Rental income at the Fisherman's Village Apartments increased by approximately 5% and 14% during 1994 as compared to 1993 and 1992, respectively, primarily due to an increase in rental rates and a decrease in rental concessions offered at the property. In addition, an increase in average occupancy at Fisherman's Village from 89% in 1992 to 94% in 1994 also contributed to the increase in rental income between periods. Rental income at the Northgreen Apartments increased by approximately 5% and 7% during 1994 as compared to 1993 and 1992, respectively, primarily due to increases in rental rates. Included in rental income for 1992 is approximately $235,000 from the Huntington Park Apartments, which were sold on March 31, 1992.\nInterest income for the year ended December 31, 1994 decreased by $18,242, or 38%, as compared to 1993, and by $20,027, or 40%, as compared to 1992. These decreases were primarily due to the fact that as of December 31, 1993, the Partnership established a provision, reflected in the Partnership's Balance Sheets, against the entire outstanding balance of the note receivable from the seller of the Waterford Apartments. As such, the interest payments received on the note during the year ended December 31, 1994 have been included as a recovery against the loss recorded in 1993. The decreases in interest income were partially offset by an increase in the Partnership's cash and cash equivalents and the interest earned on such amounts.\nInterest expense decreased in 1994 by $50,901, or 4%, as compared to 1993, and by $531,721, or 32%, as compared to 1992. Interest expense at the Fisherman's Village Apartments for the year ended December 31, 1994 was consistent with that incurred during 1993 and decreased by approximately 33% as compared to 1992 due to a reduction in the interest rate on the mortgage loan from 11.5% to 7.39%, effective November 1992. Interest expense at the Northgreen Apartments decreased by approximately 10% and 13% during 1994 as compared to 1993 and 1992, respectively, as a result of the interest rate reduction on the mortgage loan from 9.75% to 8.75%, effective October 1993. Included in interest expense in 1992 is approximately $130,000 relating to interest payments made with respect to the mortgage loan on the Huntington Park Apartments, which were sold during that year.\nItem 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nResults of Operations (continued) --------------------- Property operating expenses in 1994 decreased by $105,077, or 7%, as compared to 1993 and by $105,599, or 7%, as compared to 1992. Property operating expenses at the Fisherman's Village Apartments decreased in 1994 by approximately 6% as compared to 1993 due to a decrease in maintenance and repair expenses incurred at the property. During the year ended December 31, 1993, a significant amount of maintenance and repair costs were incurred at the Fisherman's Village Apartments in order to maintain the property's occupancy rate and its competitive position within the Orlando market. Fisherman's Village continued to incur such maintenance and repair costs during 1994, although at a reduced level as compared to 1993. Property operating expenses at the Fisherman's Village Apartments increased by approximately 11% in 1994 as compared to 1992 due to an increase in maintenance and repair expenses as described above. This increase from 1992 was partially offset by a decrease in real estate taxes. Property operating expenses at the Northgreen Apartments decreased in 1994 by approximately 9% and 12% as compared to 1993 and 1992, respectively. These decreases were due to decreases in maintenance and repair expenses and real estate taxes incurred at the property. In addition, the local governmental authorities changed their method of assessing water and sewer charges in 1994 resulting in a decrease in such expenses at the Northgreen Apartments. Included in property operating expenses for 1992 is approximately $116,000 of expenses incurred at the Huntington Park Apartments, which were sold during that year.\nDepreciation decreased in 1994 by $21,447, or 3%, as compared to 1993 and $94,888, or 13%, as compared to 1992. This decrease in 1994 as compared to 1992 is primarily due to the disposition of the Huntington Park Apartments.\nThe provision for\/(recovery of) uncollectible note receivable during 1993 reflects the Managing General Partner's decision to establish an allowance against the then entire outstanding balance of the note receivable of $298,058 as of December 31, 1993, relating to the unconditional guaranty obligation granted by the seller of the Waterford Apartments. Based on the obligor's financial condition at December 31, 1993, the Managing General Partner believed that it was probable that the Partnership would not collect all amounts due according to the contractual terms of the note. During 1994, the Partnership received payments on the note totaling $13,903. However, the obligor is in default on the note for failure to make the minimum required payments due since June 1, 1994 and for failure to pay the outstanding balance of the note, which was due on August 1, 1994. (This note receivable is also discussed in Note 7 to the Financial Statements included in Item 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data\nThe response to this Item appears beginning on page of this Report.\nItem 9","section_9":"Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNo events requiring disclosure under this Item have occurred.\nPart III\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 - Directors and Executive Officers of the Partnership\n(a-b) Identification of Directors and Executive Officers\nBy virtue of its organization as a Limited Partnership, the Partnership has no directors and executive officers. As indicated in Item 1 of this Report, the Managing General Partner of the Partnership is John Hancock Realty Equities, Inc., a Delaware corporation. Pursuant to terms of the Partnership Agreement, the Managing General Partner is solely responsible for the management of the Partnership's business. The names and ages of the directors and executive officers of the Managing General Partner are as follows:\nName Title Age ---- ----- --- William M. Fitzgerald President and Director 51 Malcolm G. Pittman, III Director 43 Susan M. Shephard Director 42 Richard E. Frank Treasurer (Chief Accounting Officer) 33\n(c) Identification of certain significant persons\nThe Managing General Partner is responsible for the identification, analysis, purchase, operation, and disposal of specific Partnership real estate investments. The Managing General Partner has established a Real Estate Investment Committee utilizing senior real estate personnel of John Hancock and its Affiliates to review each proposed investment. The members of the Real Estate Investment Committee are designated each year at the annual meeting of the Board of Directors of John Hancock Realty Equities, Inc. and are as follows:\nName Title Age ---- ----- --- Edward P. Dowd Senior Vice President of 52 John Hancock's Real Estate Investment Group\nKevin McGuire Vice President of John Hancock's 48 Real Estate Investment Group, President of John Hancock Realty Services Corp. and subsidiaries\n(d) Family relationships\nThere exist no family relationships among any of the foregoing directors or officers of the Managing General Partner.\nItem 10 - Directors and Executive Officers of the Partnership (continued)\n(e) Business experience\nWilliam M. Fitzgerald (age 51), joined John Hancock in 1968. He has been President and a Director of the Managing General Partner, and a Senior Investment Officer of John Hancock, since June 1993 and a Managing Director of Hancock Realty Investors Incorporated since November 1991. His term as a Director of the Managing General Partner expires in May 1995. From 1987 to 1991, Mr. Fitzgerald was a Senior Vice President of John Hancock Properties, Inc. Prior to that time, he held a number of positions including Senior Real Estate Management Officer and Real Estate Management Officer of John Hancock. He holds an M.B.A. from Boston University and a B.A. from Boston College.\nMalcolm G. Pittman (age 43), joined John Hancock in 1986 as an Assistant Counsel. He has been a Director of the Managing General Partner since November 1991. His term as a Director of the Managing General Partner expires in May 1995. Mr. Pittman has been Counsel of John Hancock's Mortgage and Real Estate Law Division since 1993. From 1989 to 1993, he was an Associate Counsel of John Hancock. He holds a J.D. from Yale Law School and a B.A. from Oberlin College.\nSusan M. Shephard (age 42), joined John Hancock in 1985 as an Attorney. She has been a Director of the Managing General Partner since November 1991. Her term as a Director of the Managing General Partner expires in May 1995. Ms. Shephard has been a Mortgage Investment Officer of John Hancock since 1991. From 1988 to 1991, she was an Associate Counsel of John Hancock and from 1987 to 1988, she was an Assistant Counsel of John Hancock. She holds a J.D. from Georgetown University Law Center and a B.A. from the University of Rhode Island.\nRichard E. Frank (age 33), joined John Hancock in 1983. He has been Treasurer of the Managing General Partner and a Senior Financial Administrator of John Hancock since June 1993. From 1991 to 1993, Mr. Frank was an Associate of Hancock Realty Investors Incorporated; from 1990 to 1991, he held the position of Assistant Treasurer of John Hancock Realty Services Corp.; and from 1987 to 1990, he was a Senior Accountant of John Hancock Realty Services Corp.. He holds a B.S. from Stonehill College.\nEdward P. Dowd (age 52), joined John Hancock in 1970. He has been a Director of Hancock Realty Investors, Incorporated since 1991, and a Director of John Hancock Realty Services Corp. and subsidiaries and John Hancock Property Investors Corp. since 1987. Mr. Dowd has been a Senior Vice President of John Hancock since 1991. From 1989 to 1990, he was a Vice President of John Hancock and from 1986 to 1989, he was a Second Vice President of John Hancock. Prior to that time, he held a number of positions including Senior Real Estate Investment Officer and Real Estate Investment Officer of John Hancock. From July 1982 to May 1986, Mr. Dowd was President of the Managing General Partner. He holds an A.B. from Boston College.\nKevin McGuire (age 48), joined John Hancock in 1968. He has been a Vice President of John Hancock since June 1993 and President of John Hancock Realty Services Corp. and subsidiaries since July 1993. He has been a Managing Director and a Director of Hancock Realty Investors Incorporated since 1991, and a Director of John Hancock Property Investors Corp. since 1987. Mr. McGuire served as an interim basis President of the Managing General Partner from May 1991 to November 1991 and was President of John Hancock Properties, Inc. from 1987 to 1991. Prior to that time, he held a number of positions including Second Vice President, Senior Real Estate Investment Officer and Real Estate Investment Officer of John Hancock. He holds an M.B.A. from Babson College and a B.A. from Boston College.\nItem 10 - Directors and Executive Officers of the Partnership (continued)\n(f) Involvement in certain legal proceedings\nNone\nCompliance with Section 16(a) of the Exchange Act\nUnder Section 16(a) of the Securities Exchange Act of 1934, as amended, the Managing General Partner's directors and executive officers, as well as any person holding more than ten percent of the Units, are required to report their initial ownership of Units and any subsequent change in such ownership to the Securities and Exchange Commission and the Partnership (such requirements hereinafter referred to as \"Section 16(a) filing requirements\"). Specific time deadlines for Section 16(a) filing requirements have been established.\nTo the Partnership's knowledge, no officer or director of the Managing General Partner has an ownership interest in the Partnership and no person holds more than 10% of the Units.\nItem 11","section_11":"Item 11 - Executive Compensation\nNone of the officers or directors of the Managing General Partner or any of the Real Estate Investment Committee members referred to in Item 10(c) receives any current direct remuneration in their capacities as officers, directors or Real Estate Investment Committee members, pursuant to any standard arrangements or otherwise, from the Partnership nor is any such remuneration currently proposed. In addition, the Partnership has not given and does not propose to give any options, warrants or rights, including stock appreciation rights, to any such person. No long-term incentive plan exists with such persons and no remuneration plan or arrangement exists with such persons resulting from his\/her resignation, retirement or any other termination. Therefore, tables relating to these topics have been omitted.\nFor its activities occurring during the offering period, which terminated on August 31, 1985, the General Partners and\/or their Affiliates, as defined in the Partnership Agreement, received reimbursement for certain organizational, offering, and acquisition expenses, and received certain acquisition and initial management fees, in accordance with the terms of the Partnership Agreement.\nIn accordance with the terms of the Partnership Agreement, the General Partners and\/or their Affiliates, as defined in the Partnership Agreement, are entitled to the following types of compensation, fees, profits\/(losses), expense reimbursements and distributions:\nAn Affiliate of the Managing General Partner is entitled to receive a Property Management Fee for providing property management services for Partnership properties. The Partnership is obligated to pay a fee equal to the amount customarily charged in arm's-length transactions by third parties rendering comparable services for comparable properties in the localities where such properties are located but in no event may such fee exceed 6% of the gross receipts of the property under management. No Affiliate of the Managing General Partner is providing, nor has provided, property management services to the Partnership. Therefore, the Partnership did not pay any such fees during 1994, 1993 and 1992.\nItem 11 - Executive Compensation (continued)\nThe General Partners and their Affiliates are also entitled to Reimbursement for Expenses relating to the administrative services necessary to the prudent operation of the Partnership, such as legal, accounting, computer, transfer agent and other services. The amounts charged to the Partnership for such administrative services may not exceed the lesser of the General Partners' or such Affiliates' costs or 90% of those which the Partnership would be required to pay to independent parties for comparable services in the same geographic area. The Partnership incurred $79,420, $78,390 and $86,826 of such expenses during the years ended December 31, 1994, 1993 and 1992, respectively. For the years ended December 31, 1992 and 1991, no such reimbursements were paid by the Partnership in order to enable it to meet its working capital needs.\nUpon the disposition of any property, the General Partners are entitled to a Subordinated Real Estate Commission (as defined in the Partnership Agreement) for rendering substantial services in connection with the sale of such property in the amount of 3% of the sales price of such property. However, no such Subordinated Real Estate Commission may be paid until all Limited Partners first have received a return of their total Invested Capital plus any previously unpaid cumulative return on investment of 7% per annum as defined in Section 8.2 of the Partnership Agreement. The Partnership has never paid any such Subordinated Real Estate Commission.\nA Share of the Partnership's Distributable Cash from Operations (as defined in the Partnership Agreement) is distributable to the General Partners. Distributable Cash from Operations is distributable in accordance with Section 8 of the Partnership Agreement (as described more fully in Note 3 to the Financial Statements included in Item 8 of this Report) . The Partnership has not generated any Distributable Cash from Operations since its inception and, as such, the General Partners have not received any such distributions.\nA Share of Cash from Sales or Refinancings (as defined in the Partnership Agreement) may be distributed to the General Partners. Cash from Sales or Refinancings is distributable in accordance with Section 8 of the Partnership Agreement (as described more fully in Note 3 to the Financial Statements included in Item 8 of this Report). In accordance with the Partnership Agreement, the General Partners were not entitled to receive any such distributions during 1994, 1993 and 1992.\nA Share of the Partnership's Profits or Losses for Tax Purposes (as defined in the Partnership Agreement) is allocable to the General Partners. Such allocation generally approximates, insofar as practicable, their percentage share of Distributable Cash from Operations and of Cash from Sales or Refinancings. The General Partners are generally allocated 1% of Partnership Losses for tax purposes. The General Partners' Share of such Profits and Losses were losses in the amount of $2,342, $4,912 and $7,880 during the years ended December 31, 1994, 1993 and 1992, respectively.\nItem 11 - Executive Compensation (continued)\nThis table reflects all compensation, fees, profits\/(losses), expense reimbursements and distributions from the Partnership to the General Partners and their Affiliates:\n1994 1993 1992 ---- ---- ---- Operating Expenses (a) $79,420 $78,390 $86,826 General Partners' Share of Losses (2,342) (4,912) (7,880)\n(a) Represents amounts incurred for the years ending December 31, 1994, 1993 and 1992. During the years ended December 31, 1992 and 1991 the Partnership deferred the payment of expense reimbursements in order to meet its working capital needs. During the years ended December 31, 1993 and 1994, the Partnership no longer deferred such payments and during the year ended December 31, 1994 the Partnership began to make payments towards these deferred amounts. As a result, amounts paid to the General Partners and their Affiliates during the years ended December 31, 1994, 1993 and 1992 do not reflect the amounts incurred during each period.\nCompensation Committee Interlocks and Insider Participation:\nThe Partnership did not have a Compensation Committee in 1994 and does not currently have such a committee. No current or former officer or employee of the Managing General Partner or its Affiliates participated during the 1994 fiscal year in deliberations regarding the Managing General Partner's compensation as it relates to the Partnership.\nItem 12","section_12":"Item 12 - Security Ownership of Certain Beneficial Owners and Management\nBy virtue of its organization as a limited partnership, the Partnership has no outstanding securities with traditional voting rights. However, as provided in Section 13.1 of the Partnership Agreement, 10% or more in interest of the Limited Partners may request that the Managing General Partner call a meeting of the Limited Partners, or request a vote by written consent without a meeting, as to any matter set forth in Section 13.2, which section provides that a majority in interest of the Limited Partners, without the concurrence of the General Partners and subject to certain conditions set forth in Section 13.3 of the Partnership Agreement, may:\n(1) Amend the Partnership Agreement;\n(2) Dissolve the Partnership;\n(3) Remove any General Partner and elect a replacement therefor; and\n(4) Approve or disapprove the sale of all or substantially all the assets of the Partnership.\na) Security ownership of certain beneficial owners\nNo person or group, including the General Partners, is known to own beneficially more than 5% of the Partnership's 21,954 outstanding Units as of December 31, 1994.\nItem 12 - Security Ownership of Certain Beneficial Owners and Management (continued)\nb) Security ownership of management\nBy virtue of its organization as a limited partnership, the Partnership has no officers or directors. Neither the Managing General Partner nor any officer or director of the Managing General Partner possesses the right to acquire a beneficial ownership of Units.\nc) Changes in control\nThe Partnership does not know of any arrangements the operations 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\nSee Note 4 of the Notes to Financial Statements included in Item 8 of this Report for a description of certain transactions and related amounts paid by the Partnership to the General Partners and their Affiliates during 1994, 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) - Listed on Index to Financial Statements and Financial Statement Schedules.\n(3) - Listing of Exhibits\nExhibit Number Page Number or Under Incorporation by Regulation S-K Description Reference --------------- ----------- ---------\n4 Instruments defining the rights of security holders\n4.1 Amended Agreement of Limited Exhibit A to final Partnership* Prospectus dated September 21, 1984, filed under the Partnership's Form S-11 Registration Statement (File 2-91210)\nItem 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\n(a) Amendment to the Amended Agreement Exhibit 4.1(a) to Post- of Limited Partnership dated as of Effective Amendment No. 1 December 1, 1984* No. 1 to the Partnership's Form S-11 Registration Statement (File 2-91210)\n4.2 The Subscription Agreement and Exhibit D to final Limited Partner Signature Page Prospectus dated and Power of Attorney whereby a September 21, 1984, subscriber agrees to purchase filed under the Units and adopts the provisions Partnership's of the Partnership Agreement* Form S-11 Registration Statement (File 2-91210)\n4.3 Copy of Tenth Amendment and Exhibit 4.3 to Restatement of Certificate of Item 14 to the Limited Partnership filed with Partnership's the Massachusetts Secretary of Report on Form 10-K State on August 30, 1985* dated December 31, 1986 (File 0-13473)\n10 Material contracts and other documents\n10.1 Form of Consulting Agreement Exhibit 10.2 to the between the Managing General Partnership's Partner and Merrill Lynch, Form S-11 Hubbard Inc.* Registration Statement (File 2-91210)\n10.2 Copy of revised letter from Exhibit 10.5(a) to John Hancock Subsidiaries, Inc. Post-Effective containing undertaking as to Amendment No. 1 to the net worth of the Managing the Partnership's General Partner* Form S-11 Registration Statement (File 2-91210)\n10.3 Documents relating to Waterford Apartments\n(a) Developer Note dated Exhibit 10.6(b) to April 18, 1983, from Waterford Amendment No. 1 to Partners to Savers Federal the Partnership's Savings and Loan Association* Form S-11 Registration Statement (File 2-91210)\nItem 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\n(b) Allonge to Note dated Exhibit 10.3(b) January 25, 1988, between to Item 14 to the Savers Federal Savings and Partnership's Loan Association and Report on Form 10-K Waterford Partners* dated December 31, 1987 (File 0-13473)\n(c) Limited Guaranty dated Exhibit 10.3(c) January 25, 1988, between to Item 14 to the John Hancock Properties Partnership's Limited Partnership and Report on Form 10-K Savers Federal Savings dated December 31, 1987 and Loan Association (File 0-13473) and Waterford Partners*\n(d) Deed of Trust and Security Exhibit 10.6(c) to Agreement dated April 18, 1983, Amendment No.1 to by Waterford Associates to the Partnership's John Kooistra, Jr., Trustee* Form S-11 Registration Statement (File 2-91210)\n(e) Amendment to Deed of Trust Exhibit 10.3(e) and Security Agreement dated to Item 14 to the January 25, 1988, between Partnership's Savers Federal Savings and Report on Form 10-K Loan Association and dated December 31, 1987 John Hancock Properties (File 0-13473) Limited Partnership*\n(f) Regulatory Agreement and Exhibit 10.6(d) to Declaration of Restrictive Amendment No. 1 to Covenants dated April 18, 1983, the Partnership's by and among Residential Housing Form S-11 Facilities Board of Pulaski Registration County, Arkansas, United States Statement Trust Company of New York, as (File 2-91210) Trustee, and Waterford Partners*\n(g) Assumption Agreement dated Exhibit 10.6(f) to August 9, 1984, by and among Amendment No. 1 to Residential Housing Facilities the Partnership's Board of Pulaski County, Form S-11 United States Trust Company of Registration New York and First Commercial Statement Bank, N.A., as Trustees, (File 2-91210) Waterford Partners, John Hancock Properties Limited Partnership, and Savers Federal Savings and Loan Association*\nItem 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\n(h) Repurchase Agreement dated Exhibit 10.6(g) to August 9, 1984, between Amendment No. 1 to Waterford Partners and the Partnership's John Hancock Properties Limited Form S-11 Partnership* Registration Statement (File 2-91210)\n(i) Escrow Agreement among Exhibit 10.6(i) to Little Rock Abstract Company, Amendment No.1 to John Hancock Properties Limited the Partnership's Partnership and Waterford Form S-11 Partners* Registration Statement (File 2-91210)\n(j) Unconditional Guaranty Agreement Exhibit 10.6(j) to dated July 2, 1984, as amended Amendment No. 1 to by letter dated August 15, 1984, the Partnership's executed by Mike Henderson* Form S-11 Registration Statement (File 2-91210)\n(k) Promissory Note dated Exhibit 10.3(k) December 23, 1987, between to Item 14 to the John M. Henderson and Partnership's John Hancock Properties Report on Form 10-K Limited Partnership* dated December 31, 1987 (File 0-13473)\n(l) Deed-in-Lieu of Foreclosure Exhibit 10.2(e) to the between Resolution Trust Corporation Amendment No. 1 to as Conservator for Savers Federal the Partnership's Savings and Loan Association and Report on Form 10-K John Hancock Properties Limited dated December 31, 1991 Partnership* (File 0-13473)\n10.4 Documents relating to Huntington Park Apartments\n(a) Promissory Note dated May 4, Exhibit 10.7(b) to 1983, from VSP Housing Amendment No. 1 to Associates 101 to Western the Partnership's Savings and Loan Association* Form S-11 Registration Statement (File 2-91210)\nItem 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\n(b) Deed of Trust dated May 4, 1983, Exhibit 10.7(c) to between VSP Housing Amendment No. 1 to Associates 101 and Western the Partnership's Savings and Loan Association* Form S-11 Registration Statement (File 2-91210)\n(c) Deed and Deed Restrictions dated Exhibit 10.7(d) to as of March 1, 1983, from Amendment No. 1 to The Industrial Development the Partnership's Authority of the City of Tucson, Form S-11 Arizona to VSP Housing Registration Associates 101* Statement (File 2-91210)\n(d) Rental Escrow Agreement dated Exhibit 10.7(f) to September 24, 1984, between VSP Post-Effective Housing Associates 101, Amendment No. 1 to John Hancock Properties Limited the Partnership's Partnership and Ticor Title Form S-11 Insurance Company of California* Registration Statement (File 2-91210)\n(e) Deed of Trust and Security Exhibit 10.7(i) to Agreement dated December 14, Post-Effective 1984, between John Hancock Amendment No. 1 to Properties Limited Partnership, the Partnership's Ticor Title Insurance Company of Form S-11 California and John Hancock Registration Realty Services Corp.* Statement (File 2-91210)\n(f) Purchase and Sale Agreement Exhibit 1 to the between John Hancock Properties Partnership's Report Limited Partnership and on Form 8-K dated Pacific Institutional Advisors March 31, 1992 dated February 14, 1992 * (File 0-13473)\n(g) Loan Payoff Agreement between Exhibit 2 to the Resolution Trust Corporation and Partnership's Report John Hancock Properties Limited on Form 8-K dated Partnership dated March 19, 1992 * March 31, 1992 (File 0-13473)\nItem 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\n10.5 Documents relating to Fisherman's Village Apartments\n(a) Promissory Note dated Exhibit 10.11(a) to October 17, 1985, from Item 14 of the John Hancock Properties Partnership's Report Limited Partnership to on Form 10-K dated Pacific Mutual Life December 31, 1985 Insurance Company* (File 0-13473)\n(b) Mortgage and Security Exhibit 10.11(b) to Agreement dated Item 14 of the October 16, 1985, between Partnership's Report John Hancock Properties on Form 10-K dated Limited Partnership and December 31, 1985 Pacific Mutual Life (File 0-13473) Insurance Company*\n(c) Pledge and Assignment of Account Exhibit 10.11(e) to dated October 16, 1985, between Item 14 of the John Hancock Properties Limited Partnership's Report Partnership and Pacific Mutual on Form 10-K dated Life Insurance Company* December 31,1985 (File 0-13473)\n(d) Hold Harmless and Escrow Exhibit 10.11(f) to Agreement dated October, 1985, Item 14 of the between John Hancock Properties Partnership's Report Limited Partnership and on Form 10-K dated Ticor Title Insurance* December 31,1985 (File 0-13473)\n(e) Promissory Note and Mortgage Exhibit 10.5(e) to Renewal and Modification Agreement Item 14 of the between Pacific Mutual Life Insurance Partnership's Report Company and John Hancock Properties on Form 10-K dated Limited Partnership* December 31, 1992 (File 0-13473)\n10.6 Documents relating to Northgreen Apartments\n(a) Promissory note dated Exhibit 10.6(a) September 12, 1988 from to Item 14 of the John Hancock Properties Limited Partnership's Report Partnership to Great West Life on Form 10-K dated Assurance Company* December 31, 1988 (File 0-13473)\nItem 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\n(b) Trust Deed with Security Agreement Exhibit 10.6(b) dated September 12, 1988 between to Item 14 of the John Hancock Properties Limited Partnership's Report Partnership and Great West Life on Form 10-K dated Assurance Company* December 31, 1988 (File 0-13473)\n(c) Absolute Assignment of Leases Exhibit 10.6(c) dated September 12, 1988 from to Item 14 of the John Hancock Properties Limited Partnership's Report Partnership to Great West Life on Form 10-K dated Assurance Company* December 31, 1988 (File 0-13473)\n(d) Promissory Note and Mortgage Exhibit 10.6(d) Renewal and Modification to Item 14 of the Agreement between John Hancock Partnership's Report Properties Limited Partnership and on Form 10-K dated Great West Life Assurance Company* December 31, 1993 (File 0-13473)\n10.7 Documents relating to Delta Grove Apartments\n(a) Promissory Note dated Exhibit 10.9(a) to February 28, 1985, the Partnership's from John Hancock Report on Form 10-K Properties Limited dated December 31, 1984 Partnership to Delta Grove (File 2-91210) Development Company*\n(b) Deed of Trust dated Exhibit 10.9(b) to February 25, 1985, by the Partnership's Delta Grove Development Company Report on Form 10-K to John Hancock Properties dated December 31, 1984 Limited Partnership* (File 2-91210)\n(c) Security Agreement dated Exhibit 10.9(c) to February 28, 1985, between the Partnership's John Hancock Properties Limited Report on Form 10-K Partnership and Delta Grove dated December 31, 1984 Development Company* (File 2-91210)\n(d) Memorandum of Understanding Exhibit 10.9(e) to dated February 28, 1985, the Partnership's between Delta Grove Development Report on Form 10-K Company and John Hancock dated December 31, 1984 Properties Limited Partnership* (File 2-91210)\nItem 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\n(e) Assignment of Residential Exhibit 10.9(g) to the Property Management Agreement Partnership's Report dated February 28, 1985, on Form 10-K dated between Beam & James and December 31, 1984 Bennett Management Company* (File 2-91210)\n(f) Purchase and Sale Agreement Exhibit 10.7(e) to between John Hancock Properties Amendment No. 1 to Limited Partnership and Whittaker the Partnership's Report Realty Group, Inc.* on Form 10-K dated December 31, 1991 (File 0-13473)\n10.8 Documents relating to Ramsey Place\n(a) Deed of Trust Note dated Exhibit 10.12(a) to the December 17, 1985, from Partnership's Report John Hancock Properties of Form 10-K dated Limited Partnership to December 31, 1985 National Life Insurance (File 0-13473) Company*\n(b) Deed of Trust and Security Exhibit 10.12(b) to the Agreement dated December 17, Partnership's Report 1985, between John Hancock of Form 10-K dated Properties Limited Partnership December 31, 1985 and National Life Insurance (File 0-13473) Company*\n(c) Rent Escrow Agreement dated Exhibit 10.12(d) to the December 17, 1985, between Partnership's Report John Hancock Properties of Form 10-K dated Limited Partnership and December 31, 1985 Alamo Title Co. and Ramsey (File 0-13473) Place, Ltd.*\n(d) Escrow Agreement regarding funds Exhibit 10.12(e) to the for improvement of Ramsey Road Partnership's Report dated December 17, 1985, between of Form 10-K dated John Hancock Properties Limited December 31, 1985 Partnership and Ramsey Place, Ltd.* (File 0-13473)\n(e) Escrow Agreement regarding completion Exhibit 10.12(f) to the of work dated December 17, 1985, Partnership's Report between John Hancock Properties of Form 10-K dated Limited Partnership and Ramsey December 31, 1985 Place, Ltd. and Alamo Title Co.* (File 0-13473)\nItem 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K (continued)\n(f) Special Warranty Deed between Exhibit 10.8(g) to John Hancock Properties Limited Amendment No. 1 to Partnership and National Life the Partnership's Report Insurance Company * on Form 10-K dated December 31, 1990 (File 0-13473)\n10.9 Promissory Note dated Page 50 December 1, 1994 between John Hancock Realty Equities, Inc. and John Hancock Properties Limited Partnership+\n10.10 Documents relating to Management Agreement\n(a) Management Agreement dated Exhibit 10.10 (a) to the January 1, 1992 between Hancock Partnership's Report on Realty Investors Incorporated and Form 10-K dated John Hancock Realty Equities* December 31, 1992 (File 0-13473)\n(b) Agreement dated May 28, 1993 Exhibit 10.10(b) to the Concerning Subcontracting of Partnership's Report on Management Services Pertaining to Form 10-K dated John Hancock Properties Limited December 31, 1993 Partnership between John Hancock (File 0-13473) Realty Equities, Inc., Hancock Realty Investors, Incorporated and John Hancock Mutual Life Insurance Company*\n10.11 Documents relating to Executive Compensation Plans and Arrangements\n(a) Partnership Agreement* Exhibit 4.1(a) to Post- Effective Amendment No. 1 to the Partnership's Form S-11 Registration Statement (File 2-91210)\n(b) There were no reports on Form 8-K filed during the quarter ended December 31, 1994.\n(c) Exhibits - See Item 14 (a) (3) of this Report.\n(d) Financial Statement Schedules - The response to this portion of Item 14 is submitted as a separate section of this Report commencing on Page.\n---------------------------------- +Filed herewith *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, on the 29th day of March, 1995.\nJohn Hancock Properties Limited Partnership\nBy: John Hancock Realty Equities, Inc., Managing General Partner\nBy: WILLIAM M. FITZGERALD ------------------------------- William M. Fitzgerald, 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 the 29th day of March, 1995.\nSignatures Title ---------- -----\nPresident (Principal Executive Officer) and Director of John Hancock Realty Equities, Inc. (Managing General Partner of WILLIAM M. FITZGERALD Registrant) ----------------------- William M. Fitzgerald\nTreasurer (Chief Accounting Officer) of John Hancock Realty Equities, Inc. RICHARD E.FRANK (Managing General Partner of Registrant) ----------------------- Richard E. Frank\nDirector of John Hancock Realty Equities, Inc. (Managing General Partner of MALCOLM G. PITTMAN, III Registrant) ----------------------- Malcolm G. Pittman, III\nDirector of John Hancock Realty Equities, Inc. (Managing General Partner of SUSAN M. SHEPHARD Registrant) ----------------------- Susan M. Shephard\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\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP\nBOSTON, MASSACHUSETTS\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\n(ITEMS 8 AND 14(a) (1) AND (2))\n1. Financial Statements Page\nReport 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' 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\n2. Financial Statement Schedules\nSchedule II: Valuation and Qualifying Accounts\nSchedule III: Real Estate and Accumulated Depreciation\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.\nReport of Independent Auditors\nTo the Partners John Hancock Properties Limited Partnership\nWe have audited the accompanying balance sheets of John Hancock Properties Limited Partnership as of December 31, 1994 and 1993, and the related statements of operations, partners' 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 Partnership'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 John Hancock Properties 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 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\nFebruary 3, 1995\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nBALANCE SHEETS\nASSETS\nDecember 31, 1994 1993 ---- ---- Assets: Cash and cash equivalents $578,996 $444,021 Restricted cash 417,985 452,431 Note receivable, net of allowance of $284,155 in 1994 and $298,058 in 1993 - - Prepaid expenses and other assets 79,275 87,339\nInvestment in property: Land 2,588,726 2,588,726 Buildings and improvements 18,205,348 18,205,348 ----------- ----------- 20,794,074 20,794,074 Less: accumulated depreciation (6,821,682) (6,197,321) ----------- ----------- 13,972,392 14,596,753 ----------- -----------\nTotal assets $15,048,648 $15,580,544\nLIABILITIES AND PARTNERS' EQUITY\nLiabilities: Accounts payable and accrued expenses $318,178 $325,448 Accounts payable to affiliates 268,538 562,555 Note payable to affiliate 1,000,000 1,000,000 Long-term debt 13,416,019 13,602,666 ----------- ----------- Total liabilities 15,002,735 15,490,669\nPartners' equity\/(deficit): General Partners' (707,996) (707,556) Limited Partners' 753,909 797,431 ----------- ----------- Total partners' equity 45,913 89,875 ----------- -----------\nTotal liabilities and partners' equity $15,048,648 $15,580,544 =========== ===========\nSee Notes to Financial Statements\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nSTATEMENTS OF OPERATIONS\nSee Notes to Financial Statements\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nSTATEMENTS OF PARTNERS' EQUITY Years Ended December 31, 1994, 1993 and 1992\nSee Notes to Financial Statements\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nContinued on Next Page\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nSTATEMENTS OF CASH FLOWS (continued)\nSee Notes to Financial Statements\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Organization of Partnership --------------------------- John Hancock Properties Limited Partnership (the \"Partnership\") was formed under the Massachusetts Uniform Limited Partnership Act on May 17, 1984. As of December 31, 1994, the Partnership consisted of a sole Managing General Partner, John Hancock Realty Equities, Inc. (the \"Managing General Partner\"), an Associate General Partner, JH Associates Limited Partnership (the \"Associate General Partner\"), and 2,048 Limited Partners. The Managing General Partner and Associate General Partner are collectively referred to as the \"General Partners\" and the General Partners and the Limited Partners are collectively referred to as the \"Partners\". The Managing General Partner is the general partner of the Associate General Partner and is a wholly-owned, indirect subsidiary of John Hancock Mutual Life Insurance Company (\"John Hancock\"). The Partnership is engaged solely in the acquisition, operation, and disposition of investment real estate. The initial capital of the Partnership was $6,000, representing capital contributions of $800 from the Managing General Partner, $200 from the Associate General Partner and $5,000 from the initial Limited Partner (a former director of the Managing General Partner). The Amended Agreement of Limited Partnership of the Partnership (the \"Partnership Agreement\") authorized the issuance of up to 35,000 Units of Limited Partnership Interests at $1,000 per Unit. During the offering period, which terminated on August 31, 1985, 21,954 Units of Limited Partnership Interests (\"Units) were sold. There have been no changes in the number of Units outstanding subsequent to the termination of the offering period.\nThe latest date on which the Partnership is due to terminate is December 31, 2020, unless it is terminated sooner in accordance with the terms of the Partnership Agreement. It is expected that in the ordinary course of the Partnership's business, the properties of the Partnership will be disposed of, and the Partnership terminated, before December 31, 2020. As of December 31, 1994 and the date hereof, the Partnership has two properties remaining in its portfolio. Of the two remaining properties, one property is currently listed for sale and the other property is expected to be listed for sale during 1995. Upon the sale of the last remaining property, the operations of the Partnership will terminate, and the Partnership will be dissolved, in accordance with the terms of the Partnership Agreement.\n2. Significant Accounting Policies ------------------------------- The Partnership maintains its accounting records and recognizes rental income on the accrual basis.\nCash equivalents are highly liquid investments with maturities of three months or less when purchased. These investments are recorded at cost plus accrued interest, which approximates market value. Restricted cash represents funds restricted for tenant security deposits, property tax escrows and other escrows.\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS (continued)\n2. Significant Accounting Policies (continued) ------------------------------- Investments in property are recorded at cost less any property write- downs for permanent impairment of values. Cost includes the initial purchase price of the property plus the cost of significant improvements, acquisition and legal fees, and other miscellaneous acquisition costs.\nDepreciation has been provided on a straight-line basis over the estimated useful lives of the various assets: thirty years for the buildings and five years for related improvements. Maintenance and repairs are charged to operations as incurred.\nThe net loss per Unit for each year is computed by dividing the Limited Partners' share of net loss by the number of Units outstanding at the end of each year.\nNo 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 ------------------------- Profits from the normal operations of the Partnership for each fiscal year, or portion thereof, are allocated between the Limited Partners and the General Partners in the same proportion as Distributable Cash from Operations, as defined in the Partnership Agreement, provided that (i) in no event shall the General Partners be allocated less than 1% of any such profits from normal operations, and (ii) if there is any fiscal year which produces no Distributable Cash from Operations but which produces profits for tax purposes from normal operations, such profits are allocated 90% to the Limited Partners and 10% to the General Partners.\nLosses from the normal operations of the Partnership for each fiscal year or portion thereof are allocated 99% to the Limited Partners and 1% to the General Partners, except any such profits or losses which were based upon the Partnership's operations prior to the initial closing under the Partnership's offering of Units were allocated 99% to the General Partners and 1% to the initial Limited Partner. Distributable Cash from Operations is distributed 90% to the Limited Partners and 10% to the General Partners; provided, however, that in each fiscal year the General Partners will defer their receipt of any Distributable Cash from Operations to the extent necessary to provide the Limited Partners a non-cumulative return in such year equal to 4% of their Invested Capital, as defined in the Partnership Agreement. All distributions of Distributable Cash from Operations deferred by the General Partners accrue and are payable to them, to the extent possible, out of subsequent years' Distributable Cash from Operations remaining after the receipt by the Limited Partners of the aforesaid 4% return, or out of cash from sales and refinancings as specified below.\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS (continued)\n3. The Partnership Agreement (continued) ------------------------- Cash from Sales or Refinancings, as defined in the Partnership Agreement, are distributed to the Limited Partners until the Limited Partners have received, first, a return of their total Invested Capital, and, second, such additional amount as may be necessary, after giving effect to all previous distributions of Distributable Cash from Operations and of Cash from Sales or Refinancings to the extent required to satisfy any deficiency in the Cumulative Return on Investment, as defined in the Partnership Agreement, to produce in the aggregate a Cumulative Return on Investment of 7% per annum for all fiscal quarters commencing on or after January 1, 1986, and ending prior to the date of such distribution. The General Partners are then entitled to receive an amount of Cash from Sales or Refinancings equal to any portion of the General Partners' share of Distributable Cash from Operations which was previously deferred in order to permit the payment to the Limited Partners of a non-cumulative return in each year equal to 4% of their Invested Capital. Any Cash from Sales or Refinancings remaining after the Limited Partners have received a return of their total Invested Capital plus the Cumulative Return on Investment of 7% per annum for all fiscal quarters commencing on or after January 1, 1986, and ended prior to the date of such distribution, and after the General Partners have received an amount of such cash equal to any such deferred payment of Distributable Cash from Operations, will be distributed 85% to the Limited Partners and 15% to the General Partners.\nCash from the Sale of the last of the Partnership's properties are distributed in the same manner as Cash from Sales or Refinancings, except that before any other distribution is made to the Partners, each Partner shall first receive from such cash, an amount equal to the then positive balance, if any, in such Partner's capital account after crediting or charging to such account the profits or losses for tax purposes from such sale. To the extent, if any, that a Partner is entitled to receive a distribution of cash based upon a positive balance in its capital account prior to such distribution, such distribution will be credited against the amount of such cash the Partner would have been entitled to receive based upon the manner of distribution of Cash from Sales or Refinancings as specified in the previous paragraph.\nProfits from Sales or Refinancings are generally allocated in the same manner as cash from that transaction. Losses from Sales or Refinancings are allocated 99% to the Limited Partners and 1% to the General Partners. In connection with the sale of the last of the Partnership's properties, and therefore the dissolution of the Partnership, profits will be allocated to any Partners having a deficit balance in their capital account in an amount equal to the deficit balance. Any remaining profits will be allocated in the same order as cash from the sale would be distributed.\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS (continued)\n4. Transactions with the General Partners and Affiliates ----------------------------------------------------- Expenses incurred or paid by the General Partners or their Affiliates and to which the General Partners and their Affiliates are entitled to reimbursement from the Partnership, and interest payable on borrowings from the Managing General Partner were as follows: Years Ended December 31, 1994 1993 1992 ---- ---- ---- Operating expenses $79,420 $78,390 $86,826 Interest on note payable to affiliate 80,416 80,000 98,333 -------- -------- -------- $159,836 $158,390 $185,159 ======== ======== ========\nThe expenses above are included in expenses on the Statements of Operations.\nAccounts payable to affiliates represents amounts due to the General Partners and their Affiliates for various services provided to the Partnership, including deferred amounts.\nNote payable to affiliate represents a short-term borrowing in the principal amount of $1,000,000 from the Managing General Partner, initially made to the Partnership on December 1, 1988. Due to the cash flow constraints of the Partnership, the Managing General Partner has each year made a new short-term loan to the Partnership for the outstanding principal amount of $1,000,000 and, during 1991, began deferring payment of all accrued but unpaid interest on such loans. Interest on the current short-term note accrues monthly at a rate of 8.5%. Interest is payable monthly and the principal amount is due on November 30, 1995. The Partnership commenced making payments towards such accrued but unpaid interest during the third quarter of 1993.\nFrom 1991 through the second quarter of 1993, payments towards the reimbursement of general and administrative expenses and the payment of interest on such short-term loans were deferred in order for the Partnership to meet working capital needs. The Managing General Partner also made short-term advances to the Partnership in order to cover operating expenses which could not be paid from the operating cash flow of the Partnership. Since the third quarter of 1993, the Partnership has made payments to the Managing General Partner towards reimbursement for such general and administrative expenses and interest expense. During the years ended December 31, 1994 and 1993, the Partnership paid $453,853 and $116,421, respectively, to the Managing General Partner as reimbursement for the full amount of the short-term advances and towards the then outstanding balance of general and administrative expenses and interest expense incurred on behalf of the Partnership. To the extent that the Partnership generates sufficient funds from operations and sales of investment real estate in future periods, the Partnership will continue to make payments to the Managing General Partner towards the outstanding principal balance of the short-term loan and such deferred amounts. As of December 31, 1994, the cumulative total due on the short-term loan and such deferred amounts was $1,268,538.\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS (continued)\n4. Transactions with the General Partners and Affiliates (continued) ----------------------------------------------------- The Managing General Partner serves in a similar capacity for three other affiliated real estate limited partnerships.\n5. Investment in Property ---------------------- Investment in property at cost consists of residential real estate as follows:\nDecember 31, 1994 1993 ---- ---- Fisherman's Village Apartments $13,462,613 $13,462,613 Northgreen Apartments 7,331,461 7,331,461 ----------- ----------- $20,794,074 $20,794,074 =========== ===========\nOn March 31, 1992, the Huntington Park Apartments property was sold to a non-affiliated buyer for a net sales price of $4,072,442. In connection with the sale, the Partnership secured a reduced payoff amount from the property's lender for the related mortgage indebtedness and accrued interest thereon from $5,525,028 to $3,800,000. As such the Partnership realized an extraordinary gain for financial statement purposes of $1,725,028 related to the forgiveness of debt. The gain was offset by a loss of $1,721,075 on the transaction, which represents the difference between the net sales price of $4,072,442 and the net book value of $5,793,517.\nNorthgreen Apartments has been listed for sale since the second quarter of 1994. Revenues and net income for this property totaled $1,440,582 and $263,884, respectively, in 1994.\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS (continued)\n6. Long-Term Debt --------------\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS (continued)\n6. Long-Term Debt (continued) --------------\nThe aggregate annual maturities of long-term debt for the five years after December 31, 1994 are as follows:\nYear Amount ---- ------ 1995 $8,865,311 1996 91,797 1997 100,159 1998 109,283 1999 119,238\nInterest paid for the three years ended December 31, 1994 was as follows:\nYear Amount ---- ------ 1994 $1,062,340 1993 1,172,433 1992 1,577,488\n7. Note Receivable --------------- Effective August 9, 1987, the unconditional guaranty obligation granted by the seller of the Waterford Apartments to the Partnership for operating deficits (including debt service) was extended until August 1, 1994. (The Waterford Apartments was conveyed to the property's mortgagee by a deed-in-lieu of foreclosure on August 9, 1991.) The outstanding balance due in the amount of $258,950 was restructured as a 10.5% Promissory Note due on or before August 1, 1994. In accordance with the terms of the Promissory Note, monthly installments of interest only were payable at a rate of 5.5% through July 31, 1990. The Promissory Note provided for monthly payments commencing on August 1, 1990 in the amount of $2,781 to amortize the then outstanding principal and deferred interest balance of $303,985 in accordance with a 30-year amortization at a rate of 10.5%. The Managing General Partner believed, as of December 31, 1993, based on information obtained with respect to the obligor's financial condition, that it was probable that the Partnership would be unable to collect all amounts due from the obligor according to the contractual terms of the note. Accordingly, as of December 31, 1993, the Partnership established a provision, reflected in the accompanying Balance Sheets, against the then entire outstanding balance of the note in the amount of $298,058. The provision has since been reduced to $284,155 as a result of payments received on the note during the year ended December 31, 1994.\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS (continued)\n7. Note Receivable (continued) --------------- In June 1994, the obligor notified the Partnership that he would be unable to pay both the outstanding balance of the note upon its maturity on August 1, 1994 and the minimum monthly payments on the note. As of December 31, 1994, and as of the date hereof, the obligor is in default on the Promissory Note for failure to pay the minimum required payments due since June 1, 1994 and for failure to pay the outstanding balance of the note, which was due on August 1, 1994. The Managing General Partner issued a default notice to the obligor and demand for payment and filed a complaint with the court demanding full payment of the note.\nOn December 7, 1994 the court granted the Partnership a summary judgment in response to the complaint filed against the obligor in the amount of the note plus accrued interest thereon in the aggregate amount of $305,489. As of the date hereof, the Partnership has not received payment from the obligor, and the Managing General Partner continues to pursue collection of the judgment amount.\n8. Federal Income Taxes\nA reconciliation of the net loss reported in the Statements of Operations to the net income\/(loss) reported for federal income tax purposes is as follows:\nJOHN HANCOCK PROPERTIES LIMITED PARTNERSHIP (A Massachusetts Limited Partnership)\nSCHEDULE II\nVALUATION AND QUALIFYING ACCOUNTS Year Ended December 31, 1994","section_15":""}
{"filename":"18792_1994.txt","cik":"18792","year":"1994","section_1":"Item 1. Business\nCentral Telephone Company (Central Telephone) was incorporated December 14, 1970, under the laws of Delaware and is the successor by merger on December 1, 1971, to a Delaware corporation of the same name incorporated May 25, 1944. Central Telephone and its subsidiaries (the Company) provide local exchange telephone service in portions of Nevada, North Carolina, Florida, Illinois and Virginia. In addition, intra-LATA toll service and access by other carriers to the Company's local exchange facilities are provided.\nCentral Telephone is a subsidiary of Centel Corporation (Centel) which, in addition to its ownership of all the common stock of Central Telephone, has a subsidiary which provides local exchange telephone service in portions of Texas, subsidiaries which provide cellular communications services in various markets, and various other subsidiaries. On March 9, 1993, Centel became a wholly-owned subsidiary of Sprint Corporation (Sprint), a holding company with subsidiaries in a number of telecommunications markets.\nAs of December 31, 1994, the Company served more than 1.6 million access lines. All of the access lines are served through central offices equipped with digital switching. Over 60 percent of the access lines served are located in the following seven communities:\nCommunity Access Lines Las Vegas, Nevada 573,465 Tallahassee, Florida 174,208 Des Plaines, Illinois 76,825 Charlottesville, Virginia 63,879 Fort Walton Beach, Florida 41,288 Hickory, North Carolina 39,652 Park Ridge, Illinois 34,757\n1,004,074\nThe Company is providing and continuing to introduce new services made possible by the enhancement of its facilities to a more intelligent network. A new signaling system (SS7) routes calls more efficiently and makes possible Custom Local Area Signaling Services (CLASS) features such as automatic callback, automatic recall, calling line identification\/block (Caller ID), and customer initiated trace.\nRevenues from communications services constituted 88 percent of operating revenues in 1994, with the remainder derived largely from directory operations, equipment sales and billing and collection services. The Company recovers its costs of providing telephone services, as well as a return on investment, through a combination of local rates and access charges. Access charge tariffs are the principal means by which the Company is reimbursed for services provided to interexchange carriers.\nAT&T Corp. (AT&T), as the dominant long distance telephone company, is the Company's largest customer for access services. In 1994, 15 percent of the Company's operating revenues was derived from services provided to AT&T. While AT&T is a significant customer, the Company does not believe its revenues are dependent upon AT&T as customers' demand for inter-LATA long distance telephone service is not tied to any one long distance carrier. Historically, as the market share of AT&T's long distance competitors increases, the percent of revenues derived from network access services provided to AT&T decreases.\nThe Company is subject to the jurisdiction of the Federal Communications Commission (FCC) and the utilities commissions of each of the states in which it operates. In each state in which the commission exercises authority to grant certificates of public convenience and necessity, the Company has been granted such certificates of indefinite duration to provide local exchange telephone service in its current service areas.\nThe potential for more direct competition is increasing for the Company. Illinois law allows alternative telecommunications providers to obtain certificates of local exchange telephone service authority in direct competition with existing local exchange carriers (LECs) if certain showings are made to the satisfaction of the Illinois Commerce Commission. Both MFS Intelenet of Illinois, Inc. and TC Systems - Illinois, Inc. have been granted Certificates of Service Authority to provide local exchange services to customers located in portions of the Chicago metropolitan area served by Illinois Bell Telephone Company and Central Telephone's Illinois subsidiary.\nMany states, including most of the states in which the Company offers local exchange telephone service, allow limited competitive entry into the intra-LATA long distance service market. Illinois permits the resale of local exchange telephone service, and North Carolina allows customers to participate in the sharing and resale of local exchange telephone service under shared tenant arrangements.\nAt the interstate level, the FCC has revised its rules to permit connection of customer-owned coin telephones to the local network, exposing LECs to direct coin telephone competition. Additionally, to facilitate competition in providing access to interexchange carriers and end users, the FCC mandated that all Tier 1 (over $100 million annual operating revenues) LECs allow virtual collocation of Competitive Access Provider (CAP) equipment in LEC central offices.\nNew technology, as well as changes in state law and regulatory decisions, are permitting expansion of the types of services available through the local exchange and increasing the number of competitors. Other means of communication, such as private network, satellite, cellular and cable systems, permit bypass of the local exchange. Although the extent to which bypass has occurred cannot be precisely determined, management believes it has not had a material adverse effect on the Company's operating revenues.\nThe extent and ultimate impact of competition for the Company and other LECs will continue to depend, to a considerable degree, on FCC and state regulatory actions, court decisions and possible federal or state legislation. Legislation designed to stimulate local competition between local exchange service providers and cable programming service providers, in both markets, is presently pending in the U.S. Congress. While both major political parties are predicting that legislation will be passed, such predictions have proven to be inaccurate in the past.\nEffective January 1, 1991, the FCC adopted a price caps regulatory format for the Bell Operating Companies (the LECs owned by AT&T prior to divestiture) and the LECs owned by GTE Corporation. Other LECs could volunteer to become subject to price caps regulation. Under price caps, prices for network access service must be adjusted annually to reflect industry average productivity gains (as specified by the FCC), inflation and certain allowed cost changes. The Company did not originally elect price caps, but as a result of Sprint's merger with Centel, adopted price caps effective July 1, 1993. Under the form of the plan adopted, the Company generally has an opportunity to earn up to a 14.25 percent rate of return on investment. Certain of the Company's operations have committed to produce higher than industry average productivity gains, and as a result have an opportunity to earn up to a 15.25 percent rate of return on investment. The FCC is conducting a scheduled review of all aspects of the price caps plan and the FCC is expected to implement changes in 1995. Without further action by the FCC, the current price caps plan will expire in 1995 and will be replaced by rate of return regulation. It is expected that the FCC will act and that there will not be a return to rate of return regulation.\nIn June 1993, Central Telephone Company's Illinois subsidiary filed with the Illinois Commerce Commission a petition to adjust its rates and charges to provide revenue recovery for the added costs related to the adoption of Statement of Financial Accounting Standards (SFAS) No. 106 and to recognize the phases of the FCC mandated jurisdictional cost shifts from interstate to intrastate. An order was issued in May 1994, increasing annual local service revenues by approximately $6 million. This order was appealed to the Illinois Appellate Court by petitioners representing consumers. The subsidiary subsequently filed a rate structure modification with the Illinois Commerce Commission to reduce annual revenues by approximately $3 million, effective in October 1994. The appeal of the initial order is still pending.\nThe Company's environmental compliance and remediation expenditures are primarily related to the operation of standby power generators for its telecommunications equipment. The expenditures arise in connection with permits, standards compliance or occasional remediation, which may be associated with generators, batteries or fuel storage. The Company's expenditures relating to environmental compliance and remediation have not been material to the financial statements or to the operations of the Company and are not expected to have any future material effects.\nAs of December 31, 1994, the Company had approximately 5,700 employees, of whom approximately 78 percent are members of unions. During 1994, the Company had no material work stoppages caused by labor controversies.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe properties of the Company consist principally of land, structures, facilities and equipment and are in good operating condition. All of the central office buildings are owned, except eight which are leased. Substantially all of the telephone property, plant and equipment is subject to the liens of the indentures securing indebtedness. As of December 31, 1994, cable and wire facilities represented 50 percent of total net property, plant and equipment; central office equipment, 36 percent; land and buildings, 6 percent; and other assets, 8 percent.\nThe following table sets forth the gross property additions and retirements or sales during each of the five years in the period ended December 31, 1994 (in millions):\nGross Property Retirements Year Additions or Sales\n1994 $ 204.8 $ 40.5 1993 163.4 60.1 1992 168.1 173.1 1991 162.2 254.8 [1] 1990 214.7 54.3\n[1] Includes $213 million related to the sale of the Company's operations in Iowa and Minnesota.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are no material pending legal proceedings, and the Company is a party only to ordinary routine litigation incidental to its business.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nOn November 3, 1994, Central Telephone convened its Annual Meeting of Shareholders. The meeting was adjourned to November 15, 1994. At the reconvened meeting, the shareholders elected seven directors to serve a one year term and approved a proposal to amend the Certificate of Incorporation to decrease the authorized shares of common stock and declare a 1-for-4 reverse common stock split. A proposal to amend the Certificate of Incorporation to decrease the authorized shares of Cumulative Preferred Stock and a proposal to amend the Certificate of Incorporation to decrease the authorized shares of Convertible Junior Preferred Stock were defeated because the proposals did not receive a sufficient number of affirmative votes of the Cumulative Preferred Stock and the Convertible Junior Preferred Stock, respectively.\nThe following votes were cast for each of the following nominees for Director or were withheld with respect to such nominees:\nFor Withheld\nStephen M. Bailor 9,121,922 1,262 Don A. Jensen 9,121,922 1,262 William E. McDonald 9,121,922 1,262 D. Wayne Peterson 9,121,922 1,262 M. Jeannine Strandjord 9,121,922 1,262 Alan J. Sykes 9,121,922 1,262 Dianne Ursick 9,121,922 1,262\nThe following votes were cast with respect to the proposal to amend the Certificate of Incorporation to decrease the authorized shares of common stock and declare a 1-for-4 reverse common stock split:\nTotal Common Shares\nFor 9,117,057 9,000,000 Against 4,119 -- Abstain 1,758 -- Broker Non-vote 70 --\nThe following votes were cast with respect to the proposal to amend the Certificate of Incorporation to decrease the authorized shares of Cumulative Preferred Stock:\nCumulative Total Preferred Shares Stock\nFor 9,107,697 95,251 Against 2,480 358 Abstain 1,964 1,690 Broker Non-vote 10,863 7,662\nThe following votes were cast with respect to the proposal to amend the Certificate of Incorporation to decrease the authorized shares of Convertible Junior Preferred Stock:\nConvertible Junior Total Preferred Shares Stock\nFor 9,106,009 12,456 Against 3,983 1,956 Abstain 2,149 430 Broker Non-vote 10,863 3,201\nPart II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nAll shares of common stock of Central Telephone, representing 92.4 percent of the aggregate outstanding capital stock of Central Telephone, are owned by Centel, a wholly-owned subsidiary of Sprint. There is no established public trading market for the common stock.\nOne series of voting convertible junior preferred stock and four series of voting cumulative preferred stock of Central Telephone are outstanding. Since issuance, quarterly dividends have been paid on all series of the preferred stock at the respective prescribed rates.\nThe junior preferred stock is publicly held and each share is convertible to 6.47325 shares of Sprint common stock. There were 33,168 shares outstanding as of December 31, 1994. During 1994, there were 2,360 shares converted. There is no established public trading market for this particular issue.\nThere is no active market for shares of any of the series of cumulative preferred stock.\nTransfer Agent for all Conversion Agent for the Junior Preferred Stocks Preferred Stock First Chicago Trust Company of First Chicago Trust Company of New York, New York New York, New York\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected consolidated financial data as of and for the years ended December 31, is as follows (in millions):\n1994 1993 1992 1991 1990\nOperating revenues $ 924.3 $ 868.6 $ 786.6 $ 808.9 $ 831.7 Income before extraordinary item and cumulative effect of changes in accounting principles [1], [2] 101.9 41.4 71.6 143.3 100.9 Total assets 1,834.8 1,723.6 1,724.1 1,665.9 1,743.8 Long-term debt and redeemable preferred stock (including current maturities) 521.2 470.5 518.9 527.2 545.9\n[1] During 1993, nonrecurring charges of $77 million were recorded related to the Company's portion of the transaction costs associated with Sprint's merger with Centel and the expenses of integrating and restructuring the operations of the companies. Such charges reduced consolidated 1993 income before extraordinary item and cumulative effect of changes in accounting principles by $48 million.\n[2] During 1991, gains of $92 million were recognized related to the sale of the Company's Iowa and Minnesota operations, which increased consolidated 1991 income before extraordinary item and cumulative effect of changes in accounting principles by $64 million.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nResults of Operations\nNet operating revenues increased 6 percent in 1994, following a 10 percent increase in 1993. Local service revenues, derived from providing local exchange telephone service, increased 8 percent and 11 percent in 1994 and 1993, respectively. These increases reflect continued growth in the number of access lines served, add-on services, such as custom calling, and increased Centrex revenues. Access lines grew 5.6 percent in 1994 and 5.0 percent in 1993. Rate increases also contributed to increased local service revenue in 1993. Permanent annual increases granted by the Florida Public Service Commission and the Public Service Commission of Nevada, effective January 1993, increased 1993 local service revenue by $10 million.\nToll and access service revenues are derived from interexchange long distance carriers use of the local network to complete calls, and the provision of long distance services within specified geographical areas. These revenues increased $15 million in 1994 largely due to increased minutes of use. Toll and access revenues increased $37 million in 1993 as a result of increased traffic volumes and the recognition of a portion of the merger, integration and restructuring costs associated with the Sprint\/Centel merger for regulatory purposes in certain jurisdictions, partially offset by periodic reductions in network access rates charged.\nOther revenues, including revenues from directory publishing fees, billing and collection services, and sales of telecommunications equipment, increased $8 million in 1994 following a $4 million increase in 1993. The increases are generally due to growth in equipment sales in both years.\nOperating expenses increased $36 million and $45 million in 1994 and 1993, respectively, primarily reflecting increases in the costs of providing services resulting from access line growth and increases in the costs associated with the growth in equipment sales. In addition, the increase in 1993 partially resulted from increases in systems development costs incurred to enhance the efficiency and capabilities of the billing processes.\nThe increase in operating expenses in 1993 also reflects the impact of changes in accounting principles. As a result of a change in accounting principle relating to certain software costs, the Company recognized additional expense in 1993 of $7 million. In addition, increased postretirement benefits costs of approximately $7 million was recognized as a result of the adoption of Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (see Notes 1 and 2 of Notes to Consolidated Financial Statements for additional information).\nTransaction costs associated with the Sprint\/Centel merger (consisting primarily of investment banking and legal fees) and the estimated expenses of integrating and restructuring the operations of the companies (consisting primarily of employee severance and relocation expenses and costs of eliminating duplicative facilities) resulted in a nonrecurring charge to Sprint during 1993. The portion of such charge attributable to the Company was $77 million, which reduced 1993 net income by approximately $48 million.\nDepreciation and amortization expense increased $3 million and $7 million in 1994 and 1993, respectively, generally due to plant additions.\nInterest expense was $39 million, $44 million and $43 million in 1994, 1993 and 1992, respectively. The decrease in 1994 is due to lower interest rates on debt refinanced in 1993, partially offset by increases in average levels of debt outstanding and advances from affiliates. The increase in 1993 was generally related to increased advances from affiliates.\nThe Company's income tax provisions for 1994, 1993 and 1992 resulted in effective tax rates of 34 percent, 25 percent and 29 percent, respectively. See Note 3 of Notes to Consolidated Financial Statements for information regarding the differences that cause the effective income tax rates to vary from the statutory federal income tax rates.\nEffective January 1, 1993, the Company conformed its accounting practices for certain software costs with the prevalent practice in the industry and with the accounting method used by Sprint's local communications services division. The Company now expenses these costs as incurred. The cumulative effect of this change in accounting principle reduced 1993 net income by $22 million, net of related income tax benefits of $13 million.\nRegulatory Activities\nIn June 1993, the Company's Illinois subsidiary filed with the Illinois Commerce Commission a petition to adjust its rates and charges such that annual intrastate revenues would increase by approximately $6 million. This rate proceeding was required to provide revenue recovery for the added costs related to the adoption of SFAS No. 106 and to recognize the phases of the FCC mandated jurisdictional cost shifts from interstate to intrastate. An order was issued in May 1994, which was subsequently appealed to the Illinois Appellate Court by petitioners representing consumers. The subsidiary subsequently filed a rate structure modification with the Illinois Commerce Commission to reduce annual revenues by approximately $3 million, effective October 1994. The appeal of the initial order is still pending.\nLiquidity and Capital Resources\nCash Flows-Operating Activities\nCash flows from operating activities, which are the Company's primary source of liquidity, were $217 million, $227 million and $211 million in 1994, 1993 and 1992, respectively. The decrease in 1994 net cash provided by operating activities primarily reflected increased working capital requirements. The improvement in 1993 operating cash flows reflects improved operating results, partially offset by expenditures of $26 million related to the merger, integration and restructuring actions.\nCash Flows-Investing Activities\nCapital expenditures, which represent the Company's most significant investing activity, were $205 million, $163 million and $168 million in 1994, 1993 and 1992, respectively. Capital expenditures were made to accommodate access line growth and to expand the capabilities for providing enhanced telecommunications services.\nCash Flows-Financing Activities\nThe Company's financing activities provided $33 million of cash in 1994 and used cash of $65 million and $45 million in 1993 and 1992, respectively. Increased dividend payments and capital expenditures in 1994 were funded by operating cash flows and increased short- term borrowings. Improved operating cash flows during 1993 and 1992 allowed the Company to fund capital expenditures internally and reduce total debt outstanding.\nDuring 1993 and 1992, a significant level of debt refinancing occurred in order to take advantage of lower interest rates. Accordingly, a majority of the proceeds from long-term borrowings in 1993 and 1992 were used to finance the redemption prior to scheduled maturities of $144 million and $148 million of debt, respectively.\nFinancial Position, Liquidity and Capital Requirements\nAs of December 31, 1994, the Company's total capitalization aggregated $1.22 billion, consisting of long-term debt (including current maturities), advances from affiliates, redeemable preferred stock, and common stock and other stockholders' equity. Debt (including current maturities and advances from affiliates) comprised 50 percent of total capitalization as of December 31, 1994, compared to 44 percent at year-end 1993.\nDuring 1995, the Company anticipates funding estimated capital expenditures of $215 million with cash flows from operating activities. The Company expects its external cash requirements for 1995 to be approximately $30 million which is generally required to pay scheduled long-term debt maturities and short-term borrowings. The method of financing the cash requirements will depend on prevailing market conditions during the year.\nThe Company, Sprint and Sprint Capital Corporation (a wholly-owned subsidiary of Sprint) have a $1.1 billion revolving credit agreement with a syndicate of domestic and international banks, under which the Company can borrow up to an aggregate of $200 million. As of December 31, 1994, the Company had no borrowings outstanding under this agreement. The revolving credit agreement expires in July 1996 and, subject to the approval of the lenders, may be extended for an additional year. Additionally, pursuant to a shelf registration statement filed with the Securities and Exchange Commission, up to $105 million of debt securities could be offered for sale as of December 31, 1994.\nAccounting Changes\nEffective January 1, 1994, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" (see Note 2 of Notes to Consolidated Financial Statements for additional information).\nIn 1993 the Company adopted SFAS No. 109, \"Accounting for Income Taxes\", retroactive to January 1, 1992 (see Note 1 of Notes to Consolidated Financial Statements for additional information).\nEffective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (see Note 2 of Notes to Consolidated Financial Statements for additional information).\nEffective January 1, 1993, the Company changed its method of accounting for certain software costs (see Note 1 of Notes to Consolidated Financial Statements for additional information).\nRecent Accounting Developments\nConsistent with most LECs, the Company accounts for the economic effects of regulation pursuant to SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" The application of SFAS No. 71 requires the accounting recognition of the rate actions of regulators where appropriate, including the recognition of depreciation and amortization based on estimated useful lives prescribed by regulatory commissions rather than those which might be utilized by non-regulated enterprises. Management believes the Company's operations meet the criteria for the continued application of SFAS No. 71. However, the Company operates in an evolving environment in which the regulatory framework is changing and the level and types of competition are increasing. Accordingly, the Company constantly monitors and evaluates the ongoing applicability of SFAS No. 71 by assessing the likelihood that prices which provide for the recovery of specific costs can continue to be charged to customers. In the event the Company determines that its rate-regulated operations no longer qualify for the application of the provisions of SFAS No. 71, the Company would eliminate from its financial statements the effects of any actions of regulators that had been recognized as assets and liabilities. The resulting material noncash charge would be recorded as an extraordinary item. See Note 7 of Notes to Consolidated Financial Statements for information regarding the primary components and estimated amounts of regulatory assets and liabilities as of December 31, 1994.\nEffects of Inflation\nThe effects of inflation on the Company's operations were not significant during 1994, 1993 or 1992.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Auditors - Ernst & Young LLP Report of Independent Auditors - Arthur Andersen LLP Consolidated Statements of Income and Retained Earnings for each of the three years 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 ended December 31, 1994 Notes to Consolidated Financial Statements\nFinancial Statement Schedule for each of the three years ended December 31, 1994:\nVIII - Consolidated Valuation and Qualifying Accounts\nCertain financial statement schedules are omitted because the required information is not present, or because the information required is included in the consolidated financial statements and notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Central Telephone Company\nWe have audited the accompanying consolidated balance sheets of Central Telephone Company (a wholly-owned subsidiary of Sprint Corporation) as of December 31, 1994 and 1993, and the related consolidated statements of income and retained earnings, and cash flows for the years then ended. Our audit also included the 1994 and 1993 information in the financial statement schedule listed in the Index to Financial Statements and Financial Statement Schedule. These financial statements and the schedule 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. The financial statements and schedule of Central Telephone Company for the year ended December 31, 1992, were audited by other auditors whose report dated February 3, 1993, expressed an unqualified opinion on those statements prior to restatement.\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 1994 and 1993 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Central Telephone Company at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for the years then ended, 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 Notes 1 and 2 to the consolidated financial statements, the Company changed its method of accounting for postemployment benefits in 1994 and income taxes, software costs and postretirement benefits in 1993.\nWe also audited the adjustments described in Note 1 that were applied to restate the 1992 consolidated financial statements for the change in the method of accounting for income taxes. In our opinion, such adjustments are appropriate and have been properly applied.\nERNST & YOUNG LLP\nKansas City, Missouri January 31, 1995\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareowners of Central Telephone Company\nWe have audited the consolidated statements of income, retained earnings and cash flows of CENTRAL TELEPHONE COMPANY (a Delaware corporation and wholly owned subsidiary of Centel Corporation) AND SUBSIDIARIES for the year ended December 31, 1992, prior to the restatement (and, therefore, are not presented herein) for the change in the Company's method of accounting for income taxes as described in Note 1 to the restated financial statements. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements (prior to restatement) 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 misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements (prior to restatement) referred to above present fairly, in all material respects, the results of operations and cash flows of Central Telephone Company and Subsidiaries for the year ended December 31, 1992, in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements (prior to restatement) taken as a whole. In connection with our audit, certain auditing procedures were applied to the following schedule (prior to restatement) (and, therefore, is not presented herein) which is required for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements.\nSchedule VIII - Consolidated Valuation and Qualifying Accounts\nIn our opinion, the information contained in the schedule (prior to restatement) 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 February 3, 1993\nCENTRAL TELEPHONE COMPANY CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS\nFor the Years Ended December 31, 1994 1993 1992 (In Millions) OPERATING REVENUES Local service $ 449.8 $ 416.9 $ 375.4 Toll and access service 360.5 345.8 309.1 Other 114.0 105.9 102.1 924.3 868.6 786.6\nOPERATING EXPENSES Operating expenses 594.5 558.9 514.4 Merger, integration and restructuring costs -- 77.2 -- Depreciation and amortization 137.5 134.3 127.8 732.0 770.4 642.2\nOPERATING INCOME 192.3 98.2 144.4\nInterest expense (39.3) (43.6) (43.1) Other income (expense), net 1.5 0.5 (0.6)\nIncome before income taxes, extraordinary item and cumulative effect of changes in accounting principles 154.5 55.1 100.7\nIncome tax provision (52.6) (13.7) (29.1)\nIncome before extraordinary item and cumulative effect of changes in accounting principles 101.9 41.4 71.6\nExtraordinary losses on early extinguishments of debt, net -- (4.6) -- Cumulative effect of changes in accounting principles, net (1.6) (21.6) (0.5)\nNET INCOME 100.3 15.2 71.1\nRETAINED EARNINGS AT BEGINNING OF YEAR 244.9 257.3 216.7\nCash dividends Common stock (93.0) (27.1) (30.0) Preferred stock (0.5) (0.5) (0.5)\nRETAINED EARNINGS AT END OF YEAR $ 251.7 $ 244.9 $ 257.3\nPRO FORMA AMOUNTS ASSUMING THE CHANGE IN ACCOUNTING FOR SOFTWARE COSTS WAS RETROACTIVELY APPLIED\nIncome before extraordinary item $ 101.9 $ 41.4 $ 63.0\nNet income $ 100.3 $ 36.8 $ 62.5\nSee accompanying Notes to Consolidated Financial Statements.\nCENTRAL TELEPHONE COMPANY CONSOLIDATED BALANCE SHEETS\nAs of December 31, 1994 1993 (In Millions) ASSETS CURRENT ASSETS Cash $ 19.2 $ 9.5 Receivables Customers and other, net of allowance for doubtful accounts of $0.5 million ($0.6 million in 1993) 95.4 84.0 Interexchange carriers 31.7 23.7 Affiliated companies 24.8 13.9 Advances to affiliates 38.2 3.3 Deferred income taxes 4.2 19.8 Prepaid expenses and other 15.8 13.2 Total current assets 229.3 167.4\nPROPERTY, PLANT AND EQUIPMENT Land and buildings 119.2 116.4 Telephone network equipment and outside plant 2,282.9 2,150.1 Other 136.3 138.8 Construction in progress 29.6 13.9 2,568.0 2,419.2 Less accumulated depreciation (1,026.6) (943.7) 1,541.4 1,475.5\nDEFERRED CHARGES AND OTHER ASSETS 64.1 80.7\n$ 1,834.8 $ 1,723.6\nSee accompanying Notes to Consolidated Financial Statements.\nCENTRAL TELEPHONE COMPANY CONSOLIDATED BALANCE SHEETS (continued)\nAs of December 31, 1994 1993 (In Millions) LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Outstanding checks in excess of cash balances $ 3.1 $ 17.5 Current maturities of long-term debt 4.3 22.7 Advances from affiliates 90.3 14.4 Accounts payable Vendors and other 23.2 17.6 Interexchange carriers 35.7 32.2 Affiliated companies 41.2 32.2 Accrued merger, integration and restructuring costs 17.7 24.3 Accrued interest 16.0 17.2 Advance billings 17.2 16.2 Accrued taxes 22.3 7.3 Accrued vacation pay 11.1 15.2 Other 25.5 35.4 Total current liabilities 307.6 252.2\nLONG-TERM DEBT 510.2 440.9\nDEFERRED CREDITS AND OTHER LIABILITIES Deferred income taxes and investment tax credits 259.6 276.4 Postretirement and other benefit obligations 64.8 71.6 Regulatory liability 52.1 59.1 Other 25.7 15.2 402.2 422.3\nREDEEMABLE PREFERRED STOCK 6.7 6.9\nCOMMON STOCK AND OTHER STOCKHOLDERS' EQUITY Common stock, no par value, authorized, issued and outstanding-2.3 million shares 354.4 354.4 Non-redeemable preferred stock 2.0 2.0 Retained earnings 251.7 244.9 608.1 601.3 $ 1,834.8 $ 1,723.6\nSee accompanying Notes to Consolidated Financial Statements.\nCENTRAL TELEPHONE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS\nFor the Years Ended December 31, 1994 1993 1992 (In Millions) OPERATING ACTIVITIES Net income $ 100.3 $ 15.2 $ 71.1 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 137.5 134.3 127.8 Deferred income taxes and investment tax credits (6.9) (33.8) 2.1 Extraordinary losses on early extinguishments of debt -- 7.6 -- Cumulative effect of changes in accounting principles 1.6 21.6 0.5 Changes in operating assets and liabilities Receivables, net (27.0) (10.5) (2.5) Other current assets (2.6) 0.3 (2.4) Accounts payable and outstanding checks in excess of cash balances (15.5) 0.9 12.3 Accrued expenses and other current liabilities (5.8) 32.9 (14.1) Noncurrent assets and liabilities, net 35.4 55.6 16.2 Other, net 0.4 2.5 (0.4) NET CASH PROVIDED BY OPERATING ACTIVITIES 217.4 226.6 210.6\nINVESTING ACTIVITIES Capital expenditures (204.8) (163.4) (168.1) (Increase) decrease in advances to affiliates (34.9) 3.7 19.5 Other, net (1.2) 0.6 (17.6) NET CASH USED BY INVESTING ACTIVITIES (240.9) (159.1) (166.2)\nFINANCING ACTIVITIES Proceeds from long-term debt 0.7 118.6 157.1 Retirements of long-term debt (22.1) (147.5) (190.0) Increase (decrease) in notes payable 72.0 (20.0) 20.0 Increase (decrease) in advances from affiliates 75.9 14.4 (1.5) Dividends paid (93.5) (27.6) (30.5) Other, net 0.2 (3.2) (0.1) NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 33.2 (65.3) (45.0)\nINCREASE (DECREASE) IN CASH 9.7 2.2 (0.6)\nCASH AT BEGINNING OF YEAR 9.5 7.3 7.9\nCASH AT END OF YEAR $ 19.2 $ 9.5 $ 7.3\nSUPPLEMENTAL CASH FLOWS INFORMATION Cash paid for interest $ 40.6 $ 39.4 $ 40.5 Cash paid for income taxes $ 52.1 $ 38.5 $ 39.1\nSee accompanying Notes to Consolidated Financial Statements.\nCENTRAL TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThis summary of significant accounting policies of Central Telephone Company is presented to assist in understanding the accompanying consolidated financial statements. The consolidated financial statements and notes are representations of Central Telephone Company's management, which is responsible for their integrity and objectivity. These accounting policies conform with generally accepted accounting principles and reflect practices appropriate to the industry in which Central Telephone Company operates.\nBasis of Consolidation and Presentation\nThe accompanying consolidated financial statements include the accounts of Central Telephone Company and its wholly-owned subsidiaries, Central Telephone Company of Florida, Central Telephone Company of Virginia and Central Telephone Company of Illinois (the Company). All significant intercompany transactions have been eliminated. The Company is a wholly-owned subsidiary of Centel Corporation (Centel); accordingly, earnings per share information has been omitted. Centel became a wholly-owned subsidiary of Sprint Corporation (Sprint) on March 9, 1993, in connection with the Sprint\/Centel merger (see Note 8). The Company is engaged in the business of providing communications services, principally local, network access and toll services in portions of Florida, Illinois, Nevada, North Carolina and Virginia.\nThe Company accounts for the economic effects of regulation pursuant to Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" which requires the accounting recognition of the rate actions of regulators where appropriate. Such actions can provide reasonable assurance of the existence of an asset, reduce or eliminate the value of an asset, or impose a liability on a regulated enterprise.\nCertain amounts previously reported for prior periods have been reclassified to conform to the current period presentation in the accompanying consolidated financial statements. These reclassifications had no effect on the results of operations or shareholders' equity as previously reported.\nCash\nAs part of its cash management program, the Company utilizes controlled disbursement banking arrangements. As of December 31, 1994 and 1993, outstanding checks in excess of cash balances of $3 million and $18 million, respectively, are included in current liabilities. The Company had sufficient funds available to fund these outstanding checks when they were presented for payment.\nProperty, Plant and Equipment\nProperty, plant and equipment are recorded at cost. Retirements of depreciable property are charged against accumulated depreciation with no gain or loss recognized. Repairs and maintenance costs are expensed as incurred.\nDepreciation\nThe cost of property, plant and equipment is depreciated generally on a straight-line basis over the estimated useful lives as prescribed by regulatory commissions. Depreciation rate changes granted by a state commission resulted in additional depreciation expense in 1994 and 1993 of $1 million.\nIncome Taxes\nSubsequent to the Sprint\/Centel merger, operations of the Company are included in the consolidated federal income tax returns of Sprint. Prior to the merger, operations of the Company were included in the consolidated federal income tax returns of Centel. Federal income tax is calculated by the Company on the basis of its filing a separate return.\nIn 1993, the Company retroactively changed its method of accounting for income taxes by adopting SFAS No. 109, \"Accounting for Income Taxes,\" which requires an asset and liability approach to accounting for income taxes. The new standard was adopted retroactive to January 1, 1992; accordingly, the 1992 financial statements were restated to reflect the change in accounting for income taxes. Under the provisions of SFAS No. 109, the Company adjusted existing deferred income tax amounts, using current tax rates, for the estimated future tax effects attributable to temporary differences between the tax bases of the Company's assets and liabilities and their reported amounts in the financial statements. The Company's principal temporary difference results from using different depreciable lives and methods with respect to its property, plant and equipment for tax and financial statement purposes.\nInvestment tax credits (ITC) have been deferred and are being amortized over the useful life of the related property.\nSoftware Costs\nEffective January 1, 1993, the Company changed its method of accounting for certain software costs. The change was made to conform the Company's accounting to the predominant practice among local exchange carriers. Under the new method, such costs are being expensed when incurred. The resulting nonrecurring, noncash charge of $22 million, net of related income tax benefits of $13 million, is reflected as a change in accounting principle in the 1993 consolidated statement of income.\nInterest Charged to Construction\nIn accordance with the Uniform System of Accounts, as prescribed by the Federal Communications Commission (FCC), interest is capitalized on those telephone plant construction projects for which the estimated construction period exceeds one year. In addition, the Public Service Commission of Nevada has ordered that the Company's Nevada operations capitalize interest during construction on short-term projects.\n2. EMPLOYEE BENEFIT PLANS\nEffective January 1, 1994, as a result of the Sprint\/Centel merger, corporate staff employees of Central Telephone Company and employees of Central Telephone Company of Florida are considered employees of the affiliates Sprint\/United Management Company and United Telephone Company of Florida, respectively. As a result, the Company transferred the respective assets and liabilities associated with the benefit plans for these active employees and retirees to Sprint\/United Management Company and United Telephone Company of Florida. The Company reimbursed the affiliates $19 million for the net liabilities associated with these benefit plans.\nDefined Benefit Pension Plans\nSubstantially all employees of the Company are covered by a noncontributory defined benefit pension plan sponsored by Sprint. Effective December 31, 1993, plans sponsored by Centel were merged with the defined benefit pension plan sponsored by Sprint. For participants of the plan represented by collective bargaining agreements, benefits are based upon schedules of defined amounts as negotiated by the respective parties. For participants not covered by collective bargaining agreements, the plan provides pension benefits based upon years of service and participants' compensation.\nThe Company's policy is to make contributions to the plan each year equal to an actuarially determined amount consistent with applicable federal tax regulations. The funding objective is to accumulate funds at a relatively stable rate over the participants' working lives so that benefits are fully funded at retirement. As of December 31, 1994, the plan's assets consisted principally of investments in corporate equity securities and U.S. government and corporate debt securities.\nThe components of the net pension costs and related weighted average assumptions are as follows (in millions):\n1994 1993 1992\nService cost -- benefits earned during the period $ 6.2 $ 10.0 $ 8.8 Interest cost on projected benefit obligation 17.4 20.8 18.7 Actual return on plan assets (0.1) (29.7) (18.3) Net amortization and deferral (14.7) 5.8 (5.2)\nNet pension cost $ 8.8 $ 6.9 $ 4.0\nDiscount rate 7.5% 8.0% 8.8% Expected long-term rate of return on plan assets 9.5% 9.5% 10.0% Anticipated composite rate of future increases in compensation 4.5% 5.5% 7.0%\nIn addition, the Company recognized pension curtailment losses of $5 million during 1993 as a result of the integration and restructuring actions (see Note 8).\nThe funded status and amounts recognized in the consolidated balance sheets for the plan, as of December 31, are as follows (in millions):\n1994 1993\nActuarial present value of pension benefit obligations Vested benefit obligation $ (192.9) $ (262.8) Accumulated benefit obligation $ (210.3) $ (304.4)\nProjected benefit obligation $ (217.2) $ (317.4) Plan assets at fair value 200.9 279.7\nProjected benefit obligation in excess of plan assets (16.3) (37.7) Unrecognized net losses 8.0 39.4 Unrecognized prior service cost 47.9 59.5 Unamortized portion of transition asset (21.5) (31.9)\nPrepaid pension cost $ 18.1 $ 29.3\nThe projected benefit obligations as of December 31, 1994 and 1993 were determined using a discount rate of 8.5 percent for 1994 and 7.5 percent for 1993, and anticipated composite rates of future increases in compensation of 5.0 percent for 1994 and 4.5 percent for 1993.\nDefined Contribution Plans\nSubstantially all employees of the Company are covered by defined contribution employee savings plans. Effective December 31, 1993, the plan covering participants not represented by collective bargaining agreements was merged with a defined contribution plan sponsored by Sprint. Eligible employees may contribute a portion of their compensation to the plans, and the Company makes matching contributions up to specified levels. The Company's contributions to the plans aggregated $6 million in 1994, and $10 million in 1993 and 1992.\nPostretirement Benefits\nThe Company provides other postretirement benefits (principally health care benefits) to certain retirees. Employees who retired from the Company before specified dates became eligible for these postretirement benefits at no cost to the retirees. Employees retiring after specified dates are eligible for these benefits on a shared cost basis. The Company funds the accrued costs as benefits are paid.\nEffective January 1, 1993, the Company modified its accrual method of accounting for postretirement benefits provided to certain retirees by adopting SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" As permitted by SFAS No. 106, the Company elected to recognize its previously unrecognized obligation for postretirement benefits as of January 1, 1993 by amortizing such obligation on a straight-line basis generally over a period of 20 years, except in those jurisdictions where shorter amortization periods have been authorized for regulatory treatment.\nFor regulatory purposes, the FCC permits recognition of net postretirement benefits costs, including amortization of the transition obligation, in accordance with SFAS No. 106.\nThe components of the net postretirement benefits cost are as follows (in millions):\n1994 1993\nService cost -- benefits earned during the period $ 3.8 $ 4.5 Interest on accumulated benefits obligation 8.3 12.4 Net amortization and deferral 0.8 -- Amortization of transition obligation 3.4 5.9\nNet postretirement benefits cost $ 16.3 $ 22.8\nFor measurement purposes, a weighted average annual health care cost trend rate of 12 percent was assumed for 1994, gradually decreasing to 6 percent by 2001 and remaining constant thereafter. The effect of a 1 percent annual increase in the assumed health care cost trend rate would have increased the 1994 net postretirement benefits cost by approximately $4 million. The discount rates for 1994 and 1993 were 7.5 percent and 8 percent, respectively.\nIn addition, the Company recognized postretirement benefits curtailment losses of $10 million during 1993 as a result of the integration and restructuring actions (see Note 8).\nThe cost of providing health care and life insurance benefits to retirees was $11 million in 1992. Such costs were being accrued over the service periods of employees expected to receive the benefits, with past service costs amortized over 30 years except in those jurisdictions where shorter amortization periods had been authorized for regulatory purposes.\nThe amounts recognized in the consolidated balance sheets as of December 31 are as follows (in millions):\n1994 1993\nAccumulated postretirement benefits obligation Retirees $ 59.3 $ 79.0 Active plan participants -- fully eligible 16.8 34.3 Active plan participants -- other 57.9 64.2 134.0 177.5 Unrecognized net gains (losses) 3.0 (14.9) Unrecognized transition obligation (73.1) (91.0)\nAccrued postretirement benefits cost $ 63.9 $ 71.6\nThe accumulated benefits obligations as of December 31, 1994 and 1993 were determined using discount rates of 8.5 percent and 7.5 percent, respectively. An annual health care cost trend rate of 12 percent was assumed for 1995, gradually decreasing to 6 percent by 2001 and remaining constant thereafter. The effect of a 1 percent annual increase in the assumed health care cost trend rate would have increased the accumulated benefits obligation as of December 31, 1994 by approximately $16 million.\nPostemployment Benefits\nEffective January 1, 1994, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" Upon adoption, the Company recognized certain previously unrecorded obligations for benefits being provided to former or inactive employees and their dependents, after employment but before retirement. Such postemployment benefits offered by the Company include severance, disability, and workers' compensation benefits, including the continuation of other benefits such as health care and life insurance coverage. The resulting nonrecurring, noncash charge of $2 million, net of related income tax benefits, is reflected in the 1994 consolidated statement of income as a cumulative effect of change in accounting principle. Adoption of SFAS No. 112 had no significant impact on operating expenses in 1994.\n3. INCOME TAXES\nThe components of the federal and state income tax provisions are as follows (in millions):\n1994 1993 1992\nCurrent income tax provision Federal $ 52.7 $ 42.7 $ 23.0 State 6.8 4.8 4.0 59.5 47.5 27.0 Deferred income tax provision (benefit) Federal (2.7) (26.8) 6.4 State 0.1 (2.5) 1.2 Amortization of deferred ITC (4.3) (4.5) (5.5) (6.9) (33.8) 2.1 Total income tax provision $ 52.6 $ 13.7 $ 29.1\nOn August 10, 1993, the Revenue Reconciliation Act of 1993 was enacted which, among other changes, raised the federal income tax rate for corporations to 35 percent from 34 percent, retroactive to January 1, 1993. Pursuant to SFAS No. 71, the resulting adjustments to the Company's deferred income tax assets and liabilities to reflect the revised rate have generally been reflected as reductions to the related regulatory liabilities.\nThe differences which cause the effective income tax rate to vary from the statutory federal income tax rate of 35 percent in 1994 and 1993 and 34 percent in 1992 are as follows (in millions):\n1994 1993 1992\nFederal income tax provision at the statutory rate $ 54.1 $ 19.3 $ 34.2 Less amortization of deferred ITC Expected federal income tax (4.3) (4.5) (5.5) provision after amortization of deferred ITC 49.8 14.8 28.7\nEffect of Reversal of rate differentials (3.0) (3.2) (2.9) State income tax, net of federal income tax effect 4.5 1.5 3.4 Other, net 1.3 0.6 (0.1)\nIncome tax provision, including $ 52.6 $ 13.7 $ 29.1 ITC Effective income tax rate 34% 25% 29%\nDuring 1994 and 1993, income tax benefits allocated to other items are as follows (in millions):\n1994 1993\nCumulative effect of changes in accounting principles $ 1.1 $ 12.5 Extraordinary losses on early extinguishments of debt -- 3.0\nDeferred income taxes are provided for the temporary differences between the carrying amounts of the Company's assets and liabilities for financial statement purposes and their tax bases. The sources of the differences that give rise to the deferred income tax assets and liabilities as of December 31, 1994 and 1993, along with the income tax effect of each, are as follows (in millions):\n1994 Deferred 1993 Deferred Income Tax Income Tax Assets Liabilities Assets Liabilities\nProperty, plant and equipment $ -- $ 283.4 $ -- $ 272.1 Postretirement and other benefits 24.0 -- 26.5 -- Expense accruals 8.4 -- 8.2 -- Regulatory liability 8.5 -- 2.6 -- Integration and restructuring costs 7.2 -- 11.0 -- Other, net -- 5.5 -- 13.8 $ 48.1 $ 288.9 $ 48.3 $ 285.9\n4. DEBT\nLong-term debt as of December 31 is as follows (in millions):\n1994 1993 Weighted Weighted Amount Average Amount Average Interest Interest Rate Rate\nCentral Telephone Company First mortgage bonds, due 1995 through 2021 $ 227.1 7.7% $ 245.2 7.6% Capital leases -- -- 0.2 8.5% Short-term borrowings classified as long-term debt 72.0 4.9% -- --\nSubsidiaries First mortgage bonds, due 1995 through 2021 112.7 7.9% 115.5 7.9% Notes, due 2002 through 2020 102.7 7.2% 102.7 7.2% 514.5 463.6 Less current maturities 4.3 22.7 Total long-term debt, excluding current maturities $ 510.2 $ 440.9\nLong-term debt maturities during each of the next five years are as follows (in millions):\n1995 $ 4.3 1996 23.0 1997 24.0 1998 31.7 1999 26.8\nThe first mortgage bonds are secured by substantially all of the Company's property, plant and equipment.\nProvisions in certain debt agreements and charters restrict the payment of dividends. Under the most restrictive of these provisions, at any time the ratio of equity to total capitalization falls below 50 percent, dividends are limited to a percentage, as defined, of net income for the prior twelve month period. As a result of this requirement, $242 million of retained earnings were restricted from payment of dividends as of December 31, 1994. In connection with dividend restrictions, $163 million of the related subsidiaries' $170 million of retained earnings are restricted as of December 31, 1994. The flow of cash in the form of advances from the subsidiaries to Central Telephone is generally not restricted.\nShort-term borrowings of $72 million at December 31, 1994 are classified as long-term debt due to the Company's intent and ability to refinance such borrowings on a long-term basis.\nThe Company, Sprint and Sprint Capital Corporation (a wholly-owned subsidiary of Sprint) have a $1.1 billion revolving credit agreement with a syndicate of domestic and international banks, under which the Company can borrow up to an aggregate of $200 million. The revolving credit agreement expires in July 1996 and, subject to the approval of the lenders, may be extended for an additional year. As of December 31, 1994, the Company did not have any borrowings outstanding under the agreement.\nThe Company is in compliance with all restrictive or financial covenants relating to its debt arrangements at December 31, 1994.\nDuring 1993, the Company redeemed, prior to scheduled maturities, $144 million of first mortgage bonds with interest rates ranging from 7.5 percent to 8.6 percent. Except for amounts deferred as allowed by the state commissions, the prepayment penalties incurred in connection with the early extinguishments of debt and the write- off of related debt issuance costs aggregated $5 million in 1993, net of related income tax benefits, and are reflected as extraordinary losses in the consolidated statement of income.\n5. COMMITMENTS AND CONTINGENCIES\nMinimum rental commitments as of December 31, 1994 for all non- cancelable operating leases, consisting principally of leases for data processing equipment and real estate, are as follows (in millions):\n1995 $ 2.2 1996 2.1 1997 1.9 1998 0.2 1999 0.2 Thereafter 0.2\nGross rental expense aggregated $8 million in 1994, and $22 million in 1993 and 1992.\n6. RELATED PARTY TRANSACTIONS\nUnder agreements with Sprint and Centel, the Company reimburses such affiliates for data processing services, other data related costs and certain management costs which are incurred for the Company's benefit. Total charges to the Company aggregated $83 million, $49 million and $45 million in 1994, 1993 and 1992, respectively. The Company also has agreements with various Sprint operating telephone companies in which it reimburses the affiliates for certain management costs incurred for the Company's benefit. Total charges to the Company were $90 million in 1994, and were not significant in 1993 and 1992. The Company enters into cash advance and borrowing transactions with such affiliates; generally, interest on such transactions is computed based on the rate at which the Company is able to obtain funds externally. Interest expense on advances from such affiliates was $3 million and $1 million in 1994 and 1993, respectively. Interest expense on advances from affiliates was not significant in 1992. Interest income on advances to such affiliates was $2 million in 1994 and $1 million in 1993 and 1992.\nThe Company purchases telecommunications equipment, construction and maintenance equipment, materials and supplies from its affiliate, North Supply. Total purchases for 1994 and 1993 were $51 million and $13 million, respectively.\nThe Company provides various services to Sprint's long distance communications services division, such as network access, billing and collection services, operator services and the lease of network facilities. The Company received $20 million in 1994 and 1993 for these services. The Company paid Sprint's long distance communications services division $1 million in 1994 and 1993 for interexchange telecommunications services.\nThe CenDon partnership (CenDon), a general partnership between Centel Directory Company, an affiliate, and The Reuben H. Donnelley Corporation, pays the Company a fee for the right to publish telephone directories in the Company's operating territories, for the provision of listings and for billing and collections services performed for CenDon by the Company. CenDon paid the Company $51 million in 1994 and $50 million in 1993 and 1992.\n7. REGULATORY ACCOUNTING\nConsistent with most local exchange carriers, the local communications services division accounts for the economic effects of regulation pursuant to SFAS No. 71. The application of SFAS No. 71 requires the accounting recognition of the rate actions of regulators where appropriate, including the recognition of depreciation and amortization based on estimated useful lives prescribed by regulatory commissions rather than those that might be utilized by non-regulated enterprises. The Company currently believes its rate-regulated operations meet the criteria for the continued application of the provisions of SFAS No. 71. However, the Company operates in an evolving environment in which the regulatory framework is changing and the level of competition is increasing. Accordingly, the Company constantly monitors and evaluates the ongoing applicability of SFAS No. 71 by assessing the likelihood that prices which provide for the recovery of specific costs can continue to be charged to customers.\nThe approximate amount of the Company's net regulatory assets at December 31, 1994 was between $100 million and $300 million, consisting primarily of property, plant and equipment partially offset by deferred tax liabilities. The estimate for property, plant and equipment was calculated based upon a projection of useful remaining lives which are affected by the development of competition, changes in regulation, and the expansion of broadband services to be offered to customers.\n8. MERGER, INTEGRATION AND RESTRUCTURING COSTS\nEffective March 9, 1993, Sprint consummated its merger with Centel. The transaction costs associated with the merger (consisting primarily of investment banking and legal fees) and the estimated expenses of integrating and restructuring the operations of the companies (consisting primarily of employee severance and relocation expenses and costs of eliminating duplicative facilities) resulted in nonrecurring charges to Sprint during 1993. The portion of such charges attributable to the Company was $77 million, which reduced 1993 net income by approximately $48 million.\n9. ADDITIONAL FINANCIAL INFORMATION\nFinancial Instruments Information\nThe Company's financial instruments consist of long-term debt including current maturities with carrying amounts as of December 31, 1994 and 1993, of $515 million and $464 million, respectively, and estimated fair values of $496 million and $511 million, respectively. The fair values are estimated based on the present value of estimated future cash flows using a discount rate commensurate with the risks involved.\nThe Company has not invested in derivative financial instruments.\nMajor Customer Information\nOperating revenues from AT&T Corp. resulting primarily from network access, billing and collection services and the lease of network facilities aggregated approximately $139 million, $137 million and $150 million for 1994, 1993 and 1992, respectively.\n10. SUPPLEMENTAL QUARTERLY INFORMATION - UNAUDITED\n1994 Quarters Ended March 31 June 30 September 30 December 31 (in millions)\nOperating revenues $ 222.6 $ 223.9 $ 237.6 $ 240.2 Operating income 48.9 44.6 50.4 48.4 Income before cumulative effect of changes in accounting principles 26.8 23.8 27.3 24.0 Net income 25.2 23.8 27.3 24.0\n1993 Quarters Ended March 31 June 30 September 30 December 31 (in millions)\nOperating revenues $ 204.9 $ 215.4 $ 218.8 $ 229.5 Operating income (loss)[1] (38.0) 48.0 47.3 40.9 Income (loss) before extraordinary item and cumulative effect of changes in accounting principles (28.9) 25.0 24.7 20.6 Net income (loss) (50.6) 25.0 20.9 19.9\n[1] During the first, third and fourth quarters 1993, the Company recognized nonrecurring charges of $68 million, $5 million and $4 million, respectively, associated with the Sprint\/Centel merger. Such charges reduced income before extraordinary item and cumulative effect of changes in accounting principles by $44 million, $2 million and $2 million, respectively.\nCENTRAL TELEPHONE COMPANY SCHEDULE VIII -- CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 1994, 1993 and 1992 (In Millions)\nBalance Additions Balance beginning charged to Other end of of year income deductions year\nAllowance for doubtful accounts $0.6 $3.4 $ (3.5) $0.5 [1] Allowance for doubtful accounts $0.5 $4.5 $ (4.4) $0.6 [1] Allowance for doubtful accounts $0.6 $2.8 $ (2.9) $0.5 [1]\n[1] Accounts charged off, net of collections.\nItem 9.","section_9":"Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosure\nAs reported in Central Telephone's Current Report on Form 8-K dated April 28, 1993, following consummation of the Sprint\/Centel merger, Arthur Andersen & Co. was replaced with Ernst & Young as auditors of the Company effective April 23, 1993.\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe following table sets forth certain information with respect to those persons who currently serve as Director and\/or Executive Officer of the Registrant.\nOfficer Name Age President and Chief Executive Officer, Director D. Wayne Peterson (1) 59 Vice President-Chief Financial Officer John P. Meyer (2) 44 Vice President-Controller Ralph J. Hodge (3) 42 Vice President-Treasurer, Director M. Jeannine Strandjord (4) 49 Vice President, Director Stephen M. Bailor (5) 51 Vice President Peter W. Chehayl (6) 47 Vice President-Assistant Secretary, Director Don A. Jensen (7) 59 Vice President A. Allan Kurtze (8) 50 Secretary Marion W. O'Neill (9) 54 President-North Carolina Division, Director William E. McDonald (10) 52 President-Nevada Division, Director Dianne Ursick (11) 45 Director Alan J. Sykes (12) 47\n(1)Mr. Peterson has been President and Chief Executive Officer since 1993. He has also served as President-Local Telecommunications Division of Sprint since 1993. From 1980 to 1993, he served as President of Carolina Telephone and Telegraph Company, a subsidiary of Sprint. Mr. Peterson has been a Director since 1993.\n(2)Mr. Meyer has been Vice President-Chief Financial Officer since 1993. Mr. Meyer has also served as Senior Vice President and Controller of Sprint since 1993. He served as Vice President and Controller of Centel from 1989 to 1993.\n(3)Mr. Hodge has been Vice President-Controller since 1993. He has also served as Assistant Vice President and Assistant Controller of Sprint since 1993. He was Director of Earnings Analysis and External Reporting for Sprint from 1992 to 1993. He served as Treasurer of the companies comprising the Midwest Group of local exchange companies of Sprint from 1991 to 1992 and Controller of the companies comprising the Midwest Group from 1988 to 1991.\n(4)Ms. Strandjord has been Vice President-Treasurer since 1993. She has also served as Senior Vice President and Treasurer of Sprint since 1990. She served as Vice President and Controller of Sprint from 1986 to 1990. Ms. Strandjord has been a Director since 1993.\n(5)Mr. Bailor has been Vice President since 1993. Mr. Bailor served as Vice President and Controller of Central Telephone from 1989 to 1993. He has also served as Vice President- Financial and Local Billing Services of Sprint's Finance Division since 1993. Mr. Bailor has been a Director since 1993.\n(6)Mr. Chehayl has been Vice President since 1993. He has also served as Vice President and Assistant Treasurer of Sprint since 1991. He was Vice President and Treasurer of Alert Holdings, Inc., a provider of security alarm monitoring services, during part of 1990, and from 1988 to 1990 he was Treasurer of Firestone Tire & Rubber Company (now known as Bridgestone\/Firestone, Inc.), a manufacturer and retailer of tires and a retailer of automotive services.\n(7)Mr. Jensen has been Vice President-Assistant Secretary since 1993. He has also served as Vice President and Secretary of Sprint since 1975. Mr. Jensen has been a Director since 1993.\n(8)Mr. Kurtze has been Vice President since 1991. Mr. Kurtze has also served as Senior Vice President of Sprint\/United Management Company, a subsidiary of Sprint, since 1993. He served as Executive Vice President of Centel from 1991 to 1993 and as Senior Vice President-Planning and Technology of Centel from 1986 to 1991.\n(9)Ms. O'Neill has been Secretary since 1993. She has been an attorney for Sprint for more than five years.\n(10)Mr. McDonald has been President of the Company's North Carolina Division since 1993. He has also served as President of the other four companies comprising the Mid-Atlantic Group of local exchange companies of Sprint since 1993. From 1988 to 1993, he served as President of the two companies comprising the Eastern Group of local exchange companies of Sprint. Mr. McDonald has been a Director since 1993.\n(11)Ms. Ursick has been President of the Company's Nevada Division since 1993. From 1989 to 1993, she was General Regulatory Manager of the Company's Nevada Division. Ms. Ursick has been a Director since 1993.\n(12)Mr. Sykes, has been Vice President of Revenues of Sprint's Local Telecommunications Division since 1987. Mr. Sykes has been a Director since 1993.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following tables set forth the annual compensation of the Chief Executive Officer of Central Telephone and the other executive officers of Central Telephone who earned at least $100,000 in salary and bonus for services to the Company during 1994 (the Named Officers).\nSummary Compensation Table\nThe following table reflects the cash and non-cash compensation for the Named Officers. Annual salary and bonus amounts shown are amounts attributed to the Company by Sprint. The individuals designated as Named Officers also had responsibilities during 1994 relating to Sprint, Centel and other subsidiaries of Sprint and Centel. Except for amounts shown in the \"Salary\" and \"Bonus\" columns, the compensation stated reflects all compensation earned by the individuals in all his or her capacities with Sprint, Centel, and their subsidiaries.\nLong-Term Compensation\nAnnual Compensation Awards Payouts All Other Restric Securities Other Annual ted Underly- Compen- Name and Compen- Stock ing LTIP sation Principal Year Salary Bonus sation Award(s) Options\/ Payouts ($)(1) Position Year ($) ($) ($) ($) SARs ($) (#)\nD. Wayne 1994 67,412 69,714 36,426 (3) 0 94,970 107,633 35,780 Peterson(2) Chief 1993 27,985 19,762 24,166 372,500 (4) 11,000 89,783 42,431 Executive Officer\nWilliam E. 1994 64,220 41,321 44,357 (6) 0 14,000 66,048 79,659 McDonald(5) President 1993 21,121 14,229 10,286 0 11,000 61,098 12,874 - North Carolina Division\nDianne 1994 162,598 117,419 0 0 5,000 0 4,519 Ursick(7) President 1993 74,808 41,156 4,587 0 5,000 0 6,060 Nevada Division\nNotes:\n(1) Consists of the following amounts for 1994: (a) $6,195, $5,503 and $4,080 contributed on behalf of Mr. Peterson, Mr. McDonald and Ms. Ursick, respectively, as company contributions under Sprint's Retirement Savings Plan; (b) $439 in dividends on Centel Employees' Stock Ownership Plan shares for Ms. Ursick; (c) $28,935 and $65,911 in relocation expenses for Mr. Peterson and Mr. McDonald, respectively; (d) $650 and $8,245 for Mr. Peterson and Mr. McDonald, respectively, representing the portion of interest credits on deferred compensation accounts under Sprint's Executive Deferred Compensation Plan that are deemed by Securities and Exchange Commission (SEC) rules to be at above- market rates. (2) Mr. Peterson first became an executive officer of Central Telephone on September 28, 1993. (3) Includes the cost of providing tax and financial services of $9,625 and automobile allowance of $12,500. (4) The value of the restricted stock shown is based on the closing price of Sprint common stock on October 20, 1993, the date of the grant. As of December 31, 1994, Mr. Peterson held 10,000 restricted shares valued at $276,250, based on the closing price of Sprint common stock on December 31, 1994, equal to $27.625. Mr. Peterson has the right to vote and receive dividends on the restricted shares. Twenty-five percent of the award vests on July 12, 1996, 25% on July 12, 1997, and 50% on July 12, 1998. (5) Mr. McDonald first became an executive officer of Central Telephone on September 28, 1993. (6) Includes the cost of providing club memberships of $12,110 and automobile allowance of $12,000. (7) Ms. Ursick first became an executive officer of Central Telephone on March 9, 1993.\nOption Grants\nThe following table summarizes options granted to the Named Officers during 1994 for the purchase of shares of Sprint common stock under Sprint's stock option plans. The option grants relate to compensation earned by the Named Officers for all responsibilities with Sprint, Centel and their subsidiaries. The amounts shown as potential realizable values on these options are based on arbitrarily assumed annualized rates of appreciation in the price of Sprint common stock of five percent and ten percent over the term of the options, as set forth in SEC rules. The Named Officers will realize no gain on these options without an increase in the price of Sprint common stock. No stock appreciation rights were granted during 1994.\nOption Grants in Last Fiscal Year\n% of Potential Total Realizable Number of Options Exercise Value at Assumed Securities Granted or Expira- Annual Rates of Name Underlying to Base tion Stock Price Options Employees Price Date Appreciation for Granted in Fiscal ($\/Sh) Option Term (2) (#)(1) Year 0% 5% 10%\nD. Wayne 30,000 1.1% $36.6875 02\/11\/04 $0 $692,177 $1,754,113 Peterson 30,000 1.1% 35.8125 07\/12\/04 0 675,669 1,712,277\n1,892 0.1% 36.5625 04\/23\/95 0 4,093 8,220\n3,525 0.1% 36.5625 04\/22\/96 0 14,450 29,735\n4,041 0.1% 36.5625 04\/13\/97 0 24,551 51,750\n4,895 0.2% 36.5625 02\/12\/98 0 38,425 82,720\n3,512 0.1% 32.1875 02\/12\/98 0 19,721 41,721\n10,444 0.4% 32.1875 02\/17\/99 0 78,665 170,754\n6,661 0.2% 32.1875 02\/15\/01 0 77,212 176,594\nWilliam E. 14,000 0.5% 36.6875 02\/11\/04 0 323,016 818,586 McDonald\nDianne 5,000 0.2% 36.6875 02\/11\/04 0 115,363 292,352 Ursick\n_____ Notes:\n(1) The options shown for each Named Officer include both option awards and \"reload\" option grants. The first two grants shown for Mr. Peterson are option awards and the remaining grants are reload grants. Each grant for Mr. McDonald and Ms. Ursick is an option award.\nTwenty-five percent of the first option grants shown for each Named Officer became exercisable on February 11, 1995, and an additional 25% will become exercisable on February 11 of each of the three successive years. Twenty-five percent of the second option grant shown for Mr. Peterson will become exercisable on July 12, 1995, and an additional 25% will become exercisable on July 12 of each of the three successive years. The option awards each have a reload feature.\nA reload option is an option granted when an optionee exercises a stock option and makes payment of the purchase price using shares of previously owned Sprint common stock. A reload option is granted for the number of shares equal to the number of shares utilized in payment of the purchase price and tax withholding, if any. The option price for a reload option is equal to the market price of Sprint common stock on the date of exercise of the original option. The expiration date of a reload option is the same as the expiration date of the option that was exercised. A reload option becomes exercisable one year from the date the original option was exercised, provided the shares acquired on the exercise of the original option are held by the optionee for at least six months. The reload feature is designed to encourage early exercise of options, without foregoing the opportunity for further appreciation, and to promote retention of the Sprint common stock acquired. (2) The dollar amounts in these columns are the result of calculations at the five percent and ten percent rates set by the SEC and are not intended to forecast future appreciation of Sprint common stock.\nOption Exercises and Fiscal Year-End Values\nThe following table summarizes the net value realized on the exercise of options in 1994, and the value of the outstanding options at December 31, 1994, for the Named Officers.\nAggregated Option Exercises in 1994 and Year-end Option Values\nNumber of Value of Securities Unexercised Underlying In-the-Money Unexercised Options at Options at 12\/31\/94(2) 12\/31\/94 Shares Value Exercis- Unexer- Exercis- Unexer- Name Acquired on Realized able cisable able cisable Exercise(#) (1) ($) (#) (#) ($) ($)\nD. Wayne 45,650 $704,188 18,050 111,470 $11,419 $14,953 Peterson\nWilliam E. 0 0 45,750 28,250 259,375 10,875 McDonald\nDianne 0 0 2,483 8,750 0 0 Ursick\n__________ Notes:\n(1) The value realized upon exercise of an option is the difference between the fair market value of the shares of Sprint common stock received upon the exercise, valued on the exercise date, and the exercise price paid. (2) The value of unexercised, in-the-money options is the difference between the exercise price of the options and the fair market value of Sprint common stock at December 31, 1994 ($27.625).\nLong-Term Incentive Plan Awards\nThe following table represents awards to the Named Officers (relating to all their responsibilities with Sprint, Centel and their subsidiaries) under Sprint's long-term incentive plan which, subject to Sprint's right to amend the plan at any time prior to the approval of payouts by the Organization and Compensation Committee of Sprint's Board of Directors, can be earned by the achievement of certain financial objectives over the three year period ending December 31, 1996. Payouts of awards (which represent items of compensation attributable to Sprint as a whole) are tied to achieving certain non-financial business objectives for the local Operating Telephone Company and specified levels of performance criteria, based on certain financial objectives, within the Long Distance Division (LDD), the Local Telecommunications Division (LTD), the local Operating Telephone Company (OTC) and the Cellular Division (CD). The relative weight given to the performance criteria of these divisions in computing an executive's payout is based on the executive's responsibilities with Sprint.\nThe portion of the payout applicable to the LDD is tied to achieving specified levels of operating margin and net collectible revenue growth. The portion of the payout applicable to the LTD and the OTC is tied to achieving specified levels of earnings before interest, taxes and depreciation as a percent of net revenues, and return on assets. The portion of the payout applicable to the CD is tied to achieving specified levels of operating income and net collectible revenue. The target amount will be earned if 100% of the targeted levels of such criteria is achieved and an award payout will not be earned for the portion of the payout applicable to the LDD criteria for performance below the threshold.\nThe portion of the payout applicable to the OTC nonfinancial business objectives is tied to efforts and results in the regulatory area and in improvements in employee attitude survey results.\nThe calculated payout, based on the achievement of the above financial criteria, is adjusted (increased or decreased) by the percent change in the market price of Sprint common stock as determined by the change in the average of the high and low prices on January 1, 1994 and December 31, 1996. If stock price increases over the three-year performance period, the payout is adjusted by the percentage increase in stock price. Conversely, if the stock price decreases over the three-year performance period, the payout is reduced by the percentage decrease in stock price. Upon approval of the payouts by the Organization and Compensation Committee, each payout will be paid as specified by the executive in restricted or unrestricted shares of Sprint common stock, or deferred under the Executive Deferred Compensation Plan.\nLong-Term Incentive Plans - Awards in Last Fiscal Year\nEstimated Future Payouts under Non-Stock Price Based Plans(1)\nPerformance or Other Period Name Until Maturation Threshold Target Maximum or Payout ($) ($) ($)\nD. Wayne 1\/1\/94- Peterson 12\/31\/96 $27,278 $109,110 $186,305\nWilliam E. 1\/1\/94- McDonald 12\/31\/96 17,044 68,175 109,966\nDianne Ursick 1\/1\/94- 12\/31\/96 10,100 40,000 65,165 _________ (1) Awards are based on a percentage of the Named Officers' average base salary midpoint over the three-year performance cycle which ends December 31, 1996. In calculating the average base salary midpoint, the table assumes the base salary midpoint for 1995 and 1996 will equal the 1994 base salary midpoint. In addition, the estimated future payouts shown assume that the average of the high and low price of Sprint common stock on December 31, 1996 will be the same as it was on January 1, 1994.\nPension Plans\nUnder the Sprint Retirement Pension Plan, employees earn a benefit equal to 1.5% of actual yearly salary and bonus. Prior to 1990, however, the Sprint plan provided pension benefits based on an employee's five highest consecutive years' compensation in the last ten years before retirement. The benefit was determined by taking 1.2% of the average compensation over such five year period plus .35% of such average compensation in excess of a certain amount ($23,400 in 1995) and multiplying the result by the individual's years of credited service. Employees who retire before the year 2000 will have their pension benefit calculated under both the new and old formulas and will receive the greater of the two benefits. Because the benefit for Mr. Peterson and Mr. McDonald is expected to be greater under the old formula, the table below reflects the estimated annual pension benefit payable to an individual retiring in 1994 at age 65 under the old formula. The amounts include all prospective benefits under Sprint's plans, whether tax-qualified or not. Mr. Peterson has an agreement with Sprint that if his employment is discontinued after July 31, 1996, through no fault of his own, he will not incur any penalty for early retirement.\nThe following table reflects the estimated annual pension benefit payable to an individual retiring in 1995 at age 65. The amounts include all prospective benefits under Sprint's plans, whether tax-qualified or not.\nPension Plan Table\nRemuneration Years of Service (2) (1) 15 20 25 30 35\n125,000 27,834 37,112 46,390 55,668 64,946 150,000 33,647 44,862 56,078 67,293 78,509 175,000 39,459 52,612 65,765 78,918 92,071 200,000 45,272 60,362 75,453 90,543 105,634 225,000 51,084 68,112 86,140 102,168 119,196 250,000 56,897 75,862 94,828 113,793 132,759 275,000 62,709 83,612 104,515 125,418 146,321 300,000 68,522 91,362 114,203 137,043 159,884\n__________ (1) Compensation, for purposes of estimating a pension benefit, includes salary and bonus as reflected under Annual Compensation in the Summary Compensation Table. The calculation of benefits under the pension plans generally is based upon average compensation for the highest five consecutive years of the ten years preceding retirement. (2) These amounts are straight life annuity amounts and would not be subject to reduction because of Social Security benefits. For purposes of estimating a pension benefit, the years of service credited are 37 years for Mr. Peterson and 27 years for Mr. McDonald.\nMs. Ursick's pension benefit is determined primarily by a career average formula and is not disclosed under the table above. Assuming she continues in her current position with the Company at current compensation levels and retires at age 65, her annual pension benefit payable would be approximately $102,025. This amount is a straight life annuity amount.\nEmployment Contracts\nMr. Peterson has signed a non-competition agreement with Sprint which provides that he will not associate himself with a competitor for an 18-month period following termination of employment. In addition, the agreement provides that he will receive 18 months of compensation and benefits following an involuntary termination of employment.\nSprint has a Key Management Benefit Plan providing for a survivor benefit in the event of the death of a participant or, in the alternative, a supplemental retirement benefit. Under the plan, if a participant dies prior to retirement, the participant's beneficiary will receive ten annual payments each equal to 25% of the participant's highest annual salary during the five-year period immediately prior to the time of death. If a participant dies after retiring or becoming permanently disabled, the participant's beneficiary will receive a benefit equal to 300% (or a reduced percentage if the participant retires before age 60) of the participant's highest annual salary during the five-year period immediately prior to the time of retirement or disability, payable either in a lump sum or in installments at the election of the participant. Prior to reaching age 60 and at least 13 months before retirement, a participant may elect a supplemental retirement benefit in lieu of all or a portion of the survivor benefit. Messrs. Peterson and McDonald are participants in the plan.\nDirectors' Compensation\nAll Directors of Central Telephone are employed by Sprint or its subsidiaries and receive no compensation for serving as a Director of Central Telephone.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth information about the only known beneficial owner of more than five percent of Central Telephone's outstanding voting securities as of December 31, 1994.\nName and Address Title of Number Percent of Beneficial Owner Class of Shares of Class\nCentel Corporation Common Stock 2,250,000 100% 2330 Shawnee Mission Parkway Westwood, Kansas 66205\nThe following table sets forth information as of December 31, 1994, with respect to the shares of Sprint common stock owned by each current Director, each of the executive officers named in the executive compensation tables, and by all Directors and executive officers as a group. No Director or executive officer owns any equity security of Central Telephone.\nSprint Common Name of Individual or Stock Identity of Group Beneficially Owned (1) Number of Shares Stephen M. Bailor 49,543 (2)(3) Don A. Jensen 39,341 (2) William E. McDonald 71,350 (2) D. Wayne Peterson 87,343 (2) M. Jeannine Strandjord 53,530 (2) Alan J. Sykes 32,707 (2)(3) Dianne Ursick 18,954 (2) All Directors and executive officers as a group (12 persons) 656,364 (2)(4) ___________ Notes: (1) Unless otherwise noted, the persons for whom the information is provided had sole voting and investment power over the shares of stock shown as beneficially owned. (2) Includes shares which may be acquired upon the exercise of stock options exercisable on or within 60 days after December 31, 1994, under Sprint's stock option plans as follows: 39,117, 19,359, 53,250, 45,403, 40,250, 26,500 and 3,733 shares for Mr. Bailor, Mr. Jensen, Mr. McDonald, Mr. Peterson, Ms. Strandjord, Mr. Sykes and Ms. Ursick, respectively, and 463,601 shares for all Directors and executive officers as a group. (3) Includes shares held by or for the benefit of family members in which beneficial ownership has been disclaimed: 1,095 shares held by Mr. Bailor as custodian for his daughters, and 89 shares held by Mr. Sykes as custodian for his son. (4) Represents less than 1% of class.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNone. Part IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a) 1. The consolidated financial statements of the Company and supplementary financial information are listed in the Index to Financial Statements and Financial Statement Schedule included at Item 8 of this report.\n2. The consolidated financial statement schedule of the Company is listed in the Index to Financial Statements and Financial Statement Schedule included at Item 8 of this report.\n3. The following exhibits are filed as part of this report.\n3(a) Certificate of Incorporation of Central Telephone Company, as amended.\n3(b) Bylaws of Central Telephone Company, as amended (Incorporated by reference to Exhibit No. 3(b) to Central Telephone Company Annual Report on Form 10-K for the year ended December 31, 1993).\n4(a) Indenture dated June 1, 1944, between Central Telephone Company and The First National Bank of Chicago and Robert L. Grinnell, as Trustees (under which J. G. Finley is successor to Robert L. Grinnell), as amended and supplemented by indentures supplemental thereto through and including a Thirty-third Supplemental Indenture dated as of August 15, 1982 (Incorporated by reference to Exhibit No. 4A to Central Telephone Company's Registration Statement No. 33-10475 filed December 1, 1986).\n4(b) Thirty-fourth Supplemental Indenture, dated as of December 15, 1986 (Incorporated by reference to Exhibit No. 4B to Central Telephone Company's Registration Statement No. 33-35411 filed June 14, 1990).\n4(c) Thirty-fifth Supplemental Indenture, dated as of October 15, 1990 (Incorporated by reference to Central Telephone Company's Current Report on Form 8-K dated October 26, 1990).\n4(d) Thirty-sixth Supplemental Indenture, dated as of March 15, 1991 (Incorporated by reference to Central Telephone Company's Current Report on Form 8-K dated June 14, 1991).\n4(e) Thirty-seventh Supplemental Indenture dated as of August 15, 1992 (Incorporated by reference to Exhibit No. 4(e) to Central Telephone Company Annual Report on Form 10- K for the year ended December 31, 1993).\n21 Subsidiaries of the Registrant.\n23(a) Consent of Ernst & Young LLP.\n23(b) Consent of Arthur Andersen LLP.\n27 Financial Data Schedule.\nCentral Telephone will furnish to the Securities and Exchange Commission, upon request, a copy of the instruments, other than the indentures listed as Exhibits 4(a), (b), (c), (d) and (e), defining the rights of holders of its long-term debt and the long-term debt of its subsidiaries. The total amount of securities authorized under any of said other instruments does not exceed 10 percent of the total assets of Central Telephone and its subsidiaries on a consolidated basis.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the fourth quarter of 1994.\n(c) Exhibits are listed in Item 14(a).\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCENTRAL TELEPHONE COMPANY (Registrant)\nBy \/s\/ D. Wayne Peterson D. Wayne Peterson 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 below by the following persons on behalf of the registrant and in the capacities indicated on the 29th day of March, 1995.\n\/s\/ D. Wayne Peterson D. Wayne Peterson President and Chief Executive Officer\n\/s\/ John P. Meyer John P. Meyer Vice President - Chief Financial Officer\n\/s\/ Ralph J. Hodge Ralph J. Hodge Vice President - Controller SIGNATURES\nCENTRAL TELEPHONE COMPANY (Registrant)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 29th day of March, 1995.\n\/s\/ Stephen M. Bailor Stephen M. Bailor, Director\n\/s\/ Don A. Jensen Don A. Jensen, Director\n\/s\/ William E. McDonald William E. McDonald, Director\n\/s\/ D. Wayne Peterson D. Wayne Peterson, Director\n\/s\/ Alan J. Sykes Alan J. Sykes, Director\n\/s\/ M. Jeannine Strandjord M. Jeannine Strandjord, Director\n\/s\/ Dianne Ursick Dianne Ursick, Director\nEXHIBIT INDEX\nEXHIBIT NUMBER\n3(a) Certificate of Incorporation of Central Telephone Company, as amended.\n3(b) Bylaws of Central Telephone Company, as amended (Incorporated by reference to Exhibit No. 3(b) to Central Telephone Company Annual Report on Form 10-K for the year ended December 31, 1993).\n4(a) Indenture dated June 1, 1944, between Central Telephone Company and The First National Bank of Chicago and Robert L. Grinnell, as Trustees (under which J. G. Finley is successor to Robert L. Grinnell), as amended and supplemented by indentures supplemental thereto through and including a Thirty-third Supplemental Indenture dated as of August 15, 1982 (Incorporated by reference to Exhibit No. 4A to Central Telephone Company's Registration Statement No. 33-10475 filed December 1, 1986).\n4(b) Thirty-fourth Supplemental Indenture, dated as of December 15, 1986 (Incorporated by reference to Exhibit No. 4B to Central Telephone Company's Registration Statement No. 33-35411 filed June 14, 1990).\n4(c) Thirty-fifth Supplemental Indenture, dated as of October 15, 1990 (Incorporated by reference to Central Telephone Company's Current Report on Form 8-K dated October 26, 1990).\n4(d) Thirty-sixth Supplemental Indenture, dated as of March 15, 1991 (Incorporated by reference to Central Telephone Company's Current Report on Form 8-K dated June 14, 1991).\n4(e) Thirty-seventh Supplemental Indenture dated as of August 15, 1992 (Incorporated by reference to Exhibit No. 4(e) to Central Telephone Company Annual Report on Form 10- K for the year ended December 31, 1993).\n21 Subsidiaries of the Registrant.\n23(a) Consent of Ernst & Young LLP.\n23(b) Consent of Arthur Andersen LLP.\n27 Financial Data Schedule.","section_15":""}
{"filename":"75234_1994.txt","cik":"75234","year":"1994","section_1":"ITEM 1. BUSINESS\nOwens-Corning Fiberglas Corporation, a Delaware corporation incorporated in 1938, is a world leader in advanced glass and composite materials. These products are used in industries such as home improvement, new construction, transportation, marine, aerospace, energy, appliance, packaging and electronics. Many of these products are marketed under the trademark FIBERGLAS.\nApproximately eighty percent of the Company's sales are related to home improvements in the U.S., sales of composite materials and sales outside U.S. markets. Approximately twenty percent of the Company's sales are related to new U.S. residential construction.\nOwens-Corning Fiberglas Corporation's executive offices are at Fiberglas Tower, Toledo, Ohio 43659; telephone (419) 248-8000. Unless the context requires otherwise, the terms \"Owens-Corning\" and \"Company\" in this report refer to Owens-Corning Fiberglas Corporation and its subsidiaries.\nThe Company operates in two industry segments -- Building Products and Industrial Materials -- divided into eleven strategic businesses. As a general rule, there is a commonality of process equipment and\/or products within each industry segment.\nThe Company also has affiliate companies in a number of countries. Affiliated companies' sales, earnings and assets are not included in either industry segment unless the Company owns more than 50% of the affiliate.\nRevenue, operating profit, and identifiable assets attributable to each of the Company's industry and geographic segments, as well as information concerning the dependence of the Company's industry segments on foreign operations, for each of the years 1994, 1993 and 1992, are contained in Note 1 to Owens-Corning's Consolidated Financial Statements, entitled \"Industry Segments\", on pages 35 through 40 hereof.\nBUILDING PRODUCTS\nPrincipal Products And Methods Of Distribution\nBuilding Products operates primarily in North America and Europe. It also has a growing presence in Latin America and Asia\/Pacific, through joint venture and licensee relationships. Building Products sells a variety of building and home improvement products in three major categories: insulation, roofing materials, and windows\/patio doors and other specialty products for the home exterior, such as PinkWrap(TM). The strategic businesses responsible for these products and markets include: Insulation - North America, Building Products-Europe, Retail\/ Distribution, Roofing\/Asphalt, Specialty and Foam Products, Western Fiberglass Group, Latin America, and Asia\/Pacific.\nThe Company's Retail\/Distribution business is a major source of sales of building insulation products to lumber yards and home centers, and roofing shingles and windows\/patio doors to retailers and distributors. These products are used in the home improvement and new residential construction markets. In 1994, this distribution channel accounted for nearly 40% of all of the Company's building product sales and 25% of total overall corporate sales. More than 75% of the Company's Retail\/Distribution sales are related to repair and remodeling activity within the home improvement industry.\nOther channels for the Company's building products include sales of insulation products in North America to insulation contractors, metal building insulation fabricators and distributors, specialty insulation contractors, manufactured housing producers, and appliance and equipment manufacturers. In Europe, the Company sells building insulation to large insulation wholesalers, builders\/merchants, distributors and retailers. The Company sells mechanical insulation products to distributors, fabricators, and manufacturers for use in the heating, ventilation, power and process, appliance, and fire protection industries. Fabrication centers fabricate and sell insulation products to original equipment manufacturers and metal building erectors and provide fabrication services for other Owens-Corning marketing organizations.\nIn Latin America, the Company produces and sells building and mechanical insulation through joint venture and licensee relationships. In the Asia\/Pacific region, the Company sells primarily mechanical insulation through licensees and joint venture businesses.\nIn North America, the Company sells foam products to distributors and retailers who resell to residential builders, remodelers and do-it-yourself customers. The Company serves the commercial and industrial markets through specialty distributors. The Company has licensed others for the manufacture of foam products in nine locations globally in Canada, Europe, the Middle East and Asia. The Company sells foam products through traditional agents and distributors where licensing does not exist.\nThe Company sells windows and patio doors to retailers for re-sale to contractors and do-it-yourself customers in the replacement and new construction markets.\nThe Company sells roofing shingles to distributors and retailers, who resell them to residential roofing and remodeling contractors, as well as to do-it- yourself customers. Approximately 75% of roofing shingles sold in North America are used for re-roofing, with new residential construction accounting for the remainder.\nThe Company sells industrial asphalt under the Trumbull(TM) brand name. There are three principal kinds of industrial asphalt: Built-Up Roofing Asphalt (BURA), used in commercial roofing systems to provide waterproofing and adhesion; saturants or coating asphalt, used to manufacture roofing felts and shingles; and industrial specialty asphalt, used by manufacturers in a variety of products such as waterproofing systems, adhesives, coatings, and product extenders, as well as in various automotive applications.\nThere are various channels of distribution for the Company's asphalt products. The Company's asphalt products are used internally in the manufacture of the Company's residential roofing products and are also sold to other shingle manufacturers. In addition, asphalt is sold to roofing contractors and distributors for BURA systems and to manufacturers in a variety of other industries, including automotive, chemical, rubber, and construction.\nSeasonality\nSales in the Building Products segment tend to follow seasonal home improvement, remodeling and renovation, and new construction industry patterns. Sales levels for the segment, therefore, are typically lower in the winter months.\nMajor Customers\nNo customer in the Building Products segment accounts for more than three percent of the segment's sales.\nINDUSTRIAL MATERIALS\nPrincipal Products and Methods of Distribution\nIndustrial Materials operates primarily in North America with subsidiaries in Europe and Latin America, affiliates and licensees around the world, and a growing presence in Asia\/Pacific. The strategic businesses responsible for these products include: Composites, Latin America, Pipe, and Asia\/Pacific.\nThe Company is the world's leading producer of glass fiber materials used in composites. Composites are fabricated material systems made up of two or more components (e.g., plastic resin and glass fiber) used in various applications to replace traditional materials, such as aluminum, wood, and steel. The global composites industry has expanded to include more than 40,000 end-use products. Worldwide, the composites industry has relatively few raw material component suppliers (glass fiber, resin and additives) delivering to thousands of industrial customers through various channels. Depending on the end-use application, these raw materials move through different manufacturing process chains, ultimately finding their way to consumers through myriad markets covering all regions of the world.\nA major end-use application for glass fiber is asphaltic roofing shingles, where glass fiber is used to provide fire and mildew resistance in 95% of all shingles produced in North America. The Company sells glass fiber and\/or mat directly to a small number of major shingle manufacturers (including the Company's own roofing business).\nTubs, showers and other related internal building components used for both remodeling and new construction are also major applications of glass fiber materials. These end-use products are some of the first successful material substitution conversions normally encountered in developing countries. Glass fiber for these markets is sold to direct accounts, and also to distributors around the world, who in turn service thousands of customers.\nThe use of glass fibers within the automotive industry continues to grow as the amount of composite materials used per vehicle increases. There are hundreds of composites applications, including exterior and interior body panels, instrument panels, bumpers, lamp housings, headliners, packaging for electronics, valve covers, luggage racks, distributor caps, timing belts, mufflers and tanks for alternative fuel vehicles. These composite parts are either produced by the original equipment manufacturer (OEM), or are purchased by the OEMs from first-tier suppliers. Glass fibers for these parts are sold mostly to first-tier and second-tier OEM suppliers.\nGlass fiber is used extensively in printed circuit boards made for the consumer electronics, transportation, and telecommunications industries. The Company sells glass fiber to a small number of major fabric weavers, who, in turn, supply the rest of the circuit board production value chain. Applications also include connectors, circuit breaker boxes, computer housings, electricians' safety ladders, and hundreds of various electro\/mechanical components.\nThe Company manufactures glass-reinforced plastic pipe designed for use in underground pressure and gravity fluid handling systems. The pipe is a structural composite incorporating glass fiber, polyester resins, and other component materials.\nThe Company has established a Center of Excellence for its pipe business in Sandefjord, Norway. In addition to manufacturing pipe, this operation provides technical and manufacturing support for the Company's joint ventures and wholly-owned pipe operations around the world. The Company has pipe joint ventures in Thailand, Saudi Arabia, Germany, Spain and Botswana. In China, a wholly-owned pipe plant is currently under construction in Changchun. Through its pipe business and technology licensees around the world, the Company sells its pipe directly to governments and private industry for major infrastructure projects, such as water and sewage transport systems.\nMajor Customers\nNo customer in the Industrial Materials segment accounts for more than four percent of the segment's sales.\nGENERAL\nRaw Materials And Patents\nOwens-Corning considers the sources and availability of raw materials, supplies, equipment and energy necessary for the conduct of its business in each industry segment to be adequate.\nThe Company has numerous U.S. and foreign patents issued and applied for relating to its products and processes in each industry segment resulting from research and development efforts. The Company has issued royalty- bearing patent licenses to companies in several foreign countries. The licenses cover technology relating to both industry segments.\nIncluding the registered trademark Fiberglas, the Company has approximately 82 trademarks registered in the United States and approximately 339 trademarks registered in other countries.\nThe Company considers its patent and trademark positions to be adequate for the present conduct of its business in each of its industry segments.\nWorking Capital\nOwens-Corning's manufacturing operations in each of its industry segments are generally continuous in nature and it warehouses much of its production prior to sale since it operates primarily with short delivery cycles. Inventories of finished goods, materials and supplies were within historical ranges at year-end 1994, when expressed as a percentage of fourth quarter annualized sales.\nResearch And Development\nDuring 1994, 1993 and 1992, the Company spent approximately $64 million, $61 million, and $55 million, respectively, for research and development activities. Customer sponsored research and development was not material in any of the last three years.\nEnvironmental Control\nOwens-Corning's capital expenditures relating to compliance with environmental control requirements were approximately $15 million in 1994. The Company currently estimates that such capital expenditures will be approximately $21 million in 1995 and $20 million in 1996.\nThe Company does not consider that it has experienced a material adverse effect upon its capital expenditures or competitive position as a result of environmental control legislation and regulations. Operating costs of environmental control equipment, however, were approximately $57 million in 1994. Owens-Corning continues to invest in equipment and process modifications to remain in compliance with applicable environmental laws and regulations.\nThe 1990 Clean Air Act Amendments (Act) provide that the United States Environmental Protection Agency will issue regulations on a number of air pollutants over a period of years. Until these regulations are developed, the Company cannot determine the extent the Act will affect it. The Company anticipates that its sources to be regulated will include glass fiber manufacturing and asphalt processing activities. The Company currently expects glass fiber manufacturing to be regulated by 1997. Based on information now known to the Company, including the nature and limited number of regulated materials it emits, the Company does not expect the Act to have a material adverse effect on the Company's results of operations, financial condition, or long-term liquidity.\nNumber Of Employees\nDuring 1994 Owens-Corning averaged approximately 17,200 employees. The Company had approximately 17,000 employees at December 31, 1994.\nCompetition\nOwens-Corning's products compete with a broad range of products made from numerous basic, as well as high-performance, materials.\nThe Company competes with a number of manufacturers in the United States of glass fibers in primary forms, not all of which produce a broad line of glass fiber products. Approximately one-half of these producers compete with the Company's Building Products industry segment in the sale of glass fibers in primary form. A similar number compete with the Company's Industrial Materials industry segment. Companies in other countries, primarily Japan, export glass fiber products to the United States. The Company also competes outside the United States against a number of manufacturers of glass fibers in primary forms.\nOwens-Corning also competes with many manufacturers, fabricators and distributors in the sale of products made from glass fibers. In addition, the Company competes with many other manufacturers in the sale of industrial asphalts and other products.\nMethods of competition include product performance, price, terms, service and warranty.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nPLANTS\nOwens-Corning's plants as of March 1, 1995 are listed below by industry segment and primary products, and are owned except as noted. The Company considers that these properties are in good condition and well maintained, and are suitable and adequate to carry on the Company's business. The capacity of each plant varies depending upon product mix.\nBUILDING PRODUCTS SEGMENT\nThermal And Acoustical Insulation\nBarrington, New Jersey* Newark, Ohio Delmar, New York Palestine, Texas* Eloy, Arizona Salt Lake City, Utah Fairburn, Georgia Santa Clara, California Kansas City, Kansas Waxahachie, Texas Mount Vernon, Ohio\nCandiac, Canada Queensferry, United Kingdom Edmonton, Canada Ravenhead, United Kingdom Guangzhou, China** Scarborough, Canada Pontyfelin, United Kingdom Vise, Belgium\n*Facility is mothballed. **Under construction.\nRoofing And Asphalt Processing (one of each at every location, except as noted)\nAtlanta, Georgia Medina, Ohio Brookville, Indiana (1) Memphis, Tennessee Compton, California Minneapolis, Minnesota Denver, Colorado Morehead City, North Detroit, Michigan (2) Carolina (2) (3) Houston, Texas Oklahoma City, Oklahoma (2) Irving, Texas Portland, Oregon (4) Jacksonville, Florida (3) Savannah, Georgia Jessup, Maryland Summit, Illinois (3) Kearney, New Jersey\n(1) Roofing plant only. (2) Asphalt processing plant only. (3) Facility is partially leased. (4) Two asphalt processing plants, as well as one roofing plant.\nSpecialty and Foam Products\nHazleton, Pennsylvania Rockford, Illinois Martinsville, Virginia* Tallmadge, Ohio\n*Facility is leased.\nINDUSTRIAL MATERIALS SEGMENT\nTextiles And Reinforcements\nAiken, South Carolina Fort Smith, Arkansas Amarillo, Texas Huntingdon, Pennsylvania Anderson, South Carolina Jackson, Tennessee*\nApeldoorn, The Netherlands Liversedge, United Kingdom Battice, Belgium Rio Claro, Brazil Birkeland, Norway San Vincente deCastellet\/ Guelph, Canada Barcelona, Spain L'Ardoise, France Wrexham, United Kingdom\n*Facility is leased.\nPipe\nChangchun, China** Sandefjord, Norway*\n*Facility is leased. **Under construction.\nOTHER PROPERTIES\nOwens-Corning's general offices of approximately 300,000 square feet are located in the Fiberglas Tower, Toledo, Ohio. The lease for these offices terminates December 31, 1996. Under separate leases, the Company has additional general office space of approximately 145,000 square feet, and warehouse space of approximately 100,000 square feet, located in other buildings in Toledo.\nThe Company's research and development function is conducted at its Science and Technology Center, located on approximately 500 acres of land outside Granville, Ohio. It consists of twenty-three structures totaling approximately 635,000 square feet, of which 25,000 square feet were mothballed at the end of 1994.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe paragraphs in Note 21 to the Company's Consolidated Financial Statements, entitled \"Contingent Liabilities\", on pages 64 through 69 hereof, are incorporated here by reference.\nSecurities and Exchange Commission rules require the Company to describe certain governmental proceedings arising under federal, state or local environmental provisions unless the Company reasonably believes that the proceeding will result in monetary sanctions of less than $100,000. The following proceedings are reported in response to this requirement. Based on the information presently available to it, however, the Company believes that the costs which may be associated with these matters will not have a materially adverse effect on the Company's financial position or results of operations.\nAs previously reported, the Company and more than 100 other companies have signed individual agreements with the United States Environmental Protection Agency (EPA) to conduct a Toxic Substance Control Act (TSCA) Audit Program to determine compliance status under TSCA section 8(e). The agreement provides that the Company will audit its records and report to the EPA any reportable matters which were not reported or which were reported late. The Company will pay stipulated penalties of up to $15,000 for each matter not timely reported, with a maximum penalty of $1 million in the aggregate. The Company has completed the portion of the audit dealing with substantial risk of injury to health. It has not been notified as to the amount of penalties it will be required to pay but estimates that the penalty for health related filings will be less than $150,000. The final report to the EPA, regarding environmental issues, is due six months after the EPA publishes final refined guidance on such reporting.\nIn the third quarter of 1994, the Company reported to the Texas Natural Resource Conservation Commission (TNRCC) that it had discovered that the glass forming areas of its Amarillo, Texas plant were operating without certain required air permits. The TNRCC and the Company are working together to resolve this matter. The Company is unable at this time to determine the amount of penalties that may be sought by the TNRCC.\nDuring the first quarter of 1995, the Company signed a consent order with the Tennessee Department of Environment and Conservation, providing for a remedial investigation and feasibility study for two state Superfund sites. The Company is the primary generator in both sites.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nOwens-Corning has nothing to report under this Item.\nExecutive Officers of the Company (as of March 1, 1995)\nThe term of office for elected officers is one year from the annual election of officers by the Board of Directors following the Annual Meeting of Stockholders on the third Thursday of April. All those listed have been employees of Owens-Corning during the past five years except as indicated.\nName and Age Position*\nGlen H. Hiner (60) Chairman of the Board and Chief Executive Officer since January 1992; formerly Senior Vice President - G.E. Plastics at General Electric Company (1983). Director since 1992.\nAlan D. Booth (52) Vice President and President, Insulation - North America since January 1994; formerly Vice President, Insulation Division, Construction Products Group (1993) and Vice President, Mechanical Products Division (1986).\nDavid T. Brown (46) Vice President and President, Roofing\/Asphalt since January 1994; formerly Vice President, Roofing\/Asphalt Division (1993) and Vice President, Atlanta Regional Sales, Building Materials (1986).\nChristian L. Campbell (44) Senior Vice President, General Counsel and Secretary since January 1995; formerly Vice President, General Counsel and Secretary at Nalco Chemical (1990).\nDomenico Cecere (45) Vice President and Controller since November 1993; formerly Vice President, Finance and Administration, Europe (1992), Vice President and Assistant Controller (1991) and Vice President, Finance, Industrial Business (1990) at Honeywell, Inc.\nCharles H. Dana (55) Executive Vice President since January 1994; formerly Senior Vice President, OCF, and President - Industrial Materials Group (1989).\nName and Age Position*\nDavid W. Devonshire (49) Senior Vice President and Chief Financial Officer since July 1993; formerly Corporate Vice President, Finance (1992) and Corporate Vice President and Controller (1990) at Honeywell, Inc.\nCarl B. Hedlund (47) Vice President and President, Retail\/Distribution since January 1994; formerly Vice President, Retail and Distribution, Construction Products Group (1993), Vice President, Roofing Products Operating Division (1989).\nRobert C. Lonergan (51) Vice President and President, Science and Technology since January 1995; formerly President, Windows (1993); and President of Reb Plastics, Inc. (1984).\nBradford C. Oelman (57) Vice President - Corporate Relations since November 1986.\nGregory M. Thomson (47) Senior Vice President, Human Resources since October 1994; formerly Vice President, Human Resources, Public Service Electric & Gas (1988).\nEfthimios O. Vidalis (40) Vice President and President, Composites since January 1994; formerly Vice President, Reinforcements Division, Europe (1986).\n*Information in parentheses indicates year in which service in position began.\nPart II\nITEM 5.","section_5":"ITEM 5. MARKET FOR OWENS-CORNING'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe principal market on which Owens-Corning's common stock is traded is the New York Stock Exchange. The high and low sales prices in dollars per share for Owens-Corning's common stock as reported in the consolidated transaction reporting system for each quarter during 1994 and 1993 are set forth in the following tables.\n1994 High Low 1993 High Low\nFirst Quarter 46 33-1\/2 First Quarter 47 34-3\/8\nSecond Quarter 36-1\/8 30-1\/2 Second Quarter 45-1\/4 36-1\/4\nThird Quarter 36-1\/4 30-1\/8 Third Quarter 45-5\/8 40-1\/4\nFourth Quarter 33-1\/2 27-3\/4 Fourth Quarter 49-1\/8 42-1\/2\nThe number of stockholders of record of the Company's common stock on February 21, 1995 was 7,358.\nNo dividends have been declared by the Company since the Company's November 5, 1986 recapitalization. In connection with certain of its current bank credit facilities, the Company has agreed to restrictions affecting the payment of cash dividends. As of January 1, 1995, these restrictions limited funds available for the payment of cash dividends by the Company to approximately $38 million. While the Company periodically evaluates the advisability of paying dividends, it currently does not anticipate paying dividends during 1995.\nThe Company has two unsecured, variable rate, long-term bank credit facilities. The first facility was amended in July 1994 and has a maximum commitment of $475 million at December 31, 1994, of which $211 million was used for standby letters of credit and $229 million was unused. The rate of interest is either the bank's base rate, or 13\/16% over the certificate of deposit rate, or 11\/16% over the London Interbank Offered Rate (LIBOR). The rate of interest on borrowings under this facility was 6.8125% at December 31, 1994. A commitment fee of 1\/4 of 1% is charged on the unused portions of this facility.\nThe second long-term facility is payable in Canadian dollars and has a maximum commitment of 95 million Canadian dollars (68 million U.S. dollars) at December 31, 1994, of which 89 million Canadian dollars (64 million U.S. dollars) was unused. This facility replaced the previous Canadian facility which expired in July 1994. The rate of interest is either 11\/16% over the Canadian cost of funds rate, or 11\/16% over the LIBOR rate on U.S. deposits, or .7875% over the Canadian bankers' acceptance rate. The rate of interest on borrowings under this facility was 8.0% at December 31, 1994. A commitment fee of 1\/4 of 1% is charged on the unused portions of this facility.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n2. Long-Term Debt (Continued)\nAs is typical for bank credit facilities, the agreements relating to the facilities described above contain restrictive covenants, including requirements for the maintenance of working capital, interest coverage, and minimum coverage of fixed charges; and limitations on the early retirement of subordinated debt, additional borrowings, certain investments, payment of dividends, and purchase of Company stock. The agreements include a provision which would result in all of the unpaid principal and accrued interest of the facilities becoming due immediately upon a change of control in ownership of the Company. A material adverse change in the Company's business, assets, liabilities, financial condition or results of operations constitutes a default under the agreements.\nThe convertible junior subordinated debentures are subordinated to all present and future indebtedness of the Company and may be redeemed at any time, at a premium, at the option of the Company. The debentures are convertible at any time into shares of common stock of the Company at a conversion price of $29.75 per share. The Company has reserved approximately six million additional shares of common stock necessary for conversion.\nIn November 1994, Owens-Corning Finance (U.K.) PLC, a newly formed wholly- owned subsidiary of the Company, issued $140 million of Eurobonds. These bonds bear a coupon rate of interest of 9.814%, payable semiannually, and mature in 2019. These bonds are convertible into fixed rate preference shares of Owens-Corning Finance (U.K.) PLC in November 2004 and may be redeemed at any time, at a premium, at the option of the Company. The bonds are guaranteed by the Company as to payments of principal and interest and rank similarly with all other senior unsecured debt of the Company (Note 19). Subsequently, in a separate transaction, the Company sold a put option to the holder of the bonds allowing the option holder to require the Company to purchase a portion of the bonds for $79 million on May 28, 1995. During January 1995, the Company received, from an option holder, a notice of intent to exercise approximately 30% of these put options.\nDuring 1992, the Company called, prior to maturity, its 12% sinking fund debentures having a face value of $46 million at a price in excess of book value, which resulted in an extraordinary loss of $1 million, or $.02 per share, net of related income taxes of $1 million.\nIn June 1992, the Company called, prior to maturity, its senior subordinated debentures having a face value of $240 million, which resulted in an extraordinary loss of approximately $2 million, or $.05 per share, net of related income taxes of $1 million.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n2. Long-Term Debt (Continued)\nThe aggregate maturities and sinking fund requirements for all long-term debt issues for each of the five years following December 31, 1994 are:\n3. Short-Term Debt\nDuring 1994, the Company established an unsecured, variable rate, short-term bank credit facility in order to finance the 1994 acquisition of Pilkington (Note 4). This facility has a maximum commitment of $110 million at December 31, 1994, all of which was used. This facility expires on May 31, 1995 and carries an interest rate of 1\/2 of 1% over the LIBOR rate. The rate of interest on borrowings under this facility was 6.6875% at December 31, 1994.\nThe Company had unused short-term lines of credit totalling $91 million and $115 million at December 31, 1994 and 1993, respectively.\n4. Acquisitions and Divestitures of Businesses\nOn May 31, 1994, the Company acquired UC Industries, Inc. (\"UCI\"), a privately held foam board insulation manufacturer based in New Jersey. UCI has two manufacturing facilities which are located in Ohio and Illinois.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n4. Acquisitions and Divestitures of Businesses (Continued)\nThe purchase price of UCI was $45 million. This business combination was consummated by the exchange of 855,556 shares of the Company's common stock for all of the capital stock of UCI, as well as an $18 million cash payment, $6 million of which was paid to acquire the cash of UCI. The remaining $12 million cash payment represents a stock value settlement and was paid during the fourth quarter of 1994.\nOn June 2, 1994, the Company acquired Pilkington Insulation Limited and Kitsons Insulation Products Limited (collectively, \"Pilkington\"), the United Kingdom-based insulation manufacturing and distribution businesses of the Pilkington Group. With two fiber glass insulation manufacturing facilities and one rock wool manufacturing facility, Pilkington Insulation Limited is the United Kingdom's largest manufacturer of fiber glass and rock wool insulation. Kitsons Insulation Products Limited is a major supplier of thermal and acoustical insulation products to the United Kingdom construction industry and is comprised of 14 distribution centers.\nThe purchase price of Pilkington was $110 million and was financed with borrowings from the Company's short-term bank credit facility (Note 3).\nThese acquisitions were accounted for using the purchase method of accounting. Accordingly, the assets acquired and liabilities assumed have been recorded at their fair values and the results of operations of UCI and Pilkington have been included in the Company's consolidated financial statements subsequent to May 31, 1994 and June 2, 1994, respectively.\nThe purchase price allocations were based on preliminary estimates of fair market value and are subject to revision. The estimated fair value of assets acquired from UCI, including goodwill and a non-competition agreement, was $72 million, and liabilities assumed, including $14 million in debt, totalled $27 million. The estimated fair value of assets acquired from Pilkington, including goodwill, was $165 million, and liabilities assumed, including $7 million in debt, totalled $55 million. Goodwill of $78 million and the non-competition agreement of $6 million are being amortized over 40 years and 7 years, respectively, on a straight-line basis.\nUCI and Pilkington added $134 million in post-acquisition sales for the Company during 1994. The pro forma effect of these acquisitions was not material to net income for the year ended December 31, 1994 or 1993.\nOn September 30, 1994, the Company entered into a joint venture with Alpha Corporation of Tennessee, whereby the two companies combined their existing resin businesses to form Alpha\/Owens-Corning, L.L.C., the largest manufacturer of polyester resins in North America. The Company contributed two manufacturing plants (Valparaiso, Indiana and Guelph, Ontario) and owns a 50 percent interest in the joint venture. This joint venture is being accounted for under the equity method. For the nine months ended September 30, 1994 and the years ended December 31, 1993 and 1992, resin sales totalled $58 million, $63 million, and $56 million, respectively, and were included in the Industrial Materials segment.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n4. Acquisitions and Divestitures of Businesses (Continued)\nLate in the fourth quarter of 1994, the Company completed the sale of its underground storage tank manufacturing business. Sales for this business totalled $41 million, $43 million, and $48 million in 1994, 1993, and 1992, respectively, and were included in the Building Products segment.\n5. Restructuring of Operations and Other Initiatives\nDuring the first quarter of 1994, the Company recorded a $117 million pretax charge for productivity initiatives and other actions aimed at reducing costs and enhancing the Company's speed, focus, and efficiency. This $117 million pretax charge is comprised of an $89 million charge associated with the restructuring of the Company's business segments, as well as a $28 million charge, primarily composed of final costs associated with the administration of the Company's former commercial roofing business. The components of the $89 million restructure charge include: $48 million for personnel reductions, $22 million for divestiture of non-strategic businesses and facilities, $16 million for business realignments, and $3 million for other actions. The $48 million cost for personnel reductions primarily represents severance costs associated with the elimination of nearly 400 positions worldwide. The primary employee groups affected include science and technology personnel, field sales personnel, corporate administrative personnel, and commercial roofing and resin business personnel.\nAs of December 31, 1994, the Company has recorded approximately $50 million in costs against its 1994 restructure reserve, of which $35 million represents actual cash expenditures and $15 million represents the non-cash effects of asset write-offs and business realignments. The $35 million cash expenditure includes personnel reduction costs of $22 million, primarily composed of partial payments of severance costs for over 300 employees. The remaining $13 million cash expenditure represents costs associated with the divestiture or realignment of businesses and facilities.\nDuring the first quarter of 1993, the Company recorded a $23 million charge to reorganize its European operations. This charge included $17 million for personnel reductions and $6 million for the writedown of fixed assets.\nDuring the fourth quarter of 1992, the Company recorded a $16 million charge to reorganize its Building Products segment and to centralize its accounting and information systems. This charge included $14 million for personnel reductions and $2 million for the writedown of assets.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n6. Glass Melting Furnace Rebuilds\nEffective January 1, 1994, the Company adopted the capital method of accounting for the cost of rebuilding glass melting furnaces. Under this method, costs are capitalized when incurred and depreciated over the estimated useful lives of the rebuilt furnaces. Previously, the Company established a reserve for the future rebuilding costs of its glass melting furnaces through a charge to earnings between dates of rebuilds. The change to the capital method provides a more appropriate measure of the Company's capital investment and is consistent with industry practice. The cumulative effect of this change in accounting method was an increase to earnings of $123 million, or $2.45 per share, net of related income taxes of $54 million. The effect of this change in accounting method was to increase depreciation expense and eliminate furnace rebuild provision. The pro forma effect of this change was not material to net income for the year ended December 31, 1993 and was $7 million, or $.15 per share, for the year ended December 31, 1992.\n7. Postemployment and Postretirement Benefits Other Than Pensions\nThe Company and its subsidiaries maintain health care and life insurance benefit plans for certain retired employees and their dependents. The health care plans in the U.S. are unfunded and pay either 1) stated percentages of covered medically necessary expenses, after subtracting payments by Medicare or other providers and after stated deductibles have been met, or 2) fixed amounts of medical expense reimbursement. Employees become eligible to participate in the health care plans upon retirement under one of the Company's pension plans if they have accumulated 10 years of service after age 45. Some of the plans are contributory, with some retiree contributions adjusted annually. The Company has reserved the right to change or eliminate these benefit plans subject to the terms of collective bargaining agreements during their term. During 1993, the Company approved changes in its postretirement health care plans for retirees and active employees. These changes, which reduced the accumulated benefit obligation by $120 million and 1993 expense by $18 million, resulted in an unrecognized net reduction in prior service cost which will be amortized through 1999.\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" for its non-U.S. plans. Accordingly, the expected cost of postretirement benefits is charged to expense during the years in which eligible employees render service. The cumulative effect of the adoption of this standard was a charge of $10 million, or $.20 per share. (The Company adopted Statement No. 106 for its U.S. plans effective January 1, 1991.)\nThe following table reconciles the status of the accrued postretirement benefits cost liability at October 31, 1994 and 1993, as reflected on the balance sheet as of December 31, 1994 and 1993:\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n7. Postemployment and Postretirement Benefits Other Than Pensions (Continued)\nFor measurement purposes, an 11% annual rate of increase in the per capita cost of covered health care claims was assumed for 1995. The rate was assumed to decrease to 10.5% for 1996, then decrease gradually to 6% by 2005. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rate by one percentage point in each year would increase the accumulated postretirement benefits obligation as of October 31, 1994, by $13 million and the aggregate of the service and interest cost components of net postretirement benefits cost for the year then ended by $2 million. The discount rate used in determining the accumulated postretirement benefits obligation was 8.5% in 1994, 7.5% in 1993, and 8.25% in 1992.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n7. Postemployment and Postretirement Benefits Other Than Pensions (Continued)\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\" This standard requires the Company to recognize the obligation to provide benefits to former or inactive employees after employment but before retirement under certain conditions. These benefits include, but are not limited to, salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits (including workers' compensation), job training and counseling, and continuation of benefits such as health care and life insurance coverage. The cumulative effect of the adoption of this standard was an undiscounted charge of $28 million, or $.56 per share, net of related income taxes of $18 million. At December 31, 1994, the Company's liability for postemployment benefits totalled $44 million, including current liabilities of $5 million, and is included in other employee benefits liability in the Company's consolidated balance sheet. Postemployment benefits expense was $3 million for the year ended December 31, 1994.\n8. Pension Plans\nThe Company has several defined benefit pension plans covering most employees. Under the plans, pension benefits are generally based on an employee's number of years of service. Company contributions to these pension plans are based on the calculations of independent actuaries using the projected unit credit method. Plan assets consist primarily of equity securities with the balance in fixed income investments or insurance contracts. The unrecognized cost of retroactive amendments and actuarial gains and losses are amortized over the average future service period of plan participants expected to receive benefits.\nThe Company also sponsors defined contribution plans available to substantially all U.S. employees. Company contributions for the plans are based on matching a percentage of employee savings up to a maximum savings level. The Company's contributions were $10 million in 1994, $9 million in 1993, and $7 million in 1992.\n9. Income Taxes\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Statement No. 109 changes the criteria for measuring the provision for income taxes and recognizing deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of corresponding liabilities and assets using enacted tax rates in effect for the year in which the differences are expected to reverse. The cumulative effect of the adoption of this standard was an increase to earnings of $26 million, or $.53 per share.\nAs of December 31, 1994, the Company has not provided for withholding or U.S. federal income taxes on approximately $124 million of accumulated undistributed earnings of its foreign subsidiaries as they are considered by management to be permanently reinvested. If these undistributed earnings were not considered to be permanently reinvested, approximately $11 million of deferred income taxes would have been provided.\nDuring 1994, the Company utilized tax net operating loss carryforwards for certain of its foreign subsidiaries of approximately $9 million. At December 31, 1994, the Company had tax net operating loss carryforwards for certain of its foreign subsidiaries of approximately $27 million, certain of which expire through 1999.\nFor the year ended December 31, 1992, the Company utilized book net operating loss carryforwards which resulted in an extraordinary credit of approximately $4 million, or $.08 per share.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n9. Income Taxes (Continued)\nThe cumulative temporary differences giving rise to the deferred tax assets and liabilities at December 31, 1994 and 1993 are as follows:\nManagement fully expects to realize its net deferred tax assets through income from future operations.\nThe Company's equity in undistributed net income of affiliates was $32 million at December 31, 1994.\nThe Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nSee Note 4 for supplemental disclosure of Non-cash Investing and Financing Activities.\n16. Leases\nThe Company leases certain manufacturing equipment and office and warehouse facilities under operating leases, some of which include cost escalation clauses, expiring on various dates through 2014. Total rental expense charged to operations was $54 million in 1994, $42 million in 1993, and $44 million in 1992. At December 31, 1994, the minimum future rental commitments under noncancellable leases payable over the remaining lives of the leases are:\nThe minimum future rental commitments reflected in the above table include approximately $4 million per year for the lease of the Company's corporate headquarters facility in Toledo, Ohio through 1996. The Company is currently negotiating the lease of a new headquarters facility which would result in an operating lease beginning in late 1996, which is not reflected above. This operating lease would result in future rental commitments of approximately $12 million per year through 2006, $8 million per year through 2015, and, upon renewal, $2 million per year through 2020.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n17. Stock Compensation Plans\nThe Company's Stock Performance Incentive Plan (SPIP), approved by shareholders in 1992, permits up to two percent of common shares outstanding at the beginning of each calendar year to be awarded as stock options and restricted stock (with 25% of this amount as the maximum permitted number of restricted stock awards). The Company may carry forward unused shares from prior years and may increase the shares available for awards in any calendar year through an advance of up to 25% of the subsequent year's allocation (determined by using 25% of the current year's allocation). These shares are also subject to the 25% limit for restricted stock awards. During 1994, the total number of shares available for stock awards was 953,450 shares, 894,000 of which were awarded as stock options and 59,450 as restricted stock, which includes an advance of 93,478 shares from the 1995 allocation. 598,678 shares are also available to be awarded under a prior plan; however, the Company does not expect any awards to be made under that plan. Additionally, the Company has a plan to award stock options and deferred stock awards to nonemployee directors, of which 109,500 shares were available for this purpose as of December 31, 1994.\nDuring 1993, the total number of shares available for stock awards was 868,215 shares, 813,900 of which were awarded as stock options and 54,315 as restricted stock, which included an advance of 3,149 shares from the 1994 allocation.\nOption prices represent the market price at date of grant. Shares issued under options are recorded in the common stock accounts at the option price. Options granted vest ratably through 1997.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n17. Stock Compensation Plans (Continued)\nDeferred Stock Awards\nAt December 31, 1994, the Company had 16,340 shares of deferred stock outstanding, all of which were vested. During 1994, 2,000 shares of deferred stock were granted, and 16,893 shares were issued.\nCompensation expense is measured based on the market price of the stock at date of grant and is recognized on a straight-line basis over the vesting period.\nRestricted Stock Awards\nAt December 31, 1994, the Company had 367,282 shares of restricted stock outstanding. Stock restrictions lapse, subject to alternate vesting plans for approved early retirement and involuntary termination, over various periods ending in 2004.\n18. Share Purchase Rights\nEach outstanding share of the Company's common stock includes a preferred share purchase right. Each right entitles the holder to buy from the Company one one-hundredth of a share of Series A Participating Preferred Stock of the Company at a price of $50. The Board of Directors has designated 750,000 shares of the Company's authorized preferred stock as Series A Participating Preferred Stock. There are currently no preferred shares outstanding.\nRights become exercisable and detach from the common stock ten days after a person or group acquires, or announces a tender offer for, 20% or more of the Company's outstanding shares of common stock. The rights expire on December 30, 1996, unless redeemed earlier by the Company. The rights are redeemable by the Company at one cent each at any time prior to ten days following public announcement or notice to the Company that an acquiring person or group has purchased 20% or more of the Company's outstanding common stock. If the Company is acquired in a merger or other business combination at any time after the rights become exercisable, each right would entitle its holder to buy shares of the acquiring or surviving company having a market value of twice the exercise price of the right.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n19. Derivative Financial Instruments and Fair Value of Financial Instruments\nThe Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to help meet financing needs and to reduce exposure to fluctuating foreign currency exchange rates and interest rates. The Company is exposed to credit loss in the event of nonperformance by the other parties to the financial instruments described below. However, the Company does not anticipate nonperformance by the other parties. The Company does not engage in trading activities with these financial instruments and does not generally require collateral or other security to support these financial instruments. The notional amounts of derivatives summarized in the foreign exchange risk and interest rate risk management section below 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 amounts exchanged are calculated on the basis of the notional amounts and the other terms of the derivatives, which relate to interest rates, exchange rates, securities prices, or financial or other indexes.\nForeign Exchange Risk and Interest Rate Risk Management\nThe Company enters into various types of contracts to manage its foreign exchange risk and interest rate risk, as indicated in the following table.\nCase filing rates continued at historically high levels in 1994 (approximately 27,500 new claims) following receipt of 31,700 claims in 1993 and 26,600 claims in 1992. Many of these new claims appear to be the product of mass screening programs and not to involve significant asbestos- related impairment. The large number of recent filings and the uncertain value of these claims have added to the uncertainties involved in estimating the Company's asbestos Liabilities.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n21. Contingent Liabilities (Continued)\nThe Company cautions that such factors as the number of future asbestos personal injury claims received by it, the rate of receipt of such claims, and the indemnity and defense costs associated with asbestos personal injury claims, as well as the prospects for confirming additional, applicable insurance coverage beyond the $341 million referenced above, are influenced by numerous variables that are difficult to predict, and that estimates, such as the Company's, which attempt to take account of such variables, are subject to considerable uncertainty. Depending upon the outcome of the various uncertainties described above, particularly as they relate to unimpaired claims, it may be necessary at some point in the future for the Company to make additional provision for the uninsured costs of asbestos personal injury claims received through the year 1999 (although no such amounts are reasonably estimable at this time). The Company remains confident that its estimate of Liabilities and Insurance will be sufficient to provide for the costs of all such claims that involve malignancies or significant asbestos-related functional impairment. The Company has reviewed and will continue to review the adequacy of its estimate of Liabilities and Insurance on a periodic basis and make such adjustments as may be appropriate.\nThe Company cannot estimate and is not providing for the cost of unasserted claims which may be received by the Company after the year 1999 because management is unable to predict the number of claims to be received after 1999, the severity of disease which may be involved and other factors which would affect the cost of such claims.\nCash Expenditures\nThe Company's anticipated cash expenditures for uninsured asbestos-related costs of claims received through 1999 are expected to approximate $764 million, the Company's Liabilities, net of Insurance. Cash payments will vary annually depending upon a number of factors, including the pace of the Company's resolution of claims and the timing of payment of its Insurance.\nManagement Opinion\nAlthough any opinion is necessarily judgmental and must be based on information now known to the Company, in the opinion of management, the additional uninsured and unreserved costs which may arise out of pending personal injury and property damage asbestos claims and additional similar asbestos claims filed in the future will not have a materially adverse effect on the Company's financial position. While such additional uninsured and unreserved costs incurred in and after the year 2000 may be substantial over time, management believes that any such additional costs will not impair the ability of the Company to meet its obligations, to reinvest in its businesses or to take advantage of attractive opportunities for growth.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n21. Contingent Liabilities (Continued)\nNON-ASBESTOS LIABILITIES\nIn October 1991, the Company and certain of its officers and directors were named as defendants in a lawsuit captioned Gaetana Lavalle v. Owens-Corning Fiberglas Corporation, et al. in the United States District Court for the Northern District of Ohio. Lavalle purports to be a securities class action on behalf of all purchasers of the Company's common stock during the period November 1, 1988 through October 18, 1991. The complaint alleges that the Company's disclosures during the alleged class period contained material misstatements and omissions concerning its contingent liabilities for asbestos claims. The complaint seeks an unspecified amount of damages (including punitive damages) on the theory that such alleged misstatements and omissions artificially inflated the price of the Company's stock. Various other lawsuits and claims arising in the normal course of business are pending against the Company, some of which allege substantial damages. Management believes that the outcome of these lawsuits and claims will not have a materially adverse effect on the Company's financial position or results of operations.\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n22. Quarterly Financial Information (Unaudited)\nQuarter First Second Third Fourth (In millions of dollars, except share data)\nNet sales $ 677 $ 852 $ 936 $ 886\nCost of sales 523 644 705 664 ------- ------- ------- ------- Gross margin $ 154 $ 208 $ 231 $ 222 ======= ======= ======= ======= Income (loss) before cumulative effect of accounting changes $ (67) $ 45 $ 53 $ 43\nCumulative effect of accounting changes (Notes 6 and 7) 85 - - - ------- ------- ------- ------- Net income $ 18 $ 45 $ 53 $ 43 ======= ======= ======= ======= Net income per share:\nPrimary Income (loss) before cumulative effect of accounting changes $ (1.52) $ 1.03 $ 1.19 $ .98\nCumulative effect of accounting changes 1.93 - - - ------- ------- ------- ------- Net income per share $ .41 $ 1.03 $ 1.19 $ .98 ======= ======= ======= ======= Fully diluted Income (loss) before cumulative effect of accounting changes $ (1.30) $ .95 $ 1.09 $ .91\nCumulative effect of accounting changes 1.70 - - - ------- ------- ------- ------- Net income per share $ .40 $ .95 $ 1.09 $ .91 ======= ======= ======= =======\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n22. Quarterly Financial Information (Unaudited) (Continued)\nQuarter First Second Third Fourth (In millions of dollars, except share data)\nNet sales $ 651 $ 754 $ 785 $ 754\nCost of sales 512 578 606 570 ------- ------- ------- ------- Gross margin $ 139 $ 176 $ 179 $ 184 ======= ======= ======= ======= Income (loss) before cumulative effect of accounting change $ (9) $ 33 $ 48 $ 33\nCumulative effect of accounting change for income taxes (Note 9) 26 - - - ------- ------- ------- ------- Net income $ 17 $ 33 $ 48 $ 33 ======= ======= ======= ======= Net income per share:\nPrimary Income (loss) before cumulative effect of accounting change $ (.20) $ .76 $ 1.09 $ .75\nCumulative effect of accounting change for income taxes .60 - - - ------- ------- ------- ------- Net income per share $ .40 $ .76 $ 1.09 $ .75 ======= ======= ======= ======= Fully diluted Income (loss) before cumulative effect of accounting change $ (.13) $ .71 $ 1.01 $ .70\nCumulative effect of accounting change for income taxes .53 - - - ------- ------- ------- ------- Net income per share $ .40 $ .71 $ 1.01 $ .70 ======= ======= ======= =======\nNet income per share and primary and fully diluted weighted average shares are computed independently for each of the quarters presented. Therefore, the sum of the quarterly net income per share may not equal the per share total for the year.\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nNumber Description Page\nII Valuation and Qualifying Accounts and Reserves - for the years ended December 31, 1994, 1993 and 1992. . . . .73\nOWENS-CORNING FIBERGLAS CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nAS OF DECEMBER 31, 1994, 1993 AND 1992\nColumn A Column B Column C Column D Column E\nAdditions (1) (2) Balance at Charged to Charged to Balance Beginning Costs and Other at End Classification of Period Expenses Accounts Deductions of Period (In millions of dollars)\nFOR THE YEAR ENDED DECEMBER 31, 1994: Allowance deducted from asset to which it applies - Doubtful Accounts $ 16 $ 5 $ - $ 5(A) $ 16 Shown separately - Rebuilding furnaces 124 - - 124(C) -\nFOR THE YEAR ENDED DECEMBER 31, 1993: Allowance deducted from asset to which it applies - Doubtful Accounts $ 20 $ 1 $ - $ 5(A) $ 16 Shown separately - Rebuilding furnaces 124 17 - 17(B) 124\nFOR THE YEAR ENDED DECEMBER 31, 1992: Allowance deducted from asset to which it applies - Doubtful Accounts $ 18 $ 11 $ - $ 9(A) $ 20 Shown separately - Rebuilding furnaces 113 27 - 16(B) 124\nNotes: (A) Uncollectible accounts written off, net of recoveries.\n(B) Expenditures for purposes for which reserve was created.\n(C) Effective January 1, 1994, the Company adopted the capital method for rebuilding furnaces. See Note 6 to the Consolidated Financial Statements. \/TABLE\nEXHIBIT INDEX\nExhibit Number Document Description\n(3) Articles of Incorporation and By-Laws.\nCertificate of Incorporation of Owens-Corning Fiberglas Corporation, as amended (incorporated herein by reference to Exhibit (3) to the Company's annual report on Form 10-K for 1986).\nBy-Laws of Owens-Corning Fiberglas Corporation, as amended (incorporated herein by reference to Exhibit (19) to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1988).\n(4) Instruments Defining the Rights of Security Holders, Including Indentures.\nCredit Agreement, dated as of November 2, 1993, among Owens-Corning Fiberglas Corporation, the Banks listed on Annex A thereto, and Credit Suisse, as Agent for the Banks (incorporated herein by reference to Exhibit (4) to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 1993), as amended by Amendment No. 1 thereto (incorporated herein by reference to Exhibit (10) to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 1994).\nThe Company agrees to furnish to the Securities and Exchange Commission, upon request, copies of all instruments defining the rights of holders of long-term debt of the Company where the total amount of securities authorized under each issue does not exceed ten percent of the Company's total assets.\n(10) Material Contracts.\nCredit Agreement, dated as of November 2, 1993, among Owens-Corning Fiberglas Corporation, the Banks listed on Annex A thereto, and Credit Suisse, as Agent for the Banks (incorporated herein by reference to Exhibit (4) to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 1993), as amended by Amendment No. 1 thereto (incorporated herein by reference to Exhibit (10) to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 1994).\nRights Agreement, dated as of December 18, 1986, between Owens-Corning Fiberglas Corporation and Manufacturers Hanover Trust Company, as Rights Agent, including, as Exhibit B of such Rights Agreement, the form of Right Certificate (incorporated herein by reference to Exhibits 1 and 2 to the Company's Registration Statement on Form 8- A, dated December 23, 1986).\nEXHIBIT INDEX\nExhibit Number Document Description\n* 1995 Corporate Incentive Plan - General Terms (filed herewith).\n* Agreement, dated as of January 1, 1995, with William W. Colville (filed herewith).\n* Agreement, dated June 16, 1993, with David W. Devonshire (filed herewith).\n* Owens-Corning Fiberglas Corporation Director's Charitable Award Program (incorporated herein by reference to Exhibit (10) to the Company's quarterly report on Form 10-Q for the quarter ended September 30, 1993).\n* Owens-Corning Fiberglas Corporation Executive Supplemental Benefit Plan, as amended (incorporated herein by reference to Exhibit (10) to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1993).\n* Employment Agreement, dated as of December 15, 1991, with Glen H. Hiner (incorporated herein by reference to Exhibit (10) to the Company's annual report on Form 10-K for 1991), as amended by First Amending Agreement made as of April 1, 1992 (incorporated herein by reference to Exhibit (19) to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 1992).\n* Owens-Corning Fiberglas Corporation Stock Performance Incentive Plan (incorporated herein by reference to Exhibit (19) to the Company's quarterly report on Form 10-Q for the quarter ended June 30, 1992).\n* Owens-Corning Fiberglas Corporation 1987 Stock Plan for Directors, as amended (incorporated herein by reference to Exhibit (19) to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1992).\n* Form of Key Management Severance Benefits Agreement (incorporated herein by reference to Exhibit (10) to the Company's annual report on Form 10-K for 1991).\n* Agreement, dated September 27, 1990, with William W. Boeschenstein (incorporated herein by reference to Exhibit (10) to the Company's annual report on Form 10-K for 1990).\nEXHIBIT INDEX\nExhibit Number Document Description\n* Owens-Corning Fiberglas Corporation 1986 Equity Partnership Plan, as amended (incorporated herein by reference to Exhibit (19) to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1988), as amended by Amendment 1 thereto (incorporated herein by reference to Exhibit (19) to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1989), by Amendment 2 thereto (incorporated herein by reference to Exhibit (10) to the Company's annual report on Form 10-K for 1989) and by Amendment 3 thereto (incorporated herein by reference to Exhibit (10) to the Company's annual report on Form 10-K for 1990).\nThe following documents are incorporated herein by reference to Exhibit (10) to the Company's annual report on Form 10-K for 1989:\n* - Pension Agreement, dated April 16, 1984, with William W. Colville.\n* - Form of Directors' Indemnification Agreement.\nThe following documents are incorporated herein by reference to Exhibit (10) to the Company's annual report on Form 10-K for 1987:\n* - Owens-Corning Fiberglas Corporation Officers Deferred Compensation Plan.\n* - Owens-Corning Fiberglas Corporation Deferred Compensation Plan for Directors, as amended.\n(11) Statement re Computation of Per Share Earnings (filed herewith).\n(21) Subsidiaries of Owens-Corning Fiberglas Corporation (filed herewith).\n(23) Consent of Arthur Andersen LLP (filed herewith).\n(27) Financial Data Schedule (filed herewith).\n* Denotes management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.","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":"728535_1994.txt","cik":"728535","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nJ.B. Hunt Transport Services, Inc., together with its wholly- owned subsidiaries (\"JBH\" or the \"Company\") is a diversified transportation services and logistics company operating under the jurisdiction of the Interstate Commerce Commission (\"ICC\") and various state regulatory agencies. JBH is an Arkansas holding company incorporated on August 10, 1961. Through its subsidiaries JBH transports full-load containerizable freight throughout the continental United States and portions of Canada and Mexico. The Company also provides logistics and transportation-related services which may utilize JBH equipment and employees or may employ equipment and services provided by unrelated third parties in the transportation industry.\nJBH has various operating authorities granted by the ICC and state regulatory agencies. The Company may transport any type of freight (except certain types of explosives) from any point in the continental United States to any other point in another state, over any route selected by the Company. The Company also has certain intrastate authorities, allowing pick-up and delivery within those states. Federal legislation was enacted effective January 1, 1995 which preempted each state's right to limit entry into intrastate operations. A wide range of products are transported including automotive parts, department store merchandise, paper and paper products, plastics, chemicals and manufacturing materials and supplies.\nJBH was granted certain Canadian authority initially in 1988 and currently transports freight to and from all points in the continental United States to Quebec, British Columbia and Ontario. Transportation services are also provided between certain Canadian provinces. The Company has provided transportation services to and from Mexico since 1989 through interchange operations with various Mexican motor carriers. A joint venture agreement with Transportacion Maritima Mexicana, the largest transportation company in Mexico, was signed in 1992.\nIn 1990, JBH initiated intermodal operations with the Atchison, Topeka and Santa Fe Railway Company. In accordance with this agreement, freight may be transported by rail utilizing traditional trailer-on-flatcar (TOFC) or container-on-flatcar (COFC) medium. Since this initial agreement with Santa Fe, intermodal operations have been expanded to include arrangements with twelve railroads. A number of these rail routes allow the utilization of a newly-designed container which can be double-stacked to provide improved productivity. Substantially all of the freight carried under these rail arrangements is guaranteed space on trains and receives preferential loading and unloading at rail facilities.\nThe Company also offers related full truckload transportation services. Flatbed and special (hazardous) commodities operations were commenced in 1991. A Texas intrastate operation was also acquired in 1991. A growing number of shippers are interested in logistics and dedicated equipment services, whereby all transportation requirements can be outsourced and provided by one management and services company. JBH organized a logistics services unit in 1992 and a dedicated equipment operation in 1993.\nMARKETING AND OPERATIONS\nThe truckload market has traditionally been a lower price, lower service market when compared to the less-than-truckload (LTL) segment. The Company has opted to provide a premium service and charge compensating rates rather than compete primarily on the basis of price.\nThe Company's business is well diversified and no one customer accounted for more than 6% of revenues during 1994 or 1993. Marketing efforts include significant focus on the diversified group of \"Fortune 500\" customers. A broad geographic dispersion and a good balance in the type of industries served allow JBH some protection from major seasonal fluctuations. However, consistent with the T\/L industry in general, freight is typically stronger in the second half of the year with peak months being August, September and October. In addition, demand for services is usually strong at the end of the first two calendar quarters (i.e., March and June). Revenue is also affected by bad weather and holidays, since revenue is directly related to available working days of shippers.\nThe Company markets door-to-door T\/L service through its nationwide marketing network. Services involving intermodal transportation mediums are billed by JBH and all inquiries, claims and other customer contact are handled by the Company. In late 1994, the Company reorganized its dry van and intermodal operations into five geographically based regions.\nPERSONNEL\nAt December 31, 1994, JBH employed 11,837 people, including 8,667 drivers. The transportation industry and the Company have experienced shortages of qualified drivers from time to time. The Company has developed an extensive program to attract, train and retain drivers.\nBoth experienced and non-experienced drivers are trained in all phases of Company policies and operations, as well as defensive driving, safety techniques and fuel efficient operation of equipment. During 1992, three distinct driving designations (local, regional or zone and over-the road) were identified in order to get drivers home more frequently and provide specific support for intermodal and regional operations. Drivers are compensated based upon miles driven, a specified rate per week, or a combination of both. Additional compensation may be earned based upon fuel economy and other performance criteria. The Company also employed approximately 1000 mechanics as of December 31, 1994. In the opinion of management, the Company's relationship with all of its employees is excellent.\nREVENUE EQUIPMENT\nAt December 31, 1994, JBH owned 7,412 tractors, 8,636 trailers and 14,051 specially designed containers. The average age of the tractor and trailing equipment fleet was approximately two years. In late 1992, the Company announced the development of a new multi-purpose container which can be placed on a chassis for transportation over-the-road by truck and also moved by rail or ship. The container and chassis combination may be transported by rail (TOFC) or the container can be separated from the chassis and double-stacked (COFC) on the rail for improved productivity. The Company intends to continue the conversion of a significant portion of its dry van trailer fleet to these containers.\nA periodic maintenance program is strictly enforced for all revenue equipment based upon the specific type and use of the equipment. JBH believes that modern, late-model, clean equipment differentiates quality service in the marketplace. A professional maintenance program minimizes downtime, increases utilization and enhances the trade-in value of used equipment.\nCOMPETITION\nJBH is the largest publicly-held T\/L carrier in the United States. It competes primarily with other irregular route, T\/L common carriers. LTL common carriers and private carriers generally provide limited competition. JBH is one of a few carriers offering nationwide logistics management and dedicated revenue equipment services. Although a number of carriers may provide competition on a regional basis, only a limited number of companies represent competition in all markets. The extensive rail network developed in conjunction with the various railroads also allows the Company the opportunity to differentiate its services in the marketplace.\nREGULATION\nThe Company is a motor common carrier regulated by the ICC. The ICC generally governs activities such as authority to engage in interstate motor carrier operations, accounting systems, certain mergers, consolidations, acquisitions and periodic financial reporting.\nMotor carrier operations are subject to safety requirements prescribed by the United States Department of Transportation (DOT) governing interstate operation. Such matters as weight and dimensions of equipment and commercial driver's licensing are also subject to federal and state regulations. A federal requirement that all drivers obtain a commercial driver's license became effective in April 1992.\nThe federal Motor Carrier Act of 1980 was the start of a program to increase competition among motor carriers and limit the level of regulation in the industry (sometimes referred to as \"deregulation\"). The Motor Carrier Act of 1980 enabled applicants to obtain ICC operating authority more easily and allows interstate motor carriers, such as the Company, to change their rates by a certain percentage per year without ICC approval. The new law also allowed for the removal of many route and commodity restrictions regarding the transportation of freight. As a result of the Motor Carrier Act of 1980, the Company was able to obtain unlimited authority to carry general commodities throughout the 48 contiguous states. Effective January 1, 1995, the federal government issued guidelines which allow motor carriers more flexibility in intrastate operations. Although this reduced level of state regulation may increase the level of competition in some regions, the Company believes it will ultimately benefit from this legislation.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters are in Lowell, Arkansas. A 150,000-square-foot building was constructed and occupied in September 1990. The building is situated on a 127-acre tract of land.\nIn addition to the corporate headquarters, the Company owns a separate 62-acre tract in Lowell, Arkansas with four separate buildings totaling 21,000 square feet of office space and 90,000 square feet of maintenance and warehouse space. These buildings serve as the Lowell operations terminal, tractor and trailer maintenance facilities and additional administrative offices.\nA summary of the Company's principal facilities follows:\nThe Company owns all of the above listed facilities except Chicago which is leased. In addition to the above facilities, the Company leases several small offices and\/or trailer parking yards in various locations throughout the country.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to routine litigation incidental to its business, primarily involving claims for personal injury and property damage incurred in the transportation of freight. The Company maintains excess insurance above its self-insured levels which covers extraordinary liability resulting from such claims. Adverse results in one or more of these cases would not have a material adverse effect on the financial position of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe 1994 Annual Stockholders' Meeting was held on May 12, 1994. At that meeting, the following matters were submitted to a vote of security holders:\n1. To elect ten (10) directors and to fix the number of directors for the ensuing year at ten (10).\n2. To ratify the appointment of KPMG Peat Marwick LLP as the Company's independent public accountants for the next fiscal year.\nNo matters were 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 STOCK AND RELATED SECURITY HOLDER MATTERS\nPRICE RANGE OF COMMON STOCK\nThe Company's common stock is traded in the over-the-counter market under the symbol \"JBHT\". The following table sets forth, for the calendar periods indicated, the range of high and low sales prices for the Company's common stock as reported by the National Association of Securities Dealers Automated Quotations National Market System (\"NASDAQ\").\nOn February 28, 1995, the high and low sales prices for the Company's common stock as reported by the NASDAQ were $19.50 and $19.25, respectively. As of February 28, 1995, the Company had 2,032 stockholders of record.\nDIVIDEND POLICY\nOn January 25, 1995, the Board of Directors declared a quarterly dividend of $.05 per share, payable to shareholders of record on February 2, 1995. Although it is the present intention of the Board of Directors to continue quarterly dividends, payment of future dividends will depend upon the Company's financial condition, results of operations and other factors deemed relevant by the Board of Directors. The Company declared and paid cash dividends of $.20 per share in 1994 and $.20 per share in 1993.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (Dollars in thousands, except per share amounts)\nPERCENTAGE OF OPERATING REVENUE\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nThe following should be read in conjunction with the Selected Financial Data and the Company's Consolidated Financial Statements and Notes to Consolidated Financial Statements which appear elsewhere in this report.\nRESULTS OF OPERATIONS\nThe following table sets forth the change in amounts and percentage change between years of certain revenue, expense and operating items.\n(Dollars in thousands, except tractor data)\nThe following table sets forth certain industry operating data of the Company.\nOPERATING REVENUES\nOperating revenues increased 18% from 1993 to 1994 and 12% from 1992 to 1993. These increases in revenue were primarily due to continued growth of intermodal dry van volume, expansion of specialized carrier operations and modest increases in base truck freight rates. The average number of tractors in the fleet increased only 3% in 1994 and 7% in 1993. Due to the Company's strategy of providing diversified transportation services including intermodal and full-service logistics management, revenue growth is no longer directly related to size of the tractor fleet. The $187 million increase in revenue from 1993 to 1994 included $89 million from logistics and dedicated contract services, $71 million of dry van volume and $27 million from other specialized carrier operations. The increase in 1994 dry van revenue includes intermodal revenue and an approximate 4% increase in truck freight rates. The $109 million increase in revenue from 1992 to 1993 included $43 million from dry van volume, $38 million of logistics and dedicated contract services and $28 million from other specialized carrier operations. The 1993 dry van revenue increase includes intermodal and an approximate 2% increase in truck freight rates.\nRevenue growth during 1994 and 1993 continued to reflect a focus on utilizing intermodal transportation services. Intermodal operations at December 31, 1994 include arrangements with twelve different railroads across the United States and portions of Canada and Mexico. Intermodal revenue increased 37% in 1994 and 66% in 1993, including incremental freight and some conversion of freight previously transported entirely by truck.\nIncreased operating revenues also reflect growth of logistics management and dedicated contract services. Customers continue to request customized transportation solutions to their distribution needs. Since 1992, the Company has offered customers the ability to outsource their total freight distribution process. Revenue from these logistics and dedicated contract services has more than doubled in each of the years 1994 and 1993.\nOPERATING EXPENSES\nSalaries, wages and employee benefits expense increased 9% from 1993 to 1994, reflecting primarily additional staffing in the logistics and dedicated contract services areas. The increase of 7% in 1993 was in proportion to the size of the fleet. Purchased transportation expense increased significantly during 1994 and 1993, reflecting the growth of intermodal and third- party transportation services. Fuel and fuel tax expense remained reasonably constant during 1994 and 1993 in relation to slight changes in the cost per gallon of fuel. Depreciation expense increased 33% in 1994 due to significantly lower gains on the disposition of revenue equipment and an 18% increase in the number of trailers and containers in the fleet. The decrease in depreciation expense in 1993 was primarily due to the amount of gains on equipment dispositions during that year.\nOperating supplies and expenses increased 13% in 1994. This increase was due to increased spending for tractor and trailer repairs. The increase in operating supplies and expenses during 1993 was in relative proportion to the size of the tractor fleet. Insurance and claims expense decreased in both 1994 and 1993. The Company has continued to focus on reducing accident frequency and severity since late 1992. Operating taxes and licenses decreased during 1994 due to the growth of intermodal volume and the utilization of third-party services and certain credits recognized during the year. The 12% increase in 1993 reflects the size of the tractor fleet and rate increases enacted by various state regulatory agencies.\nThe significant increase in general and administrative expenses during 1994 is primarily due to higher levels of driver advertising and recruitment cost. The Company experienced a shortage of qualified drivers during the first half of 1994. Communication and utilities expense increased 21% during 1994, primarily due to increased volume of loads and revenue. In addition, certain satellite transmission charges related to on- board tractor communication devices commenced during 1994. The decrease of communication and utilities expense in 1993 was primarily due to certain rate reductions and credits.\nInterest expense increased significantly during 1994 and 1993, primarily due to higher levels of debt associated with the acquisition of new containers and chassis and slightly higher interest rates.\nThe effective income tax rate was 38% in 1994 and 41% in 1993. The higher effective rate in 1993 was due to the increase in the federal tax rate on both current and deferred income taxes which was effective retroactive to January 1, 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nIn 1992, the Company committed to increased levels of capital spending on new technology including custom-designed on board tractor communication devices and multi-purpose container and chassis equipment. As of December 31, 1994, more than 14,000 of the newly designed containers were in service. Net capital expenditures were $219 million in 1994, $197 million in 1993 and $249 million in 1992, compared to $113 million in 1991. These expenditures were funded with proceeds from long-term debt, a secondary offering of common stock in 1992 and cash generated from operations.\nThe Company is authorized to issue up to $250 million in notes, $183 million of which was outstanding at December 31, 1994. A shelf registration statement for an aggregate principal amount of $250 million of debt securities was filed in 1993. At December 31, 1994, $100 million of 6.25% unsecured notes were outstanding in connection with this registration statement. The Company received approximately $56 million from a secondary offering of common stock in 1992. In addition, the Company had approximately $125 million of uncommitted lines of credit, none of which were outstanding at December 31, 1994.\nWith more than 70% of the dry van fleet converted to the new container equipment, the level of capital spending should decline during 1995. As of December 31, 1994, the Company had committed to purchase approximately $160 million of revenue and service equipment (net cost after expected proceeds from the sale or trade-in allowances of $15 million). The Company expects to fund future capital expenditures from cash provided by operating activities and proceeds from long-term debt.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nWe have audited the accompanying consolidated balance sheets of J.B. Hunt Transport Services, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, 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 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 J.B. Hunt Transport Services, 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(b) to the consolidated financial statements, the Company changed its method of accounting for the cost of tires in service during 1992.\nKPMG Peat Marwick LLP February 7, 1995\nMANAGEMENT'S REPORT\nManagement is responsible for the financial statements and other information contained in its annual report. The financial statements have been prepared in accordance with appropriate, generally accepted accounting principles, and the other information presented is consistent with the financial statements. In preparing these financial statements, it is necessary to make informed judgments and estimates regarding the expected effects of certain events and transactions that are currently being reported.\nTo meet its financial reporting responsibilities, management depends upon systems of internal controls which are intended to provide reasonable assurance, in relationship to reasonable cost, that assets are safeguarded, that transactions are executed in accordance with management's authorization and that the transactions are properly recorded so as to permit preparation of financial statements in accordance with generally accepted accounting principles. Management seeks to provide reasonable assurance that the objectives of internal accounting control are met by prudent selection of personnel, adoption of appropriate policies, effective communication to personnel and establishment of an effective system of authorization.\nThe Board of Directors performs an oversight role with respect to management's financial reporting responsibilities. To ensure effective discharge of its responsibilities, the Board of Directors has established an audit committee. The majority of the committee members are nonemployees of the Company and its subsidiaries. The audit committee has met and reviewed accounting issues, financial reporting and audit matters, including those pertaining to the effectiveness of the Company's systems of internal control.\nThe consolidated financial statements have been audited by KPMG Peat Marwick LLP. As part of their audit of the Company's financial statements, our independent accountants considered the Company's system of internal control structure to the extent they deemed necessary to determine the nature, timing and extent of their audit tests. These auditing procedures are intended to provide a reasonable level of assurance that the financial statements are fairly stated in all material respects.\nKirk Thompson Jerry W. Walton President and Chief Executive Officer Executive Vice President, Finance and Chief Financial Officer March 17, 1995\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993 (DOLLARS IN THOUSANDS, EXCEPT PAR VALUE)\nSee accompanying notes to consolidated financial statements.\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements December 31, 1994, 1993 and 1992\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nJ. B. Hunt Transport Services, Inc., together with its wholly-owned subsidiaries (\"Company\"), is a diversified transportation services and logistics company operating under the jurisdiction of the Interstate Commerce Commission (\"ICC\") and various state regulatory agencies.\n(A) PRINCIPLES 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.\n(B) TIRES IN SERVICE\nPrior to 1992, the cost of tires placed in service, including replacement tires, was capitalized and amortized on the straight-line method over their estimated useful life. Effective January 1, 1992, the Company began capitalizing tires placed in service on new revenue equipment as a part of the equipment cost. Replacement tires are expensed at the time they are placed in service. This new method of accounting for tires placed in service is consistent with frequent industry practice. Due to the increasing percentage of freight transported on rail cars (intermodal), this method, in the opinion of management, provides a better matching of tire costs with revenues. This change increased net earnings for 1992 by $1,310,000 ($.04 per share). The cumulative impact of $1,825,000 ($.05 per share) to retroactively apply the new method has also been credited to earnings for 1992. This accounting change resulted in the reduction of prepaid tires by $21,541,000, an increase in net revenue equipment of $24,415,000 and an increase in deferred income taxes of $1,049,000. The proforma amounts shown on the consolidated statements of earnings have been adjusted for the effect of retroactive application on expenses and the related income taxes.\n(C) PROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. Depreciation of property and equipment is calculated on the straight-line method over the estimated useful lives of 5 to 10 years for revenue and service equipment, 10 to 25 years for structures and improvements, and 3 to 10 years for furniture and office equipment. Gains on dispositions of revenue equipment are offset against depreciation expense.\nOn April 1, 1993, the Company changed the estimated salvage value for some of its revenue and service equipment. The effect upon 1993 net earnings was an increase of approximately $2,639,000 ($.07 per share).\n(D) REVENUE RECOGNITION\nThe Company recognizes revenue based on relative transit time in each reporting period with expenses recognized as incurred as permitted by the Emerging Issues Task Force of the Financial Accounting Standards Board.\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements (Continued)\n(E) INCOME TAXES\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.\nEffective January 1, 1992, the Company adopted Statement 109. The effect of this change in the method of accounting for income taxes in the 1992 consolidated statement of earnings is not significant.\n(F) EARNINGS PER SHARE\nEarnings per share have been computed based on the weighted average number of shares outstanding during each year (38,559,528 in 1994; 38,276,109 in 1993; and 35,785,692 in 1992). Shares issuable under employee stock options are excluded from the weighted average number of shares as their effect is not dilutive.\nOn January 15, 1992, the Company announced a three-for-two stock split in the form of a 50% stock dividend payable on March 13, 1992, from authorized and unissued shares to stockholders of record on February 19, 1992. All references in the consolidated financial statements with regard to number of shares of common stock and the per share amounts have been retroactively restated to reflect this stock dividend.\n(G) CREDIT RISK\nFinancial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables. Concentrations of credit risk with respect to trade receivables are limited due to the Company's large number of customers and the diverse range of industries which they represent. As of December 31, 1994, the Company had no significant concentrations of credit risk.\n(H) DERIVATIVES\nThe differential paid or received on interest rate swap agreements is accrued as interest rates change and is charged or credited to interest expense over the life of the agreements. Any gains or losses realized upon the termination of an interest rate swap agreement are deferred and amortized over the remaining life of the original term as a charge or credit to interest expense.\nThe differential paid or received on fuel swap agreements is accrued as fuel prices change and is charged or credited to fuel expense on a monthly basis.\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements (Continued)\n(2) LONG-TERM DEBT\nLong-term debt consists of (in thousands):\nUnder its commercial paper note program, the Company is authorized to issue up to $250 million in notes. These notes are supported by two credit agreements, which aggregate $250 million, with a group of banks, of which $125 million expires March 31, 1995 and $125 million expires March 31, 1997. The effective rate on the commercial note program was 5.90% and 3.51% for the years ended December 31, 1994 and 1993, respectively.\nThe 6.25% senior notes are payable at maturity on September 1, 2003, the 7.75% senior notes are payable in five equal annual installments beginning October 31, 1992, the 7.84% senior notes are payable in five equal annual installments beginning March 31, 1995, and the 7.80% senior subordinated notes are payable in five equal annual installments beginning October 30, 2000.\nUnder the terms of the credit agreements and the note agreements, the Company is required to maintain certain financial covenants including leverage tests, minimum tangible net worth levels and other financial ratios.\nThe Company has approximately $125 million of uncommitted lines of credit none of which were outstanding at December 31, 1994. These lines are with various domestic and international banks and are due on demand. Interest on borrowings is generally tied to the banks' prevailing base rates or other alternative market rates. No commitment or facility fees are paid on these lines of credit and the obligations are typically evidenced by unsecured demand notes.\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements (Continued)\nThe Company restructured the credit facilities supporting its commercial paper note program by establishing two credit agreements during 1994 in order to reduce administrative expenses. Accordingly, current maturities of long-term debt at December 31, 1994 consist of outstanding commercial paper associated with the revolving credit agreement which expires March 31, 1995 and two installments of the senior notes. The aggregate annual maturities of long-term debt for each of the five years ending December 31 are as follows (in thousands): 1995, $68,075; 1996, $9,243; 1997, $130,000; 1998, $5,000; and 1999, $5,000.\n(3) CAPITAL STOCK\nThe Company maintains a Management Incentive Plan (\"Plan\") that provides various vehicles to compensate key employees with Company common stock. Under the Plan, the Company is authorized to award, in aggregate, not more than 3,000,000 shares. At December 31, 1994 there were approximately 70,000 shares available for granting under the Plan. The Company has utilized three such vehicles to award stock or grant options to purchase the Company's common stock: restricted stock awards, restricted options and nonstatutory stock options.\nRestricted stock awards are granted to key employees subject to restrictions regarding transferability and assignment. Shares of Company common stock are issued to the key employees and held by the Company until each employee becomes vested in the award. Vesting of the awards generally occurs over a four year period of time from the award date. Termination of the employee for any reason other than death, disability or certain cases of retirement causes the unvested portion of the award to be forfeited.\nKey employees were granted restricted options to purchase stock. The option price is 50% of the fair market value of the stock at the date of grant. Vesting of the award generally occurs over a four year period beginning on the grant date. Failure to exercise a vested option within 210 days after vesting or termination of the employee for any reason other than death or disability will cause unexercised and nonvested options to be forfeited.\nThe plan provides that nonstatutory stock options may be granted to key employees for the purchase of Company common stock for 100% of the fair market value at the grant date. The options generally vest over a ten year period and are forfeited if the employee terminates for any reason.\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements (Continued)\nA summary of the restricted and nonstatutory options to purchase Company common stock follows:\nOn January 25, 1995, the Company's Board of Directors declared a cash dividend of $.05 per share payable on February 17, 1995 to shareholders of record on February 2, 1995.\n(4) INCOME TAXES\nAs discussed in note 1(e), the Company adopted Statement 109 as of January 1, 1992. There was no significant impact upon earnings as a result of this change in accounting for income taxes. Total income tax expense for the years ended December 31, 1994, 1993 and 1992 was allocated as follows (in thousands):\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements (Continued)\nIncome tax expense attributable to earnings before income taxes and cumulative effect of change in accounting method consists of (in thousands):\nThe following is a reconciliation between the effective income tax rate and the applicable statutory Federal income tax rate for each of the three fiscal years in the period ended December 31, 1994:\nThe significant components of deferred income tax expense attributable to earnings before income taxes and cumulative effect of change in accounting method are as follows (in thousands):\nJ. B. HUNT TRANSPORT SERVICES, 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 (in thousands):\nThe Company believes its substantiated history of profitability and taxable income, its taxes paid within the three- year carryback period and its utilization of tax planning sufficiently supports the value of the deferred tax assets. Accordingly, the Company has not recorded a valuation allowance on its books as all deferred tax assets are more than likely to be recovered.\nIncluded in other prepaid expenses are refundable income taxes of $386,000 and $428,000 at December 31, 1994 and 1993, respectively.\n(5) EMPLOYEE BENEFIT PLANS\nThe Company maintains bonus compensation programs for certain of its employees. Bonuses earned under the programs are based on attainment of profit objectives established by the Company's Board of Directors. Bonuses expensed under the programs for 1994, 1993 and 1992 were $4,900,000, $2,600,000 and $7,400,000, respectively.\nThe Company maintains a defined contribution employee retirement plan, which includes a 401(k) option, under which employees are eligible to participate after they complete one year of service. Company contributions to the plan each year are made at the discretionary amount determined by the Company's Board of Directors. For the year ended December 31, 1994, 1993 and 1992, total Company contributions to the plan, including matching 401(k) contributions were $1,950,000, $1,900,000 and $1,850,000, respectively.\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements (Continued)\n(6) FAIR VALUE OF FINANCIAL INSTRUMENTS\nCASH AND TEMPORARY INVESTMENTS, ACCOUNTS RECEIVABLE, AND TRADE ACCOUNTS PAYABLE\nThe carrying amount approximates fair value because of the short maturity of these instruments.\nLONG-TERM DEBT\nThe carrying amount of the commercial paper debt approximates the fair value because of the short maturity of the commercial paper instruments.\nThe fair value of the fixed rate debt is presented as the present value of future cash flows discounted using the Company's current borrowing rate for notes of comparable maturity. The calculation arrives at a theoretical amount the Company would pay a creditworthy third party to assume its fixed rate obligations and not the termination value of these obligations. Consistent with market practices, such termination values may include various prepayment and termination fees that the Company would contractually be required to pay if it retired the debt early.\nINTEREST RATE SWAP AGREEMENTS\nThe fair values of interest rate swap agreements are obtained from dealer quotes. These values represent the estimated amount the Company would pay to terminate such agreements, taking into consideration current interest rates and the creditworthiness of the counterparties.\nThe estimated fair values of the Company's financial instruments are summarized as follows (in thousands):\n(7) RELATED PARTY TRANSACTIONS\nThe Company advances premiums on a life insurance policy on the joint lives of Mr. and Mrs. J.B. Hunt. The Company has advanced $3,280,000 on this policy which, along with related accrued interest thereon of approximately $416,000, is included in other assets at December 31, 1994. All premiums paid by the Company, along with accrued interest thereon, are reimbursable from a trust which is the owner and beneficiary of the policy.\nJ. B. HUNT TRANSPORT SERVICES, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements (Continued)\n(8) COMMITMENTS AND CONTINGENCIES\nThe Company has committed to purchase approximately $160 million of revenue and service equipment (net cost, after expected proceeds from sale or trade-in allowances of $15 million).\nThe Company is involved in certain claims and pending litigation arising from the normal conduct of business. Based on the present knowledge of the facts and, in certain cases, opinions of outside counsel, management believes the resolution of claims and pending litigation will not have a material adverse effect on the financial condition of the Company.\n(9) DERIVATIVE FINANCIAL INSTRUMENTS\nInterest rate swap agreements are used to reduce the potential impact of changes in interest rates on the Company's debt portfolio. At December 31, 1994, an interest rate swap agreement with an aggregate notional amount of $20 million was outstanding. The estimated fair value of the swap at December 31, 1994 was a liability of approximately $2.0 million. This value was determined from a dealer quotation and represents the estimated amount the Company would pay to terminate the agreement. Included in other current liabilities are deferred swap gains of $0.8 million at December 31, 1994 and $1.1 million at December 31, 1993.\nThe Company uses fuel swap agreements to hedge anticipated purchases of diesel fuel. Under these agreements, the Company receives or makes payments on the differential between a contractual index price and the actual average index during such period.\n(10) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nOperating results by quarter for the years ended December 31, 1994 and 1993 are as follows (in thousands, except per share data):\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNo reports on Form 8-K have been filed within the twenty-four months prior to December 31, 1994, involving a change of accountants or disagreements on accounting and financial disclosure.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required for Items 10, 11 and 12 is hereby incorporated by reference from the Notice and Proxy Statement For Annual Stockholders' Meeting set forth under sections entitled \"Proposal One Election of Directors\", \"Board Committees\", \"Executive Officers\", \"Voting Securities and Security Ownership of Management and Principal Stockholders\", \"Executive Compensation and Other Information\", \"1995 Performance Based Compensation\" and \"Proposal Two Proposal to Approve the Adoption of The Executive Performance Bonus Plan\", \"Proposal Three Proposal to Approve the Management Incentive Plan\", and \"Proposal Four Ratification of Appointment of Auditors\".\nThe Proxy Statement had not yet been mailed to stockholders and was not available as of March 17, 1995. It will be filed no later than April 30, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS\nThe following documents are filed as part of this report: (a) Exhibits The response to this portion of Item 14 is submitted as a separate section of this report (\"Exhibit Index\").\nSIGNATURES\nPursuant to the requirements of Sections 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, in the City of Lowell, Arkansas, on the 17th day of March, 1995.\nJ.B.HUNT TRANSPORT SERVICES, INC. (Registrant)\nBy: \/s\/ Kirk Thompson ------------------------------------- Kirk Thompson President and Chief Executive Officer\nBy: \/s\/ Jerry W. Walton ------------------------------------- Jerry W. Walton Executive 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.\n\/s\/ John A. Cooper, Jr. Member of the Board March 17, 1995 ------------------------------ John A. Cooper, Jr. of Directors\n\/s\/ Fred K. Darragh, Jr. Member of the Board March 17, 1995 ------------------------------ Fred K. Darragh, Jr. of Directors\n\/s\/ Wayne Garrison Member of the Board March 17, 1995 ------------------------------ Wayne Garrison of Directors\n\/s\/ Gene George Member of the Board March 17, 1995 ------------------------------ Gene George of Directors\n\/s\/ Thomas L. Hardeman Member of the Board March 17, 1995 ------------------------------ Thomas L. Hardeman of Directors\n\/s\/ J. Bryan Hunt, Jr. Member of the Board March 17, 1995 ------------------------------ J. Bryan Hunt, Jr. of Directors (Vice Chairman)\n\/s\/ J.B. Hunt Member of the Board March 17, 1995 ------------------------------ J.B. Hunt of Directors (Chairman)\n\/s\/ Johnelle Hunt Member of the Board March 17, 1995 ------------------------------ Johnelle Hunt of Directors (Corporate Secretary)\n\/s\/ Lloyd E. Peterson Member of the Board March 17, 1995 ------------------------------ Lloyd E. Peterson of Directors\n\/s\/ Kirk Thompson Member of the Board March 17, 1995 ------------------------------ Kirk Thompson of Directors (President and Chief Executive Officer)\nEXHIBIT INDEX","section_15":""}
{"filename":"721799_1994.txt","cik":"721799","year":"1994","section_1":"ITEM 1. BUSINESS\nKrupp Realty Limited Partnership-V (the \"Partnership\") was formed on June 16, 1983 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. The Krupp Corporation (a Massachusetts corporation) and The Krupp Company Limited Partnership-II (a Massachusetts limited partnership) are the General Partners of the Partnership. The Partnership has issued all of the Original Limited Partner Interests to The Krupp Company Limited Partnership-II. On September 6, 1983, the Partnership, pursuant to a sales agent agreement, commenced the marketing and sale of units of Investor Limited Partner Interest (\"Units\") for $1,000 per unit, 35,200 of which were sold. For further details, see Note A to Financial Statements included in Appendix A to this report.\nThe Partnership considers itself to be engaged only in the industry segment of investment in real estate. The Partnership invested the net proceeds from the offering in leveraged real estate. The Partnership originally invested in four multi-family apartment complexes (Century II, Marine Terrace, Fieldcrest Apartments, Park Place Tower Apartments \"Park Place\") and a joint venture in Lakeview Towers with Krupp Realty Limited Partnership-IV, an affiliated limited partnership. The aggregate purchase price of the properties was approximately $67 million and the Partnership originally funded approximately $2.3 million to the joint venture.\nIn 1992, the Partnership sold one of its apartment complexes, Fieldcrest Apartments, and received a distribution of proceeds from the sale of Lakeview Towers.\nThe Partnership's real estate investments are subject to some material seasonal fluctuations resulting from changes in utility consumption and seasonal maintenance expenditures. Such factors include general economic and real estate market conditions, both on a national basis and in those areas where the Partnership's real estate investments are located, real estate tax rates, operating expenses, energy costs, government regulations and federal and state income tax laws. The requirements for compliance with federal, state and local regulations to date have not had an adverse effect on the Partnership's operations, and no adverse effect therefrom is now anticipated in the future.\nThe Partnership's investments in real estate are also subject to such risks as (i) competition from existing and future projects held by other owners in the locations of the Partnership's properties, (ii) fluctuations in rental income due to changes in occupancy levels, (iii) possible adverse changes in mortgage interest rates, (iv) possible adverse changes in general economic and local conditions, such as competitive over-building, increases in unemployment, or adverse changes in real estate zoning laws, (v) the possible future adoption of rent control legislation which would not permit the full amount of increased costs to be passed on to tenants in the form of rent increases, and (vi) other circumstances over which the Partnership may have little or no control.\nAs of December 31, 1994, there were 54 full and part-time on-site personnel employed by the Partnership.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of December 31, 1994, the Partnership has leveraged investments in three apartment complexes having an aggregate of 1,556 units. One of the complexes has an additional 20,000 square feet of leasable commercial space.\nA summary of the Partnership's real estate investments is presented below. Schedule III included in Appendix A to this report contains additional detailed information with respect to individual properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is a defendant in a class action suit related to the practice of giving discounts for the early or timely payments of rent at Park Place. The central issue of the complaint was whether the operative lease, by allowing tenants a discount, of typically $30, if rent was paid on or before the first day of the month, violated a Chicago municipal ordinance relating to late fee charges. The ordinance in question limited late fee charges to $10 per month if the rent was more than 5 days late. The allegation was that, notwithstanding the stated rental rate and printed discount, the practice represented an unlawful means of exacting late fee charges. In addition to seeking damages for any \"forfeited\" discounts, plaintiffs seek statutory damages of two months rent per lease violation plus reasonable attorneys' fees. To be eligible for such punitive damages plaintiffs must prove that defendants deliberately used a provision prohibited by the ordinance. During 1994, the Court ruled in favor of the Defendants, and accepted the Partnership's Motion to Dismiss the Plaintiff's Third Amended Complaint. The Plaintiffs have filed an appeal with the Appellate Court of Illinois, First District, which is pending.\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 EQUITY AND RELATED STOCKHOLDER MATTERS\nThe transfer of Units is subject to certain limitations contained in the Partnership Agreement. There is no public market for the Units and it is not anticipated that any such public market will develop.\nThe number of Investor Limited Partners as of December 31, 1994 was approximately 2,400.\nOne of the objectives of the Partnership is to generate cash available for distribution. The General Partners discontinued distributions during 1990 due to insufficient operating cash flow. The Partnership will resume distributions when the properties generate sustainable cash flow in excess of operating and capital improvement needs to provide for such distributions. However, during 1993, the Partnership distributed an amount equal to the withholding required for a Partners' tax of $27,888 in the state of Maryland arising from the sale of Fieldcrest Apartments. This amount was paid to the state of Maryland for the benefit of all Partners.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth selected financial information regarding the Partnership's financial position and operating results. This information should be used in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Financial Statements and Supplementary Data, which are included in Items 7 and 8 of this report, respectively.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLiquidity and Capital Resources\nThe Partnership's ability to generate cash adequate to meet its needs is dependent primarily upon the successful operations of its real estate investments. Such ability is also dependent upon the future availability of bank borrowing sources as current debt matures. These sources of liquidity will be used by the Partnership for payment of expenses related to real estate operations, debt service, capital improvements and expenses. Cash flow, if any, as calculated under Section 8.2(a) of the Partnership Agreement (\"Cash Flow\"), will then be available for distribution to the Partners. The General Partners discontinued distributions during 1990 due to insufficient operating cash flow. The Partnership will resume distributions when the properties generate sustainable cash flow in excess of operating and capital improvement needs.\nThe Partnership's major capital improvement project, the repair of Park Place's building facade, is approximately 95% complete as of December 31, 1994. The Partnership anticipates that the restoration project will be completed in early 1995, and will greatly enhance the appearance of the property. This improvement, along with extensive interior improvements, is being funded from established reserves and is expected to result in both increased rents and increased occupancy.\nPrior to Park Place's refinancing on September 15, 1993, management suspended payment of property management fees and expense reimbursements to an affiliate. At December 31, 1994, past due fees and reimbursements totalled approximately $1,300,000. Subsequent to the refinancing, the Partnership resumed current payments of property management fees and expense reimbursements and expects to generate sufficient cash flow to begin to repay the accrued obligation.\nCurrently, the Partnership is researching refinancing options for Marine Terrace.\nCash Flow\nShown below, as required by the Partnership Agreement, is the calculation of Cash Flow for the year ended December 31, 1994:\nOperations\nThe following discussion relates to the operations of the Partnership and its properties (Park Place, Marine Terrace, Century II and Fieldcrest) for the years ended December 31, 1994, 1993 and 1992, or portion thereof.\n1994 compared to 1993\nThe slight increase in rental revenue is primarily due to an increase in rental rates at Park Place and Marine Terrace, and increased occupancy at Century II, offset by decreased occupancy at Marine Terrace. Interest income decreased due to funds previously invested in short-term investments being used for the refinancing of Park Place's mortgage during the third quarter of 1993 and a decrease in interest earned on construction escrows.\nOperating expenses decreased due to savings in parking garage expenses as a result of management subcontracting the parking garage operations at Park Place. Additionally, a portion of this decrease resulted from a rate reduction in electric costs by the local utility company. These savings were partially offset by an increase in maintenance expense, primarily for the painting of the interior units and the installation of window dressings at Park Place. Real estate taxes decreased at Park Place due to a prior year revaluation by the taxing authority. However, real estate taxes are expected to increase upon the completion of the building facade repair.\nAs a result of the refinancing of Park Place's first mortgage from an interest rate of 10.75% to 6.75% per annum during the third quarter of 1993, interest expense decreased by $1,456,000 for the year ended December 31, 1994, as compared to the same period in 1993. The decrease in depreciation and amortization is primarily due to a mortgage premium paid and fully amortizing deferred mortgage costs in 1993 related to the mortgage loan held prior to Park Place's refinanced mortgage.\n1993 compared to 1992\nThe results of operations of the Partnership are not comparable due to the sales of Lakeview Towers and Fieldcrest Apartments in the third quarter of 1992. Rental revenues increased by $203,000, net of $748,000 revenue generated by Fieldcrest Apartments in 1992. The primary reason for the increase in rental revenue is due to increase occupancy at Park Place and Marine Terrace, offset by an increase in vacancies at Century II. The vacancies at Century II were primarily due to a softening in the rental marketplace because of significant layoffs in the area and first time home buyers taking advantage of lower interest\nContinued\nrates. Interest income increased by $60,000 primarily due to the Partnership's investment in commercial paper and interest earned on the $1,400,000 Park Place escrow.\nIn comparing 1993 to 1992, recurring operating expenses increased by $103,000, less Fieldcrest expenses of $331,000. Maintenance expenses decreased by $130,000 primarily due to the sale of Fieldcrest. Real estate taxes were lower in 1992 due to an abatement of the 1992 and 1991 taxes at Park Place and Marine Terrace totalling $601,000, recorded in 1992. Interest expense decreased by $168,000 resulting from the sale of Fieldcrest in 1992 and the refinancing of Park Place's mortgage in 1993. In conjunction with the refinancing, the Partnership wrote off the mortgage premium and deferred costs of the original Park Place loan totalling $1,190,000.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Appendix A to this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Partnership has no directors or executive officers. Information as to the directors and executive officers of The Krupp Corporation, which is a General Partner of the Partnership and is the general partner of The Krupp Company Limited Partnership-II, which is the other General Partner of the Partnership, is as follows: Position with Name and Age The Krupp Corporation\nDouglas Krupp (48) Co-Chairman of the Board\nGeorge Krupp (50) Co-Chairman of the Board\nLaurence Gerber (38) President\nMarianne Pritchard (45) Treasurer Ross V. Keeler (46) Executive Vice President\nFrank Apeseche (37) Executive Vice President\nDouglas Krupp has been Co-Chairman of The Berkshire Group (formerly The Krupp Companies) since its formation in 1966. He has been primarily responsible for overseeing the acquisition, disposition and financing of properties by the entities sponsored by The Berkshire Group and their affiliates. In addition, since 1987 Mr. Krupp has been responsible for founding and overseeing through the start-up phase certain new business ventures including the healthcare and construction businesses of The Berkshire Group. He is a graduate of Bryant College in Rhode Island. In 1989, he received an honorary Doctor of Science in Business Administration degree from Bryant College and he also serves as a Trustee of Bryant College. Douglas Krupp is the brother of George Krupp.\nContinued\nGeorge Krupp has been Co-Chairman of The Berkshire Group since its formation in 1966. His efforts over the years have encompassed the broad spectrum of The Berkshire Group's activities including responsibility for the real estate operations of The Berkshire Group through mid-1991, and he continues to be involved in strategic planning. He attended the University of Pennsylvania prior to joining his brother, Douglas Krupp, in the real estate business in 1966. Mr. Krupp currently serves as Chairman of the Board and a Trustee of Krupp Government Income Trust and Krupp Government Income Trust II, and Chairman of the Board and a director of Berkshire Realty Company, Inc.\nLaurence Gerber has been President and Chief Executive Officer of The Berkshire Group since 1991. He previously served from 1987 to 1991 as President of Berkshire Financial Company with overall responsibility for marketing, mortgage banking, product development and corporate financing, and also worked on strategic planning. Prior to that, he served as Executive Vice President, Acquisitions and, prior to that, as Senior Vice President and Chief Planning Officer since joining the firm in January 1984. Before joining the firm, Mr. Gerber was a management consultant with Bain & Co. headquartered in Boston, since July 1982. Prior to that, he was a Senior Tax Accountant with Arthur Andersen & Co., an international accounting and consulting firm, in New York. He has a B.S. degree in economics with high honors from the University of Pennsylvania Wharton School and an M.B.A. degree with High Distinction from Harvard Business School. He is a Certified Public Accountant. Mr. Gerber serves as President and a Trustee of Krupp Government Income Trust and Krupp Government Income Trust II, and as President and a director of Berkshire Realty Company, Inc.\nMarianne Pritchard, Treasurer of The Krupp Corporation and Senior Vice-President, has been Chief Financial and Accounting Officer of Berkshire Realty Affiliates since rejoining The Berkshire Group in August, 1991. Prior to rejoining The Berkshire Group, she was Vice President and Controller for Liberty Real Estate Group, a subsidiary of Liberty Mutual Insurance Company from July 1989 to August 1991. Prior to Liberty, Ms. Pritchard held the position of Controller\/Treasurer of Berkshire Mortgage Finance from April 1987 to July 1989. Prior to that, Ms. Pritchard was Senior Audit Manager with Deloitte and Touche, an international accounting and consulting firm. She is a Certified Public Accountant and received her B.B.A. degree in Accounting from the University of Texas.\nRoss V. Keeler is President of Berkshire Investment Advisors and an Executive Vice-President of The Berkshire Group. Prior to joining The Berkshire Group in November 1984, he served as Executive Vice President of Marketing and a member of the Board of Directors at First Capital Companies, a national syndicator of real estate investments. Prior to that, Mr. Keeler served as President of State Financial Corporation, a company which originated specialized leases on major equipment for municipalities. He received a B.S. degree in finance with honors from the University of Florida and received an M.B.A. degree with scholastic honors from the University of Southern California.\nFrank Apeseche was appointed Executive Vice President and Chief Financial Officer of The Berkshire Group on January 1, 1993. He oversees strategic planning, tax planning, corporate finance and product development for The Berkshire Group. Before joining the firm in 1986, Mr. Apeseche was a manager at Arthur Andersen & Co., an international accounting and consulting firm. Mr. Apeseche holds a B.A. degree with High Distinction from Cornell University and an M.B.A. degree with honors from the University of Michigan.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no directors or executive officers.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of December 31, 1994, no person of record owned or was known by the General Partners to own beneficially more than 5% of the Partnership's 35,200 outstanding Units. On that date, the General Partners or their affiliates owned 116 Units (.33% of the total outstanding) of the Partnership in addition to their General and Original Limited Partner Interests.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee Note E of Notes To Financial Statements included in Appendix A to this report.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial statements - see Index to Financial Statements and Schedule included under Item 8, Appendix A, on page to this Report.\n2. Financial statement schedule - see Index to Financial Statements and Schedule included under Item 8, Appendix A, on page to this Report. All other schedules are omitted as they are not applicable, not required or the information is provided in the financial statements or the notes thereto.\n(b) Exhibits:\nNumber and Description Under Regulation S-K\nThe following reflects all applicable Exhibits required under Item 601 of Regulation S-K.\n(4) Instruments defining the rights of security holders including indentures:\n(4.1) Amended Agreement of Limited Partnership dated as of July 27, 1983 [Exhibit A to Prospectus included in Registrant's Registration Statement on Form S-11 (File 2-84645)].*\n(4.2) Amended Certificate of Limited Partnership filed with the Massachusetts Secretary of State on December 16, 1983 [Exhibit 4.2 to Registrant's Report on Form 10-K for 1983 (File 2-84645)].*\n(10) Material Contracts\nPark Place Apartments\n(10.1) Purchase and Sale Agreement dated April 24, 1984 between Douglas Krupp and Sheldon J. Mandell, Howard J. Mandell, Jerome W. Mandell and Norman Mandell [Exhibit 1 to Registrant's Report on Form 8-K dated May 4, 1984 (File No. 2-84645)].*\n(10.2) Assignment of Beneficial Interest in Land Trust dated May 1, 1984 by Sheldon J. Mandell, Howard J. Mandell, Jerome W. Mandell and Norman Mandell to Krupp Realty Limited Partnership-V. [Exhibit 10.9 to Registrant's Report on Form 10-K for the year ended November 30, 1984 (File No. 0-11985)].*\n(10.3) Addendum to Management Agreement between Krupp Realty Park Place - Chicago Limited Partnership and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\") [Exhibit 2 to Registrant's Report on Form 8-K dated April 27, 1989 (File No. 0- 11985)].*\n(10.4) Agreement of Limited Partnership of Krupp Realty Park Place -Chicago Limited Partnership dated March 15, 1989 [Exhibit 5 to Registrant's Report on Form 8-K dated April 27, 1989 (File No. 0-11985)].*\n(10.5) Assignment of General Partners interests in Krupp Realty Park Place - Chicago Limited Partnership by The Krupp Corporation to Krupp Realty Limited Partnership- V dated March 15, 1989 [Exhibit 6 to Registrant's Report on Form 8-K dated April 27, 1989 (File No. 0- 11985)].*\n(10.6) Written Consent of Directors of The Krupp Corporation dated April 18, 1989 assigning beneficial interest in Park Place Apartments to Krupp Realty Park Place - Chicago Limited Partnership [Exhibit 7 to Registrant's Report on Form 8-K dated April 27, 1989 (File No. 0-11985)].*\n(10.7) Management Agreement dated May 4, 1984 between Krupp Realty Limited Partnership-V, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\") [Exhibit 10.18 to Registrant's Report on Form 10-K for the year ended November 30, 1984 (File No. 0-11985)].*\n(10.8) Loan Modification\/Cancellation Agreement dated September 14, 1993 between South Chicago Bank, as Trustee, and Krupp Realty Park Place - Chicago Limited Partnership (File No. 0-11985).*\n(10.9) Modification to mortgage note dated September 14, 1993 between South Chicago Bank, as Trustee, and Government National Mortgage Association (File No. 0-11985).*\n(10.10) Modification of mortgage dated September 14, 1993 between South Chicago Bank, as Trustee, and Government National Mortgage Association (File No. 0-11985).*\n(10.11) Regulatory Agreement for Multifamily Housing Projects dated September 14, 1993, between South Chicago Bank, as Trustee, and Krupp Realty Park Place - Chicago Limited Partnership (File No. 0- 11985).*\nMarine Terrace Apartments\n(10.12) Trust Agreement, dated February 15, 1983 between American National Bank and Trust Company of Chicago and Yitzhaz Persky [Exhibit 3 to Registrant's Report on Form 8-K dated August 8, 1984 (File No. 0-11985)].*\n(10.13) Trustee's Certificate of Beneficial Ownership in Trust by Douglas Krupp dated May 4, 1984 [Exhibit 4 to Registrant's Report on Form 8-K dated August 8, 1984 (File No. 0-11985)].*\n(10.14) Assignment of Interest in Trust Agreement by Douglas Krupp to Krupp Realty Limited Partnership-V dated August 8, 1984 [Exhibit 5 to Registrant's Report on Form 8-K dated August 8, 1984 (File No. 0-11985)].*\n(10.15) Management Agreement dated August 8, 1984 between Krupp Realty Limited Partnership-V, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\") [Exhibit 10.28 to Registrant's Report on Form 10-K for the year ended November 30, 1984 (File No. 0-11985)].*\n(10.16) Promissory Note, dated June 2, 1986, by American National Bank and Trust Company of Chicago, as Trustee, and Cohen Financial Corporation [Exhibit 19.1 to Registrant's Report on Form 10-Q for the quarter ended August 31, 1986 (File No. 0-11985)].*\n(10.17) Mortgage dated June 2, 1986 by American National Bank and Trust Company of Chicago, as Trustee, and Cohen Financial Corporation [Exhibit 19.2 to Registrant's Report on Form 10-Q for the quarter ended August 31, 1986 (File No. 0-11985)].*\n(10.18) Modification Agreement dated December 21, 1988 by American National Bank and Trust Company of Chicago, as Trustee, and Mutual Trust Life Insurance Company, as Mortgagee. [Exhibit 10.22 to the Registrant's Report on Form 10-K dated December 31, 1988 (File No. 0-11985)].*\n(10.19) Amended and Restated Promissory Note, dated December 21, 1988, by American National Bank and Trust Company of Chicago, as Trustee, and Mutual Trust Life Insurance Company. [Exhibit 10.23 to the Registrant's Report on Form 10-K dated December 31, 1988 (File No. 0-11985)].*\nCentury II Apartments\n(10.20) Agreement of Sale, dated September 18, 1984 between the Partners of Century III Associates and Douglas Krupp and related exhibits including Mortgage Notes and Related Mortgages [Exhibit 1 to Registrant's Report on Form 8-K dated October 11, 1984 (File No. 0-11985)].*\n(10.21) Assignment of Partnership Interest in Century III Associates dated October 10, 1984 by the Partners of Century III Associates to The Krupp Company Limited Partnership-II, The Krupp Corporation and Krupp Realty Limited Partnership-V [Exhibit 2 to Registrant's Report on Form 8-K dated October 11, 1984 (File No. 0-11985)].*\n(10.22) Fifth, Sixth and Seventh Amended and Restated Limited Partnership Agreement of Century III Associates Limited Partnership [Exhibit 3 to Registrant's Report on Form 8-K dated October 11, 1984 (File No. 0-11985)].*\n(10.23) Assignment of Beneficial Interest in Century III Associates from The Krupp Company Limited Partnership-II and The Krupp Corporation to Krupp Realty Limited Partnership-V. [Exhibit 10.32 to Registrant's Report on Form 10-K for the year ended November 30, 1984 (File No. 0-11985)].*\n(10.24) Management Agreement dated October 11, 1984 between Krupp Realty Limited Partnership-V, as Owner, and Krupp Asset Management Company, now known as Berkshire Property Management (\"BPM\") [Exhibit 10.33 to Registrant's Report on Form 10-K for the year ended November 30, 1984 (File No. 0-11985)].*\n(10.25) Third Amended and Restated Promissory Note dated April 27, 1989 between Century III Associates Limited Partnership and Bankers United Life Assurance Company. [Exhibit 8 to Registrant's Report on Form 8-K dated April 27, 1989 (File No. 0-11985)].*\n(10.26) Third Amended and Restated Deed of Trust dated April 27, 1989 between Century III Associated Limited Partnership and Bankers United Life Assurance Company. [Exhibit 9 to Registrant's Report on Form 8-K dated April 27, 1989 (File No. 0-11985)].*\n*Incorporated by reference\n(c) Reports on Form 8-K\nDuring the last quarter of the fiscal year ended December 31, 1994, the Partnership did not file any 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, on the 27th day of March, 1995.\nKRUPP REALTY LIMITED PARTNERSHIP-V\nBy: The Krupp Corporation, a General Partner\nBy:\nGeorge Krupp, Co-Chairman (Principal Executive Officer) and Director of The Krupp 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 indicated, on the 27th day of March, 1995.\nSignatures Title(s)\n\/s\/Douglas Krupp Co-Chairman (Principal Executive Officer) Douglas Krupp and Director of The Krupp Corporation, a General Partner.\n\/s\/George Krupp Co-Chairman (Principal Executive Officer) George Krupp and Director of The Krupp Corporation, a General Partner.\n\/s\/Laurence Gerber President of The Krupp Corporation, a Laurence Gerber General Partner.\n\/s\/Marianne Pritchard Treasurer of The Krupp Corporation, a Marianne Pritchard General Partner.\nAPPENDIX A\nKRUPP REALTY LIMITED PARTNERSHIP-V\nFINANCIAL STATEMENTS ITEM 8 OF FORM 10-K\nANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION For the Year Ended December 31, 1994\nKRUPP REALTY LIMITED PARTNERSHIP-V\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nBalance Sheets at December 31, 1994 and 1993\nStatements of Operations for the years ended December 31, 1994, 1993 and 1992\nStatements of Changes in Partners' 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 -\nAll other schedules are omitted as they are not applicable, not required, or the information is provided in the financial statements or the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Krupp Realty Limited Partnership-V:\nWe have audited the financial statements and financial statement schedule of Krupp Realty Limited Partnership-V (the \"Partnership\") listed in the index on page 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. 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.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Krupp Realty Limited Partnership-V 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.\nBoston, Massachusetts COOPERS & LYBRAND L.L.P. January 31, 1995\nKRUPP REALTY LIMITED PARTNERSHIP-V\nThe accompanying notes are an integral part of the financial statements.\nKRUPP REALTY LIMITED PARTNERSHIP-V\nSTATEMENTS OF OPERATIONS For the Years Ended December 31, 1994, 1993 and 1992\nThe accompanying notes are an integral part of the financial statements.\nKRUPP REALTY LIMITED PARTNERSHIP-V\nSTATEMENTS OF CHANGES IN PARTNERS' DEFICIT For the Years Ended December 31, 1994, 1993 and 1992 _____________\nThe accompanying notes are an integral part of the financial statements.\nKRUPP REALTY LIMITED PARTNERSHIP-V\nSTATEMENTS OF CASH FLOWS For the Years Ended December 31, 1994, 1993 and 1992\nThe accompanying notes are an integral part of the financial statements.\nKRUPP REALTY LIMITED PARTNERSHIP-V\nNOTES TO FINANCIAL STATEMENTS\nA. Organization\nKrupp Realty Limited Partnership-V (the \"Partnership\") was formed on June 16, 1983 by filing a Certificate of Limited Partnership in The Commonwealth of Massachusetts. The Partnership terminates on December 31, 2020, unless earlier terminated upon the sale of the last of the Partnership's properties or the occurrence of certain other events as set forth in the Partnership Agreement. The Partnership issued all of the General Partner Interests to two General Partners in exchange for capital contributions aggregating $1,000. The Krupp Corporation (a Massachusetts corporation) and The Krupp Company Limited Partnership-II (a Massachusetts limited partnership) are the General Partners of the Partnership. Except under certain limited circumstances upon termination of the Partnership, the General Partners are not required to make any additional capital contributions. The Partnership has also issued all of the Original Limited Partner Interests to The Krupp Company Limited Partnership-II in exchange for a capital contribution of $4,000.\nOn September 6, 1983, the Partnership commenced the marketing and sale of units of Investor Limited Partner Interest (\"Units\") for $1,000 per unit. The public offering was closed on December 2, 1983 at which time a total of 35,200 Units had been sold for $35,200,000.\nB. Significant Accounting Policies\nThe Partnership uses the following accounting policies for financial reporting purposes, which may differ in certain respects from those used for federal income tax purposes (see Note J).\nCash Equivalents\nThe Partnership includes all short-term investments with maturities of three months or less at the date of acquisition in cash and cash equivalents. The cash investments are recorded at cost, which approximates current market values.\nRental Revenues\nResidential leases and the base rent under commercial leases require the payment of rent monthly in advance. Rental revenues are recorded on the accrual basis.\nDepreciation\nDepreciation is provided for by the use of the straight-line method over estimated useful lives of the related assets as follows:\nBuildings and improvements 5-25 years Appliances, carpeting and equipment 3-5 years\nThe Partnership recorded depreciation expense of $3,336,689, $3,165,916 and $3,277,353 for the years ended December 31, 1994, 1993 and 1992, respectively.\nContinued\nKRUPP REALTY LIMITED PARTNERSHIP-V\nNOTES TO FINANCIAL STATEMENTS, Continued\nB. Significant Accounting Policies, Continued\nInvestment in Krupp Realty Lakeview Limited Partnership\nThe Partnership's investment in Krupp Realty Lakeview Limited Partnership (\"Joint Venture\") was accounted for using the equity method under which the Partnership's equity investment in net earnings or losses of the Joint Venture were included currently in the Partnership's net earnings. Distributions received from the Joint Venture reduced the investment (see Note C).\nDeferred Expenses\nCosts of obtaining and recording mortgages on the properties are amortized over the term of the related mortgage notes using the straight-line method.\nIncome Taxes\nThe Partnership is not liable for federal or state income taxes as Partnership income or loss is allocated to the partners for income tax purposes. In the event that the Partnership's tax returns are examined by the Internal Revenue Service or state taxing authority and the examination results in a change in the Partnership's taxable income or loss, such change will be reported to the partners.\nReclassifications\nCertain prior year balances have been reclassified to conform with the current year financial statement presentation.\nC. Disposition of Real Estate Investments\nOn August 5, 1992, the Partnership sold Fieldcrest Apartments for $3,900,000. Proceeds from the sale were used to repay the existing mortgage note on the property in the amount of $3,855,579. The property had a net book value of $4,282,597, which resulted in a loss of $399,316 for financial reporting purposes.\nOn August 28, 1992, Lakeview Towers, a property owned in a Joint Venture with an affiliate, was sold for $16,000,000. The sales price consisted of the assumption of the outstanding balance on the existing non- recourse first mortgage of $5,476,266 by the purchaser, with the balance of the sales price paid in cash. The Partnership received net proceeds of $5,190,234 from the sale and recognized a gain of $3,875,915 for financial reporting purposes.\nContinued\nKRUPP REALTY LIMITED PARTNERSHIP-V\nNOTES TO FINANCIAL STATEMENTS, Continued\nD. Mortgage Notes Payable\nSubstantially all of the property owned by the Partnership is pledged as collateral for the mortgage notes outstanding at December 31, 1994 and 1993 which consisted of the following:\nPark Place Tower Apartments\nA non-recourse mortgage note of $33,000,000 dated September 15, 1993, by the U.S. Department of Housing and Urban Development (\"HUD\") payable in equal monthly installments of principal and interest of $212,783, based on a 31-year amortization. At maturity, all unpaid principal (approximately $1,457,000) and any accrued interest is due. The note may not be prepaid prior to October 1, 1998. In the event prepayment of principal occurs any time after this date, a prepayment premium shall be due, based on a declining premium rate of 5% to 0% of the outstanding principal balance over a period of 5 years. Under the terms of the loan, HUD restricts the distribution of funds to Surplus Cash, as defined.\nMarine Terrace Apartments\nA non-recourse first mortgage note of $4,515,560 is payable in equal monthly installments of $43,619 including principal and interest based on a 25-year amortization. At maturity, all unpaid principal (approximately $3,948,000) and any accrued interest is due. Prepayment is allowed, subject to certain premiums.\nCentury II Apartments\nA non-recourse first mortgage note of $11,000,000. payable in equal monthly installments of $104,844, based on a 25-year amortization schedule. At maturity, all unpaid principal (approximately $10,077,000) and any accrued interest is due.\nThe aggregate scheduled principal amounts of long-term borrowings due during the five years ending December 31, 1999 are $584,950, $4,536,410, $569,802, $615,927 and $10,614,413.\nDuring the years ended December 31, 1994, 1993 and 1992, the Partnership paid $3,792,109, $6,124,243 and $4,235,631 of interest on its mortgage notes, respectively.\nContinued\nKRUPP REALTY LIMITED PARTNERSHIP-V\nNOTES TO FINANCIAL STATEMENTS, Continued\nE. Related Party Transactions\nCommencing with the date of acquisition of each property, the Partnership entered into agreements under which property management fees are paid to an affiliate of the General Partners for services as management agent for the properties. Such agreements provide for management fees payable monthly at the rate of up to 5% of rentals and other operating income received. The Partnership also reimburses affiliates of the General Partners for certain expenses incurred in connection with the operation of the properties including accounting, computer, travel, insurance, legal and payroll, as well as the preparation and mailing of reports and other communications to the Limited Partners.\nIn addition to the amounts presented on the face of the Statement of Operations, during 1994, 1993 and 1992, costs of $14,083, $27,658 and $74,401, respectively, were accrued or paid to the General Partners or their affiliates. These costs related to refinancing the debt on the Partnership's properties.\nDue to affiliates consists of the following as of December 31:\nF. Legal Proceeding\nThe Partnership is a defendant in a class action suit related to the practice of giving discounts for the early or timely payments of rent at Park Place. The central issue of the complaint was whether the operative lease, by allowing tenants a discount, of typically $30, if rent was paid on or before the first day of the month, violated a Chicago municipal ordinance relating to late fee charges. The ordinance in question limited late fee charges to $10 per month if the rent was more than 5 days late. The allegation was that, notwithstanding the stated rental rate and printed discount, the practice represented an unlawful means of exacting late fee charges. In addition to seeking damages for any \"forfeited\" discounts, plaintiffs seek statutory damages of two months rent per lease violation plus reasonable attorneys' fees. To be eligible for such punitive damages plaintiffs must prove that defendants deliberately used a provision prohibited by the ordinance. During 1994, the Court ruled in favor of the Defendants, and accepted the Partnership's Motion to Dismiss the Plaintiff's Third Amended Complaint. The Plaintiffs have filed an appeal with the Appellate Court of Illinois, First District, which is pending. Although management believes that the defendants will prevail on the issue of statutory damages, the ultimate outcome of this litigation, including an estimate of any potential loss, cannot be presently determined and accordingly no provision for loss has been made in the accompanying financial statements.\nG. Partners' Deficit\nUnder the terms of the Partnership Agreement, losses from operations are allocated 99% to the Investor Limited Partners and 1% to the General Partners and profits from operations are allocated 93% to the Investor Limited Partners, 6% to the Original Limited Partner and 1% to the General Partners until such\nContinued\nKRUPP REALTY LIMITED PARTNERSHIP-V\nNOTES TO FINANCIAL STATEMENTS, Continued\nG. Partners' Deficit - Continued\ntime that the Investor Limited Partners have received a return of their total invested capital plus a 9% per annum cumulative return thereon and thereafter, 65% to the Investor Limited Partners, 28% to the Original Limited Partner and 7% to the General Partners. Profit or loss from capital transactions are allocated in accordance with the Partnership Agreement.\nUnder the Partnership Agreement, cash distributions are generally made on the same basis as the allocations of profits described above. Distributions from a sale, exchange, or other disposition of a property or upon the termination of the Partnership are to be allocated differently than that described above.\nAs of December 31, 1994 the following cumulative partner contributions and allocations have been made since inception of the Partnership:\nH. Distributions\nDuring 1993, the Partnership distributed an amount equal to the withholding required for a Partners' tax of $27,888 in the state of Maryland arising from the sale of Fieldcrest Apartments. This amount was paid to the state of Maryland for the benefit of all Partners.\nI. Future Base Rents Due Under Commercial Operating Leases\nFuture base rent receivable under commercial operating leases for the years 1995 through 1999 are as follows:\nKRUPP REALTY LIMITED PARTNERSHIP-V\nNOTES TO FINANCIAL STATEMENTS, Continued\nJ.Federal Income Taxes\nFor federal income tax purposes, the Partnership is depreciating its properties using the Accelerated Cost Recovery System (\"ACRS\") and the Modified Cost Recovery System (\"MACRS\") depending on which is applicable.\nThe reconciliation of the net loss reported in the accompanying Statement of Operations with the net loss to be reported in the Partnership's 1994 federal income tax return follows:\nThe allocation of the net loss for federal income tax purposes for 1994 is as follows:\nDuring the years ended December 31, 1994, 1993 and 1992 the per Unit net income (loss) to the Investor Limited Partners for federal income tax purposes was ($40.62), ($111.61) and $77.45, respectively.\nKRUPP REALTY LIMITED PARTNERSHIP-V\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1994\nContinued\nKRUPP REALTY LIMITED PARTNERSHIP-V\nSCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued)\nDecember 31, 1994\nNote: The aggregate cost of the Partnership's real estate for federal income tax purposes is $73,325,592 and the aggregate accumulated depreciation for federal income tax purposes is $44,219,998.","section_15":""}
{"filename":"914755_1994.txt","cik":"914755","year":"1994","section_1":"ITEM 1. Business -------\nGeneral -------\nIllinois Power Company (IP) was incorporated under the laws of the State of Illinois on May 25, 1923.\nOn May 27, 1994, Illinova Corporation (Illinova), a holding company, was officially formed with the filing of documents with the Illinois Secretary of State. Illinova became the parent of IP through a merger pursuant to a share-for-share conversion of IP common stock into Illinova common stock. On June 8, 1994, Illinova Generating Company (IGC) (formerly IP Group, Inc.), originally a subsidiary of IP, was transferred as a dividend in the amount of $9.2 million from IP to Illinova, establishing IGC as a wholly owned subsidiary of Illinova. IP, the primary business and subsidiary of Illinova, is engaged in the generation, transmission, distribution and sale of electric energy and the distribution, transportation and sale of natural gas in the State of Illinois.\nIGC is Illinova's wholly owned independent power subsidiary which invests in energy supply projects throughout the world and competes in the independent power market. In 1993, IGC invested in a co-generation project in Teesside, England. During 1994, IGC became an equity partner with Tenaska, Inc., in four natural gas- fired generation plants, two of which are in operation and two of which are under construction. Tenaska, Inc. is an Omaha, Nebraska- based developer of independent power projects throughout the U.S. In August 1994, IGC purchased 50 percent of the North American Energy Services Company (NAES). NAES supplies a broad range of operations, maintenance and support services to the worldwide independent power generation industry and will operate the Tenaska generation plants in which IGC purchased an equity interest. In November 1994, IGC became an equity partner in an operating diesel engine-powered generating plant in Puerto Cortez, Honduras.\nAt December 31, 1994, Illinova's net investment in IGC was $28.8 million.\nIP provided approximately $20 million in funds to Illinova for operations and investments during 1994. Illinova is paying IP interest on these funds at a rate equal to that which Illinova would have paid had it used a currently outstanding line of credit.\nIllinova Power Marketing, Inc. (IPM) is a wholly owned subsidiary of Illinova formed in July 1994 as a Delaware corporation. IPM plans to become active in the business of brokering and marketing electric power and gas to various customers. On July 20, 1994, IPM filed a petition with the Federal Energy Regulatory Commission (FERC) seeking approval to buy electricity from various producers not affiliated with IP and to sell electricity at market rates to such wholesale customers as utilities, electric cooperatives and municipalities. IPM eventually intends to sell electricity directly to industrial and commercial customers. Subsequent to the IPM filing, the FERC issued a decision in Heartland Energy Services, Inc., et al., setting forth the general standards governing applications by utility-affiliated marketers, such as IPM, for market-based rates. Among these standards is the submission, by the marketer's affiliated utility, of an open access transmission tariff offering transmission services and prices comparable to those which the utility provides to its customers. Based on the FERC decision in the Heartland case, IPM submitted an amended filing and IP submitted the comparable open access transmission tariff, designed to satisfy the FERC's \"comparability\" requirements, to the FERC on March 20, 1995. IPM will begin power marketing operations upon receipt of FERC approval of these filings. Until that time, IPM will be limited to the brokering of electricity. In January 1995, IPM established operating headquarters in Salt Lake City, Utah.\nOn March 9, 1995 IPM agreed to purchase the fifty percent ownership interest of InterCoast Energy Services in Tenaska Marketing Ventures, a natural gas brokerage firm based in Omaha, Nebraska. Tenaska Marketing Ventures had been a partnership between Tenaska, Inc. Of Omaha and InterCoast Energy Services of Davenport, Iowa.\nIP's financial position and results of operations are currently the principal factors affecting Illinova's consolidated financial position and results of operations.\nCompetition -----------\nCompetition has become a dominant issue for the electric utility industry. Competition has been promoted by federal legislation, starting with the Public Utility Regulatory Policy Act of 1978, which facilitated the development of co-generators and independent power producers, and continuing with enactment of the Energy Policy Act of 1992 which authorized the FERC to mandate wholesale wheeling of electricity by utilities at the request of certain authorized generating entities and electric service providers. Wheeling is the transport of electricity generated by one entity over transmission and distribution lines belonging to another entity. For many years prior to enactment of the Energy Policy Act, the FERC imposed wholesale wheeling obligations as a condition of approving mergers and granting operating privileges, a practice that continues.\nCompetition arises not only from co-generation or independent power production, but from municipalities seeking to extend their service boundaries to include customers being served by IP. This is not a new risk in the industry, as the right of municipalities to have power wheeled to them by utilities was established in 1973. The Illinois Commerce Commission (ICC) has been supportive of IP's attempts to maintain its customer base through approval of special contracts and flexible pricing that help IP to compete with existing municipal providers.\nFurther competition may be introduced by state action or by further federal regulatory action. While the Energy Policy Act precludes the FERC from mandating retail wheeling, state regulators and legislators could open utility franchise territories to full competition at the retail level. Retail wheeling involves the transport of electricity to end-use residential, commercial or industrial customers. Such a change would be a significant departure from existing regulation in which public utilities have a universal obligation to serve the public in return for relatively protected service territories and regulated pricing designed to allow a reasonable return on prudent investment and recovery of operating costs. States' attempts to lay the groundwork for retail wheeling have been hampered by opposition from various interest groups, as well as the complexity of related issues, including recovery of costs associated with pre-existing generation investment. During 1995, IP, industrial customers and regulators have introduced bills to the Illinois State Legislature to amend the Illinois Public Utilities Act. Predictably, these bills vary widely, reflecting different objectives, different constituencies and different attitudes towards competition in the electric utility industry. IP's proposed legislation would allow it to transfer all of its generating plants to an affiliated company, which would then sell the output of the plants to IP under a power purchase agreement regulated by FERC. The spring legislative session is scheduled to end May 28. During this session bills can be passed, rejected, modified or set aside for further study. If a bill passes both chambers, it can be approved by the Governor and signed into law within 90 days. It is not possible to predict whether any regulatory reform proposals will be enacted.\nWhile Illinova and IP are confident of IP's present ability to compete with all current alternate sources of energy supply, the issue of competition is one that raises both risks and opportunities. At this time, the ultimate effect of competition in the electric utility industry on Illinova's consolidated financial position and results of operations is uncertain.\nUnder the Energy Policy Act, an investor-owned utility must respond to any bona fide transmission service request within 60 days. Although the Energy Policy Act created, for the first time, a FERC-administered mechanism for imposing wholesale wheeling obligations on utilities, IP has had the obligation to wheel power for interconnected electricity suppliers since 1976. That condition was included in IP's Clinton Power Station (Clinton) construction permit and operating license issued by the Nuclear Regulatory Commission (NRC). IP currently wheels power at rates originally approved by the FERC in 1984.\nIt is too soon to predict the long-term financial impact of increasing transmission access and other issues arising from such access.\nEarly Retirement ----------------\nIn December 1994, IP announced a voluntary early retirement program. Approximately 200 salaried employees would qualify for early retirement under this program. The offer will be made to employees during the fourth quarter of 1995. A similar program for union employees is the subject of contract negotiations currently underway between IP and the International Brotherhood of Electrical Workers. Approximately 450 union employees would qualify for the program if current negotiations result in the same package as offered to salaried employees. At December 31, 1994, IP employed 4,350 people, as compared to 4,540 at December 31, 1993.\nThe early retirement program for salaried employees is expected to generate a pre-tax charge of approximately $22 million against fourth quarter 1995 earnings and to generate savings of approximately $15 million annually beginning in 1996. A combined early retirement program for both salaried and union employees, based on the same package as announced for salaried employees, would generate a pre-tax charge of approximately $42 million against fourth quarter 1995 earnings and would generate savings of approximately $35 million annually beginning in 1996.\nSelected Data -------------\nThe territory served by IP comprises substantial areas in northern, central and southern Illinois, including the following larger communities (1990 Federal Census data):\nClass of Service City Population Furnished ---- ---------- ----------------- Decatur 83,885 Electric and Gas Champaign 63,502 Electric and Gas Bloomington 51,972 Electric Belleville 42,785 Electric and Gas East St. Louis 40,944 Gas Normal 40,023 Electric Urbana 36,344 Electric and Gas Danville 33,828 Electric and Gas Galesburg 33,530 Electric and Gas Granite City 32,862 Electric and Gas\nIP holds franchises in all of the 310 incorporated municipalities in which it furnishes retail electric service and in all of the 257 incorporated municipalities in which it furnishes retail gas service.\nTotal operating revenues, including interchange sales, of Illinova and IP for the past three years by classes of service were as follows:\n1994 1993 1992 ---- ---- ---- (Millions of Dollars) Electric $1,287.5 $1,266.4 $1,190.9 Gas $ 302.0 $ 314.8 $ 288.6\nOperating income before income taxes of Illinova and IP for the past three years by classes of service were as follows:\n1994 1993 1992 ---- ---- ---- (Millions of Dollars) Electric $ 411.4 $ 383.2 $ 348.4 Gas $ 27.3 $ 28.6 $ 23.9\nIdentifiable assets of Illinova and IP for the past three years by classes of service were as follows:\n1994 1993 1992 ---- ---- ---- (Millions of Dollars) Electric $4,589.0 $4,526.8 $4,602.9 Gas $ 442.6 $ 406.4 $ 355.4\nElectric Business -----------------\nOverview --------\nIP supplies electric service at retail to an estimated aggregate population of 1,265,000 in 310 incorporated municipalities, adjacent suburban and rural areas, and numerous unincorporated communities. Electric service at wholesale is supplied for resale to one electric utility and to the Illinois Municipal Electric Agency (IMEA) as agent for 10 municipalities. IP also has a power coordination agreement with Soyland Power Cooperative, Inc. (Soyland). See the sub-caption \"Power Coordi nation Agreement With Soyland\" hereunder for additional information. In 1994, IP provided interchange power to 13 utilities for resale and one power marketer.\nIP's highest system peak hourly demand (native load) in 1994 was 3,395,000 kilowatts on June 20, 1994. This 1994 peak load compares with IP's historical high of 3,508,000 kilowatts in 1988.\nIP owns and operates electric generating facilities having a net summer capability of 4,441,000 kilowatts. The major electric generating stations are Clinton (930,000 kilowatts, of which 807,000 kilowatts of capability are owned by IP and 123,000 kilowatts of capability are owned by Soyland), Baldwin (1,751,000 kilowatts), Havana (666,000 kilowatts), Wood River (607,000 kilowatts), Hennepin (289,000 kilowatts) and Vermilion (174,000 kilowatts). The other generating facilities owned by IP consist of gas turbine units at three locations which provide peaking service and have an aggregate capability of 147,000 kilowatts. Havana Units 1-5 (238,000 kilowatts) and Wood River Units 1-3 (139,000 kilowatts) are currently not staffed, but are available to meet reserve requirements with a maximum of four months' notice.\nIP owns 20% of the capital stock of Electric Energy, Inc. (EEI), an Illinois corporation, which was organized to own and operate a steam electric generating station and related transmission facilities near Joppa, Illinois to supply electric energy to the U.S. Department of Energy (DOE) for its project near Paducah, Kentucky. Under a power supply agreement with EEI, IP has the right to purchase 5.0% of the annual output of the Joppa facility. IP has the flexibility to schedule the capacity in varying amounts ranging from a nominal 51,000 kilowatts for 52 weeks up to a maximum of 203,000 kilowatts for approximately 13 weeks. IP must schedule its annual capacity entitlement by August 1 of the preceding year, and availability of the scheduled capacity is subject to certain other limitations related to scheduling considerations of the other co-owners of the Joppa facility and the DOE, and unit outages (if any).\nIP is a participant, together with Union Electric Company (UE) and Central Illinois Public Service Company (CIPS), in the Illinois-Missouri Power Pool which was formed in 1952. The Pool operates under an Interconnection Agreement which provides for the interconnection of transmission lines and contains provisions for the coordination of generating equipment maintenance schedules, inter-company sales of firm and non-firm power, and the maintenance of minimum capacity reserves by each participant equal to the greater of 15% of its peak demand, one-half of its largest unit, or one-half of its largest non-firm purchase.\nIP, CIPS and UE have a contract with Tennessee Valley Authority (TVA) providing for the interconnection of the TVA system with those of the three\ncompanies to exchange economy and emergency power and for other working arrangements.\nIP also has interconnections with Indiana-Michigan Power Company, Commonwealth Edison Company, Central Illinois Light Company, Iowa-Illinois Gas & Electric Company, Kentucky Utilities Company, Southern Illinois Power Cooperative, Soyland Power Cooperative, Inc. and the City of Springfield, Illinois for various interchanges, emergency services and other working arrangements.\nIP is also a member of the Mid-America Interconnected Network, which is one of nine regional reliability councils established to coordinate plans and operations of member companies regionally and nationally.\nPower Coordination Agreement With Soyland -----------------------------------------\nUnder the provisions of a Power Coordination Agreement (PCA) between Soyland and IP dated October 5, 1984, as amended, IP was required to provide Soyland with 8.0% (288 megawatts) of electrical capacity from its fossil-fueled generating plants through 1994. This requirement increased to 12% on January 1, 1995 and will continue at that level each year thereafter until the agreement expires or is terminated. This is in addition to the capacity Soyland receives as an owner of Clinton. IP is compensated with capacity charges and for energy costs and variable operating expenses. IP transmits energy for Soyland through IP's transmission and subtransmission systems. Under provisions of the PCA, Soyland has the option of participating financially in major capital expenditures at the fossil-fueled plants, such as those needed for Phase II Clean Air Act compliance, to the extent of its capacity entitlement with each party bearing its own direct capital costs, or by having the costs treated as plant additions and billed to Soyland in accordance with other billing provisions of the PCA. See the sub- caption \"Clean Air Act\" on page 24, under \"Environmental Matters\" for further discussion. At any time after December 31, 2004, either IP or Soyland can terminate the PCA by giving not less than seven years' prior written notice to the other party. The party to whom termination notice has been given may designate an earlier effective date of termination which shall be not less than twelve months after receiving notice. The revenues received from the power supplied to Soyland under the PCA are classified as operating revenues. In 1994, Soyland supplied electricity to 21 distribution cooperative members who serve approximately 162,400 rural customers in 69 Illinois counties.\nFuel Supply -----------\nIP used coal to generate 66.2% of the electricity produced during the year ended December 31, 1994, with nuclear, oil, and gas contributing 33.3%, 0.3%, and 0.2%, respectively. The average cost of these fuels per million Btu during 1994 was: Coal, $1.42; Nuclear, $.85; Oil, $3.89; and Gas, $3.06, for a weighted average cost of $1.24. The weighted average cost of all fuels per million Btu during the years 1993 and 1992 was $1.34 and $1.33, respectively. High-sulfur coal mined in Illinois, Indiana, Kentucky and Ohio provided 65.5%, 11.9%, 1.0% and 0.5%, respectively, of the coal delivered to IP's electric generating stations in 1994. In addition, IP received low-sulfur coal from Kentucky, Colorado, West Virginia, Wyoming, Utah and Illinois.\nThe average cost per million Btu of primary fuel consumed at IP's generating stations during the periods indicated was as follows:\nPrimary Station Fuel 1994 1993 1992 ------- ---- ---- ---- ----\nBaldwin Coal $1.36 $1.41 $1.40 Havana Coal 1.53 1.63 1.59 Hennepin Coal 1.68 1.61 1.56 Vermilion Coal 1.38 1.38 1.34 Wood River Coal 1.49 1.60 1.49 Clinton Uranium 0.85 0.91 0.99\nIP's rate schedules contain provisions for passing along to its electric customers increases or decreases in the cost of fuels used in its generating stations. For Illinova see the information under the sub-captions \"Revenue and Energy Cost\" of \"Note 1 - Summary of Significant Accounting Policies\" on page A- 15 and \"1987 Uniform Fuel Adjustment Clause Reconciliation\" on page A-17 of the 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference for additional information. For IP see the information under the sub-captions \"Revenue and Energy Cost\" of \"Note 1 - Summary of Significant Accounting Policies\" on page A- 15 and \"1987 Uniform Fuel Adjustment Clause Reconciliation\" on page A-17 of the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement which is incorporated herein by reference for additional information.\nReference is made to the sub-caption \"Environmental Matters\" hereunder for information regarding pollution control matters relating to IP's fuel supply.\nCOAL - As shown below, IP presently has coal purchase contracts with expiration dates ranging from 1995 to 2010 which will provide about 73 million tons of coal. Based upon projected 1995 usage of approximately 7.1 million tons, this is equivalent to about 10.3 years of consumption.\nLonger-term contracts with Peabody Coal Company and Arch Coal Sales Company, Inc. were renegotiated during 1993 with new terms and conditions, including significant price reductions, to provide for continued economic use of Illinois high-sulfur coal while IP complies with Phase I of the Clean Air Act amendments effective January 1, 1995. In 1994, IP signed new three-year agreements (1995-1997) amending and restating existing coal supply contracts to change, among other things, source and quality of coal. These amended and restated agreements are with Mountain Coal, Pacific Basin Resources and Coastal Coal. All of the coal can be shipped either to the Havana or Wood River stations. The Mountain and Pacific Basin coal originates in Colorado and the Coastal coal originates in Utah. IP also extended the coal supply agreement with CONSOL, Inc. through 1997 at Wood River. Total contract purchases will range between 6.6 million and 6.8 million tons of coal in 1995.\nThe sources and quantities of coal supplies, contract expiration dates, weighted average cost of coal purchases and anticipated sulfur contents are summarized in the following table:\n* High-sulfur content classified as 2.5 percent or greater.\n(a) IP has a contract with Peabody Coal Co. to purchase, in total, a maximum of 3,500,000 tons per year at Baldwin and Hennepin through 1999. During the years 2000-2010, the quantity of coal to be purchased from Peabody is a percentage of the total coal requirements at the Baldwin and Hennepin stations. The coal to be provided for contract years 2000-2010 will be at market prices.\n(b) This contract will supply 2,065,500 tons per year.\n(c) This contract will supply approximately 300,000 tons, 200,000 tons and 300,000 tons in 1995, 1996 and 1997, respectively.\n(d) This contract will supply 200,000 tons in 1995.\n(e) This contract was extended in 1994 and assigned to Pacific Basin Resources.\n(f) This contract will provide 350,000 tons of coal per year from 1995-1997.\nSee the sub-caption \"Environmental Matters\" hereunder for additional information regarding the supply of coal at the Baldwin power station.\nWhen IP's needs exceed contracted quantities, coal is purchased on the spot market. Spot purchases in 1994 represented about 10% of IP's total coal purchases. The delivered cost of coal purchased on a spot basis during the year varied between $19.84 per ton, or $0.94 per million Btu, and $40.91 per ton, or $1.78 per million Btu. Though less spot tonnage will be required between 1995 and 1997, IP anticipates that the spot market will continue to be a favorable supplemental source of supply, and IP will have adequate supplies of coal. The coal inventory at December 31, 1994 represented a 30-day supply based on IP's average daily burn projection for 1995.\nOIL - The Havana power station (five units totaling 238,000 kilowatts) is IP's only station which utilizes fuel oil for the generation of electric energy. These units are currently not staffed, but are available to meet reserve requirements with a maximum of four months' notice. GAS - Three generating units (totaling 139,000 kilowatts) at the Wood River power station and two combustion peaking plants, Stallings (77,000 kilowatts) and Oglesby (60,000 kilowatts), are fueled with natural gas. The three units at Wood River are currently not staffed, but are available to meet reserve requirements with a maximum of four months' notice. These units have the capability of burning either natural gas or distillate fuel oil. Natural gas is also used in start-up and as a secondary boiler fuel for two generating units (totaling 289,000 kilowatts) at the Hennepin power station and as a secondary boiler fuel for one generating unit (totaling 96,000 kilowatts) at the Wood River power station. Natural gas is also used as start-up fuel for one additional unit at the Wood River power station. In September 1994, IP announced that the Vermilion power station will be modified to use both natural gas and coal. By switching to natural gas as the primary fuel at Vermilion, IP will avoid the need to purchase about 6,000 emission allowances that otherwise would be required to comply with Phase I of the 1990 Clean Air Act Amendments. After modifications are completed in May 1995, gas will be used as the primary fuel and the units will operate mainly to help meet peak summer demand. IP anticipates that adequate supplies of gas for these uses will be available for the foreseeable future. See the sub-caption \"Gas Business\" hereunder.\nNUCLEAR - IP leases nuclear fuel from Illinois Power Fuel Company (Fuel Company). The Fuel Company, which is 50% owned by IP, was formed in 1981 for the purpose of leasing nuclear fuel to IP for Clinton. Lease payments are equal to the Fuel Company's cost of fuel as consumed (including related financing and administrative costs). This lease is recorded as a capital lease on IP's books. As of December 31, 1994, the Fuel Company had an investment in nuclear fuel of approximately $111 million. IP is obligated to make subordinated loans to the Fuel Company at any time the obligations of the Fuel Company which are due and payable exceed the funds available to the Fuel Company. At December 31, 1994, IP had no outstanding loans to the Fuel Company.\nAt December 31, 1994, IP's net investment in nuclear fuel consisted of $50 million of Uranium 308. This inventory represents fuel to be used in connection with the fifth reload of Clinton which began on March 12, 1995. The unamortized investment of the nuclear fuel assemblies in the reactor was $61 million.\nIP has two long term contracts for the supply of uranium concentrates. One contract is with U. S. Energy\/Crested Corporation and the other contract is with Cameco, a Canadian corporation. Each of the two contracts is for 1,179,240 lbs. of uranium concentrates, with deliveries through 1998. The contracts contain an option for an additional 479,440 lbs. of ura nium concentrates for delivery through 2000. Each of the two contracts is to provide an estimated 35% of Clinton's fuel requirements, but each contract contains provisions permitting IP to purchase 35-45% of Clinton's fuel requirements in certain years through the spot market. The decision to utilize these provisions is made the year before each delivery and depends on the estimated price and availability from the spot market versus the estimated contract prices. In 1994, the Cameco contract was renegotiated to lower the price and change it to a requirements contract, for 55%-65% of requirements through 2000. During 1994, all nuclear fuel purchases were settled in United States dollars.\nIn October 1993, IP filed suit in U.S. District Court, Central District of Illinois, Danville, seeking a declaration that IP's termination of the U.S. Energy contract is permitted by the terms of the contract as they relate to rights of termination in the event of certain receivership proceedings. Defendants in the lawsuit are U.S. Energy Corporation, Crested Corporation, U. S. Energy\/Crested Corporation, Cycle Resources Investment Corporation, Sheep Mountain Partners, Nulux Nukem Luxemburg GMBH, and Dresdner Bank. The defendants are joint ventures, partnerships, and domestic and foreign corporations who are either original parties or parties by assignment to the contract. IP purchased approximately half of its uranium concentrates supply under this contract, which IP terminated shortly before filing this action. On September 1, 1994, the Court granted defendants' motions for summary judgment and ruled that the termination constituted a breach of contract. Thereafter the parties engaged in settlement discussions, reaching a tentative agreement in principle on a restructured contract that would end the litigation. After hearings in February 1995, at which the defendants argued against one another over which was entitled to perform and receive the proceeds of the revised contract or receive any judgment entered subsequent to a trial on damages, on March 7, 1995 IP filed a Motion under Federal Rule 60 (b) for Reconsideration of the Court's September 1, 1994 ruling. That motion, and defendants' various motions concerning their respective rights under the contract were denied on March 15, 1995 and the matter set for trial on damages October 23, 1995.\nConversion services for the period 1991-2001 are contracted with Sequoyah Fuels. Sequoyah Fuels closed its Oklahoma conversion plant in 1992 and has joined with Allied Chem ical Company to form a marketing company named CoverDyn. All conversion services will be performed at Allied's Metropolis, Illinois facility, but Sequoyah Fuels will retain the contract with IP. IP has a Utility Services contract for uranium enrich ment requirements with the DOE which provides 70% of the enrich ment requirements of Clinton through September 1999. The remaining 30% has been contracted with the DOE through its incentive pricing plan through September 1995, and an amendment was signed in 1993 which covers the remaining 30% through 1999. This amendment allows IP to either purchase the enrichment services at the DOE's incentive price or provide electricity at DOE's Paducah, Kentucky enrichment plant, at an agreed exchange rate. In addition, legislation was passed to create a new private government corporation, the United States Enrichment Corporation (USEC), for enrichment services. All of the DOE's assets including all contracts were transferred to the USEC as of July 1993.\nA contract with General Electric Company provides fuel fabrication requirements for the initial core and 2,196 fuel bun dles (approximately 11 reloads through 2004). In 1993, an amendment was signed with the General Electric Company to add 1,472 fuel bundles to the contract and to change the existing price and other terms and conditions. The additional 1,472 fuel bundles are expected to cover fuel fabrication requirements through 2017.\nBeyond the stated commitments, IP may enter into additional contracts for uranium concentrates, conversion to uranium hexafluoride, enrichment and fabrication.\nCurrently, no plants for commercial reprocessing of spent nuclear fuel are in operation in the U.S., and reprocessing cannot commence until appropriate licenses are issued by the NRC. Clinton has on-site high density storage capability which will provide spent nuclear fuel storage capacity to meet requirements until the year 2004. Various governmental agencies are currently reviewing the environmental impact of nuclear fuel reprocessing and waste management. The Nuclear Waste Policy Act of 1982 was enacted to establish a government policy with respect to disposal of spent nuclear fuel and high-level radioactive waste. IP signed a contract for disposal of spent nuclear fuel and\/or high- level radioactive waste on July 6, 1984 with the DOE. Under the contract, IP is required to pay the DOE one mill (one-tenth of a cent) per net kilowatt-hour (one dollar per MWH) of electricity generated and sold. IP is recovering this amount through rates charged to customers.\nOn June 20, 1994, IP and 13 other utilities filed an action in the U.S. Court of Appeals for the District of Columbia circuit asking the Court to rule that the DOE is obligated to take responsibility for spent nuclear fuel by January 31, 1998 under the Nuclear Waste Policy Act of 1982. IP based its decision to build Clinton, in part, on the assurance that a federal repository would be built and operated by the DOE, and, under the Act, the DOE has been collecting money from IP to pay for such a repository. The utilities are asking the Court to confirm the DOE's commitment and to order the DOE to develop and monitor a compliance program with appropriate deadlines. The utilities have also asked for relief from the ongoing funding requirements or to have an escrow account established for future funds paid to DOE.\nOn January 13, 1995, the Court issued an order in this case. In response to a DOE motion to dismiss the case as premature, because of a pending DOE Notice of Inquiry on spent fuel storage issues, the Court: 1) deferred action on the DOE motion based on indications that DOE would issue a policy position in the pending Notice of Inquiry, and 2) directed the parties to file a status report on those proceedings within 60 days.\nIP has on-site storage capacity that will accommodate its spent fuel storage needs until the year 2004, based on current operating levels. If by that date the U.S. Government has not lived up to its statutory obligation to dispose of spent fuel, and IP has continued to operate the plant at current levels, then IP will have to use alternative means of disposal, such as dry storage in casks on site, or transport the fuel rods to private or collectively-owned utility repositories, neither of which exists at present. Current technology allows safe, dry, on- site storage, subject to licensing and local permitting requirements.\nUnder the Energy Policy Act of 1992, IP is responsible for a portion of the cost to decontaminate and decommission the DOE's uranium enrichment facilities. Each utility will be assessed an annual fee for a period of fifteen years based on quantities purchased from the DOE facilities prior to passage of the Act. At December 31, 1994, IP has a remaining liability of $5.7 million representing future assessments. IP is recovering these costs, as amortized, through its fuel adjustment clause.\nConstruction Program --------------------\nThe cost, including allowance for funds used during construction (AFUDC), of IP's construction program during 1995 and during the period January 1, 1995 to December 31, 1999 is estimated as follows: Five-Year Period 1995 1995-1999 ---- ---------\n(Millions of Dollars) Electric generating facilities $82 $246 Electric transmission and distribution facilities 70 296 General plant 28 112 Gas facilities 24 121 ---- -------- Total construction 204 775 Nuclear fuel 11 107 ---- -------- Total $215 $882 ==== ========\nThe above estimates exclude potential costs which may be required to comply with the Clean Air Act as discussed further in \"Environmental Matters\" hereunder. See the sub-caption \"Clean Air Act\" hereunder on page 24 for additional information.\nThe estimated construction expenditures during the period January 1, 1995 to December 31, 1999, together with the repayment at maturity of currently outstanding long-term debt (including lease payments under capital leases) and redeemable preferred stock, aggregating approximately $370 million, and sinking fund requirements of approximately $2 million are expected to require expenditures by IP of approximately $1.254 billion. Construction and capital requirements are expected to be met primarily through internal cash generation.\nIn 1992, the IP Board authorized a new general obligation mortgage (New Mortgage), which is intended to replace IP's 1943 Mortgage and Deed of Trust (First Mortgage). Bonds issued to date under the New Mortgage are secured by a corresponding issue of First Mortgage bonds under the First Mortgage. At December 31, 1994, based upon the most restrictive earnings test contained in the First Mortgage, IP could issue approximately $691 million of additional first mortgage bonds for other than refunding purposes. The amount of available unsecured borrowing capacity totaled $160 million at December 31, 1994. Also, at December 31, 1994, the unused portion of Illinova's and IP's total bank lines of credit was $293 million. IP is required to maintain unused lines of credit with lending institutions under which IP shall be entitled to borrow sums of money in an aggregate amount equal at any time to the total of (a) the aggregate principal amount of the commercial paper of the Fuel Company then outstanding plus (b) the aggregate principal amount of commercial paper of IP then outstanding. At December 31, 1994, such outstanding commercial paper of the Fuel Company was $66.6 million.\nClinton Power Station ---------------------\nGeneral -------\nIP owns 86.8% of Clinton and Soyland owns the remaining 13.2%. The terms for sharing the construction, ownership and operation of Clinton are set forth in several related agreements between IP and Soyland. Under these agreements, IP has authority to act on behalf of Soyland for purposes of various matters relating to the design, construction, operation, maintenance and decommissioning of Clinton. See the sub-caption \"Decommissioning Costs\" hereunder on page 19 for additional information on the decommissioning of Clinton.\nThe Clinton nuclear power station was placed in service in 1987 and represents approximately 18% of IP's installed generation capacity. In 1994, Clinton provided 33% of IP's generation and had the lowest fuel cost per megawatt-hour genera tion compared to all other IP-owned power stations. The investment in Clinton and its related deferred costs represented approximately 52% of Illinova's total assets at December 31, 1994. Clinton-related costs represented 32% of Illinova's total 1994 other operating, maintenance and depreciation expenses. Clinton's equivalent availability was 92%, 73% and 62% for 1994, 1993 and 1992, respectively. Clinton's equivalent availability was higher in 1994 due to no refueling outage.\nOwnership of an operating nuclear generating unit exposes IP to significant risks, including increased and changing regula tory, safety and environmental requirements and the uncertain future cost of closing and dismantling the unit. IP expects to be allowed to continue to operate Clinton; however, if any unfore seen or unexpected developments would prevent IP from doing so, Illinova and IP could be materially adversely affected. For further discussion of insurance limitations for Illinova, refer to the sub-caption \"Insurance\" of \"Note 4 - Commitments and Contingencies\" on page A-18 of the 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement which is incorporated herein by reference. For further discussion of insurance limitations for IP, refer to the sub- caption \"Insurance\" of \"Note 4 - Commitments and Contingencies\" on page A-18 of the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement which is incorporated herein by reference.\nRate and Regulatory Matters ---------------------------\n1992 Rate Order ---------------\nA September 1993 decision by the Illinois Appellate Court, Third District (Appellate Court Decision), upheld key components of the August 1992 Rehearing Order (Rehearing Order) issued by the Illinois Commerce Commission (ICC). The Rehearing Order denied IP recovery of certain deferred Clinton post-construction costs, which were composed of all deferred depreciation and real estate taxes and 72.8% of the deferred common equity return.\nIP originally recorded these deferred Clinton post- construction costs as a regulatory asset when such costs were believed probable of recovery through future rates, based on prior ICC orders. The deferred costs were recorded from the time Clinton began operations (April 1987) to the time the ICC allowed IP to begin recovering these deferred costs in rates (March 1989), otherwise known as the regulatory lag period.\nBased upon IP's assessment of the Appellate Court Decision and in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (FAS 71), IP recorded a loss of $271 million ($200 million, net of income taxes) in September 1993. This write-off included revenues and related interest of approximately $8.9 million to be refunded for deferred costs included in electric rates between April and August 1992, which were disallowed by the Rehearing Order.\nThe Appellate Court Decision remanded the case to the ICC for further proceedings to determine the amount of actual financial harm incurred by IP during the regulatory lag period. The decision also remanded the case for verification of the calculation of the amortization of deferred Clinton post- construction costs from March 1989 to June 1992.\nOn February 25, 1994, IP and the remaining parties to this case presented a joint motion to the Appellate Court requesting entry of an order remanding the case to the Commission for further proceedings in accordance with a stipulated agreement of the parties. The Appellate Court granted the joint motion on March 2, 1994. On March 16, 1994, the ICC issued an order on remand that did not result in any change in IP's rates from those adopted in the Rehearing Order. The order on remand required IP to refund $8.9 million of revenue that had been collected between April and August 1992 subject to refund. The refunds began in March 1994 and were completed in October 1994.\n1987 Uniform Fuel Adjustment Clause Reconciliation --------------------------------------------------\nIn January 1994, the ICC issued an order on remand consistent with an Illinois Appellate Court, Third District, decision which held that evidence did not support the findings in a February 1992 ICC order that $29.3 million in nuclear fuel procurement and management costs were imprudent. As a result of the Appellate Court decision and subsequent related ICC orders, IP is in the process of recovering approximately $12.7 million of nuclear fuel costs, which will not have an impact on consolidated results of operations.\nDecommissioning Costs ---------------------\nIP is responsible for its ownership share of the costs of decommissioning Clinton and for spent nuclear fuel disposal costs. IP is collecting future decommissioning costs through its rates based on an ICC-approved formula that allows IP to adjust rates annually for changes in decommissioning cost estimates.\nBased on NRC regulations that establish a minimum funding level, IP's 86.8% share of Clinton decommissioning costs is estimated to be approximately $357 million (1994 dollars). The NRC minimum is based only on the cost of removing radioactive plant structures. A site-specific study to estimate the costs of dismantlement, removal and disposal of Clinton has not been made; however, IP plans to undertake this study in 1995. This study may result in projected decommissioning costs higher than the NRC- specified funding level. At December 31, 1994 and 1993, IP had recorded a liability of $22.4 million and $17.2 million, respectively, for the future decommissioning of Clinton.\nExternal decommissioning trusts, as prescribed under Illinois law and authorized by the ICC, have been established to accumulate funds based on the expected service life of the plant for the future decommissioning of Clinton. For the years 1994, 1993 and 1992, IP has contributed $5.5 million, $3.9 million and $3.7 million, respectively, to its external nuclear decommissioning trust funds. The balances in these nuclear decommissioning funds at December 31, 1994 and 1993, were $22.4 million and $17.2 million, respectively. IP recognizes earnings and expenses from the trust funds as changes in its assets and liabilities relating to these funds. In November 1994, the ICC granted IP permission to invest up to 60% of the nuclear decommissioning trust assets in selected equity securities.\nThe Securities and Exchange Commission (SEC) staff has questioned certain current accounting practices of the electric utility industry, including those practices used by IP, regarding the recognition, measurement and classification of decommissioning costs for nuclear generating stations in financial statements. In response to these questions, the FASB has agreed to review the accounting for removal costs of nuclear generating stations, including decommissioning. If current electric utility industry accounting practices for such decommissioning are changed: 1) annual provisions for decommissioning could increase; 2) the estimated total cost for decommissioning could be recorded as a liability; and 3) trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense. Although it is too early to determine whether any changes to current electric utility industry accounting practices for decommissioning will be adopted, IP believes that based on current information, any required changes would not have an adverse effect on results of operations due to existing and anticipated future ability to recover decommissioning costs through rates. In 1992, the ICC entered an order in which it expressed concern that IP take all reasonable action to ensure that Soyland contributes its ownership share of the current or any revised estimate of decommissioning costs. The order also states that if IP becomes liable for decommissioning expenses attributable to Soyland, the ICC will then decide whether that expense should be the responsibility of IP's stockholders or its customers.\nAccounting Matters ------------------\nThe Illinova consolidated financial statements include the accounts of Illinova Corporation, a holding company, IP, a combination electric and gas utility, and IGC, a wholly-owned subsidiary that invests in energy-related projects and competes in the independent power market.\nIP's consolidated financial position and results of operations are currently the principal factors affecting Illinova's consolidated financial position and results of operations. All significant intercompany balances and transactions have been eliminated from the consolidated financial statements. All non-utility operating transactions are included in the section titled Other Income and Deductions, \"Miscellaneous- net\" in the Consolidated Statements of Income. Prior year amounts have been restated on a basis consistent with the December 31, 1994, presentation.\nThe IP consolidated financial statements include the accounts of Illinois Power Capital, L.P., a limited partnership in which IP serves as the general partner.\nIP currently prepares its financial statements in accordance with FAS 71. Accordingly, IP records various regulatory assets and liabilities to reflect the actions of regulators. Management believes that IP currently meets the criteria for continued application of FAS 71, but will continue to evaluate significant changes in the regulatory and competitive environment to assess IP's overall compliance with such criteria. These criteria include: 1) whether rates set by regulators are designed to recover the specific costs of providing regulated services and products to customers and; 2) whether regulators continue to establish rates based on cost. In the event that management determines that IP no longer meets the criteria for application of FAS 71, an extraordinary noncash charge to income would be recorded in order to remove the effects of the actions of regulators from the consolidated financial statements. The discontinuation of application of FAS 71 would likely have a material adverse effect on Illinova's and IP's consolidated financial position and results of operations.\nDividends ---------\nOn October 12, 1994, the Board of Directors of Illinova increased the common stock dividend 25 percent, declaring the common stock dividend for the first quarter of 1995 at 25 cents per share, payable February 1, 1995, to shareholders of record as of January 10, 1995.\nGas Business ------------\nIP supplies retail natural gas service to an estimated aggregate population of 920,000 in 257 incorporated municipali ties, adjacent suburban areas and numerous unincorporated communities. It does not sell gas for resale.\nDuring the twelve months ended December 31, 1994, IP purchased 62,733,000 MMBtu of natural gas from various suppliers, marketers and producers. After purchase, the gas is transported to the IP system via Panhandle Eastern Pipeline (Panhandle), Natural Gas Pipeline (Natural), Mississippi River Transmission Corporation (Mississippi), Trunkline Gas Company (Trunkline), and ANR Pipeline Company (ANR). Gas purchased including transportation for 1994 was at a cost of approximately $158 million. The average cost of natural gas purchased by IP from all suppliers for the years 1994, 1993 and 1992 was $2.52, $2.82 and $2.62 per MMBtu, respectively.\nThe total cost of natural gas delivered decreased 15.3% from 1993 due to lower pricing in the market. Gas therm sales, which exclude therms transported, decreased 2.2% in 1994. When transported gas for industrial and commercial customers is included, the total gas delivered (therms sold plus therms transported) to IP's customers increased 2.4% from 1993.\nIP's rate schedules contain provisions for passing through to its gas customers increases or decreases in the cost of purchased gas. For Illinova see the information under the sub- caption \"Revenue and Energy Cost\" of \"Note 1 - Summary of Sig nificant Accounting Policies\" on page A-15 of the 1994 Annual Re port to Shareholders in the appendix to the Illinova Proxy Statement that is incorporated herein by reference. For IP see the information under the sub-caption \"Revenue and Energy Cost\" of \"Note 1 - Summary of Significant Accounting Policies\" on page A-15 of the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement that is incorporated herein by reference.\nThe volume of customer-owned gas transported during 1994 increased 14.4% from that of 1993 due to lower spot market prices and the new gas rate structure. Approximately 150 industrial and large commercial customers purchase gas directly from gas producers and marketers. These customers are charged for the transportation of gas through IP's system to their plant facilities.\nIP has eight underground gas storage fields having a total capacity of approximately 15.2 million MMBtu and a total deliverability on a peak day of about 347,000 MMBtu. In addition to the capacity of the eight underground storage fields, IP has contracts with Panhandle for 5.6 million MMBtu of underground storage capacity and a total deliverability on a peak day of approximately 59,000 MMBtu, with Natural for 1.2 million MMBtu of storage capacity and a total deliverability on a peak day of 37,000 MMBtu, with Mississippi for 3.7 million MMBtu of storage capacity with a peak day deliverability of 64,000 MMBtu and with ANR for 63,000 MMBtu of storage capacity with a peak day deliverability of 1,270 MMBtu. Operation of underground storage permits IP to increase deliverability to its customers during peak load periods by taking gas into storage during the off-peak months.\nIP owns two active liquefied petroleum gas plants having an aggregate peak-day deliverability of about 40,000 MMBtu for peak- shaving purposes. Gas properties include approximately 7,800 miles of mains.\nIP experienced its 1994 peak-day send out of 786,070 MMBtu of natural gas on January 18, 1994. IP's highest peak-day send out was 857,324 MMBtu of natural gas on January 10, 1982.\nOn April 6, 1994, the ICC approved an increase of $18.9 million, or 6.1%, in IP's natural gas base rates. The increase to customers will be partially offset by savings from lower gas costs resulting from the expansion of the Hillsboro gas storage field. The approved authorized rate of return on rate base is 9.29%, with a rate of return on common equity of 11.24%. Concurrent with the gas rate increase, IP's gas utility plant composite depreciation rate decreased to 3.4%.\nGas Supply ----------\nPursuant to Orders 636 and 636-A, issued in April and August 1992, respectively, the FERC approved amendments to its rules that are intended to increase competition among natural gas suppliers by \"unbundling\" the interstate pipelines' merchant sales service into separate sales and transportation services and by mandating that the pipelines' firm transportation service be comparable to the transportation service included in their traditional bundled sales service. Under this rule, pipelines are required to unbundle services that they provided so that natural gas purchasers can select services as needed to meet their energy requirements. As of December 31, 1993, all of IP's pipeline suppliers had restructured their service offerings to conform with the requirements of Orders 636 and 636-A. These rules have increased the complexity of providing firm gas service. This additional complexity results from the greater number of options available to IP, as well as the added responsibility to arrange for the acquisition, transportation and storage of natural gas, which was previously bundled into the pipelines' sales service. As a result of Orders 636 and 636-A, the pipelines are charging their customers \"transition\" costs, which arise from unbundling services. IP estimates that approximately $10.5 million in transition costs will be incurred. In 1993, IP began to pay transition costs billed by gas pipelines and to recover these payments through a tariff rider. On September 23, 1994, the ICC issued a final order approving recovery of Order 636 transition costs.\nUnder Order 636, IP has entered into firm transportation agreements with the pipelines that feed its system. These contracts replace the sales contracts previously held with the respective pipelines. The amounts of firm transportation volumes under the contracts currently in effect with each pipeline are listed below.\nContract Expiration Source Firm Transportation Volume Date ------ -------------------------- ----------- Panhandle 75,900 MMBtu plus 58,370 MMBtu 04\/30\/96 Leased Storage Natural 89,454 MMBtu plus 37,675 MMBtu 11\/30\/96 Leased Storage Mississippi 102,000 MMBtu including Storage 10\/31\/96 Trunkline(1) 10,831 MMBtu 04\/30\/94 Trunkline SG-2 3,726 MMBtu 06\/30\/97 ANR 5,065 MMBtu 10\/31\/96 Noram 20,019 MMBtu 10\/31\/95\n(1) The Trunkline contract was not renewed. It was replaced with increased deliverability from the Hillsboro Storage Field.\nIP's present estimated supplies of gas from pipelines and its own storage are sufficient to serve all of its existing firm loads and to provide best efforts service to interruptible loads during critical periods. Gas service to interruptible customers was interrupted on six occasions for a total of 579 hours during the year 1994. On these occasions, storage service was made available in lieu of curtailment. Gas service continues to be available to all applicants on a current basis.\nEnvironmental Matters ---------------------\nIP is subject to regulation by certain federal and Illinois authorities with respect to environmental matters and may in the future become subject to additional regulation by such authorities or by other federal, state and local governmental bodies. Existing regulations affecting IP are principally related to air and water quality, hazardous wastes and toxic substances.\nAir Quality -----------\nPursuant to the Federal Clean Air Act (Act), the United States Environmental Protection Agency (USEPA) has established ambient air quality standards for air pollutants which in its judgment have an adverse effect on public health or welfare. The Act requires each state to adopt laws and regulations, subject to USEPA approval, designed to achieve such standards. Pursuant to the Illinois Environmental Protection Act, the Illinois Pollution Control Board (Board) adopted and, along with the Illinois Environmental Protection Agency (IEPA), is enforcing a comprehen sive set of air pollution control regulations which include emission limitations and permitting and monitoring and reporting requirements. These regulations have, with some modifications, received USEPA approval and are enforceable by both the Illinois and federal agencies.\nThe air pollution regulations of the Board impose limitations on emissions of particulate, sulfur dioxide, carbon monoxide, nitrogen oxides and various other pollutants. Enforcement of emission limitations is accomplished in part through the regulatory permitting process. To construct a facility which will produce regulated emissions, a construction permit must be obtained, usually on the basis of the design being sufficient to permit operation within applicable emission limitations. Upon completion of construction, an operating permit for the facility must be obtained. Operating permits are granted for various periods, usually within a range from two to five years. The initial granting or subsequent renewal of operating permits is based upon a demonstration that the facility operates within prescribed limitations on emissions. IP's practice is to obtain an operating permit for each source of regulated emissions. Presently, it has a total of approximately 100 permits for emission sources at its power stations and other facilities, expiring at various times. In addition to having the requisite operating permits, each source of regulated emissions must be operated within the regulatory limitations on emissions. Verification of such compliance is usually accomplished by reports to regulatory authorities and inspections by such authorities.\nJointly, IP and IEPA petitioned the Board to adopt a regulatory amendment providing for a site-specific sulfur dioxide limitation applicable to the Baldwin power station. The Board granted that relief in 1979 and amended it in 1983 to satisfy certain concerns raised by USEPA. In October 1983, the amendment, with supporting information, was submitted to USEPA for approval as part of the State Implementation Plan (SIP). On March 5, 1990, USEPA approved the Baldwin SIP allowing the use of local coal up to full capacity of the Baldwin power station.\nIn addition to the sulfur dioxide emission limitations for existing facilities, both the USEPA and the State of Illinois adopted New Source Performance Standards (NSPS) applicable to coal-fired generating units limiting emissions to 1.2 pounds of sulfur dioxide per million Btu of heat input. This standard is applicable to IP's Unit 6 at the Havana power station. The federal NSPS also limits nitrogen oxides, opacity and particulate emissions and imposes certain monitoring requirements. In 1977 and 1990 the Act was amended and, as a result, USEPA has adopted more stringent emission standards for new sources. These standards would apply to any new plant constructed by IP.\nClean Air Act -------------\nOn November 15, 1990, the U. S. Congress passed the Clean Air Act Amendments (Amendments). The Amendments create new programs to control acid rain, protect stratospheric ozone and require new permits for most air pollution sources. The Amendments also modify the existing hazardous air pollutant program and impose new air quality requirements on sources in areas which do not meet the ambient air quality standards and other sources which adversely impact these areas. As the regulations implementing the Amendments are developed, IP will develop and implement plans to maintain compliance with any new air pollutant restrictions.\nIn August 1992, IP announced that it had suspended construction of two scrubbers at the Baldwin power station, on which IP had expended approximately $34.6 million. IP has recovered approximately $3.1 million as a result of the sale of excess materials that were not used on the project. After suspending scrubber construction, IP reconsidered its alternatives for complying with Phase I of the 1990 Clean Air Act Amendments. In March 1993, IP announced its compliance plan for Phase I (1995-1999) of the Clean Air Act, which is to continue using high-sulfur Illinois coal and acquire emission allowances to comply with the Clean Air Act requirements. An emission allowance is the authorization by the USEPA to emit one ton of sulfur dioxide. The ICC approved IP's Phase I Clean Air Act compliance plan in September 1993, and IP is continuing to implement that plan. Sufficient emission allowances have been acquired to meet anticipated needs for 1995. IP will be active in the emissions allowance market in order to meet requirements for allowances in 1996 and beyond. In 1993, the Illinois General Assembly passed and the governor signed legislation authorizing but not requiring the ICC to permit expenditures and revenues from emission allowance purchases and sales to be reflected in rates charged to customers as a cost of fuel. In December 1994, the ICC approved the recovery of emission allowance costs through the Uniform Fuel Adjustment Clause. IP's compliance plan will defer, until at least 2000, any need for scrubbers or other capital projects associated with sulfur dioxide emission reductions. Additional actions and capital expenditures will be required by IP to achieve compliance with the Phase II (2000 and beyond) sulfur dioxide emission requirements of the Clean Air Act.\nIP planned to comply with the Phase I nitrogen-oxide emission reduction requirements of the acid rain provisions of the Clean Air Act by installing low-nitrogen-oxide (NOx) burners at Baldwin Unit 3. On November 29, 1994, the U.S. D.C. Circuit Court of Appeals remanded the Phase I NOx rules back to the USEPA. IP is positioned to comply with the previously established rules and does not expect the new rules to be any more stringent. Therefore, the Court's decision is not expected to have a material impact on IP's compliance activity.\nAdditional capital expenditures are anticipated prior to 2000 to comply with the Phase II nitrogen-oxide requirements, as well as potential requirements to further reduce nitrogen-oxide emissions from IP plants to help achieve compliance with air quality standards in the St. Louis and\/or Chicago metropolitan areas. IP has installed continuous emission monitoring systems at its major generating stations, as required by the acid rain provisions of the Clean Air Act.\nIn July 1993, the Alliance for Clean Coal (Alliance), a coalition of Western coal producers and railroads, filed suit against the ICC in the U.S. District Court in Chicago. The Alliance sought a declaration that an Illinois statute regarding the filing with and approval by the ICC of utility Clean Air Act compliance plans, including provisions on the construction of scrubbers or other devices to facilitate continued use of high- sulfur Illinois coal as a fuel, is unconstitutional. In December 1993, the U.S. District Court issued an opinion and an order in Alliance for Clean Coal vs. Ellen Craig, et al. declaring the statute unconstitutional. The order prohibits the ICC from enforcing the statute, and declares void compliance plans prepared and approved in reliance on the statute. Subsequent to that decision, IP filed its plan with the ICC, not for approval as it believes no approval of the plan is required, but as a supplement to informational filings made in a pending least-cost plan proceeding. The ICC concluded in its final order that IP's compliance plan represented the least-cost option for compliance. On January 9, 1995, the Seventh Circuit Court of Appeals affirmed the U.S. District Court decision.\nManufactured-Gas Plant (MGP) Sites ----------------------------------\nIP, through its predecessor companies, was identified on a State of Illinois list as the responsible party for potential environmental impairment at 24 former MGP sites. IP is investigating each of the sites to determine: (1) the type and amount of residues present; (2) whether the residues constitute environmental or health hazards and, if present, their extent; and (3) whether IP has any responsibility for remedial action. Because of the unknown and unique characteristics of each site (such as amount and type of residues present, physical characteristics of the site and the environmental risk) and uncertain regulatory requirements, IP is not able to determine its ultimate liability for the investigation and remediation of the 24 sites. However, at December 31, 1994, IP has estimated and recorded a minimum liability of $35 million. In 1994, IP spent approximately $1.3 million for investigation and remediation activities. IP is unable to determine at this time what portion of these costs, if any, will be eligible for recovery from insurance carriers or other potentially responsible parties. In addition, IP is unable to determine the time frame over which these costs may be paid out. IP has recorded a regulatory asset in the amount of $35 million, reflecting management's expectation that investigation and remediation costs for the MGP sites will be recovered from customers or insurers.\nIn September 1992, the ICC issued a generic order concluding that utilities will be allowed to collect from customers MGP remediation costs paid to third parties, subject to prudency evaluation. The order allowed recovery of such prudently incurred costs over a five-year period but with no recovery from customers of carrying costs on the unrecovered balance.\nIP is currently recovering MGP site cleanup costs from its customers through a tariff rider approved by the ICC in April 1993. In February 1994, an intervening consumer group appealed the September 1992 ICC order and an affirming December 1993 Appellate Court decision to the Illinois Supreme Court, arguing that utilities should not be permitted to recover MGP cleanup costs from customers or should not be permitted to recover such costs through riders. IP and other utilities have also appealed to the Illinois Supreme Court seeking to include carrying costs on the unrecovered balance of cleanup costs through the tariff rider. The Illinois Supreme Court agreed to hear both appeals, and briefing and oral arguments were held in September 1994. Management believes that the final disposition of these appeals will not have a material adverse effect on Illinova's or IP's consolidated financial position or results of operations.\nWater Quality -------------\nThe Federal Water Pollution Control Act Amendments of 1972 require that National Pollutant Discharge Elimination System (NPDES) permits be obtained from USEPA (or, when delegated, from individual state pollution control agencies) for any discharge into navigable waters. Such discharges are required to conform with the standards, including thermal, established by USEPA and also with applicable state standards.\nEnforcement of discharge limitations is accomplished in part through the regulatory permitting process similar to that described previously under \"Air Quality\". Presently, IP has approximately two dozen permits for discharges at its power stations and other facilities, which must be periodically renewed.\nIn addition to obtaining such permits, each source of regulated discharges must be operated within the limitations prescribed by applicable regulations. Verification of such compliance is usually accomplished by monitoring results reported to regulatory authorities and inspections by such authorities.\nThe Baldwin permit was reissued during the fourth quarter of 1993 and is due for renewal in the fourth quarter of 1997. The Hennepin NPDES permit was reissued in 1992 and is due for renewal in the third quarter of 1997. The Clinton permit was reissued in 1990 and is due for renewal in the second quarter of 1995. The application to renew this permit has been submitted and IP is allowed to continue to operate the plant at currently authorized levels. The Vermilion, Wood River and Havana permits were reissued in 1991. These permits are due for renewal in the fourth quarter of 1995.\nDuring 1994, IP investigated various compliance options for the ash pond discharge from the Vermilion Plant (Plant). One of the options considered by the Plant was to request a flow-based NPDES permit. This approach would require the new ash pond be used to store wastewater during months when the flow in the receiving stream was low and the possibility of exceeding in- stream water quality standards would be greatest. New piping, valves and sophisticated flow-monitoring equipment was installed to allow the Plant to control the rate of release from the ash pond so that in-stream standards would not be exceeded. A modified NPDES permit was received from IEPA in June 1994 which authorized this type operation.\nRecently the Baldwin NPDES permit was modified to extend the compliance schedule for achieving compliance with the boron effluent limit for the ash pond discharge. The initial date for achieving compliance was October 1996; however, because of delays caused by the flooded Kaskaskia River, necessary mixing zones studies could not be completed quickly. IEPA modified the permit to extend the compliance schedule until December 1, 1997, which allows IP sufficient time to complete all necessary studies.\nOther Issues ------------\nHazardous and non-hazardous wastes generated by IP must be managed in accordance with federal regulations under the Toxic Substances Control Act, the Comprehensive Environmental Response, Compensation and Liability Act and the Resource Conservation and Recovery Act (RCRA) and additional state regulations promulgated under both RCRA and state law. Regulations promulgated in 1988 under RCRA govern IP's use of underground storage tanks. The use, storage, and disposal of certain toxic substances, such as polychlorinated biphenyls (PCB's) in electrical equipment, are regulated under the Toxic Substances Control Act. Hazardous substances used by IP are subject to reporting requirements under the Emergency Planning Community-Right-To-Know Act (EPCRA). The State of Illinois has been delegated authority for enforcement of these regulations under the Illinois Environmental Protection Act and state statutes. These requirements impose certain monitoring, recordkeeping, reporting and operational requirements which IP has implemented or is implementing to assure compliance. IP does not anticipate that compliance will have a material adverse effect on its financial position or results of operations.\nBetween June 1983 and January 1985, IP shipped various materials containing PCB's to the Martha C. Rose Chemicals, Inc. (Rose) facility in Holden, Missouri for proper treatment and disposal. Rose, pursuant to permits issued by USEPA, had undertaken to dispose of PCB materials for IP and others, but failed in part to do so. As a result of such failure, PCB materials were being stored at the facility. In 1986, IP joined with a number of other generators to efficiently and economically cleanup the facility. The Steering Committee, consisting of IP and 15 other entities has received USEPA's approval to implement the Remedial Design Work Plan. Remedial action plan activities are scheduled for completion by the end of April 1995. The Steering Committee is required to monitor ground water at the site from a minimum of five years to a maximum of ten years after completion of the Plan. At the present time, management does not believe its ratable share of potential liability related to the cost of future activities at the Rose site will have a material adverse effect on Illinova's or IP's consolidated financial position or results of operations. IP, along with fourteen other steering committee members, reached a settlement with all potentially responsible parties to recover their ratable share of these costs.\nElectric and Magnetic Fields ----------------------------\nThe possibility that exposure to electric and magnetic fields (EMF) emanating from power lines, household appliances and other electric sources may result in adverse health effects continues to be the subject of litigation and governmental, medical and media attention. Litigants have also claimed that EMF concerns justify recovery from utilities for the loss in value of real property exposed to power lines, substations and other such sources of EMF. Scientific research worldwide has produced conflicting results and no conclusive evidence that electric and\/or magnetic field exposure causes adverse health effects. Research is continuing to resolve scientific uncertainties. The DOE and the National Institute of Environmental Health Sciences are administering a National EMF Research and Public Information Dissemination Program. A final report on the results of this Program is required by statute to be submitted to Congress by March 31, 1997. It is too soon to tell what, if any, impact these actions may have on Illinova's or IP's consolidated financial position.\nEnvironmental Expenditures --------------------------\nOperating expenses for environmentally-related activities in 1994 were approximately $48 million (including the incremental costs of alternative fuels to meet environmental requirements). IP's accumulated capital expenditures (including AFUDC) for environmental protection programs since 1969 have reached approximately $792 million.\nResearch and Development ------------------------\nIP's research and development expenditures during 1994, 1993 and 1992 were approximately $5.5 million, $6.4 million and $3.7 million, respectively. The increased research and development costs in 1993 are primarily due to increased dues to the Electric Power Research Institute and increased alternate fuel testing at the Baldwin power station. The decreased research and development costs in 1994 were because of decreased alternate fuel testing at the Baldwin power station.\nRegulation ----------\nUnder the Illinois Public Utilities Act, the ICC has broad powers of supervision and regulation with respect to the rates and charges of IP, its services and facilities, extensions or abandonment of service, classification of accounts, valuation and depreciation of property, issuance of securities and various other matters. The Illinois Public Utilities Act was amended effective January 1, 1986 to include certain provisions specifying criteria for the inclusion of utility plant investment in rate base. These provisions state in substance that the ICC shall include in a utility's rate base only the value of its investment which is both prudently incurred and used and useful in providing service to customers; that no new electric generating plant or significant addition to existing facilities shall be included in rate base unless the ICC determines that such plant or facility is reasonable in cost, prudent and used and useful in providing utility service to customers; and that the ICC is empowered to determine whether a utility's generating capacity is in excess of that reasonably necessary to provide adequate and reliable service and to make appropriate and equitable adjustments to rates upon a finding of excess capacity, provided that any such determination and adjustment with respect to generating capacity existing or under construction prior to January 1, 1986 shall be limited to the determination and adjustment, if any, appropriate under the law then in effect.\nIllinova and IP are exempt from all the provisions of the Public Utility Holding Company Act of 1935 except Section 9(a)(2) thereof. That section requires approval of the Securities and Ex change Commission prior to certain acquisitions of any securities of other public utility companies or public utility holding companies.\nIP is subject to regulation under the Federal Power Act by the FERC as to rates and charges in connection with the transmission of electric energy in interstate commerce and the sale of such energy at wholesale in interstate commerce, the issuance of debt securities maturing in not more than 12 months, accounting and depreciation policies, and certain other matters.\nThe FERC has declared IP exempt from the Natural Gas Act and the orders, rules and regulations of the Commission thereunder. IP is subject to the jurisdiction of the NRC with respect to Cl inton. NRC regulations control the granting of permits and licenses for the construction and operation of nuclear power stations and subject such stations to continuing review and regulation. Additionally, the NRC review and regulatory process covers decommissioning, radioactive waste, environmental and radiological aspects of such stations. In general, the NRC continues to propose new and revised rules relating to the operations and maintenance aspects of nuclear facilities. It is unclear whether such proposed rules will be adopted and what effect, if any, such adoption will have on IP.\nIP is subject to the jurisdiction of the Illinois Department of Nuclear Safety (IDNS) with respect to Clinton. IDNS and the NRC entered a memorandum of understanding which allows IDNS to review and regulate nuclear safety matters at state nuclear facilities. The IDNS review and regulatory process covers radiation safety, environmental safety, non-nuclear pressure vessels, emergency preparedness and emergency response. IDNS continues to propose new and revised state administrative code. It is unclear if such proposed rules will be adopted and what effect, if any, such adoption will have on IP.\nExecutive Officers of Illinova Corporation ------------------------------------------\nName of Officer Age Position --------------- --- --------\nLarry D. Haab 57 Chairman, President and Chief Executive Officer Larry F. Altenbaumer 47 Chief Financial Officer, Treasurer and Controller Leah Manning Stetzner 46 General Counsel and Corporate Secretary\nMr. Haab was elected Chairman, President and Chief Executive Officer in December 1993.\nMr. Altenbaumer was elected Chief Financial Officer, Treasurer and Controller in June 1994.\nMs. Stetzner was elected General Counsel and Corporate Secretary in June 1994.\nExecutive Officers of Illinois Power Company --------------------------------------------\nName of Officer Age Position --------------- --- --------\nLarry D. Haab 57 Chairman, President and Chief Executive Officer Charles W. Wells 60 Executive Vice President Larry F. Altenbaumer 47 Senior Vice President and Chief Financial Officer Larry S. Brodsky 46 Senior Vice President Paul L. Lang 54 Senior Vice President Wilfred Connell 57 Vice President John G. Cook 47 Vice President Larry L. Idleman 56 Vice President Leah Manning Stetzner 46 Vice President, General Counsel and Corporate Secretary Ralph F. Tschantz 42 Vice President Alec G. Dreyer 37 Treasurer and Controller\nEach of the above IP executive officers, except for Mr. Tschantz and Mr. Dreyer, has been employed by IP for more than five years in executive or management positions. Prior to election to the positions shown above, the following executive officers held the following positions since January 1, 1990.\nMr. Haab was elected Chairman in June 1991. He was elected Chief Executive Officer in April 1991 and President in April 1989.\nMr. Altenbaumer was elected Senior Vice President and Chief Financial Officer in June 1992. Prior to being elected Vice President, Chief Financial Officer and Controller in June 1990, he was Controller and Treasurer.\nMr. Brodsky was elected Senior Vice President in October 1994. He was previously elected Vice President in November 1987.\nMr. Lang was elected Senior Vice President in June 1992. He joined IP as Vice President in July 1986.\nMr. Cook was elected Vice President in June 1992. He previously held the positions of Manager of Clinton Power Station and Manager of Nuclear Planning and Support.\nMs. Stetzner was elected Vice President, General Counsel and Corporate Secretary in February 1993. She joined IP as General Counsel and Corporate Secretary in October 1989.\nMr. Tschantz joined IP as Vice President in March 1995. He previously was a Regional Account Management Director with Keebler Company since 1993 and Group Director, Sales, Systems and Planning since 1990.\nMr. Dreyer was elected Treasurer and Controller in December 1994. Prior to joining IP as Controller in June 1992, he was a Senior Audit Manager with Price Waterhouse since 1990.\nThe present term of office of each of the above executive officers extends to the first meeting of Illinova's and IP's Board of Directors after the Annual Election of Directors. There are no family relationships among the executive officers and directors of Illinova and IP.\nOperating Statistics ---------------------\nFor Illinova the information under the caption \"Selected Illinois Power Company Statistics\" on page A-33 of the 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference.\nFor IP the information under the caption \"Selected Statistics\" on page A-33 of the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties -------\nIP owns and operates electric generating stations at Havana, Wood River, Hennepin, Baldwin and near Danville, Illinois (designated as the Vermilion station), totaling 3,487,000 kilo watts of net summer capability. IP has an ownership in the Clinton power station (Clinton) of 86.8% and Soyland Power Coop erative, Inc. owns the remaining 13.2%. IP's portion of net summer output capability of Clinton is 807,000 kilowatts. IP also owns other gas turbine generating facilities, at three locations, with an aggregate capability of 147,000 kilowatts.\nIP owns an interconnected electric transmission system of approximately 2,800 circuit miles, operating from 69,000 to 345,000 volts and a distribution system which includes about 37,200 circuit miles of overhead and underground lines.\nAll outstanding first mortgage bonds issued under the Mortgage and Deed of Trust dated November 1, 1943 are secured by a first mortgage lien on substantially all of the fixed property, franchises and rights of IP with certain exceptions expressly provided in the mortgage securing the bonds. All outstanding New Mortgage Bonds issued under the General Mortgage and Deed of Trust dated November 1, 1992, are secured by a lien on IP's properties used in the generation, purchase, transmission, distribution and sale of electricity and gas, which lien is junior to the lien of the Mortgage and Deed of Trust dated November 1, 1943.\nItem 3.","section_3":"Item 3. Legal Proceedings -------\nSee discussion of legal proceedings under Item 1 \"Nuclear\" and \"Gas Manufacturing Sites\".\nFuel and Purchased Gas Adjustment Clauses -----------------------------------------\nThe ICC holds annual public hearings to determine whether each utility's fuel adjustment clause and purchased gas adjustment clause reflect actual costs of fuel and gas prudently purchased and to reconcile amounts collected with actual costs, with the possibility of surcharges or refunds to reflect amounts under-collected or over-collected. See \"1987 Uniform Fuel Adjustment Clause Reconciliation\" reported under \"Clinton Power Station\" in Item 1 for information regarding a January 1994 order on remand from the ICC.\nEnvironmental -------------\nSee \"Environmental Matters\" reported under Item 1 for information regarding legal proceedings concerning environmental matters.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders -------\nIP did not submit any matter to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1994.\nPART II -----------------------------------------------------------------\nItem 5.","section_5":"Item 5. Market for Registrants' Common Equity and Related ------- Stockholder Matters\nFor Illinova the information under the caption \"Quarterly Consolidated Financial Information and Common Stock Data (Unaudit ed)\" on page A-31 of the 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference.\nFor IP the information under the caption \"Quarterly Consolidated Financial Information and Common Stock Data (Unaudited)\" on page A-31 of the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data -------\nFor Illinova the information under the caption \"Selected Consolidated Financial Data\" on page A-32 of the 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference.\nFor IP the information under the caption \"Selected Consolidated Financial Data\" on page A-32 of the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial ------- Condition and Results of Operations\nFor Illinova the information under the caption \"Management's Discussion and Analysis\" on pages A-2 through A-9 of the 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is incorporated herein by reference.\nFor IP the information under the caption \"Management's Discussion and Analysis\" on pages A-2 through A-9 of the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement is incorporated herein by reference.\nIn December 1994, IP filed a petition with the ICC seeking approval of a program whereby IP will reacquire shares of its common stock from Illinova, from time to time, at prices determined to be equivalent to current market value. The reacquired stock will be retained as treasury stock or cancelled. On March 22, 1995, the ICC approved the common stock repurchase program. The ICC specified that IP may initiate the repurchase of shares of its common stock from Illinova subject to meeting certain financial tests. The ICC did not set a limit on the number of shares of common stock that can be repurchased.\nOn May 1, 1995, IP will redeem the remaining 240,000 shares of 8.00% Cumulative Preferred Stock for $100 per share plus accrued dividends.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -------\nFor Illinova the consolidated financial statements and related notes on pages A-11 through A-31 and Report of Inde pendent Accountants on page A-10 of the 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated in Items 5, 6 and 7, the 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement is not to be deemed filed as part of this Form 10-K Annual Report.\nFor IP the consolidated financial statements and related notes on pages A-11 through A-31 and Report of Independent Accountants on page A-10 of the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated in Items 5, 6 and 7, the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement is not to be deemed filed as part of this form 10-K Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on ------- Accounting and Financial Disclosure\nNone.\nPART III -----------------------------------------------------------------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrants --------\nFor Illinova the information under the caption \"Board of Directors\" on pages 3 through 7 of Illinova's Proxy Statement for its 1995 Annual Meeting of Stockholders is incorporated herein by reference. The information relating to Illinova's executive officers is set forth in Part I of this Annual Report on Form 10- K.\nFor IP the information under the caption \"Board of Directors\" on pages 4 through 7 of IP's Information Statement for its 1995 Annual Meeting of Stockholders is incorporated herein by reference. The information relating to Illinois Power 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 --------\nFor Illinova the information under the caption \"Executive Compensation\" on pages 8 through 12 of Illinova's Proxy Statement for its 1995 Annual Meeting of Stockholders is incorporated herein by reference.\nFor IP the information under the caption \"Executive Compensation\" on pages 8 through 13 of IP's Information Statement for its 1995 Annual Meeting of Stockholders is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and --------- Management\nFor Illinova the information under the caption \"Security Ownership of Management and Certain Beneficial Owners\" on page 7 and the information regarding securities owned by certain officers and directors under the caption \"Board of Directors\" on pages 3 through 7 of Illinova's Proxy Statement for its 1995 Annual Meeting of Stockholders is incorporated herein by reference.\nFor IP the information under the caption \"Security Ownership of Management and Certain Beneficial Owners\" on page 7 and the information regarding securities owned by certain officers and directors under the caption \"Board of Directors\" on pages 4 through 7 of IP's Information Statement for its 1995 Annual Meeting of Stockholders 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) Documents filed as part of this report. (1a) Financial Statements: Page in 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement* ----------------\nReport of Independent Accountants A-10 Consolidated Statements of Income for the three years ended December 31, 1994 A-11 Consolidated Balance Sheets at December 31, 1994 and 1993 A-12 Consolidated Statements of Cash Flows for the three years ended December 31, 1994 A-13 Consolidated Statements of Retained Earnings (Deficit) for the three years ended December 31, 1994 A-13 Notes to Financial Statements A-14 - A-31\n* Incorporated by reference from the indicated pages of the 1994 Annual Report to Shareholders in the appendix to the Illinova Proxy Statement.\n(1b) Financial Statements: Page in 1994 Annual Report to Shareholders in the appendix to the IP Information Statement** ---------------\nReport of Independent Accountants A-10 Consolidated Statements of Income for the three years ended December 31, 1994 A-11 Consolidated Balance Sheets at December 31, 1994 and 1993 A-12 Consolidated Statements of Cash Flows for the three years ended December 31, 199 A-13 Consolidated Statements of Retained Earnings (Deficit) for the three years ended December 31, 1994 A-13 Notes to Financial Statements A-14 - A-31\n** Incorporated by reference from the indicated pages of the 1994 Annual Report to Shareholders in the appendix to the IP Information Statement (See page 35 of this Form 10- K).\n(2) Financial Statement Schedules:\nAll Financial Statement Schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(3) Exhibits\nThe exhibits filed with this Form 10-K are listed in the Exhibit Index located elsewhere herein. All management contracts and compensatory plans or arrangements set forth in such list are marked with a ~.\n(b) Reports on Form 8-K since September 30, 1994:\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.\nILLINOVA CORPORATION (REGISTRANT)\nBy Larry D. Haab ------------------------ Larry D. Haab, Chairman, President and 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 on the dates indicated.\nSignature Title Date --------- ----- ----\nLarry D. Haab Chairman, President, Chief March 30, 1995 --------------------- Executive Officer and Director Larry D. Haab (Principal Executive Officer)\nLarry F. Altenbaumer Chief Financial Officer, March 30, 1995 --------------------- Treasurer and Controller Larry F. Altenbaumer (Principal Financial and Accounting Officer)\nRichard R. Berry Director March 30, 1995 --------------------- Richard R. Berry\nDonald E. Lasater Director March 30, 1995 --------------------- Donald E. Lasater\nDonald S. Perkins Director March 30, 1995 --------------------- Donald S. Perkins\nRobert M. Powers Director March 30, 1995 --------------------- Robert M. Powers\nWalter D. Scott Director March 30, 1995 --------------------- Walter D. Scott\nRonald L. Thompson Director March 30, 1995 --------------------- Ronald L. Thompson\nWalter M. Vannoy Director March 30, 1995 --------------------- Walter M. Vannoy\nMarilou von Ferstel Director March 30, 1995 --------------------- Marilou von Ferstal\nCharles W. Wells Director March 30, 1995 --------------------- Charles W. Wells\nJohn D. Zeglis Director March 30, 1995 --------------------- John D. Zeglis\nDirector March 30, 1995 --------------------- Vernon K. Zimmerman\nExhibit Index\nExhibit Description Page Number ------- ----------- -----------\n3(a)(1) Amended and Restated Articles of Incorporation of Illinois Power Company, dated September 7, 1994. Filed as Exhibit 3(a) to the Current Report on Form 8-K dated September 7, 1994 (File No. 1-3004). *\n3(a)(2) Articles of Amendment to the Articles of Incorporation of Illinova Corporation, filed as of October 31, 1994. Filed as Exhibit 3(a) to the Quarterly Report on Form 10-Q under the Securities Exchange Act of 1934 for the quarter ended September 30, 1994 (File No. 1-3004). *\n3(a)(3) Statement of Correction to the Articles of Incorporation of Illinova Corporation, filed as of October 31, 1994. Filed as Exhibit 3(b) to the Quarterly Report on Form 10-Q under the Securities Exchange Act of 1934 for the quarter ended September 30, 1994 (File No. 1-3004). *\n3(b)(1) By-laws of Illinois Power Company, as amended through December 14, 1994. 47\n3(b)(2) By-laws of Illinova Corporation, as amended through December 14, 1994. 55\n4(a) Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 2(b) Registration No. 2-14066. *\n4(b) Supplemental Indenture dated October 1, 1966. Filed as Exhibit 2(i) Registration No. 2-27783. *\n4(c) Supplemental Indenture dated October 1, 1971. Filed as Exhibit 2(r) Registration No. 2-59465. *\n4(d) Supplemental Indenture dated May 1, 1974. Filed as Exhibit 2(v) Registration No. 2-51674. *\n4(e) Supplemental Indenture dated May 1, 1977. Filed as Exhibit 2(w) Registration No. 2-59465. *\n4(f) Supplemental Indenture dated July 1, 1979. Filed as Exhibit 2 to the Quarterly Report on Form 10-Q under the Securities Exchange Act of 1934 for the quarter ended June 30, 1979. *\n4(g) Supplemental Indenture dated March 1, 1985. Filed as exhibit 4(a) to the Quarterly Report on Form 10-Q under the Securities Exchange Act of 1934 for the quarter ended March 31, 1985 (File No. 1-3004). *\n4(h) Supplemental Indenture No. 1 dated February 1, 1987, providing for $25,000,000 principal amount of 7 5\/8% First Mortgage Bonds, Pollution Control Series F, due December 1, 2016. Filed as Exhibit 4(ii) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1986 (File No. 1-3004). *\n4(i) Supplemental Indenture No. 2 dated February 1, 1987, providing for $50,000,000 principal amount of 7 5\/8% First Mortgage Bonds, Pollution Control Series G, due December 1, 2016. Filed as Exhibit 4(jj) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1986 (File No. 1-3004). *\n4(j) Supplemental Indenture No. 3 dated February 1, 1987, providing for $75,000,000 principal amount of 7 5\/8% First Mortgage Bonds, Pollution Control Series H, due December 1, 2016. Filed as Exhibit 4(kk) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1986 (File No. 1-3004). *\n4(k) Supplemental Indenture dated July 1, 1987, providing for $33,755,000 principal amount of 8.30% First Mortgage Bonds, Pollution Control Series I, due April 1, 2017. Filed as Exhibit 4(ll) to the Annual Report on Form 10-K under the Securities and Exchange Act of 1934 for the year ended December 31, 1987 (File No. 1-3004). *\n4(l) Supplemental Indenture dated December 13, 1989, providing for $300,000,000 principal amount of Medium-Term Notes, Series A. Filed as Exhibit 4 (nn) to the Annual Report on Form 10-K under the Securities and Exchange Act of 1934 for the year ended December 31, 1989 (File No. 1-3004). *\n4(m) Supplemental Indenture dated July 1, 1991, providing for $84,710,000 principal amount of 7 3\/8% First Mortgage Bonds due July 1, 2021. Filed as Exhibit 4(mm) to the Annual Report on Form 10-K under the Securities and Exchange Act of 1934 for the year ended December 31, 1991 (File No. 1-3004). *\n4(n) Supplemental Indenture No. 1 dated June 1, 1992. Filed as Exhibit 4(nn) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1992 (File No. 1-3004). *\n4(o) Supplemental Indenture No. 2 dated June 1, 1992. Filed as Exhibit 4(oo) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1992 (File No. 1-3004). *\n4(p) Supplemental Indenture No. 1 dated July 1, 1992. Filed as Exhibit 4(pp) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1992 (File No. 1-3004). *\n4(q) Supplemental Indenture No. 2 dated July 1, 1992. Filed as Exhibit 4(qq) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1992 (File No. 1-3004). *\n4(r) Supplemental Indenture dated September 1, 1992, providing for $72,000,000 principal amount of 6.5% First Mortgage Bonds due September 1, 1999. Filed as Exhibit 4(rr) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1992 (File No. 1-3004). *\n4(s) General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(cc) to the Annual Report on Form 10-K under the Securities and Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). *\n4(t) Supplemental Indenture dated February 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(dd) to the Annual Report on Form 10-K under the Securities and Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). *\n4(u) Supplemental Indenture dated February 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(ee) to the Annual Report on Form 10-K under the Securities and Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). *\n4(v) Supplemental Indenture No. 1 dated March 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(ff) to the Annual Report on Form 10-K under the Securities and Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). *\n4(w) Supplemental Indenture No. 1 dated March 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(gg) to the Annual Report on Form 10-K under the Securities and Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). *\n4(x) Supplemental Indenture No. 2 dated March 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(hh) to the Annual Report on Form 10-K under the Securities and Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). *\n4(y) Supplemental Indenture No. 2 dated March 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(ii) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1992 (File No. 1-3004). *\n4(z) Supplemental Indenture dated July 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(jj) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (File No. 1-3004). *\n4(aa) Supplemental Indenture dated July 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(kk) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (File No. 1-3004). *\n4(bb) Supplemental Indenture dated August 1, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(ll) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (File No. 1-3004). *\n4(cc) Supplemental Indenture dated August 1, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(mm) to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (File No. 1-3004). *\n4(dd) Supplemental Indenture dated October 15, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(nn) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1993. (File No. 1-3004). *\n4(ee) Supplemental Indenture dated October 15, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(oo) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1993. *\n4(ff) Supplemental Indenture dated November 1, 1993, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(pp) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File No. 1-3004). *\n4(gg) Supplemental Indenture dated November 1, 1993, to General Mortgage Indenture and Deed of Trust dated as of November 1, 1992. Filed as Exhibit 4(qq) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (File No. 1-3004). *\n4(hh) Supplemental Indenture dated February 1, 1994, to Mortgage and Deed of Trust dated November 1, 1943. Filed as Exhibit 4(hh) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1993 (File No. 1-3004). *\n4(ii) Indenture dated October 1, 1994 between Illinois Power Company and the First National Bank of Chicago. Filed as Exhibit 4(a) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 1-3004). *\n4(jj) Supplemental Indenture dated October 1, 1994, to Indenture dated as of October 1, 1994. Filed as Exhibit 4(b) to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 1-3004). *\n10(a) Group Insurance Benefits for Managerial Employees of Illinois Power Company as amended January 1, 1983. Supersedes the Group Insurance Benefits for Managerial Employees of Illinois Power Company as amended April 1, 1980 and filed as Exhibit 10(a) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1983 (File No. 1-3004).~ *\n10(b) Illinova Corporation Deferred Compensation Plan for Certain Directors, as amended April 10, 1991. Filed as Exhibit 10(b) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1991 (File No. 1-3004).~ *\n10(c) Illinois Power Company Incentive Savings Trust and Illinois Power Company Incentive Savings Plan and Amendment I thereto. Filed as Exhibit 10(d) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1984 (File No. 1-3004).~ *\n10(d) Illinova Corporation Director Emeritus Plan for Outside Directors. Filed as Exhibit 10(e) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1989 (File No. 1-3004).~ *\n10(e) Description of Illinois Power Company's Executive Incentive Compensation Plan. Filed as Exhibit 10(f) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1989 (File No. 1-3004).~ *\n10(f) Illinois Power Company Employee Retention Plan and Agreement. Filed as Exhibit 10(g) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1989 (File No. 1-3004).~ *\n10(g) Illinois Power Company Incentive Savings Plan, as amended and restated effective January 1, 1991. Filed as Exhibit 10(h) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1990 (File No. 1-3004).~ *\n10(h) Illinova Corporation Stock Plan for Outside Directors as amended and restated by the Board of Directors on April 9, 1992 and as further amended April 14, 1993. Filed as Exhibit 10(h) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1993 (File No. 1-3004).~ *\n10(i) Retirement and Consulting Agreement entered into as of June 1, 1991 between Illinois Power Company and Wendell J. Kelley. Filed as Exhibit 10(i) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1991 (File No. 1-3004).~ *\n10(j) Illinova Corporation Retirement Plan for Outside Directors, as amended through December 11, 1991. Filed as Exhibit 10(j) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1991 (File No. 1-3004).~ *\n10(k) Illinova Corporation 1992 long-term Incentive Compensation Plan. Filed as Exhibit 10(k) to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1992 (File No. 1-3004).~ *\n10(l) Illinois Power Company Executive Deferred Compensation Plan. Filed as Exhibit 10(l) to the Annual Report on Form 10-K under the Securities Exchange Act of 1934 for the year ended December 31, 1993. ~ *\n10(m) Illinois Power Company Retirement Income Plan for salaried employees as amended and restated effective January 1, 1989, as further amended through January 1, 1994.~ 63\n10(n) Illinois Power Company Retirement Income Plan for employees covered under a collective bargaining agreement as amended and restated effective as of January 1, 1994.~ 134\n10(o) Illinois Power Company Incentive Savings Plan as amended and restated effective January 1, 1991 and as further amended through amendments adopted December 28, 1994.~ 200\n10(p) Illinois Power Company Incentive Savings Plan for employees covered under a collective bargaining agreement as amended and restated effective January 1, 1991 and as further amended through amendments adopted December 28, 1994.~ 270\n12(a) Computation of ratio of earnings to fixed charges for Illinova Corporation. 336\n12(b) Computation of ratio of earnings to fixed charges for Illinois Power Company. 337\n13(a) Illinova Corporation Proxy Statement and 1994 Annual Report to Shareholders. 338\n13(b) Illinois Power Company Information Statement and 1994 Annual Report to Shareholders. 386\n21 Subsidiaries of Illinova Corporation and Illinois Power Company. 434\n23(a) Consent of Independent Accountants for Illinova Corporation. 435\n23(b) Consent of Independent Accountants for Illinois Power Company. 436\n_____________________________\n* Incorporated herein by reference.\n~ Management contract and compensatory plans or arrangements.","section_15":""}
{"filename":"28367_1994.txt","cik":"28367","year":"1994","section_1":"Item 1. (a) Business - ------ --------\nThe Company is engaged primarily in the manufacture and distribution of \"Moto Guzzi\" brand motorcycles in Italy, Europe and elsewhere in the world. Until May, 1993, the Company, through its Italian subsidiaries, was also engaged in the manufacture and distribution of automobiles for its own account and, for a limited period, for other companies as well. The Company had manufactured and distributed luxury automobiles under the \"Maserati\" brand name, while until the end of 1992, the Company had also manufactured and distributed economy automobiles under the \"Innocenti\" brand name. Additionally, from 1989 through mid-1990, the Company manufactured vehicles for Chrysler Corporation, while from mid-1990 until the end of 1991, it built vehicles for Fiat Auto S.p.A.\nIn 1993, O.A.M. S.p.A., one of the Company's Italian subsidiaries, disposed of its controlling 51% equity interest in its Maserati S.p.A. manufacturing subsidiary to Fiat, following years of steadily declining Maserati sales and mounting losses, thereby ending the Company's 18-year involvement in automobile manufacturing. Fiat had acquired a 49% interest in the newly-formed Maserati subsidiary in 1990 when O.A.M. transferred the Maserati operating assets to its new subsidiary. See \"Management's Discussion and Analysis of Financial --- Condition and Results of Operations -- The Company's Sale of Maserati Operations,\" below.\nMotorcycle manufacturing and distribution continues through the Company's 89.1%-owned subsidiary, G.B.M. S.p.A., which is the successor to businesses acquired by the Company in 1972. Until 1989, G.B.M. had also manufactured and distributed a line of motorcycles and motor scooters under the \"Benelli\" brand name. The Benelli division was sold to an entity controlled by Biesse S.p.A. in October 1989, an entity in which G.B.M. retained a minority equity interest until 1990 when it also sold that interest to Biesse S.p.A.\nThe Company's wholly-owned subsidiary, Maserati Automobiles, Inc. (\"MAI\") had been the exclusive importer in the United States of G.B.M. motorcycles until 1990 when it sold its inventory of vehicles and spare parts to an unrelated third party, which then became the exclusive importer. MAI had also been the exclusive importer of Maserati vehicles in the United Sates, but had not imported any new vehicles since 1990. MAI sold its remaining spare parts inventory and suspended operations, in 1994. The subsidiary is in the process of winding up its affairs and selling its real property.\nThe Company was incorporated under the laws of the State of Maryland in 1917.\nOther Subsidiaries - ------------------\nThe Company owns a controlling interest in a non-operating subsidiary, Nuova Callegari e Ghigi S.p.A. (\"Callegari\") and has substantially completed the liquidation of that subsidiary's assets. The Company's American Finance, S.p.A. subsidiary owns and operates a 59-room hotel in Modena. The hotel's operations are not material to the Company's consolidated operations.\n(b) Industry Segment Information. ----------------------------\nThe Company operates in one industry segment: motorcycle manufacture and sales. For financial data concerning Company operations for the last three fiscal years, which include data attributable to Maserati, see the Financial Statements which accompany this report.\n(c) Narrative Description of Business. ---------------------------------\nG.B.M., the Company's motorcycle manufacturing subsidiary, manufactures a high priced line of motorcycles under the trademark \"Moto Guzzi\". G.B.M. will continue to sell Benelli finished goods inventory in stock until that inventory has been exhausted; the Company estimates it will complete the liquidation of Benelli inventory by the end of 1995. Moto Guzzi cycles, whose engines vary in size from a displacement of 350cc to 1100cc, vary in price to retail dealers in the Italian market from Lit. 6,450,000 ($3,977*) to Lit. 13,415,000 ($8,271). These price ranges do not take into account the 19% Italian value-added tax paid by Italian retail dealers.\nIn 1994, G.B.M. introduced one new model, the 1100 Sport. The 750cc PA was significantly restyled for 1994. All motorcycle manufacturing is conducted at G.B.M.'s Mandello, Italy facility. G.B.M. acquires completed power train components from outside suppliers, and performs finishing work and assembly into motorcycle bodies. G.B.M.'s operations were supervised in 1994 by the independent consulting firm of Temporary Integrated Management, S.r.l. (\"TIM\"). TIM is a unit of Finprogetti, S.p.A., an Italian corporation. The Company is in advanced negotiations with Finprogetti involving the purchase of TIM and certain other assets for newly issued shares of the Company's common stock. See \"Management's Discussion and Analysis of Financial Conditions and Results of Operations\" below.\nItalian prices for motorcycles traditionally have been higher than export prices. Prices in Italy are customarily reviewed and are increased to cover increases in production costs at periodic intervals. In 1994, Moto Guzzi increased prices of its various models once for its domestic sales and twice for export sales (to reflect weakening in the Italian Lire exchange rate),\n- -------------------- * Italian lire amounts are reported in U.S. dollars based on the conversion rate of 1,622 lire to the dollar prevailing at December 31, 1994.\nwith such increases aggregating approximately 7% on average within Italy and 4% in respect of export sales. Export sales continued to reflect lower margins than domestic Italian sales.\nDistribution - ------------\nG.B.M. maintains a domestic distribution network of over 200 independent dealers. G.B.M. will continue to sell Benelli mopeds and Benelli motorcycles with engines of 125 cc or less until that inventory is exhausted sometime in 1995.\nIn 1994, a single importer-distributor acted as exclusive importer-distributor for Moto Guzzi in each of France, Japan, Sweden, Austria, Switzerland, Australia, the U.K., the United States and in Belgium\/Holland. These distributors will continue to handle Moto Guzzi products in 1995.\nIn October 1989, G.B.M. formed A + G Motorod GmbH (\"A&G\"), a German corporation, with Aprilia S.p.A., another Italian manufacturer of motorcycles with small displacement engines. G.B.M. and Aprilia each owned 45% of A&G, having each invested Lit. 200,000,000 ($123,305) as equity; the managing director of A&G owned the remaining 10%. A&G distributes the motorcycles of both G.B.M. and Aprilia in the German market. On January 1, 1995, A&G required a capital infusion in which G.B.M. did not participate. As a result, its ownership interest declined to 25%. In 1996, G.B.M. can choose to continue to distribute products in Germany through A&G or can choose to distribute Moto Guzzi products through others.\nNo single Italian dealer accounted for more than 5% of the sales of Moto Guzzi in 1994. The Italian dealers who distribute Moto Guzzi motorcycles generally handle other brands as well.\nSales in 1994 of Moto Guzzi machines to the Italian and other governments were 17.7% of its total motorcycle sales revenues.\nItalian dealers in 1994 normally paid for motorcycles on the following terms: if payment was received on receipt of a purchase order, a 4% discount was allowed; if payment was received 30 days after receipt of invoice, a 2% discount was allowed; if payment was received 60 days after receipt of invoice, a 1% discount was allowed. Payments made by dealers other than in cash are evidenced by promissory notes which were discounted at then-prevailing bank rates. Motorcycles sold for export are sold with a 3% discount if payment is made with delivery of a purchase order, and otherwise at full invoiced price.\nIn 1983, Centro Ricambi S.r.l. was organized as a wholly-owned subsidiary of a predecessor to G.B.M. to facilitate the distribution of spare parts for Guzzi and Benelli motorcycles. Its only business was the purchase from G.B.M. of such spare parts and their resale to Guzzi or Benelli dealers and distributors on substantially the same terms as motorcycles are sold. It will continue to sell Benelli parts until the supply is exhausted.\nBacklogs - --------\nBased on confirmed purchase orders received to date for 1995 delivery, G.B.M.'s entire production capacity for 1995 has been pre-sold, for the first time in that company's history. Backlog of Moto Guzzi for 1995 delivery as at January 1, 1995 was approximately Lit. 54,803,000,000 ($33,787,300) in the aggregate, representing 5,523 units compared to Lit 10,000,000,000 ($6,165,228) in 1994. Additionally, G.B.M. signed an agreement in March 1995 with a foreign purchaser to deliver over five years special-purpose engines based on the Company's motorcycle engine design. Backlogs under this agreement for 1995 delivery aggregate Lit. 2,576,000,000 ($1,588,163).\nCompetition - -----------\nThe sale of motorcycles is a highly competitive business, with competition typically coming from all powered passenger vehicles, as well as motorcycles. In 1994, G.B.M. sold 4,278 units, of which 4,149 had engine displacements of 350cc or greater, 77 had displacements of less than 350cc, and 52 were Benelli inventory. G.B.M.'s sales of its large motorcycles constituted a 3.2% share of the Italian domestic market for motorcycles with 350cc engines or greater, a 100% market share improvement compared to the prior year. In 1993, G.B.M. sold 3,477 units, of which 3,274 had engines of 350cc or greater. The market itself continued to contract significantly in 1994, with new vehicle registrations in Italy declining by 15% compared to 1993. The Italian market remains dominated by large, well-financed Japanese manufacturers. A number of foreign and domestic manufacturers, principally Cagiva, Honda, Yamaha, Kawasaki and Suzuki, sell their products in the Italian market. In 1994, the Italian market shares of the principal competitors of Moto Guzzi, on a unit basis were: Honda - 28.3%; Cagiva and Ducati - 8.9%; Yamaha - 19.2%; Aprilia - 3.5%; Suzuki - 11.7%; Kawasaki - 7.7%; and Harley Davidson 5.2%. From data available in early 1995, the market has begun to rebound, and G.B.M. anticipates that it will maintain its share of this larger market.\nG.B.M. maintains an extremely small share of the worldwide motorcycle market, which is dominated by many of the same Japanese manufacturers that predominate in Italy.\nRaw Materials - -------------\nThe source and supply of motorcycle raw materials, including aluminum for power train components, is not a significant issue for G.B.M. There are multiple reliable sources for motorcycle componentry as well as for manufactured engines. The cost of imported raw materials, however, is affected by variations in currency exchange rates. In 1994 the value of the Lire had declined relative to the currency of Italy's primary trading partners. The weakness of the Lire has resulted simultaneously in an increase in the cost of imported raw materials and in an improvement in the price competitiveness of Italian-made finished goods, such as G.B.M.'s motorcycles.\nDuring 1994, average prices paid for raw materials, and components by G.B.M. increased by approximately 7.82% over 1993 average price levels, approximately half of which was due to the use of higher quality materials and to outsourcing of certain componentry.\nMAI purchased all of its spare parts from O.A.M. in accordance with O.A.M.'s agreement with Fiat until MAI operations were suspended and its spare parts inventory sold in December, 1994.\nResearch and Development and Continuing Engineering - ---------------------------------------------------\nG.B.M. is continuously engaged in company-sponsored programs of product improvement and development. Aggregate 1994 research and development expenditures by G.B.M. were Lit. 197,133,421 ($121,537) compared to Lit. 409,159,000 ($252,256) in 1993, and Lit. 219,852,597 ($134,544) in 1992.\nIn addition, during 1994, on-going programs continued relating to developing more powerful engines with improved performance and durability characteristics, superior braking systems, suspensions, frames, transmissions and other components applicable to two-wheeled vehicles. G.B.M. introduced the 1100cc Sport in 1994 and is planning to introduce in 1995 a 1000cc Custom and either a 1000cc Daytona Sport Racing or an 1100cc fuel injected Sport. The Company does not anticipate that the new models will require a significant capital commitment.\nThe other companies do not conduct research and development activities.\nSeasonal Nature of Business - ---------------------------\nThere is no significant seasonal variation in the business of the Company or any of its subsidiaries except that traditionally vehicle production ceases during August of each year in Italy.\nWorking Capital Items - ---------------------\nThe subsidiaries of the Company are not affected by any unusual industry practices relating to returns of merchandise or extended payment, nor are they required to carry unusually significant inventories since their businesses are not seasonal.\nPatents and Trademarks - ----------------------\nExcept as described below, the business of G.B.M. is not and has not been in any material respect dependent upon patents, licenses, franchises or concessions. The component parts of motorcycles are manufactured pursuant to well known techniques and include components which are not unique to its products, although some of these components are specially styled and designed. Management believes that the trade names \"MOTOBI\", \"Moto Guzzi\", and their related trademarks are well known and highly regarded throughout the world, and appropriate steps have been taken to protect G.B.M's rights in these trade names and trademarks in those countries representing significant markets.\nCompliance with Governmental Regulations - ----------------------------------------\nG.B.M., along with other motorcycle manufacturers, have incurred substantial costs in designing and testing products to comply with safety and emissions requirements. Such standards have added, and will continue to add, substantially to the price of the vehicles while competitive pressures have kept export prices lower than domestic Italian sales prices.\nHaving suspended imports of new Maserati vehicles since 1990, and having sold its controlling interest in the Maserati subsidiary in 1993, the Company is no longer subject to the required federal safety equipment and damage susceptibility regulations applicable only to automobiles, such as bumper durability, and front and side impact resistance and passive restraint systems insofar as they relate to newly manufactured post-1990 vehicles. Similarly, the Company also is no longer subject to state or federal automobile fuel economy or emissions regulations with respect to such vehicles.\nAll motorcycles produced by the Company and its subsidiaries for sale in the United States are manufactured with the intent to comply with all applicable federal safety standards. The Company's 1994 model year motorcycles complied with EPA emission standards applicable in all 50 states.\nEmployees and Employee Relations - --------------------------------\nAt December 31, 1994, G.B.M. had 303 employees, compared to 329 at December 31, 1993, of whom approximately 83% were engaged in factory production and the balance in various supervisory, sales, purchasing, administrative, design, engineering and clerical activities. At December 31, 1994, Centro Ricambi had 19 employees, down from 20 employees at December 31, 1993. Approximately 42% of Centro Ricambi's employees are\nengaged in warehouse and shipping work, with the balance engaged in supervisory, purchasing, administrative and clerical activities. Labor costs increased approximately 0.4% in 1994 at Guzzi and Centro Ricambi and are estimated by Management to increase approximately 6% for 1995.\nIn 1994, G.B.M. did not avail itself of the Italian government furlough program. In 1993, workers were furloughed 48,622 production hours and G.B.M. utilized the government furlough program. The cost to the Company was immaterial.\nTwo national strikes in 1994 cost G.B.M. 3,217 production hours. G.B.M. was not the subject of any strikes or work stoppages in 1993. In Modena, the local Centro Recambi \"company\" contract expired on March 31, 1994. A new contract has not yet been signed. G.B.M.'s last \"company\" contract expired on December 31, 1992 and it also has not yet been renegotiated.\nUnder Italian law, persons in a company acquire the right to severance pay based upon salary and years of service. At December 31, 1994, the Company was obligated to pay employees an aggregate of Lit. 7,137,000,000 ($4,400,123), compared to Lit. 7,245,000,000 ($4,466,708) at December 31, 1993.\n(d) Financial Information About Foreign and Domestic (Italian) Operations and Export Sales ----------------------------------------------\nAll motorcycle production occurs in Italy and foreign sales are made to distributors located outside Italy. Most foreign sales are made to Western European countries and the U.S. Although in the aggregate such sales are significant, sales to no particular country other than Germany, the United Kingdom, Holland and Argentina are significant. Sales to other continents are more insubstantial. In 1994, the Company had aggregate sales outside of Italy of Lit. 23,172,000,000 ($14,286,067). See Note M of Notes to Consolidated Financial Statements.\nSet forth below are charts illustrating percentage of motorcycle sales revenues attributable to various geographic areas.\nGeographic Areas - ---------------- Year Ended December 31\nBenelli & Moto Guzzi Motorcycles 1994 1993 1992 -------------------------------- ---- ---- ----\nItaly 38% 35% 37% Europe (other than Italy) 51% 41% 52% United States 5% 6% 6% Elsewhere 6% 18% 5%\nAll of MAI's activities, before it suspended operations, occurred in the United States, Puerto Rico and Canada.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------ ----------\nThe following facilities were, and unless so indicated, are presently, leased or owned by the Company in the active conduct of its business:\n(a) 1,460 square feet of office space at 107 Monmouth Street, Red Bank, New Jersey 07701, in which are located the United States administrative offices of the Company, and which is occupied under a month-to-month lease, at a monthly rental of $970. This space is regarded as adequate for the present and foreseeable needs of the Company in the United States.\n(b) Factory and office facilities owned in fee and located in Mandello del Lario, Italy in a group of one, two and three story buildings aggregating 54,550 square meters, which is the facility of the Guzzi division of G.B.M. This facility will operate in 1995 at approximately 50% of production capacity calculated as a percentage of available space, compared to a utilization rate of 30% in 1994.\n(c) One single-story 2,800 square meter concrete building located in Modena, Italy and completed in late 1983, with an 8 meter ceiling, rented on a month-to-month basis by Centro Ricambi from DeTomaso- Modena, an affiliate of Mr. DeTomaso, at a monthly rental of Lit. 9,000,000 ($5,549) since January 1, 1984. This facility has been fully utilized as a spare parts distribution facility for Guzzi and Benelli.\n(d) Additional executive offices and sales facilities located in Hotel Canalgrande in Modena, Italy comprising approximately 500 square feet of office space for which no rent is paid, and 5,000 square feet of exhibition and dining space made available at prevailing commercial rates when required. The hotel was erected in the fifteenth century, rebuilt in the eighteenth century and renovated in 1970. The corporation which owns the hotel is Mr. DeTomaso's affiliate, in which G.B.M. owns a 2.17% minority interest.\n(e) Office, retail showroom, service and warehouse space at 1501 Caton Avenue, Baltimore, Maryland, situated on a 2.9 acre tract in a steel and masonry building of approximately 25,000 square feet, owned by MAI. The facility operated at approximately 40% of capacity in 1994.\n(f) A 24,000 square foot steel and masonry warehouse located on 1.4 acres at 1221 Bernard Drive, Baltimore, Maryland owned by MAI. The warehouse is nine years old and has been utilized by MAI for new vehicle storage and preparation. Since new Maserati models have not been imported since 1990, the facility is essentially unutilized.\n(g) A combined commercial and residential building in Rome owned by O.A.M. The two-story building occupies approximately 1100 square meters. The commercial portion (the basement, ground floor and access ramp) is rented to a Guzzi dealership pursuant to a long-term lease. The first floor is rented for residential purposes, and contains approximately 152 square meters of space.\n(h) A 59 room, 2500 square meter hotel, owned by the Company's American Finance, S.p.A. subsidiary. The Hotel Roma in Modena, Italy, facility was built in the 19th Century in the town's historic centre.\nItem 3.","section_3":"Item 3. Legal Proceedings - ------ -----------------\nA shareholder has commenced a litigation in federal court seeking to compel the Board of Directors to hold a shareholders meeting relating to the 1993 sale of Maserati to Fiat. While the Company believes the action is without merit, it is, in any event, currently in the process of scheduling a shareholders meeting. See \"Submission of Matters to a Vote of Security Holders,\" below.\nItem 4.","section_4":"Item 4. Submission of Matters to - ------ a Vote of Security Holders --------------------------\nOn May 19, 1993, O.A.M. sold its remaining equity interest in its Maserati subsidiary to Fiat Auto S.p.A. As a result of the Maserati sale, the Company's principal operating subsidiary was G.B.M. The Company's Board of Directors resolved to convene a shareholders meeting to ratify the sale of Maserati and to discuss the future of G.B.M. In anticipation of such a meeting, the Company commissioned the preparation of an evaluation of the Company as of the day preceding the Maserati sale and as of a current date.\nJust prior to the presentation of the evaluation report, the Company received an offer from the Italian investment firm of Finprogetti S.p.A. under which the Company would acquire certain subsidiaries of Finprogetti in exchange for newly issued shares of the Company's common stock, and Finprogetti would make or cause others to make additional capital\ninvestments with the Company. Negotiations relating to this transaction are at an advanced stage, and are expected to be completed, and a final agreement executed shortly. The planned shareholders meeting has been postponed as a result of these developments, and is now planned for July 1995, by which time the agreement with Finprogetti should have been executed. In connection with the Finprogetti transaction, the Board of Directors expects to institute a repurchase policy under which shareholders will have an opportunity to realize fair value for most of their shares. Details of the transaction and of the policy will be provided in forthcoming proxy materials.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity - ------ and Related Stockholder Matters ---------------------------------------\nAs of March 31, 1995, there were 1,393 holders of record of Registrant's common stock.\nThe Company's common stock traded on the non-NASD over-the- counter market, commonly called the \"pink sheets,\" in 1993 and until September 23, 1994. Since September 26, 1994 the common stock has traded on the NASDAQ small-capitalization market system. The reported prices represent inter-dealer prices, which do not include retail mark-ups, mark- downs or any commission to the broker-dealer, and may not necessarily represent actual transactions.\nBid Prices 1993 High Bid Low Bid - ---- ------------- ------------\n1st Quarter 3 1\/2 3 1\/2 2nd Quarter 4 1\/2 4 3rd Quarter - - 4th Quarter 2 2\n- ----\nlst Quarter 3 2 1\/2 2nd Quarter 5 1\/2 2 1\/2 3rd Quarter through September 23 5 1\/2 4 September 26 through September 30 5 4 1\/2 4th Quarter 9 1\/4 4 1\/4\n- ----\nlst Quarter through March 22 9 1\/2 7 3\/4\nNo dividends were declared or paid during 1992, 1993 or 1994. Registrant does not believe that its capital needs will permit the payment of a dividend in the foreseeable future.\nItem 6.","section_6":"Item 6. Selected Financial Data. - ------ -----------------------\n1 The above information for the year ended December 31, 1994, expressed in millions of Italian Lire, has been translated into U.S. Dollar equivalents in thousands of dollars (except for per share amounts), at the rate of exchange prevailing at December 31, 1994. The prevailing exchange rates as at the end of the five most recently completed fiscal years is as follows:\n1622 Lire per U.S. Dollar at December 31, 1994 1713 Lire per U.S. Dollar at December 31, 1993 1478 Lire per U.S. Dollar at December 31, 1992 1147 Lire per U.S. Dollar at December 31, 1991 1127 Lire per U.S. Dollar at December 31, 1990\nThe high, low and average conversion rates for the years 1990-1994 are as follows: High Low Average ---- --- ------- 1994 1,689 1,539 1,612 1993 1,713 1,478 1,574 1992 1,475 1,066 1,243 1991 1,364 1,089 1,241 1990 1,300 1,109 1,138\n2 Includes a gain of Lit. 105,622,000,000 resulting from the sale of 49% of Maserati, S.p.A. and 51% of Innocenti Milano, S.p.A. to Fiat.\n3 Long-Term Debt includes Advances from Affiliates of Lit. 61,000,000,000.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of - ------ Financial Condition and Results of Operations ---------------------------------------------\nAs a consequence of the sale of the Company's Maserati subsidiary in May, 1993, which is described in greater detail below, Management's discussion of the Company's operations in 1993 and 1992 deals only with the Company's continuing operations in those years since inclusion of the Company's discontinued Maserati operations would render the discussion not comparable. See Note C of Notes to Consolidated Financial Statements.\nResults of Operations ---------------------\n1994 Compared to 1993 ---------------------\nThe Company's operations improved markedly in 1994 compared to 1993 as a result of production and management changes made during the year at G.B.M. Unit sales of G.B.M. increased by 28%, to 4,880 motorcycles. Net sales increased by 24%, to Lit. 51,994,000,000 ($32,055,000). The increase in unit sales, moreover, was achieved despite an overall contraction in the Italian motorcycle market.\nDespite the growth in sales, gross profits declined approximately 2% and gross profit margins declined approximately 3% from 1993. Gross profit margins in 1993 were favorably impacted by a reduction in cost of goods sold resulting from a change in that year's estimate of obsolescence reserves. Excluding the effect of that reduction, GBM achieved a small increase in gross profit margins in 1994 from its sale of motorcycles.\nA 13% decline in sales, general and administrative expenses due to operating efficiencies, and a 52% decline in interest expenses due to retirement of debt more than offset reduced margins and, as a result, the Company's loss from continuing operations before minority interests dropped by nearly 64% to Lit. 2,467,000,000 ($1,520,962) in 1994 from Lit. 6,736,000,000 ($4,152,898) in 1993.\n1993 Compared to 1992 ---------------------\nResults for the 1993 fiscal year from continuing operations primarily reflect the operations of the Company's G.B.M. motorcycle subsidiary. G.B.M.'s Moto Guzzi unit sales declined 25% in 1993 compared to 1992, largely reflecting a comparable decline in overall motorcycle sales in Italy. Consolidated losses from continuing operations in the 1993 fiscal year increased by 69% to Lit. 6,736,000,000 ($4,152,898) from Lit. 3,967,000,000 ($2,445,746) in 1992. G.B.M.'s losses for the 1993 fiscal year were approximately Lit. 4,000,000,000 ($2,466,091).\nInterest expense increased by 53.2% in 1993 compared to 1992 due to increased bank advances to finance operating losses. The increase in interest income was related to interest earned on amounts due from Fiat relating to the Maserati sale.\nThe Company adopted FASB Statement No. 109 \"Accounting For Income Taxes\" effective January 1, 1993. The principal effect of FASB Statement No. 109 is that utilization of the net operating loss carry forwards is reflected as a reduction of the tax provision rather than an extraordinary item.\nThe Company's Sale of Maserati Operations\nOn May 17, 1993, the Company's 84%-owned subsidiary O.A.M. S.p.A. completed the sale to Fiat Auto S.p.A. of its 51% equity interest in its Maserati S.p.A. subsidiary. Fiat had purchased the other 49% interest in Maserati in 1990, as part of a restructuring of O.A.M.'s manufacturing capacity related to the termination of its earlier assembly agreement with a unit of the Chrysler Corporation and the commencement of a new manufacturing agreement with Fiat.\nOperations at Maserati, and, before its 1990 founding, at O.A.M., had been disappointing for many years. With significant unused manufacturing capacity at the subsidiary's Milan facility, Maserati and its O.A.M. predecessor, since 1984, had sought to create and maintain a viable alliance with a larger automobile manufacturer which would enable Maserati to make fuller and more profitable use of its plant and equipment as a means of achieving and maintaining profitability. The underutilization of Maserati's manufacturing capacity, with its resulting high ratio of fixed costs to unit sales, limited that company's ability to achieve additional market share through pricing strategies. Greater utilization, it was hoped, would permit fixed costs to be spread over a much greater volume of vehicles, improving the potential to achieve profitability.\nIn 1986, pursuing this goal, O.A.M. entered into a series of relationships with Chrysler and certain of its subsidiaries relating to the design, manufacture and assembly of a sports coupe, called the \"TC.\" As part of the agreement, Chrysler acquired a 15.6% equity interest in O.A.M. and an option to purchase from Sig. Alejandro DeTomaso, the Company's Chairman and principal stockholder, all of his common and preferred stock. The option is exercisable at any time in 1996 or 1997 at the then-market price less $1,250,000. Sig. DeTomaso can repurchase the Chrysler option for $5,000,000 plus accumulated interest at 10% from October 1986.\nThe TC production arrangement however, largely due to modest customer interest in the car, terminated prematurely in 1988, leaving Maserati's manufacturing capacity again underutilized and its future in doubt.\nIn 1989 and 1990, with O.A.M.'s management continuing to hold the view that a strategic alliance was essential to the economic recovery of Maserati, the subsidiary entered into a series of agreements with Fiat. As a consequence, Maserati was formed as a subsidiary of O.A.M., the operating assets of O.A.M. were transferred to Maserati, and Fiat acquired 49% of the Maserati equity for Lit. 132,670,000,000 ($81,794,081), all of which was contributed to Maserati. Maserati also agreed to assemble a Fiat \"Panda\" model as a contract manufacturer for Fiat at a stated assembly fee per vehicle. Fiat agreed to purchase up to 30,000 such vehicles per year for three years.\nShortly thereafter, in mid-1990, the onset of the Gulf war and a worldwide recession produced a major decline in European car sales generally; the luxury segment occupied by Maserati was particularly hard hit. Fiat's Panda sales fell substantially below expectations, reducing the need for the quantity of vehicles the parties had contemplated. Fiat formally terminated the Panda production program in December 1991. Under the terms of the production agreement, there were no financial consequences to Fiat stemming from its having terminated the program. At the same time, the Italian economy as a whole was especially hard hit, due in part to a national corruption scandal involving major leaders of government, industry and finance.\nO.A.M.'s management, with the approval of the Company's management, concluded that an upturn in European luxury vehicles sales was unlikely to occur in the foreseeable future. Absent an infusion of substantial additional capital, Maserati's ability to continue operations until the general economy and luxury car sales improved generally was highly unlikely.\nWith losses mounting at Maserati, in late 1991, its management attempted to reduce costs by terminating 500 workers, but Milanese labor unions obtained local judicial relief against the terminations. Labor strife plagued Maserati throughout 1992, causing several factory shutdowns, production stoppages and shipping delays. Losses were greatly magnified as a consequence. On January 22, 1993, after extended negotiations, Maserati, its labor unions and the Italian government resolved the dispute and related legal proceedings which stemmed from the 1991 terminations. The parties agreed to implement the terminations of Maserati's Milan work force in three stages, concluding on April 1, 1993. On March 31, 1993, operations at Maserati's Lambrate (Milan) facility ceased completely, thereby curtailing the single largest cause of its, and consequently the Company's, operating losses.\nAs part of the labor dispute resolution, the Italian government agreed to implement existing relocation and compensation programs for the benefit of the terminated workers; Maserati agreed to contribute Lit. 3,850,000,000 ($2,373,613) in connection with these government programs.\nBy the time Maserati's labor problems finally were resolved, however, the combination of the foregoing factors resulted in substantial operating losses at Maserati which no longer could continue operations without a massive cash infusion sufficient to cover its capital deficiency (as required by Italian law) and to fund projected further operated losses.\nO.A.M. had looked to Fiat for operating capital. Since its initial 1990 investment in Maserati, Fiat had helped to finance the subsidiary's current operations by providing loans aggregating Lit. 61,000,000,000 ($37,607,891) by December 31, 1992. Maserati, as expected, continued to operate at a loss during this period, losing Lit. 88,176,000,000 ($54,362,515), exclusive of a tax credit, in 1992 and another Lit. 22,885,000,000 ($14,109,125) by the time O.A.M. sold its equity share in Maserati in May 1993. By the end of 1992, Maserati had accumulated a net capital deficiency of Lit. 102,484,000,000 ($63,183,724).\nIn connection with his discussions with Fiat regarding debt financing, the Company's chairman had expanded the discussions to include the possible acquisition by Fiat of O.A.M.'s majority interest in Maserati. Sig. De Tomaso was simultaneously dealing with the Milan labor litigation. Almost immediately after the conclusion of the labor negotiations, and with talks with Fiat having reached an advanced stage concerning the acquisition of Maserati, Sig. De Tomaso suffered a major stroke, and the Fiat talks were temporarily suspended.\nO.A.M. management appointed Sig. De Tomaso's son, Sig. Santiago De Tomaso, to conclude the talks with Fiat, and an agreement to sell the Maserati subsidiary resulted on May 17, 1993. The financial terms contained in the final agreement, as executed, were substantially identical to those which had been negotiated between Fiat and the elder Sig. De Tomaso prior to his illness.\nAs required by the terms of agreement with O.A.M., Fiat paid the three installments on the aggregate Lit. 75,750,000,000 ($46,701,603) purchase price. The first installment was paid by the assignment to O.A.M. of Lit. 23,500,000,000 ($14,488,286) owed to Fiat by American Finance S.p.A., another Italian subsidiary of the Company. On January 1, 1994, Fiat paid O.A.M. the second installment of Lit. 23,750,000,000 ($14,642,417) in cash, forgave an O.A.M. debt of Lit. 1,500,000,000 ($924,784) and paid interest of Lit. 2,805,000,000 ($1,729,346). Fiat paid the final installment of Lit. 27,000,000,000 ($16,646,116) in cash, without interest, on January 1, 1995. The aggregate purchase price of Lit. 75,750,000,000 includes imputed interest of Lit. 4,826,000,000 ($2,975,339) from the final payment.\nThe agreement also contemplates, but does not require, the potential development of a parcel of land in Milan which is owned by Fiat's Maserati subsidiary which Maserati had used to manufacture Maserati and Innocenti automobiles. O.A.M. will be entitled to receive up to a 5.25% equity interest in the development company Fiat will form if certain conditions are met, including the realization by the development company of proceeds upon a sale of the parcel\nin excess of its approximate Lit. 109,800,000,000 ($67,694,205) Maserati book value. Nothing in the agreement either requires Fiat to sell or otherwise develop the parcel or limits in any way the price at which the parcel could be sold. No assurance can be given that O.A.M. will receive any additional compensation relating to the development of the land and no amounts have been recorded on the financial statements of the Company therefor.\nThe sale of Maserati produced a gain of Lit. 183,118,000,000 ($112,896,424) in fiscal 1993, net of minority interests, which solely accounted for the Company's 1993 net income of Lit. 153,497,000,000 ($94,634,402). Maserati operations prior to the Fiat sale produced a net loss in 1993 of Lit. 22,885,000,000 ($14,109,125), compared to the net loss of Lit. 88,176,000,000 ($54,362,515) for the 1992 fiscal year, exclusive of a tax credit.\nLiquidity and Capital Resources -------------------------------\nManagement anticipates that projected increases in production and sales at G.B.M. will require approximately $2,500,000 in additional capital to support operations. Management expects to fund such capital requirements from available cash at its other subsidiaries.\nAt December 31, 1994, the Company had working capital of Lit. 40,819,000,000 ($25,165,844). Additionally, the Company has Lit. 14,759,000,000 ($9,099,260) of investments in long term bonds of which all but Lit. 5,000,000 ($3,082,614) can be readily sold in established markets if necessary.\nIn addition to certain trade facilities available to finance import\/expert trade, the Company has various line of credit arrangements with a number of Italian banks under which they may borrow up to Lit. 23,934,000,000 ($14,755,856) of which Lit. 8,150,000,000 ($5,024,661) was unused at December 31, 1994.\nG.B.M. was past due at December 31, 1994 in payment of installments on a loan having an unpaid principal balance on such date of Lit. 4,151,000,000 ($2,559,186) and bearing interest at 11.5%. The Company and the lender are in an advanced stage of discussions for the full refinancing of the loan, which is expected to be completed within a matter of weeks. The lender has informally agreed to forebear from taking any action with respect to the default in the interim. The Company's American Finance, S.p.A. subsidiary was past due at December 31, 1993 on a loan having an unpaid principal balance on such date of Lit. 796,000,000 ($490,752) bearing interest at 5.15%; such loan was repaid in full in March, 1995 from funds made available from another subsidiary of the Company.\nTransaction with Finprogetti ----------------------------\nIn February 1994, the Board of Directors resolved to examine a variety of actions which could be taken to accommodate the strongly expressed sentiments of some of the Company's shareholders that the public shareholders be \"cashed out\" of their equity positions at a price reflecting the fair market value of the Company's consolidated assets. To that end, the Board of Directors undertook a number of actions:\nThe Board of Directors explored transactions with G.B.M., involving possible joint ventures, sale or the refinancing of that subsidiary's operations. Efforts to identify a relationship which would fully reflect the Company's inherent value, were unsuccessful. Finprogetti, S.p.A. was then retained to provide temporary management for G.B.M. The spare parts inventory of MAI was sold at the end of 1994 and liquidation of its remaining assets is in progress. The Board also retained a major international firm of evaluators to determine the value of the Company prior to the Maserati sale and on a current basis. Contemporaneously with the presentation by the evaluators of their report to the Board of Directors, Finprogetti, S.p.A. presented an offer to the Board in which the Company would effectively acquire the Italian real estate assets of Finprogetti (estimated to have a value of Lit. 35,000,000,000), and its TIM unit in exchange for newly issued shares of the Company's common stock at the price of Lit. 20,106.73 per share. Finprogetti would also invest, or cause others to invest, an additional Lit. 15,000,000,000 in newly issued common stock at such price. The Company has reached an agreement-in- principle with Finprogetti consistent with its offer; the parties are nearing completion of a formal agreement and are engaged in mutual due diligence efforts.\nAssuming the consummation of the transaction with Finprogetti, the Company plans to continue to build on the growth at G.B.M., to complete the winding up of the Company's non-performing Italian assets, and to seek new opportunities in which the \"turn around\" management skills of TIM can be employed profitably for the Company's benefit through its management of other troubled companies and through the investment opportunities such companies may present.\nExpecting that a definitive agreement with Finprogetti will have been reached and executed by that time, the Board, at the next annual meeting of shareholders, currently planned for July, 1995, will ask shareholders to ratify the May 17, 1993 sale of Maserati to Fiat and will offer to shareholders who dissent from the ratification vote the opportunity to obtain the fair market value of their shares as of the date immediately prior to the Maserati sale. The Company's Board of Directors, including Sig. Alejandro DeTomaso, the controlling shareholder of the Company, ratified O.A.M.'s sale in 1993.\nAdditionally, the Company, subject to completing the Finprogetti transaction plans to offer to purchase up to 80% of the shares of those shareholders who vote to ratify the Maserati sale, at the same Lit. 20,106.73 price to be paid by Finprogetti and as determined by the asset valuation. This Annual Report shall not be construed as such an offer, nor as a solicitation of\nproxies to ratify the Maserati sale. Any such offer, and any such solicitation, shall only be made by and pursuant to materials complying with applicable federal law.\nImpact of Inflation -------------------\nManagement does not believe that inflation or price increases charged by Moto Guzzi for its products had a material effect on 1994, 1993 or 1992 net sales, revenues or income. Rather, competition from third parties selling products with better market acceptance is believed to account for lower unit sales in all three years. Management believes that market response to the Company's products is by far the most significant factor impacting sales, revenues and income. Currency exchange rates have a measurable effect on the prices paid by G.B.M. for imported raw materials, and on the prices charged for its finished goods. In recent years, the Italian lire has declined in value relative to the currencies of its trading partners. While this has increased the effective cost of raw materials to G.B.M., which G.B.M. has passed through in the price of its motorcycles, it has lowered the effective cost of those goods to purchasers in foreign markets.\nICW Annual Report on Form 10-K\nItem 8, Item 14(a)(1) and (2) and Item 14(d)\nList of Financial Statements and Financial Statement Schedule\nFinancial Statements, Financial Statement Schedules and Supplementary Data\nYear Ended December 31, 1994\nDe Tomaso Industries, Inc.\nRed Bank, New Jersey\nForm 10-K--Item 14(a)(1) and (2)\nDe Tomaso Industries, Inc. and Subsidiaries\nList of Financial Statements and Financial Statement Schedule\nThe following consolidated financial statements of De Tomaso Industries, Inc. and subsidiaries are included in Item 8:","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants - ------- in Accounting and Financial Disclosure ---------------------------------------------\nNone.\nPART III\nInformation required to be included in Part III will be filed by amendment to this Annual Report on Form 10K within 120 days of the end of the Company's fiscal year.\nPART IV\nINDEX TO EXHIBITS ----------------- Page Number -----------\n3(a) Restated Articles of Incorporation of Registrant (filed as Exhibit 3(a) to Registrant's 1981 Annual Report on Form 10-K and incorporated herein by reference).\n3(b) By-laws of Registrant (filed as Exhibit 3(b) to Registrant's 1981 Annual Report on Form 10-K and incorporated herein by reference).\n3(c) Articles of Amendment to Articles of Incorporation filed January 31, 1986 with Maryland Department of Assessments and Taxa- tion (filed as Exhibit 3(c) to Registrant's 1985 Annual Report on Form 10-K and incorporated herein by reference).\n3(d) Articles of Incorporation, as amended by the Articles of Amendment described in 3(c), above (filed as Exhibit 3(d) to Registrant's 1985 Annual Report on Form 10-K and incorpo- rated herein by reference).\n10(a) Agreement dated May 17,1993 between O.A.M. S.p.A., Fiat Auto, S.p.A. and other (filed as Exhibit 10.1 to the Current Report Dated May 17, 1993 filed on Form 8-K).\n12. Subsidiaries: Maserati Automobiles Incorporated, G.B.M. S.p.A., American Finance S.p.A., O.A.M. S.p.A., Storm S.r.l., Centro Ricambi S.r.l., Nuova Callegari e Ghighi S.p.A., Tridentis Financiere, S.A., Newstead, Ltd.\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, thereupon duly authorized.\nApril 17, 1995 s\/ Santiago DeTomaso ------------------------- Santiago DeTomaso President - Director\nApril 17, 1995 s\/ Catherine D. Germano ------------------------- Catherine D. Germano 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 capacity and on the dates indicated.\nApril , 1995 ------------------------------------- Alejandro DeTomaso - Director\nApril 17, 1995 s\/ Paolo Donghi ------------------------------------- Paolo Donghi - Director\nApril 17, 1995 s\/ Roberto Corradi ------------------------------------- Roberto Corradi - Director\nApril 17, 1995 s\/ Howard E. Chase ------------------------------------- Howard E. Chase Vice President - Director\nApril 17, 1995 s\/ Patrick D'Angelo ------------------------------------- Patrick D'Angelo - Director\nApril 17, 1995 s\/ Mario Tozzi Condivi ------------------------------------- Mario Tozzi Condivi - Director","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"788043_1994.txt","cik":"788043","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES ------------------- VWR Corporation owns and leases office and warehouse space throughout the United States and Canada for wholesale distribution of scientific equipment and supplies as follows:\nBatavia, Illinois Owned Bridgeport, New Jersey Owned Buffalo Grove, Illinois Owned Cerritos, California Leased San Francisco, California Leased Houston, Texas Leased Marietta, Georgia Leased Morrisville, North Carolina Leased Catano, Puerto Rico Leased Mississauga, Ontario, Canada Leased Edmonton, Alberta, Canada Leased\nThe Company leases office space in West Chester, Pennsylvania, for executive, financial, information systems, marketing, and other administrative activities.\nThe Company also leases twenty-two smaller facilities throughout the United States and one smaller facility in Canada which support the sales and warehouse functions. All facilities have been designed to serve the Company's purpose (generic office and warehouse functions) and are sufficient for its current operations.\nITEM 3.","section_3":"ITEM 3. - LEGAL PROCEEDINGS ------ ----------------- The Corporation is involved in various environmental, contractual, warranty, and public liability cases and claims, which are considered normal to the Corporation's business.\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 ended December 31, 1994.\nPART II. --------\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ------------------------------------------------------------------------\nVWR Corporation Common Shares, $1.00 par value, are traded on the NASDAQ National Market System under the VWRX symbol. On February 28, 1995, there were approximately 6,000 shareholders represented by 1,754 holders of record.\nThe market prices of the Corporation's common shares during the years ended December 31, 1994, and 1993 are set forth below. The prices reflect bid prices as reported by NASDAQ for the Company.\nYear Ended Year Ended VWR Corporation Common Stock December 31, 1994 December 31, 1993 ---------------------------- ----------------- -----------------\nQuarter High Low High Low ------- ---- --- ---- --- First $12.13 $ 9.75 $17.00 $13.25 Second 12.25 9.63 16.00 11.75 Third 11.75 6.50 12.75 11.25 Fourth 12.00 7.00 13.75 12.00\nThe Corporation declared quarterly dividends of $0.10 per share in April, August, and October and $.04 per share in December for the year ended December 31, 1994. A quarterly dividend of $.10 per share was declared for each quarter during the fiscal year ended December 31, 1993. The Corporation's long-term debt agreements provide, among other terms, minimum limitations on working capital, tangible net worth, the current ratio, and the debt-to-equity ratio which may restrict the Corporation's ability to declare or pay dividends. Approximately $1.8 million of retained earnings was available to pay dividends at December 31, 1994.\nITEM 6.","section_6":"ITEM 6. - SELECTED FINANCIAL DATA ------ ----------------------- The following table of selected financial data should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere herein.\nFor the Years Ended December 31 ----------------------------------------------- 1994 1993* 1992 1991 1990 ---- ---- ---- ---- ---- Operations (Thousand of dollars) Sales $535,179 $509,235 $490,168 $440,983 $428,568 Gross margin 113,198 116,274 114,431 104,924 102,823 Income from continuing operations before cumulative effect of accounting change 2,053 3,890 9,430 7,743 6,970 Loss from companies distributed (269) Cumulative effect of accounting change (1,400) Net income $ 2,053 $ 2,490 $ 9,430 $ 7,743 $ 6,701 -----------------------------------------------------------------------------\nPer share Data** Dividends $0.34 $0.40 $0.40 $0.40 $0.40 Book value for continuing operations 3.62 3.68 3.80 3.34 3.02 Income from continuing operations before cumulative effect of accounting change .18 .35 0.85 0.71 0.66 Loss from companies distributed (0.03) Cumulative effect of accounting change (.13) ----------------------------------------------------- Net income per share $0.18 $0.22 $0.85 $0.71 $0.63\nFor the Years Ended December 31 ----------------------------------------------- 1994 1993* 1992 1991 1990 ---- ---- ---- ---- ---- Financial Position (Continuing operations only, thousands of dollars) Working capital $ 75,120 $ 65,197 $ 57,881 $ 52,928 $ 58,991 Property and Equipment-net 38,259 41,562 33,608 32,662 33,320 Total assets 173,375 148,777 136,093 126,896 132,876 Short-term debt 2,250 150 218 272 944 Long-term debt 79,170 61,757 47,553 46,747 57,333 Shareholders' equity 40,168 41,057 42,257 36,832 32,847 Total invested capital 121,588 102,964 90,028 83,851 91,124 ------------------------------------------------------------------------------ Operating & Financial Statistics (Continuing Operations Only)\nGross margin to sales 21.2% 22.8% 23.35% 23.79% 23.99% Income from Continuing Operations to sales .38% .76% 1.92% 1.76% 1.63% Current ratio 2.67 2.80 2.46 2.42 2.60 Return on Average Shareholders' Equity 5.06% 5.98% 23.85% 22.22% 22.21% ------------------------------------------------------------------------------ * Results include restructuring and other charges of $3.3 million pre-tax ($1.9 million net of tax).\n** All share and per share data reflect a two-for-one stock split effective May 9, 1992.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -----------------------------------------------------------------------\nResults of Operations --------------------- Sales ----- 1994 Increase 1993 Increase 1992 ---------------------------------------------------------------------- $535.2 5.1% $509.2 3.9% $490.2\nThe sales increase in 1994 was due to growth in all areas of our business. The acquisition of Canlab, the Toronto-based distribution division of Baxter International, in the fourth quarter of 1994 accounted for approximately 20% of the sales growth for the year. During the second half of 1994 our Canadian operations showed strong sales growth, improving margins and operating results.\nIn 1993 sales increased primarily due to strong growth rates in our inter- national export, high school science education (Sargent-Welch division) businesses and the effects of the acquisition of Johns Scientific and the distribution agreement with BDH Ltd. in Canada. Growth in Canada was less than expected. Combining the operations and systems of the three companies proved to be a more complex task than anticipated and we experienced higher costs. In addition, sales of our principal U.S. operating unit (VWR Scientific) lagged behind the market and we missed our internal target.\nGross Margin ------------ 1994 Decrease 1993 Increase 1992 -------------------------------------------------------------------- Margin $113.2 (2.7%) $116.3 1.7% $114.4 Percent of Sales 21.2% 22.8% 23.3%\nOver the three-year period, gross margin as a percent of sales declined primarily as a result of continued competitive price pressures and customer mix.\nOperating Expenses before Restructuring and Other Charges in 1993 ---------------------------------------------------------------------- 1994 Increase 1993 Increase 1992 ---------------------------------------------------------------------- Expenses $105.0 3.2% $101.7 6.7% $95.3 Percent of Sales 19.6% 20.0% 19.4%\nIn 1994 operating expenses grew at a rate lower than sales growth. Approximately 28% of the increase in operating expenses is the result of the acquisition of Canlab in the fourth quarter of 1994.\nIn 1993 the increase in operating expenses before restructuring and other charges is primarily due to higher personnel costs and transition costs associated with the acquisition of Johns Scientific and the distribution\nagreement with BDH, Ltd., and our investment in a new direct marketing effort. Excluding the impact from Canadian acquisitions and direct marketing, operating expenses grew approximately 1.4%.\nRestructuring and Other Charges -------------------------------\nIn December 1994, the Company made the decision to consolidate certain sales offices and functions. As a result, the Company will incur approximately $2 million in charges which are primarily for severance and other personnel- related costs. It is expected that the consolidation will be completed by the end of 1995 and will result in annualized cost savings of approximately $3 million. The cost of the consolidation effort will be accounted for in accordance with the new guidance set forth in FASB EITF Issue 94-3 \"Accounting for Restructuring Charges.\" Under EITF 94-3, the costs will be recognized primarily when they are incurred throughout 1995.\nIn the fourth quarter of 1993, the Company made the decision to refocus certain information systems efforts into customer service systems and to take actions that would reduce operating expenses. As a result of this effort, the Company recorded a $3.3 million charge which included non-cash charges of $1.3 million (primarily for software development costs that did not have continuing value) and $2 million related to the consolidation of functions and facilities which consisted primarily of severance and other personnel-related costs. In 1994 the Company completed the consolidation of certain administrative functions which was provided for in the fourth quarter of 1993 and has expended the $2 million of cost accrued at December 31, 1993, which was reflected in current liabilities.\nAt December 31, 1993 it was anticipated that the impact of the consolidation of certain functions and the reduction of expenses would result in annualized cost savings of approximately $2 million, beginning in the first-half of 1994. Actual cost savings for fiscal 1994 were approximately $1.2 million. Planned investments in sales and marketing have offset those savings in 1994.\nInterest Expense and Other --------------------------\n1994 Increase 1993 Increase 1992 --------------------------------------------------------------------- Interest and Other $5.1 8.5% $4.7 17.5% $4.0 Percent of Sales 1.0% .9% .8%\nIn 1994 interest expense and other increased primarily due to increased borrowings for the acquisition of Canlab, partially offset by replacing expired interest rate collars with fixed rate interest swaps. Foreign currency transaction losses accounted for approximately $.2 million of the increase.\nIn 1993 interest expense and other increased due to increased borrowing levels which occurred primarily for the purchase of a new warehouse facility for the Sargent-Welch division, system enhancements, and the 1992 acquisition of Johns Scientific.\nIncome Taxes ------------ 1994 Decrease 1993 Decrease 1992 -------------------------------------------------------------------- Taxes $1.0 (63.0%) $2.7 (52.6)% $5.7 Percent of Sales .2 .5% 1.2% Effective tax rate 32.0% 40.6% 37.5%\nThe income taxes footnote to the financial statements describes the difference between the statutory and effective income tax rates. The lower effective tax rate in 1994 reflects the recognition of the benefits of a portion of the Canadian net operating loss carrforwards and lower state taxes. Management expects that the realization of the deferred tax assets related to the Canadian net operating losses will result from improved margins and elimination of duplicate personnel and facility cost, coupled with the acquisition of Canlab in late 1994. The higher effective tax rate in 1993 reflects the carryforward to future years of Canadian tax benefits not recognized in 1993.\nIncome Before Cumulative Effect of Accounting Change and Per Share Data ----------------------------------------------------------------------- 1994 Decrease 1993 Decrease 1992 -------------------------------------------------------------------- Income $2.1 (46.2)% $3.9 (58.5)% $9.4 Percent of Sales .4% .8% 1.9% Per Share $ .18 $ .35 $ .85\nIn 1994, the decrease in income before cumulative effect of accounting change is primarily due to lower margins.\nIn 1993, in addition to the impact of the restructuring and other charges, which were $3.3 million pre-tax ($1.9 million net of tax or $.18 per share), income before cumulative effect of accounting change decreased primarily due to decreased operating income from lower sales and margins, and higher operating expenses along with higher interest costs.\nFinancial Condition and Liquidity --------------------------------- The ratio of debt to equity over the past four years is as follows:\n1994 1993 1992 1991 -------------------------------------------------------------- 2.0 1.5 1.1 1.3\nThe ratio of operating income, plus depreciation and amortization, to interest expense over the past four years is as follows:\n1994 1993 1992 1991 -------------------------------------------------------------- 3.8 4.5 7.1 5.8\nVWR continues to maintain a liquid financial position. VWR's current ratio was 2.7 at December 31, 1994 and accounts receivable and inventory accounted for 66% of total assets. The increase in accounts receivable is due to transition issues related to the consolidation of the Company's credit department and higher sales growth in the fourth quarter of 1994 compared to the fourth quarter of 1993. The increase in inventory and accounts payable is primarily due to various marketing programs, and to supporting new supplier partnerships with several customers. For the year ended December 31, 1994 cash flow from operations of $5.1 million and debt borrowings of $19.5 million were used to finance investments in property and equipment of $2.9 million, the Canlab acquisition of $13.9 million, the joint venture investment of $2.9 million and to pay dividends of $4.4 million. Sufficient credit availability existed at December 31, 1994 to provide for the amounts of bank checks outstanding less cash in bank of $1.4 million. Cash requirements reach a low toward the end of each calendar year due to the natural business cycle.\nOn October 27, 1994 the Company replaced its previously unsecured revolving credit facility with a dual-currency secured revolving credit and term loan agreement, expiring in 1997, with four banks which provides for committed facilities of $80 million subject to the maintenance of certain levels of accounts receivable and inventory, and a $20 million five-year loan due in varying installments beginning December 31, 1994. The facility provides for the ability to borrow Canadian dollars in an amount up to $16 million in U.S. dollars. Canadian borrowings were used to finance the acquisition of Canlab. Interest on borrowings is at variable short-term interest rates.\nTo reduce the impact of changes in interest rates on floating rate long-term debt, the Company uses a combination of interest rate swaps, and collars. The notional amounts of the interest rate collars and swaps are based upon expected actual debt levels during a five-year period. The Company provides protection to meet actual exposures and does not speculate in derivatives.\nThe Company's interest rate collar effectively establishes a minimum and maximum rate on up to $30 million of credit, and expires in 1996. The Company also has interest rate swap agreements which change interest rate exposure on $10 million of floating rate debt to a fixed rate of 4.86% through February 1996, and on $30 million at a fixed rate of 6.38% from February 1996 to February 1999. 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.\nDue to the increase in debt levels from the Canadian acquisition, the board of directors made a decision to reduce the company's quarterly dividend, declared on December 16, 1994 to $.04 per share from the previous $ .10 per share.\nOn February 27, 1995, the Company and EM Industries, Incorporated (\"EM\") (an affiliate of E. Merck, Darmstadt, Germany) entered into an agreement that calls for EM to invest $20 million in the Company for common shares (calculated at a price per share of $11) and a three-year warrant to purchase an additional $10 million of common shares at $11 per share, subject to regulatory approvals and other customary conditions. Assuming exercise of the warrant, EM would own approximately 20% of the common stock of the Company.\nEM has also agreed to a four-year \"standstill\" agreement, which limits its ability to increase its equity interest in the Company during the four years. After the four-year period, without prior approval of the Board of Directors of the Company, EM would be permitted to acquire additional equity in the Company only by offering to acquire all of the outstanding shares of the Company. The standstill agreement also grants EM certain registration rights. The Company has also agreed to elect two representatives of EM to its Board of Directors. In addition, the Companies have agreed to enter into new distribution agreements encompassing the U.S. and Canadian markets.\nThe agreements have been unanimously approved by the Company's Board of Directors and do not require shareholder approval. The expected proceeds of approximately $20 million from the issuance of the shares under the share purchase agreement are expected to be used to repay debt.\nVWR has been designated by the EPA as a potentially responsible party for various sites. Management believes that any required expenditures would be immaterial to the Company's consolidated financial statements.\nAs of December 31, 1994 the estimated cost for capital improvement projects is expected to range between $4 and $5 million in 1995 related primarily to continued investments in new computer systems and equipment and warehouse equipment.\nOperating Income Return on Average Invested Capital -----------------------------------------------------\n1994 1993 1992 1991 ---------------------------------------------------------------------\n7.3% 11.7% 22.0% 19.0%\n1993 before restructuring charges 15.1%\nOperating Income to Sales ------------------------- 1994 1993 1992 1991 ---------------------------------------------------------------------\n1.5% 2.2% 3.9% 3.8%\n1993 before restructuring charges 2.9%\nAverage Invested Capital to Sales --------------------------------- 1994 1993 1992 1991 ---------------------------------------------------------------------\n21.0% 18.9% 17.7% 19.8%\nDays Sales in Accounts Receivable --------------------------------- 1994* 1993 1992 1991 ---------------------------------------------------------------------\n45.7 42.6 41.5 42.1\nInventory Turnover (Before LIFO) -------------------------------- 1994* 1993 1992 1991 ---------------------------------------------------------------------\n6.7 6.9 6.4 6.0\n*Excludes the effect of the Canlab acquisition\nITEM 8.","section_7A":"","section_8":"ITEM 8. - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------ -------------------------------------------\nVWR CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS\nYear Ended December 31, 1994 1993 1992 ------------------------------------------------------------------------------- (Thousands of dollars, except per share data)\nSales $535,179 $509,235 $490,168 Cost of sales 421,981 392,961 375,737 ------- ------- ------- Gross margin 113,198 116,274 114,431 Operating expenses 104,124 101,713 95,322 Canlab transition expenses 916 Restructuring and other charges 3,300 ------- ------- ------- Operating income 8,158 11,261 19,109 Interest expense and other 5,137 4,708 4,021 ------- ------- ------- Income before income taxes and cumulative effect of accounting change 3,021 6,553 15,088 Income taxes 968 2,663 5,658 ------- ------- ------- Income before cumulative effect of accounting change 2,053 3,890 9,430 Cumulative effect of change in accounting for postretirement benefits, net of income tax benefit of $860 (1,400) ------- ------- ------- Net Income $ 2,053 $ 2,490 $ 9,430 ======= ======= ======= Earnings (Loss) Per Share: Income before cumulative effect of accounting change $ 0.18 $ 0.35 $ 0.85 Cumulative effect of accounting change (0.13) ------- ------- ------- Net Income $ 0.18 $ 0.22 $ 0.85 ======= ======= ======= Weighted average number of common shares outstanding (thousands) 11,128 11,153 11,128\nSee Notes to Consolidated Financial Statements.\nVWR CORPORATION CONSOLIDATED BALANCE SHEETS\n(Thousands of dollars, except share data) December 31, ASSETS 1994 1993 ------------------------------------------------------------------------------- Current Assets: Receivables-- Trade receivables, less reserves of $619 and $259 $70,777 $60,272 Other receivables 2,753 2,489 Inventories 40,091 30,243 Other 6,378 8,484 ------- -------- Total Current Assets 119,999 101,488\nProperty and Equipment--net 38,259 41,562\nOther Assets 15,117 5,727 ------- -------- $173,375 $148,777 ======= ======== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------------------------------------------------- Current Liabilities:\nBank checks outstanding, less cash in bank $ 1,398 $ 1,062 Accounts payable 35,783 26,743 Accrued liabilities 5,448 8,336 Current portion of long-term debt 2,250 150 ------- ------- Total Current Liabilities 44,879 36,291\nLong-Term Debt 79,170 61,757\nDeferred Income Taxes and Other 9,158 9,672\nShareholders' Equity: Preferred stock, $1 par value, 1,000,000 shares authorized, none issued Common stock, $1 par value, 30,000,000 shares authorized, 11,316,592 issued 11,316 11,316\n(Thousands of dollars, December 31, except share data) 1994 1993 ---- ---- Additional paid-in capital $ 29,269 $ 29,137 Retained earnings 4,941 6,651 Treasury shares at cost, 250,225 and 293,613 shares (2,463) (2,882) Unamortized ESOP contribution (1,786) (2,057) Unamortized restricted stock awards (485) (541) Cumulative translation adjustment (624) (567) -------- -------- Total Shareholders' Equity 40,168 41,057 -------- -------- $173,375 $148,777 ======== ========\nSee Notes to Consolidated Financial Statements.\nVWR CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\nYear Ended December 31, 1994 1993 1992 ------------------------------------------------------------------------------- (Thousands of dollars) OPERATING ACTIVITIES Net Income $ 2,053 $ 2,490 $ 9,430 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 9,791 9,203 8,432 Cumulative effect of accounting change 1,400 Change in assets and liabilities, net of effect of businesses acquired: Receivables, net (7,359) (4,123) (3,217) Inventories (4,459) 2,782 926 Other current assets (1,625) (5,914) (1,462) Accounts payable 9,040 (750) 4,834 Accrued liabilities (2,013) 835 197 Deferred income taxes and other (330) 495 (36) ------- ------- ------- Cash Provided by Operating Activities 5,098 6,418 19,104 ------- ------- ------- INVESTING ACTIVITIES\nAdditions to property and equipment, net (2,922) (13,402) (5,184) Acquisition of businesses net of $1,600 note payable in 1992 (13,939) (5,837) Investment in joint venture (2,881) Net additions to other assets (909) (1,854) (931) -------- -------- -------- Cash Used by Investing Activities $(20,651) $(15,256) $(11,952) -------- -------- --------\nYear Ended December 31, 1994 1993 1992 ------------------------------------------------------------------------------- (Thousands of dollars)\nFINANCING ACTIVITIES Proceeds from long-term debt $169,243 $228,983 $136,493 Repayment of long-term debt (149,730) (214,847) (137,341) Net change in bank checks outstanding 336 (741) (1,618) Cash dividends (4,419) (4,395) (4,383) Purchase of treasury shares (286) Proceeds from exercise of stock options 135 88 249 Other (12) (250) (266) ------- ------- ------- Cash Provided (Used) by Financing Activities 15,553 8,838 (7,152) ------- ------- ------- Net Change in Cash 0 0 0\nCash at beginning of year 0 0 0 ------- ------- ------- Cash at end of year $ 0 $ 0 $ 0 ======= ======= ======= Supplemental disclosures of cash flow information:\nCash paid (received) during the year for: Interest (net of capitalized interest) $ 4,568 $ 4,128 $ 3,493 Income taxes (254) 4,568 4,350\nSee Notes to Consolidated Financial Statements.\nVWR CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\n(Thousands of dollars, Unamortized except per share data) Restricted Stock, Common Unamortized Stock Additional ESOP $1 Par Paid-in Retained Treasury Contribution, Value Capital Earnings Shares and Other ----------------------------------------------------------------------------\nBalance December 31, 1991 $5,658 $34,451 $3,697 $(3,882) $(3,092)\nNet income 9,430 Two-for-one stock split 5,658 (5,658) Cash dividends ($.40 per share) (4,383) Allocation of shares to ESOP participants 235 Restricted stock awards - 7,580 shares 23 74 (97) Forfeiture of restricted stock - 2,173 shares (26) 26 Amortization of restricted stock 279 Grant of treasury shares - 14,482 shares 44 141 Acquisition of treasury stock - 21,756 shares (305) Exercise of stock options (66) (183) 507 Foreign currency translation adjustment (274)\nBalance ------ ------ ----- ----- ------ December 31, 1992 $11,316 $28,794 $8,561 $(3,491) $(2,923) ------ ------ ----- ----- ------\n(Thousands of dollars, Unamortized except per share data) Restricted Stock, Common Unamortized Stock Additional ESOP $1 Par Paid-in Retained Treasury Contribution, Value Capital Earnings Shares and Other -------------------------------------------------------------------------------\nNet income $2,490 Cash dividends ($.40 per share) (4,400) Allocation of shares to ESOP participants $ 417 Restricted stock awards 45,219 shares $ 222 $ 439 (661) Amortization of restricted stock 290 Grant of treasury shares- 4,478 shares 28 43 Acquisition of treasury stock - 1,783 shares (22) Exercise of stock options (61) 149 Tax benefit on ESOP divi- dends and restricted stock 154 Foreign currency transla- tion adjustment (288) Balance ------- ------- ------ ------- ------- December 31, 1993 $11,316 $29,137 $6,651 $(2,882) $(3,165) ------- ------- ------ ------- -------\n(Thousands of dollars, Unamortized except per share data) Restricted Stock, Common Unamortized Stock Additional ESOP $1 Par Paid-in Retained Treasury Contribution, Value Capital Earnings Shares and Other -------------------------------------------------------------------------------\nNet income $2,053 Cash dividends ($.34 per share) (3,763) Allocation of shares to ESOP participants $271 Restricted stock awards 21,816 shares $28 $211 (239) Amortization of restricted stock 295 Exercise of stock options (79) 208 Tax benefit on ESOP divi- dends and restricted stock 183 Foreign currency transla- tion adjustment (57) Balance ------- ------- ------ -------- -------- December 31, 1994 $11,316 $29,269 $4,941 $(2,463) $(2,895) ======= ======= ====== ======== ========\nSee Notes to Consolidated Financial Statements.\nVWR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\nPrinciples of Consolidation -------------------- The accompanying consolidated financial statements include the accounts of VWR Corporation and all of its subsidiaries (the Company). All significant intercompany accounts and transactions have been eliminated.\nCapitalization, Depreciation and Amortization --------------------------------------- Land, buildings, and equipment are recorded at cost. Depreciation is com- puted using the straight-line method for financial reporting purposes and, generally, accelerated methods for income tax purposes. Acquisition and development costs for significant business systems and related software for internal use are capitalized and amortized over their estimated useful lives of seven years. The Company capitalizes the costs of developing and producing catalogs, which are used by customers for ordering products. Such costs are amortized over the period of use, generally two years. Goodwill is amortized over periods of 15 and 40 years.\nIncome Taxes ------------ In 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109 \"Accounting for Income Taxes,\" which supersedes SFAS No. 96 previously followed by the Company. The adoption of SFAS 109 did not have a material effect on the Company's financial position or results of operations.\nPostretirement Benefits ----------------------- In 1993, the Company adopted SFAS No. 106 \"Accounting for Postretirement Benefits Other Than Pensions.\" This Statement requires the Company to accrue the cost of retiree medical expenses over the period earned by the participants, which is a change from the Company's prior practice of recording these costs when incurred.\nEarnings Per Share and 1992 Stock Split --------------------------------------- Earnings per share are based on the weighted average number of shares and dilutive common share equivalents outstanding during the period.\nOn April 20, 1992, the Company's Board of Directors declared a two-for-one stock split in the form of a stock dividend payable to shareholders of record as of May 9, 1992. The aggregate par value, which did not change on a per- share basis, of $5.6 million for the additional shares was transferred from additional paid-in capital to common stock. All share and per-share data in these financial statements have been restated to give effect to the stock split.\nSegment and Customer Information -------------------------------- The Company is engaged in one line of business, industrial distribution. No single customer accounts for more than 10% of sales. The majority of the Company's business activity pertains to, and accounts receivable result from, sales of laboratory equipment and supplies to businesses across a wide geographical area in various industries, mainly industrial, governmental, biomedical, and educational. At December 31, 1994, the Company had no significant concentrations of credit risk.\nReclassifications ----------------- Certain prior years' amounts have been reclassified to conform to the current year's presentation.\nINVENTORIES ----------- Inventories consist primarily of purchased goods for sale and are valued at the lower of cost or market. Inventory valued using the last-in, first-out (LIFO) method comprised 88% and 95% of inventory at December 31, 1994 and 1993, respectively. Cost of the remaining inventories is determined using the first-in, first-out (FIFO) method.\nLIFO cost at December 31, 1994, and 1993, was approximately $27.7 million and $26.8 million, respectively, less than current cost. The effect of LIFO layer liquidations decreased the cost of sales by $.6 million in 1993, and $.4 million in 1992.\nFIXED ASSETS ------------ Net property and equipment at December 31, 1994, and 1993, is: ----------------------------------------------------------------------------- (Thousands of dollars) 1994 1993 ----------------------------------------------------------------------------- Land $ 2,130 $ 2,130 Buildings 10,249 10,249 Equipment and computer software 53,029 50,339 Construction in progress 408 280 ------- ------- 65,816 62,998 Less accumulated depreciation (27,557) (21,436) ------- ------- Net property and equipment $38,259 $41,562 ======= =======\nDepreciation expense for the years ended December 31, 1994, 1993 and 1992, was $6.3 million, $5.4 million and $4.3 million, respectively.\nACCRUED LIABILITIES ------------------- Included in accrued liabilities at December 31, 1994, and 1993, is accrued compensation of approximately $3.3 million and $4.2 million, respectively.\nFOREIGN CURRENCY TRANSACTIONS ------------------------------ The Company supplies product to its Canadian subsidiary for sale to the subsidiary's Canadian customers. The Company has entered into forward exchange contracts to fix the rate of exchange on the Canadian dollar payments made to the Company upon settlement of the intercompany accounts related to those shipments to its subsidiary. As of December 31, 1994, the Company had approximately $1.1 million of forward exchange contracts outstanding. Net transaction gains and losses are not material and are included in interest expense.\nLONG-TERM DEBT AND REVOLVING CREDIT AGREEMENTS ---------------------------------------------- The long-term debt of the Company at December 31, 1994, and 1993, is: ----------------------------------------------------------------------------- (Thousands of dollars) 1994 1993 ----------------------------------------------------------------------------- Revolving Credit Agreements $61,920 $60,107 Term Note 19,500 1,800 Less current portion (2,250) (150) ------- ------- Net long-term debt $79,170 $61,757 ======= =======\nOn October 27, 1994, the Company replaced its previously unsecured revolving credit facility with a dual-currency secured revolving credit and term loan agreement, expiring in 1997, with four banks which provides for committed facilities of $80 million subject to the maintenance of certain levels of accounts receivable and inventory, and a $20 million five-year term note due quarterly in varying installments beginning December 31, 1994. The facility provides for the ability to borrow Canadian dollars up to $16 million in U.S. dollars. Canadian borrowings were used to finance the acquisition of Canlab as noted under \"Acquisitions.\" Interest on borrowings is at short-term interest rates. The agreement is secured by the Company's accounts receivable and inventory. The Company expects to have sufficient accounts receivable and inventory to provide adequate availability under these facilities. Principal amounts due on long-term debt, before the impact of the equity transaction (see \"Subsequent Event\" note), in each of the five years beginning January 1, 1995, are $2.3 million, $3.3 million, $66.6 million, $5.3 million and $4.5 million, respectively.\nFor the year ended December 31, 1994, the approximate weighted average interest rate on borrowings made under the outstanding loan facilities was 7.0%, which approximates the year-end rate. Interest expense for the years ended December 31, 1994, 1993, and 1992, was $4.8 million, $4.5 million, and $3.9 million, respectively.\nThe Company has an interest rate collar on $30 million which expires on March 1, 1996. The collar is based on the three-month London Interbank Offered Rate (\"LIBOR\") and has a floor of 6.75% and a ceiling of 9.5%. The cost of the collar is treated as a reduction of the revolving credit debt and is being amortized as revolving credit interest expense over the term of the collar.\nThe Company has entered into interest rate swap agreements with a financial institution which effectively change the Company's interest rate exposure on $10 million of floating rate debt to a fixed rate of 4.86% from March 28, 1994 through February 29, 1996, and on $30 million to a fixed rate of 6.38% from February 29, 1996 through February 28, 1999. Net receipts or payments under the agreements are recognized as an adjustment to interest expense. The fair market value of the swap agreements is based on the present value of the future cash flows determined by the interest rate difference between the contracts' fixed rate and the then current replacement rate. At December 31, 1994 the fair market value of the swap agreements, which is not recorded in the consolidated financial statements, is approximately $1.4 million. 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.\nThe Company's long-term debt agreement provides for, among other terms, restrictive covenants with respect to working capital, tangible net worth, the current ratio, and the debt-to-equity ratio, which may restrict the Company's ability to declare or pay dividends. Under the most restrictive of these terms, approximately $1.8 million of retained earnings at December 31, 1994 is available to pay dividends.\nINCOME TAXES ------------ During 1993, the Company adopted SFAS No. 109 \"Accounting for Income Taxes.\" The cumulative effect of the accounting change was not material.\nThe income (loss) before income taxes and cumulative effect of accounting change is as follows:\n------------------------------------------------------------------------------- (Thousands of dollars) 1994 1993 1992 ------------------------------------------------------------------------------- Domestic $3,470 $7,447 $15,280 Foreign (449) (894) (192) ------ ------ ------- $3,021 $6,553 $15,088 ====== ====== =======\nThe provision for income taxes on income before cumulative effect of accounting change consists of: --------------------------------------------------------------------------- (Thousands of dollars) 1994 1993 1992 --------------------------------------------------------------------------- Current: Federal $1,652 $2,320 $4,410 State 170 200 772 ------ ------ ------ 1,822 2,520 5,182 ------ ------ ------ Deferred: Federal (276) 286 351 State (213) 7 125 Foreign (365) (150) ------ ----- ------ (854) 143 476 ------ ------ ------ Total tax provision $ 968 $2,663 $5,658 ====== ====== ======\nThe reconciliation of tax computed at the federal statutory tax rates of 35% (1994 and 1993) and 34% (1992) of income before income taxes and cumulative effect of accounting change to the actual income tax provision is as follows:\n------------------------------------------------------------------------------- (Thousands of dollars) 1994 1993 1992 -------------------------------------------------------------------------------\nStatutory tax $1,058 $2,293 $5,130 State income taxes net of federal tax benefit (29) 137 592 Increase in statutory rate on deferred tax items 164 Increase (Decrease) in valuation allowance for foreign net operating loss (165) 250 Other-net 104 (181) (64) ------ ------ ------ Total tax provision $ 968 $2,663 $5,658 ====== ====== ======\nDeferred tax liabilities (assets) as of December 31, 1994 and 1993 are comprised of the following: ----------------------------------------------------------------------------- (Thousands of dollars) 1994 1993 ----------------------------------------------------------------------------- Depreciation $5,942 $6,400 Pension 1,730 1,918 ----- ----- Deferred tax liabilities 7,672 8,318 ----- ----- Postretirement benefits (800) (809) Other benefits (525) (584) Restructuring charges (720) Net operating loss carryforwards from foreign operations net of valuation allowances of $160 in 1994 and $350 in 1993 (586) (150) Other-net (714) (213) ----- ----- Deferred tax assets (2,625) (2,476) ----- ----- Net deferred tax liability $5,047 $5,842 ====== ======\nIncluded in other current assets at December 31, 1994 and 1993 are refundable income taxes of approximately $.4 million and $2.1 million, respectively, and net current deferred tax assets of $.8 million and $.6 million, respectively. The Company has Canadian tax loss carryforwards of approximately $1.0 million which expire at various dates through 2001. Management expects that the realization of the deferred tax assets related to the Canadian net operating losses will result from improved margins, elimination of duplicate personnel and facility cost, coupled with the acquisition of Canlab in late 1994.\nSHAREHOLDER RIGHTS AGREEMENT ---------------------------- On May 20, 1988, the Company established a Shareholder Rights Agreement. The Agreement is designed to deter coercive or unfair takeover tactics that could deprive shareholders of an opportunity to realize the full value of their shares. On February 23, 1995, the Company amended the Agreement to change the definition of \"Acquiring Person,\" and to provide that the Agreement be governed by the laws of the Commonwealth of Pennsylvania instead of the laws of the State of Delaware.\nUnder the Agreement, the Company has distributed a dividend of one Right for each outstanding share of the Company's stock. When exercisable, each Right will entitle its holder to buy two shares of the Company's common stock at $45.00 per share. The Rights will become exercisable if an Acquiring Person acquires or makes an offer to acquire 20 percent of the Company's common stock. In the event that a purchaser acquires 20 percent of the common stock, each Right shall entitle the holder, other than the acquirer, to purchase, at\nthe Right's then-current full exercise price, shares of the Company's common stock having a market value of twice the then-current full exercise price of the Right. In the event that, under certain circumstances, the Company is acquired in a merger or transfers 50 percent or more of its assets or earnings to any one entity,each Right entitles the holder to purchase common stock of the surviving or purchasing company having a market value of twice the full exercise price of the Right. The Rights, which expire on May 31, 1998, may be redeemed by the Company at a price of $.005 per Right.\nSTOCK AND INCENTIVE PROGRAMS ---------------------------- Under the stock option and restricted stock plans, in addition to outstanding options, 241,440 shares were reserved for issuance at December 31, 1994.\nRestricted Stock Awards ----------------------- The Company's restricted stock award plan provides for grants of common stock to certain directors, officers, and managers. The vesting periods range from one to eight years. The fair market value of the stock at the date of grant establishes the compensation amount, which is amortized to operations over the vesting period. During the years ended December 31, 1994, 1993 and 1992, the Company granted 21,816, 45,219 and 7,580 shares, respectively, at fair market values of approximately $.2 million, $.7 million and $.1 million, respectively.\nStock Options ------------- Under the stock option plan, options, which vest over 3 to 10 years, have been granted to certain officers and managers to purchase common stock of the Company at its fair market value at date of grant. Changes in options outstanding were:\n------------------------------------------------------------------------------- Shares Average Price ------------------------------------------------------------------------------ Outstanding at December 31, 1991 429,310 $7.41 Exercised (44,301) 5.62 Canceled (12,196) 7.82 ------ Outstanding at December 31, 1992 372,813 7.61 Exercised (14,469) 6.07 Granted 59,921 13.88 Canceled (12,446) 6.90 -------- Outstanding at December 31, 1993 405,819 8.61 Exercised (22,007) 6.14 Granted 5,000 10.00 Canceled (32,845) 7.75 ------- Outstanding at December 31, 1994 355,967 $8.86 =======\nAt December 31, 1994, there were 135,870 options exercisable at an average price of $7.79.\nSavings Investment Plan ----------------------- The Company has a savings investment plan whereby it matches 50% of the employee's contribution up to 3% of the employee's pay. For employee contributions between 3% and 7.5% of their pay, the Company will match 50% of the contribution within prescribed limits based on the Company's profitability for the year. All Company contributions are used to buy shares of the Company's stock. Expenses under this plan for the years ended December 31, 1994, 1993, and 1992, were $.6 million, $.5 million and $.6 million, respectively. At December 31, 1994, there were 407,513 shares available for issuance under this Plan.\nEmployee Stock Ownership Plan ----------------------------- In September, 1990, the Company established an employee stock ownership plan (ESOP) by, in effect, contributing 400,000 shares of treasury stock ($2.9 million fair value) to the ESOP of which 153,568 shares are allocated to participants at December 31, 1994. All full-time and part-time employees, except certain union employees, are eligible to participate in the plan.\nThe ESOP shares will be allocated equally to individual participants' accounts over a period up to ten years. Vesting occurs equally over an employment period of five years at which time the employee is 100% vested in the plan. The total number of shares to be allocated in a year is the higher of an amount based on the Company's profitability or the minimum allocation required per the ESOP agreement. Expenses are recognized based on shares to be allocated in the subsequent year and are reduced for dividends paid on unallocated shares.\nPOSTRETIREMENT BENEFITS ------------------------ Pension Plans\nThe Company has two defined benefit pension plans covering substantially all of its domestic employees, except for employees covered by independently operated collective bargaining plans. Pension benefits are based on years of credited service and the highest five consecutive years' average compensation. Contributions to the Company plans are based on funding standards established by the Employee Retirement Income Security Act of 1974 (ERISA).\nThe total VWR Corporation plans' funding status and the amounts recognized in the Company's Consolidated Balance Sheets at December 31, 1994, and 1993, are:\n------------------------------------------------------------------------------ (Thousands of dollars) 1994 1993 ------------------------------------------------------------------------------ Actuarial present value of plan benefit obligations\nVested benefit obligation $30,166 $31,240 Nonvested benefit obligation 1,254 1,116 ------- ------- Accumulated benefit obligation $31,420 $32,356 ======= ======= Projected benefit obligation $35,972 $37,848 Plan assets at fair value (33,313) (33,610) ------- ------- Projected benefit obligation in excess of plan assets 2,659 4,238 Prior service costs not yet recognized in net periodic pension cost 699 336 Unrecognized net transition obligation (333) (391) Unrecognized actuarial loss (6,901) (8,222) ------- ------ Prepaid pension expense included in consolidated balance sheets $(3,876) $(4,039) ======= =======\nThe assets of the Company plans consist predominantly of undivided interests in several funds structured to duplicate the performance of various stock and bond indexes.\nNet pension expense under the Company plans includes the following components:\n------------------------------------------------------------------------------ (Thousands of dollars) 1994 1993 1992 ------------------------------------------------------------------------------\nService Cost (benefits earned during the year) $1,516 $1,252 $1,184 Interest cost on projected benefit obligation 2,922 2,758 2,503 Actual return on plan assets (116) (3,412) (1,366) Net amortization and deferral (2,714) 682 (1,370) ------ ------ ------ Net pension expense $1,608 $1,280 $ 951 ====== ====== ====== The assumptions used were: Discount rate 8.75% 7.75% 9% Rate of increase in compensation levels 4% 4% 5% Expected long-term rate of return on plan assets 10% 10% 10%\nThe Company maintains a supplemental pension plan for certain senior officers. Expenses incurred under this plan in 1994 and 1993 were approximately $.2 million and $.3 million, respectively. There were no expenses incurred under this plan in 1992.\nCertain employees are covered under union-sponsored, collectively bargained plans. Expenses under these plans for each of the years ended December 31, 1994, 1993 and 1992, were $.2 million, as determined in accordance with negotiated labor contracts.\nRetiree Medical Benefits Program -------------------------------- The Company provides certain medical benefits for retired employees. In 1993, the Company adopted SFAS No. 106 \"Accounting for Postretirement Benefits Other Than Pensions.\" The Company elected to immediately recognize the calculated liability resulting in a one-time non-cash charge to income of approximately $1.4 million, net of a deferred tax benefit of approximately $.9 million.\nEmployees retired as of December 31, 1992 and active employees who reached age 55 by December 31, 1992 are eligible to participate in the Company's retiree health plan (the \"plan\"). There are also certain provisions for participation by spouses. The plan is contributory, with retiree contributions based on years of service and includes other co-payment and co-insurance provisions.\nThe Company does not fund the plan. The liability of the plan at December 31, 1994 and 1993 is as follows:\n(Thousands of dollars) 1994 1993 Accumulated postretirement benefit obligation: ---- ---- Retirees $1,486 $1,604 Eligible active participants 184 183 Other active participants 22 21 Unrecognized net gain 307 266 ------ ------ Accrued postretirement benefit obligation $1,999 $2,074 ====== ======\nThe net periodic postretirement benefit cost includes the following components: 1994 1993 ---- ---- Service cost $ 6 $ 7 Interest cost 139 174 Net amortization and deferral (3) ----- ----- $ 142 $ 181 ===== =====\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation is 10% through 1996 declining 1% per year to a level of 5.4% in 2001 and thereafter. The effect of a 1% annual increase in the assumed cost trend rate would increase the accumulated postretirement benefit obligation by approximately 9%; the annual service and interest cost components in the aggregate would not be materially affected. An 8.75% discount rate was used in determining the accumulated postretirement benefit obligation at December 31, 1994 and 7.75% was used at December 31, 1993.\nBefore the adoption of SFAS No. 106, the retiree health care expense was recorded as claims were incurred. The expense for 1992 was approximately $.2 million.\nLEASES ------ The Company leases office and warehouse space, computer equipment, and automobiles under operating leases with terms ranging up to 15 years, subject to renewal options.\nRental expense for continuing operations was approximately $5.2 million for the years ended December 31, 1994, and 1993, and $4.8 million in 1992\nFuture minimum lease payments as of December 31, 1994, under noncancelable operating leases, having initial lease terms of more than one year are:\n------------------------------------------------------------------------------ Years Ending December 31 (Thousands of dollars) ------------------------------------------------------------------------------ 1995 $ 4,436 1996 3,514 1997 3,008 1998 2,000 1999 1,710 Thereafter 3,681 ------ Total minimum payments $18,349 ====== CONTINGENCIES AND COMMITMENTS ------------------------------ The Company is involved in various environmental, contractual, warranty, and public liability cases and claims, which are considered routine to the Company's business. In the opinion of management, the potential financial impact of these matters is not material to the consolidated financial statements.\nACQUISITIONS ------------ Effective October 31, 1994, the Company, through its wholly-owned Canadian subsidiary, acquired certain assets related to the laboratory supply business of Canlab, a division of Baxter International for approximately $13.9 million. The acquisition was accounted for under the purchase method of accounting and was funded through the Company's secured term loan. The unamortized balance of the excess purchase price over net assets acquired is $5.1 million at December 31, 1994 which is included in other long-term assets. In the fourth quarter of 1994, as a result of the acquisition, VWR terminated certain of its employees and closed certain facilities. The total cost of these actions, which was expensed in 1994, was $.9 million.\nCanlab's results of operations have been included in the consolidated results of operations since the date of acquisition. The following unaudited pro forma combined results of operations for the years ended December 31, 1994 and 1993 have been prepared assuming that the acquisition had occurred as of the beginning of each period. It is based on historical information and does not necessarily reflect the actual results that would have occurred nor is it necessarily indicative of future results of operations of the combined enterprise:\n(Thousands of dollars) 1994 1993 ---- ---- Sales $570,170 $553,467\n1994 1993 ---- ----\nIncome before cumulative effect of accounting change 3,254 5,766 Net income 3,254 4,366\nEarnings per share: Before cumulative effect of accounting change $ .29 $.52 Net income .29 .39\nThe pro forma results of operations include, among other items, certain adjustments for increased interest on acquisition debt, amortization of goodwill, plus expense savings from discontinued fucntions, and related income tax effects. \t\nEffective October 5, 1992, the Company, through its wholly owned Canadian subsidiary, acquired certain assets related to the laboratory supply business of Johns Scientific, Inc. of Toronto, Canada for approximately $7.4 million. This acquisition was accounted for under the purchase method of accounting and was funded through the Company's revolving credit line, and a $1.6 million, 8% note payable which was refinanced through the revolving line of credit. The acquisition is not material in relation to the Company's consolidated financial statements. The unamortized balance of the excess purchase price over net assets acquired is $2.1 million at December 31, 1994 and $2.5 million at December 31, 1993 which is included in other long-term assets.\nJOINT VENTURE ------------- On January 1, 1994 the Company formed a joint venture with E. Merck of Germany to acquire an interest in Bender & Hobein GmbH, a distributor of laboratory supplies and equipment in Germany. The $2.9 million investment, included in other long-term assets, is accounted for using the cost method of accounting and was funded through the Company's revolving credit line.\nThe initial term of this agreement is for a period of three years. During the initial term, VWR has the right to \"put\" its investment to E. Merck and receive the original DM cost of the investment. Subsequent to the initial term, if either party terminates the agreement, E. Merck will have to re- acquire the shares from VWR at fair value.\nRESTRUCTURING AND OTHER CHARGES ------------------------------- In December 1994, the Company made the decision to consolidate certain sales offices and functions. As a result, the Company will incur approximately $2 million in charges which are primarily for severance and other personnel- related costs. The cost of the consolidation effort will be accounted for in accordance the new guidance set forth in FASB EITF Issue 94-3 \"Accounting for Restructuring Charges.\" Under EITF 94-3 costs will be recognized primarily when they are incurred throughout 1995.\nIn the fourth quarter of 1993, the Company made the decision to refocus certain information systems efforts into customer service systems and to take actions that would reduce operating expenses. As a result of this effort, the Company recorded a $3.3 million charge which included non-cash charges of $1.3 million (primarily for software development costs that did not have continuing value) and $2 million related to the consolidation of functions and facilities which consisted primarily of severance and other personnel-related costs. All of the Company's contemplated actions were completed during 1994, and all of the cash expenditures related to the $2 million accrued at December 31, 1993 have been made.\nSUBSEQUENT EVENT ----------------\nOn February 27, 1995, the Company and EM Industries, Incorporated (\"EM\") (an affiliate of E. Merck, Darmstadt, Germany) entered into an agreement that calls for EM to invest $20 million in the Company for common shares (calculated at a price per share of $11) and a three-year warrant to purchase an additional $10 million of common shares at $11 per share, subject to regulatory approvals and other customary conditions. Assuming exercise of the warrant, EM would own approximately 20% of the common stock of the Company.\nEM has also agreed to a four-year \"standstill\" agreement, which limits its ability to increase its equity interest in the Company during the four years. After the four-year period, without prior approval of the Board of Directors of the Company, EM would be permitted to acquire additional equity in the Company only by offering to acquire all of the outstanding shares of the Company. The standstill agreement also grants EM certain registration rights. The Company has also agreed to elect two representatives of EM to its Board of Directors. In addition, the Companies have agreed to enter into new distribution agreements encompassing the U.S. and Canadian markets.\nThe agreements have been unanimously approved by the Company's Board of Directors and do not require shareholder approval. The expected proceeds of approximately $20 million from the issuance of the shares under the share purchase agreement are expected to be used to repay debt.\nFOREIGN AND DOMESTIC OPERATIONS -------------------------------\nAt December 31, 1994, identifiable assets of the Company's Canadian operations were $28 million. Approximately half of the assets are attributable to the Canlab acquisition on October 31, 1994. Because Canlab's operations are reflected in the consolidated totals for only two months in 1994, net sales and operating income (loss) of the Canadian operations are proportionately smaller - - in each case less than 10 percent of the consolidated total for such amounts. For the years ended December 31, 1993 and 1992 sales and identifiable assets attributable to these Canadian operations were less than 10% of the Company's totals in each category.\nQUARTERLY FINANCIAL DATA (Unaudited) -------------------------------------------------------------------------------\n(Thousands of dollars, Gross Operating Net Earnings except per share data) Sales Margin Income* Income (Loss) Per (Loss)** Share** ------------------------------------------------------------------------------- Year Ended - December 31, 1994\nFirst Quarter $122,044 $ 26,506 $ 1,418 $ 183 $ .02 Second Quarter 130,896 26,916 1,937 516 .05 Third Quarter 145,562 30,861 4,218 2,128 .19 Fourth Quarter 136,677 28,915 1,501 (774) (.07) -------- -------- ------- ------ ------ Total $535,179 $113,198 $ 9,074 $2,053 $ .18 ======== ======== ======= ====== ======\nYear Ended - December 31, 1993 First Quarter $125,485 $ 28,554 $ 3,146 $ (95) $ (.01) Second Quarter 127,101 28,624 3,496 1,420 .13 Third Quarter 135,746 31,862 6,236 2,920 .26 Fourth Quarter 120,903 27,234 1,683 (1,755) (.16) -------- -------- ------- ------ ------ Total $509,235 $116,274 $14,561 $2,490 $ .22 ======== ======== ======= ====== ======\n*Fourth quarter 1994 amounts are before Canlab transition expenses. Fourth quarter 1993 amounts are before Restructuring and other charges.\n**1993 amounts are after the cumulative effect of a first quarter accounting change for postretirement benefits. Fourth quarter 1993 amounts have been reduced by the effects of restructuring and other charges. Fourth quarter 1994 amounts have been reduced by the effects of Canlab transition expenses.\nREPORT OF INDEPENDENT AUDITORS ------------------------------ To The Shareholders of VWR Corporation:\nWe have audited the consolidated balance sheets of VWR Corporation 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 include 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 VWR Corporation 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 the consolidated financial statements (postretirement benefits), in 1993 the Company changed its method of accounting for postretirement benefits other than pensions.\nBY (SIGNATURE)\nERNST & YOUNG LLP\nPhiladelphia, Pennsylvania February 7, 1995, except for the subsequent event note as to which the date is February 27, 1995.\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 required by this item is incorporated by reference from the section captioned \"Election of Directors\" and the last paragraph of the section captioned \"Ownership of VWR Corporation Stock\" contained in the Company's definitive Proxy Statement, which the Company will have filed with the Commission pursuant to Regulation 14A within 120 days after the close of the fiscal year.\nInformation regarding executive officers of the Company is included in Part I of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. - EXECUTIVE COMPENSATION ------- ---------------------- The information required by this item is incorporated by reference from the Sections \"Fees to Directors and Committees of the Board\" and \"Executive Compensation\" contained in the Company's definitive Proxy Statement which the Company will have filed with the Commission pursuant to regulation 14A within 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 by this item is incorporated by reference from the section captioned \"Ownership of VWR Corporation Stock\" contained in the Company's definitive Proxy Statement, which the Company will have filed with the Commission pursuant to Regulation 14A within 120 days after the close of the fiscal year.\nITEM 13.","section_13":"ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ------- ---------------------------------------------- None PART IV. -------\nITEM 14.","section_14":"ITEM 14. - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K -------- ------------------------------------------------------------ (a)(1) Financial Statements\nThe following financial statements have been included as part of this report:\nForm 10-K Page --------- Consolidated Statements of Operations 18 Consolidated Balance Sheets 19 Consolidated Statements of Cash Flows 21 Consolidated Statements of Shareholders' Equity 23 Notes to Consolidated Financial Statements 26 Report of Independent Auditors 42\n(2) Financial Statement Schedules\n(a) The following financial statement schedule is submitted herewith:\n-Schedule II - Valuation and Qualifying Accounts\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and have therefore been omitted.\n(3) Exhibits Exhibit Number and Description ------------------------------\n2 Agreement and Plan of Merger between VWR Corporation and VWR New Corporation\nAgreement and Plan of Distribution between VWR Corporation and Momentum Distribution, Inc. (1)\n3 Amended and Restated Articles of Incorporation\n3.1 Amended and Restated Bylaws\n4 Amended and Restated Credit Agreement by and among VWR Corporation and its Subsidiaries and CoreStates Bank, N.A. for itself and as agent, Seattle-First National Bank, Bank of America Canada, and PNC Bank, National Association dated October 27, 1994.\nRights Agreement dated as of May 20, 1988 between VWR Corporation and The First Jersey National Bank (filed as an exhibit to the Company's registration statement in Form 8-A dated May 23, 1988, and incorporated herein by reference).\n10 Change of Control agreements between VWR Corporation and Philip Hunsucker (3)\nChange of Control agreements between VWR Corporation and Jerrold B. Harris, Walter S. Sobon, and Richard H. Serafin (1) (3)\nChange of Control agreements between VWR Corporation and Joseph A. Panozzo, Paul J. Nowak, and Richard W. Amstutz (2) (3)\nVWR Corporation Executive Bonus Plan dated January 1, 1990.(3)\nVWR Corporation Supplemental Benefits Plan dated November 1, 1990. (3)\n11 Computation of Per Share Earnings\n21 Parent and Subsidiaries of the Company\n23 Consent of Independent Auditors\n24 Power of Attorney\n27 Article 5 FDS for year ended December 31, 1994 (4)\n(1) Filed as an Exhibit to the Company's Form 10-K Report for the year ended December 31, 1991, and incorporated herein by reference.\n(2) Filed as an Exhibit to the Company's Form 10-K Report for the year ended December 31, 1992 and incorporated herein by reference.\n(3) May be deemed a management contract or compensatory plan or arrangement.\n(4) Submitted for the benefit of the SEC.\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.\nVWR CORPORATION\nDate March 27, 1995 BY (SIGNATURE)\nJerrold B. Harris, 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 the behalf of the registrant in the capacities and on the dates indicated.\nDate March 27, 1995 BY (SIGNATURE)\nWalter S. Sobon, Vice President Finance (Principal Financial and \t\t\t\t\t\t\t Accounting Officer)\nDIRECTORS James W. Bernard Richard E. Engebrecht Jerrold B. Harris Curtis P. Lindley BY (SIGNATURE) Edward A. McGrath, Jr. Donald P. Nielsen N. Stewart Rogers Jerrold B. Harris Robert S. Rogers Attorney-in-fact James H. Wiborg Power of Attorney dated February 28, 1995\nDate: March 27, 1995\nVWR CORPORATION --------------------------------\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS ----------------------------------------------- (Thousands of dollars)\nBalance at Charged to Balance Beginning Costs and at End Description of Year Expenses Deductions (1) Other of Year ----------- --------- ---------- -------------- ----- --------- Allowances for losses (deducted from trade receivables) for:\nYear Ended December 31, 1994 $259 $656 $554 $258(2) $619 === === === === ===\nYear Ended December 31, 1993 $222 $377 $340 $259 === === === ===\nYear Ended December 31, 1992 $182 $482 $442 $222 === === === ===\n(1) Uncollectible accounts written off, net of recoveries. (2) Reserves established in connection with the Canlab acquisition.\nExhibit Index -------------\nExhibit Number and Description ------------------------------\n2 Agreement and Plan of Merger between VWR Corporation and VWR New Corporation\nAgreement and Plan of Distribution between VWR Corporation and Momentum Distribution, Inc.*\n3 Amended and Restated Articles of Incorporation\n3.1 Amended and Restated Bylaws\n4 Amended and Restated Credit Agreement by and among VWR Corporation and its Subsidiaries and CoreStates Bank, N.A. for itself and as agent, Seattle-First National Bank, Bank of America Canada, and PNC Bank, National Association dated October 27, 1994.\nRights Agreement dated as of May 20, 1988 between VWR Corporation and The First Jersey National Bank (filed as an exhibit to the Company's registration statement in Form 8-A dated May 23, 1988, and incorporated herein by reference).\n10 Change of Control agreements between VWR Corporation and Philip Hunsucker\nChange of Control agreements between VWR Corporation and Jerrold B. Harris, Walter S. Sobon, and Richard H. Serafin*\nChange of Control agreements between VWR Corporation and Joseph A. Panozzo, Paul J. Nowak, and Richard W. Amstutz**\nVWR Corporation Executive Bonus Plan dated January 1, 1990*\nVWR Corporation Supplemental Benefits Plan dated November 1, 1990*\n11 Computation of Per Share Earnings\n21 Parent and Subsidiaries of the Company\n23 Consent of Independent Auditors\n24 Power of Attorney\n27 Article 5 FDS for year ended December 31, 1994\n* Filed as an Exhibit to the Company's Form 10-K Report for the year ended December 31, 1991, and incorporated herein by reference\n** Filed as an Exhibit to the Company's Form 10-K Report for the year ended December 31, 1992.","section_15":""}
{"filename":"778201_1994.txt","cik":"778201","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is involved in a number of legal and administrative proceedings arising in the ordinary course of its oil and gas business. Although the ultimate outcome of these proceedings cannot be ascertained at this time, it is reasonably possible that some of the proceedings could be resolved unfavorably to the Partnership. Management of the Company believes that any liabilities which may arise would not be material. The Company intends to maintain liability and other insurance for the Partnership of the type customary in the oil and gas business with such coverage limits as the Company deems prudent.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF UNITHOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5.MARKET FOR THE REGISTRANT'S LIMITED PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS\nThe depositary units of Sun Energy Partners, L.P. are traded on the New York Stock Exchange, Inc. The following table sets forth the high and low sales prices per unit, as reported on the New York Stock Exchange Composite Transactions quotations, for the periods indicated:\nThe Partnership had approximately 2,656 holders of record of depositary units as of February 28, 1995.\nDuring 1994 and 1993, the quarterly cash distributions per unit paid to unitholders were as follows:\nThe first quarterly cash distribution for 1995 in the amount of $.14 per unit was paid in March 1995. Future quarterly cash distributions to unitholders are expected to be paid on or about the 10th day of March, June, September and December in each year. (See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Cash Distribution Policy.\")\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\nManagement's discussion and analysis of the Partnership's financial position and results of operations follows. This discussion should be read in conjunction with the Consolidated Financial Statements and Selected Financial Data included in this report.\nBUSINESS CLIMATE\nThe fundamentals in worldwide oil markets continue to reflect an excess of supply over demand. Following very depressed price levels in early 1994, prices improved as a result of OPEC's general adherence to announced quotas. Crude prices continue to be impacted by the overhang of Iraq oil production as well as increases in non-OPEC production. The Partnership's realized oil price in 1994\nfell by $1.27 per barrel, or 8 percent less than the 1993 price. The decline in 1994 followed a 14 percent decline in the Partnership's realized oil price in 1993 compared to 1992. Prices in early 1995 approximate the levels realized in the fourth quarter of 1994.\nAs a result of unseasonable weather, natural gas supplies have exceeded demand causing higher storage levels and depressed prices. The Partnership's realized gas price in 1994 was $1.87 per mcf or 5 percent lower than the $1.96 per mcf realized in 1993. Natural gas prices remain depressed in early 1995.\nThe Partnership produced 50 million equivalent barrels of crude oil and natural gas in 1994, 35 percent crude oil and 65 percent natural gas. Production in 1995 is expected to be to approximately 44 million equivalent barrels of crude oil and natural gas, depending on the timing of any asset sales.\nRESULTS OF OPERATIONS\nThe Partnership's income in 1994, excluding the cumulative effect of an accounting change, was $100 million, or $.24 per unit, as compared to net income of $44 million, or $.11 per unit, in 1993 and net income of $120 million, or $.29 per unit in 1992. (See Note 7 to the Consolidated Financial Statements.)\nHigher income, before the cumulative effect of the accounting change, in 1994 as compared to 1993 was caused primarily by lower depreciation, depletion and amortization expense and lower general and administrative expense offset by lower crude oil production volumes and lower prices for both crude oil and natural gas. Additionally, net income in 1993 included $7 million in losses from the sale of assets while no gains or losses were included in net income in 1994. Depreciation, depletion and amortization expense declined by $93 million or 36 percent primarily because of the accounting change effective at the beginning of 1994 which decreased the Partnership's producing property balance by $577 million. (See Note 7 to the Consolidated Financial Statements.) General and administrative expense decreased by $15 million or 22 percent primarily because of fewer employees of the Company which decreased the Company's charge to the Partnership. Total costs and expenses decreased $119 million or 19 percent to $513 million in 1994 from $632 million in 1993.\nLower net income in 1993 as compared to 1992 was caused by lower production volumes and a lower average oil price partially offset by a higher average price for gas and lower costs and expenses. Additionally, results for 1992 include $115 million in gains from the sale of assets while results for 1993 include $7 million in losses from asset disposals. Oil volumes were 13 percent lower and gas volumes were 11 percent lower in 1993 resulting from divestments of producing properties in 1992. Total costs and expenses decreased $185 million or 23 percent to $632 million in 1993 from $817 million in 1992.\nAverage net production of oil in 1994 was 47 thousand barrels daily, or 15 percent lower than the average net production in 1993 of 55 thousand barrels daily. The average price received for the Partnership's oil production in 1994 was $14.69 per barrel, representing an 8 percent decrease from the 1993 average price of $15.96.\nAverage net production of oil in 1993 was 55 thousand barrels daily, or 13 percent lower than the average net production in 1992 of 63 thousand barrels daily. The average price received for the Partnership's oil production in 1993 was $15.96 per barrel, representing a 14 percent decrease from the 1992 average price of $18.51.\nAverage net production of gas in 1994 was 533 million cubic feet daily, or 3 percent higher than average net production for 1993 of 517 million cubic feet daily. The Partnership received an average price of $1.87 per thousand cubic feet for its gas production in 1994 compared to an average price of $1.96 per thousand cubic feet in 1993, representing a 5 percent decrease.\nAverage net production of gas in 1993 was 517 million cubic feet daily, or 11 percent lower than average net production for 1992 of 578 million cubic feet daily. The Partnership received an average price of $1.96 per thousand cubic feet for its gas production in 1993 compared to an average price of $1.72 per thousand cubic feet in 1992, representing a 14 percent increase.\nLIQUIDITY AND CAPITAL RESOURCES\nIn 1992, cash flow from operating activities decreased $208 million compared to 1991 primarily due to lower sales volumes and oil prices, and reductions in current liabilities, offset in part by an increase in gas prices and reductions in costs and expenses. Cash flow provided from investing activities declined by $28 million, reflecting a $258 million decrease in proceeds from divestments, partially offset by a $206 million decrease in capital expenditures. Cash flow used for financing activities decreased by $445 million in 1992, principally reflective of declines of $361 million and $175 million in cash used for repayments of long-term debt and cash distributions paid to unitholders, offset in part by a $101 million decrease in cash flow provided from the sale of limited partnership units.\nIn 1993, cash flow from operating activities increased $68 million from 1992 primarily due to favorable increases in cash from working capital components, a higher average price for gas and lower costs and expenses partially offset by lower production volumes and a lower average price for oil. Cash flow from investing activities used $148 million in 1993 compared to providing $252 million in 1992. Proceeds from divestments were $298 million lower in 1993 while capital expenditures increased by $99 million. Cash flow used for financing activities decreased by $305 million in 1993 primarily because of the repayment of $239 million in long-term debt in 1992 compared to repayment of $19 million in 1993.\nIn 1994, cash flow from operating activities decreased $129 million compared to 1993 primarily due to lower oil volumes, lower average prices for oil and gas and unfavorable decreases in cash flow working capital components. Cash flow from investing activities used $136 million in 1994 compared to a use of $148 million in 1993. Capital expenditures were $33 million lower and proceeds from divestments were $17 million lower in 1994. Cash flow from financing activities used $128 million in 1994 compared to a use of $284 million in 1993. Cash distributions paid to unitholders were $226 million lower in 1994 than 1993 and 1993 included $70 million of cash flow from the sale of limited partnership units. No such sale occurred in 1994.\nIn the fourth quarter of 1993, the Company's Board of Directors elected to change its investment policy concerning ownership of the Partnership. Effective in 1994, the policy of distributing all cash to unitholders and then selling newly issued Partnership units to the Company to fund capital outlays was changed. The Partnership now funds its capital outlays from internally generated funds and makes distributions of only that cash remaining after such outlays.\nThe Partnership's spending levels will be governed by its cash flow from operating activities which will continue to be affected by prevailing oil and gas prices, cost levels and production volumes. Any shortfall in expected cash flow from operating activities may require adjustment of the business plans. Options include deferral of discretionary ED&A outlays and the sale of Partnership units. The Partnership's long-term cash generation capability is ultimately tied to the value of proved reserves.\nRESERVE REPLACEMENT\nThe ability to sustain cash flow is dependent, among other things, on the level of the Partnership's oil and gas reserves, oil and gas prices and cost containment. Replacement of proved reserves through extensions and discoveries, improved recovery, purchases and revisions to prior reserve estimates in 1994 was 35 percent of liquids production and 109 percent of gas production. Reserve replacement rates of liquids and gas were 74 and 93 percent in 1993 and 17 and 68 percent in 1992.\nHEDGING ARRANGEMENTS\nThe Partnership, from time to time, enters into hedging arrangements for oil and natural gas prices. The Partnership has entered into swaps for approximately 26 percent of its estimated 1995\ncrude oil production under agreements with an average price of $18.24 per barrel. An additional 14 percent is under call option agreements at an average price ceiling of $18.56 per barrel. Approximately 44 percent of its estimated 1995 gas production is under swap agreements with an average price of $1.88 per mmbtu. The Partnership's hedging activities increased oil and gas revenue by $3 million in 1994 and decreased oil and gas revenue by $17 million in 1993. (See Note 2 to the Consolidated Financial Statements.)\nENVIRONMENTAL\nThe Partnership's oil and gas operations are subject to stringent environmental regulations. The Company is dedicated to the preservation of the environment and has committed significant resources to comply with such regulations. Although the Partnership has been named as a potentially responsible party at sites related to past operations, the Company believes the Partnership is in general compliance with applicable governmental regulations and that the potential costs to it, in the aggregate, are not material to its financial condition. However, risks of substantial costs and liabilities are inherent in the oil and gas business. Should other developments occur, such as increasingly strict environmental laws, regulations and enforcement policies or claims for damages resulting from the Partnership's operations, they could result in additional costs and liabilities in the future. (See Note 14 to the Consolidated Financial Statements.)\nCASH DISTRIBUTION POLICY\nIn the fourth quarter of 1993, the Company's Board of Directors elected to change the Company's investment policy concerning purchase of additional Partnership units. Effective in 1994, the Company no longer routinely purchases newly issued Partnership units to fund capital outlays. The Partnership now funds its capital outlays from internally generated funds and make distributions of only that cash remaining after such outlays. The newly adopted policy reduced the cash paid to unitholders in 1994 and will reduce the cash paid to unitholders in the future, but will also end the ownership dilution caused by the issuance of additional units.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL AND OPERATING INFORMATION\nSUN ENERGY PARTNERS, L.P. REPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Sun Energy Partners, L.P. and the Board of Directors of Oryx Energy Company:\nWe have audited the accompanying consolidated balance sheets of Sun Energy Partners, L.P. and its 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. These financial statements are the responsibility of Oryx Energy 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 Sun Energy Partners, L.P. and its 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 7 to the Consolidated Financial Statements, the Partnership changed its accounting policy for calculating the oil and gas ceiling test in 1994.\nCOOPERS & LYBRAND L.L.P.\nDallas, Texas February 19, 1995\nSUN ENERGY PARTNERS, L.P CONSOLIDATED STATEMENTS OF INCOME (MILLIONS OF DOLLARS, EXCEPT PER UNIT AMOUNTS)\n(See Accompanying Notes)\nSUN ENERGY PARTNERS, L.P. CONSOLIDATED BALANCE SHEETS (MILLIONS OF DOLLARS)\nASSETS\n(See Accompanying Notes)\nSUN ENERGY PARTNERS, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS (MILLIONS OF DOLLARS)\n(See Accompanying Notes)\nSUN ENERGY PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nORGANIZATION AND CONTROL\nSun Energy Partners, L.P. (Sun Energy Partners), a Delaware limited partnership, was formed on October 1, 1985 and prior to December 1, 1985 had no operations and nominal assets and equity. Effective as of December 1, 1985, Sun Energy Partners succeeded to all the domestic oil and gas operations of Oryx Energy Company and certain of its affiliates (collectively, the Company). These operations consist of the exploration for and development of oil and natural gas reserves in the United States.\nSun Energy Partners is controlled by the Company, which is the managing general partner. As of December 31, 1994, the Company had a partnership interest of 98 percent in Sun Energy Partners. The remaining two percent limited partnership interest is held by public unitholders in the form of depositary units. Eighty-five percent of the Company's Board of Directors must approve any additional issuance, sale or transfer of units which would reduce the Company's holdings in Sun Energy Partners below eighty-five percent.\nSun Energy Partners operates through Sun Operating Limited Partnership, a Delaware limited partnership, and several other operating partnerships (collectively, the Operating Partnerships). In all of the partnerships which comprise the Operating Partnerships, Sun Energy Partners holds a 99 percent interest as the sole limited partner, while the Company holds a one percent interest as the managing general partner.\nSun Energy Partners and the Operating Partnerships (collectively, the Partnership) have no officers or employees. The officers and employees of the Company perform all management functions.\nBASIS OF PRESENTATION\nThe Partnership's consolidated financial statements have been prepared using the proportionate method of consolidation for Sun Energy Partners and its 99 percent interest in the Operating Partnerships. Such financial statements are prepared in accordance with generally accepted accounting principles which is different from the basis used for reporting taxable income or loss to unitholders.\nCASH EQUIVALENTS\nThe Partnership considers highly liquid investments with original maturities of less than three months to be cash equivalents. Cash equivalents are stated at cost which approximates market value.\nPROPERTIES, PLANTS AND EQUIPMENT\nThe successful efforts method of accounting is followed for costs incurred in oil and gas operations.\nCAPITALIZATION POLICY. Acquisition costs are capitalized when incurred. Costs of unproved properties are transferred to proved properties when proved reserves are found. Exploration costs, including geological and geophysical costs and costs of carrying and retaining unproved properties, are charged against income as incurred. Exploratory drilling costs are capitalized initially; however, if it is determined that an exploratory well does not contain proved reserves, such capitalized costs are charged to expense, as dry hole costs, at that time. Development costs are capitalized. Costs incurred to operate and maintain wells and equipment are expensed.\nLEASEHOLD IMPAIRMENT AND DEPRECIATION, DEPLETION AND AMORTIZATION. Periodic valuation provisions for impairment of capitalized costs of unproved properties are expensed. The acquisition costs of proved properties are depleted by the unit-of-production method based on proved reserves by field.\nSUN ENERGY PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Capitalized exploratory drilling costs which result in the discovery of proved reserves and development costs are amortized by the unit-of-production method based on proved developed reserves by field.\nCEILING TEST. The Partnership periodically compares the estimated undiscounted future cash flows of its proved reserves to their net book values, using current realized prices and costs held constant. Effective January 1, 1994, the Partnership changed its policy for performing ceiling test comparisons to a field-by-field basis (Note 7). Prior to 1994, the Partnership performed its ceiling test comparisons on a total partnership basis. The Partnership impairs the net book value of its proved properties to the extent that net book values exceed the estimated undiscounted future cash flows.\nDISMANTLEMENT, RESTORATION AND ABANDONMENT COSTS. Estimated costs of future dismantlement, restoration and abandonment are accrued as a component of depreciation, depletion and amortization expense; actual costs are charged to the accrual.\nRETIREMENTS. Gains and losses on the disposals of fixed assets are generally reflected in income. For certain property groups, the cost less salvage value of property sold or abandoned is charged to accumulated depreciation, depletion and amortization except that gains and losses for these groups are taken into income for unusual retirements or retirements involving an entire property group.\nINVESTMENT IN AFFILIATE\nEffective in 1988, the Company issued three million shares of its $1 par value common stock to an operating partnership of the Partnership in exchange for certain assets. These shares are not entitled to vote at the Company's annual meetings of shareholders. The Partnership accounts for this investment under the cost method, whereby investment income is recognized by the Partnership if and when common dividends are received from the Company. In January 1994, Oryx Energy Company suspended the payment of quarterly dividends to holders of its common stock.\nCAPITALIZED INTEREST\nThe Partnership capitalizes interest costs incurred as a result of the acquisition and installation of significant assets.\nINCOME TAXES\nThe Operating Partnerships and Sun Energy Partners are treated as partnerships for income tax purposes and, as a result, income or loss of the Partnership is includable in the tax returns of the individual unitholders. Accordingly, no recognition has been given to income taxes in the financial statements.\nAt December 31, 1994, 1993 and 1992, the Partnership's financial reporting bases of assets and liabilities exceeded the tax bases of its assets and liabilities (net temporary differences) by $544 million, $1,049 million and $1,077 million.\nCASH FLOWS\nFor purposes of reporting cash flows, cash and cash equivalents includes cash, highly liquid investments with remaining maturities of less than three months (see \"Cash Equivalents\", above) and advances to affiliate.\nInterest paid totaled $17 million, $13 million and $45 million in 1994, 1993 and 1992.\nSUN ENERGY PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) During 1994, the Partnership exchanged its interest in an undeveloped block in the Gulf of Mexico for a royalty interest in Viosca Knoll 826. This transaction was accounted for by the Partnership as a non-cash property exchange. In accordance with Statement of Financial Accounting Standards No. 95, \"Statement of Cash Flows,\" non-cash transactions are not reflected within the accompanying Consolidated Statements of Cash Flows.\nSALES OF OIL AND GAS\nSales of oil and gas are recorded on the entitlement method. Differences between actual production and entitlements result in a receivable when underproduction occurs and a payable when overproduction occurs.\nDuring 1994, sales of oil to the Partnership's top purchaser totaled approximately 8 percent of oil revenue. During 1993, sales of oil to the Partnership's top purchasers totaled approximately 21 and 16 percent. During 1994 and 1993, no individual customer accounted for more than 5 percent of the Partnership's gas sales. The Partnership believes that the loss of any major purchaser would not have a material adverse effect on its business.\nOIL AND GAS PRICE HEDGING ACTIVITY\nThe Partnership, from time to time, enters into futures contracts to hedge the impact of price fluctuations on anticipated crude oil and natural gas sales. Advance payments under such contracts are deferred and charged to oil and gas revenue during the anticipated sales periods. The differentials paid or received during the terms of such agreements are accrued as oil and gas prices change and are charged or credited to oil and gas sales (Note 2).\nENVIRONMENTAL COSTS\nThe Partnership establishes reserves for environmental liabilities as such liabilities are incurred (Note 14).\nSTATEMENT PRESENTATION\nCertain items in years prior to 1994 have been reclassified to conform to the 1994 presentation.\n2) FINANCIAL INSTRUMENTS\nDERIVATIVES\nAs discussed in Note 1, the Partnership enters into hedging arrangements for crude oil and natural gas prices with major financial institutions. The Partnership does not enter into derivative transactions for trading purposes.\nAt December 31, 1994, the Partnership was a party to crude oil and natural gas hedging contracts to hedge about 11 percent of its estimated 1995 crude oil production at $17.80 per barrel and 40 percent of its estimated 1995 natural gas production at $1.95 per mmbtu. At December 31, 1993, the Partnership was a party to natural gas hedging contracts to hedge about 30 percent of its 1994 natural gas production at an average floor of $2.04 per mmbtu and an average ceiling of $2.28 per mmbtu. These arrangements serve to reduce the volatility associated with prices of crude oil and natural gas. The aggregate carrying values of these assets at December 31, 1994 and 1993 were nil, and the aggregate fair values, based on quotes from brokers, were approximately $13 million and $4 million.\nThe above mentioned derivative contracts expose the Partnership to credit risks. The Partnership has established controls to manage this risk and closely monitors the creditworthiness of its counterparties which are major financial institutions. The Partnership believes that losses from nonperformance are unlikely to occur.\nSUN ENERGY PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2) FINANCIAL INSTRUMENTS (CONTINUED) OTHER FINANCIAL INSTRUMENTS\nAt December 31, 1994 and 1993, the carrying values of the Partnership's long-term debt, including amounts due within one year, were $86 million and $100 million (Note 10). At December 31, 1994 and 1993, the aggregate fair values of the Partnership's long-term debt were approximately $93 million and $153 million, estimated primarily based on current rates available to the Partnership for debt of the same remaining maturities.\n3) RELATED PARTY TRANSACTIONS\nADVANCES TO\/FROM AFFILIATE\nThe Company has served as the Partnership's lender and borrower of funds and a clearing-house for the settlement of intercompany receivables and payables. Deposits earn interest at a rate equal to the rate paid by a major money market fund. Demand loans bear interest at a rate based on the prime rate.\nLONG-TERM DEBT DUE AFFILIATE\nThe Partnership is indebted to the Company under a 9.75% note due 1995-2001. In 1992 the Partnership prepaid $213 million of such debt from proceeds of asset sales.\nDIRECT AND INDIRECT COSTS\nThe Company is reimbursed by the Partnership for all direct costs incurred in performing management functions and indirect costs (including payroll and payroll related costs and the cost of postemployment benefits and management incentive plans) allocable to the Partnership. The full cost of direct and indirect costs incurred on behalf of the Partnership by the Company is allocated to the Partnership based on services rendered and extent of use. Such costs, which are charged principally to production cost, exploration cost and general and administrative expense, totaled $73 million, $104 million and $127 million for the years 1994, 1993 and 1992. The Company does not receive any carried interests, promotions, back-ins or other similar compensation as the general partner of the Partnership.\nINTEREST INCOME\nInterest income received from the Company, which is reflected in other revenues in the consolidated statements of income, was earned on advances to the Company and totaled $3 million, $5 million and $9 million during the years 1994, 1993 and 1992.\nINTEREST COST\nInterest cost paid to the Company, which is included in interest and debt expense in the consolidated statements of income, was primarily incurred on long-term debt due the Company and totaled $16 million, $12 million and $43 million during the years 1994, 1993 and 1992 (Note 10).\n4) CHANGES IN BUSINESS In 1991, the Company commenced a major restructuring program (Restructuring) to reduce the Company's and Partnership's cost structures. The program outlined a plan to sell substantially all of the Partnership's gas plant business (Note 5) and certain onshore producing oil and gas properties.\nAssociated with the Restructuring, the Partnership recognized a $62 million provision for the early relinquishment of certain non-producing properties in 1992. At December 31, 1994, the asset disposals were complete.\nIn the first quarter of 1994, the Partnership recognized an $84 million restructuring charge. This provision was revised to zero because of the accounting change (Note 7).\nSUN ENERGY PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n5) OTHER REVENUES -- NET The components of other revenues were as follows:\n6) PRODUCTION TAXES Production taxes consisted of the following:\n7) ACCOUNTING CHANGE Effective January 1, 1994, the Partnership changed its accounting policy for calculating the oil and gas asset ceiling test from a total Partnership basis to an individual field basis. The Partnership believes the field basis is preferable because it is the way the Partnership manages its business. The basis underlying the calculation of the cumulative effect of this change is a comparison of the undiscounted cash flows of each field's then existing proved reserves to its net book value at each quarter-end during the life of the asset. This subjects the ceiling test valuation to the lowest quarter-end price experienced over the asset's life. As a result of this change, the Partnership recognized a non-cash cumulative effect charge of $577 million to 1994 results. Excluding the cumulative charge, the Partnership's income for 1994 was $100 million ($.24 per unit). On a pro forma basis, the Partnership reported net earnings for 1993 and 1992 would have been a net loss of $198 million ($.47 per unit) and net earnings of $63 million ($.15 per unit) if this accounting change had been enacted prior to 1992.\nSUN ENERGY PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8) PROPERTIES, PLANTS AND EQUIPMENT At December 31, the Partnership's properties, plants and equipment and accumulated depreciation, depletion and amortization were as follows:\n9) ACCRUED LIABILITIES At December 31, the Partnership's accrued liabilities were comprised of the following:\n10) LONG-TERM DEBT At December 31, the Partnership's long-term debt consisted of the following:\nUnder the Partnership's existing capitalized lease obligation, the Partnership is obligated to make an annual payment of $2 million in each of the years 1995 and 1996.\nSUN ENERGY PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n10) LONG-TERM DEBT (CONTINUED) Repayment obligations under the Partnership's long-term debt due affiliate are $10 million, $11 million, $12 million, $13 million and $14 million in 1995, 1996, 1997, 1998 and 1999.\n11) COMMITMENTS AND CONTINGENT LIABILITIES The Partnership has operating leases for office space and other property and equipment. Total rental expense for such leases for the years 1994, 1993 and 1992 was $33 million, $28 million and $28 million. Under contracts existing as of December 31, 1994, future minimum annual rentals applicable to noncancellable operating leases that have initial or remaining lease terms in excess of one year were as follows (in millions of dollars):\nSeveral legal and administrative proceedings are pending against the Partnership. Although the ultimate outcome of these proceedings cannot be ascertained at this time, and it is reasonably possible that some of them could be resolved unfavorably to the Partnership, management believes that any liabilities which may arise would not be material.\n12) PARTNERS' CAPITAL\n13) CASH DISTRIBUTIONS Beginning with the fourth quarter 1993, Distributable Cash was reduced by the cash needed for capital outlays. This policy change reduced the cash paid to unitholders but ended the ongoing ownership dilution faced by unitholders due to Oryx Energy's purchases of newly issued partnership units to fund Sun Energy's capital outlays. Distributable Cash is defined as revenues (including interest income) less production cost; seismic, geological and geophysical costs (including related costs); payments of principal of and interest on debt; general and administrative expenses including\nSUN ENERGY PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n13) CASH DISTRIBUTIONS (CONTINUED) reimbursements of the Company as managing general partner; adjustments for capital expenditures (net of proceeds from divestments); and cash exploration costs. No deduction is made for depreciation, depletion and amortization, for property acquisition, and development expenditures.\nSun Energy Partners' quarterly cash distributions per unit for the years 1994, 1993 and 1992 were as follows:\n14) DEFERRED CREDITS AND OTHER LIABILITIES At December 31, the Partnership's deferred credits and other liabilities were comprised of the following:\nEnvironmental cleanup costs have been accrued in response to the identification of several sites that require cleanup based on environmental pollution, some of which have been designated as superfund sites by the Environmental Protection Agency (EPA). The Partnership has been named as a Potentially Responsible Party (PRP) at four sites pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended. At two of these sites, the Partnership has been named as a de minimis party and therefore expects its liability to be small. At a third site, the Partnership is reviewing its options and anticipates that it will participate in steering committee activities with the Environmental Protection Agency. At the fourth and largest site, the Operating Industries, Inc. site in California, the Partnership has participated in a steering committee consisting of 139 companies. The steering committee and other PRP's previously entered into two partial consent decrees with the EPA providing for remedial actions which have been or are to be completed. The steering committee has successfully negotiated a third partial consent decree which provides for the following remedial actions: a clay cover, methane capturing wells, and leachate destruction facilities. The remaining work at the site involves groundwater evaluation and long-term operation and maintenance. The Partnership is a member of the group that is responsible for carrying out the first phase of the work, which is expected to take 5 to 8 years. Completion of all phases is estimated to take up to 30 years. The maximum liability of the group, which is joint and several for each member of the group, is expected to range from approximately $450 million to $600 million, of which the Partnership's share is expected to be approximately $10 million (net of $3 million in recoveries from third parties). Cleanup costs are payable over the period that the work is completed.\nBased on the facts outlined above and the Partnership's ongoing analyses of the actions where it has been identified as a PRP, the Partnership believes that it has accrued sufficient reserves to absorb the ultimate cost of such actions and that such costs therefore will not have a material impact on the Partnership's liquidity, capital resources or financial condition. While liability at superfund sites is typically joint and several, the Partnership has no reason to believe that defaults by other PRPs will result in liability of the Partnership materially larger than expected.\nSUN ENERGY PARTNERS, L.P. SUPPLEMENTARY FINANCIAL AND OPERATING INFORMATION (UNAUDITED)\nOIL AND GAS DATA CAPITALIZED COSTS\nCOSTS INCURRED IN OIL AND GAS PRODUCING ACTIVITIES\nEXPLORATION COSTS\nESTIMATED NET QUANTITIES OF PROVED OIL AND GAS RESERVES\nProved reserve quantities were based on estimates prepared by Company engineers in accordance with guidelines established by the Securities and Exchange Commission and were reviewed by Gaffney, Cline & Associates, Inc., independent petroleum engineers. The Partnership considers such estimates to be reasonable; however, due to inherent uncertainties and the limited nature of reservoir data, estimates of underground reserves are imprecise and subject to change over time as additional information becomes available.\nSUN ENERGY PARTNERS, L.P.\nThere has been no major discovery or other favorable or adverse event that has caused a significant change in estimated proved reserves since December 31, 1994. The Partnership has no long-term supply agreements or contracts with governments or authorities in which it acts as producer nor does it have any interest in oil and gas operations accounted for by the equity method. All reserves are located onshore and offshore within the United States.\nSUN ENERGY PARTNERS, L.P.\nSTANDARDIZED MEASURE\nThe standardized measure of discounted future net cash flows from estimated production of proved oil and gas reserves is presented in accordance with the provisions of Statement of Financial Accounting Standards No. 69, \"Disclosures about Oil and Gas Producing Activities\" (SFAS No. 69). In computing this data, assumptions other than those mandated by SFAS No. 69 could produce substantially different results. The Partnership cautions against viewing this information as a forecast of future economic conditions or revenues.\nThe standardized measure has been prepared assuming year-end selling prices adjusted for future fixed and determinable contractual price changes, year-end development, production and direct general and administrative costs and a ten percent annual discount rate. No future income tax expense has been provided for the Partnership since it incurs no income tax liability. (See Summary of Significant Accounting Policies Income Taxes in the Notes to Consolidated Financial Statements.) The year-end realized prices were $15.30 and $11.58 per barrel of oil and $1.75 and $1.91 per mcf of gas for 1994 and 1993.\nSUMMARY OF CHANGES IN THE STANDARDIZED MEASURE\nSUN ENERGY PARTNERS, L.P.\nQUARTERLY FINANCIAL INFORMATION\nSUN ENERGY PARTNERS, L.P.\nQUARTERLY OPERATING INFORMATION\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 employees. The Company, as the managing general partner of the Partnership, has the responsibility for the Partnership's conduct of operations. Set forth below is information concerning the ten current directors of the Company and the nine current executive officers of the Company (three of which are also directors). All elected executive officers of the Company are elected annually by the Board of Directors of the Company. The directors are divided into three classes with approximately one-third of the directors constituting the Board being elected each year to serve a three-year term. Class I directors (whose term expires in 1995) are Mr. Gill, Mr. Hollingsworth and Mr. Pistor. Class II directors (whose term expires in 1996) are Mr. Keiser, Mr. Seegers and Mr. White-Thomson. Class III directors (whose term expires in 1997) are Mr. Box, Mr. Bradford and Mr. Moneypenny.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe directors, officers, and employees of the Company (the managing general partner) receive no direct compensation from the Partnership for their services to the Partnership. Such persons receive compensation from the Company, a substantial portion of which is generally reimbursed to the Company by the Partnership as costs allocable to it. (See Note 2 to the Consolidated Financial Statements.)\nThe Partnership reimburses the Company for all direct costs and indirect costs associated with the Partnership's activities. For the year 1994, the Company received $73 million as reimbursement of costs allocable to the Partnership. Such amounts included salaries of employees and allocations of certain executive and administrative expenses. The aggregate amount reimbursed by the Partnership to the Company for salaries paid to each person serving as Chief Executive Officer of the Company during 1994 and each of the four most highly compensated executive officers of the Company during 1994 other than the Chief Executive Officer was approximately $1,330,000 for 1994. (See Note 3 to the Consolidated Financial Statements.)\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table provides certain information regarding beneficial ownership of the limited partnership units of Sun Energy Partners, L.P. as of December 31, 1994.\nUNITS OF SUN ENERGY PARTNERS, L.P.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn its capacity as managing general partner of the Partnership, the Company controls the Partnership and its operations, and has served as a lender and borrower of funds for the Partnership. Following is a table which summarizes lending activities between the Partnership and the Company during the year ended December 31, 1994:\nDuring 1994, the largest balance owed to the Partnership by the Company for variable rate advances was $14 million. The largest balance owed to the Company by the Partnership during 1994 resulting from advances from Oryx Energy Company and amounts due under the 9.75% Note Payable was $137 million. Certain information required by this section is included in Notes to the Consolidated Financial Statements. See Notes 1, 3 and 10 included elsewhere in 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 a part of this report:\n1. Financial Statements:\nSee Index to Financial Statements, Supplementary Financial and Operating Information on page 12.\n2. Exhibits:\n(b) Reports on Form 8-K:\nThe Partnership did not file any 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.\nSUN ENERGY PARTNERS, L.P.\nBy: ORYX ENERGY COMPANY (MANAGING GENERAL PARTNER)\n*By: \/s\/ EDWARD W. MONEYPENNY\n----------------------------------- Edward W. Moneypenny EXECUTIVE VICE PRESIDENT, FINANCE, CHIEF FINANCIAL OFFICER AND DIRECTOR Date March 22, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by or on behalf of the following persons on behalf of the Registrant and in the capacities with Oryx Energy Company, Managing General Partner, and on the date indicated:\nSIGNATURE TITLE DATE ----------------------------------- ------------------------- ---------------- JERRY W. BOX** Executive Vice President, ----------------------------------- Exploration and Jerry W. Box Production, and Director\nWILLIAM E. BRADFORD** Director ----------------------------------- William E. Bradford\nROBERT B. GILL** Director ----------------------------------- Robert B. Gill\nDAVID S. HOLLINGSWORTH** Director ----------------------------------- David S. Hollingsworth\nROBERT L. KEISER** Chairman of the Board, ----------------------------------- Chief Robert L. Keiser Executive Officer, and President (principal executive officer) March 22, 1995\n\/s\/ EDWARD W. MONEYPENNY Executive Vice President, ----------------------------------- Finance, Chief Edward W. Moneypenny Financial Officer (principal financial officer), and Director\nCHARLES H. PISTOR, JR.** Director ----------------------------------- Charles H. Pistor, Jr.\nPAUL R. SEEGERS** Director ----------------------------------- Paul R. Seegers\nIAN L. WHITE-THOMSON** Director ----------------------------------- Ian L. White-Thomson\n**By: \/s\/ EDWARD W. MONEYPENNY ----------------------------------- Edward W. Moneypenny ATTORNEY-IN-FACT\n------------------------ *Attorney-in-Fact pursuant to Resolution of the Board of Directors of the Managing General Partner which is being filed as an Exhibit to this Form 10-K.\n**Original powers of attorney authorizing Robert L. Keiser and Edward W. Moneypenny or any one of them, to sign this Form 10-K Annual Report on behalf of Sun Energy Partners, L.P., is being filed as an Exhibit to this Form 10-K.","section_15":""}
{"filename":"914164_1994.txt","cik":"914164","year":"1994","section_1":"Item 1. Business\nUnless the context otherwise requires, the term \"Company\" refers to Canandaigua Wine Company, Inc. and its subsidiaries, all references to \"net sales\" refer to gross revenues less excise taxes and returns and allowances to conform with the Company's method of classification, and all references to the Company's fiscal year shall refer to the year ended August 31 of the indicated year. Market share and industry data disclosed in this Report have been obtained from the following industry publications: Wines & Vines; The Gomberg-Fredrikson Report; Jobson's Liquor Handbook; Jobson's Wine Handbook; The U.S. Wine Market: Impact Databank Review and Forecast, 1994 Edition; The U.S. Beer Market: Impact Databank Review and Forecast, 1994 Edition; Beer Marketer's Insights: 1994 Import Insights; and 1994 Beer Industry Update. The Company has not independently verified this data. References to market share data are based on unit volume.\nThe Company is a Delaware corporation organized in 1972 as the successor to a business founded in 1945 by Marvin Sands, Chairman of the Board of the Company.\nThe Company is a leading producer and marketer of branded beverage alcohol products, with over 125 national and regional brands which are distributed by over 1,000 wholesalers throughout the United States and in selected international markets. The Company is the second largest supplier of wines, the fourth largest importer of beers and the eighth largest supplier of distilled spirits in the United States. The Company's beverage alcohol brands are marketed in five general categories: table wines, sparkling wines, dessert wines, imported beer and distilled spirits, and include the following principal brands:\n. Table Wines: Almaden, Inglenook, Paul Masson, Taylor California Cellars, Cribari, Manischewitz, Taylor New York, Marcus James, Deer Valley and Dunnewood\n. Sparkling Wines: Cook's, J. Roget, Great Western and Taylor New York\n. Dessert Wines: Richards Wild Irish Rose, Cisco, Taylor New York and Italian Swiss Colony\n. Imported Beer: Corona, St. Pauli Girl, Modelo Especial, Tsingtao and Pacifico\n. Distilled Spirits: Barton's Gin and Vodka, Ten High Bourbon Whiskey, Crystal Palace Gin and Vodka, Montezuma Tequila, Northern Light Canadian Whisky, Lauder's Scotch Whisky and Monte Alban Mezcal\nBased on available industry data, the Company believes it has a 21% share of the wine market, a 10% share of the imported beer market and a 4% share of the distilled spirits market in the United States. Within the wine market, the Company believes it has a 31% share of the non-varietal table wine market, a 10% share of the varietal table wine market, a 50% share of the dessert wine market and a 32% share of the sparkling wine\nmarket. Many of the Company's brands are leaders in their respective categories in the United States, including Corona, the second largest selling imported beer brand, Almaden and Inglenook, the fifth and sixth largest selling wine brands, Richards Wild Irish Rose, the largest selling dessert wine brand, Cook's champagne, the second largest selling sparkling wine brand, Montezuma, the second largest selling tequila brand, and Monte Alban, the largest selling mezcal brand.\nDuring the past four years, the Company has diversified its product portfolio through a series of strategic acquisitions that have resulted in an increase in the Company's net sales from $176.6 million in fiscal 1991 to $876.4 million on a pro forma basis in fiscal 1994. Through these acquisitions, the Company acquired strong market positions in growing product categories in the beverage alcohol industry, such as varietal table wine and imported beer. The Company ranks second and fourth in the varietal table wine and imported beer categories, respectively. Over the past four years, industry shipments of varietal table wine and imported beer have grown 64% and 7%, respectively. The Company has successfully integrated the acquired businesses into its existing business and achieved significant cost reductions through reduced product and organizational costs. The Company has also strengthened its relationship with wholesalers, expanded its distribution and enhanced its production capabilities as well as acquired additional management, operational, marketing and research and development expertise.\nIn October 1991, the Company acquired the Cook's, Cribari, Dunnewood and other brands and related facilities and assets (the \"Guild Acquisition\") from Guild Wineries and Distillers (\"Guild\"), which enabled the Company to establish a significant market position in the California sparkling wine category and to enter the California table wine market. The Company acquired Barton Incorporated (\"Barton\") in June 1993, further diversifying into the imported beer and distilled spirits categories (the \"Barton Acquisition\"). On October 15, 1993, the Company acquired the Paul Masson, Taylor California Cellars and other brands and related facilities and assets of Vintners International Company, Inc. (\"Vintners\") (the \"Vintners Acquisition\"). On August 5, 1994, the Company acquired the Almaden, Inglenook and other brands, a grape juice concentrate business and related facilities and assets (the \"Almaden\/Inglenook Product Lines\") from Heublein Inc. (the \"Almaden\/Inglenook Acquisition,\" and together with the Barton Acquisition and the Vintners Acquisition, the \"Acquisitions\"). See \"Recent Acquisitions.\"\nThe Company's business strategy is to continue to strengthen its market position in each of its principal product lines. Key elements of its strategy include: (i) making selective acquisitions in the beverage alcohol industry to improve market position and capitalize on growth trends within the industry; (ii) improving operating efficiencies through reduced product and organizational costs of existing and acquired businesses; (iii) capitalizing on strong wholesaler relationships resulting from its expanded portfolio of brands; and (iv) expanding distribution into new markets and increasing penetration of existing markets primarily through line extensions and promotional activities.\nIn furtherance of its business strategy of improving operating efficiencies of acquired businesses, the Company announced a plan to restructure the operations of its California wineries, including a consolidation of facilities, centralization of bottling operations and\nreduction of overhead, including the elimination of approximately 260 jobs (the \"Restructuring Plan\"). As a result of the Restructuring Plan, the Company has taken a charge in the fourth quarter of fiscal 1994 which reduced after-tax income for fiscal 1994 by $14.9 million, or $0.91 per share on a fully diluted basis. The Company anticipates that the Restructuring Plan will result in net cost savings of approximately $1.7 million in fiscal 1995 and approximately $13.3 million of annual net cost savings beginning in fiscal 1996. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nRECENT ACQUISITIONS\nThe Barton Acquisition. On June 29, 1993, the Company acquired all of the outstanding shares of capital stock of Barton. Barton is the United States' fourth largest importer of beers and eighth largest supplier of distilled spirits. The Barton Acquisition has enabled the Company to diversify within the beverage alcohol industry by participating in the imported beer and distilled spirits markets, which have similar marketing approaches and distribution channels to the Company's wine business, and to take advantage of the experienced management team that developed Barton as a successful company. With this acquisition, the Company acquired the right to distribute Corona and Modelo Especial beer in 25 primarily western states, national distribution rights for St. Pauli Girl and Tsingtao and a diversified line of distilled spirits including Barton Gin and Vodka, Ten High Bourbon Whiskey and Montezuma Tequila.\nBarton is being operated independently by its current management as a subsidiary of the Company. Until August 31, 1996, consistent with past practices and subject to annual approval by the Company's Board of Directors of an annual operating plan for the coming year, Ellis M. Goodman, the Chief Executive Officer of Barton, has full and exclusive strategic and operational responsibility for Barton and all of its subsidiaries.\nThe Vintners Acquisition. On October 15, 1993, the Company acquired substantially all of the assets of Vintners, and assumed certain liabilities. Vintners was the United States' fifth largest supplier of wine with two of the country's most highly recognized brands, Paul Masson and Taylor California Cellars. The Vintners Acquisition enabled the Company to expand its wine portfolio to include several large and highly recognized table wine brands that are distributed by a substantially common wholesaler network. Vintners' operations were immediately integrated with those of the Company at the closing of the acquisition. With this acquisition, the Company acquired the Paul Masson, Taylor California Cellars, Taylor New York, Deer Valley, St. Regis (non- alcoholic) and Great Western brands and related facilities.\nThe Almaden\/Inglenook Acquisition. On August 5, 1994, the Company acquired the Almaden and Inglenook brands, the fifth and sixth largest selling table wines in the United States, a grape juice concentrate business, and wineries in Madera and Escalon, California, from Heublein. The Company also acquired Belaire Creek Cellars, Chateau La Salle and Charles Le Franc table wines, Le Domaine champagne and Almaden, Hartley and Jacques Bonet brandy. The accounts receivable and the accounts payable related to the acquired assets were not acquired by the Company.\nAs a result of the Almaden\/Inglenook Acquisition, the Company has strengthened its position as the second largest supplier of wines in the United States. The acquisition of the Inglenook brand significantly expands the Company's restaurant and bar on-premises presence. The Company intends to maintain the existing sales force and distribution network of the Almaden and Inglenook brands. Further, the Almaden\/Inglenook Acquisition has resulted in the Company becoming the leading grape juice concentrate producer in the United States. The Company believes that the Almaden\/Inglenook Acquisition will enable the Company to achieve significant cost savings through the consolidation of its California winery operations.\nHeublein also agreed not to compete with the Company in the United States and Canada for a period of five years following the closing of the Almaden\/Inglenook Acquisition in the production and sale of grape juice concentrate or sale of packaged wines bearing the designation \"Chablis\" or \"Burgundy\" except where, among other exceptions, such designations are currently used with certain brands retained by Heublein. Certain companies acquired by Heublein, however, may compete directly with the Company.\nINDUSTRY\nThe beverage alcohol industry in the United States consists of the production, importation, marketing and distribution of beer, wine and distilled spirits products. Over the past five years there has been increasing consolidation at the supplier, wholesaler and, in some markets, retailer tiers of the beverage alcohol industry. As a result, it has become advantageous for certain suppliers to expand their portfolio of brands through acquisitions and internal development in order to take advantage of economies of scale and to increase their importance to a more limited number of wholesalers and, in some markets, retailers. From 1978 through 1993, the overall per capita consumption of beverage alcohol products in the United States has generally declined. However, table wines, and in particular varietal table wines, and imported beer consumption have increased during the period.\nThe following table sets forth the industry unit volumes for shipments of beverage alcohol products in the Company's five principal beverage alcohol product categories in the United States for the five calendar years ended December 31, 1993:\n(a) Units are in thousands of gallons. Data exclude sales of wine coolers. (b) Includes other special natural (flavored) wines under 14% alcohol. (c) Includes dessert wines, other special natural (flavored) wines over 14% alcohol and vermouth. (d) Units are in thousands of cases (2.25 gallons per case). (e) Units are in thousands of 9-liter cases (2.378 gallons per case).\nTable Wines. Wines containing 14% or less alcohol by volume are generally referred to as table wines. Within this category, table wines are further characterized as either \"non-varietal\" or \"varietal.\" Non- varietal wines include wines named after the European regions where similar types of wines were originally produced (e.g., burgundy), niche products and proprietary brands. Varietal wines are those named for the grape that comprises the principal component of the wine. Table wines that retail at less than $5.75 per 750 ml. bottle are generally considered to be popularly priced while those that retail at $5.75 or more per 750 ml. bottle are considered premium wines.\nFrom 1989 to 1993, shipments of domestic table wines increased at an average compound annual rate of approximately 1.5%. In 1992, domestic table wine shipments increased 8% from the previous year; this rate of increase was markedly larger than in previous years and was attributed in large part to the November 1991 CBS television 60 Minutes, French Paradox broadcast about the healthful benefits of moderate red wine consumption. In 1993, domestic table wine shipments declined by 2.3% when compared to 1992. This decline has been attributed to an overall wholesale and retail wine inventory surplus at the end of 1992. Based on shipments of California table wines, which constituted approximately 94% of the total domestically produced table wine market in 1993, shipments of varietal wines have grown at an average compound annual rate of 13.3% since 1989, with shipments in the first half of 1994 increasing 16% over the prior year. In contrast, shipments of non-varietal table wines have generally declined over the same period although they showed a slight increase in\n1992 as compared to 1991. For the first half of calendar 1994, shipments of California table wines increased approximately 7% over the same period in 1993. Shipments of imported table wines have generally decreased over the last six years, decreasing from 58.9 million gallons in 1989 to 52.4 million gallons in 1993. Imported table wines constituted 15% of the United States table wine market in calendar 1993.\nDessert Wines. Wines containing more than 14% alcohol by volume are generally referred to as dessert wines. Dessert wines generally fall into the same price categories as table wines. Dessert wine consumption in the United States has been declining for many years reflecting a general shift in consumer preferences to table and sparkling wines. For calendar year 1993, shipments of domestic dessert wines decreased 9.9% over calendar year 1992, a lesser rate than from 1989 to 1993, during which period shipments of domestic dessert wines declined at an average compound annual rate of 14.2%. Dessert wines, which are generally popularly priced, have been adversely affected by the January 1, 1991 increase in federal excise taxes which had the effect of increasing the cost of these products to the consumer disproportionately with certain other beverage alcohol products. Shipments of dessert wines continued to decline during the first half of calendar 1994 as compared to the first half of calendar 1993 as is evidenced by a 7% decline during this period in shipments of California dessert wines, which constituted approximately 73% of the domestically produced dessert wine market in 1993.\nSparkling Wines. Sparkling wines include effervescent wines like champagne and spumante. Sparkling wines generally fall into the same price categories as table wines. Shipments of sparkling wines declined at an average compound annual rate of 2.9% from 1989 to 1993; with shipments of domestic sparkling wines declining 0.8% in calendar 1993 as compared to calendar 1992. The decline in sparkling wine consumption is believed to reflect mounting concerns about drinking and driving, as a large part of sparkling wine consumption occurs outside the home at social gatherings and restaurants. Shipments of sparkling wines continued to decline during the first half of 1994 as compared to the first half of 1993 as is evidenced by a decline of 12% during this period in shipments of California sparkling wines which constituted approximately 92% of the domestically produced sparkling wine market in 1993. The Company believes that shipments in the first half of 1994 were also adversely affected by high levels of retail inventory at the beginning of the period.\nImported Beer. Shipments of imported beers have increased at an average compound annual rate of 1.7% from 1989 to 1993. Shipments of Mexican beers in calendar 1993 increased 10.4% over 1992. During the first half of calendar 1994 as compared to the corresponding period in 1993, shipments of Mexican beers increased 14.5% as compared to an increase of 19.3% for the entire imported beer category. In 1993, imported beers constituted 4.9% of the United States beer market. This reflects an increase from 1992 when imported beers constituted 4.4% of the United States beer market. Imported beers are generally priced above the leading domestic premium brands. This price category also includes beers produced by microbreweries and super-premium priced domestic beers.\nDistilled Spirits. Shipments of distilled spirits in the United States declined at an average compound annual rate of 1.9% from 1989 to 1993. Although shipments increased slightly in calendar 1992 as compared to calendar 1991, shipments again declined in calendar 1993 by 2.6% when\ncompared to calendar 1992. Shipments of distilled spirits have been affected by many of the same trends evident in the rest of the beverage alcohol industry. Over the past five years, whiskey sales have declined significantly while sales of rum, tequila, cordials and liqueurs have increased. The Company believes that distilled spirits can be divided into two general price segments, with distilled spirits selling for less than $7.00 a 750 ml. bottle being referred to as price value products and those selling for over $7.00 a 750 ml. bottle being referred to as premium products.\nPRODUCT CATEGORIES\nThe Company produces, imports and markets beverage alcohol products in five principal product categories: table wines, dessert wines, sparkling wines, imported beer and distilled spirits. The table below sets forth the unit volumes (in thousands of gallons) and net sales (in thousands) for all of the table, dessert and sparkling wines, grape juice concentrate and other wine related products and services sold by the Company and under brands and products acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition for the 1992, 1993 and 1994 fiscal years.\n(a) Data for fiscal years ended August 31, 1992, 1993 and 1994. The data for the Company's fiscal year ended August 31, 1994 excludes the net sales for the brands and other products acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition.\n(b) Data for fiscal years ended July 31, 1992 and 1993 and for the twelve months ended August 31, 1994.\n(c) Data for fiscal years ended September 30, 1992 and 1993 and for the twelve months ended August 31, 1994.\nTable Wines. The Company sells over 45 different brands of non- varietal table wines, substantially all of which are marketed in the popularly priced segment which constituted approximately 43% of the domestic table wine market in the United States for the 1993 calendar year. The Company also sells over 15 different brands of varietal table wines in both the popularly priced and premium categories. The table\nbelow sets forth the unit volumes (in thousands of gallons) for the domestic table wines sold by the Company and under domestic table wine brands acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition for the 1992, 1993 and 1994 fiscal years:\n(a) Excludes sales of wine coolers but includes sales of wine in bulk.\nThe Company's table wine brands include:\nAlmaden: The fifth largest selling table wine brand and the ninth largest varietal wine brand in the United States. Almaden is one of the oldest and best known table wines in the United States.\nInglenook: The sixth largest selling table wine brand and the seventh largest varietal wine in the United States with a significant restaurant and bar presence.\nPaul Masson: The 11th largest selling table wine brand in the United States which is offered in all major varietal and non-varietal product categories in a full range of sizes.\nTaylor California Cellars: The 14th largest domestic selling table wine brand in the United States which is also offered in all major varietal and non-varietal product categories in a full range of sizes.\nCribari: A well known brand of both varietal and non-varietal table wines marketed in the popularly priced segment.\nManischewitz: The largest selling brand of kosher wine in the United States.\nTaylor New York: One of the United States' oldest brands of non- varietal wine marketed primarily in the eastern half of the United States.\nRichards Wild Irish Rose: A brand of table wine possessing unique taste characteristics which is a line extension of the nation's leading dessert wine brand.\nDeer Valley: This line of California varietal and non-varietal table wines introduced in 1989 has had significant success in California. The Company is in the process of introducing this brand in other regions of the country.\nCook's: This varietal wine was created to take advantage of the brand recognition associated with Cook's sparkling wines.\nDunnewood: From California's north coast, unit volumes of this varietal wine have also increased significantly. This brand is marketed at the lower end of the premium price category.\nThe Company has pursued a strategy of increasing its unit volume sales in the table wine segment by acquiring new brands and by growing existing brands. The Company's unit volume sales of non-varietal table wines increased from approximately 9.3 million gallons in fiscal 1992 to approximately 52.6 million gallons on a pro forma basis for fiscal 1994 as a result of the Vintners Acquisition and the Almaden\/Inglenook Acquisition. Likewise, the Company's unit volume sales of varietal table wines increased from approximately 1.1 million gallons in fiscal 1992 to over 12.8 million gallons on a pro forma basis for fiscal 1994 as a result of the Vintners Acquisition and the Almaden\/Inglenook Acquisition. The Company believes that its recent acquisition of the Almaden\/Inglenook Product Lines, including the Almaden and Inglenook brands, creates additional opportunities for growth in this product category.\nThe 1993 decrease in unit volume of Vintners' table wines resulted from a number of factors including a significant decrease in Vintners' expenditures for advertising, promotion and selling activities during the three year period ended July 31, 1993. The Company believes that this decrease resulted in a reduction in the level of wholesaler attention paid to Vintners' brands, and the Company believes that certain of Vintners' products were not competitively priced. During the Company's fiscal 1994, unit volume sales of Vintners table wines continued to decline. During fiscal 1994, the Company implemented steps to address this decline, including a reduction in prices for its Taylor California brands, the implementation of new promotional programs and repackaging of selected products. As a result of these efforts, the Company believes that sales of Vintners' brands have begun to stabilize.\nThe Company also markets a selection of popularly priced imported table wines. These brands include:\nMarcus James: One of the largest selling imported varietal wines in the United States. Marcus James is a line of varietal table wines which includes white zinfandel, chardonnay, cabernet sauvignon and merlot. The Company owns the Marcus James brand and contracts for its production in Brazil.\nPartager: A popularly priced French table wine with both varietal and non-varietal products. The Company owns the Partager brand and contracts for its production in France.\nMateus: The second largest selling Portuguese table wine and a highly recognized brand name. This brand is imported by the Company under a distribution agreement.\nThe Company's unit volume sales of imported wine increased steadily from 1.3 million gallons in fiscal 1992 to 1.9 million gallons in fiscal 1994. This increase is attributable primarily to increased sales of the Marcus James brand and the inclusion of a full year of Mateus sales. Including sales of Partager by Vintners prior to its acquisition by the Company, on a pro forma basis for fiscal 1994, the Company sold approximately 2.0 million gallons of imported table wines.\nDessert Wines. The Company markets substantially all of its dessert wines in the lower end of the popularly priced segment. The popularly priced segment represented approximately 88% of the dessert wine market in calendar 1993. Sales of dessert wines comprised 10.2% of the Company's total revenues during the fiscal year ended August 31, 1994, on a pro forma basis. The table below sets forth the unit volumes (in thousands of gallons) for the domestic dessert wines sold by the Company and under domestic dessert wine brands acquired in the Vintners Acquisition for the 1992, 1993 and 1994 fiscal years:\nThe Company's dessert wines include:\nRichards Wild Irish Rose: The largest selling dessert wine brand in the United States and the Company's leading dessert wine brand in unit volume sales.\nCisco: The fourth largest selling dessert wine brand in the United States. Cisco is a flavored dessert wine positioned higher in price than Richards Wild Irish Rose.\nTaylor New York: Premium dessert wines, including port and sherry.\nThe Company's unit volume sales of dessert wines have declined over the last three years. The decline can be attributed to a general decline in dessert wine consumption in the United States. The Company's unit volume sales of its dessert wine brands (including the brands acquired from Vintners) have decreased 26.9% from fiscal 1992 to fiscal 1994.\nSparkling Wines. The Company markets substantially all of its sparkling wines in the popularly priced segment, which constituted\napproximately 48% of the domestic sparkling wine market in calendar 1993. The table below sets forth the unit volumes (in thousands of gallons) for the domestic sparkling wines sold by the Company and under domestic sparking wine brands acquired in the Vintners Acquisition and the Almaden\/Inglenook Acquisition for the 1992, 1993 and 1994 fiscal years:\nThe Company's sparkling wine brands include:\nCook's: The second largest selling domestic sparkling wine in the United States. This brand of champagne is marketed in a bell shaped bottle and is cork-finished, packaging generally associated with higher priced products.\nJ. Roget: The sixth largest selling domestic sparkling wine in the United States, priced slightly below Cook's.\nGreat Western: A premium priced champagne, fermented in the bottle.\nTaylor New York: A well known premium priced champagne also fermented in the bottle.\nCodorniu: The second largest Spanish sparkling wine imported in the United States; sold in the premium price category.\nJacques Bonet: Priced in the economy segment, this product appeals to restaurants and caterers.\nThe Company has maintained sales levels of sparkling wine over the last three years in contrast to a general industry decline in sales for this product category.\nGrape Juice Concentrate. As part of its wine business, the Company produces grape juice concentrate. Grape juice concentrate is sold to the food and wine industries as a raw material for the production of juice- based products, no-sugar-added foods and beverages. Grape juice concentrate competes with other domestically produced and imported fruit- based concentrates. As a result of the Almaden\/Inglenook Acquisition, the Company believes that it is the leading grape juice concentrate producer in the United States. Sales of grape juice concentrate accounted for approximately 11% and 12% of the Company's net sales for its fiscal years ended 1992 and 1993, respectively. The table below sets forth the unit volumes (in thousands of gallons) for the grape juice concentrate sold by the Company and the grape juice concentrate business acquired in the Almaden\/Inglenook Product Lines for the 1992, 1993 and 1994 fiscal years:\nOther Wine Product and Related Services. The Company's other wine related products and services include: grape juice; St. Regis, the leading non-alcoholic line of wines in the United States; Paul Masson and other brandies; wine coolers sold primarily under the Sun Country brand name; cooking wine; and wine for the production of vinegar. The Company also provides various bottling and distillation production services for third parties.\nBeer. The Company is the fourth largest marketer of imported beers in the United States. The Company distributes Corona, St. Pauli Girl, Modelo Especial and Tsingtao, four of the top imported beer brands in the United States. The table below sets forth the unit volume (in thousands of cases) and net sales (in thousands) for the beer sold by Barton for the years ended August 31:\n1992 1993 1994\nNET VOLUME NET VOLUME NET VOLUME SALES SALES SALES\n$131,868 10,152 $158,359 12,422 $173,883 14,100\nThe Company's principal imported beer brands include:\nCorona: The number one selling beer in Mexico and the second largest selling imported beer in the United States. In addition, the Company believes that Corona is the largest selling import in the territory in which it is distributed by the Company. The Company has represented the supplier of Corona since 1978 and currently sells Corona and its related Mexican beer brands in 25 primarily western states.\nSt. Pauli Girl: The 15th largest selling imported beer in the United States, and the second largest selling German import.\nModelo Especial: One of the family of products imported from the supplier of Corona, Modelo Especial is the number one selling canned beer in Mexico and is growing in the United States with 1994 shipments into the United States increasing by 57% over 1993 shipments in the same period.\nTsingtao: The largest selling Chinese beer in the United States.\nThe Company's other imported beer brands include Pacifico and Negra Modelo from Mexico, Peroni from Italy and Double Diamond from the United\nKingdom. In September 1992 the Company acquired the Stevens Point Brewery, a regional brewer located in Wisconsin, together with its brands including Point Special.\nNet sales and unit volumes of the Company's beer brands have grown during the previous two fiscal years as a result of the acquisition of the St. Pauli Girl and Double Diamond brands on July 1, 1992, the acquisition of the Point brands in September 1992 and increased sales of Corona and the Company's other Mexican beer brands. The Company's selling prices were not increased significantly over this time period.\nDistilled Spirits. The Company is the eighth largest producer, importer and marketer of distilled spirits in the United States. The Company produces, bottles, imports and markets a diversified line of quality distilled spirits, and also exports distilled spirits to more than 15 foreign countries. The table below sets forth the unit volumes (in thousands of 9-liter cases) and net sales (in thousands) for the distilled products case goods sold by Barton for the years ended August 31:\n1992 1993 1994\nNET VOLUME NET VOLUME NET VOLUME SALES SALES SALES\n$82,677 5,609 $82,270 5,529 $81,367 5,370\nThe Company's leading distilled spirits brands include:\nMonte Alban: A premium priced product which the Company believes is the number one selling mezcal in the United States.\nMontezuma: This brand is the number two selling tequila in the United States.\nTen High Bourbon: One of the leading bourbon brands in the United States.\nBarton Gin and Vodka: Well-known leading national brands.\nOther products include Crystal Palace Gin and Vodka, Lauder's, House of Stuart and Highland Mist Scotch whiskeys, Kentucky Gentleman, Very Old Barton and Tom Moore bourbon whiskeys, Sabroso coffee liqueur, Northern Light, Canadian Host and Canadian Supreme Canadian whiskeys and Imperial, Barton Reserve and Barton Premium blended whiskeys. Substantially all of the Company's unit volume consists of products marketed in the price value segment, which the Company believes constituted approximately 50% of the distilled spirits market in calendar 1993.\nNet sales and unit volumes of the Company's distilled spirits brands have decreased 1.6% and 4.3%, respectively, over the periods shown, there have been changes in sales of particular brands. Unit volumes of vodka and tequila have increased while Scotch and bourbon have experienced\ndecreases in unit volume. Net sales have generally not been affected by price increases.\nIn addition to the branded products described above, the Company also sells distilled spirits in bulk and provides contract production and bottling services. These activities accounted for net sales during the 12 month periods ended August 31, 1992, 1993 and 1994 of $11.8 million, $10.6 million and $7.0 million, respectively.\nMarketing and Distribution\nThe Company's products are distributed and sold throughout the United States through over 1,000 wholesalers, as well as through state alcoholic beverage control agencies. The Company employs a full-time in-house sales organization of approximately 350 people to develop and service its sales to wholesalers and state agencies. The Company's sales force is organized in four sales units: a beer unit, a spirits unit and two wine units, one of which focuses on the newly acquired brands purchased in the Almaden\/Inglenook Acquisition. The Company believes that the organization of its sales force into four divisions positions it to maintain a high degree of focus on each of its principal product categories.\nThe Company's marketing strategy places primary emphasis upon promotional programs directed at its broad national distribution network (and to the retailers served by that network). The Company closely manages its advertising expenditures in relation to the performance of its brands. The Company has extensive marketing programs for its brands including television, radio, outdoor and print advertising, promotional programs on both a national basis and regional basis in accordance with the strength of the brands, event sponsorship, market research, point-of- sale materials, trade advertising and public relations.\nTrademarks and Distribution Agreements\nThe Company's wine products are sold under a number of trademarks. All of these trademarks are either owned by the Company or used by the Company under exclusive license or distribution agreements.\nThe Company also owns the following trademarks used in its distilled spirits business: Montezuma, House of Stuart, Highland Mist, Kentucky Gentleman, Barton, Canadian Supreme and Sabroso. The Monte Alban trademark for use outside of Mexico is jointly owned by the Company and the supplier of Monte Alban Mezcal. The Company owns the world-wide sales and marketing rights outside of Mexico.\nIn September 1989, Barton purchased certain assets from Hiram Walker & Sons, Inc. (\"Hiram Walker\") and obtained licenses to use the trade names Ten High, Crystal Palace, Northern Light, Lauder's, and Imperial for an initial seven year period. Under an agreement dated January 28, 1994, the Company paid $5.1 million to Hiram Walker for the extension of licenses to use these brand names and certain other spirits brands, for varying periods, the longest of which terminates in 2116.\nAll of the Company's imported beer products are marketed and sold pursuant to exclusive distribution agreements from the suppliers of these products. These agreements have terms that vary and prohibit the Company from importing other beers from the same country. The Company's agreement\nto distribute Corona and its other Mexican beer brands exclusively throughout 25 states was renewed effective January 1994 and expires in December 1998 with automatic renewal thereafter for one year periods from year to year unless terminated. Under this agreement, the Mexican supplier has the right to consent to Mr. Goodman's successor as Chairman and Chief Executive Officer of Barton's beer subsidiary, which consent may not be unreasonably withheld, and, if such consent is properly withheld, to terminate the agreement. The Company's agreement for the importation of St. Pauli Girl expires in 1998 with automatic renewal until 2003 unless the Company terminates the Agreement. The Company's agreement for the exclusive importation of Tsingtao throughout the entire United States was renewed effective January 1994 and expires in December 1996 with an automatic renewal to December 1999. Prior to their expiration, these agreements may be terminated if the Company fails to meet certain performance criteria. The Company believes it is currently in compliance with all of its material distribution agreements. Given the Company's long-term relationships with its suppliers, the Company does not believe that these agreements will be terminated and expects that such agreements will be renewed prior to their expiration.\nCOMPETITION\nThe beverage alcohol industry is highly competitive. The Company competes on the basis of quality, price, brand recognition and distribution. The Company's beverage alcohol products compete with other alcoholic and non-alcoholic beverages for consumer purchases, as well as shelf space in retail stores and for marketing focus by the Company's wholesalers. The Company competes with numerous multinational producers and distributors of beverage alcohol products, many of which have significantly greater resources than the Company. The Company's principal competitors include E&J Gallo Winery in the wine category, Van Munching & Co., Molson Breweries USA and Guinness in the imported beer category and United Distillers Glenmore and Jim Beam Brands in the distilled spirits category.\nPRODUCTION\nThe Company's wines are produced from several varieties of wine grapes grown principally in California and New York. The grapes are crushed at the Company's wineries and stored as wine, grape juice or concentrate. Such grape products may be made into wine for sale under the Company's brand names, sold to other companies for resale under their own labels, or shipped to customers in the form of juice, juice concentrate, unfinished wines, high-proof grape spirits or brandy. Most of the Company's wines are bottled and sold within 18 months after the grape crush. The Company's inventories of wines, grape juice and concentrate are usually at their highest levels in November and December, immediately after the crush of each year's grape harvest, and are substantially reduced prior to the subsequent year's crush.\nThe bourbon whiskeys, domestic blended whiskeys and light whiskeys marketed by the Company are primarily produced and aged by the Company at its distillery in Bardstown, Kentucky, though it may from time to time supplement its inventories through purchases from other distillers. At its Atlanta, Georgia facility, the Company produces all of the grain neutral spirits used by it in the production of vodka, gin and blended whiskey sold by it to customers in the state of Georgia. The Company's\nrequirements of Canadian and Scotch whiskeys, and tequila, mezcal, and the grain neutral spirits used by it in the production of gin and vodka for sale outside of Georgia, and other spirits products, are purchased from various suppliers.\nSources and Availability of Raw Materials\nThe principal components in the production of the Company's branded beverage alcohol products are: packaging materials, primarily glass; grapes; and other agricultural products, such as grain.\nThe Company utilizes glass bottles and other materials, such as caps, corks, capsules, labels and cardboard cartons in the bottling and packaging of its products. Glass bottle costs is one of the largest components of the Company's cost of product sold. The glass bottle industry is highly concentrated with only a small number of producers. The Company has traditionally obtained, and continues to obtain, its glass requirements from a limited number of producers. The Company has not experienced difficulty in satisfying its requirements with respect to any of the foregoing and considers its sources of supply to be adequate. However, the inability of any of the Company's glass bottle suppliers to satisfy the Company's requirements could adversely affect the Company's operations.\nMost of the Company's annual grape requirements are satisfied by purchases from each year's harvest, which occurs from July through October. The Company owns no vineyards in California and purchases grapes from over 1,000 independent growers principally in California and New York. In connection with the Vintners Acquisition and the Almaden\/Inglenook Acquisition, the Company acquired certain long term grape purchase contracts. The Company enters into written purchase agreements with a majority of these growers on a year-to-year basis. As a result of this ample grape supply the Company believes that its exposure to phylloxera and other agricultural risks is minimal.\nThe distilled spirits manufactured by the Company require various agricultural products, neutral grain spirits and bulk spirits. The Company fulfills its requirements through purchases from various sources, through contractual arrangements and through purchases on the open market. The Company believes that adequate supplies of the aforementioned products are available at the present time.\nGOVERNMENT REGULATION\nThe Company's operations are subject to extensive federal and state regulation. These regulations cover, among other matters, sales promotion, advertising and public relations, labeling and packaging, changes in officers or directors, ownership or control, distribution methods and relationships, and requirements regarding brand registration and the posting of prices and price changes. All of the Company's facilities are also subject to federal, state and local environmental laws and regulations and the Company is required to obtain permits and licenses to operate its facilities. The Company believes that it is in compliance in all material respects with all presently applicable governmental laws and regulations and that the cost of administration of compliance with such laws and regulations does not have, and is not\nexpected to have, a material adverse impact on the Company's financial condition or results of operations.\nEMPLOYEES\nThe Company has approximately 2,650 full-time employees, approximately 900 of whom are covered by collective bargaining agreements. The Company's collective bargaining agreement covering 368 employees at the Mission Bell winery has expired and negotiations have commenced. Additional workers may be employed by the Company during the grape crushing season. The Company considers its employee relations to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company currently operates 15 wineries, two bottling and distilling plants, one bottling and rectifying plant and a brewery, all of which include warehousing and distribution facilities on the premises. The Company considers its principal facilities to be the Mission Bell winery in Madera, California, the Canandaigua, New York winery, and the Gonzales, California winery and the distilling and bottling facility located in Bardstown, Kentucky. Under the Restructuring Plan, the Central Cellars winery located in Lodi, California and the Soledad, California winery will be closed and offered for sale to reduce excess capacity.\nIn New York, the Company operates four wineries located in Canandaigua, Naples, Batavia and Hammondsport. The Hammondsport winery lease, acquired in the Vintners Acquisition, expires in April 1995. Production at this winery will be consolidated at the Company's other New York wineries.\nThe Company currently operates 11 winery facilities in California, including Central Cellars and Soledad Cellars which are to be closed. In the Almaden\/Inglenook Acquisition, the Company acquired two new facilities located in Escalon and Madera, California. The Madera winery (known as the Mission Bell winery) is a crushing, wine production, bottling and distribution facility and a grape juice concentrate production facility. The Mission Bell winery will absorb the production of Central Cellars. The Escalon facility is operated under a long-term lease with an option to buy. As part of the Restructuring Plan, the branded wine bottling operations at the Gonzales, California facility where Paul Masson and Taylor Cellars are currently bottled will be moved to the Mission Bell winery during fiscal 1995. The other wineries operated in California are located in Lodi, McFarland, Madera, Fresno and Ukiah.\nThe Company operates three facilities that produce and\/or bottle and store distilled spirits. It owns production, bottling and storage facilities in Bardstown, Kentucky and Atlanta, Georgia, and operates a bottling plant in Carson, California, near Los Angeles, under a management contract. The Bardstown facility distills, bottles and warehouses whiskey for the Company's account and on a contractual basis for other participants in the industry. The Company also owns a production plant in Atlanta, Georgia which produces vodka, gin and blended whiskeys. The Carson plant receives distilled spirits in bulk from Bardstown and outside vendors, which it bottles and distributes. The Company also performs contract bottling at the Carson plant.\nThe Company owns a brewery in Stevens Point, Wisconsin where it produces and bottles Point beer. In addition, the Company owns and maintains its corporate headquarters in Canandaigua, New York, and leases office space in Chicago, Illinois, for its Barton headquarters.\nThe Company believes that all of its facilities are in good condition and working order and have adequate capacity to meet its needs for the foreseeable future.\nMost of the Company's real property has been pledged under the terms of collateral security mortgages as security for the payment of outstanding loans under the Credit Facility.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are subject to litigation from time to time in the ordinary course of business. Although the amount of any liability with respect to such litigation cannot be determined, in the opinion of management, such liability will not have a material adverse effect on the Company's financial condition or results of operations.\nIn connection with an investigation in the State of New Jersey into regulatory trade practices in the beverage alcohol industry, one employee of the Company was arrested in March 1994 and another employee has subsequently come under investigation in connection with providing \"free goods\" to retailers in violation of New Jersey beverage alcohol laws. Employees of several wholesalers and other alcoholic beverage manufacturers were also arrested or are under active investigation. Although the New Jersey Attorney General's office may expand its criminal investigation to include the Company and other manufacturers, to date, no grand jury subpoenas have been issued and no charges have been brought. The Company has cooperated with the Attorney General's office and, as a result of extensive discussions, the Attorney General's office has requested and the Company has submitted a detailed proposal to achieve a resolution of all civil, criminal and regulatory issues. The Company does not believe that the dollar amount of such a settlement or its effect on the Company's operations, if any, will be material.\nThe United States Environmental Protection Agency (the \"EPA\") and the Georgia Environmental Protection Division (the \"GEPD\") conducted a Compliance Evaluation Inspection (\"CEI\") of Barton Brands of Georgia, Inc. (\"Barton Georgia\"), a subsidiary of Canandaigua Wine Company, Inc., on February 15, 1994. The CEI was conducted to determine compliance with the Resource Conservation and Recovery Act (\"RCRA\"). Following the inspection, the EPA sent a report of its findings together with a transmittal letter, dated March 7, 1994, to Barton Georgia.\nBy letter dated March 21, 1994, the GEPD implemented enforcement action by serving Barton Georgia with a formal Notice of Violation alleging that between August 1991 and August 1993, Barton Georgia has violated certain regulations pertaining to (i) generation and accumulation of hazardous waste and (ii) hazardous waste burning in boilers. These alleged violations relate to the burning of fusel oil which is a mixture of alcohols created by the distillation process used\nin manufacturing various types of liquor products. Accompanying the Notice of Violation was a proposed settlement agreement in the form of a Consent Order between the GEPD and Barton Georgia. Following counterproposals, on October 21, 1994, Barton Georgia entered into a settlement agreement under the terms of a final Consent Order (the \"Order\") with the GEPD with respect to this matter. Under the Order, Barton Georgia has paid a stipulated civil penalty of $99,000, and will incur approximately $16,000 of other costs. Barton Georgia is not burning fusel oil in its current operations. The signing of the settlement agreement by Barton Georgia does not constitute any finding, determination or adjudication of liabiity on the part of Barton Georgia, nor any finding, determination or adjudication of a violation of any State or Federal laws, rules, standards or requirements; nor did Barton Georgia make any admission with respect thereto by signing the settlement agreement.\nExecutive Officers of the Company\nThe following table sets forth information with respect to the executive officers of the Company:\nNAME AGE OFFICE HELD\nMarvin Sands 70 Chairman of the Board Richard Sands 43 President and Chief Executive Officer Robert Sands 36 Executive Vice President and General Counsel Ellis M. Goodman 57 Executive Vice President of the Company and Chief Executive Officer of Barton Incorporated Lynn K. Fetterman 47 Senior Vice President, Chief Financial Officer and Secretary Chris Kalabokes 47 Senior Vice President, President of Wine Division Bertram E. Silk 62 Senior Vice President\nMarvin Sands is the founder of the Company, which is the successor to a business he started in 1945. He has been a director of the Company and its predecessor since 1946 and was Chief Executive Officer until October 1993. Marvin Sands is the father of Richard Sands and Robert Sands.\nRichard Sands, Ph.D. has been employed by the Company in various capacities since 1979. He was elected Executive Vice President and a director in 1982, became President and Chief Operating Officer in May 1986 and was elected Chief Executive Officer in October 1993. He is a son of Marvin Sands and the brother of Robert Sands.\nRobert Sands was appointed Executive Vice President, General Counsel in October 1993. He was elected a director of the Company in January 1990 and served as Vice President, General Counsel since June 1990. From June 1986, until his appointment as Vice President, General Counsel, Mr. Sands was employed by the Company as General Counsel. He is a son of Marvin Sands and the brother of Richard Sands.\nEllis M. Goodman has been a director and Vice President since July 1993 and was elected Executive Vice President in October 1993. Mr. Goodman has been Chief Executive Officer of Barton Incorporated since\n1987 and Chief Executive Officer of Barton Brands, Ltd. (predecessor to Barton Incorporated) since 1982.\nLynn K. Fetterman joined the Company during April 1990 as its Vice President, Finance and Administration, Secretary and Treasurer and was elected Senior Vice President, Chief Financial Officer and Secretary in October 1993. For more than 10 years prior to that, he was employed by Reckitt and Colman in various executive capacities, including Vice President, Finance of its Airwick Industries Division and Vice President, Finance of its Durkee-French Foods Division. Mr. Fetterman's most recent position with Reckitt and Colman was as its Vice President-Controller. Reckitt and Colman's principal business relates to consumer food and household products.\nChris Kalabokes joined the Company during October 1991 as President and Chief Executive Officer of the Company's Guild Wineries & Distilleries, Inc. subsidiary. During September 1992, he was appointed to the position of Vice President, President of the Wine Division of the Company and in October 1993 was appointed a Senior Vice President. For more than five years prior to joining the Company, he was employed by Guild. Mr. Kalabokes joined Guild in April 1985 as its Chief Financial Officer and continued in that position until June 1987 when he was promoted to President and Chief Executive Officer.\nBertram E. Silk has been a director and Vice President of the Company since 1973 and was elected Senior Vice President in October 1993. He has been employed by the Company since 1965. Currently, Mr. Silk is in charge of the Company's grape grower relations in California. Before moving from Canandaigua, New York to California in 1989, Mr. Silk was in charge of production for the Company. From 1989 to August 1994, Mr. Silk was in charge of the Company's grape juice concentrate business in California.\nPART II\nItem 5.","section_4":"","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nThe Company's Class A Common Stock and Class B Common Stock are quoted on the Nasdaq National Market under the symbols \"WINEA\" and \"WINEB\", respectively. The following table sets forth for the periods indicated the high and low sales prices of the Class A Common Stock and the Class B Common Stock as reported on the Nasdaq National Market.\nProperty, plant and equipment - Property, plant and equipment is stated at cost. Major additions and betterments are charged to property accounts, while maintenance and repairs are charged to operations as incurred. The cost of properties sold or otherwise disposed of and the related allowance for depreciation are eliminated from the accounts at the time of disposal and resulting gains or losses are included as a component of operating income.\nOther assets - Other assets which consist of goodwill, distribution rights, agency license agreements, trademarks, deferred financing costs, cash surrender value of officers' life insurance and other amounts, are stated at cost, net of accumulated amortization. Amortization is calculated on a straight-line or effective interest basis over periods ranging from five to forty years. At August 31, 1994, the weighted average of the remaining useful lives of these assets was approximately thirty-five years. The face value of the officers' life insurance policies totaled $2,852,000 in both 1994 and 1993.\nDepreciation - Depreciation is computed primarily using the straight-line method over the following estimated useful lives:\nDescription Depreciable Life Buildings and improvements 10 to 33 1\/3 years Machinery and equipment 7 to 15 years Motor vehicles 3 to 7 years\nAmortization of assets capitalized under capital leases is included with depreciation expense. Amortization is calculated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.\nIncome taxes -\nThe Company uses the liability method of accounting for income taxes. The liability method accounts for deferred income taxes by applying statutory rates in effect at the balance sheet date to the difference between the financial reporting and tax basis of assets and liabilities. In fiscal 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" which replaced Statement of Financial Accounting Standards No. 96, which was the standard the Company previously used. The cumulative effect of this change in accounting principle was not material to the Company's financial statements and was included in the fiscal 1992 tax provision.\nEnvironmental - Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, and which do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and\/or remedial efforts are probable, and the cost can be reasonably estimated. Generally, the timing of these accruals coincides with completion of a feasibility study or the Company's commitment to a formal plan of action. At August 31,1994 and 1993, liabilities for environmental costs of $100,000 and $1,300,000, respectively, are recorded in other accrued liabilities.\nCommon stock - The Company has two classes of common stock: Class A Common Stock and Class B Common Stock. Class B Common Stock shares are convertible into shares of Class A Common Stock on a one-to-one basis at any time at the option of the holder. Holders of Class B Common Stock are entitled to ten votes per share. Holders of Class A Common Stock are entitled to only one vote per share but are entitled to a cash dividend premium. If the Company pays a cash dividend on Class B Common Stock, each share of Class A Common Stock will receive an amount at least ten percent greater than the amount of the cash dividend per share paid on Class B Common Stock. In addition, the Board of Directors may declare and pay a dividend on Class A Common Stock without paying any dividend on Class B Common Stock.\nOn September 26, 1991 and June 1, 1992, the Company approved three-for-two stock splits of both Class A and Class B Common Stock to stockholders of record on October 11, 1991 and June 22, 1992, respectively. All references in the consolidated financial statements to weighted average number of shares and issued shares have been retroactively restated to reflect the splits (see Note 10).\nNet income per common and common equivalent share - Primary net income per common and common equivalent share is based on the weighted average number of common and common equivalent shares (stock options and stock appreciation rights determined under the treasury stock method) outstanding during the year for Class A Common Stock and Class B Common Stock. Fully diluted earnings per common and common equivalent share assumes the conversion of the 7% convertible subordinated debentures under the \"if converted method\" and assumes exercise of stock options and stock appreciation rights using the treasury stock method.\nAll share and per share amounts have been adjusted for the three-for-two stock splits (see Note 10).\n2. ACQUISITIONS:\nGuild - On October 1, 1991, the Company acquired Cook's, Cribari, Dunnewood and other brands and substantially all of the assets and assumed certain liabilities (the Guild Acquisition) from Guild Wineries and Distilleries (Guild). The assets acquired included accounts receivable, inventories, property, plant and equipment and other assets. The Company also assumed certain liabilities consisting primarily of accounts payable. The aggregate purchase price, after adjustments based on a post-closing audit, was approximately $69,300,000. With respect to the purchase price, the Company paid approximately $59,400,000 in cash at closing, assumed liabilities of approximately $11,400,000 of which approximately $1,600,000 was discharged immediately and, based upon the results of a post-closing audit, received from Guild during October 1992 approximately $1,500,000, exclusive of accrued interest. The Company also paid approximately $2,700,000 of direct acquisition costs and $2,600,000 in escrow to finance the purchase of grapes related to Guild's 1991 grape harvest.\nThe Guild Acquisition was accounted for using the purchase method; accordingly, the assets and liabilities of Guild have been recorded at their estimated fair market value at the date of acquisition. The excess of purchase price over the estimated fair market value of the net assets acquired (goodwill), $1,344,000, is being amortized on a straight-line basis over forty years. The results of operations of Guild have been included in the Consolidated Statements of Income since the date of acquisition.\nBarton - On June 29, 1993, pursuant to the terms of a Stock Purchase Agreement (the Stock Purchase Agreement) among the Company, Barton Incorporated (Barton) and the Selling Stockholders, the Company acquired from the Selling Stockholders all of the outstanding shares of the capital stock of Barton (the Barton Acquisition), a marketer of imported beers and imported distilled spirits and a producer and marketer of distilled spirits and domestic beers.\nThe aggregate consideration for Barton consisted of approximately $65,510,000 in cash, one million shares of the Company's Class A Common Stock and payments of up to an aggregate amount of $57,300,000 (the Earn-Out Amounts) which are payable to the Selling Stockholders in cash over a three year period upon the satisfaction of certain performance goals. In addition, the Company paid approximately $1,981,000 of direct acquisition costs, $2,269,000 of direct financing costs, and assumed liabilities of approximately $47,926,000.\nThe purchase price was funded through a $50,000,000 term loan (see Note 7), through $18,835,000 of revolving loans under the Company's Credit Agreement (see Note 7), and through approximately $925,000 of accrued expenses. In addition, one million shares of the Company's Class A Common Stock were issued at $13.59 per share, which reflects the closing market price of the stock at the closing date, discounted for certain restrictions on the issued shares. Of these shares, 428,571 were delivered to the Selling Stockholders and 571,429 were delivered into escrow to secure the Selling Stockholders' indemnification obligations to the Company. Subsequent to year end, the 571,429 shares were released from escrow and delivered to the Selling Stockholders.\nThe Earn-Out Amounts consist of four payments scheduled to be made over a three year period ending November 29, 1996. The first payment of $4,000,000 is required to be made to the Selling Stockholders upon satisfaction of certain performance goals. These goals have been satisfied and this payment was accrued at August 31, 1993 and was made on December 31, 1993. The second payment of $28,300,000 has been accrued at August 31, 1994 and will be made to the Selling Stockholders on December 30, 1994, as a result of satisfaction of certain performance goals and the achievement of targets for earnings before interest and taxes at August 31, 1994. These additional payments have been properly accounted for as additional purchase price for the Barton acquisition. The remaining payments are contingent upon Barton achieving and exceeding certain targets for earnings before interest and taxes and certain other performance goals and are to be made as follows: up to $10,000,000 is to be made on November 30, 1995; and up to $15,000,000 is to be made on November 29, 1996. Such payment obligations are secured in part by the Company's standby irrevocable letter of credit (see Note 7) under the Credit Agreement in an original maximum face amount of $28,200,000 and are subject to acceleration in certain events as defined in the Stock Purchase Agreement. All Earn-Out amounts will be accounted for as additional purchase price for the Barton acquisition when the contingency has been satisfied in accordance with the Stock Purchase Agreement and allocated based upon the fair market value of the underlying assets.\nPursuant to Barton's Phantom Stock Plan (the Phantom Stock Plan) effective April 1, 1990 and amended and restated for Units (as defined in the Phantom Stock Plan) granted after March 31, 1992, certain participants received payments at closing amounting in the aggregate to $1,959,000 in connection with the Barton acquisition. Certain other participants will receive payments only upon vesting in the Phantom Stock Plan during years subsequent to the acquisition. All participants under the Phantom Stock Plan may receive additional payments in the event of satisfaction of the performance goals set forth in the Stock Purchase Agreement and upon release of the shares held in escrow. In the event the maximum payments are received under the Stock Purchase Agreement, the participants will receive an additional $2,137,000 in connection therewith. At August 31, 1994, $554,000 has been accrued under the Phantom Stock Plan and will be paid on January 3, 1995.\nThe Acquisition was accounted for using the purchase method; accordingly, Barton's assets were recorded at fair market value at the date of acquisition. The fair market value of Barton totaled $236,178,000 which was adjusted for negative goodwill of $72,390,000 and an additional deferred tax liability of $24,326,000 based on the difference between the fair market value of Barton's assets and liabilities as adjusted for allocation of negative goodwill and the tax basis of those assets and liabilities which was allocated on a pro-rata basis to noncurrent assets. The results of operations of Barton have been included in the Consolidated Statements of Income since the date of Acquisition.\nVintners - On October 15, 1993, the Company acquired substantially all of the tangible and intangible assets of Vintners International Company, Inc. (Vintners) other than cash and the Hammondsport Winery (the Vintners Assets), and assumed certain current liabilities associated with the ongoing business (the Vintners Acquisition). Vintners was the United States fifth largest supplier of wine with two of the country's most\nhighly recognized brands, Paul Masson and Taylor California Cellars. The wineries acquired from Vintners are the Gonzales winery in Gonzales, California and the Paul Masson wineries in Madera and Soledad, California. In addition, the Company is leasing from Vintners the Hammondsport winery in Hammondsport, New York. The lease is for a period of 18 months from the date of the Vintners Acquisition.\nThe aggregate purchase price of $148,900,000 (the Cash Consideration), is subject to adjustment based upon the determination of the Final Net Current Asset Amount (as defined below). In addition, the Company incurred $8,961,000 of direct acquisition and financing costs. The Company also delivered options to Vintners and Household Commercial of California, Inc., one of Vintners' lenders, to purchase an aggregate of 500,000 shares (the Vintners Option Shares) of the Company's Class A Common Stock, at an exercise price per share of $18.25, which are exercisable at any time until October 15, 1996. These options have been recorded at $8.42 per share, based upon an independent appraisal and $4,210,000 has been reflected as a component of additional paid-in capital. Subsequent to year-end, 432,067 of the Vintners Option Shares have been exercised (see Note 10).\nThe Cash Consideration was funded by the Company pursuant to (i) approximately $12,600,000 of Revolving Loans under the Credit Facility of which $11,200,000 funded the Cash Consideration and $1,400,000 funded the payment of direct acquisition costs; (ii) an accrued liability of approximately $7,700,000 for the holdback described below and (iii) the $130,000,000 Subordinated Bank Loan (see Note 7).\nAt closing the Company held back from the Cash Consideration approximately 10% of the then estimated net current assets of Vintners purchased by the Company, and deposited an additional $2,800,000 of the Cash Consideration into an escrow to be held until October 15, 1995. If the amount of the net current assets as determined after the closing (the Final Net Current Asset Amount) is greater than 90% and less than 100% of the amount of net current assets estimated at closing (the Estimated Net Current Asset Amount), then the Company shall pay into the established escrow an amount equal to the Final Net Current Asset Amount less 90% of the Estimated Net Current Asset Amount. If the Final Net Current Asset Amount is greater than the Estimated Net Current Asset Amount, then, in addition to the payment described above, the Company shall pay an amount equal to such excess, plus interest from the closing, to Vintners. If the Final Net Current Asset Amount is less than 90% of the Estimated Net Current Asset Amount, then the Company shall be paid such deficiency out of the escrow account. As of August 31, 1994, no adjustment to the established escrow was required and the Final Net Current Asset Amount has not been determined.\nThe Vintners Acquisition was accounted for using the purchase method; accordingly, the Vintners Assets were recorded at fair market value at the date of acquisition. The excess of the purchase price over the estimated fair market value of the net assets acquired (goodwill), $42,049,000, is being amortized on a straight-line basis over forty years. The results of operations of Vintners have been included in the Consolidated Statements of Income since the date of acquisition.\nAlmaden\/Inglenook -\nOn August 5, 1994 the Company acquired the Almaden and Inglenook brands, the fifth and sixth largest selling table wines in the United States, a grape juice concentrate business, and wineries in Madera and Escalon, California, from Heublein, Inc. (Heublein) (the Almaden\/Inglenook Acquisition). The Company also acquired Belaire Creek Cellars, Chateau La Salle and Charles Le Franc table wines, Le Domaine champagne and Almaden, Hartley and Jacques Bonet brandy. The accounts receivable and the accounts payable related to the acquired assets were not acquired by the Company.\nThe aggregate consideration for the acquired brands and other assets consisted of $130,600,000 in cash, assumption of certain current liabilities and options to purchase an aggregate of 600,000 shares of Class A Common Stock (the Almaden Option Shares). Of the Almaden Option Shares, 200,000 are exercisable at a price of $30 per share and the remaining 400,000 are exercisable at a price of $35 per share. All of the options are exercisable at any time until August 5, 1996. The 200,000 and 400,000 options have been recorded at $5.83 and $4.19 per share, respectively based upon an independent appraisal, and $2,842,000 has been reflected as a component of additional paid-in capital. The source of the cash payment made at closing, together with payment of other costs and expenses required by the Almaden\/Inglenook Acquisition, was financing provided by the Company pursuant to a term loan under the Credit Facility (see Note 7).\nThe cash purchase price is subject to adjustment based upon the determination of the Final Net Asset Amount as defined in the Asset Purchase Agreement; and, based upon a closing statement delivered to the company by Heublein, was reduced by $9,297,000. In accordance with the terms of the Asset Purchase Agreement, Heublein is obligated to the pay Company this amount plus interest from the closing date. The purchase price for the Almaden\/Inglenook Acquisition at August 31, 1994, reflects the purchase price as adjusted for the payment expected to be received from Heublein. However, as of August 31, 1994, the Final Net Asset Amount has not been determined.\nHeublein also agreed not to compete with the Company in the United States and Canada for a period of five years following the closing of the Almaden\/Inglenook Acquisition in the production and sale of grape juice concentrate or sale of packaged wines bearing the designation \"Chablis\" or \"Burgundy\" except where, among other exceptions, such designations are currently used with certain brands retained by Heublein. Certain companies acquired by Heublein, however, may compete directly with the Company.\nThe Almaden\/Inglenook Acquisition was accounted for using the purchase method; accordingly, the Almaden\/Inglenook assets were recorded at fair market value at the date of acquisition. The excess of purchase price over the estimated fair market value of the net assets acquired (goodwill), $43,939,000, is being amortized on a straight-line basis over forty years. The results of operations of Almaden\/Inglenook have been included in the Consolidated Statement of Income since the date of the acquisition.\nThe following table sets forth unaudited pro forma consolidated statements of income of the Company for the years ended August 31, 1994 and 1993. The fiscal 1994 pro forma consolidated statement of income\ngives effect to the Almaden\/Inglenook Acquisition and the Vintners Acquisition as if they occurred on September 1, 1993. The fiscal 1993 pro forma consolidated statement of income gives effect to the Almaden\/Inglenook Acquisition, the Vintners Acquisition and the Barton Acquisition as if they occurred on September 1, 1992. The August 31, 1994 and 1993 unaudited pro forma consolidated income statements are presented after giving effect to certain adjustments for depreciation, amortization of goodwill, interest expense on the acquisition financing and related income tax effects. The pro forma consolidated statements of income are based upon currently available information and upon certain assumptions that the Company believes are reasonable under the circumstances. The pro forma consolidated statements of income do not purport to represent what the Company's results of operations would actually have been if the aforementioned transactions in fact had occurred on such date or at the beginning of the period indicated or to project the Company's financial position or results of operations at any future date or for any future period.\nSenior Credit Facility - During fiscal 1993, the Company amended its Credit Agreement which provided for $50,000,000 of term loans, up to $55,000,000 in revolving credit loans and a standby, irrevocable letter of credit with a maximum\nface amount of $28,200,000. At August 31, 1993, the Company had outstanding borrowings of $50,000,000 under the term loan and $9,000,000 under the Revolving Credit Loans. At August 31, 1993, the Company had available Revolving Credit Loans totaling $46,000,000 under the amended Credit Agreement. Interest, as described in the agreement, was payable quarterly or on the last day of each interest period based upon either the base rate (higher of the Federal Funds Rate plus 1\/2 of 1% or the bank's prime rate) or the Eurodollar rate, as defined in the Credit Agreement, at the discretion of the Company.\nDuring fiscal 1994, the Company further amended its Credit Agreement in connection with the Vintners and the Almaden\/Inglenook Acquisitions. The amended Credit facility provides for (i) a $224,000,000 Term Loan (the Term Loan) facility due in June 2000, (ii) a $185,000,000 Revolving Credit (the Revolving Credit Loans) facility, which expires in June 2000 and (iii) the continuation of the existing $28,200,000 Letter of Credit related to the contingent payments incurred with the Barton Acquisition. At August 31, 1994, the Company has outstanding Term Loan borrowings of $177,000,000 and Revolving Credit Loans of $19,000,000. On October 24, 1994 the Company borrowed an additional $47,000,000 on the Term Loan and used the proceeds to repay a portion of the outstanding balance on the Revolving Credit Loans incurred since August 31, 1994. The Term Loan Commitment was fully utilized after this borrowing. The Term Loans borrowed under the Credit Facility may be either base rate loans or Eurodollar base rate loans. Base rate loans have an interest rate equal to the higher of either the Federal Funds rate plus 0.5% or the prime rate. Eurodollar rate loans have an interest rate equal to LIBOR plus a margin of 1.25%. The current interest rate margin for both base rate and Eurodollar rate loans may be increased by up to 0.25% and Eurodollar rate loans may be decreased by up to .375%, depending on the Company's debt coverage ratio and long-term senior secured securities' ratings. The principal of the Term Loans is to be repaid in twenty-two quarterly installments of $7,000,000 each beginning December 15, 1994, with a final quarterly payment of $70,000,000 due June 15, 2000. The Company may prepay the principal of the Term Loans and the Revolving Credit Loans at its discretion and must prepay the principal with 65% of its annual excess cash flow, as defined, with proceeds from the sale of certain assets in excess of $10,000,000 and the first $60,000,000 of the net proceeds from any issuance of equity plus 50% of any net proceeds in excess of $60,000,000 (see Note 10). These prepayments must be first applied against regular payments due with respect to the Term Loans in their inverse order of maturity until the Term Loans are fully retired and any further prepayments will be applied to reduce the outstanding Revolving Credit Loans.\nThe $185,000,000 revolving credit available under the Credit Facility may be utilized by the Company either in the form of Revolving Credit Loans or as revolving letters of credit up to a maximum of $12,000,000. At August 31, 1994 the Company had available Revolving Credit Loans under the Senior Credit Facility of $163,753,000. As with Term Loans, Revolving Credit Loans may be either base rate loans or Eurodollar rate loans. Revolving Credit Loans will mature and must be repaid June 15, 2000. For thirty consecutive days at any time during the last two quarters of each fiscal year, the aggregate outstanding principal amount of Revolving Credit Loans combined with the revolving letters of credit cannot exceed $50,000,000.\nThe banks under the Credit Facility have been given security interests in substantially all of the assets of the Company including mortgage liens on certain real property. The Credit Facility requires the Company to meet certain covenants and provides for restrictions on mergers, consolidations and sales of assets, payment of dividends, incurring of other debt, liens or guarantees and the making of investments. The primary financial covenants as defined in the Credit Facility require the maintenance of minimum defined tangible net worth, a debt to cash flow coverage ratio, a fixed charges ratio, maximum capital expenditures, an interest coverage ratio and a current ratio. Among the most restrictive covenants contained in the Credit Facility, the Company is required to maintain a fixed charges ratio not less than 1.0 to 1.0 at the last day of each fiscal quarter of each fiscal year.\nThe Revolving Credit Loans require commitment fees totaling .375% per annum on the daily average unused balance. Commitment fees totaled approximately $223,000, $228,000 and $154,000 in fiscal 1994, 1993 and 1992, respectively.\nThe Company maintains in accordance with the Senior Credit Facility a collar agreement, which protects the Company against three-month London Interbank Offered Rates exceeding 7.5% per annum with a floor rate of 3.3% per annum in an amount equal to $25,000,000 expiring in July 1995. At August 31, 1993, there were no interest rate swap agreements outstanding. At August 31, 1992, the Company had a contract applicable to $22,000,000 of short-term seasonal borrowings which effectively guaranteed a fixed interest rate of 6.82% for seasonal borrowing during the four month period ended September 15, 1992. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements. The Company has not incurred any credit losses in connection with these agreements.\nSenior Subordinated Notes - During fiscal 1994, the Company borrowed $130,000,000 under the Senior Subordinated Loan Agreement. The Company repaid the Subordinated Loan in December 1993 from the proceeds from the Senior Subordinated Notes offering together with revolving loan borrowings. The $130,000,000 Notes are due in 2003 with a stated interest rate of 8.75% per annum. Interest is payable semi-annually on June 15 and December 15 of each year. The Notes are unsecured and subordinated to the prior payment in full of all senior indebtedness of the Company, which includes the Credit Agreement. The Notes are guaranteed, on a senior subordinated basis, by all of the Company's significant operating subsidiaries.\nThe indenture relating to the Notes contains certain covenants, including, but not limited to, (i) limitation on indebtedness; (ii) limitation on restricted payments; (iii) limitation on transactions with affiliates; (iv) limitation on senior subordinated indebtedness; (v) limitation on liens; (vi) limitation on sale of assets; (vii) limitation on issuance of guarantees of and pledges for indebtedness; (viii) restriction on transfer of assets; (ix) limitation on subsidiary capital stock; (x) limitation on the creation of any restriction on the ability of the Company's subsidiaries to make distributions and other payments; and (xi) restrictions on mergers, consolidations and the transfer of all or substantially all of the assets of the Company to another person. The limitation on indebtedness covenant is governed by a rolling four quarter fixed charge coverage ratio covenant requiring a specified minimum.\nConvertible subordinated debentures -\nOn July 23, 1986, the Company issued $60,000,000 7% convertible subordinated debentures used to expand the Company's operations through capital expenditures and acquisitions. The debentures were convertible at any time prior to maturity, unless previously redeemed, into Class A Common Stock of the Company at a conversion price of $18.22 per share, subject to adjustment in the event of future issuances of Common Stock.\nDuring fiscal 1993, an aggregate principal amount of $977,000 of these debentures was converted to 53,620 shares of Class A Common Stock.\nOn October 18, 1993, the Company called its Convertible Debentures for redemption on November 19, 1993 at a redemption price of 102.1% plus accrued interest. Bondholders had until November 19, 1993 to convert their debentures to common stock; any debentures remaining unconverted after that date would be redeemed for cash in accordance with the terms of the original indenture.\nDuring the period September 1, 1993, through November 19, 1993, debentures in an aggregate principal amount of $58,960,000 were converted to 3,235,882 shares of the Company's Class A Common Stock at a price of $18.22 per share. Debentures in an aggregate principal amount of approximately $63,000 were redeemed. Interest was accrued on the debentures until the date of conversion but was forfeited by the debenture holders upon conversion. Accrued interest of approximately $1,370,000, net of the related tax effect of $520,000 was recorded as an addition to additional paid-in capital.\nAt the redemption date, the capitalized debenture issuance costs of approximately $2,246,000 net of accumulated amortization of approximately $677,000 were recorded as a reduction of additional paid-in-capital.\nLoans payable - Loans payable, secured by officers' life insurance policies, carry an interest rate of 5%. The notes carry no due dates and it is management's intention not to repay the notes during the next fiscal year.\nCapitalized lease agreements-Industrial Development Agencies - Certain capitalized lease agreements require the Company to make lease payments equal to the principal and interest on certain bonds issued by Industrial Development Agencies (IDA's). The bonds are secured by the leases and the related facilities. Upon payment of the outstanding bonds, title to the facilities will be conveyed to the Company. These transactions have been treated as capital leases with the related assets acquired to date ($10,731,000) included in property, plant and equipment and the lease commitments included in long-term debt. Accumulated amortization of the foregoing assets under capital leases at August 31, 1994 and 1993 is approximately $8,456,000 and $7,803,000 respectively.\nAmong the provisions under the debenture and lease agreements are covenants that define minimum levels of working capital and tangible net worth and the maintenance of certain financial ratios as defined in the debt agreements.\nPrincipal payments required under long-term debt obligations during the next five fiscal years are as follows:\nYear Ending August 31: (in thousands)\n1995 $ 31,001 1996 29,220 1997 28,698 1998 28,118 1999 28,118 Thereafter 174,968 $320,123\n8. INCOME TAXES:\nDeferred income taxes are provided to reflect the effect of temporary differences primarily related to: (1) using the FIFO basis to value certain inventories for income tax purposes and the LIFO basis for financial reporting purposes; (2) the use of accelerated depreciation methods for income tax purposes and the straight-line method for financial reporting purposes; (3) differences in the treatment of advertising expense and other accruals for financial reporting and income tax purposes and (4) differences between the financial reporting and tax basis of assets and liabilities.\nThe provision for federal and state income taxes consists of the following for the years ended August 31:\nThe deferred tax provision has been increased by approximately $45,000 and $235,000 in fiscal 1994 and 1993, respectively for the impact of the change in the federal statutory rate.\nA reconciliation of total tax provision to the amount computed by applying the expected U.S. Federal income tax rate to income before provision for income taxes is as follows for the years ended August 31:\n9. PROFIT SHARING RETIREMENT PLAN AND RETIREMENT SAVINGS PLAN:\nThe Company's profit-sharing retirement plan, which covers substantially all employees, provides for contributions by the Company in such amounts as the Board of Directors may annually determine and for voluntary contributions by employees. The plan has qualified as tax-exempt under the Internal Revenue Code and conforms with the Employee Retirement Income Security Act of 1974. Company contributions to the plan were $3,414,000, $1,290,000, and $1,249,000 in fiscal 1994, 1993 and 1992, respectively.\nThe Company's retirement savings plan, established pursuant to Section 401(k) of the Internal Revenue Code, permits substantially all full-time employees of the Company to defer a portion of their compensation on a pre-tax basis. Participants may defer up to 10% of their compensation for the year. The Company makes a matching contribution of 25% of the first 4% of compensation an employee defers. Company contributions to this plan were $207,000, $131,000, and $109,000 in fiscal 1994, 1993 , 1992, respectively.\nIn connection with the Barton acquisition, the Company assumed Barton's profit-sharing plan which covers all salaried employees. The amount of Barton's contribution is at the discretion of its Board of Directors, subject to limitations of the plan. Contribution expense was $1,395,000 in fiscal 1994 and $230,000 from the date of acquisition to August 31, 1993.\n10. STOCKHOLDERS' EQUITY:\nStock option and stock appreciation right plan - Canandaigua Wine Company, Inc. has in place a Stock Option and Stock Appreciation Right Plan (the Plan). Under the Plan, non-qualified stock options and incentive stock options may be granted to purchase and stock appreciation rights may be granted with respect to, in the aggregate, not more than 3,000,000 shares of the Company's Class A Common Stock. Options and stock appreciation rights may be issued to employees, officers, or directors of the Company. Non-employee directors are eligible to receive only non-qualified stock options and stock appreciation rights. The option price of any incentive stock option may not be less than the fair market value of the shares on the date of grant. The exercise price of any non-qualified stock option must equal or exceed 50% of the fair market value of the shares on the date of grant. Options are exercisable as determined by the Compensation Committee of the Board of Directors. Changes in the status of the stock option plan during fiscal 1994, 1993 and 1992 are summarized as follows:\nPursuant to the original Plan, on December 21, 1987, the Company granted to key employees stock appreciation rights with respect to 38,250 shares of the Company's Class A Common Stock at a base price of $4.40 per share (the average closing price per share for November 1987 adjusted for the effect of the stock splits). Such rights entitled the employees to payment in stock and cash of market price increases in the Company's stock in the excess of the base price in equal twenty-five percent increments on September 30, 1989 through 1992. In September 1992 and 1991, employees exercised their stock appreciation rights with respect to 4,104 and 2,556 shares of Class A Common Stock, respectively. In addition, an aggregate of 4,950 of the rights were canceled through August 31, 1992. During fiscal 1993, stock appreciation rights previously granted under the Plan expired in accordance with the terms of the Plan.\nEmployee stock purchase plan - In fiscal 1989, the Company approved a stock purchase plan under which 1,125,000 shares of Class A Common Stock can be issued. Under the terms of the plan, eligible employees may purchase shares of the Company's Class A Common Stock through payroll deductions. The purchase price is the lower of 85% of the fair market value of the stock on the first or last day of the purchase period. During fiscal 1993, the plan was amended to allow the participation of Barton employees. During fiscal 1994, 1993 and 1992, employees purchased 58,955, 21,071 and 18,526 shares, respectively.\nCommon stock - On September 26, 1991 and June 1, 1992, the Company's Board of Directors declared three-for-two splits of the Company's common shares. The new shares were distributed on November 8, 1991 and July 20, 1992 to holders of record on October 11, 1991 and June 22, 1992, respectively. At August 31,1994, there were 12,617,301 shares of Class A Common Stock and 3,390,051 shares of Class B Common Stock outstanding, net of treasury stock. All per share amounts have been retroactively restated to give effect to the splits.\nOn June 28, 1993, the Company approved an increase in the number of authorized shares of the Company's Class A Common Stock from 15,000,000 shares to 60,000,000 shares and an increase in the number of authorized shares of the Company's Class B Common Stock from 5,000,000 shares to 20,000,000 shares.\nStock offering - During February 1992, the Company completed a public offering of 2,589,750 shares of its Class A Common Stock resulting in net proceeds after underwriters' discounts and commissions and expenses to the Company, of approximately $31,981,000. Under the terms of the Credit Agreement, approximately $16,000,000, constituting approximately 50% of the net proceeds, was applied to reduction of the Term Loans, and $5,000,000 was applied by the Company to reduce the balances outstanding under the Revolving Credit Loans.\nOn November 10, 1994, the Company completed a public offering of 3,000,000 shares of its Class A Common Stock resulting in net proceeds after underwriters' discounts and commissions and estimated expenses to the Company, of approximately $95,428,000 . In connection with the offering, 432,067 of the Vintners Option Shares were exercised and the Company received proceeds of $7,885,000. Under the terms of the amended Credit Agreement, approximately $82,000,000, will be used to repay a portion of the Term Loan under the Company's Credit Agreement. The balance of net proceeds will be used for working capital purposes and will initially be used to repay Revolving Credit Loans under the Credit Facility.\n11. COMMITMENTS AND CONTINGENCIES:\nOperating leases - Future payments under noncancelable operating leases having initial or remaining terms of one year or more are as follows:\nYear ending August 31: (in thousands) 1995 $1,487 1996 1,352 1997 1,358 1998 1,114 1999 831 Thereafter 3,543 $9,685\nRental expense was approximately $3,318,000 in fiscal 1994, $1,841,000 in fiscal 1993 and $1,460,000 in fiscal 1992.\nPurchase commitments - The Company has two agreements with certain suppliers to purchase blended Scotch whisky through December 31, 1999. The purchase prices under the agreements are denominated in British pounds sterling and based upon exchange rates at August 31, 1994, the Company's aggregate future obligation will be approximately $13,124,000 to $16,306,000 for the contracts expiring on December 31, 1995 and approximately $11,160,000 to $13,640,000 for the contracts expiring on December 31, 1999.\nIn connection with the Vintners Acquisition, and the Almaden\/Inglenook Acquisition, the Company has assumed purchase contracts with certain growers and suppliers. Under the grape purchase contracts, the Company is committed to purchase all grape production yielded from a specified number of acres for a period of time ranging up to ten years. The actual tonnage and price of grapes that must be purchased by the Company will vary each year depending on certain factors, including weather, time of harvest, overall market conditions and the agricultural practices and location of the growers and suppliers under contract.\nThe Company purchased $ 25,167,000 of grapes under these contracts during the period October 15, 1993 through August 31, 1994. Based on current production yields and published grape prices, the Company estimates that the aggregate purchases under these contracts over the remaining term of the contracts will be approximately $394,467,000. During fiscal 1994, in connection with the Vintners Acquisition and the Almaden\/Inglenook Acquisition, the Company established a reserve for the estimated loss on these firm purchase commitments of approximately $62,664,000.\nThe Company's aggregate obligations under the grape crush and processing contracts will be approximately $5,503,000 over the remaining term of the contracts which expire through fiscal 1997.\nCurrency forward contracts - At August 31, 1994 and 1993, the Company had open currency forward contracts to purchase German deutsche marks of $6,674,000 and $6,031,000 respectively, and British pounds of $579,000 and $928,000, respectively,\nall of which mature within 12 months; their fair market values, based upon August 31, 1994 and 1993 market exchange rates, were $7,382,000 and $6,262,000, respectively, for German deutsche marks and $614,000 and $929,000 respectively for British pounds.\nEmployment contracts - The Company has employment contracts with certain of its executive officers and certain other management personnel with remaining terms ranging up to five years. These agreements provide for minimum salaries, as adjusted for annual increases, and may include incentive bonuses based upon attainment of specified management goals. In addition, these agreements also provide for severance payments in the event of specified terminations of employment. The aggregate commitment for future compensation and severance, excluding incentive bonuses, was approximately $7,300,000 as of August 31, 1994.\nLegal matters - The Company is subject to litigation from time to time in the ordinary course of business. Although the amount of any liability with respect to such litigation cannot be determined, in the opinion of management, such liability will not have a material adverse effect on the Company's financial condition or results of operations.\n12. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK:\nThe Company sells its products principally to wholesalers for resale to retail outlets including grocery stores, package liquor stores, club and discount stores and restaurants. Gross sales to the five largest wholesalers of the Company represented 23.7%, 25.1% and 28.5% of the Company's gross sales for the fiscal years ended August 31, 1994, 1993 and 1992, respectively. Gross sales to the Company's largest wholesaler represented 12.3% of the Company's gross sales for the fiscal year ended August 31, 1994; no single wholesaler was responsible for greater than 10% of gross sales during the fiscal years ended August 31, 1993 and 1992. Gross sales to the Company's five largest wholesalers are expected to continue to represent a significant portion of the Company's revenues. The Company's arrangements with certain of its wholesalers may, generally, be terminated by either party with prior notice. The Company performs ongoing credit evaluations of its customers' financial position, and management of the Company is of the opinion that any risk of significant loss is reduced due to the diversity of customers and geographic sales area.\n13. THE RESTRUCTURING PLAN\nIn the fourth quarter, the Company provided for costs to restructure the operations of its California wineries (the Restructuring Plan). Under the Restructuring Plan, all bottling operations at the Central Cellars winery in Lodi, California and the branded wine bottling operations at the Monterey Cellars Winery in Gonzales, California will be moved to the Mission Bell Winery located in Madera, California which was acquired by the Company in the Almaden\/Inglenoook Acquisition. The Monterey Cellars Winery will continue to be used as a crushing, winemaking and contract bottling facility. The Central Cellars Winery and the winery in Soledad, California will be closed and offered for sale to reduce surplus capacity. The\nRestructuring Plan reduced income before income taxes and net income by approximately $24,005,000 and $14,883,000, respectively or $.91 per share, on a fully diluted basis. Of the total pretax charge, approximately $16,481,000 is to recognize estimated losses associated with the revaluation of land, buildings and equipment related to the facilities described above to their estimated net realizable value; and approximately $7,524,000 relates to severance and other benefits associated with the elimination of 260 jobs. The Restructuring Plan will require the Company to make capital expenditures of approximately $20,000,000 during fiscal 1995 to expand storage capacity and install certain relocated equipment. As of August 31,1994, the Company has a remaining accrual of approximately $9,106,000 with respect to the Restructuring Plan. The Company expects to have the Restructuring Plan fully implemented by the end of fiscal 1995.\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nSELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (In thousands, except per share data)\nQUARTER ENDED 11\/30\/93 2\/28\/94 5\/31\/94 8\/31\/94 YEAR\nNet sales $154,485 $140,031 $154,223 $180,845 $629,584 Gross profit 44,655 41,668 42,775 53,275 182,373 Net income 5,653 5,741 6,655 (6,316) 11,733 Earnings per share: Primary .40 .35 .41 (.39) .74 Fully diluted .37 .35 .41 (.38) .74\nQUARTER ENDED 11\/30\/92 2\/28\/93 5\/31\/93 8\/31\/93 YEAR\nNet sales $71,109 $58,782 $60,495 $115,922 $306,308 Gross profit 21,537 17,693 18,411 33,737 91,378 Net income 3,604 2,952 3,391 5,657 15,604 Earnings per share: Primary .31 .25 .29 .45 1.30 Fully diluted .28 .24 .27 .41 1.20\nQUARTER ENDED 11\/30\/91 2\/28\/92 5\/31\/92 8\/31\/92 YEAR\nNet sales $63,580 $56,942 $65,068 $59,652 $245,242 Gross profit 17,834 17,211 18,829 16,683 70,557 Net income 2,410 2,128 3,357 3,461 11,356 Earnings per share: Primary .26 .23 .29 .30 1.08 Fully diluted .25 .22 .27 .27 1.01\nPer share amounts have been appropriately adjusted to reflect the Company's stock splits (see Note 10 in the Company's consolidated financial statements).\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE V CANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nPROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\nBalance at Transfers, Balance Beginning Addition Retirements at End Classification of Year at Cost or Sales of Year\nYEAR ENDED AUGUST 31, 1992: Land $ 1,206 $ 2,925 $ - $ 4,131 Buildings and improvements 19,926 6,370 - 26,296 Machinery and equipment 57,606 25,126 60 82,672 Motor vehicles 1,792 19 - 1,811 Construction in progress 937 3,702 2,425 2,214 $81,467 $38,142 $ 2,485 $117,124\nYEAR ENDED AUGUST 31, 1993: Land $ 4,131 $ 472 $ 298 $ 4,305 Buildings and improvements 26,296 3,839 - 30,135 Machinery and equipment 82,672 9,095 606 91,161 Motor vehicles 1,811 1,495 752 2,554 Construction in progress 2,214 5,404 5,543 2,075 $117,124 $20,305 $ 7,199 $130,230\nYEAR ENDED AUGUST 31, 1994: Land $ 4,305 $ 9,889 $ 380 $ 13,814 Buildings and improvements 30,135 34,160 1,855 62,440 Machinery and equipment 91,161 90,006 12,936 168,222 Motor vehicles 2,554 171 173 2,552 Construction in progress 2,075 6,964 59 8,989 $130,230 $141,190 $15,403 $256,017\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE VI\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nACCUMULATED DEPRECIATION AND AMORTIZATION OF\nPROPERTY, PLANT AND EQUIPMENT\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\nBalance at Retirements Balance at Beginning and Other End of Classification of Year Provision Disposals Year\nYEAR ENDED AUGUST 31, 1992: Buildings and improvements $ 5,990 $ 760 $ - $ 6,750 Machinery and equipment 31,523 5,150 3 36,670 Motor vehicles 962 172 - 1,134 $38,475 $6,082 $ 3 $44,554\nYEAR ENDED AUGUST 31, 1993: Buildings and improvements $ 6,750 $ 918 $ - $ 7,668 Machinery and equipment 36,670 6,315 9 42,976 Motor vehicles 1,134 156 304 986 $44,554 $7,389 $313 $51,630\nYEAR ENDED AUGUST 31, 1994: Buildings and improvements $ 7,668 $ 1,361 $ 2 $ 9,027 Machinery and equipment 42,976 8,989 296 51,669 Motor vehicles 986 184 132 1,038 $51,630 $10,534 $430 $61,734\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE IX\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nSHORT-TERM BORROWINGS\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\n1994 1993 1992\nNotes Payable to Banks for Short-Term Borrowings\nBalance at August 31, $19,000 $ 9,000 $ -\nWeighted average interest rate on notes payable to banks at end of year 6.45% 5.7% -\nMaximum amount of notes payable outstanding at any month-end 185,000 35,000 14,000\nWeighted average amount of notes payable outstanding during the year (a) 55,375 18,500 4,000 Weighted average interest rate on notes payable outstanding during the year (b) 6.07% 5.7% 7.3%\n(a) The weighted average amount of notes payable outstanding for fiscal 1994, 1993 and 1992 was calculated by dividing the sum of total short-term borrowings outstanding at each month end by the number of months in the fiscal year.\n(b) The weighted average interest rate on notes payable outstanding during fiscal 1994, 1993 and 1992 was calculated by dividing the total interest expense on all short-term borrowings by the average daily amount outstanding.\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\nSCHEDULE X\nCANANDAIGUA WINE COMPANY, INC. AND SUBSIDIARIES\nSUPPLEMENTARY OPERATING STATEMENT INFORMATION\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (in thousands)\nCharged to Cost and Expenses Item 1994 1993 1992\nExcise taxes $231,475 $83,109 $59,875\nAdvertising 64,540 33,002 24,285\nMaintenance and repairs 5,221 2,563 2,171\nThe accompanying notes to consolidated financial statements are an integral part of this schedule. \/TABLE\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 (except for the information regarding executive officers required by Item 401 of Regulation S-K which is included in Part I hereof in accordance with General Instruction G(3)) is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995 under the heading \"Nomination and Election of Directors\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\nItem 11. Executive Compensation.\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995, under the heading \"Executive Compensation\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995, under the headings \"Beneficial Ownership\" and \"Nomination and Election of Directors\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\nItem 13. Certain Relationships and Related Transactions\nThe information required by this Item is incorporated herein by reference to the Company's proxy statement to be issued in connection with the Annual Meeting of Stockholders of the Company to be held on January 19, 1995, under the heading \"Executive Compensation\", which proxy statement will be filed within 120 days after the end of the Company's fiscal year.\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 Company are submitted herewith:\nReport of Independent Public Accountants\nConsolidated Balance Sheets - August 31, 1994 and 1993\nConsolidated Statements of Income for the years ended August 31, 1994, 1993 and 1992\nConsolidated Statements of Changes in Stockholders' Equity for the years ended August 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the years ended August 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe following consolidated financial information is submitted herewith:\nSchedule V Property, Plant and Equipment for the years ended August 31, 1994, 1993 and 1992\nSchedule VI Accumulated Depreciation and Amortization of Property, Plant and Equipment for the years ended August 31, 1994, 1993 and 1992\nSchedule IX Short-term Borrowings for the years ended August 31, 1994, 1993 and 1992\nSchedule X Supplementary Operating Statement Information for the years ended August 31, 1994, 1993 and 1992\nSelected Financial Data -- Five-Year Summary\nSelected Quarterly Financial Information (Unaudited)\nAll other schedules are not submitted because they are not applicable or not required under Regulation S-X or because the required information is included in the financial statements or notes thereto.\nIndividual financial statements of the Registrant have been omitted because the Registrant is primarily an operating company and no subsidiary included in the consolidated financial statements has minority equity interests and\/or non-current indebtedness, not guaranteed by the Registrant, in excess of 5% of total consolidated assets.\n3. Exhibits required to be filed by Item 601 of Regulation S-K\nThe following exhibits are filed herewith or incorporated herein by reference, as indicated:\n2.1 Asset Purchase Agreement dated August 2, 1991 between the Registrant and Guild Wineries and Distilleries, as assigned to an acquiring subsidiary (filed as Exhibit 2(a) to the Registrant's Report on Form 8-K dated October 1, 1991 and incorporated herein by reference). 2.2 Stock Purchase Agreement dated April 27, 1993 among the Registrant, Barton Incorporated and the stockholders of Barton Incorporated, Amendment No. 1 to Stock Purchase Agreement dated May 3, 1993, and Amendment No. 2 to Stock Purchase Agreement dated June 29, 1993 (filed as Exhibit 2(a) to the Registrant's Current Report on Form 8-K dated June 29, 1993 and incorporated herein by reference). 2.3 Asset Sale Agreement dated September 14, 1993 between the Registrant and Vintners International Company, Inc. (filed as Exhibit 2(a) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 2.4 Amendment dated as of October 14, 1993 to Asset Sale Agreement dated as of September 14, 1993 by and between Vintners International Company, Inc. and the Registrant (filed as Exhibit 2(b) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 2.5 Amendment No. 2 dated as of January 18, 1994 to Asset Sale Agreement dated as of September 14, 1993 by and between Vintners International Company, Inc. and the Registrant (filed as Exhibit 2.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended February 28, 1994 and incorporated herein by reference). 2.6 Asset Purchase Agreement dated August 3, 1994 between the Registrant and Heublein, Inc. (filed as Exhibit 2(a) to the Registrant's Current Report on Form 8-K dated August 5, 1994 and incorporated herein by reference). 2.7 Amendment dated November 8, 1994 to Asset Purchase Agreement between Heublein, Inc. and Registrant (filed as Exhibit 2.2 to the Registrant's Registration Statement on Form S-3 (Amendment No. 2) (Registration No. 33-55997) filed with the Securities and Exchange Commission on November 8, 1994 and incorporated herein by reference).\n2.8 Amendment dated November 18, 1994 to Asset Purchase Agreement between Heublein, Inc. and the Registrant (filed herewith). 3.1 Restated Certificate of Incorporation of the Company (filed as Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 3.2 Amended and Restated By-laws of the Company (filed as Exhibit 4.2 to the Registrant's Registration Statement on Form S-8 (Registration No. 33-56557) and incorporated herein by reference).\n4.1 Specimen of Certificate of Class A Common Stock of the Company (filed as Exhibit 1.1 to the Registrant's Registration Statement on Form 8-A, dated April 28, 1992 and incorporated herein by reference). 4.2 Specimen of Certificate of Class B Common Stock of the Company (filed as Exhibit 1.2 to the Registrant's Registration Statement on Form 8-A, dated April 28, 1992 and incorporated herein by reference). 4.3 Indenture dated as of December 27, 1993 among the Registrant, its Subsidiaries and Chemical Bank (filed as Exhibit 4.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1993 and incorporated herein by reference). 4.4 First Supplemental Indenture dated as of August 3, 1994 among the Registrant, Canandaigua West, Inc. and Chemical Bank (filed as Exhibit 4.5 to the Registrant's Registration Statement on Form S-8 (Registration No. 33- 56557) and incorporated herein by reference). 10.1 The Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Appendix B of the Company's Definitive Proxy Statement dated December 23, 1987 and incorporated herein by reference). 10.2 Amendment No. 1 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended August 31, 1992 and incorporated herein by reference). 10.3 Amendment No. 2 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 28 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1992 and incorporated herein by reference). 10.4 Amendment No. 3 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Rights Plan (filed as Exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.5 Amendment No. 4 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended November 30, 1993 and incorporated herein by reference). 10.6 Amendment No. 5 to the Canandaigua Wine Company, Inc. Stock Option and Stock Appreciation Right Plan (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the fiscal quarter ended February 28, 1994 and incorporated herein by reference). 10.7 Employment Agreement between Barton Incorporated and Ellis M. Goodman dated as of October 1, 1991 as amended by Amendment to Employment Agreement between Barton Incorporated and Ellis M. Goodman dated as of June 29, 1993 (filed as Exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.8 Barton Incorporated Management Incentive Plan (filed as Exhibit 10.6 to the Registrant's Annual Report on Form\n10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.9 Ellis M. Goodman Split Dollar Insurance Agreement (filed as Exhibit 10.7 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.10 Barton Brands, Ltd. Deferred Compensation Plan (filed as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.11 Marvin Sands Split Dollar Insurance Agreement (filed as Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the fiscal year ended August 31, 1993 and incorporated herein by reference). 10.12 Amendment and Restatement dated as of June 29, 1993 of Credit Agreement among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(b) to the Registrant's Current Report on Form 8-K dated June 29, 1993 and incorporated herein by reference). 10.13 Amendment No. 1 dated as of October 15, 1993 to Amendment and Restatement dated as of June 29, 1993 of Credit Agreement among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(c) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 10.14 Senior Subordinated Loan Agreement dated as of October 15, 1993 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as Agent (filed as Exhibit 2(d) to the Registrant's Current Report on Form 8-K dated October 15, 1993 and incorporated herein by reference). 10.15 Second Amendment and Restatement dated as of August 5, 1994 of Amendment and Restatement of Credit Agreement dated as of June 29, 1993 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(b) to the Registrant's Current Report on Form 8-K dated August 5, 1994 and incorporated herein by reference). 10.16 Amendment No. 1 (dated as of August 5, 1994) to Second Amendment and Restatement dated as of August 5, 1994 of Amendment and Restatement of Credit Agreement dated as of June 29, 1993 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed herewith). 10.17 Security Agreement dated as of August 5, 1994 among the Registrant, its subsidiaries and certain banks for which The Chase Manhattan Bank (National Association) acts as agent (filed as Exhibit 2(c) to the Registrant's Current Report on Form 8-K dated August 5, 1994 and incorporated herein by reference. 11.1 Statement of computation of per share earnings (filed herewith). 21.1 Subsidiaries of Registrant (filed herewith). 23.1 Consent of Arthur Andersen & Co. (filed herewith).\n(b) Reports on Form 8-K\nThe following Current Reports on Form 8-K were filed with the Securities and Exchange Commission during the fourth quarter of the Company's 1994 fiscal year:\n1. Form 8-K dated June 23, 1994. This Form 8-K reported information under Item 5 (Other Events).\n2. Form 8-K dated August 5, 1994. This Form 8-K reported information under Item 2 (Acquisition or Disposition of Assets), Item 5 (Other Events) and 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":"110621_1994.txt","cik":"110621","year":"1994","section_1":"ITEM 1. BUSINESS.\nTHE COMPANY\nRPM, Inc. (\"RPM\" or the \"Company\") was organized in 1947 as an Ohio corporation under the name Republic Powdered Metals, Inc. On November 9, 1971, the Company's name was changed to RPM, Inc. As used herein, the terms \"RPM\" and the \"Company\" refer to RPM, Inc. and its subsidiaries, unless the context indicates otherwise. The Company has its principal executive offices at 2628 Pearl Road, P.O. Box 777, Medina, Ohio 44258, and its telephone number is (216) 273-5090.\nRECENT DEVELOPMENTS\nSince RPM's offering of Common Shares to the public in September 1969, the Company has made a number of significant acquisitions that have been described in previous reports on file with the Securities and Exchange Commission. RPM's acquisition strategy focuses on companies with high performance and quality products which are leaders in their respective markets. Part of RPM's acquisition strategy is to locate companies with products that can also be distributed through existing operating companies. RPM expects to continue its acquisition program, although there is no assurance that any acquisitions will be made.\nAs part of this acquisition program, on June 8, 1993 the Company acquired all of the outstanding shares of Dynatron\/Bondo Corporation, a manufacturer and marketer of auto and marine body filler and related products, and on October 26, 1993 the Company acquired all of the outstanding shares of Stonhard, Inc., a manufacturer and marketer of polymer-based floorings, linings and construction products for applications in industrial and commercial markets. In addition, on June 28, 1994 the Company acquired all of the outstanding shares of Rust-Oleum Corporation, a manufacturer and marketer of protective coatings and specialty chemicals, including consumer rust-preventative coatings. In 1991 the Company had acquired the European operations of Rust-Oleum and, thus, the Company now owns all of Rust-Oleum.\nOn June 23, 1994 the Company entered into a $300 million three-year revolving credit facility with National City Bank and The First National Bank of Chicago, as Co-Agents, and The Chase Manhattan Bank (National Association), as Administrative Agent (the \"Credit Facility\"). In connection therewith, the Company's existing credit facility with a group of banks was terminated and all amounts outstanding thereunder totalling approximately $47 million were repaid pursuant to an advance under the Credit Facility. In addition, the Company utilized a $176.5 million advance under the Credit Facility to pay for the Rust-Oleum\nCorporation acquisition. As of August 19, 1994, there was approximately $233 million of principal advanced under the Credit Facility. There have not been any other material changes or developments since June 1, 1994 in the business done or intended to be done by the Company.\nBUSINESS\nRPM operates principally in one business segment, the manufacture and marketing of protective coatings. These protective coatings products are used for both industrial and consumer applications. For industrial applications, RPM manufactures and markets coatings for waterproofing and general maintenance, corrosion control, and other specialty chemical applications. For consumer applications, RPM manufactures do-it-yourself products for the home maintenance, automotive repair, and consumer hobby and leisure markets. RPM, through its operating companies, serves niche markets within these broader categories, thus providing a foundation for its strategy of growth through product line extensions.\nThe protective coating products manufactured by RPM are used primarily on property which already exists. RPM is not involved to any great degree in new construction and, therefore, is generally less affected by cyclical movements in the economy. RPM markets its products in approximately 110 countries and operates manufacturing facilities in 45 locations in the United States, Belgium, Canada, Luxembourg and The Netherlands.\nINDUSTRIAL MARKETS AND PRODUCTS\nWATERPROOFING AND GENERAL MAINTENANCE. Waterproofing and general maintenance constitute RPM's original marketplace, having been served by Republic Powdered Metals, Inc. since the Company's founding. Operating companies and products include: REPUBLIC POWDERED METALS--heavy-duty protective coatings and single-ply roofing systems; RPM NETHERLANDS B.V.--coatings for industrial routine maintenance; MAMECO INTERNATIONAL--sealants, deck coatings and membranes; MARTIN MATHYS--water-based coatings for commercial and industrial maintenance; and STONHARD -- high-performance polymer floors, linings and wall systems.\nCORROSION CONTROL. RPM's CARBOLINE manufactures high-performance corrosion-resistant protective coatings, fireproofing, tank linings and floor coatings, and markets these products to industrial, architectural and applicator companies throughout the world. WISCONSIN PROTECTIVE COATINGS manufactures a complete line of liquid-applied, corrosion-resistant coatings used for extremely harsh environments, such as rail cars, tank linings, and smoke stacks.\nSPECIALTY CHEMICALS. RPM's specialty chemicals businesses address selected niche markets within this broad industry category. Specialty chemical companies and products include: DAY-GLO COLOR--fluorescent colorants and pigments; MOHAWK FINISHING PRODUCTS--furniture repair, cleaning and polishing products; ALOX--chemical additives used as rust preventatives, corrosion inhibitors, special lubricants and metal working compounds; CHEMICAL SPECIALTIES--chemicals used for cleaning carpet, upholstery and fabric wall covering, and chemicals used in smoke and fire restoration cleanup; and AMERICAN EMULSIONS--dye additives for textile dyeing and finishing, and water treatment products for the paper industry.\nCONSUMER MARKETS AND PRODUCTS\nCONSUMER HOBBY AND LEISURE. The hobby and leisure marketplace is served by TESTOR, America's largest producer and marketer of model paints and accessory items to the hobby and model market, CRAFT HOUSE, producer of Paint-by-Numbers sets, basic preschool activity sets, crafts and hobby products, and FLOQUIL\/POLY S COLOR, manufacturer of hobby, art and craft coatings. RPM's consumer hobby and leisure products are marketed through thousands of mass merchandise, toy and hobby stores throughout North America.\nCONSUMER DO-IT-YOURSELF. RPM's six primary consumer do-it-yourself businesses are RUST-OLEUM, WM. ZINSSER, KOP-COAT, BONDEX INTERNATIONAL, DYNATRON\/BONDO and TALSOL. RUST-OLEUM manufactures high-quality corrosion-resistant coatings for the household maintenance and light industrial markets. WM. ZINSSER is the nation's leading producer of shellac items used as pharmaceutical glazes, confectioner's glazes, citrus fruit coatings and wood coatings, including a broad line of specialty primers and sealers. KOP-COAT manufactures pleasure marine coatings and compounds and manufactures wood treatment products. BONDEX INTERNATIONAL produces a nationwide line of household patch and repair products, in addition to basement waterproofing products. DYNATRON\/BONDO manufactures auto and marine body filler and related products. TALSOL manufactures automotive paints and coatings. Other consumer do-it-yourself products include fabrics, window treatments and wall coverings sold by DESIGN\/CRAFT FABRIC and RICHARD E. THIBAUT. RPM's consumer do-it-yourself products are marketed through thousands of mass merchandise, home center and hardware stores throughout North America.\nFOREIGN OPERATIONS\nThe Company's foreign operations for the year ended May 31, 1994 accounted for approximately 12.3% of its total sales, although it also receives license fees and royalty income from numerous license agreements and joint ventures in foreign countries. The Company has manufacturing facilities in Canada,\nBelgium, the Netherlands and Luxembourg, and sales offices or public warehouse facilities in France, England, Iberia, Mexico, the Philippines and several other countries. Information concerning the Company's foreign operations is set forth in Note J (Industry Segment and Geographic Area Information) of Notes to Consolidated Financial Statements, which appear elsewhere in this Form 10-K Annual Report.\nCOMPETITION\nThe Company is engaged in a highly competitive industry and, with respect to all of its major products, faces competition from local and national firms. Several of the companies with which RPM competes have greater financial resources and sales organizations than the Company. While no accurate figures are available with respect to the size of or the Company's position in the market for any particular product, management believes that the Company is a major producer of aluminum coatings, cement-based paint, hobby paints, marine coatings, furniture finishing repair products, automotive repair products, industrial corrosion control and consumer rust-preventative coatings. The Company, however, does not believe that it has a significant share of the total protective coatings market.\nPATENTS, TRADEMARKS AND LICENSES\nNo single patent, trademark (other than the marks Day-Glo, Rust-Oleum and Carboline, which are material), name or license, or group of these rights, is material to the Company's business.\nDay-Glo Color Corp., a subsidiary of the Company, is the owner of over 50 trademark registrations of the mark and name \"DAY-GLO\" in numerous countries and the United States for a variety of fluorescent products. There are also many other foreign and domestic registrations for other trademarks of the Day-Glo Color Corp., for a total of over 100 registrations. These registrations are valid for a variety of terms ranging from one year to twenty years, which terms are renewable as long as the marks continue to be used. Many of these registrations are renewed on a regular basis.\nRust-Oleum Corporation, a subsidiary of the Company, is the owner of over 50 United States trademark registrations for the mark and name \"RUST-OLEUM\" and other trademarks covering a variety of rust-preventative coatings sold by Rust-Oleum Corporation. There are also many foreign registrations for \"RUST-OLEUM\" and the other trademarks of Rust-Oleum Corporation, for a total of nearly 400 registrations. These registrations are valid for a variety of terms ranging from one year to twenty years, which terms are renewable for as long as the marks continue to be used. Many of these registrations are renewed on a regular basis.\nCarboline Company, a subsidiary of the Company, is the owner of a United States trademark registration for the mark \"CARBOLINE\". Carboline Company is also the owner of several other United States registrations for other trademarks. Renewal of these registrations is done on a regular basis.\nProduct trade names include: ALOX, ALUMANATION, AVALON, B-I-N PRIMER-SEALER, BITUMASTIC, BONDO, BONDEX, BULLS EYE SHELLAC, CARBOLINE, COLOR DOUGH, CRAFT HOUSE, DAY-GLO, DYNALITE, DYNATRON, EASY FINISH, EPOXSTEEL, EZ WELD, FLOQUIL, GEOFLEX, LUBRASPIN, MAR-HYDE, MOHAWK, PARASEAL, PERMAROOF, PETTIT, PLASITE, RADGLO, RUST-OLEUM, SANITILE, STONCLAD, STONHARD, STONSHIELD, TALSOL, TESTORS, ULTRALITE, VULKEM, WOOLSEY, ZINSSER and Z-SPAR; and, in Europe, RUST-OLEUM and MARTIN MATHYS.\nRAW MATERIALS\nThe Company believes that alternate sources of supply of raw materials are available to the Company for most of its raw materials. Where shortages of raw materials have occurred, the Company has been able to reformulate products to use more readily available raw materials. Although the Company has been able to reformulate products to use more readily available raw materials in the past, there can be no assurance as to the Company's ability to do so in the future.\nSEASONAL FACTORS\nThe Company's business is seasonal due to outside weather factors. The Company historically experiences strong sales and income in the first, second and fourth fiscal quarters, with weaker performance in the third fiscal quarter (December through February).\nCUSTOMERS\nNo one customer accounted for 10% or more of the Company's total sales. The Company's business is not dependent upon any one customer or small group of customers and is dispersed over thousands of customers.\nBACKLOG\nThe Company historically has not had a significant backlog of orders, nor was there a significant backlog during the last fiscal year.\nRESEARCH\nThe Company's research and development work is performed in various laboratory locations throughout the United States. During fiscal years 1994, 1993 and 1992, the Company invested approximately $11.1 million, $10.0 million and $9.1 million, respectively, on research and development activities. The customer sponsored portion of such expenditures was not significant.\nENVIRONMENTAL MATTERS\nWhile the Company is involved in several environmental matters (see ITEM 3. LEGAL PROCEEDINGS), compliance with environmental laws and regulations has not had and is not expected to have a material adverse effect on capital expenditures, earnings, or the competitive position of the Company.\nEMPLOYEES\nThe Company employs approximately 4,500 persons, of whom approximately 800 were represented by unions under contracts which expire at varying times in the future. The Company believes that its relations with its employees are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's corporate headquarters and a plant and offices for one subsidiary are located on an 80-acre site in Medina, Ohio, which is owned by the Company. The Company's operations occupy a total of approximately 4.9 million square feet, with the majority, approximately 4.4 million square feet, devoted to manufacturing, assembly and storage. Of the approximately 4.9 million square feet occupied, 3.7 million square feet are owned and 1.2 million square feet are occupied under operating leases. The Company's facilities of 100,000 square feet or larger, as of August 1, 1994, are set forth in the table below.\n- - ---------------------------- (1) Rental payments are being used to pay principal and interest on Industrial Revenue Bonds issued by Wachovia National Bank on behalf of Fulton County, Georgia Development Authority. At June 1, 1994 the outstanding balance of such indebtedness was $1,950,000.\nFor information concerning the Company's rental obligations, see Note F (Leases) of Notes to Consolidated Financial Statements, which appear elsewhere in this Form 10-K Annual Report. Under all of its leases, the Company is obligated to pay certain varying insurance costs, utilities, real property taxes and other costs and expenses.\nThe Company believes that its manufacturing plants and office facilities are well maintained and suitable for the operations of the Company.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nBondex International, Inc., a wholly-owned subsidiary of the Company (\"Bondex\"), was dismissed with prejudice from a pending asbestos-related bodily injury lawsuit which had consolidated the claims of fourteen plaintiffs. The dismissal resulted from the inability of the plaintiffs to produce evidence of exposure to any Bondex asbestos-containing product. With the addition of 43 newly-filed cases (including 33 filed by one law firm in Middlesex County, New Jersey), there are currently pending against Bondex a total of 340 asbestos-related bodily injury cases filed on behalf of various individuals in various jurisdictions in the United States. All of these lawsuits name numerous other corporate defendants and all allege bodily injury as a result of the exposure to or use of asbestos-containing products. Bondex continues to deny liability in all asbestos-related lawsuits and continues to vigorously defend them. Under a cost-sharing agreement among Bondex and its insurers effected in February, 1994, the insurers are responsible for payment of a substantial portion of defense costs and indemnity payments, if any, with Bondex responsible for a minor portion of each.\nAs previously reported in the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1993, Carboline Company, a wholly-owned subsidiary of the Company (\"Carboline\"), has been named as one of 21 corporate defendants in RUFINO O. CAVAZOS, ET AL., V. CEILCOTE COMPANY, ET AL., District Court, 73rd Judicial District, Bexar County, Texas; Cause No. 89-Cl-12651, filed in March, 1990, and in similar suits subsequently filed on behalf of individuals (and, where applicable, their spouses and children) employed at the Comanche Peak Nuclear Plant. Several supplemental petitions have been filed in Bexar County for the purposes of adding other spouses and children of the worker plaintiffs, bringing the total number of Bexar County plaintiffs to 10,110. Another suit with virtually identical allegations was filed in Rusk County, Texas on December 29, 1993. That suit, Cause No. 93-470; MARY GUNN, ET AL. V. SOUTHERN IMPERIAL COATINGS CORP., 4th District Court, Rusk County, Texas, involves 201 worker plaintiffs and 128 spouses. All of the suits allege bodily injury as a result of exposure to defendants' products. As the result of the institution of receivership proceedings against Employers Casualty Insurance Company (the carrier previously defending three unrelated defendants), a stay has been entered in all the cases, and is due to expire on January 6, 1995. Prior to the stay, the litigation had been continuing in the discovery stage. Carboline has denied all liability and is conducting a vigorous defense. Several of Carboline's insurance carriers, and Carboline, are defending the lawsuit under a cost sharing agreement.\nAs previously reported in the Company's Quarterly Report on Form 10-Q for the quarter ended February 28, 1994, in September, 1991, Our Lady of the Lake Hospital, Inc. (\"OLOL\") filed suit\ncaptioned OUR LADY OF THE LAKE HOSPITAL, INC. V. CARBOLINE COMPANY, ET AL., Number 373,498, Division \"J\", Nineteenth Judicial District Court, Parish of East Baton Rouge, State of Louisiana, alleging damages to the structural steel of the hospital which it owns and operates in Baton Rouge, Louisiana. The petition alleged that the damages resulted from its use of a fireproofing product known as Pyrocrete manufactured and supplied by Carboline and that Pyrocrete is extremely corrosive when applied to structural steel, contains a latent defect, and is defective. Carboline has contested liability in the case vigorously, and on July 21, 1992, the trial court sustained an Exception of Prescription filed on Carboline's behalf and dismissed the suit with prejudice. OLOL appealed, and on December 29, 1993, the appellate court vacated the judgment dismissing the suit and remanded the matter to the trial court for the introduction of further evidence and further proceedings. On June 13, 1994, OLOL filed a Second Supplemental and Amending Petition which joined as party defendants Sun Company, Inc. (\"Sun\") and Carboline Company, a Missouri corporation which was merged into Sun pursuant to a statutory merger in 1980 (\"Carboline Missouri\"); made claims of breach of warranty and products liability against all of the defendants; and alleged that the Pyrocrete had lost its capacity as a fireproofing agent. Pursuant to an agreement between Carboline and Sun, Carboline is providing a defense for Sun in this litigation. The Petition does not set forth the amount of damages being claimed; however, in one of the briefs filed in the appellate court, OLOL claimed it would cost in excess of $20 million to repair the damages. In addition, OLOL is preparing a substantial claim for alleged lost revenues and profits.\nIn August, 1992 OLOL filed suit against Sun captioned OUR LADY OF THE LAKE HOSPITAL, INC. V. SUN COMPANY, INC., Number 384,867, Division \"I\", Nineteenth Judicial District Court, Parish of East Baton Rouge, State of Louisiana, making allegations similar to the allegations in Number 373,498, described above, and seeking to recover alleged damages to the structural steel of the OLOL hospital. In addition, in the original petition filed in this suit, OLOL alleged that Carboline Missouri manufactured and supplied the Pyrocrete to OLOL and thereafter merged with Sun in January, 1980, with Sun remaining as the surviving corporation responsible for the obligations of Carboline Missouri. On June 29, 1993 OLOL filed a First Supplemental and Amending Petition (\"Amended Petition\") which added Carboline as an additional defendant. The Amended Petition generally alleged that Carboline damaged OLOL through fraud and also breached a contractual obligation of service after the sale. The Amended Petition alleged that OLOL will incur expenses and costs in excess of $20 million to repair the damages. Carboline has filed an Exception of Lis Pendens on the basis that this suit arose out of the same transaction or occurrence as the suit described above. Pursuant to an agreement between Carboline and Sun, Carboline is providing a defense for Sun in this litigation. Sun has filed an Exception of Lis Pendens and a Failure to Assert All Causes of Action. In June,\n1994, the court transferred and consolidated this suit with the suit described above.\nCarboline has denied the allegations of both lawsuits and is vigorously contesting them. Carboline's defense has been assumed by First Colonial Insurance Company (\"First Colonial\"), a wholly-owned insurance subsidiary of the Company. First Colonial is in the process of negotiating a cost-sharing agreement with a group of Carboline's insurers to cover both defense and indemnity obligations relating to the OLOL lawsuits.\nAs previously reported in the Company's Quarterly Report on Form 10-Q for the quarter ended August 31, 1993, and as updated in the Company's Quarterly Reports on Form 10-Q for the quarters ended November 30, 1993 and February 28, 1994, Carboline was, in May, 1993, named by the U.S. Environmental Protection Agency (\"EPA\") together with 36 other entities as a potentially responsible party (\"PRP\") under the Comprehensive Environmental Response, Compensation and Liability Act, as amended (\"CERCLA\") in connection with the Powell Road Landfill Site, Huber Heights, Ohio (the \"Site\"). Carboline is alleged to be associated with the Site as a consequence of disposal of waste originating at its Xenia, Ohio plant. Carboline has joined with other PRPs (now totalling 45) in a \"PRP Organization Agreement\" for the purpose of conducting a common response to any claim for removal or response action asserted by the EPA or the State of Ohio or conducting a common defense to any such claim. Between 1987 and 1991, the owner of the Site, Waste Management, Inc., conducted a remedial investigation (\"RI\") and feasibility study (\"FS\") and, in 1991, submitted the RI\/FS to the EPA. The EPA approved the RI in March, 1992 and approved the FS in March, 1993. Based on the RI\/FS, the EPA issued its Record of Decision in September, 1993, in which it selected the remedy for the cleanup of the Site. The remedy is estimated to cost $20.5 million and take six years to implement. Four PRPs, including the owner of the Site (but not Carboline), have entered into an Administrative Order on Consent with the EPA to prepare the Remedial Design for the selected remedy. Several other PRPs, including Carboline, have offered to participate with the four settling PRPs outside of the terms of the Administrative Order on Consent by funding a share of the Remedial Design costs, which are estimated to be approximately $1.7 million. Carboline's share of the Remedial Design costs would be approximately 1.7% of the total, or $28,900. This cost-sharing agreement for the Remedial Design is without prejudice to future cost- allocation activities regarding the cleanup itself. Based upon Carboline's estimated allocated share of total waste volume at the Site (approximately 0.50 percent) the Company believes that ultimate resolution of this matter will not have a material adverse effect on the Company's financial position or results of operations.\nAs previously reported in the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1993, and as updated in\nthe Company's Quarterly Report on Form 10-Q for the quarter ended August 31, 1993, the Company has been notified by the EPA that it may have liability as a PRP under CERCLA, in connection with the Springfield Township Dump Site, Davisburg, Michigan (the \"Springfield Site\"). The Company is alleged to be associated with the Springfield Site as well as the Rose Township Site, Rose Township, Michigan (the \"Rose Township Site\") as a consequence of the disposal of waste originating at Mac-O-Lac Paints, Inc., a former subsidiary of the Company whose assets were sold in February, 1982. The EPA issued a Record of Decision (\"ROD\") setting forth the preferred remedial action for the Springfield Site which includes removal of volatile organic compound contaminants from soils and groundwater as well as removal of PCB contaminated soils. The Company and other PRPs have organized a steering committee (the \"Steering Committee\") which has engaged in negotiations with the EPA with respect to a proposed Interim Remedial Action Phase involving removal of volatile organic contaminants from soils and groundwater and reimbursement of the EPA for past response costs. The Steering Committee has strongly disputed the ROD's requirement for PCB removal and this issue is being reevaluated by the EPA. The Company and other PRPs have entered into a Consent Order to perform a portion of the remedial design work for a cleanup and to reimburse the EPA for a portion of costs the EPA incurred at the site. The Steering Committee is presently negotiating with the EPA regarding the performance of a groundwater cleanup response action. The EPA is expected to issue a Section 106 Administrative Order to the Company and eleven other parties requiring the performance of the groundwater cleanup in accordance with the negotiated work plan. The remaining settlement issues are still under discussion with the EPA. The Company is pursuing the issue of coverage for this matter with its insurance carriers. The Company believes that the ultimate resolution of this matter will not have material adverse effect on the Company's financial position or results of operations.\nAs previously reported in the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1993, the Company and certain other entities named by the EPA as PRPs under CERCLA in connection with the Rose Township Site reached an agreement with the EPA on the terms of a Consent Decree which, on July 18, 1989, was entered by the Court in UNITED STATES OF AMERICA V. AKZO COATINGS OF AMERICA, INC. ET. AL., U.S. District Court, Eastern District of Michigan, Southern Division; Civil Action No. 88-CV-73784-DT. Pursuant to the agreement, the PRPs established a $9 million fund to cover costs of remediation at the Rose Township Site. The Company's share of the fund, $300,000, has been paid. The PRPs are currently performing the remedial action required under the Consent Decree. The settling defendants have submitted to the EPA a Feasibility Study Report recommending soil vapor extraction as a method of remediation to replace soil flushing or enhanced soil flushing. The EPA had previously concluded that neither soil flushing nor enhanced soil flushing would achieve\ntarget cleanup levels for certain materials within the time frames specified in the remedial action plan attached to the Consent Decree. The Rose Township PRP Agreement provides that, upon the occurrence of such an event, the participating PRPs shall meet to discuss the allocation of the costs of performing further work. No meetings to discuss any further allocation have been held or scheduled. It is anticipated that soil vapor extraction, if approved as a remediation method, will not cost more than soil flushing or enhanced soil flushing would have cost. The Feasibility Study, and any corrected deficiencies perceived by the EPA, must be approved by the EPA prior to selection of an alternate remedy by means of an amendment to the Record of Decision. The Company is pursuing the issue of coverage for this matter with its insurance carriers.\nOn December 3, 1992 the Company together with seven other Rose Township PRPs filed a Second Amended Complaint in AKZO COATINGS OF AMERICA, INC., ET AL. V. AMERICAN RENOVATING, ET AL., U.S. District Court, Eastern District of Michigan, Southern Division; Case No. 92-CV-74105-DT, against numerous other Rose Township PRPs not parties to the Consent Degree asserting a right of contribution from each equal to each defendant's equitable share of EPA past and future oversight costs at the Rose Township Site. The litigation is currently in the discovery stage.\nAs previously reported in the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1993, the EPA has named Mac-O-Lac Paints, Inc. as a PRP under CERCLA in connection with the Metamora Landfill Site in Lapeer County, Michigan (the \"Metamora Site\"). Mac-O-Lac Paints, Inc. was the purchaser in 1982 of the assets, including the name, Mac-O-Lac Paints, Inc., a former subsidiary of the Company, whose name was subsequently changed. In May, 1991, a number of PRPs reached agreement with the EPA on the terms of settlement for performance of remedial action at the Metamora Site. The Company has not been named as a PRP in this case and consequently did not participate in the settlement agreement with the EPA. The Company believes it has no liability in connection with the Metamora Site and considers the matter closed.\nAs previously reported in the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1993, Mohawk Finishing Products, Inc., a wholly-owned subsidiary of the Company (\"Mohawk\"), had been named by the EPA as a PRP under CERCLA in connection with the Galaxy\/Spectron Site, Elkton, Maryland (the \"Site\"). Mohawk participated with the other PRPs in Phase I cleanup at the Site, completed at a total cost to Mohawk of $15,465 pursuant to a cash-out settlement provided Mohawk and other PRPs who shipped minimal quantities of materials to the Site. The Company believes that Mohawk's share of Phase II cleanup costs, if and when determined, will be similarly inconsequential; accordingly, for purposes hereof, this matter is considered closed.\nAs previously reported in the Company's Annual Report on Form 10-K for the fiscal year ended Mary 31, 1993, Mohawk and Westfield Coatings Corporation, a wholly-owned subsidiary of the Company (\"Westfield\"), were notified by the EPA of their status as PRPs under CERCLA with respect to environmental contamination at the Solvents Recovery of New England Site (the \"SRS Site\") located in Southington, Connecticut. Since June, 1992, the EPA has named in excess of 1,700 entities as PRPs in connection with the SRS Site. The EPA recently issued a volumetric list in which Mohawk was assigned a volumetric share of 0.1167% of the waste sent to the SRS Site and Westfield Coatings was assigned a volumetric share of 0.93878%. The PRPs have not as yet agreed to any allocation formula, whether based on volume or otherwise. In April, 1994, the EPA issued the first phase of settlement offers to over 1,000 DE MINIMIS parties, which were alleged to have sent 10,000 gallons or less of hazardous substances to the SRS Site. Neither Mohawk nor Westfield was eligible to participate in this first DE MINIMIS settlement offer. To date, the EPA has expended in excess of $5 million in connection with the SRS Site, but has not yet selected the final remedial action. The EPA has, however, proposed a removal action with an estimated cost in the range of $3.5 million. PRPs not participating in the DE MINIMIS settlement have been offered the opportunity to perform the removal action. A group of several hundred PRPs, including Westfield and Mohawk, has agreed to participate.\nIn January, 1994, the EPA notified Westfield of its status as one of approximately 300 PRPs at the Old Southington Landfill Superfund Site (the \"Landfill\") on the basis that process wastes from the SRS Site were sent to the Landfill prior to October, 1967. The EPA has not issued a volumetric list for the Landfill. In May, 1994, the EPA proposed a remedial action for source control at the Landfill that includes a cap on the Landfill and a gas collection system, at an estimated cost of approximately $16 million. The EPA is currently evaluating whether mitigation of migration at the Landfill is required and expects to issue a Record of Decision for source control later this year.\nAs previously reported in the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1993, the Testor Corporation, a wholly-owned subsidiary of the Company (\"Testor\"), which had been identified by the EPA as a PRP under CERCLA in 1985 in connection with the Acme Solvent Site in Rockford, Illinois (the \"Acme Site\"), participated with other Acme Site PRPs in a voluntary remedial action pursuant to a Sharing Agreement entered into in 1986. That remedial action, Phase I of which is completed, involved removal and disposal of contaminated source materials from the Acme Site and a Supplemental Technical Investigation conducted by consultants to determine actions required for permanent remediation of soils and groundwater at the Acme Site in Phase II. Testor's share of Phase I remedial action costs totaled approximately $965,000. In September, 1991, Testor entered into\na Consent Decree with the EPA and a Sharing Agreement with 30 other Acme Site PRPs with respect to Phase II remedial action at the Acme Site and to reimburse the EPA for a portion of its past response costs, of which Testor's share of $60,000 was paid to the EPA in December, 1991. The extent of Phase II has been agreed upon in principal with the EPA subject to one exception noted herein. The remedial action includes low temperature thermal stripping of contaminated soils, filtration of VOCs and non-VOCs with carbon filtering of the groundwater, provisions for an alternate water supply to the residents whose wells have been affected, a pilot test for possible vapor extraction of the bedrock, capping of the site, and maintenance of the various systems through the year 2026. The latest cost projections for these activities is $20.4 million, although that number is subject to change due to possible modifications of the remedial design and inflationary increases. Testor's percentage has not been fixed pending an allocation of responsibility for other PRPs which are expected to join the coalition. Current projections suggest that Testor's share of these costs will be approximately 4.5%. The area of remedial activity for which there is not an agreement in principal relates to the southeast corner of an adjoining but unrelated CERCLA site. Groundwater contamination has been found in that area but a determination has not been made as to the source of the contamination.\nTestor and other ACME Site PRPs filed suit in late 1986 against non-participating PRPs in ALLIED CORPORATION, ET AL. V. ACME SOLVENTS RECLAIMING INC., ET AL., U.S. District Court, Northern District of Illinois, Western Division; Case No. 86-C-2377, seeking contribution for Phase I costs. As a result of a series of settlements, Testor has recovered a total of $541,922 as its share of the amounts recovered from certain of the defendants. The action has been dismissed. Counsel for the PRPs is currently exploring the feasibility of collecting judgments against defunct or insolvent defendants but no future recoveries of funds are anticipated.\nTestor also filed a declaratory judgment action against its general liability insurers seeking judicial determination of the carriers' duties to defend and indemnify Testor in connection with the Acme Site; THE TESTOR CORPORATION V. CONTINENTAL CASUALTY COMPANY, ET AL., Circuit Court, 17th Judicial Circuit, Winnebago County, Illinois; Case No. 87-MR-69. Discovery in that action had been stayed by the court pending resolution by the Illinois Supreme Court of certain coverage issues which were to be decided in an unrelated case. That stay was lifted in March, 1994 following a decision which was largely favorable to the legal positions taken by Testor. The primary insurers reimbursed Testor for some of its past defense costs by payment of $339,000 on December 6, 1993 and $25,000 on April 4, 1994. The primary insurers are paying current defense costs related to remedial activity at the Acme Site. Negotiations are on-going regarding reimbursement of Testor's past\nresponse costs and acceptance of responsibility for future costs. No meaningful settlement proposal has been made by the insurers to date and preparations for trial are continuing.\nIn November, 1979, the EPA commenced an action captioned UNITED STATES OF AMERICA V. MIDWEST SOLVENT RECOVERY, INC., ET AL., United States District Court for the Northern District of Indiana, Eastern Division; Civil No. H-79-556, pertaining to pollution allegedly occurring at and around real property located at 7400 West Fifteenth Street, Gary, Indiana (\"MIDCO Sites\"). The Complaint was subsequently amended in January, 1984 to join Rust-Oleum Corporation, a wholly-owned subsidiary of the Company acquired on June 28, 1994 (\"Rust-Oleum\"), and other entities as additional defendants. Rust-Oleum, one of approximately 130 identified PRPs, is alleged to be associated with the MIDCO Sites as a consequence of disposal of waste originating at its former Evanston, Illinois plant in the mid-1970's. The Court approved a Consent Decree in June, 1992 under which Rust-Oleum entered into a Settlement Agreement with the other settling PRPs for the voluntary cleanup of the MIDCO Sites consistent with the EPA Record of Decision (\"ROD\"). All surface hazardous wastes have been removed from the MIDCO Sites and cleanup is now in the groundwater remediation stage. Remediation should be complete by the end of 1996, with monitoring continuing for an undetermined period. Total remediation and monitoring costs are currently estimated to be $30 million. Included in the Consent Decree is an Agreement between the Settling PRPs, including Rust-Oleum, and Third Parties who had been sued for contribution by the generator PRPs, providing for payment by the Third Parties of their fair share of the MIDCO Sites remedial and response costs. Third Party funds have been placed into the MIDCO Trust Fund, which has been created to fund the MIDCO Sites remedial actions. Rust-Oleum, as a Settling PRP, has provided financial assurance for its share of the cleanup costs in the form of a Letter of Credit.\nIn March, 1988 the EPA named Rust-Oleum and 240 other entities as PRPs under CERCLA in connection with the Ninth Avenue Site at 7537 Ninth Avenue, Gary, Indiana (the \"Ninth Avenue Site\"). Rust-Oleum is alleged to be associated with the Ninth Avenue Site as a consequence of disposal of waste originating at its former Evanston, Illinois plant in the 1970's. Rust-Oleum has cooperated with over twenty other PRPs in a voluntary cleanup under Phase I and Phase I Participating Agreement and Implementation Trust Agreements. Total Ninth Avenue Site remediation and monitoring costs are estimated to be approximately $36 million, including past costs and the Final Site Remedy, which includes groundwater remediation planned for completion by 1997 and ongoing monitoring for an undetermined period. The EPA is in the process of preparing an Amended ROD and Amended Unilateral Administrative Order under which Rust-Oleum and other participating PRPs will commit to carry out the Final Site Remedy. Rust-Oleum's allocation of cost is currently 6.048%, with approximately $500,000 remaining to be paid,\nsubject, however, to reduction to the extent settlements are made with non-participating PRPs and funds are made available from a Trust fund established by the EPA for DE MINIMIS settlors.\nBased upon prior settlement agreements with insurance carriers for potential costs and remediation liabilities in connection with the MIDCO Sites and the Ninth Avenue Site, Rust-Oleum has established appropriate reserves to cover such costs and liabilities. Accordingly, the Company believes that ultimate resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations.\nIn March, 1987, the EPA named Rust-Oleum as a PRP under CERCLA in connection with the American Chemical Service Superfund Site in Lake County, Griffith, Indiana (the \"ACS Site\"). Rust-Oleum is alleged to be associated with the ACS Site as a consequence of disposal of waste originating at its former Evanston, Illinois plant in the 1960's. The EPA has offered DE MINIMIS settlements to Rust-Oleum and other PRPs alleged to be responsible for small percentages of the total waste sent to the ACS Site. Rust-Oleum has consented to an Administrative Order on Consent (\"AOC\"), IN THE MATTER OF AMERICA CHEMICAL SERVICES SUPERFUND SITE, United States Environmental Protection Agency Region 5, authorizing settlement of Rust-Oleum's DE MINIMIS 0.16% share of the estimated $70 million cleanup for the sum of $240,000. Under the provisions of the AOC, Rust-Oleum will be protected from future suits by the EPA and the State of Indiana and suits for contribution from other PRPs. Adequate accruals have been made for the payment of the settlement amount in 1995. Rust-Oleum is pursuing its liability insurance carriers for reimbursement of its ACS Site settlement costs.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot Applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT*\nThe name, age and positions of each executive officer of the Company as of August 19, 1994 are as follows:\nThomas C. Sullivan has been Chairman of the Board and Chief Executive Officer of the Company since October 1971. From June 1971 through September 1978, Mr. Sullivan served as President and, prior thereto, as Executive Vice President of the Company. Mr. Sullivan's employment with the Company commenced in 1961, and he has been a Director since 1963. Mr. Sullivan is employed as Chairman and Chief Executive Officer under an employment agreement for a five-year period ending June 1, 1999. Mr. Sullivan is the father of Frank C. Sullivan, Vice President and Chief Financial Officer of the Company.\nJames A. Karman has been President and Chief Operating Officer since September 1978. From October 1982 to October 1993 Mr. Karman also was the Chief Financial Officer of the Company. From October 1973 through September 1978 Mr. Karman served as Executive Vice President, Secretary and Treasurer, and, prior thereto, as Vice President-Finance and Treasurer of the Company. Mr. Karman's employment with the Company commenced in 1963, and he\nhas been a Director since 1963. Mr. Karman is employed as President and Chief Operating Officer under an employment agreement for a five-year period ending June 1, 1999.\nJohn H. Morris, Jr. has been Executive Vice President since January 1981. Prior to that time, he was Corporate Vice President of the Company, having been elected to that position in September 1977. Mr. Morris was elected a Director of the Company in 1981. Mr. Morris is employed as Executive Vice President under an employment agreement for a period ending July 31, 1995.\nRichard E. Klar was elected Vice President in October 1981 and has been Treasurer since July 1980. He served as Chief Accounting Officer from July 1980 to October 1990. Mr. Klar was Treasurer of Mameco International, Inc., a wholly owned subsidiary which was acquired by the Company in February 1979, from 1979 to 1980 and was Mameco's Controller prior thereto. Mr. Klar is employed as Vice President and Treasurer under an employment agreement for a period ending July 31, 1995.\nPaul A. Granzier has served as Secretary since July 1988, and as Vice President and General Counsel since October 1987. Prior thereto, he served as General Counsel since he joined the Company in May 1985. Mr. Granzier was engaged in the private practice of law from 1981 until he joined the Company. Prior thereto, he served as Assistant Corporate Counsel and Assistant Secretary of Midland-Ross Corporation. Mr. Granzier is employed as Vice President, General Counsel and Secretary under an employment agreement for a period ending July 31, 1995.\nGlenn R. Hasman has served as Vice President-Administration since October 1993. From July 1990 to October 1993 Mr. Hasman served as Controller. From September 1982 through July 1990, Mr. Hasman served in a variety of management capacities, most recently Vice President-Operations and Finance, Chief Financial Officer and Treasurer, of Proko Industries, Inc., a former wholly owned subsidiary of the Company. From 1979 to 1982, Mr. Hasman served as RPM's Director of Internal Audit and from 1976 to 1979 he was associated with Ciulla Stephens & Co., independent accountants. Mr. Hasman is employed as Vice President-Administration under an employment agreement for a period ending July 31, 1995.\nFrank C. Sullivan has served as the Chief Financial Officer of the Company since October 1993 and has been a Vice President since October 1991. Prior thereto, he served as Director of Corporate Finance of the Company from February 1989 to October 1991. Mr. Sullivan served as Regional Sales Manager, from February 1988 to February 1989, and as a Technical Service Representative, from February 1987 to February 1988, of AGR Company, an Ohio General Partnership owned by the Company. Prior thereto, Mr. Sullivan was employed by First Union National Bank (1985-1986) and Harris Bank (1983-1985). Mr. Sullivan is employed as Vice\nPresident and Chief Financial Officer under an employment agreement for a period ending July 31, 1995. Mr. Sullivan is the son of Thomas C. Sullivan, Chairman of the Board and Chief Executive Officer of the Company.\nCharles R. Brush has served as Vice President-Environmental Affairs of the Company since October 1993. From June 1991 to October 1993 he served as the Company's Director Environmental & Regulatory Affairs. Prior thereto, from 1988 to June 1991, he served as Vice President-Environmental & Risk Management of Kop-Coat, Inc., a wholly-owned subsidiary of the Company.\nKeith R. Smiley has served as Controller of the Company since October 1993. From January 1992 until the present, Mr. Smiley also has served as the Company's Internal Auditor. Prior thereto, he was a Manager at Ciulla Stephens & Co.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nRPM Common Shares, without par value, are traded on the NASDAQ National Market System. Common Share prices are quoted daily under the symbol RPOW. The high and low sales prices for the Common Shares, and the cash dividends paid on the Common Shares, for each quarter of the two most recent fiscal years is set forth in the table below.\nCash dividends are payable quarterly, upon authorization of the Board of Directors. Regular payment dates are approximately the 30th of July, October, January and April. RPM maintains a Dividend Reinvestment Plan whereby cash dividends, and a maximum of an additional $5,000 per month, may be invested in RPM Common Shares purchased in the open market at no commission cost.\nThe number of holders of record of RPM Common Shares as of August 19, 1994 was approximately 25,000.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.(1)\nThe following table sets forth selected consolidated financial data of the Company for each of the five (5) years during the period ended May 31, 1994 which has been restated to include the fiscal 1994 acquisitions of Dynatron\/Bondo Corporation and Stonhard, Inc. The data was derived from the annual Consolidated Financial Statements of the Company which have been audited by Ciulla Stephens & Co., independent accountants.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information required by this item is included under Exhibit 99.4 to this Form 10-K Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by this item is included under Exhibit 99.5 to 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 required by this item as to the Directors of the Company appearing under the caption \"Election of Directors\" in the Company's Proxy Statement to be used in connection with the Annual Meeting of Shareholders to be held on October 10, 1994 (the \"1994 Proxy Statement\") is incorporated herein by reference. Information required by this item 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 is incorporated herein by reference to \"Executive Compensation\" in the 1994 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 \"Share Ownership of Management\" in the 1994 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 \"Election of Directors\" 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) The following financial statements and schedules and supplementary quarterly information are filed as part of this Report on Exhibit 99.5 as indicated:\n1. Financial Statements. ---------------------\nFinancial Statements --------------------\nIndependent Auditors' Report\nConsolidated Balance Sheets - May 31, 1994 and 1993\nConsolidated Statements of Income - years ended May 31, 1994, 1993, and 1992\nConsolidated Statements of Shareholders' Equity - years ended May 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows - years ended May 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nQuarterly Information\n2. Financial Statement Schedules. -----------------------------\nSchedule --------\nIndependent Auditors' Report\nSchedule VIII - Valuation and Qualifying Accounts and Reserves\nSchedule -------- Schedule IX - Short-term Borrowings\nSchedule X - Supplementary Income Statement Information\nAll other schedules have been omitted because they are not applicable or not required, or because the required information is included in the consolidated financial statements or notes thereto.\n3. Exhibits. --------- See the Index to Exhibits at page E-1 of this Form 10-K.\n(b) Reports on Form 8-K. -------------------- There were no Current Reports on Form 8-K filed during the fourth fiscal quarter ended May 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.\nRPM, INC.\nDate: August 25, 1994 By: \/s\/ Thomas C. Sullivan ----------------------------- Thomas C. Sullivan 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 and Title - - ------------------- Chairman of the Board of \/s\/ Thomas C. Sullivan Directors and Chief Execu- - - ------------------------ tive Officer (Principal Thomas C. Sullivan Executive Officer)\n\/s\/ James A. Karman President and Chief Operating - - ------------------------ Officer and a Director James A. Karman\n\/s\/ Frank C. Sullivan Vice President and Chief - - ------------------------ Financial Officer (Principal Frank C. Sullivan Financial Officer)\n\/s\/ Glenn R. Hasman Vice President-Administration - - ------------------------ (Principal Accounting Officer) Glenn R. Hasman\n\/s\/ Edward B. Brandon Director - - ------------------------ Edward B. Brandon\n\/s\/ Lorrie Gustin Director - - ------------------------ Lorrie Gustin\n\/s\/ Roy H. Holdt Director - - ------------------------ Roy H. Holdt\n\/s\/ E. Bradley Jones Director - - ------------------------ E. Bradley Jones\n\/s\/ Donald K. Miller Director - - ------------------------- Donald K. Miller\n\/s\/ John H. Morris, Jr. Executive Vice President - - ------------------------- and a Director John H. Morris, Jr.\n\/s\/ Kevin O'Donnell Director - - ------------------------- Kevin O'Donnell\n\/s\/ William A. Papenbrock Director - - ------------------------- William A. Papenbrock\n\/s\/ Stephen Stranahan Director - - ------------------------- Stephen Stranahan\nDate: August 25, 1994\n373\/06821CIF.458\nE-1\nE-2\nE-3\nE-4 (I) Incorporated herein by reference to the appropriate exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1992.\n(J) Incorporated herein by reference to the appropriate exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1989.\n(K) Incorporated herein by reference to the appropriate exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1982.\n(L) Incorporated herein by reference to the appropriate exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1991.\n373\/06821CIF.458\nE-5","section_15":""}
{"filename":"801348_1994.txt","cik":"801348","year":"1994","section_1":"ITEM 1. BUSINESS\nPruco Life Variable Contract Real Property Account (the \"Real Property Account\"), the Registrant, was established on August 27, 1986 and commenced business September 5, 1986. Pursuant to Arizona law, the Real Property Account was established as a separate investment account of Pruco Life Insurance Company (\"Pruco Life\"). The Real Property Account was established to provide a real estate investment option offered in connection with the funding of benefits under certain variable life insurance and variable annuity contracts (the \"Contracts\") issued by Pruco Life.\nThe assets of the Real Property Account are invested in The Prudential Variable Contract Real Property Partnership (the \"Partnership\"). The Partnership, a general partnership organized under New Jersey law on April 29, 1988, was formed through agreement among The Prudential Insurance Company of America, Pruco Life, and Pruco Life Insurance Company of New Jersey, to provide a means for assets allocated to the real property option under certain variable life insurance and variable annuity contracts issued by the respective companies to be invested in a commingled pool.\nThe Partnership has an investment policy of investing at least 65% of its assets in direct ownership interests in income-producing real estate and participating mortgage loans. The largest portion of these real estate investments will be direct ownership interests in income-producing real estate, such as office buildings, agricultural land, shopping centers, hotels, apartments, or industrial properties. From 10% to 15% of the Partnership's assets generally will be invested in short-term or intermediate-term marketable debt instruments. The remainder of the Partnership's assets may be invested in other types of real estate-related investments, including conventional, non-participating mortgage loans.\nThe Partnership's investments will be maintained so as to meet the diversification requirements set forth in Treasury Regulations issued pursuant to Section 817(h) of the Internal Revenue Code relating to the investments of variable life insurance and variable annuity separate accounts.\nFor information regarding the Partnership's investments, operations, and other significant events, see Item 2, Properties, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, Financial Statements and Supplementary Data.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership owns the following properties.\nWAREHOUSE FACILITY IN AZUSA, CALIFORNIA This facility consists of three one-story warehouse buildings in Azusa, California, approximately 20 miles east of downtown Los Angeles. The buildings were constructed in 1986. They contain approximately 432,000 rentable square feet which were 100% leased to four tenants at December 31, 1994.\nOFFICE FACILITY IN LISLE, ILLINOIS The property is a four-story office building on 5.6 acres of land. It was constructed in 1985 and contains approximately 102,000 square feet of leasable space. R.R. Donnelley & Sons Company currently leases the entire building under a renewable lease expiring in 1997. The facility is located at 750 Warrenville Road in the Corporetum Office Park in Lisle, Illinois. Corporetum Office Park is a 75 acre planned office development located 25 miles west of downtown Chicago.\nAPARTMENT COMPLEX IN ATLANTA, GEORGIA Brookwood Valley Apartments is a garden apartment complex located approximately 3 miles north of downtown Atlanta. It consists of eight three-story buildings containing a total of 240 units. Construction of the 7.1 acre site was completed in 1987. At December 31, 1994 the property was 97% occupied.\nWAREHOUSE FACILITY IN POMONA, CALIFORNIA The Partnership owns a leasehold estate in six industrial buildings on approximately 28 acres in Pomona, California. The site is approximately 30 miles east of downtown Los Angeles. The buildings were constructed between 1982 and 1984 and contain approximately 531,000 square feet of leasable space. The property was 83% occupied by six tenants at December 31, 1994.\nLand under the leasehold estate was capitalized upon the assignment of a ground lease from the previous owner. The lease term extends until November 2078 with no renewal options. The annual ground lease payments are $250,000 through November 1994, and, for each ten year increment thereafter, are subject to increase by 50% of the increase in the Consumer Price Index during the previous period. For 1995, the annual ground lease payment will increase $126,450 to $376,450. The ground lease agreement contains a purchase option from November 1994 to November 1997 at a fixed price of $4,000,000.\nSHOPPING CENTER IN ROSWELL, GEORGIA King's Market shopping center was constructed in 1988. It is located approximately 22 miles north of downtown Atlanta on a 30 acre site. It contains approximately 301,700 square feet of rentable space. At December 31, 1994 it was 99% occupied by 31 tenants.\nOFFICE FACILITY IN MORRISTOWN, NEW JERSEY This four-story suburban office building was constructed in 1981 and contains 85,000 rentable square feet. It is located on a 5.1 acre site, approximately 30 miles west of New York City. At December 31, 1994 it was 93% leased to 13 tenants.\nWAREHOUSE FACILITY IN BOLINGBROOK, ILLINOIS This single-story warehouse was completed in 1989. It contains 224,640 rentable square feet. It is located approximately 20 miles southwest of downtown Chicago. The entire facility is leased to the Gillette Company under a lease expiring in October, 2000.\nAPARTMENT COMPLEX IN FARMINGTON HILLS, MICHIGAN Indian Creek Apartments consists of fifteen two-story buildings containing 156 two-bedroom and 40 one- bedroom units. It was constructed in 1988 and is located approximately 20 miles northwest of Detroit. At December 31, 1994, the property was 99% occupied.\nOFFICE PARK IN FLINT, MICHIGAN This investment consists of twelve single-story buildings located in an office park in Flint, Michigan. The property contains 113,393 rentable square feet. It is currently 89% occupied by 50 tenants.\nThe property was obtained by the Partnership on July 1, 1994 through foreclosure on the mortgage loan made to Oak Creek Associates. The Partnership took title to the property at the end of the redemption period on January 3, 1995. During this period, the Partnership received all income generated by the property.\nWAREHOUSE FACILITIES The Partnership owns a 50% interest in four single-story warehouse\/distribution buildings located in Jacksonville, Fl. The remaining 50% is owned by The Prudential and one of its subsidiaries. The buildings contain approximately 502,000 rentable square feet and were 92% occupied at December 31, 1994. Associated Unit Companies or its affiliates lease approximately 328,000 square feet, Angelo Brothers leases approximately 84,000 square feet and Biaggi Brothers signed a two year lease for 90,000 square feet, effective February 1995, which would bring the occupancy of the four warehouses to 100%.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS\nContract owners participating in the Real Property Account have no voting rights with respect to the Real Property Account.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S INTERESTS AND RELATED SECURITY HOLDER MATTERS\nOwners of the Contracts may participate by allocating all or part of the net premiums or purchase payments to the Real Property Account. Contract values will vary with the performance of the Real Property Account's investments through the Partnership. Participating interests in the Real Property Account are not traded in any public market, thus a discussion of market information is not relevant.\nAs of March 1, 1995, there were approximately 62,297 Contract owners of record investing in the Real Property Account.\nA new registration statement, Commission file number 33-86780, became effective for the Pruco Life Variable Contract Real Property Account on December 22, 1994. However, all securities issued through December 31, 1994, are filed under the preceding registration statement, Commission file number 33-28156.\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\nAll of the assets of Pruco Life Variable Contract Real Property Account (the \"Real Property Account\") are invested in The Prudential Variable Contract Real Property Partnership (the \"Partnership\"). Correspondingly, the liquidity, capital resources and results of operations for the Real Property Account are contingent upon those of the Partnership. Therefore, all of management's discussion of these items is at the Partnership level. The partners in the Partnership are The Prudential Insurance Company of America, Pruco Life Insurance Company and Pruco Life Insurance Company of New Jersey.\n(a) Liquidity and Capital Resources\nAt December 31, 1994, the Partnership's liquid assets consisting of cash and cash equivalents and marketable securities totalled $48,917,436. This is an increase of $23,086,195 from liquid assets at December 31, 1993 of $25,831,241. The increase is due primarily to the sale of the Partnership's 50% interest in seven warehouses for approximately $19,020,000 and the receipt of $3,513,704 in cash upon the maturing of the Lincoln, NE mortgage loan. Sources of liquidity also include net cash flow from property operations and interest from short-term investments.\nThe Partnership has established a $10 million annually renewable unsecured revolving line of credit with First Fidelity Bank National Association to be drawn upon as needed for potential liquidity needs. As of December 31, 1994, no drawdowns had occurred. Management does not anticipate the need to draw upon this resource in the near future. In addition, The Prudential has also committed to fund up to $100 million to enable the Partnership to acquire real estate investments. Contributions to the Partnership under this commitment are utilized for property acquisitions and returned to The Prudential on an ongoing basis from Contract owners' net contributions. The amount of the commitment is reduced by $10 million for every $100 million in current value net assets of the Partnership. The amount available for future investments is approximately $51.6 million as of December 31, 1994.\nThe Partnership will ordinarily invest 10-15% of its assets in cash and short- term obligations to maintain liquidity, however its investment policy allows up to 30% investment in cash and short-term obligations. At December 31, 1994, 26.7% of the Partnership's assets consisted of cash and cash equivalents and marketable securities. The Partnership has retained a portion of the cash generated by operations as well as from the sale of properties and the maturing of the mortgage loans in 1994 pending anticipated reinvestment of these funds. The Partnership has entered into a commitment to acquire an apartment property for up to $16 million during 1995. This acquisition will be funded from cash held by the Partnership.\nDuring 1994, the partners withdrew $11.0 million. Withdrawals may be made during 1995 based upon the percentage of assets invested in short-term obligations and taking into consideration anticipated cash needs of the Partnership including potential property acquisitions and dispositions and capital expenditures. At December 31, 1994, and currently, the Partnership has adequate liquidity. Management anticipates that ongoing cashflow from operations will satisfy the Partnership's needs over the next twelve months and the foreseeable future.\nThe Partnership's two mortgage loans receivable matured in May 1994. The mortgagor on the Lincoln, NE loan paid the full amount due of $3,513,704. As previously reported, the mortgagor on the Flint, MI loan notified the Partnership that it would not make any of the payments due in 1994 on the loan. These payments totalled $8,094,271 including principal and interest. On July 1, 1994, the Partnership foreclosed on the property under a voluntary conveyance from the mortgagor. The Partnership took title to the property on January 3, 1995 upon expiration of the redemption period. Upon foreclosure,\nthe Partnership received approximately $400,000 from the mortgagor representing operating cash flow from the property for the first six months of 1994. This amount was applied against the amount due from the mortgagor.\nThe Partnership received the cash flow generated by the property's operation during the redemption period. This totalled approximately $375,000 and is included with cash provided by operating activities in the statement of cash flows.\nDuring 1994, the Partnership expended approximately $1,173,000 in capital expenditures, of which approximately $838,000 was for tenant alterations and leasing commissions. Approximately $427,000 in tenant improvements and leasing commissions was spent at the Azusa, CA warehouse related to a new tenant, Best Buy. This is the first installment of such costs related to this tenant. Approximately $214,000 was expended at the Pomona, CA warehouse related to the expansion of space by Ashley Furniture (approximately $114,000), a new tenant, JB Engineering (approximately $72,000), and a lease renewal by Performance Engineered (nearly $28,000). Approximately $164,000 was expended at the Bolingbrook, IL warehouse for the extension of Gillette's lease.\nOther major capital expenditures in 1994 included approximately $118,000 for HVAC upgrades, installation of an energy management system and expenditures related to the Americans with Disabilities Act at the Morristown, NJ office center; approximately $51,000 for improvements in the flooring at the Bolingbrook warehouse and approximately $103,000 for exterior improvements, signage and landscaping at the Pomona and Azusa, CA warehouses, the Farmington Hills, MI apartments and the Morristown office building. An additional $54,000 was expended at the Partnership's apartment complexes for various projects including remodeling the clubhouse and model apartments.\nPreviously, the Partnership reported that it expected to exercise its option to purchase the land on which the Pomona warehouse is located during the fourth quarter of 1994 for $4,000,000. However, after comparing the option price of the land to the additional benefits that the Partnership may receive from owning the land rather than leasing it, the Partnership decided not to exercise the option at the present time. The option is available until November 1997. The Partnership will continue to evaluate the relevant factors during the option period before deciding whether to exercise the option.\nProjected capital expenditures for 1995 total approximately $1,319,000. Of this, approximately $1,089,000 consists of leasing commission and tenant alterations. The largest of these is the final installment of costs related to the lease with Best Buy at the Azusa property ($300,000). At the Morristown office building, Kodak is expected to sign a new lease for which approximately $142,000 in tenant improvements and leasing commissions are anticipated. Kodak has been occupying their space on a month-to-month basis since their lease expired in 1994. An additional $284,000 in tenant improvements and commissions are projected for Morristown in 1995 as well as $202,000 for Pomona, $131,000 for the Unit warehouses and $30,000 for the Roswell, GA shopping center. Except for the Best Buy lease, all of these projected expenditures relate to prospective leases. The actual amount of such expenditures will depend on the number of new leases signed, the needs of the particular tenants and the timing of lease executions.\nOther major capital projects planned for 1995 include $57,000 for fencing and entrance gates at the Azusa warehouse and Atlanta, GA apartments; $51,000 for sprinklers, electric transformers and climate control units at Morristown; $45,000 for exterior lighting at the Lisle, IL office building; $44,000 for irrigation and drainage upgrades and landscaping at Farmington Hills, Bolingbrook and the four Jacksonville, FL warehouses (the Unit warehouses) and approximately $33,000 for smaller projects among the various properties including improvements to common areas and carpet replacements at the apartments.\nNeither of the Partnership's California properties, which are covered by earthquake insurance, suffered damage in the January 1994 Los Angeles earthquake.\nThe Partnership has entered into a commitment to purchase a garden apartment complex currently under construction in Raleigh, NC. The property consists of fourteen two and three-story buildings with a total of 250 units. The property is expected to be completed in June 1995. The initial funding will be approximately $14 million. A second funding will be made during 1995 based upon the property's achieving certain income and occupancy levels. The maximum amount of the second funding is $1,950,000. This investment will be funded from cash held by the Partnership.\n(b) Results of Operations\nThe following is a brief discussion of a comparison of the results of operations for the three years ended December 31, 1994, 1993 and 1992.\n1994 VS 1993\nThe Partnership's net investment income for 1994 was $12,848,199, an increase of $193,568 (1.5%) from net investment income for 1993 of $12,654,631. The increase was primarily the result of higher interest income from short-term investments ($827,470) and income from property operations ($270,620) partially offset by lower interest income on mortgage loans ($917,598).\nIncome from property operations, including income from interest in properties, was $14,023,251 for 1994. This is an increase of $270,620 (2.0%) from $13,752,631 for 1993. This was due primarily to increased rent from properties (approximately $533,000) and lower real estate taxes (approximately $193,000) and property administrative expenses (approximately $157,000). These were partially offset by lower income from interest in properties (approximately $546,000) and increased property operating expenses (approximately $67,000).\nRent from properties for 1994 increased by $533,265 (3.4%) to $16,344,259 from $15,810,994 for 1993. Higher occupancy in 1994 at the Roswell shopping center and the Partnership's two apartment properties resulted in approximately $430,000 in additional rental income. Percentage rent at the shopping center also increased nearly $198,000 primarily as a result of the property now billing tenants for such rent throughout the current year rather than in arrears.\nRental income at the Morristown office building increased by approximately $139,000 in 1994 due to a retroactive rent adjustment for Midlantic Bank and scheduled rent step-ups and the ending of free rent periods for various tenants.\nBeginning July 1, 1994, the Partnership is receiving all of the revenue from the property related to the foreclosed Flint mortgage loan. This amounted to approximately $675,000 for the last six months of 1994.\nThese additional revenues were partially offset by lower rental income from the Azusa warehouse (approximately $582,000) due to lower occupancy in 1994, rent no longer received on the Denver warehouse sold in 1993 (approximately $67,000), a lower rental rate and concessions granted to Gillette in 1994 related to their early lease renewal (approximately $90,000) and lower recoveries of real estate taxes at the net leased properties in Lisle and Bolingbrook (approximately $47,000). Expense recoveries also declined by approximately $159,000 at Pomona in 1994. This was the result of lower recoverable expenses at the property. Revenue in 1993 included recoveries for parking lot and roof repairs for which there were no corresponding amounts in 1994.\nIncome from interest in properties relates to the Partnership's 50% co- investment in the Unit warehouses. Income from this source decreased $546,273 (18.8%) from $2,901,477 for 1993 to $2,355,204 for 1994. The Partnership sold its investments in two of these warehouses in 1993 and in seven warehouses in 1994. This resulted in a reduction of income of approximately $476,000 in 1994. Lower occupancy at one of the remaining warehouses also reduced income by approximately $75,000.\nAdministrative expenses on the statement of operations includes both those related to property operations and the administration of the Partnership. Property administrative expenses for 1994 were $1,176,398. This is $157,368 (11.8%) lower than the $1,333,766 for 1993. Most of the decrease was the result of non-recurring expenses in 1993. In 1993, the Roswell shopping center reported approximately $46,000 in bad debt expense related to a bankrupt tenant, Lionel Playworld. No such charge was incurred in 1994. A casualty loss of approximately $53,000 was also incurred at the shopping center in 1993. At the Azusa warehouse, a tenant vacated its space in 1993, before the expiration of its lease resulting in a bad debt expense of nearly $156,000 in 1993. No such charge was incurred in 1994. In addition, the 1994 application of a security deposit to amounts owed by that tenant reduced 1994 bad debt expense by approximately $33,000.\nThese reductions were partially offset by an increase in insurance premiums of nearly $63,000, primarily at the Azusa, Pomona and Roswell properties and approximately $22,000 in higher advertising and promotional expenses at these same properties. In addition, approximately $59,000 in administrative expenses were incurred at the Flint property acquired through foreclosure in 1994.\nProperty operating expenses for 1994 were $1,707,039 compared to $1,639,828 for 1993, an increase of $67,211 (4.1%). The increase was the result of approximately $64,000 in operating expenses related to the Flint property for the last six months of 1994 and nearly $37,000 in higher repairs and maintenance expenses, particularly at the Azusa warehouse related to the painting of building exteriors. These were partially offset by a reduction of almost $34,000 due to the sale of the Denver property in 1993.\nReal estate taxes for 1994 were $1,792,775, a reduction of $193,471 (9.7%) from $1,986,246 for 1993. Approximately $110,000 of this decrease was the result of appealing the assessed values of the Azusa, Pomona and Morristown properties. The sale of the Denver warehouse reduced real estate taxes by approximately $32,000. Real estate taxes at the net lease properties in Bolingbrook and Lisle also decreased nearly $47,000. As net leased properties, the tenants absorb almost all operating costs, so this decrease also reduced rental income as noted above.\nInterest income on the mortgage loans decreased $917,598 (89.7%) from $1,023,292 for 1993 to $105,694 for 1994. This was due to the maturing of the Lincoln, NE loan in May 1994 and the default of the mortgagor on the Flint loan. These are discussed further in the Liquidity and Capital Resources section.\nInterest income from short-term investments increased $827,470 (111.2%) from $743,924 for 1993 to $1,571,394 for 1994. This was the result of increased amounts invested and higher interest rates in 1994. As noted above, the Partnership is retaining increased cash balances in anticipation of acquiring properties in 1995.\nAdministrative expenses related to the Partnership totalled $237,324 for 1994. This is a reduction of $38,202 (13.9%) from $275,526 for 1993. The decrease resulted primarily from lower professional fees for 1994.\nThe investment management fee for 1994 was $2,287,816. This is $18,610 (0.8%) higher than the fee for 1993 of $2,269,206. The fee is computed as 1.25% of gross assets. During 1994, gross assets were\nslightly higher than the prior year due to cash flow retained by the Partnership and increased market values of the real estate investments.\nInterest expense relates to the obligation under capital lease. For 1994, interest expense was $327,000. This is $6,516 (2.0%) higher than interest expense for 1993 of $320,484.\nDuring 1994, the Partnership sold its 50% interest in the two Unit warehouses located in Atlanta and the ones located in Desoto, TX; Fort Worth, TX; Shreveport, LA; Bedford Park, IL; and Normal, IL. The proceeds, net of related costs, were approximately $19,020,000, resulting in a realized loss of approximately $1,237,000. Realized loss is the difference between net sales proceeds and the cost of the properties. The Partnership had already recognized decreases in the properties' market values in prior periods, so the net sales proceeds actually exceeded the values at which the properties were carried on the sale date by approximately $445,000. The proceeds from the sale are expected to be reinvested during 1995. The Partnership still owns a 50% interest in the four warehouses located in Jacksonville, FL. These are not currently being marketed for sale.\nMARKET VALUES OF INVESTED ASSETS: 1994 VS 1993\nDuring 1994, the Partnership experienced an unrealized gain of $2,576,828 on its real estate investments. Of this, $1,502,226 represents decreases in the market values of the Unit warehouses, sold in October 1994, which had already been reported as unrealized losses in prior years. With the sale of the properties, these unrealized losses were reclassified as unrealized gains on the statement of operations. These unrealized gains revert the property value back to its historical cost, which is used to calculate the $1,237,000 realized loss described above. The remaining $1,074,602 is the net increase in the current values of the investments owned by the Partnership at the end of 1994. This represents 0.8% of the investments' December 31, 1993 value.\nThe office buildings experienced the largest increase, approximately $1,145,000. The apartments increased by about $945,000. The warehouses experienced an unrealized loss of approximately $184,000 and the retail property, an unrealized loss of about $832,000.\nThe office property acquired through the foreclosure of the Flint mortgage loan experienced the largest increase in current value, $2,423,739 (42.6% of the investment's December 31, 1993 value). After foreclosure the Partnership reviewed detailed operating information on the property. Based on current market conditions and property performance, an appraisal resulted in an increase in the estimated market value.\nThis increase in value was partially offset by decreases in the values of the Lisle office building of $1,200,000 (9% of the property's December 31, 1993 value) and the Morristown property of $78,321 (0.8% of its December 31, 1993 value). The former was caused by reduced expectations that the current tenant, R.R. Donnelley, will remain in the building when their current lease expires in 1997. This would result in downtime while a new tenant was found and necessitate incurring additional tenant improvements and leasing commissions. It is also likely that the rental rate on any new lease would be lower than that currently paid by Donnelley. The decline in the value of the Morristown property was the result of projected increases in tenant improvements and leasing commissions which will be necessary to lease the remaining vacant space.\nThe Partnership's apartment complex in Atlanta had an unrealized gain of $671,245 (6.0% of the property's December 31, 1993 value) while the Farmington Hills apartments experienced an increase of $274,134 (2.1% of its year-end 1993 value). These increases were primarily the result of higher rental rates, occupancy and tenant retention than previously projected for these properties.\nThe Partnership's sole retail property, King's Market Shopping Center in Roswell, GA, experienced an unrealized loss of $832,405 (2.5% of its December 31, 1993 value). This was due both to capital expenditures at the property during 1994, which did not result in a corresponding increase in the shopping center's value, and to reduced expectations concerning future rental rates when current leases expire.\nThe warehouses experienced an unrealized loss of almost $184,000 during 1994. The Pomona property had the largest loss, $1,679,740 (9.4% of its year-end 1993 value). This change was due primarily to the increased cost of a planned roof replacement program and an acceleration in the timing of that work. The market values of the four Unit warehouses in which the Partnership owns a 50% interest at the end of 1994 increased $214,364 (3.9% of their December 31, 1993 value). This resulted from leasing the vacant space at one of the warehouses effective February 1995 as well the improved potential for higher rental rates on new and renewal leases on these properties.\nThe warehouse in Bolingbrook experienced an unrealized loss of $80,303 (1.2% of the property's December 31, 1993 value) due to capital expenditures which did not increase the property's value.\nThe decreases in the market values of these warehouses were partially offset by an increase of $1,361,890 (10.0% of the property's December 31, 1993 value) in the market value of the Azusa warehouse. This was the result of the new lease with Best Buy bringing the property's occupancy to 100% as well as improved conditions in the local market.\nPROPERTY LEASING ACTIVITY\nOccupancy at the Partnership's properties at December 31, 1994 is generally higher than at December 31, 1993, especially for the industrial properties. During the fourth quarter of 1994, a lease covering the vacant 215,000 square feet (50% of the property) was executed at the Azusa warehouse making the property 100% leased as of the end of 1994. The tenant is Best Buy, a distributor of home appliances and electronics. The lease term is seven years and provides that the tenant will take an additional 145,000 square feet of space in 1996 when another lease expires. No leases are scheduled to expire at the property until 1996.\nOccupancy at Pomona increased from 78% at December 31, 1993 to 83% at the end of 1994. During the first quarter of 1994, Ashley Furniture expanded its space by 30,000 square feet (5% of the property). Two leases totalling 92,000 square feet expired during 1994. One tenant vacated upon lease termination, but the space was quickly leased to a new tenant, JB Engineering. The lease covers 50,000 square feet (9% of the property) and expires in 1997. The tenant on the other lease, Performance Engineered, Inc. exercised a renewal option to continue to lease the space for an additional five years. The rental rate under the option is slightly lower than the original rate. This lease covers 42,000 square feet (8% of the property). The Partnership is currently discussing lease terms with two potential tenants for the remaining vacant space. No leases are scheduled to expire until 1996.\nAfter the sale of the Unit warehouses noted above, the Partnership now owns an interest in only the four properties located in Jacksonville, FL. These total approximately 502,000 square feet. At December 31, 1994, the warehouses were 92% occupied, although one tenant occupying 40,000 square feet (8% of the four warehouses) on a month-to-month basis vacated effective January 1, 1995. A two- year lease has since been signed with a new tenant, Biaggi Brothers, covering 90,000 square feet (18% of the four buildings). This brings occupancy of the four warehouses to 100%. One lease covering 102,000 square feet (20% of the warehouses) expires on April 30, 1995. The tenant is expected to renew, although no agreement has been reached.\nThe warehouse in Bolingbrook continues to be fully occupied by Gillette under a lease expiring in 2000.\nThe Morristown office building was 93% occupied at December 31, 1994 as it was at the end of 1993. One lease, covering 6,600 square feet (8% of the property) expired on March 31, 1994. The tenant, Kodak, has continued to occupy the space on a month-to-month basis. The Partnership is negotiating with the tenant on a new lease and expects that an agreement will be reached during the first quarter of 1995. During the fourth quarter of 1994, a 2,000 square foot expansion was executed with Smith Barney, effective January 16, 1995. This represents 2% of the property and brings occupancy to 95%. The Partnership is also discussing expansions with other tenants in the property. No leases are scheduled to expire in 1995.\nThe office building in Lisle continues to be fully leased to R.R. Donnelley under a lease expiring in September 1997. The lease contains two five-year renewal options at the lower of the current rate or 85% of the then market rental rate. No discussions are currently being held with the tenant and they have not indicated whether they are considering exercising the option.\nKing's Market Shopping Center in Roswell, GA was 99% leased at December 31, 1994 as compared to 100% at the end of 1993. Two tenants whose leases totalled 2,140 square feet (less than 1% of the center) vacated at the expiration of their leases during the fourth quarter 1994. The Partnership is marketing the space and expects to lease the space during the first quarter of 1995. Four leases totalling approximately 8,800 square feet (3% of the property) are scheduled to expire in 1995. The Partnership is discussing potential renewal terms with the current tenants. Leases covering the major tenants at the shopping center, Home Depot, CompUSA and A&P, are not scheduled to expire until after 2003.\nAs of December 31, 1994, the Partnership's residential properties located in Atlanta, GA and Farmington Hills, MI were approximately 98% leased. Occupancy at these properties has been at about this level for most of 1994. At December 31, 1993, these properties were approximately 96% leased. Rental rates rose approximately 4%-5% during 1994 and tenant retention at these properties remains high. Market rental rates are expected to continue to increase slightly in 1995 in the residential markets in which the Partnership's apartments are located. Occupancy at these properties is not expected to change significantly over the upcoming year.\n1993 VS 1992\nThe Partnership's net investment income for the year ended December 31, 1993, was $12,654,631, an increase of $311,016 (2.5%) from net investment income for the corresponding period of 1992 of $12,343,615. The increase was the result of higher income from property operations ($438,239) and lower investment management fees ($135,818) offset by lower interest from short-term investments and mortgage loans ($229,679) and higher Partnership administrative expenses ($27,393) and interest expense ($5,969).\nIncome from property operations, including income from interest in properties, for the year ended December 31, 1993, was $13,752,631. This is an increase of $438,239 (3.3%) over the $13,314,392 for the corresponding period of 1992. Property revenues increased by $118,543 (0.6%) from $18,593,928 for 1992 to $18,712,471 for 1993. Property revenues at the Morristown office building increased approximately $400,000 due to higher occupancy and the expiration of free rent periods during 1993. The office building in Lisle generated approximately $200,000 in higher revenues as a result of a scheduled increase in the rental rate. These increases were partially offset by a reduction in revenues of approximately $450,000 due the sale of three properties in 1993.\nProperty operating expenses for 1993 were $4,959,840. This is a decrease of $319,696 (6.0%) from $5,279,536 for 1992. The decrease was primarily the result of lower real estate taxes at Pomona as well\nas the 1993 sale of the Denver warehouse and the Partnership's 50% interest in the warehouses located in Hightstown, NJ and one of the Jacksonville, FL warehouses.\nMortgage loans generated interest income for the year ended December 31, 1993, of $1,023,292 as compared to $1,040,803 for the corresponding period of 1992. Interest income from short-term investments decreased by $212,168 (22.2%) from $956,092 for 1992 to $743,924 for 1993. This was due to lower interest rates and decreased amounts invested.\nThe investment management fee incurred for the year ended December 31, 1993 were $2,269,206 and for the same period in 1992, $2,405,024. This is a decrease of $135,818 (5.6%) which is due to a decline in the assets upon which the fee is calculated due primarily to the sale of the three properties described below.\nAdministrative expenses on the statement of operations includes both property and Partnership administrative expenses. Partnership administrative expenses for 1993 were $275,526 and, for 1992, $248,133. This increase of $27,393 (11.0%) was primarily the result of higher appraisal fees.\nDue to a capitalized lease, the Partnership incurred $320,484 of interest expense during 1993. This change is a $5,969 (1.9%) increase from the $314,515 of interest expense incurred during 1992.\nDuring 1993, the Partnership sold its warehouse in Denver, CO and its 50% interest in warehouses located in Hightstown, NJ and Jacksonville, FL. The sale proceeds, net of related costs, totalled approximately $4,727,000, resulting in a realized loss of approximately $2,463,000 based on cost and a gain of approximately $72,700 based on the properties' carrying values on the date of the sale.\nThe Denver warehouse was sold on August 6, 1993 for $2,650,000. The net sales proceeds were approximately $2,561,000. This resulted in a loss of approximately $1,451,000 based on cost and a gain of approximately $206,500 based on the property's carrying value on the date of sale.\nOn September 2, 1993, the Partnership sold its 50% interest in one of the Unit warehouses located in Jacksonville, FL for $1,450,000. The net sales proceeds were approximately $1,380,000. This resulted in a realized loss of approximately $220,000 based on cost and a gain of approximately $29,800 based on the investment's carrying value on the date of sale.\nThe Partnership sold its 50% interest in the Unit warehouse located in Hightstown, NJ on October 29, 1993, for $825,000. Net sales proceeds were approximately $786,000. This resulted in a realized loss of approximately $792,000 based on cost and a loss of approximately $163,600 based on the investment's carrying value on the date of sale.\nMARKET VALUES OF INVESTED ASSETS: 1993 VS 1992\nThe market values of the properties and interest in properties declined approximately $1,300,000 (0.8% of the investments' December 31, 1992 values) between December 31, 1992 and 1993. The market values of the Partnership's industrial properties decreased by approximately $3,400,000 (4.9% of the properties December 31, 1992 value) in 1993. The warehouses in Azusa and Pomona experienced the largest declines totalling approximately $3,000,000. This was due to the continuing soft warehouse real estate market in southern California as well as a major tenant vacating before the expiration of its lease at Azusa. The tenant, citing a decline in its business and financial difficulties, vacated its 160,000 square foot space (37% of the property) during the fourth quarter of 1993. The lease was scheduled to expire in 1997.\nThe Partnership's office buildings declined approximately $1,400,000 (5.9% of their December 31, 1992 value) during 1993. The Morristown property experienced the larger decrease, approximately $850,000. This was due to continuing soft market conditions in the northern New Jersey office market and an expected increase in the cost of leasing and operating the property. The value of the Lisle office building decreased $600,000. This property is entirely leased to R.R. Donnelley through 1997. The decline in value is due to the expectation that rental rates on the property upon expiration of the current lease will be lower than the current rate.\nThe market value of Kings Market Shopping Center in Roswell, GA increased approximately $2,300,000 (7.4% of its December 31, 1992 value) during 1993 as a result of securing CompUSA to occupy the space vacated by Lionel Playworld earlier in 1993.\nThe Partnership's two apartment complexes increased in value by approximately $1,200,000 (5.3% of their December 31, 1992 values). All of the increase was at the Farmington Hills property. This was the result of higher actual and projected rental rates and higher retention of tenants by the property. The value of the apartments in Atlanta did not change from its December 31, 1992 value.\nThe only change in the current values of the mortgage loans during 1993 resulted from the repayments of principal.\n(c) Effects of Inflation\nThe Partnership has not experienced any significant effects from inflation during recent years. To the extent that inflation in future periods may have an adverse impact on property operating expenses, the Partnership has structured its leases to require the tenant to pay some portion of a property's operating expenses. As a result of these lease provisions, increases due to inflation generally do not have a significant adverse effect upon the Partnership's operating results. However, since no expenses are recovered on unrented space, the Partnership will be exposed to the effects of inflation on such space.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data listed in the accompanying Index to Financial Statements and Supplementary Data are incorporated herein by reference and filed as a part of this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF PRUCO LIFE\nName Position Age ---- -------- ---\nRobert P. Hill Chairman of the Board and Director 54\nI. Edward Price Vice Chairman of the Board and Director 52\nEsther H. Milnes President and Director 44\nBeverly R. Barney Senior Vice President 47\nRobert Earl Senior Vice President 43\nJohn P. Gualtieri, Jr. Senior Vice President and Assistant Secretary 60\nRichard F. Lambert Senior Vice President and Chief Actuary 38\nMichael R. Shapiro Senior Vice President 47\nLawrence J. Sundram Senior Vice President 48\nStephen P. Tooley Vice President and Comptroller 42\nE. Michael Caulfield Director 48\nGarnett L. Keith, Jr. Director 59\nIra J. Kleinman Director 47\nDonald G. Southwell Director 43\n--------------------------------------------------------------------------------\nRobert P. Hill, age 54, has been Executive Vice President of The Prudential since 1990. Prior to 1990, he was Senior Vice President and Actuary of The Prudential.\nI. Edward Price, age 52, has been Chief Executive Officer of International Insurance of The Prudential since 1993. From 1990 to 1993, he was Senior Vice President and Actuary of The Prudential. In 1990, he was Senior Vice President of The Prudential and President of the International Insurance Department of The Prudential. Prior to 1990, he was Senior Vice President of Individual Insurance Systems and Administration of The Prudential.\nEsther H. Milnes, age 44, has been Senior Vice President and Chief Actuary of Prudential Insurance and Financial Services since 1993. Prior to 1993, she was Vice President and Associate Actuary of The Prudential.\nBeverly R. Barney, age 47, has been Vice President and Associate Actuary of Prudential Direct since 1993. From 1991 to 1993, she was Senior Vice President and Actuary of Pruco Life. From 1990 to 1991, she was Vice President and Actuary of Pruco Life. Prior to 1990, she was Vice President of Human Resources for the Eastern Home Office of The Prudential.\nRobert Earl, age 43, has been Vice President of Strategic Initiatives of Prudential Preferred Financial Services since 1992. Prior to 1992, he was Vice President of Regional Marketing for The Prudential.\nJohn P. Gualtieri, Jr., age 60, has been Vice President and Insurance Counsel of Variable Products since 1993. Prior to 1993, he was Senior Vice President and General Counsel of Pruco Life.\nRichard F. Lambert, age 38, has been Vice President and Actuary of Prudential Preferred Financial Services since 1993. From 1991 to 1993, he was Vice President and Associate Actuary of The Prudential. Prior to 1991 he was Vice President of Prudential Select Marketing.\nMichael R. Shapiro, age 47, has been Senior Vice President of Prudential Select Marketing since 1987.\nLawrence J. Sundram, age 48, has been Vice President of Prudential Insurance and Financial Services since 1993. Prior to 1993, he was Vice President of District Agencies Marketing for The Prudential.\nStephen P. Tooley, age 42, has been Vice President and Comptroller of Prudential Insurance and Financial Services since 1993. From 1990 to 1993, he was Director of Financial Analysis for The Prudential. Prior to 1990, he was Director of Accounting for The Prudential.\nE. Michael Caulfield, age 48, has been President of Prudential Preferred Financial Services since 1993. From 1992 to 1993, he was President of Prudential Property and Casualty. Prior to 1992, he was President of Investment Services for The Prudential.\nGarnett L. Keith, Jr., age 59, has been Vice Chairman of The Prudential since 1984.\nIra J. Kleinman, age 47, has been President of Prudential Select Marketing since 1993. From 1992 to 1993, he was Senior Vice President of The Prudential. Prior to 1992, he was Vice President of The Prudential.\nDonald G. Southwell, age 43, has been President of Prudential Insurance and Financial Services since 1993. Prior to 1993, he was Senior Vice President of The Prudential.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Real Property Account does not pay any fees, compensation or reimbursement to any Director or Officer of the Registrant.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNot applicable.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPursuant to an investment management agreement, the Partnership has retained The Prudential to act as investment manager of the Partnership. The Prudential charges the Partnership a daily investment management fee which is equal to an effective annual rate of 1.25% of the average daily total asset valuation of the Partnership. The amount incurred by the Partnership for the year ended December 31, 1994 was $2,287,816.\nThe Partnership reimburses The Prudential for certain administrative services rendered by The Prudential. The amount incurred by the Partnership for the year ended December 31, 1994 was $95,015.\nThe Partnership owns a 50% interest in four warehouse\/distribution buildings in Jacksonville, Florida (the Unit warehouses). The total cost of the Partnership's interest is $6,108,742. The remaining 50% interest is owned by The Prudential and one of its subsidiaries.\nThe Partnership has contracted with PREMISYS Real Estate Services, Inc. (PREMISYS), an affiliate of The Prudential, to provide property management services at the Unit warehouses, the Bolingbrook, IL warehouse, and through October 1994, at the Atlanta, GA, Desoto, TX, Fort Worth, TX, Shreveport, LA, Bedford Park, IL, and Normal, IL warehouses. The property management fees earned by PREMISYS during 1994 were $92,382.\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\nSee the Index to Financial Statements and Supplementary Data on pages and.\n2. Financial Statement Schedules\nThe following financial statement schedules of The Prudential Variable Contract Real Property Partnership should be read in conjunction with the financial statements incorporated by reference in Item 8 of this Annual Report on Form 10-K:\nIII Real Estate Owned: Properties III Real Estate Owned: Interest in Properties IV Mortgage Loans on Real Estate\nSee the Index to Financial Statements and Supplementary Data on pages and.\n3. Documents Incorporated by Reference\nSee the following list of exhibits.\n4. Exhibits\nSee the following list of exhibits.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the last quarter of 1994.\n(c) The following is a list of Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. The Registrant will furnish a copy of any Exhibit listed below to any security holder of the Registrant who requests it upon payment of a fee of 15 cents per page. All Exhibits are either contained in this Annual Report on Form 10-K or are incorporated by reference as indicated below.\n3.1 Amended Articles of Incorporation of Pruco Life Insurance Company filed as Exhibit 1.A.(6)(a) to Form N-8B-2, File No. 2-80513, filed November 22, 1982, and incorporated herein by reference.\n3.2 Amended By-Laws of Pruco Life Insurance Company, filed as Exhibit 1.A.(6)(b) to Post-Effective Amendment No. 13 to Form S-6, File No. 2- 89558, filed March 2, 1989, and incorporated herein by reference.\n3.3 Resolution of the Board of Directors establishing the Pruco Life Variable Contract Real Property Account, filed as Exhibit (3C) to Form S-1, Registration Statement No. 33-8698, filed September 12, 1986, and incorporated herein by reference.\n4.1 Variable Life Insurance Contract, filed as Exhibit 1.A.(5)(a) to Pre- Effective Amendment No. 1 to Form S-6, Registration Statement No. 2- 80513, filed February 17, 1983, and incorporated herein by reference.\n4.2 Revised Variable Appreciable Life Insurance Contract with fixed death benefit, filed as Exhibit 1.A.(5)(f) to Post-Effective Amendment No. 5 to Form S-6, Registration Statement No. 2-89558, filed July 10, 1986, and incorporated herein by reference.\n4.3 Revised Variable Appreciable Life Insurance Contract with variable death benefit, filed as Exhibit 1.A.(5)(g) to Post-Effective Amendment No. 5 to Form S-6, Registration Statement No. 2-89558, filed July 10, 1986, and incorporated herein by reference.\n4.4 Single Premium Variable Annuity Contract, filed as Exhibit 4(i) to Form N-4, Registration Statement No. 2-99616, filed August 13, 1985, and incorporated herein by reference.\n4.5 Flexible Premium Variable Life Insurance Contract, filed as Exhibit 1.A.(5) to Form S-6, Registration Statement No. 2-99260, filed July 29, 1985, and incorporated herein by reference.\n9. None.\n10.1 Investment Management Agreement between The Prudential Insurance Company of America and The Prudential Variable Contract Real Property Partnership filed as Exhibit (10A) to Post-Effective Amendment No. 4 to Form S-1, Registration Statement No. 33-8698, filed May 2, 1988, and incorporated herein by reference.\n10.2 Service Agreement between The Prudential Insurance Company of America and The Prudential Investment Corporation, filed as Exhibit (10B) to Form S-1, Registration Statement No. 33-8698, filed September 12, 1986, and incorporated herein by reference.\n10.3 Partnership Agreement of The Prudential Variable Contract Real Property Partnership filed as Exhibit (10C) to Post-Effective Amendment No. 4 to Form S-1, Registration Statement No. 33-8698, filed May 2, 1988, and incorporated herein by reference.\n11. Not applicable.\n12. Not applicable.\n13. None.\n18. None.\n21. Not applicable.\n22. Not applicable.\n23. None.\n24.1 Powers of Attorney: E. Caufield, R. Hill, G. Keith, Jr., I. Kleinman, I. Price, and D. Southwell, filed as Exhibit 7 to Form S-1, Registration Statement No. 33-86780, filed November 23, 1994, and incorporated herein by reference.\n27. Not applicable.\n28. None.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPRUCO LIFE INSURANCE COMPANY in respect of Pruco Life of Variable CONTRACT REAL PROPERTY ACCOUNT (Registrant)\nDate: March 17, 1995 By: \/s\/ Esther H. Milnes -------------------------- -------------------- Esther H. Milnes 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* Chairman of the Board March 20, 1995 -------------------------- and Director Robert P. Hill\n* Vice Chairman of the Board March 20, 1995 -------------------------- and Director I. Edward Price\n\/s\/ Esther H. Milnes President and Director March 17, 1995 ------------------------- Esther H. Milnes\n\/s\/ Beverly R. Barney Senior Vice President March 17, 1995 ------------------------- Beverly R. Barney\n\/s\/ Stephen P. Tooley Vice President, Comptroller March 16, 1995 ------------------------- and Chief Accounting Officer Stephen P. Tooley\n\/s\/ Richard F. Lambert Senior Vice President March 17, 1995 ------------------------- and Chief Actuary Richard F. Lambert\nBy: * \/s\/ Thomas C. Castano -------------------------------------------- Thomas C. Castano (Attorney-in-Fact)\nSignature Title Date --------- ----- ----\n* Director March 20, 1995 ------------------------- E. Michael Caulfield\n* Director March 20, 1995 ------------------------- Garnett L. Keith, Jr.\n* Director March 20, 1995 ------------------------- Ira J. Kleinman\n* Director March 20, 1995 ------------------------- Donald G. Southwell\nBy: * \/s\/ Thomas C. Castano -------------------------------------------- Thomas C. Castano (Attorney-in-Fact)\nPRUCO LIFE VARIABLE CONTRACT REAL PROPERTY ACCOUNT (Registrant)\nINDEX\nPage ----\nA. PRUCO LIFE VARIABLE CONTRACT REAL PROPERTY ACCOUNT\nIndependent Auditors' Report\nFinancial Statements:\nStatements of Net Assets - December 31, 1994 and 1993\nStatements of Operations - Years Ended December 31, 1994, 1993 and 1992\nStatements of Changes in Net Assets - Years Ended December 31, 1994, 1993 and 1992\nNotes to Financial Statements\nB. THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP\nIndependent Auditors' Report\n1. Financial Statements:\nStatements of Assets and Liabilities - December 31, 1994 and 1993\nStatements of Operations - Years Ended December 31, 1994, 1993 and 1992\nStatements of Changes in Net Assets - Years Ended December 31, 1994, 1993 and 1992\nStatements of Cash Flows - Years Ended December 31, 1994, 1993 and 1992\nSchedule of Investments - December 31, 1994 and 1993\nNotes to Financial Statements\nPRUCO LIFE VARIABLE CONTRACT REAL PROPERTY ACCOUNT (Registrant)\nINDEX\nPage ----\nB. THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP (continued)\n2. Financial Statement Schedules:\nIII. - Real Estate Owned: Properties\nIII. - Real Estate Owned: Interest in Properties\nIV. - Mortgage Loans on Real Estate\nAll other schedules are omitted because they are not applicable, or because the required information is included in the financial statements or notes thereto.\nDeloitte & Touche LLP ------------ ----------------------------------------------------------- Two Hilton Court Telephone: (201)631-7000 P.O. Box 319 Facsimile: (201)631-7459 Parsippany, New Jersey 07054-0319\nINDEPENDENT AUDITORS' REPORT\nTo the Contract Owners of Pruco Life Variable Contract Real Property Account Newark, New Jersey\nWe have audited the accompanying statements of net assets of Pruco Life Variable Contract Real Property Account (\"Real Property Account\") as of December 31, 1994 and 1993, and the related statements of operations and changes in net assets for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Real Property Account'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 Pruco Life Variable Contract Real Property Account as of December 31, 1994 and 1993, and the results of its operations and the changes in net assets for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nInvestment in shares of The Prudential Variable Contract Real Property Partnership is stated at current value at December 31, 1994 and 1993, as discussed in Note 2 to the financial statements. Determination of current value involves subjective judgment because the actual market value of such shares can be determined only by negotiation between the parties in a sales transaction.\nDeloitte & Touche LLP March 6, 1995\nFINANCIAL STATEMENTS OF PRUCO LIFE VARIABLE CONTRACT REAL PROPERTY ACCOUNT\nSTATEMENTS OF NET ASSETS\nSTATEMENTS OF OPERATIONS\nSEE NOTES TO FINANCIAL STATEMENTS ON PAGES THROUGH.\nFINANCIAL STATEMENTS OF PRUCO LIFE VARIABLE CONTRACT REAL PROPERTY ACCOUNT\nSTATEMENTS OF CHANGES IN NET ASSETS\nSEE NOTES TO FINANCIAL STATEMENTS ON PAGES THROUGH.\nNOTES TO THE FINANCIAL STATEMENTS OF PRUCO LIFE VARIABLE CONTRACT REAL PROPERTY ACCOUNT FOR YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nNOTE 1: GENERAL\nPruco Life Variable Contract Real Property Account (the \"Real Property Account\") was established on August 27, 1986 and commenced business September 5, 1986. Pursuant to Arizona law, the Real Property Account was established as a separate investment account of Pruco Life Insurance Company (\"Pruco Life\"), a wholly- owned subsidiary of The Prudential Insurance Company of America (\"The Prudential\"). The assets of the Real Property Account are segregated from Pruco Life's other assets. The Real Property Account is used to fund benefits under certain variable life insurance and variable annuity contracts issued by Pruco Life.\nPrior to April 29, 1988, the Real Property Account invested primarily in income- producing real properties and mortgage loans. On April 29, 1988, The Prudential Variable Contract Real Property Partnership (the \"Partnership\"), a general partnership organized under New Jersey law, was formed. On that date all assets and liabilities of the Real Property Account were contributed to the Partnership in exchange for interests in the newly formed Partnership.\nThe Partnership has a policy of investing at least 65% of its assets in direct ownership interests in income-producing real estate and participating mortgage loans.\nNOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nA. CHANGE IN ACCOUNTING POLICY\nThe financial statements are prepared on a current value basis. This represents a change in accounting policy from financial statements issued prior to the year ended December 31, 1991 which utilized the historical cost basis of accounting and provided only supplementary information on current values. Since the unit values under Contracts participating in the Partnership are determined using the current value basis of investments (see General Note to the Partnership financials), this basis is deemed more meaningful to the investor than a historical cost basis.\nB. INVESTMENT IN PARTNERSHIP INTEREST\nThe investment in the Partnership is based on the Real Property Account's proportionate interest of the Partnership's current value, as discussed in Note 1 to the Partnership's financial statements. At December 31, 1994 and 1993 the Real Property Account's interest in the Partnership, based on current value equity was 51.5% or 6,302,293 shares and 52.8% or 6,879,878 shares, respectively.\nC. INCOME RECOGNITION\nThe Real Property Account recognizes its proportionate share of the Partnership's net investment income on a daily basis, consistent with the Partnership Agreement. The Net Gain\/(Loss) on Investment in Partnership reflected on the Statements of Operations represents the Real Property Account's proportionate share of the Net Gain\/(Loss) on Investments recognized by the Partnership.\nNOTE 3: ASSET BASED CHARGES\nMortality risk and expense risk charges and charges for administration are applied daily against the net assets representing equity of Contract owners investing in the Real Property Account, at an effective annual rate as shown below for each of Pruco Life's separate accounts investing in the Real Property Account:\n-------------------------------------------------------------------------------- Variable Insurance Account 0.35% Variable Appreciable Account 0.60% Single Premium Variable Life Account 1.25% Single Premium Variable Annuity Account 1.25% --------------------------------------------------------------------------------\nNOTE 4: TAXES\nIncome and capital gains and losses of the Partnership are attributed, for federal income tax purposes, to the Partners in the Partnership, including Pruco Life, in respect of the Real Property Account. The operations of the Real Property Account form a part of, and are taxed with, the operations of Pruco Life. Under the Internal Revenue Code, all ordinary income and capital gains allocated to the Contract owners are not taxable to Pruco Life. As a result, the net asset values of the Real Property Account are not affected by federal income taxes on the ordinary income and capital gains and losses attributable to the Real Property Account.\nNOTE 5: NET REALIZED LOSS ON INVESTMENT\nThe Net Realized Loss on Investment reflected on the Statement of Operations represents the Real Property Accounts's proportionate share of the loss realized by the Partnership upon the sale of certain properties. For further information, please refer to Note 8 of the Partnership's December 31, 1994 financial statements.\nDELOITTE & TOUCHE LLP ------------ ----------------------------------------------------------- Two Hilton Court Telephone: (201)631-7000 P.O. Box 319 Facsimile: (201)631-7459 Parsippany, New Jersey 07054-0319\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of The Prudential Variable Contract Real Property Partnership Newark, New Jersey\nWe have audited the accompanying statements of assets and liabilities of The Prudential Variable Contract Real Property Partnership as of December 31, 1994 and 1993, and the related statements of operations, changes in net assets and cash flows for each of the three years in the period ended December 31, 1994 (collectively referred to as the financial statements), including the schedule of investments as of December 31, 1994. Our audit also included the financial statement schedules listed in the Index at Item 14. These financial statements and financial statement schedules are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of The Prudential Variable Contract Real Property 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. 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.\nInvestment in properties, interest in properties and mortgage loans are stated at current value at December 31, 1994 and 1993, as discussed in Note 1 to the financial statements. Determination of current value involves subjective judgment because the actual market value of real estate and mortgage loans can be determined only by negotiation between the parties in a sales transaction.\nDeloitte & Touche LLP March 6, 1995\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP\nSTATEMENTS OF ASSETS AND LIABILITIES\nSEE NOTES TO FINANCIAL STATEMENTS ON PAGES THROUGH.\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP\nSTATEMENTS OF OPERATIONS\nSEE NOTES TO FINANCIAL STATEMENTS ON PAGES THROUGH.\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP\nSTATEMENTS OF CHANGES IN NET ASSETS\nSEE NOTES TO FINANCIAL STATEMENTS ON PAGES THROUGH.\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP\nSTATEMENTS OF CASH FLOWS\nSEE NOTES TO FINANCIAL STATEMENTS ON PAGES THROUGH.\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP SCHEDULE OF INVESTMENTS\n(CONTINUED)\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP SCHEDULE OF INVESTMENTS\n(CONTINUED)\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP SCHEDULE OF INVESTMENTS\nSEE NOTES TO FINANCIAL STATEMENTS ON PAGES THROUGH.\nNOTES TO FINANCIAL STATEMENTS OF THE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP FOR YEARS ENDED DECEMBER 31, 1994, 1993, 1992\nGENERAL\nOn April 29, 1988, The Prudential Variable Contract Real Property Partnership (the \"Partnership\"), a general partnership organized under New Jersey law, was formed through an agreement among The Prudential Insurance Company of America (\"The Prudential\"), Pruco Life Insurance Company (\"Pruco Life\"), and Pruco Life Insurance Company of New Jersey (\"Pruco Life of New Jersey\"). The Partnership was established as a means by which assets allocated to the real estate investment option under certain variable life insurance and variable annuity contracts issued by the respective companies could be invested in a commingled pool. The partners in the Partnership are The Prudential, Pruco Life and Pruco Life of New Jersey.\nThe Partnership has a policy of investing at least 65% of its assets in direct ownership interests in income-producing real estate and participating mortgage loans.\nThe Partnership's investments are valued on a daily basis, consistent with the Partnership Agreement. On each day during which the New York Stock Exchange is open for business, the net assets of the Partnership are valued using the current value of its investments as described in Notes 1A and 1B below, plus an estimate of net income from operations reduced by any liabilities of the Partnership.\nThe periodic adjustments to property and mortgage loan values described in Notes 1A and 1B below and the corrections of previous estimates of net income are made on a prospective basis. There can be no assurance that all such adjustments and estimates will be made timely.\nShares of the Partnership are sold to The Prudential Variable Contract Real Property Account, Pruco Life Variable Contract Real Property Account, and Pruco Life of New Jersey Variable Contract Real Property Account, (the \"Real Property Accounts\") at the current share value of the Partnership's net assets. Share value is calculated by dividing the current value of net assets of the Partnership as determined below by the number of shares outstanding. A Contract owner participates in the Partnership through interests in the Real Property Accounts.\nNote 1: Summary Of Significant Accounting Policies\nA: Real Estate Owned and Interest in Properties - The Partnership's investments in real estate owned and interests in properties are initially valued at their purchase price. Thereafter, current values are based upon appraisal reports prepared by independent real estate appraisers (members of the Appraisal Institute or an equivalent organization) which are ordinarily obtained on an annual basis.\nThe Chief Appraiser of the Prudential Comptroller's Department Valuation Unit is responsible to assure that the valuation process provides independent and accurate current value estimates. In the interest of maintaining and monitoring the independence and the accuracy of the appraisal process, the Comptroller of The Prudential has appointed a third party firm to act as the Appraisal Management Firm. The Appraisal Management Firm, among other responsibilities, approves the selection and scheduling of external appraisals; develops a standard package of information to be supplied to the appraisers; reviews and provides comments on all external appraisals and a sample of internal appraisals; assists in developing policy and procedures and assists in the evaluation of the performance and competency of external appraisers. The property valuations are reviewed quarterly by The Prudential Comptroller's Department Valuation Unit and the Chief Appraiser and adjusted if there has been any significant changes related to the property since the most recent independent appraisal.\nThe purpose of an appraisal is to estimate the current value of a property as of a specific date. Current value has been defined as the most probable price for which the appraised property will sell in a competitive market under all conditions requisite to fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self interest, and assuming that neither is under undue duress. This estimate of current value generally is a correlation of three approaches, all of which require the exercise of subjective judgement. The three approaches are: (1) current cost of reproducing a property less deterioration and functional and economic obsolescence; (2) discounting of a series of income streams and reversion at a specified yield or by directly capitalizing a single - year income estimate by an appropriate factor; and (3) value indicated by recent sales of comparable properties in the market. In the reconciliation of these three approaches, the one most heavily relied upon is the one generally most appropriate for the type of property in the market.\nB: Mortgage Loans - Investment in mortgage loans which mature in the current year are carried at the amount of unpaid principal. Impaired loans are valued at the lower of the current value as described above or the current value of the underlying property determined as described in Note 1A.\nC: Revenue Recognition - Rent from properties consists of all amounts earned under tenant operating leases including base rent, recoveries of real estate taxes and other expenses and charges for miscellaneous services provided to tenants. Revenue from leases which provide for scheduled rent increases is recognized as billed.\nD: Cash and Cash Equivalents - The Partnership considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents are carried at market value.\nE: Marketable Securities - Marketable securities are highly liquid investments with maturities of more than three months when purchased and are carried at market value.\nF: Federal Income Taxes - The Partnership is not a taxable entity under the provisions of the Internal Revenue Code. The income and capital gains and losses of the Partnership are attributed, for federal income tax purposes, to the Partners in the Partnership. The Partnership may be subject to state and local taxes in jurisdictions in which it operates.\nThe bases of the Partnership's assets and liabilities for federal income tax purposes are the same as the amounts reported on the statements of assets and liabilities except for the investment in properties. The tax basis of the properties is $148,001,027 at December 31, 1994 and $146,917,984 at December 31, 1993.\nG: Change in Accounting Policy - As of December 31, 1991, the financial statements are prepared on a current value basis. This represents a change in accounting policy from financial statements prior to the year ended December 31, 1991 which utilized the historical cost basis of accounting and provided only supplementary information on current values. Since the unit values under Contracts participating in the Partnership are determined using the current value basis of investments (see General Note), this basis is deemed more meaningful to the investor than a historical cost basis.\nH: Reclassifications - Certain reclassifications have been made to the 1992 and 1993 financial statements to conform to those used in 1994.\nNote 2: Obligation Under Capital Lease\nThe Partnership maintains an interest in a leasehold estate consisting of six one-story industrial warehouse buildings located in Pomona, California. In conjunction with this interest, the Partnership assumed assignment of a ground lease agreement which expires in November 2078, with no renewal options. The annual ground lease payments after November 1994, and for each 10 year increment thereafter, are subject to increase 50% of the increase in the Consumer Price Index during the previous period. For 1995, the annual ground lease payment will increase $126,450 to $376,450. The ground lease contains a purchase option exercisable from November 1994 to November 1997 at a fixed price of $4,000,000. Future minimum ground lease payments under capital lease at December 31, 1994 are as follows:\nNote 3: Investment In Mortgage Loans\nAt December 31, 1993, the Partnership had an investment in two mortgage loans with a current value totalling $9,223,791 with interest rates of 8.875% and 9%. Both loans were scheduled to mature in 1994. The Partnership received a final payment in May 1994 of $3,543,892 which satisfied the terms of the loan on the property in Lincoln, NE. On July 1, 1994, the Partnership foreclosed on the Flint, MI mortgage loan under a voluntary conveyance of the property by the mortgagor. The Partnership took title to the property at the expiration of the redemption period on January 3, 1995. The property is reported as investment in property in the December 31, 1994 financial statements and is carried at its current value.\nNote 4: Leasing Activity\nThe Partnership leases space to tenants under various operating lease agreements. These agreements, without giving effect to renewal options, have expiration dates ranging from 1995 to 2009. At December 31, 1994, future minimum base rental income under non-cancelable operating leases by year, and in the aggregate are shown below. Although these are non-cancelable leases, there is no assurance that all amounts will be received.\nNote 5: Transactions with affiliates\nPursuant to an investment management agreement, The Prudential charges the Partnership a daily investment management fee at an annual rate of 1.25% of the average daily gross asset valuation of the Partnership. For the years ended December 31, 1994, 1993 and 1992 management fees incurred by the Partnership were $2,287,816; $2,269,206 and $2,405,024, respectively.\nThe Partnership also reimburses The Prudential for certain administrative services rendered by The Prudential. The amounts incurred for the years ended December 31, 1994, 1993 and 1992 were $95,015; $119,467 and $147,254, respectively and are classified as administrative expenses in the statements of operations.\nThe Partnership owns a 50% interest in four warehouse\/distribution buildings in Jacksonville, Florida (the Unit warehouses). The remaining 50% interest is owned by The Prudential and one of its subsidiaries. At December 31, 1994 and 1993, these properties had total assets of $11,748,222 and $46,911,411 and liabilities of $150,964 and $33,306, respectively. For the years ended December 31, 1994, 1993 and 1992, these properties had revenues of $4,939,354, $5,931,236 and $5,909,188 and expenses of $1,611,108, $1,847,049 and $1,913,997, respectively.\nThe Partnership has contracted with PREMISYS Real Estate Services, Inc. (PREMISYS), an affiliate of The Prudential to provide property management services at the Unit warehouses, the Bolingbrook, IL warehouse, and through August, 1993 at the Azusa and Pomona warehouses. The property management fee earned by PREMISYS for the years ended December 31, 1994, 1993 and 1992 were $92,382; $89,684 and $105,664 respectively.\nNote 6: Line Of Credit\nThe Partnership established a $10 million unsecured revolving line of credit with First Fidelity Bank, N.A., which will be drawn upon as needed for potential liquidity needs. The annual cost of maintaining the line of credit is 0.1875% of the total line of credit. As of December 31, 1994, no drawdowns had occurred.\nNote 7: Commitment from Partner\nOn January 9, 1990, The Prudential committed to fund up to $100 million to enable the Partnership to take advantage of opportunities to acquire attractive real property investments whose cost is greater than the Partnership's then available cash. Contributions to the Partnership under this commitment are utilized for property acquisitions and returned to Prudential on an ongoing basis from Contract owners' net contributions. Also, the amount of the committment is reduced by $10 million for every $100 million in current value net assets of the Partnership. The amount available under this committment for property purchases as of December 31, 1994 is approximately $51.6 million.\nNote 8: Net Realized Loss on Investments\nOn October 7, 1994, the Partnership sold its 50% ownership interest in the two warehouses located in Atlanta, GA and the warehouses located in Desoto, TX; Fort Worth, TX; Shreveport, LA; Bedford Park, IL; and Normal, IL. The net proceeds on the sale were $19,014,872 resulting in a realized loss of $1,237,385.\nOn August 9, 1993, the Partnership sold its Denver, Colorado warehouse facility. The proceeds, net of related costs, amounted to approximately $2,561,000. The sale of the warehouse resulted in a realized loss of approximately $1,451,000.\nOn September 2, 1993, the Partnership sold one of the Jacksonville, Florida warehouse\/distribution buildings in which the Partnership owned a 50% interest. The proceeds, net of related costs, amounted to approximately $1,380,000, resulting in a realized loss of approximately $220,000.\nOn October 29, 1993, the Partnership sold its interest in the Unit warehouse located in Hightstown, New Jersey. The proceeds, net of related costs, were approximately $786,000, resulting in a realized loss of approximately $792,000.\nNote 9: Committment to Purchase\nThe Partnership has a committment to purchase a 250 - unit garden apartment community located in Raleigh, North Carolina at a purchase price of approximately $14 million. The apartment community which is currently under construction is expected to be completed in June, 1995. In conjunction with the purchase of the property, the Partnership will enter into an agreement to make a second funding for not more than $1,950,000 should the property meet certain income and occupancy requirements. This would increase the Partnership's total committment to approximately $16 million.\nNote 10: Per Share Information (For a share outstanding throughout the period)\nALL CALCULATIONS ARE BASED ON AVERAGE MONTH-END SHARES OUTSTANDING WHERE APPLICABLE. PER SHARE INFORMATION PRESENTED HEREIN IS SHOWN ON A BASIS CONSISTENT WITH THE FINANCIAL STATEMENTS AS DISCUSSED IN NOTE 1G.\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP SCHEDULE III - REAL ESTATE OWNED: PROPERTIES DECEMBER 31, 1994 ----------------------------------------------------------\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP SCHEDULE III - REAL ESTATE OWNED: INTEREST IN PROPERTIES DECEMBER 31, 1994 ------------------------------------------------------------------------\nTHE PRUDENTIAL VARIABLE CONTRACT REAL PROPERTY PARTNERSHIP\nSCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE\nDECEMBER 31, 1994\n----------------------------------------------------------------------","section_15":""}
{"filename":"765878_1994.txt","cik":"765878","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2 - Properties ----------\nRegistrant's principal executive office is located at 1105 North Market Street, Wilmington, Delaware. Registrant rents office space at this location and currently owns no property.\nItem 3","section_3":"Item 3 - Legal Proceedings -----------------\nRegistrant is not currently involved, nor has it been involved in any legal proceedings since its inception.\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 Registrant during the of Registrant's fiscal year.\nPART II\nItem 5","section_5":"Item 5 - Market for Registrant's Common Equity and Related Security Holder Matters -------------------------------------------------\nAll 60 shares of Registrant's $1.00 par value common stock currently outstanding are owned by Dollar Bank, a federal savings bank, an affiliate of Registrant. None of the common shares are traded on any stock exchange or in the over-the-counter market.\nAs long as any shares of MAPS are outstanding, Registrant may not pay any dividends on its common shares or engage in any other transaction relating to its common stock, except if:\na. such transaction is on an Evaluation date;\nb. the required asset coverage and dividend coverage would be met immediately after the transaction as of this Evaluation Date;\nc. full cumulative dividends on MAPS for all past dividend periods ended on or prior to this Evaluation date have been declared and paid or set aside for payment;\nd. immediately after such transaction, Registrant would have retained earnings of a least $7,500,000; and\ne. Registrant has complied with any mandatory redemption provision.\nRegistrant paid $15,000,000, $8,000,000, $10,000,000, $2,400,000 and $7,200,000 in cash dividends on its common stock during fiscal 1992, 1990, 1989, 1987 and 1986 respectively, and has maintained the necessary retained earnings level. No common stock dividends were paid in fiscal 1994, 1993, 1991 and 1988.\nOn February 26, 1987, Registrant purchased 40 of its 100 outstanding shares of common stock from Dollar Bank for $30,000,000 in cash.\nCopies of this 10-K filing are available to shareholders without charge upon request. Contact: Treasurer of Dollar Finance, Inc., 1105 North Market Street, P.O. Box 8985, Wilmington, Delaware 19899.\nItem 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations -------------------------------------------------\nResults of Operations: - - - - - ---------------------\nFor the year ended November 30, 1994, Dollar Finance, Inc. (\"Registrant\") reported net income of $3,440,000 or $16,000 per share after deducting dividends on the shares of Market Auction Preferred Stock (\"MAPS\"). Net income for fiscal 1993 was $4,745,000, or $45,000 per share after deducting MAPS dividends and for fiscal year 1992, $5,747,000, or $55,000 per share after deducting MAPS dividends. Operating income has consisted of interest earned on required assets, including mortgage-backed securities, U.S. Treasury securities and short-term money market instruments, consisting of commercial paper, certificates of deposit, treasury bills and other time deposits. Additional income\/(loss) was recognized during 1994, 1993, and 1992 from security transactions in which Registrant sold mortgage-backed securities back to Dollar Bank at market value, resulting in gains\/(losses) of $(565,962), $902,975 and $72,557, respectively. These gains\/(losses) are the result of security sales undertaken by the Registrant in actively managing its investment portfolio in light of changes in market interest rates.\nProfessional fee expense incurred during each year consisted largely of broker commission charges of approximately $25,500 incurred on each MAPS dividend payment date.\nRetained earnings of Registrant have been reduced by the amount of MAPS dividends paid and accrued during the three fiscal years. These dividends amounted to $2,502,000 in 1994, $2,071,000 in 1993 and $2,427,000 in 1992. The applicable dividend rates on MAPS dividends at November 30, 1994, 1993 and 1992 were 3.814%, 3.09% and 2.58%, respectively. Registrant's retained earnings were also reduced during 1992 by a common stock dividend payment to Dollar Bank of $15,000,000 on its shares of common stock. No common stock dividends were paid during 1994 or 1993.\nDuring 1993, Registrant 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 through 1990 were restated.\nRetained earnings was restated to reflect the cumulative effect of the change in accounting for income taxes as a result of retroactively applying FASB Statement No. 109 to 1990.\nThe Company also adopted FASB Statement No. 115 during 1993. Retained earnings for 1994 and 1993 is increased\/(decreased) by approximately $(35,000) and $1,241,000, respectively for the impact of applying FASB Statement No. 115, which requires that the unrealized gains (losses) on investment securities available for sale be recognized as a separate component of capital. The net unrealized gain\/(loss) for 1994 and 1993 of $(57,000) and $2,068,000 is shown net of deferred federal income tax\/(benefit) of $(22,000) and $827,000, respectively.\nThe deferred tax (benefit)\/liability of $(22,000) and $827,000 represents the taxes to be (refunded)\/paid in future years on the temporary difference between the financial statement and tax return values of investment securities available for sale as of November 30, 1994 and 1993, respectively. For financial statement purposes, these investment securities have been recorded at market value in accordance with FASB Statement No. 115. For tax purposes they are carried at net book value. The deferred tax (benefit)\/liability reflected in fiscal 1994 and 1993 is not included in the total tax provision for the year since, in accordance with Statement 115 it is properly reflected as a component of equity capital, and consequently has no impact on net income for the year.\nManagement expects the yield recognized on the required assets of Registrant to continue to exceed the applicable dividend rate on MAPS dividends, which averaged 3.34% on the liquidation value of each share during fiscal 1994.\nLiquidity: - - - - - ---------\nThe principal sources of short-term liquidity are principal and interest generated from the investment in Registrant's short-term assets and mortgage- backed securities. The Registrant also manages its liquidity position by maintaining adequate levels of liquid assets, such as time deposits and securities available for sale. Additional liquidity is available through the Registrant's ability to incur, under certain limited circumstances, secured and unsecured indebtedness for borrowed money of an aggregate amount not exceeding $5,000,000 and to incur additional indebtedness in the form of reverse repurchase agreements.\nRegistrant possesses dividend coverage assets consisting of short-term money market instruments with remaining maturities not in excess of the number of days until the next MAPS dividend payment, and cash. As of each Evaluation date, Registrant will calculate the aggregate adjusted value of its dividend coverage assets to assure that this value is at least equal to the required dividend coverage amount. Registrant is required to maintain required assets with a market value in excess of the product of the current liquidation value per share and the number of MAPS shares outstanding. This requirement provides long-term liquidity necessary for any future redemption of MAPS shares.\nThe Registrant does not anticipate that changes in tax legislation in 1993 will have any material impact on its liquidity position.\nItem 8 - Financial Statements and Supplementary Data -------------------------------------------\n-----------------------------\nPage No. -----\nReport of Independent Auditors . . . . . . . . . . . . . . . . . . . 11\nFinancial Statements:\nStatements of Condition, November 30, 1994 and November 30, 1993 . . . . . . . . . . . . . . . . . . . . . . 12\nStatements of Earnings, For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . . . . . . . . 13\nStatements of Changes in Equity Capital, For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . . . . . . 14\nStatements of Cash Flows, For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . . . . . . . . 15\nNotes to Financial Statements . . . . . . . . . . . . . . . . 16\nErnst & Young One Oxford Centre Pittsburgh, PA 15219\nPhone: (412) 644-7800\nIndependent Auditor's Report\nBoard of Directors Dollar Bank, Inc.\nWe have audited the financial statements of Dollar Finance, Inc., a wholly- owned subsidiary of Dollar Bank, a federal savings bank, listed in the accompanying index to financial statements on page 10. 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 listed in the accompanying index to financial statements on page 10 present fairly, in all material respects, the financial position of Dollar Finance, Inc. at November 30, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended November 30, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the financial statements, in 1993 the Company changed its method of accounting for investment securities.\nErnst & Young\nDollar Finance, Inc. Statement of Changes in Equity Capital ($-In Thousands - except dividends per share amounts)\nDollar Finance, Inc. Notes to Financial Statements\n1. Summary of Significant Accounting Policies ------------------------------------------\nThe accounting and reporting policies and practices of Dollar Finance, Inc., a wholly owned subsidiary of Dollar Bank, a federal savings bank (Dollar Bank), follow generally accepted accounting principles. The major reporting policies and practices are summarized below.\nCash and Cash Equivalents -------------------------\nCash and cash equivalents presented within the Statement of Cash Flows include cash and short-term investments with original maturities of less than 90 days.\nRequired Assets ---------------\nRequired assets may include cash, FNMA certificates, FHLMC certificates, GNMA certificates, certain short-term money market instruments, U.S. Treasury securities and other securities not adversely affecting the current rating on the shares of Market Auction Preferred Stock (\"MAPS\") by Moody's and Standard & Poors.\nMoney Market Investments ------------------------\nCommercial paper is valued at cost, which is calculated as par value less interest receivable at maturity. Cost closely approximates market value due to the short-term nature of these instruments. Certificates of deposit and other time deposits are recorded at their purchase price.\nInvestment Securities ---------------------\nInvestment securities consist of mortgage-backed securities which include FNMA pass-through certificates, FHLMC participation certificates and GNMA modified pass-through certificates. As outlined in Note 2, in 1994 and 1993 these instruments are stated at market value if classified as available for sale, or cost, adjusted for amortization of premiums and accretion of discounts if held to maturity. Fair values 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.\nPayments on mortgage-backed securities are received monthly and are applied accordingly to interest income and principal reduction. Transactions involving mortgage-backed securities are accounted for on the identified certificate basis.\nAccrued Interest Receivable ---------------------------\nIncome to be received from interest payments on money market investments and investment securities is accrued on a monthly basis.\nAccrued Preferred Stock Dividends ---------------------------------\nCash dividends on the shares of MAPS outstanding are accrued on a monthly basis and charged against retained earnings at the current applicable annual dividend rate determined through auction procedures.\nNet Income Per Common Share ---------------------------\nNet income per common share is calculated by dividing (a) net income less preferred stock dividends paid and accrued by (b) the weighted average number of common shares outstanding during the period.\n2. Accounting Changes ------------------\nIn February 1992, the Financial Accounting Standards Board issued Statement No. 109 \"Accounting for Income Taxes.\" Dollar Finance adopted the provisions of the standard in its 1993 financial statements and restated its 1992 and 1991 financial statements.\nIn May 1993, the Financial Accounting Standards Board issued Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" As permitted under the Statement, Dollar Finance elected to adopt the provisions of the standard as of the end of its fiscal year ending November 30, 1993. In accordance with the Statement, prior period financial statements were not restated to reflect the change in accounting principle. The effect of adopting FAS No. 115 as of November 30, 1993, resulted in a transfer of $124,355,000 of investment securities having a fair value of $126,423,000, from held to maturity to available for sale and an increase in retained earnings of $1,241,000, net of Federal tax of $827,000. During fiscal 1994, the securities available for sale declined $2,123,000 in market value resulting in an unrealized loss of $55,000 and reduction in retained earnings of $33,000 at November 30, 1994 net of Federal tax of $22,000.\nDollar Finance, Inc. 3. Investments -----------\nThe following is a comparison of book value to market value of short-term investments and investment securities at Nov. 30, 1993:\nWhich Issue No. Principal Gross Gross is Carried Title of Each Issue and of Amount of Cost of Unrealized Unrealized Market Value at on the Statement Name of Issuer: Units Each Issue Each Issue Gains Losses Nov. 30, 1994 of Condition - - - - - ----------------------- ----- ---------- ----------- ---------- ---------- ---------------- ----------------\nSHORT-TERM INVESTMENTS\nTime Deposits: - - - - - -------------- Harris Trust Euro 3 6,237 6,237 0 0 6,237 6,237 --- -------- -------- ------ ------- -------- -------- 3 $ 6,237 $ 6,237 $ 0 $ 0 $ 6,237 $ 6,237 ========\nSecurities Available for Sale: - - - - - ----------------------------- FNMA Certificates 11 10,918 11,020 188 0 11,208 11,208 FHLMC Certificates 33 111,986 113,385 1,880 0 115,215 115,215 --- ------- ------- ------ ---- -------- ------- 44 $122,904 $124,335 $2,068 $ 0 $126,423 $126,423 ========\n\/TABLE\n4. Capitalization --------------\nOn March 28, 1985, Dollar Bank purchased all of the 100 authorized shares of Registrant's $l.00 par value common stock for $10,000 in cash. Additional capital contributions from Dollar Bank consisted of a $75,000 cash contribution on May 13, 1985 and a required asset contribution of approximately $59,300,000 on May 23, 1985. The proceeds from these contributions above the total par value were credited to Additional Paid-in Capital from Common Stock. On May 28, 1985, Registrant issued 750 shares of MAPS at a purchase price of $100,000 per share. One thousand dollars per share of the MAPS proceeds were credited to Registrant's Preferred Stock account with the balance, net of underwriting costs, being credited to Additional Paid-In Capital from Preferred Stock.\n5. Common Stock and Dividend Restriction -------------------------------------\nDollar Bank owns all 60 shares of Registrant's outstanding common stock. No dividends may be paid on the common shares unless Registrant would have retained earnings of at least $7,500,000 immediately after the payment of such dividends. The common stock ranks junior to the MAPS with respect to payment of dividends on liquidation or dissolution.\nIn October 1992, the Board of Directors of Registrant declared and paid a cash dividend of $15,000,000 or $250,000 per share on its common stock.\nNo cash dividends were paid on common stock during fiscal 1994 or 1993.\n6. Market Auction Preferred Stock (\"MAPS\") ---------------------------------------\nDescription of MAPS -------------------\nThe shares of MAPS have a liquidation preference of $100,000 per share plus accrued and unpaid dividends. The MAPS shares are not convertible into shares of common stock and have no pre-emptive rights. The holders of MAPS are entitled to receive cumulative cash dividends on the business day following the conclusion of each dividend period, generally consisting of 49 days. The applicable dividend rate per share for each dividend period is determined through auction procedures. The applicable dividend rate for each dividend period during fiscal 1994 (the dividend payable on December 6, 1994 was accrued through November 30, 1994) was as follows:\nNovember 9, 1993 - December 29, 1993 3.090% December 30, 1993 - February 16, 1994 2.950% February 17, 1994 - April 6, 1994 2.850% April 7, 1994 - May 25, 1994 2.960% May 26, 1994 - July 13, 1994 3.500% July 14, 1994 - August 31, 1994 3.520% September 1, 1994 - October 19, 1994 3.630% October 20, 1994 - December 6, 1994 3.814%\nThe maximum applicable rate that results from an auction will not be greater than 110%, or under certain circumstances, 125% of the 60-day \"AA\" Composite Commercial Paper Rate in effect on the auction date.\nThe MAPS shares are subject to mandatory redemption if (l) the required asset coverage is not met or restored as required or (2) any portion of the dividend payments on MAPS during a calendar year constitutes a return of capital for federal income tax purposes.\nRegistrant has the option of redeeming the MAPS shares on any dividend payment date, in whole or in part, at the applicable per share amounts previously noted, plus an amount equal to accrued and unpaid dividends to the redemption date.\nThe holders of shares of MAPS have no voting rights except during a period that (l) the required asset coverage is not maintained or restored as required, (2) the aggregate amount of dividends in arrears on a dividend payment date is equal to or greater than the amount of dividends accrued during the dividend period preceding such payment date, or if (3) Registrant has not redeemed MAPS shares when required. Holders of shares of MAPS have had no voting rights during the reporting period or during any prior period.\nRequired Asset Coverage -----------------------\nAs of each Evaluation date (approximately every 25 days), Registrant must have required assets with a market value in excess of the product of (a) $100,000; and (b) the number of MAPS shares then outstanding. Registrant is obligated to maintain or restore the number of MAPS shares necessary to maintain required asset coverage as of each Evaluation date. Registrant has maintained required asset coverage throughout fiscal 1994 and for all prior periods.\nDividend Coverage -----------------\nAs of each Evaluation date, the aggregate adjusted value of Registrant's U.S. Treasury securities and short-term money market instruments maturing before the next dividend payment date and cash must at least equal the dividend coverage amount for 49 days of dividends at the applicable dividend rate then in effect. Registrant has maintained adequate dividend coverage throughout fiscal 1994 and for all prior periods.\n7. Security Transactions ---------------------\nDuring fiscal 1994, Registrant purchased from Dollar Bank twenty- two FHLMC fixed rate and three FHLMC adjustable rate certificates with an aggregate book value of $23,913,908. Registrant also purchased from Dollar Bank six U.S. government agency discount notes with an aggregate book value of $69,670,433.\nRegistrant sold to Dollar Bank twenty FHLMC adjustable rate certificates with a net book value and market value of $72,279,794 and $72,047,829, respectively. Proceeds from the sale amounted to $72,209,117 and resulted in a net loss of $565,962.\nDuring fiscal 1993, Registrant purchased from Dollar Bank thirteen FHLMC fixed rate and seven FHLMC adjustable rate certificates with an aggregate book value of $87,686,000. Registrant sold twenty-three FNMA fixed rate certificates and eleven FHLMC fixed rate certificates with a net book value and market value of $35,886,000 and $36,789,000, respectively. Proceeds from the sales amounted to $36,927,000, and resulted in a net gain of $903,000.\nDuring fiscal 1992, Registrant purchased from Dollar Bank fifteen FNMA adjustable rate certificates and twelve FHLMC adjustable rate certificates with an aggregate book value of $64,731,000 and sold nine FHLMC adjustable rate certificates with a net book value and market value of $9,147,000 and $9,220,000, respectively. Proceeds from the sales amounted to $9,370,000, and resulted in a net gain of $73,000.\n8. Income Taxes ------------\nIn February 1992, the Financial Accounting Standards Board issued Statement No. 109, \"Accounting for Income Taxes.\" As explained in Note 2, the Registrant adopted the provisions of the standard in its November 30, 1993 fiscal year and restated its 1992 and 1991 financial statements.\nUnder Statement No 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.\nThe Registrant is included in the consolidated federal income tax return of Dollar Bank. Statement 109 specifies that the amount of current and deferred tax expense for a group that files a consolidated tax return should be allocated among the members of the group. The policy of the consolidated group is to allocate its current and deferred taxes as if each member of the group were a separate taxpayer not included in a consolidated tax return.\nThe provision for income taxes for 1994, 1993, and 1992 consists of the Registrant's net income before taxes and intercompany securities gains at the statutory federal income tax rates. The resulting tax expense is recorded on the Registrant's Statement of Condition as intercompany payables to the Registrant's parent corporation, Dollar Bank, net of amounts previously paid to the parent.\nThe deferred tax asset\/(liability) for fiscal year ending November 30, 1994 and 1993 of $22,000 and ($827,000), respectively, represents the taxes to be refunded\/(paid) in future years on the temporary difference between the financial statement and tax return values of investment securities available for sale. For financial statement purposes these investment securities have been recorded at market value per FASB Statement No. 115 while for tax purposes they are carried at net book value. The deferred tax asset\/(liability) reflected in fiscal 1994 and 1993, respectively, are not included in the total tax provision for the year since, in accordance with Statement 115 it is properly reflected as a component of equity capital, and consequently has no impact on net income for the year.\nReconciliation of the effective income tax rate with the statutory Federal income tax rate is as follows:\nPercent of Income Before Income Taxes ------------------- Year Ended November 30 1994 1993 1992 ----------------------\nFederal Income Tax Statutory Rate 35% 35% 34%\nIntercompany Gain\/(Loss) on Sale of Securities; Eliminated for Federal Tax Purposes 0 (5) 0\nOther, Net 0 (1) 0 ------------------------\nEffective Rate 35% 29% 34% ======================\nItem 9 - Changes In and Disagreements with Accountants on Accounting and Financial Disclosure -------------------------------------------------\nThere have been no disagreements with accountants on accounting and financial disclosure.\nPART III\nItem 10 - Directors and Executive Officers of the Registrant --------------------------------------------------\nThe following table identifies the Registrant's directors and executive officers, their ages and their positions for the previous five years:\n============================================================================ Positions with Principal Occupations Name: Age: Registrant: since 12\/01\/85: ---- ---- -------------- ---------------------\nHay Walker 62 Chairman of the Retired since 1993; Board; Director previously Executive Vice President of Dollar Bank.\nRobert P. Oeler 45 President; Executive Vice President Director of Dollar Bank since 1992; previously Senior Vice President.\nThomas A. Kobus 42 Treasurer; Senior Vice President and Director Treasurer of Dollar Bank since 1992; previously Vice President and Treasurer.\nRobert L. German 70 Vice President Vice President, Security- and Assistant Columbian, Division, U.S. Secretary; Banknote Company. Director\nRobert T. Messner 56 Secretary; Vice President, General Director Counsel and Secretary for Dollar Bank since 1986.\nAll directors were elected at the annual meeting of the holders of Registrant's common stock to serve for a term of one year or until their respective successors are elected and qualified. The Registrant's Certificate of Incorporation requires that at least one director and one executive officer (or one individual serving in both capacities) of Registrant must not be a director, officer or employee of any entity owning beneficially more than 50% of the outstanding shares of common stock of Registrant (currently Dollar Bank) or a director, officer or employee of any such beneficial owner's subsidiaries or affiliates other than Registrant. All investment and management decisions are made for Registrant by its officers under the direction of its Board of Directors.\nItem 11 - Executive Compensation ----------------------\nEach director of Registrant is to receive an annual compensation of $1,000, plus $100 for each meeting of the Board of Directors attended. Officers will not be compensated by Registrant for their services. Directors and officers are to be reimbursed for expenses reasonably incurred in connection with their services on behalf of Registrant. The Registrant's By-Laws provide that directors and officers of Registrant may be indemnified against liabilities incurred in connection with their services on behalf of Registrant.\nItem 12 - Security Ownership of Certain Beneficial Owners and Management -----------------------------------------\nThe following table lists any beneficial owner of more than 5% of the outstanding common stock as of November 30, 1994:\nAmount of Nature Percent Name and Address of Beneficial of Title of Class of Beneficial Owner Ownership Class - - - - - -------------- ------------------- ---------------- --------\nCommon Stock Dollar Bank, a 60 Shares 100% federal savings bank Three Gateway Center Pittsburgh, PA 15222\nItem 13 - Certain Relationships and Related Transactions ----------------------------------------------\nDuring fiscal 1994, Registrant sold 20 adjustable rate mortgage- backed securities to Dollar Bank, a Federal Savings Bank, an affiliate of the Registrant. The sale was recorded at market value and a loss of $565,962 was recognized. Several securities were purchased from Dollar Bank with an aggregate book and market value of $93,584,341.\nDuring fiscal 1993, Registrant sold 34 adjustable rate mortgage- backed securities to Dollar Bank, a Federal Savings Bank, an affiliate of the Registrant. The sale was recorded at market value and a gain of $902,975 was recognized. Several securities were purchased from Dollar Bank with an aggregate book value of $87,686,000.\nDuring fiscal 1992, the Registrant sold nine adjustable rate mortgage-backed securities to Dollar Bank, a federal savings bank, an affiliate of the Registrant. The sale was recorded at market value and a gain of $72,556 was recognized. Several securities were also purchased from Dollar Bank with an aggregate book value of approximately $64,731,000.\nPART IV\nItem 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K ---------------------------------------\nPage No. --------\n(a) (l) The following financial statements are included in Part II, Item 8:\nFinancial Statements: --------------------\nStatements of Condition - November 30, 1994 and November 30, 1993 . . . . . . . . . . . . . 12\nStatements of Earnings - For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . 13\nStatements of Changes in Equity Capital - For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . 14\nStatements of Cash Flows - For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . 15\nNotes to Financial Statements . . . . . . . . . 16\n(2) The information required to be filed on Schedule I - Marketable Securities - Other Investments is included in the Notes to Financial Statements on Pages 18 and 19. No other schedules are applicable to the Registrant.\n(3) Exhibits\n3.l Certificate of Incorporation and By-Laws of the Registrant, previously filed as Exhibits 3.l and 3.2 to the Registration Statement on Form S-11 are hereby incorporated by reference.\n4.l Form of Certificate of Designation for the Registrant's Market Auction Preferred Stock (\"MAPS\"), previously filed as Exhibit 4 to the Registration Statement on Form S-11 is hereby incorporated by reference.\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed by the Registrant during the last quarter of the period covered by this report.\nPAGE\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDOLLAR FINANCE, INC.\n- - - - - ----------------------------- --------------------------- By: Robert P. Oeler By: Thomas A. Kobus President Treasurer (Principal Executive (Principal Financial & Officer) Accounting Officer)\nDate: February 22, 1995 Date: February 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 dates indicated.\n- - - - - ----------------------- Chairman of the Board; Date: February 22, 1995 Hay Walker Director\n- - - - - ----------------------- President; Director Date: February 22, 1995 Robert P. Oeler\n- - - - - ----------------------- Treasurer; Date: February 22, 1995 Thomas A. Kobus Director\n- - - - - ----------------------- Vice President and Date: February 22, 1995 Robert L. German Assistant Secretary; Director\n- - - - - ----------------------- Secretary; Director Date: February 22, 1995 Robert T. Messner\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 Registrant has not sent an annual report or proxy material to its security holders, and does not anticipate sending any such materials subsequent to the filing of the Annual Report on Form 10-K.\nIndex to Exhibits\n3.1 Certificate of Incorporation and By-Laws of the Registrant, previously filed as Exhibits 3.l and 3.2 to the Registration Statement on Form S-11 are hereby incorporated by reference.\n4.1 Form of Certificate of Designation for the Registrant's Market Auction Preferred Stock (\"MAPS\"), previously filed as Exhibit 4 to the Registration Statement on Form S-11 is hereby incorporated by reference.","section_6":"","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations -------------------------------------------------\nResults of Operations: - - - - - ---------------------\nFor the year ended November 30, 1994, Dollar Finance, Inc. (\"Registrant\") reported net income of $3,440,000 or $16,000 per share after deducting dividends on the shares of Market Auction Preferred Stock (\"MAPS\"). Net income for fiscal 1993 was $4,745,000, or $45,000 per share after deducting MAPS dividends and for fiscal year 1992, $5,747,000, or $55,000 per share after deducting MAPS dividends. Operating income has consisted of interest earned on required assets, including mortgage-backed securities, U.S. Treasury securities and short-term money market instruments, consisting of commercial paper, certificates of deposit, treasury bills and other time deposits. Additional income\/(loss) was recognized during 1994, 1993, and 1992 from security transactions in which Registrant sold mortgage-backed securities back to Dollar Bank at market value, resulting in gains\/(losses) of $(565,962), $902,975 and $72,557, respectively. These gains\/(losses) are the result of security sales undertaken by the Registrant in actively managing its investment portfolio in light of changes in market interest rates.\nProfessional fee expense incurred during each year consisted largely of broker commission charges of approximately $25,500 incurred on each MAPS dividend payment date.\nRetained earnings of Registrant have been reduced by the amount of MAPS dividends paid and accrued during the three fiscal years. These dividends amounted to $2,502,000 in 1994, $2,071,000 in 1993 and $2,427,000 in 1992. The applicable dividend rates on MAPS dividends at November 30, 1994, 1993 and 1992 were 3.814%, 3.09% and 2.58%, respectively. Registrant's retained earnings were also reduced during 1992 by a common stock dividend payment to Dollar Bank of $15,000,000 on its shares of common stock. No common stock dividends were paid during 1994 or 1993.\nDuring 1993, Registrant 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 through 1990 were restated.\nRetained earnings was restated to reflect the cumulative effect of the change in accounting for income taxes as a result of retroactively applying FASB Statement No. 109 to 1990.\nThe Company also adopted FASB Statement No. 115 during 1993. Retained earnings for 1994 and 1993 is increased\/(decreased) by approximately $(35,000) and $1,241,000, respectively for the impact of applying FASB Statement No. 115, which requires that the unrealized gains (losses) on investment securities available for sale be recognized as a separate component of capital. The net unrealized gain\/(loss) for 1994 and 1993 of $(57,000) and $2,068,000 is shown net of deferred federal income tax\/(benefit) of $(22,000) and $827,000, respectively.\nThe deferred tax (benefit)\/liability of $(22,000) and $827,000 represents the taxes to be (refunded)\/paid in future years on the temporary difference between the financial statement and tax return values of investment securities available for sale as of November 30, 1994 and 1993, respectively. For financial statement purposes, these investment securities have been recorded at market value in accordance with FASB Statement No. 115. For tax purposes they are carried at net book value. The deferred tax (benefit)\/liability reflected in fiscal 1994 and 1993 is not included in the total tax provision for the year since, in accordance with Statement 115 it is properly reflected as a component of equity capital, and consequently has no impact on net income for the year.\nManagement expects the yield recognized on the required assets of Registrant to continue to exceed the applicable dividend rate on MAPS dividends, which averaged 3.34% on the liquidation value of each share during fiscal 1994.\nLiquidity: - - - - - ---------\nThe principal sources of short-term liquidity are principal and interest generated from the investment in Registrant's short-term assets and mortgage- backed securities. The Registrant also manages its liquidity position by maintaining adequate levels of liquid assets, such as time deposits and securities available for sale. Additional liquidity is available through the Registrant's ability to incur, under certain limited circumstances, secured and unsecured indebtedness for borrowed money of an aggregate amount not exceeding $5,000,000 and to incur additional indebtedness in the form of reverse repurchase agreements.\nRegistrant possesses dividend coverage assets consisting of short-term money market instruments with remaining maturities not in excess of the number of days until the next MAPS dividend payment, and cash. As of each Evaluation date, Registrant will calculate the aggregate adjusted value of its dividend coverage assets to assure that this value is at least equal to the required dividend coverage amount. Registrant is required to maintain required assets with a market value in excess of the product of the current liquidation value per share and the number of MAPS shares outstanding. This requirement provides long-term liquidity necessary for any future redemption of MAPS shares.\nThe Registrant does not anticipate that changes in tax legislation in 1993 will have any material impact on its liquidity position.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data -------------------------------------------\n-----------------------------\nPage No. -----\nReport of Independent Auditors . . . . . . . . . . . . . . . . . . . 11\nFinancial Statements:\nStatements of Condition, November 30, 1994 and November 30, 1993 . . . . . . . . . . . . . . . . . . . . . . 12\nStatements of Earnings, For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . . . . . . . . 13\nStatements of Changes in Equity Capital, For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . . . . . . 14\nStatements of Cash Flows, For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . . . . . . . . 15\nNotes to Financial Statements . . . . . . . . . . . . . . . . 16\nErnst & Young One Oxford Centre Pittsburgh, PA 15219\nPhone: (412) 644-7800\nIndependent Auditor's Report\nBoard of Directors Dollar Bank, Inc.\nWe have audited the financial statements of Dollar Finance, Inc., a wholly- owned subsidiary of Dollar Bank, a federal savings bank, listed in the accompanying index to financial statements on page 10. 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 listed in the accompanying index to financial statements on page 10 present fairly, in all material respects, the financial position of Dollar Finance, Inc. at November 30, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended November 30, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the financial statements, in 1993 the Company changed its method of accounting for investment securities.\nErnst & Young\nDollar Finance, Inc. Statement of Changes in Equity Capital ($-In Thousands - except dividends per share amounts)\nDollar Finance, Inc. Notes to Financial Statements\n1. Summary of Significant Accounting Policies ------------------------------------------\nThe accounting and reporting policies and practices of Dollar Finance, Inc., a wholly owned subsidiary of Dollar Bank, a federal savings bank (Dollar Bank), follow generally accepted accounting principles. The major reporting policies and practices are summarized below.\nCash and Cash Equivalents -------------------------\nCash and cash equivalents presented within the Statement of Cash Flows include cash and short-term investments with original maturities of less than 90 days.\nRequired Assets ---------------\nRequired assets may include cash, FNMA certificates, FHLMC certificates, GNMA certificates, certain short-term money market instruments, U.S. Treasury securities and other securities not adversely affecting the current rating on the shares of Market Auction Preferred Stock (\"MAPS\") by Moody's and Standard & Poors.\nMoney Market Investments ------------------------\nCommercial paper is valued at cost, which is calculated as par value less interest receivable at maturity. Cost closely approximates market value due to the short-term nature of these instruments. Certificates of deposit and other time deposits are recorded at their purchase price.\nInvestment Securities ---------------------\nInvestment securities consist of mortgage-backed securities which include FNMA pass-through certificates, FHLMC participation certificates and GNMA modified pass-through certificates. As outlined in Note 2, in 1994 and 1993 these instruments are stated at market value if classified as available for sale, or cost, adjusted for amortization of premiums and accretion of discounts if held to maturity. Fair values 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.\nPayments on mortgage-backed securities are received monthly and are applied accordingly to interest income and principal reduction. Transactions involving mortgage-backed securities are accounted for on the identified certificate basis.\nAccrued Interest Receivable ---------------------------\nIncome to be received from interest payments on money market investments and investment securities is accrued on a monthly basis.\nAccrued Preferred Stock Dividends ---------------------------------\nCash dividends on the shares of MAPS outstanding are accrued on a monthly basis and charged against retained earnings at the current applicable annual dividend rate determined through auction procedures.\nNet Income Per Common Share ---------------------------\nNet income per common share is calculated by dividing (a) net income less preferred stock dividends paid and accrued by (b) the weighted average number of common shares outstanding during the period.\n2. Accounting Changes ------------------\nIn February 1992, the Financial Accounting Standards Board issued Statement No. 109 \"Accounting for Income Taxes.\" Dollar Finance adopted the provisions of the standard in its 1993 financial statements and restated its 1992 and 1991 financial statements.\nIn May 1993, the Financial Accounting Standards Board issued Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" As permitted under the Statement, Dollar Finance elected to adopt the provisions of the standard as of the end of its fiscal year ending November 30, 1993. In accordance with the Statement, prior period financial statements were not restated to reflect the change in accounting principle. The effect of adopting FAS No. 115 as of November 30, 1993, resulted in a transfer of $124,355,000 of investment securities having a fair value of $126,423,000, from held to maturity to available for sale and an increase in retained earnings of $1,241,000, net of Federal tax of $827,000. During fiscal 1994, the securities available for sale declined $2,123,000 in market value resulting in an unrealized loss of $55,000 and reduction in retained earnings of $33,000 at November 30, 1994 net of Federal tax of $22,000.\nDollar Finance, Inc. 3. Investments -----------\nThe following is a comparison of book value to market value of short-term investments and investment securities at Nov. 30, 1993:\nWhich Issue No. Principal Gross Gross is Carried Title of Each Issue and of Amount of Cost of Unrealized Unrealized Market Value at on the Statement Name of Issuer: Units Each Issue Each Issue Gains Losses Nov. 30, 1994 of Condition - - - - - ----------------------- ----- ---------- ----------- ---------- ---------- ---------------- ----------------\nSHORT-TERM INVESTMENTS\nTime Deposits: - - - - - -------------- Harris Trust Euro 3 6,237 6,237 0 0 6,237 6,237 --- -------- -------- ------ ------- -------- -------- 3 $ 6,237 $ 6,237 $ 0 $ 0 $ 6,237 $ 6,237 ========\nSecurities Available for Sale: - - - - - ----------------------------- FNMA Certificates 11 10,918 11,020 188 0 11,208 11,208 FHLMC Certificates 33 111,986 113,385 1,880 0 115,215 115,215 --- ------- ------- ------ ---- -------- ------- 44 $122,904 $124,335 $2,068 $ 0 $126,423 $126,423 ========\n\/TABLE\n4. Capitalization --------------\nOn March 28, 1985, Dollar Bank purchased all of the 100 authorized shares of Registrant's $l.00 par value common stock for $10,000 in cash. Additional capital contributions from Dollar Bank consisted of a $75,000 cash contribution on May 13, 1985 and a required asset contribution of approximately $59,300,000 on May 23, 1985. The proceeds from these contributions above the total par value were credited to Additional Paid-in Capital from Common Stock. On May 28, 1985, Registrant issued 750 shares of MAPS at a purchase price of $100,000 per share. One thousand dollars per share of the MAPS proceeds were credited to Registrant's Preferred Stock account with the balance, net of underwriting costs, being credited to Additional Paid-In Capital from Preferred Stock.\n5. Common Stock and Dividend Restriction -------------------------------------\nDollar Bank owns all 60 shares of Registrant's outstanding common stock. No dividends may be paid on the common shares unless Registrant would have retained earnings of at least $7,500,000 immediately after the payment of such dividends. The common stock ranks junior to the MAPS with respect to payment of dividends on liquidation or dissolution.\nIn October 1992, the Board of Directors of Registrant declared and paid a cash dividend of $15,000,000 or $250,000 per share on its common stock.\nNo cash dividends were paid on common stock during fiscal 1994 or 1993.\n6. Market Auction Preferred Stock (\"MAPS\") ---------------------------------------\nDescription of MAPS -------------------\nThe shares of MAPS have a liquidation preference of $100,000 per share plus accrued and unpaid dividends. The MAPS shares are not convertible into shares of common stock and have no pre-emptive rights. The holders of MAPS are entitled to receive cumulative cash dividends on the business day following the conclusion of each dividend period, generally consisting of 49 days. The applicable dividend rate per share for each dividend period is determined through auction procedures. The applicable dividend rate for each dividend period during fiscal 1994 (the dividend payable on December 6, 1994 was accrued through November 30, 1994) was as follows:\nNovember 9, 1993 - December 29, 1993 3.090% December 30, 1993 - February 16, 1994 2.950% February 17, 1994 - April 6, 1994 2.850% April 7, 1994 - May 25, 1994 2.960% May 26, 1994 - July 13, 1994 3.500% July 14, 1994 - August 31, 1994 3.520% September 1, 1994 - October 19, 1994 3.630% October 20, 1994 - December 6, 1994 3.814%\nThe maximum applicable rate that results from an auction will not be greater than 110%, or under certain circumstances, 125% of the 60-day \"AA\" Composite Commercial Paper Rate in effect on the auction date.\nThe MAPS shares are subject to mandatory redemption if (l) the required asset coverage is not met or restored as required or (2) any portion of the dividend payments on MAPS during a calendar year constitutes a return of capital for federal income tax purposes.\nRegistrant has the option of redeeming the MAPS shares on any dividend payment date, in whole or in part, at the applicable per share amounts previously noted, plus an amount equal to accrued and unpaid dividends to the redemption date.\nThe holders of shares of MAPS have no voting rights except during a period that (l) the required asset coverage is not maintained or restored as required, (2) the aggregate amount of dividends in arrears on a dividend payment date is equal to or greater than the amount of dividends accrued during the dividend period preceding such payment date, or if (3) Registrant has not redeemed MAPS shares when required. Holders of shares of MAPS have had no voting rights during the reporting period or during any prior period.\nRequired Asset Coverage -----------------------\nAs of each Evaluation date (approximately every 25 days), Registrant must have required assets with a market value in excess of the product of (a) $100,000; and (b) the number of MAPS shares then outstanding. Registrant is obligated to maintain or restore the number of MAPS shares necessary to maintain required asset coverage as of each Evaluation date. Registrant has maintained required asset coverage throughout fiscal 1994 and for all prior periods.\nDividend Coverage -----------------\nAs of each Evaluation date, the aggregate adjusted value of Registrant's U.S. Treasury securities and short-term money market instruments maturing before the next dividend payment date and cash must at least equal the dividend coverage amount for 49 days of dividends at the applicable dividend rate then in effect. Registrant has maintained adequate dividend coverage throughout fiscal 1994 and for all prior periods.\n7. Security Transactions ---------------------\nDuring fiscal 1994, Registrant purchased from Dollar Bank twenty- two FHLMC fixed rate and three FHLMC adjustable rate certificates with an aggregate book value of $23,913,908. Registrant also purchased from Dollar Bank six U.S. government agency discount notes with an aggregate book value of $69,670,433.\nRegistrant sold to Dollar Bank twenty FHLMC adjustable rate certificates with a net book value and market value of $72,279,794 and $72,047,829, respectively. Proceeds from the sale amounted to $72,209,117 and resulted in a net loss of $565,962.\nDuring fiscal 1993, Registrant purchased from Dollar Bank thirteen FHLMC fixed rate and seven FHLMC adjustable rate certificates with an aggregate book value of $87,686,000. Registrant sold twenty-three FNMA fixed rate certificates and eleven FHLMC fixed rate certificates with a net book value and market value of $35,886,000 and $36,789,000, respectively. Proceeds from the sales amounted to $36,927,000, and resulted in a net gain of $903,000.\nDuring fiscal 1992, Registrant purchased from Dollar Bank fifteen FNMA adjustable rate certificates and twelve FHLMC adjustable rate certificates with an aggregate book value of $64,731,000 and sold nine FHLMC adjustable rate certificates with a net book value and market value of $9,147,000 and $9,220,000, respectively. Proceeds from the sales amounted to $9,370,000, and resulted in a net gain of $73,000.\n8. Income Taxes ------------\nIn February 1992, the Financial Accounting Standards Board issued Statement No. 109, \"Accounting for Income Taxes.\" As explained in Note 2, the Registrant adopted the provisions of the standard in its November 30, 1993 fiscal year and restated its 1992 and 1991 financial statements.\nUnder Statement No 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.\nThe Registrant is included in the consolidated federal income tax return of Dollar Bank. Statement 109 specifies that the amount of current and deferred tax expense for a group that files a consolidated tax return should be allocated among the members of the group. The policy of the consolidated group is to allocate its current and deferred taxes as if each member of the group were a separate taxpayer not included in a consolidated tax return.\nThe provision for income taxes for 1994, 1993, and 1992 consists of the Registrant's net income before taxes and intercompany securities gains at the statutory federal income tax rates. The resulting tax expense is recorded on the Registrant's Statement of Condition as intercompany payables to the Registrant's parent corporation, Dollar Bank, net of amounts previously paid to the parent.\nThe deferred tax asset\/(liability) for fiscal year ending November 30, 1994 and 1993 of $22,000 and ($827,000), respectively, represents the taxes to be refunded\/(paid) in future years on the temporary difference between the financial statement and tax return values of investment securities available for sale. For financial statement purposes these investment securities have been recorded at market value per FASB Statement No. 115 while for tax purposes they are carried at net book value. The deferred tax asset\/(liability) reflected in fiscal 1994 and 1993, respectively, are not included in the total tax provision for the year since, in accordance with Statement 115 it is properly reflected as a component of equity capital, and consequently has no impact on net income for the year.\nReconciliation of the effective income tax rate with the statutory Federal income tax rate is as follows:\nPercent of Income Before Income Taxes ------------------- Year Ended November 30 1994 1993 1992 ----------------------\nFederal Income Tax Statutory Rate 35% 35% 34%\nIntercompany Gain\/(Loss) on Sale of Securities; Eliminated for Federal Tax Purposes 0 (5) 0\nOther, Net 0 (1) 0 ------------------------\nEffective Rate 35% 29% 34% ======================\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 accounting and financial disclosure.\nPART III\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 - Directors and Executive Officers of the Registrant --------------------------------------------------\nThe following table identifies the Registrant's directors and executive officers, their ages and their positions for the previous five years:\n============================================================================ Positions with Principal Occupations Name: Age: Registrant: since 12\/01\/85: ---- ---- -------------- ---------------------\nHay Walker 62 Chairman of the Retired since 1993; Board; Director previously Executive Vice President of Dollar Bank.\nRobert P. Oeler 45 President; Executive Vice President Director of Dollar Bank since 1992; previously Senior Vice President.\nThomas A. Kobus 42 Treasurer; Senior Vice President and Director Treasurer of Dollar Bank since 1992; previously Vice President and Treasurer.\nRobert L. German 70 Vice President Vice President, Security- and Assistant Columbian, Division, U.S. Secretary; Banknote Company. Director\nRobert T. Messner 56 Secretary; Vice President, General Director Counsel and Secretary for Dollar Bank since 1986.\nAll directors were elected at the annual meeting of the holders of Registrant's common stock to serve for a term of one year or until their respective successors are elected and qualified. The Registrant's Certificate of Incorporation requires that at least one director and one executive officer (or one individual serving in both capacities) of Registrant must not be a director, officer or employee of any entity owning beneficially more than 50% of the outstanding shares of common stock of Registrant (currently Dollar Bank) or a director, officer or employee of any such beneficial owner's subsidiaries or affiliates other than Registrant. All investment and management decisions are made for Registrant by its officers under the direction of its Board of Directors.\nItem 11","section_11":"Item 11 - Executive Compensation ----------------------\nEach director of Registrant is to receive an annual compensation of $1,000, plus $100 for each meeting of the Board of Directors attended. Officers will not be compensated by Registrant for their services. Directors and officers are to be reimbursed for expenses reasonably incurred in connection with their services on behalf of Registrant. The Registrant's By-Laws provide that directors and officers of Registrant may be indemnified against liabilities incurred in connection with their services on behalf of Registrant.\nItem 12","section_12":"Item 12 - Security Ownership of Certain Beneficial Owners and Management -----------------------------------------\nThe following table lists any beneficial owner of more than 5% of the outstanding common stock as of November 30, 1994:\nAmount of Nature Percent Name and Address of Beneficial of Title of Class of Beneficial Owner Ownership Class - - - - - -------------- ------------------- ---------------- --------\nCommon Stock Dollar Bank, a 60 Shares 100% federal savings bank Three Gateway Center Pittsburgh, PA 15222\nItem 13","section_13":"Item 13 - Certain Relationships and Related Transactions ----------------------------------------------\nDuring fiscal 1994, Registrant sold 20 adjustable rate mortgage- backed securities to Dollar Bank, a Federal Savings Bank, an affiliate of the Registrant. The sale was recorded at market value and a loss of $565,962 was recognized. Several securities were purchased from Dollar Bank with an aggregate book and market value of $93,584,341.\nDuring fiscal 1993, Registrant sold 34 adjustable rate mortgage- backed securities to Dollar Bank, a Federal Savings Bank, an affiliate of the Registrant. The sale was recorded at market value and a gain of $902,975 was recognized. Several securities were purchased from Dollar Bank with an aggregate book value of $87,686,000.\nDuring fiscal 1992, the Registrant sold nine adjustable rate mortgage-backed securities to Dollar Bank, a federal savings bank, an affiliate of the Registrant. The sale was recorded at market value and a gain of $72,556 was recognized. Several securities were also purchased from Dollar Bank with an aggregate book value of approximately $64,731,000.\nPART IV\nItem 14","section_14":"Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K ---------------------------------------\nPage No. --------\n(a) (l) The following financial statements are included in Part II, Item 8:\nFinancial Statements: --------------------\nStatements of Condition - November 30, 1994 and November 30, 1993 . . . . . . . . . . . . . 12\nStatements of Earnings - For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . 13\nStatements of Changes in Equity Capital - For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . 14\nStatements of Cash Flows - For the Years Ended November 30, 1994, November 30, 1993, and November 30, 1992 . . . . . . . . . . . . . . . 15\nNotes to Financial Statements . . . . . . . . . 16\n(2) The information required to be filed on Schedule I - Marketable Securities - Other Investments is included in the Notes to Financial Statements on Pages 18 and 19. No other schedules are applicable to the Registrant.\n(3) Exhibits\n3.l Certificate of Incorporation and By-Laws of the Registrant, previously filed as Exhibits 3.l and 3.2 to the Registration Statement on Form S-11 are hereby incorporated by reference.\n4.l Form of Certificate of Designation for the Registrant's Market Auction Preferred Stock (\"MAPS\"), previously filed as Exhibit 4 to the Registration Statement on Form S-11 is hereby incorporated by reference.\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed by the Registrant during the last quarter of the period covered by this report.\nPAGE\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDOLLAR FINANCE, INC.\n- - - - - ----------------------------- --------------------------- By: Robert P. Oeler By: Thomas A. Kobus President Treasurer (Principal Executive (Principal Financial & Officer) Accounting Officer)\nDate: February 22, 1995 Date: February 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 dates indicated.\n- - - - - ----------------------- Chairman of the Board; Date: February 22, 1995 Hay Walker Director\n- - - - - ----------------------- President; Director Date: February 22, 1995 Robert P. Oeler\n- - - - - ----------------------- Treasurer; Date: February 22, 1995 Thomas A. Kobus Director\n- - - - - ----------------------- Vice President and Date: February 22, 1995 Robert L. German Assistant Secretary; Director\n- - - - - ----------------------- Secretary; Director Date: February 22, 1995 Robert T. Messner\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 Registrant has not sent an annual report or proxy material to its security holders, and does not anticipate sending any such materials subsequent to the filing of the Annual Report on Form 10-K.\nIndex to Exhibits\n3.1 Certificate of Incorporation and By-Laws of the Registrant, previously filed as Exhibits 3.l and 3.2 to the Registration Statement on Form S-11 are hereby incorporated by reference.\n4.1 Form of Certificate of Designation for the Registrant's Market Auction Preferred Stock (\"MAPS\"), previously filed as Exhibit 4 to the Registration Statement on Form S-11 is hereby incorporated by reference.","section_15":""}
{"filename":"931006_1994.txt","cik":"931006","year":"1994","section_1":"ITEM 1. Business\nEnserch Exploration, Inc. (\"EEX\" or the \"Company\") is a newly formed publicly traded Texas corporation engaged in the exploration for and the development, production and marketing of natural gas and crude oil throughout Texas, offshore in the Gulf of Mexico, onshore in the Gulf Coast and Rocky Mountain areas and in various other areas in the United States. Activities include geological and geophysical studies; acquisition of gas, oil and mineral leases; drilling of exploratory wells; development and operation of producing properties; acquisition of interests in developed or partially developed properties; and the marketing of natural gas, crude oil and condensate.\nEEX's gas and oil operations represent the domestic gas and oil business of ENSERCH Corporation (\"ENSERCH\"). During 1994, these operations were conducted primarily through Enserch Exploration Partners, Ltd. (\"EP\"), a limited partnership in which a minority interest (less than 1%) was held by the public. At year-end 1994, pursuant to a plan for the reorganization of EP (\"Reorganization\"), EEX, through a series of transactions, acquired all of the operating properties of EP from EP's 99%-owned operating partnership, EP Operating Limited Partnership (\"EPO\"), in exchange for shares of EEX common stock. On December 30, 1994, the Reorganization was consummated, EP was dissolved, and the EEX common stock held by EP was distributed to EP's limited and general partners in accordance with their partnership interests. In this report, \"EEX\" or the \"Company\" is used to refer to either EEX or EP, or both, when a distinction is not required.\nIn connection with the Reorganization, Enserch Exploration Holdings, Inc. (\"EEH\")(named Enserch Exploration, Inc. and the Managing General Partner of EP prior to the Reorganization), received EP's interests in and assumed EP's obligations under certain equipment lease arrangements relative to the Garden Banks Block 388 project and the Mississippi Canyon Block 441 project, with the equipment being simultaneously subleased to EEX. ENSERCH affiliates also assumed approximately $395 million principal amount of EP's indebtedness, plus accrued interest. Upon the liquidation of EP and distribution of EEX common stock, public unitholders of EP received 805,914 shares of EEX common stock (.77%) and ENSERCH and its affiliates received 103,775,328 shares (99.23%) of EEX's 104,581,242 shares then outstanding. EEX common stock is listed on the New York Stock Exchange under the symbol \"EEX\".\nProduction offices are maintained in Dallas, Houston, Athens, Bridgeport, Longview and Midland, Texas. At December 31, 1994, EEX had 373 employees, including 34 geologists, 20 geophysicists and 18 land representatives who investigate prospective areas, generate drilling prospects, review submitted prospects and acquire leasehold acreage in prospective areas. In addition, EEX maintains a staff of 55 engineers and 45 technologists who plan and supervise the drilling and completion of wells, evaluate prospective gas and oil reservoirs, plan the development and management of fields and manage the daily production of gas and oil.\nVariable-priced natural-gas sales, which include monthly and long-term sales contracts, covered about 75% of 1994 natural-gas sales. Approximately 80% of EEX's natural-gas sales volumes (75% of gas revenues) for the year ended December 31, 1994 was sold to affiliated companies. Effective March 1, 1993, Enserch Gas Company, an ENSERCH subsidiary, began marketing gas for EEX for all gas not covered under existing contracts. In 1994, approximately 14% of EEX's natural gas sales volumes (approximately 14% of total revenues) was sold to Lone Star Gas Company, a division of ENSERCH, under a fixed-price service contract. A loss of sales under this contract could have an adverse financial impact on the earnings of EEX to the extent that the price in effect under the contract at such time exceeds the price at which the gas may be sold by EEX to others. Affiliated purchasers do not have a preferential right to purchase natural gas produced by EEX other than under existing contracts.\nSales data are set forth under \"Selected Financial and Operating Data\" included in Appendix A to this report.\nFollowing is a summary of EEX's exploration and development activity during 1994:\nGulf of Mexico. Exploration in the Gulf of Mexico is an important part of EEX's exploratory program. A total of 14 leases (over 37,000 acres) were acquired in the Gulf of Mexico, primarily the result of the Central Gulf lease sale in April 1994. These leases were purchased based on prospects principally defined by three-dimensional (\"3-D\") seismic acquired before the lease sale. Typically, successful wells in the Gulf produce at high rates compared with onshore wells, which is important in increasing cash flow and improving the ratio of production to reserves. State-of- the-art technology, including specialized 3-D seismic processing and innovative production techniques, is being utilized to help achieve this objective.\nMississippi Canyon Block 441, the first development project in the Gulf of Mexico that EEX has operated, is indicative of this approach. A 3-D seismic program, prior to field development, confirmed that the majority of the reservoir lies beneath a shipping fairway. A production program was developed that involved drilling highly deviated wells under the shipping fairway, subsea completing the deep-water wells and tying the wells back to a conventional shallow-water production platform using bundled flowlines. The high-angle wells required special gravel-pack completion techniques. After two years of production, the field has been essentially maintenance free. Production from the field, which declined from initial levels due to expected water encroachment, has stabilized and is expected to remain at current levels of some 35 million cubic feet (\"MMcf\") of natural gas and more than 150 barrels (\"Bbls\") of condensate per day for the foreseeable future. The 3-D seismic on Mississippi Canyon Block 441 is being reprocessed, using depth migration and other state-of-the-art techniques to aid in the identification of deeper exploratory targets, which, if successfully drilled, could add to the field reserves. EEX has a 37.5% working interest in this project.\nThroughout 1994, work progressed on the conversion of a semisubmersible rig to a floating production facility for the development of the Garden Banks Block 388 unit. The majority of the modification work on the major structural components has been completed. The 24-slot subsea template has been installed, and the two 12-inch gas and oil gathering lines have been installed and connected to the shallow-water production facility located 54 miles away. Completion operations on the two pre-drilled wells commenced in early 1995 and should enable these wells to be brought on-stream when the floating facility is moored on location and the production riser is installed. The initial well was completed in mid-March and tested at rates which indicate that the well will likely flow at an initial daily rate of 6,000 barrels. The second well should be completed in mid-1995, followed by additional development drilling, with one such well expected to be completed in late 1995. Initial daily oil production rates from the second pre-drilled well is anticipated to be between 2,500 and 6,000 barrels.\nUnder an agreement with Mobil Producing Texas and New Mexico Inc. (\"Mobil\"), an exploratory well was drilled in the third quarter of 1994 in EEX's Garden Banks unit on Block 387, approximately four miles from the discovery on Block 388. The well, drilled in 2,200 feet of water to a depth of 11,893 feet, encountered a total of 150 feet of oil pay in the two reservoirs and added significant incremental reserve potential to the development project. A delineation well will be drilled on Block 386 or 387 early in 1995. Subsea completions tied into the production facility on Block 388 will be utilized to produce these wells.\nMobil has an option to acquire a 40% interest in the entire Garden Banks unit consisting of six blocks and in the unit's production system. To obtain that option, Mobil drilled the exploratory well on Block 387 and has conducted a new 3-D seismic survey over the unit to further assess the deeper horizons correlative to nearby prolific reserves and, to extend the original option, Mobil has paid additional consideration. EEX, which currently owns 100% of the project, will remain the operator.\nEEX has a 100% working interest in a successful exploratory sidetrack well on Green Canyon Block 254, which encountered more than 400 feet of net gas and oil pay below 12,000 feet. The well was an appraisal to a discovery well drilled in 1991 that encountered multiple sands with a combined thickness of more than 300 feet of net pay. Additional drilling is planned for the first half of 1995. EEX had a 25% working interest in prior work on this project before assuming operations and a 100% working interest in the sidetrack well. EEX also has a 25% working interest in three adjacent blocks. Efforts are underway to acquire additional interests in Block 254 and the adjacent blocks to raise EEX's interest.\nOnshore. In 1994, the majority of developmental drilling activity was focused in the Freestone, Boonsville and Fashing fields, all in Texas, where some new reserves were added by establishing production in zones that had not produced in the past. In Freestone, 12 successful wells were drilled. Initial potential tests have ranged from 1.4 to 2.6 MMcf of gas per day. In the Boonsville area, 13 wells were drilled and completed in 1994. These include nine gas wells that had initial potentials averaging 0.8 MMcf of gas per day and four oil wells initially delivering an average of 76 barrels per day. In Fashing field, five wells were drilled in 1994, four of which have been completed, with initial deliveries averaging 1.7 MMcf of gas per day. Completion operations are in progress on the fifth well.\nA large portion of the development drilling and recompletion activity during the past several years has been in six major gas fields in East Texas. To offset the decline rate of hundreds of older wells, reworks, recompletions and development drilling are required, all of which are sensitive to product prices. In East Texas, the goal is to accelerate production while preserving or increasing reserves and net present value of the fields. EEX's East Texas proved reserves are currently estimated to be some 784 Bcf.\nIn 1994, EEX and the Los Alamos National Laboratory joined in a first-time effort to use technology developed for energy and national defense in the field of natural-gas exploration. Joint goals are to employ more effective and efficient methods of recovery of resources, to increase reserves and to develop applied science that will be available to the entire natural-gas industry. The EEX\/Los Alamos team is testing the extent to which producing formations have been drained by hydraulic fracturing in the Opelika gas field located in East Texas. Los Alamos scientists are deploying instrumentation to verify the extent of hydraulic fracturing in the producing Travis Peak formation. It may then be determined where additional fracturing can be used to release trapped gas, thereby maximizing the recovery of gas reserves. The data acquisition phase from the Opelika field has been completed, with significant microseismic activity detected in surrounding observation wells when the test well was hydraulically fractured. The computation phase of the project generated encouraging preliminary results regarding fracture orientation. Currently, Los Alamos' instrumentation is being modified to enhance the quality of acquired data to define fracture extent.\nCompetition. Competition in the natural gas and oil exploration and production business is intense and present from a large number of firms of varying sizes and financial resources, some of which are much larger than EEX. Competition involves all aspects of marketing products (including terms, prices, volumes and length of contracts), terms relating to lease bonus and royalty arrangements, and the schedule of future development activity.\nRegulation. Environmental Protection Agency (\"EPA\") rules, regulations and orders affect the operations of EEX. EPA regulations promulgated under the Superfund Amendments and Reauthorization Act of 1986 require EEX to report on locations and estimates of quantities of hazardous chemicals used in EEX's operations. The EPA has determined that most gas and oil exploration and production wastes are exempt from the hazardous waste management requirements of the Resource Conservation Recovery Act. However, the EPA determined that certain exploration and production wastes resulting from the maintenance of production equipment and transportation are not exempt and must be managed and disposed of as hazardous waste. Also, regulations issued by the EPA under the Clean Water Act require a permit for \"contaminated\" stormwater discharges from exploration and production facilities.\nMany states have issued new regulations under authority of the Clean Air Act Amendments of 1990, and such regulations are in the process of being implemented. These regulations may require certain gas and oil related installations to obtain federally enforceable operating permits and may require the monitoring of emissions; however, the impact of these regulations on EEX is expected to be minor.\nSeveral states have adopted regulations on the handling, transportation, storage and disposal of naturally occurring radioactive materials that are found in gas and oil operations. Although applicable to certain EEX facilities, it is not believed that such regulations will materially impact current or future operations.\nThe Oil Pollution Act of 1990 (\"OPA 90\") requires responsible parties to provide evidence of financial responsibility in the amount of $150 million to clean up oil spills into the navigable waters of the United States. The financial responsibility requirements apply to offshore facilities and possibly to onshore facilities in, on or under navigable waters. The Mineral Management Service (\"MMS\") is the agency charged with the administration and enforcement of OPA 90. The ultimate impact of the financial responsibility requirements cannot be determined until final regulations are issued by the MMS. Further Congressional action on these requirements is also possible, and the final MMS regulations could be challenged in court. The $150 million requirement will not become effective until regulations under OPA 90 are issued, probably in 1996. The insurance industry has indicated that insurance will not be available to evidence financial responsibility under OPA 90 as currently written. However, EEX has qualified as a self-insurer using the \"identified assets\" test under the current $35 million financial responsibility requirement using EEX's interest in Tri-Cities field as the identified assets. It is believed that EEX has sufficient assets to qualify as a self-insurer for $150 million under the identified assets test if the current self-insurance test is included in the OPA 90 regulations. It is unclear whether the new regulations will allow EEX to qualify as a self-insurer. Alternatively, EEX believes it could meet the current OPA 90 financial responsibility requirements by the purchase of a surety bond, although the cost of such bonds is generally much higher than insurance. The availability of surety bonds generally could also be affected by the requirements of the final MMS regulations.\nIn the aggregate, compliance with federal and state environmental rules and regulations is not expected to have a material adverse effect on EEX's operations.\nThe Railroad Commission of Texas regulates the production of natural gas and oil by EEX in Texas. Similar regulations are in effect in all states in which EEX explores for and produces natural gas and oil. These regulations generally require permits for the drilling of gas and oil wells and regulate the spacing of the wells, the prevention of waste, the rate of production and the prevention and cleanup of pollution and other materials.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe following table sets forth a summary of certain information relating to EEX's gas and oil properties:\nSee \"Financial Review - Capital Budget\" included in Appendix A to this report for a discussion of EEX's 1995 capital spending program. In light of the recent lack of heating weather and lower gas prices, EEX is proceeding cautiously in implementing its capital spending program until the amount of future cash flows can be better ascertained. Announced 1995 capital expenditures of $155 million could be reduced by up to $25 million if cash flows fail to reach budgeted levels.\nDuring 1994, EEX filed Form EIA-23 with the Department of Energy reflecting reserve estimates for the year 1993. Such reserve estimates were not materially different from the 1993 reserve estimates reported in Note 7 of the Notes to Financial Statements included in Appendix A to this report.\nAs of December 31, 1994, EEX owned leasehold interests or licenses in 17 states and offshore Texas and Louisiana as follows:\nEEX purchased about 191,000 net acres of leasehold interests in 1994, 37,000 of which were in the Gulf of Mexico. EEX's Gulf of Mexico holdings totaled some 147,000 net acres, with an average working interest of 46% in 61 blocks and an overriding royalty interest in three other blocks. EEX operates 28 offshore blocks. EEX also canceled or allowed to expire 21 Gulf of Mexico leases during the year, which had been condemned following drilling on or near them or after geophysical and geological findings.\nEEX plans further drilling on undeveloped acreage but at this time cannot specify the extent of the drilling or predict how successful it will be in establishing commercial reserves sufficient to justify retention of the acreage. The primary terms under which the undeveloped acreage can be retained by the payment of delay rentals without the establishment of gas and oil reserves expire as to 20% of undeveloped acreage in 1995, 36% in 1996, 21% in 1997, 5% in 1998, 11% in 1999, 2% in 2000 and 5% thereafter. A portion of the undeveloped acreage may be allowed to expire prior to the expiration of primary terms specified in this schedule by nonpayment of delay rentals. Aside from Texas and the Gulf of Mexico, EEX has no material concentration of undeveloped acreage in single areas at this time.\nEEX participated in 108 wells (74 net) during 1994. Of these wells, 58 wells (44 net) were successfully completed, resulting in a net success rate of 59%. Of the successful wells, 13 wells (10 net) were exploratory and 45 wells (34 net) were development. At December 31, 1994, EEX was participating in 41 wells (23 net), which were either being drilled or in some stage of completion.\nIn the 1994 drilling program, 5 wells (1.5 net) were offshore. Of these wells, 2 gas wells (.4 net) and 1 oil well (.4 net) were successfully completed. During 1993, 16 offshore wells (4.9 net) were drilled, of which 9 gas wells (2.6 net) and 1 oil well (.1 net) were successfully completed.\nAt December 31, 1994, EEX owned interests in 1,314 gas wells (1,008 net) and 1,043 oil wells (286 net). Of these, 173 gas wells (141 net) and 37 oil wells (32 net) were dual completions in single boreholes.\nDrilling activity during the three years ended December 31, 1994 is set forth below:\nThe number of wells drilled is not a significant measure or indicator of the relative success or value of a drilling program because the significance of the reserves and economic potential may vary widely for each project. It is also important to recognize that reported completions may not necessarily track capital expenditures, since Securities and Exchange Commission guidelines do not allow a well to be reported as complete until it is ready for production. In the case of offshore wells, this may be several years following initial drilling because of the timing of construction of platforms, pipelines and other necessary facilities.\nAdditional information relating to the gas and oil activities of EEX is set forth in Note 7 of the Notes to Financial Statements included in Appendix A to this report.\nEEX leases approximately 91,000 square feet of office space for its executive offices in Dallas, Texas, under a lease expiring in December 1998.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nOn December 26, 1989, a lawsuit was filed against EEH and EPO in the 130th Judicial District Court of Matagorda County, Texas. EPO was merged into the Company in December 1994. The Plaintiff claims that the defendants breached an alleged contract to sell a working interest and net revenue interest in two leases located in Matagorda County. Trial of the case resulted in a jury verdict in favor of the plaintiff. Judgement was entered by the trial court on October 8, 1992, ordering EEH and EPO to convey the leases to the plaintiff and to pay damages of $3.1 million, which includes principal, prejudgment interest, attorneys' fees and costs. In an opinion issued June 23, 1994, the Corpus Christi Court of Appeals reversed the decision of the trial court. The plaintiff's application for writ of error was denied by the Texas Supreme Court on December 8, 1994.\nSee Note 6 of the Notes to Financial Statements included in Appendix A to this report for information on additional legal proceedings. In addition, EEX is a party to lawsuits arising in the ordinary course of its business. EEX believes, based on its current knowledge and the advice of counsel, that all lawsuits and claims would not have a material adverse effect on its 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 Equity and Related Stockholder Matters\nEEX common stock began trading on the New York Stock Exchange on January 3, 1995 under the symbol \"EEX\". There were no trades in EEX common stock in any market prior to that date.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThe information required hereunder is set forth under \"Selected Financial and Operating Data\" included in Appendix A to this report.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required hereunder is set forth under \"Financial Review\" included in Appendix A to this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe information required hereunder is set forth under \"Pro Forma Statements of Operations,\" \"Notes to Pro Forma Statements of Operations,\" \"Management Report on Responsibility for Financial Reporting,\" \"Independent Auditors' Report,\" \"Balance Sheet\" \"Statements of Changes in Partners' Capital and Common Shareholders' Equity,\" \"Statements of Operations of Predecessor,\" \"Statements of Cash Flows of Predecessor,\" and \"Notes to Financial Statements\" included in Appendix A to this report.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\nSet forth below is information concerning the directors and executive officers of EEX:\nCommittees of the Board of Directors. The functions of the Audit Committee include meeting periodically with the independent and internal auditors; reviewing annual financial statements and the independent auditors' work and report thereon; reviewing the independent auditors' report on internal controls and related matters; selecting and recommending to the Board of Directors the appointment of the independent auditors; reviewing the letter of engagement and statement of fees that pertain to the scope of the annual audit and certain special audit and non-audit work, which may be required or suggested by the independent auditors; receiving and reviewing information pertaining to internal audits; directing and supervising special investigations; authorizing and reviewing transactions between EEX and ENSERCH, its subsidiaries and affiliates (the \"EC Companies\"); and performing any other function deemed appropriate by the Board of Directors. Mr. Bridgewater is the Chairman and Mr. Addy is a member of the Audit Committee.\nThe Compensation Committee establishes, approves or recommends to the Board of Directors, in those instances where their approval is required, the compensation and major items related to compensation of directors and of officers. The Committee also administers the EEX 1994 Stock Incentive Plan (\"Plan\"). Mr. Addy is the Chairman and Mr. Bridgewater is a member of the Compensation Committee.\nDirector Compensation. Directors are compensated by an annual retainer fee of $16,000 plus $1,000 for each board or committee meeting attended, with a maximum of $1,500 if more than one meeting is held on the same day. In addition, a $1,500 per annum fee is paid for services on a committee of the Board of Directors, with an additional $750 per annum paid to the chairman of a committee. Directors who are also officers of EEX do not receive any fees.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nEEX paid no compensation to any person in 1994. The total amount of compensation paid by EEH to all of the current executive officers of EEX for their services to EP for the year ended December 31, 1994 was $876,703 (3 persons). The amounts paid include base salary, bonuses and other miscellaneous earnings categories that were charged to EP.\nThe following table sets forth the annual salary as of January 1, 1995 of the Chief Operating Officer and the other executive officers of EEX who devote substantially their full time to EEX and whose annual compensation exceeds $100,000.\nAny bonus, stock option, long-term compensation or other compensation to be paid by EEX to its executive officers is determined by the Compensation Committee of the Board of Directors.\nD. W. Biegler, Chairman and Chief Executive Officer of EEX, and S. R. Singer, Senior Vice President, Chief Financial Officer of EEX, each are employed and will continue to be employed in identical positions with ENSERCH, and each are directly paid all of their compensation by ENSERCH. It is not presently anticipated that D. W. Biegler or S. R. Singer will receive any direct compensation from EEX in 1995. The salaries of D. W. Biegler and S. R. Singer at January 1, 1995 were $550,000 and $347,000, respectively. All other cash compensation (including bonuses) paid by ENSERCH during 1994 under plans currently in effect for services rendered in 1994 for D. W. Biegler and S. R. Singer totaled $322,994 and $151,172, respectively. It is anticipated that in 1995 none of D. W. Biegler's compensation and less than $100,000 of S. R. Singer's compensation will be allocated from ENSERCH to EEX under the management cost allocation or under any other arrangement.\nEmployee Benefit Plans. Executive officers of EEX are included in employee benefit plans of ENSERCH. EEX does not currently have any employee benefit plans, other than the Plan, which is described below.\nThe Plan provides for the granting of stock options (\"Options\") to officers and other key employees to purchase shares of Common Stock and has provisions for the awarding of restricted stock to officers, which are subject to vesting based on the achievement of certain performance criteria (\"Restricted Stock\"). Options granted under the Plan, (a) shall have an option price not less than the fair market value of the shares on the date of grant, (b) become exercisable in stages of 25% after one year to 100% after four years and (c) expire ten years from the date of grant.\nThe Plan covers a maximum of 2 million shares of EEX Common Stock, subject to adjustment in the event of certain changes in the capital structure of EEX. Such shares may be authorized but unissued shares or shares held in EEX's treasury. If an Option or an award of Restricted Stock is forfeited (where the forfeiting participant received no benefits of ownership), expires or terminates before being exercised, the shares covered thereby will be available for subsequent Option or Restricted Stock grants or awards within the maximum number stated above.\nAn award of Restricted Stock may be granted under the Plan, either at no cost to the recipient or for such cost as may be required by law or otherwise as determined by the Compensation Committee of the Board of Directors. The terms and conditions of the Restricted Stock will be specified at the time of the grant. Restricted Stock may not be disposed of by the recipient until the restrictions specified in the award expire. The Compensation Committee will determine at the time of the award what rights, if any, the person to whom an award of Restricted Stock is made will have with respect to Restricted Stock during the restriction period, including the right to vote the shares and the right to receive any dividends or other distributions applicable to the shares.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\nStock Ownership of Certain Beneficial Owners. The Company is aware of the following beneficial owners, as of December 31, 1994, of more than 5% of the Company's Common Stock:\nStock Ownership of Management and Board of Directors:\nEach director, the named executive officers, and all directors and executive officers as a group, reported beneficial ownership of Common Stock of the Company and ENSERCH Corporation as of March 10, 1995 as follows:\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nFor information concerning the Reorganization of EP at yearend 1994, see \"Business,\" \"Financial Review,\" \"Statements of Changes in Partner's Capital and Common Shareholders' Equity\" and Note 1 of the Notes to Financial Statements included in Appendix A to this report.\nThe equipment and facilities used in developing and producing reserves in the Mississippi Canyon Block 441 project (\"MC 441\") and Garden Banks Block 388 project (\"GB 388\") were financed under lease agreements between certain financial institutions and EPO. In connection with the Reorganization of EP, all rights and obligations under the leases were assigned to and assumed by EEH, with EEX entering into sublease arrangements with EEH for such equipment and facilities. The MC 441 sublease has a term of five years, with EEX having an option to purchase the subleased equipment at the end of the term. The GB 388 equipment is subleased under two subleases: one covers the floating production facility, which has a term of 20 years, and the other covers the subsea equipment, pipelines and shallow-water production facility, which has an initial term of 12 years. For additional information concerning the sublease agreements, see Note 6 of the Notes to Financial Statements included in Appendix A to this report.\nIn March 1995, EEX purchased ENSERCH's interest in the SACROC unit Kelly Snyder Field, Scurry County, Texas, which represented the remainder of ENSERCH's domestic gas and oil properties. The purchase price of approximately $1.65 million included $1.25 million for the fair market value of the properties, as determined by DeGolyer and MacNaughton, independent petroleum consultants, and the remainder for the net book value of related assets acquired and liabilities assumed.\nA number of transactions and relationships between EEX and the EC Companies are contemplated and specifically authorized by Article Eleven of the Restated Articles of Incorporation of EEX, including the following:\n- Any EC Company may lend funds to EEX at interest rates not greater than the lesser of the EC Company's actual interest cost of the funds or the rate that EEX would be charged by unrelated lenders on comparable loans. EEX may lend funds to EC Companies at rates not less than would be charged by unrelated lenders on comparable loans.\n- Officers, directors, employees, attorneys and agents of the Company may also serve as officers, directors, employees, attorneys and agents of EC Companies. In those situations, each party using the services will be responsible for compensation in respect of the services performed for it.\n- An EC Company may provide EEX with certain services such as: accounting and treasury, internal audit, human resources (such as training, employment and salary and benefit plan administration), tax planning and compliance, legal, financial management, corporate development and planning, investor relations, information systems, materials management, risk and claims management, office services and the management of these functions. EEX will reimburse each EC Company for the direct and indirect costs incurred with such costs to be determined on a basis that reasonably reflects the actual costs of the services performed.\n- EC Companies may sell gas, oil, goods and services to, and may purchase gas, oil, goods and services from, EEX in conformity with the provisions of Article Eleven. EC Companies are authorized to effect sales to and purchases from EEX on terms that have not been determined to be fair as long as the transaction is authorized or ratified by the EEX Board of Directors.\nOther transactions not specifically provided for above may occur if authorized or ratified by the Audit Committee of the EEX Board of Directors or the shareholders acting pursuant to the provisions of Article Eleven.\nFor a discussion of related-party transactions during 1994 prior to the Reorganization, see Note 5 of the Notes to the Financial Statements included in Exhibit A to this report.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a)-1 Financial Statements\nThe following items appear in the Financial Information section included in Appendix A to this report:\n(a)-2 Financial Statement Schedules\nThe financial statement 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.\n(a)-3 Exhibits\n2.1* EPO Plan of Complete Liquidation [(included as Appendix \"EPO-1\" to Exhibit B to the Prospectus\/Information Statement that forms a part of Registration Statement on Form S-4 (No. 33-56792)].\n2.2* EP Plan of Complete Liquidation [(included as Appendix \"EP-1\" to Exhibit C to the Prospectus\/Information Statement that forms a part of Registration Statement on Form S-4 (No. 33-56792)].\n3.1* Restated Articles of Incorporation of the Company included as Exhibit 3 to the Company's report on Form 8-K dated December 30, 1994.\n3.2* Bylaws of the Company included as Exhibit 3.2 to the Company's Registration Statement on Form S-4 (No. 33- 56792).\n4.1* Form of Common Stock Certificate included as Exhibit 4.1 to the Company's Registration Statement on Form S-4 (No. 33-56792).\n10.1* Lease Agreement for Garden Banks 388-1 between the Company and Enserch Exploration, Inc. included as Exhibit 10.3 to the Company's Registration Statement on Form S-4 (No. 33-56792).\n10.2* Lease Agreement for Garden Banks 388-2 between the Company and Enserch Exploration, Inc. included as Exhibit 10.4 to the Company's Registration Statement on Form S-4 (No. 33-56792).\n10.3* Lease Agreement for Mississippi Canyon 441 between the Company and Enserch Exploration, Inc. included as Exhibit 10.5 to the Company's Registration Statement on Form S-4 (No. 33-56792).\n10.4* Participation Agreement between EP Operating Limited Partnership and Mobil Producing Texas and New Mexico Inc. included as Exhibit 10.6 to the Company's Registration Statement on Form S-4 (No. 33-56792).\n10.5 Gas Purchase Contract between EP Operating Company and Lone Star Gas Company, a division of ENSERCH Corporation, dated January 1, 1988, Amendatory Agreement dated June 1, 1990, Amendatory Agreement dated July 1, 1992 and Letter Amendment dated August 30, 1993.\nExecutive Compensation Plan and Arrangements (Exhibits 10.6 through 10.11)\n10.6* Enserch Exploration, Inc. 1994 Stock Incentive Plan included as Exhibit 10.1 to the Company's Registration Statement on Form S-4 (No. 33-56792).\n10.7 Performance Incentive Plan - Calendar Year 1995.\n10.8 ENSERCH Corporation Deferred Compensation Plan and Amendment No. 1 dated March 28, 1995.\n10.9 ENSERCH Corporation Deferred Compensation Trust.\n10.10 ENSERCH Corporation Retirement Income Restoration Plan and Amendment No. 1 thereto dated September 30, 1994.\n10.11 ENSERCH Corporation Retirement Income Restoration Trust.\n23.1 Consent of Deloitte & Touche LLP.\n23.2 Consent of DeGolyer and MacNaughton.\n24 Powers of Attorney.\n27 Financial Data Schedule.\n--------------------\n* Incorporated herein by reference and made a part hereof.\n(b) Report on Form 8-K dated December 30, 1994 was filed on January 6, 1995 (Reorganization of Enserch Exploration Partners, Ltd. into a new corporation, Enserch Exploration, 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:\nENSERCH EXPLORATION, INC.\nMarch 30 , 1995 By \/s\/ D. W. Biegler ----- -------------------------- D. W. Biegler, Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the date indicated.\nSignature and Title Date ------------------- ----\nD. W. Biegler, Chairman, Chief Executive Officer and Director; Gary J. Junco, President, Chief Operating Officer and Director; Frederick S. Addy, Director; B. A. Bridgewater, Jr., Director; S. R. March 30 , 1995 Singer, Senior Vice President, ----- Chief Financial Officer; and J. W. Pinkerton, Vice President and Controller, Chief Accounting Officer\nBy: \/s\/ D. W. Biegler ----------------------- D. W. Biegler As Attorney-in-Fact\nAPPENDIX A\nENSERCH EXPLORATION, INC. INDEX TO FINANCIAL INFORMATION December 31, 1994\nPage\nSelected Financial and Operating Data . . . . . . . . . . . . . . . . . A-2\nFinancial Review. . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-3\nPro Forma Financial Statements (Unaudited) of Enserch Exploration, Inc.:\nPro Forma Statements of Operations . . . . . . . . . . . . . . . . . . A-6\nNote to Pro Forma Statements of Operations . . . . . . . . . . . . . . A-7\nManagement Report on Responsibility for Financial Reporting . . . . . . . A-8\nIndependent Auditors' Report. . . . . . . . . . . . . . . . . . . . . . . A-9\nHistorical Financial Statements of Enserch Exploration, Inc. and Predecessor:\nBalance Sheet at December 31, 1994 . . . . . . . . . . . . . . . . . . A-10\nStatements of Changes in Partners' Capital and Common Shareholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . A-11\nStatements of Operations of Predecessor. . . . . . . . . . . . . . . . A-12\nStatements of Cash Flows of Predecessor. . . . . . . . . . . . . . . . A-13\nNotes to Financial Statements. . . . . . . . . . . . . . . . . . . . . A-14\nSELECTED FINANCIAL AND OPERATING DATA\nThe historical selected financial information of Enserch Exploration Partners, Ltd. (EP) set forth below is derived from the historical financial statements of EP, the predecessor operating entity to Enserch Exploration, Inc. (EEX). The pro forma Statement of Operations data of EEX includes adjustments as explained in the Financial Review.\nENSERCH EXPLORATION, INC. FINANCIAL REVIEW\nOn December 30, 1994, through a series of transactions, Enserch Exploration, Inc. (EEX) acquired all of the operating properties of Enserch Exploration Partners, Ltd. (EP), and EP received common stock of EEX. EP was then liquidated, and its partners received one share of EEX common stock for each limited and general partnership interest held. The ENSERCH companies also received EP's interests in and assumed EP's obligations under certain equipment lease arrangements (the equipment was simultaneously subleased to EEX) and assumed approximately $395 million principal amount of EP's indebtedness, plus accrued interest. Upon the liquidation of EP and distribution of EEX common stock, public unitholders of EP received 805,914 shares of EEX common stock (.77%) and the ENSERCH companies received 103,775,328 shares (99.23%) of EEX's 104,581,242 shares outstanding.\nPRO FORMA RESULTS OF OPERATIONS OF EEX - EEX was formed on December 30, 1994, and it had no operations for 1994. Pro forma results for EEX represent EP's results adjusted to reflect (1) the assumption by ENSERCH companies of $395 million of EP's debt, (2) the 1% general partner interest previously not included in EP's results, (3) the changes in offshore facilities and equipment lease terms, (4) the cost allocation for management of certain corporate services, and (5) a provision for corporate income taxes that were not payable by EP as a partnership. The 1994 results included a $4.9 million after-tax ($7.6 million pretax) gain from the sale of an inactive offshore pipeline that was written-down by $11 million after-tax ($17 million pretax) in 1992. Excluding these unusual items, operating income for 1994 was $26 million versus $27 million in 1993 and $15 million in 1992. EP's historical results of operations are discussed in the Financial Review. A reconciliation of EP's historical operating results to the pro forma net income of EEX is presented below.\nRESERVES - Natural-gas reserves at January 1, 1995, were 1.04 trillion cubic feet (Tcf), compared with 1.09 Tcf the year earlier, as estimated by DeGolyer and MacNaughton, independent petroleum consultants. Oil and condensate reserves, including natural gas liquids attributable to leasehold interests, were 46 million barrels (MMBbls), compared with the year-earlier level of 38 MMBbls. The increase is associated with Garden Banks Block 388.\nOFFSHORE DEVELOPMENT - Throughout 1994, work progressed on the conversion of a semisubmersible rig to a floating production facility for the development of the Garden Banks Block 388 unit. The majority of the modification work on the major structural components has been completed. The 24-slot subsea template has been installed, and the two 12-inch oil and gas gathering lines have been installed and connected to the shallow-water production facility located 54 miles away.\nCompletion operations on two pre-drilled wells commenced in early 1995 and should enable these wells to be brought on-stream when the floating facility is moored on location and the production riser is installed. These activities should be completed in mid-1995, followed by additional development drilling, with one such well expected to be completed in late 1995. Initial daily oil production rates from the pre-drilled wells are anticipated to be between 2,500 and 5,000 barrels of oil per well.\nMobil Producing Texas and New Mexico Inc. (Mobil) has an option to acquire, for consideration, a 40% interest in the entire Garden Banks unit consisting of six blocks and in the units production system. If Mobil exercises its option, EEX, which currently owns 100% of the project, will remain the operator.\nOperating results for 1995 are expected to be negatively impacted by the midyear commencement of production from the two pre-drilled wells on Garden Banks Block 388. Revenues from the early levels of production are not expected to be sufficient to cover operating costs, amortization and the equipment lease costs on the floating production platform and related facilities. Some operating costs and amortization vary with production; however, other costs and the equipment lease costs are essentially fixed. Results are expected to improve significantly for 1996 as production begins from several development wells and equipment lease and other fixed costs are spread over significantly more production.\nCAPITAL BUDGET - Planned property, plant and equipment additions for 1995 total $155 million, compared with expenditures of $131 million in 1994 and $115 million in 1993. The planned expenditures exclude costs of the floating production platform and related facilities of the Garden Banks project, which are being provided under lease arrangements with an ENSERCH affiliate. The leases were based on an estimated cost of $300 million, including some $20 million of capitalized financing costs. The cost of the facilities is expected to increase to $350 million, including capitalized financing costs, primarily due to the recent discovery on Block 387. It is anticipated that the lease arrangements will be modified for the additional costs.\nLIQUIDITY AND FINANCIAL RESOURCES - Total capitalization at December 31, 1994 was $882 million, with common shareholders' equity representing 82% of the total.\nEEX intends to utilize substantially all of its internally generated cash flow in connection with the growth of the company. However, internally generated cash flow may be supplemented by borrowings to fund temporary cash deficiencies. EEX has a temporary credit arrangement with ENSERCH pending the expected establishment of a $200 million independent facility.\nGAS AND OIL MARKET VOLATILITY - Results of operations are dependent upon the difference between the prices received for gas and oil produced and the costs of finding and producing such resources. On an energy equivalent basis, gas reserves at January 1, 1995 constituted approximately 80% of total reserves and gas production accounted for approximately 85% of total production for 1994. Accordingly, variations in gas prices have a more significant impact on operations than variations in oil prices. The average gas prices received for production ranged from a quarterly high of $2.32 per Mcf to a low of $1.63 per Mcf over the past three years.\nGas and oil swaps, collars and futures agreements are used to hedge volatile product prices for a portion (normally 30 to 70 percent) of anticipated future gas and oil production. At December 31, 1994, EEX had outstanding swaps, collars and futures agreements extending through December 1995 to exchange payments on some 17.8 Bcf of gas and 1.2 MMBbls of oil on which EEX had $4.1 million of net unrealized gains. At December 31, 1994, realized gains on hedging activities of $.9 million were deferred.\nThe full-cost method of accounting is followed for gas and oil properties. Product prices are subject to seasonal and other fluctuations. A decline in prices from year-end 1994 or other factors, without mitigating circumstances, could cause a future write-down of capitalized costs and a noncash charge against earnings.\nRESULTS OF OPERATIONS OF PREDECESSOR - EP's net income for 1994 was $12 million, compared with a loss of $3.9 million in 1993 and a loss of $20 million in 1992. The 1994 results included a $7.5 million gain from the sale of an inactive offshore pipeline that was written-down by $16 million in 1992.\nOperating income closely follows fluctuations in product prices and volumes, as shown in the table of Selected Financial and Operating Data. Excluding effects of the previously mentioned unusual items, operating income was $25 million for 1994, $26 million for 1993 and $16 million for 1992.\nRevenues for 1994 of $175 million were 5% lower than 1993, which was 12% above 1992. In 1994, natural-gas revenues decreased slightly to $143 million, with the average natural-gas price per thousand cubic feet of $2.15 up from $2.09 in 1993 and $1.82 in 1992. Natural-gas sales volumes were 66 Bcf in 1994, 69 Bcf in 1993 and 65 Bcf in 1992. The decrease in volumes in 1994 was principally due to reduced production from several high-volume fields in South Texas and offshore Louisiana. The increase in volumes from 1992 to 1993 was principally due to accelerated natural-gas development drilling in East Texas and offshore production from Mississippi Canyon Block 441 in the Gulf of Mexico, which went on-stream in the second quarter of 1993. Oil revenues declined $5 million to $29 million in 1994 due to a 5% production decline and an 11% decrease in the average sales price to $15.30 per barrel. Oil revenues decreased to $34 million in 1993 from $41 million in 1992, as production declined 8% and the average sales price dropped 10%. The lower volumes were primarily the result of declining production from several North Texas reservoirs.\nHedges of product prices resulted in a net increase in gas revenues of $5.0 million in 1994, compared with a decrease of $4.0 million in 1993. Hedges reduced oil revenues $.7 million in 1994 but added $.4 million in 1993.\nExcluding the 1994 credit from the sale of the inactive pipeline and the 1992 write-down of that pipeline, costs and expenses for 1994 were $150 million, $9 million less than 1993 and virtually the same as 1992. Expenses for 1994 reflected a $2.0 million credit associated with litigation settlements, while 1993 included provisions totaling $7.1 million relating to litigation. Depreciation and amortization increased 3% in 1994 due to a higher-per-unit amortization of capitalized costs, partially offset by the effects of lower production. The overall rate of amortization was $.96 per million British thermal units produced for 1994, compared with $.91 for both 1993 and 1992. The Mississippi Canyon capital lease and higher onshore exploratory costs largely account for the increase in 1994.\nInterest expense for 1994 of $21 million was $10 million less than 1993 as a result of refinancing affiliated debt at a lower interest rate. Interest expense for 1993 included a $6 million provision for interest due royalty owners.\nFOURTH-QUARTER RESULTS OF PREDECESSOR - Net income for the fourth quarter of 1994 was $3.9 million, compared with a loss of $6.5 million for the fourth quarter of 1993. Fourth-quarter results for 1994 included the $7.5 million gain on the sale of the inactive offshore pipeline. Excluding the gain, operating income for the 1994 fourth quarter was $2.3 million versus $4.8 million for the year-earlier quarter. Revenues in the fourth quarter of 1994 of $42 million were 17% lower than 1993, reflecting a 17% decrease in natural-gas sales volumes and a 5% lower average sales price for natural gas. Operating expenses and interest expense were both lower than in the prior fourth quarter, which included the previously mentioned provisions for litigation and interest due royalty owners.\nCASH FLOWS OF PREDECESSOR - Net cash flows from operating activities were $62 million in 1994, $76 million in 1993 and $77 million in 1992, after payment of affiliated interest charges of $20 million, $23 million and $20 million, respectively. Investing activities required net cash flows of $105 million, compared with $124 million in 1993 and $57 million in 1992, with variances due to differing levels of capital spending. The financing requirements of $43 million in 1994 and $47 million in 1993 were provided by borrowings from affiliated companies.\nENSERCH EXPLORATION, INC. PRO FORMA STATEMENTS OF OPERATIONS (UNAUDITED)\nThe pro forma statements of operations of Enserch Exploration, Inc. (EEX) are presented based on the historical results of operations of Enserch Exploration Partners, Ltd. (EP), after certain eliminations and adjustments. These statements should be read in conjunction with the historical financial statements of EP.\nENSERCH EXPLORATION, INC. NOTES TO FINANCIAL STATEMENTS\nAll dollar amounts, except per share and per unit amounts, in the notes to financial statements are stated in thousands unless otherwise indicated.\n1. ORGANIZATION AND BASIS OF PRESENTATION\nOn December 30, 1994, Enserch Exploration Inc. (EEX) acquired all of the partnership interests of EP Operating Limited Partnership (EPO), the 99% owned operating partnership of Enserch Exploration Partners, Ltd. (EP), and EP received common stock of EEX. EPO was then merged into EEX and thereafter, EP was liquidated, and its partners received one share of EEX common stock for each limited and general partnership interest held. The ENSERCH companies also received EP's interest in and assumed EP's obligations under certain equipment lease arrangements (the equipment was simultaneously subleased to EEX) and assumed approximately $395 million principal amount of EP's indebtedness, plus accrued interest.\nThe financial statements presented herein represent the historical balance sheet of EEX, after the acquisition of the EP operating properties and the transactions described above, and the historical financial statements of EP as the predecessor operating entity to EEX. Prior to the acquisition, EEX had no operations. In the notes that follow, \"the Company\" is used to refer to either EEX or EP, or both, when a distinction is not required. EP followed the proportional consolidation method whereby the financial statements reflected EP's 99% interest in EPO's assets, liabilities and operations. Certain prior year amounts in the statements of cash flows have been reclassified to conform with the 1994 presentation.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGas and Oil Properties - The full-cost accounting method prescribed by the Securities and Exchange Commission (SEC), is followed for gas and oil properties. Costs directly associated with the acquisition and evaluation of unproved gas and oil properties are excluded from the amortization base until the related properties are evaluated. Such unproved properties are assessed periodically and a provision for impairment is made to the full-cost amortization base when appropriate. Amortization of evaluated gas and oil properties is computed on the unit-of-production method using estimated proved gas and oil reserves quantified on the basis of their equivalent energy content. Amortization of gas and oil properties was approximately 5.7% in 1994, 6.0% in 1993 and 5.7% in 1992. Depreciation of other property, plant and equipment is provided principally by the straight-line method over the estimated service lives of the related assets. At December 31, 1994, estimates of future site restoration, dismantlement and abandonment costs, as assessed on an overall cost center basis, were less than estimates of future salvage values. Therefore, no accruals were required.\nNatural Gas and Oil Hedging Contracts - Gas and oil swaps, collars and futures agreements are used to hedge volatile product prices for a portion (normally 30 to 70 percent) of anticipated future gas and oil production. The purpose of these hedging activities is to fix the prices to be received. Under these agreements, payments are received or made based on the differential between a fixed and a variable product price. These agreements are settled in cash at or prior to expiration or exchanged for physical delivery contracts. Realized gains and losses on hedging activities are deferred and included in revenues during the month that the related physical sale occurs. In the event\nof nonperformance by counterparties, the Company is exposed to price risk. The Company does not obtain collateral to support the agreements but monitors the financial viability of counterparties. The Company has no off-balance sheet risk of accounting loss.\nIncome Taxes - EP was a partnership and, as a result, the income or loss of the partnership, which reflected differences in the timing of the deduction of certain gas and oil drilling and development costs for federal income-tax purposes, was includable in the tax returns of the individual partners. Accordingly, no recognition was given to income taxes in the financial statements of EP. EEX, as a corporation, is a taxable entity. Accordingly, the deferred tax effect of the difference in financial accounting basis and income tax basis of EEX's assets and liabilities was recorded upon the formation of EEX as follows:\nFair Value of Financial Instruments - The fair value of financial instruments, consisting primarily of cash, accounts receivable, investments, accounts payable, temporary advances payable and other accrued liabilities, approximates carrying value.\n3. SHAREHOLDERS' EQUITY\nEEX is authorized to issue 200 million shares of common stock at $1.00 par value and 2 million shares of preferred stock.\nThe Company has a stock option plan that provides for the granting of stock options to officers and key employees to purchase shares of EEX common stock and has provisions for awarding restricted stock to officers, which are subject to vesting based on the achievement of certain performance criteria. Options granted under the plan have an exercise price of not less than the fair market value of the common stock on the grant date. Options become exercisable in stages of 25% after one year to 100% after four years and expire after ten years. The plan covers a maximum of 2 million shares of EEX common stock. No options or restricted stock were granted or awarded in 1994.\n4. EMPLOYEE BENEFIT PLANS\nSubstantially all personnel associated with the Company are covered by an ENSERCH Corporation pension plan and some retirees are eligible for varying levels of health care and life insurance benefits. Employees hired after July 1, 1989 are not eligible for medical benefits when they retire. The allocation of the costs of these plans is actuarially determined. Total pension costs allocated to the Company were $1,208, $867 and $1,054 in 1994, 1993 and 1992, respectively. Postretirement health care and life insurance benefit costs allocated to the Company were $816, $821 and $550 in 1994, 1993 and 1992, respectively.\nThe assumed health care cost trend rate is 12.0% for 1994, declining gradually to 6.0% in 2003, and remaining at that level thereafter. If the health care cost trend rate were increased by 1%, the accumulated postretirement benefit obligation of ENSERCH as of December 31, 1994 would be increased by $4.8 million and the net periodic postretirement benefit cost for 1994 by $.4 million.\nInvestment Plan - ENSERCH provides a voluntary contributory investment plan that is available to substantially all employees and matches a portion of employee's contribution with ENSERCH common stock. The Company's share of costs under the plan was $236, $254 and $260 in 1994, 1993 and 1992, respectively.\n5. RELATED PARTY TRANSACTIONS\nIn the ordinary course of business, the Company engages in various transactions with ENSERCH and its affiliates. The Company was charged for direct costs incurred by ENSERCH and affiliates that were associated with managing the Company's business and operations. Additionally, ENSERCH charged EP and will charge EEX for indirect costs. Prior to July 1, 1994, EP was charged for the general and administrative staff costs incurred by ENSERCH in performing accounting, treasury, internal audit, income tax planning and compliance, legal and other functions, but was not charged for the cost of higher level management (i.e. all of the elected officers of ENSERCH) of these functions. Effective July 1, 1994, ENSERCH began charging all of its affiliates, including EP, for the cost of management by higher level ENSERCH personnel of these functions. ENSERCH charges for all indirect costs amounted to $2,032, $2,026 and $1,927 in 1994, 1993 and 1992, respectively.\nThe Company had sales to affiliated companies (Enserch Gas Company, Lone Star Gas Company and Enserch Processing) of $108,936, $108,916 and $32,508 in 1994, 1993 and 1992, respectively. In March 1993, the Company entered into new contracts to sell essentially all gas production not committed under existing contracts to Enserch Gas Company.\nThe notes receivable from affiliated companies had an interest rate of 7.5%. Interest on the temporary advance from affiliated companies was based on the 30-day commercial paper rate available to ENSERCH and was 6.1% at December 31, 1994. In February 1995, the receivable and the obligation were settled. Net interest costs incurred on affiliated borrowings were $24,266, $27,120 and $25,336 in 1994, 1993 and 1992, respectively.\nSee Note 6 for information concerning lease commitments with affiliates.\n6. COMMITMENTS AND CONTINGENT LIABILITIES\nLegal Proceedings - On March 23, 1994, a lawsuit was brought in the 299th District Court of Harris County, Texas against EPO (the Company's predecessor) and five other defendants by 19 royalty owners under leases contained within the Corby Gas Unit in Leon County, Texas. Defendants are working interest owners and lessees under the leases. The Company owned a 7.1% interest in\nthese leases. The plaintiffs allege causes of action involving breach of express and implied obligations under the leases, drainage, failure to explore and develop for gas and oil under the leases, civil conspiracy, tortious interference with contractual relationships, specific performance, negligence and conversion. The plaintiffs seek to recover alleged actual damages in excess of $5.4 million, punitive damages of at least ten times the actual damages, if any, found by a jury, interest and attorneys' fees.\nA lawsuit was filed against ENSERCH, its utility division, EPO (the Company's predecessor) and EPO's managing general partner in the 348th Judicial District Court of Tarrant County in May 1989. Plaintiffs seek unspecified actual damages and punitive damages in the amount of $5 million. Plaintiffs allege royalties were not fully paid, certain expenses were improperly charged against the amount of royalties due, negligence in the venting of gas and liquid hydrocarbons into the air, and breach of duty of good faith and fair dealing by wrongfully concealing certain material facts concerning sales of gas from the subject leases to the utility division.\nA lawsuit was filed on February 24, 1987, in the 112th Judicial District of Sutton County, Texas, against subsidiaries and affiliates of ENSERCH, as well as its utility division. The plaintiffs have claimed that defendants failed to make certain production and minimum-purchase payments under a gas-purchase contract. In this connection, the plaintiffs have alleged a conspiracy to violate purchase obligations, improper accounting of amounts due, fraud, misrepresentation, duress, failure to properly market gas and failure to act in good faith. Plaintiffs seek actual damages in excess of $5 million and punitive damages in an amount equal to 0.5% of the consolidated gross revenues of ENSERCH for the years 1982 through 1986 (approximately $85 million), interest, costs and attorneys' fees.\nManagement believes that the named defendants have meritorious defenses to the claims made in these and other actions brought in the ordinary course of business. In the opinion of management, the Company will incur no liability from these and all other pending claims and suits that would be considered material for financial reporting purposes.\nLeases - The equipment and facilities used in developing and producing reserves in the Mississippi Canyon Block 441 Project (MC 441) and Garden Banks Block 388 Project (GB 388) were financed under lease agreements between certain financial institutions and EPO. In connection with the merger of EPO into EEX, the leases were assigned to and assumed by Enserch Exploration Holdings, Inc. (EEH). EEX entered into three sublease arrangements with EEH for such offshore facilities. For accounting purposes, one of the lease agreements is an operating lease, and two are capital leases, with the lease obligations and related assets totaling approximately $156 million. The operating lease is for twelve years, with an option to purchase the equipment under lease at the end of the lease term at a fixed price equal to its estimated fair value.\nA component of the payments to be made by EEX under the subleases is based on a floating interest rate of LIBOR plus 1.75% per annum.\nEstimated future minimum lease payments for the leases, based on a LIBOR rate at December 31, 1994 of 5.625% for GB 388 and 5.9375% for MC 441, are as follows:\nThe cost for the Garden Banks facilities and equipment will exceed the $300 million cost that is the basis for current lease obligations, primarily due to the recent discovery on Block 387. The total cost of these facilities and equipment is expected to be approximately $350 million, including $20 million of capitalized financing costs. The Company anticipates that the lease arrangements will be modified for the additional costs.\nThe Company bears an allocated share of rental expenses incurred by ENSERCH affiliates under noncancelable long-term operating leases, principally for office space. The Company's allocated share of rental expenses totaled $3,071, $4,985 and $3,547 in 1994, 1993 and 1992, respectively.\nEnvironmental Matters - The Company is subject to federal, state and local environmental laws and regulations that regulate the discharge of materials into the environment. Environmental expenditures are expensed or capitalized depending on their future economic benefit. The level of future expenditures for environmental matters, including costs of obtaining operating permits, enhanced equipment monitoring and modifications under the Clean Air Act and cleanup obligations, cannot be fully ascertained until the regulations that implement the applicable laws have been approved and adopted. However, the capital expenditures required to achieve compliances with the Clean Air Act regulations, in their current form, have been estimated to be less than $1 million. It is management's opinion that all such costs, when finally determined, will not have a material adverse effect on the financial position or results of operations of the Company.\n7. SUPPLEMENTARY GAS AND OIL INFORMATION\nGas and Oil Producing Activities - The following tables set forth information relating to gas and oil producing activities. Reserve data for natural gas liquids attributable to leasehold interests owned by the Company are included in oil and condensate.\nCosts excluded from the amortizable base as of December 31, 1994:\nApproximately 65% of excluded costs relates to offshore activities in the Gulf of Mexico and the remainder relates to domestic onshore exploration activities. The anticipated timing of the inclusion of these costs in the amortization computation will be determined by the rate at which exploratory and development activities continue, which are expected to be accomplished within ten years.\nThe following information is required and defined by the Financial Accounting Standards Board. The disclosure does not represent the results of operations based on historical financial statements. In addition to requiring different determinations of revenues and costs, the disclosure excludes the impact of interest expense and corporate overheads.\nHedging Activities - At December 31, 1994, the Company had outstanding swaps, collars and futures agreements extending through December 31, 1995 to exchange payments on 17.8 Bcf of natural gas and 1.2 MMBbls of oil on which the Company had $4.1 million of net unrealized gains based on the difference between the strike price and the NYMEX futures price for the applicable trading month. At December 31, 1994, realized gains on hedging activities of $.9 million were deferred. The weighted average strike price and market price per Mcf of natural gas was $2.06 and $1.84, respectively, and the weighted average strike price and market price per barrel of oil was $17.98 and $17.82, respectively.\nGas and Oil Reserves (Unaudited) - The following table of estimated proved and proved developed reserves of gas and oil has been prepared utilizing estimates of year-end reserve quantities provided by DeGolyer and MacNaughton, independent petroleum consultants. Reserve estimates are inherently imprecise and estimates of new discoveries are more imprecise than those of producing gas and oil properties. Accordingly, the reserve estimates are expected to change as additional performance data become available. All reserves are located in the United States.\nStandardized Measure of Discounted Future Net Cash Flows Relating to Proved Gas and Oil Reserve Quantities (Unaudited) - has been prepared using estimated future production rates and associated production and development costs. Continuation of economic conditions existing at the balance sheet date was assumed. Accordingly, estimated future net cash flows were computed by applying prices and contracts in effect in December to estimated future production of proved gas and oil reserves, estimating future expenditures to develop proved reserves and estimating costs to produce the proved reserves based on average costs for the year. Average prices used in the computations were: Gas (per Mcf) $2.29 in 1994, $2.38 in 1993 and $2.18 in 1992; Oil (per barrel) $14.05 in 1994, $11.68 in 1993 and $18.16 in 1992.\nBecause reserve estimates are imprecise and changes in the other variables are unpredictable, the standardized measure should be interpreted as indicative of the order of magnitude only and not as precise amounts.\n8. SUPPLEMENTAL FINANCIAL INFORMATION\nQuarterly Results (Unaudited) - The results of operations by quarters for EP are summarized below. In the opinion of the Company's management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation have been made. The historical financial statements of EP include interest charges on the debt now assumed by ENSERCH and do not include provisions for income taxes as discussed in Note 2.","section_15":""}
{"filename":"732718_1994.txt","cik":"732718","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nU S WEST, Inc. (\"U S WEST\") was incorporated under the laws of the State of Colorado and has its principal executive offices at 7800 East Orchard Road, Englewood, Colorado 80111, telephone number (303) 793-6500. U S WEST is a diversified global communications company engaged in the telecommunications, directory publishing, marketing and, most recently, entertainment services businesses. Telecommunications services are provided by U S WEST's principal subsidiary, U S WEST Communications, Inc., to more than 25 million residential and business customers in the states of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming (collectively, the \"U S WEST Region\"). Directory publishing, marketing and entertainment services as well as cellular mobile communications services are provided by other U S WEST subsidiaries to customers both inside and outside the U S WEST Region. (Financial information concerning U S WEST's operations is set forth in the Consolidated Financial Statements and Notes thereto in the U S WEST 1994 Annual Report to Shareowners (the \"1994 Annual Report\"), which is incorporated herein by reference.) U S WEST and its subsidiaries had 61,505 employees at December 31, 1994.\nRECENT DEVELOPMENTS\nU S WEST COMMUNICATIONS\nDevelopment of Multimedia Network. In 1993, U S WEST announced its intention to build a multimedia telecommunications network (the \"Multimedia Network\") capable of providing voice, data and video services to customers within the U S WEST Region. U S WEST expects that it will ultimately deliver a variety of integrated communications, entertainment and information services and other high speed digital services, including data applications, through the Multimedia Network in selected areas of the U S WEST Region. These integrated services, including video-on-demand, targeted advertising, home shopping, interactive games, high-definition broadcast television and two-way, video telephony are expected to become available over time as the Multimedia Network develops. U S WEST began limited testing of its Multimedia Network in Omaha, Nebraska in December, 1994. A market trial will begin in 1995 in an area that will cover up to 50,000 homes. U S WEST is seeking approval from the Federal Communications Commission (the \"FCC\") to install Multimedia Network architecture in several other cities within the U S WEST Region. The results of the technical and market trials will be incorporated into the network configuration and future service offerings.\nRe-engineering. U S WEST also announced in 1993 that U S WEST Communications would implement a plan (the \"Re-engineering Plan\") designed to provide faster, more responsive customer service and improved repair capabilities while reducing the costs of providing these services. Pursuant to the Re-engineering Plan, U S WEST Communications is developing new systems that will enable it to monitor networks to reduce the risk of service interruptions, activate telephone service on demand, provide automated inventory systems and centralize its service centers so that customers can have their telecommunications needs resolved with one phone call. U S WEST Communications is also gradually reducing its work force by approximately 9,000 employees and consolidating the operations of its existing 560 customer centers into 26 customer centers in ten cities. Implementation of the Re-engineering Plan is expected to extend into 1997, rather than being completed in 1996 as originally scheduled. In the third quarter of 1993, U S WEST accrued a one-time, after-tax charge of $610 million for costs associated with the Re-engineering Plan, including employee training costs, severance benefits, employee relocations costs and building preparation and system installation costs. While U S WEST estimates that total employee and related costs will be reduced upon completion of the Re-engineering Plan, these savings are expected to be offset by the effects of inflation. (See \"Restructuring Charges\" under Management's Discussion and Analysis of Financial Condition and Results of Operations on p. 14 of the 1994 Annual Report, which is incorporated by reference herein.)\nDiscontinuance of SFAS 71 Accounting. In 1993, U S WEST incurred a $3.1 billion non-cash, extraordinary charge, net of an income tax benefit of $2.3 billion, against its earnings in conjunction with its decision to discontinue accounting for the operations of U S WEST Communications in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (\"SFAS 71\"). SFAS 71 generally applies to regulated companies that meet certain requirements, including a requirement that a company be able to recover its costs, notwithstanding competition, by charging its customers at prices established by a regulator. U S WEST's decision to discontinue accounting for the operations of U S WEST Communications in accordance with SFAS 71 is based on the belief that the development of multimedia technology, competition and market conditions, more than prices established by regulators, will determine the future cost recovery by U S WEST Communications. As a result of this accounting change, the remaining asset lives of U S WEST Communications' telephone plant were shortened to more closely reflect the useful life of such plant. U S WEST Communications' financial reporting for regulatory purposes was not affected by the change. U S WEST Communications expects that it will continue to work with regulators to set appropriate prices that reflect changing market conditions, including shorter asset lives.\nCABLE INVESTMENTS\nOn December 6, 1994, U S WEST purchased Wometco Cable Corp. and Georgia Cable Holdings (the \"Atlanta Cable Properties\") for $1.2 billion, consisting of $745 million in cash and $459 million in common stock. Together, the Atlanta Cable Properties serve about 65 percent of the cable customers in the metropolitan Atlanta area. U S WEST expects that it will eventually offer local exchange services as well as multimedia services in the Atlanta area as a result of this acquisition.\nIn 1993, U S WEST acquired 25.51% pro rata priority capital and residual equity interests in Time Warner Entertainment Company, L.P. (\"TWE\") for an aggregate purchase price of approximately $2.55 billion, consisting of approximately $1.53 billion in cash and approximately $1.02 billion in the form of a four-year promissory note bearing interest at a rate of 4.391% per annum (the \"TWE Investment\"). TWE owns and operates substantially all of the filmed entertainment (including Warner Bros.), programming (including HBO and Cinemax) and cable operations previously owned and operated by Time Warner Inc. TWE is the second-largest domestic multiple system cable operator, owning or operating 22 of the top 100 cable systems in the United States.\nU S WEST has an option to increase its equity interests in TWE from 25.51% to 31.84%. The option is exercisable, in whole or in part, between January 1, 1999 and May 31, 2005 upon the attainment of certain earnings thresholds for an aggregate cash exercise price of $1.25 billion to $1.8 billion (depending on the year of exercise). At the election of U S WEST or TWE, the exercise price will be payable by surrendering a portion of the equity interests receivable upon exercise of such option. In connection with the TWE Investment, U S WEST acquired 12.75% of the common stock of Time Warner Entertainment Japan Inc., a joint venture company established to expand and develop the market for entertainment services in Japan.\nDOMESTIC WIRELESS SERVICES\nOn July 25, 1994, AirTouch Communications (\"AirTouch\") and U S WEST announced an agreement to combine their domestic wireless operations. AirTouch's initial equity ownership of the wireless joint venture will be approximately 70 percent and U S WEST's will be 30 percent. This joint venture will provide U S WEST with an expanded wireless presence and economies of scale. The joint venture will have a presence in 9 of the top 20 cellular markets in the country. The transaction is expected to close in the second quarter of 1995 upon obtaining certain federal and state regulatory approvals. Each company's cellular operations initially will continue to operate as separate entities owned by the individual partners, but upon closing will report to a joint Wireless Management Company, which will provide support services.\nA merger of the two companies' operations will take place upon the earlier of four years from July 25, 1994, the lifting of certain MFJ restrictions, or at AirTouch's option. The agreement gives U S WEST strategic flexibility, including the right to exchange its interest in the joint venture for up to 19.9 percent of\nAirTouch common stock, with any excess amounts to be received in the form of AirTouch non-voting preferred stock. A Partnership Committee, led by the president and chief operating officer of AirTouch and three other AirTouch representatives, three U S WEST representatives and one mutually agreed upon independent representative will oversee the companies' domestic cellular operations.\nOn December 5, 1994, a partnership formed by the AirTouch\/U S WEST joint venture and the Bell Atlantic\/NYNEX partnership began bidding on personal communications services (\"PCS\") licenses that are being auctioned by the FCC. The combined companies own cellular licenses in 15 of the top 20 cities and serve over five million customers. The partnership, known as PCS PrimeCo, is eligible to bid for PCS licenses in 26 markets, representing more than 100 million POPS. This entity will be governed by a board made up of three members from the Bell Atlantic\/NYNEX partnership and three members from the AirTouch\/U S WEST joint venture. A second partnership will develop a national branding and marketing strategy and a common \"look and feel\" for both cellular and PCS customers. The cellular properties of Bell Atlantic\/NYNEX will not be merged with those of AirTouch\/U S WEST.\nPERSONAL COMMUNICATIONS SERVICES\nIn 1993, Mercury One-2-One, a 50-50 joint venture between U S WEST and Cable & Wireless PLC, launched the world's first commercial PCS in the United Kingdom. Mercury One-2-One's PCS is a digital cellular communications service designed to offer consumers higher quality service, increased privacy and more features at lower prices than existing cellular communications systems. To meet growing customer demand, Mercury One-2-One has expanded its coverage to reach 30 percent of the U.K. population.\nTELEWEST INITIAL PUBLIC OFFERING\nIn 1994, TeleWest Communications PLC (\"TeleWest\"), a venture with Tele-Communications, Inc., completed an initial public offering of its common stock. U S WEST's interest in TeleWest was reduced from 50 percent to 37.8 percent as a result of the offering, but based on the offering price, its interest is valued at U.S. $1.1 billion. TeleWest is the largest provider of combined cable television and telephone service in the world. The combined services are provided over a multimedia network which has been designed to provide a wide range of interactive and integrated entertainment, telecommunication and information services as they become available in the future. TeleWest owns all or part of 23 franchises that encompass 3.6 million homes. Through TeleWest, U S WEST has gained experience in packaging video and telephone service that it utilizes in other parts of the world.\nDISCONTINUANCE OF CAPITAL ASSETS SEGMENT\nIn 1993, in connection with its decision to concentrate its resources and efforts on developing its telecommunications business, U S WEST determined to treat its capital assets business segment (the \"Capital Assets segment\") as a discontinued operation and announced its intention to dispose of the businesses comprising that segment. U S WEST's remaining business segment, \"Communications and Related Services,\" comprises the continuing operations of U S WEST. U S WEST continues to make progress in disposing of its Capital Assets segment in accordance with its plan of disposition.\nIn May, 1994, U S WEST sold 7.5 million shares of Financial Security Assurance Holdings Ltd. (\"FSA\"), including 2 million shares to Fund American Enterprises Holdings, Inc. (\"FFC\"), in an initial public offering of FSA common stock. In June, 1994, an additional 600,000 shares were issued in connection with an over-allotment option. U S WEST received $154 million in net proceeds from the offering. In conjunction with the sale of FSA shares to FFC, U S WEST issued 50,000 shares of a class of newly created cumulative redeemable preferred stock. FFC's voting rights in FSA increased to 21.0 percent through a combination of direct share ownership of common and preferred FSA shares and a voting trust agreement with U S WEST. U S WEST's voting rights are 49.8 percent.\nDuring 1994, U S WEST Real Estate, Inc. continued the liquidation of its real estate portfolio, selling 12 buildings, six parcels of land and other assets for approximately $327 million U S WEST expects that the liquidation of this portfolio will be substantially completed by 1998.\nU S WEST'S CONTINUING OPERATIONS\nU S WEST Communications. U S WEST Communications was formed January 1, 1991, when Northwestern Bell Telephone Company (\"Northwestern Bell\") and Pacific Northwest Bell Telephone Company (\"Pacific Northwest Bell\") were merged into The Mountain States Telephone and Telegraph Company (\"Mountain States\"), which simultaneously changed its name to U S WEST Communications, Inc. U S WEST acquired ownership of Mountain Bell, Northwestern Bell and Pacific Northwest Bell on January 1, 1984, when American Telephone and Telegraph Company (\"AT&T\") transferred its ownership interests in these three wholly owned operating telephone companies to U S WEST. This divestiture was made pursuant to a court-approved consent decree entitled the \"Modification of Final Judgment\" (\"MFJ\") which arose out of an antitrust action brought by the United States Department of Justice against AT&T.\nOperations of U S WEST Communications. U S WEST Communications serves approximately 80% of the population in the U S WEST Region and approximately 40% of the land area. At December 31, 1994, U S WEST Communications had approximately 14,336,000 telephone network access lines in service, a 3.6% increase over year end 1993.\nUnder the terms of the MFJ, the U S WEST Region was divided into 29 geographical areas called \"Local Access and Transport Areas\" (\"LATAs\") with each LATA generally centered on a metropolitan area or other identifiable community of interest. The principal types of telecommunications services offered by U S WEST Communications are (i) local service, (ii) exchange access service (which connects customers to the facilities of interLATA service providers), and (iii) intraLATA long distance network service. For the year ended December 31, 1994, local service, exchange access service and intraLATA long distance network service accounted for 37%, 27% and 12%, respectively, of the sales and other revenues of U S WEST's continuing operations. In 1994, revenues from a single customer, AT&T, accounted for approximately 10% of the sales and other revenues of U S WEST's continuing operations.\nU S WEST Communications incurred capital expenditures of approximately $2.45 billion in 1994 and expects to incur approximately $2.1 billion in 1995. The 1994 capital expenditures of U S WEST Communications were substantially devoted to the continued modernization of telephone plant, including investments in fiber optic cable, in order to improve customer services and network productivity.\nCentral to U S WEST Communications' competitive strategy in 1994 were its efforts respecting the Multimedia Network and the Re-engineering Plan. See \"Recent Developments -- U S WEST Communications.\"\nRegulation of U S WEST Communications. U S WEST Communications is subject to varying degrees of regulation by state commissions with respect to intrastate rates and service, and access charge tariffs. Under traditional rate of return regulation, intrastate rates are generally set on the basis of the amount of revenues needed to produce an authorized rate of return.\nU S WEST Communications has sought alternative forms of regulations (\"AFOR\") plans which provide for competitive parity, enhanced pricing flexibility and improved capability in bringing to market new products and services. In a number of states where AFOR plans have been adopted, such actions have been accompanied by requirements to refund revenues, reduce existing rates or upgrade service, any of which could have adverse short-term effects on earnings. Similar agreements may have resulted under traditional rate of return regulation. (See \"State Regulatory Issues\" under Management's Discussion and Analysis of Financial Condition and Results of Operations on p. 22 of the 1994 Annual Report, which is incorporated by reference herein.)\nU S WEST Communications is also subject to the jurisdiction of the FCC with respect to interstate access tariffs (that specify the charges for the origination and termination of interstate communications) and\nother matters. U S WEST's interstate services have been subject to price cap regulation since January 1991. Price caps are a form of incentive regulation and, ostensibly, limit prices rather than profits. However, the FCC's price cap plan includes sharing of earnings in excess of authorized levels. The Company believes that competition will ultimately be the determining factor in pricing telecommunications services. (See \"Federal Regulatory Issues\" under Management's Discussion and Analysis of Financial Condition and Results of Operations on p. 21 of the 1994 Annual Report, which is incorporated by reference herein.)\nCongress failed to pass telecommunications reform legislation in 1994. It is expected that new telecommunications legislation will be introduced in 1995. However, there is uncertainty concerning the scope and the direction of that legislation. U S WEST believes that it is in the public interest to lift all competitive restrictions, placing all competitors under the same rules. Such action would lead to wider consumer choices, and ensure the industry's technological development and long-term financial health.\nCompetition. U S WEST believes that the convergence of the communications, entertainment and information services businesses will lead to increased competition for U S WEST from companies in industries with which U S WEST did not historically compete. U S WEST Communications' principal competitors are competitive access providers (\"CAPs\") and interexchange carriers. In recent years, potential competitors have expanded to include cable television companies, combined cable television\/telecommunications companies and cellular companies. Cable television companies are expected to increase competition by offering telecommunications and other information services. Combined cable television and telecommunications companies are expected to increase competition for local telephone and alternative exchange access services as well as those services expected to be available through the Multimedia Network. AT&T's entrance into the cellular communications market through its acquisition of McCaw Cellular Communications, Inc. may create increased competition in local exchange as well as cellular services.\nCurrently, competition from long distance companies is eroding U S WEST Communications' market share of intraLATA long distance services such as Wide Area Telephone Service and \"800.\" These revenues have steadily declined over the last several years as customers have migrated to interexchange carriers who have the ability to offer these services on both an intraLATA and interLATA basis. U S WEST and its affiliates are prohibited from providing interLATA long distance services.\nThe impact of increased competition on the operations of U S WEST Communications will be influenced by the future actions of regulators and legislators who increasingly are advocating competition. The loss of local exchange customers to competitors would affect multiple revenue streams of U S WEST and could have a material adverse effect on its operations.\nOther U S WEST Subsidiaries and Investments. Other continuing operations include subsidiaries engaged in (i) publishing services, primarily \"Yellow Pages\" and other directories, (ii) designing, engineering and operating mobile telecommunications systems, (iii) cellular and land-line telecommunications, network infrastructure and cable television businesses in certain foreign countries, and (iv) entertainment services.\nU S WEST Marketing Resources Group, Inc. (\"Marketing Resources\"), which accounted for about 9% of U S WEST's 1994 revenues from continuing operations, publishes about 300 white and yellow page directories in the U S WEST Region. Marketing Resources competes with local and national publishers of directories, as well as other advertising media such as newspapers, magazines, broadcast media and direct mail. Marketing Resources intends to focus on enhancing core products, developing and packaging new information products through new and existing databases.\nU S WEST NewVector Group, Inc. (\"NewVector\"), which accounted for approximately 7% of U S WEST's 1994 revenues from continuing operations, provides communications and information products and services, including cellular services, over wireless networks in 31 Metropolitan Service Areas and 34 Rural Service Areas, primarily located in the U S WEST Region. Competition for full service cellular customers is currently limited to holders of the two cellular licenses granted in a given cellular market. Despite its rapid growth, the cellular industry is faced with many challenges including the introduction of new technologies, increased competition and an uncertain regulatory environment. In 1994, NewVector agreed to combine its domestic wireless services with those of AirTouch, and to be part of a partnership including AirTouch, Bell\nAtlantic and NYNEX that would bid on PCS licenses that are being auctioned by the FCC. See \"Recent Developments -- Domestic Wireless Services.\"\nU S WEST Multimedia Communications, Inc. (\"Multimedia Communications\") was formed to manage U S WEST's cable investments, and has primary responsibility for aiding U S WEST in achieving its strategic goal of becoming a leading provider of interactive, integrated communications, entertainment and information services outside the U S WEST Region.\nMultimedia Communications is also responsible for identifying and pursuing alliances, acquisitions and\/or investments that complement U S WEST's strategy. U S WEST is seeking to strengthen its national out-of-region presence by acquiring or forming alliances with other communications, entertainment and information services companies throughout the United States. The first major step toward that goal was the TWE Investment made in 1993. More recently, U S WEST acquired the Atlanta Cable Properties. See \"Recent Developments -- Cable Investments.\"\nU S WEST will continue to employ strategic alliances and will also make direct investments in assets or businesses that are consistent with its business strategies. Financing for new investments will primarily come from a combination of new debt and equity. In the event of a new investment of substantial magnitude, the Company may also re-evaluate its use of internally generated cash, the feasibility of further acquisitions, the possibility of sales of assets and the capital structure.\nDuring 1994, U S WEST continued expanding its international ventures, which include investments in cable television and telecommunications, wireless communications including PCS, directory publishing, and international networks. The Company completed its purchase of Thomson Directories, a publisher of 155 telephone directories that reach 80 percent of the households in Great Britain. The Company also purchased 49 percent of Listel, a Brazilian company that produces telephone directories, and acquired a minority interest in Binariang Sdn Bhd, a Malaysian telecommunications company that holds four licenses that enable it to become a second network operator in Malaysia.\nU S WEST's net investment in international ventures approximated $988 million (inclusive of consolidated entities) at December 31, 1994, approximately 68% of which is in the United Kingdom. Of the total international investment, approximately 53% is invested in cable television joint ventures, mostly in the United Kingdom and Western Europe.\nBecause U S WEST's international investments are in new, developing businesses, they typically are in a high growth, reinvestment phase for several years and do not show net income or positive cash flow until they become more mature. Consequently, start-up losses from these investments, in total, are expected to increase in 1995 and possibly beyond. The Company's future commitment to international ventures is currently planned at about $400 million in 1995, but could increase as new opportunities become available.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe properties of U S WEST do not lend themselves to description by character and location of principal units. At December 31, 1994, the majority of U S WEST property was utilized in providing telecommunications services by U S WEST Communications. Substantially all of U S WEST Communications' central office equipment is located in owned buildings situated on land owned in fee, while many garages and administrative and business offices are in leased quarters.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nU S WEST and its subsidiaries are subject to claims and proceedings arising in the ordinary course of business. While complete assurance cannot be given as to the outcome of any contingent liabilities, in the opinion of U S WEST, any financial impact to which U S WEST and its subsidiaries are subject is not expected to be material in amount to U S WEST's operating results or its financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nEXECUTIVE OFFICERS OF U S WEST\nPursuant to General Instructions G(3), the following information is included as an additional item in Part I:\n- --------------- (1) Mr. Ames, while not an officer of U S WEST, performs significant policy making functions equivalent to those typically performed by an officer.\n(2) Mr. McClellan was appointed Acting Executive Vice President effective October 10, 1994.\n(3) Mr. McCormick was appointed Chief Executive Officer on January 1, 1991, and was elected Chairman of the Board effective May 1, 1992.\n(4) Mr. Osterhoff has announced his retirement from U S WEST but will remain in his present position until a successor is named.\nExecutive Officers are not elected for a fixed term of office, but serve at the discretion of the Board of Directors.\nEach of the above executive officers has held a managerial position with U S WEST or an affiliate of U S WEST since 1990, except for Messrs. Osterhoff, Rubis and Russ. Mr. Osterhoff was Vice President -- Finance and Chief Financial Officer of Digital Equipment Corporation from 1985 to 1991. Mr. Rubis was Vice President -- Quality for U S WEST International and Business Development Group, a division of U S WEST, from 1991 to 1992; Director -- Quality and Service Improvement for U S WEST NewVector Group, Inc., a subsidiary of U S WEST, from 1990 to 1991. Prior to joining the U S WEST family, Mr. Rubis worked as an independent labor relations consultant and as co-founder and principal of Workplace One, Ltd., a Canadian-based consulting firm, from 1979 to 1988. In 1988, he merged his firm with Deltapoint Corp., a Seattle-based Quality Improvement consulting firm. Mr. Russ was Vice President, Secretary and General Counsel of NCR Corporation from February, 1984 to June, 1992.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe information required by this item is included on page 54 of the 1994 Annual Report under the heading \"Note 18: Quarterly Financial Data (Unaudited)\" and is incorporated herein by reference. The U.S. markets for trading in U S WEST common stock are the New York Stock Exchange and the Pacific Stock Exchange. As of December 31, 1994, U S WEST common stock was held by approximately 816,099 shareholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by this item is included on page 1 of the 1994 Annual Report under the heading \"Financial Highlights\" and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe information required by this item is included on pages 7 through 31 of the 1994 Annual Report and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by this item is included on pages 33 through 54 of the 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.\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information required by this item with respect to executive officers is set forth in Part I, page 10, under the caption \"Executive Officers of U S WEST.\"\nThe information required by this item with respect to Directors is included in the U S WEST definitive Proxy Statement dated March 16, 1995 (\"Proxy Statement\") under \"Election of Directors\" on pages 4 and 5 and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this item is included in the Proxy Statement under \"Executive Compensation\" on pages 10 through 16 and \"Compensation of Directors\" on pages 2 and 3 and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by this item is included in the Proxy Statement under \"Securities Owned by Management\" on page 3 and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) The following independent accountants' report and consolidated financial statements are incorporated by reference in Part II of this report on Form 10-K:\nFinancial statement schedules other than those listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not required or applicable.\n(b) Reports on Form 8-K:\nU S WEST filed the following reports on Form 8-K during the fourth quarter of 1994:\n(i) report dated October 17, 1994 relating to a release of earnings for the period ended September 30, 1994;\n(ii) report dated December 8, 1994 announcing its plan to buy back stock, and the completion of the Atlanta Cable properties acquisition.\n(c) Exhibits:\nExhibits identified in parentheses below, on file with the Securities and Exchange Commission (\"SEC\"), are incorporated herein by reference as exhibits hereto.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Englewood, State of Colorado, on March 7, 1995.\nU S WEST, Inc.\nBy: \/s\/ JAMES M. OSTERHOFF James M. Osterhoff Executive Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nDated March 7, 1995\nINDEPENDENT ACCOUNTANTS' REPORT\nOur report on the consolidated financial statements of U S WEST, Inc., which includes an explanatory paragraph regarding the discontinuance of accounting for the operations of U S WEST Communications, Inc. in accordance with Statement of Financial Accounting Standard No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" in 1993, and a change in the method of accounting for postretirement benefits other than pensions and other postemployment benefits in 1992, has been incorporated by reference in this Form 10-K from page 32 of the 1994 Annual Report to Shareowners of U S WEST, Inc. In connection with our audits or such consolidated financial statements, we have also audited the related consolidated financial statement schedules listed in the index on page 12 of this Form 10-K for the years ended December 31, 1994, 1993 and 1992.\nIn our opinion, the consolidated financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ COOPERS & LYBRAND\nCOOPERS & LYBRAND L.L.P. Denver, Colorado January 18, 1995\nU S WEST, INC.\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN MILLIONS)\n- ---------------\nNOTE: Certain reclassifications within the schedule have been made to conform to the current year presentation.\n(a) Does not include amounts charged directly to expense. These amounts were $10, $10 and $9 for 1994, 1993 and 1992, respectively.\n(b) Represents credit losses written off during the period, less collection of amounts previously written off.\n(c) Primarily due to sale of U S WEST Financial Services finance receivables and assets.\n(d) The company adopted SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts\" in 1993. SFAS No. 113 requires reinsurance receivables to be reflected as assets rather than netted against the loss reserve. Prior years have been restated for comparability.\n(e) This amount relates to loss reserves of Financial Security Assurance at the beginning of 1994. Financial Security Assurance is now accounted for under the equity method.\n(f) Primarily valuation allowance related to the 1990 purchase of a $294 face amount mobile home loan portfolio for $197.\n(g) Provision for estimated loss on disposal of the Capital Assets segment of $100 and an additional provision of $20 to reflect the cumulative effect on deferred taxes of the 1993 federally mandated increase in income tax rates.\nS-1\n(U S WEST LOGO)\n(RECYCLED PAPER LOGO) RECYCLED PAPER INDEX TO EXHIBITS","section_15":""}
{"filename":"72333_1994.txt","cik":"72333","year":"1994","section_1":"Item 1. Business. - - ------------------\nNordstrom, Inc. (the \"Company\") was incorporated in the State of Washington in 1946 as successor to a retail shoe business started in 1901. Today, the Company operates 53 large specialty stores and four smaller specialty stores in Washington, Oregon, California, Utah, Alaska, Virginia, New Jersey, Illinois, Maryland and Minnesota, selling a wide selection of apparel, shoes and accessories for women, men and children.\nThe Company also operates eighteen clearance stores under the name \"Nordstrom Rack\" which serve as outlets for clearance merchandise from the Company's large specialty stores. The Racks also purchase merchandise directly from manufacturers. The Racks are located in Washington, Oregon, California, Utah, Virginia, Maryland, Pennsylvania and Illinois. The Company also operates a men's specialty store in New York and leased shoe departments in 11 department stores in Hawaii. The Company commenced operations of its Direct Sales division with the mailing of the first catalog at the end of 1993. Over the next twelve to eighteen months, the Company will be involved in tests of Interactive Television Shopping.\nThe Company regularly employs on a full or part-time basis an average of approximately 33,000 employees. Due to the seasonal nature of the Company's business, the number increased to approximately 40,000 employees in December.\nThe Company's business is highly competitive. Its stores compete with other national, regional and local retail establishments within its operating areas which carry similar lines of merchandise, including department stores, specialty stores and boutiques. The Company believes the principal methods of competing in its industry include customer service, value, fashion, advertising, store location and depth of selection.\nCertain other information required under Item 1 is contained within the following sections of the Company's 1993 Annual Report to Shareholders, which sections are incorporated by reference herein from Exhibit 13.1 of this report:\nMessage to the Shareholders Management Discussion and Analysis Note 13 in Notes to Consolidated Financial Statements\n3 of 16\nExecutive Officers of the Registrant - - ------------------------------------\nAll of the above people that have not been officers for the past five years have been full-time employees of the Company during that period. The officers are re-elected annually by the Board of Directors following each year's Annual Meeting. Each officer is elected for a term of one year or until a successor is elected and qualifies.\n4 of 16\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. - - --------------------\nThe following table summarizes at January 31, 1994 the number of stores owned or operated by the Company and the percentage of total store area represented by each listed category:\nThe Company also operates eight merchandise distribution centers, five of which are owned and three of which are leased. The Company leases its principal offices in Seattle, Washington, and owns an office building in the Denver, Colorado metropolitan area which serves as the principal offices of Nordstrom Credit, Inc. and Nordstrom National Credit Bank.\nThe Company operates 25 full-line stores, six clearance stores and two distribution centers in California. Because of its high cost, the Company does not carry earthquake insurance.\nCertain other information required under this item is included in the following section of the Company's 1993 Annual Report to Shareholders, which section is incorporated by reference herein from Exhibit 13.1 of this report:\n\tRetail Store Facilities\nItem 3.","section_3":"Item 3. Legal Proceedings. - - --------------------------\nThe Company is not involved in any material pending legal proceedings, other than routine litigation in the ordinary course of business.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - - ------------------------------------------------------------ None\n5 of 16\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. - - ---------------------------------------------------------------------\nThe Company's Common Stock, without par value, is traded in the over-the- counter market and is quoted daily by the NASDAQ. The approximate number of holders of Common Stock as of March 22, 1994 was 71,500.\nCertain other information required under this Item with respect to stock prices and dividends is included in the following sections of the Company's 1993 Annual Report to Shareholders, which sections are incorporated by reference herein from Exhibit 13.1 of this report:\n\tFinancial Highlights - Stock Trading \tConsolidated Statements of Shareholders' Equity \tNote 9 in Notes to Consolidated Financial Statements \tNote 14 in Notes to Consolidated Financial Statements\nItem 6.","section_6":"Item 6. Selected Financial Data. - - ---------------------------------\nThe information required under this item is included in the following section of the Company's 1993 Annual Report to Shareholders, which section is incorporated by reference herein from Exhibit 13.1 of this report:\n\tTen-Year Statistical Summary\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 in the following section of the Company's 1993 Annual Report to Shareholders, which section is incorporated by reference herein from Exhibit 13.1 of this report:\n\t Management Discussion and Analysis\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. - - -----------------------------------------------------\nThe information required under this item is included in the following sections of the Company's 1993 Annual Report to Shareholders, which sections are incorporated by reference herein from Exhibit 13.1 of this report:\n\t Consolidated Statements of Earnings \t Consolidated Balance Sheets \t Consolidated Statements of Shareholders' Equity \t Consolidated Statements of Cash Flows \t Notes to Consolidated Financial Statements \t Independent Auditors' Report\n6 of 16 Item 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. - - ------------------------------------------------------------\nThe information required under this item with respect to the Company's Directors and compliance with Section 16(a) of the Exchange Act is included in the following sections of the Company's Proxy Statement for its 1994 Annual Meeting of Shareholders, which sections are incorporated by reference herein and will be filed within 120 days after the end of the Company's fiscal year:\n\t Election of Directors \t Compliance with Section 16(a) of the Exchange Act of 1934\nThe information required under this item with respect to the Company's Executive Officers is incorporated by reference from Part I, Item 1 of this report under \"Executive Officers of the Registrant\".\nItem 11.","section_11":"Item 11. Executive Compensation. - - --------------------------------\nThe information required under this item is included in the following sections of the Company's Proxy Statement for its 1994 Annual Meeting of Shareholders, which sections are incorporated by reference herein and will be filed within 120 days after the end of the Company's fiscal year:\nCompensation of Executive Officers in the Year Ended January 31, 1994 Compensation and Stock Option Committee Report on Executive Compensation Stock Price Performance Compensation of Directors \t Compensation Committee Interlocks and Insider Participation \t 1993 Non-Employee Director Stock Incentive Plan (Effectiveness of the Plan is subject to approval of the shareholders at the 1994 Annual Meeting of Shareholders.)\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. - - ------------------------------------------------------------------------\nThe information required under this item is included in the following section of the Company's Proxy Statement for its 1994 Annual Meeting of Shareholders, which sections are incorporated by reference herein and will be filed within 120 days after the end of the Company's fiscal year:\n\t Principal Shareholders\n7 of 16 Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions. - - --------------------------------------------------------\nThe information required under this item is included in the following sections of the Company's Proxy Statement for its 1994 Annual Meeting of Shareholders, which sections are incorporated by reference herein and will be filed within 120 days after the end of the Company's fiscal year:\n\t Election of Directors \t Transactions with Management\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. - - -------------------------------------------------------------------------- (a)1. Financial Statements --------------------\nThe following consolidated financial information and statements of Nordstrom, Inc. and its subsidiaries and the Independent Auditors' Report are incorporated by reference herein from Exhibit 13.1 of this report:\n\t\t Consolidated Statements of Earnings \t\t Consolidated Balance Sheets \t\t Consolidated Statements of Shareholders' Equity \t\t Consolidated Statements of Cash Flows \t\t Notes to Consolidated Financial Statements \t\t Independent Auditors' Report\n(a)2. Financial Statement Schedules -----------------------------\nOther schedules for which provision is made in Regulation S-X are not required, are inapplicable, or the information is included in the Company's 1993 Annual Report to Shareholders as incorporated by reference herein from Exhibit 13.1 of this report.\n8 of 16\n(a)3.\tExhibits --------\n(3.1) Articles of Incorporation of the Registrant are hereby incorporated by reference from the Registrant's Form 10-K for the year ended January 31, 1990, Exhibit A.\n(3.2) By-laws of the Registrant are hereby incorporated by reference from the Registrant's Form 10-K for the year ended January 31, 1992, Exhibit 3.2.\n(4.1) The Indenture between Nordstrom Credit, Inc. (a wholly-owned subsidiary of the Registrant) and First Interstate Bank of Washington, N.A. dated November 15, 1984, the First Supplement thereto dated January 15, 1988, the Second Supplement thereto dated June 1, 1989 and the Third Supplement thereto dated October 19, 1990 are hereby incorporated by reference from Registration No. 33-3765, Exhibit 4.2; Registration No. 33-19743, Exhibit 4.2; Registration No. 33-29193, Exhibit 4.3; and the Nordstrom Credit, Inc. Annual Report on Form 10-K (SEC File No. 0-12994) for the year ended January 31, 1991, Exhibit 4.2, respectively.\n\t Securities authorized under each of any other long-term debt instruments of the Company or its subsidiaries do not exceed 10% of the consolidated total assets of the Company and its subsidiaries. The Company will furnish a copy of any such long- term debt instrument or agreement to the Commission upon request.\n(10.1) Operating Agreement dated August 30, 1991 between Nordstrom Credit, Inc. and Nordstrom National Credit Bank is hereby incorporated by reference from the Nordstrom Credit, Inc. Quarterly Report on Form 10-Q, as amended (SEC File No. 0-12994) for the quarter ended July 31, 1991, Exhibit 10.1.\n(10.2) The 1987 Nordstrom Stock Option Plan is hereby incorporated by reference from the Registrants' Proxy Statement for its 1987 Annual Meeting of Shareholders.\n(10.3) The Nordstrom Supplemental Retirement Plan is hereby incorporated by reference from the Registrant's Form 10-K for the year ended January 31, 1992, Exhibit 10.3.\n(10.4) The 1993 Non-Employee Director Stock Incentive Plan is filed herein as an Exhibit. (Effectiveness of the Plan is subject to approval of the shareholders at the 1994 Annual Meeting of Shareholders.)\n(13.1) The Company's 1993 Annual Report to Shareholders is filed herein as an Exhibit.\n(21.1) List of the Registrant's Subsidiaries is filed herein as an Exhibit.\n(23.1) Independent Auditors' consent is on page 12 of this report.\nAll other exhibits are omitted because they are not applicable, not required, or because the required information is included in the Company's 1993 Annual Report to Shareholders.\n9 of 16\n(b) Reports on Form 8-K -------------------\nNo reports on Form 8-K were filed during the last quarter of the period for which this report is filed.\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the 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\tNORDSTROM, INC. \t (Registrant) \/s\/ John A. Goesling Date March 31, 1994 by __________________________________________ ____________________ John A. Goesling Executive Vice President and Treasurer (Principal Accounting and Financial Officer)\n10 of 16\nPursuant to the requirements of the 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 Officers: Principal Accounting and Financial Officer:\n\/s\/ Raymond A. Johnson \/s\/ John A. Goesling _______________________________ ________________________________ Raymond A. Johnson John A. Goesling Co-President Executive Vice President and Treasurer \/s\/ John Whitacre _______________________________ John Whitacre Co-President\nDirectors:\n\/s\/ D. Wayne Gittinger \/s\/ James F. Nordstrom _______________________________ ________________________________ D. Wayne Gittinger James F. Nordstrom Director Co-Chairman\n\/s\/ John F. Harrigan \/s\/ John N. Nordstrom _______________________________ ________________________________ John F. Harrigan John N. Nordstrom Director Co-Chairman\n\/s\/ Charles A. Lynch \/s\/ Alfred E. Osborne Jr. _______________________________ ________________________________ Charles A. Lynch Alfred E. Osborne Jr. Director Director\n\/s\/ Ann D. McLaughlin \/s\/ William D. Ruckelshaus _______________________________ ________________________________ Ann D. McLaughlin William D. Ruckelshaus Director Director\n\/s\/ John A. McMillan \/s\/ Malcolm T. Stamper _______________________________ ________________________________ John A. McMillan Malcolm T. Stamper Co-Chairman Director\n\/s\/ Bruce A. Nordstrom \/s\/ Elizabeth Crownhart Vaughan _______________________________ ________________________________ Bruce A. Nordstrom Elizabeth Crownhart Vaughan Co-Chairman Director\nDate March 31, 1994 ___________________________\n11 of 16\nINDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULES\nShareholders and Board of Directors Nordstrom, Inc.\nWe consent to the incorporation by reference in Registration Statements Nos. 33-18321 and 2-81695 of Nordstrom, Inc. on Form S-8 of our reports dated March 11, 1994 appearing in and incorporated by reference in this Annual Report on Form 10-K of Nordstrom, Inc. and subsidiaries for the year ended January 31, 1994.\nWe have audited the consolidated financial statements of Nordstrom, Inc. and subsidiaries as of January 31, 1994 and 1993, and for each of the three years in the period ended January 31, 1994, and have issued our report thereon dated March 11, 1994; such financial statements and report are included in your 1993 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedules of Nordstrom, Inc. and subsidiaries, 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 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 March 31, 1994 Seattle, Washington\n12 of 16\nNORDSTROM, INC. AND SUBSIDIARIES SCHEDULE V - PROPERTY, BUILDINGS AND EQUIPMENT (Dollars in thousands)\n13 of 16\nNORDSTROM, INC. AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, BUILDINGS AND EQUIPMENT\n(Dollars in thousands)\n14 of 16\nNORDSTROM, INC. AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\n(Dollars in thousands)\n15 of 16\nNORDSTROM INC. AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM BORROWINGS\n(Dollars in thousands)\n16 of 16\nNORDSTROM INC. AND SUBSIDIARIES\nExhibit Index","section_15":""}
{"filename":"774569_1994.txt","cik":"774569","year":"1994","section_1":"Item 1. Business - ------- -------- General - --------\nTHE CORPORATION ---------------\nThe registrant, Cortland Bancorp (herein sometimes referred to as the \"Corporation\"), is a bank holding company which was incorporated under the laws of the State of Ohio in 1984, and is registered under the Bank Holding Company Act of 1956, as amended. Its subsidiaries are The Cortland Savings and Banking Company (\"Cortland Banks\" or the \"Bank\"), which was acquired at the Corporation's inception in 1985, and New Resources Leasing Company, which was formed in 1988. The Corporation and its subsidiaries operate in one industry, domestic banking.\nThe Corporation conducts no business activities except for investment in securities as permitted under the Bank Holding Company Act.\nThe business of the Corporation and its subsidiaries is not seasonal to any significant extent and is not dependent on any single customer or group of customers.\nCORTLAND BANKS --------------\nCortland Banks is a full service, state chartered bank engaged in commercial and retail banking and trust services. Cortland Banks' commercial and consumer banking services include checking accounts, savings accounts, time deposit accounts, commercial, mortgage and installment loans, leasing, night depository, automated teller services, safe deposit boxes, money order services, travelers checks, utility bill payments and other miscellaneous services normally offered by commercial banks. In addition, Cortland Banks participates in bank charge card plans and discount brokerage services with correspondent banks. Cortland Banks' Trust Department offers a broad range of fiduciary services, including the administration of decedent and trust estates and other personal and corporate fiduciary services. Business is conducted at a total of ten offices, six of which are located in Trumbull County, Ohio. Three offices are located in the communities of Hiram, Windham and Mantua, Portage County, Ohio and one office is located in the community of Williamsfield, Ashtabula County, Ohio. Chartered by the State of Ohio, Cortland Banks is also a member of the Federal Reserve System.\nNEW RESOURCES LEASING COMPANY -----------------------------\nNew Resources Leasing Company was formed in December 1988 as a separate entity to handle the function of commercial and consumer leasing. The company has been inactive since incorporation.\nSUPERVISION AND REGULATION --------------------------\nThe Corporation is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\") pursuant to the Bank Holding Company Act of 1956, as amended. Generally, this Act limits the business of bank holding companies to owning or controlling banks and engaging in such other activities as the Federal Reserve Board may determine to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.\nI-2 Supervision and Regulation (Continued): - --------------------------------------\nCortland Banks, as a state banking organization, is subject to periodic examination and regulation by the Federal Reserve Bank of Cleveland and the State of Ohio Division of Banks. Cortland Banks is a member of the Federal Reserve System and its deposits are insured by the Federal Deposit Insurance Corporation (FDIC).\nCOMPETITION -----------\nCortland Banks actively competes with state and national banks located in the Ohio counties of Trumbull, Portage and Ashtabula. It also competes with a large number of other financial institutions, such as savings and loan associations, insurance companies, consumer finance companies, credit unions and commercial finance and leasing companies, for deposits, loans and service business. Money market mutual funds, brokerage houses and similar institutions provide in a relatively unregulated environment many of the financial services offered by banks. In the opinion of management, the principal methods of competition are the rates of interest charged for loans, the rates of interest paid for funds, the fees charged for services and the availability of services.\nEMPLOYEES ---------\nAt March 7, 1995, the Corporation and its subsidiaries had 158 full-time and 52 part-time employees. The Corporation considers its relations with its employees to be satisfactory.\nI-3 Statistical Disclosure - -----------------------\nI. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; - ---------------------------------------------------------------- INTEREST RATES AND INTEREST DIFFERENTIAL ----------------------------------------\nAVERAGE BALANCE SHEETS ----------------------\n(In Thousands of Dollars)\nThe following shows consolidated balances of average assets, liabilities and shareholders' equity for the years indicated. The averages are based on daily balances.\nI-4\nI-5\nANALYSIS OF NET INTEREST EARNINGS ---------------------------------\n(In Thousands of Dollars)\nThe following schedules show the average amounts of interest-earning assets and interest-bearing liabilities, the related amounts of interest earned or paid and the related average yields or interest rates paid for the year indicated:\nI-6\nI-7\nI-8\nI-9\nI-10 II. INVESTMENT PORTFOLIO - ------------------------\nThe following table shows the book value of investment securities by type of obligation at the dates indicated:\nA summary of securities held at December 31, 1994, classified according to the earlier of next repricing or the maturity date and the weighted average yield for each range of maturities, is set forth below. Fixed rate mortgage-backed securities are classified by their estimated contractual cash flow, adjusted for current prepayment assumptions. 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.\nI-11\nExcluding obligations of the U.S. Treasury and other agencies and corporations of the U.S. government, there were no investment or mortgage- backed securities of any one issuer which exceeded 10% of consolidated shareholders' equity at December 31, 1994.\nAs of December 31, 1994, there were $2,287 in callable U.S. Treasury Securities and $3,957 in callable U.S. Government Agencies, that are likely to be called within the next twelve months, given current and expected interest rate environments. However, these securities have been categorized according to their contractual maturities, with $1,996 scheduled to mature after one year but within five years and $4,248 scheduled to mature after five years but within ten years.\nAlso, as of December 31, 1994, there were $2,079 in callable U.S. Government Agencies that, given current and expected interest rate environments, are likely to be called during the next 1-5 year period. These securities have also been categorized according to their contractual maturities, with $2,079 scheduled to mature after five years but within ten years.\nI-12\nIII. LOAN PORTFOLIO (ALL DOMESTIC) - ----------------------------------\nMATURITIES AND SENSITIVITIES OF LOANS TO INTEREST RATES -------------------------------------------------------\n(In Thousands of Dollars)\nThe following schedule sets forth maturities based on remaining scheduled repayments of principal or next repricing opportunity for various categories of loans listed above as of December 31, 1994:\nThe amounts of total loans (excluding mortgage and consumer loans) as of December 31, 1994, based on remaining scheduled repayments of principal, are shown in the following table:\nI-13\nThe following shows the amounts of contractual interest income and interest income actually reflected in income on loans accounted for on a nonaccrual basis and loans considered troubled debt restructuring as of December 31, 1994.\nA loan is placed on a nonaccrual basis whenever sufficient information is received to question the collectibility of the loan or any time legal proceedings are initiated involving a loan. Once a loan is charged-off, any interest that may be accrued and not collected on the loan is charged against earnings.\nAs of December 31, 1994, there are $2,416 in loans, not included in the above categories, which may be considered potential problem loans. Management has established specific allocations of the allowance for loan loss of $350, which it considers adequate, based on current information, to cover potential loss related to these credits.\nAny loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed above do not (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.\nAs of December 31, 1994, the Bank had $124 in investment securities accounted for on a nonaccrual basis. On February 15, 1994 a pre-refunded, escrowed municipal bond with a par value of $100 issued by Northeast Randolph County, Alabama, was placed on nonaccrual status by the Bank. These bonds were pre-refunded with U.S. treasury securities financed by a subsequent bond issue of Northern Randolph County, Alabama, which has since defaulted. Holders of this issue have filed suit, seeking to have the escrow unwound with proceeds distributed to the claimants. The bond trustee has suspended interest payments pending a ruling from the court on this matter. The probability of an unfavorable outcome regarding this litigation cannot be ascertained at this time; management is unable to determine if any write-down will be required.\nOn December 31, 1992 the Bank had investment securities with a carrying value of $74, and a par value of $500 accounted for on a nonaccrual basis. During 1993, the LTV Corporation reached an agreement with its creditors and emerged from chapter XI bankruptcy proceedings. As a result of the settlement, in which the Bank received cash, common stock and other securities in exchange for its debt securities of the LTV Corporation, the bank realized a gain of $106 on LTV related securities in its investment portfolio.\nI-14 IV. SUMMARY OF LOAN LOSS EXPERIENCE - -----------------------------------\nFor each of the periods presented above, the provision for loan losses charged to operations is based on management's judgment after taking into consideration all known factors connected with the collectibility of the existing portfolio. Management evaluates the portfolio in light of economic conditions, changes in the nature and volume of the portfolio, industry standards and other relevant factors. Specific factors considered by management in determining the amounts charged to operations include previous loan loss experience, the status of past due interest and principal payments, the quality of financial information supplied by the customers and the general economic conditions present in the corporation's lending area.\nI-15\nThe following is an allocation of the allowance for loan losses. The allowance 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 as of the dates indicated:\nThe allocation of the allowance as shown in the table above should not be interpreted as an indication that loan losses in l995 will occur in the same proportions or that the allocation indicates future loan loss trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories since the total allowance is a general allowance applicable to the entire portfolio.\nLOAN COMMITMENTS AND LINES OF CREDIT ------------------------------------\nIn the normal course of business, the bank subsidiary has extended various commitments for credit. Commitments for mortgages, revolving lines of credit and letters of credit generally are extended for a period of one month up to one year. Normally, no fees are charged on any unused portion. A fee of 1% is typically charged for the issuance of a letter of credit.\nI-16\nV. DEPOSITS (ALL DOMESTIC) - --------------------------\nThe following table shows the classification of average deposits for the periods indicated:\nI-17 VI. RETURN ON EQUITY AND ASSETS - -------------------------------\nI-18 Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------- ----------\nCORTLAND BANCORPS' PROPERTY ---------------------------\nCortland Bancorp owns no property. Operations are conducted at 194 West Main Street, Cortland, Ohio.\nCORTLAND BANKS' PROPERTY ------------------------\nCortland Banks' main office (as described in its charter) is located at 194 West Main Street, Cortland, Ohio. Administrative offices are located at the main office. The other offices are:\nThe Brookfield, Windham, Hubbard and Mantua Offices are leased, while all of the other above offices are owned by Cortland Banks.\nItem 3.","section_3":"Item 3. Legal Proceedings - ------- -----------------\nThe subsidiary Bank was a defendant in a consumer class action lawsuit, filed on June 8, 1990 in the Court of Common Pleas of Fayette County, Pennsylvania involving the demise of a campground real estate development known as Alpine Valley Resorts, Inc. While the Bank denied liability, it negotiated a settlement agreement dated February 2, 1994. Payment on the settlement, which was fully provided for as of December 31, 1993, was fully disbursed during the quarter ended June 30, 1994.\nThe Bank is also involved in other legal actions arising in the ordinary course of business. In the opinion of management, the outcome of these matters is not expected to have a material effect on the Corporation.\nI-19 Item 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - ------- ---------------------------------------------------\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nExecutive Officers of the Registrant - ------------------------------------\nThe names, ages and positions of the executive officers as of March 7, 1995 are as follows:\nAll of the officers listed above will hold office until the next annual meeting of shareholders and until their successors are duly elected and qualified.\nPrincipal Occupation and Business Experience of Executive Officers - ------------------------------------------------------------------\nDuring the past five years the business experience of each of the executive officers has been as follows:\nRodger W. Platt has been Chairman of the Board of Cortland Bancorp and the subsidiary bank since November 1987. He became Chairman of the Board of New Resources Leasing Company in December of 1988. He has been a Director and President of Cortland Bancorp since its formation in April of 1985. He has been a Director of the subsidiary bank since 1974 and has been President since 1976.\nDennis E. Linville has been Executive Vice President of Cortland Bancorp and the subsidiary bank since November 1987. He became a Director of the subsidiary bank in June of 1989. He has been a Director of Cortland Bancorp and New Resources Leasing Company since December 1988. He has been the Secretary of Cortland Bancorp since 1985 and has been Vice President and Secretary of the subsidiary bank since 1984.\nLawrence A. Fantauzzi has been the Controller of Cortland Bancorp and the subsidiary bank since April 1987. He became Treasurer of Cortland Bancorp in December 1992.\nI-20 PART II -------\nInformation relating to Items 5, 6, 7 and 8 is set forth in the Corporation's 1994 Annual Report to Shareholders under the captions and on the pages indicated below and is incorporated herein by reference:\nII-1 PART III --------\nItem 10. Directors and Executive Officers of the Registrant - -------- --------------------------------------------------\nInformation relating to directors of the Corporation will be set forth in the Corporation's definitive proxy statement to be filed with the Securities and Exchange Commission in connection with its annual meeting of shareholders to be held April 11, 1995. Such information is incorporated herein by reference. Information relating to executive officers of the Corporation is set forth in Part I. Pages 3-6\nItem 11. Executive Compensation - -------- ----------------------\nInformation relating to this item will be set forth in the Corporation's definitive proxy statement to be filed with the Securities and Exchange Commission in connection with its annual meeting of shareholders to be held April 11, 1995. Such information is incorporated herein by reference. Pages 6-9\nItem 12. Security Ownership of Certain Beneficial Owners and Management - -------- --------------------------------------------------------------\nInformation relating to this item will be set forth in the Corporation's definitive proxy statement to be filed with the Securities and Exchange Commission in connection with its annual meeting of shareholders to be held April 11, 1995. Such information is incorporated herein by reference. Page 2\nItem 13. Certain Relationships and Related Transactions - -------- ----------------------------------------------\nInformation relating to this item will be set forth in the Corporation's definitive proxy statement to be filed with the Securities and Exchange Commission in connection with its annual meeting of shareholders to be held April 11, l995. Such information is incorporated herein by reference. Page 12\nIII-1 PART IV -------\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - -------- ---------------------------------------------------------------\n(a) 1. Financial Statements --------------------\nIncluded in Part II of this report:\nItem 8.","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"Item 8., Financial Statements and Accompanying Information, is set forth in the Corporation's 1994 Annual Report to Shareholders and is incorporated by reference in Part II of this report.\n(a) 2. Financial Statement Schedules -----------------------------\nIncluded in Part IV of this report as Exhibit 23:\nIndependent Accountants' Consent\nSchedules: All schedules are omitted because they are not applicable.\n(a) 3. Exhibits --------\nThe exhibits filed or incorporated by reference as a part of this report are listed in the Index to Exhibits which appears at page IV-3 hereof and is incorporated herein by reference.\n(b) Report on Form 8-K ------------------\nNo reports on Form 8-K were filed for the three months ended December 31, 1994.\nIV-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.\nCORTLAND BANCORP\nMarch 7, 1995 By Rodger W. Platt, President - ---------------------- ------------------------------ Date\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nIV-2 INDEX TO EXHIBITS -----------------\nThe following exhibits are filed or incorporated by reference as part of this report:\n3.1. Articles of Incorporation of the Corporation as currently in effect and any amendments thereto (incorporated by reference to Exhibit 3 of the Corporation's Report on Form S-1 filed February 5, 1988).\n3.2. Bylaws of the Corporation as currently in effect and any amendments thereto (incorporated by reference to Exhibit 3a of the Corporation's Report on Form S-1 filed February 5, l988).\n4 The rights of holders of equity securities are defined in portions of the Articles of Incorporation and Bylaws as referenced in 3.1. and 3.2.\n11 Statement regarding computation of earnings per share (filed herewith).\n13 Annual Report to security holders (filed herewith).\n21 Subsidiaries of the Registrant (filed herewith).\n23 Consents of experts and counsel - Consent of independent accountants (filed herewith).\n27 Financial Data Schedule (filed herewith).\nCopies of any exhibits will be furnished to shareholders upon written request. Requests should be directed to Dennis E. Linville, Secretary, Cortland Bancorp, 194 West Main Street, Cortland, Ohio 44410.\nIV-3","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"826619_1994.txt","cik":"826619","year":"1994","section_1":"ITEM 1. BUSINESS Introduction\nUnless the context otherwise requires, A. P. Green Industries, Inc. and its subsidiaries are referred to in this report collectively as \"A. P. Green\" or \"the Company.\" In most instances, information about A. P. Green's primary businesses and reportable industry segments (\"Refractory Products\" and \"Industrial Lime\") is presented separately.\n(a) Development of Business\nGeneral. A. P. Green Industries, Inc., a Delaware corporation, was incorporated as A. P. Green Refractories Co. in 1967. In that year, A. P. Green Refractories Co., a Missouri corporation, was acquired by United States Gypsum Company (now USG Corporation). The acquired company was a successor to a business purchased by Allen P. Green in approximately 1910.\nIn 1987, A. P. Green Refractories Co. acquired all of the outstanding stock of APG Lime Corp., a Delaware corporation, and shortly after such acquisition changed its name to A. P. Green Industries, Inc. Effective February 3, 1988, through a distribution of all the outstanding capital stock of A. P. Green Industries, Inc. to the common stockholders of USG Corporation, A. P. Green Industries, Inc. became an independent publicly held company.\nIn 1994, the Company acquired substantially all of the assets and assumed most of the liabilities of the refractory operations of General Refractories Company and its affiliated companies (collectively referred to as \"General\"). These operations include ten plants in the United States, a plant near Toronto, Canada and 49% equity interests in two Colombian refractory companies.\nThe Company, headquartered in Mexico, Missouri, mines, processes, manufactures and distributes specialty minerals and mineral-based products, including industrial lime and refractories products in the United States and international markets. The Company operates 21 plants in the United States, Canada and the United Kingdom.\nLime Operations. APG Lime Corp. (APG Lime), a wholly owned subsidiary of A. P. Green, and headquartered in Mexico, Missouri, is involved in the mining and processing of limestone for various industrial applications, including steel and aluminum production, pulp and paper processing, soil stabilization for road construction and water and waste water treatment. It operates two plants, one in Kimballton, Virginia, and one in New Braunfels, Texas. It generally serves customers in the geographic region surrounding its plants.\nRefractory Operations. Refractories are heat and atmosphere resistant materials that provide the structure or linings for high temperature furnaces and other vessels. In addition to being resistant to thermal stress and other physical phenomena induced by heat, refractories are often required to provide resistance to physical wear, thermal cycling and abrasion, as well as to provide insulating properties.\n- 2 -\nA. P. Green offers a broad product line, including basic and clay\/alumina refractories and ceramic fiber products. Basic refractories are predominantly composed of magnesite ores or silica, while clay\/alumina refractories are predominantly composed of fireclays and bauxite ores. Ceramic fiber products are lightweight refractories similar in appearance to fiberglass insulation and are provided in many forms including bulk, blanket, folded modules and vacuum formed shapes. All are used in a wide variety of industries, including steel, aluminum, cement, chemicals, ceramics and glass.\nBasic and clay\/alumina refractories are manufactured in the form of bricks and specialties. Bricks are shaped products formed by mechanical pressing or die molding. Specialty products (also known as monolithics) include refractory cements, castables, plastics and mortars. Specialized shapes to serve specific industry needs are also custom made in five cast shops located in the United States, Canada and the United Kingdom (U.K.).\nAlthough the Company purchases some refractory and refractory-related products from other manufacturers, predominantly all of the refractory products sold by it are manufactured in its own plants. The Company and its wholly owned subsidiaries, A. P Green Refractories Inc. and Detrick Refractory Fibers, Inc., manufacture refractories in 15 facilities located in the United States. The Company's wholly owned subsidiary, A. P. Green Refractories (Canada) Ltd., organized in 1931, and its subsidiary, 1086215 Ontario, Inc., operates three manufacturing facilities in Canada. The Company's wholly owned United Kingdom subsidiary, A. P. Green Refractories Limited, acquired by a predecessor of the Company in 1954, operates one manufacturing facility in Bromborough, England, and its subsidiary, Liptak Bradley Limited, installs refractory products worldwide except for North America. Significant investment has been made, particularly in the United States plants, to improve quality, production efficiency and environmental controls.\nThe Company started to withdraw from the refractory installation business in the United States in the latter part of 1988 and completed this withdrawal by 1991. This action was taken in order to concentrate on refractory production and sales to end users. In 1992, the Company's Canadian refractory installation business was also sold. Sales by these subsequently discontinued refractory installation operations in the U.S. and Canada from 1988 through 1992 were approximately as follows (in millions of U.S. dollars). There were no U.S. or Canadian refractory installation sales after 1992. These sales include both material and labor.\n1988 1989 1990 1991 1992\n$41.8 $31.9 $13.7 $9.9 $7.8\nRefractory installation services are still performed by Liptak Bradley Limited; there are no plans to discontinue this business in the U.K.\n(b) Financial Information About Industry Segments\nInformation regarding industry segments of A. P. Green is set forth in Note 19 of Notes to Consolidated Financial Statements which is included in A. P. Green's 1994 Annual Report to Stockholders and incorporated herein by reference.\n- 3 -\n(c) Narrative Description of Business\nRefractory Operations. A. P. Green manufactures refractory products in its own plants located in the United States, Canada and the United Kingdom. These products are sold world-wide to industrial end-users and to installers of refractories. The major end-users of the Company's refractory products and the percentage of the Company's 1994 domestic refractory sales to such users are as follows:\nPercent of 1994 End-User Industry Category U.S. Refractory Products Sales\nIron and Steel 33% Nonferrous Metals 14% Cement, Lime, Gypsum, Paper, Ceramics, Glass and Clay 13% Chemicals and Petrochemicals 8% Metal Castings and Fabrication 7% Other 25%\nA. P. Green is a leader in the manufacture and distribution of refractory materials in North America and throughout the world. The product is sold through a direct sales force, company owned distribution centers, independent distributors, licensees and agents to a diverse cross section of basic industry. The Company believes that success in the refractory industry is dependent, to a large extent, upon developing new products and modifying existing products in order to provide more value to the industries served. A. P. Green has a fully equipped and staffed research facility that can analyze the refractory failure mechanisms in its customers' applications in order to determine the optimum refractory solution. Often the best solution is to use a more sophisticated product which increases the up front costs but results in a lower life cycle cost. The organization of research engineers, customer service engineers and product managers have a good track record of designing optimum solutions. Product design changes that have been introduced recently include self-leveling castables and low-rebound gunning products that reduce installation costs, as well as many products that have been optimized to serve specific operating conditions. Many of the new products are based on A. P. Green's proprietary Greenlite insulating aggregate which provides high strength in combination with low thermal conductivities.\nThe Company's employee sales force is located throughout the United States and Canada and in the Caribbean, Australia, Singapore, Germany and the United Kingdom. Refractory products are shipped directly to customers from the Company's plants and from a large network of distribution centers and distribution representatives located in the United States, Canada and the United Kingdom.\nThe United States sales force is divided into four geographic regions and two industry groups. The industry groups are part of specialized sales and marketing teams that target their efforts to specific industrial end-users such as steel and aluminum. This has allowed the Company to provide a higher degree of customer assistance on refractory usage and selection and has enabled sales and marketing personnel to develop additional expertise in those end-user\n- 4 -\nindustries. This alignment has been beneficial to specific industry sales of the Company. Starting in 1992, steps were taken to more effectively coordinate Canadian and United States refractory sales. These steps were designed to take advantage of a centralized marketing plan and to source products more efficiently.\nLime Operations. APG Lime is engaged in the production of lime for industrial applications. This process involves crushing, screening and calcining limestone to produce high calcium quicklime and hydrate, dolomitic quicklime and Cal-Dol lime. This processing takes place at Company-owned facilities in New Braunfels, Texas and Kimballton, Virginia. In 1994, the Company completed a project which increased production capacity at the New Braunfels, Texas facility to take advantage of higher demand for quicklime used in making precipitated calcium carbonate and other growing markets. This project also reduced particulate air emissions and reduced the use of water. The major end-users of the Company's lime products and the percentage of the Company's 1994 lime sales to such users is as follows:\nPercent of 1994 End-User Industry Category Lime Products Sales\nPulp and Paper Processing 36% Steel and Aluminum 32% Road Construction 14% Water and Waste Water Treatment 14% Masonry 3% Chemical Processing 1%\nRecently developed lime products include Cal-Dol lime blend; high calcium quicklime noted for specialized sizing and chemical reactivity for use in production of precipitated calcium carbonate by paper producers; and several dolomitic building lime products. Due to their heavy, bulk nature, industrial lime products cannot be shipped economically over long distances. This has resulted in regional sales and distribution, generally within a 300-mile radius of each facility. A. P. Green's lime facilities are well located to take advantage of demand in the Southeastern U.S. and Texas and surrounding states. Product distribution involves direct shipments via rail and\/or truck from the plants to the customers and customer pick-up at the plants.\nRaw Materials. A. P. Green maintains programs to attempt to ensure the availability of raw materials, including the purchase of materials for its short-term needs and the development of long-term sources of supply. Refractory clay and silica requirements are obtained from Company-owned deposits located in Alabama, Arkansas, Colorado, Georgia, Idaho, Missouri, Ohio, Texas and Utah. Proven deposits contained approximately 10,900,000 tons of clay and silica as of December 31, 1994. Average annual mining of clay and silica during the last five years was 260,000 tons, with 1994 at 220,000 tons. Proven reserves are estimated to be sufficient for approximately 35 years of operations, based on recent average annual usage. The remaining refractory raw materials requirements are obtained from numerous suppliers. Refractory grade bauxite is imported from China, Guyana and Brazil, and approximately 50% of the Company's magnesite supply is obtained from China. On a long-term basis, there is an adequate supply of materials available from these countries. There has been no significant interruption in the availability of Chinese or Brazilian bauxite or Chinese magnesite. There have been brief periods of limited supplies of bauxite\n- 5 -\nfrom Guyana. Some alumina raw materials are available from only one or two suppliers in the United States. Current supplies are adequate to meet A. P. Green's planned production volume for the foreseeable future. Aluminum Company of America is a major supplier of alumina chemicals and supplies up to 90 percent of certain chemicals used by A. P. Green.\nA. P. Green's lime products require two major raw materials, high calcium limestone and dolomitic limestone. High calcium limestone is mined and quarried, respectively, from Company-owned deposits at the Kimballton, Virginia and New Braunfels, Texas plants. The deposit at New Braunfels contained about 51,600,000 tons of usable reserves as of December 31, 1994. The average annual usage of quarried limestone at New Braunfels during the five-year period ended December 31, 1994 was 770,000 tons, with 1994 usage at 906,000 tons. Proven reserves of limestone at this location are estimated to be sufficient for about 67 years of operations, based on recent average annual usage. Company-owned and leased reserves at the Kimballton plant were estimated at 22,300,000 tons as of December 31, 1994. The average annual usage of mined limestone at Kimballton during the five-year period ended December 31, 1994 was 690,000 tons, with 1994 usage at 762,000 tons. Proven reserves of limestone at this location are estimated to be sufficient for 32 years of operations, based on recent average annual usage. Dolomitic limestone is purchased from outside suppliers, primarily The Dow Chemical Company.\nEnergy. Natural gas used in the production of refractory products represents approximately 60 percent of total refractory energy costs. However, natural gas usage accounts for only approximately 4 percent of the total cost of refractory sales. Most manufacturing plants maintain a supply of standby energy. Electrical costs vary between operations and account for the balance of refractory energy costs.\nThe primary energy source used in the production of lime products is coal, which accounted for virtually all of the total fuel used at the Kimballton plant and about 65 percent of the total fuel used at the New Braunfels plant during 1994. Natural gas (in lieu of coal) is the other major energy source used at New Braunfels, accounting for approximately 35 percent of that facility's total fuel usage in 1994. Coal for both locations and gas for New Braunfels are readily available from numerous suppliers.\nPrimary energy supplies for both segments have been ample and have not been a factor in terms of curtailed plant operations. No major shift in energy use patterns for either segment is anticipated.\nSeasonality\/Cyclicality. Refractory sales are moderately seasonal and are directly related to cyclical fluctuations in production levels and new plant additions by refractory end-users.\nLime demand is fairly uniform except for the negative impact of adverse weather on soil stabilization shipments. This factor is significant in Texas and surrounding states as soil stabilization shipments for road construction projects are somewhat depressed between November and February due to typically rainy weather conditions.\n- 6 -\nBoth of the Company's industry segments are sensitive to cyclical fluctuations in the iron, steel and non-ferrous metals industries. APG Lime is also sensitive to cyclical fluctuations in the pulp and paper processing industries.\nOrder Backlog. Order backlog for refractories varies by month within a moderate range. The order backlog believed to be firm was approximately $19.0 million and $12.0 million at December 31, 1994 and 1993, respectively, requiring ten to eleven weeks to service for 1994 as compared with eight to nine weeks for 1993. During 1993, the Company changed its method of calculating order backlog for refractories by omitting orders from Company-owned distribution centers. It is estimated that the impact of this change was a reduction in refractories order backlog of approximately $2.5 million.\nLime products normally do not have any significant backlog, other than for soil stabilization backlog related to state highway lettings, which can vary significantly from period to period. Such backlog was approximately $1.2 million and $1.4 million at December 31, 1994 and 1993, respectively.\nCompetition. The refractory industry is highly competitive and demand for refractories fluctuates with the level of activity in the basic industries. A. P. Green is one of six major producers of domestic refractories. The Company competes internationally with several major domestic producers and a number of international companies. The Company intends to expand its international refractory sales efforts. In addition, there are numerous regional domestic refractory producers. The six major producers are believed to represent approximately 53% of total U.S. annual refractory sales. The major areas of competition in the refractory industry are service, price and product performance. Due to the decline of the United States heavy manufacturing industrial base, the refractory industry has become more price sensitive in recent years. New product introductions are increasing to meet demands of customer operating practices. More stringent requirements placed on product quality are being met with improved quality control at A. P. Green manufacturing plants to minimize deviations from refractory manufacturing standards. The U.K. Bromborough facility and the Fulton, Missouri and Oak Hill, Ohio plants have been ISO 9002 certified and efforts are being made for certification of the other major U.S. plants.\nThe Kimballton, Virginia and New Braunfels, Texas lime plants compete with three and four primary lime producers, respectively. Price-sensitive competition is strong within these areas.\nCapital Expenditures. A. P. Green has implemented a program of maintaining and modernizing its facilities to improve its competitive position. In the three years ended December 31, 1994, A. P. Green invested approximately $16.2 million for such purposes. Of those expenditures, 46% ($7.4 million) were for refractories operations and information systems and 54% ($8.8 million) were for improvements in lime production and environmental controls. A. P. Green believes that these expenditures have provided it with significant cost reductions in certain segments of its business.\nResearch and Development. Research activities are principally located at Mexico, Missouri, in a well equipped facility occupying 43,924 square feet. The major objective of the research department is to maintain A. P. Green at the\n- 7 -\ntechnological forefront of the refractories industry with applied research and development of new and improved refractory products and high-temperature insulators.\nThe research department also is responsible for quality systems implementation, raw materials management, analytical and environmental services, and technical liaison with foreign operations. A pilot plant allows testing during the transition of new products to the commercial stage. During 1994, the research department was expanded with the addition of basic refractory products, as a result of the General acquisition, and the hiring of two world renowned PhD's.\nResearch and development expenditures amounted to approximately $2.5 million, $2.2 million and $2.4 million during 1994, 1993 and 1992, respectively.\nSignificant Customers. A. P. Green is not dependent upon any single customer or group of customers on a regular basis, the loss of which would have a materially adverse effect on A. P. Green. No customer accounted for more than ten percent of A. P. Green's consolidated annual net sales in 1994, 1993 or 1992.\nEmployees. The average number of persons employed by A. P. Green during 1994, 1993 and 1992 was 1,656, 1,447 and 1,471, respectively. Approximately 1,040 employees are members of collective bargaining units. The represented unions in the U.S. and Canada are: the Aluminum Brick and Glass Workers International Union, the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America and the United Steel Workers of America. The represented unions in the United Kingdom are: the Transport and General Workers' Union, the Amalgamated Union of Engineering Workers and the Union of Construction and Allied Trades. A 5-year collective bargaining agreement was successfully negotiated in 1993 with the unions represented at the Mexico, Missouri and Fulton, Missouri plants. A. P. Green considers its relations with its employees to be good.\nEnvironmental Matters. Laws and regulations currently in force which do or may affect A. P. Green's domestic operations include the Federal Clean Water Act, the Clean Air Act of 1970, the National Environmental Policy Act of 1969, the Solid Waste Disposal Act (including the Resource Conservation and Recovery Act of 1976), the Comprehensive Environmental Response, Compensation and Liability Act (including the Superfund Amendments and Reauthorization Act of 1986), the Federal Surface Mining Control and Reclamation Act, the Toxic Substances Control Act, regulations under these Acts, the environmental protection regulations of various governmental agencies (e.g., the Bureau of Land Management Surface Management Regulations, Forest Service Regulations, Environment Canada Regulations and Department of Transportation Regulations) and laws and regulations concerned with mining techniques, reclamation of mined lands, air and water pollution and solid waste disposal.\nIn Europe, environmental laws and regulations currently in force which do or may affect the Company's United Kingdom subsidiary include the Rivers (Prevention of Pollution - Scotland) Act of 1951, the Clean Air Act of 1968, the Control of Pollution Act of 1974 (amended in 1989), the Health and Safety at Work Act of 1974, the EC Waste Framework Directive of 1975, the Waste Regulation and Disposal (Authorities) Order of 1985, the Control of Substances Hazardous to Health Regulations of 1988, the Water Act of 1989, the Environmental Protection\n- 8 -\nAct of 1990, local authority air pollution control, German packaging regulations and the Belgium eco-tax on waste disposal of packaging products.\nFrom time to time, the Company experiences on-site inspections by environmental regulatory authorities who may impose penalties or require remedial actions. A. P. Green believes that it has substantially complied with, and it intends in the future to so comply with, all laws and regulations (including foreign) governing pollution control and other environmental conditions in all material respects. Such compliance has not had, and is not expected to have, a material adverse effect upon A. P. Green's earnings or competitive position. Information regarding environmental and asbestos-related legal proceedings is set forth in Note 18 of Notes to Consolidated Financial Statements which are included in A. P. Green's 1994 Annual Report to Stockholders and incorporated herein by reference. Capital expenditures have been made over the last several years and are planned in 1995 to install dust and emissions control equipment to improve the impact on the environment of refractory and lime manufacturing operations.\nPatents, Trademarks, and Licenses. All major product brand names, as well as the \"A. P. Green\" name, are registered in the United States and numerous other countries. A. P. Green currently holds 25 U.S. patents, and had two patent applications outstanding at December 31, 1994. The expiration of these patents will not have a significant financial impact on A. P. Green. A. P. Green has aggressively licensed its refractory technology and formulations to refractory producers around the world. Currently, there are 15 license agreements with foreign companies, ten of which cover A. P. Green's full range of refractory products and five of which are for limited product lines. License agreements have been added in Spain, Italy, Colombia, Saudi Arabia, Chile, Korea and the United Kingdom since 1988.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nFinancial information regarding geographic segments of A. P. Green is set forth in Note 19 of Notes to Consolidated Financial Statements which is included in A. P. Green's 1994 Annual Report to Stockholders and incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nGeneral\nA. P. Green's principal properties are owned, except as noted, and none of the owned properties are subject to encumbrances, except for buildings and equipment at the Bessemer, Alabama plant used to secure the industrial development revenue bond indebtedness at that plant. The buildings are adequate and suitable for the purposes for which they are used, have been well maintained, are in sound operating condition and are in regular use.\nHeadquarters\nThe headquarters of A. P. Green, which consists of 62,800 square feet of floor space, is located in Mexico, Missouri.\n- 9 -\nRefractory Manufacturing Facilities\nThe following is a description of the U.S. refractory manufacturing facilities operated by A. P. Green. Facilities are owned unless otherwise indicated. Plants in Hitchins, Kentucky, Troup, Texas and Warren, Ohio, obtained in the General acquisition, are excluded:\nLocation and Nature Approximate Square Products of Property Feet of Floor Space Manufactured\nBessemer, Alabama 150,300 High Alumina and Manufacturing buildings, Fireclay Brick rail and office\nEllisville, Mississippi 20,000 Board and Special Shape Manufacturing and office Refractory Fiber Products building\nFulton, Missouri 240,200 High Alumina Brick, Manufacturing buildings, including Tar Impregnated rail and office and Coked Brick\nGary, Indiana 98,500 Cast Shapes & Castables Manufacturing buildings and office\nLehi, Utah 120,000 High Alumina, Silica and Manufacturing buildings, Basic Brick; Castables rail and office\nLittle Rock, Arkansas 37,800 Calcined Refractory Clay, Clay storage building, Refractory Clay rotary calcining kiln, rail and office\nMexico, Missouri 1,142,700 Fireclay, High Alumina Manufacturing buildings, and Insulating Brick; rail and office Zirconia Brick; Mortars, Plastics, Castables and Light Weight Aggregate\nMiddletown, Pennsylvania 165,000 Cast Shapes Manufacturing buildings and office\n- 10 -\nLocation and Nature Approximate Square Products of Property Feet of Floor Space Manufactured\nMinerva, Ohio 9,500 Light Weight Aggregate Leased manufacturing and Castables building and office\nOak Hill, Ohio 111,100 Mortars, Plastics Manufacturing buildings, and Castables rail and office\nPryor, Oklahoma 65,800 Industrial Ceramic Manufacturing buildings, Fiber Insulation rail and office\nPueblo, Colorado 1,600 Ground Calcined Flint Manufacturing building\nRockdale, Illinois 78,000 Basic Brick Manufacturing buildings, rail and office\nSproul, Pennsylvania 102,100 Mortars, Plastics and Manufacturing buildings, Castables rail and office\nSulphur Springs, Texas 193,100 Fireclay and High Manufacturing buildings, Alumina Brick; rail and office Mortars, Plastics and Castables\nMineral Properties\nThe refractory plants listed above utilize clay and\/or silica, which A. P. Green mines or quarries from deposits leased or owned, or purchases from various sources. Clay and silica deposits include properties known to contain commercially recoverable quantities based on core and\/or auger drilling, laboratory testing, surveying and mapping to determine quality. Such properties are held outright in fee simple; under mineral deeds which convey title to all clay or minerals with full rights of ingress, egress and mining; and under lease. The clay reserves are located in Alabama, Arkansas, Colorado, Georgia, Idaho, Missouri, Ohio and Texas, and a silica mine is located in Utah.\n- 11 -\nDistribution Centers\/Sales Offices\nA. P. Green operates distribution centers and maintains refractory stocks and sales offices as indicated in the listing below. All distribution centers are on ground level and range up to approximately 22,000 square feet. With the exception of Chicago, Illinois, Baton Rouge, Louisiana and St. Louis, Missouri, which are owned, the distribution centers\/sales office facilities are leased under initial lease terms of one to 20 years.\nDistribution Center\/Sales Office Locations:\nAtlanta, Georgia Knoxville, Tennessee Baltimore, Maryland Lehi, Utah Baton Rouge, Louisiana Los Angeles, California Birmingham, Alabama Milwaukee, Wisconsin Boston, Massachusetts Orange, Connecticut Buffalo, New York Philadelphia, Pennsylvania Charlotte, North Carolina Pittsburgh, Pennsylvania Chicago, Illinois Portland, Oregon Cincinnati, Ohio Roanoke, Virginia Cleveland, Ohio Rockford, Illinois Dallas, Texas St. Louis, Missouri Detroit, Michigan Salt Lake City, Utah East Moline, Illinois San Francisco, California Evansville, Indiana Seattle, Washington Houston, Texas Spokane, Washington Kansas City, Missouri Tampa, Florida Kearny, New Jersey\nLime Operations\nAPG Lime operates two industrial lime manufacturing plants. The facility at Kimballton, Virginia consists of an underground mine, rail and various plant buildings, totaling approximately 83,700 square feet of floorspace, situated on approximately 680 owned acres. This plant primarily manufactures industrial lime products and a small amount of soil stabilization lime. APG Lime owns one- half of the mineral rights under national forest property adjacent to the Kimballton plant by royalty lease from the Bureau of Land Management. Such lease was renewed for an additional 20-year term in 1988. The royalty is 2.5 percent of the nominal value of limestone mined. The New Braunfels, Texas facility consists of a surface mine, rail and various plant buildings, totaling approximately 81,000 square feet of floorspace, situated on approximately 1,010 owned acres. This plant manufactures industrial lime products, soil stabilization lime, and lime-based mortars.\nCanadian Subsidiary\nA. P. Green Refractories (Canada) Ltd., a wholly owned subsidiary of A. P. Green, owns and operates a refractory manufacturing facility in Weston, Ontario. A 73,900 square foot building is used for manufacturing and storage of\n- 12 -\nrefractory mortars, cements, castables, and plastics. In addition, raw materials which are imported principally from A. P. Green's U.S. facilities, are stored there. A. P. Green Refractories (Canada) Ltd. also owns 17,000 square feet of manufacturing space at Acton, Ontario to produce crucibles used by the precious metal assaying industry and vacuum formed fiber products. 1086215 Ontario, Inc., a wholly owned subsidiary of A. P. Green Refractories (Canada) Ltd., owns a 170,000 square foot building in Smithville, Ontario used for manufacturing and storage of basic brick, plastics and castables. Distribution centers and sales offices are maintained at the following locations: Burnaby, British Columbia; Calgary, Alberta; Edmonton, Alberta; Montreal, Quebec; Ottawa, Ontario; Quebec City, Quebec; and Winnipeg, Manitoba. All of the facilities are leased under initial lease terms of one to five years.\nUnited Kingdom Subsidiaries\nA. P. Green Refractories Limited, a wholly owned subsidiary of A. P. Green Industries, Inc., leases and operates its headquarters and manufacturing facility in Bromborough, Wirral, England. A full range of specialties, including mortars, plastics and dense and light weight castables are manufactured in an 76,600 square foot building at this location. Distribution centers and sales offices are maintained in Bromborough, Sheffield and London in England and Risca in Wales to ensure complete customer coverage in the U.K. All of these facilities are leased under initial lease terms of one to nine hundred ninety-nine years.\nLiptak Bradley Limited, a wholly owned subsidiary of A. P. Green Refractories Limited, operates out of the same premises in Bromborough, providing a refractory installation service using exclusively A. P. Green products.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nInformation regarding legal proceedings is set forth in Note 18 of Notes to Consolidated Financial Statements which is included in A. P. Green's 1994 Annual Report to Stockholders and incorporated herein by reference.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\n- 13 -\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nThe information set forth below the caption \"Common Stock, Market Prices and Dividends\" on page 32 of A. P. Green's 1994 Annual Report to Stockholders is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL INFORMATION\nThe information set forth below the caption \"Comparative Five-Year Summary\" on page 32 of A. P. Green's 1994 Annual Report to Stockholders is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nThe information set forth below the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on pages 13 through 16 of A. P. Green's 1994 Annual Report to Stockholders is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of A. P. Green as of December 31, 1994 and 1993 and for each of the years in the three-year period ended December 31, 1994, and notes thereto (including the quarterly supplementary data) and the Independent Auditors' Report appear on pages 17 through 31 of A. P. Green's 1994 Annual Report to Stockholders and are incorporated herein by reference. The Independent Auditors' Report for the financial statement schedules for each of the years in the three-year period ended December 31, 1994, and the financial statement schedules required by Regulation S-X appear on pages through 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\nNot applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information regarding directors is contained in A. P. Green's Proxy Statement for the 1995 Annual Meeting of Stockholders under the caption \"Item 1 - Election of Directors\" and is incorporated herein by reference.\n- 14 -\nThe following is a list as of March 24, 1995 of the names and ages of the executive officers of A. P. Green and all positions and offices with A. P. Green presently held by the person named. There is no family relationship between any of the named persons.\nName Age All Positions Held With A. P. Green\nPaul F. Hummer II 53 Chairman of the Board, President and Chief Executive Officer\nJurgen H. Abels 50 Vice President, International\nMax C. Aiken 57 Executive Vice President\nDavid G. Binder 58 Vice President and Controller\nMichael B. Cooney 54 Senior Vice President, Law\/Administration and \t\t\t\t\t Secretary\nDaniel Y. Hagan 55 Vice President, Domestic Refractory Sales\nOrville Hunter, Jr. 56 Vice President, Research\nLester C. Reed 54 Vice President, Refractory Manufacturing\nGary L. Roberts 48 Vice President, Chief Financial Officer and \t\t\t\t\t Treasurer\nThe executive officers were appointed by, and serve at the pleasure of, the Board of Directors of A. P. Green. Except for Mr. Reed, all executive officers have held the position listed or another executive position with A. P. Green or an entity affiliated with A. P. Green in excess of five years. Mr. Reed has held his present position since May 1992. Prior thereto, Mr. Reed was Director, Refractory Production of A. P. Green from January 1990 and Vice President - Manufacturing of the Insulation Group at Certainteed Corporation from October 1981 to January 1990.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation regarding executive compensation is contained in A. P. Green's Proxy Statement for the 1995 Annual Meeting of Stockholders under the caption \"Compensation of Executive Officers\" and is incorporated herein by reference.\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 contained in A. P. Green's Proxy Statement for the 1995 Annual Meeting of Stockholders under the captions \"Voting Securities and the Principal Holders Thereof\" and \"Security Ownership of Stock by Management\" and is incorporated herein by reference.\n- 15 -\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. Consolidated Financial Statements\nThe following Consolidated Financial Statements of A. P. Green are contained in A. P. Green's 1994 Annual Report to Stockholders on the following pages thereof:\nAnnual Report Page Reference Consolidated Statements of Earnings - Years Ended December 31, 1994, 1993 and 1992 17\nConsolidated Statements of Financial Position - December 31, 1994 and 1993 18\nConsolidated Statements of Stockholders' Equity - Years Ended December 31, 1994, 1993 and 1992 19\nConsolidated Statements of Cash Flows - Years Ended December 31, 1994, 1993 and 1992 20\nNotes to Consolidated Financial Statements - December 31, 1994, 1993 and 1992 21-31\nIndependent Auditors' Report as of December 31, 1994 and 1993 and for each of the years in the three-year period ended December 31, 1994 31\n2. Financial Statement Schedules\nThe following financial statement schedules of A. P. Green and the accompanying Independent Auditors' Report are set forth on the following pages of this Annual Report on Form 10-K:\n- 16 -\nForm 10-K Page Reference Independent Auditors' Report on the consolidated financial statement schedules as of December 31, 1994 and 1993 and for each of the years in the three-year period ended December 31, 1994.\nSchedule VIII Valuation and Qualifying Accounts\nSome schedules have been omitted because they are not applicable, are not required or the information is included in the consolidated financial statements or notes thereto.\n3. Exhibits\nExhibit No.\n3(a) Restated Certificate of Incorporation of A. P. Green is incorporated herein by reference to Exhibit 3(a) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1987.\n3(b) By-Laws of A. P. Green is incorporated herein by reference to Exhibit 3(b) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1987.\n4(a) Specimen Common Stock Certificate of A. P. Green is incorporated herein by reference to Exhibit 4.1 of the Registration Statement on Form 10, dated February 3, 1988.\n4(b) Rights Agreement, dated as of December 22, 1987, between A. P. Green and Harris Trust and Savings Bank, as Rights Agent, is incorporated herein by reference to Exhibit 4.2 of the Registration Statement on Form 10, dated February 3, 1988.\n4(c) Note Purchase Agreement, dated July 28, 1994, by and between A. P. Green and certain of its subsidiaries and the purchasers of the unsecured notes, is incorporated herein by reference to Exhibit 10.1 of A. P. Green's Current Report on Form 8-K dated August 12, 1994.\n10(a) A. P. Green Refractories Co. Supplemental Retirement Plan is incorporated herein by reference to Exhibit 10.10 of the Registration Statement on Form 10, dated February 3, 1988.\n10(b) 1987 Long-Term Performance Plan of A. P. Green is incorporated herein by reference to Exhibit 10(l) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1987.\n- 17 -\n10(c) 1989 Long-Term Performance Plan of A. P. Green is incorporated herein by reference to Exhibit 10(m) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1988.\n10(d) A. P. Green Management Incentive Compensation Plan is incorporated herein by reference to Exhibit 10(g) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1989.\n10(e) Form of Indemnification Agreement between A. P. Green and each of its Directors and Officers is incorporated herein by reference to Exhibit 10(m) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1987.\n10(f) Termination Compensation Agreement, dated March 1, 1988, between A. P. Green and Paul F. Hummer II, is incorporated herein by reference to Exhibit 10(o) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1987.\n10(g) Termination Compensation Agreement, dated November 16, 1988, between A. P. Green and Michael B. Cooney, is incorporated herein by reference to Exhibit 10(r) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1988.\n10(h) Form of Addendum No. 1 of Termination Compensation Agreement, dated October 19, 1989, by and between A. P. Green and Paul F. Hummer II or Michael B. Cooney, is incorporated herein by reference to Exhibit 10(w) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1989.\n10(i) Form of Termination Compensation Agreement, dated October 19, 1989, between A. P. Green and Gary L. Roberts or Max C. Aiken, is incorporated herein by reference to Exhibit 10(x) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1989.\n10(j) 1993 Performance Plan of A. P. Green is incorporated herein by reference to Exhibit 10(j) of A. P. Green's Annual Report on Form 10-K for the year ended December 31, 1993.\n10(k) Asset Acquisition Agreement, dated July 11, 1994, by and among General Refractories Company and certain of its affiliates and A. P. Green and certain of its affiliates, is incorporated herein by reference to Exhibit 2.1 of A. P. Green's Current Report on Form 8-K dated August 12, 1994.\n10(l) Retirement Plan for Directors, dated February 16, 1995.\n- 18 -\n10(m) A. P. Green Industries, Inc. Supplemental Retirement Income Plan, executed October 12, 1994, effective January 1, 1995.\n13 A. P. Green's 1994 Annual Report to Stockholders.\n22 Subsidiaries of A. P. Green\n24 Consent of KPMG Peat Marwick\n28(a) Annual Report on Form 11-K for the year ended September 30, 1994 for the A. P. Green Industries, Inc. Investment Plan (including Exhibit thereto).\n28(b) Financial Data Schedule as of December 31, 1994.\n(b) Reports on Form 8-K. None.\n(c) See Item 14(a) above.\n(d) See Item 14(a) (2) above.\n- 19 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nA. P. GREEN INDUSTRIES, INC. Registrant\nDated: March 7, 1995 By: \/s\/ Michael B. Cooney\nMichael B. Cooney, Senior Vice President, Law\/Administration 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.\nSignature Title Date\n\/s\/ Paul F. Hummer II Chairman of the Board, March 7, 1995 Paul F. Hummer II President, Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Gary L. Roberts Vice President, Chief Financial March 7, 1995 Gary L. Roberts Officer and Treasurer (Principal Financial and Accounting Officer)\n\/s\/ Jack R. Janney Director March 9, 1995 Jack R. Janney\n\/s\/ Donald E. Lasater Director March 8, 1995 Donald E. Lasater\n\/s\/ Daniel R. Toll Director March 9, 1995 Daniel R. Toll\n\/s\/ William F. Morrison Director March 8, 1995 William F. Morrison\n- 20 -\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders A. P. Green Industries, Inc.:\nUnder date of February 13, 1995, we reported on the consolidated statements of financial position of A. P. Green Industries, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, 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. As discussed in Note 3 of Notes to Consolidated Financial Statements, the Company changed its method of accounting for postretirement benefits other than pensions and its method of accounting for income taxes in 1992 and changed its method of accounting for postemployment benefits in 1994. These consolidated financial statements and our report thereon are incorporated by reference in the Annual Report on Form 10-K for the year ended December 31, 1994. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as of December 31, 1994, 1993 and 1992 and for the years then ended. These financial statement schedules are the responsibility of A. P. Green's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\n\/s\/KPMG PEAT MARWICK LLP\nSt. Louis, Missouri February 13, 1995\nSCHEDULE VIII\nA. P. GREEN INDUSTRIES, INC. SUPPLEMENTAL INFORMATION VALUATION AND QUALIFYING ACCOUNTS\nAn analysis of receivable reserves for 1992, 1993 and 1994 is as follows:\nDoubtful Accounts (Dollars In Thousands)\nBalance, December 31, 1991 $ 1,895 Additions in 1992- Current year provision 445 Reclassification to notes receivable reserves (113) Less - Receivables written off, net (918)\nBalance, December 31, 1992 1,309 Additions in 1993 - Current Year Provision 143 Less - Receivables written off, net (254)\nBalance, December 31, 1993 1,198 Additions in 1994 - Current Year Provision 373 Acquisition of General Refractories 1,088 Less - Receivables written off, net (667)\nBalance December 31, 1994 $1,992","section_15":""}
{"filename":"81020_1994.txt","cik":"81020","year":"1994","section_1":"ITEM 1. BUSINESS\nOrganization\nIn October 1994, PSI Energy, Inc. (Energy), previously PSI Resources, Inc.'s (Resources) utility subsidiary, became a subsidiary of CINergy Corp. (CINergy) as a result of the merger of The Cincinnati Gas & Electric Company (CG&E) and Resources. CINergy is a registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA).\nThe Company\nEnergy, an Indiana corporation, is engaged in the production, transmission, distribution, and sale of electric energy in north central, central, and southern Indiana. It serves an estimated population of 1.9 million people located in 69 of the state's 92 counties including the cities of Bloomington, Columbus, Kokomo, Lafayette, New Albany, and Terre Haute.\nPSI Energy Argentina, Inc. (PSI Energy Argentina), a wholly-owned subsidiary of Energy and an Indiana corporation, was formed to invest in foreign utility companies. PSI Energy Argentina is a member of a multinational consortium which has controlling ownership of Edesur, S.A. (Edesur). Edesur is an electricity-distribution network serving the southern half of Buenos Aires, Argentina. Edesur provides distribution services to 1.8 million customers. PSI Energy Argentina owns a small equity interest in this project and provides operating and consulting services.\nSouth Construction Company, Inc. (South), another wholly-owned subsidiary of Energy and an Indiana corporation, has been used solely to hold legal title to real estate and interests in real estate which are either not used and useful in the conduct of Energy's business (such as undeveloped real estate of Energy abutting an Energy office building) or which has some defect in title which is unacceptable to Energy. Most of the real estate to which South acquires title relates to Energy's utility business.\nCustomer, Sales, and Revenue Data\nApproximately 98% of Energy's operating revenues are derived from the sale of electricity. The area served by Energy is a residential, agricultural, and widely diversified industrial territory. As of December 31, 1994, Energy supplied electric service to over 636,000 customers. Energy's service territory includes approximately 710 cities, towns, unincorporated communities, and adjacent rural areas, including municipal utilities and rural electric cooperatives. No one customer accounts for more than 5% of electric operating revenues. Sales of electricity are affected by seasonal weather patterns, and, therefore, operating revenues and associated operating expenses are not distributed evenly during the year.\nRegulation\nAs direct and indirect subsidiaries of CINergy, Energy and South, respectively, are subject to regulation by the Securities and Exchange Commission (SEC) under the PUHCA with respect to, among other things, issuances and sales of securities, acquisitions and sales of certain utility properties, acquisitions and retentions of interests in non-utility businesses, intrasystem sales of certain goods and services, the method of keeping accounts, and access to books and records.\nEnergy is subject to regulation by the Federal Energy Regulatory Commission (FERC) under the Federal Power Act with respect to the classification of accounts, rates for wholesale sales of electricity, interconnection agreements, and acquisitions and sales of certain utility properties.\nEnergy, as a public utility under the laws of Indiana, is also regulated by the Indiana Utility Regulatory Commission (IURC) as to its retail rates, services, accounts, depreciation, issuance of securities, acquisitions and sales of certain utility properties, and in other respects as provided by Indiana law. Prior to the construction, purchase, or lease of a facility used for the generation of electricity, a public utility in Indiana must obtain from the IURC a certificate of public convenience and necessity.\nRate Matters\nRefer to the information appearing under the caption \"Regulatory Matters\" in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nPower Supply\nEnergy and 28 other electric utilities in an eight-state area are participating in the East Central Area Reliability Coordination Agreement for the purpose of coordinating the planning and operation of generating and transmission facilities to provide for maximum reliability of regional bulk power supply.\nEnergy's electric system, which is operated by CINergy Services, Inc., the service company which provides a variety of administrative, management, and support services to the CINergy system, is interconnected with the electric systems of CG&E, Central Illinois Public Service Company, East Kentucky Power Cooperative, Inc., Hoosier Energy R.E.C., Inc., Indiana Michigan Power Company, Indianapolis Power and Light Company, Kentucky Utilities Company, Louisville Gas and Electric Company, Northern Indiana Public Service Company, and Southern Indiana Gas and Electric Company.\nIn addition, Energy has a power supply relationship with Wabash Valley Power Association, Inc. (WVPA) and Indiana Municipal Power Agency (IMPA) through power coordination agreements. WVPA and IMPA are also parties with Energy to a joint transmission and local facilities agreement.\nFuel Supply\nA major portion of the coal required by Energy is obtained through both long- and short-term coal supply agreements, with the remaining requirements purchased on the spot market. The prices to be paid under most of these contracts are subject to adjustment to reflect suppliers' costs and certain other factors. In addition, some of these agreements include extension options and termination provisions pertaining to coal quality. The coal delivered under these contracts is primarily from mines located in Illinois and Indiana.\nEnergy monitors alternative sources to assure a continuing availability of economical fuel supplies. Energy intends to continue purchasing a portion of its coal requirements on the spot market and, at the present time, is investigating the use of low-sulfur coal in connection with its plans to comply with the Clean Air Act Amendments of 1990 (see the information appearing under the caption \"Environmental Issues\" in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\").\nEnergy believes it will be able to obtain sufficient coal to meet future generating requirements. However, Energy is unable to predict the extent to which coal availability and price may ultimately be affected by future environmental requirements. Presently, Energy expects the cost of coal to rise in the long run as the supply of more accessible and higher-grade coal diminishes and as mining, transportation, and other related costs continue an upward trend.\nCompetition\nRefer to the information appearing under the caption \"Competitive Pressures\" in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nCapital Requirements\nRefer to the information appearing under the caption \"Capital Requirements\" in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nEnvironmental Matters\nEnergy's 1995 construction expenditures for environmental compliance are forecasted to be $10 million. In addition, refer to the information appearing in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nEmployees\nThe number of employees of Energy at December 31, 1994, was 4,025, of whom 1,747 were represented by the International Brotherhood of Electrical Workers (IBEW) union.\nEnergy's collective bargaining agreement with the IBEW will expire at the end of April 1996.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSubstantially all utility plant is subject to the lien of Energy's first mortgage bond indenture.\nIn addition to the information further discussed herein, refer to the information appearing under the caption \"New Generation\" in \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 14 of the \"Notes to Consolidated Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".\nEnergy operates six steam electric generating stations, one hydroelectric generating station, and 16 rapid-start internal combustion generating units, all within the state of Indiana. Energy owns all of the above, except for 49.95% of Gibson Generating Station Unit 5 which is jointly owned by WVPA (25%) and IMPA (24.95%). Energy-owned system generating capability as of December 31, 1994, was 5,800 megawatts (mw).\nEnergy's 1994 summer peak load, which occurred on June 20, was 4,869 mw, and its 1994 winter peak load, which occurred on January 18, was 4,644 mw, exclusive of off-system transactions. For the period 1995 through 2004, summer and winter peak load and kilowatt-hour (kwh) sales are each forecasted to have annual growth rates of 2%. These forecasts reflect Energy's assessment of demand-side management programs, load growth, alternative fuel choices, population growth, and housing starts. These forecasts exclude non- firm power transactions and any potential off-system, long-term firm power sales.\nAs of December 31, 1994, Energy's transmission system consisted of 719 circuit miles of 345,000 volt line, 656 circuit miles of 230,000 volt line, 1,594 circuit miles of 138,000 volt line, and 2,426 circuit miles of 69,000 volt line, all within the state of Indiana. In addition, as of December 31, 1994, Energy's distribution system consisted of 19,012 circuit miles, all within the state of Indiana. As of the same date, Energy's transmission substations had a combined capacity of 21,450,755 kilovolt-amperes, and the distribution substations had a combined capacity of 6,051,420 kilovolt-amperes.\nFor the year ended December 31, 1994, 99% and 1% of Energy's kwh production were obtained from coal-fired generation and hydroelectric generation, respectively.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nMerger Litigation\nThe original merger agreement between CG&E and Resources was amended in response to a June 1993 ruling by the IURC, which dismissed a petition by Energy for approval of the transfer of its license or property to CINergy Corp., an Ohio corporation. The IURC held that such transfer could not be made to a corporation incorporated outside of Indiana. The original structure provided that Resources, Energy, and CG&E would be merged into CINergy Corp. Under this structure, Energy and CG&E would have become operating divisions of CINergy Corp., ceasing to exist as separate corporations, and CINergy Corp. would not have been required to register as a public utility holding company under the PUHCA. Energy appealed the IURC's decision, and in October 1994, the Indiana Court of Appeals reversed the IURC's decision. This decision by the Indiana Court of Appeals did not alter the consummation of the merger establishing CINergy as a registered holding company.\nShareholder Litigation\nIn March 1993, in conjunction with a proposed tender offer for Resources, IPALCO Enterprises, Inc. filed suit in the United States District Court for the Southern District of Indiana, Indianapolis Division (District Court), against Resources, CINergy, James E. Rogers, Energy, and CG&E (IPALCO Action). The IPALCO Action was subsequently dismissed in November 1993. In March 1993 and in the weeks following, six suits with claims similar to the IPALCO Action were filed by purported shareholders of Resources (Shareholder Litigation). Four of the suits were filed in the District Court, and two were filed in state courts, although one of those two was subsequently consolidated with the four in the District Court.\nIn January 1994, the parties to the Shareholder Litigation executed a Stipulation and Agreement of Dismissal (Stipulation) settling and dismissing with prejudice all of the parties' claims except for plaintiffs' petitions for fees and expenses and defendants' right to object thereto. An agreement in principle has been reached in the Shareholder Litigation which contemplates that counsel for all plaintiffs will receive from Energy a portion of the fees and expenses claimed. The parties have agreed to provide notice to affected shareholders of a hearing during which the order on the fees and expenses will be considered by the District Court. Pending such order, the agreed upon fees and expenses will be deposited into an interest-bearing escrow account.\nFuel Litigation\n(a) Amax Coal Company Energy has initiated several arbitration proceedings to resolve disputes, including disputes related to price and coal quality, which have arisen under long-term coal supply agreements between Amax Coal Company (Amax) and Energy. In October 1994, Energy and Amax entered into an interim agreement, effective through 1996, which provides, in part, that the price pursuant to the 3.6 million ton per year Wabash Mine long-term contract will remain fixed through 1995. During 1996, the price may be reduced as a result of arbitration, but it may not be increased. In addition, the parties agreed to waive all rights to recover damages or other amounts based upon the parties' claims against each other for past periods. Accordingly, the interim agreement eliminated any liability on the part of Energy to Amax's claims through 1995. The interim agreement also provides that the parties will arbitrate any remaining disputes during 1995. Such arbitration decisions will serve to establish various rights and obligations of the parties, and the price beginning in 1996.\n(b) Exxon Corporation Energy was involved in litigation with Exxon Coal USA, Inc. and Exxon Corporation (Exxon) regarding the price for coal delivered under a coal supply contract. In June 1994, the United States Supreme Court denied Energy's request for review of a ruling by the United States Court of Appeals for the Seventh Circuit, which established the contract price at $30 per ton and reversed the trial court's decision holding that the price should be $23.266 per ton. The IURC has authorized Energy to recover the additional cost through the fuel adjustment clause process. In addition, in August 1994, Energy announced that it had resolved the two remaining lawsuits with Exxon related to coal quality, price and price components, and Exxon's claims against Energy for Energy's failure to take coal after Energy terminated its contract pursuant to a December 1992 court decision. This August 1994 settlement concluded all outstanding litigation between Energy and Exxon with no significant effect on Energy's financial condition.\nIn addition to the above litigation, see Notes 2 and 13(b) and 13(c) of the \"Notes to Consolidated Financial Statements\" in \"Item 8. Financial Statements and Supplementary Data\".\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT (at February 28, 1995)\nAge at Dec. 31, Name 1994 Office & Date Elected or in Job\nJackson H. Randolph 64 Chairman and Chief Executive Officer of CINergy, CG&E, and Energy - 1994 Chairman, President and Chief Executive Officer of CG&E - 1993 President and Chief Executive Officer of CG&E - 1986\nJames E. Rogers 47 Vice Chairman, President, and Chief Operating Officer of CINergy - 1994 Vice Chairman and Chief Operating Officer of CG&E and Energy - 1994 Chairman and Chief Executive Officer of Resources - 1993 Chairman, President and Chief Executive Officer of Energy - 1990 Chairman, President and Chief Executive Officer of Resources - 1988 Chairman and Chief Executive Officer of Energy - 1988\nCheryl M. Foley 47 Vice President, General Counsel and Corporate Secretary of CG&E - 1995 Vice President, General Counsel and Corporate Secretary of CINergy - 1994 Vice President, General Counsel and Secretary of Resources and Energy - 1991 Vice President and General Counsel of Resources - 1990 Vice President and General Counsel of Energy - 1989\nJ. Wayne Leonard 44 Group Vice President and Chief Financial Officer of CG&E - 1995 Group Vice President and Chief Financial Officer of CINergy - 1994 Senior Vice President and Chief Financial Officer of Resources and Energy - 1992 Vice President and Chief Financial Officer of Resources and Energy - 1989\nEXECUTIVE OFFICERS OF THE REGISTRANT (continued)\nAge at Dec. 31, Name 1994 Office & Date Elected or in Job\nJohn M. Mutz 1\/ 59 Vice President of CINergy - 1995 2\/ President of Energy - 1994 President of Resources - 1993 President - Lilly Endowment, Inc. 3\/ - 1989\nWilliam L. Sheafer 51 Treasurer of CINergy and Energy - 1994 Treasurer of CG&E - 1987\nLarry E. Thomas 49 Group Vice President, Reengineering and Operations Services of CG&E - 1995 Group Vice President, Reengineering and Operations Services of CINergy - 1994 Senior Vice President and Chief Operations Officer of Energy - 1992 Senior Vice President and Chief Operating Officer, Customer Operations of Energy - Senior Vice President, Customer Operations of Energy - 1986\nCharles J. Winger 49 Comptroller of CG&E - 1995 Comptroller of CINergy - 1994 Comptroller of Resources - 1988 Comptroller of Energy - 1984\nUnder the Amended and Restated Agreement and Plan of Reorganization (the Merger Agreement) by and among CG&E, Resources, Energy, and CINergy, a Delaware corporation, dated as of December 11, 1992, as amended on July 2, 1993, and as of September 10, 1993, Jackson H. Randolph will be entitled to serve as Chairman and Chief Executive Officer (CEO) of CINergy until November 30, 1995, and Chairman of CINergy until November 30, 2000. James E. Rogers will be entitled to serve as Vice Chairman, President and Chief Operating Officer of CINergy until November 30, 1995, at which time he will be entitled to serve as Vice Chairman, President and CEO.\nNone of the officers are related in any manner. Executive officers of Energy are elected to the offices set opposite their respective names until the next annual meeting of the Board of Directors and until their successors shall have been duly elected and shall have been qualified.\n1\/ Prior to becoming President of Resources, Mr. Mutz was president of Lilly Endowment, Inc., a private philanthropic foundation located in Indianapolis, Indiana, and also served two terms as lieutenant governor of Indiana.\n2\/ Mr. Mutz was elected Vice President of CINergy effective March 3, 1995.\n3\/ Non-affiliate of CINergy.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll Energy common stock is held by CINergy; therefore, there is no public trading market for Energy common stock.\nThe following table shows Energy's common stock dividends declared for the past two years (all dividends were paid to Resources, previously Energy's parent company):\nDividends (in thousands) Quarter 1994 1993 4th $10 376 $17 898 3rd 16 174 13 868 2nd 16 622 15 375 1st 15 970 15 050\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee \"Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nMERGER CONSUMMATION\nCINergy Corp. (CINergy) was created for the October 1994 merger of PSI Resources, Inc. (Resources) and The Cincinnati Gas & Electric Company (CG&E) and is a registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA). The business combination was accounted for as a pooling of interests. Each outstanding share of common stock of Resources and CG&E was exchanged for 1.023 shares and one share, respectively, of CINergy common stock. Following the merger, CINergy became the parent holding company of CG&E and PSI Energy, Inc. (Energy or Company), previously Resources' utility subsidiary. The outstanding preferred stock and debt securities of Energy were not affected by the merger. Following the merger, CG&E and Energy (the Operating Companies) began jointly dispatching their generating units.\nFINANCIAL CONDITION\nCompetitive Pressures\nElectric Utility Industry\nIntroduction The primary factor influencing the future profitability of CINergy and its utility subsidiaries is the changing competitive environment for energy services and the related commoditization of electric power markets. Changes in the industry include more competition in wholesale power markets and the imminent likelihood of \"customer choice\" by large industrial customers and, ultimately, by all retail customers. For an electric utility to be successful in this competitive environment, it is critical that regulatory reform keep pace with the competitive realities facing electric utilities and their customers. Strict adherence to traditional, cost-based rate of return regulation will significantly disadvantage a utility's ability to successfully compete to supply customer needs. For example, performance-based regulation (e.g., price caps) would likely add substantial flexibility for the franchise utility in the transition to a fully competitive environment.\nAlthough the Operating Companies provide service in separate retail regulatory jurisdictions, as a result of the merger, strategies and opportunities for success in a more competitive environment are most appropriately discussed for CINergy as a whole. Consequently, the discussion that follows addresses issues for CINergy as a whole while recognizing that regulatory response to competitive pressures may vary between regulatory jurisdictions.\nPressures for \"Customer Choice\" The granting of choice to end-user customers, commonly referred to as retail wheeling, would allow a customer within a particular utility's service territory to buy power directly from another source using the power lines of the local utility for delivery. The regulatory and legislative reform to facilitate this result is primarily driven by large industrial energy users' needs for low-cost power to remain competitive in the global marketplace. These industrial customers are intensifying their efforts to change the regulatory process that currently denies them access to lower-cost power. The current restrictions on access to low-cost power are exacerbated by cost-of-service regulation which has produced average industrial rates to customers that vary substantially across the United States (from approximately 3 cents per kilowatt-hour [kwh] to 10 cents per kwh).\nFederal Law, the New Competitors, and the Commoditization of Electric Power Markets The Energy Policy Act of 1992 (Energy Act), the most comprehensive energy legislation enacted since the late 1970s, has essentially provided for open competition at the wholesale level. The Energy Act created a new class of wholesale power providers, exempt wholesale generators (EWGs), that are not subject to the restrictive requirements of the PUHCA nor the ownership restrictions of the Public Utility Regulatory Policies Act of 1978. However, due to excess capacity in the industry, EWGs have not yet significantly affected competition in the wholesale power market. To date, the primary impetus for increased wholesale competition has been the provision of the Energy Act that granted the Federal Energy Regulatory Commission (FERC) the authority to order wholesale transmission access. This provision, combined with the excess capacity in the bulk-power markets, has resulted in the emergence of power marketers and brokers.\nBrokers are intermediaries between buyers and sellers (i.e., they do not take title to the power). Power marketers are entities licensed by the FERC to conduct bulk power trades at market-based prices. They manage portfolios of power contracts (which they have title to) and owned generation and package energy products for customers of bulk power, including price risk management contracts such as options on fixed price energy or guaranteed fixed price contracts.\nAs regulatory issues such as transmission pricing are resolved, power marketers and brokers will become more significant factors in wholesale power markets and, ultimately, the retail markets. With respect to transmission pricing, the FERC recently issued a policy statement indicating its intent to allow flexibility in pricing, permitting parties to submit either traditional, cost-based plans or pricing schemes based on non-traditional designs. The transmission pricing policy enumerates five principles that the FERC will consider in approving future proposals, including cost-based rates, adherence to the FERC's comparability standard, economic efficiency, fairness, and practicality.\nStates' Role in Customer Choice (Retail Wheeling) As discussed above, the Energy Act allows real competition in the wholesale power market; however, it prohibits the FERC from ordering utilities to provide transmission access to retail customers (retail wheeling) and is silent with respect to the states' role and authority in this issue.\nSeveral states are currently reviewing retail wheeling proposals. In particular, the California Public Utilities Commission proposed a plan in 1994 that would allow all customers to choose their electric supplier by the year 2002. However, it is currently anticipated that implementation of this proposal could be substantially delayed due to the complex issues involved (e.g., exclusive use of a power pool run by an impartial third party vs. bilateral contract arrangements). In addition to California, Michigan regulators have proposed a limited retail wheeling experiment, and Wisconsin regulators are reviewing numerous proposals for restructuring that state's electric supply and related services. Connecticut regulators, on the other hand, recently decided to delay consideration of retail wheeling until new capacity is needed in the state (approximately the year 2007).\nA significant issue for states and utilities to resolve with respect to retail wheeling is the regulatory treatment of any stranded investments, or costs without a customer. California's proposal and a recent proposal by the FERC contain mechanisms for recovery by the franchise utility of certain sunk costs or investments \"stranded\" by the loss of the monopoly franchise; however, there are numerous arguments being advanced against the collection of stranded costs. For example, there are concerns that an efficient competitive market cannot exist if regulators allow recovery in the future of all uncollected past costs. Given that the most severe electric competition is expected to be in the commodity sector, stranded costs are usually considered uneconomical generating property. In addition, stranded costs could include assets created by the actions of regulators (i.e., regulatory assets) under the provisions of Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (Statement 71), or operating costs such as fuel supply contracts. The substantial accounting implications from the loss of franchise territory and related regulatory protections are discussed further herein.\nCINergy's Response to the Changing Competitive Environment CINergy and its utility subsidiaries support increased competition in the electric utility industry. In fact, the foresight that competition was about to substantially increase and that retail wheeling was inevitable was a catalyst for the merger (which was announced in 1992). CINergy possesses certain competitive advantages (e.g., low-cost generation) that could be substantially eroded by restrictive regulations that lag the development of a competitive market and limit CINergy's ability to preempt the competition in responding to customer needs. As such, CINergy has chosen to initiate the retail wheeling debate and be a leader in establishing the \"ground rules\" in its franchise area.\nEnergy recently announced its plans to offer its larger industrial customers some form of retail wheeling in Indiana. Energy plans to submit a proposal that would permit certain customers to choose their electric supplier. In return, Energy would require some form of reciprocal arrangement (i.e., the opportunity to similarly compete for customers of the selected supplier). Under this proposal, Energy would be free to negotiate specific contracts with customers who choose to give up the protection of the franchise obligation to serve. Energy intends for these contractual relationships to satisfy customer needs, while at the same time provide an appropriate risk-return relationship for investors. In addition to the above proposal, Energy, along with other Indiana utilities, proposed legislation in 1995 that would allow the Indiana Utility Regulatory Commission (IURC) to adopt alternative regulatory schemes such as performance-based regulation and the use of more flexible pricing mechanisms. Energy is also participating in a series of informal conferences sponsored by the IURC to discuss the consequences of competition and appropriate responses thereto.\nWith respect to Ohio, a retail wheeling bill was introduced in early 1994 that would have given customers the ability to purchase power from their provider of choice and would have required utilities to provide access to their transmission lines for delivery of the electric service. No action was taken on the bill in 1994; however, similar legislation may be introduced in 1995. CG&E is also participating in roundtable discussions being held by the Public Utilities Commission of Ohio (PUCO) to more fully consider the emerging competitive environment.\nCINergy will continue to aggressively pursue any legislative or regulatory reforms necessary to provide the opportunity for its success in a competitive environment.\nCINergy's Competitive Position As stand-alone companies, CG&E and Energy were well positioned to succeed in a more competitive environment -- as a combined organization, CINergy believes it is even better positioned to compete in such an environment. The merger (1) combines two low-cost providers, resulting in savings in nominal dollars of approximately $1.5 billion over the first 10 years; (2) enhances the companies' transmission capabilities; (3) diversifies the customer base; and (4) creates a financially stronger company -- all of which improve an already competitively strong position. CINergy's strategy will be to aggressively build on its cost advantage by continually focusing on flexible strategies that are directed toward reducing the cost structure and shifting the cost mix from fixed to variable. CG&E and Energy have industrial rates that are below the national average (based on 1993 data) and own generating plants that are consistently ranked among the most efficient in the country.\nCINergy believes its low-cost position and strategic initiatives will allow it to maintain, and perhaps expand, its wholesale market share and its current base of industrial customers. Recent successes in these markets include Energy's 10-year agreement to serve the power needs of Blue Ridge Power Agency, a group of municipal utilities organized in Virginia, and CG&E's 14- year agreement to provide power to a municipal utility serving a portion of Cleveland, Ohio. Also, CG&E's and Energy's low industrial rates have produced regional leadership over the last five years (1989 through 1993) with respect to growth in industrial kwh sales.\nIn addition, CINergy intends to aggressively pursue the substantial opportunities that exist in the electricity markets for power marketing and brokering. These opportunities are being created by the increasing commoditization of electricity. CINergy believes that the ability to identify and manage various business risks and innovative packaging of power supply services and products based upon superior acquisition and analysis of information will be key factors that will ensure successful participation in these markets. CINergy's strategy for success in this business is to leverage its understanding of customer needs and the intricacies of operating in power markets with new skills and expertise of operating in commodity markets that are being developed and selectively acquired from outside the industry.\nOutsiders' View of CINergy's Competitive Position Major credit rating agencies have issued reports recognizing the increased risk in the electric utility industry due to competition. Specifically, in conjunction with fundamentally changing the way it evaluates the credit quality of electric utilities, Standard & Poor's has categorized each electric utility's business position in one of seven categories ranging from \"Above Average\" to \"Below Average\". As a result, Standard & Poor's placed Energy in the second highest category, \"Somewhat Above Average\", and CG&E in the third highest category, \"High Average\". In addition, Moody's recently issued a credit report stating its belief that Energy is well positioned to compete in a more competitive environment. At the same time, certain sell-side equity analysts have placed CINergy near the top of their lists of those best equipped to handle increasing competitive pressures. CINergy believes these actions support its position that its competitive strategy will be successful.\nWith respect to accessing financial markets for capital needs, U.S. utilities must compete for capital in world markets where some forecasts indicate that as much as $250 billion will be needed by the year 2000 for state-owned electricity privatization. These forecasts enforce CINergy's belief that regulatory reform establishing a market structure for utilities similar to that already existing in other countries is critical in order to successfully compete for not only customers, but also capital.\nDespite the numerous published reports discussing the increased business risk that investors face from deregulation of the electric utility industry, the 1994 decline in electric utility stocks, taken as a whole, can be substantially attributed to historical relationships of common stock prices to changes in interest rates. Therefore, electric utility stocks could see additional pressures to reflect the increased fundamental business risk as markets become more workably competitive, particularly, without regulatory recognition through higher allowed returns and increased flexibility (e.g., price caps) in order to compete. On the other hand, there is an increasingly large disparity between the fundamental valuation measures (e.g., yield, market-to-book ratio) of low-cost producers, like CINergy, and high-cost producers. For example, it should be noted that the merger of Resources and CG&E combined two utilities whose common stocks have outperformed the industry average for the five-year period 1990 through 1994.\nSubstantial Accounting Implications\nA potential outcome of the changing competitive environment could be the inability of regulated utilities to continue application of Statement 71, the linchpin of regulated industry accounting, which allows the deferral of costs (i.e., regulatory assets) to future periods based on assurances of a regulator as to the recoverability of the costs in rates charged to customers. In connection with assessing the financial exposure related to stranded costs, regulatory assets would have to be evaluated to determine the portion for which deferral could be continued based on the existence of the necessary regulatory assurances.\nAlthough CINergy's current regulatory orders and regulatory environment fully support the recognition of its regulatory assets, the ultimate outcome of the changing competitive environment could result in CINergy discontinuing application of Statement 71 for all or part of its business. Such an event would require the write-off of the portion of any regulatory asset for which no regulatory assurance of recovery continues to exist. No evidence currently exists that would support a write-off of any portion of CINergy's regulatory assets. CINergy intends to pursue competitive strategies that would mitigate the impact of this issue on the financial condition of CINergy or its utility subsidiaries (see Note 1(c) of the \"Notes to Consolidated Financial Statements\" in \"Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of PSI Energy, Inc.:\nWe have audited the consolidated balance sheets and schedules of cumulative preferred stock and long-term debt of PSI Energy, Inc. (an Indiana Corporation and a wholly owned subsidiary of CINergy Corp.) and subsidiary as of December 31, 1994 and 1993, and the related consolidated statements of income, changes in common stock equity and cash flows for each of the three years in the period ended December 31, 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 PSI Energy, Inc. 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 explained in Notes 8 and 12 to the consolidated financial statements, PSI Energy, Inc. changed its methods of accounting for postretirement health care benefits and income taxes effective January 1, 1993.\nAs more fully discussed in Note 13 to the consolidated financial statements, Wabash Valley Power Association, Inc. (WVPA) filed suit in 1984 against PSI Energy, Inc. for $478 million plus interest and other damages to recover its share of Marble Hill Nuclear Project costs. PSI Energy, Inc. and its officers reached a settlement with WVPA in 1989 that is subject to approval of judicial and regulatory authorities and has recorded an estimated loss related to the litigation. The eventual outcome of this litigation cannot presently be determined.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supplemental schedules listed in Item 14 are presented for purposes of complying with the Securities and Exchange Commission's Rules and Regulations under the Securities Exchange Act of 1934 and are not a required part of the basic financial statements. The supplemental schedules have been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP Indianapolis, Indiana, January 23, 1995.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\n(a) Merger On October 24, 1994, PSI Resources, Inc. (Resources), previously PSI Energy, Inc.'s (Energy or Company) parent holding company, was merged with and into CINergy Corp. (CINergy), and a subsidiary of CINergy was merged with and into The Cincinnati Gas & Electric Company (CG&E). Each outstanding share of common stock of Resources and CG&E was exchanged for 1.023 shares and one share, respectively, of CINergy common stock, resulting in the issuance of approximately 148 million shares of CINergy common stock, par value $.01 per share. The outstanding preferred stock and debt securities of Energy were not affected by the merger. Following the merger, CINergy became the parent holding company of Energy and CG&E. The merger was accounted for as a pooling of interests. Due to immateriality, no adjustments were made to conform the accounting policies of the two companies.\n(b) Consolidation Policy The accompanying Consolidated Financial Statements include the accounts of Energy and its subsidiary, PSI Energy Argentina, Inc., after elimination of significant intercompany transactions and balances.\n(c) Regulation Energy is subject to regulation by the Securities and Exchange Commission (SEC) under the Public Utility Holding Company Act of 1935 (PUHCA). Energy is also subject to regulation by the Federal Energy Regulatory Commission (FERC) and the Indiana Utility Regulatory Commission (IURC). Energy's accounting policies conform to the accounting requirements and ratemaking practices of these regulatory authorities and to generally accepted accounting principles, including the provisions of Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation (Statement 71).\nRegulatory assets represent probable future revenue to Energy associated with deferred costs to be recovered from customers through the ratemaking process. The following regulatory assets of Energy are reflected in the Consolidated Balance Sheets as of December 31: 1994 1993 (in millions) Post-in-service carrying costs and deferred depreciation . . . . . . . . . . . $ 30 $ 11 Deferred demand-side management (DSM) costs. . . . . . . . . . . 94 53 Amounts due from customers - income taxes . . 27 18 Deferred merger costs . . . . . . . . . . . . 38 15 Costs of reacquiring debt . . . . . . . . . . 37 40 Postretirement benefit costs. . . . . . . . . 21 10 Other . . . . . . . . . . . . . . . . . . . . 9 11\nTotal . . . . . . . . . . . . . . . . . . . $256 $158\nIn February 1995, the IURC issued an order (February 1995 Order) which approved a rate settlement agreement among Energy and certain intervenors (see Note 2(b)). This order, together with previous regulatory orders, provides for recovery of $153 million of Energy's regulatory assets as of December 31, 1994. In addition, testimony to be filed in 1995 in connection with Energy's July 1994 retail rate petition will include a request for additional recovery of regulatory assets, including approximately $100 million of the balance at December 31, 1994 (see Note 2(c)).\nSee Note 1(g), (h), (i), and (k) for additional information regarding post-in- service carrying costs and deferred depreciation, deferred DSM costs, amounts due from customers - income taxes, and costs of reacquiring debt, respectively. For additional information regarding deferred merger costs and postretirement benefit costs, see Notes 2(b), 8, and 9.\nAlthough Energy's current regulatory orders and regulatory environment fully support the recognition of these regulatory assets, the ultimate outcome of the changing competitive environment discussed in the \"Competitive Pressures\" section of \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\" could result in Energy discontinuing application of Statement 71 for all or part of its business. Such an event would require the write-off of the portion of any regulatory asset for which no regulatory assurance of recovery continues to exist. No evidence currently exists that would support a write-off of any portion of Energy's regulatory assets. Energy intends to pursue competitive strategies that would mitigate the impact of this issue on the financial condition of the Company.\n(d) Electric Utility Plant Electric utility plant is stated at the original cost of construction, which includes an allowance for funds used during construction (AFUDC) and a proportionate share of overhead costs. Construction overhead costs include salaries, payroll taxes, fringe benefits, and other expenses.\nSubstantially all electric utility plant is subject to the lien of Energy's first mortgage bond indenture.\n(e) AFUDC Energy capitalizes AFUDC, a non-cash income item, which is defined in the regulatory system of accounts prescribed by the FERC as including \"the net cost for the period of construction of borrowed funds used for construction purposes and a reasonable rate on other funds when so used\". The AFUDC accrual rate was 6.4% in 1994, 9.5% in 1993, and 8.5% in 1992, and is compounded semi-annually.\n(f) Depreciation and Maintenance Energy's provision for depreciation is determined by using the straight-line method applied to the cost of depreciable plant in service. The rate is based on periodic studies of the estimated service lives and net cost of removal of the properties. The depreciation rate for electric utility plant was 3.8% for each of the years 1992 through 1994. In accordance with the IURC's February 1995 Order discussed further herein, Energy's annual depreciation expense will decrease by approximately $30 million.\nMaintenance and repairs of property units and replacements of minor items of property are charged to maintenance expense. The costs of replacements of property units are capitalized. The original cost of the property retired and the related costs of removal, less salvage recovered, are charged to accumulated depreciation.\n(g) Post-in-service Carrying Costs and Deferred Depreciation In January 1993, Energy received authority from the IURC to continue accrual of the debt component of AFUDC and to defer depreciation expense on the combustion turbine generating unit constructed at its Cayuga Generating Station and major environmental compliance projects from the date the projects are placed in service until the effective date of an order in a general retail rate proceeding. The February 1995 Order authorizes Energy to begin recovering amounts deferred as of May 31, 1994 ($9 million), for AFUDC continuation and July 31, 1993 ($1 million), for depreciation expense over the remaining lives of the related electric utility plant. Additionally, the February 1995 Order authorizes Energy to continue deferral of the applicable AFUDC and depreciation recorded after the above cut-off dates through February 1995, for subsequent recovery in an IURC order associated with Energy's July 1994 retail rate petition which is currently pending before the IURC. The February 1995 Order also authorizes Energy to continue the accrual of the debt component of AFUDC and to defer depreciation expense on two major environmental projects from the date the projects are placed in service until the projects' costs are reflected in retail electric rates.\n(h) DSM Costs Energy is authorized by the February 1995 Order to amortize and recover DSM expenditures deferred through July 1993 ($35 million), together with carrying costs, over a five-year period. Deferred DSM expenditures as of February 1995, which are not included for recovery in the February 1995 Order, will continue to be deferred, with carrying costs, for recovery in subsequent rate proceedings. In addition, base rates will include recovery of $23 million of DSM expenditures on an annual basis. Future deferral of DSM expenditures will be the amount by which actual annual expenditures exceed the base level of $23 million. If DSM expenditures in any calendar year are less than the $23 million in base rates, the unamortized balance of deferred DSM expenditures would be reduced by such difference.\n(i) Federal and State Income Taxes Deferred tax assets and liabilities are recognized for the expected future tax consequences of existing differences between the financial reporting and tax reporting bases of assets and liabilities. Investment tax credits utilized to reduce Federal income taxes payable have been deferred for financial reporting purposes and are being amortized over the useful lives of the property which gave rise to such credits.\nIncome tax provisions reflected in customer rates are regulated by the various regulatory commissions overseeing the regulated business operations of Energy. To the extent deferred income taxes are not reflected in rates charged to customers, income taxes payable in future years are recoverable from customers as paid. These amounts are reflected in the accompanying Consolidated Financial Statements as a regulatory asset on the basis of their probable recovery in future periods.\n(j) Operating Revenues and Fuel Costs Energy recognizes revenues for electric service rendered during the month, which includes revenues for sales unbilled at the end of each month. Revenues reflect fuel cost charges based on the actual costs of fuel. Fuel cost charges applicable to all of Energy's metered kilowatt-hour sales are included in customer billings based on the estimated costs of fuel. Customer bills are adjusted in subsequent months to reflect the difference between actual and estimated costs of fuel. Indiana law subjects the recovery of fuel costs to a determination that such recovery will not result in earning a return in excess of that allowed by the IURC in its last general rate order.\n(k) Debt Discount, Premium, and Issuance Expense and Costs of Reacquiring Debt Debt discount, premium, and issuance expense on Energy's outstanding long-term debt are amortized over the lives of the respective issues.\nIn accordance with established ratemaking practices, Energy is deferring costs (principally call premiums) from the reacquisition of long-term debt and is amortizing such amounts over periods ranging from four years to 18 years.\n(l) Consolidated Statements of Cash Flows All temporary cash investments with maturities of three months or less, when acquired, are reported as cash equivalents. Energy had no material non-cash investing or financing transactions during the years 1992 through 1994.\n(m) Reclassification Certain amounts in the 1992 and 1993 Consolidated Financial Statements have been reclassified to conform to the 1994 presentation.\n2. Rates\n(a) Settlement Agreement - IURC's June 1987 and April 1990 Orders In December 1993, the IURC issued an order (December 1993 Order) approving a settlement agreement entered into by Energy, the appellants, and certain other intervenors which resolved the outstanding issues related to the appeals of the IURC's April 1990 retail rate order (April 1990 Order) and the IURC's June 1987 tax order (June 1987 Order). The December 1993 Order provided for Energy to refund $150 million to its retail customers ($119 million applicable to the June 1987 Order and $31 million applicable to the April 1990 Order). The December 1993 Order further provided for Energy to reduce its retail rates by 1.5% (approximately $13.5 million on an annual basis) to reflect a return on common equity of 14.25%. The refunds and rate reduction commenced in December 1993.\nEnergy had previously recognized a loss of $139 million for the June 1987 Order. The difference between the $139 million and the $119 million portion of the refund applicable to the June 1987 Order is reflected in the Consolidated Statement of Income for the year ended December 31, 1993, as a reduction of the loss. The $31 million portion of the refund applicable to the April 1990 Order is reflected in the Consolidated Statement of Income for the same period as a reduction in operating revenues.\n(b) February 1995 Order - Retail Rate Proceeding and Merger Savings Allocation Plan The IURC issued the February 1995 Order approving a settlement agreement entered into by Energy, the Office of the Utility Consumer Counselor, Citizens Action Coalition of Indiana, Inc., and the PSI- Industrial Group concerning Energy's petition for a $93 million retail rate increase ($103 million including carrying costs attributable to certain environmental expenditures not included in Energy's base retail electric rates) and Energy's previously filed plan for the allocation of its portion of merger savings between Energy's customers and CINergy's shareholders.\nThe February 1995 Order authorizes Energy to increase annual retail rates $33.6 million, effective February 1995. The increase excludes reductions for customer credits for non-fuel operation and maintenance expense merger savings (Non-fuel Merger Savings) and increases for carrying costs attributable to certain environmental expenditures not included in Energy's base retail electric rates, both of which are further discussed herein. The increase includes the recovery of the costs of postretirement benefits other than pensions on an accrual basis, the recovery of DSM expenditures, the recovery of a portion of amounts deferred for AFUDC continuation and depreciation expense, and the adoption of lower depreciation rates, which will reduce annual depreciation expense by approximately $30 million. This rate increase reflects an 11.9% return on common equity with an 8.25% overall rate of return on net original cost rate base.\nAdditionally, the February 1995 Order provides a mechanism to allocate Energy's share of net Non-fuel Merger Savings through December 31, 1997, between Energy's customers and CINergy's shareholders. CINergy currently anticipates that the estimated nominal merger savings of $1.5 billion will be apportioned approximately equally between CG&E and Energy. In essence, the mechanism guarantees Energy's customers 50% of Energy's portion of the projected net Non-fuel Merger Savings. Energy's customers will receive these merger savings via credits to base rates of $4.4 million in 1995, an additional $2.2 million in 1996, and an additional $2.4 million in 1997. After 1997, the accumulated credits will continue until the effective date of an order in an Energy general retail rate proceeding. Energy will have to achieve these levels of merger savings in order to realize the 11.9% return on equity. This arrangement for sharing of merger savings allows Energy to recover its portion of transaction costs (currently estimated at $27 million) and costs to achieve merger savings (currently estimated at $21 million) over a 10-year period.\nThe February 1995 Order also provides Energy with a financial incentive to achieve, or exceed, merger savings projections and enhance operating efficiencies by allowing Energy to earn up to a 13.25% return on common equity until the effective date of an order in connection with Energy's July 1994 retail rate petition, which is currently pending before the IURC. Energy expects an order in this proceeding in the second quarter of 1996. Upon the effective date of an order relating to the July 1994 retail rate petition, the February 1995 Order provides Energy an opportunity to earn an additional 100 basis points above the common equity return to be granted by the IURC in such rate proceeding until December 31, 1997. In order to be eligible for such additional earnings, Energy must meet certain service-related conditions. Any mechanism for sharing of merger savings after December 31, 1997, will be determined in subsequent regulatory proceedings.\nFinally, the February 1995 Order includes ratemaking and accounting mechanisms to address regulatory lag. The February 1995 Order approves Energy's proposal for current recovery of carrying costs associated with environmental compliance projects and the applicable portion of the Wabash River Clean Coal Project (Clean Coal Project) not included in Energy's base retail electric rates. The Clean Coal Project, which is located at the Wabash River Generating Station, is a 262-megawatt clean coal power generating facility planned to be placed in service during the third quarter of 1995. The February 1995 Order also includes provisions for the deferral of certain operating costs associated with the Clean Coal Project, together with the debt component of carrying costs thereon, and continued accrual of the debt component of carrying costs (to the extent not reflected in rates currently) and deferral of depreciation expense on the Clean Coal Project and a scrubber at Gibson Generating Station (Gibson) until the projects' costs are fully reflected in retail electric rates.\n(c) July 1994 Retail Rate Petition In addition to the rate petition addressed in the February 1995 Order, Energy filed a petition in July 1994 with the IURC for a retail rate increase to recover, among other things, the costs of the Clean Coal Project and the scrubber at Gibson which was placed in service in September 1994. These two projects were previously approved by the IURC. Energy initially estimated a rate increase of 8%. Energy is currently evaluating how the rate settlement and the ability to earn a cash return during construction on certain projects, as previously discussed, will affect the estimated rate increase. Energy intends to file testimony supporting its rate increase request in May 1995 and, as previously discussed, anticipates an order in this proceeding in the second quarter of 1996. Energy cannot predict what action the IURC may take with respect to this proposed rate increase.\n3. Common Stock\nAll of Energy's common stock is held by CINergy. No common dividends can be paid by Energy if dividends are in arrears on its preferred stock.\n4. Preferred Stock\nChanges in preferred stock outstanding during 1994, 1993, and 1992, were as follows:\nShares Issued Par (Retired) Value (dollars in thousands) Cumulative preferred stock Not subject to mandatory redemption Par value $100 per share 3 1\/2% Series. . . . . . . . . . . . (598) $ (60)\nCumulative preferred stock Not subject to mandatory redemption Par value $25 per share 7.44 % Series. . . . . . . . . . . . 4 000 000 100 000 Par value $100 per share 3 1\/2% Series. . . . . . . . . . . . (237) (24) 8.52 % Series. . . . . . . . . . . . (211 190) (21 119) 8.38 % Series. . . . . . . . . . . . (162 520) (16 252) 8.96 % Series. . . . . . . . . . . . (216 900) (21 690) 6 7\/8% Series. . . . . . . . . . . . 600 000 60 000\nCumulative preferred stock Not subject to mandatory redemption Par value $100 per share 3 1\/2% Series. . . . . . . . . . . . (10) (1) Subject to mandatory redemption Par value $100 per share 13.25% Series. . . . . . . . . . . . (255 000) (25 500)\nCurrently, Energy can sell up to an additional $40 million of preferred stock under an effective shelf registration statement and IURC authority.\n5. Long-term Debt\nLong-term debt maturities, excluding sinking fund requirements, for the next five years are $60 million in 1995, $50 million in 1996, $10 million in 1997, $35 million in 1998, and $6 million in 1999.\n6. Sale of Accounts Receivable and Interest Rate Swap\nEnergy has an agreement through January 1996 to sell, with limited recourse, an undivided percentage interest in certain of its accounts receivable from customers up to a maximum of $90 million. As of December 31, 1994, Energy's obligation under the limited recourse provision is $20 million. The refund provided for by the December 1993 Order, as previously discussed (see Note 2(a)), reduced accounts receivable available for sale at December 31, 1993, to $40 million. Accounts receivable on the Consolidated Balance Sheets are net of the $87 million and $40 million interest sold at December 31, 1994, and December 31, 1993, respectively. The excess of $90 million over the accounts receivable available for sale at December 31, 1993, is reflected in the Consolidated Balance Sheet as \"Advance under accounts receivable purchase agreement\".\nAs a hedge against floating rate conditions, effective February 1, 1991, Energy entered into an interest rate swap agreement which effectively changed Energy's variable interest rate exposure on its $90 million (the notional principal amount) sale of accounts receivable to a fixed rate of 8.19%. Costs associated with the interest rate swap agreement are included in \"Other - net\" in the Consolidated Statements of Income. The interest rate swap agreement matures January 31, 1996. In the event of nonperformance by the other parties to the interest rate swap agreement, Energy would be exposed to floating rate conditions.\n7. Pension Plan\nEnergy's defined benefit pension plan covers substantially all employees meeting certain minimum age and service requirements. Plan benefits are determined under a final average pay formula with consideration of years of participation, age at retirement, and the applicable average Social Security wage base.\nEnergy's funding policy is to contribute annually to the plan an amount which is not less than the minimum amount required by the Employee Retirement Income Security Act of 1974 and not more than the maximum amount deductible for income tax purposes. Contributions for the 1994, 1993, and 1992 plan years were $3.5 million, $8.2 million, and $7.4 million, respectively. The plan's assets consist of investments in equity and fixed income securities.\nPension cost for 1994, 1993, and 1992 included the following components:\n1994 1993 1992 (in millions)\nBenefits earned during the period . . . . . . . $ 8.7 $ 7.7 $ 7.1 Interest accrued on projected benefit obligation . . . . . . . . . . . . . 19.8 19.4 18.3 Actual (return) loss on plan's assets . . . . . 2.4 (38.5) (24.1) Net amortization and deferral . . . . . . . . . (23.1) 20.1 7.4\nNet periodic pension cost . . . . . . . . . . . $ 7.8 $ 8.7 $ 8.7\n1994 1993 1992 Actuarial Assumptions: For determination of projected benefit obligation Discount rate . . . . . . . . . . . . . . . 8.5% 7.5% 8.5% Rate of increase in future compensation . . 5.5 4.5 5.5\nFor determination of pension cost Rate of return on plan's assets . . . . . . . 9.0 9.0 9.0\nThe following table reconciles the plan's funded status with amounts recorded in the Consolidated Financial Statements. Under the provisions of Statement of Financial Accounting Standards No. 87, Employers' Accounting for Pensions (Statement 87), certain assets and obligations of the plan are deferred and recognized in the Consolidated Financial Statements in subsequent periods.\n1994 1993 (in millions) Actuarial present value of benefits Vested benefits . . . . . . . . . . $(197.5) $(206.1) Non-vested benefits . . . . . . . . (8.0) (8.5)\nAccumulated benefit obligation. . (205.5) (214.6)\nEffect of future compensation increases . . . . . . . . . . . . (67.3) (55.4)\nProjected benefit obligation. . . (272.8) (270.0)\nPlan's assets at fair value . . . . . 256.3 266.0\nProjected benefit obligation in excess of plan's assets . . . . . . (16.5) (4.0)\nRemaining balance of plan's net assets existing at date of initial application of Statement 87 to be recognized as a reduction of pension cost in future periods. . . (5.7) (6.4)\nUnrecognized net (gain) loss resulting from experience different from that assumed and effects of changes in assumptions. . . . . . . 5.7 (.9)\nPrior service cost not yet recognized in net periodic pension cost. . . . 17.2 14.9\nPrepaid pension cost at December 31 . $ .7 $ 3.6\n8. Other Postretirement Benefits\nEnergy provides certain health care and life insurance benefits to retired employees and their eligible dependents. The health care benefits include medical and dental coverage and prescription drugs. Prior to 1993, the cost of retiree health care was charged to expense as claims were paid, and the cost of life insurance benefits was charged to expense at retirement. Energy, in connection with the settlement which resulted in the February 1995 Order, agreed to begin funding its obligation for these postretirement benefits.\nEffective with the first quarter of 1993, Energy implemented the provisions of Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (Statement 106). Under the provisions of Statement 106, the costs of health care and life insurance benefits provided to retirees are recognized for accounting purposes during periods of employee service (accrual basis). The unrecognized and unfunded Accumulated Postretirement Benefit Obligation (APBO) existing at the date of initial application of Statement 106 (i.e., the transition obligation) of $107.6 million is being amortized over a 20-year period.\nPostretirement benefit cost for 1994 and 1993 included the following components: 1994 1993 (in millions)\nBenefits earned during the period. . . . . . $ 4.4 $ 3.4 Interest accrued on APBO . . . . . . . . . . 10.1 9.3 Net amortization and deferral. . . . . . . . .1 - Amortization of transition obligation. . . . 5.4 5.4\nNet periodic postretirement benefit cost . . $20.0 $18.1\nThe following table reconciles the APBO of the health care and life insurance plans with amounts recorded in the Consolidated Financial Statements. Under the provisions of Statement 106, certain obligations of the plan are deferred and recognized in the Consolidated Financial Statements in subsequent periods.\n1994 1993 (in millions) Actuarial present value of benefits Fully eligible active plan participants. . $ (9.3) $ (11.7) Other active plan participants . . . . . . (58.5) (63.7) Retirees and beneficiaries . . . . . . . . (68.6) (61.5) Projected APBO . . . . . . . . . . . . . (136.4) (136.9) Unamortized transition obligation. . . . . . 96.8 102.2 Unrecognized net loss resulting from experience different from that assumed and effects of changes in assumptions. . . 7.5 17.0 Accrued postretirement benefit obligation at December 31 . . . . . . . . . . . . . . $ (32.1) $ (17.7)\nThe following assumptions were used to determine the APBO:\n1994 1993 1992\nDiscount rate. . . . . . . . . . 8.5% 7.5% 8.5%\nHealth care cost trend rate, gradually declining to 5%. . . 8.0-12.0% 8.0-12.0% 8.0-12.0%\nYear ultimate trend rates achieved . . . . . . . . . . . 2007 2007 2007\nIncreasing the health care cost trend rate by one percentage point in each year would increase the APBO by approximately $17 million and $19 million for 1994 and 1993, respectively, and the aggregate of the service and interest cost components of the postretirement benefit cost for 1994 and 1993 by approximately $2.5 million and $2 million, respectively.\nIn accordance with the February 1995 Order, Energy will recover the cost of postretirement benefits other than pensions on an accrual basis commencing February 1995. Prior to the recovery of these costs in customers' rates on an accrual basis, the difference between postretirement benefit costs determined in accordance with the provisions of Statement 106 and the costs determined in accordance with Energy's previous accounting practice was deferred for future recovery. Energy's deferrals totaled $21 million as of December 31, 1994. Commencing February 1995, approximately $6 million of costs deferred for the period January 1, 1993, to July 31, 1993, will be recovered over a five-year period. Recovery over a five-year period of the remaining deferrals is being requested in Energy's July 1994 retail rate petition.\n9. Voluntary Workforce Reduction\nIn an effort to begin to realize merger savings, Energy completed a voluntary workforce reduction program in 1994. Under the program, 169 employees elected to terminate their employment with Energy, resulting in a pre-tax cost of approximately $11.3 million. This cost was deferred as a cost to achieve merger savings. In accordance with the February 1995 Order, Energy began amortization of costs to achieve merger savings October 1, 1994.\n10. Notes Payable\nEnergy had authority to borrow up to $330 million as of December 31, 1994. In connection with this authority, Energy has established unsecured lines of credit (Committed Lines) which currently permit borrowings of up to $230 million, of which $110 million remained unused. Energy also issues commercial paper from time to time. All outstanding commercial paper is supported by Energy's Committed Lines. Additionally, this authority allows Energy to arrange for additional short-term borrowings with various banks on an \"as offered\" basis (Uncommitted Lines). All Uncommitted Lines provide for maturities of up to 365 days with various interest rate options.\nAmounts outstanding under the Committed Lines would become immediately due upon an event of default which includes non-payment, default under other agreements governing company indebtedness, bankruptcy, or insolvency. Certain of the Uncommitted Lines have similar default provisions. The Committed Lines are maintained by commitment fees, which were immaterial during the 1992 through 1994 period.\nFor the years 1994, 1993, and 1992, Energy's short-term borrowings outstanding at various times were as follows: Weighted Weighted Maximum Average Average Average Amount Amount Interest Balance Interest Outstanding Outstanding Rate at Rate at at Any During the During Dec. 31 Dec. 31 Month-end Year the Year (dollars in millions) Bank loans. . . . . . $139.4 6.19% $298.9 $246.6 4.73% Commercial paper. . . - - 7.9 1.0 4.22 Note payable to CINergy . . . . . . 54.2 5.76 54.2 54.0 5.39\nBank loans. . . . . . 126.7 3.38 126.7 69.8 3.41 Commercial paper. . . - - 24.8 6.4 3.29\nBank loans. . . . . . 120.8 3.91 120.8 77.3 4.02 Commercial paper. . . - - 30.7 8.2 3.82\n11. Fair Values of Financial Instruments\nThe estimated fair values of financial instruments were as follows (this information does not purport to be a valuation of Energy as a whole):\nDecember 31 December 31 1994 1993 Carrying Fair Carrying Fair Financial Instrument Amount Value Amount Value (in millions)\nLong-term debt (includes amounts due within one year) First mortgage bonds. . . $315 $326 $265 $314 Other long-term debt. . . 623 586 551 580\nThe following methods and assumptions were used to estimate the fair values of each major class of financial instrument:\nCash and temporary cash investments, restricted deposits, and notes payable Due to the short period to maturity, the carrying amounts reflected on the Consolidated Balance Sheets approximate fair values.\nLong-term debt The fair values of long-term debt issues were estimated based on the latest quoted market prices or, if not listed on the New York Stock Exchange, on the present value of future cash flows. The discount rates used approximate the incremental borrowing costs for similar instruments.\n12. Income Taxes\nEffective with the first quarter of 1993, Energy implemented the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (Statement 109). Statement 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of existing differences between the financial reporting and tax reporting bases of assets and liabilities. Net-of-tax accounting and reporting is prohibited. Energy adopted this new accounting standard as the cumulative effect of a change in accounting principle with no restatement of prior periods. The adoption of Statement 109 had no material effect on Energy's earnings.\nIn August 1993, Congress enacted the Omnibus Budget Reconciliation Act of 1993, which included a provision to increase the Federal corporate income tax rate from 34% to 35%, retroactive to January 1, 1993. In accordance with the provisions of Statement 109, the income tax rate increase resulted in an increase in the net deferred income tax liability and recognition of a regulatory asset to reflect expected future recovery of the increased liability through rates charged to customers.\nThe significant components of Energy's net deferred income tax liability at December 31, 1994, and 1993, are as follows:\n1994 1993 (in millions) Deferred Income Tax Liabilities Electric utility plant. . . . . . . . . . . . $308.0 $305.4 Unamortized costs of reacquiring debt . . . . 15.8 15.0 Deferred operating expenses and accrued carrying costs. . . . . . . . . 11.4 4.2 Deferred demand-side management costs . . . . 37.2 21.2 Other . . . . . . . . . . . . . . . . . . . . 13.7 13.1 Total deferred income tax liabilities . . . 386.1 358.9\nDeferred Income Tax Assets Unamortized investment tax credits. . . . . . 22.9 24.5 Litigation settlement . . . . . . . . . . . . 29.8 29.8 Accrued pension and other benefit costs . . . 6.1 5.4 Other . . . . . . . . . . . . . . . . . . . . 2.6 17.8 Total deferred income tax assets. . . . . . 61.4 77.5\nNet Deferred Income Tax Liability . . . . . . . $324.7 $281.4\nA summary of Federal and state income taxes charged (credited) to income and the allocation of such amounts is as follows:\n1994 1993 1992 (in millions)\nCurrent Income Taxes Federal . . . . . . . . . . . . . . . . . . . $22.0 $ .6 $47.3 State . . . . . . . . . . . . . . . . . . . . 5.5 .4 7.4 Total current income taxes. . . . . . . . . 27.5 1.0 54.7\nDeferred Income Taxes Federal Depreciation and other electric utility plant-related items . . . . . . . . . . . 19.2 9.6 7.5 Loss related to settlement of the IURC's June 1987 and April 1990 Orders (Note 2). (5.2) 45.9 - Property taxes. . . . . . . . . . . . . . . (2.0) 2.0 - Demand-side management costs. . . . . . . . 12.6 10.6 5.3 Other items - net . . . . . . . . . . . . . 1.7 (2.7) (.8) Total deferred Federal income taxes . . . 26.3 65.4 12.0\nState . . . . . . . . . . . . . . . . . . . . 2.2 7.0 1.3 Total deferred income taxes . . . . . . . 28.5 72.4 13.3\nInvestment Tax Credits - Net. . . . . . . . . . (4.3) (4.2) (4.4)\nTotal Income Taxes. . . . . . . . . . . . $51.7 $69.2 $63.6\nAllocated to: Operating income. . . . . . . . . . . . . . . $50.4 $64.9 $66.4 Other income and expenses - net . . . . . . . 1.3 4.3 (2.8) $51.7 $69.2 $63.6\nAs a result of the merger, Resources will file its final consolidated Federal and state income tax returns for the period January 1, 1994, through October 24, 1994. This return will include Energy to the extent its activities are allocable to that period. For the remainder of Energy's taxable income and tax liability, Energy will participate in the filing of a consolidated Federal income tax return with its parent, CINergy, and other affiliated companies for the year ended December 31, 1994. The current tax liability is allocated among the members of the group pursuant to a tax sharing agreement consistent with Rule 45(c) of the PUHCA.\nFederal income taxes, computed by applying the statutory Federal income tax rate to book income before Federal income tax, are reconciled to Federal income tax expense reported in the Consolidated Statements of Income as follows:\n1994 1993 1992 (in millions)\nStatutory Federal income tax provision. . . . . $44.2 $65.3 $55.0 Increases (Reductions) in taxes resulting from: Amortization of investment tax credits. . . . (4.3) (4.2) (4.4) Depreciation and other electric utility plant-related differences . . . . . . . . . 1.8 4.1 4.2 AFUDC equity. . . . . . . . . . . . . . . . . (1.5) (3.9) (1.6) Other - net . . . . . . . . . . . . . . . . . 3.8 .5 1.7 Federal income tax expense. . . . . . . . . . . $44.0 $61.8 $54.9\n13. Commitments and Contingencies\n(a) Construction Energy will have substantial commitments in connection with its construction program. Aggregate expenditures for Energy's construction program for the 1995 through 1999 period are currently estimated to be approximately $1 billion.\nIn connection with Energy's Clean Coal Project, Energy has a 25-year contractual agreement with Destec Energy, Inc. (Destec) which requires Energy to pay Destec a fixed monthly fee plus certain monthly operating expenses once the facility is operational. Over the next five years (1995 through 1999), the fixed fee will be $56 million, and the variable fee is estimated at $95 million. As previously discussed, Energy received authorization in the February 1995 Order to defer these costs for subsequent recovery in an IURC order associated with Energy's July 1994 retail rate petition.\n(b) Manufactured Gas Plants Coal tar residues and other substances associated with manufactured gas plant (MGP) sites have been found at former MGP sites in Indiana, including, but not limited to, sites in Shelbyville and Lafayette, two sites previously owned by Energy. Energy has identified at least 21 MGP sites which it previously owned, including 19 it sold in 1945 to Indiana Gas and Water Company, Inc. (now Indiana Gas Company [IGC]), including the Shelbyville and Lafayette sites.\nThe Shelbyville site has been the subject of an investigation and cleanup enforcement action by the Indiana Department of Environmental Management (IDEM) against IGC and Energy. Without admitting liability, Energy and IGC have conducted an investigation and remedial activities at the Shelbyville site. Energy and IGC are sharing equally in the costs of investigation and cleanup of this site.\nIn 1992, the IDEM issued an order to IGC, naming IGC as a potentially responsible party (PRP) as defined by the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), which requires investigation and remediation of the Lafayette MGP site. IGC entered into an agreed order with the IDEM for the removal of MGP contamination at the site.\nIn April 1993, IGC filed testimony with the IURC seeking recovery of costs incurred in complying with Federal, state, and local environmental regulations related to MGP sites in which it has an interest, including sites acquired from Energy. In its testimony, IGC stated that it would also seek to recover a portion of these costs from other PRPs, including previous owners. IGC has informed Energy of the basis for IGC's position that Energy, as a PRP under CERCLA, should contribute to IGC's response costs related to investigating and remediating contamination at MGP sites which Energy sold to IGC. The IURC has not ruled on IGC's petition. In its July 1994 retail rate petition, Energy is seeking approval to defer, and subsequently recover through rates, any costs it incurs for investigation and remediation of previously owned MGP sites.\nExcept for the Shelbyville site, Energy has not assumed any responsibility to reimburse IGC for its costs for investigating and cleaning up MGP sites. With respect to the Shelbyville site, based upon environmental investigations completed to date, Energy believes that any further required investigation and remediation will not have a material adverse effect on its financial condition or results of operations. At this time, it is premature for Energy to predict the nature, extent, and costs of, or Energy's responsibility for, any environmental investigations and remediations which may be required at other MGP sites owned, or previously owned, by Energy.\n(c) Wabash Valley Power Association, Inc. (WVPA) Litigation In February 1984, WVPA discontinued payments to Energy for its 17% share of Marble Hill, a nuclear project jointly owned by Energy and WVPA which was cancelled by Energy in 1984, and filed suit against Energy in the United States District Court for the Southern District of Indiana (Indiana District Court), seeking $478 million plus interest and other damages to recover its Marble Hill costs. The suit was amended to include as defendants several officers of Energy along with certain contractors and their officers involved in the Marble Hill project, and to allege claims against all defendants under the Racketeer Influenced and Corrupt Organizations Act (RICO). Claims proven and damages allowed under RICO may be trebled and attorneys' fees assessed against the defendants. The suit was further amended to add claims of common law fraud, constructive fraud and deceit, and negligent misrepresentation against Energy and the other defendants.\nIn 1985, Energy and WVPA entered into an agreement under which Energy agreed to place in escrow 17% of all salvage proceeds received from the sales of Marble Hill equipment, materials, and nuclear fuel after May 23, 1985, as a result of WVPA's filing for protection under Chapter 11 of the Federal Bankruptcy Code.\nIn 1989, Energy and its officers reached a settlement with WVPA which, if approved by judicial and regulatory authorities, will settle the suit filed by WVPA. The settlement is also contingent on the resolution of the WVPA bankruptcy proceeding.\nThe principal terms of the settlement are:\n- Energy, on behalf of itself and its officers, will pay $80 million on behalf of WVPA to Rural Utility Services (RUS), previously called the Rural Electrification Administration, and the National Rural Utilities Cooperative Finance Corporation (CFC). The $80 million obligation, net of insurance proceeds, other credits, and applicable income tax effects, was charged to income in 1988 and 1989.\n- WVPA will transfer its 17% ownership interest in the site to Energy, and Energy will assume responsibility for all future costs associated with the site, excluding WVPA's 17% share of future salvage program expenses. Additionally, RUS and CFC will receive the balance in the salvage escrow account and 17% of future salvage proceeds, net of related salvage program expenses.\n- Energy will enter into a 35-year take-or-pay power supply agreement for the sale of 70 megawatts of firm power to WVPA. This power will be supplied from Gibson Unit 1 and will be priced at Energy's firm power rates for service to WVPA. The difference between the revenues received from WVPA and the costs of operating Gibson Unit 1 (the Margin) will be remitted annually by Energy, on behalf of itself and its officers, to RUS and CFC to discharge a $90 million obligation, plus accrued interest. If, at the end of the term of the power supply agreement, the $90 million obligation plus accrued interest has not been fully discharged, Energy must do so within 60 days. The settlement provides that in the event Energy is party to a merger or acquisition, Energy and WVPA will use their best efforts to obtain regulatory approval to price the power sale exclusive of the effects of the merger or acquisition.\nCertain aspects of the settlement are subject to approval by the FERC and potentially by the IURC and the Michigan Public Service Commission. At such time as the necessary approvals from these regulatory authorities are received, Energy will record a $90 million regulatory asset. Concurrently, a $90 million obligation to RUS and CFC will be recorded as a long-term commitment. Recognition of the asset is based, in part, on projections which indicate that the Margin will be sufficient to discharge the $90 million obligation to RUS and CFC, plus accrued interest, within the 35-year term of the power supply agreement. If, in some future period, projections indicate the Margin would not be sufficient to discharge the obligation plus accrued interest within the 35-year term, the deficiency would be recognized as a loss.\nRUS has proposed a plan of reorganization which, similar to WVPA's plan, incorporates the settlement agreement. However, RUS's plan provides for full recovery of principal and interest on WVPA's debt to RUS, which is substantially in excess of the amount to be recovered under WVPA's proposed plan. In 1991, the United States Bankruptcy Court for the Southern District of Indiana (Bankruptcy Court) confirmed WVPA's plan of reorganization and denied confirmation of RUS's opposing plan. The Bankruptcy Court's approval of WVPA's reorganization plan is contingent upon WVPA's receipt of regulatory approval to change its rates. RUS appealed the Bankruptcy Court's decision to the Indiana District Court. In June 1994, the Indiana District Court ruled in favor of WVPA's plan. RUS subsequently appealed this decision. Energy cannot predict the outcome of this appeal, nor is it known whether WVPA can obtain regulatory approval to change its rates. If reasonable progress is not made in satisfying conditions to the settlement by February 1, 1996, either party may terminate the settlement agreement.\n14. Jointly Owned Plant\nEnergy is a joint owner of Gibson Unit 5 with WVPA and the Indiana Municipal Power Agency (IMPA). Additionally, Energy is a co-owner with WVPA and IMPA of certain transmission property and local facilities. These facilities constitute part of the integrated transmission and distribution systems which are operated and maintained by Energy. The Consolidated Statements of Income reflect Energy's portion of all operating costs associated with the commonly owned facilities.\nEnergy's investment in jointly owned plant is as follows:\n15. Quarterly Financial Data (unaudited)\nOperating Operating Net Quarter Ended Revenues Income Income (in millions)\nMarch 31 . . . . . . . . . . . $ 301 $ 48 $ 35 June 30. . . . . . . . . . . . 280 37 19 September 30 . . . . . . . . . 281 38 20 December 31. . . . . . . . . . 265 29 (a) 8 (a) Total. . . . . . . . . . . . $1 127 $152 $ 82\nMarch 31 . . . . . . . . . . . $ 286 $ 51 $ 35 June 30. . . . . . . . . . . . 221 17 16 September 30 . . . . . . . . . 293 49 36 December 31. . . . . . . . . . 278 48 38 Total. . . . . . . . . . . . $1 078 $165 $125\n(a) In the fourth quarter of 1994, Energy recognized a charge to earnings of approximately $10 million ($6.5 million, net of taxes) for severance benefits to former officers of Energy which the Company does not expect to recover from customers due to a rate settlement related to securing support for the merger. The total $10 million charge is reflected in \"OPERATING EXPENSES - Other operation\".\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nBoard of Directors\nReference is made to PSI Energy, Inc.'s (Energy) 1995 Information Statement with respect to identification of directors and their current principal occupations. In addition, reference is made to Energy's 1995 Information Statement regarding compliance with Section 16 of the Securities Exchange Act of 1934.\nExecutive Officers\nThe information included in Part I of this report on pages 9 through 11 under the caption \"Executive Officers of the Registrant\" is referenced in reliance upon General Instruction G to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is made to Energy's 1995 Information Statement with respect to executive compensation.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nReference is made to Energy's 1995 Information Statement with respect to security ownership of certain beneficial owners, security ownership of management, and changes in control.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to Energy's 1995 Information Statement concerning 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) Financial Statements and Schedules.\nRefer to the page captioned \"Index to Financial Statements and Financial Statement Schedules\", page 30 of this report, for an index of the financial statements and financial statement schedules included in this report.\n(b) Reports on Form 8-K.\nThe following report on Form 8-K was filed during the last quarter of 1994:\nDate of Report Items Filed\nDecember 9, 1994 Item 5. Other Events Item 7. Financial Statements and Exhibits\n(c) Exhibits.\nCopies of the documents listed below which are identified with an asterisk (*) have heretofore been filed with the Securities and Exchange Commission and are incorporated herein by reference and made a part hereof. Exhibits not so identified are filed herewith.\nExhibit Designation Nature of Exhibit\n3-a *Amended Articles of Consolidation, as amended to May 11, 1994. (Exhibit to PSI Energy, Inc.'s (Energy) September 30, 1994, Form 10-Q in File No. 1-3543.)\n3-b By-laws, as amended March 3, 1995.\n4-a *Original Indenture (First Mortgage Bonds) dated September 1, 1939, between Energy and The First National Bank of Chicago, as Trustee (Exhibit A-Part 3 in File No. 70-258), and LaSalle National Bank as Successor Trustee (Supplemental Indenture dated March 30, 1984).\n4-b *Nineteenth Supplemental Indenture between Energy and The First National Bank of Chicago dated January 1, 1972. (Exhibit to File No. 2-42545.)\n4-c *Twenty-third Supplemental Indenture between Energy and The First National Bank of Chicago dated January 1, 1977. (Exhibit to File No. 2-57828.)\n4-d *Twenty-fifth Supplemental Indenture between Energy and The First National Bank of Chicago dated September 1, 1978. (Exhibit to File No. 2-62543.)\n4-e *Twenty-seventh Supplemental Indenture between Energy and The First National Bank of Chicago dated March 1, 1979. (Exhibit to File No. 2-63753.)\nExhibit Designation Nature of Exhibit\n4-f *Thirty-fifth Supplemental Indenture between Energy and The First National Bank of Chicago dated March 30, 1984. (Exhibit to Energy's 1984 Form 10-K in File No. 1-3543.)\n4-g *Thirty-ninth Supplemental Indenture between Energy and The First National Bank of Chicago dated March 15, 1987. (Exhibit to Energy's 1987 Form 10-K in File No. 1-3543.)\n4-h *Forty-first Supplemental Indenture between Energy and The First National Bank of Chicago dated June 15, 1988. (Exhibit to Energy's 1988 Form 10-K in File No. 1-3543.)\n4-i *Forty-second Supplemental Indenture between Energy and The First National Bank of Chicago dated August 1, 1988. (Exhibit to Energy's 1988 Form 10-K in File No. 1-3543.)\n4-j *Forty-fourth Supplemental Indenture between Energy and The First National Bank of Chicago dated March 15, 1990. (Exhibit to Energy's 1990 Form 10-K in File No. 1-3543.)\n4-k *Forty-fifth Supplemental Indenture between Energy and The First National Bank of Chicago dated March 15, 1990. (Exhibit to Energy's 1990 Form 10-K in File No. 1-3543.)\n4-l *Forty-sixth Supplemental Indenture between Energy and The First National Bank of Chicago dated June 1, 1990. (Exhibit to Energy's 1991 Form 10-K in File No. 1-3543.)\n4-m *Forty-seventh Supplemental Indenture between Energy and The First National Bank of Chicago dated July 15, 1991. (Exhibit to Energy's 1991 Form 10-K in File No. 1-3543.)\n4-n *Forty-eighth Supplemental Indenture between Energy and The First National Bank of Chicago dated July 15, 1992. (Exhibit to Energy's 1992 Form 10-K in File No. 1-3543.)\n4-o *Forty-ninth Supplemental Indenture between Energy and The First National Bank of Chicago dated February 15, 1993. (Exhibit to Energy's 1992 Form 10-K in File No. 1- 3543.)\nExhibit Designation Nature of Exhibit\n4-p *Fiftieth Supplemental Indenture between Energy and The First National Bank of Chicago dated February 15, 1993. (Exhibit to Energy's 1992 Form 10-K in File No. 1- 3543.)\n4-q *Fifty-first Supplemental Indenture between Energy and The First National Bank of Chicago dated February 1, 1994. (Exhibit to Energy's 1993 Form 10-K in File No. 1-3543.)\n4-r *Indenture (Secured Medium-term Notes, Series A), dated July 15, 1991, between Energy and The First National Bank of Chicago, as Trustee. (Exhibit to Energy's Form 10-K\/A in File No. 1-3543, Amendment No. 2, dated July 15, 1993.)\n4-s *Indenture (Secured Medium-term Notes, Series B), dated July 15, 1992, between Energy and The First National Bank of Chicago, as Trustee. (Exhibit to Energy's Form 10-K\/A in File No. 1-3543, Amendment No. 2, dated July 15, 1993.)\n10-a *+Energy Supplemental Retirement Plan amended and restated December 16, 1992, retroactively effective January 1, 1989. (Exhibit to Energy's 1992 Form 10-K in File No. 1-3543.)\n10-b *+Energy Excess Benefit Plan, formerly named the Supplemental Pension Plan, amended and restated December 16, 1992, retroactively effective January 1, 1989. (Exhibit to Energy's 1992 Form 10-K in File No. 1-3543.)\n10-c *+Employment Agreement dated October 4, 1993, among CINergy Corp. (CINergy), Energy, and John M. Mutz. (Exhibit to Energy's September 30, 1993, Form 10-Q in File No. 1-3543.)\nExhibit Designation Nature of Exhibit\n10-d *Text of Settlement Agreement dated October 27, 1993, by and among PSI Resources, Inc., Energy, The Cincinnati Gas & Electric Company (CG&E), CINergy, IPALCO Enterprises, Inc., Indianapolis Power & Light Company, James E. Rogers, John R. Hodowal, and Ramon L. Humke (together with the exhibits and schedules thereto). (Exhibit to Energy's Form 8-K in File No. 1-3543, dated October 27, 1993.)\n10-e *+Amended and Restated Employment Agreement dated July 2, 1993, among PSI Resources, Inc., Energy, CG&E, CINergy, CINergy Sub, Inc., and James E. Rogers, Jr. (Exhibit to CINergy's Amendment No. 3 to Form S-4, filed October 8, 1993.)\n10-f *+Amended and Restated Employment Agreement dated October 24, 1994, among CG&E, CINergy Corp. (an Ohio corporation), CINergy (a Delaware corporation), PSI Resources, Inc., Energy, and Jackson H. Randolph. (Exhibit to CINergy's 1994 Form 10-K in File No. 1-11377.)\n10-g *+Employment Agreement dated January 1, 1995, among CINergy, CG&E, CINergy Services, Inc., CINergy Investments, Inc., Energy, and William J. Grealis. (Exhibit to CINergy's 1994 Form 10-K in File No. 1-11377.)\n21 Not Applicable.\n23 Consent of Independent Public Accountants.\n24 Power of Attorney.\n27 Financial Data Schedule (included in electronic submission only).\n____________________\n+ Management contract, compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPSI ENERGY, INC. Registrant\nDated: March 28, 1995\nBy Jackson H. Randolph Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nSignature Title Date James K. Baker Director Hugh A. Barker Director Michael G. Browning Director Kenneth M. Duberstein Director John A. Hillenbrand, II Director Emerson Kampen Director John M. Mutz President and Director Melvin Perelman, Ph.D. Director Van P. Smith Director\nJames E. Rogers Vice Chairman, Chief Operating March 28, 1995 Attorney-in-fact for all Officer and Director the foregoing persons\nJ. Wayne Leonard Senior Vice President, Chief March 28, 1995 Financial Officer and Director (Principal Financial Officer)\nJackson H. Randolph Chairman, Chief Executive March 28, 1995 Officer and Director (Principal Executive Officer)\nCharles J. Winger Comptroller March 28, 1995 (Principal Accounting Officer)","section_15":""}
{"filename":"742126_1994.txt","cik":"742126","year":"1994","section_1":"ITEM 1. BUSINESS\nAmerican Ecology Corporation and its subsidiaries (hereinafter collectively referred to as the \"Company\" unless the context indicates otherwise) provide processing, packaging, transportation, remediation and disposal services for generators of hazardous waste and low-level radioactive waste. Hazardous waste consists primarily of industrial waste, including waste regulated under the Resource Conservation and Recovery Act of 1976, as amended (\"RCRA\"), the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\" or \"Superfund\"), and the Toxic Substance Control Act (\"TSCA\"). Low- level radioactive waste (\"LLRW or \"low-level waste\") consists of materials contaminated with low-levels of radioactivity and is generated by nuclear power facilities, industry, hospitals, universities, laboratories and other research facilities. In 1994, 65% of the Company's revenues were derived from hazardous waste services and 35% of the Company's revenues were derived from LLRW services.\nThe Company completed two acquisitions in 1994. In September 1994, the Company acquired a LLRW processing and recycling facility (the \"Recycle Center\") from Quadrex Corporation (\"Quadrex\") in exchange for assuming approximately $28.4 million of the facility's net liabilities. The Recycle Center is one of six such LLRW processing facilities in the United States and provides decontamination, recycling, compaction and other processing services for LLRW generated primarily by nuclear utilities and the federal government. For more information on the Recycle Center, see \"- Low-Level Radioactive Waste Services - LLRW Processing and Recycling Services at the Recycle Center\". On December 31, 1994, the Company acquired Gibraltar Chemical Resources, Inc. (\"Gibraltar\") from Mobley Environmental Services, Inc. Gibraltar was subsequently renamed American Ecology Environmental Services Corporation (\"AEESC\" or \"Winona facility\"). The total acquisition price of $10.6 million consisted of cash, a note, working capital advances, re-payment of debt, and other assumed liabilities. The acquired facility, located in Winona, Texas, includes two deepwell disposal systems and fuels blending and solvent recycling operations. For more information on the Company's Winona facility, see \"-- Hazardous Waste Services - - -- Stabilization and Disposal Services -- Winona, Texas Facility\" and \"Hazardous Waste Services -- Fuels Blending and Solvent Recycling\".\nThe Company generally performs its operations through its wholly owned subsidiaries. The Company's material subsidiaries are: US Ecology, Inc., a California corporation (\"US Ecology\"), Texas Ecologists, Inc., a Texas corporation wholly owned by US Ecology (\"Texas Ecologists\"); American Ecology Recycle Center, Inc., a Delaware corporation (\"AERC\"), American Ecology Environmental Services Corporation, a Texas corporation (\"AEESC\"), American Ecology Services Corporation, a Delaware corporation (\"AESC\"), WPI Transportation, Inc., a Texas corporation wholly owned by AESC (\"WPI Transportation\"), Transtec Environmental, Inc., an Ohio corporation wholly owned by AESC (\"Transtec\"), WPI Waste Carriers, Inc, a Texas corporation wholly owned by AESC (\"WPI Waste Carriers\"), and American Liability and Excess Insurance Company, a Vermont corporation.\nThe Company and its predecessors have been in business for over 40 years. The Company was originally incorporated in California in October 1983. In May 1987, the Company was reincorporated as a Delaware corporation by merger into a newly formed wholly-owned subsidiary incorporated in Delaware for that purpose.\nHAZARDOUS WASTE SERVICES\nThe Company provides a variety of hazardous waste management services to its customers including stabilization, solid waste disposal, aqueous waste disposal, fuels blending and solvent recovery. The Company's customers are generally in the chemical, petroleum, manufacturing, electronics and transportation industries.\nThe hazardous waste management services provided by the Company are generally performed pursuant to non-exclusive service agreements that obligate the Company to accept hazardous waste from the customer. Fees are determined by such factors as the chemical composition and volume or weight of the wastes involved, the type of transportation or processing equipment used and distance to the processing or disposal facility. The Company periodically reviews and adjusts the fees charged for its services.\nPrior to performing services for a customer, the Company's specially trained personnel review the waste profile\nsheet prepared by the customer which contains information about the chemical composition of the waste. A sample of the waste may be analyzed in a Company laboratory or in an independent laboratory to enable the Company to recommend and approve the best method of transportation, treatment and disposal. Upon arrival at one of the Company's facilities, and prior to unloading, a sample of the delivered waste is analyzed to confirm that it conforms to the customer's waste profile sheet.\nSTABILIZATION AND DISPOSAL SERVICES\nThe Company operates two of the eighteen commercial hazardous waste landfill disposal sites in the United States. The facilities are located in Robstown, Texas and Beatty, Nevada. In addition, as a result of the Winona facility acquisition, the Company also operates one of the nation's nine commercial deepwell disposal facilities, located in Winona, Texas. These operations primarily serve the needs of hazardous waste generators in the Gulf Coast and West Coast regions of the country.\nThe Robstown and Beatty facilities may dispose of only solid wastes. The two facilities also have the ability to stabilize waste for disposal. Stabilization involves the mixing of sludges and certain wet wastes with cement, lime or other solidifying and stabilizing agents to prevent leaching under acidic conditions. These facilities are sited, designed, constructed, operated and monitored to provide long-term containment of the waste in accordance with regulatory requirements. The Winona deepwell disposal system accepts only liquid wastes. The Company also maintains two closed hazardous waste landfills previously operated by the Company in Sheffield, Illinois. See \"-Closed Facilities\" for more detailed information about these closed facilities. The following sections describe the Company's active hazardous waste disposal facilities.\nBeatty, Nevada Facility. The Company's Beatty, Nevada hazardous waste landfill site is located on 80 acres of land 11 miles southeast of Beatty, Nevada in the Amargosa Desert, approximately 100 miles northwest of Las Vegas and 8 miles northeast of Death Valley and the California border. The Company leases the site from the State of Nevada pursuant to a 1977 lease which provides for an initial 20-year term, with a 10-year option for renewal. The waste site is operated under license from the State of Nevada. The State of Nevada charges waste fees which are deposited in state maintained trust funds for closure and perpetual care and maintenance. These funds contained approximately $8.4 million as of December 31, 1994.\nThe facility has approximately 1.5 million cubic yards of remaining capacity. In 1994, 1993 and 1992, 202,000, 147,000 and 111,000 cubic yards of waste, respectively, were disposed of at the facility. The hazardous waste site was opened in 1970 and operates under authority from the Nevada Department of Conservation and Natural Resources and the Environmental Protection Agency's (\"EPA\") Region IX. It is also subject to regulations of the U.S. Department of Transportation (\"DOT\") relating to methods of handling, packaging and transporting chemical waste. Disposal operations at the Beatty site involve stabilization of certain wastes to meet land disposal criteria, and the burial of chemical waste in secure landfill cells which are engineered, constructed operated and monitored so as to provide for the long-term containment of the waste. During 1988, the Beatty site received its RCRA Part B five-year permit from the EPA and the State of Nevada. The renewal application for the Part B permit was submitted to the State of Nevada in January 1993 and is expected to be renewed in 1995.\nThe Beatty site is one of seven landfill sites in the United States which are authorized by the EPA under TSCA to receive and dispose of certain types of solid polychlorinated biphenyls (\"PCBs\"). This authority was issued jointly to the Company and the State of Nevada by EPA Region IX. The disposal of PCBs accounted for approximately 21% and 27% of the Beatty site's total volumes in 1994 and 1993, respectively. In November 1989, the Company was issued a five- year permit which allows the Company to continue to dispose of non-liquid PCBs at the Beatty site. A permit renewal application was submitted to the Nevada Department of Conservation and Natural Resources and Division of Environmental Protection in accordance with RCRA requirements in 1994 and is expected to be renewed for another five year period in 1995. In February 1990, the Company received written confirmation from the EPA that the Beatty site was currently authorized to accept CERCLA clean-up waste for disposal.\nRobstown, Texas Facility. The Company owns 400 acres of land near Robstown, Texas, located 15 miles west of Corpus Christi, and operates a hazardous waste disposal site on 240 acres of the land. The site is operated under the regulations of, and a permit issued by, the Texas Natural Resource Conservation Commission (\"TNRCC\"). In addition to TNRCC regulation, the site is subject to EPA and DOT regulation. In 1988, the Robstown site was permitted under RCRA for a five-year period. A permit renewal application was submitted to the TNRCC in accordance with RCRA requirements and renewal for a five-year period is expected to occur in 1995. Disposal operations at the Robstown site involve the burial of hazardous waste in secure landfill cells which are engineered, constructed, operated, and monitored so as to provide for the long- term containment of the waste.\nGroundwater at the Robstown site is monitored through the use of an extensive well system. In 1978, an analysis of the non-potable aquifer underlying the site showed the presence of chemical contamination. The Company has no evidence that the contaminants have migrated beyond the permitted site boundaries and continues to address corrective action plans in connection with the permitting process. The Company is currently operating a non-commercial deep-injection well at the facility for the disposal of contaminated groundwater and leachate in order to comply with its groundwater cleanup program.\nThe facility is currently the only operating commercial landfill in Texas with a RCRA Part B hazardous waste disposal permit. The facility serves a wide range of industries including refining, petrochemical, agricultural and manufacturing. In operation since 1972, the facility has disposed of more than 840,000 cubic yards of hazardous waste and there are approximately 3 million cubic yards of remaining capacity. In 1994, 1993 and 1992, 68,000 47,000 and 51,000 cubic yards of waste, respectively, were disposed of at the facility.\nWinona, Texas Facility. The Winona facility is a 179-acre fuels blending and solvent recycling facility with two hazardous waste deepwells. The first deepwell has been in operation since 1981 and currently can accept waste at a rate of 50 gallons per minute. The deepwell accepts both hazardous and non- hazardous liquid industrial wastes that are not suitable for recycling or landfill disposal. The deepwell accepts aqueous wastestreams, including spent acids, landfill leachates, rinse water, storm water from contaminated containment areas, and wastewaters with heavy metal content. Wastes remaining from the facility's fuels blending and solvent recycling processes are also injected into its deepwell. The second deepwell, which was constructed in 1991, is expected to receive final EPA approval and commence operation in the second quarter of 1995. The second deepwell will have a capacity of 200 gallons per minute and will expand the facility's capacity and increase its flexibility in handling wastestreams. The facility's permits allow receipt of most categories of liquid wastes except for PCBs, dioxins, radioactive materials, and biological wastes. Prior to the injection of any wastes, the facility's laboratory conducts tests on the wastes to ensure that the materials are compatible with the geological characteristics of the formation surrounding the Company's two hazardous waste deepwells. In 1994, 1993 and 1992, 11 million, 12 million and 21 million gallons of waste, respectively, were disposed of at the facility.\nThe Winona site was selected for its favorable geological characteristics for deepwell injection and the absence of any nearby oil and gas production. Its two wells are completed to a depth of approximately 5,500 feet in the Woodbine formation, which is highly porous and permeable. The formation is separated from sources of drinking water by impermeable layers of shale and limestone. In order for the facility to commence deepwell operations without incurring the added costs of treating the hazardous waste, it was required to obtain from the EPA an exemption from the land disposal restrictions based on proof of \"no-migration\". To obtain the exemption, the facility was required to demonstrate to the satisfaction of the EPA that the wastes would not migrate from the geological zone into which the wastes are injected for at least 10,000 years.\nCompetition. In the Gulf Coast market for solid hazardous waste disposal, the Company primarily competes with a hazardous waste landfill in Oklahoma and a landfill in Louisiana. Each of these facilities offers similar disposal capabilities, and competition is based on the level of ongoing service provided to the customer, distance from the waste site to the landfill and price. In the Gulf Coast market for liquid hazardous waste disposal services, the Company competes primarily with three other deepwell facilities, two facilities in Houston, Texas; and a facility in Corpus Christi, Texas. In the West Coast market for solid hazardous waste disposal, the Company competes with three hazardous waste landfills in California, one in Utah, and one in Idaho.\nTRANSPORTATION SERVICES\nGeneral. As a complement to its disposal operations, the Company also offers hazardous waste transportation services to its customers. The Company's waste transportation operations focus on the Gulf Coast market. The Company transports both hazardous and non-hazardous solid and liquid wastes generally by truck or trailer from a waste site to a disposal or treatment facility, such as a landfill or incinerator. Hazardous waste is transported by the Company primarily in specially-constructed vehicles designed to comply with applicable regulations and specifications of the DOT. The Company's hazardous waste fleet includes 34 tractors and 43 trailers. Liquid waste is frequently transported in bulk, but also may be transported in drums. Heavier sludges and bulk solids are transported in sealed roll-off boxes or bulk trailers.\nThe Company also operates a scheduled, containerized hazardous waste collection service in the Gulf Coast market called Surecycle(R), which provides small quantity generators with comprehensive waste management services that includes waste analysis, technical advice, labeling, manifesting, collecting, transporting, treating and disposing of hazardous wastes. An important feature of the Surecycle(R) program is the use of intermediate bulk containers as a replacement for drums in many applications.\nCompetition. The hazardous and non-hazardous waste transportation business is highly fragmented, with no company having established itself as a national competitor. There are numerous local and regional companies providing solid or liquid hazardous waste transportation services. Many of the large environmental services companies have transportation divisions; however, most of these companies with fixed-based disposal landfills or incinerators primarily use their transportation divisions to provide services to customers where the contract stipulates disposal or treatment at their own facilities.\nREMEDIATION SERVICES\nThe Company also performs site remediation services and specialized hazardous waste services to a limited extent, using a variety of equipment and technologies to implement specific waste removal and clean-up plans. Most site remediation projects are bid by the Company based on the customer's project specifications, with the contract awarded to the lowest qualified bidder on a unit price basis. Remediation services are generally provided in conjunction with disposal services by the Company. The remediation market is highly competitive and the Company does not have a significant presence in the market.\nFUELS BLENDING AND SOLVENT RECYCLING SERVICES\nAs a result of its acquisition of the Winona facility in December 1994, the Company expanded its hazardous waste services in the Gulf Coast Region to include two important new services: fuels blending and solvent recycling. These two new services have enabled the Company to substantially increase the range of waste services that it provides to its existing transportation and disposal customers and have added new customers to the Company's client base.\nA substantial portion of the organic wastes received at the Winona facility is placed into its fuels blending operations. The Company blends these wastes into fuels to meet specifications prescribed for use in cement kilns. The Company also employs a thinfilm evaporator for reclaiming limited quantities of certain waste solvents. In this process, a solvent is mechanically wiped onto a steam-heated metal surface in extremely thin layers, causing most of the solvent to evaporate and be condensed as a liquid. Reclaimed solvents, which include metal cleaning and paint solvents and freon, are sold to end-users or returned to the customer who generated them. Wastes that are separated from the reclaimed solvent are used in the fuels blending process or injected into the Company's deepwell.\nThe Company also receives waste in bulk shipments through specialized containers that are picked up at the customer,s site, placed on rail for shipment to the railroad,s transfer facility and then delivered to the Winona facility. This method of transportation is more efficient for long-distance shipments than truck transportation. In addition, the Winona facility maintains a rail spur transhipment facility nearby that provides the capability of transferring certain wastes from railcar to the facility.\nCompetition. In fuels blending services, the Company primarily competes with several Texas competitors. Competition is generally based upon overall services provided to the customer, distance from the customer, price and off- site disposal fees.\nLOW-LEVEL RADIOACTIVE WASTE SERVICES\nRadioactive waste is generally classified as either high-level or low- level. High-level radioactive wastes, such as spent nuclear fuel and waste generated during the reprocessing of spent fuel from nuclear reactors, contain substantial quantities of long-lived radioactive isotopes and require hundreds or thousands of years to decay to safe levels.\nLow-level radioactive waste consists primarily of solid materials containing far less radioactive contamination, generally decaying to safe levels within several decades to approximately 500 years. The Company's LLRW business includes the packaging, transportation, disposal, treatment, recycling and processing of low-level waste. Low-level waste is generated by nuclear power facilities, industry, hospitals, universities, laboratories and other research facilities. This waste consists generally of material such as contaminated equipment, discarded glassware, tools, gloves and protective clothing, radio- pharmaceuticals and other hospital wastes, and laboratory waste materials. This waste generally requires minimal packaging for the protection of the public or employees and is usually packed in metal boxes or 55-gallon drums for transport and disposal.\nThe LLRW services market is generally composed of three segments: (i) disposal, including both commercial and government markets, (ii) commercial processing and volume reduction, and (iii) government services. The Company operates in all three of these segments. The Company's LLRW disposal activities involve the operation of a government-owned landfill site near Richland, Washington. The Company's LLRW commercial processing and volume reduction services include both fixed base processing facilities and service capabilities located at the Oak Ridge, Tennessee Recycle Center which the Company acquired in September 1994. The government services segment activities includes processing, volume reduction and disposal, at US Department of Energy (\"DOE\") and US Department of Defense (\"DOD\") locations. The Recycle Center provides these services and intends to pursue these DOE and DOD markets.\nTHE COMPACT SYSTEM\nThe Low-Level Radioactive Waste Policy Act of 1980 and the Low-Level Radioactive Policy Amendments of 1985 (collectively, the \"Low-Level Act\") established the general framework for the management of commercial LLRW disposal facilities. The Low-Level Act created incentives for states to form formal regional alliances (\"compacts\") as ratified by the U.S. Congress, each containing a designated landfill for use by member states. One state within each compact is required to site and build a permitted landfill on a rotating basis so that continuous disposal capacity for that compact can be maintained.\nThe Low-Level Act also provides that any compact approved by Congress may restrict the use of its disposal facility to low-level waste generated within the member states, and may limit the export of waste from that compact as of January 1, 1993. As a result, in 1992 the Company saw a marked increase in LLRW volumes disposed because of this pending limitation of disposal space availability. Since January 1, 1993, the state of Washington, through the Northwest Compact (Washington, Oregon, Idaho, Montana, Utah, Wyoming, Alaska, and Hawaii), has prohibited disposal of LLRW generated from outside the Northwest Compact at the Company's Richland, Washington facility; however, the Northwest Compact also agreed to accept waste generated by the Rocky Mountain Compact (Nevada, Colorado, and New Mexico). As a result, the implementation of the Low-Level Act has resulted in a reduction of waste receipts at the Company's low-level waste disposal site in Richland, Washington. This restriction is expected to continue in the foreseeable future.\nIt is also possible that, pending the full implementation of the Low-Level Act and the final alignment of compacts, other actions could be taken which would further restrict the ability of LLRW facilities to continue to receive low-level waste. Such actions could include the implementation of additional state-imposed fees, which could further restrict volumes, or the imposition of higher insurance or bonding requirements.\nDISPOSAL SERVICES\nThe Company operates one of the nation's two LLRW disposal facilities operating within the regional compact system, located near Richland, Washington. This facility serves the LLRW disposal needs of the states in the Northwest Compact and the Rocky Mountain Compact. In most instances, the LLRW is delivered to the site either by the generators of the waste or by independent shippers or brokers. The Company is in the process of developing two additional LLRW disposal facilities. The Company also maintains two closed LLRW landfills in Sheffield, Illinois and Beatty, Nevada. See \"-Closed Facilities\" for more detailed information about each of these closed facilities' operations. The following sections describe the Company's active and proposed LLRW disposal operations.\nRichland, Washington Facility. This facility is located on 100 acres, 25 miles northwest of Richland, Washington on the DOE,s Hanford Nuclear Reservation (\"Hanford\") and is operated by the Company. The State of Washington leases the land from the federal government and the Company subleases the land from the State of Washington. In 1990, the Company exercised its option to renew its sublease for another 15-year period. Under the terms of the lease, the site is to be used for LLRW burial and related activities. The primary disposal operations at the site are conducted under a license issued by the State of Washington. The Company's license was renewed for a five-year period in May 1992. The Company also holds a special nuclear materials permit license, reissued in December 1988 for a five-year period by the NRC, which permits burial at Richland of materials containing certain radioactive elements in amounts greater than those permitted under the license issued by the State of Washington. The Company applied for renewal of this special nuclear materials permit in 1993 and continues to operate under the license pending renewal by the NRC, which is expected in 1996 or 1997. \"Special nuclear material\" is not classified as LLRW and consists primarily of reactor-produced materials which contain plutonium, uranium 235 and any material artificially enriched by these isotopes.\nThe disposal rates charged at the Richland facility are regulated by the Washington Utilities Transportation Commission (\"WUTC\"). Rate regulation is designed to set disposal rates sufficient to cover the costs of operation and provide the Company with a reasonable profit margin. In January 1994, the Company entered into a rate settlement covering 1993, 1994 and 1995 calculated to provide the Company with an estimated 29% operating profit margin. Under the settlement, revenues were capped at $4.9 million and $5.1 million in 1994 and 1993, respectively, and will be capped at $5.0 million in 1995. The Company expects to file a new rate setting case with the WUTC to establish rates beginning in January 1996. While the Company cannot predict the exact revenue and profit margin figures to be set by the WUTC, management believes that the rates will not materially differ from those of previous years.\nThe Company charges a base rate per cubic foot for disposal at Richland, which includes amounts for perpetual care and maintenance which are paid into a state trust fund containing approximately $21.3 million as of December 31, 1994. In addition, from January 1990 through December 1992, the Company charged a fee for disposal which was paid into a state maintained site closure trust fund. This closure fund contains approximately $21.3 million as of December 31, 1994. Additionally, the state of Washington charges fees for burial, site surveillance, and user fees to low-level waste generators using the Richland site.\nThe Richland facility is also permitted to accept naturally occurring radioactive materials (\"NORM\") waste from outside the Compact. Although NORM waste disposal historically has represented only a small portion of the Company's business (accounting for 2.6% of LLRW revenues in 1994), the Company believes it may become a more significant business in the future. NORM waste disposal revenues to the Company are not currently regulated. However, the State of Washington has proposed regulations which would limit NORM volume to 8,600 cubic feet per year at the Richland facility and individual generator volume to 1,000 cubic feet per year. The Company has submitted its comments on the proposed regulations to the State of Washington but it is not possible to predict the ultimate form of such regulations or when they might be finally issued.\nProposed Ward Valley, California Facility. In December 1985, the Company was selected as the State of California,s license designee to site, develop and operate a LLRW disposal facility (\"Ward Valley\") in that state to serve the Southwestern Compact (California, Arizona, North Dakota and South Dakota). In September 1993, the California Department of Health Services (\"DHS\") certified its final environmental impact report, issued its\nRecord of Decision on the project, issued a license to the Company to construct and operate the facility and executed a lease of the site with the Company. The license and lease become effective and construction can only begin once the land for the site is conveyed from the U.S. Department of Interior to the State of California. In connection with the development of this LLRW facility, the Company has expended and capitalized $35.0 million, including interest, as of December 31, 1994.\nConstruction and operation of the facility has been delayed in large measure because the federal government has not yet conveyed the land for the facility, located in California's Ward Valley, to the State of California. In January 1993, former Secretary of the Interior in the Bush Administration, Manuel Lujan, decided to sell the Ward Valley site to the State of California. That sale was enjoined, however, as a result of the lawsuit described below. Subsequently, the new Secretary of Interior in the Clinton administration, Bruce Babbitt, rescinded Secretary Lujan's land sale decision and decided to conduct additional federal hearings before determining whether to convey the land. In August 1993, Secretary Babbitt requested that California Governor Pete Wilson hold an adjudicatory hearing on behalf of the U.S. Department of the Interior to provide information that might be relevant to the Secretary's decision on the land transfer, and in September 1993, the Governor agreed to hold such a hearing. In November 1993, Secretary Babbitt sent a letter to Governor Wilson stating that he is postponing further action on his proposed hearing in order to await the final outcome of two state court litigations that had been filed against the project in October 1993. In 1994, Secretary Babbitt asked the National Academy of Sciences (\"NAS\") to conduct an independent review of certain geological issues related to the suitability of the Ward Valley site. The NAS convened a panel in 1994, conducted hearings on the project in June and September 1994, and is expected to issue its findings in May 1995. The Company believes the Secretary of the Interior will not make a land transfer decision until after the release of the NAS report. It is also possible that the Secretary of the Interior will not make a decision until the state court appeal process is concluded and additional federal hearings are conducted.\nTwo lawsuits challenging the decision by DHS to issue a license and a lease to the Company for the construction and operation of the Ward Valley disposal site were filed in the California Superior Court for the County of Los Angeles (the \"License Litigation\") in October 1993. The Company was named as a real party in interest in both lawsuits. In general, the plaintiffs in the License Litigation alleged that the DHS violated various procedural and substantive requirements of the California Radiation Control Law and the California Environmental Quality Act in reaching its license decision and sought to have the facility's license invalidated. In July 1994, one of the plaintiffs in the License Litigation voluntarily dismissed its lawsuit. In June 1994, the judge ruled in favor of the DHS and the Company on all issues with the exception of one. In December 1993, nearly three months after the license had been issued, three geologists from the US Geological Survey issued an unofficial report which suggested that groundwater protection and protection of the Colorado River had not been adequately evaluated by DHS. The trial court concluded this report should be considered by the DHS in a \"pre-approval setting\", and remanded the case to the DHS for reconsideration. Because the DHS determined that the report contained no significant new information, DHS asked the court to reconsider its decision concerning this report. The trial court refused to do so, and cross- appeals of the judge's several rulings were taken by the plaintiffs, DHS and the Company, among others. Briefing on these cross-appeals is expected to conclude in May 1995.\nIn January 1993, a lawsuit was filed against the Secretary of the Interior in federal district court for the Northern District of California to enjoin the intended sale of the land for the Ward Valley site to the State of California on the grounds that the Secretary could not sell the land until he had designated critical habitat for the desert tortoise, a threatened species under the Federal Endangered Species Act, and that the 1990 U.S. Fish and Wildlife Service's (\"FWS\") biologic opinion, which concluded that the project would not jeopardize the continued existence of the desert tortoise, impermissibly failed to analyze the project's potential radiological impacts on the desert tortoise. In February 1994, the U.S. Department of Interior designated approximately 6,400,000 acres in the states of California, Nevada, Utah and Arizona as critical habitat for the desert tortoise. The designation includes the proposed Ward Valley site. Based on these developments, the lawsuit was dismissed without prejudice. Inclusion of the Ward Valley as critical habitat requires the Bureau of Land Management, the EPA and the FWS to consider and weight several factors, including whether the project would result in the destruction or adverse modification of critical habitat. These deliberations are ongoing, however, the Company does not believe that the decisions concerning the project's impact on the desert tortoise and its critical habitat will prevent conveyance of the land to the State of California.\nA second lawsuit was also filed in 1993 against the Secretary of Interior which alleged violations of the National Environmental Policy Act by Secretary Lujan in his decision to transfer the land to the State of California. Based on Secretary Babbitt's decisions later in 1993 to rescind the land transfer and supplement the project's Final Environmental Impact Statement, this action was stayed by agreement of the parties, but technically is still pending in federal district court. The Company is not a defendant in this matter.\nAdditional legal challenges and political delays could delay the opening of the facility to between 1996 and 1999. Assuming the land is transferred and all challenges and appeals to the land transfer and the facility license decision are favorably resolved, the Company expects that the construction and start-up of the facility will take approximately eight to twelve months. It is not possible to assess the ultimate length of the delay at this time, nor can there be any assurance that the land will be transferred. If the land is not transferred or the facility is not established for any reason, the Company may proceed with legal action to protect its rights. Because the reasons for not transferring the land or otherwise preventing the establishment of the facility are not known, the ultimate outcome of any such legal action at this time is uncertain, and there is no assurance that the Company will recover any monetary damages or restitution of its past expenditures. The Company expects to incur expenses of approximately $250,000 per month, excluding interest, until construction begins. These expenses are not currently reimbursable from the Southwestern Compact or any other party. Once the construction period commences, expenditures are expected to be approximately $16 million, excluding interest, including payment for the land.\nIf the California LLRW facility cannot be established and if the Company is unable to recoup its investment through legal recourse, the Company would suffer a loss that would have a material adverse effect on its financial condition.\nProposed Butte, Nebraska Facility. In June 1987, the Company was designated to develop and operate a LLRW disposal facility (\"Butte\") by the Central Interstate Low-Level Radioactive Waste Commission (\"CIC\"). The facility is on a schedule to be completed by 1999 and will cost an estimated $146 million to license, design and construct. Project costs through 1994 totaled $66.1 million. Additional funding of approximately $21 million in the pre-licensing phase of the contract has been authorized by the major generators of the waste in the Central Interstate Compact (Nebraska, Kansas, Oklahoma, Arkansas and Louisiana). The Company's portion of the project costs through 1994, which have been capitalized, totaled $6.1 million, and the Company anticipates no additional investment in the project development prior to construction.\nIn January 1993, the State of Nebraska filed suit against the CIC and the Company asking that the court require the defendants to demonstrate community consent for the facility or withdraw the license application. In October 1993, the court granted the CIC's and the Company's motion for summary judgment dismissing the lawsuit. In June 1994, the U.S. Court of Appeals for the Eight Circuit upheld the lower court's decision. In October 1993, the State of Nebraska filed a similar suit on the same issue of community consent. The court also dismissed this second suit and the dismissal has not been appealed.\nIn December 1993, the County of Boyd, Nebraska and the Boyd County Local Monitoring Committee sued the Company asserting fraud and misrepresentation regarding the community consent requirement for the disposal facility. In July 1994 the federal district court granted the Company's motion for summary judgment and dismissed the lawsuit. In February 1995, the U.S. Court of Appeals for the Eighth Circuit upheld the lower court's decision.\nIn January 1993, the directors of the Nebraska Department of Environmental Quality and the Department of Health issued a Notice of Intent to Deny the Company's license application based on their interpretation of a regulatory requirement. The two agencies took the position that the presence of wetlands included in the proposed site boundaries, even though not in the area to be used for waste disposal, precluded the issuance of the license. The Company contested the decision by initiating an administrative review. Subsequently, the proposed site boundaries were reconfigured to eliminate the presence of wetlands which rendered the Notice of Intent to Deny License moot. In October 1993, the two agencies informed the Company that the Notice of Intent to Deny License for the proposed LLRW facility was withdrawn and the Company's administrative action was dismissed. The Boyd County Local Monitoring Committee appeal of the dismissal was denied in June 1994.\nIn August 1994, the U.S. Corps of Engineers determined that a small wetland, less than one acre in size, exists on the reconfigured site. The disposal of waste will not take place in the area determined to be a wetland by the Corps. The Company does not agree with the Corps' wetland determination. The State of Nebraska has taken no action against the Company's license application as the result of the Corps' wetland determination. However, there can be no assurance that some action will not be taken.\nIt is not presently possible to assess the length of delay that may be experienced prior to construction of the facility. The facility is currently on a schedule for a licensing decision in late 1996 or early 1997. However, there can be no assurance that a license will be issued. The Company expects to incur expenses of approximately $600,000 per month until the license is received. All these expenses are reimbursed monthly by the CIC. Once the two year construction period commences, expenditures are expected to be approximately $50 million excluding interest. Under the present contract with the CIC, this construction expense will be the Company's responsibility.\nCompetition. The Company operates one of the two commercial low-level waste disposal sites operating within the regional compact system in the United States. The Company's Richland, Washington facility operates as the exclusive LLRW disposal site for the Northwest and Rocky Mountain Compacts. The other United States LLRW disposal facility, operated by Chem-Nuclear, a subsidiary of WMX Technologies, Inc., is located near Barnwell, South Carolina, and serves the states of the Southeast Compact (South Carolina, North Carolina, Virginia, Georgia, Florida, Alabama, Mississippi and Tennessee). The Barnwell site is scheduled to close to all generators on December 31, 1995 and a new proposed LLRW site in North Carolina is subsequently expected to serve the Southeast Compact.\nA disposal facility located near Clive, Utah is licensed by the State of Utah to accept NORM and certain types of LLRW. This facility has not been designated as a regional facility under the Low-Level Act. The Clive, Utah facility accepts principally low-level radioactive contaminated soil from clean- up sites. The Company does not generally compete for soil clean-up waste.\nLLRW PROCESSING AND RECYCLING SERVICES AT THE RECYCLE CENTER\nThe commercial processing and volume reduction segment of the LLRW services market includes both fixed-based facilities and service capabilities located at the radioactive waste generator sites. The Company's processing and volume reduction services are conducted through its Recycle Center in Oak Ridge, Tennessee.\nThe Company acquired the Recycle Center from Quadrex in September 1994. The Recycle Center is equipped to process and recycle materials which are contaminated with low levels of radioactivity. The Recycle Center provides services primarily to nuclear power facilities, industrial nuclear generators and the federal government. Historically, the Recycle Center's customers have included a substantial number of public utilities located in the northeast United States. The Recycle Center's principal services include the following:\nMetal Waste Decontamination. Radioactive contaminated metals exist primarily in the form of large components such as pumps, valves, fuel racks, stream generators, and smaller items such as condensers, heat exchangers, racks, stands, pumps and valves. The Recycle Center can decontaminate these metals through an abrasive process, or an acid dip process expected to be operational in the third quarter of 1995.\nDry Active Waste (\"DAW\") Processing. DAW processing services include volume reduction and free release programs. This waste is primarily in the form of wood, glass, clothing, and paper products. The Recycle Center uses its super-compactor to reduce the volume of this waste before it is shipped for disposal. The Recycle Center facility differentiates itself in this service by compacting and\/or baling waste prior to supercompaction. The combination of compacting, binding and super-compacting accomplishes superior volume reduction by reducing the resiliency of the waste material. The Recycle Center also sorts and segregates waste prior to super-compaction.\nGreen is Clean Program. In 1989, the Recycle Center initiated its free release, or Green is Clean program. Under this program, generators place potentially contaminated waste in yellow bags and waste believed to be non- contaminated in green bags. The bags are then shipped to the Recycle Center for radioactivity scanning. Waste\ncertified as non-radioactive undergoes super-compaction and is packaged for disposal in an industrial waste landfill. Radioactive resin that cannot be decontaminated is packaged for disposal in a LLRW facility.\nMotor Refurbishment. Motors, valves, pumps and other components of nuclear power facilities in the United States require periodic maintenance which requires them to be decontaminated before they can be refurbished. The Company can remove radioactive contaminated insulation, decontaminate the motor and rebuild and test the motor with minimal outside service providers. The Company believes that the Recycle Center is the only major facility in the United States combining all of these services.\nScaffolding and Lead Management Services. During maintenance periods, nuclear utilities require the use of scaffolding and lead blankets. The Recycle Center maintains an inventory of approximately two million pounds of scaffolding and 350,000 pounds of lead blankets. The scaffolding and lead blankets are decontaminated, surveyed for release and then rented to the customer.\nCompetition. The Company's competitors in the commercial LLRW processing and recycling market include Scientific Ecology Group (a division of Westinghouse), Chem-Nuclear Systems, Inc., Allied Technology Group, Inc., Frank Hake and Associates, Inc. and Alaron, Inc.\nLLRW PACKAGING AND TRANSPORTATION SERVICES\nThe Company packages and transports small quantities of LLRW from laboratories, hospitals, universities and other commercial facilities to disposal facilities. In 1994, the Company serviced the eastern and mid-eastern United States directly from its Canton, Ohio office. In 1995, the Company expects to consolidate this operation with its Recycle Center operations. The Company may contract with low-level waste generators to pick up waste which is shipped to commercial LLRW sites. The waste is either shipped by the Company in its own vehicles or is shipped by common carriers under subcontract. The Company supplies many of these customers with equipment and material for the packaging, labeling and transportation of the LLRW material. The packaging and transportation market is highly competitive, and the Company does not have a significant presence in the market.\nCLOSED FACILITIES\nThe Company's closed hazardous waste and LLRW disposal facilities are described below.\nSheffield, Illinois Facility. The Company previously operated two hazardous waste disposal sites at Sheffield, Illinois. The sites are located on property owned by the Company on 45 acres adjacent to a closed state-owned LLRW site also previously operated by the Company. One hazardous waste site was opened in 1974 and ceased accepting hazardous waste in 1983. A second closed hazardous waste disposal site occupied less than five acres, and accepted hazardous waste pursuant to Illinois authorization from 1968 through 1974. The two sites were operated and are maintained under federal and state environmental regulations.\nThe Company also maintains a 20-acre LLRW disposal facility three miles southwest of Sheffield, Illinois located on land owned by the State of Illinois. The Company has closed the facility, which last received low-level waste in 1978, and is maintaining the site pursuant to a 1988 Agreed Order settling long- standing litigation between the Company and the State of Illinois.\nIn 1984, the Company submitted for approval a closure and post-closure plan for the hazardous waste disposal sites to the Illinois EPA and to the United States EPA. The regulatory agencies have approved the Company's detailed program for implementation and operation of comprehensive corrective action, but have not approved the Company's closure and post closure plan. The Company believes that its closure and post-closure plan fully satisfies the health and safety needs of the public and all regulatory requirements. Review of the plan by the Illinois EPA and the United States EPA has been suspended pending further implementation of a Remedial Investigation and Feasibility Study. The Illinois EPA could reject the present plan or seek to impose additional closure conditions which, if required, might have a material adverse financial effect upon the Company.\nIn 1982, hazardous waste was detected in site-monitoring wells at one of the two Sheffield facilities and as a result, the Illinois EPA requested that the Company conduct an investigation of the site. The Company completed, pursuant to a 1985 Consent Order, a Remedial Investigation and Feasibility Study of the Sheffield facility. Pursuant to that order, a final Corrective Measures Implementation Plan was issued by the United States EPA in October 1990 and the Company is in the process of implementing this plan. The Company completed its source isolation programs in 1994 and is planning to complete groundwater monitoring and extraction programs in 1995. The Company initially reserved for the estimated costs to provide for the closure and long-term care and maintenance of the Sheffield site in 1988.\nRCRA regulations also require the Company to carry environmental impairment insurance against sudden and accidental occurrences, as well as against non- sudden occurrences such as subsurface migration. See \"--Insurance\". These coverages are not able to be maintained for the Sheffield, Illinois site due to the history of the facility as described above.\nMaxey Flats, Kentucky Facility. Between 1963 and 1978, the Company operated the Maxey Flats, Kentucky LLRW site, a facility that was owned, licensed and maintained by the Commonwealth of Kentucky (the \"Commonwealth\"). In 1978, the Commonwealth entered into an agreement with the Company to permanently close the facility and the Commonwealth agreed, in part, to assume any and all liabilities related to the facility and to exercise responsibility for perpetual care and maintenance of the facility. The Commonwealth later filed a lawsuit against the Company seeking to have that agreement declared invalid. The Company then filed an action against the Commonwealth seeking cost recovery and contribution and to enforce its rights under the agreement. After several federal court decisions in favor of the Company on the issues, in July 1994, the Commonwealth and the Company settled all pending litigation regarding the Maxey flats facility. The Company and the Commonwealth also agreed to cooperate in the resolution of any third party indemnification claims against the Company from potentially responsible parties involved with the facility. The Company estimates that the maximum amount of the Company's share of these third party claims is less than $1.1 million, and the Company has recognized this liability in its 1994 financial statements.\nLLRW Portion of Beatty, Nevada Facility. In December 1992, the governor of Nevada, citing the federal Low-Level Act as authority, issued an executive order for the Company's Beatty, Nevada LLRW disposal site to cease accepting LLRW for disposal. In January 1993, the Company filed a lawsuit challenging that order. In September 1993, the Company and the State of Nevada executed a settlement agreement disposing of all pending litigation between the parties. The settlement resulted in the dismissal of three lawsuits. Two of the lawsuits had been filed by the Company challenging the authority of the Nevada Environmental Commission to establish two new fees on disposal of waste at the Beatty facility. The other suit dismissed was filed by Nevada seeking to obtain a declaration from the court that it had the right to terminate the lease agreement with the Company for the Beatty facility. The Company also dismissed its claims against Nevada for damages associated with the Governor's executive order closing the LLRW facility. Pursuant to the settlement agreement, the parties also agreed that until December 31, 1996, regulatory, statutory and lease fees for hazardous waste disposal would not exceed $40.20 per ton in the aggregate, though subject to decrease in certain events. The settlement agreement also provides for the permanent closure of the Company's LLRW disposal facility at Beatty, Nevada. The state of Nevada has agreed to accelerate the licensing process of the unused disposal acreage from the LLRW site for use in the Company's hazardous waste disposal operations at Beatty. If the additional capacity is licensed, the capacity of the Company's Beatty hazardous waste disposal facility will approximately double. As a result of the above order and settlement agreement, the Beatty facility accepted no LLRW for disposal after January 1, 1993. The State of Nevada maintains a perpetual care and maintenance trust fund for the Beatty, Nevada LLRW and hazardous waste facilities which is funded by the Company. See \"Business - Hazardous Waste Services - Stabilization and Disposal Services - Beatty, Nevada Facility\".\nREGULATION\nThe environmental services industry is subject to extensive regulation by federal, state and local authorities. In particular, the regulatory process requires the Company to obtain and retain numerous governmental permits or other authorizations to conduct various aspects of its operations, any of which may be subject to revocation, modification or denial. Adverse decisions by governmental authorities on permit applications submitted by the\nCompany may result in premature closure of facilities or restriction of operations, which could have a material adverse effect on the Company's results of operations.\nBecause of the heightened public awareness of environmental issues, companies in the environmental service business, including the Company, may in the normal course of their business be expected periodically to become subject to judicial and administrative proceedings. The Company may also be subject to actions brought by private parties or special interest groups in connection with the permitting or licensing of its operations, alleging violations of such permits, licenses or environmental laws and regulations.\nThe Company's business is heavily dependent upon environmental laws and regulations which effectively require wastes to be managed in facilities of the type owned and operated by the Company. The Company makes a continuing effort to anticipate regulatory, political and legal developments that might affect its operations, but is not always able to do so. Federal, state and local governments have from time to time proposed or adopted other types of laws or regulations which significantly affect the environmental services industry. These have included laws and regulations to ban or restrict the interstate shipment of hazardous wastes, impose higher taxes on out-of-state hazardous waste shipments than in-state shipments and to reclassify certain categories of hazardous wastes as non-hazardous. In particular, the federal government currently is considering several fundamental changes to laws and regulations that define which wastes are hazardous, that establish treatment standards for certain wastes that could lead to their reclassification as non-hazardous, and that revise the nature and extent of responsible parties, obligations to remediate contaminated property. While the outcome of these deliberations cannot be predicted, it is possible that some of the changes under consideration could facilitate exemptions from hazardous waste requirements for significant volumes of waste and alter the types of treatment and disposal that will be required. If such changes are implemented, the overall impact on the Company's business is likely to be unfavorable. 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.\nHazardous Waste Regulations. The Company is required to obtain federal, state, local and foreign governmental permits for its hazardous waste treatment, storage and disposal facilities. Such permits are difficult to obtain, and in most instances extensive geological studies, tests and public hearings are required before permits may be issued. In particular, the Company's operations are subject to RCRA (as discussed below), the Safe Drinking Water Act (which regulates deep well injection), TSCA (pursuant to which the EPA has promulgated regulations concerning the disposal of PCBs), the Clean Water Act (which regulates the discharge of pollutants into surface waters and sewers by municipal, industrial and other sources) and the Clean Air Act (which regulates emissions into the air of certain potentially harmful substances). In its transportation operations, the Company is subject to the jurisdiction of the Interstate Commerce Commission and is regulated by the DOT and by state regulatory agencies. Employee safety and health standards under the Occupational Safety and Health Act (\"OSHA\") are also applicable to the Company's operations.\nRCRA. Pursuant to RCRA, the EPA has established and administers a comprehensive, \"cradle-to-grave\" system for the management of a wide range of solid and \"hazardous\" wastes. States that have adopted hazardous waste management programs with standards at least as stringent as those promulgated by the EPA may be authorized by the EPA to administer their programs in lieu of the EPA.\nUnder RCRA and federal transportation laws, all generators of hazardous wastes are required to label shipments in accordance with detailed regulations and prepare a detailed manifest identifying the material and stating its destination before shipment offsite. A transporter must deliver the hazardous wastes in accordance with the manifest and generally only to a treatment, storage or disposal facility having a RCRA permit or interim status under RCRA. Every facility that treats or disposes of hazardous wastes must obtain a RCRA permit from the EPA or an authorized state and must comply with certain operating standards. The RCRA permitting process involves applying for interim status and also for a final permit. Under RCRA and the implementing regulations, facilities which have obtained interim status are allowed to continue operating by complying with certain minimum standards pending issuance of a permit. The Company believes that each of its facilities is in substantial compliance with the applicable requirements promulgated pursuant to RCRA.\nIt is possible that the EPA may consider a number of fundamental changes to its regulations under RCRA that could facilitate exemptions from hazardous waste management requirements, including policies and regulations that could implement the following changes: redefine the criteria for determining whether wastes are hazardous; prescribe treatment levels which, if achieved, could render wastes non-hazardous; encourage further recycling and waste minimization; reduce treatment requirements for certain wastes to encourage alternatives to incineration; establish new operating standards for combustion technologies; and indirectly encourage on-site remediation. Because many of these initiatives are at an early stage of development, the Company cannot predict the final decisions that the EPA might make or the extent of their impact on the Company's business.\nSuperfund. Superfund provides for immediate response and removal actions coordinated by the EPA to releases of hazardous substances into the environment, and authorizes the federal government either to clean up facilities at which hazardous substances have created actual or potential environmental hazards or to order persons responsible for the situation to do so. Moreover, Superfund grants a right of recovery to private parties who incur costs in response to the release or threatened release of hazardous substances. Superfund has been interpreted as creating strict, joint and several liability for costs of removal and remediation, other necessary response costs and damages for injury to natural resources. Liability extends to owners and operators of waste disposal facilities (and waste transportation vehicles) from which a release occurs, persons who owned or operated such facilities at the time the hazardous substances were disposed, persons who arranged for disposal or treatment of a hazardous substance at or transportation of a hazardous substance to such a facility, and waste transporters who selected such facilities for treatment or disposal of hazardous substances.\nIt is possible that the U.S. Congress could revise the Superfund statute in the future. In addition to possible changes in the statute's funding mechanisms and provisions for allocating cleanup responsibility, it is possible that Congress could fundamentally alter the statute's provisions governing the selection of appropriate site cleanup remedies, conclude not to continue Superfund's current reliance on stringent technology standards issued under other statutes to govern removal and treatment of remediation wastes or could adopt new approaches such as national or site-specific risk based standards. These and other potential policy changes could significantly affect the stringency and extent of site remediation, the types of remediation techniques that will be employed, and the degree to which permitted hazardous waste management facilities will be used for remediation wastes.\nLLRW Regulations. The LLRW services of the Company are also subject to extensive governmental regulation. Various phases of the Company's LLRW services are regulated by various state agencies, the Nuclear Regulatory Commission (\"NRC\") and the DOT. Regulations applicable to the Company's operations include those dealing with packaging, handling, labelling and routing of radioactive materials, and prescribe detailed safety and equipment standards and requirements for training, quality control and insurance, among other matters. Employee safety and health standards under OSHA are also applicable to the Company's operations.\nFinancial Assurance and Site Maintenance. The Company operates its hazardous waste disposal sites under RCRA permits. The LLRW sites are operated under licenses from state and, in some cases, federal agencies. When one of these facilities reach capacity, or lease or license termination dates, the facility must be closed and maintained for a period of time prescribed by law or by license. In the case of the RCRA-permitted hazardous sites, federal regulation requires that operators demonstrate the financial capability to close sites on an immediate, unscheduled (worst-case) basis. The estimated costs of such a closure are set forth in the operator's RCRA closure and post-closure plan.\nFinancial assurance requirements for closure\/post-closure plans may generally be satisfied by various means, including insurance, letters of credit, surety bonds, trust funds, a financial net worth test and\/or a corporate guarantee. The Company is currently satisfying such requirements through a combination of certain of the various allowable methods. Cash and investment securities totaling $13.2 million and $13.6 million at December 31, 1994, and 1993, respectively, have been pledged as collateral for the Company's closure and post-closure obligations, performance of a Remedial Investigation and Feasibility Study and performance of corrective action at the closed Sheffield, Illinois facility, compliance with the TNRCC requirements related to the Company's non-commercial use deepwell at its Robstown, Texas facility, closure costs for the Beatty, Nevada LLRW site, closure costs for the Recycle Center, closure costs for the Winona, Texas facility, test borings at the proposed LLRW sites in Nebraska and California, settlement with generators of waste at the Richland, Washington LLRW\nfacility and other general performance bonds. The amounts pledged by the Company generally equal the present value of its estimated future closure and post-closure obligations.\nINSURANCE\nThe nature of the Company's business exposes it to a risk of accidental release of harmful substances into the environment resulting in contamination, the cost of which could be substantial. The Company currently has liability insurance coverage for non-nuclear related occurrences under environmental impairment liability, primary casualty and excess liability policies. Pursuant to RCRA, the Company is required to maintain environmental impairment liability insurance coverage with specified minimum policy limits for sudden and non- sudden accidental occurrences. The Company is in compliance with required limits and coverage.\nThe Company has organized and funded a wholly-owned corporation, American Liability and Excess Insurance Company, to provide for financial assurance for the Company's site closure and post-closure responsibilities in certain instances and to provide a source of insurance for the Company in the event that traditional third party insurance becomes unavailable. The Company is not currently utilizing its insurance subsidiary because of unavailability of other insurance. The Company has funded insurance policies issued by this insurance subsidiary with cash representing the present value of the closure or post- closure obligation being insured. As of January 1, 1995, the Company's insurance subsidiary had pledged $7.1 million of collateral for policies issued to insure site closing or post-closing obligations of the Company.\nCUSTOMERS\nNo single customer accounted for 10% of the Company's consolidated revenues for 1994. Revenues resulting from the cost reimbursement contract with the Central Interstate Low-Level Radioactive Waste Commission were approximately $9,800,000 in 1994, or 14% of the Company's consolidated revenues.\nPERSONNEL\nThe Company had a total of 491 employees as of March 2, 1995. The Company has a collective bargaining agreement which covers 12 employees at its Richland, Washington facility. The Company has a collective bargaining agreement which covers 44 employees at its Winona, Texas facility. The Company believes that its relationship with its employees is good.\nUnfair labor practice charges filed by the Oil, Chemical and Atomic Workers Union are currently pending before a regional office of the National Labor Relations Board (\"NLRB\") relating to the union's allegation that a subsidiary of the Company should be held to the terms of a collective bargaining agreement negotiated by the union and Quadrex, the previous owner of the Oak Ridge, Tennessee facility purchased by the Company in September 1994. The Company has recognized the union as the collective bargaining agent of its employees and has sought to negotiate a new collective bargaining agreement with the union. An administrative complaint has been issued by a Regional Director of the NLRB alleging that the Company has committed an unfair labor practice by not assuming the prior union contract. The matter has been set to be heard by an Administrative Law Judge of the NLRB.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company believes that its property and equipment are well-maintained, in good operating condition and adequate for the Company's present needs. The Company's headquarters are located in Houston, Texas in leased office space. The Company also leases sales and administrative offices in Washington, California, Nebraska, Illinois, Ohio, Nevada, Texas, and Kentucky.\nThe following table sets forth certain information regarding the principal operating, treatment, processing or disposal facilities owned or leased by the Company.\nThe Company also owns an office, warehouse and shop facility in Pasadena, Texas to service its Gulf Coast transportation and Surecycle(R) operations. The Company owns a transportation terminal in Robstown, Texas and leases transportation terminals in Beaumont, Texas and Niagara Falls, New York. The Company leases transfer facilities in El Paso and Laredo, Texas for the transfer of wastes collected from maquiladora plants in Mexico and a facility in Dallas, Texas to support its Surecycle(R) operations. The Company also leases a hazardous waste drum transfer station in Anaheim, California to consolidate waste volumes for small quantity generators.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company's business inherently involves risks of unintended or unpermitted discharge of materials into the environment. In the ordinary course of conducting its business activities, the Company becomes involved in judicial and administrative proceedings involving governmental authorities at the federal, state and local levels (including, in certain instances, proceedings instituted by citizens or local governmental authorities seeking to overturn governmental action where governmental officials or agencies are named as defendants together with the Company or one or more of its subsidiaries, or both). In the majority of the situations where regulatory enforcement proceedings are commenced by governmental authorities the matters involved relate to alleged technical violations of licenses or permits pursuant to which the Company operates or of laws or regulations to which its operations are subject, or are the result of different interpretations of the applicable requirements.\nIn addition, the Company and certain of its subsidiaries are involved in civil litigation relating to the conduct of their business. While the outcome of any particular lawsuit or governmental investigation cannot be predicted with certainty, the Company believes that the ultimate disposition of these matters will not have a material adverse effect upon the consolidated financial position of the Company.\nRichland, Washington Facility. In 1964, the Washington Department of Ecology (\"WDOE\") leased from the DOE a 1,000 acre portion of the Hanford Reservation. In 1965, the WDOE subleased 100 acres of that property to the Company for use as a LLRW disposal facility under the regulation of the Washington Department of Health pursuant to the Atomic Energy Act. In 1990 the DOE applied to the EPA for a permit under the RCRA and other laws and regulations to obtain the appropriate regulatory approvals needed to proceed with the environmental cleanup of the Hanford Reservation. In 1994, in a consent order among the EPA, DOE and WDOE, the EPA and DOE issued a corrective action permit that includes all of the land owned by the DOE at the Hanford Reservation, including that portion leased to WDOE, which includes the 100 acres subleased to the Company for its LLRW disposal facility. Thirteen trenches at the Company's LLRW disposal facility have been included in the final permit as solid waste management units which will require further investigation to determine whether releases of any hazardous wastes or constituents have occurred. Because portions of the Company's facility remains included in the final permit issued to the DOE, the Company is potentially subject to proposed permit conditions for site investigation and possible cleanup should any releases be discovered even though the Company is not a permittee and though it was not involved in the activities contributing to the\nHanford facility contamination that are the subject of the Hanford consent order. It is the Company's opinion that it has legal defenses to the inclusion of its Hanford site in the DOE permit and to any corrective action that may be proposed of the site pursuant to the DOE permit. The Company has appealed to the Environmental Hearing Board of the EPA the terms of the permit that apply to any of Company's facilities. By agreement of all the parties, appeals have been stayed in order for the Company to negotiate a settlement with DOE and EPA to resolve corrective action concerns. If the Company is unsuccessful in the negotiation or the challenge to the permit, the cost of conducting the site investigation and any corrective action could be material.\nThe Company was assessed a substantial property tax increase by the Benton County Assessor's Office and has filed suit challenging the property tax increase imposed by the Benton County Assessor on improvements at the Company's leased disposal facility on the Hanford Reservation. The County Treasurer issued tax statements based upon these assessments for payments covering the years 1989, 1990 and 1991, which totaled $1.7 million. The Company sued Benton County and the Assessor and Treasurer to enjoin them from collecting these taxes. The Benton County Superior Court issued an injunction in favor of the Company. The County appealed to the Court of Appeals. The Court of Appeals ruled in favor of the County and reversed the decision of the Benton County Superior Court by holding that the injunction should not have been issued pending the Company's pursuit of administrative remedies. The Company is appealing the Court of Appeal's decision to the Washington Supreme Court. Management believes that the County's assessments were improper and intends to vigorously defend this matter in the courts and through any appropriate administrative process, if necessary.\nWinona, Texas Facility. The Company purchased the stock of Gibraltar, since renamed American Ecology Environmental Services Corporation, from Mobley Environmental Services, Inc. (\"Mobley\") on December 31, 1994. The Company's stock purchase agreement with Mobley provides that Mobley will indemnify the Company, without limitation as to amount, for any damages or costs, including legal fees, associated with certain pre-closing liabilities, including the claims set forth hereunder. Pursuant to its stock purchase agreement with Mobley, the Company has also been named as an additional insured for pre-closing claims under Mobley's pollution liability insurance policy. The policy has a $10 million aggregate limit and a $5 million per loss limit.\nIn 1992, a citizens group filed a petition with the TNRCC for revocation of the Winona facility's deepwell permits alleging that a geological fault exists in the vicinity of the Winona facility's deepwells and other alleged grounds. The EPA has previously concluded in its proceedings relating to the Winona facility's second injection well that no such fault exists. The Company believes the petition is without merit.\nA group called Mothers Organized to Stop Environmental Sins filed a lawsuit in 1994 against the Company in the United States Eastern District Court for the State of Texas alleging that the Winona facility violated certain permits and regulations, and contributed to the handling, storage, treatment, transportation and disposal of solid and hazardous waste that presents an imminent and substantial endangerment to health and the environment. The plaintiffs have requested that the facility be shut down and civil penalties imposed on the Company. The Company has filed an answer denying these allegations and a motion for summary judgment and believes the suit is without merit. The Company intends to vigorously defend this litigation. However, if the plaintiffs were to ultimately prevail on their claim and be awarded the remedies sought, such outcome could have a material adverse effect on the Company's consolidated financial position and results of operations.\nFour lawsuits, including one purported class action, were filed against Gibraltar, in 1992 and 1993 which were subsequently transferred to State District Court in Smith County, Texas, by certain persons in Winona, Texas. The suits assert various theories of liability including subsurface trespass, nuisance, and negligence for alleged air emissions. The suits also allege that the plaintiffs have experienced personal injuries, diminution in property values, and other economic losses which are alleged to have been caused by operation of the Winona facility. The plaintiffs assert various grounds for recovery, including allegations that their property has been used without their consent as a hazardous waste facility, and seek unspecified actual and punitive damages. The Company disputes the material allegations of the plaintiffs' suits and intends to vigorously defend this litigation. To date, the Company and Mobley have settled certain of the plaintiff's claims in these actions for amounts that were not material and which were funded by the Mobley insurance policy referred to above.\nCompact Related Disputes. The Company is involved in numerous challenges and legal proceedings in connection with its siting efforts for LLRW facilities for the Southwest Compact and Central Interstate Compact. For a description of these proceedings, see \"Business -- Low-Level Radioactive Waste Services -- Disposal Services -- Ward Valley, California Facility\" and \"-- Butte, Nebraska Facility\".\nThe Company has received invoices from the Southeast Compact Commission for approximately $1.5 million and a notice that an additional $1.5 million will be invoiced in the aggregate in the second and third quarter of 1995. The invoices relate to an access fee for the Barnwell, South Carolina LLRW disposal facility in the Southeast Compact utilized by Quadrex. The fee for each generator is calculated pursuant to a Commission formula which is based on the historical amount of LLRW shipped to the Barnwell facility by such generator. The Company believes that it did not assume such access fees liabilities relating to pre-acquisition volumes of Quadrex in its asset acquisition of the Recycle Center and that the Company has legitimate defenses to this claim. The Company appealed the Commission's invoices and in February 1995 at an appeal hearing, the Commission again concluded that the full access fees were payable by the Company. As a result of the fee dispute, on March 29, 1995, the Southeast Compact Commission directed the Department of Health and Environmental Control of the State of South Carolina to deny the Company access to the Barnwell, South Carolina LLRW disposal facility. The Company has appealed the Commission's action to the Department under South Carolina law. As of the date of this report, the Department has not denied the Company access to the Barnwell facility. While the Company continues to discuss alternate resolutions of this dispute with the Commission, the Company believes it has no material liability in connection with this matter and intends to vigorously defend any material assessment or attempt to deny access to the Barnwell facility.\nOther Litigation. The City of San Antonio (the \"City\") filed suit against several parties related to environmental issues in connection with the acquisition, development and construction of a bus transit station and multi- purpose stadium and sports complex, commonly known as the Alamodome. The City has named as the defendants: the former owner of the property, various consultants involved in the project, the project manager, and a subsidiary of the Company which served as the construction contractor for the project. The City has alleged several theories of recovery, including breach of contract, negligent misrepresentation and gross negligence. The City alleges its consultants failed to advise the City that the selected site was contaminated, thereby breaching their contracts and committing torts. The City alleges further that following the discovery of actual or potential environmental problems, the City's consultants and project manager failed to act properly in handling allegedly contaminated soil and groundwater. The City has also alleged that construction of the landfill did not conform to contract requirements. The City has decided to exhume the onsite landfill and dispose of it at another location. Minimal discovery has been taken. The Company does not believe that the claims against its subsidiary are meritorious and intends to vigorously defend against such claims. Furthermore, the Company intends to pursue a counterclaim to recover sums related to its construction of the on-site landfill.\nIn November 1994, the Company was named as a defendant in a purported class action lawsuit by former employees of Quadrex that relates to unpaid medical benefits and an underfunded pension plan of Quadrex. Based on information available to it, the Company believes that the aggregate amount of these claims are less than $1 million. The Company purchased the assets of the Quadrex Recycle Center from Quadrex on September 19, 1994. However, the asserted claims in the purported class action were specifically excluded by the purchase agreement pursuant to which the Company purchased the assets of the Quadrex Recycle Center. Some of the former Quadrex employees on whose behalf the suit was brought are now employees of the Company. The Company does not believe it has any liability in this matter and intends to contest the matter vigorously. The Company's purchase agreement with Quadrex provides that Quadrex will indemnify the Company for any damages or costs, including legal fees, associated with a claim of this sort. However, because Quadrex filed for bankruptcy protection in February 1995, it is very likely that the Company will not realize the benefits of such indemnification.\nThe Company has received a notice from an individual purporting to own debt secured by certain real property in Midlothian, Texas. The individual alleges that a predecessor of the Company's subsidiary, Texas Ecologists, caused environmental contamination of the property in the early 1970's. The Company believes it has no liability in connection with the matter and intends to contest the matter vigorously. In connection with its investigation of the matter, the Company also conducted its own assessment of the property with an independent environmental consultant and concluded that any contamination on the property falls below material levels.\nOther Matters. In 1990, the Company was sued by certain landowners owning property adjacent to the Company's Robstown, Texas disposal facility. The landowners have alleged that there has been migration of pollutants through groundwater which has contaminated water resources on their respective property. These landowners have alleged theories including nuisance per se, negligence and trespass. The Company's investigation has found no migration of pollutants onto the adjacent landowners' properties and the Company intends to contest this matter vigorously.\nIn 1992, the Company received notice from the EPA alleging that the Company had violated financial assurance and liability insurance requirements at the closed Sheffield, Illinois hazardous waste disposal site formerly operated by the Company. The EPA is seeking a penalty of approximately $1 million and ordering compliance. Both the EPA and the Company have filed cross-motions for an accelerated decision by the administrative law judge regarding the issue of liability. Though the ultimate outcome of this matter is uncertain, the Company believes these insurance requirements are not applicable to this closed site and intends to vigorously contest this matter.\nIn April 1995, management of the Company became aware that the Company had held hazardous waste containers at certain of its transportation terminals for periods greater than the 10-day temporary storage periods permitted by TNRCC regulations. The Company has reported the matter to the TNRCC. The Company has also put in place procedures to safeguard against future violations of this type and, upon completion of its review of the matter, may put in place additional safeguard procedures if so warranted. While the Company believes the steps that it has taken are appropriate and responsive, it is possible that the TNRCC may seek to impose a fine on the Company in connection with the matter. The Company is not in a position to assess the amount of such a fine. However, a fine of sufficient magnitude could have a material adverse effect upon the consolidated financial position of the Company.\nIn addition to the above-described litigation, the Company and its subsidiaries from time to time are involved in various other administrative matters of litigation, including personal injury and other civil actions, as well as other claims, disputes and assessments that could result in additional litigation or other proceedings. The Company and its subsidiaries are also involved in various other environmental matters or proceedings, including permit application proceedings in connection with the establishment, operation, closure and post-closure activities of certain sites, as well as other matters or claims that could result in additional environmental proceedings.\nWhile the final resolution of any matter may have an impact on the Company's consolidated financial results for a particular reporting period, management believes that the ultimate disposition of the matters described in Item 3. will not have a material adverse effect upon the consolidated financial position of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to the Company's security holders during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR AMERICAN ECOLOGY CORPORATION COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nAmerican Ecology Corporation common stock is currently listed on the NASDAQ National Market System under the symbol ECOL. As of March 1, 1995, there were approximately 8,000 record holders of common stock. The high and low sales prices for the common stock on the NASDAQ and the dividends paid per common share for each quarter in the last two years are shown below:\nFuture cash dividends, if any, will be considered by the Board of Directors based upon the Company's earnings and financial position and such other factors as the Board of Directors considers relevant. The Company's credit facility with its bank lender restricts cash dividends payable by the Company to $200,000 per quarter. In addition, the credit facility provides that if the Company has not completed a debt or equity offering of at least $35 million prior to May 1, 1995, then after May 1, 1995, payment of cash dividends by the Company will be prohibited.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nAMERICAN ECOLOGY CORPORATION\nThis summary should be read in conjunction with the consolidated financial statements and related notes.\n(Dollars in thousands, except per share amounts)\n- ------------ (1) Adjusted for July 1992 three-for-two stock split.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nAmerican Ecology provides waste management services to generators of hazardous waste and low-level radioactive waste (\"LLRW\") in the United States. The Company's services include processing, packaging, remediation, recycling, transportation and disposal of waste. In recent years, Company volumes have increased despite overall industry volumes of hazardous waste declining due to waste minimization efforts reducing industrial process wastes, and to an overall slowdown in site remediation efforts reducing clean-up wastes. The hazardous disposal industry has experienced significant competitive pricing pressures as a result of this trend. Disposal volumes of LLRW have been greatly impacted by the geographical restrictions imposed by the implementation of the federally mandated compact system. Also, the LLRW disposal industry has transitioned from being commercially unregulated prior to 1993, to an industry economically regulated as a monopoly by the compacts and states in which current and future disposal sites reside.\nIn recognition of these industry trends, the Company developed a strategy to broaden the Company's businesses from primarily disposal services to include more comprehensive non-disposal services such as the treatment, processing and recycling of hazardous waste and LLRW. In September 1994, the Company acquired a LLRW treatment, processing and recycling facility (\"Recycle Center\") in Oak Ridge, Tennessee, and on December 31, 1994, the Company acquired a fuels blending, solvent recycling, and liquid hazardous waste deepwell disposal facility in Winona, Texas (\"Winona Facility\"). In addition to these two acquisitions, the Company has expanded its revenue base and obtained value added hazardous waste disposal contracts by marketing and performing waste stabilization, and by providing turnkey remediation services which include site remediation, transportation, and ultimate disposal of wastes in the Company's landfills. Additionally, the Company has been successful in entering the naturally occurring radioactive materials (\"NORM\") disposal market which provides attractive disposal margin opportunities at the Company's Richland, Washington LLRW facility, and in performing profitable LLRW remediation projects.\nAs a result of the changes in the industry and the implementation of the Company's business strategies, the 1994 results reflected a 19% increase in revenues, though income from operations and net income decreased 19% from the prior year. Exclusive of material unusual events and non-recurring accounting adjustments in both 1994 and 1993, income from operations increased by approximately $2,800,000 in 1994 as compared to 1993, which is attributable, in part, to increased revenues from NORM business and LLRW remediation projects, and a decrease in certain operating costs due to utilizing personnel and equipment on deferred site maintenance projects, and to a lesser degree, headcount reductions.\nThe following table sets forth items in the Statements of Operations for the three years ended December 31, 1994, as a percentage of revenue:\nRevenues\nRevenues for 1994 were $71,891,000, a 19% increase over 1993 revenues of $60,312,000. Of the $11,579,000 increase in revenues, 55% was attributable to hazardous waste businesses and 45% was attributable to LLRW businesses.\nHazardous waste revenues increased 16% compared to 1993 hazardous waste revenues. Hazardous waste disposal revenues increased 2% in 1994 despite a declining, very competitive, disposal market for remedial waste. Disposal volumes increased approximately 34% due to obtaining several large volume contracts for remedial projects on the West Coast and in Texas. However, due to the high volume nature of these contracts and the competitive remedial pricing environment, average disposal prices for the Company's two hazardous landfills decreased by approximately 23%. Similar conditions were experienced in 1993 when disposal volumes increased approximately 24% and average prices fell approximately 22% as compared to 1992. An increase in transportation revenues of 29% in 1994 resulted from a full year of results from the operations of Waste Processors Industries, Inc. (\"WPI\") acquired in March 1993, and the successful integration of marketing transportation and disposal services with the Robstown, Texas facility. Other significant revenue increases resulted from remediation services and waste stabilization services. Hazardous waste remediation revenues result from services performed at the customer's site, either directly by the Company or subcontracted by the Company, in order to accommodate the customers' desire to contract with one vendor for all phases of a remediation project. Remediation revenues increased 17% in 1994 due principally to the large remediation and disposal contracts obtained in the West Coast region with ultimate waste disposal occurring at the Company's Beatty, Nevada facility. Stabilization revenues nearly tripled in 1994 compared to 1993 due to state regulatory requirements for debris treatment and to the large debris cleanup projects requiring stabilization treatment prior to disposal. The 1994 Statement of Operations does not include any results of operations from the acquisition of the Winona Facility purchased on December 31, 1994.\nLLRW revenues increased 26% compared to 1993. LLRW disposal revenues decreased 8% due principally to the implementation of the Federal Low-Level Radioactive Waste Policy Amendments Act of 1985 (the \"Low-Level Act\") on January 1, 1993. The Low-Level Act together with state regulatory initiatives resulted in the inactivity of the Beatty, Nevada LLRW facility and the regulatory restrictions placed on the Richland, Washington facility and caused unusually large volumes of waste receipts at the end of 1992 which were not buried and recognized as revenues until the first quarter of 1993. Exclusive of the carryover effect of volumes received in 1992, 1994 disposal revenues increased by approximately 37% compared to 1993 due to penetration of the NORM waste disposal market. It is uncertain whether the Company will be able to continue unregulated disposal of NORM wastes at the Richland facility indefinitely due to possible state regulatory restrictions. In 1994, the Company entered the LLRW on-site remediation business generating approximately $1,900,000 of revenues by providing technical and remedial services for several projects in various regions of the country. Additionally, the acquisition of the Recycle Center in September 1994, contributed approximately $2,800,000 in treatment, processing, and recycling revenues, $1,200,000 of which is attributable to management's estimated settlement of a fourth quarter 1994 business interruption claim for a fire which damaged a processing building and related equipment at the Recycle Center in July 1994. Management expects the Recycle Center's 1995 results to include recognition of anticipated business interruption claim settlements for the period until the facility is fully operational. Final determination of the amounts of proceeds from business interruption claims is subject to negotiations with the insurance carrier.\nRevenues for 1993 were $60,312,000, a 15% decrease from 1992 revenues of $70,940,000. LLRW revenues decreased $22,701,000, or 53%, while total hazardous waste revenues increased $12,073,000, or 43%, from 1992. The LLRW business decline was due to the Low-Level Act, which resulted in the inactivity of the Beatty, Nevada LLRW facility and the regulatory restrictions placed on the Richland, Washington facility. Increased hazardous waste revenues were attributable to acquiring WPI in March, 1993, whose revenues of $10,947,000 were comprised of transportation (70%) and remediation services (30%).\nRevenues resulting from the cost reimbursement contract with the Central Interstate Low-Level Radioactive Waste Commission were approximately $9,800,000, $9,300,000, and $10,300,000 in 1994, 1993, and 1992, respectively.\nOperating Costs\nOperating costs in fiscal 1994 increased $12,391,000, or 30%, as compared to 1993, $1,768,000 of which was attributable to the acquisition of the Recycle Center. As a percentage of revenues, operating costs were 75%, 69%, and 66% for the years ended 1994, 1993, and 1992, respectively. The following table sets forth unusual events and non-recurring accounting adjustments which affected operating costs for the years ended December 31, 1994 and 1993, respectively. There were no such items for the year ended December 31, 1992.\nExclusive of these unusual events and non-recurring adjustments, operating costs for 1994 and 1993 would have been $57,993,000 and $50,688,000, or 81% and 84% of revenues, respectively. The improvement in operating margin in 1994, net of unusual events and non-recurring adjustments, is attributable to strong margins in the NORM disposal business and on certain LLRW remediation projects, and the integration of hazardous waste transportation services since the March 1993 acquisition of WPI which directed disposal volumes to the Robstown, Texas facility. Operating costs were reduced as a result of maximizing the utilization of operations personnel on deferred site maintenance projects and to headcount reductions. The decline in operating margin in 1993 from 1992 reflected the decline in the profitable LLRW disposal business as a result of the Low-Level Act and the trend toward lower margins in the hazardous waste disposal business.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses (SG&A) for 1994 were $12,362,000, an increase of $430,000 compared to 1993. The increase is attributable principally to incremental selling costs and amortization of intangible assets resulting from acquired businesses. As a percentage of revenues, SG&A was 17%, 20%, and 14% for 1994, 1993, and 1992, respectively. The 1994 decrease in SG&A as a percentage of revenue was due principally to the revenue increase in 1994 as compared to 1993. SG&A for 1993 was $11,932,000, an increase of $2,037,000 from 1992. SG&A for 1992 included a non-recurring charge of $1,250,000 for costs of relocating\nthe Company's corporate office from Louisville, Kentucky to Houston, Texas which was completed during the second quarter of 1993. Exclusive of this charge in 1992, SG&A in 1993 increased due principally to the acquisition of WPI in March 1993, legal fees incurred for certain corporate matters, and various costs related to establishing the corporate office in Houston. These costs included additional depreciation on new computer hardware and software development costs for financial and operational reporting systems and on newly acquired office furniture and equipment, greater rental expenses for operating two offices during the transition to Houston, and various start-up and temporary duplicate items such as office supplies, communications and travel.\nInvestment Income\nNet investment income is comprised of interest income earned on various debt securities, certificates of deposit and other interest bearing deposits, and dividend income and capital gains and losses earned on the Company's preferred stock portfolio. Investment income recognized in 1994 decreased from 1993 due to lower preferred stock portfolio performance as a result of rising interest rates and to the decrease in interest bearing investments outstanding. This portfolio is principally the Company's captive insurance investments reinsuring the present value of certain long-term closure and post closure liabilities. The amount of investment income in 1993 decreased from 1992 due principally to a lower weighted average of outstanding investments in 1993 as compared to 1992.\nInterest Expense\nInterest expense is the total interest expense incurred by the Company on outstanding indebtedness less capitalized amounts. For the year ended December 31, 1994, the Company incurred $968,000 in interest cost, all of which was capitalized for the development of the Company's LLRW facilities in California and Nebraska in accordance with Statement of Financial Accounting Standards No. 34, Capitalization of Interest Cost. Substantially all of the interest cost incurred for 1994 related to borrowings under the Company's credit agreement with its bank lender.\nIncome Taxes\nThe Company's effective income tax rates were 32%, 37%, and 20% for the fiscal years 1994, 1993, and 1992, respectively. The effective rate of 32% in 1994 includes the benefit of the recognition of an estimated state income tax settlement of $300,000. Exclusive of this amount, the year's effective rate would have been 37%. The lower effective rate in 1992 was due to the benefit of the recognition of certain deferred tax assets as determined under applicable income tax accounting standards in effect during that period. Effective January 1, 1993, the Company prospectively adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The effect of the adoption was not material to the Company.\nCapital Resources and Liquidity\nDuring 1994, the Company invested in acquisitions to diversify and enable the Company to provide more comprehensive hazardous and LLRW services in response to the changing environmental services markets. Principally as a result of the acquisitions of the Recycle Center and the Winona facility, the Company's consolidated total assets at December 31, 1994 increased $47,317,000 and total liabilities increased $43,836,000 as compared to December 31, 1993. Working capital at December 31, 1994 and 1993 was $1,563,000 and $4,771,000, respectively. The decrease in working capital was attributable to acquisition expenditures of $27,871,000, capital and site development expenditures of $8,035,000, and cash used in operating activities of $1,800,000, most of which was financed with borrowings from the bank credit facility, all of which was classified non-current on the consolidated balance sheet at December 31, 1994.\nIn addition to payments for assumed liabilities of the Recycle Center, which amounted to $17,014,000 at the September 19, 1994 acquisition date and were comprised principally of processing and burial costs for waste stockpiled at the facility prior to 1994, the Company has accrued for additional obligations relating to the Recycle Center at December 31, 1994 as follows: accruals for waste processing and burial costs and associated deferred revenues of approximately $9,547,000; accruals for sales tax settlements of $950,000; and other accounts payable and accruals. The liabilities for waste processing and burial costs is based on management estimates of\nanticipated waste treatment methods and associated volume reductions. Should estimated volume reductions not be attainable, the costs for processing and burial could increase materially. The Southeast Compact, in which the Recycle Center is located, charges disposal site access fees to waste generators for development of the Southeast Compact's future disposal site. The Compact has assessed the Company with fees based on volumes disposed of prior to the Recycle Center acquisition. For the period from October 1, 1993 to September 30, 1994, the potential assessment related to pre-acquisition waste volumes is estimated at $3 million. The Company intends to vigorously challenge this assessment, and accordingly, has accrued the estimated assessment related to post-acquisition disposal volumes. (See Note 10 to the consolidated financial statements.)\nThe Company's bank credit agreement, as amended, provides for borrowings up to $35,000,000. At December 31, 1994, borrowings under the credit facility totaled $32,905,000. The secured credit facility matures on January 31, 1996 and is comprised of a $30,000,000 term loan, a $5,000,000 revolving credit facility, and $5,000,000 in standby letters of credit. Interest is payable quarterly and the interest rate is equal to either a base rate (the greater of the bank's prime rate or the federal funds rate plus .5%) plus a margin of 0% to .75%, or a Eurodollar rate plus a margin of 2% to 3%. The marginal rate increases are based on a debt coverage ratio. The Company's actual interest rate as of December 31, 1994 was approximately 8.7%. These rates are subject to increase by .25% to .75% and the bank may enforce financial and other restrictions on the Company if the Company is unable to refinance the facility by May 1, 1995 or is unable to comply with financial covenants of the credit agreement. Subsequent to December 31, 1994, the Company was not in compliance with a financial covenant requiring the maintenance of a specified amount of accounts receivable and obtained a waiver from the bank regarding such non- compliance. The Company subsequently requested that the required level of accounts receivable be adjusted to a lower amount and that certain financial covenants be adjusted to a level in which the Company would remain in compliance based on the Company's projected financial position through 1995. The bank approved this request on April 12, 1995. Under the terms of the credit agreement, the bank may accelerate the maturity of the debt in the event a material adverse effect is deemed by the bank to have occurred. If the Company is unable to remain in compliance with the terms of the credit agreement or obtain waivers in the event of a default and the bank accelerates maturity of the credit agreement, the Company does not have adequate financial resources to extinguish the loan and the Company's operations may be negatively impacted.\nThe Company is in process of arranging for long-term refinancing for the credit facility and, if successful, anticipates a closing of a private placement debt offering in the second quarter of 1995. If the private debt placement is not successful, management will seek alternative financing which may include an equity offering or an offering combining debt and equity. Absent new financing in the anticipated timeframe, forbearance will be required from the Company's bank lender to meet obligations as they become due. There is no certainty that the refinancing will be obtained or that the Company's existing lender will provide such forebearance. Management believes that the Company will be able to remain in compliance with the terms of the credit agreement. (See Note 6 to the consolidated financial statements.)\nIn addition to working capital funding, the Company anticipates capital expenditures of approximately $4,600,000, expenditures for deferred site development, excluding capitalized interest, of approximately $3,000,000, and expenditures of approximately $2,400,000 for remedial costs, cell capping, and various site maintenance projects in 1995. The Company believes that funds generated from operations and available borrowing capacity will be sufficient to meet the Company's current capital and operating requirements. As discussed above, the Company will need to obtain long-term refinancing for the credit facility prior to its maturity on January 31, 1996.\nThe following table sets forth the Company's summary cash flows for the last three fiscal years:\nFinancial Assurance and Site Maintenance\nThe Company operates its chemical waste disposal sites under Resource Conservation and Recovery Act of 1976 (\"RCRA\") permits. The LLRW sites are operated under licenses from state and, in some cases, federal agencies. When these facilities reach capacity, or lease or license termination dates, as the case may be, they must be closed and maintained for a period of time prescribed by law or by license. In the case of the RCRA-permitted chemical sites, federal regulation requires that operators demonstrate the financial capability to close sites on an immediate, unscheduled (worst-case) basis. The estimated costs of such a closure are set forth in the operator's RCRA closure\/post-closure plan.\nTo secure closure\/post-closure obligations of its chemical waste disposal sites under federal and state regulations, the Company has provided letters of credit, certificates of insurance, and corporate guarantees as financial assurance. Cash and investment securities totaling $13,175,000 and $13,632,000 at December 31, 1994, and 1993, respectively, have been pledged as collateral for the Company's closure\/post-closure obligations, performance of a Remedial Investigation and Feasibility Study (\"RI\/FS\") and performance of corrective action at the closed Sheffield, Illinois chemical waste facility, compliance with the Texas Natural Resources Conservation Commission requirements related to a deepwell at the Company's Robstown, Texas chemical disposal site, closure costs for the Beatty, Nevada LLRW site, closure costs for the Recycle Center, closure costs for the Winona facility, test borings at the proposed LLRW sites in Nebraska and California, settlement with generators of waste at the Richland, Washington facility and performance bonds.\nThe RI\/FS for the closed Sheffield facility was completed and approved by the U.S. Environmental Protection Agency in 1990. The Company is in the remedial phase of the Sheffield program as set forth in the EPA's corrective measures implementation plan. During 1994, the Company spent approximately $4,100,000 on remediation at the closed Sheffield chemical disposal site.\nThe nature of the hazardous material handled by the Company and its subsidiaries could give rise to substantial damages if spills, accidents or migration of hazardous material occurs. The occurrence of such events could have a material adverse effect upon the Company's liquidity and operating results.\nCorporate Development Considerations\nSee \"Business -- Low-Level Radioactive Waste Services -- Disposal Services -- Ward Valley, California Facility\" and \"Butte, Nebraska Facility\" for a description of the Company's and the impact of such facilities and other future considerations on the Company's financial condition and results of operations.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nThe Board of Directors and Shareholders of American Ecology Corporation\nWe have audited the accompanying consolidated balance sheets of American Ecology Corporation (a Delaware Corporation) 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. 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 6, the terms of the Credit Agreement call for a principal maturity date of January 31, 1996. Management's current projections indicate that there will not be sufficient cash flow from operations to fund that obligation. Management is currently seeking long term re-financing arrangements that would enable the Company to repay amounts outstanding under the Credit Agreement before its maturity and to enable the Company to continue to meet its obligations as they become due from funds generated by operations. Management's plans in regard to these matters are discussed in Note 6.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of American Ecology 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.\nARTHUR ANDERSEN LLP\nHouston, Texas April 13, 1995\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nAMERICAN ECOLOGY CORPORATION CONSOLIDATED BALANCE SHEETS ($ IN 000'S)\nThe accompanying notes are an integral part of these financial statements.\nAMERICAN ECOLOGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS ($ IN 000'S EXCEPT PER SHARE AMOUNTS)\nThe accompanying notes are an integral part of these financial statements.\nAMERICAN ECOLOGY CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ($ IN 000'S)\nThe accompanying notes are an integral part of these financial statements.\nAMERICAN ECOLOGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS ($ IN 000'S)\nThe accompanying notes are an integral part of these financial statements.\nAMERICAN ECOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Summary of Significant Accounting Policies\nPrinciples of Consolidation. The accompanying financial statements present the consolidated accounts of American Ecology Corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nRevenue Recognition. Generally, revenues are recognized as services are performed and as waste materials are buried or processed.\nCash Equivalents. Cash equivalents consist of short-term, highly liquid investments with original maturities of three months or less, which are readily convertible into cash.\nInvestments in Debt and Equity Securities. The Company has adopted Statement of Financial Accounting Standards No. 115 (SFAS 115), \"Accounting for Certain Investments in Debt and Equity Securities\", effective January 1, 1994. Debt and equity securities that the Company has the intent and ability to hold to maturity are classified as \"securities held-to-maturity\" and reported at amortized cost. Debt and equity securities that are held for current resale are classified as \"trading securities\" and reported at fair value with unrealized holding gains and losses included in earnings. Debt and equity securities not classified as either \"securities held-to-maturity\" or \"trading securities\" are classified as \"securities available-for-sale\" and reported at estimated fair value with net unrealized holding gains and losses reported as a component of shareholders' equity. The adoption of SFAS 115 did not have a material effect on the Company's financial position or results of operations. The Company uses the specific identification method to determine the cost basis used in computing realized gains or losses.\nProperty and Equipment. Property and equipment are recorded at cost and depreciated on straight-line and declining balance methods over estimated useful lives. Land is comprised of land owned at the processing and disposal sites. Land owned at disposal sites is depleted over the estimated useful life of the disposal site on a straight-line basis. Cell development costs represent waste disposal site preparation costs which are capitalized and charged to operating costs as disposal space is utilized. Cell development costs include direct costs related to site preparation, including legal, engineering, construction, and the direct cost of Company personnel dedicated for these purposes. The estimated useful lives of buildings and improvements is fifteen to thirty-one years. The estimated useful lives of vehicles, decontamination, processing and other equipment is three to ten years. See Note 3. for major categories of property and equipment. Expenditures for major renewals and betterments are capitalized and expenditures for maintenance and repairs are charged to expense as incurred. During 1994, 1993 and 1992, maintenance and repairs expense was $750,000, $642,000, and $506,000, respectively.\nDeferred Site Development Costs. The Company has been selected to locate, develop and operate the low-level radioactive waste (\"LLRW\") facilities for the Southwestern Compact (\"Ward Valley facility\") and the Central Interstate Compact (\"Butte facility\").\nThe license application for the Southwestern Compact was approved by the California Department of Health Services (\"DHS\") in September 1993. All costs related to the development of the Ward Valley facility have been paid and capitalized by the Company. As of December 31, 1994, the Company had deferred $35,020,000 of pre-operational facility development costs of which $841,000 was capitalized interest. These deferred costs relating to the development of the Ward Valley facility are expected to be recovered during the facility's 20 year operating period from future waste disposal revenues based upon disposal fees approved by the DHS in accordance with existing state rate-base regulations. Hearings on the established rates must be conducted upon the request of any interested person. The disposal fee approval process is expected to include an independent prudency review of all the pre-operational costs incurred by the Company prior to their inclusion in the rate-base. The Company expects all of the costs which it has deferred for this facility, excluding capitalized interest, to be included as a component in the rate-base as well as their associated costs of capital.\nAllowable costs incurred by the Company for the development of the Butte facility are reimbursed under a contract with the Central Interstate LLRW Compact Commission and are recognized as revenues. Substantially all funding to develop the Butte facility is being provided by the major generators of the waste in the Central Interstate LLRW Compact. To date the Company has contributed and capitalized approximately $6,219,000, of which $127,000 was capitalized interest, toward the development of the Butte facility and no additional capital investment is expected to be required from the Company prior to granting of the license. All unreimbursed costs and fees relating to the Butte facility have been deferred and are also expected to be realized from the revenue of the LLRW site when operational.\nThe construction and operation of the Ward Valley and Butte facilities are currently being delayed by various political and environmental opposition toward the development of the sites and by various legal proceedings as further discussed under \"Business - Low-Level Radioactive Waste Services - Disposal Services - Ward Valley, California Facility\" and \"- Butte, Nebraska Facility\". At this time, it is not possible to assess the length of these delays or when, or if, the Butte facility license will be granted, and when, or if, the land for the Ward Valley facility will be obtained, and whether the validity of the Ward Valley facility's license will be upheld on judicial review. Although the timing and outcome of the proceedings referred to above are not presently determinable, the Company continues to actively urge the conveyance of the land from the federal government to the State of California so that construction may begin, and to actively pursue licensing of the Butte facility. The Company believes that the Butte facility license will be granted, operations of both facilities will commence and that the deferred site development costs for both facilities will be realized.\nIn 1994, the Company began to capitalize interest in accordance with Statement of Financial Accounting Standards No. 34, Capitalization of Interest Cost, on the site development projects and will continue to do so while the facilities being developed are undergoing activities to ready them for their intended use. Interest capitalized during 1994 was $968,000.\nIntangible Assets. Intangible assets relating to acquired businesses consist primarily of the cost of purchased businesses in excess of fair value of net assets acquired (\"goodwill\"). Intangible assets are being amortized on the straight-line method over periods not exceeding 40 years with the majority being amortized over 25 years. The accumulated amortization of intangible assets amounted to $962,000 and $442,000 at December 31, 1994 and 1993, respectively. On an ongoing basis, the Company measures realizability of goodwill by the ability of the acquired business to generate current and expected future operating income in excess of annual amortization. If realizability is in doubt, an adjustment is made to reduce the carrying value of the goodwill. There were no such adjustments for the three years ended December 31, 1994.\nPermitting Costs. Permitting costs, which are primarily comprised of outside engineering and legal expenses, are capitalized and amortized over the life of the applicable permits. At December 31, 1994 and 1993, there were $1,389,000 and $937,000, respectively, of such costs included in other assets in the accompanying consolidated balance sheet.\nDeferred Site Maintenance. Deferred site maintenance includes the accruals associated with obligations for closure and post-closure of the Company's operating and closed disposal sites and for corrective actions and remediation. The portion of these obligations expected to be spent within the following twelve month period is classified as deferred site maintenance, current portion in the accompanying consolidated balance sheet. The Company generally provides accruals for the estimated costs of closures and post-closure monitoring and maintenance as permitted airspace of such sites is consumed. Liabilities are recorded when environmental assessments and\/or remedial efforts are probable, and the costs can be reasonably estimated. The Company performs routine periodic reviews of closed operating sites and revises accruals for estimated post-closure, remediation or other costs related to these locations as deemed necessary. The Company's recorded liabilities are based on best estimates of current costs and are updated periodically to include the effects of existing technology, presently enacted laws and regulations, inflation and other economic factors. The Company estimates its future cost requirements for closure and post-closure monitoring and maintenance for operating chemical disposal sites based on RCRA and the respective site permits. RCRA requires that companies provide financial assurance for the closure and post-closure care and maintenance of their chemical sites for at least thirty years following closure. Where both the amount of a particular environmental liability and the timing of the payments\nare reliably determinable, the cost is discounted to present value at a discount rate of 2.5%, net of inflation. See Note 5 and the discussion of Operating Costs included in Management's Discussion and Analysis of Financial Condition and Results of Operations for information concerning certain adjustments recorded in 1994 and 1993.\nNet Income Per Share. The calculation of net income per common and common equivalent share is in accordance with the treasury stock method for the year ended December 31, 1994 and the modified treasury stock method for the years ended December 31, 1993 and 1992. The change in methods relates to the reductions in common stock equivalents due to the expiration of an outstanding warrant in 1993.\nThere was no difference between the primary and fully diluted earnings per share calculations in 1994, 1993 and 1992.\nStock Split. On May 28, 1992, the Board of Directors of the Company approved a 3-for-2 stock split, effective July 15, 1992. Retroactive effect has been given to the 3-for-2 stock split in shareholders' equity and in all share and per share data in the accompanying consolidated financial statements and notes thereto.\nReclassification. Certain reclassifications have been made to prior year financial statements to conform to the fiscal 1994 presentation.\nNote 2. Cash and Investment Securities\nCash and investment securities at December 31, 1994 and 1993, were as follows (in thousands):\nInvestments in trading securities consist principally of preferred stocks, which are held by a captive insurance company wholly-owned by the Company. The change in net unrealized holding loss on trading securities was $177,000 in 1994. Investments in securities available-for-sale consist of common stock of Perma-Fix, Inc. (see Note 10) which has an original cost value of $1,635,000, fair value of $1,703,000 and a gross unrealized holding gain of $68,000 at December 31, 1994. There were no sales of securities available-for- sale during 1994. Investments in securities held-to-maturity mature over various dates during 1995 and are reported at their amortized cost basis, all of which approximates fair value at December 31, 1994. Investments in securities held- to-maturity at December 31, 1994, and 1993 consisted of the following (in thousands):\nCertain cash accounts and substantially all investments in securities held-to-maturity and trading securities totaling $13,175,000 and $13,632,000 at December 31, 1994 and 1993, respectively, have been classified as non-current assets as cash and investment securities, pledged. The pledged cash and investment securities represent collateral for the Company's closure\/post closure obligations, performance of a Remedial Investigation and Feasibility Study (\"RI\/FS\") and performance of corrective action at the closed Sheffield, Illinois facility, compliance with Texas Natural Resource Conservation Commission requirements related to the Company's non-commercial use deepwell at the Company's Robstown, Texas, facility, closure costs for the Beatty, Nevada LLRW site, test borings at the proposed LLRW facilities in Nebraska and California, settlement with generators of waste at the Richland, Washington facility, and various performance bonds. Also, a portion of the pledged cash and investment securities at December 31, 1994 is pledged as collateral for closure costs relating to the two facilities acquired in 1994 (see Note 10). The amounts pledged by the Company generally equal the present value of its estimated future closure and post-closure obligations.\nNote 3. Property and Equipment\nProperty and equipment at December 31, 1994 and 1993, was as follows (in thousands):\nNote 4. Accrued Liabilities\nAccrued liabilities at December 31, 1994 and 1993 were as follows (in thousands):\nNote 5. Deferred Site Maintenance\nDeferred site maintenance accruals at December 31, 1994 and 1993 were as follows (in thousands):\nAccrued costs associated with open facilities principally relate to closure and post-closure for the permitted and developed portion of the Robstown, Texas facility, groundwater contamination remediation at the Robstown and Winona, Texas facilities, and to capping of active cells at the chemical waste disposal facilities in Robstown, Texas and Beatty, Nevada and the LLRW facility in Richland, Washington. The Company is in process of re-permitting the Robstown facility to include development of an additional portion of the site. The Company's current estimate of the Robstown site's closure and post- closure costs of approximately $4.9 million does not include the incremental closure and post-closure costs for this undeveloped portion of the site.\nThe Company is in the process of addressing corrective action plans at the Robstown, Texas site. A 1978 analysis showed the presence of chemical contamination in the shallow, non-potable aquifer underlying the site. The Company operates a deep-injection well for the disposal of contaminated groundwater and leachate generated at the facility. The Company has recorded an accrual for the estimated costs of the groundwater remediation program based upon a compliance plan agreed to with the state's regulatory authority in 1992. Based on remediation results to date, the reduction in contamination levels outlined in the compliance plan are not being achieved. In 1993, the state's regulatory rules were amended to base clean-up requirements upon reasonable standards criteria. The Company believes that the standards upon which the costs are estimated should be reduced and has proposed an alternative plan to the State which could substantially mitigate future groundwater remediation costs. The Company is unable to predict the outcome of the state's response to the Company's proposal. If the Company's proposal is not accepted, significant costs may be required to remediate the site to the state's specifications in the current compliance plan.\nThe Winona facility, acquired on December 31, 1994, has on-site, underground chemical contamination for which the facility has developed a corrective action plan and is in process of remediating. Groundwater is recovered and disposed of in the facility's deep-injection well. The estimated cost of the remediation of approximately $1.1 million was included in the Company's deferred site maintenance accruals at December 31, 1994.\nThe State of Nevada and the State of Washington have responsibility for the costs of closure and post-closure care and maintenance of the respective Beatty, Nevada and Richland, Washington sites. The Company currently submits waste volume-based fees to state maintained funds. Such fees are periodically negotiated with, or\nestablished by, the states and are based upon engineering cost estimates provided by the Company and approved by the state. The estimated additional cell capping costs to be expensed over the remaining developed cell space at the Company's disposal facilities was approximately $803,000 at December 31, 1994.\nAccrued costs associated with closed facilities relate to remediation, closure and post-closure of the Sheffield, Illinois chemical facility, maintenance of the Sheffield LLRW facility, and agreed to and estimated settlements with potentially responsible parties for the remediation of the LLRW disposal facility at Maxey Flats, Kentucky.\nThe Company is in the process of remediating the closed chemical waste disposal facility in Sheffield, Illinois under a final corrective measures implementation plan issued by the U.S. EPA in 1990 pursuant to the Remedial Investigation and Feasibility Study completed by the Company. The Company has submitted for approval a closure\/post closure plan for the site to the Illinois EPA and to the U.S. EPA. The plan has not been approved by the agencies pending further implementation of the RI\/FS. The estimated term of the closure plan combined with the required thirty years post-closure monitoring is forty years. Additionally, the Company is maintaining until 1998 a closed LLRW disposal facility adjacent to the closed chemical waste disposal facility pursuant to a May 25, 1988 Agreed Order with the State of Illinois. The estimated costs of the remediation and closure program, maintenance and post-closure monitoring of the Sheffield facilities with the expected timing of future payments at December 31, 1994 were as follows (in thousands):\nDuring 1994, the Company settled its litigation with the Commonwealth of Kentucky regarding cost recovery and contribution from the Commonwealth in connection with the closed Maxey Flats LLRW site of which the Company was named a potentially responsible party (\"PRP\"). This settlement resulted in the Company's receipt of $1,000,000 from the Commonwealth and a $500,000 indemnification by the Commonwealth for claims made by other PRP's against the Company. At December 31, 1994, the Company had settlement agreements or was negotiating settlement with three PRP's and had recorded a liability of approximately $1 million for such settlements. The Company recorded a receivable of $500,000 for indemnification due from the Commonwealth.\nNote 6. Long Term Debt\nLong term debt at December 31, 1994 consisted of the following (in thousands):\nThe secured bank credit facility, as amended, (\"Credit Agreement\") matures on January 31, 1996 and is comprised of a $30,000,000 term loan, a $5,000,000 revolving credit facility and $5,000,000 in standby letters of credit. Interest is payable quarterly and the interest rate is equal to either the base rate (the greater of the bank's prime rate or the federal funds rate plus .5%) plus a margin of 0% to .75%, or a Eurodollar rate plus a margin of 2% to 3%. The marginal rate increases are based on a debt coverage ratio. The Company's actual interest rate as of December 31, 1994 was approximately 8.7%. These rates are subject to increase by .25% to .75% and the bank may enforce financial and other restrictions on the Company if the Company is unable to refinance the facility by May 1, 1995. Commitment fees of .25% are payable on the unused portion of the revolving credit facility. The Credit Agreement includes maintenance of debt coverage and other financial covenants, which, among other things, could restrict payment of dividends, and is secured by substantially all of the Company's assets. Subsequent to December 31, 1994, the Company was not in compliance with a financial covenant requiring the maintenance of a specified amount of accounts receivable and obtained a waiver from the bank regarding such non-compliance. The Company subsequently requested that the required level of accounts receivable be adjusted to a lower amount and that certain financial covenants be adjusted to a level in which the Company would remain in compliance based on the Company's projected financial position through 1995. The bank approved this request on April 12, 1995. Under the terms of the Credit Agreement, the bank may accelerate the maturity of the debt in the event a material adverse effect is deemed by the bank to have occurred. If the Company is unable to remain in compliance with the terms of the Credit Agreement or obtain waivers in the event of a default and the bank accelerates maturity of the Credit Agreement, the Company does not have adequate financial resources to extinguish the loan and the Company's operations may be negatively impacted. See \"Capital Resources and Liquidity\" elsewhere herein.\nThe Company is in process of arranging for long-term refinancing for the credit facility and, if successful, anticipates the successful closing of a private placement debt offering in the second quarter of 1995. If the private debt placement is not successful, management will seek alternative financing which may include an equity offering or an offering combining debt and equity. Absent new financing in the anticipated timeframe, forbearance will be required from the Company's existing bank lender to meet obligations as they become due. There is no certainty that the refinancing will be obtained or that the Company's existing lender will provide such forbearance. Management believes that the Company will be able to remain in compliance with the terms of the Credit Agreement.\nThe acquisition note payable matures on December 31, 1995 and represents a note payable to Mobley Environmental Services, Inc. (\"Mobley\"). This note was incurred as part of the acquisition of Gibraltar Chemical Resources, Inc. on December 31, 1994. This note is non-interest bearing and payment of the note is subject to set-off of any indemnification amounts owed by Mobley.\nAt December 31, 1994, the Company had $4,466,995 of issued letters of credit outstanding, including $1,951,995 of letters of credit issued under the bank credit facility, of which the most significant relate to site operating permits for licenses and guarantees for site closure and post-closure required in obtaining operating permits for the disposal sites. The issued letters of credit are secured by cash and investment securities.\nNote 7. Income Taxes\nEffective January 1, 1993, the Company prospectively adopted Financial Accounting Standards No. 109, Accounting for Income Taxes (\"Statement 109\"). The effect of the adoption was not material to the Company's\nfinancial position or results of operations. The Company previously accounted for income taxes under Statement of Financial Accounting Standards No. 96.\nThe components of the income tax provision (benefit) were as follows (in thousands):\nThe following is a reconciliation between the effective income tax rate and the applicable statutory federal income tax rate:\nThe tax effects of temporary differences between income for financial reporting and taxes that gave rise to significant portions of the deferred tax assets and liabilities and their changes during the year were as follows (in thousands):\nThe Company has established a valuation allowance for certain deferred tax assets due to realization uncertainties inherent with the long-term nature of deferred site maintenance costs and for limitations on utilization of acquired net operating loss carryforwards for tax purposes. The realization of a significant portion of net deferred tax assets is based in part on the Company's estimates of the timing of reversals of certain temporary differences and on the generation of taxable income before such reversals. The net operating loss carryforward of approximately $6,271,000 at December 31, 1994, begins to expire in the year 2007 and its utilization is limited pursuant to the net operating loss limitation rules of Internal Revenue Code Section 382. The portion of the valuation allowance for which future recognized tax benefits will be allocated to reduce goodwill was approximately $2,754,000 at December 31, 1994.\nThe Company is currently in process of negotiating a settlement for the audit of its 1991 federal income tax return by the Internal Revenue Service. Management believes the results of this settlement will not have a material adverse effect on the Company's consolidated results of operations or financial condition.\nNote 8. Employee's Benefit Plans\nRetirement Plan. The Company has a defined contribution retirement plan covering substantially all of the Company's full-time employees after one full year of employment. The Company makes contributions to the plan equal to 5% of the participant's monthly compensation, as defined. The Company also makes an additional 5% contribution for employees who earn in excess of the prior year's FICA base compensation, as defined. The Company's contributions vest to the employees at 20% per year, beginning with the first full year of employment.\n401(k) Plan. The Company maintains a 401(k) plan for employees who voluntarily contribute a portion of their compensation, thereby deferring income for federal income tax purposes. The plan covers substantially all of the Company's employees. Participants may contribute between 1% and 10% of their compensation. The Company matches 55% of participant contributions up to 6% of an employee's compensation. The Company's matching contributions vest to the employee over a three year period.\nThe Company's total contribution for both the retirement plan and 401(k) plan was $946,000, $783,000 and $610,000, for the years ended December 31, 1994, 1993, and 1992, respectively. The Company has no post-retirement or post- employment benefit plans.\nNote 9. Stock Option Plans\nThe Company presently maintains four stock option plans affording employees and outside directors of the Company the right to purchase shares of its common stock. The exercise price, term and other conditions applicable to each option granted under the Company's plans are generally determined by the Compensation Committee of the Board of Directors at the time of the grant of each option and may vary with each option granted. No option may be granted at a price less than the fair market value of the shares when the option is granted, and no options may have a term longer than ten years. The following is a summary of the transactions under the plans:\nNote 10. Acquisitions\nOn September 19, 1994, the Company acquired the assets of Quadrex Recycle Center, (\"Recycle Center\"), a business segment of Quadrex Corporation (\"Quadrex\") that provides recycling, decontamination, volume reduction of radioactive waste and related equipment rental services to government, commercial and nuclear power industries. The purchase consideration was comprised of payments by the Company for assumed liabilities and working capital for the Recycle Center through the closing date, additional unpaid liabilities assumed as of the closing date, and direct acquisition costs, all of which total approximately $27,686,000. The purchase method of accounting has been used for this asset acquisition, therefore, the Recycle Center's results of operations are consolidated with the Company's since September 19, 1994. The excess of acquisition cost over fair value of net tangible assets of the Recycle Center of approximately $21,704,000 is to be amortized on a straight-line basis over a 25 year period. The acquisition cost has been reduced by the estimated fair value of 545,000 common shares of Perma-Fix, Inc. (\"Perma-Fix\") which Quadrex transferred to the Company effective September 30, 1994. The Company has the right to receive up to 355,000 additional common shares of Perma-Fix, Inc. from Quadrex pending certain regulatory approvals and approval of the bankruptcy court where Quadrex has filed its bankruptcy proceedings. The fair value of these additional shares will reduce the acquisition cost when received.\nAt the date of acquisition, the Company recorded a liability for the waste processing and burial of waste on-site at the Recycle Center. The liability is based on management estimates of anticipated waste treatment methods and associated volume reductions. Should estimated volume reductions not be attainable, the costs for processing and burial could increase materially. Additionally, the Company has recorded receivables totaling $2,937,000 at December 31, 1994 for anticipated insurance claim settlements relating to a fire which damaged a processing building and related equipment at the Recycle Center in July 1994. The amount of proceeds from business interruption and other damage claims is subject to negotiations and final determination. See Note 11 for discussion of other material contingent liabilities related to the Recycle Center.\nOn December 31, 1994, the Company acquired Gibraltar Chemical Resources, Inc. (\"the Winona facility\"), a wholly-owned subsidiary of Mobley. The Winona facility provides fuels blending, solvent recycling, and deepwell injection services to the hazardous and industrial waste disposal markets with a fixed base facility in Winona, Texas and collections and technical operations in El Paso, Texas and Laredo, Texas. The total acquisition cost of $10,628,000 included cash, a $550,000 note payable to Mobley, assumed liabilities, and direct acquisition costs. The excess of cost over fair market of net assets of the Winona facility of approximately $3,468,000 is to be amortized on a straight-line basis over a 25 year period. Since the acquisition was effective the last day of the year and since the purchase method of accounting has been used for this acquisition, no results of operations of the Winona facility were included in the Company's 1994 consolidated results.\nIn allocating purchase price of acquisitions, the assets acquired and liabilities assumed have been initially assigned and recorded based on preliminary estimates of fair value and may be revised as additional information concerning the valuation of such assets and liabilities becomes available. As a result, the financial information included in the Company's consolidated financial statements is subject to adjustment as subsequent revisions in estimates of fair value, if any, are necessary.\nThe consolidated results of operations on an unaudited proforma basis as though the businesses acquired in 1994 and 1993 had been acquired on January 1, 1993 are as follows (in thousands, except per share amounts):\nThe pro forma financial information is presented for information purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisitions been consummated as of the above dates, nor are they necessarily indicative of future operating results.\nNote 11. Commitments and Contingencies\nRichland, Washington Facility. In 1964, the Washington Department of Ecology (\"WDOE\") leased from the DOE a 1,000 acre portion of the Hanford Reservation. In 1965, the WDOE subleased 100 acres of that property to the Company for use as a LLRW disposal facility under the regulation of the Washington Department of Health pursuant to the Atomic Energy Act. In 1990 the DOE applied to the EPA for a permit under the RCRA and other laws and regulations to obtain the appropriate regulatory approvals needed to proceed with the environmental cleanup of the Hanford Reservation. In 1994, in a consent order among the EPA, DOE and WDOE, the EPA and DOE issued a corrective action permit that includes all of the land owned by the DOE at the Hanford Reservation, including that portion leased to WDOE, which includes the 100 acres subleased to the Company for its LLRW disposal facility. Thirteen trenches at the Company's LLRW disposal facility have been included in the final permit as solid waste management units which will require further investigation to determine whether releases of any hazardous wastes or constituents have occurred. Because portions of the Company's facility remains included in the final permit issued to the DOE, the Company is potentially subject to proposed permit conditions for site investigation and possible cleanup should any releases be discovered even though the Company is not a permittee and though it was not involved in the activities contributing to the\nHanford facility contamination that are the subject of the Hanford consent order. It is the Company's opinion that it has legal defenses to the inclusion of its Hanford site in the DOE permit and to any corrective action that may be proposed of the site pursuant to the DOE permit. The Company has appealed to the Environmental Hearing Board of the EPA the terms of the permit that apply to any of the Company's facilities. By agreement of all the parties, appeals have been stayed in order for the Company to negotiate a settlement with DOE and EPA to resolve corrective action concerns. If the Company is unsuccessful in the negotiation or the challenge to the permit, the cost of conducting the site investigation and any corrective action could be material.\nThe Company was assessed a substantial property tax increase by the Benton County Assessor's Office and has filed suit challenging the property tax increase imposed by the Benton County Assessor on improvements at the Company's leased disposal facility on the Hanford Reservation. The County Treasurer issued tax statements based upon these assessments for payments covering the years 1989, 1990 and 1991, which totaled $1.7 million. The Company sued Benton County and the Assessor and Treasurer to enjoin them from collecting these taxes. The Benton County Superior Court issued an injunction in favor of the Company. The County appealed to the Court of Appeals. The Court of Appeals ruled in favor of the County and reversed the decision of the Benton County Superior Court by holding that the injunction should not have been issued pending the Company's pursuit of administrative remedies. The Company is appealing the Court of Appeal's decision to the Washington Supreme Court. Management believes that the County's assessments were improper and intends to vigorously defend this matter in the courts and through any appropriate administrative process, if necessary.\nWinona, Texas Facility. The Company purchased the stock of Gibraltar, since renamed American Ecology Environmental Services Corporation, from Mobley on December 31, 1994. The Company's stock purchase agreement with Mobley provides that Mobley will indemnify the Company, without limitation as to amount, for any damages or costs, including legal fees, associated with certain pre-closing liabilities, including the claims set forth hereunder. Pursuant to its stock purchase agreement with Mobley, the Company has also been named as an additional insured for pre-closing claims under Mobley's pollution liability insurance policy. The policy has a $10 million aggregate limit and a $5 million per loss limit.\nIn 1992, a citizens group filed a petition with the TNRCC for revocation of the Winona facility's deepwell permits alleging that a geological fault exists in the vicinity of the Winona facility's deepwells and other alleged grounds. The EPA has previously concluded in its proceedings relating to the Winona facility's second injection well that no such fault exists. The Company believes the petition is without merit.\nA group called Mothers Organized to Stop Environmental Sins filed a lawsuit in 1994 against the Company in the United States Eastern District Court for the State of Texas alleging that the Winona facility violated certain permits and regulations, and contributed to the handling, storage, treatment, transportation and disposal of solid and hazardous waste that presents an imminent and substantial endangerment to health and the environment. The plaintiffs have requested that the facility be shut down and civil penalties imposed on the Company. The Company has filed an answer denying these allegations and a motion for summary judgment and believes the suit is without merit. The Company intends to vigorously defend this litigation. However, if the plaintiffs were to ultimately prevail on their claim and be awarded the remedies sought, such outcome could have a material adverse effect on the Company's consolidated financial position and results of operations.\nFour lawsuits, including one purported class action, were filed against Gibraltar, in 1992 and 1993 which were subsequently transferred to State District Court in Smith County, Texas, by certain persons in Winona, Texas. The suits assert various theories of liability including subsurface trespass, nuisance, and negligence for alleged air emissions. The suits also allege that the plaintiffs have experienced personal injuries, diminution in property values, and other economic losses which are alleged to have been caused by operation of the Winona facility. The plaintiffs assert various grounds for recovery, including allegations that their property has been used without their consent as a hazardous waste facility, and seek unspecified actual and punitive damages. The Company disputes the material allegations of the plaintiffs' suits and intends to vigorously defend this litigation. To date, the Company and Mobley have settled certain of the plaintiffs' claims in these actions for amounts that were not material and which were funded by the Mobley insurance policy referred to above.\nCompact Related Disputes. The Company is involved in numerous challenges and legal proceedings in connection with its siting efforts for LLRW facilities for the Southwest Compact and Central Interstate Compact. For a description of these proceedings, see \"Business - Low-Level Radioactive Waste Services - Disposal Services - Ward Valley, California Facility\" and \"-Butte, Nebraska Facility\".\nThe Company has received invoices from the Southeast Compact Commission for approximately $1.5 million and a notice that an additional $1.5 million will be invoiced in the aggregate in the second and third quarter of 1995. The invoices relate to an access fee for the Barnwell, South Carolina LLRW disposal facility in the Southeast Compact utilized by Quadrex. The fee for each generator is calculated pursuant to a Commission formula which is based on the historical amount of LLRW shipped to the Barnwell facility by such generator. The Company believes that it did not assume such access fees liabilities relating to pre-acquisition volumes of Quadrex in its asset acquisition of the Recycle Center and that the Company has legitimate defenses to this claim. The Company appealed the Commission's invoices and in February 1995 at an appeal hearing, the Commission again concluded that the full access fees were payable by the Company. As a result of the fee dispute, on March 29, 1995, the Southeast Compact Commission directed the Department of Health and Environmental Control of the State of South Carolina to deny the Company access to the Barnwell, South Carolina LLRW disposal facility. The Company has appealed the Commission's action to the Department under South Carolina law. As of the date of this report, the Department has not denied the Company access to the Barnwell facility. While the Company continues to discuss alternate resolutions of this dispute with the Commission, the Company believes it has no material liability in connection with this matter and intends to vigorously defend any material assessment or attempt to deny access to the Barnwell facility.\nOther Litigation. The City of San Antonio (the \"City\") filed suit against several parties related to environmental issues in connection with the acquisition, development and construction of a bus transit station and multi- purpose stadium and sports complex, commonly known as the Alamodome. The City has named as the defendants: the former owner of the property, various consultants involved in the project, the project manager, and a subsidiary of the Company which served as the construction contractor for the project. The City has alleged several theories of recovery, including breach of contract, negligent misrepresentation and gross negligence. The City alleges its consultants failed to advise the City that the selected site was contaminated, thereby breaching their contracts and committing torts. The City alleges further that following the discovery of actual or potential environmental problems, the City's consultants and project manager failed to act properly in handling allegedly contaminated soil and groundwater. The City has also alleged that construction of the landfill did not conform to contract requirements. The City has decided to exhume the onsite landfill and dispose of it at another location. Minimal discovery has been taken. The Company does not believe that the claims against its subsidiary are meritorious and intends to vigorously defend against such claims. Furthermore, the Company intends to pursue a counterclaim to recover sums related to its construction of the on-site landfill.\nIn November 1994, the Company was named as a defendant in a purported class action lawsuit by former employees of Quadrex that relates to unpaid medical benefits and an underfunded pension plan of Quadrex. Based on information available to it, the Company believes that the aggregate amount of these claims are less than $1 million. The Company purchased the assets of the Quadrex Recycle Center from Quadrex on September 19, 1994. However, the asserted claims in the purported class action were specifically excluded by the purchase agreement pursuant to which the Company purchased the assets of the Quadrex Recycle Center. Some of the former Quadrex employees on whose behalf the suit was brought are now employees of the Company. The Company does not believe it has any liability in this matter and intends to contest the matter vigorously. The Company's purchase agreement with Quadrex provides that Quadrex will indemnify the Company for any damages or costs, including legal fees, associated with a claim of this sort. However, because Quadrex filed for bankruptcy protection in February 1995, it is very likely that the Company will not realize the benefits of such indemnification.\nThe Company has received a notice from an individual purporting to own debt secured by certain real property in Midlothian, Texas. The individual alleges that a predecessor of the Company's subsidiary, Texas Ecologists, caused environmental contamination of the property in the early 1970's. The Company believes it has no liability in connection with the matter and intends to contest the matter vigorously. In connection with its investigation of the matter, the Company also conducted its own assessment of the property with an independent environmental consultant and concluded that any contamination on the property falls below material levels.\nOther Matters. In 1990, the Company was sued by certain landowners owning property adjacent to the Company's Robstown, Texas disposal facility. The landowners have alleged that there has been migration of pollutants through groundwater which has contaminated water resources on their respective property. These landowners have alleged theories including nuisance per se, negligence and trespass. The Company's investigation has found no migration of pollutants onto the adjacent landowners' properties and the Company intends to contest this matter vigorously.\nIn 1992, the Company received notice from the EPA alleging that the Company had violated financial assurance and liability insurance requirements at the closed Sheffield, Illinois hazardous waste disposal site formerly operated by the Company. The EPA is seeking a penalty of approximately $1 million and ordering compliance. Both the EPA and the Company have filed cross-motions for an accelerated decision by the administrative law judge regarding the issue of liability. Though the ultimate outcome of this matter is uncertain, the Company believes these insurance requirements are not applicable to this closed site and intends to vigorously contest this matter.\nIn April 1995, management of the Company became aware that the Company had held hazardous waste containers at certain of its transportation terminals for periods greater than the 10-day temporary storage periods permitted by TNRCC regulations. The Company has reported the matter to the TNRCC. The Company has also put in place procedures to safeguard against future violations of this type and, upon completion of its review of the matter, may put in place additional safeguard procedures if so warranted. While the Company believes the steps that it has taken are appropriate and responsive, it is possible that the TNRCC may seek to impose a fine on the Company in connection with the matter. The Company is not in a position to assess the amount of such a fine. However, a fine of sufficient magnitude could have a material adverse effect upon the consolidated financial position of the Company.\nIn addition to the above-described litigation and the litigation related to the Southwestern and Central Interstate compacts referred to in Note 1, the Company and its subsidiaries are involved in various other administrative matters of litigation, including personal injury and other civil actions, as well as other claims, disputes and assessments that could result in additional litigation or other proceedings. The Company and its subsidiaries are also involved in various other environmental matters or proceedings, including permit application proceedings in connection with the establishment, operation, closure and post-closure activities of certain sites, as well as other matters or claims that could result in additional environmental proceedings.\nFinancial Assurance and Insurance. Under RCRA, the Company is required to develop closure and post-closure plans for each of its chemical waste disposal sites. In conjunction with these plans, the Company must prepare closure and post-closure cost estimates and give financial assurance that the planned actions will be completed. Financial assurance must be given by either funding a trust, posting a bond, providing a letter of credit, providing a certificate of insurance, or if the operator meets certain financial tests, giving a corporate guarantee. The Company currently covers these requirements by pledging letters of credit, providing certificates of insurance and by corporate guarantee. Cash and investment securities have been pledged as collateral for these instruments (See Note 2.). The Company could be required to fund additional monies for financial assurance if the Company was to fail to meet certain financial tests under existing corporate guarantees, or if a regulatory entity requires additional funding.\nRCRA regulations require the Company to carry environmental impairment insurance against sudden and accidental occurrences, as well as against non- sudden occurrences such as subsurface migration. While the Company's current level of coverage meets the requirements (except for the Sheffield chemical site), there is no assurance that insurance carriers will continue to provide such coverage to operators, or that such coverage will be obtainable in future years.\nWhile the final resolution of any matter may have an impact on the Company's consolidated financial results for a particular reporting period, management believes that the ultimate disposition of the matters discussed in Note 11 will not have a materially adverse effect upon the consolidated financial position of the Company. See Item 3 \"Legal Proceedings\" elsewhere herein.\nLease Commitments. The Company leases substantial portions of its office and other facilities under various lease agreements. Future minimum lease commitments under noncancellable operating leases as of December 31, 1994, were as follows (in thousands):\nRental expense, which also includes month-to-month equipment rentals, was $2,307,000, $1,848,000, and $1,186,000, for the years ended December 31, 1994, 1993, and 1992, respectively.\nNote 12. Stockholder Rights Plan\nDuring December 1993, the Company adopted a Stockholder Rights Plan (the \"Plan\"). Pursuant to the Plan each outstanding share of the Company's Common Stock on December 17, 1993, received one Right as a dividend that becomes exercisable upon certain triggering events. On March 29, 1995, the Company terminated the Plan and authorized the redemption of all outstanding Rights issued under the Plan. The redemption price is $.01 per Right and is payable on April 15, 1995 to stockholders of record on April 10, 1995.\nNote 13. Fair Value of Financial Instruments\nEffective December 31, 1994, the Company adopted Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments. This statement requires disclosure of fair market value information for financial instruments. The book values of investment securities, excluding investments in common and preferred stocks, receivables, accounts payable and financial instruments included in other assets and accrued liabilities approximate their fair values principally because of the short-term maturities of these instruments. Investments in common and preferred stocks are stated at fair market values. The quoted market price was used to determine the fair market value of the investment in common stock and estimated market values were used to determine the fair market value of the investments in preferred stocks. The carrying value of long-term debt approximates fair value principally because of the variable interest rates terms set forth in the bank credit facility agreement.\nITEM 9.","section_9":"ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItems 10, 11, 12 and 13 of Part III have been omitted from this report because the Company will file with the Securities and Exchange Commission, not later than 120 days after the close of its fiscal year, a definitive proxy statement. 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.\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) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS\n1. Financial statements and reports of Arthur Andersen LLP Reports of Independent Auditors Consolidated Balance Sheets - December 31, 1994 and 1993 Consolidated Statements of Operations for the years ended December 31, 1994,1993, 1992 Consolidated Statements of Shareholders, 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\n2. Financial statement schedules Report of Independent Public Accountants Schedule II - Valuation Accounts and Reserves\nOther schedules are omitted because they are not required or because the information is included in the financial statements or notes thereto.\n3. Exhibits\n* Management contract or compensatory plan.\n(B) REPORTS ON FORM 8-K\nA Form 8-K reporting the closing of the acquisition of the Recycle Center was filed on October 4, 1994. Amendment No. 1 to that Form 8-K with historical and pro-forma financial information on the Recycle Center was filed on December 5, 1994.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nThe Board of Directors and Shareholders of American Ecology Corporation\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of American Ecology Corporation (a Delaware 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 13, 1995, included in this Form 10-K. Reference is made to said report in which the opinion contains an emphasis of a matter paragraph with respect to the maturity of the Company's Credit Agreement in January 1996. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The following Schedule II for American Ecology Corporation and subsidiaries is the responsibility of the Company's management and 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, as it relates to the three years ended December 31, 1994, in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN LLP\nHouston, Texas April 13, 1995\nSCHEDULE II\nAMERICAN ECOLOGY CORPORATION VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 ($ IN 000'S)\nThe notes to consolidated financial statements are an integral part of this schedule.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMERICAN ECOLOGY CORPORATION\nDated: April 13, 1995 By: \/s\/ Jack K. Lemley ------------------------ Jack K. Lemley Chief Executive Officer, President and Chief Operating Officer","section_15":""}
{"filename":"59880_1994.txt","cik":"59880","year":"1994","section_1":"Item 1. Business - -----------------\nLitton Industries, Inc. (hereafter together with its consolidated subsidiaries referred to as the \"Company\" or \"Litton\" unless the context otherwise indicates) is mainly a high-technology aerospace\/defense corporation which provides advanced electronic and defense systems and marine engineering and production to U.S. and world markets. The Company also provides electronic components and interconnect products to customers worldwide. The Company was founded in California in 1953 and has evolved into a major international organization with approximately 29,000 employees at more than 20 major divisions.\nThe Company's businesses are reported in three business segments: Advanced Electronics, Marine Engineering and Production, and Interconnect Products. Information about the Company's business segments appears on pages and of this Annual Report on Form 10-K. This information includes sales and service revenues, operating profit (loss) and identifiable assets for the Company's business segments for each of the three years in the period ended July 31, 1994.\nAdvanced Electronics - --------------------\nThe Company is a major supplier of electronic systems and related services to the United States and international military electronics markets. Principal programs and products include development, manufacture and assembly of inertial navigation and guidance systems; command, control, communications and intelligence systems; and electronic warfare systems. The Company participates in ongoing development and production programs as well as upgrade and retrofit business worldwide to serve both defense and commercial aerospace markets. The Company also provides navigation systems for the worldwide commercial aircraft market, as well as electronic components and computer services to a variety of commercial customers.\nSales backlog for the Advanced Electronics segment was $1.703 billion and $1.934 billion at July 31, 1994 and 1993, respectively. Of the backlog at July 31, 1994, $1.152 billion has been funded and $512 million is expected to be realized as sales in years after fiscal 1995.\nSignificant revenues of the Advanced Electronics segment in 1994 were derived from sales to the U.S. Government (approximately 65%).\nMarine Engineering and Production - ---------------------------------\nThe Company's Ingalls Shipbuilding subsidiary is a leading designer and builder of complex surface combat ships for the U.S. Navy. Ingalls has delivered a total of 64 new destroyers, cruisers and amphibious assault ships to the Navy since 1975. Current construction work includes twelve Aegis destroyers and three amphibious assault ships for the U.S. Navy, and two corvettes for another country. The division is also a major provider of modernization, overhaul and repair work.\nItem 1. Business, continued - -----------------\nMarine Engineering and Production, continued - ---------------------------------\nSales backlog for the Marine Engineering and Production segment was $3.694 billion and $4.638 billion at July 31, 1994 and 1993, respectively. Of the backlog at July 31, 1994, $3.578 billion has been funded and approximately $2.321 billion is expected to be realized as sales in years after fiscal 1995. In an announcement made in June 1994, the U.S. Navy awarded the Company a contract to construct an additional Aegis destroyer with options for two more. The backlog at July 31, 1994 did not include the options for the two destroyers, but it is anticipated that the U.S. Navy will fund their construction from its fiscal year 1995 budget.\nSignificant revenues of the Marine Engineering and Production segment in 1994 were derived from sales to the U.S. Government (approximately 93%).\nInterconnect Products - ---------------------\nThe Company's interconnect products operations provide interconnection subsystems, electronic and electrical connectors, printed circuit boards, back panels, card cages and solder products.\nDiscontinued Operations - -----------------------\nOn June 17, 1993, the Company's Board of Directors approved a plan to distribute to Litton shareholders all of the outstanding common stock of Western Atlas Inc. (\"WAI\"), a then wholly-owned subsidiary of Litton. WAI owned and conducted the oilfield services and industrial automation systems businesses. The accounts of WAI have been segregated and reflected as discontinued operations in the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K. On March 17, 1994, Litton distributed the outstanding common stock of WAI to shareholders of record on March 14, 1994. For further information, see Note B of Notes to Consolidated Financial Statements.\nItem 1. Business, continued - -----------------\nMethods of Distribution - -----------------------\nThe Company principally markets its products and services throughout the world through the home offices and branch offices of its various operations. In general, each of the Company's operations is responsible for selecting, implementing and maintaining an efficient and effective marketing program.\nRaw Materials - -------------\nThe Company uses a wide variety of raw materials in the manufacture of its many products. The availability of any individual raw material is not critical to the Company's operations.\nWorking Capital - ---------------\nThe working capital requirements of the Company's divisions and subsidiaries are financed primarily from operations. The Company also has available credit commitments of up to $400 million for its general use.\nPatents - -------\nThe Company owns a large number of patents, trademarks and copyrights relating to its manufactured products, which have been secured over a period of years. These patents, trademarks and copyrights have been of value in the growth of the Company's business and may continue to be of value in the future. However, the Company's business generally is not dependent upon the protection of any patent, patent application or patent license agreement, or group thereof, and would not be materially affected by expiration thereof.\nCompetition - -----------\nCompetition exists with respect to all products manufactured and services rendered by the Company. Competition ranges from companies which produce a single product or offer a single service to some of the world's largest corporations.\nU.S. Government Contracts - -------------------------\nContracts with the U.S. Government are, in many cases, performed over extended periods of time and are subject to changes in design, scope, schedules, costs and funding. In addition, contracts with the U.S. Government are subject to certain laws and regulations, the non-compliance with which by the contractor may result in various sanctions including monetary penalties and fines as well as debarment or suspension from further Government contracts.\nItem 1. Business, continued - ----------------\nU.S Government Contracts, continued - ------------------------\nSubstantially all of the Company's contracts for and with the U.S. Government are terminable at the option of the Government whenever it believes that such termination would be in its best interests. Under contracts so terminated, the Company is generally entitled to receive payment for work completed and reasonable allowable costs incurred. Whether the occurrence of any such termination would have an adverse effect on the Company would depend upon the particular contract and the nature of the termination. At the present time, management is not aware of any circumstances which would result in a material impact on its consolidated financial statements.\nApproximately 73% of the Company's consolidated revenues for fiscal year 1994 were derived from sales to the U.S. Government. Although uncertainties exist with regards to future defense budgets, the Company's current operating plans assume continuing reductions in defense spending.\nResearch and Development - ------------------------\nWorldwide expenditures on research and development activities amounted to $220.1 million, $254.6 million and $201.9 million, of which approximately 26%, 21% and 38% were Company-sponsored in the years ended July 31, 1994, 1993 and 1992, respectively. In fiscal 1994, the Advanced Electronics segment accounted for 99% of total research and development expenditures.\nEnvironmental Protection - ------------------------\nDuring the fiscal year ended July 31, 1994, the amounts incurred in compliance with federal, state and local regulations pertaining to environmental standards did not have a material effect upon the capital expenditures or earnings of the Company. For additional information with respect to environmental matters, see Items 3, 7, and 8 of this Annual Report on Form 10-K.\nNumber of Employees - -------------------\nAt July 31, 1994, the Company had approximately 29,000 full-time employees. Employment by business segment was as follows:\nFinancial Information by Geographic Area - ----------------------------------------\nSee the table and related notes thereto, Operations by Geographic Area, which appear on pages and of this Annual Report on Form 10-K.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nThe Company's principal plants and offices have an aggregate floor area of approximately 7,640,000 square feet, of which 6,502,000 square feet (85.1%) are located in the United States, and 1,138,000 square feet (14.9%) are located outside of the United States, primarily in Canada and Western Europe. The Company's executive offices are currently located in Beverly Hills, California, but will be moving to owned premises located in Woodland Hills, California.\nThese properties are used by the various business segments as follows:\nApproximately 6,963,000 square feet (91.1%) of the principal plant, office and commercial floor area is owned by the Company, and the balance is held under lease.\nThe Company's principal plants and offices in the United States are situated in 26 locations in 17 states as follows:\nThe above-mentioned facilities are in satisfactory condition and suitable for the particular purposes for which they were acquired or constructed and are adequate for present operations.\nThe foregoing information excludes Company held properties leased to others and also excludes plants or offices which, when added to all other Company plants and offices in the same city, have a total floor area of less than 50,000 square feet.\nItem 3.","section_3":"Item 3. Legal Proceedings - --------------------------\n(a) Litton Systems, Inc. (\"LSI\"), a subsidiary of the Company, was a defendant in a previously reported civil suit brought under the so-called qui tam provisions of the False Claims Act, which permit an individual to bring suit in the name of the United States Government and share in any recovery received. If the plaintiffs had prevailed in such litigation, the total damages and penalties could have exceeded $500 million. Without admitting any liability or wrongdoing, LSI and the plaintiffs, on July 14, 1994, agreed to settle all issues in connection with the matter. The Court dismissed the civil suit with prejudice, thereby terminating this proceeding. Accordingly, results for fiscal year 1994 included a charge of $86.0 million pre-tax, or $53.8 million after-tax, to reflect the settlement.\n(b) The Company and certain of its divisions or subsidiaries have been named as potentially responsible parties by the United States Environmental Protection Agency, various state environmental agencies, and other potentially responsible parties for costs associated with cleanup of several sites to which they may have contributed wastes. Also, the Company and certain of its divisions and subsidiaries have incurred costs, which have not had a material impact on the Company's consolidated financial statements in any one year, for cleaning up a number of sites owned or leased by the Company (or by subsidiaries or divisions thereof). In addition, the Company and certain of its divisions or subsidiaries have been named as defendants in certain lawsuits for personal injuries allegedly resulting from environmental contamination.\nAt this time, the Company believes that its ultimate liability for additional expenditures associated with these matters will not materially adversely affect its consolidated financial statements.\nItem 3. Legal Proceedings, continued - -------------------------\n(c) On August 31, 1993 a U.S. District Court jury rendered a verdict in favor of Litton against Honeywell, Inc. in the amount of $1.2 billion. The jury found that Honeywell willfully infringed a Litton patent relating to the manufacture of ring laser gyro navigation systems which are used in commercial aircraft. The jury also found that Honeywell actively induced a Litton licensee to infringe Litton's patent and Honeywell interfered with Litton's prospective economic advantage. The Court is currently considering post trial motions filed by both Honeywell and Litton. It is expected that any decision of the Court would be appealed by the party which does not prevail, and the Company cannot predict when this litigation will be ultimately concluded.\nThere are various other litigation proceedings in which the Company is involved. Although the results of litigation cannot be predicted with certainty, it is the opinion of the General Counsel that the Company does not have a potential liability in connection with these other proceedings which would have an adverse material 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, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year ended July 31, 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder - -------------------------------------------------------------------------- Matters -------\nSee the information with respect to the market for and number of holders of the Company's Common stock and quarterly market information which is set forth on pages through and dividend information which is set forth on page of this Annual Report on Form 10-K. The number of holders of record of the Company's Common stock was computed by a count of record holders on September 30, 1994.\nItem 6.","section_6":"Item 6. Selected Financial Data - --------------------------------\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SUMMARY OF FINANCIAL INFORMATION (dollar amounts in millions, except per share amounts)\nSee Notes on page 9d.\n-9a- Item 6. Selected Financial Data, continued - --------------------------------\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SUMMARY OF FINANCIAL INFORMATION (dollar amounts in millions, except per share amounts)\nSee Notes on page 9d.\n-9b- Item 6. Selected Financial Data, continued - --------------------------------\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SUMMARY OF FINANCIAL INFORMATION (dollar amounts in millions, except per share amounts)\nSee Notes on page 9d.\n-9c-\nItem 6. Selected Financial Data, continued - --------------------------------\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SUMMARY OF FINANCIAL INFORMATION (dollar amounts in millions, except per share amounts)\nNotes:\n(A) Information has been restated to conform with the current presentation and, as applicable, for the two-for-one Common stock split which occurred in fiscal year 1992 (see Note F on page). (B) Results for fiscal year 1994 included the settlement of a civil suit (see Notes I and J on pages and) and extraordinary loss on early extinguishment of debt (see Notes C and J on pages and). (C) In the fourth quarter of fiscal year 1991, the Company provided for the loss on sale of a division, which resulted in a charge to pre-tax earnings of $120.0 million or $100.1 million after tax. The effect on primary earnings per share for the year was a decrease of $2.31. (D) During the five year period ended July 31, 1994, the Company declared no dividends on its Common stock.\n-9d-\nItem 7.","section_7":"Item 7. Financial Review and Analysis - --------------------------------------\nSales for the Company's continuing operations amounted to $3.45 billion, $3.47 billion and $3.71 billion for fiscal years 1994, 1993 and 1992, respectively. Earnings before extraordinary loss on the early extinguishment of debt for fiscal year 1994 were $51.3 million. Fiscal year 1993 earnings before the cumulative effect of a change in accounting for retiree health care and life insurance benefits amounted to $87.3 million. Earnings for fiscal year 1992 were $87.3 million.\nThe Advanced Electronics segment reported sales of $1.73 billion, $1.84 billion and $1.96 billion for fiscal years 1994, 1993 and 1992, respectively. Related operating profit was $36 million, $118 million and $138 million, respectively. The decline in sales reflected the continuing reduction in defense budgets both in the U.S. and internationally. Although uncertainties exist with regards to the size and focus of future defense budgets, management believes that the Company's participation in a broad mix of programs will help lessen the impact of single program reductions or cancellations. The Company continues to focus on improving the cost structures and capacity of these operations to facilitate their competitive positions. The upfront costs of these efforts have affected profit and profit margin, but will enhance the ability of these operations to effectively compete for future contracts. Operating profit for fiscal year 1994 reflected a charge of $86.0 million for the settlement of a civil suit brought under the provisions of the False Claims Act (see Notes I and J of Notes to Consolidated Financial Statements). The U. S. Government and the other plaintiffs agreed to release all claims in connection with the settlement. The settlement brought a conclusion to an uncertainty which would have required the commitment of company resources on a long-term basis. The strong cash flow generated by these operations, along with a lower level of debt, provide the Company with flexibility to pursue selective acquisitions in the defense industry. The backlog for this segment at July 31, 1994 was $1.70 billion compared with $1.93 billion at July 31, 1993.\nThe Marine Engineering and Production segment reported sales of $1.48 billion, $1.39 billion and $1.49 billion for fiscal years 1994, 1993 and 1992, respectively. Related operating profit was $141 million, $130 million and $138 million, respectively. This segment's major customer is the U.S. Government; however, it is continuing to explore opportunities internationally. Management has continued to monitor and adjust the size of its operations to enhance efficiency, which will benefit its ability to compete successfully in the marketplace. This segment continued its solid performance and strong cash flow during fiscal year 1994. Sales showed a modest increase and there was an improvement in profit margin in fiscal year 1994 over 1993. Backlog at July 31, 1994 was $3.69 billion compared with $4.64 billion at July 31, 1993. In an announcement made in June 1994, the U.S. Navy awarded the Company a contract to construct an additional Aegis destroyer with options for two more. The backlog at July 31, 1994 did not include the options for the two destroyers, but it is anticipated that the U.S. Navy will fund their construction from its fiscal year 1995 budget.\nThe Interconnect Products segment provides a broad line of electronic components and interconnect products to diverse markets worldwide. This segment reported sales of $289 million, $307 million and $324 million for fiscal years 1994, 1993 and 1992, respectively. Operating profit for each of\nItem 7. Financial Review and Analysis, continued - --------------------------------------\nthese years was $8 million, $19 million and $16 million, respectively. The lower operating profit in fiscal year 1994 was primarily due to a charge recorded to adjust the net assets of a division to net realizable value in connection with its possible sale or closure.\nInformation about the Company's segments can be found on pages and.\nIn the current environment, the Company, along with other government contractors, will be subject to reviews and investigations by the U.S. Government in connection with the performance of and accounting for contracts. In the event a contractor is found to be in noncompliance with procurement rules and regulations, the U.S. Government may impose various sanctions including monetary payments as well as suspension or debarment from receiving further contracts. The U.S. Government may also unilaterally terminate contracts with compensation for work completed and costs incurred. At the present time, management is not aware of any circumstances which would result in a material impact on its consolidated financial statements.\nDiscontinued Operations\nOn March 17, 1994, Litton distributed all of the issued and outstanding shares of common stock of its previously wholly-owned subsidiary, Western Atlas Inc. (\"WAI\"), which has been reflected herein as discontinued operations (see Note B of Notes to Consolidated Financial Statements). The balance sheet effect of the distribution was a reduction to Litton's Shareholders' Investment in the amount of $915.3 million representing the book value of net assets distributed. Results for fiscal year 1994 included special charges totalling $179 million, net of tax, recorded to reflect the write-down of net assets in connection with WAI's decision to sell the Core Laboratories division of Western Atlas International, Inc. and to provide for obsolescence of older technology equipment, vessels and inventory and the consolidation of facilities.\nLiquidity and Capital Resources\nCash and marketable securities amounted to $117.1 million and $353.7 million at July 31, 1994 and 1993, respectively. The significant uses of cash during fiscal year 1994 included the early extinguishment (see Note C of Notes to Consolidated Financial Statements) of the Company's 12 5\/8% Subordinated Debentures in the principal amount of $435.8 million and the $86.0 million payment in connection with the settlement of the civil suit previously discussed. Both of these transactions occurred in July 1994. Cash flow from operations was the primary source of funds utilized in these transactions. The Company also received approximately $100 million repayment from WAI for certain intercompany indebtedness at the time of the distribution of the common stock of WAI.\nNet interest expense for fiscal year 1994 was $32.6 million compared with $66.1 million for fiscal year 1993 and $85.2 million for fiscal year 1992. Interest expense declined significantly in fiscal year 1994 compared with 1993 due primarily to the June 28, 1993 call for redemption of the zero coupon convertible subordinated notes. Substantially all of the notes outstanding were converted into 6.114 million shares of Litton Common stock\nItem 7. Financial Review and Analysis, continued - --------------------------------------\nand the remainder was redeemed in cash. Corporate interest costs of $7.0 million, $12.0 million and $12.0 million were attributed to WAI and, therefore, reclassified to discontinued operations for fiscal years 1994, 1993 and 1992, respectively. Additionally, interest income was higher in fiscal year 1994 due to higher average invested cash balances. The decrease in net interest expense in fiscal year 1993 compared with 1992 was primarily due to the redemption in July 1992 of the Company's 11 1\/2% Subordinated Notes in the principal amount of $435.8 million. In connection with the transaction, the Company repatriated certain earnings of a foreign subsidiary for which U.S. taxes had been provided, but not previously paid. The taxes due on the repatriated earnings were the principal reason for the higher tax payments in fiscal year 1992. Tax payments amounted to $195.0 million, $180.6 million and $220.7 million in fiscal years 1994, 1993 and 1992, respectively.\nManagement believes that the Company will be able to meet its working capital requirements with existing cash and marketable securities and internally generated funds. In addition, the Company has available credit commitments of up to $400 million for its general use.\nShareholder Rights Plan\nOn August 17, 1994, the Company's Board of Directors declared a dividend of one purchase right to a portion of a preferred share for each outstanding share of Common stock, payable August 31, 1994 to shareholders of record on that date. See Note F of Notes to Consolidated Financial Statements for further discussion.\nEnvironmental Matters\nThe Company has been named as a potentially responsible party in respect to various sites to which certain of its operations may have contributed wastes. Also, the Company and certain of its divisions and subsidiaries have incurred costs, which have not had a material impact on the Company's consolidated financial statements in any one year, for cleaning up a number of sites owned or leased by the Company. At this time, the Company believes that its ultimate liability for additional expenditures associated with sites owned and other sites to which it may have contributed wastes will not have a material adverse effect on its consolidated financial statements.\nItem 7. Financial Review and Analysis, continued - --------------------------------------\nNew Accounting Standards\nIn November 1992, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits, which establishes standards of accounting and reporting for the estimated costs of benefits provided to former or inactive employees after employment but before retirement. In May 1993, the FASB issued Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, which addresses the accounting and reporting for investments in debt securities and equity securities. The Company believes that the adoption of these standards, to be made in the first quarter of fiscal year 1995, will have virtually no impact on its consolidated financial statements.\nPART III\nItem 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------\nInformation on directors of the Company will be included under the caption \"The Election of Directors\" of the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on December 8, 1994, which is hereby incorporated by reference.\nThe executive officers of the Company are elected each year by the Board of Directors at its first meeting following the Annual Meeting of Shareholders 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 Company. The following information indicates the position and age of the executive officers at October 10, 1994 and their business experience during the prior five years:\nItem 10. Directors and Executive Officers of the Registrant, continued - ------------------------------------------------------------\nItem 11. Executive Compensation - --------------------------------\nInformation on executive compensation will be included under the caption \"Compensation of Executive Officers\" of the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on December 8, 1994, which is hereby incorporated by reference.\nItem 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------\nInformation on 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 will be included under the caption \"Beneficial Ownership of the Company's Securities\" of the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on December 8, 1994, which is hereby incorporated by reference.\nItem 13. Certain Relationships and Related Transactions - --------------------------------------------------------\nInformation on certain relationships and related transactions including information with respect to management indebtedness will be included under the caption \"Information Regarding Indebtedness of Management to the Company\" of the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on December 8, 1994, which is hereby incorporated by reference.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - -------------------------------------------------------------------------\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES EXECUTIVE COMPENSATION PLANS and ARRANGEMENTS\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES EXECUTIVE COMPENSATION PLANS and ARRANGEMENTS (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.\nLITTON INDUSTRIES, INC.\n\/s\/ Carol A. Wiesner ----------------------------- Carol A. Wiesner Vice President and Controller (Chief Accounting Officer)\nOctober 14, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nLitton Industries, Inc. Management's Responsibility for Financial Reporting\nThe consolidated financial statements of Litton Industries, Inc. and subsidiary companies, and related financial information included in this Annual Report, have been prepared by the Company, whose management is responsible for their integrity. These statements, which necessarily reflect estimates and judgments, have been prepared in conformity with generally accepted accounting principles.\nThe Company maintains a system of internal controls to provide reasonable assurance that assets are safeguarded and transactions are properly executed and recorded. As part of this system, the Company has an internal audit staff to monitor the compliance with and the effectiveness of established procedures.\nThe consolidated financial statements have been audited by DELOITTE & TOUCHE LLP, independent certified public accountants, whose report appears on page.\nThe Audit and Compliance Committee of the Board of Directors, which consists solely of directors who are not employees of the Company, meets periodically with management, the independent auditors and the Company's internal auditors to review the scope of their activities and reports relating to internal controls and financial reporting matters. The independent and internal auditors have full and free access to the Audit and Compliance Committee and meet with the Committee both with and without the presence of Company management.\n\/s\/ Rudolph E. Lang, Jr. - ------------------------ Rudolph E. Lang, Jr. Senior Vice President and Chief Financial Officer\nOctober 10, 1994\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Litton Industries, Inc. Beverly Hills, California\nWe have audited the accompanying consolidated balance sheets of Litton Industries, Inc. and subsidiary companies as of July 31, 1994 and 1993, and the related consolidated statements of operations, shareholders' investment and cash flows for each of the three years in the period ended July 31, 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 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 Litton Industries, Inc. and subsidiary companies as of July 31, 1994 and 1993, and the 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. 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 H to the consolidated financial statements, in fiscal year 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\nLos Angeles, California September 22, 1994\nLitton Industries, Inc. Consolidated Statements of Operations\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Statements of Operations (continued)\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Balance Sheets\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Balance Sheets (continued)\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Statements of Shareholders' Investment\nFinancial information at July 31, 1991 has been adjusted for a two-for-one common stock split (see Note F).\nSee accompanying notes to consolidated financial statements.\nLitton Industries Inc. Consolidated Statements of Shareholders' Investment (continued)\nFinancial information at July 31, 1991 has been adjusted for a two-for-one common stock split (see Note F).\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Statements of Cash Flows\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Statements of Cash Flows (continued)\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Notes To Consolidated Financial Statements\nNote A: Significant Accounting Policies\nPRINCIPLES OF CONSOLIDATION The accounts of Litton Industries, Inc. and all its majority-owned subsidiaries (the \"Company\" or \"Litton\") are included in the accompanying consolidated financial statements. All material intercompany transactions have been eliminated. Certain reclassifications of prior period information were made to conform to the current year presentation. The shares of common stock of Western Atlas Inc. (\"WAI\"), a former subsidiary of Litton, were distributed to holders of Litton Common stock in the form of a dividend on March 17, 1994. The accounts of WAI have been segregated and reflected as discontinued operations (see Note B).\nCASH EQUIVALENTS The Company considers securities purchased within three months of their date of maturity to be cash equivalents.\nEARNINGS PER SHARE Primary earnings per share computations are based on the weighted average number of common shares outstanding and common share equivalents with dilutive effects, if applicable. Computations were based on 45,720,585 (1994), 41,160,479 (1993) and 41,175,564 (1992) weighted average shares and net earnings after provision for cash dividends on preferred stock.\nFully diluted earnings per share are calculated assuming the conversion of all potentially dilutive securities, if applicable. For fiscal year 1992 the calculation included an increase to available income by pro forma reduction of interest expense for the zero coupon convertible subordinated notes, net of income taxes. For fiscal year 1993 the impact of the pro forma earnings adjustment of the foregoing interest expense caused fully diluted earnings per share to be anti-dilutive, therefore primary earnings per share amounts also reflected fully diluted earnings per share amounts. See the \"Quarterly Financial Information (Unaudited)\" for fully diluted earnings per share for the interim quarters of fiscal year 1993. As discussed in Note C, on June 28, 1993 the Company called for redemption its zero coupon convertible subordinated notes due 2010. Shares used in calculating fully diluted earnings per share for the fiscal year ended July 31, 1992 were 47,326,240.\nINVENTORIES AND LONG-TERM CONTRACTS Inventories are stated at the lower of cost or market. Costs accumulated under long-term contracts approximate actual costs incurred. Other inventories are generally valued using the first-in, first-out method or average cost method. General and administrative costs are allocated to and included in the work in process inventory of the Marine Engineering and Production segment and certain divisions of the Advanced Electronics segment. Otherwise, general and administrative costs are expensed as incurred.\nRevenues and profits on long-term contracts are recorded under the percentage-of-completion method of accounting. Major contracts for complex weapons and defense systems are performed over extended periods of time and are subject to changes in scope of work and delivery schedules. Total revenues on these contracts are necessarily estimated while the changes are being negotiated and their impact assessed. Any anticipated losses on contracts are charged to operations as soon as they are determinable.\nNote A: (continued)\nRESEARCH AND DEVELOPMENT Company-sponsored research and development expenditures are charged to expense as incurred. Worldwide expenditures on research and development activities amounted to $220.1 million, $254.6 million and $201.9 million, of which 26%, 21% and 38% were Company-sponsored, in the years ended July 31, 1994, 1993 and 1992, respectively.\nPROPERTY, PLANT AND EQUIPMENT Investment in property, plant and equipment is stated at cost. Allowances for depreciation and amortization, computed generally by the straight-line method for financial reporting purposes, are provided over the estimated useful lives of the related assets.\nINCOME TAXES The Company adopted the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109), effective August 1, 1993 (see Note G). The adoption of this statement did not have a material impact on the Company's consolidated financial statements. Prior years' financial statements have not been restated.\nFOREIGN CURRENCIES The currency effects of translating the financial statements of those non-U.S. subsidiaries and divisions of the Company which operate in local currency environments are included in the \"Cumulative currency translation adjustment\" component of Shareholders' Investment. Currency adjustments included in the Consolidated Statements of Operations are principally related to transactions and are as follows:\nThe Company enters into forward purchase contracts and buys put options to hedge, at amounts deemed appropriate, the exposure of certain of its assets (exclusive of property, plant and equipment) and liabilities. The carrying amounts of the hedging contracts at July 31, 1994 and 1993 were not material, nor were the amounts hedged.\nPENSION AND OTHER POSTRETIREMENT BENEFIT PLANS The Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (SFAS No. 106) in the fourth quarter of fiscal year 1993. The Company's postretirement plans other than pensions consist primarily of health care and life insurance benefits. The Company elected immediate recognition of the transition liability. For further discussion of accounting policies for pension and other postretirement benefit plans see Note H.\nNote A: (continued)\nGOODWILL AND OTHER INTANGIBLES For financial statement purposes, goodwill and other intangibles are generally amortized using the straight-line method over their estimated useful lives, not exceeding 40 years. The current and future profitability of the operations to which the goodwill relates are continually evaluated (at least annually). These factors, along with management's plans with respect to the operations and the projected undiscounted cash flows, are considered in assessing the recoverability of the goodwill.\nENVIRONMENTAL COSTS Provisions for environmental costs are recorded when the Company determines its responsibility for remedial efforts and such amounts are reasonably estimable. The Company's exposure is mitigated by potential insurance reimbursements and to the extent such costs are recoverable under the Company's U.S. Government contracts. These recoveries are not recorded until collection is probable.\nNote B: Business Divestitures and Acquisitions\nDistribution of WAI\nOn March 17, 1994, Litton distributed all of the issued and outstanding shares of common stock of its previously wholly-owned subsidiary Western Atlas Inc. (\"WAI\"). The WAI operations, reflected herein as discontinued operations, comprised substantially all of the Company's former oilfield services and industrial automation systems businesses. The distribution (\"Distribution\") was made in the form of a dividend to holders of record of Litton Common stock at the close of business on March 14, 1994. Litton shareholders of record received one share of WAI common stock for each share of Litton Common stock owned. The consolidated financial statements reflect an accounting date for the Distribution of February 28, 1994, which resulted in a reduction of Litton's Shareholders' Investment in the amount of $915.3 million representing the book value of net assets distributed.\nSales were $1.09 billion, $2.01 billion and $1.98 billion for the seven months ended February 28, 1994, fiscal year 1993 and fiscal year 1992, respectively. Net earnings (loss) were ($173) million, $85 million and $87 million for the same periods. Results for the seven months ended February 28, 1994 included special charges totalling $179 million, net of tax, recorded to reflect the write-down of net assets of a certain division and to provide for obsolescence of older technology equipment, vessels and inventory and the consolidation of facilities. Net earnings for fiscal year 1993 included the cumulative effect of a change in accounting principle for $10 million. Corporate interest costs of $7 million, $12 million and $12 million have been attributed to WAI and, therefore, reclassified to discontinued operations for the seven months ended February 28, 1994, fiscal year 1993 and fiscal year 1992, respectively. Income tax expense (benefit) allocated to WAI for the same periods was ($55) million, $79 million and $73 million.\nDuring fiscal year 1994, WAI purchased from Dresser Industries, Inc. its 29.5% minority interest in Western Atlas International, Inc. for $358 million in cash and four subordinated notes of $50 million each which mature, respectively, in each of four years commencing in 1998. Additionally, WAI purchased the business and substantially all of the assets of Halliburton Company's geophysical services business for an estimated purchase price of $190 million, of which $100 million was paid in cash and the remainder in notes maturing over periods of three and one-half to four years following the closing date of the transaction. The funds used to effect these transactions were advanced by Litton and were reimbursed to Litton at Distribution.\nAcquisitions\nIn August 1992, the Company acquired General Instrument Corporation's Defense Systems group (\"Defense Systems group\"). The Defense Systems group is a leading supplier of passive electronic warfare systems, such as threat warning and electronic support measures systems, for the U.S. Department of Defense and for allied nations. The purchase price was $83 million, inclusive of goodwill of $27 million which is being amortized over a period of 10 years.\nOther acquisitions which were made during the three years ended July 31, 1994 are integral to the Company's goals though not material in aggregate to the Company's consolidated financial statements in any one year. The acquisitions were paid in cash and have been accounted by the purchase method.\nNote C: Cash and Marketable Securities, Debt and Interest\nCash and marketable securities consist of the following interest-earning investments:\nThe Company's marketable securities consist of high quality securities issued by a number of institutions having high credit ratings. This investment policy limits the Company's exposure to concentrations of credit risk. In July 1994, the Company purchased approximately $489 million face value in U.S. Government obligations to effect the early extinguishment of debt as further explained below.\nCash and cash equivalents (see Note A) at July 31, 1994 consisted of $37.1 million in time deposits and certificates of deposit, $5.4 million in U.S. Government obligations and $2.0 million in commercial paper. At July 31, 1993 cash and cash equivalents consisted of $110.6 million in time deposits and certificates of deposit and $126.8 million in commercial paper.\nNotes payable and current portion of long-term obligations are composed of:\nLong-term obligations consist of the following:\nNote C: (continued)\nOther long-term obligations at July 31, 1994 mature as follows:\nOn July 11, 1994 the Company effected an early extinguishment of debt through an in-substance defeasance of its 12 5\/8% Subordinated Debentures in the principal amount of $435.8 million due July 1, 2005. The Company purchased approximately $489 million face value in U.S. Government obligations and deposited them in an irrevocable trust administered by The Bank of New York for the sole purpose of satisfying the scheduled payments with respect to the 12 5\/8% Subordinated Debentures. The trust can not be rescinded or revoked nor its assets otherwise accessed by the Company or others. The U.S. Government obligations provide cash flows, from interest at fixed rates and at maturity, which coincide with the scheduled interest payments and the eventual redemption, at 104.2% of par plus accrued interest, on July 1, 1995. Due to this in-substance defeasance, results for the fourth quarter of fiscal year 1994 included an extraordinary loss on early extinguishment of debt of $49.2 million pre-tax, or $30.7 million after tax.\nOn June 28, 1993, the Company called for redemption its zero coupon convertible subordinated notes due 2010. The notes were convertible into 6.126 shares of Litton Common stock per $1,000 principal amount of the notes. At July 31, 1993, substantially all of the notes outstanding had been converted into 6,114,401 shares of Litton Common stock and the remainder had been settled for cash. This transaction resulted in an increase to Shareholders' Investment of $312.6 million.\nThe Company has various credit commitments which provide for revolving credit or term loans of up to $400 million for its general use at July 31, 1994.\nNote C: (continued)\nThe estimated market value, based on quoted market prices, of the Company's marketable securities at July 31, 1994 was $59.3 million compared with the carrying amount of $56.1 million. The other financial instruments on the Company's Consolidated Balance Sheet included Accounts receivable, Accounts payable, Payrolls and related expenses, Notes payable and current portion of long-term obligations and other miscellaneous long-term assets and liabilities. The carrying amounts of the short-term assets and liabilities were deemed to approximate their market values due to their short maturity. The carrying amounts of the remainder of the financial instruments were not material. As discussed in Note I, the Company also has off-balance sheet guarantees and letter of credit agreements with face values totalling $190 million at July 31, 1994 relating principally to the guarantee of future performance on mainly foreign government contracts.\nNet interest expense is composed of the following:\nTotal cash interest payments made during fiscal year 1994 amounted to $100.6 million which included $37 million of prepaid interest in connection with the previously discussed early extinguishment of debt. Payments for fiscal years 1993 and 1992 were $66.1 million and $121.6 million, respectively. Capitalized interest costs in each of the three years in the period ended July 31, 1994 were not material.\nNote D: Accounts Receivable and Inventories\nFollowing are the details of accounts receivable:\nOf the retentions balance and amounts not billed at July 31, 1994, $31.1 million is expected to be collected in fiscal year 1995 with the balance to be collected in subsequent years, as contract deliveries are made and warranty periods expire.\nSummarized below are the components of inventory balances:\nThe amounts included in \"Inventoried costs related to long-term contracts\" representing general and administrative costs and production cost of delivered units in excess of anticipated average cost of all units expected to be produced are not significant.\nIf the receivable, inventory and progress billings amounts related to any one contract result in a net credit balance, such amounts are classified in current liabilities as \"Customer deposits and contract liabilities.\"\nNote E: Property, Plant and Equipment\nInvestment in property, plant and equipment consists of the following:\nThe net book value of assets utilized under capital leases was not material at July 31, 1994 and 1993.\nAs of July 31, 1994, minimum rental commitments under capital and noncancellable operating leases were:\nRental expense for operating leases, including amounts for short-term leases with nominal, if any, future rental commitments, was $32.4 million, $33.6 million and $34.9 million for the years ended July 31, 1994, 1993 and 1992, respectively. The minimum future rentals receivable under subleases and the contingent rental expenses were not significant.\nNote F: Shares Outstanding and Shareholders' Investment\nSHARE INFORMATION\nAt July 31, 1994, there were authorized 120 million shares of Common stock, par value $1.00; 22 million shares of preferred stock, par value $5.00 and 8 million shares of Preference stock, par value $2.50.\nNo cash dividends were paid on the Common stock in the three fiscal years ended July 31, 1994.\nThe Series B preferred stock receives a $2.00 annual dividend, is not convertible into Common stock and is redeemable at the option of the Company at $80.00 plus accrued dividends and, in the event of liquidation, is entitled to receive $25.00 plus accrued dividends.\nOn March 12, 1992, the Company's Board of Directors declared a two-for-one common stock split which was effected in the form of a 100 percent stock dividend, distributed on May 8, 1992 to shareholders of record on April 3, 1992. Par value remains $1 per share.\nSTOCK OPTION INFORMATION The Company has stock option plans which provide for the grant of incentive awards to officers and other key employees. Incentive awards may be granted in the form of stock options at not less than 50% nor more than 100% of the fair market value of the Company's Common stock on the date of grant.\nIn connection with the Distribution of the shares of Western Atlas common stock (see Note B), each option granted pursuant to the plans was adjusted to account for the Distribution. Each Litton optionee with options outstanding on the Distribution date received an equivalent number of Western Atlas options. The option price was allocated in accordance with a predetermined formula.\nNote F: (continued)\nThe awards outstanding under the Company's employee incentive plans at July 31, 1994 and 1993 were stock options to purchase 2,499,771 and 2,482,129 shares, respectively, at exercise prices per share ranging from $7.40 to $37.19 and $14.35 to $57.38, respectively. Of these options, 979,461 and 1,129,019 were exercisable by their terms at July 31, 1994 and 1993, respectively. During fiscal year 1994, prior to the Distribution, options were granted under these plans to purchase 7,000 shares at prices per share ranging from $33.14 to $66.69 and options to purchase 323,288 shares were exercised at prices per share ranging from $14.35 to $47.94. For the period in fiscal year 1994 subsequent to the Distribution, options were granted under these plans to purchase 421,000 shares at prices per share ranging from $15.19 to $37.19 and options to purchase 81,070 shares were exercised at prices per share ranging from $7.41 to $20.18. During fiscal year 1993, options were granted under these plans to purchase 372,000 shares at prices per share ranging from $23.38 to $57.38 and options to purchase 719,424 shares were exercised at prices per share ranging from $14.35 to $47.94. At July 31, 1994, there were 699,750 shares available for grants of future awards under these plans.\nThe Company has a Director Stock Option Plan which provides for the grant of stock options to the Company's non-employee directors. Under this plan, stock options are granted annually at the fair market value of the Company's Common stock on the date of grant. The number of options so granted annually is fixed by the plan. Such options become fully exercisable on the first anniversary of their respective grant. The total number of shares to be issued under this plan may not exceed 400,000 shares. During fiscal years 1994 (prior to the Distribution) and 1993, options under this plan were granted to purchase 42,000 and 24,000 shares at prices per share of $64.06 and $42.50, respectively. During fiscal year 1994, prior to the Distribution, options to purchase 18,350 shares were exercised at prices per share ranging from $34.97 to $43.03. For the period in fiscal year 1994 subsequent to the Distribution, options to purchase 18,000 shares were exercised at prices per share ranging from $14.72 to $18.12. Options outstanding at July 31, 1994 and 1993 were 145,650 and 140,000, respectively. Of these options, 103,650 were exercisable at July 31, 1994 and 116,000 were exercisable at July 31, 1993.\nSHAREHOLDER RIGHTS PLAN On August 17, 1994 the Company's Board of Directors adopted a Share Purchase Rights Plan (the \"Plan\") and, in accordance with such Plan, declared a dividend of one preferred share purchase right for each outstanding share of Common stock, payable August 31, 1994 to shareholders of record on that date. The Plan contains provisions to protect shareholders in the event of an unsolicited attempt to acquire the Company. The Plan should deter any attempt to acquire the Company in a manner or on terms not approved by the Board of Directors.\nOnce exercisable, each right will entitle the holder to purchase one one-thousandth of a share of Series A Participating Preferred Stock, par value $5, at a price of $150 per one one-thousandth of a Preferred Share, subject to adjustment. Alternatively, under certain circumstances involving the acquisition by a person or group of 15 percent or more of the Company's Common stock, each right will entitle its holder to purchase a number of shares of the Company's Common stock having a market value of two times the exercise price of the right. In the event a merger or other business combination transaction is effected after a person or group has acquired 15 percent or more of the Company's Common shares, each right will entitle its holder to purchase a number of the resulting company's common shares having a market value of two times the exercise price of the right.\nNote F: (continued)\nThe Company may exchange the rights at an exchange ratio of one Common share per right. The Company may also redeem the rights at $.01 per right at any time prior to a 15 percent acquisition. The rights, which do not have voting rights and are not entitled to dividends until such time as they become exercisable, expire in August 2004.\nWAI DISTRIBUTION In connection with the Distribution (see Note B), Shareholders' Investment was reduced in the amount of $915.3 million representing the book value of net assets distributed. The adjustments to Retained earnings, Additional paid-in capital and Cumulative currency translation adjustment were based, generally, on the respective Litton and WAI balances as of the accounting date for the Distribution.\nNote G: Taxes on Income\nEffective August 1, 1993, the Company adopted the provisions of SFAS No. 109 which requires the measurement of tax assets and liabilities based on a balance sheet approach. Under SFAS No. 109, deferred tax assets and liabilities reflect the effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and for income tax reporting purposes. The adoption of SFAS No. 109 did not have a material impact on the Company's consolidated financial statements and prior years' financial statements have not been restated.\nEarnings from continuing operations before taxes on income, extraordinary item and cumulative effect of a change in accounting principle by geographic area are as follows:\nNote G: (continued)\nThe primary components of the Company's deferred income tax assets and liabilities at July 31, 1994 are as follows:\nThe following is a reconciliation of income taxes at the U.S. statutory rate to the provision for income taxes:\nUndistributed earnings of non-U.S. subsidiaries for which U.S. taxes have not been provided are included in consolidated retained earnings in the amounts of $123 million and $109 million at July 31, 1994 and 1993, respectively. If such earnings were distributed, U.S. income taxes would be partially reduced by available credits for taxes paid to the jurisdictions in which the income was earned.\nThe Company made tax payments of $195.0 million, $180.6 million and $220.7 million in fiscal years 1994, 1993 and 1992, respectively.\nThe Company and WAI have entered into a tax-sharing agreement which, among other items, provides for the treatment of tax matters for periods through the Distribution date and responsibility for any adjustment as a result of audit by any taxing authority. The general terms and conditions provide that Litton will indemnify and hold harmless WAI and its subsidiaries included in Litton's consolidated U.S. tax returns against all liabilities for Federal income taxes with respect to periods prior to the Distribution date.\nNote H: Pension and Other Postretirement Benefit Plans\nPension Benefits\nThe Company has various retirement and pension plans which cover most of its employees. Net pension income for these plans for the years ended July 31, 1994, 1993 and 1992 was $14.7 million, $11.2 million and $4.4 million, respectively.\nMost of the Company's U.S. employees are covered by contributory defined benefit plans under which employees are eligible for benefits at age 65. Generally, benefits are determined under a formula based primarily on the participant's total plan contributions. The Company's funding policy is to make annual contributions to the extent such contributions are actuarially determined and tax deductible.\nThe Company has a defined contribution voluntary savings plan for eligible U.S. employees. This 401(K) plan is designed to enhance the existing retirement programs of participating employees. The Company matches 50% of a certain portion of participants' contributions to the plan.\nThe Company's non-U.S. subsidiaries also have retirement plans for long-term employees. These plans are not considered to be significant individually or in the aggregate to the Company's consolidated financial position. The pension liabilities and their related costs are computed in accordance with the laws of the individual nations and appropriate actuarial practices.\nA summary of the components of net periodic pension income (cost) for the U.S. defined benefit plans, defined contribution plans and non-U.S. pension plans for fiscal years 1994, 1993 and 1992 are as follows:\nThe projected benefit obligation of the U.S. defined benefit plans was $832.0 million and $744.4 million at July 31, 1994 and 1993, respectively. The fair value of plan assets, primarily equity securities and U.S. Government securities, was $1,172.7 million at July 31, 1994 compared with $1,089.7 million at July 31, 1993. The unrecognized net transition asset was $70.4 million and $84.7 million at July 31, 1994 and 1993, respectively, and the unrecognized net gain was $116.6 million at fiscal year end 1994 compared with $166.5 million at fiscal year end 1993. Prepaid pension cost was $141.6 million at July 31, 1994 compared with $80.9 million at July 31, 1993.\nNote H: (continued)\nThe accumulated benefit obligation was $743.1 million at July 31, 1994, inclusive of the vested benefit obligation of $719.1 million. At July 31, 1993, the accumulated benefit obligation was $650.9 million, inclusive of the vested benefit obligation of $635.2 million.\nActuarial assumptions for the Company's U.S. defined benefit plans included an expected long-term rate of return on plan assets of 9 1\/4% for fiscal years 1994 and 1993. The weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation at July 31, 1994 was 8 1\/4% and at July 31, 1993 was 8 1\/2%. The rate of increase in future compensation levels was 5% at July 31, 1994 and 1993.\nThe excess of plan assets over the projected benefit obligation at August 1, 1986 (when the Company adopted Statement of Financial Accounting Standards No. 87) and subsequent unrecognized gains and losses are fully amortized over the average remaining service period of active employees expected to receive benefits under the plans, generally 15 years. Pension assets included in Long-term Investments and Other Assets were $181.1 million and $122.9 million at July 31, 1994 and 1993, respectively.\nIn fiscal years 1994, 1993 and 1992, the Company incurred $18.7 million, $13.5 million and $25.0 million, respectively, in costs for special separation and supplemental early retirement benefits for certain employees in connection with workforce reductions at certain operations.\nIn conjunction with the Distribution discussed in Note B, the Company and WAI have entered into an Employee Benefits Agreement which provides for, among other items, the transfer to WAI of plan assets with an estimated fair market value of $188.2 million and the assumption by WAI of a projected benefit obligation estimated at a present value of $116.5 million.\nOther Postretirement Benefits\nIn addition to pension benefits, certain of the Company's U.S. employees are covered by postretirement health care and life insurance benefits plans. These benefit plans are unfunded. In the fourth quarter of fiscal year 1993, the Company adopted, effective as of the beginning of the fiscal year, the provisions of SFAS No. 106 related to these plans. The Company elected immediate recognition of the transition liability for such benefits and the resultant cumulative effect of a change in accounting principle amounted to $106.7 million, net of tax.\nThe components of net periodic postretirement benefit costs for fiscal years 1994 and 1993 recognized under the provisions of SFAS No. 106 are as follows:\nNote H: (continued)\nThe amount expensed in fiscal year 1992 under the cash basis of accounting for postretirement benefits was not materially different. The accumulated benefit obligation at July 31, 1994 was $198.8 million, of which $146.1 million was attributable to retirees and $52.7 million was attributable to active plan participants. The accumulated benefit obligation at July 31, 1993 was $182.8 million, of which $116.3 million was attributable to retirees and $66.5 million was attributable to active plan participants.\nActuarial assumptions used to measure the accumulated benefit obligation include a discount rate of 8 1\/4% and 8 1\/2% at July 31, 1994 and 1993, respectively. The assumed health care cost trend rate for fiscal year 1994 was 14.4% and is projected to decrease over 23 years to 6.75%, where it is expected to remain thereafter. The effect of a one-percentage-point increase in the assumed health care cost trend rate on the service cost and interest cost components of the net periodic postretirement benefit cost is not material. A one-percentage-point increase in the assumed health care cost trend rate on the accumulated benefit obligation results in an increase of approximately $12.6 million.\nNote I: Defense Contracts, Litigation and Contingencies\nApproximately 73%, 73% and 70% of total sales and service revenues of the Company for the years ended July 31, 1994, 1993 and 1992, respectively, were from U.S. Government contracts and subcontracts. Approximately 87% of these revenues for 1994 related to fixed-price type contracts. At July 31, 1994, of the total Company backlog of $5.5 billion, the amount of worldwide defense contract backlog was approximately $5.2 billion, of which $4.7 billion has been funded. At July 31, 1993 and 1992, the amount of worldwide defense contract backlog was $6.3 billion and $6.2 billion, respectively.\nAs is common with U.S. Government contracts, the Company's U.S. defense contracts are unilaterally terminable at the option of the U.S. Government with compensation for work completed and costs incurred. Contracts with the U.S. Government are subject to certain laws and regulations, the noncompliance with which may result in various sanctions.\nLitton Systems, Inc. (\"LSI\"), a subsidiary of the Company, was a defendant in a previously reported civil suit brought under the so-called qui tam provisions of the False Claims Act, which permit an individual to bring suit in the name of the United States Government and share in any recovery received. If the plaintiffs had prevailed in such litigation, the total damages and penalties could have exceeded $500 million. Without admitting any liability or wrongdoing, LSI and the plaintiffs, on July 14, 1994, agreed to settle all issues in connection with the matter. The Court dismissed the civil suit with prejudice, thereby terminating this proceeding. Accordingly, results for fiscal year 1994 included a charge of $86.0 million pre-tax, or $53.8 million after-tax, to reflect the settlement.\nOn August 31, 1993 a U.S. District Court jury rendered a verdict in favor of Litton against Honeywell, Inc. in the amount of $1.2 billion. The jury found that Honeywell willfully infringed a Litton patent relating to the manufacture of ring laser gyro navigation systems which are used in commercial aircraft. The jury also found that Honeywell actively induced a Litton licensee to infringe Litton's patent and Honeywell interfered with Litton's prospective economic advantage. The Court is currently considering post trial motions filed by both Honeywell and Litton. It is expected that any decision of the Court would be appealed by the party which does not prevail, and the Company cannot predict when this litigation will be ultimately concluded.\nThere are various other litigation proceedings in which the Company is involved. Although the results of litigation proceedings cannot be predicted with certainty, it is the opinion of the General Counsel that the Company does not have a potential liability in connection with these other proceedings which would have an adverse material effect on the consolidated financial statements.\nThe Company has issued or is a party to various guarantees and letter of credit agreements totalling $190 million at July 31, 1994. These arrangements relate principally to the guarantee of future performance, mainly on foreign government contracts.\nNote J: Extraordinary Item and Unusual Item\nOn July 11, 1994, the Company effected an in-substance defeasance of its 12 5\/8% Subordinated Debentures by placing direct U.S. Government obligations in an irrevocable trust to provide for the redemption, according to their terms, on July 1, 1995 at 104.2% of their principal amount, plus accrued interest (see Note C). Due to this in-substance defeasance, results for fiscal year 1994 included an extraordinary loss on early extinguishment of debt of $49.2 million pre-tax, or $30.7 million after tax. The effect on primary earnings per share for the year was a decrease of $.67.\nOn July 14, 1994, the Company settled a civil suit brought under the so-called qui tam provisions of the False Claims Act (see Note I) and recorded a charge of $86.0 million to the operating results of the Advanced Electronics segment. On an after-tax basis, the impact of this settlement was a $53.8 million loss, or a decrease of $1.18 to primary earnings per share for the year.\nNote K: Business Segment Reporting\nAs a result of the Distribution discussed in Note B, the Company's primary operations now comprise three business segments: Advanced Electronics, Marine Engineering and Production, and Interconnect Products.\nThe Advanced Electronics segment designs, develops and manufactures inertial navigation, guidance and control, command, control and communications and electronic warfare systems. The fiscal year 1994 Advanced Electronics segment operating profit includes the effects of the settlement of a civil suit (see Notes I and J).\nThe Marine Engineering and Production segment is involved in the design, construction and overhaul of naval ships.\nIntersegment sales, sales between geographic areas and export sales are not material. All internal sales and transfers are based on negotiated prices.\nThe U.S. Government is a significant customer of both the Advanced Electronics and Marine Engineering and Production segments (see Note I).\nIn the first quarter of fiscal year 1994, the Company named its other businesses \"Interconnect Products\" to reflect the principal products of this group of businesses. This segment manufactures and distributes interconnection subsystems, electronic connectors, printed circuit boards, backpanels and soldering materials to diverse markets worldwide. Operating profit for fiscal year 1994 includes a charge recorded to adjust the net assets of a division to net realizable value in connection with its possible sale or closure.\nCosts for Corporate and Other Amounts include net interest expense and foreign currency adjustments. Assets classified as Corporate and Other Amounts consist primarily of cash and marketable securities, deferred tax assets and, for fiscal years 1993 and 1992, net assets of WAI of $1,085 and $1,042 million, respectively. In fiscal year 1994, the Company used cash and marketable securities to effect an early extinguishment of debt as discussed in Note C.\nPrior years' information has been restated to conform to the current presentation.\nNote K: (continued)\nOperations by Business Segment (millions of dollars)\n* Results for fiscal year 1994 included the settlement of a civil suit (see Notes I and J).\nNote K: (continued)\nOperations by Geographic Area (millions of dollars)\nLitton Industries, Inc. Quarterly Financial Information (unaudited)\n* Results for the fourth quarter of fiscal year 1994 included the settlement of a civil suit (see Notes I and J of Notes to Consolidated Financial Statements). The impact on fourth quarter and fiscal year 1994 primary and fully diluted earnings per share was a loss of $1.17 and $1.18, respectively. In addition, the Company effected an early extinguishment of debt in the fourth quarter of fiscal year 1994 which resulted in an extraordinary loss (see Notes C and J of Notes to Consolidated Financial Statements).\n** Primary earnings (loss) per share also reflected fully diluted earnings (loss) per share in each of the four quarters of fiscal year 1994.\n*** Pursuant to the Distribution, Western Atlas common stock began trading separately from Litton Common stock in the third quarter of fiscal year 1994 (see Note B of Notes to Consolidated Financial Statements).\nLitton Industries, Inc. Quarterly Financial Information (unaudited)\nLitton Industries, Inc. Quarterly Financial Information (unaudited) (continued)\nLitton Common stock is traded principally on the New York Stock Exchange and the Pacific Stock Exchange. The symbol is \"LIT\".\nAs of September 30, 1994, there were approximately 36,900 holders of record of the Common stock.\nThe total of quarterly amounts for earnings per share will not necessarily equal the annual amount, since the computations are based on the average number of common shares and dilutive common share equivalents outstanding during each period.\n* In the fourth quarter of fiscal year 1993, the Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other than Pensions, effective as of August 1, 1992.\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE I - MARKETABLE SECURITIES AND OTHER INVESTMENTS JULY 31, 1994 (thousands of dollars)\n(A) Included in the caption \"Cash and marketable securities\" in the Consolidated Balance Sheet at July 31, 1994.\nS-1 LITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND EMPLOYEES OTHER THAN RELATED PARTIES YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nS-2a\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND EMPLOYEES OTHER THAN RELATED PARTIES, continued YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nS-2b\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nS-3 LITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nNote:\nSee Note A of Notes to Consolidated Financial Statements for discussion on method of depreciation and amortization.\n(A) Includes amortization of leasehold improvements and depreciation of leased equipment.\nS-4 LITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE IX - SHORT-TERM BORROWINGS YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nNOTES:\n(A) These balances were calculated by considering the beginning balance on August 1 and the 12 month-end balances during the years ended July 31, 1994, 1993 and 1992, respectively. (B) These percentages were determined by considering the time each obligation was outstanding and the interest rate in effect during that time.\nS-5\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nNOTE:\nOther items of supplementary income statement information are less than one percent of total sales and service revenues reported in the Consolidated Statements of Operations.\nS-6\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES INDEX TO EXHIBITS\nExhibit No. and Applicable Section of Item 601 of Regulation S-K - ------------------\n3.1(a) Restated Certificate of Incorporation of the Company, filed as Exhibit 3.1 to the Company's 1984 Annual Report on Form 10-K, and incorporated herein by reference.\n3.1(b) Amendment to the Company's Restated Certificate of Incorpo- ration, filed as Exhibit 3.1(a) to the Company's October 31, 1986 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n3.2(a) By-laws of the Company as amended through the date of this filing, filed as Exhibit 3.2 to the Company's 1988 Annual Report on Form 10-K, and incorporated herein by reference.\n3.2(b) Board of Directors Resolution amending the by-laws of the Company with respect to the number of members of the Board of Directors through the date of the filing and incorporated herein by reference.*\n4.1 Indenture dated as of June 10, 1985 between the Company and The Bank of New York, Trustee, under which the 12 5\/8% Subordinated Debentures Due 2005 were issued, filed as Exhibit 4.1 to the Company's April 30, 1985 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n4.2 Form of definitive 12 5\/8% Subordinated Debenture Due 2005, filed as Exhibit 4.4 to the Company's 1985 Annual Report on Form 10-K, and incorporated herein by reference.\n4.3 $400,000,000 Credit Agreement dated December 23, 1993 among Litton Industries, Inc., a group of banks and Morgan Guaranty Trust Company of New York, as Agent, and Wells Fargo Bank, N.A., as Co-agent, filed as Exhibit 4.1 to the Company's April 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n4.4 Other instruments defining the rights of holders of other long-term debt of the Registrant are not filed as exhibits because the amount of debt authorized under any such instrument does not exceed 10% of the total assets of the Registrant and its consolidated subsidiaries. The Registrant hereby undertakes to furnish a copy of any such instrument to the Commission upon request.\n* Copies of these documents have been included in this Annual Report on Form 10-K filed with the Securities and Exchange Commission.\nE-1 INDEX TO EXHIBITS, continued\n4.5 Rights Agreement, together with exhibits thereto, dated August 17, 1994 between Litton Industries, Inc. and The Bank of New York, as Rights Agent, filed as Exhibit 99.2 to Form 8-K dated August 17, 1994, and incorporated herein by reference.\n10.1(a) Board of Directors Resolutions, adopted December 8, 1993, with respect to nonemployee directors' annual retainer and attendance fees filed as Exhibit 10.1 to the Company's April 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.1(b) Board of Directors Resolutions with respect to director retirement age and with respect to postretirement payments to directors, including those payments made in the event of a change in control of the Company, adopted on October 16, 1991, filed as Exhibit 10.2(b) to the Company's 1991 Annual Report on Form 10-K, and incorporated herein by reference.\n10.2(a) Litton Supplemental Retirement Plan, filed as Exhibit 10.3 to the Company's 1983 Annual Report on Form 10-K, and incorporated herein by reference.\n10.2(b) Board of Directors Resolution, adopted December 2, 1992, amending the Litton Supplemental Retirement Plan, filed as Exhibit 10.1 to the Company's April 30, 1993 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.2(c) Agreement of Trust between the Company and First Interstate Bank of California, dated December 20, 1988, regarding pay- ments of pension benefits under the Litton Supplemental Retirement Plan to certain former and present employees or their beneficiaries, filed as Exhibit 10.17 to the Company's 1989 Annual Report on Form 10-K, and incorporated herein by reference.\n10.2(d) Amendments, through the date of the filing, to the Agreement of Trust dated December 20, 1988, and incorporated herein by reference.\n10.2(e) Instruments dated April 16, 1990, and April 25, 1990, removing First Interstate Bank of California as Trustee under Agreement of Trust dated December 20, 1988, and appointing Wells Fargo Bank, N.A., as Successor Trustee, filed as Exhibit 10.17(c) to the Company's 1990 Annual Report on Form 10-K, and incorporated herein by reference.\nE-2\nINDEX TO EXHIBITS, continued\n10.2(f) Letter of Credit dated November 17, 1989, issued by Wells Fargo Bank, N.A. pursuant to Agreement of Trust dated December 20, 1988, filed as Exhibit 10.17(d) to the Company's 1990 Annual Report on Form 10-K, and incorporated herein by reference.\n10.3(a) Specimen of the form of the agreement presently outstanding under the Litton Industries, Inc. Executive Survivor Benefit Plan, applicable to officers and certain key employees, filed as Exhibit 10.4 to the Company's 1984 Annual Report on Form 10-K, and incorporated herein by reference.\n10.3(b) Board of Directors Resolutions amending the Executive Survivor Benefit Plan, adopted June 12, 1986, filed as Exhibit 10.4(a) to the Company's 1986 Annual Report on Form 10-K, and incorporated herein by reference.\n10.4 Board of Directors Resolutions with respect to extended notice of termination of certain officers, adopted December 5, 1985, filed as Exhibit 10.7 to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.5(a) Board of Directors Resolution with respect to incentive loans, adopted September 26, 1991, filed as Exhibit 10.8(a) to the Company's 1991 Annual Report on Form 10-K, and incorporated herein by reference.\n10.5(b) Specimen of the form of promissory note applicable to loans presently outstanding under the Company's incentive loan program, filed as Exhibit 10.8(b) to the Company's 1991 Annual Report on Form 10-K, and incorporated herein by reference.\n10.6 Copy of Agreement between the Company and the Foundation of the Litton Industries dated May 1, 1978, filed as Exhibit 1 to Post-Effective Amendment No. 7 to Registration Statement No. 2-52592 on Form S-8, and incorporated herein by reference.\n10.7(a) Supplemental Medical Insurance Plan for Key Executive Employees incorporating all amendments thereto through the date of this filing, filed as Exhibit 10.10 to the Company's 1990 Annual Report on Form 10-K, and incorporated herein by reference.\nE-3\nINDEX TO EXHIBITS, continued\n10.7(b) Resolution adopted by the Compensation and Selection Committee, dated January 26, 1994, approving the participation by Orion L. Hoch and Catherine Nan Hoch in the Supplemental Medical Insurance Plan, filed as Exhibit 10.2 to the Company's April 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.8(a) Litton Industries, Inc. 1981 Incentive Stock Option Plan, filed as Exhibit 10.12(a) to the Company's 1982 Annual Report on Form 10-K, and incorporated herein by reference.\n10.8(b) Compensation and Selection Committee Resolution, adopted September 29, 1993, adjusting the options outstanding under Litton Industries, Inc. 1981 Incentive Stock Option Plan.\n10.9(a) Supplemental Retirement Agreement between the Company and Orion L. Hoch, filed as Exhibit 10.13(b) to the Company's 1983 Annual Report on Form 10-K, and incorporated herein by reference.\n10.9(b) Amendments, through the date of the filing, to the Supplemental Retirement Agreement between the Company and Orion L. Hoch, and incorporated herein by reference.\n10.9(c) Extract of the minutes of a meeting of the Compensation and Selection Committee of the Board of Directors, held on March 31, 1988, with respect to the lifetime participation of Fred W. O'Green and Mildred G. O'Green in the Supplemental Medical Insurance Plan, filed as Exhibit 10.13(e) to the Company's 1988 Annual Report on Form 10-K, and incorporated herein by reference.\n10.10(a) Litton Industries, Inc. 1984 Long-Term Stock Incentive Plan, as amended, filed as Exhibit 10.14(a) to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.10(b) Compensation and Selection Committee Resolutions, adopted March 12, 1992, amending the Litton Industries, Inc. 1984 Long-Term Stock Incentive Plan for the effects of the two-for-one Common stock split which was effective May 8, 1992, filed as Exhibit 10.14(b) to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.10(c) Board of Directors Resolutions, adopted August 12, 1993, amending the Litton Industries, Inc. 1984 Long-term Stock Incentive Plan.\n10.10(d) Compensation and Selection Committee Resolution, adopted September 29, 1993, adjusting the options outstanding under the Litton Industries, Inc. 1984 Long-term Stock Incentive Plan for the distribution of Western Atlas Inc. Common stock.\nE-4 INDEX TO EXHIBITS, continued\n10.11(a) Litton Industries, Inc. Performance Award Plan, filed as Exhibit 10.15 to the Company's 1984 Annual Report on Form 10-K, and incorporated herein by reference.\n10.11(b) Board of Directors Resolution, adopted December 2, 1992, amending the Litton Industries, Inc. Performance Award Plan, filed as Exhibit 10.2 to the Company's April 30, 1993 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.12 Litton Industries, Inc. Restoration Plan filed as Exhibit 10.16 to the Company's 1989 Annual Report on Form 10-K, and incorporated herein by reference.\n10.13(a) Litton Industries, Inc. Director Stock Option Plan, filed as Exhibit 10.18(a) to the Company's 1989 Annual Report on Form 10-K, and incorporated herein by reference.\n10.13(b) Board of Directors Resolution, adopted March 12, 1992, amending the Litton Industries, Inc. Director Stock Option Plan for the two-for-one Common stock split which was effective May 8, 1992, filed as Exhibit 10.18(b) to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.13(c) Board of Directors Resolution, adopted September 30, 1993, adjusting the options outstanding under the Litton Industries, Inc. Director Stock Option Plan for the distribution of Western Atlas Inc. Common stock.\n10.14 Consulting agreement between a subsidiary of the Company and Thomas B. Hayward, a director of the Company, dated December 17, 1993, filed as Exhibit 10.5 to the Company's April 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.15 Board of Directors Resolution with respect to election of Robert H. Lentz as Advisory Director effective April 1, 1990, filed as Exhibit 10.22 to the Company's 1992 Annual Report of Form 10-K, and incorporated herein by reference.\n10.16 Copy of the Company's \"Group Bonus Plan Fiscal 1992\", which provides for incentive compensation rewards for certain Group Executives and other key group personnel, filed as Exhibit 10.24 to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.17 Copy of the incentive compensation plan of Ingalls Shipbuilding, Inc., a subsidiary of the Company, filed as Exhibit 10.25 to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\nE-5\nINDEX TO EXHIBITS, continued\n10.18 Litton Industries, Inc. Deferred Compensation Plan for Directors together with Board of Directors Resolution adopted December 2, 1992, filed as Exhibit 10.3 to the Company's April 30, 1993 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.19 Form of Change of Control Employment Agreement between the Company and certain executive officers.\n10.20 Distribution and Indemnity Agreement between Litton Industries, Inc. and Western Atlas Inc. dated as of March 17, 1994, filed as Exhibit 99.1 to Form 8-K dated March 17, 1994, and incorporated herein by reference.\n10.21 Tax Sharing Agreement between Litton Industries, Inc. and Western Atlas Inc. dated as of March 17, 1994, filed as Exhbit 99.1 to Form 8-K dated March 17, 1994, and incorporated herein by reference.\n11 Statement of Computation of Earnings per Share included herein on pages E-7a through E-8c.\n21 Subsidiaries of the Registrant included herein on page E-9.\n23 Independent Auditors' Consent included herein on page E-10.\n27 Financial Data Schedule included herein.\n99 Undertaking re: Indemnification for liabilities under Securities Act, filed as Exhibit 19 to the Company's 1990 Annual Report on Form 10-K, and incorporated herein by reference.\nE-6","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------\nInformation on directors of the Company will be included under the caption \"The Election of Directors\" of the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on December 8, 1994, which is hereby incorporated by reference.\nThe executive officers of the Company are elected each year by the Board of Directors at its first meeting following the Annual Meeting of Shareholders 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 Company. The following information indicates the position and age of the executive officers at October 10, 1994 and their business experience during the prior five years:\nItem 10. Directors and Executive Officers of the Registrant, continued - ------------------------------------------------------------\nItem 11.","section_11":"Item 11. Executive Compensation - --------------------------------\nInformation on executive compensation will be included under the caption \"Compensation of Executive Officers\" of the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on December 8, 1994, which is hereby incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------\nInformation on 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 will be included under the caption \"Beneficial Ownership of the Company's Securities\" of the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on December 8, 1994, which is hereby incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------\nInformation on certain relationships and related transactions including information with respect to management indebtedness will be included under the caption \"Information Regarding Indebtedness of Management to the Company\" of the Company's definitive Proxy Statement relating to the Annual Meeting of Shareholders to be held on December 8, 1994, which is hereby incorporated by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - -------------------------------------------------------------------------\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES EXECUTIVE COMPENSATION PLANS and ARRANGEMENTS\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES EXECUTIVE COMPENSATION PLANS and ARRANGEMENTS (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.\nLITTON INDUSTRIES, INC.\n\/s\/ Carol A. Wiesner ----------------------------- Carol A. Wiesner Vice President and Controller (Chief Accounting Officer)\nOctober 14, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nLitton Industries, Inc. Management's Responsibility for Financial Reporting\nThe consolidated financial statements of Litton Industries, Inc. and subsidiary companies, and related financial information included in this Annual Report, have been prepared by the Company, whose management is responsible for their integrity. These statements, which necessarily reflect estimates and judgments, have been prepared in conformity with generally accepted accounting principles.\nThe Company maintains a system of internal controls to provide reasonable assurance that assets are safeguarded and transactions are properly executed and recorded. As part of this system, the Company has an internal audit staff to monitor the compliance with and the effectiveness of established procedures.\nThe consolidated financial statements have been audited by DELOITTE & TOUCHE LLP, independent certified public accountants, whose report appears on page.\nThe Audit and Compliance Committee of the Board of Directors, which consists solely of directors who are not employees of the Company, meets periodically with management, the independent auditors and the Company's internal auditors to review the scope of their activities and reports relating to internal controls and financial reporting matters. The independent and internal auditors have full and free access to the Audit and Compliance Committee and meet with the Committee both with and without the presence of Company management.\n\/s\/ Rudolph E. Lang, Jr. - ------------------------ Rudolph E. Lang, Jr. Senior Vice President and Chief Financial Officer\nOctober 10, 1994\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Litton Industries, Inc. Beverly Hills, California\nWe have audited the accompanying consolidated balance sheets of Litton Industries, Inc. and subsidiary companies as of July 31, 1994 and 1993, and the related consolidated statements of operations, shareholders' investment and cash flows for each of the three years in the period ended July 31, 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 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 Litton Industries, Inc. and subsidiary companies as of July 31, 1994 and 1993, and the 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. 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 H to the consolidated financial statements, in fiscal year 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\nLos Angeles, California September 22, 1994\nLitton Industries, Inc. Consolidated Statements of Operations\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Statements of Operations (continued)\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Balance Sheets\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Balance Sheets (continued)\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Statements of Shareholders' Investment\nFinancial information at July 31, 1991 has been adjusted for a two-for-one common stock split (see Note F).\nSee accompanying notes to consolidated financial statements.\nLitton Industries Inc. Consolidated Statements of Shareholders' Investment (continued)\nFinancial information at July 31, 1991 has been adjusted for a two-for-one common stock split (see Note F).\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Statements of Cash Flows\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Consolidated Statements of Cash Flows (continued)\nSee accompanying notes to consolidated financial statements.\nLitton Industries, Inc. Notes To Consolidated Financial Statements\nNote A: Significant Accounting Policies\nPRINCIPLES OF CONSOLIDATION The accounts of Litton Industries, Inc. and all its majority-owned subsidiaries (the \"Company\" or \"Litton\") are included in the accompanying consolidated financial statements. All material intercompany transactions have been eliminated. Certain reclassifications of prior period information were made to conform to the current year presentation. The shares of common stock of Western Atlas Inc. (\"WAI\"), a former subsidiary of Litton, were distributed to holders of Litton Common stock in the form of a dividend on March 17, 1994. The accounts of WAI have been segregated and reflected as discontinued operations (see Note B).\nCASH EQUIVALENTS The Company considers securities purchased within three months of their date of maturity to be cash equivalents.\nEARNINGS PER SHARE Primary earnings per share computations are based on the weighted average number of common shares outstanding and common share equivalents with dilutive effects, if applicable. Computations were based on 45,720,585 (1994), 41,160,479 (1993) and 41,175,564 (1992) weighted average shares and net earnings after provision for cash dividends on preferred stock.\nFully diluted earnings per share are calculated assuming the conversion of all potentially dilutive securities, if applicable. For fiscal year 1992 the calculation included an increase to available income by pro forma reduction of interest expense for the zero coupon convertible subordinated notes, net of income taxes. For fiscal year 1993 the impact of the pro forma earnings adjustment of the foregoing interest expense caused fully diluted earnings per share to be anti-dilutive, therefore primary earnings per share amounts also reflected fully diluted earnings per share amounts. See the \"Quarterly Financial Information (Unaudited)\" for fully diluted earnings per share for the interim quarters of fiscal year 1993. As discussed in Note C, on June 28, 1993 the Company called for redemption its zero coupon convertible subordinated notes due 2010. Shares used in calculating fully diluted earnings per share for the fiscal year ended July 31, 1992 were 47,326,240.\nINVENTORIES AND LONG-TERM CONTRACTS Inventories are stated at the lower of cost or market. Costs accumulated under long-term contracts approximate actual costs incurred. Other inventories are generally valued using the first-in, first-out method or average cost method. General and administrative costs are allocated to and included in the work in process inventory of the Marine Engineering and Production segment and certain divisions of the Advanced Electronics segment. Otherwise, general and administrative costs are expensed as incurred.\nRevenues and profits on long-term contracts are recorded under the percentage-of-completion method of accounting. Major contracts for complex weapons and defense systems are performed over extended periods of time and are subject to changes in scope of work and delivery schedules. Total revenues on these contracts are necessarily estimated while the changes are being negotiated and their impact assessed. Any anticipated losses on contracts are charged to operations as soon as they are determinable.\nNote A: (continued)\nRESEARCH AND DEVELOPMENT Company-sponsored research and development expenditures are charged to expense as incurred. Worldwide expenditures on research and development activities amounted to $220.1 million, $254.6 million and $201.9 million, of which 26%, 21% and 38% were Company-sponsored, in the years ended July 31, 1994, 1993 and 1992, respectively.\nPROPERTY, PLANT AND EQUIPMENT Investment in property, plant and equipment is stated at cost. Allowances for depreciation and amortization, computed generally by the straight-line method for financial reporting purposes, are provided over the estimated useful lives of the related assets.\nINCOME TAXES The Company adopted the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109), effective August 1, 1993 (see Note G). The adoption of this statement did not have a material impact on the Company's consolidated financial statements. Prior years' financial statements have not been restated.\nFOREIGN CURRENCIES The currency effects of translating the financial statements of those non-U.S. subsidiaries and divisions of the Company which operate in local currency environments are included in the \"Cumulative currency translation adjustment\" component of Shareholders' Investment. Currency adjustments included in the Consolidated Statements of Operations are principally related to transactions and are as follows:\nThe Company enters into forward purchase contracts and buys put options to hedge, at amounts deemed appropriate, the exposure of certain of its assets (exclusive of property, plant and equipment) and liabilities. The carrying amounts of the hedging contracts at July 31, 1994 and 1993 were not material, nor were the amounts hedged.\nPENSION AND OTHER POSTRETIREMENT BENEFIT PLANS The Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (SFAS No. 106) in the fourth quarter of fiscal year 1993. The Company's postretirement plans other than pensions consist primarily of health care and life insurance benefits. The Company elected immediate recognition of the transition liability. For further discussion of accounting policies for pension and other postretirement benefit plans see Note H.\nNote A: (continued)\nGOODWILL AND OTHER INTANGIBLES For financial statement purposes, goodwill and other intangibles are generally amortized using the straight-line method over their estimated useful lives, not exceeding 40 years. The current and future profitability of the operations to which the goodwill relates are continually evaluated (at least annually). These factors, along with management's plans with respect to the operations and the projected undiscounted cash flows, are considered in assessing the recoverability of the goodwill.\nENVIRONMENTAL COSTS Provisions for environmental costs are recorded when the Company determines its responsibility for remedial efforts and such amounts are reasonably estimable. The Company's exposure is mitigated by potential insurance reimbursements and to the extent such costs are recoverable under the Company's U.S. Government contracts. These recoveries are not recorded until collection is probable.\nNote B: Business Divestitures and Acquisitions\nDistribution of WAI\nOn March 17, 1994, Litton distributed all of the issued and outstanding shares of common stock of its previously wholly-owned subsidiary Western Atlas Inc. (\"WAI\"). The WAI operations, reflected herein as discontinued operations, comprised substantially all of the Company's former oilfield services and industrial automation systems businesses. The distribution (\"Distribution\") was made in the form of a dividend to holders of record of Litton Common stock at the close of business on March 14, 1994. Litton shareholders of record received one share of WAI common stock for each share of Litton Common stock owned. The consolidated financial statements reflect an accounting date for the Distribution of February 28, 1994, which resulted in a reduction of Litton's Shareholders' Investment in the amount of $915.3 million representing the book value of net assets distributed.\nSales were $1.09 billion, $2.01 billion and $1.98 billion for the seven months ended February 28, 1994, fiscal year 1993 and fiscal year 1992, respectively. Net earnings (loss) were ($173) million, $85 million and $87 million for the same periods. Results for the seven months ended February 28, 1994 included special charges totalling $179 million, net of tax, recorded to reflect the write-down of net assets of a certain division and to provide for obsolescence of older technology equipment, vessels and inventory and the consolidation of facilities. Net earnings for fiscal year 1993 included the cumulative effect of a change in accounting principle for $10 million. Corporate interest costs of $7 million, $12 million and $12 million have been attributed to WAI and, therefore, reclassified to discontinued operations for the seven months ended February 28, 1994, fiscal year 1993 and fiscal year 1992, respectively. Income tax expense (benefit) allocated to WAI for the same periods was ($55) million, $79 million and $73 million.\nDuring fiscal year 1994, WAI purchased from Dresser Industries, Inc. its 29.5% minority interest in Western Atlas International, Inc. for $358 million in cash and four subordinated notes of $50 million each which mature, respectively, in each of four years commencing in 1998. Additionally, WAI purchased the business and substantially all of the assets of Halliburton Company's geophysical services business for an estimated purchase price of $190 million, of which $100 million was paid in cash and the remainder in notes maturing over periods of three and one-half to four years following the closing date of the transaction. The funds used to effect these transactions were advanced by Litton and were reimbursed to Litton at Distribution.\nAcquisitions\nIn August 1992, the Company acquired General Instrument Corporation's Defense Systems group (\"Defense Systems group\"). The Defense Systems group is a leading supplier of passive electronic warfare systems, such as threat warning and electronic support measures systems, for the U.S. Department of Defense and for allied nations. The purchase price was $83 million, inclusive of goodwill of $27 million which is being amortized over a period of 10 years.\nOther acquisitions which were made during the three years ended July 31, 1994 are integral to the Company's goals though not material in aggregate to the Company's consolidated financial statements in any one year. The acquisitions were paid in cash and have been accounted by the purchase method.\nNote C: Cash and Marketable Securities, Debt and Interest\nCash and marketable securities consist of the following interest-earning investments:\nThe Company's marketable securities consist of high quality securities issued by a number of institutions having high credit ratings. This investment policy limits the Company's exposure to concentrations of credit risk. In July 1994, the Company purchased approximately $489 million face value in U.S. Government obligations to effect the early extinguishment of debt as further explained below.\nCash and cash equivalents (see Note A) at July 31, 1994 consisted of $37.1 million in time deposits and certificates of deposit, $5.4 million in U.S. Government obligations and $2.0 million in commercial paper. At July 31, 1993 cash and cash equivalents consisted of $110.6 million in time deposits and certificates of deposit and $126.8 million in commercial paper.\nNotes payable and current portion of long-term obligations are composed of:\nLong-term obligations consist of the following:\nNote C: (continued)\nOther long-term obligations at July 31, 1994 mature as follows:\nOn July 11, 1994 the Company effected an early extinguishment of debt through an in-substance defeasance of its 12 5\/8% Subordinated Debentures in the principal amount of $435.8 million due July 1, 2005. The Company purchased approximately $489 million face value in U.S. Government obligations and deposited them in an irrevocable trust administered by The Bank of New York for the sole purpose of satisfying the scheduled payments with respect to the 12 5\/8% Subordinated Debentures. The trust can not be rescinded or revoked nor its assets otherwise accessed by the Company or others. The U.S. Government obligations provide cash flows, from interest at fixed rates and at maturity, which coincide with the scheduled interest payments and the eventual redemption, at 104.2% of par plus accrued interest, on July 1, 1995. Due to this in-substance defeasance, results for the fourth quarter of fiscal year 1994 included an extraordinary loss on early extinguishment of debt of $49.2 million pre-tax, or $30.7 million after tax.\nOn June 28, 1993, the Company called for redemption its zero coupon convertible subordinated notes due 2010. The notes were convertible into 6.126 shares of Litton Common stock per $1,000 principal amount of the notes. At July 31, 1993, substantially all of the notes outstanding had been converted into 6,114,401 shares of Litton Common stock and the remainder had been settled for cash. This transaction resulted in an increase to Shareholders' Investment of $312.6 million.\nThe Company has various credit commitments which provide for revolving credit or term loans of up to $400 million for its general use at July 31, 1994.\nNote C: (continued)\nThe estimated market value, based on quoted market prices, of the Company's marketable securities at July 31, 1994 was $59.3 million compared with the carrying amount of $56.1 million. The other financial instruments on the Company's Consolidated Balance Sheet included Accounts receivable, Accounts payable, Payrolls and related expenses, Notes payable and current portion of long-term obligations and other miscellaneous long-term assets and liabilities. The carrying amounts of the short-term assets and liabilities were deemed to approximate their market values due to their short maturity. The carrying amounts of the remainder of the financial instruments were not material. As discussed in Note I, the Company also has off-balance sheet guarantees and letter of credit agreements with face values totalling $190 million at July 31, 1994 relating principally to the guarantee of future performance on mainly foreign government contracts.\nNet interest expense is composed of the following:\nTotal cash interest payments made during fiscal year 1994 amounted to $100.6 million which included $37 million of prepaid interest in connection with the previously discussed early extinguishment of debt. Payments for fiscal years 1993 and 1992 were $66.1 million and $121.6 million, respectively. Capitalized interest costs in each of the three years in the period ended July 31, 1994 were not material.\nNote D: Accounts Receivable and Inventories\nFollowing are the details of accounts receivable:\nOf the retentions balance and amounts not billed at July 31, 1994, $31.1 million is expected to be collected in fiscal year 1995 with the balance to be collected in subsequent years, as contract deliveries are made and warranty periods expire.\nSummarized below are the components of inventory balances:\nThe amounts included in \"Inventoried costs related to long-term contracts\" representing general and administrative costs and production cost of delivered units in excess of anticipated average cost of all units expected to be produced are not significant.\nIf the receivable, inventory and progress billings amounts related to any one contract result in a net credit balance, such amounts are classified in current liabilities as \"Customer deposits and contract liabilities.\"\nNote E: Property, Plant and Equipment\nInvestment in property, plant and equipment consists of the following:\nThe net book value of assets utilized under capital leases was not material at July 31, 1994 and 1993.\nAs of July 31, 1994, minimum rental commitments under capital and noncancellable operating leases were:\nRental expense for operating leases, including amounts for short-term leases with nominal, if any, future rental commitments, was $32.4 million, $33.6 million and $34.9 million for the years ended July 31, 1994, 1993 and 1992, respectively. The minimum future rentals receivable under subleases and the contingent rental expenses were not significant.\nNote F: Shares Outstanding and Shareholders' Investment\nSHARE INFORMATION\nAt July 31, 1994, there were authorized 120 million shares of Common stock, par value $1.00; 22 million shares of preferred stock, par value $5.00 and 8 million shares of Preference stock, par value $2.50.\nNo cash dividends were paid on the Common stock in the three fiscal years ended July 31, 1994.\nThe Series B preferred stock receives a $2.00 annual dividend, is not convertible into Common stock and is redeemable at the option of the Company at $80.00 plus accrued dividends and, in the event of liquidation, is entitled to receive $25.00 plus accrued dividends.\nOn March 12, 1992, the Company's Board of Directors declared a two-for-one common stock split which was effected in the form of a 100 percent stock dividend, distributed on May 8, 1992 to shareholders of record on April 3, 1992. Par value remains $1 per share.\nSTOCK OPTION INFORMATION The Company has stock option plans which provide for the grant of incentive awards to officers and other key employees. Incentive awards may be granted in the form of stock options at not less than 50% nor more than 100% of the fair market value of the Company's Common stock on the date of grant.\nIn connection with the Distribution of the shares of Western Atlas common stock (see Note B), each option granted pursuant to the plans was adjusted to account for the Distribution. Each Litton optionee with options outstanding on the Distribution date received an equivalent number of Western Atlas options. The option price was allocated in accordance with a predetermined formula.\nNote F: (continued)\nThe awards outstanding under the Company's employee incentive plans at July 31, 1994 and 1993 were stock options to purchase 2,499,771 and 2,482,129 shares, respectively, at exercise prices per share ranging from $7.40 to $37.19 and $14.35 to $57.38, respectively. Of these options, 979,461 and 1,129,019 were exercisable by their terms at July 31, 1994 and 1993, respectively. During fiscal year 1994, prior to the Distribution, options were granted under these plans to purchase 7,000 shares at prices per share ranging from $33.14 to $66.69 and options to purchase 323,288 shares were exercised at prices per share ranging from $14.35 to $47.94. For the period in fiscal year 1994 subsequent to the Distribution, options were granted under these plans to purchase 421,000 shares at prices per share ranging from $15.19 to $37.19 and options to purchase 81,070 shares were exercised at prices per share ranging from $7.41 to $20.18. During fiscal year 1993, options were granted under these plans to purchase 372,000 shares at prices per share ranging from $23.38 to $57.38 and options to purchase 719,424 shares were exercised at prices per share ranging from $14.35 to $47.94. At July 31, 1994, there were 699,750 shares available for grants of future awards under these plans.\nThe Company has a Director Stock Option Plan which provides for the grant of stock options to the Company's non-employee directors. Under this plan, stock options are granted annually at the fair market value of the Company's Common stock on the date of grant. The number of options so granted annually is fixed by the plan. Such options become fully exercisable on the first anniversary of their respective grant. The total number of shares to be issued under this plan may not exceed 400,000 shares. During fiscal years 1994 (prior to the Distribution) and 1993, options under this plan were granted to purchase 42,000 and 24,000 shares at prices per share of $64.06 and $42.50, respectively. During fiscal year 1994, prior to the Distribution, options to purchase 18,350 shares were exercised at prices per share ranging from $34.97 to $43.03. For the period in fiscal year 1994 subsequent to the Distribution, options to purchase 18,000 shares were exercised at prices per share ranging from $14.72 to $18.12. Options outstanding at July 31, 1994 and 1993 were 145,650 and 140,000, respectively. Of these options, 103,650 were exercisable at July 31, 1994 and 116,000 were exercisable at July 31, 1993.\nSHAREHOLDER RIGHTS PLAN On August 17, 1994 the Company's Board of Directors adopted a Share Purchase Rights Plan (the \"Plan\") and, in accordance with such Plan, declared a dividend of one preferred share purchase right for each outstanding share of Common stock, payable August 31, 1994 to shareholders of record on that date. The Plan contains provisions to protect shareholders in the event of an unsolicited attempt to acquire the Company. The Plan should deter any attempt to acquire the Company in a manner or on terms not approved by the Board of Directors.\nOnce exercisable, each right will entitle the holder to purchase one one-thousandth of a share of Series A Participating Preferred Stock, par value $5, at a price of $150 per one one-thousandth of a Preferred Share, subject to adjustment. Alternatively, under certain circumstances involving the acquisition by a person or group of 15 percent or more of the Company's Common stock, each right will entitle its holder to purchase a number of shares of the Company's Common stock having a market value of two times the exercise price of the right. In the event a merger or other business combination transaction is effected after a person or group has acquired 15 percent or more of the Company's Common shares, each right will entitle its holder to purchase a number of the resulting company's common shares having a market value of two times the exercise price of the right.\nNote F: (continued)\nThe Company may exchange the rights at an exchange ratio of one Common share per right. The Company may also redeem the rights at $.01 per right at any time prior to a 15 percent acquisition. The rights, which do not have voting rights and are not entitled to dividends until such time as they become exercisable, expire in August 2004.\nWAI DISTRIBUTION In connection with the Distribution (see Note B), Shareholders' Investment was reduced in the amount of $915.3 million representing the book value of net assets distributed. The adjustments to Retained earnings, Additional paid-in capital and Cumulative currency translation adjustment were based, generally, on the respective Litton and WAI balances as of the accounting date for the Distribution.\nNote G: Taxes on Income\nEffective August 1, 1993, the Company adopted the provisions of SFAS No. 109 which requires the measurement of tax assets and liabilities based on a balance sheet approach. Under SFAS No. 109, deferred tax assets and liabilities reflect the effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and for income tax reporting purposes. The adoption of SFAS No. 109 did not have a material impact on the Company's consolidated financial statements and prior years' financial statements have not been restated.\nEarnings from continuing operations before taxes on income, extraordinary item and cumulative effect of a change in accounting principle by geographic area are as follows:\nNote G: (continued)\nThe primary components of the Company's deferred income tax assets and liabilities at July 31, 1994 are as follows:\nThe following is a reconciliation of income taxes at the U.S. statutory rate to the provision for income taxes:\nUndistributed earnings of non-U.S. subsidiaries for which U.S. taxes have not been provided are included in consolidated retained earnings in the amounts of $123 million and $109 million at July 31, 1994 and 1993, respectively. If such earnings were distributed, U.S. income taxes would be partially reduced by available credits for taxes paid to the jurisdictions in which the income was earned.\nThe Company made tax payments of $195.0 million, $180.6 million and $220.7 million in fiscal years 1994, 1993 and 1992, respectively.\nThe Company and WAI have entered into a tax-sharing agreement which, among other items, provides for the treatment of tax matters for periods through the Distribution date and responsibility for any adjustment as a result of audit by any taxing authority. The general terms and conditions provide that Litton will indemnify and hold harmless WAI and its subsidiaries included in Litton's consolidated U.S. tax returns against all liabilities for Federal income taxes with respect to periods prior to the Distribution date.\nNote H: Pension and Other Postretirement Benefit Plans\nPension Benefits\nThe Company has various retirement and pension plans which cover most of its employees. Net pension income for these plans for the years ended July 31, 1994, 1993 and 1992 was $14.7 million, $11.2 million and $4.4 million, respectively.\nMost of the Company's U.S. employees are covered by contributory defined benefit plans under which employees are eligible for benefits at age 65. Generally, benefits are determined under a formula based primarily on the participant's total plan contributions. The Company's funding policy is to make annual contributions to the extent such contributions are actuarially determined and tax deductible.\nThe Company has a defined contribution voluntary savings plan for eligible U.S. employees. This 401(K) plan is designed to enhance the existing retirement programs of participating employees. The Company matches 50% of a certain portion of participants' contributions to the plan.\nThe Company's non-U.S. subsidiaries also have retirement plans for long-term employees. These plans are not considered to be significant individually or in the aggregate to the Company's consolidated financial position. The pension liabilities and their related costs are computed in accordance with the laws of the individual nations and appropriate actuarial practices.\nA summary of the components of net periodic pension income (cost) for the U.S. defined benefit plans, defined contribution plans and non-U.S. pension plans for fiscal years 1994, 1993 and 1992 are as follows:\nThe projected benefit obligation of the U.S. defined benefit plans was $832.0 million and $744.4 million at July 31, 1994 and 1993, respectively. The fair value of plan assets, primarily equity securities and U.S. Government securities, was $1,172.7 million at July 31, 1994 compared with $1,089.7 million at July 31, 1993. The unrecognized net transition asset was $70.4 million and $84.7 million at July 31, 1994 and 1993, respectively, and the unrecognized net gain was $116.6 million at fiscal year end 1994 compared with $166.5 million at fiscal year end 1993. Prepaid pension cost was $141.6 million at July 31, 1994 compared with $80.9 million at July 31, 1993.\nNote H: (continued)\nThe accumulated benefit obligation was $743.1 million at July 31, 1994, inclusive of the vested benefit obligation of $719.1 million. At July 31, 1993, the accumulated benefit obligation was $650.9 million, inclusive of the vested benefit obligation of $635.2 million.\nActuarial assumptions for the Company's U.S. defined benefit plans included an expected long-term rate of return on plan assets of 9 1\/4% for fiscal years 1994 and 1993. The weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation at July 31, 1994 was 8 1\/4% and at July 31, 1993 was 8 1\/2%. The rate of increase in future compensation levels was 5% at July 31, 1994 and 1993.\nThe excess of plan assets over the projected benefit obligation at August 1, 1986 (when the Company adopted Statement of Financial Accounting Standards No. 87) and subsequent unrecognized gains and losses are fully amortized over the average remaining service period of active employees expected to receive benefits under the plans, generally 15 years. Pension assets included in Long-term Investments and Other Assets were $181.1 million and $122.9 million at July 31, 1994 and 1993, respectively.\nIn fiscal years 1994, 1993 and 1992, the Company incurred $18.7 million, $13.5 million and $25.0 million, respectively, in costs for special separation and supplemental early retirement benefits for certain employees in connection with workforce reductions at certain operations.\nIn conjunction with the Distribution discussed in Note B, the Company and WAI have entered into an Employee Benefits Agreement which provides for, among other items, the transfer to WAI of plan assets with an estimated fair market value of $188.2 million and the assumption by WAI of a projected benefit obligation estimated at a present value of $116.5 million.\nOther Postretirement Benefits\nIn addition to pension benefits, certain of the Company's U.S. employees are covered by postretirement health care and life insurance benefits plans. These benefit plans are unfunded. In the fourth quarter of fiscal year 1993, the Company adopted, effective as of the beginning of the fiscal year, the provisions of SFAS No. 106 related to these plans. The Company elected immediate recognition of the transition liability for such benefits and the resultant cumulative effect of a change in accounting principle amounted to $106.7 million, net of tax.\nThe components of net periodic postretirement benefit costs for fiscal years 1994 and 1993 recognized under the provisions of SFAS No. 106 are as follows:\nNote H: (continued)\nThe amount expensed in fiscal year 1992 under the cash basis of accounting for postretirement benefits was not materially different. The accumulated benefit obligation at July 31, 1994 was $198.8 million, of which $146.1 million was attributable to retirees and $52.7 million was attributable to active plan participants. The accumulated benefit obligation at July 31, 1993 was $182.8 million, of which $116.3 million was attributable to retirees and $66.5 million was attributable to active plan participants.\nActuarial assumptions used to measure the accumulated benefit obligation include a discount rate of 8 1\/4% and 8 1\/2% at July 31, 1994 and 1993, respectively. The assumed health care cost trend rate for fiscal year 1994 was 14.4% and is projected to decrease over 23 years to 6.75%, where it is expected to remain thereafter. The effect of a one-percentage-point increase in the assumed health care cost trend rate on the service cost and interest cost components of the net periodic postretirement benefit cost is not material. A one-percentage-point increase in the assumed health care cost trend rate on the accumulated benefit obligation results in an increase of approximately $12.6 million.\nNote I: Defense Contracts, Litigation and Contingencies\nApproximately 73%, 73% and 70% of total sales and service revenues of the Company for the years ended July 31, 1994, 1993 and 1992, respectively, were from U.S. Government contracts and subcontracts. Approximately 87% of these revenues for 1994 related to fixed-price type contracts. At July 31, 1994, of the total Company backlog of $5.5 billion, the amount of worldwide defense contract backlog was approximately $5.2 billion, of which $4.7 billion has been funded. At July 31, 1993 and 1992, the amount of worldwide defense contract backlog was $6.3 billion and $6.2 billion, respectively.\nAs is common with U.S. Government contracts, the Company's U.S. defense contracts are unilaterally terminable at the option of the U.S. Government with compensation for work completed and costs incurred. Contracts with the U.S. Government are subject to certain laws and regulations, the noncompliance with which may result in various sanctions.\nLitton Systems, Inc. (\"LSI\"), a subsidiary of the Company, was a defendant in a previously reported civil suit brought under the so-called qui tam provisions of the False Claims Act, which permit an individual to bring suit in the name of the United States Government and share in any recovery received. If the plaintiffs had prevailed in such litigation, the total damages and penalties could have exceeded $500 million. Without admitting any liability or wrongdoing, LSI and the plaintiffs, on July 14, 1994, agreed to settle all issues in connection with the matter. The Court dismissed the civil suit with prejudice, thereby terminating this proceeding. Accordingly, results for fiscal year 1994 included a charge of $86.0 million pre-tax, or $53.8 million after-tax, to reflect the settlement.\nOn August 31, 1993 a U.S. District Court jury rendered a verdict in favor of Litton against Honeywell, Inc. in the amount of $1.2 billion. The jury found that Honeywell willfully infringed a Litton patent relating to the manufacture of ring laser gyro navigation systems which are used in commercial aircraft. The jury also found that Honeywell actively induced a Litton licensee to infringe Litton's patent and Honeywell interfered with Litton's prospective economic advantage. The Court is currently considering post trial motions filed by both Honeywell and Litton. It is expected that any decision of the Court would be appealed by the party which does not prevail, and the Company cannot predict when this litigation will be ultimately concluded.\nThere are various other litigation proceedings in which the Company is involved. Although the results of litigation proceedings cannot be predicted with certainty, it is the opinion of the General Counsel that the Company does not have a potential liability in connection with these other proceedings which would have an adverse material effect on the consolidated financial statements.\nThe Company has issued or is a party to various guarantees and letter of credit agreements totalling $190 million at July 31, 1994. These arrangements relate principally to the guarantee of future performance, mainly on foreign government contracts.\nNote J: Extraordinary Item and Unusual Item\nOn July 11, 1994, the Company effected an in-substance defeasance of its 12 5\/8% Subordinated Debentures by placing direct U.S. Government obligations in an irrevocable trust to provide for the redemption, according to their terms, on July 1, 1995 at 104.2% of their principal amount, plus accrued interest (see Note C). Due to this in-substance defeasance, results for fiscal year 1994 included an extraordinary loss on early extinguishment of debt of $49.2 million pre-tax, or $30.7 million after tax. The effect on primary earnings per share for the year was a decrease of $.67.\nOn July 14, 1994, the Company settled a civil suit brought under the so-called qui tam provisions of the False Claims Act (see Note I) and recorded a charge of $86.0 million to the operating results of the Advanced Electronics segment. On an after-tax basis, the impact of this settlement was a $53.8 million loss, or a decrease of $1.18 to primary earnings per share for the year.\nNote K: Business Segment Reporting\nAs a result of the Distribution discussed in Note B, the Company's primary operations now comprise three business segments: Advanced Electronics, Marine Engineering and Production, and Interconnect Products.\nThe Advanced Electronics segment designs, develops and manufactures inertial navigation, guidance and control, command, control and communications and electronic warfare systems. The fiscal year 1994 Advanced Electronics segment operating profit includes the effects of the settlement of a civil suit (see Notes I and J).\nThe Marine Engineering and Production segment is involved in the design, construction and overhaul of naval ships.\nIntersegment sales, sales between geographic areas and export sales are not material. All internal sales and transfers are based on negotiated prices.\nThe U.S. Government is a significant customer of both the Advanced Electronics and Marine Engineering and Production segments (see Note I).\nIn the first quarter of fiscal year 1994, the Company named its other businesses \"Interconnect Products\" to reflect the principal products of this group of businesses. This segment manufactures and distributes interconnection subsystems, electronic connectors, printed circuit boards, backpanels and soldering materials to diverse markets worldwide. Operating profit for fiscal year 1994 includes a charge recorded to adjust the net assets of a division to net realizable value in connection with its possible sale or closure.\nCosts for Corporate and Other Amounts include net interest expense and foreign currency adjustments. Assets classified as Corporate and Other Amounts consist primarily of cash and marketable securities, deferred tax assets and, for fiscal years 1993 and 1992, net assets of WAI of $1,085 and $1,042 million, respectively. In fiscal year 1994, the Company used cash and marketable securities to effect an early extinguishment of debt as discussed in Note C.\nPrior years' information has been restated to conform to the current presentation.\nNote K: (continued)\nOperations by Business Segment (millions of dollars)\n* Results for fiscal year 1994 included the settlement of a civil suit (see Notes I and J).\nNote K: (continued)\nOperations by Geographic Area (millions of dollars)\nLitton Industries, Inc. Quarterly Financial Information (unaudited)\n* Results for the fourth quarter of fiscal year 1994 included the settlement of a civil suit (see Notes I and J of Notes to Consolidated Financial Statements). The impact on fourth quarter and fiscal year 1994 primary and fully diluted earnings per share was a loss of $1.17 and $1.18, respectively. In addition, the Company effected an early extinguishment of debt in the fourth quarter of fiscal year 1994 which resulted in an extraordinary loss (see Notes C and J of Notes to Consolidated Financial Statements).\n** Primary earnings (loss) per share also reflected fully diluted earnings (loss) per share in each of the four quarters of fiscal year 1994.\n*** Pursuant to the Distribution, Western Atlas common stock began trading separately from Litton Common stock in the third quarter of fiscal year 1994 (see Note B of Notes to Consolidated Financial Statements).\nLitton Industries, Inc. Quarterly Financial Information (unaudited)\nLitton Industries, Inc. Quarterly Financial Information (unaudited) (continued)\nLitton Common stock is traded principally on the New York Stock Exchange and the Pacific Stock Exchange. The symbol is \"LIT\".\nAs of September 30, 1994, there were approximately 36,900 holders of record of the Common stock.\nThe total of quarterly amounts for earnings per share will not necessarily equal the annual amount, since the computations are based on the average number of common shares and dilutive common share equivalents outstanding during each period.\n* In the fourth quarter of fiscal year 1993, the Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other than Pensions, effective as of August 1, 1992.\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE I - MARKETABLE SECURITIES AND OTHER INVESTMENTS JULY 31, 1994 (thousands of dollars)\n(A) Included in the caption \"Cash and marketable securities\" in the Consolidated Balance Sheet at July 31, 1994.\nS-1 LITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND EMPLOYEES OTHER THAN RELATED PARTIES YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nS-2a\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND EMPLOYEES OTHER THAN RELATED PARTIES, continued YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nS-2b\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nS-3 LITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nNote:\nSee Note A of Notes to Consolidated Financial Statements for discussion on method of depreciation and amortization.\n(A) Includes amortization of leasehold improvements and depreciation of leased equipment.\nS-4 LITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE IX - SHORT-TERM BORROWINGS YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nNOTES:\n(A) These balances were calculated by considering the beginning balance on August 1 and the 12 month-end balances during the years ended July 31, 1994, 1993 and 1992, respectively. (B) These percentages were determined by considering the time each obligation was outstanding and the interest rate in effect during that time.\nS-5\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION YEARS ENDED JULY 31, 1994, 1993 AND 1992 (thousands of dollars)\nNOTE:\nOther items of supplementary income statement information are less than one percent of total sales and service revenues reported in the Consolidated Statements of Operations.\nS-6\nLITTON INDUSTRIES, INC. AND SUBSIDIARY COMPANIES INDEX TO EXHIBITS\nExhibit No. and Applicable Section of Item 601 of Regulation S-K - ------------------\n3.1(a) Restated Certificate of Incorporation of the Company, filed as Exhibit 3.1 to the Company's 1984 Annual Report on Form 10-K, and incorporated herein by reference.\n3.1(b) Amendment to the Company's Restated Certificate of Incorpo- ration, filed as Exhibit 3.1(a) to the Company's October 31, 1986 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n3.2(a) By-laws of the Company as amended through the date of this filing, filed as Exhibit 3.2 to the Company's 1988 Annual Report on Form 10-K, and incorporated herein by reference.\n3.2(b) Board of Directors Resolution amending the by-laws of the Company with respect to the number of members of the Board of Directors through the date of the filing and incorporated herein by reference.*\n4.1 Indenture dated as of June 10, 1985 between the Company and The Bank of New York, Trustee, under which the 12 5\/8% Subordinated Debentures Due 2005 were issued, filed as Exhibit 4.1 to the Company's April 30, 1985 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n4.2 Form of definitive 12 5\/8% Subordinated Debenture Due 2005, filed as Exhibit 4.4 to the Company's 1985 Annual Report on Form 10-K, and incorporated herein by reference.\n4.3 $400,000,000 Credit Agreement dated December 23, 1993 among Litton Industries, Inc., a group of banks and Morgan Guaranty Trust Company of New York, as Agent, and Wells Fargo Bank, N.A., as Co-agent, filed as Exhibit 4.1 to the Company's April 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n4.4 Other instruments defining the rights of holders of other long-term debt of the Registrant are not filed as exhibits because the amount of debt authorized under any such instrument does not exceed 10% of the total assets of the Registrant and its consolidated subsidiaries. The Registrant hereby undertakes to furnish a copy of any such instrument to the Commission upon request.\n* Copies of these documents have been included in this Annual Report on Form 10-K filed with the Securities and Exchange Commission.\nE-1 INDEX TO EXHIBITS, continued\n4.5 Rights Agreement, together with exhibits thereto, dated August 17, 1994 between Litton Industries, Inc. and The Bank of New York, as Rights Agent, filed as Exhibit 99.2 to Form 8-K dated August 17, 1994, and incorporated herein by reference.\n10.1(a) Board of Directors Resolutions, adopted December 8, 1993, with respect to nonemployee directors' annual retainer and attendance fees filed as Exhibit 10.1 to the Company's April 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.1(b) Board of Directors Resolutions with respect to director retirement age and with respect to postretirement payments to directors, including those payments made in the event of a change in control of the Company, adopted on October 16, 1991, filed as Exhibit 10.2(b) to the Company's 1991 Annual Report on Form 10-K, and incorporated herein by reference.\n10.2(a) Litton Supplemental Retirement Plan, filed as Exhibit 10.3 to the Company's 1983 Annual Report on Form 10-K, and incorporated herein by reference.\n10.2(b) Board of Directors Resolution, adopted December 2, 1992, amending the Litton Supplemental Retirement Plan, filed as Exhibit 10.1 to the Company's April 30, 1993 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.2(c) Agreement of Trust between the Company and First Interstate Bank of California, dated December 20, 1988, regarding pay- ments of pension benefits under the Litton Supplemental Retirement Plan to certain former and present employees or their beneficiaries, filed as Exhibit 10.17 to the Company's 1989 Annual Report on Form 10-K, and incorporated herein by reference.\n10.2(d) Amendments, through the date of the filing, to the Agreement of Trust dated December 20, 1988, and incorporated herein by reference.\n10.2(e) Instruments dated April 16, 1990, and April 25, 1990, removing First Interstate Bank of California as Trustee under Agreement of Trust dated December 20, 1988, and appointing Wells Fargo Bank, N.A., as Successor Trustee, filed as Exhibit 10.17(c) to the Company's 1990 Annual Report on Form 10-K, and incorporated herein by reference.\nE-2\nINDEX TO EXHIBITS, continued\n10.2(f) Letter of Credit dated November 17, 1989, issued by Wells Fargo Bank, N.A. pursuant to Agreement of Trust dated December 20, 1988, filed as Exhibit 10.17(d) to the Company's 1990 Annual Report on Form 10-K, and incorporated herein by reference.\n10.3(a) Specimen of the form of the agreement presently outstanding under the Litton Industries, Inc. Executive Survivor Benefit Plan, applicable to officers and certain key employees, filed as Exhibit 10.4 to the Company's 1984 Annual Report on Form 10-K, and incorporated herein by reference.\n10.3(b) Board of Directors Resolutions amending the Executive Survivor Benefit Plan, adopted June 12, 1986, filed as Exhibit 10.4(a) to the Company's 1986 Annual Report on Form 10-K, and incorporated herein by reference.\n10.4 Board of Directors Resolutions with respect to extended notice of termination of certain officers, adopted December 5, 1985, filed as Exhibit 10.7 to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.5(a) Board of Directors Resolution with respect to incentive loans, adopted September 26, 1991, filed as Exhibit 10.8(a) to the Company's 1991 Annual Report on Form 10-K, and incorporated herein by reference.\n10.5(b) Specimen of the form of promissory note applicable to loans presently outstanding under the Company's incentive loan program, filed as Exhibit 10.8(b) to the Company's 1991 Annual Report on Form 10-K, and incorporated herein by reference.\n10.6 Copy of Agreement between the Company and the Foundation of the Litton Industries dated May 1, 1978, filed as Exhibit 1 to Post-Effective Amendment No. 7 to Registration Statement No. 2-52592 on Form S-8, and incorporated herein by reference.\n10.7(a) Supplemental Medical Insurance Plan for Key Executive Employees incorporating all amendments thereto through the date of this filing, filed as Exhibit 10.10 to the Company's 1990 Annual Report on Form 10-K, and incorporated herein by reference.\nE-3\nINDEX TO EXHIBITS, continued\n10.7(b) Resolution adopted by the Compensation and Selection Committee, dated January 26, 1994, approving the participation by Orion L. Hoch and Catherine Nan Hoch in the Supplemental Medical Insurance Plan, filed as Exhibit 10.2 to the Company's April 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.8(a) Litton Industries, Inc. 1981 Incentive Stock Option Plan, filed as Exhibit 10.12(a) to the Company's 1982 Annual Report on Form 10-K, and incorporated herein by reference.\n10.8(b) Compensation and Selection Committee Resolution, adopted September 29, 1993, adjusting the options outstanding under Litton Industries, Inc. 1981 Incentive Stock Option Plan.\n10.9(a) Supplemental Retirement Agreement between the Company and Orion L. Hoch, filed as Exhibit 10.13(b) to the Company's 1983 Annual Report on Form 10-K, and incorporated herein by reference.\n10.9(b) Amendments, through the date of the filing, to the Supplemental Retirement Agreement between the Company and Orion L. Hoch, and incorporated herein by reference.\n10.9(c) Extract of the minutes of a meeting of the Compensation and Selection Committee of the Board of Directors, held on March 31, 1988, with respect to the lifetime participation of Fred W. O'Green and Mildred G. O'Green in the Supplemental Medical Insurance Plan, filed as Exhibit 10.13(e) to the Company's 1988 Annual Report on Form 10-K, and incorporated herein by reference.\n10.10(a) Litton Industries, Inc. 1984 Long-Term Stock Incentive Plan, as amended, filed as Exhibit 10.14(a) to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.10(b) Compensation and Selection Committee Resolutions, adopted March 12, 1992, amending the Litton Industries, Inc. 1984 Long-Term Stock Incentive Plan for the effects of the two-for-one Common stock split which was effective May 8, 1992, filed as Exhibit 10.14(b) to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.10(c) Board of Directors Resolutions, adopted August 12, 1993, amending the Litton Industries, Inc. 1984 Long-term Stock Incentive Plan.\n10.10(d) Compensation and Selection Committee Resolution, adopted September 29, 1993, adjusting the options outstanding under the Litton Industries, Inc. 1984 Long-term Stock Incentive Plan for the distribution of Western Atlas Inc. Common stock.\nE-4 INDEX TO EXHIBITS, continued\n10.11(a) Litton Industries, Inc. Performance Award Plan, filed as Exhibit 10.15 to the Company's 1984 Annual Report on Form 10-K, and incorporated herein by reference.\n10.11(b) Board of Directors Resolution, adopted December 2, 1992, amending the Litton Industries, Inc. Performance Award Plan, filed as Exhibit 10.2 to the Company's April 30, 1993 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.12 Litton Industries, Inc. Restoration Plan filed as Exhibit 10.16 to the Company's 1989 Annual Report on Form 10-K, and incorporated herein by reference.\n10.13(a) Litton Industries, Inc. Director Stock Option Plan, filed as Exhibit 10.18(a) to the Company's 1989 Annual Report on Form 10-K, and incorporated herein by reference.\n10.13(b) Board of Directors Resolution, adopted March 12, 1992, amending the Litton Industries, Inc. Director Stock Option Plan for the two-for-one Common stock split which was effective May 8, 1992, filed as Exhibit 10.18(b) to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.13(c) Board of Directors Resolution, adopted September 30, 1993, adjusting the options outstanding under the Litton Industries, Inc. Director Stock Option Plan for the distribution of Western Atlas Inc. Common stock.\n10.14 Consulting agreement between a subsidiary of the Company and Thomas B. Hayward, a director of the Company, dated December 17, 1993, filed as Exhibit 10.5 to the Company's April 30, 1994 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.15 Board of Directors Resolution with respect to election of Robert H. Lentz as Advisory Director effective April 1, 1990, filed as Exhibit 10.22 to the Company's 1992 Annual Report of Form 10-K, and incorporated herein by reference.\n10.16 Copy of the Company's \"Group Bonus Plan Fiscal 1992\", which provides for incentive compensation rewards for certain Group Executives and other key group personnel, filed as Exhibit 10.24 to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\n10.17 Copy of the incentive compensation plan of Ingalls Shipbuilding, Inc., a subsidiary of the Company, filed as Exhibit 10.25 to the Company's 1992 Annual Report on Form 10-K, and incorporated herein by reference.\nE-5\nINDEX TO EXHIBITS, continued\n10.18 Litton Industries, Inc. Deferred Compensation Plan for Directors together with Board of Directors Resolution adopted December 2, 1992, filed as Exhibit 10.3 to the Company's April 30, 1993 Quarterly Report on Form 10-Q, and incorporated herein by reference.\n10.19 Form of Change of Control Employment Agreement between the Company and certain executive officers.\n10.20 Distribution and Indemnity Agreement between Litton Industries, Inc. and Western Atlas Inc. dated as of March 17, 1994, filed as Exhibit 99.1 to Form 8-K dated March 17, 1994, and incorporated herein by reference.\n10.21 Tax Sharing Agreement between Litton Industries, Inc. and Western Atlas Inc. dated as of March 17, 1994, filed as Exhbit 99.1 to Form 8-K dated March 17, 1994, and incorporated herein by reference.\n11 Statement of Computation of Earnings per Share included herein on pages E-7a through E-8c.\n21 Subsidiaries of the Registrant included herein on page E-9.\n23 Independent Auditors' Consent included herein on page E-10.\n27 Financial Data Schedule included herein.\n99 Undertaking re: Indemnification for liabilities under Securities Act, filed as Exhibit 19 to the Company's 1990 Annual Report on Form 10-K, and incorporated herein by reference.\nE-6","section_15":""}
{"filename":"36995_1994.txt","cik":"36995","year":"1994","section_1":"ITEM 1. BUSINESS. GENERAL First Union Corporation (the \"Corporation\" or \"FUNC\") was incorporated under the laws of North Carolina in 1967 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"). Pursuant to a corporate reorganization in 1968, First Union National Bank of North Carolina (\"FUNB-NC \") and First Union Mortgage Corporation, a mortgage banking firm acquired by FUNB-NC in 1964, became subsidiaries of the Corporation. In addition to FUNB-NC, the Corporation also operates banking subsidiaries in Florida (since November 1985), South Carolina (since March 1986), Georgia (since March 1986), Tennessee (since December 1987), Maryland (since December 1992), Virginia (since December 1992) and Washington, D.C. (since December 1992). In addition to providing a wide range of commercial and retail banking and trust services through its banking subsidiaries, the Corporation also provides various other financial services, including mortgage banking, home equity lending, insurance and securities brokerage services, through other subsidiaries. The Corporation's principal executive offices are located at One First Union Center, Charlotte, North Carolina 28288-0013 (telephone number (704)374-6565). Since the 1985 Supreme Court decision upholding regional interstate banking legislation, the Corporation has concentrated its efforts on building a large regional banking organization in the southeastern and south atlantic regions of the United States. Since November 1985, the Corporation has completed 50 banking related acquisitions and currently has five pending acquisitions, including the more significant completed and pending acquisitions (I.E., acquisitions involving the acquisition of $3.0 billion or more of assets or deposits) set forth in the following table.\n(1) Additional information relating to certain of the foregoing and other acquisitions is set forth in the Annual Report in Note 2 on pages 62 and 63. (2) The dollar amounts indicated represent assets of the related organization as of the last reporting period prior to acquisition, except for (i) the dollar amount relating to RTC acquisitions, which represents deposits acquired from the RTC and (ii) the dollar amount relating to Southeast banks, which represents assets of the two banking subsidiaries of Southeast Banking Corporation acquired from the Federal Deposit Insurance Corporation (the \"FDIC\"). (3) In addition, the Corporation purchased Lieber & Company (\"Lieber\"), a mutual fund advisory company with approximately $3.4 billion in assets under management, in June 1994. Since such assets are not owned by Lieber, they are not reflected on the Corporation's balance sheet. (4) The ASF acquisition was announced on December 5, 1994, and is currently expected to close during the first half of 1995, subject to certain conditions of closing. The acquisition provides for issuance of $21.00 in value of shares of the Corporation's Common Stock, $3.33 1\/3 par value per share (the \"Common Stock\"), based on the price of Common Stock prior to the closing, in exchange for each share of ASF common stock, resulting in a purchase price of approximately $253 million. The Corporation paid $161 million for the purchase in the open market of 3.8 million shares of Common Stock expected to be issued in the acquisition and will account for the acquisition as a purchase. The Corporation is continually evaluating acquisition opportunities and frequently conducts due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations frequently take place and future acquisitions involving cash, debt or equity securities can be expected. Acquisitions typically involve the payment of a premium over book and market values, and therefore some dilution of the Corporation's book value and net income per common share may occur in connection with any future transactions. Additional information relating to the business of the Corporation and its subsidiaries is set forth on pages 6 through 10 in the Annual Report and incorporated herein by reference. Information relating to the Corporation only is set forth in Note 16 on pages 81 through 84 in the Annual Report and incorporated herein by reference. COMPETITION The Corporation's subsidiaries face substantial competition in their operations from banking and nonbanking institutions, including savings and loan associations, credit unions, money market funds and other investment vehicles, brokerage firms, insurance companies, leasing companies, credit card issuers, mortgage banking companies, finance companies and other types of financial institutions. Based on the volume of permanent mortgages serviced on December 31, 1994, the Corporation's mortgage banking subsidiary, First Union Mortgage Corporation, was the 17th largest mortgage banking company in the United States. SUPERVISION AND REGULATION GENERAL As a bank holding company, the Corporation is subject to regulation under the BHCA and its examination and reporting requirements. Under the BHCA, bank holding companies may not directly or indirectly acquire the ownership or control of more than five percent of the voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"). In addition, bank holding companies are generally prohibited under the BHCA from engaging in nonbanking activities, subject to certain exceptions. The earnings of the Corporation's subsidiaries, and therefore the earnings of the Corporation, are affected by general economic conditions, management policies and the legislative and governmental actions of various regulatory authorities, including the Federal Reserve Board and the Comptroller of the Currency (the \"Comptroller\"). In addition, there are numerous governmental requirements and regulations which affect the activities of the Corporation and its subsidiaries. PAYMENT OF DIVIDENDS The Corporation is a legal entity separate and distinct from its banking and other subsidiaries. A major portion of the revenues of the Corporation result from amounts paid as dividends to the Corporation by its national bank subsidiaries. The Corporation's banking subsidiaries are subject to legal limitations on the amount of dividends they can pay. The prior\napproval of the Comptroller is required if the total of all dividends declared by a national bank in any calendar year will exceed the sum of such bank's net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits national banks from paying dividends which would be greater than the bank's undivided profits after deducting statutory bad debt in excess of the bank's allowance for loan losses. Under the foregoing dividend restrictions and certain restrictions applicable to certain of the Corporation's nonbanking subsidiaries, as of December 31, 1994, the Corporation's subsidiaries, without obtaining affirmative governmental approvals, could pay aggregate dividends of $397 million to FUNC during 1995. During 1994, the Corporation's subsidiaries paid $682 million in cash dividends to FUNC. In addition, both the Corporation and its national bank subsidiaries are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authority is authorized to determine under certain circumstances relating to the financial condition of a national bank or bank holding company that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The Comptroller has indicated that paying dividends that deplete a national bank's capital base to an inadequate level would be an unsound and unsafe banking practice. The Comptroller and the Federal Reserve Board have each indicated that banking organizations should generally pay dividends only out of current operating earnings. BORROWINGS BY THE CORPORATION There are also various legal restrictions on the extent to which the Corporation and its nonbank subsidiaries can borrow or otherwise obtain credit from its bank subsidiaries. In general, these restrictions require that any such extensions of credit must be secured by designated amounts of specified collateral and are limited, as to any one of the Corporation or such nonbank subsidiaries, to ten percent of the lending bank's capital stock and surplus, and as to the Corporation and all such nonbank subsidiaries in the aggregate, to 20 percent of such lending bank's capital stock and surplus. CAPITAL Under the risk-based capital requirements for bank holding companies, the minimum requirement for the ratio of capital to risk-weighted assets (including certain off-balance-sheet activities, such as standby letters of credit) is eight percent. At least half of the total capital is to be composed of common equity, retained earnings and qualifying perpetual preferred stock, less goodwill (\"tier 1 capital\" and together with tier 2 capital \"total capital\"). The remainder may consist of subordinated debt, non-qualifying preferred stock and a limited amount of the loan loss allowance (\"tier 2 capital\"). At December 31, 1994, the Corporation's tier 1 capital and total capital ratios were 7.76 percent and 12.94 percent, respectively. In addition, the Federal Reserve Board has established minimum leverage ratio requirements for bank holding companies. These requirements provide for a minimum leverage ratio of tier 1 capital to adjusted average quarterly assets (\"leverage ratio\") equal to three percent for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a leverage ratio of from at least four to five percent. The Corporation's leverage ratio at December 31, 1994, was 6.12 percent. The requirements 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. Furthermore, the requirements indicate that the Federal Reserve Board will continue to consider a \"tangible tier 1 leverage ratio\" (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve Board has not advised the Corporation of any specific minimum tier 1 leverage ratio applicable to it.\nEach of the Corporation's subsidiary national banks is subject to similar capital requirements adopted by the Comptroller. The Comptroller has not advised any of the Corporation's subsidiary national banks of any specific minimum leverages ratio applicable to it. As of December 31, 1994, the capital ratios of the bank subsidiaries of the Corporation, FUNB-NC, First Union National Bank of South Carolina (\"FUNB-SC\"), First Union National Bank of Georgia (\"FUNB-GA\"), First Union National Bank of Florida (\"FUNB-FL\"), First Union National Bank of Washington, D.C. (\"FUNB-DC\"), First Union National Bank of Maryland (\"FUNB-MD\"), First Union National Bank of Tennessee (\"FUNB-TN\"), First Union National Bank of Virginia (\"FUNB-VA\") and First Union Home Equity Bank, N.A. (\"FUHEB\"), were as follows:\nBanking regulators continue to indicate their desire to raise capital requirements applicable to banking organizations, including a proposal to add an interest rate risk component to risk-based capital requirements. FIRREA; SUPPORT OF SUBSIDIARY BANKS The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\"), among other things, imposes liability on an institution the deposits of which are insured by the FDIC, such as the Corporation's subsidiary national banks, for certain potential obligations to the FDIC incurred in connection with other FDIC-insured institutions under common control with such institution. Under the National Bank Act, if the capital stock of a national bank is impaired by losses or otherwise, the Comptroller is authorized to require payment of the deficiency by assessment upon the bank's stockholders, pro rata, and to the extent necessary, if any such assessment is not paid by any stockholder after three months notice, to sell the stock of such stockholder to make good the deficiency. Under Federal Reserve Board policy, the Corporation is expected to act as a source of financial strength to each of its subsidiary banks and to commit resources to support each of such subsidiaries. This support may be required at times when, absent such Federal Reserve Board policy, the Corporation may not find itself able to provide it. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. FDICIA The Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), among other things, requires the federal banking agencies to take \"prompt corrective action\" in respect of depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: \"well capitalized\", \"adequately capitalized\", \"undercapitalized\", \"significantly undercapitalized\" and \"critically undercapitalized\". A depository institution's capital tier will depend upon where its capital levels compare to various relevant capital measures and certain other factors, as established by regulation. The Comptroller has adopted regulations establishing relevant capital measures and relevant capital levels. The relevant capital measures are the total capital ratio, tier 1 capital ratio and the leverage ratio. Under the regulations, a bank will be: (i) \"well capitalized\" if it has a total capital ratio of ten percent or greater, a tier 1 capital ratio of six percent or greater and a leverage ratio of five percent or greater and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) \"adequately capitalized\" if it has a total capital ratio of eight percent or greater, a tier 1 capital ratio of four percent or greater and a leverage ratio of four percent or greater (three percent in certain circumstances) and is not \"well capitalized\"; (iii) \"undercapitalized\" if it has a total capital ratio of less than eight percent, a tier 1 capital ratio of less than four percent or a leverage ratio of less than four percent (three percent in certain circumstances); (iv) \"significantly undercapitalized\" if it has a total capital ratio of less than six percent, a tier 1 capital ratio of less than three percent or a leverage ratio of less than three percent; and (v) \"critically undercapitalized\" if its tangible equity is equal to or less than two percent of average quarterly tangible\nassets. As of December 31, 1994, all of the Corporation's subsidiary banks had capital levels that qualify them as being \"well capitalized\" under such regulations. FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be \"undercapitalized\". \"Undercapitalized\" depository institutions are subject to growth limitations and are required to submit a capital restoration 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. In addition, for a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to five percent of the depository institution's total assets at the time it became \"undercapitalized\", and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. 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\" institutions are subject to the appointment of a receiver or conservator. FDICIA directs that each federal banking agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares and such other standards as the agency deems appropriate. The ultimate effect of these standards cannot be ascertained until final regulations are adopted. FDICIA also contains a variety of other provisions that may affect the operations of the Corporation, including reporting requirements, regulatory standards for real estate lending, \"truth in savings\" provisions, the requirement that a depository institution give 90 days' prior notice to customers and regulatory authorities before closing any branch, and a prohibition on the acceptance or renewal of brokered deposits by depository institutions that are not \"well capitalized\" or are \"adequately capitalized\" and have not received a waiver from the FDIC. Under regulations relating to the brokered deposit prohibition, all of the Corporation's subsidiary banks are \"well capitalized\" and not subject to the prohibition. DEPOSITOR PREFERENCE STATUTE Legislation has been enacted providing that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the \"liquidation or other resolution\" of such an institution by any receiver. INTERSTATE BANKING AND BRANCHING LEGISLATION The Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"IBBEA\"), authorizes interstate acquisitions of banks and bank holding companies without geographic limitation beginning one year after enactment. In addition, beginning June 1, 1997, the IBBEA authorizes a bank to merge with a bank in another state as long as neither of the states has opted out of interstate branching between the date of enactment of the IBBEA and May 31, 1997. The IBBEA further provides that states may enact laws permitting interstate bank merger transactions prior to June 1, 1997. A bank may establish and operate a DE NOVO branch in a state in which the bank does not maintain a branch if that state expressly permits DE NOVO branching. Once a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where any bank involved in the interstate merger transaction could have established or acquired branches under applicable federal or state law. A bank that has established a branch in a state through DE NOVO branching may establish and acquire additional branches in such state in the same manner and to the same extent as a bank having a branch in such state as a result of an interstate merger. If a state opts out of interstate branching within the specified time period, no bank in any other state may establish a branch in the opting out state, whether through an acquisition or DE NOVO.\nADDITIONAL INFORMATION Additional information related to certain regulatory and accounting matters is set forth on pages 21 and 22 in the Annual Report and incorporated herein by reference. ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. As of December 31, 1994, the Corporation and its subsidiaries owned or leased 1,562 locations in 42 states and two foreign countries from which their business is conducted, including a multi-story office complex in Charlotte, North Carolina, which serves as the administrative headquarters of the Corporation, FUNB-NC, FUHEB and most of the Corporation's nonbanking subsidiaries. Listed below are the number of banking and nonbanking locations of the Corporation that are leased or owned, as of December 31, 1994:\nThe principal offices of each of the Corporation's subsidiary banks in Jacksonville, Florida; Atlanta, Georgia; Greenville, South Carolina; Nashville, Tennessee; Roanoke, Virginia; Rockville, Maryland; and Washington, D.C., are all leased. Additional information relating to the Corporation's lease commitments is set forth in Note 17 on page 87 in the Annual Report and incorporated herein by reference. ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. The Corporation and certain of its subsidiaries have been named as defendants in various legal actions arising from their normal business activities in which varying amounts are claimed. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, based upon the opinions of counsel, any such liability will not have a material effect on the consolidated financial position of the Corporation and its subsidiaries. ITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Common Stock is listed on the New York Stock Exchange. Table 6 on page 29 in the Annual Report sets forth information relating to the quarterly prices of, and quarterly dividends paid on, the Common Stock for the two-year period ended December 31, 1994, and is incorporated herein by reference. Prices shown represent the high, low and quarter-end sale prices of the Common Stock as reported on the New York Stock Exchange, Inc. Composite Transactions Tape for the periods indicated. As of December 31, 1994, there were 54,236 holders of record of the Common Stock. In December 1990, the Board of Directors of the Corporation adopted a Shareholder Protection Rights Plan (the \"Plan\") designed to enhance the ability of the Board to protect stockholders against attempts to acquire control of the Corporation by means of unfair or abusive tactics. The Plan provides, among other things, that the rights granted under the Plan to the holders of shares of Common Stock (one right for each share of Common Stock) will become exercisable (after a specified period) if any person or group announces a tender or exchange offer for, or acquires, 15 percent or more of the Common Stock. At that time each right will enable the holders of the rights (other than such person or group, whose rights become void) to purchase additional shares of Common Stock (or at the option of the Board of Directors, shares of junior participating Class A Preferred Stock) having a market value of twice the $110 exercise price of the right, subject to adjustment in certain events. If any person or group acquires beneficial ownership of between 15 percent and 50 percent of the Common Stock, the Corporation's Board of Directors may, at its option, exchange for each outstanding and not voided right either two shares of Common Stock or junior participating Class A Preferred Stock having economic and voting terms similar to two shares of Common Stock, subject to adjustment in certain events. The rights are redeemable by the Corporation at $0.01 per right (subject to adjustment in certain events) prior to becoming exercisable and, in certain events, may be cancelled and terminated without any payment to holders. The rights have no voting rights and are not entitled to dividends. The rights will expire on December 28, 2000, unless sooner redeemed or terminated. Each share of Common Stock has attached to it one right, and the rights will not trade separately from the Common Stock unless they become exercisable. Subject to the prior rights of the holders of the Series 1990 Cumulative Perpetual Adjustable Rate Preferred Stock (\"Series 1990 Preferred Stock\"), holders of the Common Stock are entitled to receive such dividends as may be legally declared by the Board of Directors and, in the event of dissolution and liquidation, to receive the net assets of the Corporation remaining after payment of all liabilities, in proportion to their respective holdings. All of the 6.3 million outstanding shares of Series 1990 Preferred Stock have been called for redemption on March 31, 1995, at the redemption price of $51.50 per share. Additional information concerning certain limitations on the payment of dividends by the Corporation and its subsidiaries is set forth above under \"Business -- Supervision and Regulation; Payment of Dividends\" and in Note 16 on page 81 in the Annual Report and incorporated herein by reference. Additional information relating to the Series 1990 Preferred Stock and Common Stock is set forth in Note 12 on page 75 in the Annual Report and incorporated herein by reference. ITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. In response to this Item the information set forth in Table 2 on page 26 in the Annual Report is incorporated herein by reference. ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. In response to this Item the information set forth on pages 12 through 53 in the Annual Report is incorporated herein by reference. ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. In response to this Item the information set forth on page 29 and on pages 54 through 89 in the Annual Report is incorporated herein by reference. ITEM 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 executive officers of the Corporation are elected to their offices for one year terms at the meeting of the Board of Directors in April of each year. The terms of any executive officers elected after such date expire at the same time as the terms of the executive officers elected on such date. The names of each of the current executive officers of the Corporation, their ages, their current positions with the Corporation and certain subsidiaries and, if different, their business experience during the past five years, are as follows: Edward E. Crutchfield (53). Chairman and Chief Executive Officer, the Corporation. Also, President, the Corporation, October 1988 to June 1990. John R. Georgius (50). President, the Corporation, since June 1990. Chairman and Chief Executive Officer, FUNB-NC, from October 1988 to February 1993. Vice Chairman, the Corporation, August 1987 to June 1990. B. J. Walker (64). Vice Chairman, the Corporation. Also, Chairman and Chief Executive Officer, FUNB-FL, prior to March 1991. Robert T. Atwood (54). Executive Vice President and Chief Financial Officer, the Corporation, since March 1991. Prior to that time, Mr. Atwood was a partner with the accounting firm of Deloitte & Touche. Marion A. Cowell, Jr. (60). Executive Vice President, Secretary, and General Counsel, the Corporation. Mr. Cowell served as Senior Vice President, Secretary and General Counsel of the Corporation prior to December 1991. In addition to the foregoing, the information set forth in the Proxy Statement under the heading \"General Information and Nominees\", and in the last paragraph under the heading \"Other Matters Relating to Executive Officers and Directors\" is incorporated herein by reference. ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. In response to this Item the information set forth in the Proxy Statement under the heading \"Executive Compensation\", excluding the information under the subheadings \"HR Committee Report on Executive Compensation\" and \"Performance Graph\", is incorporated herein by reference. ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. In response to this Item the information set forth in the Proxy Statement relating to the ownership of Common Stock and Series 1990 Preferred Stock by the directors and executive officers of the Corporation under the heading \"General Information and Nominees\" is incorporated herein by reference. ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. In response to this Item the information set forth in the Proxy Statement in the first paragraph under the heading \"Other Matters Relating to Executive Officers and Directors\" is incorporated herein by reference. PART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) The consolidated financial statements of the Corporation, including the notes thereto and independent auditors' report thereon, are set forth on pages 54 through 89 of the Annual Report. All financial statement schedules are omitted since the required information is either not applicable, is immaterial or is included in the consolidated financial statements of the Corporation and notes thereto. A list of the exhibits to this Form 10-K is set forth on the Exhibit Index immediately preceding such exhibits and is incorporated herein by reference. (b) During the quarter ended December 31, 1994, a Current Report on Form 8-K, dated December 20, 1994, was filed by the Corporation with the Securities and Exchange 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. FIRST UNION CORPORATION Date: March 3, 1995 By: MARION A. COWELL, JR. MARION A. COWELL, JR. EXECUTIVE VICE PRESIDENT, SECRETARY AND GENERAL COUNSEL 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 and on the date indicated.\nDate: March 3, 1995\nEXHIBIT INDEX\n* The Corporation agrees to furnish to the Securities and Exchange Commission upon request, copies of the instruments, including indentures, defining the rights of the holders of the long-term debt of the Corporation and its subsidiaries.\n** Except for those portions of the Annual Report which are expressly incorporated by reference in this Form 10-K, the Annual Report is furnished for the information of the Securities and Exchange Commission only and is not to be deemed \"filed\" as part of such Form 10-K. *** Filing by Electronic Data Gathering, Analysis and Retrieval System only.","section_15":""}
{"filename":"355787_1994.txt","cik":"355787","year":"1994","section_1":"Item 1. Business.\nGENERAL\nThe Company is a nationwide communications company whose current primary business is owning and operating television stations through wholly-owned indirect subsidiaries. The Company's television properties currently consist of one ABC affiliated television station, WHTM-TV (which was acquired by the Company during September 1994), serving Harrisburg\/Lancaster\/ Lebanon\/York, Pennsylvania; and three NBC affiliated television stations, KSNF-TV, serving Joplin, Missouri\/Pittsburg, Kansas; KJAC-TV, serving Beaumont\/Port Arthur, Texas; and KFDX-TV, serving Wichita Falls, Texas\/Lawton, Oklahoma. During 1994, the Company sold its three AM and three FM radio stations serving the Fort Wayne, Indiana; Buffalo, New York; and West Palm Beach, Florida markets. The Company intends to continue to investigate potential media acquisitions involving television and radio properties and, possibly, outdoor advertising and newspapers.\nThe Company's business strategy is to acquire communications properties at prices it considers attractive, finance such properties on terms satisfactory to it, manage such properties in accordance with its operating strategy and dispose of them if and when the Company determines such disposition to be in its best interest. See \"Recent Developments\" regarding sales and acquisitions of properties since the beginning of 1994. For the foregoing reasons, the results of the Company's historical operations are not comparable to or indicative of results in the future. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe Company was organized in New York in 1979 and began active operations in 1981. Its principal executive offices are located at 45 Rockefeller Plaza, New York, New York 10020, and its telephone number is (212) 757-5600. References to the \"Company\" or \"Price\" in this report include Price Communications Corporation and its subsidiaries, unless the context otherwise indicates.\nRECENT DEVELOPMENTS\nIn February, 1994, the Company entered into an agreement to purchase WHTM-TV, Channel 27, serving Harrisburg\/Lancaster\/ Lebanon\/York, Pennsylvania, the nation's 44th largest television market, at a purchase price based (subject to adjustment) on a 7.25 multiple of the station's cash flow during a 12-month period preceding the closing. The purchase was consummated on September 16, 1994, at which time the Company paid cash consideration of approximately $47 million plus a $4 million working capital adjustment. The funds utilized to make such acquisition were\nI-1 principally supplied under an amended and restated line of credit agreement (the \"Amended Line of Credit\") with Bank of Montreal.\nThe Amended Line of Credit provided a seven year revolving credit facility of up to $45 million, which amount is permanently reduced periodically over its term. On October 17, 1994, the net proceeds from the sale of the Company's radio stations in West Palm Beach, Florida, were used to repay $22.5 million of borrowings under the Amended Line of Credit, at which time the facility was reduced to $22.5 million. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nDuring 1994, the Company consummated the sale of all of its radio properties as described below (see Note 3 of Notes to Consolidated Financial Statements), realizing gains on such dispositions and utilizing the proceeds of such sales principally to reduce indebtedness. The Company continues to investigate acquisitions of media properties and may reenter radio broadcasting.\nOn April 14, 1994, the Company sold substantially all of the assets of radio stations WWKB-AM and WKSE-FM in Buffalo, New York, for $5 million in cash. A pre-tax gain of approximately $3.2 million was recognized on the sale.\nOn October 17, 1994, the Company sold substantially all of the assets of radio stations WBZT-AM and WIRK-FM, West Palm Beach, Florida, for approximately $23 million in cash. The Company realized a pre-tax gain of approximately $13.5 million on this transaction.\nOn November 11, 1994, the Company sold substantially all of the assets of radio stations WOWO-AM, Fort Wayne, Indiana and WOWO-FM, Huntington, Indiana for approximately $2.3 million in cash. The Company recognized a pre-tax gain of approximately $.8 million on this transaction.\nIn addition to the radio dispositions, the Company sold certain other properties during 1994 (see Note 3 of Notes to Consolidated Financial Statements), as follows:\nDuring February 1994, the Company sold its outdoor advertising business for a total sales price of $875,000, including $200,000 cash and a note from the buyer for $675,000. A pre-tax loss of approximately $350,000 was recognized in connection with the sale.\nOn May 20, 1994, the Company sold to TLM Corporation, a former majority owned subsidiary of the Company, all of the capital stock of Eimar Realty Corporation, the sole asset of which is a Nashville, Tennessee office building, for a total purchase price of $815,000 including $275,000 in cash and a note from the buyer for\nI-2 $540,000. The Company had attempted unsuccessfully to find an unrelated buyer for the Eimar property during the approximately two years preceding such sale. A de minimis gain was recognized on the sale.\nOn October 28, 1994 the Company sold its building in Red Bank, New Jersey for $1.7 million in cash. The Company realized a small gain on the sale.\nPrior to 1994, the Company had written off its investment in Fairmont Communications Corporation (\"Fairmont\"), which had filed for relief under Chapter 11 of the U.S. Bankruptcy Code, with the result that the Company's carrying value in such investment was zero. In January 1994, the Company entered into a settlement agreement with the various parties to the Fairmont bankruptcy proceedings whereby the Company agreed to desist in its challenge to the Fairmont plan of reorganization, Fairmont reimbursed the Company for $300,000 of legal fees previously incurred by the Company in connection with such bankruptcy proceeding, and, as an incentive to the manager of the Fairmont properties to maximize recovery, the Company agreed that any excess over a recovery of $5 million by the Company from the sale of Fairmont's properties would be split with such manager. Although the exact amount of any such recovery is uncertain at this time, the Company believes it will receive a cash payment of approximately $7 million in respect of such sale shortly, and anticipates that it may receive a smaller additional payment in the future upon the resolution by Fairmont of various state tax issues. See \"Interests in Fairmont\" below.\nDue to the developments described above, the Company's historical results of operations should not be regarded as indicative of its future results.\nSEGMENT DATA\nSee Note 13 of Notes to Consolidated Financial Statements for segment data concerning the Company's television, radio and other operations. The Company's television and radio segments contributed 70 percent and 30 percent, respectively, of the Company's net revenue for the year ended December 31, 1994. The Company sold 75 percent of its interest in The New York Law Publishing Company at the end of 1992, and during 1993 accounted for its remaining 25 percent interest (which was disposed of during 1993) as an investment under the equity method of accounting. For the year ended December 31, 1993, the Company's television, radio, and other segments contributed 52 percent, 45 percent and 3 percent, respectively. For the year ended December 31, 1992, the Company's television, radio, and publishing and other segments contributed 21 percent, 17 percent and 62 percent, respectively.\nI-3 ACQUISITIONS AND DIVESTITURES\nThrough its history, the Company has actively acquired and divested broadcasting and other properties. In pursuing its acquisition and divestiture strategy, the Company has no fixed formula for determining the purchase price of properties it seeks. With respect to media properties, to date, the Company generally concentrates its acquisition activities on properties that have a history of generating Media Cash Flow (operating profits before deductions for interest, depreciation, amortization and income taxes) or properties that have potential for growth. In seeking acquisitions of media properties, the Company generally gives greater weight to a property's Media Cash Flow than to its net income, because such Media Cash Flow is a standard widely used in the industry to evaluate media properties. The Company's strategy is to seek properties that can be purchased at attractive multiples of \"trailing\" Media Cash Flow, the Media Cash Flow for the twelve months immediately prior to such acquisition, either in anticipation that such Media Cash Flow will continue at historical levels, or in anticipation that the Company will be able to improve it. However, the Company may consider acquiring properties without such cash flow if it believes them to have sufficient potential for growth or to otherwise be consistent with the Company's objectives.\nPrices of media properties are affected by a number of factors in addition to a property's Media Cash Flow, including the characteristics and anticipated growth of the market area, the terms of purchase, programming, the competitive situation within the market area, the possibility of improving Media Cash Flow, the dial position and signal strength (in the case of radio stations), operating history, network affiliation and assigned signal frequency (in the case of television stations), and the value of the fixed assets acquired in connection with the purchase.\nTo finance its acquisitions and to provide funds for other purposes, the Company may consider using a variety of sources, including borrowings from banks and other institutional lenders, the proceeds of debt sold to the public, seller financing, convertible preferred stock and common stock issued by the Company or its subsidiaries, and cash on hand. Historically, the Company often acquired properties through newly organized subsidiaries, based on the credit of the properties being acquired or by borrowing or issuing securities at the parent company level.\nFrom time to time brokers and potential buyers approach the Company with respect to the potential sale of certain of its media properties. The Company has generally not listed its properties with brokers, but management follows the practice of permitting potential responsible buyers to visit its media properties and of presenting bona fide offers from financially responsible parties to the Company's Board of Directors for consideration. Proceeds of asset sales will be used to retire outstanding debt, to repurchase equity, to finance the Company's\nI-4 investments in new properties or for other corporate purposes as determined by the Board of Directors.\nINTERESTS IN FAIRMONT\nIn connection with the sale in 1987 of seven radio stations to Fairmont for an aggregate sale price of $120 million, the Company loaned $50 million to Fairmont (the \"Fairmont Notes\") and acquired a 27% equity interest in Fairmont. On August 28, 1992, Fairmont filed for voluntary relief under Chapter 11 of the U.S. Bankruptcy Code. The Fairmont Notes owned by the Company and the Company's equity investment in Fairmont had no book value as of December 31, 1994.\nBy order dated September 10, 1993, the United States Bankruptcy Court for the Southern District of New York confirmed the Chapter 11 plan of reorganization (the \"Fairmont Plan\") for Fairmont and the Fairmont Subsidiaries. Essentially, the Fairmont Plan provided for the orderly liquidation of the assets of Fairmont and the Fairmont Subsidiaries, and the distribution of the proceeds derived therefrom according to the relative priorities of the parties asserting interests therein. In January 1994, the Company entered into a settlement agreement with the various parties to the Fairmont bankruptcy proceedings whereby the Company agreed to desist in its challenge to the Fairmont Plan, Fairmont reimbursed the Company for $300,000 of legal fees previously incurred by the Company in connection with such bankruptcy proceeding, and, as an incentive to the manager of the Fairmont properties to maximize recovery, the Company agreed that any excess over a recovery of $5 million by the Company from the sale of Fairmont's properties would be split with such manager. Although the exact amount of any such recovery is uncertain at this time, the Company believes it will receive a cash payment of approximately $7 million in respect of such sale shortly, and anticipates that it may receive a smaller additional payment in the future upon resolution by Fairmont of various state tax issues.\nOPERATING STRATEGY\nAt the outset, the Company develops specific plans for each property acquired in an effort to improve its efficiency. The Company attempts to increase the Media Cash Flow of its broadcasting properties and to make each property a significant one relative to its competitors. The Company's goal is to realize annual increases in the net revenue of its properties that exceed increases in operating expenses.\nThe Company has sought both to elevate its television and radio stations' positions in their markets and to increase advertising rates, although the position of stations in their markets tends to fluctuate. Station revenue growth benefits from the advertising revenue growth of the markets themselves, which the\nI-5 Company believes can generally be measured by the growth in retail sales in the areas involved.\nLocal demographic considerations and promotion play less of a role in television station programming than in the case of radio stations, because a significant portion of station programming is provided by the television networks to the Company's network affiliated television stations. The Company strives to improve or maintain the ratings of its television stations by fine tuning non-network programming and news coverage, improving promotional activities and upgrading physical and technical facilities where necessary.\nWithin each radio market, the Company historically targeted key demographic groups (determined by age and\/or sex), based on advertiser demand and the nature of competition in the market. Research was periodically conducted by outside consultants to help refine and improve the programming of each station, and the Company attempted to direct its sales efforts, both local and national, to obtain the largest possible share of advertising budgets. Although broadcast ratings normally reflect all listeners in a market and the Company's stations may have performed well in the overall ratings, the Company's emphasis was on superior performance in the targeted demographic group, which it believed could result in substantial improvement in revenues and Media Cash Flow by attracting advertisers interested in reaching the target groups. The Company also sought to generate radio revenues through promotional events and print-media tie-ins, techniques that may be particularly important as a station grows more successful and its ability to increase the number of commercials sold becomes more limited.\nTHE TELEVISION BROADCASTING INDUSTRY\nTelevision station revenues are primarily derived from local, regional and national advertising and from compensation paid by television networks for the local broadcast of network programming, with a small percentage of revenue sometimes obtained from studio rental and programming-related activities. The primary costs involved in owning and operating television stations are salaries, programming, promotion, depreciation and amortization, and selling expenses.\nThe majority of national and local advertising contracts are short-term, generally running for only a few weeks, while advertising contracts sold by networks are typically for longer periods. National spot and local advertising revenues are more susceptible to fluctuations in the economy than network compensation. Advertising rates charged by a television station vary, depending upon the population and number of television sets in the area served by the station, a program's popularity among the viewers an advertiser wishes to attract, the number of advertisers vying for available time, the prices being charged by competitors\nI-6 and the availability of alternative media in the market area. The number of television sets in an area and a program's popularity are reflected in surveys made by a rating service of the number of sets tuned to the station at various times. Advertising rates are highest during the most desirable viewing hours. Local and most regional sales of advertising time are made by a station's sales staff. National sales are made by a national \"rep firm\", specializing in television advertising sales on the national level, which is compensated on a commission-only basis.\nFor most network programming that is broadcast by a network affiliate, the network pays the affiliate compensation, which varies in amount depending upon the time of day during which the program is broadcast. \"Prime-time\" programming (7 to 11 P.M. E.S.T. Sundays and 8 to 11 P.M. E.S.T. other days) generally earns the highest rates. Recent trends indicate a general increase in network compensation levels, and the Company has been attempting to negotiate increased compensation levels under its network affiliation agreements. In addition, a network often allocates portions of advertising time during network broadcasts for direct sale by the local station to advertisers and these time slots have generally been increasing.\nWhile revenues are spread over the calendar year, the first quarter generally reflects the lowest and the fourth quarter the highest revenue for the year. The increase in retail advertising each fall in preparation for the holiday season, combined with political advertising in election years and new fall television programming, tend to increase fourth quarter revenues.\nA significant portion of the programs broadcast by the Company's television stations is provided by their networks. Programming costs are generally lower for network affiliates than the independent television stations, and network programs generally achieve higher ratings than non-network programs. The Company's television stations also acquire programs from non- network sources. Programs obtained from non-network sources usually consists of syndicated television shows, some of which have been shown previously on a network, and feature films.\nThe competitive position of a network affiliated television station is significantly affected by viewer acceptance of the network's programs. Network affiliation agreements have historically generally been for a term of one or two years (although the recent trend has been toward longer terms), and are generally renewed automatically. A network affiliate may reject particular network programs, which might then be offered to other stations in the area.\nCompetitive factors, in addition to management experience, include a station's authorized transmitter power and antenna location, assigned frequency, network affiliation, carriage of the station's signal on local cable television systems, viewer\nI-7 acceptance of network and local programming and the strength of local competition. Generally a television broadcasting station in one market does not compete with stations in another market.\nDuring the past several years, there has been a steady growth of cable communications and a significant liberalization of FCC rules which allow cable systems, satellite master antenna systems, and MMDS services located in areas served by the stations to provide additional program choices. Additionally, direct broadcast satellite service is increasingly being made available on a nationwide basis. Moreover, the FCC has begun to issue authorizations for telephone companies to offer \"video dialtone\" service that will be similar in nature to that provided by cable communications systems. By federal statute, local telephone companies have been precluded from providing cable television service within their local service areas. However, several U.S. Courts of Appeals have ruled that the federal statutory ban is unconstitutional. To date, the existence of additional program services has not had a demonstrably adverse effect upon the Company's television stations.\nThe FCC has adopted \"must carry\" and \"retransmission consent\" rules at the direction of Congress pursuant to the 1992 Cable Television Consumer Protection and Competition Act. Under this new regulatory regime, virtually all cable systems that carried the Company's television stations have continued to do so. Some systems have agreed to provide compensation to the Company's television stations in return for carriage on the cable system under the new regulations, although such compensation is not substantial. A number of cable television entities have appealed the must carry and retransmission consent rules. A three- judge panel of the U.S. District Court for the District of Columbia upheld the rules, but the U.S. Supreme Court decided to review the ruling and heard oral argument in January 1994. A decision by the Court is expected during 1995. In any event, the Company believes that cable subscriber demand for programming carried by the Company's television stations makes it unlikely that the stations will cease to be carried by cable systems served by those stations, even in the absence of must carry rules.\nSeveral 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. The FCC has recently determined that local television stations such as the Company's will be entitled to frequencies necessary to broadcast high definition television so long as those frequencies are used within a specified time period. These developing technologies have had no immediate impact on the television broadcast industry, and their potential impact on the Company's business cannot be predicted.\nI-8 THE RADIO BROADCASTING INDUSTRY\nAs indicated above, the Company sold during 1994 all of its radio properties, although it continues to investigate possible radio acquisitions and may reenter radio broadcasting. Virtually all of the revenue of a radio station is derived from local and national advertising, and to a minor extent from network compensation. Local sales are made by a station's sales staff. National sales are made by a national \"rep firm\", specializing in radio advertising sales on the national level, which is compensated on a commission-only basis. Advertising rates charged by a radio station are based primarily on the station's ability to attract audiences in the market area. A station's listenership is reflected in rating service surveys of the number of radios tuned to the station at various times. The primary costs incurred in owning and operating radio stations are salaries, programming, depreciation and amortization, promotion and advertising, rental of premises for studios and transmitting equipment, music license royalty fees and selling expenses.\nRadio broadcasting stations compete with the other broadcasting stations in their respective market areas, as well as with other advertising media such as newspapers, broadcast and cable television, magazines, outdoor advertising, transit advertising and direct mail marketing. Competition within the radio broadcasting industry occurs primarily in individual market areas, so that a station in one market does not generally compete with stations in other market areas. In addition to management experience, factors that are material to competitive position include the station's rank in its market, authorized power, assigned frequency, audience characteristics, local program acceptance and the number and characteristics of other stations in the market area.\nFEDERAL REGULATION OF BROADCASTING\nTelevision and radio broadcasting (as well as some other potential communications investments of the Company) are subject to the jurisdiction of the FCC under the Communications Act of 1934, as amended (\"Communications Act\"). The Communications Act, among other things, prohibits the assignment of a broadcast license or the transfer of control of a corporation holding a license without the prior approval of the FCC. Legislation has been introduced from time to time which would amend the Communications Act in various respects and the FCC from time to time considers new regulations or amendments to its existing regulations. During the 103rd Congress, legislation involving major revisions to the Communications Act passed the House of Representatives but was not acted on by the Senate. It is expected that one or more bills proposing a comprehensive revision of the Communications Act will be given substantial attention in the 104th Congress. The Company cannot predict the effect of any such new legislation or amendments on the Company.\nI-9\nTelevision licenses are issued and renewable for terms of five years. The Company's licenses have the following expiration dates, until renewed:\nKSNF-TV . . . . . . . . . . . . . . February 1, 1998 KJAC-TV . . . . . . . . . . . . . . * KFDX-TV . . . . . . . . . . . . . . August 1, 1998 WHTM-TV . . . . . . . . . . . . . . August 1, 1999\n* The license term for KJAC-TV was to have expired on August 1, 1993. KJAC-TV filed a timely application for renewal, thereby extending the license term until action is taken on the renewal application. That application remains pending due to a viewer complaint about the Phil Donahue program. The Company expects the station's license to be renewed during 1995 for a term ending August 1, 1998.\nIn the vast majority of cases, broadcast licenses are renewed by the FCC. Current FCC regulations permit cognizable ownership by one entity of up to 12 television stations, 20 FM radio stations and 20 AM radio stations. With respect to television stations, however, 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 television stations only if the aggregate number of television households reached by the television stations does not exceed 25% of the national television household audience as determined by the Arbitron ADI market rankings. The percentage of the national television household audience reached by the Company's television stations is significantly under these limitations. On December 15, 1994, the FCC commenced a rulemaking proceeding to review its television ownership rules. The FCC has proposed to relax its national ownership limitations with regard to the number of stations an entity may own and to permit a higher national audience reach. Any new rules are not likely to take effect until late 1995 or early 1996. The Company is unable to predict at this time the impact of this initiative on its television broadcast operations.\nThe FCC's rules generally prohibit the common ownership of a television station and an AM radio station, an FM radio station or general circulation daily newspaper in the same market, although ownership of up to two AM and two FM stations is generally permitted. Ownership of a CATV system and television station in the same market is also prohibited. These rules apply to entities such as the Company, that seek new authorizations or approval of a transfer of an existing combination. The FCC has relaxed its ownership restrictions such that common ownership of television and radio stations may be permissible in the 25 largest markets. In\nI-10 its review of the television ownership rules, the FCC has proposed to relax or eliminate the current restriction outside the 25 largest markets on common ownership of a television station and radio stations in the same market and has also proposed to permit common ownership of two television stations in some large markets. Any new rules are not likely to take effect until late 1995 or early 1996. The Company is unable to predict at this time the impact of these initiatives on its television broadcast operations.\nThe FCC requires the attribution to a broadcast company not only of licenses held by the Company, but also of licenses attributable to its officers and directors and certain of its stockholders and their affiliates, such that there would be a violation of FCC regulations where such an officer, director, stockholder or stockholder's affiliate together held attributable interest in more than the permitted number of stations on a nationwide or local market basis. The Company's By-Laws state that the Board of Directors shall prohibit any voting or transfer of its capital stock, including its Common Stock, which would cause the Company to violate the Communications Act or FCC regulations.\nThe foregoing is only a brief summary of certain provisions of the Communications Act and the regulations of the FCC. Reference is made to the Communications Act, FCC regulations and the public notices promulgated by the FCC for further information. The Company is unable to predict what impact, if any, changes in these laws would have on its operations.\nEMPLOYEES\nAs of December 31, 1994, the Company employed approximately 222 full time persons at its television stations. The stations have not experienced any significant labor problems under the Company's ownership and the Company considers its labor relations on the whole to be good.\nThe Company relies on experienced managers for its broadcasting operations, who are given considerable authority at the local level. Where appropriate, the Company has also hired new management in an effort to improve the operations of a particular property.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company and its subsidiaries own their studio and production facilities and own or lease space for other offices, antenna sites and certain equipment for each of its stations. The Company believes that its other facilities are suitable and adequate for carrying on its broadcasting and other operations and that no major capital improvements will be necessary over the next year. (See Note 16 of the Notes to Consolidated Financial Statements for information on minimum lease payments of the Company and its subsidiaries for the next five years.)\nI-11\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth the executive officers of the Company, their respective ages, the year in which each was first elected an executive officer and the office of the Company held by each. Each executive officer will hold office until removed or until their respective successors have been duly elected and qualified.\nRobert Price (Director, President, Chief Executive Officer and Treasurer of the Company), an attorney, is a former General Partner of Lazard Freres & Co. He has served as an Assistant United States Attorney, practiced law in New York and served as Deputy Mayor of New York City. After leaving public office, Mr. Price became Executive Vice President of The Dreyfus Corporation and an Investment Officer of The Dreyfus Fund. In 1972 he joined Lazard Freres & Co. Mr. Price has served as a Director of Holly Sugar Corporation, Atlantic States Industries, The Dreyfus Corporation, Graphic Scanning Corp. and Lane Bryant, Inc., and is currently a member of The Council on Foreign Relations. Mr. Price is also a Director and President of TLM Corporation, and a Director and President of PriCellular Corporation.\nKim I. Pressman, a certified public accountant, is a graduate of Indiana University and holds an M.B.A. from New York University. Before assuming her present office as Executive Vice President and Secretary in October 1994, Ms. Pressman was Vice President and\nI-12 Treasurer of the Company from November 1987 to December 1989, and Senior Vice President of the Company from January 1990 to September 1994. She was also Secretary of the Company from July 1989 to February 1990. Ms. Pressman was Vice President- Broadcasting and Vice President, Controller, and Assistant Treasurer of the Company from 1984 to October 1987. Prior to joining the Company in 1984, Ms. Pressman was employed by Peat, Marwick, Mitchell & Co., a national certified public accounting firm, was Supervisor, Accounting Policies for International Paper Company and then Manager, Accounting Operations for Corinthian Broadcasting Division of Dun & Bradstreet Company, a large group owner of broadcasting stations. Ms. Pressman is a Director, Vice President, Treasurer and Secretary of TLM Corporation, and a Director, Vice President and Secretary of PriCellular Corporation.\nBill Bengtson has held a variety of positions in the broadcasting industry for 34 years and assumed his current position in July 1989. Mr. Bengtson is also Vice President and General Manager of KSNF-TV, the Company's NBC affiliate in Joplin, Missouri\/Pittsburg, Kansas, a position he has held since April 1987. From January 1985 to March 1987, he was Vice President and General Manager of KRCG-TV, a CBS affiliate in Jefferson City\/Columbia, Missouri formerly owned by the Company. Prior to joining the Company in 1985, Mr. Bengtson was Vice President and General Manager of KOAM-TV in Pittsburg, Kansas for 12 years. Mr. Bengtson has served on the National Association of Broadcasters' Television Board of Directors, and as President of the Pittsburg, Kansas Chamber of Commerce, President of the Pittsburg, Kansas Industrial Development Corporation and Mayor of Pittsburg, Kansas.\nJames Lyndon Kreps, a certified public accountant and graduate of Bucknell University, assumed his current position in July 1994. Prior to joining the Company in 1994, Mr. Kreps was Vice President of Promotional Concept Group, Inc. From June 1989 to September 1992 Mr. Kreps served in various positions at Paramount Pictures Corporation including Director of Financial Reporting and Analysis for the Television Group. From April 1988 to June 1989, Mr. Kreps was a Supervisor of Internal Audit for Gulf & Western (Paramount Communications Corporation). Mr. Kreps also spent four years with Coopers & Lybrand.\nI-13 PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\na) Market for Common Stock\nThe Company's Common Stock is listed for trading on the American Stock Exchange (\"AMEX\") under the ticker symbol \"PR\". The range of high and low last sale prices for the Company's Common Stock on the AMEX for each of the four quarters of 1994 and 1993, as reported by the AMEX was:\nThe high and low last sale prices for the Company's Common Stock on the AMEX for January 23, 1995, as reported by the AMEX were 6 1\/2 and 6 3\/8, respectively. The Company's Common Stock has been afforded unlisted trading privileges on the Pacific Stock Exchange under the ticker symbol \"PR.P\", on the Chicago Stock Exchange under the ticker symbol \"PR.M\" and on the Boston Stock Exchange under the ticker symbol \"PR.B\".\nb) Holders\nOn January 23, 1995, there were 705 holders of record of the Company's Common Stock. The Company estimates that brokerage firms hold Common Stock in street name for approximately 3,000 persons.\nc) Dividends\nThe Company, to date, has paid no cash dividends on its Common Stock. The Board of Directors will determine future dividend policy based on the Company's earnings, financial condition, capital requirements and other circumstances. It is not anticipated that dividends will be paid on its Common Stock in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table sets forth certain selected consolidated financial data with respect to the Company for each of the five\nII-1 years in the period ended December 31, 1994, derived from audited consolidated financial statements of the Company and Notes thereto. On December 30, 1992, the Company's consensual Plan of Reorganization, which had been approved by the United States Bankruptcy Court in the Southern District of New York in July of that year, became effective. A vertical black line has been placed to separate pre-reorganization consolidated operating statement and balance sheet items from the post-reorganization consolidated operating statement and balance sheet items since they are not prepared on a comparable basis (see Note 1 of Notes to Consolidated Financial Statements).\nII-2 CONSOLIDATED OPERATING STATEMENT ITEMS (in thousands, except for per share amounts)\n(1) Reflects results of operations of WHTM-TV since its acquisition during September 1994 and the results of the properties disposed of through their respective dates of sale. See Notes to 2 and 3 to Consolidated Financial Statements. (2) Due to the acquisition and dispositions discussed under \"Business-Recent Developments,\" the borrowings incurred to effect such acquisition, the retirement of the Company's Secured Notes, the consummation of the Plan of Reorganization and the adoption of Fresh Start Reporting, the Company's historical results should not be regarded as indicative of its future results. (3) See Note 1 of Notes to Consolidated Financial Statements. (4) Per share amounts for the Predecessor Company are neither comparable nor meaningful due to the forgiveness of debt, partial sale of subsidiary, issuance of new common stock and adoption of Fresh Start Reporting.\nII-3 CONSOLIDATED BALANCE SHEET ITEMS (in thousands, including notes)\n- ----------------------------------- (1) Net of unamortized original issue discount of $5,124 and $6,203 as of December 31, 1991 and 1990, respectively. (2) Net of unamortized original issue discount of $8,705 as of December 31, 1992, respectively.\nII-4 ITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Result of Operations.\nThe Company reorganized and emerged from bankruptcy proceedings on December 30, 1992 and adopted Fresh Start Reporting in accordance with the guidelines established by the American Institute of Certified Public Accountants in Statement of Position 90-7 \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\". Under Fresh Start Reporting, assets and liabilities were recorded at their estimated fair market value and the historical deficit was eliminated. Accordingly, the Company's financial statements have been prepared as if it is a new reporting entity and a vertical black line has been placed to separate the pre- reorganization consolidated statements of operations and cash flows from the post-reorganization consolidated statements of operations and cash flows since they are not prepared on a comparable basis.\nDue to the acquisition and dispositions discussed under \"Business - Recent Developments,\" the borrowings incurred to effect the acquisition, the retirement of the Company's Secured Notes, the consummation of the Plan of Reorganization and the adoption of Fresh Start Reporting, the Company's historical results of operations should not be regarded as indicative of its future results. The following discussion should be read in conjunction with the Consolidated Financial Statements and the Notes thereto.\nRESULTS OF OPERATIONS - GENERAL\nThe comparability of results for future periods will be affected by the acquisition and dispositions during 1994 (see Notes 2 and 3 of Notes to Consolidated Financial Statements) and by the nature and timing of any future acquisitions or dispositions. Future acquisitions could substantially increase the Company's operating expenses, depreciation and amortization charges and, if additional financing is required, interest expense, as well as increasing revenues. For these reasons, the results of the Company's historical operations may not be comparable from period to period or indicative of results in the future.\n1994 COMPARED TO 1993\nThe Company's net revenue, operating expenses, depreciation and amortization, and interest expense for the year ended December 31, 1994 are not comparable to the year ended December 31, 1993 due to the acquisition of WHTM-TV and the borrowings under the Amended Line of Credit to effect such acquisition, and the dispositions of the Company's radio properties and other assets (see Notes 2 and 3 of Notes to Consolidated Financial Statements). During 1994, net revenue increased by 5% to $24.0 million from $22.8 million. This increase was due to the acquisition of WHTM-TV during September of 1994 which resulted in an increase in television segment revenues of 42.7% to $16.8 million from $11.7 million during 1993. This\nII-5 increase was partially offset by a decline in net revenue from radio and other segment to $7.3 million from $11.0 million. Television revenues during 1994 were impacted by a large influx of political dollars which contributed to increases in the Company's stations. Operating expenses of the Company decreased overall to $15.0 million from $16.3 million due to the dispositions and despite the acquisition largely as a result of the higher operating margins in television broadcasting as compared to radio broadcasting. Depreciation and amortization expense rose to $3.3 million from $2.3 million primarily as a result of the write off of the portion of the reorganization value remaining on the Company's balance sheet after adjustment for dispositions (see Note 1(e) of Notes to Consolidated Financial Statements) and amortization of intangibles associated with the acquisition of WHTM-TV.\nThe Company recognized net income of approximately $14.4 million in 1994, primarily as a result of the net gains on the sales of properties during the year of approximately $17.2 million. Additionally, the Company did not have a share of loss of partially owned companies since it disposed of its interest in PriCellular Corporation during the fourth quarter of 1993 and interest expense decreased by approximately $670,000 due to the retirement of the Secured Notes at the end of 1993. For a substantial portion of 1994, the Company had little or no long-term debt outstanding until the acquisition of WHTM-TV during September of 1994.\nThese improvements were offset, in part, by the increase in depreciation and amortization noted above, and by an increase in corporate expenses of approximately $800,000 and an increase in income taxes of $1.5 million. The increase in corporate expenses was primarily attributable to increased legal, consulting and fees of investment advisors due to the acquisition of WHTM-TV and the exploration by the Company of various business opportunities, as well as to the write off of deferred compensation attributable to an employment agreement related to the Plan of Reorganization which was renegotiated. The increase in income taxes was attributable mainly to the state tax consequences of gains the Company recognized on the sale of properties.\nThe Company had net income per share according to generally accepted accounting principles of $1.44 in 1994, as opposed to a net loss per share of $.14 in 1993. During 1993 net loss includes an extraordinary gain of $.17 due to the extinguishment of debt. No such extraordinary item existed during 1994.\n1993 COMPARED TO 1992\nThe Company's net revenue, operating expenses and depreciation and amortization for the year ended December 31, 1993 are not comparable to the year ended December 31, 1992 due to the sale of 75 percent of its stock of The New York Law Publishing Company as part of the Plan. The Company's net revenue decreased by approximately $31.2 million and operating expenses by $23.2 million\nII-6 as the result of that sale. However, net revenue from the broadcasting segment increased by $1.5 million or 7.1 percent, due to an overall improvement in the market for broadcast advertising, the impact of political revenues and an improvement in market shares at certain of the Company's properties. Operating expenses for the broadcasting segment increased 4% primarily as the result of programming additions at the Company's radio properties.\nThe Company's corporate expenses decreased from 1992 primarily because professional fees and administrative expenses incurred during the Company's reorganization negotiations, excluding those that are classified as reorganization items, decreased during 1993. Interest expense and the amortization of debt discount during 1993 decreased from 1992 primarily because the Company's long-term debt was substantially reduced as a result of its Plan of Reorganization. Additionally, approximately $23.2 million face amount of the new Secured Notes was retired in October 1993, further reducing those expenses.\nThe Company's share of loss of partially owned companies decreased in 1993 primarily because the Company ceased to record losses on its share of PriCellular Corporation, once that investment was reduced to its realizable value of $11 million, the amount that the Company sold it for in October of 1993. The decrease was offset, in part, by losses related to The New York Law Publishing Company which was accounted for under the equity method in 1993. The Company's \"Other (income) expense, net\" decreased to an expense of $539,000 in 1993, as a result of the purchase of 2,249,086 shares of the Company's Common Stock from Huff (see Note 14 of Notes to Consolidated Financial Statements) on which a loss of approximately $4.0 million was recognized. This loss was offset in part by the sale of the Company's preferred and common stock in NTG for $2.4 million which resulted in a gain of the same amount since the stock was carried at a book value of zero. Additionally, the Company had a recovery of approximately $300,000 on the repayment of the note from LL Broadcasting which had been recorded at $2.9 million under Fresh Start Reporting. As a result of the foregoing, the Company recognized a loss before extraordinary items of approximately $3.7 million as compared to a loss of $23.5 million in 1992. The 1992 loss also includes net reorganization expense items totalling approximately $6 million relating to the Company's period under Chapter 11.\nExtraordinary income for 1992 was approximately $313 million due to the forgiveness of debt and the partial sale of The New York Law Publishing Company as part of the Company's Plan of Reorganization. Extraordinary income for 1993 was approximately $2 million due to the early extinguishment of the Company's Secured Notes.\nThe Company had net loss per share before extraordinary item of $.31 and net loss per share of $.14 for 1993. Per share amounts for prior periods are not comparable or meaningful due to the\nII-7 forgiveness of debt, partial sale of subsidiary, issuance of new common stock and adoption of Fresh Start Reporting.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company had approximately $1.1 million in cash and cash equivalents and positive net working capital at December 31, 1994. Long-term debt of $22.5 million was owed by the Company as of December 31, 1994.\nDuring September 1994, certain of the Company's subsidiaries entered into an Amended Line of Credit with the Bank of Montreal (\"BMO\"). The Amended Line of Credit was for $45 million, which the Company permanently reduced upon the sale of its West Palm Beach radio stations to $22.5 million. The Amended Line of Credit is permanently reduced quarterly by varying amounts, beginning on September 30, 1995, bears interest at a rate equal to the BMO base rate, as defined, plus up to a maximum of .75% and is secured by the assets of the Company's subsidiaries who are the borrowers on the Amended Line of Credit. See Note 10 of Notes to Consolidated Financial Statements.\nIf the Company's acquisition strategy (see \"Business-Acquisitions and Divestitures\") continues to be successful the Company may require substantial capital to finance them. The Company may use a variety of sources including the proceeds of debt sold to the public, additional borrowings from banks and other institutional lenders, seller financing, convertible preferred stock and common stock issued at the parent company or subsidiary level. There can be no assurance that the Company will be successful in obtaining funds from those sources.\nAlthough the Company has incurred substantial depreciation and amortization expenses as a result of the purchase of its properties, it does not anticipate the need to make major capital expenditures in respect of its existing media properties (see \"Properties\") during 1995 and it does not believe that such lack of major capital expenditures will affect its competitive position. Capital expenditures for 1994 were approximately $750,000.\nThe Company's sources of funds to serve its debt and meet its other obligations historically have been provided by its liquid assets, cash flow from its operating and investment activities, proceeds from the sale of properties and proceeds from loans and financings. The Company intends to seek to improve cash flow from operations by continuing to impose stringent budget procedures on its media properties and by continuing to seek to increase revenues at its properties in excess of increases in operating expenses.\nOn February 10, 1994, the Company's Board of Directors authorized the repurchase by the Company of up to 2,000,000 shares of its Common Stock. The Company is authorized to make such purchases from time to time in the market or in privately\nII-8 negotiated transactions. During the year ended December 31, 1994, the Company repurchased approximately 996,000 shares pursuant to that authorization.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPrice Communications Corporation and Subsidiaries Consolidated Financial Statements are set forth on the following pages of this Part II.\n___________\nPRICE COMMUNICATIONS CORPORATION and SUBSIDIARIES\nCONSOLIDATED FINANCIAL STATEMENTS\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nII-9\nAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nPrice Communications Corporation and Subsidiaries\nDecember 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994 with Reports of Independent Auditors\n[KPMG PEAT MARWICK LLP LETTERHEAD]\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Price Communications Corporation:\nWe have audited the accompanying consolidated balance sheet of Price Communications Corporation and subsidiaries as of December 31, 1994, and the related consolidated statements of operations, shareholders' equity (deficit), and cash flows for the year then ended (Reorganized Company) and the consolidated statements of operations, shareholders' equity (deficit), and cash flows for the year ended December 31, 1992 (Predecessor Company). In connection with our audits of the consolidated financial statements, we have also audited the related financial statement schedules as listed in Part IV, Item 14(a). 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 Price Communications Corporation and subsidiaries as of December 31, 1994, and the results of their operations and their cash flows for the years ended December 31, 1994 and 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.\nAs discussed in note 4 to the consolidated financial statements, effective December 30, 1992, Price Communications Corporation was reorganized under a plan confirmed by the Federal Bankruptcy Court and adopted a new basis of accounting whereby all remaining assets and liabilities were revalued at their estimated fair values. As discussed in notes 1 and 11, Price Communications Corporation and subsidiaries (Reorganized Company) have changed their method of accounting for income taxes in 1992 to adopt the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\n\/s\/ KPMG Peat Marwick LLP ------------------------- KPMG PEAT MARWICK LLP\nNEW YORK, NEW YORK JANUARY 20, 1995\nReport of Independent Auditors\nThe Board of Directors and Shareholders Price Communications Corporation\nWe have audited the accompanying consolidated balance sheet of Price Communications Corporation and subsidiaries (the \"Company\") as of December 31, 1993 and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for the year then ended. Our audit also included the financial statement schedules listed in Part IV, Item 14(a). These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 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 Price Communications Corporation and subsidiaries at December 31, 1993 and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. 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.\n\/s\/ Ernst & Young LLP\nMarch 8, 1994\nPrice Communications Corporation and Subsidiaries\nConsolidated Balance Sheets\n(continued)\nPrice Communications Corporation and Subsidiaries\nConsolidated Balance Sheets - continued\n*The Company also has net operating loss carryforwards which may mitigate federal income taxes, if any, resulting from disposition of the acquired assets during the carryforward period (see Note 11).\nSee accompanying notes to consolidated financial statements.\nPrice Communications Corporation and Subsidiaries\nConsolidated Statements of Operations\n*Per share amounts for the Predecessor Company are neither comparable nor meaningful due to forgiveness of debt, partial sale of subsidiary, issuance of new common stock and adoption of Fresh Start Reporting.\nSee accompanying notes to consolidated financial statements.\nPrice Communications Corporation and Subsidiaries\nConsolidated Statements of Shareholders' Equity (Deficit)\nYears ended December 31, 1994, 1993 and 1992\nSee accompanying notes to consolidated financial statements.\nPrice Communications Corporation and Subsidiaries\nConsolidated Statements of Cash Flows ============\n(continued)\nPrice Communications Corporation and Subsidiaries\nConsolidated Statements of Cash Flows (continued)\nSee accompanying notes to consolidated financial statements.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\na. Basis of Presentation - The consolidated financial statements include the accounts of Price Communications Corporation (the \"Company\" or \"Price\") and its subsidiaries. All significant intercompany items and transactions have been eliminated.\nb. Fresh Start Reporting - The Company reorganized and emerged from Chapter 11 bankruptcy proceedings on December 30, 1992 (the \"Effective Date\"-see Note 4), and adopted Fresh Start Reporting in accordance with the guidelines established by the American Institute of Certified Public Accountants in Statement of Position 90-7, \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code.\" Under Fresh Start Reporting, assets and liabilities are recorded at their estimated fair market value and the historical deficit is eliminated. Accordingly, the Company's financial statements were prepared as if it were a new reporting entity (referred to as the \"Reorganized Company\") as of the Effective Date. A vertical black line has been placed to separate the consolidated statements of operations and cash flows of the Company prior to the reorganization (referred to as the \"Predecessor Company\") from those of the Reorganized Company, since they are not prepared on a comparable basis.\nThe Company's operations for the two-day period of December 30 and December 31, 1992 were insignificant. Accordingly, December 31, 1992 was used as the cut-off date for financial reporting purposes in lieu of the Effective Date.\nThe revaluation of the Company's assets and liabilities as of December 31, 1992 was based on an independent appraisal, modified as appropriate, and resulted in a reduction in net carrying values of assets and liabilities of approximately $5,027,000.\nc. Depreciation and Amortization - Depreciation is computed on the straight-line method on the basis of estimated useful lives, as follows:\nBuildings-15 to 25 years Broadcasting equipment-10 to 12 years Leasehold improvements-the life of the underlying lease Furniture and fixtures-3 to 10 years Transportation equipment-3 years\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nd. Intangible Assets:\ni. Excess of purchase price over the fair value of net assets acquired includes FCC licenses, station call letters, and goodwill. These assets are integral determinants of a communications property's economic value, and have long and productive lives. In connection with Fresh Start Reporting, unamortized goodwill related to acquisitions prior to December 31, 1992 was eliminated and corresponding FCC licenses were restated at their approximate fair value as of December 31, 1992. The Predecessor Company amortized such intangible assets over a 40-year period, the maximum life allowable under Accounting Principles Board Opinion No. 17. The Reorganized Company continues to amortize such assets over a 40-year life commencing from the original date of acquisition.\nii. Deferred expenses associated with debt instruments were amortized under the straight-line method over their respective lives. Debt discounts were amortized under the effective interest method. As of December 31, 1992, the unamortized carrying value of deferred debt expense and unamortized debt discount associated with debt forgiven or exchanged under the Company's Plan of Reorganization (the \"Plan\"-see Note 4) was eliminated.\ne. Reorganization Value in Excess of Amounts Allocable to Identifiable Assets-The reorganization value in excess of amounts allocable to identifiable assets, which resulted from the implementation of Fresh Start Reporting was amortized using the straight-line method over 20 years. During the year ended December 31, 1994, the portion of this asset remaining after adjustment for dispositions (approximately $670,000) was written off.\nf. Per Share Data-Primary income per common share is based on income for the period divided by the weighted average number of shares of common stock and common stock equivalents outstanding, which was approximately 9.9 million shares for 1994 and 11.9 million shares for 1993. Per share amounts for the Predecessor Company are not presented because they are neither comparable nor meaningful due to forgiveness of debt, partial sale of subsidiary, issuance of new common stock and adoption of Fresh Start Reporting.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\ng. Allowance for Doubtful Accounts-The Company provides an allowance for doubtful accounts based on reviews of its customers' accounts. Included in operating expense is bad debt expense of approximately $319,000, $264,000, and $514,000 for the years ended December 31, 1994, 1993, and 1992, respectively.\nh. Barter Transactions-Revenue from barter transactions (advertising provided in exchange for goods and services) is recognized as income when advertisements are broadcast, and merchandise or services received are charged to expense when received or used.\ni. Advertising Revenues-Sales of advertisements are recognized as income when advertisements are broadcasted or printed.\nj. Film Broadcast Rights-The capitalized cost of film broadcast rights is amortized on the basis of the estimated number of showings or, if unlimited showings are permitted, over the term of the broadcast license agreements. Unamortized film broadcast rights are classified as current or noncurrent on the basis of their estimated future usage. Amortization of film broadcast rights is included in operating expenses and amounted to approximately $1,077,000, $800,000, and $940,000 for the years ended December 31, 1994, 1993, and 1992, respectively.\nk. Cash and Cash Equivalents-For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments, including Treasury bills, purchased with maturities of three months or less at the time of purchase to be cash equivalents.\nl. Marketable Securities-Dividend and interest income are accrued as earned. Net realized gains (losses) on the sale of marketable securities are based upon weighted average cost (see Note 12).\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nm. Income Taxes-Effective December 31, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"Statement 109\"), issued by the Financial Accounting Standards Board (see Note 11). The cumulative effect of this change had no significant impact on the Company's consolidated financial statements, including income tax expense. 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.\nPrior to December 31, 1992, the Company accounted for income taxes pursuant to the deferred method under APB Opinion 11. Under the deferred method, 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 calculation.\n2. ACQUISITION OF WHTM-TV\nOn September 16, 1994, the Company acquired all of the outstanding shares of the corporation which owns all of the assets of WHTM- TV, the ABC affiliate serving the Harrisburg-York-Lancaster-Lebanon, Pennsylvania television market for approximately $47 million plus a working capital adjustment of approximately $4 million. The acquisition has been accounted for under the purchase method, and accordingly, the operating results of WHTM-TV have been included in the consolidated operating results since the date of acquisition. The purchase price is subject to adjustment in the Company's favor based upon resolution of contemplated arbitration proceedings. Funds for the acquisition were provided by cash on hand and a credit facility from the Bank of Montreal (\"BMO\") of $45 million (see Note 10), which was reduced to $22.5 million upon the sale of the Company's radio properties in West Palm Beach during October of 1994 (see Note 3). The acquisition resulted in intangible assets, primarily broadcast licenses of approximately $44.2 million and goodwill of approximately $19.7 million, both of which are being amortized over a forty year period. Condensed pro forma financial information regarding this acquisition and dispositions during 1994 are included under Note 3.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n3. DISPOSITIONS\nIn February 1994, the Company sold its outdoor advertising business for a total of $875,000 in cash and notes receivable. (see Note 5). This disposition resulted in a pretax loss of $350,000.\nIn April 1994, the Company sold substantially all of the assets of its radio properties, WWKB-AM and WKSE-FM in Buffalo, New York, for $5 million in cash. The Company realized a pretax gain of approximately $3.2 million on this transaction.\nIn May 1994, the Company sold all of the stock of Eimar Realty Corporation, its then wholly owned subsidiary, owning a building in Nashville, Tennessee, to TLM Corporation, a former subsidiary of the Company. The purchase price was $815,000 including a note from the purchaser of $540,000 (see Note 5). The Company's pretax gain on the transaction was de minimis.\nIn October 1994, the Company sold substantially all of the assets, together with certain liabilities of radio stations WBZT-AM and WIRK-FM, West Palm Beach, Florida, for approximately $23 million in cash. The Company realized a pretax gain of approximately $13.5 million on this transaction. The net proceeds were used to retire $22.5 million under the BMO credit facility (see Note 10).\nIn October 1994, the Company sold its building in Red Bank, New Jersey for $1.7 million in cash. The Company realized a de minimis gain on the sale.\nIn November 1994, the Company sold substantially all of the assets of radio stations WOWO- AM and WOWO-FM in Fort Wayne and Huntington, Indiana, respectively, for $2.3 million in cash. The Company recognized a pretax gain on the sale of approximately $.8 million.\nThe gains and losses on the dispositions outlined above have been included in other (income) expense, net on the Company's statement of operations for the year ended December 31, 1994.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n3. DISPOSITIONS (CONTINUED)\nThe following unaudited pro forma financial information has been prepared based on the assumption that the aforementioned 1994 acquisition had occurred on January 1, 1994 and 1993:\n*Further reflects the sales during 1994 of radio stations and other properties as if they had occurred on January 1, 1994.\nThe pro forma information reflects adjustments for changes in depreciation, amortization, interest expense and income taxes resulting from the acquisition and dispositions.\nThe proforma financial information is not necessarily indicative either of results of operations that would have occurred had the acquisition and dispositions been made at the beginning of the periods, or of future results of operations of the Company.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n4. REORGANIZATION\nOn December 30, 1992, The Plan of Reorganization (\"the Plan\"), which had been approved by the United States Bankruptcy Court for the Southern District of New York became effective. Under the Plan, the following occurred:\na. Holders of approximately $31 million principal amount of the Company's senior debt received new $31 million face amount seven-year 5% Senior Secured Notes (the \"Secured Notes\"-see Notes 6 and 10).\nb. Apollo Investment Fund, L.P. and James Finkelstein purchased 75% of Alexandra Publishing Corporation, which owns The New York Law Publishing Company, in exchange for the cancellation of approximately $19 million principal amount of senior debt, the payment to the Company of $7.5 million in cash and the assumption of certain liabilities of the Company of approximately $45 million. See note 14 for subsequent disposal of the remaining 25% interest in the publishing subsidiaries.\nc. The holders of the existing subordinated debt received 94.5% of the common stock of Price.\nd. Shareholders received shares which constituted 3.5% of the common stock of the Reorganized Company, and Robert Price, President of the Company, received 2% of such common stock in exchange for the junior common stock, all of which was held by Mr. Price.\nThe gain on the partial sale of publishing companies and the gain from cancellation of indebtedness resulted in extraordinary income of approximately $312.7 million which is net of a tax provision of $900,000 relating to the sale of the publishing companies. The gain resulting from the forgiveness of debt is not taxable for Federal income tax purposes.\nIn a related transaction, on August 5, 1992, the Company exchanged its interest in TLM Corporation (until then a 90.7% owned subsidiary) for 90.7% of the assets of TLM Corporation. These assets consisted of cash and common stock and certain public debt securities of the Company. The Company's loss from the transaction was de minimis.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n5. NOTES RECEIVABLE\nInvestments in notes receivable include the following:\na. In connection with the sale in 1987 of seven radio stations to Fairmont Communications Corporation (\"Fairmont\") for an aggregate sale price of $120 million, the Company loaned $50 million to Fairmont (the \"Fairmont Notes\") and acquired a 27% equity interest in Fairmont. The Fairmont Notes were issued in three series of 12 1\/2% increasing rate subordinated notes due in 1992, extendible at Fairmont's option to 1994. Interest on the notes was payable quarterly in cash or additional notes at Fairmont's election.\nDuring 1992, Fairmont filed for voluntary relief under Chapter 11 of the U.S. Bankruptcy Code. At that time the Company ceased to record additional notes related to interest paid in kind since it was not entitled to interest after that date under the Bankruptcy Code.\nThe $94.8 million principal amount of Fairmont Notes owned by the Company (which includes accrued interest paid in additional Fairmont Notes) and the Company's equity investment in Fairmont had no book value as of December 31, 1994 and 1993.\nDuring September 1993, the United States Bankruptcy Court for the Southern District of New York confirmed the Chapter 11 Plan of Reorganization (the \"Fairmont Plan\") for Fairmont and its subsidiaries. Essentially, the Fairmont Plan provides for the orderly liquidation of the assets of Fairmont and its subsidiaries, and the distribution of the proceeds derived therefrom according to the relative priorities of the parties asserting interests therein. The Company believes that the level of asset sales will be sufficiently high to provide for some recovery upon the Fairmont Notes, although the exact amount of any such recovery is uncertain at this time.\nb. During February 1994, in connection with the sale of its outdoor advertising business, the Company received a note from the buyer, Midwest Media, Inc., for a total of $675,000 (see Note 3). The note bears interest at the rate of 8% and is payable quarterly. Principal is payable in quarterly installments of varying amounts beginning in November 1994 through November 1997 with the balance of the principal of $465,000 due in February 1998. During 1994, the Company set up a partial reserve of $337,500 against this note.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n5. NOTES RECEIVABLE (CONTINUED)\nc. During May 1994, in connection with the sale of Eimar Realty Corporation, the Company received a note from the buyer, TLM Corporation (a former subsidiary of the Company-see Note 3), in the amount of $540,000. The note bears interest at the rate of 5% per annum, payable quarterly, with principal payable on May 20, 1998.\n6. INVESTMENT IN PARTIALLY OWNED COMPANIES\na. Alexandra Publishing Corporation (\"Alexandra\")\nOn December 30, 1992, the Company, in connection with its Plan of Reorganization, sold 75% of Alexandra (see Note 4). The Company retained a 25% interest in Alexandra which owns 100% of The New York Law Publishing Company. In November 1993, in connection with the repurchase of common stock (see Note 14), the Company transferred its remaining 25% interest in Alexandra, which had a carrying value of approximately $3.8 million.\nFor the year ended December 31, 1992, these subsidiaries were consolidated in the statements of operations and cash flows of the Predecessor Company. Based upon audited financial information, Alexandra had net revenue, operating expenses, and depreciation and amortization of approximately $32.6 million, $23.9 million (including intercompany expenses of $1.3 million), and $1.6 million, respectively, for the year ended December 31, 1992. For the year ended December 31, 1993, the 25% interest in such subsidiaries was accounted for by the equity method and the Reorganized Company recognized a charge to operations of approximately $230,000 for its period of ownership.\nb. PriCellular Corporation (\"PriCellular\")\nDuring 1992 and 1993, the Company accounted for its investment in PriCellular under the equity method of accounting as it believed its control in PriCellular to be temporary. The Company recognized 75% of PriCellular's losses as a charge to operations to the extent of its investment in PriCellular representing $2.9 million for the year ended December 31, 1992. Prior to Fresh Start Reporting, the Predecessor Company's investment in PriCellular had been reduced to zero book value. In accordance with the court approved Plan, the Company transferred 1% of PriCellular's common stock to Robert Price, reducing the Company's interest to 74%. In connection with fresh start reporting, this investment was reflected at an approximate fair market value of $11.5 million at December 31, 1992.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n6. INVESTMENT IN PARTIALLY OWNED COMPANIES (CONTINUED)\nOn October 1, 1993, the Company sold its remaining 74% interest in PriCellular to a subsidiary of PriCellular for $11 million in cash. The proceeds from the sale were used to repurchase a portion of the Secured Notes, in accordance with the terms of the indenture of such notes (see Note 10). During 1993, the Company recognized a charge of approximately $890,000 related to its share of PriCellular's losses through October 1, 1993, and realized no gain or loss from the sale of its interest in PriCellular.\n7. PROPERTY AND EQUIPMENT\nProperty and equipment consists of the following:\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\nAccounts payable and accrued expenses consist of the following:\n9. OTHER LIABILITIES\nOther liabilities consist of:\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n10. LONG-TERM DEBT\nLong-term debt consists of the following notes payable by wholly-owned subsidiaries of the Company at December 31, 1994 and 1993 as follows:\n(A) On September 16, 1994, certain subsidiaries of the Company entered into an Amended and Restated Line of Credit Agreement with BMO (the \"Amended Line of Credit\"). The Amended Line of Credit was for $45 million, permanently reduced by $22.5 million upon the sale of the Company's radio stations in West Palm Beach (see Note 3) and reduced further quarterly, in varying amounts through the year 2001 as follows:\nPrice Communication Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n10. LONG-TERM DEBT (CONTINUED)\nBorrowings under the Amended Line of Credit bear interest at the BMO Base Rate, as defined, plus up to a maximum of .75%, and are secured by the assets of the subsidiaries, which have a book value of approximately $81.3 million as of December 31, 1994. There is also a fee of .5% on the unused portion, if any, of the Amended Line of Credit. On December 31, 1994 the effective interest rate was 9.25%. The terms of the Amended Line of Credit require the Company to maintain certain financial ratios, restrict the declaration of dividends and require the Company to apply the proceeds from future asset sales to the outstanding balance due.\n(B) In December 1993, certain subsidiaries of the Company entered into a $10 million Line of Credit Agreement (the \"Line of Credit\") with BMO. Borrowings under the Line of Credit bore interest at the BMO Base Rate, as defined (or at other rates at the borrowers' option), and were secured by the assets of the subsidiaries. Borrowings of $5.6 million under the Line of Credit were used to retire the remaining Secured Notes issued in connection with the Plan of Reorganization. Also in December 1993, the Company used proceeds of $2.4 million from the sale of its position in Northstar Television Group, Inc. (\"NTG\") to repay borrowings under the Line of Credit (see Note 12).\n(C) In connection with the Plan, the Company issued $30,805,000 face amount of 5% Senior Secured Notes. The Company recorded these notes net of a discount of $8,705,000 under Fresh Start Reporting (see Note 1). During October and December 1993, the Company repurchased all of the notes for approximately $20.8 million, plus accrued interest, and realized a gain of approximately $2.0 million, net of taxes of zero.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n11. INCOME TAXES\nAs discussed in Note 1, the Company adopted Statement 109 as of December 31, 1992. The cumulative effect of this change had no significant impact on the Company's consolidated financial statements, including tax expense, for the year then ended.\nProvision (benefit) for income taxes is approximately:\nIn addition, a provision of $900,000, primarily for Federal alternative minimum tax, has been included in extraordinary items for the year ended December 31, 1992 (see Note 4).\nFor the years ended December 31, 1992 and 1993, the Company was unable to utilize the tax benefit of capital and net operating losses, and accordingly, no amounts were provided therefor. For the year ended December 31, 1994, the provision for income taxes differs from the amount computed by applying the federal income tax rate (35%) because of the effect of the following items:\nPrice Communication Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n11. INCOME TAXES (CONTINUED)\nThe Company had, as of December 31, 1994 and 1993, deferred tax assets which were subject to a valuation allowance of approximately $39,529,000 and $46,031,000, respectively, and deferred tax liabilities of approximately $21,154,000 and $3,943,000, respectively. The allowance has been recognized to offset the related deferred tax asset due to the uncertainty of the realization of benefit of such amount. These deferred tax assets and liabilities consist of the following:\nNet operating loss carryforwards aggregating approximately $32.9 million are available for federal income tax purposes at December 31, 1994. These carryforwards expire in the years 2002 through 2006. The Company also has available investment tax credit carryforwards of approximately $100,000 expiring in the year 2000 and capital loss carryforwards of approximately $41 million expiring in the year 1998. A portion of these carryforwards arose prior to the reorganization and are subject to the limitations of Internal Revenue Code Sections 382 and 383.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n12. OTHER (INCOME) EXPENSE-NET\nOther (income) expense-net consists of:\nAs of December 31, 1992, in conjunction with the adoption of Fresh Start Reporting, the investment in common and preferred stock of NTG was removed from the Company's consolidated balance sheet since its estimated realizable value was zero (see Note 1). In December 1993, the Company sold its investment in NTG for approximately $2.4 million in cash and recognized a gain of approximately $2.4 million on the sale.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n13. SEGMENT DATA\nThe Reorganized Company's business operations are classified into two segments: Television and Radio Broadcasting and Other. The Company sold its radio stations during 1994 and has no current contracts to acquire any other radio stations (see Note 3). The Predecessor Company's business operations included Publishing with Other. The Company's Publishing operations were transferred to third parties in 1992 (see Note 4) and therefore, are no longer consolidated in the Reorganized Company's operations. There are no transfers between segments of the Company. The segment data follows:\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n13. SEGMENT DATA (CONTINUED)\n*Operating income (loss) is before corporate expenses, other (expense) income-net, interest expense, amortization of debt discount and deferred debt expense, unrealized non-cash loss (recovery) on marketable securities, share of loss of partially owned companies, reorganization items, income taxes and extraordinary items.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n13. SEGMENT DATA (CONTINUED)\n====================================\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n14. SHAREHOLDERS' EQUITY (DEFICIT)\na. Refer to notes 1 and 4 for a description of changes to shareholders' equity (deficit) pursuant to the Plan of Reorganization.\nb. On November 24, 1993, the Company purchased from investment advisory clients of W.R. Huff Asset Management Co., L.P. (\"Huff\") a block of 2,249,086 shares of its common stock. The purchase price consisted of $3.75 per share in cash, plus the stock of its indirect wholly-owned subsidiary, Price Publishing Corporation, which held the remaining 25% interest in the New York Law Publishing Company (see Note 4). The stock of Price Publishing Corporation had a book value of approximately $3,836,000 at such date which in the opinion of management approximated its fair value (see Note 6). In connection with this transaction, the Company recorded a loss of approximately $3,977,000 reflecting the difference between the value of the cash and stock of Price Publishing Corporation transferred to Huff and the then current trading market price of the common stock. The loss has been included in other expense (income) for 1993 in the accompanying statement of operations (see Note 12), and the common stock purchased from Huff has been treated as constructively retired in the accompanying balance sheet at December 31, 1993.\nc. In connection with the Plan, warrants on the Company's common stock, originally issued on April 12, 1990, were amended. The warrants will be exercisable for approximately 124,000 shares of the Reorganized Company's common stock at an exercise price of $4.23 per share during the five-year period commencing October 1, 1993.\nd. In October 1994, the Company's Board of Directors enacted a Stockholders Rights Plan designed to protect the interests of the Company's shareholders in the event of a potential takeover for a price which does not reflect the Company's full value or which is conducted in a manner or on terms not approved by the Board as being in the best interests of the Company and its shareholders. The Board has declared a dividend distribution of One Common Stock Purchase Right on each outstanding share of Common Stock of the Company. The Rights provide, in substance, that should any person or group acquire 20% or more of the Company's Common Stock, each Right, other than Rights held by the acquiring person or group, would entitle its holder to purchase a specified number of Price Communications Corporation common shares for 50% of their then-current market value. In addition, the Rights may be exercised, at the holders option, at a purchase price of $22.50 per share at any time prior to the termination of the Plan. Unless a 20% acquisition has occurred, the Rights may be redeemed by the Company at any time prior to the termination date of the Plan.\ne. On February 10, 1994, the Company's Board of Directors authorized the repurchase by the Company of up to 2,000,000 shares of its Common Stock. The Company is authorized to make such purchases from time to time in the market or in privately negotiated transactions\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n14. SHAREHOLDERS' EQUITY (DEFICIT) - CONTINUED\nwhen it is legally permissible to do so or believed to be in the best interests of its shareholders. During the year ended December 31, 1994, the Company repurchased approximately 996,000 shares pursuant to that authorization. Repurchased common stock of the Company has been treated as constructively retired in the accompanying balance sheet as of December 31, 1994.\n15. STOCK OPTION PLAN\nA long-term incentive plan, (the \"1992 Long Term Incentive Plan\") was established under the Plan, which provides for granting incentive stock options, as defined under current tax law, and other stock-based incentives to key employees and officers. The maximum number of shares of the Company that are subject to awards granted under the 1992 Long Term Incentive Plan is 1,000,000. The exercise of such options, other than those granted on December 10, 1992, will be exercisable at a price not less than the fair market value on the date of the grant, for a period up to ten years.\nNew incentive stock options were granted on December 10, 1992 under the 1992 Long Term Incentive Plan to key employees and officers. The number of options issued represents essentially a 1 for 2 reverse split for all previously awarded stock options granted, which were canceled pursuant to the Plan, except for options previously awarded to Robert Price which were surrendered by Mr. Price. Options granted on December 10, 1992 represent 170,911 shares and the exercise price was set at $2.67 per share.\nThe following table sets forth information with respect to the Company's stock options for the years ended December 31, 1994 and 1993:\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n16. COMMITMENTS AND CONTINGENCIES\nThe Company is involved in various claims and litigation arising in the ordinary course of business. In the opinion of legal counsel and management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial condition.\nThe Company has an employment agreement with Robert Price covering base salary and incentive compensation. The agreement is for a term of three years commencing October 1994 at a base salary of $300,000 and is extendable for periods of three years at the Company's option. Cash performance bonuses and stock options awards are determined solely at the discretion of the Board of Directors or the Stock Option Committee, respectively.\nThe Company and its subsidiaries lease a variety of assets used in their operations, including office space and antenna sites. Renewal options are available in the majority of leases. The following is a schedule of the Company's minimum rental commitment for operating leases of real and personal property for each of the five years subsequent to 1994 and in the aggregate:\nRental expense for operating leases was approximately $312,000, $312,000, and $1,468,000 for the years ended December 31, 1994, 1993, and 1992, respectively.\nAt December 31, 1994, the Company is committed to the purchase of film broadcast rights of various syndicated programming aggregating approximately $1,602,000, $1,141,000, $378,000, and $111,000 for the years 1995, 1996, 1997, and 1998, respectively.\nPrice Communications Corporation and Subsidiaries\nNotes to Consolidated Financial Statements (continued)\n17. SUPPLEMENTAL CASH FLOW INFORMATION\nThe following is supplemental disclosure cash flow information for the years ended December 31, 1994, 1993, and 1992:\nPART III\nThe information called for by Items 10, 11, 12 and 13 is incorporated herein by reference from the following portions of the definitive proxy statement to be filed by the Company in connection with its 1995 Meeting of Shareholders.\nIII-1 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) and (2) List of financial statements and financial statement schedules:\nIndependent Auditors' Reports Consolidated Balance Sheets at December 31, 1994 and 1993 Consolidated Statements of Operations for Years ended December 31, 1994, 1993 and 1992 Consolidated Statements of Shareholders' Equity (Deficit) for 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\nIII. Condensed Financial Information of Registrant VIII. Valuation and Qualifying Accounts\n(Schedules 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(3) Exhibits\nSee Exhibit Index at page E-1, which is incorporated herein by reference.\n(b) Reports on Form 8-K.\nDuring the quarter ended December 31, 1994, Registrant filed the following Current Reports on Form 8-K:\nOn October 6, 1994, the Company filed a Form 8-K to report an event of September 16, 1994. The report included an Item 2 discussion of the purchase of WHTM-TV, Harrisburg, Pennsylvania.\nOn October 14, 1994, Registrant filed a report on Form 8-K wherein a change of the Company's Certifying Accountants on October 6, 1994, was reported at Item 4.\nOn October 24, 1994, Registrant filed an amended Form 8-K to its Current Report on Form 8-K filed on October 14, 1994, regarding a change in the Registrant's Certifying Accountants at Item 4.\nIV-1\nOn December 5, 1994, Registrant filed a report on Form 8-K wherein adoption of the Registrant's Shareholder Rights Plan was reported in Item 5.\nIV-2\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nBalance Sheets December 31, 1994 and 1993\n- --------------- * Eliminated in consolidation\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nStatements of Operations\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nStatements of Cash Flows\n- --------------- * Eliminated in consolidation.\nPRICE COMMUNICATIONS CORPORATION AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nDECEMBER 1994, 1993 AND 1992\n--------------- (a) Amounts written off as uncollectible and payments. (b) Includes adjustments for the disposition of properties and the acquisition of WHTM-TV. (c) $85,000 relates to the partial sale of companies in 1992.\nSIGNATURES\nPursuant to the requirements of Section 13 and 15(d) of the Securities and Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPRICE COMMUNICATIONS CORPORATION\nBy \/s\/ Robert Price ------------------------------------- Robert Price, President\nDated: January 26, 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 Company and in the capacities and on the dates indicated. Each person whose signature appears below hereby authorizes and appoints Robert Price as his attorney-in-fact to sign and file in his behalf individually and in each capacity stated below any and all amendments to this Annual Report.\nDated: January 26, 1995 By \/s\/ Robert Price -------------------------------------- Robert Price, Director and President (Principal Executive Officer, Financial Officer and Accounting Officer)\nDated: January 26, 1995 By \/s\/ George H. Cadgene -------------------------------------- George H. Cadgene, Director\nDated: January 26, 1995 By \/s\/ Robert F. Ellsworth -------------------------------------- Robert F. Ellsworth, Director\nDated: January 26, 1995 By \/s\/ Robert Paul -------------------------------------- Robert Paul, Director\nDated: January 26, 1995 By \/s\/ Kim I. Pressman -------------------------------------- Kim I. Pressman, Director\nDated: January 26, 1995 By \/s\/ Steven Price -------------------------------------- Steven Price, Director EXHIBIT INDEX ITEM 14(a)(3)\nPRICE COMMUNICATIONS CORPORATION\nAnnual Report on Form 10-K for the year ended December 31, 1994\nPage(1) ----\n(3)(a) Restated Certificate of Incorporation of the Registrant as filed with the Secretary of State of the State of New York on December 29, 1992, incorporated by reference to Exhibit 3(a) to Registrant's Form 10-K for the year ended December 31, 1992.\n(b) Restated By-laws of the Registrant, incorporated by reference to Exhibit 3(b) to the Registrant's Form 10-K for the year ended December 31, 1993.\n(4)(a) Indenture dated as of December 30, 1992 between the Registrant and IBJ Schroder Bank & Trust Company, as trustee, relating to the Company's 5% Senior Secured Notes due 1999 (the \"Indenture\"), incorporated by reference to Exhibit 4(a) to Registrant's Form 10-K for the year ended December 31, 1992.\n(b) Pledge, Intercreditor and Collateral Agency Agreement dated as of December 30, 1992, among the Registrant, IBJ Schroder Bank & Trust Company, as Trustee under the Indenture, and IBJ Schroder Bank & Trust Company, as Collateral Agent, incorporated by reference to Exhibit 4(b) to Registrant's Form 10-K for the year ended December 31, 1992.\n(10)(a) The Registrant's 1992 Long Term Incentive Plan, incorporated by reference to Exhibit 10(a) to\n- -------------------- 1 Page numbers are sequentially numbered pages.\nE-1 Page ----\nRegistrant's Form 10-K for the year ended December 31, 1992.\n(b) Amended and Restated Employment Agreement dated as of May 8, 1992 between The New York Law Publishing Company and Robert Price, incorporated by reference to Exhibit 10(b) to Registrant's Form 10-K for the year ended December 31, 1992.\n(c) Employment Agreement with Robert Price, dated May 8, 1992, incorporated by reference to Exhibit 10(c) to Registrant's Form 10-K for the year ended December 31, 1992.\n(d) Agreement dated May 8, 1992 between the Registrant and Robert Price with respect to PriCellular Corporation, incorporated by reference to Exhibit 10(d) to Registrant's Form 10-K for the year ended December 31, 1992.\n(e) Amended and Restated Stock Purchase Agreement dated as of May 8, 1992 among the Registrant, Price Publishing Corporation, Alexandra Publishing Corporation, The New York Law Publishing Company and Apollo Investment Fund, L.P., incorporated by reference to Exhibit 10(e) to Registrant's Form 10-K for the year ended December 31, 1992.\n(f) Amended and Restated Shareholders Agreement dated as of May 8, 1992 among the Registrant, Apollo Investment Fund, L.P., Price Publishing Company, Alexandra Publishing Corporation and The New York Law Publishing Company, incorporated by reference to Exhibit 10(f) to Registrant's Form 10-K for the year ended December 31, 1992.\n(g) Registration Rights Undertaking, incorporated by reference to Exhibit\nE-2\nPage ----\n10(g) to Registrant's Form 10-K for the year ended December 31, 1992.\n(h) Warrant Agreement dated April 12, 1990 between Price Communications Corporation and Warner Communications Investors, Inc., incorporated by reference to Exhibit (4) to Registrant's Form 8-K filed to report an event of April 12, 1990.\n(i) Form of Amendment to Time Warner Warrant, incorporated by reference to Exhibit 10(i) to Registrant's Form 10-K for the year ended December 31, 1992.\n(j) Stock Purchase Agreement, dated as of April 27, 1987, among Registrant, Republic Broadcasting Corporation and Fairfield Broadcasting, Inc., as amended July 16, 1987, incorporated by reference to Annex I to Registrant's Definitive Proxy Statement dated July 27, 1987.\n(k) Notes and Stock Purchase Agreement between and among Fairfield Broadcasting, Inc., Price Communications Corporation and Republic Broadcasting Corporation dated as of September 30, 1987, as amended, incorporated by reference to Exhibit 10(a) to Registration Statement on Form S-1 (File No. 33-30318).\n(l) Stockholders' Agreement among Fairfield Broadcasting, Inc., Price Communications Corporation, Citicorp Venture Capital Ltd., Osborn Communications Corporation and Prudential-Bache Interfunding Inc., dated as of September 30, 1987, incorporated by reference to Exhibit 10(b) to Registration Statement on Form S-1 (File No. 33-30318).\n(m) Asset Purchase Agreement by and among\nE-3\nPage ----\nNTG, Inc., Price Communications Corporation and Western Michigan Broadcasting Corporation, Rhode Island Broadcasting Corporation, Magnolia Broadcasting Corporation and Keystone Broadcasting Corporation, dated as of June 28, 1989, incorporated by reference to Exhibit 10(c) to Registration Statement on Form S-1 (File No. 33-30318).\n(n) Stock Purchase Agreement between NTG Holdings, Inc. and Price Communications Corporation, dated as of June 28, 1989, incorporated by reference to Exhibit 10(d) to Registration Statement on Form S-1 (File No. 33-30318).\n(o) Network Affiliation Agreement, dated September 10, 1982, between National Broadcasting Company, Inc., and Tri-State Broadcasting Corporation, as amended (KSNF-TV), incorporated by reference to Exhibit 10(v) to Registration Statement on Form S-1 (File No. 33-30318).\n(p) Network Affiliation Agreement, dated April 22, 1989, between National Broadcasting Company, Inc. and Continental Broadcasting Corporation (KJAC-TV), incorporated by reference to Exhibit 10(w) to Registration Statement on Form S-1 (File No. 33-30318).\n(q) Network Affiliation Agreement, dated January 1, 1981, between National Broadcasting Company, Inc. and Clay Broadcasting Corporation of Texas, as amended (KFDX-TV), incorporated by reference to Exhibit 10(x) to Registration Statement on Form S-1 (File No. 33-30318).\n(r) Stock Purchase Agreement dated March 1, 1990 among Time Warner Inc., Warner Communications Investors, Inc., Price Communications Corporation, and PriCellular Corporation, incorporated by reference to Exhibit (1) to\nE-4\nPage ----\nRegistrant's Form 8-K filed to report events of April 12, 1990.\n(s) Amendment No. 1 to Stock Purchase Agreement dated April 6, 1990, among Time Warner Inc., Warner Communications Investors, Inc., Price Communications Corporation, and PriCellular Corporation, incorporated by reference to Exhibit (2) to Registrant's Form 8-K filed to report an event of April 12, 1990.\n(t) Stock Option Agreement, dated April 12, 1990 between PriCellular Corporation and Warner Communications Investors, Inc., incorporated by reference to Exhibit (3) to Registrant's Form 8-K filed to report an event of April 12, 1990.\n(u) Line of Credit Agreement, dated as of December 21, 1993 among Atlantic Broadcasting Corporation, Southeast Texas Broadcasting Corporation, Texoma Broadcasting Corporation, Tri-State Broadcasting Corporation, the Lenders Parties Thereto and the Bank of Montreal, incorporated by reference to Exhibit 10(u) to the Registrant's Form 10-K for the year ended December 31, 1993.\n(v) Securities Purchase Agreement, dated December 30, 1993, among Apple Publishing Corporation, Price Communications Corporation, Equity-Linked Investors, L.P. and Equity-Linked Investors-II, incorporated by reference to Exhibit 10(v) to the Registrant's Form 10-K for the year ended December 31, 1993.\n(w) Agreement dated November 19, 1993, between Price Communications Corporation, Apple Publishing Corporation, the Sellers listed on Exhibit A thereto and W.R. Huff Asset Management Co., L.P., incorporated by reference to Exhibit 10(w) to the\nE-5\nPage ----\nRegistrant's Form 10-K for the year ended December 31, 1993.\n(x) Stock Purchase Agreement, dated as of October 1, 1993, by and between Price Communications Cellular, Inc., Price Communications Corporation and Atlas Cellular Corporation, incorporated by reference to Exhibit 10 to Registrant's Form 8-K filed to report an event of October 1, 1993.\n(y) Form of Indemnification Agreement between Registrant and its officers and directors, incorporated by reference to Exhibit 10(y) to the Registrant's Form 10-K for the year ended December 31, 1993.\n(z) Amended and Restated Line of Credit Agreement among the Co- Borrowers named therein, the Several Lenders named therein, and Bank of Montreal, as Agent, dated as of September 16, 1994.\n(aa) Employment Agreement, dated as of October 6, 1994, between the Registrant and Robert Price.\n(bb) Employment Agreement, dated as of January 5, 1995, between the Registrant and Kim Pressman.\n(cc) Stock Option Agreement, dated as of February 10, 1994, between the Registrant and Robert Price.\n(dd) Rights Agreement dated as of October 6, 1994 between the Registrant and Harris Trust Company of New York, incorporated by reference to Exhibit 4 to Registrant's Form 8-K filed to report an event on October 6, 1994.\n(ee) Amendment dated January 12, 1995 to Rights Agreement dated as of October 6, 1994 between the Registrant and Harris Trust Company of New York, incorporated by reference to Exhibit 4 to\nE-6\nPage ----\nRegistrant's Form 8-K filed to report an event on January 12, 1995.\n(ff) Securities Purchase Agreement, dated as of February 15, 1994, between the stockholders and warrant holders of Smith Acquisition Corp. and the Registrant, incorporated by reference to Exhibit 10 to the Registrant's Form 8-K filed to report an event of September 16, 1994.\n(11) Statement regarding computation of per share earnings (omitted; computation can be clearly determined from material contained in the Report).\n(21) Subsidiaries of Registrant.\n(24) The powers of attorney to sign amendments to this Report appear on the signature page.\n(27) Financial Data Schedule.\nE-7","section_15":""}
{"filename":"107815_1994.txt","cik":"107815","year":"1994","section_1":"ITEM 1. BUSINESS - Electric Utility Operations (Cont'd)\nThe 300 megawatt natural gas-fired combustion turbine peaking facility, located near Watertown, Wisconsin is expected to run approximately 5% of the time helping meet electric peak demand requirements.\nDuring 1994, Wisconsin Electric continued construction of the Paris Generating Station, a four unit, approximately 300 megawatt, gas-fired combustion turbine power plant, to be placed in service during the summer of 1995. The cost of this facility, located near Union Grove, Wisconsin, is currently estimated at $104 million.\nThe supply of natural gas to operate the Concord and Paris units is to be provided by Wisconsin Natural, an affiliated company, but may be purchased from other suppliers with Wisconsin Natural providing gas transportation services.\nWisconsin Electric and the Milwaukee Regional Medical Center (\"MRMC\"), received preliminary approval from Milwaukee County on September 22, 1994, for the purchase of the Milwaukee County Power Plant. The 11 megawatt power plant in Wauwatosa, Wisconsin provides steam, chilled water and electricity for the MRMC facilities. Under the terms of the agreement, Wisconsin Electric is expected to pay $7 million to $8 million for the electric generation and distribution facilities. The MRMC will purchase the plant's steam and water- chilling facilities. Wisconsin Electric will manage and operate the facility, and collect a management fee from the MRMC. Electric revenues of about $3 million annually will be generated from the investment. It is anticipated that this transaction will be finalized in 1995.\nApprovals from various regulatory agencies including the PSCW, the U. S. Environmental Protection Agency (\"EPA\") and the Wisconsin Department of Natural Resources (\"DNR\") are required prior to constructing new generation capacity. All proposed generating facilities will meet or exceed the applicable federal and state environmental requirements.\nFor further information regarding future capacity additions, see Item 1. BUSINESS - \"REGULATION\".\nFor information regarding estimated costs of Wisconsin Electric's construction program and projected investments in conservation programs for the five years ending December 31, 1999, see Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"LIQUIDITY AND CAPITAL RESOURCES\". All estimates of construction expenditures exclude Allowance For Funds Used During Construction. For additional information regarding matters related to Allowance for Funds Used During Construction, see Note D to the Financial Statements in Item 8.\nIn accordance with a PSCW order issued in November 1993, after completing a capacity-related competitive bidding process, Wisconsin Electric signed a long-term agreement to purchase the electricity that would be generated from a 215 megawatt cogeneration facility planned to be constructed by an unaffiliated independent power producer (\"IPP\"), LSP-Whitewater Limited Partnership. The agreement is contingent upon the facility being completed and going into operation, which at this time is planned for mid-1996. On March 9, 1995, the PSCW approved the IPP's application to construct a cogeneration plant in Whitewater, Wisconsin. For additional information and related matters, see Item 3. LEGAL PROCEEDINGS - \"OTHER LITIGATION - PSCW Two- Stage CPCN Order\" and Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"Capital Requirements 1995- 1999\". - 6 -\nITEM 1. BUSINESS - Electric Utility Operations (Cont'd)\nIn response to increasing competitive pressures in the markets for electricity and natural gas, Wisconsin Electric and Wisconsin Natural are implementing a revitalization process to increase efficiencies and improve customer service by reengineering and restructuring their organizations. The new structures consolidate many business functions and simplify work processes. Due to productivity improvements, staffing levels at Wisconsin Electric have been reduced; 347 employees elected to retire under an early retirement option and 573 employees have enrolled in severance packages. For additional information, see Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"Wisconsin Electric and Wisconsin Natural Revitalization\".\nSOURCES OF GENERATION\nThe table below indicates sources of energy generation by Wisconsin Electric:\nYear Ended December 31 ---------------------- 1994 1995* ---- ----- Coal 69.0% 69.8% Nuclear 29.0 27.9 Hydro-electric 1.4 1.6 Gas 0.5 0.6 Oil 0.1 0.1 ------ ------ TOTAL 100.0% 100.0% ------------------\n*Estimated assuming that there are no unforeseen contingencies such as unscheduled maintenance or repairs.\nCOAL: Wisconsin Electric diversifies its coal sources by purchasing from Northern Appalachia, the Southern Powder River Basin (Wyoming) and the Raton Basin (New Mexico) mining districts for the power plants in Wisconsin, and from central Appalachia and western mines for the Presque Isle Power Plant in Michigan.\nApproximately 75 percent of Wisconsin Electric's 1995 coal requirements are expected to be delivered by Wisconsin Electric-owned unit trains. The unit trains will transport coal for the Oak Creek and Pleasant Prairie Power Plants from New Mexico and Wyoming mines. Coal from Pennsylvania mines is transported via rail to Lake Erie transfer docks and delivered to the Valley and Port Washington Power Plants by lake vessels. Montana coal for Presque Isle is transported via rail to Superior, Wisconsin, placed in dock storage and reloaded into lake vessels for plant delivery. The Presque Isle central Appalachian origin and Colorado origin coal is shipped via rail to Lake Erie and Lake Michigan (Chicago) coal transfer docks, respectively, for lake vessel delivery to the plant. Wisconsin Electric's 1995 coal requirements, projected to be 10.0 million tons, are 98 percent under contract. Wisconsin Electric does not anticipate any problem in procuring its remaining 1995 requirements through short-term or spot purchases and inventory adjustments.\nPleasant Prairie Power Plant: All of the estimated 1995 coal requirements at this plant are presently covered by three long-term contracts.\n- 7 -\nITEM 1. BUSINESS - Sources of Generation (Cont'd)\nOak Creek Power Plant: All of the estimated 1995 coal requirements for this plant are covered by long-term contract. Contract provisions permit Wisconsin Electric to increase\/decrease the annual volume to match burn requirements.\nPresque Isle Power Plant: This plant has six generating units designed to burn bituminous coal and three other units designed to burn sub-bituminous coal. The units burning sub-bituminous coal are supplied by three long-term contracts the annual volumes of which are anticipated to be adequate to cover coal requirements through 1996. Bituminous coal is generally purchased through one-year contracts from central Appalachia and under a 5 year contract for the Colorado origin coal.\nEdgewater 5 Generating Unit: Coal for this unit, in which Wisconsin Electric has a 25 percent interest, is purchased by Wisconsin Power and Light Company, a non-affiliated utility, which is the majority owner of the facility.\nValley and Port Washington Power Plants: These plants are both supplied through a long-term contract that, in combination with coal supplied to Wisconsin Electric's other Wisconsin plants, allows the plants to meet the requirements of the Wisconsin acid rain law. In the event of further air quality emission requirements affecting these plants, the contract can be terminated without liability.\nThe periods and annual tonnage amounts for Wisconsin Electric's principal coal contracts are as follows:\nContract Period Annual Tonnage --------------- -------------- Jan. 1977 to Dec. 1996 240,000 Nov. 1987 to Dec. 1997 500,000(A) Jan. 1980 to Dec. 2006 2,000,000 Jul. 1983 to Dec. 2002 1,000,000 Apr. 1990 to Nov. 1996 375,000(B) Jan. 1992 to Dec. 2005 1,200,000(C)(1995) Oct. 1992 to Sep. 2007 2,000,000 Sep. 1994 to Aug. 1999 500,000\n--------------------------- (A) The contract can be extended if the total volume has not been purchased by the respective termination dates.\n(B) Annual volume can be increased to meet requirements for the Port Washington and Valley Power Plants above the 375,000 ton volume indicated herein.\n(C) Subsequent years may be of greater tonnage as allowed under certain provisions of the contract.\nFor information regarding emission restrictions, see Item 1. BUSINESS - ENVIRONMENTAL COMPLIANCE - \"Air Quality - Acid Rain Legislation\".\nNUCLEAR: Wisconsin Electric purchases uranium concentrates (\"yellowcake\") and contracts for its conversion, enrichment and fabrication. Wisconsin Electric maintains title to the nuclear fuel until the fabricated fuel assemblies are delivered to the Point Beach Nuclear Plant (\"Point Beach\"), whereupon it is sold to and leased back from the Wisconsin Electric Fuel Trust (\"Trust\"). See Note F to the Financial Statements in Item 8.\n- 8 -\nITEM 1. BUSINESS - Sources of Generation (Cont'd)\nUranium Requirements: Wisconsin Electric requires approximately 450,000 pounds of yellowcake annually for its two-units at Point Beach. Uranium requirements through 1997 will be provided from a combination of existing contracts with Malapai Resources Company (of Arizona); Energy Resources of Australia, Ltd.; and Nukem Inc. (U.S.). Wisconsin Electric may exercise flexibilities in these contracts and purchase certain quantities of uranium on the spot-market, should market conditions prove favorable. Wisconsin Electric believes that adequate supplies of uranium concentrates will be available to satisfy current and future operating requirements.\nUnder a contract with Nuexco Trading Corporation, Wisconsin Electric was to receive 200,000 pounds of uranium concentrates on specified delivery dates in 1995 at conversion facilities in the United States or Canada in exchange for the transfer to Nuexco of an identical quantity of concentrates held by Wisconsin Electric at the conversion facilities of Comurhex in France. However, Nuexco is in default under the contract and has filed for bankruptcy law protection. Wisconsin Electric is reviewing various options that might be available for use of its concentrates located at Comurhex.\nConversion: Wisconsin Electric has a contract with Sequoyah Fuels Corporation, a subsidiary of General Atomics, to provide conversion services for the Point Beach reactors through 1995. Due to operating difficulties encountered in 1992, Sequoyah Fuels has decided to place its Gore, Oklahoma conversion plant on indefinite stand-by. In November 1992, Sequoyah Fuels signed an agreement with Allied Signal Corporation which formed a partnership called Converdyn Corporation.\nConverdyn administers all existing Allied and Sequoyah contracts, with all conversion services being performed at the existing Allied Signal conversion facility in Metropolis, Illinois.\nWisconsin Electric also has a conversion contract with the Cameco Corporation, to provide for an alternate supply of up to approximately 30 percent of conversion requirements through 1995 and up to 100 percent of conversion requirements from 1996 through 1999. Cameco is a Canadian based corporation located in Saskatoon, Saskatchewan, and is a major producer of uranium concentrates.\nEnrichment: Wisconsin Electric currently has a Utility Services Contract with the U.S. Department of Energy (\"DOE\") for 70 percent of the enrichment services required for the operation of both of the Point Beach units. The contract can provide enrichment services for the entire operating life of each unit. For a discussion of litigation involving the Utility Services Contract, see Item 3. LEGAL PROCEEDINGS - OTHER LITIGATION - \"Uranium Enrichment Charges\". Wisconsin Electric entered into a supplemental agreement with the DOE to supply the remaining 30 percent of enrichment service requirements for the period through 1995 at prices below those offered under the Utility Services Contract. Responsibility for administering these contracts and agreements for enrichment services was transferred from DOE to the U.S. Enrichment Corporation (\"USEC\") under the Energy Policy Act of 1992. In March 1992, Wisconsin Electric entered into an agreement with Global Nuclear Services and Supply Limited, an international supplier of enrichment services, for the remaining 30 percent of enrichment service requirements after 1995.\nFabrication: Fabrication of fuel assemblies from enriched uranium for Point Beach is covered under a contract with Westinghouse Electric Corporation for the balance of the plant's current operating license.\n- 9 -\nITEM 1. BUSINESS - Sources of Generation (Cont'd)\nSpent Fuel Storage and Disposal: Wisconsin Electric currently has the capability to store certain amounts of spent nuclear fuel at Point Beach. Previous modifications to the storage facilities at Point Beach have made it possible to accommodate all spent fuel expected to be discharged from the reactors through 1995 while maintaining the capability for one full core off- load. In accordance with the provisions of the Nuclear Waste Policy Act of 1982, which require the DOE to provide for the disposal of spent fuel from all U.S. nuclear plants, Wisconsin Electric entered into a disposal contract providing for deliveries of spent fuel to the DOE for ultimate disposal commencing in January 1998. It is anticipated that the DOE will be unable to accept spent fuel by the 1998 timeframe as contracted. In November of 1991, Wisconsin Electric filed an application with the PSCW to construct and operate an Independent Spent Fuel Storage Installation (\"ISFSI\"). The ISFSI can provide additional interim dry cask storage until the DOE begins to remove spent fuel from Point Beach in accordance with the terms of the contract it has with Wisconsin Electric. Public hearings on the proposed project were held during October 1994. On February 13, 1995, Wisconsin Electric received a Certificate of Authority from the PSCW to construct and operate the ISFSI. Loading of the first storage unit of the ISFSI could take place in the summer of 1995. In March 1995 separate petitions were filed by intervenors in Dane County Circuit Court and Fond du Lac County Circuit Court. The Dane County petition seeks reversal of the order and a remand to the PSCW directing it to deny Wisconsin Electric's request for authorization to construct the dry cask facility, or in the alternative, to correct the alleged errors in the PSCW's order. No specific relief is identified in the Fond du Lac County petition; however, numerous grounds of error are alleged. Wisconsin Electric intends to fully participate in both judicial review proceedings and to vigorously oppose the petitions. For additional information, see Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"Capital Requirements 1995-1999\".\nPoint Beach Nuclear Plant: Point Beach provided 29 percent of Wisconsin Electric's net generation in 1994. The plant has two generating units which had a combined dependable capability during December 1994 of 980 megawatts and which together constituted 18.3 percent of Wisconsin Electric's dependable generating capability in 1994. The U.S. Nuclear Regulatory Commission (\"NRC\") licenses for Point Beach Units 1 and 2 expire October 5, 2010 and March 8, 2013, respectively.\nThe NRC has, at various times, directed that certain inspections, modifications and changes in operating practices be made at all nuclear plants. At Point Beach, such inspections have been made and necessary changes to equipment and in operating practices have either been completed or are expected to be completed within the time schedules permitted by the NRC or within approved extensions thereof.\nWisconsin Electric has initiated certain plant betterment projects at Point Beach that are judged to be appropriate and beneficial. Construction is progressing on the addition of two safety-related emergency diesel powered electrical generators with installation to be completed in 1996.\nOn October 1, 1992, Wisconsin Electric filed an application with the PSCW for the replacement of the Unit 2 steam generators, which would allow for the unit's operation until the expiration of its operating license in 2013. This project is estimated to cost $119 million. (In 1984 Wisconsin Electric replaced the Unit 1 steam generators.) The PSCW deferred the decision on the steam generator replacements until after the next refueling outage in\n- 10 -\nITEM 1. BUSINESS - Sources of Generation (Cont'd)\nSeptember 1995. In the Interim Order dated February 13, 1995, the PSCW directed Wisconsin Electric to make suitable arrangements with the fabricator of the new steam generators to allow the fabrication, delivery and replacement to proceed promptly if authorized by the PSCW as result of further investigation. The reasonable costs of such arrangements to maintain a place in line with the fabricator will be afforded rate recovery. It is anticipated that the final order in this matter will be issued in early 1996. Without the replacement of the steam generators, it is believed the unit would not be able to operate to the end of its current license.\nDecommissioning Fund: Pursuant to a 1985 PSCW order amended in 1994, Wisconsin Electric provides for costs associated with the eventual decommissioning of Point Beach through the use of an external trust fund. Payments to this fund, together with investment earnings, brought the balance in the trust fund on December 31, 1994 to approximately $227 million. For additional information regarding decommissioning see Note F to the Financial Statements in Item 8.\nNuclear Plant Insurance: For information regarding matters pertaining to nuclear plant insurance, see Note F to the Financial Statements in Item 8.\nNATURAL GAS (FOR ELECTRIC GENERATION): Natural gas for boiler ignition and flame stabilization purposes for the Pleasant Prairie, Oak Creek and Valley Power Plants, is purchased under an agency agreement. The agent purchases natural gas and arranges for interstate pipeline transportation to the local gas distribution utility. Gas for the Pleasant Prairie and Oak Creek Power Plants is delivered by Wisconsin Natural. Gas for the Valley Power Plant is delivered by Wisconsin Gas Company, a non-affiliated company.\nThe Concord Generation Station and the Oak Creek combustion turbine use natural gas as their primary fuel, with Number 2 fuel oil as backup, as will the Paris Generating Station, expected to go into commercial service in the summer of 1995. Gas for these plants may be purchased directly from Wisconsin Natural on an interruptible basis.\nOIL: Oil is used for combustion turbines at the Germantown and Port Washington Power Plants and at Point Beach. Small amounts of oil are also used for boiler ignition and flame stabilization at some coal-fired plants. Number 2 fuel oil requirements for 1995 at the Presque Isle Power Plant and the Point Beach combustion turbine are provided under one-year contracts with equitable price adjustment formulas. All other oil requirements are purchased as needed from local suppliers. The Concord and Paris Generating Stations and the Oak Creek combustion turbine use oil as a secondary fuel source.\nHYDRO: Wisconsin Electric has various licenses from the Federal Energy Regulatory Commission (\"FERC\") for its hydroelectric generating facilities that expire during the period 1998 to 2004. Wisconsin Electric has begun the licensing process for its largest hydro facility, Big Quinnesec Falls, which has a license expiring in 1998. Wisconsin Electric continues to support FERC's efforts to complete the licensing process and issue licenses for four hydro projects with 1993 expiration dates. These projects are currently being operated by Wisconsin Electric under annual licenses issued by FERC. The three hydro facilities, with a total of 2.5 megawatts installed capacity, that Wisconsin Electric decided not to relicense in 1993 are still being operated by Wisconsin Electric under annual licenses until FERC determines their disposition. Wisconsin Electric continues to consult with the U.S. Fish and\n- 11 -\nITEM 1. BUSINESS - Sources of Generation (Cont'd)\nWildlife Service, DNR, Michigan Department of Natural Resources (\"MDNR\") and the National Park Service in conjunction with the licensing process. Hydroelectric facilities provided 1.4% of Wisconsin Electric's total energy generation in 1994.\nINTERCONNECTIONS WITH OTHER UTILITIES: Wisconsin Electric's system is interconnected at various locations with the systems of Madison Gas and Electric Company, Wisconsin Power and Light Company, Wisconsin Public Service Corporation, Commonwealth Edison Company, Northern States Power Company and Upper Peninsula Power Company. These interconnections provide for interchange of power to assure system reliability as well as facilitating access to generating capacity and the transfer of energy for economic purposes.\nWisconsin Electric is a member of Wisconsin-Upper Michigan Systems (\"WUMS\"), a coordinating group which includes four other electric companies in Wisconsin and Upper Michigan. WUMS, in turn, is a member of Mid-America Interconnected Network, which is one of nine regional members of the North American Electric Reliability Council. Membership in these groups permits better utilization of reserve generating capacity and coordination of long-range system planning and day-to-day operations.\nIn March 1994, Wisconsin Electric executed a transmission service agreement with Commonwealth Edison that will allow Wisconsin Electric to purchase energy from southern Illinois and Indiana suppliers, using the Commonwealth Edison transmission system to import such energy into Wisconsin.\nA transmission service agreement has been executed to allow Wisconsin Electric to reserve capacity and import energy from members of the Mid-Continent Area Power Pool (\"MAPP\"), a group consisting of electric utilities generally located west of Wisconsin. Considerable non-firm energy is expected to be purchased from MAPP members over the next several years.\nSALES TO WHOLESALE CUSTOMERS: Wisconsin Electric currently provides wholesale electric energy to five municipally owned systems, three rural cooperatives, two municipal joint action agencies and one isolated system of an investor- owned utility in Wisconsin, Illinois, and the Upper Peninsula of Michigan under rates approved by the FERC. Sales to these wholesale customers accounted for 5.3 percent of total kilowatt-hour sales in 1994. Under two agreements, service is being provided subject to a seven-year notice of cancellation from the Wisconsin Public Power Inc. SYSTEM (\"WPPI\"). Wisconsin Electric also has an eight-year power supply agreement with the Badger Power Marketing Authority. Sales to the Badger Power Marketing Authority and WPPI combined are expected to account for approximately one half of the wholesale sales for 1995.\nService to UPPCO, under a 65 megawatt agreement which expires on December 31, 1997, is expected to account for 30 percent of 1995 wholesale sales. In October 1993, UPPCO announced that it had reached an agreement in principle with NSP to purchase 90 megawatts of base-load electric energy beginning in 1998. Wisconsin Electric expects to apply the 65 megawatts of capacity toward the electric energy needs of new customers and toward the overall increase in system supply needs anticipated by 1998.\nService to the remaining wholesale customers is provided under agreements which require a three-year notice of cancellation from the customers.\n- 12 -\nITEM 1. BUSINESS - Sources of Generation (Cont'd)\nDuring 1994, sales to wholesale customers declined 10.4 percent from 1993, largely the result of reductions in sales to WPPI. WPPI has been reducing its purchases from Wisconsin Electric subsequent to acquiring generation capacity in 1990. Sales to WPPI during 1994, 1993 and 1992 were approximately 725,000 megawatt-hours (\"MWh\"), 944,000 MWh and 1,166,000 MWh, respectively. Further reductions are expected as WPPI installs additional capacity. These sales reductions are not expected to have a significant effect on future earnings. Under the provisions of a long-term agreement, Wisconsin Electric will continue to provide transmission services to WPPI.\nWisconsin Electric's existing FERC tariffs also provide for transmission service to its wholesale customers. During 1994, Wisconsin Electric had three customers taking transmission service. For further information see Item 1. BUSINESS - \"REGULATION\".\nIn October 1992, the Energy Policy Act was signed into law. Passage of this law is expected to remove perceived encumbrances and facilitate the entry of power producers into the already competitive bulk power market. Notable among its provisions are the creation of a new class of energy producer called Exempt Wholesale Generators (\"EWGs\"), who are exempt from the requirements of the Public Utility Holding Company Act of 1935, and the rights that the Energy Policy Act provides them and utilities to request a FERC order directing the provision of transmission service if denied transmission access from utilities. The transmission aspects of this law are expected to have little impact on Wisconsin Electric since it has had open access transmission tariffs on file with the FERC since 1980.\nIn September 1994 Wisconsin Electric, responding to WPPI's request and a PSCW order in a transmission construction proceeding, filed an unexecuted Network Transmission Service Agreement for service to WPPI at the FERC. In November 1994 Wisconsin Electric made a second filing at the FERC to extend network transmission service to non-WPPI wholesale customers. The proposed Network Transmission Service is firm service for the loads of wholesale customers located in Wisconsin Electric's retail service area. It is designed to be comparable to service provided for the Company's native load.\nThe electric utility industry continues to become increasingly competitive. Some municipal utilities are approaching competing utilities in a search for lower energy prices. Additionally, some large industrial customers are seeking regulatory changes that could permit retail wheeling to allow them to seek proposals for energy from alternate suppliers. IPPs are also exploring cogeneration projects which would provide process steam to customers in Wisconsin Electric's service territory and sell electricity to Wisconsin Electric. Consequently, electric wholesale and large retail customers of Wisconsin Electric or other non-affiliated utilities may determine, from time to time, to switch energy suppliers, purchase interests in existing power plants or build new generating capacity, either directly or through joint ventures with third parties. The advent of EWGs can be expected to accelerate this practice. For additional information, see Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"LIQUIDITY AND CAPITAL RESOURCES\".\nSALES TO LARGE CUSTOMERS\nWisconsin Electric provides utility service to a diversified base of industrial customers. Major industries served include the iron ore mining industry, the paper industry, the machinery production industry, the foundry\n- 13 -\nITEM 1. BUSINESS - Sales to Large Customers (Cont'd)\nindustry and the food products industry. The Empire and Tilden iron ore mines, the two largest customers of Wisconsin Electric, accounted for 4.6 percent and 4.0 percent, respectively, of total electric kilowatt-hour sales in 1994. Sales to the mines were 15.0 percent higher in 1994 compared to 1993, attributable to a five week strike in 1993. For additional information, see Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"Electric Sales and Revenues\".\nSTEAM UTILITY OPERATIONS\nWisconsin Electric operates a district steam system for space heating and processing in downtown and near southside Milwaukee. Sales of the steam utility fluctuate with the heating cycle of the year and are impacted by varying weather conditions from year-to-year. The system consists of approximately 28 miles of high and low pressure mains and related regulating equipment. Steam for the system is supplied by Wisconsin Electric's Valley Power Plant. At December 31, 1994, there were 471 customers on the system. Steam sales in 1994 were 2,395 million pounds, an increase of 0.8 percent from the 2,376 million pounds sold in 1993.\nREGULATION\nWisconsin Electric is subject to the regulation of the PSCW as to retail electric and steam rates in Wisconsin, standards of service, issuance of securities, construction of new facilities, transactions with affiliates, levels of short-term debt obligations, billing practices and various other matters. Wisconsin Electric is also subject to the regulation of the MPSC as to the various matters associated with retail electric service in Michigan as noted above except as to construction of certain new facilities, levels of short-term debt obligations and advance approval of transactions with affiliates. Wisconsin Electric, with respect to hydro-electric facilities, wholesale rates and accounting, is subject to FERC regulation. Operation and construction relating to Wisconsin Electric's Point Beach facilities are subject to regulation by the NRC. Wisconsin Electric's operations are also subject to regulations of the EPA, the DNR and the MDNR.\nThe PSCW is authorized to direct expenditures for promoting conservation if it determines that the programs are in the public interest. Recent rate orders have included provisions for substantial conservation programs initiated by Wisconsin Electric. For additional information, see Note A to the Financial Statements in Item 8.\nWisconsin Electric is subject to a power plant siting law in Wisconsin which requires that electric utilities file updated long-term forecasts (called \"Advance Plans\") for the location, size and type of future large generating plants and high voltage transmission lines about every two years for PSCW approval after public hearings. Generally, the law provides that the PSCW may not authorize the construction of any large generating plants or high voltage transmission lines unless they are in substantial compliance with the most recently approved plan. The law also prohibits Wisconsin Electric from acquiring any interest in land for such plants or transmission lines by condemnation until construction authorization has been received. Advance Plan orders are based on a review of the utilities' long-term planning options. However, separate project-specific PSCW approval is required for the construction of generating facilities and transmission lines.\n- 14 -\nITEM 1. BUSINESS - Regulation (Cont'd)\nWisconsin Electric employs a least-cost integrated planning process, which examines a full range of supply and demand side options to meet its customers' electric needs, such as the renovation of existing power plants, promotion of cost-effective conservation and load management options, development of renewable energy sources, purchased power and construction of new company- owned generation facilities.\nFor additional information regarding Advance Plans, see Item 3. LEGAL PROCEEDINGS - \"OTHER LITIGATION\" and Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"LIQUIDITY AND CAPITAL RESOURCES\".\nIn 1992, the PSCW ordered that utilities should include a cost of $15 per ton of carbon dioxide (\"CO2\") when comparing resource planning options (both supply and demand-side) to account for the economic risk of future greenhouse gas regulation. Appeals through 1993 and 1994 did not substantially change the order. Recent supply and DSM plans included the greenhouse gas adder. There are only minor differences in supply and DSM plans prepared with and without the greenhouse gas adder.\nIn 1994, the PSCW ordered the state's utilities to competitively bid all new generation needs in excess of 12 megawatts to be built in Wisconsin. The two stage process established by the PSCW consists of: (1) an all-parties (including utilities) bidding procedure for fossil-fueled and renewable generation projects and (2) the conventional Certificate of Public Convenience and Necessity (\"CPCN\") procedure for the winner or winners. For additional information regarding the CPCN process, see Item 3. LEGAL PROCEEDINGS - OTHER LITIGATION and Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"Capital Requirements 1995-1999.\"\nThe PSCW is conducting an investigation into the state of the electric utility industry in Wisconsin, particularly its institutional structure and regulatory regime, in order to evaluate what changes would be beneficial for Wisconsin. The PSCW stated that this investigation may result in profound and fundamental changes to the nature and regulation of the electric utility industry in Wisconsin. About 50 interested parties, including Wisconsin Electric, submitted comments as to appropriate objectives for regulation of the electric utility industry and the utility structures and regulatory approaches likely to provide the best balance of such objectives. Initial question and answer sessions were held in November, 1994. The PSCW also scheduled meetings for early 1995 for the purpose of narrowing the scope of the investigation and has indicated it anticipates submitting a final report to the Wisconsin Legislature in late 1995. Copies of Wisconsin Electric's proposal are available upon request.\nWisconsin Electric's view of industry restructuring separates various electric utility functions into two major categories - natural monopolies and competitive entities. The natural monopolies are functions where a single entity can provide the lowest cost. The competitive entities are functions where competition can provide the lowest cost. The natural monopolies would be re-regulated so the appropriate incentives exist to provide electricity at reasonable prices. The competitive entities would eventually see an elimination of traditional regulation.\nIn Wisconsin Electric's plan, the re-regulated natural monopolies are the transmission and distribution functions. Re-regulation of these entities should involve some form of price cap and performance-standard operation rules. In the new structure, the FERC would regulate the transmission - 15 -\nITEM 1. BUSINESS - Regulation (Cont'd)\nsystems through a regional transmission group to ensure open access, comparable pricing, comparable service and adequate cost recovery. The PSCW would regulate the distribution function for reasonable price, reliability, public safety and customer satisfaction.\nThe competitive entities in the Wisconsin Electric model are the generation, customer service and energy merchant functions. In the restructured electric utility industry, utilities would unbundle costs into the individual components of generation, transmission, distribution and service.\nRATE MATTERS\nSee Item 3. LEGAL PROCEEDINGS - \"RATE MATTERS\" - for a discussion of rate matters, including recent rate changes and a discussion of the tariffs and procedures with respect to recovery of changes in the costs of fuel and purchased power.\nENERGY EFFICIENCY\nThe management of Wisconsin Electric believes that a strong and continuing emphasis must be placed on energy management and efficient energy use. Wisconsin Electric is continuing to develop programs to inform and assist its customers with respect to conservation options. This policy is regarded by Wisconsin Electric as in the best interests of its customers and security holders.\nEfficient use of energy is not limited to reduced consumption. Time-of-use rates for certain electric customers promote the shifting of electricity usage to those times when electric generating facilities are not fully utilized. Interruptible and curtailable rates, along with an energy cooperative managed load curtailment program, are offered to certain industrial customers to control peak demand. Direct load control of some residential central air conditioners continues as part of a pilot program which began in 1992.\nTo promote its energy management and conservation policies, Wisconsin Electric offers various programs and services to its customers. For industrial and commercial customers, Wisconsin Electric offers energy evaluations identifying cost-effective customer conservation opportunities as well as financial assistance, including direct grants and interest-free financing to purchase and maintain energy-efficient equipment. Additional financial incentives are also offered to residential electric customers to encourage the purchase of energy-efficient appliances and the removal of older inefficient appliances from the system.\nENVIRONMENTAL COMPLIANCE\nCompliance with federal, state and local environmental protection requirements resulted in capital expenditures by Wisconsin Electric of approximately $57 million in 1994, a decrease of $8 million from 1993. Expenditures incurred during 1994 included costs associated with the replacement of the precipitators at Valley Power Plant the installation of pollution abatement facilities at Wisconsin Electric's power plants, the installation of underground distribution lines and environmental studies associated with power plants. Such expenditures are budgeted at approximately $35 million for 1995.\nOperation, maintenance and depreciation expenses of Wisconsin Electric's fly ash removal equipment and other environmental protection systems are estimated to have been $47 million in 1994. Other environmental costs, primarily for environmental studies, amounted to $1 million in 1994. - 16 -\nITEM 1. BUSINESS - Environmental Compliance (Cont'd)\nSolid Waste Landfills\nWisconsin Electric provides for the disposal of non-ash related solid wastes and hazardous wastes through licensed independent contractors, but federal statutory provisions impose joint and several liability on the generators of waste for certain cleanup costs. Remediation-related activity pertaining to specific sites is discussed below.\nMuskego Sanitary Landfill: In 1992, Wisconsin Electric was informed by the EPA that it was included in a group of approximately 50 potentially responsible parties (\"PRPs\") against which the EPA will issue orders requiring that the PRPs clean up the Muskego Sanitary Landfill (located in Southeastern Waukesha County, Wisconsin). On January 14, 1993, Wisconsin Electric notified EPA that it was proceeding, with other PRPs, to comply with the order. The first step toward remediation has been identified with the Wisconsin Electric portion of the $16.8 million dollar effort identified as $115,414 (paid in 1994). Remedial actions for the second step (Groundwater Operable Unit Remedy) are being evaluated, with EPA recommending a limited pump and treat option, estimated to cost $7.4 million. Costs would be allocated among the PRPs based on their waste contribution to the site. Wisconsin Electric has been identified as one of the small waste contributors to the site.\nMaxey Flats Nuclear Disposal Site: In 1986, Wisconsin Electric was advised by EPA that it is one of a number of PRPs for cleanup at this low-level radioactive waste site located in Morehead, Kentucky. The amount of waste contributed by Wisconsin Electric is significantly less than one percent of the total. Under the terms of a consent decree agreed to by all parties, Wisconsin Electric will pay the amount of $163,830 (minus a small credit for an amount previously paid) as its share of the settlement fund for site clean up costs.\nManistique River\/Harbor Area: Wisconsin Electric received a request for information or PRP letter from EPA on March 12, 1993. The letter states that the river\/harbor has PCB contamination. EPA has requested information regarding company PCB and oil filled equipment management in the Manistique River drainage basin. Wisconsin Electric responded to this request on April 22, 1993. Additional information requests from EPA have also been responded to by Wisconsin Electric. Wisconsin Electric has no reason to believe that the company is responsible in total or in part for the PCB contamination in the Manistique River\/harbor area. Wisconsin Electric has learned through newspaper articles that the EPA announced a preliminary plan to dredge most of the PCB-contaminated sediments, with only limited capping along the breakwater. The two identified PRPs, Manistique Papers and Edison Sault Electric Company, have advocated installation of a permanent cap.\nKenosha Iron and Metal: Wisconsin Electric received a request for information or PRP letter from EPA on December 9, 1994. The letter requested information regarding any involvement Wisconsin Electric's Pleasant Prairie Power Plant may have had with this operation. A response to EPA was sent December 29, 1994 indicating that Wisconsin Electric had no reason to believe that the power plant or Wisconsin Electric did any business with Kenosha Iron and Metal. No cleanup schedule has been set or remediation costs identified.\n- 17 -\nITEM 1. BUSINESS - Environmental Compliance (Cont'd)\nMarina Cliffs Barrel Dump Site: Wisconsin Electric received a special notice letter and information request on March 25, 1994 from the DNR. The letter describes a release of hazardous substances at a former barrel reclamation facility and landfill site, and requests information on any business dealings Wisconsin Electric may have had with this former operation. Wisconsin Electric has no reason to believe that it is responsible for the contamination problems at this site. No known cleanup schedule has been set or remediation costs identified.\nETSM Property: Iron cyanide bearing wastes were found both on property owned by Wisconsin Electric (ETSM facility) and adjacent landowners. The wastes were removed and properly disposed, with Wisconsin Electric's share of the cleanup at about $100,000. Adjacent landowners believe Wisconsin Electric to be the source of the material, however, records do not support that allegation.\nAsh Landfills\nWisconsin Electric aggressively seeks environmentally acceptable, beneficial uses of its combustion byproducts. However, ash materials have been, and to some degree, continue to be disposed in company-owned, licensed landfills. Some early designed and constructed landfills may allow the release of low levels of constituents, resulting in the need for various levels of remediation. These costs are included in the environmental operating and maintenance costs for Wisconsin Electric. Sites currently undergoing remediation include:\nPresque Isle Landfill: Wisconsin Electric entered into a settlement agreement with the MDNR for conditions existing at an ash landfill site acquired by Wisconsin Electric when it purchased the Presque Isle Power Plant in 1988. Wisconsin Electric's groundwater monitoring program at the site detected elevated levels of certain substances at the oldest portion of the landfill. Wisconsin Electric has reconstructed and capped that portion of the landfill to prevent further leachate from entering the groundwater at an approximate cost of $2.6 million. The cost to implement a remediation plan for the cleanup of the current groundwater conditions, when approved by the MDNR, is estimated to not exceed $1 million.\nHighway 59 Landfill: In 1989, a sulfate plume was detected in the groundwater beneath a Wisconsin Electric-owned former ash landfill located in the town of Waukesha, Wisconsin. After notifying the DNR, Wisconsin Electric initiated a five-year expanded monitoring program. In response to a request from the DNR, Wisconsin Electric is preparing an environmental contamination assessment of the landfill, and will submit the report to the DNR in May, 1995. Wisconsin Electric believes that any remediation plan developed, approved and implemented for this site would not have a material adverse effect on its financial condition.\nAir Quality - Acid Rain Legislation\nIn 1986, the Wisconsin Legislature passed legislation establishing new sulfur dioxide (\"SO2\") limitations applicable to Wisconsin's five major electric utilities, including Wisconsin Electric. The law requires each of the five\n- 18 -\nITEM 1. BUSINESS - (Cont'd)\nmajor electric utilities to meet a 1.20 lb SO2 per million BTU corporate average annual emission rate limit beginning in 1993. Prior to 1993, Wisconsin law limited the total annual SO2 emissions from the five major electric utilities to 500,000 tons per year. During 1994, approximately 181,000 tons of SO2 were emitted by such utilities, equivalent to an annual average emission rate of 0.97 lbs SO2 per million BTU.\nWisconsin Electric's compliance plan to meet the SO2 limitations under Wisconsin's acid rain law includes the increased use of low-sulfur coal at certain power plant units. Some changes to existing power plant equipment were made to accommodate the use of low-sulfur coals.\nThe 1990 amendments to the Federal Clean Air Act mandate significant nation- wide reductions in air emissions. Most significant to the country's electric utility companies are the \"acid rain\" provisions of the amendments which are scheduled to limit SO2 and nitrogen oxide (\"NOX\") emissions in phases which take effect in 1995 and 2000. Wisconsin Electric evaluated the potential impact resulting from this legislation and concluded that minimal impact will result from Phase I requirements because of actions taken to meet the above mentioned Wisconsin acid rain law. Phase II requirements, together with separate ozone nonattainment provisions of the Clean Air Act which may call for additional NOX reductions, however, will necessitate the implementation of a compliance strategy which is not expected to impact rates. Since a portion of the regulations that have been issued by the EPA are not complete or are not yet final, the rate impact is subject to change and will be reevaluated as needed.\nFor additional information regarding the impact of the Clean Air Act Amendments, including estimates of the cost of compliance, see Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"Environmental Issues\".\nOTHER\nWisconsin Electric is authorized to provide electric service in designated territories in the state of Wisconsin, as established by indeterminate permits, certificates of public convenience and necessity, or boundary agreements with other utilities. Wisconsin Electric provides electric service in certain territories in the state of Michigan pursuant to franchises granted by municipalities.\nResearch and development expenditures of Wisconsin Electric amounted to $7,996,000 in 1994, $8,485,000 in 1993, and $7,835,000 in 1992. Such expenditures were primarily for improvement of service and abatement of air and water pollution. The capitalized portion of research and development costs amounted to $15,000 in 1993 and $55,000 in 1992; there were no such capitalized costs in 1994. Research and development activities include work done by employees, consultants and contractors, plus sponsorship of research by industry associations.\nAt December 31, 1994, Wisconsin Electric employed 4,132 persons, of which 105 were part-time.\n- 19 -\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nWisconsin Electric owns the following generating stations with 1994 capabilities as indicated: Dependable Capability In Megawatts (1) ----------------------- No. of Generating August December Name Fuel Units 1994 1994 ---- ---- ---------- ------- -------- Steam Plants: Point Beach Nuclear 2 974 980 Oak Creek Coal 4 1,135 1,141 Presque Isle (2) Coal 9 612 612 Pleasant Prairie Coal 2 1,200 1,210 Port Washington Coal 4 322 324 Valley Coal 2 267 227 Edgewater (3) Coal 1 98 98 -- ----- ----- TOTAL STEAM 24 4,608 4,592\nHydro Plants (16 in number) 38 75 75 Germantown Combustion Turbines Oil 4 212 252 Other Combustion Turbines & Diesel(4) Gas\/Oil 6 393 450 -- ----- ----- TOTAL SYSTEM 72 5,288 5,369 == ===== =====\n------------------- (1) Dependable capability is the net power output under average operating conditions with equipment in an average state of repair as of a given month in a given year. Changing seasonal conditions are responsible for the different capabilities reported for the winter and summer periods in the above table. The values were established by test and may change slightly from year to year.\n(2) UPPCO, a non-affiliated utility, staffs and operates the Presque Isle Power Plant under an operating agreement with Wisconsin Electric which extends through December 31, 1997.\n(3) Wisconsin Electric has a 25 percent interest in Edgewater 5 Generating Unit, which is operated by Wisconsin Power and Light Company, a non- affiliated utility.\n(4) During the second quarter of 1994, two units, or approximately 150 megawatts of additional peaking combustion turbine generation capacity, were placed in service at Wisconsin Electric's Concord Generating Station.\nAt December 31, 1994, the Wisconsin Electric system had 2,759 miles of transmission circuits, of which 639 miles were operating at 345 kilovolts, 123 miles at 230 kilovolts, 1,603 miles at 138 kilovolts, and 394 miles at voltage levels less than 138 kilovolts. At December 31, 1994, Wisconsin Electric was operating 22,327 pole miles of overhead distribution lines and 13,481 miles of underground distribution cable, as well as 360 distribution substations and 216,973 line transformers.\n- 20 -\nITEM 2. PROPERTIES - (Cont'd)\nWisconsin Electric owns various office buildings and service centers throughout its service area. The principal properties of Wisconsin Electric are owned in fee except that the major portion of electric transmission and distribution lines and steam distribution mains are located, for the most part, on or in streets and highways and on land owned by others. Substantially all utility property is subject to a first mortgage lien.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nENVIRONMENTAL MATTERS\nWisconsin Electric is subject to federal, state and certain local laws and regulations governing the environmental aspects of its operations. Wisconsin Electric believes that, with immaterial exceptions, its existing facilities are in compliance with applicable environmental requirements.\nStephenson Building: Crown Life Insurance Company has sued Wisconsin Electric in federal court, seeking contribution and damages from Wisconsin Electric for the cost of removing asbestos from boilers and piping in a building owned by Crown Life. Wisconsin Electric sold that equipment and piping to a former building owner in 1970. Wisconsin Electric is defending this lawsuit.\nSee Item 1. BUSINESS - ENVIRONMENTAL COMPLIANCE for a discussion of matters related to certain solid waste and ash landfills sites.\nRATE MATTERS\nWisconsin Retail Electric Jurisdiction\nFuel Cost Adjustment Procedure: Wisconsin Electric's retail rates in Wisconsin do not contain an automatic fuel adjustment clause, but can be adjusted by the PSCW if actual cumulative fuel and purchased power costs, when compared to the costs projected in the retail electric rate proceeding, deviate from a prescribed range and are expected to continue to be above or below the authorized annual range of 3 percent.\n1994 Fuel Cost Adjustment: Effective August 4, 1994 the PSCW authorized Wisconsin Electric to reduce Wisconsin retail electric rates through the use of a fuel adjustment credit to reflect lower fuel and purchased power expenses. The adjustment reduced Wisconsin retail electric revenue by approximately $6.8 million through December 31, 1994. The level of fuel expenses currently included in rates will continue until either the actual cumulative fuel and purchased power costs exceed the range in the fuel cost adjustment procedure, at which time Wisconsin Electric can apply for a change to the fuel adjustment factor currently in place, or rates are revised by the PSCW in a rate case.\n1994 Test Year: In April 1993, Wisconsin Electric filed with the PSCW required data relating to the 1994 test year. In support of its goal to become the lowest-cost energy provider in the region, Wisconsin Electric did not seek an increase in retail electric rates for 1994 over those which were authorized on February 17, 1993.\n1995 Test Year: In 1993 the PSCW discontinued the practice of conducting annual rate case proceedings, replacing it with a new schedule which calls for future rate cases to be conducted once every two years. As a result, no filing was made with respect to the 1995 test year.\n- 21 -\nITEM 3. LEGAL PROCEEDINGS - Rate Matters (Cont'd)\n1996 Test Year: Under the PSCW's biennial rate case schedule, Wisconsin Electric would be scheduled to file in mid-1995 for rates to reflect a 1996 test year. Wisconsin Electric and Wisconsin Natural may make a single combined filing covering electric, steam and gas operations in May 1995 for the test year beginning January 1, 1996. On March 27, 1995, Wisconsin Electric and Wisconsin Natural sent a letter to the PSCW proposing a one year deferral of their upcoming rate case filing. The matter is pending.\nWholesale Electric Jurisdiction\nFuel and Purchased Power Adjustment Tariffs: Wisconsin Electric's wholesale rates contain an automatic fuel adjustment provision to reflect varying fuel and purchased power costs. Wholesale sales, to municipals and cooperatives, represented approximately 5% of total electric sales in 1994.\nMichigan Retail Electric Jurisdiction\n1993 Test Year: Effective July 9, 1993, the MPSC authorized an annualized rate increase of $1.4 million, or 4.3%, for Wisconsin Electric's non-mine retail electric customers. Excluding sales to the two mine customers, which are separately regulated by the MPSC, retail electric sales in Michigan account for approximately 2% of Wisconsin Electric's total kilowatt-hour sales.\nPower Supply Cost Recovery Clause: Rates are adjusted to reflect varying fuel and purchased power costs through a power supply cost recovery (\"PSCR\") clause in Wisconsin Electric's tariffs. Such PSCR clause provides for, among other things, an annual filing of a PSCR plan and, after notice and an opportunity for hearing, the development of PSCR factors to be applied to customers' bills during the period covered by the PSCR plan to allow Wisconsin Electric to recover its costs of fuel and purchased power transactions, as estimated in its annual filing. The amounts so collected are subject to a reconciliation proceeding conducted by the MPSC at the end of the period covered by the plan for recovery of any undercollections of actual costs or for refund or credit of any amounts in excess of its actual costs in such period. On November 30, 1994, the MPSC approved the proposed PSCR credit factor of $.00535 per kilowatt-hour for the year 1995.\nWisconsin Retail Steam Jurisdiction\nFuel Adjustment: Wisconsin Electric steam rates contain a provision to adjust rates to reflect varying fuel costs for all customers except for a large volume contract representing approximately 14 percent of steam sales in 1994.\n1994 Test Year: Consistent with the actions taken with respect to Wisconsin Electric's Wisconsin Retail Electric Jurisdiction, Wisconsin Electric did not seek an increase in retail steam rates for 1994 above those authorized in February 1993.\n1995 Test Year: In 1993 the PSCW discontinued the practice of conducting annual rate case proceedings, replacing it with a new schedule which calls for future rate cases to be conducted once every two years. As a result, no filing was made with respect to the 1995 test year.\n1996 Test Year: Under the PSCW's biennial rate case schedule, Wisconsin Electric would be scheduled to file in mid-1995 for rates to reflect a 1996 test year period. Wisconsin Electric and Wisconsin Natural may make a single\n- 22 -\nITEM 3. LEGAL PROCEEDINGS - Rate Matters (Cont'd)\ncombined filing covering electric, steam, and gas operations in May, 1995, for the test year beginning January 1, 1996. On March 27, 1995, Wisconsin Electric and Wisconsin Natural sent a letter to the PSCW proposing a one year deferral of their upcoming rate case filing. The matter is pending.\nFor additional information see Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"Rates and Regulatory Matters\".\nOTHER LITIGATION\nAdvance Plan 6: In 1992, Wisconsin Electric joined with other state utilities in a petition filed in Brown County Circuit Court requesting judicial review of one aspect of the PSCW's Advance Plan 6 order. The action involved the Commission's authority to require the utilities to consider, in their planning, monetized effects of so-called \"greenhouse gases\".\nAlso, in 1992, Wisconsin's Environmental Decade (\"WED\") filed a petition in Dane County Circuit Court requesting judicial review of another aspect of the PSCW's Advance Plan 6 order. That proceeding involved the question of whether the PSCW should have required the utilities to reflect, in their planning, claimed beneficial employment impacts associated with demand-side management activities and whether the PSCW's environmental assessment was sufficient. A group of utilities, including Wisconsin Electric, appeared in that proceeding in opposition to WED.\nThe two petitions were consolidated for judicial review in Dane County Circuit Court. On September 2, 1994, the Court issued a decision that the PSCW (1) has authority to require the utilities to monetize the economic risk of potential future regulation of greenhouse gases for advance planning purposes, and (2) was not required to direct utilities to include the economic impact of employment benefits in their advance plans. In addition, the Court held the PSCW's environmental assessment was deficient. The Court remanded the Advance Plan order to the PSCW for the purpose of providing a factual basis for the monetized values of greenhouse gases and correcting the environmental assessment deficiencies. On December 21, 1994, the PSCW issued a supplemental order purporting to explain the factual basis for the monetized values.\nPSCW Two-Stage CPCN Order: In January 1994, Wisconsin Electric filed an action in Milwaukee County Circuit Court seeking judicial determination concerning the PSCW's authority to adopt a new \"two-stage\" CPCN process and to order utilities to enter into contracts to buy power from other entities. This action was in response to the PSCW's December 1993 order which detailed the requirements of the new process to be implemented by the PSCW in making the final selection from among competing alternatives to construct proposed future capacity additions, including projects that would be owned and operated by unaffiliated IPPs. On June 27, 1994, this action was dismissed by stipulation of the parties. Wisconsin Electric is also an intervenor in a similar action brought by an unaffiliated IPP in Dane County Circuit Court. The matter is pending. For additional information see Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - \"Capital Requirements 1995-1999\".\nSpent Fuel Storage and Disposal: See Item 1. BUSINESS - SOURCES OF GENERATION - NUCLEAR - \"Spent Fuel Storage and Disposal\" for information concerning the PSCW's approval of Wisconsin Electric's application to utilize dry cask\n- 23 -\nITEM 3. LEGAL PROCEEDINGS - Other Litigation (Cont'd)\nstorage for spent nuclear fuel generated at Point Beach, and pending petitions for judicial review of the PSCW's decision.\nPittsburg & Midway Case: In a matter brought before the FERC, in July 1993, Wisconsin Electric filed an initial brief supporting its right to retain coal reclamation costs collected through the wholesale fuel adjustment clause in 1986 that it believes were prudently incurred in a settlement with the Pittsburg & Midway Coal Mining Company. Of the total costs involved, the portion recovered through the wholesale fuel clause amounts to approximately $750,000. This filing was made in response to a FERC audit staff determination that Wisconsin Electric should have applied for a waiver of the FERC's fuel clause regulations in order to attempt to pass through the wholesale portion of the settlement costs. In order for a final decision to be made, the FERC must first await the initial decision expected from an Administrative Law Judge. The matter is pending.\nIn November 1993, the FERC rejected Wisconsin Electric's request to be allowed to recover, in wholesale rates in the future, the amount which may have to be refunded to customers in the event of an unfavorable ruling in the pending fuel adjustment clause proceeding concerning the Pittsburg & Midway reclamation charges. In January 1994, Wisconsin Electric filed an appeal with the U.S. Court of Appeals for the District of Columbia Circuit regarding this rejection. The matter is pending.\nElectromagnetic Fields: Claims are being made or threatened with increasing frequency against electric utilities across the country for bodily injury, disease or other damages allegedly caused or aggravated by exposure to electromagnetic fields (\"EMFs\") associated with electric transmission and distribution lines. Results of scientific studies conducted to date do not establish the existence of a causal connection between EMFs and any adverse health effects. Wisconsin Electric believes that its facilities are constructed and operated in accordance with all applicable legal requirements and standards. Wisconsin Electric does not believe that any claims thus far made or threatened against it in connection with EMFs will result in any substantial liability on the part of Wisconsin Electric.\nUranium Enrichment Charges: On February 9, 1995, Wisconsin Electric and ten other utilities filed an action against USEC in the U.S. Court of Federal Claims challenging the final decision of the USEC contracting officer in November 1994 which denied claims of the utilities for damages by reason of overcharges for uranium enrichment services provided under Utility Services Contracts between July 1, 1993 and September 30, 1994. The damages sought by Wisconsin Electric total $3.3 million.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nAt a special meeting of Wisconsin Electric stockholders held on December 15, 1994, the common and preferred stockholders approved several items. A brief description of each item voted upon, the number of votes cast for, against or withheld, as well as the number of abstentions and broker non-votes as to each matter are listed below:\nItem 1: Proposal to approve the Plan and Agreement of Merger, dated June 30, 1994, by and between Wisconsin Electric and Wisconsin Natural, providing for the merger of Wisconsin Natural with and into Wisconsin Electric. (Vote\n- 24 -\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - (Cont'd)\nrequired on this proposal: The majority of outstanding shares of preferred stock, as well as the majority of outstanding shares of preferred and common stock.)\nNo. of No. of Shares Voted Shares Voted No. of FOR AGAINST Shares BROKER the Proposal the Proposal ABSTAINING NON-VOTES ------------------------------------------------------------------------------ Common Stock 33,289,327 0 0 0 Six Per Cent. Preferred Stock 34,176 731 1,144 4,142 3.60% Preferred Stock 202,047 3,066 4,604 18,948\nItem 2: Proposal to amend Wisconsin Electric's Restated Articles of Incorporation (the \"Restated Articles\") to remove the specific reference to electric and steam operations in the description of Wisconsin Electric's purpose. (Vote required on this proposal: The majority of outstanding shares of preferred and common stock.)\nNo. of No. of Shares Voted Shares Voted No. of FOR AGAINST Shares BROKER the Proposal the Proposal ABSTAINING NON-VOTES ------------------------------------------------------------------------------ Common Stock 33,289,327 0 0 0 Six Per Cent. Preferred Stock 37,789 926 1,478 0 3.60% Preferred Stock 217,108 5,086 6,471 0\nItem 3: Proposal to amend the Restated Articles to remove the special voting rights of the preferred stockholders in connection with the issuance of certain unsecured indebtedness or consummation of certain mergers or consolidations. (Vote required on this proposal: Two thirds of the outstanding shares of each series of preferred stock, as well as the majority of the outstanding shares of preferred and common stock.)\nNo. of No. of Shares Voted Shares Voted No. of FOR AGAINST Shares BROKER the Proposal the Proposal ABSTAINING NON-VOTES ------------------------------------------------------------------------------ Common Stock 33,289,327 0 0 0 Six Per Cent. Preferred Stock 30,389 3,315 2,347 4,142 3.60% Preferred Stock 184,471 16,684 8,562 18,948\nItem 4: Proposal to amend the Restated Articles to remove designations of certain series of preferred stock which are no longer outstanding. (Vote required on this proposal: The majority of outstanding shares of preferred and common stock.)\nNo. of No. of Shares Voted Shares Voted No. of FOR AGAINST Shares BROKER the Proposal the Proposal ABSTAINING NON-VOTES ------------------------------------------------------------------------------ Common Stock 33,289,327 0 0 0 Six Per Cent. Preferred Stock 36,079 1,540 1,704 870 3.60% Preferred Stock 210,095 5,723 9,890 2,957\n- 25 -\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - (Cont'd)\nItem 5:","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe amount of cash dividends declared on Wisconsin Electric's Common Stock during the two most recent fiscal years are set forth below. Dividends were paid to Wisconsin Electric's sole common stockholder, Wisconsin Energy.\nQuarter Total Dividend ----------------------------------------------------------------------------- 1993 1 $16,250,000 2 $16,250,000 3 $16,250,000 4 $16,250,000 ----------------------------------------------------------------------------- 1994 1 $33,700,000 2 $35,583,667 3 $35,583,667 4 $35,583,667\n- 29 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nEarnings\nNet income for Wisconsin Electric decreased to $165,594,000 in 1994 compared to $173,548,000 in 1993, reflecting a non-recurring charge of approximately $63.5 million ($39 million net of tax), associated with Wisconsin Electric's organizational restructuring program.\nThe charge primarily reflects the costs of severance and early retirement packages which are elements of a \"revitalization\" program designed to better position Wisconsin Electric in a changing energy marketplace. The company anticipates that the non-recurring restructuring charge, which was taken in the first quarter of 1994, will be offset by the end of 1995 through savings in operation and maintenance costs.\nExcluding the non-recurring charge, net income was $204,594,000 for the 12 months ended December 31, 1994, compared with $173,548,000 in 1993, an increase of $31 million, or 18 percent. Earnings reflect a 4.8 percent increase in electric kilowatt-hour sales and a 5.7 percent reduction in non- fuel operation and maintenance expenses. Electric sales increased primarily due to warmer weather during the summer of 1994 and additional economic activity in the company's service area. The reduction in non-fuel operation and maintenance expenses reflects, among other things, payroll-related savings as a result of workforce reductions, and lower expenditures made in connection with power plant renovation work as maintenance programs were completed.\nWisconsin Electric and Wisconsin Natural Revitalization\nIn response to increasing competitive pressures in the markets for electricity and natural gas, Wisconsin Electric and Wisconsin Natural have developed and are implementing a revitalization process to increase efficiencies and improve customer service.\nWisconsin Electric and Wisconsin Natural are \"reengineering\" and restructuring their organizations. The new structures consolidate many business functions and simplify work processes. Due to productivity improvements, staffing levels at Wisconsin Electric have been reduced; 347 employees elected to retire under an early retirement option and 573 employees have enrolled in severance packages. See Note H to the Financial Statements - Benefits Other Than Pensions, for additional information.\nAs part of the revitalization effort, Wisconsin Energy intends to merge Wisconsin Electric and Wisconsin Natural to form a single combined utility subsidiary. The proposed merger will improve customer service and reduce operating costs. The merger, which is anticipated to be effective by year-end 1995, is subject to a number of conditions, including requisite regulatory and other approvals. Wisconsin Electric and Wisconsin Natural filed a joint application on October 11, 1994, to obtain the PSCW's approval of the merger. Wisconsin Electric also filed an application to obtain the MPSC consent to assume Wisconsin Natural's liabilities in connection with the merger. Both approvals are expected by year-end 1995.\n- 32 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Cont'd)\nElectric Sales and Revenues\nTotal electric sales of Wisconsin Electric, detailed below by customer class, increased 4.8 percent in 1994 compared to 1993.\nElectric Sales - Megawatt Hours 1994 1993 % Change ------------------------------- ---------- ---------- -------- Residential 6,670,081 6,551,061 1.8 Small Commercial and Industrial 6,699,073 6,357,510 5.4 Large Commercial and Industrial 10,471,869 9,771,383 7.2 Other 1,603,741 1,776,061 (9.7) ---------- ---------- Total Retail and Municipal 25,444,764 24,456,015 4.0 Resale-Utilities 1,466,599 1,229,421 19.3 ---------- ---------- Total Sales 26,911,363 25,685,436 4.8 --------------------------------------------------------------------------\nElectric energy sales were positively impacted by warmer summer weather in 1994, which resulted in increased use of electricity for air conditioning and other cooling purposes, and increased economic activity. The increase in electric sales also reflects colder winter weather during the first quarter of 1994 and increased sales to the Empire and Tilden iron ore mines.\nElectric energy sales to the Empire and Tilden iron ore mines, Wisconsin Electric's two largest customers, were 15.0 percent higher in 1994 compared to 1993. The increase is attributable to a five-week long mine strike during the third quarter of 1993 which reduced sales during 1993. Wisconsin Electric's contracts with the mines require the payment of a demand charge regardless of power usage which partially offset the impact of lost sales on 1993 revenues. Excluding the mines, sales to large commercial and industrial customers increased 5.1 percent in 1994. Sales to the mines represented 8.6 percent, 7.8 percent and 9.0 percent of total electric sales during 1994, 1993 and 1992, respectively.\nThe 19.3 percent increase in the resale of energy to other utilities is attributable to the increased availability of Wisconsin Electric's power plants. This allowed Wisconsin Electric additional energy for external sales. The percentage change is not indicative of future sales growth in this customer class.\nThe 9.7 percent reduction in sales to the Other customer class, referred to in the table above, is largely the result of reductions in sales to WPPI, Wisconsin Electric's largest municipal customer consortium. WPPI has been reducing its purchases from Wisconsin Electric subsequent to acquiring generation capacity in 1990. Since that time, WPPI has expanded the use of its existing generation facilities and has installed additional capacity, further reducing its reliance on energy purchases from Wisconsin Electric. These sales reductions did not have a significant effect on earnings.\n- 33 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Cont'd)\nTotal electric kilowatt-hour sales increased at a compound annual rate of 4.3 percent between the years 1992 and 1994, while electric revenues increased at a compound annual rate of 4.0 percent during this period. These increases reflect among other things, more favorable weather conditions in 1994 compared to 1992. The warmer than normal summer in 1994 contrasted sharply with the summer of 1992, the coolest since Wisconsin Electric began keeping records in 1948.\nElectric Operation and Maintenance Expenses\nTotal electric operating expenses, excluding income taxes, depreciation and the non-recurring revitalization charge, decreased $17 million in 1994 compared to 1993. The decrease largely reflects the payroll-related savings as a result of workforce reductions referred to above and lower expenditures made in connection with power plant renovation work as maintenance programs were completed. These decreases were partially offset by expenses associated with the implementation of the revitalization program and growth in conservation-related expenses associated with improving the efficiency of customers' electric energy usage. Operating expenses, excluding income taxes, depreciation and the non-recurring charge, have remained relatively flat over the three-year period ended December 31, 1994.\nOther Items\nDeferred Income Taxes decreased $33 million during 1994 compared to 1993, due in part to tax matters related to the timing of payments made in connection with the severance and early retirement packages associated with the company's organizational restructuring program. Deferred Income Taxes also reflect a prior period reclassification between current and deferred income taxes.\nOther Interest increased $3.6 million during 1994 compared to 1993 reflecting increased short-term debt balances at Wisconsin Electric. Interest charges on long-term debt increased $11 million during 1993 compared to 1992 largely due to the additional debt issued to finance Wisconsin Electric's construction programs and the amortization of premiums associated with the debt securities refinanced during 1992 and 1993.\nWith expectations of low-to-moderate inflation and future operating cost reductions discussed above, Wisconsin Electric does not believe the impact of inflation will have a material effect on its future results of operations.\nElectric Sales Outlook\nAssuming moderate growth in the service territory economy and normal weather, Wisconsin Electric presently anticipates electric kilowatt-hour sales to grow at a compound annual rate of approximately 1.0 percent over the five-year period ending December 31, 1999. This forecast is subject to a number of variables, including the economy and weather, which may affect the actual growth in sales.\n- 34 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Cont'd)\nRates and Regulatory Matters\nThe table below summarizes the projected annual revenue impact of recent rate changes authorized by regulatory commissions based on the sales projections utilized by those commissions in setting rates. The PSCW regulates Wisconsin retail electric and steam rates, while the FERC regulates wholesale electric rates. The MPSC regulates retail electric rates in Michigan. The PSCW has discontinued the practice of conducting annual rate case proceedings, replacing it with a new schedule which calls for future rate cases to be conducted once every two years.\nIn support of its goal to become the lowest-cost energy provider in the region and in light of the operating cost reductions expected from the reengineering process discussed above, Wisconsin Electric did not seek an increase in rates for 1994 or 1995.\nRevenue Percent Increase Change in Effective Company\/Service (Decrease) Rates Date ------------------------- ------------ --------- --------- Wisconsin Electric Retail electric, WI $ 26,655,000 2.3 02\/17\/93 Steam heating 505,000 3.5 02\/17\/93 Wholesale electric 6,000,000 10.6 06\/09\/93 Retail electric, MI 1,366,000 4.3 07\/09\/93 Fuel electric, WI (8,596,000)* (0.9) 11\/05\/93 Fuel electric, WI (16,179,000) (1.3) 08\/04\/94 ------------------------------------------------------------------------------ * The 1993 fuel credit was eliminated 1\/1\/94 by PSCW Order.\nUnder the Wisconsin retail electric fuel adjustment procedure, retail electric rates may be adjusted, on a prospective basis, if cumulative fuel and purchased power costs, when compared to the costs projected in the retail electric rate proceeding, deviate from a prescribed range and are expected to continue to be above or below that range.\nOn September 8, 1994, the PSCW issued a notice that it will conduct an investigation into the state of the electric utility industry in Wisconsin, particularly its institutional structure and regulatory regime, in order to evaluate what changes would be beneficial for Wisconsin. The notice states that this investigation may result in profound and fundamental changes to the nature and regulation of the electric utility industry in Wisconsin. It is the PSCW's stated intention that this proceeding will establish criteria and direction for utilities to incorporate into any proposals involving structural or regulatory changes they may put forward. The PSCW also intends that the proceeding reflect input from all those having a stake in Wisconsin's electric utility industry, including large and small retail customers; wholesale customers; utility management; utility securities holders; independent power producers; purveyors of demand-side options and renewable resources; representatives of the environmental, financial, academic, labor, small business and governmental communities; and elected representatives. The PSCW invited interested persons to submit comments as to appropriate objectives for regulation of the electric utility industry and the utility structures and regulatory approaches likely to provide the best balance of such objectives.\n- 35 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Cont'd)\nOn November 1, 1994, Wisconsin Electric submitted its comments to the PSCW in a paper describing a framework for a restructured industry. Wisconsin Electric's view of industry restructuring would seek to achieve the benefits of competition while maintaining reliability of electric service, controlling costs during the transition to the envisioned end-state, and protecting the environment with increasing vigor. Today's various electric utility functions would be split into two major categories--natural monopolies and competitive entities. The natural monopolies are functions where a single entity can provide the lowest cost. The competitive entities would perform functions where competition can provide the lowest cost. The natural monopolies would be re-regulated so the appropriate incentives exist to provide electricity at reasonable prices. The competitive entities would eventually see an elimination of traditional regulation.\nIn Wisconsin Electric's plan, the re-regulated natural monopolies are the transmission and distribution functions. Re-regulation of these entities should involve some form of price cap and performance-standard operation rules. In the new structure, the FERC would regulate the transmission systems through a regional transmission group to ensure open access, comparable pricing, comparable service and adequate cost recovery. The PSCW would regulate the distribution function for reasonable price, reliability, public safety and customer satisfaction. The competitive entities in the Wisconsin Electric model are the generation, customer service and energy merchant functions.\nInitial question and answer sessions were held November 28-29, 1994. At a meeting on January 24, 1995, the PSCW approved the establishment of an advisory committee that will examine all aspects of electrical service and the electric utility industry and suggest which functions should be performed by a competitive market. The PSCW established a timetable which would have a final committee report available to the Wisconsin Legislature by the end of 1995.\nWisconsin Electric operates under utility rates which are subject to the approval of the PSCW, MPSC and FERC. Such rates are designed to recover the cost of service and provide a reasonable return to investors. Developing competitive pressures in the utility industry may result in future utility rates which are based upon factors other than the traditional original cost of investment. In such a situation, continued deferral of certain regulatory asset and liability amounts on Wisconsin Electric's books may no longer be appropriate as allowed under Statement of Financial Accounting Standards No. 71, Accounting for the Effects of Certain Types of Regulation. At this time, Wisconsin Electric is unable to predict whether any adjustments to regulatory assets and liabilities will occur in the future. See Note A to the Financial Statements - Summary of Significant Accounting Policies - Deferred Regulatory Assets and Liabilities, for further information.\nLIQUIDITY AND CAPITAL RESOURCES\nInvesting Activities\nWisconsin Electric invested $1,060 million in its businesses during the three years ended December 31, 1994. The investments made during this three-year period include construction expenditures for new or improved facilities totaling $850 million, net capitalized conservation expenditures of $87 million, purchases of nuclear fuel at $64 million and payments to an external trust for the eventual decommissioning of Wisconsin Electric's Point Beach Nuclear Plant totaling $42 million. - 36 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Cont'd)\nDuring the second quarter of 1994, Wisconsin Electric placed in service the last two units, or approximately 150 megawatts of capacity, at its Concord Generating Station, a four unit 300 megawatt natural gas-fired combustion turbine facility designed to meet peak demand requirements. The first two units were completed in 1993. Capital expenditures of $6 million, $35 million and $47 million were made during 1994, 1993 and 1992, respectively, for construction of this facility. Total capital costs of the Concord facility were approximately $107 million.\nAdditionally, during 1994, Wisconsin Electric continued construction of the new Paris Generating Station, a four unit, approximately 300 megawatt natural gas-fired combustion turbine facility intended to meet growing peak demand requirements. This generating station, which is expected to have all four units in service during the summer of 1995, is currently estimated to cost $104 million. Capital expenditures of $54 million and $28 million were made during 1994 and 1993, respectively, for construction of this facility.\nWisconsin Electric completed the $107 million renovation project at its Port Washington Power Plant in 1994. Unit 4, the last of four units to be renovated, returned to service in July. The renovation work, which began in September 1991, restored approximately 320 megawatts of capacity and included the installation of additional emission control equipment. Expenditures totaling $12 million, $36 million and $43 million were made during 1994, 1993 and 1992, respectively.\nCash Provided by Operating and Financing Activities\nDuring the three years ended December 31, 1994, cash provided by operating activities totaled $1,109 million. During this period, internal sources of funds, after the payment of dividends to Wisconsin Energy, Wisconsin Electric's sole common shareholder, provided 79 percent of the company's capital requirements.\nFinancing activities during the three-year period ended December 31, 1994, included the issuance of $952 million of long-term debt, principally to refinance higher coupon debt and the retirement of $73 million of preferred stock. No preferred stock was issued during this period. Additionally, during the three-year period ended December 31, 1994, Wisconsin Electric retired a total of $846 million of long-term debt and increased short-term debt by $148 million. Dividends on the company's common stock were $140 million, $65 million, and $65 million, during 1994, 1993 and 1992, respectively.\nDuring 1993, Wisconsin Electric issued five new series of First Mortgage Bonds aggregating $350 million in principal amount, the proceeds of which were used to redeem $284.3 million principal amount of four outstanding series of First Mortgage Bonds and 626,500 shares of Wisconsin Electric's 6.75% Series Preferred Stock.\nDuring 1992, Wisconsin Electric issued five new series of First Mortgage Bonds the proceeds of which provided $431 million principal amount to redeem 12 outstanding series of higher coupon First Mortgage Bonds and $130 million of new capital.\n- 37 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Cont'd)\nThese refunding transactions are expected to result in approximately $191 million in savings over the lives of the new debt issues. Depending on market conditions and other factors, additional debt refundings may occur.\nCapital Structure\nThe company's capitalization at December 31 is shown as follows:\n1994 1993 ------ ------\nCommon Equity 50.5% 50.7% Preferred Stock 1.0 1.3 Long-Term Debt (including current maturities) 42.0 43.7 Short-Term Debt 6.5 4.3 ------ ------ 100.0% 100.0%\nCompared to the electric utility industry generally, Wisconsin Electric has maintained a relatively high ratio of common equity to total capitalization and low debt and preferred stock ratios. This conservative capital structure, along with strong bond ratings (Wisconsin Electric currently has ratings of AA+ by Standard & Poor's Corporation, Aa2 by Moody's Investors Service and AA+ by Duff & Phelps Inc.) and internal cash generation has provided, and should continue to provide, the company with access to the capital markets when necessary to finance the anticipated growth in the company's business. At year-end 1994, the company had $102 million of unused lines of bank credit, $5 million of cash and cash equivalents, $207 million of short-term debt (including long-term debt due currently) and $21 million of construction funds held by trustees.\nCapital Requirements 1995-1999\nThe estimated capital requirements for Wisconsin Electric for the years 1995- 1999 are outlined in the table below. The construction expenditures have decreased significantly from the estimates reported previously in the 1993 Annual Report on Form 10-K. The primary reason for the decrease is the revitalization initiative which will reduce the cost to design, build and maintain company facilities.\n1995 1996 1997 1998 1999 ---- ---- ---- ---- ---- (Millions of Dollars)\nConstruction $215 $198 $159 $151 $153 Conservation 14 13 13 14 14 Bond Maturities and Refinancings 0 30 130 60 91 Changes in Fuel Inventories 6 8 3 4 (2) Decommissioning Trust Payments 20 30 32 35 37 ---- ---- ---- ---- ---- Total $255 $279 $337 $264 $293 ==============================================================================\n- 38 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Cont'd)\nIn January 1994, a coordinated state-wide plan for meeting future electricity needs of Wisconsin customers was filed with the PSCW in the Advance Plan 7 Docket. In the Advance Plan process, Wisconsin Electric, in conjunction with the other regulated electric utilities located in Wisconsin, is required to file long-term forecasts of resource requirements, such as the need for generation and transmission facilities, along with plans to meet those requirements, including the use of energy management and conservation.\nIn order to reliably meet its forecasted growth in demand, Wisconsin Electric employs a least-cost integrated planning process which includes renovation of existing power plants, promotion of cost-effective conservation and load management options, development of renewable energy sources, purchases of power and construction of new company-owned generation facilities.\nInvestments in demand-side management programs have reduced and delayed the need to add new generating capacity but have not eliminated the need entirely. Purchases of power from other utilities and transmission system upgrades will also combine to help delay the need to install some new generating capacity in the future. However, in order to serve the near-term growth in peak demand requirements, Wisconsin Electric has received PSCW approval and is currently in various stages of adding new capacity as previously described under \"Investing Activities\".\nFinally, Wisconsin Electric's Advance Plan 7 filing indicates a need for additional peaking capacity after the turn of the century, along with an anticipated need for additional intermediate-load capacity during the 2000 to 2010 time period. Wisconsin Electric's next base load power plant is not expected to be placed in service until after 2010.\nThe addition of new generating units requires approval from various regulatory agencies including the PSCW, the EPA and the DNR. All generating facilities proposed by Wisconsin Electric will meet or exceed the applicable federal and state environmental requirements.\nIn 1993, the PSCW, after conducting a competitive bidding process, issued an order selecting a proposal submitted by an unaffiliated IPP to construct a generation facility to meet a portion of Wisconsin Electric's anticipated increase in system supply needs. In accordance with the PSCW Order, Wisconsin Electric subsequently signed a long-term agreement to purchase electricity from the proposed facility. The agreement is contingent upon the facility being completed and going into operation, which at this time is planned for mid-1996. A number of parties have filed petitions for judicial review of this PSCW Order, taking the position that the Order should be set aside on various legal grounds. In a decision dated March 17, 1995, the Dane County Circuit Court affirmed the PSCW's selection of the LS Power project and the PSCW's approval of the power purchase agreement entered into by the Company and LSP-Whitewater L.P., the project's developer. The Court remanded to the PSCW for further proceedings the PSCW's selection of Wisconsin Electric's Kimberly project as the conditional second place project to proceed if the LS Power project does not.\nPrior to the PSCW selection of the IPP's generation facility, Wisconsin Electric had proposed to construct its own 220 megawatt cogeneration facility in Kimberly, Wisconsin, which was intended to provide process steam to Repap Wisconsin, Inc. (\"Repap\") starting in mid-1995. Wisconsin Electric had made expenditures toward the Kimberly facility amounting to approximately $70 million. These expenditures were primarily associated with the procurement of - 39 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Cont'd)\ncombustion turbines, the steam turbine and the heat recovery boiler in order to achieve the in-service dates as agreed to in a steam service contract with Repap. Wisconsin Electric is currently evaluating its options regarding its Kimberly Cogeneration Facility investment. The equipment procured to date is a technology of natural gas-fired combined cycle generation equipment that is marketed worldwide. Wisconsin Electric believes that a market for the equipment exists and is investigating opportunities to sell the equipment or to use it in another power project. At this time, Wisconsin Electric does not believe that the PSCW's selection of an IPP proposal will have a material adverse effect on its financial condition.\nThe PSCW has approved Wisconsin Electric's application to utilize dry storage for spent nuclear fuel generated at Point Beach. The decision completed a multi-year state review of the Wisconsin Electric proposal. The storage system to be used at Point Beach also has been certified by the NRC after a four-year technical review. Dry cask storage at Point Beach will use a two- container system made of steel and reinforced concrete. Capital costs associated with this facility are estimated at $6.5 million and are included in the above forecast. In March 1995 separate petitions were filed by intervenors in Dane County Circuit Court and Fond du Lac County Circuit Court. The Dane County petition seeks reversal of the order and a remand to the PSCW directing it to deny Wisconsin Electric's request for authorization to construct the dry cask facility, or in the alternative, to correct the alleged errors in the PSCW's order. No specific relief is identified in the Fond du Lac petition; however, numerous grounds of error are alleged. Wisconsin Electric intends to fully participate in both judicial review proceedings and to vigorously oppose the petitions.\nThe temporary dry storage facility is necessary because the spent fuel pool inside the plant is becoming full. The plant would be forced to shut down by 1998 without additional on-site storage capacity. The dry storage facility will be used until the DOE takes ownership of the spent fuel. While the DOE and the operators of nuclear power facilities have a contract mandated by federal law that calls for the DOE to begin accepting fuel in 1998, the government is not in a position to meet its commitment. If this commitment is not met, Wisconsin Electric will need to construct additional casks and will seek PSCW approval to do so.\nIn a related matter, Wisconsin Electric filed with the PSCW for a Certificate of Authority to proceed with the planned 1996 replacement of the Unit 2 steam generators at Point Beach. In 1984, Wisconsin Electric replaced the Unit 1 steam generators. Estimated at a cost of $119 million, which is also included in the above forecast, the Unit 2 project would allow for its operation until the expiration of its operating license in 2013. Without the replacement of the steam generators, it is believed the unit would not be able to operate to the end of its current license. The PSCW deferred a decision on Wisconsin Electric's request to replace Unit 2 steam generators until early 1996, but directed Wisconsin Electric to make arrangements with the fabricator of the new steam generators to allow replacement to proceed promptly if authorized by the PSCW.\nCapital Resources\nDuring the five-year forecast period ending December 31, 1999, Wisconsin Electric expects internal sources of funds from operations, after dividends to\n- 40 -\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - (Cont'd)\nWisconsin Energy, to provide about 80 percent of the utility capital requirements. The remaining utility cash requirements are expected to be met through the reduction of existing cash investments and construction funds on deposit with trustees, short-term borrowings, the issuance of long-term debt and capital contributions from Wisconsin Energy.\nExclusive of debt refundings, utility debt issues of $100 million are anticipated in 1995 and 1997.\nEnvironmental Issues\nThe 1990 Amendments to the Clean Air Act mandate significant nation-wide reductions in SO2 and NOx emissions to address acid rain and ground level ozone control requirements.\nIn 1994, Wisconsin Electric completed the installation of continuous emission monitors at all of its facilities and installed low NOx burners on one boiler at its Oak Creek Power Plant and two boilers at its Valley Power Plant. These actions, along with the burning of low sulfur coal and the installation of low NOx burners on other boilers at Oak Creek and Valley Power Plants in early 1995, meet the requirements that became effective January 1, 1995. To date, approximately $31 million has been spent on Clean Air Act compliance.\nWisconsin Electric elected to voluntarily bring the Valley and Port Washington Power Plants under jurisdiction of the NOx and SO2 requirements of the Clean Air Act, five years earlier than mandated. This was possible because these units meet the more stringent phase II emissions standards today.\nWisconsin Electric projects a surplus of SO2 emission allowances and is seeking additional allowances available as a result of energy conservation programs. As an integral component of its least-cost plan, Wisconsin Electric is active in SO2 allowance trading. Revenue from the sale of allowances is being used to offset future potential rate increases.\nAdditional fuel switching and the installation of NOx controls at various power plants will be required to meet the second phase of reduction requirements that become effective January 1, 2000. These costs, along with additional operating expenses, are not expected to exceed $54 million based on today's cost.\nWisconsin Electric aggressively seeks environmentally acceptable, beneficial uses of its combustion byproducts. However, ash byproducts have been, and to some degree, continue to be disposed in company-owned, licensed landfills. Some early designed and constructed landfills may allow the release of low levels of constituents, resulting in the need for various levels of remediation. These costs are included in the environmental operating and maintenance costs for Wisconsin Electric.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe \"Quarterly Financial Data\" in Item 6","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\nIn accordance with General Instruction G(3) of Form 10-K, the information under \"Election of Directors\" in Wisconsin Electric's definitive Information Statement for its Annual Meeting of Stockholders to be held May 16, 1995 (the \"1995 Annual Meeting Information Statement\") is incorporated herein by reference. Also see \"Executive Officers of the Registrant\" in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIn accordance with General Instruction G(3) of Form 10-K, the information under \"Compensation\" and \"Retirement Plans\" in the 1995 Annual Meeting Information Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAll of Wisconsin Electric's Common Stock (100% of such class) is owned by the parent company, Wisconsin Energy Corporation, 231 West Michigan Street, P.O. Box 2949, Milwaukee, Wisconsin 53201. The directors, director nominees and executive officers of Wisconsin Electric do not own any of the voting securities of Wisconsin Electric. In accordance with General Instruction G(3) of Form 10-K, the information concerning their beneficial ownership of Wisconsin Energy stock set forth under \"Stock Ownership of Directors, Nominees and Executive Officers\" in the 1995 Annual Meeting Information Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements and Report of Independent Accountants\nIncluded in Part II of this report:\nIncome Statement for the three years ended December 31,\nStatement of Cash Flows for the three years ended December 31, 1994\n- 62 -\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Cont'd)\nBalance Sheet at December 31, 1994 and 1993\nCapitalization Statement at December 31, 1994 and 1993\nCommon Stock Equity Statement for the three years ended December 31, 1994\nNotes to Financial Statements\nReport of Independent Accountants\n2. Financial Statement Schedules\nSchedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.\n3. Exhibits\nThe following Exhibits are filed with this report:\nExhibit No.\n(3)-1 Restated Articles of Incorporation of Wisconsin Electric Power Company, as amended and restated effective January 10, 1995.\n2 Bylaws of Wisconsin Electric Power Company, as amended to November 1, 1994, to increase the size of the Board of Directors from 12 to 13. (Section 1 of Bylaw II.)\n(23) Consent of Independent Accountants, dated March 30, 1995 appearing on page 67 of this Annual Report on Form 10-K for the year ended December 31, 1994.\n(27) Wisconsin Electric Power Company Financial Data Schedule for the fiscal year ended December 31, 1994.\nIn addition to the Exhibits shown above, which are filed herewith, Wisconsin Electric hereby incorporates the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation Section 201.24 by reference to the filings set forth below:\n(2) Plan and Agreement of Merger, dated June 30, 1994, by and between Wisconsin Electric Power Company and Wisconsin Natural Gas Company. (Appendix A to Wisconsin Electric's Proxy Statement dated October 31, 1994 in File No. 1-1245.)\n(4)-1 Reference is made to Article III of the Restated Articles of Incorporation of Wisconsin Electric. (Exhibit (3)-1 herein.)\n- 63 -\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Cont'd)\nMortgage or Supplemental Indenture Company Date Exhibit # Under File No. ------------------------------------------------------------------------------ (4)- 2 Mortgage and Wisconsin 10\/28\/38 B-1 2-4340 Deed of Trust Electric (\"WE\") 3 Second WE 6\/1\/46 7-C 2-6422 4 Third WE 3\/1\/49 7-C 2-8456 5 Fourth WE 6\/1\/50 7-D 2-8456 6 Fifth WE 5\/1\/52 4-G 2-9588 7 Sixth WE 5\/1\/54 4-H 2-10846 8 Seventh WE 4\/15\/56 4-I 2-12400 9 Eighth WE 4\/1\/58 2-I 2-13937 10 Ninth WE 11\/15\/60 2-J 2-17087 11 Tenth WE 11\/1\/66 2-K 2-25593 12 Eleventh WE 11\/15\/67 2-L 2-27504 13 Twelfth WE 5\/15\/68 2-M 2-28799 14 Thirteenth WE 5\/15\/69 2-N 2-32629 15 Fourteenth WE 11\/1\/69 2-0 2-34942 16 Fifteenth WE 7\/15\/76 2-P 2-54211 17 Sixteenth WE 1\/1\/78 2-Q 2-61220 18 Seventeenth WE 5\/1\/78 2-R 2-61220 19 Eighteenth WE 5\/15\/78 2-S 2-61220 20 Nineteenth WE 8\/1\/79 (a)2(a) 1-1245 (9\/30\/79 Form 10-Q) 21 Twentieth WE 11\/15\/79 (a)2(a) 1-1245 (12\/31\/79 Form 10-K) 22 Twenty-First WE 4\/15\/80 (4)-21 2-69488 23 Twenty-Second WE 12\/1\/80 (4)-1 1-1245 (12\/31\/80 Form 10-K) 24 Twenty-Third WE 9\/15\/85 (4)-1 1-1245 (9\/30\/85 Form 10-Q) 25 Twenty-Four WE 9\/15\/85 (4)-2 1-1245 (9\/30\/85 Form 10-Q) 26 Twenty-Fifth WE 12\/15\/86 (4)-25 1-1245 (12\/31\/86 Form 10-K) 27 Twenty-Sixth WE 1\/15\/88 4 1-1245 (1\/26\/88 Form 8-K) 28 Twenty-Seventh WE 4\/15\/88 4 1-1245 (3\/31\/88 Form 10-Q) 29 Twenty-Eighth WE 9\/1\/89 4 1-1245 (9\/30\/89 Form 10-Q) 30 Twenty-Ninth WE 10\/1\/91 (4)-1 1-1245 (12\/31\/91 Form 10-K) 31 Thirtieth WE 12\/1\/91 (4)-2 1-1245 (12\/31\/91 Form 10-K) 32 Thirty-First WE 8\/1\/92 (4)-1 1-1245 (6\/30\/92 Form 10-Q) 33 Thirty-Second WE 8\/1\/92 (4)-2 1-1245 (6\/30\/92 Form 10-Q) 34 Thirty-Third WE 10\/1\/92 (4)-1 1-1245 (9\/30\/92 Form 10-Q) 35 Thirty-Fourth WE 11\/1\/92 (4)-2 1-1245 (9\/30\/92 Form 10-Q)\n- 64 -\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Cont'd)\nMortgage or Supplemental Indenture Company Date Exhibit # Under File No. ------------------------------------------------------------------------------ 36 Thirty-Fifth WE 12\/15\/92 (4)-1 1-1245 (12\/31\/92 Form 10-K) 37 Thirty-Sixth WE 1\/15\/93 (4)-2 1-1245 (12\/31\/92 Form 10-K) 38 Thirty-Seventh WE 3\/15\/93 (4)-3 1-1245 (12\/31\/92 Form 10-K) 39 Thirty-Eighth WE 8\/01\/93 (4)-1 1-1245 (6\/30\/93 Form 10-Q) 40 Thirty-Ninth WE 9\/15\/93 (4)-1 1-1245 (9\/30\/93 Form 10-Q)\nAll agreements and instruments with respect to long-term debt not exceeding 10 percent of the total assets of the Registrant have been omitted as permitted by related instructions. The Registrant agrees pursuant to Item 601(b)(4) of Regulation S-K to furnish to the Securities and Exchange Commission, upon request, a copy of all such agreements and instruments.\n(10)-1 Purchase and Sale Agreement by and among The Cleveland-Cliffs Iron Company, Cliffs Electric Service Company, Upper Peninsula Generating Company, Upper Peninsula Power Company and Wisconsin Electric Power Company, dated as of December 8, 1987. (Exhibit 10 to Wisconsin Electric's Form 8-K dated December 18, 1987 in File No. 1-1245.)\n2 Supplemental Benefits Agreement between Wisconsin Energy Corporation and employee Richard A. Abdoo dated November 21, 1994. (Exhibit (10)-2 to Wisconsin Energy's 1994 Form 10-K in File No. 1-9057.) *\n3 Supplemental Benefits Agreement between Wisconsin Electric and employee John W. Boston dated November 21, 1994. (Exhibit (10)-3 to Wisconsin Energy's 1994 Form 10-K in File No. 1-9057.) *\n4 Directors' Deferred Compensation Plan of Wisconsin Electric Power Company, as restated as of January 1, 1994. (Exhibit (10)-6 to Wisconsin Energy's 1994 Form 10-K in File No. 1-9057.) *\n5 Executive Non-Qualified Trust by and between Wisconsin Energy Corporation and Firstar Trust Company, dated May 12, 1994, established to provide a source of funds to assist in the meeting of the liabilities under various nonqualified deferred compensation plans made between Wisconsin Energy and its subsidiaries and various plan participants. (Exhibit 10-1 to Wisconsin Energy's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, File No. 1-9057.) *\n6 Service Agreement dated January 1, 1987 between Wisconsin Electric Power Company, Wisconsin Energy Corporation and other non-utility affiliated companies. (Exhibit (10)-(a) to Wisconsin Electric's Form 8-K dated January 2, 1987 in File No. 1-1245.)\n- 65 -\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (Cont'd)\n* Management contracts and executive compensation plans or arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10-K. Certain compensatory plans in which directors or executive officers of the Registrant are eligible to participate are not filed in reliance on the exclusion in Item 601(b)(10)(iii)(B)(6) of Regulation S-K.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the fourth quarter of the year ended December 31, 1994.\n- 66 -\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statements and Prospectuses constituting part of the Registration Statements on Form S-3 (Nos. 33-49199 and 33-51749) of Wisconsin Electric Power Company of our report dated January 25, 1995 appearing on page 61 of this Form 10-K.\n\/s\/ Price Waterhouse LLP ------------------------ PRICE WATERHOUSE LLP\nMilwaukee, Wisconsin March 30, 1995\n- 67 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nWISCONSIN ELECTRIC POWER COMPANY\n\/s\/R. A. Abdoo By ------------------------------------- Date March 30, 1995 (R. A. Abdoo, 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 and Title Date\n\/s\/R. A. Abdoo --------------------------------------------------- March 30, 1995 (R. A. Abdoo, Chairman of the Board and Chief Executive Officer and Director - Principal Executive Officer)\n\/s\/R. R. Grigg --------------------------------------------------- March 30, 1995 (R. R. Grigg, Jr., President and Chief Operating Officer and Director)\n\/s\/J. G. Remmel --------------------------------------------------- March 30, 1995 (J. G. Remmel, Chief Financial Officer and Director)\n\/s\/A. K. Klisurich --------------------------------------------------- March 30, 1995 (A. K. Klisurich, Controller - Principal Accounting Officer)\n\/s\/D. K. Porter --------------------------------------------------- March 30, 1995 (D. K. Porter, Senior Vice President and Director)\n- 68 -\nSignature and Title Date\n\/s\/J. F. Ahearne --------------------------------------------------- March 30, 1995 (J. F. Ahearne, Director)\n\/s\/J. F. Bergstrom --------------------------------------------------- March 30, 1995 (J. F. Bergstrom, Director)\n\/s\/J. W. Boston ---------------------------------------------------- March 30, 1995 (J. W. Boston, Director)\n\/s\/R. A. Cornog ---------------------------------------------------- March 30, 1995 (R. A. Cornog, Director)\n\/s\/G. B. Johnson ---------------------------------------------------- March 30, 1995 (G. B. Johnson, Director)\n\/s\/J. L. Murray ---------------------------------------------------- March 30, 1995 (J. L. Murray, Director)\n\/s\/M. W. Reid ---------------------------------------------------- March 30, 1995 (M. W. Reid, Director)\n\/s\/F. P. Stratton, Jr. ---------------------------------------------------- March 30, 1995 (F. P. Stratton, Jr., Director)\n\/s\/J. G. Udell ---------------------------------------------------- March 30, 1995 (J. G. Udell, Director)\n- 69 -\nWisconsin Electric Power Company\nEXHIBIT INDEX -------------\n1994 Annual Report on Form 10-K For the Year Ended December 31, 1994\nExhibit Number -------\n(3)-1 Restated Articles of Incorporation of Wisconsin Electric Power Company, as amended and restated effective January 10, 1995.\n2 Bylaws of Wisconsin Electric Power Company, as amended to November 1, 1994, to increase the size of the Board of Directors from 12 to 13. (Section 1 of Bylaw II.)\n(23) Consent of Independent Accountants, dated March 30, 1995 appearing on page 67 of this Annual Report on Form 10-K for the year ended December 31, 1994.\n(27) Wisconsin Electric Power Company Financial Data Schedule for the fiscal year ended December 31, 1994.\nThe foregoing Exhibits are filed with this report. The additional Exhibits which are incorporated by reference are listed in Item 14(a)(3) of this report.\n- 70 -","section_15":""}
{"filename":"893958_1994.txt","cik":"893958","year":"1994","section_1":"ITEM 1. BUSINESS\nEach Capital Auto Receivables Asset Trust, (each a \"Trust\") was formed pursuant to a Trust Agreement, between Capital Auto Receivables, Inc. (CARI) (the \"Seller\") and Bankers Trust (Delaware), as Owner Trustee of the related Trust. The Trusts have issued Asset-Backed Notes (the \"Notes\"). The Notes are issued and secured pursuant to Indentures, between the related Trust and The First National Bank of Chicago as Indenture Trustee. Each Trust has also issued Asset-Backed Certificates.\nCAPITAL AUTO RECEIVABLES ASSET TRUSTS ------------------------------------- CAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\n___________________________\nPART II.\nITEM 7.","section_1A":"","section_1B":"","section_2":"","section_3":"","section_4":"","section_5":"","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nEach of the Trusts was formed pursuant to a trust agreement between Capital Auto Receivables, Inc. (CARI) (the \"Seller\") and Bankers Trust (Delaware), as Owner Trustee, and issued the following Asset-Backed Notes and Certificates. Each Trust acquired retail finance receivables from the Seller in the aggregate amount as shown below in exchange for Asset-Backed Notes and Asset-Backed Certificates representing undivided interests in each of the Trusts. Each Trust's property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due thereunder, security interests in the vehicles financed thereby and certain other property.\nRetail Finance Date of Sale Receivables and Servicing Aggregate Asset-Backed Asset-Backed Trust Agreement Amount Notes Certificates ---------- ----------------- --------- ---------------- ------------ (Millions) (Millions) (Millions) Capital December 17, 1992 $1,607.1 Class A-1 $ 657.7 $ 56.2 Auto Class A-2 $ 641.6 Receivables Class A-3 $ 251.6 Asset Trust 1992-1\nCapital February 11, 1993 $2,912.9 Class A-1 $ 322.0 $ 101.9 Auto Class A-2 $ 225.0 Receivables Class A-3 $ 125.0 Asset Trust Class A-4 $ 478.0 1993-1 Class A-5 $1,147.0 Class A-6 $ 318.0 Class A-7 $ 196.0\nCapital June 2, 1993 $2,009.3 Class A-1 $ 750.0 $ 58.6 Auto Class A-2 $ 100.0 Receivables Class A-3 $ 641.0 Asset Trust Class A-4 $ 403.0 1993-2\nCapital October 21, 1993 $2,504.9 Class A-1 $ 430.0 $ 81.4 Auto Class A-2 $ 59.0 Receivables Class A-3 $ 63.0 Asset Trust Class A-4 $ 210.0 1993-3 Class A-5 $ 484.3 Class A-6 $1,177.2 (Private Placement)\nGeneral Motors Acceptance Corporation (GMAC), the originator of the retail receivables, continues to service the receivables for the aforementioned Trusts and receives compensation and fees for such services. Investors receive periodic payments of principal and interest for each class of notes and certificates as the receivables are liquidated.\n____________________\nII-1\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCROSS REFERENCE SHEET\nExhibit No. Caption Page ----------- ------------------------------------------------- ------\n-- Capital Auto Receivables Asset Trust 1992-1, Independent Auditors' Report, Financial Statements II-3 and Selected Quarterly Data for the Year Ended December 31, 1994.\n-- Capital Auto Receivables Asset Trust 1993-1, Independent Auditors' Report, Financial Statements II-9 and Selected Quarterly Data for the Year Ended December 31, 1994.\n-- Capital Auto Receivables Asset Trust 1993-2, Independent Auditors' Report, Financial Statements II-15 and Selected Quarterly Data for the Year Ended December 31, 1994.\n-- Capital Auto Receivables Asset Trust 1993-3, Independent Auditors' Report, Financial Statements II-21 and Selected Quarterly Data for the Year Ended December 31, 1994.\n27. Financial Data Schedule (for SEC electronic filing purposes only). --\n_____________________\nII-2\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe Capital Auto Receivables Asset Trust 1992-1, its Noteholders and Certificateholders, Capital Auto Receivables, Inc., Bankers Trust (Delaware), Owner Trustee, and The First National Bank of Chicago, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Capital Auto Receivables Asset Trust 1992-1 as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the years then ended. These financial statements are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets, liabilities and equity of the Capital Auto Receivables Asset Trust 1992-1 at December 31, 1994 and 1993, and its distributable income and distributions for the years then ended, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------ Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-3\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY (in millions of dollars)\nDecember 31, ------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) ................... 252.5 759.3 ------- -------\nTOTAL ASSETS ........................... 252.5 759.3 ======= =======\nLIABILITIES AND EQUITY (Notes 2 and 3)\nAsset-Backed Notes ..................... 220.6 709.7\nAsset-Backed Certificates (Equity) ..... 31.9 49.6 ------- -------\nTOTAL LIABILITIES AND EQUITY............ 252.5 759.3 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-4\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1 (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the years ended December 31, 1994 and 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 506.8 847.8\nAllocable to Interest ...................... 27.1 53.3 -------- -------- Distributable Income .......................... 533.9 901.1 ======== ========\nIncome Distributed ............................ 533.9 901.1 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-5\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1 (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Capital Auto Receivables Asset Trust 1992-1 (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to noteholders and certificateholders are recognized when paid rather than when the respective obligation is incurred. Certain expenses of the Trust are paid by Capital Auto Receivables, Inc. (CARI) (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn December 17, 1992, Capital Auto Receivables Asset Trust 1992-1 acquired retail finance receivables aggregating approximately $1,607.1 million from the Seller in exchange for three classes of Asset-Backed Notes representing indebtedness of the Trust of $657.7 million Class A-1, $641.6 million Class A-2 and $251.6 million Class A-3, and $56.2 million of Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due or received thereunder, security interests in the vehicles financed thereby and certain other property. The Servicer has the option to repurchase the remaining receivables and certain other property as of the last day of any month on or after which the principal balance declines to 10% or less of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPayments of interest and principal (including prepayments) on the Notes are made on the fifteenth day of March, June, September and December or, if any such day is not a Business Day, on the next succeeding Business Day, commencing March 15, 1993 (each, a \"Payment Date\"). Principal of the Notes will be payable on each Payment Date in an amount equal to the sum of the Noteholders' Principal Distributable Amounts for each of the three Monthly Periods preceding such Payment Date, to the extent of funds available therefor. Payments of principal on the Notes are made (i) on the Class A-1 Notes until they are paid in full, (ii) then on the Class A-2 Notes until they are paid in full and (iii) then on the Class A-3 Notes until they are paid in full. The principal balance of the Class A-1 Notes was paid in full on September 15, 1993, the principal balance of the Class A-2 Notes was paid in full on December 15, 1994 and the then-unpaid principal balance of the Class A-3 Notes will be payable on December 15, 1997. The final scheduled Distribution Date for the Certificates will be December 15, 1997.\nOn each Distribution Date on and after the date on which the Class A-1 Notes have been paid in full, Certificateholders will receive, in respect of the certificate balance, an amount equal to the Certficateholders' Principal Distributable Amount for the Monthly Period preceding such Distribution Date, to the extent of funds available therefor.\nII-6\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1 (continued)\nNOTES TO FINANCIAL STATEMENTS (concluded)\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\nInterest on the outstanding principal amount of the Notes accrues from December 15, 1992 (in the case of the Class A-2 Notes, December 17, 1992) or, from the most recent Payment Date on which interest has been paid to but excluding the following Payment Date. During 1993, the Class A-1 Notes received interest at the rate of 3.73% per annum.\nThe Class A-2 Notes received a floating rate of interest from December 17, 1992 through December 14, 1994 at a weighted average rate of 3.7394%.\nThe Class A-3 Notes will bear interest at the rate of 5.75% per annum. On each Distribution Date, the Owner Trustee will distribute pro rata to Certificateholders accrued interest at the pass through rate of 6.20% per annum on the outstanding Certificate Balance.\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each Noteholder and Certificateholder, by the acceptance of a Note or Certificate, agrees to treat the Notes as indebtedness and the Certificates as equity interests in the Trust for federal, state and local income and franchise tax purposes.\n__________________________\nII-7\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1 (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 160.9 8.5 169.4\nSecond quarter ..................... 140.9 7.5 148.4\nThird quarter ...................... 113.3 6.2 119.5\nFourth quarter ..................... 91.7 4.9 96.6 --------- -------- ----- Total ......................... 506.8 27.1 533.9 ========= ======== =====\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ----- $ $ $\nFirst quarter ...................... 225.4 16.7 242.1\nSecond quarter ..................... 226.9 14.3 241.2\nThird quarter ...................... 210.0 12.3 222.3\nFourth quarter ..................... 185.5 10.0 195.5 --------- -------- ----- Total ......................... 847.8 53.3 901.1 ========= ======== =====\nII-8\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe Capital Auto Receivables Asset Trust 1993-1, its Noteholders and Certificateholders, Capital Auto Receivables, Inc., Bankers Trust (Delaware), Owner Trustee, and The First National Bank of Chicago, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Capital Auto Receivables Asset Trust 1993-1 as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the year ended December 31, 1994 and the period February 11, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets, liabilities and equity of the Capital Auto Receivables Asset Trust 1993-1 at December 31, 1994 and 1993, and its distributable income and distributions for the year ended December 31, 1994 and the period February 11, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------ Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-9\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY (in millions of dollars)\nDecember 31, ------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) ................... 711.1 1,660.8 ------- -------\nTOTAL ASSETS ........................... 711.1 1,660.8 ======= =======\nLIABILITIES AND EQUITY (Notes 2 and 3)\nAsset-Backed Notes ..................... 647.9 1,565.8\nAsset-Backed Certificates (Equity) ..... 63.2 95.0 ------- -------\nTOTAL LIABILITIES AND EQUITY............ 711.1 1,660.8 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-10\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1 (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the year ended December 31, 1994 and the period February 11, 1993 (inception) through December 31, 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 949.7 1,252.1\nAllocable to Interest ...................... 58.5 72.5 -------- -------- Distributable Income .......................... 1,008.2 1,324.6 ======== ========\nIncome Distributed ............................ 1,008.2 1,324.6 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-11\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1 (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Capital Auto Receivables Asset Trust 1993-1 (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to noteholders and certificateholders are recognized when paid rather than when the respective obligation is incurred. Certain expenses of the Trust are paid by Capital Auto Receivables, Inc. (CARI) (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn February 11, 1993, Capital Auto Receivables Asset Trust 1993-1 acquired retail finance receivables aggregating approximately $2,912.9 million from the Seller in exchange for seven classes of Asset-Backed Notes representing indebtedness of the Trust of $322.0 million Class A-1; $225.0 million Class A-2; $125.0 million Class A-3; $478.0 million Class A-4; $1,147.0 million Class A-5; $318.0 million Class A-6; $196.0 million Class A-7 and $101.9 million of Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due or received thereunder, security interests in the vehicles financed thereby, an interest rate cap and certain other property. The Servicer has the option to repurchase the remaining receivables and certain other property as of the last day of any month on or after which the principal balance declines to 10% or less of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPayments of interest and principal (including prepayments) on the Notes are made on the fifteenth day of February, May, August and November or, if any such day is not a Business Day, on the next succeeding Business Day, commencing May 17, 1993 (each, a \"Payment Date\"). Principal of the Notes will be payable on each Payment Date in an amount equal to the sum of the Noteholders' Principal Distributable Amounts for each of the three Monthly Periods preceding such Payment Date, to the extent of funds available therefor. Payments of principal on the Notes are payable by class in the priorities set forth in the Indenture (previously filed by Form 8-K).\nThe principal balance of the Class A-1 Notes was paid in full on May 17, 1993; the principal balance of the Class A-2 Notes was paid in full on August 16, 1993; the principal balance of the Class A-3 Notes and the Class A-4 Notes were paid in full on November 15, 1993; the principal balance of the Class A-5 Notes was paid in full on February 15, 1995; and the then- unpaid principal balance of the Class A-6 Notes and the Class A-7 Notes will be payable on February 17, 1998. Payment of principal to the Certificateholders in respect of the Certificate Balance was initiated in 1993, subsequent to the full payment of the Class A-1, Class A-2, Class A-3, and Class A-4 Notes. On each Distribution Date, the Certificateholders receive an amount equal to the Certificateholders' Principal Distributable Amount for the Monthly Period preceding such Distribution Date, to the extent of funds available therefor. The final scheduled Distribution Date for the Certificates is February 17, 1998.\nII-12\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1 (continued)\nNOTES TO FINANCIAL STATEMENTS (concluded)\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\nInterest on the outstanding principal amount of the Notes accrues from February 11, 1993 or, from the most recent Payment Date on which interest has been paid to but excluding the following Payment Date. The Class A-1 Notes received interest at the rate of 3.1875% per annum. The Class A-2 Notes received interest at the rate of 3.3125% per annum. The Class A-3 Notes received interest at the rate of 3.4375% per annum. The Class A-4 Notes received a floating rate of interest from February 11 through November 14, 1993 at a weighted average rate of 3.2657%.\nThe Class A-5 Notes receive a floating rate of interest which is reset for each Payment Date to be equal to LIBOR plus 0.15% The Class A-5 Notes received interest at a weighted average rate of 3.7069% from February 11, 1993 through November 14, 1994.\nThe Class A-6 Notes bear interest at the rate of 4.90% per annum. The Class A-7 Notes bear interest at the rate of 5.35% per annum. On each Distribution Date, the Owner Trustee distributes pro rata to Certificateholders accrued interest at the pass-through rate of 5.85% per annum on the outstanding Certificate Balance.\nNOTE 4. DERIVATIVE FINANCIAL INSTRUMENT AND RISK MANAGEMENT\nThe Trust was a party to an interest rate cap, which matured in February 1995. The interest rate cap required payments to the Trust from the counterparty in the event the three-month London Interbank Offering Rate (LIBOR) exceeded 10%. These payments would have offset increased interest expense on the Asset-Backed Notes. No payments were received in connection with the derivative in 1994 or 1993.\nCredit risk of the instrument was limited to payments due from the counterparty and was mitigated through the use of a financially sound counterparty. If the counterparty had defaulted, the cost, if the positions were replaced at market rates in effect at December 31, 1994 and 1993, would have been $5,000 and $0, respectively. Market risk of the derivative was inherently limited, since market variations offset the underlying Asset-Backed Notes.\nThe notional amounts of the interest rate cap approximated the outstanding balance in the Class A-5 Notes and was $133.8 million and $1,051.8 million at December 31, 1994 and 1993, respectively.\nNOTE 5. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each Noteholder and Certificateholder, by the acceptance of a Note or Certificate, agrees to treat the Notes as indebtedness and the Certificates as equity interests in the Trust for federal, state and local income and franchise tax purposes.\nII-13\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1 (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ------- $ $ $\nFirst quarter ..................... 287.0 17.7 304.7\nSecond quarter ..................... 253.3 14.9 268.2\nThird quarter ...................... 217.2 14.3 231.5\nFourth quarter ..................... 192.2 11.6 203.8 --------- -------- ------- Total ......................... 949.7 58.5 1,008.2 ========= ======== =======\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ------- $ $ $\nFirst quarter ..................... 0.0 1.0 1.0\nSecond quarter ..................... 523.8 28.8 552.6\nThird quarter ...................... 391.3 22.9 414.2\nFourth quarter ..................... 337.0 19.8 356.8 --------- -------- ------- Total ......................... 1,252.1 72.5 1,324.6 ========= ======== =======\nII-14\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe Capital Auto Receivables Asset Trust 1993-2, its Noteholders and Certificateholders, Capital Auto Receivables, Inc., Bankers Trust (Delaware), Owner Trustee, and The First National Bank of Chicago, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Capital Auto Receivables Asset Trust 1993-2 as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the year ended December 31, 1994 and the period June 2, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets, liabilities and equity of the Capital Auto Receivables Asset Trust 1993-2 at December 31, 1994 and 1993, and its distributable income and distributions for the year ended December 31, 1994 and the period June 2, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------ Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-15\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY (in millions of dollars)\nDecember 31, ------------------ 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2)................................. 662.0 1,423.2 ------- -------\nTOTAL ASSETS ........................................ 662.0 1,423.2 ======= =======\nLIABILITIES AND EQUITY (Notes 2 and 3)\nAsset-Backed Notes .................................. 617.7 1,364.6\nAsset-Backed Certificates (Equity) .................. 44.3 58.6 ------- -------\nTOTAL LIABILITIES AND EQUITY......................... 662.0 1,423.2 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-16\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2 (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the year ended December 31, 1994 and the period June 2, 1993 (inception) through December 31, 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 761.2 529.4\nAllocable to Interest ...................... 46.0 37.4 -------- -------- Distributable Income .......................... 807.2 566.8 ======== ========\nIncome Distributed ............................ 807.2 566.8 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-17\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2 (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Capital Auto Receivables Asset Trust 1993-2 (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to noteholders and certificateholders are recognized when paid rather than when the respective obligation is incurred. Certain expenses of the Trust are paid by Capital Auto Receivables, Inc. (CARI) (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn June 2, 1993, Capital Auto Receivables Asset Trust 1993-2 acquired retail finance receivables aggregating approximately $2,009.3 million at a discount of $56.7 million from the Seller in exchange for four classes of Asset-Backed Notes representing indebtedness of the Trust of $750.0 million Class A-1, $100.0 million Class A-2, $641.0 million Class A-3, $403.0 million Class A-4, and $58.6 million of Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, certain monies due or received thereunder, security interests in the vehicles financed thereby and certain other property. Substantially all of the Receivables comprising the Trust property were acquired by GMAC under special incentive rate financing programs. The Servicer has the option to repurchase the remaining receivables and certain other property as of the last day of any month on or after which the principal balance declines to 10% or less of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPayments of interest and principal (including prepayments) on the Notes are made on the fifteenth day of each month or, if any such day is not a Business Day, on the next succeeding Business Day, commencing June 15, 1993 (each, a \"Distribution Date\"). Principal of the Notes is payable on each Distribution Date in an amount equal to the sum of the Noteholders' Principal Distributable Amounts for the related Monthly Period to the extent of funds available therefor. Payments of principal on the Notes are payable by class in the priorities set forth in the Indenture (previously filed by Form 8-K). The principal balance of the Class A-1 Notes was paid in full on April 15, 1994; the principal balance of the Class A-2 Notes was paid in full on May 16, 1994; the then-unpaid principal balance of the Class A-3 Notes will be payable on November 15, 1995; and the then-unpaid principal balance of the Class A-4 Notes will be payable on May 15, 1997.\nII-18\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2 (continued)\nNOTES TO FINANCIAL STATEMENTS (concluded)\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\nOn each Distribution Date on and after the date on which the Class A-1 and Class A-2 Notes have been paid in full, Certificateholders will receive, in respect of the certificate balance, an amount equal to the Certificateholders' Principal Distributable Amount for the Monthly Period preceding such Distribution Date, to the extent of funds available therefor. The final scheduled Distribution Date for the Certificates is May 15, 1997.\nInterest on the outstanding principal amount of the Notes accrues from June 2, 1993 or, from the most recent Distribution Date on which interest has been paid to but excluding the following Distribution Date.\nThe Class A-1 Notes received interest at the rate of 3.35% per annum. The Class A-2 Notes received interest at the rate of 3.71% per annum.\nThe Class A-3 Notes bear interest at the rate of 4.20% per annum. The Class A-4 Notes bear interest at the rate of 4.70% per annum. On each Distribution Date, the Owner Trustee distributes pro rata to Certificateholders accrued interest at the pass-through rate of 4.70% per annum on the outstanding Certificate Balance.\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a partnership, and therefore is not taxable as a corporation for federal income tax purposes. Each Noteholder and Certificateholder, by the acceptance of a Note or Certificate, has agreed to treat the Notes as indebtedness and the Certificates as equity interests in the Trust for federal, state and local income and franchise tax purposes.\n__________________________\nII-19\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2 (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ------- $ $ $\nFirst quarter ..................... 213.8 14.4 228.2\nSecond quarter ..................... 200.5 12.5 213.0\nThird quarter ...................... 182.5 10.5 193.0\nFourth quarter ..................... 164.4 8.6 173.0 --------- -------- ------- Total ......................... 761.2 46.0 807.2 ========= ======== =======\n1993 Quarters Principal Interest Total ------------------------------------ --------- -------- ------- $ $ $\nSecond quarter ..................... 77.5 2.9 80.4\nThird quarter ...................... 227.0 18.3 245.3\nFourth quarter ..................... 224.9 16.2 241.1 --------- -------- ------- Total ......................... 529.4 37.4 566.8 ========= ======== =======\nII-20\nINDEPENDENT AUDITORS' REPORT\nMarch 10, 1995\nThe Capital Auto Receivables Asset Trust 1993-3, its Noteholders and Certificateholders, Capital Auto Receivables, Inc., Bankers Trust (Delaware), Owner Trustee, and The First National Bank of Chicago, Indenture Trustee:\nWe have audited the accompanying Statement of Assets, Liabilities and Equity of the Capital Auto Receivables Asset Trust 1993-3 as of December 31, 1994 and 1993, and the related Statement of Distributable Income for the year ended December 31, 1994 and the period October 21, 1993 (inception) through December 31, 1993. These financial statements are the responsibility of the Trust'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 described in Note 1 to the financial statements, these financial statements are prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.\nIn our opinion, such financial statements present fairly, in all material respects, the assets, liabilities and equity of the Capital Auto Receivables Asset Trust 1993-3 at December 31, 1994 and 1993, and its distributable income and distributions for the year ended December 31, 1994 and the period October 21, 1993 (inception) through December 31, 1993, on the basis of accounting described in Note 1.\ns\\ Deloitte & Touche LLP ------------------------ Deloitte & Touche LLP 600 Renaissance Center Detroit, Michigan 48243\nII-21\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\nSTATEMENT OF ASSETS, LIABILITIES AND EQUITY (in millions of dollars)\nDecember 31, ------------------- 1994 1993 ------- ------- ASSETS $ $\nReceivables (Note 2) ................... 1,278.7 2,438.7 ------- -------\nTOTAL ASSETS ........................... 1,278.7 2,438.7 ======= =======\nLIABILITIES AND EQUITY (Notes 2 and 3)\nAsset-Backed Notes ..................... 1,212.4 2,357.3\nAsset-Backed Certificates (Equity) ..... 66.3 81.4 ------- -------\nTOTAL LIABILITIES AND EQUITY............ 1,278.7 2,438.7 ======= =======\nReference should be made to the Notes to Financial Statements.\nII-22\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3 (continued)\nSTATEMENT OF DISTRIBUTABLE INCOME For the year ended December 31, 1994 and the period October 21, 1993 (inception) through December 31, 1993 (in millions of dollars)\n1994 1993 -------- -------- $ $ Distributable Income\nAllocable to Principal ...................... 1,160.0 66.2\nAllocable to Interest ...................... 78.5 5.4 -------- -------- Distributable Income .......................... 1,238.5 71.6 ======== ========\nIncome Distributed ............................ 1,238.5 71.6 ======== ========\nReference should be made to the Notes to Financial Statements.\nII-23\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3 (continued)\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. BASIS OF ACCOUNTING\nThe financial statements of Capital Auto Receivables Asset Trust 1993-3 (the \"Trust\") are prepared on the basis of cash receipts and cash disbursements. Such financial statements differ from financial statements prepared in accordance with generally accepted accounting principles in that interest income and the related assets are recognized when received rather than when earned and distributions to noteholders and certificateholders are recognized when paid rather than when the respective obligation is incurred. Certain expenses of the Trust are paid by Capital Auto Receivables, Inc. (CARI) (the \"Seller\").\nNOTE 2. SALE OF NOTES AND CERTIFICATES\nOn October 21, 1993, Capital Auto Receivables Asset Trust 1993-3 acquired retail finance receivables aggregating approximately $2,504.9 million from the Seller in exchange for six classes of Asset-Backed Notes representing indebtedness of the Trust of $430.0 million Class A-1; $59.0 million Class A-2; $63.0 million Class A-3; $210.0 million Class A-4; $484.3 million Class A-5; $1,177.2 million Class A-6; and $81.4 million of Asset-Backed Certificates representing equity interests in the Trust. The Trust property includes a pool of retail instalment sale contracts for automobiles and light trucks, monies due or received thereunder, security interests in the vehicles financed thereby and certain other property. The Servicer has the option to repurchase the remaining receivables and certain other property as of the last day of any month on or after which the principal balance declines to 10% or less of the aggregate amount financed.\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS\nPayments of interest on the Class A-1 Notes and the Class A-5 Notes will be made on the fifteenth day of each month or, if any such day is not a Business Day, on the next succeeding Business Day, commencing on November 15, 1993 (each a \"Distribution Date\"). Payments of interest on the Class A-2 Notes, the Class A-3 Notes, the Class A-4 Notes, and the Class A-6 Notes are made on the fifteenth day of January, April, July and October or, if any such day is not a Business Day, on the next succeeding Business Day, commencing January 18, 1994 (each, a \"Payment Date\"). Principal of the Notes will be payable by class in the priorities and in the amounts as set forth in the Indenture (previously filed by Form 8-K), equal to the sum of the Aggregate Noteholders' Principal Distributable Amounts to the extent of funds available therefor.\nII-24\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3 (continued)\nNOTES TO FINANCIAL STATEMENTS (concluded)\nNOTE 3. PRINCIPAL AND INTEREST PAYMENTS (concluded)\nThe principal balance of the Class A-1 Notes was paid in full on November 15, 1994; the principal balance of the Class A-2 Notes was paid in full on January 18, 1994; the principal balance of the Class A-3 Notes and the Class A-4 Notes were paid in full on April 15, 1994; the then-unpaid principal balance of the Class A-5 Notes will be payable on October 16, 1995; and the then-unpaid principal balance of the Class A-6 Notes will be payable on October 15, 1998. On each Distribution Date on and after the date on which the Class A-2 Notes, the Class A-3 Notes and the Class A-4 Notes were paid (or provided for) in full, Certificateholders received, in respect of the certificate balance, an amount equal to the Certificateholders' Principal Distributable Amount for the Monthly Period preceding such Distribution Date, to the extent of funds available therefor. The final scheduled Distribution Date for the Certificates will be October 15, 1998.\nInterest on the outstanding principal amount of the Notes accrues from October 21, 1993 or, from the most recent Distribution Date or Payment Date, as applicable, on which interest has been paid to but excluding the following Payment Date. The Class A-1 Notes received interest at the rate of 3.30% per annum. The Class A-2 Notes received interest at the rate of 3.25% per annum. The Class A-3 Notes received interest at the rate of 3.25% per annum. The Class A-4 Notes received interest at the rate of 3.30% per annum.\nThe Class A-5 Notes bear interest at the rate of 3.65% per annum. The Class A-6 Notes bear interest at the rate of 4.60% per annum. On each Distribution Date, the Owner Trustee distributes pro rata to Certificateholders accrued interest at the pass-through rate of 4.60% per annum on the outstanding Certificate Balance.\nNOTE 4. FEDERAL INCOME TAX\nThe Trust is classified as a grantor trust, and therefore is not taxable as a corporation for federal income tax purposes. Each Noteholder and Certificateholder, by the acceptance of a Note or Certificate, agrees to treat the Notes as indebtedness and the Certificates as equity interests in the Trust for federal, state and local income and franchise tax purposes.\nII-25\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3 (concluded)\nSUPPLEMENTARY FINANCIAL DATA (unaudited)\nSUMMARY OF QUARTERLY DISTRIBUTABLE INCOME (in millions of dollars)\n1994 Quarters Principal Interest Total ------------------------------------ --------- -------- ------- $ $ $\nFirst quarter ..................... 303.1 23.4 326.5\nSecond quarter ..................... 405.1 21.3 426.4\nThird quarter ...................... 238.8 17.9 256.7\nFourth quarter ..................... 213.0 15.9 228.9 --------- -------- ------- Total ......................... 1,160.0 78.5 1,238.5 ========= ======== =======\n1993 Quarter Principal Interest Total ------------------------------------ --------- -------- ------- $ $ $\nFourth quarter ..................... 66.2 5.4 71.6 ========= ======== =======\nII-26\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 8K\n(a) (1) FINANCIAL STATEMENTS.\nIncluded in Part II, Item 8, of Form 10-K.\n(a) (2) FINANCIAL STATEMENT SCHEDULES.\nAll schedules have been omitted because they are not applicable or because the information called for is shown in the financial statements or notes thereto.\n(a) (3) EXHIBITS (Included in Part II of this report).\n-- Capital Auto Receivables Asset Trust 1992-1 Financial Statements for the Year Ended December 31, 1994.\n-- Capital Auto Receivables Asset Trust 1993-1 Financial Statements for the Year Ended December 31, 1994.\n-- Capital Auto Receivables Asset Trust 1993-2 Financial Statements for the Year Ended December 31, 1994.\n-- Capital Auto Receivables Asset Trust 1993-3 Financial Statements for the Year Ended December 31, 1994.\n27. Financial Data Schedule (for SEC electronic filing purposes only).\n(b) REPORTS ON FORM 8-K.\nNo current reports on Form 8-K have been filed by any of the above-mentioned Owner Trusts during the fourth quarter ended December 31, 1994.\nITEMS 2, 3, 4, 5, 6, 9, 10, 11, 12 and 13 are not applicable and have been omitted.\nIV-1\nSIGNATURE\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Trustees have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized.\nCAPITAL AUTO RECEIVABLES ASSET TRUST 1992-1 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-1 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-2 CAPITAL AUTO RECEIVABLES ASSET TRUST 1993-3\nby: Bankers Trust (Delaware) -------------------------------------- (Owner Trustee, not in its individual capacity but solely as Owner Trustee on behalf of the Issuer.)\ns\\ Louis Bodi --------------------------------- (Louis Bodi, Assistant Vice President)\nDate: March 29, 1995 --------------\nIV-2","section_15":""}
{"filename":"4672_1994.txt","cik":"4672","year":"1994","section_1":"ITEM 1 - BUSINESS\nGeneral\nAmerican Business Products was incorporated under the laws of Delaware in December 1967 to acquire the stock of Curtis 1000 Inc., a producer of envelopes and forms which has operated since 1882. Hereinafter, American Business Products, Inc. and its subsidiaries are collectively referred to as the \"Company.\" In April 1986, the Company was reincorporated under the laws of Georgia. The Company is one of the nation's leading producers of printed business supplies, principally envelope products, custom business forms, and custom labels. Additionally, the Company manufactures and distributes books for the publishing industry and also is engaged in specialty extrusion coating and laminating of papers, films, and nonwoven fabrics for packaging.\nBusiness Segments\nThe Company's product line is composed of three business segments: business supplies printing, book manufacturing, and specialty extrusion coating and laminating.\nBusiness supplies printing consists principally of the manufacture of a wide variety of specialty mailers, envelopes, labels and lightweight packaging; the printing and production of business forms; and other related products and services including digital imaging or on-demand printing of various documents and materials for businesses. The manufacture and distribution of customized specialty labels is a rapidly growing part of this segment. The company produces a complete line of standard and special types and sizes of commercial mailing products including specialty mailers utilizing multi-part forms and envelopes. Business forms products and services include customized continuous forms for computers and word processors, custom cutsheet and roll laser paper for laser printers, the imprinting of variable, customized data on forms, electronic forms, and the management of forms inventories for customers. Business supplies printing accounted for 76% of the Company's sales in 1994, 74% in 1993, and 74% in 1992.\nBook manufacturing consists of the printing and binding of both hard cover and soft cover books for the publishing industry. In addition, the Company provides storage and order fulfillment services by shipping orders to publishers' customers from two large distribution centers. This business segment accounted for 9% of the Company's sales in 1994, 9% in 1993, and 9% in 1992.\nSpecialty extrusion coating and laminating consists of applying plastic coatings in varying degrees of thickness to rolls of paper, film or fabric. The Company also prints and metalizes certain of these products for customers. The materials produced by this segment are used primarily for packaging consumer products such as individual servings of sugar, salt and pepper, sugar substitutes, and candy and ice cream bars, as well as medical and pharmaceutical products. These materials also are used for composite can liners and release liner papers for pressure sensitive products such as labels. This business segment accounted for 15% of the Company's sales in 1994, 17% in 1993, and 17% of sales in 1992.\nFinancial information regarding the Company's three business segments is presented in the Notes to Consolidated Financial Statements under the heading \"Business Segment Information\" on page 24 of the Company's 1994 Annual Report, which information is incorporated herein by reference. Portions of the 1994 Annual Report are filed as Exhibit 13 to this Annual Report on Form 10-K.\nProduction\nSubstantially all of the Company's products are manufactured by wholly owned subsidiaries of the Company in 36 manufacturing facilities located throughout the United States. (See \"Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe Company's executive offices are located in approximately 21,400 square feet of space at 2100 RiverEdge Parkway, Suite 1200, Atlanta, Georgia 30328. The offices are leased from an unaffiliated party under a lease expiring on January 26, 2003.\nThe principal properties of the Company include production facilities, administrative\/sales offices and warehouses. The Company operates 36 production facilities throughout the United States encompassing approximately 1,924,000 square feet. The Company owns 29 of these facilities while 7 are leased facilities. In addition, the Company and a European joint venture\/partner operate production facilities which are owned or leased by the joint venture in Germany, Poland, England, and Luxembourg. The facilities in Germany and Poland are owned by the joint venture, and the facilities in England and Luxembourg are leased.\nThe Company leases 50 administrative\/sales offices and 10 warehouses, all of which are located in the United States. All of the Company's production facilities, administrative\/sales offices and warehouses are used in the Company's business supplies printing business except for three of such facilities which are used in the Company's book manufacturing business and one which is used in the extrusion coating and laminating business.\nCertain properties owned by the Company are held subject to mortgages. See the information set forth under the heading \"Long Term Debt\" in the Notes to Consolidated Financial Statements on page 20 in the Company's 1994 Annual Report, which information is incorporated herein by reference.\nThe Company believes that all of its properties and equipment are in good condition, adequately utilized and suitable for the purposes for which they are being used.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nAs of March 20, 1995, there were no material pending legal proceedings, other than routine litigation incidental to the business, to which the Company was a party or of which any of it's properties were the subject, and none are expected by management to materially effect the Company's financial position and results of operations.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted to a vote of the shareholders of the Company during the fourth quarter of 1994.\nITEM 4 (A) - EXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below is information as of March 20, 1995 regarding the executive officers of the Company:\nTHOMAS R. CARMODY, 61 has been Chairman of the Board of Directors of the Company since April 1994 and Chief Executive Officer of the Company since 1988. He previously served as President of the Company from 1985 until April 1994, as Executive Vice President of the Company from 1982 until 1985 and as Chief Operating Office of the Company from 1982 until 1988. He has been a director of the Company since 1983 and has served with the Company or Curtis 1000 Inc., a wholly-owned subsidiary of the Company, for over 39 years.\nWILLIAM C. DOWNER, 58, has served as Vice President-Finance and Chief Financial and Accounting Officer of the Company since August 1982. He has served with the Company or Curtis 1000 Inc., a wholly-owned subsidiary of the Company, for over 27 years.\nDAWN M. GRAY, 50, has served as Secretary of the Company since July 1989. She served as Assistant Secretary from October 1976 to June 1989. She has served with the Company or Curtis 1000 Inc., a wholly-owned subsidiary of the Company, for over 28 years.\nROBERT W. GUNDECK, 52, has been President of the Company since April 1994 and Chief Operating Officer of the Company since 1993. He previously served as Executive Vice President of the Company from 1993 until April 1994 and as Vice President - Corporate Development of the Company from 1990 until 1993. From 1988 until 1990 Mr. Gundeck was Director of Acquisitions and Corporate Development of the Company. He has been a director of the Company since 1993, and he has served with the Company for over 7 years.\nRICHARD A. LEFEBER, 59, has served as Vice President-Administration of the Company since January 1980. He served as Secretary of the Company from August 1982 to June 1989. He has served with the Company or Curtis 1000 Inc., a wholly-owned subsidiary of the Company, for over 37 years.\nThe Board of Directors elects officers annually in April for one year terms or until their successors are elected and qualified. Officers are subject to removal by the Board of Directors at any time.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation relating to the market for, holders of and dividends paid on the Company's Common Stock is set forth under the captions \"Quarterly Data 1994,\" \"Quarterly Data 1993,\" \"Stock Exchange Listing,\" and \"Shareholders of Record,\" on pages 14, 15 and 30 of the Company's 1994 Annual Report, which information is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nSelected consolidated financial data for the Company for each year of the eleven year period ended December 31, 1994 is set forth under the caption \"Eleven Year Financial Review\" on pages 14 and 15 in the Company'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\nA discussion of the Company's financial condition and results of operations at and for the dates and periods covered by the consolidated financial statements set forth in the Company's 1994 Annual Report is set forth under the caption \"Management's Discussion and Analysis\" on pages 25 through 27 of the Company's 1994 Annual Report. Such discussion is incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following Consolidated Financial Statements of the Company and its subsidiaries, together with the Independent Auditors' Report, which are set forth on pages 16 through 24 in the Company's 1994 Annual Report, are incorporated herein by reference:\nConsolidated Statements of Income 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\nNotes to Consolidated Financial Statements\nThe supplementary consolidated financial information regarding the Company which is required by Item 302 of Regulation S-K is set forth under the caption \"Quarterly Data 1994\" on page 14 and \"Quarterly Data 1993\" on page 15 of the Company's 1994 Annual Report. Such information is incorporated herein by reference.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere has been no change of or disagreements with independent accountants by the Company in the past two fiscal years or subsequently.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation relating to the directors of the Company is set forth in \"Proposal 1 - Election of Directors\" under the captions \"Nominees,\" \"Information Regarding Nominees and Directors\" and \"Meetings and Committees of the Board of Directors\" in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders to be held on April 26, 1995 (the \"Proxy Statement\"). Such information is incorporated herein by reference. Pursuant to Instruction 3 of Item 401(b) of Regulation S-K and General Instruction G(3) of Form 10-K, information relating to the executive officers of the Company is set forth in Part I, Item 4(A) of this Report under the caption \"Executive Officers of the Registrant.\" Information regarding compliance by directors and executive officers of the Company and owners of more than ten percent of the Company's Common Stock with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, is set forth in the Proxy Statement under the caption \"Compliance with Section 16(a) of the Securities Exchange Act of 1934.\" Such information is incorporated herein by reference.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nInformation relating to compensation of the executive officers and directors of the Company is set forth in \"Proposal 1 - Election of Directors\" under the caption \"Director Compensation\" and in \"Executive Compensation\" in the Proxy Statement. Such information is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation regarding ownership of the Company's $2.00 par value Common Stock by certain persons is set forth in \"Voting\" under the caption \"Principal Shareholders\" and in \"Proposal 1 - Election of Directors\" under the caption \"Information Regarding Nominees and Directors\" and under the caption \"Executive Compensation\" in the Proxy Statement. Such information is incorporated herein by reference.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTION\nThe Company is aware of no relationships or transactions between the Company and affiliates of the Company which are required to be reported under this Item 13.\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) Documents filed as part of this Report:\n1. Financial Statements\nThe Consolidated Financial Statements and the Independent Auditors' Report thereon which are required to be filed as part of this Report are included in the Company's 1994 Annual Report and are set forth in and incorporated by reference in Part II, Item 8 hereof. These Consolidated Financial Statements are as follows:\nConsolidated Statements of Income for each of the three years in the period ended December 31, 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\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nThe financial statement schedule filed as part of this Report pursuant to Article 12 of Regulation S-X and the Independent Auditors' Report in connection therewith are contained in the Index of Financial Statement Schedule on page S-1 of this Report. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because such schedules are not required under the related instructions or are inapplicable or because the information required is included in the Consolidated Financial Statements or notes thereto.\n3. Exhibits\nThe exhibits required to be filed as part of this Report are set forth in the Index of Exhibits on page E-1 of this Report.\n(b) Reports on Form 8-K:\nNo current reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this report.\n(c) The exhibits required to be filed as part of this Report are set forth in the Index of Exhibits on page E-1 of this report\n(d) The financial statement schedules required to be filed as part of this Report are set forth in the Index of Financial Statement Schedules on page S-1 of this Report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMERICAN BUSINESS PRODUCTS, INC.\nBY: \/S\/ Thomas R. Carmody ------------------------------------- Thomas R. Carmody Director, Chairman of the Board 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 date indicated.\nAMERICAN BUSINESS PRODUCTS, INC.\nINDEX OF FINANCIAL STATEMENT SCHEDULES\nS-1\nINDEPENDENT AUDITORS' REPORT\nAmerican Business Products, Inc.:\nWe have audited the consolidated financial statements of American Business Products, 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 24, 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 consolidated financial statement schedule of American Business Products, 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.\n\/S\/ DELOITTE & TOUCHE LLP - ------------------------- DELOITTE & TOUCHE LLP\nAtlanta, Georgia February 24, 1995\nSCHEDULE VIII\nAMERICAN BUSINESS PRODUCTS, INC. AND SUBSIDIARIES VALUATION RESERVES (IN THOUSANDS)\n(1) Reserve assumed from Discount Labels, Inc. on September 1, 1993. (2) Deductions represent uncollectible accounts charged off, less recoveries.\nS-3\nAMERICAN BUSINESS PRODUCTS, INC. INDEX OF EXHIBITS\nWhere an exhibit is filed by incorporation by reference to a previously filed registration statement or report, such registration statement or report is identified in parentheses.\nE-1\n(h) Form of 1993 Directors Stock Incentive Plan.\n10.2 Agreement for the Purchase of Stock dated as of September 21, 1990 by and among the Company, Edward C. Leavy, Edward C. Leavy, Executor under the will of Jean L. Leavy, and James B. Kauffman relating to the purchase of Jen-Coat, Inc. (Exhibit 2, Current Report on Form 8-K, dated October 1, 1990).\n10.3 (a) Stock Purchase Agreement dated September 1, 1993 among the Company, Home Safety Equipment Co., Inc., and William Frederick Conway, Sr., Betty Conway, Allen C. Conway, Winifred Conway Arledge, William Frederick Conway, Jr., Winifred B. Arledge, QSST Trust #1, Winifred B. Arledge, QSST Trust #2, Allen C. Conway, QSST Trust #1, Allen C. Conway, QSST Trust #2, Allen C. Conway, QSST Trust #3, and William Frederick Conway, Jr., QSST Trust #1, William Frederick Conway, Jr., QSST Trust #2 (Exhibit 2, Current Report on Form 8-K dated September 13, 1993).\n(b) Non-Competition Agreement dated as of August 10, 1993 by and among William Frederick Conway, Sr., Betty Conway, Allen C. Conway, Winifred Conway Arledge, Sol A. Arledge, and William Frederick Conway, Jr. and the Company (Exhibit 99.1, Current Report on Form 8-K, dated September 13, 1993).\n13 Pages 14 through 27, and page 30 of the Company's 1994 Annual Report which are incorporated herein by reference.\n21 Subsidiaries of the Registrant.\n23 Consent of Independent Auditors.\n24 Power of Attorney.\nE-2","section_15":""}
{"filename":"802481_1994.txt","cik":"802481","year":"1994","section_1":"Item 1. Business\nGeneral The Company, which was incorporated in Texas in 1968 and reincorporated in Delaware in 1986, is the successor to a predecessor partnership founded in 1946 by Lonnie \"Bo\" Pilgrim and his brother, Aubrey E. Pilgrim, as a retail feed store. Over the years, the Company grew through both internal growth and various acquisitions of farming operations and chicken processors. In addition to domestic growth, the Company expanded into Mexico through acquisitions beginning in 1988 and subsequent substantial capital investments.\nThe Company is a vertically integrated producer of chicken products, controlling the breeding, hatching and growing of chickens and the processing, preparation and packaging of its product lines. The Company is the fifth largest producer of chicken in the United States, with production and distribution facilities located in Texas, Arkansas, Oklahoma and Arizona, and the second largest producer of chicken in Mexico, with production and distribution facilities located in Mexico City and the states of Coahuila, San Louis Potosi, Queretaro and Hidalgo. The Company is also a producer of table eggs, animal feeds and ingredients. See Note H to the Consolidated Financial Statements of the Company for information concerning revenues, operating profit and identifiable assets attributable to the Company's U.S. and Mexican operations.\nThe Company's chicken products consist primarily of (i) prepared foods, which include portion-controlled breast fillets, tenderloins and strips, formed nuggets and patties and bone-in chicken parts, which are generally sold frozen and may be either fully cooked or ready to cook; (ii) fresh foodservice chicken, which includes whole or cut-up chicken for the foodservice industry; (iii) prepackaged chicken, which includes various combinations of chicken parts in trays and fresh whole chickens labeled and priced ready for the retail grocer's fresh meat counter; and (iv) bulk packaged chicken parts and whole chicken, which is sold eviscerated in the U.S. and in both eviscerated and uneviscerated forms in Mexico.\nDuring recent years, the Company's strategy has been to identify and develop specific, defined markets where it can achieve significant advantages over competing suppliers. Management believes that this strategy has enabled the Company to achieve both higher rates of growth and higher profits than otherwise would have resulted. The Company has targeted three principal markets: U.S. foodservice, U.S. consumer and Mexico. The following table sets forth, for the periods since 1990, net sales attributable to each of the Company's primary markets and net sales attributable to certain products sold within such market. The table is based on the Company's internal sales reports and its classification of product types and customers.\nFiscal Year Ended September September September October October 29, 1990 28, 1991 26, 1992 2, 1993 1, 1994 (52 Weeks)(52 Weeks)(52 Weeks)(53 Weeks)(52 Weeks)\n(in thousands) Chicken Sales: U.S. Foodservice: Prepared foods........... $112,509 $151,661 $178,185 $183,165 $205,224 Fresh Foodservice chicken 118,158 127,303 126,472 149,197 155,294 Total U.S. Foodservice.. 230,667 278,964 304,657 332,362 360,518\nU.S. Consumer: Prepared foods........... 60,069 60,188 85,700 89,822 61,068 Prepackaged chicken..... 122,907 125,897 105,636 100,063 125,133 Bulk-packaged chicken... 95,907 85,323 72,724 77,709 88,437 Total U.S. Consumer.... 278,883 271,408 264,060 267,594 274,638\nMexico: Bulk-packaged chicken.... 110,632 141,570 160,620 188,754 188,744 Total Chicken Sales..... 620,182 691,942 729,337 788,710 823,900 Sales of Other Domestic Products........ 100,373 94,709 88,024 99,133 98,709 Total Net Sales......... $720,555 $786,651 $817,361 $887,843 $922,609\nUnited States The following table sets forth, since fiscal 1990, the percentage of net U.S. chicken sales attributable to each of the Company's primary U.S. markets and certain products sold within such markets. The table and related discussion are based on the Company's internal sales reports and its classification of product types and customers.\nFiscal Year Ended September September September October October 29, 1990 28, 1991 26, 1992 2, 1993 1, 1994 (52 Weeks)(52 Weeks)(52 Weeks)(53 Weeks)(52 Weeks) Foodservice: Prepared foods ........... 22.1% 27.6% 31.3% 30.5% 32.3% Fresh Foodservice chicken. 23.2 23.1 22.2 24.9 24.5 Total Foodservice........ 45.3% 50.7% 53.5% 55.4% 56.8% Consumer: Prepared foods............ 11.8% 10.9% 15.1% 15.0% 9.6% Prepackaged chicken....... 24.1 22.9 18.6 16.6 19.7 Bulk-packaged chicken..... 18.8 15.5 12.8 13.0 13.9 Total Consumer........... 54.7% 49.3% 46.5% 44.6% 43.2%\nStrategy Domestic chicken sales can be segmented into two principal markets - - - foodservice and consumer. The Company's strategy is to (i) focus on the development of the prepared foods business within each of these two markets, which is generally characterized by higher growth and more stable margins than the chicken industry as a whole; and (ii) achieve significant cost and product advantages over competing suppliers across all market segments, thereby achieving greater growth in sales and profits than would otherwise result.\nU.S. Foodservice The majority of the Company's U.S. chicken sales are derived from products sold to the foodservice market. The foodservice market principally consists of chain restaurants, institutions and foodservice distributors located throughout the continental United States, which purchase chicken products ranging from fully cooked and frozen chicken nuggets to portion-controlled refrigerated chicken parts. As the second largest full-line supplier of chicken to the foodservice market, the Company believes it is well-positioned to be a major supplier to large customers who require multiple suppliers of chicken products. Additionally, the Company believes it is well- positioned to meet the needs of midsized customers who require a primary supplier of chicken products. Due to its comparatively large size in this market, management believes the Company has significant competitive advantages in terms of product capability, production capacity, research and development expertise, and distribution and marketing experience relative to smaller producers. As a result of these competitive advantages, the Company's sales to the foodservice market from fiscal 1990 through fiscal 1994 grew at a compound annual growth rate of approximately 12%, while, based on industry data, the Company estimates that total industry dollar sales to the foodservice market during this period grew at a compound annual growth rate of approximately 5%. The Company markets two main types of products to the foodservice market: prepared foods and fresh foodservice chicken.\nPrepared Foods: Prepared foods sales to the foodservice market were $205 million in fiscal 1994 and have increased at a compound annual growth rate of approximately 16% from fiscal 1990 through fiscal 1994. The Company's prepared foods products include portion-controlled breast fillets, tenderloins and strips, formed nuggets and patties and bone-in chicken parts, which are generally sold frozen and in various stages of preparation, including blanched, battered, breaded and partially or fully- cooked. The Company attributes this growth in sales of prepared foods to the foodservice market to a number of factors:\nFirst, there has been significant growth in the number of foodservice operators offering chicken on their menus and the number of chicken items offered;\nSecond, there is a strong need among larger foodservice companies for a second supplier upon which they rely to ensure supply, encourage innovation and new product development and provide price competition due, in part, to the dominance of the Company's principal competitor in the prepared foods market. The Company has been successful in its attempt to become a second supplier to many large foodservice companies because it (i) is vertically integrated, giving the Company control over raw material supplies, (ii) has the capability to produce many types of chicken items and (iii) has established a reputation for dependable quality, service and technical support;\nThird, as a result of the experience and reputation developed with larger customers, the Company has increasingly become the principal supplier to midsized foodservice organizations; and\nFourth, the Company's in-house product development group, responding to the changing needs of the foodservice market, has enabled the Company to provide foodservice customers with new and improved prepared foods. Approximately $94 million of the Company's sales to foodservice customers in 1994 consisted of products which were not sold by the Company in 1990.\nThe Company establishes prices for its prepared chicken products based primarily upon perceived value to the customer, production costs and prices of competing products. However, many of these products are priced according to formulas which are based on an underlying commodity market, and this factor causes some revenue fluctuation correspondingly with such markets.\nFresh Foodservice Chicken: The Company produces and markets fresh, refrigerated chicken for sale to domestic quick-service restaurant chains, delicatessens and other customers. These chickens have the giblets removed, are usually of specific weight ranges and are usually pre-cut to customer specifications. By growing and processing to customers specifications, the Company is able to assist quick service restaurant chains in controlling costs and maintaining size consistency of chicken pieces sold to the consumer. Most of these products are sold to established customers based upon certain weekly market prices reported by the U.S.D.A., plus a markup, which is dependent upon the customer's location, volume, product specifications and other factors.\nU.S. Consumer The U.S. consumer market consists primarily of grocery store chains, retail distributor and wholesale clubs. The Company concentrates its efforts in this market on sales of prepared foods, branded, prepackaged chicken and bulk-packaged, whole chicken to grocery chains and retail distributors in the midwestern, southwestern and western portions of the United States. This regional marketing focus enables the Company to capitalize on proximity to the ultimate consumer, both in terms of lower transportation costs and enhanced product freshness. For a number of years the Company has invested in both trade and consumer marketing designed to establish high levels of brand name awareness and consumer preferences within these markets.\nPrepared Foods: The Company sells consumer-prepared foods to grocery store chains primarily located in the midwestern, southwestern and western portions of the U.S. and, until January 1994, to wholesale clubs located throughout the continental U.S. The wholesale club industry is characterized by a limited number of large national operators, each tending to purchase particular products from a limited number of suppliers. During 1994 the wholesale club industry consolidated significantly with the acquisition of Pace Membership Warehouse by Sam's Club and the merger of Price Club and Costco Wholesale Club. As a result of these consolidations, in January 1994 the Company lost a substantial portion of its wholesale club business; however, it was able to direct this prepared foods capacity to other lines of business with better overall gross margins and a more diversified customer base.\nPrepackaged Chicken: The Company's prepackaged products include various combinations of fresh whole chickens and chicken parts in trays, labeled and priced ready for the retail grocer's fresh meat counter.\nThe Company utilizes numerous marketing techniques, including advertising, to develop and strengthen trade and consumer awareness and increase brand loyalty for its Pilgrim's Pride products. The Company's founder, Lonnie \"Bo\" Pilgrim, is the featured spokesman in the Company's television and radio commercials and a trademark cameo of a person in a Pilgrim's hat appears on all of the Company's branded products. As a result of this marketing strategy, the Company has established a well-known brand name in certain southwestern metropolitan markets, including the Dallas\/Fort Worth area where, according to a market research company, the Company's brand name was recognized by 96% of grocery shoppers in an aided brand recall study conducted in 1994. Management believes that its branded products command a price premium in certain southwestern markets, which the Company believes can be attributed to its efforts to achieve brand awareness. The Company also maintains an active program to identify consumer preferences primarily by testing new product ideas, packaging designs and methods through taste panels and focus groups located in key geographic markets.\nBulk-Packaged Chicken: The Company sells bulk whole chickens and cut-up parts primarily to retail grocers and food distributors in the United States. In recent years, the Company has de-emphasized its marketing of bulk-packaged chicken in the United States in favor of more value-added products. Historically, sales of the Company's bulk-packaged, whole chicken have been characterized by lower prices and greater price volatility than the Company's more value-added product lines. In the United States, prices of these products are negotiated daily or weekly and are generally lower than market prices quoted by the U.S.D.A.\nA significant portion of the Company's sales to the foodservice market and to the U.S. consumer market is governed by agreements with customers that provide for the pricing methods and volume of products to be purchased. The Company believes its practices with respect to sales to the foodservice market and the U.S. consumer market are generally consistent with those of its competitors.\nMexico Strategy In Mexico, the Company has made capital investments in advanced production technology, transferred experienced management personnel and utilized proven domestic production techniques in order to be a low cost producer of chicken. At the same time, the Company has directed its marketing efforts toward more value added chicken products. Management believes that this strategy has resulted in increased market share and higher profit margins relative to other Mexican chicken producers and has positioned the Company to participate in any growth in chicken demand which may occur in the future. Recent demand growth in Mexico is evidenced by the increase in per capita consumption of chicken in Mexico, from approximately 24 pounds in 1982 to approximately 38 pounds in 1994, according to an industry source.\nBackground: The Mexican market is one of the Company's fastest growing markets and represented approximately 20% of the Company's net sales in fiscal 1994. The Company entered the Mexican market in 1981 when it began selling eggs on a limited basis. Recognizing favorable demographic trends and improving economic conditions in Mexico, the Company began exploring opportunities to produce and market chicken in Mexico. In fiscal 1988, the Company acquired four vertically integrated poultry production operations in Mexico for approximately $15.1 million. Since such acquisitions and through fiscal 1994, the Company has made capital expenditures in Mexico totaling $106 million to expand and improve such operations. The Company believes its facilities are among the most technologically advanced in Mexico. As a result of these expenditures, the Company has increased weekly production in its Mexico operations by over 300%. The Company believes that it is one of the lowest cost producers of chicken in Mexico. The Company continues to explore its business alternatives in the Mexican market, including possible acquisitions or the expansion of its existing operations.\nProducts: During the last three years, the Company's Mexico operation has dramatically increased its value added sales of chicken products, which should provide higher, more stable margins. Although changing now, the market for chicken products in Mexico is less developed than in the United States with sales attributed to fewer, more basic products.\nMarkets: The Company sells its Mexican chicken products primarily to large wholesalers and, to a lesser extent, to retailers through its own distribution network, which includes several warehouse facilities located throughout Central Mexico. The Company's customer base in Mexico covers a broad geographic area from Mexico City, the capital of Mexico with a population estimated to be over 20 million, to Saltillo, the capital of the State of Coahuila, about 500 miles north of Mexico City, and from Tampico on the Gulf of Mexico to Acapulco on the Pacific, which region includes the cities of San Luis Potosi and Queretaro, capitals of the states of the same name.\nCompetition The chicken industry is highly competitive and certain of the Company's competitors have greater financial and marketing resources than the Company. In the United States and Mexico, the Company competes principally with other vertically integrated chicken companies. In general, the competitive factors in the domestic chicken industry include price, product quality, brand identification, breadth of product line and customer service. Competitive factors vary by major market. In the foodservice market, competition is based on consistent quality, product development, service and price. In the domestic consumer market, management believes that product quality, brand awareness and customer service are the primary bases of competition. In Mexico, where product differentiation is limited, price and product quality are the most critical competitive factors.\nOther Activities The Company markets fresh eggs under the Pilgrim's Pride brand name as well as private labels in various sizes of cartons and flats to domestic retail grocery and institutional foodservice customers located primarily in Texas. The Company has a housing capacity for approximately 2.3 million commercial egg laying hens which can produce approximately 41 million dozen eggs annually. Domestic egg prices are determined weekly based upon reported market prices. The domestic egg industry has been consolidating over the last few years with the 20 largest producers accounting for approximately 65% of the total number of egg laying hens in service during 1994. The Company competes with other domestic egg producers, primarily on the basis of product quality, reliability, price and customer service. According to an industry publication, the Company is the twenty-fourth largest producer of eggs in the United States.\nIn fiscal 1994, the Company exported a small percentage of its domestically produced poultry products, primarily to Asian, Middle Eastern and European countries. While current activity in these markets contributes only a small percentage of sales, if export market conditions become more favorable, management believes the Company is well-positioned to increase sales to foreign countries.\nThe Company has regional distribution centers located in Arlington, El Paso, Mt. Pleasant and San Antonio, Texas; Phoenix and Tucson, Arizona; and Oklahoma City, Oklahoma that distribute the Company's poultry products along with certain non-poultry products purchased from third parties to quick service restaurants. The Company's non-poultry distribution business is conducted primarily as an accommodation to these customers.\nThe Company also converts chicken by-products into protein products primarily for sale to manufacturers of pet foods. In addition, the Company produces and sells livestock feeds at its feed mill and farm supply store in Pittsburg, Texas, to dairy farmers and livestock producers in northeastern Texas.\nRegulation The chicken industry is subject to government regulation, particularly in the health and environmental areas. The Company's domestic poultry processing facilities are subject to on-site examination, inspection and regulation by the U.S.D.A. The F.D.A. inspects the production of the Company's domestic feed mills. The Company's Mexican food processing facilities and feed mills are subject to on-site examination, inspection and regulation by a Mexican governmental agency which performs functions similar to those performed by the U.S.D.A. and F.D.A. Since commencement of operations by the Company's predecessor in 1946, compliance with applicable regulations has not had a material adverse effect upon the Company's earnings or competitive position and such compliance is not anticipated to have a materially adverse effect in the future. Management believes that the Company is in substantial compliance with all applicable laws and regulations relating to the operations of its facilities.\nThe Company anticipates increased regulation by the U.S.D.A. concerning food safety, as well as by the F.D.A. concerning the use of medications in feed. Although the Company does not anticipate any such regulation having a material adverse effect upon the Company, no assurances can be given to that effect.\nEmployees and Labor Relations As of December 15, 1994, the Company employed approximately 7,200 persons in the U.S. and 3,100 persons in Mexico. Approximately 650 employees at the Company's Lufkin, Texas facility are members of a collective bargaining unit represented by Local 540 of the United Food and Commercial Workers Union (the \"UFCW\"). None of the Company's other domestic employees have union representation. The Company has operated the Lufkin facility since its purchase in 1986 without a collective bargaining agreement. Since February 1993, the Company has been negotiating with the UFCW to reach a collective bargaining agreement. On May 24 and 25, 1993, the Company experienced a UFCW-initiated work stoppage involving approximately 200 employees at the Lufkin facility. By May 26, 1993, substantially all of the employees had returned to work. On June 22, 1993, negotiations with the UFCW reached an impasse, and the Company implemented the terms of the last contract offer. The National Labor Relations Board has been asked to rule regarding the status of the impasse, but as of this filing, no ruling has been made. Unless and until a collective bargaining agreement is reached, there may be further work disruptions at this facility. However, because of the adequate labor supply in the Lufkin area and the Company's ability to shift portions of its production to other facilities, the Company does not believe that additional work disruptions, if any, will have a material adverse effect on the Company's operations or financial condition. In Mexico, most of the Company's hourly employees are covered by collective bargaining agreements as most employees are in Mexico. Except as described above, the Company has not experienced any work stoppages, and management believes that relations with the Company's employees are satisfactory.\nExecutive Officers of the Registrant As of December 15, 1994, the following were the Executive Officers of the Company. Officers are elected annually by the Board of Directors to serve at the pleasure of the Board of Directors.\nExecutive Officers of the Company Age Positions\nLonnie \"Bo\" Pilgrim 66 Chief Executive Officer\nLindy M. \"Buddy\" Pilgrim 40 President and Chief Operating Officer\nClifford E. Butler 52 Chief Financial Officer, Secretary and Treasurer\nDavid Van Hoose 52 President, Mexican Operations\nRobert L. Hendrix 58 Executive Vice President Operations\nTerry Berkenbile 44 Senior Vice President Sales & Marketing, Retail and Fresh Products\nRichard A. Cogdill 34 Senior Vice President Corporate Controller\nRay Gameson 46 Senior Vice President Human Resources\nO.B. Goolsby, Jr. 47 Senior Vice President Prepared Foods\nMichael D. Martin 40 Senior Vice President DeQueen, Arkansas Complex\nJames J. Miner, Ph.D. 66 Senior Vice President Technical Services\nMichael J. Murray 36 Senior Vice President Sales & Marketing, Prepared Foods\nRobert N. Palm 50 Senior Vice President, Lufkin, Texas Complex\nMr. L. A. Pilgrim has served as Chairman of the Board and Chief Executive Officer since the organization of the Company in 1968. Prior to the incorporation of the Company, Mr. Pilgrim was a partner in the Company's predecessor partnership business founded in 1945.\nMr. L. M. Pilgrim has been employed by the Company as President and Chief Operating Officer since March 1994, and was elected a Director on March 8, 1993. He was previously President of U.S. Operations and Sales & Marketing from April 1993 to March 1994. Up to October 1990, Mr. Pilgrim was employed by the Company for 12 years in marketing and 9 years in operations. From October 1990 to April 1993, he was President of Integrity Management Services, Inc., as consulting firm to the poultry industry. He is a nephew of Lonnie \"Bo\" Pilgrim.\nMr. Butler has been employed by the Company since 1969. He has been a Director of the Company since 1969, was named Senior Vice President of Finance in 1973, and became Chief Financial Officer and Vice Chairman of the Board in July 1983.\nMr. Van Hoose has been President of Mexican Operations since April 1993. He was previously Senior Vice President, Director General, Mexican Operations since August 1990. Mr. Van Hoose was employed by Pilgrim's Pride in September 1988 as Senior Vice President, Texas Processing. Prior to that, Mr. Van Hoose was employed by Cargill, Inc., as General Manager of one of its chicken operations.\nMr. Hendrix has been Executive Vice President, Operations, of the Company since March 1994. Prior to that he served as Senior Vice President, NETEX Processing from August 1992 to March 1994 and as President and Chief of Complex Operations from July 1983 to March 1992. He became Senior Vice President in September 1981 when Pilgrim's Pride acquired Mountaire Corporation of DeQueen, Arkansas, and, prior thereto, he was Vice President of Mountaire Corporation.\nMr. Berkenbile was named Senior Vice President, Sales & Marketing, Retail and Fresh Products in July 1994. Prior to that he was Vice President, Sales & Marketing, Retail and Fresh Products since May 1993. From February 1991 to April 1993 Mr. Berkenbile was Director Retail Sales & Marketing at Hudson Foods. Prior to February 1991, Mr. Berkenbile was Director Plant Sales at Pilgrim's Pride.\nMr. Cogdill has been Senior Vice President, Corporate Controller, since August 1992. He was previously Vice President, Corporate Controller since October 1991. Prior to that he was a Senior Manager with Ernst & Young. He is a Certified Public Accountant.\nMr. Gameson has been Senior Vice President of Human Resources since October 1994. He previously served as Vice President of Human Resources since August, 1993. From December 1991 to July 1993, he was employed by Townsends, Inc. and served as Complex Human Resource, Manager. Prior to that he was employed by the Company as Complex Human Resource, Manager, at its Mt. Pleasant, Texas location.\nMr. Martin has been Senior Vice President, DeQueen, Arkansas Complex Manager, of the Company since April 1993. He previously served as Plant Manager at the Company's Lufkin, Texas operations and Vice President, Processing, at the Company's Mt. Pleasant, Texas, operations from September 1981 to April 1993. Prior to that he was employed by Mountaire Corporation of DeQueen, Arkansas, until it was acquired by the Company in 1981.\nDr. Miner, Ph.D., has been Senior Vice President, Technical Services, since April 1994. He has been employed by the Company and its predecessor partnership since 1966 and previously served as Senior Vice President responsible for live production and feed nutrition. He has been a Director since the incorporation of the Company in 1968.\nMr. Murray has been Senior Vice President, Sales & Marketing, Prepared Foods since October 1994. He previously served as Vice President of Sales and Marketing, Food Service since August 1993. From 1990 to July 1993, he was employed by Cargill, Inc. Prior to that, from March 1987 to 1990 he was employed by Pilgrim's Pride in a sales and marketing position and prior thereto, he was employed by Tyson Foods, Inc.\nMr. Palm has been Senior Vice President, Lufkin, Texas, Complex Manager of the Company, since 1985 and was previously employed by Plus-Tex Poultry, Inc., a company acquired by Pilgrim's Pride in 1985.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nProduction and Facilities Breeding and Hatching The Company supplies all of its domestic chicks by producing its own hatching eggs from domestic breeder flocks owned by the Company, approximately 38% of which are maintained on 38 Company-operated breeder farms. The Company currently owns or contracts for approximately 6.4 million square feet of breeder housing on approximately 178 breeder farms. In Mexico, all of the Company's breeder flocks are maintained on Company- owned farms.\nThe Company owns six hatcheries in the Unites States, located in Nacogdoches and Pittsburg, Texas, and DeQueen and Nashville, Arkansas, where eggs are incubated and hatched in a process requiring 21 days. Once hatched, the day-old chicks are inspected and vaccinated against common poultry diseases and transported by Company vehicles to grow-out farms. The Company's six domestic hatcheries have an aggregate production capacity of approximately 6.3 million chicks per week. In Mexico, the Company owns four hatcheries, which have an aggregate production capacity of approximately 1.9 million chicks per week.\nGrow-out The Company places its domestically grown chicks on approximately 929 grow-out farms located in Texas and Arkansas. These farms provide the Company with approximately 43 million square feet of growing facilities. The Company operates 32 grow-out farms which account for approximately 10% of its total annual domestic chicken capacity. The Company also places chicks with farms owned by affiliates of the Company under grow-out contracts. The remaining chicks are placed with independent farms under grow-out contracts. Under such grow-out contracts, the farmers provide the facilities, utilities and labor. The Company supplies the chicks, the feed and all veterinary and technical services. Contract grow-out farmers are paid based on live weight under an incentive arrangement. In Mexico, the Company owns approximately 58% of its grow-out farms and contracts with independent farmers for the balance of its production. Arrangements with independent farmers in Mexico are similar to the Company's arrangements with contractors in the United States.\nFeed Mills An important factor in the production of chicken is the rate at which feed is converted into body weight. The Company purchases feed ingredients on the open market. The primary feed ingredients include corn, milo and soybean meal, which historically have been the largest component of the Company's total production cost. The quality and composition of the feed is critical to the conversion rate, and accordingly, the Company formulates and produces its own feed. Domestically, the Company operates four feed mills located in Nacogdoches and Pittsburg, Texas and Nashville and Hope, Arkansas. The Company currently has annual domestic feed requirements of approximately 1.6 million tons and the capacity to produce approximately 1.9 million tons. The Company owns three feed mills in Mexico which produce all of the requirements of its Mexican operations. Mexican feed requirements are approximately .5 million tons with a capacity to produce approximately .6 million tons. In fiscal 1994, approximately 49% of the grain used was imported from the United States. However, this percentage fluctuates based on the availability and cost of local grain supplies.\nFeed grains are commodities subject to volatile price changes caused by weather, size of harvest, transportation and storage costs and the agricultural policies of the United States and foreign governments. Although the Company can and sometimes does purchase grain in forward markets, it cannot eliminate the potential adverse effect of grain price increases.\nProcessing Once the chickens reach processing weight, they are transported in the Company's trucks to the Company's processing plants. These plants utilize modern, highly automated equipment to process and package the chickens. The Company periodically reviews possible application of new processing technologies in order to enhance productivity and reduce costs. The Company's five domestic processing plants, two of which are located in Mt. Pleasant, Texas, and the remainder of which are located in Dallas and Lufkin, Texas, and DeQueen, Arkansas, have the capacity, under present U.S.D.A. inspection procedures, to produce approximately 1 billion pounds of dressed chicken annually. The Company's three processing plants located in Mexico, which perform fewer processing functions than the Company's U.S. facilities, have the capacity to process approximately 340 million pounds of dressed chicken annually.\nPrepared Foods Plant The Company's prepared foods plant in Mt. Pleasant, Texas, was constructed in 1986 and expanded in 1987. This facility has deboning lines, marination systems, batter\/breading systems, fryers, ovens, both mechanical and cryogenic freezers, a variety of packaging systems and cold storage. This plant is currently operating at the equivalent of two shifts a day for five and one- half days a week. If necessary, the Company could add additional shifts during the remaining days of the week.\nEgg Production The Company produces eggs at three farms near Pittsburg, Texas. One farm is owned by the Company, while two farms are operated under contract by an entity owned by a major stockholder of the Company. The eggs are cleaned, sized, graded and packaged for shipment at processing facilities located on the egg farms. The farms have a housing capacity for approximately 2.3 million producing hens and are currently housing approximately 1.9 million hens.\nOther Facilities and Information The Company operates a rendering plant located in Mt. Pleasant, Texas, that currently processes by-products from approximately 1.6 million chickens daily into protein products, which are used in the manufacture of chicken and livestock feed and pet foods. The Company operates a feed supply store in Pittsburg, Texas, from which it sells various bulk and sacked livestock feed products. The Company owns an office building in Pittsburg, Texas, which houses its executive offices, and an office building in Mexico City, which houses the Company's Mexican marketing offices. The Company also owns approximately 16,500 acres of farmland previously used in the Company's non-poultry farming operations. The Company is currently in the process of disposing of such land and related assets.\nSubstantially all of the Company's property, plant and equipment is pledged as collateral on its secured debt.\nItem 3.","section_3":"Item 3. Legal Proceedings\nFrom time to time the Company is named as a defendant or co- defendant in lawsuits arising in the course of its business. The Company does not believe that such pending lawsuits will have a material adverse impact 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 the Registrant's Common Stock and Related Security Holder Matters\nQuarterly Stock Prices and Dividends High and low sales prices and dividends were:\nPrices Prices 1994 1993 Dividends\nQuarter High Low High Low 1994 1993\nFirst 8 1\/4 6 5\/8 $7 $5 3\/8 $.015 $. -- Second 9 1\/4 6 5\/8 9 1\/2 6 1\/4 .015 . -- Third 9 6 3\/8 9 1\/8 7 1\/2 .015 .015 Fourth 9 5\/8 7 1\/4 8 5\/8 7 .015 .015\nPursuant to an agreement with some of the Company's secured lenders, dividends were suspended until the completion of the refinancing plans. Dividends were reinstated for the quarter ended July 3, 1993.\nThe Company's stock is traded on the New York Stock Exchange (ticker symbol CHX). The Company estimates there were approximately 12,500 holders (including individual participants in security position listings) of the Company's common stock as of December 15, 1994.\nS E L E C T E D F I N A N C I A L D A T A Pilgrim's Pride Corporation and Subsidiaries\nYears Ended 1994 1993(a) 1992(b) 1991 1990 1989 (in thousands, except per share data)\nOPERATING RESULTS SUMMARY:\nNet sales $922,609(c) $887,843 $817,361(c) $786,651 $720,555 $661,077 Gross margin 110,827 106,036(d) 32,802(d) 75,567 74,190 83,356 Operating income (loss) 59,955 56,102 (13,475) 31,039 33,379 47,014 Income (loss) before income taxes and extraordinary charge 42,448 32,838 (33,712) 12,235 20,463 31,027 Income tax expense (benefit) 11,390 10,543 (4,048) (59) 4,826 10,745 Income (loss) before extraordinary charge 31,058 22,295 (29,664) 12,294 15,637 20,282 Extraordinary charge - early repayment of debt, net of tax - (1,286) - - - - Net income (loss) 31,058 21,009 (29,664) 12,294 15,637 20,282\nPer common share data: Income (loss before extraordinary charge $ 1.1 $ 0.81 $ (1.24) $ 0.54 $ 0.69 $ 0.90 Extraordinary charge - early repayment of debt - (0.05) - - - - Net income (loss) 1.13 0.76 (1.24) 0.54 0.69 0.90 Cash dividends 0.06 0.03 0.06 0.06 0.06 0.06 Book value(e) 5.86 4.80 4.06 4.97 4.49 3.86\nBALANCE SHEET SUMMARY: Working capital $ 99,724 $ 72,688 $ 11,227 $ 44,882 $ 54,161 $ 60,313 Total assets 438,683 422,846 434,566 428,090 379,694 291,102 Short-term debt 4,493 25,643 86,424 44,756 30,351 9,528 Long-term debt, less current maturities 152,631 159,554 131,534 175,776 154,277 109,412 Total stockholders' equity 161,696 132,293 112,112 112,353 101,414 87,132\nKEY INDICATORS (As a percent of sales): Gross Margin 12.0% 11.9%(d) 4.0%(d) 9.6% 10.3% 12.6% Selling, general and administrative expenses 5.5% 5.6%(d) 5.7%(d) 5.7% 5.7% 5.5% Operating income (loss) 6.5% 6.3% (1.6)% 3.9% 4.6% 7.1% Net interest expense 2.1% 2.9% 2.8% 2.5% 2.3% 2.7% Net income (loss) 3.4% 2.4% (3.6)% 1.6% 2.2% 3.1%\n(a) 1993 had 53 weeks. (b) During 1992, the Company changed the fiscal year-end of its Mexican subsidiaries from August to September to coincide with that of its domestic operations. 1992 operating results included the operations of the Mexican subsidiaries for the twelve months ended September 26, 1992. Operating results for the Mexican subsidiaries during the month of September, 1991 have been reflected as a direct addition to stockholders' equity. (See Note A to the Consolidated Financial Statements.) (c) Excluded from net sales in 1994 and 1992 is approximately $.7 million and $2.2 million, respectively, of business interruption insurance proceeds resulting from a fire at the Company's prepared foods plant in Mt. Pleasant, Texas. (See Note I to the Consolidated Financial Statements.) (d) Reflects reclassification of certain expenses from selling, general and administrative to cost of sales of $4.2 million and $1.8 million in 1993 and 1992, respectively. (See Note A to the Consolidated Financial Statements). (e) Amounts are based on end-of-period shares of common stock outstanding.\nItem 7. Management's Discussion and Analysis of Results of Operations and Financial Condition\nGeneral The profitability of the chicken industry is affected by market prices of chicken and of feed grains, both of which may fluctuate significantly and exhibit cyclical characteristics. In an effort to reduce price volatility and to generate higher, more consistent profit margins, the Company has concentrated on the production and marketing of prepared food products, which generally have higher margins than the Company's other products. This concentration has resulted in an increase in sales of prepared food products as a percentage of total domestic net sales from 28.3% in fiscal 1990 to 39.0% in fiscal 1993. Management believes that sales of prepared food products will become a larger component of its total chicken sales, and, accordingly, changes in market prices for chicken and feed costs should have less impact on profitability.\nRESULTS OF OPERATIONS\nFiscal 1994 Compared to Fiscal 1993: The Company's accounting cycle resulted in 52 weeks of operations in fiscal 1994 and 53 weeks in fiscal 1993.\nConsolidated net sales were $922.6 million for fiscal 1994, an increase of $34.8 million, or 3.9%, over fiscal 1993. The increase in consolidated net sales resulted from a $35.2 million increase in domestic chicken sales to $635.2 million, partially offset by a $.4 million decrease in sales of other domestic products to $98.7 million. Mexican chicken sales remained constant at $188.7 million. The increase in domestic chicken sales was primarily due to a 3.9% increase in the total revenue per dressed pound produced and a 1.9% increase in dressed pounds produced. The constant Mexican chicken sales resulted from a 2.4% increase in dressed pounds produced offset by a 2.3% decrease in the total revenue per dressed pound produced.\nConsolidated cost of sales was $812.5 million in fiscal 1994, an increase of $30.7 million, or 3.9%, over fiscal 1993. The increase primarily resulted from a $35.9 million increase in cost of sales of domestic operations offset by a $5.2 million decrease in the cost of sales from Mexican operations.\nThe cost of sales increase in domestic operations of $35.9 million was primarily due to a 5.7% increase in feed ingredient cost and a 1.9% increase in dressed pounds produced.\nThe cost of sales decrease in Mexican operations of $5.2 million was primarily the result of a decrease in the average cost of sales per dressed pound produced, offset by a 2.4% increase in dressed pounds produced. The decrease in the average cost of sales per dressed pound produced when compared to the same period in 1993 was due to lower live production costs due to increased efficiencies.\nGross profit as a percentage of sales increased to 12.0% in fiscal 1994 from 11.9% in fiscal 1993. The improved gross profit resulted primarily from increased gross profit in the Company's domestic chicken operations resulting primarily from increased total revenue per dressed pound. The increase in gross profit as a percentage of sales in Mexican chicken operations resulted from a decrease in the average cost of sales per dressed pound produced, resulting from reduced live production costs.\nConsolidated selling, general and administrative expenses were $50.9 million for fiscal 1994, an increase of $0.9 million, or 1.9%, when compared to fiscal 1993. Consolidated selling, general and administrative expenses as a percentage of sales decreased in fiscal 1994 to 5.5% from 5.6% in fiscal 1993.\nConsolidated operating income for fiscal 1994 was $60.0 million compared to $56.1 million in fiscal 1993. The increase was due primarily to higher margins in domestic and Mexican chicken operations as described previously.\nConsolidated net interest expense was $19.2 million in fiscal 1994, a decrease of $6.5 million, or 25.5%, when compared to fiscal 1993. This decrease was due to a reduction of fees and expenses incurred for refinancing and lower amounts of outstanding debt when compared to fiscal 1993.\nFiscal 1993 Compared to Fiscal 1992: The Company's accounting cycle resulted in 53 weeks of operations in fiscal 1993 compared to 52 weeks in fiscal 1992.\nConsolidated net sales were $887.8 million for fiscal 1993, an increase of $70.5 million or 8.6%, over fiscal 1992. The increase in consolidated net sales resulted from a $31.2 million increase in domestic chicken sales to $600.0 million, a $28.2 million increase in Mexican chicken sales to $188.7 million and a $11.1 million increase in sales of other domestic products to $99.1 million. The increase in domestic chicken sales was primarily due to a 4.9% increase in dressed pounds produced and a .6% increase in the total revenue per dressed pound produced. The increase in Mexican chicken sales resulted from a 6.8% increase in dressed pounds produced and a 10.1% increase in the total revenue per dressed pound produced.\nConsolidated cost of sales was $781.8 million in fiscal 1993, a decrease of $5.0 million, or .6% over fiscal 1992. The decrease primarily resulted from an $8.8 million decrease in cost of sales of domestic operations offset by a $5.7 million increase in the cost of sales from Mexican operations.\nThe cost of sales decrease in domestic operations of $8.8 million, occurring while dressed pounds produced increased 4.9%, was due primarily to reduced live production cost, improved efficiencies, lower feed cost and elimination of cost of sales resulting from the cessation of non-poultry farming operations. While average feed costs were lower in fiscal 1993 than the previous year, since the third quarter of fiscal 1993, feed costs have increased primarily attributable to flooding which occurred during the summer of 1993 in the Midwestern United States. Due to the commodity nature of feed there can be no assurance as to future feed costs.\nThe cost of sales increase in Mexican operations of $5.7 million was primarily the result of a 6.8% increase in dressed pounds produced offset by a decrease in the average cost of sales per dressed pound produced. The decrease in the average cost of sales per dressed pound produced when compared to the same period in 1992, was due to decreased feed prices and reduced production costs resulting from improved performance levels which are a result of capital expenditures made by the Company in 1990 and 1991.\nGross profit as a percentage of sales increased to 11.9% in fiscal 1993 from 4.0% in fiscal 1992. The improved gross profit resulted primarily from increased gross profit in the Company's domestic chicken operations resulting primarily from improved results in live production, improved efficiencies and decreased feed costs. The improved gross profit also results from significant improvement in gross profit on other domestic products including the elimination of the negative gross profit experienced in the same period of fiscal 1992 upon the cessation of non-poultry farming operations, and improved margins in the Company's commercial egg operations. The increase in gross profit as a percentage of sales in Mexican chicken operations resulted from a 10.1% increase in total revenue per dressed pound produced and a decrease in the average cost of sales per dressed pound produced, resulting from decreased feed prices and reduced production costs.\nConsolidated selling, general and administrative expenses were $49.9 million for fiscal 1993, an increase of $3.7 million, or 7.9%, when compared to fiscal 1992. The increase was not significantly attributable to any individual expense category with the exception of accrued retirement and bonuses which are dependent upon consolidated profits. Consolidated selling, general and administrative expenses as a percentage of sales decreased in fiscal 1993 to 5.6% compared to 5.7% in fiscal 1992.\nConsolidated operating income for fiscal 1993 was $56.1 million compared to an operating loss of $13.5 million in fiscal 1992. The increase was due primarily to higher margins in all areas of the Company's operations as described previously.\nConsolidated net interest expense was $25.7 million in fiscal 1993, an increase of $3.2 million, or 14.3% when compared to fiscal 1992. The increase was primarily due to higher rates on short-term borrowings due to the renegotiation of revolving credit agreements with lenders occurring in the third quarter of fiscal 1992 and the amortization of issue costs on interim financing agreements.\nLiquidity and Capital Resources:\nThe Company's liquidity improved from the previous year-end due to record net income. The Company's working capital increased to $99.7 million ($93.3 million, excluding current deferred income taxes recorded in connection with the adoption of FAS 109) from $72.7 million at the prior year-end. The current ratio increased to 2.34 to 1 (2.25 to 1, excluding current deferred income taxes recorded in connection with the adoption of FAS 109) from 1.77 to 1 at the prior year-end. Stockholder's equity for the Company increased to $161.7 million from $132.3 million at the prior year-end. The Company also reduced the ratio of total debt to capitalization from 58.3% at the prior year-end to 49.3%. The Company maintains a $75 million revolving credit facility maturing in May 1997 with unused lines of credit of $61.7 million available at November 15, 1994. In July 1994, the Company secured $10 million in stand-by long-term financing from an existing lender, secured by existing collateral. The facility is available through June 20, 1995 and the Company expects to renew the facility annually unless drawn upon.\nTrade accounts and other accounts receivable at October 1, 1994, were $53.3 million, a $6.3 million decrease from the 1993 fiscal year-end balance. This 10.6% decrease was due primarily to a decrease in the amounts of insurance claims receivable at year end 1994. See Note I to the Consolidated Financial Statements.\nInventories were $100.7 million at October 1, 1994, a $9.0 million increase from October 2, 1993. This 9.8% increase was primarily due to increased production which requires higher inventories and higher feed costs which are included in live broiler and hens and feed, eggs and other inventories until such time as they are sold.\nDeferred tax assets recorded in accordance with FAS 109 were $14.4 million as of October 1, 1994, a $4.7 million decrease from October 2, 1993. The Company believes that all remaining deferred tax assets will be realized through the reversal of existing temporary differences and anticipated future taxable earnings.\nOther current assets were $1.2 million at October 1, 1994, a 87.3% decrease from October 2, 1993, due primarily to the reclassification of assets held for sale, principally farmland which had previously been used in the Company's non-poultry farming operation, to other assets. The reclassification was made upon conclusion that liquidation of these assets is not likely to occur within the next fiscal year.\nCapital expenditures for fiscal 1994 were $25.6 million primarily for additional production facilities and other projects designed to improve efficiencies and the routine replacement of equipment. The Company's capital budget for fiscal 1995 provides for capital expenditures of approximately $29 million, which the Company anticipates will be used to improve efficiencies. The Company expects to finance its 1995 capital expenditures with available operating cash flow and leases.\nCash flows provided by (used in) operating activities were $60.7 million, $45.0 million and $(1.6) million in fiscal 1994, 1993 and 1992, respectively. The increase in cash flows provided by operating activities from fiscal 1993 to fiscal 1994 and fiscal 1992 to fiscal 1993 resulted primarily from increased net income in both fiscal 1994 and fiscal 1993.\nCash provided by (used in) financing activities was $(30.3) million, $(40.3) million and $25.1 million in fiscal 1994, 1993 and 1992, respectively. The cash provided by (used in) financing activities primarily reflects the proceeds from the sales of stock in fiscal 1992 and debt retirements in fiscal 1994, 1993 and 1992.\nThe Company's deferred income taxes have resulted primarily from the Company's change from the cash method of accounting to the accrual method of accounting for taxable periods beginning after July 2, 1988. The Company's deferred income taxes arising from such change in method of accounting will continue to be deferred as long as (i) at least 50% of the voting stock and at least 50% of all other classes of stock of the Company continue to be owned by the Lonnie \"Bo\" Pilgrim family and (ii) the Company's net sales from its agricultural operation in a taxable year equal or exceed the Company's net sales from such operations in its taxable year ending July 2, 1988. Failure of the first requirement will cause all of the deferred taxes attributable to the change in accounting method to be due. Failure of the second requirement will cause a portion of such deferred taxes to be due based upon the amount of the relative decline in net sales from the agricultural operations. The family of Lonnie \"Bo\" Pilgrim currently owns approximately 65.1% of the stock of the company. However, a sufficient amount of that stock is pledged to secure obligations to third parties such that foreclosure on that pledged stock by such third parties could result in the failure to satisfy one of the conditions to the continuation of the deferral of such deferred taxes. Management believes that likelihood of the (i) Pilgrim family ownership falling below 50%, or (ii) gross receipts from agricultural activities falling below the 1988 level, is remote.\nImpact of Inflation: Due to moderate inflation and the Company's rapid inventory turnover rate, the results of operations have not been adversely affected by inflation during the past three-year period.\nItem 8. Financial Statements and Supplementary Data\nThe consolidated financial statements together with the report of independent auditors, and financial statement schedules are included on pages 34 through 51 of this document. Financial statement schedules other than those included herein have been omitted because the required information is contained in the consolidated financial statements or related notes, or such information is not applicable.\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNOT APPLICABLE\nPART III\nItem 10. Directors and Executive Officers of Registrant\nReference is made to \"Election of Directors\" on pages 3 through 5 of Registrant's Proxy Statement for its 1994 Annual Meeting of Stockholders, which section is incorporated herein by reference.\nReference is made to \"Compliance with Section 16(a) of the Exchange Act\" on page 9 of Registrant's Proxy Statement for its 1994 Annual Meeting of Stockholders, which section is incorporated herein by reference.\nItem 11. Executive Compensation\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nItem 13. Certain Relationships and Related Transactions\nInformation responsive to Items 11, 12 and 13 is incorporated by reference from sections entitled \"Security Ownership\", \"Election of Directors\", \"Executive Compensation\", and \"Certain Transactions\" of the Registrant's Proxy Statement for its 1994 Annual Meeting of Stockholders. Part IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8- K\n(a) (1) The financial statements listed in the accompanying index to financial statements and schedules are filed as part of this report.\n(2) The schedules listed in the accompanying index to financial statements and schedules are filed as part of this report.\n(3) Exhibits\n2.1 Agreement and Plan of Reorganization dated September 15, 1986, by and among Pilgrim's Pride Corporation, A Texas corporation; Pilgrim's Pride Corporation, a Delaware corporation; and Doris Pilgrim Julian, Aubrey Hal Pilgrim, Paulette Pilgrim Rolston, Evanne Pilgrim, Lonnie \"Bo\" Pilgrim, Lonnie Ken Pilgrim, Greta Pilgrim Owens and Patrick Wayne Pilgrim (incorporated by reference from Exhibit 2.1 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n3.1 Certificate of Incorporation of the Company (incorporated by reference from Exhibit 3.1 of the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n3.2 By-Laws of the Company (incorporated by reference from Exhibit 3.2 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n4.1 Certificate of Incorporation of the Company (incorporated by reference from Exhibit 3.1 of the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n4.2 By-Laws of the Company (incorporated by reference from Exhibit 3.2 of the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n4.3 Indenture dated as of May 1, 1988, between the Company and Mtrust Corporation National Association relating to the Company's 14 1\/4% Senior Notes Due 1995 (incorporated by reference from Exhibit 4.1 of the Company's Registration Statement on Form S-1 (No. 33- 21057) effective May 2, 1988).\n4.4 First Supplemental Indenture dated as of October 4, 1990, between the Company and Ameritrust Texas, N.A. supplementing the Indenture dated as of May 1, 1988, between the Company and Mtrust Corporation National Association relating to the Company's 14 1\/4% Senior Notes Due 1995 (incorporated by reference from Exhibit 4.4 of the Company's Form 8 filed on July 1, 1992).\n4.5 Form of 14 1\/4% Senior Note Due 1995 (incorporated by reference from Exhibit 4.2 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n4.6 Specimen Certificate for shares of Common Stock, Par value $.01 per share, of the Company (incorporated by reference from Exhibit 4.6 of the Company's Form 8 filed on July 1, 1992).\n4.7 Form of Indenture between the Company and Ameritrust Texas National Association relating to the Company's 10 7\/8% Senior Subordinated Notes Due 2003 (incorporated by reference from Exhibit 4.6 of the Company's Registration Statement on Form S-1 (No. 33-59626) filed on March 16, 1993).\n4.8 Form of 10 7\/8% Senior Subordinated Note Due 2003 (incorporated by reference from Exhibit 4.8 of the Company's Registration Statement on Form S-1 (No. 33-61160) filed on June 16, 1993).\n10.1 Pilgrim Industries, Inc., Profit Sharing Retirement Plan, restated as of July 1, 1987 (incorporated by reference from Exhibit 10.1 of the Company's Form 8 filed on July 1, 1992).\n10.2 Bonus Plan of the Company (incorporated by reference from Exhibit 10.2 to the Company's Registration Statement on Form S-1 (No. 33- 8805) effective November 14, 1986).\n10.3 Aircraft Lease dated November 15, 1984, by and between L.A. Pilgrim d\/b\/a B.P. Leasing Company and the Company (incorporated by reference from Exhibit 10.5 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.4 Broiler Grower Contract dated November 11, 1985, between the Company and Lonnie \"Bo\" Pilgrim (Farm #30) (incorporated by reference from Exhibit 10.9 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.5 Broiler Growing Agreements dated October 28, 1985, between the Company and Monty K. Henderson d\/b\/a Central Farms and Lone Oak Farms (incorporated by reference from Exhibit 10.11 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.6 Broiler Growing Agreement dated March 27, 1986, between the Company and Clifford E. Butler (incorporated by reference from Exhibit 10.12 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.7 Broiler Grower Contract dated July 10, 1990 between the Company and James J. Miner d\/b\/a\/ BJM Farms (incorporated by reference from Exhibit 10.7 of the Company's Form 8 filed on July 1, 1992).\n10.8 Commercial Egg Grower Contract dated July 1, 1986, between the Company and Pilgrim Poultry, Ltd. (incorporated by reference from exhibit 10.14 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.9 Agreement dated November 28, 1978, by and between the Company and Pilgrim Poultry, Ltd. (incorporated by reference from Exhibit 10.15 to the Company's Registration Statement on Form S-1 (No. 33- 8805) effective November 14, 1986).\n10.10 Agreement between the Company and its Principal Shareholders dated October 2, 1974, as amended July 1, 1979 (incorporated by reference from Exhibit 10.19 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.11 Note Purchase Agreement dated as of October 1, 1986, by and between the Company and Aetna Life Insurance Company with related Collateral Trust Indenture, as amended by First Supplemental Indenture dated as of November 1, 1986, and by letter dated September 29, 1987, Texas Mortgage, Arkansas Mortgage, Guarantee Agreement, as amended by First Amendment to Guarantee Agreement dated June 9, 1987, and Cash Pledge Agreement (incorporated by reference from Exhibit 10.21 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.12 Letter Agreement dated April 26, 1988, by and among Aetna Life Insurance Company, The Aetna Casualty and Surety Company, The Connecticut Bank and Trust Company and the Company and Letter Agreement dated April 26, 1988, by and among Bank of America National Trust and Savings Association, The Connecticut Bank and Trust Company and the Company amending Note Purchase Agreement dated as of October 1, 1986 (incorporated by reference from Exhibit 10.36 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.13 Note Purchase Agreement dated as of September 21, 1990, by and among the Company, Aetna Life Insurance Company and Bank of America National Trust and Savings Association (incorporated by reference from Exhibit 10.20 of the Company's Form 8 filed on July 1, 1992).\n10.14 Amended and Restated Collateral Trust Indenture dated as of September 21, 1990, by and between the Company and State Street Bank and Trust Company of Connecticut, N.A. with related Notes, Modification Agreements and First Amendment to Guaranty (incorporated by reference from Exhibit 10.21 of the Company's Form 8 filed on July 1, 1992).\n10.15 Supplemental Indenture and Waiver dated as of December 9, 1991, by and between the Company and State Street Bank and Trust Company of Connecticut, N.A. with related Notes, Modification Agreements and First Amendment to Guaranty, Amended and Restated Collateral Trust Indenture dated as of September 20, 1990 (incorporated by reference from Exhibit 10.24 of the Company's Form 10-K for the year ended September 26, 1992).\n10.16 Loan Agreement dated as of August 1, 1988, by and between the Company and Angelina and Neches River Authority Industrial Development Corporation, with related Reimbursement and Credit Agreement (incorporated by reference from Exhibit 10.22 of the Company's Form 8 filed on July 1, 1992).\n10.17 Indenture of Trust dated as of August 1, 1988, related to Loan Agreement by and between the Company and Angelina and Neches River Authority Industrial Development Corporation, with related Bond, Irrevocable Letter of Credit, Deed of Trust, Security Agreement, Assignment of Rents and Financing Statement (incorporated by reference from Exhibit 10.23 of the Company's Form 8 filed on July 1, 1992).\n10.18 Assumption Agreement by and between the Company, Lonnie \"Bo\" Pilgrim and RepublicBank Lufkin, as trustee, dated June 14, 1985 (incorporated by reference from Exhibit 10.31 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.19 Stock Purchase Agreement dated September 15, 1986, among the Company, Doris Pilgrim Julian, Aubrey Hal Pilgrim, Paulette Pilgrim Rolston and Evanne Pilgrim (incorporated by reference from Exhibit 2.2 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.20 Amendment No. 1 to Stock Purchase Agreement, dated as of October 31, 1986, among the Company, Doris Pilgrim Julian, Aubrey Hal Pilgrim, Paulette Pilgrim Rolston and Evanne Pilgrim (incorporated by reference from Exhibit 2.3 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.21 Limited Partnership Interest Purchase Agreement dated September 15, 1986, by and between the Company and Doris Pilgrim Julian (incorporated by reference from Exhibit 2.5 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.22 Employee Stock Investment Plan of the Company (incorporated by reference from Exhibit 10.28 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.23 Promissory Note dated February 1, 1988, by and between the Company and John Hancock Mutual Life Insurance Company with related Deed of Trust, Assignment of Rents and Security Agreement and Mortgage and Guaranty of Note and Mortgage (incorporated by reference from Exhibit 10.29 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.24 Letter from John Hancock Mutual Life Insurance Company dated April 25, 1988, amending Deed of Trust, Assignment of Rents and Security Agreement dated February 1, 1988 (incorporated by reference from Exhibit 10.35 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.25 Promissory Note dated April 25, 1991, by and between the Company and John Hancock Mutual Life Insurance Company, with related Modification Agreement and Guaranty of Note and Mortgage (incorporated by reference from Exhibit 10.31 of the Company's Form 8 filed on July 1, 1992).\n10.26 Stock Purchase Agreement dated May 12, 1992, between the Company and Archer Daniels Midland Company (incorporated by reference from Exhibit 10.45 of the Company's Form 10-K for the year ended September 26, 1992).\n10.27 Promissory Note dated September 21, 1988, by and between the Company and Charles Schreiner Bank, with related Warranty Deed with Vendor's Lien and Deed of Trust and Security Agreement (incorporated by reference from Exhibit 10.40 of the Company's Form 8 filed on July 1, 1992).\n10.28 Promissory Note dated November 1, 1988, by and between the Company and The Connecticut Mutual Life Insurance Company, with related Deed of Trust (incorporated by reference from Exhibit 10.41 of the Company's Form 8 filed on July 1, 1992).\n10.29 Promissory Note dated September 20, 1990, by and between the Company and Hibernia National Bank of Texas (incorporated by reference from Exhibit 10.42 of the Company's Form 8 filed on July 1, 1992).\n10.30 Loan Agreement dated October 16, 1990, by and among the Company, Lonnie \"Bo\" Pilgrim and North Texas Production Credit Association, with related Variable Rate Term Promissory Note and Deed of Trust (incorporated by reference from Exhibit 10.43 of the Company's Form 8 filed on July 1, 1992).\n10.31 Secured Credit Agreement dated May 27, 1993, by and among the Company and Harris Trust and Savings Bank, and FBS AG Credit, Inc., Internationale Nederlanden Bank, N.V., Boatmen's First National Bank of Kansas City, and First Interstate Bank of Texas, N.A. (incorporated by reference from Exhibit 10.31 of the Company's Registration Statement on Form S-1 (No. 33-61160) filed on June 16, 1993).\n10.32 Loan and Security Agreement dated as of June 3, 1993, by and among the Company, the banks party thereto and Creditanstalt-Bankverein, as agent (incorporated by reference from Exhibit 10.32 of the Company's Registration Statement on Form S-1 (No. 33-61160) filed on June 16, 1993).\n10.33 First Amendment to Secured Credit Agreement dated June 30, 1994 to the Secured Credit Agreement dated May 27, 1993, by and among the Company and Harris Trust and Savings Bank, and FBS AG Credit, Inc., Internationale Nederlanden Bank N.V., Boatman's First National Bank of Kansas City and First Interstate Bank of Texas, N.A.\n10.34 Amended and Restated Loan and Security Agreement date July 29, 1994, by and among the Company, the banks party thereto and Creditanstalt-Bankverein, as agent.\n10.35 Supplemental Indenture dated October 2, 1994, by and between the Company and State Street Bank and Trust Company of Connecticut, N.A., and Guarantee Agreement, as amended by Second Amendment to Guarantee Agreement dated October 2, 1994.\n22. Subsidiaries of Registrant.*\n23. Consent of Ernst & Young LLP.*\n27. Financial Data Statement.\n* Filed herewith\nPursuant to Item 601(b)(4)(iii)(A) of Regulation S-K promulgated by the Securities and Exchange Commission, the Company has not filed as exhibits certain other instruments defining the rights of holders of long- term debt of the Company which instruments do not pertain to indebtedness in excess of 10% of the total assets of the Company. The Company hereby agrees to furnish copies of such instruments to the Securities and Exchange Commission upon request.\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 issuer has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 16th day of December 1994.\nPILGRIM'S PRIDE CORPORATION\nBy: _________________________ Clifford E. Butler Vice Chairman of the Board 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 dated indicated.\nSignature Title Date\n________________________ Chairman of the Board 12\/16\/94 Lonnie \"Bo\" Pilgrim of Directors and Chief Executive Officer (Principal Executive Officer)\n_______________________ Vice Chairman of the 12\/16\/94 Clifford E. Butler Board of Directors, Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer)\n________________________ President and 12\/16\/94 Lindy M. \"Buddy\" Pilgrim Chief Operating Officer and Director\n_______________________ Executive Vice President 12\/16\/94 Robert L. Hendrix Operations and Director\n_______________________ Senior Vice President 12\/16\/94 James J. Miner Technical Services and Director\n_______________________ Vice President and 12\/16\/94 Lonnie Ken Pilgrim Director\n_______________________ Director 12\/16\/94 Robert E. Hilgenfeld\n_______________________ Director 12\/16\/94 Vance C. Miller\n_______________________ Director 12\/16\/94 James J. Vetter, Jr.\n_______________________ Director 12\/16\/94 Donald L. Wass\nREPORT OF INDEPENDENT AUDITORS\nStockholders and Board of Directors Pilgrim's Pride Corporation\nWe have audited the accompanying consolidated balance sheets of Pilgrim's Pride Corporation and subsidiaries as of October 1, 1994, and October 2, 1993, and the related consolidated statements of income (loss), stockholders' equity and cash flows for each of the three years in the period ended October 1, 1994. Our audits also included the financial statement schedules listed on 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 Pilgrim's Pride Corporation and subsidiaries at October 1, 1994, and October 2, 1993, 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. 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\n2121 San Jacinto Street Dallas, Texas 75201 November 15, 1994\nC O N S O L I D A T E D B A L A N C E S H E E T S Pilgrim's Pride Corporation and Subsidiaries\nOctober 1, 1994 October 2, 1993 ASSETS CURRENT ASSETS Cash and cash equivalents $ 11,244,000 $ 4,526,000 Trade accounts and other receivables, less allowance for doubtfulaccounts 53,264,000 59,608,000 Inventories 100,749,000 91,794,000 Deferred income taxes 6,459,000 - Prepaid expenses 1,280,000 1,260,000 Other current assets 1,249,000 9,843,000 TOTAL CURRENT ASSETS 174,245,000 167,031,000\nOTHER ASSETS 20,891,000 13,114,000\nPROPERTY, PLANT AND EQUIPMENT Land 15,153,000 14,824,000 Buildings, machinery and equipment 332,289,000 317,657,000 Autos and trucks 27,457,000 25,877,000 Construction-in-progress 4,853,000 7,863,000 379,752,000 366,221,000 Less accumulated depreciation and amortization 136,205,000 123,520,000 243,547,000 242,701,000 $ 438,683,000 $ 422,846,000\nLIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Notes payable to banks $ - $ 12,000,000 Accounts payable 38,675,000 38,330,000 Accrued expenses 31,353,000 30,370,000 Current maturities of long-term debt 4,493,000 13,643,000 TOTAL CURRENT LIABILITIES 74,521,000 94,343,000\nLONG-TERM DEBT, less current maturities 152,631,000 159,554,000\nDEFERRED INCOME TAXES 49,835,000 36,656,000\nSTOCKHOLDERS' EQUITY Preferred stock, $.01 par value, authorized 5,000,000 shares; none issued - - Common stock, $.01 par value, authorized 45,000,000 shares; 27,589,250 issued and outstanding in 1994 and 1993 276,000 276,000 Additional paid-in capital 79,763,000 79,763,000 Retained earnings 81,657,000 52,254,000 TOTAL STOCKHOLDERS' EQUITY 161,696,000 132,293,000 COMMITMENTS AND CONTINGENCIES - - $ 438,683,00 $ 422,846,000\nSee notes to consolidated financial statements.\nC O N S O L I D A T E D S T A T E M E N T S O F I N C O M E (L O S S) Pilgrim's Pride Corporation and Subsidiaries\nYears Ended October October September 1, 1994 2, 1993 26, 1992 (52 weeks) (53 weeks) (52 weeks) Net sales $922,609,000 $887,843,000 $817,361,000 Business interruption insurance 731,000 - 2,225,000 923,340,000 887,843,000 819,586,000 Costs and expenses: Cost of sales 812,513,000 781,807,000 786,784,000 Selling, general and administrative 50,872,000 49,934,000 46,277,000 863,385,000 831,741,000 833,061,000 OPERATING INCOME (LOSS) 59,955,000 56,102,000 (13,475,000)\nOther expenses (income): Interest expense, net 19,173,000 25,719,000 22,502,000 Miscellaneous, net (1,666,000) (2,455,000) (2,265,000) Total other expenses, net 17,507,000 23,264,000 20,237,000 Income (loss) before income taxes and extraordinary charge 42,448,000 32,838,000 (33,712,000) Income tax expense (benefit) 11,390,000 10,543,000 (4,048,000) Net income (loss) before extraordinary charge 31,058,000 22,295,000 (29,664,000) Extraordinary charge-early repayment of debt, net of tax - (1,286,000) -\nNET INCOME (LOSS) $ 31,058,000 $ 21,009,000 $(29,664,000)\nNet income (loss) per common share before extraordinary charge $ 1.1 $ 0.81 $ (1.24) Extraordinary charge per common share - (0.05) - Net income (loss) per common share $ 1.1 $ 0.76 $ (1.24)\nSee notes to consolidated financial statements.\nC O N S O L I D A T E D S T A T E M E N T S O F S T O C K H O L D E R S ' E Q U I T Y Pilgrim's Pride Corporation and Subsidiaries\nNumber Additional of Common Paid-in Retained Shares Stock Capital Earnings Total Balance at September 28, 1991 22,589,250 $226,000 $49,890,000 $62,237,000 $112,353,000\nNet income for the month ended September 28, 1991, excluded below due to the change in fiscal year-end of Mexican subsidiaries - - - 931,000 931,000 Net loss for year - - - (29,664,000) (29,664,000) Common stock issued 5,000,000 50,000 29,873,000 - 29,923,000 Cash dividends declared ($0.06 per share) - - - (1,431,000) (1,431,000)\nBalance at September 26, 1992 27,589,250 276,000 79,763,000 32,073,000 112,112,000\nNet income for year - - - 21,009,000 21,009,000 Cash dividends declared ($0.03 per share) - - - (828,000) (828,000)\nBalance at October 2, 1993 27,589,250 276,000 79,763,000 52,254,000 132,293,000\nNet income for year - - - 31,058,000 31,058,000 Cash dividends declared ($0.06 per share) - - - (1,655,000) (1,655,000)\nBalance at October 1, 1994 27,589,250 $ 276,000 $79,763,000 $81,657,000 $161,696,000\nSee notes to consolidated financial statements.\nC O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S Pilgrim's Pride Corporation and Subsidiaries\nYears Ended October October September 1, 1994 2, 1993 26, 1992 (52 weeks) (53 weeks) (52 weeks)\nCash Flows From Operating Activities:\nNet income (loss) $ 31,058,000 $ 21,009,000 $ (29,664,000) Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: Depreciation and amortization 25,177,000 26,034,000 24,090,000 Gain on property disposals (608,000) (2,187,000) (620,000) Provision for doubtful accounts 2,666,000 2,124,000 1,045,000 Deferred income taxes 6,720,000 5,028,000 (5,382,000) Extraordinary charge - 1,904,000 - Net income for the month ended September 28, 1991 excluded above due to the change in fiscal year of Mexican subsidiaries - - 931,000 Changes in operating assets and liabilities: Accounts and other receivables 3,412,000 (6,555,000) (9,720,000) Inventories (8,955,000) (2,366,000) 7,807,000 Prepaid expenses (459,000) 4,175,000 (4,416,000) Accounts payable and accrued expenses 1,742,000 (4,168,000) 14,598,000 Other (89,000) (28,000) (242,000) Net Cash Flows Provided by (Used In) Operating Activities 60,664,000 44,970,000 (1,573,000)\nInvesting Activities: Acquisitions of property, plant and equipment (25,547,000) (15,201,000) (18,043,000) Proceeds from property disposal 2,103,000 2,977,000 3,766,000 Other assets (128,000) 713,000 (536,000) Net Cash Used in Investing Activities (23,572,000) (11,511,000) (14,813,000)\nFinancing Activities: Proceeds from notes payable to banks 7,000,000 28,419,000 163,629,000 Repayments on notes payable to banks (19,000,000) (81,398,000) (156,150,000) Proceeds from long-term debt 31,000 126,468,000 - Payments on long-term debt (16,253,000) (106,302,000) (11,502,000) Cost of refinancing debt - (5,510,000) - Extraordinary charge, cash items - (1,188,000) - Proceeds from leasing transaction - - 565,000 Net proceeds from sale of stock - - 29,923,000 Cash dividends paid (2,069,000) (828,000) (1,355,000) Cash (Used in) Provided by Financing Activities (30,291,000) (40,339,000) 25,110,000\nEffect of exchange rate changes on cash and cash equivalents (83,000) (144,000) (49,000) Increase (decrease) in cash and cash equivalents 6,718,000 (7,024,000) 8,675,000 Cash and cash equivalents at beginning of year 4,526,000 11,550,000 2,875,000 Cash and cash equivalents at end of year $11,244,000 $ 4,526,000 $11,550,000\nSupplemental disclosure information: Cash paid during the year for: Interest (net of amount capitalized) $19,572,000 $23,015,000 $22,507,000 Income taxes $ 7,108,000 $ 3,688,000 $ 1,455,000\nSee notes to consolidated financial statements.\nN O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Pilgrim's Pride Corporation and Subsidiaries\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: The consolidated financial statements include the accounts of Pilgrim's Pride Corporation and its wholly owned subsid iaries (the \"Company\"). Significant intercompany accounts and transactions have been eliminated.\nThe financial statements of the Company's Mexican subsidiaries are remeasured as if the U.S. dollar were the functional currency. According ly, assets and liabilities of the Mexican subsidiaries are translated at end-of-period exchange rates, except for non current assets which are translated at equivalent dollar costs at dates of acquisition using historical rates. Operations are translated at average exchange rates in effect during the period. Translation (gains) losses for 1994, 1993 and 1992 of $(257,000), $243,000, and $736,000, respectively, are included in the statements of income as components of \"Costs and expenses - Selling, general and administrative\" in the Consolidated Statement of Income (Loss).\nDuring the fourth quarter of fiscal 1994, the Company reclassified certain expenses of its Mexican subsidiaries to conform to the classification in the United States. The effect of this change was to decrease selling, general and administrative expense and increase cost of sales by $4,177,000 and $1,844,000 in 1993 and 1992, respectively.\nDuring the fourth quarter of fiscal 1992, the Company changed the fiscal year-end for its Mexican subsidiaries from August 31 to a 52-53 week year- end coinciding with the fiscal year of its domestic operations. Accordingly, the fiscal 1992 Consolidated Statement of Loss includes the operations of the Company's Mexican subsidiaries for the twelve-month period ended September 26, 1992. Operating results for the Company's Mexican subsidiaries during the month of September 1991 have been reflected as a direct addition to stockholders' equity. If this change in the Company's Mexican subsidiaries' fiscal year-end had not occurred, operating loss, net loss, and net loss per common share for the fiscal year ended September 26, 1992, would have been $(8,760,000), $(24,683,000) and $(1.03), respect ively. The effect of the change on the remaining components of the Consolidated Statement of Loss was not significant.\nCash Equivalents: The Company considers highly liquid investments with a maturity of 3 months or less when purchased to be cash equivalents.\nAccounts Receivable: The Company does not believe it has significant concentrations of credit risk. Credit evaluations are performed on all significant customers and updated as circumstances dictate. The Company generally does not require collateral. Allowances for doubtful accounts were $ 5,906,000 and $3,240,000 in 1994 and 1993, respectively.\nInventories: Live poultry inventories of broilers are stated at the lower of cost or market and hens at the lower of cost, less accumulated amorti zation or market. The costs associated with hens are accumulated up to the production stage and amortized over the productive lives using the straight-line method. Finished poultry products, feed, eggs and other inventories are stated at the lower of cost (first-in, first-out method) or market. Under certain circumstances, the Company hedges purchases of its major feed ingredients using futures contracts to minimize the risk of adverse price fluctuations. Gains and losses on the hedge transactions are deferred and recognized as a component of cost of sales when products are sold.\nOther Assets\/Other Current Assets: Other assets includes approximately $8.9 million of non poultry farming assets, primarily farmland, held for sale. These assets, previously classified as other current assets in the October 2, 1993 Consolidated Balance Sheet, were reclassified upon the conclusion that their liquidation is not likely to occur within the next fiscal year. Related debt on these assets has also been reclassified.\nProperty, Plant and Equipment: Property, plant and equipment is stated on the basis of cost. For financial reporting purposes, depreciation is computed using the straight-line method over the estimated useful lives of these assets. Depreciation expense was $23.7 million, $23.4 million and $23.1 million in 1994, 1993 and 1992, respectively.\nNet Income (Loss) per Common Share: Net income (loss) per share is based on the weighted average shares of common stock outstanding during the year. The weighted average number of shares outstanding was 27,589,250 in 1994 and 1993 and 23,880,459 in 1992.\nNOTE B - INVENTORIES Inventories consist of the following:\nOctober 1, 1994 October 2,1993 Live broilers and hens $ 47,743,000 $ 44,417,000 Feed, eggs and other 22,529,000 25,473,000 Finished poultry products 30,477,000 21,904,000 $ 100,749,000 $ 91,794,000\nNOTE C - NOTES PAYABLE AND LONG-TERM DEBT The Company maintains a $75 million credit facility with various banks providing short-term lines of credit at interest rates of approximately one and one-eighth percent above LIBOR and, at October 1, 1994, availability under these lines totaled $63.9 million. Inventories and trade accounts receivable of the Company are pledged as collateral on this facility. The fair value of the Company's long-term debt was estimated using quoted market prices, where available. For long-term debt not actively traded, fair values were estimated using discounted cash flow analysis using current market rates for similar types of borrowings. For certain debt instruments recently issued or modified, including the credit facility, the Company believes that their carrying amounts approximate fair value at October 1, 1994 and October 2, 1993.\nThe table below sets forth maturities on long-term debt during the next five years. Year Amount 1995 $ 4,493,000 1996 7,595,000 1997 11,068,000 1998 8,480,000 1999 8,137,000\nDuring 1993, the Company retired certain debt prior to their scheduled maturities. These repayments resulted in an extraordinary charge of $1.3 million, net of $.6 million tax benefit.\nIn July 1994, the Company secured $10 million in stand-by long-term financing from an existing lender, secured by existing collateral. The facility is available through June 20, 1995 and the Company expects to renew the facility annually unless drawn upon.\nThe Company is required, by certain provisions of its debt agreements, to maintain minimum levels of working capital and net worth, to limit dividends to a maximum of $1.7 million per year, to maintain various fixed charge, leverage, current and debt-to-equity ratios, and to limit annual capital expenditures to 115% of the prior year's depreciation and amortization expense.\nTotal interest during 1994, 1993 and 1992 was $20,109,000, $26,415,000 and $23,115,000, respectively. Interest related to new construction capitalized in 1994, 1993 and 1992 was $525,000, $220,000 and $456,000, respectively.\nLong-term debt and the related fair values consist of the following:\nOctober 1, 1994 October 2, 1993 Carrying Fair Carrying Fair Amounts Value Amounts Value Senior subordinated notes due August 1, 2003, interest at 10 % (effective rate of 11 %) payable in semi- annual installments, less discount of $1,330,000 and $1,480,000 in 1994 and 1993, respectively $ 98,670,000 $ 96,824,000 $ 98,520,000 $ 98,520,000 Notes payable to bank, interest at LIBOR plus 1.8% and 2.5% in 1994 and 1993, respectively, principal payments of $700,000 in quarterly installments including interest plus one final balloon payment at maturity on June 1, 2000 15,400,000 15,400,000 23,800,000 23,800,000 Senior secured debt payable to an insurance company at 10.49%, payable in equal annual installments beginning October 5, 1996 through September 21, 2002 22,000,000 23,293,000 22,000,000 24,549,000 Note payable to an insurance company at 10.78%, payable in equal monthly installments including interest through March 1, 1998 8,633,000 8,909,000 11,485,000 12,170,000 Senior secured debt payable to an insurance company, interest at 9.55%, payable in equal annual installments through October 1, 1998 4,440,000 4,458,000 5,520,000 5,696,000 Note payable to an insurance company at 10.35%, payable in equal monthly installments plus interest through May 1, 2001 3,544,000 3,683,000 4,220,000 4,568,000 Other notes payable 4,437,000 4,925,000 7,652,000 7,652,000 157,124,000 157,492,000 173,197,000 176,955,000 Less current maturities 4,493,000 13,643,000 $152,631,000 $159,554,000\nSubstantially all of the Company's property, plant and equipment is pledged as collateral on its long-term debt.\nNOTE D - INCOME TAXES Income (loss) before income taxes after allocation of certain expenses to foreign operations for 1994, 1993 and 1992 was $33,852,000, $30,816,000 and ($16,273,000), respectively, for domestic operations, and $8,596,000, $2,022,000 and ($17,439,000), respectively, for foreign operations. Provisions (benefits) for income taxes are based on pretax financial statement income. The major components of the deferred tax liability are related to the Company's prior use of the cash method of accounting for tax purposes and differences in book and tax basis of depreciable assets.\nThe components of income tax expense (benefit) are set forth below:\nYears Ended October October September 1, 1994 2, 1993 26, 1992 Current: Federal $ 4,573,000 $ 2,993,000 $ (49,000) Foreign 423,000 2,775,000 1,892,000 Other (326,000) (253,000) (509,000) 4,670,000 5,515,000 1,334,000 Deferred: Reinstatement (reversal) of deferred taxes through utilization (application) of net operating losses 6,589,000 6,210,000 (5,971,000) Accelerated tax depreciation 1,002,000 1,130,000 1,082,000 Effect of U.S. tax rate change on temporary differences - 1,000,000 - Expenses deductible in a different year for tax and financial reporting purposes (580,000) (1,782,000) - Reversal of deferred foreign income taxes upon Mexican tax law and restructuring changes - (1,110,000) - Other, net (291,000) (420,000) (493,000) 6,720,000 5,028,000 5,382,000) $11,390,000 $10,543,000 (4,048,000)\nThe following is a reconciliation between the statutory U.S. federal income tax rate and the Company's effective income tax rate:\nYears Ended October October September 1, 1994 2, 1993 26, 1992\nFederal income tax rate 35.0% 34.8% (34.0)% State tax rate, net 2.3 2.2 - Reversal of deferred foreign income taxes upon Mexican law and restructuring changes - (3.4) - Effect of U.S. tax rate change on temporary differences - 3.0 - Benefit of (prior) current year losses not recognized - (5.3) 5.0 Difference in U.S. statutory tax rate and Mexican effective tax rate (10.7) (2.5) 16.5 Other, net 0.2 3.3 0.5 26.8% 32.1% (12.0)%\nEffective October 3, 1993, the Company adopted the provisions of FAS Statement 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 FAS Statement No. 109 as of October 3, 1993 and the impact of the adoption on the reported net income amounts for 1994 was not material.\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:\nYears Ended October 1, 1994 October 2,1993 Deferred tax liabilities: Tax over book depreciation $ 24,006,000 $ 23,004,000 Prior use of cash accounting 33,290,000 32,758,000 Other 516,000 - Total deferred tax liabilities 57,812,000 55,762,000\nDeferred tax assets: AMT credit carryforward 6,629,000 3,967,000 General business credit carryforward 1,344,000 2,462,000 Net operating loss carryforward - 6,589,000 Other 6,463,000 6,088,000 Total deferred tax asset 14,436,000 19,106,000 Net deferred tax liabilities $ 43,376,000 $ 36,656,000\nPursuant to a restructuring of activities completed by the Company's Mexican subsidiaries on January 1, 1993 approximately $1.1 million of deferred taxes previously provided on earnings of the Company's nonagricultural Mexican subsidiaries was reversed as a credit to income tax expense in fiscal 1993. This restructuring, along with further restructuring of activities completed on January 1, 1994, allowed previously nonagricultural Mexican operations to be combined with existing agricultural operations and, as such, qualify for taxability as agricultural operations, which are currently not subject to taxes in Mexico. The current provision for foreign income taxes in 1994 is the result of taxes at certain of the Company's nonagricultural Mexican subsidiaries which were subject to income taxes prior to the restructurings or, absent earnings, an asset based minimum tax. The Company has not provided any U.S. deferred federal income taxes on the undistributed earnings of its Mexican subsidiaries based upon its determination that such earnings will be indefinitely reinvested. As of October 1, 1994, the cumulative undistributed earnings of these subsidiaries were approximately $49,484,000. If such earnings were not considered indefinitely reinvested, deferred federal and foreign income taxes would have been provided, after consideration of estimated foreign tax credits. (Included in this amount would be foreign taxes resulting from earnings of the Mexican agricultural subsidiaries which would be due upon distribution of such earnings to the U.S.). However, determination of the amount of deferred federal and foreign income taxes is not practicable.\nAs of October 1, 1994, approximately $6,629,000 of alternative minimum tax credits and $1,193,000 of targeted jobs credits were available to offset future taxable income. The targeted jobs credits expire in years ending in 2001 through 2009. All credits have been reflected in the financial statements as a reduction of deferred taxes. As these credits are utilized for tax purposes, deferred taxes will be reinstated.\nNOTE E - SAVINGS PLAN The Company maintains a Section 401(k) Salary Deferral Plan (the \"Plan\"). Under the Plan, eligible domestic employees may voluntarily contribute a percentage of their compensation. The Plan provides for a contribution of up to four percent of compensation subject to an overall Company contribution limit of five percent of income before taxes.\nUnder the plan outlined above, the Company's expenses were $2,636,000, $1,074,000 and $831,000 in 1994, 1993 and 1992, respectively.\nNOTE F - RELATED PARTY TRANSACTIONS The major stockholder of the Company owns a broiler and egg operation. Transactions with related entities are summarized as follows:\nYears Ended October October September 1, 1994 2, 1993 26, 1992\nContract egg grower fees to major stockholder $ 5,137,000 $ 4,739,000 $ 4,326,000 Chick, feed and other sales to major stockholder 9,373,000 8,298,000 15,146,000 Broiler purchases from major stockholder 9,346,000 8,275,000 15,075,000 Purchases of feed ingredients from Archer Daniels Midland Company - (See Note J) 56,499,000 37,757,000 51,549,000\nThe Company leases an airplane from its major stockholder under an operating lease agreement. The terms of the lease agreement require monthly payments of $33,000 plus operating expenses. Lease expense was $396,000 for each of the years 1994, 1993 and 1992. Operating expenses were $213,000 in 1994 and $108,000 in 1993 and 1992.\nExpenses incurred for the guarantee of certain debt by stockholders were $526,000, $1,192,000 and $1,632,000 in 1994, 1993 and 1992, respectively.\nDuring 1992, the Company acquired real estate from its profit sharing plan for approximately $574,000. The acquisition price was determined by an independent appraisal and was approved by the Audit Committee of the Board of Directors of the Company.\nNOTE G - COMMITMENTS AND CONTINGENCIES The Consolidated Statements of Income (Loss) included rental expense for operating leases of approximately $10,058,000, $9,320,000 and $8,734,000 in 1994, 1993 and 1992, respectively. The Company's future minimum lease commitments under noncancelable operating leases are as follows:\nYear Amount 1995 $ 8,597,000 1996 6,316,000 1997 4,745,000 1998 4,146,000 1999 3,200,000 Thereafter 7,278,000\nThe estimated costs to complete construction-in-progress at various locations at October 1, 1994, are approximately $4,419,000.\nAt October 1, 1994, the Company had $11,055,000 letters of credit outstanding relating to normal business transactions.\nThe Company is subject to various 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 financial position or results of operations of the Company.\nNOTE H - BUSINESS SEGMENTS The Company operates in a single business segment as a producer of agricultural products and conducts separate operations in the United States and Mexico.\nInterarea sales, which are not material, are accounted for at prices comparable to normal trade customer sales. Identifiable assets by geographic area are those assets that are used in the Company's operation in each area.\nInformation about the Company's operations in these geographic areas is as follows: Years Ended October October September 1, 1994 2, 1993 26, 1992 52 Weeks 53 Weeks 52 Weeks Sales to unaffiliated customers: United States $733,865,000 $699,089,000 $656,741,000 Mexico 188,744,000 188,754,000 160,620,000 $922,609,000 $887,843,000 $817,361,000 Operating profit (loss): United States $ 46,421,000 $ 46,471,000 $ (1,565,000) Mexico 13,534,000 9,631,000 (11,910,000) $ 59,955,000 $ 56,102,000 $(13,475,000) Identifiable assets: United States $302,911,000 $288,761,000 $297,369,000 Mexico 135,772,000 134,085,000 137,197,000 $438,683,000 $422,846,000 $434,566,000 NOTE I - INSURANCE CLAIMS The Company's Lufkin, Texas poultry processing production was shifted to several of the Company's other processing facilities due to a fire that occurred on July 26, 1993. Insurance claims covering this loss were settled in 1994. Proceeds collected or estimated to be collected under the property insurance claim exceeded the book value of the property destroyed, resulting in a gain of approximately $.7 million and $1.9 million in fiscal 1994 and 1993, respectively; such gains are included as components of \"Other expenses (income) -Miscellaneous, net\" in the fiscal 1994 and 1993 Consolidated Statements of Income.\nThe Company's prepared foods plant in Mt. Pleasant, Texas experienced a temporary shutdown of the plant caused by a fire which occurred on January 8, 1992. Insurance claims covering this loss were settled in 1994. The Company recorded approximately $.7 million and $2.2 million in fiscal 1994 and 1992, respectively, for amounts collected or expected to be collected under the business interruption insurance claim. Proceeds collected under the property insurance exceeded the book value of the property damaged by $.8 million; such gain is included as a component of \"Other expenses (income) - Miscellaneous, net\" in the fiscal 1992 Consolidated Statement of Loss.\nNOTE J - SALE OF COMMON STOCK On May 12, 1992 the Company entered into a stock purchase agreement to sell 5,000,000 shares of its previously unissued but authorized common stock at a purchase price of $6.00 per share to Archer Daniels Midland Company (\"ADM\"), a processor and merchandiser of agricultural products and a supplier of several products to the Company. The stock purchase agreement was closed on June 25, 1992 and proceeds from the sale of common stock to ADM were applied immediately to repay notes payable to banks.\nThe 1992 net loss per common share computed on a supplemental basis, as if the sale of common stock to ADM had occurred at the beginning of 1992 is $1.03.\nThe stock purchase agreement also contains a \"no-loss guarantee\" issued by the Company's major stockholder to ADM. Under the guarantee, ADM is indemnified against loss and guaranteed a market rate return on their investment through July 8, 1995. The guarantee is secured by 6,670,000 shares of Company stock owned by the Company's major stockholder.\nNOTE K - QUARTERLY RESULTS - (Unaudited)\nYear Ended October 1, 1994 First Second Third Fourth Fiscal Quarter Quarter Quarter Quarter Year (13 Weeks) (13 Weeks) (13 Weeks) (13 Weeks) (13 Weeks)\nNet sales $221,851,000 $223,167,000 $238,302,000 $239,289,000 $922,609,000 Business Interruption Insurance(a) - - - 731,000 731,000 Gross profit(b) 29,354,000 24,684,000 28,675,000 28,114,000 110,827,000 Operating income 16,508,000 12,632,000 15,322,000 15,493,000 59,955,000 Net income 8,421,000 7,920,000 7,196,000 7,521,000(c)31,058,000 Per share: Net income(d) 0.31 0.29 0.26 0.27 1.13 Cash dividends 0.015 0.015 0.015 0.015 0.060 Market price: High 8 1\/4 9 1\/4 9 9 5\/8 9 5\/8 Low 6 5\/8 6 5\/8 6 3\/8 7 1\/4 6 3\/8\nYear Ended October 2, 1993 First Second Third Fourth Fiscal Quarter Quarter Quarter Quarter Year (14 Weeks) (13 Weeks) (13 Weeks) (13 Weeks) (53 Weeks) Net sales $220,453,000 $227,670,000 $220,645,000 $219,075,000 $887,843,000 Gross profit(b) 27,002,000 31,876,000 24,088,000 23,070,000 106,036,000 Operating income 14,143,000 18,911,000 11,529,000 11,519,000 56,102,000 Extraordinary charge(e) - - (1,286,000) - 1,286,000 Net income 6,828,000 7,807,000 2,332,000 4,042,000(c)21,009,000 Per share: Net income before extraordinary charge(d) 0.25 0.28 0.14 0.14 0.81 Extraordinary charge(d) - - (0.05) - (0.05) Net income(d) 0.25 0.28 0.09 0.14 0.76 Cash dividends(f) - - 0.015 0.015 0.030 Market price: High 7 9 1\/2 9 1\/8 8 5\/8 9 1\/2 Low 5 3\/8 6 1\/4 7 1\/2 7 5 3\/8\n(a) Represents amounts collected under a business interruption insurance claim resulting from a fire at the Company's prepared foods plant in Mt. Pleasant, Texas on January 8, 1992. (See Note I) (b) In the fourth quarter of fiscal 1994, the Company reclassified certain expenses previously reflected in selling, general and administrative expenses as cost of sales. Conforming changes have been made and reflected in the first three quarters of fiscal 1994 and the four quarters of fiscal 1993 presented above. (See Note A) (c) Includes gains on property insurance settlement of $.7 million and $1.9 million in fiscal 1994 and fiscal 1993, respectively. (See Note I) (d) Amounts are based on the weighted average shares of common stock outstanding during each of the quarters. (e) The extraordinary charge of $1.3 million, net of tax, is the result of the early repayment of the Company's $50 million, 14 1\/4% Senior Secured Notes and certain other debts. (f) Pursuant to an agreement with some of the Company's secured lenders, dividends were suspended until the completion of the refinancing plans. Dividends were reinstated for the quarter ended July 3, 1993.\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES.\nCol. A Col. B Col. C Col. D Col. E DEDUCTIONS BALANCE AT END NAME OF BALANCE AT AMOUNTS OF PERIOD DEBTOR BEGINNING OF AMOUNTS WRITTEN NOT PERIOD ADDITIONS COLLECTED OFF CURRENT CURRENT Year ended October 1, 1994: Accounts receivable: Major Stockholder(1) $ 51,000 $ 9,523,000 $ 9,460,000 $ -- $114,000 $ --\nYear ended October 2, 1993: Accounts receivable: Major Stockholder(1) $111,000 $ 8,458,000 $ 8,518,000 $ -- $ 51,000 $ --\nYear ended September 26, 1992: Accounts receivable: Major Stockholder(1) $398,000 $15,300,000 $15,587,000 $ -- $111,000 $ --\n(1) Includes amounts for both the major stockholder and Pilgrim Poultry G.P., wholly owned by major stockholder.\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT\nCol. A Col. B Col. C Col. D Col. E Col. F Other Balance at Changes- Balance at CLASSIFI- Beginning Additions Add (Deduct) End of CATION of Period at Cost Retirements Describe Period\nYear ended October 1, 1994(3): Land $ 14,824,000 $ 475,000 $ 177,000 $ 31,000 $ 15,153,000 Building, machinery and equip. 317,657,000 25,069,000 10,401,000 (36,000) 332,289,000 Autos and trucks 25,877,000 3,317,000 1,743,000 6,000 27,457,000 Construction in progress 7,863,000 (3,010,000)(1) -- -- 4,853,000 TOTAL $366,221,000 $ 25,851,000(2) $12,321,000(5)$ 1,000(6)$ 379,752,000\nYear ended October 2, 1993(3): Land $ 15,063,000 $ 168,000 $ 185,000 $ (222,000) $ 14,824,000 Building, machinery and equip. 315,392,000 8,486,000 6,690,000 469,000 317,657,000 Autos and trucks 24,622,000 1,623,000 550,000 182,000 25,877,000 Construction in progress 2,939,000 4,924,000(1) -- -- 7,863,000 TOTAL $358,016,000 $15,201,000(2) $ 7,425,000(5)$ 429,000(6)$ 366,221,000\nYear ended September 26, 1992(3): Land $ 23,111,000 $ 676,000 $ 223,000 $ (8,501,000) $ 15,063,000 Building, machinery and equip. 288,913,000 34,794,000 7,821,000 (494,000) 315,392,000 Autos and trucks 26,777,000 1,809,000 3,798,000 (166,000) 24,622,000 Construction in progress 21,126,000 (18,123,000)(1) -- (64,000) 2,939,000 TOTAL $359,927,000 $19,156,000(2)(4)$11,842,000(5)$(9,225,000)(6)$358,016,000\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\n(1) Represents net change in construction-in-progress.\n(2) Additions relate primarily to expansion of poultry equipment and facilities in both U.S. and Mexican operations.\n(3) Provisions for depreciation have been computed using the following range of useful lives:\nBuilding, machinery and equipment 5 to 40 years Autos and trucks 5 to 7 years\n(4) Includes assets acquired under capital lease of approximately $1,113,000.\n(5) Amounts relate primarily to the retirement of fixed assets destroyed in the fires at the prepared foods plant in fiscal 1992 and the Lufkin processing plant in fiscal 1993. (See Note I to Consolidated Financial Statements).\n(6) Amounts relate primarily to asset reclassification between Other current assets and Property, Plant and Equipment. (See Note A to Consolidated Financial Statements).\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nCol. A Col. B Col. C Col. D Col. E Col. F Additions Other Balance at Charges to Changes Balance at Beginning Cost and Add (Deduct) End of DESCRIPTION of Period Expenses Retirements Describe Period\nYear ended October 1, 1994: Building $107,853,000 $20,750,000 $ 9,345,000 $(133,000) $119,125,000 Autos and trucks 15,667,000 2,974,000 1,561,000 -- 17,080,000 TOTAL $123,520,000 $23,724,000 $10,906,000(1)$(133,000) $136,205,000\nYear ended October 2, 1993: Building $ 91,109,000 $20,424,000 $ 3,500,000 $ (180,000) $107,853,000 Autos and trucks 12,891,000 2,995,000 342,000 123,000 15,667,000 TOTAL $104,000,000 $23,419,000 $ 3,842,000(1)$ (57,000) $123,520,000\nYear ended September 26, 1992 (2): Building $ 76,471,000 $19,434,000 $ 4,625,000 $ (171,000) $ 91,109,000 Autos and trucks 13,364,000 3,647,000 3,968,000 (152,000) 12,891,000 TOTAL $ 89,835,000 $23,081,000 $ 8,593,000(1) $ (323,000) $104,000,000\n(1) Amounts relate primarily to retirement of fixed assets destroyed in the fires at the prepared foods plant in fiscal 1992 and the Lufkin processing plant in fiscal 1993. (See Note I to Consolidated Financial Statements.)\n(2) Provisions for depreciation include charges for the Company's Mexican subsidiaries for the month of September, 1991 as follows:\nBuilding, Machinery and Equipment $ 398,000 Autos and Trucks 68,000 $ 466,000\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nCol. A Col. B Col. C Col. D Col. E\nBalance at Charged to Charged to Balance Beginning of Cost and Other Accts. Deductions at end DESCRIPTION Period Expenses Describe Describe(1) of Period\nYear ended October 1, 1994: Reserves and allowances deducted from asset accounts: Allowance $ 3,240,000 $ 2,666,000 $ -- $ -- $ 5,906,000\nYear ended October 2, 1993: Reserves and allowances deducted from asset accounts: Allowance $ 1,146,000 $ 2,124,000 $ -- $ 30,000 $ 3,240,000\nYear ended September 26, 1992 (2): Reserves and allowances deducted from asset accounts: Allowance $ 101,000 $ 1,045,000 $ -- $ -- $ 1,146,000\n(1) Uncollectible accounts written off, net of recoveries.\n(2) Fiscal 1992 amounts have been restated to exclude amounts related to sales adjustments previously included.\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM BORROWINGS\nCol. A Col. B Col. C Col. D Col. E Col. F Average Weighted Maximum Amount Average CATEGORY OF Weighted Amount Outstanding Interest AGGREGATE Balance Average Outstanding During Rate During SHORT-TERM at end Interest During the Period the Period BORROWINGS of Period Rate the Period (1) (2)\nYear ended October 1, 1994: Notes payable to banks $ -- 5.44% $12,000,000 $ 5,167,000 4.03%\nYear ended October 2, 1993: Notes payable to banks $12,000,000 5.00% $64,979,000 $46,098,840 7.44%(3)\nYear ended September 26, 1992: Notes payable to banks $64,979,000 6.63% $97,000,000 $71,657,000 5.97%\n(1) The average amount outstanding during the period was computed by dividing the total of month-end outstanding principal balances by 12.\n(2) The weighted average interest rate during the period was computed by dividing the actual interest expense by the average short-term borrowings outstanding.\n(3) The calculation of weighted average interest rate during the period excludes interest expense of approximately $3.3 million relating to issue costs on interim financing agreements.\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE X - SUPPLEMENTARY INCOME INFORMATION\nCol. A Col. B Item Charged to Costs and Expenses For Year Ended\n1994 1993 1992 (1) Maintenance and Repairs $ 30,824,000 $ 30,525,000 $ 29,954,000\nAdvertising Costs $ --(2) $ 8,957,000 $ 9,929,000\nAmounts for royalties, taxes other than payroll and income taxes, and amortization of preoperating costs and intangible assets are not presented as such amounts are less than 1% of net sales.\n(1) Amounts include charges for the Company's Mexican subsidiaries for the month of September, 1991, as follows:\nMaintenance and Repairs $824,000 Advertising Costs 20,000 $844,000\n(2) Amount does not exceed 1% of total sales and revenue.\nEXHIBIT 22-SUBSIDIARIES OF REGISTRANT\n1. AVICOLA PILGRIM'S PRIDE DE MEXICO, S.A. DE C.V. 2. ALIMENTOS BLANCEADOS PILGRIM'S PRIDE S.A. DE C.V. 3. AVICOLA PILGRIM'S PRIDE, S.A. DE C.V. 4. AVICOLA SAN MIGUEL, S.A. DE C.V. 5. AVICOLA Y GANADERA COLIAH, S.A. DE C.V. 6. AVICOLA Y GRANADERA DEL BAJIO, S.A. DE C.V. 7. AVINDUSTRIA COMERCIAL, S.A. DE C.V. 8. AVINDUSTRIA E INVESTIGACION, S.A. DE C.V. 9. AVIPECUARIA IXTA, S.A. DE C.V. 10. AVIPECURIA VALVACO, S.A. DE C.V. 11. AVIPRODUCTORA, S.A. DE C.V. 12. COMPANIA INCUBADORA AVICOLA PILGRIM'S PRIDE, S.A. DE C.V. 13. CIA. INCUBADORA HIDALGO, S.A. DE C.V. 14. EMPACADORA CAMPO REAL, S.A. DE C.V. 15. INMOBILIARIA AVICOLA PILGRIM'S PRIDE, S. DE R.L. DE C.V. 16. PILGRIM'S PRIDE, S.A. DE C.V. 17. PRODUCTORA Y DISTRIBUIDORA DE ALIMENTOS, S.A. DE. C.V. 18. SERVICIOS AUXILIARES AVICOLAS, S.A. DE C.V. 19. TRANSCOMPO, S.A. DE C.V.\nEXHIBIT 23 - CONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 3-12043) of Pilgrim's Pride Corporation of our report dated November 15, 1994, with respect to the consolidated financial statements and schedules of Pilgrim's Pride Corporation included in this Annual Report (Form 10-K) for the year ended October 1, 1994.\n2121 San Jacinto Dallas, Texas 75201 December 13, 1994\nSecured Credit Agreement Among Pilgrim s Pride Corporation And Harris Trust and Savings Bank Individually and as Agent And FBS Ag Credit, Inc. Internationale Nederlanden Bank N. V. Boatmen s First National Bank of Kansas City First Interstate Bank of Texas, N.A. Dated as of May 27, 1993\nPilgrim s Pride Corporation Secured Credit Agreement Harris Trust and Savings Bank Chicago, Illinois\nFBS Ag Credit, Inc. Denver, Colorado\nInternationale Nederlanden Bank N. V. ( ING Bank ) New York, New York\nBoatmen s First National Bank of Kansas City Kansas City, Missouri\nFirst Interstate Bank of Texas, N.A. Dallas, Texas Ladies and Gentlemen: The undersigned, Pilgrim s Pride Corporation, a Delaware corporation (the Company ), applies to you for your several commitment, subject to all the terms and conditions hereof and on the basis of the representations and warranties hereinafter set forth, to make a revolving credit (the Revolving Credit ) available to the Company, all as more fully hereinafter set forth. Each of you is hereinafter referred to individually as Bank and collectively as Banks. Harris Trust and Savings Bank in its individual capacity is sometimes referred to herein as Harris , and in its capacity as Agent for the Banks is hereinafter in such capacity called the Agent. .c1.1. The Credit;. .c2.Section 1.1. The Revolving Credit.; (a) Subject to all of the terms and conditions hereof, the Banks agree, severally and not jointly, to extend a Revolving Credit to the Company which may be utilized by the Company in the form of loans (individually a Revolving Credit Loan and collectively the Revolving Credit Loans ), B\/As and L\/Cs (each as hereinafter defined). The aggregate principal amount of all Revolving Credit Loans under the Revolving Credit plus the amount available for drawing under all L\/Cs, the aggregate face amount of all B\/As and the aggregate principal amount of all unpaid Reimbursement Obligations (as hereinafter defined) at any time outstanding shall not exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments (as hereinafter defined) in effect from time to time during the term of this Agreement (as hereinafter defined) and (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate. The Revolving Credit shall be available to the Company, and may be availed of by the Company from time to time, be repaid (subject to the restrictions on prepayment set forth herein) and used again, during the period from the date hereof to and including May 31, 1995 (the Termination Date ). (b) At any time not earlier than 120 days prior to, nor later than 60 days prior to, the date that is one year before the Termination Date then in effect (the Anniversary Date ), the Company may request that the Banks extend the then scheduled Termination Date to the date one year from such Termination Date. If such request is made by the Company each Bank shall inform the Agent of its willingness to extend the Termination Date no later than 20 days prior to such Anniversary Date. Any Bank s failure to respond by such date shall indicate its unwillingness to agree to such requested extension, and all Banks must approve any requested extension. At any time more than 15 days before such Anniversary Date the Banks may propose, by written notice to the Company, an extension of this Agreement to such later date on such terms and conditions as the Banks may then require. If the extension of this Agreement to such later date is acceptable to the Company on the terms and conditions proposed by the Banks, the Company shall notify the Banks of its acceptance of such terms and conditions no later than the Anniversary Date, and such later date will become the Termination Date hereunder and this Agreement shall otherwise be amended in the manner described in the Banks notice proposing the extension of this Agreement upon the Agent s receipt of (i) an amendment to this Agreement signed by the Company and all of the Banks, (ii) resolutions of the Company s Board of Directors authorizing such extension and (iii) an opinion of counsel to the Company equivalent in form and substance to the form of opinion attached hereto as Exhibit E and otherwise acceptable to the Banks. (c) The respective maximum aggregate principal amounts of the Revolving Credit at any one time outstanding and the percentage of the Revolving Credit available at any time which each Bank by its acceptance hereof severally agrees to make available to the Company are as follows (collectively, the Revolving Credit Commitments and individually, a Revolving Credit Commitment ): Harris Trust and Savings Bank $35,000,00046.66666667% FBS Ag Credit, Inc. $15,000,000 20% Internationale Nederlanden Bank N. V. $10,000,000 13.33333334% Boatmen s First National Bank of Kansas City $10,000,000 13.33333334% First Interstate Bank of Texas, N.A. $ 5,000,000 6.66666667% Total $75,000,000 100%\n(d) Loans under the Revolving Credit may be Eurodollar Loans, CD Rate Loans or Domestic Rate Loans. All Loans under the Revolving Credit shall be made from each Bank in proportion to its respective Revolving Credit Commitment as above set forth. Each Domestic Rate Loan shall be in an amount not less than $3,000,000 or such greater amount which is an integral multiple of $500,000 and each Fixed Rate Loan shall be in an amount not less than $3,000,000 or such greater amount which is an integral multiple of $1,000,000. (e) The initial borrowing under this Agreement shall be in an amount sufficient to pay all amounts outstanding under that certain Revolving Credit Agreement dated as of February 1, 1993 (the Existing Agreement ) between the Company, Rabobank Nederland and the other banks party thereto (the Existing Lenders ). The Company shall apply the proceeds of the initial borrowing hereunder to pay all amounts outstanding under the Existing Agreement and the Series D Notes. .c2.Section 1.2. The Notes;. All Revolving Credit Loans made by each Bank hereunder shall be evidenced by a single Secured Revolving Credit Note of the Company substantially in the form of Exhibit A hereto (individually, a Revolving Note and together, the Revolving Notes ) payable to the order of each Bank in the principal amount of such Bank s Revolving Credit Commitment, but the aggregate principal amount of indebtedness evidenced by such Revolving Note at any time shall be, and the same is to be determined by, the aggregate principal amount of all Revolving Credit Loans made by such Bank to the Company pursuant hereto on or prior to the date of determination less the aggregate amount of principal repayments on such Revolving Credit Loans received by or on behalf of such Bank on or prior to such date of determination. Each Revolving Note shall be dated as of the execution date of this Agreement, shall be delivered concurrently herewith, and shall be expressed to mature on the Termination Date and to bear interest as provided in Section 1.3 hereof. Each Bank shall record on its books or records or on a schedule to its Revolving Note the amount of each Revolving Credit Loan made by it hereunder, whether each Revolving Credit Loan is a Domestic Rate Loan, CD Rate Loan or Eurodollar Loan, and, with respect to Eurodollar Loans, the interest rate and Interest Period applicable thereto, and all payments of principal and interest and the principal balance from time to time outstanding, provided that prior to any transfer of such Revolving Note all such amounts shall be recorded on a schedule to such Revolving Note. The record thereof, whether shown on such books or records or on the schedule to the Revolving Note, shall be prima facie evidence as to all such amounts; provided, however, that the failure of any Bank to record or any mistake in recording any of the foregoing shall not limit or otherwise affect the obligation of the Company to repay all Revolving Credit Loans made hereunder together with accrued interest thereon. Upon the request of any Bank, the Company will furnish a new Revolving Note to such Bank to replace its outstanding Revolving Note and at such time the first notation appearing on the schedule on the reverse side of, or attached to, such Revolving Note shall set forth the aggregate unpaid principal amount of Revolving Credit Loans then outstanding from such Bank, and, with respect to each Fixed Rate Loan, the interest rate and Interest Period applicable thereto. Such Bank will cancel the outstanding Revolving Note upon receipt of the new Revolving Note. .c2.Section 1.3. Interest Rates;. (a) Domestic Rate Loans. Each Domestic Rate Loan shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until maturity (whether by acceleration, upon prepayment or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Domestic Rate from time to time in effect, payable quarterly in arrears on the last day of each calendar quarter, commencing on the first of such dates occurring after the date hereof and at maturity (whether by acceleration, upon prepayment or otherwise). (b) Eurodollar Loans. Each Eurodollar Loan under the Revolving Credit shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until the last day of the Interest Period applicable thereto or, if earlier, until maturity (whether by acceleration or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Adjusted Eurodollar Rate, payable on the last day of each Interest Period applicable thereto and at maturity (whether by acceleration or otherwise) and, with respect to Eurodollar Loans with an Interest Period in excess of three months, on the date occurring every three months from the first day of the Interest Period applicable thereto. (c) CD Rate Loans. Each CD Rate Loan under the Revolving Credit shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until the last day of the Interest Period applicable thereto or, if earlier, until maturity (whether by acceleration or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Adjusted CD Rate, payable on the last day of each Interest Period applicable thereto and at maturity (whether by acceleration of otherwise) and, with respect to CD Rate Loans with an Interest Period in excess of 90 days, on the date occurring every 90 days from the first day of the Interest Period applicable thereto. (d) Default Rate. During the existence of an Event of Default all Loans and Reimbursement Obligations shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) from the date of such Event of Default until paid in full, payable on demand, at a rate per annum equal to the sum of 2.5% plus the Domestic Rate from time to time in effect plus the Applicable Margin. .c2.Section 1.4. Conversion and Continuation of Loans;. (a) Provided that no Event of Default or Potential Default has occurred and is continuing, the Company shall have the right, subject to the other terms and conditions of this Agreement, to continue in whole or in part (but, if in part, in the minimum amount specified for Fixed Rate Loans in Section 1.1 hereof) any Fixed Rate Loan from any current Interest Period into a subsequent Interest Period, provided that the Company shall give the Bank notice of the continuation of any such Loan as provided in Section 1.8 hereof. (b) In the event that the Company fails to give notice pursuant to Section 1.8 hereof of the continuation of any Fixed Rate Loan or fails to specify the Interest Period applicable thereto, or an Event of Default or Potential Default has occurred and is continuing at the time any such Loan is to be continued hereunder, then such Loan shall be automatically converted as (and the Company shall be deemed to have given notice requesting) a Domestic Rate Loan, subject to Sections 1.8(b), 8.2 and 8.3 hereof, unless paid in full on the last day of the then applicable Interest Period. (c) Provided that no Event of Default or Potential Default has occurred and is continuing, the Company shall have the right, subject to the terms and conditions of this Agreement, to convert Loans of one type (in whole or in part) into Loans of another type from time to time provided that: (i) the Company shall give the Bank notice of each such conversion as provided in Section 1.8 hereof, (ii) the principal amount of any Loan converted hereunder shall be in an amount not less than the minimum amount specified for the type of Loan in Section 1.1 hereof, (iii) after giving effect to any such conversion in part, the principal amount of any Fixed Rate Loan then outstanding shall not be less than the minimum amount specified for the type of Loan in Section 1.1 hereof, (iv) any conversion of a Loan hereunder shall only be made on a Banking Day, and (v) any Fixed Rate Loan may be converted only on the last day of the Interest Period then applicable thereto. .c2.Section 1.5. Bankers Acceptances;. Subject to all the terms and conditions hereof, satisfaction of all conditions precedent to borrowing under this Agreement and so long as no Potential Default or Event of Default is in existence, at the Company s request Harris, in its discretion, may create acceptances in an amount of at least $5,000,000 (a B\/A and collectively the B\/As ) for the Company within the limits of, and subject to availability under the Revolving Credit, and the Banks hereby agree to participate therein as more fully described in Section 1.9 hereof. Each B\/A shall be created pursuant to a General Acceptance Agreement (the B\/A Agreement ) in the form of Exhibit B hereto and an Acceptance Request in Harris standard form at the time such B\/A is requested with respect to such draft presented to Harris for acceptance hereunder. To provide the Company with immediate cash for the B\/As created hereunder, Harris agrees to discount such B\/As at a rate determined by adding a rate per annum (calculated on the basis of a 360-day year and actual days elapsed) equal to the Applicable Margin to the then current bankers acceptance rate for B\/As on which Harris is the acceptor and to credit the proceeds of such discounting to the Company s account at Harris. The face amount of each B\/A created and outstanding pursuant hereto shall be deducted from the credit which may be otherwise available under the Revolving Credit. Each B\/A shall have a term of 30, 60, 90, 120, 150 or 180 days (but not later than the Termination Date), and shall be an acceptance eligible for discount with Federal Reserve Bank in accordance with paragraph 7A of Section 13 of the Federal Reserve Act and regulations and interpretations applicable thereto. The Company shall present to Harris evidence of such eligibility satisfactory to the Banks, and Harris in its sole discretion may refuse to issue any B\/A. .c2.Section 1.6. Letters of Credit.; Subject to all the terms and conditions hereof, satisfaction of all conditions precedent to borrowing under this Agreement and so long as no Potential Default or Event of Default is in existence, at the Company s request Harris may in its discretion issue letters of credit (an L\/C and collectively the L\/Cs ) for the account of the Company subject to availability under the Revolving Credit, and the Banks hereby agree to participate therein as more fully described in Section 1.9 hereof. Each L\/C shall be issued pursuant to an Application for Letter of Credit (the L\/C Agreement ) in the form of Exhibit C hereto. The L\/Cs shall consist of standby letters of credit in an aggregate face amount not to exceed $20,000,000. Each L\/C shall have an expiry date not more than one year from the date of issuance thereof (but in no event later than the Termination Date). The amount available to be drawn under each L\/C issued pursuant hereto shall be deducted from the credit otherwise available under the Revolving Credit. In consideration of the issuance of L\/Cs the Company agrees to pay Harris a fee (the L\/C Fee ) in the amount per annum equal to 1.0% of the face amount of each Performance L\/C and 1.5% of the stated amount of each Financial Guarantee L\/C (in each case computed on the basis of a 360 day year and actual days elapsed) of the face amount for any L\/C issued hereunder. In addition the Company shall pay Harris for its own account an issuance fee (the L\/C Issuance Fee ) in an amount equal to one-eighth of one percent (0.125%) of the stated amount of each L\/C issued by Harris hereunder. All L\/C Fees and L\/C Issuance Fees shall be payable on the date of issuance of each L\/C hereunder and on the date of each extension, if any, of the expiry date of each L\/C. .c2.Section 1.7. Reimbursement Obligation;. The Company is obligated, and hereby unconditionally agrees, to pay in immediately available funds to the Agent for the account of Harris and the Banks who are participating in L\/Cs and B\/As pursuant to Section 1.9 hereof the face amount of (a) each B\/A created by Harris hereunder not later than 11:00 A.M. (Chicago Time) on the maturity date of such B\/A, and (b) each draft drawn and presented under an L\/C issued by Harris hereunder not later than 11:00 a.m. (Chicago Time) on the date such draft is presented for payment to Harris (the obligation of the Company under this Section 1.7 with respect to any B\/A or L\/C is a Reimbursement Obligation ). If at any time the Company fails to pay any Reimbursement Obligation when due, the Company shall be deemed to have automatically requested a Domestic Rate Loan from the Banks hereunder, as of the maturity date of such Reimbursement Obligation, the proceeds of which Loan shall be used to repay such Reimbursement Obligation. Such Loan shall only be made if no Potential Default or Event of Default shall exist and upon approval by all of the Banks, and shall be subject to availability under the Revolving Credit. If such Loan is not made by the Banks for any reason, the unpaid amount of such Reimbursement Obligation shall be due and payable to the Agent for the pro rata benefit of the Banks upon demand and shall bear interest at the rate of interest specified in Section 1.3(d) hereof. .c2.Section 1.8. Manner of Borrowing and Rate Selection;. (a) The Company shall give telephonic, telex or telecopy notice to the Agent (which notice, if telephonic, shall be promptly confirmed in writing) no later than (i) 11:00 a.m. (Chicago time) on the date the Banks are requested to make each Domestic Rate Loan, (ii) 11:00 a.m. (Chicago time) on the date at least three (3) Banking Days prior to the date of (A) each Eurodollar Loan which the Banks are requested to make or continue, and (B) the conversion of any CD Rate Loan or Domestic Rate Loan into a Eurodollar Loan and (iii) 11:00 a.m. (Chicago time) on the date at least one (1) Business Day prior to the date of (A) each CD Rate Loan which the Banks are requested to make and (B) the conversion of any Eurodollar Loan or Domestic Rate Loan into a CD Rate Loan. Each such notice shall specify the date of the Loan requested (which shall be a Business Day in the case of Domestic Rate Loans and CD Rate Loans and a Banking Day in the case of a Eurodollar Loan), the amount of such Loan, whether the Loan is to be made available by means of a Domestic Rate Loan, CD Rate Loan or Eurodollar Loan and, with respect to Fixed Rate Loans, the Interest Period applicable thereto; provided, that in no event shall the principal amount of any requested Revolving Credit Loan plus the aggregate principal or face amount, as appropriate, of all Loans, L\/Cs, B\/As and unpaid Reimbursement Obligations outstanding hereunder exceed the amounts specified in Section 1.1 hereof. The Company agrees that the Agent may rely on any such telephonic, telex or telecopy notice given by any person who the Agent believes is authorized to give such notice without the necessity of independent investigation and in the event any notice by such means conflicts with the written confirmation, such notice shall govern if any Bank has acted in reliance thereon. The Agent shall, no later than 12:30 p.m. (Chicago time) on the day any such notice is received by it, give telephonic, telex or telecopy (if telephonic, to be confirmed in writing within one Business Day) notice of the receipt of notice from the Company hereunder to each of the Banks, and, if such notice requests the Banks to make, continue or convert any Fixed Rate Loans, the Agent shall confirm to the Company by telephonic, telex or telecopy means, which confirmation shall be conclusive and binding on the Company in the absence of manifest error, the Interest Period and the interest rate applicable thereto promptly after such rate is determined by the Agent. (b) Subject to the provisions of Section 6 hereof, the proceeds of each Loan shall be made available to the Company at the principal office of the Agent in Chicago, Illinois, in immediately available funds, on the date such Loan is requested to be made, except to the extent such Loan represents (i) the conversion of an existing Loan or (ii) a refinancing of a Reimbursement Obligation, in which case each Bank shall record such conversion on the schedule to its Revolving Note, or in lieu thereof, on its books and records, and shall effect such conversion or refinancing, as the case may be, on behalf of the Company in accordance with the provisions of Section 1.4(a) hereof and 1.9 hereof, respectively. Not later than 2:00 p.m. Chicago time, on the date specified for any Loan to be made hereunder, each Bank shall make its portion of such Loan available to the Company in immediately available funds at the principal office of the Agent, except (i) as otherwise provided above with respect to converting or continuing any outstanding Loans and (ii) to the extent such Loan represents a refinancing of any outstanding Reimbursement Obligations. (c) Unless the Agent shall have been notified by a Bank prior to 1:00 p.m. (Chicago time) on the date a Loan is to be made by such Bank (which notice shall be effective upon receipt) that such Bank does not intend to make the proceeds of such Loan available to the Agent, the Agent may assume that such Bank has made such proceeds available to the Agent on such date and the Agent may in reliance upon such assumption (but shall not be required to) make available to the Company a corresponding amount. If such corresponding amount is not in fact made available to the Agent by such Bank, the Agent shall be entitled to receive such amount on demand from such Bank (or, if such Bank fails to pay such amount forthwith upon such demand, to recover such amount, together with interest thereon at the rate otherwise applicable thereto under Section 1.3 hereof, from the Company) together with interest thereon in respect of each day during the period commencing on the date such amount was made available to the Company and ending on the date the Agent recovers such amount, at a rate per annum equal to the effective rate charged to the Agent for overnight Federal funds transactions with member banks of the Federal Reserve System for each day, as determined by the Agent (or, in the case of a day which is not a Business Day, then for the preceding Business Day) (the Fed Funds Rate ). Nothing in this Section 1.8(c) shall be deemed to permit any Bank to breach its obligations to make Loans under the Revolving Credit or to limit the Company s claims against any Bank for such breach. .c2.Section 1.9. Participation in B\/As and L\/Cs;. Each of the Banks will acquire a risk participation for its own account, without recourse to or representation or warranty from Harris, in each B\/A upon the creation thereof and in each L\/C upon the issuance thereof ratably in accordance with its Commitment Percentage. In the event any Reimbursement Obligation is not immediately paid by the Company pursuant to Section 1.7 hereof, each Bank will pay to Harris funds in an amount equal to such Bank s ratable share of the unpaid amount of such Reimbursement Obligation (based upon its proportionate share relative to its percentage of the Revolving Credit (as set forth in Section 1.1 hereof)). At the election of all of the Banks, such funding by the Banks of the unpaid Reimbursement Obligations shall be treated as additional Revolving Credit Loans to the Company hereunder rather than a purchase of participations by the Banks in the related B\/As and L\/Cs held by Harris. The availability of funds to the Company under the Revolving Credit shall be reduced in an amount equal to any such B\/A or L\/C. The obligation of the Banks to Harris under this Section 1.9 shall be absolute and unconditional and shall not be affected or impaired by any Event of Default or Potential Default which may then be continuing hereunder. Harris shall notify each Bank by telephone of its proportionate share relative to its percentage of the total Banks Revolving Credit Commitments set forth in Section 1.1 hereof (a Commitment Percentage ) of such unpaid Reimbursement Obligation. If such notice has been given to each Bank by 12:00 Noon, Chicago time, each Bank agrees to pay Harris in immediately available and freely transferable funds on the same Business Day. If such notice is received after 12:00 noon, Chicago time, each Bank agrees to pay Harris in immediately available and freely transferable funds no later than the following Business Day. Funds shall be so made available at the account designated by Harris in such notice to the Banks. Upon the election by the Banks to treat such funding as additional Revolving Credit Loans hereunder and payment by each Bank, such Loans shall bear interest in accordance with Section 1.3(a) hereof. Harris shall share with each Bank on a pro rata basis relative to its Commitment Percentage a portion of each payment of a Reimbursement Obligation (whether of principal or interest) and any B\/A commission and any L\/C Fee (but not any L\/C Issuance Fee) payable by the Company. Any such amount shall be promptly remitted to the Banks when and as received by Harris from the Company. .c2.Section 1.10. Capital Adequacy;. If, after the date hereof, any Bank or the Agent shall have determined in good faith that the adoption of any applicable law, rule or regulation regarding capital adequacy, or any change therein (including, without limitation, any revision in the Final Risk-Based Capital Guidelines of the Board of Governors of the Federal Reserve System (12 CFR Part 208, Appendix A; 12 CFR Part 225, Appendix A) or of the Office of the Comptroller of the Currency (12 CFR Part 3, Appendix A), or in any other applicable capital rules heretofore adopted and issued by any governmental authority), or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Lending Office) with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on such Bank s capital, or on the capital of any corporation controlling such Bank, in each case as a consequence of its obligations hereunder to a level below that which such Bank would have achieved but for such adoption, change or compliance (taking into consideration such Bank s policies with respect to capital adequacy) by an amount reasonably deemed by such Bank to be material, then from time to time, within fifteen (15) days after demand by such Bank (with a copy to the Agent), the Company shall pay to such Bank such additional amount or amounts as will compensate such Bank for such reduction. .c1.2. Fees, Prepayments And Terminations. .c2.Section 2.1. Facility Fee;. For the period from the date hereof to and including the Termination Date, the Company shall pay to the Agent for the account of the Banks a facility fee with respect to the Revolving Credit at the rate of one-half of one percent (0.5%) per annum (computed in each case on the basis of a year of 360 days for the actual number of days elapsed) of the aggregate maximum amount of the Banks Revolving Credit Commitments hereunder in effect from time to time and whether or not any credit is in use under the Revolving Credit, all such fees to be payable quarterly in arrears on the last day of each calendar quarter commencing on the last day of June, 1993, and on the Termination Date, unless the Revolving Credit is terminated in whole on an earlier date, in which event the facility fee for the final period shall be paid on the date of such earlier termination in whole. .c2.Section 2.2. Agent s Fee;. The Company shall pay to and for the sole account of the Agent such fees as may be agreed upon in writing from time to time by the Agent and the Company. Such fees shall be in addition to any fees and charges the Agent may be entitled to receive under Section 10 hereunder or under the other Loan Documents. .c2.Section 2.3. Optional Prepayments;. The Company shall have the privilege of prepaying without premium or penalty and in whole or in part (but if in part, then in a minimum principal amount of $2,500,000 or such greater amount which is an integral multiple of $100,000) any Domestic Rate Loan at any time upon prior telex or telephonic notice to the Agent on or before 12:00 Noon on the same Business Day. The Company may not prepay any Fixed Rate Loan. Any amount prepaid under the Revolving Credit may, subject to the terms and conditions of this Agreement, be borrowed, repaid and borrowed again. .c2.Section 2.4. Mandatory Prepayments (a) Borrowing Base. The Company shall not permit the sum of the principal amount of all Loans plus the aggregate face amount of all B\/As, the amount available for drawing under all L\/Cs and the aggregate principal amount of all unpaid Reimbursement Obligations at any time outstanding to exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments or (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate. In addition to the Company s obligations to pay any outstanding Reimbursement Obligations as set forth in Section 1.7 hereof, the Company will make such payments on any outstanding Loans and Reimbursement Obligations (and, if any B\/As are then outstanding, deposit an amount equal to the aggregate face amount of all such B\/As into an interest bearing account with the Agent which shall be held as additional collateral security for such B\/As) which are necessary to cure any such excess within three Business Days after the occurrence thereof. Any amount prepaid under the Revolving Credit may, subject to the terms and conditions of this Agreement, be borrowed, prepaid and borrowed again. (b) Excess Cash Flow. No later than 60 days after the last day of each fiscal quarter (except the last fiscal quarter in each fiscal year) of the Company and no later than 90 days after the last day of each Fiscal Year of the Company, the Company shall apply an amount equal to 75% of its Excess Cash Flow for such fiscal quarter if its Leverage Ratio for such fiscal quarter was greater than 0.60 to 1, or 50% of its Excess Cash Flow for such fiscal quarter if its Leverage Ratio for such fiscal quarter was equal to or less than 0.60 to 1 but greater than 0.55 to 1, first to the prepayment in full of Revolving Credit Loans and Reimbursement Obligations outstanding hereunder and then to the prepayment of Funded Debt. .c2.Section 2.5. Closing Fee;. The Company shall pay to the Agent for the pro rata benefit of the Banks a closing fee in an amount equal to one-half of one percent (0.5%) of the Banks Revolving Credit Commitments (determined without regard to any credit in use hereunder), one-half of which fee shall be payable on the date of the execution and delivery of this Agreement and the other half of which fee shall be payable on the date that the initial Loan is made hereunder, the initial B\/A is created hereunder or the initial L\/C is issued hereunder. .c2.Section 2.6. Termination of Commitments;. The Revolving Credit Commitments of the Banks hereunder shall automatically terminate on June 15, 1993 if the initial extension of credit hereunder is not made on or before June 15, 1993. .c1.3. Place and Application of Payments;. All payments of principal and interest made by the Company in respect of the Notes and Reimbursement Obligations and all fees payable by the Company hereunder, shall be made to the Agent at its office at 111 West Monroe Street, Chicago, Illinois 60690 and in immediately available funds, prior to 12:00 noon on the date of such payment. All such payments shall be made without setoff or counterclaim and without reduction for, and free from, any and all present and future levies, imposts, duties, fees, charges, deductions withholdings, restrictions or conditions of any nature imposed by any government or any political subdivision or taxing authority thereof. Unless the Banks otherwise agree, any payments received after 12:00 noon Chicago time shall be deemed received on the following Business Day. The Agent shall remit to each Bank its proportionate share of each payment of principal, interest and facility fees, B\/A fees and L\/C fees received by the Agent by 3:00 P.M. Chicago time on the same day of its receipt if received by the Agent by 12:00 noon, Chicago time, and its proportionate share of each such payment received by the Agent after 12:00 noon on the Business Day following its receipt by the Agent. In the event the Agent does not remit any amount to any Bank when required by the preceding sentence, the Agent shall pay to such Bank interest on such amount until paid at a rate per annum equal to the Fed Funds Rate. The Company hereby authorizes the Agent to automatically debit its account with Harris for any principal, interest and fees when due under the Notes, the B\/A Agreement, any L\/C Agreement or this Agreement and to transfer the amount so debited from such account to the Agent for application as herein provided. All proceeds of Collateral shall be applied in the manner specified in the Security Agreement. .c1.4. Definitions;. The terms hereinafter set forth when used herein shall have the following meanings: 4.1. Account Debtor shall mean the Person who is obligated on a Receivable. 4.2. Adjusted CD Rate shall mean a rate per annum (rounded upwards, if necessary, to the nearest 1\/100 of 1%) determined in accordance with the following formula:\nAdjusted CD Rate = CD Rate \/ 100% - CD Reserve Percentage + Assessment Rate 4.3. Adjusted Eurodollar Rate means a rate per annum determined pursuant to the following formula: Adjusted Eurodollar Rate = Eurodollar Rate \/ 100% - Reserve Percentage 4.4. Affiliate shall mean any person, firm or corporation which, directly or indirectly controls, or is controlled by, or is under common control with, the Company. As used in this Section 4.30 the term controls (including the terms controlled by and under common control with ) shall have the meaning given in Section 4.30. 4.5. Agent is defined in the first paragraph of this Agreement. 4.6. Agreement shall mean this Secured Credit Agreement as supplemented, modified, restated and amended from time to time. 4.7. Anniversary Date has the meaning specified in Section 1.1(b) hereof. 4.8. Applicable Margin shall mean, with respect to each type of Loan and the B\/As described in Column A below, the rate of interest per annum shown in Columns B, C and D below for the range of Leverage Ratio specified for each Column:\nA B C D\nLeverage Ratio <0.5 to 1 >.50 to 1 and\n<.60 to 1 .60 to 1 and <.70 to 1 Eurodollar Loans 1.125% 1.375% 1.75% B\/As 1.125% 1.375% 1.75% Domestic Rate Loans 0.125% 0.375% 0.75% CD Rate Loans 1.25% 1.50% 1.875%\nNot later than 5 Business Days after receipt by the Agent of the financial statements called for by Section 7.4 hereof for the applicable fiscal quarter, the Agent shall determine the Leverage Ratio for the applicable period and shall promptly notify the Company and the Banks of such determination and of any change in the Applicable Margins resulting therefrom. Any such change in the Applicable Margins shall be effective as of the date the Agent so notifies the Company and the Banks with respect to all Loans and B\/As outstanding on such date, and such new Applicable Margins shall continue in effect until the effective date of the next quarterly redetermination in accordance with this Section. Each determination of the Leverage Ratio and Applicable Margins by the Agent in accordance with this Section shall be conclusive and binding on the Company and the Banks absent manifest error. From the date hereof until the Applicable Margins are first adjusted pursuant hereto, the Applicable Margins shall be those set forth in column D above. 4.9. Assessment Rate shall mean the assessment rate (rounded upwards, if necessary, to the nearest 1\/100 of 1%) imposed by the Federal Deposit Insurance Corporation or its successors for insuring the Agent s liability for time deposits, as in effect from time to time. 4.10. B\/A and B\/As shall have the meanings specified in Section 1.5 hereof. 4.11. B\/A Agreement shall have the meaning set forth in Section 1.5. 4.12. Bank and Banks shall have the meanings specified in the first paragraph of this Agreement. 4.13. Banking Day shall mean a day on which banks are open for business in Nassau, Bahamas, London, England, Dallas, Texas, Denver, Colorado, Kansas City, Missouri, New York, New York and Chicago, Illinois, other than a Saturday or Sunday, and dealing in United States Dollar deposits in London, England and Nassau, Bahamas. 4.14. Borrowing Base , as determined on the basis of the information contained in the most recent Borrowing Base Certificate, shall mean an amount equal to: (a) 80% of the amount of Eligible Receivables, plus (b) 65% of the Value of Eligible Inventory consisting of feed grains, feed and ingredients, plus (c) 65% percent of the Value of Eligible Inventory consisting of live and dressed broiler chickens and commercial eggs, plus (d) 65% of the Value of Eligible Inventory consisting of prepared foods, plus (e) 100% of the Value of Eligible Inventory consisting of breeder hens, breeder pullets, commercial hens, commercial pullets and hatching eggs, plus (f) 40% of the Value of Eligible Inventory consisting of packaging materials, vaccines and supplies, minus (g) the aggregate outstanding amount of all Grower Payables that are more than 15 days past due. 4.15. Borrowing Base Certificate shall mean the certificate in the form of Exhibit H hereto which is required to be delivered to the Banks in accordance with Section 7.4(d) hereof. 4.16. Business Day shall mean any day except Saturday or Sunday on which banks are open for business in Chicago, Illinois, Dallas, Texas, Denver, Colorado, Kansas City, Missouri and New York, New York. 4.17. Capitalized Lease shall mean, as applied to any Person, any lease of any Property the discounted present value of the rental obligations of such person as lessee under which, in accordance with generally accepted accounting principles, is required to be capitalized on the balance sheet of such Person. 4.18. Capitalized Lease Obligation shall mean, as applied to any Person, the discounted present value of the rental obligation, as aforesaid, under any Capitalized Lease. 4.19. CD Rate shall mean, with respect to each Interest Period applicable to a CD Rate Loan, the rate per annum determined by the Agent to be the arithmetic average of the rate per annum determined by the Agent to be the average of the bid rates quoted to the Agent at approximately 10:00 a.m. Chicago time (or as soon thereafter as practicable) on the first day of such Interest Period by at least two certificate of deposit dealers of recognized national standing selected by the Agent for the purchase at face value of certificates of deposit of the Agent having a term comparable to such Interest Period and in an amount comparable to the principal amount of the CD Rate Loan to be made by the Agent for such Interest Period. Each determination of the CD Rate made by the Agent in accordance with this paragraph shall be conclusive and binding on the Company except in the case of manifest error or willful misconduct. 4.20. CD Reserve Percentage shall mean the rate (as determined by the Bank) of the maximum reserve requirement (including, without limitation, any supplemental, marginal and emergency reserves) imposed on the Agent by the Board of Governors of the Federal Reserve System (or any successor) from time to time on non-personal time deposits having a maturity equal to the applicable Interest Period and in an amount equal to the unpaid principal amount of the relevant CD Rate Loan, subject to any amendments of such reserve requirement by such Board or its successor, taking into account any transitional adjustments thereto. The Adjusted CD Rate shall automatically be adjusted as of the date of any change in the CD Reserve Percentage. 4.21. CERCLA shall mean the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended. 4.22. CERCLIS shall mean the CERCLA Information System. 4.23. Change in Law shall have the meaning specified in Section 9.3 hereof. 4.24. CoBank shall mean the National Bank for Cooperatives. 4.25. CoBank Agreement shall have the meaning specified in Section 11.15(a) hereof. 4.26. CoBank Participation shall have the meaning set forth in Section 11.15(a) hereof. 4.27. Collateral shall mean the collateral security provided to the Agent for the benefit of the Banks pursuant to the Security Agreement. 4.28. Commitment Percentage shall have the meaning set forth in Section 1.9 hereof. 4.29. Company shall have the meaning specified in the first paragraph of this Agreement. 4.30. Control or Controlled By or Under Common Control shall mean possession, directly or indirectly, of power to direct or cause the direction of management or policies (whether through ownership of voting securities, by contract or otherwise); provided that, in any event any Person which beneficially owns, directly or indirectly, 10% or more (in number of votes) of the securities having ordinary voting power for the election of directors of a corporation shall be conclusively presumed to control such corporation, and provided further that any Consolidated Subsidiary shall be conclusively presumed to be controlled by the Company. 4.31. Current Assets of any Person shall mean the aggregate amount of assets of such Person which in accordance with generally accepted accounting principles may be properly classified as current assets after deducting adequate reserves where proper. 4.32. Current Liabilities shall mean all items (including taxes accrued as estimated) which in accordance with generally accepted accounting principles may be properly classified as current liabilities, and including in any event all amounts outstanding from time to time under this Agreement. 4.33. Current Ratio shall mean the ratio of Current Assets to Current Liabilities of the Company and its Subsidiaries. 4.34. Debt of any Person shall mean as of any time the same is to be determined, the aggregate of: (a) all indebtedness, obligations and liabilities of such Person with respect to borrowed money (including by the issuance of debt securities); (b) all guaranties, endorsements and other contingent obligations of such Person with respect to indebtedness arising from money borrowed by others; (c) all reimbursement and other obligations with respect to letters of credit, bankers acceptances, customer advances and other extensions of credit whether or not representing obligations for borrowed money; (d) the aggregate of the principal components of all leases and other agreements for the use, acquisition or retention of real or personal property which are required to be capitalized under generally accepted accounting principles consistently applied; (e) all indebtedness, obligations and liabilities representing the deferred purchase price of property or services; and (f) all indebtedness secured by a lien on the Property of such Person, whether or not such Person has assumed or become liable for the payment of such indebtedness. 4.35. Domestic Rate means for any day the rate of interest announced by Harris from time to time as its prime commercial rate in effect on such day, with any change in the Domestic Rate resulting from a change in said prime commercial rate to be effective as of the date of the relevant change in said prime commercial rate (the Harris Prime Rate ), provided that if the rate per annum determined by adding 1\/2 of 1% to the rate at which Harris would offer to sell federal funds in the interbank market on or about 10:00 a.m. (Chicago time) on any day (the Adjusted Fed Funds Rate ) shall be higher than the Harris Prime Rate on such day, then the Domestic Rate for such day and for any succeeding day which is not a Business Day shall be such Adjusted Fed Funds Rate. The determination of the Adjusted Fed Funds Rate by Harris shall be final and conclusive except in the case of manifest error or willful misconduct. 4.36. Domestic Rate Loan means a Revolving Credit Loan which bears interest as provided in Section 1.3(a) hereof. 4.37. EBITDA shall mean, in any fiscal year of the Company, all earnings (other than extraordinary items) of the Company before interest and income tax obligations of the Company for said year and before depreciation and amortization charges of the Company for said year, all determined in accordance with generally accepted accounting principles, consistently applied. 4.38. Eligible Inventory shall mean any Inventory of the Company in which the Agent has a first priority perfected security interest, which the Banks in their sole judgment deem to be acceptable for inclusion in the Borrowing Base and which complies with each of the following requirements: (a) it consists solely of feed grains, feed, ingredients, live broiler chickens, dressed broiler chickens, commercial eggs, prepared food products, breeder hens, breeder pullets, hatching eggs, commercial hens, commercial pullets, packaging materials, vaccines and supplies; (b) it is in first class condition, not obsolete, and is readily usable or salable by the Company in the ordinary course of its business; (c) it substantially conforms to the advertised or represented specifications and other quality standards of the Company, and has not been determined by the Banks to be unacceptable due to age, type, category, quality and\/or quantity; (d) all warranties as set forth in this Agreement and the Security Agreement are true and correct with respect thereto; (e) it has been identified to the Banks in the manner prescribed pursuant to the Security Agreement; (f) it is located at a location within the United States disclosed to and approved by the Banks and, if requested by the Agent, any Person (other than the Company) owning or controlling such location shall have waived all right, title and interest in and to such Inventory in a manner satisfactory to the Banks; and (g) it is covered by a warehouse receipt issued by the Warehouseman and delivered to the Agent. 4.39. Eligible Receivables shall mean any Receivable of the Company in which the Agent has a first priority perfected security interest, which the Banks, in their sole judgment deem to be acceptable for inclusion in the Borrowing Base and which complies with each of the following requirements: (a) It arises out of a bona fide rendering of services or sale of goods sold and delivered by or on behalf of the Company to, or in the process of being delivered by or on behalf of the Company to, the Account Debtor on said Receivables; (b) all warranties set forth in this Agreement and the Security Agreement are true and correct with respect thereto; (c) it has been identified to the Banks in a manner satisfactory to the Banks; (d) it is evidenced by an invoice (dated not later than five days after the date of shipment or performance of services) rendered to the Account Debtor thereunder; (e) the invoice representing such Receivable shall have a due date not more than 45 days following the invoice date for such products; (f) it is not owing by an Account Debtor who shall have failed to pay 10% or more of all Receivables owed by such Account Debtor within the period set forth in (g) below or who has become insolvent or is the subject of any bankruptcy, arrangement, reorganization proceedings or other proceedings for relief of debtors; (g) it has not remained unpaid in whole or in part from and after the due date thereof; (h) it is payable in United States Dollars; (i) it is not owing by the United States of America or any department, agency or instrumentality thereof; (j) it is not owing by any Account Debtor located outside of the United States; (k) it is net of any credit or allowance given by the Company to such Account Debtor; (l) the Receivable is not subject to any counterclaim or defense asserted by the Account Debtor thereunder, nor is it subject to any offset or contra account payable to the Account Debtor (in any case, unless the amount of such Receivable is net of such counterclaim, defense, offset or contra account); and (m) it is not owing by an Account Debtor that is an Affiliate of the Company other than Archer Daniels Midland. 4.40. Environmental Laws shall have the meaning specified in Section 5.10 hereof. 4.41. ERISA shall mean the Employee Retirement Income Security Act of 1974, as amended. 4.42. Eurodollar Loan shall mean a Revolving Credit Loan which bears interest as provided in Section 1.3(b) hereof. 4.43. Eurodollar Rate shall mean for each Interest Period applicable to a Eurodollar Loan, (a) the LIBOR Index Rate for such Interest Period, if such rate is available, and (b) if the LIBOR Index Rate cannot be determined, the arithmetic average of the rate of interest per annum (rounded upwards, if necessary, to nearest 1\/100 of 1%) at which deposits in U.S. dollars in immediately available funds are offered to the Agent at 11:00 a.m. (London, England time) two (2) Business Days before the beginning of such Interest Period by major banks in the interbank eurodollar market for a period equal to such Interest Period and in an amount equal or comparable to the principal amount of the Eurodollar Loan scheduled to be made by the Agent during such Interest Period. 4.44. Event of Default shall mean any event or condition identified as such in Section 8.1 hereof. 4.45. Excess Cash Flow shall mean an amount equal to (a) net cash provided by operating activities (determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied) minus (b) the sum of capital expenditures (determined in accordance with generally accepted accounting principles, consistently applied) plus principal payments on Debt due during such period plus all dividends paid during such period. 4.46. Existing Agreement shall have the meaning specified in Section 1.1(e) hereof. 4.47. Existing Lenders shall have the meaning specified in Section 1.1(e) hereof. 4.48. Fed Funds Rate shall have the meaning specified in Section 1.8(c) hereof. 4.49. Financial Guarantee L\/C shall mean an L\/C issued hereunder that constitutes a financial guaranty letter of credit under the capital adequacy requirements applicable to any of the Banks. 4.50. Fiscal Year shall mean the 52 or 53 week period ending on the Saturday closest to September 30 in each calendar year, regardless of whether such Saturday occurs in September or October of any calendar year. 4.51. Fixed Charge Coverage Ratio shall mean the ratio of (a) the sum of EBITDA and all amounts payable under all non-cancellable operating leases (determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied) for the period in question, to (b) the sum of (without duplication) (i) Interest Expense for such period, (ii) the sum of the scheduled current maturities (determined in accordance with generally accepted accounting principles consistently applied, but excluding in any event any payments due under Section 2.4(b) of this Agreement) of Funded Debt during the period in question, (iii) all amounts payable under non-cancellable operating leases (determined as aforesaid) during such period, and (iv) all amounts payable with respect to capitalized leases (determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied) for the period in question. 4.52. Fixed Rate shall mean either of the Eurodollar Rate or the Adjusted CD Rate. 4.53. Fixed Rate Loan shall mean a Eurodollar Loan or a CD Rate Loan and Fixed Rate Loans shall mean either or both of such types of Loans. 4.54. Funded Debt, with respect to any Person shall mean all indebtedness for borrowed money of such Person and with respect to the Company all indebtedness for borrowed money of the Company, in each case maturing by its terms more than one year after, or which is renewable or extendible at the option of such Person for a period ending one year or more after, the date of determination, and shall include indebtedness for borrowed money of such maturity created, assumed or guaranteed by such Person either directly or indirectly, including obligations of such maturity secured by liens upon Property of such Person and upon which such entity customarily pays the interest, all current maturities of all such indebtedness of such maturity and all rental payments under capitalized leases of such maturity. 4.55. Grower Payables shall mean all amounts owed from time to time by the Company to any Person on account of the purchase price of agricultural products or services (including poultry and livestock) if the Agent reasonably determines that such Person is entitled to the benefits of any grower s lien, statutory trust or similar security arrangements to secure the payment of any amounts owed to such Person. 4.56. Guaranty Fees shall have the meaning specified in Section 7.30 hereof. 4.57. Harris shall have the meaning specified in the first paragraph of this Agreement. 4.58. Highest Lawful Rate shall have the meaning specified in Section 11.19 hereof. 4.59. Intangible Assets shall mean license agreements, trademarks, trade names, patents, capitalized research and development, proprietary products (the results of past research and development treated as long term assets and excluded from Inventory) and goodwill (all determined on a consolidated basis in accordance with generally accepted accounting principles consistently applied). 4.60. Interest Expense for any period shall mean all interest charges during such period, including all amortization of debt discount and expense and imputed interest with respect to capitalized lease obligations, determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.61. Interest Period shall mean with respect to (a) the Eurodollar Loans, the period used for the computation of interest commencing on the date the relevant Eurodollar Loan is made, continued or effected by conversion and concluding on the date one, two, three or six months thereafter and, (b) with respect to the CD Rate Loans, the period used for the computation of interest commencing on the date the relevant CD Rate Loan is made, continued or effected by conversion and concluding on the date 30, 60, 90 or 180 days thereafter; provided, however, that no Interest Period for any Fixed Rate Loan made under the Revolving Credit may extend beyond the Termination Date. For purposes of determining an Interest Period applicable to a Eurodollar Loan, a month means a period starting on one day in a calendar month and ending on a numerically corresponding day in the next calendar month; provided, however, that if there is no numerically corresponding day in the month in which an Interest Period is to end or if an Interest Period begins on the last day of a calendar month, then such Interest Period shall end on the last Banking Day of the calendar month in which such Interest Period is to end. 4.62. Inventory shall mean all raw materials, work in process, finished goods, and goods held for sale or lease or furnished or to be furnished under contracts of service in which the Company or any Subsidiary now has or hereafter acquires any right. 4.63. L\/C shall have the meaning set forth in Section 1.6 hereof. 4.64. L\/C Agreement shall have the meaning set forth in Section 1.6 hereof. 4.65. L\/C Fee has the meaning specified in Section 1.6 hereof. 4.66. L\/C Issuance Fee has the meaning specified in Section 1.6 hereof. 4.67. Leverage Ratio shall mean the ratio for the Company and its Subsidiaries of (a) the aggregate outstanding principal amount of all Debt (other than Debt consisting of reimbursement and other obligations with respect to undrawn letters of credit) to (b) the sum of the aggregate outstanding principal amount of all Debt included in clause (a) above plus Net Worth. 4.68. LIBOR Index Rate shall mean, for any Interest Period applicable to a Eurodollar Loan, the rate per annum (rounded upwards, if necessary, to the next higher one hundred-thousandth of a percentage point) for deposits in U.S. Dollars for a period equal to such Interest Period, which appears on the Telerate Page 3750 as of 11:00 a.m. (London, England time) on the day two Banking Days before the commencement of such Interest Period. 4.69. Loan shall mean a Revolving Credit Loan and the term Loans shall mean any two or more Revolving Credit Loans collectively. 4.70. Loan Documents shall mean this Agreement and any and all exhibits hereto, the Notes, the B\/A Agreement, the L\/C Agreements and the Security Agreement. 4.71. Net Income shall mean the net income of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.72. Net Tangible Assets shall mean the excess of the value of the Total Assets over the value of the Intangible Assets of the Company and its Subsidiaries. 4.73. Net Working Capital shall mean the excess for the Company of Current Assets over Current Liabilities. 4.74. Net Worth shall mean the Total Assets minus the Total Liabilities of the Company and its Subsidiaries, all determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.75. Notes shall mean the Revolving Notes, and Note means any of the Notes. 4.76. PBGC shall mean the Pension Benefit Guaranty Corporation. 4.77. Performance L\/C shall mean any L\/C issued hereunder that does not constitute a Financial Guarantee L\/C. 4.78. Person shall mean and include any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, institution, entity, party or government (whether national, federal, state, county, city, municipal, or otherwise, including, without limitation, any instrumentality, division, agency, body or department thereof). 4.79. Plan shall mean any employee benefit plan covering any officers or employees of the Company or any Subsidiary, any benefits of which are, or are required to be, guaranteed by the PBGC. 4.80. Potential Default shall mean any event or condition which, with the lapse of time, or giving of notice, or both, would constitute an Event of Default. 4.81. Property shall mean any interest in any kind of property or asset, whether real, personal or mixed or tangible or intangible. 4.82. Receivables shall mean all accounts, contract rights, instruments, documents, chattel paper and general intangibles in which the Company now has or hereafter acquires any right. 4.83. Reimbursement Obligation has the meaning specified in Section 1.7 hereof. 4.84. Required Banks shall mean any Bank or Banks which in the aggregate hold at least 66-2\/3% of the aggregate unpaid principal balance of the Loans and Reimbursement Obligations or, if no Loans are outstanding hereunder, any Bank or Banks in the aggregate having at least 66-2\/3% of the Revolving Credit Commitments. For purposes of determining the Required Banks, CoBank shall be deemed to have a Revolving Credit Commitment in the amount of the CoBank s Participation and Harris Revolving Credit Commitment shall be reduced by a like amount. 4.85. Reserve Percentage means the daily arithmetic average maximum rate at which reserves (including, without limitation, any supplemental, marginal and emergency reserves) are imposed on member banks of the Federal Reserve System during the applicable Interest Period by the Board of Governors of the Federal Reserve System (or any successor) under Regulation D on eurocurrency liabilities (as such term is defined in Regulation D), subject to any amendments of such reserve requirement by such Board or its successor, taking into account any transitional adjustments thereto. For purposes of this definition, the Eurodollar Loans shall be deemed to be eurocurrency liabilities as defined in Regulation D without benefit or credit for any prorations, exemptions or offsets under Regulation D. 4.86. Retained Percentage shall mean with respect to Harris Revolving Credit Commitment a percentage determined by dividing (a) the amount of Harris Revolving Credit Commitment minus the amount of the CoBank Participation therein by (b) the amount of Harris Revolving Credit Commitment without reduction for CoBank s Participation therein. 4.87. Revolving Credit shall have the meaning specified in the first paragraph of this Agreement. 4.88. Revolving Credit Commitment and Revolving Credit Commitments shall have the meanings specified in Section 1.1(c) hereof. 4.89. Revolving Credit Loan and Revolving Credit Loans shall have the meanings specified in Section 1.1(a) hereof. 4.90. Revolving Note or Revolving Notes shall have the meanings specified in Section 1.1(d) hereof. 4.91. Security Agreement shall mean that certain Security Agreement Re: Accounts Receivable, Farm Products and Inventory from the Company to Harris, as Agent, as such agreement may be supplemented and amended from time to time. 4.92. Series D Notes shall mean the Company s Variable Rate Senior Secured Notes, Series D, due December 31, 1996 in the original aggregate principal amount of $18,000,000. 4.93. Senior Secured Notes shall mean, collectively, the Company s 9.55% Senior Secured Notes, Series A, due October 1, 1998 in the original principal amount of $12,000,000, the Company s 10.49% Senior Secured Notes, Series C, due September 21, 2002 in the aggregate principal amount of $22,000,000, the Company s promissory note dated February 1, 1988 payable to the order of John Hancock Mutual Life Insurance Company in the original principal amount of $20,000,000, the Company s promissory note dated April 25, 1991 in the original principal amount of $5,000,000 payable to the order of John Hancock Mutual Life Insurance Company and the Company s promissory notes in an aggregate principal amount not to exceed $28,000,000 issued pursuant to the commitment described in Section 6.2(p) hereof. 4.94. Subordinated Debt shall mean indebtedness for borrowed money of the Company which is subordinate in right of payment to the prior payment in full of the Company s indebtedness, obligations and liabilities to the Banks under the Loan Documents pursuant to written subordination provisions satisfactory in form and substance to the Banks. 4.95. Subsidiary shall mean collectively any corporation or other entity at least a majority of the outstanding voting equity interests (other than directors qualifying shares) of which is at the time owned directly or indirectly by the Company or by one of more Subsidiaries or by the Company and one or more Subsidiaries. The term Consolidated Subsidiary shall mean any Subsidiary whose accounts are consolidated with those of the Company in accordance with generally accepted accounting principles. 4.96. Tangible Net Worth shall mean the Net Worth minus the amount of all Intangible Assets of the Company and its Subsidiaries, determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.97. Telerate Page 3750 shall mean the display designated as Page 3750 on the Telerate Service (or such other page as may replace Page 3750 on that service or such other service as may be nominated by the British Bankers Association as the information vendor for the purpose of displaying British Bankers Association Interest Settlement Rates for U.S. Dollar deposits). 4.98. Termination Date shall have the meaning set forth in Section 1.1(a) hereof. 4.99. Total Assets shall mean at any date, the aggregate amount of assets of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles consistently applied. 4.100. Total Liabilities shall mean at any date, the aggregate amount of all liabilities of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.101. Value of Eligible Inventory shall mean as of any given date with respect to Eligible Inventory: (a) With respect to Eligible Inventory consisting of feed grains, feed, ingredients, dressed broiler chickens and commercial eggs, an amount equal to the lower of (i) costs determined on a first-in-first-out inventory basis (determined in accordance with generally accepted accounting principles consistently applied), or (ii) wholesale market value; (b) With respect to Eligible Inventory consisting of live broiler chickens, the price quoted on the Arkansas live market on the date of calculation; (c) With respect to Eligible Inventory consisting of prepared food products, the standard cost value; (d) With respect to Eligible Inventory consisting of: breeder hens, $1.50 per head; breeder pullets, $1.00 per head; commercial hens, $0.70 per head; commercial pullets, $0.40 per head; and hatching eggs, $1.25 a dozen; or in each case such other values as may be agreed upon by the Company and the Required Banks; and (e) With respect to Eligible Inventory consisting of packaging materials, vaccines and supplies, actual costs. 4.102. Warehouseman shall mean Field Warehousing Corp., a California corporation, and any other Person approved by the Agent and the Required Banks. 4.103. Any accounting term or the character or amount of any asset or liability or item of income or expense required to be determined under this Agreement, shall be determined or made in accordance with generally accepted accounting principles at the time in effect, to the extent applicable, except where such principles are inconsistent with the requirements of this Agreement. .c1.5. Representations and Warranties. The Company represents and warrants to the Banks as follows: .c2.Section 5.1. Organization and Qualification;. The Company is a corporation duly organized and existing and in good standing under the laws of the State of Delaware, has full and adequate corporate power to carry on its business as now conducted, is duly licensed or qualified in all jurisdictions wherein the nature of its activities requires such licensing or qualification except where the failure to be so licensed or qualified would not have a material adverse effect on the condition, financial or otherwise, of the Company, has full right and authority to enter into this Agreement and the other Loan Documents, to make the borrowings herein provided for, to issue the Notes in evidence thereof, to encumber its assets as collateral security for such borrowings and to perform each and all of the matters and things herein and therein provided for; and this Agreement does not, nor does the performance or observance by the Company of any of the matters or things provided for in the Loan Documents, contravene any provision of law or any charter or by-law provision or any covenant, indenture or agreement of or affecting the Company or its Properties. .c2.Section 5.2. Subsidiaries;. Each Subsidiary is duly organized and existing under the laws of the jurisdiction of its incorporation, has full and adequate corporate power to carry on its business as now conducted and is duly licensed or qualified in all jurisdictions wherein the nature of its business requires such licensing or qualification and the failure to be so licensed or qualified would have a material adverse effect upon the business, operations or financial condition of such Subsidiary and the Company taken as a whole. The only Subsidiaries of the Company are set forth on Exhibit I hereto. .c2.Section 5.3. Financial Reports;. The Company has heretofore delivered to the Banks a copy of the Audit Report as of September 26, 1992 of the Company and its Subsidiaries and unaudited financial statements (including a balance sheet, statement of income and retained earnings, statement of cash flows, footnotes and comparison to the comparable prior year period) of the Company as of, and for the period ending April 3, 1993. Such audited financial statements have been prepared in accordance with generally accepted accounting principles on a basis consistent, except as otherwise noted therein, with that of the previous fiscal year or period and fairly reflect the financial position of the Company and its Subsidiaries as of the dates thereof, and the results of its operations for the periods covered thereby. The Company and its Subsidiaries have no material contingent liabilities other than as indicated on said financial statements and since said date of April 3, 1993 there has been no material adverse change in the condition, financial or otherwise, of the Company or any Subsidiary that has not been disclosed in writing to the Banks. .c2. Section 5.4. Litigation; Tax Returns; Approvals ;. There is no litigation or governmental proceeding pending, nor to the knowledge of the Company threatened, against the Company or any Subsidiary which, if adversely determined, is likely to result in any material adverse change in the Properties, business and operations of the Company or any Subsidiary. All income tax returns for the Company required to be filed have been filed on a timely basis, all amounts required to be paid as shown by said returns have been paid. There are no pending or, to the best of the Company s knowledge, threatened objections to or controversies in respect of the United States federal income tax returns of the Company for any fiscal year. No authorization, consent, license, exemption or filing (other than the filing of financing statements) or registration with any court or governmental department, agency or instrumentality, is or will be necessary to the valid execution, delivery or performance by the Company of the Loan Documents. .c2.Section 5.5. Regulation U;. Neither the Company nor any Subsidiary is engaged in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U of the Board of Governors of the Federal Reserve System) and no part of the proceeds of any Loan made or any B\/A created hereunder will be used to purchase or carry any margin stock or to extend credit to others for such a purpose. .c2.Section 5.6. No Default;. As of the date of this Agreement, the Company is in full compliance with all of the terms and conditions of this Agreement, and no Potential Default or Event of Default is existing under this Agreement. .c2.Section 5.7. ERISA;. The Company and its Subsidiaries are in compliance in all material respects with ERISA to the extent applicable to them and have received no notice to the contrary from the PBGC or any other governmental entity or agency. .c2.Section 5.8. Security Interests and Debt;. There are no security interests, liens or encumbrances on any of the Property of the Company or any Subsidiary except such as are permitted by Section 7.16 of this Agreement, and the Company and its Subsidiaries have no Debt except such as is permitted by Section 7.17 of this Agreement. .c2.Section 5.9. Accurate Information;. No information, exhibit or report furnished by the Company to the Banks in connection with the negotiation of the Loan Documents contained any material misstatement of fact or omitted to state a material fact or any fact necessary to make the statements contained therein not misleading in light of the circumstances in which made. The financial projections furnished by the Company to the Banks contain to the Company s knowledge and belief, reasonable projections as of the date hereof of future results of operations and financial position of the Company. .c2.Section 5.10. Environmental Matters;. (a) Except as disclosed on Exhibit D, the Company has not received any notice to the effect, or has any knowledge, that its or any Subsidiary s Property or operations are not in compliance with any of the requirements of applicable federal, state and local environmental, health and safety statutes and regulations ( Environmental Laws ) or are the subject of any federal or state investigation evaluating whether any remedial action is needed to respond to a release of any toxic or hazardous waste or substance into the environment, which non-compliance or remedial action could have a material adverse effect on the business, operations, Property, assets or conditions (financial or otherwise) of the Company or any Subsidiary; (b) there have been no releases of hazardous materials at, on or under any Property now or previously owned or leased by the Company or any Subsidiary that, singly or in the aggregate, have, or may reasonably be expected to have, a material adverse effect on the financial condition, operations, assets, business, Properties or prospects of the Company or such Subsidiary; (c) there are no underground storage tanks, active or abandoned, including petroleum storage tanks, on or under any property now or previously owned or leased by the Company or any Subsidiary that, singly or in the aggregate, have, or may reasonably be expected to have, a material adverse effect on the financial condition, operations, assets, business, Properties or prospects of the Company or such Subsidiary; (d) neither the Company nor any Subsidiary has directly transported or directly arranged for the transportation of any hazardous material to any location which is listed or proposed for listing on the National Priorities List pursuant to CERCLA, on the CERCLIS or on any similar state list or which is the subject of federal, state or local enforcement actions or other investigations which may lead to material claims against the Company or any Subsidiary thereof for any remedial work, damage to natural resources or personal injury, including claims under CERCLA; and (e) no conditions exist at, on or under any Property now or previously owned or leased by the Company or any Subsidiary which, with the passage of time, or the giving of notice or both, would give rise to any material liability under any Environmental Law. .c2.Section 5.11. Enforceability;. This Agreement and the other Loan Documents are legal, valid and binding agreements of the Company, enforceable against it in accordance with their terms, except as may be limited by (a) bankruptcy, insolvency, reorganization, fraudulent transfer, moratorium or other similar laws or judicial decisions for the relief of debtors or the limitation of creditors rights generally; and (b) any equitable principles relating to or limiting the rights of creditors generally. .c2.Section 5.12. Restrictive Agreements;. Neither the Company nor any Subsidiary is a party to any contract or agreement, or subject to any charge or other corporate restriction, which affects its ability to execute, deliver and perform the Loan Documents to which it is a party and repay its indebtedness, obligations and liabilities under the Loan Documents or which materially and adversely affects or, insofar as the Company can reasonably foresee, could materially and adversely affect, the property, business, operations or condition (financial or otherwise) of the Company or any of its Subsidiaries, or would in any respect materially and adversely affect the Collateral, the repayment of the indebtedness, obligations and liabilities under the Loan Documents, or any Bank s or the Agent s rights under the Loan Documents. .c2.Section 5.13. Labor Disputes;. Except as set forth on Exhibit K, (a) there is no collective bargaining agreement or other labor contract covering employees of the Company or any of its Subsidiaries; (b) no such collective bargaining agreement or other labor contract is scheduled to expire during the term of this Agreement; (c) no union or other labor organization is seeking to organize, or to be recognized as, a collective bargaining unit of employees of the Company or any of its Subsidiaries; and (d) there is no pending or (to the best of the Company s knowledge) threatened strike, work stoppage, material unfair labor practice claim or other material labor dispute against or affecting the Company or any of its Subsidiaries or their respective employees. .c2.Section 5.14. No Violation of Law;. Neither the Company nor any Subsidiary is in violation of any law, statute, regulation, ordinance, judgment, order or decree applicable to it which violation might in any respect materially and adversely affect the Collateral, the repayment of the indebtedness, obligations and liabilities under the Loan Documents, any Bank s or the Agent s rights under the Loan Documents, or the Property, business, operations or condition (financial or otherwise) of the Company or such Subsidiary. .c2.Section 5.15. No Default Under Other Agreements;. Neither the Company nor any Subsidiary is in default with respect to any note, indenture, loan agreement, mortgage, lease, deed, or other agreement to which it is a party or by which it or its Property is bound, which default might materially and adversely affect the Collateral, the repayment of the indebtedness, obligations and liabilities under the Loan Documents, any Bank s or the Agent s rights under the Loan Documents or the Property, business, operations or condition (financial or otherwise) of the Company or any Subsidiary. .c2.Section 5.16. Status Under Certain Laws;. Neither the Company nor any of its Subsidiaries is an investment company or a person directly or indirectly controlled by or acting on behalf of an investment company within the meaning of the Investment Company Act of 1940, as amended, or a holding company, or a subsidiary company of a holding company, or an affiliate of a holding company or a subsidiary company of a holding company, within the meaning of the Public Utility Holding Company Act of 1935, as amended. .c2.Section 5.17. Federal Food Security Act;. The Company has received no notice given pursuant to Section 1324(e)(1) or (3) of the Federal Food Security Act and there has not been filed any financing statement or notice, purportedly in compliance with the provisions of the Federal Food Security Act, purporting to perfect a security interest in farm products purchased by the Company in favor of a secured creditor of the seller of such farm products. The Company has registered, pursuant to Section 1324(c)(2)(D) of the Federal Food Security Act, with the Secretary of State of each State in which are produced farm products purchased by the Company and which has established or hereafter establishes a central filing system, as a buyer of farm products produced in such State; and each such registration is in full force and effect. .c2. Section 5.18. Certain Tax Benefits;. On the date of this Agreement the aggregate amount of all net operating losses and credits or other tax benefits available to the Company are approximately $37,500,000, and $4,600,000, respectively. .c2.Section 5.19. Fair Labor Standards Act;. The Company and each Subsidiary has complied in all material respects with, and will continue to comply with, the provisions of the Fair Labor Standards Act of 1938, 29 U.S.C. Section 201, et seq., as amended from time to time (the FLSA ), including specifically, but without limitation, 29 U.S.C. Section 215(a). This representation and warranty, and each reconfirmation hereof, shall constitute written assurance from the Company, given as of the date hereof and as of the date of each reconfirmation, that the Company and each Subsidiary has complied with the requirements of the FLSA, in general, and Section 15(a)(1), 29 U.S.C. Section 215(a)(1), thereof, in particular. .c1.6. Conditions Precedent;. The obligation of the Banks to make any Loan pursuant hereto or to create any B\/A or to issue any L\/C shall be subject to the following conditions precedent: .c2.Section 6.1. General;. The Agent shall have received the notice of borrowings and requests for L\/Cs and B\/As and the Notes hereinabove provided for. .c2.Section 6.2. Initial Extension of Credit;. Prior to the initial Loan, L\/C and B\/A hereunder, the Company shall have delivered the required Collateral and a Borrowing Base Certificate to the Agent, and shall have delivered to the Agent for the benefit of the Banks in sufficient counterparts for distribution to the Banks: (a) a fully executed B\/A Agreement; (b) a fully executed Security Agreement ; (c) appropriate forms of financing statements to perfect the security interest of the Agent provided for by the Security Agreement; (d) a fully executed counterpart of a Guaranty Agreement from Mr. and Mrs. Lonnie A. Pilgrim to the Banks satisfactory in form and substance to the Banks; (e) a fully executed Warehousing Agreement among the Company and the Warehouseman, and related delivery instructions and leases, in substantially the form of Exhibit M attached hereto; (f) a warehouse receipt issued by the Warehouseman covering the Inventory shown on the Borrowing Base Certificate; (g) an agreement between the Banks and each of the holders of the Company s Senior Secured Notes, in substantially the form of Exhibit L attached hereto; (h) evidence of insurance required by Section 7.3 hereof and by the Security Agreement showing the Agent as loss payee thereunder; (i) a good standing certificate or certificate of existence for the Company, dated as of the date no earlier than 30 days prior to the date hereof, from the office of the secretary of state of the state of its incorporation and each state in which it is qualified to do business as a foreign corporation; (j) copies of the Certificate of Incorporation, and all amendments thereto, of the Company certified by the office of the secretary of state of its state of incorporation as of the date no earlier than the date 30 days prior to the date hereof; (k) copies of the By-Laws, and all amendments thereto, of the Company, certified as true, correct and complete on the date hereof by the Secretary of the Company; (l) copies, certified by the Secretary or Assistant Secretary of the Company, of resolutions regarding the transactions contemplated by this Agreement, duly adopted by the Board of Directors of the Company, and satisfactory in form and substance to all of the Banks; (m) an incumbency and signature certificate for the Company satisfactory in form and substance to all of the Banks; (n) copies of a fully executed Trust Indenture and other documents providing for the issuance by the Company of senior Subordinated Debt on terms and conditions acceptable to all of the Banks, certified as true, complete and correct by the Secretary or Assistant Secretary of the Company; (o) evidence satisfactory in form and substance to all of the Banks that (i) the Company has issued Subordinated Debt in an aggregate principle amount of no less than $100,000,000.00, (ii) proceeds thereof in amount of not less than $50,000,000.00 have been placed in escrow for the sole purpose of funding the prepayment, redemption or repurchase by the Company of its 14 1\/4% Senior Notes due 1995 and to reduction of the Company s Debt under the Existing Agreement (iii) the Company has given all notices required to be given to prepay such 14 1\/4% Senior Notes due 1995 no later than July 10, 1993; (p) copies of a fully executed commitment issued by one or more lenders or investors providing for the issuance of additional senior indebtedness in an amount not greater than $28,000,000 to refinance existing secured bank term debt, containing terms and conditions satisfactory to the Banks; (q) a pay-off letter satisfactory in form and substance to all of the Banks from the Existing Lenders and the holders of the Series D Notes; (r) the closing fee payable pursuant to Section 2.5 of this Agreement; (s) evidence that the Company has given all required notices for the prepayment in full of the $2,300,000 Angelinas and Neches River Authority Industrial Development Corporation Variable Rate Demand Refunding Revenue Bonds; and (t) such other documents as the Banks may reasonably require. .c2.Section 6.3. Each Extension of Credit;. As of the time of the making of each Loan, the issuance of each L\/C hereunder and creation of each B\/A hereunder (including the initial Loan, L\/C or B\/A, as the case may be): (a) each of the representations and warranties set forth in Section 5 hereof shall be and remain true and correct as of said time as if made at said time, except that (i) the representations and warranties made under Section 5.3 shall be deemed to refer to the most recent financial statements furnished to the Banks pursuant to Section 7.4 hereof and (ii) with respect to the Company s Subsidiaries in Mexico the representations and warranties made under Section 5.13(d) shall be deemed to refer only to material, strikes, work stoppages, unfair labor practice claims or other material labor disputes; (b) the Company shall be in full compliance with all of the terms and conditions hereof, and no Potential Default or Event of Default shall have occurred and be continuing; and (c) after giving effect to the requested extension of credit and to each Loan that has been made, B\/A created and L\/C issued hereunder, the aggregate principal amount of all Loans, the aggregate face amount of all B\/As, the amount available for drawing under all L\/Cs and the aggregate principal amount of all Reimbursement Obligations then outstanding shall not exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments then in effect and (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate, except as otherwise agreed by the Company and all of the Banks; and the request by the Company for any Loan, L\/C or B\/A pursuant hereto shall be and constitute a warranty to the foregoing effects. .c2.Section 6.4. Legal Matters;. Legal matters incident to the execution and delivery of the Loan Documents shall be satisfactory to each of the Banks and their legal counsel; and prior to the initial Loan, L\/C or B\/A hereunder, the Agent shall have received the favorable written opinion of Godwin & Carlton, counsel for the Company, substantially in the form of Exhibit F, in substance satisfactory to each of the Banks and their respective legal counsel. .c2.Section 6.5. Documents;. The Agent shall have received copies (executed or certified, as may be appropriate) of all documents or proceedings taken in connection with the execution and delivery of the Loan Documents to the extent any Bank or its respective legal counsel requests. .c2.Section 6.6. Lien Searches;. The Agent shall have received lien searches showing that the Property of the Company is subject to no security interest or liens except those permitted by Section 7.16 hereof. .c1.7. Covenants;. It is understood and agreed that so long as credit is in use or available under this Agreement or any amount remains unpaid on any Note, Reimbursement Obligation, L\/C or B\/A, except to the extent compliance in any case or cases is waived in writing by the Required Banks: .c2.Section 7.1. Maintenance;. The Company will, and will cause each Subsidiary to, maintain, preserve and keep its plant, Properties and equipment in good repair, working order and condition and will from time to time make all needful and proper repairs, renewals, replacements, additions and betterments thereto so that at all times the efficiency thereof shall be preserved and maintained in all material respects, normal wear and tear excepted. .c2.Section 7.2. Taxes;. The Company will, and will cause each Subsidiary to, duly pay and discharge all taxes, rates, assessments, fees and governmental charges upon or against the Company or its Subsidiaries or against their respective Properties in each case before the same become delinquent and before penalties accrue thereon unless and to the extent that the same are being contested in good faith and by appropriate proceedings diligently conducted and for which adequate reserves in form and amount reasonably satisfactory to the Required Banks have been established, provided that the Company shall pay or cause to be paid all such taxes, rates, assessments, fees and governmental charges forthwith upon the commencement of proceedings to foreclose any lien which is attached as security therefor, unless such foreclosure is stayed by the filing of an appropriate bond in a manner satisfactory to the Required Banks. .c2.Section 7.3. Maintenance of Insurance;. The Company will, and will cause each Subsidiary to, maintain insurance coverage by good and responsible insurance underwriters in such forms and amounts and against such risks and hazards as are customary for companies engaged in similar businesses and owning and operating similar Properties, provided that the Company and its Subsidiaries may self-insure for workmen s compensation, group health risks and their live chicken inventory in accordance with applicable industry standards. In any event, the Company will insure any of its Property which is insurable against loss or damage by fire, theft, burglary, pilferage and loss in transit, all in amounts and under policies containing loss payable clauses to the Agent as its interest may appear (and, if the Required Banks request, naming the Agent as additional insured therein) and providing for advance notice to the Agent of cancellation thereof, issued by sound and reputable insurers accorded a rating of A-XII or better by A.M. Best Company, Inc. or A or better by Standard & Poor s Corporation or Moody s Investors Service, Inc. and all premiums thereon shall be paid by the Company and certificates summarizing the same delivered to the Agent. .c2.Section 7.4. Financial Reports;. The Company will, and will cause each Subsidiary to, maintain a standard and modern system of accounting in accordance with sound accounting practice and will furnish to the Banks and their duly authorized representatives such information respecting the business and financial condition of the Company and its Subsidiaries as may be reasonably requested and, without any request, will furnish to CoBank and the Banks: (a) as soon as available, and in any event within 45 days after the close of each monthly fiscal period of the Company a copy of the consolidated and consolidating balance sheet, statement of income and retained earnings, statement of cash flows, and the results of operations for each division of the Company, for such period of the Company and its Subsidiaries, together with all such information for the year to date, all in reasonable detail, prepared by the Company and certified on behalf of the Company by the Company s chief financial officer; (b) as soon as available, and in any event within 90 days after the close of each fiscal year, (i) a copy of the audit report for such year and accompanying financial statements, including a consolidated balance sheet, a statement of income and retained earnings, and a statement of cash flows, together with all footnotes thereto, for the Company and its Subsidiaries, and unaudited consolidating balance sheets, statement of income and retained earnings and statements of cash flows for the Company and its Subsidiaries, in each case, showing in comparative form the figures for the previous fiscal year of the Company, all in reasonable detail, accompanied by an unqualified opinion of Ernst & Young or other independent public accountants of nationally recognized standing selected by the Company and satisfactory to the Required Banks, such opinion to indicate that such statements are made in accordance with generally accepted accounting principles, and (ii) a written report of such independent public accountants addressed to the Banks stating that they have reviewed the Borrowing Base Certificate and the Compliance Certificate as of the Fiscal Year end and that both of such certificates were prepared in accordance with the requirements of this Agreement; (c) each of the financial statements furnished to the Banks pursuant to paragraph (a) and (b) above shall be accompanied by a Compliance Certificate in the form of Exhibit G hereto signed on behalf of the Company by its chief financial officer; (d) within 10 Business Days after the end of each month, a Borrowing Base Certificate in the form of Exhibit H hereto, setting forth a computation of the Borrowing Base as of that month s end date, certified as correct on behalf of the Company by the Company s chief financial officer and certifying that as of the last day of the preceding monthly period the signer thereof has re-examined the terms and provisions of this Agreement and the Security Agreement and that to the best of his knowledge and belief, no Potential Default or Event of Default has occurred or, if any such Potential Default or Event of Default has occurred, setting forth the description of such Potential Default or Event of Default and specifying the action, if any, taken by the Company to remedy the same, accompanied by a warehouse receipt issued by the Warehouseman covering no less than all of the Inventory shown on such Borrowing Base Certificate; (e) with 10 Business Days after the end of each month, an accounts receivable aging report in the form of Exhibit J hereto, signed by the chief financial officer of the Company; (f) promptly upon preparation thereof copies in the form presented to the Company s Board of Directors of its annual budgets and forecasts of operations and capital expenditures including investments, a balance sheet, an income statement and a projection of cash flow by months for each fiscal year; (g) promptly upon their becoming available, copies of all registration statements and regular periodic reports, if any, which the Company shall have filed with the Securities and Exchange Commission or any governmental agency substituted therefor, or any national securities exchange, including copies of the Company s form 10-K annual report, including financial statements audited by Ernst & Young or other independent public accountants of nationally recognized standing selected by the Company and satisfactory to the Bank, its form 10-Q quarterly report to the Securities and Exchange Commission and any Form 8 filed by the Company with the Securities and Exchange Commission; (h) promptly upon the mailing thereof to the shareholders of the Company generally, copies of all financial statements, reports and proxy statements so mailed; and (i) within 45 days of the last day of each fiscal quarter of the Company, a summary of the capital expenditures for the applicable period and the year to date, all in reasonable detail, prepared by the Company and certified on behalf of the Company by the Company s chief financial officer. .c2.Section 7.5. Inspection and Reviews;. The Company shall, and shall cause each Subsidiary to, permit the Agent and the Banks, by their representatives and agents, to inspect any of the properties, corporate books and financial records of the Company and its Subsidiaries, to review and make copies of the books of accounts and other financial records of the Company and its domestic Subsidiaries, and to discuss the affairs, finances and accounts of the Company and its Subsidiaries with, and to be advised as to the same by, its officers at such reasonable times and intervals as the Agent or the Banks may designate. In addition to any other compensation or reimbursement to which the Agent and the Banks may be entitled under the Loan Documents, the Company shall pay to the Agent from time to time upon demand (a) the amount necessary to compensate it for all fees, charges and expenses incurred by the Agent or its designee and (b) up to $10,000 per year to compensate the Banks, other than the Agent, for any such fees, charges and expenses incurred by such Banks, in each case in connection with the audits of Collateral, or inspections or review of the books, records and accounts of the Company or any domestic Subsidiary conducted by the Agent or its designee or any of the Banks. .c2.Section 7.6. Consolidation and Merger;. The Company will not, and will not permit any Subsidiary to, consolidate with or merge into any Person, or permit any other Person to merge into it, or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the Property of the other Person, or acquire substantially as an entirety the business of any other Person, without the prior written consent of the Required Banks. .c2.Section 7.7. Transactions with Affiliates;. The Company will not, and will not permit any Subsidiary to, enter into any transaction, including without limitation, the purchase, sale, lease or exchange of any Property, or the rendering of any service, with any Affiliate of the Company or such Subsidiary except (a) in the ordinary course of and pursuant to the reasonable requirements of the Company s or such Subsidiary s business and upon fair and reasonable terms not materially less favorable to the Company than would be obtained in a comparable arm s-length transaction with a Person not an Affiliate of the Company or such Subsidiary, and (b) on-going transactions with Affiliates of the type disclosed in the Company s proxy statement for its Fiscal Year ended September 26, 1992. .c2.Section 7.8. Leverage Ratio;. The Company will not permit the ratio of its Leverage Ratio at any time during each period specified below to exceed the ratio specified below for such period: (a) from the date hereof through the next to last day in Fiscal Year of 1994, 0.70 to 1; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, 0.65 to 1; and (c) on the last day of Fiscal Year 1995 and thereafter, 0.625 to 1. .c2.Section 7.9. Tangible Net Worth;. The Company shall maintain its Tangible Net Worth at all times during the periods specified below in an amount not less than the minimum required amount for each period set forth below: (a) from the date hereof through the next to last day in Fiscal Year 1993, $105,000,000; (b) from the last day of Fiscal Year 1993 through the next to last day of Fiscal Year 1994, $105,000,000 plus an amount equal to 75% of the Company s Net Income (but not less than zero) for the last six months of Fiscal Year 1993; and (c) from the last day of Fiscal Year 1994 and at all times thereafter, an amount equal to the minimum amount required to be maintained during Fiscal Year 1994 plus an amount equal to 75% of the Company s Net Income (but not less than zero) during Fiscal Year 1994. .c2.Section 7.10. Current Ratio;. The Company will maintain at all times and measured as of the last day of each monthly fiscal accounting period a Current Ratio of not less than 1.5 to 1. .c2.Section 7.11. Net Tangible Assets to Total Liabilities;. The Company will not permit the ratio of its Net Tangible Assets to its Total Liabilities at any time during each period specified below to be less than the ratio specified for such period: (a) from the date hereof through the next to last day in Fiscal Year 1994, 1.20 to 1; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, 1.25 to 1; and (c) from the last day of Fiscal Year 1995 and at all times thereafter, 1.30 to 1. Section 7.12. Fixed Charge Coverage Ratio. The Company will not permit its Fixed Charge Coverage Ratio to be less than 1.50 to 1 at any time during any period specified below: (a) the three consecutive fiscal quarters ending July 3, 1993; (b) the four consecutive fiscal quarters of the Company ending on October 2, 1993; (c) the five consecutive fiscal quarters of the Company ending December 31, 1993; (d) the six consecutive fiscal quarters of the Company ending April 2, 1994; (e) the seven consecutive fiscal quarters of the Company ending July 2, 1994; and (f) the eight consecutive fiscal quarters of the Company ending on the last day of each fiscal quarter thereafter commencing with the fiscal quarter ending October 1, 1994. .c2.Section 7.13. Minimum Net Working Capital;. The Company will maintain Net Working Capital at all times during each period specified below (measured as of the last day of each monthly fiscal accounting period) in an amount not less than the amount specified below for each period: (a) from the date hereof through the next to last day in Fiscal Year 1994, $65,000,000; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, $70,000,000; and (c) from the last day of Fiscal Year 1995 and at all times thereafter, $75,000,000. .c2.Section 7.14. Capital Expenditures;. The Company will not, and will not permit any Subsidiary to, make or commit to make any capital expenditures (as defined and classified in accordance with generally accepted accounting principles consistently applied;) provided, however, that if no Event of Default or Potential Default shall exist before and after giving effect thereto, the Company and its Subsidiaries may make capital expenditures during the period beginning on the date hereof through the Termination Date in an aggregate amount in each Fiscal Year commencing with Fiscal Year 1993 not to exceed the sum of (a) $20,000,000 and (b) in Fiscal 1994 and each Fiscal Year thereafter the amount, if any, by which such capital expenditures made by the Company in the immediately preceding Fiscal Year was less than $20,000,000 but not to exceed $5,000,000 in any Fiscal Year. .c2.Section 7.15. Dividends and Certain Other Restricted Payments;. The Company will not (a) declare or pay any dividends or make any distribution on any class of its capital stock (other than dividends payable solely in its capital stock) or (b) directly or indirectly purchase, redeem or otherwise acquire or retire any of its capital stock (except out of the proceeds of, or in exchange for, a substantially concurrent issue and sale of capital stock) or (c) make any other distributions with respect to its capital stock; provided, however, that if no Potential Default or Event of Default shall exist before and after giving effect thereto, the Company may pay dividends in an aggregate amount not to exceed $1,700,000 in any Fiscal Year at any time after the Company s Net Income for each of three consecutive fiscal quarters occurring no earlier than Fiscal Year 1993 has equaled or exceeded $1,000,000. .c2.Section 7.16. Liens;. The Company will not, and will not permit any Subsidiary to, pledge, mortgage or otherwise encumber or subject to or permit to exist upon or be subjected to any lien, charge or security interest of any kind (including any conditional sale or other title retention agreement and any lease in the nature thereof), on any of its Properties of any kind or character other than: (a) liens, pledges or deposits for workmen s compensation, unemployment insurance, old age benefits or social security obligations, taxes, assessments, statutory obligations or other similar charges, good faith deposits made in connection with tenders, contracts or leases to which the Company or a Subsidiary is a party or other deposits required to be made in the ordinary course of business, provided in each case the obligation secured is not overdue or, if overdue, is being contested in good faith by appropriate proceedings and adequate reserves have been provided therefor in accordance with generally accepted accounting principles and that the obligation is not for borrowed money, customer advances, trade payables or obligations to agricultural producers; (b) the pledge of Property for the purpose of securing an appeal or stay or discharge in the course of any legal proceedings, provided that the aggregate amount of liabilities of the Company and its Subsidiaries so secured by a pledge of Property permitted under this subsection (b) including interest and penalties thereon, if any, shall not be in excess of $1,000,000 at any one time outstanding; (c) liens, pledges, mortgages, security interests, or other charges granted to the Agent to secure the Notes, the B\/As, L\/Cs or the Reimbursement Obligations; (d) liens, pledges, security interests or other charges now or hereafter created under the Security Agreement; (e) security interests or other interests of a lessor in equipment leased by the Company or any Subsidiary as lessee under any financing lease, to the extent such security interest or other interest secures rental payments payable by the Company thereunder; (f) liens on the Collateral securing the Senior Secured Notes created in accordance with the agreements described in Section 6.2(g), provided such liens are subordinated to the Agent s liens therein and provided that the Agent is concurrently granted a lien in the collateral security for the Senior Secured Notes; (g) liens of carriers, warehousemen, mechanics and materialmen and other like liens, in each case arising in the ordinary course of the Company s or any Subsidiary s business to the extent they secure obligations that are not past due; (h) such minor defects, irregularities, encumbrances, easements, rights of way, and clouds on title as normally exist with respect to similar properties which do not materially impair the Property affected thereby for the purpose for which it was acquired; (i) liens, pledges, mortgages, security interests or other charges granted by any of the Company s Subsidiaries in Mexico in such Subsidiary s Inventory and certain fixed assets located in Mexico and such Subsidiary s accounts receivable, in each case securing only indebtedness in an aggregate principal amount of up to $10,000,000 incurred by such Subsidiaries for working capital purposes; (j) statutory landlord s liens under leases; (k) existing liens described on Exhibit E hereto; (l) liens and security interests securing the Company s 14.25% Senior Notes Due 1995; (m) liens on the cash surrender value of the life insurance policy maintained by the Company on the life of Mr. Lonnie A. Pilgrim, to the extent such liens secure loans in an aggregate principal amount not to exceed $700,000; (n) liens, security interests, pledges, mortgages or other charges in any Property other than the Collateral securing obligations in an aggregate amount not exceeding $1,000,000 at any time; and (o) liens and security interests in favor of Barclays Business Credit, Inc. ( Barclays ) in certificates of deposit or other cash equivalents in an aggregate amount not to exceed $5,000,000 securing obligations owing to Barclays under that certain Lease Agreement dated December 27, 1989, as amended, between the Company and Barclays. .c2.Section 7.17. Borrowings and Guaranties;. The Company will not, and will not permit any Subsidiary to, issue, incur, assume, create or have outstanding any indebtedness for borrowed money (including as such all indebtedness representing the deferred purchase price of Property) or customer advances, nor be or remain liable, whether as endorser, surety, guarantor or otherwise, for or in respect of any liability or indebtedness of any other Person, other than: (a) indebtedness of the Company arising under or pursuant to this Agreement or the other Loan Documents; (b) the liability of the Company arising out of the endorsement for deposit or collection of commercial paper received in the ordinary course of business; (c) the indebtedness evidenced by the Company s 14-1\/4% Senior Notes Due 1995, provided such indebtedness is prepaid in full within 46 days of the date of this Agreement; (d) trade payables of the Company arising in the ordinary course of the Company s business; (e) indebtedness disclosed on the audited financial statements referred to in Section 5.3 hereof, except (i) indebtedness to the Existing Lenders under the Existing Agreement, and (ii) from and after the initial extension of credit under this Agreement, indebtedness evidenced by the Series D Notes; (f) indebtedness in an aggregate principal amount not to exceed $28,000,000 incurred pursuant to the commitment described in Section 6.2(p); (g) Subordinated Debt in an aggregate principal amount not to exceed $100,000,000 maturing no earlier than August 1, 2003; (h) indebtedness in an aggregate principal amount of up to $10,000,000 incurred by the Company s Subsidiaries in Mexico for working capital purposes; (i) Debt arising from sale\/leaseback transactions permitted by Section 7.32 hereof and under Capitalized Lease Obligations; (j) indebtedness of any Mexican Subsidiary to any other Mexican Subsidiary; and (k) loans in an aggregate principal amount of up to $700,000 against the cash surrender value of the life insurance policy maintained on the life of Mr. Lonnie A. Pilgrim. .c2.Section 7.18. Investments, Loans and Advances;. The Company will not, and will not permit any Subsidiary to, make or retain any investment (whether through the purchase of stock, obligations or otherwise) in or make any loan or advance to, any other Person, other than: (a) investments in certificates of deposit having a maturity of one year or less issued by any United States commercial bank having capital and surplus of not less than $50,000,000; (b) investments in an aggregate amount of up to $8,000,000 in deposits maintained with the First State Bank of Pittsburg; (c) investments in commercial paper rated P1 by Moody s Investors Service, Inc. or A1 by Standard & Poor s Corporation maturing within 180 days of the date of issuance thereof; (d) marketable obligations of the United States; (e) marketable obligations guaranteed by or insured by the United States, or those for which the full faith and credit of the United States is pledged for the repayment of principal and interest thereof; provided that such obligations have a final maturity of no more than one year from the date acquired by the Company; (f) repurchase, reverse repurchase agreements and security lending agreements collateralized by securities of the type described in subsection (c) and having a term of no more than 90 days, provided, however, that the Company shall hold (individually or through an agent) all securities relating thereto during the entire term of such arrangement; (g) loans, investments (excluding retained earnings) and advances by the Company to its Subsidiaries located in Mexico in an aggregate outstanding amount not to exceed the sum of the amount thereof outstanding on the date hereof (being $94,000,000) plus $5,000,000 at any time, provided, however, that the Company may make loans, investments (excluding retained earnings) and advances to its Subsidiaries located in Mexico in an aggregate amount equal to the aggregate amount of any capital withdrawn from its Mexican Subsidiaries after the date hereof but not to exceed an aggregate amount of $25,000,000 in any Fiscal Year of the Company, provided further that any such investments (excluding retained earnings), loans and advances shall not cause the aggregate outstanding amount of all such loans, investments (excluding retained earnings) and advances to exceed $94,000,000 plus $5,000,000 at any time; (h) loans and advances to employees and contract growers (other than executive officers and directors of the Company) for reasonable expenses incurred in the ordinary course of business; and (i) loans and advances from one Mexican Subsidiary to another Mexican Subsidiary.\n.c2.Section 7.19. Sale of Property;. The Company will not, and will not permit any Subsidiary to, sell, lease, assign, transfer or otherwise dispose of (whether in one transaction or in a series of transactions) all or a material part of its Property to any other Person in any Fiscal Year of the Company; provided, however, that this Section shall not prohibit: (a) sales of Inventory by the Company in the ordinary course of business; (b) sales or leases by the Company of its surplus, obsolete or worn-out machinery and equipment; and (c) sales of approximately 16,500 acres of farm land in Lamar and Fannin Counties, Texas. For purposes of this Section 7.19, material part shall mean 5% or more of the lesser of the book or fair market value of the Property of the Company. .c2.Section 7.20. Notice of Suit, Adverse Change in Business or Default;. The Company shall, as soon as possible, and in any event within fifteen (15) days after the Company learns of the following, give written notice to the Banks of (a) any proceeding(s) that, if determined adversely to the Company or any Subsidiary could have a material adverse effect on the Properties, business or operations of the Company or such Subsidiary being instituted or threatened to be instituted by or against the Company or such Subsidiary in any federal, state, local or foreign court or before any commission or other regulatory body (federal, state, local or foreign); (b) any material adverse change in the business, Property or condition, financial or otherwise, of the Company or any Subsidiary; and (c) the occurrence of a Potential Default or Event of Default. .c2.Section 7.21. ERISA;. The Company will, and will cause each Subsidiary to, promptly pay and discharge all obligations and liabilities arising under ERISA of a character which if unpaid or unperformed might result in the imposition of a lien against any of its Property and will promptly notify the Agent of (i) the occurrence of any reportable event (as defined in ERISA) which might result in the termination by the PBGC of any Plan covering any officers or employees of the Company or any Subsidiary any benefits of which are, or are required to be, guaranteed by PBGC, (ii) receipt of any notice from PBGC of its intention to seek termination of any Plan or appointment of a trustee therefor, and (iii) its intention to terminate or withdraw from any Plan. The Company will not, and will not permit any Subsidiary to, terminate any Plan or withdraw therefrom unless it shall be in compliance with all of the terms and conditions of this Agreement after giving effect to any liability to PBGC resulting from such termination or withdrawal. .c2.Section 7.22. Use of Loan Proceeds;. The Company will use the proceeds of all Loans and B\/As made or created hereunder solely to refinance existing Debt and to finance its temporary working capital requirements. .c2.Section 7.23. Conduct of Business and Maintenance of Existence;. The Company will, and will cause each Subsidiary to, continue to engage in business of the same general type as now conducted by it, and the Company will, and will cause each Subsidiary to, preserve, renew and keep in full force and effect its corporate existence and its rights, privileges and franchises necessary or desirable in the normal conduct of business. .c2.Section 7.24. Additional Information;. Upon request of the Agent, the Company shall provide any reasonable additional information pertaining to any of the Collateral. .c2.Section 7.25. Supplemental Performance;. The Company will at its own expense, register, file, record and execute all such further agreements and documents, including without limitation financing statements, and perform such acts as are necessary and appropriate, or as the Agent or any Bank may reasonably request, to effect the purposes of the Loan Documents. .c2.Section 7.26. Company Chattel Paper - Delivery to Bank;. The Company will keep in its exclusive possession all components of its respective Receivables which constitute chattel paper. The Agent may request in its sole discretion, and the Company agrees to deliver to the Agent upon such request, any or all of such Receivables constituting chattel paper. .c2.Section 7.27. Compliance with Laws, etc. ;The Company will, and will cause each of its Subsidiaries to, comply in all material respects with all applicable laws, rules, regulations and orders, such compliance to include (without limitation) (a) the maintenance and preservation of its corporate existence and qualification as a foreign corporation, (b) the registration pursuant to the Food Security Act of 1985, as amended, with the Secretary of State of each State in which are produced any farm products purchased by the Company and which has established a central filing system, as a buyer of farm products produced in such state, and the maintenance of each such registration, (c) compliance with the Packers and Stockyard Act of 1921, as amended, (d) compliance with all applicable rules and regulations promulgated by the United States Department of Agriculture and all similar applicable state rules and regulations, and (e) compliance with all rules and regulations promulgated pursuant to the Occupational Safety and Health Act of 1970, as amended. .c2.Section 7.28. Environmental Covenant;. The Company will, and will cause each of its Subsidiaries to: (a) use and operate all of its facilities and Properties in material compliance with all Environmental Laws, keep all necessary permits, approvals, certificates, licenses and other authorizations relating to environmental matters in effect and remain in material compliance therewith, and handle all hazardous materials in material compliance with all applicable Environmental Laws; (b) immediately notify the Agent and provide copies upon receipt of all material written claims, complaints, notices or inquiries relating to the condition of its facilities and Property or compliance with Environmental Laws, and shall promptly cure and have dismissed, to the reasonable satisfaction of the Required Banks, any actions and proceedings relating to compliance with Environmental Laws unless and to the extent that the same are being contested in good faith and by appropriate proceedings diligently conducted and for which adequate reserves in form and amount reasonably satisfactory to the Required Banks have been established, provided that no proceedings to foreclose any lien which is attached as security therefor shall have been commenced unless such foreclosure is stayed by the filing of an appropriate bond in a manner satisfactory to the Required Banks; and (c) provide such information and certifications which the Agent may reasonably request from time to time to evidence compliance with this Section 7.29. .c2.Section 7.29. New Subsidiaries;. The Company will not, directly or indirectly, create or acquire any Subsidiary. Section 7.30. Guaranty Fees. The Company will not, and it will not permit any Subsidiary to, directly or indirectly, pay to Mr. and\/or Mrs. Lonnie A. Pilgrim or any other guarantor of any of the Company s indebtedness, obligations and liabilities, any fee or other compensation, but excluding salary, bonus and other compensation for services rendered as an employee (collectively the Guaranty Fees ) in an aggregate amount in excess of $500,000.00 in any Fiscal Year of the Company, provided, however, that if after the date hereof the Company s Net Income for any four consecutive fiscal quarters of the Company equals or exceeds $1,000,000.00 for each of such consecutive fiscal quarters, beginning no earlier than the first fiscal quarter of the current Fiscal Year of the Company, the Company may pay Guaranty Fees in each Fiscal Year thereafter in an amount not to exceed $1,400,000.00. Nothing contained herein shall prohibit the Company from accruing, but not paying, Guaranty Fees in an aggregate amount of up to $1,400,000.00 in any Fiscal Year in which it is permitted to pay no more than $500,000.00, or from paying such accrued and unpaid Guaranty Fees once it is permitted to pay Guaranty Fees in an aggregate amount not to exceed $1,400,000.00 in any fiscal year, provided that all such accrued Guaranty Fees and current Guaranty Fees actually paid in any Fiscal Year shall not exceed an aggregate amount of up to $1,400,000.00. Section 7.31. Key Man Life Insurance. The Company shall continuously maintain a policy of insurance on the life of Mr. Lonnie A. Pilgrim in the amount of $1,500,000.00, of which the Company shall be the beneficiary, such policy to be maintained with a good and responsible insurance company acceptable to the Required Banks. Section 7.32. Sale and Leasebacks. The Company will not, and will not permit any Subsidiary to, enter into any arrangement with any lender or investor providing for the leasing by the Company or any Subsidiary of any real or personal property previously owned by the Company or any Subsidiary, except: (a) any such sale and leaseback transaction, provided that (i) such transactions may be entered into only in the year, or in the year immediately preceding the year, in which net operating losses, credits or other tax benefits would otherwise expire unutilized and the Company delivers on officer s certificate to the Agent to the effect that such expiration of such net operating losses, credits or other tax benefits would occur but for entering into the sale\/leaseback transaction; (ii) the Company shall be completely discharged with respect to any Debt of the Company or such Subsidiary assumed by the purchaser\/lessor in such sale\/leaseback transaction; (iii) the Company shall deliver to the Agent an opinion of counsel that the sale of assets and related lease will be treated as a sale and lease, respectively, for federal income tax purposes; and (iv) the proceeds of such transactions are applied to the payment of Debt; and (b) such transactions in which the aggregate consideration received by the Company upon the sale of such property does not exceed $6,000,000 during the term of this Agreement. .c1.8. Events of Default and Remedies. .c2.Section 8.1. Definitions;. Any one or more of the following shall constitute an Event of Default: (a) Default in the payment when due of any interest on or principal of any Note or Reimbursement Obligation, whether at the stated maturity thereof or as required by Section 2.4 hereof or at any other time provided in this Agreement, or of any fee or other amount payable by the Company pursuant to this Agreement; (b) Default in the observance or performance of any covenant set forth in Sections 7.4, 7.5, 7.6, 7.7, 7.15, 7.17, 7.19 and 7.20, inclusive, hereof, or of any provision of any Security Document requiring the maintenance of insurance on the Collateral subject thereto or dealing with the use or remittance of proceeds of such Collateral; (c) Default in the observance or performance of any covenant set forth in Sections 7.8, 7.9, 7.10, 7.11, 7.12, 7.13, 7.14, 7.16, 7.18, 7.21, 7.23 and 7.31, inclusive, hereof and such default shall continue for 10 days after written notice thereof to the Company by any Bank; (d) Default in the observance or performance of any other covenant, condition, agreement or provision hereof or any of the other Loan Documents and such default shall continue for 30 days after written notice thereof to the Company by any Bank; (e) Default shall occur under any evidence of indebtedness in a principal amount exceeding $1,000,000 issued or assumed or guaranteed by the Company, or under any mortgage, agreement or other similar instrument under which the same may be issued or secured and such default shall continue for a period of time sufficient to permit the acceleration of maturity of any indebtedness evidenced thereby or outstanding or secured thereunder; (f) Any representation or warranty made by the Company herein or in any Loan Document or in any statement or certificate furnished by it pursuant hereto or thereto, proves untrue in any material respect as of the date made or deemed made pursuant to the terms hereof; (g) Any judgment or judgments, writ or writs, or warrant or warrants of attachment, or any similar process or processes in an aggregate amount in excess of $1,000,000 shall be entered or filed against the Company or any Subsidiary or against any of their respective Property or assets and remain unbonded, unstayed and undischarged for a period of 30 days from the date of its entry; (h) Any reportable event (as defined in ERISA) which constitutes grounds for the termination of any Plan or for the appointment by the appropriate United States District Court of a trustee to administer or liquidate any such Plan, shall have occurred and such reportable event shall be continuing thirty (30) days after written notice to such effect shall have been given to the Company by any Bank; or any such Plan shall be terminated; or a trustee shall be appointed by the appropriate United States District Court to administer any such Plan; or the Pension Benefit Guaranty Corporation shall institute proceedings to administer or terminate any such Plan; (i) The Company or any Subsidiary shall (i) have entered involuntarily against it an order for relief under the Bankruptcy Code of 1978, as amended, (ii) admit in writing its inability to pay, or not pay, its debts generally as they become due or suspend payment of its obligations, (iii) make an assignment for the benefit of creditors, (iv) apply for, seek, consent to, or acquiesce in, the appointment of a receiver, custodian, trustee, conservator, liquidator or similar official for it or any substantial part of its property, (v) file a petition seeking relief or institute any proceeding seeking to have entered against it an order for relief under the Bankruptcy Code of 1978, as amended, to adjudicate it insolvent, or seeking dissolution, winding up, liquidation, reorganization, arrangement, marshalling of assets, adjustment or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors or fail to file an answer or other pleading denying the material allegations of any such proceeding filed against it, or (vi) fail to contest in good faith any appointment or proceeding described in Section 8.1(j) hereof; (j) A custodian, receiver, trustee, conservator, liquidator or similar official shall be appointed for the Company, any Subsidiary or any substantial part of its respective Property, or a proceeding described in Section 8.1(i)(v) shall be instituted against the Company or any Subsidiary and such appointment continues undischarged or any such proceeding continues undismissed or unstayed for a period of 60 days; (k) The existence of an Event of Default as defined in the Security Agreement; (l) Any shares of the capital stock of the Company owned legally or beneficially by Mr. and\/or Mrs. Lonnie A. Pilgrim shall be pledged, assigned or otherwise encumbered for any reason, other than (i) the pledge of up to 6,670,000 shares pledged to secure that certain Stock Purchase Agreement dated as of June 25, 1992 between the Company and Archer Daniels Midland, as amended from time to time, and (ii) the pledge of up to 2,000,000 shares to secure personal obligations of Mr. and Mrs. Lonnie A. Pilgrim or such other personal obligations incurred by any Person so long as such obligations are not related to the financing of the Company of any of its Subsidiaries; (m) Mr. and Mrs. Lonnie A. Pilgrim and their descendants and heirs shall for any reason cease to have legal and\/or beneficial ownership of no less than 51% of the issued and outstanding shares of all classes of capital stock of the Company; (n) Either Mr. or Mrs. Lonnie A. Pilgrim shall terminate, breach, repudiate or disavow his or her guaranty of the Company s indebtedness, obligations and liabilities to the Banks under the Loan Documents or any part thereof, or any event specified in Sections 8.1(i) or (j) shall occur with regard to either or both of Mr. and Mrs. Lonnie A. Pilgrim; (o) The Required Banks shall have determined that one or more conditions exist or events have occurred which may result in a material adverse change in the business, operations, Properties or condition (financial or otherwise) of the Company or any Subsidiary; or (p) The occurrence of a Change of Control as defined in that certain Indenture dated as of May 1, 1993 from the Company to Ameritrust Texas National Association, as Trustee, relating to the Company s ___% Senior Subordinated Notes Due 2003. .c2.Section 8.2. Remedies for Non-Bankruptcy Defaults;. When any Event of Default, other than an Event of Default described in subsections (i) and (j) of Section 8.1 hereof, has occurred and is continuing, the Agent, if directed by the Required Banks, shall give notice to the Company and take any or all of the following actions: (i) terminate the remaining Revolving Credit Commitments hereunder on the date (which may be the date thereof) stated in such notice, (ii) declare the principal of and the accrued interest on the Notes and unpaid Reimbursement Obligations to be forthwith due and payable and thereupon the Notes and unpaid Reimbursement Obligations including both principal and interest, shall be and become immediately due and payable without further demand, presentment, protest or notice of any kind, and (iii) proceed to foreclose against any Collateral under any of the Security Documents, take any action or exercise any remedy under any of the Loan Documents or exercise any other action, right, power or remedy permitted by law. Any Bank may exercise the right of set off with regard to any deposit accounts or other accounts maintained by the Company with any of the Banks. .c2.Section 8.3. Remedies for Bankruptcy Defaults;. When any Event of Default described in subsections (i) or (j) of Section 8.1 hereof has occurred and is continuing, then the Notes and all Reimbursement Obligations shall immediately become due and payable without presentment, demand, protest or notice of any kind, and the obligation of the Banks to extend further credit pursuant to any of the terms hereof shall immediately terminate. .c2.Section 8.4. L\/Cs and B\/As;. Promptly following the acceleration of the maturity of the Notes pursuant to Section 8.2 or 8.3 hereof, the Company shall immediately pay to the Agent for the benefit of the Banks the full aggregate amount of all outstanding B\/As and L\/Cs. The Agent shall hold all such funds and proceeds thereof as additional collateral security for the obligations of the Company to the Banks under the Loan Documents. The amount paid under any of the B\/As and L\/Cs for which the Company has not reimbursed the Banks shall bear interest from the date of such payment at the default rate of interest specified in Section 1.3(c)(i) hereof. .c1.9. Change in Circumstances Regarding Fixed Rate Loans;. .c2.Section 9.1. Change of Law;. Notwithstanding any other provisions of this Agreement or any Note to the contrary, if at any time after the date hereof with respect to Fixed Rate Loans, any Bank shall determine in good faith that any change in applicable law or regulation or in the interpretation thereof makes it unlawful for such Bank to make or continue to maintain any Fixed Rate Loan or to give effect to its obligations as contemplated hereby, such Bank shall promptly give notice thereof to the Company to such effect, and such Bank s obligation to make, relend, continue or convert any such affected Fixed Rate Loans under this Agreement shall terminate until it is no longer unlawful for such Bank to make or maintain such affected Loan. The Company shall prepay the outstanding principal amount of any such affected Fixed Rate Loan made to it, together with all interest accrued thereon and all other amounts due and payable to the Banks under Section 9.4 of this Agreement, on the earlier of the last day of the Interest Period applicable thereto and the first day on which it is illegal for such Bank to have such Loans outstanding; provided, however, the Company may then elect to borrow the principal amount of such affected Loan by means of another type of Loan available hereunder, subject to all of the terms and conditions of this Agreement. .c2.Section 9.2. Unavailability of Deposits or Inability to Ascertain the Adjusted Eurodollar Rate or Adjusted CD Rate;. Notwithstanding any other provision of this Agreement or any Note to the contrary, if prior to the commencement of any Interest Period any Bank shall determine (i) that deposits in the amount of any Fixed Rate Loan scheduled to be outstanding are not available to it in the relevant market or (ii) by reason of circumstances affecting the relevant market, adequate and reasonable means do not exist for ascertaining the Adjusted Eurodollar Rate or the Adjusted CD Rate, then such Bank shall promptly give telephonic or telex notice thereof to the Company, the Agent and the other Banks (such notice to be confirmed in writing), and the obligation of the Banks to make, continue or convert any such Fixed Rate Loan in such amount and for such Interest Period shall terminate until deposits in such amount and for the Interest Period selected by the Company shall again be readily available in the relevant market and adequate and reasonable means exist for ascertaining the Adjusted Eurodollar Rate or the Adjusted CD Rate, as the case may be. Upon the giving of such notice, the Company may elect to either (i) pay or prepay, as the case may be, such affected Loan or (ii) reborrow such affected Loan as another type of Loan available hereunder, subject to all terms and conditions of this Agreement. .c2.Section 9.3. Taxes and Increased Costs;. With respect to the Fixed Rate Loans, if any Bank shall determine in good faith that any change in any applicable law, treaty, regulation or guideline (including, without limitation, Regulation D of the Board of Governors of the Federal Reserve System) or any new law, treaty, regulation or guideline, or any interpretation of any of the foregoing by any governmental authority charged with the administration thereof or any central bank or other fiscal, monetary or other authority having jurisdiction over such Bank or its lending branch or the Fixed Rate Loans contemplated by this Agreement (whether or not having the force of law) ( Change in Law ) shall: (i) impose, modify or deem applicable any reserve, special deposit or similar requirements against assets held by, or deposits in or for the account of, or Loans by, or any other acquisition of funds or disbursements by, such Bank (other than reserves included in the determination of the Adjusted Eurodollar Rate or the Adjusted CD Rate); (ii) subject such Bank, any Fixed Rate Loan or any Note to any tax (including, without limitation, any United States interest equalization tax or similar tax however named applicable to the acquisition or holding of debt obligations and any interest or penalties with respect thereto), duty, charge, stamp tax, fee, deduction or withholding in respect of this Agreement, any Fixed Rate Loan or any Note except such taxes as may be measured by the overall net income of such Bank or its lending branch and imposed by the jurisdiction, or any political subdivision or taxing authority thereof, in which such Bank s principal executive office or its lending branch is located; (iii) change the basis of taxation of payments of principal and interest due from the Company to such Bank hereunder or under any Note (other than by a change in taxation of the overall net income of such Bank); or (iv) impose on such Bank any penalty with respect to the foregoing or any other condition regarding this Agreement, any Fixed Rate Loan or any Note; and such Bank shall determine that the result of any of the foregoing is to increase the cost (whether by incurring a cost or adding to a cost) to such Bank of making or maintaining any Fixed Rate Loan hereunder or to reduce the amount of principal or interest received by such Bank, then the Company shall pay to such Bank from time to time as specified by such Bank such additional amounts as such Bank shall reasonably determine are sufficient to compensate and indemnify it for such increased cost or reduced amount. If any Bank makes such a claim for compensation, it shall provide to the Company a certificate setting forth such increased cost or reduced amount as a result of any event mentioned herein specifying such Change in Law, and such certificate shall be conclusive and binding on the Company as to the amount thereof except in the case of manifest error. Upon the imposition of any such cost, the Company may prepay any affected Loan, subject to the provisions of Sections 2.3 and 9.4 hereof. .c2.Section 9.4. Funding Indemnity;. (a) In the event any Bank shall incur any loss, cost, expense or premium (including, without limitation, any loss of profit and any loss, cost, expense or premium incurred by reason of the liquidation or re-employment of deposits or other funds acquired by such Bank to fund or maintain any Fixed Rate Loan or the relending or reinvesting of such deposits or amounts paid or prepaid to such Bank) as a result of: (i) any payment or prepayment of a Fixed Rate Loan on a date other than the last day of the then applicable Interest Period; (ii) any failure by the Company to borrow, continue or convert any Fixed Rate Loan on the date specified in the notice given pursuant to Section 1.8 hereof; or (iii) the occurrence of any Event of Default; then, upon the demand of such Bank, the Company shall pay to such Bank such amount as will reimburse such Bank for such loss, cost or expense. (b) If any Bank makes a claim for compensation under this Section 9.4, it shall provide to the Company a certificate setting forth the amount of such loss, cost or expense in reasonable detail and such certificate shall be conclusive and binding on the Company as to the amount thereof except in the case of manifest error. .c2.Section 9.5. Lending Branch;. Each Bank may, at its option, elect to make, fund or maintain its Eurodollar Loans hereunder at the branch or office specified opposite its signature on the signature page hereof or such other of its branches or offices as such Bank may from time to time elect, subject to the provisions of Section 1.8(b) hereof. .c2.Section 9.6. Discretion of Bank as to Manner of Funding;. Notwithstanding any provision of this Agreement to the contrary, each Bank shall be entitled to fund and maintain its funding of all or any part of its Loans in any manner it sees fit, it being understood however, that for the purposes of this Agreement all determinations hereunder shall be made as if the Banks had actually funded and maintained each Fixed Rate Loan during each Interest Period for such Loan through the purchase of deposits in the relevant interbank market having a maturity corresponding to such Interest Period and bearing an interest rate equal to the Adjusted Eurodollar Rate or Adjusted CD Rate, as the case may be, for such Interest Period. .c1.10. The Agent;. .c2.Section 10.1. Appointment and Powers;. Harris Trust and Savings Bank is hereby appointed by the Banks as Agent under the Loan Documents, including but not limited to the Security Agreement, wherein the Agent shall hold a security interest for the benefit of the Banks, solely as the Agent of the Banks, and each of the Banks irrevocably authorizes the Agent to act as the Agent of such Bank. The Agent agrees to act as such upon the express conditions contained in this Agreement. .c2.Section 10.2. Powers;. The Agent shall have and may exercise such powers hereunder as are specifically delegated to the Agent by the terms of the Loan Documents, together with such powers as are incidental thereto. The Agent shall have no implied duties to the Banks, nor any obligation to the Banks to take any action under the Loan Documents except any action specifically provided by the Loan Documents to be taken by the Agent. .c2.Section 10.3. General Immunity;. Neither the Agent nor any of its directors, officers, agents or employees shall be liable to the Banks or any Bank for any action taken or omitted to be taken by it or them under the Loan Documents or in connection therewith except for its or their own gross negligence or willful misconduct. .c2.Section 10.4. No Responsibility for Loans, Recitals, etc;. The Agent shall not (i) be responsible to the Banks for any recitals, reports, statements, warranties or representations contained in the Loan Documents or furnished pursuant thereto, (ii) be responsible for the payment or collection of or security for any Loans or Reimbursement Obligations hereunder except with money actually received by the Agent for such payment, (iii) be bound to ascertain or inquire as to the performance or observance of any of the terms of the Loan Documents, or (iv) be obligated to determine or verify the existence, eligibility or value of any Collateral, or the correctness of any Borrowing Base Certificate or compliance certificate. In addition, neither the Agent nor its counsel shall be responsible to the Banks for the enforceability or validity of any of the Loan Documents or for the existence, creation, attachment, perfection or priority of any security interest in the Collateral. .c2.Section 10.5. Right to Indemnity;. The Banks hereby indemnify the Agent for any actions taken in accordance with this Section 10, and the Agent shall be fully justified in failing or refusing to take any action hereunder, unless it shall first be indemnified to its satisfaction by the Banks pro rata against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action, other than any liability which may arise out of Agent s gross negligence or willful misconduct. .c2.Section 10.6. Action Upon Instructions of Banks.; The Agent agrees, upon the written request of the Required Banks, to take any action of the type specified in the Loan Documents as being within the Agent s rights, duties, powers or discretion. The Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder in accordance with written instructions signed by the Required Banks, and such instructions and any action taken or failure to act pursuant thereto shall be binding on all of the Banks and on all holders of the Notes. In the absence of a request by the Required Banks, the Agent shall have authority, in its sole discretion, to take or not to take any action, unless the Loan Documents specifically require the consent of the Required Banks or all of the Banks. .c2.Section 10.7. Employment of Agents and Counsel;. The Agent may execute any of its duties as Agent hereunder by or through agents (other than employees) and attorneys-in-fact and shall not be answerable to the Banks, except as to money or securities received by it or its authorized agents, for the default or misconduct of any such agents or attorneys-in-fact selected by it in good faith and with reasonable care. The Agent shall be entitled to advice and opinion of legal counsel concerning all matters pertaining to the duties of the agency hereby created. .c2. Section 10.8. Reliance on Documents; Counsel ;. The Agent shall be entitled to rely upon any Note, notice, consent, certificate, affidavit, letter, telegram, statement, paper or document believed by it to be genuine and correct and to have been signed or sent by the proper person or persons, and, in respect to legal matters, upon the opinion of legal counsel selected by the Agent. .c2.Section 10.9. May Treat Payee as Owner;. The Agent may deem and treat the payee of any Note as the owner thereof for all purposes hereof unless and until a written notice of the assignment or transfer thereof shall have been filed with the Agent. Any request, authority or consent of any person, firm or corporation who at the time of making such request or giving such authority or consent is the holder of any such Note shall be conclusive and binding on any subsequent holder, transferee or assignee of such Note or of any Note issued in exchange therefor. .c2.Section 10.10. Agent s Reimbursement;. Each Bank agrees to reimburse the Agent pro rata in accordance with its Commitment Percentage for any reasonable out-of-pocket expenses (including fees and charges for field audits) not reimbursed by the Company (a) for which the Agent is entitled to reimbursement by the Company under the Loan Documents and (b) for any other reasonable out-of-pocket expenses incurred by the Agent on behalf of the Banks, in connection with the preparation, execution, delivery, administration and enforcement of the Loan Documents and for which the Agent is entitled to reimbursement by the Company and has not been reimbursed. .c2.Section 10.11. Rights as a Lender;. With respect to its commitment, Loans made by it, L\/Cs and B\/As issued by it and the Notes issued to it, Harris shall have the same rights and powers hereunder as any Bank and may exercise the same as though it were not the Agent, and the term Bank or Banks shall, unless the context otherwise indicates, include Harris in its individual capacity. Harris and each of the Banks may accept deposits from, lend money to, and generally engage in any kind of banking or trust business with the Company as if it were not the Agent or a Bank hereunder, as the case may be. .c2.Section 10.12. Bank Credit Decision;. Each Bank acknowledges that it has, independently and without reliance upon the Agent or any other Bank and based on the financial statements referred to in Section 5.3 and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into the Loan Documents. Each Bank also acknowledges that it will, independently and without reliance upon the Agent or any other Bank and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Loan Documents. .c2.Section 10.13. Resignation of Agent;. Subject to the appointment of a successor Agent, the Agent may resign as Agent for the Banks under this Agreement and the other Loan Documents at any time by sixty days notice in writing to the Banks. Such resignation shall take effect upon appointment of such successor. The Required Banks shall have the right to appoint a successor Agent who shall be entitled to all of the rights of, and vested with the same powers as, the original Agent under the Loan Documents. In the event a successor Agent shall not have been appointed within the sixty day period following the giving of notice by the Agent, the Agent may appoint its own successor. Resignation by the Agent shall not affect or impair the rights of the Agent under Sections 10.5 and 10.10 hereof with respect to all matters preceding such resignation. Any successor Agent must be a Bank, a national banking association, a bank chartered in any state of the United States or a branch of any foreign bank which is licensed to do business under the laws of any state or the United States. .c2.Section 10.14. Duration of Agency;. The agency established by Section 10.1 hereof shall continue, and Sections 10.1 through and including Section 10.15 shall remain in full force and effect, until the Notes and all other amounts due hereunder and thereunder, including without limitation all Reimbursement Obligations, shall have been paid in full and the Banks commitments to extend credit to or for the benefit of the Company shall have terminated or expired. .c1.11. Miscellaneous. .c2.Section 11.1. Amendments and Waivers;. Any term, covenant, agreement or condition of this Agreement may be amended only by a written amendment executed by the Company, the Required Banks and, if the rights or duties of the Agent are affected thereby, the Agent, or compliance therewith only may be waived (either generally or in a particular instance and either retroactively or prospectively), if the Company shall have obtained the consent in writing of the Required Banks and, if the rights or duties of the Agent are affected thereby, the Agent, provided, however, that without the consent in writing of the holders of all outstanding Notes and unpaid Reimbursement Obligations and the creator of any B\/A and the issuer of any L\/C, or all Banks if no Notes, L\/Cs or B\/As are outstanding, no such amendment or waiver shall (i) change the amount or postpone the date of payment of any scheduled payment or required prepayment of principal of the Notes or reduce the rate or extend the time of payment of interest on the Notes, or reduce the amount of principal thereof, or modify any of the provisions of the Notes with respect to the payment or prepayment thereof, (ii) give to any Note any preference over any other Notes, (iii) amend the definition of Required Banks, (iv) alter, modify or amend the provisions of this Section 11.1, (v) change the amount or term of any of the Banks Revolving Credit Commitments or the fees required under Section 2.1 hereof, (vi) alter, modify or amend the provisions of Sections 1.10, 6 or 9 of this Agreement, (vii) alter, modify or amend any Bank s right hereunder to consent to any action, make any request or give any notice, (viii) change the advance rates under the Borrowing Base or the definitions of Eligible Inventory or Eligible Receivables, (ix) release any Collateral under the Security Documents or release or discharge any guarantor of the Company s indebtedness, obligations and liabilities to the Banks, in each case, unless such release or discharge is permitted or contemplated by the Loan Documents, or (x) alter, amend or modify any subordination provisions of any Subordinated Debt. Any such amendment or waiver shall apply equally to all Banks and the holders of the Notes and Reimbursement Obligations and shall be binding upon them, upon each future holder of any Note and Reimbursement Obligation and upon the Company, whether or not such Note shall have been marked to indicate such amendment or waiver. No such amendment or waiver shall extend to or affect any obligation not expressly amended or waived. Harris shall have the right to vote the amount of the CoBank Participation as though the CoBank Participation were a separate extension of credit by CoBank hereunder. .c2.Section 11.2. Waiver of Rights;. No delay or failure on the part of the Agent or any Bank or on the part of the holder or holders of any Note or Reimbursement Obligation in the exercise of any power or right shall operate as a waiver thereof, nor as an acquiescence in any Potential Default or Event of Default, nor shall any single or partial exercise of any power or right preclude any other or further exercise thereof, or the exercise of any other power or right, and the rights and remedies hereunder of the Agent, the Banks and of the holder or holders of any Notes are cumulative to, and not exclusive of, any rights or remedies which any of them would otherwise have. .c2.Section 11.3. Several Obligations;. The commitments of each of the Banks hereunder shall be the several obligations of each Bank and the failure on the part of any one or more of the Banks to perform hereunder shall not affect the obligation of the other Banks hereunder, provided that nothing herein contained shall relieve any Bank from any liability for its failure to so perform. In the event that any one or more of the Banks shall fail to perform its commitment hereunder, all payments thereafter received by the Agent on the principal of Loans and Reimbursement Obligations hereunder, whether from any Collateral or otherwise, shall be distributed by the Agent to the Banks making such additional Loans ratably as among them in accordance with the principal amount of additional Loans made by them until such additional Loans shall have been fully paid and satisfied. All payments on account of interest shall be applied as among all the Banks ratably in accordance with the amount of interest owing to each of the Banks as of the date of the receipt of such interest payment. .c2.Section 11.4. Non-Business Day;. (a) If any payment of principal or interest on any Domestic Rate Loan shall fall due on a day which is not a Business Day, interest at the rate such Loan bears for the period prior to maturity shall continue to accrue on such principal from the stated due date thereof to and including the next succeeding Business Day on which the same is payable. (b) If any payment of principal or interest on any Eurodollar Loan shall fall due on a day which is not a Banking Day, the payment date thereof shall be extended to the next date which is a Banking Day and the Interest Period for such Loan shall be accordingly extended, unless as a result thereof any payment date would fall in the next calendar month, in which case such payment date shall be the next preceding Banking Day. .c2.Section 11.5. Survival of Indemnities;. All indemnities and all provisions relative to reimbursement to the Banks of amounts sufficient to protect the yield to the Banks with respect to Eurodollar Loans, including, but not limited to, Sections 9.3 and 9.4 hereof, shall survive the termination of this Agreement and the payment of the Notes for a period of one year. .c2.Section 11.6. Documentary Taxes;. Although the Company is of the opinion that no documentary or similar taxes are payable in respect of this Agreement or the Notes, the Company agrees that it will pay such taxes, including interest and penalties, in the event any such taxes are assessed irrespective of when such assessment is made and whether or not any credit is then in use or available hereunder. .c.; .c2.Section 11.7. Representations;. All representations and warranties made herein or in certificates given pursuant hereto shall survive the execution and delivery of this Agreement and of the Notes, and shall continue in full force and effect with respect to the date as of which they were made and as reaffirmed on the date of each borrowing, request for L\/C or request for B\/A and as long as any credit is in use or available hereunder. .c2.Section 11.8. Notices;. Unless otherwise expressly provided herein, all communications provided for herein shall be in writing or by telex and shall be deemed to have been given or made when served personally, when an answer back is received in the case of notice by telex or 2 days after the date when deposited in the United States mail (registered, if to the Company) addressed if to the Company to 110 South Texas, Pittsburg, Texas 75686 Attention: Clifford E. Butler; if to the Agent or Harris at 111 West Monroe Street, Chicago, Illinois 60690, Attention: Agribusiness Division; and if to any of the Banks, at the address for each Bank set forth under its signature hereon; or at such other address as shall be designated by any party hereto in a written notice to each other party pursuant to this Section 11.8. .c2. Section 11.9. Costs and Expenses; Indemnity ;. The Company agrees to pay on demand all costs and expenses of the Agent, in connection with the negotiation, preparation, execution and delivery of this Agreement, the Notes and the other instruments and documents to be delivered hereunder or in connection with the transactions contemplated hereby, including the fees and expenses of Messrs. Chapman and Cutler, special counsel to the Agent; all costs and expenses of the Agent (including attorneys fees) incurred in connection with any consents or waivers hereunder or amendments hereto, and all costs and expenses (including attorneys fees), if any, incurred by the Agent, the Banks or any other holders of a Note or any Reimbursement Obligation in connection with the enforcement of this Agreement or the Notes and the other instruments and documents to be delivered hereunder. The Company agrees to indemnify and save harmless the Banks and the Agent from any and all liabilities, losses, costs and expenses incurred by the Banks or the Agent in connection with any action, suit or proceeding brought against the Agent or any Bank by any Person which arises out of the transactions contemplated or financed hereby or by the Notes, or out of any action or inaction by the Agent or any Bank hereunder or thereunder, except for such thereof as is caused by the gross negligence or willful misconduct of the party indemnified. The provisions of this Section 11.9 shall survive payment of the Notes and Reimbursement Obligations and the termination of the Revolving Credit Commitments hereunder. .c2.Section 11.10. Counterparts;. This Agreement may be executed in any number of counterparts and all such counterparts taken together shall be deemed to constitute one and the same instrument. One or more of the Banks may execute a separate counterpart of this Agreement which has also been executed by the Company, and this Agreement shall become effective as and when all of the Banks have executed this Agreement or a counterpart thereof and lodged the same with the Agent. .c2.Section 11.11. Successors and Assigns.;. This Agreement shall be binding upon each of the Company and the Banks and their respective successors and assigns, and shall inure to the benefit of the Company and each of the Banks and the benefit of their respective successors and assigns, including any subsequent holder of any Note or Reimbursement Obligation. The Company may not assign any of its rights or obligations hereunder without the written consent of the Banks. .c2.Section 11.12. No Joint Venture;. Nothing contained in this Agreement shall be deemed to create a partnership or joint venture among the parties hereto. .c2.Section 11.13. Severability;. In the event that any term or provision hereof is determined to be unenforceable or illegal, it shall deemed severed herefrom to the extent of the illegality and\/or unenforceability and all other provisions hereof shall remain in full force and effect. .c2.Section 11.14. Table of Contents and Headings;. The table of contents and section headings in this Agreement are for reference only and shall not affect the construction of any provision hereof. .c2.Section 11.15. Participants;. (a) Each Bank shall have the right at its own cost to grant participations (to be evidenced by one or more agreements or certificates of participation) in the Loans made, and\/or Revolving Credit Commitment and participations in L\/Cs, B\/As and Reimbursement Obligations held, by such Bank at any time and from time to time, and to assign its rights under such Loans, participations in L\/Cs and B\/As and Reimbursement Obligations or the Notes evidencing such Loans to one or more other Persons; provided that no such participation (except the participation described in Section 11.15(b) hereof (the CoBank Participation )) shall relieve any Bank of any of its obligations under this Agreement, and any agreement pursuant to which such participation (except the CoBank Participation) or assignment of a Note or the rights thereunder is granted shall provide that the granting Lender shall retain the sole right and responsibility to enforce the obligations of the Company under the Loan Documents, including, without limitation, the right to approve any amendment, modification or waiver of any provision thereof, except that such agreement (except the CoBank Agreement) may provide that such Bank will not agree without the consent of such participant or assignee to any modification, amendment or waiver of this Agreement that would (A) increase any Revolving Credit Commitment of such Lender, or (B) reduce the amount of or postpone the date for payment of any principal of or interest on any Loan or Reimbursement Obligation or of any fee payable hereunder in which such participant or assignee has an interest or (C) reduce the interest rate applicable to any Loan or other amount payable in which such participant or assignee has an interest or (D) release any collateral security for or guarantor for any of the Company s indebtedness, obligations and liabilities under the Loan Documents, and provided further that no such assignee or participant except CoBank shall have any rights under this Agreement except as provided in this Section 11.15, and the Agent shall have no obligation or responsibility to such participant or assignee, except that nothing herein provided is intended to affect the rights of an assignee of a Note to enforce the Note assigned. Any party to which such a participation or assignment has been granted shall have the benefits of Section 1.10, Section 9.3 and Section 9.4 hereof but shall not be entitled to receive any greater payment under any such Section than the Bank granting such participation or assignment would have been entitled to receive with respect to the rights transferred. (b) The Company acknowledges that concurrently with the execution and delivery of this Agreement Harris has entered into that certain Participation Agreement of even date herewith with CoBank (as such agreement may be supplemented and amended from time to time, the CoBank Agreement ) a copy of which has been provided to the Company. In the event that CoBank fails to furnish to Harris its ratable participation in any Loan to be made by Harris to the Company, notwithstanding anything whatsoever contained in this Agreement to the contrary obligating Harris to make such Loan to the Company, Harris shall not be obligated to advance to the Company more than Harris Retained Percentage of such Loan plus any amount of such Loan actually advanced by CoBank to Harris to fund CoBank s Participation therein. .c2.Section 11.16. Assignment of Commitments by Bank;. Each Bank shall have the right at any time, with the prior consent of the Company and the Agent (which consent will not be unreasonably withheld), to sell, assign, transfer or negotiate all or any part of its Revolving Credit Commitment to one or more commercial banks or other financial institutions; provided that such assignment is in an amount of at least $10,000,000, provided further that no Bank (except ING Bank) may so assign more than one-half of its original Revolving Credit Commitment hereunder and provided further that ING Bank may assign all of its interest hereunder to any of its subsidiaries or affiliates that are Under Common Control with ING Bank. Upon any such assignment, and its notification to the Agent, the assignee shall become a Bank hereunder, all Loans and the Revolving Credit Commitment it thereby holds shall be governed by all the terms and conditions hereof, and the Bank granting such assignment shall have its Revolving Credit Commitment and its obligations and rights in connection therewith, reduced by the amount of such assignment. Upon each such assignment the Bank granting such assignment shall pay to the Agent for the Agent s sole account a fee of $2,500. .c2.Section 11.17. Sharing of Payments;. Each Bank agrees with each other Bank that if such Bank shall receive and retain any payment, whether by set-off or application of deposit balances or otherwise ( Set-Off ), on any Loan, Reimbursement Obligation or other amount outstanding under this Agreement in excess of its ratable share of payments on all Loans, Reimbursement Obligations and other amounts then outstanding to the Banks, then such Bank shall purchase for cash at face value, but without recourse, ratably from each of the other Banks such amount of the Loans and Reimbursement Obligations held by each such other Bank (or interest therein) as shall be necessary to cause such Bank to share such excess payment ratably with all the other Banks; provided, however, that if any such purchase is made by any Bank, and if such excess payment or part thereof is thereafter recovered from such purchasing Bank, the related purchases from the other Banks shall be rescinded ratably and the purchase price restored as to the portion of such excess payment so recovered, but without interest. Each Bank s ratable share of any such Set-Off shall be determined by the proportion that the aggregate principal amount of Loans and Reimbursement Obligations then due and payable to such Bank bears to the total aggregate principal amount of Loans and Reimbursement Obligations then due and payable to all the Banks. .c2. Section 11.18. Jurisdiction; Venue ;. The company hereby submits to the nonexclusive jurisdiction of the united states district court for the northern district of Illinois and of any Illinois court sitting in Chicago for purposes of all legal proceedings arising out of or relating to this agreement or the transactions contemplated hereby. The company irrevocably waives, to the fullest extent permitted by law, any objection which it may now or hereafter have to the laying of the venue of any such proceeding brought in such a court and any claim that any such proceeding brought in such a court has been brought in an inconvenient forum. .c2.Section 11.19. Lawful Rate;. All agreements between the Company, the Agent and each of the Banks, whether now existing or hereafter arising and whether written or oral, are expressly limited so that in no contingency or event whatsoever, whether by reason of demand or acceleration of the maturity of any of the indebtedness hereunder or otherwise, shall the amount contracted for, charged, received, reserved, paid or agreed to be paid to the Agent or each Bank for the use, forbearance, or detention of the funds advanced hereunder or otherwise, or for the performance or payment of any covenant or obligation contained in any document executed in connection herewith (all such documents being hereinafter collectively referred to as the Credit Documents ), exceed the highest lawful rate permissible under applicable law (the Highest Lawful Rate ), it being the intent of the Company, the Agent and each of the Banks in the execution hereof and of the Credit Documents to contract in strict accordance with applicable usury laws. If, as a result of any circumstances whatsoever, fulfillment by the Company of any provision hereof or of any of such documents, at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by applicable usury law or result in the Agent or any Bank having or being deemed to have contracted for, charged, reserved or received interest (or amounts deemed to be interest) in excess of the maximum, lawful rate or amount of interest allowed by applicable law to be so contracted for, charged, reserved or received by the Agent or such Bank, then, ipso facto, the obligation to be fulfilled by the Company shall be reduced to the limit of such validity, and if, from any such circumstance, the Agent or such Bank shall ever receive interest or anything which might be deemed interest under applicable law which would exceed the Highest Lawful Rate, such amount which would be excessive interest shall be refunded to the Company or, to the extent (i) permitted by applicable law and (ii) such excessive interest does not exceed the unpaid principal balance of the Notes and the amounts owing on other obligations of the Company to the Agent or any Bank under any Loan Document applied to the reduction of the principal amount owing on account of the Notes or the amounts owing on other obligations of the Company to the Agent or any Bank under any Loan Document and not to the payment of interest. All interest paid or agreed to be paid to the Agent or any Bank shall, to the extent permitted by applicable law, be amortized, prorated, allocated, and spread throughout the full period of the indebtedness hereunder until payment in full of the principal of the indebtedness hereunder (including the period of any renewal or extension thereof) so that the interest on account of the indebtedness hereunder for such full period shall not exceed the highest amount permitted by applicable law. This paragraph shall control all agreements between the Company, the Agent and the Banks. .c2.Section 11.20. Governing Law;. (a) This Agreement and the rights and duties of the parties hereto, shall be construed and determined in accordance with the internal laws of the State of Illinois, except to the extent provided in Section 11.20(b) hereof and to the extent that the Federal laws of the United States of America may otherwise apply. (b) Notwithstanding anything in Section 11.20(a) hereof to the contrary, nothing in this Agreement, the Notes, or the Other Loan Documents shall be deemed to constitute a waiver of any rights which the Company, the Agent or any of the Banks may have under the National Bank Act or other applicable Federal law. .c2.Section 11.21. Limitation of Liability;. No claim may be made by the Company, any Subsidiary or any Guarantor against any Bank or its Affiliates, Directors, officers, employees, attorneys or Agents for any special, indirect or consequential damages in respect of any breach or wrongful conduct (whether the claim therefor is based on contract, tort or duty imposed by law) in connection with, arising out of or in any way related to the transactions contemplated and relationships established by this Agreement or any of the Other Loan Documents, or any act, omission or event occurring in connection therewith. The Company, each Subsidiary and each Guarantor hereby waive, release and agree not to sue upon such claim for any such damages, whether or not accrued and whether or not known or suspected to exist in its favor. .c2.Section 11.22. Nonliability of Lenders;. The relationship between the Company and the Banks is, and shall at all times remain, solely that of borrower and lenders, and the Banks and the Agent neither undertake nor assume any responsibility or duty to the Company to review, inspect, supervise, pass judgment upon, or inform the Company of any matter in connection with any phase of the Company s business, operations, or condition, financial or otherwise. The Company shall rely entirely upon its own judgment with respect to such matters, and any review, inspection, supervision, exercise of judgment, or information supplied to the Company by any Bank or the Agent in connection with any such matter is for the protection of the Bank and the Agent, and neither the Company nor any third party is entitled to rely thereon. .c2.Section 11.23. No Oral Agreements.; This written agreement, together with the Other Loan Documents executed contemporaneously herewith, represent the final agreement between the parties and may not be contradicted by evidence of prior, contemporaneous or subsequent oral agreements of the parties. There are no unwritten oral agreements between the parties. .c2.Section 11.24. Treatment of Certain Indebtedness;. The Agent and the Banks agree that for purposes of determining compliance with the financial covenants contained in this Agreement the Company s indebtedness evidenced by its 14.25% Senior Notes Due 1995 shall be deemed paid in an amount equal to the amount deposited with the trustee for such notes in an escrow account for the payment of such notes and with respect to which notice of redemption shall have been given to the holders of such notes in accordance with the terms thereof. Upon your acceptance hereof in the manner hereinafter set forth, this Agreement shall be a contract between us for the purposes hereinabove set forth.\nDated as of May 27, 1993. Pilgrim s Pride Corporation By Lonnie A. Pilgrim Its Chief Executive Officer\nAccepted and Agreed to as of the day and year last above written.\nHarris Trust And Savings Bank individually and as Agent By Carl A. Blackham Its Vice President Address: 111 West Monroe Street Chicago, Illinois 60690\nFBS Ag Credit, Inc. By Douglas S. Hoffner Its Vice President Address: 4643 South Ulster Street, Suite 1280 Denver, Colorado 80237\nInternationale Nederlanden Bank N. V. By Sheila M. Greatrex Its Vice President Address: 135 East 57th Street New York, New York 10022-2101\nBoatmen s First National Bank of Kansas City By Martha Carpenter Smith Its Senior Vice President Address: 10th and Baltimore Kansas City, Missouri 64183\nFirst Interstate Bank of Texas, N.A. By Connor J. Duffey Its Vice President Address: 1445 Ross Avenue Dallas, Texas 75202\nPilgrim s Pride Corporation First Amendment to Secured Credit Agreement\nHarris Trust and Savings Bank Chicago, Illinois\nFBS Ag Credit, Inc. Denver, Colorado\nInternationale Nederlanden (U.S) Capital Corporation, formerly known as Internationale Nederlanden Bank N. V. ( ING Bank ) New York, New York\nBoatmen s First National Bank of Kansas City Kansas City, Missouri\nFirst Interstate Bank of Texas, N.A. Dallas, Texas Ladies and Gentlemen: Reference is hereby made to that certain Secured Credit Agreement dated as of May 27, 1993 (the Credit Agreement ) among the undersigned, Pilgrim s Pride Corporation, a Delaware corporation (the Company ), you (the Banks ) and Harris Trust and Savings Bank, as agent for the Banks (the Agent ). All defined terms used herein shall have the same meanings as in the Credit Agreement unless otherwise defined herein. The Banks extend a $75,000,000 revolving credit facility to the Company on the terms and conditions set forth in the Credit Agreement. The Company, the Agent and the Banks now wish to amend the Credit Agreement to, among other things, extend the termination date thereof from May 31, 1995 to May 31, 1997, to provide for a competitive bid facility and change the rate of interest applicable to loans made under the Credit Agreement, all on the terms and conditions and in the manner set forth in this Amendment. 1. Amendments. Upon satisfaction of all of the conditions precedent set forth in Section 2 hereof, the Credit Agreement shall be amended as follows: 1.1. Sections 1, 2 and 3 of the Credit Agreement shall be amended in their entirety to read as follows: 1. The Credit. .c2.Section 1.1. The Revolving Credit.; (a) Subject to all of the terms and conditions hereof, the Banks agree, severally and not jointly, to extend a Revolving Credit to the Company which may be utilized by the Company in the form of loans (individually a Revolving Credit Loan and collectively the Revolving Credit Loans ), B\/As and L\/Cs (each as hereinafter defined). The aggregate principal amount of all Revolving Credit Loans under the Revolving Credit plus the aggregate principal amount of all Bid Loans outstanding under this Agreement plus the amount available for drawing under all L\/Cs, the aggregate face amount of all B\/As and the aggregate principal amount of all unpaid Reimbursement Obligations (as hereinafter defined) at any time outstanding shall not exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments (as hereinafter defined) in effect from time to time during the term of this Agreement (as hereinafter defined) or (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate. The Revolving Credit shall be available to the Company, and may be availed of by the Company from time to time, be repaid (subject to the restrictions on prepayment set forth herein) and used again, during the period from the date hereof to and including May 31, 1997 (the Termination Date ). (b) At any time not earlier than 120 days prior to, nor later than 60 days prior to, the date that is two years before the Termination Date then in effect (the Anniversary Date ), the Company may request that the Banks extend the then scheduled Termination Date to the date one year from such Termination Date. If such request is made by the Company each Bank shall inform the Agent of its willingness to extend the Termination Date no later than 20 days prior to such Anniversary Date. Any Bank s failure to respond by such date shall indicate its unwillingness to agree to such requested extension, and all Banks must approve any requested extension. At any time more than 15 days before such Anniversary Date the Banks may propose, by written notice to the Company, an extension of this Agreement to such later date on such terms and conditions as the Banks may then require. If the extension of this Agreement to such later date is acceptable to the Company on the terms and conditions proposed by the Banks, the Company shall notify the Banks of its acceptance of such terms and conditions no later than the Anniversary Date, and such later date will become the Termination Date hereunder and this Agreement shall otherwise be amended in the manner described in the Banks notice proposing the extension of this Agreement upon the Agent s receipt of (i) an amendment to this Agreement signed by the Company and all of the Banks, (ii) resolutions of the Company s Board of Directors authorizing such extension and (iii) an opinion of counsel to the Company equivalent in form and substance to the form of opinion attached hereto as Exhibit E and otherwise acceptable to the Banks. (c) The respective maximum aggregate principal amounts of the Revolving Credit at any one time outstanding and the percentage of the Revolving Credit available at any time which each Bank by its acceptance hereof severally agrees to make available to the Company are as follows (collectively, the Revolving Credit Commitments and individually, a Revolving Credit Commitment ):\nHarris Trust and Savings Bank $35,000,000 46.66666667% FBS Ag Credit, Inc. $15,000,000 20% Internationale Nederlanden (U.S.) Capital Corporation $10,000,000 13.33333334% Boatmen s First National Bank of Kansas City $10,000,000 13.33333334% First Interstate Bank of Texas, N.A. $ 5,000,000 6.66666667% Total $75,000,000 100%Each Bank s Revolving Credit Commitment shall be reduced from time to time by the aggregate outstanding principal amount of all Bid Loans made by such Bank, and shall be increased (but in no event above the amount set forth above for each Bank) by the aggregate principal amount of each principal repayment of such Bid Loans made from time to time. (d) Loans under the Revolving Credit may be Eurodollar Loans, CD Rate Loans or Domestic Rate Loans. All Loans under the Revolving Credit shall be made from each Bank in proportion to its respective Revolving Credit Commitment as above set forth, as adjusted from time to time to reflect outstanding Bid Loans. Each Domestic Rate Loan shall be in an amount not less than $3,000,000 or such greater amount which is an integral multiple of $500,000 and each Fixed Rate Loan shall be in an amount not less than $3,000,000 or such greater amount which is an integral multiple of $1,000,000. .c2.Section 1.2. The Notes;. All Revolving Credit Loans made by each Bank hereunder shall be evidenced by a single Secured Revolving Credit Note of the Company substantially in the form of Exhibit A hereto (individually, a Revolving Note and together, the Revolving Notes ) payable to the order of each Bank in the principal amount of such Bank s Revolving Credit Commitment, but the aggregate principal amount of indebtedness evidenced by such Revolving Note at any time shall be, and the same is to be determined by, the aggregate principal amount of all Revolving Credit Loans made by such Bank to the Company pursuant hereto on or prior to the date of determination less the aggregate amount of principal repayments on such Revolving Credit Loans received by or on behalf of such Bank on or prior to such date of determination. Each Revolving Note shall be dated as of the execution date of this Agreement, and shall be expressed to mature on the Termination Date and to bear interest as provided in Section 1.3 hereof. Each Bank shall record on its books or records or on a schedule to its Revolving Note the amount of each Revolving Credit Loan made by it hereunder, whether each Revolving Credit Loan is a Domestic Rate Loan, CD Rate Loan or Eurodollar Loan, and, with respect to Eurodollar Loans, the interest rate and Interest Period applicable thereto, and all payments of principal and interest and the principal balance from time to time outstanding, provided that prior to any transfer of such Revolving Note all such amounts shall be recorded on a schedule to such Revolving Note. The record thereof, whether shown on such books or records or on the schedule to the Revolving Note, shall be prima facie evidence as to all such amounts; provided, however, that the failure of any Bank to record or any mistake in recording any of the foregoing shall not limit or otherwise affect the obligation of the Company to repay all Revolving Credit Loans made hereunder together with accrued interest thereon. Upon the request of any Bank, the Company will furnish a new Revolving Note to such Bank to replace its outstanding Revolving Note and at such time the first notation appearing on the schedule on the reverse side of, or attached to, such Revolving Note shall set forth the aggregate unpaid principal amount of Revolving Credit Loans then outstanding from such Bank, and, with respect to each Fixed Rate Loan, the interest rate and Interest Period applicable thereto. Such Bank will cancel the outstanding Revolving Note upon receipt of the new Revolving Note. .c2.Section 1.3. Interest Rates;. (a) Domestic Rate Loans. Each Domestic Rate Loan shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until maturity (whether by acceleration, upon prepayment or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Domestic Rate from time to time in effect, payable quarterly in arrears on the last day of each calendar quarter, commencing on the first of such dates occurring after the date hereof and at maturity (whether by acceleration, upon prepayment or otherwise). (b) Eurodollar Loans. Each Eurodollar Loan under the Revolving Credit shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until the last day of the Interest Period applicable thereto or, if earlier, until maturity (whether by acceleration or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Adjusted Eurodollar Rate, payable on the last day of each Interest Period applicable thereto and at maturity (whether by acceleration or otherwise) and, with respect to Eurodollar Loans with an Interest Period in excess of three months, on the date occurring every three months from the first day of the Interest Period applicable thereto. (c) CD Rate Loans. Each CD Rate Loan under the Revolving Credit shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until the last day of the Interest Period applicable thereto or, if earlier, until maturity (whether by acceleration or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Adjusted CD Rate, payable on the last day of each Interest Period applicable thereto and at maturity (whether by acceleration of otherwise) and, with respect to CD Rate Loans with an Interest Period in excess of 90 days, on the date occurring every 90 days from the first day of the Interest Period applicable thereto. (d) Default Rate. During the existence of an Event of Default all Loans and Reimbursement Obligations shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) from the date of such Event of Default until paid in full, payable on demand, at a rate per annum equal to the sum of 2.5% plus the Domestic Rate from time to time in effect plus the Applicable Margin. .c2.Section 1.4. Conversion and Continuation of Revolving Credit Loans;. (a) Provided that no Event of Default or Potential Default has occurred and is continuing, the Company shall have the right, subject to the other terms and conditions of this Agreement, to continue in whole or in part (but, if in part, in the minimum amount specified for Fixed Rate Loans in Section 1.1 hereof) any Fixed Rate Loan made under the Revolving Credit from any current Interest Period into a subsequent Interest Period, provided that the Company shall give the Agent notice of the continuation of any such Loan as provided in Section 1.8 hereof. (b) In the event that the Company fails to give notice pursuant to Section 1.8 hereof of the continuation of any Fixed Rate Loan under the Revolving Credit or fails to specify the Interest Period applicable thereto, or an Event of Default or Potential Default has occurred and is continuing at the time any such Loan is to be continued hereunder, then such Loan shall be automatically converted as (and the Company shall be deemed to have given notice requesting) a Domestic Rate Loan, subject to Sections 1.8(b), 8.2 and 8.3 hereof, unless paid in full on the last day of the then applicable Interest Period. (c) Provided that no Event of Default or Potential Default has occurred and is continuing, the Company shall have the right, subject to the terms and conditions of this Agreement, to convert Revolving Credit Loans of one type (in whole or in part) into Revolving Credit Loans of another type from time to time provided that: (i) the Company shall give the Agent notice of each such conversion as provided in Section 1.8 hereof, (ii) the principal amount of any Revolving Credit Loan converted hereunder shall be in an amount not less than the minimum amount specified for the type of Revolving Credit Loan in Section 1.1 hereof, (iii) after giving effect to any such conversion in part, the principal amount of any Fixed Rate Loan under the Revolving Credit then outstanding shall not be less than the minimum amount specified for the type of Loan in Section 1.1 hereof, (iv) any conversion of a Revolving Credit Loan hereunder shall only be made on a Banking Day, and (v) any Fixed Rate Loan may be converted only on the last day of the Interest Period then applicable thereto. .c2.Section 1.5. Bankers Acceptances;. Subject to all the terms and conditions hereof, satisfaction of all conditions precedent to borrowing under this Agreement and so long as no Potential Default or Event of Default is in existence, at the Company s request Harris, in its discretion, may create acceptances in an amount of at least $5,000,000 (a B\/A and collectively the B\/As ) for the Company within the limits of, and subject to availability under the Revolving Credit, and the Banks hereby agree to participate therein as more fully described in Section 1.9 hereof. Each B\/A shall be created pursuant to a General Acceptance Agreement (the B\/A Agreement ) in the form of Exhibit B hereto and an Acceptance Request in Harris standard form at the time such B\/A is requested with respect to such draft presented to Harris for acceptance hereunder. To provide the Company with immediate cash for the B\/As created hereunder, Harris agrees to discount such B\/As at a rate determined by adding a rate per annum (calculated on the basis of a 360-day year and actual days elapsed) equal to the Applicable Margin to the then current bankers acceptance rate for B\/As on which Harris is the acceptor and to credit the proceeds of such discounting to the Company s account at Harris. The face amount of each B\/A created and outstanding pursuant hereto shall be deducted from the credit which may be otherwise available under the Revolving Credit. Each B\/A shall have a term of 30, 60, 90, 120, 150 or 180 days (but not later than the Termination Date), and shall be an acceptance eligible for discount with Federal Reserve Bank in accordance with paragraph 7A of Section 13 of the Federal Reserve Act and regulations and interpretations applicable thereto. The Company shall present to Harris evidence of such eligibility satisfactory to the Banks, and Harris in its sole discretion may refuse to issue any B\/A. .c2.Section 1.6. Letters of Credit.; Subject to all the terms and conditions hereof, satisfaction of all conditions precedent to borrowing under this Agreement and so long as no Potential Default or Event of Default is in existence, at the Company s request Harris may in its discretion issue letters of credit (an L\/C and collectively the L\/Cs ) for the account of the Company subject to availability under the Revolving Credit, and the Banks hereby agree to participate therein as more fully described in Section 1.9 hereof. Each L\/C shall be issued pursuant to an Application for Letter of Credit (the L\/C Agreement ) in the form of Exhibit C hereto. The L\/Cs shall consist of standby letters of credit in an aggregate face amount not to exceed $20,000,000. Each L\/C shall have an expiry date not more than one year from the date of issuance thereof (but in no event later than the Termination Date). The amount available to be drawn under each L\/C issued pursuant hereto shall be deducted from the credit otherwise available under the Revolving Credit. In consideration of the issuance of L\/Cs the Company agrees to pay Harris a fee (the L\/C Fee ) in the amount per annum equal to (a) 1.0% of the face amount of each Performance L\/C and (b) the Applicable Margin for Eurodollar Loans of the stated amount of each Financial Guarantee L\/C (in each case computed on the basis of a 360 day year and actual days elapsed) of the face amount for any L\/C issued hereunder. In addition the Company shall pay Harris for its own account an issuance fee (the L\/C Issuance Fee ) in an amount equal to one-eighth of one percent (0.125%) of the stated amount of each L\/C issued by Harris hereunder. All L\/C Fees shall be payable quarterly in arrears on the last day of each calendar quarter and on the Termination Date, and all L\/C Issuance Fees shall be payable on the date of issuance of each L\/C hereunder and on the date of each extension, if any, of the expiry date of each L\/C. .c2.Section 1.7. Reimbursement Obligation;. The Company is obligated, and hereby unconditionally agrees, to pay in immediately available funds to the Agent for the account of Harris and the Banks who are participating in L\/Cs and B\/As pursuant to Section 1.9 hereof the face amount of (a) each B\/A created by Harris hereunder not later than 11:00 A.M. (Chicago Time) on the maturity date of such B\/A, and (b) each draft drawn and presented under an L\/C issued by Harris hereunder not later than 11:00 a.m. (Chicago Time) on the date such draft is presented for payment to Harris (the obligation of the Company under this Section 1.7 with respect to any B\/A or L\/C is a Reimbursement Obligation ). If at any time the Company fails to pay any Reimbursement Obligation when due, the Company shall be deemed to have automatically requested a Domestic Rate Loan from the Banks hereunder, as of the maturity date of such Reimbursement Obligation, the proceeds of which Loan shall be used to repay such Reimbursement Obligation. Such Loan shall only be made if no Potential Default or Event of Default shall exist and upon approval by all of the Banks, and shall be subject to availability under the Revolving Credit. If such Loan is not made by the Banks for any reason, the unpaid amount of such Reimbursement Obligation shall be due and payable to the Agent for the pro rata benefit of the Banks upon demand and shall bear interest at the rate of interest specified in Section 1.3(d) hereof. .c2.Section 1.8. Manner of Borrowing and Rate Selection;. (a) The Company shall give telephonic, telex or telecopy notice to the Agent (which notice, if telephonic, shall be promptly confirmed in writing) no later than (i) 11:00 a.m. (Chicago time) on the date the Banks are requested to make each Domestic Rate Loan, (ii) 11:00 a.m. (Chicago time) on the date at least three (3) Banking Days prior to the date of (A) each Eurodollar Loan which the Banks are requested to make or continue, and (B) the conversion of any CD Rate Loan or Domestic Rate Loan into a Eurodollar Loan and (iii) 11:00 a.m. (Chicago time) on the date at least one (1) Business Day prior to the date of (A) each CD Rate Loan which the Banks are requested to make and (B) the conversion of any Eurodollar Loan or Domestic Rate Loan into a CD Rate Loan. Each such notice shall specify the date of the Revolving Credit Loan requested (which shall be a Business Day in the case of Domestic Rate Loans and CD Rate Loans and a Banking Day in the case of a Eurodollar Loan), the amount of such Revolving Credit Loan, whether the Revolving Credit Loan is to be made available by means of a Domestic Rate Loan, CD Rate Loan or Eurodollar Loan and, with respect to Fixed Rate Loans, the Interest Period applicable thereto; provided, that in no event shall the principal amount of any requested Revolving Credit Loan plus the aggregate principal or face amount, as appropriate, of all Revolving Credit Loans, L\/Cs, B\/As and unpaid Reimbursement Obligations outstanding hereunder exceed the amounts specified in Section 1.1 hereof. The Company agrees that the Agent may rely on any such telephonic, telex or telecopy notice given by any person who the Agent believes is authorized to give such notice without the necessity of independent investigation and in the event any notice by such means conflicts with the written confirmation, such notice shall govern if any Bank has acted in reliance thereon. The Agent shall, no later than 12:30 p.m. (Chicago time) on the day any such notice is received by it, give telephonic, telex or telecopy (if telephonic, to be confirmed in writing within one Business Day) notice of the receipt of notice from the Company hereunder to each of the Banks, and, if such notice requests the Banks to make, continue or convert any Fixed Rate Loans, the Agent shall confirm to the Company by telephonic, telex or telecopy means, which confirmation shall be conclusive and binding on the Company in the absence of manifest error, the Interest Period and the interest rate applicable thereto promptly after such rate is determined by the Agent. (b) Subject to the provisions of Section 6 hereof, the proceeds of each Revolving Credit Loan shall be made available to the Company at the principal office of the Agent in Chicago, Illinois, in immediately available funds, on the date such Revolving Credit Loan is requested to be made, except to the extent such Revolving Credit Loan represents (i) the conversion of an existing Revolving Credit Loan or (ii) a refinancing of a Reimbursement Obligation, in which case each Bank shall record such conversion on the schedule to its Revolving Note, or in lieu thereof, on its books and records, and shall effect such conversion or refinancing, as the case may be, on behalf of the Company in accordance with the provisions of Section 1.4(a) hereof and 1.9 hereof, respectively. Not later than 2:00 p.m. Chicago time, on the date specified for any Revolving Credit Loan to be made hereunder, each Bank shall make its portion of such Revolving Credit Loan available to the Company in immediately available funds at the principal office of the Agent, except (i) as otherwise provided above with respect to converting or continuing any outstanding Revolving Credit Loans and (ii) to the extent such Revolving Credit Loan represents a refinancing of any outstanding Reimbursement Obligations. (c) Unless the Agent shall have been notified by a Bank prior to 1:00 p.m. (Chicago time) on the date a Revolving Credit Loan is to be made by such Bank (which notice shall be effective upon receipt) that such Bank does not intend to make the proceeds of such Revolving Credit Loan available to the Agent, the Agent may assume that such Bank has made such proceeds available to the Agent on such date and the Agent may in reliance upon such assumption (but shall not be required to) make available to the Company a corresponding amount. If such corresponding amount is not in fact made available to the Agent by such Bank, the Agent shall be entitled to receive such amount on demand from such Bank (or, if such Bank fails to pay such amount forthwith upon such demand, to recover such amount, together with interest thereon at the rate otherwise applicable thereto under Section 1.3 hereof, from the Company) together with interest thereon in respect of each day during the period commencing on the date such amount was made available to the Company and ending on the date the Agent recovers such amount, at a rate per annum equal to the effective rate charged to the Agent for overnight Federal funds transactions with member banks of the Federal Reserve System for each day, as determined by the Agent (or, in the case of a day which is not a Business Day, then for the preceding Business Day) (the Fed Funds Rate ). Nothing in this Section 1.8(c) shall be deemed to permit any Bank to breach its obligations to make Loans under the Revolving Credit or to limit the Company s claims against any Bank for such breach. .c2.Section 1.9. Participation in B\/As and L\/Cs;. Each of the Banks will acquire a risk participation for its own account, without recourse to or representation or warranty from Harris, in each B\/A upon the creation thereof and in each L\/C upon the issuance thereof ratably in accordance with its Commitment Percentage. In the event any Reimbursement Obligation is not immediately paid by the Company pursuant to Section 1.7 hereof, each Bank will pay to Harris funds in an amount equal to such Bank s ratable share of the unpaid amount of such Reimbursement Obligation (based upon its proportionate share relative to its percentage of the Revolving Credit (as set forth in Section 1.1 hereof)). At the election of all of the Banks, such funding by the Banks of the unpaid Reimbursement Obligations shall be treated as additional Revolving Credit Loans to the Company hereunder rather than a purchase of participations by the Banks in the related B\/As and L\/Cs held by Harris. The availability of funds to the Company under the Revolving Credit shall be reduced in an amount equal to any such B\/A or L\/C. The obligation of the Banks to Harris under this Section 1.9 shall be absolute and unconditional and shall not be affected or impaired by any Event of Default or Potential Default which may then be continuing hereunder. Harris shall notify each Bank by telephone of its proportionate share relative to its percentage of the total Banks Revolving Credit Commitments set forth in Section 1.1 hereof (a Commitment Percentage ) of such unpaid Reimbursement Obligation. If such notice has been given to each Bank by 12:00 Noon, Chicago time, each Bank agrees to pay Harris in immediately available and freely transferable funds on the same Business Day. If such notice is received after 12:00 noon, Chicago time, each Bank agrees to pay Harris in immediately available and freely transferable funds no later than the following Business Day. Funds shall be so made available at the account designated by Harris in such notice to the Banks. Upon the election by the Banks to treat such funding as additional Revolving Credit Loans hereunder and payment by each Bank, such Loans shall bear interest in accordance with Section 1.3(a) hereof. Harris shall share with each Bank on a pro rata basis relative to its Commitment Percentage a portion of each payment of a Reimbursement Obligation (whether of principal or interest) and any B\/A commission and any L\/C Fee (but not any L\/C Issuance Fee) payable by the Company. Any such amount shall be promptly remitted to the Banks when and as received by Harris from the Company. .c2.Section 1.10. Capital Adequacy;. If, after the date hereof, any Bank or the Agent shall have determined in good faith that the adoption of any applicable law, rule or regulation regarding capital adequacy, or any change therein (including, without limitation, any revision in the Final Risk-Based Capital Guidelines of the Board of Governors of the Federal Reserve System (12 CFR Part 208, Appendix A; 12 CFR Part 225, Appendix A) or of the Office of the Comptroller of the Currency (12 CFR Part 3, Appendix A), or in any other applicable capital rules heretofore adopted and issued by any governmental authority), or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Lending Office) with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on such Bank s capital, or on the capital of any corporation controlling such Bank, in each case as a consequence of its obligations hereunder to a level below that which such Bank would have achieved but for such adoption, change or compliance (taking into consideration such Bank s policies with respect to capital adequacy) by an amount reasonably deemed by such Bank to be material, then from time to time, within fifteen (15) days after demand by such Bank (with a copy to the Agent), the Company shall pay to such Bank such additional amount or amounts as will compensate such Bank for such reduction. Section 2. The Competitive Bid Facility;. .c2.Section 2.1. Amount and Term;. The Company may from time to time before the Termination Date request Competitive Bids from the Banks and the Banks may make, at their sole discretion, Bid Loans to the Company on the terms and conditions set forth in this Agreement. Notwithstanding any provision to the contrary contained in this Agreement, (a) the aggregate principal amount of all Bid Loans outstanding hereunder at any time may not exceed $50,000,000, (b) no Bank may make Bid Loans in an aggregate principal amount in excess of the maximum amount of such Bank s Revolving Credit Commitment set forth in Section 1.1(b) of this Agreement, and (c) the aggregate principal amount of all Bid Loans outstanding hereunder at any time together with the aggregate principal amount of all Revolving Credit Loans outstanding under the Revolving Credit shall not exceed the Banks Revolving Credit Commitments from time to time in effect. The Company may request Competitive Bids and the Banks may, in their discretion, make such Competitive Bids on the terms and conditions set forth in this Section 2. .c2.Section 2.2. Competitive Bid Requests;. In order to request Competitive Bids, the Company shall give telephonic notice to be received by the Agent no later than 11:00 A.M., Chicago time, one Business Day before the date, which must be a Business Day, on which a proposed Bid Loan is to be made (the Borrowing Date ), followed on the same day by a duly completed Competitive Bid Request Confirmation in the form of Exhibit N hereto to be received by the Agent not later than 11:30 A.M., Chicago time. Competitive Bid Request Confirmations that do not conform substantially to the format of Exhibit N may be rejected and the Agent shall give telephonic notice to the Company of such rejection promptly after it determines (which determination shall be conclusive) that a Competitive Bid Request Confirmation does not substantially conform to the format of Exhibit N. Competitive Bid Requests shall in each case refer to this Agreement and specify (x) the proposed Borrowing Date (which shall be a Business Day), (y) the aggregate principal amount thereof (which shall not be less than $3,000,000 and shall be an integral multiple of $1,000,000), and (z) up to 3 Interest Periods with respect to the entire amount specified in such Competitive Bid Request (which must be of no less than 30 and no more than 180 days duration and may not end after the Termination Date). Upon receipt by the Agent of a Competitive Bid Request Confirmation which conforms substantially to the format of Exhibit N attached hereto, the Agent shall invite, by telephone promptly confirmed in writing in the form of Exhibit O attached hereto, the Banks to bid, on the terms and conditions of this Agreement, to make Bid Loans pursuant to the Competitive Bid Request. .c2.Section 2.3. Submission of Competitive Bids;. Each Bank may, in its sole discretion, make one or more Competitive Bids to the Company responsive to the Competitive Bid Request. Each Competitive Bid by a Bank must be received by the Agent by telephone not later than 8:45 A.M., Chicago time, on the Borrowing Date, promptly confirmed in writing by a duly completed Confirmation of Competitive Bid substantially in the form of Exhibit P attached hereto to be received by the Agent no later than 9:00 A.M. on the same day; provided, however, that any Competitive Bid made by Harris must be made by telephone to the Company no later than 8:30 A.M., Chicago time, and confirmed by telecopier to the Company no later than 8:45 A.M., Chicago time, on the Borrowing Date. Competitive Bids which do not conform precisely to the terms of this Section 2.3 may be rejected by the Agent and the Agent shall notify the Bank submitting such Competitive Bid of such rejection by telephone as soon as practicable after determining that the Competitive Bid does not conform precisely to the terms of this Section 2.3. Each Competitive Bid shall refer to this Agreement and specify (x) the maximum principal amount (which shall not be less than $3,000,000 and shall be an integral multiple of $1,000,000) of the Bid Loan that the Bank is willing to make to the Company (y) the Yield (which shall be computed on the basis of a 360-day year and actual days elapsed and for a period equal to the Interest Period applicable thereto) at which the Bank is prepared to make the Bid Loan and (z) the Interest Period applicable thereto. The Agent shall reject any Competitive Bid if such Competitive Bid (i) does not specify all of the information specified in the immediately preceding sentence, (ii) contains any qualifying, conditional, or similar language, (iii) proposes terms other than or in addition to those set forth in the Competitive Bid Request to which it responds, or (iv) is received by the Agent later than 8:45 A.M. (Chicago time). Any Competitive Bid submitted by a Bank pursuant to this Section 2.3 shall be irrevocable and shall be promptly confirmed in writing in the form of Exhibit P; provided that in all events the telephone Competitive Bid received by the Agent shall be binding on the relevant Bank and shall not be altered, modified, or in any other manner affected by any inconsistent terms contained in, or terms missing from, the Bank s Confirmation of Competitive Bid. .c2.Section 2.4. Notice of Bids;. The Agent shall give telephonic notice to the Company no later than 9:15 A.M., Chicago time, on the proposed Borrowing Date, of the number of Competitive Bids made, the Yield with respect to each proposed Bid Loan, the Interest Period applicable thereto and the maximum principal amount of each Bid Loan in respect of which a Competitive Bid was made and the identity of the Bank making each bid. The Agent shall send a summary of all Competitive Bids received by the Agent to the Company as soon as practicable after receipt of a Competitive Bid from each Bank that has made a Competitive Bid. .c2.Section 2.5. Acceptance or Rejection of Bids;. The Company may in its sole and absolute discretion, subject only to the provisions of this Section, irrevocably accept or reject, in whole or in part, any Competitive Bid referred to in Section 2.4 above. No later than 9:45 A.M., Chicago time, on the proposed Borrowing Date, the Company shall give telephonic notice to the Agent of whether and to what extent it has decided to accept or reject any or all the Competitive Bids referred to in Section 2.4 above, which notice shall be promptly confirmed in a writing to be received by the Agent on the proposed Borrowing Date; provided, however, that (x) no bid shall be accepted for a Bid Loan in a minimum principal amount of less than $3,000,000, (y) the Company shall accept bids solely on the basis of ascending Yields for each Interest Period, (z) if the Company declines to borrow, or it is restricted by other conditions hereof from borrowing, the maximum principal amount of Bid Loans in respect of which bids at such Yield have been made, then the Company shall accept a pro rata portion of each bid made at the same Yield, based as nearly as possible on the ratio of the maximum aggregate principal amounts of Bid Loans for which each such bid was made (provided that if the available principal amount of Bid Loans to be so allocated is not sufficient to enable Bid Loans to be so allocated to each such Bank in integral multiples of $1,000,000, the Company shall select which Banks will be allocated such Bid Loans and will round allocations up or down to the next higher or lower multiple of $1,000,000 as it shall deem appropriate but in no event shall any Bid Loan be allocated in a principal amount of less than $3,000,000), and (w) the aggregate principal amount of all Competitive Bids accepted by the Company shall not exceed the amount contained in the related Confirmation of Competitive Bid Request. A notice given by the Company pursuant to this Section 2.5 shall be irrevocable and shall not be altered, modified, or in any other manner affected by any inconsistent terms contained in, or terms missing from, any written confirmation of such notice. .c2.Section 2.6. Notice of Acceptance or Rejection of Bid;. The Agent shall promptly (but in any event no later than 10:30 A.M., Chicago time) give telephonic notice to the Banks whether or not their Competitive Bids have been accepted (and if so, in what amount and at what Yield) on the proposed Borrowing Date, and each successful bidder will thereupon become bound, subject to Section 7 and the other applicable conditions hereof, to make the Bid Loan in respect of which its bid has been accepted. Each Bank so bound shall notify the Agent upon making the Bid Loan. As soon as practicable on each Borrowing Date, the Agent shall notify each Bank of the aggregate principal amount of all Bid Loans made pursuant to a Competitive Bid Request on such Borrowing Date, the Interest Period(s) applicable thereto and the highest and lowest Yields at which such Bid Loans were made for each Interest Period. .c2.Section 2.7. Restrictions on Bid Loans;. A Bid Loan shall not be made if an Event of Default or Potential Default shall have occurred and be continuing on the date on which such Bid Loan is to be made and the Company may not obtain more than three Bid Loans in any calendar week. .c2.Section 2.8. Minimum Amount;. Each Bid Loan made to the Company on any date shall be in an integral multiple of $1,000,000 and in a minimum principal amount of $3,000,000. Bid Loans shall be made in the amounts accepted by the Company in accordance with Section 2.5. .c2.Section 2.9. The Notes;. The Bid Loans made by each Bank to the Company shall be evidenced by the Revolving Note of the Company payable to the order of such Bank as described in Section 1.2. The outstanding principal balance of each Bid Loan, as evidenced by a Note, shall be payable at the end of every Interest Period applicable to such Bid Loan. Each Bid Loan evidenced by each Revolving Note shall bear interest from the date such Bid Loan is made on the outstanding principal balance thereof as set forth in Section 2.10 below. .c2.Section 2.10. Term of and Interest on Bid Loans;. Each Bid Loan shall bear interest during the Interest Period applicable thereto at a rate per annum equal to the rate of interest offered in the Competitive Bid therefor submitted by the Bank making such Bid Loan and accepted by the Company pursuant to Section 2.5 above. The principal amount of each Bid Loan, together with all accrued interest thereon, shall be due and payable on the last day of the Interest Period applicable thereto and at maturity (whether by acceleration or otherwise) and, with respect to any Interest Period in excess of three months, interest on the unpaid principal amount shall be due on the date occurring every three months after the date the relevant Bid Loan was made. If any payment of principal or interest on any Bid Loan is not made when due, such Bid Loan shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) from the date such payment was due until paid in full, payable on demand, at a rate per annum equal to the sum of 2.5% plus the rate of interest in effect thereon at the time of such default until the end of the Interest Period then applicable thereto, and, thereafter, at a rate per annum equal to the sum of 2.5 plus the Domestic Rate from time to time in effect. .c2.Section 2.11. Disbursement of Bid Loans;. (a) Subject to the provisions of Section 6 hereof, the proceeds of each Bid Loan shall be made available to the Company by, at the Company s option, crediting an account maintained by the Company at Harris Trust and Savings Bank or by wire transfer of such proceeds to such account as the Company shall designate in writing to the Agent from time to time, in immediately available funds. Not later than 12:00 Noon, Chicago time, on the date specified for any Bid Loan to be made hereunder, each Bank which is bound to make such Bid Loan pursuant to Section 2.6 hereof shall make its portion of such Bid Loan available to the Company in immediately available funds at the principal office of the Agent in Chicago, Illinois. (b) Unless the Agent shall have been notified by a Bank no later than the time the Agent gives such Bank a notice pursuant to Section 2.6 hereof (which notice shall be effective upon receipt) that such Bank does not intend to make the proceeds of such Bid Loan available to the Agent, the Agent may assume that such Bank has made such proceeds available to the Agent on such date and the Agent may in reliance upon such assumption (but shall not be required to) make available to the Company a corresponding amount. If such corresponding amount is not in fact made available to the Agent by such Bank, the Agent shall be entitled to receive such amount on demand from such Bank (or, if such Bank fails to pay such amount forthwith upon such demand, to recover such amount from the Company) together with interest thereon in respect of each day during the period commencing on the date such amount was made available to the Company and ending on the date the Agent recovers such amount, at a rate per annum equal to the effective rate charged to the Agent for overnight Federal funds transactions with member banks of the Federal Reserve System for each day, as determined by the Agent (or, in the case of a day which is not a Business Day, then for the preceding Business Day). Nothing in this Section 2.11(b) shall be deemed to permit any Bank to breach its obligations to make Bid Loans hereunder, or to limit the Company s claims against any Bank for such breach. .c2.Section 2.12. Reliance on Telephonic Notices; Indemnity;. (a) The Company agrees that the Agent may rely on any telephonic notice referred to in this Section 2 and given by any person the Agent reasonably believes is authorized to give such notice without the necessity of independent investigation, and in the event any such telephonic notice conflicts with any written notice relating thereto, or in the event no such written notice is received by the Agent, such telephonic notice shall govern if the Agent or any Bank has acted in reasonable reliance thereon. The Agent s books and records shall be prima facie evidence of all of the matters set forth in Sections 2.2, 2.3, 2.4., 2.5 and 2.6 hereof. (b) The Company hereby agrees to indemnify and hold the Agent harmless from and against any and all claims, damages, losses, liabilities and expenses, including court costs and legal expenses, paid or incurred by the Agent in connection with any action the Agent may take, or fail to take, in reasonable reliance upon and in accordance with any telephonic notice received by the Agent as described in this Section 2. (c) The Banks hereby agree to indemnify and hold the Agent harmless from and against any and all claims, damages, losses, liabilities and expenses, including court costs and legal expenses, paid or incurred by the Agent in connection with any action the Agent may take, or fail to take, in reasonable reliance upon and in accordance with any telephonic notice received by the Agent as described in this Section 2, to the extent the Agent is not promptly reimbursed therefor by the Company. .c2.Section 2.13. Telephonic Notice;. Each Bank s telephonic notice to the Agent of its Competitive Bid pursuant to Section 2.3, and the Company s telephonic acceptance of any offer contained in a Bid pursuant to Section 2.5, shall be irrevocable and binding on such Bank and the Company, as applicable, and shall not be altered, modified, or in any other manner affected by any inconsistent terms contained in, or missing from, any written confirmation of such telephonic notice. It is understood and agreed by the parties hereto that the Agent shall be entitled to act, or to fail to act, hereunder in reliance on its records of any telephonic notices provided for herein and that the Agent shall not incur any liability to any Person in so doing if its records conflict with any written confirmation of a telephone notice or otherwise, provided that any such action taken or omitted by the Agent is taken or omitted reasonably and in good faith. It is further understood and agreed by the parties hereto that each party hereto shall in good faith endeavor to provide the notices specified herein by the times of day as set forth in this Section 2 but that no party shall incur any liability or other responsibility for any failure to provide such notices within the specified times; provided, however, that the Agent shall have no obligation to notify the Company of any Competitive Bid received by it later than 8:45 A.M. (Chicago time) on the proposed Borrowing Date, and no acceptance by the Company of any offer contained in a Competitive Bid shall be effective to bind any Bank to make a Bid Loan, nor shall the Agent be under any obligation to notify any Person of an acceptance, if notice of such acceptance is received by the Agent later than 9:45 A.M. (Chicago time) on the proposed Borrowing Date. 3. Fees, Prepayments, Terminations and Place and Application of Payments. .c2.Section 3.1. Facility Fee;. For the period from the date hereof to and including the Termination Date, the Company shall pay to the Agent for the account of the Banks a facility fee with respect to the Revolving Credit at the rate of three-eighths of one percent (0.375%) per annum if the Company s Leverage Ratio is equal to or greater than 0.45 to 1 and one-quarter of one percent (0.25%) per annum if the Company s Leverage Ratio is less than 0.45 to 1 (in each case computed in each case on the basis of a year of 360 days for the actual number of days elapsed) of the aggregate maximum amount of the Banks Revolving Credit Commitments hereunder in effect from time to time and whether or not any credit is in use under the Revolving Credit, all such fees to be payable quarterly in arrears on the last day of each calendar quarter commencing on the last day of June, 1993, and on the Termination Date, unless the Revolving Credit is terminated in whole on an earlier date, in which event the facility fee for the final period shall be paid on the date of such earlier termination in whole. .c2.Section 3.2. Agent s Fee;. The Company shall pay to and for the sole account of the Agent such fees as may be agreed upon in writing from time to time by the Agent and the Company. Such fees shall be in addition to any fees and charges the Agent may be entitled to receive under Section 10 hereunder or under the other Loan Documents. .c2.Section 3.3. Optional Prepayments;. The Company shall have the privilege of prepaying without premium or penalty and in whole or in part (but if in part, then in a minimum principal amount of $2,500,000 or such greater amount which is an integral multiple of $100,000) any Domestic Rate Loan at any time upon prior telex or telephonic notice to the Agent on or before 12:00 Noon on the same Business Day. The Company may not prepay any Eurodollar Loan, CD Rate Loan or Bid Loan. Any amount prepaid under the Revolving Credit may, subject to the terms and conditions of this Agreement, be borrowed, repaid and borrowed again. .c2.Section 3.4. Mandatory Prepayments - Borrowing Base. The Company shall not permit the sum of the principal amount of all Loans plus the aggregate face amount of all B\/As, the amount available for drawing under all L\/Cs and the aggregate principal amount of all unpaid Reimbursement Obligations at any time outstanding to exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments or (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate. In addition to the Company s obligations to pay any outstanding Reimbursement Obligations as set forth in Section 1.7 hereof, the Company will make such payments on any outstanding Loans and Reimbursement Obligations (and, if any B\/As are then outstanding, deposit an amount equal to the aggregate face amount of all such B\/As into an interest bearing account with the Agent which shall be held as additional collateral security for such B\/As) which are necessary to cure any such excess within three Business Days after the occurrence thereof. Any amount prepaid under the Revolving Credit may, subject to the terms and conditions of this Agreement, be borrowed, prepaid and borrowed again. Section 3.5. Place and Application of Payments. All payments of principal and interest made by the Company in respect of the Notes and Reimbursement Obligations and all fees payable by the Company hereunder, shall be made to the Agent at its office at 111 West Monroe Street, Chicago, Illinois 60690 and in immediately available funds, prior to 12:00 noon on the date of such payment. All such payments shall be made without setoff or counterclaim and without reduction for, and free from, any and all present and future levies, imposts, duties, fees, charges, deductions withholdings, restrictions or conditions of any nature imposed by any government or any political subdivision or taxing authority thereof. Unless the Banks otherwise agree, any payments received after 12:00 noon Chicago time shall be deemed received on the following Business Day. The Agent shall remit to each Bank its proportionate share of each payment of principal, interest and facility fees, B\/A fees and L\/C fees received by the Agent by 3:00 P.M. Chicago time on the same day of its receipt if received by the Agent by 12:00 noon, Chicago time, and its proportionate share of each such payment received by the Agent after 12:00 noon on the Business Day following its receipt by the Agent. In the event the Agent does not remit any amount to any Bank when required by the preceding sentence, the Agent shall pay to such Bank interest on such amount until paid at a rate per annum equal to the Fed Funds Rate. The Company hereby authorizes the Agent to automatically debit its account with Harris for any principal, interest and fees when due under the Notes, the B\/A Agreement, any L\/C Agreement or this Agreement and to transfer the amount so debited from such account to the Agent for application as herein provided. All proceeds of Collateral shall be applied in the manner specified in the Security Agreement. 1.2. Section 4.8 of the Credit Agreement shall be amended to read as follows: 4.8. Applicable Margin shall mean, with respect to each type of Loan and the B\/As described in Column A below, the rate of interest per annum shown in Columns B, C, D and E below for the range of Leverage Ratio specified for each Column:\nA B C D E\nLeverage Ratio 0.45 to 1 .45 to 1 and 0.5 to 1 .50 to 1 and .60 to 1 .60 to 1 and .70 to 1\nEurodollar Loans 0.75% 1.125% 1.375% 1.75% B\/As 0.75% 1.125% 1.375% 1.75% Domestic Rate Loans 0.0% 0.125% 0.375% 0.75% CD Rate Loans 0.875% 1.25% 1.50% 1.875%\nNot later than 5 Business Days after receipt by the Agent of the financial statements called for by Section 7.4 hereof for the applicable fiscal quarter, the Agent shall determine the Leverage Ratio for the applicable period and shall promptly notify the Company and the Banks of such determination and of any change in the Applicable Margins resulting therefrom. Any such change in the Applicable Margins shall be effective as of the date the Agent so notifies the Company and the Banks with respect to all Loans and B\/As outstanding on such date, and such new Applicable Margins shall continue in effect until the effective date of the next quarterly redetermination in accordance with this Section. Each determination of the Leverage Ratio and Applicable Margins by the Agent in accordance with this Section shall be conclusive and binding on the Company and the Banks absent manifest error. From the date hereof until the Applicable Margins are first adjusted pursuant hereto, the Applicable Margins shall be those set forth in column E above. 1.3. Section 4.45 of the Credit Agreement shall be amended to read as follows: 4.45. Intentionally Omitted. 1.4. Section 4.53 of the Credit Agreement shall be amended to read as follows: 4.53. Fixed Rate Loan shall mean a Eurodollar Loan, a CD Rate Loan or a Bid Loan, and Fixed Rate Loans shall mean any one or more of such types of Loans. 1.5. Section 4.61 of the Credit Agreement shall be amended to read as follows: 4.61. Interest Period shall mean with respect to (a) the Eurodollar Loans, the period used for the computation of interest commencing on the date the relevant Eurodollar Loan is made, continued or effected by conversion and concluding on the date one, two, three or six months thereafter and, (b) to the CD Rate Loans, the period used for the computation of interest commencing on the date the relevant CD Rate Loan is made, continued or effected by conversion and concluding on the date 30, 60, 90 or 180 days thereafter, and (c) the Bid Loans, the period used for the computation of interest commencing on the date the relevant Bid Loan is made and ending on the date such Bid Loan is scheduled to mature, but in no event may such period have a duration of less than 30 days or more than 180 days; provided, however, that no Interest Period for any Fixed Rate Loan may extend beyond the Termination Date. For purposes of determining an Interest Period applicable to a Eurodollar Loan, a month means a period starting on one day in a calendar month and ending on a numerically corresponding day in the next calendar month; provided, however, that if there is no numerically corresponding day in the month in which an Interest Period is to end or if an Interest Period begins on the last day of a calendar month, then such Interest Period shall end on the last Banking Day of the calendar month in which such Interest Period is to end. 1.6. Section 4.69 of the Credit Agreement shall be amended to read as follows: 4.69. Loan shall mean a Revolving Credit Loan as a Bid Loan, and Loans shall mean any two or more Revolving Credit Loans and\/or Bid Loans. 1.7. The Credit Agreement shall be amended by adding the following provisions after Section 4.103 as Section 4.104, 4.105 and 4.106 of the Credit Agreement: 4.104. Bid Loan shall mean an advance from a Bank to the Company pursuant to the binding procedures described in Section 2 hereof. 4.105. Competitive Bid shall mean an offer by a Bank to make a Bid Loan pursuant to Section 2 hereof. 4.106. Competitive Bid Request shall mean a request made by the Company pursuant to Section 2.2 hereof. 1.8. Section 7.4(b) of the Credit Agreement shall be amended to read as follows: (b) as soon as available, and in any event within 90 days after the close of each fiscal year, a copy of the audit report for such year and accompanying financial statements, including a consolidated balance sheet, a statement of income and retained earnings, and a statement of cash flows, together with all footnotes thereto, for the Company and its Subsidiaries, and unaudited consolidating balance sheets, statement of income and retained earnings and statements of cash flows for the Company and its Subsidiaries, in each case, showing in comparative form the figures for the previous fiscal year of the company, all in reasonable detail, accompanied by an unqualified opinion of Ernst & Young or other independent public accountants of nationally recognized standing selected by the Company and satisfactory to the Required Banks, such opinion to indicate that such statements are made in accordance with generally accepted accounting principles; . 1.9. Sections 7.4(d) and (e) shall each be amended by replacing the phrase 10 Business Days appearing in the first lines thereof with the phrase 30 days . 1.10. Section 7.4(f) of the Credit Agreement shall be amended by deleting the phrase by month appearing in the least line thereof. 1.11. Section 7.4(i) of the Credit Agreement shall be amended to read as follows: (i) within 90 days of the last day of each Fiscal Year of the Company, a summary of the capital expenditures made or incurred by the Company and its Subsidiaries during such Fiscal Year, all in reasonable detail, prepared by the Company and certified on behalf of the Company by the Company s chief financial officer. 1.12. Section 7.6 of the Credit Agreement shall be amended to read as follows: .c2. Section 7.6. Consolidation and Merger;. The Company will not, and will not permit any Subsidiary to, consolidate with or merge into any Person, or permit any other Person to merge into it, or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the Property of the other Person, or acquire substantially as an entirety the business of any other Person, without the prior written consent of the Required Banks; provided, however, that if no Potential Default or Event of Default shall have occurred and be continuing the Company may acquire all or substantially all the Property of the other Person, or acquire substantially as an entirety the business of any other Person if the aggregate fair market value of all consideration paid or payable by the Company in all such acquisitions made in any Fiscal Year does not exceed $10,000,000. 1.13. Sections 7.8 and 7.9 of the Credit Agreement shall be amended to read as follows: .c2. Section 7.8. Leverage Ratio;. The Company will not permit the ratio of its Leverage Ratio at any time during each period specified below to exceed the ratio specified below for such period: (a) from the date hereof through the next to last day in Fiscal Year of 1994, 0.65 to 1; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, 0.65 to 1; (c) from the last day of Fiscal Year 1995 through the next to last day of Fiscal Year 1996, 0.625 to 1; and (d) on the last day of Fiscal Year 1996 and thereafter, 0.60 to 1. .c2.Section 7.9. Tangible Net Worth;. The Company shall maintain its Tangible Net Worth at all times during the periods specified below in an amount not less than the minimum required amount for each period set forth below: (a) from the last day of Fiscal Year 1993 through the next to last day in Fiscal Year 1994, $109,780,000; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, $109,780,000 plus an amount equal to 75% of the Company s Net Income (but not less than zero) for Fiscal Year 1994, if the Company s Leverage Ratio for such Fiscal Year is equal to or greater than 0.5 to 1, or 50% of the Company s Net Income (but not less than zero) if the Company s Leverage Ratio for such Fiscal Year is less than 0.5 to 1; and (c) from the last day of Fiscal Year 1995 and at all times during each Fiscal Year thereafter, an amount in any Fiscal Year equal to the minimum amount required to be maintained during the preceding Fiscal Year plus an amount equal to 75% of the Company s Net Income (but not less than zero) during such Fiscal Year 1994, if the Company s Leverage Ratio for such Fiscal Year is equal to or greater than 0.5 to 1, or 50% of the Company s Net Income (but not less than zero) if the Company s Leverage Ratio for such Fiscal Year is less than 0.5 to 1. 1.14. Sections 7.13 and 7.14 of the Credit Agreement shall be amended to read as follows: .c2. Section 7.13. Minimum Net Working Capital;. The Company will maintain Net Working Capital at all times during each period specified below (measured as of the last day of each monthly fiscal accounting period) in an amount not less than the amount specified below for each period: (a) from the date hereof through the last day in Fiscal Year 1996, $65,000,000; and (b) from the first day of Fiscal Year 1997 and at all times thereafter, $70,000,000. .c2.Section 7.14. Capital Expenditures;. The Company will not, and will not permit any Subsidiary to, make or commit to make any capital expenditures (as defined and classified in accordance with generally accepted accounting principles consistently applied;) provided, however, that if no Event of Default or Potential Default shall exist before and after giving effect thereto, the Company and its Subsidiaries may make capital expenditures (a) during Fiscal Year 1994, in an amount not to exceed an amount equal to 115% of the Company s depreciation and amortization charges for Fiscal Year 1993, and (b) during each Fiscal Year thereafter, in an aggregate amount in each Fiscal Year commencing with Fiscal Year 1995 not to exceed the sum of (i) an amount equal to 115% of the Company s depreciation and amortization charges for the preceding Fiscal Year and (ii) the amount, if any, by which such capital expenditures made by the Company in the immediately preceding Fiscal Year was less than the maximum amount of capital expenditures the Company was permitted to make under this Section 7.14 during such Fiscal Year, determined without regard to any carryover amount from any prior Fiscal Year, but not to exceed $5,000,000 in any Fiscal Year. 1.15. Section 7.16 of the Credit Agreement shall be amended by deleting the word and appearing after the semicolon appearing in the last line of subsection 7.16(n), by replacing the period at the end of Subsection 7.16(o) with the phrase ; and , and by adding the following provision after subsection 7.16(o) as subsection 7.16(p) of the Credit Agreement: (p) liens, mortgages and security interests in the Company s real estate, buildings, machinery and equipment securing indebtedness permitted only by subsection 7.17(l) of this Agreement. 1.16. Section 7.17 of the Credit Agreement shall be amended by deleting the word and appearing after the semicolon in the last line of subsection 7.17(j), by replacing the period at the end of subsection 7.17(k) with a semicolon, and by adding the following provisions after subsection 7.17(k) as subsections 7.17(l) and (m) of the Credit Agreement. (l) Funded Debt incurred to finance capital expenditures permitted by Section 7.14 hereof, provided the aggregate principal amount of all such Funded Debt incurred during the term of this Agreement does not exceed an amount equal to 50% of the amount of all such capital expenditures actually made through any date of determination; and (m) unsecured indebtedness in an aggregate principal amount not to exceed $20,000,000 outstanding at any time incurred to finance the Company s working capital needs. 1.17. Section 7.22 of the Credit Agreement shall be amended by replacing the phrase to finance its temporary working capital requirements with the phrase for its general corporate purposes . 1.18. Section 7.29 of the Credit Agreement shall be amended to read as follows: Section 7.29. New Subsidiaries. The Company will not, directly or indirectly, create or acquire any Subsidiary unless (a) after giving effect to any such creation or acquisition, the total assets (determined in accordance with generally accepted accounting principles, consistently applied) of all such Subsidiaries would not exceed 5% of the Total Assets of the Company and its Subsidiaries, and (b) all Inventory and Receivables of such Subsidiaries are pledged to the Agent for the benefit of the Banks pursuant to a security agreement substantially identical to the Security Agreement. 1.19. Section 7.30 of the Credit Agreement shall be amended by adding the following sentence after the last sentence thereof: For purposes of this Section 7.30, any Guaranty Fees paid within 45 days after the last day of any Fiscal Year shall be deemed to have been paid during such Fiscal Year. 1.20. Section 7.32(b) of the Credit Agreement shall be amended by replacing the phrase during the term of this Agreement with the phrase in any Fiscal Year. 1.21. Section 8.1(g) shall be amended by replacing the figure $1,000,000 appearing therein with the figure $2,000,000 . 1.22. All reference to the Revolving Notes , Revolving Note , Notes and Note contained in the Credit Agreement and the other Loan Documents shall be deemed to be references to the Secured Revolving Credit Notes executed and delivered by the Company in satisfaction of Section 2.6(a) of this Amendment. 2. Conditions Precedent. The effectiveness of the Amendment is subject to the satisfaction of all of the following conditions precedent: 2.1. The Company and each of the Banks shall have executed this Amendment (such execution may be in several counterparts and the several parties hereto may execute on separate counterparts). 2.2. Mr. and Mrs. Lonnie A. Pilgrim shall have executed and delivered to the Banks the Guarantors Consent in the form set forth below. 2.3. Each of the representations and warranties set forth in Section 5 of the Credit Agreement shall be true and correct. 2.4. The Company shall be in full compliance with all of the terms and conditions of the Credit Agreement and no Event of Default or Potential Default shall have occurred and be continuing thereunder or shall result after giving effect to this Amendment. 2.5. All legal matters incident to the execution and delivery hereof and the instruments and documents contemplated hereby shall be satisfactory to the Banks. 2.6. The Agent shall have received (in sufficient counterparts for distribution to each of the Banks) all of the following in a form satisfactory to the Agent, the Banks and their respective counsel: (a) a Security Revolving Credit Note of the Company payable to the order of each of the Banks in the principal amount equal to each Banks Revolving Credit Commitment, in the form attached hereto as Exhibit A; (b) copies (executed or certified as may be appropriate) of all legal documents or proceedings taken in connection with the execution and delivery of this Amendment, and the other instruments and documents contemplated hereby; and (c) Opinion of counsel to the Company substantially in a form as set forth in Exhibit B hereto and satisfactory to the Agent, the Banks and their respective counsel. 2.7. Harris shall have received a written consent from CoBank with respect to this Amendment and an amendment to the CoBank Participation Agreement in form and substance satisfactory to Harris and CoBank. 2.8. The Agent shall have received for the ratable benefit of the Banks an amendment fee in an amount equal to one-eighth of one percent (0.125%) of the maximum amount of the Revolving Credit. Section 3. Representations And Warranties. Section 3.1. The Company, by its execution of this Amendment, hereby represents and warrants the following: (a) each of the representations and warranties set forth in Section 5 of the Credit Agreement is true and correct as of the date hereof, except that the representations and warranties made under Section 5.3 shall be deemed to refer to the most recent annual report furnished to the Banks by the Company; and (b) the Company is in full compliance with all of the terms and conditions of the Credit Agreement and no Event of Default or Potential Default has occurred and is continuing thereunder. 4. Miscellaneous. 4.1. The Company has heretofore executed and delivered to the Agent that certain Security Agreement Re: Accounts Receivable, Farm Products and Inventory dated as of May 27, 1993 (the Security Agreement ) and the Company hereby agrees that the Security Agreement shall secure all of the Company s indebtedness, obligations and liabilities to the Agent and the Banks under the Credit Agreement as amended by this Amendment, that notwithstanding the execution and delivery of this Amendment, the Security Agreement shall be and remain in full force and effect and that any rights and remedies of the Agent thereunder, obligations of the Company thereunder and any liens or security interests created or provided for thereunder shall be and remain in full force and effect and shall not be affected, impaired or discharged thereby. Nothing herein contained shall in any manner affect or impair the priority of the liens and security interests created and provided for by the Security Agreement as to the indebtedness which would be secured thereby prior to giving effect to this Amendment. 4.2. Except as specifically amended herein the Credit Agreement and the Notes shall continue in full force and effect in accordance with their original terms. Reference to this specific Amendment need not be made in any note, document, letter, certificate, the Credit Agreement itself, the Notes, or any communication issued or made pursuant to or with respect to the Credit Agreement or the Notes, any reference to the Credit Agreement or Notes being sufficient to refer to the Credit Agreement or the Notes as amended hereby. 4.3. The Company agrees to pay all out-of-pocket costs and expenses incurred by the Agent and Banks in connection with the preparation, execution and delivery of this Amendment and the documents and transactions contemplated hereby, including the fees and expenses of Messrs. Chapman and Cutler. 4.4. This Amendment may be executed in any number of counterparts, and by the different parties on different counterparts, all of which taken together shall constitute one and the same Agreement. Any of the parties hereto may execute this Amendment by signing any such counterpart and each of such counterparts shall for all purposes be deemed to be an original. 4.5. (a) This Amendment and the rights and duties of the parties hereto, shall be construed and determined in accordance with the internal laws of the State of Illinois, except to the extent provided in Section 4.5(b) hereof and to the extent that the Federal laws of the United States of America may otherwise apply. (b) Notwithstanding anything in Section 4.5(a) hereof to the contrary, nothing in this Amendment, the Credit Agreement, the Notes, or the Other Loan Documents shall be deemed to constitute a waiver of any rights which the Company, the Agent or any of the Banks may have under the National Bank Act or other applicable Federal law.\nDated as of December 6, 1994. Pilgrim s Pride Corporation By Lonnie A. Pilgrim Its Chief Executive Officer\nAccepted and Agreed to as of the day and year last above written.\nHarris Trust And Savings Bank individually and as Agent By Carl A. Blackham Its Vice President\nFBS Ag Credit, Inc. By Douglas S. Hoffner Its Vice President\nInternationale Nederlanden (U.S.) Capital Corporation, formerly known as Internationale Nederlanden Bank N. V. By \/s Its Vice President\nBoatmen s First National Bank of Kansas City By Randall J. Anderson Its Vice President\nFirst Interstate Bank of Texas, N.A. By \/s Its Vice President Guarantors Consent The undersigned, Lonnie A. Pilgrim and Patty R. Pilgrim, have executed and delivered a Guaranty Agreement dated as of May 27, 1993 (the Guaranty ) to the Banks. As an additional inducement to and in consideration of the Banks acceptance of the foregoing Amendment, the undersigned hereby agree with the Banks as follows: 1. Each of the undersigned consents to the execution of the foregoing Amendment by the Company and acknowledges that this consent is not required under the terms of the Guaranty and that the execution hereof by the undersigned shall not be construed to require the Banks to obtain the undersigneds consent to any future amendment, modification or waiver of any term of the Credit Agreement except as otherwise provided in said Guaranty. Each of the undersigned hereby agrees that the Guaranty shall apply to all indebtedness, obligations and liabilities of the Company to the Banks, the Agent and under the Credit Agreement, as amended pursuant to the foregoing Amendment. Each of the undersigned further agrees that the Guaranty shall be and remain in full force and effect. 2. All terms used herein shall have the same meaning as in the foregoing Amendment, unless otherwise expressly defined herein. Dated as of December 6, 1994.\nLonnie A. Pilgrim\nPatty R. Pilgrim\nAMENDED AND RESTATED LOAN AND SECURITY AGREEMENT\nDated July 29, 1994,\nbetween\nPILGRIM'S PRIDE CORPORATION, as Borrower,\nTHE BANKS PARTY HERETO, and\nCREDITANSTALT-BANKVEREIN, as Agent\nAGREEMENT\nTHIS AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT (the \"Agreement\") is made and entered into the 29th day of July, 1994, by and among PILGRIM'S PRIDE CORPORATION, a Delaware corporation (hereinafter referred to as \"Borrower\"), each of the Banks signatory hereto (hereinafter referred to individually as a \"Bank\" and collectively as the \"Banks\"), and CREDITANSTALT-BANKVEREIN, as agent for the Banks (in such capacity, together with its successors and assigns in such capacity, hereinafter referred to as the \"Agent\");\nW I T N E S S E T H:\nWHEREAS, Borrower, the Banks and the Agent are parties to that certain Loan and Security Agreement, dated as of June 3, 1993 (the \"Original Loan Agreement\"), which currently provides for a term loan (the \"Existing Facility\") in the original principal amount of Twenty-Eight Million Dollars ($28,000,000.00); and\nWHEREAS, the Borrower, the Banks and the Agent wish to amend the Loan Agreement (a) to continue the Existing Facility at its current outstanding balance of $21,700,000.00; (b) to make a standby\/term loan to borrower to be utilized on or before June 20, 1995; and (c) to make certain other changes as more fully set forth herein;\nWHEREAS, for the sake of convenience, Borrower, the Banks and the Agent desire to restate in its entirety the Original Loan Agreement;\nWHEREAS, this Agreement represents a continuation of the Existing Facility, as amended hereby, and not a replacement of the Existing Facility;\nNOW, THEREFORE, in consideration of the foregoing premises, to induce the Banks to extend the financing provided for herein, and for other good and valuable consideration, the sufficiency and receipt of all of which are acknowledged by Borrower, Borrower, the Banks and Agent agree as follows:\n1. DEFINITIONS, TERMS AND REFERENCES\n1.1 Certain Definitions. When used herein, the following terms shall have the following meanings:\n\"Affiliate\" shall mean, as to any Person, any other Person which, directly or indirectly, owns or controls, on an aggregate basis, including all beneficial ownership and ownership or control as a trustee, guardian or other fiduciary, at least ten percent (10%) of the outstanding shares of capital stock having ordinary voting power to elect a majority of the board of directors (irrespective of whether, at the time, stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) of such Person; or which controls, is controlled by or is under common control with such Person. For the purposes of this definition, \"control\" means the possession, directly or indirectly, of the power to direct or cause the direction of management and policies, whether through the ownership of voting securities, by contract or otherwise.\n\"Agreement\" shall mean this Amended and Restated Loan and Security Agreement, as amended or supplemented from time to time.\n\"Applicable Law\" shall mean all provisions of statutes, rules, regulations and orders of any Federal, state, municipal or other governmental department, commission, board, bureau, agency or instrumentality or any court, in each case, whether of the United States or foreign, applicable to a Person, and all orders and decrees of all courts and arbitrators in proceedings or actions in which the Person in question is a party.\n\"Assignee\" shall mean any bank or other entity to which a Bank assigns all or any part of any Loan pursuant to Section 13.4(c) and \"Assignees\" shall mean, collectively, all banks and other entities to which any Bank assigns all or any part of any Loan pursuant to Section 13.4(c) hereof.\n\"Bankruptcy Code\" shall mean the Bankruptcy Reform Act of 1978, as may be amended from time to time.\n\"Base Rate\" shall mean an interest rate per annum, fluctuating daily, equal to the higher of (a) the rate announced by Creditanstalt from time to time at its principal office in New York, New York, as its prime rate for domestic (United States) commercial loans in effect on such day; and (b) the Federal Funds Rate in effect on such day plus one-half percent (1\/2%). (Such Base Rate is not necessarily intended to be the lowest rate of interest charged by Creditanstalt in connection with extensions of credit.) Each change in the Base Rate shall result in a corresponding change in the interest rate hereunder with respect to a Base Rate Loan and such change shall be effective on the effective date of such change in the Base Rate.\n\"Base Rate Loan\" shall mean a Loan bearing interest at a rate based on the Base Rate.\n\"Business Day\" shall mean any day for dealings by and between banks in U.S. dollar deposits in the interbank Eurodollar market in New York City, New York, and London, England, other than a Saturday, Sunday or any day which shall be in London, England or New York City, New York or Atlanta, Georgia, a legal holiday or a day on which banking institutions are authorized by law to close.\n\"Capital Lease\" shall mean, as to any Person, any lease of (or other agreement conveying the right to use) real and\/or personal property which is required to be classified and accounted for as a capital lease on a balance sheet of such Person under GAAP (including Statement of Financial Accounting Standards No. 13 of the Financial Accounting Standards Board).\n\"Closing Date\" shall mean the date that this Agreement has been signed by Borrower, the Banks and the Agent and has become effective in accordance with Section 11 hereof.\n\"Code\" shall mean the Internal Revenue Code of 1986, as amended, and the rules and regulations promulgated thereunder from time to time.\n\"Collateral\" shall mean the property of Borrower described in Section 4.1, or any part thereof, as the context shall require, in which Agent has, or is to have, a Lien pursuant thereto, as security for payment of the Obligations.\n\"Commitment\" shall mean the aggregate obligation of the Banks to make Standby\/Term Loans to Borrower, subject to the terms and conditions hereof, up to an aggregate principal amount at any one time outstanding as to all the Banks equal to Ten Million Dollars ($10,000,000), subject to reduction as set forth in Section 2.7 hereof.\n\"Continue\", \"Continuation\" and \"Continued\" shall refer to the continuation pursuant to Section 3.4 hereof as a Eurodollar Loan from one Interest Period to the next Interest Period.\n\"Convert\", \"Conversion\" and \"Converted\" shall refer to a conversion pursuant to Section 3.4 hereof of a Base Rate Loan into a Eurodollar Loan or of a Eurodollar Loan into a Base Rate Loan.\n\"Creditanstalt\" shall mean Creditanstalt-Bankverein, an Austrian banking corporation, and its successors and assigns.\n\"Current Assets\" of any Person shall mean the aggregate amount of assets of such Person which in accordance with GAAP may be property classified as current assets after deducting adequate reserves where proper.\n\"Current Liabilities\" shall mean all items (including taxes accrued as estimated) which in accordance with GAAP may be properly classified as current liabilities, including in any event all amounts outstanding from time to time under this Agreement, but excluding any current liability under the Working Capital Credit Agreement.\n\"Current Ratio\" shall mean the ratio of Current Assets to Current Liabilities of the Borrower and its Subsidiaries.\n\"Deed of Trust\" shall mean the Deed of Trust, Assignment of Rents and Security Agreement dated June __, 1993, filed for record June 3, 1993, recorded in Volume 775, page 1, Titus County, Texas Deed Records, executed by Borrower, conveying the Mortgaged Property to secure the repayment of the Loans and performance of the Obligations, and all amendments thereto, recorded or to be recorded in the Titus County, Texas Deed Records, including, without limitation, that certain First Amendment to Deed of Trust, Assignment of Rents and Security Agreement dated of even date herewith, recorded or to be recorded in the Titus County, Texas Deed Records.\n\"Default\" shall mean the occurrence of any event or condition which, after satisfaction of any requirement for the giving of notice or the lapse of time, or both, would become an Event of Default.\n\"Default Rate\" shall mean (a) with respect to the unpaid portion of any Loan, an interest rate per annum equal to two percent (2%) above the interest rate set forth for such Loan in Section 3.1(a) hereof or (b) with respect to any portion of the Obligations other than Loans, two percent (2%) above the rate set forth in Section 3.1(a)(ii) hereof.\n\"Equipment\" shall mean all of Borrower's equipment, as such term is defined in Section 9-109(2) of the UCC, now or hereafter located on or based at the Land, whether now owned or existing or hereafter acquired or manufactured and whether or not subsequently removed from the Land, including, but not limited to, all equipment described in or covered by that certain Appraisal of Broiler Processing and Related Facilities in Mt. Pleasant, Texas, dated as of April 30, 1993, prepared for Borrower by Bob G. Derryberry, ARA, ASA, together with any and all accessories, accessions, parts and appurtenances thereto, replacements thereof and substitutions therefor.\n\"ERISA\" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time, and all rules and regulations from time to time promulgated thereunder.\n\"ERISA Affiliate\" shall mean each trade or business (whether or not incorporated) which, together with Borrower, is treated as a single employer under Section 414(b), (c), (m) or (o) of the Code.\n\"Eurodollar Loan\" shall mean a Loan bearing interest at a rate based on a Quoted Rate.\n\"Event of Default\" shall mean any of the events or conditions described in Article 9 hereof.\n\"Federal Funds Rate\" shall mean, for any day, the overnight federal funds rate in New York City, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) in the Federal Reserve Statistical Release H.15 (519) or any successor publication, or if such rate is not so published for any day which is a Business Day, the average of the quotations for such day on overnight federal funds transactions in New York City received by Agent from three federal funds brokers of recognized standing selected by Agent.\n\"Fiscal Year\" shall mean, for any year, the 52 or 53 week period ending on the Saturday closest to September 30 of such year, regardless of whether such Saturday occurs in September or October of such year.\n\"Fixed Charge Coverage Ratio\" shall mean, for any fiscal period, the ratio of (a) the sum of (i) net income before income taxes for such fiscal period plus (ii) interest expense for such fiscal period plus (iii) depreciation and amortization for financial reporting purposes for such fiscal period plus (iv) the aggregate amount payable during such fiscal period under Operating Leases to (b) the sum of (i) interest expense for such fiscal period plus (ii) current maturities for long term debt plus (iii) the aggregate amount payable during such fiscal period under Operating Leases, in each case calculated for Borrower and its Subsidiaries on a consolidated basis in accordance with GAAP.\n\"Funded Debt\" shall mean, collectively, (a) the aggregate principal amount of Indebtedness for borrowed money which would, in accordance with GAAP, be classified as long-term debt, together with the current maturities thereof; (b) all Indebtedness outstanding under any revolving credit, line of credit or similar agreement providing for borrowings (and any extensions or renewals thereof), notwithstanding that any such Indebtedness is created within one year of the expiration of such agreement; (c) the principal component of obligations under Capital Lease; and (d) any other Indebtedness bearing interest or carrying a similar payment requirement (including any Indebtedness issued at a discount to its face amount), calculated in all case for Borrower and its Subsidiaries on a consolidated basis in accordance with GAAP.\n\"GAAP\" shall mean generally accepted accounting principles consistently applied and maintained throughout the period indicated and consistent with the prior financial practice of Borrower and any of its predecessors, as reflected in the financial information referred to in Section 5.11 hereof.\n\"Indebtedness\" shall mean, as applied to any Person at any time, (a) all indebtedness, obligations or other liabilities of such Person (i) for borrowed money or evidenced by debt securities, debentures, acceptances, notes or other similar instruments, and any accrued interest, fees and charges relating thereto; (ii) under profit payment agreements or similar agreement; (iii) with respect to letters of credit issued for such Person's account; (iv) to pay the deferred purchase price of property or services, except unsecured accounts payable and accrued expenses arising in the ordinary course of business; or (v) in respect of Capital Leases; (b) all indebtedness, obligations or other liabilities of such Person or others secured by a Lien on any property of such Person, whether or not such indebtedness, obligations or liabilities are assumed by such Person, all as of such time; (c) all indebtedness, obligations or other liabilities of such Person in respect of any foreign exchange contract, interest rate protection agreement, interest rate future, interest rate option, interest rate swap, interest rate cap or other interest rate hedge arrangement, net of liabilities owed to such Person by the counterparties thereon; (d) all preferred stock subject (upon the occurrence of any contingency or otherwise) to mandatory redemption; (e) Indebtedness of others guaranteed by such Person.\n\"Intangible Assets\" shall mean license agreements, trademarks, trade names, patents, capitalized research and development, proprietary products (the results of past research and development treated as long term assets and excluded from Inventory) and goodwill (all determined on a consolidated basis in accordance with GAAP).\n\"Interest Period\" shall mean, in connection with any Eurodollar Loan, the period beginning on the date such Eurodollar Loan is made and continuing for one, two, three or six months as selected by Borrower in its notice of Conversion or Continuation. Notwithstanding the foregoing, however, (a) any applicable Interest Period which would otherwise end on a day which is not a Business Day shall be extended to the next succeeding Business Day unless such Business Day falls in another calendar month, in which case such Interest Period shall end on the immediately preceding Business Day, (b) with respect to Eurodollar Loans, any applicable Interest Period which begins on a day for which there is no numerically corresponding day in the calendar month during which such Interest Period is to end shall (subject to clause (a) above) end on the last day of such calendar month, and (c) no Interest Period shall extend beyond any date as would interfere with the repayment obligations of Borrower hereunder.\n\"Land\" shall mean the real estate or interest therein described in Exhibit \"A\" attached hereto and incorporated herein by this reference, all fixtures or other improvements situated thereon and all rights, titles and interests appurtenant thereto.\n\"Leases\" shall mean any and all leases, subleases, licenses, concessions or other agreements (written or oral, now or hereafter in effect), whether an Operating Lease or a Capital Lease, which grant a possessory interest in and to, together with and all security and other deposits made in connection therewith and all other agreements, such as architect's contracts, engineer's contracts, utility contracts, maintenance agreements and service contracts, which in any way relate to the design, use, occupancy, operation, maintenance, enjoyment or ownership of the Equipment or the Mortgaged Property.\n\"Leverage Ratio\" shall mean, on any date, the ratio of (a) Funded Debt, as of such date, to (b) the sum of (i) Net Worth as of such date, and (ii) Funded Debt, as of such date, in each case computed for the Borrower and its Subsidiaries on a consolidated basis in accordance with GAAP.\n\"Lien\" means any mortgage, deed of trust, deed to secure debt, pledge, hypothecation, assignment for security, security interest, encumbrance, lien or charge of any kind, whether voluntarily incurred or arising by operation of law, by statute, by contract, or otherwise, affecting any property, in cluding any agreement to grant any of the foregoing, any conditional sale or other title retention agreement, any lease in the nature of a security interest, and\/or the filing of or agreement to give any financing statement (other than a precautionary financing statement with respect to a lease that is not in the nature of a security interest) under the UCC or comparable law of any jurisdiction with respect to any property.\n\"Loan\" shall mean either a Term Loan or a Standby\/Term Loan, and \"Loans\" shall mean, collectively, all Term Loans and Standby\/Term Loans. Loans may be either Eurodollar Loans or Base Rate Loans, each of which is a \"type\" of Loan.\n\"Loan Documents\" shall mean this Agreement, the Deed of Trust, the Second Deed of Trust, the Notes, any financing statements covering portions of the Collateral and any and all other instruments, documents, and agreements now or hereafter executed and\/or delivered by Borrower or its Subsidiaries in connection herewith, or any one, more, or all of the foregoing, as the context shall require, and \"Loan Document\" shall mean any one of the Loan Documents.\n\"Loan Percentage\" shall mean, as to each Bank, that amount, expressed as a percentage, equal to the ratio of the outstanding principal amount of such Bank's Loans to the aggregate outstanding principal amount of the Loans, or, if no Loans are outstanding, the ratio of the amount set forth opposite the name of such Bank on the signature pages hereto under the heading \"Commitment\" to the aggregate amount of the Commitment; provided that the Loan Percentage of each Bank shall be increased or decreased, as appropriate, to reflect any assignments made pursuant to Sections 13.4, 13.4(c) hereof.\n\"Majority Banks\" shall mean, at any time, Banks holding at least sixty-seven percent (67%) of the aggregate outstanding principal amount of the Loans.\n\"Material Adverse Effect\" shall mean any event or condition which, alone or when taken with other events or conditions occurring or existing concurrently therewith (a) has or is reasonably expected to have a material adverse effect on the business, operations, condition (financial or otherwise), assets, liabilities, properties or prospects of Borrower or any of its Subsidiaries or of the industry in which Borrower operates; (b) has or is reasonably expected to have any material adverse effect whatsoever on the validity or enforceability of this Agreement, the Deed of Trust or any other Loan Document; (c) materially impairs or is reasonably expected to materially impair either the ability of Borrower to pay and perform the Obligations; (d) materially impairs or is reasonably expected to materially impair the ability of the Banks to enforce their rights and remedies under this Agreement and the Loan Documents; or (e) has or is reasonably expected to have any material adverse effect on the Collateral, the Liens of the Banks in the Collateral or the priority of such Liens.\n\"Maturity Date\" shall mean June 30, 2000.\n\"Mortgaged Property\" shall mean the Land, Leases, Equipment and all other property (real, personal or mixed) which is conveyed by the Deed of Trust, the Second Deed of Trust or any other Loan Document in which a Lien is therein created and all other property (real, personal or mixed) on which a Lien is placed or granted to secure the repayment or the performance of the Obligations.\n\"MPPAA\" shall mean the Multiemployer Pension Plan Amendments Act of 1980, amending Title IV of ERISA.\n\"Multiemployer Plan\" shall have the same meaning as set forth in Section 4001(a)(3) of ERISA.\n\"Net Worth\" shall mean the excess of Borrower's total assets over Total Liabilities, excluding, however, from the definition of assets the amount of (a) any write-up in the book value of any asset resulting from a revaluation thereof subsequent to the later to occur of (i) the Closing Date and (ii) the date Borrower acquired such asset; (b) treasury stock; (c) receivables from Affiliates of Borrower; and (d) unamortized original issue debt discount, all determined on a consolidated basis for Borrower and its Subsidiaries in accordance with GAAP.\n\"Notes\" shall mean, collectively, the Term Notes and the Standby\/Term Notes.\n\"Obligations\" shall mean the Loans and any and all other indebtedness, liabilities and obligations of Borrower and its Subsidiaries, or any of them, to any Bank of every kind and nature (including, without limitation, interest, charges, expenses, attorneys' fees and other sums chargeable to Borrower by Agent or any Bank and future advances made to or for the benefit of Borrower), arising under this Agreement, the Deed of Trust or the other Loan Documents, whether direct or indirect, absolute or contingent, primary or secondary, due or to become due, now existing or hereafter acquired.\n\"Operating Leases\" shall mean all leases of (or other agreements, conveying the right to use) real and\/or personal property (other than short term leases which are cancellable at any time by the lessee) which are not required to be classified and accounted for as capital leases on a balance sheet under GAAP (including Statement of Financial Accounting Standards No. 13 of the Financial Accounting Standards Board) and \"Operating Lease\" shall mean any one of the Operating Leases.\n\"Participant\" shall mean any bank or other entity to which a Bank sells a participating interest in any Loan or Loans pursuant to Section 13.4(b) hereof and \"Participants\" shall mean, collectively, all banks or other entities to which any Bank sells a participating interest in any Loan or Loans pursuant to Section 13.4(b) hereof.\n\"PBGC\" shall mean the Pension Benefit Guaranty Corporation established under ERISA.\n\"Permitted Liens\" shall mean: (a) Liens existing on the date hereof with respect to the Mortgaged Property and which the Agent and the Banks permit to be listed on Schedule B of the Title Insurance; (b) Liens in favor of Agent; (c) the interest of lessors under Operating Leases permitted hereunder; (d) Liens for (i) property taxes not delinquent, (ii) taxes not yet due, (iii) pledges or deposits made under Workmen's Compensation, Unemployment Insurance, Social Security and similar legislation, or in connection with appeal or surety bonds incident to litigation, or to secure statutory obligations, and (iv) mechanics' and materialmen's Liens with respect to liabilities which are not yet due or which are being contested in good faith and not listed on Schedule B of the Title Insurance; and (e) purchase money Liens on Equipment; provided, however, that (i) such Lien is created within 120 days of the acquisition of such Equipment; (ii) such Lien attaches only to the specific items of Equipment so acquired; (iii) such Lien secures only the Indebtedness incurred to acquire such Equipment; and (iv) the aggregate principal amount of Indebtedness secured by such Liens does not exceed $10,000,000 at any one time outstanding.\n\"Person\" shall mean and include any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, institution, entity, party or government (whether national, federal, state, county, city, municipal, or otherwise, including, without limitation, any instrumentality, division, agency, body or department thereof).\n\"Plan\" shall mean any employee benefit plan, program, arrangement, practice or contract, maintained by or on behalf of the Borrower or an ERISA Affiliate, which provides benefits or compensation to or on behalf of employees or former employees, whether formal or informal, whether or not written, including but not limited to the following types of plans:\n(i) Executive Arrangements - any bonus, incentive compensation, stock option, deferred compensation, commission, severance, \"golden parachute,\" \"rabbi trust,\" or other executive compensation plan, program, contract, arrangement or practice (\"Executive Arrangements\");\n(ii) ERISA Plans - any \"employee benefit plan\", except any Multiemployer Plan, as defined in Section 3(3) of ERISA, whether maintained by or for a single employee or by or for multiple employees, including, but not limited to, any defined benefit pension plan, profit sharing plan, money purchase plan, savings or thrift plan, stock bonus plan, employee stock ownership plan, or any plan, fund, program, arrangement or practice providing for medical (including post-retirement medical), hospitalization, accident, sickness, disability, or life insurance benefits (\"ERISA Plans\");\n(iii) Other Employee Fringe Benefits - any stock purchase, vacation, scholarship, day care, prepaid legal services, severance pay or other fringe benefit plan, program, arrangement, contract or practice (\"Fringe Benefit Plans\"); and\n(iv) Multiemployer Plan - any Multiemployer Plan.\n\"Quoted Rate\" shall mean, when used with respect to an Interest Period for a Eurodollar Loan, the quotient of (i) the offered rate quoted by Agent in the interbank Eurodollar market in New York City, New York or London, England on or about 11:00 a.m. (New York or London time, as the case may be) two Business Days prior to such Interest Period for U.S. dollar deposits of an aggregate amount approximately comparable to the Eurodollar Loan to which the quoted rate is to be applicable and for a period comparable to such Interest Period, divided by (ii) one minus the Reserve Percentage. For purposes of this definition, (a) \"Reserve Percentage\" shall mean with respect to any Interest Period, the percentage which is in effect on the first day of such Interest Period under Regulation D as the maximum reserve requirement for member banks of the Federal Reserve System in New York City with deposits comparable in amount to those of Agent against Eurocurrency Liabilities. (The Quoted Rate for the applicable period shall be adjusted automatically on and as of the effective date of any change in the applicable Reserve Percentage); and (b) \"Eurocurrency Liabilities\" has the meaning assigned to that term in Regulation D, as in effect from time to time.\n\"Regulation D\" shall mean Regulation D of the Board of Governors of the Federal Reserve System, as it may be amended from time to time.\n\"Regulatory Change\" shall mean, with respect to any Bank, the adoption on or after the date hereof of any applicable federal, state, or foreign law, rule or regulation or any change after such date in any such federal, state or foreign law, rule or regulation (including, without limitation, Regulation D), or any adoption or change in the interpretation or administration thereof by any court, governmental authority, central bank or comparable agency or monetary authority charged with the interpretation or administration thereof, or compliance by such Bank with any request or directive made after such date (whether or not having the force of law) of any such court, authority, central bank or comparable agency or monetary authority.\n\"Reportable Event\" shall have the meaning set forth in Section 4043 of ERISA.\n\"Second Deed of Trust\" shall mean the Deed of Trust, Assignment of Rents and Security Agreement of even date herewith, executed by Borrower conveying a second Lien security interest in the Mortgaged Property to secure repayment of the Standby\/Term Loans and performance of certain of the Obligations, and all amendments thereto, recorded or to be recorded in the Titus County, Texas Deed Records.\n\"Standby\/Term Loans\" shall mean, collectively, the loans made pursuant to Section 2.1(b) hereof, and \"Standby\/Term Loan\" shall mean any loan made pursuant to Section 2.1(b) hereof.\n\"Standby\/Term Note\" or \"Standby\/Term Notes\" shall have the meanings given to such terms in Section 2.1(b) hereof.\n\"Subordinated Notes\" shall mean the $100,000,000 Pilgrim's Pride Corporation Senior Subordinated Notes Due 2003, issued under the Subordinated Notes Indenture.\n\"Subordinated Notes Indenture\" shall mean that certain Indenture dated as of June 3, 1993, between Borrower, as Issuer, and Ameritrust Texas National Association, as Trustee providing for the issuance of Borrower's Senior Subordinated Notes Due 2003, in an aggregate principal amount not to exceed $100,000,000.\n\"Subordination Agreement\" shall mean that certain Subordination Agreement between the Agent, as agent for the Banks and John Hancock Mutual Life Insurance Company, a Massachusetts corporation (\"Hancock\"), dated June 3, 1993, recorded in Volume 775, page 42, Deed Records, Titus County, Texas, subordinating to the Lien of the Banks (up to $31,700,000) Hancock's Lien on the Mortgaged Property, evidenced by (i) that certain promissory note dated February 1, 1988, executed by the Borrower and payable to Hancock's order in the original principal amount of $20,000,000, secured by that certain Deed of Trust, Mortgage and Security Agreement dated February 1, 1988, executed by the Borrower for the benefit of Hancock, and recorded in Volume 182, Page 315, aforesaid Records, amended by instruments recorded in Volume 656, page 163, aforesaid Records and Volume 698, page 77, and (ii) that certain promissory note dated April 25, 1991, executed by the Borrower and payable to Hancock's order in the original principal amount of $5,000,000 (collectively the \"Hancock Indebtedness\"), secured by that certain Deed of Trust, Assignment of Rents and Security Agreement dated April 25, 1991, executed by the Borrower for the benefit of Hancock, and recorded in Volume 656, Page 168, Deed of Trust Records, Titus County, Texas, amended by instrument recorded in Volume 698, page 77, aforesaid Records.\n\"Subsidiary\" shall mean, as to any Person, any other Person, of which more than fifty percent (50%) of the outstanding shares of capital stock or other ownership interest having ordinary voting power to elect a majority of the board of directors of such corporation or similar governing body of such other Person (irrespective of whether or not at the time stock or other ownership interests of any other class or classes of such other Person shall have or might have voting power by reason of the happening of any contingency) is at the time directly or indirectly owned or controlled by such Person or by one or more \"Subsidiaries\" of such Person.\n\"Tangible Net Worth\" shall mean the Net Worth minus the amount of all Intangible Assets of the Borrower and its Subsidiaries, determined on a consolidated basis in accordance with GAAP.\n\"Term Loans\" shall mean, collectively, the loans made pursuant to Section 2.1(a) hereof and \"Term Loan\" shall mean any loan made pursuant to Section 2.1(a) hereof.\n\"Term Note\" and \"Term Notes\" shall have the meanings given to such terms in Section 2.1(a) hereof.\n\"Title Company\" shall mean the issuer of the Title Insurance.\n\"Title Insurance\" shall mean a mortgagee's policy of title insurance, all in form and substance satisfactory to the Agent and Banks and containing no exceptions (printed or otherwise) which are unacceptable to the Agent and Banks, issued by a title company (or, if the Agent or the Banks so require, by several title companies on a re-insured or co-insured basis, at the Agent or the Banks' option) acceptable to the Agent and Banks in the face amount of the Note and insuring that the Agent and Banks have a first and prior deed of trust on the Mortgaged Property, subject only to the Permitted Liens described in the Deed of Trust.\n\"Total Liabilities\" shall mean all obligations, indebtedness or other liabilities of any kind or nature, fixed or contingent, due or not due, which, in accordance with GAAP, would be classified as a liability on the balance sheet of Borrower.\n\"Transferee\" shall mean any Participant or Assignee under this Agreement and \"Transferees\" shall mean all Participants and Assignees under this Agreement.\n\"UCC\" shall mean the Uniform Commercial Code as in effect in the State of New York.\n\"Working Capital Credit Agreement\" shall mean that certain Secured Credit Agreement, dated as of May 27, 1993, among the Borrower, Harris Trust and Savings Bank, individually and as Agent, and the other banks party thereto, as hereafter amended, modified or supplemented from time to time, together with any agreement governing Indebtedness incurred to refinance in its entirety the Indebtedness and commitments then outstanding or permitted to be outstanding under such Working Capital Credit Agreement.\n1.2 Use of Defined Terms. All terms defined in this Agreement and the Exhibits hereto shall have the same defined meanings when used in any other Loan Document, unless the context shall require otherwise.\n1.3 Accounting Terms; Calculations. All accounting terms not specifically defined herein shall have the meanings generally attributed to such terms under GAAP. Calculations hereunder shall be made and financial data required hereby shall be prepared, both as to classification of items and as to amounts, in accordance with GAAP, consistently applied (except as otherwise specifically required herein).\n1.4 Other Terms. All other terms used in this Agreement which are not specifically defined herein but which are defined in the UCC shall have the meanings set forth therein.\n1.5 Terminology. All personal pronouns used in this Agreement, whether used in the masculine, feminine or neuter gender, shall include all other genders; the singular shall include the plural, and the plural shall include the singular. Titles of Articles and Sections in this Agreement are for convenience only, and neither limit nor amplify the provisions of this Agreement, and all references in this Agreement to Articles, Sections, Subsections, paragraphs, clauses, subclauses, Exhibits or Schedules shall refer to the corresponding Article, Section, Subsection, paragraph, clause, subclause of, Exhibit or Schedule attached to, this Agreement, unless specific reference is made to the articles, sections or other subdivisions of, Exhibits or Schedules to, another document or instrument.\n1.6 Exhibits. All Exhibits and Schedules attached hereto are by reference made a part hereof.\n2. THE LOANS\n2.1 Loans.\n(a) Term Loans.\n(i) The Banks have heretofore made \"Term Loans\" under, and as such term is defined in, the Original Loan Agreement, to Borrower in the aggregate original principal amount of Twenty-Eight Million Dollars ($28,000,000.00). Borrower acknowledges and agrees that the Term Loans outstanding on the date hereof under the Original Loan Agreement shall be Term Loans under this Agreement and are hereinafter referred to individually as a \"Term Loan\" and collectively as the \"Term Loans\"). Contemporaneously with the execution with this Agreement, Borrower has executed replacement term notes in the aggregate amount of $21,700,000.00, the current aggregate outstanding balance of the Term Loans, substantially in the form of Exhibit B attached hereto, payable to such Bank in the principal face amount of such Bank's Term Loans (together with any and all amendments, modifications and supplements thereto, and any renewals, replacements or extensions thereof (including, but not limited to, pursuant to Sections 13.4 and 13.4(e) hereof), in whole or in part, individually a \"Term Note\" and, collectively, the \"Term Notes\").\n(ii) The aggregate principal amount of the Term Loans shall be repaid in twenty-four (24) quarterly installments of principal, payable on March 31, June 30, September 30 and December 31 of each year, commencing September 30, 1994, with the first twenty-three (23) such quarterly installments being in the amount of Seven Hundred Thousand and No\/100 Dollars ($700,000) each and with the twenty-fourth (24th) and final such quarterly installment being in an amount equal to the then-outstanding aggregate principal amount of the Term Loans, together with all accrued but unpaid interest thereon.\n(b) Standby\/Term Loans.\n(i) Subject to the terms and conditions hereof and provided there exists no Default or Event of Default, each Bank severally agrees to make on the Closing Date loans (each a \"Standby\/Term Loan\" and collectively the \"Standby\/Term Loans\"), as requested by Borrower in accordance with the provisions of Section 2.3 hereof, to Borrower from time to time on and after the date hereof and up to, but not including, June 20, 1995, in an aggregate amount not to exceed such Bank's Loan. The Standby\/Term Loans made by each Bank shall be evidenced by a promissory note, substantially in the form of Exhibit C attached hereto, payable to such Bank in the principal face amount of such Bank's Loan (together with any and all amendments, modifications and supplements thereto, and any renewals, replacements or extensions thereof (including, but not limited to, pursuant to Sections 13.4 and 13.4(e) hereof), in whole or in part, individually a \"Standby\/Term Note\" and collectively the \"Standby\/Term Notes\"). Standby\/Term Loans, once borrowed and repaid, may not be reborrowed.\n(ii) The aggregate principal amount of the Standby\/Term Loans outstanding on June 20, 1995 shall be repayable in twenty (20) quarterly installments of principal, payable on March 31, June 30, September 30 and December 31 of each year, commencing September 30, 1995, with the first nineteen (19) such installments each being in an amount equal to one and sixty-seven hundredths percent (1.67%) of the aggregate principal amount of Standby\/Term Loans outstanding on June 20, 1995 and the final such quarterly installment being in an amount equal to the then-outstanding unpaid aggregate principal amount of the Standby\/Term Loans, together with all accrued but unpaid interest thereon.\n2.2 Borrowing Procedures. Borrower shall give the Agent notice of Borrower's request for the funding of the Loans in accordance with Section 2.8 hereof. Not later than 11:00 a.m (New York time), on the date specified for each borrowing hereunder, each Bank shall make available to the Agent the amount of the Loan to be made by such Bank, in immediately available funds at an account with Creditanstalt designated by the Agent. The Agent shall, subject to the terms and conditions of this Agreement, not later than 1:00 p.m. (New York time) on the Business Day specified for such borrowing, make such amount available to Borrower at the Agent's office in New York, New York.\n2.3 Loan Account; Statements of Account. The Banks will maintain one or more loan accounts for Borrower to which such Bank will charge all amounts advanced to or for the benefit of Borrower hereunder or under any of the other Loan Documents and to which such Bank will credit all amounts collected under each such credit facility from or on behalf of such Borrower. The Banks will account to Borrower periodically with a statement of charges and payments made pursuant to this Agreement, and each such account statement shall be deemed final, binding and conclusive, absent manifest error, unless such Bank is notified by Borrower in writing to the contrary within thirty (30) days of the date of each account statement. Any such notice shall only be deemed an objection to those items specifically objected to therein. The unpaid principal amount of the Loans, the unpaid interest accrued thereon, the interest rate or rates applicable to such unpaid principal amount, and the accrued and unpaid fees, premiums and other amounts due hereunder shall at all times be ascertained from the records of the Banks and such records shall constitute prima facie evidence of the amounts so due and payable.\n2.4 Use of Proceeds. The proceeds of the Loans shall be used for (a) Borrower's general working capital needs; (b) expenditures incurred under any Capital Leases; (c) acquisitions permitted by Section 7.3 hereof; and (d) in the case of any proceeds of the Standby\/Term Loans to repay the Indebtedness under the Subordinated Notes Indenture. No portion of the proceeds of any Loan may be used to \"purchase\" or \"carry\" any \"margin stock,\" as such terms are defined in Regulations G, T, U or X of the Board of Governors of the Federal Reserve System, or to extend credit for the purpose of purchasing or carrying margin stocks.\n2.5 Several Obligations of the Banks; Remedies Independent. The failure of any Bank to make any Loan to be made by it on the date specified therefor shall not relieve any other Bank of its obligation to make its Loan on such date, but neither any Bank nor the Agent shall be responsible for the failure of any other Bank to make a Loan to be made by such other Bank. The amounts payable by the Borrower at any time hereunder and under the Notes to each Bank shall be a separate and independent debt and each Bank shall be entitled to protect and enforce its rights arising out of this Agreement and the Notes, and it shall not be necessary for any other Bank or the Agent to consent to, or be joined as an additional party in, any proceeding for such purposes.\n2.6 Payments.\n(a) Each payment by the Borrower to Agent pursuant to any of the Notes shall be made prior to 1:00 p.m. (New York time) on the date due and shall be made without set-off or counterclaim to the Agent at the address set forth in Section 13.8 below or at such other place or places as Agent may designate from time to time in writing to Borrower and in such amounts as may be necessary in order that all such payments (after withholding for or on account of any present or future taxes, levies, imposts, duties or other similar charges of whatsoever nature imposed on any Bank by any government or any political subdivision or taxing authority thereof, other than any tax on or measured by the net income of any such Bank pursuant to the income tax laws of the jurisdiction where such Bank's principal or lending office is located) shall not be less than the amounts otherwise specified to be paid under the Notes. Each such payment shall be in lawful currency of the United States of America and in immediately available funds. If the due date of any payment hereunder or under any of the Notes would otherwise fall on a day which is not a Business Day, then such payment shall be due on the next succeeding Business Day and interest shall be payable on the principal amount of such payment for the period of such extension.\n(b) Except to the extent otherwise provided herein: (i) the funding of the Loans by the Banks under Section 2.1 hereof shall be made by the relevant Banks prorata according to their respective Loan Percentages; (ii) the Conversion and Continuation of Loans of a particular type shall be made prorata among the relevant Banks according to their Loan Percentage of the Loans and the then current Interest Period for each Eurodollar Loan shall be coterminous; and (iii) each payment or prepayment of principal of Loans and each payment of interest by Borrower shall be made for the account of relevant Banks prorata in accordance with their Loan Percentage.\n2.7 Prepayment; Commitment Reduction.\n(a) Upon written notice to the Agent in accordance with Section 2.8, Borrower may, at its option, reduce the Commitment or prepay the Loans, in whole or in part, in integral multiples of $100,000, on the date specified in such notice, without premium or penalty.\n(b) In no event may Borrower reduce the Commitment below the aggregate principal amount of Loans outstanding thereunder.\n(c) The Commitment shall be automatically reduced on June 20, 1995 to the aggregate principal amount of the Standby\/Term Loans outstanding on such date.\n(d) The Commitment shall be automatically reduced by the amount of any payment or prepayment of the principal amount of the Standby\/Term Loans, effective on the date of such payment or prepayment.\n(e) The Commitment, once terminated or reduced, may not be reinstated.\n(f) All prepayments shall be applied first to the aggregate outstanding principal amount of the Term Loans, so long as any Term Loans are outstanding, and then to the Standby\/Term Loans.\n(g) All prepayments of the Loans shall be applied to the principal installments thereof in the inverse order of their maturities.\n(h) Borrower may not prepay any Loan which is a Eurodollar Loan prior to the last day of the Interest Period applicable to such Eurodollar Loan unless Borrower pays to the Bank, concurrently with such prepayment, all amounts payable to the Bank pursuant to Sections 3.6 and 3.7 hereof.\n2.8 Certain Notices. All notices given by Borrower to the Agent of termination or reduction of the Commitment, or of Conversions, Continuations or prepayments of Loans hereunder and the request by Borrower for the funding of the Loans shall either be oral, with prompt written confirmation by telecopy, or in writing, with such written confirmation or writing, in the case of a Conversion or Continuation, to be substantially in the form of Exhibit D attached hereto; shall be irrevocable; shall be effective only if received by Agent prior to 10:00 a.m. (New York time): (a) at least fifteen (15) days prior to such termination or reduction of the Commitment; (b) not later than the date such Loan is to be Converted or Continued as a Base Rate Loan; (c) three (3) Business Days prior to the date such Loan is to be Converted or Continued as a Eurodollar Loan; or (d) fifteen (15) days prior to any such prepayment, in the case of a prepayment of any Loans; or (e) four (4) Business Days prior to the date any Loans are to be funded. Each such notice to reduce the Commitment or to prepay any Loans shall specify the Commitment or Loans to be reduced or prepaid, the amount of the Commitment or Loans to be reduced or prepaid and the date of such reduction or prepayment. Each such notice of Conversion or Continuation shall specify: (i) the amount of such Conversion or Continuation (which shall be an integral multiple of $100,000 and, if a Eurodollar Loan, shall be in a minimum principal amount of $1,000,000); (ii) whether such Loan will be Converted or Continued as a Eurodollar Loan or as a Base Rate Loan; (iii) the date such Loan is to be Converted or Continued (which shall be a Business Day and, if such Loan is to Convert or Continue a Eurodollar Loan then outstanding, shall not be prior to the then current Interest Period for such outstanding Loan); and (iv) if such Loan is a Eurodollar Loan, the duration of the Interest Period with respect thereto. The request for the funding of the Loans and each request for a Conversion or Continuation of a Loan or for any other financial accommodation by Borrower pursuant to this Agreement or the other Loan Documents shall constitute (x) an automatic warranty and representation by Borrower to each Bank that there does not then exist a Default or Event of Default or any event or condition which, with the making of such Loan, would constitute a Default or Event of Default and (y) an affirmation that as of the date of said request all of the representations and warranties of Borrower contained in this Agreement and the other Loan Documents are true and correct in all material respects, both before and after giving effect to the application of the proceeds of the Loans. If on the last day of the Interest Period of any Eurodollar Loan hereunder, Agent has not received a notice hereunder to Convert, Continue or prepay such Loan, Borrower shall be deemed to have submitted a notice to convert such Loan to a Base Rate Loan, if such Loan was a Eurodollar Loan, or to continue such Loan as a Base Rate Loan, if such Loan was a Base Rate Loan.\n3. INTEREST\n3.1 Interest. Borrower, the Banks and the Agent agree that, effective as of June 20, 1994, the following shall apply:\n(a) Subject to modification pursuant to Subsection (b) below and Section 10.1 hereof, the average daily outstanding principal amount of the Loans and all other sums payable by Borrower hereunder shall bear interest from June 20, 1994 until paid in full at the following rates:\n(i) the outstanding principal amount of each Eurodollar Loan shall bear interest at a fixed rate of interest per annum equal to the Quoted Rate for the then-current Interest Period for such Loan plus one and eight-tenths percent (1.8%), calculated daily on the basis of a 360-day year and actual days elapsed;\n(ii) the outstanding principal amount of each Base Rate Loan and all other sums payable by Borrower hereunder shall bear interest at a fluctuating rate per annum equal to the Base Rate plus one-fourth percent (1\/4%), calculated daily on the basis of a 360-day year and actual days elapsed; and\n(iii) the outstanding principal amount of any payment on any Loan or other Obligations which is not paid in full when due, together with accrued and unpaid interest thereon (to the extent permitted by law), shall bear interest at the Default Rate.\n(b) Accrued interest shall be payable (i) in the case of Base Rate Loans, monthly on the first day of each month hereafter for the previous month, commencing with the first such day following the date hereof; (ii) in the case of a Eurodollar Loan, on the last day of each Interest Period provided, however, that if any Interest Period in respect of a Eurodollar Loan is longer than three (3) months, such interest prior to maturity shall be paid on the last Business Day of each three (3) month interval within such Interest Period as well as on the last day of such Interest Period; (iii) in the case of any Loan, upon the payment or prepayment thereof; (iv) in the case of any other sum payable hereunder as set forth elsewhere in this Agreement or, if not so set forth, on demand; and (v) in the case of interest payable at the Default Rate, on demand.\n3.2 Interest Period. The Interest Period for any Eurodollar Loan shall commence on the date such Loan is made as specified in the notice of Conversion or Continuation applicable thereto and shall continue for a period of one (1), two (2), three (3) or six (6) months, in the case of a Eurodollar Loan, as specified in the notice of Conversion or Continuation for such Eurodollar Loan. If Borrower fails to specify the duration of the Interest Period for any Eurodollar Loan in the notice of Conversion or Continuation therefor, such Loan shall instead be Converted to, or Continued as, as the case may be, a Base Rate Loan.\n3.3 Limitations on Interest Periods. Borrower may not select any Interest Period which extends beyond the first day of any succeeding calendar quarter, unless, giving effect to such Loan, the aggregate outstanding principal amount of Eurodollar Loans having Interest Periods extending beyond the first day of each such calendar quarter is not greater than the aggregate principal amount of the Loans scheduled to be outstanding immediately following such first day of the calendar quarter. Borrower shall not have in effect at any given time during the term of this Agreement more than three (3) different interest rates for Loans (whether Base Rate Loans or Eurodollar Loans).\n3.4 Conversions and Continuations. Borrower shall have the right, from time to time, to Convert Loans of one type to Loans of the other type and to Continue Loans of one type as Loans of the same type provided that Eurodollar Loans may not be Converted to Base Rate Loans prior to the end of the Interest Period applicable thereto.\n3.5 Illegality. Notwithstanding any other provision of this Agreement to the contrary, in the event that it shall become unlawful for any Bank to obtain funds in the London interbank market or for such Bank to maintain a Eurodollar Loan, then such Bank shall promptly notify Borrower whereupon (a) the right of Borrower to request any Eurodollar Loan shall thereupon terminate and (b) any Eurodollar Loan then outstanding shall commence to bear interest at the rate applicable to Base Rate Loans on the last day of the then applicable Interest Period or at such earlier time as may be required by law.\n3.6 Increased Costs and Reduced Return.\n(a) If any Regulatory Change shall:\n(i) subject any Bank to any tax, duty or other charge with respect to any Eurodollar Loan, or shall change the basis of taxation of payments to such Bank of the principal of or interest on any Eurodollar Loan (except for changes in the rate of tax on the overall net income of such Bank imposed by the jurisdiction in which such Bank's principal office is located); or\n(ii) impose, modify or deem applicable any reserve, special deposit or similar requirement (including, without limitation, any such requirement imposed by the Board of Governors of the Federal Reserve System) against assets of, deposits with or for the account of, or credit extended by, any Bank; or\n(iii) impose on any Bank or on the London interbank market any other condition or expense with respect to this Agreement, the Notes or their making, issuance or maintenance of any Eurodollar Loan;\nand the result of any such Regulatory Change is, in such Bank's reasonable judgment, to increase the costs which such Bank determines are attributable to its making or maintaining any Loan, or its obligation to make available any Loan, or to reduce the amount of any sum received or receivable by such Bank under this Agreement or the Notes with respect to any Loan, then, within ten (10) days after demand by such Bank, Borrower shall pay to such Bank such additional amount or amounts as will compensate such Bank for such increased cost or reduction.\n(b) In addition to any amounts payable pursuant to subsection (a) above, if any Bank shall have determined that the applicability of any law, rule, regulation or guideline adopted pursuant to or arising out of the July 1988 report of the Basle Committee on Banking Regulations and Supervisory Practices entitled \"International Convergence of Capital Measurement and Capital Standards,\" or the adoption after the date hereof of any other law, rule, regulation or guideline regarding capital adequacy, or any change in any of the foregoing or in the enforcement or interpretation or administration of any of the foregoing by any court or any governmental authority, central bank or comparable agency charged with the enforcement or interpretation or administration thereof, or compliance by such Bank (or any lending office of such Bank) or such Bank's holding company with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on such Bank's capital or on the capital of such Bank's holding company, if any, as a consequence of its making or maintaining any Loan or its obligations under this Agreement to a level below that which such Bank or such Bank's holding company could have achieved but for such applicability, adoption, change or compliance (taking into consideration such Bank's policies and the policies of such Bank's holding company with respect to capital adequacy) by an amount deemed by such Bank to be material, then, upon demand by such Bank, the Borrower shall pay to such Bank from time to time such additional amount or amounts as will compensate such Bank or such Bank's holding company for any such reduction suffered. Each demand for compensation pursuant to this paragraph (b) shall be accompanied by a certificate of such Bank in reasonable detail setting forth the computation of such compensation (including the reason therefor), which certificate shall be conclusive, absent manifest error.\n3.7 Indemnity. Borrower hereby indemnifies and agrees to hold harmless the Agent and each Bank from and against any and all losses or expenses which it may sustain or incur as a consequence of failure by Borrower to consummate any notice of funding, prepayment, Conversion or Continuation made by Borrower, including, without limitation, any such loss or expense arising from interest or fees payable by any Bank to lenders of funds obtained by it in order to maintain any Eurodollar Loan. Borrower hereby further indemnifies and agrees to hold harmless the Agent and each Bank from and against any and all losses or expenses which it may sustain or incur as a consequence of prepayment of any Eurodollar Loan on other than the last day of the Interest Period for such Loan (including, without limitation, any prepayment pursuant to Sections 2.7 and 3.5 hereof). Borrower's obligations under this Section shall survive the termination of this Agreement and the repayment of the Obligations.\n3.8 Notice of Amounts Payable to Banks. If any Bank shall seek payment of any amounts from Borrower pursuant to Section 3.6 hereof it shall notify Borrower of the amount payable by Borrower to such Bank thereunder. A certificate of such Bank seeking payment pursuant to Section 3.6 hereof, setting forth in reasonable detail the factual basis for and the computation of the amounts specified, shall be conclusive, absent manifest error, as to the amounts owed. Borrower's obligations under this Section shall survive the termination of this Agreement and the repayment of the Obligations.\n3.9 Inability to Determine Quoted Rate. In the event that Agent determines (which determination shall be conclusive absent manifest error) that, by reason of circumstances affecting the London interbank market, quotation of interest rates for the relevant deposits referred to in the definition of the \"Quoted Rate\" herein are not being provided in the relevant amounts or for the relevant maturities for the purpose of determining rates of interest for a Eurodollar Loan, Agent will give notice of such determination to Borrower and at least one day prior to the date specified in such notice of Conversion or Continuation for such Loan to be made. If any such notice is given, no Bank shall have any obligation to make available, maintain, Convert or Continue Eurodollar Loans. Until the earlier of the date any such notice has been withdrawn by Agent or the date when Agent and Borrower have mutually agreed upon an alternate method of determining the rates of interest payable on a Eurodollar Loan, as the case may be, Borrower shall not have the right to have or maintain any Eurodollar Loan.\n3.10 Interest Savings Clause. It is expressly stipulated and agreed to be the intent of Borrower, the Agent and the Banks at all times to comply with applicable law governing the maximum rate or amount of interest payable on the Indebtedness (or applicable United States federal law to the extent that it permits any Bank to contract for, charge, take, reserve or receive a greater amount of interest). If the applicable law is ever judicially interpreted so as to render usurious any amount called for under this Agreement, the Notes or under any of the other Loan Documents, or contracted for, charged, taken, reserved or received with respect to the Obligations, or if Agent's exercise of the option to accelerate the maturity of the Notes or if any prepayment by Borrower results in Borrower having paid any interest in excess of that permitted by applicable law, then it is Borrower's, the Agent's and the Banks' express intent that all excess amounts theretofore collected by the Agent and\/or the Banks be credited on the principal balance of the Notes (or, if the Notes and all other Obligations have been or would thereby be paid in full, refunded to Borrower), and the provisions of the Notes and the other Loan Documents immediately be deemed reformed and the amounts thereafter collectible hereunder and thereunder reduced, without the necessity of the execution of any new documents, so as to comply with the applicable law, but so as to permit the recovery of the fullest amount otherwise called for hereunder or thereunder, not exceeding the highest lawful amount of interest on the Obligations. All sums paid or agreed to be paid to the Agent and\/or the Banks for the use, forbearance or detention of the Obligations shall, to the extent permitted by applicable law, be amortized, prorated, allocated and spread throughout the full term of the Notes until payment in full so that the rate or amount of interest on account of the Obligations does not exceed the usury ceiling from time to time in effect and applicable to the Notes for so long as the Obligations are outstanding. Notwithstanding anything to the contrary contained herein or in any of the other Loan Documents, it is not the intention of the Agent or any Bank to accelerate the maturity or demand payment of any interest that has not accrued at the time of such acceleration or to collect unearned interest at the time of such acceleration.\n3.11 Commitment Fee. Borrower shall pay to the Agent for the account of each Bank a commitment fee (the \"Commitment Fee\"), calculated on the basis of a 360-day year and actual days elapsed, equal to one-fourth percent (1\/4%) per annum of the sum of the aggregate average daily unused amount of such Bank's Loan Percentage of the Commitments, payable in arrears (commencing on October 1, 1994) on the the first day of each calendar quarter for the previous calendar quarter or portion thereof and on Maturity Date. This Section 3.11 shall be effective as of June 20, 1994, and on October 1, 1994, Borrower shall also pay to Agent for the account of each Bank the prorata portion of the Commitment Fee due for the period from June 20, 1994 through June 30, 1994.\n4. SECURITY INTEREST - COLLATERAL\n4.1 Security Interest. As security for the Obligations, Borrower hereby grants to Agent, for the benefit of the Banks, a continuing Lien on and security interest in and to the following described property, whether now owned or existing or hereafter acquired or arising or in which Borrower now has or hereafter acquires any rights (sometimes herein collectively referred to as \"Collateral\"):\n(a) Leases;\n(b) Equipment;\n(c) all books and records (including, without limitation, computer programs, print-outs and other computer materials and records) of Borrower pertaining to any of the foregoing; and\n(d) all accessions to, substitutions for and all replacements, products and proceeds of the foregoing, including, without limitation, proceeds of insurance policies insuring the Collateral.\n4.2 Mortgaged Property. As additional security for the Obligations, Borrower has heretofore granted to Agent, for the benefit of the Banks, a first (except for prior liens expressly permitted thereby) priority lien on and security interest in the Mortgaged Property, evidenced by the Deed of Trust, and Borrower has of even date herewith granted to Agent, for the benefit of the Banks, a second (except for prior Liens expressly permitted thereby) priority Lien on and security interest in the Mortgaged Property, evidenced by the Second Deed of Trust, recorded or to be recorded in the Titus County, Texas Deed Records.\n4.3 Perfection of Liens. Until the payment and satisfaction in full of all Obligations, Agent's Liens in the Collateral and all products and proceeds thereof, shall continue in full force and effect. Borrower shall perform any and all steps requested by Agent or the Majority Banks to perfect, maintain and protect Agent's Liens in the Collateral including, without limitation, executing and filing financing or continuation statements, or amendments thereof, in form and substance satisfactory to Agent. Agent may file one or more financing statements disclosing Agent's Liens under this Agreement without Borrower's signature appearing thereon and Borrower shall pay the costs of, or incidental to, any recording or filing of any financing statements concerning the Collateral. Borrower agrees that a carbon, photographic, photostatic, or other reproduction of this Agreement or of a financing statement is sufficient as a financing statement.\n4.4 Right to Inspect. Agent and each Bank (or any person or persons designated by it), in its sole discretion, shall have the right to call at the Mortgaged Property or any place of business or property location of Borrower at any reasonable time, and, without hindrance or delay, to inspect the Collateral and to inspect, review, check and make extracts from Borrower's books, records, journals, orders, receipts and any correspondence and other data relating to the Collateral, to Borrower's business or to any other transactions between the parties hereto and to discuss any of the foregoing with any of Borrower's employees, officers and directors and with its independent accountants.\n5. REPRESENTATIONS AND WARRANTIES\nIn order to induce the Banks to enter into this Agreement and to make Loans hereunder, Borrower hereby makes the following representations and warranties to the Agent and the Banks which shall be true and correct on the date hereof and shall continue to be true and correct at the time of the making of any Loan and until the Loans have been repaid in full:\n5.1 Corporate Existence and Qualification. Each of Borrower and its Subsidiaries is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation. Borrower is duly qualified as a foreign corporation in good standing in the State of Texas and in each other state wherein the conduct of its business or the ownership of its property requires such qualification and each Subsidiary is duly qualified as a foreign corporation in good standing in each state wherein the conduct of its business or the ownership of its property requires such qualification.\n5.2 Chief Executive Office; Collateral Locations. Borrower's and each Subsidiary's principal place of business, chief executive office and office where it keeps all of its books and records is located at 110 South Texas Street, Pittsburg, Texas 75686, and except as set forth on Schedule 5.2 attached hereto neither Borrower nor any of its respective predecessors has had any other chief executive office or principal place of business outside the State of Texas during the preceding four (4) months. Schedule 5.2 attached hereto and incorporated herein by reference sets forth a true, correct and complete list of all places of business and all locations at which Collateral is located.\n5.3 Corporate Authority. Borrower has the corporate power and authority to execute, deliver and perform under this Agreement and the Loan Documents to which it is a party, and to borrow hereunder, and has taken all necessary and appropriate corporate action to authorize the execution, delivery and performance of this Agreement and such Loan Documents.\n5.4 No Consents; Validity and Binding Effect. The execution, delivery and performance of this Agreement, the Deed of Trust and the other Loan Documents are not in contravention of any provisions of law or any agreement or indenture by which Borrower is bound or of the Articles of Incorporation or By-laws of Borrower or any of its Subsidiaries and do not require the consent or approval of any governmental body, agency, authority or other Person which has not been obtained and a copy thereof furnished to Agent. This Agreement and the other Loan Documents to which Borrower is a party constitute the valid and legally binding obligations of Borrower, enforceable against Borrower in accordance with their respective terms.\n5.5 No Material Litigation. Except as set forth on Schedule 5.5 hereof, there are no proceedings pending or threatened before any court or administrative agency which might have a Material Adverse Effect.\n5.6 Corporate Organization. The Articles of Incorporation and By-laws of Borrower and each of its Subsidiaries are in full force and effect under the laws of their respective states of incorporation and all amendments to said Articles of Incorporation and By-laws have been duly and properly made under and in accordance with all applicable laws.\n5.7 Solvency. Giving effect to the execution and delivery of the Loan Documents and the consummation of the transactions contemplated hereby, including, but not limited to, the making of the Loans hereunder, the issuance of the Subordinated Notes and the making of the initial loans under the Working Capital Credit Agreement, Borrower (a) has capital sufficient to carry on its business and transactions and all business and transactions in which it is about to engage, (b) is able to pay its debts as they mature and (c) owns property whose fair saleable value is greater than the amount required to pay its debts.\n5.8 Adequacy of Intangible Assets. Borrower and its Subsidiaries possess all Intangible Assets reasonably necessary to continue to conduct their respective businesses as heretofore conducted by them.\n5.9 Taxes. Borrower and each of its Subsidiaries has filed all federal, state, local and foreign tax returns, reports and estimates which are required to be filed, and all taxes (including penalties and interest, if any) shown on such returns, reports and estimates which are due and not yet delinquent or which are otherwise due and payable have been fully paid. Such tax returns properly and correctly reflect the income and taxes of Borrower and its Subsidiaries for the periods covered thereby except for such amounts which in the aggregate are immaterial.\n5.10 ERISA. Except as disclosed on Schedule 5.10 attached hereto and incorporated herein by reference:\n(a) Identification of Plans. Neither the Borrower, any of its Subsidiaries nor any ERISA Affiliate maintains or contributes to, or has maintained or contributed to, any Plan or Multiemployer Plan that is subject to regulation by Title IV of ERISA;\n(b) Compliance. Each Plan has at all times been maintained, by its terms and in operation, in accordance with all applicable laws, except for such noncompliance (when taken as a whole) that will not have a Material Adverse Effect on Borrower or any of its Subsidiaries;\n(c) Liabilities. Neither the Borrower, any of its Subsidiaries nor any ERISA Affiliate is currently or to the best knowledge of Borrower or any ERISA Affiliate will become subject to any liability (including withdrawal liability), tax or penalty whatsoever to any person whomsoever with respect to any Plan including, but not limited to, any tax, penalty or liability arising under Title I or Title IV of ERISA or Chapter 43 of the Code;\n(d) Funding. The Borrower, its Subsidiaries and each ERISA Affiliate have made full and timely payment of (i) all amounts required to be contributed under the terms of each Plan and applicable law and (ii) all material amounts required to be paid as expenses of each Plan. No Plan has any \"amount of unfunded benefit liabilities\" (as defined in Section 4001(a)(18) of ERISA); and\n(e) Insolvency; Reorganization. No Plan is insolvent (within the meaning of Section 4245 of ERISA) or in reorganization (within the meaning of Section 4241 of ERISA).\n5.11 Financial Information.\n(a) The consolidated financial statements of Borrower and its Subsidiaries for fiscal year ended October 2, 1993 disclosed in the Borrower's Form 10-K certified by Ernst & Young, and the consolidated interim financial statements of Borrower and its Subsidiaries for the six-month period ended April 2, 1994, each consisting of a consolidated balance sheet, consolidated statement of income (loss), consolidated statement of changes in stockholders equity and consolidated statement of cash flows, copies of which have been delivered by Borrower to each Bank, are true and correct in all material respects and contain no material misstatement or omission, and fairly present the consolidated financial position, assets and liabilities of Borrower and its Subsidiaries as of the date thereof and the consolidated results of operations of Borrower and its Subsidiaries for the period then ended, and as of the date thereof there are no liabilities of Borrower or any of its Subsidiaries, fixed or contingent, which are material that are not reflected in such financial statements.\n(b) Since the date of the financial statements referred to in subsection (a), there has been no material adverse change in the assets, liabilities, financial position or results of operations of Borrower or any of its Subsidiaries, and neither Borrower nor any of its Subsidiaries has (i) incurred any obligation or liability, fixed or contingent, which would have a Material Adverse Effect, (ii) incurred any Indebtedness or obligations under Capital Leases, other than the Obligations, and trade payables and other liabilities arising in the ordinary course of the Borrower's or such Subsidiary's business, or (iii) guaranteed the obligations of any other Person.\n5.12 Title to Assets. Borrower has good and marketable title to and ownership of the Collateral, including, but not limited to, the Mortgaged Property, and Borrower and its Subsidiaries have good and marketable title to and ownership of all of their other assets, free and clear of all Liens except for Permitted Liens or as otherwise expressly permitted by this Agreement.\n5.13 Violations of Law. Neither Borrower nor any of its Subsidiaries is in violation of any applicable statute, regulation or ordinance of any governmental entity, or of any agency thereof, which violation could have a Material Adverse Effect.\n5.14 No Default. Neither Borrower nor any of its Subsidiaries is in default with respect to (a) any note, indenture, loan agreement, mortgage, lease, deed or other similar agreement relating to Indebtedness to which Borrower or such Subsidiary is a party or by which Borrower or such Subsidiary is bound or (b) any other instrument, document or agreement to which Borrower or such Subsidiary is a party or by which Borrower or such Subsidiary or any of their respective properties are bound, which other instrument, document or agreement is material to the operations or condition, financial or otherwise, of Borrower or such Subsidiary.\n5.15 Corporate and Trade or Fictitious Names. During the five (5) years immediately preceding the date of this Agreement, neither Borrower nor any of its Subsidiaries nor any of their respective predecessors has been known as or used any corporate, trade or fictitious name other than its current corporate name and except as disclosed on Schedule 5.15 hereto.\n5.16 Equipment. The Equipment is and shall remain in good condition, normal wear and tear excepted, meets all standards imposed by any governmental agency, or department or division thereof having regulatory authority over such material and its use and is currently usable in the normal course of Borrower's business.\n5.17 Investments. Except as set forth in Schedule 5.17 hereof, Borrower has no Subsidiaries and has no interest in any partnership or joint venture with, or any investment in, any Person.\n5.18 Trade Relations. There exists no actual or, to the best of Borrower's knowledge, threatened termination, cancellation or limitation of, or any modification or change in, the business relationship of Borrower with any material supplier or with any company whose contracts with Borrower individually or in the aggregate are material to the operations of Borrower; after the consummation of the transactions contemplated by this Agreement, the Subordinated Notes Indenture and the Working Capital Credit Agreement, to the best knowledge of Borrower, all such companies and suppliers will continue a business relationship with Borrower on a basis materially no less favorable to Borrower than that heretofore conducted; and there exists no condition or state of facts or circumstances which would have a Material Adverse Effect on Borrower or prevent Borrower from conducting its business after the consummation of the transactions contemplated by this Agreement in essentially the same manner in which it has heretofore been conducted by Borrower.\n5.19 Broker's or Finder's Fees. No broker's or finder's fees or commissions have been incurred or will be payable by Borrower or any of its Subsidiaries, or any of its predecessors, to any Person in connection with the transactions contemplated by this Agreement. Notwithstanding the foregoing, Borrower acknowledges that MONY Capital Markets, Inc. has been paid that certain broker's commission contemplated in the Original Loan Agreement.\n5.20 Security Interest. This Agreement creates a valid security interest in the Collateral securing payment of the Obligations, subject only to Permitted Liens, and all filings and other actions necessary or desirable to perfect and protect such security interest have been taken, and, Agent has a valid and perfected first priority security interest in the Collateral, subject only to Permitted Liens.\n5.21 Regulatory Matters. Borrower is not subject to regulation under the Investment Company Act of 1940, as amended, the Public Utility Holding Company Act of 1935, as amended, the Federal Power Act, the Interstate Commerce Act or any other federal or state statue or regulation which materially limits its ability to incur indebtedness or its ability to consummate the transactions contemplated hereby.\n5.22 Disclosure. Neither this Agreement nor any other instrument, document, agreement, financial statement or certificate furnished to the Agent or any of the Banks by or on behalf of Borrower in connection with this Agreement or the Working Capital Credit Agreement contains an untrue statement of a material fact or omits to state any material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading or omits to state any fact which, insofar as Borrower can now foresee, may in the future materially and adversely affect the condition (financial or otherwise), business, operations or properties of Borrower and its Subsidiaries which has not been set forth in this Agreement or in an instrument, document, agreement, financial statement or certificate furnished to the Agent and the Banks in connection herewith.\n(a) Registration Statement. Borrower has heretofore furnished to the Agent and each Bank a true, correct and complete copy, including all amendments thereto, of the Registration Statement, on Form S-1, in respect to the Subordinated Notes and all other materials filed with the Securities and Exchange Commission in connection with the issuance of the Subordinated Notes. No portion of the Registration Statement, the prospectus relating thereto, nor any other written material filed with the Securities and Exchange Commission with respect thereto, relating to the Borrower or its Subsidiaries or their respective businesses, does or will contain any statement which is false or misleading with respect to any material fact, or does or will omit to state a material fact necessary in order to make the statements therein not false or misleading, or otherwise violate any state or federal securities laws.\n6. AFFIRMATIVE COVENANTS\nBorrower covenants to the Agent and the Banks that from and after the date hereof, and until the satisfaction in full of the Obligations, it will and it shall cause each of its Subsidiaries to, unless the Majority Banks otherwise consent in writing:\n6.1 Records Respecting Collateral. Keep all records with respect to the Collateral at its office set forth in Section 5.2 hereof and not remove such records from such address without the prior written consent of the Majority Banks.\n6.2 Reporting Requirements. Furnish or cause to be furnished to the Agent and each Bank:\n(a) As soon as practicable, and in any event within 45 days after the end of each fiscal quarter, consolidated interim unaudited financial statements, including a balance sheet, income statement and statement of cash flow, for the quarter and year-to-date period then ended, prepared in accordance with GAAP, consistent with the past practice or Borrower and its Subsidiaries, and certified as to truth and accuracy thereof by the chief financial officer of Borrower;\n(b) As soon as available, and in any event within 90 days after the end of each fiscal year, consolidated audited annual financial statements, including a consolidated balance sheet, consolidated statement of income, consolidated statement of shareholders' equity and consolidated statement of cash flow for the fiscal year then ended, prepared in accordance with GAAP, in comparative form and accompanied by the unqualified opinion of a nationally recognized firm of independent certified public accountants regularly retained by Borrower and its Subsidiaries and acceptable to the Majority Banks;\n(c) Together with the annual financial statements referred to in clause (b) above, a statement from such independent certified public accountants that, in making their examination of such financial statements, they obtained no knowledge of any Default or Event of Default or, in lieu thereof, a statement specifying the nature and period of existence of any such Default or Event of Default disclosed by their examination;\n(d) Together with the annual or interim financial statements referred to in clauses (a) and (b) above, a certificate of the chief financial officer of Borrower certifying that, to the best of his knowledge, no Default or Event of Default has occurred and is continuing or, if a Default or Event of Default has occurred and is continuing, a statement as to the nature thereof and the action which is proposed to be taken with respect thereto;\n(e) Promptly after the sending or filing thereof, as the case may be, copies of any definitive proxy statements, financial statements or reports which Borrower or any Subsidiary sends to its shareholders and copies of any regular periodic and special reports or registration statements which Borrower or any Subsidiary files with the Securities and Exchange Commission (or any governmental agency substituted therefor), including, but not limited to, all Form 10-K and Form 10-Q reports, or any report or registration statement which Borrower or any Subsidiary files with any national securities exchange;\n(f) At least fifteen (15) Business Days prior to the time any consent by the Majority Banks will be necessary, Borrower and any Subsidiary shall furnish to the Agent and the Banks all pertinent information regarding any proposed acquisition by Borrower or any Subsidiary to which the consent of the Majority Banks is required hereunder which is reasonably necessary or appropriate to permit the Banks to evaluate such acquisitions in a manner consistent with prudent banking standards;\n(g) Together with the annual and, if requested by the Agent, interim financial statements referred to in clauses (a) and (b) above, a certificate of the chief financial officer of Borrower certifying as to (i) the items of Equipment subject to purchase money Liens permitted by clause (e) of the definition of \"Permitted Liens\" and (ii) the principal amount of Indebtedness secured by each such Lien; and\n(h) Such other information respecting the condition or operations, financial or otherwise, of Borrower and its Subsidiaries as the Agent or the Banks may from time to time reasonably request.\n6.3 Tax Returns. File all federal, state and local tax returns and other reports that Borrower and its Subsidiaries are required by law to file, maintain adequate reserves for the payment of all taxes, assessments, governmental charges and levies imposed upon them, their respective incomes, or their respective profits, or upon any property belonging to them, and pay and discharge all such taxes, assessments, governmental charges and levies prior to the date on which penalties attach thereto.\n6.4 Compliance With Laws. Comply with all laws, statutes, rules, regulations and ordinances of any governmental entity, or of any agency thereof, applicable to Borrower or any Subsidiary, a violation of which, in any respect, might have a Material Adverse Effect, including, without limitation, any such laws, statutes, rules, regulations or ordinances regarding the collection, payment, and deposit of employees' income, unemployment, and Social Security taxes and with respect to pension liabilities.\n6.5 ERISA.\n(a) At all times make prompt payment of contributions required to meet the minimum funding standards set forth in Section 302 and 305 of ERISA with respect to each Plan and otherwise comply with ERISA and all rules and regulations promulgated thereunder in all material respects;\n(b) Promptly after the occurrence thereof with respect to any Plan, or any trust established thereunder, notify the Agent and the Banks of (i) a \"reportable event\" described in Section 4043 of ERISA and the regulations issued from time to time thereunder (other than a \"reportable event\" not subject to the provisions for 30-day notice to the PBGC under such regulations), or (ii) any other event which could subject the Borrower, any of its Subsidiaries or any ERISA Affiliate to any tax, penalty or liability under Title I or Title IV of ERISA or Chapter 43 of the Code which, in the aggregate, would have a Material Adverse Effect on the Borrower, any of its Subsidiaries or upon their respective financial condition, assets, business operations, liabilities or property;\n(c) At the same time and in the same manner as such notice must be provided to the PBGC, or to a Plan participant, beneficiary or alternative payee, give the Agent and the Banks any notice required under Section 101(d), 302(f)(4), 303, 307, 4041(b)(1)(A) or 4041(c)(1)(A) or ERISA or under Section 401(a)(29) or 412 of the Code with respect to any Plan;\n(d) Furnish to the Agent or any Bank, promptly upon the request of the Agent or such Bank, (i) true and complete copies of any and all documents, government reports and determination or opinion letters for any Plan; and (ii) a current statement of withdrawal liability, if any, for each Multiemployer Plan; and\n(e) Furnish to the Agent or any Bank, promptly upon the request of the Agent or such Bank therefor, such additional information concerning any Plan that relates to the ability of Borrower to make any payments hereunder, as may be reasonably requested.\n6.6 Books and Records. Keep adequate records and books of account with respect to its business activities in which proper entries are made in accordance with GAAP reflecting all its financial transactions.\n6.7 Notifications to the Agent and the Banks. Notify the Agent and the Banks by telephone within one (1) Business Day (with each such notice to be confirmed in writing within two (2) Business Days following such telephone notice): (a) upon Borrower's learning thereof, of any litigation affecting Borrower or any of its Subsidiaries claiming damages of $1,000,000 or more, individually or when aggregated with other litigation pending against Borrower or any of its Subsidiaries, whether or not covered by insurance, and of the threat or institution of any suit or administrative proceeding against Borrower or any of its Subsidiaries which may have a Material Adverse Effect on Borrower or any of its Subsidiaries, or Agent's Lien in the Collateral or the Mortgaged Property, and establish such reasonable reserves with respect thereto as the Majority Banks may request; (b) upon learning thereof, of any Default or Event of Default hereunder; (c) upon occurrence thereof, of any change to the operations, financial condition or business of Borrower or any of its Subsidiaries which would have a Material Adverse Effect; (d) upon the occurrence thereof, of any amendment or modification of the Working Capital Credit Agreement; and (e) upon the occurrence thereof, of Borrower's or any Subsidiary's default under (i) any note, indenture, loan agreement, mortgage, lease, deed or other similar agreement relating to any indebtedness of Borrower or any of its Subsidiaries or (ii) any other instrument, document or agreement material to the operations or condition, financial or otherwise, of Borrower or any of its Subsidiaries to which Borrower or any of its Subsidiaries is a party or by which Borrower or any of its Subsidiaries or any of their respective property is bound.\n6.8 Insurance.\n(a) Keep all of the Collateral, whether now owned or hereafter acquired, insured by insurance companies (i) reasonably acceptable to the Majority Banks or having an A or better rating according to Best's Insurance Reports; Property-Casualty and (ii) licensed to do business in the State of Texas against loss or damage by fire or other risk usually insured against under extended coverage endorsement and theft, burglary, and pilferage, together with such other hazards as the Majority Banks may from time to time reasonably request, in amounts reasonably satisfactory to the Majority Banks and naming Agent as loss payee thereon pursuant to a lender's loss payee clause satisfactory to the Majority Banks;\n(b) Keep all of its property other than the Collateral and the Mortgaged Property, whether now owned or hereafter acquired, insured by insurance companies (i) reasonably acceptable to the Majority Banks or having an A or better rating according to Best's Insurance Reports; Property-Casualty and (ii) licensed to do business in the State of Texas and in all jurisdictions in which such Borrower does business against such risks and in such amounts as are customarily maintained by others in similar businesses;\n(c) Maintain at all times liability insurance coverage against such risks and in such amounts as are customarily maintained by others in similar businesses, such insurance to be carried by insurance companies (i) reasonably acceptable to the Majority Banks or having an A or better rating according to Best's Insurance Reports; Property-Casualty and (ii) licensed to do business in the State of Texas and in all jurisdictions in which such Borrower does business; and\n(d) Deliver certificates of insurance for such policy or policies to Agent, containing endorsements, in form satisfactory to the Majority Banks, providing that the insurance shall not be cancellable, except upon thirty (30) days' prior written notice to Agent.\n6.9 Preservation of Corporate Existence. Except as permitted by Section 7.4 hereof, preserve and maintain its corporate existence, rights, franchises and privileges in the jurisdiction of its incorporation.\n6.10 Equipment. Keep and maintain the Equipment in good operating condition, reasonable wear and tear excepted, shall repair and make all necessary replacements thereof so that the operating efficiency thereof shall at all times be maintained and preserved and, shall not permit any item of Equipment to become a fixture to real estate or accession to other personal property unless Agent has a first priority Lien on or in such real estate or other personal property. Borrower shall, immediately on demand therefor by Agent, deliver to Agent any and all evidence of ownership of any of the Equipment (including, without limitation, certificates of title and applications for title, together with any necessary applications to have Agent's lien noted thereon, in the case of vehicles).\n6.11 Additional Collateral. Intentionally deleted.\n7. NEGATIVE COVENANTS\nBorrower covenants with the Agent and the Banks that from and after the date hereof and until the termination of this Agreement and the payment and satisfaction in full of the Obligations, it will not, and it will not permit its Subsidiaries to, without the prior written consent of the Majority Banks:\n7.1 No Encumbrances. Create, assume, or suffer to exist any Lien of any kind in any of the Collateral or the Mortgaged Property except for (a) Permitted Liens and (b) a Lien on the Equipment and the Mortgaged Property, expressly subordinated to the Lien in favor of the Agent, in favor of the agent under the Working Capital Credit Agreement (the \"Working Capital Agent\"), as security for the Obligations under the Working Capital Credit Agreement; provided, however, that concurrently with the granting of such Lien in favor of the Working Capital Agent, Borrower grants to the Agent, as security for the Obligations, a Lien, subordinate only to the Lien of the Working Capital Agent, in the current assets of Borrower as provided for in Section 6.11 hereof.\n7.2 Asset Sales.\n(a) Sell, lease or dispose of any of the Collateral or any interest therein except for the sale of Equipment no longer used or useful in the business of Borrower or any Subsidiary having (i) an aggregate value not in excess of $1,000,000 during any Fiscal Year or (ii) an aggregate value not in excess of $5,000,000 during any Fiscal Year; provided that any Equipment sold, leased or otherwise disposed of pursuant to this clause (ii) is replaced within 90 days after such sale, trade-in or other disposition by replacement Equipment which is in good operating condition and which has a value and utility at least equal to that of the Equipment sold, traded in or disposed of and the Agent receives, for the benefit of the Banks, a valid perfected first Lien with respect to such replacement Equipment, subject only to Permitted Liens; or\n(b) Sell, lease or otherwise transfer any of its assets other than the Collateral except: (i) in the ordinary course of business; (ii) as permitted by Section 7.9; (iii) transfers to the Borrower or a Subsidiary; (iv) worn or obsolete property; or (v) any other sale or transfer of assets, which, together with all other assets sold or transferred during the preceding 12 month period (other than in accordance with the preceding clauses (i), (ii), (iii) or (iv)), does not exceed 15% of the Borrower's total consolidated tangible assets as computed at the time of such sale or transfer.\n7.3 Loans and Investments. Make or retain any loan or investment (whether through the purchase of stock, obligations or otherwise) in or make any loan or advance to, any other Person, whether by acquisition of stock indebtedness, other obligations or security or by loan, advance, capital contribution, or otherwise (\"Restricted Investments\") other than:\n(a) investments in certificates of deposit having a maturity of one year or less issued by any United States commercial bank having capital and surplus of not less than $50,000,000;\n(b) investments in an aggregate amount of up to $8,000,000 in deposits maintained with the First State Bank of Pittsburg, Texas;\n(c) investments in commercial paper rated P1 by Moody's Investors Service, Inc. or A1 by Standard & Poor's Corporation maturing within 180 days of the date of issuance thereof;\n(d) investments in mutual funds composed of either money market securities or marketable obligations of the United States or guaranteed by or insured by the United States, or those for which the full faith and credit of the United States is pledged for the repayment or principal and interest thereof; provided that such obligations have a final maturity of no more than three years from the date acquired by the Borrower;\n(e) investments existing prior to the Closing Date; and\n(f) investments in a corporate Subsidiary of the Borrower provided that such Subsidiary is consolidated with Borrower for financial reporting purposes;\nunless, immediately after giving effect thereto, the aggregate Restricted Investments of the Borrower and its Subsidiaries made since the Closing Date does not exceed 5% of the Borrower's total assets.\n7.4 Corporate Structure. Dissolve or otherwise terminate its corporate status; enter into any merger, reorganization or consolidation; issue any shares of any class of capital stock of any Subsidiary or any securities or other instruments for or which are convertible into any shares of any class of capital stock of any Subsidiary; or make any substantial change in the basic type of business conducted by Borrower or any Subsidiary as of the date hereof, provided that (a) the Borrower may merge with another corporation, if the surviving corporation is the Borrower and (b) a Subsidiary may merge or consolidate with or sell, lease or otherwise transfer all or substantially all of its assets to: (i) the Borrower or another Subsidiary; or, (ii) another Person if immediately after giving effect to the transaction no Default or Event of Default would exist.\n7.5 Fiscal Year. Change its fiscal year.\n7.6 ERISA. Take, or fail to take, or permit any ERISA Affiliate to take, or fail to take, any action with respect to a Plan including, but not limited to, (i) establishing any Plan, (ii) amending any Plan, (iii) terminating or withdrawing from any Plan, or (iv) incurring an amount of unfunded benefit liabilities, as defined in Section 4001(a)(18) of ERISA, where such action or failure could have a material adverse effect on the Borrower or any Subsidiary, result in a lien on the property of the Borrower or any Subsidiary, or require the Borrower or any Subsidiary to provide any security.\n7.7 Relocations; Use of Name. Relocate its executive office; maintain any Collateral at any location other than the Mortgaged Property or maintain records with respect to Collateral at any locations other than the Mortgaged Property or at the location of its chief executive office set forth in Section 5.2 hereto; or use any corporate name (other than its own) or any fictitious name except upon thirty (30) days prior written notice to Agent and after the delivery to Agent of financing statements, if required by Agent, in form satisfactory to Agent.\n7.8 Arm's-Length Transactions. The Borrower will not, and will not permit any Subsidiary to, enter into any transaction, including without limitation, the purchase, sale, lease or exchange of any Collateral, or the rendering of any service, with any Affiliate of the Borrower or such Subsidiary or any Person except in the ordinary course of and pursuant to the reasonable requirements of the Borrower's or such Subsidiary's business and upon fair and reasonable terms not materially less favorable to the Borrower than would be obtained in a comparable arm's-length transaction with a Person not an Affiliate of the Company or such Subsidiary and which would be subject to approval by the Borrower's Audit Committee of the Board of Directors.\n7.9 Dividends. Declare or pay any dividends on, or make any distribution with respect to, its shares of any class of capital stock, redeem or retire any capital stock, or take any action having an effect equivalent to the foregoing (in any fiscal year of Borrower or any Subsidiary) except for (a) the declaration and payment of cash dividends by a Subsidiary and payable to Borrower and (b) the declaration and payment of cash dividends on the capital stock of the Borrower not in excess of $0.08 per share of the issued and authorized common stock plus twenty-five percent (25%) of the net income of Borrower, as set forth in the audited financial statements for the fiscal year of Borrower immediately preceding the year during which such declaration and payment of dividends is made; provided, however, that at the time such dividend is paid there does not exist any Default or Event of Default hereunder or any event or condition which, with the payment of such dividend would constitute a Default or Event of Default.\n7.10 Subordinated Notes. Neither the Borrower or any of its Subsidiaries shall, directly or indirectly:\n(a) purchase, redeem, retire or otherwise acquire for value, set apart any money for a sinking, defeasance or other analogous fund for, the purchase, redemption, retirement or other acquisition of, or make any voluntary payment or prepayment of the principal of or interest on, where any other amount owing in respect of, the Subordinated Notes other than regularly scheduled payments of interest thereon; or\n(b) agree to any amendment, modification or waiver of any of the provisions of the Subordinated Notes Indenture.\n7.11 Guaranty Fees. The Borrower will not, and will not permit any Subsidiary to, directly or indirectly, pay to Mr. and\/or Mrs. Lonnie A. Pilgrim or any other guarantor of any of the Borrower's Indebtedness, obligations and liabilities, any fee or other compensation, but excluding salary, bonus and other compensation for services rendered as an employee (collectively the \"Guaranty Fees\") except that, so long as there is not Default or Event of Default nor any event or condition which, with the payment of such fee would constitute a Default or Event of Default, Borrower may pay Guarantee Fees not to exceed $2,000,000 in the aggregate during any fiscal year of the Borrower.\n8. FINANCIAL COVENANTS\nBorrower covenants with the Agent and the Banks that from and after the date hereof and until the termination of this Agreement and the payment and satisfaction in full of the Obligations, unless the Majority Banks otherwise consent in writing:\n8.1 Leverage Ratio. The Borrower will not permit the ratio of its Leverage Ratio at any time during each period specified below to exceed the ratio specified below for such period:\nPERIOD MAXIMUM RATIO\nClosing Date through the penultimate day of Fiscal Year 1995 0.675:1.000\nAt all times thereafter 0.650:1.000\n8.2 Tangible Net Worth. The Borrower shall maintain a Tangible Net Worth at all times during each period specified below of not less than the amount specified below for such period:\n(a) Closing Date through the penultimate day of Fiscal Year 1995, $100,000,000, plus 25% of Borrower's consolidated net income (but not less than zero) for Borrower's Fiscal Year 1995; and\n(b) For the successive periods commencing on the last day of each Fiscal Year thereafter and ending on the penultimate day of next succeeding Fiscal Year, with the first such period commencing on the last day of Fiscal Year 1996, an amount equal to the minimum required Tangible Net Worth in effect under this Section 8.2 during the immediately preceding period plus 25% of Borrower's consolidated net income (but not less than zero) for Borrower's Fiscal Year ending on the date the applicable period commences.\n8.3 Current Ratio. The Borrower will maintain at all times and measured as of the last day of each fiscal year a Current Ratio of not less than 1.35 to 1.00.\n8.4 Fixed Charge Coverage Ratio. The Borrower will not permit its Fixed Charge Coverage Ratio to be less than 1.35 to 1.00 as of the last day of each fiscal period specified below:\n(a) the seven fiscal quarters of Borrower ending July 2, 1994; and\n(b) the eight fiscal quarters of Borrower ending on the last day of each fiscal quarter thereafter commencing with the fiscal quarter ending October 1, 1994.\n9. EVENTS OF DEFAULT\nThe occurrence of any of the following events or conditions shall constitute an Event of Default hereunder:\n9.1 Obligations. Borrower shall fail to make any payments of principal or interest of the Obligations when due;\n9.2 Misrepresentations. Borrower shall make any representations or warranties in any of the Loan Documents or in any certificate or statement furnished at any time hereunder or in connection with any of the Loan Documents which proves to have been untrue or misleading in any material respect when made or furnished and which continues to be untrue or misleading in any material respect.\n9.3 Certain Covenants. Borrower shall default in the observance or performance of any covenant or agreement contained in Sections 6 (other than Sections 6.7 or 6.11), 7 or 8 of this Agreement and such default continues for more than thirty (30) days after the earlier of (a) the date of notice thereof to such Borrower by the Agent or (b) the date Borrower knew or should have known of such default.\n9.4 Other Covenants. Either Borrower shall default in the observance or performance of any other covenant or agreement contained in this Agreement or under any of the other Loan Documents.\n9.5 Other Debts. Either Borrower or any Subsidiary shall default in the payment when due of any Indebtedness under any guaranty, note, indenture or other agreement relating to or evidencing Indebtedness having a principal balance of $1,000,000 or more, including, but not limited to, the Subordinated Notes and the Indebtedness under the Working Capital Credit Agreement, or any event specified in any guaranty, note, indenture or other agreement relating to or evidencing any such Indebtedness shall occur if the effect of such event is to cause or to permit (giving effect to any grace or cure period applicable thereto) the holder or holders of such Indebtedness to cause such Indebtedness to become due, or to be prepaid in full (whether by redemption, purchase or otherwise), prior to its stated maturity.\n9.6 Tax Lien. A notice of Lien, levy or assessment is filed of record with respect to all or any of any Borrower's or any Subsidiary's assets by the United States, or any department, agency or instrumentality thereof, or by any state, county, municipal or other governmental agency, including, without limitation, the PBGC, which in the opinion of the Majority Banks, adversely affects the priority of the Liens granted to Agent hereunder under the Deed of Trust or under the other Loan Documents.\n9.7 ERISA. The occurrence of any of the following events: (i) the happening of a Reportable Event with respect to any Plan which Reportable Event could result in a material liability for Borrower, any of its Subsidiaries or an ERISA Affiliate or which otherwise could have a material adverse effect on the financial condition, assets, business, operations, liabilities or property of Borrower, any of its Subsidiaries or such ERISA Affiliate; (ii) the disqualification or involuntary termination of a Plan for any reason which could result in a material liability for Borrower, any of its Subsidiaries or an ERISA Affiliate or which otherwise could have a material adverse effect on the financial condition, assets, business, operations, liabilities or property of Borrower, any of its Subsidiaries or such ERISA Affiliate; (iii) the voluntary termination of any Plan while such Plan has a funding deficiency (as determined under Section 412 of the Code) which could result in a material liability for Borrower, any of its Subsidiaries or an ERISA Affiliate or which otherwise could have a material adverse effect on the financial condition, assets, business, operations, liabilities or property of Borrower, any of its Subsidiaries or such ERISA Affiliate; (iv) the appointment of a trustee by an appropriate United States district court to administer any such Plan; (v) the institution of any proceedings by the PBGC to terminate any such Plan or to appoint a trustee to administer any such Plan; (vi) the failure of Borrower to notify the Agent and the Banks promptly upon receipt by Borrower or any of its Subsidiaries of any notice of the institution of any proceeding or other actions which may result in the termination of any such Plan.\n9.8 Voluntary Bankruptcy. Borrower or any of its Subsidiaries shall: (a) file a voluntary petition or assignment in bankruptcy or a voluntary petition or assignment or answer seeking liquidation, reorganization, arrangement, readjustment of its debts, or any other relief under the Bankruptcy Code, or under any other act or law pertaining to insolvency or debtor relief, whether State, Federal, or foreign, now or hereafter existing; (b) enter into any agreement indicating consent to, approval of, or acquiescence in, any such petition or proceeding; (c) apply for or permit the appointment, by consent or acquiescence, of a receiver, custodian or trustee of Borrower or any of its Subsidiaries or for all or a substantial part of its property; (d) make a general assignment for the benefit of creditors; or (e) be unable or shall fail to pay its debts generally as such debts become due, admit in writing its inability or failure to pay its debts generally as such debts become due, or otherwise become insolvent.\n9.9 Involuntary Bankruptcy. There shall have been filed against Borrower or any of its Subsidiaries an involuntary petition in bankruptcy or seeking liquidation, reorganization, arrangement, readjustment of its debts or any other relief under the Bankruptcy Code, or under any other act or law pertaining to insolvency or debtor relief, whether State, Federal or foreign, now or hereafter existing; Borrower or any of its Subsidiaries shall suffer or permit the involuntary appointment of a receiver, custodian or trustee of Borrower or any of its Subsidiaries or for all or a substantial part of its property; or Borrower or any of its Subsidiaries shall suffer or permit the issuance of a warrant of attachment, execution or similar process against all or any substantial part of the property of Borrower or any of its Subsidiaries.\n9.10 Suspension of Business. The suspension of the transaction of the usual business of the Borrower or of the usual business of any of its Subsidiaries or the involuntary dissolution of the Borrower or the involuntary dissolution of any of its Subsidiaries.\n9.11 Judgments. Any judgment, decree or order for the payment of money which, when aggregated with all other judgments, decrees or orders for the payment of money pending against Borrower or any of its Subsidiaries, exceeds the sum of $1,000,000, shall be rendered against Borrower or any of its Subsidiaries and remain unsatisfied and in effect for a period of sixty (60) consecutive days without being vacated, discharged, satisfied or stayed or bonded pending appeal.\n9.12 Change in Control. There occurs a \"Change in Control\" as such term is defined on the date hereof in the Subordinated Notes Indenture.\n9.13 Event of Default under Deed of Trust or Second Deed of Trust. There occurs an \"Event of Default\" under the Deed of Trust or the Second Deed of Trust.\n10. REMEDIES\nUpon the occurrence or existence of any Event of Default, and during the continuation thereof, without prejudice to the rights of the Agent and the Banks to enforce their claims against Borrower for damages for failure by Borrower to fulfill any of the obligations hereunder, the Agent and the Banks shall have the following rights and remedies, in addition to any other rights and remedies available to the Agent and the Banks at law, in equity or otherwise:\n10.1 Default Rate. At the election of the Majority Banks, evidenced by written notice to the Borrower, the outstanding principal balance of the Obligations and, to the extent permitted by applicable law, accrued and unpaid interest thereon, shall bear interest at the Default Rate until paid in full.\n10.2 Acceleration of the Obligations. In the event of the occurrence of (a) an Event of Default set forth in Sections 9.8 or 9.9 hereof, the Obligations shall automatically and immediately become due and payable; and (b) any other Event of Default, the Majority Banks, at their option, may declare all of the Obligations to be immediately due and payable, whereupon all of the Obligations shall become immediately due and payable, in either case without presentment, demand, protest, notice of non-payment or any other notice required by law relative thereto, all of which are hereby expressly waived by Borrower, anything contained herein to the contrary notwithstanding.\n10.3 Set-Off. The right of each Bank to set-off, without notice to Borrower, any and all deposits at any time credited by or due from such Bank to Borrower, whether in a general or special, time or demand, final or provisional account or any other account or represented by a certificate of deposit and whether or not unmatured or contingent.\n10.4 Rights and Remedies of a Secured Party. All of the rights and remedies of a secured party under the UCC or under other applicable law, all of which rights and remedies shall be cumulative, and none of which shall be exclusive, to the extent permitted by law, in addition to any other rights and remedies contained in this Agreement, and in any of the other Loan Documents.\n10.5 Take Possession of Collateral. The right of the Agent to (a) enter upon the Land, or any other place or places where the Collateral is located and kept, through self-help and without judicial process, without first obtaining a final judgment or giving Borrower notice and opportunity for a hearing on the validity of the Agent's or the Banks' claim and without any obligation to pay rent to Borrower, and remove the Collateral therefrom to the premises of Agent or any agent of Agent, for such time as Agent may desire, in order to effectively collect or liquidate the Collateral, and\/or (b) require Borrower to assemble the Collateral and make it available to Agent at a place to be designated by Agent which is reasonably convenient to both Borrower and Agent.\n10.6 Sale of Collateral. The right of the Agent to sell or to otherwise dispose of all or any of the Collateral, at public or private sale or sales, with such notice as may be required by law, in lots or in bulk, for cash or on credit, all as Agent, in its sole discretion, may deem advisable; such sales may be adjourned from time to time with or without notice. Agent shall have the right to conduct such sales on Borrower's premises or elsewhere and shall have the right to use Borrower's premises without charge for such sales for such time or times as Agent may see fit. Agent is hereby granted a license or other right to use, without charge, Borrower's labels, patents, copyrights, rights of use of any name, trade secrets, trade names, trademarks, service marks and advertising matter, or any property of a similar nature, whether owned by Borrower or with respect to which Borrower has rights under license, sublicense or other agreements, as it pertains to the Collateral, in preparing for sale, advertising for sale and selling any Collateral and Borrower's rights under all licenses and all franchise agreements shall inure to the benefit of the Agent and the Banks. Agent shall have the right to sell, lease or otherwise dispose of the Collateral, or any part thereof, for cash, credit or any combination thereof, and the Agent or any Bank may purchase all or any part of the Collateral at public or, if permitted by law, private sale and, in lieu of actual payment of such purchase price, may set off the amount of such price against the Obligations. The proceeds realized from the sale of any Collateral shall be applied first to the costs, expenses and reasonable attorneys' fees and expenses incurred by Agent for collection and for acquisition, completion, protection, removal, storage, sale and delivery of the Collateral; second to interest due upon any of the Obligations; and third to the principal of the Obligations. If any deficiency shall arise, Borrower shall remain liable to the Banks therefor.\n10.7 Remedies Under Deed of Trust and Second Deed of Trust. The right of the Agent to sell or otherwise dispose of all or any of the Mortgaged Property, in the manner provided for in the Deed of Trust and the Second Deed of Trust and all other rights and remedies available to the Agent under the Deed of Trust and the Second Deed of Trust.\n10.8 Notice. Any notice required to be given by Agent of a sale, lease, other disposition of the Collateral or any other intended action by Agent, given to Borrower in the manner set forth in Section 13.8 below, ten (10) days prior to such proposed action, shall constitute commercially reasonable and fair notice thereof to Borrower.\n10.9 Appointment of Agent as Borrower's Lawful Attorney. Borrower irrevocably designates, makes, constitutes and appoints Agent (and all persons designated by Agent) as Borrower's true and lawful attorney, and Agent or Agent's agent, may, without notice to Borrower, and at such time or times thereafter as Agent or said agent, in its sole discretion, may determine, in Borrower's or Agent's name do all acts and things necessary, in Agent's sole discretion, to fulfill Borrower's obligations under this Agreement.\n11. CONDITIONS PRECEDENT\nNotwithstanding any other provision of this Agreement, it is understood and agreed that the Banks shall have no obligation to make any Loan unless and until the following conditions have been met, to the sole and complete satisfaction of the Banks, the Agent and their respective counsel:\n11.1 No Injunction. No action, proceeding, investigation, regulation or legislation shall have been instituted, threatened or proposed before any court, governmental agency or legislative body to enjoin, restrain, or prohibit, or to obtain substantial damages in respect of, or which is related to or arises out of this Agreement or the making of such Loan, or which in the Banks' sole discretion, would make it inadvisable to make such Loan.\n11.2 No Material Adverse Change. Since October 2, 1993 there shall not have occurred any material adverse change in Borrower's or any Subsidiary's business, or any event, condition, or state of facts which would be expected materially and adversely to affect the prospects of Borrower or any of its Subsidiaries subsequent to consummation of the transactions contemplated by this Agreement as determined by the Majority Banks in their sole discretion.\n11.3 No Default or Event of Default. There shall exist no Default or Event of Default or any event or condition which, with the making of the Loans would constitute a Default or Event of Default.\n11.4 Regulatory Restrictions. Neither Borrower nor any of its Subsidiaries shall be subject to any applicable statute, rule, regulation, order, writ or injunction of any court or governmental authority or agency which would materially restrict or hinder the conduct of Borrower's or such Subsidiary's business as conducted on the date hereof or which would have a material adverse affect on the business, property, assets, operations or condition, financial or otherwise of Borrower or such Subsidiary.\n11.5 Compliance with Law. The Agent shall have received such evidence as it may reasonably request that the Land and the Mortgaged Property and the uses thereof comply in all material respects with all applicable laws, regulations, codes, orders, ordinances, rules and statutes, including, without limitation, those relating to zoning and environmental protection.\n11.6 Documentation. The Agent and the Banks shall have received the following, each duly executed and delivered to the Agent and the Banks, and each to be satisfactory in form and substance to Agent and its counsel:\n(a) the Notes;\n(b) the Deed of Trust;\n(c) the Second Deed of Trust;\n(d) an amendment to that certain Environmental Indemnity Agreement dated June 3, 1993, reaffirming the warranties and representations made by Borrower thereunder;\n(e) a certificate signed by the chief executive officer and chief financial officer of Borrower dated as of the Closing Date, stating that the representations and warranties set forth in Article 5 hereof are true and correct in all material respects on and as of such date with the same effect as though made on and as of such date, stating that Borrower is on such date in compliance with all the terms and conditions set forth in this Agreement on its part to be observed and performed, and stating that on such date, and after giving effect to the making of any initial Loan no Default or Event of Default has occurred or is continuing;\n(f) a certificate executed by the chief financial officer of Borrower dated as of the Closing Date with respect to the Equipment owned by Borrower;\n(g) a certificate of the Secretary of Borrower dated as of the Closing Date certifying (i) that attached thereto is a true and correct copy of the By-Laws of Borrower, as in effect on the date of such certification, (ii) that attached thereto is a true and complete copy of Resolutions adopted by the Board of Directors of Borrower, authorizing the execution, delivery and performance of this Agreement and the other Loan Documents; and (iii) as to the incumbency and genuineness of the signatures of the officers of Borrower executing this Agreement or any of the other Loan Documents;\n(h) a copy of the Articles of Incorporation of the Borrower, and all amendments thereto, certified by the Secretary of State of the State of Delaware dated as of a date close to the Closing Date;\n(i) copies of all filing receipts or acknowledgements issued by any governmental authority to evidence any filing or recordation necessary to perfect the Liens of Agent in the Collateral and evidence in a form acceptable to the Majority Banks that such Liens constitute valid and perfected first priority Liens;\n(j) a Good Standing Certificate for Borrower, issued by the Secretary of State of Texas, dated as of a date close to the Closing Date;\n(k) certified copies of Borrower's casualty and liability insurance policies with evidence of the payment of the premium therefor, together, in the case of such casualty policies, with loss payable and mortgagee endorsements on Agent's standard form naming Agent as loss payee;\n(l) the written opinion of Godwin & Carlton, counsel to Borrower, dated as of the Closing Date, in the form attached hereto as Exhibit E hereto, as to the transactions contemplated by this Agreement;\n(m) assurance from a title insurance company satisfactory to the Agent and the Banks that such title insurance company is committed to cause the Second Deed of Trust to be recorded and, upon re cordation of the Second Deed of Trust, to issue its ALTA lender's title insurance policies in a form acceptable to the Agent and in amounts satisfactory to the Agent, showing the Second Deed of Trust as the \"insured mortgage\" and insuring the validity and priority of the Second Deed of Trust as a Lien upon the specified Owned Real Property, subject only to the First Deed of Trust, subordinated Lien in favor of John Hancock Mutual Life Insurance Company and to the Permitted Liens described in clauses (b) - (d) of the definition thereof;\n(n) an amendment to the Subordination Agreement; and\n(o) such other documents, instruments and agreements with respect to the transactions contemplated by this Agreement, in each case in such form and containing such additional terms and conditions as may be reasonably satisfactory to the Majority Banks, and containing, without limitation, representations and warranties which are customary and usual in such documents.\n12. THE AGENT\n12.1 Appointment, Powers and Immunities. Each Bank hereby irrevocably appoints and authorizes the Agent to act as its agent hereunder with such powers as are specifically delegated to the Agent by the terms of this Agreement, together with such other powers as are reasonably incidental thereto. The Agent (which term as used in this sentence and in Section 12.5 and the first sentence of Section 12.6 hereof shall include reference to its Affiliates and its own and its Affiliates' officers, directors, employees and agents): (a) shall have no duties or responsibilities except those expressly set forth in this Agreement, and shall not by reason of this Agreement be a trustee for any Bank; (b) shall not be responsible to the Banks for any recitals, statements, representations or warranties contained in this Agreement or any of the other Loan Documents, or in any certificate or other instrument, document or agreement referred to or provided for in, or received by any of them under, this Agreement or any of the other Loan Documents, or for the value, validity, effectiveness, genuineness, enforceability or sufficiency of this Agreement, any Note or any of the other Loan Documents or for any failure by any Borrower or any other Person to perform any of its obligations hereunder or thereunder; (c) subject to Section 12.3 hereof, shall not be required to initiate or conduct any litigation or collection proceedings hereunder; and (d) shall not be responsible for any action taken or omitted to be taken by it hereunder or under any other agreement, document or instrument referred to or provided for herein or in connection herewith, except for its own gross negligence or willful misconduct. The Agent may employ agents and attorneys-in-fact and shall not be responsible for the negligence or misconduct of any such agents or attorneys-in-fact selected by it in good faith. The Agent may deem and treat the payee of any Note as the holder thereof for all purposes hereof unless and until a written notice of the assignment or transfer.\n12.2 Reliance by Agent. The Agent shall be entitled to rely upon any certification, notice or other communication (including any thereof by telephone, telex, facsimile, telegram or cable) believed by it to be genuine and correct and to have been signed or sent by or on behalf of the proper Person or Persons, and upon advice and statements of legal counsel, independent accountants and other experts selected by the Agent. As to any matters not expressly provided for by this Agreement, the Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder in accordance with instructions signed by the Majority Banks, and such instructions of the Majority Banks and any action taken or failure to act pursuant thereto shall be binding on all of the Banks.\n12.3 Defaults. The Agent shall not be deemed to have knowledge or notice of the occurrence of a Default or Event of Default (other than the non-payment of principal of or interest on Loans) unless the Agent has received notice from a Bank or the Borrower specifying such Default or Event of Default and stating that such notice is a \"Notice of Default\". In the event that the Agent receives such a notice of the occurrence of a Default or Event of Default, the Agent shall give prompt notice thereof to the Banks (and shall give each Bank prompt notice of each such non-payment). The Agent shall (subject to Section 12.7 hereof) take such action with respect to such Default or Event of Default as shall be directed by the Majority Banks, provided that, unless and until the Agent shall have received such directions, the Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Default or Event of Default as it shall deem advisable in the best interest of the Banks.\n12.4 Rights as a Bank. With respect to its Loan Percentage and the Loans made by it, Creditanstalt (and any successor acting as Agent) in its capacity as a Bank hereunder shall have the same rights and powers hereunder as any other Bank and may exercise the same as though it were not acting as the Agent, and the term \"Bank\" or \"Banks\" shall, unless the context otherwise indicates, include the Agent in its individual capacity. Creditanstalt (and any successor acting as Agent) and its Affiliates may (without having to account therefor to any Bank) accept deposits from, lend money to and generally engage in any kind of banking, trust or other business with Borrower (and any of its Affiliates) as if it were not acting as the Agent, and Creditanstalt and its Affiliates may accept fees and other consideration from Borrower for services in connection with this Agreement or otherwise without having to account for the same to the Banks.\n12.5 Indemnification. The Banks agree to indemnify the Agent (to the extent not reimbursed under Sections 13.6 or 13.14 hereof, but without limiting the obligations of Borrower under said Sections 13.6 and 13.14), for their Loan Percentage of any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind and nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of this Agreement or any other instruments, documents or agreements contemplated by or referred to herein or the transactions contemplated hereby (including, without limitation, the costs and expenses which Borrower is obligated to pay under Section 13.6 hereof but excluding, unless an Event of Default has occurred and is continuing, normal administrative costs expenses incident to the performance of its agency duties hereunder) or the enforcement of any of the terms hereof or of any such other instruments, documents or agreements, provided that no Bank shall be liable for any of the foregoing to the extent they arise from the gross negligence or willful misconduct of the party to be indemnified.\n12.6 Non-Reliance on Agent and other Banks. Each Bank agrees that it has, independently and without reliance on the Agent or any other Bank, and based on such documents and information as it has deemed appropriate, made its own credit analysis of the Borrower and its own decision to enter into this Agreement and that it will, independently and without reliance upon the Agent or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own analysis and decisions in taking or not taking action under this Agreement. The Agent shall not be required to keep itself informed as to the performance or observance by the Borrower of this Agreement or any other instrument, document or agreement referred to or provided for herein or to inspect the properties or books of the Borrower. Except for notice, reports and other documents and information expressly required to be furnished to the Banks by the Agent hereunder, the Agent shall not have any duty or responsibility to provide any Bank with any credit or other information concerning the affairs, financial condition or business of the Borrower (or any of its Affiliates) which may come into the possession of the Agent or any of its Affiliates.\n12.7 Failure to Act. Except for action expressly required of the Agent hereunder, the Agent shall in all cases be fully justified in failing or refusing to act hereunder unless it shall receive further assurances to its satisfaction from the Banks of their indemnification obligations under Section 12.5 hereof against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action.\n12.8 Resignation or Removal of Agent; Co-Agent.\n(a) Subject to the appointment and acceptance of a successor Agent as provided below, the Agent may resign at any time by giving notice thereof to the Banks and the Borrower and the Agent may be removed at any time with cause by the Majority Banks. Upon any such resignation or removal, the Majority Banks shall have the right to appoint a successor Agent. If no successor Agent shall have been so appointed by the Majority Banks and shall have accepted such appointment with 30 days after the retiring Agent's giving of notice of resignation or the Majority Bank's removal of the retiring Agent, the retiring Agent may, on behalf of the Banks, appoint a successor Agent, which shall be a bank which has a combined capital and surplus of at least Five Hundred Million Dollars ($500,000,000). Upon the acceptance of any appointment as Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations hereunder. After any retiring Agent's resignation or removal hereunder as Agent, the provisions of this Section 12 shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as the Agent.\n(b) In the event that applicable law imposes any restrictions on the identity of an agent such as the Agent or requires the appointment of any co-agent in connection therewith, the Agent may, in its discretion, for the purpose of complying with such restrictions, appoint one or more co-agents hereunder. Any such Co- Agent(s) shall have the same rights, powers, privileges and obligations as the Agent and shall be subject to and entitled to the benefits of all provisions of this Agreement and the Loan Documents relative to the Agent. In addition to any rights of the Majority Banks set forth in subsection (a) above, any such Co-Agent may be removed at any time by the Agent.\n13. MISCELLANEOUS\n13.1 Intellectual Property License. Agent is hereby granted a non-exclusive, assignable license or other right to use, without charge, Borrower's copyrights, patents, patent applications, designs, rights of use, or any property of a similar nature, whether owned by Borrower or with respect to which Borrower has rights under license, sublicense or other agreements (collectively, the \"Intellectual Property Rights\"), to the extent such Intellectual Property Rights are necessary for the proper operation of, or are used by Borrower in the operation of, the Collateral or the Mortgaged Property. Such license (a) may only be used in connection with the operation of the Collateral and the Mortgaged Property, (b) shall terminate upon the payment in full of the Obligations at any time when there does not exist an Event of Default, and (c) shall become perpetual (and shall survive the termination of this Agreement) upon the transfer of any of the Collateral or the Mortgaged Property in foreclosure of the Agent's Liens in such Collateral or Mortgaged Property, whether such foreclosure is by right of private sale, judicial sale, deed in lieu, retention in satisfaction of the Obligations or otherwise. Borrower agrees, at the request of the Agent or the Majority Banks, to take any and all actions and to execute, deliver and\/or record any and all instruments, documents, licenses or agreements, as may be necessary or appropriate to confirm the foregoing license and\/or evidence such license in any public record.\n13.2 Waiver. Each and every right and remedy granted to the Agent and the Banks under this Agreement, or any other document delivered hereunder or in connection herewith or allowed it by law or in equity, shall be cumulative and may be exercised from time to time. No failure on the part of the Agent or any Bank to exercise, and no delay in exercising, any right or remedy shall operate as a waiver thereof, nor shall any single or partial exercise by the Agent or any Bank of any right or remedy preclude any other or future exercise thereof or the exercise of any other right or remedy. No waiver by the Agent or the Banks of any Default or Event of Default shall constitute a waiver of any subsequent Default or Event of Default.\n13.3 Survival. All representations, warranties and covenants made herein shall survive the execution and delivery of all of the Loan Documents. The terms and provisions of this Agreement shall continue in full force and effect until all of the Obligations have been indefeasibly paid in full; provided, further, that Borrower's obligations under Sections 3.6, 3.7, 13.6 and 13.14 shall survive the termination of this Agreement.\n13.4 Assignments; Successors and Assigns.\n(a) This Agreement is a continuing obligation and binds, and the benefits hereof shall inure to, Borrower, Agent and each Bank and their respective successors and assigns provided, that Borrower may not transfer or assign any or all of its rights or obligations hereunder without the prior written consent of all of the Banks.\n(b) Any Bank may, in the ordinary course of its commercial banking business and in accordance with the applicable law, at any time sell to one or more banks or other entities (\"Participants\") participating interests in any Loans owing to such Bank, any of the Notes held by such Bank, or any other interests of such Bank hereunder. Borrower agrees that each Participant shall be entitled to the benefits of Section 3.7 and 13.14 with respect to its participation; provided that no Participant shall be entitled to receive any greater amount pursuant to such Section than such Bank would have been entitled to receive in respect of the amount of the participation transferred by such Bank to such Participant had no such transfer occurred.\n(c) Each Bank may, in the ordinary course of its commercial banking business and in accordance with applicable law, at any time assign, pursuant to an assignment substantially in the form of Exhibit F attached hereto and incorporated herein by reference, without the Borrower's consent, to one or more banks having unimpaired capital and surplus of $250,000,000 or more or may assign with the Borrower's consent (which shall not be unreasonably withheld) to any other entities (in either case, \"Assignees\") all or any part of any Loans owing to such Bank, any of the Notes held by such Bank, or any other interest of such Bank hereunder; provided, however, that any such assignment shall be in a minimum principal amount of Two Million Dollars ($2,000,000). Borrower and the Banks agree that to the extent of any assignment the Assignee shall be deemed to have the same rights and benefits with respect to Borrower under this Agreement and any of the Notes as it would have had if it were a Bank hereunder on the date hereof and the assigning Bank shall be released from its obligations hereunder, to the extent of such assignment.\n(d) Borrower authorizes each Bank to disclose to any Participant or Assignee (\"Transferee\") and any prospective Transferee any and all financial information in such Bank's possession concerning Borrower which has been delivered to such Bank by Borrower pursuant to this Agreement or which has been delivered to such Bank by Borrower in connection with such Bank's credit evaluation of Borrower prior to entering into this Agreement.\n(e) Any Bank shall be entitled to have any Note held by it subdivided in connection with a permitted assignment of all or any portion of such Note and the respective Loans evidenced thereby pursuant to Section 13.4(c) above. In the case of any such subdivision, the new Note (the \"New Note\") issued in exchange for a Note (the \"Old Note\") previously issued hereunder (i) shall be substantially in the form of Exhibit B hereto, (ii) shall be dated the date of such assignment, (iii) shall be otherwise duly completed and (iv) shall bear a legend, to the effect that such New Note is issued in exchange for such Old Note and that the indebtedness represented by such Old Note shall not have been extinguished by reason of such exchange. Without limiting the obligations of Borrower under Section 13.6 hereof, the Banks shall use reasonable best efforts to ensure that any such assignment does not result in the imposition of any intangibles, documentary stamp and other taxes, if any, which may be payable in connection with the execution and delivery of any such New Note.\n(f) If, pursuant to this subsection, any interest in this Agreement or any of the Notes is transferred to any Transferee which is organized under the laws of any jurisdiction other than the United States or any State thereof, the Bank making such transfer shall cause such Transferee, concurrently with the effectiveness of such transfer, (i) to represent to such Bank (for the benefit of such Bank and Borrower) that under applicable law and treaties no taxes will be required to be withheld by such Bank or Borrower with respect to any payments to be made to such Transferee hereunder or in respect of the Loans, (ii) to furnish to such Bank and Borrower either U.S. Internal Revenue Service Form 4224 or U.S. Internal Revenue Service Form 1001 (wherein such Transferee claims entitlement to complete exemption from U.S. federal withholding tax on all payments hereunder) and (iii) to agree (for the benefit of such Bank and Borrower) to provide such Bank and Borrower a new Form 4224 or Form 1001 upon the obsolescence of any previously delivered form and comparable statements in accordance with applicable U.S. laws and regulations and amendments duly executed and completed by such Transferee, and to comply from time to time with all applicable U.S. laws and regulations with regard to such withholding tax exemption.\n13.5 Counterparts. This Agreement may be executed in two or more counterparts, each of which when fully executed shall be an original, and all of said counterparts taken together shall be deemed to constitute one and the same agreement. Any signature page to this Agreement may be witnessed by a telecopy or other facsimile of any original signature page and any signature page of any counterpart hereof may be appended to any other counterpart hereof to form a completely executed counterpart hereof.\n13.6 Expense Reimbursement. Borrower agrees to reimburse the Agent for all of the Agent's expenses incurred in connection with the development, preparation, execution, delivery, modification, regular review and administration of this Agreement, the Notes and the other Loan Documents, including audit costs, appraisal costs, the cost of searches, filings and filing fees, taxes and the fees and disbursements of Agent's attorneys, Messrs. Troutman Sanders, and any counsel retained by them, and all costs and expenses incurred by the Agent and the Banks (including attorney's fees and disbursements) to: (i) commence, defend or intervene in any court proceeding; (ii) file a petition, complaint, answer, motion or other pleading, or to take any other action in or with respect to any suit or proceeding (bankruptcy or otherwise) relating to the Collateral, the Mortgaged Property or this Agreement, the Deed of Trust, the Notes or any of the other Loan Documents; (iii) protect, collect, lease, sell, take possession of, or liquidate any of the Collateral or the Mortgaged Property; (iv) attempt to enforce any Lien in any of the Collateral or the Mortgaged Property or to seek any advice with respect to such enforcement; and (v) enforce any of the Agent's and the Banks' rights to collect any of the Obligations. Borrower also agrees to pay, and to save harmless the Agent and the Banks from any delay in paying, any intangibles, mortgage, documentary stamp and other taxes, if any, which may be payable in connection with the execution and delivery of this Agreement, the Notes or any of the other Loan Documents, or the recording of any thereof, or in any modification hereof or thereof. Additionally, Borrower shall pay to the Agent and each Bank on demand any and all fees, costs and expenses which the Agent or such Bank pays to a bank or other similar institution arising out of or in connection with (a) the forwarding to Borrower or any other Person on Borrower's behalf, by the Agent or such Bank of proceeds of any Loan and (b) the depositing for collection by of any check or item of payment received by or delivered to the Agent or such Bank on account of the Obligations. Borrower's obligations under this Section shall survive the termination of this Agreement and the repayment of the Obligations.\n13.7 Severability. If any provision of this Agreement or any of the Loan Documents or the application thereof to any party thereto or circumstances shall be invalid or unenforceable to any extent, the remainder of this Agreement or such Loan Documents and the application of such provisions to any other party thereto or circumstance shall not be affected thereby and shall be enforced to the greatest extent permitted by law.\n13.8 Notices. All notices, requests, demands and other communications under this Agreement shall be in writing and shall be deemed to have been given or made when (a) delivered by hand, (b) sent by telex or telecopier (with receipt confirmed), provided that a copy is mailed by certified mail, return receipt requested, or (c) except as otherwise provided herein, deposited in the mail, registered or certified mail, postage prepaid, addressed to such party at the \"Address for Notices\" specified below its name on the signature pages hereto or to such other address as may be designated hereafter in writing by the respective parties hereto.\n13.9 Entire Agreement - Amendment. This Agreement and the Loan Documents constitute the entire agreement between the parties hereto with respect to the subject matter hereof and supersede all prior negotiations, understandings and agreements between such parties in respect of such subject matter, including, without limitation, as set forth in that certain commitment letter dated June 17, 1994 from Creditanstalt to Borrower, accepted by Borrower June 20, 1994. Neither this Agreement nor any provision hereof may be changed, waived, discharged, modified or terminated except pursuant to a written instrument signed by Borrower, the Agent and the Majority Banks or by the Borrower and the Agent acting with the consent of the Majority Banks; provided, however, that no such amendment, waiver, discharge, modification or termination shall, except pursuant to an instrument signed by Borrower, the Agent and all of the Banks or by the Borrower and the Agent acting with the consent of all of the Banks, (a) extend the date fixed for the payment of principal of, or interest on, any Loan; (b) reduce the amount of any payment of principal of, or the rate of interest on, any Loan (except for changes in interest rates pursuant to Section 3.1(b) hereof); (c) reduce any fee payable hereunder; (d) alter the terms of this Section 13.9; (e) release any collateral securing the Loans, or any portion thereof; (f) change the Loan Percentage of any Bank; or (g) amend the definitions of the term \"Majority Banks\" set forth in Section 1.1 hereof; provided, further, that any amendment, waiver, discharge modification or termination of any provision of Section 12 hereof, or which increases the obligations of the Agent hereunder, shall require the written consent of the Agent.\n13.10 Time of the Essence. Time is of the essence in this Agreement and the other Loan Documents.\n13.11 Interpretation. No provision of this Agreement shall be construed against or interpreted to the disadvantage of any party hereto by any court or other governmental or judicial authority by reason of such party having or being deemed to have structured or dictated such provision.\n13.12 Banks Not a Joint Venturer. Neither this Agreement nor any agreements, instruments, documents or transactions contemplated hereby (including the Loan Documents) shall in any respect be interpreted, deemed or construed as making the Agent or the Banks a partner or joint venturer with Borrower or as creating any similar relationship or entity, and Borrower agrees that it will not make any assertion, contention, claim or counterclaim to the contrary in any action, suit or other legal proceeding involving the Agent or the Banks and Borrower.\n13.13 Cure of Defaults by Banks. If, hereafter, Borrower defaults in the performance of any duty or obligation to the Agent and the Banks hereunder, the Agent or any Bank may, at its option, but without obligation, cure such default and any costs, fees and expenses incurred by the Agent or such Bank in connection therewith including, without limitation, for payment on mortgage or note obligations, for the purchase of insurance, the payment of taxes and the removal or settlement of Liens and claims, shall be included in the Obligations and be secured by the Collateral and the Mortgaged Property.\n13.14 Indemnity. In addition to any other indemnity provided for herein, or in the other Loan Documents, Borrower hereby indemnifies the Agent and each Bank from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever (including, without limitation, fees and disbursements of counsel) which may be imposed on, incurred by, or asserted against the Agent or such Bank in any litigation, proceeding or investigation instituted or conducted by any governmental agency or instrumentality or any other Person (other than Borrower) with respect to any aspect of, or any transaction contemplated by, or referred to in, or any matter related to, this Agreement or the other Loan Documents, or the other transactions contemplated hereby, whether or not Agent or such Bank is a party thereto, except to the extent that any of the foregoing arises out of gross negligence or willful misconduct of Agent or such Bank, as the case may be. Borrower's obligations under this Section shall survive the termination of this Agreement and the repayment of the Obligations.\n13.15 Attorney-in-Fact. Borrower hereby designates, appoints and empowers Agent irrevocably as its attorney-in-fact, at Borrower's cost and expense, to do in the name of Borrower any and all actions which Agent may deem necessary or advisable to carry out the terms hereof upon the failure, refusal or inability of Borrower to do so, and Borrower hereby agrees to indemnify and hold Agent harmless from any costs, damages, expenses or liabilities arising against or incurred by the Agent in connection therewith except to the extent that any of such costs, damages, expenses or liabilities arise out of Agent's gross negligence or willful misconduct.\n13.16 Sole Benefit. The rights and benefits set forth in this Agreement and in the other Loan Documents are for the sole and exclusive benefit of the parties thereto and may be relied upon only by them.\n13.17 Termination Statements. Borrower acknowledges and agrees that it is Borrower's intent that all financing statements filed hereunder shall remain in full force and effect until this Agreement shall have been terminated in accordance with the provisions hereof, even if, at any time or times prior to such termination, no loans or Loans shall be outstanding hereunder. Accordingly, Borrower waives any right which it may have under Section 9-404(1) of the UCC to demand the filing of termination statements with respect to the Collateral, and agrees that the Agent shall not be required to send such termination statements to Borrower, or to file them with any filing office, unless and until this Agreement shall have been terminated in accordance with its terms and all Obligations paid in full in immediately available funds. Upon such termination and payment in full, Agent shall execute appropriate termination statements and deliver the same to Borrower.\n13.18 Governing Law; Jurisdiction. THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS, AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER AND THEREUNDER, SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK (WITHOUT REGARD TO PRINCIPLES OF CONFLICTS OF LAW). BORROWER HEREBY (A) SUBMITS TO THE NONEXCLUSIVE JURISDICTION OF THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK AND OF ANY NEW YORK STATE COURT SITTING IN NEW YORK CITY FOR THE PURPOSES OF ALL LEGAL PROCEEDINGS ARISING OUT OF OR RELATING TO THIS AGREEMENT AND (B) IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF THE VENUE OF ANY SUCH PROCEEDING BROUGHT IN SUCH A COURT OR ANY CLAIM THAT ANY SUCH PROCEEDING BROUGHT IN SUCH A COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. NOTWITHSTANDING ANYTHING HEREIN TO THE CONTRARY, NOTHING HEREIN SHALL LIMIT THE RIGHT OF THE AGENT OR THE BANKS TO BRING PROCEEDINGS AGAINST BORROWER IN THE COURTS OF ANY OTHER JURISDICTION.\n13.19 Waiver of Jury Trial. BORROWER, AGENT AND EACH BANK EACH HEREBY KNOWINGLY, INTELLIGENTLY AND INTENTIONALLY WAIVES ANY AND ALL RIGHTS IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LEGAL PROCEEDING BASED ON OR ARISING OUT OF, UNDER, IN CONNECTION WITH, OR RELATING TO THIS AGREEMENT, ANY OF THE NOTES, ANY OF THE OTHER LOAN DOCUMENTS, THE TRANSACTIONS CONTEMPLATED HEREBY, OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER ORAL OR WRITTEN), OR ACTIONS OF BORROWER, AGENT OR ANY BANK. THIS PROVISION IS A MATERIAL INDUCEMENT FOR THE BANKS MAKING THE LOANS TO BORROWER.\nIN WITNESS WHEREOF, each of Borrower, the Agent and the Banks has set its hand and seal as of the day and year first above written.\n\"BORROWER\"\nPILGRIM'S PRIDE CORPORATION\nBy: Lonnie A. Pilgrim Chief Executive Officer\nAttest: Clifford E. Butler Chief Financial Officer\n[CORPORATE SEAL]\nAddress for Notices:\nPilgrim's Pride Corporation 110 South Texas P.O. Box 93 Pittsburg, Texas 75686 Attn: Mr. Clifford E. Butler Telecopy Number: (903) 856-7505\nwith a copy to:\nGodwin & Carlton 901 Main Street Dallas, Texas 75202 Attn: James R. Vetter, Esq. Telecopy Number: (214) 760-7332\n[Signatures continued on following page] [Signatures continued from previous page]\n\"AGENT\"\nCREDITANSTALT-BANKVEREIN\nBy: Robert M. Biringer Senior Vice President\nBy: Gregory F. Mathis Vice President\nAddress for Notices: Creditanstalt-Bankverein 245 Park Avenue New York, New York 10167 Attn: Dennis O'Dowd Telecopy Number: (212) 851-1234\nwith copies to:\nCreditanstalt-Bankverein Two Ravinia Drive Suite 1680 Atlanta, Georgia 30346 Attn: Robert M. Biringer\/Joseph P. Longosz Telecopy Number: (404) 390-1851\nand\nTroutman Sanders NationsBank Plaza, Suite 5200 600 Peachtree Street, N.E. Atlanta, Georgia 30308-2216 Attn: Hazen H. Dempster, Esq. Telecopy Number: (404) 885-3900\nCommitment \"BANKS\"\nCREDITANSTALT-BANKVEREIN $10,000,000\nBy: Robert M. Biringer Senior Vice President\nBy: Gregory F. Mathis Vice President\nAddress for Notices: Creditanstalt-Bankverein 245 Park Avenue New York, New York 10167 Attn: Dennis O'Dowd Telecopy Number: (212) 851-1234\nwith copies to:\nCreditanstalt-Bankverein Two Ravinia Drive Suite 1680 Atlanta, Georgia 30346 Attn: Robert M. Biringer\/Joseph P. Longosz Telecopy Number: (404) 390-1851\nand\nTroutman Sanders NationsBank Plaza, Suite 5200 600 Peachtree Street, N.E. Atlanta, Georgia 30308-2216 Attn: Hazen H. Dempster, Esq. Telecopy Number: (404) 885-3900 EXHIBIT \"E\"\nForm of Opinion of Godwin & Carlton\nSECOND AMENDMENT TO GUARANTEE AGREEMENT\nSECOND AMENDMENT TO GUARANTEE AGREEMENT (this \"Second Amendment\"), dated as of October 2, 1994, by and among LONNIE A. PILGRIM, an individual residing in the State of Texas (\"L. Pilgrim\") and PATTY R. PILGRIM, an individual residing in the State of Texas (\"P. Pilgrim\") (L. Pilgrim and P. Pilgrim being hereinafter referred to, individually, as a \"Guarantor\" and, collectively, as the \"Guarantors\") and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee under an Amended and Restated Collateral Trust Indenture, dated as of September 21, 1990 (as amended to and including the date hereof, the \"Indenture\"), between Pilgrim's Pride Corporation, a Delaware corporation, and State Street Bank and Trust Company of Connecticut, N.A., as Security Trustee (referred to herein as the \"Security Trustee\", which term shall also include its successors and assigns, including, without limitation, any successor security trustee under said Indenture).\nW I T N E S S E T H:\nWHEREAS, the Guarantors have guaranteed the payment and performance of all obligations of Pilgrim's Pride Corporation arising under, or in respect of (i) all Notes at any time issued or delivered pursuant to the Indenture or delivered in substitution and exchange therefor, (ii) the Indenture, and (iii) certain other obligations, pursuant to a certain Guarantee Agreement dated as of October 1, 1986 (as amended by a First Amendment dated as of September 21, 1990, the \"Existing Guarantee\"), and\nWHEREAS, the Guarantors currently own sixty-five percent (65%) of the issued and outstanding common stock of Pilgrim's Pride Corporation; and\nWHEREAS, the Guarantors have requested certain modifications to the Existing Guarantee which modifications are acceptable to the holders of the Notes; and\nWHEREAS, the holders of the Notes have instructed the Security Trustee to execute and deliver this Second Amendment to Guarantee Agreement.\nNOW THEREFORE, the Security Trustee and the Guarantors hereby agree as follows:\nSection 1. Deletion of Certain Sections of Existing Guarantee. Sections 1A, 1B and Schedule A of the Existing Guarantee are hereby deleted.\nSection 2. Stock Ownership. Section 2.1(i) of the Existing Guarantee is hereby deleted, and a new Section 2.1(g) is hereby added to the Existing Guarantee, as follows:\n(g) Ownership -- the Guarantors or their respective executors or administrators shall at any time fail to own, in the aggregate, at least 51% of the Common Stock outstanding at such time, or any Common Stock owned by either or both of the Guarantors shall be subject to any pledge or other encumbrance whatsoever.\nSection 3. Amendments to Defined Terms. Section 3.1 of the Existing Guarantee is hereby amended by redefining the following terms as follows:\nAgreement -- the eighth recital to this Agreement.\nExisting Note Purchase Agreement -- the sixth recital to this Agreement.\nGuarantee Agreement -- the eighth recital to this Agreement.\nIndenture -- that certain amended and restated Collateral Trust Indenture dated as of September 21, 1990, between Pilgrim's Pride Corporation and State Street Bank and Trust Company of Connecticut, N.A., as Security Trustee, as the same may be amended or supplemented from time to time.\n1990 Note Purchase Agreement -- the sixth recital to this Agreement.\nSeries C Notes -- the fourth recital to this agreement.\nSeries D Notes -- the fourth recital to this agreement.\nSection 4. Financing Documents. Each of the Financing Documents is hereby amended and modified to the extent that all references therein to, and descriptions therein of, the Existing Guarantee shall be deemed to refer to and describe the Existing Guarantee as amended and modified by this Second Amendment.\nSection 5. Modification: Full Force and Effect. The parties hereto hereby acknowledge and agree that, except as provided in this Second Amendment, the Existing Guarantee remains in full force and effect.\nSection 6. Counterparts. This Second Amendment may be executed in two or more counterparts, each of which shall be deemed an original, and all of which, taken together, shall constitute and be taken as one and the same instrument.\nIN WITNESS THEREOF, the parties hereto have executed this Second Amendment as of the date first hereinabove mentioned.\nLONNIE A. PILGRIM\nPATTY R. PILGRIM\nSTATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee\nBy: Michael J. D'Angelico\nIts Vice President\nSUPPLEMENTAL INDENTURE\nRE: PILGRIM'S PRIDE CORPORATION\nTHIS SUPPLEMENTAL INDENTURE (this \"Supplemental Indenture\"), dated as of October 2, 1994, between PILGRIM'S PRIDE CORPORATION (the \"Company\"), a Delaware corporation, and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as trustee (together with any successor security trustee, herein referred to as the \"Security Trustee\") for the trust created by the Amended and Restated Collateral Trust Indenture (as amended and in effect immediately prior to the effectiveness of this Supplemental Indenture, the \"Existing Indenture,\" and as amended and\/or supplemented from time to time, the \"Trust Indenture\"), dated as of September 21, 1990, between the Security Trustee and the Company.\nRECITALS:\nWHEREAS, the Company heretofore duly executed and delivered under the Existing Indenture (a) a Series of Notes limited, except as otherwise provided in the Existing Indenture, in aggregate principal amount to Twelve Million Dollars ($12,000,000), to be known as its 9.55% Senior Secured Notes, Series A, due October 1, 1998 (hereinafter sometimes called, and as more particularly defined in Section 2.1 of the Existing Indenture, the \"Series A Notes\"), (b) a Series of Notes limited, except as otherwise provided in the Existing Indenture, in aggregate principal amount to Eight Million Dollars ($8,000,000), to be known as its Variable Rate Senior Secured Notes, Series B, due October 1, 1992 (hereinafter sometimes called, and as more particularly defined in Section 2.1 of the Existing Indenture, the \"Series B Notes\"), (c) a Series of Notes limited, except as otherwise provided in the Existing Indenture, in aggregate principal amount to $22,000,000, to be known as its 10.49% Senior Secured Notes, Series C, due September 21, 2002 (hereinafter sometimes called, and as more particularly defined in Section 2.1 of the Existing Indenture, the \"Series C Notes\"), and (d) a Series of Notes limited, except as otherwise provided in the Existing Indenture, in aggregate principal amount to $18,000,000, to be known as its Variable Rate Senior Secured Notes, Series D, due December 31, 1996 (hereinafter sometimes called, and as more particularly defined in Section 2.1 of the Existing Indenture, the \"Series D Notes\"); and\nWHEREAS, the Series B Notes were exchanged for Series D Notes on October 5, 1990 and additional Series D Notes were issued in conjunction therewith; and\nWHEREAS, the Series D Notes have been prepaid in full; and\nWHEREAS, the Series A Notes and the Series C Notes are the only Notes still outstanding as of the date on which this Supplemental Indenture becomes effective; and\nWHEREAS, the Company has requested that certain financial covenants in the Existing Indenture be modified; and\nWHEREAS, the Company and all the holders of Notes wish to cancel the effect of the Supplemental Indentures dated as of December 9, 1991 and as of March 28, 1992, respectively, and to otherwise supplement the Existing Indenture pursuant to this Supplemental Indenture; and\nWHEREAS, in accordance with Section 9.2 of the Existing Indenture, all holders of Notes, as of the date hereof, have consented to the terms, provisions and conditions of, and have directed the Security Trustee to enter into, this Supplemental Indenture; and\nWHEREAS, for purposes of this Supplemental Indenture, the capitalized terms used herein and not defined herein shall have the respective meanings given to such terms in the Existing Indenture; and\nWHEREAS, all acts and proceedings required by law and by the Certificate of Incorporation and By-laws of the Company necessary to constitute this Supplemental Indenture a valid and binding agreement for the uses and purposes herein set forth, in accordance with its terms, have been done and taken, and the execution and delivery of this Supplemental Indenture have been in all respects duly authorized;\nAGREEMENT:\nNOW THEREFORE, THIS AGREEMENT AND SUPPLEMENTAL INDENTURE WITNESSETH, that to set forth the terms and conditions with respect to all of the Notes now and hereafter issued and delivered and outstanding under the Existing Indenture, and in consideration of the premises and of the covenants herein contained, the consent of the holders of Notes to the provisions of this Supplemental Indenture and the sum of $1.00 paid to the Security Trustee by the Company at or before the delivery hereof, the receipt and sufficiency of which are hereby acknowledged, it is hereby covenanted and agreed by and between the parties hereto that all of the Notes issued under the Existing Indenture are to be issued, delivered and outstanding subject to the further covenants, conditions, uses and trusts hereinafter set forth and set forth in the Trust Indenture; and the Company, for itself and its successors, does hereby covenant and agree to and with the Security Trustee with respect to said trust, for the benefit of all present and future holders of the Notes as follows:\nARTICLE 1 DEFINITIONS.\nArticle 1 of the Existing Indenture is hereby amended and restated to read in its entirety as follows:\nSection 1.1 Certain Definitions. For purposes of this Indenture, the following terms shall have the respective meanings set forth below or provided for in the section of this Indenture referred to immediately following such term (such definitions, unless otherwise expressly provided, to be equally applicable to both the singular and plural forms of the terms defined):\nAcceptable Bank -- a commercial bank organized under the laws of the United States or any state thereof, having deposits of not less than One Hundred Million Dollars ($100,000,000).\nAcceptable Repurchase Securities -- means United States Government Securities, Bankers Acceptances and certificates of deposit from an Acceptable Bank.\nAcceptable Transferor -- means any corporate entity not an Affiliate which is organized under the laws of the United States of America or any State thereof, which has capital, surplus and undivided profits aggregating at least One Hundred Million Dollars ($100,000,000) and in which the Company and its Subsidiaries shall not have, at any one time, made Investments having an aggregate value in excess of Five Million Dollars ($5,000,000).\nAdjusted Funded Debt -- with respect to any Person, means without duplication\n(1) its liabilities for borrowed money, other than Current Debt;\n(2) liabilities secured by any Lien existing on Property owned by such Person (whether or not such liabilities have been assumed) other than Current Debt;\n(3) the present value of all payments due under any lease or under any other arrangement for retention of title (discounted at the implicit rate if known or 8% per annum otherwise) if such lease or other arrangement is in substance (a) a financing or capital lease (including any lease (i) under which the lessee has or will have an option to purchase the Property subject thereto at a nominal amount or an amount less than a reasonable estimate of the Fair Market Value of such Property at the date of such purchase, (ii) with respect to which the lessor has filed a financing statement other than for information purposes with respect to an operating lease, (iii) with respect to which the present value of all rental and other fixed payments due under such lease is equal to or exceeds ninety percent (90%) of the remainder of (x) the fair value of the Property subject thereto minus (y) the amount of any related investment tax credit retained by the lessor under such lease, or (iv) the term of which approximates or exceeds seventy- five percent (75%) of the reasonably estimated economic life of the Property subject thereto), (b) an arrangement for the retention of title for security purposes, or (c) an installment purchase;\n(4) its liabilities under Guaranties; and\n(5) any other obligations (other than deferred taxes) which are required by generally accepted accounting principles to be shown as liabilities on its balance sheet and which are payable or remain unpaid more than one (1) year from the creation thereof.\nAdjusted Tangible Assets -- means at any time, with respect to any Person, all assets of such Person (including, without duplication, the capitalized value of any leasehold interest under any financing lease constituting Adjusted Funded Debt) except:\n(a) deferred assets, other than prepaid insurance and prepaid taxes;\n(b) patents, copyrights, trademarks, trade names, franchises, goodwill, experimental expense and other similar intangibles;\n(c) Restricted Investments;\n(d) unamortized debt discount and expense; and\n(e) assets reflecting the capitalized value of leased property (or reflecting any improvement thereto), to the extent that the leases of such property are not reflected in, or do not constitute, Adjusted Funded Debt.\nAdvance Closing Date -- means any date on or prior to October 31, 1990 on which Series D Notes are sold by the Company to a purchaser thereof in accordance with the provisions of the Note Purchase Agreement in respect thereof.\nAffiliate -- a Person (other than a Subsidiary) (a) which directly or indirectly through one or more intermediaries controls, or is controlled by, or is under common control with any one or more of the Company and its Subsidiaries, (b) which beneficially owns or holds five percent (5%) or more of any class of the Voting Stock of any one or more of the Company and its Subsidiaries or (c) five percent (5%) or more of the Voting Stock (or in the case of a Person which is not a corporation, five percent (5%) or more of the equity interest) of which is beneficially owned or held by any one or more of the Company and its Subsidiaries. The term \"control\" means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise.\nAmended and Restated Collateral Trust Indenture, this Trust Indenture, this Agreement or this Indenture -- this Amended and Restated Collateral Trust Indenture, as the same may from time to time be amended.\nApplicable Premium Amount -- means, at any time and with respect to the outstanding principal amount of Notes of any Series of Notes then required to be paid or prepaid, the following percentage of such outstanding principal amount of Notes of such Series then required to be paid or prepaid:\n(i) with respect to any Series of Notes if at such time the Company is not permitted to optionally prepay such outstanding principal of Notes of such Series pursuant to the provisions of this Indenture, a percentage equal to the greater of (a) the rate of interest per annum stated in the Notes of such Series to be in effect on the date immediately preceding such payment or (b) the Make Whole Amount with respect to such payment; and\n(ii) with respect to any Series of Notes if at such time the Company is permitted to optionally prepay such outstanding principal of Notes of such Series pursuant to the provisions of this Indenture, a percentage equal to the premium which would have been payable if the Company then had elected to optionally prepay such Notes pursuant to the provisions of this Indenture.\nApplicable Series B Interest Period -- shall mean:\n(i) with respect to any Series B Portion to which the Company has elected to have the Eurodollar Series B Rate applicable, shall be any period of one (1), three (3) or six (6) months commencing on (x) the Closing Date for the Series B Notes if such rate is to be then applicable to such Series B Portion, and (y) thereafter, the next Applicable Series B Rate Adjustment Date, as shall be selected by the Company not less than two (2) Business Days prior to such Applicable Series B Rate Adjustment Date for such Series B Portion (or, with respect to such Series B Portion of Series B Notes issued on the Closing Date for such Series, if any, two (2) Business Days prior to such Closing Date) and ending on the last day of such period which is immediately followed by a Business Day;\n(ii) with respect to any Series B Portion to which the Company has elected to have the Fixed Series B Rate applicable, shall be any period of thirty (30), sixty (60), ninety (90), one hundred twenty (120), one hundred fifty (150) or one hundred eighty (180) days commencing on (x) the Closing Date for the Series B Notes if such rate is to be then applicable to such Series B Portion, and (y) thereafter, the next Applicable Series B Rate Adjustment Date, as shall be selected by the Company not less than one (1) Business Day prior to such Applicable Series B Rate Adjustment Date for such Series B Portion (or, with respect to such Series B Portion of Series B Notes issued on the Closing Date for such Series, if any, one (1) Business Day prior to such Closing Date) and ending on the last day of such period which is immediately followed by a Business Day; and\n(iii) with respect to any Series B Portion to which the Company has elected to have the Reference Series B Rate applicable, shall be any period of days not exceeding one hundred eighty (180) days commencing on (x) the Closing Date for the Series B Notes if such rate is to be then applicable to such Series B Portion and (y) thereafter, the next Applicable Series B Rate Adjustment Date, as shall be selected by the Company not less than one (1) Business Day prior to such Applicable Series B Rate Adjustment Date for such Series B Portion (or, with respect to such Series B Portion of Series B Notes issued on the Closing Date for such Series, if any, one (1) Business Day prior to such Closing Date), and ending on the day prior to the following Applicable Series B Rate Adjustment Date.\nApplicable Series B Interest Rate -- shall mean the interest rate in effect for each Series B Portion of Series B Notes, as determined by Section 2.1 of this Indenture, which shall be either (x) the Reference Series B Rate plus one-quarter percent (.25%), computed on the basis of a 360-day year and actual days elapsed, (y) the Eurodollar Series B Rate plus one and one-half percent (1-1\/2%), computed on the basis of a 360-day year of twelve 30-day months, or (z) the Fixed Series B Rate plus one and one-half percent (1-1\/2%), computed on the basis of a 360-day year of twelve 30-day months.\nApplicable Series B Rate Adjustment Date -- with respect to any Series B Portion, shall mean (x) the first (1st) Business Day of any Applicable Series B Interest Period as shall have been selected by the Company for the Applicable Series B Interest Rate applicable to such Series B Portion or (y) if no selection shall have been made by the Company on any Series B Determination Date for such Series B Portion, such Series B Determination Date.\nApplicable Series D Interest Period -- shall mean:\n(i) with respect to any Series D Portion to which the Company has elected to have the Eurodollar Series D Rate applicable, shall be any period of one (1), three (3) or six (6) months commencing on (x) in the case of such Series D Portion to be advanced on any Advance Closing Date, such Advance Closing Date, and (y) thereafter, the next Applicable Series D Rate Adjustment Date, as shall be selected by the Company not less than two (2) Business Days (or such shorter period of time as the holders of Series D Notes may agree to) prior to such Applicable Series D Rate Adjustment Date for such Series D Portion (or, with respect to such Series D Portion to be advanced on an Advance Closing Date, two (2) Business Days prior to such Advance Closing Date) and ending on the last day of such period;\n(ii) with respect to any Series D Portion to which the Company has elected to have the Fixed Series D Rate applicable, shall be any period of thirty (30), sixty (60), ninety (90), one hundred twenty (120), one hundred fifty (150) or one hundred eighty (180) days commencing on (x) in the case of such Series D Portion to be advanced on any Advance Closing Date, such Advance Closing Date and (y) thereafter, the next Applicable Series D Rate Adjustment Date, as shall be selected by the Company not less than one (1) Business Day (or such shorter period of time as the holders of Series D Notes may agree to) prior to such Applicable Series D Rate Adjustment Date for such Series D Portion (or, with respect to such Series D Portion advanced on an Advance Closing Date, one (1) Business Day prior to such Advance Closing Date) and ending on the last day of such period; and\n(iii) with respect to any Series D Portion to which the Company has elected to have the Reference Series D Rate appli cable, shall be any period of days not exceeding one hundred eighty (180) days commencing on (x) in the case of such Series D Portion to be advanced on any Advance Closing Date, such Advance Closing Date and (y) thereafter, the next Applicable Series D Rate Adjustment Date, as shall be selected by the Company not less than one (1) Business Day (or such shorter period of time as the holders of Series D Notes may agree to) prior to such Applicable Series D Rate Adjustment Date for such Series D Portion (or, with respect to such Series D Portion to be advanced on any Advance Closing Date, one (1) Business Day prior to such Advance Closing Date) or as deemed selected pursuant to Section 2.1(d) hereof, and ending on the last day of such period or as provided in said Section 2.1(d);\nprovided, however, that:\n(A) if any Applicable Series D Interest Period would end on a day not a Business Day, it shall end on the next succeeding Business Day except that with respect to any Applicable Series D Interest Period in respect of which the Eurodollar Series D Rate is applicable, if the next succeeding Business Day would fall in the next calendar month, such Applicable Series D Interest Period shall end on the Business Day immediately preceding the last day of such Applicable Series D Interest Period but for such change;\n(B) any Applicable Series D Interest Period which would otherwise extend beyond December 31, 1996 shall end on December 31, 1996; and\n(C) interest shall accrue in respect of any Applicable Series D Interest Period from and including the first day thereof to (but excluding) the last day thereof and each Applicable Series D Interest Period that succeeds any then expiring Applicable Series D Interest Period shall be deemed to commence on the last day of such expiring Applicable Series D Interest Period.\nApplicable Series D Interest Rate -- shall mean the interest rate in effect for each Series D Portion of Series D Notes, as determined by Section 2.1(d) hereof, which shall be either (x) the Reference Series D Rate plus one-quarter percent (.25%), computed on the basis of a 360-day year and actual days elapsed, (y) the Eurodollar Series D Rate plus one and one-half percent (1-1\/2%), computed on the basis of a 360-day year of twelve 30-day months, or (z) the Fixed Series D Rate plus one and one-half percent (1-1\/2%), computed on the basis of a 360-day year of twelve 30-day months.\nApplicable Series D Rate Adjustment Date -- with respect to any Series D Portion, shall mean (x) the first (1st) Business Day of any Applicable Series D Interest Period as shall have been selected by the Company in accordance with the terms of Section 2.1(d) hereof for the Applicable Series D Interest Rate also selected by the Company in accordance with the terms of said Section 2.1(d) applicable to such Series D Portion or (y) if no such selection of either an Applicable Series D Interest Period or an Applicable Series D Interest Rate in accordance with the terms of Section 2.1(d) of this Indenture shall have been made by the Company, the last day of the then Applicable Series D Interest Period in respect of such Series D Portion.\nBankers Acceptance -- any draft drawn on an Acceptable Bank and accepted by such Acceptable Bank which is due and payable not more than one hundred eighty (180) days from the original date thereof.\nBoard of Directors -- the board of directors of the Company or any committee thereof which, in the instance, has the lawful power to exercise the power and authority of such board of directors.\nBusiness Day -- a day other than a Saturday, a Sunday or a day on which banks are required by law (other than a general banking moratorium or holiday for a period exceeding four consecutive days) to be closed in the State of Texas, the State of New York, the State of Connecticut or the State of California, and, with respect to all notices and determinations in connection with, and payments of principal of, and interest on, any Series B Portion to which the Eurodollar Series B Rate is applicable or any Series D Portion to which the Eurodollar Series D Rate is applicable, any day which is a \"Business Day,\" as described above, and is also a day on which banks are open for business and quoting interest rates for dollar deposits in Grand Cayman, British West Indies.\nClosing Date -- Section 1.2 of the Note Purchase Agreements in respect of the Series A Notes and the Series B Notes.\nCode -- Uniform Commercial Code as in effect from time to time in the State of Connecticut.\nCollateral -- Paragraph C of the Granting Clauses hereof.\nCompany -- first paragraph of this Indenture.\nConsolidated Adjusted Current Liabilities -- at any time means the amount at which the current liabilities of the Company and all Subsidiaries (specifically including, without limitation, the current portion of any obligation constituting Adjusted Funded Debt) would be shown on a consolidated balance sheet at such time, but excluding from such current liabilities any amount constituting the current portion of any deferred income taxes arising as the result of differences between the Company's method of reporting and determining income under the Internal Revenue Code, as amended, and its method of reporting and determining income pursuant to generally accepted accounting principles (including, without limitation, the use, for Internal Revenue Code purposes, of the so-called farm price method of accounting), but including in such current liabilities any income tax liability of the Company and its Subsidiaries payable within 12 months of such time, whether presented as a part of the aforesaid current portion of deferred income taxes or as a separate line item in current liabilities pursuant to generally accepted accounting principles.\nConsolidated Adjusted Funded Debt -- means Adjusted Funded Debt of the Company and its Subsidiaries, determined on a consolidated basis.\nConsolidated Adjusted Net Income -- for any fiscal period means net earnings (or loss) after income taxes of the Company and its Subsidiaries determined on a consolidated basis for each period, but excluding:\n(1) any gain or loss arising from the sale of capital assets;\n(2) any gain arising from any write-up of assets;\n(3) earnings of any Subsidiary accrued prior to the date it became a Subsidiary;\n(4) earnings of any Person, substantially all the assets of which have been acquired in any manner, realized by such other Person prior to the date of such acquisition;\n(5) net earnings of any Person (other than a Subsidiary) in which the Company or any Subsidiary has an ownership interest unless such net earnings shall have actually been received by the Company or such Subsidiary in the form of cash distributions;\n(6) any portion of the net earnings of any Subsidiary which for any reason is unavailable for payment of dividends to the Company or any other Subsidiary;\n(7) the earnings of any Person to which assets of the Company shall have been sold, transferred or disposed of, or into which the Company or any Subsidiary shall have merged, prior to the date of such transaction;\n(8) any gain arising from the acquisition of any Securities by the Company or any Subsidiary; and\n(9) any portion of the net earnings of the Company or any Subsidiary which cannot be freely converted into United States dollars.\nConsolidated Adjusted Working Capital -- at any time means the difference between Consolidated Current Assets at such time minus Consolidated Adjusted Current Liabilities at such time.\nConsolidated Current Assets -- at any time means the amount at which the current assets of the Company and all Subsidiaries would be shown on a consolidated balance sheet at such time, but excluding any amount on account of any assets which do not constitute Adjusted Tangible Assets.\nConsolidated Current Liabilities -- at any time means the amount at which the current liabilities of the Company and all Subsidiaries would be shown on a consolidated balance sheet at such time.\nConsolidated Net Tangible Assets -- at any time means the result of:\n(a) the net book value (after deducting related depreciation, obsolescence, amortization, valuation and other proper reserves) at which the Adjusted Tangible Assets of the Company and all Subsidiaries would be shown on a consolidated balance sheet at such time, but excluding any amount on account of write-ups of assets after September 30, 1985,\nminus\n(b) Consolidated Adjusted Current Liabilities outstanding at such time.\nConsolidated Tangible Net Worth -- at any time means:\n(1) the net book value (after deducting related depreciation, obsolescence, amortization, valuation and other proper reserves) at which the Adjusted Tangible Assets of the Company and all Subsidiaries would be shown on a consolidated balance sheet at such time, but excluding any amount on account of write-ups of assets after September 30, 1985,\nminus\n(2) the amount (such amount from time to time herein referred to as \"Consolidated Total Liabilities\") at which their liabilities (other than capital stock and surplus) would be shown on such balance sheet, and includ ing as liabilities all deferred taxes and reserves for contingencies and other potential liabilities (specifically including therein, without limitation, actuarially determined unfunded vested pension liabilities) and all minority interests in Subsidiaries.\nConsolidated Total Liabilities -- clause (2) of the definition of Consolidated Tangible Net Worth.\nCurrent Debt -- with respect to any Person, means, without duplication, all liabilities for borrowed money and all liabilities secured by any Lien existing on Property owned by such Person whether or not such liabilities have been assumed, which, in either case are payable on demand or within one (1) year from the creation thereof, except:\n(1) any such liabilities which are renewable or extendible (whether or not renewed or extended) at the option of such Person to a date more than one (1) year from the date of creation thereof or renewable or extendible under, or payable from the proceeds of other indebtedness incurred pursuant to the provisions of, any revolving credit agreement or similar agreement, and\n(2) any such liabilities which, although payable within one (1) year, constitute payments required to be made on account of principal of indebtedness expressed to mature more than one (1) year from the date of creation thereof.\nCurrent Expenses -- with respect to any Person for any fiscal period, means the sum of interest expense accrued for such Person for such period, plus principal amounts payable during such period on or with respect to Adjusted Funded Debt of such Person.\nDebt -- with respect to any Person means all Current Debt and Adjusted Funded Debt for or on account of which such Person is liable.\nDefault -- an event or condition the occurrence of which would, with the lapse of time or giving of notice or both, become an Event of Default.\nDesignated Officers -- Lonnie A. Pilgrim, Clifford E. Butler, or such other Persons as may be agreed to by the holders of the Series B Notes.\nERISA -- the Employee Retirement Income Security Act of 1974, as amended from time to time.\nEurodollar Series B Rate -- with respect to any determination on any Series B Determination Date, shall mean the rate of interest at which deposits in United States dollars in the amount to be outstanding would be offered by the Grand Cayman Branch of the Bank of America National Trust and Savings Association, Grand Cayman, British West Indies, to major banks in the offshore United States dollar interbank markets upon request of such banks at approximately 11:00 a.m., New York time, two (2) Business Days prior to the Applicable Series B Rate Adjustment Date. For each Series B Portion, to which the Company has elected to have the Eurodollar Series B Rate applicable, such offered rate of interest shall be effective for the entire Applicable Series B Interest Period selected by the Company for such Series B Portion.\nEurodollar Series D Rate -- with respect to any determination on any Series D Determination Date, shall mean the rate of interest at which deposits in United States dollars in the amount to be outstanding would be offered by the Grand Cayman Branch of the Bank of America National Trust and Savings Association, Grand Cayman, British West Indies, to major banks in the offshore United States dollar interbank markets upon request of such banks at approximately 11:00 a.m., New York time, on such Series D Determination Date. For each Series D Portion, to which the Company has elected to have the Eurodollar Series D Rate be applicable, such offered rate of interest shall be effective for the entire Applicable Series D Interest Period selected by the Company for such Series D Portion.\nEvent -- Section 4.4(a)(vii) hereof.\nEvent of Default -- Section 6.1 hereof.\nExchange Act -- means the Securities and Exchange Act of 1934, as amended.\nExisting Indenture -- first recital hereof.\nExisting Promissory Note -- Section 2.1(d) hereof.\nFair Market Value -- means, with respect to any assets, the sale value of such assets that would be realized in an arm's- length sale between an informed and willing buyer and an informed and willing seller, under no compulsion to buy or sell, respectively.\nFinancing Documents -- this Indenture, the Note Purchase Agreements, the Notes, the Guarantee Agreement, all documents (in the respective forms thereof as executed) the forms of which are appended to the Note Purchase Agreements as exhibits or schedules, and all other documents or instruments contemplated hereby and by the Note Purchase Agreements or this Indenture, in each case as the same may be amended from time to time, and excluding in each case any opinion of counsel.\nFixed Charge Ratio -- at any time means with respect to any fiscal period the quotient of (a) the sum of (i) Consolidated Adjusted Net Income for such period plus (ii) the aggregate amount of depreciation, amortization, income taxes, Rentals and interest expense accrued for such period by the Company and its Subsidiaries to the extent, but only to the extent, such aggregate amount was reflected in the computation of Consolidated Adjusted Net Income for such period, divided by (b) the sum of (i) the aggregate amount of Rentals accrued for such period by the Company and its Subsidiaries plus (ii) the aggregate amount of Current Expenses accrued for such fiscal period, by the Company and its Subsidiaries.\nFixed Series B Rate -- with respect to any determination on any Series B Determination Date, shall mean the interest rate quoted to the Company on such date by Bank of America National Trust and Savings Association in San Francisco, California. For each Series B Portion, to which the Company has elected to have the Fixed Series B Rate applicable, such quoted interest rate shall be effective for the entire Applicable Series B Interest Period selected by the Company for such Series B Portion.\nFixed Series D Rate -- with respect to any determination on any Series D Determination Date, shall mean the interest rate quoted to the Company on such date by Bank of America National Trust and Savings Association in San Francisco, California. For each Series D Portion, to which the Company has elected to have the Fixed Series D Rate applicable, such quoted interest rate shall be effective for the entire Applicable Series D Interest Period selected by the Company for such Series D Portion.\nGuarantee Agreement -- means that certain Guarantee Agreement, dated as of October 1, 1986, among The Connecticut Bank and Trust Company, N.A., as the predecessor security trustee to the Security Trustee, Lonnie A Pilgrim and Patty R. Pilgrim, as amended and modified, from time to time.\nGuarantors -- means any one or more Persons which shall have guarantied the payment of the Notes and the performance of the Company of its obligations hereunder.\nGuaranty -- with respect to any Person shall mean any obligation (except the endorsement in the ordinary course of business of negotiable instruments for deposit or collection) of such Person guarantying or in effect guarantying any indebtedness, dividend or other obligation of any other Person (the \"primary obligor\") in any manner, whether directly or indirectly, including (without limitation) obligations incurred through an agreement, contingent or otherwise, by such Person:\n(1) to purchase such indebtedness or obligation or any Property or assets constituting security therefor;\n(2) to advance or supply funds\n(i) for the purpose or payment of such indebtedness or obligation, or\n(ii) to maintain working capital or other balance sheet condition or any income statement condition or otherwise to advance or make available funds for the purchase or payment of such indebtedness or obligation;\n(3) to lease Property or to purchase Securities or other Property or services primarily for the purpose of assuring the owner of such indebtedness or obligation of the ability of the primary obligor to make payment of the indebtedness or obligation; or\n(4) otherwise to assure the owner of the indebtedness or obligation of the primary obligor against loss in respect thereof.\nIndenture -- the first paragraph hereof.\nIndenture Estate -- Paragraph C of the Granting Clauses hereof.\nIntangible Assets -- license agreements, trademarks, trade names, patents, capitalized research and development costs, proprietary products (the results of past research and development treated as long term assets and excluded from Inventory) and goodwill, all determined on a consolidated basis in accordance with generally accepted accounting principles consistently applied.\nInvestment -- Article 1 (in the definition of Restricted Investment).\nLien -- any interest in Property securing an obligation owed to, or a claim by, a Person other than the owner of the Property, whether such interest is based on the common law, statute or contract, and including, but not limited to, the security interest lien arising from a mortgage, security agreement, encumbrance, pledge, conditional sale or trust receipt or a lease, consignment or bailment for security purposes. The term \"Lien\" shall include reservations, exceptions, encroachments, easements, rights-of-way, covenants, conditions, restrictions, leases and other title exceptions and encumbrances (including, with respect to stock, stockholder agreements, voting trust agreements, buy-back agreements and all similar arrangements) affecting Property. For the purposes of this Indenture, the Company or a Subsidiary shall be deemed to be the owner of any Property which it has acquired or holds subject to a conditional sale agreement, financing lease or other arrangement pursuant to which title to the Property has been retained by or vested in some other Person for security purposes, and such retention or vesting shall constitute a Lien.\nMacaulay Formula -- at any time with respect to any borrowing means the number produced by dividing\n(a) the Present Value of the Outstanding Dollar- Years of such borrowing at such time, by\n(b) the present value of the required payments of interest and principal in respect of such borrowing remaining immediately prior to such time.\nThe discount rate for purposes of determining the present value of such remaining principal and interest payments shall be the original yield to maturity of such borrowing.\nMajority Noteholders -- at any time means holder or holders of more than fifty percent (50%) in aggregate principal amount of all Notes then Outstanding.\nMake-Whole Amount -- with respect to any payment of Notes, to the extent the Treasury Rate at such time is lower than the original yield to maturity of the Notes, means an amount equal to the excess of (a) the then remaining scheduled payments of interest and principal on such Notes, discounted to present value at an annual rate equal to the Treasury Rate, minus (b) the aggregate principal amount of the Notes so paid. To the extent that the Treasury Rate at such time is equal to or above the original yield to maturity of the Notes, the Make-Whole Amount is zero (0).\nMargin Security -- Section 7.20 hereof.\nMaximum Rate -- Section 2.1(e) hereof.\nMexican Subsidiary -- shall mean any Subsidiary of the Company which is organized under the laws of Mexico (or any State or Province thereof) and\/or has manufacturing operations located in Mexico (or any State or Province thereof).\nMoney Market -- Section 4.5 hereof.\nMoney Market Rate -- Section 4.5 hereof.\nNet Future Capital Stock Proceeds -- the cash proceeds received by the Company after the Second Closing Date upon issuance of any new capital stock of the Company, and any contributions (valued at Fair Market Value for any noncash contributions) to capital received by the Company after the Second Closing Date, minus any and all commissions and expenses incurred in connection with the issuance of such capital stock.\nNet Tangible Assets -- at any time means the excess of Total Assets over Intangible Assets of the Company and its subsidiaries at such time.\nNote Purchase Agreements -- means (a) the Note Purchase Agreements dated as of October 1, 1986, between the Company and each of The Aetna Casualty and Surety Company, the Aetna Life Insurance Company and Bank of America National Trust and Savings Association in respect of the Series A Notes and the Series B Notes, (b) the Note Purchase Agreements dated as of September 21, 1990, between the Company and Aetna Life Insurance Company and Bank of America National Trust and Savings Association in respect of the Series C Notes and the Series D Notes and (c) any other note purchase agreement between the Company and a Purchaser in respect of the initial purchase and sale of any other Series of Notes.\nNotes -- the Series A Notes, the Series B Notes, the Series C Notes, the Series D Notes and all other additional notes issued pursuant to the provisions of Section 2.12 hereof.\nOfficer's Certificate -- a certificate signed by the President or a principal financial officer of the Company.\nOpinion of Counsel -- an opinion of independent counsel (which may from time to time serve as counsel for the Company, for the Security Trustee or for the holder of any Note) acceptable to the Security Trustee which opinion is in form, scope and content satisfactory to the Security Trustee and (if not rendered by counsel for the Security Trustee) counsel for the Security Trustee.\nOrder Notes -- in respect of Series A Notes shall have the meaning set forth in Section 2.1 hereof; in respect of Series C Notes shall have the meaning set forth in Section 2.1 hereof; and any other Note which is not a Registered Note.\nOriginal Payment Date -- Section 4.5 hereof.\nOutstanding -- with respect to the Notes at any time, means all Notes which have been duly authorized, authenticated (with respect to Notes of each Series of Notes), issued and delivered (except for Notes which have been replaced by new Notes which have been issued pursuant to Section 2.4, Section 2.5 or Section 2.9 hereof) exclusive of, and under no circumstances including, any Notes then owned by any one or more of the Company, its Subsidiaries or any Affiliates.\nPension Plans -- all employee pension benefit plans (as such term is defined in ERISA) from time to time maintained by, or for the benefit of the employees of, any one or more of the Company and its Subsidiaries or with respect to which any of such Persons may be liable to the Pension Benefit Guaranty Corporation (or its successor entity).\nPermitted Liens -- Section 3.3 hereof.\nPerson -- an individual, partnership, corporation, trust, unincorporated organization, government, governmental agency or governmental subdivision.\nPlan -- an employee benefit plan (as such term is defined in ERISA) from time to time maintained by, or for the benefit of the employees of, any one or more of the Company and its Subsidiaries or with respect to which any of such Persons may be liable to the Pension Benefit Guaranty Corporation (or its successor entity).\nPrepayment Date -- Section 4.4(a)(vii) hereof.\nPresent Value of the Outstanding Dollar-Years -- at any time with respect to any borrowing shall mean the product obtained by\n(a) multiplying\n(i) the present value of each required principal and interest payment (including repayment of principal at final maturity) of such borrowing unpaid immediately prior to such time, by\n(ii) the number of years (calculated to the nearest one-twelfth) that will elapse between such time and the date each such required principal or interest payment is due, and\n(b) calculating the sum of the products obtained in the preceding subsection (a).\nThe discount rate for purposes of determining the present value of such remaining principal and interest payments is the original yield to maturity of such borrowing.\nProperty -- any interest in any kind of property or asset, whether real, personal or mixed, and whether tangible or intangible.\nPurchase Money Lien -- (a) any Lien held by any Person (whether or not the seller of such assets) on assets (other than assets acquired to replace or repair assets owned by the Company or any Subsidiary on the date of the initial issuance of the Series A Notes and the Series B Notes) acquired, or constructed or improved, by the Company or any Subsidiary after the date of the initial issuance of the Series A Notes, which Lien secures all or a portion of the related purchase price, or construction or improvement cost, of such assets and is created at the time of, or within twelve (12) months after, such acquisition or the completion of such construction or improvement, (b) any Lien existing on any Property of any corporation at the time it becomes a Subsidiary, provided that in each such case such Lien (i) does not extend to any other asset or secure any other obligations of the Company or any other Subsidiary and (ii) the obligations secured thereby are not increased in aggregate amount of liability after the date such corporation becomes a Subsidiary or (c) any Lien on the assets or Voting Stock of any Subsidiary which was created on the date such Voting Stock was acquired by the Company or any other Subsidiary and which secures the payment by the Company or such other Subsidiary of all or part of the purchase price of such Voting Stock.\nPurchaser -- in respect of (a) the Series A Notes, means each of The Aetna Casualty and Surety Company and Aetna Life Insurance Company, (b) the Series B Notes, means Bank of America National Trust and Savings Association, (c) the Series C Notes, means Aetna Life Insurance Company, (d) the Series D Notes, means Bank of America National Trust and Savings Association, and (e) any other Series of Notes, means the initial purchaser thereof pursuant to a Note Purchase Agreement entered into by and between such purchaser and the Company.\nReference Series B Rate -- with respect to any determination on any Series B Rate Adjustment Date, shall mean the rate of interest publicly announced from time to time by Bank of America, National Trust and Savings Association, in San Francisco, California, as its \"reference rate,\" which \"reference rate is based upon various factors including such bank's costs and desired return, general economic conditions, and other factors, and is used as a reference point for pricing some loans, which may be price at, above or below such reference rate. Each change in the reference rate shall be effective as to any Series B Portion, to which the Company has elected to have the Reference Series B Rate applicable, at the opening of business on the day specified in the public announcement of such change.\nReference Series D Rate -- with respect to any determination on any Series D Rate Adjustment Date, shall mean the rate of interest publicly announced from time to time by Bank of America, National Trust and Savings Association, in San Francisco, California, as its \"reference rate,\" which \"reference rate is based upon various factors including such bank's costs and desired return, general economic conditions, and other factors, and is used as a reference point for pricing some loans, which may be priced at, above or below such reference rate. Each change in the reference rate shall be effective as to any Series D Portion, to which the Company has elected to have the Reference Series D Rate applicable, at the opening of business on the day specified in the public announcement of such change.\nRegistered Notes -- in respect of Series A Notes shall have the meaning set forth in Section 2.1 hereof; in respect of Series C Notes shall have the meaning set forth in Section 2.1 hereof; and any other Note which is registered in accordance with Section 2.3 hereof and which contains language substantially to the effect that such Note is a registered Note and is transferable only by surrender thereof at the principal office of the Company where a register therefor is maintained, duly endorsed or accompanied by a written instrument of transfer duly executed by the registered holder of such Note or his attorney duly authorized in writing.\nRemaining Dollar-Years -- of any indebtedness for borrowed money at any time means the amount obtained by (a) (i) multiplying the amount of each then remaining sinking fund, serial maturity or other required repayment, (including repayment at final maturity of such indebtedness), of such indebtedness by (ii) the number of years (calculated at the nearest one-twelfth) which will elapse between such time and the date of that required repayment, and (b) totaling all the products obtained in (a).\nRemaining Duration of the Series C Notes -- at any time with respect to any Series C Notes being prepaid means the number produced by\n(a) dividing the Present Value of the Outstanding Dollar-Years of such Series C Notes at such time, by\n(b) the present value of the remaining required payments of principal and interest on such Series C Notes immediately prior to such time.\nThe discount rate for purposes of determining the present value of such remaining principal and interest payments is ten and forty- nine one-hundredths percent (10.49%). The number produced by the foregoing calculation shall be rounded to one decimal point, with rounding up if the tail is 0.05 or higher, and rounding down otherwise.\nRentals -- as of the date of determination, means all non- cancelable, fixed payments which the lessee is required to make by the terms of any operating lease (including any renewal terms exercisable at the option of the lessor) of one year or more, but shall not include amounts required to be paid in respect of maintenance, repairs, income taxes, insurance, assessments or other similar charges or additional rentals (in excess of fixed minimums) based upon a percentage of gross receipts.\nRepurchase Agreement -- means any written agreement (a) which provides for (i) the transfer of one or more Acceptable Repurchase Securities to the Company or a Subsidiary from an Acceptable Transferor against a transfer of funds (the \"Transfer Price\") by the Company or such Subsidiary to such Acceptable Transferor and (ii) a simultaneous agreement by the Company or such Subsidiary, in connection with such transfer of funds, to transfer to such Acceptable Transferor the same or substantially similar Acceptable Repurchase Securities for a price not less than the Transfer Price plus a reasonable return thereon at a date certain not later than thirty (30) days after such transfer of funds, (b) in respect of which the Company or such Subsidiary shall have the contractual right to liquidate such repurchase agreement in accordance with 11 U.S.C. Section 559 (or any successor provision thereto) and (c) in connection with which the Company or such Subsidiary, or an agent thereof (other than the Acceptable Transferor or any agent thereof), shall take physical possession of the Acceptable Repurchase Securities so transferred to the Company or such Subsidiary, or in the case of any uncertified Acceptable Repurchase Securities so transferred, shall have taken all action required by any applicable law or regulations to perfect its Lien therein.\nResponsible Officer -- any vice president, trust officer or corporate trust officer, in each case employed in the Corporate Trust Services Department of the Security Trustee.\nRestricted Investments -- all investments, made in cash or by delivery of Property, by any one or more of the Company and its Subsidiaries (a) in any Person (other than the Company or a Subsidiary), whether by acquisition of stock, indebtedness or other obligation or Security, or by loan, advance or capital contribution, or otherwise, or (b) in any Property (items (a) and (b) herein called \"Investments\"), except the following:\n(i) Property to be used in the ordinary course of the business as described in Section 2.3 of the Note Purchase Agreements;\n(ii) current assets arising from the sale of goods and services in the ordinary course of business of the Company and its Subsidiaries;\n(iii) Investments in the Company or any Subsidiary;\n(iv) loans to Affiliates in an aggregate amount at any time not exceeding One Million Dollars ($1,000,000);\n(v) Investments in any Person (other than the Company, a Wholly-Owned Subsidiary or an Affiliate) engaged in the same line of business as the Company, if after giving effect to such Investments and all contemporaneous transactions, the aggregate outstanding amount of such Investments made by the Company and all Subsidiaries in the then current fiscal year of the Company will not exceed fifteen percent (15%) of Consolidated Tangible Net Worth as of the end of the fiscal year of the Company then most recently ended;\n(vi) Bankers Acceptances or interest bearing obligations, having an original maturity of one (1) year or less, in each case issued by an Acceptable Bank;\n(vii) Investments in interest bearing direct obligations of the United States of America, or any agency thereof, or obligations guaranteed by the United States of America, provided that such obligations mature within one (1) year from the date of acquisition thereof;\n(viii) Repurchase Agreements, having an original maturity of ninety (90) days or less, with Acceptable Banks or with recognized securities brokers; and\n(ix) Investments in commercial paper of corporations organized under the laws of the United States or any state thereof, given one of the two highest ratings by Standard and Poor's Bond Rating Index or by NCO Moody's Investor Service and maturing not more than two hundred seventy (270) days from the date of creation thereof.\nInvestments shall be valued at cost less any net return of capital through the sale or liquidation thereof or other return of capital thereon.\nSecond Closing Date -- (a) in respect of the Series C Notes, the date provided for in Section 1.2 of the Note Purchase Agreements and (b) in respect of the first purchase of Series D Notes, the date provided for in Section 1.2 of the Note Purchase Agreements.\nSecurities Act -- the Securities Act of 1933, as amended.\nSecurity -- shall have the same meaning as in Section 2(1) of the Securities Act. Security Trustee -- State Street Bank and Trust Company of Connecticut, N.A., as security trustee under this Indenture and any successor security trustee named in accordance with the provisions hereof.\nSeries, Series of Notes -- the Series A Notes, the Series B Notes, the Series C Notes, the Series D Notes or any other series of Notes issued pursuant to the provisions of Section 2.12 hereof.\nSeries A Notes -- Section 2.1 hereof.\nSeries A Order Notes -- Section 2.1 hereof.\nSeries A Registered Notes -- Section 2.1 hereof.\nSeries B Deferred Amount -- Section 2.1 hereof.\nSeries B Determination Date -- shall mean (i) with respect to any Series B Portion to which the Eurodollar Series B Rate shall be applicable, the day which is two (2) Business Days prior to the next Applicable Series B Rate Adjustment Date for such Series B Portion, (ii) with respect to any Series B Portion to which the Fixed Series B Rate shall be applicable, the day which is one (1) Business Day prior to the next Applicable Series B Rate Adjustment Date for such Series B Portion and (iii) with respect to any Series B Portion to which the Reference Series B Rate shall be applicable, the Applicable Series B Rate Adjustment Date.\nSeries B Noteholders -- each and every holder of Series B Notes.\nSeries B Notes -- Section 2.1 hereof.\nSeries B Portion -- a portion of the outstanding principal amount of the Series B Notes with respect to which a particular Applicable Series B Interest Rate is applicable.\nSeries C Make-Whole Amount -- at any time with respect to any Series C Notes being prepaid shall mean, to the extent that (a) the Treasury Constant Yield at such time in respect of such Series C Notes plus (b) twenty-five one-hundredths of one percent (0.25%), is lower than ten and forty-nine one-hundredths percent (10.49%) per annum, the excess of\n(a) the present value of the principal and interest payments due on such Series C Notes then being paid, discounted at a rate that is equal to (i) such Treasury Constant Yield plus (ii) twenty-five one- hundredths percent (0.25%) per annum, minus\n(b) the principal amount of such Series C Notes then being prepaid, at par.\nIf (A) such Treasury Constant Yield at the time of such payment plus (2) twenty-five one-hundredths percent (0.25%) per annum is equal to or higher than ten and forty-nine one-hundredths percent (10.49%) per annum, then the Series C Make-Whole Amount is Zero Dollars ($0).\nSeries C Notes -- Section 2.1 hereof.\nSeries C Order Notes -- Section 2.1 hereof.\nSeries C Registered Notes -- Section 2.1 hereof.\nSeries D Deferred Amount -- Section 2.1 hereof.\nSeries D Designated Officers -- Lonnie A. Pilgrim, Clifford E. Butler, or such other Persons as may be agreed to by the holders of the Series D Notes.\nSeries D Determination Date -- shall mean (i) with respect to any Series D Portion to which the Eurodollar Series D Rate shall be applicable, the day which is two (2) Business Days (or such shorter period of time as the holders of Series D Notes may agree to) prior to the next Applicable Series D Rate Adjustment Date for such Series D Portion, (ii) with respect to any Series D Portion to which the Fixed Series D Rate shall be applicable, the day which is one (1) Business Day (or such shorter period of time as the holders of Series D Notes may agree to) prior to the next Applicable Series D Rate Adjustment Date for such Series D Portion and (iii) with respect to any Series D Portion to which the Reference Series D Rate shall be applicable, the Applicable Series D Rate Adjustment Date.\nSeries D Notes -- Section 2.1 hereof.\nSeries D Noteholders -- each and every holder of Series D Notes.\nSeries D Prepaid Installment -- Section 4.5 hereof.\nSeries D Portion -- a portion of the outstanding principal amount of the Series D Notes with respect to which a particular Applicable Series D Interest Rate is applicable.\nSpecial Majority Noteholders -- at any time means all of the following holders of Notes: (w) holder or holders of more than fifty percent (50%) in aggregate principal amount of the Series A Notes then Outstanding, (x) holder or holders of more than fifty percent (50%) in aggregate principal amount of the Series C Notes then Outstanding, (y) holder or holders of more than fifty percent (50%) in aggregate principal amount of the Series D Notes then Outstanding, and (z) the holder or holder of more than fifty percent (50%) in aggregate principal amount of all other Notes then Outstanding.\nSubsidiary -- a corporation of which the Company owns, directly or indirectly, more than fifty percent (50%) of the Voting Stock.\nSubsidiary Stock -- Section 7.4 hereof.\nSuper-Majority Noteholders -- at any time means holder or holders of more than sixty-six and two-thirds percent (66-2\/3%) in aggregate principal amount of all Notes then Outstanding.\nThis Indenture -- this instrument as originally executed or as it may from time to time be supplemented or amended in accordance with the provisions hereof.\nTotal Assets -- at any time means the aggregate amount of assets of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles consistently applied.\nTreasury Constant Yield -- at any time with respect to any prepayment of Series C Notes means the yield on a hypothetical United States Treasury security with a duration matching the Remaining Duration of the Series C Notes at such time with respect to such Series C Notes. The Hypothetical Treasury security is derived by referring to the United States Federal Reserve Statistical Release designated H.15(519) or its successor publication published immediately prior to such prepayment of the Series C Notes (the \"Applicable H-15\"). The duration of all such Treasury securities with maturities listed in the Applicable H-15 shall be calculated by using the Macaulay Formula and assuming that the coupon on each such Treasury security equals the weekly average yield on such Treasury security. The Remaining Duration of the Series C Notes shall be determined using a maturity date of September 21, 2002. If there is a Treasury security with a constant maturity listed in Applicable H-15 with a duration equal to such Remaining Duration of the Series C Notes, then the yield on such Treasury security shall be the Treasury Constant Yield. If no such security with a constant maturity exists, then the security with a duration closest to and greater than such Remaining Duration of the Series C Notes shall be used, along with the Treasury security with a duration closest to and less than such Remaining Duration of the Series C Notes, in the following formula, in order to calculate the Treasury Constant Yield:\nTCY=(YA+((RDN-DA)X((YB-YA)\/(DB-DA)))\nTCY = Treasury Constant Yield RDN = Remaining Duration of the Series C Notes Security A = Constant maturity Treasury security with a duration closest to and less than RDN Security B = Constant maturity Treasury security with a duration closest to and greater than RDN YA = Yield to Maturity of security A YB = Yield to Maturity of security B DA = Duration of security A DB = Duration of security B\nThe Treasury Constant Yield will be rounded to two decimal points with rounding up if the tail is 0.005 or higher, and rounding down otherwise.\nTreasury Rate -- at any time with respect to any Notes being paid at such time means the yield to maturity at such time of United States Treasury obligations with a constant maturity (as compiled by and published in the most recently published issue of The Wall Street Journal or any successor publication) most nearly equal to the Weighted Average Life to Maturity of the Notes then being paid.\nUnfriendly Investment -- any purchase or offer to purchase all or any portion of the Voting Stock of any corporation which is opposed or objected to by the board of directors of such corporation or any other proposed acquisition of Securities of any Person of the type normally referred to as a \"hostile tender offer.\"\nVoting Stock -- capital stock of any class or classes of a corporation the holders of which are ordinarily, in the absence of contingencies, entitled to elect a majority of the corporate directors (or Persons performing similar functions).\nWeighted Average Life to Maturity --with respect to any indebtedness for borrowed money means as at the date of the determination thereof the number of years obtained by dividing the then Remaining Dollar-Years of such indebtedness as of the date of determination by the then outstanding principal amount of such indebtedness.\nWholly-Owned Subsidiary -- any Subsidiary, 100% of the equity Securities and voting Securities of which are owned by one or more of the Company and the Company's other Wholly-Owned Subsidiaries.\nWritten Request -- with respect to any Person a written order or request signed in the name of such Person by the President or a Vice-President of such Person (if a corporation other than one of the holders of Notes) or a general or managing partner (if a partnership) or the Person (if an individual) or any officer of such Person (if such Person is a corporation and a holder of a Note).\nARTICLE 2 COMPANY BUSINESS COVENANTS.\nArticle 7 of the Existing Indenture is hereby amended and restated to read in its entirety as follows:\nThe Company covenants that on and after the date of initial issue of the Notes, so long as any one or more of the Notes or any other obligation secured hereby is outstanding:\nSection 7.1. Payment of Taxes and Claims. The Company, and each Subsidiary, will pay, before they become delinquent:\n(a) all taxes, assessments and governmental charges or levies imposed upon it or its Property;\n(b) all claims or demands of materialmen, mechanics, carriers, warehousemen, landlords and other like Persons which, if unpaid, might result in the creation of a Lien upon its Property; and\n(c) all claims, assessments and levies required to be paid by the Company or any Subsidiary pursuant to any agreement, contract, law, ordinance, or governmental rule or regulation governing any Plan of the Company or any Subsidiary;\nprovided that items of the foregoing description need not be paid while being contested in good faith and by appropriate proceedings and provided further that adequate book reserves have been established with respect thereto and provided further that the owning Person's title to, and its right to use, its Property is not materially and adversely affected thereby. In the case of any item of the foregoing description involving in excess of Two Hundred Fifty Thousand Dollars ($250,000), the appropriateness of the proceedings shall be supported by an opinion of the independent counsel responsible for such proceedings and the adequacy of such reserves shall be supported by the opinion of the independent accountants of the contesting company.\nSection 7.2. Maintenance of Properties and Existence. The Company and each Subsidiary will:\n(a) Property -- maintain its Property in good condition and make all necessary renewals, replacements, additions, betterments and improvements thereto;\n(b) Insurance -- maintain, with financially sound and reputable insurers, insurance with respect to its Properties and business against such casualties and contingencies, of such types (including, without limitation, in each case, if available, loss or damage, public liability, business interruption, war risk, larceny, embezzlement or other criminal misappropriation insurance) and in such amounts as is customary in the case of corporations engaged in the same or a similar business and similarly situated;\n(c) Financial Records -- (i) keep true books of records and accounts in which full and correct entries will be made of all its business transactions, and will reflect in its financial statements adequate accruals and appropriations to reserves, all in accordance with generally accepted accounting principles, practices and procedures at the time in effect and consistently applied except for changes in application in which its independent certified public accountants concur, and (ii) do or cause to be done all things necessary to ensure that the Company and each Subsidiary maintains the same fiscal year;\n(d) Corporate Existence and Rights -- do or cause to be done all things necessary (i) subject to the provisions of Section 7.5 hereof, to preserve and keep in full force and effect its corporate existence, rights and franchises; and\n(e) Compliance with Law -- not be in violation of any law, ordinance or governmental rule or regulation to which it is subject and will not fail to obtain any license, permit, franchise or other governmental authorization necessary to the ownership of its Properties or to the conduct of its business, which violation or failure to obtain might materially adversely affect the business, prospects, profits, Properties or condition (financial or otherwise) of the Company and its Subsidiaries, taken as a whole.\nSection 7.3. Payment of Notes and Maintenance of Office. The Company will punctually pay or cause to be paid the principal and interest (and premium, if any) to become due in respect of the Notes according to the terms thereof and will maintain an office in the State of Texas where notices, presentations and demands in respect of this Indenture or the Notes may be made upon it. The address of such office shall be 110 South Texas Street, P.O. Box 93, Pittsburg, Texas 75686, until such time as the Company shall notify the holders of the Notes of any change of location of such office within such State.\nSection 7.4. Disposal of Shares of a Subsidiary. The Company will not, nor will it permit any Subsidiary to, sell or otherwise dispose of any shares of the stock (or any options or warrants to purchase stock or other Securities exchangeable for or convertible into stock) of a Subsidiary (said stock, options, warrants and other Securities herein called \"Subsidiary Stock\") except to the Company or another Subsidiary, nor will any Subsidiary issue, sell or otherwise dispose of any shares of its own Subsidiary Stock except to the Company or another Subsidiary.\nSection 7.5. Sale of Assets, Merger and Consolidation.\nThe Company will not, nor will it permit any Subsidiary to, consolidate with or merge into any other Person or permit any other Person to consolidate with or merge into it (except that a Subsidiary may consolidate with or merge into another Subsidiary) or sell or otherwise transfer all or substantially all of its Property to any other Person (except that a Subsidiary may sell or otherwise transfer all or substantially all of its Property to another Subsidiary), unless such consolidation, merger or sale is consented to in writing by the Special Majority Noteholders; provided that the foregoing restriction does not apply to the merger of another corporation with the Company, if:\n(a) the corporation which results from such merger or consolidation (the \"surviving corporation\") is organized under the laws of the United States or a jurisdiction thereof;\n(b) the due and punctual payment of the principal of, and premium, if any, and interest on, all of the Notes, according to their respective tenor, and the due and punctual performance and observance of all of the covenants in the Notes, this Indenture and the documents evidencing or creating any other obligations secured hereby to be performed or observed by the Company, are expressly assumed in writing by the surviving corporation;\n(c) after giving effect to the proposed merger or consolidation, the surviving corporation will be engaged in substantially the same lines of business as referred to in Section 2.3 of the Note Purchase Agreements in respect of the Series A Notes, the Series B Notes, the Series C Notes and the Series D Notes; and\n(d) immediately after the consummation of the transaction, and after giving effect thereto, (i) no Default or Event of Default would exist and (ii) the surviving corporation would be permitted by the provisions of Section 7.9 hereof to incur at least one dollar ($1.00) of additional Adjusted Funded Debt.\nSection 7.6. Lease Payments; Sale Leasebacks.\n(a) Limitation on Leases. Neither the Company nor any Subsidiary will become liable as lessee under any lease (other than a financing lease which constitutes Adjusted Funded Debt, a lease of rolling stock or a lease under which the Company or a Subsidiary is lessor) of Property if the aggregate annual Rentals payable during any current or future fiscal year under the lease in question and all other such leases under which the Company or a Subsidiary is then lessee would exceed four percent (4%) of the remainder of Net Tangible Assets less Consolidated Current Liabilities.\n(b) Subsidiary Leases. Any corporation which becomes a Subsidiary after September 1, 1994 shall be deemed to have become liable as lessee, at the time it becomes a Subsidiary, under all leases (under which it is liable as lessee) of such corporation existing immediately after it becomes a Subsidiary.\n(c) Sale Leasebacks. Neither the Company nor any Subsidiary shall sell or otherwise transfer, in one or more related transactions, any of its Property to any Person (other than the Company or a Subsidiary) and thereafter rent or lease such Property, or substantially identical Property, provided that the Company or a Subsidiary may sell Property (other than Collateral) to any Person (other than the Company or a Subsidiary) and thereafter rent or lease such Property if (i) such sale and such rental and\/or leasing is consummated within 365 days of the acquisition of such Property by the Company or such Subsidiary or, if such Property shall have been constructed by the Company or such Subsidiary, within 365 days of the completion of such construction, or (ii) after giving effect to such transaction, the aggregate book value of the Property so sold in any fiscal year of the Company would not exceed Ten Million Dollars ($10,000,000).\nSection 7.7. Liens and Encumbrances.\n(a) Negative Pledge. Neither the Company nor any Subsidiary will (i) cause or permit or (ii) agree or consent to cause or permit in the future (upon the happening of a contingency or otherwise) any of the Indenture Estate, whether now owned or hereafter acquired, to be subject to a Lien except:\n(1) Liens securing taxes, assessments or governmental charges or levies or the claims or demands of materialmen, mechanics, carriers, warehousemen, landlords and other like Persons; provided that the payment thereof is not at the time required by Section 7.1 hereof;\n(2) Liens incurred or deposits made (i) in the ordinary course of business in connection with workmen's compensation, unemployment insurance, social security and other like laws, (ii) in the ordinary course of business to secure the performance of letters of credit, bids, tenders, sales contracts, leases, statutory obligations, surety (other than of the type referred to in clause (iii) of this Section 7.7(a)(2)), and performance bonds and other similar obligations not incurred in connection with the borrowing of money, the obtaining of advances or the payment of the deferred purchase price of Property or (iii) to secure appeal bonds, supersedeas bonds and other similar bonds provided the aggregate amount of such bonds shall not at any time exceed Five Hundred Thousand Dollars ($500,000);\n(3) attachments, judgments and other similar Liens arising in connection with court proceedings; provided, that the execution or other enforcement of such Liens is effectively stayed and the claims secured thereby are being actively contested in good faith and by appropriate proceedings and provided further, that the aggregate amount of such attachments, judgments and other similar Liens shall not at any time exceed Five Hundred Thousand Dollars ($500,000);\n(4) Liens on Property of a Subsidiary; provided that such Liens secure only obligations owing to the Company or a Wholly-Owned Subsidiary;\n(5) reservations, exceptions, encroachments, easements, rights-of-way, covenants, conditions, restrictions, leases and other similar title exceptions or encumbrances affecting real Property; provided, that they do not in the aggregate materially detract from the value of said Properties as used in owner's business or materially interfere with their use in the ordinary conduct of the owner's business;\n(6) (y) Liens in existence on the date of this Indenture and disclosed on the Exhibits to the Note Purchase Agreements in respect of the Series A Notes, the Series B Notes, the Series C Notes and the Series D Notes and (z) Liens securing those certain 14.25% Senior Notes Due 1995 of the Company issued under that certain Indenture, dated as of May 1, 1988, between MTrust Corp, National Association, and the Company, as amended up to and including the Second Closing Date provided that such subordination shall be satisfactory in form and substance to the holders of Series A Notes, Series C Notes and Series D Notes and the principal amount of such Senior Notes shall not exceed at any time the remainder of fifty million dollars ($50,000,000) minus the aggregate principal amount of such Senior Notes repaid by the Company at or prior to such time;\n(7) Liens in favor of the Security Trustee with respect to the Indenture Estate;\n(8) Purchase Money Liens, if after giving effect thereto and any concurrent transactions (A) no Default or Event of Default would exist and (B) the Company would be permitted by the provisions of Section 7.9(a) hereof to incur the indebtedness secured thereby; and\n(9) extensions and renewals of Liens described in Sec tion 7.7(a)(6)(y) hereof which secure indebtedness for money borrowed in connection with the extension, renewal or refunding of the indebtedness secured thereby, provided (A) the amount of such indebtedness is not increased at any time and (B) such Liens are not extended to Property not encumbered thereby on the date hereof, and provided further that this clause (9) shall not apply to any of the Company's 14.25% Senior Notes due 1995 referred to in Section 7.7(a)(6)(z).\n(b) Equal and Ratable Lien; Equitable Lien. In any case wherein Property is subjected to a Lien in violation of this Section 7.7, the Company will make or cause to be made provision whereby the Notes and the other obligations secured hereby will be secured equally and ratably with all other obligations secured thereby, and in any case the Notes and such obligations shall have (in addition to the benefits of the Lien in favor of the Security Trustee with respect to the Indenture Estate) the benefit, to the full extent that, and with such priority as, the holders may be entitled thereto under applicable law, of an equitable Lien on such Property securing the Notes and such obligations. Such violation of Section 7.7 shall constitute an Event of Default hereunder, whether or not any such provision is made pursuant to this Section 7.7(b). (c) Financing Statements. The Company will not, nor will it permit any Subsidiary to, sign or file any financing statement under the Uniform Commercial Code of any jurisdiction which names the Company or such Subsidiary as debtor, or sign any security agreement authorizing any secured party thereunder to file any such financing statement, except, in any such case, a financing statement filed or to be filed to perfect or protect a security interest which the Company or such Subsidiary is entitled to create, assume or incur, or permit to exist, under the foregoing provisions of this Section 7.7.\n(d) Opinions. The Company will cause this Indenture, any and all supplemental indentures, mortgages, security agreements, instruments of further assignment and financing statements and continuation statements at all times to be kept recorded and filed in such manner and in such places as may be required by law to fully preserve and protect the rights of the holders of the obligations secured hereby and the Security Trustee hereunder and under all other documents and instruments evidencing or securing the obligations secured hereby (including, without limitation, documents and instruments granting Liens to the Security Trustee with respect to the Indenture Estate), and it will furnish to the Security Trustee between April 1 and June 1 of each year beginning with the year 1987, an Opinion of Counsel stating that in the opinion of such counsel such action (if any be required) has been taken with respect to the recording, filing, registering, pre-recording, refiling and reregistering of this Indenture, any and all supplemental indentures, mortgages, security agreements, instruments of further assurance and financing and continuation statements as is necessary for such purposes, and reciting the details of such action (if any), and stating that in the opinion of such counsel no additional action is, or will become during the twelve (12) months following the date of such opinion, necessary for such purpose.\nSection 7.8. Current Liabilities. The Company will not, nor will it permit any Subsidiary to, have any material current liabilities which are more than thirty (30) days overdue unless contested in good faith.\nSection 7.9. Debt; Total Liabilities.\n(a) Adjusted Funded Debt. Neither the Company nor any Subsidiary will permit at any time Consolidated Net Tangible Assets to be less than one hundred seventy-five percent (175%) of the aggregate principal amount of Adjusted Funded Debt of the Company and the Subsidiaries outstanding at such time (after eliminating therefrom (i) the current portion of any obligation constituting such Adjusted Funded Debt and (ii) any Adjusted Funded Debt owing from the Company to a Subsidiary, from a Subsidiary to the Company or from a Subsidiary to another Subsidiary).\n(b) Subsidiary Debt. Intentionally deleted.\n(c) Total Liabilities. On the last day of each fiscal quarter of the Company, Consolidated Total Liabilities will not exceed three hundred fifty percent (350%) of Consolidated Tangible Net Worth.\n(d) Guaranties. Neither the Company nor any Subsidiary will permit at any time the aggregate obligations (whether contingent or matured) in respect of all of the Guaranties issued by the Company or any Subsidiary to exceed One Million Dollars ($1,000,000); provided, however, that the foregoing restriction shall not include Guaranties (i) issued by the Company and payable to a Subsidiary, (ii) issued by a Subsidiary and payable to the Company, (iii) issued by a Subsidiary and payable to another Subsidiary, and (iv) of the obligations of one or more Mexican Subsidiaries not to exceed $25,000,000 in the aggregate. The obligations of the Company or any Subsidiary under any Guaranty which, by the terms thereof, are unliquidated or contingent shall be the amount which the Board of Directors shall, in good faith, reasonably estimate.\nSection 7.10. Consolidated Tangible Net Worth. The Company and its Subsidiaries will, at all times, maintain Consolidated Tangible Net Worth of not less than the sum of (x) One Hundred Million Dollars ($100,000,000) plus (y) an amount equal to the sum of (i) sixty percent (60%) of Consolidated Adjusted Net Income earned since October 3, 1994 through and including the last day of the then most recently ended fiscal year (excluding any fiscal year in which Consolidated Adjusted Net Income was less than $0), plus (ii) one hundred percent (100%) of Net Future Capital Stock Proceeds.\nSection 7.11. Restricted Investments.\n(a) Limit on Restricted Investments. The Company will not, nor will it permit any Subsidiary to, make or incur any liability to make any Restricted Investment or any Unfriendly Investment.\nAny corporation which becomes a Subsidiary after the date of the initial issuance of the Series A Notes and the Series B Notes, shall be deemed to have made, at the time it becomes a Subsidiary, all Restricted Investments of such corporation existing immediately after it becomes a Subsidiary.\n(b) No Defaults. Anything herein contained to the contrary notwithstanding, neither the Company nor any Subsidiary will authorize or make any Investment if, after giving effect to the proposed Investment a Default or an Event of Default would exist.\n(c) Restricted Payments. The Company will not and will not permit any Subsidiary to:\n(i) declare or pay any dividends, either in cash or Property, on any shares of capital stock of any class (except dividends or other distributions payable solely in shares of common stock of the Company and dividends paid by any Subsidiary to the Company or to any other Subsidiary); or\n(ii) directly or indirectly, or through any Subsidiary, purchase, redeem or retire any shares of capital stock of any class of the Company or any Subsidiary or any warrants, rights or options to purchase or acquire any shares of such capital stock (other than shares of capital stock of the Company acquired by the Company in exchange for other shares of common stock of the Company or shares of capital stock of such Subsidiary acquired by such Subsidiary in exchange for other shares of common stock of such Subsidiary); or\n(iii) make any other payment or distribution, either directly or indirectly or through any Subsidiary, in respect of its capital stock (other than to the Company or a Subsidiary),\nunless, after giving effect thereto, the aggregate of all such payments, purchases or distributions in respect of the then current fiscal year of the Company shall not exceed Two Million Three Hundred Thousand Dollars ($2,300,000). For the purposes of this subsection, the amount of any of the aforesaid payments which is payable or distributable in Property other than cash or shares of capital stock of the Company shall be deemed to be the greater of the book value or Fair Market Value (as determined in good faith by the Board of Directors of the Company) of such Property as of the date of the declaration of such payment. The Company shall not authorize any dividend, payment or distribution in respect of its capital stock which is not payable within sixty (60) days of authorization.\nSection 7.12. Current Ratio; Consolidated Working Capital.\n(a) Current Ratio. At all times, Consolidated Current Assets as of the end of the fiscal quarter of the Company then most recently ended shall be not less than one hundred forty percent (140%) of Consolidated Adjusted Current Liabilities as at the end of such fiscal quarter.\n(b) Maintenance of Consolidated Adjusted Working Capital. At all times, Consolidated Adjusted Working Capital will be not less than Fifty Million Dollars ($50,000,000).\nSection 7.13. Fixed Charge Ratio. At all times, the Fixed Charge Ratio for the period of eight (8) consecutive fiscal quarters then most recently ended shall be not less than 1.40.\nSection 7.14. ERISA Compliance.\n(a) Relationship of Vested Benefits to Pension Plan Assets. The Company will not at any time permit the present value of all employee benefits vested under all Pension Plans to exceed a sum equal to the present value of the assets allocable to such vested benefits.\n(b) Valuations. All assumptions and methods used to determine the actuarial valuation of vested employee benefits under Pension Plans and the present value of assets of such Pension Plans shall be reasonable in the good faith judgment of the Company and shall comply with all requirements of law.\n(c) Prohibited Actions. Neither the Company nor any Subsidiary nor any Plan at any time maintained by any one or more of the Company and its Subsidiaries will\n(1) engage in any \"prohibited transaction\" (as such term is defined in Section 406 or Section 2003(a) of ERISA;\n(2) incur any \"accumulated funding deficiency\" (as such term is defined in Section 302 of ERISA) whether or not waived; or\n(3) terminate any such Plan in a manner which could result in the imposition of a Lien on the Property of the Company or any Subsidiary pursuant to Section 4068 of ERISA.\nSection 7.15. Transactions with Affiliates. Neither the Company nor any Subsidiary will enter into any transaction, including, without limitation, the purchase, sale or exchange of Property or the rendering of any service, with any Affiliate except in the ordinary course of and pursuant to the reasonable requirements of the Company's or such Subsidiary's business and upon fair and reasonable terms no less favorable to the Company or such Subsidiary than would obtain in a comparable arm's- length transaction with a Person not an Affiliate.\nSection 7.16. Tax Consolidation. The Company will not file or consent to the filing of any consolidated income tax return with any Person other than a Subsidiary.\nSection 7.17. Sale or Discount of Receivables. The Company will not, nor will it permit any Subsidiary to, discount or sell with recourse, or sell for less than the greater of the face value or market value thereof, any of its notes receivable or accounts receivable.\nSection 7.18. Acquisition of Notes. Neither the Company, any Subsidiary nor any Affiliate will, directly or indirectly, acquire or make any offer to acquire any Notes unless the Company or such Subsidiary or Affiliate has offered to acquire Notes, pro rata, from all holders of the Notes and upon the same terms. In case the Company acquires any Notes, such Notes shall thereafter be cancelled and no Notes shall be issued in substitution therefor.\nSection 7.19. Line of Business. Neither the Company nor any Subsidiary will engage, directly or indirectly, in any business if, as a result thereof, the business of the Company and the Subsidiaries, taken as a whole, would not be substantially the same as on the date of this Indenture.\nSection 7.20. Margin Securities. Neither the Company nor any Subsidiary will own, purchase or acquire or enter into any contract to purchase or acquire, any \"margin security\" (a \"Margin Security\") as such term is presently defined in Part 207 of Title 12 of the Code of Federal Regulations or as such term may in the future be defined in the substantially similar applicable rules and regulations of the Federal Reserve Board or its successor agency.\nSection 7.21. Financial and Business Information. The Company will deliver to the Security Trustee and each institutional holder of the then outstanding Notes:\n(a) Quarterly Statements -- as soon as practicable after the end of each quarterly fiscal period in each fiscal year of the Company, and in any event within forty-five (45) days thereafter, two (2) copies of:\n(1) a consolidated balance sheet of the Company and its Subsidiaries as at the end of such quarter, and\n(2) consolidated statements of income, surplus and cash flows of the Company and its Subsidiaries for such quarter and (in the case of the second and third quarters) for the portion of the fiscal year ending with such quarter,\nsetting forth in each case in comparative form the figures for the corresponding periods in the previous fiscal year, all in reasonable detail and certified as complete and correct, subject to changes resulting from year-end adjustments, by a principal financial officer of the Company;\n(b) Annual Statements -- as soon as practicable after the end of each fiscal year of the Company, and in any event within ninety (90) days thereafter, two (2) copies of:\n(1) a consolidated balance sheet of the Company and its Subsidiaries as at the end of such year, and\n(2) consolidated statements of income, surplus and cash flows of the Company and its Subsidiaries for such year,\nsetting forth in each case in comparative form the figures for the previous fiscal year, all in reasonable detail and accompanied by (y) an opinion thereon of independent certified public accountants of recognized national standing selected by the Company and acceptable to the Special Majority Noteholders, which opinion shall state that such consolidated financial statements fairly present the financial condition of the companies being reported upon and have been prepared in accordance with generally accepted accounting principles consistently applied (except for changes in application which were required as a condition to obtain such opinion from such accountants) and that the examination of such accountants in connection with such financial statements has been made in accordance with generally accepted auditing standards, and accordingly included such tests of the accounting records and such other auditing procedures as were considered necessary in the circumstances and (z) a certification by a principal financial officer of the Company that such consolidated financial statements are complete and correct;\n(c) Opinions of Independent Accountants and Counsel -- as soon as practicable after the end of each fiscal year of the Company, and in any event within ninety (90) days thereafter, duplicate copies of all opinions of independent accountants and counsel required pursuant to Section 7.1 hereof;\n(d) Audit Reports -- promptly upon receipt thereof, one (1) copy of each other report submitted to the Company or any Subsidiary by independent accountants in connection with any annual, interim or special audit made by them of the books of the Company or any Subsidiary;\n(e) SEC and Other Reports -- promptly upon their becoming available one (1) copy of each financial statement, report, notice or proxy statement sent by the Company or any Subsidiary to stockholders generally, and of each regular or periodic report and any registration statement, prospectus or written communication (other than transmittal letters) in respect thereof filed by the Company or any Subsidiary with, or received by such Person in connection therewith from, any securities exchange or the Securities and Exchange Commission or any successor agency;\n(f) ERISA -- immediately upon becoming aware of the occurrence of any (i) \"reportable event\" (as such term is defined in Section 4043 of ERISA) or (ii) \"prohibited transaction\" (as such term is defined in Section 406 or Section 2003(a) of ERISA) in connection with any Plan or any trust created thereunder, a written notice specifying the nature thereof, what action the Company is taking or proposes to take with respect thereto, and, when known, any action taken by the Internal Revenue Service or the Department of Labor, as the case may be, with respect thereto;\n(g) Notice of Default or Event of Default -- immediately upon becoming aware of the existence of any condition or event which constitutes a Default or an Event of Default a written notice specifying the nature and period of existence thereof and what action the Company is taking or proposes to take with respect thereto;\n(h) Notice of Claimed Default -- immediately upon becoming aware that the holder of any note or of any evidence of indebtedness or other Security of the Company or any Subsidiary has given notice or taken any other action with respect to a claimed default or event of default, a written notice specifying the notice given or action taken by such holder and the nature of the claimed default or event of default and what action the Company is taking or proposes to take with respect thereto;\n(i) Other Information; Rule 144A -- promptly upon request such financial or other information as any holder of Notes may reasonably determine is required to permit such holder to comply with the requirements of Rule 144A promulgated under the Securities Act in connection with the resale by it of such Notes; and\n(j) Requested Information -- with reasonable promptness, such other data and information as from time to time may be reasonably requested.\nSection 7.22. Officers' Certificates. Each set of financial statements delivered to the Security Trustee or any institutional holder of the Notes pursuant to Section 7.21(a) or Section 7.21(b) hereof will be accompanied by a certificate signed by a principal financial officer of the Company setting forth:\n(a) Covenant Compliance -- the information (including detailed calculations, and, where required by the appropriate covenant, information and calculations presented on a consolidated basis) required in order to establish whether the Company and the Subsidiaries were in compliance with the requirements of Section 7.4 through Section 7.20 hereof during the period covered by the income statement then being furnished.\n(b) Event of Default -- that the signers have reviewed the relevant terms of this Indenture and have made, or caused to be made, under their supervision, a review of the transactions and conditions of the Company and its Subsidiaries from the beginning of the accounting period covered by the income statements being delivered therewith to the date of the certificate and that such review has not disclosed the existence during such period of any condition or event which constitutes a Default or an Event of Default or, if any such condition or event existed or exists, specifying the nature and period of existence thereof and what action the Company and each Subsidiary has taken or proposes to take with respect thereto.\nSection 7.23. Accountants' Certificates. Each set of annual financial statements delivered pursuant to Section 7.21(b) hereof will be accompanied by a certificate of the accountants who certify such financial statements, stating that they have reviewed this Indenture and stating further, whether, in making their audit, such accountants have become aware of any condition or event which then constitutes a Default or an Event of Default, and, if any such condition or event then exists, specifying the nature and period of existence thereof.\nSection 7.24. Inspection. The Company will, and will cause each Subsidiary to, permit representatives of the Security Trustee or the representatives of any institutional holder of any Note, at the Security Trustee's or such holder's expense, to visit and inspect any of the Properties of the Company or any Subsidiary, to examine all their books of account, records, reports and other papers, to make copies and extracts therefrom, and to discuss their respective affairs, finances and accounts with their respective officers, employees and independent public accountants (and by this provision the Company authorizes said accountants to discuss the finances and affairs of the Company and its Subsidiaries) all at such reasonable times and as often as may be reasonably requested.\nARTICLE 3 REPRESENTATIONS AND WARRANTIES.\n3.1 Corporate Organization and Authority. The Company (a) is a corporation duly organized and validly in good standing under the laws of the State of Delaware, (b) has all requisite power and authority and all necessary licenses and permits to own and operate its Properties and to carry on its business as now conducted and presently proposed to be conducted, (c) is duly qualified and is authorized to do business and is in good standing as a foreign corporation in each jurisdiction where the character of its Properties or the nature of its activities makes such qualification necessary and (d) has the corporate power and authority to (i) enter into this Supplemental Indenture and (ii) perform its obligations under this Supplemental Indenture, the Trust Indenture and the other Financing Documents.\n3.2 Lien Priority. The Liens in and to the Collateral have been duly granted, are in full force and effect, are perfected and are senior to all other Liens except as provided for in Section 7.7(a) of the Existing Indenture.\n3.3 Authorization. This Supplemental Indenture has been duly authorized, executed and delivered by the Company and the obligations of the Company hereunder and under the other Financing Documents constitute the legal, valid and binding obligations of the Company, enforceable in accordance with their respective terms, except that the enforceability of this Supplemental Indenture, the Trust Indenture and the other Financing Documents, as amended hereby may be (a) limited by bankruptcy, insolvency or other similar laws affecting the enforceability of creditors' rights generally and (b) subject to the availability of equitable remedies. The execution and delivery by the Company of this Supplemental Indenture are not, and the performance by the Company of its obligations hereunder will not be, inconsistent with its certificate of incorporation or by-laws, do not and will not contravene any law, governmental rule or regulation, judgment or order applicable to the Company, and do not and will not contravene any provision of, or constitute a default under, any indenture, mortgage, contract or other instrument to which the Company is a party or by which any of its Property is bound.\n3.4 Consent. No consent or approval of, giving of notice to, registration with, or taking of any other action in respect of or by, any federal, state or local governmental authority or agency, or other Person is required with respect to (a) the execution and delivery by the Company of this Supplemental Indenture and (b) the performance by the Company of any of its obligations hereunder or thereunder or under the Trust Indenture.\n3.5 Default. After giving effect to this Supplemental Indenture, no Default or Event of Default will exist. There are no defaults or events of default under any other agreement or instrument of the Company relating to or evidencing Debt.\n3.6 Mexican Advances. The aggregate inter-company advances owed to the Company or its U.S. Subsidiaries by its Mexican Subsidiaries as of August 27, 1994 is $24,755,375 and the net equity investment (exclusive of retained earnings) made by the Company in its Mexican Subsidiaries as of August 27, 1994 is $51,285,344.\nARTICLE 4 CONDITIONS TO EFFECTIVENESS.\nThis Supplemental Indenture shall become effective only upon the satisfaction in all respects of the conditions set forth below. The first date upon which all such conditions shall have been satisfied shall be the date that this Supplemental Indenture becomes effective. The aforesaid conditions are as follows:\n4.1 Holder Instructions to Security Trustee. Each of the holders of Notes shall have executed the addendum hereto instructing the Security Trustee to execute and deliver this Supplemental Indenture.\n4.2 Execution of this Supplemental Indenture. The Security Trustee and the Company shall have executed this Supplemental Indenture.\n4.3 Security Trustee Fees. All fees of the Security Trustee due and payable upon the execution and delivery of this Supplemental Indenture shall have been paid by the Company. 4.4 Representations and Warranties. The representations and warranties set forth in Article 3 hereof shall be true and correct as of the date hereof and as of the date this Supplemental Indenture becomes effective.\n4.5 Guarantee Agreement Confirmation. Each of the Guarantors shall have executed the addendum hereto, and the Guarantors and the Security Trustee shall have entered into an amendment to the Guaranty Agreement in form and substance satisfactory to the holders of the Notes.\n4.6 Proceedings; Expenses. All proceedings taken in connection with the closing of this Supplemental Indenture and all documents and papers relating thereto shall be satisfactory to each of the holders of Notes and their respective counsel. All costs and expenses of the holders of Notes and the Security Trustee required to be paid by Section 5.9 hereof shall have been paid in full.\nARTICLE 5 MISCELLANEOUS.\nSection 5.1 Benefit of Existing Indenture. The Security Trustee shall be entitled to, may exercise, and shall be protected by, where and to the full extent the same shall be applicable, all the rights, powers, privileges, immunities and exemptions provided in the Existing Indenture as if the provisions concerning the same, as amended (if at all) hereby, were incorporated herein at length. The recitals and statements in this Supplemental Indenture shall be taken as statements by the Company alone, and shall not be considered as made by or imposing any obligation or liability upon the Security Trustee, nor shall the Security Trustee be held responsible for the legality or validity of this Supplemental Indenture, and the Security Trustee makes no covenant or representation, and shall not be responsible, as to and for the effect, authorization, execution, delivery or recording of this Supplemental Indenture. As provided in the Existing Indenture, this Supplemental Indenture shall hereafter form a part of the Trust Indenture.\nSection 5.2 Successors and Assigns. Whenever any of the parties hereto is referred to, such reference shall be deemed to include the successors and assigns of such party, and all the covenants, promises and agreements in this Supplemental Indenture contained by or on behalf of the Company or by or on behalf of the Security Trustee shall bind and inure to the benefit of the respective successors and assigns of such parties whether so expressed or not.\nSection 5.3 Partial Invalidity. The unenforceability or invalidity of any provision or provisions of this Supplemental Indenture shall not render any other provision or provisions herein or otherwise within the Trust Indenture contained unenforceable or invalid.\nSection 5.4 Governing Law. THE TRUST INDENTURE, INCLUDING THIS SUPPLEMENTAL INDENTURE, AND THE NOTES SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE INTERNAL LAWS OF THE STATE OF CONNECTICUT (WITHOUT REGARD TO ANY CONFLICTS-OF-LAW PRINCIPLES)\nSection 5.5 Counterparts. This Supplemental Indenture may be executed and delivered in any number of counterparts, each of such counterparts constituting an original but altogether only one Supplemental Indenture; provided, however, that this Supplemental Indenture shall not be deemed to be delivered until at least one counterpart shall have been executed by the Company and the Security Trustee.\nSection 5.6 Headings, etc. Any headings or captions preceding the text of the several articles and sections hereof are intended solely for convenience of reference and shall not constitute a part of this Supplemental Indenture nor shall they affect its or the Trust Indenture's meaning, construction or effect. Each covenant contained in this Supplemental Indenture shall be construed (absent an express contrary provision therein) as being independent of each and every other covenant herein and in the Trust Indenture contained and compliance with any one covenant shall not (absent such an express contrary provision) be deemed to excuse compliance with any and all other covenants.\nSection 5.7 Amendments. This Supplemental Indenture may, subject to the provisions of Article 9 of the Trust Indenture, from time to time and at any time, be amended or supplemented by, and only by, an instrument or instruments in writing executed by the parties hereto.\nSection 5.8 Benefits of Indenture Restricted to Parties and Note Holders. Nothing in this Supplemental Indenture expressed or implied is intended or shall be construed to give to any Person other than the Company, the Security Trustee, the holders of the Notes issued under the Trust Indenture and other obligations secured thereby any legal or equitable right, remedy or claim under or in respect of the Trust Indenture or any covenant, condition or provision therein or herein contained; and all such covenants, conditions and provisions are and shall be held to be for the sole and exclusive benefit of the Company, the Security Trustee, the holders of the Notes issued under the Trust Indenture and other obligations secured hereby.\nSection 5.9 Expenses. The Company agrees to pay, and save the Security Trustee and all holders of Notes harmless against liability for the payment of, all attorney's fees and other out-of-pocket expenses arising in connection with the transactions contemplated by this Supplemental Indenture, including all document production and duplication charges and the fees and expenses of any special counsel engaged by the Security Trustee or any holder of Notes in connection with this Supplemental Indenture and\/or such transactions.\nSection 5.10 Directly or Indirectly. Where any provision in this Supplemental Indenture refers to action to be taken by any Person, or which such Person is prohibited from taking, such provision shall be applicable whether such action is taken directly or indirectly by such Person.\nSection 5.11 Existing Indenture Not Otherwise Affected. Except as modified, amended or supplemented hereby, and except as modified, amended or supplemented hereafter, the Existing Indenture and the Notes issued in respect thereof and all other Financing Documents shall remain unchanged and in full force and effect and the Company hereby ratifies and reaffirms all of its obligations thereunder.\n[REMAINDER OF PAGE INTENTIONALLY BLANK. NEXT PAGE IS SIGNATURE PAGE] IN WITNESS WHEREOF, the Company has caused this Supplemental Indenture to be executed and its seal hereunto affixed and said seal and this Supplemental Indenture to be attested by its Assistant Secretary, and State Street Bank and Trust Company of Connecticut, N.A., in evidence of its acceptance of the trusts hereby created, has caused this Supplemental Indenture to be executed on its behalf by one of its authorized trust officers all as of the day and year first above written.\nAttest: PILGRIM'S PRIDE CORPORATION Name: C.E. Butler Name: Lonnie A. Pilgrim Title: Secretary Title: Chief Executive Officer\n[CORPORATE SEAL]\nSTATE STREET BANK AND TRUST COMPANY OF CONNECTI CUT, N.A., as Security Trustee\nName: Michael J. D'Angelico Title: Vice President\n[Signature Page of the SUPPLEMENTAL INDENTURE, dated as of October 2, 1994, between PILGRIM'S PRIDE CORPORATION and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee] CONSENT AND DIRECTION TO THE SECURITY TRUSTEE:\nThe undersigned, The Aetna Casualty and Surety Company, and Aetna Life Insurance Company (collectively, the \"Noteholders\") in the aggregate own one hundred percent (100%) in principal amount of the Series A Notes and the Series C Notes, being all of the outstanding Notes issued under the Existing Indenture. Pursuant to Section 9.2 of the Existing Indenture and this paragraph, the Security Trustee is hereby directed to execute and deliver this Supplemental Indenture, the Second Amendment to Guarantee Agreement and such other related documents and instruments as are contemplated by the provisions of the foregoing. Each of the Noteholders hereby consents to the terms, provisions and conditions of this Supplemental Indenture.\nTHE AETNA CASUALTY AND SURETY COMPANY\nName: Drew M. Thomas Title: Assistant Vice President\nAETNA LIFE INSURANCE COMPANY\nName: Drew M. Thomas Title: Assistant Vice President\n[Consent and Direction Signature Page of the SUPPLEMENTAL INDENTURE, dated as of October 2, 1994, between PILGRIM'S PRIDE CORPORATION and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee]\nCONSENT OF GUARANTORS:\nEach of the undersigned, Lonnie A. Pilgrim and Patty R. Pilgrim, hereby consents to all of the transactions and modifications in and to the Financing Documents provided for, or contemplated by, this Supplemental Indenture.\nLONNIE A. PILGRIM\nPATTY R. PILGRIM\n[Consent of Guarantors Signature Page of the SUPPLEMENTAL INDENTURE, dated as of October 2, 1994, between PILGRIM'S PRIDE CORPORATION and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee]","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition\nGeneral The profitability of the chicken industry is affected by market prices of chicken and of feed grains, both of which may fluctuate significantly and exhibit cyclical characteristics. In an effort to reduce price volatility and to generate higher, more consistent profit margins, the Company has concentrated on the production and marketing of prepared food products, which generally have higher margins than the Company's other products. This concentration has resulted in an increase in sales of prepared food products as a percentage of total domestic net sales from 28.3% in fiscal 1990 to 39.0% in fiscal 1993. Management believes that sales of prepared food products will become a larger component of its total chicken sales, and, accordingly, changes in market prices for chicken and feed costs should have less impact on profitability.\nRESULTS OF OPERATIONS\nFiscal 1994 Compared to Fiscal 1993: The Company's accounting cycle resulted in 52 weeks of operations in fiscal 1994 and 53 weeks in fiscal 1993.\nConsolidated net sales were $922.6 million for fiscal 1994, an increase of $34.8 million, or 3.9%, over fiscal 1993. The increase in consolidated net sales resulted from a $35.2 million increase in domestic chicken sales to $635.2 million, partially offset by a $.4 million decrease in sales of other domestic products to $98.7 million. Mexican chicken sales remained constant at $188.7 million. The increase in domestic chicken sales was primarily due to a 3.9% increase in the total revenue per dressed pound produced and a 1.9% increase in dressed pounds produced. The constant Mexican chicken sales resulted from a 2.4% increase in dressed pounds produced offset by a 2.3% decrease in the total revenue per dressed pound produced.\nConsolidated cost of sales was $812.5 million in fiscal 1994, an increase of $30.7 million, or 3.9%, over fiscal 1993. The increase primarily resulted from a $35.9 million increase in cost of sales of domestic operations offset by a $5.2 million decrease in the cost of sales from Mexican operations.\nThe cost of sales increase in domestic operations of $35.9 million was primarily due to a 5.7% increase in feed ingredient cost and a 1.9% increase in dressed pounds produced.\nThe cost of sales decrease in Mexican operations of $5.2 million was primarily the result of a decrease in the average cost of sales per dressed pound produced, offset by a 2.4% increase in dressed pounds produced. The decrease in the average cost of sales per dressed pound produced when compared to the same period in 1993 was due to lower live production costs due to increased efficiencies.\nGross profit as a percentage of sales increased to 12.0% in fiscal 1994 from 11.9% in fiscal 1993. The improved gross profit resulted primarily from increased gross profit in the Company's domestic chicken operations resulting primarily from increased total revenue per dressed pound. The increase in gross profit as a percentage of sales in Mexican chicken operations resulted from a decrease in the average cost of sales per dressed pound produced, resulting from reduced live production costs.\nConsolidated selling, general and administrative expenses were $50.9 million for fiscal 1994, an increase of $0.9 million, or 1.9%, when compared to fiscal 1993. Consolidated selling, general and administrative expenses as a percentage of sales decreased in fiscal 1994 to 5.5% from 5.6% in fiscal 1993.\nConsolidated operating income for fiscal 1994 was $60.0 million compared to $56.1 million in fiscal 1993. The increase was due primarily to higher margins in domestic and Mexican chicken operations as described previously.\nConsolidated net interest expense was $19.2 million in fiscal 1994, a decrease of $6.5 million, or 25.5%, when compared to fiscal 1993. This decrease was due to a reduction of fees and expenses incurred for refinancing and lower amounts of outstanding debt when compared to fiscal 1993.\nFiscal 1993 Compared to Fiscal 1992: The Company's accounting cycle resulted in 53 weeks of operations in fiscal 1993 compared to 52 weeks in fiscal 1992.\nConsolidated net sales were $887.8 million for fiscal 1993, an increase of $70.5 million or 8.6%, over fiscal 1992. The increase in consolidated net sales resulted from a $31.2 million increase in domestic chicken sales to $600.0 million, a $28.2 million increase in Mexican chicken sales to $188.7 million and a $11.1 million increase in sales of other domestic products to $99.1 million. The increase in domestic chicken sales was primarily due to a 4.9% increase in dressed pounds produced and a .6% increase in the total revenue per dressed pound produced. The increase in Mexican chicken sales resulted from a 6.8% increase in dressed pounds produced and a 10.1% increase in the total revenue per dressed pound produced.\nConsolidated cost of sales was $781.8 million in fiscal 1993, a decrease of $5.0 million, or .6% over fiscal 1992. The decrease primarily resulted from an $8.8 million decrease in cost of sales of domestic operations offset by a $5.7 million increase in the cost of sales from Mexican operations.\nThe cost of sales decrease in domestic operations of $8.8 million, occurring while dressed pounds produced increased 4.9%, was due primarily to reduced live production cost, improved efficiencies, lower feed cost and elimination of cost of sales resulting from the cessation of non-poultry farming operations. While average feed costs were lower in fiscal 1993 than the previous year, since the third quarter of fiscal 1993, feed costs have increased primarily attributable to flooding which occurred during the summer of 1993 in the Midwestern United States. Due to the commodity nature of feed there can be no assurance as to future feed costs.\nThe cost of sales increase in Mexican operations of $5.7 million was primarily the result of a 6.8% increase in dressed pounds produced offset by a decrease in the average cost of sales per dressed pound produced. The decrease in the average cost of sales per dressed pound produced when compared to the same period in 1992, was due to decreased feed prices and reduced production costs resulting from improved performance levels which are a result of capital expenditures made by the Company in 1990 and 1991.\nGross profit as a percentage of sales increased to 11.9% in fiscal 1993 from 4.0% in fiscal 1992. The improved gross profit resulted primarily from increased gross profit in the Company's domestic chicken operations resulting primarily from improved results in live production, improved efficiencies and decreased feed costs. The improved gross profit also results from significant improvement in gross profit on other domestic products including the elimination of the negative gross profit experienced in the same period of fiscal 1992 upon the cessation of non-poultry farming operations, and improved margins in the Company's commercial egg operations. The increase in gross profit as a percentage of sales in Mexican chicken operations resulted from a 10.1% increase in total revenue per dressed pound produced and a decrease in the average cost of sales per dressed pound produced, resulting from decreased feed prices and reduced production costs.\nConsolidated selling, general and administrative expenses were $49.9 million for fiscal 1993, an increase of $3.7 million, or 7.9%, when compared to fiscal 1992. The increase was not significantly attributable to any individual expense category with the exception of accrued retirement and bonuses which are dependent upon consolidated profits. Consolidated selling, general and administrative expenses as a percentage of sales decreased in fiscal 1993 to 5.6% compared to 5.7% in fiscal 1992.\nConsolidated operating income for fiscal 1993 was $56.1 million compared to an operating loss of $13.5 million in fiscal 1992. The increase was due primarily to higher margins in all areas of the Company's operations as described previously.\nConsolidated net interest expense was $25.7 million in fiscal 1993, an increase of $3.2 million, or 14.3% when compared to fiscal 1992. The increase was primarily due to higher rates on short-term borrowings due to the renegotiation of revolving credit agreements with lenders occurring in the third quarter of fiscal 1992 and the amortization of issue costs on interim financing agreements.\nLiquidity and Capital Resources:\nThe Company's liquidity improved from the previous year-end due to record net income. The Company's working capital increased to $99.7 million ($93.3 million, excluding current deferred income taxes recorded in connection with the adoption of FAS 109) from $72.7 million at the prior year-end. The current ratio increased to 2.34 to 1 (2.25 to 1, excluding current deferred income taxes recorded in connection with the adoption of FAS 109) from 1.77 to 1 at the prior year-end. Stockholder's equity for the Company increased to $161.7 million from $132.3 million at the prior year-end. The Company also reduced the ratio of total debt to capitalization from 58.3% at the prior year-end to 49.3%. The Company maintains a $75 million revolving credit facility maturing in May 1997 with unused lines of credit of $61.7 million available at November 15, 1994. In July 1994, the Company secured $10 million in stand-by long-term financing from an existing lender, secured by existing collateral. The facility is available through June 20, 1995 and the Company expects to renew the facility annually unless drawn upon.\nTrade accounts and other accounts receivable at October 1, 1994, were $53.3 million, a $6.3 million decrease from the 1993 fiscal year-end balance. This 10.6% decrease was due primarily to a decrease in the amounts of insurance claims receivable at year end 1994. See Note I to the Consolidated Financial Statements.\nInventories were $100.7 million at October 1, 1994, a $9.0 million increase from October 2, 1993. This 9.8% increase was primarily due to increased production which requires higher inventories and higher feed costs which are included in live broiler and hens and feed, eggs and other inventories until such time as they are sold.\nDeferred tax assets recorded in accordance with FAS 109 were $14.4 million as of October 1, 1994, a $4.7 million decrease from October 2, 1993. The Company believes that all remaining deferred tax assets will be realized through the reversal of existing temporary differences and anticipated future taxable earnings.\nOther current assets were $1.2 million at October 1, 1994, a 87.3% decrease from October 2, 1993, due primarily to the reclassification of assets held for sale, principally farmland which had previously been used in the Company's non-poultry farming operation, to other assets. The reclassification was made upon conclusion that liquidation of these assets is not likely to occur within the next fiscal year.\nCapital expenditures for fiscal 1994 were $25.6 million primarily for additional production facilities and other projects designed to improve efficiencies and the routine replacement of equipment. The Company's capital budget for fiscal 1995 provides for capital expenditures of approximately $29 million, which the Company anticipates will be used to improve efficiencies. The Company expects to finance its 1995 capital expenditures with available operating cash flow and leases.\nCash flows provided by (used in) operating activities were $60.7 million, $45.0 million and $(1.6) million in fiscal 1994, 1993 and 1992, respectively. The increase in cash flows provided by operating activities from fiscal 1993 to fiscal 1994 and fiscal 1992 to fiscal 1993 resulted primarily from increased net income in both fiscal 1994 and fiscal 1993.\nCash provided by (used in) financing activities was $(30.3) million, $(40.3) million and $25.1 million in fiscal 1994, 1993 and 1992, respectively. The cash provided by (used in) financing activities primarily reflects the proceeds from the sales of stock in fiscal 1992 and debt retirements in fiscal 1994, 1993 and 1992.\nThe Company's deferred income taxes have resulted primarily from the Company's change from the cash method of accounting to the accrual method of accounting for taxable periods beginning after July 2, 1988. The Company's deferred income taxes arising from such change in method of accounting will continue to be deferred as long as (i) at least 50% of the voting stock and at least 50% of all other classes of stock of the Company continue to be owned by the Lonnie \"Bo\" Pilgrim family and (ii) the Company's net sales from its agricultural operation in a taxable year equal or exceed the Company's net sales from such operations in its taxable year ending July 2, 1988. Failure of the first requirement will cause all of the deferred taxes attributable to the change in accounting method to be due. Failure of the second requirement will cause a portion of such deferred taxes to be due based upon the amount of the relative decline in net sales from the agricultural operations. The family of Lonnie \"Bo\" Pilgrim currently owns approximately 65.1% of the stock of the company. However, a sufficient amount of that stock is pledged to secure obligations to third parties such that foreclosure on that pledged stock by such third parties could result in the failure to satisfy one of the conditions to the continuation of the deferral of such deferred taxes. Management believes that likelihood of the (i) Pilgrim family ownership falling below 50%, or (ii) gross receipts from agricultural activities falling below the 1988 level, is remote.\nImpact of Inflation: Due to moderate inflation and the Company's rapid inventory turnover rate, the results of operations have not been adversely affected by inflation during the past three-year period.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated financial statements together with the report of independent auditors, and financial statement schedules are included on pages 34 through 51 of this document. Financial statement schedules other than those included herein have been omitted because the required information is contained in the consolidated financial statements or related notes, or such information is not applicable.\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\nReference is made to \"Election of Directors\" on pages 3 through 5 of Registrant's Proxy Statement for its 1994 Annual Meeting of Stockholders, which section is incorporated herein by reference.\nReference is made to \"Compliance with Section 16(a) of the Exchange Act\" on page 9 of Registrant's Proxy Statement for its 1994 Annual Meeting of Stockholders, which section is incorporated herein by reference.\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 responsive to Items 11, 12 and 13 is incorporated by reference from sections entitled \"Security Ownership\", \"Election of Directors\", \"Executive Compensation\", and \"Certain Transactions\" of the Registrant's Proxy Statement for its 1994 Annual Meeting of Stockholders. Part IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8- K\n(a) (1) The financial statements listed in the accompanying index to financial statements and schedules are filed as part of this report.\n(2) The schedules listed in the accompanying index to financial statements and schedules are filed as part of this report.\n(3) Exhibits\n2.1 Agreement and Plan of Reorganization dated September 15, 1986, by and among Pilgrim's Pride Corporation, A Texas corporation; Pilgrim's Pride Corporation, a Delaware corporation; and Doris Pilgrim Julian, Aubrey Hal Pilgrim, Paulette Pilgrim Rolston, Evanne Pilgrim, Lonnie \"Bo\" Pilgrim, Lonnie Ken Pilgrim, Greta Pilgrim Owens and Patrick Wayne Pilgrim (incorporated by reference from Exhibit 2.1 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n3.1 Certificate of Incorporation of the Company (incorporated by reference from Exhibit 3.1 of the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n3.2 By-Laws of the Company (incorporated by reference from Exhibit 3.2 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n4.1 Certificate of Incorporation of the Company (incorporated by reference from Exhibit 3.1 of the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n4.2 By-Laws of the Company (incorporated by reference from Exhibit 3.2 of the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n4.3 Indenture dated as of May 1, 1988, between the Company and Mtrust Corporation National Association relating to the Company's 14 1\/4% Senior Notes Due 1995 (incorporated by reference from Exhibit 4.1 of the Company's Registration Statement on Form S-1 (No. 33- 21057) effective May 2, 1988).\n4.4 First Supplemental Indenture dated as of October 4, 1990, between the Company and Ameritrust Texas, N.A. supplementing the Indenture dated as of May 1, 1988, between the Company and Mtrust Corporation National Association relating to the Company's 14 1\/4% Senior Notes Due 1995 (incorporated by reference from Exhibit 4.4 of the Company's Form 8 filed on July 1, 1992).\n4.5 Form of 14 1\/4% Senior Note Due 1995 (incorporated by reference from Exhibit 4.2 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n4.6 Specimen Certificate for shares of Common Stock, Par value $.01 per share, of the Company (incorporated by reference from Exhibit 4.6 of the Company's Form 8 filed on July 1, 1992).\n4.7 Form of Indenture between the Company and Ameritrust Texas National Association relating to the Company's 10 7\/8% Senior Subordinated Notes Due 2003 (incorporated by reference from Exhibit 4.6 of the Company's Registration Statement on Form S-1 (No. 33-59626) filed on March 16, 1993).\n4.8 Form of 10 7\/8% Senior Subordinated Note Due 2003 (incorporated by reference from Exhibit 4.8 of the Company's Registration Statement on Form S-1 (No. 33-61160) filed on June 16, 1993).\n10.1 Pilgrim Industries, Inc., Profit Sharing Retirement Plan, restated as of July 1, 1987 (incorporated by reference from Exhibit 10.1 of the Company's Form 8 filed on July 1, 1992).\n10.2 Bonus Plan of the Company (incorporated by reference from Exhibit 10.2 to the Company's Registration Statement on Form S-1 (No. 33- 8805) effective November 14, 1986).\n10.3 Aircraft Lease dated November 15, 1984, by and between L.A. Pilgrim d\/b\/a B.P. Leasing Company and the Company (incorporated by reference from Exhibit 10.5 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.4 Broiler Grower Contract dated November 11, 1985, between the Company and Lonnie \"Bo\" Pilgrim (Farm #30) (incorporated by reference from Exhibit 10.9 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.5 Broiler Growing Agreements dated October 28, 1985, between the Company and Monty K. Henderson d\/b\/a Central Farms and Lone Oak Farms (incorporated by reference from Exhibit 10.11 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.6 Broiler Growing Agreement dated March 27, 1986, between the Company and Clifford E. Butler (incorporated by reference from Exhibit 10.12 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.7 Broiler Grower Contract dated July 10, 1990 between the Company and James J. Miner d\/b\/a\/ BJM Farms (incorporated by reference from Exhibit 10.7 of the Company's Form 8 filed on July 1, 1992).\n10.8 Commercial Egg Grower Contract dated July 1, 1986, between the Company and Pilgrim Poultry, Ltd. (incorporated by reference from exhibit 10.14 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.9 Agreement dated November 28, 1978, by and between the Company and Pilgrim Poultry, Ltd. (incorporated by reference from Exhibit 10.15 to the Company's Registration Statement on Form S-1 (No. 33- 8805) effective November 14, 1986).\n10.10 Agreement between the Company and its Principal Shareholders dated October 2, 1974, as amended July 1, 1979 (incorporated by reference from Exhibit 10.19 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.11 Note Purchase Agreement dated as of October 1, 1986, by and between the Company and Aetna Life Insurance Company with related Collateral Trust Indenture, as amended by First Supplemental Indenture dated as of November 1, 1986, and by letter dated September 29, 1987, Texas Mortgage, Arkansas Mortgage, Guarantee Agreement, as amended by First Amendment to Guarantee Agreement dated June 9, 1987, and Cash Pledge Agreement (incorporated by reference from Exhibit 10.21 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.12 Letter Agreement dated April 26, 1988, by and among Aetna Life Insurance Company, The Aetna Casualty and Surety Company, The Connecticut Bank and Trust Company and the Company and Letter Agreement dated April 26, 1988, by and among Bank of America National Trust and Savings Association, The Connecticut Bank and Trust Company and the Company amending Note Purchase Agreement dated as of October 1, 1986 (incorporated by reference from Exhibit 10.36 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.13 Note Purchase Agreement dated as of September 21, 1990, by and among the Company, Aetna Life Insurance Company and Bank of America National Trust and Savings Association (incorporated by reference from Exhibit 10.20 of the Company's Form 8 filed on July 1, 1992).\n10.14 Amended and Restated Collateral Trust Indenture dated as of September 21, 1990, by and between the Company and State Street Bank and Trust Company of Connecticut, N.A. with related Notes, Modification Agreements and First Amendment to Guaranty (incorporated by reference from Exhibit 10.21 of the Company's Form 8 filed on July 1, 1992).\n10.15 Supplemental Indenture and Waiver dated as of December 9, 1991, by and between the Company and State Street Bank and Trust Company of Connecticut, N.A. with related Notes, Modification Agreements and First Amendment to Guaranty, Amended and Restated Collateral Trust Indenture dated as of September 20, 1990 (incorporated by reference from Exhibit 10.24 of the Company's Form 10-K for the year ended September 26, 1992).\n10.16 Loan Agreement dated as of August 1, 1988, by and between the Company and Angelina and Neches River Authority Industrial Development Corporation, with related Reimbursement and Credit Agreement (incorporated by reference from Exhibit 10.22 of the Company's Form 8 filed on July 1, 1992).\n10.17 Indenture of Trust dated as of August 1, 1988, related to Loan Agreement by and between the Company and Angelina and Neches River Authority Industrial Development Corporation, with related Bond, Irrevocable Letter of Credit, Deed of Trust, Security Agreement, Assignment of Rents and Financing Statement (incorporated by reference from Exhibit 10.23 of the Company's Form 8 filed on July 1, 1992).\n10.18 Assumption Agreement by and between the Company, Lonnie \"Bo\" Pilgrim and RepublicBank Lufkin, as trustee, dated June 14, 1985 (incorporated by reference from Exhibit 10.31 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.19 Stock Purchase Agreement dated September 15, 1986, among the Company, Doris Pilgrim Julian, Aubrey Hal Pilgrim, Paulette Pilgrim Rolston and Evanne Pilgrim (incorporated by reference from Exhibit 2.2 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.20 Amendment No. 1 to Stock Purchase Agreement, dated as of October 31, 1986, among the Company, Doris Pilgrim Julian, Aubrey Hal Pilgrim, Paulette Pilgrim Rolston and Evanne Pilgrim (incorporated by reference from Exhibit 2.3 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.21 Limited Partnership Interest Purchase Agreement dated September 15, 1986, by and between the Company and Doris Pilgrim Julian (incorporated by reference from Exhibit 2.5 to the Company's Registration Statement on Form S-1 (No. 33-8805) effective November 14, 1986).\n10.22 Employee Stock Investment Plan of the Company (incorporated by reference from Exhibit 10.28 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.23 Promissory Note dated February 1, 1988, by and between the Company and John Hancock Mutual Life Insurance Company with related Deed of Trust, Assignment of Rents and Security Agreement and Mortgage and Guaranty of Note and Mortgage (incorporated by reference from Exhibit 10.29 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.24 Letter from John Hancock Mutual Life Insurance Company dated April 25, 1988, amending Deed of Trust, Assignment of Rents and Security Agreement dated February 1, 1988 (incorporated by reference from Exhibit 10.35 of the Company's Registration Statement on Form S-1 (No. 33-21057) effective May 2, 1988).\n10.25 Promissory Note dated April 25, 1991, by and between the Company and John Hancock Mutual Life Insurance Company, with related Modification Agreement and Guaranty of Note and Mortgage (incorporated by reference from Exhibit 10.31 of the Company's Form 8 filed on July 1, 1992).\n10.26 Stock Purchase Agreement dated May 12, 1992, between the Company and Archer Daniels Midland Company (incorporated by reference from Exhibit 10.45 of the Company's Form 10-K for the year ended September 26, 1992).\n10.27 Promissory Note dated September 21, 1988, by and between the Company and Charles Schreiner Bank, with related Warranty Deed with Vendor's Lien and Deed of Trust and Security Agreement (incorporated by reference from Exhibit 10.40 of the Company's Form 8 filed on July 1, 1992).\n10.28 Promissory Note dated November 1, 1988, by and between the Company and The Connecticut Mutual Life Insurance Company, with related Deed of Trust (incorporated by reference from Exhibit 10.41 of the Company's Form 8 filed on July 1, 1992).\n10.29 Promissory Note dated September 20, 1990, by and between the Company and Hibernia National Bank of Texas (incorporated by reference from Exhibit 10.42 of the Company's Form 8 filed on July 1, 1992).\n10.30 Loan Agreement dated October 16, 1990, by and among the Company, Lonnie \"Bo\" Pilgrim and North Texas Production Credit Association, with related Variable Rate Term Promissory Note and Deed of Trust (incorporated by reference from Exhibit 10.43 of the Company's Form 8 filed on July 1, 1992).\n10.31 Secured Credit Agreement dated May 27, 1993, by and among the Company and Harris Trust and Savings Bank, and FBS AG Credit, Inc., Internationale Nederlanden Bank, N.V., Boatmen's First National Bank of Kansas City, and First Interstate Bank of Texas, N.A. (incorporated by reference from Exhibit 10.31 of the Company's Registration Statement on Form S-1 (No. 33-61160) filed on June 16, 1993).\n10.32 Loan and Security Agreement dated as of June 3, 1993, by and among the Company, the banks party thereto and Creditanstalt-Bankverein, as agent (incorporated by reference from Exhibit 10.32 of the Company's Registration Statement on Form S-1 (No. 33-61160) filed on June 16, 1993).\n10.33 First Amendment to Secured Credit Agreement dated June 30, 1994 to the Secured Credit Agreement dated May 27, 1993, by and among the Company and Harris Trust and Savings Bank, and FBS AG Credit, Inc., Internationale Nederlanden Bank N.V., Boatman's First National Bank of Kansas City and First Interstate Bank of Texas, N.A.\n10.34 Amended and Restated Loan and Security Agreement date July 29, 1994, by and among the Company, the banks party thereto and Creditanstalt-Bankverein, as agent.\n10.35 Supplemental Indenture dated October 2, 1994, by and between the Company and State Street Bank and Trust Company of Connecticut, N.A., and Guarantee Agreement, as amended by Second Amendment to Guarantee Agreement dated October 2, 1994.\n22. Subsidiaries of Registrant.*\n23. Consent of Ernst & Young LLP.*\n27. Financial Data Statement.\n* Filed herewith\nPursuant to Item 601(b)(4)(iii)(A) of Regulation S-K promulgated by the Securities and Exchange Commission, the Company has not filed as exhibits certain other instruments defining the rights of holders of long- term debt of the Company which instruments do not pertain to indebtedness in excess of 10% of the total assets of the Company. The Company hereby agrees to furnish copies of such instruments to the Securities and Exchange Commission upon request.\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 issuer has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 16th day of December 1994.\nPILGRIM'S PRIDE CORPORATION\nBy: _________________________ Clifford E. Butler Vice Chairman of the Board 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 dated indicated.\nSignature Title Date\n________________________ Chairman of the Board 12\/16\/94 Lonnie \"Bo\" Pilgrim of Directors and Chief Executive Officer (Principal Executive Officer)\n_______________________ Vice Chairman of the 12\/16\/94 Clifford E. Butler Board of Directors, Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer)\n________________________ President and 12\/16\/94 Lindy M. \"Buddy\" Pilgrim Chief Operating Officer and Director\n_______________________ Executive Vice President 12\/16\/94 Robert L. Hendrix Operations and Director\n_______________________ Senior Vice President 12\/16\/94 James J. Miner Technical Services and Director\n_______________________ Vice President and 12\/16\/94 Lonnie Ken Pilgrim Director\n_______________________ Director 12\/16\/94 Robert E. Hilgenfeld\n_______________________ Director 12\/16\/94 Vance C. Miller\n_______________________ Director 12\/16\/94 James J. Vetter, Jr.\n_______________________ Director 12\/16\/94 Donald L. Wass\nREPORT OF INDEPENDENT AUDITORS\nStockholders and Board of Directors Pilgrim's Pride Corporation\nWe have audited the accompanying consolidated balance sheets of Pilgrim's Pride Corporation and subsidiaries as of October 1, 1994, and October 2, 1993, and the related consolidated statements of income (loss), stockholders' equity and cash flows for each of the three years in the period ended October 1, 1994. Our audits also included the financial statement schedules listed on 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 Pilgrim's Pride Corporation and subsidiaries at October 1, 1994, and October 2, 1993, 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. 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\n2121 San Jacinto Street Dallas, Texas 75201 November 15, 1994\nC O N S O L I D A T E D B A L A N C E S H E E T S Pilgrim's Pride Corporation and Subsidiaries\nOctober 1, 1994 October 2, 1993 ASSETS CURRENT ASSETS Cash and cash equivalents $ 11,244,000 $ 4,526,000 Trade accounts and other receivables, less allowance for doubtfulaccounts 53,264,000 59,608,000 Inventories 100,749,000 91,794,000 Deferred income taxes 6,459,000 - Prepaid expenses 1,280,000 1,260,000 Other current assets 1,249,000 9,843,000 TOTAL CURRENT ASSETS 174,245,000 167,031,000\nOTHER ASSETS 20,891,000 13,114,000\nPROPERTY, PLANT AND EQUIPMENT Land 15,153,000 14,824,000 Buildings, machinery and equipment 332,289,000 317,657,000 Autos and trucks 27,457,000 25,877,000 Construction-in-progress 4,853,000 7,863,000 379,752,000 366,221,000 Less accumulated depreciation and amortization 136,205,000 123,520,000 243,547,000 242,701,000 $ 438,683,000 $ 422,846,000\nLIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Notes payable to banks $ - $ 12,000,000 Accounts payable 38,675,000 38,330,000 Accrued expenses 31,353,000 30,370,000 Current maturities of long-term debt 4,493,000 13,643,000 TOTAL CURRENT LIABILITIES 74,521,000 94,343,000\nLONG-TERM DEBT, less current maturities 152,631,000 159,554,000\nDEFERRED INCOME TAXES 49,835,000 36,656,000\nSTOCKHOLDERS' EQUITY Preferred stock, $.01 par value, authorized 5,000,000 shares; none issued - - Common stock, $.01 par value, authorized 45,000,000 shares; 27,589,250 issued and outstanding in 1994 and 1993 276,000 276,000 Additional paid-in capital 79,763,000 79,763,000 Retained earnings 81,657,000 52,254,000 TOTAL STOCKHOLDERS' EQUITY 161,696,000 132,293,000 COMMITMENTS AND CONTINGENCIES - - $ 438,683,00 $ 422,846,000\nSee notes to consolidated financial statements.\nC O N S O L I D A T E D S T A T E M E N T S O F I N C O M E (L O S S) Pilgrim's Pride Corporation and Subsidiaries\nYears Ended October October September 1, 1994 2, 1993 26, 1992 (52 weeks) (53 weeks) (52 weeks) Net sales $922,609,000 $887,843,000 $817,361,000 Business interruption insurance 731,000 - 2,225,000 923,340,000 887,843,000 819,586,000 Costs and expenses: Cost of sales 812,513,000 781,807,000 786,784,000 Selling, general and administrative 50,872,000 49,934,000 46,277,000 863,385,000 831,741,000 833,061,000 OPERATING INCOME (LOSS) 59,955,000 56,102,000 (13,475,000)\nOther expenses (income): Interest expense, net 19,173,000 25,719,000 22,502,000 Miscellaneous, net (1,666,000) (2,455,000) (2,265,000) Total other expenses, net 17,507,000 23,264,000 20,237,000 Income (loss) before income taxes and extraordinary charge 42,448,000 32,838,000 (33,712,000) Income tax expense (benefit) 11,390,000 10,543,000 (4,048,000) Net income (loss) before extraordinary charge 31,058,000 22,295,000 (29,664,000) Extraordinary charge-early repayment of debt, net of tax - (1,286,000) -\nNET INCOME (LOSS) $ 31,058,000 $ 21,009,000 $(29,664,000)\nNet income (loss) per common share before extraordinary charge $ 1.1 $ 0.81 $ (1.24) Extraordinary charge per common share - (0.05) - Net income (loss) per common share $ 1.1 $ 0.76 $ (1.24)\nSee notes to consolidated financial statements.\nC O N S O L I D A T E D S T A T E M E N T S O F S T O C K H O L D E R S ' E Q U I T Y Pilgrim's Pride Corporation and Subsidiaries\nNumber Additional of Common Paid-in Retained Shares Stock Capital Earnings Total Balance at September 28, 1991 22,589,250 $226,000 $49,890,000 $62,237,000 $112,353,000\nNet income for the month ended September 28, 1991, excluded below due to the change in fiscal year-end of Mexican subsidiaries - - - 931,000 931,000 Net loss for year - - - (29,664,000) (29,664,000) Common stock issued 5,000,000 50,000 29,873,000 - 29,923,000 Cash dividends declared ($0.06 per share) - - - (1,431,000) (1,431,000)\nBalance at September 26, 1992 27,589,250 276,000 79,763,000 32,073,000 112,112,000\nNet income for year - - - 21,009,000 21,009,000 Cash dividends declared ($0.03 per share) - - - (828,000) (828,000)\nBalance at October 2, 1993 27,589,250 276,000 79,763,000 52,254,000 132,293,000\nNet income for year - - - 31,058,000 31,058,000 Cash dividends declared ($0.06 per share) - - - (1,655,000) (1,655,000)\nBalance at October 1, 1994 27,589,250 $ 276,000 $79,763,000 $81,657,000 $161,696,000\nSee notes to consolidated financial statements.\nC O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S Pilgrim's Pride Corporation and Subsidiaries\nYears Ended October October September 1, 1994 2, 1993 26, 1992 (52 weeks) (53 weeks) (52 weeks)\nCash Flows From Operating Activities:\nNet income (loss) $ 31,058,000 $ 21,009,000 $ (29,664,000) Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: Depreciation and amortization 25,177,000 26,034,000 24,090,000 Gain on property disposals (608,000) (2,187,000) (620,000) Provision for doubtful accounts 2,666,000 2,124,000 1,045,000 Deferred income taxes 6,720,000 5,028,000 (5,382,000) Extraordinary charge - 1,904,000 - Net income for the month ended September 28, 1991 excluded above due to the change in fiscal year of Mexican subsidiaries - - 931,000 Changes in operating assets and liabilities: Accounts and other receivables 3,412,000 (6,555,000) (9,720,000) Inventories (8,955,000) (2,366,000) 7,807,000 Prepaid expenses (459,000) 4,175,000 (4,416,000) Accounts payable and accrued expenses 1,742,000 (4,168,000) 14,598,000 Other (89,000) (28,000) (242,000) Net Cash Flows Provided by (Used In) Operating Activities 60,664,000 44,970,000 (1,573,000)\nInvesting Activities: Acquisitions of property, plant and equipment (25,547,000) (15,201,000) (18,043,000) Proceeds from property disposal 2,103,000 2,977,000 3,766,000 Other assets (128,000) 713,000 (536,000) Net Cash Used in Investing Activities (23,572,000) (11,511,000) (14,813,000)\nFinancing Activities: Proceeds from notes payable to banks 7,000,000 28,419,000 163,629,000 Repayments on notes payable to banks (19,000,000) (81,398,000) (156,150,000) Proceeds from long-term debt 31,000 126,468,000 - Payments on long-term debt (16,253,000) (106,302,000) (11,502,000) Cost of refinancing debt - (5,510,000) - Extraordinary charge, cash items - (1,188,000) - Proceeds from leasing transaction - - 565,000 Net proceeds from sale of stock - - 29,923,000 Cash dividends paid (2,069,000) (828,000) (1,355,000) Cash (Used in) Provided by Financing Activities (30,291,000) (40,339,000) 25,110,000\nEffect of exchange rate changes on cash and cash equivalents (83,000) (144,000) (49,000) Increase (decrease) in cash and cash equivalents 6,718,000 (7,024,000) 8,675,000 Cash and cash equivalents at beginning of year 4,526,000 11,550,000 2,875,000 Cash and cash equivalents at end of year $11,244,000 $ 4,526,000 $11,550,000\nSupplemental disclosure information: Cash paid during the year for: Interest (net of amount capitalized) $19,572,000 $23,015,000 $22,507,000 Income taxes $ 7,108,000 $ 3,688,000 $ 1,455,000\nSee notes to consolidated financial statements.\nN O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Pilgrim's Pride Corporation and Subsidiaries\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: The consolidated financial statements include the accounts of Pilgrim's Pride Corporation and its wholly owned subsid iaries (the \"Company\"). Significant intercompany accounts and transactions have been eliminated.\nThe financial statements of the Company's Mexican subsidiaries are remeasured as if the U.S. dollar were the functional currency. According ly, assets and liabilities of the Mexican subsidiaries are translated at end-of-period exchange rates, except for non current assets which are translated at equivalent dollar costs at dates of acquisition using historical rates. Operations are translated at average exchange rates in effect during the period. Translation (gains) losses for 1994, 1993 and 1992 of $(257,000), $243,000, and $736,000, respectively, are included in the statements of income as components of \"Costs and expenses - Selling, general and administrative\" in the Consolidated Statement of Income (Loss).\nDuring the fourth quarter of fiscal 1994, the Company reclassified certain expenses of its Mexican subsidiaries to conform to the classification in the United States. The effect of this change was to decrease selling, general and administrative expense and increase cost of sales by $4,177,000 and $1,844,000 in 1993 and 1992, respectively.\nDuring the fourth quarter of fiscal 1992, the Company changed the fiscal year-end for its Mexican subsidiaries from August 31 to a 52-53 week year- end coinciding with the fiscal year of its domestic operations. Accordingly, the fiscal 1992 Consolidated Statement of Loss includes the operations of the Company's Mexican subsidiaries for the twelve-month period ended September 26, 1992. Operating results for the Company's Mexican subsidiaries during the month of September 1991 have been reflected as a direct addition to stockholders' equity. If this change in the Company's Mexican subsidiaries' fiscal year-end had not occurred, operating loss, net loss, and net loss per common share for the fiscal year ended September 26, 1992, would have been $(8,760,000), $(24,683,000) and $(1.03), respect ively. The effect of the change on the remaining components of the Consolidated Statement of Loss was not significant.\nCash Equivalents: The Company considers highly liquid investments with a maturity of 3 months or less when purchased to be cash equivalents.\nAccounts Receivable: The Company does not believe it has significant concentrations of credit risk. Credit evaluations are performed on all significant customers and updated as circumstances dictate. The Company generally does not require collateral. Allowances for doubtful accounts were $ 5,906,000 and $3,240,000 in 1994 and 1993, respectively.\nInventories: Live poultry inventories of broilers are stated at the lower of cost or market and hens at the lower of cost, less accumulated amorti zation or market. The costs associated with hens are accumulated up to the production stage and amortized over the productive lives using the straight-line method. Finished poultry products, feed, eggs and other inventories are stated at the lower of cost (first-in, first-out method) or market. Under certain circumstances, the Company hedges purchases of its major feed ingredients using futures contracts to minimize the risk of adverse price fluctuations. Gains and losses on the hedge transactions are deferred and recognized as a component of cost of sales when products are sold.\nOther Assets\/Other Current Assets: Other assets includes approximately $8.9 million of non poultry farming assets, primarily farmland, held for sale. These assets, previously classified as other current assets in the October 2, 1993 Consolidated Balance Sheet, were reclassified upon the conclusion that their liquidation is not likely to occur within the next fiscal year. Related debt on these assets has also been reclassified.\nProperty, Plant and Equipment: Property, plant and equipment is stated on the basis of cost. For financial reporting purposes, depreciation is computed using the straight-line method over the estimated useful lives of these assets. Depreciation expense was $23.7 million, $23.4 million and $23.1 million in 1994, 1993 and 1992, respectively.\nNet Income (Loss) per Common Share: Net income (loss) per share is based on the weighted average shares of common stock outstanding during the year. The weighted average number of shares outstanding was 27,589,250 in 1994 and 1993 and 23,880,459 in 1992.\nNOTE B - INVENTORIES Inventories consist of the following:\nOctober 1, 1994 October 2,1993 Live broilers and hens $ 47,743,000 $ 44,417,000 Feed, eggs and other 22,529,000 25,473,000 Finished poultry products 30,477,000 21,904,000 $ 100,749,000 $ 91,794,000\nNOTE C - NOTES PAYABLE AND LONG-TERM DEBT The Company maintains a $75 million credit facility with various banks providing short-term lines of credit at interest rates of approximately one and one-eighth percent above LIBOR and, at October 1, 1994, availability under these lines totaled $63.9 million. Inventories and trade accounts receivable of the Company are pledged as collateral on this facility. The fair value of the Company's long-term debt was estimated using quoted market prices, where available. For long-term debt not actively traded, fair values were estimated using discounted cash flow analysis using current market rates for similar types of borrowings. For certain debt instruments recently issued or modified, including the credit facility, the Company believes that their carrying amounts approximate fair value at October 1, 1994 and October 2, 1993.\nThe table below sets forth maturities on long-term debt during the next five years. Year Amount 1995 $ 4,493,000 1996 7,595,000 1997 11,068,000 1998 8,480,000 1999 8,137,000\nDuring 1993, the Company retired certain debt prior to their scheduled maturities. These repayments resulted in an extraordinary charge of $1.3 million, net of $.6 million tax benefit.\nIn July 1994, the Company secured $10 million in stand-by long-term financing from an existing lender, secured by existing collateral. The facility is available through June 20, 1995 and the Company expects to renew the facility annually unless drawn upon.\nThe Company is required, by certain provisions of its debt agreements, to maintain minimum levels of working capital and net worth, to limit dividends to a maximum of $1.7 million per year, to maintain various fixed charge, leverage, current and debt-to-equity ratios, and to limit annual capital expenditures to 115% of the prior year's depreciation and amortization expense.\nTotal interest during 1994, 1993 and 1992 was $20,109,000, $26,415,000 and $23,115,000, respectively. Interest related to new construction capitalized in 1994, 1993 and 1992 was $525,000, $220,000 and $456,000, respectively.\nLong-term debt and the related fair values consist of the following:\nOctober 1, 1994 October 2, 1993 Carrying Fair Carrying Fair Amounts Value Amounts Value Senior subordinated notes due August 1, 2003, interest at 10 % (effective rate of 11 %) payable in semi- annual installments, less discount of $1,330,000 and $1,480,000 in 1994 and 1993, respectively $ 98,670,000 $ 96,824,000 $ 98,520,000 $ 98,520,000 Notes payable to bank, interest at LIBOR plus 1.8% and 2.5% in 1994 and 1993, respectively, principal payments of $700,000 in quarterly installments including interest plus one final balloon payment at maturity on June 1, 2000 15,400,000 15,400,000 23,800,000 23,800,000 Senior secured debt payable to an insurance company at 10.49%, payable in equal annual installments beginning October 5, 1996 through September 21, 2002 22,000,000 23,293,000 22,000,000 24,549,000 Note payable to an insurance company at 10.78%, payable in equal monthly installments including interest through March 1, 1998 8,633,000 8,909,000 11,485,000 12,170,000 Senior secured debt payable to an insurance company, interest at 9.55%, payable in equal annual installments through October 1, 1998 4,440,000 4,458,000 5,520,000 5,696,000 Note payable to an insurance company at 10.35%, payable in equal monthly installments plus interest through May 1, 2001 3,544,000 3,683,000 4,220,000 4,568,000 Other notes payable 4,437,000 4,925,000 7,652,000 7,652,000 157,124,000 157,492,000 173,197,000 176,955,000 Less current maturities 4,493,000 13,643,000 $152,631,000 $159,554,000\nSubstantially all of the Company's property, plant and equipment is pledged as collateral on its long-term debt.\nNOTE D - INCOME TAXES Income (loss) before income taxes after allocation of certain expenses to foreign operations for 1994, 1993 and 1992 was $33,852,000, $30,816,000 and ($16,273,000), respectively, for domestic operations, and $8,596,000, $2,022,000 and ($17,439,000), respectively, for foreign operations. Provisions (benefits) for income taxes are based on pretax financial statement income. The major components of the deferred tax liability are related to the Company's prior use of the cash method of accounting for tax purposes and differences in book and tax basis of depreciable assets.\nThe components of income tax expense (benefit) are set forth below:\nYears Ended October October September 1, 1994 2, 1993 26, 1992 Current: Federal $ 4,573,000 $ 2,993,000 $ (49,000) Foreign 423,000 2,775,000 1,892,000 Other (326,000) (253,000) (509,000) 4,670,000 5,515,000 1,334,000 Deferred: Reinstatement (reversal) of deferred taxes through utilization (application) of net operating losses 6,589,000 6,210,000 (5,971,000) Accelerated tax depreciation 1,002,000 1,130,000 1,082,000 Effect of U.S. tax rate change on temporary differences - 1,000,000 - Expenses deductible in a different year for tax and financial reporting purposes (580,000) (1,782,000) - Reversal of deferred foreign income taxes upon Mexican tax law and restructuring changes - (1,110,000) - Other, net (291,000) (420,000) (493,000) 6,720,000 5,028,000 5,382,000) $11,390,000 $10,543,000 (4,048,000)\nThe following is a reconciliation between the statutory U.S. federal income tax rate and the Company's effective income tax rate:\nYears Ended October October September 1, 1994 2, 1993 26, 1992\nFederal income tax rate 35.0% 34.8% (34.0)% State tax rate, net 2.3 2.2 - Reversal of deferred foreign income taxes upon Mexican law and restructuring changes - (3.4) - Effect of U.S. tax rate change on temporary differences - 3.0 - Benefit of (prior) current year losses not recognized - (5.3) 5.0 Difference in U.S. statutory tax rate and Mexican effective tax rate (10.7) (2.5) 16.5 Other, net 0.2 3.3 0.5 26.8% 32.1% (12.0)%\nEffective October 3, 1993, the Company adopted the provisions of FAS Statement 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 FAS Statement No. 109 as of October 3, 1993 and the impact of the adoption on the reported net income amounts for 1994 was not material.\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:\nYears Ended October 1, 1994 October 2,1993 Deferred tax liabilities: Tax over book depreciation $ 24,006,000 $ 23,004,000 Prior use of cash accounting 33,290,000 32,758,000 Other 516,000 - Total deferred tax liabilities 57,812,000 55,762,000\nDeferred tax assets: AMT credit carryforward 6,629,000 3,967,000 General business credit carryforward 1,344,000 2,462,000 Net operating loss carryforward - 6,589,000 Other 6,463,000 6,088,000 Total deferred tax asset 14,436,000 19,106,000 Net deferred tax liabilities $ 43,376,000 $ 36,656,000\nPursuant to a restructuring of activities completed by the Company's Mexican subsidiaries on January 1, 1993 approximately $1.1 million of deferred taxes previously provided on earnings of the Company's nonagricultural Mexican subsidiaries was reversed as a credit to income tax expense in fiscal 1993. This restructuring, along with further restructuring of activities completed on January 1, 1994, allowed previously nonagricultural Mexican operations to be combined with existing agricultural operations and, as such, qualify for taxability as agricultural operations, which are currently not subject to taxes in Mexico. The current provision for foreign income taxes in 1994 is the result of taxes at certain of the Company's nonagricultural Mexican subsidiaries which were subject to income taxes prior to the restructurings or, absent earnings, an asset based minimum tax. The Company has not provided any U.S. deferred federal income taxes on the undistributed earnings of its Mexican subsidiaries based upon its determination that such earnings will be indefinitely reinvested. As of October 1, 1994, the cumulative undistributed earnings of these subsidiaries were approximately $49,484,000. If such earnings were not considered indefinitely reinvested, deferred federal and foreign income taxes would have been provided, after consideration of estimated foreign tax credits. (Included in this amount would be foreign taxes resulting from earnings of the Mexican agricultural subsidiaries which would be due upon distribution of such earnings to the U.S.). However, determination of the amount of deferred federal and foreign income taxes is not practicable.\nAs of October 1, 1994, approximately $6,629,000 of alternative minimum tax credits and $1,193,000 of targeted jobs credits were available to offset future taxable income. The targeted jobs credits expire in years ending in 2001 through 2009. All credits have been reflected in the financial statements as a reduction of deferred taxes. As these credits are utilized for tax purposes, deferred taxes will be reinstated.\nNOTE E - SAVINGS PLAN The Company maintains a Section 401(k) Salary Deferral Plan (the \"Plan\"). Under the Plan, eligible domestic employees may voluntarily contribute a percentage of their compensation. The Plan provides for a contribution of up to four percent of compensation subject to an overall Company contribution limit of five percent of income before taxes.\nUnder the plan outlined above, the Company's expenses were $2,636,000, $1,074,000 and $831,000 in 1994, 1993 and 1992, respectively.\nNOTE F - RELATED PARTY TRANSACTIONS The major stockholder of the Company owns a broiler and egg operation. Transactions with related entities are summarized as follows:\nYears Ended October October September 1, 1994 2, 1993 26, 1992\nContract egg grower fees to major stockholder $ 5,137,000 $ 4,739,000 $ 4,326,000 Chick, feed and other sales to major stockholder 9,373,000 8,298,000 15,146,000 Broiler purchases from major stockholder 9,346,000 8,275,000 15,075,000 Purchases of feed ingredients from Archer Daniels Midland Company - (See Note J) 56,499,000 37,757,000 51,549,000\nThe Company leases an airplane from its major stockholder under an operating lease agreement. The terms of the lease agreement require monthly payments of $33,000 plus operating expenses. Lease expense was $396,000 for each of the years 1994, 1993 and 1992. Operating expenses were $213,000 in 1994 and $108,000 in 1993 and 1992.\nExpenses incurred for the guarantee of certain debt by stockholders were $526,000, $1,192,000 and $1,632,000 in 1994, 1993 and 1992, respectively.\nDuring 1992, the Company acquired real estate from its profit sharing plan for approximately $574,000. The acquisition price was determined by an independent appraisal and was approved by the Audit Committee of the Board of Directors of the Company.\nNOTE G - COMMITMENTS AND CONTINGENCIES The Consolidated Statements of Income (Loss) included rental expense for operating leases of approximately $10,058,000, $9,320,000 and $8,734,000 in 1994, 1993 and 1992, respectively. The Company's future minimum lease commitments under noncancelable operating leases are as follows:\nYear Amount 1995 $ 8,597,000 1996 6,316,000 1997 4,745,000 1998 4,146,000 1999 3,200,000 Thereafter 7,278,000\nThe estimated costs to complete construction-in-progress at various locations at October 1, 1994, are approximately $4,419,000.\nAt October 1, 1994, the Company had $11,055,000 letters of credit outstanding relating to normal business transactions.\nThe Company is subject to various 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 financial position or results of operations of the Company.\nNOTE H - BUSINESS SEGMENTS The Company operates in a single business segment as a producer of agricultural products and conducts separate operations in the United States and Mexico.\nInterarea sales, which are not material, are accounted for at prices comparable to normal trade customer sales. Identifiable assets by geographic area are those assets that are used in the Company's operation in each area.\nInformation about the Company's operations in these geographic areas is as follows: Years Ended October October September 1, 1994 2, 1993 26, 1992 52 Weeks 53 Weeks 52 Weeks Sales to unaffiliated customers: United States $733,865,000 $699,089,000 $656,741,000 Mexico 188,744,000 188,754,000 160,620,000 $922,609,000 $887,843,000 $817,361,000 Operating profit (loss): United States $ 46,421,000 $ 46,471,000 $ (1,565,000) Mexico 13,534,000 9,631,000 (11,910,000) $ 59,955,000 $ 56,102,000 $(13,475,000) Identifiable assets: United States $302,911,000 $288,761,000 $297,369,000 Mexico 135,772,000 134,085,000 137,197,000 $438,683,000 $422,846,000 $434,566,000 NOTE I - INSURANCE CLAIMS The Company's Lufkin, Texas poultry processing production was shifted to several of the Company's other processing facilities due to a fire that occurred on July 26, 1993. Insurance claims covering this loss were settled in 1994. Proceeds collected or estimated to be collected under the property insurance claim exceeded the book value of the property destroyed, resulting in a gain of approximately $.7 million and $1.9 million in fiscal 1994 and 1993, respectively; such gains are included as components of \"Other expenses (income) -Miscellaneous, net\" in the fiscal 1994 and 1993 Consolidated Statements of Income.\nThe Company's prepared foods plant in Mt. Pleasant, Texas experienced a temporary shutdown of the plant caused by a fire which occurred on January 8, 1992. Insurance claims covering this loss were settled in 1994. The Company recorded approximately $.7 million and $2.2 million in fiscal 1994 and 1992, respectively, for amounts collected or expected to be collected under the business interruption insurance claim. Proceeds collected under the property insurance exceeded the book value of the property damaged by $.8 million; such gain is included as a component of \"Other expenses (income) - Miscellaneous, net\" in the fiscal 1992 Consolidated Statement of Loss.\nNOTE J - SALE OF COMMON STOCK On May 12, 1992 the Company entered into a stock purchase agreement to sell 5,000,000 shares of its previously unissued but authorized common stock at a purchase price of $6.00 per share to Archer Daniels Midland Company (\"ADM\"), a processor and merchandiser of agricultural products and a supplier of several products to the Company. The stock purchase agreement was closed on June 25, 1992 and proceeds from the sale of common stock to ADM were applied immediately to repay notes payable to banks.\nThe 1992 net loss per common share computed on a supplemental basis, as if the sale of common stock to ADM had occurred at the beginning of 1992 is $1.03.\nThe stock purchase agreement also contains a \"no-loss guarantee\" issued by the Company's major stockholder to ADM. Under the guarantee, ADM is indemnified against loss and guaranteed a market rate return on their investment through July 8, 1995. The guarantee is secured by 6,670,000 shares of Company stock owned by the Company's major stockholder.\nNOTE K - QUARTERLY RESULTS - (Unaudited)\nYear Ended October 1, 1994 First Second Third Fourth Fiscal Quarter Quarter Quarter Quarter Year (13 Weeks) (13 Weeks) (13 Weeks) (13 Weeks) (13 Weeks)\nNet sales $221,851,000 $223,167,000 $238,302,000 $239,289,000 $922,609,000 Business Interruption Insurance(a) - - - 731,000 731,000 Gross profit(b) 29,354,000 24,684,000 28,675,000 28,114,000 110,827,000 Operating income 16,508,000 12,632,000 15,322,000 15,493,000 59,955,000 Net income 8,421,000 7,920,000 7,196,000 7,521,000(c)31,058,000 Per share: Net income(d) 0.31 0.29 0.26 0.27 1.13 Cash dividends 0.015 0.015 0.015 0.015 0.060 Market price: High 8 1\/4 9 1\/4 9 9 5\/8 9 5\/8 Low 6 5\/8 6 5\/8 6 3\/8 7 1\/4 6 3\/8\nYear Ended October 2, 1993 First Second Third Fourth Fiscal Quarter Quarter Quarter Quarter Year (14 Weeks) (13 Weeks) (13 Weeks) (13 Weeks) (53 Weeks) Net sales $220,453,000 $227,670,000 $220,645,000 $219,075,000 $887,843,000 Gross profit(b) 27,002,000 31,876,000 24,088,000 23,070,000 106,036,000 Operating income 14,143,000 18,911,000 11,529,000 11,519,000 56,102,000 Extraordinary charge(e) - - (1,286,000) - 1,286,000 Net income 6,828,000 7,807,000 2,332,000 4,042,000(c)21,009,000 Per share: Net income before extraordinary charge(d) 0.25 0.28 0.14 0.14 0.81 Extraordinary charge(d) - - (0.05) - (0.05) Net income(d) 0.25 0.28 0.09 0.14 0.76 Cash dividends(f) - - 0.015 0.015 0.030 Market price: High 7 9 1\/2 9 1\/8 8 5\/8 9 1\/2 Low 5 3\/8 6 1\/4 7 1\/2 7 5 3\/8\n(a) Represents amounts collected under a business interruption insurance claim resulting from a fire at the Company's prepared foods plant in Mt. Pleasant, Texas on January 8, 1992. (See Note I) (b) In the fourth quarter of fiscal 1994, the Company reclassified certain expenses previously reflected in selling, general and administrative expenses as cost of sales. Conforming changes have been made and reflected in the first three quarters of fiscal 1994 and the four quarters of fiscal 1993 presented above. (See Note A) (c) Includes gains on property insurance settlement of $.7 million and $1.9 million in fiscal 1994 and fiscal 1993, respectively. (See Note I) (d) Amounts are based on the weighted average shares of common stock outstanding during each of the quarters. (e) The extraordinary charge of $1.3 million, net of tax, is the result of the early repayment of the Company's $50 million, 14 1\/4% Senior Secured Notes and certain other debts. (f) Pursuant to an agreement with some of the Company's secured lenders, dividends were suspended until the completion of the refinancing plans. Dividends were reinstated for the quarter ended July 3, 1993.\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES.\nCol. A Col. B Col. C Col. D Col. E DEDUCTIONS BALANCE AT END NAME OF BALANCE AT AMOUNTS OF PERIOD DEBTOR BEGINNING OF AMOUNTS WRITTEN NOT PERIOD ADDITIONS COLLECTED OFF CURRENT CURRENT Year ended October 1, 1994: Accounts receivable: Major Stockholder(1) $ 51,000 $ 9,523,000 $ 9,460,000 $ -- $114,000 $ --\nYear ended October 2, 1993: Accounts receivable: Major Stockholder(1) $111,000 $ 8,458,000 $ 8,518,000 $ -- $ 51,000 $ --\nYear ended September 26, 1992: Accounts receivable: Major Stockholder(1) $398,000 $15,300,000 $15,587,000 $ -- $111,000 $ --\n(1) Includes amounts for both the major stockholder and Pilgrim Poultry G.P., wholly owned by major stockholder.\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT\nCol. A Col. B Col. C Col. D Col. E Col. F Other Balance at Changes- Balance at CLASSIFI- Beginning Additions Add (Deduct) End of CATION of Period at Cost Retirements Describe Period\nYear ended October 1, 1994(3): Land $ 14,824,000 $ 475,000 $ 177,000 $ 31,000 $ 15,153,000 Building, machinery and equip. 317,657,000 25,069,000 10,401,000 (36,000) 332,289,000 Autos and trucks 25,877,000 3,317,000 1,743,000 6,000 27,457,000 Construction in progress 7,863,000 (3,010,000)(1) -- -- 4,853,000 TOTAL $366,221,000 $ 25,851,000(2) $12,321,000(5)$ 1,000(6)$ 379,752,000\nYear ended October 2, 1993(3): Land $ 15,063,000 $ 168,000 $ 185,000 $ (222,000) $ 14,824,000 Building, machinery and equip. 315,392,000 8,486,000 6,690,000 469,000 317,657,000 Autos and trucks 24,622,000 1,623,000 550,000 182,000 25,877,000 Construction in progress 2,939,000 4,924,000(1) -- -- 7,863,000 TOTAL $358,016,000 $15,201,000(2) $ 7,425,000(5)$ 429,000(6)$ 366,221,000\nYear ended September 26, 1992(3): Land $ 23,111,000 $ 676,000 $ 223,000 $ (8,501,000) $ 15,063,000 Building, machinery and equip. 288,913,000 34,794,000 7,821,000 (494,000) 315,392,000 Autos and trucks 26,777,000 1,809,000 3,798,000 (166,000) 24,622,000 Construction in progress 21,126,000 (18,123,000)(1) -- (64,000) 2,939,000 TOTAL $359,927,000 $19,156,000(2)(4)$11,842,000(5)$(9,225,000)(6)$358,016,000\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\n(1) Represents net change in construction-in-progress.\n(2) Additions relate primarily to expansion of poultry equipment and facilities in both U.S. and Mexican operations.\n(3) Provisions for depreciation have been computed using the following range of useful lives:\nBuilding, machinery and equipment 5 to 40 years Autos and trucks 5 to 7 years\n(4) Includes assets acquired under capital lease of approximately $1,113,000.\n(5) Amounts relate primarily to the retirement of fixed assets destroyed in the fires at the prepared foods plant in fiscal 1992 and the Lufkin processing plant in fiscal 1993. (See Note I to Consolidated Financial Statements).\n(6) Amounts relate primarily to asset reclassification between Other current assets and Property, Plant and Equipment. (See Note A to Consolidated Financial Statements).\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nCol. A Col. B Col. C Col. D Col. E Col. F Additions Other Balance at Charges to Changes Balance at Beginning Cost and Add (Deduct) End of DESCRIPTION of Period Expenses Retirements Describe Period\nYear ended October 1, 1994: Building $107,853,000 $20,750,000 $ 9,345,000 $(133,000) $119,125,000 Autos and trucks 15,667,000 2,974,000 1,561,000 -- 17,080,000 TOTAL $123,520,000 $23,724,000 $10,906,000(1)$(133,000) $136,205,000\nYear ended October 2, 1993: Building $ 91,109,000 $20,424,000 $ 3,500,000 $ (180,000) $107,853,000 Autos and trucks 12,891,000 2,995,000 342,000 123,000 15,667,000 TOTAL $104,000,000 $23,419,000 $ 3,842,000(1)$ (57,000) $123,520,000\nYear ended September 26, 1992 (2): Building $ 76,471,000 $19,434,000 $ 4,625,000 $ (171,000) $ 91,109,000 Autos and trucks 13,364,000 3,647,000 3,968,000 (152,000) 12,891,000 TOTAL $ 89,835,000 $23,081,000 $ 8,593,000(1) $ (323,000) $104,000,000\n(1) Amounts relate primarily to retirement of fixed assets destroyed in the fires at the prepared foods plant in fiscal 1992 and the Lufkin processing plant in fiscal 1993. (See Note I to Consolidated Financial Statements.)\n(2) Provisions for depreciation include charges for the Company's Mexican subsidiaries for the month of September, 1991 as follows:\nBuilding, Machinery and Equipment $ 398,000 Autos and Trucks 68,000 $ 466,000\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nCol. A Col. B Col. C Col. D Col. E\nBalance at Charged to Charged to Balance Beginning of Cost and Other Accts. Deductions at end DESCRIPTION Period Expenses Describe Describe(1) of Period\nYear ended October 1, 1994: Reserves and allowances deducted from asset accounts: Allowance $ 3,240,000 $ 2,666,000 $ -- $ -- $ 5,906,000\nYear ended October 2, 1993: Reserves and allowances deducted from asset accounts: Allowance $ 1,146,000 $ 2,124,000 $ -- $ 30,000 $ 3,240,000\nYear ended September 26, 1992 (2): Reserves and allowances deducted from asset accounts: Allowance $ 101,000 $ 1,045,000 $ -- $ -- $ 1,146,000\n(1) Uncollectible accounts written off, net of recoveries.\n(2) Fiscal 1992 amounts have been restated to exclude amounts related to sales adjustments previously included.\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE IX - SHORT-TERM BORROWINGS\nCol. A Col. B Col. C Col. D Col. E Col. F Average Weighted Maximum Amount Average CATEGORY OF Weighted Amount Outstanding Interest AGGREGATE Balance Average Outstanding During Rate During SHORT-TERM at end Interest During the Period the Period BORROWINGS of Period Rate the Period (1) (2)\nYear ended October 1, 1994: Notes payable to banks $ -- 5.44% $12,000,000 $ 5,167,000 4.03%\nYear ended October 2, 1993: Notes payable to banks $12,000,000 5.00% $64,979,000 $46,098,840 7.44%(3)\nYear ended September 26, 1992: Notes payable to banks $64,979,000 6.63% $97,000,000 $71,657,000 5.97%\n(1) The average amount outstanding during the period was computed by dividing the total of month-end outstanding principal balances by 12.\n(2) The weighted average interest rate during the period was computed by dividing the actual interest expense by the average short-term borrowings outstanding.\n(3) The calculation of weighted average interest rate during the period excludes interest expense of approximately $3.3 million relating to issue costs on interim financing agreements.\nPILGRIM'S PRIDE CORPORATION AND SUBSIDIARIES\nSCHEDULE X - SUPPLEMENTARY INCOME INFORMATION\nCol. A Col. B Item Charged to Costs and Expenses For Year Ended\n1994 1993 1992 (1) Maintenance and Repairs $ 30,824,000 $ 30,525,000 $ 29,954,000\nAdvertising Costs $ --(2) $ 8,957,000 $ 9,929,000\nAmounts for royalties, taxes other than payroll and income taxes, and amortization of preoperating costs and intangible assets are not presented as such amounts are less than 1% of net sales.\n(1) Amounts include charges for the Company's Mexican subsidiaries for the month of September, 1991, as follows:\nMaintenance and Repairs $824,000 Advertising Costs 20,000 $844,000\n(2) Amount does not exceed 1% of total sales and revenue.\nEXHIBIT 22-SUBSIDIARIES OF REGISTRANT\n1. AVICOLA PILGRIM'S PRIDE DE MEXICO, S.A. DE C.V. 2. ALIMENTOS BLANCEADOS PILGRIM'S PRIDE S.A. DE C.V. 3. AVICOLA PILGRIM'S PRIDE, S.A. DE C.V. 4. AVICOLA SAN MIGUEL, S.A. DE C.V. 5. AVICOLA Y GANADERA COLIAH, S.A. DE C.V. 6. AVICOLA Y GRANADERA DEL BAJIO, S.A. DE C.V. 7. AVINDUSTRIA COMERCIAL, S.A. DE C.V. 8. AVINDUSTRIA E INVESTIGACION, S.A. DE C.V. 9. AVIPECUARIA IXTA, S.A. DE C.V. 10. AVIPECURIA VALVACO, S.A. DE C.V. 11. AVIPRODUCTORA, S.A. DE C.V. 12. COMPANIA INCUBADORA AVICOLA PILGRIM'S PRIDE, S.A. DE C.V. 13. CIA. INCUBADORA HIDALGO, S.A. DE C.V. 14. EMPACADORA CAMPO REAL, S.A. DE C.V. 15. INMOBILIARIA AVICOLA PILGRIM'S PRIDE, S. DE R.L. DE C.V. 16. PILGRIM'S PRIDE, S.A. DE C.V. 17. PRODUCTORA Y DISTRIBUIDORA DE ALIMENTOS, S.A. DE. C.V. 18. SERVICIOS AUXILIARES AVICOLAS, S.A. DE C.V. 19. TRANSCOMPO, S.A. DE C.V.\nEXHIBIT 23 - CONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 3-12043) of Pilgrim's Pride Corporation of our report dated November 15, 1994, with respect to the consolidated financial statements and schedules of Pilgrim's Pride Corporation included in this Annual Report (Form 10-K) for the year ended October 1, 1994.\n2121 San Jacinto Dallas, Texas 75201 December 13, 1994\nSecured Credit Agreement Among Pilgrim s Pride Corporation And Harris Trust and Savings Bank Individually and as Agent And FBS Ag Credit, Inc. Internationale Nederlanden Bank N. V. Boatmen s First National Bank of Kansas City First Interstate Bank of Texas, N.A. Dated as of May 27, 1993\nPilgrim s Pride Corporation Secured Credit Agreement Harris Trust and Savings Bank Chicago, Illinois\nFBS Ag Credit, Inc. Denver, Colorado\nInternationale Nederlanden Bank N. V. ( ING Bank ) New York, New York\nBoatmen s First National Bank of Kansas City Kansas City, Missouri\nFirst Interstate Bank of Texas, N.A. Dallas, Texas Ladies and Gentlemen: The undersigned, Pilgrim s Pride Corporation, a Delaware corporation (the Company ), applies to you for your several commitment, subject to all the terms and conditions hereof and on the basis of the representations and warranties hereinafter set forth, to make a revolving credit (the Revolving Credit ) available to the Company, all as more fully hereinafter set forth. Each of you is hereinafter referred to individually as Bank and collectively as Banks. Harris Trust and Savings Bank in its individual capacity is sometimes referred to herein as Harris , and in its capacity as Agent for the Banks is hereinafter in such capacity called the Agent. .c1.1. The Credit;. .c2.Section 1.1. The Revolving Credit.; (a) Subject to all of the terms and conditions hereof, the Banks agree, severally and not jointly, to extend a Revolving Credit to the Company which may be utilized by the Company in the form of loans (individually a Revolving Credit Loan and collectively the Revolving Credit Loans ), B\/As and L\/Cs (each as hereinafter defined). The aggregate principal amount of all Revolving Credit Loans under the Revolving Credit plus the amount available for drawing under all L\/Cs, the aggregate face amount of all B\/As and the aggregate principal amount of all unpaid Reimbursement Obligations (as hereinafter defined) at any time outstanding shall not exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments (as hereinafter defined) in effect from time to time during the term of this Agreement (as hereinafter defined) and (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate. The Revolving Credit shall be available to the Company, and may be availed of by the Company from time to time, be repaid (subject to the restrictions on prepayment set forth herein) and used again, during the period from the date hereof to and including May 31, 1995 (the Termination Date ). (b) At any time not earlier than 120 days prior to, nor later than 60 days prior to, the date that is one year before the Termination Date then in effect (the Anniversary Date ), the Company may request that the Banks extend the then scheduled Termination Date to the date one year from such Termination Date. If such request is made by the Company each Bank shall inform the Agent of its willingness to extend the Termination Date no later than 20 days prior to such Anniversary Date. Any Bank s failure to respond by such date shall indicate its unwillingness to agree to such requested extension, and all Banks must approve any requested extension. At any time more than 15 days before such Anniversary Date the Banks may propose, by written notice to the Company, an extension of this Agreement to such later date on such terms and conditions as the Banks may then require. If the extension of this Agreement to such later date is acceptable to the Company on the terms and conditions proposed by the Banks, the Company shall notify the Banks of its acceptance of such terms and conditions no later than the Anniversary Date, and such later date will become the Termination Date hereunder and this Agreement shall otherwise be amended in the manner described in the Banks notice proposing the extension of this Agreement upon the Agent s receipt of (i) an amendment to this Agreement signed by the Company and all of the Banks, (ii) resolutions of the Company s Board of Directors authorizing such extension and (iii) an opinion of counsel to the Company equivalent in form and substance to the form of opinion attached hereto as Exhibit E and otherwise acceptable to the Banks. (c) The respective maximum aggregate principal amounts of the Revolving Credit at any one time outstanding and the percentage of the Revolving Credit available at any time which each Bank by its acceptance hereof severally agrees to make available to the Company are as follows (collectively, the Revolving Credit Commitments and individually, a Revolving Credit Commitment ): Harris Trust and Savings Bank $35,000,00046.66666667% FBS Ag Credit, Inc. $15,000,000 20% Internationale Nederlanden Bank N. V. $10,000,000 13.33333334% Boatmen s First National Bank of Kansas City $10,000,000 13.33333334% First Interstate Bank of Texas, N.A. $ 5,000,000 6.66666667% Total $75,000,000 100%\n(d) Loans under the Revolving Credit may be Eurodollar Loans, CD Rate Loans or Domestic Rate Loans. All Loans under the Revolving Credit shall be made from each Bank in proportion to its respective Revolving Credit Commitment as above set forth. Each Domestic Rate Loan shall be in an amount not less than $3,000,000 or such greater amount which is an integral multiple of $500,000 and each Fixed Rate Loan shall be in an amount not less than $3,000,000 or such greater amount which is an integral multiple of $1,000,000. (e) The initial borrowing under this Agreement shall be in an amount sufficient to pay all amounts outstanding under that certain Revolving Credit Agreement dated as of February 1, 1993 (the Existing Agreement ) between the Company, Rabobank Nederland and the other banks party thereto (the Existing Lenders ). The Company shall apply the proceeds of the initial borrowing hereunder to pay all amounts outstanding under the Existing Agreement and the Series D Notes. .c2.Section 1.2. The Notes;. All Revolving Credit Loans made by each Bank hereunder shall be evidenced by a single Secured Revolving Credit Note of the Company substantially in the form of Exhibit A hereto (individually, a Revolving Note and together, the Revolving Notes ) payable to the order of each Bank in the principal amount of such Bank s Revolving Credit Commitment, but the aggregate principal amount of indebtedness evidenced by such Revolving Note at any time shall be, and the same is to be determined by, the aggregate principal amount of all Revolving Credit Loans made by such Bank to the Company pursuant hereto on or prior to the date of determination less the aggregate amount of principal repayments on such Revolving Credit Loans received by or on behalf of such Bank on or prior to such date of determination. Each Revolving Note shall be dated as of the execution date of this Agreement, shall be delivered concurrently herewith, and shall be expressed to mature on the Termination Date and to bear interest as provided in Section 1.3 hereof. Each Bank shall record on its books or records or on a schedule to its Revolving Note the amount of each Revolving Credit Loan made by it hereunder, whether each Revolving Credit Loan is a Domestic Rate Loan, CD Rate Loan or Eurodollar Loan, and, with respect to Eurodollar Loans, the interest rate and Interest Period applicable thereto, and all payments of principal and interest and the principal balance from time to time outstanding, provided that prior to any transfer of such Revolving Note all such amounts shall be recorded on a schedule to such Revolving Note. The record thereof, whether shown on such books or records or on the schedule to the Revolving Note, shall be prima facie evidence as to all such amounts; provided, however, that the failure of any Bank to record or any mistake in recording any of the foregoing shall not limit or otherwise affect the obligation of the Company to repay all Revolving Credit Loans made hereunder together with accrued interest thereon. Upon the request of any Bank, the Company will furnish a new Revolving Note to such Bank to replace its outstanding Revolving Note and at such time the first notation appearing on the schedule on the reverse side of, or attached to, such Revolving Note shall set forth the aggregate unpaid principal amount of Revolving Credit Loans then outstanding from such Bank, and, with respect to each Fixed Rate Loan, the interest rate and Interest Period applicable thereto. Such Bank will cancel the outstanding Revolving Note upon receipt of the new Revolving Note. .c2.Section 1.3. Interest Rates;. (a) Domestic Rate Loans. Each Domestic Rate Loan shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until maturity (whether by acceleration, upon prepayment or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Domestic Rate from time to time in effect, payable quarterly in arrears on the last day of each calendar quarter, commencing on the first of such dates occurring after the date hereof and at maturity (whether by acceleration, upon prepayment or otherwise). (b) Eurodollar Loans. Each Eurodollar Loan under the Revolving Credit shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until the last day of the Interest Period applicable thereto or, if earlier, until maturity (whether by acceleration or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Adjusted Eurodollar Rate, payable on the last day of each Interest Period applicable thereto and at maturity (whether by acceleration or otherwise) and, with respect to Eurodollar Loans with an Interest Period in excess of three months, on the date occurring every three months from the first day of the Interest Period applicable thereto. (c) CD Rate Loans. Each CD Rate Loan under the Revolving Credit shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until the last day of the Interest Period applicable thereto or, if earlier, until maturity (whether by acceleration or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Adjusted CD Rate, payable on the last day of each Interest Period applicable thereto and at maturity (whether by acceleration of otherwise) and, with respect to CD Rate Loans with an Interest Period in excess of 90 days, on the date occurring every 90 days from the first day of the Interest Period applicable thereto. (d) Default Rate. During the existence of an Event of Default all Loans and Reimbursement Obligations shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) from the date of such Event of Default until paid in full, payable on demand, at a rate per annum equal to the sum of 2.5% plus the Domestic Rate from time to time in effect plus the Applicable Margin. .c2.Section 1.4. Conversion and Continuation of Loans;. (a) Provided that no Event of Default or Potential Default has occurred and is continuing, the Company shall have the right, subject to the other terms and conditions of this Agreement, to continue in whole or in part (but, if in part, in the minimum amount specified for Fixed Rate Loans in Section 1.1 hereof) any Fixed Rate Loan from any current Interest Period into a subsequent Interest Period, provided that the Company shall give the Bank notice of the continuation of any such Loan as provided in Section 1.8 hereof. (b) In the event that the Company fails to give notice pursuant to Section 1.8 hereof of the continuation of any Fixed Rate Loan or fails to specify the Interest Period applicable thereto, or an Event of Default or Potential Default has occurred and is continuing at the time any such Loan is to be continued hereunder, then such Loan shall be automatically converted as (and the Company shall be deemed to have given notice requesting) a Domestic Rate Loan, subject to Sections 1.8(b), 8.2 and 8.3 hereof, unless paid in full on the last day of the then applicable Interest Period. (c) Provided that no Event of Default or Potential Default has occurred and is continuing, the Company shall have the right, subject to the terms and conditions of this Agreement, to convert Loans of one type (in whole or in part) into Loans of another type from time to time provided that: (i) the Company shall give the Bank notice of each such conversion as provided in Section 1.8 hereof, (ii) the principal amount of any Loan converted hereunder shall be in an amount not less than the minimum amount specified for the type of Loan in Section 1.1 hereof, (iii) after giving effect to any such conversion in part, the principal amount of any Fixed Rate Loan then outstanding shall not be less than the minimum amount specified for the type of Loan in Section 1.1 hereof, (iv) any conversion of a Loan hereunder shall only be made on a Banking Day, and (v) any Fixed Rate Loan may be converted only on the last day of the Interest Period then applicable thereto. .c2.Section 1.5. Bankers Acceptances;. Subject to all the terms and conditions hereof, satisfaction of all conditions precedent to borrowing under this Agreement and so long as no Potential Default or Event of Default is in existence, at the Company s request Harris, in its discretion, may create acceptances in an amount of at least $5,000,000 (a B\/A and collectively the B\/As ) for the Company within the limits of, and subject to availability under the Revolving Credit, and the Banks hereby agree to participate therein as more fully described in Section 1.9 hereof. Each B\/A shall be created pursuant to a General Acceptance Agreement (the B\/A Agreement ) in the form of Exhibit B hereto and an Acceptance Request in Harris standard form at the time such B\/A is requested with respect to such draft presented to Harris for acceptance hereunder. To provide the Company with immediate cash for the B\/As created hereunder, Harris agrees to discount such B\/As at a rate determined by adding a rate per annum (calculated on the basis of a 360-day year and actual days elapsed) equal to the Applicable Margin to the then current bankers acceptance rate for B\/As on which Harris is the acceptor and to credit the proceeds of such discounting to the Company s account at Harris. The face amount of each B\/A created and outstanding pursuant hereto shall be deducted from the credit which may be otherwise available under the Revolving Credit. Each B\/A shall have a term of 30, 60, 90, 120, 150 or 180 days (but not later than the Termination Date), and shall be an acceptance eligible for discount with Federal Reserve Bank in accordance with paragraph 7A of Section 13 of the Federal Reserve Act and regulations and interpretations applicable thereto. The Company shall present to Harris evidence of such eligibility satisfactory to the Banks, and Harris in its sole discretion may refuse to issue any B\/A. .c2.Section 1.6. Letters of Credit.; Subject to all the terms and conditions hereof, satisfaction of all conditions precedent to borrowing under this Agreement and so long as no Potential Default or Event of Default is in existence, at the Company s request Harris may in its discretion issue letters of credit (an L\/C and collectively the L\/Cs ) for the account of the Company subject to availability under the Revolving Credit, and the Banks hereby agree to participate therein as more fully described in Section 1.9 hereof. Each L\/C shall be issued pursuant to an Application for Letter of Credit (the L\/C Agreement ) in the form of Exhibit C hereto. The L\/Cs shall consist of standby letters of credit in an aggregate face amount not to exceed $20,000,000. Each L\/C shall have an expiry date not more than one year from the date of issuance thereof (but in no event later than the Termination Date). The amount available to be drawn under each L\/C issued pursuant hereto shall be deducted from the credit otherwise available under the Revolving Credit. In consideration of the issuance of L\/Cs the Company agrees to pay Harris a fee (the L\/C Fee ) in the amount per annum equal to 1.0% of the face amount of each Performance L\/C and 1.5% of the stated amount of each Financial Guarantee L\/C (in each case computed on the basis of a 360 day year and actual days elapsed) of the face amount for any L\/C issued hereunder. In addition the Company shall pay Harris for its own account an issuance fee (the L\/C Issuance Fee ) in an amount equal to one-eighth of one percent (0.125%) of the stated amount of each L\/C issued by Harris hereunder. All L\/C Fees and L\/C Issuance Fees shall be payable on the date of issuance of each L\/C hereunder and on the date of each extension, if any, of the expiry date of each L\/C. .c2.Section 1.7. Reimbursement Obligation;. The Company is obligated, and hereby unconditionally agrees, to pay in immediately available funds to the Agent for the account of Harris and the Banks who are participating in L\/Cs and B\/As pursuant to Section 1.9 hereof the face amount of (a) each B\/A created by Harris hereunder not later than 11:00 A.M. (Chicago Time) on the maturity date of such B\/A, and (b) each draft drawn and presented under an L\/C issued by Harris hereunder not later than 11:00 a.m. (Chicago Time) on the date such draft is presented for payment to Harris (the obligation of the Company under this Section 1.7 with respect to any B\/A or L\/C is a Reimbursement Obligation ). If at any time the Company fails to pay any Reimbursement Obligation when due, the Company shall be deemed to have automatically requested a Domestic Rate Loan from the Banks hereunder, as of the maturity date of such Reimbursement Obligation, the proceeds of which Loan shall be used to repay such Reimbursement Obligation. Such Loan shall only be made if no Potential Default or Event of Default shall exist and upon approval by all of the Banks, and shall be subject to availability under the Revolving Credit. If such Loan is not made by the Banks for any reason, the unpaid amount of such Reimbursement Obligation shall be due and payable to the Agent for the pro rata benefit of the Banks upon demand and shall bear interest at the rate of interest specified in Section 1.3(d) hereof. .c2.Section 1.8. Manner of Borrowing and Rate Selection;. (a) The Company shall give telephonic, telex or telecopy notice to the Agent (which notice, if telephonic, shall be promptly confirmed in writing) no later than (i) 11:00 a.m. (Chicago time) on the date the Banks are requested to make each Domestic Rate Loan, (ii) 11:00 a.m. (Chicago time) on the date at least three (3) Banking Days prior to the date of (A) each Eurodollar Loan which the Banks are requested to make or continue, and (B) the conversion of any CD Rate Loan or Domestic Rate Loan into a Eurodollar Loan and (iii) 11:00 a.m. (Chicago time) on the date at least one (1) Business Day prior to the date of (A) each CD Rate Loan which the Banks are requested to make and (B) the conversion of any Eurodollar Loan or Domestic Rate Loan into a CD Rate Loan. Each such notice shall specify the date of the Loan requested (which shall be a Business Day in the case of Domestic Rate Loans and CD Rate Loans and a Banking Day in the case of a Eurodollar Loan), the amount of such Loan, whether the Loan is to be made available by means of a Domestic Rate Loan, CD Rate Loan or Eurodollar Loan and, with respect to Fixed Rate Loans, the Interest Period applicable thereto; provided, that in no event shall the principal amount of any requested Revolving Credit Loan plus the aggregate principal or face amount, as appropriate, of all Loans, L\/Cs, B\/As and unpaid Reimbursement Obligations outstanding hereunder exceed the amounts specified in Section 1.1 hereof. The Company agrees that the Agent may rely on any such telephonic, telex or telecopy notice given by any person who the Agent believes is authorized to give such notice without the necessity of independent investigation and in the event any notice by such means conflicts with the written confirmation, such notice shall govern if any Bank has acted in reliance thereon. The Agent shall, no later than 12:30 p.m. (Chicago time) on the day any such notice is received by it, give telephonic, telex or telecopy (if telephonic, to be confirmed in writing within one Business Day) notice of the receipt of notice from the Company hereunder to each of the Banks, and, if such notice requests the Banks to make, continue or convert any Fixed Rate Loans, the Agent shall confirm to the Company by telephonic, telex or telecopy means, which confirmation shall be conclusive and binding on the Company in the absence of manifest error, the Interest Period and the interest rate applicable thereto promptly after such rate is determined by the Agent. (b) Subject to the provisions of Section 6 hereof, the proceeds of each Loan shall be made available to the Company at the principal office of the Agent in Chicago, Illinois, in immediately available funds, on the date such Loan is requested to be made, except to the extent such Loan represents (i) the conversion of an existing Loan or (ii) a refinancing of a Reimbursement Obligation, in which case each Bank shall record such conversion on the schedule to its Revolving Note, or in lieu thereof, on its books and records, and shall effect such conversion or refinancing, as the case may be, on behalf of the Company in accordance with the provisions of Section 1.4(a) hereof and 1.9 hereof, respectively. Not later than 2:00 p.m. Chicago time, on the date specified for any Loan to be made hereunder, each Bank shall make its portion of such Loan available to the Company in immediately available funds at the principal office of the Agent, except (i) as otherwise provided above with respect to converting or continuing any outstanding Loans and (ii) to the extent such Loan represents a refinancing of any outstanding Reimbursement Obligations. (c) Unless the Agent shall have been notified by a Bank prior to 1:00 p.m. (Chicago time) on the date a Loan is to be made by such Bank (which notice shall be effective upon receipt) that such Bank does not intend to make the proceeds of such Loan available to the Agent, the Agent may assume that such Bank has made such proceeds available to the Agent on such date and the Agent may in reliance upon such assumption (but shall not be required to) make available to the Company a corresponding amount. If such corresponding amount is not in fact made available to the Agent by such Bank, the Agent shall be entitled to receive such amount on demand from such Bank (or, if such Bank fails to pay such amount forthwith upon such demand, to recover such amount, together with interest thereon at the rate otherwise applicable thereto under Section 1.3 hereof, from the Company) together with interest thereon in respect of each day during the period commencing on the date such amount was made available to the Company and ending on the date the Agent recovers such amount, at a rate per annum equal to the effective rate charged to the Agent for overnight Federal funds transactions with member banks of the Federal Reserve System for each day, as determined by the Agent (or, in the case of a day which is not a Business Day, then for the preceding Business Day) (the Fed Funds Rate ). Nothing in this Section 1.8(c) shall be deemed to permit any Bank to breach its obligations to make Loans under the Revolving Credit or to limit the Company s claims against any Bank for such breach. .c2.Section 1.9. Participation in B\/As and L\/Cs;. Each of the Banks will acquire a risk participation for its own account, without recourse to or representation or warranty from Harris, in each B\/A upon the creation thereof and in each L\/C upon the issuance thereof ratably in accordance with its Commitment Percentage. In the event any Reimbursement Obligation is not immediately paid by the Company pursuant to Section 1.7 hereof, each Bank will pay to Harris funds in an amount equal to such Bank s ratable share of the unpaid amount of such Reimbursement Obligation (based upon its proportionate share relative to its percentage of the Revolving Credit (as set forth in Section 1.1 hereof)). At the election of all of the Banks, such funding by the Banks of the unpaid Reimbursement Obligations shall be treated as additional Revolving Credit Loans to the Company hereunder rather than a purchase of participations by the Banks in the related B\/As and L\/Cs held by Harris. The availability of funds to the Company under the Revolving Credit shall be reduced in an amount equal to any such B\/A or L\/C. The obligation of the Banks to Harris under this Section 1.9 shall be absolute and unconditional and shall not be affected or impaired by any Event of Default or Potential Default which may then be continuing hereunder. Harris shall notify each Bank by telephone of its proportionate share relative to its percentage of the total Banks Revolving Credit Commitments set forth in Section 1.1 hereof (a Commitment Percentage ) of such unpaid Reimbursement Obligation. If such notice has been given to each Bank by 12:00 Noon, Chicago time, each Bank agrees to pay Harris in immediately available and freely transferable funds on the same Business Day. If such notice is received after 12:00 noon, Chicago time, each Bank agrees to pay Harris in immediately available and freely transferable funds no later than the following Business Day. Funds shall be so made available at the account designated by Harris in such notice to the Banks. Upon the election by the Banks to treat such funding as additional Revolving Credit Loans hereunder and payment by each Bank, such Loans shall bear interest in accordance with Section 1.3(a) hereof. Harris shall share with each Bank on a pro rata basis relative to its Commitment Percentage a portion of each payment of a Reimbursement Obligation (whether of principal or interest) and any B\/A commission and any L\/C Fee (but not any L\/C Issuance Fee) payable by the Company. Any such amount shall be promptly remitted to the Banks when and as received by Harris from the Company. .c2.Section 1.10. Capital Adequacy;. If, after the date hereof, any Bank or the Agent shall have determined in good faith that the adoption of any applicable law, rule or regulation regarding capital adequacy, or any change therein (including, without limitation, any revision in the Final Risk-Based Capital Guidelines of the Board of Governors of the Federal Reserve System (12 CFR Part 208, Appendix A; 12 CFR Part 225, Appendix A) or of the Office of the Comptroller of the Currency (12 CFR Part 3, Appendix A), or in any other applicable capital rules heretofore adopted and issued by any governmental authority), or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Lending Office) with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on such Bank s capital, or on the capital of any corporation controlling such Bank, in each case as a consequence of its obligations hereunder to a level below that which such Bank would have achieved but for such adoption, change or compliance (taking into consideration such Bank s policies with respect to capital adequacy) by an amount reasonably deemed by such Bank to be material, then from time to time, within fifteen (15) days after demand by such Bank (with a copy to the Agent), the Company shall pay to such Bank such additional amount or amounts as will compensate such Bank for such reduction. .c1.2. Fees, Prepayments And Terminations. .c2.Section 2.1. Facility Fee;. For the period from the date hereof to and including the Termination Date, the Company shall pay to the Agent for the account of the Banks a facility fee with respect to the Revolving Credit at the rate of one-half of one percent (0.5%) per annum (computed in each case on the basis of a year of 360 days for the actual number of days elapsed) of the aggregate maximum amount of the Banks Revolving Credit Commitments hereunder in effect from time to time and whether or not any credit is in use under the Revolving Credit, all such fees to be payable quarterly in arrears on the last day of each calendar quarter commencing on the last day of June, 1993, and on the Termination Date, unless the Revolving Credit is terminated in whole on an earlier date, in which event the facility fee for the final period shall be paid on the date of such earlier termination in whole. .c2.Section 2.2. Agent s Fee;. The Company shall pay to and for the sole account of the Agent such fees as may be agreed upon in writing from time to time by the Agent and the Company. Such fees shall be in addition to any fees and charges the Agent may be entitled to receive under Section 10 hereunder or under the other Loan Documents. .c2.Section 2.3. Optional Prepayments;. The Company shall have the privilege of prepaying without premium or penalty and in whole or in part (but if in part, then in a minimum principal amount of $2,500,000 or such greater amount which is an integral multiple of $100,000) any Domestic Rate Loan at any time upon prior telex or telephonic notice to the Agent on or before 12:00 Noon on the same Business Day. The Company may not prepay any Fixed Rate Loan. Any amount prepaid under the Revolving Credit may, subject to the terms and conditions of this Agreement, be borrowed, repaid and borrowed again. .c2.Section 2.4. Mandatory Prepayments (a) Borrowing Base. The Company shall not permit the sum of the principal amount of all Loans plus the aggregate face amount of all B\/As, the amount available for drawing under all L\/Cs and the aggregate principal amount of all unpaid Reimbursement Obligations at any time outstanding to exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments or (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate. In addition to the Company s obligations to pay any outstanding Reimbursement Obligations as set forth in Section 1.7 hereof, the Company will make such payments on any outstanding Loans and Reimbursement Obligations (and, if any B\/As are then outstanding, deposit an amount equal to the aggregate face amount of all such B\/As into an interest bearing account with the Agent which shall be held as additional collateral security for such B\/As) which are necessary to cure any such excess within three Business Days after the occurrence thereof. Any amount prepaid under the Revolving Credit may, subject to the terms and conditions of this Agreement, be borrowed, prepaid and borrowed again. (b) Excess Cash Flow. No later than 60 days after the last day of each fiscal quarter (except the last fiscal quarter in each fiscal year) of the Company and no later than 90 days after the last day of each Fiscal Year of the Company, the Company shall apply an amount equal to 75% of its Excess Cash Flow for such fiscal quarter if its Leverage Ratio for such fiscal quarter was greater than 0.60 to 1, or 50% of its Excess Cash Flow for such fiscal quarter if its Leverage Ratio for such fiscal quarter was equal to or less than 0.60 to 1 but greater than 0.55 to 1, first to the prepayment in full of Revolving Credit Loans and Reimbursement Obligations outstanding hereunder and then to the prepayment of Funded Debt. .c2.Section 2.5. Closing Fee;. The Company shall pay to the Agent for the pro rata benefit of the Banks a closing fee in an amount equal to one-half of one percent (0.5%) of the Banks Revolving Credit Commitments (determined without regard to any credit in use hereunder), one-half of which fee shall be payable on the date of the execution and delivery of this Agreement and the other half of which fee shall be payable on the date that the initial Loan is made hereunder, the initial B\/A is created hereunder or the initial L\/C is issued hereunder. .c2.Section 2.6. Termination of Commitments;. The Revolving Credit Commitments of the Banks hereunder shall automatically terminate on June 15, 1993 if the initial extension of credit hereunder is not made on or before June 15, 1993. .c1.3. Place and Application of Payments;. All payments of principal and interest made by the Company in respect of the Notes and Reimbursement Obligations and all fees payable by the Company hereunder, shall be made to the Agent at its office at 111 West Monroe Street, Chicago, Illinois 60690 and in immediately available funds, prior to 12:00 noon on the date of such payment. All such payments shall be made without setoff or counterclaim and without reduction for, and free from, any and all present and future levies, imposts, duties, fees, charges, deductions withholdings, restrictions or conditions of any nature imposed by any government or any political subdivision or taxing authority thereof. Unless the Banks otherwise agree, any payments received after 12:00 noon Chicago time shall be deemed received on the following Business Day. The Agent shall remit to each Bank its proportionate share of each payment of principal, interest and facility fees, B\/A fees and L\/C fees received by the Agent by 3:00 P.M. Chicago time on the same day of its receipt if received by the Agent by 12:00 noon, Chicago time, and its proportionate share of each such payment received by the Agent after 12:00 noon on the Business Day following its receipt by the Agent. In the event the Agent does not remit any amount to any Bank when required by the preceding sentence, the Agent shall pay to such Bank interest on such amount until paid at a rate per annum equal to the Fed Funds Rate. The Company hereby authorizes the Agent to automatically debit its account with Harris for any principal, interest and fees when due under the Notes, the B\/A Agreement, any L\/C Agreement or this Agreement and to transfer the amount so debited from such account to the Agent for application as herein provided. All proceeds of Collateral shall be applied in the manner specified in the Security Agreement. .c1.4. Definitions;. The terms hereinafter set forth when used herein shall have the following meanings: 4.1. Account Debtor shall mean the Person who is obligated on a Receivable. 4.2. Adjusted CD Rate shall mean a rate per annum (rounded upwards, if necessary, to the nearest 1\/100 of 1%) determined in accordance with the following formula:\nAdjusted CD Rate = CD Rate \/ 100% - CD Reserve Percentage + Assessment Rate 4.3. Adjusted Eurodollar Rate means a rate per annum determined pursuant to the following formula: Adjusted Eurodollar Rate = Eurodollar Rate \/ 100% - Reserve Percentage 4.4. Affiliate shall mean any person, firm or corporation which, directly or indirectly controls, or is controlled by, or is under common control with, the Company. As used in this Section 4.30 the term controls (including the terms controlled by and under common control with ) shall have the meaning given in Section 4.30. 4.5. Agent is defined in the first paragraph of this Agreement. 4.6. Agreement shall mean this Secured Credit Agreement as supplemented, modified, restated and amended from time to time. 4.7. Anniversary Date has the meaning specified in Section 1.1(b) hereof. 4.8. Applicable Margin shall mean, with respect to each type of Loan and the B\/As described in Column A below, the rate of interest per annum shown in Columns B, C and D below for the range of Leverage Ratio specified for each Column:\nA B C D\nLeverage Ratio <0.5 to 1 >.50 to 1 and\n<.60 to 1 .60 to 1 and <.70 to 1 Eurodollar Loans 1.125% 1.375% 1.75% B\/As 1.125% 1.375% 1.75% Domestic Rate Loans 0.125% 0.375% 0.75% CD Rate Loans 1.25% 1.50% 1.875%\nNot later than 5 Business Days after receipt by the Agent of the financial statements called for by Section 7.4 hereof for the applicable fiscal quarter, the Agent shall determine the Leverage Ratio for the applicable period and shall promptly notify the Company and the Banks of such determination and of any change in the Applicable Margins resulting therefrom. Any such change in the Applicable Margins shall be effective as of the date the Agent so notifies the Company and the Banks with respect to all Loans and B\/As outstanding on such date, and such new Applicable Margins shall continue in effect until the effective date of the next quarterly redetermination in accordance with this Section. Each determination of the Leverage Ratio and Applicable Margins by the Agent in accordance with this Section shall be conclusive and binding on the Company and the Banks absent manifest error. From the date hereof until the Applicable Margins are first adjusted pursuant hereto, the Applicable Margins shall be those set forth in column D above. 4.9. Assessment Rate shall mean the assessment rate (rounded upwards, if necessary, to the nearest 1\/100 of 1%) imposed by the Federal Deposit Insurance Corporation or its successors for insuring the Agent s liability for time deposits, as in effect from time to time. 4.10. B\/A and B\/As shall have the meanings specified in Section 1.5 hereof. 4.11. B\/A Agreement shall have the meaning set forth in Section 1.5. 4.12. Bank and Banks shall have the meanings specified in the first paragraph of this Agreement. 4.13. Banking Day shall mean a day on which banks are open for business in Nassau, Bahamas, London, England, Dallas, Texas, Denver, Colorado, Kansas City, Missouri, New York, New York and Chicago, Illinois, other than a Saturday or Sunday, and dealing in United States Dollar deposits in London, England and Nassau, Bahamas. 4.14. Borrowing Base , as determined on the basis of the information contained in the most recent Borrowing Base Certificate, shall mean an amount equal to: (a) 80% of the amount of Eligible Receivables, plus (b) 65% of the Value of Eligible Inventory consisting of feed grains, feed and ingredients, plus (c) 65% percent of the Value of Eligible Inventory consisting of live and dressed broiler chickens and commercial eggs, plus (d) 65% of the Value of Eligible Inventory consisting of prepared foods, plus (e) 100% of the Value of Eligible Inventory consisting of breeder hens, breeder pullets, commercial hens, commercial pullets and hatching eggs, plus (f) 40% of the Value of Eligible Inventory consisting of packaging materials, vaccines and supplies, minus (g) the aggregate outstanding amount of all Grower Payables that are more than 15 days past due. 4.15. Borrowing Base Certificate shall mean the certificate in the form of Exhibit H hereto which is required to be delivered to the Banks in accordance with Section 7.4(d) hereof. 4.16. Business Day shall mean any day except Saturday or Sunday on which banks are open for business in Chicago, Illinois, Dallas, Texas, Denver, Colorado, Kansas City, Missouri and New York, New York. 4.17. Capitalized Lease shall mean, as applied to any Person, any lease of any Property the discounted present value of the rental obligations of such person as lessee under which, in accordance with generally accepted accounting principles, is required to be capitalized on the balance sheet of such Person. 4.18. Capitalized Lease Obligation shall mean, as applied to any Person, the discounted present value of the rental obligation, as aforesaid, under any Capitalized Lease. 4.19. CD Rate shall mean, with respect to each Interest Period applicable to a CD Rate Loan, the rate per annum determined by the Agent to be the arithmetic average of the rate per annum determined by the Agent to be the average of the bid rates quoted to the Agent at approximately 10:00 a.m. Chicago time (or as soon thereafter as practicable) on the first day of such Interest Period by at least two certificate of deposit dealers of recognized national standing selected by the Agent for the purchase at face value of certificates of deposit of the Agent having a term comparable to such Interest Period and in an amount comparable to the principal amount of the CD Rate Loan to be made by the Agent for such Interest Period. Each determination of the CD Rate made by the Agent in accordance with this paragraph shall be conclusive and binding on the Company except in the case of manifest error or willful misconduct. 4.20. CD Reserve Percentage shall mean the rate (as determined by the Bank) of the maximum reserve requirement (including, without limitation, any supplemental, marginal and emergency reserves) imposed on the Agent by the Board of Governors of the Federal Reserve System (or any successor) from time to time on non-personal time deposits having a maturity equal to the applicable Interest Period and in an amount equal to the unpaid principal amount of the relevant CD Rate Loan, subject to any amendments of such reserve requirement by such Board or its successor, taking into account any transitional adjustments thereto. The Adjusted CD Rate shall automatically be adjusted as of the date of any change in the CD Reserve Percentage. 4.21. CERCLA shall mean the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended. 4.22. CERCLIS shall mean the CERCLA Information System. 4.23. Change in Law shall have the meaning specified in Section 9.3 hereof. 4.24. CoBank shall mean the National Bank for Cooperatives. 4.25. CoBank Agreement shall have the meaning specified in Section 11.15(a) hereof. 4.26. CoBank Participation shall have the meaning set forth in Section 11.15(a) hereof. 4.27. Collateral shall mean the collateral security provided to the Agent for the benefit of the Banks pursuant to the Security Agreement. 4.28. Commitment Percentage shall have the meaning set forth in Section 1.9 hereof. 4.29. Company shall have the meaning specified in the first paragraph of this Agreement. 4.30. Control or Controlled By or Under Common Control shall mean possession, directly or indirectly, of power to direct or cause the direction of management or policies (whether through ownership of voting securities, by contract or otherwise); provided that, in any event any Person which beneficially owns, directly or indirectly, 10% or more (in number of votes) of the securities having ordinary voting power for the election of directors of a corporation shall be conclusively presumed to control such corporation, and provided further that any Consolidated Subsidiary shall be conclusively presumed to be controlled by the Company. 4.31. Current Assets of any Person shall mean the aggregate amount of assets of such Person which in accordance with generally accepted accounting principles may be properly classified as current assets after deducting adequate reserves where proper. 4.32. Current Liabilities shall mean all items (including taxes accrued as estimated) which in accordance with generally accepted accounting principles may be properly classified as current liabilities, and including in any event all amounts outstanding from time to time under this Agreement. 4.33. Current Ratio shall mean the ratio of Current Assets to Current Liabilities of the Company and its Subsidiaries. 4.34. Debt of any Person shall mean as of any time the same is to be determined, the aggregate of: (a) all indebtedness, obligations and liabilities of such Person with respect to borrowed money (including by the issuance of debt securities); (b) all guaranties, endorsements and other contingent obligations of such Person with respect to indebtedness arising from money borrowed by others; (c) all reimbursement and other obligations with respect to letters of credit, bankers acceptances, customer advances and other extensions of credit whether or not representing obligations for borrowed money; (d) the aggregate of the principal components of all leases and other agreements for the use, acquisition or retention of real or personal property which are required to be capitalized under generally accepted accounting principles consistently applied; (e) all indebtedness, obligations and liabilities representing the deferred purchase price of property or services; and (f) all indebtedness secured by a lien on the Property of such Person, whether or not such Person has assumed or become liable for the payment of such indebtedness. 4.35. Domestic Rate means for any day the rate of interest announced by Harris from time to time as its prime commercial rate in effect on such day, with any change in the Domestic Rate resulting from a change in said prime commercial rate to be effective as of the date of the relevant change in said prime commercial rate (the Harris Prime Rate ), provided that if the rate per annum determined by adding 1\/2 of 1% to the rate at which Harris would offer to sell federal funds in the interbank market on or about 10:00 a.m. (Chicago time) on any day (the Adjusted Fed Funds Rate ) shall be higher than the Harris Prime Rate on such day, then the Domestic Rate for such day and for any succeeding day which is not a Business Day shall be such Adjusted Fed Funds Rate. The determination of the Adjusted Fed Funds Rate by Harris shall be final and conclusive except in the case of manifest error or willful misconduct. 4.36. Domestic Rate Loan means a Revolving Credit Loan which bears interest as provided in Section 1.3(a) hereof. 4.37. EBITDA shall mean, in any fiscal year of the Company, all earnings (other than extraordinary items) of the Company before interest and income tax obligations of the Company for said year and before depreciation and amortization charges of the Company for said year, all determined in accordance with generally accepted accounting principles, consistently applied. 4.38. Eligible Inventory shall mean any Inventory of the Company in which the Agent has a first priority perfected security interest, which the Banks in their sole judgment deem to be acceptable for inclusion in the Borrowing Base and which complies with each of the following requirements: (a) it consists solely of feed grains, feed, ingredients, live broiler chickens, dressed broiler chickens, commercial eggs, prepared food products, breeder hens, breeder pullets, hatching eggs, commercial hens, commercial pullets, packaging materials, vaccines and supplies; (b) it is in first class condition, not obsolete, and is readily usable or salable by the Company in the ordinary course of its business; (c) it substantially conforms to the advertised or represented specifications and other quality standards of the Company, and has not been determined by the Banks to be unacceptable due to age, type, category, quality and\/or quantity; (d) all warranties as set forth in this Agreement and the Security Agreement are true and correct with respect thereto; (e) it has been identified to the Banks in the manner prescribed pursuant to the Security Agreement; (f) it is located at a location within the United States disclosed to and approved by the Banks and, if requested by the Agent, any Person (other than the Company) owning or controlling such location shall have waived all right, title and interest in and to such Inventory in a manner satisfactory to the Banks; and (g) it is covered by a warehouse receipt issued by the Warehouseman and delivered to the Agent. 4.39. Eligible Receivables shall mean any Receivable of the Company in which the Agent has a first priority perfected security interest, which the Banks, in their sole judgment deem to be acceptable for inclusion in the Borrowing Base and which complies with each of the following requirements: (a) It arises out of a bona fide rendering of services or sale of goods sold and delivered by or on behalf of the Company to, or in the process of being delivered by or on behalf of the Company to, the Account Debtor on said Receivables; (b) all warranties set forth in this Agreement and the Security Agreement are true and correct with respect thereto; (c) it has been identified to the Banks in a manner satisfactory to the Banks; (d) it is evidenced by an invoice (dated not later than five days after the date of shipment or performance of services) rendered to the Account Debtor thereunder; (e) the invoice representing such Receivable shall have a due date not more than 45 days following the invoice date for such products; (f) it is not owing by an Account Debtor who shall have failed to pay 10% or more of all Receivables owed by such Account Debtor within the period set forth in (g) below or who has become insolvent or is the subject of any bankruptcy, arrangement, reorganization proceedings or other proceedings for relief of debtors; (g) it has not remained unpaid in whole or in part from and after the due date thereof; (h) it is payable in United States Dollars; (i) it is not owing by the United States of America or any department, agency or instrumentality thereof; (j) it is not owing by any Account Debtor located outside of the United States; (k) it is net of any credit or allowance given by the Company to such Account Debtor; (l) the Receivable is not subject to any counterclaim or defense asserted by the Account Debtor thereunder, nor is it subject to any offset or contra account payable to the Account Debtor (in any case, unless the amount of such Receivable is net of such counterclaim, defense, offset or contra account); and (m) it is not owing by an Account Debtor that is an Affiliate of the Company other than Archer Daniels Midland. 4.40. Environmental Laws shall have the meaning specified in Section 5.10 hereof. 4.41. ERISA shall mean the Employee Retirement Income Security Act of 1974, as amended. 4.42. Eurodollar Loan shall mean a Revolving Credit Loan which bears interest as provided in Section 1.3(b) hereof. 4.43. Eurodollar Rate shall mean for each Interest Period applicable to a Eurodollar Loan, (a) the LIBOR Index Rate for such Interest Period, if such rate is available, and (b) if the LIBOR Index Rate cannot be determined, the arithmetic average of the rate of interest per annum (rounded upwards, if necessary, to nearest 1\/100 of 1%) at which deposits in U.S. dollars in immediately available funds are offered to the Agent at 11:00 a.m. (London, England time) two (2) Business Days before the beginning of such Interest Period by major banks in the interbank eurodollar market for a period equal to such Interest Period and in an amount equal or comparable to the principal amount of the Eurodollar Loan scheduled to be made by the Agent during such Interest Period. 4.44. Event of Default shall mean any event or condition identified as such in Section 8.1 hereof. 4.45. Excess Cash Flow shall mean an amount equal to (a) net cash provided by operating activities (determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied) minus (b) the sum of capital expenditures (determined in accordance with generally accepted accounting principles, consistently applied) plus principal payments on Debt due during such period plus all dividends paid during such period. 4.46. Existing Agreement shall have the meaning specified in Section 1.1(e) hereof. 4.47. Existing Lenders shall have the meaning specified in Section 1.1(e) hereof. 4.48. Fed Funds Rate shall have the meaning specified in Section 1.8(c) hereof. 4.49. Financial Guarantee L\/C shall mean an L\/C issued hereunder that constitutes a financial guaranty letter of credit under the capital adequacy requirements applicable to any of the Banks. 4.50. Fiscal Year shall mean the 52 or 53 week period ending on the Saturday closest to September 30 in each calendar year, regardless of whether such Saturday occurs in September or October of any calendar year. 4.51. Fixed Charge Coverage Ratio shall mean the ratio of (a) the sum of EBITDA and all amounts payable under all non-cancellable operating leases (determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied) for the period in question, to (b) the sum of (without duplication) (i) Interest Expense for such period, (ii) the sum of the scheduled current maturities (determined in accordance with generally accepted accounting principles consistently applied, but excluding in any event any payments due under Section 2.4(b) of this Agreement) of Funded Debt during the period in question, (iii) all amounts payable under non-cancellable operating leases (determined as aforesaid) during such period, and (iv) all amounts payable with respect to capitalized leases (determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied) for the period in question. 4.52. Fixed Rate shall mean either of the Eurodollar Rate or the Adjusted CD Rate. 4.53. Fixed Rate Loan shall mean a Eurodollar Loan or a CD Rate Loan and Fixed Rate Loans shall mean either or both of such types of Loans. 4.54. Funded Debt, with respect to any Person shall mean all indebtedness for borrowed money of such Person and with respect to the Company all indebtedness for borrowed money of the Company, in each case maturing by its terms more than one year after, or which is renewable or extendible at the option of such Person for a period ending one year or more after, the date of determination, and shall include indebtedness for borrowed money of such maturity created, assumed or guaranteed by such Person either directly or indirectly, including obligations of such maturity secured by liens upon Property of such Person and upon which such entity customarily pays the interest, all current maturities of all such indebtedness of such maturity and all rental payments under capitalized leases of such maturity. 4.55. Grower Payables shall mean all amounts owed from time to time by the Company to any Person on account of the purchase price of agricultural products or services (including poultry and livestock) if the Agent reasonably determines that such Person is entitled to the benefits of any grower s lien, statutory trust or similar security arrangements to secure the payment of any amounts owed to such Person. 4.56. Guaranty Fees shall have the meaning specified in Section 7.30 hereof. 4.57. Harris shall have the meaning specified in the first paragraph of this Agreement. 4.58. Highest Lawful Rate shall have the meaning specified in Section 11.19 hereof. 4.59. Intangible Assets shall mean license agreements, trademarks, trade names, patents, capitalized research and development, proprietary products (the results of past research and development treated as long term assets and excluded from Inventory) and goodwill (all determined on a consolidated basis in accordance with generally accepted accounting principles consistently applied). 4.60. Interest Expense for any period shall mean all interest charges during such period, including all amortization of debt discount and expense and imputed interest with respect to capitalized lease obligations, determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.61. Interest Period shall mean with respect to (a) the Eurodollar Loans, the period used for the computation of interest commencing on the date the relevant Eurodollar Loan is made, continued or effected by conversion and concluding on the date one, two, three or six months thereafter and, (b) with respect to the CD Rate Loans, the period used for the computation of interest commencing on the date the relevant CD Rate Loan is made, continued or effected by conversion and concluding on the date 30, 60, 90 or 180 days thereafter; provided, however, that no Interest Period for any Fixed Rate Loan made under the Revolving Credit may extend beyond the Termination Date. For purposes of determining an Interest Period applicable to a Eurodollar Loan, a month means a period starting on one day in a calendar month and ending on a numerically corresponding day in the next calendar month; provided, however, that if there is no numerically corresponding day in the month in which an Interest Period is to end or if an Interest Period begins on the last day of a calendar month, then such Interest Period shall end on the last Banking Day of the calendar month in which such Interest Period is to end. 4.62. Inventory shall mean all raw materials, work in process, finished goods, and goods held for sale or lease or furnished or to be furnished under contracts of service in which the Company or any Subsidiary now has or hereafter acquires any right. 4.63. L\/C shall have the meaning set forth in Section 1.6 hereof. 4.64. L\/C Agreement shall have the meaning set forth in Section 1.6 hereof. 4.65. L\/C Fee has the meaning specified in Section 1.6 hereof. 4.66. L\/C Issuance Fee has the meaning specified in Section 1.6 hereof. 4.67. Leverage Ratio shall mean the ratio for the Company and its Subsidiaries of (a) the aggregate outstanding principal amount of all Debt (other than Debt consisting of reimbursement and other obligations with respect to undrawn letters of credit) to (b) the sum of the aggregate outstanding principal amount of all Debt included in clause (a) above plus Net Worth. 4.68. LIBOR Index Rate shall mean, for any Interest Period applicable to a Eurodollar Loan, the rate per annum (rounded upwards, if necessary, to the next higher one hundred-thousandth of a percentage point) for deposits in U.S. Dollars for a period equal to such Interest Period, which appears on the Telerate Page 3750 as of 11:00 a.m. (London, England time) on the day two Banking Days before the commencement of such Interest Period. 4.69. Loan shall mean a Revolving Credit Loan and the term Loans shall mean any two or more Revolving Credit Loans collectively. 4.70. Loan Documents shall mean this Agreement and any and all exhibits hereto, the Notes, the B\/A Agreement, the L\/C Agreements and the Security Agreement. 4.71. Net Income shall mean the net income of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.72. Net Tangible Assets shall mean the excess of the value of the Total Assets over the value of the Intangible Assets of the Company and its Subsidiaries. 4.73. Net Working Capital shall mean the excess for the Company of Current Assets over Current Liabilities. 4.74. Net Worth shall mean the Total Assets minus the Total Liabilities of the Company and its Subsidiaries, all determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.75. Notes shall mean the Revolving Notes, and Note means any of the Notes. 4.76. PBGC shall mean the Pension Benefit Guaranty Corporation. 4.77. Performance L\/C shall mean any L\/C issued hereunder that does not constitute a Financial Guarantee L\/C. 4.78. Person shall mean and include any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, institution, entity, party or government (whether national, federal, state, county, city, municipal, or otherwise, including, without limitation, any instrumentality, division, agency, body or department thereof). 4.79. Plan shall mean any employee benefit plan covering any officers or employees of the Company or any Subsidiary, any benefits of which are, or are required to be, guaranteed by the PBGC. 4.80. Potential Default shall mean any event or condition which, with the lapse of time, or giving of notice, or both, would constitute an Event of Default. 4.81. Property shall mean any interest in any kind of property or asset, whether real, personal or mixed or tangible or intangible. 4.82. Receivables shall mean all accounts, contract rights, instruments, documents, chattel paper and general intangibles in which the Company now has or hereafter acquires any right. 4.83. Reimbursement Obligation has the meaning specified in Section 1.7 hereof. 4.84. Required Banks shall mean any Bank or Banks which in the aggregate hold at least 66-2\/3% of the aggregate unpaid principal balance of the Loans and Reimbursement Obligations or, if no Loans are outstanding hereunder, any Bank or Banks in the aggregate having at least 66-2\/3% of the Revolving Credit Commitments. For purposes of determining the Required Banks, CoBank shall be deemed to have a Revolving Credit Commitment in the amount of the CoBank s Participation and Harris Revolving Credit Commitment shall be reduced by a like amount. 4.85. Reserve Percentage means the daily arithmetic average maximum rate at which reserves (including, without limitation, any supplemental, marginal and emergency reserves) are imposed on member banks of the Federal Reserve System during the applicable Interest Period by the Board of Governors of the Federal Reserve System (or any successor) under Regulation D on eurocurrency liabilities (as such term is defined in Regulation D), subject to any amendments of such reserve requirement by such Board or its successor, taking into account any transitional adjustments thereto. For purposes of this definition, the Eurodollar Loans shall be deemed to be eurocurrency liabilities as defined in Regulation D without benefit or credit for any prorations, exemptions or offsets under Regulation D. 4.86. Retained Percentage shall mean with respect to Harris Revolving Credit Commitment a percentage determined by dividing (a) the amount of Harris Revolving Credit Commitment minus the amount of the CoBank Participation therein by (b) the amount of Harris Revolving Credit Commitment without reduction for CoBank s Participation therein. 4.87. Revolving Credit shall have the meaning specified in the first paragraph of this Agreement. 4.88. Revolving Credit Commitment and Revolving Credit Commitments shall have the meanings specified in Section 1.1(c) hereof. 4.89. Revolving Credit Loan and Revolving Credit Loans shall have the meanings specified in Section 1.1(a) hereof. 4.90. Revolving Note or Revolving Notes shall have the meanings specified in Section 1.1(d) hereof. 4.91. Security Agreement shall mean that certain Security Agreement Re: Accounts Receivable, Farm Products and Inventory from the Company to Harris, as Agent, as such agreement may be supplemented and amended from time to time. 4.92. Series D Notes shall mean the Company s Variable Rate Senior Secured Notes, Series D, due December 31, 1996 in the original aggregate principal amount of $18,000,000. 4.93. Senior Secured Notes shall mean, collectively, the Company s 9.55% Senior Secured Notes, Series A, due October 1, 1998 in the original principal amount of $12,000,000, the Company s 10.49% Senior Secured Notes, Series C, due September 21, 2002 in the aggregate principal amount of $22,000,000, the Company s promissory note dated February 1, 1988 payable to the order of John Hancock Mutual Life Insurance Company in the original principal amount of $20,000,000, the Company s promissory note dated April 25, 1991 in the original principal amount of $5,000,000 payable to the order of John Hancock Mutual Life Insurance Company and the Company s promissory notes in an aggregate principal amount not to exceed $28,000,000 issued pursuant to the commitment described in Section 6.2(p) hereof. 4.94. Subordinated Debt shall mean indebtedness for borrowed money of the Company which is subordinate in right of payment to the prior payment in full of the Company s indebtedness, obligations and liabilities to the Banks under the Loan Documents pursuant to written subordination provisions satisfactory in form and substance to the Banks. 4.95. Subsidiary shall mean collectively any corporation or other entity at least a majority of the outstanding voting equity interests (other than directors qualifying shares) of which is at the time owned directly or indirectly by the Company or by one of more Subsidiaries or by the Company and one or more Subsidiaries. The term Consolidated Subsidiary shall mean any Subsidiary whose accounts are consolidated with those of the Company in accordance with generally accepted accounting principles. 4.96. Tangible Net Worth shall mean the Net Worth minus the amount of all Intangible Assets of the Company and its Subsidiaries, determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.97. Telerate Page 3750 shall mean the display designated as Page 3750 on the Telerate Service (or such other page as may replace Page 3750 on that service or such other service as may be nominated by the British Bankers Association as the information vendor for the purpose of displaying British Bankers Association Interest Settlement Rates for U.S. Dollar deposits). 4.98. Termination Date shall have the meaning set forth in Section 1.1(a) hereof. 4.99. Total Assets shall mean at any date, the aggregate amount of assets of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles consistently applied. 4.100. Total Liabilities shall mean at any date, the aggregate amount of all liabilities of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles, consistently applied. 4.101. Value of Eligible Inventory shall mean as of any given date with respect to Eligible Inventory: (a) With respect to Eligible Inventory consisting of feed grains, feed, ingredients, dressed broiler chickens and commercial eggs, an amount equal to the lower of (i) costs determined on a first-in-first-out inventory basis (determined in accordance with generally accepted accounting principles consistently applied), or (ii) wholesale market value; (b) With respect to Eligible Inventory consisting of live broiler chickens, the price quoted on the Arkansas live market on the date of calculation; (c) With respect to Eligible Inventory consisting of prepared food products, the standard cost value; (d) With respect to Eligible Inventory consisting of: breeder hens, $1.50 per head; breeder pullets, $1.00 per head; commercial hens, $0.70 per head; commercial pullets, $0.40 per head; and hatching eggs, $1.25 a dozen; or in each case such other values as may be agreed upon by the Company and the Required Banks; and (e) With respect to Eligible Inventory consisting of packaging materials, vaccines and supplies, actual costs. 4.102. Warehouseman shall mean Field Warehousing Corp., a California corporation, and any other Person approved by the Agent and the Required Banks. 4.103. Any accounting term or the character or amount of any asset or liability or item of income or expense required to be determined under this Agreement, shall be determined or made in accordance with generally accepted accounting principles at the time in effect, to the extent applicable, except where such principles are inconsistent with the requirements of this Agreement. .c1.5. Representations and Warranties. The Company represents and warrants to the Banks as follows: .c2.Section 5.1. Organization and Qualification;. The Company is a corporation duly organized and existing and in good standing under the laws of the State of Delaware, has full and adequate corporate power to carry on its business as now conducted, is duly licensed or qualified in all jurisdictions wherein the nature of its activities requires such licensing or qualification except where the failure to be so licensed or qualified would not have a material adverse effect on the condition, financial or otherwise, of the Company, has full right and authority to enter into this Agreement and the other Loan Documents, to make the borrowings herein provided for, to issue the Notes in evidence thereof, to encumber its assets as collateral security for such borrowings and to perform each and all of the matters and things herein and therein provided for; and this Agreement does not, nor does the performance or observance by the Company of any of the matters or things provided for in the Loan Documents, contravene any provision of law or any charter or by-law provision or any covenant, indenture or agreement of or affecting the Company or its Properties. .c2.Section 5.2. Subsidiaries;. Each Subsidiary is duly organized and existing under the laws of the jurisdiction of its incorporation, has full and adequate corporate power to carry on its business as now conducted and is duly licensed or qualified in all jurisdictions wherein the nature of its business requires such licensing or qualification and the failure to be so licensed or qualified would have a material adverse effect upon the business, operations or financial condition of such Subsidiary and the Company taken as a whole. The only Subsidiaries of the Company are set forth on Exhibit I hereto. .c2.Section 5.3. Financial Reports;. The Company has heretofore delivered to the Banks a copy of the Audit Report as of September 26, 1992 of the Company and its Subsidiaries and unaudited financial statements (including a balance sheet, statement of income and retained earnings, statement of cash flows, footnotes and comparison to the comparable prior year period) of the Company as of, and for the period ending April 3, 1993. Such audited financial statements have been prepared in accordance with generally accepted accounting principles on a basis consistent, except as otherwise noted therein, with that of the previous fiscal year or period and fairly reflect the financial position of the Company and its Subsidiaries as of the dates thereof, and the results of its operations for the periods covered thereby. The Company and its Subsidiaries have no material contingent liabilities other than as indicated on said financial statements and since said date of April 3, 1993 there has been no material adverse change in the condition, financial or otherwise, of the Company or any Subsidiary that has not been disclosed in writing to the Banks. .c2. Section 5.4. Litigation; Tax Returns; Approvals ;. There is no litigation or governmental proceeding pending, nor to the knowledge of the Company threatened, against the Company or any Subsidiary which, if adversely determined, is likely to result in any material adverse change in the Properties, business and operations of the Company or any Subsidiary. All income tax returns for the Company required to be filed have been filed on a timely basis, all amounts required to be paid as shown by said returns have been paid. There are no pending or, to the best of the Company s knowledge, threatened objections to or controversies in respect of the United States federal income tax returns of the Company for any fiscal year. No authorization, consent, license, exemption or filing (other than the filing of financing statements) or registration with any court or governmental department, agency or instrumentality, is or will be necessary to the valid execution, delivery or performance by the Company of the Loan Documents. .c2.Section 5.5. Regulation U;. Neither the Company nor any Subsidiary is engaged in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U of the Board of Governors of the Federal Reserve System) and no part of the proceeds of any Loan made or any B\/A created hereunder will be used to purchase or carry any margin stock or to extend credit to others for such a purpose. .c2.Section 5.6. No Default;. As of the date of this Agreement, the Company is in full compliance with all of the terms and conditions of this Agreement, and no Potential Default or Event of Default is existing under this Agreement. .c2.Section 5.7. ERISA;. The Company and its Subsidiaries are in compliance in all material respects with ERISA to the extent applicable to them and have received no notice to the contrary from the PBGC or any other governmental entity or agency. .c2.Section 5.8. Security Interests and Debt;. There are no security interests, liens or encumbrances on any of the Property of the Company or any Subsidiary except such as are permitted by Section 7.16 of this Agreement, and the Company and its Subsidiaries have no Debt except such as is permitted by Section 7.17 of this Agreement. .c2.Section 5.9. Accurate Information;. No information, exhibit or report furnished by the Company to the Banks in connection with the negotiation of the Loan Documents contained any material misstatement of fact or omitted to state a material fact or any fact necessary to make the statements contained therein not misleading in light of the circumstances in which made. The financial projections furnished by the Company to the Banks contain to the Company s knowledge and belief, reasonable projections as of the date hereof of future results of operations and financial position of the Company. .c2.Section 5.10. Environmental Matters;. (a) Except as disclosed on Exhibit D, the Company has not received any notice to the effect, or has any knowledge, that its or any Subsidiary s Property or operations are not in compliance with any of the requirements of applicable federal, state and local environmental, health and safety statutes and regulations ( Environmental Laws ) or are the subject of any federal or state investigation evaluating whether any remedial action is needed to respond to a release of any toxic or hazardous waste or substance into the environment, which non-compliance or remedial action could have a material adverse effect on the business, operations, Property, assets or conditions (financial or otherwise) of the Company or any Subsidiary; (b) there have been no releases of hazardous materials at, on or under any Property now or previously owned or leased by the Company or any Subsidiary that, singly or in the aggregate, have, or may reasonably be expected to have, a material adverse effect on the financial condition, operations, assets, business, Properties or prospects of the Company or such Subsidiary; (c) there are no underground storage tanks, active or abandoned, including petroleum storage tanks, on or under any property now or previously owned or leased by the Company or any Subsidiary that, singly or in the aggregate, have, or may reasonably be expected to have, a material adverse effect on the financial condition, operations, assets, business, Properties or prospects of the Company or such Subsidiary; (d) neither the Company nor any Subsidiary has directly transported or directly arranged for the transportation of any hazardous material to any location which is listed or proposed for listing on the National Priorities List pursuant to CERCLA, on the CERCLIS or on any similar state list or which is the subject of federal, state or local enforcement actions or other investigations which may lead to material claims against the Company or any Subsidiary thereof for any remedial work, damage to natural resources or personal injury, including claims under CERCLA; and (e) no conditions exist at, on or under any Property now or previously owned or leased by the Company or any Subsidiary which, with the passage of time, or the giving of notice or both, would give rise to any material liability under any Environmental Law. .c2.Section 5.11. Enforceability;. This Agreement and the other Loan Documents are legal, valid and binding agreements of the Company, enforceable against it in accordance with their terms, except as may be limited by (a) bankruptcy, insolvency, reorganization, fraudulent transfer, moratorium or other similar laws or judicial decisions for the relief of debtors or the limitation of creditors rights generally; and (b) any equitable principles relating to or limiting the rights of creditors generally. .c2.Section 5.12. Restrictive Agreements;. Neither the Company nor any Subsidiary is a party to any contract or agreement, or subject to any charge or other corporate restriction, which affects its ability to execute, deliver and perform the Loan Documents to which it is a party and repay its indebtedness, obligations and liabilities under the Loan Documents or which materially and adversely affects or, insofar as the Company can reasonably foresee, could materially and adversely affect, the property, business, operations or condition (financial or otherwise) of the Company or any of its Subsidiaries, or would in any respect materially and adversely affect the Collateral, the repayment of the indebtedness, obligations and liabilities under the Loan Documents, or any Bank s or the Agent s rights under the Loan Documents. .c2.Section 5.13. Labor Disputes;. Except as set forth on Exhibit K, (a) there is no collective bargaining agreement or other labor contract covering employees of the Company or any of its Subsidiaries; (b) no such collective bargaining agreement or other labor contract is scheduled to expire during the term of this Agreement; (c) no union or other labor organization is seeking to organize, or to be recognized as, a collective bargaining unit of employees of the Company or any of its Subsidiaries; and (d) there is no pending or (to the best of the Company s knowledge) threatened strike, work stoppage, material unfair labor practice claim or other material labor dispute against or affecting the Company or any of its Subsidiaries or their respective employees. .c2.Section 5.14. No Violation of Law;. Neither the Company nor any Subsidiary is in violation of any law, statute, regulation, ordinance, judgment, order or decree applicable to it which violation might in any respect materially and adversely affect the Collateral, the repayment of the indebtedness, obligations and liabilities under the Loan Documents, any Bank s or the Agent s rights under the Loan Documents, or the Property, business, operations or condition (financial or otherwise) of the Company or such Subsidiary. .c2.Section 5.15. No Default Under Other Agreements;. Neither the Company nor any Subsidiary is in default with respect to any note, indenture, loan agreement, mortgage, lease, deed, or other agreement to which it is a party or by which it or its Property is bound, which default might materially and adversely affect the Collateral, the repayment of the indebtedness, obligations and liabilities under the Loan Documents, any Bank s or the Agent s rights under the Loan Documents or the Property, business, operations or condition (financial or otherwise) of the Company or any Subsidiary. .c2.Section 5.16. Status Under Certain Laws;. Neither the Company nor any of its Subsidiaries is an investment company or a person directly or indirectly controlled by or acting on behalf of an investment company within the meaning of the Investment Company Act of 1940, as amended, or a holding company, or a subsidiary company of a holding company, or an affiliate of a holding company or a subsidiary company of a holding company, within the meaning of the Public Utility Holding Company Act of 1935, as amended. .c2.Section 5.17. Federal Food Security Act;. The Company has received no notice given pursuant to Section 1324(e)(1) or (3) of the Federal Food Security Act and there has not been filed any financing statement or notice, purportedly in compliance with the provisions of the Federal Food Security Act, purporting to perfect a security interest in farm products purchased by the Company in favor of a secured creditor of the seller of such farm products. The Company has registered, pursuant to Section 1324(c)(2)(D) of the Federal Food Security Act, with the Secretary of State of each State in which are produced farm products purchased by the Company and which has established or hereafter establishes a central filing system, as a buyer of farm products produced in such State; and each such registration is in full force and effect. .c2. Section 5.18. Certain Tax Benefits;. On the date of this Agreement the aggregate amount of all net operating losses and credits or other tax benefits available to the Company are approximately $37,500,000, and $4,600,000, respectively. .c2.Section 5.19. Fair Labor Standards Act;. The Company and each Subsidiary has complied in all material respects with, and will continue to comply with, the provisions of the Fair Labor Standards Act of 1938, 29 U.S.C. Section 201, et seq., as amended from time to time (the FLSA ), including specifically, but without limitation, 29 U.S.C. Section 215(a). This representation and warranty, and each reconfirmation hereof, shall constitute written assurance from the Company, given as of the date hereof and as of the date of each reconfirmation, that the Company and each Subsidiary has complied with the requirements of the FLSA, in general, and Section 15(a)(1), 29 U.S.C. Section 215(a)(1), thereof, in particular. .c1.6. Conditions Precedent;. The obligation of the Banks to make any Loan pursuant hereto or to create any B\/A or to issue any L\/C shall be subject to the following conditions precedent: .c2.Section 6.1. General;. The Agent shall have received the notice of borrowings and requests for L\/Cs and B\/As and the Notes hereinabove provided for. .c2.Section 6.2. Initial Extension of Credit;. Prior to the initial Loan, L\/C and B\/A hereunder, the Company shall have delivered the required Collateral and a Borrowing Base Certificate to the Agent, and shall have delivered to the Agent for the benefit of the Banks in sufficient counterparts for distribution to the Banks: (a) a fully executed B\/A Agreement; (b) a fully executed Security Agreement ; (c) appropriate forms of financing statements to perfect the security interest of the Agent provided for by the Security Agreement; (d) a fully executed counterpart of a Guaranty Agreement from Mr. and Mrs. Lonnie A. Pilgrim to the Banks satisfactory in form and substance to the Banks; (e) a fully executed Warehousing Agreement among the Company and the Warehouseman, and related delivery instructions and leases, in substantially the form of Exhibit M attached hereto; (f) a warehouse receipt issued by the Warehouseman covering the Inventory shown on the Borrowing Base Certificate; (g) an agreement between the Banks and each of the holders of the Company s Senior Secured Notes, in substantially the form of Exhibit L attached hereto; (h) evidence of insurance required by Section 7.3 hereof and by the Security Agreement showing the Agent as loss payee thereunder; (i) a good standing certificate or certificate of existence for the Company, dated as of the date no earlier than 30 days prior to the date hereof, from the office of the secretary of state of the state of its incorporation and each state in which it is qualified to do business as a foreign corporation; (j) copies of the Certificate of Incorporation, and all amendments thereto, of the Company certified by the office of the secretary of state of its state of incorporation as of the date no earlier than the date 30 days prior to the date hereof; (k) copies of the By-Laws, and all amendments thereto, of the Company, certified as true, correct and complete on the date hereof by the Secretary of the Company; (l) copies, certified by the Secretary or Assistant Secretary of the Company, of resolutions regarding the transactions contemplated by this Agreement, duly adopted by the Board of Directors of the Company, and satisfactory in form and substance to all of the Banks; (m) an incumbency and signature certificate for the Company satisfactory in form and substance to all of the Banks; (n) copies of a fully executed Trust Indenture and other documents providing for the issuance by the Company of senior Subordinated Debt on terms and conditions acceptable to all of the Banks, certified as true, complete and correct by the Secretary or Assistant Secretary of the Company; (o) evidence satisfactory in form and substance to all of the Banks that (i) the Company has issued Subordinated Debt in an aggregate principle amount of no less than $100,000,000.00, (ii) proceeds thereof in amount of not less than $50,000,000.00 have been placed in escrow for the sole purpose of funding the prepayment, redemption or repurchase by the Company of its 14 1\/4% Senior Notes due 1995 and to reduction of the Company s Debt under the Existing Agreement (iii) the Company has given all notices required to be given to prepay such 14 1\/4% Senior Notes due 1995 no later than July 10, 1993; (p) copies of a fully executed commitment issued by one or more lenders or investors providing for the issuance of additional senior indebtedness in an amount not greater than $28,000,000 to refinance existing secured bank term debt, containing terms and conditions satisfactory to the Banks; (q) a pay-off letter satisfactory in form and substance to all of the Banks from the Existing Lenders and the holders of the Series D Notes; (r) the closing fee payable pursuant to Section 2.5 of this Agreement; (s) evidence that the Company has given all required notices for the prepayment in full of the $2,300,000 Angelinas and Neches River Authority Industrial Development Corporation Variable Rate Demand Refunding Revenue Bonds; and (t) such other documents as the Banks may reasonably require. .c2.Section 6.3. Each Extension of Credit;. As of the time of the making of each Loan, the issuance of each L\/C hereunder and creation of each B\/A hereunder (including the initial Loan, L\/C or B\/A, as the case may be): (a) each of the representations and warranties set forth in Section 5 hereof shall be and remain true and correct as of said time as if made at said time, except that (i) the representations and warranties made under Section 5.3 shall be deemed to refer to the most recent financial statements furnished to the Banks pursuant to Section 7.4 hereof and (ii) with respect to the Company s Subsidiaries in Mexico the representations and warranties made under Section 5.13(d) shall be deemed to refer only to material, strikes, work stoppages, unfair labor practice claims or other material labor disputes; (b) the Company shall be in full compliance with all of the terms and conditions hereof, and no Potential Default or Event of Default shall have occurred and be continuing; and (c) after giving effect to the requested extension of credit and to each Loan that has been made, B\/A created and L\/C issued hereunder, the aggregate principal amount of all Loans, the aggregate face amount of all B\/As, the amount available for drawing under all L\/Cs and the aggregate principal amount of all Reimbursement Obligations then outstanding shall not exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments then in effect and (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate, except as otherwise agreed by the Company and all of the Banks; and the request by the Company for any Loan, L\/C or B\/A pursuant hereto shall be and constitute a warranty to the foregoing effects. .c2.Section 6.4. Legal Matters;. Legal matters incident to the execution and delivery of the Loan Documents shall be satisfactory to each of the Banks and their legal counsel; and prior to the initial Loan, L\/C or B\/A hereunder, the Agent shall have received the favorable written opinion of Godwin & Carlton, counsel for the Company, substantially in the form of Exhibit F, in substance satisfactory to each of the Banks and their respective legal counsel. .c2.Section 6.5. Documents;. The Agent shall have received copies (executed or certified, as may be appropriate) of all documents or proceedings taken in connection with the execution and delivery of the Loan Documents to the extent any Bank or its respective legal counsel requests. .c2.Section 6.6. Lien Searches;. The Agent shall have received lien searches showing that the Property of the Company is subject to no security interest or liens except those permitted by Section 7.16 hereof. .c1.7. Covenants;. It is understood and agreed that so long as credit is in use or available under this Agreement or any amount remains unpaid on any Note, Reimbursement Obligation, L\/C or B\/A, except to the extent compliance in any case or cases is waived in writing by the Required Banks: .c2.Section 7.1. Maintenance;. The Company will, and will cause each Subsidiary to, maintain, preserve and keep its plant, Properties and equipment in good repair, working order and condition and will from time to time make all needful and proper repairs, renewals, replacements, additions and betterments thereto so that at all times the efficiency thereof shall be preserved and maintained in all material respects, normal wear and tear excepted. .c2.Section 7.2. Taxes;. The Company will, and will cause each Subsidiary to, duly pay and discharge all taxes, rates, assessments, fees and governmental charges upon or against the Company or its Subsidiaries or against their respective Properties in each case before the same become delinquent and before penalties accrue thereon unless and to the extent that the same are being contested in good faith and by appropriate proceedings diligently conducted and for which adequate reserves in form and amount reasonably satisfactory to the Required Banks have been established, provided that the Company shall pay or cause to be paid all such taxes, rates, assessments, fees and governmental charges forthwith upon the commencement of proceedings to foreclose any lien which is attached as security therefor, unless such foreclosure is stayed by the filing of an appropriate bond in a manner satisfactory to the Required Banks. .c2.Section 7.3. Maintenance of Insurance;. The Company will, and will cause each Subsidiary to, maintain insurance coverage by good and responsible insurance underwriters in such forms and amounts and against such risks and hazards as are customary for companies engaged in similar businesses and owning and operating similar Properties, provided that the Company and its Subsidiaries may self-insure for workmen s compensation, group health risks and their live chicken inventory in accordance with applicable industry standards. In any event, the Company will insure any of its Property which is insurable against loss or damage by fire, theft, burglary, pilferage and loss in transit, all in amounts and under policies containing loss payable clauses to the Agent as its interest may appear (and, if the Required Banks request, naming the Agent as additional insured therein) and providing for advance notice to the Agent of cancellation thereof, issued by sound and reputable insurers accorded a rating of A-XII or better by A.M. Best Company, Inc. or A or better by Standard & Poor s Corporation or Moody s Investors Service, Inc. and all premiums thereon shall be paid by the Company and certificates summarizing the same delivered to the Agent. .c2.Section 7.4. Financial Reports;. The Company will, and will cause each Subsidiary to, maintain a standard and modern system of accounting in accordance with sound accounting practice and will furnish to the Banks and their duly authorized representatives such information respecting the business and financial condition of the Company and its Subsidiaries as may be reasonably requested and, without any request, will furnish to CoBank and the Banks: (a) as soon as available, and in any event within 45 days after the close of each monthly fiscal period of the Company a copy of the consolidated and consolidating balance sheet, statement of income and retained earnings, statement of cash flows, and the results of operations for each division of the Company, for such period of the Company and its Subsidiaries, together with all such information for the year to date, all in reasonable detail, prepared by the Company and certified on behalf of the Company by the Company s chief financial officer; (b) as soon as available, and in any event within 90 days after the close of each fiscal year, (i) a copy of the audit report for such year and accompanying financial statements, including a consolidated balance sheet, a statement of income and retained earnings, and a statement of cash flows, together with all footnotes thereto, for the Company and its Subsidiaries, and unaudited consolidating balance sheets, statement of income and retained earnings and statements of cash flows for the Company and its Subsidiaries, in each case, showing in comparative form the figures for the previous fiscal year of the Company, all in reasonable detail, accompanied by an unqualified opinion of Ernst & Young or other independent public accountants of nationally recognized standing selected by the Company and satisfactory to the Required Banks, such opinion to indicate that such statements are made in accordance with generally accepted accounting principles, and (ii) a written report of such independent public accountants addressed to the Banks stating that they have reviewed the Borrowing Base Certificate and the Compliance Certificate as of the Fiscal Year end and that both of such certificates were prepared in accordance with the requirements of this Agreement; (c) each of the financial statements furnished to the Banks pursuant to paragraph (a) and (b) above shall be accompanied by a Compliance Certificate in the form of Exhibit G hereto signed on behalf of the Company by its chief financial officer; (d) within 10 Business Days after the end of each month, a Borrowing Base Certificate in the form of Exhibit H hereto, setting forth a computation of the Borrowing Base as of that month s end date, certified as correct on behalf of the Company by the Company s chief financial officer and certifying that as of the last day of the preceding monthly period the signer thereof has re-examined the terms and provisions of this Agreement and the Security Agreement and that to the best of his knowledge and belief, no Potential Default or Event of Default has occurred or, if any such Potential Default or Event of Default has occurred, setting forth the description of such Potential Default or Event of Default and specifying the action, if any, taken by the Company to remedy the same, accompanied by a warehouse receipt issued by the Warehouseman covering no less than all of the Inventory shown on such Borrowing Base Certificate; (e) with 10 Business Days after the end of each month, an accounts receivable aging report in the form of Exhibit J hereto, signed by the chief financial officer of the Company; (f) promptly upon preparation thereof copies in the form presented to the Company s Board of Directors of its annual budgets and forecasts of operations and capital expenditures including investments, a balance sheet, an income statement and a projection of cash flow by months for each fiscal year; (g) promptly upon their becoming available, copies of all registration statements and regular periodic reports, if any, which the Company shall have filed with the Securities and Exchange Commission or any governmental agency substituted therefor, or any national securities exchange, including copies of the Company s form 10-K annual report, including financial statements audited by Ernst & Young or other independent public accountants of nationally recognized standing selected by the Company and satisfactory to the Bank, its form 10-Q quarterly report to the Securities and Exchange Commission and any Form 8 filed by the Company with the Securities and Exchange Commission; (h) promptly upon the mailing thereof to the shareholders of the Company generally, copies of all financial statements, reports and proxy statements so mailed; and (i) within 45 days of the last day of each fiscal quarter of the Company, a summary of the capital expenditures for the applicable period and the year to date, all in reasonable detail, prepared by the Company and certified on behalf of the Company by the Company s chief financial officer. .c2.Section 7.5. Inspection and Reviews;. The Company shall, and shall cause each Subsidiary to, permit the Agent and the Banks, by their representatives and agents, to inspect any of the properties, corporate books and financial records of the Company and its Subsidiaries, to review and make copies of the books of accounts and other financial records of the Company and its domestic Subsidiaries, and to discuss the affairs, finances and accounts of the Company and its Subsidiaries with, and to be advised as to the same by, its officers at such reasonable times and intervals as the Agent or the Banks may designate. In addition to any other compensation or reimbursement to which the Agent and the Banks may be entitled under the Loan Documents, the Company shall pay to the Agent from time to time upon demand (a) the amount necessary to compensate it for all fees, charges and expenses incurred by the Agent or its designee and (b) up to $10,000 per year to compensate the Banks, other than the Agent, for any such fees, charges and expenses incurred by such Banks, in each case in connection with the audits of Collateral, or inspections or review of the books, records and accounts of the Company or any domestic Subsidiary conducted by the Agent or its designee or any of the Banks. .c2.Section 7.6. Consolidation and Merger;. The Company will not, and will not permit any Subsidiary to, consolidate with or merge into any Person, or permit any other Person to merge into it, or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the Property of the other Person, or acquire substantially as an entirety the business of any other Person, without the prior written consent of the Required Banks. .c2.Section 7.7. Transactions with Affiliates;. The Company will not, and will not permit any Subsidiary to, enter into any transaction, including without limitation, the purchase, sale, lease or exchange of any Property, or the rendering of any service, with any Affiliate of the Company or such Subsidiary except (a) in the ordinary course of and pursuant to the reasonable requirements of the Company s or such Subsidiary s business and upon fair and reasonable terms not materially less favorable to the Company than would be obtained in a comparable arm s-length transaction with a Person not an Affiliate of the Company or such Subsidiary, and (b) on-going transactions with Affiliates of the type disclosed in the Company s proxy statement for its Fiscal Year ended September 26, 1992. .c2.Section 7.8. Leverage Ratio;. The Company will not permit the ratio of its Leverage Ratio at any time during each period specified below to exceed the ratio specified below for such period: (a) from the date hereof through the next to last day in Fiscal Year of 1994, 0.70 to 1; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, 0.65 to 1; and (c) on the last day of Fiscal Year 1995 and thereafter, 0.625 to 1. .c2.Section 7.9. Tangible Net Worth;. The Company shall maintain its Tangible Net Worth at all times during the periods specified below in an amount not less than the minimum required amount for each period set forth below: (a) from the date hereof through the next to last day in Fiscal Year 1993, $105,000,000; (b) from the last day of Fiscal Year 1993 through the next to last day of Fiscal Year 1994, $105,000,000 plus an amount equal to 75% of the Company s Net Income (but not less than zero) for the last six months of Fiscal Year 1993; and (c) from the last day of Fiscal Year 1994 and at all times thereafter, an amount equal to the minimum amount required to be maintained during Fiscal Year 1994 plus an amount equal to 75% of the Company s Net Income (but not less than zero) during Fiscal Year 1994. .c2.Section 7.10. Current Ratio;. The Company will maintain at all times and measured as of the last day of each monthly fiscal accounting period a Current Ratio of not less than 1.5 to 1. .c2.Section 7.11. Net Tangible Assets to Total Liabilities;. The Company will not permit the ratio of its Net Tangible Assets to its Total Liabilities at any time during each period specified below to be less than the ratio specified for such period: (a) from the date hereof through the next to last day in Fiscal Year 1994, 1.20 to 1; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, 1.25 to 1; and (c) from the last day of Fiscal Year 1995 and at all times thereafter, 1.30 to 1. Section 7.12. Fixed Charge Coverage Ratio. The Company will not permit its Fixed Charge Coverage Ratio to be less than 1.50 to 1 at any time during any period specified below: (a) the three consecutive fiscal quarters ending July 3, 1993; (b) the four consecutive fiscal quarters of the Company ending on October 2, 1993; (c) the five consecutive fiscal quarters of the Company ending December 31, 1993; (d) the six consecutive fiscal quarters of the Company ending April 2, 1994; (e) the seven consecutive fiscal quarters of the Company ending July 2, 1994; and (f) the eight consecutive fiscal quarters of the Company ending on the last day of each fiscal quarter thereafter commencing with the fiscal quarter ending October 1, 1994. .c2.Section 7.13. Minimum Net Working Capital;. The Company will maintain Net Working Capital at all times during each period specified below (measured as of the last day of each monthly fiscal accounting period) in an amount not less than the amount specified below for each period: (a) from the date hereof through the next to last day in Fiscal Year 1994, $65,000,000; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, $70,000,000; and (c) from the last day of Fiscal Year 1995 and at all times thereafter, $75,000,000. .c2.Section 7.14. Capital Expenditures;. The Company will not, and will not permit any Subsidiary to, make or commit to make any capital expenditures (as defined and classified in accordance with generally accepted accounting principles consistently applied;) provided, however, that if no Event of Default or Potential Default shall exist before and after giving effect thereto, the Company and its Subsidiaries may make capital expenditures during the period beginning on the date hereof through the Termination Date in an aggregate amount in each Fiscal Year commencing with Fiscal Year 1993 not to exceed the sum of (a) $20,000,000 and (b) in Fiscal 1994 and each Fiscal Year thereafter the amount, if any, by which such capital expenditures made by the Company in the immediately preceding Fiscal Year was less than $20,000,000 but not to exceed $5,000,000 in any Fiscal Year. .c2.Section 7.15. Dividends and Certain Other Restricted Payments;. The Company will not (a) declare or pay any dividends or make any distribution on any class of its capital stock (other than dividends payable solely in its capital stock) or (b) directly or indirectly purchase, redeem or otherwise acquire or retire any of its capital stock (except out of the proceeds of, or in exchange for, a substantially concurrent issue and sale of capital stock) or (c) make any other distributions with respect to its capital stock; provided, however, that if no Potential Default or Event of Default shall exist before and after giving effect thereto, the Company may pay dividends in an aggregate amount not to exceed $1,700,000 in any Fiscal Year at any time after the Company s Net Income for each of three consecutive fiscal quarters occurring no earlier than Fiscal Year 1993 has equaled or exceeded $1,000,000. .c2.Section 7.16. Liens;. The Company will not, and will not permit any Subsidiary to, pledge, mortgage or otherwise encumber or subject to or permit to exist upon or be subjected to any lien, charge or security interest of any kind (including any conditional sale or other title retention agreement and any lease in the nature thereof), on any of its Properties of any kind or character other than: (a) liens, pledges or deposits for workmen s compensation, unemployment insurance, old age benefits or social security obligations, taxes, assessments, statutory obligations or other similar charges, good faith deposits made in connection with tenders, contracts or leases to which the Company or a Subsidiary is a party or other deposits required to be made in the ordinary course of business, provided in each case the obligation secured is not overdue or, if overdue, is being contested in good faith by appropriate proceedings and adequate reserves have been provided therefor in accordance with generally accepted accounting principles and that the obligation is not for borrowed money, customer advances, trade payables or obligations to agricultural producers; (b) the pledge of Property for the purpose of securing an appeal or stay or discharge in the course of any legal proceedings, provided that the aggregate amount of liabilities of the Company and its Subsidiaries so secured by a pledge of Property permitted under this subsection (b) including interest and penalties thereon, if any, shall not be in excess of $1,000,000 at any one time outstanding; (c) liens, pledges, mortgages, security interests, or other charges granted to the Agent to secure the Notes, the B\/As, L\/Cs or the Reimbursement Obligations; (d) liens, pledges, security interests or other charges now or hereafter created under the Security Agreement; (e) security interests or other interests of a lessor in equipment leased by the Company or any Subsidiary as lessee under any financing lease, to the extent such security interest or other interest secures rental payments payable by the Company thereunder; (f) liens on the Collateral securing the Senior Secured Notes created in accordance with the agreements described in Section 6.2(g), provided such liens are subordinated to the Agent s liens therein and provided that the Agent is concurrently granted a lien in the collateral security for the Senior Secured Notes; (g) liens of carriers, warehousemen, mechanics and materialmen and other like liens, in each case arising in the ordinary course of the Company s or any Subsidiary s business to the extent they secure obligations that are not past due; (h) such minor defects, irregularities, encumbrances, easements, rights of way, and clouds on title as normally exist with respect to similar properties which do not materially impair the Property affected thereby for the purpose for which it was acquired; (i) liens, pledges, mortgages, security interests or other charges granted by any of the Company s Subsidiaries in Mexico in such Subsidiary s Inventory and certain fixed assets located in Mexico and such Subsidiary s accounts receivable, in each case securing only indebtedness in an aggregate principal amount of up to $10,000,000 incurred by such Subsidiaries for working capital purposes; (j) statutory landlord s liens under leases; (k) existing liens described on Exhibit E hereto; (l) liens and security interests securing the Company s 14.25% Senior Notes Due 1995; (m) liens on the cash surrender value of the life insurance policy maintained by the Company on the life of Mr. Lonnie A. Pilgrim, to the extent such liens secure loans in an aggregate principal amount not to exceed $700,000; (n) liens, security interests, pledges, mortgages or other charges in any Property other than the Collateral securing obligations in an aggregate amount not exceeding $1,000,000 at any time; and (o) liens and security interests in favor of Barclays Business Credit, Inc. ( Barclays ) in certificates of deposit or other cash equivalents in an aggregate amount not to exceed $5,000,000 securing obligations owing to Barclays under that certain Lease Agreement dated December 27, 1989, as amended, between the Company and Barclays. .c2.Section 7.17. Borrowings and Guaranties;. The Company will not, and will not permit any Subsidiary to, issue, incur, assume, create or have outstanding any indebtedness for borrowed money (including as such all indebtedness representing the deferred purchase price of Property) or customer advances, nor be or remain liable, whether as endorser, surety, guarantor or otherwise, for or in respect of any liability or indebtedness of any other Person, other than: (a) indebtedness of the Company arising under or pursuant to this Agreement or the other Loan Documents; (b) the liability of the Company arising out of the endorsement for deposit or collection of commercial paper received in the ordinary course of business; (c) the indebtedness evidenced by the Company s 14-1\/4% Senior Notes Due 1995, provided such indebtedness is prepaid in full within 46 days of the date of this Agreement; (d) trade payables of the Company arising in the ordinary course of the Company s business; (e) indebtedness disclosed on the audited financial statements referred to in Section 5.3 hereof, except (i) indebtedness to the Existing Lenders under the Existing Agreement, and (ii) from and after the initial extension of credit under this Agreement, indebtedness evidenced by the Series D Notes; (f) indebtedness in an aggregate principal amount not to exceed $28,000,000 incurred pursuant to the commitment described in Section 6.2(p); (g) Subordinated Debt in an aggregate principal amount not to exceed $100,000,000 maturing no earlier than August 1, 2003; (h) indebtedness in an aggregate principal amount of up to $10,000,000 incurred by the Company s Subsidiaries in Mexico for working capital purposes; (i) Debt arising from sale\/leaseback transactions permitted by Section 7.32 hereof and under Capitalized Lease Obligations; (j) indebtedness of any Mexican Subsidiary to any other Mexican Subsidiary; and (k) loans in an aggregate principal amount of up to $700,000 against the cash surrender value of the life insurance policy maintained on the life of Mr. Lonnie A. Pilgrim. .c2.Section 7.18. Investments, Loans and Advances;. The Company will not, and will not permit any Subsidiary to, make or retain any investment (whether through the purchase of stock, obligations or otherwise) in or make any loan or advance to, any other Person, other than: (a) investments in certificates of deposit having a maturity of one year or less issued by any United States commercial bank having capital and surplus of not less than $50,000,000; (b) investments in an aggregate amount of up to $8,000,000 in deposits maintained with the First State Bank of Pittsburg; (c) investments in commercial paper rated P1 by Moody s Investors Service, Inc. or A1 by Standard & Poor s Corporation maturing within 180 days of the date of issuance thereof; (d) marketable obligations of the United States; (e) marketable obligations guaranteed by or insured by the United States, or those for which the full faith and credit of the United States is pledged for the repayment of principal and interest thereof; provided that such obligations have a final maturity of no more than one year from the date acquired by the Company; (f) repurchase, reverse repurchase agreements and security lending agreements collateralized by securities of the type described in subsection (c) and having a term of no more than 90 days, provided, however, that the Company shall hold (individually or through an agent) all securities relating thereto during the entire term of such arrangement; (g) loans, investments (excluding retained earnings) and advances by the Company to its Subsidiaries located in Mexico in an aggregate outstanding amount not to exceed the sum of the amount thereof outstanding on the date hereof (being $94,000,000) plus $5,000,000 at any time, provided, however, that the Company may make loans, investments (excluding retained earnings) and advances to its Subsidiaries located in Mexico in an aggregate amount equal to the aggregate amount of any capital withdrawn from its Mexican Subsidiaries after the date hereof but not to exceed an aggregate amount of $25,000,000 in any Fiscal Year of the Company, provided further that any such investments (excluding retained earnings), loans and advances shall not cause the aggregate outstanding amount of all such loans, investments (excluding retained earnings) and advances to exceed $94,000,000 plus $5,000,000 at any time; (h) loans and advances to employees and contract growers (other than executive officers and directors of the Company) for reasonable expenses incurred in the ordinary course of business; and (i) loans and advances from one Mexican Subsidiary to another Mexican Subsidiary.\n.c2.Section 7.19. Sale of Property;. The Company will not, and will not permit any Subsidiary to, sell, lease, assign, transfer or otherwise dispose of (whether in one transaction or in a series of transactions) all or a material part of its Property to any other Person in any Fiscal Year of the Company; provided, however, that this Section shall not prohibit: (a) sales of Inventory by the Company in the ordinary course of business; (b) sales or leases by the Company of its surplus, obsolete or worn-out machinery and equipment; and (c) sales of approximately 16,500 acres of farm land in Lamar and Fannin Counties, Texas. For purposes of this Section 7.19, material part shall mean 5% or more of the lesser of the book or fair market value of the Property of the Company. .c2.Section 7.20. Notice of Suit, Adverse Change in Business or Default;. The Company shall, as soon as possible, and in any event within fifteen (15) days after the Company learns of the following, give written notice to the Banks of (a) any proceeding(s) that, if determined adversely to the Company or any Subsidiary could have a material adverse effect on the Properties, business or operations of the Company or such Subsidiary being instituted or threatened to be instituted by or against the Company or such Subsidiary in any federal, state, local or foreign court or before any commission or other regulatory body (federal, state, local or foreign); (b) any material adverse change in the business, Property or condition, financial or otherwise, of the Company or any Subsidiary; and (c) the occurrence of a Potential Default or Event of Default. .c2.Section 7.21. ERISA;. The Company will, and will cause each Subsidiary to, promptly pay and discharge all obligations and liabilities arising under ERISA of a character which if unpaid or unperformed might result in the imposition of a lien against any of its Property and will promptly notify the Agent of (i) the occurrence of any reportable event (as defined in ERISA) which might result in the termination by the PBGC of any Plan covering any officers or employees of the Company or any Subsidiary any benefits of which are, or are required to be, guaranteed by PBGC, (ii) receipt of any notice from PBGC of its intention to seek termination of any Plan or appointment of a trustee therefor, and (iii) its intention to terminate or withdraw from any Plan. The Company will not, and will not permit any Subsidiary to, terminate any Plan or withdraw therefrom unless it shall be in compliance with all of the terms and conditions of this Agreement after giving effect to any liability to PBGC resulting from such termination or withdrawal. .c2.Section 7.22. Use of Loan Proceeds;. The Company will use the proceeds of all Loans and B\/As made or created hereunder solely to refinance existing Debt and to finance its temporary working capital requirements. .c2.Section 7.23. Conduct of Business and Maintenance of Existence;. The Company will, and will cause each Subsidiary to, continue to engage in business of the same general type as now conducted by it, and the Company will, and will cause each Subsidiary to, preserve, renew and keep in full force and effect its corporate existence and its rights, privileges and franchises necessary or desirable in the normal conduct of business. .c2.Section 7.24. Additional Information;. Upon request of the Agent, the Company shall provide any reasonable additional information pertaining to any of the Collateral. .c2.Section 7.25. Supplemental Performance;. The Company will at its own expense, register, file, record and execute all such further agreements and documents, including without limitation financing statements, and perform such acts as are necessary and appropriate, or as the Agent or any Bank may reasonably request, to effect the purposes of the Loan Documents. .c2.Section 7.26. Company Chattel Paper - Delivery to Bank;. The Company will keep in its exclusive possession all components of its respective Receivables which constitute chattel paper. The Agent may request in its sole discretion, and the Company agrees to deliver to the Agent upon such request, any or all of such Receivables constituting chattel paper. .c2.Section 7.27. Compliance with Laws, etc. ;The Company will, and will cause each of its Subsidiaries to, comply in all material respects with all applicable laws, rules, regulations and orders, such compliance to include (without limitation) (a) the maintenance and preservation of its corporate existence and qualification as a foreign corporation, (b) the registration pursuant to the Food Security Act of 1985, as amended, with the Secretary of State of each State in which are produced any farm products purchased by the Company and which has established a central filing system, as a buyer of farm products produced in such state, and the maintenance of each such registration, (c) compliance with the Packers and Stockyard Act of 1921, as amended, (d) compliance with all applicable rules and regulations promulgated by the United States Department of Agriculture and all similar applicable state rules and regulations, and (e) compliance with all rules and regulations promulgated pursuant to the Occupational Safety and Health Act of 1970, as amended. .c2.Section 7.28. Environmental Covenant;. The Company will, and will cause each of its Subsidiaries to: (a) use and operate all of its facilities and Properties in material compliance with all Environmental Laws, keep all necessary permits, approvals, certificates, licenses and other authorizations relating to environmental matters in effect and remain in material compliance therewith, and handle all hazardous materials in material compliance with all applicable Environmental Laws; (b) immediately notify the Agent and provide copies upon receipt of all material written claims, complaints, notices or inquiries relating to the condition of its facilities and Property or compliance with Environmental Laws, and shall promptly cure and have dismissed, to the reasonable satisfaction of the Required Banks, any actions and proceedings relating to compliance with Environmental Laws unless and to the extent that the same are being contested in good faith and by appropriate proceedings diligently conducted and for which adequate reserves in form and amount reasonably satisfactory to the Required Banks have been established, provided that no proceedings to foreclose any lien which is attached as security therefor shall have been commenced unless such foreclosure is stayed by the filing of an appropriate bond in a manner satisfactory to the Required Banks; and (c) provide such information and certifications which the Agent may reasonably request from time to time to evidence compliance with this Section 7.29. .c2.Section 7.29. New Subsidiaries;. The Company will not, directly or indirectly, create or acquire any Subsidiary. Section 7.30. Guaranty Fees. The Company will not, and it will not permit any Subsidiary to, directly or indirectly, pay to Mr. and\/or Mrs. Lonnie A. Pilgrim or any other guarantor of any of the Company s indebtedness, obligations and liabilities, any fee or other compensation, but excluding salary, bonus and other compensation for services rendered as an employee (collectively the Guaranty Fees ) in an aggregate amount in excess of $500,000.00 in any Fiscal Year of the Company, provided, however, that if after the date hereof the Company s Net Income for any four consecutive fiscal quarters of the Company equals or exceeds $1,000,000.00 for each of such consecutive fiscal quarters, beginning no earlier than the first fiscal quarter of the current Fiscal Year of the Company, the Company may pay Guaranty Fees in each Fiscal Year thereafter in an amount not to exceed $1,400,000.00. Nothing contained herein shall prohibit the Company from accruing, but not paying, Guaranty Fees in an aggregate amount of up to $1,400,000.00 in any Fiscal Year in which it is permitted to pay no more than $500,000.00, or from paying such accrued and unpaid Guaranty Fees once it is permitted to pay Guaranty Fees in an aggregate amount not to exceed $1,400,000.00 in any fiscal year, provided that all such accrued Guaranty Fees and current Guaranty Fees actually paid in any Fiscal Year shall not exceed an aggregate amount of up to $1,400,000.00. Section 7.31. Key Man Life Insurance. The Company shall continuously maintain a policy of insurance on the life of Mr. Lonnie A. Pilgrim in the amount of $1,500,000.00, of which the Company shall be the beneficiary, such policy to be maintained with a good and responsible insurance company acceptable to the Required Banks. Section 7.32. Sale and Leasebacks. The Company will not, and will not permit any Subsidiary to, enter into any arrangement with any lender or investor providing for the leasing by the Company or any Subsidiary of any real or personal property previously owned by the Company or any Subsidiary, except: (a) any such sale and leaseback transaction, provided that (i) such transactions may be entered into only in the year, or in the year immediately preceding the year, in which net operating losses, credits or other tax benefits would otherwise expire unutilized and the Company delivers on officer s certificate to the Agent to the effect that such expiration of such net operating losses, credits or other tax benefits would occur but for entering into the sale\/leaseback transaction; (ii) the Company shall be completely discharged with respect to any Debt of the Company or such Subsidiary assumed by the purchaser\/lessor in such sale\/leaseback transaction; (iii) the Company shall deliver to the Agent an opinion of counsel that the sale of assets and related lease will be treated as a sale and lease, respectively, for federal income tax purposes; and (iv) the proceeds of such transactions are applied to the payment of Debt; and (b) such transactions in which the aggregate consideration received by the Company upon the sale of such property does not exceed $6,000,000 during the term of this Agreement. .c1.8. Events of Default and Remedies. .c2.Section 8.1. Definitions;. Any one or more of the following shall constitute an Event of Default: (a) Default in the payment when due of any interest on or principal of any Note or Reimbursement Obligation, whether at the stated maturity thereof or as required by Section 2.4 hereof or at any other time provided in this Agreement, or of any fee or other amount payable by the Company pursuant to this Agreement; (b) Default in the observance or performance of any covenant set forth in Sections 7.4, 7.5, 7.6, 7.7, 7.15, 7.17, 7.19 and 7.20, inclusive, hereof, or of any provision of any Security Document requiring the maintenance of insurance on the Collateral subject thereto or dealing with the use or remittance of proceeds of such Collateral; (c) Default in the observance or performance of any covenant set forth in Sections 7.8, 7.9, 7.10, 7.11, 7.12, 7.13, 7.14, 7.16, 7.18, 7.21, 7.23 and 7.31, inclusive, hereof and such default shall continue for 10 days after written notice thereof to the Company by any Bank; (d) Default in the observance or performance of any other covenant, condition, agreement or provision hereof or any of the other Loan Documents and such default shall continue for 30 days after written notice thereof to the Company by any Bank; (e) Default shall occur under any evidence of indebtedness in a principal amount exceeding $1,000,000 issued or assumed or guaranteed by the Company, or under any mortgage, agreement or other similar instrument under which the same may be issued or secured and such default shall continue for a period of time sufficient to permit the acceleration of maturity of any indebtedness evidenced thereby or outstanding or secured thereunder; (f) Any representation or warranty made by the Company herein or in any Loan Document or in any statement or certificate furnished by it pursuant hereto or thereto, proves untrue in any material respect as of the date made or deemed made pursuant to the terms hereof; (g) Any judgment or judgments, writ or writs, or warrant or warrants of attachment, or any similar process or processes in an aggregate amount in excess of $1,000,000 shall be entered or filed against the Company or any Subsidiary or against any of their respective Property or assets and remain unbonded, unstayed and undischarged for a period of 30 days from the date of its entry; (h) Any reportable event (as defined in ERISA) which constitutes grounds for the termination of any Plan or for the appointment by the appropriate United States District Court of a trustee to administer or liquidate any such Plan, shall have occurred and such reportable event shall be continuing thirty (30) days after written notice to such effect shall have been given to the Company by any Bank; or any such Plan shall be terminated; or a trustee shall be appointed by the appropriate United States District Court to administer any such Plan; or the Pension Benefit Guaranty Corporation shall institute proceedings to administer or terminate any such Plan; (i) The Company or any Subsidiary shall (i) have entered involuntarily against it an order for relief under the Bankruptcy Code of 1978, as amended, (ii) admit in writing its inability to pay, or not pay, its debts generally as they become due or suspend payment of its obligations, (iii) make an assignment for the benefit of creditors, (iv) apply for, seek, consent to, or acquiesce in, the appointment of a receiver, custodian, trustee, conservator, liquidator or similar official for it or any substantial part of its property, (v) file a petition seeking relief or institute any proceeding seeking to have entered against it an order for relief under the Bankruptcy Code of 1978, as amended, to adjudicate it insolvent, or seeking dissolution, winding up, liquidation, reorganization, arrangement, marshalling of assets, adjustment or composition of it or its debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors or fail to file an answer or other pleading denying the material allegations of any such proceeding filed against it, or (vi) fail to contest in good faith any appointment or proceeding described in Section 8.1(j) hereof; (j) A custodian, receiver, trustee, conservator, liquidator or similar official shall be appointed for the Company, any Subsidiary or any substantial part of its respective Property, or a proceeding described in Section 8.1(i)(v) shall be instituted against the Company or any Subsidiary and such appointment continues undischarged or any such proceeding continues undismissed or unstayed for a period of 60 days; (k) The existence of an Event of Default as defined in the Security Agreement; (l) Any shares of the capital stock of the Company owned legally or beneficially by Mr. and\/or Mrs. Lonnie A. Pilgrim shall be pledged, assigned or otherwise encumbered for any reason, other than (i) the pledge of up to 6,670,000 shares pledged to secure that certain Stock Purchase Agreement dated as of June 25, 1992 between the Company and Archer Daniels Midland, as amended from time to time, and (ii) the pledge of up to 2,000,000 shares to secure personal obligations of Mr. and Mrs. Lonnie A. Pilgrim or such other personal obligations incurred by any Person so long as such obligations are not related to the financing of the Company of any of its Subsidiaries; (m) Mr. and Mrs. Lonnie A. Pilgrim and their descendants and heirs shall for any reason cease to have legal and\/or beneficial ownership of no less than 51% of the issued and outstanding shares of all classes of capital stock of the Company; (n) Either Mr. or Mrs. Lonnie A. Pilgrim shall terminate, breach, repudiate or disavow his or her guaranty of the Company s indebtedness, obligations and liabilities to the Banks under the Loan Documents or any part thereof, or any event specified in Sections 8.1(i) or (j) shall occur with regard to either or both of Mr. and Mrs. Lonnie A. Pilgrim; (o) The Required Banks shall have determined that one or more conditions exist or events have occurred which may result in a material adverse change in the business, operations, Properties or condition (financial or otherwise) of the Company or any Subsidiary; or (p) The occurrence of a Change of Control as defined in that certain Indenture dated as of May 1, 1993 from the Company to Ameritrust Texas National Association, as Trustee, relating to the Company s ___% Senior Subordinated Notes Due 2003. .c2.Section 8.2. Remedies for Non-Bankruptcy Defaults;. When any Event of Default, other than an Event of Default described in subsections (i) and (j) of Section 8.1 hereof, has occurred and is continuing, the Agent, if directed by the Required Banks, shall give notice to the Company and take any or all of the following actions: (i) terminate the remaining Revolving Credit Commitments hereunder on the date (which may be the date thereof) stated in such notice, (ii) declare the principal of and the accrued interest on the Notes and unpaid Reimbursement Obligations to be forthwith due and payable and thereupon the Notes and unpaid Reimbursement Obligations including both principal and interest, shall be and become immediately due and payable without further demand, presentment, protest or notice of any kind, and (iii) proceed to foreclose against any Collateral under any of the Security Documents, take any action or exercise any remedy under any of the Loan Documents or exercise any other action, right, power or remedy permitted by law. Any Bank may exercise the right of set off with regard to any deposit accounts or other accounts maintained by the Company with any of the Banks. .c2.Section 8.3. Remedies for Bankruptcy Defaults;. When any Event of Default described in subsections (i) or (j) of Section 8.1 hereof has occurred and is continuing, then the Notes and all Reimbursement Obligations shall immediately become due and payable without presentment, demand, protest or notice of any kind, and the obligation of the Banks to extend further credit pursuant to any of the terms hereof shall immediately terminate. .c2.Section 8.4. L\/Cs and B\/As;. Promptly following the acceleration of the maturity of the Notes pursuant to Section 8.2 or 8.3 hereof, the Company shall immediately pay to the Agent for the benefit of the Banks the full aggregate amount of all outstanding B\/As and L\/Cs. The Agent shall hold all such funds and proceeds thereof as additional collateral security for the obligations of the Company to the Banks under the Loan Documents. The amount paid under any of the B\/As and L\/Cs for which the Company has not reimbursed the Banks shall bear interest from the date of such payment at the default rate of interest specified in Section 1.3(c)(i) hereof. .c1.9. Change in Circumstances Regarding Fixed Rate Loans;. .c2.Section 9.1. Change of Law;. Notwithstanding any other provisions of this Agreement or any Note to the contrary, if at any time after the date hereof with respect to Fixed Rate Loans, any Bank shall determine in good faith that any change in applicable law or regulation or in the interpretation thereof makes it unlawful for such Bank to make or continue to maintain any Fixed Rate Loan or to give effect to its obligations as contemplated hereby, such Bank shall promptly give notice thereof to the Company to such effect, and such Bank s obligation to make, relend, continue or convert any such affected Fixed Rate Loans under this Agreement shall terminate until it is no longer unlawful for such Bank to make or maintain such affected Loan. The Company shall prepay the outstanding principal amount of any such affected Fixed Rate Loan made to it, together with all interest accrued thereon and all other amounts due and payable to the Banks under Section 9.4 of this Agreement, on the earlier of the last day of the Interest Period applicable thereto and the first day on which it is illegal for such Bank to have such Loans outstanding; provided, however, the Company may then elect to borrow the principal amount of such affected Loan by means of another type of Loan available hereunder, subject to all of the terms and conditions of this Agreement. .c2.Section 9.2. Unavailability of Deposits or Inability to Ascertain the Adjusted Eurodollar Rate or Adjusted CD Rate;. Notwithstanding any other provision of this Agreement or any Note to the contrary, if prior to the commencement of any Interest Period any Bank shall determine (i) that deposits in the amount of any Fixed Rate Loan scheduled to be outstanding are not available to it in the relevant market or (ii) by reason of circumstances affecting the relevant market, adequate and reasonable means do not exist for ascertaining the Adjusted Eurodollar Rate or the Adjusted CD Rate, then such Bank shall promptly give telephonic or telex notice thereof to the Company, the Agent and the other Banks (such notice to be confirmed in writing), and the obligation of the Banks to make, continue or convert any such Fixed Rate Loan in such amount and for such Interest Period shall terminate until deposits in such amount and for the Interest Period selected by the Company shall again be readily available in the relevant market and adequate and reasonable means exist for ascertaining the Adjusted Eurodollar Rate or the Adjusted CD Rate, as the case may be. Upon the giving of such notice, the Company may elect to either (i) pay or prepay, as the case may be, such affected Loan or (ii) reborrow such affected Loan as another type of Loan available hereunder, subject to all terms and conditions of this Agreement. .c2.Section 9.3. Taxes and Increased Costs;. With respect to the Fixed Rate Loans, if any Bank shall determine in good faith that any change in any applicable law, treaty, regulation or guideline (including, without limitation, Regulation D of the Board of Governors of the Federal Reserve System) or any new law, treaty, regulation or guideline, or any interpretation of any of the foregoing by any governmental authority charged with the administration thereof or any central bank or other fiscal, monetary or other authority having jurisdiction over such Bank or its lending branch or the Fixed Rate Loans contemplated by this Agreement (whether or not having the force of law) ( Change in Law ) shall: (i) impose, modify or deem applicable any reserve, special deposit or similar requirements against assets held by, or deposits in or for the account of, or Loans by, or any other acquisition of funds or disbursements by, such Bank (other than reserves included in the determination of the Adjusted Eurodollar Rate or the Adjusted CD Rate); (ii) subject such Bank, any Fixed Rate Loan or any Note to any tax (including, without limitation, any United States interest equalization tax or similar tax however named applicable to the acquisition or holding of debt obligations and any interest or penalties with respect thereto), duty, charge, stamp tax, fee, deduction or withholding in respect of this Agreement, any Fixed Rate Loan or any Note except such taxes as may be measured by the overall net income of such Bank or its lending branch and imposed by the jurisdiction, or any political subdivision or taxing authority thereof, in which such Bank s principal executive office or its lending branch is located; (iii) change the basis of taxation of payments of principal and interest due from the Company to such Bank hereunder or under any Note (other than by a change in taxation of the overall net income of such Bank); or (iv) impose on such Bank any penalty with respect to the foregoing or any other condition regarding this Agreement, any Fixed Rate Loan or any Note; and such Bank shall determine that the result of any of the foregoing is to increase the cost (whether by incurring a cost or adding to a cost) to such Bank of making or maintaining any Fixed Rate Loan hereunder or to reduce the amount of principal or interest received by such Bank, then the Company shall pay to such Bank from time to time as specified by such Bank such additional amounts as such Bank shall reasonably determine are sufficient to compensate and indemnify it for such increased cost or reduced amount. If any Bank makes such a claim for compensation, it shall provide to the Company a certificate setting forth such increased cost or reduced amount as a result of any event mentioned herein specifying such Change in Law, and such certificate shall be conclusive and binding on the Company as to the amount thereof except in the case of manifest error. Upon the imposition of any such cost, the Company may prepay any affected Loan, subject to the provisions of Sections 2.3 and 9.4 hereof. .c2.Section 9.4. Funding Indemnity;. (a) In the event any Bank shall incur any loss, cost, expense or premium (including, without limitation, any loss of profit and any loss, cost, expense or premium incurred by reason of the liquidation or re-employment of deposits or other funds acquired by such Bank to fund or maintain any Fixed Rate Loan or the relending or reinvesting of such deposits or amounts paid or prepaid to such Bank) as a result of: (i) any payment or prepayment of a Fixed Rate Loan on a date other than the last day of the then applicable Interest Period; (ii) any failure by the Company to borrow, continue or convert any Fixed Rate Loan on the date specified in the notice given pursuant to Section 1.8 hereof; or (iii) the occurrence of any Event of Default; then, upon the demand of such Bank, the Company shall pay to such Bank such amount as will reimburse such Bank for such loss, cost or expense. (b) If any Bank makes a claim for compensation under this Section 9.4, it shall provide to the Company a certificate setting forth the amount of such loss, cost or expense in reasonable detail and such certificate shall be conclusive and binding on the Company as to the amount thereof except in the case of manifest error. .c2.Section 9.5. Lending Branch;. Each Bank may, at its option, elect to make, fund or maintain its Eurodollar Loans hereunder at the branch or office specified opposite its signature on the signature page hereof or such other of its branches or offices as such Bank may from time to time elect, subject to the provisions of Section 1.8(b) hereof. .c2.Section 9.6. Discretion of Bank as to Manner of Funding;. Notwithstanding any provision of this Agreement to the contrary, each Bank shall be entitled to fund and maintain its funding of all or any part of its Loans in any manner it sees fit, it being understood however, that for the purposes of this Agreement all determinations hereunder shall be made as if the Banks had actually funded and maintained each Fixed Rate Loan during each Interest Period for such Loan through the purchase of deposits in the relevant interbank market having a maturity corresponding to such Interest Period and bearing an interest rate equal to the Adjusted Eurodollar Rate or Adjusted CD Rate, as the case may be, for such Interest Period. .c1.10. The Agent;. .c2.Section 10.1. Appointment and Powers;. Harris Trust and Savings Bank is hereby appointed by the Banks as Agent under the Loan Documents, including but not limited to the Security Agreement, wherein the Agent shall hold a security interest for the benefit of the Banks, solely as the Agent of the Banks, and each of the Banks irrevocably authorizes the Agent to act as the Agent of such Bank. The Agent agrees to act as such upon the express conditions contained in this Agreement. .c2.Section 10.2. Powers;. The Agent shall have and may exercise such powers hereunder as are specifically delegated to the Agent by the terms of the Loan Documents, together with such powers as are incidental thereto. The Agent shall have no implied duties to the Banks, nor any obligation to the Banks to take any action under the Loan Documents except any action specifically provided by the Loan Documents to be taken by the Agent. .c2.Section 10.3. General Immunity;. Neither the Agent nor any of its directors, officers, agents or employees shall be liable to the Banks or any Bank for any action taken or omitted to be taken by it or them under the Loan Documents or in connection therewith except for its or their own gross negligence or willful misconduct. .c2.Section 10.4. No Responsibility for Loans, Recitals, etc;. The Agent shall not (i) be responsible to the Banks for any recitals, reports, statements, warranties or representations contained in the Loan Documents or furnished pursuant thereto, (ii) be responsible for the payment or collection of or security for any Loans or Reimbursement Obligations hereunder except with money actually received by the Agent for such payment, (iii) be bound to ascertain or inquire as to the performance or observance of any of the terms of the Loan Documents, or (iv) be obligated to determine or verify the existence, eligibility or value of any Collateral, or the correctness of any Borrowing Base Certificate or compliance certificate. In addition, neither the Agent nor its counsel shall be responsible to the Banks for the enforceability or validity of any of the Loan Documents or for the existence, creation, attachment, perfection or priority of any security interest in the Collateral. .c2.Section 10.5. Right to Indemnity;. The Banks hereby indemnify the Agent for any actions taken in accordance with this Section 10, and the Agent shall be fully justified in failing or refusing to take any action hereunder, unless it shall first be indemnified to its satisfaction by the Banks pro rata against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action, other than any liability which may arise out of Agent s gross negligence or willful misconduct. .c2.Section 10.6. Action Upon Instructions of Banks.; The Agent agrees, upon the written request of the Required Banks, to take any action of the type specified in the Loan Documents as being within the Agent s rights, duties, powers or discretion. The Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder in accordance with written instructions signed by the Required Banks, and such instructions and any action taken or failure to act pursuant thereto shall be binding on all of the Banks and on all holders of the Notes. In the absence of a request by the Required Banks, the Agent shall have authority, in its sole discretion, to take or not to take any action, unless the Loan Documents specifically require the consent of the Required Banks or all of the Banks. .c2.Section 10.7. Employment of Agents and Counsel;. The Agent may execute any of its duties as Agent hereunder by or through agents (other than employees) and attorneys-in-fact and shall not be answerable to the Banks, except as to money or securities received by it or its authorized agents, for the default or misconduct of any such agents or attorneys-in-fact selected by it in good faith and with reasonable care. The Agent shall be entitled to advice and opinion of legal counsel concerning all matters pertaining to the duties of the agency hereby created. .c2. Section 10.8. Reliance on Documents; Counsel ;. The Agent shall be entitled to rely upon any Note, notice, consent, certificate, affidavit, letter, telegram, statement, paper or document believed by it to be genuine and correct and to have been signed or sent by the proper person or persons, and, in respect to legal matters, upon the opinion of legal counsel selected by the Agent. .c2.Section 10.9. May Treat Payee as Owner;. The Agent may deem and treat the payee of any Note as the owner thereof for all purposes hereof unless and until a written notice of the assignment or transfer thereof shall have been filed with the Agent. Any request, authority or consent of any person, firm or corporation who at the time of making such request or giving such authority or consent is the holder of any such Note shall be conclusive and binding on any subsequent holder, transferee or assignee of such Note or of any Note issued in exchange therefor. .c2.Section 10.10. Agent s Reimbursement;. Each Bank agrees to reimburse the Agent pro rata in accordance with its Commitment Percentage for any reasonable out-of-pocket expenses (including fees and charges for field audits) not reimbursed by the Company (a) for which the Agent is entitled to reimbursement by the Company under the Loan Documents and (b) for any other reasonable out-of-pocket expenses incurred by the Agent on behalf of the Banks, in connection with the preparation, execution, delivery, administration and enforcement of the Loan Documents and for which the Agent is entitled to reimbursement by the Company and has not been reimbursed. .c2.Section 10.11. Rights as a Lender;. With respect to its commitment, Loans made by it, L\/Cs and B\/As issued by it and the Notes issued to it, Harris shall have the same rights and powers hereunder as any Bank and may exercise the same as though it were not the Agent, and the term Bank or Banks shall, unless the context otherwise indicates, include Harris in its individual capacity. Harris and each of the Banks may accept deposits from, lend money to, and generally engage in any kind of banking or trust business with the Company as if it were not the Agent or a Bank hereunder, as the case may be. .c2.Section 10.12. Bank Credit Decision;. Each Bank acknowledges that it has, independently and without reliance upon the Agent or any other Bank and based on the financial statements referred to in Section 5.3 and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into the Loan Documents. Each Bank also acknowledges that it will, independently and without reliance upon the Agent or any other Bank and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Loan Documents. .c2.Section 10.13. Resignation of Agent;. Subject to the appointment of a successor Agent, the Agent may resign as Agent for the Banks under this Agreement and the other Loan Documents at any time by sixty days notice in writing to the Banks. Such resignation shall take effect upon appointment of such successor. The Required Banks shall have the right to appoint a successor Agent who shall be entitled to all of the rights of, and vested with the same powers as, the original Agent under the Loan Documents. In the event a successor Agent shall not have been appointed within the sixty day period following the giving of notice by the Agent, the Agent may appoint its own successor. Resignation by the Agent shall not affect or impair the rights of the Agent under Sections 10.5 and 10.10 hereof with respect to all matters preceding such resignation. Any successor Agent must be a Bank, a national banking association, a bank chartered in any state of the United States or a branch of any foreign bank which is licensed to do business under the laws of any state or the United States. .c2.Section 10.14. Duration of Agency;. The agency established by Section 10.1 hereof shall continue, and Sections 10.1 through and including Section 10.15 shall remain in full force and effect, until the Notes and all other amounts due hereunder and thereunder, including without limitation all Reimbursement Obligations, shall have been paid in full and the Banks commitments to extend credit to or for the benefit of the Company shall have terminated or expired. .c1.11. Miscellaneous. .c2.Section 11.1. Amendments and Waivers;. Any term, covenant, agreement or condition of this Agreement may be amended only by a written amendment executed by the Company, the Required Banks and, if the rights or duties of the Agent are affected thereby, the Agent, or compliance therewith only may be waived (either generally or in a particular instance and either retroactively or prospectively), if the Company shall have obtained the consent in writing of the Required Banks and, if the rights or duties of the Agent are affected thereby, the Agent, provided, however, that without the consent in writing of the holders of all outstanding Notes and unpaid Reimbursement Obligations and the creator of any B\/A and the issuer of any L\/C, or all Banks if no Notes, L\/Cs or B\/As are outstanding, no such amendment or waiver shall (i) change the amount or postpone the date of payment of any scheduled payment or required prepayment of principal of the Notes or reduce the rate or extend the time of payment of interest on the Notes, or reduce the amount of principal thereof, or modify any of the provisions of the Notes with respect to the payment or prepayment thereof, (ii) give to any Note any preference over any other Notes, (iii) amend the definition of Required Banks, (iv) alter, modify or amend the provisions of this Section 11.1, (v) change the amount or term of any of the Banks Revolving Credit Commitments or the fees required under Section 2.1 hereof, (vi) alter, modify or amend the provisions of Sections 1.10, 6 or 9 of this Agreement, (vii) alter, modify or amend any Bank s right hereunder to consent to any action, make any request or give any notice, (viii) change the advance rates under the Borrowing Base or the definitions of Eligible Inventory or Eligible Receivables, (ix) release any Collateral under the Security Documents or release or discharge any guarantor of the Company s indebtedness, obligations and liabilities to the Banks, in each case, unless such release or discharge is permitted or contemplated by the Loan Documents, or (x) alter, amend or modify any subordination provisions of any Subordinated Debt. Any such amendment or waiver shall apply equally to all Banks and the holders of the Notes and Reimbursement Obligations and shall be binding upon them, upon each future holder of any Note and Reimbursement Obligation and upon the Company, whether or not such Note shall have been marked to indicate such amendment or waiver. No such amendment or waiver shall extend to or affect any obligation not expressly amended or waived. Harris shall have the right to vote the amount of the CoBank Participation as though the CoBank Participation were a separate extension of credit by CoBank hereunder. .c2.Section 11.2. Waiver of Rights;. No delay or failure on the part of the Agent or any Bank or on the part of the holder or holders of any Note or Reimbursement Obligation in the exercise of any power or right shall operate as a waiver thereof, nor as an acquiescence in any Potential Default or Event of Default, nor shall any single or partial exercise of any power or right preclude any other or further exercise thereof, or the exercise of any other power or right, and the rights and remedies hereunder of the Agent, the Banks and of the holder or holders of any Notes are cumulative to, and not exclusive of, any rights or remedies which any of them would otherwise have. .c2.Section 11.3. Several Obligations;. The commitments of each of the Banks hereunder shall be the several obligations of each Bank and the failure on the part of any one or more of the Banks to perform hereunder shall not affect the obligation of the other Banks hereunder, provided that nothing herein contained shall relieve any Bank from any liability for its failure to so perform. In the event that any one or more of the Banks shall fail to perform its commitment hereunder, all payments thereafter received by the Agent on the principal of Loans and Reimbursement Obligations hereunder, whether from any Collateral or otherwise, shall be distributed by the Agent to the Banks making such additional Loans ratably as among them in accordance with the principal amount of additional Loans made by them until such additional Loans shall have been fully paid and satisfied. All payments on account of interest shall be applied as among all the Banks ratably in accordance with the amount of interest owing to each of the Banks as of the date of the receipt of such interest payment. .c2.Section 11.4. Non-Business Day;. (a) If any payment of principal or interest on any Domestic Rate Loan shall fall due on a day which is not a Business Day, interest at the rate such Loan bears for the period prior to maturity shall continue to accrue on such principal from the stated due date thereof to and including the next succeeding Business Day on which the same is payable. (b) If any payment of principal or interest on any Eurodollar Loan shall fall due on a day which is not a Banking Day, the payment date thereof shall be extended to the next date which is a Banking Day and the Interest Period for such Loan shall be accordingly extended, unless as a result thereof any payment date would fall in the next calendar month, in which case such payment date shall be the next preceding Banking Day. .c2.Section 11.5. Survival of Indemnities;. All indemnities and all provisions relative to reimbursement to the Banks of amounts sufficient to protect the yield to the Banks with respect to Eurodollar Loans, including, but not limited to, Sections 9.3 and 9.4 hereof, shall survive the termination of this Agreement and the payment of the Notes for a period of one year. .c2.Section 11.6. Documentary Taxes;. Although the Company is of the opinion that no documentary or similar taxes are payable in respect of this Agreement or the Notes, the Company agrees that it will pay such taxes, including interest and penalties, in the event any such taxes are assessed irrespective of when such assessment is made and whether or not any credit is then in use or available hereunder. .c.; .c2.Section 11.7. Representations;. All representations and warranties made herein or in certificates given pursuant hereto shall survive the execution and delivery of this Agreement and of the Notes, and shall continue in full force and effect with respect to the date as of which they were made and as reaffirmed on the date of each borrowing, request for L\/C or request for B\/A and as long as any credit is in use or available hereunder. .c2.Section 11.8. Notices;. Unless otherwise expressly provided herein, all communications provided for herein shall be in writing or by telex and shall be deemed to have been given or made when served personally, when an answer back is received in the case of notice by telex or 2 days after the date when deposited in the United States mail (registered, if to the Company) addressed if to the Company to 110 South Texas, Pittsburg, Texas 75686 Attention: Clifford E. Butler; if to the Agent or Harris at 111 West Monroe Street, Chicago, Illinois 60690, Attention: Agribusiness Division; and if to any of the Banks, at the address for each Bank set forth under its signature hereon; or at such other address as shall be designated by any party hereto in a written notice to each other party pursuant to this Section 11.8. .c2. Section 11.9. Costs and Expenses; Indemnity ;. The Company agrees to pay on demand all costs and expenses of the Agent, in connection with the negotiation, preparation, execution and delivery of this Agreement, the Notes and the other instruments and documents to be delivered hereunder or in connection with the transactions contemplated hereby, including the fees and expenses of Messrs. Chapman and Cutler, special counsel to the Agent; all costs and expenses of the Agent (including attorneys fees) incurred in connection with any consents or waivers hereunder or amendments hereto, and all costs and expenses (including attorneys fees), if any, incurred by the Agent, the Banks or any other holders of a Note or any Reimbursement Obligation in connection with the enforcement of this Agreement or the Notes and the other instruments and documents to be delivered hereunder. The Company agrees to indemnify and save harmless the Banks and the Agent from any and all liabilities, losses, costs and expenses incurred by the Banks or the Agent in connection with any action, suit or proceeding brought against the Agent or any Bank by any Person which arises out of the transactions contemplated or financed hereby or by the Notes, or out of any action or inaction by the Agent or any Bank hereunder or thereunder, except for such thereof as is caused by the gross negligence or willful misconduct of the party indemnified. The provisions of this Section 11.9 shall survive payment of the Notes and Reimbursement Obligations and the termination of the Revolving Credit Commitments hereunder. .c2.Section 11.10. Counterparts;. This Agreement may be executed in any number of counterparts and all such counterparts taken together shall be deemed to constitute one and the same instrument. One or more of the Banks may execute a separate counterpart of this Agreement which has also been executed by the Company, and this Agreement shall become effective as and when all of the Banks have executed this Agreement or a counterpart thereof and lodged the same with the Agent. .c2.Section 11.11. Successors and Assigns.;. This Agreement shall be binding upon each of the Company and the Banks and their respective successors and assigns, and shall inure to the benefit of the Company and each of the Banks and the benefit of their respective successors and assigns, including any subsequent holder of any Note or Reimbursement Obligation. The Company may not assign any of its rights or obligations hereunder without the written consent of the Banks. .c2.Section 11.12. No Joint Venture;. Nothing contained in this Agreement shall be deemed to create a partnership or joint venture among the parties hereto. .c2.Section 11.13. Severability;. In the event that any term or provision hereof is determined to be unenforceable or illegal, it shall deemed severed herefrom to the extent of the illegality and\/or unenforceability and all other provisions hereof shall remain in full force and effect. .c2.Section 11.14. Table of Contents and Headings;. The table of contents and section headings in this Agreement are for reference only and shall not affect the construction of any provision hereof. .c2.Section 11.15. Participants;. (a) Each Bank shall have the right at its own cost to grant participations (to be evidenced by one or more agreements or certificates of participation) in the Loans made, and\/or Revolving Credit Commitment and participations in L\/Cs, B\/As and Reimbursement Obligations held, by such Bank at any time and from time to time, and to assign its rights under such Loans, participations in L\/Cs and B\/As and Reimbursement Obligations or the Notes evidencing such Loans to one or more other Persons; provided that no such participation (except the participation described in Section 11.15(b) hereof (the CoBank Participation )) shall relieve any Bank of any of its obligations under this Agreement, and any agreement pursuant to which such participation (except the CoBank Participation) or assignment of a Note or the rights thereunder is granted shall provide that the granting Lender shall retain the sole right and responsibility to enforce the obligations of the Company under the Loan Documents, including, without limitation, the right to approve any amendment, modification or waiver of any provision thereof, except that such agreement (except the CoBank Agreement) may provide that such Bank will not agree without the consent of such participant or assignee to any modification, amendment or waiver of this Agreement that would (A) increase any Revolving Credit Commitment of such Lender, or (B) reduce the amount of or postpone the date for payment of any principal of or interest on any Loan or Reimbursement Obligation or of any fee payable hereunder in which such participant or assignee has an interest or (C) reduce the interest rate applicable to any Loan or other amount payable in which such participant or assignee has an interest or (D) release any collateral security for or guarantor for any of the Company s indebtedness, obligations and liabilities under the Loan Documents, and provided further that no such assignee or participant except CoBank shall have any rights under this Agreement except as provided in this Section 11.15, and the Agent shall have no obligation or responsibility to such participant or assignee, except that nothing herein provided is intended to affect the rights of an assignee of a Note to enforce the Note assigned. Any party to which such a participation or assignment has been granted shall have the benefits of Section 1.10, Section 9.3 and Section 9.4 hereof but shall not be entitled to receive any greater payment under any such Section than the Bank granting such participation or assignment would have been entitled to receive with respect to the rights transferred. (b) The Company acknowledges that concurrently with the execution and delivery of this Agreement Harris has entered into that certain Participation Agreement of even date herewith with CoBank (as such agreement may be supplemented and amended from time to time, the CoBank Agreement ) a copy of which has been provided to the Company. In the event that CoBank fails to furnish to Harris its ratable participation in any Loan to be made by Harris to the Company, notwithstanding anything whatsoever contained in this Agreement to the contrary obligating Harris to make such Loan to the Company, Harris shall not be obligated to advance to the Company more than Harris Retained Percentage of such Loan plus any amount of such Loan actually advanced by CoBank to Harris to fund CoBank s Participation therein. .c2.Section 11.16. Assignment of Commitments by Bank;. Each Bank shall have the right at any time, with the prior consent of the Company and the Agent (which consent will not be unreasonably withheld), to sell, assign, transfer or negotiate all or any part of its Revolving Credit Commitment to one or more commercial banks or other financial institutions; provided that such assignment is in an amount of at least $10,000,000, provided further that no Bank (except ING Bank) may so assign more than one-half of its original Revolving Credit Commitment hereunder and provided further that ING Bank may assign all of its interest hereunder to any of its subsidiaries or affiliates that are Under Common Control with ING Bank. Upon any such assignment, and its notification to the Agent, the assignee shall become a Bank hereunder, all Loans and the Revolving Credit Commitment it thereby holds shall be governed by all the terms and conditions hereof, and the Bank granting such assignment shall have its Revolving Credit Commitment and its obligations and rights in connection therewith, reduced by the amount of such assignment. Upon each such assignment the Bank granting such assignment shall pay to the Agent for the Agent s sole account a fee of $2,500. .c2.Section 11.17. Sharing of Payments;. Each Bank agrees with each other Bank that if such Bank shall receive and retain any payment, whether by set-off or application of deposit balances or otherwise ( Set-Off ), on any Loan, Reimbursement Obligation or other amount outstanding under this Agreement in excess of its ratable share of payments on all Loans, Reimbursement Obligations and other amounts then outstanding to the Banks, then such Bank shall purchase for cash at face value, but without recourse, ratably from each of the other Banks such amount of the Loans and Reimbursement Obligations held by each such other Bank (or interest therein) as shall be necessary to cause such Bank to share such excess payment ratably with all the other Banks; provided, however, that if any such purchase is made by any Bank, and if such excess payment or part thereof is thereafter recovered from such purchasing Bank, the related purchases from the other Banks shall be rescinded ratably and the purchase price restored as to the portion of such excess payment so recovered, but without interest. Each Bank s ratable share of any such Set-Off shall be determined by the proportion that the aggregate principal amount of Loans and Reimbursement Obligations then due and payable to such Bank bears to the total aggregate principal amount of Loans and Reimbursement Obligations then due and payable to all the Banks. .c2. Section 11.18. Jurisdiction; Venue ;. The company hereby submits to the nonexclusive jurisdiction of the united states district court for the northern district of Illinois and of any Illinois court sitting in Chicago for purposes of all legal proceedings arising out of or relating to this agreement or the transactions contemplated hereby. The company irrevocably waives, to the fullest extent permitted by law, any objection which it may now or hereafter have to the laying of the venue of any such proceeding brought in such a court and any claim that any such proceeding brought in such a court has been brought in an inconvenient forum. .c2.Section 11.19. Lawful Rate;. All agreements between the Company, the Agent and each of the Banks, whether now existing or hereafter arising and whether written or oral, are expressly limited so that in no contingency or event whatsoever, whether by reason of demand or acceleration of the maturity of any of the indebtedness hereunder or otherwise, shall the amount contracted for, charged, received, reserved, paid or agreed to be paid to the Agent or each Bank for the use, forbearance, or detention of the funds advanced hereunder or otherwise, or for the performance or payment of any covenant or obligation contained in any document executed in connection herewith (all such documents being hereinafter collectively referred to as the Credit Documents ), exceed the highest lawful rate permissible under applicable law (the Highest Lawful Rate ), it being the intent of the Company, the Agent and each of the Banks in the execution hereof and of the Credit Documents to contract in strict accordance with applicable usury laws. If, as a result of any circumstances whatsoever, fulfillment by the Company of any provision hereof or of any of such documents, at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by applicable usury law or result in the Agent or any Bank having or being deemed to have contracted for, charged, reserved or received interest (or amounts deemed to be interest) in excess of the maximum, lawful rate or amount of interest allowed by applicable law to be so contracted for, charged, reserved or received by the Agent or such Bank, then, ipso facto, the obligation to be fulfilled by the Company shall be reduced to the limit of such validity, and if, from any such circumstance, the Agent or such Bank shall ever receive interest or anything which might be deemed interest under applicable law which would exceed the Highest Lawful Rate, such amount which would be excessive interest shall be refunded to the Company or, to the extent (i) permitted by applicable law and (ii) such excessive interest does not exceed the unpaid principal balance of the Notes and the amounts owing on other obligations of the Company to the Agent or any Bank under any Loan Document applied to the reduction of the principal amount owing on account of the Notes or the amounts owing on other obligations of the Company to the Agent or any Bank under any Loan Document and not to the payment of interest. All interest paid or agreed to be paid to the Agent or any Bank shall, to the extent permitted by applicable law, be amortized, prorated, allocated, and spread throughout the full period of the indebtedness hereunder until payment in full of the principal of the indebtedness hereunder (including the period of any renewal or extension thereof) so that the interest on account of the indebtedness hereunder for such full period shall not exceed the highest amount permitted by applicable law. This paragraph shall control all agreements between the Company, the Agent and the Banks. .c2.Section 11.20. Governing Law;. (a) This Agreement and the rights and duties of the parties hereto, shall be construed and determined in accordance with the internal laws of the State of Illinois, except to the extent provided in Section 11.20(b) hereof and to the extent that the Federal laws of the United States of America may otherwise apply. (b) Notwithstanding anything in Section 11.20(a) hereof to the contrary, nothing in this Agreement, the Notes, or the Other Loan Documents shall be deemed to constitute a waiver of any rights which the Company, the Agent or any of the Banks may have under the National Bank Act or other applicable Federal law. .c2.Section 11.21. Limitation of Liability;. No claim may be made by the Company, any Subsidiary or any Guarantor against any Bank or its Affiliates, Directors, officers, employees, attorneys or Agents for any special, indirect or consequential damages in respect of any breach or wrongful conduct (whether the claim therefor is based on contract, tort or duty imposed by law) in connection with, arising out of or in any way related to the transactions contemplated and relationships established by this Agreement or any of the Other Loan Documents, or any act, omission or event occurring in connection therewith. The Company, each Subsidiary and each Guarantor hereby waive, release and agree not to sue upon such claim for any such damages, whether or not accrued and whether or not known or suspected to exist in its favor. .c2.Section 11.22. Nonliability of Lenders;. The relationship between the Company and the Banks is, and shall at all times remain, solely that of borrower and lenders, and the Banks and the Agent neither undertake nor assume any responsibility or duty to the Company to review, inspect, supervise, pass judgment upon, or inform the Company of any matter in connection with any phase of the Company s business, operations, or condition, financial or otherwise. The Company shall rely entirely upon its own judgment with respect to such matters, and any review, inspection, supervision, exercise of judgment, or information supplied to the Company by any Bank or the Agent in connection with any such matter is for the protection of the Bank and the Agent, and neither the Company nor any third party is entitled to rely thereon. .c2.Section 11.23. No Oral Agreements.; This written agreement, together with the Other Loan Documents executed contemporaneously herewith, represent the final agreement between the parties and may not be contradicted by evidence of prior, contemporaneous or subsequent oral agreements of the parties. There are no unwritten oral agreements between the parties. .c2.Section 11.24. Treatment of Certain Indebtedness;. The Agent and the Banks agree that for purposes of determining compliance with the financial covenants contained in this Agreement the Company s indebtedness evidenced by its 14.25% Senior Notes Due 1995 shall be deemed paid in an amount equal to the amount deposited with the trustee for such notes in an escrow account for the payment of such notes and with respect to which notice of redemption shall have been given to the holders of such notes in accordance with the terms thereof. Upon your acceptance hereof in the manner hereinafter set forth, this Agreement shall be a contract between us for the purposes hereinabove set forth.\nDated as of May 27, 1993. Pilgrim s Pride Corporation By Lonnie A. Pilgrim Its Chief Executive Officer\nAccepted and Agreed to as of the day and year last above written.\nHarris Trust And Savings Bank individually and as Agent By Carl A. Blackham Its Vice President Address: 111 West Monroe Street Chicago, Illinois 60690\nFBS Ag Credit, Inc. By Douglas S. Hoffner Its Vice President Address: 4643 South Ulster Street, Suite 1280 Denver, Colorado 80237\nInternationale Nederlanden Bank N. V. By Sheila M. Greatrex Its Vice President Address: 135 East 57th Street New York, New York 10022-2101\nBoatmen s First National Bank of Kansas City By Martha Carpenter Smith Its Senior Vice President Address: 10th and Baltimore Kansas City, Missouri 64183\nFirst Interstate Bank of Texas, N.A. By Connor J. Duffey Its Vice President Address: 1445 Ross Avenue Dallas, Texas 75202\nPilgrim s Pride Corporation First Amendment to Secured Credit Agreement\nHarris Trust and Savings Bank Chicago, Illinois\nFBS Ag Credit, Inc. Denver, Colorado\nInternationale Nederlanden (U.S) Capital Corporation, formerly known as Internationale Nederlanden Bank N. V. ( ING Bank ) New York, New York\nBoatmen s First National Bank of Kansas City Kansas City, Missouri\nFirst Interstate Bank of Texas, N.A. Dallas, Texas Ladies and Gentlemen: Reference is hereby made to that certain Secured Credit Agreement dated as of May 27, 1993 (the Credit Agreement ) among the undersigned, Pilgrim s Pride Corporation, a Delaware corporation (the Company ), you (the Banks ) and Harris Trust and Savings Bank, as agent for the Banks (the Agent ). All defined terms used herein shall have the same meanings as in the Credit Agreement unless otherwise defined herein. The Banks extend a $75,000,000 revolving credit facility to the Company on the terms and conditions set forth in the Credit Agreement. The Company, the Agent and the Banks now wish to amend the Credit Agreement to, among other things, extend the termination date thereof from May 31, 1995 to May 31, 1997, to provide for a competitive bid facility and change the rate of interest applicable to loans made under the Credit Agreement, all on the terms and conditions and in the manner set forth in this Amendment. 1. Amendments. Upon satisfaction of all of the conditions precedent set forth in Section 2 hereof, the Credit Agreement shall be amended as follows: 1.1. Sections 1, 2 and 3 of the Credit Agreement shall be amended in their entirety to read as follows: 1. The Credit. .c2.Section 1.1. The Revolving Credit.; (a) Subject to all of the terms and conditions hereof, the Banks agree, severally and not jointly, to extend a Revolving Credit to the Company which may be utilized by the Company in the form of loans (individually a Revolving Credit Loan and collectively the Revolving Credit Loans ), B\/As and L\/Cs (each as hereinafter defined). The aggregate principal amount of all Revolving Credit Loans under the Revolving Credit plus the aggregate principal amount of all Bid Loans outstanding under this Agreement plus the amount available for drawing under all L\/Cs, the aggregate face amount of all B\/As and the aggregate principal amount of all unpaid Reimbursement Obligations (as hereinafter defined) at any time outstanding shall not exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments (as hereinafter defined) in effect from time to time during the term of this Agreement (as hereinafter defined) or (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate. The Revolving Credit shall be available to the Company, and may be availed of by the Company from time to time, be repaid (subject to the restrictions on prepayment set forth herein) and used again, during the period from the date hereof to and including May 31, 1997 (the Termination Date ). (b) At any time not earlier than 120 days prior to, nor later than 60 days prior to, the date that is two years before the Termination Date then in effect (the Anniversary Date ), the Company may request that the Banks extend the then scheduled Termination Date to the date one year from such Termination Date. If such request is made by the Company each Bank shall inform the Agent of its willingness to extend the Termination Date no later than 20 days prior to such Anniversary Date. Any Bank s failure to respond by such date shall indicate its unwillingness to agree to such requested extension, and all Banks must approve any requested extension. At any time more than 15 days before such Anniversary Date the Banks may propose, by written notice to the Company, an extension of this Agreement to such later date on such terms and conditions as the Banks may then require. If the extension of this Agreement to such later date is acceptable to the Company on the terms and conditions proposed by the Banks, the Company shall notify the Banks of its acceptance of such terms and conditions no later than the Anniversary Date, and such later date will become the Termination Date hereunder and this Agreement shall otherwise be amended in the manner described in the Banks notice proposing the extension of this Agreement upon the Agent s receipt of (i) an amendment to this Agreement signed by the Company and all of the Banks, (ii) resolutions of the Company s Board of Directors authorizing such extension and (iii) an opinion of counsel to the Company equivalent in form and substance to the form of opinion attached hereto as Exhibit E and otherwise acceptable to the Banks. (c) The respective maximum aggregate principal amounts of the Revolving Credit at any one time outstanding and the percentage of the Revolving Credit available at any time which each Bank by its acceptance hereof severally agrees to make available to the Company are as follows (collectively, the Revolving Credit Commitments and individually, a Revolving Credit Commitment ):\nHarris Trust and Savings Bank $35,000,000 46.66666667% FBS Ag Credit, Inc. $15,000,000 20% Internationale Nederlanden (U.S.) Capital Corporation $10,000,000 13.33333334% Boatmen s First National Bank of Kansas City $10,000,000 13.33333334% First Interstate Bank of Texas, N.A. $ 5,000,000 6.66666667% Total $75,000,000 100%Each Bank s Revolving Credit Commitment shall be reduced from time to time by the aggregate outstanding principal amount of all Bid Loans made by such Bank, and shall be increased (but in no event above the amount set forth above for each Bank) by the aggregate principal amount of each principal repayment of such Bid Loans made from time to time. (d) Loans under the Revolving Credit may be Eurodollar Loans, CD Rate Loans or Domestic Rate Loans. All Loans under the Revolving Credit shall be made from each Bank in proportion to its respective Revolving Credit Commitment as above set forth, as adjusted from time to time to reflect outstanding Bid Loans. Each Domestic Rate Loan shall be in an amount not less than $3,000,000 or such greater amount which is an integral multiple of $500,000 and each Fixed Rate Loan shall be in an amount not less than $3,000,000 or such greater amount which is an integral multiple of $1,000,000. .c2.Section 1.2. The Notes;. All Revolving Credit Loans made by each Bank hereunder shall be evidenced by a single Secured Revolving Credit Note of the Company substantially in the form of Exhibit A hereto (individually, a Revolving Note and together, the Revolving Notes ) payable to the order of each Bank in the principal amount of such Bank s Revolving Credit Commitment, but the aggregate principal amount of indebtedness evidenced by such Revolving Note at any time shall be, and the same is to be determined by, the aggregate principal amount of all Revolving Credit Loans made by such Bank to the Company pursuant hereto on or prior to the date of determination less the aggregate amount of principal repayments on such Revolving Credit Loans received by or on behalf of such Bank on or prior to such date of determination. Each Revolving Note shall be dated as of the execution date of this Agreement, and shall be expressed to mature on the Termination Date and to bear interest as provided in Section 1.3 hereof. Each Bank shall record on its books or records or on a schedule to its Revolving Note the amount of each Revolving Credit Loan made by it hereunder, whether each Revolving Credit Loan is a Domestic Rate Loan, CD Rate Loan or Eurodollar Loan, and, with respect to Eurodollar Loans, the interest rate and Interest Period applicable thereto, and all payments of principal and interest and the principal balance from time to time outstanding, provided that prior to any transfer of such Revolving Note all such amounts shall be recorded on a schedule to such Revolving Note. The record thereof, whether shown on such books or records or on the schedule to the Revolving Note, shall be prima facie evidence as to all such amounts; provided, however, that the failure of any Bank to record or any mistake in recording any of the foregoing shall not limit or otherwise affect the obligation of the Company to repay all Revolving Credit Loans made hereunder together with accrued interest thereon. Upon the request of any Bank, the Company will furnish a new Revolving Note to such Bank to replace its outstanding Revolving Note and at such time the first notation appearing on the schedule on the reverse side of, or attached to, such Revolving Note shall set forth the aggregate unpaid principal amount of Revolving Credit Loans then outstanding from such Bank, and, with respect to each Fixed Rate Loan, the interest rate and Interest Period applicable thereto. Such Bank will cancel the outstanding Revolving Note upon receipt of the new Revolving Note. .c2.Section 1.3. Interest Rates;. (a) Domestic Rate Loans. Each Domestic Rate Loan shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until maturity (whether by acceleration, upon prepayment or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Domestic Rate from time to time in effect, payable quarterly in arrears on the last day of each calendar quarter, commencing on the first of such dates occurring after the date hereof and at maturity (whether by acceleration, upon prepayment or otherwise). (b) Eurodollar Loans. Each Eurodollar Loan under the Revolving Credit shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until the last day of the Interest Period applicable thereto or, if earlier, until maturity (whether by acceleration or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Adjusted Eurodollar Rate, payable on the last day of each Interest Period applicable thereto and at maturity (whether by acceleration or otherwise) and, with respect to Eurodollar Loans with an Interest Period in excess of three months, on the date occurring every three months from the first day of the Interest Period applicable thereto. (c) CD Rate Loans. Each CD Rate Loan under the Revolving Credit shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) on the unpaid principal amount thereof from the date such Loan is made until the last day of the Interest Period applicable thereto or, if earlier, until maturity (whether by acceleration or otherwise) at a rate per annum equal to the lesser of (i) the Highest Lawful Rate and (ii) the sum of the Applicable Margin plus the Adjusted CD Rate, payable on the last day of each Interest Period applicable thereto and at maturity (whether by acceleration of otherwise) and, with respect to CD Rate Loans with an Interest Period in excess of 90 days, on the date occurring every 90 days from the first day of the Interest Period applicable thereto. (d) Default Rate. During the existence of an Event of Default all Loans and Reimbursement Obligations shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) from the date of such Event of Default until paid in full, payable on demand, at a rate per annum equal to the sum of 2.5% plus the Domestic Rate from time to time in effect plus the Applicable Margin. .c2.Section 1.4. Conversion and Continuation of Revolving Credit Loans;. (a) Provided that no Event of Default or Potential Default has occurred and is continuing, the Company shall have the right, subject to the other terms and conditions of this Agreement, to continue in whole or in part (but, if in part, in the minimum amount specified for Fixed Rate Loans in Section 1.1 hereof) any Fixed Rate Loan made under the Revolving Credit from any current Interest Period into a subsequent Interest Period, provided that the Company shall give the Agent notice of the continuation of any such Loan as provided in Section 1.8 hereof. (b) In the event that the Company fails to give notice pursuant to Section 1.8 hereof of the continuation of any Fixed Rate Loan under the Revolving Credit or fails to specify the Interest Period applicable thereto, or an Event of Default or Potential Default has occurred and is continuing at the time any such Loan is to be continued hereunder, then such Loan shall be automatically converted as (and the Company shall be deemed to have given notice requesting) a Domestic Rate Loan, subject to Sections 1.8(b), 8.2 and 8.3 hereof, unless paid in full on the last day of the then applicable Interest Period. (c) Provided that no Event of Default or Potential Default has occurred and is continuing, the Company shall have the right, subject to the terms and conditions of this Agreement, to convert Revolving Credit Loans of one type (in whole or in part) into Revolving Credit Loans of another type from time to time provided that: (i) the Company shall give the Agent notice of each such conversion as provided in Section 1.8 hereof, (ii) the principal amount of any Revolving Credit Loan converted hereunder shall be in an amount not less than the minimum amount specified for the type of Revolving Credit Loan in Section 1.1 hereof, (iii) after giving effect to any such conversion in part, the principal amount of any Fixed Rate Loan under the Revolving Credit then outstanding shall not be less than the minimum amount specified for the type of Loan in Section 1.1 hereof, (iv) any conversion of a Revolving Credit Loan hereunder shall only be made on a Banking Day, and (v) any Fixed Rate Loan may be converted only on the last day of the Interest Period then applicable thereto. .c2.Section 1.5. Bankers Acceptances;. Subject to all the terms and conditions hereof, satisfaction of all conditions precedent to borrowing under this Agreement and so long as no Potential Default or Event of Default is in existence, at the Company s request Harris, in its discretion, may create acceptances in an amount of at least $5,000,000 (a B\/A and collectively the B\/As ) for the Company within the limits of, and subject to availability under the Revolving Credit, and the Banks hereby agree to participate therein as more fully described in Section 1.9 hereof. Each B\/A shall be created pursuant to a General Acceptance Agreement (the B\/A Agreement ) in the form of Exhibit B hereto and an Acceptance Request in Harris standard form at the time such B\/A is requested with respect to such draft presented to Harris for acceptance hereunder. To provide the Company with immediate cash for the B\/As created hereunder, Harris agrees to discount such B\/As at a rate determined by adding a rate per annum (calculated on the basis of a 360-day year and actual days elapsed) equal to the Applicable Margin to the then current bankers acceptance rate for B\/As on which Harris is the acceptor and to credit the proceeds of such discounting to the Company s account at Harris. The face amount of each B\/A created and outstanding pursuant hereto shall be deducted from the credit which may be otherwise available under the Revolving Credit. Each B\/A shall have a term of 30, 60, 90, 120, 150 or 180 days (but not later than the Termination Date), and shall be an acceptance eligible for discount with Federal Reserve Bank in accordance with paragraph 7A of Section 13 of the Federal Reserve Act and regulations and interpretations applicable thereto. The Company shall present to Harris evidence of such eligibility satisfactory to the Banks, and Harris in its sole discretion may refuse to issue any B\/A. .c2.Section 1.6. Letters of Credit.; Subject to all the terms and conditions hereof, satisfaction of all conditions precedent to borrowing under this Agreement and so long as no Potential Default or Event of Default is in existence, at the Company s request Harris may in its discretion issue letters of credit (an L\/C and collectively the L\/Cs ) for the account of the Company subject to availability under the Revolving Credit, and the Banks hereby agree to participate therein as more fully described in Section 1.9 hereof. Each L\/C shall be issued pursuant to an Application for Letter of Credit (the L\/C Agreement ) in the form of Exhibit C hereto. The L\/Cs shall consist of standby letters of credit in an aggregate face amount not to exceed $20,000,000. Each L\/C shall have an expiry date not more than one year from the date of issuance thereof (but in no event later than the Termination Date). The amount available to be drawn under each L\/C issued pursuant hereto shall be deducted from the credit otherwise available under the Revolving Credit. In consideration of the issuance of L\/Cs the Company agrees to pay Harris a fee (the L\/C Fee ) in the amount per annum equal to (a) 1.0% of the face amount of each Performance L\/C and (b) the Applicable Margin for Eurodollar Loans of the stated amount of each Financial Guarantee L\/C (in each case computed on the basis of a 360 day year and actual days elapsed) of the face amount for any L\/C issued hereunder. In addition the Company shall pay Harris for its own account an issuance fee (the L\/C Issuance Fee ) in an amount equal to one-eighth of one percent (0.125%) of the stated amount of each L\/C issued by Harris hereunder. All L\/C Fees shall be payable quarterly in arrears on the last day of each calendar quarter and on the Termination Date, and all L\/C Issuance Fees shall be payable on the date of issuance of each L\/C hereunder and on the date of each extension, if any, of the expiry date of each L\/C. .c2.Section 1.7. Reimbursement Obligation;. The Company is obligated, and hereby unconditionally agrees, to pay in immediately available funds to the Agent for the account of Harris and the Banks who are participating in L\/Cs and B\/As pursuant to Section 1.9 hereof the face amount of (a) each B\/A created by Harris hereunder not later than 11:00 A.M. (Chicago Time) on the maturity date of such B\/A, and (b) each draft drawn and presented under an L\/C issued by Harris hereunder not later than 11:00 a.m. (Chicago Time) on the date such draft is presented for payment to Harris (the obligation of the Company under this Section 1.7 with respect to any B\/A or L\/C is a Reimbursement Obligation ). If at any time the Company fails to pay any Reimbursement Obligation when due, the Company shall be deemed to have automatically requested a Domestic Rate Loan from the Banks hereunder, as of the maturity date of such Reimbursement Obligation, the proceeds of which Loan shall be used to repay such Reimbursement Obligation. Such Loan shall only be made if no Potential Default or Event of Default shall exist and upon approval by all of the Banks, and shall be subject to availability under the Revolving Credit. If such Loan is not made by the Banks for any reason, the unpaid amount of such Reimbursement Obligation shall be due and payable to the Agent for the pro rata benefit of the Banks upon demand and shall bear interest at the rate of interest specified in Section 1.3(d) hereof. .c2.Section 1.8. Manner of Borrowing and Rate Selection;. (a) The Company shall give telephonic, telex or telecopy notice to the Agent (which notice, if telephonic, shall be promptly confirmed in writing) no later than (i) 11:00 a.m. (Chicago time) on the date the Banks are requested to make each Domestic Rate Loan, (ii) 11:00 a.m. (Chicago time) on the date at least three (3) Banking Days prior to the date of (A) each Eurodollar Loan which the Banks are requested to make or continue, and (B) the conversion of any CD Rate Loan or Domestic Rate Loan into a Eurodollar Loan and (iii) 11:00 a.m. (Chicago time) on the date at least one (1) Business Day prior to the date of (A) each CD Rate Loan which the Banks are requested to make and (B) the conversion of any Eurodollar Loan or Domestic Rate Loan into a CD Rate Loan. Each such notice shall specify the date of the Revolving Credit Loan requested (which shall be a Business Day in the case of Domestic Rate Loans and CD Rate Loans and a Banking Day in the case of a Eurodollar Loan), the amount of such Revolving Credit Loan, whether the Revolving Credit Loan is to be made available by means of a Domestic Rate Loan, CD Rate Loan or Eurodollar Loan and, with respect to Fixed Rate Loans, the Interest Period applicable thereto; provided, that in no event shall the principal amount of any requested Revolving Credit Loan plus the aggregate principal or face amount, as appropriate, of all Revolving Credit Loans, L\/Cs, B\/As and unpaid Reimbursement Obligations outstanding hereunder exceed the amounts specified in Section 1.1 hereof. The Company agrees that the Agent may rely on any such telephonic, telex or telecopy notice given by any person who the Agent believes is authorized to give such notice without the necessity of independent investigation and in the event any notice by such means conflicts with the written confirmation, such notice shall govern if any Bank has acted in reliance thereon. The Agent shall, no later than 12:30 p.m. (Chicago time) on the day any such notice is received by it, give telephonic, telex or telecopy (if telephonic, to be confirmed in writing within one Business Day) notice of the receipt of notice from the Company hereunder to each of the Banks, and, if such notice requests the Banks to make, continue or convert any Fixed Rate Loans, the Agent shall confirm to the Company by telephonic, telex or telecopy means, which confirmation shall be conclusive and binding on the Company in the absence of manifest error, the Interest Period and the interest rate applicable thereto promptly after such rate is determined by the Agent. (b) Subject to the provisions of Section 6 hereof, the proceeds of each Revolving Credit Loan shall be made available to the Company at the principal office of the Agent in Chicago, Illinois, in immediately available funds, on the date such Revolving Credit Loan is requested to be made, except to the extent such Revolving Credit Loan represents (i) the conversion of an existing Revolving Credit Loan or (ii) a refinancing of a Reimbursement Obligation, in which case each Bank shall record such conversion on the schedule to its Revolving Note, or in lieu thereof, on its books and records, and shall effect such conversion or refinancing, as the case may be, on behalf of the Company in accordance with the provisions of Section 1.4(a) hereof and 1.9 hereof, respectively. Not later than 2:00 p.m. Chicago time, on the date specified for any Revolving Credit Loan to be made hereunder, each Bank shall make its portion of such Revolving Credit Loan available to the Company in immediately available funds at the principal office of the Agent, except (i) as otherwise provided above with respect to converting or continuing any outstanding Revolving Credit Loans and (ii) to the extent such Revolving Credit Loan represents a refinancing of any outstanding Reimbursement Obligations. (c) Unless the Agent shall have been notified by a Bank prior to 1:00 p.m. (Chicago time) on the date a Revolving Credit Loan is to be made by such Bank (which notice shall be effective upon receipt) that such Bank does not intend to make the proceeds of such Revolving Credit Loan available to the Agent, the Agent may assume that such Bank has made such proceeds available to the Agent on such date and the Agent may in reliance upon such assumption (but shall not be required to) make available to the Company a corresponding amount. If such corresponding amount is not in fact made available to the Agent by such Bank, the Agent shall be entitled to receive such amount on demand from such Bank (or, if such Bank fails to pay such amount forthwith upon such demand, to recover such amount, together with interest thereon at the rate otherwise applicable thereto under Section 1.3 hereof, from the Company) together with interest thereon in respect of each day during the period commencing on the date such amount was made available to the Company and ending on the date the Agent recovers such amount, at a rate per annum equal to the effective rate charged to the Agent for overnight Federal funds transactions with member banks of the Federal Reserve System for each day, as determined by the Agent (or, in the case of a day which is not a Business Day, then for the preceding Business Day) (the Fed Funds Rate ). Nothing in this Section 1.8(c) shall be deemed to permit any Bank to breach its obligations to make Loans under the Revolving Credit or to limit the Company s claims against any Bank for such breach. .c2.Section 1.9. Participation in B\/As and L\/Cs;. Each of the Banks will acquire a risk participation for its own account, without recourse to or representation or warranty from Harris, in each B\/A upon the creation thereof and in each L\/C upon the issuance thereof ratably in accordance with its Commitment Percentage. In the event any Reimbursement Obligation is not immediately paid by the Company pursuant to Section 1.7 hereof, each Bank will pay to Harris funds in an amount equal to such Bank s ratable share of the unpaid amount of such Reimbursement Obligation (based upon its proportionate share relative to its percentage of the Revolving Credit (as set forth in Section 1.1 hereof)). At the election of all of the Banks, such funding by the Banks of the unpaid Reimbursement Obligations shall be treated as additional Revolving Credit Loans to the Company hereunder rather than a purchase of participations by the Banks in the related B\/As and L\/Cs held by Harris. The availability of funds to the Company under the Revolving Credit shall be reduced in an amount equal to any such B\/A or L\/C. The obligation of the Banks to Harris under this Section 1.9 shall be absolute and unconditional and shall not be affected or impaired by any Event of Default or Potential Default which may then be continuing hereunder. Harris shall notify each Bank by telephone of its proportionate share relative to its percentage of the total Banks Revolving Credit Commitments set forth in Section 1.1 hereof (a Commitment Percentage ) of such unpaid Reimbursement Obligation. If such notice has been given to each Bank by 12:00 Noon, Chicago time, each Bank agrees to pay Harris in immediately available and freely transferable funds on the same Business Day. If such notice is received after 12:00 noon, Chicago time, each Bank agrees to pay Harris in immediately available and freely transferable funds no later than the following Business Day. Funds shall be so made available at the account designated by Harris in such notice to the Banks. Upon the election by the Banks to treat such funding as additional Revolving Credit Loans hereunder and payment by each Bank, such Loans shall bear interest in accordance with Section 1.3(a) hereof. Harris shall share with each Bank on a pro rata basis relative to its Commitment Percentage a portion of each payment of a Reimbursement Obligation (whether of principal or interest) and any B\/A commission and any L\/C Fee (but not any L\/C Issuance Fee) payable by the Company. Any such amount shall be promptly remitted to the Banks when and as received by Harris from the Company. .c2.Section 1.10. Capital Adequacy;. If, after the date hereof, any Bank or the Agent shall have determined in good faith that the adoption of any applicable law, rule or regulation regarding capital adequacy, or any change therein (including, without limitation, any revision in the Final Risk-Based Capital Guidelines of the Board of Governors of the Federal Reserve System (12 CFR Part 208, Appendix A; 12 CFR Part 225, Appendix A) or of the Office of the Comptroller of the Currency (12 CFR Part 3, Appendix A), or in any other applicable capital rules heretofore adopted and issued by any governmental authority), or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Bank (or its Lending Office) with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on such Bank s capital, or on the capital of any corporation controlling such Bank, in each case as a consequence of its obligations hereunder to a level below that which such Bank would have achieved but for such adoption, change or compliance (taking into consideration such Bank s policies with respect to capital adequacy) by an amount reasonably deemed by such Bank to be material, then from time to time, within fifteen (15) days after demand by such Bank (with a copy to the Agent), the Company shall pay to such Bank such additional amount or amounts as will compensate such Bank for such reduction. Section 2. The Competitive Bid Facility;. .c2.Section 2.1. Amount and Term;. The Company may from time to time before the Termination Date request Competitive Bids from the Banks and the Banks may make, at their sole discretion, Bid Loans to the Company on the terms and conditions set forth in this Agreement. Notwithstanding any provision to the contrary contained in this Agreement, (a) the aggregate principal amount of all Bid Loans outstanding hereunder at any time may not exceed $50,000,000, (b) no Bank may make Bid Loans in an aggregate principal amount in excess of the maximum amount of such Bank s Revolving Credit Commitment set forth in Section 1.1(b) of this Agreement, and (c) the aggregate principal amount of all Bid Loans outstanding hereunder at any time together with the aggregate principal amount of all Revolving Credit Loans outstanding under the Revolving Credit shall not exceed the Banks Revolving Credit Commitments from time to time in effect. The Company may request Competitive Bids and the Banks may, in their discretion, make such Competitive Bids on the terms and conditions set forth in this Section 2. .c2.Section 2.2. Competitive Bid Requests;. In order to request Competitive Bids, the Company shall give telephonic notice to be received by the Agent no later than 11:00 A.M., Chicago time, one Business Day before the date, which must be a Business Day, on which a proposed Bid Loan is to be made (the Borrowing Date ), followed on the same day by a duly completed Competitive Bid Request Confirmation in the form of Exhibit N hereto to be received by the Agent not later than 11:30 A.M., Chicago time. Competitive Bid Request Confirmations that do not conform substantially to the format of Exhibit N may be rejected and the Agent shall give telephonic notice to the Company of such rejection promptly after it determines (which determination shall be conclusive) that a Competitive Bid Request Confirmation does not substantially conform to the format of Exhibit N. Competitive Bid Requests shall in each case refer to this Agreement and specify (x) the proposed Borrowing Date (which shall be a Business Day), (y) the aggregate principal amount thereof (which shall not be less than $3,000,000 and shall be an integral multiple of $1,000,000), and (z) up to 3 Interest Periods with respect to the entire amount specified in such Competitive Bid Request (which must be of no less than 30 and no more than 180 days duration and may not end after the Termination Date). Upon receipt by the Agent of a Competitive Bid Request Confirmation which conforms substantially to the format of Exhibit N attached hereto, the Agent shall invite, by telephone promptly confirmed in writing in the form of Exhibit O attached hereto, the Banks to bid, on the terms and conditions of this Agreement, to make Bid Loans pursuant to the Competitive Bid Request. .c2.Section 2.3. Submission of Competitive Bids;. Each Bank may, in its sole discretion, make one or more Competitive Bids to the Company responsive to the Competitive Bid Request. Each Competitive Bid by a Bank must be received by the Agent by telephone not later than 8:45 A.M., Chicago time, on the Borrowing Date, promptly confirmed in writing by a duly completed Confirmation of Competitive Bid substantially in the form of Exhibit P attached hereto to be received by the Agent no later than 9:00 A.M. on the same day; provided, however, that any Competitive Bid made by Harris must be made by telephone to the Company no later than 8:30 A.M., Chicago time, and confirmed by telecopier to the Company no later than 8:45 A.M., Chicago time, on the Borrowing Date. Competitive Bids which do not conform precisely to the terms of this Section 2.3 may be rejected by the Agent and the Agent shall notify the Bank submitting such Competitive Bid of such rejection by telephone as soon as practicable after determining that the Competitive Bid does not conform precisely to the terms of this Section 2.3. Each Competitive Bid shall refer to this Agreement and specify (x) the maximum principal amount (which shall not be less than $3,000,000 and shall be an integral multiple of $1,000,000) of the Bid Loan that the Bank is willing to make to the Company (y) the Yield (which shall be computed on the basis of a 360-day year and actual days elapsed and for a period equal to the Interest Period applicable thereto) at which the Bank is prepared to make the Bid Loan and (z) the Interest Period applicable thereto. The Agent shall reject any Competitive Bid if such Competitive Bid (i) does not specify all of the information specified in the immediately preceding sentence, (ii) contains any qualifying, conditional, or similar language, (iii) proposes terms other than or in addition to those set forth in the Competitive Bid Request to which it responds, or (iv) is received by the Agent later than 8:45 A.M. (Chicago time). Any Competitive Bid submitted by a Bank pursuant to this Section 2.3 shall be irrevocable and shall be promptly confirmed in writing in the form of Exhibit P; provided that in all events the telephone Competitive Bid received by the Agent shall be binding on the relevant Bank and shall not be altered, modified, or in any other manner affected by any inconsistent terms contained in, or terms missing from, the Bank s Confirmation of Competitive Bid. .c2.Section 2.4. Notice of Bids;. The Agent shall give telephonic notice to the Company no later than 9:15 A.M., Chicago time, on the proposed Borrowing Date, of the number of Competitive Bids made, the Yield with respect to each proposed Bid Loan, the Interest Period applicable thereto and the maximum principal amount of each Bid Loan in respect of which a Competitive Bid was made and the identity of the Bank making each bid. The Agent shall send a summary of all Competitive Bids received by the Agent to the Company as soon as practicable after receipt of a Competitive Bid from each Bank that has made a Competitive Bid. .c2.Section 2.5. Acceptance or Rejection of Bids;. The Company may in its sole and absolute discretion, subject only to the provisions of this Section, irrevocably accept or reject, in whole or in part, any Competitive Bid referred to in Section 2.4 above. No later than 9:45 A.M., Chicago time, on the proposed Borrowing Date, the Company shall give telephonic notice to the Agent of whether and to what extent it has decided to accept or reject any or all the Competitive Bids referred to in Section 2.4 above, which notice shall be promptly confirmed in a writing to be received by the Agent on the proposed Borrowing Date; provided, however, that (x) no bid shall be accepted for a Bid Loan in a minimum principal amount of less than $3,000,000, (y) the Company shall accept bids solely on the basis of ascending Yields for each Interest Period, (z) if the Company declines to borrow, or it is restricted by other conditions hereof from borrowing, the maximum principal amount of Bid Loans in respect of which bids at such Yield have been made, then the Company shall accept a pro rata portion of each bid made at the same Yield, based as nearly as possible on the ratio of the maximum aggregate principal amounts of Bid Loans for which each such bid was made (provided that if the available principal amount of Bid Loans to be so allocated is not sufficient to enable Bid Loans to be so allocated to each such Bank in integral multiples of $1,000,000, the Company shall select which Banks will be allocated such Bid Loans and will round allocations up or down to the next higher or lower multiple of $1,000,000 as it shall deem appropriate but in no event shall any Bid Loan be allocated in a principal amount of less than $3,000,000), and (w) the aggregate principal amount of all Competitive Bids accepted by the Company shall not exceed the amount contained in the related Confirmation of Competitive Bid Request. A notice given by the Company pursuant to this Section 2.5 shall be irrevocable and shall not be altered, modified, or in any other manner affected by any inconsistent terms contained in, or terms missing from, any written confirmation of such notice. .c2.Section 2.6. Notice of Acceptance or Rejection of Bid;. The Agent shall promptly (but in any event no later than 10:30 A.M., Chicago time) give telephonic notice to the Banks whether or not their Competitive Bids have been accepted (and if so, in what amount and at what Yield) on the proposed Borrowing Date, and each successful bidder will thereupon become bound, subject to Section 7 and the other applicable conditions hereof, to make the Bid Loan in respect of which its bid has been accepted. Each Bank so bound shall notify the Agent upon making the Bid Loan. As soon as practicable on each Borrowing Date, the Agent shall notify each Bank of the aggregate principal amount of all Bid Loans made pursuant to a Competitive Bid Request on such Borrowing Date, the Interest Period(s) applicable thereto and the highest and lowest Yields at which such Bid Loans were made for each Interest Period. .c2.Section 2.7. Restrictions on Bid Loans;. A Bid Loan shall not be made if an Event of Default or Potential Default shall have occurred and be continuing on the date on which such Bid Loan is to be made and the Company may not obtain more than three Bid Loans in any calendar week. .c2.Section 2.8. Minimum Amount;. Each Bid Loan made to the Company on any date shall be in an integral multiple of $1,000,000 and in a minimum principal amount of $3,000,000. Bid Loans shall be made in the amounts accepted by the Company in accordance with Section 2.5. .c2.Section 2.9. The Notes;. The Bid Loans made by each Bank to the Company shall be evidenced by the Revolving Note of the Company payable to the order of such Bank as described in Section 1.2. The outstanding principal balance of each Bid Loan, as evidenced by a Note, shall be payable at the end of every Interest Period applicable to such Bid Loan. Each Bid Loan evidenced by each Revolving Note shall bear interest from the date such Bid Loan is made on the outstanding principal balance thereof as set forth in Section 2.10 below. .c2.Section 2.10. Term of and Interest on Bid Loans;. Each Bid Loan shall bear interest during the Interest Period applicable thereto at a rate per annum equal to the rate of interest offered in the Competitive Bid therefor submitted by the Bank making such Bid Loan and accepted by the Company pursuant to Section 2.5 above. The principal amount of each Bid Loan, together with all accrued interest thereon, shall be due and payable on the last day of the Interest Period applicable thereto and at maturity (whether by acceleration or otherwise) and, with respect to any Interest Period in excess of three months, interest on the unpaid principal amount shall be due on the date occurring every three months after the date the relevant Bid Loan was made. If any payment of principal or interest on any Bid Loan is not made when due, such Bid Loan shall bear interest (computed on the basis of a year of 360 days and actual days elapsed) from the date such payment was due until paid in full, payable on demand, at a rate per annum equal to the sum of 2.5% plus the rate of interest in effect thereon at the time of such default until the end of the Interest Period then applicable thereto, and, thereafter, at a rate per annum equal to the sum of 2.5 plus the Domestic Rate from time to time in effect. .c2.Section 2.11. Disbursement of Bid Loans;. (a) Subject to the provisions of Section 6 hereof, the proceeds of each Bid Loan shall be made available to the Company by, at the Company s option, crediting an account maintained by the Company at Harris Trust and Savings Bank or by wire transfer of such proceeds to such account as the Company shall designate in writing to the Agent from time to time, in immediately available funds. Not later than 12:00 Noon, Chicago time, on the date specified for any Bid Loan to be made hereunder, each Bank which is bound to make such Bid Loan pursuant to Section 2.6 hereof shall make its portion of such Bid Loan available to the Company in immediately available funds at the principal office of the Agent in Chicago, Illinois. (b) Unless the Agent shall have been notified by a Bank no later than the time the Agent gives such Bank a notice pursuant to Section 2.6 hereof (which notice shall be effective upon receipt) that such Bank does not intend to make the proceeds of such Bid Loan available to the Agent, the Agent may assume that such Bank has made such proceeds available to the Agent on such date and the Agent may in reliance upon such assumption (but shall not be required to) make available to the Company a corresponding amount. If such corresponding amount is not in fact made available to the Agent by such Bank, the Agent shall be entitled to receive such amount on demand from such Bank (or, if such Bank fails to pay such amount forthwith upon such demand, to recover such amount from the Company) together with interest thereon in respect of each day during the period commencing on the date such amount was made available to the Company and ending on the date the Agent recovers such amount, at a rate per annum equal to the effective rate charged to the Agent for overnight Federal funds transactions with member banks of the Federal Reserve System for each day, as determined by the Agent (or, in the case of a day which is not a Business Day, then for the preceding Business Day). Nothing in this Section 2.11(b) shall be deemed to permit any Bank to breach its obligations to make Bid Loans hereunder, or to limit the Company s claims against any Bank for such breach. .c2.Section 2.12. Reliance on Telephonic Notices; Indemnity;. (a) The Company agrees that the Agent may rely on any telephonic notice referred to in this Section 2 and given by any person the Agent reasonably believes is authorized to give such notice without the necessity of independent investigation, and in the event any such telephonic notice conflicts with any written notice relating thereto, or in the event no such written notice is received by the Agent, such telephonic notice shall govern if the Agent or any Bank has acted in reasonable reliance thereon. The Agent s books and records shall be prima facie evidence of all of the matters set forth in Sections 2.2, 2.3, 2.4., 2.5 and 2.6 hereof. (b) The Company hereby agrees to indemnify and hold the Agent harmless from and against any and all claims, damages, losses, liabilities and expenses, including court costs and legal expenses, paid or incurred by the Agent in connection with any action the Agent may take, or fail to take, in reasonable reliance upon and in accordance with any telephonic notice received by the Agent as described in this Section 2. (c) The Banks hereby agree to indemnify and hold the Agent harmless from and against any and all claims, damages, losses, liabilities and expenses, including court costs and legal expenses, paid or incurred by the Agent in connection with any action the Agent may take, or fail to take, in reasonable reliance upon and in accordance with any telephonic notice received by the Agent as described in this Section 2, to the extent the Agent is not promptly reimbursed therefor by the Company. .c2.Section 2.13. Telephonic Notice;. Each Bank s telephonic notice to the Agent of its Competitive Bid pursuant to Section 2.3, and the Company s telephonic acceptance of any offer contained in a Bid pursuant to Section 2.5, shall be irrevocable and binding on such Bank and the Company, as applicable, and shall not be altered, modified, or in any other manner affected by any inconsistent terms contained in, or missing from, any written confirmation of such telephonic notice. It is understood and agreed by the parties hereto that the Agent shall be entitled to act, or to fail to act, hereunder in reliance on its records of any telephonic notices provided for herein and that the Agent shall not incur any liability to any Person in so doing if its records conflict with any written confirmation of a telephone notice or otherwise, provided that any such action taken or omitted by the Agent is taken or omitted reasonably and in good faith. It is further understood and agreed by the parties hereto that each party hereto shall in good faith endeavor to provide the notices specified herein by the times of day as set forth in this Section 2 but that no party shall incur any liability or other responsibility for any failure to provide such notices within the specified times; provided, however, that the Agent shall have no obligation to notify the Company of any Competitive Bid received by it later than 8:45 A.M. (Chicago time) on the proposed Borrowing Date, and no acceptance by the Company of any offer contained in a Competitive Bid shall be effective to bind any Bank to make a Bid Loan, nor shall the Agent be under any obligation to notify any Person of an acceptance, if notice of such acceptance is received by the Agent later than 9:45 A.M. (Chicago time) on the proposed Borrowing Date. 3. Fees, Prepayments, Terminations and Place and Application of Payments. .c2.Section 3.1. Facility Fee;. For the period from the date hereof to and including the Termination Date, the Company shall pay to the Agent for the account of the Banks a facility fee with respect to the Revolving Credit at the rate of three-eighths of one percent (0.375%) per annum if the Company s Leverage Ratio is equal to or greater than 0.45 to 1 and one-quarter of one percent (0.25%) per annum if the Company s Leverage Ratio is less than 0.45 to 1 (in each case computed in each case on the basis of a year of 360 days for the actual number of days elapsed) of the aggregate maximum amount of the Banks Revolving Credit Commitments hereunder in effect from time to time and whether or not any credit is in use under the Revolving Credit, all such fees to be payable quarterly in arrears on the last day of each calendar quarter commencing on the last day of June, 1993, and on the Termination Date, unless the Revolving Credit is terminated in whole on an earlier date, in which event the facility fee for the final period shall be paid on the date of such earlier termination in whole. .c2.Section 3.2. Agent s Fee;. The Company shall pay to and for the sole account of the Agent such fees as may be agreed upon in writing from time to time by the Agent and the Company. Such fees shall be in addition to any fees and charges the Agent may be entitled to receive under Section 10 hereunder or under the other Loan Documents. .c2.Section 3.3. Optional Prepayments;. The Company shall have the privilege of prepaying without premium or penalty and in whole or in part (but if in part, then in a minimum principal amount of $2,500,000 or such greater amount which is an integral multiple of $100,000) any Domestic Rate Loan at any time upon prior telex or telephonic notice to the Agent on or before 12:00 Noon on the same Business Day. The Company may not prepay any Eurodollar Loan, CD Rate Loan or Bid Loan. Any amount prepaid under the Revolving Credit may, subject to the terms and conditions of this Agreement, be borrowed, repaid and borrowed again. .c2.Section 3.4. Mandatory Prepayments - Borrowing Base. The Company shall not permit the sum of the principal amount of all Loans plus the aggregate face amount of all B\/As, the amount available for drawing under all L\/Cs and the aggregate principal amount of all unpaid Reimbursement Obligations at any time outstanding to exceed the lesser of (i) the sum of the Banks Revolving Credit Commitments or (ii) the Borrowing Base as determined on the basis of the most recent Borrowing Base Certificate. In addition to the Company s obligations to pay any outstanding Reimbursement Obligations as set forth in Section 1.7 hereof, the Company will make such payments on any outstanding Loans and Reimbursement Obligations (and, if any B\/As are then outstanding, deposit an amount equal to the aggregate face amount of all such B\/As into an interest bearing account with the Agent which shall be held as additional collateral security for such B\/As) which are necessary to cure any such excess within three Business Days after the occurrence thereof. Any amount prepaid under the Revolving Credit may, subject to the terms and conditions of this Agreement, be borrowed, prepaid and borrowed again. Section 3.5. Place and Application of Payments. All payments of principal and interest made by the Company in respect of the Notes and Reimbursement Obligations and all fees payable by the Company hereunder, shall be made to the Agent at its office at 111 West Monroe Street, Chicago, Illinois 60690 and in immediately available funds, prior to 12:00 noon on the date of such payment. All such payments shall be made without setoff or counterclaim and without reduction for, and free from, any and all present and future levies, imposts, duties, fees, charges, deductions withholdings, restrictions or conditions of any nature imposed by any government or any political subdivision or taxing authority thereof. Unless the Banks otherwise agree, any payments received after 12:00 noon Chicago time shall be deemed received on the following Business Day. The Agent shall remit to each Bank its proportionate share of each payment of principal, interest and facility fees, B\/A fees and L\/C fees received by the Agent by 3:00 P.M. Chicago time on the same day of its receipt if received by the Agent by 12:00 noon, Chicago time, and its proportionate share of each such payment received by the Agent after 12:00 noon on the Business Day following its receipt by the Agent. In the event the Agent does not remit any amount to any Bank when required by the preceding sentence, the Agent shall pay to such Bank interest on such amount until paid at a rate per annum equal to the Fed Funds Rate. The Company hereby authorizes the Agent to automatically debit its account with Harris for any principal, interest and fees when due under the Notes, the B\/A Agreement, any L\/C Agreement or this Agreement and to transfer the amount so debited from such account to the Agent for application as herein provided. All proceeds of Collateral shall be applied in the manner specified in the Security Agreement. 1.2. Section 4.8 of the Credit Agreement shall be amended to read as follows: 4.8. Applicable Margin shall mean, with respect to each type of Loan and the B\/As described in Column A below, the rate of interest per annum shown in Columns B, C, D and E below for the range of Leverage Ratio specified for each Column:\nA B C D E\nLeverage Ratio 0.45 to 1 .45 to 1 and 0.5 to 1 .50 to 1 and .60 to 1 .60 to 1 and .70 to 1\nEurodollar Loans 0.75% 1.125% 1.375% 1.75% B\/As 0.75% 1.125% 1.375% 1.75% Domestic Rate Loans 0.0% 0.125% 0.375% 0.75% CD Rate Loans 0.875% 1.25% 1.50% 1.875%\nNot later than 5 Business Days after receipt by the Agent of the financial statements called for by Section 7.4 hereof for the applicable fiscal quarter, the Agent shall determine the Leverage Ratio for the applicable period and shall promptly notify the Company and the Banks of such determination and of any change in the Applicable Margins resulting therefrom. Any such change in the Applicable Margins shall be effective as of the date the Agent so notifies the Company and the Banks with respect to all Loans and B\/As outstanding on such date, and such new Applicable Margins shall continue in effect until the effective date of the next quarterly redetermination in accordance with this Section. Each determination of the Leverage Ratio and Applicable Margins by the Agent in accordance with this Section shall be conclusive and binding on the Company and the Banks absent manifest error. From the date hereof until the Applicable Margins are first adjusted pursuant hereto, the Applicable Margins shall be those set forth in column E above. 1.3. Section 4.45 of the Credit Agreement shall be amended to read as follows: 4.45. Intentionally Omitted. 1.4. Section 4.53 of the Credit Agreement shall be amended to read as follows: 4.53. Fixed Rate Loan shall mean a Eurodollar Loan, a CD Rate Loan or a Bid Loan, and Fixed Rate Loans shall mean any one or more of such types of Loans. 1.5. Section 4.61 of the Credit Agreement shall be amended to read as follows: 4.61. Interest Period shall mean with respect to (a) the Eurodollar Loans, the period used for the computation of interest commencing on the date the relevant Eurodollar Loan is made, continued or effected by conversion and concluding on the date one, two, three or six months thereafter and, (b) to the CD Rate Loans, the period used for the computation of interest commencing on the date the relevant CD Rate Loan is made, continued or effected by conversion and concluding on the date 30, 60, 90 or 180 days thereafter, and (c) the Bid Loans, the period used for the computation of interest commencing on the date the relevant Bid Loan is made and ending on the date such Bid Loan is scheduled to mature, but in no event may such period have a duration of less than 30 days or more than 180 days; provided, however, that no Interest Period for any Fixed Rate Loan may extend beyond the Termination Date. For purposes of determining an Interest Period applicable to a Eurodollar Loan, a month means a period starting on one day in a calendar month and ending on a numerically corresponding day in the next calendar month; provided, however, that if there is no numerically corresponding day in the month in which an Interest Period is to end or if an Interest Period begins on the last day of a calendar month, then such Interest Period shall end on the last Banking Day of the calendar month in which such Interest Period is to end. 1.6. Section 4.69 of the Credit Agreement shall be amended to read as follows: 4.69. Loan shall mean a Revolving Credit Loan as a Bid Loan, and Loans shall mean any two or more Revolving Credit Loans and\/or Bid Loans. 1.7. The Credit Agreement shall be amended by adding the following provisions after Section 4.103 as Section 4.104, 4.105 and 4.106 of the Credit Agreement: 4.104. Bid Loan shall mean an advance from a Bank to the Company pursuant to the binding procedures described in Section 2 hereof. 4.105. Competitive Bid shall mean an offer by a Bank to make a Bid Loan pursuant to Section 2 hereof. 4.106. Competitive Bid Request shall mean a request made by the Company pursuant to Section 2.2 hereof. 1.8. Section 7.4(b) of the Credit Agreement shall be amended to read as follows: (b) as soon as available, and in any event within 90 days after the close of each fiscal year, a copy of the audit report for such year and accompanying financial statements, including a consolidated balance sheet, a statement of income and retained earnings, and a statement of cash flows, together with all footnotes thereto, for the Company and its Subsidiaries, and unaudited consolidating balance sheets, statement of income and retained earnings and statements of cash flows for the Company and its Subsidiaries, in each case, showing in comparative form the figures for the previous fiscal year of the company, all in reasonable detail, accompanied by an unqualified opinion of Ernst & Young or other independent public accountants of nationally recognized standing selected by the Company and satisfactory to the Required Banks, such opinion to indicate that such statements are made in accordance with generally accepted accounting principles; . 1.9. Sections 7.4(d) and (e) shall each be amended by replacing the phrase 10 Business Days appearing in the first lines thereof with the phrase 30 days . 1.10. Section 7.4(f) of the Credit Agreement shall be amended by deleting the phrase by month appearing in the least line thereof. 1.11. Section 7.4(i) of the Credit Agreement shall be amended to read as follows: (i) within 90 days of the last day of each Fiscal Year of the Company, a summary of the capital expenditures made or incurred by the Company and its Subsidiaries during such Fiscal Year, all in reasonable detail, prepared by the Company and certified on behalf of the Company by the Company s chief financial officer. 1.12. Section 7.6 of the Credit Agreement shall be amended to read as follows: .c2. Section 7.6. Consolidation and Merger;. The Company will not, and will not permit any Subsidiary to, consolidate with or merge into any Person, or permit any other Person to merge into it, or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the Property of the other Person, or acquire substantially as an entirety the business of any other Person, without the prior written consent of the Required Banks; provided, however, that if no Potential Default or Event of Default shall have occurred and be continuing the Company may acquire all or substantially all the Property of the other Person, or acquire substantially as an entirety the business of any other Person if the aggregate fair market value of all consideration paid or payable by the Company in all such acquisitions made in any Fiscal Year does not exceed $10,000,000. 1.13. Sections 7.8 and 7.9 of the Credit Agreement shall be amended to read as follows: .c2. Section 7.8. Leverage Ratio;. The Company will not permit the ratio of its Leverage Ratio at any time during each period specified below to exceed the ratio specified below for such period: (a) from the date hereof through the next to last day in Fiscal Year of 1994, 0.65 to 1; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, 0.65 to 1; (c) from the last day of Fiscal Year 1995 through the next to last day of Fiscal Year 1996, 0.625 to 1; and (d) on the last day of Fiscal Year 1996 and thereafter, 0.60 to 1. .c2.Section 7.9. Tangible Net Worth;. The Company shall maintain its Tangible Net Worth at all times during the periods specified below in an amount not less than the minimum required amount for each period set forth below: (a) from the last day of Fiscal Year 1993 through the next to last day in Fiscal Year 1994, $109,780,000; (b) from the last day of Fiscal Year 1994 through the next to last day of Fiscal Year 1995, $109,780,000 plus an amount equal to 75% of the Company s Net Income (but not less than zero) for Fiscal Year 1994, if the Company s Leverage Ratio for such Fiscal Year is equal to or greater than 0.5 to 1, or 50% of the Company s Net Income (but not less than zero) if the Company s Leverage Ratio for such Fiscal Year is less than 0.5 to 1; and (c) from the last day of Fiscal Year 1995 and at all times during each Fiscal Year thereafter, an amount in any Fiscal Year equal to the minimum amount required to be maintained during the preceding Fiscal Year plus an amount equal to 75% of the Company s Net Income (but not less than zero) during such Fiscal Year 1994, if the Company s Leverage Ratio for such Fiscal Year is equal to or greater than 0.5 to 1, or 50% of the Company s Net Income (but not less than zero) if the Company s Leverage Ratio for such Fiscal Year is less than 0.5 to 1. 1.14. Sections 7.13 and 7.14 of the Credit Agreement shall be amended to read as follows: .c2. Section 7.13. Minimum Net Working Capital;. The Company will maintain Net Working Capital at all times during each period specified below (measured as of the last day of each monthly fiscal accounting period) in an amount not less than the amount specified below for each period: (a) from the date hereof through the last day in Fiscal Year 1996, $65,000,000; and (b) from the first day of Fiscal Year 1997 and at all times thereafter, $70,000,000. .c2.Section 7.14. Capital Expenditures;. The Company will not, and will not permit any Subsidiary to, make or commit to make any capital expenditures (as defined and classified in accordance with generally accepted accounting principles consistently applied;) provided, however, that if no Event of Default or Potential Default shall exist before and after giving effect thereto, the Company and its Subsidiaries may make capital expenditures (a) during Fiscal Year 1994, in an amount not to exceed an amount equal to 115% of the Company s depreciation and amortization charges for Fiscal Year 1993, and (b) during each Fiscal Year thereafter, in an aggregate amount in each Fiscal Year commencing with Fiscal Year 1995 not to exceed the sum of (i) an amount equal to 115% of the Company s depreciation and amortization charges for the preceding Fiscal Year and (ii) the amount, if any, by which such capital expenditures made by the Company in the immediately preceding Fiscal Year was less than the maximum amount of capital expenditures the Company was permitted to make under this Section 7.14 during such Fiscal Year, determined without regard to any carryover amount from any prior Fiscal Year, but not to exceed $5,000,000 in any Fiscal Year. 1.15. Section 7.16 of the Credit Agreement shall be amended by deleting the word and appearing after the semicolon appearing in the last line of subsection 7.16(n), by replacing the period at the end of Subsection 7.16(o) with the phrase ; and , and by adding the following provision after subsection 7.16(o) as subsection 7.16(p) of the Credit Agreement: (p) liens, mortgages and security interests in the Company s real estate, buildings, machinery and equipment securing indebtedness permitted only by subsection 7.17(l) of this Agreement. 1.16. Section 7.17 of the Credit Agreement shall be amended by deleting the word and appearing after the semicolon in the last line of subsection 7.17(j), by replacing the period at the end of subsection 7.17(k) with a semicolon, and by adding the following provisions after subsection 7.17(k) as subsections 7.17(l) and (m) of the Credit Agreement. (l) Funded Debt incurred to finance capital expenditures permitted by Section 7.14 hereof, provided the aggregate principal amount of all such Funded Debt incurred during the term of this Agreement does not exceed an amount equal to 50% of the amount of all such capital expenditures actually made through any date of determination; and (m) unsecured indebtedness in an aggregate principal amount not to exceed $20,000,000 outstanding at any time incurred to finance the Company s working capital needs. 1.17. Section 7.22 of the Credit Agreement shall be amended by replacing the phrase to finance its temporary working capital requirements with the phrase for its general corporate purposes . 1.18. Section 7.29 of the Credit Agreement shall be amended to read as follows: Section 7.29. New Subsidiaries. The Company will not, directly or indirectly, create or acquire any Subsidiary unless (a) after giving effect to any such creation or acquisition, the total assets (determined in accordance with generally accepted accounting principles, consistently applied) of all such Subsidiaries would not exceed 5% of the Total Assets of the Company and its Subsidiaries, and (b) all Inventory and Receivables of such Subsidiaries are pledged to the Agent for the benefit of the Banks pursuant to a security agreement substantially identical to the Security Agreement. 1.19. Section 7.30 of the Credit Agreement shall be amended by adding the following sentence after the last sentence thereof: For purposes of this Section 7.30, any Guaranty Fees paid within 45 days after the last day of any Fiscal Year shall be deemed to have been paid during such Fiscal Year. 1.20. Section 7.32(b) of the Credit Agreement shall be amended by replacing the phrase during the term of this Agreement with the phrase in any Fiscal Year. 1.21. Section 8.1(g) shall be amended by replacing the figure $1,000,000 appearing therein with the figure $2,000,000 . 1.22. All reference to the Revolving Notes , Revolving Note , Notes and Note contained in the Credit Agreement and the other Loan Documents shall be deemed to be references to the Secured Revolving Credit Notes executed and delivered by the Company in satisfaction of Section 2.6(a) of this Amendment. 2. Conditions Precedent. The effectiveness of the Amendment is subject to the satisfaction of all of the following conditions precedent: 2.1. The Company and each of the Banks shall have executed this Amendment (such execution may be in several counterparts and the several parties hereto may execute on separate counterparts). 2.2. Mr. and Mrs. Lonnie A. Pilgrim shall have executed and delivered to the Banks the Guarantors Consent in the form set forth below. 2.3. Each of the representations and warranties set forth in Section 5 of the Credit Agreement shall be true and correct. 2.4. The Company shall be in full compliance with all of the terms and conditions of the Credit Agreement and no Event of Default or Potential Default shall have occurred and be continuing thereunder or shall result after giving effect to this Amendment. 2.5. All legal matters incident to the execution and delivery hereof and the instruments and documents contemplated hereby shall be satisfactory to the Banks. 2.6. The Agent shall have received (in sufficient counterparts for distribution to each of the Banks) all of the following in a form satisfactory to the Agent, the Banks and their respective counsel: (a) a Security Revolving Credit Note of the Company payable to the order of each of the Banks in the principal amount equal to each Banks Revolving Credit Commitment, in the form attached hereto as Exhibit A; (b) copies (executed or certified as may be appropriate) of all legal documents or proceedings taken in connection with the execution and delivery of this Amendment, and the other instruments and documents contemplated hereby; and (c) Opinion of counsel to the Company substantially in a form as set forth in Exhibit B hereto and satisfactory to the Agent, the Banks and their respective counsel. 2.7. Harris shall have received a written consent from CoBank with respect to this Amendment and an amendment to the CoBank Participation Agreement in form and substance satisfactory to Harris and CoBank. 2.8. The Agent shall have received for the ratable benefit of the Banks an amendment fee in an amount equal to one-eighth of one percent (0.125%) of the maximum amount of the Revolving Credit. Section 3. Representations And Warranties. Section 3.1. The Company, by its execution of this Amendment, hereby represents and warrants the following: (a) each of the representations and warranties set forth in Section 5 of the Credit Agreement is true and correct as of the date hereof, except that the representations and warranties made under Section 5.3 shall be deemed to refer to the most recent annual report furnished to the Banks by the Company; and (b) the Company is in full compliance with all of the terms and conditions of the Credit Agreement and no Event of Default or Potential Default has occurred and is continuing thereunder. 4. Miscellaneous. 4.1. The Company has heretofore executed and delivered to the Agent that certain Security Agreement Re: Accounts Receivable, Farm Products and Inventory dated as of May 27, 1993 (the Security Agreement ) and the Company hereby agrees that the Security Agreement shall secure all of the Company s indebtedness, obligations and liabilities to the Agent and the Banks under the Credit Agreement as amended by this Amendment, that notwithstanding the execution and delivery of this Amendment, the Security Agreement shall be and remain in full force and effect and that any rights and remedies of the Agent thereunder, obligations of the Company thereunder and any liens or security interests created or provided for thereunder shall be and remain in full force and effect and shall not be affected, impaired or discharged thereby. Nothing herein contained shall in any manner affect or impair the priority of the liens and security interests created and provided for by the Security Agreement as to the indebtedness which would be secured thereby prior to giving effect to this Amendment. 4.2. Except as specifically amended herein the Credit Agreement and the Notes shall continue in full force and effect in accordance with their original terms. Reference to this specific Amendment need not be made in any note, document, letter, certificate, the Credit Agreement itself, the Notes, or any communication issued or made pursuant to or with respect to the Credit Agreement or the Notes, any reference to the Credit Agreement or Notes being sufficient to refer to the Credit Agreement or the Notes as amended hereby. 4.3. The Company agrees to pay all out-of-pocket costs and expenses incurred by the Agent and Banks in connection with the preparation, execution and delivery of this Amendment and the documents and transactions contemplated hereby, including the fees and expenses of Messrs. Chapman and Cutler. 4.4. This Amendment may be executed in any number of counterparts, and by the different parties on different counterparts, all of which taken together shall constitute one and the same Agreement. Any of the parties hereto may execute this Amendment by signing any such counterpart and each of such counterparts shall for all purposes be deemed to be an original. 4.5. (a) This Amendment and the rights and duties of the parties hereto, shall be construed and determined in accordance with the internal laws of the State of Illinois, except to the extent provided in Section 4.5(b) hereof and to the extent that the Federal laws of the United States of America may otherwise apply. (b) Notwithstanding anything in Section 4.5(a) hereof to the contrary, nothing in this Amendment, the Credit Agreement, the Notes, or the Other Loan Documents shall be deemed to constitute a waiver of any rights which the Company, the Agent or any of the Banks may have under the National Bank Act or other applicable Federal law.\nDated as of December 6, 1994. Pilgrim s Pride Corporation By Lonnie A. Pilgrim Its Chief Executive Officer\nAccepted and Agreed to as of the day and year last above written.\nHarris Trust And Savings Bank individually and as Agent By Carl A. Blackham Its Vice President\nFBS Ag Credit, Inc. By Douglas S. Hoffner Its Vice President\nInternationale Nederlanden (U.S.) Capital Corporation, formerly known as Internationale Nederlanden Bank N. V. By \/s Its Vice President\nBoatmen s First National Bank of Kansas City By Randall J. Anderson Its Vice President\nFirst Interstate Bank of Texas, N.A. By \/s Its Vice President Guarantors Consent The undersigned, Lonnie A. Pilgrim and Patty R. Pilgrim, have executed and delivered a Guaranty Agreement dated as of May 27, 1993 (the Guaranty ) to the Banks. As an additional inducement to and in consideration of the Banks acceptance of the foregoing Amendment, the undersigned hereby agree with the Banks as follows: 1. Each of the undersigned consents to the execution of the foregoing Amendment by the Company and acknowledges that this consent is not required under the terms of the Guaranty and that the execution hereof by the undersigned shall not be construed to require the Banks to obtain the undersigneds consent to any future amendment, modification or waiver of any term of the Credit Agreement except as otherwise provided in said Guaranty. Each of the undersigned hereby agrees that the Guaranty shall apply to all indebtedness, obligations and liabilities of the Company to the Banks, the Agent and under the Credit Agreement, as amended pursuant to the foregoing Amendment. Each of the undersigned further agrees that the Guaranty shall be and remain in full force and effect. 2. All terms used herein shall have the same meaning as in the foregoing Amendment, unless otherwise expressly defined herein. Dated as of December 6, 1994.\nLonnie A. Pilgrim\nPatty R. Pilgrim\nAMENDED AND RESTATED LOAN AND SECURITY AGREEMENT\nDated July 29, 1994,\nbetween\nPILGRIM'S PRIDE CORPORATION, as Borrower,\nTHE BANKS PARTY HERETO, and\nCREDITANSTALT-BANKVEREIN, as Agent\nAGREEMENT\nTHIS AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT (the \"Agreement\") is made and entered into the 29th day of July, 1994, by and among PILGRIM'S PRIDE CORPORATION, a Delaware corporation (hereinafter referred to as \"Borrower\"), each of the Banks signatory hereto (hereinafter referred to individually as a \"Bank\" and collectively as the \"Banks\"), and CREDITANSTALT-BANKVEREIN, as agent for the Banks (in such capacity, together with its successors and assigns in such capacity, hereinafter referred to as the \"Agent\");\nW I T N E S S E T H:\nWHEREAS, Borrower, the Banks and the Agent are parties to that certain Loan and Security Agreement, dated as of June 3, 1993 (the \"Original Loan Agreement\"), which currently provides for a term loan (the \"Existing Facility\") in the original principal amount of Twenty-Eight Million Dollars ($28,000,000.00); and\nWHEREAS, the Borrower, the Banks and the Agent wish to amend the Loan Agreement (a) to continue the Existing Facility at its current outstanding balance of $21,700,000.00; (b) to make a standby\/term loan to borrower to be utilized on or before June 20, 1995; and (c) to make certain other changes as more fully set forth herein;\nWHEREAS, for the sake of convenience, Borrower, the Banks and the Agent desire to restate in its entirety the Original Loan Agreement;\nWHEREAS, this Agreement represents a continuation of the Existing Facility, as amended hereby, and not a replacement of the Existing Facility;\nNOW, THEREFORE, in consideration of the foregoing premises, to induce the Banks to extend the financing provided for herein, and for other good and valuable consideration, the sufficiency and receipt of all of which are acknowledged by Borrower, Borrower, the Banks and Agent agree as follows:\n1. DEFINITIONS, TERMS AND REFERENCES\n1.1 Certain Definitions. When used herein, the following terms shall have the following meanings:\n\"Affiliate\" shall mean, as to any Person, any other Person which, directly or indirectly, owns or controls, on an aggregate basis, including all beneficial ownership and ownership or control as a trustee, guardian or other fiduciary, at least ten percent (10%) of the outstanding shares of capital stock having ordinary voting power to elect a majority of the board of directors (irrespective of whether, at the time, stock of any other class or classes of such corporation shall have or might have voting power by reason of the happening of any contingency) of such Person; or which controls, is controlled by or is under common control with such Person. For the purposes of this definition, \"control\" means the possession, directly or indirectly, of the power to direct or cause the direction of management and policies, whether through the ownership of voting securities, by contract or otherwise.\n\"Agreement\" shall mean this Amended and Restated Loan and Security Agreement, as amended or supplemented from time to time.\n\"Applicable Law\" shall mean all provisions of statutes, rules, regulations and orders of any Federal, state, municipal or other governmental department, commission, board, bureau, agency or instrumentality or any court, in each case, whether of the United States or foreign, applicable to a Person, and all orders and decrees of all courts and arbitrators in proceedings or actions in which the Person in question is a party.\n\"Assignee\" shall mean any bank or other entity to which a Bank assigns all or any part of any Loan pursuant to Section 13.4(c) and \"Assignees\" shall mean, collectively, all banks and other entities to which any Bank assigns all or any part of any Loan pursuant to Section 13.4(c) hereof.\n\"Bankruptcy Code\" shall mean the Bankruptcy Reform Act of 1978, as may be amended from time to time.\n\"Base Rate\" shall mean an interest rate per annum, fluctuating daily, equal to the higher of (a) the rate announced by Creditanstalt from time to time at its principal office in New York, New York, as its prime rate for domestic (United States) commercial loans in effect on such day; and (b) the Federal Funds Rate in effect on such day plus one-half percent (1\/2%). (Such Base Rate is not necessarily intended to be the lowest rate of interest charged by Creditanstalt in connection with extensions of credit.) Each change in the Base Rate shall result in a corresponding change in the interest rate hereunder with respect to a Base Rate Loan and such change shall be effective on the effective date of such change in the Base Rate.\n\"Base Rate Loan\" shall mean a Loan bearing interest at a rate based on the Base Rate.\n\"Business Day\" shall mean any day for dealings by and between banks in U.S. dollar deposits in the interbank Eurodollar market in New York City, New York, and London, England, other than a Saturday, Sunday or any day which shall be in London, England or New York City, New York or Atlanta, Georgia, a legal holiday or a day on which banking institutions are authorized by law to close.\n\"Capital Lease\" shall mean, as to any Person, any lease of (or other agreement conveying the right to use) real and\/or personal property which is required to be classified and accounted for as a capital lease on a balance sheet of such Person under GAAP (including Statement of Financial Accounting Standards No. 13 of the Financial Accounting Standards Board).\n\"Closing Date\" shall mean the date that this Agreement has been signed by Borrower, the Banks and the Agent and has become effective in accordance with Section 11 hereof.\n\"Code\" shall mean the Internal Revenue Code of 1986, as amended, and the rules and regulations promulgated thereunder from time to time.\n\"Collateral\" shall mean the property of Borrower described in Section 4.1, or any part thereof, as the context shall require, in which Agent has, or is to have, a Lien pursuant thereto, as security for payment of the Obligations.\n\"Commitment\" shall mean the aggregate obligation of the Banks to make Standby\/Term Loans to Borrower, subject to the terms and conditions hereof, up to an aggregate principal amount at any one time outstanding as to all the Banks equal to Ten Million Dollars ($10,000,000), subject to reduction as set forth in Section 2.7 hereof.\n\"Continue\", \"Continuation\" and \"Continued\" shall refer to the continuation pursuant to Section 3.4 hereof as a Eurodollar Loan from one Interest Period to the next Interest Period.\n\"Convert\", \"Conversion\" and \"Converted\" shall refer to a conversion pursuant to Section 3.4 hereof of a Base Rate Loan into a Eurodollar Loan or of a Eurodollar Loan into a Base Rate Loan.\n\"Creditanstalt\" shall mean Creditanstalt-Bankverein, an Austrian banking corporation, and its successors and assigns.\n\"Current Assets\" of any Person shall mean the aggregate amount of assets of such Person which in accordance with GAAP may be property classified as current assets after deducting adequate reserves where proper.\n\"Current Liabilities\" shall mean all items (including taxes accrued as estimated) which in accordance with GAAP may be properly classified as current liabilities, including in any event all amounts outstanding from time to time under this Agreement, but excluding any current liability under the Working Capital Credit Agreement.\n\"Current Ratio\" shall mean the ratio of Current Assets to Current Liabilities of the Borrower and its Subsidiaries.\n\"Deed of Trust\" shall mean the Deed of Trust, Assignment of Rents and Security Agreement dated June __, 1993, filed for record June 3, 1993, recorded in Volume 775, page 1, Titus County, Texas Deed Records, executed by Borrower, conveying the Mortgaged Property to secure the repayment of the Loans and performance of the Obligations, and all amendments thereto, recorded or to be recorded in the Titus County, Texas Deed Records, including, without limitation, that certain First Amendment to Deed of Trust, Assignment of Rents and Security Agreement dated of even date herewith, recorded or to be recorded in the Titus County, Texas Deed Records.\n\"Default\" shall mean the occurrence of any event or condition which, after satisfaction of any requirement for the giving of notice or the lapse of time, or both, would become an Event of Default.\n\"Default Rate\" shall mean (a) with respect to the unpaid portion of any Loan, an interest rate per annum equal to two percent (2%) above the interest rate set forth for such Loan in Section 3.1(a) hereof or (b) with respect to any portion of the Obligations other than Loans, two percent (2%) above the rate set forth in Section 3.1(a)(ii) hereof.\n\"Equipment\" shall mean all of Borrower's equipment, as such term is defined in Section 9-109(2) of the UCC, now or hereafter located on or based at the Land, whether now owned or existing or hereafter acquired or manufactured and whether or not subsequently removed from the Land, including, but not limited to, all equipment described in or covered by that certain Appraisal of Broiler Processing and Related Facilities in Mt. Pleasant, Texas, dated as of April 30, 1993, prepared for Borrower by Bob G. Derryberry, ARA, ASA, together with any and all accessories, accessions, parts and appurtenances thereto, replacements thereof and substitutions therefor.\n\"ERISA\" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time, and all rules and regulations from time to time promulgated thereunder.\n\"ERISA Affiliate\" shall mean each trade or business (whether or not incorporated) which, together with Borrower, is treated as a single employer under Section 414(b), (c), (m) or (o) of the Code.\n\"Eurodollar Loan\" shall mean a Loan bearing interest at a rate based on a Quoted Rate.\n\"Event of Default\" shall mean any of the events or conditions described in Article 9 hereof.\n\"Federal Funds Rate\" shall mean, for any day, the overnight federal funds rate in New York City, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) in the Federal Reserve Statistical Release H.15 (519) or any successor publication, or if such rate is not so published for any day which is a Business Day, the average of the quotations for such day on overnight federal funds transactions in New York City received by Agent from three federal funds brokers of recognized standing selected by Agent.\n\"Fiscal Year\" shall mean, for any year, the 52 or 53 week period ending on the Saturday closest to September 30 of such year, regardless of whether such Saturday occurs in September or October of such year.\n\"Fixed Charge Coverage Ratio\" shall mean, for any fiscal period, the ratio of (a) the sum of (i) net income before income taxes for such fiscal period plus (ii) interest expense for such fiscal period plus (iii) depreciation and amortization for financial reporting purposes for such fiscal period plus (iv) the aggregate amount payable during such fiscal period under Operating Leases to (b) the sum of (i) interest expense for such fiscal period plus (ii) current maturities for long term debt plus (iii) the aggregate amount payable during such fiscal period under Operating Leases, in each case calculated for Borrower and its Subsidiaries on a consolidated basis in accordance with GAAP.\n\"Funded Debt\" shall mean, collectively, (a) the aggregate principal amount of Indebtedness for borrowed money which would, in accordance with GAAP, be classified as long-term debt, together with the current maturities thereof; (b) all Indebtedness outstanding under any revolving credit, line of credit or similar agreement providing for borrowings (and any extensions or renewals thereof), notwithstanding that any such Indebtedness is created within one year of the expiration of such agreement; (c) the principal component of obligations under Capital Lease; and (d) any other Indebtedness bearing interest or carrying a similar payment requirement (including any Indebtedness issued at a discount to its face amount), calculated in all case for Borrower and its Subsidiaries on a consolidated basis in accordance with GAAP.\n\"GAAP\" shall mean generally accepted accounting principles consistently applied and maintained throughout the period indicated and consistent with the prior financial practice of Borrower and any of its predecessors, as reflected in the financial information referred to in Section 5.11 hereof.\n\"Indebtedness\" shall mean, as applied to any Person at any time, (a) all indebtedness, obligations or other liabilities of such Person (i) for borrowed money or evidenced by debt securities, debentures, acceptances, notes or other similar instruments, and any accrued interest, fees and charges relating thereto; (ii) under profit payment agreements or similar agreement; (iii) with respect to letters of credit issued for such Person's account; (iv) to pay the deferred purchase price of property or services, except unsecured accounts payable and accrued expenses arising in the ordinary course of business; or (v) in respect of Capital Leases; (b) all indebtedness, obligations or other liabilities of such Person or others secured by a Lien on any property of such Person, whether or not such indebtedness, obligations or liabilities are assumed by such Person, all as of such time; (c) all indebtedness, obligations or other liabilities of such Person in respect of any foreign exchange contract, interest rate protection agreement, interest rate future, interest rate option, interest rate swap, interest rate cap or other interest rate hedge arrangement, net of liabilities owed to such Person by the counterparties thereon; (d) all preferred stock subject (upon the occurrence of any contingency or otherwise) to mandatory redemption; (e) Indebtedness of others guaranteed by such Person.\n\"Intangible Assets\" shall mean license agreements, trademarks, trade names, patents, capitalized research and development, proprietary products (the results of past research and development treated as long term assets and excluded from Inventory) and goodwill (all determined on a consolidated basis in accordance with GAAP).\n\"Interest Period\" shall mean, in connection with any Eurodollar Loan, the period beginning on the date such Eurodollar Loan is made and continuing for one, two, three or six months as selected by Borrower in its notice of Conversion or Continuation. Notwithstanding the foregoing, however, (a) any applicable Interest Period which would otherwise end on a day which is not a Business Day shall be extended to the next succeeding Business Day unless such Business Day falls in another calendar month, in which case such Interest Period shall end on the immediately preceding Business Day, (b) with respect to Eurodollar Loans, any applicable Interest Period which begins on a day for which there is no numerically corresponding day in the calendar month during which such Interest Period is to end shall (subject to clause (a) above) end on the last day of such calendar month, and (c) no Interest Period shall extend beyond any date as would interfere with the repayment obligations of Borrower hereunder.\n\"Land\" shall mean the real estate or interest therein described in Exhibit \"A\" attached hereto and incorporated herein by this reference, all fixtures or other improvements situated thereon and all rights, titles and interests appurtenant thereto.\n\"Leases\" shall mean any and all leases, subleases, licenses, concessions or other agreements (written or oral, now or hereafter in effect), whether an Operating Lease or a Capital Lease, which grant a possessory interest in and to, together with and all security and other deposits made in connection therewith and all other agreements, such as architect's contracts, engineer's contracts, utility contracts, maintenance agreements and service contracts, which in any way relate to the design, use, occupancy, operation, maintenance, enjoyment or ownership of the Equipment or the Mortgaged Property.\n\"Leverage Ratio\" shall mean, on any date, the ratio of (a) Funded Debt, as of such date, to (b) the sum of (i) Net Worth as of such date, and (ii) Funded Debt, as of such date, in each case computed for the Borrower and its Subsidiaries on a consolidated basis in accordance with GAAP.\n\"Lien\" means any mortgage, deed of trust, deed to secure debt, pledge, hypothecation, assignment for security, security interest, encumbrance, lien or charge of any kind, whether voluntarily incurred or arising by operation of law, by statute, by contract, or otherwise, affecting any property, in cluding any agreement to grant any of the foregoing, any conditional sale or other title retention agreement, any lease in the nature of a security interest, and\/or the filing of or agreement to give any financing statement (other than a precautionary financing statement with respect to a lease that is not in the nature of a security interest) under the UCC or comparable law of any jurisdiction with respect to any property.\n\"Loan\" shall mean either a Term Loan or a Standby\/Term Loan, and \"Loans\" shall mean, collectively, all Term Loans and Standby\/Term Loans. Loans may be either Eurodollar Loans or Base Rate Loans, each of which is a \"type\" of Loan.\n\"Loan Documents\" shall mean this Agreement, the Deed of Trust, the Second Deed of Trust, the Notes, any financing statements covering portions of the Collateral and any and all other instruments, documents, and agreements now or hereafter executed and\/or delivered by Borrower or its Subsidiaries in connection herewith, or any one, more, or all of the foregoing, as the context shall require, and \"Loan Document\" shall mean any one of the Loan Documents.\n\"Loan Percentage\" shall mean, as to each Bank, that amount, expressed as a percentage, equal to the ratio of the outstanding principal amount of such Bank's Loans to the aggregate outstanding principal amount of the Loans, or, if no Loans are outstanding, the ratio of the amount set forth opposite the name of such Bank on the signature pages hereto under the heading \"Commitment\" to the aggregate amount of the Commitment; provided that the Loan Percentage of each Bank shall be increased or decreased, as appropriate, to reflect any assignments made pursuant to Sections 13.4, 13.4(c) hereof.\n\"Majority Banks\" shall mean, at any time, Banks holding at least sixty-seven percent (67%) of the aggregate outstanding principal amount of the Loans.\n\"Material Adverse Effect\" shall mean any event or condition which, alone or when taken with other events or conditions occurring or existing concurrently therewith (a) has or is reasonably expected to have a material adverse effect on the business, operations, condition (financial or otherwise), assets, liabilities, properties or prospects of Borrower or any of its Subsidiaries or of the industry in which Borrower operates; (b) has or is reasonably expected to have any material adverse effect whatsoever on the validity or enforceability of this Agreement, the Deed of Trust or any other Loan Document; (c) materially impairs or is reasonably expected to materially impair either the ability of Borrower to pay and perform the Obligations; (d) materially impairs or is reasonably expected to materially impair the ability of the Banks to enforce their rights and remedies under this Agreement and the Loan Documents; or (e) has or is reasonably expected to have any material adverse effect on the Collateral, the Liens of the Banks in the Collateral or the priority of such Liens.\n\"Maturity Date\" shall mean June 30, 2000.\n\"Mortgaged Property\" shall mean the Land, Leases, Equipment and all other property (real, personal or mixed) which is conveyed by the Deed of Trust, the Second Deed of Trust or any other Loan Document in which a Lien is therein created and all other property (real, personal or mixed) on which a Lien is placed or granted to secure the repayment or the performance of the Obligations.\n\"MPPAA\" shall mean the Multiemployer Pension Plan Amendments Act of 1980, amending Title IV of ERISA.\n\"Multiemployer Plan\" shall have the same meaning as set forth in Section 4001(a)(3) of ERISA.\n\"Net Worth\" shall mean the excess of Borrower's total assets over Total Liabilities, excluding, however, from the definition of assets the amount of (a) any write-up in the book value of any asset resulting from a revaluation thereof subsequent to the later to occur of (i) the Closing Date and (ii) the date Borrower acquired such asset; (b) treasury stock; (c) receivables from Affiliates of Borrower; and (d) unamortized original issue debt discount, all determined on a consolidated basis for Borrower and its Subsidiaries in accordance with GAAP.\n\"Notes\" shall mean, collectively, the Term Notes and the Standby\/Term Notes.\n\"Obligations\" shall mean the Loans and any and all other indebtedness, liabilities and obligations of Borrower and its Subsidiaries, or any of them, to any Bank of every kind and nature (including, without limitation, interest, charges, expenses, attorneys' fees and other sums chargeable to Borrower by Agent or any Bank and future advances made to or for the benefit of Borrower), arising under this Agreement, the Deed of Trust or the other Loan Documents, whether direct or indirect, absolute or contingent, primary or secondary, due or to become due, now existing or hereafter acquired.\n\"Operating Leases\" shall mean all leases of (or other agreements, conveying the right to use) real and\/or personal property (other than short term leases which are cancellable at any time by the lessee) which are not required to be classified and accounted for as capital leases on a balance sheet under GAAP (including Statement of Financial Accounting Standards No. 13 of the Financial Accounting Standards Board) and \"Operating Lease\" shall mean any one of the Operating Leases.\n\"Participant\" shall mean any bank or other entity to which a Bank sells a participating interest in any Loan or Loans pursuant to Section 13.4(b) hereof and \"Participants\" shall mean, collectively, all banks or other entities to which any Bank sells a participating interest in any Loan or Loans pursuant to Section 13.4(b) hereof.\n\"PBGC\" shall mean the Pension Benefit Guaranty Corporation established under ERISA.\n\"Permitted Liens\" shall mean: (a) Liens existing on the date hereof with respect to the Mortgaged Property and which the Agent and the Banks permit to be listed on Schedule B of the Title Insurance; (b) Liens in favor of Agent; (c) the interest of lessors under Operating Leases permitted hereunder; (d) Liens for (i) property taxes not delinquent, (ii) taxes not yet due, (iii) pledges or deposits made under Workmen's Compensation, Unemployment Insurance, Social Security and similar legislation, or in connection with appeal or surety bonds incident to litigation, or to secure statutory obligations, and (iv) mechanics' and materialmen's Liens with respect to liabilities which are not yet due or which are being contested in good faith and not listed on Schedule B of the Title Insurance; and (e) purchase money Liens on Equipment; provided, however, that (i) such Lien is created within 120 days of the acquisition of such Equipment; (ii) such Lien attaches only to the specific items of Equipment so acquired; (iii) such Lien secures only the Indebtedness incurred to acquire such Equipment; and (iv) the aggregate principal amount of Indebtedness secured by such Liens does not exceed $10,000,000 at any one time outstanding.\n\"Person\" shall mean and include any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, institution, entity, party or government (whether national, federal, state, county, city, municipal, or otherwise, including, without limitation, any instrumentality, division, agency, body or department thereof).\n\"Plan\" shall mean any employee benefit plan, program, arrangement, practice or contract, maintained by or on behalf of the Borrower or an ERISA Affiliate, which provides benefits or compensation to or on behalf of employees or former employees, whether formal or informal, whether or not written, including but not limited to the following types of plans:\n(i) Executive Arrangements - any bonus, incentive compensation, stock option, deferred compensation, commission, severance, \"golden parachute,\" \"rabbi trust,\" or other executive compensation plan, program, contract, arrangement or practice (\"Executive Arrangements\");\n(ii) ERISA Plans - any \"employee benefit plan\", except any Multiemployer Plan, as defined in Section 3(3) of ERISA, whether maintained by or for a single employee or by or for multiple employees, including, but not limited to, any defined benefit pension plan, profit sharing plan, money purchase plan, savings or thrift plan, stock bonus plan, employee stock ownership plan, or any plan, fund, program, arrangement or practice providing for medical (including post-retirement medical), hospitalization, accident, sickness, disability, or life insurance benefits (\"ERISA Plans\");\n(iii) Other Employee Fringe Benefits - any stock purchase, vacation, scholarship, day care, prepaid legal services, severance pay or other fringe benefit plan, program, arrangement, contract or practice (\"Fringe Benefit Plans\"); and\n(iv) Multiemployer Plan - any Multiemployer Plan.\n\"Quoted Rate\" shall mean, when used with respect to an Interest Period for a Eurodollar Loan, the quotient of (i) the offered rate quoted by Agent in the interbank Eurodollar market in New York City, New York or London, England on or about 11:00 a.m. (New York or London time, as the case may be) two Business Days prior to such Interest Period for U.S. dollar deposits of an aggregate amount approximately comparable to the Eurodollar Loan to which the quoted rate is to be applicable and for a period comparable to such Interest Period, divided by (ii) one minus the Reserve Percentage. For purposes of this definition, (a) \"Reserve Percentage\" shall mean with respect to any Interest Period, the percentage which is in effect on the first day of such Interest Period under Regulation D as the maximum reserve requirement for member banks of the Federal Reserve System in New York City with deposits comparable in amount to those of Agent against Eurocurrency Liabilities. (The Quoted Rate for the applicable period shall be adjusted automatically on and as of the effective date of any change in the applicable Reserve Percentage); and (b) \"Eurocurrency Liabilities\" has the meaning assigned to that term in Regulation D, as in effect from time to time.\n\"Regulation D\" shall mean Regulation D of the Board of Governors of the Federal Reserve System, as it may be amended from time to time.\n\"Regulatory Change\" shall mean, with respect to any Bank, the adoption on or after the date hereof of any applicable federal, state, or foreign law, rule or regulation or any change after such date in any such federal, state or foreign law, rule or regulation (including, without limitation, Regulation D), or any adoption or change in the interpretation or administration thereof by any court, governmental authority, central bank or comparable agency or monetary authority charged with the interpretation or administration thereof, or compliance by such Bank with any request or directive made after such date (whether or not having the force of law) of any such court, authority, central bank or comparable agency or monetary authority.\n\"Reportable Event\" shall have the meaning set forth in Section 4043 of ERISA.\n\"Second Deed of Trust\" shall mean the Deed of Trust, Assignment of Rents and Security Agreement of even date herewith, executed by Borrower conveying a second Lien security interest in the Mortgaged Property to secure repayment of the Standby\/Term Loans and performance of certain of the Obligations, and all amendments thereto, recorded or to be recorded in the Titus County, Texas Deed Records.\n\"Standby\/Term Loans\" shall mean, collectively, the loans made pursuant to Section 2.1(b) hereof, and \"Standby\/Term Loan\" shall mean any loan made pursuant to Section 2.1(b) hereof.\n\"Standby\/Term Note\" or \"Standby\/Term Notes\" shall have the meanings given to such terms in Section 2.1(b) hereof.\n\"Subordinated Notes\" shall mean the $100,000,000 Pilgrim's Pride Corporation Senior Subordinated Notes Due 2003, issued under the Subordinated Notes Indenture.\n\"Subordinated Notes Indenture\" shall mean that certain Indenture dated as of June 3, 1993, between Borrower, as Issuer, and Ameritrust Texas National Association, as Trustee providing for the issuance of Borrower's Senior Subordinated Notes Due 2003, in an aggregate principal amount not to exceed $100,000,000.\n\"Subordination Agreement\" shall mean that certain Subordination Agreement between the Agent, as agent for the Banks and John Hancock Mutual Life Insurance Company, a Massachusetts corporation (\"Hancock\"), dated June 3, 1993, recorded in Volume 775, page 42, Deed Records, Titus County, Texas, subordinating to the Lien of the Banks (up to $31,700,000) Hancock's Lien on the Mortgaged Property, evidenced by (i) that certain promissory note dated February 1, 1988, executed by the Borrower and payable to Hancock's order in the original principal amount of $20,000,000, secured by that certain Deed of Trust, Mortgage and Security Agreement dated February 1, 1988, executed by the Borrower for the benefit of Hancock, and recorded in Volume 182, Page 315, aforesaid Records, amended by instruments recorded in Volume 656, page 163, aforesaid Records and Volume 698, page 77, and (ii) that certain promissory note dated April 25, 1991, executed by the Borrower and payable to Hancock's order in the original principal amount of $5,000,000 (collectively the \"Hancock Indebtedness\"), secured by that certain Deed of Trust, Assignment of Rents and Security Agreement dated April 25, 1991, executed by the Borrower for the benefit of Hancock, and recorded in Volume 656, Page 168, Deed of Trust Records, Titus County, Texas, amended by instrument recorded in Volume 698, page 77, aforesaid Records.\n\"Subsidiary\" shall mean, as to any Person, any other Person, of which more than fifty percent (50%) of the outstanding shares of capital stock or other ownership interest having ordinary voting power to elect a majority of the board of directors of such corporation or similar governing body of such other Person (irrespective of whether or not at the time stock or other ownership interests of any other class or classes of such other Person shall have or might have voting power by reason of the happening of any contingency) is at the time directly or indirectly owned or controlled by such Person or by one or more \"Subsidiaries\" of such Person.\n\"Tangible Net Worth\" shall mean the Net Worth minus the amount of all Intangible Assets of the Borrower and its Subsidiaries, determined on a consolidated basis in accordance with GAAP.\n\"Term Loans\" shall mean, collectively, the loans made pursuant to Section 2.1(a) hereof and \"Term Loan\" shall mean any loan made pursuant to Section 2.1(a) hereof.\n\"Term Note\" and \"Term Notes\" shall have the meanings given to such terms in Section 2.1(a) hereof.\n\"Title Company\" shall mean the issuer of the Title Insurance.\n\"Title Insurance\" shall mean a mortgagee's policy of title insurance, all in form and substance satisfactory to the Agent and Banks and containing no exceptions (printed or otherwise) which are unacceptable to the Agent and Banks, issued by a title company (or, if the Agent or the Banks so require, by several title companies on a re-insured or co-insured basis, at the Agent or the Banks' option) acceptable to the Agent and Banks in the face amount of the Note and insuring that the Agent and Banks have a first and prior deed of trust on the Mortgaged Property, subject only to the Permitted Liens described in the Deed of Trust.\n\"Total Liabilities\" shall mean all obligations, indebtedness or other liabilities of any kind or nature, fixed or contingent, due or not due, which, in accordance with GAAP, would be classified as a liability on the balance sheet of Borrower.\n\"Transferee\" shall mean any Participant or Assignee under this Agreement and \"Transferees\" shall mean all Participants and Assignees under this Agreement.\n\"UCC\" shall mean the Uniform Commercial Code as in effect in the State of New York.\n\"Working Capital Credit Agreement\" shall mean that certain Secured Credit Agreement, dated as of May 27, 1993, among the Borrower, Harris Trust and Savings Bank, individually and as Agent, and the other banks party thereto, as hereafter amended, modified or supplemented from time to time, together with any agreement governing Indebtedness incurred to refinance in its entirety the Indebtedness and commitments then outstanding or permitted to be outstanding under such Working Capital Credit Agreement.\n1.2 Use of Defined Terms. All terms defined in this Agreement and the Exhibits hereto shall have the same defined meanings when used in any other Loan Document, unless the context shall require otherwise.\n1.3 Accounting Terms; Calculations. All accounting terms not specifically defined herein shall have the meanings generally attributed to such terms under GAAP. Calculations hereunder shall be made and financial data required hereby shall be prepared, both as to classification of items and as to amounts, in accordance with GAAP, consistently applied (except as otherwise specifically required herein).\n1.4 Other Terms. All other terms used in this Agreement which are not specifically defined herein but which are defined in the UCC shall have the meanings set forth therein.\n1.5 Terminology. All personal pronouns used in this Agreement, whether used in the masculine, feminine or neuter gender, shall include all other genders; the singular shall include the plural, and the plural shall include the singular. Titles of Articles and Sections in this Agreement are for convenience only, and neither limit nor amplify the provisions of this Agreement, and all references in this Agreement to Articles, Sections, Subsections, paragraphs, clauses, subclauses, Exhibits or Schedules shall refer to the corresponding Article, Section, Subsection, paragraph, clause, subclause of, Exhibit or Schedule attached to, this Agreement, unless specific reference is made to the articles, sections or other subdivisions of, Exhibits or Schedules to, another document or instrument.\n1.6 Exhibits. All Exhibits and Schedules attached hereto are by reference made a part hereof.\n2. THE LOANS\n2.1 Loans.\n(a) Term Loans.\n(i) The Banks have heretofore made \"Term Loans\" under, and as such term is defined in, the Original Loan Agreement, to Borrower in the aggregate original principal amount of Twenty-Eight Million Dollars ($28,000,000.00). Borrower acknowledges and agrees that the Term Loans outstanding on the date hereof under the Original Loan Agreement shall be Term Loans under this Agreement and are hereinafter referred to individually as a \"Term Loan\" and collectively as the \"Term Loans\"). Contemporaneously with the execution with this Agreement, Borrower has executed replacement term notes in the aggregate amount of $21,700,000.00, the current aggregate outstanding balance of the Term Loans, substantially in the form of Exhibit B attached hereto, payable to such Bank in the principal face amount of such Bank's Term Loans (together with any and all amendments, modifications and supplements thereto, and any renewals, replacements or extensions thereof (including, but not limited to, pursuant to Sections 13.4 and 13.4(e) hereof), in whole or in part, individually a \"Term Note\" and, collectively, the \"Term Notes\").\n(ii) The aggregate principal amount of the Term Loans shall be repaid in twenty-four (24) quarterly installments of principal, payable on March 31, June 30, September 30 and December 31 of each year, commencing September 30, 1994, with the first twenty-three (23) such quarterly installments being in the amount of Seven Hundred Thousand and No\/100 Dollars ($700,000) each and with the twenty-fourth (24th) and final such quarterly installment being in an amount equal to the then-outstanding aggregate principal amount of the Term Loans, together with all accrued but unpaid interest thereon.\n(b) Standby\/Term Loans.\n(i) Subject to the terms and conditions hereof and provided there exists no Default or Event of Default, each Bank severally agrees to make on the Closing Date loans (each a \"Standby\/Term Loan\" and collectively the \"Standby\/Term Loans\"), as requested by Borrower in accordance with the provisions of Section 2.3 hereof, to Borrower from time to time on and after the date hereof and up to, but not including, June 20, 1995, in an aggregate amount not to exceed such Bank's Loan. The Standby\/Term Loans made by each Bank shall be evidenced by a promissory note, substantially in the form of Exhibit C attached hereto, payable to such Bank in the principal face amount of such Bank's Loan (together with any and all amendments, modifications and supplements thereto, and any renewals, replacements or extensions thereof (including, but not limited to, pursuant to Sections 13.4 and 13.4(e) hereof), in whole or in part, individually a \"Standby\/Term Note\" and collectively the \"Standby\/Term Notes\"). Standby\/Term Loans, once borrowed and repaid, may not be reborrowed.\n(ii) The aggregate principal amount of the Standby\/Term Loans outstanding on June 20, 1995 shall be repayable in twenty (20) quarterly installments of principal, payable on March 31, June 30, September 30 and December 31 of each year, commencing September 30, 1995, with the first nineteen (19) such installments each being in an amount equal to one and sixty-seven hundredths percent (1.67%) of the aggregate principal amount of Standby\/Term Loans outstanding on June 20, 1995 and the final such quarterly installment being in an amount equal to the then-outstanding unpaid aggregate principal amount of the Standby\/Term Loans, together with all accrued but unpaid interest thereon.\n2.2 Borrowing Procedures. Borrower shall give the Agent notice of Borrower's request for the funding of the Loans in accordance with Section 2.8 hereof. Not later than 11:00 a.m (New York time), on the date specified for each borrowing hereunder, each Bank shall make available to the Agent the amount of the Loan to be made by such Bank, in immediately available funds at an account with Creditanstalt designated by the Agent. The Agent shall, subject to the terms and conditions of this Agreement, not later than 1:00 p.m. (New York time) on the Business Day specified for such borrowing, make such amount available to Borrower at the Agent's office in New York, New York.\n2.3 Loan Account; Statements of Account. The Banks will maintain one or more loan accounts for Borrower to which such Bank will charge all amounts advanced to or for the benefit of Borrower hereunder or under any of the other Loan Documents and to which such Bank will credit all amounts collected under each such credit facility from or on behalf of such Borrower. The Banks will account to Borrower periodically with a statement of charges and payments made pursuant to this Agreement, and each such account statement shall be deemed final, binding and conclusive, absent manifest error, unless such Bank is notified by Borrower in writing to the contrary within thirty (30) days of the date of each account statement. Any such notice shall only be deemed an objection to those items specifically objected to therein. The unpaid principal amount of the Loans, the unpaid interest accrued thereon, the interest rate or rates applicable to such unpaid principal amount, and the accrued and unpaid fees, premiums and other amounts due hereunder shall at all times be ascertained from the records of the Banks and such records shall constitute prima facie evidence of the amounts so due and payable.\n2.4 Use of Proceeds. The proceeds of the Loans shall be used for (a) Borrower's general working capital needs; (b) expenditures incurred under any Capital Leases; (c) acquisitions permitted by Section 7.3 hereof; and (d) in the case of any proceeds of the Standby\/Term Loans to repay the Indebtedness under the Subordinated Notes Indenture. No portion of the proceeds of any Loan may be used to \"purchase\" or \"carry\" any \"margin stock,\" as such terms are defined in Regulations G, T, U or X of the Board of Governors of the Federal Reserve System, or to extend credit for the purpose of purchasing or carrying margin stocks.\n2.5 Several Obligations of the Banks; Remedies Independent. The failure of any Bank to make any Loan to be made by it on the date specified therefor shall not relieve any other Bank of its obligation to make its Loan on such date, but neither any Bank nor the Agent shall be responsible for the failure of any other Bank to make a Loan to be made by such other Bank. The amounts payable by the Borrower at any time hereunder and under the Notes to each Bank shall be a separate and independent debt and each Bank shall be entitled to protect and enforce its rights arising out of this Agreement and the Notes, and it shall not be necessary for any other Bank or the Agent to consent to, or be joined as an additional party in, any proceeding for such purposes.\n2.6 Payments.\n(a) Each payment by the Borrower to Agent pursuant to any of the Notes shall be made prior to 1:00 p.m. (New York time) on the date due and shall be made without set-off or counterclaim to the Agent at the address set forth in Section 13.8 below or at such other place or places as Agent may designate from time to time in writing to Borrower and in such amounts as may be necessary in order that all such payments (after withholding for or on account of any present or future taxes, levies, imposts, duties or other similar charges of whatsoever nature imposed on any Bank by any government or any political subdivision or taxing authority thereof, other than any tax on or measured by the net income of any such Bank pursuant to the income tax laws of the jurisdiction where such Bank's principal or lending office is located) shall not be less than the amounts otherwise specified to be paid under the Notes. Each such payment shall be in lawful currency of the United States of America and in immediately available funds. If the due date of any payment hereunder or under any of the Notes would otherwise fall on a day which is not a Business Day, then such payment shall be due on the next succeeding Business Day and interest shall be payable on the principal amount of such payment for the period of such extension.\n(b) Except to the extent otherwise provided herein: (i) the funding of the Loans by the Banks under Section 2.1 hereof shall be made by the relevant Banks prorata according to their respective Loan Percentages; (ii) the Conversion and Continuation of Loans of a particular type shall be made prorata among the relevant Banks according to their Loan Percentage of the Loans and the then current Interest Period for each Eurodollar Loan shall be coterminous; and (iii) each payment or prepayment of principal of Loans and each payment of interest by Borrower shall be made for the account of relevant Banks prorata in accordance with their Loan Percentage.\n2.7 Prepayment; Commitment Reduction.\n(a) Upon written notice to the Agent in accordance with Section 2.8, Borrower may, at its option, reduce the Commitment or prepay the Loans, in whole or in part, in integral multiples of $100,000, on the date specified in such notice, without premium or penalty.\n(b) In no event may Borrower reduce the Commitment below the aggregate principal amount of Loans outstanding thereunder.\n(c) The Commitment shall be automatically reduced on June 20, 1995 to the aggregate principal amount of the Standby\/Term Loans outstanding on such date.\n(d) The Commitment shall be automatically reduced by the amount of any payment or prepayment of the principal amount of the Standby\/Term Loans, effective on the date of such payment or prepayment.\n(e) The Commitment, once terminated or reduced, may not be reinstated.\n(f) All prepayments shall be applied first to the aggregate outstanding principal amount of the Term Loans, so long as any Term Loans are outstanding, and then to the Standby\/Term Loans.\n(g) All prepayments of the Loans shall be applied to the principal installments thereof in the inverse order of their maturities.\n(h) Borrower may not prepay any Loan which is a Eurodollar Loan prior to the last day of the Interest Period applicable to such Eurodollar Loan unless Borrower pays to the Bank, concurrently with such prepayment, all amounts payable to the Bank pursuant to Sections 3.6 and 3.7 hereof.\n2.8 Certain Notices. All notices given by Borrower to the Agent of termination or reduction of the Commitment, or of Conversions, Continuations or prepayments of Loans hereunder and the request by Borrower for the funding of the Loans shall either be oral, with prompt written confirmation by telecopy, or in writing, with such written confirmation or writing, in the case of a Conversion or Continuation, to be substantially in the form of Exhibit D attached hereto; shall be irrevocable; shall be effective only if received by Agent prior to 10:00 a.m. (New York time): (a) at least fifteen (15) days prior to such termination or reduction of the Commitment; (b) not later than the date such Loan is to be Converted or Continued as a Base Rate Loan; (c) three (3) Business Days prior to the date such Loan is to be Converted or Continued as a Eurodollar Loan; or (d) fifteen (15) days prior to any such prepayment, in the case of a prepayment of any Loans; or (e) four (4) Business Days prior to the date any Loans are to be funded. Each such notice to reduce the Commitment or to prepay any Loans shall specify the Commitment or Loans to be reduced or prepaid, the amount of the Commitment or Loans to be reduced or prepaid and the date of such reduction or prepayment. Each such notice of Conversion or Continuation shall specify: (i) the amount of such Conversion or Continuation (which shall be an integral multiple of $100,000 and, if a Eurodollar Loan, shall be in a minimum principal amount of $1,000,000); (ii) whether such Loan will be Converted or Continued as a Eurodollar Loan or as a Base Rate Loan; (iii) the date such Loan is to be Converted or Continued (which shall be a Business Day and, if such Loan is to Convert or Continue a Eurodollar Loan then outstanding, shall not be prior to the then current Interest Period for such outstanding Loan); and (iv) if such Loan is a Eurodollar Loan, the duration of the Interest Period with respect thereto. The request for the funding of the Loans and each request for a Conversion or Continuation of a Loan or for any other financial accommodation by Borrower pursuant to this Agreement or the other Loan Documents shall constitute (x) an automatic warranty and representation by Borrower to each Bank that there does not then exist a Default or Event of Default or any event or condition which, with the making of such Loan, would constitute a Default or Event of Default and (y) an affirmation that as of the date of said request all of the representations and warranties of Borrower contained in this Agreement and the other Loan Documents are true and correct in all material respects, both before and after giving effect to the application of the proceeds of the Loans. If on the last day of the Interest Period of any Eurodollar Loan hereunder, Agent has not received a notice hereunder to Convert, Continue or prepay such Loan, Borrower shall be deemed to have submitted a notice to convert such Loan to a Base Rate Loan, if such Loan was a Eurodollar Loan, or to continue such Loan as a Base Rate Loan, if such Loan was a Base Rate Loan.\n3. INTEREST\n3.1 Interest. Borrower, the Banks and the Agent agree that, effective as of June 20, 1994, the following shall apply:\n(a) Subject to modification pursuant to Subsection (b) below and Section 10.1 hereof, the average daily outstanding principal amount of the Loans and all other sums payable by Borrower hereunder shall bear interest from June 20, 1994 until paid in full at the following rates:\n(i) the outstanding principal amount of each Eurodollar Loan shall bear interest at a fixed rate of interest per annum equal to the Quoted Rate for the then-current Interest Period for such Loan plus one and eight-tenths percent (1.8%), calculated daily on the basis of a 360-day year and actual days elapsed;\n(ii) the outstanding principal amount of each Base Rate Loan and all other sums payable by Borrower hereunder shall bear interest at a fluctuating rate per annum equal to the Base Rate plus one-fourth percent (1\/4%), calculated daily on the basis of a 360-day year and actual days elapsed; and\n(iii) the outstanding principal amount of any payment on any Loan or other Obligations which is not paid in full when due, together with accrued and unpaid interest thereon (to the extent permitted by law), shall bear interest at the Default Rate.\n(b) Accrued interest shall be payable (i) in the case of Base Rate Loans, monthly on the first day of each month hereafter for the previous month, commencing with the first such day following the date hereof; (ii) in the case of a Eurodollar Loan, on the last day of each Interest Period provided, however, that if any Interest Period in respect of a Eurodollar Loan is longer than three (3) months, such interest prior to maturity shall be paid on the last Business Day of each three (3) month interval within such Interest Period as well as on the last day of such Interest Period; (iii) in the case of any Loan, upon the payment or prepayment thereof; (iv) in the case of any other sum payable hereunder as set forth elsewhere in this Agreement or, if not so set forth, on demand; and (v) in the case of interest payable at the Default Rate, on demand.\n3.2 Interest Period. The Interest Period for any Eurodollar Loan shall commence on the date such Loan is made as specified in the notice of Conversion or Continuation applicable thereto and shall continue for a period of one (1), two (2), three (3) or six (6) months, in the case of a Eurodollar Loan, as specified in the notice of Conversion or Continuation for such Eurodollar Loan. If Borrower fails to specify the duration of the Interest Period for any Eurodollar Loan in the notice of Conversion or Continuation therefor, such Loan shall instead be Converted to, or Continued as, as the case may be, a Base Rate Loan.\n3.3 Limitations on Interest Periods. Borrower may not select any Interest Period which extends beyond the first day of any succeeding calendar quarter, unless, giving effect to such Loan, the aggregate outstanding principal amount of Eurodollar Loans having Interest Periods extending beyond the first day of each such calendar quarter is not greater than the aggregate principal amount of the Loans scheduled to be outstanding immediately following such first day of the calendar quarter. Borrower shall not have in effect at any given time during the term of this Agreement more than three (3) different interest rates for Loans (whether Base Rate Loans or Eurodollar Loans).\n3.4 Conversions and Continuations. Borrower shall have the right, from time to time, to Convert Loans of one type to Loans of the other type and to Continue Loans of one type as Loans of the same type provided that Eurodollar Loans may not be Converted to Base Rate Loans prior to the end of the Interest Period applicable thereto.\n3.5 Illegality. Notwithstanding any other provision of this Agreement to the contrary, in the event that it shall become unlawful for any Bank to obtain funds in the London interbank market or for such Bank to maintain a Eurodollar Loan, then such Bank shall promptly notify Borrower whereupon (a) the right of Borrower to request any Eurodollar Loan shall thereupon terminate and (b) any Eurodollar Loan then outstanding shall commence to bear interest at the rate applicable to Base Rate Loans on the last day of the then applicable Interest Period or at such earlier time as may be required by law.\n3.6 Increased Costs and Reduced Return.\n(a) If any Regulatory Change shall:\n(i) subject any Bank to any tax, duty or other charge with respect to any Eurodollar Loan, or shall change the basis of taxation of payments to such Bank of the principal of or interest on any Eurodollar Loan (except for changes in the rate of tax on the overall net income of such Bank imposed by the jurisdiction in which such Bank's principal office is located); or\n(ii) impose, modify or deem applicable any reserve, special deposit or similar requirement (including, without limitation, any such requirement imposed by the Board of Governors of the Federal Reserve System) against assets of, deposits with or for the account of, or credit extended by, any Bank; or\n(iii) impose on any Bank or on the London interbank market any other condition or expense with respect to this Agreement, the Notes or their making, issuance or maintenance of any Eurodollar Loan;\nand the result of any such Regulatory Change is, in such Bank's reasonable judgment, to increase the costs which such Bank determines are attributable to its making or maintaining any Loan, or its obligation to make available any Loan, or to reduce the amount of any sum received or receivable by such Bank under this Agreement or the Notes with respect to any Loan, then, within ten (10) days after demand by such Bank, Borrower shall pay to such Bank such additional amount or amounts as will compensate such Bank for such increased cost or reduction.\n(b) In addition to any amounts payable pursuant to subsection (a) above, if any Bank shall have determined that the applicability of any law, rule, regulation or guideline adopted pursuant to or arising out of the July 1988 report of the Basle Committee on Banking Regulations and Supervisory Practices entitled \"International Convergence of Capital Measurement and Capital Standards,\" or the adoption after the date hereof of any other law, rule, regulation or guideline regarding capital adequacy, or any change in any of the foregoing or in the enforcement or interpretation or administration of any of the foregoing by any court or any governmental authority, central bank or comparable agency charged with the enforcement or interpretation or administration thereof, or compliance by such Bank (or any lending office of such Bank) or such Bank's holding company with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or would have the effect of reducing the rate of return on such Bank's capital or on the capital of such Bank's holding company, if any, as a consequence of its making or maintaining any Loan or its obligations under this Agreement to a level below that which such Bank or such Bank's holding company could have achieved but for such applicability, adoption, change or compliance (taking into consideration such Bank's policies and the policies of such Bank's holding company with respect to capital adequacy) by an amount deemed by such Bank to be material, then, upon demand by such Bank, the Borrower shall pay to such Bank from time to time such additional amount or amounts as will compensate such Bank or such Bank's holding company for any such reduction suffered. Each demand for compensation pursuant to this paragraph (b) shall be accompanied by a certificate of such Bank in reasonable detail setting forth the computation of such compensation (including the reason therefor), which certificate shall be conclusive, absent manifest error.\n3.7 Indemnity. Borrower hereby indemnifies and agrees to hold harmless the Agent and each Bank from and against any and all losses or expenses which it may sustain or incur as a consequence of failure by Borrower to consummate any notice of funding, prepayment, Conversion or Continuation made by Borrower, including, without limitation, any such loss or expense arising from interest or fees payable by any Bank to lenders of funds obtained by it in order to maintain any Eurodollar Loan. Borrower hereby further indemnifies and agrees to hold harmless the Agent and each Bank from and against any and all losses or expenses which it may sustain or incur as a consequence of prepayment of any Eurodollar Loan on other than the last day of the Interest Period for such Loan (including, without limitation, any prepayment pursuant to Sections 2.7 and 3.5 hereof). Borrower's obligations under this Section shall survive the termination of this Agreement and the repayment of the Obligations.\n3.8 Notice of Amounts Payable to Banks. If any Bank shall seek payment of any amounts from Borrower pursuant to Section 3.6 hereof it shall notify Borrower of the amount payable by Borrower to such Bank thereunder. A certificate of such Bank seeking payment pursuant to Section 3.6 hereof, setting forth in reasonable detail the factual basis for and the computation of the amounts specified, shall be conclusive, absent manifest error, as to the amounts owed. Borrower's obligations under this Section shall survive the termination of this Agreement and the repayment of the Obligations.\n3.9 Inability to Determine Quoted Rate. In the event that Agent determines (which determination shall be conclusive absent manifest error) that, by reason of circumstances affecting the London interbank market, quotation of interest rates for the relevant deposits referred to in the definition of the \"Quoted Rate\" herein are not being provided in the relevant amounts or for the relevant maturities for the purpose of determining rates of interest for a Eurodollar Loan, Agent will give notice of such determination to Borrower and at least one day prior to the date specified in such notice of Conversion or Continuation for such Loan to be made. If any such notice is given, no Bank shall have any obligation to make available, maintain, Convert or Continue Eurodollar Loans. Until the earlier of the date any such notice has been withdrawn by Agent or the date when Agent and Borrower have mutually agreed upon an alternate method of determining the rates of interest payable on a Eurodollar Loan, as the case may be, Borrower shall not have the right to have or maintain any Eurodollar Loan.\n3.10 Interest Savings Clause. It is expressly stipulated and agreed to be the intent of Borrower, the Agent and the Banks at all times to comply with applicable law governing the maximum rate or amount of interest payable on the Indebtedness (or applicable United States federal law to the extent that it permits any Bank to contract for, charge, take, reserve or receive a greater amount of interest). If the applicable law is ever judicially interpreted so as to render usurious any amount called for under this Agreement, the Notes or under any of the other Loan Documents, or contracted for, charged, taken, reserved or received with respect to the Obligations, or if Agent's exercise of the option to accelerate the maturity of the Notes or if any prepayment by Borrower results in Borrower having paid any interest in excess of that permitted by applicable law, then it is Borrower's, the Agent's and the Banks' express intent that all excess amounts theretofore collected by the Agent and\/or the Banks be credited on the principal balance of the Notes (or, if the Notes and all other Obligations have been or would thereby be paid in full, refunded to Borrower), and the provisions of the Notes and the other Loan Documents immediately be deemed reformed and the amounts thereafter collectible hereunder and thereunder reduced, without the necessity of the execution of any new documents, so as to comply with the applicable law, but so as to permit the recovery of the fullest amount otherwise called for hereunder or thereunder, not exceeding the highest lawful amount of interest on the Obligations. All sums paid or agreed to be paid to the Agent and\/or the Banks for the use, forbearance or detention of the Obligations shall, to the extent permitted by applicable law, be amortized, prorated, allocated and spread throughout the full term of the Notes until payment in full so that the rate or amount of interest on account of the Obligations does not exceed the usury ceiling from time to time in effect and applicable to the Notes for so long as the Obligations are outstanding. Notwithstanding anything to the contrary contained herein or in any of the other Loan Documents, it is not the intention of the Agent or any Bank to accelerate the maturity or demand payment of any interest that has not accrued at the time of such acceleration or to collect unearned interest at the time of such acceleration.\n3.11 Commitment Fee. Borrower shall pay to the Agent for the account of each Bank a commitment fee (the \"Commitment Fee\"), calculated on the basis of a 360-day year and actual days elapsed, equal to one-fourth percent (1\/4%) per annum of the sum of the aggregate average daily unused amount of such Bank's Loan Percentage of the Commitments, payable in arrears (commencing on October 1, 1994) on the the first day of each calendar quarter for the previous calendar quarter or portion thereof and on Maturity Date. This Section 3.11 shall be effective as of June 20, 1994, and on October 1, 1994, Borrower shall also pay to Agent for the account of each Bank the prorata portion of the Commitment Fee due for the period from June 20, 1994 through June 30, 1994.\n4. SECURITY INTEREST - COLLATERAL\n4.1 Security Interest. As security for the Obligations, Borrower hereby grants to Agent, for the benefit of the Banks, a continuing Lien on and security interest in and to the following described property, whether now owned or existing or hereafter acquired or arising or in which Borrower now has or hereafter acquires any rights (sometimes herein collectively referred to as \"Collateral\"):\n(a) Leases;\n(b) Equipment;\n(c) all books and records (including, without limitation, computer programs, print-outs and other computer materials and records) of Borrower pertaining to any of the foregoing; and\n(d) all accessions to, substitutions for and all replacements, products and proceeds of the foregoing, including, without limitation, proceeds of insurance policies insuring the Collateral.\n4.2 Mortgaged Property. As additional security for the Obligations, Borrower has heretofore granted to Agent, for the benefit of the Banks, a first (except for prior liens expressly permitted thereby) priority lien on and security interest in the Mortgaged Property, evidenced by the Deed of Trust, and Borrower has of even date herewith granted to Agent, for the benefit of the Banks, a second (except for prior Liens expressly permitted thereby) priority Lien on and security interest in the Mortgaged Property, evidenced by the Second Deed of Trust, recorded or to be recorded in the Titus County, Texas Deed Records.\n4.3 Perfection of Liens. Until the payment and satisfaction in full of all Obligations, Agent's Liens in the Collateral and all products and proceeds thereof, shall continue in full force and effect. Borrower shall perform any and all steps requested by Agent or the Majority Banks to perfect, maintain and protect Agent's Liens in the Collateral including, without limitation, executing and filing financing or continuation statements, or amendments thereof, in form and substance satisfactory to Agent. Agent may file one or more financing statements disclosing Agent's Liens under this Agreement without Borrower's signature appearing thereon and Borrower shall pay the costs of, or incidental to, any recording or filing of any financing statements concerning the Collateral. Borrower agrees that a carbon, photographic, photostatic, or other reproduction of this Agreement or of a financing statement is sufficient as a financing statement.\n4.4 Right to Inspect. Agent and each Bank (or any person or persons designated by it), in its sole discretion, shall have the right to call at the Mortgaged Property or any place of business or property location of Borrower at any reasonable time, and, without hindrance or delay, to inspect the Collateral and to inspect, review, check and make extracts from Borrower's books, records, journals, orders, receipts and any correspondence and other data relating to the Collateral, to Borrower's business or to any other transactions between the parties hereto and to discuss any of the foregoing with any of Borrower's employees, officers and directors and with its independent accountants.\n5. REPRESENTATIONS AND WARRANTIES\nIn order to induce the Banks to enter into this Agreement and to make Loans hereunder, Borrower hereby makes the following representations and warranties to the Agent and the Banks which shall be true and correct on the date hereof and shall continue to be true and correct at the time of the making of any Loan and until the Loans have been repaid in full:\n5.1 Corporate Existence and Qualification. Each of Borrower and its Subsidiaries is a corporation duly organized, validly existing and in good standing under the laws of its jurisdiction of incorporation. Borrower is duly qualified as a foreign corporation in good standing in the State of Texas and in each other state wherein the conduct of its business or the ownership of its property requires such qualification and each Subsidiary is duly qualified as a foreign corporation in good standing in each state wherein the conduct of its business or the ownership of its property requires such qualification.\n5.2 Chief Executive Office; Collateral Locations. Borrower's and each Subsidiary's principal place of business, chief executive office and office where it keeps all of its books and records is located at 110 South Texas Street, Pittsburg, Texas 75686, and except as set forth on Schedule 5.2 attached hereto neither Borrower nor any of its respective predecessors has had any other chief executive office or principal place of business outside the State of Texas during the preceding four (4) months. Schedule 5.2 attached hereto and incorporated herein by reference sets forth a true, correct and complete list of all places of business and all locations at which Collateral is located.\n5.3 Corporate Authority. Borrower has the corporate power and authority to execute, deliver and perform under this Agreement and the Loan Documents to which it is a party, and to borrow hereunder, and has taken all necessary and appropriate corporate action to authorize the execution, delivery and performance of this Agreement and such Loan Documents.\n5.4 No Consents; Validity and Binding Effect. The execution, delivery and performance of this Agreement, the Deed of Trust and the other Loan Documents are not in contravention of any provisions of law or any agreement or indenture by which Borrower is bound or of the Articles of Incorporation or By-laws of Borrower or any of its Subsidiaries and do not require the consent or approval of any governmental body, agency, authority or other Person which has not been obtained and a copy thereof furnished to Agent. This Agreement and the other Loan Documents to which Borrower is a party constitute the valid and legally binding obligations of Borrower, enforceable against Borrower in accordance with their respective terms.\n5.5 No Material Litigation. Except as set forth on Schedule 5.5 hereof, there are no proceedings pending or threatened before any court or administrative agency which might have a Material Adverse Effect.\n5.6 Corporate Organization. The Articles of Incorporation and By-laws of Borrower and each of its Subsidiaries are in full force and effect under the laws of their respective states of incorporation and all amendments to said Articles of Incorporation and By-laws have been duly and properly made under and in accordance with all applicable laws.\n5.7 Solvency. Giving effect to the execution and delivery of the Loan Documents and the consummation of the transactions contemplated hereby, including, but not limited to, the making of the Loans hereunder, the issuance of the Subordinated Notes and the making of the initial loans under the Working Capital Credit Agreement, Borrower (a) has capital sufficient to carry on its business and transactions and all business and transactions in which it is about to engage, (b) is able to pay its debts as they mature and (c) owns property whose fair saleable value is greater than the amount required to pay its debts.\n5.8 Adequacy of Intangible Assets. Borrower and its Subsidiaries possess all Intangible Assets reasonably necessary to continue to conduct their respective businesses as heretofore conducted by them.\n5.9 Taxes. Borrower and each of its Subsidiaries has filed all federal, state, local and foreign tax returns, reports and estimates which are required to be filed, and all taxes (including penalties and interest, if any) shown on such returns, reports and estimates which are due and not yet delinquent or which are otherwise due and payable have been fully paid. Such tax returns properly and correctly reflect the income and taxes of Borrower and its Subsidiaries for the periods covered thereby except for such amounts which in the aggregate are immaterial.\n5.10 ERISA. Except as disclosed on Schedule 5.10 attached hereto and incorporated herein by reference:\n(a) Identification of Plans. Neither the Borrower, any of its Subsidiaries nor any ERISA Affiliate maintains or contributes to, or has maintained or contributed to, any Plan or Multiemployer Plan that is subject to regulation by Title IV of ERISA;\n(b) Compliance. Each Plan has at all times been maintained, by its terms and in operation, in accordance with all applicable laws, except for such noncompliance (when taken as a whole) that will not have a Material Adverse Effect on Borrower or any of its Subsidiaries;\n(c) Liabilities. Neither the Borrower, any of its Subsidiaries nor any ERISA Affiliate is currently or to the best knowledge of Borrower or any ERISA Affiliate will become subject to any liability (including withdrawal liability), tax or penalty whatsoever to any person whomsoever with respect to any Plan including, but not limited to, any tax, penalty or liability arising under Title I or Title IV of ERISA or Chapter 43 of the Code;\n(d) Funding. The Borrower, its Subsidiaries and each ERISA Affiliate have made full and timely payment of (i) all amounts required to be contributed under the terms of each Plan and applicable law and (ii) all material amounts required to be paid as expenses of each Plan. No Plan has any \"amount of unfunded benefit liabilities\" (as defined in Section 4001(a)(18) of ERISA); and\n(e) Insolvency; Reorganization. No Plan is insolvent (within the meaning of Section 4245 of ERISA) or in reorganization (within the meaning of Section 4241 of ERISA).\n5.11 Financial Information.\n(a) The consolidated financial statements of Borrower and its Subsidiaries for fiscal year ended October 2, 1993 disclosed in the Borrower's Form 10-K certified by Ernst & Young, and the consolidated interim financial statements of Borrower and its Subsidiaries for the six-month period ended April 2, 1994, each consisting of a consolidated balance sheet, consolidated statement of income (loss), consolidated statement of changes in stockholders equity and consolidated statement of cash flows, copies of which have been delivered by Borrower to each Bank, are true and correct in all material respects and contain no material misstatement or omission, and fairly present the consolidated financial position, assets and liabilities of Borrower and its Subsidiaries as of the date thereof and the consolidated results of operations of Borrower and its Subsidiaries for the period then ended, and as of the date thereof there are no liabilities of Borrower or any of its Subsidiaries, fixed or contingent, which are material that are not reflected in such financial statements.\n(b) Since the date of the financial statements referred to in subsection (a), there has been no material adverse change in the assets, liabilities, financial position or results of operations of Borrower or any of its Subsidiaries, and neither Borrower nor any of its Subsidiaries has (i) incurred any obligation or liability, fixed or contingent, which would have a Material Adverse Effect, (ii) incurred any Indebtedness or obligations under Capital Leases, other than the Obligations, and trade payables and other liabilities arising in the ordinary course of the Borrower's or such Subsidiary's business, or (iii) guaranteed the obligations of any other Person.\n5.12 Title to Assets. Borrower has good and marketable title to and ownership of the Collateral, including, but not limited to, the Mortgaged Property, and Borrower and its Subsidiaries have good and marketable title to and ownership of all of their other assets, free and clear of all Liens except for Permitted Liens or as otherwise expressly permitted by this Agreement.\n5.13 Violations of Law. Neither Borrower nor any of its Subsidiaries is in violation of any applicable statute, regulation or ordinance of any governmental entity, or of any agency thereof, which violation could have a Material Adverse Effect.\n5.14 No Default. Neither Borrower nor any of its Subsidiaries is in default with respect to (a) any note, indenture, loan agreement, mortgage, lease, deed or other similar agreement relating to Indebtedness to which Borrower or such Subsidiary is a party or by which Borrower or such Subsidiary is bound or (b) any other instrument, document or agreement to which Borrower or such Subsidiary is a party or by which Borrower or such Subsidiary or any of their respective properties are bound, which other instrument, document or agreement is material to the operations or condition, financial or otherwise, of Borrower or such Subsidiary.\n5.15 Corporate and Trade or Fictitious Names. During the five (5) years immediately preceding the date of this Agreement, neither Borrower nor any of its Subsidiaries nor any of their respective predecessors has been known as or used any corporate, trade or fictitious name other than its current corporate name and except as disclosed on Schedule 5.15 hereto.\n5.16 Equipment. The Equipment is and shall remain in good condition, normal wear and tear excepted, meets all standards imposed by any governmental agency, or department or division thereof having regulatory authority over such material and its use and is currently usable in the normal course of Borrower's business.\n5.17 Investments. Except as set forth in Schedule 5.17 hereof, Borrower has no Subsidiaries and has no interest in any partnership or joint venture with, or any investment in, any Person.\n5.18 Trade Relations. There exists no actual or, to the best of Borrower's knowledge, threatened termination, cancellation or limitation of, or any modification or change in, the business relationship of Borrower with any material supplier or with any company whose contracts with Borrower individually or in the aggregate are material to the operations of Borrower; after the consummation of the transactions contemplated by this Agreement, the Subordinated Notes Indenture and the Working Capital Credit Agreement, to the best knowledge of Borrower, all such companies and suppliers will continue a business relationship with Borrower on a basis materially no less favorable to Borrower than that heretofore conducted; and there exists no condition or state of facts or circumstances which would have a Material Adverse Effect on Borrower or prevent Borrower from conducting its business after the consummation of the transactions contemplated by this Agreement in essentially the same manner in which it has heretofore been conducted by Borrower.\n5.19 Broker's or Finder's Fees. No broker's or finder's fees or commissions have been incurred or will be payable by Borrower or any of its Subsidiaries, or any of its predecessors, to any Person in connection with the transactions contemplated by this Agreement. Notwithstanding the foregoing, Borrower acknowledges that MONY Capital Markets, Inc. has been paid that certain broker's commission contemplated in the Original Loan Agreement.\n5.20 Security Interest. This Agreement creates a valid security interest in the Collateral securing payment of the Obligations, subject only to Permitted Liens, and all filings and other actions necessary or desirable to perfect and protect such security interest have been taken, and, Agent has a valid and perfected first priority security interest in the Collateral, subject only to Permitted Liens.\n5.21 Regulatory Matters. Borrower is not subject to regulation under the Investment Company Act of 1940, as amended, the Public Utility Holding Company Act of 1935, as amended, the Federal Power Act, the Interstate Commerce Act or any other federal or state statue or regulation which materially limits its ability to incur indebtedness or its ability to consummate the transactions contemplated hereby.\n5.22 Disclosure. Neither this Agreement nor any other instrument, document, agreement, financial statement or certificate furnished to the Agent or any of the Banks by or on behalf of Borrower in connection with this Agreement or the Working Capital Credit Agreement contains an untrue statement of a material fact or omits to state any material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading or omits to state any fact which, insofar as Borrower can now foresee, may in the future materially and adversely affect the condition (financial or otherwise), business, operations or properties of Borrower and its Subsidiaries which has not been set forth in this Agreement or in an instrument, document, agreement, financial statement or certificate furnished to the Agent and the Banks in connection herewith.\n(a) Registration Statement. Borrower has heretofore furnished to the Agent and each Bank a true, correct and complete copy, including all amendments thereto, of the Registration Statement, on Form S-1, in respect to the Subordinated Notes and all other materials filed with the Securities and Exchange Commission in connection with the issuance of the Subordinated Notes. No portion of the Registration Statement, the prospectus relating thereto, nor any other written material filed with the Securities and Exchange Commission with respect thereto, relating to the Borrower or its Subsidiaries or their respective businesses, does or will contain any statement which is false or misleading with respect to any material fact, or does or will omit to state a material fact necessary in order to make the statements therein not false or misleading, or otherwise violate any state or federal securities laws.\n6. AFFIRMATIVE COVENANTS\nBorrower covenants to the Agent and the Banks that from and after the date hereof, and until the satisfaction in full of the Obligations, it will and it shall cause each of its Subsidiaries to, unless the Majority Banks otherwise consent in writing:\n6.1 Records Respecting Collateral. Keep all records with respect to the Collateral at its office set forth in Section 5.2 hereof and not remove such records from such address without the prior written consent of the Majority Banks.\n6.2 Reporting Requirements. Furnish or cause to be furnished to the Agent and each Bank:\n(a) As soon as practicable, and in any event within 45 days after the end of each fiscal quarter, consolidated interim unaudited financial statements, including a balance sheet, income statement and statement of cash flow, for the quarter and year-to-date period then ended, prepared in accordance with GAAP, consistent with the past practice or Borrower and its Subsidiaries, and certified as to truth and accuracy thereof by the chief financial officer of Borrower;\n(b) As soon as available, and in any event within 90 days after the end of each fiscal year, consolidated audited annual financial statements, including a consolidated balance sheet, consolidated statement of income, consolidated statement of shareholders' equity and consolidated statement of cash flow for the fiscal year then ended, prepared in accordance with GAAP, in comparative form and accompanied by the unqualified opinion of a nationally recognized firm of independent certified public accountants regularly retained by Borrower and its Subsidiaries and acceptable to the Majority Banks;\n(c) Together with the annual financial statements referred to in clause (b) above, a statement from such independent certified public accountants that, in making their examination of such financial statements, they obtained no knowledge of any Default or Event of Default or, in lieu thereof, a statement specifying the nature and period of existence of any such Default or Event of Default disclosed by their examination;\n(d) Together with the annual or interim financial statements referred to in clauses (a) and (b) above, a certificate of the chief financial officer of Borrower certifying that, to the best of his knowledge, no Default or Event of Default has occurred and is continuing or, if a Default or Event of Default has occurred and is continuing, a statement as to the nature thereof and the action which is proposed to be taken with respect thereto;\n(e) Promptly after the sending or filing thereof, as the case may be, copies of any definitive proxy statements, financial statements or reports which Borrower or any Subsidiary sends to its shareholders and copies of any regular periodic and special reports or registration statements which Borrower or any Subsidiary files with the Securities and Exchange Commission (or any governmental agency substituted therefor), including, but not limited to, all Form 10-K and Form 10-Q reports, or any report or registration statement which Borrower or any Subsidiary files with any national securities exchange;\n(f) At least fifteen (15) Business Days prior to the time any consent by the Majority Banks will be necessary, Borrower and any Subsidiary shall furnish to the Agent and the Banks all pertinent information regarding any proposed acquisition by Borrower or any Subsidiary to which the consent of the Majority Banks is required hereunder which is reasonably necessary or appropriate to permit the Banks to evaluate such acquisitions in a manner consistent with prudent banking standards;\n(g) Together with the annual and, if requested by the Agent, interim financial statements referred to in clauses (a) and (b) above, a certificate of the chief financial officer of Borrower certifying as to (i) the items of Equipment subject to purchase money Liens permitted by clause (e) of the definition of \"Permitted Liens\" and (ii) the principal amount of Indebtedness secured by each such Lien; and\n(h) Such other information respecting the condition or operations, financial or otherwise, of Borrower and its Subsidiaries as the Agent or the Banks may from time to time reasonably request.\n6.3 Tax Returns. File all federal, state and local tax returns and other reports that Borrower and its Subsidiaries are required by law to file, maintain adequate reserves for the payment of all taxes, assessments, governmental charges and levies imposed upon them, their respective incomes, or their respective profits, or upon any property belonging to them, and pay and discharge all such taxes, assessments, governmental charges and levies prior to the date on which penalties attach thereto.\n6.4 Compliance With Laws. Comply with all laws, statutes, rules, regulations and ordinances of any governmental entity, or of any agency thereof, applicable to Borrower or any Subsidiary, a violation of which, in any respect, might have a Material Adverse Effect, including, without limitation, any such laws, statutes, rules, regulations or ordinances regarding the collection, payment, and deposit of employees' income, unemployment, and Social Security taxes and with respect to pension liabilities.\n6.5 ERISA.\n(a) At all times make prompt payment of contributions required to meet the minimum funding standards set forth in Section 302 and 305 of ERISA with respect to each Plan and otherwise comply with ERISA and all rules and regulations promulgated thereunder in all material respects;\n(b) Promptly after the occurrence thereof with respect to any Plan, or any trust established thereunder, notify the Agent and the Banks of (i) a \"reportable event\" described in Section 4043 of ERISA and the regulations issued from time to time thereunder (other than a \"reportable event\" not subject to the provisions for 30-day notice to the PBGC under such regulations), or (ii) any other event which could subject the Borrower, any of its Subsidiaries or any ERISA Affiliate to any tax, penalty or liability under Title I or Title IV of ERISA or Chapter 43 of the Code which, in the aggregate, would have a Material Adverse Effect on the Borrower, any of its Subsidiaries or upon their respective financial condition, assets, business operations, liabilities or property;\n(c) At the same time and in the same manner as such notice must be provided to the PBGC, or to a Plan participant, beneficiary or alternative payee, give the Agent and the Banks any notice required under Section 101(d), 302(f)(4), 303, 307, 4041(b)(1)(A) or 4041(c)(1)(A) or ERISA or under Section 401(a)(29) or 412 of the Code with respect to any Plan;\n(d) Furnish to the Agent or any Bank, promptly upon the request of the Agent or such Bank, (i) true and complete copies of any and all documents, government reports and determination or opinion letters for any Plan; and (ii) a current statement of withdrawal liability, if any, for each Multiemployer Plan; and\n(e) Furnish to the Agent or any Bank, promptly upon the request of the Agent or such Bank therefor, such additional information concerning any Plan that relates to the ability of Borrower to make any payments hereunder, as may be reasonably requested.\n6.6 Books and Records. Keep adequate records and books of account with respect to its business activities in which proper entries are made in accordance with GAAP reflecting all its financial transactions.\n6.7 Notifications to the Agent and the Banks. Notify the Agent and the Banks by telephone within one (1) Business Day (with each such notice to be confirmed in writing within two (2) Business Days following such telephone notice): (a) upon Borrower's learning thereof, of any litigation affecting Borrower or any of its Subsidiaries claiming damages of $1,000,000 or more, individually or when aggregated with other litigation pending against Borrower or any of its Subsidiaries, whether or not covered by insurance, and of the threat or institution of any suit or administrative proceeding against Borrower or any of its Subsidiaries which may have a Material Adverse Effect on Borrower or any of its Subsidiaries, or Agent's Lien in the Collateral or the Mortgaged Property, and establish such reasonable reserves with respect thereto as the Majority Banks may request; (b) upon learning thereof, of any Default or Event of Default hereunder; (c) upon occurrence thereof, of any change to the operations, financial condition or business of Borrower or any of its Subsidiaries which would have a Material Adverse Effect; (d) upon the occurrence thereof, of any amendment or modification of the Working Capital Credit Agreement; and (e) upon the occurrence thereof, of Borrower's or any Subsidiary's default under (i) any note, indenture, loan agreement, mortgage, lease, deed or other similar agreement relating to any indebtedness of Borrower or any of its Subsidiaries or (ii) any other instrument, document or agreement material to the operations or condition, financial or otherwise, of Borrower or any of its Subsidiaries to which Borrower or any of its Subsidiaries is a party or by which Borrower or any of its Subsidiaries or any of their respective property is bound.\n6.8 Insurance.\n(a) Keep all of the Collateral, whether now owned or hereafter acquired, insured by insurance companies (i) reasonably acceptable to the Majority Banks or having an A or better rating according to Best's Insurance Reports; Property-Casualty and (ii) licensed to do business in the State of Texas against loss or damage by fire or other risk usually insured against under extended coverage endorsement and theft, burglary, and pilferage, together with such other hazards as the Majority Banks may from time to time reasonably request, in amounts reasonably satisfactory to the Majority Banks and naming Agent as loss payee thereon pursuant to a lender's loss payee clause satisfactory to the Majority Banks;\n(b) Keep all of its property other than the Collateral and the Mortgaged Property, whether now owned or hereafter acquired, insured by insurance companies (i) reasonably acceptable to the Majority Banks or having an A or better rating according to Best's Insurance Reports; Property-Casualty and (ii) licensed to do business in the State of Texas and in all jurisdictions in which such Borrower does business against such risks and in such amounts as are customarily maintained by others in similar businesses;\n(c) Maintain at all times liability insurance coverage against such risks and in such amounts as are customarily maintained by others in similar businesses, such insurance to be carried by insurance companies (i) reasonably acceptable to the Majority Banks or having an A or better rating according to Best's Insurance Reports; Property-Casualty and (ii) licensed to do business in the State of Texas and in all jurisdictions in which such Borrower does business; and\n(d) Deliver certificates of insurance for such policy or policies to Agent, containing endorsements, in form satisfactory to the Majority Banks, providing that the insurance shall not be cancellable, except upon thirty (30) days' prior written notice to Agent.\n6.9 Preservation of Corporate Existence. Except as permitted by Section 7.4 hereof, preserve and maintain its corporate existence, rights, franchises and privileges in the jurisdiction of its incorporation.\n6.10 Equipment. Keep and maintain the Equipment in good operating condition, reasonable wear and tear excepted, shall repair and make all necessary replacements thereof so that the operating efficiency thereof shall at all times be maintained and preserved and, shall not permit any item of Equipment to become a fixture to real estate or accession to other personal property unless Agent has a first priority Lien on or in such real estate or other personal property. Borrower shall, immediately on demand therefor by Agent, deliver to Agent any and all evidence of ownership of any of the Equipment (including, without limitation, certificates of title and applications for title, together with any necessary applications to have Agent's lien noted thereon, in the case of vehicles).\n6.11 Additional Collateral. Intentionally deleted.\n7. NEGATIVE COVENANTS\nBorrower covenants with the Agent and the Banks that from and after the date hereof and until the termination of this Agreement and the payment and satisfaction in full of the Obligations, it will not, and it will not permit its Subsidiaries to, without the prior written consent of the Majority Banks:\n7.1 No Encumbrances. Create, assume, or suffer to exist any Lien of any kind in any of the Collateral or the Mortgaged Property except for (a) Permitted Liens and (b) a Lien on the Equipment and the Mortgaged Property, expressly subordinated to the Lien in favor of the Agent, in favor of the agent under the Working Capital Credit Agreement (the \"Working Capital Agent\"), as security for the Obligations under the Working Capital Credit Agreement; provided, however, that concurrently with the granting of such Lien in favor of the Working Capital Agent, Borrower grants to the Agent, as security for the Obligations, a Lien, subordinate only to the Lien of the Working Capital Agent, in the current assets of Borrower as provided for in Section 6.11 hereof.\n7.2 Asset Sales.\n(a) Sell, lease or dispose of any of the Collateral or any interest therein except for the sale of Equipment no longer used or useful in the business of Borrower or any Subsidiary having (i) an aggregate value not in excess of $1,000,000 during any Fiscal Year or (ii) an aggregate value not in excess of $5,000,000 during any Fiscal Year; provided that any Equipment sold, leased or otherwise disposed of pursuant to this clause (ii) is replaced within 90 days after such sale, trade-in or other disposition by replacement Equipment which is in good operating condition and which has a value and utility at least equal to that of the Equipment sold, traded in or disposed of and the Agent receives, for the benefit of the Banks, a valid perfected first Lien with respect to such replacement Equipment, subject only to Permitted Liens; or\n(b) Sell, lease or otherwise transfer any of its assets other than the Collateral except: (i) in the ordinary course of business; (ii) as permitted by Section 7.9; (iii) transfers to the Borrower or a Subsidiary; (iv) worn or obsolete property; or (v) any other sale or transfer of assets, which, together with all other assets sold or transferred during the preceding 12 month period (other than in accordance with the preceding clauses (i), (ii), (iii) or (iv)), does not exceed 15% of the Borrower's total consolidated tangible assets as computed at the time of such sale or transfer.\n7.3 Loans and Investments. Make or retain any loan or investment (whether through the purchase of stock, obligations or otherwise) in or make any loan or advance to, any other Person, whether by acquisition of stock indebtedness, other obligations or security or by loan, advance, capital contribution, or otherwise (\"Restricted Investments\") other than:\n(a) investments in certificates of deposit having a maturity of one year or less issued by any United States commercial bank having capital and surplus of not less than $50,000,000;\n(b) investments in an aggregate amount of up to $8,000,000 in deposits maintained with the First State Bank of Pittsburg, Texas;\n(c) investments in commercial paper rated P1 by Moody's Investors Service, Inc. or A1 by Standard & Poor's Corporation maturing within 180 days of the date of issuance thereof;\n(d) investments in mutual funds composed of either money market securities or marketable obligations of the United States or guaranteed by or insured by the United States, or those for which the full faith and credit of the United States is pledged for the repayment or principal and interest thereof; provided that such obligations have a final maturity of no more than three years from the date acquired by the Borrower;\n(e) investments existing prior to the Closing Date; and\n(f) investments in a corporate Subsidiary of the Borrower provided that such Subsidiary is consolidated with Borrower for financial reporting purposes;\nunless, immediately after giving effect thereto, the aggregate Restricted Investments of the Borrower and its Subsidiaries made since the Closing Date does not exceed 5% of the Borrower's total assets.\n7.4 Corporate Structure. Dissolve or otherwise terminate its corporate status; enter into any merger, reorganization or consolidation; issue any shares of any class of capital stock of any Subsidiary or any securities or other instruments for or which are convertible into any shares of any class of capital stock of any Subsidiary; or make any substantial change in the basic type of business conducted by Borrower or any Subsidiary as of the date hereof, provided that (a) the Borrower may merge with another corporation, if the surviving corporation is the Borrower and (b) a Subsidiary may merge or consolidate with or sell, lease or otherwise transfer all or substantially all of its assets to: (i) the Borrower or another Subsidiary; or, (ii) another Person if immediately after giving effect to the transaction no Default or Event of Default would exist.\n7.5 Fiscal Year. Change its fiscal year.\n7.6 ERISA. Take, or fail to take, or permit any ERISA Affiliate to take, or fail to take, any action with respect to a Plan including, but not limited to, (i) establishing any Plan, (ii) amending any Plan, (iii) terminating or withdrawing from any Plan, or (iv) incurring an amount of unfunded benefit liabilities, as defined in Section 4001(a)(18) of ERISA, where such action or failure could have a material adverse effect on the Borrower or any Subsidiary, result in a lien on the property of the Borrower or any Subsidiary, or require the Borrower or any Subsidiary to provide any security.\n7.7 Relocations; Use of Name. Relocate its executive office; maintain any Collateral at any location other than the Mortgaged Property or maintain records with respect to Collateral at any locations other than the Mortgaged Property or at the location of its chief executive office set forth in Section 5.2 hereto; or use any corporate name (other than its own) or any fictitious name except upon thirty (30) days prior written notice to Agent and after the delivery to Agent of financing statements, if required by Agent, in form satisfactory to Agent.\n7.8 Arm's-Length Transactions. The Borrower will not, and will not permit any Subsidiary to, enter into any transaction, including without limitation, the purchase, sale, lease or exchange of any Collateral, or the rendering of any service, with any Affiliate of the Borrower or such Subsidiary or any Person except in the ordinary course of and pursuant to the reasonable requirements of the Borrower's or such Subsidiary's business and upon fair and reasonable terms not materially less favorable to the Borrower than would be obtained in a comparable arm's-length transaction with a Person not an Affiliate of the Company or such Subsidiary and which would be subject to approval by the Borrower's Audit Committee of the Board of Directors.\n7.9 Dividends. Declare or pay any dividends on, or make any distribution with respect to, its shares of any class of capital stock, redeem or retire any capital stock, or take any action having an effect equivalent to the foregoing (in any fiscal year of Borrower or any Subsidiary) except for (a) the declaration and payment of cash dividends by a Subsidiary and payable to Borrower and (b) the declaration and payment of cash dividends on the capital stock of the Borrower not in excess of $0.08 per share of the issued and authorized common stock plus twenty-five percent (25%) of the net income of Borrower, as set forth in the audited financial statements for the fiscal year of Borrower immediately preceding the year during which such declaration and payment of dividends is made; provided, however, that at the time such dividend is paid there does not exist any Default or Event of Default hereunder or any event or condition which, with the payment of such dividend would constitute a Default or Event of Default.\n7.10 Subordinated Notes. Neither the Borrower or any of its Subsidiaries shall, directly or indirectly:\n(a) purchase, redeem, retire or otherwise acquire for value, set apart any money for a sinking, defeasance or other analogous fund for, the purchase, redemption, retirement or other acquisition of, or make any voluntary payment or prepayment of the principal of or interest on, where any other amount owing in respect of, the Subordinated Notes other than regularly scheduled payments of interest thereon; or\n(b) agree to any amendment, modification or waiver of any of the provisions of the Subordinated Notes Indenture.\n7.11 Guaranty Fees. The Borrower will not, and will not permit any Subsidiary to, directly or indirectly, pay to Mr. and\/or Mrs. Lonnie A. Pilgrim or any other guarantor of any of the Borrower's Indebtedness, obligations and liabilities, any fee or other compensation, but excluding salary, bonus and other compensation for services rendered as an employee (collectively the \"Guaranty Fees\") except that, so long as there is not Default or Event of Default nor any event or condition which, with the payment of such fee would constitute a Default or Event of Default, Borrower may pay Guarantee Fees not to exceed $2,000,000 in the aggregate during any fiscal year of the Borrower.\n8. FINANCIAL COVENANTS\nBorrower covenants with the Agent and the Banks that from and after the date hereof and until the termination of this Agreement and the payment and satisfaction in full of the Obligations, unless the Majority Banks otherwise consent in writing:\n8.1 Leverage Ratio. The Borrower will not permit the ratio of its Leverage Ratio at any time during each period specified below to exceed the ratio specified below for such period:\nPERIOD MAXIMUM RATIO\nClosing Date through the penultimate day of Fiscal Year 1995 0.675:1.000\nAt all times thereafter 0.650:1.000\n8.2 Tangible Net Worth. The Borrower shall maintain a Tangible Net Worth at all times during each period specified below of not less than the amount specified below for such period:\n(a) Closing Date through the penultimate day of Fiscal Year 1995, $100,000,000, plus 25% of Borrower's consolidated net income (but not less than zero) for Borrower's Fiscal Year 1995; and\n(b) For the successive periods commencing on the last day of each Fiscal Year thereafter and ending on the penultimate day of next succeeding Fiscal Year, with the first such period commencing on the last day of Fiscal Year 1996, an amount equal to the minimum required Tangible Net Worth in effect under this Section 8.2 during the immediately preceding period plus 25% of Borrower's consolidated net income (but not less than zero) for Borrower's Fiscal Year ending on the date the applicable period commences.\n8.3 Current Ratio. The Borrower will maintain at all times and measured as of the last day of each fiscal year a Current Ratio of not less than 1.35 to 1.00.\n8.4 Fixed Charge Coverage Ratio. The Borrower will not permit its Fixed Charge Coverage Ratio to be less than 1.35 to 1.00 as of the last day of each fiscal period specified below:\n(a) the seven fiscal quarters of Borrower ending July 2, 1994; and\n(b) the eight fiscal quarters of Borrower ending on the last day of each fiscal quarter thereafter commencing with the fiscal quarter ending October 1, 1994.\n9. EVENTS OF DEFAULT\nThe occurrence of any of the following events or conditions shall constitute an Event of Default hereunder:\n9.1 Obligations. Borrower shall fail to make any payments of principal or interest of the Obligations when due;\n9.2 Misrepresentations. Borrower shall make any representations or warranties in any of the Loan Documents or in any certificate or statement furnished at any time hereunder or in connection with any of the Loan Documents which proves to have been untrue or misleading in any material respect when made or furnished and which continues to be untrue or misleading in any material respect.\n9.3 Certain Covenants. Borrower shall default in the observance or performance of any covenant or agreement contained in Sections 6 (other than Sections 6.7 or 6.11), 7 or 8 of this Agreement and such default continues for more than thirty (30) days after the earlier of (a) the date of notice thereof to such Borrower by the Agent or (b) the date Borrower knew or should have known of such default.\n9.4 Other Covenants. Either Borrower shall default in the observance or performance of any other covenant or agreement contained in this Agreement or under any of the other Loan Documents.\n9.5 Other Debts. Either Borrower or any Subsidiary shall default in the payment when due of any Indebtedness under any guaranty, note, indenture or other agreement relating to or evidencing Indebtedness having a principal balance of $1,000,000 or more, including, but not limited to, the Subordinated Notes and the Indebtedness under the Working Capital Credit Agreement, or any event specified in any guaranty, note, indenture or other agreement relating to or evidencing any such Indebtedness shall occur if the effect of such event is to cause or to permit (giving effect to any grace or cure period applicable thereto) the holder or holders of such Indebtedness to cause such Indebtedness to become due, or to be prepaid in full (whether by redemption, purchase or otherwise), prior to its stated maturity.\n9.6 Tax Lien. A notice of Lien, levy or assessment is filed of record with respect to all or any of any Borrower's or any Subsidiary's assets by the United States, or any department, agency or instrumentality thereof, or by any state, county, municipal or other governmental agency, including, without limitation, the PBGC, which in the opinion of the Majority Banks, adversely affects the priority of the Liens granted to Agent hereunder under the Deed of Trust or under the other Loan Documents.\n9.7 ERISA. The occurrence of any of the following events: (i) the happening of a Reportable Event with respect to any Plan which Reportable Event could result in a material liability for Borrower, any of its Subsidiaries or an ERISA Affiliate or which otherwise could have a material adverse effect on the financial condition, assets, business, operations, liabilities or property of Borrower, any of its Subsidiaries or such ERISA Affiliate; (ii) the disqualification or involuntary termination of a Plan for any reason which could result in a material liability for Borrower, any of its Subsidiaries or an ERISA Affiliate or which otherwise could have a material adverse effect on the financial condition, assets, business, operations, liabilities or property of Borrower, any of its Subsidiaries or such ERISA Affiliate; (iii) the voluntary termination of any Plan while such Plan has a funding deficiency (as determined under Section 412 of the Code) which could result in a material liability for Borrower, any of its Subsidiaries or an ERISA Affiliate or which otherwise could have a material adverse effect on the financial condition, assets, business, operations, liabilities or property of Borrower, any of its Subsidiaries or such ERISA Affiliate; (iv) the appointment of a trustee by an appropriate United States district court to administer any such Plan; (v) the institution of any proceedings by the PBGC to terminate any such Plan or to appoint a trustee to administer any such Plan; (vi) the failure of Borrower to notify the Agent and the Banks promptly upon receipt by Borrower or any of its Subsidiaries of any notice of the institution of any proceeding or other actions which may result in the termination of any such Plan.\n9.8 Voluntary Bankruptcy. Borrower or any of its Subsidiaries shall: (a) file a voluntary petition or assignment in bankruptcy or a voluntary petition or assignment or answer seeking liquidation, reorganization, arrangement, readjustment of its debts, or any other relief under the Bankruptcy Code, or under any other act or law pertaining to insolvency or debtor relief, whether State, Federal, or foreign, now or hereafter existing; (b) enter into any agreement indicating consent to, approval of, or acquiescence in, any such petition or proceeding; (c) apply for or permit the appointment, by consent or acquiescence, of a receiver, custodian or trustee of Borrower or any of its Subsidiaries or for all or a substantial part of its property; (d) make a general assignment for the benefit of creditors; or (e) be unable or shall fail to pay its debts generally as such debts become due, admit in writing its inability or failure to pay its debts generally as such debts become due, or otherwise become insolvent.\n9.9 Involuntary Bankruptcy. There shall have been filed against Borrower or any of its Subsidiaries an involuntary petition in bankruptcy or seeking liquidation, reorganization, arrangement, readjustment of its debts or any other relief under the Bankruptcy Code, or under any other act or law pertaining to insolvency or debtor relief, whether State, Federal or foreign, now or hereafter existing; Borrower or any of its Subsidiaries shall suffer or permit the involuntary appointment of a receiver, custodian or trustee of Borrower or any of its Subsidiaries or for all or a substantial part of its property; or Borrower or any of its Subsidiaries shall suffer or permit the issuance of a warrant of attachment, execution or similar process against all or any substantial part of the property of Borrower or any of its Subsidiaries.\n9.10 Suspension of Business. The suspension of the transaction of the usual business of the Borrower or of the usual business of any of its Subsidiaries or the involuntary dissolution of the Borrower or the involuntary dissolution of any of its Subsidiaries.\n9.11 Judgments. Any judgment, decree or order for the payment of money which, when aggregated with all other judgments, decrees or orders for the payment of money pending against Borrower or any of its Subsidiaries, exceeds the sum of $1,000,000, shall be rendered against Borrower or any of its Subsidiaries and remain unsatisfied and in effect for a period of sixty (60) consecutive days without being vacated, discharged, satisfied or stayed or bonded pending appeal.\n9.12 Change in Control. There occurs a \"Change in Control\" as such term is defined on the date hereof in the Subordinated Notes Indenture.\n9.13 Event of Default under Deed of Trust or Second Deed of Trust. There occurs an \"Event of Default\" under the Deed of Trust or the Second Deed of Trust.\n10. REMEDIES\nUpon the occurrence or existence of any Event of Default, and during the continuation thereof, without prejudice to the rights of the Agent and the Banks to enforce their claims against Borrower for damages for failure by Borrower to fulfill any of the obligations hereunder, the Agent and the Banks shall have the following rights and remedies, in addition to any other rights and remedies available to the Agent and the Banks at law, in equity or otherwise:\n10.1 Default Rate. At the election of the Majority Banks, evidenced by written notice to the Borrower, the outstanding principal balance of the Obligations and, to the extent permitted by applicable law, accrued and unpaid interest thereon, shall bear interest at the Default Rate until paid in full.\n10.2 Acceleration of the Obligations. In the event of the occurrence of (a) an Event of Default set forth in Sections 9.8 or 9.9 hereof, the Obligations shall automatically and immediately become due and payable; and (b) any other Event of Default, the Majority Banks, at their option, may declare all of the Obligations to be immediately due and payable, whereupon all of the Obligations shall become immediately due and payable, in either case without presentment, demand, protest, notice of non-payment or any other notice required by law relative thereto, all of which are hereby expressly waived by Borrower, anything contained herein to the contrary notwithstanding.\n10.3 Set-Off. The right of each Bank to set-off, without notice to Borrower, any and all deposits at any time credited by or due from such Bank to Borrower, whether in a general or special, time or demand, final or provisional account or any other account or represented by a certificate of deposit and whether or not unmatured or contingent.\n10.4 Rights and Remedies of a Secured Party. All of the rights and remedies of a secured party under the UCC or under other applicable law, all of which rights and remedies shall be cumulative, and none of which shall be exclusive, to the extent permitted by law, in addition to any other rights and remedies contained in this Agreement, and in any of the other Loan Documents.\n10.5 Take Possession of Collateral. The right of the Agent to (a) enter upon the Land, or any other place or places where the Collateral is located and kept, through self-help and without judicial process, without first obtaining a final judgment or giving Borrower notice and opportunity for a hearing on the validity of the Agent's or the Banks' claim and without any obligation to pay rent to Borrower, and remove the Collateral therefrom to the premises of Agent or any agent of Agent, for such time as Agent may desire, in order to effectively collect or liquidate the Collateral, and\/or (b) require Borrower to assemble the Collateral and make it available to Agent at a place to be designated by Agent which is reasonably convenient to both Borrower and Agent.\n10.6 Sale of Collateral. The right of the Agent to sell or to otherwise dispose of all or any of the Collateral, at public or private sale or sales, with such notice as may be required by law, in lots or in bulk, for cash or on credit, all as Agent, in its sole discretion, may deem advisable; such sales may be adjourned from time to time with or without notice. Agent shall have the right to conduct such sales on Borrower's premises or elsewhere and shall have the right to use Borrower's premises without charge for such sales for such time or times as Agent may see fit. Agent is hereby granted a license or other right to use, without charge, Borrower's labels, patents, copyrights, rights of use of any name, trade secrets, trade names, trademarks, service marks and advertising matter, or any property of a similar nature, whether owned by Borrower or with respect to which Borrower has rights under license, sublicense or other agreements, as it pertains to the Collateral, in preparing for sale, advertising for sale and selling any Collateral and Borrower's rights under all licenses and all franchise agreements shall inure to the benefit of the Agent and the Banks. Agent shall have the right to sell, lease or otherwise dispose of the Collateral, or any part thereof, for cash, credit or any combination thereof, and the Agent or any Bank may purchase all or any part of the Collateral at public or, if permitted by law, private sale and, in lieu of actual payment of such purchase price, may set off the amount of such price against the Obligations. The proceeds realized from the sale of any Collateral shall be applied first to the costs, expenses and reasonable attorneys' fees and expenses incurred by Agent for collection and for acquisition, completion, protection, removal, storage, sale and delivery of the Collateral; second to interest due upon any of the Obligations; and third to the principal of the Obligations. If any deficiency shall arise, Borrower shall remain liable to the Banks therefor.\n10.7 Remedies Under Deed of Trust and Second Deed of Trust. The right of the Agent to sell or otherwise dispose of all or any of the Mortgaged Property, in the manner provided for in the Deed of Trust and the Second Deed of Trust and all other rights and remedies available to the Agent under the Deed of Trust and the Second Deed of Trust.\n10.8 Notice. Any notice required to be given by Agent of a sale, lease, other disposition of the Collateral or any other intended action by Agent, given to Borrower in the manner set forth in Section 13.8 below, ten (10) days prior to such proposed action, shall constitute commercially reasonable and fair notice thereof to Borrower.\n10.9 Appointment of Agent as Borrower's Lawful Attorney. Borrower irrevocably designates, makes, constitutes and appoints Agent (and all persons designated by Agent) as Borrower's true and lawful attorney, and Agent or Agent's agent, may, without notice to Borrower, and at such time or times thereafter as Agent or said agent, in its sole discretion, may determine, in Borrower's or Agent's name do all acts and things necessary, in Agent's sole discretion, to fulfill Borrower's obligations under this Agreement.\n11. CONDITIONS PRECEDENT\nNotwithstanding any other provision of this Agreement, it is understood and agreed that the Banks shall have no obligation to make any Loan unless and until the following conditions have been met, to the sole and complete satisfaction of the Banks, the Agent and their respective counsel:\n11.1 No Injunction. No action, proceeding, investigation, regulation or legislation shall have been instituted, threatened or proposed before any court, governmental agency or legislative body to enjoin, restrain, or prohibit, or to obtain substantial damages in respect of, or which is related to or arises out of this Agreement or the making of such Loan, or which in the Banks' sole discretion, would make it inadvisable to make such Loan.\n11.2 No Material Adverse Change. Since October 2, 1993 there shall not have occurred any material adverse change in Borrower's or any Subsidiary's business, or any event, condition, or state of facts which would be expected materially and adversely to affect the prospects of Borrower or any of its Subsidiaries subsequent to consummation of the transactions contemplated by this Agreement as determined by the Majority Banks in their sole discretion.\n11.3 No Default or Event of Default. There shall exist no Default or Event of Default or any event or condition which, with the making of the Loans would constitute a Default or Event of Default.\n11.4 Regulatory Restrictions. Neither Borrower nor any of its Subsidiaries shall be subject to any applicable statute, rule, regulation, order, writ or injunction of any court or governmental authority or agency which would materially restrict or hinder the conduct of Borrower's or such Subsidiary's business as conducted on the date hereof or which would have a material adverse affect on the business, property, assets, operations or condition, financial or otherwise of Borrower or such Subsidiary.\n11.5 Compliance with Law. The Agent shall have received such evidence as it may reasonably request that the Land and the Mortgaged Property and the uses thereof comply in all material respects with all applicable laws, regulations, codes, orders, ordinances, rules and statutes, including, without limitation, those relating to zoning and environmental protection.\n11.6 Documentation. The Agent and the Banks shall have received the following, each duly executed and delivered to the Agent and the Banks, and each to be satisfactory in form and substance to Agent and its counsel:\n(a) the Notes;\n(b) the Deed of Trust;\n(c) the Second Deed of Trust;\n(d) an amendment to that certain Environmental Indemnity Agreement dated June 3, 1993, reaffirming the warranties and representations made by Borrower thereunder;\n(e) a certificate signed by the chief executive officer and chief financial officer of Borrower dated as of the Closing Date, stating that the representations and warranties set forth in Article 5 hereof are true and correct in all material respects on and as of such date with the same effect as though made on and as of such date, stating that Borrower is on such date in compliance with all the terms and conditions set forth in this Agreement on its part to be observed and performed, and stating that on such date, and after giving effect to the making of any initial Loan no Default or Event of Default has occurred or is continuing;\n(f) a certificate executed by the chief financial officer of Borrower dated as of the Closing Date with respect to the Equipment owned by Borrower;\n(g) a certificate of the Secretary of Borrower dated as of the Closing Date certifying (i) that attached thereto is a true and correct copy of the By-Laws of Borrower, as in effect on the date of such certification, (ii) that attached thereto is a true and complete copy of Resolutions adopted by the Board of Directors of Borrower, authorizing the execution, delivery and performance of this Agreement and the other Loan Documents; and (iii) as to the incumbency and genuineness of the signatures of the officers of Borrower executing this Agreement or any of the other Loan Documents;\n(h) a copy of the Articles of Incorporation of the Borrower, and all amendments thereto, certified by the Secretary of State of the State of Delaware dated as of a date close to the Closing Date;\n(i) copies of all filing receipts or acknowledgements issued by any governmental authority to evidence any filing or recordation necessary to perfect the Liens of Agent in the Collateral and evidence in a form acceptable to the Majority Banks that such Liens constitute valid and perfected first priority Liens;\n(j) a Good Standing Certificate for Borrower, issued by the Secretary of State of Texas, dated as of a date close to the Closing Date;\n(k) certified copies of Borrower's casualty and liability insurance policies with evidence of the payment of the premium therefor, together, in the case of such casualty policies, with loss payable and mortgagee endorsements on Agent's standard form naming Agent as loss payee;\n(l) the written opinion of Godwin & Carlton, counsel to Borrower, dated as of the Closing Date, in the form attached hereto as Exhibit E hereto, as to the transactions contemplated by this Agreement;\n(m) assurance from a title insurance company satisfactory to the Agent and the Banks that such title insurance company is committed to cause the Second Deed of Trust to be recorded and, upon re cordation of the Second Deed of Trust, to issue its ALTA lender's title insurance policies in a form acceptable to the Agent and in amounts satisfactory to the Agent, showing the Second Deed of Trust as the \"insured mortgage\" and insuring the validity and priority of the Second Deed of Trust as a Lien upon the specified Owned Real Property, subject only to the First Deed of Trust, subordinated Lien in favor of John Hancock Mutual Life Insurance Company and to the Permitted Liens described in clauses (b) - (d) of the definition thereof;\n(n) an amendment to the Subordination Agreement; and\n(o) such other documents, instruments and agreements with respect to the transactions contemplated by this Agreement, in each case in such form and containing such additional terms and conditions as may be reasonably satisfactory to the Majority Banks, and containing, without limitation, representations and warranties which are customary and usual in such documents.\n12. THE AGENT\n12.1 Appointment, Powers and Immunities. Each Bank hereby irrevocably appoints and authorizes the Agent to act as its agent hereunder with such powers as are specifically delegated to the Agent by the terms of this Agreement, together with such other powers as are reasonably incidental thereto. The Agent (which term as used in this sentence and in Section 12.5 and the first sentence of Section 12.6 hereof shall include reference to its Affiliates and its own and its Affiliates' officers, directors, employees and agents): (a) shall have no duties or responsibilities except those expressly set forth in this Agreement, and shall not by reason of this Agreement be a trustee for any Bank; (b) shall not be responsible to the Banks for any recitals, statements, representations or warranties contained in this Agreement or any of the other Loan Documents, or in any certificate or other instrument, document or agreement referred to or provided for in, or received by any of them under, this Agreement or any of the other Loan Documents, or for the value, validity, effectiveness, genuineness, enforceability or sufficiency of this Agreement, any Note or any of the other Loan Documents or for any failure by any Borrower or any other Person to perform any of its obligations hereunder or thereunder; (c) subject to Section 12.3 hereof, shall not be required to initiate or conduct any litigation or collection proceedings hereunder; and (d) shall not be responsible for any action taken or omitted to be taken by it hereunder or under any other agreement, document or instrument referred to or provided for herein or in connection herewith, except for its own gross negligence or willful misconduct. The Agent may employ agents and attorneys-in-fact and shall not be responsible for the negligence or misconduct of any such agents or attorneys-in-fact selected by it in good faith. The Agent may deem and treat the payee of any Note as the holder thereof for all purposes hereof unless and until a written notice of the assignment or transfer.\n12.2 Reliance by Agent. The Agent shall be entitled to rely upon any certification, notice or other communication (including any thereof by telephone, telex, facsimile, telegram or cable) believed by it to be genuine and correct and to have been signed or sent by or on behalf of the proper Person or Persons, and upon advice and statements of legal counsel, independent accountants and other experts selected by the Agent. As to any matters not expressly provided for by this Agreement, the Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder in accordance with instructions signed by the Majority Banks, and such instructions of the Majority Banks and any action taken or failure to act pursuant thereto shall be binding on all of the Banks.\n12.3 Defaults. The Agent shall not be deemed to have knowledge or notice of the occurrence of a Default or Event of Default (other than the non-payment of principal of or interest on Loans) unless the Agent has received notice from a Bank or the Borrower specifying such Default or Event of Default and stating that such notice is a \"Notice of Default\". In the event that the Agent receives such a notice of the occurrence of a Default or Event of Default, the Agent shall give prompt notice thereof to the Banks (and shall give each Bank prompt notice of each such non-payment). The Agent shall (subject to Section 12.7 hereof) take such action with respect to such Default or Event of Default as shall be directed by the Majority Banks, provided that, unless and until the Agent shall have received such directions, the Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Default or Event of Default as it shall deem advisable in the best interest of the Banks.\n12.4 Rights as a Bank. With respect to its Loan Percentage and the Loans made by it, Creditanstalt (and any successor acting as Agent) in its capacity as a Bank hereunder shall have the same rights and powers hereunder as any other Bank and may exercise the same as though it were not acting as the Agent, and the term \"Bank\" or \"Banks\" shall, unless the context otherwise indicates, include the Agent in its individual capacity. Creditanstalt (and any successor acting as Agent) and its Affiliates may (without having to account therefor to any Bank) accept deposits from, lend money to and generally engage in any kind of banking, trust or other business with Borrower (and any of its Affiliates) as if it were not acting as the Agent, and Creditanstalt and its Affiliates may accept fees and other consideration from Borrower for services in connection with this Agreement or otherwise without having to account for the same to the Banks.\n12.5 Indemnification. The Banks agree to indemnify the Agent (to the extent not reimbursed under Sections 13.6 or 13.14 hereof, but without limiting the obligations of Borrower under said Sections 13.6 and 13.14), for their Loan Percentage of any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind and nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of this Agreement or any other instruments, documents or agreements contemplated by or referred to herein or the transactions contemplated hereby (including, without limitation, the costs and expenses which Borrower is obligated to pay under Section 13.6 hereof but excluding, unless an Event of Default has occurred and is continuing, normal administrative costs expenses incident to the performance of its agency duties hereunder) or the enforcement of any of the terms hereof or of any such other instruments, documents or agreements, provided that no Bank shall be liable for any of the foregoing to the extent they arise from the gross negligence or willful misconduct of the party to be indemnified.\n12.6 Non-Reliance on Agent and other Banks. Each Bank agrees that it has, independently and without reliance on the Agent or any other Bank, and based on such documents and information as it has deemed appropriate, made its own credit analysis of the Borrower and its own decision to enter into this Agreement and that it will, independently and without reliance upon the Agent or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own analysis and decisions in taking or not taking action under this Agreement. The Agent shall not be required to keep itself informed as to the performance or observance by the Borrower of this Agreement or any other instrument, document or agreement referred to or provided for herein or to inspect the properties or books of the Borrower. Except for notice, reports and other documents and information expressly required to be furnished to the Banks by the Agent hereunder, the Agent shall not have any duty or responsibility to provide any Bank with any credit or other information concerning the affairs, financial condition or business of the Borrower (or any of its Affiliates) which may come into the possession of the Agent or any of its Affiliates.\n12.7 Failure to Act. Except for action expressly required of the Agent hereunder, the Agent shall in all cases be fully justified in failing or refusing to act hereunder unless it shall receive further assurances to its satisfaction from the Banks of their indemnification obligations under Section 12.5 hereof against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action.\n12.8 Resignation or Removal of Agent; Co-Agent.\n(a) Subject to the appointment and acceptance of a successor Agent as provided below, the Agent may resign at any time by giving notice thereof to the Banks and the Borrower and the Agent may be removed at any time with cause by the Majority Banks. Upon any such resignation or removal, the Majority Banks shall have the right to appoint a successor Agent. If no successor Agent shall have been so appointed by the Majority Banks and shall have accepted such appointment with 30 days after the retiring Agent's giving of notice of resignation or the Majority Bank's removal of the retiring Agent, the retiring Agent may, on behalf of the Banks, appoint a successor Agent, which shall be a bank which has a combined capital and surplus of at least Five Hundred Million Dollars ($500,000,000). Upon the acceptance of any appointment as Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations hereunder. After any retiring Agent's resignation or removal hereunder as Agent, the provisions of this Section 12 shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as the Agent.\n(b) In the event that applicable law imposes any restrictions on the identity of an agent such as the Agent or requires the appointment of any co-agent in connection therewith, the Agent may, in its discretion, for the purpose of complying with such restrictions, appoint one or more co-agents hereunder. Any such Co- Agent(s) shall have the same rights, powers, privileges and obligations as the Agent and shall be subject to and entitled to the benefits of all provisions of this Agreement and the Loan Documents relative to the Agent. In addition to any rights of the Majority Banks set forth in subsection (a) above, any such Co-Agent may be removed at any time by the Agent.\n13. MISCELLANEOUS\n13.1 Intellectual Property License. Agent is hereby granted a non-exclusive, assignable license or other right to use, without charge, Borrower's copyrights, patents, patent applications, designs, rights of use, or any property of a similar nature, whether owned by Borrower or with respect to which Borrower has rights under license, sublicense or other agreements (collectively, the \"Intellectual Property Rights\"), to the extent such Intellectual Property Rights are necessary for the proper operation of, or are used by Borrower in the operation of, the Collateral or the Mortgaged Property. Such license (a) may only be used in connection with the operation of the Collateral and the Mortgaged Property, (b) shall terminate upon the payment in full of the Obligations at any time when there does not exist an Event of Default, and (c) shall become perpetual (and shall survive the termination of this Agreement) upon the transfer of any of the Collateral or the Mortgaged Property in foreclosure of the Agent's Liens in such Collateral or Mortgaged Property, whether such foreclosure is by right of private sale, judicial sale, deed in lieu, retention in satisfaction of the Obligations or otherwise. Borrower agrees, at the request of the Agent or the Majority Banks, to take any and all actions and to execute, deliver and\/or record any and all instruments, documents, licenses or agreements, as may be necessary or appropriate to confirm the foregoing license and\/or evidence such license in any public record.\n13.2 Waiver. Each and every right and remedy granted to the Agent and the Banks under this Agreement, or any other document delivered hereunder or in connection herewith or allowed it by law or in equity, shall be cumulative and may be exercised from time to time. No failure on the part of the Agent or any Bank to exercise, and no delay in exercising, any right or remedy shall operate as a waiver thereof, nor shall any single or partial exercise by the Agent or any Bank of any right or remedy preclude any other or future exercise thereof or the exercise of any other right or remedy. No waiver by the Agent or the Banks of any Default or Event of Default shall constitute a waiver of any subsequent Default or Event of Default.\n13.3 Survival. All representations, warranties and covenants made herein shall survive the execution and delivery of all of the Loan Documents. The terms and provisions of this Agreement shall continue in full force and effect until all of the Obligations have been indefeasibly paid in full; provided, further, that Borrower's obligations under Sections 3.6, 3.7, 13.6 and 13.14 shall survive the termination of this Agreement.\n13.4 Assignments; Successors and Assigns.\n(a) This Agreement is a continuing obligation and binds, and the benefits hereof shall inure to, Borrower, Agent and each Bank and their respective successors and assigns provided, that Borrower may not transfer or assign any or all of its rights or obligations hereunder without the prior written consent of all of the Banks.\n(b) Any Bank may, in the ordinary course of its commercial banking business and in accordance with the applicable law, at any time sell to one or more banks or other entities (\"Participants\") participating interests in any Loans owing to such Bank, any of the Notes held by such Bank, or any other interests of such Bank hereunder. Borrower agrees that each Participant shall be entitled to the benefits of Section 3.7 and 13.14 with respect to its participation; provided that no Participant shall be entitled to receive any greater amount pursuant to such Section than such Bank would have been entitled to receive in respect of the amount of the participation transferred by such Bank to such Participant had no such transfer occurred.\n(c) Each Bank may, in the ordinary course of its commercial banking business and in accordance with applicable law, at any time assign, pursuant to an assignment substantially in the form of Exhibit F attached hereto and incorporated herein by reference, without the Borrower's consent, to one or more banks having unimpaired capital and surplus of $250,000,000 or more or may assign with the Borrower's consent (which shall not be unreasonably withheld) to any other entities (in either case, \"Assignees\") all or any part of any Loans owing to such Bank, any of the Notes held by such Bank, or any other interest of such Bank hereunder; provided, however, that any such assignment shall be in a minimum principal amount of Two Million Dollars ($2,000,000). Borrower and the Banks agree that to the extent of any assignment the Assignee shall be deemed to have the same rights and benefits with respect to Borrower under this Agreement and any of the Notes as it would have had if it were a Bank hereunder on the date hereof and the assigning Bank shall be released from its obligations hereunder, to the extent of such assignment.\n(d) Borrower authorizes each Bank to disclose to any Participant or Assignee (\"Transferee\") and any prospective Transferee any and all financial information in such Bank's possession concerning Borrower which has been delivered to such Bank by Borrower pursuant to this Agreement or which has been delivered to such Bank by Borrower in connection with such Bank's credit evaluation of Borrower prior to entering into this Agreement.\n(e) Any Bank shall be entitled to have any Note held by it subdivided in connection with a permitted assignment of all or any portion of such Note and the respective Loans evidenced thereby pursuant to Section 13.4(c) above. In the case of any such subdivision, the new Note (the \"New Note\") issued in exchange for a Note (the \"Old Note\") previously issued hereunder (i) shall be substantially in the form of Exhibit B hereto, (ii) shall be dated the date of such assignment, (iii) shall be otherwise duly completed and (iv) shall bear a legend, to the effect that such New Note is issued in exchange for such Old Note and that the indebtedness represented by such Old Note shall not have been extinguished by reason of such exchange. Without limiting the obligations of Borrower under Section 13.6 hereof, the Banks shall use reasonable best efforts to ensure that any such assignment does not result in the imposition of any intangibles, documentary stamp and other taxes, if any, which may be payable in connection with the execution and delivery of any such New Note.\n(f) If, pursuant to this subsection, any interest in this Agreement or any of the Notes is transferred to any Transferee which is organized under the laws of any jurisdiction other than the United States or any State thereof, the Bank making such transfer shall cause such Transferee, concurrently with the effectiveness of such transfer, (i) to represent to such Bank (for the benefit of such Bank and Borrower) that under applicable law and treaties no taxes will be required to be withheld by such Bank or Borrower with respect to any payments to be made to such Transferee hereunder or in respect of the Loans, (ii) to furnish to such Bank and Borrower either U.S. Internal Revenue Service Form 4224 or U.S. Internal Revenue Service Form 1001 (wherein such Transferee claims entitlement to complete exemption from U.S. federal withholding tax on all payments hereunder) and (iii) to agree (for the benefit of such Bank and Borrower) to provide such Bank and Borrower a new Form 4224 or Form 1001 upon the obsolescence of any previously delivered form and comparable statements in accordance with applicable U.S. laws and regulations and amendments duly executed and completed by such Transferee, and to comply from time to time with all applicable U.S. laws and regulations with regard to such withholding tax exemption.\n13.5 Counterparts. This Agreement may be executed in two or more counterparts, each of which when fully executed shall be an original, and all of said counterparts taken together shall be deemed to constitute one and the same agreement. Any signature page to this Agreement may be witnessed by a telecopy or other facsimile of any original signature page and any signature page of any counterpart hereof may be appended to any other counterpart hereof to form a completely executed counterpart hereof.\n13.6 Expense Reimbursement. Borrower agrees to reimburse the Agent for all of the Agent's expenses incurred in connection with the development, preparation, execution, delivery, modification, regular review and administration of this Agreement, the Notes and the other Loan Documents, including audit costs, appraisal costs, the cost of searches, filings and filing fees, taxes and the fees and disbursements of Agent's attorneys, Messrs. Troutman Sanders, and any counsel retained by them, and all costs and expenses incurred by the Agent and the Banks (including attorney's fees and disbursements) to: (i) commence, defend or intervene in any court proceeding; (ii) file a petition, complaint, answer, motion or other pleading, or to take any other action in or with respect to any suit or proceeding (bankruptcy or otherwise) relating to the Collateral, the Mortgaged Property or this Agreement, the Deed of Trust, the Notes or any of the other Loan Documents; (iii) protect, collect, lease, sell, take possession of, or liquidate any of the Collateral or the Mortgaged Property; (iv) attempt to enforce any Lien in any of the Collateral or the Mortgaged Property or to seek any advice with respect to such enforcement; and (v) enforce any of the Agent's and the Banks' rights to collect any of the Obligations. Borrower also agrees to pay, and to save harmless the Agent and the Banks from any delay in paying, any intangibles, mortgage, documentary stamp and other taxes, if any, which may be payable in connection with the execution and delivery of this Agreement, the Notes or any of the other Loan Documents, or the recording of any thereof, or in any modification hereof or thereof. Additionally, Borrower shall pay to the Agent and each Bank on demand any and all fees, costs and expenses which the Agent or such Bank pays to a bank or other similar institution arising out of or in connection with (a) the forwarding to Borrower or any other Person on Borrower's behalf, by the Agent or such Bank of proceeds of any Loan and (b) the depositing for collection by of any check or item of payment received by or delivered to the Agent or such Bank on account of the Obligations. Borrower's obligations under this Section shall survive the termination of this Agreement and the repayment of the Obligations.\n13.7 Severability. If any provision of this Agreement or any of the Loan Documents or the application thereof to any party thereto or circumstances shall be invalid or unenforceable to any extent, the remainder of this Agreement or such Loan Documents and the application of such provisions to any other party thereto or circumstance shall not be affected thereby and shall be enforced to the greatest extent permitted by law.\n13.8 Notices. All notices, requests, demands and other communications under this Agreement shall be in writing and shall be deemed to have been given or made when (a) delivered by hand, (b) sent by telex or telecopier (with receipt confirmed), provided that a copy is mailed by certified mail, return receipt requested, or (c) except as otherwise provided herein, deposited in the mail, registered or certified mail, postage prepaid, addressed to such party at the \"Address for Notices\" specified below its name on the signature pages hereto or to such other address as may be designated hereafter in writing by the respective parties hereto.\n13.9 Entire Agreement - Amendment. This Agreement and the Loan Documents constitute the entire agreement between the parties hereto with respect to the subject matter hereof and supersede all prior negotiations, understandings and agreements between such parties in respect of such subject matter, including, without limitation, as set forth in that certain commitment letter dated June 17, 1994 from Creditanstalt to Borrower, accepted by Borrower June 20, 1994. Neither this Agreement nor any provision hereof may be changed, waived, discharged, modified or terminated except pursuant to a written instrument signed by Borrower, the Agent and the Majority Banks or by the Borrower and the Agent acting with the consent of the Majority Banks; provided, however, that no such amendment, waiver, discharge, modification or termination shall, except pursuant to an instrument signed by Borrower, the Agent and all of the Banks or by the Borrower and the Agent acting with the consent of all of the Banks, (a) extend the date fixed for the payment of principal of, or interest on, any Loan; (b) reduce the amount of any payment of principal of, or the rate of interest on, any Loan (except for changes in interest rates pursuant to Section 3.1(b) hereof); (c) reduce any fee payable hereunder; (d) alter the terms of this Section 13.9; (e) release any collateral securing the Loans, or any portion thereof; (f) change the Loan Percentage of any Bank; or (g) amend the definitions of the term \"Majority Banks\" set forth in Section 1.1 hereof; provided, further, that any amendment, waiver, discharge modification or termination of any provision of Section 12 hereof, or which increases the obligations of the Agent hereunder, shall require the written consent of the Agent.\n13.10 Time of the Essence. Time is of the essence in this Agreement and the other Loan Documents.\n13.11 Interpretation. No provision of this Agreement shall be construed against or interpreted to the disadvantage of any party hereto by any court or other governmental or judicial authority by reason of such party having or being deemed to have structured or dictated such provision.\n13.12 Banks Not a Joint Venturer. Neither this Agreement nor any agreements, instruments, documents or transactions contemplated hereby (including the Loan Documents) shall in any respect be interpreted, deemed or construed as making the Agent or the Banks a partner or joint venturer with Borrower or as creating any similar relationship or entity, and Borrower agrees that it will not make any assertion, contention, claim or counterclaim to the contrary in any action, suit or other legal proceeding involving the Agent or the Banks and Borrower.\n13.13 Cure of Defaults by Banks. If, hereafter, Borrower defaults in the performance of any duty or obligation to the Agent and the Banks hereunder, the Agent or any Bank may, at its option, but without obligation, cure such default and any costs, fees and expenses incurred by the Agent or such Bank in connection therewith including, without limitation, for payment on mortgage or note obligations, for the purchase of insurance, the payment of taxes and the removal or settlement of Liens and claims, shall be included in the Obligations and be secured by the Collateral and the Mortgaged Property.\n13.14 Indemnity. In addition to any other indemnity provided for herein, or in the other Loan Documents, Borrower hereby indemnifies the Agent and each Bank from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever (including, without limitation, fees and disbursements of counsel) which may be imposed on, incurred by, or asserted against the Agent or such Bank in any litigation, proceeding or investigation instituted or conducted by any governmental agency or instrumentality or any other Person (other than Borrower) with respect to any aspect of, or any transaction contemplated by, or referred to in, or any matter related to, this Agreement or the other Loan Documents, or the other transactions contemplated hereby, whether or not Agent or such Bank is a party thereto, except to the extent that any of the foregoing arises out of gross negligence or willful misconduct of Agent or such Bank, as the case may be. Borrower's obligations under this Section shall survive the termination of this Agreement and the repayment of the Obligations.\n13.15 Attorney-in-Fact. Borrower hereby designates, appoints and empowers Agent irrevocably as its attorney-in-fact, at Borrower's cost and expense, to do in the name of Borrower any and all actions which Agent may deem necessary or advisable to carry out the terms hereof upon the failure, refusal or inability of Borrower to do so, and Borrower hereby agrees to indemnify and hold Agent harmless from any costs, damages, expenses or liabilities arising against or incurred by the Agent in connection therewith except to the extent that any of such costs, damages, expenses or liabilities arise out of Agent's gross negligence or willful misconduct.\n13.16 Sole Benefit. The rights and benefits set forth in this Agreement and in the other Loan Documents are for the sole and exclusive benefit of the parties thereto and may be relied upon only by them.\n13.17 Termination Statements. Borrower acknowledges and agrees that it is Borrower's intent that all financing statements filed hereunder shall remain in full force and effect until this Agreement shall have been terminated in accordance with the provisions hereof, even if, at any time or times prior to such termination, no loans or Loans shall be outstanding hereunder. Accordingly, Borrower waives any right which it may have under Section 9-404(1) of the UCC to demand the filing of termination statements with respect to the Collateral, and agrees that the Agent shall not be required to send such termination statements to Borrower, or to file them with any filing office, unless and until this Agreement shall have been terminated in accordance with its terms and all Obligations paid in full in immediately available funds. Upon such termination and payment in full, Agent shall execute appropriate termination statements and deliver the same to Borrower.\n13.18 Governing Law; Jurisdiction. THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS, AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER AND THEREUNDER, SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK (WITHOUT REGARD TO PRINCIPLES OF CONFLICTS OF LAW). BORROWER HEREBY (A) SUBMITS TO THE NONEXCLUSIVE JURISDICTION OF THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK AND OF ANY NEW YORK STATE COURT SITTING IN NEW YORK CITY FOR THE PURPOSES OF ALL LEGAL PROCEEDINGS ARISING OUT OF OR RELATING TO THIS AGREEMENT AND (B) IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF THE VENUE OF ANY SUCH PROCEEDING BROUGHT IN SUCH A COURT OR ANY CLAIM THAT ANY SUCH PROCEEDING BROUGHT IN SUCH A COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. NOTWITHSTANDING ANYTHING HEREIN TO THE CONTRARY, NOTHING HEREIN SHALL LIMIT THE RIGHT OF THE AGENT OR THE BANKS TO BRING PROCEEDINGS AGAINST BORROWER IN THE COURTS OF ANY OTHER JURISDICTION.\n13.19 Waiver of Jury Trial. BORROWER, AGENT AND EACH BANK EACH HEREBY KNOWINGLY, INTELLIGENTLY AND INTENTIONALLY WAIVES ANY AND ALL RIGHTS IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LEGAL PROCEEDING BASED ON OR ARISING OUT OF, UNDER, IN CONNECTION WITH, OR RELATING TO THIS AGREEMENT, ANY OF THE NOTES, ANY OF THE OTHER LOAN DOCUMENTS, THE TRANSACTIONS CONTEMPLATED HEREBY, OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER ORAL OR WRITTEN), OR ACTIONS OF BORROWER, AGENT OR ANY BANK. THIS PROVISION IS A MATERIAL INDUCEMENT FOR THE BANKS MAKING THE LOANS TO BORROWER.\nIN WITNESS WHEREOF, each of Borrower, the Agent and the Banks has set its hand and seal as of the day and year first above written.\n\"BORROWER\"\nPILGRIM'S PRIDE CORPORATION\nBy: Lonnie A. Pilgrim Chief Executive Officer\nAttest: Clifford E. Butler Chief Financial Officer\n[CORPORATE SEAL]\nAddress for Notices:\nPilgrim's Pride Corporation 110 South Texas P.O. Box 93 Pittsburg, Texas 75686 Attn: Mr. Clifford E. Butler Telecopy Number: (903) 856-7505\nwith a copy to:\nGodwin & Carlton 901 Main Street Dallas, Texas 75202 Attn: James R. Vetter, Esq. Telecopy Number: (214) 760-7332\n[Signatures continued on following page] [Signatures continued from previous page]\n\"AGENT\"\nCREDITANSTALT-BANKVEREIN\nBy: Robert M. Biringer Senior Vice President\nBy: Gregory F. Mathis Vice President\nAddress for Notices: Creditanstalt-Bankverein 245 Park Avenue New York, New York 10167 Attn: Dennis O'Dowd Telecopy Number: (212) 851-1234\nwith copies to:\nCreditanstalt-Bankverein Two Ravinia Drive Suite 1680 Atlanta, Georgia 30346 Attn: Robert M. Biringer\/Joseph P. Longosz Telecopy Number: (404) 390-1851\nand\nTroutman Sanders NationsBank Plaza, Suite 5200 600 Peachtree Street, N.E. Atlanta, Georgia 30308-2216 Attn: Hazen H. Dempster, Esq. Telecopy Number: (404) 885-3900\nCommitment \"BANKS\"\nCREDITANSTALT-BANKVEREIN $10,000,000\nBy: Robert M. Biringer Senior Vice President\nBy: Gregory F. Mathis Vice President\nAddress for Notices: Creditanstalt-Bankverein 245 Park Avenue New York, New York 10167 Attn: Dennis O'Dowd Telecopy Number: (212) 851-1234\nwith copies to:\nCreditanstalt-Bankverein Two Ravinia Drive Suite 1680 Atlanta, Georgia 30346 Attn: Robert M. Biringer\/Joseph P. Longosz Telecopy Number: (404) 390-1851\nand\nTroutman Sanders NationsBank Plaza, Suite 5200 600 Peachtree Street, N.E. Atlanta, Georgia 30308-2216 Attn: Hazen H. Dempster, Esq. Telecopy Number: (404) 885-3900 EXHIBIT \"E\"\nForm of Opinion of Godwin & Carlton\nSECOND AMENDMENT TO GUARANTEE AGREEMENT\nSECOND AMENDMENT TO GUARANTEE AGREEMENT (this \"Second Amendment\"), dated as of October 2, 1994, by and among LONNIE A. PILGRIM, an individual residing in the State of Texas (\"L. Pilgrim\") and PATTY R. PILGRIM, an individual residing in the State of Texas (\"P. Pilgrim\") (L. Pilgrim and P. Pilgrim being hereinafter referred to, individually, as a \"Guarantor\" and, collectively, as the \"Guarantors\") and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee under an Amended and Restated Collateral Trust Indenture, dated as of September 21, 1990 (as amended to and including the date hereof, the \"Indenture\"), between Pilgrim's Pride Corporation, a Delaware corporation, and State Street Bank and Trust Company of Connecticut, N.A., as Security Trustee (referred to herein as the \"Security Trustee\", which term shall also include its successors and assigns, including, without limitation, any successor security trustee under said Indenture).\nW I T N E S S E T H:\nWHEREAS, the Guarantors have guaranteed the payment and performance of all obligations of Pilgrim's Pride Corporation arising under, or in respect of (i) all Notes at any time issued or delivered pursuant to the Indenture or delivered in substitution and exchange therefor, (ii) the Indenture, and (iii) certain other obligations, pursuant to a certain Guarantee Agreement dated as of October 1, 1986 (as amended by a First Amendment dated as of September 21, 1990, the \"Existing Guarantee\"), and\nWHEREAS, the Guarantors currently own sixty-five percent (65%) of the issued and outstanding common stock of Pilgrim's Pride Corporation; and\nWHEREAS, the Guarantors have requested certain modifications to the Existing Guarantee which modifications are acceptable to the holders of the Notes; and\nWHEREAS, the holders of the Notes have instructed the Security Trustee to execute and deliver this Second Amendment to Guarantee Agreement.\nNOW THEREFORE, the Security Trustee and the Guarantors hereby agree as follows:\nSection 1. Deletion of Certain Sections of Existing Guarantee. Sections 1A, 1B and Schedule A of the Existing Guarantee are hereby deleted.\nSection 2. Stock Ownership. Section 2.1(i) of the Existing Guarantee is hereby deleted, and a new Section 2.1(g) is hereby added to the Existing Guarantee, as follows:\n(g) Ownership -- the Guarantors or their respective executors or administrators shall at any time fail to own, in the aggregate, at least 51% of the Common Stock outstanding at such time, or any Common Stock owned by either or both of the Guarantors shall be subject to any pledge or other encumbrance whatsoever.\nSection 3. Amendments to Defined Terms. Section 3.1 of the Existing Guarantee is hereby amended by redefining the following terms as follows:\nAgreement -- the eighth recital to this Agreement.\nExisting Note Purchase Agreement -- the sixth recital to this Agreement.\nGuarantee Agreement -- the eighth recital to this Agreement.\nIndenture -- that certain amended and restated Collateral Trust Indenture dated as of September 21, 1990, between Pilgrim's Pride Corporation and State Street Bank and Trust Company of Connecticut, N.A., as Security Trustee, as the same may be amended or supplemented from time to time.\n1990 Note Purchase Agreement -- the sixth recital to this Agreement.\nSeries C Notes -- the fourth recital to this agreement.\nSeries D Notes -- the fourth recital to this agreement.\nSection 4. Financing Documents. Each of the Financing Documents is hereby amended and modified to the extent that all references therein to, and descriptions therein of, the Existing Guarantee shall be deemed to refer to and describe the Existing Guarantee as amended and modified by this Second Amendment.\nSection 5. Modification: Full Force and Effect. The parties hereto hereby acknowledge and agree that, except as provided in this Second Amendment, the Existing Guarantee remains in full force and effect.\nSection 6. Counterparts. This Second Amendment may be executed in two or more counterparts, each of which shall be deemed an original, and all of which, taken together, shall constitute and be taken as one and the same instrument.\nIN WITNESS THEREOF, the parties hereto have executed this Second Amendment as of the date first hereinabove mentioned.\nLONNIE A. PILGRIM\nPATTY R. PILGRIM\nSTATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee\nBy: Michael J. D'Angelico\nIts Vice President\nSUPPLEMENTAL INDENTURE\nRE: PILGRIM'S PRIDE CORPORATION\nTHIS SUPPLEMENTAL INDENTURE (this \"Supplemental Indenture\"), dated as of October 2, 1994, between PILGRIM'S PRIDE CORPORATION (the \"Company\"), a Delaware corporation, and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as trustee (together with any successor security trustee, herein referred to as the \"Security Trustee\") for the trust created by the Amended and Restated Collateral Trust Indenture (as amended and in effect immediately prior to the effectiveness of this Supplemental Indenture, the \"Existing Indenture,\" and as amended and\/or supplemented from time to time, the \"Trust Indenture\"), dated as of September 21, 1990, between the Security Trustee and the Company.\nRECITALS:\nWHEREAS, the Company heretofore duly executed and delivered under the Existing Indenture (a) a Series of Notes limited, except as otherwise provided in the Existing Indenture, in aggregate principal amount to Twelve Million Dollars ($12,000,000), to be known as its 9.55% Senior Secured Notes, Series A, due October 1, 1998 (hereinafter sometimes called, and as more particularly defined in Section 2.1 of the Existing Indenture, the \"Series A Notes\"), (b) a Series of Notes limited, except as otherwise provided in the Existing Indenture, in aggregate principal amount to Eight Million Dollars ($8,000,000), to be known as its Variable Rate Senior Secured Notes, Series B, due October 1, 1992 (hereinafter sometimes called, and as more particularly defined in Section 2.1 of the Existing Indenture, the \"Series B Notes\"), (c) a Series of Notes limited, except as otherwise provided in the Existing Indenture, in aggregate principal amount to $22,000,000, to be known as its 10.49% Senior Secured Notes, Series C, due September 21, 2002 (hereinafter sometimes called, and as more particularly defined in Section 2.1 of the Existing Indenture, the \"Series C Notes\"), and (d) a Series of Notes limited, except as otherwise provided in the Existing Indenture, in aggregate principal amount to $18,000,000, to be known as its Variable Rate Senior Secured Notes, Series D, due December 31, 1996 (hereinafter sometimes called, and as more particularly defined in Section 2.1 of the Existing Indenture, the \"Series D Notes\"); and\nWHEREAS, the Series B Notes were exchanged for Series D Notes on October 5, 1990 and additional Series D Notes were issued in conjunction therewith; and\nWHEREAS, the Series D Notes have been prepaid in full; and\nWHEREAS, the Series A Notes and the Series C Notes are the only Notes still outstanding as of the date on which this Supplemental Indenture becomes effective; and\nWHEREAS, the Company has requested that certain financial covenants in the Existing Indenture be modified; and\nWHEREAS, the Company and all the holders of Notes wish to cancel the effect of the Supplemental Indentures dated as of December 9, 1991 and as of March 28, 1992, respectively, and to otherwise supplement the Existing Indenture pursuant to this Supplemental Indenture; and\nWHEREAS, in accordance with Section 9.2 of the Existing Indenture, all holders of Notes, as of the date hereof, have consented to the terms, provisions and conditions of, and have directed the Security Trustee to enter into, this Supplemental Indenture; and\nWHEREAS, for purposes of this Supplemental Indenture, the capitalized terms used herein and not defined herein shall have the respective meanings given to such terms in the Existing Indenture; and\nWHEREAS, all acts and proceedings required by law and by the Certificate of Incorporation and By-laws of the Company necessary to constitute this Supplemental Indenture a valid and binding agreement for the uses and purposes herein set forth, in accordance with its terms, have been done and taken, and the execution and delivery of this Supplemental Indenture have been in all respects duly authorized;\nAGREEMENT:\nNOW THEREFORE, THIS AGREEMENT AND SUPPLEMENTAL INDENTURE WITNESSETH, that to set forth the terms and conditions with respect to all of the Notes now and hereafter issued and delivered and outstanding under the Existing Indenture, and in consideration of the premises and of the covenants herein contained, the consent of the holders of Notes to the provisions of this Supplemental Indenture and the sum of $1.00 paid to the Security Trustee by the Company at or before the delivery hereof, the receipt and sufficiency of which are hereby acknowledged, it is hereby covenanted and agreed by and between the parties hereto that all of the Notes issued under the Existing Indenture are to be issued, delivered and outstanding subject to the further covenants, conditions, uses and trusts hereinafter set forth and set forth in the Trust Indenture; and the Company, for itself and its successors, does hereby covenant and agree to and with the Security Trustee with respect to said trust, for the benefit of all present and future holders of the Notes as follows:\nARTICLE 1 DEFINITIONS.\nArticle 1 of the Existing Indenture is hereby amended and restated to read in its entirety as follows:\nSection 1.1 Certain Definitions. For purposes of this Indenture, the following terms shall have the respective meanings set forth below or provided for in the section of this Indenture referred to immediately following such term (such definitions, unless otherwise expressly provided, to be equally applicable to both the singular and plural forms of the terms defined):\nAcceptable Bank -- a commercial bank organized under the laws of the United States or any state thereof, having deposits of not less than One Hundred Million Dollars ($100,000,000).\nAcceptable Repurchase Securities -- means United States Government Securities, Bankers Acceptances and certificates of deposit from an Acceptable Bank.\nAcceptable Transferor -- means any corporate entity not an Affiliate which is organized under the laws of the United States of America or any State thereof, which has capital, surplus and undivided profits aggregating at least One Hundred Million Dollars ($100,000,000) and in which the Company and its Subsidiaries shall not have, at any one time, made Investments having an aggregate value in excess of Five Million Dollars ($5,000,000).\nAdjusted Funded Debt -- with respect to any Person, means without duplication\n(1) its liabilities for borrowed money, other than Current Debt;\n(2) liabilities secured by any Lien existing on Property owned by such Person (whether or not such liabilities have been assumed) other than Current Debt;\n(3) the present value of all payments due under any lease or under any other arrangement for retention of title (discounted at the implicit rate if known or 8% per annum otherwise) if such lease or other arrangement is in substance (a) a financing or capital lease (including any lease (i) under which the lessee has or will have an option to purchase the Property subject thereto at a nominal amount or an amount less than a reasonable estimate of the Fair Market Value of such Property at the date of such purchase, (ii) with respect to which the lessor has filed a financing statement other than for information purposes with respect to an operating lease, (iii) with respect to which the present value of all rental and other fixed payments due under such lease is equal to or exceeds ninety percent (90%) of the remainder of (x) the fair value of the Property subject thereto minus (y) the amount of any related investment tax credit retained by the lessor under such lease, or (iv) the term of which approximates or exceeds seventy- five percent (75%) of the reasonably estimated economic life of the Property subject thereto), (b) an arrangement for the retention of title for security purposes, or (c) an installment purchase;\n(4) its liabilities under Guaranties; and\n(5) any other obligations (other than deferred taxes) which are required by generally accepted accounting principles to be shown as liabilities on its balance sheet and which are payable or remain unpaid more than one (1) year from the creation thereof.\nAdjusted Tangible Assets -- means at any time, with respect to any Person, all assets of such Person (including, without duplication, the capitalized value of any leasehold interest under any financing lease constituting Adjusted Funded Debt) except:\n(a) deferred assets, other than prepaid insurance and prepaid taxes;\n(b) patents, copyrights, trademarks, trade names, franchises, goodwill, experimental expense and other similar intangibles;\n(c) Restricted Investments;\n(d) unamortized debt discount and expense; and\n(e) assets reflecting the capitalized value of leased property (or reflecting any improvement thereto), to the extent that the leases of such property are not reflected in, or do not constitute, Adjusted Funded Debt.\nAdvance Closing Date -- means any date on or prior to October 31, 1990 on which Series D Notes are sold by the Company to a purchaser thereof in accordance with the provisions of the Note Purchase Agreement in respect thereof.\nAffiliate -- a Person (other than a Subsidiary) (a) which directly or indirectly through one or more intermediaries controls, or is controlled by, or is under common control with any one or more of the Company and its Subsidiaries, (b) which beneficially owns or holds five percent (5%) or more of any class of the Voting Stock of any one or more of the Company and its Subsidiaries or (c) five percent (5%) or more of the Voting Stock (or in the case of a Person which is not a corporation, five percent (5%) or more of the equity interest) of which is beneficially owned or held by any one or more of the Company and its Subsidiaries. The term \"control\" means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise.\nAmended and Restated Collateral Trust Indenture, this Trust Indenture, this Agreement or this Indenture -- this Amended and Restated Collateral Trust Indenture, as the same may from time to time be amended.\nApplicable Premium Amount -- means, at any time and with respect to the outstanding principal amount of Notes of any Series of Notes then required to be paid or prepaid, the following percentage of such outstanding principal amount of Notes of such Series then required to be paid or prepaid:\n(i) with respect to any Series of Notes if at such time the Company is not permitted to optionally prepay such outstanding principal of Notes of such Series pursuant to the provisions of this Indenture, a percentage equal to the greater of (a) the rate of interest per annum stated in the Notes of such Series to be in effect on the date immediately preceding such payment or (b) the Make Whole Amount with respect to such payment; and\n(ii) with respect to any Series of Notes if at such time the Company is permitted to optionally prepay such outstanding principal of Notes of such Series pursuant to the provisions of this Indenture, a percentage equal to the premium which would have been payable if the Company then had elected to optionally prepay such Notes pursuant to the provisions of this Indenture.\nApplicable Series B Interest Period -- shall mean:\n(i) with respect to any Series B Portion to which the Company has elected to have the Eurodollar Series B Rate applicable, shall be any period of one (1), three (3) or six (6) months commencing on (x) the Closing Date for the Series B Notes if such rate is to be then applicable to such Series B Portion, and (y) thereafter, the next Applicable Series B Rate Adjustment Date, as shall be selected by the Company not less than two (2) Business Days prior to such Applicable Series B Rate Adjustment Date for such Series B Portion (or, with respect to such Series B Portion of Series B Notes issued on the Closing Date for such Series, if any, two (2) Business Days prior to such Closing Date) and ending on the last day of such period which is immediately followed by a Business Day;\n(ii) with respect to any Series B Portion to which the Company has elected to have the Fixed Series B Rate applicable, shall be any period of thirty (30), sixty (60), ninety (90), one hundred twenty (120), one hundred fifty (150) or one hundred eighty (180) days commencing on (x) the Closing Date for the Series B Notes if such rate is to be then applicable to such Series B Portion, and (y) thereafter, the next Applicable Series B Rate Adjustment Date, as shall be selected by the Company not less than one (1) Business Day prior to such Applicable Series B Rate Adjustment Date for such Series B Portion (or, with respect to such Series B Portion of Series B Notes issued on the Closing Date for such Series, if any, one (1) Business Day prior to such Closing Date) and ending on the last day of such period which is immediately followed by a Business Day; and\n(iii) with respect to any Series B Portion to which the Company has elected to have the Reference Series B Rate applicable, shall be any period of days not exceeding one hundred eighty (180) days commencing on (x) the Closing Date for the Series B Notes if such rate is to be then applicable to such Series B Portion and (y) thereafter, the next Applicable Series B Rate Adjustment Date, as shall be selected by the Company not less than one (1) Business Day prior to such Applicable Series B Rate Adjustment Date for such Series B Portion (or, with respect to such Series B Portion of Series B Notes issued on the Closing Date for such Series, if any, one (1) Business Day prior to such Closing Date), and ending on the day prior to the following Applicable Series B Rate Adjustment Date.\nApplicable Series B Interest Rate -- shall mean the interest rate in effect for each Series B Portion of Series B Notes, as determined by Section 2.1 of this Indenture, which shall be either (x) the Reference Series B Rate plus one-quarter percent (.25%), computed on the basis of a 360-day year and actual days elapsed, (y) the Eurodollar Series B Rate plus one and one-half percent (1-1\/2%), computed on the basis of a 360-day year of twelve 30-day months, or (z) the Fixed Series B Rate plus one and one-half percent (1-1\/2%), computed on the basis of a 360-day year of twelve 30-day months.\nApplicable Series B Rate Adjustment Date -- with respect to any Series B Portion, shall mean (x) the first (1st) Business Day of any Applicable Series B Interest Period as shall have been selected by the Company for the Applicable Series B Interest Rate applicable to such Series B Portion or (y) if no selection shall have been made by the Company on any Series B Determination Date for such Series B Portion, such Series B Determination Date.\nApplicable Series D Interest Period -- shall mean:\n(i) with respect to any Series D Portion to which the Company has elected to have the Eurodollar Series D Rate applicable, shall be any period of one (1), three (3) or six (6) months commencing on (x) in the case of such Series D Portion to be advanced on any Advance Closing Date, such Advance Closing Date, and (y) thereafter, the next Applicable Series D Rate Adjustment Date, as shall be selected by the Company not less than two (2) Business Days (or such shorter period of time as the holders of Series D Notes may agree to) prior to such Applicable Series D Rate Adjustment Date for such Series D Portion (or, with respect to such Series D Portion to be advanced on an Advance Closing Date, two (2) Business Days prior to such Advance Closing Date) and ending on the last day of such period;\n(ii) with respect to any Series D Portion to which the Company has elected to have the Fixed Series D Rate applicable, shall be any period of thirty (30), sixty (60), ninety (90), one hundred twenty (120), one hundred fifty (150) or one hundred eighty (180) days commencing on (x) in the case of such Series D Portion to be advanced on any Advance Closing Date, such Advance Closing Date and (y) thereafter, the next Applicable Series D Rate Adjustment Date, as shall be selected by the Company not less than one (1) Business Day (or such shorter period of time as the holders of Series D Notes may agree to) prior to such Applicable Series D Rate Adjustment Date for such Series D Portion (or, with respect to such Series D Portion advanced on an Advance Closing Date, one (1) Business Day prior to such Advance Closing Date) and ending on the last day of such period; and\n(iii) with respect to any Series D Portion to which the Company has elected to have the Reference Series D Rate appli cable, shall be any period of days not exceeding one hundred eighty (180) days commencing on (x) in the case of such Series D Portion to be advanced on any Advance Closing Date, such Advance Closing Date and (y) thereafter, the next Applicable Series D Rate Adjustment Date, as shall be selected by the Company not less than one (1) Business Day (or such shorter period of time as the holders of Series D Notes may agree to) prior to such Applicable Series D Rate Adjustment Date for such Series D Portion (or, with respect to such Series D Portion to be advanced on any Advance Closing Date, one (1) Business Day prior to such Advance Closing Date) or as deemed selected pursuant to Section 2.1(d) hereof, and ending on the last day of such period or as provided in said Section 2.1(d);\nprovided, however, that:\n(A) if any Applicable Series D Interest Period would end on a day not a Business Day, it shall end on the next succeeding Business Day except that with respect to any Applicable Series D Interest Period in respect of which the Eurodollar Series D Rate is applicable, if the next succeeding Business Day would fall in the next calendar month, such Applicable Series D Interest Period shall end on the Business Day immediately preceding the last day of such Applicable Series D Interest Period but for such change;\n(B) any Applicable Series D Interest Period which would otherwise extend beyond December 31, 1996 shall end on December 31, 1996; and\n(C) interest shall accrue in respect of any Applicable Series D Interest Period from and including the first day thereof to (but excluding) the last day thereof and each Applicable Series D Interest Period that succeeds any then expiring Applicable Series D Interest Period shall be deemed to commence on the last day of such expiring Applicable Series D Interest Period.\nApplicable Series D Interest Rate -- shall mean the interest rate in effect for each Series D Portion of Series D Notes, as determined by Section 2.1(d) hereof, which shall be either (x) the Reference Series D Rate plus one-quarter percent (.25%), computed on the basis of a 360-day year and actual days elapsed, (y) the Eurodollar Series D Rate plus one and one-half percent (1-1\/2%), computed on the basis of a 360-day year of twelve 30-day months, or (z) the Fixed Series D Rate plus one and one-half percent (1-1\/2%), computed on the basis of a 360-day year of twelve 30-day months.\nApplicable Series D Rate Adjustment Date -- with respect to any Series D Portion, shall mean (x) the first (1st) Business Day of any Applicable Series D Interest Period as shall have been selected by the Company in accordance with the terms of Section 2.1(d) hereof for the Applicable Series D Interest Rate also selected by the Company in accordance with the terms of said Section 2.1(d) applicable to such Series D Portion or (y) if no such selection of either an Applicable Series D Interest Period or an Applicable Series D Interest Rate in accordance with the terms of Section 2.1(d) of this Indenture shall have been made by the Company, the last day of the then Applicable Series D Interest Period in respect of such Series D Portion.\nBankers Acceptance -- any draft drawn on an Acceptable Bank and accepted by such Acceptable Bank which is due and payable not more than one hundred eighty (180) days from the original date thereof.\nBoard of Directors -- the board of directors of the Company or any committee thereof which, in the instance, has the lawful power to exercise the power and authority of such board of directors.\nBusiness Day -- a day other than a Saturday, a Sunday or a day on which banks are required by law (other than a general banking moratorium or holiday for a period exceeding four consecutive days) to be closed in the State of Texas, the State of New York, the State of Connecticut or the State of California, and, with respect to all notices and determinations in connection with, and payments of principal of, and interest on, any Series B Portion to which the Eurodollar Series B Rate is applicable or any Series D Portion to which the Eurodollar Series D Rate is applicable, any day which is a \"Business Day,\" as described above, and is also a day on which banks are open for business and quoting interest rates for dollar deposits in Grand Cayman, British West Indies.\nClosing Date -- Section 1.2 of the Note Purchase Agreements in respect of the Series A Notes and the Series B Notes.\nCode -- Uniform Commercial Code as in effect from time to time in the State of Connecticut.\nCollateral -- Paragraph C of the Granting Clauses hereof.\nCompany -- first paragraph of this Indenture.\nConsolidated Adjusted Current Liabilities -- at any time means the amount at which the current liabilities of the Company and all Subsidiaries (specifically including, without limitation, the current portion of any obligation constituting Adjusted Funded Debt) would be shown on a consolidated balance sheet at such time, but excluding from such current liabilities any amount constituting the current portion of any deferred income taxes arising as the result of differences between the Company's method of reporting and determining income under the Internal Revenue Code, as amended, and its method of reporting and determining income pursuant to generally accepted accounting principles (including, without limitation, the use, for Internal Revenue Code purposes, of the so-called farm price method of accounting), but including in such current liabilities any income tax liability of the Company and its Subsidiaries payable within 12 months of such time, whether presented as a part of the aforesaid current portion of deferred income taxes or as a separate line item in current liabilities pursuant to generally accepted accounting principles.\nConsolidated Adjusted Funded Debt -- means Adjusted Funded Debt of the Company and its Subsidiaries, determined on a consolidated basis.\nConsolidated Adjusted Net Income -- for any fiscal period means net earnings (or loss) after income taxes of the Company and its Subsidiaries determined on a consolidated basis for each period, but excluding:\n(1) any gain or loss arising from the sale of capital assets;\n(2) any gain arising from any write-up of assets;\n(3) earnings of any Subsidiary accrued prior to the date it became a Subsidiary;\n(4) earnings of any Person, substantially all the assets of which have been acquired in any manner, realized by such other Person prior to the date of such acquisition;\n(5) net earnings of any Person (other than a Subsidiary) in which the Company or any Subsidiary has an ownership interest unless such net earnings shall have actually been received by the Company or such Subsidiary in the form of cash distributions;\n(6) any portion of the net earnings of any Subsidiary which for any reason is unavailable for payment of dividends to the Company or any other Subsidiary;\n(7) the earnings of any Person to which assets of the Company shall have been sold, transferred or disposed of, or into which the Company or any Subsidiary shall have merged, prior to the date of such transaction;\n(8) any gain arising from the acquisition of any Securities by the Company or any Subsidiary; and\n(9) any portion of the net earnings of the Company or any Subsidiary which cannot be freely converted into United States dollars.\nConsolidated Adjusted Working Capital -- at any time means the difference between Consolidated Current Assets at such time minus Consolidated Adjusted Current Liabilities at such time.\nConsolidated Current Assets -- at any time means the amount at which the current assets of the Company and all Subsidiaries would be shown on a consolidated balance sheet at such time, but excluding any amount on account of any assets which do not constitute Adjusted Tangible Assets.\nConsolidated Current Liabilities -- at any time means the amount at which the current liabilities of the Company and all Subsidiaries would be shown on a consolidated balance sheet at such time.\nConsolidated Net Tangible Assets -- at any time means the result of:\n(a) the net book value (after deducting related depreciation, obsolescence, amortization, valuation and other proper reserves) at which the Adjusted Tangible Assets of the Company and all Subsidiaries would be shown on a consolidated balance sheet at such time, but excluding any amount on account of write-ups of assets after September 30, 1985,\nminus\n(b) Consolidated Adjusted Current Liabilities outstanding at such time.\nConsolidated Tangible Net Worth -- at any time means:\n(1) the net book value (after deducting related depreciation, obsolescence, amortization, valuation and other proper reserves) at which the Adjusted Tangible Assets of the Company and all Subsidiaries would be shown on a consolidated balance sheet at such time, but excluding any amount on account of write-ups of assets after September 30, 1985,\nminus\n(2) the amount (such amount from time to time herein referred to as \"Consolidated Total Liabilities\") at which their liabilities (other than capital stock and surplus) would be shown on such balance sheet, and includ ing as liabilities all deferred taxes and reserves for contingencies and other potential liabilities (specifically including therein, without limitation, actuarially determined unfunded vested pension liabilities) and all minority interests in Subsidiaries.\nConsolidated Total Liabilities -- clause (2) of the definition of Consolidated Tangible Net Worth.\nCurrent Debt -- with respect to any Person, means, without duplication, all liabilities for borrowed money and all liabilities secured by any Lien existing on Property owned by such Person whether or not such liabilities have been assumed, which, in either case are payable on demand or within one (1) year from the creation thereof, except:\n(1) any such liabilities which are renewable or extendible (whether or not renewed or extended) at the option of such Person to a date more than one (1) year from the date of creation thereof or renewable or extendible under, or payable from the proceeds of other indebtedness incurred pursuant to the provisions of, any revolving credit agreement or similar agreement, and\n(2) any such liabilities which, although payable within one (1) year, constitute payments required to be made on account of principal of indebtedness expressed to mature more than one (1) year from the date of creation thereof.\nCurrent Expenses -- with respect to any Person for any fiscal period, means the sum of interest expense accrued for such Person for such period, plus principal amounts payable during such period on or with respect to Adjusted Funded Debt of such Person.\nDebt -- with respect to any Person means all Current Debt and Adjusted Funded Debt for or on account of which such Person is liable.\nDefault -- an event or condition the occurrence of which would, with the lapse of time or giving of notice or both, become an Event of Default.\nDesignated Officers -- Lonnie A. Pilgrim, Clifford E. Butler, or such other Persons as may be agreed to by the holders of the Series B Notes.\nERISA -- the Employee Retirement Income Security Act of 1974, as amended from time to time.\nEurodollar Series B Rate -- with respect to any determination on any Series B Determination Date, shall mean the rate of interest at which deposits in United States dollars in the amount to be outstanding would be offered by the Grand Cayman Branch of the Bank of America National Trust and Savings Association, Grand Cayman, British West Indies, to major banks in the offshore United States dollar interbank markets upon request of such banks at approximately 11:00 a.m., New York time, two (2) Business Days prior to the Applicable Series B Rate Adjustment Date. For each Series B Portion, to which the Company has elected to have the Eurodollar Series B Rate applicable, such offered rate of interest shall be effective for the entire Applicable Series B Interest Period selected by the Company for such Series B Portion.\nEurodollar Series D Rate -- with respect to any determination on any Series D Determination Date, shall mean the rate of interest at which deposits in United States dollars in the amount to be outstanding would be offered by the Grand Cayman Branch of the Bank of America National Trust and Savings Association, Grand Cayman, British West Indies, to major banks in the offshore United States dollar interbank markets upon request of such banks at approximately 11:00 a.m., New York time, on such Series D Determination Date. For each Series D Portion, to which the Company has elected to have the Eurodollar Series D Rate be applicable, such offered rate of interest shall be effective for the entire Applicable Series D Interest Period selected by the Company for such Series D Portion.\nEvent -- Section 4.4(a)(vii) hereof.\nEvent of Default -- Section 6.1 hereof.\nExchange Act -- means the Securities and Exchange Act of 1934, as amended.\nExisting Indenture -- first recital hereof.\nExisting Promissory Note -- Section 2.1(d) hereof.\nFair Market Value -- means, with respect to any assets, the sale value of such assets that would be realized in an arm's- length sale between an informed and willing buyer and an informed and willing seller, under no compulsion to buy or sell, respectively.\nFinancing Documents -- this Indenture, the Note Purchase Agreements, the Notes, the Guarantee Agreement, all documents (in the respective forms thereof as executed) the forms of which are appended to the Note Purchase Agreements as exhibits or schedules, and all other documents or instruments contemplated hereby and by the Note Purchase Agreements or this Indenture, in each case as the same may be amended from time to time, and excluding in each case any opinion of counsel.\nFixed Charge Ratio -- at any time means with respect to any fiscal period the quotient of (a) the sum of (i) Consolidated Adjusted Net Income for such period plus (ii) the aggregate amount of depreciation, amortization, income taxes, Rentals and interest expense accrued for such period by the Company and its Subsidiaries to the extent, but only to the extent, such aggregate amount was reflected in the computation of Consolidated Adjusted Net Income for such period, divided by (b) the sum of (i) the aggregate amount of Rentals accrued for such period by the Company and its Subsidiaries plus (ii) the aggregate amount of Current Expenses accrued for such fiscal period, by the Company and its Subsidiaries.\nFixed Series B Rate -- with respect to any determination on any Series B Determination Date, shall mean the interest rate quoted to the Company on such date by Bank of America National Trust and Savings Association in San Francisco, California. For each Series B Portion, to which the Company has elected to have the Fixed Series B Rate applicable, such quoted interest rate shall be effective for the entire Applicable Series B Interest Period selected by the Company for such Series B Portion.\nFixed Series D Rate -- with respect to any determination on any Series D Determination Date, shall mean the interest rate quoted to the Company on such date by Bank of America National Trust and Savings Association in San Francisco, California. For each Series D Portion, to which the Company has elected to have the Fixed Series D Rate applicable, such quoted interest rate shall be effective for the entire Applicable Series D Interest Period selected by the Company for such Series D Portion.\nGuarantee Agreement -- means that certain Guarantee Agreement, dated as of October 1, 1986, among The Connecticut Bank and Trust Company, N.A., as the predecessor security trustee to the Security Trustee, Lonnie A Pilgrim and Patty R. Pilgrim, as amended and modified, from time to time.\nGuarantors -- means any one or more Persons which shall have guarantied the payment of the Notes and the performance of the Company of its obligations hereunder.\nGuaranty -- with respect to any Person shall mean any obligation (except the endorsement in the ordinary course of business of negotiable instruments for deposit or collection) of such Person guarantying or in effect guarantying any indebtedness, dividend or other obligation of any other Person (the \"primary obligor\") in any manner, whether directly or indirectly, including (without limitation) obligations incurred through an agreement, contingent or otherwise, by such Person:\n(1) to purchase such indebtedness or obligation or any Property or assets constituting security therefor;\n(2) to advance or supply funds\n(i) for the purpose or payment of such indebtedness or obligation, or\n(ii) to maintain working capital or other balance sheet condition or any income statement condition or otherwise to advance or make available funds for the purchase or payment of such indebtedness or obligation;\n(3) to lease Property or to purchase Securities or other Property or services primarily for the purpose of assuring the owner of such indebtedness or obligation of the ability of the primary obligor to make payment of the indebtedness or obligation; or\n(4) otherwise to assure the owner of the indebtedness or obligation of the primary obligor against loss in respect thereof.\nIndenture -- the first paragraph hereof.\nIndenture Estate -- Paragraph C of the Granting Clauses hereof.\nIntangible Assets -- license agreements, trademarks, trade names, patents, capitalized research and development costs, proprietary products (the results of past research and development treated as long term assets and excluded from Inventory) and goodwill, all determined on a consolidated basis in accordance with generally accepted accounting principles consistently applied.\nInvestment -- Article 1 (in the definition of Restricted Investment).\nLien -- any interest in Property securing an obligation owed to, or a claim by, a Person other than the owner of the Property, whether such interest is based on the common law, statute or contract, and including, but not limited to, the security interest lien arising from a mortgage, security agreement, encumbrance, pledge, conditional sale or trust receipt or a lease, consignment or bailment for security purposes. The term \"Lien\" shall include reservations, exceptions, encroachments, easements, rights-of-way, covenants, conditions, restrictions, leases and other title exceptions and encumbrances (including, with respect to stock, stockholder agreements, voting trust agreements, buy-back agreements and all similar arrangements) affecting Property. For the purposes of this Indenture, the Company or a Subsidiary shall be deemed to be the owner of any Property which it has acquired or holds subject to a conditional sale agreement, financing lease or other arrangement pursuant to which title to the Property has been retained by or vested in some other Person for security purposes, and such retention or vesting shall constitute a Lien.\nMacaulay Formula -- at any time with respect to any borrowing means the number produced by dividing\n(a) the Present Value of the Outstanding Dollar- Years of such borrowing at such time, by\n(b) the present value of the required payments of interest and principal in respect of such borrowing remaining immediately prior to such time.\nThe discount rate for purposes of determining the present value of such remaining principal and interest payments shall be the original yield to maturity of such borrowing.\nMajority Noteholders -- at any time means holder or holders of more than fifty percent (50%) in aggregate principal amount of all Notes then Outstanding.\nMake-Whole Amount -- with respect to any payment of Notes, to the extent the Treasury Rate at such time is lower than the original yield to maturity of the Notes, means an amount equal to the excess of (a) the then remaining scheduled payments of interest and principal on such Notes, discounted to present value at an annual rate equal to the Treasury Rate, minus (b) the aggregate principal amount of the Notes so paid. To the extent that the Treasury Rate at such time is equal to or above the original yield to maturity of the Notes, the Make-Whole Amount is zero (0).\nMargin Security -- Section 7.20 hereof.\nMaximum Rate -- Section 2.1(e) hereof.\nMexican Subsidiary -- shall mean any Subsidiary of the Company which is organized under the laws of Mexico (or any State or Province thereof) and\/or has manufacturing operations located in Mexico (or any State or Province thereof).\nMoney Market -- Section 4.5 hereof.\nMoney Market Rate -- Section 4.5 hereof.\nNet Future Capital Stock Proceeds -- the cash proceeds received by the Company after the Second Closing Date upon issuance of any new capital stock of the Company, and any contributions (valued at Fair Market Value for any noncash contributions) to capital received by the Company after the Second Closing Date, minus any and all commissions and expenses incurred in connection with the issuance of such capital stock.\nNet Tangible Assets -- at any time means the excess of Total Assets over Intangible Assets of the Company and its subsidiaries at such time.\nNote Purchase Agreements -- means (a) the Note Purchase Agreements dated as of October 1, 1986, between the Company and each of The Aetna Casualty and Surety Company, the Aetna Life Insurance Company and Bank of America National Trust and Savings Association in respect of the Series A Notes and the Series B Notes, (b) the Note Purchase Agreements dated as of September 21, 1990, between the Company and Aetna Life Insurance Company and Bank of America National Trust and Savings Association in respect of the Series C Notes and the Series D Notes and (c) any other note purchase agreement between the Company and a Purchaser in respect of the initial purchase and sale of any other Series of Notes.\nNotes -- the Series A Notes, the Series B Notes, the Series C Notes, the Series D Notes and all other additional notes issued pursuant to the provisions of Section 2.12 hereof.\nOfficer's Certificate -- a certificate signed by the President or a principal financial officer of the Company.\nOpinion of Counsel -- an opinion of independent counsel (which may from time to time serve as counsel for the Company, for the Security Trustee or for the holder of any Note) acceptable to the Security Trustee which opinion is in form, scope and content satisfactory to the Security Trustee and (if not rendered by counsel for the Security Trustee) counsel for the Security Trustee.\nOrder Notes -- in respect of Series A Notes shall have the meaning set forth in Section 2.1 hereof; in respect of Series C Notes shall have the meaning set forth in Section 2.1 hereof; and any other Note which is not a Registered Note.\nOriginal Payment Date -- Section 4.5 hereof.\nOutstanding -- with respect to the Notes at any time, means all Notes which have been duly authorized, authenticated (with respect to Notes of each Series of Notes), issued and delivered (except for Notes which have been replaced by new Notes which have been issued pursuant to Section 2.4, Section 2.5 or Section 2.9 hereof) exclusive of, and under no circumstances including, any Notes then owned by any one or more of the Company, its Subsidiaries or any Affiliates.\nPension Plans -- all employee pension benefit plans (as such term is defined in ERISA) from time to time maintained by, or for the benefit of the employees of, any one or more of the Company and its Subsidiaries or with respect to which any of such Persons may be liable to the Pension Benefit Guaranty Corporation (or its successor entity).\nPermitted Liens -- Section 3.3 hereof.\nPerson -- an individual, partnership, corporation, trust, unincorporated organization, government, governmental agency or governmental subdivision.\nPlan -- an employee benefit plan (as such term is defined in ERISA) from time to time maintained by, or for the benefit of the employees of, any one or more of the Company and its Subsidiaries or with respect to which any of such Persons may be liable to the Pension Benefit Guaranty Corporation (or its successor entity).\nPrepayment Date -- Section 4.4(a)(vii) hereof.\nPresent Value of the Outstanding Dollar-Years -- at any time with respect to any borrowing shall mean the product obtained by\n(a) multiplying\n(i) the present value of each required principal and interest payment (including repayment of principal at final maturity) of such borrowing unpaid immediately prior to such time, by\n(ii) the number of years (calculated to the nearest one-twelfth) that will elapse between such time and the date each such required principal or interest payment is due, and\n(b) calculating the sum of the products obtained in the preceding subsection (a).\nThe discount rate for purposes of determining the present value of such remaining principal and interest payments is the original yield to maturity of such borrowing.\nProperty -- any interest in any kind of property or asset, whether real, personal or mixed, and whether tangible or intangible.\nPurchase Money Lien -- (a) any Lien held by any Person (whether or not the seller of such assets) on assets (other than assets acquired to replace or repair assets owned by the Company or any Subsidiary on the date of the initial issuance of the Series A Notes and the Series B Notes) acquired, or constructed or improved, by the Company or any Subsidiary after the date of the initial issuance of the Series A Notes, which Lien secures all or a portion of the related purchase price, or construction or improvement cost, of such assets and is created at the time of, or within twelve (12) months after, such acquisition or the completion of such construction or improvement, (b) any Lien existing on any Property of any corporation at the time it becomes a Subsidiary, provided that in each such case such Lien (i) does not extend to any other asset or secure any other obligations of the Company or any other Subsidiary and (ii) the obligations secured thereby are not increased in aggregate amount of liability after the date such corporation becomes a Subsidiary or (c) any Lien on the assets or Voting Stock of any Subsidiary which was created on the date such Voting Stock was acquired by the Company or any other Subsidiary and which secures the payment by the Company or such other Subsidiary of all or part of the purchase price of such Voting Stock.\nPurchaser -- in respect of (a) the Series A Notes, means each of The Aetna Casualty and Surety Company and Aetna Life Insurance Company, (b) the Series B Notes, means Bank of America National Trust and Savings Association, (c) the Series C Notes, means Aetna Life Insurance Company, (d) the Series D Notes, means Bank of America National Trust and Savings Association, and (e) any other Series of Notes, means the initial purchaser thereof pursuant to a Note Purchase Agreement entered into by and between such purchaser and the Company.\nReference Series B Rate -- with respect to any determination on any Series B Rate Adjustment Date, shall mean the rate of interest publicly announced from time to time by Bank of America, National Trust and Savings Association, in San Francisco, California, as its \"reference rate,\" which \"reference rate is based upon various factors including such bank's costs and desired return, general economic conditions, and other factors, and is used as a reference point for pricing some loans, which may be price at, above or below such reference rate. Each change in the reference rate shall be effective as to any Series B Portion, to which the Company has elected to have the Reference Series B Rate applicable, at the opening of business on the day specified in the public announcement of such change.\nReference Series D Rate -- with respect to any determination on any Series D Rate Adjustment Date, shall mean the rate of interest publicly announced from time to time by Bank of America, National Trust and Savings Association, in San Francisco, California, as its \"reference rate,\" which \"reference rate is based upon various factors including such bank's costs and desired return, general economic conditions, and other factors, and is used as a reference point for pricing some loans, which may be priced at, above or below such reference rate. Each change in the reference rate shall be effective as to any Series D Portion, to which the Company has elected to have the Reference Series D Rate applicable, at the opening of business on the day specified in the public announcement of such change.\nRegistered Notes -- in respect of Series A Notes shall have the meaning set forth in Section 2.1 hereof; in respect of Series C Notes shall have the meaning set forth in Section 2.1 hereof; and any other Note which is registered in accordance with Section 2.3 hereof and which contains language substantially to the effect that such Note is a registered Note and is transferable only by surrender thereof at the principal office of the Company where a register therefor is maintained, duly endorsed or accompanied by a written instrument of transfer duly executed by the registered holder of such Note or his attorney duly authorized in writing.\nRemaining Dollar-Years -- of any indebtedness for borrowed money at any time means the amount obtained by (a) (i) multiplying the amount of each then remaining sinking fund, serial maturity or other required repayment, (including repayment at final maturity of such indebtedness), of such indebtedness by (ii) the number of years (calculated at the nearest one-twelfth) which will elapse between such time and the date of that required repayment, and (b) totaling all the products obtained in (a).\nRemaining Duration of the Series C Notes -- at any time with respect to any Series C Notes being prepaid means the number produced by\n(a) dividing the Present Value of the Outstanding Dollar-Years of such Series C Notes at such time, by\n(b) the present value of the remaining required payments of principal and interest on such Series C Notes immediately prior to such time.\nThe discount rate for purposes of determining the present value of such remaining principal and interest payments is ten and forty- nine one-hundredths percent (10.49%). The number produced by the foregoing calculation shall be rounded to one decimal point, with rounding up if the tail is 0.05 or higher, and rounding down otherwise.\nRentals -- as of the date of determination, means all non- cancelable, fixed payments which the lessee is required to make by the terms of any operating lease (including any renewal terms exercisable at the option of the lessor) of one year or more, but shall not include amounts required to be paid in respect of maintenance, repairs, income taxes, insurance, assessments or other similar charges or additional rentals (in excess of fixed minimums) based upon a percentage of gross receipts.\nRepurchase Agreement -- means any written agreement (a) which provides for (i) the transfer of one or more Acceptable Repurchase Securities to the Company or a Subsidiary from an Acceptable Transferor against a transfer of funds (the \"Transfer Price\") by the Company or such Subsidiary to such Acceptable Transferor and (ii) a simultaneous agreement by the Company or such Subsidiary, in connection with such transfer of funds, to transfer to such Acceptable Transferor the same or substantially similar Acceptable Repurchase Securities for a price not less than the Transfer Price plus a reasonable return thereon at a date certain not later than thirty (30) days after such transfer of funds, (b) in respect of which the Company or such Subsidiary shall have the contractual right to liquidate such repurchase agreement in accordance with 11 U.S.C. Section 559 (or any successor provision thereto) and (c) in connection with which the Company or such Subsidiary, or an agent thereof (other than the Acceptable Transferor or any agent thereof), shall take physical possession of the Acceptable Repurchase Securities so transferred to the Company or such Subsidiary, or in the case of any uncertified Acceptable Repurchase Securities so transferred, shall have taken all action required by any applicable law or regulations to perfect its Lien therein.\nResponsible Officer -- any vice president, trust officer or corporate trust officer, in each case employed in the Corporate Trust Services Department of the Security Trustee.\nRestricted Investments -- all investments, made in cash or by delivery of Property, by any one or more of the Company and its Subsidiaries (a) in any Person (other than the Company or a Subsidiary), whether by acquisition of stock, indebtedness or other obligation or Security, or by loan, advance or capital contribution, or otherwise, or (b) in any Property (items (a) and (b) herein called \"Investments\"), except the following:\n(i) Property to be used in the ordinary course of the business as described in Section 2.3 of the Note Purchase Agreements;\n(ii) current assets arising from the sale of goods and services in the ordinary course of business of the Company and its Subsidiaries;\n(iii) Investments in the Company or any Subsidiary;\n(iv) loans to Affiliates in an aggregate amount at any time not exceeding One Million Dollars ($1,000,000);\n(v) Investments in any Person (other than the Company, a Wholly-Owned Subsidiary or an Affiliate) engaged in the same line of business as the Company, if after giving effect to such Investments and all contemporaneous transactions, the aggregate outstanding amount of such Investments made by the Company and all Subsidiaries in the then current fiscal year of the Company will not exceed fifteen percent (15%) of Consolidated Tangible Net Worth as of the end of the fiscal year of the Company then most recently ended;\n(vi) Bankers Acceptances or interest bearing obligations, having an original maturity of one (1) year or less, in each case issued by an Acceptable Bank;\n(vii) Investments in interest bearing direct obligations of the United States of America, or any agency thereof, or obligations guaranteed by the United States of America, provided that such obligations mature within one (1) year from the date of acquisition thereof;\n(viii) Repurchase Agreements, having an original maturity of ninety (90) days or less, with Acceptable Banks or with recognized securities brokers; and\n(ix) Investments in commercial paper of corporations organized under the laws of the United States or any state thereof, given one of the two highest ratings by Standard and Poor's Bond Rating Index or by NCO Moody's Investor Service and maturing not more than two hundred seventy (270) days from the date of creation thereof.\nInvestments shall be valued at cost less any net return of capital through the sale or liquidation thereof or other return of capital thereon.\nSecond Closing Date -- (a) in respect of the Series C Notes, the date provided for in Section 1.2 of the Note Purchase Agreements and (b) in respect of the first purchase of Series D Notes, the date provided for in Section 1.2 of the Note Purchase Agreements.\nSecurities Act -- the Securities Act of 1933, as amended.\nSecurity -- shall have the same meaning as in Section 2(1) of the Securities Act. Security Trustee -- State Street Bank and Trust Company of Connecticut, N.A., as security trustee under this Indenture and any successor security trustee named in accordance with the provisions hereof.\nSeries, Series of Notes -- the Series A Notes, the Series B Notes, the Series C Notes, the Series D Notes or any other series of Notes issued pursuant to the provisions of Section 2.12 hereof.\nSeries A Notes -- Section 2.1 hereof.\nSeries A Order Notes -- Section 2.1 hereof.\nSeries A Registered Notes -- Section 2.1 hereof.\nSeries B Deferred Amount -- Section 2.1 hereof.\nSeries B Determination Date -- shall mean (i) with respect to any Series B Portion to which the Eurodollar Series B Rate shall be applicable, the day which is two (2) Business Days prior to the next Applicable Series B Rate Adjustment Date for such Series B Portion, (ii) with respect to any Series B Portion to which the Fixed Series B Rate shall be applicable, the day which is one (1) Business Day prior to the next Applicable Series B Rate Adjustment Date for such Series B Portion and (iii) with respect to any Series B Portion to which the Reference Series B Rate shall be applicable, the Applicable Series B Rate Adjustment Date.\nSeries B Noteholders -- each and every holder of Series B Notes.\nSeries B Notes -- Section 2.1 hereof.\nSeries B Portion -- a portion of the outstanding principal amount of the Series B Notes with respect to which a particular Applicable Series B Interest Rate is applicable.\nSeries C Make-Whole Amount -- at any time with respect to any Series C Notes being prepaid shall mean, to the extent that (a) the Treasury Constant Yield at such time in respect of such Series C Notes plus (b) twenty-five one-hundredths of one percent (0.25%), is lower than ten and forty-nine one-hundredths percent (10.49%) per annum, the excess of\n(a) the present value of the principal and interest payments due on such Series C Notes then being paid, discounted at a rate that is equal to (i) such Treasury Constant Yield plus (ii) twenty-five one- hundredths percent (0.25%) per annum, minus\n(b) the principal amount of such Series C Notes then being prepaid, at par.\nIf (A) such Treasury Constant Yield at the time of such payment plus (2) twenty-five one-hundredths percent (0.25%) per annum is equal to or higher than ten and forty-nine one-hundredths percent (10.49%) per annum, then the Series C Make-Whole Amount is Zero Dollars ($0).\nSeries C Notes -- Section 2.1 hereof.\nSeries C Order Notes -- Section 2.1 hereof.\nSeries C Registered Notes -- Section 2.1 hereof.\nSeries D Deferred Amount -- Section 2.1 hereof.\nSeries D Designated Officers -- Lonnie A. Pilgrim, Clifford E. Butler, or such other Persons as may be agreed to by the holders of the Series D Notes.\nSeries D Determination Date -- shall mean (i) with respect to any Series D Portion to which the Eurodollar Series D Rate shall be applicable, the day which is two (2) Business Days (or such shorter period of time as the holders of Series D Notes may agree to) prior to the next Applicable Series D Rate Adjustment Date for such Series D Portion, (ii) with respect to any Series D Portion to which the Fixed Series D Rate shall be applicable, the day which is one (1) Business Day (or such shorter period of time as the holders of Series D Notes may agree to) prior to the next Applicable Series D Rate Adjustment Date for such Series D Portion and (iii) with respect to any Series D Portion to which the Reference Series D Rate shall be applicable, the Applicable Series D Rate Adjustment Date.\nSeries D Notes -- Section 2.1 hereof.\nSeries D Noteholders -- each and every holder of Series D Notes.\nSeries D Prepaid Installment -- Section 4.5 hereof.\nSeries D Portion -- a portion of the outstanding principal amount of the Series D Notes with respect to which a particular Applicable Series D Interest Rate is applicable.\nSpecial Majority Noteholders -- at any time means all of the following holders of Notes: (w) holder or holders of more than fifty percent (50%) in aggregate principal amount of the Series A Notes then Outstanding, (x) holder or holders of more than fifty percent (50%) in aggregate principal amount of the Series C Notes then Outstanding, (y) holder or holders of more than fifty percent (50%) in aggregate principal amount of the Series D Notes then Outstanding, and (z) the holder or holder of more than fifty percent (50%) in aggregate principal amount of all other Notes then Outstanding.\nSubsidiary -- a corporation of which the Company owns, directly or indirectly, more than fifty percent (50%) of the Voting Stock.\nSubsidiary Stock -- Section 7.4 hereof.\nSuper-Majority Noteholders -- at any time means holder or holders of more than sixty-six and two-thirds percent (66-2\/3%) in aggregate principal amount of all Notes then Outstanding.\nThis Indenture -- this instrument as originally executed or as it may from time to time be supplemented or amended in accordance with the provisions hereof.\nTotal Assets -- at any time means the aggregate amount of assets of the Company and its Subsidiaries determined on a consolidated basis in accordance with generally accepted accounting principles consistently applied.\nTreasury Constant Yield -- at any time with respect to any prepayment of Series C Notes means the yield on a hypothetical United States Treasury security with a duration matching the Remaining Duration of the Series C Notes at such time with respect to such Series C Notes. The Hypothetical Treasury security is derived by referring to the United States Federal Reserve Statistical Release designated H.15(519) or its successor publication published immediately prior to such prepayment of the Series C Notes (the \"Applicable H-15\"). The duration of all such Treasury securities with maturities listed in the Applicable H-15 shall be calculated by using the Macaulay Formula and assuming that the coupon on each such Treasury security equals the weekly average yield on such Treasury security. The Remaining Duration of the Series C Notes shall be determined using a maturity date of September 21, 2002. If there is a Treasury security with a constant maturity listed in Applicable H-15 with a duration equal to such Remaining Duration of the Series C Notes, then the yield on such Treasury security shall be the Treasury Constant Yield. If no such security with a constant maturity exists, then the security with a duration closest to and greater than such Remaining Duration of the Series C Notes shall be used, along with the Treasury security with a duration closest to and less than such Remaining Duration of the Series C Notes, in the following formula, in order to calculate the Treasury Constant Yield:\nTCY=(YA+((RDN-DA)X((YB-YA)\/(DB-DA)))\nTCY = Treasury Constant Yield RDN = Remaining Duration of the Series C Notes Security A = Constant maturity Treasury security with a duration closest to and less than RDN Security B = Constant maturity Treasury security with a duration closest to and greater than RDN YA = Yield to Maturity of security A YB = Yield to Maturity of security B DA = Duration of security A DB = Duration of security B\nThe Treasury Constant Yield will be rounded to two decimal points with rounding up if the tail is 0.005 or higher, and rounding down otherwise.\nTreasury Rate -- at any time with respect to any Notes being paid at such time means the yield to maturity at such time of United States Treasury obligations with a constant maturity (as compiled by and published in the most recently published issue of The Wall Street Journal or any successor publication) most nearly equal to the Weighted Average Life to Maturity of the Notes then being paid.\nUnfriendly Investment -- any purchase or offer to purchase all or any portion of the Voting Stock of any corporation which is opposed or objected to by the board of directors of such corporation or any other proposed acquisition of Securities of any Person of the type normally referred to as a \"hostile tender offer.\"\nVoting Stock -- capital stock of any class or classes of a corporation the holders of which are ordinarily, in the absence of contingencies, entitled to elect a majority of the corporate directors (or Persons performing similar functions).\nWeighted Average Life to Maturity --with respect to any indebtedness for borrowed money means as at the date of the determination thereof the number of years obtained by dividing the then Remaining Dollar-Years of such indebtedness as of the date of determination by the then outstanding principal amount of such indebtedness.\nWholly-Owned Subsidiary -- any Subsidiary, 100% of the equity Securities and voting Securities of which are owned by one or more of the Company and the Company's other Wholly-Owned Subsidiaries.\nWritten Request -- with respect to any Person a written order or request signed in the name of such Person by the President or a Vice-President of such Person (if a corporation other than one of the holders of Notes) or a general or managing partner (if a partnership) or the Person (if an individual) or any officer of such Person (if such Person is a corporation and a holder of a Note).\nARTICLE 2 COMPANY BUSINESS COVENANTS.\nArticle 7 of the Existing Indenture is hereby amended and restated to read in its entirety as follows:\nThe Company covenants that on and after the date of initial issue of the Notes, so long as any one or more of the Notes or any other obligation secured hereby is outstanding:\nSection 7.1. Payment of Taxes and Claims. The Company, and each Subsidiary, will pay, before they become delinquent:\n(a) all taxes, assessments and governmental charges or levies imposed upon it or its Property;\n(b) all claims or demands of materialmen, mechanics, carriers, warehousemen, landlords and other like Persons which, if unpaid, might result in the creation of a Lien upon its Property; and\n(c) all claims, assessments and levies required to be paid by the Company or any Subsidiary pursuant to any agreement, contract, law, ordinance, or governmental rule or regulation governing any Plan of the Company or any Subsidiary;\nprovided that items of the foregoing description need not be paid while being contested in good faith and by appropriate proceedings and provided further that adequate book reserves have been established with respect thereto and provided further that the owning Person's title to, and its right to use, its Property is not materially and adversely affected thereby. In the case of any item of the foregoing description involving in excess of Two Hundred Fifty Thousand Dollars ($250,000), the appropriateness of the proceedings shall be supported by an opinion of the independent counsel responsible for such proceedings and the adequacy of such reserves shall be supported by the opinion of the independent accountants of the contesting company.\nSection 7.2. Maintenance of Properties and Existence. The Company and each Subsidiary will:\n(a) Property -- maintain its Property in good condition and make all necessary renewals, replacements, additions, betterments and improvements thereto;\n(b) Insurance -- maintain, with financially sound and reputable insurers, insurance with respect to its Properties and business against such casualties and contingencies, of such types (including, without limitation, in each case, if available, loss or damage, public liability, business interruption, war risk, larceny, embezzlement or other criminal misappropriation insurance) and in such amounts as is customary in the case of corporations engaged in the same or a similar business and similarly situated;\n(c) Financial Records -- (i) keep true books of records and accounts in which full and correct entries will be made of all its business transactions, and will reflect in its financial statements adequate accruals and appropriations to reserves, all in accordance with generally accepted accounting principles, practices and procedures at the time in effect and consistently applied except for changes in application in which its independent certified public accountants concur, and (ii) do or cause to be done all things necessary to ensure that the Company and each Subsidiary maintains the same fiscal year;\n(d) Corporate Existence and Rights -- do or cause to be done all things necessary (i) subject to the provisions of Section 7.5 hereof, to preserve and keep in full force and effect its corporate existence, rights and franchises; and\n(e) Compliance with Law -- not be in violation of any law, ordinance or governmental rule or regulation to which it is subject and will not fail to obtain any license, permit, franchise or other governmental authorization necessary to the ownership of its Properties or to the conduct of its business, which violation or failure to obtain might materially adversely affect the business, prospects, profits, Properties or condition (financial or otherwise) of the Company and its Subsidiaries, taken as a whole.\nSection 7.3. Payment of Notes and Maintenance of Office. The Company will punctually pay or cause to be paid the principal and interest (and premium, if any) to become due in respect of the Notes according to the terms thereof and will maintain an office in the State of Texas where notices, presentations and demands in respect of this Indenture or the Notes may be made upon it. The address of such office shall be 110 South Texas Street, P.O. Box 93, Pittsburg, Texas 75686, until such time as the Company shall notify the holders of the Notes of any change of location of such office within such State.\nSection 7.4. Disposal of Shares of a Subsidiary. The Company will not, nor will it permit any Subsidiary to, sell or otherwise dispose of any shares of the stock (or any options or warrants to purchase stock or other Securities exchangeable for or convertible into stock) of a Subsidiary (said stock, options, warrants and other Securities herein called \"Subsidiary Stock\") except to the Company or another Subsidiary, nor will any Subsidiary issue, sell or otherwise dispose of any shares of its own Subsidiary Stock except to the Company or another Subsidiary.\nSection 7.5. Sale of Assets, Merger and Consolidation.\nThe Company will not, nor will it permit any Subsidiary to, consolidate with or merge into any other Person or permit any other Person to consolidate with or merge into it (except that a Subsidiary may consolidate with or merge into another Subsidiary) or sell or otherwise transfer all or substantially all of its Property to any other Person (except that a Subsidiary may sell or otherwise transfer all or substantially all of its Property to another Subsidiary), unless such consolidation, merger or sale is consented to in writing by the Special Majority Noteholders; provided that the foregoing restriction does not apply to the merger of another corporation with the Company, if:\n(a) the corporation which results from such merger or consolidation (the \"surviving corporation\") is organized under the laws of the United States or a jurisdiction thereof;\n(b) the due and punctual payment of the principal of, and premium, if any, and interest on, all of the Notes, according to their respective tenor, and the due and punctual performance and observance of all of the covenants in the Notes, this Indenture and the documents evidencing or creating any other obligations secured hereby to be performed or observed by the Company, are expressly assumed in writing by the surviving corporation;\n(c) after giving effect to the proposed merger or consolidation, the surviving corporation will be engaged in substantially the same lines of business as referred to in Section 2.3 of the Note Purchase Agreements in respect of the Series A Notes, the Series B Notes, the Series C Notes and the Series D Notes; and\n(d) immediately after the consummation of the transaction, and after giving effect thereto, (i) no Default or Event of Default would exist and (ii) the surviving corporation would be permitted by the provisions of Section 7.9 hereof to incur at least one dollar ($1.00) of additional Adjusted Funded Debt.\nSection 7.6. Lease Payments; Sale Leasebacks.\n(a) Limitation on Leases. Neither the Company nor any Subsidiary will become liable as lessee under any lease (other than a financing lease which constitutes Adjusted Funded Debt, a lease of rolling stock or a lease under which the Company or a Subsidiary is lessor) of Property if the aggregate annual Rentals payable during any current or future fiscal year under the lease in question and all other such leases under which the Company or a Subsidiary is then lessee would exceed four percent (4%) of the remainder of Net Tangible Assets less Consolidated Current Liabilities.\n(b) Subsidiary Leases. Any corporation which becomes a Subsidiary after September 1, 1994 shall be deemed to have become liable as lessee, at the time it becomes a Subsidiary, under all leases (under which it is liable as lessee) of such corporation existing immediately after it becomes a Subsidiary.\n(c) Sale Leasebacks. Neither the Company nor any Subsidiary shall sell or otherwise transfer, in one or more related transactions, any of its Property to any Person (other than the Company or a Subsidiary) and thereafter rent or lease such Property, or substantially identical Property, provided that the Company or a Subsidiary may sell Property (other than Collateral) to any Person (other than the Company or a Subsidiary) and thereafter rent or lease such Property if (i) such sale and such rental and\/or leasing is consummated within 365 days of the acquisition of such Property by the Company or such Subsidiary or, if such Property shall have been constructed by the Company or such Subsidiary, within 365 days of the completion of such construction, or (ii) after giving effect to such transaction, the aggregate book value of the Property so sold in any fiscal year of the Company would not exceed Ten Million Dollars ($10,000,000).\nSection 7.7. Liens and Encumbrances.\n(a) Negative Pledge. Neither the Company nor any Subsidiary will (i) cause or permit or (ii) agree or consent to cause or permit in the future (upon the happening of a contingency or otherwise) any of the Indenture Estate, whether now owned or hereafter acquired, to be subject to a Lien except:\n(1) Liens securing taxes, assessments or governmental charges or levies or the claims or demands of materialmen, mechanics, carriers, warehousemen, landlords and other like Persons; provided that the payment thereof is not at the time required by Section 7.1 hereof;\n(2) Liens incurred or deposits made (i) in the ordinary course of business in connection with workmen's compensation, unemployment insurance, social security and other like laws, (ii) in the ordinary course of business to secure the performance of letters of credit, bids, tenders, sales contracts, leases, statutory obligations, surety (other than of the type referred to in clause (iii) of this Section 7.7(a)(2)), and performance bonds and other similar obligations not incurred in connection with the borrowing of money, the obtaining of advances or the payment of the deferred purchase price of Property or (iii) to secure appeal bonds, supersedeas bonds and other similar bonds provided the aggregate amount of such bonds shall not at any time exceed Five Hundred Thousand Dollars ($500,000);\n(3) attachments, judgments and other similar Liens arising in connection with court proceedings; provided, that the execution or other enforcement of such Liens is effectively stayed and the claims secured thereby are being actively contested in good faith and by appropriate proceedings and provided further, that the aggregate amount of such attachments, judgments and other similar Liens shall not at any time exceed Five Hundred Thousand Dollars ($500,000);\n(4) Liens on Property of a Subsidiary; provided that such Liens secure only obligations owing to the Company or a Wholly-Owned Subsidiary;\n(5) reservations, exceptions, encroachments, easements, rights-of-way, covenants, conditions, restrictions, leases and other similar title exceptions or encumbrances affecting real Property; provided, that they do not in the aggregate materially detract from the value of said Properties as used in owner's business or materially interfere with their use in the ordinary conduct of the owner's business;\n(6) (y) Liens in existence on the date of this Indenture and disclosed on the Exhibits to the Note Purchase Agreements in respect of the Series A Notes, the Series B Notes, the Series C Notes and the Series D Notes and (z) Liens securing those certain 14.25% Senior Notes Due 1995 of the Company issued under that certain Indenture, dated as of May 1, 1988, between MTrust Corp, National Association, and the Company, as amended up to and including the Second Closing Date provided that such subordination shall be satisfactory in form and substance to the holders of Series A Notes, Series C Notes and Series D Notes and the principal amount of such Senior Notes shall not exceed at any time the remainder of fifty million dollars ($50,000,000) minus the aggregate principal amount of such Senior Notes repaid by the Company at or prior to such time;\n(7) Liens in favor of the Security Trustee with respect to the Indenture Estate;\n(8) Purchase Money Liens, if after giving effect thereto and any concurrent transactions (A) no Default or Event of Default would exist and (B) the Company would be permitted by the provisions of Section 7.9(a) hereof to incur the indebtedness secured thereby; and\n(9) extensions and renewals of Liens described in Sec tion 7.7(a)(6)(y) hereof which secure indebtedness for money borrowed in connection with the extension, renewal or refunding of the indebtedness secured thereby, provided (A) the amount of such indebtedness is not increased at any time and (B) such Liens are not extended to Property not encumbered thereby on the date hereof, and provided further that this clause (9) shall not apply to any of the Company's 14.25% Senior Notes due 1995 referred to in Section 7.7(a)(6)(z).\n(b) Equal and Ratable Lien; Equitable Lien. In any case wherein Property is subjected to a Lien in violation of this Section 7.7, the Company will make or cause to be made provision whereby the Notes and the other obligations secured hereby will be secured equally and ratably with all other obligations secured thereby, and in any case the Notes and such obligations shall have (in addition to the benefits of the Lien in favor of the Security Trustee with respect to the Indenture Estate) the benefit, to the full extent that, and with such priority as, the holders may be entitled thereto under applicable law, of an equitable Lien on such Property securing the Notes and such obligations. Such violation of Section 7.7 shall constitute an Event of Default hereunder, whether or not any such provision is made pursuant to this Section 7.7(b). (c) Financing Statements. The Company will not, nor will it permit any Subsidiary to, sign or file any financing statement under the Uniform Commercial Code of any jurisdiction which names the Company or such Subsidiary as debtor, or sign any security agreement authorizing any secured party thereunder to file any such financing statement, except, in any such case, a financing statement filed or to be filed to perfect or protect a security interest which the Company or such Subsidiary is entitled to create, assume or incur, or permit to exist, under the foregoing provisions of this Section 7.7.\n(d) Opinions. The Company will cause this Indenture, any and all supplemental indentures, mortgages, security agreements, instruments of further assignment and financing statements and continuation statements at all times to be kept recorded and filed in such manner and in such places as may be required by law to fully preserve and protect the rights of the holders of the obligations secured hereby and the Security Trustee hereunder and under all other documents and instruments evidencing or securing the obligations secured hereby (including, without limitation, documents and instruments granting Liens to the Security Trustee with respect to the Indenture Estate), and it will furnish to the Security Trustee between April 1 and June 1 of each year beginning with the year 1987, an Opinion of Counsel stating that in the opinion of such counsel such action (if any be required) has been taken with respect to the recording, filing, registering, pre-recording, refiling and reregistering of this Indenture, any and all supplemental indentures, mortgages, security agreements, instruments of further assurance and financing and continuation statements as is necessary for such purposes, and reciting the details of such action (if any), and stating that in the opinion of such counsel no additional action is, or will become during the twelve (12) months following the date of such opinion, necessary for such purpose.\nSection 7.8. Current Liabilities. The Company will not, nor will it permit any Subsidiary to, have any material current liabilities which are more than thirty (30) days overdue unless contested in good faith.\nSection 7.9. Debt; Total Liabilities.\n(a) Adjusted Funded Debt. Neither the Company nor any Subsidiary will permit at any time Consolidated Net Tangible Assets to be less than one hundred seventy-five percent (175%) of the aggregate principal amount of Adjusted Funded Debt of the Company and the Subsidiaries outstanding at such time (after eliminating therefrom (i) the current portion of any obligation constituting such Adjusted Funded Debt and (ii) any Adjusted Funded Debt owing from the Company to a Subsidiary, from a Subsidiary to the Company or from a Subsidiary to another Subsidiary).\n(b) Subsidiary Debt. Intentionally deleted.\n(c) Total Liabilities. On the last day of each fiscal quarter of the Company, Consolidated Total Liabilities will not exceed three hundred fifty percent (350%) of Consolidated Tangible Net Worth.\n(d) Guaranties. Neither the Company nor any Subsidiary will permit at any time the aggregate obligations (whether contingent or matured) in respect of all of the Guaranties issued by the Company or any Subsidiary to exceed One Million Dollars ($1,000,000); provided, however, that the foregoing restriction shall not include Guaranties (i) issued by the Company and payable to a Subsidiary, (ii) issued by a Subsidiary and payable to the Company, (iii) issued by a Subsidiary and payable to another Subsidiary, and (iv) of the obligations of one or more Mexican Subsidiaries not to exceed $25,000,000 in the aggregate. The obligations of the Company or any Subsidiary under any Guaranty which, by the terms thereof, are unliquidated or contingent shall be the amount which the Board of Directors shall, in good faith, reasonably estimate.\nSection 7.10. Consolidated Tangible Net Worth. The Company and its Subsidiaries will, at all times, maintain Consolidated Tangible Net Worth of not less than the sum of (x) One Hundred Million Dollars ($100,000,000) plus (y) an amount equal to the sum of (i) sixty percent (60%) of Consolidated Adjusted Net Income earned since October 3, 1994 through and including the last day of the then most recently ended fiscal year (excluding any fiscal year in which Consolidated Adjusted Net Income was less than $0), plus (ii) one hundred percent (100%) of Net Future Capital Stock Proceeds.\nSection 7.11. Restricted Investments.\n(a) Limit on Restricted Investments. The Company will not, nor will it permit any Subsidiary to, make or incur any liability to make any Restricted Investment or any Unfriendly Investment.\nAny corporation which becomes a Subsidiary after the date of the initial issuance of the Series A Notes and the Series B Notes, shall be deemed to have made, at the time it becomes a Subsidiary, all Restricted Investments of such corporation existing immediately after it becomes a Subsidiary.\n(b) No Defaults. Anything herein contained to the contrary notwithstanding, neither the Company nor any Subsidiary will authorize or make any Investment if, after giving effect to the proposed Investment a Default or an Event of Default would exist.\n(c) Restricted Payments. The Company will not and will not permit any Subsidiary to:\n(i) declare or pay any dividends, either in cash or Property, on any shares of capital stock of any class (except dividends or other distributions payable solely in shares of common stock of the Company and dividends paid by any Subsidiary to the Company or to any other Subsidiary); or\n(ii) directly or indirectly, or through any Subsidiary, purchase, redeem or retire any shares of capital stock of any class of the Company or any Subsidiary or any warrants, rights or options to purchase or acquire any shares of such capital stock (other than shares of capital stock of the Company acquired by the Company in exchange for other shares of common stock of the Company or shares of capital stock of such Subsidiary acquired by such Subsidiary in exchange for other shares of common stock of such Subsidiary); or\n(iii) make any other payment or distribution, either directly or indirectly or through any Subsidiary, in respect of its capital stock (other than to the Company or a Subsidiary),\nunless, after giving effect thereto, the aggregate of all such payments, purchases or distributions in respect of the then current fiscal year of the Company shall not exceed Two Million Three Hundred Thousand Dollars ($2,300,000). For the purposes of this subsection, the amount of any of the aforesaid payments which is payable or distributable in Property other than cash or shares of capital stock of the Company shall be deemed to be the greater of the book value or Fair Market Value (as determined in good faith by the Board of Directors of the Company) of such Property as of the date of the declaration of such payment. The Company shall not authorize any dividend, payment or distribution in respect of its capital stock which is not payable within sixty (60) days of authorization.\nSection 7.12. Current Ratio; Consolidated Working Capital.\n(a) Current Ratio. At all times, Consolidated Current Assets as of the end of the fiscal quarter of the Company then most recently ended shall be not less than one hundred forty percent (140%) of Consolidated Adjusted Current Liabilities as at the end of such fiscal quarter.\n(b) Maintenance of Consolidated Adjusted Working Capital. At all times, Consolidated Adjusted Working Capital will be not less than Fifty Million Dollars ($50,000,000).\nSection 7.13. Fixed Charge Ratio. At all times, the Fixed Charge Ratio for the period of eight (8) consecutive fiscal quarters then most recently ended shall be not less than 1.40.\nSection 7.14. ERISA Compliance.\n(a) Relationship of Vested Benefits to Pension Plan Assets. The Company will not at any time permit the present value of all employee benefits vested under all Pension Plans to exceed a sum equal to the present value of the assets allocable to such vested benefits.\n(b) Valuations. All assumptions and methods used to determine the actuarial valuation of vested employee benefits under Pension Plans and the present value of assets of such Pension Plans shall be reasonable in the good faith judgment of the Company and shall comply with all requirements of law.\n(c) Prohibited Actions. Neither the Company nor any Subsidiary nor any Plan at any time maintained by any one or more of the Company and its Subsidiaries will\n(1) engage in any \"prohibited transaction\" (as such term is defined in Section 406 or Section 2003(a) of ERISA;\n(2) incur any \"accumulated funding deficiency\" (as such term is defined in Section 302 of ERISA) whether or not waived; or\n(3) terminate any such Plan in a manner which could result in the imposition of a Lien on the Property of the Company or any Subsidiary pursuant to Section 4068 of ERISA.\nSection 7.15. Transactions with Affiliates. Neither the Company nor any Subsidiary will enter into any transaction, including, without limitation, the purchase, sale or exchange of Property or the rendering of any service, with any Affiliate except in the ordinary course of and pursuant to the reasonable requirements of the Company's or such Subsidiary's business and upon fair and reasonable terms no less favorable to the Company or such Subsidiary than would obtain in a comparable arm's- length transaction with a Person not an Affiliate.\nSection 7.16. Tax Consolidation. The Company will not file or consent to the filing of any consolidated income tax return with any Person other than a Subsidiary.\nSection 7.17. Sale or Discount of Receivables. The Company will not, nor will it permit any Subsidiary to, discount or sell with recourse, or sell for less than the greater of the face value or market value thereof, any of its notes receivable or accounts receivable.\nSection 7.18. Acquisition of Notes. Neither the Company, any Subsidiary nor any Affiliate will, directly or indirectly, acquire or make any offer to acquire any Notes unless the Company or such Subsidiary or Affiliate has offered to acquire Notes, pro rata, from all holders of the Notes and upon the same terms. In case the Company acquires any Notes, such Notes shall thereafter be cancelled and no Notes shall be issued in substitution therefor.\nSection 7.19. Line of Business. Neither the Company nor any Subsidiary will engage, directly or indirectly, in any business if, as a result thereof, the business of the Company and the Subsidiaries, taken as a whole, would not be substantially the same as on the date of this Indenture.\nSection 7.20. Margin Securities. Neither the Company nor any Subsidiary will own, purchase or acquire or enter into any contract to purchase or acquire, any \"margin security\" (a \"Margin Security\") as such term is presently defined in Part 207 of Title 12 of the Code of Federal Regulations or as such term may in the future be defined in the substantially similar applicable rules and regulations of the Federal Reserve Board or its successor agency.\nSection 7.21. Financial and Business Information. The Company will deliver to the Security Trustee and each institutional holder of the then outstanding Notes:\n(a) Quarterly Statements -- as soon as practicable after the end of each quarterly fiscal period in each fiscal year of the Company, and in any event within forty-five (45) days thereafter, two (2) copies of:\n(1) a consolidated balance sheet of the Company and its Subsidiaries as at the end of such quarter, and\n(2) consolidated statements of income, surplus and cash flows of the Company and its Subsidiaries for such quarter and (in the case of the second and third quarters) for the portion of the fiscal year ending with such quarter,\nsetting forth in each case in comparative form the figures for the corresponding periods in the previous fiscal year, all in reasonable detail and certified as complete and correct, subject to changes resulting from year-end adjustments, by a principal financial officer of the Company;\n(b) Annual Statements -- as soon as practicable after the end of each fiscal year of the Company, and in any event within ninety (90) days thereafter, two (2) copies of:\n(1) a consolidated balance sheet of the Company and its Subsidiaries as at the end of such year, and\n(2) consolidated statements of income, surplus and cash flows of the Company and its Subsidiaries for such year,\nsetting forth in each case in comparative form the figures for the previous fiscal year, all in reasonable detail and accompanied by (y) an opinion thereon of independent certified public accountants of recognized national standing selected by the Company and acceptable to the Special Majority Noteholders, which opinion shall state that such consolidated financial statements fairly present the financial condition of the companies being reported upon and have been prepared in accordance with generally accepted accounting principles consistently applied (except for changes in application which were required as a condition to obtain such opinion from such accountants) and that the examination of such accountants in connection with such financial statements has been made in accordance with generally accepted auditing standards, and accordingly included such tests of the accounting records and such other auditing procedures as were considered necessary in the circumstances and (z) a certification by a principal financial officer of the Company that such consolidated financial statements are complete and correct;\n(c) Opinions of Independent Accountants and Counsel -- as soon as practicable after the end of each fiscal year of the Company, and in any event within ninety (90) days thereafter, duplicate copies of all opinions of independent accountants and counsel required pursuant to Section 7.1 hereof;\n(d) Audit Reports -- promptly upon receipt thereof, one (1) copy of each other report submitted to the Company or any Subsidiary by independent accountants in connection with any annual, interim or special audit made by them of the books of the Company or any Subsidiary;\n(e) SEC and Other Reports -- promptly upon their becoming available one (1) copy of each financial statement, report, notice or proxy statement sent by the Company or any Subsidiary to stockholders generally, and of each regular or periodic report and any registration statement, prospectus or written communication (other than transmittal letters) in respect thereof filed by the Company or any Subsidiary with, or received by such Person in connection therewith from, any securities exchange or the Securities and Exchange Commission or any successor agency;\n(f) ERISA -- immediately upon becoming aware of the occurrence of any (i) \"reportable event\" (as such term is defined in Section 4043 of ERISA) or (ii) \"prohibited transaction\" (as such term is defined in Section 406 or Section 2003(a) of ERISA) in connection with any Plan or any trust created thereunder, a written notice specifying the nature thereof, what action the Company is taking or proposes to take with respect thereto, and, when known, any action taken by the Internal Revenue Service or the Department of Labor, as the case may be, with respect thereto;\n(g) Notice of Default or Event of Default -- immediately upon becoming aware of the existence of any condition or event which constitutes a Default or an Event of Default a written notice specifying the nature and period of existence thereof and what action the Company is taking or proposes to take with respect thereto;\n(h) Notice of Claimed Default -- immediately upon becoming aware that the holder of any note or of any evidence of indebtedness or other Security of the Company or any Subsidiary has given notice or taken any other action with respect to a claimed default or event of default, a written notice specifying the notice given or action taken by such holder and the nature of the claimed default or event of default and what action the Company is taking or proposes to take with respect thereto;\n(i) Other Information; Rule 144A -- promptly upon request such financial or other information as any holder of Notes may reasonably determine is required to permit such holder to comply with the requirements of Rule 144A promulgated under the Securities Act in connection with the resale by it of such Notes; and\n(j) Requested Information -- with reasonable promptness, such other data and information as from time to time may be reasonably requested.\nSection 7.22. Officers' Certificates. Each set of financial statements delivered to the Security Trustee or any institutional holder of the Notes pursuant to Section 7.21(a) or Section 7.21(b) hereof will be accompanied by a certificate signed by a principal financial officer of the Company setting forth:\n(a) Covenant Compliance -- the information (including detailed calculations, and, where required by the appropriate covenant, information and calculations presented on a consolidated basis) required in order to establish whether the Company and the Subsidiaries were in compliance with the requirements of Section 7.4 through Section 7.20 hereof during the period covered by the income statement then being furnished.\n(b) Event of Default -- that the signers have reviewed the relevant terms of this Indenture and have made, or caused to be made, under their supervision, a review of the transactions and conditions of the Company and its Subsidiaries from the beginning of the accounting period covered by the income statements being delivered therewith to the date of the certificate and that such review has not disclosed the existence during such period of any condition or event which constitutes a Default or an Event of Default or, if any such condition or event existed or exists, specifying the nature and period of existence thereof and what action the Company and each Subsidiary has taken or proposes to take with respect thereto.\nSection 7.23. Accountants' Certificates. Each set of annual financial statements delivered pursuant to Section 7.21(b) hereof will be accompanied by a certificate of the accountants who certify such financial statements, stating that they have reviewed this Indenture and stating further, whether, in making their audit, such accountants have become aware of any condition or event which then constitutes a Default or an Event of Default, and, if any such condition or event then exists, specifying the nature and period of existence thereof.\nSection 7.24. Inspection. The Company will, and will cause each Subsidiary to, permit representatives of the Security Trustee or the representatives of any institutional holder of any Note, at the Security Trustee's or such holder's expense, to visit and inspect any of the Properties of the Company or any Subsidiary, to examine all their books of account, records, reports and other papers, to make copies and extracts therefrom, and to discuss their respective affairs, finances and accounts with their respective officers, employees and independent public accountants (and by this provision the Company authorizes said accountants to discuss the finances and affairs of the Company and its Subsidiaries) all at such reasonable times and as often as may be reasonably requested.\nARTICLE 3 REPRESENTATIONS AND WARRANTIES.\n3.1 Corporate Organization and Authority. The Company (a) is a corporation duly organized and validly in good standing under the laws of the State of Delaware, (b) has all requisite power and authority and all necessary licenses and permits to own and operate its Properties and to carry on its business as now conducted and presently proposed to be conducted, (c) is duly qualified and is authorized to do business and is in good standing as a foreign corporation in each jurisdiction where the character of its Properties or the nature of its activities makes such qualification necessary and (d) has the corporate power and authority to (i) enter into this Supplemental Indenture and (ii) perform its obligations under this Supplemental Indenture, the Trust Indenture and the other Financing Documents.\n3.2 Lien Priority. The Liens in and to the Collateral have been duly granted, are in full force and effect, are perfected and are senior to all other Liens except as provided for in Section 7.7(a) of the Existing Indenture.\n3.3 Authorization. This Supplemental Indenture has been duly authorized, executed and delivered by the Company and the obligations of the Company hereunder and under the other Financing Documents constitute the legal, valid and binding obligations of the Company, enforceable in accordance with their respective terms, except that the enforceability of this Supplemental Indenture, the Trust Indenture and the other Financing Documents, as amended hereby may be (a) limited by bankruptcy, insolvency or other similar laws affecting the enforceability of creditors' rights generally and (b) subject to the availability of equitable remedies. The execution and delivery by the Company of this Supplemental Indenture are not, and the performance by the Company of its obligations hereunder will not be, inconsistent with its certificate of incorporation or by-laws, do not and will not contravene any law, governmental rule or regulation, judgment or order applicable to the Company, and do not and will not contravene any provision of, or constitute a default under, any indenture, mortgage, contract or other instrument to which the Company is a party or by which any of its Property is bound.\n3.4 Consent. No consent or approval of, giving of notice to, registration with, or taking of any other action in respect of or by, any federal, state or local governmental authority or agency, or other Person is required with respect to (a) the execution and delivery by the Company of this Supplemental Indenture and (b) the performance by the Company of any of its obligations hereunder or thereunder or under the Trust Indenture.\n3.5 Default. After giving effect to this Supplemental Indenture, no Default or Event of Default will exist. There are no defaults or events of default under any other agreement or instrument of the Company relating to or evidencing Debt.\n3.6 Mexican Advances. The aggregate inter-company advances owed to the Company or its U.S. Subsidiaries by its Mexican Subsidiaries as of August 27, 1994 is $24,755,375 and the net equity investment (exclusive of retained earnings) made by the Company in its Mexican Subsidiaries as of August 27, 1994 is $51,285,344.\nARTICLE 4 CONDITIONS TO EFFECTIVENESS.\nThis Supplemental Indenture shall become effective only upon the satisfaction in all respects of the conditions set forth below. The first date upon which all such conditions shall have been satisfied shall be the date that this Supplemental Indenture becomes effective. The aforesaid conditions are as follows:\n4.1 Holder Instructions to Security Trustee. Each of the holders of Notes shall have executed the addendum hereto instructing the Security Trustee to execute and deliver this Supplemental Indenture.\n4.2 Execution of this Supplemental Indenture. The Security Trustee and the Company shall have executed this Supplemental Indenture.\n4.3 Security Trustee Fees. All fees of the Security Trustee due and payable upon the execution and delivery of this Supplemental Indenture shall have been paid by the Company. 4.4 Representations and Warranties. The representations and warranties set forth in Article 3 hereof shall be true and correct as of the date hereof and as of the date this Supplemental Indenture becomes effective.\n4.5 Guarantee Agreement Confirmation. Each of the Guarantors shall have executed the addendum hereto, and the Guarantors and the Security Trustee shall have entered into an amendment to the Guaranty Agreement in form and substance satisfactory to the holders of the Notes.\n4.6 Proceedings; Expenses. All proceedings taken in connection with the closing of this Supplemental Indenture and all documents and papers relating thereto shall be satisfactory to each of the holders of Notes and their respective counsel. All costs and expenses of the holders of Notes and the Security Trustee required to be paid by Section 5.9 hereof shall have been paid in full.\nARTICLE 5 MISCELLANEOUS.\nSection 5.1 Benefit of Existing Indenture. The Security Trustee shall be entitled to, may exercise, and shall be protected by, where and to the full extent the same shall be applicable, all the rights, powers, privileges, immunities and exemptions provided in the Existing Indenture as if the provisions concerning the same, as amended (if at all) hereby, were incorporated herein at length. The recitals and statements in this Supplemental Indenture shall be taken as statements by the Company alone, and shall not be considered as made by or imposing any obligation or liability upon the Security Trustee, nor shall the Security Trustee be held responsible for the legality or validity of this Supplemental Indenture, and the Security Trustee makes no covenant or representation, and shall not be responsible, as to and for the effect, authorization, execution, delivery or recording of this Supplemental Indenture. As provided in the Existing Indenture, this Supplemental Indenture shall hereafter form a part of the Trust Indenture.\nSection 5.2 Successors and Assigns. Whenever any of the parties hereto is referred to, such reference shall be deemed to include the successors and assigns of such party, and all the covenants, promises and agreements in this Supplemental Indenture contained by or on behalf of the Company or by or on behalf of the Security Trustee shall bind and inure to the benefit of the respective successors and assigns of such parties whether so expressed or not.\nSection 5.3 Partial Invalidity. The unenforceability or invalidity of any provision or provisions of this Supplemental Indenture shall not render any other provision or provisions herein or otherwise within the Trust Indenture contained unenforceable or invalid.\nSection 5.4 Governing Law. THE TRUST INDENTURE, INCLUDING THIS SUPPLEMENTAL INDENTURE, AND THE NOTES SHALL BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE INTERNAL LAWS OF THE STATE OF CONNECTICUT (WITHOUT REGARD TO ANY CONFLICTS-OF-LAW PRINCIPLES)\nSection 5.5 Counterparts. This Supplemental Indenture may be executed and delivered in any number of counterparts, each of such counterparts constituting an original but altogether only one Supplemental Indenture; provided, however, that this Supplemental Indenture shall not be deemed to be delivered until at least one counterpart shall have been executed by the Company and the Security Trustee.\nSection 5.6 Headings, etc. Any headings or captions preceding the text of the several articles and sections hereof are intended solely for convenience of reference and shall not constitute a part of this Supplemental Indenture nor shall they affect its or the Trust Indenture's meaning, construction or effect. Each covenant contained in this Supplemental Indenture shall be construed (absent an express contrary provision therein) as being independent of each and every other covenant herein and in the Trust Indenture contained and compliance with any one covenant shall not (absent such an express contrary provision) be deemed to excuse compliance with any and all other covenants.\nSection 5.7 Amendments. This Supplemental Indenture may, subject to the provisions of Article 9 of the Trust Indenture, from time to time and at any time, be amended or supplemented by, and only by, an instrument or instruments in writing executed by the parties hereto.\nSection 5.8 Benefits of Indenture Restricted to Parties and Note Holders. Nothing in this Supplemental Indenture expressed or implied is intended or shall be construed to give to any Person other than the Company, the Security Trustee, the holders of the Notes issued under the Trust Indenture and other obligations secured thereby any legal or equitable right, remedy or claim under or in respect of the Trust Indenture or any covenant, condition or provision therein or herein contained; and all such covenants, conditions and provisions are and shall be held to be for the sole and exclusive benefit of the Company, the Security Trustee, the holders of the Notes issued under the Trust Indenture and other obligations secured hereby.\nSection 5.9 Expenses. The Company agrees to pay, and save the Security Trustee and all holders of Notes harmless against liability for the payment of, all attorney's fees and other out-of-pocket expenses arising in connection with the transactions contemplated by this Supplemental Indenture, including all document production and duplication charges and the fees and expenses of any special counsel engaged by the Security Trustee or any holder of Notes in connection with this Supplemental Indenture and\/or such transactions.\nSection 5.10 Directly or Indirectly. Where any provision in this Supplemental Indenture refers to action to be taken by any Person, or which such Person is prohibited from taking, such provision shall be applicable whether such action is taken directly or indirectly by such Person.\nSection 5.11 Existing Indenture Not Otherwise Affected. Except as modified, amended or supplemented hereby, and except as modified, amended or supplemented hereafter, the Existing Indenture and the Notes issued in respect thereof and all other Financing Documents shall remain unchanged and in full force and effect and the Company hereby ratifies and reaffirms all of its obligations thereunder.\n[REMAINDER OF PAGE INTENTIONALLY BLANK. NEXT PAGE IS SIGNATURE PAGE] IN WITNESS WHEREOF, the Company has caused this Supplemental Indenture to be executed and its seal hereunto affixed and said seal and this Supplemental Indenture to be attested by its Assistant Secretary, and State Street Bank and Trust Company of Connecticut, N.A., in evidence of its acceptance of the trusts hereby created, has caused this Supplemental Indenture to be executed on its behalf by one of its authorized trust officers all as of the day and year first above written.\nAttest: PILGRIM'S PRIDE CORPORATION Name: C.E. Butler Name: Lonnie A. Pilgrim Title: Secretary Title: Chief Executive Officer\n[CORPORATE SEAL]\nSTATE STREET BANK AND TRUST COMPANY OF CONNECTI CUT, N.A., as Security Trustee\nName: Michael J. D'Angelico Title: Vice President\n[Signature Page of the SUPPLEMENTAL INDENTURE, dated as of October 2, 1994, between PILGRIM'S PRIDE CORPORATION and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee] CONSENT AND DIRECTION TO THE SECURITY TRUSTEE:\nThe undersigned, The Aetna Casualty and Surety Company, and Aetna Life Insurance Company (collectively, the \"Noteholders\") in the aggregate own one hundred percent (100%) in principal amount of the Series A Notes and the Series C Notes, being all of the outstanding Notes issued under the Existing Indenture. Pursuant to Section 9.2 of the Existing Indenture and this paragraph, the Security Trustee is hereby directed to execute and deliver this Supplemental Indenture, the Second Amendment to Guarantee Agreement and such other related documents and instruments as are contemplated by the provisions of the foregoing. Each of the Noteholders hereby consents to the terms, provisions and conditions of this Supplemental Indenture.\nTHE AETNA CASUALTY AND SURETY COMPANY\nName: Drew M. Thomas Title: Assistant Vice President\nAETNA LIFE INSURANCE COMPANY\nName: Drew M. Thomas Title: Assistant Vice President\n[Consent and Direction Signature Page of the SUPPLEMENTAL INDENTURE, dated as of October 2, 1994, between PILGRIM'S PRIDE CORPORATION and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee]\nCONSENT OF GUARANTORS:\nEach of the undersigned, Lonnie A. Pilgrim and Patty R. Pilgrim, hereby consents to all of the transactions and modifications in and to the Financing Documents provided for, or contemplated by, this Supplemental Indenture.\nLONNIE A. PILGRIM\nPATTY R. PILGRIM\n[Consent of Guarantors Signature Page of the SUPPLEMENTAL INDENTURE, dated as of October 2, 1994, between PILGRIM'S PRIDE CORPORATION and STATE STREET BANK AND TRUST COMPANY OF CONNECTICUT, N.A., as Security Trustee]","section_15":""}
{"filename":"79732_1994.txt","cik":"79732","year":"1994","section_1":"Item 1 BUSINESS ------ -------- GENERAL -------\nPotomac Electric Power Company (Company), which was incorporated in the District of Columbia in 1896 and in the Commonwealth of Virginia in 1949, is engaged in the generation, transmission, distribution and sale of electric energy in the Washington, D.C. metropolitan area. The Company's retail service territory includes the District of Columbia and major portions of Montgomery and Prince George's counties in suburban Maryland. The area served at retail covers approximately 640 square miles and had a population of approximately 1.9 million at the end of 1994 and 1993. The Company also sells electricity, at wholesale, to Southern Maryland Electric Cooperative, Inc. (SMECO), which distributes electricity in Calvert, Charles, Prince George's and St. Mary's counties in southern Maryland. During 1994, approximately 59% of the Company's revenue were derived from Maryland sales (including wholesale) and 41% from sales in the District of Columbia. About 30% of the Company's revenue were derived from residential customers, 64% from sales to commercial and government customers and 6% from sales at wholesale. Approximately 14% and 3% of 1994 revenue were derived from sales to the U.S. and D.C. governments, respectively.\nThe Company holds valid franchises, permits and other rights adequate for its business in the territory it serves, and such franchises, permits and other rights contain no unduly burdensome restrictions.\nThe Company is a member of the Pennsylvania-New Jersey-Maryland Interconnection Association (PJM) pursuant to an agreement under which its generating and transmission facilities are operated on an integrated basis with those of the other PJM member utilities in Pennsylvania, New Jersey, Maryland, Delaware and a small portion of Virginia. The purpose of PJM is to improve the operating economy and reliability of the systems in the group and to provide capital economies by permitting lower reserve requirements than would be required on a system basis. The Company also has direct high voltage connections with the Potomac Edison Company and Virginia Power, neither of which is a member of PJM.\nSALES -----\nThe following data presents the Company's sales and revenue by class of service and by customer type, including data as to sales to the United States and District of Columbia governments.\n1994 1993 1992 ---------- ---------- ---------- Electric Energy Sales (Thousands of Kilowatt-hours) --------------------- Kilowatt-hours Sold - Total 25,546,210 25,693,999 24,484,444 ========== ========== ========== By Class of Service - Residential service 6,586,970 6,739,987 6,155,793 General service 15,345,484 15,388,525 14,969,669 Large power service (a) 683,762 704,292 705,113 Street lighting 162,439 163,827 163,739 Rapid transit 404,634 370,428 360,432 Wholesale 2,362,921 2,326,940 2,129,698\nBy Type of Customer - Residential 6,574,199 6,726,520 6,142,414 Commercial 11,685,351 11,750,542 11,391,337 U.S. Government 4,009,810 3,986,149 3,947,611 D.C. Government 913,929 903,848 873,384 Wholesale 2,362,921 2,326,940 2,129,698\nElectric Revenue (Thousands of Dollars) ---------------- Sales of Electricity - Total (b) $1,783,064 $1,696,435 $1,556,098 ========== ========== ========== By Class of Service - Residential service $ 525,660 $ 506,096 $ 433,648 General service 1,066,710 1,010,552 958,369 Large power service (a) 35,701 33,913 33,454 Street lighting 13,783 13,605 12,363 Rapid transit 27,892 24,107 22,914 Wholesale 113,318 108,162 95,350\nBy Type of Customer - Residential $ 524,738 $ 505,173 $ 432,797 Commercial 834,323 791,357 748,550 U.S. Government 254,030 238,192 229,586 D.C. Government 56,655 53,551 49,815 Wholesale 113,318 108,162 95,350\n(a) Large power service customers are served at high voltage of 66KV or higher. (b) Exclusive of Other Electric Revenue (000s omitted) of $7,536 in 1994, $6,007 in 1993 and $6,069 in 1992.\nThe Company's sales of electric energy are seasonal, and, accordingly, rates have been designed to closely reflect the daily and seasonal variations in the cost of producing electricity, in part by raising summer rates and lowering winter rates. Mild weather during the summer billing months of June through October, when base rates are high to encourage customer conservation and peak load shifting, has an adverse effect on revenue and, conversely, hot weather during these months has a favorable effect.\nThe Company includes in revenue the amounts received for sales to other utilities related to pooling and interconnection agreements. Amounts received for such interchange deliveries are a component of the Company's fuel rates.\nCAPACITY PLANNING ----------------- General -------\nDuring the period 1995 through 2004 the Company estimates that its peak demand will grow at a compound annual rate of approximately 1%. Based upon average weather conditions, the Company expects its compound annual growth in kilowatt-hour sales to range between 1% and 2% over the next decade. The Company's ongoing strategies to meet the increasing energy needs of its customers include conservation and energy use management programs which are designed to curb growth in peak demand. The need for new capacity has been further reduced by programs to maintain older generating units to ensure their continued efficiency over an extended life and the cost-effective purchase of capacity and energy.\nConservation ------------\nCost-effective conservation programs have been a major component of the Company's success in limiting the need for new construction during the past decade.\nThe Company's conservation and energy use management programs are designed to curb growth in demand in order to defer the need for construction of additional generating capacity and to cost-effectively increase the efficiency of energy use. During 1994, the Company reevaluated its conservation programs, including additional review and consideration of the current and prospective effect of these programs on customer rates and bills. As a result of this reevaluation, the Company phased out several conservation programs and reduced rebate levels for others. In addition, in November 1994 the Company temporarily suspended approval of additional applications for its Custom Rebate Program. By narrowing its conservation offerings, the Company expects to be able to continue to encourage its customers to use energy efficiently without significantly increasing electricity prices. The Company expects approximately 80% of the previously estimated benefits from conservation for approximately 45% of estimated cost.\nFor residential customers the Company continues to offer rebates for high efficiency heating and air conditioning equipment. These rebates are paid directly to customers when customers buy equipment which significantly exceeds the efficiency of average available equipment.\nIn 1995, the Company expects to resume operation of its highly successful Custom Rebate Program for commercial customers. This program pays rebates to customers who install energy efficient lighting, motors, heating and cooling systems and other measures. The Company also continues to operate the New Building Design Program, which offers cash incentives as well as technical assistance to developers and designers who incorporate energy efficient designs and equipment in new commercial construction.\nDuring 1994, the Company invested approximately $90 million in energy conservation programs. The Company recovers the costs of its conservation programs in its Maryland jurisdiction through a rate surcharge which amortizes costs over a five year period and permits the Company to earn a return on its conservation investment while receiving compensation for lost revenue. In addition, when the Company's performance exceeds its annual goals, the Company earns a performance bonus. The Company was awarded a bonus of approximately $5 million in 1994 based on its 1993 performance. At the end of 1994 the conservation surcharge in Maryland was $.00338 per kilowatt-hour. In the District of Columbia, conservation costs are amortized over 10 years with an accrued return on unamortized costs. To date, costs have been considered in base rate cases.\nIn 1994, approximately 151,000 customers participated in continuing energy use management programs which cycle air conditioners and water heaters during peak periods. In addition, the Company operates a commercial load program which provides incentives to customers for reducing energy use during peak periods. Time-of-use rates have been in effect since the early 1980s and currently approximately 60% of the Company's revenue is based on time-of-use rates.\nIt is estimated that peak load reductions of approximately 525 megawatts have been achieved to date from conservation and energy use management programs and that additional peak load reductions of approximately 380 megawatts will be achieved in the next five years. The Company also estimates that in 1994 energy savings of more than 760 million kilowatt-hours have been realized through operation of its conservation and energy use management programs. During the next five years, the Company plans to expend an estimated $370 million ($86 million in 1995) to encourage the efficient use of electric energy and to reduce the need to build new generating facilities.\nAlthough the Company is continuing its conservation and energy use management efforts, new sources of supply will be needed to assure the future reliability of electric service to the Washington area. These new sources of supply will be provided through the Company's plans for purchases of capacity and energy and through its ongoing construction program.\nPurchase of Capacity and Energy -------------------------------\nPursuant to the Company's 1987 long-term capacity purchase agreements with Ohio Edison and Allegheny Power System, the Company is purchasing 450 megawatts of capacity and associated energy through the year 2005. In addition, effective June 1, 1994 through May 31, 1995, the Company is purchasing 147 megawatts of capacity from Pennsylvania Power and Light Company. The Company also has a purchase agreement with SMECO, through 2015, for 84 megawatts of capacity supplied by a combustion turbine installed and owned by SMECO at the Company's Chalk Point Generating Station. The Company is responsible for all costs associated with operating and maintaining the facility.\nThe Company has been exploring other cost-effective sources of energy and has entered into contracts for two nonutility generation projects which total 270 megawatts of capacity. A 40-megawatt resource recovery facility with which the Company has a contract is now under construction in Montgomery County, Maryland. In addition, the Company has an agreement with Panda Energy Corporation for a 230-megawatt gas-fueled combined-cycle cogeneration project in Prince George's County, Maryland. This project has received a certificate of convenience and necessity from the Maryland Public Service Commission. These nonutility generation projects are expected to begin operating in 1995 and 1996, respectively.\nCONSTRUCTION PROGRAM --------------------\nThe Company carries on a continuous construction program, the nature and extent of which is determined by the Company's strategic planning process which integrates supply-side and demand-side resource options.\nFrom January 1, 1992 to December 31, 1994, the Company made property additions, net of an Allowance for Funds Used During Construction (AFUDC), of $926 million (of which $298 million were made in 1994) and had property retirements of $122 million (of which $44 million were made in 1994).\nThe Company's current construction program calls for estimated expenditures, excluding AFUDC, of $215 million in 1995, $170 million in 1996, $210 million in 1997, $240 million in 1998 and $250 million in 1999, an aggregate of $1.1 billion for the five-year period. AFUDC is estimated to be $7 million in 1995, $7 million in 1996, $7 million in 1997, $9 million in 1998 and $10 million in 1999. The 1995-1999 construction program includes approximately $544 million for generating facilities (including $165 million for Clean Air Act compliance), $35 million for transmission facilities, $497 million for distribution, service and other facilities, and $9 million associated with the Company's energy use management programs. Making use of the flexibilities in its long-term construction plan, the Company in 1994 reduced projected expenditures for the five years 1995 through 1999 by $190 million from amounts previously planned. This reduction followed a $365 million reduction in 1993. The construction reductions and deferrals are\nassociated with lower rates of projected growth in usage of electricity resulting in large part from implementing economical conservation programs. The Company plans to finance its construction program primarily through funds provided by operations.\nThe construction program includes amounts for the construction of facilities that will not be completed until after 1999. Although the program includes provision for escalation of construction costs, generally at an annual rate of 4%, the aggregate budget for long lead time projects will increase or decrease depending upon the actual rates of inflation in construction costs. The program is reviewed continuously and revised as appropriate to reflect changes in projections of demand, consumption patterns and economic trends.\nThe Clean Air Act Amendments of 1990 (CAA) requires utilities to reduce emissions of sulfur dioxide and nitrogen oxides in two phases, January 1995 (Phase I) and January 2000 (Phase II). The Company has developed plans for complying with the CAA to achieve prescribed standards in Phases I and II. The Company anticipates capital expenditures totaling $165 million over the next five years pursuant to these plans. The plans call for replacement of boiler burner equipment for nitrogen oxides emissions control, the use of lower-sulfur fuel and cofiring with natural gas at selected baseload plants. The CAA allows companies to achieve required emission levels by using a market-based emission allowance trading system. If economical, emission allowances may be purchased in lieu of burning lower-sulfur fuel.\nInstallation of scrubbers is not contemplated for the Company's wholly owned plants. Both the District of Columbia and Maryland commissions have approved the Company's plans for meeting Phase I requirements including cost recovery of investment and inclusion of emission allowance expenses in the Company's fuel adjustment clause.\nThe Company owns a 9.72% undivided interest in the Conemaugh Generating Station located in western Pennsylvania. As a result of installing flue gas scrubbing equipment to meet Phase I requirements of the CAA, this station will receive additional allowances. The Company's share of these \"bonus\" allowances may be used to reduce the need for lower-sulfur fuel at its other plants. The Company's share of the construction costs is approximately $38 million.\nIn addition, the final segment of a 500,000 volt transmission line which provides links in the transmission systems of the Company, Baltimore Gas and Electric Company and Virginia Power was placed in service prior to June 1, 1994.\nFUEL ----\nFor customer billing purposes, all of the Company's kilowatt-hour sales are covered by separately stated fuel rates (see Item 8 - Note 2 of \"Notes to Consolidated Financial Statements\").\nThe Company's generating units burn only fossil fuels. The principal fuel is coal. The Company owns no nuclear generation facilities and none are planned. The following table sets forth the quantities of each type of fuel used by the Company in the years 1994, 1993 and 1992 and the contribution, on the basis of Btus, of each fuel to energy generated.\n1994 1993 1992 -------------- -------------- -------------- % of % of % of Quantity Btu Quantity Btu Quantity Btu -------- ----- -------- ----- -------- -----\nCoal (000s net tons) 5,788 76.1 6,010 79.4 5,926 82.9 Residual oil (000s barrels) 4,868 15.7 4,835 15.9 3,294 11.4 Natural gas (000s dekatherms) 10,780 5.5 6,090 3.2 8,200 4.5 No. 2 fuel oil (000s barrels) 919 2.7 480 1.5 376 1.2\nThe following table sets forth the average cost of each type of fuel burned, for the years shown.\n1994 1993 1992 ------ ------ ------\nCoal: per ton $44.39 $43.69 $43.66 per million Btu 1.73 1.72 1.72 Residual oil: per barrel 15.31 15.09 14.35 per million Btu 2.44 2.39 2.28 Natural gas: per dekatherm 2.49 2.88 2.32 per million Btu 2.49 2.88 2.32 No. 2 fuel oil: per barrel 24.34 24.98 26.70 per million Btu 4.17 4.30 4.60\nThe average cost of fuel burned per million Btu was $1.95 in 1994, compared with $1.90 in 1993 and $1.85 in 1992. The increase of approximately 3% in each of the past two years in the system average unit fuel cost resulted from increased use of major cycling and peaking generation units which burn higher cost fuels. The Company's major cycling and certain peaking units can burn natural gas or oil, adding flexibility in selecting the most cost- effective fuel mix. The increase in the actual percent of gas contribution in 1994 to the fuel mix reflects the decreased price of gas and the increased price of oil. The decrease in the actual percent of coal contribution to the fuel mix in 1994 primarily reflects major outages for construction related to Clean Air Act additions on baseload coal-fired generation units.\nTen of the Company's sixteen steam-electric generating units can burn only coal; two can burn only residual oil; two can burn either coal or residual oil or a combination of both and two units can burn either residual oil or natural gas. Those units capable of burning either coal or residual oil normally burn coal as their primary fuel. The Company also has combustion turbines, some of which can burn only No. 2 fuel oil, and others which can burn natural gas or No. 2 fuel oil. The following table provides details of the Company's generating capability from the standpoint of plant configuration as well as actual energy generation (see Item 2","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3 LEGAL PROCEEDINGS ------ -----------------\nFor information regarding pending environmental legal proceedings, see \"Environmental Matters\" under Item 1 - Business.\nThe Company was a defendant in employment discrimination litigation which was pending in the United States District Court for the District of Columbia. In February 1993, the parties to the case reached tentative settlement of the claims and, in April 1993, the Company paid $38.26 million into a trust fund pursuant to the terms of the Agreement. The funds will be disbursed from the trust fund to certain covered classes of current and former employees and applicants for employment and to cover the plaintiffs' legal and expert fees and costs. The Court approved the settlement agreement, effective in July 1993. The Company received insurance payments of $13.5 million in October 1993 and $24 million in January 1994, bringing the total recovered from insurance companies to $37.5 million. At December 31, 1993, approximately $.8 million was charged to non-operating expense. Subsequently, in November 1994, the Company received an additional insurance recovery of $.8 million which was treated as a credit to amounts previously charged to non- operating expense.\nItem 4","section_4":"Item 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ------ ---------------------------------------------------\nNone.\nPart II ------- Item 5","section_5":"Item 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER ------ ----------------------------------------------------------------- MATTERS -------\nThe following table presents the dividends per share of Common Stock and the high and low of the daily Common Stock transaction prices as reported in The Wall Street Journal during each period. The New York Stock Exchange is the principal market on which the Company's Common Stock is traded.\nDividends Price Range Period Per Share High Low --------------------- --------------- -------- ---------\n1994: First Quarter...... $.415 $26-5\/8 $21-3\/4 Second Quarter..... .415 23-1\/2 18-1\/2 Third Quarter...... .415 21-1\/2 18-3\/8 Fourth Quarter..... .415 $1.66 19-3\/4 18-1\/4\n1993: First Quarter...... $.41 $26-1\/2 $23-7\/8 Second Quarter..... .41 27-3\/8 25-5\/8 Third Quarter...... .41 28-7\/8 27-1\/8 Fourth Quarter..... .41 $1.64 28-3\/4 24-5\/8\nThe number of holders of Common Stock was 104,047 at March 7, 1995 and 96,638 at December 31, 1994.\nThere were 118,248,594 and 118,248,103 shares of the Company's $1 par value Common Stock outstanding at March 7, 1995, and December 31, 1994, respectively. A total of 200 million shares is authorized.\nAt its January 1995 meeting, the Company's Board of Directors declared a quarterly dividend on Common Stock of 41-1\/2 cents per share continuing the $1.66 annual dividend rate set in January 1994. The dividend is payable March 31, 1995, to shareholders of record on February 27, 1995.\nItem 6","section_6":"Item 6 SELECTED FINANCIAL DATA ------ -----------------------\nThe information required by Item 6 is incorporated herein by reference to \"Selected Consolidated Financial Data\" in the Financial Information 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 Item 7 is incorporated herein by reference to the \"Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition\" in the Financial Information section of the Company's 1994 Annual Report to shareholders.\nSee \"Nonutility Subsidiary\" under Item 1 - Business for an update to the discussion of the Company's nonutility subsidiary, including developments relating to the subsidiary's aircraft leasing portfolio.\nSee \"Rates\" under Item 1 - Business for an update to the discussion of the Company's base rate proceeding in the District of Columbia.\nItem 8","section_7A":"","section_8":"Item 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------ -------------------------------------------\nThe consolidated financial statements, together with the report thereon of Price Waterhouse LLP dated January 26, 1995, and supplementary data from the Company's 1994 Annual Report to shareholders are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated in Items 5, 6, 7, 8 and 9, the 1994 Annual Report to shareholders is not deemed filed as part of this Form 10-K Annual Report.\nItem 9","section_9":"Item 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND ------ --------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------\nNone.\nPart III -------- Item 10","section_9A":"","section_9B":"","section_10":"Item 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ------- --------------------------------------------------\nThe information required by Item 10 with regard to Directors of the registrant is incorporated herein by reference to the Company's Notice of Annual Meeting of Shareholders and Proxy Statement dated March 17, 1995.\nInformation with regard to the executive officers of the registrant as of March 7, 1995, is as follows:\nServed in such position Name Position Age since -------------------- -------------------------------- --- -------------\nEdward F. Mitchell Chairman of the Board and Chief Executive Officer 63 1992 (1)\nJohn M. Derrick Jr. President and Chief Operating Officer and Director 54 1992 (2)\nH. Lowell Davis Vice Chairman and Chief Financial Officer and Director 62 1983\nPaul Dragoumis Executive Vice President 60 1989\nWilliam T. Torgerson Senior Vice President, General Counsel and Secretary 50 1994 (3)\nDennis R. Wraase Senior Vice President - Finance and Accounting 50 1992 (4)\nIraline G. Barnes Vice President - Corporate 47 1990 (5) Relations\nEarl K. Chism Vice President and Comptroller 59 1994 (6)\nKirk J. Emge Vice President - Regulatory Law 45 1994 (7)\nSusann D. Felton Vice President - Materials 46 1992 (8)\nWilliam R. Gee Jr. Vice President - System Engineering 54 1991 (9)\nRobert C. Grantley Vice President - Customers and Community Relations 46 1989\nAnthony J. Kamerick Vice President and Treasurer 47 1994 (10)\nServed in such position Name Position Age since -------------------- -------------------------------- --- -------------\nAnthony S. Macerollo Vice President - Corporate Administration and Services 53 1989\nEddie R. Mayberry Vice President - Market Planning and Policy 47 1993 (11)\nJohn D. McCallum Vice President - Corporate Tax 45 1992 (12)\nJames S. Potts Vice President - Environment 49 1993 (13)\nWilliam J. Sim Vice President - Power Supply and Delivery 50 1991 (14)\nAndrew W. Williams Vice President - Energy and Market Policy and Development 45 1989\nNone of the above persons has a \"family relationship\" with any other officer listed or with any director or nominee for director.\nThe term of office for each of the above persons is from April 27, 1994 to April 26, 1995.\n(1) Mr. Mitchell was elected to the position of Chairman of the Board on December 21, 1992. He was elected Chief Executive Officer effective September 1, 1989.\n(2) Mr. Derrick was elected to the position of President on December 21, 1992. He was elected Executive Vice President and Chief Operating Officer on July 27, 1989.\n(3) Mr. Torgerson was elected Senior Vice Present and General Counsel on April 27, 1994. He was elected Secretary effective August 22, 1994. Prior to 1994 he held the position of Vice President and General Counsel.\n(4) Mr. Wraase was elected to his present position on April 22, 1992. He was elected Senior Vice President and Comptroller on July 27, 1989.\n(5) Mrs. Barnes was elected to her present position effective April 1, 1990. Prior to that time she served as Associate Judge of the Superior Court of the District of Columbia for ten years.\n(6) Mr. Chism was elected to his present position on April 27, 1994. Prior to that time he held the position of Vice President and Treasurer since July 1989.\n(7) Mr. Emge was elected to his present position on April 27, 1994. Prior to that time he held the position of Deputy General Counsel.\n(8) Ms. Felton was elected to her present position on April 22, 1992. Prior to that time she held the position of Manager, Materials.\n(9) Mr. Gee was elected to his present position on April 24, 1991. Prior to that time he held the position of Vice President - Generating Engineering and Construction, since 1989.\n(10) Mr. Kamerick was elected to his present position on April 27, 1994. Prior to that time he held the position of Comptroller from 1992 to 1994. Prior to 1992 he held the position of Assistant Comptroller.\n(11) Dr. Mayberry was elected to his present position on April 28, 1993. Prior to that time he held the position of Manager, Market Planning and Policy, since 1989.\n(12) Mr. McCallum was elected to his present position on April 22, 1992. Prior to that time he held the position of Assistant Comptroller.\n(13) Mr. Potts was elected to his present position on April 28, 1993. Prior to that time he held the position of Manager, Generating Strategic Support since 1991. Prior to 1991 he held the position of Manager, Production Performance.\n(14) Mr. Sim was elected to his present position on April 24, 1991. Prior to that time he was President of the American Energy division of the Company's nonutility subsidiary, Potomac Capital Investment Corporation, since 1988.\nItem 11","section_11":"Item 11 EXECUTIVE COMPENSATION ------- ----------------------\nThe information required by Item 11 is incorporated herein by reference to the Company's Notice of Annual Meeting of Shareholders and Proxy Statement dated March 17, 1995.\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 Company's Notice of Annual Meeting of Shareholders and Proxy Statement dated March 17, 1995.\nItem 13","section_13":"Item 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ------- ----------------------------------------------\nNone.\nPart IV ------- Item 14","section_14":"Item 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K ------- --------------------------------------------------------------\n(a) Documents List --------------\n1. Financial Statements\nThe following documents are filed as part of this report as incorporated herein by reference from the indicated pages of the Company's 1994 Annual Report.\nReference (Page) ---------------- Form 10-K Annual Report Annual Report to Shareholders Exhibit 13 --------------- -------------\nConsolidated Statements of Earnings - for the years ended December 31, 1994, 1993 and 1992 15 28\nConsolidated Balance Sheets - December 31, 1994 and 1993 16-17 29-30\nConsolidated Statements of Cash Flows - for the years ended December 31, 1994, 1993 and 1992 18 31\nNotes to Consolidated Financial Statements 19-30 32-69\nReport of Independent Accountants 31 27\n2. Financial Statement Schedule\nUnaudited supplementary data entitled \"Quarterly Financial Summary (Unaudited)\" is incorporated herein by reference in Item 8 (included in \"Notes to Consolidated Financial Statements\" as Note 16).\nSchedule VIII (Valuation and Qualifying Accounts) and the Report of Independent Accountants on Consolidated Financial Statement Schedule is submitted pursuant to Item 14(d).\nAll other schedules are omitted because they are not applicable, or the required information is presented in the financial statements.\n3. Exhibits required by Securities and Exchange Commission Regulation S-K (summarized below).\nExhibit No. Description of Exhibit Reference* ------- ---------------------- ----------\n3-A Charter of the Company.............. Filed herewith.\n3-B By-Laws of the Company.............. Filed herewith.\n4 Mortgage and Deed of Trust dated July 1, 1936, of the Company to The Riggs National Bank of Washington, D.C., as Trustee, securing First Mortgage Bonds of the Company, and Supplemental Indenture dated July 1, 1936........................ Exh. B-4 to First Amendment, 6\/19\/36, to Registration Statement No. 2-2232.\nSupplemental Indentures, to the aforesaid Mortgage and Deed of Trust, dated - December 1, 1939 and December 10, 1939.......................... Exhs. A & B to Form 8-K, 1\/3\/40. August 1, 1940...................... Exh. A to Form 8-K, 9\/25\/40.\nJuly 15, 1942 and August 10, 1942................................ Exh. B-1 to Amendment No. 2, 8\/24\/42, and B-3 to Post- Effective Amendment, 8\/31\/42, to Registration Statement No. 2-5032. August 1, 1942...................... Exh. B-4 to Form 8-A, 10\/8\/42. October 15, 1942.................... Exh. A to Form 8-K, 12\/7\/42.\nOctober 15, 1947.................... Exh. A to Form 8-K, 12\/8\/47.\nJanuary 1, 1948..................... Exh.7-B to Post-Effective Amendment No. 2, 1\/28\/48, to Registration Statement No. 2-7349. December 31, 1948................... Exh. A-2 to Form 10-K, 4\/13\/49.\nExhibit No. Description of Exhibit Reference* ------- ---------------------- ----------\n4 May 1, 1949......................... Exh. 7-B to Post-Effective (cont.) Amendment No. 1, 5\/10\/49, to Registration Statement No. 2-7948. December 31, 1949................... Exh. (a)-1 to Form 8-K, 2\/8\/50. May 1, 1950......................... Exh. 7-B to Amendment No. 2, 5\/8\/50, to Registration Statement No. 2-8430. February 15, 1951................... Exh. (a) to Form 8-K, 3\/9\/51.\nMarch 1, 1952....................... Exh. 4-C to Post-Effective Amendment No. 1, 3\/12\/52, to Registration Statement No. 2-9435. February 16, 1953................... Exh. (a)-1 to Form 8-K, 3\/5\/53. May 15, 1953........................ Exh. 4-C to Post-Effective Amendment No. 1, 5\/26\/53, to Registration Statement No. 2-10246. March 15, 1954 and March 15, 1955................................ Exh. 4-B to Registration Statement No. 2-11627, 5\/2\/55. May 16, 1955........................ Exh. A to Form 8-K, 7\/6\/55.\nMarch 15, 1956...................... Exh. C to Form 10-K, 4\/4\/56. June 1, 1956........................ Exh. A to Form 8-K, 7\/2\/56.\nApril 1, 1957....................... Exh. 4-B to Registration Statement No. 2-13884, 2\/5\/58. May 1, 1958......................... Exh. 2-B to Registration Statement No. 2-14518, 11\/10\/58. December 1, 1958.................... Exh. A to Form 8-K, 1\/2\/59. May 1, 1959......................... Exh. 4-B to Amendment No. 1, 5\/13\/59, to Registration Statement No. 2-15027. November 16, 1959................... Exh. A to Form 8-K, 1\/4\/60. May 2, 1960......................... Exh. 2-B to Registration Statement No. 2-17286, 11\/9\/60. December 1, 1960 and April 3, 1961................................ Exh. A-1 to Form 10-K, 4\/24\/61.\nExhibit No. Description of Exhibit Reference* ------- ---------------------- ----------\n4 May 1, 1962......................... Exh. 2-B to Registration (cont.) Statement No. 2-21037, 1\/25\/63. February 15, 1963................... Exh. A to Form 8-K, 3\/4\/63. May 1, 1963......................... Exh. 4-B to Registration Statement No. 2-21961, 12\/19\/63. April 23, 1964...................... Exh. 2-B to Registration Statement No. 2-22344, 4\/24\/64. May 15, 1964........................ Exh. A to Form 8-K, 6\/2\/64.\nMay 3, 1965......................... Exh. 2-B to Registration Statement No. 2-24655, 3\/16\/66. April 1, 1966....................... Exh. A to Form 10-K, 4\/21\/66. June 1, 1966........................ Exh. 1 to Form 10-K, 4\/11\/67. April 28, 1967...................... Exh. 2-B to Post-Effective Amendment No. 1 to Registration Statement No. 2-26356, 5\/3\/67. May 1, 1967......................... Exh. A to Form 8-K, 6\/1\/67. July 3, 1967........................ Exh. 2-B to Registration Statement No. 2-28080, 1\/25\/68. February 15, 1968................... Exh. II-I to Form 8-K, 3\/7\/68. May 1, 1968......................... Exh. 2-B to Registration Statement No. 2-31896, 2\/28\/69. March 15, 1969...................... Exh. A-2 to Form 8-K, 4\/8\/69. June 16, 1969....................... Exh. 2-B to Registration Statement No. 2-36094, 1\/27\/70. February 15, 1970................... Exh. A-2 to Form 8-K, 3\/9\/70. May 15, 1970........................ Exh. 2-B to Registration Statement No. 2-38038, 7\/27\/70. August 15, 1970..................... Exh. 2-D to Registration Statement No. 2-38038, 7\/27\/70. September 1, 1971................... Exh. 2-C to Registration Statement No. 2-45591, 9\/1\/72. September 15, 1972.................. Exh. 2-E to Registration Statement No. 2-45591, 9\/1\/72. April 1, 1973....................... Exh. A to Form 8-K, 5\/9\/73. January 2, 1974..................... Exh. 2-D to Registration Statement No. 2-49803, 12\/5\/73.\nExhibit No. Description of Exhibit Reference* ------- ---------------------- ----------\n4 August 15, 1974..................... Exhs. 2-G and 2-H to (cont.) Amendment No. 1 to Registration Statement No. 2-51698, 8\/14\/74. June 15, 1977....................... Exh. 4-A to Form 10-K, 3\/19\/81. July 1, 1979........................ Exh. 4-B to Form 10-K, 3\/19\/81. June 16, 1981....................... Exh. 4-A to Form 10-K, 3\/19\/82. June 17, 1981....................... Exh. 2 to Amendment No. 1, 6\/18\/81, to Form 8-A. December 1, 1981.................... Exh. 4-C to Form 10-K, 3\/19\/82. August 1, 1982...................... Exh. 4-C to Amendment No. 1 to Registration Statement No. 2-78731, 8\/17\/82. October 1, 1982..................... Exh. 4 to Form 8-K, 11\/8\/82.\nApril 15, 1983...................... Exh. 4 to Form 10-K, 3\/23\/84.\nNovember 1, 1985.................... Exh. 2-B to Form 8-A, 11\/1\/85.\nMarch 1, 1986....................... Exh. 4 to Form 10-K, 3\/28\/86. November 1, 1986.................... Exh. 2-B to Form 8-A, 11\/5\/86.\nMarch 1, 1987....................... Exh. 2-B to Form 8-A, 3\/2\/87. September 16, 1987.................. Exh. 4-B to Registration Statement No. 33-18229, 10\/30\/87. May 1, 1989......................... Exh. 4-C to Registration Statement No. 33-29382, 6\/16\/89. August 1, 1989...................... Exh. 4 to Form 10-K, 3\/23\/90.\nApril 5, 1990....................... Exh. 4 to Form 10-K, 3\/29\/91.\nMay 21, 1991........................ Exh. 4 to Form 10-K, 3\/27\/92.\nMay 7, 1992......................... Exh. 4 to Form 10-K, 3\/26\/93. September 1, 1992................... Exh. 4 to Form 10-K, 3\/26\/93. November 1, 1992.................... Exh. 4 to Form 10-K, 3\/26\/93. March 1, 1993....................... Exh. 4 to Form 10-K, 3\/26\/93. March 2, 1993....................... Exh. 4 to Form 10-K, 3\/26\/93. July 1, 1993........................ Exh. 4.4 to Registration Statement No. 33-49973, 8\/11\/93.\nExhibit No. Description of Exhibit Reference* ------- ---------------------- ----------\n4 August 20, 1993..................... Exh. 4.4 to Registration (cont.) Statement No. 33-50377, 9\/23\/93. September 29, 1993.................. Exh. 4 to Form 10-K, 3\/25\/94. September 30, 1993.................. Exh. 4 to Form 10-K, 3\/25\/94. October 1, 1993..................... Exh. 4 to Form 10-K, 3\/25\/94. February 10, 1994................... Exh. 4 to Form 10-K, 3\/25\/94. February 11, 1994................... Exh. 4 to Form 10-K, 3\/25\/94.\n4-A Indenture, dated as of January 15, 1988, between the Company and Centerre Trust Company of St. Louis (now known as Boatmen's Trust Company), Trustee for the Company's $75,000,000 issue of 7% Convertible Debentures due 2018 ................ Exh. 4-A to Form 10-K, 3\/25\/88. 4-B Indenture, dated as of July 28, 1989, between the Company and The Bank of New York, Trustee, with respect to the Company's Medium-Term Note Program............ Exh. 4 to Form 8-K, 6\/21\/90.\n4C Indenture, dated as of August 15, 1992, between the Company and the Bank of New York, Trustee, for the Company's $115,000,000 issue of 5% Convertible Debentures due 2002..... Exh. 4-C to Form 10-K, 3\/26\/93.\n10 Agreement, effective July 23, 1993, between the Company and the International Brotherhood of Electrical Workers (Local Union #1900).............................. Exh. 10 to Form 10-Q, 7\/30\/93.\nExhibit No. Description of Exhibit Reference* ------- ---------------------- ----------\n**11 Computation of Earnings Per Common Share...................... Filed herewith.\n**12 Computation of Ratios............... Filed herewith.\n13 Financial Information Section of Annual Report .................... Filed herewith.\n**21 Subsidiaries of the Registrant...... Filed herewith.\n**23 Consent of Independent Accountants.. Filed herewith.\n*The exhibits referred to in this column by specific designations and date have heretofore been filed with the Securities and Exchange Commission under such designations and are hereby incorporated herein by reference. The Forms 8-A, 8-K and 10-K referred to were filed by the Company under the Commission's File No. 1-1072 and the Registration Statements referred to are registration statements of the Company.\n**These exhibits are submitted pursuant to Item 14(c).\n(b) Reports on Form 8-K -------------------\nNone.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Washington, District of Columbia, on the 24th day of March, 1995.\nPOTOMAC ELECTRIC POWER COMPANY (Registrant)\nBy \/s\/ E. F. Mitchell -------------------------- (Edward F. Mitchell, 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(i) Principal Executive Officers\n\/s\/ E. F. Mitchell --------------------------- Chairman of the Board and (Edward F. Mitchell) Chief Executive Officer\n\/s\/ John M. Derrick Jr. --------------------------- President and Director (John M. Derrick Jr.)\n(ii) Principal Financial Officer\n\/s\/ H. L. Davis --------------------------- Vice Chairman and Chief (H. Lowell Davis) Financial Officer and Director\n(iii) Principal Accounting Officer\n\/s\/ D. R. Wraase --------------------------- Senior Vice President (Dennis R. Wraase) Finance and Accounting\nMarch 24, 1995\nSignature Title Date --------- ----- ----\n(iv) Directors:\n\/s\/ Roger R. Blunt ------------------------- Director (Roger R. Blunt Sr.)\n\/s\/ A. J. Clark ------------------------- Director (A. James Clark)\n\/s\/ Richard E. Marriott ------------------------- Director (Richard E. Marriott)\n\/s\/ David O. Maxwell ------------------------ Director (David O. Maxwell)\n\/s\/ Floretta D. McKenzie ------------------------- Director (Floretta D. McKenzie)\n\/s\/ Ann D. McLaughlin ------------------------- Director (Ann D. McLaughlin)\n\/s\/ Peter F. O'Malley ------------------------- Director (Peter F. O'Malley)\n\/s\/ Louis A. Simpson ------------------------- Director (Louis A. Simpson)\n\/s\/ W. Reid Thompson ------------------------- Director (W. Reid Thompson)\nMarch 24, 1995\nExhibit 21 Subsidiaries of the Registrant ---------- ------------------------------\nThe Company has two wholly owned nonutility investment subsidiary companies, Potomac Capital Investment Corporation and PEPCO Enterprises, Inc., (PEI) both of which were incorporated in Delaware in 1983. Subsidiaries of PEI and Columbia Gas System, Inc. have formed the Cove Point joint venture partnership discussed in Part II, Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nExhibit 23 Consent of Independent Accountants ---------- ----------------------------------\nWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Numbers 33-36798, 33-53685 and 33-54197) and to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Forms S-3 (Numbers 33-58810 and 33-50377) of Potomac Electric Power Company of our report dated January 26, 1995 appearing in the Annual Report to shareholders which is also incorporated by reference in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Consolidated Financial Statement Schedule, which appears under Item 14(a) of this Form 10-K.\n\/s\/ Price Waterhouse LLP Washington, D.C. March 24, 1995\nReport of Independent Accountants on Consolidated ------------------------------------------------- Financial Statement Schedule ----------------------------\nJanuary 26, 1995\nTo the Board of Directors of Potomac Electric Power Company\nOur audits of the consolidated financial statements referred to in our report dated January 26, 1995 appearing in the 1994 Annual Report to shareholders of Potomac Electric Power 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 consolidated financial statement schedule listed in Item 14(a) of this Form 10-K. In our opinion, this consolidated 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 Washington, D.C.","section_15":""}
{"filename":"701708_1994.txt","cik":"701708","year":"1994","section_1":"Item 1. - Business. - ------- ---------\nRoadway Services, Inc. (registrant), a corporation organized in 1982 under the laws of the State of Ohio, is a holding company engaged through its operating companies in the transportation and logistics businesses. Its operating companies are Roadway Express, Inc., Roadway Package System, Inc. (RPS), Roadway Global Air, Inc. (RGA), Roberts Express, Inc., (Roberts), Roadway Logistics Systems, Inc. (ROLS), and Roadway Regional Group, Inc. (RRG), which is the corporate parent of Viking Freight System, Inc., Spartan Express, Inc., Coles Express, Inc. and Central Freight Lines Inc.\nThe registrant's largest operating group consists of Roadway Express, Inc. (Akron, Ohio), its subsidiary Roadway Express (Canada), Inc. (Calgary, Alberta, Canada), and joint venture TNL-Roadway (Mexico City, D.F., Mexico). Collectively, this group is one of the industry's major carriers of long haul, less-than-truckload (LTL) general freight. Roadway Express, providing common carrier interstate transportation since 1930, serves North America, including all 50 states, South America, Europe, Asia and Australia through 577 terminal facilities. The Roadway Express system primarily handles long haul, interstate shipments of LTL freight. No single carrier, or small number of carriers, is dominant in the portion of the industry in which Roadway Express operates. Additional information concerning this operating group is set forth in the discussion contained on pages 4 through 7, except for the section entitled Quality, of the Annual Report to Shareholders for the year ended December 31, 1994, and is incorporated herein by reference.\nThe registrant's other motor carrier subsidiaries provide service to various portions of the motor carrier transportation market, none of which is dominated by a single carrier or small number of carriers with one exception. The surface small package shipping market area, in which RPS competes, is dominated by United Parcel Service. Additional information concerning the registrant's other motor carrier subsidiaries is set forth in the discussion contained on pages 8 through 11, except for the sections entitled People and Quality, the discussion contained on pages 14 through 17, except for the sections entitled People and Quality, and except for the second paragraph under each of the sections entitled Viking Freight System, Central Freight Lines, Spartan Central, Spartan South and Coles Express, and the discussion contained on page 18 and 19, except for the sections entitled People and Quality, of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, and is incorporated herein by reference.\nRGA provides air cargo service to customers worldwide through 77 air logistics centers in North America, Europe, Asia and Australia, including a hub facility in Terre Haute, Indiana. Additional information concerning RGA is set forth in the discussion contained on pages 12 and 13, except for the sections entitled People and Quality, of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, and is incorporated herein by reference.\n- 2 - ROLS provides contract logistics services. Additional information concerning ROLS is set forth in the discussion contained on pages 20 and 21, except for the sections entitled People and Quality, of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, and is incorporated herein by reference.\nAll domestic motor carrier subsidiaries are subject to regulation by the Interstate Commerce Commission and the Department of Transportation. At the end of 1994 the registrant and its affiliates employed approximately 50,600 persons (on a full time equivalent basis) and utilized the services of approximately 8,000 independent contractors.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. - Properties. - ------- -----------\nRoadway Services, Inc. - ----------------------\nCorporate offices of the registrant and its information systems subsidiary are located in Akron, Ohio in facilities leased from one of the registrant's subsidiaries. Limited additional corporate office space is located in nearby leased facilities.\nRoadway Express, Inc. - ---------------------\nAs of December 31, 1994, the Roadway Express operating group owned or leased 577 terminal facilities, of which 29 were major consolidation and distribution facilities referred to as \"breakbulk terminals.\" Of the total facilities, 356 were owned and 221 were leased, generally for terms of three years or less. The number of loading spaces, a measure of freight handling capacity, totaled 15,079 at year end 1994, of which 12,857 were at owned facilities and 2,222 were at leased facilities. All significant leased and owned facilities were being utilized at year end 1994, and are adequate to meet current needs.\nThe 29 major breakbulk terminals, all of which are owned by Roadway Express, are located in strategic locations throughout the continental United States. These facilities, averaging 87,000 square feet, range in size from 31,000 to 220,000 square feet.\nThe general offices are located in the company-owned headquarters building in Akron, Ohio. Limited additional general office space is located in nearby leased facilities. Divisional offices are located throughout the United States, generally in office space at company-owned terminal facilities.\nThe investment by Roadway Express in its revenue vehicle fleet represents 50% of the investment in revenue vehicles by the registrant and its subsidiaries. At the end of 1994, the average age of the Roadway Express intercity tractors was 5.8 years and that of the intercity trailers was 7.3 years. There is sufficient capacity to meet normal requirements. Leased equipment may be utilized to meet peak demands.\n- 3 - Roadway Package System, Inc. - ----------------------------\nAs of December 31, 1994, Roadway Package System operated 317 terminals, including 22 hub facilities. Forty-four of the terminals, 18 of which are hub facilities, are owned and 273 terminals, including the other four hub facilities, are leased, generally for terms of three years or less. Twelve of the terminals, including three hub facilities, are operated by Roadway Package System, Ltd. in Canada. The 22 hub facilities are strategically located to cover the geographic area served by RPS. These facilities, averaging 78,000 square feet, range in size from 22,000 to 143,000 square feet.\nThe general offices and information systems center are located in leased facilities in the Pittsburgh, Pennsylvania area. A new 300,000 square foot corporate headquarters and data center is nearing completion and will be occupied by RPS in 1995. The owned facility is located in suburban Pittsburgh.\nRoadway Global Air, Inc. - ------------------------\nAs of December 31, 1994, Roadway Global Air, Inc. operated 77 leased air logistics centers located in North America, Europe, Asia and Australia, and a leased hub facility in Terre Haute, Indiana. These facilities, averaging 10,400 square feet, range in size from 1,000 to 42,000 square feet. The company's general offices are located in leased facilities in Indianapolis, Indiana.\nRoadway Regional Group, Inc. - ----------------------------\nAs of December 31, 1994, Roadway Regional Group occupied 14 regional sales offices located primarily in the midwestern and eastern United States. RRG's general offices are located in San Jose, California in a leased facility.\nAs of December 31, 1994, Viking Freight System, Inc. operated 48 terminals located in eight western states. Twenty-nine of the terminals, with 1,342 loading spaces, are owned and the remaining 19 terminals, with 479 loading spaces, are leased. The largest terminal facility, located in San Leandro, California, has 132 loading spaces and is leased by Viking Freight System, Inc. The company's general offices are located in leased facilities in San Jose, California.\nAs of December 31, 1994, Central Freight Lines Inc. operated 85 terminals located primarily in eight southwestern and midwestern states. Fifty-five of the terminals, with 2,726 loading spaces, are owned and the remaining 30, with 417 loading spaces, are leased. The largest terminal, located in Dallas, Texas, has 525 loading spaces and is owned by Central Freight Lines Inc. The company's general offices are located in Waco, Texas in owned facilities.\nAs of December 31, 1994, Spartan Express, Inc. operated 74 terminals located in 17 central and southern states through two divisions: Spartan Central and Spartan South. Thirteen of the terminals, with 437 loading spaces, are owned and the remaining 61, with 1,373 loading spaces, are leased. The largest terminal, a leased facility located in the Atlanta, Georgia area, has 102 loading spaces. The general offices of Spartan South are located in Greer, South Carolina in facilities owned by Spartan Express. Spartan Central's general offices are located in a leased facility in Worthington, Ohio.\n- 4 - As of December 31, 1994, Coles Express, Inc. operated 25 terminals located in 11 New England and Middle Atlantic states. Five of the terminals, with 127 loading spaces, are owned and the remaining 20, with 401 loading spaces, are leased. The largest terminals have 39 loading spaces each, and are located in leased facilities in Elizabeth, New Jersey and in facilities owned by Coles Express, Inc. in Portland, Maine. The company's general offices are located in Bangor, Maine.\nRoberts Transportation Services, Inc. - -------------------------------------\nThe company's general offices are located in Akron, Ohio in facilities owned by its principal operating subsidiary, Roberts Express, Inc. Terminal facilities are not required, due to the exclusive use service provided.\nRoadway Logistics Systems, Inc. - -------------------------------\nThe company's general offices are located in Hudson, Ohio in leased facilities.\nItem 3.","section_3":"Item 3. - Legal Proceedings. - ------- ------------------\nDuring 1989, the Internal Revenue Service (IRS) completed an examination of the registrant's employment tax returns for the years 1985 and 1986 proposing changes in classification of certain drivers at RPS and subjecting the registrant to payment of approximately $5 million of certain employment taxes for those years. The registrant paid the amounts claimed although it disagreed with the IRS position both as to liability for and amounts of taxes claimed. Suit was filed in the United States Court of Claims to recover the amounts paid. In 1992, the IRS completed its examination of the registrant's 1987 through 1989 employment tax returns and proposed additional employment taxes of approximately $27 million. The registrant estimates that the total potential liability could have been as much as $119 million through 1993 on the same basis as adjustments proposed for years 1985 through 1989.\nThe registrant has reached agreement with the IRS and the Department of Justice in full settlement of all assessed, asserted or potential employment tax deficiencies and interest related to this matter through 1993. The net after-tax cost of the settlement amounted to $13.7 million or $.35 per share and is included in the 1994 statement of consolidated income.\nAs an incident of the settlement, the IRS provided a letter of assurance that states that operations conducted in accordance with the terms of an arrangement described therein would not be inconsistent with an independent contractor relationship within the meaning of the Internal Revenue Code. Since January 1, 1994, RPS has executed revised agreements with its pickup and delivery owner-operators that coincide with the terms described in the letter of assurance.\nVarious other legal proceedings arising from the normal conduct of business are pending but, in the opinion of management, the ultimate disposition of these matters will have no material effect on the financial condition of the registrant.\n- 5 - Item 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. - -------------------------------------\nName and Age Present Positions and Recent Business Experience - ------------ ------------------------------------------------\nDonald C. Brown, 39 Vice President-Corporate Support Services since January 1995; previously he served as Assistant Controller from January 1992 through 1994; Assistant to Vice President and Controller from December 1990 thru 1991; previous to employment with the registrant he was an audit senior manager with Ernst & Young LLP since 1984.\nJohn P. Chandler, 51 Vice President-Administration and Treasurer since January 1994; previously he served as Vice President-Administration during 1993; President of Roadway Package System, Inc. from July 1990 to December 1992 and Vice President-Finance and Administration of Roadway Package System, Inc. through June 1990.\nJoseph M. Clapp, 58 Director since 1982, and Chairman and Chief Executive Officer since January 1994; previously he served as Chairman and President from 1987 through December 1993.\nJohn M. Glenn, 63 Vice President and General Counsel since 1987.\nRoy E. Griggs, 58 Vice President and Controller since August 1990; previously he served as Assistant Controller.\nWilliam F. Klug, 55 Vice President-Real Estate and Environmental Services since January 1995; previously he served as Vice President-Properties and Material Management from 1988 through 1994.\nRodger G. Marticke, 46 Vice President and Group Executive since August 1994; previously he served as Assistant to the President since January 1993; previous to employment with the registrant he was a Principal with Temple, Barker and Sloan\/Mercer Management, a management consulting firm since 1988.\nJonathan T. Pavloff, 45 Vice President-Corporate Planning since February 1991; previously he served as President of Roadway Information Technology, Inc. (formerly Summit Information Systems, Inc.) a company owned management information subsidiary, from 1989 to February 1991.\n- 6 -\nDaniel J. Sullivan, 48 Director since August 1990 and President and Chief Operating Officer since January 1994; previously he served as Senior Vice President and President-National Carrier Group during 1993; Vice President and President-National Carrier Group during 1992; Vice President and Group Executive from July 1990 through 1991 and President of Roadway Package System, Inc. through June 1990.\nD. A. Wilson, 50 Senior Vice President-Finance and Planning, Secretary and Chief Financial Officer since January 1994; previously he served as Senior Vice President-Finance and Planning and Secretary during 1993 and as Vice President- Finance and Secretary from 1989 through 1992.\nOfficers are elected to serve on a calendar year basis except for the Chairman, President, Treasurer and Secretary, who are elected for an annual term following the annual meeting of shareholders. No family relationships exist between any of the executive officers named above or between any executive officer and any director of the registrant.\nPART II\nItem 5.","section_5":"Item 5. - Market for Registrant's Common Equity and Related Stockholder - ------- ------------------------------------------------------------- Matters. --------\nIn response to the information called for by this Item, the material set forth under the heading \"Common Stock and Dividends\" on page 38 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, is incorporated herein by reference.\nItem 6.","section_6":"Item 6. - Selected Financial Data. - ------- ------------------------\nIn response to the information called for by this Item, the historical data set forth for the years 1994, 1993, 1992, 1991 and 1990, and Notes (1) and (2) on pages 36 and 37 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, are incorporated herein by reference.\nItem 7.","section_7":"Item 7. - Management's Discussion and Analysis of Financial Condition and - ------- --------------------------------------------------------------- Results of Operations. ----------------------\nIn response to the information called for by this Item, the material set forth on pages 23 through 25 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 consolidated financial statements of the registrant and its subsidiaries set forth on pages 26 through 34 and the Report of Independent Auditors on page 35 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, are incorporated herein by reference.\n- 7 - The Report of Independent Auditors on the Financial Statement Schedule listed in Item 14(a) is included as Exhibit 99 of this report.\nThe material set forth under the heading \"Summary of Quarterly Results of Operations\" on page 38 of the registrant's 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 the Registrant. - -------- ---------------------------------------------------\nIn response to the information called for by Item 401 of Regulation S-K with respect to directors of the registrant, the material set forth under the heading \"Information About Nominees for Directors\" in the registrant's proxy statement for the annual meeting of shareholders to be held on May 10, 1995, which will be filed pursuant to Regulation 14A with the Securities and Exchange Commission, is incorporated herein by reference.\nIn response to the information called for by Item 401 of Regulation S-K with respect to executive officers of the registrant, the material set forth under the heading \"Executive Officers of the Registrant\" in Part I of this Form 10-K Annual Report for the year ended December 31, 1994, is incorporated herein by reference.\nItem 11.","section_11":"Item 11. - Executive Compensation. - -------- -----------------------\nIn response to the information called for by this Item with respect to directors of the registrant, the material set forth under the heading \"Director Compensation\" in the registrant's proxy statement for the annual meeting of shareholders to be held on May 10, 1995, which will be filed pursuant to Regulation 14A with the Securities and Exchange Commission, is incorporated herein by reference.\nIn response to the information called for by this Item with respect to executive officers of the registrant, the material set forth under the heading \"Executive Compensation and Shareholdings by Executive Officers\" in the registrant's proxy statement for the annual meeting of shareholders to be held on May 10, 1995, which will be filed pursuant to Regulation 14A with the Securities and Exchange Commission, is incorporated herein by reference.\nItem 12.","section_12":"Item 12. - Security Ownership of Certain Beneficial Owners and Management. - -------- ---------------------------------------------------------------\nIn response to the information called for by this Item, the material set forth under the heading \"Principal Holders of Company Common Stock on February 28, 1995,\" including the notes thereto, the material set forth under the heading \"Information About Nominees for Directors,\" including the notes thereto and the material set forth under the heading \"Ownership of Company Common Stock by Management,\" including the notes thereto, in the registrant's proxy statement for the annual meeting of shareholders to be held on May 10, 1995, which will be filed pursuant to Regulation 14A with the Securities and Exchange Commission, is incorporated herein by reference.\n- 8 - Item 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) List of Financial Statements and Financial Statement Schedules--The response to this portion of Item 14 is submitted as a separate section of this report.\n(3) Exhibit Index--The response to this portion of Item 14 is submitted as a separate section of this report.\n(b) Reports on Form 8-K Filed in the Fourth Quarter of 1994--None.\n(c) Exhibits--The response to this portion of Item 14 is submitted as a separate section of this report.\n(d) Financial Statement Schedules--The response to this portion of Item 14 is submitted as a separate section of this report.\n- 9 - 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.\nROADWAY SERVICES, INC.\nDate March 8, 1995 By Joseph M. Clapp -------------- ------------------------------------ Joseph M. Clapp, Chairman and Chief Executive Officer\nDate March 8, 1995 By D. A. Wilson -------------- ------------------------------------ D. A. Wilson, Senior Vice President- Finance and Planning, Secretary and Chief Financial Officer\nDate March 8, 1995 By R. E. Griggs -------------- ------------------------------------ Roy E. Griggs, Vice President 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.\nROADWAY SERVICES, INC.\nDate March 8, 1995 By G. B. Beitzel -------------- ------------------------------------ G. B. Beitzel, Director\nDate March 8, 1995 By R. A. Chenoweth -------------- ------------------------------------ R. A. Chenoweth, Director\nDate March 8, 1995 By Joseph M. Clapp -------------- ------------------------------------ Joseph M. Clapp, Director\nDate March 8, 1995 By Norman C. Harbert -------------- ------------------------------------ Norman C. Harbert, Director\nDate March 8, 1995 By Charles R. Longsworth -------------- ------------------------------------ Charles R. Longsworth, Director\nDate March 8, 1995 By Daniel J. Sullivan -------------- ------------------------------------ Daniel J. Sullivan, Director\n- 10 -\nANNUAL REPORT ON FORM 10-K\nITEM 14(a) (1) AND (2), AND 14(d)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nFINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1994\nROADWAY SERVICES, INC.\nAKRON, OHIO\n- 11 - FORM 10-K--ITEM 14(a) (1) AND (2)\nROADWAY SERVICES, INC. AND SUBSIDIARIES\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements, included in the registrant's Annual Report to Shareholders for the year ended December 31, 1994, are incorporated by reference in Item 8:\nConsolidated Balance Sheets--December 31, 1994 and 1993--pages 26 and 27 Statements of Consolidated Income--Years ended December 31, 1994, 1993 and 1992--page 28 Statements of Consolidated Earnings Reinvested in the Business-- Years ended December 31, 1994, 1993 and 1992--page 28 Statements of Consolidated Cash Flows--Years ended December 31, 1994, 1993 and 1992--page 29 Notes to Consolidated Financial Statements--December 31, 1994-- pages 30 through 34\nThe following consolidated financial statement schedule of Roadway Services, Inc. and subsidiaries is included in Item 14(d):\nSchedule VIII-Valuation and Qualifying Accounts\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.\n- 12 -\nSCHEDULE VIII-VALUATION AND QUALIFYING ACCOUNTS\nROADWAY SERVICES, INC. AND SUBSIDIARIES\nYears Ended December 31, 1994, 1993 and 1992\n(dollars in thousands)\nEXHIBIT INDEX\n3.1 Restated Amended Articles of Incorporation of the Registrant (filed as Exhibit 4(a) to Post-Effective Amendment No. 1 to Registration Statement No. 33-44502 and incorporated herein by reference).\n3.2 Restated Amended Code of Regulations of the Registrant effective May 10, 1989 (filed as Exhibit 3.2 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and incorporated herein by reference).\n9 Amended Restated Voting Trust Agreement effective November 1, 1992 (filed as Exhibit 9 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and incorporated herein by reference).\n*10.1 Roadway Services, Inc. Long-Term Stock Award Incentive Plan (as Amended and Restated December 1992) (filed as Exhibit 10.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and incorporated herein by reference).\n*10.2 Restricted Book Value Shares Plan for Roadway Services, Inc. and Certain Operating Companies (as Amended and Restated as of January 13, 1994) (filed as Exhibit 4(c) to Post-Effective Amendment No. 3 to Registration Statement No. 33-44502 and incorporated herein by reference).\n*10.3 Roadway Services, Inc. Directors' Deferred Fee Plan (filed as Exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, and incorporated herein by reference).\n*10.4 Roadway Services, Inc. 1994 Nonemployee Directors' Stock Plan.\n*10.5 Roadway Services, Inc. Retirement Plan for Nonemployee Directors (as Amended as of February 10, 1993) (filed as Exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and incorporated herein by reference).\n*10.6 Written description of Officers' Incentive Compensation Plan.\n*10.7(a) Roadway Services, Inc. Excess Plan effective January 1, 1993 (filed as Exhibit 10.7(a) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, and incorporated herein by reference).\n*10.7(b) Roadway Services, Inc. 401(a)(17) Benefit Plan effective January 1, 1993 (filed as Exhibit 10.7(b) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, and incorporated herein by reference).\n________________________________\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of this report. EXHIBIT INDEX\n*10.7(c) Roadway Services, Inc. Administrative Document for Excess Plan and 401(a)(17) Benefit Plan effective January 1, 1993 (filed as Exhibit 10.7(c) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, and incorporated herein by reference).\n10.8 Credit Agreement among Roadway Services, Inc., Several Lenders and Chemical Bank dated as of March 31, 1994 (filed as Exhibit 10 to the Registrant's Current Report on Form 8-K dated January 17, 1995, and incorporated herein by reference).\n13 Annual Report to Shareholders for the year ended December 31, 1994.\n21 Significant Subsidiaries of the Registrant.\n23 Consent of Ernst & Young LLP.\n27 Financial Data Schedule.\n99 Report of Independent Auditors on Financial Statement Schedule.\n________________________________\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of this report.\n- 2 -","section_15":""}
{"filename":"357020_1994.txt","cik":"357020","year":"1994","section_1":"ITEM 1. BUSINESS\nOVERVIEW\nLTX Corporation (the \"Company\" or \"LTX\") designs, manufactures and markets automatic test equipment for the semiconductor industry that is used to test digital, linear and mixed signal (a combination of digital and linear) integrated circuits (\"ICs\") and discrete semiconductor components. The Company currently offers products in four broad categories: three lines of semiconductor test systems and a line of test system networking products. The three lines of test systems are: digital test systems, which test digital ICs, including microprocessors and microcontrollers; linear\/mixed signal test systems, which test a wide range of linear and mixed signal ICs; and discrete component test systems, which test small signal and high-power semiconductor components. The Company also sells service and applications support for its test systems. The semiconductors tested by the Company's test systems are widely used in the computer, communications, automotive and consumer electronics industries. The Company markets its products worldwide to both manufacturers and users of digital, linear and mixed signal ICs and discrete semiconductor components.\nThe semiconductor industry is segmented into broad product categories, including digital, linear, mixed signal and memory ICs and discrete components. The testing of each semiconductor product category requires specific procedures and capabilities, which may vary significantly. All semiconductor manufacturers use semiconductor test equipment (\"STE\") in the design and manufacture of ICs. During design, STE is used for design verification, characterization, qualification and failure analysis of ICs. During manufacture, STE is used during wafer probing to select usable ICs and after packaging to classify ICs by performance characteristics and to assure conformance with quality standards. In addition, certain large electronic equipment manufacturers employ STE for incoming inspection and for further classification of ICs.\nAdvances in semiconductor technology have permitted the design and manufacture of increasingly complex semiconductor devices. These devices provide improved performance, lower cost and greater reliability than earlier generations of devices. As a result, the use of semiconductors has proliferated across many industries, particularly in applications for the computer, communications, automotive and consumer electronics industries. In turn, the increasing complexity and variety of ICs has created a demand for STE that is faster, more versatile, more accurate, more productive and easier to program and maintain.\nPRODUCTS AND MARKETS\nThe Company offers products in four broad product categories:\n- digital test systems, which include the Deltamaster and Micromaster test systems and enVision test development software, with the Company's new Delta 100 and Delta 50 test systems scheduled for delivery in fiscal 1995;\n- linear\/mixed signal test systems, which include the Synchro and Ninety;\n- discrete component test systems, marketed as the iPTest product line; and\n- test system networking products, marketed under the name EZNET.\nAll of the Company's test systems are comprised of a set of computer-controlled instruments which send signals to a device under test and measure the responses of that device to classify the device by performance characteristics and to ensure conformance with quality standards.\nDIGITAL PRODUCTS\nThe Company markets its digital test systems under the Trillium name. These digital products are used to test digital ICs, in particular microprocessors and microcontrollers. These digital devices are used to operate and control nearly all electronic products. Microprocessors are found in personal computers, engineering workstations and industrial control systems and are among the most expensive semiconductor devices. Microcontrollers are used in automobiles, home appliances, cellular phones and televisions. Products that\nincorporate microprocessors or microcontrollers typically include other digital ICs that are tested to the same standards as the related microprocessor or microcontroller.\nDeltamaster and Micromaster\nThe Deltamaster, introduced in 1990, is a high-performance system with the capability of testing up to 256 pins at data rates of up to 80 MHz or up to 128 pins at data rates of up to 160 MHz. The Micromaster, introduced in 1987, is a lower-priced system that can test up to 256 pins at data rates of up to 40 MHz. The Micromaster is device interface and software compatible with the Deltamaster. Both test systems achieve timing accuracy of 250 pico seconds, feature resource-per-pin architecture and are compatible for use with the Company's HiPer pin card.\nIn resource-per-pin architecture, there is a complete set of the test system's key features (timing generators, waveform formatting and pattern memory) for each pin of the test system. The Company believes that this architecture provides faster, simpler characterization and engineering debugging of new ICs, better system timing accuracy and simplified interfacing to computer-aided design systems.\nPin cards located in the test head interface the capabilities of the test system to the device under test. In many test systems, pin card performance is the limiting factor of overall system performance. The Company's HiPer pin card has been designed to provide a high degree of signal fidelity, fast rise time and constant impedance.\nPrices for the Deltamaster and Micromaster lines of testers currently range from approximately $400,000 to approximately $2,000,000, depending on the system configuration and timing accuracy specifications. The Company intends to continue manufacturing, marketing and servicing both of these systems, although it expects that its Delta 100 and Delta 50 new generation of test systems, described below, will begin to replace the Deltamaster and Micromaster when deliveries begin in fiscal 1995.\nenVision\nIn fiscal 1993, LTX completed the development of its new object-oriented enVision programming software for use on all LTX digital systems. In earlier generation software languages, programming commands made direct reference to the hardware of the test system, which required the user to have a detailed knowledge of the system's hardware. In contrast, this detailed knowledge is not required when using enVision, thereby allowing the programmer to focus attention on refining the test program for the specific IC under test. Thus, the Company has designed enVision to be more device oriented than tester oriented.\nenVision permits a user to test multiple devices at the same time. For example, when used with a Deltamaster, enVision permits simultaneous testing of four microprocessors with 64 pins each. This capability of enVision significantly improves the throughput of the Company's digital test systems.\nenVision has been designed to run with the Deltamaster and Micromaster test systems and is an integral feature of the Delta 100 and Delta 50 test systems. The current price for enVision is approximately $15,000 per workstation.\nDelta 100 and Delta 50\nThe Company plans to deliver in fiscal 1995 two new digital test systems, the Delta 100 and the Delta 50. The Delta 100 is specifically designed for testing high performance CISC (complex instruction set computing) and RISC (reduced instruction set computing) microprocessors and the ICs that make up the chip sets that are used with them. The Delta 100 has resource-per-pin architecture and can test up to 512 pins at data rates of up to 100 MHz. Timing accuracy of 150 pico seconds is a significant improvement over the Deltamaster and Micromaster test systems.\nThe Delta 50 is designed for the production test needs of microcontroller and digital IC manufacturers who do not require the sophisticated performance characteristics of the Delta 100. The Delta 50 has resource-per-pin architecture and is capable of testing 512 pins at data rates of up to 50 MHz or 256 pins at data rates of up to 100 MHz.\nIn fiscal 1993, the Company entered into a development, manufacturing and marketing agreement with Ando Electric Co., Ltd. (\"Ando\"), a Japanese STE manufacturer and majority owned subsidiary of Nippon Electric Corporation, Ltd., relating to the Delta 50. The Company has developed the Delta 50 in conjunction with Ando and has granted Ando exclusive rights to manufacture the Delta 50 in Japan. The Company has retained exclusive rights to manufacture the Delta 50 outside of Japan. With certain exceptions in each case, Ando has the exclusive right to sell the Delta 50 in Japan and the Company has exclusive marketing rights for the rest of the world. In July 1994, the Company amended its development agreement with Ando to allow for further development and enhancements to the Delta 50 (see Note 5).\nBoth the Delta 100 and Delta 50 operate with the Company's enVision software, which will enable the Company to offer these compatible high and low end products in the same market. The Company expects the compatibility of these systems to facilitate migration to the Delta 100 test system by Delta 50 users.\nPrices for the Delta 100 will range from approximately $1,200,000 to approximately $4,900,000, depending on the system configuration. Prices for the Delta 50 range from approximately $500,000 to approximately $2,500,000, also depending on the system configuration.\nLINEAR\/MIXED SIGNAL PRODUCTS\nLTX offers two product lines for testing linear\/mixed signal ICs, Synchro and Ninety, introduced in 1990 and 1986, respectively. Linear ICs are used in almost every electronic application. The very nature of physical occurrences, such as sound, images, temperature, pressure, speed, acceleration, position and rotation, consists of continuously varying information. Linear ICs are used to amplify, filter and shape this information. Mixed signal ICs are capable of converting the signals from linear ICs into a digital format that can be processed by a computer. Mixed signal devices can also convert processed digital information into a linear form to control physical phenomena or to improve sound and images.\nLinear and mixed signal ICs are widely used in automobiles, computers, telephones and such home entertainment products as video cassette recorders, cameras, compact disc players and video games. The complexity and density of these ICs have increased rapidly over the past several years, particularly as the demand for portable, battery operated products has required IC manufacturers to integrate more functions on each chip and reduce size and power consumption. These technological advances have resulted in increased demand for higher performance linear\/mixed signal test systems.\nSynchro\nThe Synchro is the latest generation of the Company's linear\/mixed signal test systems. Synchro test systems are designed for high throughput testing of linear devices and for testing of mixed signal devices that require high digital pattern rates and high digital pin counts. The Synchro features independent microprocessors that concurrently control both linear and digital resources at each pin of the IC under test. This design permits the generation of test signals and measurements on many device pins at the same time, producing faster test times on high pin count ICs.\nLTX offers a wide array of options with the Synchro to address the various linear\/mixed signal test requirements of its customers. In fiscal 1994, the Company began delivering a new Synchro test system, the Synchro 160, to meet the test requirements of newer disk drive and communications devices. The Synchro 160 can test up to 160 pins at data rates of up to 200 MHZ and is compatible with other existing systems in the Synchro line. All Synchro test systems can incorporate the HiPer pin card used on the Company's digital test systems. The Company offers equipment, some of which is manufactured by third parties, and software with its Synchro systems that expand the use of these systems into other manufacturing applications, such as laser trimming and testing of electronic sub-assemblies. Current prices of the Synchro range from approximately $350,000 for a low pin count linear system to approximately $2,000,000 for a high pin count mixed signal system.\nNinety\nThe Ninety system is an improved version of the LTX77, the Company's first linear\/mixed signal test system introduced in 1977. Although the Synchro has largely superseded the Ninety, the Company continues\nto manufacture the Ninety for customers who are already using the Ninety or LTX77 systems and desire to expand capacity. As with the Synchro, a wide array of options are available. The current price range for the Ninety is from approximately $200,000 to approximately $700,000, depending on the system configuration.\nOver the years, the Company has significantly upgraded the performance and capabilities of the Ninety and LTX77 systems through the introduction of new hardware and software. In fiscal 1992, the Company introduced the CP100, an improved computer for use with the Ninety and LTX77 systems. The CP100 is smaller and faster than the computer originally installed with these systems. The Company currently offers the CP100 for approximately $80,000.\nDISCRETE PRODUCTS\nThe Company's iPTest systems are used to test discrete semiconductor components, such as diodes, small signal transistors and power transistors, as well as arrays of these components. These discrete components are used in every area of electronics. iPTest systems are also capable of accurately measuring the characteristics of transient voltage suppression components, which are widely used to protect personal computers and telecommunications products from harmful voltage spikes or surges.\nThe Company expects that arrays of discrete components, such as multi-device modules, will replace transistors in electric motor control and will permit a wider use of semiconductors in extremely high power applications, such as air conditioners, domestic appliances, electric locomotives and automobiles. These arrays of discrete components are mostly constructed from high power transistors of IGBT (insulated gate bipolar transistor) and MOSFET technology. The Company's development programs for iPTest products are largely focused on testing of these newer components, which the Company believes may become the most significant market for discrete component test systems.\nPrices of iPTest systems currently range from approximately $100,000 to approximately $700,000, depending on the system configuration and testing specifications.\nNETWORKING PRODUCTS\nLTX offers its EZNET hardware and software products to enable its customers to interface LTX test systems as well as competitors' test systems with the customer's manufacturing, engineering or management information systems. These products enable the Company to provide its customers with a complete solution to their test information needs. Included in the Company's EZNET product line is its dataVision software package, which is used by customers to collect, analyze and archive data from the testing process. EZNET systems typically range in price from approximately $80,000 to approximately $250,000.\nSALES, SERVICE AND CUSTOMER SUPPORT\nThe Company sells, services and supports its products primarily through its worldwide sales and support organization. In Japan, the Company sells, services and supports its products through its joint venture with Sumitomo Metal Industries, Ltd. (\"SMI\"), except that Ando has the right to manufacture and sell the Delta 50 to certain customers in Japan and to sell the Delta 100 to these customers. The Company shares with its joint venture with SMI specified portions of the royalties paid by Ando on the Delta 50 and of the revenues received on the Delta 100. The Company uses a small number of independent sales representatives in certain other regions of the world.\nThe Company considers service and support to be important to the success of its business because of the highly technical nature of its products. Customer support activities include installation, training, field service and applications assistance. At July 31, 1994, the Company maintained 22 customer support centers and three additional sales offices around the world. The Company's support personnel are capable of performing all necessary maintenance of test systems sold by the Company, including routine servicing of components manufactured by third parties.\nThe Company is subject to the usual risks of international trade, including unfavorable economic conditions, political instability, restrictive trade policies, controls on funds transfers and foreign currency\nfluctuations. Most of the Company's export sales have been made in United States dollars or dollar equivalents. For the fiscal years 1994, 1993 and 1992 export sales made either directly from the United States or through foreign subsidiaries and the joint venture accounted for 61%, 47% and 43%, respectively, of net sales. Profit margins on export sales are approximately the same as on domestic sales. For information about the Company's foreign operations and export sales, see Note 10 of Notes to the Company's Consolidated Financial Statements.\nThe Company provides a one-year parts and three-month labor warranty on test systems or options designed and manufactured by the Company, and a three-month labor warranty on components that have been purchased from other manufacturers and incorporated into the Company's test systems. Customers who desire longer term warranties may enter into maintenance contracts with LTX.\nCUSTOMERS\nThe Company's customers include many of the world's leading semiconductor manufacturers. The Company's major customers in fiscal 1994 include:\nAT&T Philips Hitachi Samsung Intel SGS-Thomson Motorola Silicon Systems National Semiconductor Sony\nSales to these major customers accounted for approximately 58% of net sales in fiscal 1994. No single customer accounted for 10% or more of net sales in fiscal 1994. Sales to Intel accounted for approximately 16% and 22% of net sales in fiscal 1993 and 1992, respectively. Sales to National Semiconductor accounted for 10% of net sales in fiscal 1992.\nENGINEERING AND PRODUCT DEVELOPMENT\nThe market for STE is characterized by rapid technological change. The Company believes that the timely introduction of new products and improvements to existing products are essential for the Company to maintain its competitive position. Accordingly, the Company devotes a significant portion of its personnel and financial resources to engineering and product development programs and seeks to maintain close relationships with its customers in order to be responsive to their product needs. The Company's expenditures for engineering and product development were $19,604,000, $19,744,000 and $21,943,000 during fiscal year 1994, 1993 and 1992, respectively.\nMANUFACTURING AND SUPPLY\nLTX's principal manufacturing operations consist of component parts assembly, final assembly and testing at its manufacturing facilities in Westwood, Massachusetts and San Jose, California. The Company uses standard components and prefabricated parts manufactured to the Company's specifications. Most of the components for the Company's products are available from a number of different suppliers; however, certain components are purchased from a single supplier. Although LTX believes that all single-source components currently are available in adequate amounts, there can be no assurance that shortages will not develop in the future. Any disruption or termination of supply of certain single-source components could have an adverse effect on the Company's business and results of operations.\nCOMPETITION\nThe STE industry is highly competitive, with many other domestic and foreign companies participating in the markets for each of the Company's products. The Company's major competitors in the market for digital test systems are Advantest Corporation (an affiliate of Fujitsu Limited), Schlumberger Limited and Teradyne, Inc. The Company's principal competitor for linear\/mixed signal test systems is Teradyne, Inc. The Company's principal competitor for discrete component test systems is Tesec, Ltd. Most of the Company's\nmajor competitors are also suppliers of other types of automatic test equipment and have significantly greater financial and other resources than the Company.\nThe Company principally competes on the basis of performance, reliability, customer service, applications support, price and ability to deliver its products on a timely basis. Although the Company believes that it competes favorably with respect to each of these factors, new product introductions by the Company's competitors could cause a decline in sales or loss of market acceptance of the Company's existing products. In addition, increased competitive pressure could lead to intensified price-based competition, resulting in lower prices and adversely affecting the Company's business and results of operations.\nBACKLOG\nAt July 31, 1994, the Company's backlog of unfilled orders for all products and services was $71.8 million, compared with $42.2 million at July 31, 1993. The Company expects to ship 90% of its July 31, 1994 backlog in fiscal 1995. While backlog is calculated on the basis of firm orders, no assurance can be given that customers will purchase the equipment subject to such orders. As a result, the Company's backlog at a particular date is not necessarily indicative of actual sales for any succeeding period.\nPROPRIETARY RIGHTS\nThe development of the Company's products is largely based on proprietary information. The Company relies upon a combination of contract provisions, copyright, trademark and trade secret laws to protect its proprietary rights in products. It also has a policy of seeking patents on technology considered of particular strategic importance. Although the Company believes that the copyrights, trademarks and patents it owns are of value, the Company believes that they will not determine the Company's success, which depends principally upon its engineering, manufacturing, marketing and service skills. However, the Company intends to protect its rights when, in its view, these rights are infringed upon.\nEXECUTIVE OFFICERS OF THE COMPANY\nExecutive officers are chosen by and serve at the discretion of the Board of Directors of the Company.\nRoger W. Blethen was elected a President of the Company in February 1994. Mr. Blethen has been a Director since 1980 and had been a Senior Vice President of the Company from 1985 until February 1994. Mr. Blethen was a founder of LTX and has served in a number of senior management positions with the Company since its formation in 1976.\nMartin S. Francis was elected a President of the Company in February 1994. Mr. Francis has been a Director since 1991 and had been responsible for International Sales and Support Activities of the Company from 1989 until 1991, as a Vice President, and from 1991 until 1994, as a Senior Vice President. Prior to 1989, Mr. Francis had held senior management positions in the Company's European and Japanese operations from the time that he joined LTX in 1982.\nJohn J. Arcari has been Chief Financial Officer and Treasurer of the Company since 1987. He had been Controller of LTX since joining the Company in 1981. Prior to joining LTX, Mr. Arcari spent ten years with the public accounting firm of Price Waterhouse as a certified public accountant.\nKenneth E. Daub was appointed a Senior Vice President of the Company in 1991 and is responsible for North American and Pacific Rim sales. From the time he joined the Company in 1987 until 1991, Mr. Daub\nserved as Vice President responsible for North American sales. Prior to joining the Company in 1987, Mr. Daub held various senior positions with Schlumberger Limited.\nAt July 31, 1994, the Company had a total of 880 employees, including 219 in engineering and product development, 180 in service and customer support, 293 in manufacturing, and 188 in sales, marketing and administration. Many of the Company's employees are highly skilled, and the Company believes its future success will depend in large part on its ability to attract and retain such employees. None of the Company's employees are represented by a labor union, and the Company has experienced no work stoppages. The Company believes that its employee relations are excellent.\nENVIRONMENTAL AFFAIRS\nThe Company's manufacturing facilities are subject to numerous laws and regulations designed to protect the environment. The Company does not anticipate that compliance with these laws and regulations will have a material effect on its capital expenditures, earnings or competitive position.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAll of the Company's facilities are leased. The Company maintains its headquarters in Westwood, Massachusetts, where corporate administration, sales and customer support and manufacturing and engineering for its linear\/mixed signal products are located in two buildings that total 375,000 square feet. The leases of these two buildings expire in 2007 and 2010. Manufacturing and engineering for the Company's digital products are located in a 70,000 square foot facility in San Jose, California. The lease of this facility expires in 1999. The Company also leases seven sales and customer support offices at various locations in the United States totaling approximately 70,000 square feet. The Company is consolidating its facilities and is actively seeking to sub-lease a 208,000 square foot facility in Westwood, Massachusetts and a 42,000 square foot facility in San Jose, California.\nThe Company's European headquarters is located in Woking, United Kingdom. The Company also maintains sales and customer support offices in facilities at four other locations in Europe. The manufacturing and engineering facilities for the Company's iPTest systems are located in Guildford, United Kingdom. The Company also maintains sales and customer support offices in six locations in the Far East. Office space leased in Europe and the Far East totals approximately 100,000 square feet.\nThe headquarters of LTX Co., Ltd., the Company's joint venture with SMI, is located in Kawasaki, Japan. The joint venture also leases additional sales and customer support offices in four other locations in Japan. Office space leased in Japan totals approximately 15,000 square feet.\nThe Company believes that its existing facilities are adequate to meet its current and foreseeable future requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company has no material pending legal proceedings other than routine litigation relating to its business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of stockholders during the fourth quarter of fiscal 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET VALUE FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe Company has never paid cash dividends. It is the present policy of the Company's Board of Directors to retain earnings to finance expansion of the Company's operations. The Company does not expect to pay dividends in the foreseeable future.\nAs of September 30, 1994, there were 1,482 stockholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe information set forth on page 5 of the registrant's 1994 Annual Report under the caption \"Selected Financial Information Five Year Summary\" is incorporated herein by reference. That information summarizes certain selected consolidated financial data and should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nFiscal 1994 Compared to Fiscal 1993\nOrders for the Company's products and services increased to $197.9 million in fiscal 1994, the highest level in the Company's history, from $182.1 million in fiscal 1993. The increase in orders was largely a result of expanding production capacity in the semiconductor industry and new product options offered by the Company, which created additional demand for the Company's test systems. Orders for the Company's linear and mixed signal products increased by over 60% in fiscal 1994 over fiscal 1993. This increase was partially offset by a decline in orders for the Company's digital product line in fiscal 1994, particularly for testing microprocessors, as compared to fiscal 1993. Geographically, orders from European and Japanese customers increased significantly year-to-year, while orders from customers in North America and the Pacific Rim were below the level of the prior fiscal year. At July 31, 1994, the Company had increased its backlog to a record $71.8 million, from $42.2 million at July 31, 1993.\nNet sales were $168.3 million in fiscal 1994 as compared to $172.9 million in fiscal 1993. Sales of the Company's linear and mixed signal products increased by over 30% in fiscal 1994 as compared to fiscal 1993, and service revenues increased by over 20% year-to-year. However, this improvement was offset by a reduction of over 30% in sales of the Company's digital product line in fiscal 1994 as compared to fiscal 1993. The decline in shipments of the Company's digital product line was due to lower demand from customers, particularly in North America, for testing microprocessor and other personal computer-related devices.\nThe gross profit margin was 28.4% of net sales in fiscal 1994 as compared to 34.4% in fiscal 1993. In the second quarter of fiscal 1994, the Company recorded a $3.5 million provision for excess inventories primarily as a result of lower than anticipated shipment levels in the first half of fiscal 1994. This provision lowered the gross profit margin by 2.1% of net sales in fiscal 1994. In fiscal 1993, the gross profit margin was increased by 2.6% as a result of a $6.5 million payment made by Ando Electric Co., Ltd. (\"Ando\") under the terms of a development contract that was included in product sales. There was no similar contract revenue in fiscal 1994. The gross profit margin in fiscal 1994 was also adversely affected by proportionately higher fixed manufacturing costs on lower digital product sales and by lower average selling prices for the Company's digital products.\nEngineering and product development expenses were $19.6 million in fiscal 1994 as compared to $19.7 million in fiscal 1993. Engineering expenses in both fiscal 1994 and fiscal 1993 included significant development costs for the Company's new generation of digital products, the Delta 50 and Delta 100, as well as enhancements to the mixed signal product line.\nIn February 1994, Graham Miller resigned as President of LTX and, since that date, has continued as Chairman of the Board of Directors of the Company. The Board of Directors formed an Office of the Presidents and elected Roger W. Blethen and Martin S. Francis as Presidents of LTX. This change in management structure was made to decentralize management and profitability responsibilities.\nIn March 1994, the Company announced a major restructuring to properly size operations to its current level of business. The restructuring consisted of a planned consolidation of facilities, primarily involving the Company's leased facilities in Westwood, Massachusetts, and a workforce reduction of 100 employees. As a result of those decisions, the Company took a $14.4 million restructuring charge to its second quarter results of operations. The restructuring charge largely relates to the Company's plan to eliminate excess leased facilities and included amounts for severance payments and outplacement benefits for terminated employees. Largely as a result of the restructuring, engineering and product development expenses and selling, general and administrative expenses, combined, were $2.1 million lower in the fourth quarter of fiscal 1994 as compared to the second quarter of fiscal 1994.\nAlthough the initial effects of the restructuring benefited the second half of fiscal 1994, selling, general and administrative expenses were $1.2 million higher in fiscal 1994 as compared to fiscal 1993. This increase was primarily a result of personnel additions and higher costs for sales activities in the first half of fiscal 1994.\nInterest expense was $4.3 million in both fiscal 1994 and fiscal 1993. A decrease in interest expense in fiscal 1994 as a result of the conversion of the Company's 10 1\/2% Convertible Subordinated Debenture Due 2010 to common stock in July 1993, was offset by an increase in interest expense on higher average bank borrowings in fiscal 1994.\nThe Company's Japanese subsidiary had a net loss in fiscal 1994 and fiscal 1993. The minority interest in net loss of subsidiary represents the minority partner's share of the Company's Japanese subsidiary's loss in both years. The net loss in fiscal 1994 was reduced substantially from the prior fiscal year primarily as a result of an increase in sales and gross margin in fiscal 1994 over fiscal 1993.\nThere was no tax provision in fiscal 1994 or fiscal 1993 due to the net loss in both years. The Company is in a net operating loss carryforward position in most tax jurisdictions.\nThe Company had a net loss of $31.3 million in fiscal 1994 as compared to a net loss of $4.3 million in fiscal 1993. The Company reported a net loss of $1.6 million in the first quarter of fiscal 1994 and a net loss of $24.0 million in the second quarter of fiscal 1994, including the restructuring charge of $14.4 million and a provision for excess inventories of $3.5 million. The Company reduced its net loss to $4.3 million in the third quarter of fiscal 1994 and to $1.4 million in the fourth quarter of fiscal 1994 as a result of a combination of lower operating expenses from the restructuring effort initiated in March and an improvement in the Company's shipment level and gross profit margin.\nFiscal 1993 Compared to Fiscal 1992\nGeographically, the Company's fiscal 1993 order levels improved significantly in the Pacific Rim other than Japan, with orders from domestic and European customers also posting solid gains. The improvement in the Pacific Rim other than Japan reflected both favorable conditions in fiscal 1993 for semiconductors used in personal computers and the continued transfer of semiconductor assembly and testing to that region. In Japan, orders for the Company's systems were at a low level throughout fiscal 1993 as a result of continuing weak business conditions in that country.\nNet sales rose to $172.9 million in fiscal 1993 as compared to $149.1 million in the prior fiscal year. The Company increased its backlog from $33.0 million at July 31, 1992 to $42.2 million at July 31, 1993. Net sales of the Company's digital products in fiscal 1993 increased 30% over the prior fiscal year. Although net sales of linear\/mixed signal systems were down slightly year-to-year, the Company experienced significant growth in orders for these products in the second half of fiscal 1993. Virtually all of the net sales increase in fiscal 1993 reflected an increase in unit sales. Service revenues in fiscal 1993 increased 26% over the prior fiscal year to $18.5 million, reflecting the Company's service coverage of its growing base of installed equipment.\nThe gross profit margin in fiscal 1993 was 34.4% of net sales as compared to 28.9% in fiscal 1992. The majority of the improvement in gross profit margin (2.9%) was the result of higher service revenues, better coverage of fixed manufacturing costs and lower provisions for excess inventories in fiscal 1993, as compared to the prior fiscal year. These improvements were partially offset by lower average selling prices for the Company's digital products in fiscal 1993, primarily as a result of changes in product mix. The balance of the improvement (2.6%) resulted from a $6.5 million payment made by Ando under the terms of a development contract that was included in North American product sales.\nEngineering and product development expenses were $19.7 million in fiscal 1993 as compared to $21.9 million in fiscal 1992 because of cost reduction measures initiated in fiscal 1992. Expenses in both years included substantial development costs relating to the Delta 100 and Delta 50 generation of test systems, enVision test system software and significant enhancements to the Synchro product line. The Delta 50 efforts were partially funded in fiscal 1993 by the Ando development contract.\nSelling, general and administrative expenses were $0.4 million lower in fiscal 1993 as compared to fiscal 1992. The lower level of expenses in the current year were primarily a result of cost reduction measures taken in fiscal 1992. This reduction was partially offset by an increase in selling expenses associated with the higher level of net sales in fiscal 1993 over fiscal 1992.\nThe Company incurred a translation loss of $1.5 million in fiscal 1993. The loss was a result of the adverse effect of exchange rates on the Company's foreign operations, primarily in Japan.\nIn fiscal 1992, the Company took a $2.8 million charge for severance and restructuring costs associated with the cost reduction measures initiated in that fiscal year. There was no provision for severance and restructuring charged to operations in fiscal 1993.\nInterest expense rose slightly in fiscal 1993, primarily due to higher average bank borrowings. In addition, interest income was lower year-to-year as a result of a decline in average cash balances and lower interest rates.\nThe minority interest in net loss of subsidiary of $2.6 million represents the minority partner's share of the Company's Japanese subsidiary's loss for fiscal 1993. While the minority partner's original investment in the Company's Japanese subsidiary was consumed in fiscal 1993, the minority partner made an additional contribution in fiscal 1993 in the form of guarantees of a portion of the subsidiary's bank lines.\nThere was no tax provision in fiscal 1993 or fiscal 1992 as the Company operated at a loss and is in a net operating loss carryforward position in most tax jurisdictions.\nThe Company made steady quarter-to-quarter improvement in its results of operations in fiscal 1993, starting with a net loss of $2.8 million in the first quarter and ending with net income of $1.0 million in the fourth quarter. For the fiscal year, the Company had a net loss of $4.3 million as compared to a net loss of $24.3 million in fiscal 1992.\nLIQUIDITY AND CAPITAL RESOURCES\nCash and equivalents were $17.2 million and $21.7 million at July 31, 1994 and July 31, 1993, respectively. The $4.5 million decrease in cash and equivalents during fiscal 1994 was a result of $17.5 million in net cash used in operating activities, $12.7 million of net cash used for property and equipment expenditures and $25.7 million of net cash provided by financing activities.\nThe Company used $17.5 million in cash for operating activities in fiscal 1994, primarily as a result of the net loss for the fiscal year, before non-cash restructuring charges and the provision for excess inventories. The Company sold $1.7 million and $5.1 million of accounts receivable to its domestic bank, without recourse, under factoring agreements at July 31, 1994 and July 31, 1993, respectively. Excluding these transactions, accounts receivable were $5.1 million lower at July 31, 1994 as compared to July 31, 1993. This reduction is primarily a result of the lower level of sales in the fourth quarter of fiscal 1994 as compared to the fourth quarter of the prior year. Inventories were lowered by $2.5 million in fiscal 1994 as a result of the provision for excess inventories of $3.5 million, together with lower inventory purchases in the second half of fiscal 1994 as compared to the second half of the prior year. However, these inventory reductions were partially offset by an increase in inventories during fiscal 1994 for the Company's new generation of digital test systems which the Company plans to deliver in fiscal 1995. Accounts payable were reduced by $11.4 million in fiscal 1994 primarily as a result of the lower level of inventory purchases in the second half of fiscal 1994 as compared to the second half of fiscal 1993. At July 31, 1994, the Company had $11.7 million in accrued restructuring charges which were primarily related to the provision for excess leased facilities. Cash outflows for severance payments were $1.0 million during fiscal 1994 and are estimated to be $0.9 million thereafter. Cash outflows related to excess leased facilities were $1.7 million during fiscal 1994 and are estimated to be $10.8 million thereafter. The Company is actively seeking to sub-lease these facilities. Finalization of sub-leasing arrangements may change the reserves provided and related cash flows.\nAdditions to property and equipment in fiscal 1994 were $12.7 million and exceeded depreciation charges in fiscal 1994 of $9.2 million. The capital equipment additions consisted primarily of LTX test systems and modules for engineering and customer support requirements. The Company financed $3.5 million of the capital equipment additions with lease financing during fiscal 1994.\nIn July 1994, the Company received $20.0 million from Ando under a term loan agreement through July 2001. The loan bears interest at 8%, which is payable semi-annually beginning in January 1995, and has semi-annual principal payments of $2.0 million beginning in January 1997. The loan is secured by the Company's inventories and capital equipment and is subordinated in right of payment to senior indebtedness of the Company. In conjunction with this loan agreement, the Company issued to Ando a warrant to purchase\nup to 2.0 million shares of common stock, at the fair market value of $2.31 per share, during the term of the loan agreement. The Company also expanded its existing license and development agreement with Ando to allow for further joint development of the Company's Delta 50 technology. Proceeds from the loan were used to repay domestic bank borrowings and to finance working capital requirements.\nAt July 31, 1994, the Company's Japanese subsidiary had bank borrowings of $6.9 million as compared to $9.9 million in borrowings at July 31, 1993. These bank borrowings are on demand and are guaranteed by the Company's minority partner in the Japanese subsidiary. The Company's Japanese subsidiary also had an unused demand bank line of $2.0 million available at July 31, 1994 which is guaranteed by the Company.\nAt July 31, 1994 and July 31, 1993, the Company had no borrowings outstanding under its $5.0 million domestic bank line. This bank line was amended in June 1994 and the financial covenants under this line were restructured. On October 6, 1994, this line was replaced with a $5.0 million line which extends through December 1995. The new line bears interest at the bank's prime rate plus 1% and is secured by accounts receivable and inventories.\nIn January 1994, the Company received $4.0 million from the sale of 972,000 shares of its common stock to several private investors. The Company used the proceeds from this sale for working capital requirements. In the third quarter of fiscal 1993, the Company received $9.8 million from the sale of 2,458,000 shares of its common stock to a private investor.\nThe Company has two issues of convertible subordinated debentures outstanding at July 31, 1994: $15.7 million (face amount) of 13 1\/2% Convertible Subordinated Debentures Due 2011 and $7.3 million of 7 1\/4% Convertible Subordinated Debentures Due 2011. Interest is payable on these debentures semi-annually. Annual sinking fund payments of $785,000 and $366,000, respectively, are due on these two debenture issues beginning in April 1996.\nIn fiscal 1993, the Company's operating activities provided $4.8 million in cash. Financing activities provided $13.0 million in cash in fiscal 1993, including $9.8 million from the sale of common stock. The Company used $7.8 million in cash for capital equipment expenditures in fiscal 1993. In fiscal 1992, the Company used $12.4 million in cash for operating activities, primarily as a result of the net loss for the fiscal year before non-cash depreciation charges. The Company used $7.6 million in cash for capital equipment expenditures and additional bank borrowings provided $5.1 million in cash in fiscal 1992.\nInflation during the years presented did not have any significant effects on the operations of the Company. The Company attempts to mitigate inflationary cost increases by continuing improvements in operating efficiency through improved methods and technologies.\nManagement believes the Company has sufficient cash resources to meet its fiscal 1995 requirements through a combination of existing cash balances, future cash flows from operations and borrowing availability under its domestic and Japanese bank lines of credit. The Company's fiscal 1995 cash requirements include plans for capital equipment expenditures of approximately $8.0 million.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholders of LTX Corporation:\nWe have audited the accompanying consolidated balance sheets of LTX Corporation and subsidiaries as of July 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 July 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 LTX Corporation and subsidiaries as of July 31, 1994 and 1993, and the 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.\nOur audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed on page 28 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 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 Boston, Massachusetts September 13, 1994 (Except with respect to the matter discussed in Note 4, as to which the date is October 6, 1994)\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 LTX's previously filed registration statements on Form S-8 (File No. 2-77475, File No. 2-90698, File No. 33-7018, File No. 33-14179, File No. 33-32140, File No. 33-32141, File No. 33-33614, File No. 33-38675, File No. 33-51683 and File No. 33-51685).\nARTHUR ANDERSEN LLP Boston, Massachusetts October 14, 1994\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe accompanying notes are an integral part of these consolidated financial statements.\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned domestic subsidiaries and wholly-owned and majority-owned foreign subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.\nMinority interest in net loss of subsidiary represents the minority shareholder's proportionate share of the results of operations of the Company's majority-owned Japanese subsidiary (see Note 12).\nForeign Currency Translation\nThe financial statements of the Company's foreign subsidiaries are translated in accordance with Statement of Financial Accounting Standards No. 52. The Company's functional currency is the U.S. dollar. Accordingly, the Company's foreign subsidiaries translate monetary assets and liabilities at year-end exchange rates while nonmonetary items are translated at historical rates. Income and expense accounts are translated at the average rates in effect during the year, except for sales, cost of sales and depreciation which are primarily translated at historical rates. Net realized and unrealized gains and losses resulting from foreign currency remeasurement and transaction gains and losses are included in the results of operations.\nCash Equivalents\nCash equivalents consist of short-term investments with maturity dates of one month or less and which are readily convertible into cash.\nInventories\nInventories are stated at the lower of cost or market, cost being determined on the first-in, first-out method, and include material, labor and manufacturing overhead.\nProperty and Equipment\nProperty and equipment is recorded at cost. The Company provides for depreciation and amortization on the straight-line method. Charges are made to operating expenses in amounts which are sufficient to amortize the cost of the assets over their estimated useful lives.\nRevenue Recognition\nRevenue from product sales is recognized at the time of shipment. Service revenues are recognized over the applicable contractual periods or as services are performed. Revenues from engineering contracts are recognized over the contract period on a percentage of completion basis.\nWarranty Costs\nWarranty costs incurred by the Company during the three years ended July 31, 1994 were not significant. Future warranty costs are not expected to be significant, and therefore, the Company has not provided any warranty reserves.\nEngineering and Product Development Costs\nThe Company expenses all engineering, research and development costs as incurred. Expenses subject to capitalization in accordance with the Statement of Financial Accounting Standards No. 86, relating to certain software development costs, were insignificant.\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIncome Taxes\nThe Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" in fiscal 1994. The change in accounting principles was not material to the results of operations for the years ended July 31, 1994, 1993 or 1992.\nDeferred income taxes are recorded for temporary differences between the financial reporting and tax basis of assets and liabilities. Research and development tax credits are recognized for financial reporting purposes to the extent they can be used to reduce the tax provision. The Company has not provided for federal income taxes on the cumulative undistributed earnings of its foreign subsidiaries in the past since it reinvested those earnings. At July 31, 1994, the Company's foreign subsidiaries had accumulated deficits.\nNet Loss per Share\nNet loss per share is based on the weighted average number of shares of common stock outstanding only, as the inclusion of common stock equivalents would be anti-dilutive. Common stock equivalents include shares issuable under stock option plans and warrants to purchase shares. None of the Company's Convertible Subordinated Debentures are common stock equivalents.\n2. INVENTORIES\n3. PROPERTY AND EQUIPMENT\n4. NOTES PAYABLE\nThe Company's Japanese subsidiary had borrowings outstanding of $6,870,000 at July 31, 1994 under demand bank lines of credit of $7,000,000, which are guaranteed by the Company's minority partner in Japan. The Company's Japanese subsidiary also had an unused demand bank line of $2,000,000 at July 31, 1994, which is guaranteed by the Company. At July 31, 1993, the Company's Japanese subsidiary had borrowings outstanding of $9,933,000 under demand bank lines of credit.\nThe Company had no borrowings outstanding under a $5,000,000 domestic bank line at July 31, 1994 and July 31, 1993. This line was available to finance certain designated foreign receivables and designated export\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\ninventories of the Company and was guaranteed by the Export-Import Bank of the United States. This line was amended in June 1994 and the financial covenants under this line were restructured. On October 6, 1994, this line was replaced with a new $5,000,000 line of credit which matures in December 1995 and which requires no guarantees. The new line bears interest at the bank's prime rate plus 1%. Borrowing availability under the line is on a formula basis and borrowings are secured by accounts receivable and inventories. The line of credit has financial covenants which largely relate to results of operations and a minimum level of liquidity.\n5. LONG-TERM LIABILITIES\nIn July 1994, the Company received $20,000,000 from Ando Electric Co., Ltd. of Japan (\"Ando\") under a long-term loan agreement which extends through July 2001. The loan bears interest at 8%, which is payable semi-annually beginning in January 1995 and has semi-annual principal payments of $2,000,000 beginning in January 1997. The loan is secured by the Company's inventories and capital equipment and is subordinated in right of payment to senior indebtedness of the Company. In connection with this loan agreement, the Company issued to Ando a warrant to purchase up to 2,000,000 shares of common stock during the term of the loan agreement. (See Note 8). The Company also expanded its existing license and development agreement with Ando to allow for further joint development of the Company's Delta 50 technology. Proceeds from the loan were used to repay domestic bank borrowings and to finance working capital requirements.\n6. CONVERTIBLE SUBORDINATED DEBENTURES\nOn July 31, 1990, the Company exchanged $27,532,000 of its original issue of $35,000,000 of 7 1\/4% Convertible Subordinated Debentures Due 2011 for $15,693,000 at par value of a new issue of 13 1\/2% Convertible Subordinated Debentures Due 2011. The debentures were issued at a value of $11,839,000, the market value of the securities on the date of the exchange. The resulting original issue discount of $3,854,000 is being charged to operations through 2011. The debentures are subordinated in right of payment to senior indebtedness and are convertible by the holders into common stock at $7.00 per share at any time prior to redemption. The debentures are redeemable at the Company's option, in whole or in part, at 100% of the principal amount. Holders of the debentures have the right to require the Company to redeem the debentures if, prior to April 15, 2000, a change in control of the Company occurs. Annual sinking fund payments of $785,000 are required beginning April 15, 1996. Interest is payable semi-annually on April 15 and October 15.\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIn April 25, 1986, the Company issued and sold at par $35,000,000 of 7 1\/4% Convertible Subordinated Debentures Due 2011. A total of $7,308,000 of the original issue of $35,000,000 of 7 1\/4% Convertible Subordinated Debentures remain outstanding on July 31, 1994. The debentures are subordinated in right of payment to senior indebtedness and are convertible by the holders into common stock at $18 per share at any time prior to redemption or maturity. The debentures are redeemable at the Company's option at any time, in whole or in part, at 100% of the principal amount. Annual sinking fund payments of $366,000 are required beginning April 15, 1996. Interest is payable semi-annually on April 15 and October 15.\nOn July 30, 1993, Sumitomo Metal Industries, Ltd. of Japan converted its $6,375,000 10 1\/2% Convertible Subordinated Debenture Due 2010 into 1,500,000 shares of common stock of the Company. The Company had issued the debenture to Sumitomo Metal Industries, Ltd. in May 1990 (see Note 12).\n7. INCOME TAXES\nAt July 31, 1994, the Company had $4,575,000 of federal tax credits available for carryforward, which expire in fiscal years 1998 through 2004. In addition, the Company had a federal net operating loss carryforward available of $29,600,000 which expires in fiscal years 2007 through 2009.\nThe valuation allowance relates to uncertainty surrounding the realization of the deferred tax assets as a result of the Company's operating losses.\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n8. STOCKHOLDERS' EQUITY\nAuthorized Shares\nAt the Company's Annual Meeting of Stockholders in December 1993, the stockholders approved an increase in the Company's authorized common stock from 50,000,000 shares to 100,000,000 shares.\nStock Option Plans\nThe Company has three stock option plans: the 1990 Incentive Stock Option Plan (\"1990 I.S.O. Plan\"), the 1984 Stock Option Plan for LTX (Europe) Ltd. (\"U.K. Plan\") and the 1983 Non-Qualified Stock Option Plan (\"Non-Qualified Plan\").\nThe 1990 I.S.O. Plan and the U.K. Plan provide for the granting of options to employees to purchase shares of common stock at not less than 100% of the fair market value on the date of grant. Options under both plans are exercisable over a three-year vesting period beginning one year from the date of grant. In December 1993, the stockholders of the Company approved an increase to the number of shares of common stock that may be granted under the 1990 I.S.O. Plan, through October 2000, from 1,000,000 shares to 1,500,000 shares. At July 31, 1994, options to purchase 1,119,818 shares had been granted, and 380,182 shares were subject to future grant under the 1990 I.S.O. Plan. At July 31, 1994, options to purchase 108,800 shares had been granted, and 41,200 shares were subject to future grant under the U.K. Plan.\nThe Non-Qualified Plan provides for the granting of options to key employees, directors and advisors of the Company to purchase shares of common stock at prices to be determined by the Board of Directors. Compensation expense relating to shares granted under this plan at less than fair market value has been charged to operations over the applicable vesting period. At July 31, 1994, options to purchase 731,820 shares had been granted, and 118,180 shares were subject to future grant under this plan.\nOf the total options outstanding at July 31, 1994, 1,451,473 shares were exercisable and 32,500 shares were at the option price of $0.05 per share.\nWarrants\nIn July 1994, in connection with a term loan agreement, the Company issued to Ando Electric Co., Ltd. a warrant to purchase up to 2,000,000 shares of common stock, at the fair market value of $2.31 per share, during the term of the loan agreement (see Note 5). At July 31, 1994, the total warrant was outstanding.\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nEmployees' Stock Purchase Plan\nIn December 1993, the stockholders of the Company approved the adoption of the 1993 Employees' Stock Purchase Plan, which replaced the 1983 Employees' Stock Purchase Plan which expired in December 1993. Under this plan, eligible employees may contribute up to 15% of their annual compensation for the purchase of common stock of the Company up to $25,000 of fair market value of the stock per calendar year. The plan limits the number of shares which can be issued for any semi-annual plan period to 150,000 shares and, over the term of the plan, the Company may issue up to 600,000 shares. Under the plan, 280,772 shares were issued in fiscal 1994 and 319,228 shares were available for future issuance under this plan at July 31, 1994.\nRights Agreement\nThe Board of Directors of the Company adopted a Rights Agreement, dated as of May 11, 1989, between the Company and The First National Bank of Boston, as rights agent (the \"Rights Agreement\") and in connection therewith, distributed one common share purchase right for each outstanding share of common stock. The rights will become exercisable only if a person or group acquires 20% or more of the Company's common stock or announces a tender offer that would result in ownership of 30% or more of the common stock. Initially, each right will entitle a stockholder to buy one share of common stock of the Company at a purchase price of $30.00 per share, subject to significant adjustment depending upon the occurrence thereafter of certain events. Before any person or group has acquired 20% or more of the common stock of the Company, the rights are redeemable by the Board of Directors at $0.01 per right. The rights will expire on May 11, 1999, unless redeemed by the Company prior to that date.\n9. RETIREMENT PLAN\nThe Company's retirement plan provides for an annual discretionary contribution by the Company from current or accumulated profits of an amount not to exceed 5% of the eligible compensation of the participants in the plan. Amounts are allocated to the accounts of the participants based on their compensation and years of service and are subject to certain vesting provisions. No contribution was made in fiscal 1994, 1993 or 1992. Eligible employees may also make voluntary contributions to the plan through a salary reduction contract up to the statutory limit or 15% of their annual compensation.\n10. GEOGRAPHIC AREA INFORMATION\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nTransfer prices on products sold to foreign subsidiaries are intended to produce profit margins that correspond to the subsidiary's sale and support efforts.\nThe Company incurred translation losses, from foreign currency remeasurement, of $1,468,000, primarily in Japan, in fiscal 1993. Transaction gains or losses were not significant in fiscal 1993. Translation and transaction gains or losses were not significant in fiscal 1994 or fiscal 1992.\n11. COMMITMENTS\nTotal rental expense for fiscal 1994, 1993 and 1992 was $9,849,000, $10,822,000 and $11,295,000, respectively.\nAs a result of the Company's restructuring in fiscal 1994, certain leased facilities have been considered excess. At July 31, 1994, the Company had accrued $8,200,000, which is included in restructuring charges on the accompanying balance sheet, relating to the lease commitments on these facilities.\nLTX CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n12. JOINT VENTURE AGREEMENT\nIn May 1990, the Company completed a joint venture agreement with Sumitomo Metal Industries, Ltd. (\"SMI\") of Japan to manufacture, sell and support the Company's semiconductor test equipment products in Japan. Under this joint agreement, SMI acquired 235,000 newly issued shares of the Company's Japanese subsidiary for $12,000,000 and the Company invested an additional $4,000,000 in the subsidiary. As a result, 50.5% of the shares of the Japanese company are owned by LTX and 49.5% are owned by SMI. As part of the joint venture agreement, the Company has licensed certain of its test technology to the joint venture, and will receive royalties should its products be manufactured by the joint venture. SMI also purchased 1,500,000 shares of the Company's common stock for $5,625,000 and purchased a $6,375,000 convertible debenture that was converted into common stock in July 1993 (see Note 6).\nAt July 31, 1994, other assets include a minority interest receivable from SMI of $2,320,000 which arose as a result of cumulative losses of the Company's Japanese subsidiary allocable to SMI, exceeding SMI's investment in the Company's subsidiary. The Company believes this asset is fully realizable from SMI due to SMI's guarantee of a portion of the Company's Japanese subsidiary's bank lines of credit.\nITEM 9.","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 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required under these Items is included in Item 1. of Part I of this report and in the Proxy Statement for the Annual Meeting of Stockholders to be held on December 7, 1994, under the headings \"Certain Stockholders,\" \"Election of Directors,\" and \"Compensation of Executives,\" which information is incorporated herein by reference. Such Proxy Statement shall be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year, July 31, 1994.\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 following consolidated financial statements of LTX Corporation are included in response to Item 8:\nReport of Independent Public Accountants Consolidated Balance Sheet -- July 31, 1994 and 1993 Consolidated Statement of Operations for the years ended July 31, 1994, 1993 and 1992 Consolidated Statement of Stockholders' Equity for the years ended July 31, 1994, 1993 and 1992 Consolidated Statement of Cash Flows for the years ended July 31, 1994, 1993 and 1992 Notes to the Consolidated Financial Statements\n(B) 2. SCHEDULES\nAll other schedules have been omitted since they are not required, not applicable or the information is included in the financial statements or notes thereto.\nSeparate financial statements of LTX Corporation (parent only) have been omitted since they are not required.\n(A) 3. EXHIBITS\nCertain of the exhibits listed hereunder have previously been filed with the Commission as exhibits to the Company's Registration Statement No. 2-75470 on Form S-1 filed December 23, 1981, as amended (the 1981 Registration Statement); to the Company's Registration Statement No. 2-94218 on Form S-1 filed November 8, 1984, as amended (the 1984 Registration Statement); to the Company's Registration Statement No. 33-35401 on Form S-4 filed June 26, 1990, as amended (the 1990 Registration Statement No. 1); to the Company's Registration Statement No. 33-39610 on Form S-3 filed June 10, 1991, as amended (the 1991 Registration Statement No. 1); to the Company's Form 8A\/A filed September 30, 1993 amending the Company's Registration Statement on Form 8-A filed November 24, 1982 (the 1993 8A\/A); to the Company's Current Report on Form 8-K, filed May 11, 1989; or the Company's Annual Reports on Form 10-K for one of the years ended July 31, 1993, 1992, 1991, 1990, 1989, 1988, 1987, 1986, 1985, 1984 and 1983 and are hereby incorporated by reference. The location of each document so incorporated by reference is noted parenthetically.\nPursuant to Item 601 of Regulation S-K, certain instruments with respect to long-term debt not exceeding 10% of the total assets of the Company and its subsidiaries on a consolidated basis are not filed herewith. The Company hereby agrees to furnish to the Commission a copy of each such instrument upon request.\nITEM 14(B). REPORTS ON FORM 8-K\nThe Company did not file any reports on Form 8-K during the fourth quarter of fiscal 1994.\nThe subsidiaries listed are all included in the consolidated financial statements 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.\nLTX CORPORATION\n\/S\/ ROGER W. BLETHEN \/S\/ MARTIN S. FRANCIS By ................................ ROGER W. BLETHEN DIRECTOR AND PRESIDENT MARTIN S. FRANCIS DIRECTOR AND PRESIDENT October 14, 1994\nAmounts for other items required in this schedule have been omitted since they are less than one percent of net sales.","section_15":""}
{"filename":"94610_1994.txt","cik":"94610","year":"1994","section_1":"ITEM 1. BUSINESS\n(a) GENERAL DEVELOPMENT OF BUSINESS\nThe information relating to the general development of the Registrant's business for the year ended December 31, 1994, is incorporated herein by reference to Item 7 - --Management's Discussion and Analysis of Financial Condition and Results of Operations (\"MD&A\") included in this report, under the sections entitled \"Financial Condition and Liquidity,\" pages 15-21, and to the Financial Statements, included in this report, under Notes to the Consolidated Financial Statements, \"Note 3--Acquisitions\/Dispositions,\" page 37, \"Note 16--Related Party Transactions,\" page 53, and \"Note 19--Segment Information,\" pages 57-59.\nExcept where the context clearly indicates otherwise, the terms \"Registrant\" and \"Company\" as hereinafter used refer to Stone Container Corporation together with its consolidated subsidiaries.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nFinancial information relating to the Registrant's industry segments, for the year ended December 31, 1994, is incorporated herein by reference to the MD&A, included in this report, under the section entitled \"Results of Operations,\" pages 12-15, and to the Financial Statements, included in this report, under Notes to the Consolidated Financial Statements, \"Note 19--Segment Information,\" pages 57-59.\n(c) NARRATIVE DESCRIPTION OF BUSINESS\nDescriptive information relating to the Registrant's principal products, markets and industry ranking is outlined in the table entitled \"Profile\" on page 2 of this report and is also incorporated herein by reference to the MD&A, included in this report, under the sections entitled \"Results of Operations,\" pages 12-15, \"Investing Activities,\" page 20, and \"Environmental Issues,\" pages 20-21, and to the Financial Statements, included in this report, under Notes to the Consolidated Financial Statements, \"Note 3--Acquisitions\/Dispositions,\" page 37, and \"Note 19--Segment Information,\" pages 57-59.\nPROFILE\nThe major markets in which the Company sells its principal products are highly competitive. Its products compete with similar products manufactured by others and, in some instances, with products manufactured from other materials. Areas of competition include price, innovation, quality and service. The Company's business is affected by cyclical industry conditions and economic factors such as industry capacity, growth in the economy, interest rates, unemployment levels and fluctuations in foreign currency exchange rates.\nWood fiber and recycled fiber, the principal raw materials in the manufacture of the Company's products, are purchased in highly competitive, price sensitive markets. These raw materials have historically exhibited price and demand cyclicality. In addition, the supply and price of wood fiber, in particular, is dependent upon a variety of factors over which the Company has no control, including environmental and conservation regulations, natural disasters, such as forest fires and hurricanes, and weather.\nThe Company purchases or cuts a variety of species of timber from which the Company utilizes wood fiber depending upon the product being manufactured and each mill's geographic location. Despite this diversification, wood fiber prices increased in 1994. A decrease in the supply of wood fiber has caused, and will likely continue to cause, higher wood fiber costs in some of the regions in which the Company procures wood. In addition, the increase in demand for products manufactured in whole or in part from recycled fiber has caused a tightness in supply of recycled fiber and a resulting significant increase in the cost of such fiber used in the manufacture of recycled containerboard and related products. The Company's paperboard and paper packaging products use a large volume of recycled fiber. While the Company has not experienced any significant difficulty in obtaining wood fiber and recycled fiber in economic proximity to its mills, there can be no assurances that this will continue to be the case for any or all of its mills. In addition, recent increased demand for the Company's products has resulted in greater demand for raw materials which has recently translated into higher raw material prices, including the significant increase in costs of recycled fiber.\nAt December 31, 1994, the Company owned approximately 10 thousand and 325 thousand acres of private fee timberland in the United States and Canada, respectively.\nThe Company's business is not dependent upon a single customer or upon a small number of major customers. The loss of any one customer would not have a material adverse effect on the Company.\nBacklogs are not a significant factor in the industry in which the Company operates; most orders placed with the Company are for delivery within 60 days or less.\nThe Company expenses research and development expenditures as incurred. Research and development costs for 1994 were approximately $12 million.\nThe Company owns patents, licenses, trademarks and tradenames on products. The loss of any patent, license, trademark and tradename would not have a material adverse effect on the Company's operations.\nAs of December 31, 1994, the Registrant had approximately 29,100 employees, of whom approximately 21,400 were employees of U.S. operations and the remainder were employees of foreign operations. Of those in the United States, approximately 14,200 are union employees.\n(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nFinancial information relating to the Registrant's foreign and domestic operations and export sales for the year ended December 31, 1994, is incorporated herein by reference to the Financial Statements, included in this report, under Notes to the Consolidated Financial Statements, \"Note 19--Segment Information,\" pages 57-59. The Company's results are affected by economic conditions in certain foreign countries and fluctuations in foreign exchange rates, particularly in the white paper and other segment, where the majority of such operations of the Company are conducted in Canada and the United Kingdom.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant, including its subsidiaries and affiliates, maintains manufacturing facilities and sales offices throughout North America, Latin America, Continental Europe, United Kingdom and Australia, as well as sales offices in Japan and China. A listing of such worldwide facilities as of December 31, 1994 is provided on pages 5-6 of this report.\nThe approximate annual production capacity of the Company's mills is summarized in the following table:\nAll mills and converting facilities are owned, or partially owned through investments in other companies, by the Registrant, except for 45 converting plants in the United States, which are leased.\nThe Registrant owns certain properties that have been mortgaged or otherwise encumbered. These properties include 16 paper mills and 76 corrugated container plants, including those subject to a leasehold mortgage.\nThe Registrant's properties and facilities are properly equipped with machinery suitable for their use. Such facilities and related equipment are well maintained and adequate for the Registrant's current operations.\nAdditional information relating to the Registrant's properties for the year ended December 31, 1994 is incorporated herein by reference to the Financial Statements, included in this report, under Notes to the Consolidated Financial Statements, \"Note 3--Acquisitions\/Dispositions,\" page 37, \"Note 10--Long-term Debt,\" pages 44-48, and \"Note 13--Long-term Leases,\" page 50.\nWORLDWIDE FACILITIES\n- ----------------------------------------------------------------\nUNITED STATES\nALABAMA Birmingham (corrugated container)\nARIZONA Eagar (forest products) Glendale (corrugated container) Phoenix (bag) Snowflake (paperboard\/paper\/pulp) Snowflake (paperboard\/paper\/pulp) The Apache Railway Company\nARKANSAS Jacksonville (bag) (Little Rock) Little Rock (corrugated container) Rogers (corrugated container)\nCALIFORNIA City of Industry (corrugated container) (Los Angeles) Fullerton (corrugated container) Los Angeles (bag) Salinas (corrugated container) San Jose (corrugated container) Santa Fe Springs (corrugated container, 2)\nCOLORADO Denver (corrugated container) South Fork (forest products)\nCONNECTICUT Portland (corrugated container) Torrington (corrugated container) Uncasville (paperboard\/paper\/pulp)\nFLORIDA Cantonment (bag) (Pensacola) Graceville (forest products) Jacksonville (paperboard\/paper\/pulp) Panama City (paperboard\/paper\/pulp) Yulee (bag) Orlando (corrugated container) Packaging Systems Jacksonville (corrugated container) Preprint\nGEORGIA Atlanta (corrugated container, 3) Port Wentworth (paperboard\/paper\/pulp) Atlanta (paperboard\/paper\/pulp) Technology and Engineering Center\nILLINOIS Bedford Park (corrugated container) (Chicago) Bloomington (corrugated container) Cameo (corrugated container) (Chicago) Danville (corrugated container) *Herrin (corrugated container) Joliet (corrugated container) Naperville (corrugated container) (Chicago) North Chicago (corrugated container) Plainfield (bag) Quincy (bag) *Zion (corrugated container) Burr Ridge (paperboard\/paper\/pulp) Technology and Engineering Center Oakbrook (corrugated container) Marketing and Technical Center\nINDIANA Columbus (corrugated container) Indianapolis (corrugated container) Mishawaka (corrugated container) South Bend (corrugated container)\nIOWA Des Moines (corrugated container); (bag) Keokuk (corrugated container) Sioux City (corrugated container)\nKANSAS Kansas City (corrugated container)\nKENTUCKY Louisville (corrugated container); (bag)\nLOUISIANA Arcadia (bag) Hodge (paperboard\/paper\/pulp); (bag) New Orleans (corrugated container)\nMARYLAND Savage (bag) (Baltimore)\nMASSACHUSETTS Mansfield (corrugated container) Westfield (corrugated container)\nMICHIGAN *Detroit (corrugated container) Grand Rapids (bag) Ontonagon (paperboard\/paper\/pulp) *Melvindale (corrugated container) (Detroit)\nMINNESOTA Minneapolis (corrugated container) Rochester (corrugated container) St. Cloud (corrugated container) St. Paul (corrugated container) Minneapolis (corrugated container) Preprint\nMISSISSIPPI Jackson (corrugated container) Tupelo (corrugated container, 2)\nMISSOURI Blue Springs (corrugated container) Kansas City (bag) Liberty (corrugated container) (Kansas City) Springfield (corrugated container) St. Joseph (corrugated container) St. Louis (corrugated container)\nMONTANA Missoula (paperboard\/paper\/pulp)\nNEBRASKA Omaha (corrugated container)\nNEW JERSEY Elizabeth (bag) Teterboro (corrugated container)\nNEW MEXICO Reserve (forest products)\nNEW YORK Buffalo (corrugated container)\nNORTH CAROLINA Charlotte (corrugated container) Lexington (corrugated container) Raleigh (corrugated container)\nNORTH DAKOTA Fargo (corrugated container)\nOHIO Cincinnati (corrugated container) Coshocton (paperboard\/paper\/pulp) Jefferson (corrugated container) Mansfield (corrugated container) Marietta (corrugated container) New Philadelphia (bag)\nOKLAHOMA Oklahoma City (corrugated container) Sand Springs (corrugated container) (Tulsa)\nOREGON Grants Pass (forest products) Medford (forest products) White City (forest products)\nPENNSYLVANIA Philadelphia (corrugated container, 2) Williamsport (corrugated container) York (paperboard\/paper\/pulp)\nSOUTH CAROLINA Columbia (corrugated container); (forest products) Florence (paperboard\/paper\/pulp) Fountain Inn (corrugated container) Orangeburg (forest products)\nSOUTH DAKOTA Sioux Falls (corrugated container)\nTENNESSEE Chattanooga (corrugated container) Collierville (corrugated container) (Memphis) Nashville (corrugated container)\nTEXAS Dallas (corrugated container) El Paso (corrugated container, 2); (folding carton) Grand Prairie (corrugated container) (Dallas) Houston (corrugated container) Temple (corrugated container) Tyler (corrugated container)\nUTAH Salt Lake City (bag) Salt Lake City (bag) Bag Packaging Systems\nVIRGINIA Hopewell (paperboard\/paper\/pulp) Martinsville (corrugated container) Richmond (corrugated container, 2); (bag)\nWEST VIRGINIA Wellsburg (bag)\nWISCONSIN Beloit (corrugated container) Germantown (corrugated container) (Milwaukee) Neenah (corrugated container)\nCANADA\nALBERTA *Calgary (corrugated container) *Edmonton (corrugated container)\nBRITISH COLUMBIA *Castlegar (paperboard\/paper\/pulp) *New Westminster (corrugated container)\nMANITOBA *Winnipeg (corrugated container)\nNEW BRUNSWICK Bathurst (paperboard\/paper\/pulp); (forest products) *Saint John (corrugated container)\nNOVA SCOTIA *Dartmouth (corrugated container)\nONTARIO *Etobicoke (corrugated container) *Guelph (corrugated container) *Pembroke (corrugated container) *Rexdale (corrugated container) *Whitby (corrugated container)\nPRINCE EDWARD ISLAND *Summerside (corrugated container)\n- -----------------------\nQUEBEC Chibougamau (forest products) Grand-Mere (paperboard\/paper\/pulp) La Baie (paperboard\/paper\/pulp) New Richmond (paperboard\/paper\/pulp) Portage-du-Fort (paperboard\/paper\/pulp) Roberval (forest products) Saint-Fulgence (forest products) *Saint-Laurent (corrugated container) Shawinigan (paperboard\/paper\/pulp) Trois-Rivieres (paperboard\/paper\/pulp) *Ville Mont-Royal (corrugated container) Grand-Mere (paperboard\/paper\/pulp) Research Center\nSASKATCHEWAN *Regina (corrugated container)\nGERMANY *Augsburg (folding carton) *Bremen (folding carton) Dusseldorf (corrugated container) *Frankfurt (folding carton) Germersheim (corrugated container) Hamburg (corrugated container) Heppenheim (corrugated container) Hoya (paperboard\/paper\/pulp) Julich (corrugated container) Lauenburg (corrugated container) Lubbecke (corrugated container) Neuburg (corrugated container) Plattling (corrugated container) Viersen (paperboard\/paper\/pulp) Waren (corrugated container)\nHamburg Institute for Package and Corporate Design\nUNITED KINGDOM *Chesterfield (folding carton) Ellesmere Port (paperboard\/paper\/pulp)\nNETHERLANDS *Sneek (folding carton)\nBELGIUM Ghlin (corrugated container) Grand-Bigard (corrugated container)\nFRANCE *Bordeaux (folding carton) *Cholet (folding carton) Molieres-Sur-Ceze (corrugated container) Nimes (corrugated container) *Soissons (folding carton) *Strasbourg (folding carton)\nAUSTRALIA *Melbourne (corrugated container) *Sydney (corrugated container)\nMEXICO Monterrey (corrugated container)\nCOSTA RICA Palmar Norte (forest products) San Jose (forest products) Administrative Office\nVENEZUELA *Puerto Ordaz (forest products) Administrative Office\nCORPORATE HEADQUARTERS Chicago, Illinois\nFAR EAST OFFICES Beijing, China\nTokyo, Japan *STONE CONTAINER JAPAN COMPANY, LTD.\n*affiliates\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn October 27, 1992, the Florida Department of Environmental Regulation, predecessor to the Department of Environmental Protection (\"DEP\"), filed a civil complaint in the Fourteenth Judicial Circuit Court of Bay County, Florida against the Company seeking injunctive relief, an unspecified amount of fines and civil penalties, and other relief based on alleged groundwater contamination at the Company's Panama City, Florida pulp and paperboard mill. In addition, the complaint alleges operation of a solid waste facility without a permit and discrepancies in hazardous waste shipping manifests. Because of uncertainties in the interpretation and application of DEP's rules, it is premature to assess the Company's potential liability, if any, in the event of an adverse ruling. At the parties' request, the case has been placed in abeyance pending the conclusion of a related administrative proceeding petitioned by the Company in June 1992 following DEP's proposal to deny the Company a permit renewal to continue operating its wastewater pretreatment facility at the mill site. The administrative proceeding has been referred to a hearing officer for an administrative hearing on the consolidated issues of compliance with a prior consent order, denial of the permit renewal, completion of a contamination assessment and denial of a sodium exemption. The consolidated cases were abated at the parties' request in order to allow additional studies to be performed. The Company intends to vigorously assert its entitlement to the permit renewal and to defend against the groundwater contamination and unpermitted facility allegations.\nIn November 1990, the U.S. Environmental Protection Agency (\"EPA\") announced its decision to list two bodies of water in Arizona, Dry Lake and Twin Lakes, as \"waters of the United States\" impacted by toxic pollutant discharges under Section 304(l) of the federal Clean Water Act. These bodies of water have been used by the Company's Snowflake, Arizona pulp and paperboard mill for the evaporation of its process wastewater. The EPA is preparing a draft consent decree to resolve the alleged past unpermitted discharges which will include the EPA's proposal that the Company pay civil penalties in the amount of $900,000. The Company has vigorously disputed the application of the Clean Water Act to these two privately owned evaporation ponds. The Company has begun implementation of a plan to use its wastewater to irrigate a biomass plantation and discontinue using Dry Lake to evaporate wastewater. It is premature to predict the amount of penalties that will eventually be assessed.\nAs a result of the April 13, 1994 digester vessel rupture at the Company's Panama City, Florida pulp and paperboard mill (the \"Panama City Mill\") the Occupational Safety and Health Administration (\"OSHA\") conducted an investigation at the Panama City Mill which resulted in the issuance by OSHA of citations with fines totalling $1,072,000. In October 1994, Company representatives met informally with OSHA representatives to discuss the citations and related fines. As a result of that meeting, the Company filed a notice of contest, and thereafter the Secretary of Labor filed a complaint with the Occupational Safety and Health Review Commission (the \"Commission\") to enforce the citations. The matter is pending before the Commission and the Company intends to vigorously contest the alleged violations.\nOn April 20, 1994, Carolina Power & Light (\"CP&L\") commenced proceedings against the Company before the Federal Energy Regulatory Commission (\"FERC\") (the \"FERC Proceeding\") and in the United States District Court for the Eastern District of North Carolina (the \"Federal Court Action\"). Both proceedings relate to the Company's electric cogeneration facility located at its Florence, South Carolina mill (the \"Facility\") and the Company's Electric Power Purchase Agreement (the \"Agreement\") with CP&L. Prior to the filing of the proceedings, the Company and CP&L had been in discussions relating to a transaction involving the Facility and the Agreement.\nIn the FERC Proceeding, CP&L alleges that the Facility lost its qualifying facility (\"QF\") certification under the Public Utility Regulatory Policy Act of 1978 on August 13, 1991, when the Agreement, pursuant to which CP&L purchases electricity generated by the Facility, was amended to reflect the Company's election under the Agreement to switch to a \"buy-all\/sell-all mode of operation\". As a result, CP&L alleges the Company became a \"public utility\" on August 13, 1991 subject to FERC regulation under the Federal Power Act. CP&L has also requested that the FERC determine the \"just and reasonable rate\" for sales of electric energy and capacity from the Facility since August 13, 1991 and to order the Company to refund any amounts paid in excess of that rate, plus interest and penalties.\nIn its answer filed with the FERC on June 2, 1994, the Company stated that its power sales to CP&L fully complied with the FERC's regulations. The Company also requested that the FERC waive compliance with any applicable FERC regulations in the event that the FERC should determine, contrary to the Company's position, that the Company has not complied with the FERC's regulations in any respect. CP&L has also filed several other pleadings to which the Company has responded. If the FERC were to determine that the Company had become a \"public utility\", the Company's issuance of securities and incurrence of debt after the date that it became a \"public utility\" could be subject to the jurisdiction and approval of the FERC unless the FERC granted a waiver. In the absence of such a waiver, certain other activities and contracts of the Company after such date could also be subject to additional federal and\nstate regulatory requirements, and defaults might be created under certain existing agreements. Based on past administrative practice of the FERC in granting waivers of certain other regulations, the Company believes that it is likely that such a waiver would be granted by the FERC in the event that such a waiver became necessary. However, the FERC Proceeding is in its preliminary stages and no assurance can be provided as to the timing of the FERC's decision or the outcome.\nIn the Federal Court Action, CP&L has requested declaratory judgements that sales of electric energy and capacity under the Agreement since August 13, 1991 are subject to a just and reasonable rate to be determined by the FERC and that the Agreement has been terminated as a result of the Company's failure to maintain the Facility's QF status and the invalidity of the Agreement's rate provisions. CP&L has also sought damages for breach of contract and for purchases in excess of the just and reasonable rate to be determined by the FERC. On June 9, 1994, the Company moved to dismiss CP&L's Federal Court Action on the principal grounds that any proceedings in the United States District Court are premature unless and until the FERC Proceeding is finally resolved. On September 20, 1994, the United States District Court stayed the Federal Court action pending the outcome of the FERC proceeding.\nThe Company intends to contest these actions vigorously. Due to the pendency of the litigation, a planned transaction involving a favorable energy contract related to the Facility and the Agreement did not occur.\nOn September 30, 1994, the United States Environmental Protection Agency, Region IV, (\"EPA\") issued an Administrative Order (\"Order\") to the Company's Panama City Mill pursuant to Section 3008(h) of the Federal Resource Conservation and Recovery Act (\"RCRA\"), 42 U.S.C. Section6928(h)(l). The Order requires the Company to perform a RCRA Facility Investigation at the Panama City Mill together with confirmatory sampling, interim corrective measures and any other activities necessary to correct alleged actual or threatened releases of hazardous substances or hazardous constituents at or from the Panama City Mill. The Company has filed a protest and requested a hearing to contest the EPA's RCRA Section 3008(h) jurisdiction over the Pamana City Mill. The Company believes that the Panama City Mill is not currently a RCRA facility. The corrective measures mandated by the Order would require the Company to conduct extensive groundwater and soil sampling and analyses. The Company does not know at this time the likelihood of success in challenging the Order. Notwithstanding the success in challenging the Order, an owner of property adjacent to the Panama City Mill is currently subject to extensive clean-up under RCRA, and the EPA is empowered to require clean-up for materials discharged from the property which may have migrated onto the Panama City Mill's property. The Company does not yet know the extent, if any, of such adjacent property owner's responsibility to remediate contamination, if any, at the Panama City Mill site.\nIn July 1994, the State of Ohio Environmental Protection Agency (\"OEPA\") informed the Company of OEPA's intent to initiate an enforcement action against the Company's paperboard mill in Coshocton, Ohio (the \"Coshocton Mill\") for alleged violations of the Coshocton Mill's wastewater discharge permit. Company representatives have commenced settlement negotiations with OEPA, and no enforcement action has been taken to date. The Company intends to continue negotiations with OEPA to resolve the matter. If settlement negotiations are unsuccessful, the Company intends to vigorously contest the matter if an enforcement action is taken by OEPA.\nOn September 13, 1994 and December 21, 1994, the Ministry of Environment of the Province of Quebec (\"MEF\") filed notices of violation against Stone-Consolidated Corporation (\"Stone-Consolidated\"), alleging violations of the Province's pulp and paper regulations relating to wastewater at Stone-Consolidated's Wayagamack mill in Trois-Rivieres, Quebec. If found in violation of the regulations, the Company would be fined an undetermined amount. The Company intends to vigorously contest the alleged violations.\nIn addition, the Registrant is from time to time subject to litigation and governmental proceedings regarding environmental matters in which injunctive and\/or monetary relief is sought. The Company has been named as a potentially responsible party (\"PRP\") at a number of sites which are the subject of remedial activity under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\" or \"Superfund\") or comparable state laws. Although the Company is subject to joint and several liability imposed under Superfund, at most of the multi-PRP sites there are organized groups of PRPs and costs are being shared among PRPs.\nThe Registrant is involved in contractual disputes, administrative and legal proceedings and investigations of various types. Although any litigation, proceeding or investigation has an element of uncertainty, the Registrant believes that the outcome of any proceeding, lawsuit or claim which is pending or threatened, or all of them combined, would not have a material adverse effect on its consolidated financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) PRINCIPAL MARKET, STOCK PRICE AND DIVIDEND INFORMATION\nInformation relating to the principal market, stock price and dividend information for the Registrant's Common and Preferred Stock and related stockholder matters, for the year ended December 31, 1994, is incorporated herein by reference to the MD&A, included in this report, under the sections entitled \"Common and Series E Cumulative Preferred Stock--Cash Dividends, Market and Price Range,\" pages 21-22 and \"Financial Condition and Liquidity,\" pages 15-21, and to the Financial Statements, included in this report, under Notes to the Consolidated Financial Statements, \"Note 10--Long-term Debt,\" pages 44-48, \"Note 14--Preferred Stock,\" pages 50-51, \"Note 15--Common Stock,\" pages 51-53 and \"Note 20--Summary of Quarterly Data (unaudited),\" page 60.\n(b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK\nThere were approximately 6,513 holders of record of the Registrant's common stock, as of February 28, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIn addition to the table set forth on pages 10-11 of this report, selected financial data of the Registrant is incorporated herein by reference to the Financial Statements, included in this report, under Notes to the Consolidated Financial Statements, \"Note 1--Summary of Significant Accounting Policies,\" pages 35-37, and \"Note 3--Acquisitions\/Dispositions,\" page 37.\nSELECTED FINANCIAL DATA\n- ------------ NOTES TO SELECTED FINANCIAL DATA\n(a) Amounts per average common share and average common shares outstanding have been adjusted to reflect the 2 percent stock dividend in 1992, the 3-for-2 stock split in 1988 and the 2-for-1 stock split in 1987. The price range of common shares outstanding has been adjusted only to reflect the previously mentioned stock splits.\n(b) The Company made major acquisitions in 1989, 1987 and 1986.\n(c) For 1986, calculation assumes conversion of convertible preferred stock and convertible subordinated debentures which were converted\/redeemed in 1987.\n(d) Includes non-consolidated affiliates.\n(e) In accordance with Statement of Financial Accounting Standards No. 95, \"Statements of Cash Flows,\" the Company now discloses \"Net cash provided by (used in) operating activities\". For years prior to 1986, \"Net funds provided by operations\" are presented in this summary.\n(f) Represents the percentage of long-term debt to the sum of long-term debt, stockholders' equity, redeemable preferred stock, minority interest and deferred taxes.\n(g) 1994, 1993 and 1992 return on beginning common stockholders' equity calculated using the loss before extraordinary losses and cumulative effects of accounting changes.\n(h) For 1994 and 1993, includes the Company's 25.4 percent minority interest liability in the common shares of Stone-Consolidated.\n(i) Fully diluted amounts and average common shares outstanding have not been presented as amounts are either anti-dilutive or when compared to primary earnings per share, the potential dilution effect is less than 3 percent.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nCOMPARATIVE RESULTS OF OPERATIONS\n1994 COMPARED WITH 1993\nNet sales for 1994 were $5.7 billion, an increase of 13.6 percent over 1993 net sales of $5.1 billion. Net sales increased as a result of both increased sales volume and higher average selling prices for most of the Company's products. In 1994, the Company incurred a loss before extraordinary losses from the early extinguishments of debt and the cumulative effect of a change in the accounting for postemployment benefits of $129 million, or $1.60 per share of common stock. The Company recorded extraordinary losses from the early extinguishments of debt totalling $61.6 million, net of income tax benefits, or $.70 per share of common stock and a one-time, non-cash charge of $14.2 million, net of income tax benefit, or $.16 per share of common stock, to reflect the cumulative effect of adopting Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS 112\"), resulting in a net loss for 1994 of $205 million, or $2.46 per share of common stock. In 1993, the Company incurred a loss before the cumulative effect of a change in the accounting for postretirement benefits other than pensions of $319 million, or $4.59 per share of common stock. The Company adopted Statement of Financial Accounting Standards No. 106, \"Accounting for Postretirement Benefits Other than Pensions\" (\"SFAS 106\"), effective January 1, 1993 and recorded a one-time, non-cash cumulative effect charge of $39.5 million, net of income tax benefit, or $.56 per share of common stock, resulting in a net loss of $359 million, or $5.15 per share of common stock.\nThe improved results for 1994 over 1993 primarily reflect improved product pricing for most of the Company's products which more than offset a substantial increase in recycled fiber costs, higher interest expense and a decrease in the income tax benefit. The Company incurred a significant increase in recycled fiber costs for 1994 over 1993 mainly as a result of a shortage for this raw material. The 1994 results were also unfavorably impacted by an increase in interest expense, primarily as a result of higher interest rates, and by foreign currency transaction losses of $15.8 million. The 1993 results included foreign currency transaction losses of $11.8 million. The 1994 results included a\n$22 million pretax involuntary conversion gain associated with a digester vessel rupture at the Company's Panama City, Florida pulp and paperboard mill, whereas the 1993 results included a $35.4 million pretax gain from the sale of the Company's 49 percent equity interest in Empaques de Carton Titan, S.A., (\"Titan\") and the favorable effect of a reduction in an accrual relating to a change in the Company's vacation pay policy. The Company recorded an income tax benefit of $35.5 million in 1994 as compared with an income tax benefit of $147.7 million in 1993. The decrease in the income tax benefit primarily reflects the tax effect associated with the lower pretax loss for 1994 as compared with 1993. The Company's effective tax rates for both years reflect the impact of non-deductible depreciation and amortization.\nSEGMENT DATA\nSEGMENT AND PRODUCT LINE SALES DATA\nSee Note 19 of the consolidated financial statements included in this report for additional segment information.\nPAPERBOARD AND PAPER PACKAGING:\nThe 1994 net sales for the paperboard and paper packaging segment increased 11.3 percent over 1993 reflecting sales increases for virtually every product line within this segment. Net sales for 1993 included sales for the Company's European folding carton operations, which in the early part of 1993 were merged into a joint venture and accordingly,\nare now accounted for under the equity method of accounting. Sales from these operations prior to the merger in May of 1993 were approximately $60 million. Excluding the effect of the folding carton operations, 1994 net sales increased 13.1 percent from the prior year.\nNet sales of corrugated containers and paperboard increased 12.9 percent and 17.7 percent, respectively, over 1993. These increases reflect both increased sales volume and higher average selling prices.\nAlso, reflecting volume increases and higher average selling prices, net sales for paper bags and sacks increased 10.7 percent over 1993. Additionally, net sales of kraft paper increased 2.2 percent over 1993 solely as a result of increased sales volume.\nOperating income for the paperboard and paper packaging segment for 1994 increased $146.8 million, or 70.8 percent over 1993 due to improved operating margins primarily as a result of higher average selling prices and improved sales volumes for corrugated containers, containerboard and paper bags and sacks. Operating income for 1994 includes a pretax gain of approximately $11 million which represents the segment's portion of the previously mentioned involuntary conversion gain relating to a digester vessel rupture at the Company's Panama City, Florida pulp and paperboard mill. Operating income for 1993 included a $35.4 million pretax gain from the sale of Titan and a favorable effect of a reduction in an accrual resulting from a change in the Company's vacation policy. The earnings impact from these 1993 non-recurring items were partially offset by the writedowns of the carrying values of certain Company assets.\nWHITE PAPER AND OTHER:\nThe 1994 net sales for the white paper and other segment increased 19.6 percent as a result of sales increases for market pulp and for newsprint and groundwood paper. The sales increase for market pulp of 63.1 percent over 1993 primarily reflects significantly higher average selling prices, although improved volume also contributed to the increase. Net sales of newsprint and groundwood paper increased 14.7 percent in 1994 over 1993 primarily as a result of increased sales volume, with higher average selling prices also contributing to the increase. The increased sales volume and higher average selling prices for newsprint and groundwood paper more than offset unfavorable foreign exchange translation effects attributable to the stronger U.S. dollar.\nOperating income for the white paper and other segment for 1994 was $25.4 million compared to an operating loss in 1993 of $158.8 million. This significant improvement in operating income was mainly attributable to improved operating margins primarily resulting from the significantly higher average selling prices for market pulp and, to a lesser extent, to the increased volume and higher average selling prices for newsprint and groundwood paper. Additionally, operating income for 1994 included a pretax gain of approximately $11 million which represents the segment's portion of the previously mentioned involuntary conversion gain relating to a digester vessel rupture at the Company's Panama City, Florida pulp and paperboard mill.\n1993 COMPARED WITH 1992\nNet sales for 1993 were $5.1 billion, a decrease of 8.4 percent over 1992 net sales of $5.5 billion. Net sales decreased as a result of both reduced sales volume and lower average selling prices for most of the Company's products. In 1993, the Company incurred a loss before the cumulative effect of a change in the accounting for postretirement benefits other than pensions of $319 million, or $4.59 per common share. The Company adopted Statement of Financial Accounting Standards No. 106, \"Accounting for Postretirement Benefits Other than Pensions\" (\"SFAS 106\"), effective January 1, 1993, and recorded a one-time, non-cash cumulative effect charge of $39.5 million, net of income tax benefit, or $.56 per common share, resulting in a net loss of $359 million or $5.15 per common share. In 1992, the Company incurred a loss before the cumulative effect of a change in the accounting for income taxes of $170 million, or $2.49 per common share. The adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), effective January 1, 1992, required a one-time, non-cash cumulative effect charge of $99.5 million, or $1.40 per common share, resulting in a net loss of $269 million or $3.89 per common share. The increase in the loss before the cumulative effects of accounting changes primarily resulted from lower average selling prices for most of the Company's products.\nThe 1993 results included a $35.4 million pretax gain from the sale of Titan and the favorable effect of a reduction in an accrual relating to a change in the Company's vacation pay policy. The earnings impact of these non-recurring items was partially offset by the writedowns of the carrying values of certain Company assets. The 1993 results also reflect both an increase in interest expense, primarily associated with a reduction in capitalized interest caused by completion of capital projects, and foreign currency transaction losses of $11.8 million. The 1992 results included foreign currency transaction losses of $15.0 million and an $8.8 million pretax charge relating to the writedown of\ninvestments. The Company recorded an income tax benefit of $147.7 million in 1993 as compared with an income tax benefit of $59.4 million in 1992. The increase in the income tax benefit primarily reflects the tax effect associated with the increased pretax loss for 1993 over 1992. Additionally, deferred income taxes were provided for the retroactive increase in the U.S. federal income tax rate, which was more than offset by the effects of an enacted decrease in German and Canadian income tax rates. The Company's effective income tax rates for both years reflect the impact of non-deductible depreciation and amortization.\nPAPERBOARD AND PAPER PACKAGING:\nThe 1993 net sales for the paperboard and paper packaging segment decreased 9.0 percent compared to 1992. This decrease was due in part to the exclusion of sales for the Company's European folding carton operations which in the early part of 1993 were merged into a joint venture and accordingly are now accounted for under the equity method of accounting. Sales from these operations were approximately $178 million in 1992. Sales for 1993 were approximately $60 million prior to the merger in May. Excluding the effect of the folding carton operations, 1993 net sales for the paperboard and paper packaging segment decreased 6.4 percent.\nNet sales of corrugated containers decreased 3.5 percent from 1992 primarily due to lower average selling prices in 1993 which more than offset a slight increase in sales volume. Net sales of paperboard decreased 11.9 percent from 1992 as a result of significantly lower average selling prices and declines in sales volume. Net sales of kraft paper decreased 28.0 percent from 1992 primarily due to reduced sales volume.\nNet sales for paper bags and sacks decreased from 1992 primarily due to lower sales volume and a decrease in average selling prices for retail paper bags which more than offset a modest increase in average selling prices for industrial paper bags.\nOperating income for the paperboard and paper packaging segment for 1993 decreased 35.9 percent from 1992 due to significantly lower operating margins, primarily resulting from the lower average selling prices for corrugated containers and containerboard. Operating income for this segment includes the previously mentioned $35.4 million pretax gain from the sale of Titan and a favorable effect of a reduction in an accrual resulting from a change in the Company's vacation policy. The earnings impact from these non-recurring items was partially offset by the writedowns of the carrying values of certain Company assets.\nWHITE PAPER AND OTHER:\nThe 1993 net sales for the white paper and other segment decreased 6.2 percent, as significant sales declines for market pulp more than offset a sales increase for groundwood paper. The sales declines for market pulp were primarily attributable to significantly lower average selling prices which deteriorated further in 1993 from the low average selling prices of 1992. Reduced sales volume in 1993 also contributed to the lower market pulp sales. Newsprint sales declined slightly in 1993 compared to 1992, primarily as a result of unfavorable foreign exchange translation effects attributable to the stronger U.S. dollar, which more than offset the benefits of higher average selling prices and a slight volume increase. Net sales for groundwood paper increased 11 percent, primarily as a result of significant volume increases which more than offset the effects of slightly lower average selling prices.\nThe operating loss for the white paper and pulp segment for 1993 increased significantly over 1992 due to reduced operating margins primarily resulting from the significantly lower average selling prices for market pulp. Slightly lower average selling prices for groundwood paper also contributed to the reduced earnings, although to a much lesser extent. While average selling prices for newsprint in 1993 improved over the depressed levels of 1992 (although such prices declined in the fourth quarter of 1993 and in the first quarter of 1994), and certain cost reductions had been implemented, the margins associated with such improvements only partially offset the effects of the lower average selling prices for market pulp and groundwood paper.\nFINANCIAL CONDITION AND LIQUIDITY\nThe Company's working capital ratio was 1.8 to 1 at December 31, 1994 and 1.9 to 1 at December 31, 1993. The Company's long-term debt to total capitalization ratio was 78.0 percent at December 31, 1994 and 75.9 percent at December 31, 1993. Capitalization, for purposes of this ratio, includes long-term debt (which includes debt of certain consolidated affiliates which is non-recourse to the Company), deferred income taxes, redeemable preferred stock, minority interest and stockholders' equity.\nThe Company's primary capital requirements consist of debt service and capital expenditures, including capital investment for compliance with certain environmental legislation requirements and ongoing maintenance expenditures and improvements. The Company continues to be highly leveraged and will continue to incur substantial ongoing interest expense. No significant debt amortization obligations are due until June 1997 other than for the\nSeptember 1995 maturities of Stone Financial Corporation (\"Stone Fin\") and Stone Fin II Receivables Corporation (\"Stone Fin II\"), which the Company is currently planning to refinance. The proposed refinancing transaction is currently contemplated to approximate $300 million of receivables financing, which would have a 5-year maturity together with a supplementary revolving credit facility. The proposed receivables refinancing is subject to the placement and execution of definitive documentation. At December 31, 1994, the Company's Consolidated Balance Sheet included $253.8 million of outstanding indebtedness under the Stone Fin and Stone Fin II receivables securitization program. Refer to Note 10 of the Consolidated Financial Statements, included in this report, for further information relating to the Company's repayment obligations with respect to its indebtedness. See also \"Outlook\" included in this section.\nIn October 1994, the Company entered into a new credit agreement consisting of a $400 million senior secured term loan facility maturing through April 1, 2000, which has been fully drawn down to repay other indebtedness, and a $450 million senior secured revolving credit facility commitment maturing May 15, 1999, which includes a $25 million swing-line sub-facility maturing May 15, 1999 (the \"Credit Agreement\"). See also \"Financing Activities\" included later in this section. At February 28, 1995, the Company had unused borrowing availability of $355.2 million under the revolving credit facility, net of letters of credit of $84.8 million issued under this facility which reduce the amount available to be borrowed.\nBorrowings under the Credit Agreement are secured with a significant portion of the assets of the Company. The Credit Agreement contains covenants that include, among other things, the maintenance of certain financial tests and ratios consisting of an indebtedness ratio and a minimum interest coverage ratio and certain restrictions and limitations, including those on capital expenditures, changes in control, payment of dividends, sales of assets, lease payments, investments, additional borrowings, liens, repurchases or prepayment of certain indebtedness, guarantees of indebtedness, mergers and purchases of stock and assets. The Credit Agreement also contains cross-default provisions to the indebtedness of $10 million or more of the Company and certain subsidiaries, as well as cross-acceleration provisions to the non-recourse debt of $10 million or more of Stone-Consolidated, Seminole Kraft Corporation (\"Seminole\") and Stone Venepal (Celgar) Pulp Inc. (\"SVCPI\"). Additionally, the term loan portion of the Credit Agreement provides for mandatory prepayments from sales of certain assets, certain debt financings and a percentage of excess cash flow (as defined). The Company's bank lenders at their option may waive the receipt of any mandatory prepayment. The amortizations for each semi-annual period is 1\/2 of 1 percent of the principal amount of the outstanding term loans and all mandatory and voluntary prepayments are allocated against the term loan amortizations in inverse order of maturity. Mandatory prepayments from sales of collateral, unless replacement collateral is provided, will be applied ratably to the term loan and revolving credit facility, permanently reducing the loan commitments under the Credit Agreement. See Note 10 of the Consolidated Financial Statements for additional information regarding the Credit Agreement.\nThe Credit Agreement limits, except in certain specific circumstances, any additional investments by the Company in Stone-Consolidated and Seminole. Seminole had incurred substantial indebtedness in connection with project financings and is significantly leveraged. As of December 31, 1994, Seminole had $143.1 million in outstanding indebtedness (including $111.7 million in secured indebtedness owed to bank lenders). Seminole produces 100 percent recycled linerboard and is dependent upon an adequate supply of recycled fiber, in particular old corrugated containers (\"OCC\"). Pursuant to an output purchase agreement entered into in 1986 with Seminole, the Company is obligated to purchase from Seminole and Seminole is obligated to sell to the Company all of Seminole's linerboard production. Under the agreement, the Company paid fixed prices for linerboard, which generally exceeded market prices, until June 3, 1994. Subsequent to that date, the Company began purchasing linerboard at market prices and will continue to do so for the remainder of the agreement which is scheduled to expire on December 31, 2000. Seminole did not comply with certain financial covenants at September 30, 1994 and accordingly, had received waivers and amendments with respect to such covenants from its bank lenders for periods up to and including June 30, 1995. Additionally, Seminole is in the process of seeking and expects to receive future covenant relief from certain of its other financial covenants covering the periods from March 31, 1995 through March 29, 1996. There can be no assurance that Seminole will not require additional waivers in the future or, if required, that the lenders will grant them. Furthermore, in the event that management determines that it is probable that Seminole will not be able to comply with any covenant contained in the Seminole credit agreement within twelve months after the waiver of a violation of such covenant, then certain Seminole debt would be reclassified as short-term debt under the provisions of Emerging Issues Task Force Issue No. 86-30 \"Classification of Obligations When a Violation is Waived By the Creditor\". Depending upon the level of market prices and the cost and supply of recycled fiber, Seminole may need to undertake additional measures to meet its financial covenants and its debt service requirements, including obtaining additional sources of funds or liquidity, postponing or restructuring of debt service payments or refinancing the\nindebtedness. In the event that such measures are required and are not successful, and such indebtedness is accelerated by the respective lenders to Seminole, the lenders to the Company under the Credit Agreement and various other of its debt instruments would be entitled to accelerate the indebtedness owed by the Company.\nAdditionally, the Credit Agreement contains cross-acceleration provisions relating to the non-recourse debt of SVCPI. At December 31, 1994, SVCPI had approximately $288 million in secured indebtedness owed to bank lenders. The Credit Agreement allows, under certain specific circumstances, for the Company to make further investments in SVCPI, if necessary.\nOUTLOOK:\nThe Company's liquidity and financial flexibility was adversely affected by the net losses incurred during the past four years. The Company improved its liquidity and financial flexibility by operating profitably in the 1994 fourth quarter, by completing significant refinancings in February and October of 1994 and by entering into the previously mentioned Credit Agreement which provides for, among other things, a $450 million revolving credit facility (see also \"Financing activities\" later in this section). At February 28, 1995, the Company had borrowing availability of $355.2 million (net of letters of credit which reduce the amount available to be borrowed) under its $450 million revolving credit facility. Additionally, at February 28, 1995, Stone-Consolidated, a non-recourse subsidiary of the Company, had no outstanding borrowings under its $100 million revolving credit facility. (All amounts presented for Stone-Consolidated are in U.S. dollars unless otherwise indicated.) Notwithstanding these improvements in the Company's liquidity and financial flexibility, the Company will be required in the future to generate sufficient cash flows to fully meet the Company's debt service requirements. Included in the Company's current maturities of debt at December 31, 1994 are the previously mentioned $253.8 million of obligations related to the Company's accounts receivable securitization program which matures September 15, 1995. While the Company is in the process of refinancing such obligations, no assurance can be given that it will be successful in doing so. In the event this refinancing is not consummated, management nevertheless believes that operating cash flows and borrowing availability under the Credit Agreement will provide more than sufficient liquidity for the Company to meet its 1995 and 1996 debt service requirements. Beginning in 1997 and continuing thereafter, the Company will be required to make significant amortization payments on its existing indebtedness. In the event the Company is unable to generate sufficient operating cash flows to fully meet such debt service requirements, it may deplete a substantial portion of its cash resources and borrowing availability under its revolving credit facility. In such event, the Company would be required to pursue other alternatives to improve liquidity, including cost reductions, sales of assets, the deferral of certain capital expenditures and\/or obtaining additional sources of funds.\nThe financial resources of Seminole and Stone-Consolidated are not available to the Company until certain financial covenants contained in debt instruments of Seminole and Stone-Consolidated are satisfied. Such financial covenants have not been satisfied to date.\nAs previously mentioned, the Company realized price increases for most of its products during 1994, and current industry conditions appear to indicate that further product price improvement should occur in 1995. While certain of the Company's competitors in the containerboard industry have announced plans for some future capacity increases, the Company does not believe that such capacity increases will significantly affect the favorable supply\/demand characteristics currently present in the industry.\nAs a result of such favorable industry conditions, the Company has implemented a containerboard price increase and also began implementing price increases for corrugated containers in January of 1995. The Company's containerboard and corrugated container product lines represent a substantial portion of the Company's net sales. The Company converts more than 80 percent of its containerboard production into corrugated containers making the achievement of price increases for corrugated containers essential for the Company to realize substantial financial benefit from containerboard price increases. A further containerboard price increase has been announced effective April 1, 1995. Also in January 1995, the Company implemented price increases for market pulp and has announced a further price increase effective March 1995. Additionally, the Company has announced newsprint and groundwood paper price increases beginning March 1995 and also a May 1995 price increase for newsprint. While there can be no assurance that prices will continue to increase, the Company believes that the supply\/demand characteristics for its product lines have substantially improved which should allow for sustained product price improvement over 1994 year-end levels.\nWood fiber and recycled fiber, the principal raw materials used in the manufacture of the Company's products, are purchased in highly competitive, price sensitive markets. These raw materials have historically exhibited price and demand cyclicality. In addition, the supply and price of wood fiber in particular, is dependent upon a variety of factors\nover which the Company has no control, including environmental and conservation regulations, natural disasters, such as forest fires and hurricanes, and weather. In addition, recent increased demand for the Company's products has resulted in greater demand for raw materials which has recently translated into higher raw material prices, including the significant increase in costs of recycled fiber. The Company purchases or cuts a variety of species of timber from which the Company utilizes wood fiber depending upon the product being manufactured and each mill's geographic location. A decrease in the supply of wood fiber has caused, and will likely continue to cause, higher wood fiber costs in some of the regions in which the Company procures wood. In addition, the increase in demand for products manufactured, in whole or in part, from recycled fiber has caused a tightness in supply of recycled fiber and a resulting significant increase in the cost of such fiber used in the manufacture of recycled containerboard and related products. As a result, the cost of recycled fiber increased significantly in 1994 and remains high. There can be no assurance that recycled fiber costs will not continue to escalate in the future. Additionally, while the Company has not experienced any significant difficulty in obtaining wood fiber and recycled fiber in economic proximity to its mills, there can be no assurances that this will continue to be the case for any or all of its mills.\nThe Company is continuing to pursue its financial strategy of enhancing its liquidity and financial flexibility by evaluating certain alternatives related to certain of its non-core assets, including the U.S. wood products business. As an initial step in achieving this objective, the Company ceased operations of three wood products facilities in the Pacific Northwest and intends to divest the assets of these facilities as appropriate opportunities arise during 1995. Accordingly, such net assets held for sale are included in other current assets within the December 31, 1994 Consolidated Balance Sheet. The impact of such closures did not have a material effect on the Company's 1994 Statement of Operations.\nAs previously mentioned, in the second quarter of 1994, a digester vessel ruptured at the Company's pulp and paperboard mill in Panama City, Florida causing extensive damage to certain of the facility's assets. The Company is seeking recovery for both the losses to property and the losses as a result of business interruption arising from the Panama City occurrence. A partial recovery of $20 million has already been received by the Company from certain carriers and claims of approximately $66 million covering the major portion of such losses are still pending. The insurance carrier providing boiler and machinery coverage for the Company has denied the Company's claim; the Company has not accepted such denial. In addition, the all-risks insurance carriers, which would cover the losses not covered under the boiler and machinery coverage, have reserved their rights with respect to the Company's claim in order to investigate the application of coverage without prejudicing their rights. Management believes the receivable recorded on its financial statements is fully recoverable.\nCASH FLOWS FROM OPERATIONS:\nThe following table shows, for the last three years, the net cash provided by (used in) operating activities:\nThe results of operations for the past four years have had a significant adverse impact on the Company's cash flow and liquidity. Borrowings in each of these years were necessary in order to meet cash flow needs.\nDuring 1994, the Company entered into various financing and investing activities designed to provide liquidity and enhance financial flexibility. See \"Financing activities\" and \"Investing activities\".\nSignificant working capital changes affecting the Company's cash flows from operations are as follows:\nThe 1994 increase in accounts and notes receivable primarily reflects increased sales volume and higher average selling prices for the majority of the Company's products. The 1993 decrease in accounts and notes receivable reflects the timing of receivable collections, lower average selling prices for a majority of the Company's products and the writedown of certain receivables to net realizable value.\nThe decrease in inventories for 1994 primarily reflects a reduction in quantities of certain paperstock levels due to increased sales volume. Inventories decreased in 1993 due primarily to a reduction in certain paperstock levels, partially attributable to market-related downtime.\nThe 1994 increase in other current assets resulted mainly from the insurance claim receivable associated with the digester vessel rupture at the Company's pulp and paperboard mill in Panama City, Florida, partially offset by the receipt of an income tax refund relating to prior years.\nThe increase in accounts payable for 1994 was due primarily to the timing of payments while the increase in accrued and other current liabilities mainly reflects an increase in accrued interest primarily associated with interest on the Company's 9 7\/8 percent Senior Notes, 10 3\/4 percent First Mortgage Notes and the 11 1\/2 percent Senior Notes which is payable semi-annually at various dates throughout the year. The 1993 decrease in accounts payable and other current liabilities was due primarily to the timing of payments.\nFINANCING ACTIVITIES:\nThe following summarizes the Company's significant financing activities in 1994:\n- On October 12, 1994, the Company sold $500 million principal amount of 10 3\/4 percent First Mortgage Notes due October 1, 2002 (the \"10 3\/4 percent First Mortgage Notes\") and $200 million principal amount of 11 1\/2 percent Senior Notes due October 1, 2004 (the \"11 1\/2 percent Senior Notes\") (hereafter referred together as the \"October Offering\"). The 10 3\/4 percent First Mortgage Notes and the 11 1\/2 percent Senior Notes are redeemable by the Company after September 30, 1999 and interest is payable semi-annually on April 1 and October 1, commencing April 1, 1995. Net proceeds from the sale of these securities was approximately $679.1 million.\nConcurrent with the October Offering, the Company (i) entered into the Credit Agreement, (ii) repaid all of the outstanding indebtedness and commitments under its previously existing bank credit agreements which consisted of two term loan facilities, two revolving credit facilities and an additional term loan (the \"1989 Credit Agreement\") which were then terminated, (iii) merged the Company's 93 percent owned subsidiary Stone Savannah River Pulp & Paper Corporation (\"Stone Savannah River\") into a wholly-owned subsidiary of the Company and, (iv) as described below, repaid or acquired Stone Savannah River's outstanding indebtedness, preferred stock and common stock (collectively, the \"October Related Transactions\"). In connection with the Stone Savannah River merger, the Company (i) repaid all the indebtedness outstanding under and terminated Stone Savannah River's bank credit agreement, (ii) redeemed the $130 million principal amount of Stone Savannah River's 14 1\/8 percent Senior Subordinated Notes due 2000 for approximately $139.2 million, equal to the principal amount and the applicable premium percentage of the principal amount, plus accrued interest, (iii) redeemed on November 14, 1994 the 425,243 outstanding shares of Series A Cumulative Redeemable Exchangeable Preferred Stock of Stone Savannah River not owned by the Company for approximately $52 million, representing the applicable premium percentage of the principal amount plus accrued and unpaid dividends, and (iv) acquired the 72,346 outstanding shares of common stock of Stone Savannah River not owned by the Company. The Credit Agreement also provides for the issuance of letters of credit which to the extent utilized serve to reduce borrowing availability under the revolving credit facility of the Credit Agreement. The completion of the October Offering, together with the October Related Transactions, has extended the scheduled amortization obligations and final maturities of more than $1 billion of the Company's indebtedness and improved the Company's liquidity and financial flexibility by, among other things, providing for the $450 million senior secured revolving credit facility commitment under the Credit Agreement.\n- In February 1994, the Company sold $710 million principal amount of 9 7\/8 percent Senior Notes due February 1, 2001 and 18.97 million shares of common stock for an additional $289.3 million at $15.25 per common share\n(the \"February Offerings\"). The net proceeds from the February Offerings of approximately $962 million were used as follows: (i) approximately $652 million was used to prepay all of the 1995 and portions of the 1996 and 1997 scheduled amortizations under the Company's then existing 1989 Credit Agreement including the ratable amortization payment under the revolving credit facilities of the 1989 Credit Agreement; (ii) to redeem the Company's 13 5\/8 percent Subordinated Notes due 1995 at a price equal to par, approximately $98 million principal amount, plus accrued interest to the redemption date; (iii) approximately $136 million was used to repay the outstanding borrowings under the Company's revolving credit facilities without reducing the commitments thereunder; and (iv) provided incremental liquidity in the form of cash.\nAs a result of the debt prepayments associated with the October Offering and Related Transactions and the February Offerings, the Company's 1994 results reflect charges of $61.6 million, net of income tax benefit of $36.5 million, for the write-off of unamortized deferred debt issuance costs and other costs associated with the debt that was repaid. Such charges are reflected as losses from early extinguishments of debt in the Company's Consolidated Statement of Operations for the year ended December 31, 1994.\nINVESTING ACTIVITIES:\nThe following summarizes the Company's primary 1994 investing activities:\n- In December 1994, the Company acquired an additional 40 percent of the common stock of SVCPI, previously a 50-percent owned non-consolidated affiliate, thereby increasing the Company's ownership interest to 90 percent. Accordingly, SVCPI is now accounted for as a consolidated subsidiary. As a result, approximately $288 million of existing indebtedness of SVCPI, which is non-recourse to the Company, is included in the December 31, 1994 Consolidated Balance Sheet. Additionally, this transaction indirectly increased the Company's ownership interest in the Celgar pulp mill located in Castlegar, British Columbia from 25 percent to 45 percent as SVCPI has a 50 percent joint venture interest in the Celgar pulp mill.\n- In October 1994, the Company acquired the remaining 7 percent of the common stock of Stone Savannah River, thereby making it a wholly-owned subsidiary of the Company. See Note 10 -- \"Long-term Debt\" for further discussion.\n- The Company received approximately $37 million in cash from the sales of certain assets.\n- Capital expenditures for 1994 totaled approximately $233 million. The Company's capital expenditures for 1995 are budgeted at approximately $400 million, of which approximately $172 million are budgeted for Stone- Consolidated.\nENVIRONMENTAL ISSUES:\nThe Company's operations are subject to extensive environmental regulation by federal, state and local authorities in the United States and regulatory authorities with jurisdiction over its foreign operations. The Company has in the past made significant capital expenditures to comply with water, air and solid and hazardous waste regulations and expects to make significant expenditures in the future. Capital expenditures for environmental control equipment and facilities were approximately $53 million in 1994 and the Company anticipates that 1995 and 1996 environmental capital expenditures will approximate $95 million and $67 million, respectively (exclusive of any potential expenditures which may be required if the proposed \"cluster rules\" described below are adopted). Included in these amounts are capital expenditures for Stone-Consolidated which were approximately $32 million in 1994 and are anticipated to approximate $56 million in 1995 and $19 million in 1996. Although capital expenditures for environmental control equipment and facilities and compliance costs in future years will depend on legislative and technological developments which cannot be predicted at this time, the Company anticipates that these costs will increase when final \"cluster rules\" as described below, are adopted and as other environmental regulations become more stringent. Environmental control expenditures include projects which, in addition to meeting environmental concerns, yield certain benefits to the Company in the form of increased capacity and production cost savings. In addition to capital expenditures for environmental control equipment and facilities, other expenditures incurred to maintain environmental regulatory compliance (including any remediation) represent ongoing costs to the Company.\nIn December 1993, the U.S. Environmental Protection Agency (the \"EPA\") issued a proposed rule affecting the pulp and paper industry. These proposed regulations, informally known as the \"cluster rules,\" would make more stringent requirements for discharge of wastewaters under the Clean Water Act and would impose new requirements on air emissions under the Clean Air Act. Pulp and paper manufacturers (including the Company) have submitted extensive comments to the EPA on the proposed regulations in support of the position that requirements under the\nproposed regulations are unnecessarily complex, burdensome and environmentally unjustified. The EPA has indicated that it may reopen the comment period on the proposed regulations to allow review and comment on new data that the industry will submit to the agency on the industry's air toxic emissions. It cannot be predicted at this time whether the EPA will modify the requirements in the final regulations which are currently scheduled to be issued in 1996, with compliance required within three years from such date. The Company is considering and evaluating the potential impact of the rules, as proposed, on its operating and capital expenditures over the next several years. Estimates, based on currently proposed regulations, indicate that the Company could be required to make capital expenditures of $350-$450 million during the period of 1996 through 1998 in order to meet the requirements of the rules. In addition, annual operating expenses would increase by as much as $20 million beginning in 1998. The ultimate financial impact of the regulations cannot be accurately estimated at this time but will be affected by several factors, including the actual requirements imposed under the final rule, advancements in control process technologies, possible reconfiguration of mills and inflation.\nIn addition, the Company is from time to time subject to litigation and governmental proceedings regarding environmental matters in which injunctive and\/or monetary relief is sought. The Company has been named as a potentially responsible party (\"PRP\") at a number of sites which are the subject of remedial activity under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\" or \"Superfund\") or comparable state laws. Although the Company is subject to joint and several liability imposed under Superfund, at most of the multi-PRP sites there are organized groups of PRPs and costs are being shared among PRPs. Future environmental regulations, including the final \"cluster rules,\" may have an unpredictable adverse effect on the Company's operations and earnings, but they are not expected to adversely affect the Company's competitive position.\nCOMMON AND SERIES E CUMULATIVE PREFERRED STOCK -- CASH DIVIDENDS, MARKET AND PRICE RANGE\nDue to limitations and restrictions imposed upon the Company either under certain of its Indentures, the Credit Agreement or under the previous 1989 Credit Agreement, the Company did not declare or pay a cash dividend on its shares of common stock during 1994, 1993 or in the third and fourth quarters of 1992. Cash dividends per common share were $.35 for 1992. Cash dividends on common stock cannot be declared and paid until the Company fully satisfies all accumulated preferred stock dividends in arrears and there is an available dividend pool under the Senior Subordinated Indenture and under the Credit Agreement.\nThe Company paid cash dividends during the first two quarters of 1993 on its Series E Cumulative Convertible Exchangeable Preferred Stock (\"Series E Cumulative Preferred Stock\"). Due to the restrictive provisions in the Company's indentures, of which the most restrictive provision is contained in the Senior Subordinated Indenture dated March 15, 1992 (the \"Senior Subordinated Indenture\") relating to the Company's 10 3\/4 percent Senior Subordinated Notes due June 15, 1997, its 11 percent Senior Subordinated Notes due August 15, 1999 and its 10 3\/4 percent Senior Subordinated Debentures due April 1, 2002, the Board of Directors did not declare the scheduled August 15, 1993 or the November 15, 1993 quarterly dividend of $.4375 per share on the Company's Series E Cumulative Preferred Stock. As a result of the February 1994 Offerings, the \"dividend pool\" established by the restrictions on payment of dividends under the Senior Subordinated Indenture was replenished from the sale of the common stock. On May 16, 1994, the Company paid both a regular quarterly cash dividend of $.4375 per share and a cumulative cash dividend of $1.3125 per share on the Series E Cumulative Preferred Stock to stockholders of record on April 15, 1994. The cumulative cash dividend fully satisfied all accumulated dividends in arrears on the Series E Cumulative Preferred Stock at that time. As a result of net losses in the 1994 second and third quarters, the dividend pool had been subsequently depleted and, accordingly, the Company's Board of Directors did not declare the scheduled August 15, 1994, November 15, 1994 or the February 15, 1995 quarterly dividend of $.4375 on the 4.6 million shares of Series E Cumulative Preferred Stock. The dividend pool was partially replenished with the net income from the fourth quarter of 1994. At December 31, 1994, the dividend pool in the Senior Subordinated Indenture had a deficit of approximately $103 million.\nIn the event the Company has six quarterly dividends which remain unpaid on the Series E Cumulative Preferred Stock, the holders of the Series E Cumulative Preferred Stock would have the right to elect two members to the Company's Board of Directors until the accumulated dividends on such Series E Cumulative Preferred Stock have been declared and paid or set apart for payment. The dividend pool under the Credit Agreement will be calculated\nfrom October 1, 1994. Irrespective of the amount of the dividend pool under the Credit Agreement, the Credit Agreement permits dividends to be paid on the Series E Cumulative Preferred Stock if there is available dividend pool under the Senior Subordinated Indenture.\nThere were approximately 6,634 common stockholders and 405 preferred stockholders of record at December 31, 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Registrant's financial statements required by Item 8, together with the report thereon of the independent accountants dated February 6, 1995, are set forth on pages 30-60 of this report. The financial statement schedules listed under Item 14(a)2, together with the report thereon of the independent accountants dated February 6, 1995, are set forth on pages 61 and 63 of this report and should be read in conjunction with the financial statements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation relating to the Registrant's Directors and Executive Officers is incorporated herein by reference to the Proxy Statement, to be filed on or before April 30, 1995, for the Annual Meeting of Stockholders scheduled May 9, 1995, under the captions \"Nominees for Directors,\" \"Information as to Directors and Executive Officers\" and \"Directors -- Certain Transactions\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to the Registrant's executive compensation is incorporated herein by reference to the Proxy Statement, to be filed on or before April 30, 1995, for the Annual Meeting of Stockholders scheduled May 9, 1995, under the caption \"Compensation\", excluding the section thereunder entitled \"Compensation Committee Report on Executive Compensation\" and \"Performance Graph\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nInformation relating to certain beneficial ownership of the Registrant's common stock is incorporated herein by reference to the Proxy Statement, to be filed on or before April 30, 1995, for the Annual Meeting of Stockholders scheduled May 9, 1995, under the captions \"Nominees for Directors\" and \"Security Ownership by Certain Beneficial Owners and Management -- Security Ownership by Certain Beneficial Owners\".\n(b) SECURITY OWNERSHIP OF MANAGEMENT\nInformation relating to ownership of the Registrant's equity securities by Directors and Executive Officers is incorporated herein by reference to the Proxy Statement, to be filed on or before April 30, 1995, for the Annual Meeting of Stockholders scheduled May 9, 1995, under the captions \"Nominees for Directors\" and \"Security Ownership by Certain Beneficial Owners and Management - -- Security Ownership by Management\".\n(c) CHANGES IN CONTROL\nThe Registrant knows of no contractual arrangements which may, at a subsequent date, result in a change in control of the Registrant.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation related to certain relationships and related transactions is incorporated herein by reference to the Proxy Statement, to be filed on or before April 30, 1995, for the Annual Meeting of Stockholders scheduled May 9, 1995, under the caption \"Directors -- Certain Transactions\".\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. The Registrant's financial statements, for the year ended December 31, 1994, together with the Report of Independent Accountants are set forth on pages 30-60 of this report. The supplemental financial information listed and appearing hereafter should be read in conjunction with the Financial Statements included in this report. Separate financial statements of 50-percent or less owned persons accounted for by the equity method have been omitted because they would not constitute a significant subsidiary.\n2. SUPPLEMENTAL FINANCIAL INFORMATION. The following are included in Part IV of this report for each of the years ended December 31, 1994, 1993 and 1992 as applicable:\nFinancial statement schedules not included in this report have been omitted, either because they are not applicable or because the required information is shown in the financial statements or notes thereto, included in this report. At December 31, 1994, the Company had outstanding loans receivable of $412,483 and $250,000, respectively, to James Doughan, President and Chief Executive Officer of Stone-Consolidated, and to James B. Heider, Senior Vice President and General Manager, North American Containerboard, Paper and Pulp Division. Such loans bear no interest and are repayable on demand pursuant to request by the Company.\n3. EXHIBITS. The exhibits required to be filed by Item 601 of Regulation S-K are listed under the caption \"Exhibits\" in Item 14(c). (b) REPORTS ON FORM 8-K\nA Report on Form 8-K dated January 3, 1994 was filed reporting (i) under Item 2 - -Acquisition or Disposition of Assets, that Stone-Consolidated, an indirect Canadian subsidiary of the Company, sold in Canada in an initial public offering both common stock and convertible subordinated debentures and concurrently sold in the United States senior secured notes and; (ii) under Item 5 - -Other Events, that the Company and its bank group entered into an Amended and Restated Credit Agreement effective December 17, 1993 (the \"Third Restated Credit Agreement\").\nA Report on Form 8-K dated January 5, 1994 was filed reporting under Item 5 - -Other Events, with respect to certain amendments to the 1989 Credit Agreements and disclosure relating to the Offerings, and other recent developments.\nA Report on Form 8-K dated January 24, 1994 was filed reporting under Item 5 - -Other Events, that (i) the Company issued a press release on February 3, 1994 announcing its financial results for the fourth quarter of 1993 and for the year ended December 31, 1993 and the recent developments concerning the Company's issuance of common stock and senior unsecured notes and (ii) the Company amended and received a waiver to its 1989 Credit Agreements as of January 24, 1994.\nA Report on Form 8-K dated April 19, 1994 was filed reporting under Item 5 - -Other Events, certain environmental capital expenditures and expenses which could be required if and when the \"cluster rules\" are finalized by the U.S. Environmental Protection Agency.\nA Report on Form 8-K dated February 16, 1995 was filed reporting under Item 5 - -Other Events, that the Company issued a press release on February 6, 1995 announcing its financial results for the fourth quarter of 1994 and for the year ended December 31, 1994.\n(c) EXHIBITS\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSIGNATURES--(CONTINUED)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nINDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReport of Independent Accountants\nTo the Board of Directors and Stockholders of Stone Container Corporation\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of cash flows and of stockholders' equity present fairly, in all material respects, the financial position of Stone Container 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 1 to the consolidated financial statements, the Company changed its method of accounting for income taxes, for postretirement benefits other than pensions and for postemployment benefits effective January 1, 1992, 1993 and 1994, respectively.\nPRICE WATERHOUSE LLP\nChicago, Illinois February 6, 1995\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS (in millions except per share)\nThe accompanying notes are an integral part of these statements.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in millions)\nThe accompanying notes are an integral part of these statements.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions)\n- --------- See Note 5 regarding non-cash financing and investing activities and supplemental cash flow information.\nThe accompanying notes are an integral part of these statements.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in millions except per share)\nThe accompanying notes are an integral part of these statements.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION:\nThe consolidated financial statements include the accounts of the Company and all subsidiaries that are more than 50 percent owned. All significant intercompany accounts and transactions have been eliminated. Investments in non-consolidated affiliated companies are primarily accounted for by the equity method.\nPER SHARE DATA:\nNet loss per common share is computed by dividing net loss applicable to common shares by the weighted average number of common shares outstanding during each year. The weighted average number of common shares outstanding was 88,195,190 in 1994, 71,162,646 in 1993 and 70,986,564 in 1992. Common stock equivalent shares, issuable upon exercise of outstanding stock options, are included in these calculations when they would have a dilutive effect on the per share amounts. All amounts per common share and the weighted average number of common shares outstanding have been adjusted for the 2 percent common stock dividend issued September 15, 1992. Fully diluted earnings per share for the years ended December 31, 1994, 1993 and 1992 is not disclosed because the amounts are anti-dilutive.\nRECLASSIFICATIONS:\nCertain prior year amounts have been restated to conform with the current year presentation in the Consolidated Statements of Operations and the Consolidated Statements of Cash Flows.\nCASH AND CASH EQUIVALENTS:\nThe Company considers all highly liquid short-term investments with original maturities of three months or less to be cash equivalents and, therefore, includes such investments as cash and cash equivalents in its financial statements.\nINVENTORIES:\nInventories are stated at the lower of cost or market. The primary methods used to determine inventory costs are the first-in-first-out (\"FIFO\") method, the last-in-first-out (\"LIFO\") method and the average cost method.\nPROPERTY, PLANT, EQUIPMENT AND DEPRECIATION:\nProperty, plant and equipment is stated at cost. Expenditures for maintenance and repairs are charged to income as incurred. Additions, improvements and major replacements are capitalized. The cost and accumulated depreciation related to assets sold or retired are removed from the accounts and any gain or loss is credited or charged to income.\nFor financial reporting purposes, depreciation and amortization is primarily provided on the straight-line method over the estimated useful lives of depreciable assets, or over the duration of the lease for certain capitalized leases, based on the following annual rates:\nTIMBERLANDS:\nTimberlands are stated at cost less accumulated cost of timber harvested. The Company amortizes its private fee timber costs over the estimated total fiber that will be available during the estimated growth cycle. Cost of non-fee timber harvested is determined on the basis of timber removal rates and the estimated volume of recoverable timber. The Company capitalizes interest costs related to pre-merchantable timber.\nINCOME TAXES:\nEffective January 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), which required a change from the deferred method to the liability method of accounting for income taxes. In connection with the adoption of SFAS 109, the Company recorded a one-time, non-cash after-tax charge to its first quarter 1992 earnings of $99.5 million or $1.40 per share of common stock. This adjustment is reported as a cumulative effect of a change in accounting principles in the Company's Consolidated\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Statements of Operations. SFAS 109 requires that assets and liabilities acquired in a business combination accounted for under the purchase method of accounting be recorded at their gross fair values, with a separate deferred tax balance recorded for the related tax effects.\nGOODWILL AND OTHER ASSETS:\nGoodwill is amortized on a straight-line basis over 40 years, and is recorded net of accumulated amortization of approximately $147 million and $129 million at December 31, 1994 and 1993, respectively. The Company assesses at each balance sheet date whether there has been a permanent impairment in the value of goodwill. This is accomplished by determining whether projected undiscounted future cash flows from operations exceed the net book value of goodwill as of the assessment date. Such projections reflect price, volume and cost assumptions. Additional factors considered by management in the preparation of the projections and in assessing the value of goodwill include the effects of obsolescence, demand, competition and other pertinent economic factors and trends and prospects that may have an impact on the value or remaining useful life of goodwill.\nDeferred debt issuance costs are amortized over the expected life of the related debt using the interest method. Start-up costs on major projects were capitalized and amortized over a ten-year period prior to October 1, 1993. Effective October 1, 1993, the Company changed its estimate of the useful life of deferred start-up costs to a five-year period. The effect of this change in estimate was to increase depreciation and amortization expense by approximately $12.2 million and $3.1 million and increase the net loss by $7.7 million and $2.0 million or $.09 per common share and $.02 per common share for 1994 and 1993, respectively. Other long-term assets include approximately $68 million and $80 million of unamortized deferred start-up costs at December 31, 1994 and 1993, respectively.\nPUBLIC OFFERING OF STOCK OF A SUBSIDIARY:\nWhen the sale of stock of a subsidiary takes the form of a direct sale of its unissued shares, the Company records the difference relating to the carrying amount per share and the offering price per share as an adjustment to common stock in those instances in which the Company has determined that the difference does not represent a permanent impairment.\nFOREIGN CURRENCY TRANSLATION:\nThe functional currency for the Company's foreign operations is the applicable local currency. Accordingly, assets and liabilities are translated at the exchange rate in effect at the balance sheet date and income and expenses are translated at average exchange rates prevailing during the year. Translation gains or losses are accumulated as a separate component of stockholders' equity entitled Foreign Currency Translation Adjustment. Foreign currency transaction gains or losses are credited or charged to income. These transaction gains or losses arise primarily from the translation of monetary assets and liabilities that are denominated in a currency other than the local currency.\nFOREIGN CURRENCY AND FINANCIAL INSTRUMENTS:\nThe Company has utilized various financial instruments to hedge certain of its foreign currency and\/or interest rate exposures. Premiums received and fees paid on the financial instruments are deferred and amortized over the period of the agreements. Gains and losses or interest received and paid on the instruments are recorded as foreign exchange transaction gains or losses or as interest in the Consolidated Statements of Operations.\nPOSTRETIREMENT 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\" (\"SFAS 106\"), which required the Company to change from the pay-as-you-go (cash) method to the accrual method of accounting for such postretirement benefits (primarily health care and life insurance). Upon adoption of SFAS 106, the Company recorded its catch-up accumulated postretirement benefit obligation (approximately $63 million) by recognizing a one-time, non-cash charge of $39.5 million, net of income tax benefit, as a cumulative effect of an accounting change in its 1993 first quarter Consolidated Statement of Operations.\nPOSTEMPLOYMENT BENEFITS:\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS 112\"), which requires accrual accounting for the estimated\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) costs of providing certain benefits to former or inactive employees and the employees' beneficiaries and dependents after employment but before retirement. Upon adoption of SFAS 112, the Company recorded its catch-up obligation (approximately $24 million) by recognizing a one-time, non-cash charge of $14.2 million, net of income tax benefit, as a cumulative effect of an accounting change in its 1994 first quarter Consolidated Statement of Operations.\nNOTE 2--INSURANCE MATTERS In the second quarter of 1994, a digester vessel ruptured at the Company's pulp and paperboard mill in Panama City, Florida causing extensive damage to certain of the facility's assets. As a result of this occurrence, the Company's 1994 Statement of Operations includes a $22 million pretax involuntary conversion gain (approximately $13.7 million after taxes). The Company is seeking recovery for both the losses to property and the losses as a result of business interruption arising from the Panama City occurrence. A partial recovery of $20 million has already been received by the Company from certain carriers and claims of approximately $66 million covering the major portion of such losses are still pending. The insurance carrier providing boiler and machinery coverage for the Company has denied the Company's claim; the Company has not accepted such denial. In addition, the all-risks insurance carriers, which would cover the losses not covered under the boiler and machinery coverage, have reserved their rights with respect to the Company's claim in order to investigate the application of coverage without prejudicing their rights. Management believes the receivable recorded on its financial statements is fully recoverable.\nNOTE 3--ACQUISITIONS\/DISPOSITIONS In December 1994, the Company acquired an additional 40 percent of the common stock of Stone Venepal (Celgar) Pulp Inc. (\"SVCPI\"), previously a 50-percent owned nonconsolidated affiliate, thereby increasing the Company's ownership interest to 90 percent. As a result of this transaction, SVCPI is now accounted for as a consolidated subsidiary. Additionally, this transaction indirectly increased the Company's ownership interest in the Celgar pulp mill located in Castlegar, British Columbia from 25 percent to 45 percent as SVCPI has a 50 percent joint venture interest in the Celgar pulp mill.\nIn October 1994, the Company acquired the remaining 7 percent of the common stock of Stone Savannah River Pulp & Paper Corporation (\"Stone Savannah River\") thereby making it a wholly-owned subsidiary of the Company. See Note 10--\"Long-term Debt\" for further discussion. The Company had previously increased its ownership in the common stock of Stone Savannah River from 50 percent to 93 percent through a series of equity transactions from 1991 through 1993. Stone Savannah River operates a linerboard and market pulp mill in Port Wentworth, Georgia.\nIn December 1993, the Company sold its 49 percent equity interest in Empaques de Carton Titan, S.A. (\"Titan\").\nOn May 6, 1993, the Company's wholly-owned German subsidiary, Europa Carton A.G., (\"Europa Carton\"), completed a joint venture with Financiere Carton Papier (\"FCP\"), a French company, to merge the folding carton operations of Europa Carton with those of FCP (\"FCP Group\"). Under the joint venture, FCP Group is owned equally by Europa Carton and the former shareholders of FCP. The Company's investment in the joint venture is being accounted for under the equity method of accounting.\nNOTE 4--PUBLIC OFFERING OF STOCK OF A SUBSIDIARY In December 1993, Stone-Consolidated Corporation (\"Stone-Consolidated\"), a newly-created Canadian subsidiary, acquired the newsprint and uncoated groundwood papers business of Stone Container (Canada) Inc. (\"Stone-Canada\") (formerly Stone-Consolidated, Inc.) and sold $346.5 million of units in an initial public offering comprised of both common stock and convertible subordinated debentures (the \"Units Offering\"). Each unit was priced at $2,100 and consisted of 100 shares of common stock at $10.50 per share and $1,050 principal amount of convertible subordinated debentures. The convertible subordinated debentures mature December 31, 2003, bear interest at an annual rate of 8 percent and are convertible into 6.211 shares of common stock for each Canadian $100 principal amount, representing a conversion price of $12.08 per share. Concurrent with the initial public offering, Stone-Consolidated sold $225 million of senior secured notes in a public offering in the United States. The senior secured notes mature December 15, 2000 and bear interest at an annual rate of 10.25 percent.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--PUBLIC OFFERING OF STOCK OF A SUBSIDIARY (CONTINUED) As a result of the Units Offering, 16.5 million shares of common stock, representing 25.4 percent of the total shares outstanding of Stone-Consolidated, were sold to the public, resulting in the recording in the Company's December 31, 1993 Consolidated Balance Sheet of a minority interest liability of $236.7 million.\nThe Company used approximately $373 million of the net proceeds from the sale of the Stone-Consolidated securities for repayment of commitments under its previously existing 1989 bank credit agreement (which was subsequently terminated and replaced by a new credit agreement--see Note 10--\"Long-term Debt\") and the remainder for general corporate purposes. As a result of the Units Offering, the Company recorded in 1993 a charge of $74.4 million to common stock related to the excess carrying value per common share over the offering price per common share associated with the shares issued.\nNOTE 5--ADDITIONAL CASH FLOW STATEMENT INFORMATION The Company's non-cash investing and financing activities and cash payments (receipts) for interest and income taxes were as follows:\nIn 1994 and 1993, the other-net component of net cash used in operating activities included debt issuance costs of approximately $79 million and $84 million, respectively. In 1992, the other-net component of net cash provided by operating activities included $54 million of cash received from the sale of an energy contract in October 1992.\nNOTE 6--INVENTORIES\nInventories are summarized as follows:\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 6--INVENTORIES (CONTINUED) At December 31, 1994 and 1993, the percentages of total inventories costed by the LIFO, FIFO and average cost methods were as follows:\nNOTE 7--PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment is summarized as follows:\nProperty, plant and equipment includes capitalized leases of $13.8 million and $70.3 million and related accumulated amortization of $5.3 million and $24.2 million at December 31, 1994 and 1993, respectively.\nNOTE 8--INCOME TAXES The Company provides for income taxes in accordance with the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases.\nThe provision (credit) for income taxes consists of the following:\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 8--INCOME TAXES (CONTINUED) The income tax credit at the federal statutory rate is reconciled to the credit for income taxes as follows:\nThe components of the net deferred tax liability as of December 31, 1994 and 1993 were as follows:\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 8--INCOME TAXES (CONTINUED) The components of the loss before income taxes, minority interest, extraordinary losses and cumulative effects of accounting changes are:\nAt December 31, 1994, the Company had approximately $404 million of net operating loss carryforwards for U.S. federal tax purposes and, additionally, approximately $167 million of net operating loss carryforwards for Canadian tax purposes. To the extent not utilized, the U.S. federal net operating losses will expire in 2007, 2008 and 2009 and the Canadian net operating losses will expire in 1998, 1999 and 2000. Further, the Company had approximately $900 million of net operating loss carryforwards for U.S. state tax purposes (which represents approximately $59 million of deferred tax assets), which, to the extent not utilized, expire in 1995 through 2009. The Company also had approximately $11 million of alternative minimum tax credit carryforwards for U.S. federal tax purposes which are available indefinitely.\nIn addition, as a result of certain acquisitions, the Company had, at December 31, 1994, approximately $27 million of pre-acquisition net operating loss carryforwards and approximately $5 million of investment tax credit carryforwards for federal income tax purposes. To the extent not utilized, the carryforwards will expire in the period commencing in the year 1996 and ending in the year 2004.\nAt December 31, 1994, Bridgewater Paper Company Ltd., a wholly-owned subsidiary of Stone-Consolidated, had approximately $87 million of net operating loss carryforwards for United Kingdom income tax purposes. These losses are available indefinitely.\nNOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS The Company has contributory and noncontributory pension plans for the benefit of most salaried and certain hourly employees. The funding policy for the plans, with the exception of the Company's salaried supplemental unfunded plans and the Company's German subsidiary's unfunded plan, is to annually contribute the statutory required minimum. The salaried pension plans provide benefits based on a formula that takes into account each participant's estimated final average earnings. The hourly pension plans provide benefits under a flat benefit formula. The salaried and hourly plans provide reduced benefits for early retirement. The salaried plans take into account offsets for governmental benefits.\nNet pension expense for the combined pension plans includes the following components:\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) The following table sets forth the funded status of the Company's pension plans and the amounts recorded in the Consolidated Balance Sheets:\nIn accordance with Statement of Financial Accounting Standards No. 87, \"Employer's Accounting for Pensions,\" the Company has recorded an additional minimum liability for underfunded plans representing the excess of the unfunded accumulated benefit obligation over previously recorded liabilities. The additional minimum liability at December 31, 1994 of $63.4 million is recorded as a long-term liability with an offsetting intangible asset of $25.8 million and a charge to stockholders' equity of $23.7 million, net of a tax benefit of $13.9 million. At December 31, 1993, the additional minimum liability of $92.4 million was recorded as a long-term liability with an offsetting intangible asset of $29.4 million and a charge to stockholders' equity of $39.6 million, net of a tax benefit of $23.4 million.\nThe weighted average discount rates used in determining the actuarial present value of the projected benefit obligations at December 31, 1994 were 9.0 percent and at December 31, 1993 were 7.5 percent for all U.S. and German operations and 8.0 percent for Canadian and United Kingdom operations. The rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations was 4.0 percent for 1994 and 1993. The expected long-term rate of return on assets was 11 percent for 1994 and 1993. The change in the weighted average discount rates during 1994 had the effect of decreasing the total projected benefit obligation at December 31, 1994 by $88.4 million.\nCertain domestic operations of the Company participate in various multi-employer union-administered defined benefit pension plans that principally cover production workers. Pension expense under these plans was $5.2 million for 1994 and $5.1 million for 1993 and 1992.\nIn addition to providing pension benefits, the Company provides certain retiree health care and life insurance benefits covering substantially all U.S. salaried and hourly employees and certain Canadian employees. Employees become eligible for such benefits if they are fully vested in one of the Company's pension plans when they retire from the Company and they begin to draw retirement benefits upon termination of service. Such retiree health care costs were expensed as the claims were paid through December 31, 1992. However, as discussed in Note 1--\"Summary of Significant Accounting Policies,\" effective January 1, 1993, the Company adopted SFAS 106, which required the\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 9--PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) Company to accrue for its obligation to pay such postretirement health care costs during the employees' years of service, as opposed to when such costs are actually paid. The effect of SFAS 106 on income before interest expense, income taxes, minority interest, extraordinary losses and cumulative effects of accounting changes is not material.\nNet worldwide periodic postretirement benefits costs for 1994 and 1993 included the following components:\nWorldwide postretirement benefits costs for retired employees approximated $4.7 million for 1992.\nThe following table sets forth the components of the Company's accumulated postretirement benefit obligation and the amount recorded in the Consolidated Balance Sheets:\nThe Company has not currently funded any of its accumulated postretirement benefit obligation.\nThe discount rates used in determining the accumulated postretirement benefit obligation were 9.0 percent at December 31, 1994 and 7.5 percent for U.S. operations and 8.0 percent for Canadian operations at December 31, 1993. The change in the discount rates had the effect of decreasing the total projected benefit obligation at December 31, 1994 by $8.9 million. The assumed health care cost trend rates for substantially all employees used in measuring the accumulated postretirement benefit obligation at December 31, 1994 and 1993 ranged from 7 percent to 13 percent decreasing to ultimate rates of 5.5 percent to 8 percent. If the health care cost trend rate assumptions were increased by 1 percent, the accumulated postretirement benefit obligation at December 31, 1994 and 1993 and the net periodic postretirement benefit cost for the years ended December 31, 1994 and 1993 would have increased by $5.6 million and $6.5 million and by $.7 million and $.6 million, respectively.\nAt December 31, 1994, the Company had approximately 8,700 retirees and 29,100 active employees of which approximately 3,400 and 21,400, respectively, were employees of U.S. operations.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 10--LONG-TERM DEBT Long-term debt consists of the following:\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 10--LONG-TERM DEBT (CONTINUED)\nIn October 1994, the Company sold $500 million principal amount of 10 3\/4 percent First Mortgage Notes due October 1, 2002 (the \"10 3\/4 percent First Mortgage Notes\") and $200 million principal amount of 11 1\/2 percent Senior Notes due October 1, 2004 (the \"11 1\/2 percent Senior Notes\") (hereafter referred together as the \"October Offering\"). The 10 3\/4 percent First Mortgage Notes and the 11 1\/2 percent Senior Notes are redeemable by the Company after September 30, 1999 and interest is payable semi-annually on April 1 and October 1, commencing April 1, 1995. Net proceeds from the sale of these securities were approximately $679.1 million.\nConcurrent with the October Offering, the Company (i) entered into a new credit agreement (the \"Credit Agreement\") consisting of a $400 million senior secured term loan maturing through April 1, 2000, a $450 million senior secured revolving credit facility commitment maturing May 15, 1999, which includes a $25 million swing-line sub-facility maturing May 15, 1999 (any borrowings under the swing-line sub-facility would reduce the borrowing availability under the revolving credit facility), (ii) repaid all of the outstanding indebtedness and commitments under its previously existing bank credit agreements which had consisted of two term loan facilities, two revolving credit facilities and an additional term loan (the \"1989 Credit Agreement\") which were then terminated, (iii) merged the Company's 93 percent owned subsidiary Stone Savannah River into a wholly-owned subsidiary of the Company and, (iv) as described below, repaid or acquired Stone Savannah River's outstanding indebtedness, preferred stock and common stock (collectively, the \"October Related Transactions\"). In connection with the Stone Savannah River merger, the Company (i) repaid all the indebtedness outstanding under and terminated Stone Savannah River's bank credit agreement, (ii) redeemed the $130 million principal amount of Stone Savannah River's 14 1\/8 percent Senior Subordinated Notes due 2000 for approximately $139.2 million, equal to the principal amount and the applicable premium percentage of the principal amount, plus accrued interest, (iii) redeemed on November 14, 1994 the 425,243 outstanding shares of Series A Cumulative Redeemable Exchangeable Preferred Stock of Stone Savannah River not owned by the Company for approximately $52 million, representing the applicable premium percentage of the principal amount plus accrued and unpaid dividends, and (iv) acquired the 72,346 outstanding shares of common stock of Stone Savannah River not owned by the Company. The Credit Agreement also provides for the issuance of letters of credit which to the extent utilized serve to reduce borrowing availability under the revolving credit facility of the Credit Agreement. The completion of the October Offering, together with the October Related Transactions, has\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 10--LONG-TERM DEBT (CONTINUED) extended the scheduled amortization obligations and final maturities of more than $1 billion of the Company's indebtedness and improved the Company's liquidity and financial flexibility by, among other things, providing for the $450 million senior secured revolving credit facility commitment under the Credit Agreement.\nThe Credit Agreement permits the Company to choose among various interest rate options for the revolving credit facility and the term loan and to specify the interest rate period to which the interest rate options are to apply, subject to certain parameters. The applicable interest rate options available to the Company are: (i) under the revolving credit facility (a) the higher of (1) Bankers Trust Company's prime rate and (2) the Federal Funds Effective Rate plus 1\/2 of 1 percent (the alternative base rate (\"ABR\")), plus, in the case of (1) or (2), 1 5\/8 percent per annum or (b) the London Interbank Offered Rate (\"LIBOR\") plus 2 5\/8 percent per annum; (ii) under the swing-line sub-facility, ABR plus 1 5\/8 percent per annum and (iii) under the term loan, ABR plus 2 1\/8 percent per annum or LIBOR plus 3 1\/8 percent per annum. Upon achievement of specified indebtedness ratios and cash flow coverage ratios or other performance related tests, the interest rate margins for the revolving credit facility (including the swing-line sub-facility) will be reduced. Additionally, the Company pays a 1\/2 percent commitment fee on the unused portions of the revolving credit facility and pays 2 5\/8 percent over LIBOR less 1\/2 percent plus a facing fee on letters of credit issued under the revolving credit facility.\nAt December 31, 1994, the $426.4 million of borrowings and accrued interest outstanding under the Credit Agreement were secured by property, plant and equipment with a net book value of $1.23 billion, and by a lien on certain of the Company's inventories. Additionally, other loan agreements with a net book value of $1.42 billion were collateralized by approximately $1.26 billion of property, plant and equipment-net and an investment and by $376.4 million of cash, accounts receivable and inventories.\nIn February 1994, the Company sold $710 million principal amount of 9 7\/8 percent Senior Notes due February 1, 2001 and 18.97 million shares of common stock for an additional $289.3 million at $15.25 per common share (the \"February Offerings\"). The net proceeds from the February Offerings of approximately $962 million, were used as follows: (i) approximately $652 million was used to prepay all of the 1995 and portions of the 1996 and 1997 scheduled amortizations under the Company's then existing 1989 Credit Agreement including the ratable amortization payment under the revolving credit facilities of the 1989 Credit Agreement; (ii) to redeem the Company's 13 5\/8 percent Subordinated Notes due 1995 at a price equal to par, approximately $98 million principal amount, plus accrued interest to the redemption date; (iii) approximately $136 million was used to repay the outstanding borrowings under the Company's revolving credit facilities of the 1989 Credit Agreement without reducing the commitments thereunder; and (iv) provided incremental liquidity in the form of cash. The 9 7\/8 percent Senior Notes are redeemable by the Company on or after February 1, 1999. Interest is payable semi-annually commencing August 1, 1994 and continuing each February 1 and August 1 until maturity.\nAs a result of the debt prepayments associated with the October Offering and Related Transactions and the February Offerings, the Company's 1994 results reflect charges of $61.6 million, net of income tax benefit of $36.5 million, for the write-off of unamortized deferred debt issuance costs and other costs associated with the debt that was repaid. Such charges are reflected as extraordinary losses from the early extinguishments of debt in the Company's Consolidated Statement of Operations for the year ended December 31, 1994.\nAs a result of the consolidation of SVCPI (see Note 3--\"Acquisitions\/Dispositions\") the Company's Consolidated Balance Sheet at December 31, 1994 includes the debt of this subsidiary. Such debt is solely the obligation of SVCPI and is without recourse to the Company.\nAt December 31, 1993, certain long-term debt of Stone Savannah River had been classified as current in accordance with the provisions of Emerging Issues Task Force Issue No. 86-30, \"Classification of Obligations When a Violation is Waived by the Creditor\". Such debt was fully repaid as part of the October Offering and the October Related Transactions.\nOn July 6, 1993, the Company sold $150 million principal amount of 12 5\/8 percent Senior Notes due July 15, 1998 (the \"12 5\/8 percent Senior Notes\"). The 12 5\/8 percent Senior Notes are not redeemable by the Company prior to maturity. Interest is payable semi-annually on January 15 and July 15, commencing January 15, 1994.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 10--LONG-TERM DEBT (CONTINUED) Also on July 6, 1993, the Company sold, in a private transaction, $250 million principal amount of 8 7\/8 percent Convertible Senior Subordinated Notes due July 15, 2000 (the \"8 7\/8 percent Convertible Senior Subordinated Notes\"). The Company filed a shelf registration statement registering the 8 7\/8 percent Convertible Senior Subordinated Notes for resale by the holders thereof, which was declared effective August 13, 1993. The 8 7\/8 percent Convertible Senior Subordinated Notes are convertible, at the option of the holder, into shares of the Company's common stock at a conversion price of $11.55 per share of common stock, subject to adjustment in certain events. Additionally, the 8 7\/8 percent Convertible Senior Subordinated Notes are redeemable, at the option of the Company, in whole or in part, on and after July 15, 1998. Interest is payable semi-annually on January 15 and July 15, commencing January 15, 1994.\nThe net proceeds of approximately $386 million received from the sales of the 12 5\/8 percent Senior Notes and the 8 7\/8 percent Convertible Senior Subordinated Notes were used by the Company to repay bank indebtedness.\nIn December 1993, Stone-Consolidated sold $173.3 million of 8 percent convertible subordinated debentures as part of the Units Offering. Concurrent with the Units Offering, Stone-Consolidated sold $225 million of 10 1\/4 percent Senior Secured Notes maturing on December 15, 2000 in a public offering in the United States. See Note 4--\"Public Offering of Stock of a Subsidiary\", for further details.\nThe Company has an accounts receivable securitization program consisting of two tranches whereby various of its subsidiaries sell certain of their accounts receivable to one of two wholly-owned subsidiaries of the Company, Stone Financial Corporation (\"Stone Fin\") or Stone Fin II Receivables Corporation (\"Stone Fin II\"). In accordance with the program, Stone Fin and Stone Fin II purchase, on an ongoing basis, certain of the accounts receivable of various subsidiaries. These accounts receivable are purchased by Stone Fin and Stone Fin II with proceeds provided primarily from borrowings under their respective revolving credit facilities. Stone Fin has a $185 million revolving credit facility and Stone Fin II has a $90 million revolving credit facility, both of which mature in September 1995. The purchased accounts receivable are solely the assets of either Stone Fin or Stone Fin II, both of which are wholly-owned but separate corporate entities of the Company, with their own separate creditors. In the event of a liquidation of Stone Fin or Stone Fin II, such creditors would be entitled to satisfy their claims from Stone Fin or Stone Fin II, as the case may be, prior to any distribution to the Company. At December 31, 1994, the Company's Consolidated Balance Sheet included $226.0 million and $100.3 million, respectively, of Stone Fin and Stone Fin II accounts receivable and $187.8 million and $66.0 million, respectively, of borrowings under the program. At December 31, 1993, the Company's Consolidated Balance Sheet included $175.6 million and $124.4 million, respectively, of Stone Fin and Stone Fin II accounts receivable and $150.5 million and $81.9 million, respectively, of borrowings under the program. The Company is currently planning to refinance its accounts receivable securitization program. The proposed refinancing is currently contemplated to approximate $300 million of receivables financing which would have a 5-year maturity together with a supplementary revolving credit facility. The proposed refinancing is subject to the placement and execution of definitive documentation.\nThe amounts of long-term debt outstanding at December 31, 1994 maturing during the next five years are as follows:\nThe 1995 maturities include $253.8 million outstanding under Stone Fin's and Stone Fin II's revolving credit facilities. Stone Fin and Stone Fin II have the option, subject to bank consents, to extend or refinance such obligations beyond 1995. As previously mentioned, the Company intends to refinance the Stone Fin and Stone Fin II obligations in 1995.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 10--LONG-TERM DEBT (CONTINUED)\nAmounts payable under capitalized lease agreements are excluded from the above tabulation. See Note 13 for capitalized lease maturities.\nBorrowings under the Credit Agreement are secured with a significant portion of the assets of the Company. The Credit Agreement contains covenants that include, among other things, the maintenance of certain financial tests and ratios consisting of an indebtedness ratio and a minimum interest coverage ratio and certain restrictions and limitations, including those on capital expenditures, changes in control, payment of dividends, sales of assets, lease payments, investments, additional borrowings, liens, repurchases or prepayment of certain indebtedness, guarantees of indebtedness, mergers and purchases of stock and assets. The Credit Agreement also contains cross-default provisions to the indebtedness of $10 million or more of the Company and certain subsidiaries, as well as cross-acceleration provisions to the non-recourse debt of $10 million or more of Stone-Consolidated, Seminole and SVCPI. Additionally, the term loan portion of the Credit Agreement provides for mandatory prepayments from sales of certain assets, certain debt financings and a percentage of excess cash flow (as defined). The Company's bank lenders at their option may waive the receipt of any mandatory prepayment. The amortizations for each semi-annual period is 1\/2 of 1 percent of the principal amount of the outstanding term loans and all mandatory and voluntary prepayments are allocated against the term loan amortizations in inverse order of maturity. Mandatory prepayments from sales of collateral, unless replacement collateral is provided, will be applied ratably to the term loan and revolving credit facility, permanently reducing the loan commitments under the Credit Agreement. Further, the Credit Agreement limits, except in certain specific circumstances, any additional investments by the Company in Stone-Consolidated, Seminole and SVCPI.\nIn 1994, the Company entered into two long-term interest rate swap transactions related to $250 million of certain fixed rate indebtedness. These swaps effectively reduced the interest expense pertaining to such debt during 1994. Also, in March of 1994, an interest rate swap contract which had fixed the interest rate on $150 million of bank indebtedness at 12.9 percent, expired. In 1993, the Company sold, prior to their expiration date, certain interest rate swaps and cross currency swaps associated with certain U.S. dollar denominated bank indebtedness of Stone-Canada. The net proceeds of approximately $34.9 million received from the sale of these swaps were primarily used to repay bank indebtedness.\nNOTE 11--LIQUIDITY MATTERS The Company's liquidity and financial flexibility was adversely affected by the net losses incurred during the past four years. The Company improved its liquidity and financial flexibility through the completion of: (i) the October Offering and the October Related Transactions; and (ii) the February Offerings as discussed in Note 10-- \"Long-term Debt\". At December 31, 1994, the Company had borrowing availability of $350 million (net of letters of credit which reduce the amount available to be borrowed) under its $450 million revolving credit facility. Additionally, at December 31, 1994, Stone-Consolidated, a non-recourse subsidiary of the Company, had no borrowings outstanding under its $100 million revolving credit facility. (All amounts presented for Stone-Consolidated are in U.S. dollars, unless otherwise indicated). Notwithstanding these improvements in the Company's liquidity and financial flexibility, the Company will be required in the future to generate sufficient cash flows to fully meet the Company's debt service requirements. Included in the Company's current maturities of debt at December 31, 1994 are $253.8 million of obligations related to the Company's accounts receivable securitization program that mature September 15, 1995 (see Note 10--\"Long-term Debt\"). While the Company is in the process of refinancing such obligations, no assurance can be given that it will be successful in doing so. In the event this refinancing is not consummated, management nevertheless believes that operating cash flows and borrowing availability under the Credit Agreement will provide more than sufficient liquidity for the Company to meet its 1995 and 1996 debt service requirements. Beginning in 1997 and continuing thereafter, the Company will be required to make significant amortization payments on its existing indebtedness. In the event the Company is unable to generate sufficient operating cash flows to fully meet such debt service requirements, it may deplete a substantial portion of its cash resources and borrowing availability under its revolving credit facility. In such event, the Company would be required to pursue other alternatives to improve liquidity, including cost reductions, sales of assets, the deferral of certain capital expenditures and\/or obtaining additional sources of funds.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 12--FINANCIAL INSTRUMENTS At December 31, 1994 and 1993, the carrying values and fair values of the Company's financial instruments are listed below:\nThe fair values of notes receivable and certain investments are based on discounted future cash flows or the applicable quoted market price. The fair value of the Company's debt is estimated based on the quoted market prices for the same or similar issues. The fair value of the letters of credit is based on fees currently charged for similar agreements. The face amount on the letters of credit was $88.3 million and $76.1 million at December 31, 1994 and 1993, respectively. The fair value of interest rate swap agreements are obtained from dealer quotes. These values represent the estimated amount the Company would pay to terminate agreements, taking into consideration the current interest rate and market conditions. The Company does not hold or issue financial instruments for trading purposes.\nThe Company is party to two interest rate swap contracts with durations of five and ten years to hedge against interest rate exposures on $250 million of certain fixed rate indebtedness. The separate contracts have the effect of converting the fixed rate of interest into a floating interest rate on $100 million of the 9 7\/8 percent Senior Notes and on $150 million of the 11 1\/2 percent Senior Notes. These interest rate swap contracts were entered into in order to balance the Company's fixed-rate and floating-rate debt portfolios. Under the interest rate swaps, the Company agrees with the other party to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated by reference to an agreed notional principal amount. While the Company is exposed to credit loss on its interest-rate swaps in the event of nonperformance by the counterparties to such swaps, management believes that such nonperformance is unlikely to occur given the financial resources of the counterparties.\nThe following table indicates the weighted average receive rate and pay rate during 1994 relating to the interest rate swaps outstanding at December 31, 1994:\nThe average pay rate for both interest rate swaps is the six month LIBOR.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 13--LONG-TERM LEASES The Company leases certain of its facilities and equipment under leases expiring through the year 2023.\nFuture minimum lease payments under capitalized leases and their present value at December 31, 1994, and future minimum rental commitments (net of sublease rental income and exclusive of real estate taxes and other expenses) under operating leases having initial or remaining non-cancellable terms in excess of one year, are reflected below:\nMinimum lease payments for capitalized leases have not been reduced by minimum sublease rental income of $.9 million due in the future under a non-cancellable lease.\nRent expense for operating leases, including leases having a duration of less than one year, was approximately $87 million in 1994, $83 million in 1993 and $84 million in 1992.\nNOTE 14--PREFERRED STOCK The Company has authorized 10,000,000 shares of preferred stock, $.01 par value, of which 4.6 million shares are outstanding at December 31, 1994. Shares of preferred stock can be issued in series with varying terms as determined by the Board of Directors.\nOn February 20, 1992, the Company issued 4.6 million shares of $1.75 Series E Cumulative Convertible Exchangeable Preferred Stock (the \"Series E Cumulative Preferred Stock\") at $25.00 per share. Dividends on the Series E Cumulative Preferred Stock are payable quarterly when, as and if declared by the Company's Board of Directors. The Series E Cumulative Preferred Stock is convertible, at the option of the holder at any time, into shares of the Company's common stock at a conversion price of $33.94 per share of common stock (adjusted for the 2 percent common stock dividend issued September 15, 1992), subject to adjustment under certain conditions. The Series E Cumulative Preferred Stock may alternatively be exchanged, at the option of the Company, on any dividend payment date commencing February 15, 1994, for the Company's 7 percent Convertible Subordinated Exchange Debentures due February 15, 2007 (the \"Exchange Debentures\") in a principal amount equal to $25.00 per share of Series E Cumulative Preferred Stock so exchanged. The Exchange Debentures would be virtually identical to the 6 3\/4 percent Subordinated Debentures, except that the Exchange Debentures would bear interest at the rate of 7 percent per annum and the interest payment dates would differ. Additionally, the Series E Cumulative Preferred Stock is redeemable at the option of the Company, in whole or from time to time in part, on and after February 16, 1996. The net proceeds of $111 million from the sale of the Series E Cumulative Preferred Stock were used to prepay bank indebtedness.\nThe Company paid cash dividends during the first two quarters of 1993 on its Series E Cumulative Preferred Stock. However, due to the restrictive provisions in the Company's indentures, of which the most restrictive provision is contained in the Senior Subordinated Indenture, dated March 15, 1992 (the \"Senior Subordinated Indenture\") relating to the Company's 10 3\/4 percent Senior Subordinated Notes, its 11 percent Senior Subordinated Notes and its 10 3\/4 percent Senior Subordinated Debentures, the Board of Directors did not declare the scheduled August 15, 1993, November 15, 1993 or the February 15, 1994 quarterly dividend of $.4375 per share on the 4.6 million shares of\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 14--PREFERRED STOCK (CONTINUED) Series E Cumulative Preferred Stock nor was it permitted to declare or pay future dividends on the Series E Cumulative Preferred Stock until the Company generated income, or effected certain sales of capital stock, to replenish the \"dividend pool\" under various of its debt instruments.\nAs a result of the February Offerings discussed in Note 10--\"Long-term Debt\", the \"dividend pool\" established by the restrictions on payment of dividends under the Senior Subordinated Indenture was replenished from the sale of the common shares. On May 16, 1994, the Company paid both a regular quarterly cash dividend of $.4375 per share and a cumulative cash dividend of $1.3125 per share on the Company's Series E Cumulative Preferred Stock to stockholders of record on April 15, 1994. The cumulative cash dividend fully satisfied all accumulated dividends in arrears on the Series E Cumulative Preferred Stock at that time. As a result of net losses in the 1994 second and third quarters, the dividend pool had been subsequently depleted and, accordingly, the Company's Board of Directors did not declare the scheduled August 15, 1994, November 15, 1994 or the February 15, 1995 quarterly dividend of $.4375 on the 4.6 million shares of Series E Cumulative Preferred Stock. The dividend pool was partially replenished with the net income from the fourth quarter of 1994. At December 31, 1994, the dividend pool in the Senior Subordinated Indenture had a deficit of approximately $103 million. In the event the Company has six quarterly dividends which remain unpaid on the Series E Cumulative Preferred Stock, the holders of the Series E Cumulative Preferred Stock would have the right to elect two members to the Company's Board of Directors until the accumulated dividends on such Series E Cumulative Preferred Stock have been declared and paid or set apart for payment. The dividend pool under the Credit Agreement will be calculated from October 1, 1994. Irrespective of the amount available in the dividend pool under the Credit Agreement, the Credit Agreement permits dividends to be paid on the Series E Cumulative Preferred Stock if there is an available dividend pool under the Senior Subordinated Indenture.\nREDEEMABLE PREFERRED STOCK OF A CONSOLIDATED AFFILIATE:\nThe Company's Consolidated Balance Sheet at December 31, 1993 includes the Series A Cumulative Redeemable Exchangeable Preferred Stock (the \"Series A Preferred Stock\") of Stone Savannah River. Stone Savannah River had authorized 650,000 shares of Series A Preferred Stock, of which 637,900 shares, having a total liquidation preference of $63.8 million, were outstanding at December 31, 1993. The Company owned one-third of the Series A Preferred Stock and eliminated such investment in consolidation. As discussed in Note 10--\"Long-term Debt\", as part of the October Related Transactions, the Company redeemed the remaining 425,243 outstanding shares of Series A Preferred Stock of Stone Savannah River not owned by the Company for approximately $52 million, representing the applicable premium percentage of the principal amount plus accrued and unpaid dividends.\nThe Series A Preferred Stock, $.01 par value, liquidation preference $100 per share, was cumulative with dividends of $15.375 per annum payable quarterly when, as and if declared by Stone Savannah River's Board of Directors. On or prior to December 15, 1993, dividends were payable through the issuance of additional shares of Series A Preferred Stock; thereafter, such dividends were payable in cash. Stock dividends of approximately $6.0 million in 1993 and $5.1 million in 1992 representing approximately 60,000 shares and 51,000 shares, respectively, were distributed to shareholders other than the Company.\nSERIES F PREFERRED STOCK:\nAs a result of a cash payment by the Company in 1994 as settlement for the exchange agreement between the Company and Venezalona de Pulpa y Papel (\"Venepal\"), a Venezuelan pulp and paper company, the authorized 400,000 shares of 7 percent Series F Cumulative Convertible Exchangeable Preferred Stock will be cancelled.\nNOTE 15--COMMON STOCK The Company has authorized 200,000,000 shares of common stock, $.01 par value, of which 90,396,099 shares were outstanding at December 31, 1994.\nIn February 1994, the Company issued 18.97 million shares of common stock at $15.25 per share. See also Note 10--\"Long-term Debt.\"\nThe Company has restrictions on the payment of cash dividends on its common stock under certain of the Company's Indentures and under its Credit Agreement. Cash dividends on common stock cannot be declared and\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--COMMON STOCK (CONTINUED) paid until the Company fully satisfies all accumulated preferred stock dividends in arrears (see also Note 14-- \"Preferred Stock\") and there is an available dividend pool under the Senior Subordinated Indenture and under the Credit Agreement.\nOn September 15, 1992, the Company issued a 2 percent stock dividend to common stockholders of record August 25, 1992. The stock dividend was effected by the issuance of one share of common stock for every 50 shares of common stock held. Accordingly, all amounts per common share and the weighted average number of common shares for all periods included in the consolidated financial statements have been retroactively adjusted to reflect this stock dividend.\nSTOCK RIGHTS:\nEach outstanding share of the Company's common stock carries a stock purchase right (\"Right\"). Each Right entitles the holder to purchase from the Company one one-hundredth of a share of Series D Junior Participating Preferred Stock, par value $.01 per share, at a purchase price of $130 subject to adjustment under certain circumstances. The Rights expire August 8, 1998 unless extended or earlier redeemed by the Company.\nThe Rights will be exercisable only if a person or group, subject to certain exceptions, acquires 15 percent or more of the Company's common stock or announces a tender offer, the consummation of which would result in ownership by such person or group of 15 percent or more of the Company's common stock. The Company can redeem the Rights at the rate of $.01 per Right at any time before the tenth business day (subject to extension) after a 15 percent position is acquired.\nIf the Company is acquired in a merger or other business combination transaction, each Right will entitle its holder (other than the acquiring person or group) to purchase, at the Right's then-current exercise price, a number of the acquiring company's shares of common stock having a market value at that time of twice the Right's then-current exercise price.\nIn addition, in the event that a 15 percent or greater stockholder acquires the Company by means of a reverse merger in which the Company and its common stock survive, or engages in self-dealing transactions with the Company, each holder of a Right (other than the acquiring person or group) will be entitled to purchase the number of shares of the Company's common stock having a market value of twice the then-current exercise price of the Right.\nSTOCK OWNERSHIP AND OPTION PLANS:\nThe Company's Board of Directors adopted an Incentive Stock Option Plan, effective January 1, 1993, which replaced a previous plan. The plan authorizes 1,530,000 shares of common stock. The plan provides for the issuance of either incentive stock options or non-qualified stock options for the purchase of common shares at prices not less than 100 percent of the market value of such shares on the date of grant. The options are exercisable, in whole or in part, after one year but no later than ten years from the date of the respective grant. No accounting recognition is given to stock options until they are exercised, at which time the option price received is credited to common stock.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 15--COMMON STOCK (CONTINUED) Transactions under the stock option plans are summarized as follows:\nAdditionally, the Company's Long-Term Incentive Program provides for contingent awards of restricted shares of common stock and cash to certain key employees. The payment of the cash portion of the awards granted will depend on the extent to which the Company has met certain long-term performance goals as established by a committee of outside directors. The compensation related to this program is amortized over the related five-year restricted periods. The charge (credit) to compensation expense under this plan was $3.6 million, $(1.2) million and $3.6 million in 1994, 1993 and 1992, respectively. In 1993, prior cash awards that had been accrued were deemed to be not payable due to the financial results of the Company. Under the 1992 plan, 1,800,000 shares have been reserved for issuance, of which 249,655, 186,253 and 120,834 shares were granted in 1994, 1993 and 1992, respectively. At December 31, 1994, there were 1,248,376 shares available for grant.\nNOTE 16--RELATED PARTY TRANSACTIONS The Company sells paperboard to various non-consolidated affiliates including MacMillian Bathurst, FCP Group and Laimbeer Packaging Company, each of which is 50 percent owned, and Mannkraft Corporation and ORPACK, each of which is 49 percent owned. Such transactions are primarily at market prices.\nThe following table summarizes the Company's sales to and receivable balances due from its non-consolidated affiliates at the end of each year presented.\nThe Company has outstanding loans and interest receivable from a non-consolidated affiliate of approximately $7.8 million and $3.4 million at December 31, 1994 and 1993, respectively.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 17--ADDITIONAL INFORMATION RELATING TO THE CONSOLIDATED FINANCIAL STATEMENTS\nOTHER OPERATING (INCOME) EXPENSE -- NET:\nThe major components of other operating (income) expense -- net are as follows:\nINTEREST EXPENSE:\nPROVISION FOR DOUBTFUL ACCOUNTS AND NOTES RECEIVABLE:\nSelling, general and administrative expenses include provisions for doubtful accounts and notes receivable of $6.6 million for 1994, $12.2 million for 1993 and $8.3 million for 1992.\nOTHER (INCOME) EXPENSE -- NET:\nThe major components of other (income) expense -- net are as follows:\nASSETS HELD FOR SALE:\nThe Company ceased operations of three wood products facilities in the Pacific Northwest and intends on divesting the assets of these facilities as appropriate opportunities arise during 1995. Accordingly, such net assets of approximately $60 million are included in other current assets within the December 31, 1994 Consolidated Balance Sheet.\nINVESTMENTS IN NON-CONSOLIDATED AFFILIATES:\nThe Company had investments in non-consolidated affiliates of $345.4 million and $107.2 million at December 31, 1994 and 1993, respectively. These amounts are included in other long-term assets in the Company's Consolidated Balance Sheets. See Note 16 for discussion of the transactions between the Company and its major non-consolidated affiliates.\nLONG-TERM NOTE RECEIVABLE:\nThe Company had a net receivable with a domestic customer of approximately $90 million at December 31, 1994. Of this amount, approximately $77 million is included in other long-term assets with the remaining amount reflected in\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 17--ADDITIONAL INFORMATION RELATING TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) accounts and notes receivable in the Company's Consolidated Balance Sheet. The seven year interest bearing note requires quarterly payments which commenced in the first quarter of 1995. The Company believes this note receivable, which is partially guaranteed, is fully recoverable.\nACCRUED AND OTHER CURRENT LIABILITIES:\nThe major components of accrued and other current liabilities are as follows:\nOTHER LONG-TERM LIABILITIES:\nIncluded in other long-term liabilities at December 31, 1994 and 1993 is approximately $47.0 million and $52.3 million, respectively, of deferred income relating to the October 1992 sale of an energy contract at the Company's Hopewell mill. This amount is being amortized over a 12 year period.\nNOTE 18--COMMITMENTS AND CONTINGENCIES At December 31, 1994, the Company, excluding Seminole and SVCPI, had commitments outstanding for capital expenditures under purchase orders and contracts of approximately $75.8 million of which $49.9 million relates to Stone-Consolidated. Seminole and SVCPI had, at December 31, 1994, commitments outstanding for capital expenditures of approximately $.4 million and $.1 million, respectively.\nThe Credit Agreement limits, except in certain specific circumstances, any further investments by the Company in Stone-Consolidated and Seminole. Seminole had incurred substantial indebtedness in connection with project financings and is significantly leveraged. As of December 31, 1994, Seminole had $143.1 million in outstanding indebtedness (including $111.7 million in secured indebtedness owed to bank lenders). Seminole produces 100 percent recycled linerboard and is dependent upon an adequate supply of recycled fiber, in particular old corrugated containers (\"OCC\"). The Company in 1986 entered into an output purchase agreement with Seminole under which it is obligated to purchase and Seminole is obligated to sell to the Company all of Seminole's linerboard production. Under the agreement, the Company paid fixed prices for linerboard, which generally exceeded market prices, until June 3, 1994. Subsequent to that date, the Company began purchasing linerboard at market prices and will continue to do so for the remainder of the agreement which is scheduled to expire on December 31, 2000. Seminole did not comply with certain financial covenants at September 30, 1994 and accordingly, had received waivers and amendments with respect to such covenants from its bank lenders for periods up to and including June 30, 1995. Additionally, Seminole is in the process of seeking and expects to receive future covenant relief from certain of its other financial covenants covering the periods from March 31, 1995 through March 29, 1996. There can be no assurance that Seminole will not require additional waivers in the future or, if required, that the lenders will grant them. Furthermore, in the event that management determines that it is probable that Seminole will not be able to comply with any covenant contained in the Seminole credit agreement within twelve months after the waiver of a violation of such covenant, then certain Seminole debt would be reclassified as short-term debt under the provisions of Emerging Issues Task Force Issue No. 86-30 \"Classification of Obligations When a Violation is Waived By the Creditor\". Depending upon the level of market prices and the cost and supply of recycled fiber, Seminole may need to undertake additional measures to meet its financial covenants and its debt service requirements, including obtaining additional sources of funds or liquidity, postponing or restructuring of debt service payments or refinancing the indebtedness. In the event that such measures are required and are not successful, and such indebtedness is accelerated by the respective lenders to Seminole, the lenders to the Company under the Credit Agreement and various other of its debt instruments would be entitled to accelerate the indebtedness owed by the Company.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 18--COMMITMENTS AND CONTINGENCIES (CONTINUED) Additionally, the Credit Agreement contains cross-acceleration provisions relating to the non-recourse debt of SVCPI. At December 31, 1994, SVCPI had approximately $288 million in secured indebtedness owed to bank lenders. The Credit Agreement allows, under certain specific circumstances, for the Company to make further investments in SVCPI, if necessary.\nUnder certain timber contracts, title passes as the timber is cut. These are considered to be commitments and are not recorded until the timber is removed. At December 31, 1994 commitments on such contracts, which run through 1998, were approximately $8 million.\nThe Company's operations are subject to extensive environmental regulation by federal, state and local authorities in the United States and regulatory authorities with jurisdiction over its foreign operations. The Company has in the past made significant capital expenditures to comply with water, air and solid and hazardous waste regulations and expects to make significant expenditures in the future. Capital expenditures for environmental control equipment and facilities were approximately $53 million in 1994 and the Company anticipates that 1995 and 1996 environmental capital expenditures will approximate $95 million and $67 million, respectively (exclusive of any potential expenditures which may be required if the proposed \"cluster rules\" described below are adopted). Included in these amounts are capital expenditures for Stone-Consolidated which were approximately $32 million in 1994 and are anticipated to approximate $56 million in 1995 and $19 million in 1996. Although capital expenditures for environmental control equipment and facilities and compliance costs in future years will depend on legislative and technological developments which cannot be predicted at this time, the Company anticipates that these costs will increase when final \"cluster rules\" are adopted and as other environmental regulations become more stringent.\nIn December 1993, the U.S. Environmental Protection Agency (the \"EPA\") issued a proposed rule affecting the pulp and paper industry. These proposed regulations, informally known as the \"cluster rules,\" would make more stringent requirements for discharge of wastewaters under the Clean Water Act and would impose new requirements on air emissions under the Clean Air Act. Pulp and paper manufacturers (including the Company) have submitted extensive comments to the EPA on the proposed regulations in support of the position that requirements under the proposed regulations are unnecessarily complex, burdensome and environmentally unjustified. The EPA has indicated that it may reopen the comment period on the proposed regulations to allow review and comment on new data that the industry will submit to the agency on the industry's air toxic emissions. It cannot be predicted at this time whether the EPA will modify the requirements in the final regulations which are currently scheduled to be issued in 1996, with compliance required within three years from such date. The Company is considering and evaluating the potential impact of the rules, as proposed, on its operations and capital expenditures over the next several years. Estimates, based on the currently proposed regulations, indicate that the Company could be required to make capital expenditures of $350-$450 million during the period of 1996 through 1998 in order to meet the requirements of the rules. In addition, annual operating expenses would increase by as much as $20 million beginning in 1998. The ultimate financial impact of the regulations cannot be accurately estimated at this time but will be affected by several factors, including the actual requirements imposed under the final rule, advancements in control process technologies, possible reconfiguration of mills and inflation.\nOn September 30, 1994, the EPA, Region IV, issued an Administrative Order (\"Order\") to the Company's Panama City mill pursuant to Section 3008(h) of the Federal Resource Conservation and Recovery Act (\"RCRA\"), 42 U.S.C. Section6928(h)(l). The Order requires the Company to perform a RCRA Facility Investigation at the Panama City mill together with confirmatory sampling, interim corrective measures and any other activities necessary to correct alleged actual or threatened releases of hazardous substances or hazardous constituents at or from the Panama City mill. The Company has filed a protest and requested a hearing to contest the EPA's RCRA Section 3008(h) jurisdiction over the Pamana City mill. The Company believes that the Panama City mill is not currently a RCRA facility. The corrective measures mandated by the Order would require the Company to conduct extensive groundwater and soil sampling and analyses. The Company does not know at this time the likelihood of success in challenging the Order. Notwithstanding the success in challenging the Order, an owner of property adjacent to the Panama City mill is currently subject to extensive clean-up under RCRA, and the EPA is empowered to require clean-up for materials discharged\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 18--COMMITMENTS AND CONTINGENCIES (CONTINUED) from the property which may have migrated onto the Panama City mill's property. The Company does not yet know the extent, if any, of such adjacent property owner's responsibility to remediate contamination, if any, at the Panama City mill site.\nIn addition, the Company is from time to time subject to litigation and governmental proceedings regarding environmental matters in which injunctive and\/or monetary relief is sought. The Company has been named as a potentially responsible party (\"PRP\") at a number of sites which are the subject of remedial activity under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"CERCLA\" or \"Superfund\") or comparable state laws. Although the Company is subject to joint and several liability imposed under Superfund, at most of the multi-PRP sites there are organized groups of PRPs and costs are being shared among PRPs. Future environmental regulations, including the final \"cluster rules,\" may have an unpredictable adverse effect on the Company's operations and earnings, but they are not expected to adversely affect the Company's competitive position.\nRefer to Notes 10 and 13 for further discussion of the Company's debt, hedging and lease commitments.\nAdditionally, the Company is involved in certain litigation primarily arising in the normal course of business. In the opinion of management, the Company's liability under any pending litigation would not materially affect its financial condition or results of operations.\nNOTE 19--SEGMENT INFORMATION\nBUSINESS SEGMENTS:\nThe Company operates principally in two business segments. The paperboard and paper packaging segment is comprised primarily of facilities that produce containerboard, kraft paper, boxboard, corrugated containers and paper bags and sacks. The white paper and other segment consists primarily of facilities that manufacture and sell newsprint, groundwood paper and market pulp. Intersegment sales are accounted for at transfer prices which approximate market prices.\nOperating profit includes all costs and expenses directly related to the segment involved. The corporate portion of operating profit includes corporate general and administrative expenses and equity income (loss) of non-consolidated affiliates.\nAssets are assigned to segments based on use. Corporate assets primarily consist of cash and cash equivalents, fixed assets, certain deferred charges and investments in non-consolidated affiliates.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 19--SEGMENT INFORMATION (CONTINUED) Financial information by business segment is summarized as follows:\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 19--SEGMENT INFORMATION (CONTINUED) GEOGRAPHIC SEGMENTS:\nThe chart below provides financial information for the Company's operations based on the region in which the operations are located.\nThe Company's export sales from the United States were $476 million, $341 million and $428 million for 1994, 1993 and 1992, respectively.\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nNOTE 20--SUMMARY OF QUARTERLY DATA (UNAUDITED)\nThe following table summarizes quarterly financial data for 1994 and 1993:\nReport of Independent Accountants on Supplemental Financial Information -----------------------------------\nTo the Board of Directors of Stone Container Corporation\nOur audits of the consolidated financial statements referred to in our report dated February 6, 1995 appearing on page 30 of this Annual Report on Form 10-K (such report contains an explanatory paragraph referring to the change in accounting methods discussed in Note 1 to the Company's consolidated financial statements) also included an audit of the Supplemental Financial Information listed and appearing in Item 14(a)2 of this Form 10-K. In our opinion, this Supplemental Financial Information presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\nChicago, Illinois February 6, 1995\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. 33-66086) and in the Registration Statements on Form S-8 (Nos. 2-79221, 33-33784, 33-56345 and 33-66132) of Stone Container Corporation of our report dated February 6, 1995 appearing on page 30 of this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Supplemental Financial Information, which appears on page 61 of this Form 10-K.\nPRICE WATERHOUSE LLP\nChicago, Illinois March 10, 1995\nSTONE CONTAINER CORPORATION AND SUBSIDIARIES SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN MILLIONS)\nSUMMARIZED FINANCIAL INFORMATION--STONE SOUTHWEST, INC.\nShown below is consolidated, summarized financial information for Stone Southwest, Inc. (formerly known as Southwest Forest Industries, Inc.). The summarized financial information for Stone Southwest, Inc. (\"Stone Southwest\") does not include purchase accounting adjustments or the impact of the debt incurred to finance the acquisition of Stone Southwest:\n[LOGO] STONE CONTAINER CORPORATION\n150 North Michigan Avenue Chicago, Illinois 60601-7568\nThis entire report is printed on paper with recycled content. The body of the report is uncoated free sheet paper produced by Stone-Consolidated's Wayagamack mill in Trois-Rivieres, Quebec.","section_15":""}
{"filename":"105598_1994.txt","cik":"105598","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":"797975_1994.txt","cik":"797975","year":"1994","section_1":"ITEM 1. BUSINESS\nSubstantially all of the Company's operations are currently in one business segment, marketing branded appearance enhancement products targeted primarily for the do-it-yourself automotive appearance aftermarket. In January 1994, the Company began marketing a line of branded home care products.\nPrior to May 1993, McKesson Corporation (\"McKesson\") owned approximately 83% of the Company's outstanding shares of common stock. In May 1993, McKesson reduced its ownership level to approximately 57% through a sale of shares to the public. In March 1994, McKesson issued debentures which are exchangeable into additional shares of the Company's common stock owned by McKesson at a price of $25.94 per share at any time through February 2004, subject to McKesson's right to pay cash equal to the market price of the stock in lieu of making the exchange. If all such debentures were actually exchanged, McKesson's ownership level would be reduced to approximately 25%.\nPRODUCTS\nThe Company develops and markets a broad line of automotive appearance chemicals under four brand names: Armor All\/(R)\/, Rain Dance\/(R)\/, Rally\/(R)\/ and No. 7\/(R)\/. The Company also markets home care products under the E-Z Deck Wash\/ (R)\/ and E-Z D\/TM\/ brand names.\nArmor All Brand\nThe Company develops and markets protectants, waxes, washes and other cleaning aids under the Armor All name.\nThe Company's principal product, Armor All\/(R)\/ Protectant, is designed to protect and beautify natural and synthetic polymer materials and is primarily used on automobile surfaces made of rubber, vinyl and plastic, such as dashboards, seats, vinyl tops, door panels, tire sidewalls and rubber bumpers. Sales of Armor All Protectant, including the new low-gloss version mentioned below, accounted for 68% and 70% of the Company's revenues in fiscal 1994 and 1993, respectively.\nArmor All\/(R)\/ Tire Foam\/(R)\/ Protectant, introduced in November 1991, is designed to clean, shine and protect tire sidewalls without wiping. Armor All\/(R)\/ Leather Care Protectant, also introduced in November 1991, is designed primarily for leather upholstery. The Company also markets a liquid car wax, a multi-purpose cleaner, and a car wash liquid concentrate under the Armor All name.\nIn December 1993, the Company began shipping three new products under the Armor All brand name: Armor All Protectant Low-Gloss Natural Finish\/TM\/, a low-gloss version of Armor All Protectant designed to minimize dashboard glare for consumers who prefer a less shiny appearance; Armor All\/(R)\/ QuickSilver\/TM\/ Wheel Cleaner, a spray-on wheel cleaner designed for use on wheels, wheel covers and hubcaps; and Armor All \/(R)\/ Spot & Wash\/TM\/ Concentrate, a car wash product designed to remove bugs, tar residue and tree sap from car finishes.\nRain Dance Brand\nThe Company markets polishes, waxes and car wash products under the Rain Dance name. In November 1991, the Company introduced Rain Dance\/(R)\/ Advanced Formula\/TM\/ Car Polish, and in January 1993, the Company introduced two additional car polishes, Rain Dance\/(R)\/ Light Car Formula Polish and Rain Dance\/(R)\/ Dark Car Formula Polish, with different light reflectant characteristics. Liquid and paste car wax and a variety of car wash products are also marketed under the Rain Dance name.\nRally and No. 7 Brands\nThe Company markets cream and liquid waxes under the Rally name. Under the No. 7 name, the Company markets a variety of polishing and rubbing compounds and other cleaning aids.\nE-Z Deck Wash and E-Z D Brands\nThe Company acquired the E-Z Deck Wash and E-Z D brands on January 28, 1994. The E-Z Deck Wash product cleans and restores wood surfaces such as patio decks, siding and fences. Products in the E-Z D line include a vinyl wash, a paint preparation treatment, a roof wash , an aluminum wash and a mobile home\/recreational vehicle wash. The E-Z Deck Wash and E-Z D products are being marketed under the Armor All name.\nGEOGRAPHIC MARKETS\nThe Company's products are sold predominantly in the United States and Canada, with additional sales occurring in 70 other countries. In fiscal 1994, 86% of sales were in the United States, 6% in Canada and 8% in other foreign countries, principally Australia, Germany, Japan, Mexico and the United Kingdom. The Company does not have large fixed capital investments in its foreign operations. Foreign currency exchange fluctuations have not had a significant impact on the Company's operating results.\nSALES AND MARKETING\nIn the United States and Canadian automotive appearance market, a sales force of 13 employees accounted directly for over 50% of the Company's revenues in fiscal 1994. In addition, the Company's sales force oversees 21 independent manufacturers' representative organizations that also market the Company's products. Primary customers include mass merchandise retailers, auto supply stores, warehouse clubs, hardware stores and other retail outlets. The Company believes that its automotive appearance products are sold at over 100,000 retail outlets.\nIn the United States home care market, a sales force of 4 employees oversees 18 manufacturers' representative organizations that market the Company's products. Primary customers include home centers, warehouse clubs, mass merchandise retailers and hardware stores. In Canada, the Company licenses the distribution of its home care products to an independent sales agency.\nThe Company's largest customers represent an increasing percentage of its revenues. Sales to the Company's 20 largest customers accounted for 65%, 63% and 59% of the Company's consolidated revenues in fiscal 1994, 1993 and 1992, respectively. Sales to the Company's two largest customers, Wal-Mart Stores, Inc. (and its affiliates) and Kmart Corporation (and its affiliates), accounted for the following respective percentages of the Company's revenues: 17% and 8% in fiscal 1994, 15% and 11% in fiscal 1993, and 12% and 11% in fiscal 1992.\nThe Company's direct sales force works closely with the Company's largest customers on joint marketing and promotional activities. The Company also assists its customers with inventory management supported in certain cases, by electronic data interchange (\"EDI\") links between the Company and the customer. In addition, EDI provides the Company with valuable marketing information. Among other things, the Company uses EDI point-of-sale statistics to analyze geographic purchase patterns, measure the success of test marketing programs and monitor sales of holiday gift packs and other time-sensitive promotions.\nThe Company's management assists in sales and marketing efforts by providing national advertising and promotional support and retail merchandising management assistance, including product information and sales training. The Company's promotional activities target both trade accounts and retail consumers. Over the past three years, the Company has increased the proportion of marketing funds which are offered to trade customers as fixed sums in return for specific promotional activities, as opposed to more general cooperative advertising arrangements. From time to time, the Company uses various retail sales incentive devices, such as coupons, rebates, \"Bonus Packs\" (e.g., 10 ounces for the price of 8), merchandise with attached free samples, and other special offers to stimulate retail sales.\nRetail sales of the Company's products are seasonal and are highest between April and September. However, sales to the Company's customers are highest in its fourth fiscal quarter (from January through March). Consistent with industry practice, the Company offers extended payment terms in conjunction with its winter promotional activities.\nInternational sales are effected through sales offices in Canada and the United Kingdom, through foreign distributors, and through a marketing and distribution alliance with S. C. Johnson & Son, Inc. Under an agreement between the Company and S.C. Johnson, S. C. Johnson is the exclusive distributor of Armor All Protectant and certain of the Company's other products in Germany, Japan and Mexico, subject to agreement with the Company on annual business and marketing plans for each country. Under the agreement, S. C. Johnson pays virtually all selling and marketing expenses, and the Company and S.C. Johnson share in the profits or losses. The S.C. Johnson agreement expires in June 2001, with automatic five-year renewals unless either party provides 12 months' prior notice. The Company will have the right to terminate the agreement on a country-by-country basis if S.C. Johnson fails to meet certain revenue objectives over specified periods, subject to S.C. Johnson's right to avoid termination by compensating the Company for any shortfall. S. C. Johnson is also the exclusive distributor of Armor All Protectant in several Southeast Asian countries under separate agreements that do not involve profit or loss sharing.\nMANUFACTURING AND PACKAGING\nThe Company's products are manufactured by contract packagers. The Company's relationships with its three most important packagers have lasted for 6, 9 and 21 years, respectively. Subject to contractual arrangements, the Company periodically reevaluates its selection of packagers and believes that other acceptable packagers are readily available.\nThe Company avoids significant investments in inventory. In general, the Company's full-service packagers are responsible for purchasing product ingredients and approved component packaging materials. The Company negotiates the raw material supply arrangements on behalf of its packagers. The packagers blend, package and warehouse the finished product. With certain exceptions, the full-service packagers own all the raw materials and finished products in their possession and transfer title to the Company just prior to shipment to the Company's customers. In the case of Armor All Protectant and Armor All Tire Foam Protectant, the Company premixes a concentrate which it sells to the full- service packagers. For certain other products, the Company has title to raw materials and finished products and pays a manufacturing fee to the packager.\nThe Company's products are manufactured in five principal locations in the United States, one location in Canada and one location in Australia. Protectants are manufactured at five of these locations, waxes at one location, and home care products at the other location. Management believes that the existing packagers can accommodate the Company's production needs for the foreseeable future.\nThe Company has alternative sources for the ingredients used in, and packaging components for, all of its products. The Company has contracts with certain suppliers to provide a continued supply of the primary chemical ingredients and packaging components used in producing its products, which expire by their terms on various dates through March 1995.\nTRADEMARKS AND PATENTS\nThe Company's principal trademarks are:\n. ARMOR ALL(R) . Symbol of a male VIKING figure surrounded by a rainbow design . Symbol of a male VIKING figure surrounded by a sunburst design . RAIN DANCE(R) . RALLY(R) . NO. 7(R) . E-Z DECK WASH(R) . E-Z D\/TM\/\nThe Company also owns other registered and unregistered trademarks. All of the principal trademarks are registered in the United States and Canada. The ARMOR ALL and VIKING trademarks are also registered in over 80 other countries. All of the other principal trademarks are also registered in at least several other countries. The Company believes it has taken all necessary steps to preserve the registration of its trademarks.\nThe Company also owns a process patent on ARMOR ALL Protectant and a patent on RAIN DANCE wax, and has applied for patents on ARMOR ALL QuickSilver Wheel Cleaner and ARMOR ALL Spot & Wash Concentrate. In addition, the Company owns a patent on an E-Z DECK WASH product and has other domestic and foreign E-Z DECK WASH patents pending. The Company's process patent on ARMOR ALL Protectant will expire in 1996. Management believes that the Company's trademarks are more important assets than its patents, and that the termination or invalidity of its patents would not have a materially adverse effect on the Company.\nCOMPETITION\nIn the domestic protectant market, the Company has two principal competitors, STP\/(R)\/ Son-of-a-Gun\/(R)\/ Protectant and Turtle Wax\/(R)\/ Formula 2001\/(R)\/, and several secondary competitors. Armor All Tire Foam Protectant has three principal competitors, Turtle Wax\/(R)\/ Formula 2001, STP\/(R)\/ Son-of- a-Gun\/(R)\/ Tire Care and No Touch\/(R)\/, and several secondary competitors. Armor All brand cleaner competes against many specialty automotive cleaner products. Armor All brand wax and wash products and all of the Rain Dance and Rally brand products compete with numerous wash, wax and polish products in the automotive aftermarket. The No. 7 brand products compete with many wash and specialty cleaning products. Competition in international markets varies by country.\nIn the domestic home care products market, the E-Z Deck Wash and E-Z D brand products have two principal competitors, Thompson's\/(R)\/ Deck Wash and Olympic\/(R)\/ Deck Cleaner, and several secondary competitors.\nEMPLOYEES\nAt March 31, 1994, the Company employed 128 persons. None are represented by unions. The Company believes its employee relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns its headquarters facility located in Aliso Viejo, California. The facility, which was built in 1989, comprises 45,000 square feet of office space on a 4.6 acre site.\nThe Company also leases approximately 17,000 square feet of warehouse space in Aliso Viejo, California. The facility is used primarily for warehousing certain components, finished goods and promotional items. The Company also mixes the Armor All Protectant and Armor All Tire Foam Protectant concentrates and performs various special product-packaging functions at this location. The Company utilizes limited space in various public warehouses in the United States and abroad for temporary inventory storage and shipping.\nThe Company maintains sales offices in Tennessee, Canada and the United Kingdom, each with less than 2,000 square feet. It conducts its laboratory research and development activities at a leased facility of approximately 5,000 square feet located near the Company's headquarters in Aliso Viejo, California.\nThe Company believes that these properties will be sufficient to meet its needs for the next several years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn addition to commitments and obligations which arise in the ordinary course of business, the Company is subject to various claims, proceedings and legal actions from time to time involving contracts, competitive practices, advertising claims, trademark rights, product liability claims, tax assessments and other matters arising out of the conduct of the Company's business. Management believes that, based on current knowledge, the outcome of any such pending matters 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\nNo matters were submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended March 31, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth information concerning the executive officers of the Registrant as of June 1, 1994.\nThere are no family relationships between any of the executive officers or directors of the Registrant. The executive officers 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 have qualified, or until death, resignation or removal, whichever is sooner.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\n(A) MARKET INFORMATION\nThe Company's Common Stock, par value of $0.01 per share, is traded in the over-the-counter market under the symbol ARMR. The high and low closing prices reported by the NASDAQ National Market System appear in financial note 12, \"Quarterly Financial Information\" (unaudited) on page 23 of the 1994 Annual Report to Stockholders, which information is incorporated by reference.\n(B) HOLDERS\nThe approximate number of record holders of the Company's common stock as of May 15, 1994 was 350. The estimated number of beneficial holders was 2,500.\n(C) DIVIDENDS\nDividend information is included in financial note 12, \"Quarterly Financial Information\" (unaudited) on page 23 of the 1994 Annual Report to Stockholders, which information is incorporated by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected financial data appear on page 1 of the 1994 Annual Report to Stockholders, which information is incorporated 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 appears in the section entitled \"Financial Review\" on pages 12 to 14 of the 1994 Annual Report to Stockholders, which information is incorporated by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements appear on pages 15 to 24 of the 1994 Annual Report to Stockholders, which financial statements 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 with respect to Directors of the Company is incorporated by reference from the Registrant's 1994 Proxy Statement. Certain information relating to Executive Officers of the Company appears on page 5 of this Form 10- K Annual Report. The information with respect to this item required by Item 405 of Regulation S-K is incorporated by reference from the Company's 1994 Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to this item is incorporated by reference from the Registrant's 1994 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to this item is incorporated by reference from the Registrant's 1994 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to certain transactions with McKesson and management is incorporated by reference from the Registrant's 1994 Proxy Statement.\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\nThe following consolidated financial statements of the Company, other financial information and independent auditors' report are contained in the 1994 Annual Report to Stockholders and are incorporated by reference.\nFinancial statements and schedules not included or incorporated by reference herein have been omitted because of the absence of conditions under which they are required or because the required information, where material, is shown in the financial statements, financial notes or supplementary financial information.\nSee Exhibit Index on pages 15 and 16.\nThe following exhibits listed on the Exhibit Index are included herein:\n(3)B By-Laws of the Company as amended through March 21, 1994.\n(10)A Services Agreement dated as of July 1, 1986 between the Company and McKesson, as amended through March 23, 1993.\n(10)E Form of Termination Agreement dated as of May 15, 1994 between the Company and certain executive officers.\n(10)N Armor All Products Corporation Supplemental Profit-Sharing Investment Plan adopted August 1, 1989.\n(10)P Letter Agreement dated November 4, 1993 amending the Distribution Agreement between S.C.Johnson & Son, Inc. and the Company (portions of which are not disclosed pursuant to the Company's request for confidential treatment).\n(10)Q Asset Purchase and Sale Agreement dated January 26, 1994 between Agri-Products Special Markets, Inc. and the Company (portions of which are not disclosed pursuant to the Company's request for confidential treatment).\n(13) Portions of the Company's Annual Report to Stockholders for the fiscal year ended March 31, 1994.\n(21) Subsidiaries of the Registrant.\n(23) Independent Auditors' Consent.\n(B) REPORTS ON FORM 8-K\nThere were no reports filed on Form 8-K during the quarter ended March 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.\nARMOR ALL PRODUCTS CORPORATION Dated: May 17, 1994 ------------\nBy \/s\/Kenneth M. Evans -------------------------------------- Kenneth M. Evans President and Chief Executive Officer\nBy \/s\/Mervyn J. McCulloch -------------------------------------- Mervyn J. McCulloch Executive Vice President and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on May 17, 1994 by the following persons on behalf of the Registrant and in the capacities indicated.\ns\/William A. Armstrong \/s\/David E. McDowell - - - -------------------------------- ---------------------------------- William A. Armstrong, Director David E. McDowell, Chairman of the Board and Director\n\/s\/Jon S. Cartwright \/s\/Karen Gordon Mills - - - -------------------------------- ---------------------------------- Jon S. Cartwright, Director Karen Gordon Mills, Director\n\/s\/Kenneth M. Evans \/s\/Joseph A. Sasenick - - - -------------------------------- ---------------------------------- Kenneth M. Evans, President Joseph A. Sasenick, Director and Chief Executive Officer and Director\n\/s\/David L. Mahoney - - - -------------------------------- ---------------------------------- David L. Mahoney, Director Alan Seelenfreund, Director\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Director and Stockholders of Armor All Products Corporation:\nWe have audited the consolidated financial statements of Armor All Products Corporation and subsidiaries 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 April 22, 1994; 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 consolidated financial statement schedules of Armor All Products Corporation, listed in Item 14(a). 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.\nDELOITTE & TOUCHE Costa Mesa, California April 22, 1994\nSCHEDULE II\nARMOR ALL PRODUCTS CORPORATION AMOUNTS 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: (1) Consists of a promissory note secured by real property in Southern California. The principal amount of the note is due on the earlier of the date the real property is sold or February 15, 1996. Interest is payable monthly at 3.875% through August 15, 1994 and at rates thereafter based on a specified market rate, subject to a maximum increase of 1.0% in any six-month period.\n(2) Includes a $450,000 loan used by the employee in connection with his purchase of real property in Southern California after beginning employment with the Company. The loan, which has been fully repaid, was unsecured and noninterest-bearing.\n(3) Represents a noninterest-bearing relocation loan which has been fully repaid.\nSCHEDULE VIII\nARMOR ALL PRODUCTS CORPORATION VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992 (IN THOUSANDS)\n*Included as a reduction of Accounts Receivable in the consolidated balance sheets.\nSCHEDULE X\nARMOR ALL PRODUCTS CORPORATION SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nAll other items required by Rule 12-11 of Regulation S-X are omitted because they are disclosed in the consolidated financial statements or are less than 1% of total revenues.\n* Document has heretofore been filed with the Commission and is incorporated by reference and made a part hereof.\nExecutive Compensation Plans and Arrangements ---------------------------------------------\nArmor All Products Corporation 1986 Stock Option Plan as amended through January 21, 1993 - Exhibit (10)I to Form 10-K Report for the fiscal year ended March 31, 1993.\nArmor All Products Corporation Deferred Compensation Administration Plan - Exhibit (19)C to Form 10-Q Report for the quarter ended December 31, 1987.\nArmor All Products Corporation 1988 Restricted Stock Plan as amended through July 23, 1993 - Exhibit (10) to Form 10-Q Report for the quarter ended June 30, 1993.\nArmor All Products Corporation 1988 Long-Term Incentive Plan as amended through November 28, 1990 - Exhibit (10)N to Form 10-K Report for the fiscal year ended March 31, 1991.\nArmor All Products Corporation 1989 Short-Term Incentive Plan - Exhibit (10)P to Form 10-K Report for the fiscal year ended March 31, 1989.\nArmor All Products Corporation Supplemental Profit-Sharing Investment Plan - Exhibit (10)N to Form 10-K Report for the fiscal year ended March 31, 1994.\nForm of Employment Agreement dated as of April 15, 1991 between the Company and its President and Chief Executive Officer - Exhibit (10)D to Form 10-K Report for the fiscal year ended March 31, 1991.\nForm of Termination Agreement between the Company and its President and Chief Executive Officer - Exhibit (10)F to Form 10-K Report for the fiscal year ended March 31, 1991.\nForm of Termination Agreement between the Company and certain executive officers - Exhibit (10)E to Form 10-K Report for the fiscal year ended March 31, 1994.\nDATA STATED IN MILLIONS\nARMOR ALL PRODUCTS CORPORATION VOLUNTARY SCHEDULE - CERTAIN FINANCIAL INFORMATION","section_15":""}
{"filename":"804124_1994.txt","cik":"804124","year":"1994","section_1":"ITEM 1. BUSINESS\nInvestors Bank Corp. is a savings and loan holding company incorporated under Delaware law and headquartered in Minneapolis, Minnesota. Investors Bank Corp.'s principal asset consists of all the outstanding capital stock of Investors Savings Bank, F.S.B. (the \"Bank\"), a federally chartered savings bank formed in June 1984. The Bank is the second largest thrift institution in Minnesota based on assets. Unless the context otherwise requires, Investors Bank Corp. together with its consolidated subsidiary, the Bank, are herein referred to as \"Investors\" or the \"Company.\"\nAt a special meeting on March 15, 1995, the Company's stockholders approved a merger agreement with Firstar Corporation and Firstar Corporation of Minnesota (Firstar Minnesota) under which the Company will be merged with and into Firstar Minnesota. The merger is expected to be consummated on April 28, 1995. For additional information see Item 7 -- \"Management's Discussion and Analysis -- Merger Agreement\" and Item 8 -- Notes 2 and 14 of Notes to Consolidated Financial Statements.\nThe Company currently operates twelve retail banking offices and seven mortgage production offices in the Minneapolis-St. Paul metropolitan area, mortgage production offices in Duluth and Rochester, Minnesota, one mortgage production office in a Milwaukee suburb, and four mortgage production offices in the Chicago region. Since commencement of its operations in 1984, the Company has focused on the retail banking business of attracting deposits from the general public within the communities it serves, and on originating and investing in, or selling and servicing, loans secured by mortgages on residential property primarily in the same communities. The Company's operations, however, are distinguishable from many other thrift and community banking institutions by a proportionately large and active mortgage banking organization. In its primary market, the twin cities of Minneapolis and St. Paul, the Company is one of the largest originators of residential mortgages.\nThe Company's operations during the year ended December 31, 1994 were negatively affected by increased market interest rates and a low level of mortgage banking activity. Net interest margins, which had increased to a record high level in 1992, declined during 1993 and 1994. The decline in 1993 resulted from asset yields repricing more rapidly than liability cost repricings. In 1994 liabilities repriced upwards as market interest rates increased, but asset repricings were limited by annual caps on the adjustable rate mortgages (\"ARMs\") in the Company's portfolio. The increased market interest rates contributed to a significant decline in mortgage banking activity and the related income. Because of continuing demand for ARMs, the Company's interest earning assets increased 15% between December 31, 1993 and 1994, and contributed significantly to the increased net interest income. See Item 7 -- \"Management's Discussion and Analysis\" for a complete discussion of 1994 operating results.\nLENDING\nGENERAL. As a federally chartered savings bank, the Bank is authorized by Federal law to invest without limitation in loans secured by residential real property and by savings accounts, in government securities, in Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) and Government National Mortgage Association (GNMA) securities, in deposits insured by the Federal Deposit Insurance Corporation (FDIC), in securities of states or municipalities, and in various liquid investments. In addition, the Bank may invest in loans secured by commercial real estate to the extent of 400% of its capital; in secured and unsecured commercial, corporate, business and agricultural loans to the extent of 10% of its assets; in secured and unsecured consumer loans to the extent of 35% of its assets; in education loans, nonconforming loans, and unsecured construction loans each to the extent of 5% of its assets; and in service corporations to the extent of 2% of its assets. The Company is in compliance with all the above requirements.\nDespite this broad investment authority, the Company, through the Bank, has historically conducted primarily the traditional savings and loan business of originating, purchasing, holding and selling residential real estate loans. During the past few years, the Company has also placed increasing emphasis on consumer loans originated through its retail banking offices.\n- 1 -\nThe following table sets forth the composition of the Company's loan portfolio at December 31 by type of loan:\nBecause virtually all of the loans retained by the Company are ARMs or other loans that are prime related, 97.1% of the Company's loan portfolio adjusts periodically in accordance with market interest rates. See Item 7 -- \"Management's Discussion and Analysis -- Asset\/Liability Management and Interest Rate Risk.\" Nevertheless, because most of the loans originated by the Company are 15 or 30 year residential loans with principal payments that amortize over the loan period and are relatively young, a majority of the principal payments on the Company's loans are due (or \"mature\") in more than 10 years. The following table sets forth the contractual principal maturities of the Company's assets at December 31, 1994:\nRESIDENTIAL MORTGAGE LENDING. Residential mortgage lending constitutes the vast majority of the Company's lending activities. One to four family residential mortgage loans comprised 85.2% of the Company's loan portfolio at December 31, 1994. Loans secured by residential real estate generally have presented a lower level of credit risk than consumer loans or loans secured by commercial properties.\nSubstantially all of the residential first mortgage lending activities of the Company are conducted out of the Company's mortgage production offices. The Company originates mortgages on one to four family residential properties for inclusion in the Company's loan portfolio or for sale in the secondary market. Although the Company has authority to make loans secured by real property throughout the United States, because of its desire to\n- 2 -\nmaintain close control over such activities and because of the relatively stable markets they represent, substantially all of the loans originated by the Company are secured by real property in the metropolitan areas of Minneapolis-St. Paul, Duluth, Rochester, Milwaukee and Chicago.\nMost of the Company's loans are originated by loan officers through contacts with local realtors and builders rather than through direct solicitation. Before funding a mortgage loan, employees process applications, perform a credit review (including verification of employment, credit standing and personal assets), obtain an appraisal of the property to be financed and obtain title insurance in the Company's favor. At the time an application is accepted, the Company collects a deposit on loans for appraisal and credit reports. At the loan closing, the Company advances an amount equal to the principal amount of the mortgage less a discount based on its loan pricing policies. In addition, the borrower pays the Company an origination fee for its services, which is normally equal to one percent of the principal amount of the mortgage.\nSubstantially all mortgage loans secured by one to four family residential properties originated by the Company conform to established Federal Housing Authority (FHA), Veterans Administration (VA), FHLMC and FNMA guidelines and include both fixed rate and adjustable rate loans. Loan size, occupancy\/ownership characteristics, appraisal requirements and loan-to-value relationships are determined by internal policy and secondary marketing guidelines. The Company's internal policy requires that a loan that exceeds 80% of the value of the secured property be made only if it is insured by a FNMA or FHLMC qualified insurer. Second mortgage loans are generally made in an amount in excess of unpaid prior mortgages, liens and encumbrances on the property, and do not exceed the lesser of 80% of the fair market value of the property or the purchase price of such property.\nThe Company retains for its own loan portfolio most of the ARMs it originates. At December 31, 1994, the Company's portfolio consisted of $842.2 million principal amount of first mortgage loans and $11.6 million principal amount of second mortgage loans. The Company offers a variety of ARM plans, including ARMs that reprice every six months and every year. For a portion of the one year ARM loans, the interest rate is fixed for an initial two-year or three-year period. At December 31, 1994, 99.5% of the Company's ARMs were set to reprice based upon a fixed margin over the weekly average yield of treasury securities generally having a maturity equal to the repricing period of the ARMs. All ARMs originated by the Company are subject to a lifetime cap on the maximum interest rate they may bear (currently ranging from 12-5\/8% to 13-3\/8%) and to caps on the maximum amount that they may adjust during any repricing period (currently 1% for a 6 month ARM and generally 2% for a one year ARM). The Company's ARMs do not contain due on sale clauses but are instead assumable by qualified buyers. The Company's ARMs generally provide for an increase or decrease in loan payments at the end of each repricing period to an amount that will amortize the loan over its remaining term at the adjusted interest rate. Although this avoids negative amortization, during periods of rapidly increasing interest rates it could result in significant increases in a borrower's monthly mortgage payments.\nSubstantially all long-term fixed-rate mortgages and government insured ARMs originated by the Company are sold in the secondary market or pooled and sold as mortgage-backed securities. Conventional fixed-rate loans may be sold to FHLMC, FNMA or other investors. Most FHA and VA mortgage loans originated by the Company have been placed in mortgage pools backing GNMA mortgage pass-through certificates. The Company also pools conventional mortgages to back FHLMC participation certificates and to back FNMA pass-through securities.\nTo increase its servicing portfolio, the Company purchases newly originated mortgage loans from correspondents and pools the loans to support mortgage-backed securities. The same underwriting criteria are applied to correspondent loans as loans originated by the Company.\n- 3 -\nThe following table sets forth the residential real estate lending and loan purchase and sale activities of the Company for the year ended December 31:\nA gain or loss may be realized on the sale of a loan in the secondary market depending on whether the mortgage is sold at a principal amount above or below the amount advanced by the Company and, in the case of loans on which the Company has retained the servicing, on whether the servicing fees over the life of the loan exceed a normal servicing fee (\"excess servicing fees\"). For \"covered loans\" (loans for which the Bank has obtained a purchase commitment when it executes a pricing commitment), the Company may originate loans above the sales price and incur a marketing loss. The value of the servicing that is retained and the resulting servicing fee income or gain on sale of servicing rights has exceeded such marketing loss to the Company. During periods of high volume loan production and rapidly increasing rates, the Company's ability to match pricing commitments with purchase commitments may be impaired and marketing losses may occur which would reduce gain on sales of mortgage loans.\nSERVICING. The Company retains all of the servicing on private investor ARM loan sales, and a portion of the servicing on GNMA securities and other mortgage-backed securities. The Company collects principal and interest payments and remits them, less a servicing fee, to holders of the mortgages or mortgage-backed securities. The Company also deposits property taxes and insurance payments which it receives in escrow accounts until such payments are due. For such servicing, the Company typically collects a servicing fee ranging from 1\/4% to 1\/2% of the outstanding principal balance of the mortgage per year.\nThe following table sets forth certain information regarding the Company's servicing for the year ended December 31:\nThe Company has capitalized as a deferred charge the discounted present value of the amount by which future servicing fees it is entitled to collect exceeds a normal market rate servicing fee. These capitalized fees are\n- 4 -\namortized as fees are collected. The amount that is capitalized is adjusted based on certain prepayment assumptions. If the actual prepayments exceed the Company's assumptions, charge-offs of amounts capitalized may be necessary.\nSince 1988, the Company has sold loan servicing rights to offset the cost of originating mortgage loans and provide noninterest income. The Company may deviate from this policy periodically because of market fluctuations in the pricing of loan servicing rights. When it elects to sell servicing rights, the Company normally contracts with a broker and submits a portion of its servicing portfolio for competitive bids. The broker contacts other financial institutions and mortgage banking companies through circulation of a disclosure document describing the servicing to be sold and the minimum sale terms. As part of the Merger Agreement, the Company agreed not to sell any loan servicing rights after the third quarter of 1994.\nCONSUMER LENDING. A Federal savings institution such as the Bank is authorized to make secured or unsecured consumer loans in various forms including home equity loans, home improvement loans, loans secured by deposit accounts, car loans, boat loans and personal lines of credit. These loans generally have a higher degree of credit risk than residential mortgage loans and the Company maintains a higher level of general reserves for loan losses. At December 31, 1994, consumer loans totaled $117.2 million or 11.7% of the Company's permanent loan portfolio.\nSince 1990 the Company has placed increased emphasis on consumer lending and has located consumer lending officers in most of its retail banking offices. Approximately 89.5% of the Company's consumer loans at December 31, 1994 were home equity loans secured by residential real estate. To expand its home equity loan origination, the Company has periodically offered special programs, such as a low fee home equity loan program in which the Company does not charge for appraisals or origination fees. In addition, during 1993 the Company established a home improvement lending division, and during 1994, an alternative lending division was created to offer 1st and 2nd mortgage loans to individuals with a past credit problem. The Company's policy is to make home equity loans which, when combined with the balance of the first mortgage on the same property, do not exceed 80% of the property's appraised value. Private mortgage insurance is obtained for any loans which exceed such limit.\nConsumer loans are also made for other housing related expenditures as well as to finance education, debt consolidation, and major purchases, such as autos, boats, recreational vehicles and vacation homes. Loan products are marketed through the local media, direct mail, point of sale advertising in the retail banking offices, and solicitation of the Company's existing mortgage customer base.\nSince commencement of operations, the Company has also had a private banking department through which it makes consumer loans and a limited amount of business purpose loans. A majority of such loans are made to upper income, high net worth individuals on both a secured and unsecured basis. The Company's private banking department generally processes applications for such loans, performs credit checks and monitors delinquencies.\nCOMMERCIAL REAL ESTATE LENDING. Because of competitive markets and the treatment of commercial real estate loans under risk-based capital regulations, the Company eliminated commercial real estate lending as a separate lending activity in early 1989. The commercial real estate loans originated prior to 1989 consist primarily of loans secured by apartment complexes and small retail shopping malls in the Minneapolis-St. Paul metropolitan area. The Company maintains a higher general loss reserve on commercial real estate loans, which represent a higher credit risk, than residential real estate loans. Most of the Company's commercial real estate loans are adjustable rate loans that reprice annually, mature in ten years and are paid based on a 30-year amortization schedule. At December 31, 1994, the Company's commercial real estate loans totaled approximately $31.4 million, or 3.1% of its permanent loan portfolio.\nCONSTRUCTION LENDING. The Company makes a limited amount of construction loans to established home builders in the Minneapolis-St. Paul metropolitan area. There were $219 thousand in outstanding construction loans and an additional $100 thousand in commitments to home builders at December 31, 1994. In addition, the Company occasionally makes construction loans directly to homeowners, which are often secured by collateral in addition to the subject real estate, through its private banking department. At December 31, 1994, the Company had\n- 5 -\n$578 thousand outstanding and additional commitments of $602 thousand for such construction loans to homeowners.\nDELINQUENT LOANS. When a borrower fails to make a required payment on a mortgage loan, the loan is considered delinquent and, after expiration of the applicable cure period, the borrower is charged a late fee. The Company follows practices customary in the banking industry in attempting to cure delinquencies and in pursuing remedies upon default. Generally, if the borrower does not cure the delinquency within 90 days, the Company initiates foreclosure action. During foreclosure and the statutory redemption period, such property is carried in the \"real estate in judgment\" account and included in \"foreclosed real estate.\" If the loan is not reinstated, paid in full or refinanced, the collateral is sold. The Company is often the purchaser. In such instances, acquired property is carried in the Company's \"real estate owned\" account, also part of \"foreclosed real estate,\" until the property is sold.\nAll residential mortgage loans delinquent for 90 days or more are considered nonaccrual. Commercial real estate loans are considered non accrual when collection of interest is doubtful.\nThe Company includes in nonperforming assets all nonaccrual loans and foreclosed real estate, both net of specific reserves.\nThe following table summarizes the Company's nonperforming assets at December 31:\nSee Item 7 -- \"Management's Discussion and Analysis -- Nonperforming Assets\" for discussion on these properties and an analysis of the changes in nonperforming assets.\nRESERVES FOR LOAN AND REAL ESTATE LOSSES. The reserves for losses provide for potential losses in the Company's loan and real estate portfolios. The reserves are increased by the provision for losses and recoveries and decreased by charge-offs. The adequacy of the reserves is judgmental and is based on continual evaluation of the nature and volume of the loan and real estate portfolios, overall portfolio quality, specific problem loans, collateral values, historical experience and current economic conditions that may affect borrowers' ability to pay. Pursuant to regulations governing the classification of assets, insured institutions such as the Bank are required to classify troubled assets as \"substandard,\" \"doubtful,\" and \"loss.\" Institutions must establish specific loss reserves for assets classified as doubtful and loss and the Office of Thrift Supervision (OTS) through their examinations may require an increase in the institution's reserve for loan and real estate losses if the examiner concludes such reserves are inadequate. In December 1993, the OTS completed a routine examination of the Bank. No additions to loss reserves were required following this examination. At December 31, 1994, the Company had classified $4.5 million, $50\n- 6 -\nthousand and $386 thousand of its assets as substandard, doubtful and loss, respectively. For information on interest income excluded on nonaccrual loans see Item 8 -- Note 5 of Notes to Consolidated Financial Statements.\nThe following table sets forth information regarding the Company's reserve for loan losses for the year ended December 31:\nAs the foregoing table illustrates, the Company's reserve for loan losses has increased over the periods presented as the Company's loan portfolio has increased. The provision for loan losses over the periods presented reflects both recent experience in charge-offs, and a reevaluation of the methods of establishing the reserve for loan losses in 1990. In 1990, the Company established for the first time an unallocated general reserve for unforeseen loan losses and a general reserve for losses on performing real estate.\nThe following tables present the separate reserves allocated for each category of loans and those allocated reserves as a percentage of the Company's total loan portfolio at December 31:\nAs discussed in Item 7 -- \"Management's Discussion and Analysis -- Analysis of Reserves for Loan and Real Estate Losses,\" the Company changed its method of calculating its loan loss in 1994. The most significant\n- 7 -\neffects of this change were to reduce the amount of reserve attributable to residential real estate and increase the unallocated portion of the reserve. The Company's portfolio continues to consist primarily of residential real estate loans and the reserve for losses allocated to residential real estate loans reflects the low loss experience associated with these loans. Residential real estate loans are well collateralized and property values have remained stable in the markets the Company lends in. The reserve for losses allocated to commercial real estate loans reflects the higher credit risk associated with commercial real estate lending. The reserve for losses allocated to consumer loans has grown as outstandings have grown.\nThe following tables present the allocation of the reserve for real estate losses and those allocated reserves as a percentage of the foreclosed real estate as of December 31 for the years indicated:\nThe reserve for real estate losses reflects the decline in commercial real estate values in 1990. In 1991 and 1992 the reserve was increased for a specific commercial retail property. In 1993 the reserve decreased because of the charge-off related to the disposal of that property. While several other commercial properties were disposed of at minimal loss in 1994, the remaining properties each had certain characteristics reducing their marketability. Accordingly, the increased 1994 reserve reflects this increased risk.\nINVESTMENT PORTFOLIO\nAlthough the Company has authority to make investments in a number of government, municipal and corporate debt securities, the Company does not have a large portfolio of investment securities. The portfolio of investment securities the Company maintains are mostly U.S. Government agency securities and investment grade corporate debt securities. The following table sets forth the components of the Company's investment portfolio at December 31:\nSee Note 4 -- Notes to Consolidated Financial Statements included as Item 8 to this report for information regarding the carrying values and market values of the Company's investment securities.\n- 8 -\nThe following table presents information regarding the scheduled maturities and yields on investment securities at December 31, 1994:\nDEPOSITS AND SOURCES OF FUNDS\nThe primary sources of funds for the lending and general business activities of the Company are retail deposits and advances from the FHLB. In addition, the Company derives funds from loan sales and principal and interest payments on loans. Scheduled loan payments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments, which are influenced significantly by general interest rate levels, interest rates available on other investments, economic conditions and other factors, are less stable.\nDEPOSITS. The following table sets forth the deposit flows of the Company for the years ended December 31:\nThe Company has built its savings business through retail deposits at its twelve retail banking offices in the Minneapolis-St. Paul metropolitan area. Substantially all of the Bank's depositors are Minnesota residents. The Company does not currently bid on, or actively solicit, deposits from municipalities or governmental agencies and none of the Company's outstanding deposits has been obtained in brokered transactions.\nThe Company attracts deposits by advertising through newspaper, radio and direct mail advertising and by various special promotions. The Company also offers deposit and withdrawal services for customers at automated teller machines by participating in the CIRRUS -TM- network.\nThe Company offers a variety of savings plans to its depositors including interest-bearing checking accounts, regular passbook savings accounts, money market deposit accounts, time certificates and Keogh and individual retirement accounts. For a description of the portion of total deposits represented by each type of account and the average rate of interest paid on such accounts as well as the maturities of the Company's certificate accounts, see Item 8 -- Note 10 of Notes to Consolidated Financial Statements.\nAt December 31, 1994, the Company had $43.9 million of certificate accounts with individual balances of $100,000 or more. For additional information on deposits see Item 7 -- \"Management's Discussion and Analysis -- Net Interest Income Yield Analysis Table.\"\n- 9 -\nBORROWINGS. The following table sets forth the Company's borrowings at December 31:\nAs a depository institution insured by the Savings Association Insurance Fund (\"SAIF\") of the FDIC, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain mortgages and other assets (principally securities which are obligations of, or guaranteed by, the United States government), provided standards related to creditworthiness are met. See \"Federal Home Loan Bank System.\" FHLB advances are made in accordance with several credit programs of the FHLB, each of which has its own interest rate and range of maturities. The FHLB prescribes the acceptable uses of such advances and the limitations on the amount of advances to each member.\nOn December 11, 1992, the Company issued $23.0 million of 9.25% Subordinated Notes due 2002. Of the $22.1 million net proceeds, $12.0 million was contributed to the Bank's paid-in capital during 1992 and an additional $5.0 million in 1993 (there was no additional contribution in 1994). The balance of the net proceeds remains at the Company to support future growth of the Bank's operations. For additional information on borrowings, see Item 7 -- \"Management's Discussion and Analysis, Net Interest Income, Liquidity and Capital Management\" sections and see Item 8 -- Note 11 of Notes to Consolidated Financial Statements.\nCOMPETITION\nThe Company faces substantial competition both in its retail banking and its mortgage banking operations. Competition for deposits comes from other savings institutions, banks, credit unions, money market funds and other mutual funds, corporate and government debt securities, insurance companies and pension funds, many of which have greater capital resources than the Company and offer investment alternatives without comparable regulatory restrictions. The Company's most direct deposit competition comes from one large federally-chartered thrift institution and a large number of commercial banks, including two major banks. The Company believes that the primary factors in competing for deposits are interest rates offered, type of products offered and location of banking offices. Competition in residential lending comes primarily from other mortgage companies, banks and savings institutions. The primary factors in competing for mortgage loans are interest rates offered, type of products offered, origination fees charged and range of services offered.\nEMPLOYEES\nThe Company had 428 employees at December 31, 1994, 410 of whom were full-time employees and 18 of whom were part-time employees. Of such employees, 233 were mortgage banking personnel, 135 were retail banking personnel and 60 were corporate and administrative personnel. None of the employees of the Company is a member of a union or subject to a collective bargaining agreement, and the Company believes that its relationship with its employees is satisfactory.\nFEDERAL HOME LOAN BANK SYSTEM\nThe bank is required to invest in FHLB stock in an amount equal to the greater of 1% of the unpaid principal of home mortgage loans or 5% of the Bank's borrowings with the FHLB. Investment in capital stock of the FHLB increased to $20.0 million at December 31, 1994. The increase was the result of additional stock purchases to meet the requirement to maintain stock equal to 5% of the Bank's FHLB borrowings.\n- 10 -\nFEDERAL RESERVE SYSTEM\nUnder Federal Reserve Board regulations, depository institutions are required to maintain reserves against their transaction accounts (primarily checking accounting for the Bank), nonpersonal time deposits and Eurocurrency liabilities. At present, the reserve requirement for transaction accounts is 3% of the first $54.0 million of such accounts and 10% of the amount in excess of $54.0 million. The Federal Reserve Board also has authority to impose supplemental reserves of up to 4% of transaction accounts and emergency reserve requirements upon consultation with committees of Congress.\nREGULATION\nGENERAL. As a federally-chartered savings bank engaged in mortgage and consumer lending and in the acceptance of deposits, the Bank is subject to extensive federal and state regulation in virtually all areas of its operations, including regulations that govern the type of its investments and liabilities, the form of the instruments used to represent such assets and liabilities, the advertisement and promotion of such assets and liabilities, its efforts to support community reinvestment, its dealings with affiliates, the location and, in some instances configuration of its offices and various other matters. As a federally-chartered savings bank with accounts insured by SAIF of the FDIC, the Bank's primary regulators are the OTS, an office of the Department of Treasury and the FDIC. In addition, the Bank is a member of and may obtain advances from the Federal Home Loan Bank system which provides credit for home finance to savings institutions and other financial institutions that meet certain tests as to the composition of their assets.\nINSURANCE OF ACCOUNTS. The FDIC administers both the fund that insures commercial banks (the \"Bank Insurance Fund\" or \"BIF\") and the SAIF. FDIC insurance assessments for SAIF members must be not less than .185% of deposits from January 1, 1994 to December 31, 1997 and .15% of deposits after 1997. The FDIC may, in its discretion, increase the rate of assessments to a rate which is adequate to increase the SAIF reserves to a specified percentage of deposits.\nThe FDIC currently uses a risk-based assessment system for all SAIF and BIF members. Members are assigned an assessment risk classification based on the institution's capitalization as of a date six months prior to the beginning of the assessment period (assigning the institution to one of three categories) and an evaluation by the institution's primary regulator of the risk posed by the institution to the insurance fund (assigning the institution to one of three subgroups). Well capitalized institutions (institutions with risk-based capital exceeding 10%, core capital exceeding 5% and core capital to risk-weighted assets exceeding 6%) are assessed at between .23% and .29% of deposits, depending on their subgroup assignment. Adequately capitalized institutions (institutions with risk-based capital exceeding 8%, core capital exceeding 4% and core capital to risk-weighted assets exceeding 4%) are assessed at between .26% to .30% of deposits. Undercapitalized institutions (institutions that do not meet applicable capital requirements) are assessed at between .28% and .31% of deposits. The Bank qualifies as a well-capitalized institution and its assessment rate was .23% during 1993 and 1994.\nDeposits in institutions insured by SAIF are insured to $100,000 per insured depositor and are backed by the full faith and credit of the United States government.\nREGULATORY CAPITAL. A federal savings institution such as the Bank is required to satisfy three capital requirements: (i) a requirement that \"tangible capital\" be not less than 1.5% of adjusted total assets, (ii) a requirement that \"core capital\" be not less than 3% of adjusted total assets, and (iii) a risk-based capital standard of 8% of \"risk-adjusted\" assets. The Bank currently meets each such test. See Item 7 -- \"Management's Discussion and Analysis -- Capital Management\" or Note 12 of Notes to Consolidated Financial Statements included as Item 8 for discussion of capital compliance.\nTangible capital includes stockholder's equity, noncumulative perpetual preferred stock, certain nonwithdrawable accounts, pledged deposits of mutual savings institutions, and minority interests in fully consolidated subsidiaries, less intangible assets and certain investments in subsidiaries that conduct activities not\n- 11 -\npermissible for a national bank. Purchased mortgage servicing rights may be included in tangible capital at the lower of 90% of fair market value, 90% of original cost, or 100% of current amortized book value.\nCore capital consists of tangible capital plus a percentage of certain marketable intangible assets, and a decreasing portion (through 1994) of qualifying supervisory goodwill. Because the Bank does not have any supervisory goodwill or marketable intangible assets that would be added to tangible capital, its core capital is equivalent to its tangible capital.\nRisk-based capital is determined by assigning a risk-weight, ranging from 0% for government securities to 200% for certain equity investments, to each of an institution's assets, including the credit-equivalent amount of off-balance sheet assets. An institution is required to maintain total regulatory capital (consisting of both \"core capital\" and supplementary capital such as the Bank's subordinated debt) equal to the regulatory mandated percentage (currently 8.0%) of the sum of its assets multiplied by their respective risk-weights. In August 1993, the OTS adopted final regulations effective in January 1994 for all savings institutions (except certain institutions with less than $300 million of assets) that add an interest rate risk component to the risk based capital test. Under these regulations, each institution is required to submit a complex report of its assets and liabilities to the OTS that forms the basis for calculation of the effect a 200 basis point change in market interest rates would have on the institution's \"net portfolio value\" (a measure based on the cash flows from, and required by, the institution's assets, liabilities and off-balance sheet contracts). If such net portfolio value declines by more than two percent of the estimated value of the institution's assets, one half of the excess is subtracted from the institution's total capital in calculating the risk based capital test. The interest rate risk is calculated based on the assets and liabilities two quarters preceding the calculation date. As of December 31, 1994, the Bank's required regulatory capital was not impacted by the interest rate risk rule.\nA savings institution that fails to meet its capital requirements is subject to an increased level of monitoring and must submit a capital restoration plan to the OTS within 45 days of the date its capital falls below the applicable standard. The capital plan must include a guarantee by the institution's holding company that the institution will comply with the plan until it is adequately capitalized for four quarters or the holding company is liable for the deficiency in the institution's capital deficit (up to 5% of the institution's assets). A savings institution not meeting its capital requirements may not, without approval of the OTS, allow assets to increase beyond interest credited to deposits. The OTS may impose a number of conditions on approval of capital plans, including growth restrictions, operating restrictions, and disposition plans, if objectives are not achieved. The OTS may also mandate the replacement of officers or directors, place restrictions on distributions of controlling companies, prohibit interest payments on subordinated debt and prohibit salary increases or bonuses for significantly undercapitalized institutions. Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), a critically undercapitalized institution with tangible capital of less than 2% of total assets or 65% of the minimum tangible capital requirement is subject to conservatorship or receivership within 90 days unless the OTS makes periodic determinations to forbear such action.\nIn accordance with the requirements of FDICIA, the four principal banking agencies adopted prompt corrective action rules in September and October 1992. The rules divide depository institutions into five categories: \"well capitalized\" institutions have a risk-based capital ratio of 10% or greater, a core capital to risk-weighted assets ratio of 6% or greater and a core capital ratio of 5% or better; \"adequately capitalized\" institutions have a risk-based capital ratio of 8% or greater, a core capital to risk-weighted asset ratio of 4% of greater and a core capital ratio of 4% or greater; \"undercapitalized\" institutions have a risk-based capital ratio of greater than 6% but less than 8%, a core capital to risk-weighted asset ratio of at least 3% and a core capital of at least 3%; \"significantly undercapitalized\" institutions have a risk- based capital ratio of less than 6% and core capital ratio of less than 3%; \"critically undercapitalized\" institutions have a tangible equity to total assets ratio of less than 2%. The greatest amount of operating flexibility is afforded a \"well capitalized\" institution and the regulations impose increasing operational restrictions on each category of less \"well capitalized\" institutions. \"Critically undercapitalized\" institutions must be placed in receivership 90 days after being so determined unless significant progress is made to improve capital. The Bank qualified as a \"well capitalized\" institution at December 31, 1994.\n- 12 -\nRESTRICTIONS ON DIVIDENDS. Under OTS regulations, savings associations are limited in the amount of \"capital distributions\" that they are permitted to make, including cash dividends, payments to repurchase or otherwise acquire its shares, payments to stockholders or another entity in a cash out merger and other distributions charged against capital. The regulation also applies to capital distributions that the Bank may make to the Company, thereby affecting the dividends that the Company may pay to its stockholders. The regulation establishes a three tiered system of regulation, with the greatest flexibility being afforded to well capitalized institutions. An institution that has regulatory capital that is at least equal to its fully phased in capital requirement, and has not been notified that it \"is in need of more than normal supervision,\" is a Tier 1 institution. Any institution that has regulatory capital at least equal to its minimum capital requirement, but less than its fully phased in capital requirement, is a Tier 2 institution. An institution having regulatory capital that is less than its minimum capital requirement is a Tier 3 institution. At December 31, 1994, the Bank qualified as a Tier 1 institution.\nA Tier 1 institution is permitted, after prior notice to the OTS, to make capital distributions in amounts 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\" (the percentage by which the ratio of its regulatory capital to assets exceeds its fully phased in capital ratio) at the beginning of the calendar year. Any additional amount of capital distributions would require prior regulatory approval. A Tier 2 institution is permitted to make capital distributions in amounts up to 75% of its net income for the most recent four quarters, if it satisfies the risk based capital requirement. In each case, the amount of capital distributions permitted is reduced by the amount of capital distributions that the institution previously has made during the four quarter period. A Tier 3 institution is not authorized to make any capital distributions except with prior OTS approval or pursuant to an OTS approved capital plan. Under FDIC regulation, no institution may make a capital distribution that causes it to fail its minimum capital requirement.\nQUALIFIED THRIFT LENDER TEST. Unless a savings institution meets the qualified thrift lender test (QTL), it is classified and subject to regulation as a national bank or becomes subject to a number of limitations on investment, branching, advances, dividends and other activities. In addition, a unitary savings and loan holding company, such as the Company, that owns a thrift failing the QTL test becomes subject to limitations on activities applicable to multiple savings and loan holding companies. The QTL test, generally requires that an insured institution's \"qualified thrift investments\" equal or exceed 65% of the institutions \"portfolio assets.\" Qualified thrift investments include (i) loans for the purchase, refinance, construction, and improvement of residential housing (including manufactured housing), (ii) home equity loans, (iii) mortgage-backed securities, (iv) obligations of the FDIC, the Resolution Trust Corporation (RTC), or FSLIC Resolution Fund, (v) 50% of loans held for sale less than 90 days after origination, (vi) investments in qualifying service corporations, (vii) subject to certain limitations, 200% of loans to acquire developed or constructed lower income residential properties, (viii) loans for the purchase or construction of churches, schools, nursing homes, and hospitals and (ix) loans for personal, family, household or educational purposes up to 5% of the portfolio assets. Portfolio assets include all of an institution's assets less intangible assets, the value of property used in the business and qualifying liquidity assets (up to 20% of total assets). An institution must satisfy the QTL test on a monthly average basis during 9 out of every 12 months. The Bank has always satisfied such test and had qualifying thrift investments equal to 94% of portfolio assets on December 31, 1994.\nLIQUID ASSET REQUIREMENT. FIRREA requires each savings institution to maintain qualifying liquid assets (which include cash, certain time deposits, banker's acceptances and specified United States Government, State or Federal agency obligations, certain money market funds and qualifying assets that would qualify except for maturity) of a percentage designated by the Director of the OTS (currently 5%) of the balance of its withdrawable deposit accounts and borrowings payable in one year or less. Monetary penalties will be imposed, unless waived, for failure to meet liquidity requirements. The Bank had liquid assets in excess of the requirements for each month in the year ended December 31, 1994.\nLOANS TO ONE BORROWER RESTRICTIONS. Under FIRREA permissible lending limits for loans to one borrower are generally equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable securities, in which case this limit is increased to 25% of unimpaired capital and surplus).\n- 13 -\nLIMITATIONS ON CERTAIN INVESTMENTS. As a federally chartered institution, the Bank is generally 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, the Bank's authority to invest directly in service corporations is limited to a maximum of 2% of the Bank's assets, plus an additional 1% of assets if the amount over 2% is used for specified community or inner city development purposes. In addition, because the Bank meets all of the minimum capital requirements, the Bank is permitted to make additional loans in an amount not exceeding 50% of its regulatory capital to its service corporations.\nTRANSACTIONS WITH AFFILIATES. Under FIRREA all transactions involving a savings association and its affiliates are subject to sections 23A and 23B of the Federal Reserve Act (FRA). Generally, these sections restrict \"covered transactions\" (loans, purchases of assets, guarantees and similar transactions) to 10% of the institution's capital stock and surplus, restrict all transactions with affiliates to 20% of such capital stock and surplus, and require such transactions to be on terms as favorable to the savings association as transactions with nonaffiliates. The affiliates of a savings association include any company whose management is under a common controlling influence with the management of the savings associations (including the savings association's holding company), any company controlled by controlling stockholders of the savings association or with a majority of interlocking directors with the savings association, and any company sponsored and advised on a contractual basis by the savings association or any of its subsidiaries or affiliates. The Bank's subsidiaries are not deemed affiliates; however, transactions between the Bank or any of its subsidiaries and any affiliates are subject to the requirements and limits of sections 23A and 23B of FRA.\nFIRREA and FDICIA also subject loans to insiders (officers, directors and 10% stockholders) to Sections 22(g) and (h) of FRA and the regulations promulgated thereunder. The OTS recently amended its regulations governing loans to officers and directors to provide that such transactions will be governed by Regulation O of the Federal Reserve Board. Among other things, such loans must be made on terms substantially the same as loans to non-insiders.\nREGULATORY SANCTIONS. Any institution that does not operate in accordance with or conform to OTS or FDIC regulations, policies and directives may be sanctioned for noncompliance. For example, proceedings may be instituted against any insured institution or any director, officer, employee or person participating in the conduct of the affairs of an insured institution who engages in unsafe and unsound practices, including violation of applicable laws, regulations, orders, agreements or similar items. In addition, noncompliance may result in the OTS or FDIC declining to approve various actions by an institution that may be taken only with such approval. FIRREA substantially increases enforcement remedies, including civil monetary damages, that may be assessed against an institution or its officers, directors, employees, agents or independent contractors. For knowing violations and under certain aggravated circumstances, penalties of up to $1,000,000 may be assessed. For lesser violations where there is a pattern of misconduct, or under certain other circumstances, a penalty of up to $25,000 per day may be assessed.\nFDIC insurance may be terminated upon a finding that an insured institution is engaging in unsafe and unsound practices, is in an unsafe or unsound condition or has violated any applicable laws, regulation or order of or condition imposed by the FDIC. Upon termination, funds then on deposit continue to be insured for at least six months and up to two years and notice is provided to all depositors.\nHOLDING COMPANY REGULATION. By virtue of owning 100% of the outstanding capital stock of the Bank, the Company is a unitary savings and loan holding company under the National Housing Act, as amended by the Savings and Loan Holding Company Amendments of 1967 and FIRREA (the \"Holding Company Act\").\nAs a savings and loan holding company, the Company is required to register with, and is subject to direct regulation by, the Director of the OTS under the Holding Company Act. There are very few limitations on unitary holding companies whose insured institution subsidiary complies with the qualified thrift lender test. The Holding Company Act does place certain restrictions on dealings between the holding company and its insured institution subsidiary. Management believes it currently complies with all such regulations.\n- 14 -\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns a 48,800 square foot, three story building in Wayzata, Minnesota that was constructed in 1990 to its specifications and that serves as its corporate and mortgage banking headquarters as well as a retail bank. The Company also owns a 9,400 square foot single story retail banking facility in Brooklyn Center, Minnesota completed to its specifications in mid-1992. The Company acquired in September of 1993 a 6,080 square foot single story retail banking facility in St. Louis Park, Minnesota that is subject to a ground lease which expires in 2031. The Company's remaining nine retail banking facilities in the Minneapolis\/St. Paul metropolitan area are leased pursuant to agreements that provide various renewal and\/or purchase options. The following table presents certain information regarding leases for retail banking offices:\nRetail Banking Lease Expiration Office Location (after renewal option) --------------- ---------------------- Rand Tower 2009 St. Paul 2032 Ridgedale 2007 Edina 2007 Highland Park 2012 Roseville 2010 Bloomington 2001 Cub Foods Minnetonka 2013 IDS Center 2008\nThe Company leases space for its mortgage loan offices and its mortgage loan servicing operations. These leases have generally been for terms of three to five years. The location for each of the mortgage offices is as follows:\nMortgage Office Lease Location Expiration -------- ----------\nMinnesota: --------- Edina 1998 Minnetonka (Builder Division) 1995 Minnetonka 1996 Roseville 2000 Eagan 1995 Coon Rapids 1995 Duluth 1995 St. Louis Park (Loan Servicing) 1998\nIllinois: -------- Oak Brook 1996 Crystal Lake 1996 Orland Park 1996\nIndiana: ------- Merrillville 1997\nWisconsin: --------- Waukesha 1996\n- 15 -\nThe Company also leases space for its private banking division in downtown Minneapolis which expires in 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not currently engaged in any litigation. The Bank is party to various forms of litigation in the ordinary course of business, including foreclosure proceedings and various forms of consumer and employee complaints. The Company does not believe that any of such litigation is material.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nA Special Meeting of Stockholders of the Company was held on March 15, 1995 to consider and vote upon the approval and adoption of an Agreement and Plan of Reorganization and a Plan of Merger, that provide for the merger of the Company with and into Firstar Corporation of Minnesota, a wholly owned subsidiary of Firstar Corporation. Stockholders holding 2,782,368, or approximately 79.3%, of the outstanding shares of Common Stock were represented at the meeting in person or by proxy. The breakdown of the vote is as follows:\nTABULATION OF VOTES ---------------------------------------------------- FOR AGAINST WITHHELD --- ------- -------- 2,757,048 18,730 6,590\n- 16 -\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nSTOCK PRICES AND TRADING DATA\nThe Company's Common Stock is traded on the Nasdaq National Market under the symbol INVS.\nAs of March 24, 1995, there were 3,467,097 shares of Common Stock outstanding. As of that date, there were approximately 246 shareholders of record.\nThe following table sets forth the high and low sale prices of the Company's Common Stock as reported by the Nasdaq National Market. These prices include interdealer prices, without retail markup, markdown or commissions, and do not always represent transactions with the public.\nThe Company paid quarterly common dividends in fiscal year 1993 at the annual rate of $.375 per share and in fiscal year 1994 at the annual rate of $.50 per share.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nINVESTORS BANK CORP. AND SUBSIDIARY\nFIVE YEAR FINANCIAL HIGHLIGHTS (Dollars in thousands except per share data)\n- 17 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nMERGER AGREEMENT\nOn August 21, 1994 the Company, Firstar Corporation (Firstar) and Firstar Corporation of Minnesota (Firstar Minnesota) entered into an Agreement and Plan of Reorganization (the Merger Agreement), pursuant to which the Company will be merged (the Merger) with and into Firstar Minnesota. The Agreement also calls for the merger of the Company's subsidiary, Investors Savings Bank, F.S.B. (the Bank) with and into Firstar Bank Minnesota, N.A. (Firstar Bank), on the date of, and immediately after the Merger becomes effective. Upon consummation of the Merger, each share of the Company's Common Stock will become the right to receive .8676 shares of Firstar common stock and each share of the Company's preferred stock will become the right to receive $27.50, plus accumulated dividends, in cash. See Note 14 of the accompanying Consolidated Financial Statements for additional discussion of the effect of the Merger on the Company's preferred stock, outstanding warrants and options and restricted stock.\nThe Company's stockholders approved the Merger Agreement at a special meeting on March 15, 1995. The Merger is expected to be consummated not prior to late April, 1995. The transactions required to consummate the Merger have been approved by the Federal Reserve Board and approved by the office of the Comptroller of the Currency remains pending.\nAt the Merger, the Company will be merged into Firstar Minnesota and the separate corporate existence of the Company will cease. Firstar Minnesota, as the surviving corporation in the Merger and a wholly owned subsidiary of Firstar, will continue operations. The officers and directors of Firstar Minnesota prior to the Merger will continue as the officers and directors of the surviving corporation, except that James M. Burkholder, President and Chief Executive Officer of the Company will be elected to the Board of Directors of Firstar Minnesota and Firstar Bank. The Bank will merge into Firstar Bank. After the Merger, Firstar Bank's management will be drawn from the officers of both banks, and its Board of Directors will consist of the same directors as just before the Merger, except that Mr. Burkholder will be added to the Board. Mr. Burkholder will also become President and Chief Executive Officer of Firstar's mortgage banking subsidiary, Firstar Home Mortgage Corporation. Because of the Merger, the following discussion focuses on the Company's recent performance with little discussion of the business policies and strategies and related risks to which the Company would be subjected should it continue in operation.\nRESULTS OF OPERATIONS\nPERFORMANCE SUMMARY. Investors Bank Corp.'s (the Company) net earnings were $8.3 million for 1994, compared to $10.0 million for 1993 and $7.8 million for 1992. Earnings per common share were $2.00 for 1994, compared to $2.49 for 1993 and $1.98 for 1992. The Company's 1994 results reflect increased net interest income from substantial interest-earning asset growth but reduced income from mortgage banking operations and increased expenses arising primarily from the opening of additional offices in late 1993. Total assets grew 10.8% during the year and were $1.1 billion at December 31, 1994.\nReturn on average assets was .82% in 1994, compared to 1.13% in 1993 and 1.14% in 1992. Return on average common equity decreased to 17.1% in 1994 from 25.6% in 1993 and 24.2% in 1992.\nThe Company's interest-earning asset base continued to grow in 1994 causing net interest income to increase $1.4 million or 5.6% despite a decline in the net interest margin from 2.94% in 1993 to 2.71% in 1994. Average interest-earning assets, primarily loans, were $980 million in 1994 compared to $855 million in 1993. Interest-earning assets reached $1.1 billion at December 31, 1994. This growth in interest-earning assets resulted from internally generated loans. The Company originated $290 million in new adjustable rate mortgage (ARM) loans, increasing mortgage loans $183 million during 1994. Through the Company's retail banking network, consumer loans were increased $25.5 million during the year. These increases were partially offset by a $72.9 million reduction in mortgage loans held for sale as increased market interest rates significantly reduced the demand for fixed rate mortgages.\nThe asset growth was funded primarily by increased borrowings from the Federal Home Loan Bank of Des Moines (FHLB) which increased $75 million to $400 million at December 31, 1994. In addition, the Company's efforts to increase deposits resulted in a $32.4 million increase or 5.4% during the current year to $636 million at December 31, 1994.\n- 18 -\nAs a result of the decreased level of mortgage banking activity in 1994, noninterest income decreased $1.8 million or 9.7% compared to 1993. The primary reason for the decline was the increase in market interest rates which brought refinancing activity to a very low level and also dampened demand for mortgages to purchase residences. In 1994, the Company closed $303 million of loans for sale in the secondary market, down from $838 million in 1993. Loans for sale purchased from correspondent lenders also declined with $50 million such loans purchased in 1994 compared to $115 million in 1993. Mortgage banking income decreased $3.7 million or 27.7% in 1994 compared to 1993. The portfolio of loans serviced for others declined $57 million during 1994 to $1.3 billion at year end because of early payoffs of mortgages during the year. However, loan servicing fees were up 83.7% or $2.4 million for the year primarily because high prepayments in 1993 resulted in adjustments of $1.4 million being made to capitalized servicing rights which did not occur in 1994.\nNoninterest expense increased $1.8 million or 6.7% to $28.2 million in 1994. Staff levels in mortgage banking were reduced in response to the decreased activity resulting in level compensation expense compared to 1993. Other noninterest expenses increased in 1994 for a variety of reasons including greater occupancy costs from additional branches, higher data processing costs from vendor fee increases, costs incurred to dispose of foreclosed real estate and merger related costs.\nThe significantly higher earnings in 1993 as compared to 1992 resulted from strong retail banking and mortgage banking performance. Net interest income increased $3.0 million or 13.3% from $22.2 million in 1992 to $25.1 million in 1993, while noninterest income increased $4.4 million or 30.7% from $14.3 million in 1992 to $18.6 million in 1993. The increased net interest income for 1993 was due to the higher level of interest-earning assets. Average interest-earning assets, primarily loans, were $855 million in 1993 compared to $653 million in 1992. The higher noninterest income was primarily the result of the increase in mortgage banking income. Loans originated for sale in 1993 increased 26.3% over originations in 1992.\nNET INTEREST INCOME. A significant portion of the Company's earnings is derived from net interest income. Net interest income is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income, when divided by average interest-earning assets, is referred to as the net interest margin. The net interest rate spread is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities.\nNet interest income was $26.5 million in 1994, up $1.4 million or 5.6% from 1993. As shown in the volume\/rate analysis table below, an increase in average interest-earning assets contributed $3.3 million to increasing net interest income during 1994. The positive contribution from the increased volume of interest-earning assets was partially offset by a $1.8 million decrease in net interest income due to a lower net interest rate spread in 1994 than in 1993. Net interest income in 1993 had increased $3.0 million or 13.3% from 1992 caused by a $5.5 million volume increase reflecting an increase in average interest-earning assets, but partially offset by a $2.5 million decrease from a decreased interest rate spread in 1993 over 1992.\n- 19 -\nNET INTEREST INCOME VOLUME\/RATE ANALYSIS (IN THOUSANDS)\nChanges attributable to the combined impact of volume and rate have been allocated proportionately to the change due to volume and the change due to rate. - 20 -\nNET INTEREST INCOME YIELD ANALYSIS (DOLLARS IN THOUSANDS)\nDuring 1994, the Company's average interest-earning assets were $980 million, a 14.6% increase over 1993. This increase was primarily in loans which averaged $917 million in 1994 compared to $798 million in 1993. Increased market interest rates during 1994 caused a shift in mortgage demand away from fixed rate mortgages to ARMs. Consequently, during 1994, the Company increased its mortgage loans held in portfolio $183 million and its consumer loan portfolio $25.5 million while its mortgage loans held for sale declined $72.9 million.\n- 21 -\nInterest-earning assets were $1.1 billion at the current year end compared to $982 million at the end of 1993. Average interest-earning assets grew 31.0% in 1993 as average loans increased 30.4%. As a result of the significant lending activity during 1993, the mortgage loans held in portfolio increased $120 million and consumer loan portfolio increased $25.1 million.\nIn 1994, the Company funded the asset growth with increases in FHLB advances and deposits. Average interest-bearing liabilities increased 14.3% compared to 1993. Average FHLB advances increased $63.2 million and average interest-bearing deposits increased $55.9 million. The increase in deposits in 1994 was due to special deposit promotions and to the opening of new retail bank offices in late 1993. During 1993, average interest-bearing liabilities increased 28.8% compared to 1992. The increase occurred in FHLB advances and interest-bearing deposits which were used to fund the growth in interest-earning assets. FHLB advances averaged $249 million in 1993 compared to $132 million in 1992. Average interest-bearing deposits were up $40.1 million in 1993 compared to 1992.\nThe net interest rate spread decreased to 2.45% for 1994 from 2.70% during 1993 and 3.19% in 1992. The interest rate maturity of the Company's interest-bearing liabilities has historically been shorter than its interest-earning assets. The relatively high spread in 1992 was due to deposits and FHLB advances repricing at lower rates and decreasing the overall cost of funds while asset yields decreased at a slower rate. With short term interest rates remaining relatively flat in 1993, asset yield repricings caught up with liability repricings by declining at a more rapid rate causing the net interest rate spread to decline. In addition, adjustable rate mortgage loans originated in 1993 were at lower initial rates and the more aggressive deposit pricing in 1993 combined to further reduce the net interest rate spread. As the market interest rates increased in 1994, the Company's interest-sensitive liabilities repriced upward more rapidly than its assets. In addition, the Company's ARM loans have \"caps\" on the annual increase in interest rate allowed due to increased market rates. These caps, generally 2%, limited the amount of increase in yield on the Company's ARM portfolio during 1994.\nThe net interest margin was 2.71% for 1994, compared to 2.94% for 1993 and 3.39% in 1992. The majority of the changes in margin were the result of the changes in net interest rate spread previously explained. The difference between net interest margin and net interest spread widened in 1994, 1993 and 1992 as the ratio of average interest-earning assets to average interest-bearing liabilities increased. The increase in this ratio was largely due to the increase in equity from the retention of earnings for all three years. In addition, average noninterest bearing deposits increased during 1993 and 1992.\nNONINTEREST INCOME. Noninterest income is a significant source of revenue for the Company and has a major impact on operating results. An active mortgage banking operation is an integral part of the Company's strategy to supplement net interest income with a significant amount of noninterest income. Mortgage banking generates income primarily through the sale of loan servicing rights and the sale of mortgage loans. This mortgage banking activity also adds to the portfolio of loans serviced for others, generating continuing noninterest income from loan servicing fees. Through mortgage banking, the Company originates government insured loans and fixed-rate conventional loans and sells such loans in the secondary market or pools the loans and sells the resulting mortgage-backed securities, generating a gain on sale of mortgage loans. For most of these sales the Company retains the servicing rights. The Company also regularly engages in the sale of portions of servicing rights it creates, generating significant gains on such sales. Historically, the amount of loans the Company has originated for sale has been significant.\n- 22 -\nNONINTEREST INCOME (IN THOUSANDS)\nThe Company's mortgage banking income is highly dependent on the amount of mortgage loans originated for sale. Most of its loans are originated through loan closings by its mortgage loan offices, but loans are also purchased from correspondents. The Company has six Twin Cities offices, a Duluth office, four offices in the Chicago market and an office in the Milwaukee area which opened in late 1993. The Company's strategy is to employ experienced and high performing lending officers and to support their efforts with a wide range of competitive mortgage products. During 1993 and 1992 the Company also benefitted from the strong mortgage demand generated by reduced market interest rates. Mortgage refinancings increased to 49.0% and 46.5% of the total loans closed during 1993 and 1992, respectively. However, in 1994, market interest rates increased rapidly and significantly. As a result, refinancings declined to 17.5% of total loans closed. Furthermore, demand for mortgages to purchase homes weakened substantially. Reflecting these market conditions, mortgage banking income decreased $3.7 million or 27.7% in 1994 from the prior year and increased $2.1 million or 19.1% in 1993 compared to 1992. The decrease in 1994 was from a $6.4 million decrease in gain on sales of mortgage loans partially offset by a $2.7 million increase in gain on sales of loan servicing rights. Conversely, in 1993 there was a higher gain on sales of mortgage loans while there was reduced gain on sales of loan servicing rights.\nMORTGAGE BANKING ACTIVITY (IN THOUSANDS)\nThe Company closed $303 million loans for sale in 1994, 63.8% less than in 1993. Also in 1994, loan purchases declined 56.8% to $49.7 million. In 1993, loans originated for sale totaled $838 million which was a 26.4% increase from 1992 and loan purchases were up 25.9% to $115 million.\n- 23 -\nThe 67.9% reduction in gain on sales of mortgage loans in 1994 was due to a 55.8% reduction in the amount of mortgage loans sold and less favorable market pricing. In 1993, the gain on sales of mortgage loans was $3.1 million or 48.4% greater than in 1992. This reflected 22.9% more loans sold in 1993 and higher cash gains as a result of the higher refinancing activity level in 1993.\nGain on sales of loan servicing rights was $6.0 million in 1994, an 80.0% increase from the gain earned in the previous year. Because of the reduced gains realized on the sales of mortgage loans in 1994, the Company increased the amount of loan servicing rights sold in the current year by 90.9% to $481 million. As part of the Merger Agreement discussed above, the Company agreed not to sell any loan servicing rights after the third quarter of 1994. During the third quarter of 1994, the Company sold $140 million of loan servicing rights to Firstar for a gain of $2.4 million. Gain on sales of loan servicing rights was $3.3 million for 1993, a 21.3% decrease from the gain earned in 1992. The decreased gain in 1993 reflects the Company's decision to retain more servicing rights because of the substantial gains on sales of mortgage loans.\nLoan servicing fees were $5.2 million in 1994 compared to $2.8 million in 1993 and $1.5 million in 1992. In 1994, the average servicing portfolio was $110 million greater than in 1993. In addition, no adjustments were required to capitalized servicing rights. Loan servicing fees were negatively impacted in 1993 and 1992 by adjustments of $1.4 million and $1.5 million, respectively, made to capitalized servicing rights. These adjustments were necessary to reflect the high prepayment activity in the low interest rate environment and to conform with accounting and regulatory guidelines adopted in 1992. Because of the high level of originations in 1993, the servicing portfolio experienced a net growth during 1993 of $376 million.\nCommissions on annuity sales were $566 thousand on sales of $11.5 million in 1994, almost the same as the $561 thousand on annuity sales of $11.4 million in 1993. The Company earned $575 thousand on annuity sales of $11.0 million in 1992. In early 1992, there were proposals to Congress that certain tax benefits enjoyed by the insurance industry be eliminated. This had the effect of increasing sales during 1992. During 1993 and 1994, sales remained strong due to the strength of the Company's experienced staff of licensed agents who regularly promote these products.\nCommissions on title insurance sales were $427 thousand in 1994, $936 thousand in 1993 and $135 thousand in 1992. This activity began in late 1992 with 1993 being the first full year of operation and a year with record mortgage origination activity for the Company. During 1994, title insurance was sold on 832 loans compared to 2,894 loans in 1993 and 476 loans in 1992. The 1994 title insurance activity was adversely affected by the significantly reduced mortgage banking activity.\nOther income increased to $1.0 million for 1994 from $991 thousand in 1993 and $876 thousand in 1992. Other income includes fees on retail accounts, credit life insurance commissions and other activity-related fees which have increased all three years along with the increasing numbers of loans and accounts.\nNONINTEREST EXPENSE. Noninterest expense increased 6.7% to $28.2 million for the year ended December 31, 1994 compared to $26.5 million for the same period in 1993. Noninterest expense grew 17.6% in 1993 from the $22.5 million in 1992. The increase in noninterest expense over the three year period was generally attributable to the Company's continued expansion of both its mortgage banking and retail banking activities.\n- 24 -\nNONINTEREST EXPENSE (In thousands)\nEmployee compensation and benefits for 1994 and 1993 were both $15.4 million. Three retail and two mortgage offices were opened during the second half of 1993, and 1994 experienced the first full year expense of the staff for these offices. Offsetting this was a 25% decrease in mortgage production staff overall as staff levels were adjusted for the decreased mortgage banking activity during 1994. Employee compensation and benefits for 1993 were 22.0% more than 1992 primarily because of an 18.2% increase in staffing to support the high level of mortgage activity and new offices. Mortgage production, title insurance, consumer lending, mortgage servicing and marketing increased staff to support the higher level of activity. Benefits increased in step with compensation and were also affected by higher health insurance costs.\nOccupancy expense increased $326 thousand or 8.6% in 1994 over 1993 and $407 thousand or 11.9% in 1993 over 1992. The new offices opened in the second half of 1993 were largely responsible for the increases as 1994 expense included a full year of the new office expenses. Rents and related expenses increased 10.2% between 1994 and 1993 and 7.9% between 1993 and 1992. Equipment expenses were up 4.6% in 1994 over 1993 and 20.2% between 1993 and 1992. In 1993, depreciation expense for a full year was first incurred on computer equipment purchased in 1992 as part of a major networking project.\nContinuing a strategy that began in 1993, the Company promoted its retail banking products in the media and through point of sale displays in its locations during 1994. In addition, a new mortgage product was heavily promoted. These efforts resulted in a $176 thousand or 19.0% increase to $1.1 million in advertising expense in 1994 over 1993. Advertising expense increased 38.8% to $926 thousand in 1993 from $667 thousand in 1992. In 1993, as part of its strategy to increase deposits and consumer loans, the Company increased both its advertising of retail products and targeted marketing efforts such as promotions for the new retail banks and point of sale materials.\nFederal deposit insurance premiums increased 13.8% in 1994 from 1993 and 4.3% between 1993 and 1992 along with increased deposits. The Bank's insurance premium rate was .23% of the deposit base for 1994, 1993 and 1992 due to the Bank being categorized by the FDIC as \"well capitalized.\" The increase in insurance expense does not always match the percent of deposit increase between periods because the premiums are based on deposit levels of prior six month periods.\nOther expenses increased $1.1 million or 22.3% in 1994 over 1993. Data processing fees were $259 thousand greater in 1994 due to fee increases by the vendor. Foreclosure expenses increased by $369 thousand in 1994 as the Company incurred significant costs in connection with the disposal of several commercial real estate properties. The provision for real estate losses in 1994 was up by $208 thousand due to increased reserves on foreclosed commercial property. In connection with the Merger, the Company incurred $203 thousand in expenses in 1994. Other expenses were up 9.9% in 1993 over 1992 primarily due to the record production level and the Company's growth and new product lines. Decreases in expenses associated with holding foreclosed real estate were offset by increases in other categories. These included telephone expenses, which grew to support new offices and enhanced computer network capabilities, supplies, postage, data processing and professional fees.\n- 25 -\nINCOME TAXES. Income tax expense was $6.1 million for 1994 compared to $6.8 million for 1993 and $5.2 million for 1992. Income tax expense has been between 40.1% and 42.3% of earnings before income tax expense for all three years. For additional information on income taxes, refer to Note 13 of Notes to Consolidated Financial Statements. Effective January 1, 1993, the Company adopted the new accounting standard for income taxes, Statement of Financial Accounting Standards No. 109. A $125 thousand cumulative effect of adopting the new standard was recognized in the first quarter of 1993.\nFINANCIAL CONDITION\nThe Company's assets grew 10.8% to $1.1 billion between December 31, 1994 and 1993. This growth was primarily the result of origination of significant amounts of adjustable rate residential mortgage loans and, to a lesser extent, of consumer home equity loans. This reflects the Company's strategy to grow with high quality, interest-rate sensitive assets. Residential real estate loans continue to make up the largest portion of the Company's permanent loan portfolio. These loans were 85.2% of portfolio loans at December 31, 1994, up slightly from 84.6% at December 31, 1993. The Company has increased its emphasis on supplementing its residential loan portfolio by increasing its consumer lending capability, primarily through home equity loans. Continued marketing and exposure to the loans in the retail bank offices caused consumer loans to grow $25.5 million to 11.7% of the permanent loan portfolio at December 31, 1994 from 11.5% at December 31, 1993. The Company maintains a small commercial real estate loan portfolio originated in prior years and does not actively seek new commercial real estate loans.\nFAIR VALUE OF FINANCIAL INSTRUMENTS. In Note 18 of the accompanying Consolidated Financial Statements, the Company has disclosed the estimated fair values of all on and off-balance sheet financial instruments. At December 31, 1994 and 1993, total financial assets had estimated fair values in excess of their carrying amounts of $14.8 million and $51.4 million, respectively. These excess amounts were primarily due to excess servicing rights in both years and also mortgage loans at December 31, 1993. Total financial liabilities had estimated fair values of $8.8 million less than their carrying amounts at December 31, 1994 and $3.5 million in excess of their carrying amounts at December 31, 1993. These amounts were due to changes in the estimated fair values of deposits and notes payable.\nWhile the estimated fair values of mortgage loans were $32.1 million greater than the respective carrying amounts at December 31, 1993, at December 31, 1994 the estimated fair values had declined to a $746 thousand excess over the carrying amount. At year end 1993, ARM loans, such as the Company's, were generally being sold at a premium because their then current indexed rates were higher than initial market yields. Since that time, market rates have risen substantially, and the premium pricing advantage no longer existed at December 31, 1994. Excess servicing rights had estimated fair values greater than carrying amounts by $16.0 million at year end 1994 and $17.4 million at year end 1993. Excess servicing rights relate to servicing that the Company has created and retained from its own origination activities. Carrying amounts represent only the discounted present value of future service fee income in excess of a normal market rate servicing fee. Estimated fair values are significantly greater than these amounts.\nDeposits had estimated fair values less than carrying amounts of $3.4 million at December 31, 1994 and $4.3 million greater than carrying amounts at December 31, 1993. Because of increases in market interest rates between year ends, certificates of deposits at December 31, 1994 had interest rates which were somewhat less than the Company's rates offered for deposits with similar maturities at that date. The reverse situation was true at December 31, 1993. At December 31, 1994 and 1993, the estimated fair values of notes payable were less than their carrying amounts by $5.3 million and $1.4 million, respectively. These differences result from the Company's borrowings at both year ends having interest rates somewhat less than rates charged at those dates by the FHLB for borrowings with similar maturities.\nNONPERFORMING ASSETS. Nonperforming assets include all nonaccrual loans and real estate acquired through foreclosure net of specific reserves. Nonperforming assets were $4.6 million at December 31, 1994, down 45.8% from year end 1993. The substantial decline reflects reductions of $1.7 million in foreclosed residential real estate and $2.9 million in foreclosed commercial real estate partially offset by a $620 thousand increase in\n- 26 -\nnonperforming residential real estate loans. During 1994, substantially all of the foreclosed residential real estate property was disposed of. In addition, several foreclosed commercial real estate properties were sold while there were no additional commercial properties foreclosed upon during 1994. Nonperforming assets were $8.6 million at December 31, 1993, down 7.5% from December 31, 1992. The decline resulted primarily from the net of a $1.4 million decrease in foreclosed residential real estate and an $810 thousand increase in foreclosed commercial real estate. Foreclosed commercial real estate had a net increase because two properties, valued at about $2.1 million, were added while a $1.3 million property was sold during 1993. Nonperforming loans as a percentage of loans held in portfolio increased slightly to .26% at December 31, 1994 from .24% at December 31, 1993 and declined from .31% at December 31, 1992. Nonperforming assets as a percentage of total assets also continued to decline and were .41% at December 31, 1994 compared to .85% at December 31, 1993 and 1.14% at December 31, 1992. The improvement in these ratios was both the result of the decline in nonperforming assets along with the increases in loans held in portfolio and total assets during 1994 and 1993.\nNONPERFORMING ASSETS (DOLLARS IN THOUSANDS)\nIn accordance with generally accepted accounting principles, real estate owned and in judgment is carried at the lower of cost or fair value less estimated cost to sell. At December 31, 1994, commercial real estate owned included $1.9 million in properties acquired through foreclosure of three loans. In January, 1994, the Company completed foreclosure on a combination office and warehouse in a western suburb of Minneapolis which had an estimated fair value of $859 thousand at December 31, 1994. The Company is attempting to sell this property. In April 1993, the Company received title to seven fully leased retail and convenience store properties located in the Minneapolis-St. Paul area which originally secured a $1.1 million loan. The Company sold five of these properties in 1994 and is actively marketing the remaining two properties which had an estimated fair value of $492 thousand at December 31, 1994. No other nonperforming asset had a carrying value exceeding $400 thousand at December 31, 1994.\nANALYSIS OF RESERVES FOR LOAN AND REAL ESTATE LOSSES. The reserves for losses provide for potential losses in the Company's loan and real estate portfolios. The reserves are increased by the provision for losses and by recoveries and are decreased by charge-offs. The adequacy of the reserves is judgmental and based on the continued evaluation of the nature and volume of the loan and real estate portfolios, overall portfolio quality, specific problem loans, collateral values, historical experience and current economic conditions that may affect the borrowers' ability to pay.\n- 27 -\nThe reserve for loan losses was $3.6 million at December 31, 1994, $3.0 million at December 31, 1993, and $2.6 million at December 31, 1992. The increases over the three year period are a result of increased provisions to cover larger residential and consumer loan portfolios as well as a determination by the Company to increase the size of its unallocated general reserve which was established to cover unforeseen loan losses. The provision for loan losses was $652 thousand in 1994, $631 thousand in 1993 and $869 thousand in 1992. Of these provisions, $450 thousand, $192 thousand and $499 thousand, respectively, were allocated to the unallocated general reserve. In December, 1993 Federal bank regulatory agencies issued the \"Interagency Policy Statement on the Allowance for Loan and Lease Losses\" (Statement). The Statement provides guidance on the level of allowances considered adequate by regulators. In response to this Statement, the Company revised its loan loss reserve policies. As a result, while the total loan loss reserves maintained by the Company were not reduced, $631 thousand was reclassified from the general reserves to the unallocated reserves during 1994. Partially offsetting the provision were net charge-offs of $10 thousand, $250 thousand, and $252 thousand in 1994, 1993 and 1992, respectively. For a summary of the reserve for loan losses, see Note 5 of Notes to Consolidated Financial Statements of this report.\nThe reserve for real estate losses was $386 thousand, $135 thousand, and $696 thousand at December 31, 1994, 1993 and 1992, respectively. The provision for real estate losses (included in other expenses) was $328 thousand, $120 thousand and $286 thousand in 1994, 1993, and 1992, respectively. During 1994, the Company increased the reserves on its remaining foreclosed commercial real estate properties to reflect the characteristics of the properties that reduce their marketability. During 1993, the reserve declined because of the charge-off of a $599 thousand loss that had been previously reserved for on a commercial property acquired in late 1989. While the Company has experienced occasional losses on foreclosed residential real estate, its experience has generally been favorable. For a summary of the reserve for real estate losses, see Note 9 of Notes to Consolidated Financial Statements of this report.\nASSET\/LIABILITY MANAGEMENT AND INTEREST RATE RISK. The Company's continuing objective is to minimize the sensitivity of its earnings to interest rate fluctuations by matching the repricing characteristics of its assets and liabilities at a profitable interest rate spread. In order to achieve such matching, the Company has emphasized the origination and retention of ARMs and prime-rate related consumer lending for its own loan portfolio which have interest rates that adjust periodically in accordance with market interest rates. At December 31, 1994, loans that adjust with market interest rates constituted 97.1% of the Company's permanent loan portfolio. The Company sells substantially all of the long-term fixed-rate mortgages it originates.\nThe Company monitors its interest rate risk primarily through analysis of the match between the repricing characteristics of its assets and liabilities and the potential impact on net interest income from possible interest rate movements. The Company has not utilized hedging techniques such as financial futures or interest rate swaps.\nThe accompanying table sets forth the Company's interest rate sensitive assets and interest rate sensitive liabilities at December 31, 1994 and the related \"gap\" (the difference between the interest-earning assets and the interest-bearing liabilities that reprice during such period) for each repricing period. Loans are shown based on the repricing date or contractual maturity date, if applicable, and then adjusted for scheduled amortization and prepayment assumptions based on historical experience. Mortgage loans held for sale are shown in the \"6 months or less\" category. All fixed rate and noninterest-bearing checking and savings accounts have been adjusted for an annual decay rate based on industry experience. Certain advances and loan payments from borrowers held under escrow (escrow accounts) are included in transaction accounts while other escrow accounts are included in other borrowings depending on the nature of the escrow deposit. These escrow accounts have also been adjusted for annual decay rates. Other borrowings also include subordinated debt.\n- 28 -\nASSET\/LIABILITY MATURITIES (DOLLARS IN THOUSANDS)\nThe Company's cumulative one year gap was a positive $27.5 million or 2.4% of assets at December 31, 1994 versus a positive 12.3% at December 31, 1993. During 1994, assets in the \"one year or less\" categories increased $74.3 million while liabilities in the same categories increased $172 million. The increase in assets for such categories was due primarily to an increase in one year ARM loans and also to an increase in prime rate related consumer loans originated offset slightly by a reduced cash position at year end. The increase in liabilities for these categories was from a $140 million increase in fixed maturity deposits and an $81.0 million increase in FHLB advances. These were reduced by $46.8 million decrease in money market and transaction accounts. The cumulative three year gap was $67.4 million or 6.0% of assets at December 31, 1994 which was less positive than the 9.1% at December 31, 1993.\nThe recorded value of capitalized servicing rights is susceptible to interest rate risk. At December 31, 1994, capitalized servicing rights were $4.1 million. The capitalized amounts and the amortization is based partly on prepayment assumptions of the underlying loans. Increased levels of prepayments generally occur in a declining interest rate environment. When a loan is prepaid, the Company ceases to collect servicing income on such loan. If actual prepayments exceed the Company's assumptions in the future, adjustments to the carrying value of servicing rights may be required. During 1994, because of the increase in market interest rates, actual prepayments did not exceed the assumed level of prepayments. Consequently, no additional adjustment to the carrying value of servicing rights was required in 1994. During 1993 and 1992, adjustments of $1.4 million, $1.5 million, respectively, were made to capitalized servicing rights on loans because of the higher prepayments experienced in the related periods. For additional information on these adjustments, see the discussion on loan servicing fees included in the \"Noninterest Income\" section.\nLIQUIDITY. Cash and cash equivalents totaled $29.9 million at December 31, 1994, a decrease of $28.4 million from December 31, 1993. The decrease resulted from $210 million in net cash used by investing activities, primarily to fund new loans, partially offset by $82.2 million in net cash provided by operating activities and $99.4 million in net cash provided by financing activities. See the Statement of Cash Flows in the Consolidated Financial Statements for detail. As discussed earlier, increased market interest rates during 1994 reduced the market demand for fixed rate mortgage loans but increased the demand for ARMs. Consequently, the Company invested $209 million\n- 29 -\nin additional loans. These loans were principally funded by $75.9 million in cash provided by the reduction in the amount of mortgage loans held for sale, $31.1 million in increased deposits, $75.0 million in additional FHLB advances and a $28.4 million reduction in cash and cash equivalents.\nCash and cash equivalents increased $18.1 million during 1993 to $58.3 million at December 31, 1993. The increase resulted from $191 million in net cash provided by financing activities less $159 million in net cash used by investing activities and $14.4 million in net cash used by operating activities.\nCash and cash equivalents totaled $40.2 million at December 31, 1992, an increase of $22.4 million from December 31, 1991. This increase was the result of $12.9 million in net cash provided from operating activities and $200 million in net cash provided by financing activities less $191 million in net cash used by investing activities.\nNet cash was used by operating activities in 1993 primarily to fund a $14.3 million increase in mortgage loans held for sale. In 1992, net cash was provided by operating activities from a number of sources as detailed in the Statement of Cash Flows.\nDuring 1993, $148 million of the net cash used by investing activities funded an increase in loans. Of this growth, $120 million was in mortgage loans as customer demand continued. Consumer loans made up the remainder of the increase. Funds were also invested in investment securities for a net increase of $9.6 million to help the Company meet its growing liquidity requirement caused by the asset growth. Of the net cash used by investing activities in 1992, $185 million was used to fund a net increase in loans. Approximately $149 million of this growth was in mortgage loans with consumer loans causing the remaining increase.\nDuring 1993, the net cash provided by financing activities was from a $91 million increase in deposits and a $100 million net increase in FHLB advances. These funds were used to fund loan growth during the year. The net cash provided by financing activities in 1992 was due to a net increase of $175 million in FHLB advances used to fund loan growth and the $22.1 million of net proceeds from the issuance of subordinated notes. Deposits increased only $3.1 million as the Company had difficulty attracting deposits in the low interest rate environment. FHLB advances provided funding not met by other sources. FHLB borrowings were $400 million at December 31, 1994 and $325 million at December 31, 1993. The maximum FHLB borrowings were $400 million in 1994 compared to $325 million and $243 million for 1993 and 1992, respectively.\nAt December 31, 1994 the Company had aggregate loan funding commitments (including committed lines of credit) of $81.3 million and aggregate commitments for the sale of loans of $21.5 million. The Company's expected proceeds from loan sales and its ability to obtain advances from the FHLB exceeded its funding commitments at December 31, 1994.\nThe Bank is required by the OTS to maintain \"liquidity\" (cash and certain eligible investments) in an amount equal to a certain percentage of its deposits and short-term borrowings to assure its ability to meet demands for withdrawals and repayment of short-term borrowings. The percentage, which may be changed at any time by the OTS, is currently 5%. Management believes that the liquidity maintained by the Bank, together with the sources of funds discussed above, is adequate to meet contingencies.\nCAPITAL MANAGEMENT. The Company's stockholders' equity increased 15.1% to $54.3 million at December 31, 1994 from $47.2 million at December 31, 1993. This increase was primarily the result of net earnings retained of $5.8 million. The Company began paying quarterly common stock dividends in the second quarter of 1992 at the annual rate of $.24 per share. For 1993, the Company increased the dividend rate 56.3% to $.375 per share and the 1994 dividend increased 33.3% to an annual rate of $.50 per share. Book value per common share was $13.31 at December 31, 1994 compared to $11.90 at December 31, 1993.\nThe Company increased its capital position in 1992 by issuing $23.0 million of 10 year subordinated notes. Of the net proceeds of $22.1 million, $12.0 million was contributed to the Bank's paid in capital during 1992 and an additional $5.0 million in 1993.\n- 30 -\nThe Bank is categorized by regulations as a \"well capitalized\" institution, the highest level obtainable. This categorization has allowed the Bank to have a lower deposit insurance premium cost and to have more operation flexibility. For additional information on capital requirements see Note 12 of Notes to Consolidated Financial Statements of this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe following financial statements and notes thereto are set forth beginning on the page immediately following the signature page to this Annual Report on Form 10-K:\nConsolidated Statements of Earnings for the years ended December 31, 1994, December 31, 1993, and December 31, 1992\nConsolidated Balance Sheets at December 31, 1994 and 1993\nConsolidated Statements of Stockholders' Equity for the period from January 1, 1992 to December 31, 1994\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, December 31, 1993 and December 31, 1992\nNotes to Consolidated Financial Statements\nReport of KPMG Peat Marwick LLP\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\n- 31 -\nPART III.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following information is furnished with respect to each director as of March 1, 1995:\nPRINCIPAL OCCUPATION AND BUSINESS NAME AGE EXPERIENCE FOR PAST FIVE YEARS ---- --- --------------------------------- E. Thomas Binger . . . . . 72 General Partner in Pittsburgh Pacific Company, Ltd., a general partnership with interests in the iron ore business, from 1970 to 1993, at which time the company was liquidated. Member of the Board of Directors of MTS Systems Corp. and Bemis Company Inc.\nLeonard E. Brown . . . . . 60 Partner with the accounting firm of KPMG Peat Marwick LLP, Minneapolis, Minnesota for over five years until his retirement in August 1988. Member of the Board of Directors of Gate City Federal Savings Bank, Fargo, North Dakota.\nJames M. Burkholder. . . . 52 President and Chief Executive Officer of the Company and Investors Bank, F.S.B. since September 1990 and Chairman since December 1990. Executive Vice President and Chief Financial Officer of the Company and Investors Savings Bank, F.S.B. from 1983 to September 1990.\nGraham N. Heikes . . . . . 58 Sole practitioner since January 1994. Partner with Rice & Heikes, Ltd., a law firm he founded, from October 1989 to January 1994. Partner with the law firm of Jardine, Logan & O'Brien, St. Paul, Minnesota for over five years prior thereto.\nJohn G. Lohmann, Jr. . . . 55 Executive Vice President and Secretary of the Company and Executive Vice President, Chief Lending Officer and Secretary of Investors Savings Bank, F.S.B. since 1983.\nGeorge E. Maas . . . . . . 57 Director of Simon-Telelect Inc. (\"Simon- Telelect\"). Chairman of the Board of Directors of Simon-Telelect from 1991 to 1993, and President of Simon-Telelect from 1979 to 1991.\nAlice D. Mortenson . . . . 54 Director of Community Relations of M.A. Mortenson Co., a construction company, since 1989. Trustee of Westminister Presbyterian Church. Member of the Board of Directors of Courage Center, Dunwoody Institute and the Greater Minneapolis Council of Churches. Homemaker and community volunteer for at least five years.\nFor fiscal year 1994, the directors of the Company (other than executive officers) were compensated at a rate of $12,000 plus $500 per Board meeting attended, $250 per committee meeting associated with a Board meeting and $500 per committee meeting not associated with a Board meeting. With the exception of annual grants (on July 1 of each year prior to 1994, and on May 3, 1994) of non-qualified stock options to purchase 2,666 shares (and 2,000 shares with respect to the May 3, 1994 grant) of Common Stock of the Company at fair market value, directors who are not officers or employees receive no other compensation from the Company.\n- 32 -\nEXECUTIVE OFFICERS\nThe following sets forth the Company's current executive officers:\nNAME AGE POSITION ----------------------- --- ------------------------------------- James M. Burkholder 52 Chief Executive Officer, President and Chairman of the Board of Directors of the Company and the Bank\nJohn G. Lohmann, Jr. 55 Executive Vice President, Secretary and Director of the Company and the Bank, Chief Lending Officer of the Bank\nDaniel Arrigoni 44 Executive Vice President of the Company and the Bank\nLynn V. Bueltel 44 Senior Vice President and Chief Financial Officer of the Company and the Bank and Treasurer of the Bank\nMr. Burkholder has been President and Chief Executive Officer of the Company and Investors Savings Bank, F.S.B. since September 1990 and Chairman since December 1990. Mr. Burkholder was Executive Vice President and Chief Financial Officer of the Company and Investors Savings Bank, F.S.B. from 1983 to September 1990.\nMr. Lohmann has been Executive Vice President and Secretary of the Company and Executive Vice President, Chief Lending Officer and Secretary of Investors Savings Bank, F.S.B. since 1983.\nMr. Arrigoni has been Executive Vice President of the Company since May 1992 and Executive Vice President of the Bank since October 1, 1991. From September 1, 1986 until October 1, 1991, Mr. Arrigoni was President of the North Central Region of Margarettan Mortgage Co., Inc.\nMr. Bueltel has been Senior Vice President of the Company since May 1992, Senior Vice President, Treasurer and Chief Financial Officer of the Bank since September 1990, and a Vice President of the Bank since June 1984.\n- 33 -\nSUMMARY COMPENSATION TABLE\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 the Company and the three executive officers of the Company (there being no other executive officers of the Company) whose salary and bonus earned in the fiscal year ended December 31, 1994 exceeded $100,000 for services rendered.\nSTOCK OPTIONS\nThe Company maintains a Restated Stock Option Plan and 1993 Stock Incentive Plan, pursuant to which executive officers, and other employees and consultants of the Company, may receive options to purchase the Company's common stock.\nOPTION GRANTS IN FISCAL YEAR 1994\nIn fiscal year 1994, the Company did not grant stock options to the Chief Executive Officer or the executive officers named in the Summary Compensation Table.\nAGGREGATED OPTION EXERCISES IN FISCAL YEAR 1994 AND FISCAL YEAR-END OPTION VALUES\nThe following table summarizes option exercises during 1994 by the Chief Executive Officer and by the executive officers named in the Summary Compensation Table, and the value of the options held by such persons at the end of 1994.\nLONG-TERM INCENTIVE PLAN AWARDS\nOther than its Restated Stock Option Plan and 1993 Stock Incentive Plan, the Company does not maintain any long-term incentive plans.\n- 35 -\nCHANGE IN CONTROL ARRANGEMENTS\nIn addition to the employment and severance pay agreements discussed below, the Company has certain other compensatory arrangements with its executive officers which will result from a change in control of the Company. All outstanding stock option agreements provide for the acceleration of exercisability of options upon a change in control. The restricted stock award agreements also provide for the full vesting of all outstanding shares of restricted stock if the holder is terminated following a change in control.\nEMPLOYMENT AGREEMENTS\nThe Company has Employment Agreements with Messrs. Burkholder and Lohmann terminating December 31, 1996 but renewing annually thereafter. The employment agreements provide that the annual salaries of Messrs. Burkholder and Lohmann will be at least $195,000 and $161,000, respectively, that such officers shall be entitled to participate in incentive and other plans of the Company, and that the Company will establish and maintain disability insurance, term life insurance and retirement plans for such officers. See \"Compensation Committee Report on Executive Compensation -- Long-Term Incentive Compensation.\" Both agreements also contain confidentiality obligations and covenants not to compete for one year after termination of employment. The agreements provide for severance pay on failure to renew in certain instances and provide that under certain circumstances (including a change in control) in the event of termination of employment prior to the termination of the agreements, the Company will pay to Messrs. Burkholder and Lohmann severance pay in an amount equal to three times and two times, respectively, the average annualized cash compensation (based on the last five years) of such officers.\nIn the event that the Merger (as described above in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\") is consummated, the Merger Agreements provide that Firstar and FCM will appoint Mr. Burkholder as President and Chief Executive Officer of Firstar Home Mortgage Corporation (\"FHMC\") and elect Mr. Burkholder a director of FCM and of Firstar Bank. In addition, the Company and Firstar have entered into amended employment agreements with Mr. Burkholder and Mr. Lohmann and an amended severance agreement with Mr. Bueltel, that amend the provisions of the existing agreements between the Company and such officers, and have entered into a new employment agreement with Mr. Arrigoni, each of which is effective upon consummation of the Merger. Mr. Burkholder's amended employment agreement provides for his employment as President and Chief Executive Officer of FHMC for a period of four years after consummation of the Merger at an annual salary of $210,000, an annual bonus of at least $100,000, participation in the other bonus, incentive compensation and other benefit plans generally offered to Firstar's executives, and continuation of the disability and life insurance benefits received as an officer of the Company. Mr. Lohmann's amended employment agreement provides for his employment as Executive Vice President of Firstar Bank for a period of one year after the Merger, at an annual salary of $165,000 and with benefits similar to those afforded Mr. Burkholder. Mr. Bueltel's amended severance agreement provides for continuation of his severance agreement with Firstar on terms similar to his severance arrangement with the Company (which provides that in the event of termination for good reason (as defined in the agreement) Firstar will pay Mr. Bueltel as severance pay an amount equal to one year's compensation). Mr. Arrigoni's agreement provides for his employment as Executive Vice President of FHMC for a period of 30 months after the Merger at an annual salary of $158,000, an annual bonus of at least $100,000, and other benefits similar to those afforded Mr. Burkholder and Mr. Lohmann. Each of Mr. Burkholder, Mr. Lohmann and Mr. Arrigoni have also entered into agreements not to compete with Firstar for periods of four years, three years and 30 months, respectively, after the date of the Merger.\n- 36 -\nITEM 12.","section_11":"","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of March 1, 1995, information about the ownership of Common Stock by each director, by each executive officer named in the Summary Compensation Table and by all directors and executive officers (including the named individuals) as a group and by any other shareholder who is known by the Company to own beneficially more than 5% of the outstanding Common Stock of the Company. Except as otherwise indicated, the shareholders listed in the table have sole voting and investment powers with respect to the shares indicated.\nSHARES BENEFICIALLY OWNED --------------------------------- NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER(1) PERCENT ------------------------------------ -------- ------- James M. Burkholder. . . . . . . . . . . . . 268,953 (1) 7.7% 200 East Lake Street Wayzata, Minnesota 55391\nJohn G. Lohmann, Jr. . . . . . . . . . . . . 276,777 (2) 7.9% 200 East Lake Street Wayzata, Minnesota 55391\nE. Thomas Binger . . . . . . . . . . . . . . 212,291 (3) 6.2% 5775 Wayzata Boulevard St. Louis Park, Minnesota 55416\nGeorge Maas. . . . . . . . . . . . . . . . . 173,334 (4) 5.2% P.O. Box 7 Watertown, South Dakota 57201\nFirst Bank System, Inc.. . . . . . . . . . . 179,589 (5) 5.3% 601 Second Avenue South Minneapolis, MN 55402-4302\nAlice D. Mortenson . . . . . . . . . . . . . 60,130 (6) 1.7%\nGraham N. Heikes . . . . . . . . . . . . . . 22,663 (7) *\nLeonard E. Brown . . . . . . . . . . . . . . 19,997 (8) *\nDaniel A. Arrigoni . . . . . . . . . . . . . 66,890 (9) 1.4%\nLynn V. Bueltel. . . . . . . . . . . . . . . 71,694 (10) 2.0%\nAll directors and executive officers as a group (9 persons) . . . . . . . . . . 1,172,729 (11) 31.3%\n* Less than 1%.\n(1) Includes 23,635 shares held in the Company's 401(k) plan, 18,333 shares purchasable upon exercise of options currently exercisable or options which become exercisable within 60 days, 32,333 shares held by such officer and director's spouse and 31,389 shares subject to Restricted Stock Agreements and certain forfeiture provisions.\n- 37 -\n(2) Includes 22,507 shares held in the Company's 401(k) plan, 18,333 shares purchasable upon exercise of options currently exercisable or options which become exercisable within 60 days, 4,977 shares held by such officer and director's spouse and children and 31,389 shares subject to Restricted Stock Agreements and certain forfeiture provisions.\n(3) Includes 6,665 shares purchasable upon exercise of options currently exercisable or options which become exercisable within 60 days.\n(4) Includes 2,000 shares purchasable upon exercise of exercisable warrants.\n(5) Based on information in Amendment No. 1 to a Schedule 13G Report dated February 13, 1995, delivered to the Company and indicating that First Bank Systems is the beneficial owner of such shares. Includes 172,477 shares for which First Bank System, Inc. exercises sole dispositive power and 7,112 shares for which it exercises shared dispositive power. Such shares are held by the banking affiliates of such entity in a fiduciary capacity on behalf of various customers.\n(6) Includes 15,997 shares purchasable upon exercise of options currently exercisable or options which become exercisable within 60 days and 24,800 shares held by such director's spouse.\n(7) Includes 15,997 shares purchasable upon exercise of options currently exercisable or options which become exercisable within 60 days and 2,000 shares purchasable upon exercise of warrants.\n(8) Includes 18,664 shares purchasable upon exercise of options currently exercisable or options which become exercisable within 60 days.\n(9) Includes 3,358 shares held in the Company's 401(k) plan, 40,000 shares purchasable upon exercise of options currently exercisable or options which become exercisable within 60 days and 13,532 shares purchasable upon exercise of exercisable warrants.\n(10) Includes 16,879 shares held in the Company's 401(k) plan, 4,000 shares purchasable upon exercise of options currently exercisable or options which become exercisable within 60 days, 4,000 shares purchasable upon exercise of warrants and 1,333 shares subject to a Restricted Stock Agreement and subject to forfeiture.\n(11) Includes 66,379 shares held in the Company's 401(k) plan as of September 30, 1994, 137,989 shares purchasable upon exercise of options currently exercisable or options which become exercisable within 60 days, 21,532 shares purchasable upon exercise of warrants, 64,778 shares subject to Restricted Stock Awards and 62,110 shares held by the spouses and children of officers and directors.\nThe Company also has outstanding 303,640 shares of Cumulative Perpetual Preferred Stock, Series 1991, a non-voting, nonparticipating preferred stock. None of the executive officers or directors held any shares of such series of preferred stock as of March 1, 1995, except Mr. Burkholder who held 60 shares through an IRA account and whose spouse held 500 shares directly and 60 shares through an IRA account and Mr. Maas who holds 4,000 such shares.\nUnder federal securities laws, the Company's directors and officers, and any beneficial owner of more than 10% of a class of equity securities of the Company, are required to report their ownership of the Company's equity securities and any changes in such ownership to the Securities and Exchange Commission (the \"Commission\") and the securities exchange on which the equity securities are registered. Specific due dates for these reports have been established by the Commission, and the Company is required to disclose in this Annual Report on Form 10-K any delinquent filing of such reports and any failure to file such reports during the fiscal year ended December 31, 1994. All of the required reports were timely filed by each of the directors and officers of the Company during 1994.\n- 38 -\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe following table sets forth certain information relating to mortgage and line of credit loans aggregating more than $60,000 made to executive officers named in the Summary Compensation Table and directors of the Company since December 31, 1993:\nAll of the loans set forth in the table above were made in the ordinary course of business and on substantially the same terms as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collection or present other unfavorable features.\nThomas R. Lohmann leases property constituting two banking offices to the Bank pursuant to leases expiring in 2010 and 2012. Thomas R. Lohmann is the brother of John G. Lohmann, Jr., an executive officer of the Company. Monthly net lease payments under such leases total approximately $36,600 (subject to adjustment for changes in price indices).\n- 39 -\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORT ON FORM 8-K\n(a) 1. FINANCIAL STATEMENTS\nThe following financial statements and notes thereto are set forth beginning on the page immediately following the signature page to this Annual Report on Form 10-K:\nConsolidated Statements of Earnings for the years ended December 31, 1994, December 31, 1993, and December 31, 1992\nConsolidated Balance Sheets at December 31, 1994 and 1993\nConsolidated Statements of Stockholders' Equity for the period from January 1, 1992 to December 31, 1994\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, December 31, 1993 and December 31, 1992\nNotes to Consolidated Financial Statements\nReport of KPMG Peat Marwick LLP\n(a) 2. FINANCIAL STATEMENT SCHEDULES\nThe schedules have been omitted because of absence of conditions under which they are required or because the required information is included in the consolidated financial statements or notes thereto.\n(a) 3. LISTING OF EXHIBITS\nExhibit Number Description -------------- -----------\n2.1 Agreement and Plan of Reorganization between Investors Bank Corp., Firstar Corporation and Firstar Corporation of Minnesota (Incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed August 25, 1994 (File No. 0-16163)).\n2.2 Form of Voting Agreement (Incorporated by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed August 25, 1994 (File No. 0-16163)).\n3.1 Certificate of Incorporation of Company, as amended (Incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1 (Registration No. 33-9554) (the \"Registration Statement\")).\n3.2 Certificate of Amendment to Certificate of Incorporation (Incorporated by reference to Exhibit 4.18 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992) (File No. 0-16163)).\n3.3 Certificate of Amendment to Certificate of Incorporation (Incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994) (File No. 0-16163)).\n- 40 -\n3.4 Charter of Investors Savings Bank, F.S.B. (the \"Bank\") (Incorporated by reference to Exhibit 3.2 of the Registration Statement).\n3.5 Bylaws of the Company (Incorporated by reference to Exhibit 3.3 to the Registration Statement).\n3.6 Restated Bylaws of the Bank (Incorporated by reference to Exhibit 3.4 of the Registration Statement).\n3.7 Certificate of Designation of Series A Junior Participating Preferred Stock (Incorporated by reference to Exhibit 3.2 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1991).\n3.8 Certificate of Designation of Cumulative Perpetual Preferred Stock, Series 1991, of the Company (Incorporated by reference to Exhibit 4.5 to Amendment No. 1 to the Registration Statement on Form S-4 filed by the Company with the Commission on October 11, 1992 (File No. 33-42684) (hereafter \"S-4 Amendment No. 1\").\n3.9 Amended Certificate of Designation of Cumulative Perpetual Preferred Stock, Series 1991 (Incorporated by reference to Exhibit 4.17 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992 (File No. 0-16163)).\n3.10 Warrant Agreement dated October 15, 1991 between the Company and Norwest Bank Minnesota National Association (Incorporated by reference to Exhibit 4.7 to the S-4 Amendment No. 1).\n3.11 Specimen form of certificate for the Company's Cumulative Perpetual Preferred Stock, Series 1991 (Incorporated by reference to Exhibit 1.1 to the Company's Form 8-A dated January 6, 1992).\n3.12 Specimen Certificate of the Company's Warrants to Purchase Common Stock (Incorporated by reference to Exhibit 1.2 to the Company's Form 8-A dated January 6, 1992).\n3.13 Specimen Certificate for the Company's Common Stock (Incorporated by reference to Exhibit 4.1 to the Registration Statement).\n3.14 Rights Agreement dated as of May 7, 1991, between the Company and Norwest Bank Minnesota National Association (Incorporated by reference to Exhibit 4 to the Company's current report on Form 8-K dated May 7, 1991).\n4.1 First Amendment to Rights Agreement, as executed (Incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 16163)).\n4.2 Form of Subordinated Debenture Due 1996 of the Bank (Incorporated by reference to Exhibit 4.3 to the Registration Statement).\n4.3 Stock Option Plan of the Company, as amended (Incorporated by reference to Exhibit 4.6 to the Company's Registration Statement on Form S-8 (File No. 33-12893)).\n- 41 -\n4.4 Investors Bank Corp. 1993 Stock Incentive Plan (Incorporated by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0-16163)).\n4.5 Form of Indemnification Agreement with Directors (Incorporated by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended June 30, 1987).\n4.6 Indenture dated as of March 21, 1989 between the Bank and First Trust National Association relating to the 12.75% Subordinated Capital Notes due 1999 (Incorporated by reference to Exhibit 4.8 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1989 (File No. 0-16163)).\n4.7 Form of 12.75% Subordinated Capital Note due 1999 of the Bank (Incorporated by reference to Exhibit 4.7 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1989 (File No. 0-16163)).\n10.1 Lease dated January 7, 1987 between Thomas R. Lohmann, Susan M. Lohmann and the Bank relating to the Bank's Highland Park office (Incorporated by reference to Exhibit 10.14 of the Exchange Statement).\n10.2 Leases dated June 3, 1988 between Pinehurst Properties, Inc. and the Bank relating to the Roseville office of the Bank and the Investors Mortgage division. (Incorporated by reference to Exhibit 10.2 to the Company's Form 10-K for the fiscal year ended June 30, 1988 (File No. 0-16163)).\n10.3 Investors Savings 401(k) Plan Trust Agreement (1988 Restatement). (Incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended June 30, 1988 (File No. 0-16163)).\n*10.4 Deferred Compensation Plan (Incorporated by reference to Exhibit 4.9 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1989 (File No. 0-16163)).\n*10.5 Restated Employment Agreement between the Company and James M. Burkholder (Incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10- K for the year ended December 31, 1993 (File No. 0- 16163)).\n*10.6 Restated Employment Agreement between the Company and John G. Lohmann, Jr. (Incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10- K for the year ended December 31, 1993 (File No. 0- 16163)).\n*10.7 Form of Severance Agreement (Incorporated by reference to Exhibit 19.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992 (File No. 0-16163)).\n*10.8 Restricted Stock Award Agreement dated December 31, 1992 between the Company and James M. Burkholder (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. 0-16163)).\n- 42 -\n*10.9 Restricted Stock Award Agreement dated December 31, 1992 between the Company and John G. Lohmann, Jr. (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. 0-16163)).\n*10.10 Nonqualified Stock Option Agreement between the Company and Daniel Arrigoni (Incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16163)).\n*10.11 Nonqualified Stock Option Agreement between the Company and Daniel Arrigoni (Incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0- 16163)).\n*10.12 Performance Bonus Policy of the Company (Incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16163)).\n*10.13 Restricted Stock Award Agreement dated January 4, 1994 between the Company and James M. Burkholder (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. 0-16163)).\n*10.14 Restricted Stock Award Agreement dated January 4, 1994 between the Company and John G. Lohmann, Jr. (Incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0-16163)).\n*10.15 Restricted Stock Award Agreement dated January 4, 1994 between the Company and Lynn V. Bueltel (Incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0-16163)).\n*10.16 Employment Agreement dated August 21, 1994 between the Company, Firstar Corporation and James M. Burkholder (Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.17 Employment Agreement dated August 21, 1994 between the Company, Firstar Corporation and John G. Lohmann, Jr. (Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.18 Employment Agreement dated August 21, 1994 between the Company, Firstar Corporation and Daniel P. Arrigoni (Incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.19 Noncompetition Agreement dated August 21, 1994 between Firstar Corporation and James M. Burkholder (Incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.20 Noncompetition Agreement dated August 21, 1994 between Firstar Corporation and John G. Lohmann, Jr. (Incorporated by reference to Exhibit 10.5 to the Company's\n- 43 -\nQuarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.21 Noncompetition Agreement dated August 21, 1994 between Firstar Corporation and Daniel P. Arrigoni (Incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n11 Computation of Earnings per Common Share.\n22 Subsidiaries of the Company (Incorporated by reference to Exhibit 22 to the Registration Statement).\n24.1 Consent of KPMG Peat Marwick LLP\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K.\n(b) Reports on Form 8-K -------------------\nNone\n(c) See Exhibit Index and Exhibits attached as a separate section of this report.\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.\nINVESTORS BANK CORP.\nDated: March 29, 1995 By \/s\/JAMES M. BURKHOLDER ------------------------------ James M. Burkholder, 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.\nName Title Date\n\/s\/JAMES M. BURKHOLDER President, Chief Executive March 29, 1995 ------------------------- Officer and Director James M. Burkholder (Principal Executive Officer)\nExecutive Vice President, March __, 1995 ------------------------- Secretary and Director John G. Lohmann, Jr.\n\/s\/LYNN V. BUELTEL Senior Vice President and March 29, 1995 ------------------------- Chief Financial Officer Lynn V. Bueltel (principal finacial and accounting officer)\n\/s\/E. THOMAS BINGER Director March 29, 1995 ------------------------- E. Thomas Binger\n\/s\/LEONARD E. BROWN Director March 29, 1995 ------------------------- Leonard E. Brown\nDirector March __, 1995 ------------------------- George E. Maas\n\/s\/GRAHAM N. HEIKES Director March 29, 1995 ------------------------- Graham N. Heikes\nDirector March __, 1995 ------------------------- Alice D. Mortenson\n- 45 -\n[KPMG Peat Marwick LLP LETTERHEAD]\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Investors Bank Corp.:\nWe have audited the accompanying consolidated balance sheets of Investors Bank Corp. and subsidiary as of December 31, 1994 and 1993 and the related consolidated statements of earnings, 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 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 Investors Bank Corp. and subsidiary 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 3 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993 to adopt the provisions of Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES.\n\/s\/ KPMG Peat Marwick LLP\nKPMG Peat Marwick LLP Minneapolis, Minnesota January 20, 1995\nINVESTORS BANK CORP. AND SUBSIDIARY Consolidated Balance Sheets\nSee accompanying notes to consolidated financial statements.\nINVESTORS BANK CORP. AND SUBSIDIARY Consolidated Statements of Earnings\nSee accompanying notes to consolidated financial statements.\nINVESTORS BANK CORP. AND SUBSIDIARY Consolidated Statements of Stockholders' Equity\nSee accompanying notes to consolidated financial statements.\nINVESTORS BANK CORP. AND SUBSIDIARY Consolidated Statements of Cash Flows\nSee accompanying notes to consolidated financial statements.\nINVESTORS BANK CORP. AND SUBSIDIARY\nNotes to Consolidated Financial Statements\nYears ended December 31, 1994, 1993 and 1992\nNOTE 1. DESCRIPTION OF THE BUSINESS\nInvestors Bank Corp. (the Company) is a holding company for a subsidiary engaged in the retail banking and mortgage banking businesses.\nThe subsidiary, Investors Savings Bank, F.S.B. (the Bank), is a federally chartered savings bank with deposits insured by the Federal Deposit Insurance Corporation through the Savings Association Insurance Fund. The Bank is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities.\nNOTE 2. MERGER AGREEMENT\nOn August 21, 1994, the Company, Firstar Corporation (\"Firstar\") and Firstar Corporation of Minnesota (\"Firstar Minnesota\") entered into an Agreement and Plan of Reorganization (the \"Agreement\"), pursuant to which the Company will be merged (the \"Merger\") with and into Firstar Minnesota. The Agreement also calls for the merger of the Bank with and into Firstar Bank Minnesota, N.A., on the date of, and immediately after the Merger becomes effective. The Merger is to be accomplished by the exchange of .8676 shares of Firstar common stock for each share of the Company's common stock. See Note 14 for additional discussion of the effect of the Merger on the Company's preferred stock, outstanding warrants and options and restricted stock. For the year ended December 31, 1994, the Company had incurred $203,479 in costs related to the Merger.\nThe Merger is subject to a number of conditions including regulatory approval. The Agreement requires the Company to use its best efforts to repurchase shares of the Company common stock to be held in treasury for issuance upon exercise of outstanding options and warrants to the extent such repurchases do not exceed $2,000,000. Subsequent to the Agreement it was determined such a repurchase plan would violate a covenant in the Company's 9.25% Subordinated Notes (\"Notes\"). On January 20, 1995, the Company obtained consent of the holders of a majority in principal amount of the outstanding Notes to waive the covenant.\nA special meeting of the Company's stockholders is scheduled for March 15, 1995 to vote on the Merger. All of the executive officers and directors of the Company have entered into agreements that require them to vote for the Merger. The Company may terminate the Agreement if the trading price of Firstar common stock during the ten trading days ending three days before the special stockholders' meeting to approve the Merger is below $29 per share and at least 12.5% below an index composed of certain commercial banks.\nNOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe consolidated financial statements have been prepared in conformity with generally accepted accounting principles. 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 date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates or assumptions.\nMaterial estimates that are particularly susceptible to significant change in the near term relate to the determination of the reserve for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the reserves for loan and real estate losses, management obtains independent appraisals for significant properties.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Investors Bank Corp. and its wholly owned subsidiary, Investors Savings Bank, F.S.B. All material intercompany balances and transactions have been eliminated in consolidation.\nINVESTMENT SECURITIES\nThe Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES, as of January 1, 1994. Under SFAS No. 115, the Company must classify 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. Securities available for sale include securities that management intends to use as part of its asset\/liability strategy or that may be sold in response to changes in interest rate, changes in prepayment risk, the need to increase regulatory capital, or similar factors. The Company has the ability and intent to hold its securities to maturity. Accordingly, there are no securities held in a trading acount or available for sale and the adoption of SFAS No. 115 had no impact on the Company's consolidated financial statements as of January 1, 1994.\nInvestment securities, consisting primarily of investment grade corporate bonds and U.S. Government agency obligations, are stated at cost, adjusted for amortization of premiums and accretion of discounts on purchase. Premiums and discounts are amortized on the interest method over the term of the securities.\nMORTGAGE LOANS\nThe Bank originates and purchases both adjustable rate mortgage (ARM) and fixed interest rate mortgage loans. Substantially all conventional ARM loans are held for portfolio investment while substantially all government insured ARM loans and all fixed interest rate loans are sold in the secondary market. Mortgage loans held for sale are carried at the lower of cost or market determined on an aggregate loan basis.\nInterest is accrued monthly on outstanding principal balances unless management considers collection to be doubtful, which generally occurs when principal or interest payments are three months or more past due. Interest is subsequently recognized as income only to the extent cash is received. When properties securing loans are foreclosed upon, previously accrued but unpaid interest is reversed from income.\nLOAN ORIGINATION FEES AND DISCOUNTS\nLoan origination fees and certain other fees and certain direct loan origination costs are deferred and amortized to interest income as an adjustment of yield using the interest method, or recognized as a portion of gain on sales when the loans are sold. Loan discounts representing a return of yield are deferred and amortized to income using the interest method over the related periods to achieve a level yield.\nMORTGAGE BANKING INCOME\nIncluded in mortgage banking income are gain on sales of mortgage loans, gain on sales of loan servicing rights, and other lending fees.\nGain on sales of mortgage loans are recognized when the loans are sold. Gain on sales include any discounts or premiums and the excess value of servicing rights retained. The excess value of servicing rights retained represents the discounted present value of future service fee income in excess of a normal market rate servicing fee.\nThe Company engages in the sale of loan servicing rights. Gain on sales of servicing rights are recognized when the servicing rights are sold. Gains on sale result from net cash proceeds less the carrying value of capitalized servicing rights on the servicing pools sold.\nLOAN SERVICING FEES\nThe Company derives loan servicing fees by collecting loan payments and performing certain escrow services for mortgage investors. Amortization of excess servicing rights and purchased servicing rights are recorded as a reduction to loan servicing fees.\nCAPITALIZED SERVICING RIGHTS\nIncluded in capitalized servicing rights is the unamortized balance of excess servicing rights capitalized. The amounts capitalized and the amortization thereon is based, in part, on certain prepayment assumptions of the underlying loans. If, in the future, actual prepayments exceed the Company's assumptions, adjustments to the carrying value of servicing rights may be required. Excess servicing rights are being amortized over the estimated remaining life of the related loans sold in proportion to estimated net servicing income.\nThe Company has engaged in bulk purchases of loan servicing rights. The cost of these rights is capitalized and amortized over the estimated remaining life of the related loans in proportion to estimated net servicing income. Loan servicing rights are also purchased from correspondents in connection with the purchase of mortgage loans. Service release premiums are paid to acquire these rights. These amounts are amortized over the estimated life of the related loans or are offset against gain on sales of mortgage loans when the related loans are sold.\nFORWARD CONTRACTS\nThe Company uses mandatory, optional and standby forward contracts as part of its overall interest rate risk management strategy for its mortgage banking operations. Outstanding contracts represent future commitments and are not included in the consolidated balance sheets. Gains and losses on forward contracts used as hedges in mortgage banking operations are deferred and recognized when the related mortgages or commitments are sold or when a loss adjustment is recognized on an aggregate basis to reduce the Bank's unsold loans and loan commitments to the lower of cost or market. Forward contracts which are no longer needed to hedge specific assets or commitments are valued at market and the resulting gains or losses are recognized immediately.\nRESERVE FOR LOAN LOSSES\nThe reserve for loan losses provides for potential losses in the loan portfolio. The reserve is increased by the provision for loan losses and by recoveries and is decreased by charge-offs. The adequacy of the reserve is judgmental and is based on continual evaluation of the nature and volume of the loan portfolio, overall portfolio quality, specific problem loans, collateral values, historical experience and current economic conditions that may affect the borrowers' ability to pay.\nThe Company adopted the provisions of SFAS No. 114, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN, as amended by SFAS No. 118, ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN - INCOME RECOGNITION AND DISCLOSURES, as of January 1, 1994. SFAS No. 114 specifies how reserves for losses related to \"impaired\" loans should be measured. A loan is considered impaired if it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is impaired, the Company will measure the amount of impairment based on the present value of expected future cash flows, the loan's observable market price or the fair value of any collateral. If foreclosure is probable, the Company shall measure impairment based on the fair value of the collateral. SFAS No. 114 does not apply to large groups of small balance, homogeneous loans that are collectively evaluated for impairment. The adoption of SFAS Nos. 114 and 118 had no effect on the consolidated financial statements as of January 1, 1994.\nManagement believes that the reserves for losses on loans are adequate. While management uses available information to recognize losses on loans, future additions to the reserves may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the reserves for losses on loans. Such agencies may require additions to the reserves based on their judgments of information available to them at the time of their examination.\nFORECLOSED REAL ESTATE\nReal estate in judgment and acquired through foreclosure is initially recorded at the lower of cost or estimated fair value less selling costs. Provisions for possible losses on real estate are charged to earnings when necessary to reduce carrying values to estimated fair value less selling costs.\nDEPRECIATION AND AMORTIZATION\nDepreciation is computed on a straight-line basis over three to twelve years for office furniture and equipment and over forty years for buildings. Leasehold improvements are amortized using the straight-line method over the life of the asset or the term of the lease, whichever is less.\nINCOME TAXES\nThe Company adopted SFAS No. 109 , \"ACCOUNTING FOR INCOME TAXES\", as of January 1, 1993 and applied the provisions prospectively as of that date. SFAS No. 109 requires a change from the deferred method of accounting for income taxes to the asset and liability method. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The cumulative effect of the application of SFAS No. 109 as of January 1, 1993 increased net earnings for the year ended December 31, 1993 by $125,000.\nEARNINGS PER COMMON SHARE\nNet earnings are adjusted for preferred stock dividends in the computation of earnings per common share. Earnings per common share are computed on the basis of the weighted average number of common and common equivalent shares outstanding during the year. Common equivalent shares represent the dilutive effect of outstanding stock options and warrants.\nSTATEMENT OF CASH FLOWS\nFor purposes of the statement of cash flows, cash equivalents include investments in certificates of deposit with maturities of three months or less.\nRECLASSIFICATIONS\nCertain reclassifications have been made to the financial statements of prior periods to conform to the current presentation. The reclassifications had no effect on net earnings or stockholders' equity as previously reported.\nNOTE 4. INVESTMENTS\nInvestments consisted of the following:\nThere were no sales of investments during 1994, 1993 or 1992.\nThe amortized cost and estimated market value of investment securities at December 31, 1994, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because obligors may have the right to call or prepay obligations with or without call or prepayment penalties.\nIncluded in accrued interest receivable at December 31, 1994 and 1993 is interest receivable on investments of $357,174 and $315,587, respectively.\nNOTE 5. LOANS HELD IN PORTFOLIO\nMortgage loans consisted of the following:\nConsumer loans consisted of the following:\nThe Company originates consumer and residential real estate loans in the metropolitan area of Minneapolis\/St. Paul. The Company also originates residential real estate loans in Duluth, Minnesota and the Chicago and Milwaukee metropolitan areas. The Company maintains a small commercial real estate loan portfolio originated in prior years and is not actively seeking new commercial real estate loans. The commercial real estate portfolio consists mainly of loans secured by apartment complexes and small retail shopping malls in the Minneapolis\/St. Paul metropolitan area. Although the Company has a diversified loan portfolio, a substantial portion of its borrowers' ability to honor their loans is dependent on the economic strength of the metropolitan areas of Minneapolis\/St. Paul, Duluth, Chicago and Milwaukee.\nFollowing is a summary of the reserve for losses on loans:\nAt December 31, 1994 and 1993 the Company had approximately $2,105,000 and $1,903,000, respectively, of loans in a nonaccrual status. Had nonaccrual loans been accruing interest in accordance with original terms, interest income would have been increased by approximately $41,000 , $40,000 and $54,000 for the years ended December 31, 1994, 1993 and 1992, respectively. The Company's loan portfolio as of December 31, 1994 includes no restructured loans. There are no commitments to lend additional funds to customers whose loans were in a nonaccrual status at December 31, 1994.\nIncluded in accrued interest receivable at December 31, 1994 and 1993 is interest receivable on loans of $4,928,718 and $3,237,750, respectively.\nThe aggregate amount of loans to executive officers and directors of the Company and executive officers of the Bank were $126,000 and $243,000 at December 31, 1994 and 1993, respectively. During the year ended December 31, 1994, approximately $1,000 of new loans were made and reductions totaled $118,000. Such loans were made in the ordinary course of business at the normal credit terms and collateralization and do not represent more than normal risk of collection.\nNOTE 6. MORTGAGE BANKING\nMortgage loans held for sale consisted of the following:\nMortgage banking income consisted of the following:\nMortgage banking activity is summarized as follows:\nIncluded in accrued interest receivable at December 31, 1994 and 1993 is interest receivable on loans held for sale of $36,443 and $100,116, respectively.\nNOTE 7. LOAN SERVICING\nMortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The mortgage loans serviced for others consisted of the following:\nCapitalized servicing rights, net of accumulated amortization were as follows:\nNOTE 8. OFFICE PROPERTIES AND EQUIPMENT\nOffice properties and equipment consisted of the following:\nNOTE 9. FORECLOSED REAL ESTATE\nForeclosed real estate consisted of the following:\nThe following is a summary of the reserve for losses on real estate:\nNOTE 10. DEPOSITS\nDeposits are summarized as follows:\nAt December 31, 1994 and 1993 the Bank had $43,929,650 and $38,675,442, respectively, of certificate accounts with balances of $100,000 or more.\nScheduled maturities and related weighted average rates of certificate accounts at December 31, 1994 are as follows:\nInterest expense on deposits for the years presented are as follows:\nNOTE 11. BORROWINGS\nNotes payable to Federal Home Loan Bank (FHLB) of Des Moines consisted of the following:\nThe interest rates on notes due in 1997, 1998 and 2000 are reset by the FHLB on the anniversary dates to a rate indexed to the current rate charged by the FHLB for one year borrowings. The Company also has the option of repaying each such note at its anniversary date without penalty.\nNotes payable to the FHLB are collateralized by FHLB stock and first mortgage real estate loans. At December 31, 1994, the Company had a collateral requirement on first mortgage real estate loans of $500,000,000 and had pledged specific collateral with an aggregate carrying value of approximately $553,000,000.\nSubordinated debt is as follows:\nThe subordinated debt is unsecured. At the option of the Company, the 9.25% notes may be redeemed at par on or after December 15, 1995. On November 7, 1994, the Company elected to exercise its right to redeem at par the 10% debentures on January 3, 1995. The 12.75% capital notes were redeemed at par on April 1, 1994. During 1991, $7,591,000 of the 12.75% capital notes were exchanged by the capital note holders for preferred stock (see Note 14).\nCovenants for the 9.25% notes provide that the Company must maintain at least $1,000,000 in certain investments with a maturity of one year or less, of which no more than $500,000 may be placed on account at the Bank.\nThe interest is payable monthly for the 9.25% notes and quarterly for the 10% debentures. The notes and debentures are subordinated in payment of principal and interest to all customer deposits and other indebtedness of the Bank for borrowed money as defined in the note and debenture agreements.\nUnamortized debt issue costs of $817,882 and $852,248 are included in other assets at December 31, 1994 and 1993, respectively.\nInterest expense for borrowings for the periods presented are as follows:\nNOTE 12. FEDERAL HOME LOAN BANK STOCK, LIQUIDITY AND CAPITAL REQUIREMENTS\nThe Bank, as a member of the FHLB, is required to hold a specified number of shares of capital stock, which is carried at cost, in the FHLB of Des Moines. In addition, under regulations currently in effect, the Bank is required to maintain cash and other liquid assets in an amount equal to 5% of its deposit accounts and other obligations due within one year. The Bank has met these requirements.\nThe Bank is subject to capital standards established by the Federal Deposit Insurance Corporation Improvement Act of 1991 which defines five capital tiers, the highest of which is \"well capitalized\". Under the regulations a \"well capitalized\" institution must have a leverage ratio of at least 5%, a tier 1 risk based capital ratio of at least 6% and a total risk based capital ratio of at least 10%.\nAt December 31, 1994 and 1993, the Bank exceeded each of these requirements and is categorized as a \"well capitalized\" institution.\nThe following is a summary of the Bank's capital ratios (unaudited):\nManagement believes the Bank will continue to meet the requirements to be categorized as a \"well capitalized\" institution in 1995.\nThe Bank is also required by federal regulations to maintain minimum levels of capital that are measured by three ratios: a tangible capital ratio of at least 1.5% of tangible assets; a core capital ratio of at least 3%, and a risk based capital ratio of at least 8%. The Bank exceeded all three ratios during 1994 and 1993 and management believes the Bank will continue to do so in 1995.\nIn 1993, the Office of Thrift Supervision (OTS) issued its final regulations on interest rate risk. Under the final rule, institutions deemed to have an \"above normal\" level of interest rate risk are subject to a capital charge and must deduct a portion of that risk from total capital for regulatory capital purposes. As of December 31, 1994 and 1993 the Bank's required regulatory capital was not impacted by the interest rate risk rule.\nNOTE 13. INCOME TAXES\nThe Company and the Bank file consolidated federal income tax returns. Federal income taxes are allocated to the Company and the Bank based on their contributions to consolidated taxable income.\nThe components of income tax expense for the years ended December 31 consists of the following:\nA reconciliation of the statutory federal income tax rate with the actual rate provided on earnings is as follows:\nThe Bank qualifies under various provisions of the Internal Revenue Code which permit it to deduct from taxable income an allowance for bad debts which differs from the provision for such losses charged to income for financial statement purposes. Accordingly, retained earnings at December 31, 1994 includes approximately $1,072,000 for which no provision for income taxes has been made. If, in the future, this portion of retained earnings is used for any purpose other than to absorb bad debt losses, income taxes may be imposed at the then applicable rates. It is not contemplated that any portion of retained earnings will be used in a manner that will result in additional taxable income.\nThe tax effects of temporary differences that gave rise to the deferred tax assets and deferred tax liabilities at December 31, 1994 and 1993 are as follows:\nNo valuation allowance was required for deferred tax assets at December 31, 1994 and 1993.\nDeferred income taxes for 1992 relate primarily to the difference in recognition of components of gains on sales of mortgage loans and depreciation for financial reporting and income tax purposes.\nNOTE 14. STOCKHOLDERS' EQUITY\nPREFERRED STOCK\nThe Company has outstanding 303,640 shares of preferred stock originally issued in exchange for $7,591,000 of the Bank's 12.75% Subordinated capital notes due 1999. The preferred stock was issued in units consisting of one share of preferred stock and one warrant to purchase one-half share of the Company's common stock (See \"Stock Warrants\"). Dividends on the preferred stock were at an annual rate of $3.1875 per share until October 31, 1993 and are at an annual rate of $2.75 per share thereafter. Dividends are cumulative and are payable quarterly. There were no preferred dividends due but not paid as of December 31, 1994. The preferred stock has a liquidation preference of $25.00 per share plus accumulated and unpaid dividends. The preferred stock is redeemable at the option of the Company, in whole or in part, at any time on or after October 31, 1996, at $25.00 per share plus accumulated and unpaid dividends. Pursuant to the Merger discussed in Note 2, each outstanding share of the preferred stock would become the right to receive $27.50 plus accumulated and unpaid dividends in cash.\nCOMMON STOCK\nIn November, 1993, the Company declared a four-for-three split of its common stock payable on December 31, 1993 to all holders of record as of December 1, 1993. The split was effected by means of a stock dividend. No fractional shares were issued.\nSTOCKHOLDER RIGHTS PLAN\nOn May 7, 1991 the Company's Board of Directors adopted a stockholders rights plan (Plan) under which each share of the Company's common stock has an associated preferred stock purchase right that would allow the holders to purchase the Company's common stock at a discounted price upon certain events. In contemplation of execution of the Merger Agreement as discussed in Note 2, the Company's Board of Directors amended the Plan as of August 21, 1994 to provide that the Merger would not trigger provisions of the Plan.\nDIVIDEND RESTRICTIONS\nThe Company is limited in its ability to declare dividends by the dividend restrictions imposed on its savings bank subsidiary. Under applicable regulations of the OTS, the Bank could declare dividends to the Company without regulatory approval in an amount equal to accumulated net income for the current calendar year plus 50% of the amount by which its capital exceeded its capital requirements at the beginning of the year. However, the Bank could not declare dividends that would cause it to fall below its capital requirement without OTS approval.\nSTOCK OPTIONS\nThe Company has a stock option plan under which 618,554 shares of common stock are reserved for issuance to employees and directors of the Company.\nAt the Company's annual meeting of shareholders on May 3, 1994, the shareholders voted to approve the Investors Bank Corp. 1993 Stock Incentive Plan (\"1993 Plan\") which, in effect, replaced the Company's Restricted Stock Option Plan. The 1993 Plan permits the granting of a variety of different types of awards valued in whole or in part by reference to or otherwise based upon the Company's stock. An award may not be for less than 100% of the fair value of the Company's common stock on the date of the award. Under terms of the Merger agreement discussed in Note 2, the Company agreed not to grant any awards without the prior approval of Firstar. Since the date of the Merger announcement, no additional awards have been granted. Pursuant to the terms of the Merger, all options would become fully exercisable immediately upon the effective date of the Merger as options in Firstar common stock at the exchange ratio of .8676 shares of Firstar common stock for each share of the Company's common stock.\nThe following is a summary of activity in the plan:\nSTOCK WARRANTS\nIn conjunction with the issuance of preferred stock there are warrants to purchase 201,427 shares of common stock at a price of $11.06 per share on or after February 11, 1992. The warrants expire on November 13, 1996. The Company has reserved common stock for the outstanding warrants. Pursuant to the Merger discussed in Note 2, the warrants would become warrants to purchase an equivalent .8676 shares of Firstar common stock.\nRESTRICTED STOCK AWARD AGREEMENTS\nThe Company entered into Restricted Stock Award Agreements in 1992 and 1994. Under the terms of the 1992 agreement, 45,973 shares of restricted stock were granted to two executive officers of the Company. These shares vest over a ten-year period at the rate of 10% per year. A January 4, 1994 agreement granted an additional 28,000 shares of restricted stock to three executive officers of the Company. These shares vest over a three-year period at 33 1\/3% per year. Compensation expense for all the shares vesting in 1994, 1993 and 1992 was $384,087, $182,048 and $49,996, respectively.\nUnder the terms of the Merger agreement discussed in Note 2, the value of the stock award granted in 1992 will be independently appraised and, based upon the appraised value, exchanged for .8676 equivalent unrestricted shares of Firstar common stock. The 1994 restricted stock will be exchanged for .8676 equivalent restricted shares of Firstar common stock.\nNOTE 15. 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 and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, mortgage loan purchase commitments and forward mortgage loan sales commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments.\nThe Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and purchase mortgage loans is represented by the contract or notional amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. For forward mortgage loan sales commitments, the contract or notional amounts do not represent exposure to credit loss. The Company controls the credit risk of forward mortgage loan sales commitments through credit approvals, credit limits and monitoring procedures.\nThe contract or notional amounts of these financial instruments at December 31, 1994 were as follows:\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 a portion 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 the loan type and on management's credit evaluation of the borrower. Collateral consists primarily of residential real estate and personal property.\nForward mortgage loan sales commitments are contracts for the delivery of securities backed by mortgage loans in which the Company agrees to make delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise from the possible inability of the counterparties to meet the terms of their contracts and from movements in mortgage loan values and interest rates.\nNOTE 16. COMMITMENTS\nThe Company has several noncancelable operating lease agreements for its office properties which have remaining lease terms of up to fourteen years except for one land lease with a remaining term of thirty-seven years. In addition, one retail banking office is under a capital lease which has a remaining term of six years. Future minimum payments under these leases are as follows:\nIn addition, the Company has several renewal options on all its retail banking office leases and some of its mortgage office leases ranging from two- to five-year periods. At present, the Company intends to exercise most options on its retail banking offices when the original leases expire. If this occurs, total future minimum payments (estimated using original lease term costs) under these leases, as shown above, would increase by approximately $7,689,000.\nThe Company previously sold two retail banking office properties to third parties under sale\/leaseback arrangements. These lease agreements include purchase options at market value at certain points during the lease terms.\nTotal rent expense for the years ended December 31, 1994, 1993 and 1992 was approximately $1,659,000, $1,509,000 and $1,007,000, respectively.\nNOTE 17. RETIREMENT PLAN\nThe Company currently offers a 401(k) plan which is available to all permanent employees who have attained age twenty-one and have met the one year eligibility requirement, as defined. Under the 401(k) plan, an employee may defer up to 15% of his or her compensation, as defined, with discretionary matching Company contributions. The Company may also make discretionary profit sharing contributions to be invested in common stock of the Company and has done so in 1994, 1993 and 1992. Eligible employees vest in the Company's matching and profit sharing contributions ratably over their first five years of employment. Total expense under the plan for the years ended December 31, 1994, 1993 and 1992 was $421,914, $541,579 and $403,294, respectively.\nUnder terms of the merger agreement, the Company agreed not to amend the 401(k) plan without the consent of Firstar. The Company expects the 401(k) plan to be maintained for a period after the Merger and to eventually be merged with Firstar's 401(k) plan.\nNOTE 18. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company is required to disclose estimated fair values of its financial instruments, including assets, liabilities and off- balance sheet items, for which it is practicable to estimate fair value. These fair values are estimates made as of December 31, 1994 and 1993 based on relevant market information, if available, and upon characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company's financial instruments, many of the fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk\ncharacteristics of various financial instruments and other factors. Thus, the estimates are subjective in nature, involving uncertainties and requiring judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.\nFair value estimates are based only on existing financial instruments. The Company has not attempted to estimate the value of anticipated future business or assets, liabilities or activities that are not considered financial instruments. For example, the Company has a substantial mortgage banking operation that contributes significant amounts of noninterest income annually. The mortgage banking operation is not a financial instrument and its value has not been incorporated into the fair value estimates. In addition, the tax effects of unrealized gains or losses implied in the fair value estimates have not been considered in the estimates nor have costs necessary to consummate a sale been considered. Accordingly, the aggregate fair value amounts do not represent an estimate of the underlying fair value of the Company.\nThe estimated fair value of the Company's financial instruments are shown below. Following the table, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instrument.\nCASH AND CASH EQUIVALENTS\nThe carrying amount of cash and cash equivalents approximates their fair value.\nINVESTMENT SECURITIES HELD TO MATURITY\nThe fair values of investment securities are based on quoted market prices. See Note 4 for the carrying amounts and fair values of the various components of the Company's investment portfolio.\nMORTGAGE LOANS HELD FOR SALE\nIn order to manage the market exposure on its residential loans held for sale and its commitments to extend credit for residential loans, the Company enters into forward mandatory, optional and standby mortgage loan sales commitments. Therefore, the estimated fair value of mortgage loans held for sale is based on the committed sales prices.\nMORTGAGE LOANS\nThe fair values of mortgage loans were estimated for groups of loans with similar characteristics. See Note 5 for the descriptions and amounts of these groups. Nonperforming loans were subtracted and discounted by the average historical rate of loss that the Company has experienced on these types of loans.\nThe largest group, adjustable first mortgage loans, has experienced no significant change in credit risk. Its fair value was estimated by subtracting nonperforming loans, classifying the loans into segments with similar characteristics which determine saleability and obtaining market quotes for each of the segments.\nThe fair value of the commercial real estate loans was estimated using discounted cash flow analysis. The discount rates used were estimated market rates for similar types of loans adjusted upward to reflect the decline in the collateral market values of commercial real estate properties over the last few years. In addition, certain loans have experienced increased credit risk since origination. The discount rate for these loans was further adjusted upward to compensate for this additional risk.\nThe credit risk of the adjustable second mortgage loans and other mortgages has not changed appreciably. Discounted cash flow analysis of scheduled payments applying a discount rate based on an estimated market rate appropriate for each type of loan was used to estimate the fair value of these loans.\nCONSUMER LOANS\nConsumer loans consist primarily of loans secured by residential real estate. See Note 5 for the classifications of such loans. The Company believes the credit risk of these loans has not changed significantly since origination. Nonperforming second mortgage loans were removed from the total and discounted to reduce them to estimated fair value. The remaining loans were segmented into groups with similar characteristics and the fair value was estimated by discounting the expected cash flows using discount rates that equaled the Company's origination rates for similar loans as of December 31, 1994 and 1993.\nFEDERAL HOME LOAN BANK STOCK\nThe carrying amount of FHLB stock approximates its fair value.\nEXCESS SERVICING FEES\nExcess servicing fees are included in capitalized servicing rights on the balance sheet. See Note 7 for additional information. The fair value of excess servicing fees was estimated by discounting the expected cash flows associated with the servicing of the underlying loans. The mortgages serviced for others were sorted into groups with characteristics similar to loan pools for which servicing is typically bought or sold. An estimated market rate of return was assumed for each pool and these rates were used as the discount rates in the analysis.\nACCRUED INTEREST RECEIVABLE\nThe carrying amount of accrued interest receivable approximates its fair value since it is short term in nature and does not present unanticipated credit concerns.\nDEPOSITS\nThe fair value of deposits with no stated maturity, such as checking, savings and money market accounts, is equal to the amount payable on demand as of December 31, 1994 and 1993. See Note 10 for deposit classifications. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using as discount rates the rates that were offered by the Company as of December 31, 1994 and\n1993 for deposits with maturities similar to the remaining maturities of the existing certificates of deposit.\nThe fair value estimate for deposits does not include the benefit that results from the low-cost funding provided by the Company's existing deposits and long-term customer relationships compared to the cost of obtaining different sources of funding. This benefit, generally referred to as core deposit intangible, has not been quantified by the Company.\nNOTES PAYABLE\nNotes payable consist of FHLB advances. The carrying amount of notes payable which may be repaid at any time without penalty at the Company's discretion approximates their fair value. The fair values of the notes payable with fixed maturities are estimated based on discounted cash flow analyses using as discount rates interest rates charged by the FHLB at December 31, 1994 and 1993 for borrowings of similar remaining maturities.\nSUBORDINATED DEBT\nThere are two subordinated debt instruments at December 31, 1994. See Note 11 for more information. The fair value of the 9.25% notes due 2002 was estimated based on the bid market prices as of December 31, 1994 and 1993. The fair value of the 10% debentures due 1996 as of December 31, 1994 was based upon their carrying value because the Bank called the debentures on January 3, 1995. As of December 31, 1993 the 10% debentures were valued based on an estimated market price taking into account their rate, maturity and risk in relation to the 9.25% notes. The fair value at December 31, 1993 of the 12.75% capital notes due 1999 approximated their carrying amount because the market anticipated the Company's redemption of the notes at par on April 1, 1994.\nCOMMITMENTS TO EXTEND CREDIT\nAt December 31, 1994 and 1993, the Company had commitments to extend credit with total notional amount of $81,324,000 and $94,549,000, respectively. See Note 15 for the type and amounts of commitments as well as related discussion. The fair value of commitments to extend credit is not based on the notional amounts, but rather is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the\nagreements and the present creditworthiness of the counter parties. For commitments to extend credit for residential mortgage loans and for commercial development of residential property, the fair value is based on the fees charged for these commitments. Because of the short term nature of the commitments, no adjustment was necessary for change in creditworthiness or changes in market interest rates. The Company does not charge fees for commitments to retail customers to extend credit under available lines of credit. Accordingly, no fair value was assigned to these commitments. The estimated fair values of commitments to extend credit at December 31, 1994 and 1993 were $24,000 and $73,000, respectively.\nNOTE 19. PARENT COMPANY FINANCIAL INFORMATION\nThe Investors Bank Corp. (parent company only) condensed financial statements are as follows:\nNOTE 20. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nSummarized quarterly data for 1994 and 1993 follows: (in thousands except per share data)\nINVESTORS BANK CORP. ANNUAL REPORT ON FORM 10-K\nEXHIBIT INDEX\nExhibit Number Description Page -------------- ----------- ---- 2.1 Agreement and Plan of Reorganization between Investors Bank Corp., Firstar Corporation and Firstar Corporation of Minnesota (Incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed August 25, 1994 (File No. 0-16163)).\n2.2 Form of Voting Agreement (Incorporated by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K filed August 25, 1994 (File No. 0-16163)).\n3.1 Certificate of Incorporation of Company, as amended (Incorporated by reference to Exhibit 3.1 of the Company's Registration Statement on Form S-1 (Registration No. 33-9554) (the \"Registration Statement\")).\n3.2 Certificate of Amendment to Certificate of Incorporation (Incorporated by reference to Exhibit 4.18 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992) (File No. 0-16163)).\n3.3 Certificate of Amendment to Certificate of Incorporation (Incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994) (File No. 0-16163)).\n3.4 Charter of Investors Savings Bank, F.S.B. (the \"Bank\") (Incorporated by reference to Exhibit 3.2 of the Registration Statement).\n3.5 Bylaws of the Company (Incorporated by reference to Exhibit 3.3 to the Registration Statement).\n3.6 Restated Bylaws of the Bank (Incorporated by reference to Exhibit 3.4 of the Registration Statement).\n3.7 Certificate of Designation of Series A Junior Participating Preferred Stock (Incorporated by reference to Exhibit 3.2 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1991).\n3.8 Certificate of Designation of Cumulative Perpetual Preferred Stock, Series 1991, of the Company (Incorporated by reference to Exhibit 4.5 to Amendment No. 1 to the Registration Statement on Form S-4 filed by the Company with the Commission on October 11, 1992 (File No. 33- 42684) (hereafter \"S-4 Amendment No. 1\").\n3.9 Amended Certificate of Designation of Cumulative Perpetual Preferred Stock, Series 1991 (Incorporated by reference to Exhibit 4.17 to the\nCompany's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992 (File No. 0- 16163)).\n3.10 Warrant Agreement dated October 15, 1991 between the Company and Norwest Bank Minnesota National Association (Incorporated by reference to Exhibit 4.7 to the S-4 Amendment No. 1).\n3.11 Specimen form of certificate for the Company's Cumulative Perpetual Preferred Stock, Series 1991 (Incorporated by reference to Exhibit 1.1 to the Company's Form 8-A dated January 6, 1992).\n3.12 Specimen Certificate of the Company's Warrants to Purchase Common Stock (Incorporated by reference to Exhibit 1.2 to the Company's Form 8-A dated January 6, 1992).\n3.13 Specimen Certificate for the Company's Common Stock (Incorporated by reference to exhibit 4.1 to the Registration Statement).\n3.14 Rights Agreement dated as of May 7, 1991, between the Company and Norwest Bank Minnesota National Association (Incorporated by reference to Exhibit 4 to the Company's current report on Form 8-K dated May 7, 1991).\n4.1 First Amendment to Rights Agreement, as executed (Incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 16163)).\n4.2 Form of Subordinated Debenture Due 1996 of the Bank (Incorporated by reference to Exhibit 4.3 to the Registration Statement).\n4.3 Stock Option Plan of the Company, as amended (Incorporated by reference to Exhibit 4.6 to the Company's Registration Statement on Form S-8 (File No. 33-12893)).\n4.4 Investors Bank Corp. 1993 Stock Incentive Plan (Incorporated by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0- 16163)).\n4.5 Form of Indemnification Agreement with Directors (Incorporated by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended June 30, 1987).\n4.6 Indenture dated as of March 21, 1989 between the Bank and First Trust National Association relating to the 12.75% Subordinated Capital Notes due 1999 (Incorporated by reference to Exhibit 4.8 of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1989 (File No. 0-16163)).\n4.7 Form of 12.75% Subordinated Capital Note due 1999 of the Bank (Incorporated by reference to Exhibit 4.7 to the Company's quarterly\nreport on Form 10-Q for the quarter ended March 31, 1989 (File No. 0-16163)).\n10.1 Lease dated January 7, 1987 between Thomas R. Lohmann, Susan M. Lohmann and the Bank relating to the Bank's Highland Park office (Incorporated by reference to Exhibit 10.14 of the Exchange Statement).\n10.2 Leases dated June 3, 1988 between Pinehurst Properties, Inc. and the Bank relating to the Roseville office of the Bank and the Investors Mortgage division. (Incorporated by reference to Exhibit 10.2 to the Company's Form 10-K for the fiscal year ended June 30, 1988 (File No. 0-16163)).\n10.3 Investors Savings 401(k) Plan Trust Agreement (1988 Restatement). (Incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended June 30, 1988 (File No. 0-16163)).\n*10.4 Deferred Compensation Plan (Incorporated by reference to Exhibit 4.9 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1989 (File No. 0-16163)).\n*10.5 Restated Employment Agreement between the Company and James M. Burkholder (Incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0-16163)).\n*10.6 Restated Employment Agreement between the Company and John G. Lohmann, Jr. (Incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0-16163)).\n*10.7 Form of Severance Agreement (Incorporated by reference to Exhibit 19.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992 (File No. 0-16163)).\n*10.8 Restricted Stock Award Agreement dated December 31, 1992 between the Company and James M. Burkholder (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. 0-16163)).\n*10.9 Restricted Stock Award Agreement dated December 31, 1992 between the Company and John G. Lohmann, Jr. (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. 0-16163))\n*10.10 Nonqualified Stock Option Agreement between the Company and Daniel Arrigoni (Incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16163)).\n*10.11 Nonqualified Stock Option Agreement between the Company and Daniel Arrigoni (Incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-16163)).\n*10.12 Performance Bonus Policy of the Company (Incorporated by reference to Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0- 16163)).\n*10.13 Restricted Stock Award Agreement dated January 4, 1994 between the Company and James M. Burkholder (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. 0-16163)).\n*10.14 Restricted Stock Award Agreement dated January 4, 1994 between the Company and John G. Lohmann, Jr. (Incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0- 16163)).\n*10.15 Restricted Stock Award Agreement dated January 4, 1994 between the Company and Lynn V. Bueltel (Incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 0- 16163)).\n*10.16 Employment Agreement dated August 21, 1994 between the Company, Firstar Corporation and James M. Burkholder (Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.17 Employment Agreement dated August 21, 1994 between the Company, Firstar Corporation and John G. Lohmann, Jr. (Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.18 Employment Agreement dated August 21, 1994 between the Company, Firstar Corporation and Daniel P. Arrigoni (Incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.19 Noncompetition Agreement dated August 21, 1994 between Firstar Corporation and James M. Burkholder (Incorporated by reference to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.20 Noncompetition Agreement dated August 21, 1994 between Firstar Corporation and John G. Lohmann, Jr. (Incorporated by reference to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n*10.21 Noncompetition Agreement dated August 21, 1994 between Firstar Corporation and Daniel P. Arrigoni (Incorporated by reference to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-16163)).\n11 Computation of Earnings per Common Share.\n22 Subsidiaries of the Company (Incorporated by reference to Exhibit 22 to the Registration Statement).\n24.1 Consent of KPMG Peat Marwick LLP\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K.","section_15":""}
{"filename":"792924_1994.txt","cik":"792924","year":"1994","section_1":"Item 1. Business\nGeneral\nSummit Tax Exempt L.P. II, a Delaware limited partnership (the ``Registrant''), was formed on April 11, 1986 and will terminate on December 31, 2020 unless terminated sooner under the provisions of the Agreement of Limited Partnership (the ``Partnership Agreement''). The Registrant was formed to invest in tax-exempt participating first mortgage revenue bonds (``First Mortgage Bonds'' or ``FMBs'') issued by various state or local governments or their agencies or authorities. These investments were made with proceeds from the initial sale of 9,151,620 Beneficial Unit Certificates (``BUC$''). The FMBs are secured by participating first mortgage loans (``Mortgage Loans'') on multi-family residential apartment properties (``Properties'') developed by unaffiliated developers. The Properties are garden apartment projects diversified nationwide. The Registrant's fiscal year for book and tax purposes ends on December 31.\nThe Registrant is engaged solely in the business of investing in FMBs; therefore, presentation of industry segment information is not applicable.\nGeneral Partners\nThe general partners of the Registrant are Prudential-Bache Properties, Inc. (``PBP'') and Related Tax Exempt Associates II, Inc. (the ``Related General Partner'') (collectively, the ``General Partners''). Related BUC$ Associates II, Inc. (the ``Assignor Limited Partner''), which acquired and holds limited partnership interests on behalf of those persons who purchase BUC$, has assigned to those persons substantially all of its rights and interest in and under such limited partnership interests. The Related General Partner and the Assignor Limited Partner are under common ownership.\nCompetition\nThe General Partners and\/or their affiliates have formed, and may continue to form, various entities to engage in businesses which may be competitive with the Registrant.\nThe Registrant's business is affected by competition to the extent that the underlying Properties from which it derives interest and, ultimately, principal payments may be subject to competition relating to rental rates and amenities from comparable neighboring properties.\nStructure of First Mortgage Bonds\nThe principal and interest payments on each FMB are payable only from the cash flows, including proceeds in the event of a sale, from the Properties underlying the FMBs. None of these FMBs constitutes a general obligation of any state or local government, agency or authority. The FMBs are secured by the Mortgage Loans on the underlying Properties and the structure of each Mortgage Loan mirrors the structure of the corresponding FMB.\nUnless otherwise modified, the principal of the FMBs will not be amortized during their respective terms (which are generally up to 24 years) and will be required to be repaid in lump sum ``balloon'' payments at the expiration of the respective terms or at such earlier times as the Registrant may require pursuant to the terms of the bond documents. The Registrant has a right to require redemption of the FMBs approximately twelve years after their issuance. The Registrant anticipates holding the FMBs for approximately 12 to 15 years from the date of issuance; however, it can elect to hold to maturity.\nIn addition to the stated base rates of interest ranging from 4.87% to 8.25% per annum, each of the FMBs provides for ``contingent interest'' which is equal to: (a) an amount equal to 50% to 100% of net property cash flow and 75% to 100% of net sale or refinancing proceeds until the borrower has paid, during the post-construction period, annually compounded interest at a rate ranging from 9.0% to 9.25% on a cumulative basis and thereafter (b) an amount equal to 25% to 50% of the remaining net property cash flow and 25% to 50% of the remaining net sale or refinancing proceeds until the borrower has paid a cumulative interest at a simple annual rate of 16% over the terms of the FMBs. Both the stated and contingent interest are exempt from federal income taxation.\nIn order to protect the tax-exempt status of the FMBs, the owners of Properties are required to enter into certain agreements to own, manage and operate such Properties in accordance with requirements of the Internal Revenue Code.\nBond Modifications\/Forbearance Agreements\nThe following table lists the FMBs that the Registrant owns together with the occupancy and current rental rates of the underlying properties:\n--------------------------------------------------------------------------------\nProvisions for loss on impairment of assets of $500,000 and $1,000,000 were recorded during the years ended December 31, 1994 and 1993, respectively, to record the estimated impairment of FMBs based upon an analysis of estimated cash flows from the individual properties securing the FMBs.\nThe FMB for the Bay Club property was modified during 1990 when the equity interest in the property and the related obligation of the FMB were sold by an affiliate of the Related General Partner to an unrelated third party. The modification provides for a new minimum pay rate of interest beginning at 6.0% per annum for the first year (1990) increasing in annual stages to 7.5% per annum in the seventh year (1996). The FMB provides for a fluctuation in the minimum interest rate in any one year to defray certain rehabilitation costs. Beginning in year eight (1997), the minimum rate of interest due and payable will be the stated rate of 8.25%. The difference between the minimum interest rate and the original stated rate is payable out of available future cash flow. In addition, the contingent interest feature was changed. Under the revised terms, after the Registrant receives the maximum rate of interest (8.25%), the borrower will receive all excess cash flow until it receives a 10% simple cumulative annual return on its initial investment. The Registrant will then receive all accrued and unpaid contingent interest (0.75% per annum) and then 25% of all remaining cash flow, if any, in excess of the amount necessary to increase the borrower's return to 12% per annum calculated on a cumulative, compounded basis.\nA forbearance agreement with the owner of the Shannon Lake property made in 1991 was further modified in April 1993 to allow the borrower to pay interest at 6.0% through December 1995. In 1992, forbearance agreements were finalized with the owners of the Newport Village, Bristol Village, Sunset Downs, Suntree and Players Club properties. In October 1992, the Newport Village and Bristol Village properties began paying debt service at 6.0% and are scheduled to increase in annual increments to the original stated rate of 8.0% in September 1996 and January 1997, respectively. In June 1992, the Sunset Downs property began paying debt service at 7.0% and is scheduled to increase in annual increments to the original stated rate of 8.0% in June 1996. During 1992, the Suntree and Players Club properties began paying debt service at 7.0% which increased to 7.25% in January 1993. In 1994, the Suntree and Players\nClub forbearance agreements were modified to allow minimum debt service payments to be made at 6.0% through the end of 1994. Effective January 1, 1995, the Suntree and Players Club forbearance agreements were further modified to allow minimum debt service payments to be made at 7.5% and 7.0%, respectively, through the end of 1995. The difference between the rate paid and the original stated rate for these FMBs is deferred and is payable out of available future cash flow or ultimately from sales or refinancing proceeds.\nEffective January 24, 1994, The Lakes FMB was modified to allow debt service payments be made at 4.87% per annum with 100% of the excess property cash flow paid to the Registrant up to a rate of 5.24% and participation in the net cash flow thereafter. On August 31, 1994, the equity interest in The Lakes and the related obligation of the modified FMB were sold by an affiliate of the Related General Partner to an unrelated third party. The payment terms will continue to require a base interest rate of 4.87%. The net cash proceeds from the sale of approximately $487,000 paid to the Registrant as accrued and unpaid interest was deferred and will be accreted as interest income over the remaining life of the FMB. All other accrued and unpaid interest as well as an outstanding second mortgage loan were forgiven.\nThe original owner of the underlying property and obligor of the Pelican Cove FMB has been replaced with an affiliate of the Related General Partner who has not made an equity investment. This entity has assumed the day-to-day responsibilities and obligations of the underlying property. Buyers are being sought who would make an equity investment in the underlying property and assume the nonrecourse obligations for the FMB. Although this property is not producing sufficient cash flow to fully service the debt, the Registrant has no present intention to declare a default on the FMB. [This FMB is classified as an asset held for sale in the financial statements in the Registrant's Annual Report which is filed as an Exhibit hereto.]\nThe determination as to whether it is in the best interest of the Registrant to enter into forbearance agreements on the FMBs, or alternatively, to pursue its remedies under the loan documents, including foreclosure, is based upon several factors. These factors include, but are not limited to, property performance, owner cooperation and projected legal costs.\nNo single FMB provided interest income which exceeded 15% of the Registrant's total revenue for any of the years ended December 31, 1994, 1993 or 1992.\nEmployees\nThe Registrant has no employees. Management and administrative services for the Registrant are performed by the General Partners and their affiliates pursuant to the Partnership Agreement. See Notes B and F to the financial statements in the Registrant's Annual Report, which is filed as an exhibit hereto.\nOther Information\nOn October 27, 1994, an affiliate of PBP, Prudential Securities Incorporated (``PSI''), entered into cooperation and deferred prosecution agreements (the ``Agreements'') with the Office of the United States Attorney for the Southern District of New York (the ``U.S. Attorney''). The Agreements resolved a grand jury investigation that had been conducted by the U.S. Attorney into PSI's sale during the 1980's of the Prudential-Bache Energy Income Fund oil and gas limited partnerships (the ``Income Funds''). In connection with the Agreements, the U.S. Attorney filed a complaint charging PSI with a criminal violation of the securities laws. In its request for a deferred prosecution, PSI acknowledged to having made certain misstatements in connection with the sale of the Income Funds. Pursuant to the Agreements, the U.S. Attorney will defer any prosecution of the charge in the complaint for a period of three years, provided that PSI complies with certain conditions during the three-year period. These include conditions that PSI not violate any criminal laws; that PSI contribute an additional $330 million to a pre-existing settlement fund; that PSI cooperate with the government in any future inquiries; and that PSI comply with various compliance-related provisions. If, at the end of the three-year period, PSI has complied with the terms of the Agreements, the U.S. Attorney will be barred from prosecuting PSI on the charges set forth in the complaint. If, on the other hand, during the course of the three-year period, PSI violates the terms of the Agreements, the U.S. Attorney can elect to pursue such charges.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Registrant does not own or lease any property.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThis information is incorporated by reference to Note G to the financial statements of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of BUC$holders\nNone\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's BUC$ and Related BUC$holder Matters\nAs of March 1, 1995, there were 9,286 holders of record owning 9,151,620 BUC$. A significant secondary market for the BUC$ has not developed and it is not expected that one will develop in the future. There are also certain restrictions set forth in Sections 12 and 13 of the Partnership Agreement limiting the ability of a BUC$holder to transfer BUC$. Consequently, BUC$holders may not be able to liquidate their investments in the event of an emergency or for any other reason.\nCash distributions per BUC were paid during the following calendar quarters. Distributions were funded by adjusted cash flow from operations and, in 1993, previously undistributed cash from operations.\nThere are no material restrictions upon the Registrant's present or future ability to make distributions in accordance with the provisions of the Partnership Agreement. No portion of the distributions paid to BUC$holders in 1994 represents a return of capital on a generally accepted accounting principles (GAAP) basis; however, approximately $1,398,000 of the $9,518,000 paid to BUC$holders in 1993 represent a return of capital on a GAAP basis (the return of capital on a GAAP basis is calculated as BUC$holder distributions less net income allocated to BUC$holders). The Registrant currently expects that cash distributions will continue to be paid in the foreseeable future from cash generated by operations. For discussion of other factors that may affect the amount of future distributions, see Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 13 through 15 of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table presents selected financial data of the Registrant. This data should be read in conjunction with the financial statements of the Registrant and the notes thereto on pages 2 through 12 of the Registrant's Annual Report which is filed as an exhibit hereto.\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 13 through 15 of the Registrant's Annual Report, which is filed as an exhibit hereto.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements are incorporated by reference to pages 2 through 12 of the Registrant's Annual Report, which is filed as an exhibit hereto.\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 are no directors or executive officers of the Registrant. The Registrant is managed by the General Partners.\nThe Registrant, the General Partners and their directors and executive officers, and any persons holding more than ten percent of the Registrant's BUC$ are required to report their initial ownership of such BUC$ and any subsequent changes in that ownership to the Securities and Exchange Commission on Forms 3, 4 and 5. Such executive officers, directors and BUC$holders who own greater than ten percent of the Registrant's BUC$ are required by Securities and Exchange Commission regulations to furnish the Registrant with copies of all Forms 3, 4 or 5 they file. All of these filing requirements were satisfied on a timely basis. In making these disclosures, the Registrant has relied solely on written representations of the General Partners' directors and executive officers and BUC$holders who own greater than ten percent of the Registrant's BUC$ or copies of the reports they have filed with the Securities and Exchange Commission during and with respect to its most recent fiscal year.\nPrudential-Bache Properties, Inc.\nThe directors and executive officers of PBP and their positions with regard to managing the Registrant are as follows:\nName Position James M. Kelso President, Chief Executive Officer, Chairman of the Board of Directors and Director Barbara J. Brooks Vice President-Finance and Chief Financial Officer Robert J. Alexander Vice President and Chief Accounting Officer Chester A. Piskorowski Vice President Frank W. Giordano Director Nathalie P. Maio Director\nJAMES M. KELSO, age 40, is the President, Chief Executive Officer, Chairman of the Board of Directors and a Director of PBP. He is a Senior Vice President of PSI. Mr. Kelso also serves in various capacities for other affiliated companies. Mr. Kelso joined PSI in July 1981.\nBARBARA J. BROOKS, age 46, is the Vice President-Finance and Chief Financial Officer of PBP. She is a Senior Vice President of PSI. Ms. Brooks also serves in various capacities for other affiliated companies. She has held several positions within PSI since 1983. Ms. Brooks is a certified public accountant.\nROBERT J. ALEXANDER, age 33, is a Vice President of PBP. He is a First Vice President of PSI. Mr. Alexander also serves in various capacities for other affiliated companies. Prior to joining PSI in July 1992, he was with Price Waterhouse for nine years. Mr. Alexander is a certified public accountant.\nCHESTER A. PISKOROWSKI, age 51, is a Vice President of PBP and is a Senior Vice President of PSI and is the Senior Manager of the Specialty Finance Asset Management area. Mr. Piskorowski has held several positions with PSI since April 1972. Mr. Piskorowski is a member of the New York and Federal Bars.\nFRANK W. GIORDANO, age 52, is a Director of PBP. He is a Senior Vice President of PSI and General Counsel of Prudential Mutual Fund Management Inc., an affiliate of PSI. Mr. Giordano also serves in various capacities for other affiliated companies. He has been with PSI since July 1967.\nNATHALIE P. MAIO, age 44, is a Director of PBP. She is a Senior Vice President and Deputy General Counsel of PSI and supervises non-litigation legal work for PSI. She joined PSI's Law Department in 1983; presently, she also serves in various capacities for other affiliated companies.\nThere are no family relationships among any of the foregoing directors or executive officers. All of the foregoing directors and executive officers have indefinite terms.\nRelated Tax Exempt Associates II, Inc.\nThe directors and executive officers of RFI are as follows:\nName Position J. Michael Fried President and Director Stuart J. Boesky Vice President Alan P. Hirmes Vice President Lawrence J. Lipton Treasurer Stephen M. Ross Director Lynn A. McMahon Secretary\nJ. MICHAEL FRIED, 50, is President and a Director of the Related General Partner. Mr. Fried is President, a Director and a principal shareholder of Related Capital Company (``Capital''), a real estate finance and acquisition affiliate of the Related General Partner. In that capacity, he is the chief executive officer of Capital, and is responsible for initiating and directing all of Capital's syndication, finance, acquisition and investor reporting activities. Mr. Fried practiced corporate law in New York City with the law firm of\nProskauer, Rose, Goetz & Mendelsohn from 1974 until he joined Capital in 1979. Mr. Fried graduated from Brooklyn Law School with a Juris Doctor degree, magna cum laude; from Long Island University Graduate School with a Master of Science degree in psychology; and from Michigan State University with a Bachelor of Arts degree in history.\nSTUART J. BOESKY, 39, is Vice President of the Related General Partner. Mr. Boesky practiced real estate and tax law in New York City with the law firm of Shipley & Rothstein from 1984 until February 1986 when he joined Capital. From 1983 to 1984 Mr. Boesky practiced law with the Boston law firm of Kaye, Fialkow, Richard & Rothstein and from 1978 to 1980 was a consultant specializing in real estate at the accounting firm of Laventhol & Horwath. Mr. Boesky graduated from Michigan State University with a Bachelor of Arts degree and from Wayne State School of Law with a Juris Doctor degree. He then received a Master of Law degree in taxation from Boston University School of Law.\nALAN P. HIRMES, 40, is a Vice President of the Related General Partner. Mr. Hirmes has been a certified public accountant in New York since 1978. Mr. Hirmes is a Vice President of Capital. Prior to joining Capital in October 1983, Mr. Hirmes was employed by Weiner & Co., certified public accountants. Mr. Hirmes graduated from Hofstra University with a Bachelor of Arts degree.\nLAWRENCE J. LIPTON, 38, is a Controller of the Related General Partner. Mr. Lipton has been a certified public accountant in New York since 1989. Prior to joining Capital. Mr. Lipton was employed by Deloitte & Touche from 1987-1991. Mr. Lipton graduated from Rutgers College with a Bachelor of Arts degree and from Baruch College with a Master of Business Administration degree.\nSTEPHEN M. ROSS, 54, is a Director of the Related General Partner. Mr. Ross is President of The Related Companies, L.P. He graduated from The University of Michigan with a Bachelor of Business Administration degree and from Wayne State University School of Law. Mr. Ross then received a Master of Law degree in taxation from New York University School of Law. He joined the accounting firm of Coopers & Lybrand in Detroit as a tax specialist and later moved to New York, where he worked for two large Wall Street investment banking firms in their real estate and corporate finance departments. Mr. Ross formed The Related Companies, Inc. in 1972, to develop, manage, finance and acquire subsidized and conventional apartment developments. To date, The Related Companies, Inc. has developed multi-family properties totalling in excess of 25,000 units, all of which it manages.\nLYNN A. McMAHON, 39, is Secretary of the Related General Partner. Since 1983, she has served as Assistant to the President of Capital. From 1978 to 1983 she was employed at Sony Corporation of America in the Government Relations Department.\nThere are no family relationships among any of the foregoing directors or executive officers. All of the foregoing directors and executive officers serve indefinite terms.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Registrant does not pay or accrue any fees, salaries or any other form of compensation to directors and officers of the General Partners for their services. Certain officers and directors of the General Partners receive compensation from affiliates of the General Partners, not from the Registrant, for services performed for various affiliated entities, which may include services performed for the Registrant; however, the General Partners believe that any compensation attributable to services performed for the Registrant is immaterial. See Item 13 Certain Relationships and Related Transactions for information regarding compensation to the General Partners.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 1, 1995, the directors and officers of the Related General Partner directly own 99.97% of the voting securities of the Related General Partner; however, no director or officer of either General Partner owns directly or beneficially any interest in the voting securities of PBP.\nAs of March 1, 1995, directors and officers of the Related General Partner own directly or beneficially BUC$ issued by the Registrant as follows:\n* Less than 1% of the outstanding BUC$.\n** All BUC$ are owned directly by BF Security Partners (a New York general partnership) of which Messrs. Fried and Boesky are each 50% partners.\nAs of March 1, 1995, no director or officer of PBP owns directly or beneficially any BUC$ issued by the Registrant.\nAs of March 1, 1995, no BUC$holder beneficially owns more than five percent (5%) of the BUC$ issued by the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Registrant has, and will continue to have, certain relationships with the General Partners and their affiliates. However, there have been no direct financial transactions between the Registrant and the directors or officers of the General Partners.\nReference is made to Notes B and F to the financial statements in the Registrant's Annual Report which is filed as an exhibit hereto, which identify the related parties and discuss the services provided by these parties and the amounts paid or payable for their services.\nPART IV\nPage in Annual Report Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. Financial Statements and Independent Auditors' Report-Incorporated by reference to the Registrant's Annual Report, which is filed as an exhibit hereto\nIndependent Auditors' Report 2\nFinancial Statements:\nStatements of Financial Condition--December 31, 1994 and 1993 3\nStatements of Operations--Three years ended December 31, 1994 4\nStatements of Changes in Partners' Capital--Three years ended December 31, 1994 4\nStatements of Cash Flows--Three years ended December 31, 1994 5\nNotes to Financial Statements 6\n2. Financial Statement Schedule and Independent Auditors' Report on Schedule\nIndependent Auditors' Report on Schedule\nSchedule:\nII - Valuation and Qualifying Accounts and Reserves-Three years ended December 31, 1994 All other schedules have been omitted because they are not applicable or the required information is included in the financial statements and the notes thereto.\n3. Exhibits\nDescription:\n3(a) and 4(a) Partnership Agreement, incorporated by reference to Exhibit A to the Pro- spectus of Registrant, dated July 2, 1986, filed pursuant to Rule 424(b) under the Securities Act of 1933, File No. 33-5213\n3(b) and 4(b) Certificate of Limited Partnership (incorporated by reference to Exhibit 4 to Amendment No.1 to Registration Statement on Form S-11, File No. 33-5213)\n10(a) First Mortgage Bond, dated September 11, 1986, with respect to the Bay Club project, in the principal amount of $6,400,000 (incorporated by refer- ence to exhibit 10(a) in Registrant's Current Report on Form 8-K dated September 11, 1986)\n10(b) First Mortgage Bond, dated November 13, 1986, with respect to the Love- ridge project, in the principal amount of $8,550,000 (incorporated by reference to exhibit 10(d) in Registrant's Form 8 Amendment No.1 to Current Report on Form 8-K, dated February 10, 1987)\n10(c) First Mortgage Bond, dated December 30, 1986 with respect to The Lakes project, in the principal amount of $13,650,000 (incorporated by reference to exhibit 10(a) in Registrant's Current Report on Form 8-K dated December 30, 1986)\n10(d) First Mortgage Bond, dated December 31, 1986, with respect to the Crowne Pointe project, in the principal amount of $5,075,000 (incorporated by reference to exhibit 10(b) in Registrant's Current Report on Form 8-K dated December 31, 1986)\n10(e) First Mortgage Bond, dated December 31, 1986, with respect to the Orchard Hills project, in the principal amount of $5,650,000 (incorporated by reference to exhibit 10(c) in Registrant's Current Report on Form 8-K dated December 31, 1986)\n10(f) First Mortgage Bond, dated February 2, 1987, with respect to the Highland Ridge project, in the principal amount of $15,000,000 (incorporated by reference to exhibit 10(a) in Registrant's Current Report on Form 8-K dated February 2, 1987)\n10(g) First Mortgage Bond, dated February 11, 1987, with respect to the Newport Village project, in the principal amount of $13,000,000 (incorporated by reference to exhibit 10(a) in Registrant's Current Report on Form 8-K dated February 11, 1987)\n10(h) First Mortgage Bond, dated February 11, 1987,with respect to the Sunset Downs project, in the principal amount of $15,000,000 (incorporated by reference to exhibit 10(b) in Registrant's Current Report on Form 8-K dated February 11, 1987)\n10(i) First Mortgage Bond, dated February 27, 1987, with respect to the Pelican Cove project, in the principal amount of $18,000,000 (incorporated by reference to exhibit 10(a) in Registrant's Current Report on Form 8-K dated February 27, 1987)\n10(j) First Mortgage Bond, dated February 27, 1987, with respect to the Willow Creek project, in the principal amount of $6,100,000 (incorporated by reference to exhibit 10(c) in Registrant's Current Report on Form 8-K dated February 27, 1987)\n10(k) First Mortgage Bond, dated April 22, 1987, with respect to the Cedar Pointe project, in the principal amount of $9,500,000 (incorporated by reference to exhibit 10(a) in Registrant's Current Report on Form 8-K dated April 22, 1987)\n10(l) First Mortgage Bond, dated June 26, 1987, with respect to the Shannon Lake project, in the principal amount of $12,000,000 (incorporated by reference to exhibit 10(a) in Registrant's Current Report on Form 8-K dated June 26, 1987)\n10(m) First Mortgage Bond, dated July 31, 1987, with respect to the Bristol Village project, in the principal amount of $17,000,000 (incorporated by reference to exhibit 10(a) in Registrant's Current Report on Form 8-K dated July 31, 1987)\n10(n) First Mortgage Bond, dated July 31, 1987, with respect to the Suntree project, in the principal amount of $7,500,000 (incorporated by reference to exhibit 10(b) in Registrant's Current Report on Form 8-K dated July 31, 1987)\n10(o) First Mortgage Bond, dated August 7, 1987, with respect to the River Run project, in the principal amount of $6,700,000 (incorporated by reference to exhibit 10(b) in Registrant's Current Report on Form 8-K dated August 7, 1987)\n10(p) First Mortgage Bond, dated August 14,1987, with respect to the Players Club project, in the principal amount of $2,500,000 (incorporated by refer- ence to exhibit 10(a) in Registrant's Current Report on Form 8-K dated August 14, 1987)\n10(q) Settlement Agreement for the Shannon Lake First Mortgage Bond dated December 3, 1990 (incorporated by reference to Exhibit 10(q) in Regis- trant's 1991 Annual Report on Form 10K)\n10(r) Settlement Agreement for the Newport Village First Mortgage Bond dated October 9, 1992 (incorporated by reference to Exhibit 10(r) in Registrant's 1992 Annual Report on Form 10K)\n10(s) Settlement Agreement for the Sunset Downs First Mortgage Bond dated July 10, 1992 (incorporated by reference to Exhibit 10(s) in Registrant's 1992 Annual Report on Form 10K)\n10(t) Settlement Agreement for the Suntree First Mortgage Bond dated February 1, 1992 (incorporated by reference to Exhibit 10(t) in Registrant's 1992 Annual Report on Form 10K)\n10(w) Settlement Agreement for the Players Club First Mortgage Bond dated February 1, 1992 (incorporated by reference to Exhibit 10(w) in Registrant's 1992 Annual Report on Form 10K)\n10(x) Settlement Agreement for the Bristol Village First Mortgage Bond dated March 2, 1993 (incorporated by reference to Exhibit 10(x) in Registrant's 1992 Annual Report on Form 10K)\n10(y) Amended Settlement Agreement for the Shannon Lake First Mortgage Bond dated June 1, 1993 (incorporated by reference to Exhibit 10(y) in Registrant's 1993 Annual Report on Form 10K)\n10(z) Amended Settlement Agreement for the Player's Club First Mortgage Bond dated December 1, 1993 (incorporated by reference to Exhibit 10(z) in Registrant's 1993 Annual Report on Form 10K)\n(10aa) Amended Settlement Agreement for the Suntree First Mortgage Bond dated December 1, 1993 (incorporated by reference to Exhibit 10(aa) in Regis- trant's 1993 Annual Report on Form 10K)\n(10ab) First Supplemental Indenture between The Industrial Development Authority of the City of Kansas City, Missouri and Boatmen's First National Bank of Kansas City dated January 24, 1994 (incorporated by reference to Exhibit 10(ab) in the Registrant's Quarterly Report on Form 10Q dated March 31, 1994)\n(10ac) Option Agreement between The Lakes Project Investors, Inc., Seller, and ZIPCO, Inc., Purchaser, dated January 27, 1994 (incorporated by reference to Exhibit 10(ac) in the Registrant's Quarterly Report on Form 10Q dated September 30, 1994)\n(10ad) Assignment and Assumption Agreements between The Lakes Apartments, Inc., Seller, and ZIPCO, Inc., Purchaser, dated August 31, 1994 (incorporated by reference to Exhibit 10(ad) in the Registrant's Quarterly Report on Form 10Q dated September 30, 1994)\n(10ae) Sale-Purchase Agreement between The Lakes Project Investors, Inc., Sell- er, and ZIPCO, Inc., Purchaser, dated August 31, 1994 (incorporated by reference to Exhibit 10(ae) in the Registrant's Quarterly Report on Form 10Q dated September 30, 1994)\n(10af) Amended Settlement Agreement for the Player's Club First Mortgage Bond dated December 1, 1994 (filed herewith)\n(10ag) Amended Settlement Agreement for the Suntree First Mortgage Bond dated December 1, 1994 (filed herewith)\n13 Registrant's 1994 Annual Report (with the exception of the information and data incorporated by reference in Items 3, 7 and 8 of this Annual Report on Form 10-K, no other information or data appearing in the Registrant's 1994 Annual Report is to be deemed filed as part of this report)\n27 Financial Data Schedule (filed herewith)\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(LOGO)\nTwo World Financial Center Telephone: (212) 436-2000 New York, New York 10281-1414 Facsimile: (212) 436-5000\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Summit Tax Exempt L.P. II New York, New York\nWe have audited the financial statements of Summit Tax Exempt L.P. II (a Delaware Limited Partnership) 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 March 14, 1995; such financial statements and report are included in your 1994 Annual Report to Limited Partners and are incorporated herein by reference. Our audits also included the financial statement schedule of Summit Tax Exempt L.P. II, listed in Item 14(a)2. This financial statement schedule is the responsibility of the General Partners. 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.\n\/s\/ Deloitte & Touche LLP --------------------------- March 14, 1995\n(LOGO)\nSUMMIT TAX EXEMPT L.P. II (a limited partnership) SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nValuation allowance for first mortgage bonds\nValuation allowance for assets held for sale\nValuation allowance for uncollectible receivables\nValuation allowance for promissory notes\n(A) Related asset was reclassified from an asset held for sale to a first mortgage bond.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSummit Tax Exempt L.P. II\nBy: Prudential-Bache Properties, Inc. A Delaware corporation, General Partner\nBy: \/s\/ Robert J. Alexander Date: March 31, 1995 --------------------------------------------- Robert J. Alexander Vice President and Chief Accounting Officer\nBy: Related Tax Exempt Associates II, Inc. A Delaware corporation, General Partner\nBy: \/s\/ Alan P. Hirmes Date: March 31, 1995 --------------------------------------------- Alan P. Hirmes 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 (with respect to the General Partners) and on the dates indicated.\nBy: Prudential-Bache Properties, Inc. A Delaware corporation, General Partner By: \/s\/ James M. Kelso Date: March 31, 1995 --------------------------------------------- James M. Kelso President, Chief Executive Officer and Chairman of the Board of Directors\nBy: \/s\/ Barbara J. Brooks Date: March 31, 1995 --------------------------------------------- Barbara J. Brooks Vice President Finance and Chief Financial Officer\nBy: \/s\/ Robert J. Alexander Date: March 31, 1995 --------------------------------------------- Robert J. Alexander Vice President\nBy: \/s\/ Frank W. Giordano Date: March 31, 1995 --------------------------------------------- Frank W. Giordano Director By: \/s\/ Nathalie P. Maio Date: March 31, 1995 --------------------------------------------- Nathalie P. Maio Director\nBy: Related Tax Exempt Associates II, Inc. A Delaware corporation, General Partner By: \/s\/ J. Michael Fried Date: March 31, 1995 --------------------------------------------- J. Michael Fried President and Director (Principal Executive Officer)\nBy: \/s\/ Alan P. Hirmes Date: March 31, 1995 --------------------------------------------- Alan P. Hirmes Vice President (Principal Financial and Accounting Officer)\nBy: \/s\/ Lawrence J. Lipton Date: March 31, 1995 --------------------------------------------- Lawrence J. Lipton Treasurer\nBy: Stephen M. Ross Date: March 31, 1995 --------------------------------------------- Stephen M. Ross Director","section_15":""}
{"filename":"775272_1994.txt","cik":"775272","year":"1994","section_1":"Item 1 (continued)\nOn February 17, 1995, the Company entered into a new credit agreement for a $150 million unsecured, revolving bank line, replacing the previous $60 million line of credit. The new bank line has an initial borrowing base limitation of $110 million, which will be redetermined annually. Under the new agreement, outstanding borrowings at the end of the revolving period in January 1997 convert to a term loan. See Note Three of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report on Form 10-K for further information on the line of credit terms.\n(2) OIL AND GAS ACQUISITION, EXPLORATION AND DEVELOPMENT\nThe Company's oil and gas development and production operations are conducted principally on-shore in the geographic locations indicated in \"General\", section (1) above. In addition, primary exploration areas include the Green River Basin of Wyoming, the Gulf Coast region and west Texas.\nProspects are identified for acreage acquisition and for exploratory or developmental drilling primarily through in-house staff geologists, geophysicists, landmen and petroleum engineers. This staff directs various seismic and other geological and geophysical tests on prospective oil and gas properties and, based on its analysis of the data provided by such tests, evaluates such properties and directs the acquisition of oil and gas leases or interests in drilling prospects. Prospects are acquired by purchasing oil and gas leasehold interests from other companies or directly from landowners in areas considered favorable for oil and gas exploration and by participating in projects and prospects that permit the Company to earn an ownership interest in leases owned by others in consideration for performing or participating in certain drilling operations.\nThe Company typically conducts drilling activities with other companies as joint working interest owners in order to increase its participation in different prospects and to reduce the concentration of risk through diversification. Under the terms of these joint operating arrangements, one of the working interest owners acts as the operator in charge of the day-to- day management of the properties and is paid a fee and certain expenses by the other working interest owners. The Company is generally the operator of properties in which it generates interests. Where it acts as operator, the engineering staff directs the drilling of test wells and supervises the development and operation of properties for the production of oil and gas. It contracts with independent drilling contractors to perform the actual drilling and completion of the wells.\nHistorically, the Company has directed most of its expenditures toward drilling development wells; that is, wells located in fields having proved oil or gas reserves. Drilling development wells generally involves fewer risks and meets with a higher degree of success than exploratory drilling. Cash provided by operations is expected to sufficiently fund the Company's 1995 capital spending program, which includes approximately $7-1\/2 million for exploration activities.\nThe Company continues to seek additional acquisition opportunities. Supported by its $150 million bank credit line and its market capitalization, the Company has the financing capability to pursue such opportunities as they become available. For 1995, the Company has targeted acquiring $25 million of oil and gas properties. See \"Competition\" in section (4) below.\nItem 1 (continued)\n(3) MARKETING\n(i) GAS\nApproximately one-half of the Company's total gas revenues were generated under a long-term contract for sales from the Hugoton field in southwestern Kansas and a contract covering the Niobrara area of northeastern Colorado. This production was sold at a wellhead price of $2.00 per million British Thermal Unit (MMBtu) for the five months (January through March, November and December) of the 1994 heating season and $1.80 and $1.75 per MMBtu for the balance of the year for the Hugoton field and Niobrara field, respectively. Gathering, transportation, dehydration, processing and other similar costs of marketing are included in wellhead prices. Spot market sales are burdened by these marketing costs, which range from 15 cents to 40 cents per MMBtu in the Rocky Mountain and Mid-continent areas. A second major customer purchased natural gas representing approximately 11% of total oil and gas revenues. No other single customer purchased gas which accounted for more than 10% of the Company's total revenues.\nIn the annual price redetermination of its long-term gas sales contract with its principal purchaser, the Company negotiated a two-tier seasonal price arrangement for 1995. Under this agreement, the Company will sell 14 Bcf of natural gas to K N at a weighted average wellhead price for 1995 of $1.80 per MMBtu. Another 2-1\/2 Bcf will be sold to K N on a spot market basis. In 1994, the Company negotiated the release of 66 Hugoton field wells connected to Company-owned gathering lines covered by this contract. Another 37 wells were released for 1995. The contract covering Niobrara production was not renewed for 1995. The gas from these wells will be sold on the spot market to third parties. Negotiations with the principal purchaser for 1996 prices under the long-term contract will begin in late 1995.\nThrough its marketing department, the Company sells the balance of its gas supplies to various purchasers under percentage of proceeds, short-term or spot sales and limited term contracts of up to one year in duration. Prices for these sales are negotiated between the buyer and seller and depend upon the length of the term during which the supplies are committed and the supply-demand conditions in both the geographic area where the gas is produced and the market area where it is consumed.\nFederal price controls of natural gas expired on January 1, 1993 pursuant to the Natural Gas Wellhead Decontrol Act of 1989.\n(ii) OIL AND CONDENSATE\nOil, including wellhead condensate production, is generally sold from the leases at currently posted field prices. Due to its increased oil production, the Company has negotiated with purchasers prices with bonuses in excess of the posted price. In 1994, these bonuses added a total of $1.6 million in revenues. Marketing arrangements are made locally with purchasers, who are various petroleum companies. The Company sells its oil production to numerous customers. No customer's total 1994 oil purchases represented more than 10% of total Company revenues. Oil revenues totaled $17.2 million for 1994 and represented 28% of the Company's total revenues for the year.\nItem 1 (continued)\n(4) COMPETITION\nThe Company faces strong competition in all phases of its operations from major oil and gas companies, independent operators and other entities, particularly in the areas of acquisition of oil and gas properties and undeveloped leases and marketing of crude oil and natural gas. Many of these competitors have financial resources, operating staffs, geological and geophysical data and facilities substantially greater than those of the Company. Furthermore, there exists many factors which may impact the production, process- ing and marketing of crude oil and natural gas that are beyond the control of the Company and cannot be accurately predicted. One of many factors is the significant influence of foreign producers on the production and pricing of crude oil. The demand for viable prospects available for exploration and development of oil and gas reserves as well as the necessary supportive servic- ing equipment and experienced personnel continues to be intense. Although the Company believes it has adequate financial and operating resources to remain competitive, there is no assurance of the continued availability of these resources, and consequently, it may be at a significant disadvantage with its competitors.\n(5) OPERATING HAZARDS\nThe Company's operations are subject to all the risks normally incident to the exploration for and production of oil and gas, including blowouts, encountering formations with abnormal pressure, cratering, pollution and fires. Any of these events could result in damage to, or destruction of, oil and gas wells or producing facilities, suspension of operations, damage to property or the environment, and injury to persons. Losses and liabilities arising from such events could reduce revenues and increase costs to the extent the Company is liable and such loss or liability is not covered by insurance. The Company maintains insurance which it believes is customary in the industry against some, but not all, of these risks. There is no assurance that such insurance will continue to be available in the future at a reasonable cost.\n(6) ENVIRONMENTAL, PRODUCTION AND PRICE REGULATION\nThe states where the Company operates control production from oil and gas wells. State conservation statutes or regulations require drilling permits, establish the spacing of wells, allow the pooling and unitization of properties and limit the rate of allowable production. Such conservation regulations have not had a material adverse effect on the Company's operations in the past, and management does not anticipate that they will in the future.\nThe Company, as an owner and operator of oil and gas properties, is subject to various federal, state and local laws and regulations relating to the protection of the environment. These laws and regulations may, among other things, impose liability on an oil and gas lessee for the cost of pollution clean-up and pollution damages to the property of others, require suspension or cessation of operations in affected areas and impose restrictions on the injection of liquids into subsurface aquifers that may contaminate groundwater.\nItem 1 (continued)\nThe Company has made and will continue to make expenditures to comply with these requirements, which are necessary costs of doing business in the oil and gas industry. As part of the Company's commitment to environmental responsibility, it has adopted a corporate environmental policy, and retained the services of an independent consulting firm to conduct an initial audit of Company properties and train operations and professional employees in environ- mental awareness, as well as in preventative and remedial work, when appropri- ate. Environmental requirements have a substantial impact upon the energy industry; however, these requirements do not appear to affect the Company any differently or to any greater or lesser extent than other companies in the industry as a whole.\nAt present, there are no known environmental or other regulatory matters related to the Company's operations which are reasonably expected to result in a material liability to the Company. The Company believes that expenditures for compliance with current federal, state or 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 in the future upon the capital expenditures, earnings or competitive position of the Company.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES\n(A) LOCATION AND CHARACTER OF PROPERTIES\nThe Company had an interest in 1,506 wells as of December 31, 1994 and operated 772 of those wells.\nMost of the Company's wells and associated reserves are located in the Hugoton field in southwest Kansas and the Oklahoma panhandle, the Permian Basin of west Texas and southeastern New Mexico and the Powder River and Green River Basins of Wyoming. The wells are located on leases held by production.\nGross acres are the total number of acres in which the Company owns a working interest; net acres are the sum of the fractional working interests owned by the Company in gross acres. Acreage is deemed to be developed if it is either held by existing production or is part of a unit held by existing production. At yearend, 344,455 gross and 240,548 net acres were held by production, and 229,412 gross and 99,974 net acres were held for exploration.\nKANSAS\nThe majority of gas production is generated from the Company's interest in wells (394 gross, 322 net) located in two fields in Kansas. Approximately 71% of the Company's total proved producing gas reserves are located in the Hugoton field, the larger of the two fields. The Company operates 275 wells of the 323 Hugoton wells in which it has an interest.\nItem 2 (continued)\nThe Kansas Corporation Commission ruled in 1986 that optional infill drilling is permitted in the Chase group of the Hugoton field. Infill drilling allows a second well to be drilled in each unit. Units are generally 640 acres in size. The Company has participated in or drilled 121 infill wells, all of which are currently producing.\nRecently, the Company drilled two horizontal legs to an old Hugoton field well with relatively weaker deliverability. Should this effort prove successful, it could enhance the economics of drilling on 55 of the Company's remaining potential infill locations and provide opportunities of adding horizontal legs on a number of the older wells.\nWYOMING\nThe Company has an interest in 406 gross wells (86 net wells) located in the Powder River, Washakie and Greater Green River Basins of Wyoming. In addition to the acquisition of Wyoming properties described in Item 1, the Company participated in various exploitation and exploration projects.\nIn November 1994, the Snowbank No. 1, an Almond formation discovery in the Washakie Basin in Carbon County, was completed. It was connected to a temporary pipeline in late January 1995 and is currently producing 1.12 MMcf of natural gas per day. The Company operates this well and has a 50 percent working interest. Approximately 12,000 acres surrounding this well are con- trolled by the Company and its co-venturers. Further development of this acreage will begin after evaluation of the discovery well's production.\nUnder a development program commenced in 1993, the Company participated as a 50% working interest owner in the drilling of fourteen natural gas wells to the Almond-Mesaverde formation in Washakie Basin. Eight wells were completed and four are on production. Five wells are awaiting completion or a pipeline connection. One well was unsuccessful. In March 1994, the Company acquired, for $1.7 million, interests in seven wells drilled in the Washakie Basin prior to 1994. Due to current low natural gas prices, the 1995 drilling program with the co-owner has been reduced to four wells.\nTEXAS\nAs of December 1994, the Company had an interest in 323 gross wells (213 net wells) located in Texas. During 1994, the Company's exploitation and exploration activities included the participation in five successful exploratory wells located in Dawson County. These prospects were identified through the use of three-dimensional seismic technology. Drilling of a second offset well commenced in late January 1995. The Company has a 10 percent working interest in this project. In 1995, the Company plans to drill six additional west Texas exploratory prospects.\nItem 2 (continued)\nThe Company acquired a working interest (80 percent before payout; 50 percent after payout) in a waterflood project in the Moss Grayburg San Andres Unit located in Ector County. Six producing wells and six water injection wells were drilled in 1994. Three other wells were recompleted as water injection wells. The Company plans to join in two additional Ector County waterflood projects in 1995.\nLOUISIANA\nThe first of two exploratory prospects begun in 1994, the Patterson Deep Prospect in St. Mary Parish, was completed as a dry hole in the first quarter of 1995. The Company's share of dry hole costs approximated $600,000. Drilling on a second prospect, South Perry Point in Acadia and Vermillion Parish, is expected to reach its total depth in the second quarter of 1995.\nThe 1992 discovery well of the Ship Shoal Block 45 field in shallow state waters offshore Louisiana was placed on production in September 1993 after a second well was completed. Three additional wells were drilled in 1994, two of which were placed on production in August and one in late December. The Company has a 33 percent working interest (25 percent net revenue interest) in this project. For 1995, the Company plans to continue its exploratory efforts in the Gulf of Mexico.\nOTHER ACTIVITIES\nThe Company joined in the drilling of a Morrow well located in Eddy County, New Mexico and two Simpson-McKee wells and a Devonian well located in the Teague field in Lea County. These wells were placed on production in 1994. Other 1994 New Mexico exploitation projects included the recompletion of eight wells to the P1 formation in the Bluitt area of Roosevelt County and the drilling of four Niobrara wells in northeastern Colorado.\nIn a joint venture effort, the Company participated in a project to develop infill locations identified using three-dimensional seismic technology in the Eagle Springs field located in Nye County, Nevada. Two wells were drilled and completed in 1994 and a third was placed on production in mid- January 1995. The Company has a 40 percent working interest in the three new wells and, after spending an additional $432,000 on drilling, will earn a 40 percent working interest in the remainder of the field. Four additional wells are planned in 1995.\nItem 2 (continued)\nDRILLING ACTIVITY\nThe following table sets forth the Company's drilling activity for each of the three years ended December 31, 1994.\nProved reserves added from extensions, discoveries and other additions in each year were as follows:\n(B) DISCLOSURE OF OIL AND GAS OPERATIONS (provided in accordance with the Securities Act Industry Guide 2 and including information in Item 2 (A) above))\n(1) OIL AND GAS RESERVES\nAll of the Company's proved developed reserve quantities of 292 Bcf of gas and 7.5 million barrels of oil were estimated at yearend 1994 by Netherland, Sewell & Associates, Inc., an independent petroleum engineering firm. Proved undeveloped reserves were estimated to be 20.1 Bcf and 3.5 million barrels by the Company's petroleum engineers and amounted to approximately 11% of total proved reserve equivalents at December 31, 1994. Proved developed reserve quantities in prior years were estimated annually by independent petroleum engineers. The Company's reserves are located in the lower 48 states, princi- pally in the Kansas and Oklahoma portions of the Hugoton Field, the Permian Basin of west Texas and southeastern New Mexico, and in the Powder River and Green River Basins of Wyoming.\nItem 2 (continued)\nThe report of the independent petroleum engineering firm provides estimated proved developed reserves and future revenues as of December 31, 1994 and includes an estimate of proved developed reserves established by the Company's infill drilling in the Kansas Hugoton Field. Reserve estimates for infill wells are based upon the initial test results and the completion report of each newly completed well rather than an extrapolation of field-wide data. However, no proved undeveloped reserves for the Hugoton Field are included in the Company's estimate.\nThe reserve quantities are estimates of the Company's net volumes which can be expected to be recovered commercially at current prices and with existing conventional equipment and operating methods. Proved developed reserves are only those reserves expected to be recovered from existing wells. Proved undeveloped reserves include those reserves expected to be recovered from new wells and improved recovery projects where additional expenditures are required.\nAt December 31, 1994, the Company believes that there are no material estimated future dismantlement and abandonment costs for its properties. For the purpose of computing the discounted future net cash flows, estimated future dismantlement and abandonment costs are assumed to equal the estimated salvage values of the properties.\nFor further information on the Company's reserves, see Note Eight of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report on Form 10-K.\n(2) RESERVES REPORTED TO OTHER AGENCIES\nThe Company will file the Annual Survey of Domestic Oil and Gas Reserves with the Energy Information Administration (EIA) as required by law. Only minor differences of less than five percent are anticipated in reserve estimates, which were due to small variances in actual production versus yearend estimates, and in certain classifications reported in Form 10-K as compared to those in the EIA report.\n(3) GAS PRODUCTION, SALES PRICES AND PRODUCTION COSTS\nThe following table sets forth the average sales price of gas and oil produced and sold and the average production costs per thousand cubic feet equivalent (Mcfe) of gas for each of the periods presented.\nItem 2 (continued)\n(4) FUTURE NET CASH FLOWS\nAt yearend 1994, the pre-tax present value (discounted at 10%) of future net cash flows from proved reserves was $235 million, with gas represent- ing 83% and oil 17% of proved reserves. Net cash flows from properties under the K N contract were computed using (1) the price which was renegotiated with KN for 1995 and (2) yearend costs. Net cash flows from other properties used yearend prices or prices under production sales contracts and yearend costs. The discount factor was applied on a year-by-year basis utilizing anticipated sales over the life of the reserves. Additional information concerning the future net cash flows from proved oil and gas reserves is presented in Note Eight of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report on Form 10-K.\n(5) NET PROFIT AGREEMENTS\nThe Company produces gas in the Oklahoma portion of the Hugoton field under a \"Dry Gas Agreement\" with Chevron USA, Inc. (Chevron). This agreement allows the Company to expend funds for the operation of the properties (including the cost of drilling wells) and to recoup the funds so expended from current production income. Eighty percent of net operating income generated by the gas production (after operational costs are recouped, including the cost of drilling and equipping wells) is then paid to Chevron. At December 31, 1994, the Company had working interests in 21 Guymon-Hugoton wells and 43 Camrick wells under the terms of this agreement.\nThe Company also produces gas in the Kansas Hugoton field under various agreements similar to the Chevron agreement, except that net operating income is allocated 15% to the Company and 85% to the other parties. At December 31, 1994, the Company had working interests in 47 Chase wells and eight Council Grove wells under such agreements.\nAdditional or replacement wells drilled on the properties, including wells drilled under the infill drilling program in the Hugoton field, would be operated under the same terms and conditions as existing wells, and would result in the commencement of the 80\/20 or 85\/15 net operating income allocation after the cost of the new wells is recovered.\n(6) HUGOTON GAS TRUST AGREEMENT\nGas rights established in 1955 to some 50,000 partially developed acres in Finney and Kearny Counties, Kansas were transferred by K N on October 1, 1984 to the Company subject to a gas payment of six cents per Mcf for gas produced from the acreage. Quarterly payments are made by the Company to the Hugoton Gas Trust, a publicly-held trust created in 1955. Payments terminate when the recoverable gas reserves decline to 50 Bcf or less. At yearend 1994, the Company has working interests in 156 Chase wells and 42 Council Grove wells which are subject to such payments. Any additional gas wells drilled on this acreage will also be subject to the six-cent payment per Mcf of gas produced.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS\nSee Note Six of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report on Form 10-K.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nADDITIONAL ITEM -\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following information required by Item 401 of Regulation S-K pertains to the executive officers who are not directors of the Registrant and are not included with information under Item 10, Part III of this Form 10-K:\nDarrel Reed: Vice President, Controller and Treasurer Age: 53 Term ends: April 1995 Period served: Since July 1985 Past five years - business experience: Vice President - Finance and Treasurer and Chief Financial and Accounting Officer from July 1985 through May 1994.\nEugene A. Lang, Jr: Senior Vice President, General Counsel and Secretary Age: 41 Term ends: April 1995 Period served: Since October 1990 Past five years - business experience: Vice President, General Counsel and Secretary from October 1990 through May 1994. Attorney at Law, Houston, Texas, from September 1986 through September 1990.\nLee B. VanRamshorst: Senior Vice President - Business Development of Plains Petroleum Operating Company (PPOC), the Registrant's operating subsidiary. Age: 55 Term ends: May 1995 Period served: Since November 1985 Past five years - business experience: Vice President - Engineering of PPOC from May 1988 through November 1991.\nRobert A. Miller, Jr: Vice President - Law of PPOC Age: 53 Term ends: May 1995 Period served: Since September 1985 Past five years - business experience: Vice President, General Counsel from August 1987 through September 1990.\nRobert W. Wagner: Vice President - Land and Marketing of PPOC Age: 54 Term ends: May 1995 Period served: Since May 1985 Past five years - business experience: Manager - Land of PPOC from May 1985 through April 1988.\nAdditional Item (Continued)\nJohn N. Wood: Vice President - Information Systems of PPOC Age: 47 Term ends: May 1995 Period served: Since November 1990 Past five years - business experience: Vice President - Geoscience Systems of PPOC from May through November 1991; Manager - Geoscience Systems of PPOC from November 1990 through April 1991; Vice President - Exploration Computing, McAdams, Roux and Associates, Inc. from 1988 through October 1990.\nPART II\nITEM 5:","section_5":"ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe common stock of Plains Petroleum Company was first listed on the New York Stock Exchange on September 16, 1985. The reported high and low market prices for the two most recent fiscal years and the most recent interim period are shown below.\nThere are approximately 3,800 record holders as of March 15, 1995 of the Company's common stock. In addition, Plains estimates that approximately 5,200 shareholders hold stock as beneficial owners in nominee accounts.\nThe Company paid quarterly dividends of 6 CENTS per share, or 24 CENTS per annum, during each of the three years ending December 31, 1994. On February 15, 1995 the Company declared a quarterly dividend of 6 CENTS per share payable on March 31, 1995.\nThe Company has a rights plan designed to insure that stockholders receive full value for their shares in the event of certain takeover attempts.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company achieved growth in oil and gas reserves of 11% through a combined program of acquisitions, exploration and exploitation. In a highly competitive market for a limited quantity of quality properties, the Company successfully acquired 20 billion cubic feet (Bcf) of gas and 2.5 million barrels of oil. Exploration and exploitation achievements added another 19.6 Bcf of gas and 2.3 million barrels of oil. In a year marked by fluctuating and declining prices resulting in production curtailments, the Company reported net earnings of 68 CENTS per share as compared to 18 CENTS per share in the previous year. Concentrated efforts to reduce operating costs and improve operating efficiencies offset declines in revenues stemming from lower prices.\nLIQUIDITY AND CAPITAL RESOURCES\nAt yearend 1994, the Company's working capital increased to $1.9 million, as compared to $1 million the prior yearend. Cash provided by operations was used principally to fund the Company's 1994 capital expenditures for development drilling and exploration, totaling approximately $21 million and for production facilities including gathering and automation facilities and compression units in the Hugoton field of $1.3 million. Additionally, cash provided in excess of funding operational requirements was used to repay a portion of the borrowings and to fund dividend payments. Development drilling and production enhancement projects in 1994 comprised approximately 63% of the capital expenditures. Of the total expenditures, 1994 exploration projects represented approximately $7 million.\nDuring 1994, the Company utilized a portion of its bank credit line to finance acquisitions of properties in Colorado, Wyoming, Montana, North Dakota, Utah and Oklahoma totaling approximately $27 million.\nOn February 17, 1995, the Company entered into a new credit agreement for a $150 million unsecured, revolving bank line replacing the previous $60 million line of credit. (See Note Three of Notes to Consolidated Financial Statements.) Together with cash provided from operations, the Company believes that this new bank line provides the financial strength to aggressively pursue acquisition opportunities and to support an active development and exploration program, all of which are necessary for growth.\nThe Company plans a 1995 capital spending program of approximately $34 million for exploitation, exploration and production enhancement projects. An additional $25 million has been targeted for acquisition of oil and gas properties. Approximately $16 million, or 46% of the capital spending program will be directed toward development drilling projects located principally in Wyoming, Nevada and offshore Texas and Louisiana. Secondary recovery projects consisting of waterflood enhancement programs in the Cambridge, Rozet, N. Adon Road and other Minnelusa fields of Wyoming and the Moss Grayburg San Andres Unit located in Texas will require capital spending of approximately $8 million. Exploration drilling efforts of approximately $3 1\/2 million will focus on projects in the Permian Basin of west Texas, the offshore Gulf Coast and the Green River Basin of Wyoming. Other exploration capital spending efforts, estimated to cost approximately $4 million will be directed toward the development of prospects through lease acquisitions and utilization of seismic and other geological studies.\nIn mid-February 1995, an exploratory test, the Patterson Deep Prospect in Louisiana, was completed as a dry hole. The Company's investment in this well approximated $600,000 and will be expensed in the first quarter of 1995.\nFor the three-year period ended December 31, 1994, the Company paid quarterly dividends of 6 CENTS per share, or 24 CENTS per annum. It has repurchased a total of approximately 48,000 shares of its common stock for use in its employee benefit plans.\nRESULTS OF OPERATIONS\nDuring 1994, the Company generated net earnings of $6.6 million (68 CENTS per share) compared to $1.7 million (18 CENTS per share) in 1993. In an effort to improve profitability, the Company concentrated its efforts on improving the efficiency of field operations while simultaneously reducing costs. Lower production and exploration operating costs in 1994 offset increases in depreciation, depletion and amortization expense and in general and administrative expenses. Net earnings in 1993 were impacted by a $9.3 million impairment charge on certain properties and a net credit of $1.3 million derived from two mandatory accounting changes.\nREVENUES\nRevenues for 1994 were $62 million, 4% lower than 1993 revenues of $64 million, primarily due to lower average gas and oil prices. Revenues for 1993 increased 10% over 1992 as a result of higher volumes sold and increased average gas prices. Gas revenues represented nearly 72% of the Company's total revenues for 1994 and 1993.\nGas revenues declined 4% to $44 million from $46 million in 1993 principally due to declining prices. Average gas prices for 1994 ranged from $2.08 per Mcf in the first quarter to $1.74 in the fourth quarter, resulting in average prices for the year of $1.86, down 8 CENTS, or 4%, from 1993. Average prices for 1993 were up 11 CENTS per Mcf from 1992.\nOne-half of the Company's total gas revenues were received from the Company's principal purchaser for sales from the Hugoton field in southwestern Kansas and the Niobrara area of northeastern Colorado. The Company received a wellhead price of $2.00 per million British Thermal Unit (MMBtu) from this purchaser for the five months of January through March, November and December. For the months of April through October 1994, the Company received $1.80 and $1.75 per MMBtu at the wellhead for the Hugoton field and the Niobrara field, respectively. Under a two-tier seasonal pricing contract effective for 1995, the Company will receive a weighted average wellhead price of $1.80 per MMBtu on net sales volumes of 14 Bcf and spot market prices on another 5 Bcf (net). In addition to the 1994 negotiated permanent release of 66 Hugoton field wells connected to Company-owned gathering lines, an additional 37 wells were released for 1995. Production from these wells will be sold on the spot market. Negotiations with the purchaser for 1996 prices will commence in late 1995.\nWellhead prices include all transportation and marketing charges, whereas spot market sales are burdened with these additional costs. These charges currently range from 15 CENTS to 40 CENTS per MMBtu in the Rocky Mountain and Mid-continent area. The balance of the Company's gas supplies are sold to various purchasers under percentage of proceeds, short-term or spot sales contracts.\nNatural gas production volumes of 23.9 Bcf sold in 1994 increased 1% over 1993 volumes of 23.8 Bcf. This nominal increase was attributed to constraints on the principal purchaser's gathering system in the Hugoton field for the first quarter and curtailment of production due to low prices during the third quarter.\nOil revenues of $17 million declined 5% from 1993 primarily due to a 6% drop in average prices. Oil revenues of $18 million for 1993 declined 4% as compared to 1992 revenues. Average oil prices realized during 1994 were at a five-year average low of $13.91 per barrel, in comparison to $14.83 for 1993 and $18.20 for 1992. Oil production of 1.2 million barrels for 1994 was comparable to 1993. However, due to the acquisition of primarily oil properties in November 1994, average daily production by yearend was 4,602 barrels, an increase of 34% from the beginning of the year.\nOPERATING EXPENSES\nOperating expenses for 1994 were relatively unchanged as compared with 1993, excluding the $9.3 million impairment charge in 1993. Operating expenses in 1993, exclusive of the impairment charge, were 14% over 1992 due to increased lease operating costs and higher depreciation, depletion and amortization charges associated with acquired properties.\nProduction costs, including lease operating costs, production and property taxes, transportation and processing fees and net profits payments, declined $2.6 million to $24.7 million in 1994, a 10% decrease from 1993. Production costs for 1994 approximated $4.73 per barrel of oil equivalent (BOE) compared to $5.28 per BOE in 1993 and $5.48 per BOE in 1992.\nA decline in lease operating costs of 14% from 1993 is directly attributed to the Company's program to improve operating efficiencies, dispose of marginally economic wells and reduce costs, particularly with respect to oil field operations. Lease operating costs for 1993 were 9% over 1992 due to increased operating costs associated with acquisitions, drilling programs and production workovers and increased transportation and processing costs on spot sales of natural gas.\nProduction and property taxes increased 10% over the prior year. Production taxes for 1994 decreased 6% due to lower revenues. 1993 production taxes were at a comparable level to 1992. Conversely, property taxes consisting principally of ad valorem taxes increased 31% over 1993. This increase is primarily attributable to rising rates and valuation methods utilized by Kansas tax authorities for the Hugoton field properties.\nTransportation and processing (T&P) costs decreased 6% from 1993 due to lower average charges of 10 CENTS to 15 CENTS per MMBtu related to spot market sales. Increased spot market sales volumes in 1993 resulted in a 41% increase in T&P over 1992. Lower gas sales (down 7%) and an 11% decline in average prices received for production from Oklahoma properties resulted in a 32% decline in net profits expense as compared to 1993. In 1993, gas sales from these same properties were higher as compared to 1992 resulting in an increase in net profits expense of 4% above 1992.\nConsistent with industry practices, certain general and administrative costs attributed directly to other operating expense classifications of lease operations, exploration and transportation were reclassified to the respective operating expense categories for the years 1994, 1993 and 1992. Employee payroll expenses declined by 10% in 1994 from 1993 as a result of a 14% staff reduction in 1993. After reclassifications of $2.3 million and $3.4 million for 1994 and 1993, respectively, to the operating expense categories, general and administrative costs were approximately $935,000, or 15%, above 1993, primarily due to higher costs related to employee benefit plans. Termination of an administrative overhead sharing arrangement in mid-1992 and reduction of operating overhead reimbursement attributed to properties sold caused 1993 general and administrative costs to increase 15% above 1992.\nDepreciation, depletion and amortization increased by 13% in 1994 primarily due to an 11% increase in depletion rates over 1993. Depletion expenses for 1993 increased one-third over 1992. Higher cost-basis oil properties acquired in previous years and revisions of oil reserves in 1993 and 1992 caused depletion rates to increase for both periods. As recognition of the excess cost basis over market value of certain Permian Basin properties in 1993, the Company reduced the depletable basis through the recognition of an impairment provision of $9.3 million.\nExploration expenses consisting of unsuccessful exploration drilling, seismic costs and lease impairments and rentals, were 38% lower than 1993, which, in turn, was 5% lower than 1992 due to reduced exploration activities.\nBorrowings for property acquisitions in the latter half of 1994 and increasing interest rates resulted in higher interest expense than in 1993. Interest rates and debt balances were lower in 1993 than in 1992.\nOther income was generated principally from third party utilization of the Company's gathering and automation systems in the Hugoton field. Restructuring and staff reduction costs and unsuccessful acquisition expenses contributed to an increase in other expenses in 1993.\nEffective January 1, 1993, the Company adopted the Financial Accounting Standards Board Statement No. 106 on accounting for postretirement benefits other than pensions. As a result of this adoption, the Company recognized a one-time, cumulative charge of approximately $800,000 (pretax) in 1993 (see Note Five of the Notes to Consolidated Financial Statements in Part II, Item 8","section_7A":"","section_8":"ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPLAINS PETROLEUM COMPANY CONSOLIDATED STATEMENTS OF EARNINGS\nThe accompanying notes are an integral part of these financial statements.\nPLAINS PETROLEUM COMPANY\nCONSOLIDATED BALANCE SHEETS Successful Efforts Accounting Method\nThe accompanying notes are an integral part of these financial statements.\nPLAINS PETROLEUM COMPANY CONSOLIDATED BALANCE SHEETS Successful Efforts Accounting Method\nThe accompanying notes are an integral part of these financial statements.\nPLAINS PETROLEUM COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\nPLAINS PETROLEUM COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nPLAINS PETROLEUM COMPANY\nNotes to Consolidated Financial Statements\nNOTE ONE SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Plains Petroleum Company (Plains) and its wholly-owned subsidiaries, which are hereinafter referred to collectively as the \"Company\". All significant intercompany transactions have been eliminated. Certain reclassifications have been made to 1992 and 1993 amounts to conform to the 1994 presentation.\nOIL AND GAS PROPERTIES\nThe Company follows the successful efforts method of accounting for its oil and gas exploration and development activities. Acquisition costs, successful exploration costs and all development costs are capitalized. Unsuccessful exploratory drilling costs, seismic costs, and lease impairments and rentals are expensed. Generally, gains or losses from disposal of properties are recognized currently. The estimated salvage value of a property on its sale, disposal or abandonment generally approximates the estimated dismantlement, site restoration and abandonment costs. As a result, the accrued liability for any excess cost is not material and not separately disclosed in the financial statements.\nFor certain oil properties located in the Permian Basin in west Texas and southeastern New Mexico, a property impairment reserve of $9.3 million was recorded in 1993 to adjust the net book value to an approximate net realizable market value.\nDEPRECIATION, DEPLETION AND AMORTIZATION\nThe unit-of-production method is used for computing depreciation, depletion and amortization for oil and gas properties. The Company accrues for estimated dismantlement and abandonment costs as a part of the unit-of-production amortization. The accrued costs are classified as a component of accumulated depreciation, depletion and amortization of the oil and gas properties. Depreciation and amortization of other assets are provided for using the straight-line method.\nNote One (Continued)\nINCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (FAS 109), \"Accounting for Income Taxes\". FAS 109 utilizes the liability method, with deferred taxes determined on the basis of estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities. A valuation allowance must be established for a deferred tax asset if a tax benefit may not be realized from the asset. In 1993, the Company recognized the one-time, cumulative benefit of the accounting change on prior years of $2 million and established a valuation allowance for its deferred tax assets (see Note Four).\nSTOCKHOLDERS' EQUITY\nQuarterly dividend payments charged to retained earnings were $2,354,000 in 1994, $2,352,000 in 1993 and $2,350,000 in 1992. During these three years, the Company has repurchased a total of approximately 48,000 shares of its common stock, primarily for use in its employee benefit plans.\nPlains has a rights plan designed to insure that stockholders receive full value for their shares in the event of certain takeover attempts.\nEARNINGS PER SHARE\nEarnings per share are computed based on the weighted average number of common shares outstanding during each year. There are no other securities or common stock equivalents which have a dilutive effect on earnings per share.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nSupplemental disclosures of cash flow information:\nNote One (Continued)\nSupplemental information of noncash investing and financing activities:\nIn May 1994, the Company completed the contingent provisions of the 1990 McAdams, Roux and Associates, Inc. (MRA) Agreement and Plan of Merger, as it related to the right of the MRA shareholders to receive additional shares of the Company's common stock and cash (\"Contingent Consideration\"). The Contingent Consideration was based on the determination that additional reserves were attributed to certain property interests owned by MRA prior to the merger. Under the Agreement, 31,873 additional shares of the Company's common stock valued at $750,000 were issued to MRA's shareholders to satisfy a portion of the Contingent Consideration. A cash payment of $1 1\/2 million was made to the MRA shareholders for the remainder of the obligation.\nAt yearend 1993, prior to the Contingent Consideration payments in 1994, an estimated current liability of $1,850,000 was reflected on the balance sheet for the estimated cash payment, with the remainder of $650,000 related to the common stock to be issued reflected as a long-term liability.\nNOTE TWO ACQUISITIONS\nThe Company acquired interests in certain producing oil and gas properties located in Colorado, Wyoming, Montana, North Dakota, Utah and Oklahoma totaling approximately $27 million. Properties were acquired from Anadarko Petroleum Corporation on November 1, 1994 for approximately $24 million. The acquisition was financed with a portion of the Company's bank line of credit (see Note Three) and is reflected on the balance sheet using the purchase method of accounting.\nThe accompanying Consolidated Statements of Earnings include the operations of the acquired properties commencing with completion of the purchases in 1994. The unaudited pro forma financial information which follows represents condensed consolidated operating results as if the acquisitions had been consummated as of January 1, 1993. Consequently, the unaudited pro forma adjustments to historical information reflect the addition of the revenues and direct operating expenses of the acquired properties for the respective periods in addition to pro forma adjustments for depreciation, depletion and amortization expense, interest expense, general and administrative expense and related income tax effects. Earnings per share is based on the weighted average number of common shares outstanding of Plains' stock during each year. The pro forma financial information is provided for comparative purposes only and should be read in conjunction with the historical consolidated financial statements of the Company. The pro forma financial information presented is not necessarily indicative of the combined financial results as they may be in the future, or might have been during the periods presented had the acquisition been consummated at the beginning of 1993.\nNOTE THREE LONG-TERM DEBT\nOn February 17, 1995 (effective date), a new credit agreement was entered into which replaced the previous $60 million unsecured, revolving line of credit with a $150 million bank line. The new bank line has an initial borrowing base limitation of $110 million, which will be redetermined annually. Under the new agreement, outstanding borrowings at the end of the revolving period in January 1997 convert to a term loan. The new agreement also provides for a maximum of treasury stock purchases, which are not to exceed $75 million during the eighteen-month period following the effective date. Subsequent to that period, aggregate treasury stock purchases during the previous four fiscal quarters may not exceed 50% of net earnings based upon the preceding two years.\nInterest only payments are required during the revolving period; thereafter, principal is to be repaid over six years in equal quarterly installments beginning in April 1997. The outstanding principal balance shall bear interest at the prime rate (8 1\/2% per annum at yearend 1994) during the revolving period. In addition, if the aggregate amount of treasury stock purchases is greater than $50 million, and the principal outstanding is 80% or greater of the borrowing base, then the interest rate margin is increased an additional one-half of one percent per annum. The Company may also elect at any time to borrow funds at more favorable rates offered by the interbank eurocurrency market (LIBOR), which it utilizes frequently, or by domestic certificates of deposit. LIBOR was elected for the entire outstanding debt balance at yearend 1994 at an effective rate of 6.76% per annum.\nNote Three (Continued)\nThe margin on fixed interest rates and the commitment fee rates vary depending upon the percentage of the loan principal outstanding in relation to the borrowing base as determined under the agreement. The rates are on a sliding scale from five-eighths of one percent to one and one-half percent per annum. The commitment fee is from one-quarter of one percent to seventeen-fortieths of one percent per annum.\nThe Company must also maintain a book net worth of at least $80 million and a ratio of current assets to current liabilities of at least 1 to 1. In addition, the Company may pay cash dividends as long as the aggregate payments during the previous four fiscal quarters do not exceed 50% of its net earnings based upon the preceding two years.\nNOTE FOUR INCOME TAXES\nThe effective tax rate on income from operations before taxes and the cumulative effect of changes in accounting methods is different from the prevailing federal income tax rate as follows:\nFor 1992, income tax expense differs from the amounts computed by applying the statutory Federal income tax rate to earnings before income taxes. The reasons for these differences are shown as a percent of earnings as follows:\nNote Four (Continued)\nThe tax effect of temporary differences giving rise to the Company's consolidated deferred income tax asset (liability) at December 31, 1994, is as follows:\nThe Company has established a valuation allowance to the extent that it may not be able to utilize its deferred tax assets. As of December 31, 1994, the Company's estimate of taxable income increased for future periods which resulted in a decrease in the valuation allowance from the prior yearend.\nAs of December 31, 1994, the Company had estimated alternative minimum tax loss carryforwards totaling $12 million. Such carryforwards are subject to separate return limitation year provisions and they expire, if not utilized, during the years 1998 through 2005. The Company has no loss carryforwards for state income tax purposes. The Company also has available depletion and other credit carryforwards which may be utilized upon expiration of the loss carryforwards.\nNOTE FIVE EMPLOYEE BENEFIT PLANS\nThe Company has a qualified, defined benefit retirement plan covering substantially all of its employees. The benefits are based on a specified level of the employee's compensation during plan participation. The Company's funding policy is to contribute annually an amount that provides not only for benefits attributed to service to date, but also for benefits expected to be earned in the future. Plan assets consist of U.S. Treasury obligations, corporate stocks and bonds, insured annuity contracts, cash and cash equivalents and accrued interest. Contributions by the Company were $312,000, $341,000 and $239,000 for the 1994, 1993 and 1992 plan years, respectively.\nThe following table sets forth the plan's funded status:\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 8%. The rate of increase used for compensation levels was 5% in 1994 and 1993 and 6% in 1992. The expected long-term rate of return on assets was 8 1\/2%.\nNote Five (Continued)\nThe Company also contributes the lesser of 10% of its net earnings or 10% of employee compensation to a profit sharing plan of the Company. For 1994, 1993, and 1992, the Company contributed $334,000, $188,000 and $471,000, respectively.\nDuring 1993 and 1992, employees were allowed to defer from 1% to 10% of their salary under a 401(k) salary redirection plan. Effective January 1, 1994, three changes were made to the 401(k) plan. First, employee deferrals are limited to 9% of current salary. Second, the Company began matching deferrals with contributions equal to 50% of each deferral up to 6% of current salary. Company contributions are invested in Company stock and are subject to a vesting schedule. Third, the payroll-based employee stock ownership plan (PAYSOP) was terminated and merged into the 401(k) plan. Prior to its termination and merger with the 401(k) plan, PAYSOP contributions were based upon 1\/2 of 1% of compensation and amounted to $22,700 for 1993 and $23,500 for 1992.\nPlains has established three incentive stock option plans for employees and a non-qualified stock option plan for its non-employee directors. Stock options are granted at not less than 100% of the market value of the stock on the date of grant. Plains has reserved one million shares under the employee plans and 50,000 shares under the non-employee directors' plan. Options granted, exercised and outstanding are as follows:\nNote Five (Continued)\nThe Company has established an executive deferred compensation plan and a directors' deferred fee plan which permit the deferral of current salary or directors' fees for the purpose of providing funds at retirement or death for employees, directors and their beneficiaries. The total accrued liability under these plans at December 31, 1994 and 1993 was $1,006,000 and $838,000, respectively.\nThe Company provides postretirement healthcare benefits to retiring employees and their spouses and a salary continuation (death) benefit to certain eligible retirees. These benefits are subject to a medical cost escalation limit, deductibles, co-payments, lifetime limits and other limitations. The Company reserves the right to change or terminate the benefits at any time.\nEffective January 1, 1993, the Company adopted Statement No. 106 (FAS 106) issued by the Financial Accounting Standards Board on accounting for postretirement benefits other than pensions. This statement requires the accrual of the cost of providing postretirement benefits over the active service period of the employee. FAS 106 requires recognition of the Company's accumulated postretirement benefit obligation for its healthcare plan and salary continuation plan existing at the time of adoption, as well as incremental expense recognition for changes in the obligation attributable to each successive fiscal period. The Company elected to immediately recognize the accumulated liability as of the effective date, totaling approximately $800,000 (pretax). Prior to 1993, the Company recognized postretirement costs in the year the benefits were paid.\nAs of yearend, the status of the obligation, after reflecting anticipated changes in plan provisions, is as follows:\n* THE COMPANY HAS SPECIFICALLY IDENTIFIED CERTAIN ASSETS, PRIMARILY INSURANCE POLICIES OWNED BY THE COMPANY, TO FUND POSTRETIREMENT BENEFIT OBLIGATIONS. HOWEVER, THESE ASSETS ARE NOT CONSIDERED \"PLAN ASSETS\" AS DEFINED IN THE TAX REGULATIONS. AS OF DECEMBER 31, 1994 AND 1993, THE INSURANCE POLICIES HAVE A TOTAL CASH SURRENDER VALUE OF APPROXIMATELY $860,000 AND $770,000, RESPECTIVELY.\nNote Five (Continued)\nNet periodic postretirement benefit cost included the following components:\nThe Company has utilized independent actuaries to estimate the expected costs of healthcare benefits using current data from the Company and various assumptions. The estimates are subject to significant revisions based on a number of factors, including possible changes in the assumed healthcare cost trend rate and the discount rate used in the calculations.\nThe accumulated postretirement benefit obligation was computed using an assumed discount rate of 8%. The future healthcare cost trend rate was assumed to be 11 1\/2%, then it declines by 1.5 percentage points for each of three successive years and remains constant at 7% thereafter. If the healthcare cost trend rate was increased one percent for all future years, both the accumulated postretirement benefit obligation and the aggregate of service and interest costs for 1994 would have increased 1%.\nNOTE SIX COMMITMENTS AND CONTINGENCIES\nThe Company leases office facilities in Lakewood, Colorado; Midland, Texas; Lakin, Kansas and Gillette, Wyoming under operating leases with 6 to 60 months remaining on the lease terms as of December 31, 1994. The Company's computer and phone system leases terminate in 2 to 31 months. Minimum annual rental commitments amount to approximately $725,514 in 1995, $370,215 in 1996, $124,310 in 1997, $112,404 in 1998 and $3,800 in 1999.\nOn October 20, 1994, the Company issued a press release stating that it had authorized its financial advisors to help the Company study strategic alternatives in light of a recent Schedule 13-D filing by Cross Timbers Oil Company. The press release stated that as part of the study, the financial advisors would seek indications of interest from certain possible merger partners. The press release also indicated that the Company's board had amended its shareholder rights plan.\nOn November 2, 1994, a putative class action was filed in Delaware Chancery Court. In that case, entitled MILLER V. CODY, et al., the plaintiff has alleged that certain named directors and the Company have, among other things, breached their fiduciary duties by unreasonably amending the Company's shareholder rights plan and otherwise acting to entrench themselves in office. Plaintiff seeks various forms of injunctive relief, damages and an award of plaintiff's costs and disbursements.\nNote Six (Continued)\nThe Company and the named directors deny the principal allegations of wrongdoing in the complaint and intend to pursue a vigorous defense. A putative class action entitled BEHRENS V. MILLER, et al., that was filed on October 21, 1994, was voluntarily dismissed without prejudice by the plaintiff. The allegations and relief sought in the BEHRENS case were similar to those in the MILLER action, described above.\nAt December 31, 1994, the Company was a party to certain legal proceedings which have arisen out of the ordinary course of business. Based on the facts currently available, in management's opinion the liability, individually or in the aggregate, if any, to the Company resulting from such actions will not have a material adverse effect on the Company's consolidated financial position or results of operations.\nENVIRONMENTAL CONTROLS\nAt yearend 1994, there were no known environmental or other regulatory matters related to the Company's operations which are reasonably expected to result in a material liability to the Company. Compliance with environmental laws and regulations has not had, and is not expected to have, a material adverse effect on the Company's capital expenditures, earnings or competitive position.\nNOTE SEVEN COMPARATIVE QUARTERLY RESULTS (UNAUDITED)\nNOTE EIGHT OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)\nThe following disclosures concerning the Company's oil and gas producing activities are presented in accordance with FAS No. 69, \"Disclosures about Oil and Gas Producing Activities\".\nESTIMATED OIL AND GAS RESERVE QUANTITIES\nAll of the Company's proved developed reserve quantities were estimated at yearend 1994 by Netherland, Sewell & Associates, Inc., an independent petroleum engineering firm. Proved undeveloped reserves were estimated by the Company's petroleum engineers and amounted to approximately 11% of total proved reserve equivalents at December 31, 1994. Proved developed reserve quantities in prior years were also estimated annually by independent petroleum engineers.\nNote Eight (Continued)\nThe reserve balances presented below are estimates of net quantities which can be expected to be recovered commercially at current prices and with existing conventional equipment and operating methods. Proved developed reserves are only those reserves expected to be recovered from existing wells. Proved undeveloped reserves, estimated to be 20.1 Bcf of gas and 3.5 million barrels of oil at yearend 1994, include those reserves expected to be recovered from new wells and improved recovery projects where additional expenditures are required. The Company's reserves are in the lower 48 states, principally in the Kansas and Oklahoma portions of the Hugoton Field, the Permian Basin of West Texas and southeastern New Mexico, and in the Powder River and Green River Basins of Wyoming.\nNote Eight (Continued)\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS AND CHANGE THEREIN RELATING TO PROVED RESERVES (UNAUDITED)\nNote Eight (Continued)\nThe 1994, 1993 and 1992 standardized measure of discounted future net cash flows and related changes were computed using either yearend prices or prices under contractual arrangements for oil and gas and yearend costs. A significant portion of the Company's gas reserves are dedicated under a long- term contract with its principal purchaser, K N Energy, Inc. (K N). The price applicable to this contract is subject to annual renegotiation. Sales of gas to K N during 1994, 1993 and 1992 represented 34%, 48% and 47%, respectively, of total revenues of the Company. During 1994 and 1993, Associated Natural Gas, Inc. purchased natural gas representing 11% of total revenues. A second major customer during 1992 was Scurlock Oil Company which purchased oil representing 13% of total revenues of the Company. There were no other sales to customers which accounted for more than 10% of total revenues of the Company during the three years presented.\nEstimated dismantlement and abandonment costs, net of estimated salvage values of the properties, if material, are included as future costs in computing discounted future net cash flows.\nThe Company periodically performs an impairment test by comparing total capitalized costs with future undiscounted net revenues of its properties on a geographic basis, by field or basin. No impairment was recognized in 1994. An impairment of $9.3 million was recorded in 1993.\nEffective tax rates of 30% for 1994 and 28% for 1993 and 1992 were used in computing discounted future income taxes, respectively, which reflect the benefits which will accrue to the Company because of the reduction from statutory tax rates due to the utilization of available tax loss carryforwards which are present at yearend (see Note Four). Accretion of discount recognizes the increase resulting from the passage of time.\nReport of Independent Public Accountants\nTo the Board of Directors and Stockholders of Plains Petroleum Company:\nWe have audited the accompanying consolidated balance sheets of Plains Petroleum Company (a Delaware corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, 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 Plains Petroleum 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.\n\/s\/ ARTHUR ANDERSEN LLP\nDenver, Colorado January 31, 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\n------------------------------------------------------------------------------- The table below provides compensation information for the Company's chief executive officer and the Company's four most highly compensated executive officers, other than the chief executive officer, who were serving as executive officers at the end of 1994 and whose total annual salary and bonus exceeded $100,000.\n------------------------------------------------------------------------------- SUMMARY COMPENSATION TABLE -------------------------------------------------------------------------------\nThe table below provides information on the grants of stock options to the named executive officers during 1994.(1)\nThe table below provides information on the value of the named executive officers' unexercised options. No stock options were exercised by the named individuals during 1994.\nOPTION VALUES AT DECEMBER 31, 1994(1)\nThe following table shows the estimated annual benefits payable upon retirement to Company employees under the Company's retirement plan and supplemental retirement plan.\nAnnual pension benefits under such plan at the normal retirement age of 65 are equal to accrued annuity credits. The yearly retirement credit for each plan year from September 13, 1985 until December 31, 1988 equaled 1.3 percent of the first $8,400 of compensation and 2.1 percent of amounts in excess of $8,400. For participants who complete a year of service after December 31, 1988, the credits are equal to the greater of (a) the foregoing credits plus those based on 2.0 percent of total monthly compensation after January 1, 1989 or (b) credits based upon 1.25 percent of average compensation during the three consecutive years within the last ten years of employment when compensation was the highest, times years of service, plus 0.50 percent of such average compensation that exceeds the Social Security taxable wage base in effect for each year of service, times years of service (not to exceed 35 years). For purposes of the pension plan, compensation includes salary, overtime and special duty compensation and excludes bonuses and commissions. For each of the named executive officers, the compensation covered by the plan is the amount reported as such officer's salary in the summary compensation table above. Benefits under the plan are paid monthly after retirement for the life of the participant (straight-life annuity amount). Benefits under the plan are not subject to the deduction for Social Security benefits or other offset amounts. The named executive officers have accrued the following years of service for funding of benefits under the plan: Mr. Miller, 7 years; Mr. Danos, 6 years; Mr. VanRamshorst, 10 years; Mr. Lang, 5 years; and Mr. Wagner, 10 years. Mr. Danos retired on January 3, 1995. The benefits illustrated in this table do not reflect Internal Revenue Code Sections 415 and 401(a) limitations to which the plan is subject. If payment of actual retirement benefits is limited by such provisions, an amount equal to any reduction in retirement benefits will be paid as supplemental benefits under the Plains Petroleum Supplemental Retirement Plan.\nEMPLOYMENT CONTRACTS --------------------------------------------------------------------------------\nMr. Miller is a party to an agreement with the Company which provides, among other things, that if, within three years after a \"change in control\" (as defined in such agreement), Mr. Miller's employment with the Company is involuntarily terminated or is terminated by Mr. Miller for \"Good Reason,\" he is to be paid promptly a cash amount equal to 299 percent of the higher of (a) his then annual compensation (including salary, bonuses and incentive compensation) or (b) the highest annual compensation (including salary, bonuses and incentive compensation) paid or payable during any of the three calendar years ending with the year of his termination. \"Good Reason\" is defined as a reduction in Mr. Miller's compensation or employment responsibilities, a required relocation outside the greater Denver, Colorado area or, generally, any conduct by the Company which renders the executive unable to discharge his employment duties effectively.\nMessrs. VanRamshorst, Wagner and Lang are also parties to severance agreements identical to the agreement with Mr. Miller, except that the agreements with Messrs. VanRamshorst, Wagner and Lang provide for payment equal to two times the then annual compensation or the highest annual compensation paid or payable during either one of the two calendar years immediately preceding termination.\nCOMPENSATION OF DIRECTORS --------------------------------------------------------------------------------\nEffective December 1, 1993, a director who is otherwise not employed by the Company or its subsidiaries receives a retainer of $1,300 per month and a fee of $900 per day of each Board or committee meeting attended. Directors who are full-time employees of the Company or its subsidiary receive no additional compensation for their services as directors. All directors, however, are reimbursed for reasonable travel expenses incurred in attending all meetings.\nDirectors who are not also employees of the Company participate in the 1985 Stock Option Plan for Non-Employee Directors (the \"Directors Plan\"). Options granted pursuant to the Directors Plan are not intended to qualify as incentive stock options. Under the Directors Plan, each Director who is not a salaried employee of the Company, within 30 days after election or re-election to the Company's Board of Directors, will be granted options to purchase a number of shares of Common Stock equal to 1,000 multiplied by the number of years in the term to which he or she is elected. If any person is elected by the Board of Directors to fill an unexpired term or vacancy on the Board of Directors, within 30 days of the election, such person will be granted options for a number of shares equal to 1,000 multiplied by the number of twelve-month periods of the director's term (rounded up for any fraction of a twelve-month period). In 1994, Harry S. Welch received options to purchase 3,000 shares at the exercise price of $21.00 per share.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------------------------\nThe following table sets forth, as of March 15, 1995, the beneficial ownership of the Company's Common Stock by the Company's directors, each of the executive officers listed in the Summary Compensation Chart and all executive officers and directors as a group.\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS --------------------------------------------------------------------------------\nThe Company had a loan commitment through February 17, 1995 from three banks, one of which was Colorado National Bank (\"CNB\"), a wholly owned subsidiary of Colorado National Bankshares, Inc. CNB's portion of the commitment was $9 million, and it received an annual commitment fee of approximately $17,978 in 1994. William W. Grant, III, a director of the Company, was Chairman of the Board of CNB and a director of Colorado National Bankshares, Inc. through June 1993, and he now serves as an advisory director of CNB and Colorado National Bankshares, Inc.\nPART IV\nITEM 14:","section_14":"ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K --------------------------------------------------------------------------------\n(A) See Item 8 of Form 10-K with respect to financial statements.\n(B) The Financial Data Schedule included as an exhibit to this report on Form 10-K should be read in conjunction with the financial statements in Item 8. 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.\n(C) The Exhibit Index which follows lists the exhibits to this report which are filed herewith, except those incorporated by reference as indicated.\n(D) REPORTS ON FORM 8-K:\nThe following report on Form 8-K was filed by the Company during the last quarter of the year ended December 31, 1994 included in this Form 10-K, and is incorporated by reference in this report:\n(1) Date of Report: October 19, 1994\nItems Reported:\nITEM 5 - OTHER EVENTS\nAmendment to Rights Agreement dated October 19, 1994 between the Registrant and Chemical Bank, as successor Rights Agent, to Rights Agreement dated May 12, 1988, to preserve the ability of the Board of Directors to control the study process and to pursue business combinations to the best interest of the shareholders.\nITEM 7 - FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS\nExhibits related to Amendment to Rights Agreement dated October 19, 1994, noted in Item 5.\n(2) Date of Report: November 15, 1994\nItems Reported:\nITEM 2 - ACQUISITION OR DISPOSITION OF ASSETS\nAcquisition of certain oil and gas properties from Anadarko Petroleum Corporation.\nITEM 7 - FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS\nNo financial information was available at the time of the report filing. Information was subsequently provided in an amended report in January 1995.\nEXHIBIT INDEX Exhibit Footnote Number Reference Description of Document ------ --------- ----------------------- 3(a) Restated Certificate of Incorporation of Plains Petroleum Company.\n3(b) Certificate of Correction of Restated Certificate of Incorporation of Plains Petroleum Company.\n3(c) (1) By-laws of Plains Petroleum Company.\n4(a) (2) Preferred Stock Rights Purchase Agreement made as of May 12, 1988 between Plains Petroleum Company and Manufacturers Hanover Trust Company.\n4(b) (24) Amendment dated October 19, 1994 between Plains Petroleum Company and Manufacturers Hanover Trust to Exhibit 4(a).\nThe provisions in Registrant's Restated Certificate of Incorporation and By-laws defining the rights of holders of its equity securities are included in Exhibits 3(a), 3(b) and 3(c).\n4(c) (15) Credit Agreement effective January 1, 1991 between Plains Petroleum Company, Plains Petroleum Operating Company and NCNB Texas National Bank, et.al.\n4(d) (17) Amendment to Credit Agreement effective January 1, 1992 between Plains Petroleum Company, Plains Petroleum Operating Company and NationsBank of Texas, N.A., et.al.\n4(e) (20) Second amendment to Credit Agreement effective January 1, 1993 between Plains Petroleum Company, Plains Petroleum Operating Company and NationsBank of Texas, N.A., et.al.\n4(f) (22) Third Amendment to Credit Agreement effective January 1, 1994 between Plains Petroleum Company, Plains Petroleum Operating Company and NationsBank of Texas, N.A., et al.\n4(g) Credit Agreement effective February 17, 1995 between Plains Petroleum Operating Company and NationsBank of Texas, N.A., et.al.\n10(a) (3) Service Agreement between Plains Petroleum Company and K N Energy, Inc.\n10(b) (6) Amendment dated August 11, 1986 between Plains Petroleum Company and K N Energy, Inc. to Exhibit Number 10(a).\n10(c) (1) Amendment as of January 1, 1988 between Plains Petroleum Company and K N Energy, Inc. to Exhibit Number 10(a).\nExhibit Footnote Number Reference Description of Document ------- --------- -----------------------\n10(d) (4) Gas Purchase Contract. No. P-1090, dated April 20, 1984, as amended June 25, 1985, between Plains Petroleum Company and K N Energy, Inc.\n10(e) (6) Amendment dated October 30, 1986 between Plains Petroleum Company and K N Energy, Inc. to Exhibit Number 10(d).\n10(f) (12) Amendment dated April 11, 1990 between Plains Petroleum Operating Company and K N Energy, Inc. to Exhibit Number 10(d).\n10(g) (17) Amendments dated July 12, July 24 and July 25 of 1991 between Plains Petroleum Operating Company and K N Energy, Inc. to Exhibit Number 10(d).\n10(h) (19) Agreement dated September 3, 1992 to Redetermine Price Under Purchase Contract No. P-1090 and Conditions of Future Amendment for Release of Contract Gas Purchases between K N Energy, Inc. and Plains Petroleum Operating Company\n10(i)-1 (21) Agreement dated August 25, 1993 to Redetermine Price Under Purchase Contract No. P-1090 between KN Energy, Inc. and Plains Petroleum Operating Company.\n10(i)-2 (23) Agreement to Release of Pre-636 Exchange Gas P-1090 dated July 13, 1994 between Plains Petroleum Operating Company and K N Gas Supply Services, Inc.\n10(i)-3 Agreement dated December 8, 1994 between Plains Petroleum Operating Company and K N Energy, Inc. to Exhibit Number 10(d).\n21 Subsidiaries of the registrant.\n23(a) Consent of Independent Public Accountants.\n23(b) Consent of Independent Reservoir Engineer.\n27 Financial Data Schedule for the year ended December 31, 1994.\n99(a) Form 11-K for the year ended December 31, 1992 dated March 31, 1995.\n99(b) Form 11-K for the year ended December 31, 1993 dated March 31, 1995.\n99(c) Form 11-K for the year ended December 31, 1994 dated March 31, 1995.\nExhibit Footnote Number Reference Description of Document ------- --------- -----------------------\nCOMPENSATION PLANS AND AGREEMENTS\n10(j) (4) 1985 Incentive Stock Option Plan.\n10(k) (4) 1985 Stock Option Plan for Non-Employee Directors\n10(l) (9) 1989 Stock Option Plan\n10(m) (18) 1992 Stock Option Plan\n10(n) (4) Employment Agreement dated April 1, 1985 between Plains Petroleum Company and Elmer J. Jackson.\n10(o) (10) Amended and Restated Employment Agreement dated March 17, 1989 between Plains Petroleum Company and Elmer J. Jackson.\n10(p) (4) Severance Agreement dated May 1, 1985 between Plains Petroleum Company and Robert W. Wagner.\n10(q) (6) Severance Agreements between Plains Petroleum Company and Darrel M. Reed, Robert A. Miller, Jr., David L. Cook, and Lee B. VanRamshorst, and dated July 22, 1985; September 16, 1985; August 26, 1985; and November 18, 1985, respectively.\n10(r) (8) Amendment to Severance Agreements dated June 1, 1988 between Plains Petroleum Company and Darrel M. Reed, Robert A. Miller, Jr., Robert W. Wagner, and Lee B. VanRamshorst, respectively.\n10(s) (20) Director's Deferred Fee Plan dated August 8, 1987.\n10(t) (20) Executive Deferred Compensation Plan dated August 8, 1987.\n10(u) (20) First and Second Amendments to the Executive Deferred Compensation Plan dated December 1, 1988 and August 26, 1992, respectively.\n10(v) (13) Plains Petroleum Company 401(k) Plan & Trust.\n10(w) (7) Severance Agreement dated May 1, 1988 between Plains Petroleum Company and James A. Miller.\nExhibit Footnote Number Reference Description of Document ------ --------- -----------------------\n10(x) (10) Severance Agreement dated January 23, 1989 between Plains Petroleum Company and Robert M. Danos.\n10(y) (11) Amendment to Severance Agreements dated May 12, 1989 between Plains Petroleum Company and James A. Miller and Robert M. Danos, respectively.\n10(z) (14) Severance Agreement dated September 26, 1990 between Plains Petroleum Company and Eugene A. Lang, Jr.\n10(aa) (16) Severance Agreement dated May 13, 1991 between Plains Petroleum Company and John N. Wood.\n10(bb) (20) Incentive Compensation Plan dated February 18, 1993.\n10(cc) (24) Amendment to 1985, 1989 and 1992 Stock Option Plans, dated September 8, 1994.\n10(dd) (24) Employment Agreement dated August 7, 1994 between Plains Petroleum Operating Company and William F. Wallace.\n10(ee) (24) Amendment of Employment Agreement dated October 3, 1994 between Plains Petroleum Operating Company and William F. Wallace.\n______________________________\n(1) Incorporated by reference to Plains Petroleum Company's Annual Report on Form 10-K dated March 28, 1988. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(2) Incorporated by reference to Plains Petroleum Company's Registration Statement on Form 8-A dated May 20, 1988.\n(3) Incorporated by reference to Plains Petroleum Company's Annual Report on Form 10-K dated March 27, 1986. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(4) Incorporated by reference to Plains Petroleum Company's Registration Statement on Form 10 dated August 21, 1985.\n(5) [Intentionally omitted]\n(6) Incorporated by reference to Plains Petroleum Company's Annual Report on Form 10-K dated March 30, 1987. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(7) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated May 13, 1988. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(8) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated August 11, 1988. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(9) Incorporated by reference to Plains Petroleum Company's Proxy Statement, Exhibit A, dated March 21, 1989. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(10) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated May 12, 1989. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(11) Incorporated by reference to Plains Petroleum Company's Annual Report on Form 10-K dated March 28, 1990. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(12) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated May 7, 1990. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(13) Incorporated by reference to Plains Petroleum Company's Registration Statement on Form S-8 (Amendment No. 1) dated June 18, 1990 and (Amendment No. 2) dated December 21, 1993.\n(14) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated November 13, 1990. [SEC file number 1-8975] [available on] microfiche at the SEC]\n(15) Incorporated by reference to Plains Petroleum Company's Annual Report on Form 10-K dated March 27, 1991.\n(16) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated August 13, 1992.\n(17) Incorporated by reference to Plains Petroleum Company's Annual Report on Form 10-K dated March 26, 1992.\n(18) Incorporated by reference to Plains Petroleum Company's Proxy Statement, Exhibit A, dated March 26, 1992.\n(19) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated November 12, 1992.\n(20) Incorporated by reference to Plains Petroleum Company's Annual Report on Form 10-K dated March 26, 1993.\n(21) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated November 11, 1993.\n(22) Incorporated by reference to Plains Petroleum Company's Annual Report on Form 10-K dated March 28, 1994.\n(23) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated August 12, 1994.\n(24) Incorporated by reference to Plains Petroleum Company's Quarterly Report on Form 10-Q dated November 11, 1994.\nADDITIONAL ITEM -\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 registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 Nos. 33-30507 (filed August 11, 1989), 33-35306 (filed June 18, 1990 and December 21, 1993) and 33-54636 (filed November 16, 1992);\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person 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 the Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPLAINS PETROLEUM COMPANY\nMarch 30, 1995 By: \/s\/ Darrel Reed --------------------------------\nDarrel Reed 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 date indicated.\n\/s\/ James A. Miller Chairman, Chief Executive March 30, 1995 -------------------------- Officer and Director James A. Miller\n\/s\/ William F. Wallace President and Chief Operating March 30, 1995 -------------------------- Officer (Plains Petroleum William F. Wallace Operating Company) and Director\n\/s\/ Derrill Cody Director March 30, 1995 -------------------------- Derrill Cody\n\/s\/ William W. Grant, III Director March 30, 1995 -------------------------- William W. Grant, III\n\/s\/ Harry S. Welch Director March 30, 1995 -------------------------- Harry S. Welch\n\/s\/ Charles E. Wright Director March 30, 1995 -------------------------- Charles E. Wright","section_15":""}
{"filename":"40729_1994.txt","cik":"40729","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral Motors Acceptance Corporation (the \"Company\" or \"GMAC\"), a wholly-owned subsidiary of General Motors Corporation (\"General Motors\" or \"GM\"), was incorporated in 1919 under the New York Banking Law relating to investment companies.\nIn conducting its primary form of business, GMAC and its affiliated companies offer a wide variety of automotive financial services to and through franchised General Motors dealers in many countries throughout the world. GMAC also offers financial services to other automobile dealerships and to the customers of those dealerships. GMAC also provides commercial financing for real estate, equipment and capital loans to automobile dealerships, GM suppliers and customers of GM affiliates. GMAC's other financial services include insurance, mortgage banking and investment services. The Company had 17,246 and 18,322 employees worldwide, as of December 31, 1994 and 1993, respectively.\nThe Company operates directly and through its subsidiaries and through affiliates in which the Company or GM has equity investments. In its principal markets, GMAC offers automotive financing and other services as described below. The Company operates its automotive financing services similarly outside of the U.S. and Canada, subject to local laws or other circumstances that may modify procedures. The Company's policies and internal accounting controls are designed to ensure compliance with applicable laws and regulations.\nThe automotive financing industry is highly competitive. The Company's principal competitors for retail financing and leasing are affiliated finance subsidiaries of other major manufacturers as well as a large number of banks, commercial finance companies, savings and loan associations and credit unions. Wholesale and lease financing competitors are primarily comprised of the manufacturer's affiliated finance companies, independent commercial finance companies and banks. Neither the Company nor any of its competitors is considered to be a dominant force in the industry when analyzed individually. The Company's ability to offer competitive financing rates, the primary basis of competition, is directly affected by its access to capital markets. The Company applies a strategy of constantly reviewing funding alternatives to foster continued success. The quality of service provided to automotive dealerships and their customers contributes to the Company's competitive advantages.\nIn the U.S. automotive business, there are seasonal retail sales fluctuations that cause production levels to vary from month to month. In addition, the changeover period related to the annual new model introduction has traditionally occurred in the third quarter of each year, causing an unfavorable impact on the operating results of automobile manufacturers. These factors produce slight fluctuations in financing volume with the second quarter of each year generally experiencing the strongest activity. However, seasonal variations in vehicle deliveries do not have a material impact on the Company's interim results as quarterly financing revenue remains relatively consistent throughout the year, primarily attributable to the use of the interest method for recognition of income from retail and lease financing as well as consistent dealer inventory levels.\nITEM 1. BUSINESS (continued)\nRETAIL FINANCING\nGMAC conducts its U.S. and Canadian retail automotive financing business under the trade name GMAC Financial Services. The Company provides financing services to customers through dealers who have established relationships with GMAC. GMAC purchases retail instalment obligations for new and used products directly from dealers. These obligations must first meet GMAC's credit standards. Thereafter, GMAC collects and administers the obligations.\nRetail obligations are generally secured by lien notation on vehicles and\/or other forms of security interest in the products financed. GMAC acquires the security interest when it purchases the instalment obligations. After satisfying state requirements, GMAC can generally repossess the product if the instalment buyer fails to meet the obligations of the contract. The interests of both GMAC and the retail buyer usually are protected by automobile physical damage insurance.\nWHOLESALE FINANCING\nUsing GMAC's wholesale financing, qualifying dealers can finance new and used vehicles held in inventory pending sale or lease to retail or fleet buyers. When a dealer uses GMAC's Wholesale Finance Plan to acquire vehicles from a manufacturer or other vehicle sources, GMAC is generally granted a security interest in those vehicles. GMAC can generally repossess the product if the dealer does not pay the amount advanced or fails to comply with other conditions specified in the security agreement.\nGMAC also makes term loans to dealers and their affiliates for business acquisitions, facilities refurbishing, real estate purchases and working capital. The Company generally secures the loans with liens on real estate, other dealership assets and\/or the personal guarantee of the dealer.\nLEASING\nOperating Leases: ----------------- GMAC offers leasing plans to retail customers as well as dealers or other companies that rent or lease vehicles to others. GMAC's most successful leasing program, called SmartLease in the U.S. and Canada, is a plan in which dealers originate the leases and offer them for purchase by GMAC. As GMAC assumes ownership of the vehicle, these leases are accounted for as operating leases with the capitalized cost of the vehicle recorded as a depreciable asset (net investment in operating leases). Dealers are not responsible for the customer's performance during the lease period nor for the value of the vehicle at the time of lease maturity. The SmartLease program encourages shorter customer trading cycles and allows greater flexibility in dealers' retail lease transactions. Similar operating lease programs are offered in Germany and eleven other countries. On occasion, General Motors Corporation may elect to sponsor retail leasing programs by supporting special lease rates and\/or guaranteeing residual values in excess of published residual guide books used by GMAC.\nITEM 1. BUSINESS (continued)\nFinance Leases: --------------- GMAC also offers other leasing plans directly to individual customers and other entities. Under these plans, the leases are accounted for as finance leases and the receivables from the customers are recorded as finance receivables. GMAC does not assume ownership of the vehicle. These leasing receivables essentially represent instalment sales of vehicles, with the vehicle usually being acquired by the customer at the end of the lease contract.\nLease Financing: ---------------- Dealers, their affiliates and other companies also may obtain GMAC financing to buy vehicles that they lease or rent to others. These leases, sometimes referred to as Fleet leases, are categorized as finance receivables. GMAC generally has a security interest in these products as well as rents payable under a lease or rental agreement with a customer. However, competitive factors occasionally result in a limited security interest in this collateral. More than half of GMAC's inventory financing receivables are covered by General Motors programs which provide a limited payment guarantee to participating financing institutions as consideration for extending credit to a fleet customer. Under this program, General Motors will reimburse the financing institution, subject to certain limitations, for losses on the sale of vehicles which are repossessed and returned to the selling dealer.\nINSURANCE\nMotors Insurance Corporation and its subsidiaries (\"MIC\") conduct insurance operations in the United States, Canada and Europe. MIC insures and reinsures selected personal, mechanical, commercial and credit insurance coverages.\nPersonal lines coverages, which include automobile, homeowners and umbrella liability insurance, are offered primarily on a direct response basis. MIC insures mechanical coverage for new and used vehicles sold by GM dealers and others. In addition, MIC provides credit life and disability coverage through dealerships to vehicle purchasers. Commercial lines include insurance for dealer vehicle inventories, and other dealer property and casualty coverages. MIC also provides collateral protection coverage to GMAC on vehicles securing GMAC retail instalment contracts. Additionally, MIC is a reinsurer of diverse property and casualty risks, primarily in the domestic market.\nMORTGAGE BANKING\nGMAC Mortgage Corporation (\"GMACMC\") and its subsidiaries, collectively the GMAC Mortgage Group (\"GMACMG\"), conduct mortgage banking operations in the United States. GMACMG originates and markets single-family and commercial mortgage loans to investors and services these loans on behalf of investors. During 1994, GMACMG began retaining certain originated loans for investment purposes. GMACMG also offers other consumer services including home equity loans, insurance services and title and trustee services.\nITEM 1. BUSINESS (concluded)\nGMACMC, through its wholly-owned subsidiary, Residential Funding Corporation (\"RFC\"), is engaged in the residential wholesale mortgage conduit business. RFC purchases high balance, single- family residential mortgages from mortgage lenders throughout the United States, securitizes such mortgages into AA or AAA rated mortgage pass-through certificates, sells the certificates to investors and performs master servicing of these securities on behalf of investors. In addition, RFC also provides warehouse lending facilities to certain mortgage banking customers secured by mortgage collateral as well as long-term secured lines of credit to construction lending project managers.\nSERVICING\nGMAC services the retail instalment and wholesale obligations it has sold to third parties through GMAC's asset-backed securities program.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and its subsidiaries have 308 finance branches, 27 insurance offices and 140 mortgage offices. Of the number of finance branches, 232 are in the United States and the Commonwealth of Puerto Rico, 24 in Canada and 52 in other countries. There are 17 insurance offices in the United States, three in Canada and seven in Europe. Mortgage offices are all located in the United States. All premises are generally occupied under lease. 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\nThere are various claims and actions pending against the Company and its subsidiaries with respect to commercial and consumer financing matters, taxes and other matters arising out of the conduct of the business. Certain of these actions are or purport to be class actions, seeking damages in very large amounts. The probability of adverse verdicts from individual claims and actions is determined by a periodic review conducted by management and the Company's General Counsel which involves soliciting input from staff attorneys as well as outside counsel. Based on these reviews and examinations, the amounts of liability on these claims and actions at December 31, 1994, were not determinable but, in the opinion of management, the ultimate liability resulting therefrom should not have a material adverse effect on the Company's consolidated financial position or results of operations.\n-------------------\nPART II\nITEM 5.","section_4":"","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company is a wholly-owned subsidiary of General Motors Corporation and, accordingly, all shares of the Company's common stock are owned by General Motors Corporation. There is no market for the Company's common stock.\nThe Company paid cash dividends to General Motors Corporation of $875 million in 1994, $1,250 million in 1993 and $1,100 million in 1992.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFIVE-YEAR SUMMARY OF CONSOLIDATED OPERATIONS --------------------------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ---------- INCOME AND NET (in millions of dollars) INCOME RETAINED FOR USE IN THE BUSINESS\nGross revenue and other income ..... $ 12,145.0 $ 12,483.5 $ 13,739.3 $ 14,503.1 $ 14,815.8 ---------- ---------- ---------- ---------- ----------\nInterest and discount ......... 4,230.9 4,721.2 5,828.6 6,844.7 7,965.8 Depreciation on operating leases . 3,233.8 2,702.0 2,429.6 1,902.4 1,387.9 Operating expenses 1,986.8 1,949.0 1,900.1 1,907.1 1,677.9 Insurance losses and loss adjustment expenses ......... 1,030.9 1,096.6 987.9 1,061.6 1,014.1 Provision for financing losses . 177.3 300.8 371.0 1,047.9 843.2 Amortization of intangible assets 45.5 141.1 121.1 91.2 78.5 ---------- ---------- ---------- ---------- ---------- Total expenses .... 10,705.2 10,910.7 11,638.3 12,854.9 12,967.4 ---------- ---------- ---------- ---------- ---------- Income before income taxes ..... 1,439.8 1,572.8 2,101.0 1,648.2 1,848.4 United States, foreign and other income taxes ..... 512.7 591.7 882.3 610.0 658.3 ---------- ---------- ---------- ---------- ---------- Income before cumu- lative effect of accounting changes 927.1 981.1 1,218.7 1,038.2 1,190.1 Cumulative effect of accounting changes (7.4) -- (282.6) 331.5 -- ---------- ---------- ---------- ---------- ---------- Net income ........ 919.7 981.1 936.1 1,369.7 1,190.1 Cash dividends .... 875.0 1,250.0 1,100.0 850.0 1,000.0 ---------- ---------- ---------- ---------- ---------- Net income retained in the year ...... $ 44.7 $ (268.9) $ (163.9) $ 519.7 $ 190.1 ========== ========== ========== ========== ========== ASSETS Cash and cash equivalents ...... $ 1,339.5 $ 4,028.1 $ 3,871.1 $ 2,412.5 $ 205.1 Earning assets .... 82,074.6 74,783.8 87,198.7 98,614.3 103,407.9 Other assets ...... 2,123.3 1,938.9 1,738.4 1,607.7 1,477.9 ---------- ---------- ---------- ---------- ---------- Total ............. $ 85,537.4 $ 80,750.8 $ 92,808.2 $102,634.5 $105,090.9 ========== ========== ========== ========== ========== NOTES, LOANS AND DEBENTURES\nPayable within one year ......... $ 35,114.8 $ 35,084.4 $ 41,364.4 $ 51,018.6 $ 53,715.8 Payable after one year ......... 31,539.6 27,688.8 33,174.2 34,480.9 34,185.4 ---------- ---------- ---------- ---------- ---------- Total ............. $ 66,654.4 $ 62,773.2 $ 74,538.6 $ 85,499.5 $ 87,901.2 ========== ========== ========== ========== ==========\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nConsolidated net income for General Motors Acceptance Corporation (GMAC) and its subsidiaries totaled $919.7 million in 1994, or $61.4 million and $16.4 million below income reported in 1993 and 1992, respectively. In this regard, 1994 income reflects an unfavorable first quarter after-tax charge of $7.4 million related to the cumulative effect on income resulting from the implementation of Statement of Financial Accounting Standards (SFAS) No. 112, Employers' Accounting for Postemployment Benefits. Also, 1992 income reflects a cumulative unfavorable adjustment of $282.6 million related to implementation of SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions.\nNet income from financing operations, including GMAC Mortgage Group (GMACMG) results, totaled $809.0 million in 1994 (excluding the $6.8 million unfavorable impact due to the adoption of SFAS No. 112). The 1994 results were favorable $18.4 million relative to the $790.6 million earned in 1993 and unfavorable $202.6 million relative to the $1,011.6 million earned in 1992 (excluding the $232.8 million unfavorable impact due to the adoption of SFAS No. 106). The $18.4 million increase from 1993 earnings reflects record earnings from international operations as well as continued positive credit loss experience, and a more favorable funding mix in the U.S., resulting from greater investor confidence in General Motors and GMAC.\nThe $221.0 million decrease in earnings from 1992 to 1993 is primarily attributable to lower asset levels and tighter net interest rate margins in North America, partially offset by higher earnings outside North America.\nNet income from insurance operations totaled $118.1 million in 1994 (excluding the $0.6 million unfavorable impact due to the adoption of SFAS No. 112). These results compare with $190.5 million in 1993 and $207.1 million in 1992 (excluding the $49.8 million unfavorable impact due to the 1992 adoption of SFAS No. 106). Income earned in 1994, in comparison to 1993, reflects non-recurring capital gains recognized in 1993, partially offset by improved underwriting results in 1994. Insurance operations in 1993 compared unfavorably to 1992 due to unfavorable underwriting results which were partially offset by higher capital gains.\nThe following table summarizes the earnings of GMAC's financing and insurance businesses on a reported and comparable year-to-year basis:\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nIncome Cumulative Before Effect of Accounting Accounting Net Changes Changes Income ----------- ---------- ---------- (in millions of dollars, after tax) Financing Operations $ 809.0 $ (6.8) $ 802.2 Insurance Operations* 118.1 (0.6) 117.5 ---------- ---------- ---------- Total $ 927.1 $ (7.4) $ 919.7 ========== ========== ========== Financing Operations $ 790.6 $ -- $ 790.6 Insurance Operations* 190.5 -- 190.5 ---------- ---------- ---------- Total $ 981.1 $ -- $ 981.1 ========== ========== ========== Financing Operations $ 1,011.6 $ (232.8) $ 778.8 Insurance Operations* 207.1 (49.8) 157.3 ---------- ---------- ---------- Total $ 1,218.7 $ (282.6) $ 936.1 ========== ========== ==========\n* Motors Insurance Corporation\nOn a consolidated basis, GMAC's return on average equity capital was 11.6% in 1994, down from 11.9% reported in 1993 and up from 11.1% in 1992 (or down from 14.2% excluding the cumulative effect of the accounting change). Total cash dividends paid to General Motors Corporation in 1994 were $875 million, compared with $1,250 million in 1993 and $1,100 million in 1992.\nThe Company has disclosed in the financial statements certain amounts associated with estimated future retirement benefits other than pensions and characterized such amounts as \"accumulated postretirement benefit obligations,\" \"liabilities\" or \"obligations.\" Notwithstanding the recording of such amounts and the use of these terms, the Company does not admit or otherwise acknowledge that such amounts or existing postretirement benefit plans of the Company (other than pensions) represent legally enforceable liabilities of the Company.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nFINANCING VOLUME\nIndustry deliveries of new passenger cars and trucks in the United States in the 1994 calendar year increased to 15.4 million units from 14.2 million units and 13.1 million units in 1993 and 1992, respectively. Deliveries of new General Motors (GM) vehicles in the U.S. increased to 5.0 million units in 1994 from 4.7 million units in 1993 and 4.5 million units in 1992. GMAC financed 25% of new General Motors products delivered in the U.S. during 1994, a three percentage point decrease from 1993 and an eight percentage point decrease from 1992. The decline in penetration of retail delivery financing reflects continued intense competitive pressures within a robust sales environment.\nGMAC financed or leased worldwide 1,936,000 new passenger cars and trucks during 1994, 2.0% above 1,898,000 units in 1993 and 12.4% below 2,210,000 units in 1992. In the United States, GMAC financed or leased 1,323,000 new vehicles during the year, 48,000 and 325,000 units fewer than in 1993 and 1992, respectively. Outside the United States, GMAC financed or leased 613,000 new vehicles in 1994, up 86,000 units from 1993 and 52,000 units from 1992.\nThe average new passenger car contract purchased by GMAC in the United States during 1994 was $17,800 up from $16,400 in 1993 and $15,900 in 1992. The average term for new car contracts was 55 months in 1994, compared to 54 months in 1993 and 52 months in 1992, while the average monthly payment on new passenger car contracts increased to $325 in 1994, compared to $302 in 1993 and $305 in 1992.\nThe Company's worldwide retail leasing volume remained strong during 1994, with 628,000 units leased -- 81% above the prior year and 102% above 1992. The increase can be attributed to continued growth in the popularity of retail leasing, particularly in the United States where 448,000 units were leased during 1994, 119% above the prior year and 138% above 1992.\nGMAC also provides wholesale financing for GM and other dealers' new and used vehicle inventories. In the United States, inventory financing was provided on 3.8 million, 3.6 million and 3.4 million new GM vehicles, representing 76%, 77% and 78% of all GM sales to dealers during 1994, 1993 and 1992, respectively.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nASSETS\nTotal consolidated assets of the Company at December 31, 1994, were $85.5 billion, $4.8 billion above the previous year. Consolidated earning assets, which comprised $82.1 billion of the total consolidated assets, increased $7.3 billion from 1993 year-end levels. The year-to-year increase can be largely attributed to an increase in operating lease assets due to the continued popularity of the SmartLease program. Total consolidated assets at December 31, 1993, were $80.8 billion, $12.1 billion below year end 1992, with the majority of the reduction in earning assets due to sales of retail receivables as well as asset liquidations in excess of acquisitions in the United States.\nCash and Cash Equivalents, primarily consisting of excess funds from short term borrowings beyond current requirements which are invested in short-term marketable securities, decreased by $2,688.6 million in 1994 to $1,339.5 million from $4,028.1 million at the end of 1993. This portfolio, which is maintained primarily for liquidity assurance purposes, was purposefully reduced as a direct result of the Company's continued favorable access to the capital markets. The consolidated investment portfolio, primarily attributable to MIC, valued at market in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, totaled $3,891.7 million at year-end 1994. The consolidated investment portfolio balance at December 31, 1993 totaled $3,449.7 million with equity securities valued at market and bonds, notes and other securities at amortized cost. As of adoption at January 1, 1994, the cumulative favorable effect on stockholder's equity was $127.5 million, net of tax.\nConsolidated worldwide retail finance receivables, net of unearned income, amounted to $28.0 billion at December 31, 1994, a $2.0 billion increase from the prior year-end. The Company continues to utilize an asset securitization program as an alternative funding source and as a result sold retail receivables with principal aggregating $3.7 billion and $13.6 billion, respectively, during 1994 and 1993. With respect to sold receivables, GMAC continues to service these receivables for a fee. The Company's servicing portfolio reflected a principal balance of sold retail receivables amounting to $9.9 billion at year-end 1994, down $5.0 billion from $14.9 billion at year-end 1993. The decline in this portfolio reflects fewer sales of retail receivables during 1994 and paydowns of pools sold in prior years.\nWholesale receivables financed by GMAC, primarily dealer vehicle inventories, totaled $19.9 billion at year-end 1994, down $0.8 billion from 1993. The level of wholesale receivables at December 31, 1994, as compared to the asset levels at December 31, 1993, primarily reflects the sale of wholesale receivables through a special purpose subsidiary during 1994. GMAC continues to service these wholesale receivables which totaled $2.6 billion at December 31, 1994. (See Note 3.)\nConsolidated worldwide capital leasing and lease financing receivables, net of unearned income, at December 31, 1994 were $3,186.6 million, down $592.3 million from December 31, 1993. This reduction is primarily reflective of General Motors' reduction in fleet sales and the resultant decrease in GMAC fleet financing transactions.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nTerm loans to GM dealers and others were $4,237.8 million at the close of 1994, compared to $4,372.3 million the prior year-end. These loans provide dealers and their affiliates with a source of funds to help finance dealership acquisitions, building improvements and seasonal working capital requirements.\nReceivables from General Motors Corporation decreased by $275.0 million to $1,080.5 million at the end of 1994, compared with $1,355.5 million at year-end 1993.\nOperating lease assets, net of depreciation, acquired principally under the GMAC SmartLease program, totaled $17.8 billion at year-end 1994, an increase of $6.4 billion when compared to 1993. The increase primarily reflects growth in the U.S. and Canadian markets, driven by continued consumer acceptance of leasing and enhanced manufacturers' sponsored programs. Retail leasing is expected to continue to rise in all vehicle segments next year as customers seek alternative financing for vehicle purchases. The SmartLease program encourages shorter customer trading cycles and allows greater flexibility in dealers' retail lease transactions.\nReal estate mortgage inventory held for sale, including warehouse advances, amounted to $1,244.0 million at December 31, 1994, down $583.5 million from the prior year-end level. This decrease is primarily due to reduced mortgage origination volume as a result of increases in interest rates. During 1994, GMAC Mortgage Group established a portfolio of loans to be retained for investment purposes which totaled $920.6 million at December 31, 1994. The Company's due and deferred from receivable sales (net) decreased $293.0 million to $1,564.6 million at year-end 1994 compared to $1,857.6 million at December 31, 1993, with the decrease primarily attributable to the normal amortization of net assets on existing sales of receivables and a reduction in the sales of receivables during the year. (See Note 3.) Other earning assets totaled $938.9 million at December 31, 1994, $143.7 million higher than the prior year, with the increase primarily attributable to a larger inventory of vehicles acquired from fleet and rental customers of General Motors.\nIntangible assets included in other assets, primarily consisting of purchased mortgage servicing rights and goodwill from MIC's acquisition of NAVCO Corporation, totaled $377.4 million at the end of 1994, compared with $360.9 million at the prior year end. Other nonearning assets, essentially comprised of insurance premium receivables, excess mortgage servicing fees, foreclosed mortgages or mortgages otherwise classified as nonearning and repossessed vehicles, increased $167.9 million to $1,745.9 million at December 31, 1994, compared to $1,578.0 million at year-end 1993. This increase can be primarily attributed to increased excess mortgage servicing rights.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nLIQUIDITY\nThe Company's liquidity, as well as its ability to profit from ongoing acquisition activity, is in large part dependent upon its timely access to capital and the costs associated with raising funds in different segments of the capital markets. In this regard, GMAC regularly accesses the short-, medium-, and long-term debt markets, principally through commercial paper, medium-term notes and underwritten transactions.\nAs of December 31, 1994, GMAC's total borrowings were $66.7 billion compared with $62.8 billion at December 31, 1993. Approximately 78.7% represented funding for operations in the United States, with the remaining 21.3% of borrowings for operations in Canada (6.0%), Germany (7.0%), and other countries (8.3%). Total short-term notes outstanding at December 31, 1994, amounted to $22.3 billion compared with $17.7 billion at December 31, 1993.\nLonger-term funding is provided through the sale of medium-term notes, which are offered by prospectus worldwide on a continuous basis, and the issuance of underwritten debt. GMAC sells medium- term notes worldwide through dealer agents and directly to the public in either book-entry or physical note form for any maturity ranging from nine months to thirty years. In the U.S. and Euro markets, sales of medium-term notes totaled $8.3 billion in 1994, compared with $5.2 billion in 1993. Medium-term notes outstanding in the U.S. and Euro markets totaled $20.7 billion at December 31, 1994, a decrease of $0.4 billion from the prior-year period. In the U.S., underwritten debt issues totaling $0.7 billion were completed during 1994, compared with $1.1 billion in 1993. Underwritten debt issues outstanding in the U.S. at December 31, 1994 totaled $11.1 billion, a decrease of $1.3 billion from year-end 1993.\nOutside the United States, funding needs are met primarily by a combination of short- and medium-term loans from banks and other financial institutions. The Company also issues commercial paper and medium- and long-term debt, where cost-effective, to fund certain non-U.S. operations.\nGMAC maintains substantial bank lines of credit and sells finance receivables in the public market. At December 31, 1994, GMAC maintained or had access to approximately $25.7 billion of unused credit lines with banks worldwide, an increase of $3.9 billion from 1993. Included in the unused credit lines are a committed bank credit facility of $10 billion, and an $8.5 billion asset-backed commercial paper liquidity and receivables credit facility to a non- consolidated special purpose entity established to issue asset- backed commercial paper. Effective January 25, 1995, the special purpose entity's credit facility was increased by $2.0 billion to $10.5 billion. In addition, GMAC has $4.8 billion in committed bank credit facilities to support the funding needs of the Company's international subsidiaries.\nThe $10 billion bank credit facility includes a covenant such that, so long as the commitments remain in effect or any amount is owing to any lender under such commitments, the ratio of consolidated debt to total stockholder's equity as of the last day of any fiscal year shall not exceed 11.0:1. With regard to such covenant, the year-end ratio of total borrowings to equity capital was 8.4:1, compared with 8.0:1 at year-end 1993.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nAs discussed in Note 3 in the Notes to the Financial Statements, retail receivables were sold through special purpose bankruptcy- remote subsidiaries. Net proceeds from these sales totaled $3.5 billion, $13.1 billion and $11.2 billion during 1994, 1993 and 1992, respectively. Sales of wholesale receivables, sold through a special purpose bankruptcy-remote subsidiary, resulted in net proceeds of $2.6 billion in 1994. GMAC continues to service sold receivables for a fee and earns other related ongoing income. The subsidiaries generally retain a subordinated or restricted cash interest in the total receivable pools, which are included in other earning assets as due and deferred from receivable sales. Such subsidiaries also retain limited recourse for credit losses in the underlying receivables to the extent of their investments. These special purpose subsidiaries are consolidated for financial reporting purposes, while the transfer of underlying assets to the issuing trusts and subsequent sale of securities to investors represents a sale for financial reporting purposes. New Center Asset Trust (NCAT), a non-consolidated limited-purpose business trust was established in 1993 to issue asset-backed commercial paper. Pursuant to an administration agreement, GMAC acts as administrator for NCAT. NCAT enables the Company to diversify funding sources, establish incremental liquidity, and achieve cost savings (relative to its other funding alternatives) by accessing both the A-1+\/P-1 and A-1\/P-1 commercial paper markets. NCAT purchases certain qualifying asset-backed securities from special purpose subsidiaries of GMAC and finances the purchases through the issuance of commercial paper and equity certificates, virtually all of which have been sold to unrelated third parties.\nThe scope of GMAC's capability to tap the capital markets for unsecured debt is linked to both its term debt and commercial paper ratings. This is particularly true with respect to the Company's commercial paper ratings. Security ratings are intended to provide guidance to investors in determining the credit risk associated with particular securities based on current information obtained by the rating organizations from the Company or other sources that such organizations consider to be reliable. Lower ratings generally result in higher borrowing costs as well as reduced access to capital markets. A security rating is not a recommendation to buy, sell, or hold securities and is subject to revision or withdrawal at any time by the assigning rating organization. Each rating should be evaluated independently of any other rating.\nSubstantially all of the Company's short-, medium-, and long-term debt has been rated by four nationally recognized statistical rating organizations. As of March 14, 1995, all of the latest ratings assigned were within the investment grade category.\nDuff & Phelps Credit Rating Co. (D&P), has assigned a rating of A- to the senior debt of the Company, the seventh highest among ten investment grade ratings available, indicating adequate likelihood of timely payment of principal and interest. The Company's commercial paper has received a rating of D-1 from D&P, the second highest of five investment grade ratings available, signifying a very high certainty of timely payment based on excellent liquidity factors and good fundamental protection factors.\nFitch Investors Service, Inc. (Fitch), has assigned ratings of A- and to the Company's senior debt and commercial paper, the seventh and second highest among ten and four investment grade\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nratings available, respectively. The A- rating is assigned by Fitch to bonds considered to be of high credit quality with the obligor's ability to pay interest and repay principal considered to be strong. The rating is assigned to short-term issues which possess a very strong credit quality based primarily on the existence of liquidity necessary to meet the obligation in a timely manner.\nMoody's Investors Service, Inc. (Moody's), has rated the senior debt of the Company as Baa1, eighth highest among ten investment grade ratings available, reflecting adequate protection of present interest payments and principal. Moody's has rated the Company's commercial paper as Prime-2, the second highest of three such ratings, indicating a strong ability for repayment based on sound earnings trends and coverage ratios, appropriate capitalization characteristics and adequate maintenance of alternative liquidity.\nStandard & Poor's Corporation (S&P), rates the Company's senior debt at BBB+, eighth highest of the ten investment grade ratings available for long-term debt, based on a determination of adequate capacity to pay interest and repay principal. The S&P rating for the Company's commercial paper is A-2, third highest of the four investment grade ratings available, indicating strong capacity for timely payment determined by significant safety characteristics.\nAt this date, GMAC is not under review by any of the above agencies; however, in January 1995, Standard & Poor's Corporation affirmed the current rating of the Company and its parent, General Motors Corporation (GM). In addition, Duff and Phelps Credit Rating Co. affirmed the debt and commercial paper ratings of the Company and GM on December 1, 1994.\nThe Company and its subsidiaries utilize a variety of interest rate and currency derivative financial instruments in managing its interest rate and foreign exchange exposures. GMAC is not a dealer in derivative instruments, but is an end-user of such instruments in the normal course of business. By employing derivative instruments to manage the risks of a multinational finance company, GMAC is in a better position to offer attractive, competitive financing rates to its customers. The derivative instruments utilized by the Company are relatively straightforward and involve little complexity -- centering on interest rate swaps and options (including swaptions and interest rate caps) as well as currency swaps and futures.\nIn the context of the commercial and financial transactions arising in the ordinary course of business, GMAC's policy is to primarily employ derivative instruments which reduce the risks which result from interest rate changes and exchange rate movements. Consistent with this policy, GMAC addresses interest rate and currency risks by using derivative instruments to offset a companion asset or funding obligation as well as to adjust the fixed\/floating nature of its funding position.\nThe Company does not use any of these classes of instruments for trading purposes. These instruments involve, to varying degrees, elements of credit risk in the event a counterparty should default and market risk as the instruments are subject to rate and price fluctuations. Credit risk is managed through the periodic monitoring and approval of financially sound counterparties and limiting the potential exposure to individual counterparties to predetermined notional limits. Market risk is inherently limited by\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nthe fact that the Company holds offsetting asset or liability positions. Market risk is also managed on an ongoing basis by determining and monitoring the fair value of each agreement in the portfolio. The aggregate fair value of GMAC s derivatives portfolio has varied within a narrow range over time and represents a very small percentage of the Company s $7.9 billion equity base. GMAC employs a variety of internal swap and option models, using mid-market rates, to calculate mark-to-market values of its derivative positions. Periodically, the models are validated by comparing valuations with counterparties.\nThe Company enters into interest rate swaps to achieve the desired fixed\/floating mix in its debt portfolio, similar to the way it would enter into a fixed\/floating rate debt issuance to achieve a certain funding exposure. Floating rate swaps are typically used to achieve a more cost efficient funding. Thus, any floating rate swaps are exposed to rising interest rates, but would benefit from declining rates. Conversely, any fixed rate debt issues or fixed rate swaps provide GMAC with known fixed costs, but would not provide the Company a benefit from a decline in interest rates.\nThe Company enters into currency swaps to hedge exposures related to debt denominated in a currency other than the local currency of the entity issuing the debt.\nCurrency and interest rate swaps correspond to specific fundings with matching terms and maturities. Typical maturities range from two to five years. Each swap contract incorporates one or a series of payments to be made and one or a series of payments to be received. The payments received in each rate swap mirror the payments made on the underlying funding transactions, obligating GMAC to make payments, either fixed or floating, under the swap. The Company also has portfolio interest rate swaps which are tied to the commercial paper portfolio and to the wholesale receivables portfolio, converting a floating rate exposure to a fixed exposure. Amounts due and payments relating to the portfolio swaps are offset against commercial paper interest expense or wholesale financing revenue.\nThe total notional amount of off-balance sheet instruments at December 31, 1994 and 1993, including written options of $3.2 billion and $5.3 billion, respectively, was $11.6 billion and $8.6 billion, for the respective years. Summary schedules of outstanding contracts by type and term as well as a reconciliation of the Company's interest rate and currency swap activities for the years ended December 31, 1994 and 1993, are included in Note 15 in the Notes to Financial Statements.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nCASH FLOWS\nCash provided by operating and financing activities in 1994 totaled $4,735.8 million and $3,382.5 million, respectively, excluding dividend payments totaling $875.0 million. Such cash was used in net investing activities totaling $9,933.4 million with a resultant decrease in cash and cash equivalents amounting to $2,688.6 million. The decrease in cash and cash equivalents reflects a planned reduction in the liquidity portfolio, due to continued favorable access to the capital markets, reduced net funding from sales of finance receivables and increased net investments in operating leases. In comparison, cash provided by operating and investing activities in 1993 totaled $4,901.8 million and $7,824.9 million, respectively. Such cash was utilized to reduce debt by $11,314.6 million and pay dividends to General Motors Corporation of $1,250.0 million, with the net increase in cash and cash equivalents totaling $157.0 million. Also in comparison, cash provided by operating and investing activities in 1992 amounted to $5,166.8 million and $7,231.3 million, respectively. Such cash was also used to reduce debt by $9,834.4 million, pay dividends of $1,100.0 million and increased cash and cash equivalents by $1,458.6 million.\nBORROWING COSTS\nThe U.S. bank prime rate, which began the year at 6.0%, climbed to 8.5% by year-end 1994. GMAC's cost of short-term debt in the United States increased 80 basis points during 1994, averaging 4.55%, compared to 3.75% in 1993 and 4.10% in 1992. United States medium- and long-term money costs decreased to an average of 7.49% for 1994, 34 and 78 basis points below 1993 and 1992, respectively. The composite cost of debt for United States operations averaged 6.48% in 1994, down from 6.51% in 1993 and 6.75% in 1992.\nThe Company's worldwide cost of short-term debt averaged 5.09% in 1994, compared with 4.86% in 1993 and 5.31% in 1992. Worldwide medium- and long-term money costs decreased 45 and 96 basis points from 1993 and 1992, respectively, to average 7.60% in 1994, down from 8.05% in 1993 and 8.56% in 1992. Overall cost of funds averaged 6.69% in 1994, down 25 and 61 basis points from 6.94% and 7.30% in 1993 and 1992, respectively. The decline in 1994 borrowing costs reflects a more favorable funding mix resulting from reduced medium- and long-term cost of funds as well as an increasingly positive perception of GMAC's financial position by the capital markets.\nCOLLECTION RESULTS\nDelinquency and repossession rates on retail and fleet leasing accounts serviced worldwide were relatively unchanged during 1994. Accounts past due over 30 days averaged 2.5% as a percent of accounts outstanding during 1994, unchanged from 2.5% in 1993 and slightly higher than 2.4% in 1992. Repossessions of new vehicles averaged 1.7%, unchanged from 1.7% in 1993 and improved from 2.0% in 1992, while repossessions of used vehicles increased to 2.6% from 2.3% in 1993 and 2.5% in 1992. In total, the number of repossessed vehicles decreased to 110,000 units in 1994, compared to 121,000 units in 1993 and 151,000 units in 1992.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nNet retail losses were 0.54% of total average serviced assets in 1994, as compared to 0.63% and 0.89% for the prior year and 1992, respectively. Retail losses as a percent of total serviced assets liquidated decreased to 0.85% in 1994, down from 0.97% and 1.38% in 1993 and 1992, respectively. Allowance for financing losses, including the allowance for off-balance sheet sold receivables, amounted to $756.1 million at December 31, 1994, down $99.2 million and $257.7 million from $855.3 million and $1,013.8 million at December 31, 1993 and 1992, respectively. This reduction reflects a decrease in the level of assets serviced, a net transfer to non- earning assets and improved loss experience, primarily in the United States. At this level, the loss allowance represented 1.1% of net serviced assets, down from 1.2% in 1993 and from 1.3% in 1992.\nINSURANCE OPERATIONS\nGross premiums written by Motors Insurance Corporation and its subsidiaries (MIC) totaled $1,360.9 million in 1994, up slightly from $1,343.0 million and $1,322.9 million in 1993 and 1992, respectively, while net premiums written totaled $1,211.1 million in 1994, $6.3 million higher than in 1993 and $38.3 million lower than 1992. For the year, MIC contributed $118.1 million to consolidated net income, excluding the cumulative effect of the 1994 charge for SFAS No. 112, down $72.4 million from the comparable $190.5 million reported in 1993, and down $89.0 million from the comparable $207.1 million reported in 1992, excluding the cumulative effect of the 1992 charge for SFAS No. 106. Earnings in 1994, as compared to 1993, reflect significant declines in recognized capital gains which were partially offset by improved underwriting results. Income earned in 1993, when compared to 1992, reflects unfavorable underwriting results, partially offset by higher capital gains.\nMORTGAGE OPERATIONS\nGMAC Mortgage Group continued to be one of the largest mortgage bankers in the United States. For the 1994 calendar year, loan origination, purchased mortgage servicing and correspondent loan volume totaled $16.9 billion, a decrease of $7.0 billion and $11.3 billion from 1993 and 1992, respectively, reflecting substantially reduced industry origination volume as a result of increasing interest rates.\nAt December 31, 1994, the combined mortgage servicing portfolio, including $23.6 billion of loans master-serviced by Residential Funding Corporation (RFC), was $58.7 billion, up $4.9 billion from 1993, reflecting a reduction in prepayment rates which move in the opposite direction of interest rates.\nFINANCING REVENUES\nConsolidated financing revenue totaled $9,418.8 million in 1994, up $666.8 million from 1993 but down $983.3 million from 1992. The increase from 1993 to 1994 is primarily attributable to increases in leasing revenues, resulting from continued growth in operating lease activity and greater wholesale revenue due to GMAC's resumption of dealer wholesale inventory financing formerly transacted by General Motors. This increase was partially offset by reduced lease financing revenues due to General Motors' reduction in fleet sales.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nRetail and lease financing revenue, at $2,955.0 million for 1994, was $718.4 million and $2,552.0 million lower than 1993 and 1992, respectively. Contributing to these declines were lower asset levels, primarily due to net asset liquidations through the sale of retail finance receivables since December 1990. Leasing revenue reached $4,855.7 million in 1994, compared to $3,870.9 million in 1993 and $3,527.9 million in 1992, as leasing continues to gain consumer acceptance. In 1994, wholesale and term loan financing revenue amounted to $1,608.1 million, compared with $1,207.7 million in 1993 and $1,367.2 million in 1992, with the increase primarily attributed to the aforementioned resumption of wholesale inventory financing previously transacted by General Motors as well as greater dealer inventory and higher floorplan financing rates, partially offset by sales of wholesale receivables.\nInterest and discount expense decreased to $4,230.9 million in 1994 from $4,721.2 million reported in 1993 and $5,828.6 million in 1992. The $490.3 million decrease from 1993 is primarily due to a more favorable medium- and long-term funding mix resulting from increasing positive perception of GMAC's financial position by the capital markets. The $1,107.4 million decrease from 1992 to 1993 is due to the more favorable funding mix, a general decrease in U.S. interest rates and a lower level of total borrowings.\nDepreciation expense on operating leases, primarily GMAC's SmartLease program, totaled $3,233.8 million in 1994, in comparison to $2,702.0 million in 1993 and $2,429.6 million in 1992. The continued increase was primarily attributable to successful marketing of the SmartLease program in the United States and Canada.\nNet pre-tax margin from financing operations after interest and discount and depreciation expense totaled $1,954.1 million in 1994, up $625.3 million from 1993, but down $189.8 million from 1992. The year-to-year improvement from 1993 to 1994 primarily reflects increased wholesale financing revenue and the continued acceptance and popularity of retail leasing, partially offset by reduced retail and lease financing revenue.\nNet insurance premiums earned by MIC in 1994 were relatively stable and amounted to $1,127.6 million, compared with $1,107.2 million in 1993 and $1,159.7 million in 1992.\nOther income, including gains on receivable sales, as well as servicing fees and other income related to sold finance receivables, totaled $1,598.6 million for 1994, as compared to $2,624.3 million and $2,177.5 million in 1993 and 1992, respectively. The decrease since 1993 is largely due to lower interest and service fees of $532.4 million from General Motors as a result of the termination of the financing agreement whereby GM had previously assumed some dealer wholesale inventory financing. This reduction is offset by increased financing revenues on wholesale receivables. Capital gains at MIC for 1994 decreased $139.5 million and $58.4 million from 1993 and 1992, respectively, primarily reflecting non-recurring capital gains recognized in 1993.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nPre-tax gains on sold retail receivables, excluding the related limited recourse loss provision totaled $30.8 million during 1994 compared with $436.4 million for the previous year and $588.8 million in 1992. Retail receivables sales generally accelerate the recognition of income on retail contracts, net of servicing fees and other related deferrals, into the period the receivables are sold. The amount of such gains is affected by a number of factors and may create variability in quarterly earnings depending on the type and amount of receivables sold, the structure used to effect the sale, as well as the prevailing financial market conditions. This acceleration results in the pre-tax gains reflected above, and can create variability in annual earnings depending on the amount, timing and the net margin between the average yield on and all-in- cost of the sold receivables. The acceleration also reduces profit potential in future periods. Although this acceleration can significantly impact quarterly or year-to-year comparisons, it should be noted that the Company historically recognizes approximately 70% of interest and discount revenue in the first two years of a retail contract (reflecting the term of the underlying contracts, revenue recognition methods and historical prepayment experience). As such, depending on the timing of receivables sales in a given year, the net impact on annual earnings may be substantially less than the gains indicated.\nEXPENSES\nSalaries and benefits declined in 1994 to $813.7 million from $825.8 million and $854.4 million in 1993 and 1992, respectively. The lower salary costs in 1994, when compared to 1993, were a result of a lower employee population, partially offset by increased benefit costs primarily for retirement and post-retirement benefits.\nOther operating expenses, excluding salaries and benefits and insurance losses and loss adjustment expenses, totaled $1,173.1 million for 1994, $49.9 million and $127.4 million higher than the respective comparable 1993 and 1992 periods. The increase is primarily attributable to sales promotion expense and valuation adjustments related to repossessed automobiles.\nThe Company's provisions for loan losses reflect continued favorable loss experience related to its finance receivables. This experience has been affected by both an improving economy (which reduces the frequency of loss) and by a strong used car market (which reduces the severity of loss). Although the performance of all asset classes has been favorably influenced, the largest impact on loss provisions and total loss allowances is related to GMAC's retail receivables portfolio. In the United States, the Company's losses as a percent of liquidations for new retail receivables serviced dropped in 1994 to 0.78%, from 1.02% in 1993 and 1.55% in 1992.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nDue to the selective criteria employed in forming pools for receivable sales transactions, the loss performance related to sold retail receivables is better than that related to on-balance sheet receivables. The loss-to-liquidation levels for sold receivables in the United States for 1994, 1993 and 1992 equate to 0.46%, 0.49% and 0.52%, respectively. In late 1993, the Company refined its methodology for loss provisions to distinguish between the performance of on-balance sheet and off-balance sheet receivables. This resulted in a $155.1 million reclassification in the loss allowance related to sold receivables.\nOn a total Company basis, charge-offs, net of recoveries, for the 1994 calendar year amounted to $276.5 million, including sold receivables -- an improvement of $142.6 million versus 1993 and an improvement of $307.6 million versus 1992. Based on these continued improvements, the Company adjusted its allowances accordingly during 1994 which resulted in a provision for losses on financing receivables of $177.3 million, including sold receivables, $123.5 million and $193.7 million lower than 1993 and 1992, respectively. Gross charge-offs for 1994, excluding sold receivables, were $361.0 million, as compared to $437.9 million in 1993 and $695.6 million in 1992. As a result of this continued favorable loss experience, net retail losses were 0.54% of total average serviced assets in 1994, as compared to 0.63% and 0.89% for the prior year and 1992, respectively.\nAmortization of intangible assets totaled $45.5 million in 1994, compared with $141.1 million and $121.1 million in 1993 and 1992, respectively. The decrease is primarily attributable to reduced amortization of purchased mortgage servicing rights.\nUnited States, foreign and other income taxes amounted to $512.7 million for 1994, $79.0 million and $369.6 million less than 1993 and 1992, respectively. The decrease primarily reflects reduced pre-tax income and a lower effective tax rate on a consolidated basis. The two percentage point reduction in the effective tax rate between 1993 (37.6%) and 1994 (35.6%) is attributable to reductions in accruals from prior years based upon the periodic assessment of the adequacy of such accruals, while the unusually high rate of 42.0% in 1992 included a non-recurring state and local deferred tax adjustment.\nACCOUNTING STANDARDS\nIn November 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 112, Employers' Accounting for Postemployment Benefits, which established a new accounting principle for the cost of benefits provided to former or inactive employees after employment but before retirement. The Statement is effective for fiscal years beginning after December 15, 1993. The Company adopted this standard effective January 1, 1994; the after-tax unfavorable cumulative effect of this change was $7.4 million. The ongoing effect in subsequent periods is not expected to be material.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (concluded)\nIn May 1993, the FASB issued SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires a creditor to measure impairment based on the fair value of the collateral when it is determined that foreclosure is probable. It also clarifies that a creditor should evaluate the collectibility of both contractual interest and principal of all receivables when assessing the need for a loss accrual. In October 1994, the FASB issued SFAS No. 118, Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures, an amendment of FASB Statement No. 114. This Statement amended SFAS No. 114 to allow a creditor to use existing methods for recognizing interest income on an impaired loan. Both Statements apply to financial statements for fiscal years beginning after December 15, 1994. The Company adopted SFAS No. 114 effective January 1, 1994 and SFAS No. 118 retroactive to January 1, 1994. The Company's loans primarily consist of large groups of smaller- balance homogeneous loans which are collectively evaluated for impairment and to which these standards do not apply. The loans of the Company that are affected by these Statements were previously, and continue to be, carried at the lower of book value or the fair value of the collateral. There was no material impact on the consolidated financial position or results of operations as a result of adoption.\nIn May 1993, the FASB also issued SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, which addresses the accounting and reporting for investments in debt and equity securities that have readily determinable fair values. The Company's investments are predominantly categorized as \"Available- for-Sale\", reported at fair value with unrealized gains or losses reported separately (net of tax) in stockholder's equity. The two other classifications in this Statement are \"Held-to-Maturity Securities\", reported at amortized cost, and \"Trading Securities\", reported at fair value with unrealized gains or losses reported in earnings. Investments are categorized based upon the intent of the Company for which the securities were purchased. This statement is effective for fiscal years beginning after December 15, 1993. The Company adopted this standard effective January 1, 1994. The cumulative favorable effect to stockholder's equity at January 1, 1994, was $127.5 million, net of tax.\nIn October 1994, the FASB issued SFAS No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments, which requires classification of derivative financial instruments as either held or issued for trading purposes or purposes other than trading. It also requires specific disclosures about the notional amounts, nature and terms of derivative financial instruments held or issued. SFAS No. 119 amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosure of fair values within one footnote to the financial statements. This Statement is effective for fiscal years ending after December 15, 1994. The Company adopted this standard December 31, 1994 with the related disclosures reflected in Note 15 in the Notes to the Financial Statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA RESPONSIBILITIES FOR CONSOLIDATED FINANCIAL STATEMENTS\nThe following consolidated financial statements of General Motors Acceptance Corporation and subsidiaries were prepared by management, which is responsible for their integrity and objectivity. The statements have been prepared in conformity with generally accepted accounting principles and, as such, include amounts based on judgments of management. Financial information elsewhere in Part II is consistent with that in the consolidated financial statements.\nManagement is further responsible for maintaining a system of internal accounting controls, designed to provide reasonable assurance that the books and records reflect the transactions of the companies and that its established policies and procedures are carefully followed. Perhaps the most important feature in the system of control is that it is continually reviewed for its effectiveness and is augmented by written policies and guidelines, the careful selection and training of qualified personnel and a strong program of internal audit.\nDeloitte & Touche LLP, an independent auditing firm, is engaged to audit the consolidated financial statements of General Motors Acceptance Corporation and its subsidiaries and issue reports thereon. The audit is conducted in accordance with generally accepted auditing standards which comprehend the consideration of internal accounting controls and tests of transactions to the extent necessary to form an independent opinion on the financial statements prepared by management. The Independent Auditors' Report appears on the next page.\nThe Board of Directors, through its Audit Committee (the \"Committee\"), is responsible for: (1) assuring that management fulfills its responsibilities in the preparation of the consolidated financial statements and (2) engaging the independent auditors. The Committee reviews the scope of the audits and the accounting principles being applied in financial reporting. The independent auditors, representatives of management and the internal auditors meet regularly (separately and jointly) with the Committee to review the activities of each, to ensure that each is properly discharging its responsibilities and to assess the effectiveness of the system of internal accounting controls. It is management's conclusion that the system of internal accounting controls at December 31, 1994, provides reasonable assurance that the books and records reflect the transactions of the companies and that its established policies and procedures are complied with. To ensure complete independence, Deloitte & Touche LLP has full and free access to meet with the Committee, without management representatives present, to discuss the results of the audit, the adequacy of internal accounting controls and the quality of the financial reporting.\ns\/ J. M. Losh s\/ J. D. Finnegan --------------- ------------------------------------- J. Michael Losh John D. Finnegan, Executive Vice Chairman President and Chief Financial Officer\nINDEPENDENT AUDITORS' REPORT\nGeneral Motors Acceptance Corporation:\nWe have audited the Consolidated Balance Sheet of General Motors Acceptance Corporation and subsidiaries as of December 31, 1994 and 1993 and the related Consolidated Statement of Income and Net Income Retained for Use in the Business and Consolidated Statement 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, such financial statements present fairly, in all material respects, the financial position of General Motors Acceptance 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.\nAs discussed in Notes 5 and 12 to the financial statements, effective January 1, 1994 the Company changed its method of accounting for certain investments in debt and equity securities and postemployment benefits, respectively. Also, as discussed in Note 12 to the financial statements, effective January 1, 1992 the Company changed its method of accounting for postretirement benefits other than pensions.\ns\\ DELOITTE & TOUCHE LLP ------------------------ DELOITTE & TOUCHE LLP\n600 Renaissance Center Detroit, Michigan 48243-1704\nJanuary 30, 1995\nGENERAL MOTORS ACCEPTANCE CORPORATION CONSOLIDATED BALANCE SHEET\nGENERAL MOTORS ACCEPTANCE CORPORATION CONSOLIDATED STATEMENT OF INCOME AND NET INCOME RETAINED FOR USE IN THE BUSINESS\nFor the Years Ended December 31 ---------------------------------- 1994 1993 1992 ---------- ---------- ---------- (in millions of dollars) FINANCING REVENUE (Note 1) Retail and lease financing ................ $ 2,955.0 $ 3,673.4 $ 5,507.0 Leasing ................................... 4,855.7 3,870.9 3,527.9 Wholesale and term loans .................. 1,608.1 1,207.7 1,367.2 ---------- ---------- ---------- Total financing revenue ................... 9,418.8 8,752.0 10,402.1 Interest and discount ..................... (4,230.9) (4,721.2) (5,828.6) Depreciation on operating leases .......... (3,233.8) (2,702.0) (2,429.6) ---------- ---------- ---------- Net financing revenue ..................... 1,954.1 1,328.8 2,143.9 Insurance premiums earned ................. 1,127.6 1,107.2 1,159.7 Other income (Notes 3 and 13) ............. 1,598.6 2,624.3 2,177.5 ---------- ---------- ---------- NET FINANCING REVENUE AND OTHER ........... 4,680.3 5,060.3 5,481.1\nEXPENSES\nSalaries and benefits ..................... 813.7 825.8 854.4 Other operating expenses .................. 1,173.1 1,123.2 1,045.7 Insurance losses and loss adjustment expenses ................................. 1,030.9 1,096.6 987.9 Provision for financing losses (Note 2) ... 177.3 300.8 371.0 Amortization of intangible assets (Note 1) 45.5 141.1 121.1 ---------- ---------- ---------- Total expenses ............................ 3,240.5 3,487.5 3,380.1 ---------- ---------- ---------- Income before income taxes ................ 1,439.8 1,572.8 2,101.0 United States, foreign and other income taxes (Note 10) .......................... 512.7 591.7 882.3 ---------- ---------- ---------- Income before cumulative effect of accounting changes ....................... 927.1 981.1 1,218.7 Cumulative effect of accounting changes ... (7.4) -- (282.6) ---------- ---------- ---------- NET INCOME ................................ 919.7 981.1 936.1 Net income retained for use in the business at beginning of the year ................. 5,609.0 5,877.9 6,041.8 ---------- ---------- ---------- Total ..................................... 6,528.7 6,859.0 6,977.9 Cash dividends ............................ 875.0 1,250.0 1,100.0 ---------- ---------- ---------- NET INCOME RETAINED FOR USE IN THE BUSINESS AT END OF THE YEAR ....................... $ 5,653.7 $ 5,609.0 $ 5,877.9 ========== ========== ==========\nReference should be made to the Notes to Financial Statements.\nGENERAL MOTORS ACCEPTANCE CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation --------------------------- The consolidated financial statements include the accounts of General Motors Acceptance Corporation and its domestic and foreign subsidiaries (the Company).\nThe Company, a wholly-owned subsidiary of General Motors Corporation, was incorporated in 1919 under the New York Banking Law relating to investment companies.\nRevenue Recognition ------------------- In the case of finance receivables in which the face amount includes the finance charge (principally retail financing), earnings are recorded in income over the terms of the receivables using the interest method. On finance receivables in which the face amount represents the principal (principally wholesale, interest-bearing financing and fleet leasing), the interest is taken into income as earned. Certain loan origination costs are deferred and amortized to financing revenue over the life of the related loans using the interest method.\nIncome from operating leases, included in leasing revenues, is recognized as scheduled payments become due.\nSales of Receivables -------------------- The Company sells retail and wholesale receivables through special purpose subsidiaries which absorb all losses related to sold receivables to the extent of their subordinated investments, as well as certain segregated restricted cash flows. Appropriate limited recourse loss allowances associated with sold receivables are transferred from the allowance for financing losses and are included in \"Due and deferred from receivable sales, net\". Normal servicing fees on sold receivables are earned over time on a level yield basis.\nPre-tax gains on sold receivables are recorded in other income. In determining the gain or loss for each qualifying sale of retail receivables, 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. The receivables sold are removed from the balance sheet caption \"Finance receivable, net\", and the Company's retained interests in such receivables are included in \"Due and deferred from receivable sales, net\".\nAllowance for Financing Losses ------------------------------ An allowance for credit losses is generally established during the period in which receivables are acquired and is maintained in amounts considered by management to be appropriate in relation to receivables outstanding.\nLosses arising from repossession of the collateral supporting doubtful accounts are recognized upon repossession of the collateral. Repossessed collateral is recorded at estimated realizable value in other nonearning assets and adjustments to the related valuation allowance are included in operating expense. Where repossession has not been effected, losses are charged off as soon as it is determined that the collateral cannot be repossessed, generally not more than 150 days after default.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES (continued)\nNonretail finance receivables are reduced to the estimated fair value of collateral when determined to be impaired or uncollectible.\nCash Equivalents ---------------- Cash equivalents are defined as short-term, highly liquid investments with original maturities of 90 days or less.\nInsurance Operations -------------------- Insurance premiums are earned on a basis related to coverage provided over the terms of the policies. Commission costs and premium taxes incurred in acquiring new business are deferred and amortized over the terms of the related policies on the same basis as premiums are earned. Acquisition costs associated with direct mail programs are amortized over a three year period. The liability for losses includes a provision for unreported losses, based on past experience, net of the estimated salvage and subrogation recoverable.\nIntangible Assets ----------------- Intangible assets representing purchased mortgage servicing rights are being amortized over periods that generally match future net mortgage servicing revenues, while goodwill is being amortized on a straight-line basis over 40 years. Amortization is applied directly to the asset account.\nDepreciation ------------ The Company and its subsidiaries provide for depreciation of vehicles and other equipment on operating leases or in company use generally on a straight-line basis. The difference between the net book value and the proceeds of sale or salvage on items disposed of is included in income as a charge against or credit to the provision for depreciation.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES (concluded)\nFinancial Instruments --------------------- The Company is party to a variety of interest rate and foreign exchange swap agreements and options.\nThe Company accounts for interest rate swap agreements using settlement accounting as they alter the characteristics of assets or liabilities to which they are matched. The cash flows from interest rate swaps are accounted for as adjustments to interest income or expense depending on the underlying exposure. Gains and losses from terminated contracts are deferred and amortized over the remaining period of the original swap or the remaining term of the underlying instrument whichever is shorter. Open swap positions are reviewed regularly to ensure that they remain effective in managing interest rate risk. Written options (including swaptions and interest rate caps) and related premiums as well as interest rate basis swaps are marked-to-market on a current basis with the related income or expense included in other income. Portfolio swaps are identified with specific portfolios of assets or liabilities with any amounts due or payable, and amounts paid or received, offset against the related interest income or expense.\nForeign exchange swap agreements are entered into in connection with the Company's management of its foreign currency exposures and are accounted for using settlement accounting as it relates to periodic interest payments. The foreign currency gains and losses associated with these contracts offset the correlating foreign currency gains and losses related to the designated liabilities.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 2. FINANCE RECEIVABLES\nThe composition of finance receivables outstanding at December 31, 1994 and 1993 is summarized as follows: December 31 ---------------------- 1994 1993 ---------- ---------- (in millions of dollars) United States Retail ..................................... $ 23,486.8 $ 22,322.2 Wholesale .................................. 14,560.9 16,290.3 Leasing and lease financing ................ 1,613.4 2,372.1 Term loans to dealers and others ........... 3,753.6 3,984.4 ---------- ---------- Total United States ......................... 43,414.7 44,969.0 ---------- ---------- Canada Retail ..................................... 1,101.1 1,644.5 Wholesale .................................. 1,335.1 1,163.0 Leasing and lease financing ................ 671.4 673.6 Term loans to dealers and others ........... 128.0 123.1 ---------- ---------- Total Canada ................. .............. 3,235.6 3,604.2 ---------- ---------- Europe Retail ..................................... 5,340.5 4,294.1 Wholesale .................................. 3,413.8 2,942.5 Leasing and lease financing ................ 547.8 520.1 Term loans to dealers and others ........... 249.3 165.1 ---------- ---------- Total Europe ................. .............. 9,551.4 7,921.8 ---------- ---------- Other Countries Retail ..................................... 1,306.3 907.8 Wholesale .................................. 565.9 277.8 Leasing and lease financing ................ 447.5 297.6 Term loans to dealers and others ........... 106.9 99.7 ---------- ---------- Total Other Countries......... .............. 2,426.6 1,582.9 ---------- ---------- Total finance receivables ................... 58,628.3 58,077.9 ---------- ---------- Deductions Unearned income ............................ 3,309.9 3,195.1 Allowance for financing losses ............. 693.3 748.0 ---------- ---------- Total deductions ............................ 4,003.2 3,943.1 ---------- ---------- Finance receivables, net .................... $ 54,625.1 $ 54,134.8 ========== ==========\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 2. FINANCE RECEIVABLES (continued)\nRetail, lease financing and leasing receivable installments past due over 30 days amounted to $55.5 million and $79.2 million at December 31, 1994 and 1993, respectively. Installments on term loans to dealers and others past due over 30 days aggregated $70.7 million at December 31, 1994 and $82.0 million at December 31, 1993.\nThe aggregate amount of total finance receivables maturing in each of the five years following December 31, 1994, is as follows: 1995 - $34,927.5 million; 1996 - $10,672.1 million; 1997 - $7,362.8 million; 1998 - $3,875.5 million; 1999 $1,533.2 million; 2000 and thereafter - $257.2 million.\nThe following table presents an analysis of the allowance for financing losses: December 31 ---------------------- 1994 1993 1992 ---------------------- (in millions of dollars) Allowance for financing losses at beginning of the year ................. $ 748.0 $ 817.0 $1,261.0 Charge-offs ------- ------- -------- United States ......................... (310.7) (365.3) (573.6) Other Countries ....................... (50.3) (72.6) (122.0) ------- ------- -------- Total charge-offs ...................... (361.0) (437.9) (695.6) Recoveries and other ................... 116.0 74.5 139.6 Transfers to other nonearning assets ... -- (40.2) (135.0) Transfers from\/(to) sold receivables allowance ............................. 13.0 33.8 (124.0) Provisions charged to income ........... 177.3 300.8 371.0 ------- ------- -------- Allowance for financing losses at end of the year .................... $ 693.3 $ 748.0 $ 817.0 ======= ======= ========\nIn May 1993, the FASB issued SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires a creditor to measure impairment based on the fair value of the collateral when it is determined that foreclosure is probable. It also clarifies that a creditor should evaluate the collectibility of both contractual interest and principal of all receivables when assessing the need for a loss accrual. In October 1994, the FASB issued SFAS No. 118, Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures, an amendment of FASB Statement No. 114. This Statement amended SFAS No. 114 to allow a creditor to use existing methods for recognizing interest income on an impaired loan. Both Statements apply to financial statements for fiscal years beginning after December 15, 1994. The Company adopted SFAS No. 114 effective January 1, 1994 and SFAS No. 118 retroactive to January 1, 1994. The Company's loans primarily consist of large groups of smaller- balance homogeneous loans which are collectively evaluated for impairment and to which these standards do not apply. The loans of the Company that are affected by this Statement were previously, and continue to be, carried at the lower of book value or the fair value of the collateral. There was no material impact on the consolidated financial position or results of operations as a result of adoption.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 2. FINANCE RECEIVABLES (concluded)\nThe following table presents an analysis of the allowance for financing losses on impaired loans for 1994:\nDecember 31, 1994 ---------------------- (in millions of dollars) Allowance for Financing Losses at beginning of year .......................... $ 173.9 Additions ............................... 30.1 Charge-offs ............................. (69.2) ---------- Allowance for Financing Losses at end of year ................................. $ 134.8 ==========\nThe total investment in these loans was $277.8 million at December 31, 1994. The average recorded investment during 1994 was $326.0 million. The Company's policy is to recognize interest income related to impaired loans on a cash-basis.\nNOTE 3. SALE OF FINANCE RECEIVABLES\nThe Company participates in various sales of receivables programs and sold retail finance receivables through special purpose subsidiaries with principal aggregating $3.7 billion in 1994, $13.6 billion in 1993 and $12.0 billion in 1992. These subsidiaries generally retain a subordinated investment of no greater than 9% of the total receivables pool and market the remaining portion. These subordinated investments absorb losses related to sold receivables to the extent that such losses are greater than the excess cash flows from those receivables and cash reserves related to the sale transaction. Pre-tax gains relating to such sales recorded in \"Other income\" (excluding limited recourse loss provisions which generally have been provided at the time the contracts were originally acquired) amounted to $30.8 million in 1994, $436.4 million in 1993 and $588.8 million in 1992. The Company continues to service these receivables for a fee. The Company's retail finance receivable servicing portfolio amounted to $9.9 billion and $14.9 billion at December 31, 1994 and 1993, respectively.\nDuring 1994, the Company completed its first wholesale receivable sale which included floating rate term notes sold to the public and floating rate subordinated certificates and a floating rate revolving note, privately placed. Wholesale receivable sales resulted in a decrease in outstandings of $2.6 billion which comprised the Company's wholesale finance servicing portfolio at December 31, 1994. The certificates, when taken together with the reserve fund, provide credit support for the notes.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 3. SALE OF FINANCE RECEIVABLES (concluded)\nThe Company's interest in excess servicing cash flows, subordinated interest in trusts, cash deposits and other related amounts are generally restricted assets and subject to limited recourse provisions. The following is a summary of amounts included in \"Due and deferred from receivable sales, net.\" December 31 ---------------------- 1994 1993 ---------- ---------- (in millions of dollars) Excess servicing ............................ $ 392.3 $ 745.5 Other restricted amounts: Subordinated interest in trusts ............ 526.6 726.8 Cash deposits held by trusts ............... 710.8 557.5 Deferred servicing and other ................ (2.3) (64.9) Allowance for estimated credit losses on sold receivables ................................ (62.8) (107.3) ---------- ---------- Total ....................................... $ 1,564.6 $ 1,857.6 ========== ==========\nThe following table presents an analysis of the allowance for estimated credit losses on sold receivables:\nDecember 31 ---------------------------- 1994 1993 1992 ---------------------------- (in millions of dollars) Allowance for estimated credit losses at beginning of the year ...... $ 107.3 $ 196.8 $ 100.9 Transfers (to)\/from allowance for financing losses ..................... (13.0) (33.8) 124.0 Charge-offs ........................... (31.5) (55.7) (28.1) -------- -------- -------- Allowance for estimated credit losses at end of the year ................... $ 62.8 $ 107.3 $ 196.8 ======== ======== ========\nNOTE 4. INVESTMENT IN OPERATING LEASES\nOperating leases at year-end were as follows: December 31 ---------------------- 1994 1993 ---------- ---------- (in millions of dollars) Investment in operating leases Vehicles and other equipment, at cost..... $ 22,876.1 $ 15,727.9 Less: Accumulated depreciation.......... 5,066.9 4,364.4 ---------- ---------- Net investment in operating leases........... $ 17,809.2 $ 11,363.5 ========== ==========\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 4. INVESTMENT IN OPERATING LEASES (concluded)\nThe lease payments applicable to equipment on operating leases maturing in each of the five years following December 31, 1994, are as follows: 1995 - $4,864.8 million; 1996 - $3,146.2 million; 1997 - $1,309.4 million; 1998 - $130.8 million and 1999 - $5.2 million.\nNOTE 5. INVESTMENTS IN SECURITIES\nAs of January 1, 1994, the Company adopted SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. As a result, bonds, notes, certificates of deposit, other investments and preferred stocks with mandatory redemption terms are carried at market value. In prior years, these investments were carried at amortized cost. Equity securities are carried at market (fair) value for both years. The aggregate excess of market value over cost, net of related income taxes, is included as a separate component of stockholder's equity. The Company determines cost on the specific identification basis. The fair value of the financial instruments presented herein is based on quoted market prices.\nDecember 31, 1994 ---------------------------------------------- Fair Unrealized Unrealized Type of Security Cost Value Gains Losses --------------------- ---------- ---------- ---------- ---------- (in millions of dollars) Bonds, notes and other securities United States government and governmental agencies and authorities ....... $ 298.5 $ 285.0 $ 0.3 $ (13.8) States, municipalities and political subdivisions ...... 1,813.3 1,747.4 38.0 (103.9) Other .............. 1,417.0 1,387.3 4.2 (33.9) ---------- ---------- ---------- ---------- Total debt securities ......... $ 3,528.8 $ 3,419.7 $ 42.5 $ (151.6) ---------- ---------- ---------- ----------\nEquity securities ... $ 280.9 $ 472.0 $ 203.2 $ (12.1) ---------- ---------- ---------- ---------- Total investment in securities ......... $ 3,809.7 $ 3,891.7 $ 245.7 $ (163.7) ========== ========== ========== ==========\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 5. INVESTMENTS IN SECURITIES (continued)\nDecember 31, 1993 ---------------------------------------------- Fair Unrealized Unrealized Type of Security Cost Value Gains Losses --------------------- ---------- ---------- ---------- ---------- (in millions of dollars) Bonds, notes and other securities United States government and governmental agencies and authorities ....... $ 195.1 $ 206.3 $ 11.4 $ (0.2) States, municipalities and political subdivisions ...... 1,997.7 2,137.6 146.2 (6.3) Other .............. 735.9 781.0 48.3 (3.2) ---------- ---------- ---------- ---------- Total debt securities ......... $ 2,928.7 $ 3,124.9 $ 205.9 $ (9.7) ---------- ---------- ---------- ---------- Equity securities ... $ 266.2 $ 521.0 $ 270.9 $ (16.1) ---------- ---------- ---------- ---------- Total investment in securities ......... $ 3,194.9 $ 3,645.9 $ 476.8 $ (25.8) ========== ========== ========== ==========\nThe distribution of maturities of debt securities outstanding at December 31, 1994 and 1993 is summarized as follows:\nDecember 31, 1994 December 31, 1993 ---------------------- ---------------------- Fair Fair Maturity Cost Value Cost Value --------------------- ---------- ---------- ---------- ---------- (in millions of dollars) Due in one year or less ............... $ 177.6 $ 179.0 $ 168.0 $ 173.5 Due after one year through five years . 637.9 631.5 621.6 663.7 Due after five years through ten years .. 997.9 968.8 876.6 931.8 Due after ten years . 1,094.3 1,027.4 1,080.0 1,162.2 Mortgage-backed securities ......... 621.1 613.0 182.5 193.7 ---------- ---------- ---------- ---------- Total debt securities $ 3,528.8 $ 3,419.7 $ 2,928.7 $ 3,124.9 ========== ========== ========== ==========\nProceeds from the sale of debt securities amounted to $ 1,036.4 million in 1994, $2,093.4 million in 1993 and $1,690.3 million in 1992. Gross realized gains amounted to $15.0 million in 1994, $58.6 million in 1993 and $54.7 million in 1992. Gross realized losses amounted to $18.9 million in 1994, $13.3 million in 1993 and $5.4 million in 1992.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 5. INVESTMENTS IN SECURITIES (concluded)\nProceeds from the sale of equity securities amounted to $185.1 million in 1994, $258.6 million in 1993 and $232.4 million in 1992. Gross realized gains amounted to $80.5 million in 1994, $160.5 million in 1993 and $79.3 million in 1992. Gross realized losses amounted to $11.9 million in 1994, $2.3 million in 1993 and $6.3 million in 1992.\nNOTE 6. OTHER NONEARNING ASSETS\nOther nonearning assets consist of:\nDecember 31 ---------------------- 1994 1993 ---------- ---------- (in millions of dollars)\nProperty and equipment at cost............... $ 257.6 $ 249.5 Accumulated depreciation .................... ( 127.8) ( 120.2) ---------- ---------- Net property ................................ $ 129.8 $ 129.3 Nonperforming assets (net of valuation reserves) .................................. 304.8 319.5 Insurance premiums receivable ............... 209.4 224.3 Residential servicing advances and excess servicing fees ............................. 217.7 137.8 Deferred policy acquisition cost ............ 200.3 182.5 Other assets ................................ 683.9 584.6 ---------- ---------- Total ....................................... $ 1,745.9 $ 1,578.0 ========== ==========\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 7. LINES OF CREDIT WITH BANKS\nThe Company maintains four syndicated bank credit facilities in the U.S. and Europe.\nAs of December 31, 1994, syndicated bank credit facilities in the U.S. included a four year, $10.0 billion revolving credit facility, as well as an $8.5 billion 364-day asset-backed commercial paper liquidity and receivables credit facility to a non-consolidated special purpose entity established to issue asset-backed commercial paper. On January 25, 1995, the credit facility for the special purpose entity was increased by $2.0 billion to $10.5 billion. These facilities serve primarily as back-up for GMAC's unsecured and asset-backed commercial paper programs, respectively.\nIn Europe, the syndicated facilities will be used as needed to fund GMAC's financing operations in line with the Company's historical reliance on bank debt outside the U.S. and Canada. In this regard, the syndicated facilities include a four year, $500 million revolving credit facility to GMAC International Finance in the Netherlands and a 400 million pound sterling revolving credit facility to GMAC (UK) plc.\nWith respect to the $10 billion revolving credit facility, GMAC has agreed to a covenant such that, so long as the commitments remain in effect or any amount is owing to any lender under such commitments, the ratio of consolidated debt to total stockholder's equity at the last day of any fiscal quarter shall not exceed 11.0:1. At December 31, 1994 and 1993, this ratio amounted to 8.4:1 and 8.0:1, respectively.\nInclusive of these syndicated agreements, credit facilities maintained worldwide totaled $34,007.6 million at December 31, 1994, compared to $29,203.2 million at December 31, 1993. Facilities available for use as commercial paper back-up in the United States amounted to $18,505.0 million and $15,000.0 million at December 31, 1994 and 1993, respectively, all of which were unused. GMAC Mortgage had $965.0 million of bank lines of credit at December 31, 1994, compared with $1,255.0 million at December 31, 1993, which are utilized in the normal course of business. Of these lines, $465.0 million and $480.0 million were unused at December 31, 1994 and 1993, respectively.\nCredit facilities supporting operations in Canada, Europe, Latin America and Asia Pacific totaled $14,537.6 million at December 31, 1994 and $12,948.2 million at December 31, 1993, of which $6,682.1 million and $6,314.3 million were unused at December 31, 1994 and 1993, respectively. As of December 31, 1994, the committed and uncommitted portion of such credit facilities totaled $4,812.1 million and $9,725.5 million, respectively. As of December 31, 1993, the committed and uncommitted portion of such credit facilities totaled $4,350.2 million and $8,598.0 million, respectively.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 8. NOTES, LOANS AND DEBENTURES PAYABLE WITHIN ONE YEAR\nDecember 31 ---------------------- 1994 1993 ---------- ---------- (in millions of dollars) Short-term notes Commercial paper ........................... $ 18,644.4 $ 14,521.1 Master notes ............................... 500.9 467.8 Demand notes ............................... 2,542.6 2,161.0 Other ...................................... 742.2 645.5 ---------- ---------- Total principal amount ...................... 22,430.1 17,795.4 Unamortized discount ........................ (131.5) (61.6) ---------- ---------- Total ....................................... 22,298.6 17,733.8 ---------- ---------- Bank loans and overdrafts United States .............................. 552.0 823.0 Other Countries ............................ 5,271.4 4,893.6 ---------- ---------- Total ....................................... 5,823.4 5,716.6 ---------- ---------- Other notes, loans and debentures payable within one year United States: Medium-term notes ....................... 5,072.0 8,569.0 Other (net) ............................. 1,164.6 1,791.9 Other countries ........................... 756.2 1,273.1 ---------- ---------- Total ....................................... 6,992.8 11,634.0 ---------- ---------- Total payable within one year ............... $ 35,114.8 $ 35,084.4 ========== ==========\nCommercial paper is offered in the United States and Europe in varying terms ranging up to 270 days. The weighted average interest rates on commercial paper at December 31, 1994, 1993 and 1992 were 6.04%, 3.56% and 4.47%, respectively.\nMaster notes represent borrowings on a demand basis arranged generally under agreements with trust departments of certain banks. The weighted average interest rates on master notes at December 31, 1994, 1993 and 1992 were 6.06%, 3.30% and 4.18%, respectively.\nGMAC's Variable Rate Demand Note Program is made available to employees and retirees of General Motors Corporation and their participating subsidiaries and affiliates, and their immediate family members, GM dealers and their employees and affiliates, and stockholders of General Motors Corporation.\nBank loans are generally made on a demand basis. Medium-term notes are offered in the United States, Canada, Europe and Asia in varying terms ranging from more than nine months to thirty years.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 8. NOTES, LOANS AND DEBENTURES PAYABLE WITHIN ONE YEAR (concluded)\nThe above maturities denominated in currencies other than the U.S. Dollar primarily consist of Canadian Dollar ($2,173.2 million), German Mark ($2,678.2 million), Australian Dollar ($720.9 million) and United Kingdom Pound Sterling ($1,331.3 million). The Company and its subsidiaries have entered into foreign currency swap agreements to hedge exposures related to notes and loans payable in currencies other than the local currency of the debt issuing entity.\nTo achieve its desired balance between fixed and variable rate debt, the Company has entered into interest rate swap, interest rate cap and swaption agreements. The breakdown between the fixed and variable (predominately based on London Interbank Offering Rate or LIBOR) interest rate amounts based on contractual terms and after the effect of interest rate derivatives is as follows: December 31 1994 1993 ------ ------ (in millions of dollars) Debt balances based on contractual terms: ---------------------- Fixed amount .......................... $31,676.9 $32,139.3 Variable amount ....................... 3,569.4 3,006.7\nDebt balances after effect of derivatives: ----------------------------- Fixed amount .......................... $31,696.7 $31,890.7 Variable amount ....................... 3,549.6 3,255.3\nOn a consolidated basis, short-term borrowing amounts during the prior three years were as follows: 1994 1993 1992 ---------- ---------- ---------- (in millions of dollars) Maximum amount outstanding at any month-end .................. $ 27,547.8 $ 28,439.4 $ 36,914.0 Average borrowings outstanding during the year ................ $ 22,989.3 $ 23,462.9 $ 30,731.1 Weighted average short-term interest rates* ................ 5.09% 4.86% 5.31% Weighted average commercial paper rates* Worldwide ..................... 4.46% 3.67% 4.33% United States ................. 4.37% 3.44% 4.01%\n* Rates have been determined by relating short-term interest costs for each year to the daily average dollar amounts outstanding.\nDerivative activities resulted in interest expense increases of $5.8 million, $2.2 million and $1.2 million for the years ended December 31, 1994, 1993 and 1992, respectively. The effect of these transactions is not included in the above weighted average borrowing rates and were basis point increases of two and one for 1994 and 1993, respectively, and less than one basis point for 1992.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 9. NOTES, LOANS AND DEBENTURES PAYABLE AFTER ONE YEAR Weighted average interest rates at December 31 Maturity December 31, 1994 1994 1993 --------------------------- ----------------- ---------- ---------- NOTES, LOANS AND DEBENTURES (in millions of dollars) United States currency 1995 ..................... -- $ -- $ 6,040.1 1996 ..................... 7.0% 8,588.5 5,173.1 1997 ..................... 7.0% 6,539.7 4,391.6 1998 ..................... 6.7% 2,048.3 1,455.7 1999 ..................... 7.1% 3,209.1 1,600.0 2000 ..................... 8.0% 1,443.1 1,050.1 2001 - 2005 .............. 8.5% 2,703.3 2,399.0 2005 - 2010 .............. 8.9% 500.0 500.0 2011 - 2015 .............. 11.0% 1,077.2 1,077.2 2016 - 2049 .............. 7.8% 375.0 375.0 ---------- ---------- Total United States currency 26,484.2 24,061.8 Other currencies 1995 - 2004 .............. 7.2% 5,844.9 4,442.4 ---------- ---------- Total notes, loans and debentures ............... 32,329.1 28,504.2 Unamortized discount ...... (789.5) (815.4) ---------- ---------- Total notes, loans and debentures payable after one year ................. $ 31,539.6 $ 27,688.8 ========== ========== The aggregate principal amounts of notes, loans and debentures with terms of more than one year from dates of issue, maturing in each of the five years following December 31, 1994, are as follows: 1996 - $11,186.7 million; 1997 - $8,403.3 million; 1998 - $3,075.9 million; 1999 - $3,840.4 million; and 2000 - $1,454.4 million.\nThe above maturities which are denominated in currencies other than the U.S. Dollar, primarily consist of the Canadian Dollar ($1,830.7 million), German Mark ($1,985.4 million), Australian Dollar ($703.8 million), Japanese Yen ($475.0 million) and United Kingdom Pound Sterling ($269.1 million). The Company and its subsidiaries have entered into foreign currency swap agreements to hedge exposures related to notes and loans payable in currencies other than the local currency of the debt issuing entity.\nThe Company has issued warrants to subscribe for up to $75 million aggregate principal amount of 7.00% Notes due August 15, 2001. The warrants are exercisable up to and including August 15, 2000.\nThe Company has issued warrants to subscribe for up to $300 million aggregate principal amount of 6.50% Notes due October 15, 2009. The warrants are exercisable up to and including October 15, 2007.\nDebt issues totaling $1,847.2 million are redeemable, at par or slightly above, at the Company's option. The debt issues are redeemable anytime until prior to their maturity dates -- the latest date being April 2016.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 9. NOTES, LOANS AND DEBENTURES PAYABLE AFTER ONE YEAR (concluded)\nThe above maturities include $1,000.0 million in notes with fixed rates and $850.0 million in notes with variable rates which provide investors the option to cause GMAC to repurchase them at specific dates through June 2005. Generally, the probability of exercising an option would increase in the event of a reduction in one or more of the Company's security ratings or, where the notes are subject to fixed interest rates, an increase in market interest rates. For purposes of the above maturities, it is assumed that no repurchase will occur.\nTo achieve its desired balance between fixed and variable rate debt, the Company has entered into interest rate swap, interest rate cap and swaption agreements. The breakdown between the fixed and variable (predominately based on London Interbank Offering Rate or LIBOR) interest rate amounts based on contractual terms and after the effect of interest rate instruments is as follows:\nDecember 31 1994 1993 ---------- ---------- (in millions of dollars) Debt balances based on contractual terms: ---------------------- Fixed amount .......................... $27,372.6 $26,730.1 Variable amount ....................... 4,956.5 1,774.1\nDebt balances after effect of derivatives: ----------------------------- Fixed amount .......................... 27,255.7 26,744.2 Variable amount ....................... $ 5,073.4 $ 1,760.0\nDerivative activities resulted in interest expense decreases of $11.0 million, $18.8 million and $11.8 million for the years ended December 31, 1994, 1993 and 1992, respectively. The effect of these transactions on the Company's weighted average borrowing rates were basis point decreases of three, seven and three for 1994, 1993 and 1992, respectively.\nNOTE 10. UNITED STATES, FOREIGN AND OTHER INCOME TAXES\nThe Company and its domestic subsidiaries join with General Motors Corporation in filing a consolidated United States Federal income tax return. The portion of the consolidated tax recorded by the Company and its subsidiaries included in the consolidated tax return generally is equivalent to the liability that would have been incurred on a separate return basis. Provisions are made for estimated United States and foreign income taxes, less available tax credits and deductions, which may be incurred on remittance of the Company's share of subsidiaries' undistributed earnings less those deemed to be indefinitely reinvested.\nDeferred income taxes reflect the impact of \"temporary differences\" between values recorded for assets and liabilities for financial reporting purposes and values utilized for measurement in accordance with tax laws.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 10. UNITED STATES, FOREIGN AND OTHER INCOME TAXES (continued)\nThe tax effects of the primary temporary differences giving rise to the Company's deferred tax assets and liabilities for 1994 and 1993 are as follows: December 31, 1994 ---------------------- Asset Liability ---------- ---------- (in millions of dollars) Lease transactions .......................... $ -- $ 1,707.2 Provision for financing losses .............. 250.0 -- Debt transactions ........................... -- 298.1 Recognition of income on non-recourse receivables ................................ -- 92.5 Unrealized gain on securities ............... -- 17.0 Sales of finance receivables ................ -- 57.0 State and local taxes ....................... -- 145.5 Insurance loss reserve discount ............. 89.8 -- Unearned insurance premiums ................. 90.0 -- Other postretirement benefits ............... 201.5 -- Alternative minimum tax ..................... 180.3 -- Other ....................................... 76.1 274.9 ---------- ---------- Total deferred income taxes ................. $ 887.7 $ 2,592.2 ========== ==========\nDecember 31, 1993 ---------------------- Asset Liability ---------- ---------- (in millions of dollars) Lease transactions .......................... $ -- $ 1,100.5 Provision for financing losses .............. 330.6 -- Debt transactions ........................... -- 332.2 Recognition of income on non-recourse receivables ................................ -- 179.5 Unrealized gain on securities ............... 88.5 Sales of finance receivables ................ 29.1 -- State and local taxes ....................... -- 126.5 Insurance loss reserve discount ............. 85.6 -- Unearned insurance premiums ................. 82.1 -- Other postretirement benefits ............... 182.4 -- Other ....................................... 150.1 225.9 ---------- ---------- Total deferred income taxes ................. $ 859.9 $ 2,053.1 ========== ==========\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 10. UNITED STATES, FOREIGN AND OTHER INCOME TAXES (concluded)\nThe significant components of income tax expense are as follows:\nFor the Years Ended December 31 ---------------------------------- 1994 1993 1992 ---------- ---------- ---------- (in millions of dollars) Income taxes estimated to be currently payable\/(refundable) United States Federal .......... $ (129.5) $ 32.9 $ 535.9 Foreign ........................ 147.3 162.8 125.8 United States state and local .. (31.3) 28.9 63.8 ---------- ---------- ---------- Total income taxes payable\/ recoverable currently .......... (13.5) 224.6 725.5 ---------- ---------- ---------- Deferred income taxes: United States Federal .......... 352.9 343.7 10.7 Foreign ........................ 104.1 (3.0) 55.1 United States state and local .. 69.2 26.4 91.0 ---------- ---------- ---------- Total deferred income taxes (credits) ...................... 526.2 367.1 156.8 ---------- ---------- ---------- Income tax expense .............. $ 512.7* $ 591.7 $ 882.3* ========== ========== ==========\nIncome tax provisions recorded by the Company differ from the computed amounts developed by applying the statutory United States Federal income tax rate to income before income taxes. The following schedule reconciles the U.S. statutory income tax rate to the actual income tax rate recorded by the Company:\nFor the Years Ended December 31 ---------------------------------- 1994 1993 1992 ---------- ---------- ----------\nUnited States Federal statutory income tax rate.................. 35.0% 35.0% 34.0% Effect of (in percentage points) State and local income taxes .... 1.7 2.8 6.3 Tax exempt interest and dividends received which are not fully taxable .................. (2.5) (1.9) (1.2) Adjustment to U.S. taxes on foreign income ................. 0.9 3.4 0.4 Foreign income tax rate differential .................. 2.3 (.4) 1.9 Other ........................... (1.8) (1.3) 0.6 ---------- ---------- ---------- Effective tax rate ............... 35.6%* 37.6% 42.0%* ========== ========== ========== ----------\n* Excludes cumulative effects of changes in accounting principles.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 11. PENSION PROGRAM\nThe Company and certain of its subsidiaries participate in various pension plans of General Motors Corporation and its domestic and foreign subsidiaries, which cover substantially all of their employees. Benefits under the plans are generally related to an employee's length of service, salary and, where applicable, contributions. GMAC Mortgage Corporation and NAVCO Corp., two wholly-owned subsidiaries, have separate retirement plans which provide for pension payments to their eligible employees upon retirement. Pension expense of the Company and its subsidiaries amounted to $17.6 million in 1994, $38.9 million in 1993 and $3.4 million in 1992.\nDuring 1992, the Company offered voluntary early retirement to certain employees. Under the provision of SFAS No. 88, Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, this early retirement opportunity resulted in a 1992 expense of $51.5 million.\nNOTE 12. OTHER POSTRETIREMENT BENEFITS\nThe Company and certain of its subsidiaries participate in various postretirement medical, dental, vision and life insurance plans of General Motors Corporation. These benefits are funded as incurred from the general assets of the Company.\nIn November 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 112, Employers' Accounting for Postemployment Benefits, which established a new accounting principle for the cost of benefits provided to former or inactive employees after employment but before retirement. The Statement is effective for fiscal years beginning after December 15, 1993. The Company adopted this standard effective January 1, 1994; the after-tax unfavorable cumulative effect of this change was $7.4 million.\nIn December 1990, the FASB issued SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, which requires the accrual of future retiree benefit costs over the active service period of employees to the date of full eligibility for such benefits. The Company elected to adopt this standard effective January 1, 1992. The unfavorable cumulative effect of this accounting change as of January 1, 1992, was $282.6 million (net-of- tax). Prior years financial statements have not been restated.\nThe Company accrues postretirement benefit costs over the active service period of employees to the date of full eligibility for such benefits. The Company has provided for certain amounts associated with estimated future postretirement benefits other than pensions and characterized such amounts as \"accumulated postretirement benefit obligations,\" \"liabilities\" or \"obligations.\" Notwithstanding the recording of such amounts and the use of these terms, the Company does not admit or otherwise acknowledge that such amounts or existing postretirement benefit plans of the Company (other than pensions) represent legally enforceable liabilities of the Company.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 12. OTHER POSTRETIREMENT BENEFITS (concluded)\nThe total non-pension postretirement benefits expense of the Company amounted to $70.7 million, $65.8 million and $51.4 million in 1994, 1993, and 1992 respectively, and included the components set forth below:\nDecember 31 ---------------------------------- 1994 1993 1992 ---------- ---------- ---------- (in millions of dollars) Benefits attributed to the current year .............. $ 19.9 $ 14.7 $ 10.8 Interest accrued on benefits attributed to prior years ................... 50.8 51.1 40.6 ---------- ---------- ---------- Total non-pension postretirement benefits expense .............. $ 70.7 $ 65.8 $ 51.4 ========== ========== ==========\nNOTE 13. TRANSACTIONS WITH AFFILIATES\nUnder special rate programs sponsored by General Motors, an interest rate differential is provided as reimbursement for amounts advanced to dealers on behalf of GM. These amounts are recognized over the life of the related contracts. The earned portion of such amounts constituted 7.1% of gross revenue in 1994, compared with 6.1% in 1993 and 5.1% in 1992.\nThe Company extends loans to GM subsidiaries and affiliates. Over the periods ended November 30, 1993 and December 31, 1992, these loans included amounts provided to GM related to its dealer inventory financing. The Company serviced such GM wholesale receivables for a fee. As of December 1, 1993, the Company resumed the financing of wholesale receivables previously owned by GM. At December 31, 1994 and 1993, $1,080.5 million and $1,355.5 million, respectively, of loans to GM and affiliates were outstanding. Total interest and service fee income from these loans and receivables amounted to $117.3 million in 1994, $649.7 million in 1993 and $758.5 million in 1992.\nThe amounts due General Motors Corporation and affiliated companies at the balance sheet dates relate principally to current wholesale financing of sales of General Motors products. To the extent that wholesale settlements with General Motors are made in advance of transit time (which may occur from time-to-time due to seasonal or other factors), interest is received from General Motors.\nThe Company purchases certain vehicles which General Motors acquired from its fleet and rental customers. The cost of these vehicles held for resale, which is included in other earning assets, was $938.9 million at December 31, 1994, compared with $607.7 million at December 31, 1993.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 13. TRANSACTIONS WITH AFFILIATES (concluded)\nThe Company and certain of its subsidiaries lease capital equipment to various units of General Motors in the ordinary course of business. At December 31, 1994 and 1993, leasing receivables relating to such leases amounted to $12.2 million and $5.4 million, respectively.\nThe Company purchases data processing and communications services from Electronic Data Systems Corporation, a subsidiary of General Motors Corporation. Such purchases, which are included in operating expenses, amounted to $268.8 million in 1994, compared with $272.5 million in 1993 and $266.6 million in 1992.\nInsurance premiums earned in 1994, 1993 and 1992 include $278.3 million, $322.1 million and $390.8 million, respectively, earned by Motors Insurance Corporation on certain insurance coverages provided to General Motors.\nNOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe Company has developed the following fair value estimates by utilization of available market information or other appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value, so the estimates are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange. The effect of using different market assumptions and\/or estimation methodologies may be material to the estimated fair value amounts.\nFair value information presented herein is based on information available at December 31, 1994 and 1993. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been updated since those dates and, therefore, the current estimates of fair value at dates subsequent to December 31, 1994 and 1993 may differ significantly from these amounts. The estimated fair value of financial instruments held by the Company, for which it is practicable to estimate that value, were as follows:\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)\nBalance sheet financial instruments:\n1994 1993 ---------------------- ---------------------- Estimated Estimated Book Fair Book Fair Value Value Value Value ---------- ---------- ---------- ---------- (in millions of dollars) Assets Cash and cash equivalents ....... $ 1,339.5 $ 1,339.5 $ 4,028.1 $ 4,028.1 Investments in securities ........ 3,891.7 3,891.7 3,449.7 3,645.9 Finance receivables.. 54,625.1 54,446.5 54,134.8 54,906.4 Other earning assets. 1,080.5 1,091.3 1,355.5 1,382.8 Real estate mortgages held for resale ... 1,244.0 1,244.0 1,827.5 1,827.5 held as investing . 920.6 920.6 -- -- excess servicing .. 156.1 156.1 89.9 89.9 Due and deferred from receivable sales... 1,564.6 1,730.9 1,857.6 2,046.1\nLiabilities Debt ................ $ 66,654.4 $ 67,199.7 $ 62,773.2 $ 64,379.3\nOff-balance sheet financial instruments: ------------------------------------------------ December 31, 1994 December 31, 1993 Contract\/ Contract\/ Notional Unrealized Notional Unrealized Amount Gain\/(Loss) Amount Gain\/(Loss) ---------- ----------- ---------- ---------- (in millions of dollars) Commitments to originate\/purchase mortgages ......... $ 689.5 $ (2.4) $ 1,795.6 $ (7.6) Commitments to sell mortgages ......... 694.1 (4.2) 2,139.0 9.6 Mortgage-related Futures ........... 4,399.0 2.5 -- -- Unused revolving credit lines to dealers ........ 400.0 -- 301.1 -- Interest rate instruments ....... 9,829.5 (68.3) 7,059.0 35.0 Foreign currency instruments (1) ... $ 1,757.1 $ 88.2 $ 1,564.9 $ (3.3)\n(1) Includes $907.0 million and $1,182.5 million in cross currency interest rate swaps with unrealized gains of $65.8 million and $1.6 million at December 31, 1994 and 1993, respectively.\nCash and Cash Equivalents ------------------------- The book value approximates fair value because of the short maturity of these instruments.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)\nInvestments in Securities ------------------------- As of January 1, 1994, the Company adopted SFAS No. 115. As a result, certificates of deposit, bonds, notes, and other temporary investments are carried at market value. In prior years, these investments were carried at amortized cost. Equity securities are carried at fair value for both years. The aggregate excess of fair value over, net of related income taxes, is included as a cost component of stockholder s equity. The fair value of the financial instruments reflected above is based on quoted market prices.\nFinance Receivables ------------------- The fair value is estimated by discounting the future cash flows using applicable spreads to approximate current rates applicable to each category of finance receivables. The carrying value of wholesale receivables and other receivables whose interest rates adjust on a short-term basis with applicable market indices (generally the prime rate) are assumed to approximate fair value either due to their short maturities or due to the interest rate adjustment feature.\nOther Earning Assets -------------------- The fair value is estimated by discounting the future cash flows using applicable spreads to approximate current rates applicable to certain categories of other earning assets.\nReal Estate Mortgages and Excess Servicing Fees ----------------------------------------------- The fair values of real estate mortgages held for sale (including warehouse lines) and loans held for investment approximated their carrying values. The fair value of excess servicing fees was determined by discounting net future cash flows at current market rates.\nDue and Deferred from Receivable Sales -------------------------------------- The fair values of retained subordinated interests in trusts and excess servicing assets (net of deferred costs) are derived by discounting expected cash flows using current market rates.\nDebt ---- The fair value of the debt payable within one year is determined by using quoted market prices, if available, or calculating the estimated value of each bank loan, note or debenture in the portfolio at the applicable rate in effect. Commercial paper, master notes, and demand notes have an original term of less than 90 days and, therefore, the carrying amount of these liabilities is considered fair value. Debt payable beyond one year has an estimated fair value based on quoted market prices for the same or similar issues or based on the current rates offered to the Company for debt with similar remaining maturities.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded)\nCommitments to Originate\/Purchase Mortgages ------------------------------------------- The fair value of commitments is estimated using quoted market prices associated with commitments to sell similar mortgages in estimated future periods.\nCommitments to Sell Mortgages ----------------------------- The fair value of commitments is estimated using quoted market prices associated with similar commitments.\nMortgage-Related Futures ------------------------ The fair value of these exchange traded Eurodollar futures contracts is determined using quoted market prices.\nUnused Revolving Credit Lines ----------------------------- The contractual value of the unused portion of inventory floorplan lines of credit extended to dealers will approximate market value since they reprice at prevailing market rates.\nInterest Rate Instruments ------------------------- The fair value of the existing interest rate swaps is estimated by discounting expected cash flows using quoted market interest rates. The fair value of the written options is estimated using quoted market prices.\nForeign Currency Instruments ---------------------------- The estimated fair value of the foreign currency swaps is derived by discounting expected cash flows using market exchange rates over the remaining term of the agreement.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT\nThe Company is a party to derivative financial instruments with off- balance-sheet risk which it uses in the normal course of business to reduce its exposure to fluctuations in interest and foreign exchange rates. The objectives of the derivative financial instruments portfolio are to manage interest rate and currency risks by offsetting a companion asset or funding obligation; adjusting fixed and floating rate funding levels. The primary classes of derivatives used by the Company are interest rate and foreign exchange swaps and options (including swaptions and interest rate caps). Those instruments involve, to varying degrees, elements of credit risk in the event a counterparty should default and market risk as the instruments are subject to rate and price fluctuations. Credit risk is managed through the periodic monitoring and approval of financially sound counterparties. Market risk is mitigated because the derivatives are generally used to hedge underlying transactions. The financial instrument transactions include some embedded options and structured interest rate swaps of which all are either marked-to-market or specifically matched, respectively. Cash receipts or payments on these agreements normally occur at periodic contractually defined intervals. The Company does not use any of these classes of derivatives for trading purposes, except for limited mortgage-related transactions entered into by its wholly- owned mortgage subsidiaries.\nInterest Rate Instruments ------------------------- The Company s financing and cash management activities subject it to market risk from exposure to changes in interest rates. To manage these exposures, the Company has entered into various financial instrument transactions. The Company s objective of entering into these transactions is to minimize interest expense while maintaining the desired level of exposure to the risk of interest rate fluctuations. Interest rate swaps are contractual agreements between the Company and another party to exchange the net difference between a fixed and floating interest rate periodically over the life of the contract without the exchange of the underlying principal amount. The Company will at times use written options (including swaptions and interest rate caps). Interest rate options such as swaptions generally permit but do not require the purchaser of the option to exchange interest payments in the future. Interest rate cap agreements provide the holder protection against interest rate movements above the established rate. In exchange for assuming this risk, the writer receives a premium at the outset of the agreement.\nThe Company uses swaps to alter its fixed and floating interest rate exposures. As such, the majority of swaps are executed as an integral element of a specific financing transaction. In a limited number of cases, swaps, matched to specific portfolios of wholesale assets or debt, are executed on a portfolio basis to achieve specific interest rate management objectives. The differential paid or received on such swaps is recorded as an adjustment to interest expense or income over the term of the underlying debt agreement or matched portfolio. Written interest rate caps, swaptions and basis swaps are marked to market with related gains and losses recognized in other income on a current basis.\nSummaries of the Company s interest rate swaps and written options by maturity and weighted average rate (predominately based on London Interbank Offering Rate or LIBOR) at December 31, 1994 and 1993, are as follows:\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)\nInterest Rate Swaps December 31, 1994 --------------------------------------------------------------- Notional GMAC GMAC Year Amount Receives Pays Due (in millions) Floating(2) Fixed -------- ------------- ----------- ----------- 1995 $ 207.8 6.59% 8.03% 1996 157.9 7.93% 4.57% 1997 33.9 8.09% 7.68% 1998 43.3 11.44% 10.50% 1999 152.0 8.77% 7.51% ------------- Subtotal $ 594.9 -------------\nGMAC GMAC Pays Receives Floating(2) Fixed ----------- ----------- 1995 $ 968.0 7.94% 7.19% 1996 651.3 8.52% 7.37%\n1997 626.2 8.42% 7.32% 1998 205.7 8.56% 7.34% 1999 245.9 8.85% 8.72% 2002 500.0 8.17% 6.67% ------------- Subtotal $ 3,197.1(3) -------------\nGMAC GMAC Pays Receives Floating(2) Floating(2) ----------- ----------- 1996 $ 250.0 8.53% 8.33% 1999 2,578.0 8.13% 8.75% ------------ Subtotal $ 2,828.0 ------------ Total $ 6,620.0(1) ============\n(1) Excludes GMAC Mortgage Corporation derivatives that are discussed under Mortgage Contracts.\n(2) An implied forward yield curve as of December 31, 1994 was utilized as a basis to estimate the weighted average variable rate of the swap over the remaining term of the swap.\n(3) Includes notional amounts for swaps with amortizing balances. The swap balances amortize in relation to expected prepayments on the principal balances of the matched assets.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)\nInterest Rate Swaps December 31, 1993 ------------------------------------------------------------------ Notional GMAC GMAC Year Amount Receives Pays Due (in millions) Floating(2) Fixed -------- ------------- ----------- ----------- 1995 $ 207.4 3.96% 8.04% 1996 152.8 4.60% 4.48% ------------- Subtotal $ 360.2 ------------- GMAC GMAC Pays Receives Floating(2) Fixed ----------- ----------- 1994 $ 550.0 3.81% 6.41% 1995 100.0 4.30% 5.38% 2002 500.0 6.27% 6.67% ------------- Subtotal $ 1,150.0 ------------- GMAC GMAC Receives Pays Floating(2) Floating(2) ----------- ----------- 1996 $ 250.0 3.88% 5.27% ------------- Subtotal $ 250.0 -------------\nTotal $ 1,760.2(1) =============\n(1) Excludes GMAC Mortgage Corporation derivatives that are discussed under Mortgage Contracts.\n(2) An implied forward yield curve as of December 31, 1993 was utilized as a basis to estimate the weighted average variable rate of the swap over the remaining term of the swap.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)\nWritten Options -----------------------------------------------------------------\nDecember 31 Year Due 1994 1993 -------- ---------- ---------- Notional Amounts (in millions of dollars) Interest Rate Caps: 1995 $ 133.8 $ 956.1 1996 300.0 300.0 1998 2,475.7 3,492.8 2000 -- 250.0 ---------- ---------- Subtotal $ 2,909.5 $ 4,998.9 ---------- ---------- Swaptions: 2000 $ 300.0 $ 300.0 ---------- ---------- Total $ 3,209.5 $ 5,298.9 ========== ==========\nForeign Currency Instruments ---------------------------- The Company s financing activities subject it to market risk from exposure to changes in foreign exchange rates. Currency swaps are used to hedge foreign exchange exposure on foreign currency denominated debt by converting the funding currency to the currency of the assets being financed. Foreign exchange swaps are legal agreements between two parties to purchase and sell a foreign currency, for a price specified at the contract date, with delivery and settlement in the future.\nThe notional maturities of currency swaps as of December 31, 1994 and 1993 are as follows:\nCurrency Swaps -------------------------------------------\nDecember 31 1994 1993 ---------- ---------- (in millions of dollars) Year Due: 1994 $ -- $ 441.2 1995 310.0 34.9 1996 329.2 201.3 1997 660.5 488.8 1998 234.7 177.9 1999 222.7 220.8 ---------- ---------- Total $ 1,757.1 $ 1,564.9 ========== ==========\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)\nA reconciliation of the Company and its subsidiaries' interest rate and currency swaps activities for the years ended December 31, 1994 and 1993, is as follows:\nInterest Rate Swaps Currency Swaps ------------------- -------------------- December 31 December 31 1994 1993 1994 1993 --------- --------- --------- --------- (in millions of dollars)\nBeginning notional amount $ 1,760.2 $ 2,056.8 $ 1,564.9 $ 957.5 Add: New contracts 5,408.9 160.2 561.3 940.2 Less: Terminated contracts -- -- -- -- Expired contracts 549.1 456.8 369.1 332.7 --------- --------- --------- --------- Ending notional amount $ 6,620.0 $ 1,760.2 $ 1,757.1 $ 1,564.9 ========= ========= ========= =========\nThe following table summarizes the notional amounts of the Company and its subsidiaries currency and interest rate swaps by major currency:\nDecember 31 1994 1993 ---------- ---------- (in millions of dollars) Currency Swaps (by currency paid): Australian dollars $ 510.4 $ 260.3 Canadian dollars 393.2 445.2 United Kingdom pounds sterling 464.9 401.0 United States dollars 258.9 278.9 Other 129.7 179.5 ---------- ---------- Total currency swaps $ 1,757.1 $ 1,564.9 ---------- ---------- Interest Rate Swaps: Canada $ 206.5 $ 150.0 United States 6,363.9 1,600.0 Other 49.6 10.2 ---------- ---------- Total interest rate swaps $ 6,620.0 $ 1,760.2 ---------- ---------- Total currency and interest rate swaps $ 8,377.1 $ 3,325.1 ========== ==========\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)\nMortgage Contracts ------------------ The Company's mortgage subsidiaries, collectively, the GMAC Mortgage Group (\"GMACMG\"), hold certain financial derivative instruments for trading purposes in accordance with approved policies. These instruments are generally mandatory and optional forward mortgage backed securities contracts and the purchase and sale of futures contracts. At December 31, 1994, the notional amounts of the purchase and sale positions on these instruments were $37.7 million and $35.0 million, respectively. The average net fair value of these instruments for 1994 and at December 31, 1994 was insignificant. The net trading gain for 1994 was $1.6 million.\nGMACMG also holds and issues various financial instruments to manage interest rate risk associated with loans held for sale and investment, mortgage-backed securities held for sale, loan commitments and prepayment risk associated with purchased mortgage servicing rights. These instruments include various mandatory and optional forward commitments, futures contracts, interest rate caps and floors, options and individually tailored swap products.\nIn an effort to manage interest rate risk, GMACMG enters into various mandatory and optional forward commitments to sell its originated and purchased first mortgage loan inventory to investment bankers, private mortgage investors, FNMA, FHLMC and GNMA, and also buys and sells futures. At December 31, 1994 and 1993, the notional amount of the forward commitments totaled $694.1 million and $2,139.0 million, respectively. Realized and unrealized amounts related to these forward commitments are considered in the lower of cost or market determination. Changes in market value related to instruments used to hedge mortgage-backed securities held for trading and interest only and principal only securities held for trading are recognized in the current period.\nIn order to reduce exposure to interest rate risk associated with the GMACMG adjustable rate mortgage loan and mortgage backed securities inventory, GMACMG entered into exchange-traded Eurodollar future contracts, which are used to hedge the funding of adjustable rate mortgage loan and mortgage backed securities inventory, and will mature in the first three quarters of 1995 in notional amounts of approximately $1.2 billion, $2.1 billion, and $1.1 billion, respectively. The contracts require the future delivery or receipt of cash based upon a specific three month LIBOR rate. The contracts' values fluctuate, with a high degree of correlation, in the opposite direction of the values of the related adjustable rate mortgage loan inventory. Gains and losses on the contracts used to reduce interest rate exposure on GMACMG's mortgage loan inventory are considered in GMACMG's lower of cost or market determination for the mortgage loan inventory. Deferred gains amounted to $2.5 million as of December 31, 1994. Gains and losses on contracts used to reduce interest rate exposure on mortgage backed securities are recognized in the current period.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (continued)\nGMACMG enters into various commitments to purchase or close first mortgage loans in the normal course of its operations. In addition, GMACMG also has outstanding commitments to lend on closed lines, primarily home equity lines of credit. Commitments to purchase or close first mortgage loans totaled $689.5 million and $1,795.6 million at December 31, 1994 and 1993, respectively. These commitment obligations are considered in conjunction with GMACMG's lower of cost or market valuation of its mortgage inventory held for sale.\nWarehouse lending involves the extension of short-term secured lines of credit to mortgage originators to finance mortgage loans until such loans are purchased by a permanent investor. Advances under the lines of credit are fully secured by the underlying mortgages and bear interest at a rate which is tied to a short-term index. At December 31, 1994 and 1993, GMACMG had unused warehouse lending commitments of $1,418.8 million and $1,072.0 million, respectively.\nGMACMG has purchased and written interest rate caps, with maturities of four to five years, in an effort to hedge short-term borrowing costs and maintain a minimum profit margin associated with certain adjustable rate loans held for investment. The notional amounts of the caps were $461.0 million and $0.0 as of December 31, 1994 and 1993, respectively. Proceeds derived from the purchased caps are recorded as an offset to interest expense in the period in which they are received. The written caps are marked to market on a current basis. As of December 31, 1994 and 1993, the market value of interest rate caps owned was $7.7 million and $0.0, respectively.\nIn an effort to minimize the effect of increased potential prepayment activity associated with purchased mortgage servicing rights GMACMG has bought interest rate floors and caps, options and individually tailored cap products. The notional amount of these instruments was $482.0 million and $0.2 million at December 31, 1994 and 1993, respectively, with maturities of one to five years. Proceeds derived from these instruments are recorded as an offset to amortization expense in the period in which they are received. As of December 31, 1994 and 1993, the market values of these instruments were $1.1 million and $ 0.2 million, respectively.\nUnused Lines of Credit ---------------------- The Company has granted revolving lines of credit to dealers with unused amounts of $400.0 million and $301.1 million at December 31, 1994 and 1993, respectively. Commitments supported by collateral, generally dealer inventories and real estate, were approximately 52% and 44% of the contract amounts at December 31, 1994 and 1993, respectively.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 15. DERIVATIVE FINANCIAL INSTRUMENTS AND RISK MANAGEMENT (concluded)\nCredit Risk ----------- These aforementioned instruments contain an element of risk in the event the counterparties are unable to meet the terms of the agreements. However, the Company minimizes the risk exposure by limiting the counterparties to those major banks and financial institutions who meet established credit guidelines. Management also reduces its credit risk for unused lines of credit by applying the same credit policies in making commitments as it does for extending loans. Management does not expect any counterparty to default on its obligations and, therefore, does not expect to incur any cost due to counterparty default. The Company does not require or place collateral for these financial instruments, except for the lines of credit.\nConcentrations of Credit Risk ----------------------------- The Company's primary business is to provide vehicle financing for GM products and GM dealers. Wholesale and dealer loan financing relates primarily to GM dealers, with collateral primarily GM vehicles (for wholesale) and GM dealership property (for loans). In wholesale financing, GMAC is also provided further protection by GM factory repurchase programs. Retail contracts and operating lease assets relate primarily to the secured sale and lease, respectively, of vehicles (primarily GM).\nIn terms of geographic concentrations as of December 31, 1994, 75.5% of GMAC's consolidated financing assets were U.S. based; 6.4% were in Canada; 15.0% were in Europe (of which 56.8% reside in Germany); 0.6% were in Latin America; and 2.5% were in Asia Pacific (of which Australia represents 81.8%). Reflecting general U.S. population patterns and GM sales activities, GMAC's five largest U.S. state concentrations, which in aggregate total 38.4% of U.S. financing assets, are as follows: 9.5% in Texas; 8.7% in California; 7.2% in Florida; 6.5% in New York; and 6.5% in Michigan.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 16. MORTGAGE BANKING\nThe Company's mortgage subsidiaries, collectively the GMAC Mortgage Group (GMACMG), performs mortgage banking activities which generally consist of the origination or acquisition of mortgage loans, the sale of such loans to investors and the continual long-term servicing of the loans. In addition, GMACMG provides short-term secured lines of credit to mortgage originators to finance mortgage loans until such loans are purchased by permanent investors (warehouse lines). The right to service loans is contracted under primary or master servicing agreements. Under primary servicing agreements, GMACMG collects the monthly principal, interest and escrow payments from individual mortgagors and performs certain accounting and reporting functions on behalf of the mortgage investors. As master servicer, GMACMG collects monthly payments from various sub-servicers and performs certain accounting and reporting functions on behalf of the mortgage investors. The servicing portfolio and its related escrow balances are not reflected in the Company's financial statements, since GMACMG does not own the mortgages or the related escrow balances. As compensation for such servicing activities, GMACMG earns a servicing fee.\nIn 1994, GMACMG began originating certain loans, primarily certain adjustable rate products, to be held for investment. In connection with this program, GMACMG utilizes various financial instruments to hedge its associated borrowing costs.\nThe cost of purchased mortgage servicing rights acquired is capitalized and amortized in proportion to and over the period of the projected net servicing income. Similarly, GMACMG capitalizes excess servicing fees on the sale of certain mortgage loans to permanent investors. Excess servicing fees represent the present value of the difference between the estimated future servicing revenues and normal servicing revenues. The deferred charge is amortized over the expected life of the servicing rights in proportion to projected servicing revenues, which approximates a level yield. Purchased mortgage servicing rights and excess servicing fee values are highly sensitive to accelerated prepayments caused by declines in interest rates. As such, GMACMG utilizes financial instruments, primarily floors and caps, options and individually tailored swap products, which increase in value during periods of declining rates. As part of its conduit mortgage banking activities, GMACMG retains subordinated and stripped mortgage-backed securities in the amount of $377.6 million and $158.3 million at December 31, 1994 and 1993, respectively, which are held at market value. On certain transactions, GMACMG will retain full or limited recourse for credit or other losses incurred by the purchaser of the loans sold. GMACMG establishes allowances for estimated future losses related to the outstanding recourse obligations which management considers adequate. In addition, GMACMG provides appropriate loss allowances on warehouse lines and other loans held as investments.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 16. MORTGAGE BANKING (concluded)\nFollowing are selected financial and statistical information of GMACMG as of December 31, 1994 and 1993:\nFor the Years Ended ---------------------- 1994 1993 ---------- ---------- (in millions of dollars) Servicing portfolio Residential ................................ $ 34,477.6 $ 30,676.4 Commercial ................................. 4,872.5 3,837.2 Master Servicing* .......................... 19,374.5 19,312.8 ---------- ---------- Total ....................................... $ 58,724.6 $ 53,826.4 ========== ==========\n* Represents loans for which GMACMG performs solely a master servicing function.\nPurchased mortgage servicing rights and excess servicing fees .................. $ 372.6 $ 281.0 ---------- ---------- Loans sold with recourse .................... $ 6,811.6 $ 10,405.7 ---------- ---------- Maximum exposure on loans sold Full recourse .............................. $ 299.9 $ 324.8 Limited recourse ........................... 703.1 882.2 ---------- ---------- Total ....................................... $ 1,003.0 $ 1,207.0 ---------- ---------- Allowance for losses on loans sold with recourse .............................. $ 18.3 $ 79.8 ---------- ----------\nThe maximum recourse exposure shown above is net of amounts reinsured with third parties which totaled $238.0 million and $215.0 million at December 31, 1994 and 1993, respectively.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 17. SEGMENT INFORMATION\nIndustry Segments ----------------- The business of the Company and its subsidiaries is comprised primarily of financing and insurance operations.\nGross revenue, income before income taxes and assets applicable to financing and insurance operations are as follows:\n1994 1993 1992 ---------- ---------- ---------- (in millions of dollars) Gross revenue Financing operations ........... $ 10,638.5 $ 10,871.2 $ 12,248.0 Insurance operations ........... 1,536.2 1,651.2 1,540.2 Eliminations (a) ............... (29.7) (38.9) (48.9) ---------- ---------- ---------- Total ........................... $ 12,145.0 $ 12,483.5 $ 13,739.3 ========== ========== ==========\nIncome before income taxes and cumulative effect of accounting changes Financing operations ........... $ 1,298.6 $ 1,324.1 $ 1,798.2 Insurance operations ........... 141.2 248.7 302.8 ---------- ---------- ---------- Total ........................... $ 1,439.8 $ 1,572.8 $ 2,101.0 ========== ========== ==========\nAssets at end of the year Financing operations ........... $ 81,208.4 $ 76,394.6 $ 88,959.9 Insurance operations ........... 4,390.7 4,415.0 3,898.9 Eliminations (b) ............... (61.7) (58.8) (50.6) ---------- ---------- ---------- Total ........................... $ 85,537.4 $ 80,750.8 $ 92,808.2 ========== ========== ==========\n(a) Primarily intersegment insurance premiums earned. (b) Intersegment insurance receivables.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 17. SEGMENT INFORMATION (concluded)\nGeographic Segments ------------------- Although the majority of its business is done in the United States, the Company also operates directly or through subsidiaries in many other countries around the world.\nGross revenue, income before income taxes and assets applicable to the Company's geographic areas of operations are as follows:\n1994 1993 1992 ---------- ---------- ---------- (in millions of dollars) Gross revenue United States .................. $ 9,069.6 $ 9,472.1 $ 10,516.7 Canada ......................... 835.3 730.8 921.9 Europe ......................... 1,973.1 2,020.6 2,030.1 Other countries ................ 278.6 264.3 271.6 Eliminations (a) ............... (11.6) (4.3) (1.0) ---------- ---------- ---------- Total ........................... $ 12,145.0 $ 12,483.5 $ 13,739.3 ========== ========== ==========\nIncome before income taxes and cumulative effect of accounting changes United States .................. $ 878.2 $ 1,166.5 $ 1,709.2 Canada ......................... 45.1 18.4 127.7 Europe ......................... 480.2 333.5 253.7 Other countries ................ 36.3 54.4 10.4 ---------- ---------- ---------- Total ........................... $ 1,439.8 $ 1,572.8 $ 2,101.0 ========== ========== ==========\nAssets at end of the year United States .................. $ 66,987.1 $ 64,755.2 $ 74,620.6 Canada ......................... 5,023.7 4,657.7 6,052.2 Europe ......................... 11,118.8 9,352.0 10,343.6 Other countries ................ 2,742.3 2,146.8 1,992.4 Eliminations (b) ............... (334.5) (160.9) (200.6) ---------- ---------- ---------- Total ........................... $ 85,537.4 $ 80,750.8 $ 92,808.2 ========== ========== ==========\n(a) Intersegment interest income. (b) Intersegment finance receivables.\nNOTE 18. COMMITMENTS AND CONTINGENT LIABILITIES\nMinimum future commitments under operating leases having noncallable lease terms in excess of one year, primarily for real property, aggregating $121.4 million, are payable $46.9 million in 1995, $31.6 million in 1996, $17.7 million in 1997, $9.2 million in 1998, $4.9 million in 1999, and $11.1 million in 2000 and thereafter. Certain of the leases contain escalation clauses and renewal or purchase options. Rental expenses under operating leases were $57.6 million in 1994, $55.4 million in 1993 and $56.3 million in 1992.\nGENERAL MOTORS ACCEPTANCE CORPORATION NOTES TO FINANCIAL STATEMENTS\nNOTE 18. COMMITMENTS AND CONTINGENT LIABILITIES (concluded)\nThere are various claims and pending actions against the Company and its subsidiaries with respect to commercial and consumer financing matters, taxes and other matters arising out of the conduct of the business. Certain of these actions are or purport to be class actions, seeking damages in very large amounts. The amounts of liability on these claims and actions at December 31, 1994 were not determinable but, in the opinion of management, the ultimate liability resulting therefrom should not have a material adverse effect on the Company's consolidated financial position or results of operations..\nNOTE 19. ISSUANCE OF COMMON STOCK\nIn July 1994, the State of New York approved an increase in the amount of authorized capital stock to $2,500,000,000, consisting of 25,000,000 shares of common stock of the par value of $100. On July 29, 1994, General Motors Corporation, the Company's sole stockholder, purchased an additional 350,000 shares of such common stock at the par value of $100.\n--------------------\nSUPPLEMENTARY FINANCIAL DATA\nSUMMARY OF CONSOLIDATED QUARTERLY EARNINGS\n1994 QUARTERS ---------------------------------------------- FIRST SECOND THIRD FOURTH ---------- ---------- ---------- ---------- (in millions of dollars) Total financing revenue ..... $ 2,163.0 $ 2,304.7 $ 2,351.5 $ 2,599.6 Interest and discount expense .................... 1,010.0 1,045.3 1,041.6 1,134.0 Net financing revenue and other income ............... 1,155.2 1,158.2 1,157.3 1,209.6 Provision for financing losses ..................... 64.1 54.8 (8.5) 66.9 Income before cumulative effect of accounting change ..................... 224.9 216.1 244.6 241.5 Cumulative effect of accounting change ..................... (7.4)* -- -- -- Net Income .................. $ 217.5 $ 216.1 $ 244.6 $ 241.5\n------------------------------------------------------------------------------ * Effective January 1, 1994, the Company adopted SFAS No.112 - Employer's Accounting for Postemployment Benefits.\n1993 QUARTERS ---------------------------------------------- FIRST SECOND THIRD FOURTH ---------- ---------- ---------- ---------- (in millions of dollars) Total financing revenue ..... $ 2,267.8 $ 2,219.8 $ 2,187.2 $ 2,077.2 Interest and discount expense .................... 1,300.0 1,221.5 1,114.1 1,085.6 Net financing revenue and other income ............... 1,267.0 1,378.9 1,313.3 1,101.1 Provision for financing losses ..................... 57.0 118.9 116.7 8.2 Net income .................. $ 284.1 $ 285.4 $ 204.8 $ 206.8 -----------------------------------------------------------------------------\n1992 QUARTERS ---------------------------------------------- FIRST SECOND THIRD FOURTH ---------- ---------- ---------- ---------- (in millions of dollars) Total financing revenue ..... $ 2,552.7 $ 2,548.9 $ 2,816.0 $ 2,484.5 Interest and discount expense .................... 1,581.6 1,470.0 1,406.3 1,370.7 Net financing revenue and other income ............... 1,343.8 1,324.6 1,422.4 1,390.3 Provision for financing losses ..................... 130.1 163.4 101.5 (24.0) Income before cumulative effect of accounting change ....... 349.1* 282.4* 296.9* 290.3 Cumulative effect of accounting change ..................... (282.6)* -- -- -- Net income .................. $ 66.5* $ 282.4* $ 296.9* $ 290.3 -----------------------------------------------------------------------------\n* Effective January 1, 1992, the Company adopted SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. First quarter income was restated for the cumulative effect of this change, and all quarters have been restated to reflect the 1992 adoption of this statement.\nSUPPLEMENTARY FINANCIAL DATA (continued)\nFIVE YEAR SUMMARY OF FINANCING OPERATIONS*\nFor the Years Ended December 31 ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ---------- (in millions of dollars) INCOME\nFinancing revenue $ 9,421.3 $ 8,754.6 $ 10,404.2 $ 11,155.9 $ 11,787.8 Interest and discount ....... (4,230.9) (4,721.2) (5,828.6) (6,844.7) (7,965.8) Depreciation on operating leases (3,233.8) (2,702.0) (2,429.6) (1,902.4) (1,387.9) ---------- ---------- ---------- ---------- ---------- Net financing revenue ......... 1,956.6 1,331.4 2,146.0 2,408.8 2,434.1 Other income ..... 1,217.2 2,116.6 1,843.8 1,872.9 1,715.6 ---------- ---------- ---------- ---------- ---------- Net financing revenue and other 3,173.8 3,448.0 3,989.8 4,281.7 4,149.7 ---------- ---------- ---------- ---------- ----------\nExpenses Salaries and benefits ....... 679.3 697.2 749.0 674.6 632.7 Other operating expenses ....... 983.2 994.9 960.4 1,066.6 907.0 Provision for financing losses 177.3 300.8 371.0 1,047.9 843.2 Amortization of intangible assets 35.4 131.0 111.2 81.5 78.4 ---------- ---------- ---------- ---------- ---------- Total expenses ... 1,875.2 2,123.9 2,191.6 2,870.6 2,461.3 ---------- ---------- ---------- ---------- ---------- Income before income taxes .... 1,298.6 1,324.1 1,798.2 1,411.1 1,688.4 United States, foreign and other income taxes .... 489.6 533.5 786.6 545.2 643.7 ---------- ---------- ---------- ---------- ---------- Income before cumulative effect of accounting changes ......... 809.0 790.6 1,011.6 865.9 1,044.7 Cumulative effect of accounting changes ......... (6.8) -- (232.8) 299.1 -- ---------- ---------- ---------- ---------- ---------- Income from financing operations ...... $ 802.2 $ 790.6 $ 778.8 $ 1,165.0 $ 1,044.7 ========== ========== ========== ========== ==========\nSUPPLEMENTARY FINANCIAL DATA (continued)\nFIVE-YEAR SUMMARY OF FINANCING OPERATIONS* (concluded)\nFor the Years Ended December 31 ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ---------- (in millions of dollars) NET ASSETS\nASSETS Cash and cash equivalents ..... $ 1,305.7 $ 3,980.6 $ 3,834.8 $ 2,396.4 $ 193.5 ---------- ---------- ---------- ---------- ---------- Earning Assets Investments in securities ..... 539.8 18.4 48.2 71.6 112.9 Finance receivables (net) .......... 54,625.1 54,134.8 57,427.3 70,335.6 79,073.3 Receivable General Motors Corporation .... 1,080.5 1,355.5 11,563.2 12,358.0 13,018.0 Other earning assets ......... 22,477.3 15,843.8 14,933.7 12,599.5 8,308.5 ---------- ---------- ---------- ---------- ---------- Total earning assets........... 78,722.7 71,352.5 83,972.4 95,364.7 100,512.7 ---------- ---------- ---------- ---------- ---------- Other assets ..... 1,180.0 1,061.5 1,152.7 1,062.9 928.6 ---------- ---------- ---------- ---------- ---------- Total assets ..... $ 81,208.4 $ 76,394.6 $ 88,959.9 $ 98,824.0 $101,634.8 ---------- ---------- ---------- ---------- ---------- LIABILITIES Notes, loans and debentures payable within one year . $ 35,114.8 $ 35,084.4 $ 41,364.4 $ 51,018.6 $ 53,715.8 ---------- ---------- ---------- ---------- ---------- Accounts payable and other liabilities General Motors Corporation and affiliated companies ...... 1,894.0 2,514.0 2,860.1 2,032.4 2,870.1 Other postretirement benefits ....... 476.8 436.9 405.8 -- -- Other ........... 5,405.6 3,991.9 3,993.0 3,873.6 3,780.6 ---------- ---------- ---------- ---------- ---------- Total accounts payable and other liabilities ..... 7,776.4 6,942.8 7,258.9 5,906.0 6,650.7 ---------- ---------- ---------- ---------- ---------- Notes, loans and debentures payable after one year .. 31,539.6 27,688.8 33,174.2 34,480.9 34,185.4 ---------- ---------- ---------- ---------- ---------- Total liabilities ..... $ 74,430.8 $ 69,716.0 $ 81,797.5 $ 91,405.5 $ 94,551.9 ---------- ---------- ---------- ---------- ---------- Net assets of financing operations ...... $ 6,777.6 $ 6,678.6 $ 7,162.4 $ 7,418.5 $ 7,082.9 ========== ========== ========== ========== ==========\n* Before elimination of intercompany amounts.\nSUPPLEMENTARY FINANCIAL DATA (continued)\nFIVE YEAR SUMMARY OF INSURANCE OPERATIONS*\nFor the Years Ended December 31 ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ---------- (in millions of dollars) INCOME\nNet premiums written Personal lines . $ 483.8 $ 458.7 $ 405.4 $ 364.0 $ 177.8 Mechanical ..... 312.7 323.2 342.0 308.2 342.1 Life and disability .... 70.7 85.7 66.0 50.1 49.2 Commercial lines, reinsurance and miscellaneous . 343.9 337.2 436.0 577.2 501.0 ---------- ---------- ---------- ---------- ---------- Net premiums written ........ 1,211.1 1,204.8 1,249.4 1,299.5 1,070.1 Changes in unearned premiums ....... (56.3) (61.3) (43.6) (72.4) (5.1) ---------- ---------- ---------- ---------- ---------- Premiums earned . 1,154.8 1,143.5 1,205.8 1,227.1 1,065.0 Investments and other income ... 381.4 507.7 334.4 291.2 272.4 ---------- ---------- ---------- ---------- ---------- Total ........... 1,536.2 1,651.2 1,540.2 1,518.3 1,337.4\nExpenses Salaries and benefits ...... 134.4 128.6 105.4 98.3 84.6 Other operating expenses ...... 282.5 203.8 134.2 111.6 78.6 Losses and loss adjustment expenses ...... 968.0 1,060.0 987.9 1,061.6 1,014.1 Amortization of intangible assets ........ 10.1 10.1 9.9 9.7 0.1 ---------- ---------- ---------- ---------- ---------- Total expenses .. 1,395.0 1,402.5 1,237.4 1,281.2 1,177.4 ---------- ---------- ---------- ---------- ---------- Income before income taxes ... 141.2 248.7 302.8 237.1 160.0 Income taxes .... 23.1 58.2 95.7 64.8 14.6 ---------- ---------- ---------- ---------- ---------- Income before cumulative effect of accounting changes ........ 118.1 190.5 207.1 172.3 145.4 Cumulative effect of accounting changes ........ (0.6) -- (49.8) 32.4 -- ---------- ---------- ---------- ---------- ---------- Income from insurance operations ..... $ 117.5 $ 190.5 $ 157.3 $ 204.7 $ 145.4 ========== ========== ========== ========== ==========\nSUPPLEMENTARY FINANCIAL DATA (concluded)\nFIVE-YEAR SUMMARY OF INSURANCE OPERATIONS* (concluded)\nFor the Years Ended December 31 ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ---------- (in millions of dollars) NET ASSETS\nASSETS\nCash ............ $ 33.8 $ 47.5 $ 36.3 $ 16.1 $ 11.6 Investments in securities ..... 3,351.9 3,431.3 3,227.7 3,263.9 2,895.2 Premiums and other receivables .... 271.1 262.5 291.4 261.7 300.2 Deferred policy acquisition cost ........... 74.5 77.0 65.5 48.5 35.9 Prepaid reinsurance premiums ....... 125.8 105.5 -- -- -- Reinsurance recoverable on unpaid insurance losses and loss adjustment expense ........ 240.2 220.3 -- -- -- Other assets .... 293.4 270.9 278.0 269.6 271.2 ---------- ---------- ---------- ---------- ---------- Total assets .... $ 4,390.7 $ 4,415.0 $ 3,898.9 $ 3,859.8 $ 3,514.1 ---------- ---------- ---------- ---------- ----------\nLIABILITIES\nUnpaid insurance losses and loss adjustment expenses ....... $ 1,563.6 $ 1,569.4 $ 1,265.8 $ 1,263.4 $ 1,235.7 Unearned insurance premiums ....... 1,422.0 1,337.4 1,174.9 1,130.5 1,054.7 Deferred federal income taxes ... (85.9) (11.3) 30.7 54.6 27.9 Other postretirement benefits ....... 97.7 88.0 80.4 -- -- Other ........... 277.2 257.8 259.5 245.0 276.5 ---------- ---------- ---------- ---------- ---------- Total liabilities .... $ 3,274.6 $ 3,241.3 $ 2,811.3 $ 2,693.5 $ 2,594.8 ---------- ---------- ---------- ---------- ---------- Net assets of insurance operations ..... $ 1,116.1 $ 1,173.7 $ 1,087.6 $ 1,166.3 $ 919.3 ========== ========== ========== ========== ==========\n* Before elimination of intercompany amounts.\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) FINANCIAL STATEMENTS.\nIncluded in Part II, Item 8 of Form 10-K.\n(a) (2) FINANCIAL STATEMENT SCHEDULES.\nAll schedules have been omitted because they are inapplicable or because the information called for is shown in the financial statements or notes thereto.\n(a) (3) EXHIBITS (Included in Part IV of this report). Page ---- 12 -- Statement of Ratio of Earnings to Fixed 75 Charges for the years 1994, 1993, 1992, 1991 and 1990.\n23.1 -- Consent of Independent Auditors. 76\n27 -- Financial Data Schedule (for SEC electronic -- filing information only).\n(b) REPORTS ON FORM 8-K.\nNo current reports on Form 8-K have been filed by the Company during the fourth quarter of 1994.\nITEMS 4, 9, 10, 11, 12 and 13 are inapplicable and have been omitted.\n--------------------\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.\nGENERAL MOTORS ACCEPTANCE CORPORATION ------------------------------------- (Registrant) By s\/ J. M. Losh ---------------------------------------- Date: March 14, 1995 (J. Michael Losh, Chairman of the Board) -------------\nPursuant to the Requirements of the Securities Exchange Act of 1934, this report has been signed below on the 14th day of March, 1995, by the following persons on behalf of the Registrant and in the capacities indicated.\nSignature Title --------- -----\ns\/ J. M. Losh ------------------------- (J. Michael Losh) Chairman of the Board of Directors\ns\/ J. R. Rines ------------------------- (John R. Rines) President and (Signing as Director Chief Executive Officer)\ns\/ J. D. Finnegan ------------------------- (John D. Finnegan) Executive Vice (Chief President and Director Financial Officer)\ns\/ G. E. Gross ------------------------ (Gerald E. Gross) Comptroller (Chief Accounting Officer)\ns\/ R. J. S. Clout ------------------------- (Richard J. S. Clout) Executive Vice President and Director s\/ J. E. Gibson ------------------------- (John E. Gibson) Executive Vice President and Director s\/ M. L. Korell ------------------------- (Mark L. Korell) Director\nSIGNATURES (concluded)\nSignature Title --------- -----\ns\/ L. J. Krain ------------------------- (Leon J. Krain) Director\ns\/ H. Kunz ------------------------- (Heidi Kunz) Director\ns\/ H. J. Pearce ------------------------- (Harry J. Pearce) Director\ns\/ W. A. Reed ------------------------- (W. Allen Reed) Director\ns\/ J. F. Smith, Jr. ------------------------- (John F. Smith, Jr.) Director\ns\/ R. L. Zarrella ------------------------- (Ronald L. Zarrella) Director\nEXHIBIT INDEX\nExhibit Number Exhibit Name ------- ------------------------------------\n12 Ratio of Earnings to Fixed Charges\n23.1 Consent of Independent Auditors, Deloitte & Touche LLP\n27 Financial Data Schedule (for SEC electronic filing information only)\nEXHIBIT 12\nGENERAL MOTORS ACCEPTANCE CORPORATION\nRATIO OF EARNINGS TO FIXED CHARGES\nFor the Years ended December 31 ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ---------- (in millions of dollars) Consolidated net income* .......... $ 927.1 $ 981.1 $ 1,218.7 $ 1,038.2 $ 1,190.1 Provision for income taxes ..... 512.7 591.7 882.3 610.0 658.3 ---------- ---------- ---------- ---------- ---------- Consolidated income before income taxes ............ 1,439.8 1,572.8 2,101.0 1,648.2 1,848.4 ---------- ---------- ---------- ---------- ---------- Fixed charges Interest, debt discount and expense ......... 4,230.9 4,721.2 5,828.6 6,844.7 7,965.8 Portion of rentals representative of the interest factor .......... 51.2 43.6 31.7 30.3 29.5 ---------- ---------- ---------- ---------- ---------- Total fixed charges 4,282.1 4,764.8 5,860.3 6,875.0 7,995.3 ---------- ---------- ---------- ---------- ---------- Earnings available for fixed charges $ 5,721.9 $ 6,337.6 $ 7,961.3 $ 8,523.2 $ 9,843.7 ========== ========== ========== ========== ==========\nRatio of earnings to fixed charges 1.33 1.33 1.35 1.23 1.23 ==== ==== ==== ==== ====\n---------- * Before cumulative effect of accounting change of ($7.4) million in 1994, ($282.6) million in 1992 and $331.5 million in 1991.\nEXHIBIT 23.1\nCONSENT OF INDEPENDENT AUDITORS\nGENERAL MOTORS ACCEPTANCE CORPORATION:\nWe consent to the incorporation by reference of our report dated January 30, 1995, appearing in this Annual Report on Form 10-K of General Motors Acceptance Corporation for the year ended December 31, 1994, in the following Registration Statements:\nRegistration Form Statement No. Description ---- ------------- ------------------------------\nS-3 33-12059, $5,000,000,000 General Motors 33-26057 and Acceptance Corporation GMAC 33-31596 Variable Denomination Adjustable Rate Demand Notes\nS-3 33-45308 and $5,000,000,000 General Motors 33-49133 Acceptance Corporation Debt Securities\nS-3 33-51381 and $10,000,000,000 General Motors 33-55799 Acceptance Corporation Medium-Term Notes\ns\/ DELOITTE & TOUCHE LLP ------------------------ DELOITTE & TOUCHE LLP\n600 Renaissance Center Detroit, Michigan 48243-1704\nMarch 13, 1995","section_15":""}
{"filename":"19731_1994.txt","cik":"19731","year":"1994","section_1":"Item 1. Business\nGENERAL\nChesapeake Corporation, a Virginia corporation organized in 1918, is a paper and packaging company, whose primary businesses are kraft products, tissue and packaging. Our operating businesses include: Chesapeake Paper Products Company and Chesapeake Forest Products Company (kraft products, building products and woodlands operations); Wisconsin Tissue Mills Inc. (commercial and industrial tissue products); Chesapeake Consumer Products Company (consumer tabletop tissue products); Chesapeake Packaging Co. (point-of-sale displays and specialty packaging, consumer graphic packaging and corrugated shipping containers); and Delmarva Properties, Inc. and Stonehouse Inc. (land development).\nChesapeake competes in a large, capital-intensive industry. Until the mid 1980s, Chesapeake's products were primarily kraft commodity products manufactured by Chesapeake Paper Products. In commodity markets, selling prices are controlled by total market supply and demand. To be successful in these markets, it is important to maximize production and minimize operating costs. Selling prices and profits for commodity products are usually cyclical and follow general economic conditions.\nDuring the past several years, Chesapeake has pursued a strategy of focusing on specialty products in markets that management believes have growth potential or in which the Company has or may be able to achieve competitive advantages. The Company's strategy for success with its specialty products is to utilize its recycling expertise creatively, to differentiate itself from its competition by producing products which are distinctive and to utilize its superior ability to respond to customers' requirements. Management believes this strategy allows the Company to achieve less cyclical and greater profits than with commodity products and to better utilize Chesapeake's strengths. During 1994, sales of specialty products were more than 60% of Chesapeake's total sales. During the three years prior to 1994, low selling prices for commodity products offset much of the benefit derived from specialty product sales. In 1994, sales prices for the paper industry recovered significantly. See \"Financial Review 1992-1994\" of the Company's 1994 Annual Report to Stockholders (the \"1994 Annual Report\"), incorporated herein by reference.\nBecause we understand the service needs of our customers, we believe we are able to provide quality products quickly and efficiently. Our decentralized management style allows quick and creative decisionmaking. Our operations are designed to be flexible to changing customer demands and business conditions.\nChesapeake's businesses are run to generate cash flow and earn an acceptable long-term return on investment for stockholders.\nOur manufacturing and converting processes are capital intensive; property, plant and equipment, including timber and timberlands, comprise approximately 64% of our total assets. Our tissue and kraft operations require major investments in paper machines, fiber preparation equipment and converting equipment. In 1992, the Company completed an eight-year $600 million capital spending program for machinery, equipment and new technology to increase production of specialty products while reducing the Company's emphasis on commodity products such as brown paperboard and bleached hardwood pulp. About one-half of these expenditures were for paper machine projects for our kraft and tissue businesses. This program also included a $100 million project for a recovery boiler, evaporators and related equipment for our kraft business. In our other businesses, we have continued to invest in specialized converting and processing equipment needed to meet our strategic goals and customer requirements. Other recent capital spending has focused on enhancing efficiency, productivity and product quality. Recent acquisitions, primarily in packaging, have benefited the Company with immediate expertise or marketing strength for our future needs and requirements.\nOur businesses are grouped into three major segments: kraft products, tissue and packaging. The information presented in \"Notes to Consolidated Financial Statements, Note 14 - Business Segment Information\" of the 1994 Annual Report is incorporated herein by reference. Information with respect to the Company's working capital is set forth under the caption \"Financial Review 1992-1994, Liquidity and Capital Structure\" of the 1994 Annual Report and is incorporated herein by reference. Information regarding the Company's anticipated capital spending is set forth under the caption \"Financial Review 1992-1994, Capital Expenditures\" of the 1994 Annual Report and is incorporated herein by reference.\nKRAFT PRODUCTS\nChesapeake's kraft products segment consists of Chesapeake Paper Products Company, our kraft products operations, and Chesapeake Forest Products Company, our woodlands and building products operations, both based in West Point, Virginia. Chesapeake Building Products Company, a wholly owned subsidiary of Chesapeake Forest Products Company, was formed in 1993 with the merger of the company's lumber division and Chesapeake Wood Treating Co.\nChesapeake Paper Products Company\nChesapeake Paper Products manufactures white top paperboard, which accounts for approximately 80% of the total paperboard product mix, kraft paperboard, kraft paper, corrugating medium and bleached hardwood pulp at its mill located in West Point, Virginia. Paperboard and corrugating medium, the outer and inner materials of a corrugated container, are sold to external and company-owned container and packaging plants. Kraft paper is sold to external converters to make bags and wrappings. Bleached hardwood pulp is sold primarily to non-pulp producing paper manufacturers which manufacture predominantly printing and writing paper. Most of our customers are located in the eastern half of the United States, primarily in the mid-Atlantic and northeastern states, where we have the advantage of lower freight rates compared to many of our competitors. We also sell to international customers, primarily in Europe, Asia and Canada. Our salesforce markets these products to integrated and independent converters and manufacturers. Total shipments from the West Point mill were 850,000 tons in 1994, 798,000 tons in 1993 and 721,000 tons in 1992.\nIn 1994, approximately 66% of the raw material for products manufactured by our kraft products mill was virgin wood fiber, with the remainder being recycled fiber recovered through our recycling system. Three company-owned recycling centers collect recycled fiber for the mill, which has the capacity to use 360,000 tons of recycled fiber annually. About 78% of the virgin wood fiber used in 1994 was purchased from wood producers or independent timberland owners and the rest was from company-owned timberlands. In addition to our three paper machines and a market pulp machine, the West Point facility includes wood storage, wood pulping, paper recycling and steam and power generation equipment.\nIn recent years much emphasis has been placed on training, problem-solving and employee involvement in all phases of the mill's operation. These factors, as well as the installation of new equipment, have enabled the mill to improve product quality and lower reject levels.\nChesapeake Forest Products Company, Woodlands Division\nChesapeake Forest Products, Woodlands Division,owns and actively manages approximately 328,000 acres of timberland located in Virginia, Maryland,and Delaware. The primary objective of our woodlands operation is to provide an adequate supply of wood at a competitive cost to our kraft products mill located at West Point. Wood comes from our company-owned lands and from independent landowners. Our foresters use environmentally sound, modern forestry methods intended to ensure a long-term, low-cost fiber supply. Our genetically superior pine seedlings, which are used in our reforestation program on company-owned land and made available to private landowners, grow quicker and provide higher quality, more uniform fibers at the time of harvest than traditional seedlings. We are actively utilizing natural reforestation techniques to generate new hardwood timber stands on company-owned and privately held land. For more than 25 years, Chesapeake has participated in research programs that have improved the quality, disease resistance and growth rate of our planted trees.\nChesapeake Building Products Company\nChesapeake Building Products operates four sawmills in Virginia and Maryland, manufacturing pine and hardwood lumber. The raw materials are provided from both company-owned timberlands and from other landowners. Our sawmill products are sold by our own salesforce to independent users.\nSubstantially all of the assets of the former Chesapeake Wood Treating Co. were conveyed to Universal Forest Products, Inc. under lease and purchase agreements in October 1993. Chesapeake Wood Treating Co. produced chemically treated pine lumber for the home improvement and residential construction markets. Net sales of this business were $85.8 million in 1993 and $97.7 million in 1992.\nTISSUE\nChesapeake's tissue segment consists of Wisconsin Tissue Mills Inc., which produces tissue for industrial and commercial markets, and Chesapeake Consumer Products Company, a converter of tissue products for the consumer market.\nWisconsin Tissue Mills Inc.\nWisconsin Tissue, acquired in 1985, manufactures napkins, tablecovers, toweling, placemats, wipers and facial and bathroom tissue for commercial and industrial markets at its paper mill and converting facilities located in Menasha, Wisconsin and Neenah, Wisconsin. Our strategy is to provide a full line of disposable products for the commercial and industrial tissue markets. Our 2,200 products are found in full-menu and fast-food restaurants, hotels, motels, clubs, health care facilities, schools and office locations and on airlines.\nThe raw material for the paper manufactured by Wisconsin Tissue is 100% recycled fiber. Four paper machines manufacture base tissue stock that is converted on over 100 specialized machines, with additional converting machines scheduled to come on-line in 1995. The Company believes that its computerized warehouse inventory and distribution systems give it an advantage over many of its competitors in product shipping efficiency and inventory control. Our tissue products are sold throughout the United States and in Canada by our own salesforce. Shipments by Wisconsin Tissue were 217,000 tons in 1994, 220,000 tons in 1993 and 211,000 tons in 1992.\nChesapeake Consumer Products Company\nThe strategic objective of Chesapeake Consumer Products, formed in 1989 from acquired companies and an internally developed product line, is to expand the marketing and distribution of tabletop tissue products and boost the nonseasonal sales volume of these products. In 1990, the product line was narrowed to focus on napkins, plates, cups, tablecovers and accessories, and in 1992 and 1993 the company reorganized the former Finess portion of the business to reduce the variety of products sold, increase operating efficiencies and lower overhead. With our narrower product focus we believe we can be successful in the highly competitive consumer products marketplace. In 1994, more consistent sales levels combined with improved operating efficiencies produced the company's first profitable year. Our consumer products are sold throughout the United States by our own salesforce and by independent representatives, and can be found in supermarkets, retail chain and specialty stores and other mass merchandisers. We have improved our manufacturing process by installing flexographic edge-to-edge printing technology, state-of-the-art napkin converting and napkin wrapping machines and adding a new warehouse and shipping area.\nPACKAGING\nChesapeake Packaging Co.\nChesapeake Packaging has three marketing thrusts: point-of-sale displays and specialty packaging, consumer graphic packaging and corrugated shipping containers.\nWe believe that our packaging group is a leader in serving the point-of-sale display and specialty packaging needs of major national consumer products companies. Through a network of regional sales and design offices, the point-of-sale group, Chesapeake Display and Packaging Company, provides creative design services to our customers to meet their promotional and permanent display needs. Our manufacturing facilities utilize modern production, assembly and packaging processes to meet our customers' stringent quality and shipment demands. We have two strategically located point-of-sale display and specialty packaging manufacturing plants and three assembly plants which provide service to customers throughout the United States.\nOur Color-Box subsidiary, the fastest growing area of our packaging segment, supplies consumer graphic packaging to customers nationwide that require attractive full litho-laminated retail packaging. The final phase of a $13 million expansion project to double the capacity of this business was completed in 1993. In January 1994, Chesapeake Packaging acquired Lawless Holding Corporation, which included Lawless Packaging and Display, a consumer graphic packaging plant in Buffalo, New York, which is now operated as the Buffalo division of Color-Box. Further expansion of Color-Box is planned for 1995, with the expected start-up of a new graphic packaging plant in Visalia, California, and installation of additional equipment at the existing Color-Box facility in Richmond, Indiana.\nEleven corrugated shipping container plants located in seven states manufacture corrugated boxes and specialty packaging for customers within each plant's geographic area. The raw materials for the packaging plants include paperboard and corrugating medium (purchased both from independent suppliers and from Chesapeake Paper Products) that are converted to make the walls of the packaging unit. Various converting equipment is used to print, cut, slot and glue the container to customer specifications. The Lawless acquisition in January 1994 included the Lawless Container Corporation corrugated container plant in North Tonawanda, New York and corrugated sheet plants in Scotia, New York, Le Roy, New York and Madison, Ohio.\nOTHER BUSINESSES\nDelmarva Properties, Inc. and Stonehouse Inc.\nDelmarva Properties develops and markets land that has potential for value greater than as timberland. Nearly all of Delmarva Properties' present land inventory of approximately 15,000 acres was formerly timberland owned by Chesapeake Forest Products. Delmarva Properties develops land in Virginia, Maryland and Delaware primarily for residential housing. Sales also include large lots and acreage for others to develop for both residential and commercial uses. A major project involves the development of a mixed-use site next to a proposed horse racing track in New Kent, Virginia.\nStonehouse Inc. is managing the planning for development of a new 7,600-acre planned community near Williamsburg, Virginia. The company is in the process of applying for required permits and approvals for this large project. While the first sales are anticipated in 1995, significant sales are not anticipated until at least the latter part of the 1990s. Most of Stonehouse's land was formerly timberland owned by Chesapeake Forest Products.\nRAW MATERIALS\nMost of the Company's raw materials are readily available at competitive prices. Currently, supplies of recycled fiber, a major raw material for our paper mills, are tight and these costs have risen significantly. See \"Financial Review 1992-1994\" of the 1994 Annual Report, incorporated herein by reference.\nENVIRONMENTAL\nThe information presented under the caption \"Financial Review 1992-1994, Environmental\" of the 1994 Annual Report is incorporated herein by reference.\nEMPLOYEES\nAs of December 31, 1994, the Company had 5,209 employees. The Company believes that its relations with its employees are good. In 1992, Wisconsin Tissue and Chesapeake Paper Products entered into five-year collective bargaining agreements with the unions representing employees at these mills. During 1994, a five-year labor contract extension was negotiated with the union representing employees at Chesapeake Paper Products. During 1994, Chesapeake Paper Products Company and Chesapeake Forest Products Company implemented an enhanced retirement program affecting about 55 employees at these operations. See \"Financial Review 1992-1994\" of the 1994 Annual Report incorporated herein by reference.\nCOMPETITION AND SEASONALITY\nWith its diversity of products, Chesapeake has many customers buying different products and is not dependent on any single customer, or group of customers, in any market segment. Longstanding relationships exist with many of our customers who place orders on a continuing basis. Because of the nature of our business, order backlog is not large. The third and fourth quarters of each year are usually the highest in sales and earnings. Our major businesses generally experience peak activity during the months of August through October.\nCompetition is intense in all business segments from much larger companies and from local and regional producers and converters. The Company believes that competitive factors in our industry preclude a meaningful estimate of the number of competitors and, except as noted, the Company's relative competitive position. The Company does not have any appreciable market share in commodity products, such as bleached hardwood pulp and brown paperboard. For this reason, the Company has de-emphasized these products to pursue specialty products that we believe will provide less pricing volatility and increased profitability. We believe that, with our strengths of customer service and competitive products, we are well positioned to compete in these specialized markets.\nRESEARCH AND DEVELOPMENT\nIn addition to forestry research programs, the Company conducts limited continuing technical research and development projects relating to new products and improvements of existing products and processes. Expenditures for research and development activities are not material.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAt year-end 1994, Chesapeake manufactured or converted paper and wood products at 38 facilities in 11 states. The information presented under \"Operating Managers and Locations\" in the 1994 Annual Report is incorporated herein by reference. The Company owns most of its production facilities, which are well maintained and in good operating condition, and are utilized at practical capacities that vary in accordance with product mixes, market conditions and machine configurations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe information presented in \"Notes to Consolidated Financial Statements, Note 10 - Litigation\" of the 1994 Annual Report is incorporated herein by reference.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nExecutive Officers of the Registrant\nThe name and age of each executive officer of the Company as of February 15, 1995, together with a brief description of the principal occupation or employment of each such person during the last five years, is set forth below. Executive officers serve at the pleasure of the board of directors and are elected at each annual organizational meeting of the board of directors.\nJ. Carter Fox (55) Chairman since 1994 Chief Executive Officer since 1980 President 1980-1995 Paul A. Dresser, Jr. (52) President since 1995 Chief Operating Officer since 1991 Executive Vice President 1990-1995 Chief Financial Officer 1981-1991 Group Vice President-Finance & Administration 1984-1990 Thomas Blackburn (43) Group Vice President-Kraft Products since 1991 President, Chesapeake Paper Products Company and Chesapeake Forest Products Company since 1991 Kraft Products-Executive Vice President 1990-1991 General Manager, Crossett, Arkansas, Georgia-Pacific Corporation 1988-1990 Andrew J. Kohut (36) Group Vice President-Finance & Strategic Development since 1995 Chief Financial Officer since 1991 Vice President-Finance 1991-1995 President and General Manager, Color-Box, Inc. 1989-1991 Senior Director-Strategic Development 1987-1989 William A. Raaths (48) Group Vice President-Tissue Products since 1995 President-Wisconsin Tissue Mills Inc. since 1995 Executive Vice President- Wisconsin Tissue Mills Inc. 1994-1995 President, Chesapeake Consumer Products Company 1989-1994 Samuel J. Taylor (55) Group Vice President-Packaging since 1988 President, Chesapeake Packaging Co. since 1988 J. P. Causey Jr. (51) Vice President, Secretary & General Counsel since 1986 John W. Kirk (48) Vice President-Strategic Development since 1992 Controller & Chief Accounting Officer 1990-1992 Controller 1981-1992 Thomas A. Smith (48) Vice President-Human Resources & Assistant Secretary since 1987\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe dividend and stock price information presented under the caption \"Recent Quarterly Results\" and the information concerning retained earnings available for dividends presented in \"Notes to Consolidated Financial Statements, Note 3 - Long-Term Debt\" of the 1994 Annual Report are incorporated herein by reference. The Company's common stock is listed on the New York Stock Exchange under the symbol - \"CSK\". As of February 28, 1995, there were 7,510 stockholders of record of the Company's common stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information for the years 1990-1994 presented under the caption \"Eleven-Year Comparative Record\" 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 Operation\nThe information presented under the caption \"Financial Review 1992-1994\" 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 the Company and its subsidiaries, including the notes thereto, and the information presented under the caption \"Recent Quarterly Results\" 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\nThe information presented under the captions \"Information Concerning Nominees\" and \"Directors Continuing in Office\" of the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held April 26, 1995 (the \"1995 Proxy Statement\") is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information presented under the captions \"Compensation of Directors\" and \"Executive Compensation\" of the 1995 Proxy Statement (excluding, however, the information presented under the subheadings \"Compensation Committee Report on Executive Compensation\" and \"Performance Graph\") is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information presented under the caption \"Security Ownership of Certain Beneficial Owners and Management\" of the 1995 Proxy Statement is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information presented under the caption \"Certain Transactions\" of the 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\na. Documents\n(i) Financial Statements\nThe consolidated balance sheet of Chesapeake 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, including the notes thereto, are presented in the Company's 1994 Annual Report and are incorporated herein by reference. The \"Report of Independent Accountants\" as presented in the Company's 1994 Annual Report, is incorporated herein by reference. With the exception of the aforementioned information, and the information incorporated by reference in numbered Items 1, 2, 3, 5, 6, 7 and 8, no other data appearing in the 1994 Annual Report is deemed to be \"filed\" as part of this Form 10-K.\n(ii) Financial Statement Schedules\nNo schedules are filed as part of this report because they are not applicable or are not required.\n(iii) Exhibits filed or incorporated by reference\nThe exhibits that are required to be filed or incorporated by reference herein are listed in the Exhibit Index found on pages 16-17 hereof. Exhibits 10.1 - 10.9 hereto constitute management contracts or compensatory plans or arrangements required to be filed as exhibits hereto.\nb. Reports on Form 8-K\nNone\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCHESAPEAKE CORPORATION (Registrant)\nFebruary 14, 1995 By \/s\/ CHRISTOPHER R. BURGESS Christopher R. Burgess Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated.\nBy \/s\/ PAUL A. DRESSER, JR. By \/s\/ WALLACE STETTINIUS Paul A. Dresser, Jr. Wallace Stettinius Director Director\nBy \/s\/ J. CARTER FOX By \/s\/ JOHN HOYT STOOKEY J. Carter Fox John Hoyt Stookey Chairman of the Board Director of Directors; President & Chief Executive Officer\nBy \/s\/ ROBERT L. HINTZ By \/s\/ RICHARD G. TILGHMAN Robert L. Hintz Richard G. Tilghman Director Director\nBy \/s\/ WILLIAM D. McCOY By \/s\/ JOSEPH P. VIVIANO William D. McCoy Joseph P. Viviano Director Director\nBy \/s\/ C. ELIS OLSSON By \/s\/ H. H. WARNER C. Elis Olsson Harry H. Warner Director Director\nBy \/s\/ JOHN W. ROSENBLUM By \/s\/ ANDREW J. KOHUT John W. Rosenblum Andrew J. Kohut Director Vice President - Finance & Chief Financial Officer\nBy \/s\/ FRANK S. ROYAL By \/s\/ CHRISTOPHER R. BURGESS Frank S. Royal Christopher R. Burgess Director Controller\nEach of the above signatures is affixed as of February 14, 1995.\nEXHIBIT INDEX\n3.1 Articles of Incorporation (filed as Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference)\n3.2 Bylaws\n4.1 Indenture, dated as of July 15, 1985, between the Registrant and Sovran Bank, N.A., as Trustee (filed as Exhibit 4.1 to Form S-3 Registration Statement No. 33-30900 and incorporated herein by reference)\n4.2 First Supplemental Indenture, dated as of September 1, 1989, to the Indenture dated as of July 15, 1985, between the Registrant and Sovran Bank, N.A., as Trustee (filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed October 9, 1990, and incorporated herein by reference)\n4.3 Rights Agreement, dated as of March 15, 1988, between the Registrant and Crestar Bank (filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K dated March 15, 1988, and incorporated herein by reference)\n4.4 Rights Agreement Amendment, dated as of August 24, 1992, between the Registrant and Harris Trust and Savings Bank, as successor rights agent (filed as Exhibit 4.4 to the Registrant's Registration Statement on Form S-8, File No. 33-56473, and incorporated herein by reference)\nThe registrant agrees to furnish to the Securities and Exchange Commission, upon request, copies of those agreements defining the rights of holders of long-term debt of the registrant and its subsidiaries that are not filed herewith pursuant to Item 601(b)(4)(iii) of Regulation S-K.\n10.1 1987 Stock Option Plan (filed as Exhibit A to the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders held April 22, 1987 and incorporated herein by reference)\n10.2 Directors' Deferred Compensation Plan (filed as Exhibit VII to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1980 and incorporated herein by reference)\n10.3 Non-Employee Director Stock Option Plan (filed as Exhibit 4.1 to Form S-8 Registration Statement No. 33-53478 and incorporated herein by reference)\n10.4 Executive Supplemental Retirement Plan (filed as Exhibit VI to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1980 and incorporated herein by reference)\n10.5 Retirement Plan for Outside Directors (filed as Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference)\n10.6 Officers' Incentive Program (filed as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference)\n10.7 Chesapeake Corporation Salaried Employees' Benefits Continuation Plan (filed as Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference)\n10.8 Chesapeake Corporation Long-Term Incentive Plan (filed as Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference)\n10.9 Chesapeake Corporation 1993 Incentive Plan (filed as Exhibit 4.1 to Form S-8 Registration Statement No. 33-67384 and incorporated herein by reference)\n11.1 Computation of Net Income Per Share of Common Stock\n13.1 Portions of the Chesapeake Corporation Annual Report to Stockholders for the year ended December 31, 1994\n18.1 Preferability letter from Coopers & Lybrand L.L.P. regarding change in accounting method\n21.1 Subsidiaries\n23.1 Consent of Coopers & Lybrand L.L.P.\n27.1 Financial Data Schedule\n99.1 Form 11-K Annual Report, Hourly Employees' Stock Purchase Plan for the plan fiscal year ended November 30, 1994","section_15":""}
{"filename":"24545_1994.txt","cik":"24545","year":"1994","section_1":"ITEM 1. Business.\n(a) General Development of Business\nFounded in 1873, Adolph Coors Company (\"ACC\" or the \"Company\"), through its subsidiary, Coors Brewing Company (\"CBC\"), produces and markets beer and other malt-based beverages. The Company's business was conducted as a partnership or sole proprietorship until 1913, when it incorporated under the laws of the State of Colorado. During the 1980s, the Company developed a number of technology-based businesses. At the end of 1992, ACC spun off its aluminum, packaging, ceramics and other technology businesses in a tax-free distribution to shareholders. The spin-off was accomplished through a dividend of the shares of common stock in a new public company, ACX Technologies, Inc. (ACXT)(NASDAQ:ACXT).\nCBC remains as the single direct subsidiary of ACC. CBC owns Coors Distributing Company, and a number of smaller subsidiaries, including Coors Transportation Company; Coors Energy Company; The Wannamaker Ditch Company; The Rocky Mountain Water Company; CBC International, Inc.; Coors Global, Inc.; and Coors Intercontinental, Inc. CBC indirectly owns, through its subsidiaries, Coors Brewing International C.V. and Coors Brewing Iberica, S.A. In 1992, substantially all of the assets of Coors Energy Company and Coors Transportation Company were sold.\n(b) Financial Information About Industry Segments\nThe Company has continuing operations in a single industry segment, the production and marketing of beer and other malt-based beverages.\n(c) Narrative Description of Business\nCoors Brewing Company - General ------------------------------- CBC is engaged in the production and marketing of high quality malt-based beverage products. CBC places a priority on higher-margin products in the premium and above-premium categories and has a number of distinctive brands that satisfy consumer demands and taste trends. The majority of CBC's sales come from U.S. markets; however, CBC is also committed to building profitable sales in international markets. Sales of malt beverage products totaled 20.4 million barrels in 1994, a 2.7% increase compared to 19.8 million barrels in 1993.\nMarketing --------- Principal products and services: There are currently 22 products in the CBC brand portfolio. CBC produces 7 premium products in the Coors family of brands, including Coors Light, Original Coors, Coors Artic Ice, Coors Artic Ice Light, Coors Extra Gold, Coors Dry and Coors Cutter, a non-alcoholic brew.\nCBC produces and markets Zima Clearmalt, an innovative malt-based beverage in the above-premium category. CBC also offers beers in the specialty, above-premium category, including the Coors seasonal beers -- which in 1994 were Winterfest, Eisbock, Weizenbier and Oktoberfest Marzen -- and a number of import or licensed products, including George Killian's Irish Red, Castlemaine XXXX and Steinlager.\nCBC also offers products in the popular-priced category: Keystone, Keystone Light, Keystone Dry, Keystone Ice and Keystone Amber Light. In target markets with a high demand for economy beers, CBC offers two value-added beers, Shulers Lager and Shulers Light. With the exception of Shulers and Shulers Light, which are in limited distribution, other Coors malt beverage products are sold in most states. A number of Coors products are exported or produced and sold in overseas markets. International sales are described in greater detail below.\nNew products\/opportunities: CBC completed the national expansion of Zima Clearmalt in the first half of 1994. In addition, Coors Artic Ice and Coors Artic Ice Light were rolled out into 54% of the U.S. by September 1994. Both ice brands were sold nationally by January 1995. These products are brewed using patented ice brewing technology licensed from Labatt Breweries of Canada.\nIn order to tap into the fast-growing popularity of special-occasion brews, UniBev Limited (Unibev), a unit of CBC that focuses on the import and specialty beer market, introduced three new seasonal beers to complement the well-established Coors Winterfest brand. Each of these beers -- Eisbock, a springtime bock; Weizenbier, a summertime wheat beer; and Oktoberfest Marzen beer -- was available in limited quantities for their respective seasons in 1994. UniBev also distributes Steinlager in the U.S. Steinlager is the number-one premium beer in New Zealand, and is distributed by Coors under license from Lion Nathan International of New Zealand.\nEarly in 1995, CBC announced the introduction of a new product, Zima Gold. Zima Gold features a distinctive taste that is full-flavored. The product is being tested with select retailers in Nebraska and Arizona, and will be rolled out nationally in time for the peak summer selling season. Also in the first quarter of 1995, CBC announced a distribution arrangement between UniBev and F.X. Matt Company of Utica, New York. UniBev will initiate a distribution test of a number of F.X. Matt's Saranac brands -- including Saranac Adirondack Amber, Saranac Golden Pilsner, Saranac Black and Tan, Saranac Black Forest and Saranac Pale Ale -- in limited markets.\nIn 1994, CBC also introduced two new Keystone line brands: Keystone Ice and Keystone Amber Light.\nBrand names, trademarks, patents and licenses: Trademarks of CBC include: Original Coors, Coors Light, Coors Artic Ice, Coors Artic Ice Light, Coors Extra Gold, Coors Dry, Coors Cutter, Zima Clearmalt, Winterfest, Eisbock, Weizenbier, Oktoberfest Marzen, Keystone, Keystone Light, Keystone Dry, Keystone Ice, Keystone Amber Light, Shulers Lager, and Shulers Light. CBC regards consumer recognition of and loyalty to its brand names and trademarks as being extremely important to the long-term success of its business. CBC also holds a number of patents on innovative processes related to can-making and can-decorating and other technical operations and derives incremental revenues from related royalties and licenses. Although CBC owns a number of patents, it does not consider its business to be dependent upon any one or related group of such patents.\nBrand performance: Coors Light is the largest selling brand in CBC's product portfolio. For the past few years, Coors Light has accounted for approximately two-thirds of CBC's total sales volume. Despite a competitive assault in 1994 on the light beer category from the proliferation of ice beers in U.S. markets, Coors Light posted another volume gain in 1994. CBC's next strongest volume growth came from its above-premium beverages, including Zima and George Killian's Irish Red. CBC also gained volume in 1994 from the introduction of Coors Artic Ice and Coors Artic Ice Light, as well as CBC's seasonal and import beers. Products in the premium and above-premium categories make up more than 87% of CBC's volume.\nDomestic sales operations: CBC's highest volume sales are in the states of California, Texas, Pennsylvania, New York and New Jersey.\nIn August 1994, CBC completed the restructuring of its field sales operations into eight field business areas (FBAs) strategically located throughout the United States and managed by newly appointed area vice presidents. The goal of each new FBA is to align CBC resources more effectively and improve CBC's competitiveness and responsiveness at retail, distributor and field marketing levels. The new structure focuses increased autonomy and bottom-line accountability in the field sales organization.\nCBC also continued its emphasis on specialty, import and licensed beer brands through UniBev, an import and specialty unit of CBC. Organized in 1993, UniBev provides CBC with a separate marketing organization dedicated to specialty brands in the U.S.\nInternational marketing\/partnerships: International markets provide significant opportunities for profitable growth, and CBC is committed to increasing its international presence. This will be accomplished through a number of alternatives, including export products, licensing agreements and joint ventures. CBC's goal in seeking international opportunities is superior financial returns to those found in the U.S. beer market. CBC's first priority is to seek on-site profitable production capability in strategic international markets.\nCBC exports its products to a number of markets outside of the United States, including American Samoa, the Bahamas, Bahrain, Bermuda, Cayman Islands, France, Greece, Guam, Ireland, Italy, Panama, Puerto Rico, St. Maarten, Singapore and the U.S. and British Virgin Islands. In addition, CBC exports its products to U.S. military bases worldwide. While export volumes do not account for a significant portion of CBC's sales, they are significantly more profitable, on a per barrel basis, than sales in U.S. markets.\nCBC has existing licensing agreements with a number of international brewers. CBC licenses Molson Breweries of Canada Limited (Molson) to brew and distribute Original Coors and Coors Light in Canada, where Coors Light is the best selling light beer. In 1992, Miller Brewing Company (Miller) increased its ownership in Molson to 20%. As a result, CBC initiated two legal actions related to its licensing agreement with Molson -- seeking to allow CBC to terminate the agreement or, alternatively, asking that Miller Brewing Company be removed as a partner in Molson. These legal actions are ongoing and have not impacted the success of CBC's brands in Canada. In Japan, Original Coors has been produced under license by Asahi Breweries Ltd. for seven years and remains one of the top foreign brands in that country.\nIn early 1994, CBC announced that it had licensed proprietary ice brewing technology from Labatt Breweries of Canada.\nIn September 1992, a joint venture between CBC and Scottish & Newcastle Breweries of Scotland began to brew and distribute Coors Extra Gold in the United Kingdom. Coors Extra Gold was introduced in Scotland and northwest England in August 1992, and in 1993 distribution was expanded into the remainder of Great Britain. In June of 1993, CBC announced the launch of Coors Extra Gold into Ireland; the brand is brewed by Scottish & Newcastle in the U.K. and distributed under license by Murphy Brewery Ireland Ltd., Dublin, a subsidiary of Heineken, N.V. Coors Extra Gold was rated best for overall Best Draught Lager at the 1994 Brewing Industry International Awards in England.\nIn 1993, CBC announced that it would produce and market Castlemaine XXXX (an Australian lager) in the U.S. through a joint venture with Lion Nathan International of New Zealand. In 1994, CBC expanded its relationship with Lion Nathan to include exclusive U.S. distribution of Steinlager, the best-selling premium beer in New Zealand.\nBeginning in 1991, CBC made an investment in a joint venture with Jinro Limited of the Republic of Korea. Jinro-Coors Brewing Company is one- third owned by CBC and two-thirds owned by Jinro Limited. In the second quarter of 1994, Jinro-Coors completed construction of a 1.8-million-barrel brewery in South Korea and launched its first product, Cass Fresh. In its first few months in the market, Cass Fresh captured a 10% share of the South Korean beer market. In October of 1994, Jinro-Coors launched Coors Extra Gold in the South Korean market. In the first quarter of 1995, the joint venture will complete improvements and additions to double the brewery's capacity. Volumes from Jinro-Coors Brewing Company are not included in CBC's financial results.\nIn March 1994, CBC completed the purchase of a 500,000-hectoliter brewery in Zaragoza, Spain. The brewery was purchased from El Aguila S.A., based in Madrid, Spain, which is 51% owned by Amsterdam-based Heineken, N.V., the world's second-largest brewer. The total investment by CBC in Spain over the next few years is expected to exceed $50 million, including purchase price and future spending on operations and product marketing. Under terms of an agreement, CBC will contract brew El Aguila products through 1998. In 1994, CBC also brewed Coors Extra Gold in Zaragoza for export to France, Greece and Italy. Sales and distribution in Spain will be handled by El Aguila. This arrangement will provide significant cost and other advantages over exporting beer from U.S. facilities. Volumes from the Zaragoza brewery are included in CBC's sales results. Product distribution: Delivery to retail markets in the United States is accomplished through a national network of 587 independent distributors and five distributors owned and operated by CBC's subsidiary, Coors Distributing Company. Some distributors have multiple branches. The total number of distributor locations in the U.S., including branch operations, is 645. Delivery to export\/international markets is accomplished via licensing and distribution agreements with independent distributors.\nIn order to ensure the highest product quality, CBC has one of the industry's most extensive distributor monitoring programs. This program is designed to ensure that guidelines for proper refrigeration and rotation of CBC's malt beverage products at both the wholesale and retail levels are followed. Distributors are responsible for maintaining proper rotation of the products at retail accounts and are required to replace CBC's malt beverage products at their own expense if sales to consumers have not occurred within the prescribed time period.\nNo single distributor accounted for more than 5% of 1994 barrel sales.\nTransportation -------------- The number and geographic location of CBC's brewing operations require its malt beverage products to be shipped farther than competitors' products. Major competitors have multiple breweries and, therefore, incur lower transportation costs than CBC incurs to deliver its products to their respective distributors. By packaging some of its products in Memphis, Tennessee and Elkton, Virginia (Shenandoah), CBC is able to achieve more efficient product distribution and a reduction of freight costs for certain markets. During 1994, 27% of total CBC products sold were first shipped in CBC's insulated rail tank cars from Golden and then blended, finished and packaged at the Memphis and Shenandoah plants.\nCBC's Golden facilities are served by Burlington Northern, Inc., which transports approximately 74% of CBC products packaged at the Golden facility 14 miles from Golden to Denver. From Denver the products are shipped by various railroad lines to satellite distribution centers and distributors throughout the country. CBC is able to maintain the high rail volume through the use of 24 satellite distribution centers strategically located throughout the country. These centers, operated by public warehouse companies and CBC, transfer CBC's malt beverage products from railcars for shipment to distributors by truck. In 1994, approximately 82% of total railcar volume from Golden moved through the satellite distribution centers. The railcars assigned to CBC by the shipping railroads are specially built and insulated to maintain temperature control en route. A national rail strike of any duration could substantially impair CBC's ability to transport their products to its markets and cause a shortage of CBC's malt beverage products to a greater degree than might be experienced by competitors with multiple breweries. Although an extended shutdown of the Burlington Northern, Inc. rail spur at Golden could adversely affect CBC's business, CBC believes that such an interruption of service is unlikely. In addition, the satellite distribution system would mitigate the potential impact of interrupted rail service.\nThe remaining 26% of CBC volume packaged in Golden is shipped by truck and intermodal (piggyback) directly to distributors. Transportation vehicles are refrigerated or insulated to keep CBC's malt beverage products at proper temperatures while in transit to distributor locations.\nOperations ---------- Production\/packaging capacity: CBC currently has three domestic production facilities. It owns and operates the world's largest single-site brewery in Golden, Colorado; a packaging and brewing facility in Memphis, Tennessee; and a packaging plant and distribution facility near Elkton, Virginia (referred to as the Shenandoah facility).\nThe Golden brewery is the source for all brands with the Coors name, except for Coors Cutter. The majority of CBC's beer is packaged in Golden. The remainder is shipped in bulk from the Colorado brewery to the Shenandoah and Memphis facilities for blending, finishing and packaging. To support the development of new products, CBC maintains a fully-equipped pilot brewery within the Golden facility, with a 6,500-barrel annual capacity. This on-site resource enables CBC to brew small batches of innovative products without interrupting ongoing production and operations.\nThe Memphis facility is currently packaging all domestic CBC products for export outside of the United States and producing Zima Clearmalt, Zima Gold, Castlemaine XXXX and Coors Cutter. Depending on product mix and market opportunities, the full utilization of brewing capacity in Memphis may require incremental expansion in plant and equipment.\nThe Shenandoah facility, which currently packages certain CBC products for distribution into eastern markets, was designed so that it could be expanded to include brewing capability if volumes and economics warrant additional brewing capacity.\nAt the end of 1994, CBC had approximately 25 million barrels of annual brewing capacity and 28 million barrels of annual packaging capacity. Current capacity figures are dependent on product mix and can change with shifting consumer preferences for specific brands and\/or packages. The increasing proliferation of products and packages creates logistical challenges for CBC as well as for all brewers. Together, the three facilities provide sufficient brewing and packaging capacity to meet consumer demand for CBC's products into the foreseeable future.\nSignificant portions of CBC's aluminum can, end, glass bottle and malt requirements are also produced in its own facilities. CBC has sufficient capacity in container and malting operations to fulfill its current and projected requirements.\nContainer manufacturing facilities: CBC owns a can manufacturing facility, which produces approximately 3.5 billion aluminum cans per year. In addition, CBC owns an end manufacturing facility, which provides aluminum ends and tabs to CBC. Together, container assets comprise approximately 15% of CBC's property assets. In May of 1994, CBC and American National Can Company entered into a joint venture to produce reduced-diameter 202 beverage can ends at the CBC end manufacturing facility for sale to CBC and to outside customers. This innovative joint venture was expanded in the third quarter to include can manufacturing. Over time, this joint venture is intended to improve utilization of both facilities and improve the return on this investment. In 1994, substantially all of the cans, ends and tabs produced were purchased by CBC.\nIn 1994, the CBC bottle manufacturing plant produced approximately 790 million bottles for consumption by CBC. There were no sales to outside customers. Bottles manufactured by CBC are made with an average total recycled content of 35%. To assist in its goal of manufacturing bottles with 50% recycled content, in 1992 CBC announced its intent to build a glass recycling facility in Wheat Ridge, Colorado. Construction of the facility was completed mid-year in 1994 and doubled the amount of glass CBC can recycle annually.\nCBC is currently completing negotiations with Anchor Glass Container Corporation to form a partnership to produce glass bottles. When negotiations arescompleted in the near future, an announcement of the partnership will be released.\nOther facilities: CBC owns waste treatment facilities which process waste from CBC's manufacturing operations as well as municipal waste from the nearby City of Golden. CBC owns and operates its own power plant. In 1994, a proposed divestiture of its electric-generating assets to Public Service Company of Colorado was terminated when the parties could not agree on an acceptable financial package. CBC is currently evaluating other options for improving utilization and\/or divesting the electric-generating assets.\nCBC continues to explore opportunities to improve asset utilization, including the divestiture of non-core assets and continuing improvement in capacity utilization through innovative joint ventures and alliances.\nCapital expansion: In 1994, the Company spent approximately $160.3 million to provide additional new product capacity. While management plans to invest appropriately in order to ensure the ongoing productivity and efficiency of CBC assets, a priority will be placed on those projects that offer returns on investment spending that are well in excess of CBC's cost of capital. CBC expects its capital expenditures for 1995 to be approximately $167 million.\nRaw Materials\/Sources and Availability -------------------------------------- CBC uses all-natural ingredients in the production of its malt beverages. In addition, CBC has one of the longest beer brewing cycles in the industry. CBC adheres to strict formulation and quality standards in selecting its raw materials. CBC believes it has sufficient access to raw materials and packaging materials to meet its production requirements in the foreseeable future.\nBarley, barley malt, starch and hops: CBC uses a proprietary strain of barley, developed by CBC's agronomists, in most of its malt beverage products. Virtually all of this barley is grown on irrigated farmland in the western United States under contractual agreements with area farmers. CBC's malting facility located in Golden, Colorado, produces malt for all of CBC's products with the exception of Zima Clearmalt. CBC maintains inventory levels in several locations owned by CBC which it believes are sufficient to supply the business in the event of any natural disaster or contingency.\nRice and refined cereal starch, which are considered to be interchangeable in CBC's brewing process, are purchased from several suppliers. Both foreign and domestic hops are purchased from various suppliers.\nWater: CBC utilizes naturally filtered water from underground aquifers to brew malt beverages at its Golden, Colorado facility. Water from private deep wells is used for final blending and packaging operations for malt beverages packaged at plants located outside Colorado. Water quality and composition were primary factors in all facility site selections. Water from CBC's sources in Golden, Memphis and Shenandoah is soft, with the required balance of minerals and dissolved solids to brew high-quality malt beverages. CBC continually monitors the quality of all the water used in its brewing and packaging processes for compliance with CBC's own stringent quality standards as well as applicable federal and state water standards. CBC owns water rights believed to be adequate to meet all of CBC's present requirements for both brewing and industrial uses; however, it continues to acquire water rights and add water reservoir capacity, as appropriate, to provide for long-term strategic growth plans and to sustain brewing operations in the event of a prolonged drought.\nPackaging materials: During 1994, approximately 57% of CBC's malt beverage products were packaged in aluminum cans. This is a slight reduction from 1993, when 60% of CBC's malt beverages were packaged in aluminum cans. Aluminum cans for CBC's malt beverage products packaged at the Memphis plant were purchased from an outside supplier.\nApproximately 25% of the cost of malt beverage products packaged in cans represents the cost of aluminum. CBC's aluminum requirements for can-and-end-making are purchased through CBC's joint venture agreement with American National Can Company (ANC), including the portion purchased from Golden Aluminum Company, a subsidiary of ACXT.\nGlass bottles were used to package approximately 31% of CBC's malt beverage products in 1994. Approximately half of all bottle requirements were produced in CBC's bottle manufacturing plant. In addition, CBC has two other qualified suppliers under contract to supply glass bottles.\nThe remainder of the malt beverages sold during 1994 was packaged in quarter-and half-barrel stainless steel kegs and two different sizes of a plastic sphere called \"The Party Ball,\" an innovative package introduced by CBC in 1988.\nMost of the secondary packaging for CBC's products, including bottle labels and paperboard products, is supplied by Graphic Packaging Corporation, an ACXT subsidiary.\nThe cost of packaging materials is expected to increase significantly in 1995. See Management's Discussion and Analysis for further discussion.\nSupply contracts with ACXT companies: At the time of the spin-off of ACXT, at the end of 1992, CBC negotiated long-term supply contracts with operating subsidiaries of ACXT for aluminum and packaging materials. These contracts are in effect through 1997 and were negotiated at market prices.\nEnergy: CBC uses both coal and natural gas as primary sources of energy. Coal is used as the primary fuel in CBC's steam generation system and is supplied from outside sources. Natural gas was supplied by public utilities and various natural gas purchase contracts during the year. CBC also has, through Coors Energy Company, access to fuel oil and propane as alternate sources of energy. CBC does not anticipate future supply problems for these natural resources.\nSeasonality of the Business --------------------------- Due to the seasonality of the beer industry, CBC's sales volumes are normally at their lowest in the first and fourth quarters and highest in the second and third quarters. The fiscal year of the Company is a 52- or 53-week period ending on the last Sunday in December. The 1995 fiscal year is 53-weeks and ends on December 31, 1995.\nCompetitive conditions ---------------------- Known trends and competitive conditions: Industry and competitive information was compiled from the following industry sources: Beer Marketer's Insights, The Maxwell Consumer Report and various securities analyst reports. While management believes these sources are reliable, CBC cannot guarantee the absolute accuracy of these numbers and estimates.\n1994 Industry overview: The beer industry in the United States is highly competitive. Industry volume growth in domestic markets has been below 1% a year for the past several years and per capita consumption fell in 1994, down to 22.7 gallons per person, compared with 22.9 gallons in 1993. For the past several years, brewers have attempted to gain share through competitive pricing. In 1994, price promotions and price discounting continued to erode net price realizations for brewers. While projected increases in raw materials costs throughout the industry could result in modest price increases and some relief from price discounting in the near term, it is anticipated that competitors will continue to concentrate on market share gains vs. profitability, which will place continued downward pressure on pricing. Industry growth is increasingly dependent on introductions of new, higher-margin products -- including imports, specialty brews and other innovative brands -- and expansion into international markets.\nA number of important trends emerged in the U.S. beer market in 1994. The first was a trend toward \"trading up.\" Consumers moved away from lower-priced brands to higher-priced brands, including specialty products and imports in the above-premium category. This caused a related shift in packaging preferences, toward glass bottles and away from aluminum cans. Concurrent with the shift in consumer preference is a recent proliferation of microbreweries.\nTo capitalize on the trend toward specialty products and craft-brewed beers, brewers are introducing new products at an accelerating rate. It is estimated that the top six brewers introduced or expanded more than 60 new brands in 1994. G. Heileman Brewing announced in 1994 that it expects to introduce a total of 150 new products and\/or line extensions by mid-1995. This proliferation of products creates unique challenges in operations, logistics and marketing for all brewers, distributors and retailers.\nCBC competitive position: CBC's malt beverage products compete with numerous above-premium, premium, low-calorie, popular-priced, non-alcohol and imported brands produced by national, regional, local and international brewers. More than 90% of domestic volume is attributable to the top six domestic brewers, Anheuser-Busch Companies, Inc. (AB), Philip Morris, Inc. through its subsidiary Miller Brewing Company (Miller), Coors Brewing Company, The Stroh Brewery Company, G. Heileman Brewing, and S & P Company. CBC competes most directly with AB and Miller, the dominant players in the industry. CBC is the nation's third-largest brewer and, according to Beer Marketer's Insights (BMI) estimates, CBC accounted for approximately 10.2% of the total 1994 U.S. brewing industry shipments of malt beverages (including exports and U.S. shipments of imports). This compares to Miller's 22.6% share and AB's 44.1% share.\nCBC is well-positioned in the malt beverage industry, with strong, quality brands in the fastest-growing categories. Compared to AB (77%) and Miller (80%), CBC's premium and above-premium categories make up more than 87% of total volume. Given its position in the industry, CBC continues to face significant competitive disadvantages related to economies of scale. In addition to lower transportation costs achieved by major competitors with multiple breweries, these larger brewers also recognize economies of scale in advertising expenditures. CBC, in an effort to achieve and maintain national advertising exposure, must spend substantially more per barrel of beer sold than its major competitors. On a per barrel basis, it is estimated that CBC pays nearly twice as much for its advertising as AB; however, the gap between CBC's and Miller's costs (on a per barrel basis) appears to be narrowing. A significant level of advertising expenditures is necessary for CBC to hold and increase its share of the U.S. beer market. This, coupled with ongoing price competition, puts more pressure on CBC's margins in comparison to CBC's principal competitors.\nResearch and Development ------------------------ CBC's research and development expenditures are primarily devoted to new product and package development, its brewing process and ingredients, brewing equipment, improved manufacturing techniques for packaging supplies and environmental improvements in CBC's processes and packaging materials. The focus of these programs is to improve the quality and value of its malt beverage products while reducing costs through more efficient processing and packaging techniques, equipment design and improved varieties of raw materials. CBC's research and development dollars are strategically applied to short-term as well as long-term opportunities. Approximately $13.3 million was spent on research and development in 1994.\nRegulations ----------- Federal laws and regulations govern the operations of breweries; the federal government and all states regulate trade practices, advertising and marketing practices, relationships with distributors and related matters. Governmental entities also levy various taxes, license fees and other similar charges and may require bonds to ensure compliance with applicable laws and regulations.\nThere are a number of emerging regulatory issues that could impact business operations over the next few years, including potential increases in state and federal excise taxes, restrictions on the advertising and sale of alcohol beverages, new packaging regulations and others.\nFederal excise taxes on malt beverages are presently $18.00 per barrel. State excise taxes are also levied at rates that ranged in 1994 from a high of $32.65 per barrel in Alabama to a low of $0.62 per barrel in Wyoming, with an average of $7.81 per barrel. In 1994, CBC paid more than $377 million in federal and state excise taxes. A substantial increase in federal excise taxes would have a negative impact on the entire industry and could have a material effect on CBC sales and profitability. CBC is vigorously opposed to any additional increases in federal and\/or state excise taxes and will work diligently to ensure that its view is adequately represented in the ongoing debate.\nEnvironmental ------------- A top priority of the Company is to ensure compliance with all federal, state and local environmental protection laws and regulations. Compliance with the provisions of federal, state and local environmental laws and regulations did not have a material effect on the capital expenditures, earnings or competitive position of the Company during 1994.\nThe Company also continues its commitment to programs directed toward efficient use of resources, waste reduction and pollution prevention. Programs currently underway include recycling initiatives, down-weighting of product packages, and, where practicable, increasing the recycled content of product packaging materials, paper and other supplies. A new recycled glass processing facility at Coors Glass Manufacturing in Wheat Ridge, Colorado, opened in May of 1994, resulting in the capability to increase the recycled content in CBC beer bottles. A number of employee task forces throughout CBC continually seek effective alternatives for hazardous materials and work to develop innovative technologies to reduce emissions and waste.\nEmployees --------- The Company has approximately 6,300 full-time employees. Approximately 1,600 employees are salaried. Over the past few years, CBC has worked diligently to reduce overhead and general and administrative expense.\nForeign Operations ------------------ The Company's foreign operations and export sales are not a material part of its business. The Company is committed to expanding its foreign operations throughexport sales, licensing agreements and joint ventures.\nBrewing Company Subsidiaries ---------------------------- Coors Distributing Company (CDC) is CBC's largest subsidiary. CDC owns and operates distributorships in five markets across the United States. Together, CDC operations in 1994 accounted for approximately 5% of CBC's total beer sales.\nIn late 1992, Coors Energy Company (CEC) became a subsidiary of CBC. During 1992, CEC sold substantially all of its oil and gas exploration and production assets. CEC retained a transmission pipeline to bring natural gas to various CBC facilities in Colorado and, through a subsidiary, continues to operate a gas transmission pipeline to provide for the energy needs of CBC's Shenandoah facility. In early 1995, CEC divested a portion of its Colorado coal reserves on terms favorable to CBC.\nIn 1992, CBC sold substantially all of the assets and operations of Coors Transportation Company.\nOther subsidiary operations of CBC include The Wannamaker Ditch Company and The Rocky Mountain Water Company (both carry process water from Clear Creek to various CBC reservoirs).\nCBC and three of its subsidiaries are partners in a partnership that owns Coors Brewing Iberica S.A. Coors Brewing Iberica S.A. manufactures and markets beer for sale in Spain and for export to other European countries.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\n* Leased\nThe original brewery site at Golden, which is approximately 2,400 acres, contains brewing, packaging and can manufacturing facilities, as well as gravel deposits and water-storage facilities. CBC also owns and operates a glass-bottle making facility in Wheat Ridge, Colorado, just east of Golden.\nCBC's can and end plants are operated by a joint venture between CBC and American National Can Company.\nThe Company owns 2,600 acres of land in Rockingham County, Virginia, where the Shenandoah facility is located, and 131 acres in Shelby County, Tennessee, where the Memphis plant is located.\nAll of the Company's facilities are well maintained and suitable for their respective operations. In 1994, CBC estimates the brewing facilities operated at approximately 83% of the 1995 brewing capacity and the packaging facilities operated at approximately 73% of the 1995 packaging capacity. Annual production capacity can vary due to product mix, packaging mix and seasonality.\nCEC has retained a transmission pipeline to bring natural gas from certain wells for use at various CBC facilities in Colorado, and through a subsidiary, will continue to operate a gas transmission pipeline to provide for the energy needs of the Shenandoah facility.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nIn January 1992, ACC and CBC (as well as two former affiliates that are now subsidiaries of ACXT) were sued by TransRim Enterprises (USA) Ltd. in Federal District Court for the District of Colorado. TransRim alleged that the defendants misused confidential information and breached an implied contract to proceed with a joint venture project to build and operate a paper board mill. TransRim initially claimed damages totaling $159 million based on a number of theories, some of which were dismissed from the case by the judge granting the defendants' motion for the partial summary judgement. Trial by a jury was held in April 1994, and the jury returned a verdict in favor of all defendants on all claims. TransRim filed an appeal to the U.S. Court of Appeals, 10th Judicial Circuit. Oral arguments were heard March 7, 1995. Management believes that ACC and CBC have meritorious defenses and that the ultimate outcome will not have a material impact on the Company's financial position and results of operations.\nSee the Environmental section of Management's Discussion and Analysis for a discussion of the Company's obligation for potential remediation costs at the Lowry Landfill Superfund site and related legal proceedings.\nThe Company is party to numerous other legal proceedings arising from its business operations. In each proceeding, the Company is vigorously defending the allegations. Although the eventual outcome of the various proceedings cannot be predicted, no single such proceeding, and no group of such similar matters, is expected to result in liability that would be material to 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 ended December 25, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nAdolph Coors Company Class B common stock is traded on the over-the-counter market and is included in the NASDAQ Stock Market National Market (NNM) listings, under the symbol \"ACCOB.\" Daily stock prices are listed in major newspapers, generally alphabetically under \"CoorsB.\"\nThe approximate number of record security holders by class of stock at March 15, 1995, is listed below:\nThe range of the high and low quotations and the dividends paid per share on the Class B Common Stock for each quarter of the past two years are shown below:\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nFollowing is selected financial data for ACC for the eight years ended December 25, 1994: (In thousands, except per share data)\n*Numbers in italics include results of discontinued operations. **Reflects the dividend of ACX Technologies, Inc. to shareholders during 1992. 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\nINTRODUCTION Adolph Coors Company (\"ACC\" or the \"Company\") is the holding company for a single subsidiary, Coors Brewing Company (\"CBC\"). CBC produces and markets quality malt-based beverages.\nThe following discussion summarizes the significant factors affecting the consolidated results of operations and liquidity and capital resources of ACC during the three year period ended December 25, 1994. Unusual or nonrecurring items make it difficult to evaluate the Company's ongoing operations. Consequently, consolidated financial results for each year are first reviewed separately including the effects of special and nonrecurring items. Then consolidated financial results are reviewed excluding these special and nonrecurring items. This analysis should be read in conjunction with the financial statements and notes to the financial statements included in this annual report.\nCONSOLIDATED RESULTS OF OPERATIONS FOR FISCAL YEARS 1994, 1993 AND\n1994 Consolidated Results of Operations: For the 52-week fiscal year ended December 25, 1994, ACC reported net income of $58.1 million, or $1.52 per share.\nTwo nonrecurring items in 1994 resulted in a net special credit to ACC. First, the Company reached a settlement with a number of its insurance carriers which enabled it to recover a portion of the costs associated with the Lowry Landfill Superfund site. This was partially offset by a writedown of distributor assets.\nThe net effect of these two items was a net special credit of approximately $13.9 million pretax, or $0.22 per share after tax. Without the net special credit, ACC would have reported 1994 net income of $49.7 million, or $1.30 per share.\n1993 Consolidated Results of Operations: For the 52-week fiscal year ended December 26, 1993, the Company reported a net loss of $41.9 million, or $1.10 per share. The Company recorded restructuring and other special charges of $122.5 million in the fourth quarter primarily related to the costs of a significant restructuring intended to reduce costs and improve performance. The net loss was also the result of an after-tax charge of $3.2 million, or $0.08 per share, related to the 1993 retroactive increase of 1% in the federal corporate income tax rate, and the related revaluation of deferred income tax liability. Excluding these special charges, the Company's net income would have been $33.6 million, or $0.88 per share.\nThe 1993 restructuring charge, which totaled $109.5 million pretax, included $70.2 million for voluntary separation and enhanced early retirement packages designed to reduce CBC's white collar work force. Of the remaining $39.3 million, approximately $22.0 million related to workplace redesign and other profit improvement initiatives, and approximately $17.3 million related to asset writedowns. Substantially all of the charges related to voluntary separation and enhanced early retirement packages were paid in 1993; other costs related to workplace redesign and other profit improvement initiatives were accrued in 1993 and substantially all were paid in 1994. Special charges related to the writedown of certain distributor assets and a provision for environmental enhancements totaled $13.0 million. Together the aggregate impact of the special charges was $1.98 per share.\n1992 Consolidated Results of Operations: At the end of 1992, ACC significantly restructured its operations by spinning off its diversified technology business into a new, public company, ACX Technologies, Inc. (NASDAQ:ACXT). The results of ACXT are reported as discontinued operations in the consolidated financial statements for all periods presented, except as noted.\nIn 1992, ACC reported a net loss of $2.0 million. The loss was a result of a loss from discontinued operations of $29.4 million related to the spin-off of ACXT, as well as the net after-tax expense of $8.3 million for the adoption of new financial accounting standards for employee postretirement benefits (FAS 106) and income taxes (FAS 109). Income from continuing operations totaled $35.7 million, or $0.95 per share.\nTrend summary: percentage increase\/(decrease) 1994, 1993 and 1992. The table below reflects trends in operating results, excluding the 1994 special credit, the 1993 restructuring and other special charges and the 1992 impact of discontinued operations and adoption of new accounting standards. Earnings per share are shown both as reported and excluding a special credit and\/or charges, the impact of discontinued operations and adoption of new accounting standards.\nCONSOLIDATED RESULTS OF CONTINUING OPERATIONS: 1994 VS. 1993, 1993 VS. 1992 Excludes the 1994 special credit, the 1993 restructuring and other special charges and the 1992 impact of discontinued operations and adoption of new accounting standards.\n1994 vs. 1993 ------------- Net sales increased by 5.1% in 1994 from 1993. This increase was due to a 2.7% increase in volume and a shift in product mix to products in the premium and above-premium price categories. Gross profit improved to 36.1% of net sales as compared to 34.5% in 1993. This improvement was primarily the result of increased volume, improved brand mix profitability, operational efficiencies and lower aluminum costs.\nOperating income improved 21.1% in 1994 over 1993. Although marketing expense (including advertising) grew substantially in 1994, general and administrative (G&A) expense declined by 9.7%. The increase in marketing expense was primarily due to the national rollout of Zima Clearmalt and the introduction and expansion of Coors Artic Ice and Coors Artic Ice Light. The decline in G&A expense resulted from the restructuring effort that began in 1993 to reduce overhead costs. Research and development expense was essentially unchanged in 1994 as compared to 1993.\nNet non-operating expenses decreased to $3.9 million in 1994 compared to $12.1 million in 1993. Income from miscellaneous items increased by $4.9 million due to a gain on the sale of investments and higher royalty income related to licensed can-making and can-decorating technology. Net interest expense decreased $3.3 million because of the $50 million principal payment in June 1994 on ACC's medium-term notes.\nThe Company's effective tax rate declined in 1994 to 45.0% from 48.9% in 1993. The decline was largely attributable to the revaluation of ACC's deferred tax liability in 1993 related to the 1993 1% increase in the federal corporate income tax rate. The 1994 effective tax rate was higher than the statutory tax rate because of non-deductible expenses (meals and entertainment expenses and lobbying costs) and a valuation allowance for a tax loss carryforward.\nNet income was $49.7 million, or $1.30 per share, in 1994 compared to $33.6 million, or $0.88 per share, representing a 47.7% improvement in earnings per share.\n1993 vs. 1992 ------------- Net sales increased by 2.0% in 1993 from 1992. This increase was due to a 1.3% increase in volume, a shift in product mix to products in the premium and above-premium price categories and modest price increases in 1993. Gross profit improved to 34.5% of net sales vs. 33.2% in 1992. The improvement was primarily the result of increased volume, improved brand mix profitability, operational efficiencies and lower aluminum costs. The 1993 increase also reflected the divestiture of lower margin activities associated with CBC's transportation and energy businesses.\nOperating income improved 6.1% in 1993 over 1992 due to the $29.7 million, or 5.8%, improvement in gross profit. The increase in gross profit more than offset increases in marketing, general and administrative (MG&A) expense of $24.6 million and research and project development expense of $0.6 million.\nNet non-operating expenses decreased to $12.1 million in 1993 compared to $14.7 million in 1992. Net interest expense decreased $2.6 million because of an increase in investable cash and higher interest income.\nThe effective tax rate increased in 1993 to 48.9% from 39.1% in 1992. The increase was largely attributable to the 1993 1% increase in the federal corporate income tax rate, the related revaluation of ACC's deferred tax liability and non-deductible foreign losses.\nNet income in 1993 was $33.6 million, or $0.88 per share, compared to $35.7 million, or $0.95 per share in 1992.\nLIQUIDITY AND CAPITAL RESOURCES:\nThe Company's primary sources of liquidity are cash provided from operating activities and external borrowing. The Company continues to be in a strong position to generate cash internally. The Company's 1994 net cash position was $27.2 million, a significant decrease compared to $82.2 million in 1993. The Company's 1993 net cash position increased 107% from $39.7 million in 1992.\nThe Company believes that cash flows from operations and short-term borrowings are adequate to meet its ongoing operating requirements, scheduled principal debt repayments and debt service costs, anticipated capital expenditures and dividend payments.\nOperating Activities Including net special credits\/charges, net cash provided by operations was $186.4 million in 1994, $168.5 million in 1993 and $155.8 million in 1992. The 1994 increase in cash from operations was primarily due to higher net income, higher accumulated deferred income taxes, and higher depreciation offset in part by an increase in accounts and notes receivable, a decrease in accrued expenses and other liabilities (primarily due to the payment of obligations related to the 1993 restructuring) and an increase in accounts payable. The increase in accounts and notes receivable reflects higher 1994 sales and amounts owed to CBC by the new joint venture between CBC and American National Can formed to manufacture cans and ends. Higher accounts payable are due primarily to amounts owed to the new can and end joint venture for purchases by CBC.\nThe 1993 increase in cash from operations was due primarily to higher depreciation, lower accounts and notes receivable, higher accounts payable and higher accrued expenses (primarily related to restructuring and special charges). Lower accounts receivable were primarily related to a change in credit terms from 1992.\nInvesting Activities (including capital expenditures) The Company is shifting its strategic emphasis toward projects that offer returns on investments (ROI) that are equal to or greater than ACC's weighted average cost of capital. The Company's anticipated capital expenditures for 1995 are $167 million relating primarily to capacity expansion, repair and upkeep, return on investment projects and environmental compliance. In 1994, the Company spent $174.7 million on investment activities, compared with $119.3 million in 1993 and $140.4 million in 1992. Capital expenditures were $160.3 million in 1994, $120.4 million in 1993 and $115.5 million in 1992. In 1994, capital expenditures focused on expansion of facilities (primarily to expand bottling capacity) and the purchase of a brewery in Zaragoza, Spain. In 1993, capital expenditures were made for expansion of capacity in Memphis for Zima Clearmalt, routine maintenance and incremental upgrades to all production facilities.\nNet Cash Used\/Provided by Financing Activities The Company used $67.0 million of cash in financing activities in 1994. At the beginning of the third quarter, the Company made its first principal payment on its medium-term notes, in the amount of $50 million. In addition, the Company paid dividends of $19.1 million. Offsetting this was approximately $2.1 million provided by the exercise of stock options.\nIn 1993, the Company used $6.6 million in cash in financing activities. The Company paid $19 million in dividends. The Company received cash through the exercise of stock options and the proceeds from industrial revenue bonds for an expansion project. Net cash provided by financing activities in 1992 resulted from the assumption of additional debt related to the spin-off of ACXT, offset by the payment of short-term borrowings and the payment of dividends.\nDebt Securities A shelf registration was filed with the Securities and Exchange Commission for $300 million of debt securities in 1990. As of December 25, 1994, the Company had $170.0 million outstanding in medium-term notes, having made the first scheduled principal payment of $50 million on the notes in June 1994. That payment was funded by a combination of cash on hand and borrowings under the Company's bank revolving credit facility. Fixed interest rates on the Company's medium-term notes range between 8.3% and 9.15%. The repayment schedule for the remaining outstanding notes is $44 million in 1995, $36 million in 1996, $19 million in 1997, $31 million in 1998 and $40 million in 1999. The Company's debt-to-total capitalization ratios were 20.6% at the end of 1994, 26.3% at the end of 1993 and 24.3% at the end of 1992.\nRevolving Line of Credit In addition to the medium-term notes, the Company has an unsecured, committed revolving line of credit totaling $144 million. From time to time this line of credit is used for working capital requirements and general corporate purposes. In an effort to increase its financial flexibility, the Company increased the available credit under the facility to $144 million in 1994 from $100 million in 1993. As of December 25, 1994, the full $144 million was available. For 1994, the Company met its two financial covenants under the committed revolving line of credit: a minimum tangible net worth test and a debt-to-total capitalization test.\nHedging Activities As of December 25, 1994, hedging activities consisted exclusively of hard currency forward contracts to directly offset hard currency exposures. These irrevocable contracts eliminated the risk to financial position and results of operations of changes in foreign exchange rates. Any variation in the exchange rate that would accrue to the contract would be directly offset by an equal change in the related obligation. Therefore, after the contract entrance date, variation in the exchange rate would have no additional impact on the Company's financial statements. ACC's hedging activities are minimal and hard currency exposures are not material.\nOUTLOOK 1995:\nThe Company will report 1995 results based on a 53-week fiscal calendar because the Company's accounting calendar is based on 13 periods rather than a 12-month calendar year.\nThe Company expects a significant increase in cost of goods sold in 1995 over 1994 based on projections for volume growth and increased costs of aluminum and other packaging materials. The Company also anticipates that MG&A expense will increase in the aggregate. Other overhead costs should remain basically unchanged, except for increases associated with hiring to fill positions that were vacant in 1994. Most of the anticipated 1995 increase in MG&A is related to increased advertising support for the Company's best-selling brands, including Coors Light, George Killian's Irish Red and other specialty brands.\nThe Company anticipates that the increased costs will be offset in part through volume gains, modest price increases, productivity gains arising from restructuring and benefits from the American National Can joint venture including incremental income and minimizing increased aluminum costs. The Company's effective tax rate will remain higher than the statutory rate due primarily to non-deductible expenses, such as meals, entertainment and lobbying expenses.\nThe Company anticipates that the effect of raw material cost increases will occur early in 1995, while the expected offsets from cost savings will occur primarily in the second half of 1995.\nENVIRONMENTAL:\nThe Company was one of numerous parties named by the Environmental Protection Agency (EPA) as a \"potentially responsible party\" (PRP) for the Lowry Landfill Superfund site, a legally permitted landfill owned by the City and County of Denver. In 1990, the Company recorded a special pretax charge of $30 million for potential clean-up costs of the site.\nThe City and County of Denver, Waste Management of Colorado, Inc. and Chemical Waste Management, Inc. brought litigation in 1991 in U.S. District Court against the Company and 37 other PRP's to determine the allocation of costs of Lowry site remediation. In 1993, the Court approved a settlement agreement between the Company and the plaintiffs, resolving the Company's liabilities for the site. The Company agreed to initial payments based on an assumed present value of $120 million in total site remediation costs. In addition, the Company agreed to pay a specified share of costs if total remediation costs are in excess of this amount. Payments representing the Company's agreed share based on the $120 million assumption were made into a trust to be applied to costs of site remediation and operating and maintenance costs.\nThe EPA recently announced remediation objectives and requirements for the site and projected costs of its remediation plan. The EPA's projected costs are below the $120 million total assumed as a basis for the Company's settlement. The City and County of Denver, Waste Management of Colorado and Chemical Waste Management, Inc. are expected to implement remediation of the site. The Company has no reason to believe that total remediation costs will result in additional liability to the Company.\nIn 1991, the Company filed suit against certain of its former and current insurance carriers, seeking recovery of past defense costs and investigation, study and remediation costs. Settlements were reached during 1993 and 1994 with all defendants. As a result, in the fourth quarter of 1994, the Company recognized a special pretax credit of $18.9 million.\nThe Company has also been notified that it is or may be a PRP under Comprehensive Environmental Response, Compensation and Liability (CERCLA) or similar state laws with respect to the cleanup of other sites where hazardous substances have allegedly been released into the environment. The Company cannot predict with certainty the total costs of cleanup, its share of the total cost or the extent to which contributions will be available from other parties, the amount of time necessary to complete the cleanups, or insurance coverage. However, based on investigations to date, the Company believes that any liability would not be material to the financial condition of the Company with respect to these sites. There can be no certainty, however, that the Company will not be named as a PRP at additional Superfund sites in the future, or that the costs associated with those additional sites will not be material.\nWhile it is impossible to predict the eventual aggregate cost to the Company for environmental and related matters, management believes that any payments, if required, for these matters would be made over a period of years in amounts that would not be material in any one year to the consolidated results of operations or to the financial or competitive position of the Company. The Company believes adequate disclosures have been provided for losses that are reasonably possible. Furthermore, as the Company continues to focus attention on resource conservation, waste reduction and pollution prevention, it is the Company's belief that potential future liabilities will be reduced.\nACCOUNTING CHANGES:\nThe results of operations for 1992 include the adoption of certain accounting rule changes. In 1992, the Company adopted FAS 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions,\" and the financial results for 1992 reflect the adoption. The transition effect of adopting FAS 106 on the immediate recognition basis resulted in a charge of $38.8 million to 1992 earnings, net of approximately $23.4 million of income tax effects. The ongoing cost of adopting the new standard increased 1992 net periodic postretirement benefit cost by $5.2 million.\nAlso in 1992, the Company adopted FAS 109, \"Accounting for Income Taxes,\" retroactive to the first quarter, and the financial results for 1992 reflect that adoption as well. The adoption increased 1992 earnings by $30.5 million because of the reversal of excess deferred income tax liability balances.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPage(s)\nConsolidated Financial Statements:\nReport of Independent Accountants\nConsolidated Statement of Income for each of the three years ended December 25, 1994\nConsolidated Balance Sheet at December 25, 1994 and December 26, 1993\nConsolidated Statement of Cash Flows for each of the three years ended December 25, 1994\nConsolidated Statement of Shareholders' Equity for each of the three years ended December 25, 1994\nNotes to Consolidated Financial Statements\nReport of Independent Accountants\nTo the Board of Directors and Shareholders of Adolph Coors Company\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14 (a)(1) and (2) on page present fairly, in all material respects, the financial position of Adolph Coors Company and its subsidiaries at December 25, 1994, and December 26, 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 25, 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. As discussed in Notes 5 and 8 to the consolidated financial statements, the Company adopted Statements of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" and No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" in 1992.\nPRICE WATERHOUSE LLP\nDenver, Colorado February 28, 1995\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.\nSee accompanying notes to consolidated financial statements.\nADOLPH COORS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1:\nSummary of Accounting Policies\nFiscal year: The fiscal year of the Company is a 52- or 53-week period ending on the last Sunday in December. Fiscal years for the financial statements included herein ended December 25, 1994, December 26, 1993, and December 27, 1992, and were 52-week periods.\nPrinciples of consolidation: The consolidated financial statements include the accounts of Adolph Coors Company, its only direct subsidiary, Coors Brewing Company (CBC), and all subsidiaries of CBC (collectively referred to as \"the Company\"). All significant intercompany accounts and transactions have been eliminated.\nInventories: Inventories are stated at the lower of cost or market. Cost is determined by the last-in, first-out (LIFO) method for substantially all inventories.\nCurrent cost, as determined principally on the first-in, first-out method, exceeded LIFO cost by $41,655,000 and $46,705,000 at December 25, 1994 and December 26, 1993, respectively. During 1994 and 1993, total inventory costs and quantities were reduced, resulting in a LIFO liquidation, the effect of which was not material.\nProperties: Land, buildings and equipment are capitalized at cost. For financial reporting purposes, depreciation is provided principally on the straight-line method over the estimated useful lives of the assets. Accelerated depreciation methods are generally used for income tax purposes. Expenditures for new facilities and improvements that substantially extend the capacity or useful life of an asset are capitalized. Start-up costs associated with manufacturing facilities, but not related to construction, are expensed as incurred. Ordinary repairs and maintenance are expensed as incurred (Note 3).\nExcess of cost over net assets of businesses acquired: The excess of cost over the net assets of businesses acquired in transactions accounted for as purchases is being amortized on a straight-line basis, generally over a 40-year period.\nHedging transactions: The Company periodically enters into forward, future and option contracts for foreign currency and commodities to hedge its exposure to exchange rates and price fluctuations for raw materials and fixed assets used in the production of beer. The gains and losses on these contracts are deferred and recognized in cost of sales as part of the product cost.\nAs of December 25, 1994, hedging activities consisted exclusively of hard currency forward contracts to directly offset hard currency exposures. These irrevocable contracts eliminated the risk to financial position and results of operations from changes in the underlying foreign exchange rate. Any variation in the exchange rate that would accrue to the contract would be directly offset by an equal change in the related obligation. Therefore, after the contract entrance date, variation in the exchange rate would have had no additional impact on the Company. The Company's hedging activities are minimal and hard currency exposures are not material.\nConcentration of credit risk: The majority of the accounts receivable balances as of December 25, 1994, and December 26, 1993, were from malt beverage distributors. The Company secures substantially all of this credit risk with purchase money security interests in inventory and proceeds, personal guarantees and\/or letters of credit. Statement of Cash Flows: The Company defines cash equivalents as highly liquid investments with original maturities of 90 days or less. Income taxes paid were $30,995,000 in 1994, $15,367,000 in 1993 and $26,167,000 in 1992.\nNet income per common share: Net income per common share is based on the weighted average number of shares of common stock outstanding during each year. Except for voting, both classes of common stock have the same rights and privileges.\nEnvironmental expenditures: Environmental expenditures that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past operations, 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.\nNOTE 2:\nDiscontinued Operations\nIn May 1992, the board of directors of the Company authorized development of a plan to distribute to its shareholders its ceramics, aluminum, packaging and technology-based developmental businesses (the \"Technology Businesses\"). On August 12, 1992, the Company formed ACX Technologies, Inc. (\"ACXT\" or \"ACX Technologies\") to own the Technology Businesses. On December 27, 1992, the Company distributed to its shareholders the common stock of ACXT. Accordingly, the results of ACXT and the Technology Businesses are reported as discontinued operations in these consolidated financial statements for all periods presented except as noted. Each holder of record of the Company's common stock on December 16, 1992, received one share of ACXT common stock for every three shares of Adolph Coors Company common stock held as of such date. ACXT stock is publicly traded on the over-the-counter market under the symbol \"ACXT.\"\nThe loss from discontinued operations for the year ended December 27, 1992, was $29,415,000, or $0.78 per share. The 1992 results included approximately $7,200,000, or $0.19 per share, for transaction costs associated with the spin-off and a fourth quarter pretax charge of $13,700,000, or $0.36 per share, related to restructuring of operations primarily at Coors Ceramics Company and Golden Technologies Company, Inc. Discontinued operations for 1992 also included the operating results of the Technology Businesses and ACXT's adoption of the new accounting standards for postretirement benefits and income taxes. Net income from discontinued operations for the year ended December 29, 1991, was $8,433,000, or $0.22 per share.\nHistorical marketing, general and administrative expenses for the Technology Businesses, which included costs incurred directly by and for the Technology Businesses, plus a reasonable portion of other shared historical corporate expenses, were allocated to discontinued operations. Interest expense in 1992 was allocated based on short-term borrowings up to $75,000,000, which is approximately the amount of outside debt owed by ACXT immediately after the distribution. Interest expense on the short-term borrowings was based on interest rates ranging from 3.1% to 6.9% resulting in interest costs of $6,044,000 for the year ended December 27, 1992. Interest expense was capitalized based on construction in progress balances rather than on actual interest expense allocated.\nThe following summarizes the results of operations for discontinued operations:\nNOTE 3:\nProperties\nThe cost of properties and related accumulated depreciation, depletion and amortization consists of the following:\nInterest capitalized, expensed and paid was as follows:\nNOTE 4:\nDebt\nThe Company is obligated to pay the principal, interest and premium, if any, on the $5 million, City of Wheat Ridge, Colorado Industrial Development Bonds (Adolph Coors Company Project) Series 1993. The bonds mature in 2013. They are currently variable rate securities with interest payable on the first of March, June, September and December. The weighted average interest rate during 1994 was 3.0%.\nAs of December 25, 1994, the Company had outstanding $170 million of unsecured medium-term notes. All notes have interest due semi-annually in April and October at fixed interest rates ranging from 8.30% to 9.15% per annum. The repayment schedule for the notes issued is $44 million in 1995, $36 million in 1996, $19 million in 1997, $31 million in 1998 and $40 million in 1999.\nThe Company has an unsecured committed credit arrangement totaling $144 million, and as of December 25, 1994, all $144 million was available. This line of credit has a four-year term through December 12, 1998, and is subject to the Company maintaining certain financial ratios. The only restriction for withdrawal is that the Company meet specific covenant criteria. As of December 25, 1994, the Company also had approximately $100 million of uncommitted credit arrangements available, of which nothing was outstanding. The Company pays no commitment fees for these uncommitted arrangements, which are on a funds- available basis. Interest rates are negotiated at the time of borrowing.\nNOTE 5:\nIncome Taxes\nIn 1992, the Company and its subsidiaries adopted Statement of Financial Accounting Standards No. 109 (FAS 109), \"Accounting for Income Taxes.\" The transition effect of adopting FAS 109 resulted in a $30.5 million increase in net income reflected as the cumulative effect of a change in accounting principle in 1992.\nThe provision for income taxes charged to continuing operations was as follows:\nThe deferred tax assets (liabilities) are composed of the tax effect of the following:\nIn 1992, the Company's income tax expense for discontinued operations differed from the federal statutory rate of 34% because of non-deductible expenses of 8.8% and other items (similar to those below) of 4.5%. The effective rate was 29.7%.\nIncome taxes as reflected in the Consolidated Statement of Income differ from the amounts computed by applying the statutory federal corporate tax rate to income as follows:\nThe Internal Revenue Service (IRS) has completed its examination of the Company's federal income tax returns through 1990. The IRS is currently examining the fiscal years 1991 and 1992. In the opinion of management, adequate accruals have been provided for all income tax matters and related interest.\nThe Company and ACXT are parties to a tax sharing agreement that provides for, among other things, the treatment of tax matters for periods prior to the distribution of ACXT stock and responsibility for adjustments as a result of audits by taxing authorities and is designed to preserve the status of the distribution as tax-free.\nNOTE 6:\nStock Option and Restricted Stock Award Plans\nUnder the Company's stock option plans, officers and other key employees may be granted options which allow for the purchase of shares of the Company's common stock. The option price on outstanding options is equal to the fair market value of the stock at the date of grant. The 1983 non-qualified Adolph Coors Company Stock Option Plan, as amended, provides for options to be granted at the discretion of the board of directors. These options expire 10 years from date of grant. No options have been granted under this plan since 1989. At this time, the board of directors has decided not to grant additional options under this plan. The 1990 Equity Incentive Plan (1990 EI Plan) that became effective January 1, 1990, as amended, provides for two types of grants: restricted stock awards and stock options. The stock options have a term of 10 years with exercise prices equal to market on the day of the grant. Prior to 1994, one-third of the stock option grant was vested in each of the three successive years after the date of grant. Effective January 1, 1994, stock options vest at 10% for each one dollar increase in fair market value of ACC stock from date of grant, or vest 100% after nine years. Vesting in the restricted stock awards is over a three-year period from the date of grant. All restricted shares outstanding as of December 27, 1992, became fully vested because of the spin-off. The compensation cost associated with these awards is amortized to expense over the vesting period. In 1991, the Company adopted an Equity Compensation Plan for Non-Employee Directors (EC Plan). The EC Plan provides for two grants of the Company's stock; the first grant is automatic and equals 20% of the Director's annual retainer and the second grant is elective and covers all or any portion of the balance of the retainer. The compensation cost associated with the EC Plan is amortized over the Director's term. In 1992, all then outstanding grants under the restricted stock plan were accelerated to fully vest because of the spin-off.\nChanges in stock options are as follows:\nCommon stock reserved for options, and restricted stock awards totaled 1,866,800 shares as of December 25, 1994, and 2,331,800 shares as of December 26, 1993.\nIn January 1993, the number and exercise price of all options outstanding at the time of the ACX Technologies spin-off were adjusted to compensate for the economic value of the options as a result of the distribution to shareholders. The options of officers who transferred to ACX Technologies were canceled. The net effect of these adjustments decreased the number of options outstanding by 147,400.\nNOTE 7:\nEmployee Retirement Plans\nThe Company maintains several defined benefit pension plans for the majority of its employees. Benefits are based on years of service and average base compensation levels over a period of years. Plan assets consist primarily of equity, real estate and interest-bearing investments. The Company's funding policy is to contribute annually not less than the ERISA minimum funding standards, nor more than the maximum amount which can be deducted for federal income tax purposes. Total expense for these plans, as well as a savings and investment (thrift) plan, was $29,485,000 in 1994, $39,873,000 in 1993 and $20,282,000 in 1992. The 1993 increase in plan expense resulted primarily from the offering of the early retirement program and plan changes. Included in the 1993 service cost is $16.5 million which was the result of the early retirement program. The 1993 expense has been included in restructuring costs (Note 9).\nThe funded status of the pension plans and amounts recognized in the Consolidated Balance Sheet are as follows:\nSignificant assumptions used in determining the valuation of the projected benefit obligations as of the end of 1994, 1993 and 1992 were:\nNOTE 8:\nNon-Pension Postretirement Benefits\nThe Company has postretirement plans that provide medical benefits and life insurance for retirees and eligible dependents. The plans are not funded.\nThis obligation was determined by the application of the terms of medical and life insurance plans, together with relevant actuarial assumptions and health care cost trend rates ranging ratably from 11.0% in 1994 to 6.5% in the year 2006. The effect of an annual 1% increase in trend rates would increase the accumulated postretirement benefit obligation by approximately $8.5 million and $10.5 million in 1994 and 1993, respectively. The effect of a 1% increase in trend rates also would have increased the ongoing annual cost by $1.2 million and $1.0 million in 1994 and 1993, respectively. The discount rate used in determining the accumulated postretirement benefit obligation was 8.50% and 7.25% at December 25, 1994, and December 26, 1993, respectively.\nNet periodic postretirement benefit cost included the following:\nThe 1994 decrease in plan expense resulted principally from the 1993 early retirement program. Included in the 1993 service cost is $7.7 million which was the result of the early retirement program. That 1993 expense has been included in restructuring costs (Note 9).\nThe status of the plan was as follows:\nNOTE 9:\nSpecial (Credit) Charges\nFourth quarter results for 1994 include a net special credit of $13.9 million which is shown as a separate item in the accompanying Consolidated Statement of Income and resulted in $0.22 per share after tax. Two nonrecurring items contributed to the net special credit. First, the Company reached a settlement with a number of its insurance carriers which enabled it to recover a portion of the costs associated with the Lowry Landfill Superfund site. Secondly, CBC recorded an impairment reserve for the writedown of distributor assets.\nFourth quarter results for 1993 include several special charges. These special charges resulted in a pretax charge of $122.5 million, or $1.98 per share after tax. A restructuring charge, which totaled $109.5 million, or $1.77 per share after tax, resulted from the Company's announcement in July 1993 of a restructuring program designed to reduce costs, improve operating efficiencies and increase shareholder value. The restructuring charge includes $70.2 million for voluntary severance and enhanced early retirement incentives designed to reduce the Company's white-collar work force, as well as $39.3 million for workplace redesign, asset writedowns and other expenses related to profit improvement initiatives. Substantially all of the payments for voluntary severance and enhanced early retirement incentives occurred in 1993. Of the $39.3 million, approximately $22 million related to workplace redesign and other expenses related to profit improvement initiatives, and approximately $17.3 million related to asset writedowns. Substantially all costs related to workplace redesign and other profitability improvement initiatives, which were accrued in 1993, were paid in 1994. Other special charges unrelated to the profit improvement initiatives totaled $13.0 million for the writedown of certain distributor assets and a provision for environmental enhancements.\nThe 1993 restructuring charge and subsequent activity are summarized as follows:\nThe majority of the remaining accruals relate to obligations under deferred compensation arrangements and postretirement benefits other than pensions.\nNOTE 10:\nCommitments and Contingencies\nIt is the policy of the Company to act as a self-insurer for certain insurable risks consisting primarily of employee health insurance programs, workers'compensation and general liability contract deductibles. In 1994, a subsidiary of CBC continued to perform under an agreement to purchase coal for CBC's steam generation facility. The agreement runs for a five-year period beginning in 1990 and requires the purchase of a minimum of 330,000 tons of coal per contract year.\nIn 1992, CBC entered into a five-year supply contract to purchase substantial amounts of packaging raw materials from two subsidiaries of ACX Technologies. These contracts are for pre-determined quantities and based on market pricing.\nIn 1992, ACC and CBC (as well as two former affiliates that are now subsidiaries of ACXT) were sued by TransRim Enterprises (USA) Ltd. in Federal District Court for the District of Colorado. TransRim alleged that the defendants misused confidential information and breached an implied contract to proceed with a joint venture project to build and operate a paper board mill. TransRim initially claimed damages totaling $159 million based on a number of theories, some of which were removed from the case by the judge granting the defendants' motion for the partial summary judgement. Trial by a jury was held in April 1994, and the jury returned a verdict in favor of all defendants to all claims. TransRim filed an appeal to the U.S. Court of Appeals, 10th Judicial Circuit. Oral arguments were heard March 7, 1995. Management believes that ACC and CBC have meritorious defenses and that the ultimate outcome will not have a material impact on the Company's financial position and results of operations.\nIn 1992, CBC appealed to the U.S. Circuit Court of Appeals for the First Circuit seeking a review of a ruling of the U.S. District Court for the State of New Hampshire. The District Court had upheld a 1991 U.S. Bankruptcy Court order awarding damages of $10 million, plus interest and attorneys' fees, to a former beer distributor. In the fourth quarter of 1993, CBC entered into a settlement of this matter and a related case. The settlement was within the amount of reserves previously established for the matter.\nIn 1991, the Company became aware that Mutual Benefit Life Insurance Company (MBLIC) had been placed under the control of the State of New Jersey. The Company is a holder of several life insurance policies and annuities through MBLIC. The cash surrender value under these policies, net of outstanding loans, approximates $7,621,000. Policyholders have been notified that all claims, benefits and annuity payments will continue to be paid in full; however, at this time policyholders are able to only partially redeem their policies for cash.\nIn 1991, CBC entered into an agreement with Colorado Baseball Partnership 1993, Ltd. for an equity investment and multi-year signage and advertising package. This commitment, totaling approximately $30 million was finalized upon the awarding of a National League baseball franchise to Colorado in 1991. The initial investment as a limited partner has been paid. The multi-year signage and advertising package will commence in 1995.\nIn 1991, the City and County of Denver, Waste Management of Colorado, Inc. and Chemical Waste Management, Inc. brought litigation in U.S. District Court against the Company and 37 other PRP's to determine the allocation of costs of Lowry site remediation. In 1993, the Court approved a settlement agreement between the Company and the plaintiffs, resolving the Company's liabilities for the site. The Company agreed to initial payments based on an assumed present value of $120 million in total site remediation costs. In addition, the Company agreed to pay a specified share of costs if total remediation costs are in excess of this amount. Payments representing the Company's agreed share based on the $120 million assumption were made into a trust to be applied to costs of site remediation and operating and maintenance costs. None of these payments were material to the Company's cash flow or financial position. The terms did not result in any adjustment to the $30 million reserve established in 1990.\nThe Environmental Protection Agency (EPA) recently announced remediation objectives and requirements for the site and projected costs of its remediation plan. The EPA's projected costs are below the $120 million total assumed as a basis for the Company's settlement. The City and County of Denver, Waste Management of Colorado, Inc. and Chemical Waste Management are expected to implement remediation of the site. The Company has no reason to believe that total remediation costs will result in additional liability to the Company.\nIn 1991, the Company filed suit against certain of its former and current insurance carriers, seeking recovery of past defense costs and investigation, study and remediation costs. Settlements were reached during 1993 and 1994 with all defendants. As a result, in the fourth quarter of 1994, the Company recognized a special pretax credit of $18.9 million (Note 9).\nThe Company also is named as defendant in various actions and proceedings arising in the normal course of business. In all of these cases, the Company is denying the allegations and is vigorously defending against them and, in some instances, has filed counterclaims. Although the eventual outcome of the various lawsuits cannot be predicted, it is management's opinion these suits will not result in liabilities to such extent that they would materially affect the Company's financial position or results of operations.\nNOTE 11:\nQuarterly Financial Information (Unaudited)\nThe following summarizes selected quarterly financial information for each of the two years in the period ended December 25, 1994. The third quarter is a 16-week period; all other fiscal quarters are 12 weeks.\nAs described in Note 9, income in the fourth quarter of 1994 was increased by a special pretax credit of $13,949,000 or $.22 per share, and income from continuing operations in the fourth quarter of 1993 was reduced by special pretax charges of $122,540,000, or $1.98 per share.\nITEM 9.","section_9":"ITEM 9. Disagreements on Accounting and Financial Disclosure\nWithin the last two fiscal years there have been no changes in the Company's independent accounting firm or disagreements on material accounting and financial statement disclosure matters.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\n(a) Directors.\nJOSEPH COORS (Age 77) is Vice Chairman of Adolph Coors Company and has served in that capacity since 1975. He has served as a Director since 1942. He retired from day-to-day operations in December 1987. He serves as a member of the Executive Committee, the Debt Pricing Committee, the Compensation Committee and the Audit Committee. He is also a Director of Coors Brewing Company and ACX Technologies, Inc.\nPETER H. COORS (Age 48) has served as a Director of Adolph Coors Company since 1973. Prior to 1993, he served as Executive Vice President of Adolph Coors Company and Chairman of the Brewing Group. Also in 1993, he became Vice President and Secretary of Adolph Coors Company and was elected CEO and Vice Chairman of Coors Brewing Company. In December 1993, he was named interim treasurer. He is also a member of the Board of Directors of Coors Brewing Company. He serves as a member of the Debt Pricing Committee and the Executive Committee. In his career at Coors Brewing Company, he has served in a number of different positions, including Divisional President of Sales Marketing and Administration and Secretary (1982-1985), Senior Vice President, Sales and Marketing (1978-1982), Vice President (1976-1978), and Assistant Secretary and Assistant Treasurer (1974-1976).\nWILLIAM K. COORS (Age 78) is Chairman of the Board and President of Adolph Coors Company and has served in such capacities since 1970 and 1989, respectively. He has served as a Director since 1940. He serves as Chairman of the Debt Pricing Committee and the Executive Committee. He is also a director and Chairman of the Board of Coors Brewing Company and ACX Technologies, Inc.\nJ. BRUCE LLEWELLYN (Age 67) has served as a Director and member of the Audit Committee since 1989. In 1993, he was named chairman of the Audit Committee. He also serves on the Compensation Committee and the Special Performance-Based Compensation Committee. He is a member of the Board of Directors of Coors Brewing Company. He is an attorney and involved in the management of several businesses in which he is an investor. He is presently the Chairman of the Board and Chief Executive Officer of Philadelphia Coca Cola Bottling, Inc. and Queen City Broadcasting, Inc. He is also a Director of Manufacturers Hanover Trust\/Chemical Bank and QVC, Inc.\nLUIS G. NOGALES (Age 51) has served as a Director since 1989. He became a member of the Audit Committee in 1992. He has served as a member of the Compensation Committee since 1989 and was named chairman in May 1994. He is also a member of the Special Performance-Based Compensation Committee. He is a member of the Board of Directors of Coors Brewing Company. He is chairman and chief executive officer of Embarcadero Media, Inc., a media (radio) acquisition company in Los Angeles. In the past he was president of Nogales Partners (1990 to present), a media acquisition firm, general partner of Nogales Castro Partners (1989-1990), President of Univision, the nation's largest Spanish language television network (1986-1988), and Chairman and Chief Executive Officer of United Press International (1983-1986). From 1981-1983 he served as Senior Vice President of Fleishman-Hillard, Inc. He is also a Director of Southern California Edison Company and SCEcorp.\nWAYNE R. SANDERS (Age 47) joined the Company as a Director in February of 1995. He is chairman of the board and chief executive officer of Kimberly Clark (K-C) Corporation in Dallas. Sanders joined Kimberly Clark in 1975 as Senior Financial Analyst. For the past 20 years, he has served in a number of positions with K-C. He was named to his current position in 1992. Prior to that, he served as president and chief executive officer (1991); president, World Consumer, Nonwovens and Service and Industrial Operations (1990). He was elected to K-C's board of directors in August 1989.\n(b) Executive Officers.\nOf the above directors, Peter H. Coors and William K. Coors are executive officers of the Adolph Coors Company. The following also were executive officers of Adolph Coors Company (as defined by SEC rules) at March 1, 1995:\nALVIN C. BABB (Age 62) is Senior Vice President of Operations and Technology for CBC and has served in that capacity since 1983. Prior to that, he served as Group Vice President of Brewery Operations (1982-1983), Senior Vice President of Brewery Operations (1981-1982) and Senior Vice President of Plant Operations (1978-1981). He has been with CBC for more than 40 years. He is a member of the Master Brewing Association of America.\nCARL L. BARNHILL (Age 46) joined CBC in May of 1994 as Senior Vice President of Sales. Barnhill brings more than 20 years of marketing experience with consumer goods companies. Most recently, he was Vice President of Selling Systems Development for the European and Middle East division of Pepsi Foods International. Prior to joining Pepsi in 1993, he spent 16 years with Frito-Lay in various upper-level sales and marketing positions.\nROBERT W. EHRET (Age 50) joined CBC in May of 1994 as Senior Vice President, Human Resources. Prior to joining CBC, Ehret served as Senior Vice President of Human Resources for A.C. Nielsen. From 1983 to 1989, Ehret worked for PepsiCo Inc., as Director of Employee Relations and Personnel Director for two of PepsiCo's international divisions based in Tokyo and London. He also worked in various Human Resource capacities at Celanese Corporation.\nW. LEO KIELY, III (Age 48) became President and Chief Operating Officer of CBC as of March 1, 1993. Prior to joining CBC, he served as division vice president and then division president of the Frito-Lay, Inc. subsidiary of PepsiCo in Plano, Texas. From 1989-1991, he served as senior vice president of field operations, overseeing the operations of Frito-Lay's four regional business teams. From 1984-1989, he was the vice president of sales and marketing for Frito-Lay.\nROBERT D. KLUGMAN (Age 47) was named Senior Vice President of Corporate Development in May 1994, and Vice President of Corporate Development in July 1993. Prior to that, he vas Vice President of Brand Marketing, a position he held from 1981 - 1987, and again from 1990 - 1993. From 1987 to 1990 he was Vice President of International, Development and Marketing Services. Before joining CBC, Klugman was a Vice President of Client Services at Leo Burnett USA, a Chicago-based advertising agency.\nMICHAEL A. MARRANZINO (Age 47) has served as CBC's Senior Vice President and Chief International Officer since 1994. Prior to that, he served as Vice President and Director of International Marketing. He has been with CBC since 1976, and has held positions in the sales and marketing area, including director of development, director for Coors and Coors Extra Gold brands, director of sales and marketing operations, director of field sales and director of sales operations.\nM. CAROLINE TURNER (Age 45) was named Vice President and Assistant Secretary of ACC and Vice President, Chief Legal Officer and Assistant Secretary of CBC in 1993. In the past she served as Vice President, Chief Legal Officer (1991-1992) and Director, Legal Affairs (1986-1991) of ACC. Prior to joining the Company, she was a partner with the law firm of Holme Roberts & Owen (1983-1986), an associate for Holme Roberts and Owen (1977-1982) and a clerk in the U.S. 10th Circuit Court of Appeals (1976-1977).\nWILLIAM H. WEINTRAUB (Age 52) was named Senior Vice President of Marketing in 1994. He joined CBC as Vice President of Marketing in July, 1993. Prior to joining CBC, he directed all marketing and advertising for Tropicana Products as Senior Vice President. From 1982 - 1991, Weintraub was with the Kellogg Company, with responsibility for marketing and sales. He also held a number of positions at Procter & Gamble from 1967 - 1982.\nTIMOTHY V. WOLF (Age 41) was named Vice President, Treasurer and Chief Financial Officer of ACC and Senior Vice President and Chief Financial Officer of CBC in February, 1995. Wolf came to CBC from Hyatt Hotels Corporation, where he served as Senior Vice President of Planning and Human Resources from 1993 to 1994. From 1989 to 1993 he served in several executive positions for The Walt Disney Company including Vice President, Controller and Chief Accounting Officer.\nACC and CBC employ a number of other officers who are not considered executive officers of the Registrant as defined under SEC regulations. Terms for all officers and directors are for a period of one year, except that vacancies may be filled and additional officers elected at any regular or special meeting. Directors are elected at the Annual Shareholders' Meeting held in May. There are no arrangements or understandings between any officer or director pursuant to which any officer or director was elected as such.\n(d) Family Relationships.\nWilliam K. Coors and Joseph Coors are brothers. Peter H. Coors is a son of Joseph Coors.\n(e) Section 16 Disclosures.\nAll filing and disclosure requirements were met in 1994.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nI. SUMMARY COMPENSATION TABLE\n(a) Amounts awarded under the Management Incentive Compensation Program.\n(b) No restricted stock grants were made in 1994.\nIn 1993, restricted stock was granted to three of the named officers. The number of grants and their values at December 25, 1994 are as follows: Peter H. Coors - 3,000 shares valued at $47,625; W. Leo Kiely III - 1,000 shares valued at $15,875; and Alvin C. Babb - 300 shares valued at $4,763.\nRestricted stock awards granted in 1993 have a three-year vesting period based on year of grant and expire with termination of employment. Dividends are paid to the holders of the grants during the vesting period.\nNo restricted stock grants were made in 1992. In 1992, restricted stock grants existing as of December 27, 1992 became vested due to the spin-off. No restricted stock grants were outstanding as of December 27, 1992.\n(c) In 1992, cash was paid under CBC's 1990 Long-Term Incentive Plan for the three-year performance period ended December 27, 1992.\n(d) Under the 1983 Non-Qualified Stock Option Plan, the Company reimburses a portion of the taxes the executive will incur. In 1994, none of the named executives received perquisites in excess of the lesser of $50,000 or 10% of salary plus bonus. In 1993, W. Leo Kiely III and William H. Weintraub received perquisites including moving expenses of $299,639 for W. Leo Kiely III and $28,320 for William H. Weintraub. In 1992, William K. Coors had perquisites including personal use of the Company's Lear jet - $13,118 and auto allowance- $8,694. The Company no longer owns the Lear jet.\n(e) No stock option grants were made in 1992.\n(f) The amounts shown in this column are attributable to the officer life insurance and 401(k) plans. The named executives receive officer life insurance provided by the Company until retirement. At the time of retirement, the officer's life insurance program terminates and for some of the officers, the salary continuation agreement becomes effective. The officer life insurance provides six times the executive base salary until retirement, at which time the Company becomes the beneficiary. The 1994 annual benefit for each executive: William K. Coors - $79,354; Peter H. Coors - $4,969; W. Leo Kiely III - $3,423; Alvin C. Babb - $9,062; William H. Weintraub - $3,284. The Company's 50% match on the first 6% of salary contributed by the officer to ACC's qualified 401(k) plan was $4,133 for Peter H. Coors; $1,728 for W. Leo Kiely III; $4,389 for Alvin C. Babb; $4,501 for William H. Weintraub.\nIn response to Code Section 162 of the Revenue Reconciliation Act of 1993, the Company appointed a special compensation committee to approve and monitor performance criteria in certain performance based executive compensation plans for 1994.\nII. OPTION\/SAR GRANTS TABLE\n(a) From the date of grant, one-tenth of the grant vests for each one dollar increment in fair market value (FMV) of the stock over the exercise price. For example, when the FMV reaches $17.25, 10% of the grant is vested; when it reaches $18.25, 20% is vested; etc. FMV is calculated by averaging the high and low stock price for each day. Once a portion has vested, it is not reversed even if the FMV drops. If not sooner, the grant is 100% vested after 9 years. At December 25, 1994, the grants were 40% vested.\nIII. OPTION\/SAR EXERCISES AND YEAR-END VALUE TABLE\nAggregated Option\/SAR Exercises in Last Fiscal Year, and FY-End Option\/SAR Value\n(a) Values stated are the bargain element received in 1994, which is the difference between the option price and the market price at the time of exercise.\n(b) No grants were made in 1992. In 1992, ACC approved the adjustment of all options outstanding as of December 27, 1992, for both the amount and exercise price pursuant to a formula which retained the same option spread for the employee after the spin-off as had existed immediately prior to the spin-off.\nIV. LONG-TERM INCENTIVE PLAN AWARDS TABLE\n* Number of options to be granted. ** Award of 1\/2 restricted shares and 1\/2 cash.\nUnder the Long-Term Incentive Plan (LTIP), payout targets are dependent on cumulative Return on Invested Capital (ROIC) which is defined as earnings before interest expense and after tax, divided by debt plus equity. The LTIP cycle is three years, with any payout at the beginning of the fourth year. Under the first cycle, the earliest potential payout is for 1994-1996. Participants elect the form of payout from several options. The first option is to receive one-half of the payout in cash, one-half in shares of restricted stock. Restricted shares will be fully vested, but will be restricted from sale for a period of five years. The second option allows the participant to use the cash portion of payout to purchase discounted shares of stock (based on 75% of the fair market value of the stock at the time of payout.) Shares purchased under this option are fully vested, but cannot be sold for a period of three years.The third option allows the participant to elect a percentage (a multiple of10, but not more than 100) of the total award amount to be received in the form of stock options; the number of options to be three times the total award amount divided by the fair market value of the stock at the time the participant enters the LTIP. The options will be fully vested and have a ten-year term. The remainder of the award, if the percentage elected is less than 100%, will be awarded one-half in cash, one-half in restricted shares of stock. All shares will receive dividends during the restriction period.\nV. PENSION PLAN TABLE\nThe following table sets forth annual retirement benefits for representative years of service and average annual earnings.\n*Maximum permissible benefit under ERISA from the qualified retirement income plan for 1994 was $118,800 and annual compensation in excess of $150,000 is not considered for benefits under the qualified plan. The Company has a non-qualified supplemental retirement plan to provide full accrued benefits to all employees in excess of IRS maximums.\nAnnual average compensation covered by the retirement plan and credited years of service for individuals named in Item 11(a) are as follows: William K. Coors - $247,340 and 55 years; Peter H. Coors - $456,339 and 23 years; and Alvin C. Babb - $280,224 and 41 years; W. Leo Kiely III - $379,454 and 1 year; William H. Weintraub - $270,479 and 1 year.\nThe Company's principal retirement income plan is a defined benefit plan. The amount of contribution for officers is not included in the above table since total plan contributions cannot be readily allocated to individual employees. The Company's most recent actuarial valuation was as of January 1, 1994, in which the ratio of plan contributions to total compensation covered by the plan was approximately 9.2%. Covered compensation is defined as the total base salary (average of three highest consecutive years out of the last ten) of employees participating in the plan, including commissions but excluding bonuses and overtime pay. Compensation also includes amounts deferred by the individual under Internal Revenue Code Section 401(k) and any amounts deferred into a plan under Internal Revenue Code Section 125. Normal retirement age under the plan is 65. An employee with at least 5 years of vesting service may retire as early as age 55. Benefits are reduced for early retirement based on an employee's age and years of service at retirement; however, benefits are not reduced if (1) the employee is at least age 62 when payments commence or (2) the employee's age plus years of service equal at least 85 and the employee has worked for CBC at least 25 years. The amount of pension actually accrued under the pension formula is in the form of a straight line annuity.\nIn addition to the annual benefit from the qualified Retirement Plan, two of the named executives are covered by salary continuation agreements. These agreements provide for a lump sum cash payment to the officer upon normal retirement in an amount actuarially equivalent in value to 30% of the officer's last annual base salary, payable for the remainder of the officer's life, but not less than 10 years. If the officer should die after age 55, the surviving spouse receives the lump sum. The interest rate used in calculating the lump sum is determined using 80% of the annual average yield of the 10-year Treasury constant maturities for the month preceding the month of retirement. Using 1994 eligible salary amounts as representative of the last annual base salary, the estimated annual benefit upon normal retirement for these officers would be: Peter H. Coors- $140,500 and Alvin C. Babb - $86,900.\nCompensation of Directors\nThe Company adopted the Equity Compensation Plan for Non-Employee Directors (EC Plan) effective May 16, 1991. The EC Plan provides for two grants of Adolph Coors Company's Class B (non-voting) common stock to non-employee (NE) directors. The first grant is automatic and equals 20% of the annual retainer. The second grant is elective and allows the NE directors to take a portion, or all, of the remaining annual retainer in stock. Amounts of both grants are determined by the market value of the shares on the date of grant. Shares received under either grant may not be sold or disposed of before completion of the annual term. The Company reserved 50,000 shares of stock to be issued under the EC Plan. The retainer for the 1992-1993 term was $25,000 plus $1,500 per meeting. Beginning with the 1993-1994 annual term the Company increased the NE directors' annual retainer to $32,000 and eliminated the per meeting fee.\nThe NE members of the Board of Directors in 1993 were paid 50% of the $25,000 annual retainer for the 1992-1993 term plus $1,500 per meeting and 50% of the $32,000 annual retainer for the 1993-1994 term and reimbursement of expenses incurred to perform their duties as directors. Directors who are full-time employees of the Company receive $15,000 annually. All directors are reimbursed for any expenses incurred while attending Board of Directors or committee meetings and in connection with any other CBC business. In addition, Joseph Coors, as a director and retired executive officer, is provided an office, transportation and secretarial support from CBC.\nEmployment Contracts and Termination of Employment Arrangements\nCBC has no agreements with executives or employees providing employment for a set period. W. Leo Kiely III, President and COO, has an agreement with CBC that provided for a guaranteed bonus equal to 50% of base salary for the first and second year of his employment (1993 and 1994). In the event of termination without cause prior to June 1, 1995, CBC would pay his base monthly salary plus the guaranteed bonus for 30 months. If Mr. Kiely were terminated without cause on or after June 1, 1995, he would receive his then current salary for 18 months plus 1 1\/2 times his last bonus amount. In either case, health benefits would continue through the payout period or when he commenced other employment if earlier.\nWilliam H. Weintraub, Senior Vice President, Marketing, has an agreement which provided for a guaranteed bonus equal to 40% of base salary for 1993 and 1994. It provides that, if Mr. Weintraub were terminated without cause prior to July 1, 1995, he would receive 15 months of salary plus the 40% bonus for that period.\nIn 1993, Alvin C. Babb, Senior Vice President, Operations & Technology, and CBC entered into an agreement providing for certain payments to Mr. Babb if his employment terminates on or before December 31, 1996. CBC would pay Mr. Babb an amount equal to two times his salary plus a lump-sum payment under his salary continuation agreement using a 5% discount factor and would pay any differential between medical benefits then provided and medical benefits provided under CBC's 1993 medical program.\nThe standard severance program for officers is one year of base salary plus a prorated portion of any earned bonus for the year of severance.\nComparison of 5-year Cumulative Total Return*\n*Assumes that the value of the investment in ACC Common Stock and each index was $100 on December 25, 1989, and that all dividends were reinvested.\n**Results for 1992 includes $7.92 for the spin-off occurring in December 1992.\nCompensation Committee Report on Executive Compensation\nThe Compensation Committee of the Board of Directors has furnished the following report on executive compensation for Adolph Coors Company's operating subsidiary, Coors Brewing Company (CBC). This report represents Adolph Coors Company's compensation philosophy for fiscal year 1994.\nOverview of Compensation Strategy for Executives\nUnder the supervision of the three member 1994 Compensation Committee of the Board of Directors, the Company continued to support the philosophy that compensation policies, plans and programs must enhance the profitability of the Company by linking financial incentives of senior CBC management with the Company's financial performance. While the base salary philosophy remained the same, all incentive programs were changed to drive shareholder value and increase profitability.\nAnnual base salaries were set at median levels found in the external market. A more aggressive posture was adopted for base salaries for senior officers who have accountability for major functions. Incentive compensation strategies were tied to Company performance and shareholder return to encourage a greater return on invested capital and to increase share price.\nThe Compensation Committee's compensation strategy for CBC's CEO and other executive officers consisted of:\n-targeting base salary to the 50th percentile of relevant,\nbroadly-defined external markets;\n-a Company-wide annual profit sharing program under which all eligible employees share profits based on an equal percentage of payout;\n-providing an annual cash incentive award targeted at the 75th percentile of the same external markets;\n-providing annual stock grants designed to increase shareholder return;\n-developing a long-term incentive plan designed to increase return on invested capital.\nRelationship of Performance to Specific Elements of the Compensation Strategy\nFollowing are brief descriptions that outline details and performance measures of each component of the 1994 executive compensation strategy.\nBase Salary\nThe Company used compensation survey data to determine salaries competitive at the 50th percentile for like positions in similar sized manufacturing companies. Company size was determined by total net sales.\nSalary ranges were established for executives by using the 50th percentile market data as the mid-point, with a 50% spread between minimum and maximum. Where the executive was paid within the range was determined by individual performance.\nAnnual Profit Sharing Program\nAll full time and part time employees of the Company are eligible for a payout based on annual pre-tax profit goals being met. Payouts to all employees are based on an equal percentage of their 1994 eligible earnings.\nManagement Incentive Compensation Program\nIn 1994, the annual Management Incentive Compensation Program was changed to drive both Company profitability and individual performance. Executive officers and other key management personnel were measured based on pre-tax profit and written individual performance plans tied to Company objectives. Payout may only occur after profit objectives are realized. The Compensation Committee approved annual pre-tax profit objectives as well as minimum and maximum payout levels within the program. Annual targets were met and payouts to all eligible employees were based on those profit and individual performance results as a percentage of their beginning 1994 salary.\nIn 1994, the Chief Operating Officer and Senior Vice President of Marketing, as part of their agreements with CBC, earned a cash incentive award based on a percentage of their 1994 base salary.\nAnnual Stock Option Grants\nIn 1994, the Committee approved granting of stock options to the executive officers and to other key management personnel. Options were granted as a percentage of base salary and based on the individual's level in the organization. Options were granted with a ten year term. Option vesting is based on a one year holding period and an increase in share value. Options vest 10% for each one dollar increase in fair market value. All options vest after nine years regardless of share value increase. Options were granted through the 1990 Equity Incentive Plan (1990 EI Plan).\nThe 1990 EI Plan was administered by the Compensation Committee. That committee was composed of non-employee, independent directors. The 1990 EI Plan provided that options be granted at exercise prices equal to the fair market value on the date the option was granted.\nLong Term Incentive Plan\nIn 1994, the Committee established a Long Term Incentive Plan (LTIP). Participants are all officers and selected key personnel. The plan is on a biannual basis. Each plan has a three year measurement cycle (first plan cycle is for years 1994 through 1996). The plan measures cumulative return on invested capital. The Committee established both minimum and maximum payout levels for participants as a percentage of 1994 salary and level within the organization. The plan provides for three different options regarding payout, which must be elected before the start of the plan cycle.\nThe first option of payout is to receive one-half of the payout in restricted shares, one-half in cash. The restricted shares have a five year restriction. The second option is to take the cash portion of the first option to purchase shares of Company stock at a 25% discount, with a three year restriction on the purchased shares. The third option is to take stock options in lieu of both restricted shares and cash in 10% increments at a three to one ratio. These options have a ten year term with no further restrictions.\nCEO Compensation for 1994\nThe CEO's compensation for 1994 did not reflect any of the incentive elements of the Company's compensation strategy. While fully supportive of the executive compensation strategy and fully committed to the Company goal of improved profitability and an increase in shareholder value, CEO William K. Coors has elected not to participate in the incentive programs. It is Mr. Coors' belief that his compensation, although low relative to market and industry standards, is adequate to support his needs and that, given his strong commitment to corporate goals and objectives, financial incentives would not enhance his motivation to achieve superior performance. Mr. Coors did however, receive a 8.0% increase in base salary, which was his first increase in salary over the past twelve years.\nLuis G. Nogales, Chairman Joseph Coors J. Bruce Llewellyn\nCompensation Committee Interlocks and Insider Participation\nJoseph Coors, J. Bruce Llewellyn and Luis G. Nogales served on the Compensation Committee during the past fiscal year. Joseph Coors, retired as the President and Chief Operating Officer of the Company in December 1987.\nJoe Coors sold a Coors beer distributorship in Cincinnati, Ohio on December 31, 1993.\nJoseph Coors is a director of both ACC and ACXT. He, along with William K. Coors, a Director of both ACC and ACXT, and Peter H. Coors, a Director and an executive officer of ACC, are trustees of several family trusts that collectively own a majority of the common stock of ACXT. ACC and ACXT, or their subsidiaries, have certain business relationships and have engaged in certain transactions with one another, as described below.\nIn connection with the spin-off of ACXT in December 1992, CBC entered into market-based, long-term supply contracts with certain ACXT subsidiaries to provide packaging, aluminum and starch products to CBC. Under the packaging supply agreement, CBC agreed to purchase from an ACXT subsidiary substantially all of CBC's paperboard and label requirements through 1997. Under the aluminum supply agreement, CBC agreed to purchase from another ACXT subsidiary all of CBC's requirements for aluminum can end stock and a substantial amount of CBC's tab stock needs, as well as substantial quantities of body stock through 1994. In addition, CBC agreed to purchase substantial volumes ofaluminum stock to meet CBC's requirements, based on absolute pounds or percentages of CBC needs through 1997. ANC is acting as a purchasing agent under the agreement for the CBC\/ANC end and can joint venture. These supply contracts are a material source of revenue for ACXT and provide CBC a stable source for a significant portion of its raw materials and packaging materials. In addition, CBC sells brewery by- products to an ACXT subsidiary and sells aluminum scrap from CBC's can making operations to another ACXT subsidiary.\nAlso in connection with the spin-off, ACC and ACXT and their subsidiaries negotiated several other agreements, including employee matters, environmental management, tax sharing, trademark licensing agreements. In addition, there were numerous one-year transitional agreements for various services and materials. A few continuing service agreements between ACC and ACXT subsidiaries include agreements under which Coors Energy Company supplies natural gas to certain Colorado facilities of ACXT and an agreement by CBC to provide water and waste water treatment services for an ACXT ceramics facility. A joint defense agreement that commenced at the time of the spin-off is in effect with respect to the TransRim litigation described in Item 3, Legal Proceedings. A description of the foregoing agreements was included in the Company's report on Form 8-K dated December 27, 1992, in Exhibit B, \"Information Statement,\" dated December 9, 1992, mailed by the Company to its shareholders.\nCBC is a limited partner in a limited partnership, formed in connection with the spin-off, with an ACXT subsidiary as general partner. The partnership owns, develops, operates and sells certain real estate previously owned directly by CBC or ACC. Each partner is obligated to make additional cash contributions of up to $500,000 upon call of the general partner. Distributions of $1,000,000 were made to both partners in 1994. Distributions are allocated equally between the partners until CBC recovers its investment, and thereafter 80% to the general partner and 20% to CBC.\nIn 1993, CBC sold certain laboratory facilities and technology to an ACXT subsidiary for approximately $350,000, the estimated fair value of the assets. In addition, certain subsidiaries of ACC and ACXT are parties to miscellaneous market-based transactions. For instance, CBC buys ceramic can tooling from an ACXT subsidiary to test on CBC can lines and CBC serves as aggregator for long distance telephone services for itself and certain ACXT companies. During 1994, a lease of office space from CBC to the limited partnership, mentioned above, terminated.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security Ownership of Certain Beneficial Owners\nThe following table sets forth stock ownership of persons holding in excess of five percent of any class of voting securities, as of March 15, 1995:\nIn addition, certain officers and directors hold interests in other family trusts, as indicated in Item 12, Section (b) (1) following.\n(b) Security Ownership of Management\nThe following table sets forth stock ownership of the Company's directors, and all executive officers and directors as a group, as of March 15, 1995:\n(1) William K. Coors and Peter H. Coors are two of the trustees of the Adolph Coors Foundation, which owns 732,413 shares of Class B Common Stock. William K. Coors, Joseph Coors and Peter H. Coors are trustees, in addition to other trustees, and beneficiaries or contingent beneficiaries in certain cases, of various trusts that own an aggregate of 16,762,111 shares. These individuals, and others, are trustees of five other trusts owning 1,762,921 shares. In certain of these trusts, they act solely as trustees and have novested or contingent benefits. The total of these trust shares, together with other management shares shown above, represents 53% of the total number of shares ofsuch class outstanding.\n(2) This represents exercisable options to purchase shares under the Company's 1983 Non-Qualified Stock Option Plan and 1990 Equity Incentive Plan (as amended in 1994) that could be exercised as of March 15, 1995. In addition,it reflects restricted stock awards granted under the 1990 Equity Incentive Plan. Vesting in the restricted stock is over a three year period from date of grant. All restricted stock awards became fully vested at the time of the ACXTspin-off. In the event of a change in control of the Company, all vesting restrictions on the restricted stock awards would be lifted.\n(c) Changes in Control.\nThere are no arrangements that would at some subsequent date result in a change of control of the Company.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\n(a) & (b) For a description of certain business relationships and related transactions see the discussion under the caption \"Compensation Committee Interlock and Insider Participation\" contained in Item 11 of this report.\n(c) Indebtedness of Management\nLoans are made available to employees in connection with the exercise of stock options. No such loans were made or outstanding in 1994.\nThere was no other indebtedness in excess of $60,000 between the Company and any member of management or others that have a direct or indirect interest in the Company.\nPART IV ITEM 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 of financial statements in Item 8.\n(2) Financial Statement Schedules:\nSchedule II - Valuation and Qualifying Accounts\nCertain financial schedules that were presented in previous years' reports are no longer required by Regulation S-X. These schedules have been omitted from this report.\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(3) Exhibits:\nExhibit 3.1 - Amended Articles of Incorporation. (Incorporated by reference to Exhibit 3.1 to Form 10-K for the fiscal year ended December 30, 1990)\nExhibit 3.2 - Amended By-laws. (Incorporated by reference to Exhibit 3.2 to Form 10-Q for the fiscal quarter ended June 13, 1993)\nExhibit 4.1 - Form of Indenture for Adolph Coors Company Senior Debt Securities. (Incorporated by reference to Exhibit 4 to Registration Statement on Form S-3 filed March 14, 1990 and amended on March 26, 1990, file No.33-33831). Upon request, the Company agrees to provide a copy of any debt instrument as applicable under Regulation S-K, Item 601, (b)(4)(iii).\nExhibit 10.1 - Officers' Life Insurance Program. (Incorporated by reference to Exhibit 10 to Form 10-K for the fiscal year ended December 28, 1980)\nExhibit 10.2* - Officers and Directors Salary Continuation Agreement. (Incorporated by reference to Exhibit 10 to Form 10-K for the fiscal year ended December 26, 1982)\nExhibit 10.3* - Adolph Coors Company 1983 Non-Qualified Stock Option Plan, as amended effective February 13, 1992 (Incorporated by reference to Exhibit 10.3 to Form 10-K for the fiscal year ended December 29, 1991)\nExhibit 10.4* - Model of Coors Brewing Company Annual Incentive Plan\nExhibit 10.5* - Coors Brewing Company Long-Term Incentive Plan, 1994-1996 Plan Cycle.\nExhibit 10.6* - Adolph Coors Company Equity Incentive Plan. Amended as of May 12, 1994.\nExhibit 10.7* - Coors Brewing Company Employee Profit Sharing Program. (Incorporated by reference to Exhibit 10.8 to Form 10-K for the fiscal year ended December 31, 1989)\nExhibit 10.8 - Adolph Coors Company Non-Employee Director Compensation Deferral Plan. (Incorporated by reference to Exhibit 10.9 to Form 10-K for the fiscal year ended December 31, 1989)\nExhibit 10.9 - Agreement between Adolph Coors Company and a former Executive Officer and current Director. (Incorporated by reference to Exhibit 10.10 to Form 10-K for the fiscal year ended December 31, 1989)\nExhibit 10.10 - Form of Coors Brewing Company Distributorship Agreement. (Introduced 1989) (Incorporated by reference to Exhibit 10.11 to Form 10-K for the fiscal year ended December 31, 1989)\nExhibit 10.11 - Adolph Coors Company Water Augmentation Plan.\n(Incorporated by reference to Exhibit 10.12 to Form 10-K for the fiscal year ended December 31, 1989)\nExhibit 10.12 - Adolph Coors Company Equity Compensation Plan for Non- Employee Directors (Incorporated by reference to Exhibit 4.1 to registration Statement on Form S-8 filed on May 21, 1991, file No. 33-40730)\nExhibit 10.13 - Distribution Agreement dated as of October 5, 1992, between the Company and ACX Technologies, Inc. (Incorporated herein by reference to the Distribution Agreement included as Exhibits 2, 19.1 and 19.1A to the Registration Statement on Form 10 filed by ACX Technologies, Inc. (file No. 0-20704) with the Commission on October 6, 1992, as amended.)\nExhibit 10.14* - Employment Contracts and Termination of Employment Agreements for W. Leo Kiely III, Alvin C. Babb and William H. Weintraub. (Incorporated by reference to Exhibit 10.17 to Form 10-K for the fiscal year ended December 26, 1993)\nExhibit 10.15 - Revolving Credit Agreement, dated as of December 12, 1994.\nExhibit 21 - Subsidiaries.\nExhibit 23 - Consent of Independent Accountants.\n*Represents a management contract.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the fourth quarter ended December 25, 1994.\n(c) Other Exhibits\nNo exhibits in addition to those previously filed and listed in Item 14 (a) (2) are filed herein.\n(d) Other Financial Statement Schedules\nNo additional financial statement schedules are required.\nOther Matters\nFor the purpose 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-8No. 33-2761 (filed January 17, 1986), 33-35035 (filed May 24, 1990) and 33-40730 (filed May 21, 1991) and on Form S-3 No. 33-33831 (filed March 14, 1990):\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.","section_15":""}
{"filename":"92088_1994.txt","cik":"92088","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nBellSouth Telecommunications, Inc. (BellSouth Telecommunications), a corporation wholly-owned by BellSouth Corporation (BellSouth), is the surviving corporation from the merger, effective at midnight December 31, 1991, of South Central Bell Telephone Company (South Central Bell) and Southern Bell Telephone and Telegraph Company (Southern Bell). BellSouth Telecommunications provides predominantly tariffed wireline telecommunications services to approximately two-thirds of the population and one-half of the territory within Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina, South Carolina and Tennessee. These areas were previously served by South Central Bell and Southern Bell. BellSouth Telecommunications continues to use the names South Central Bell and Southern Bell for various purposes.\nSouth Central Bell was incorporated in 1967 under the laws of the State of Delaware and Southern Bell was incorporated in 1879 under the laws of the State of New York. On December 31, 1983, pursuant to a consent decree approved by the United States District Court for the District of Columbia (the D. C. District Court) entitled \"Modification of Final Judgment\" (the MFJ) settling antitrust litigation brought by the United States Department of Justice (the Justice Department) in 1974 and the related Plan of Reorganization (the POR), American Telephone and Telegraph Company, now AT&T Corp. (AT&T), transferred to BellSouth its 100% ownership of South Central Bell and Southern Bell. On the same date, South Central Bell and Southern Bell were reincorporated through mergers into Georgia corporations. On January 1, 1984, ownership of BellSouth was divested from AT&T and BellSouth became a publicly traded company.\nBellSouth Telecommunications has its principal executive offices at 675 West Peachtree Street, N.E., Atlanta, Georgia 30375 (telephone number 404-529-8611).\nMODIFICATION OF FINAL JUDGMENT\nPursuant to the MFJ, AT&T divested the 22 wholly-owned operating telephone companies, including South Central Bell and Southern Bell, that were formerly part of the Bell System. The ownership of such 22 operating telephone companies was transferred by AT&T to seven holding companies (the Holding Companies), including BellSouth. All territory in the continental United States served by the operating telephone companies was divided into geographical areas termed \"Local Access and Transport Areas\" (LATAs). These LATAs are generally centered on a city or other identifiable community of interest.\nThe MFJ limits the telecommunications-related scope of the post-divestiture business activities of the operating telephone companies and their successors (the Operating Telephone Companies), and the D. C. District Court retained jurisdiction over construction, implementation, modification and enforcement of the MFJ*. Under the MFJ, the Operating Telephone Companies may provide local exchange, exchange access, information access and toll telecommunications services within the LATAs. Although prohibited from providing service between LATAs, the Operating Telephone Companies provide exchange access services that link a subscriber's telephone or other equipment in one of their LATAs to the transmission facilities of carriers (the Interexchange Carriers), which provide toll telecommunications services between different LATAs. The Operating Telephone Companies may market, but not manufacture, customer premises equipment (CPE), which is defined in the MFJ as equipment used on customers' premises to originate, route or terminate telecommunications. A\n- ------------------------ * The provisions of the MFJ are applicable also to the Holding Companies.\nsimilar restriction applies to the manufacture or provision of \"telecommunications equipment,\" which is defined in the MFJ as including equipment used by carriers to provide telecommunications services.\nThe D.C. District Court has established procedures for obtaining generic and specific waivers from the manufacturing and interLATA communications restrictions of the MFJ, although the required filings with and review by the Justice Department and the D.C. District Court usually result in lengthy and uncertain proceedings. The foregoing restrictions present significant obstacles to the provision of certain wireless, cable television and other communications services and require that such business operations, even where waivers are ultimately obtained, be conducted under burdensome arrangements or subject to elaborate structural separation or other conditions. BellSouth is a party to litigation and is advocating legislation intended to remove or relax the MFJ restrictions. (See \"Competition -- BellSouth Telecommunications' Competitive Strategy.\")\nThe MFJ requires the Operating Telephone Companies to provide, upon a bona fide request by any Interexchange Carrier or information service provider, exchange access, information access and exchange services for such access that will be equal to that provided to AT&T in quality, type and price. BellSouth Telecommunications believes it is in compliance with this requirement.\nBUSINESS OPERATIONS\nApproximately 86% of BellSouth Telecommunications' operating revenues for the years ended December 31, 1994, 1993 and 1992, respectively, were from wireline telecommunications services and the remainder of revenues was principally from directory publishing fees, CPE sales and maintenance and other nonregulated services.\nCertain communications services and products are provided to business customers by BellSouth Business Systems, Inc., BellSouth Communication Systems, Inc. and Dataserv, Inc., subsidiaries of BellSouth Telecommunications. Respectively, these companies provide sales, marketing, product management and customer service for BellSouth Telecommunications' large business customers within traditional telephone operating company service areas and nationwide; sell, install and maintain CPE; and maintain and provide parts and integration services for computer and data processing equipment.\nRevenues from services provided to AT&T, BellSouth Telecommunications' largest customer, comprised approximately 13%, 16% and 16% of 1994, 1993 and 1992 operating revenues, respectively.\nTELEPHONE COMPANY OPERATIONS\nBellSouth Telecommunications provides services, which include local exchange, exchange access and intraLATA toll services, within each of the 38 LATAs in its combined nine-state operating area. BellSouth Telecommunications experienced an increase in access lines of approximately 887,400 during 1994, resulting in a total of 20,220,000 lines at December 31, 1994. The overall increase of 4.6% was primarily attributable to continued economic improvement in BellSouth Telecommunications' nine-state service region and an increase in the number of second residential lines. Second residential lines accounted for approximately 23% of the overall increase in access lines since December 31, 1993. (See \"Management's Discussion and Analysis of Results of Operations -- Volumes of Business.\")\nAt December 31, 1994, approximately 76% of access lines were in 53 metropolitan areas, each having a population of 125,000 or more. Many localities and some sizable areas in the states in which BellSouth Telecommunications operates are served by non-affiliated telephone companies, which had approximately 29% of the network access lines in such states on December 31, 1994. BellSouth Telecommunications does not furnish local exchange, access or toll services in the areas served by such companies.\nLOCAL AND TOLL SERVICES\nCharges for local services for each of the years ended December 31, 1994, 1993 and 1992 accounted for approximately 49%, 48% and 47%, respectively, of BellSouth Telecommunications' operating revenues. Local services operations provide lines from telephone exchange offices to subscribers' premises for the origination and termination of telecommunications including the following: basic local telephone service provided through the regular switching network; dedicated private line facilities for voice and special services, such as transport of data, radio and video and foreign exchange services; switching services for customers' internal communications through facilities owned by BellSouth Telecommunications; services for data transport that include managing and configuring special service networks; and dedicated low or high capacity public or private digital networks. Other local services revenue is derived from intercept and directory assistance, public telephones and various secondary central office features.\nSecondary central office features may be purchased by access line subscribers for a charge in addition to the basic monthly fee. They include Custom Calling service (including Call Waiting, 3-Way Calling, Call Forwarding and Speed Dialing services) and Touchtone service. During 1994, revenues from secondary central office features comprised approximately 17% of local service revenues.\nIn addition to secondary central office features, BellSouth Telecommunications offers certain enhanced services through its network. Enhanced services differ from basic services and secondary central office features in that they employ computer processing applications to alter the subscriber's transmitted information; provide the subscriber additional, different or restructured information; or involve subscriber interaction with stored information. The terms of enhanced service offerings are not regulated under the rules of the Federal Communications Commission (FCC), but the FCC prescribes the method by which such services may be provided (for example, through structurally separated subsidiaries or arrangements providing access to competitive providers). Such offerings include voice messaging and storage services, such as MemoryCall-Registered Trademark- voice messaging service.\nBellSouth Telecommunications provides intraLATA toll services within, but not between, its 38 LATAs. Such toll services provided approximately 8%, 9% and 10% of BellSouth Telecommunications' operating revenues for the years ended December 31, 1994, 1993 and 1992, respectively. These services include the following: intraLATA service beyond the local calling area; Wide Area Telecommunications Service (\"WATS\" or \"800\" services) for customers with highly concentrated demand; and special services, such as transport of data, radio and video.\nBellSouth Telecommunications is subject to state regulatory authorities in each state in which it provides telecommunications services with respect to intrastate rates, services and other issues. Traditionally, BellSouth Telecommunications' rates were set in each state in its service areas at levels which were anticipated to generate revenues sufficient to cover its allowed expenses and to provide an opportunity to earn a fair return on its capital investment. Such a regulatory structure was satisfactory in a less competitive era; however, BellSouth Telecommunications is currently advocating changes to the regulatory processes responsive to the increasingly competitive telecommunications environment. Modified forms of state regulation are in effect in Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi and Tennessee.\nUnder one such modified form of regulation, economic incentives are provided to lower costs and increase productivity through the potential availability of \"shared\" earnings over a benchmark rate of return. Generally, when levels above targeted returns are reached, earnings are \"shared\" by providing refunds or rate reductions to customers. The amounts of any such excess that may be retained under some plans depend upon attaining mandated service standards, certain productivity improvement provisions or both. Some sharing plans have a maximum point above which all earnings must be returned to customers. Under some plans, if earnings fall below a targeted minimum, additional earnings required to return to the bottom of the allowed range can be obtained through rate increases. Sharing plans are generally subject to renewal after two or three years, and may be subject to modification prior to renewal.\nDespite the potential advantages offered by sharing plans, substantial rate reductions have been incurred in connection with their adoption and operation. Of the states in which these types of plans were in place, BellSouth Telecommunications attained the earnings sharing range in Alabama, Florida, Kentucky and Louisiana in 1994.\nAnother form of regulation focuses on the prices that can be charged for telecommunications services. While such a plan limits the amount of increase for specified services, it enhances the company's ability to adjust prices and service options to more effectively respond to changing market conditions and competition. For these reasons, BellSouth Telecommunications is focusing its regulatory and legislative efforts on replacing existing plans with price regulation. The Florida, Georgia, North Carolina and Tennessee legislatures are considering bills that would provide for or allow price regulation and\/or local exchange competition. (See \"Management's Discussion and Analysis of Results of Operations -- Operating Environment and Trends of the Business.\")\nALABAMA\nAn incentive regulation plan has been in effect in Alabama since December 1988, which provides for a return on average total capital* in the range of 11.65% to 12.30%. If earnings exceed 12.30% or drop below 11.65%, sharing with customers may range from 50% to 100%, depending upon whether certain service and efficiency requirements are met.\nIn December 1993, in conjunction with approval of rate adjustments required by its incentive plans, the Alabama Public Service Commission approved a settlement of several outstanding issues. The settlement resulted in a net rate reduction to the company of $15.7 million.\nAs a result of the first, second and third quarter filings under the plan in effect, the Alabama Commission accepted rate reductions of $13.1 million in April 1994, $16.4 million in July 1994 and $8.9 million in October 1994.\nIn February 1995, BellSouth Telecommunications filed a proposed price regulation plan with the Alabama Commission. The proposal includes provisions that basic rates for residential and business customers would not increase for five years, intrastate switched access prices would be capped at the interstate level for five years and the company would reduce rates by $30 million.\nFLORIDA\nFrom 1988 through 1992, the Florida incentive plan provided for a return on equity* of 11.5% to 16%, with earnings above 14% to be shared 40% by BellSouth Telecommunications and 60% by customers with an after-sharing cap of 16%. The sharing level was not attained under the plan.\nIn 1993, BellSouth Telecommunications filed a petition to extend the existing plan. In January 1994, after extensive proceedings and negotiations between BellSouth Telecommunications, Public Counsel and intervenors, the Florida Public Service Commission approved a settlement that extends incentive regulation through 1996. Among other things, the terms of the settlement provided for rate reductions of $55 million in February 1994, an additional $60 million in July 1994, $80 million in October 1995 and $84 million in October 1996. The settlement provided for other changes in service offerings and tariffs including approximately $21 million in revenue reductions or increased expenses. Basic service rates have been capped at their current levels through 1997, and BellSouth Telecommunications has agreed not to propose any local measured service on a statewide basis through the same time period.\nThe agreement established a 1994 return on equity* sharing level of 12% with an after-sharing cap of 14%, increasing in 1995 to a 12.5% sharing level with an after-sharing cap of 14.5%. Rates of return beyond 1995 would vary based upon changes in utility bond yields but would change no more than 75 basis points from 1995 levels.\n- ------------------------ * As defined in the plan for this state.\nFinancial results for 1994 include an accrual for BellSouth Telecommunications' estimated sharing obligation of $38 million.\nGEORGIA\nThe Georgia incentive plan adopted in 1990 provided that BellSouth Telecommunications would retain all earnings up to a 14% return on equity*. Subject to the attainment of service standards and productivity improvement provisions, BellSouth Telecommunications could retain a portion of earnings between 14% and 16%. The plan also provided for a reduction of rates if earnings exceed a 14% return on equity, even if the service standards and productivity improvement provisions are met. The amount of any sharing and rate adjustments would depend upon attaining certain service standards and productivity improvements. Effective January 1, 1994, the Georgia Public Service Commission extended the plan for six months and modified the return on equity at which sharing would occur from 14% to 13%. BellSouth Telecommunications has yet to attain the sharing level under the Georgia plan. However, a proceeding is pending regarding this issue and several parties assert that some sharing for the six-month period ending June 30, 1994 may be required; no accrual has been made for sharing during this period.\nIn August 1994, the Georgia Commission approved a staff recommendation to implement a sharing plan on an interim basis, effective September 1994, until pending decisions regarding ongoing regulation of the Company are finalized. Earnings between 13.5% and 15.5% would be shared 50\/50 by BellSouth Telecommunications and its customers.\nIn June 1994, BellSouth Telecommunications filed with the Georgia Commission a proposed price regulation plan. The proposal includes provisions that basic rates for residential and single-line business customers would not increase for five years and intrastate switched access would not increase for three years. The rates, terms and conditions for interconnection and non-basic services would be set by BellSouth Telecommunications based on market considerations. Hearings have been held, and a decision is pending.\nKENTUCKY\nUnder the Kentucky incentive regulation plan, BellSouth Telecommunications may earn a return on average total capital* in the range of 10.99% to 11.61%. Earnings above 11.61% or below 10.99% are subject to sharing with customers on either a 50\/50 or 25\/75 basis depending upon the actual rate of return achieved. BellSouth Telecommunications achieved the sharing level during 1993 and 1994 and reduced rates by $4.2 million in June 1993, $2.2 million in July 1993, $2.7 million in January 1994 and $1.2 million in June 1994.\nBellSouth Telecommunications filed with the Kentucky Public Service Commission in March 1994 a proposed price regulation plan. The proposal includes provisions that basic residential rates would not increase for three years, residential touch-tone charges would be eliminated over a four-year period, intrastate switched access charges would be reduced to interstate levels and prices for non-basic services would be based on market factors. Hearings are scheduled for April 1995.\nLOUISIANA\nIn February 1992, in settlement of several years of regulatory and judicial proceedings, BellSouth Telecommunications and the Louisiana Public Service Commission agreed to a three year incentive regulation plan providing for an immediate $55 million refund, a rate reduction of $31.4 million and an authorized return on investment* in the range of 10.7% to 11.7%, with sharing of earnings above 11.7% and below 12.7%. Based on 1992 results, BellSouth Telecommunications reduced rates by $13.8 million in February and $7.8 million in August 1993, reflecting its sharing obligation under the new plan.\n- ------------------------ * As defined in the plan for this state.\nAdditionally, effective March 1994, BellSouth Telecommunications was ordered to reduce rates by $47 million annually and refund approximately $14.6 million for prior periods. This rate adjustment and refund was associated with the November 1993 expiration of the company's reserve deficiency amortization. Based on 1994 data, BellSouth Telecommunications reduced rates by $11.1 million, effective February 1, 1995, reflecting its sharing obligation under the plan.\nIn January 1994, BellSouth Telecommunications filed a petition with the Louisiana Commission requesting a price regulation plan. In November 1994, the Louisiana Commission rejected the company's price regulation plan as filed. The company intends to continue seeking such a plan.\nIn its February 1995 meeting, the Louisiana Commission extended the current incentive plan pending further regulatory action. The authorized return on investment was changed to a range of 9.98% to 10.98% with sharing of earnings between 10.98% and 11.98% to reflect the change in the capital structure and the cost of debt since inception of the plan. The authorized cost of equity was not changed. The change in the revenue requirement associated with the lower authorized return on investment will be offset by the recovery of debt refinancing costs and an increase of approximately $9 million in annual intrastate depreciation expense.\nMISSISSIPPI\nIn June 1990, the Mississippi Public Service Commission authorized implementation of an incentive plan that includes a return on average net investment* ranging from 10.74% to 11.74% and provides that earnings above 11.74% and shortfalls below 10.74% would be shared with customers on a 50\/50 basis. Rate reductions totaling $22.8 million on an annual basis were required prior to implementation of the plan.\nAdditional revenue reductions in the amount of $12.8 million related to intrastate access and area calling plan impacts became effective in January 1993. In June 1993, the Mississippi Commission renewed, through July 1, 1995 the incentive plan and ordered BellSouth Telecommunications to reduce rates, effective July 1993, based on a targeted 11.24% return. Effective November 1, 1994, rates were increased by $8.9 million to provide recovery of the costs associated with a February 1994 ice storm.\nIn response to an order issued by the Mississippi Commission, BellSouth Telecommunications filed in September 1994 a model price regulation plan. The proposal includes provisions that basic exchange and intrastate switched access rates will not increase for three years and the rates for interconnection services and other services (as defined in the model plan) would be set by BellSouth Telecommunications based on market considerations, subject to certain defined limitations. Hearings are scheduled during the second quarter of 1995.\nOn December 1, 1994, BellSouth Telecommunications filed for an increase in rates of $5.1 million pursuant to the terms of the incentive plan. The increase was suspended by the Mississippi Commission while they consider the matter.\nNORTH CAROLINA\nIn 1989, legislation was enacted in North Carolina authorizing the North Carolina Utilities Commission to consider alternative forms of regulation. No specific proposal has been approved or is pending. The North Carolina Commission reviews BellSouth Telecommunications' rates on an ongoing basis under its traditional rate of return plan.\nIn November 1993, the North Carolina Commission approved one-time depreciation reserve deficiency amortizations of $28.5 million and $25 million for 1993 and 1994, respectively. In December 1994, the Commission approved an additional one-time depreciation reserve deficiency amortization of $20.4 million for 1994.\n- ------------------------ * As defined in the plan for this state.\nSOUTH CAROLINA\nIn August 1991, the South Carolina Public Service Commission authorized implementation of an incentive plan, but in August 1993, the South Carolina Supreme Court ruled that the South Carolina Commission lacked the statutory authority to approve incentive regulation plans. In April 1994, the South Carolina Legislature enacted a law which permits the South Carolina Commission to adopt alternative forms of regulation.\nIn December 1994, the South Carolina Commission issued an order requiring that rates be reduced prospectively by approximately $26 million. The Company was also ordered to refund approximately $28.6 million through a one-time credit to all residential and business customers for 1992. This order has been appealed to the courts. Any consideration of earnings for 1993 and 1994 has been delayed pending resolution of the appeal. In establishing rates prospectively, the South Carolina Commission retained a 13% return on equity* as the allowed return under traditional rate of return regulation.\nTENNESSEE\nIn August 1993, the Tennessee Public Service Commission approved a three year revised incentive regulation plan which lowered the sharing range as a percentage return on average net investment* from 11.0% - 12.2% to 10.65% - 11.85%. Earnings between 11.85% - 15.85% must be shared with ratepayers in varying degrees, depending on the quality of service. The plan also provides for rate increases to cover up to 60% of the amount by which earnings fall below 10.65%.\nIn December 1994, the Tennessee Commission adopted rules that provide that local exchange carriers (LECs), such as BellSouth Telecommunications, could elect to operate under price regulation no earlier than January 1, 1996. Following implementation of price regulation, local basic service rates would be capped for four years, after which a formula would be used to change basic rates. All other service prices will not increase for a minimum period of two years after the effective date of price regulation. Such approval has not yet been granted.\n------------------------\nIn addition to the above matters, BellSouth Telecommunications is a party to numerous proceedings pending before state regulatory bodies which involve, among other things, terms and conditions of services provided by BellSouth Telecommunications, rates charged for such services and relationships with affiliates. No assurance can be given as to the outcome of any such matters.\nACCESS SERVICES\nBellSouth Telecommunications provides access services by connecting the communications networks of Interexchange Carriers with the equipment and facilities of subscribers. These connections are provided by linking these carriers and subscribers through the public switched network of BellSouth Telecommunications or through dedicated private lines furnished by BellSouth Telecommunications.\nAccess charges, which are payable both by Interexchange Carriers and subscribers, provided approximately 29% of BellSouth Telecommunications' operating revenues for the years ended December 31, 1994, 1993 and 1992, respectively. These charges are designed to recover the costs of the common and dedicated facilities and switching equipment used to connect networks of Interexchange Carriers with the telephone company's local network. In addition, an interstate subscriber line access charge of $3.50 per line per month applies to single-line business and residential customers. The interstate subscriber access charge for multi-line business customers varies by state but cannot exceed $6.00 per line per month.\n- ------------------------ * As defined in the plan for this state.\nIn October 1990, the FCC authorized an alternative to traditional rate of return regulation called \"price caps,\" effective January 1, 1991, which is mandatory for certain LECs, including BellSouth Telecommunications. In contrast to traditional rate of return regulation price caps limits the prices telephone companies can charge for their services. The price cap plan limits aggregate price changes to the rate of inflation minus a productivity offset, plus or minus exogenous cost changes recognized by the FCC. Price cap regulation provides LECs with enhanced incentives to increase productivity and efficiency. Concurrent with the implementation of price caps, the FCC reduced the allowed rate of return on interstate operations from 12.0% to 11.25%.\nLECs that operate under price caps are allowed to elect annually by April 1 a productivity offset factor of 3.3% or 4.3%. If the lower offset is chosen, such carriers will be allowed to earn up to a 12.25% overall rate of return without sharing. If such carriers earn between 12.25% and 16.25%, half of the earnings in this range will be flowed through to customers in the form of a lower price cap index in the following year. All earnings over 16.25% would be flowed through to customers. If such carriers elect a 4.3% productivity offset, all earnings below 13.25% may be retained, earnings up to 17.25% would be shared and earnings over 17.25% would be flowed through to customers. BellSouth Telecommunications elected to operate under the 3.3% productivity offset factor for the period July 1, 1994 through June 30, 1995.\nIn February 1994, the FCC initiated its review of the price cap plan described above. The FCC identified three broad sets of issues for examination including those related to the basic goals of price cap regulation, the operation of price caps and the transition of local exchange services to a fully competitive market. BellSouth Telecommunications believes and advocates that a revised price cap plan should be structured to provide increased pricing flexibility for services as competition evolves in the telecommunications markets and that sharing be eliminated from the plan. Any changes to the plan are not expected to be effective until mid-1995.\nState regulatory commissions have jurisdiction over charges related to the provision of access to the Interexchange Carriers to complete intrastate telecommunications. The state commissions have authorized BellSouth Telecommunications to collect access charges from the Interexchange Carriers and, in several states, from customers.\nIn addition to the above matters, BellSouth Telecommunications is a party to numerous proceedings pending before the FCC which involve, among other things, terms and conditions of services provided by BellSouth Telecommunications, rates charged for such services and relationships with affiliates. No assurance can be given as to the outcome of any such matters.\nBILLING AND COLLECTION SERVICES\nBellSouth Telecommunications provides, under contract and\/or tariff, billing and collection services for certain long distance services of AT&T and several other Interexchange Carriers. The agreement with AT&T has been extended through 1996, subject to the right of AT&T to assume billing and collection for certain of its services prior to the expiration of the agreement. Revenues from such services are expected to decrease as AT&T and other carriers assume more direct billing for their own services.\nOPERATOR SERVICES\nDirectory assistance and local and toll operator services are provided by BellSouth Telecommunications in its service areas. Toll operator services include alternate billing arrangements, such as collect calls, third number billing, person-to-person and calling card calls; dialing instructions; pre- billed credit; and rate information. In addition, directory assistance is provided for some Interexchange Carriers which do not directly provide such services for their own customers.\nOTHER BUSINESS OPERATIONS\nDIRECTORY PUBLISHING FEES\nA percentage of the billed revenues from directory advertising operations of BellSouth Advertising & Publishing Corporation, a wholly-owned subsidiary of BellSouth, are paid as publication fees to BellSouth Telecommunications for publishing rights and other services in its franchise areas. Such fees amounted to approximately $638, $616 and $598 million in 1994, 1993 and 1992, respectively.\nSELLING AND MAINTAINING EQUIPMENT\nThrough its subsidiaries, BellSouth Telecommunications sells and maintains customer premises equipment (CPE), and to a lesser extent, computers and related office equipment. The Holding Companies, AT&T and other substantial enterprises compete in the provision of CPE and other services and products. In April 1994, BellSouth Communications Systems, Inc., a wholly-owned subsidiary, disposed of its customer premises equipment sales and service operations outside the nine- state region served by BellSouth Telecommunications.\nCOMPETITION\nGENERAL\nBellSouth Telecommunications is subject to increasing competition in all areas of its business. Regulatory, legislative and judicial actions and technological developments have expanded the types of available services and products and the number of companies that may offer them. Increasingly, this competition is from large companies which have substantial capital, technological and marketing resources.\nA technological convergence is occurring in the telephone, cable and broadcast television, computer, entertainment and information services industries. The technologies utilized and being developed in these industries will enable companies to provide multiple and integrated forms of communications offerings.\nCurrent policies of federal and state legislative and regulatory bodies strongly favor lowering legal barriers to competition in the telecommunications industry. Accordingly, the nature of competition which BellSouth Telecommunications will face will depend to a large degree on regulatory actions at the state and federal levels, decisions with respect to the MFJ and possible state and federal legislation. Legislative or regulatory initiatives are pending or expected in a number of BellSouth Telecommunications' jurisdictions.\nNETWORK AND RELATED SERVICES\nLOCAL SERVICE\nMany services traditionally provided exclusively by the LECs have been opened for competition. For example, some carriers and other customers with concentrated, high usage characteristics are utilizing shared tenant services, private branch exchange (PBX) systems (which are owned by customers and provide internal switching functions), private line services and other telecommunications links which bypass the switched networks of BellSouth Telecommunications. An increasing number of private voice and data communications networks utilizing fiber optic lines have been and are being constructed in metropolitan areas, including Atlanta, Georgia, Charlotte, North Carolina and Jacksonville, Miami and Orlando, Florida, which will offer certain high volume users a competitive alternative to the public and private line offerings of the LECs. In addition, the networks of some cable television systems will be capable of carrying two-way interactive data messages and will be configured to provide voice communications. Furthermore, wireless services, such as cellular telephone and paging services and PCS services when operational, increasingly compete with wireline communications services.\nBellSouth Telecommunications is presently vulnerable to bypass to the extent that its access charges reflect subsidies for other services. Although BellSouth Telecommunications believes that\nbypass has already occurred to a significant degree in its nine-state area, it is difficult to quantify the lost revenues since customers are not required to report to the telephone companies the components of their telecommunications systems. In general, telephone company telecommunications services in highly concentrated population and business areas are more vulnerable to bypass.\nIn January 1994, MCI Communications Corporation announced long range plans to invest more than $20 billion to create and deliver a wide array of communications services. Included in these plans is an investment of $2 billion to construct local networks in major United States cities, including Atlanta, Georgia and other cities in the Southeast. MCI has stated that it would connect directly to customers and provide alternative local voice and data communications services. MCI has applied for local telecommunications licenses in eight states that have significantly deregulated local service. As states in BellSouth Telecommunications' wireline region adopt legislation or regulations enabling multiple local service providers, MCI and other carriers are expected to seek licenses to compete.\nIn 1994, AT&T acquired McCaw Communications, Inc., the largest domestic cellular communications company, which serves customers in 10 cities in BellSouth Telecommunications' local wireline territory. Furthermore, alliances are also being formed between other Holding Companies and large corporations that operate cable television systems in many localities throughout the United States, for example, U S West, Inc.\/Time Warner Communications and NYNEX Corporation\/Viacom, Inc. As technological and regulatory developments make it more feasible for cable television to carry data and voice communications, it is probable that BellSouth Telecommunications will face competition within its region from the other Holding Companies through their cable television venture arrangements.\nIn July 1994, U S West and Time Warner announced plans to upgrade certain of their cable TV systems to full-service networks which would support new interactive and telephone services that would compete with the incumbent LECs. The first of these full-service networks is being built in Orlando, Florida and a limited trial of services has begun. Tele-Communications, Inc. has announced plans to offer similar services in South Florida and Louisville, Kentucky. Time Warner and U S West have made major cable system acquisitions that are expected to provide voice and video competition in BellSouth Telecommunications' service areas. In December 1994, U S West acquired Atlanta's two largest cable operators.\nACCESS SERVICE\nThe FCC has adopted rules requiring local exchange carriers to offer expanded interconnection for interstate special and switched transport. As a result, BellSouth Telecommunications is required to permit competitive carriers and customers to terminate their transmission facilities in its central office buildings through virtual collocation arrangements. The effects of the rules are to increase competition for access transport.\nTOLL SERVICE\nA number of firms compete with BellSouth Telecommunications for intraLATA toll business by reselling toll services obtained at bulk rates from BellSouth Telecommunications or, subject to the approval of the applicable state public utility commission, providing toll services over their own facilities. Commissions in the states in BellSouth Telecommunications' operating territory have allowed the latter type of intraLATA toll calling, whereby the Interexchange Carriers are assigned a multiple digit access code (10XXX) which customers may dial to place intraLATA toll calls through facilities of such Interexchange Carriers. The Kentucky and Florida Commissions have concluded that competing carriers should be allowed to provide intraLATA toll presubscribed calling with a single digit access code (1+ or 0+) and are considering how and when such authorization should be implemented.\nPERSONAL COMMUNICATIONS SERVICES (PCS)\nPersonal communications services (PCS) are in the developmental stage and are anticipated to provide a wide range of wireless communications services. The FCC is currently auctioning licenses for spectrum for broadband PCS with up to six licenses per geographic area.\nBELLSOUTH TELECOMMUNICATIONS COMPETITIVE STRATEGY\nREGULATORY AND LEGISLATIVE CHANGES, LITIGATION The states in BellSouth Telecommunications' service area currently provide for some form of regulation of earnings, a regulatory framework that BellSouth Telecommunications believes is not appropriate for the increasingly competitive telecommunications environment. Accordingly, BellSouth Telecommunications' primary regulatory focus continues to be directed toward modifying the regulatory process to one that is more closely aligned with changing market conditions and overall public policy objectives. As an alternative to the current regulatory process, BellSouth Telecommunications believes that price regulation, whereby prices of basic local exchange service are directly regulated and prices for other products and services are based on market factors, is a logical progression toward regulatory flexibility and is fair to consumers. As such, BellSouth Telecommunications is pursuing implementation of price regulation plans through filings with state regulatory commissions or through legislative initiatives.\nBellSouth Telecommunications is also seeking relief in the courts and before Congress and regulatory agencies from current laws, regulations and judicial restrictions (including the MFJ) for the provision of voice, data and video communications throughout its wireline service territory and elsewhere. It is furthermore advocating legislative and regulatory initiatives which would eliminate or modify restrictions on its current and future business offerings. Bills are being developed in Congress that would provide the opportunity for the Holding Companies to engage in interLATA long distance and cable and other video businesses, subject to various conditions and delays. The interexchange carriers and other competitors and interest groups with substantial resources oppose many of these initiatives. The ultimate outcome and timing of any relief obtained cannot be predicted with certainty, but it is unlikely that meaningful opportunities to engage in interLATA business can be obtained through legislation without the local and intraLATA toll businesses being opened to competition.\nBellSouth, NYNEX Corporation and SBC Communications Inc. are involved in litigation in the D.C. District Court seeking relief from the remaining provisions of the MFJ. BellSouth and BellSouth Telecommunications believe that the MFJ restrictions are contrary to the public interest in that they impair the effectiveness of competitive markets, harm consumers economically and undermine the efficient development of new technology. Final resolution of this motion is not expected in the near term.\nTechnological changes and the effects of competition reduce the economic useful lives of BellSouth Telecommunications' fixed assets. As competition increases in both the exchange access and local exchange markets, the economic lives of related properties should continue to decrease. Therefore, BellSouth Telecommunications is examining the rates of depreciation of fixed assets authorized by the FCC and state regulatory commissions to ensure that these rates are adequate to recover fixed asset costs in a timely fashion. The FCC and the state commissions represcribe depreciation rates for BellSouth Telecommunications at three-year intervals. Such rates will be represcribed in Florida, Georgia, North Carolina and South Carolina in 1995 and in Alabama, Kentucky, Louisiana, Mississippi and Tennessee in 1996. (See \"Management's Discussion and Analysis of Results of Operations -- Operating Environment and Trends of the Business -- Accounting Under SFAS No. 71.\")\nENTRY INTO NEW MARKETS Notwithstanding the risks associated with increased competition, BellSouth Telecommunications will have the opportunity to benefit from entry into new business markets. BellSouth Telecommunications believes that in order to remain competitive in the future, it must aggressively pursue a corporate strategy of expanding its offerings beyond its traditional businesses and markets. These offerings may include information services, interactive communications and cable television and other entertainment services.\nIn August 1992, the FCC issued an order allowing the LECs to offer video dial tone for transmitting video services. In February 1995, the FCC approved BellSouth Telecommunications' application to conduct a trial of video dial tone services. This trial will be undertaken to better position the\ncompany to respond to the increasingly competitive telecommunications market. BellSouth Telecommunications will construct the network in Chamblee, Georgia, that will provide for 70 analog channels and over 200 digital channels to deliver video programming and interactive services, which will be offered by various programming service providers. The new services will include broadcast entertainment, interactive video services, such as video games, enhanced personal computer and communications services, including electronic mail, transactional services, such as home shopping and banking, and customer-choice video services, such as movies on demand.\nIn September 1994, the U.S. District Court for the Northern District of Alabama declared unconstitutional a provision of the Cable Communications Policy Act of 1984 that prohibits BellSouth and its affiliates from providing cable television programming in the areas served by BellSouth Telecommunications. As a result of the Court's decision, which was rendered in response to a suit filed by BellSouth in 1993 and is now pending appeal by the United States, BellSouth and its affiliates, including BellSouth Telecommunications, may seek the appropriate governmental authorizations to provide video programming directly to consumers throughout its service area.\nRESTRUCTURING BellSouth Telecommunications is restructuring its telephone operations by streamlining its fundamental processes and work activities to better respond to an increasingly competitive business environment. This activity is expected to improve overall responsiveness to customer needs and reduce costs. For a discussion of the restructuring begun in 1993, see \"Management's Discussion and Analysis of Results of Operations -- Other Matters -- Restructuring of Telephone Operations.\"\nRESEARCH AND DEVELOPMENT\nThe majority of BellSouth Telecommunications' research and development activity is conducted at Bell Communications Research, Inc. (Bellcore), one-seventh of which is owned by BellSouth, through BellSouth Telecommunications, with the remainder owned by the other Holding Companies. Bellcore provides research and development and other services for its owners and is the central point of contact for coordinating the Federal government's telecommunications requirements relating to national security and emergency preparedness.\nLICENSES AND FRANCHISES\nBellSouth Telecommunications' local exchange business is typically provided under certificates of public convenience and necessity granted pursuant to state statutes and public interest findings of the various public utility commissions of the states in which BellSouth Telecommunications does business. These certificates provide for a franchise of indefinite duration, subject to the maintenance of satisfactory service at reasonable rates. MCI Communications Corporation and U S West have announced plans to pursue approval to provide local telephone service, thereby challenging the exclusivity of BellSouth Telecommunications' franchise for local service.\nBellSouth Telecommunications owns or has licenses to use all patents, copyrights, licenses, trademarks and other intellectual property necessary for it to conduct its present business operations. It is not anticipated that any of such property will be subject to expiration or non-renewal of rights which would materially and adversely affect BellSouth Telecommunications or its subsidiaries.\nEMPLOYEES\nOn December 31, 1994, 1993, and 1992 BellSouth Telecommunications employed approximately 76,700, 81,400 and 82,900 persons, respectively. About 72% of these employees at December 31, 1994 were represented by the Communications Workers of America (the CWA), which is affiliated with the AFL-CIO. BellSouth Telecommunications' collective bargaining agreement with the CWA, as well as the agreements with certain of its subsidiaries, are scheduled to terminate on August 5, 1995. Negotiations with the CWA over the terms of the new agreements will begin early in June 1995. The outcome of these negotiations cannot be determined at this time.\nIn November 1993, BellSouth Telecommunications announced a plan to reduce its workforce by approximately 10,200 employees by the end of 1996 through normal attrition, transitional programs, other voluntary options and involuntary separations. For the years ended December 31, 1994 and 1993, total employee reductions under this plan were 3,900 and 1,300, respectively. (See \"Management's Discussion and Analysis of Results of Operations -- Other Matters - -- Restructuring of Telephone Operations.\")\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nGENERAL\nBellSouth Telecommunications' properties do not lend themselves to description by character and location of principal units. BellSouth Telecommunications' investment in property, plant and equipment consisted of the following at December 31:\nOutside plant consists of connecting lines (aerial, underground and buried cable) not on customers' premises, the majority of which are on or under public roads, highways or streets, while the remainder is on or under private property. BellSouth Telecommunications currently self-insures a substantial amount of its outside plant against casualty losses. Central office equipment consists of analog switching equipment, digital electronic switching equipment and circuit equipment. Land and buildings are occupied principally by central offices. Operating and other equipment consists of embedded intrasystem wiring, substantially all of which is on the premises of customers, motor vehicles and equipment.\nSubstantially all of the installations of central office equipment and administrative offices are located in buildings and on land owned by BellSouth Telecommunications. Many garages, business offices and telephone service centers are in leased quarters.\nBellSouth Telecommunications' customers are now served by electronic switching systems that provide a wider variety of services than their mechanical predecessors. The BellSouth Telecommunications network is in transition from an analog to a digital network, which provides capabilities for BellSouth Telecommunications to furnish advanced data transmission and information management services.\nPROPERTY ADDITIONS\nProperty additions include gross additions to property, plant and equipment having an estimated service life of one year or more, plus the incidental costs of preparing the asset for its intended use. In the case of constructed assets, an amount related to the cost of debt and equity used in the construction of an asset is capitalized as part of the asset when the construction period is in excess of one year. Property additions also include assets acquired by means of entering into a capital lease agreement, gross additions to operating lease equipment and reused materials.\nThe total investment in telephone plant has increased from approximately $34,820 million at January 1, 1990 to approximately $41,696 million at December 31, 1994, not including deductions of accumulated depreciation. Significant additions to property, plant and equipment will be required to meet the demand for telecommunications services and to further modernize and improve such services to meet competitive demands. Population and economic expansion is projected by BellSouth Telecommunications in certain growth centers within its nine-state area during the next five to ten years. Expansion of the network will be needed to accommodate such projected growth.\nBellSouth Telecommunications' capital expenditures for 1990 through 1994 were as follows:\nBellSouth Telecommunications currently projects capital expenditures to be approximately $3,000 million for 1995. In 1994, BellSouth Telecommunications generated substantially all of its funds for capital expenditures internally. In 1995, such capital expenditures are expected to be financed primarily through internally generated funds and, to the extent necessary, from external sources.\nENVIRONMENTAL MATTERS\nBellSouth Telecommunications is subject to a number of environmental matters as a result of its operations and the shared liability provisions in the Plan of Reorganization (POR). As a result, BellSouth Telecommunications expects that it will be required to expend funds to remedy certain facilities, including those Superfund sites for which BellSouth Telecommunications has been named as a potentially responsible party, for the remediation of sites with underground fuel storage tanks and other expenses associated with environmental compliance. At December 31, 1994, BellSouth Telecommunications' recorded liability related primarily to remediation of these sites was $35.8 million.\nBellSouth Telecommunications continually monitors its operations with respect to potential environmental issues, including changes in legally mandated standards and remediation technologies. BellSouth Telecommunications' recorded liability reflects those specific issues where remediation activities are currently deemed to be probable and where the cost of remediation is estimable. BellSouth Telecommunications continues to believe that expenditures in connection with additional remedial actions under the current environmental protection laws or related matters will not be material to its financial position.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe MFJ and the related POR provide for the recognition and payment of liabilities by AT&T and the Operating Telephone Companies that are attributable to pre-divestiture events but that did not become certain until after divestiture. These contingent liabilities relate principally to litigation and other claims with respect to the former Bell System's environmental liabilities, rates, taxes, contracts and torts (including business torts, such as alleged violations of the antitrust laws). Contingent liabilities attributable to pre-divestiture events have been shared by AT&T and the Operating Telephone Companies in accordance with formulae prescribed by the POR, 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. BellSouth Telecommunications' share of these liabilities to date has not been material to its financial position or results of operations for any period.\nThe Operating Telephone Companies have agreed among themselves to disengage from the sharing of most categories of contingent liabilities formerly subject to the POR sharing mechanism. Sharing under the POR would continue for matters for which notice was given as of May 23, 1994 and certain pre-divestiture environmental claims. The sharing of liabilities for pre-divestiture claims between AT&T and one or more Operating Telephone Companies are not affected by this agreement.\nBellSouth Telecommunications and its subsidiaries are subject to numerous claims and proceedings arising in the ordinary course of business involving allegations of personal injury, breach of contract, anti-competitive conduct and other matters. While complete assurance cannot be given as to the outcome of any contingent liabilities, in the opinion of BellSouth Telecommunications, any financial impact to which BellSouth Telecommunications is subject is not expected to be material in amount to BellSouth Telecommunications' financial position.\nPART II\nITEM 6.","section_4":"","section_5":"","section_6":"ITEM 6. SELECTED FINANCIAL AND OPERATING DATA (DOLLARS IN MILLIONS)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (DOLLARS IN MILLIONS)\nBellSouth Telecommunications, Inc. (BellSouth Telecommunications) is a wholly-owned subsidiary of BellSouth Corporation (BellSouth). BellSouth Telecommunications serves, in the aggregate, approximately two-thirds of the population and one-half of the territory within Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina, South Carolina and Tennessee. BellSouth Telecommunications primarily provides local exchange service and toll communications services within court-defined geographic areas, called Local Access and Transport Areas (LATAs), and provides network access services to enable interLATA communications using the long-distance facilities of interexchange carriers. Through subsidiaries, other telecommunications services and products are provided both inside and outside the nine-state BellSouth Telecommunications region.\nApproximately 86% of BellSouth Telecommunications' Total Operating Revenues for the years ended December 31, 1994 and 1993, respectively, were from wireline services. Charges for local service, access services and toll for the year ended December 31, 1994 accounted for approximately 57%, 33% and 10%, respectively, of the wireline revenues discussed above. The remainder of BellSouth Telecommunications' Total Operating Revenues was derived principally from directory publishing fees, sales and maintenance of customer premises equipment and other nonregulated services.\nRESULTS OF OPERATIONS\nNet Income for 1994 increased $1,116.6 compared to 1993. The increase was attributable in part to revenue growth, driven by continued growth of access lines and other key volumes, and cost control measures, including salary and wage savings attributable to the restructuring plan implemented in 1993. The increase was also due to the effect of charges which occurred in 1993 and, in the aggregate, reduced Net Income by $920.0 for that year. The 1993 charges include $696.6 for restructuring of the core telephone operations (see Note J); $86.6 for the refinancing of certain long-term debt issues at lower interest rates (see Note E); $64.8 for the retroactive adoption of Statement of Financial Accounting Standards (SFAS) No. 112, \"Employers' Accounting for Postemployment Benefits\" (see Note H); $47 for the initial impact of a regulatory settlement in Florida; and approximately $25 associated with severe 1993 winter weather conditions.\nVOLUMES OF BUSINESS\nNetwork Access Lines in Service at December 31 (Thousands):\nThe rate of growth in access lines continued to be particularly strong, 4.6% in 1994, compared to a 3.7% rate of increase in 1993. The number of access lines in service since December 31, 1993 increased by approximately 887,400. The overall increase, led by growth in Georgia, North Carolina and Florida, was primarily attributable to continued economic improvement, including expanding employment in BellSouth Telecommunications' nine-state region, and an increase in the number of second residential lines. Second residential lines accounted for approximately 40.2% and 22.8% of the overall increases in residence access lines and total access lines, respectively, since December 31, 1993. The growth rates in 1994 for total residence and business lines of 3.7% and 7.1%, respectively, improved compared to growth rates of 3.0% and 5.9%, respectively, in 1993.\nAccess Minutes of Use (Millions):\nAccess minutes of use represent the volume of traffic carried by interexchange carriers between LATAs, both interstate and intrastate, using BellSouth Telecommunications' local facilities. In 1994, total access minutes of use increased by 6,060.0 million (8.8%) compared to an increase of 6.3% in 1993. The 1994 increase in access minutes of use was partially attributable to access line growth, promotions by the interexchange carriers and intraLATA toll competition, which has the effect of increasing access minutes of use while reducing toll messages carried over BellSouth Telecommunications' network. The growth rate in total minutes of use continues to be negatively impacted by the effects of bypass and the migration of interexchange carriers to categories of service (e.g., special access) that have a fixed charge as opposed to a volume-driven charge and to high capacity services, which causes a decrease in minutes of use.\nToll messages are comprised of Message Telecommunications Service and Wide Area Telecommunications Service. Also, effective in 1994, toll messages include messages completed under optional calling plans (OCPs), which provide reduced rates for toll calls within a LATA. Prior period toll message volumes have been restated to reflect this change. The pricing of services provided under OCPs has stimulated volume growth. Accordingly, the trend of declining toll message volumes in prior periods has been reversed by the inclusion of messages completed under these plans.\nToll messages increased by 47.2 million (3.1%) compared to a restated increase of 3.4% in 1993. The 1994 increase, attributable in part to the growth of messages completed under OCPs and stimulation resulting from access line growth, was partially offset by the effect of optional extended area calling plans which, based on a customer's election, provide for a wider toll-free calling area.\nIn September 1994, South Carolina implemented an expanded local area calling plan. While the South Carolina plan's impact on 1994 toll message volumes was negligible, this plan and future implementation of other such plans in BellSouth Telecommunications' service region, coupled with competition in the intraLATA toll market, will adversely impact future toll message volumes. Local area and optional extended area calling plans and the effects of competition result in the transfer of calls from toll to local service and access categories, respectively, but the corresponding revenues are not generally shifted at commensurate rates.\nOPERATING REVENUES\nTotal Operating Revenues increased $460.3 (3.4%). The components of Total Operating Revenues were as follows:\nLOCAL SERVICE revenues reflect amounts billed to customers for local exchange services, which include connection to the network and secondary central office feature services, such as custom calling features and custom dialing packages. (Revenues from cellular interconnection and other mobile services are included in Other operating revenues for both periods presented.)\nThe increase in 1994 of $285.8 (4.3%) was due primarily to an increase of 887,400 access lines since December 31, 1993. Also contributing to the increase was growth attributable to optional extended area calling plans. The increase in 1994 was partially offset by rate reductions, principally in Louisiana and also in Florida and Alabama.\nINTERSTATE ACCESS revenues result from the provision of access services to interexchange carriers to provide telecommunications services between states. Interstate Access revenues increased $136.0 (4.5%) in 1994.\nThe 1994 increase was attributable to growth in minutes of use, additional end user charges due primarily to access line growth and the effect of billing and other adjustments recorded in 1993, which reduced revenues for that period by approximately $20. The increases were partially offset by the effect of rate reductions effective in July 1994 and October 1994, additional revenue deferrals under the Federal Communications Commission's (FCC) price cap plan and decreased net settlements with the National Exchange Carriers Association.\nSee \"Operating Environment and Trends of the Business.\"\nINTRASTATE ACCESS revenues result from the provision of access services to interexchange carriers which provide telecommunications services between LATAs within a state. In 1994, Intrastate Access revenues increased $26.4 (3.0%). Such increase was attributable to growth in minutes of use and the reclassification in 1994 of independent company settlements in certain states, which would have previously reduced revenues, to operating expenses. The increase was partially offset by the impact of rate reductions, primarily in Alabama and Florida.\nTOLL revenues are received from the provision of long-distance services within (but not between) LATAs. These services include intraLATA service beyond the local calling area; Wide Area Telecommunications Service (WATS or 800 services) for customers with highly concentrated demand; and special services, such as transport of voice, data and video. Toll revenues decreased $29.4 (2.4%) in 1994. The decrease was primarily attributable to several settlements with independent companies, the reclassification of certain settlements to Intrastate Access revenue, net rate reductions since December 31, 1993 and the impact of optional extended area calling plans. The decrease was partially offset by growth in toll message volumes, reflecting improvements related in part to OCPs. The overall decline in Toll revenues is expected to continue over the long term.\nOTHER revenues are principally comprised of revenues from publishing rights fees, customer premises equipment (CPE) sales and maintenance services, billing and collection services, cellular interconnect services and other nonregulated services (primarily inside wire services). Other revenues increased $41.5 (2.2%) in 1994. The increase was attributable to growth in publishing rights and cellular interconnect fees and higher demand for unregulated products and services, including CPE for residential customers, voice messaging and inside wire services. In addition, the effects of adjustments and reclassifications related to services under certain state regulatory plans and billing and collection services contributed to the increase. Revenues derived from billing and collection are expected to decline over the long term due to interexchange carriers' assuming more direct billing for\ntheir own services. The increase was partially offset by increased revenue deferrals related to potential sharing under certain state regulatory plans and the sale in April 1994 of BellSouth Telecommunications' out-of-region CPE sales and service operations.\nOPERATING EXPENSES\nPrimarily as a result of the effect of the 1993 restructuring charge, Total Operating Expenses decreased $1,138.3 (9.8%) in 1994. The components of Total Operating Expenses were as follows:\nDEPRECIATION AND AMORTIZATION increased $51.0 (1.8%) in 1994. The increase in 1994 was due to higher levels of property, plant and equipment since December 31, 1993 resulting from continued growth in the customer base, continued modernization of the network and a special reserve deficiency amortization of $20.4 in North Carolina. The increase for the period was partially offset by the expiration of reserve deficiency amortizations in Louisiana and the inclusion in 1993 of approximately $20 of additional depreciation expense related to extraordinary property retirements in conjunction with a regulatory settlement in Florida.\nOTHER OPERATING EXPENSES are comprised of Cost of Services and Products, Selling, General and Administrative and, in 1993, a Restructuring Charge. Cost of Services and Products includes employee and employee-related expenses associated with network repair and maintenance, material and supplies expense, cost of tangible goods sold and other expenses associated with providing services. Selling, General and Administrative includes expenses related to sales activities such as salaries, commissions, benefits, travel, marketing and advertising expenses and administrative expenses. Other Operating Expenses decreased $1,189.3 (13.7%) in 1994. Excluding the $1,136.4 restructuring charge in 1993, Other Operating Expenses decreased $52.9 (0.7%) in 1994.\nAs adjusted, the 0.7% decrease in 1994 was primarily attributable to the sale in 1994 of the out-of-region CPE sales and service operations, the inclusion in 1993 of approximately $55 and $40, respectively, related to a regulatory settlement in Florida and severe 1993 weather conditions and a reduction in 1994 expenses for rents, uncollectibles and contract services. The decrease was partially offset by increased expenses related to volume growth and network modernization, primarily for software license fees and materials, and the effect of reclassifying settlements with independent telephone companies in certain states from Intrastate Access revenues to operating expenses in 1994. Total employee-related costs also increased, reflecting annual compensation increases for management and represented employees, increased overtime attributable to volume growth and network service activities and higher expenses for employee benefits, partially offset by salary and wage savings from employee reductions attributable to the restructuring plan begun in 1993 and a reduction in pension expense (see Note H).\nOTHER INCOME STATEMENT ITEMS\nINTEREST EXPENSE includes interest on debt, certain other accrued liabilities and capital leases, offset by an allowance for funds used during construction, which is capitalized as a cost of installing equipment and constructing plant. Interest expense decreased $13.8 (2.5%) in 1994. The decrease resulted primarily from interest savings attributable to refinancings in 1993 of long-term debt at lower interest rates. The decrease was partially offset by higher average levels of short-term borrowings at higher average interest rates. (See Notes E and K.)\nPROVISION FOR INCOME TAXES increased $644.1 (139.6%) in 1994. BellSouth Telecommunications' effective tax rates were 36.2% and 31.9% in 1994 and 1993, respectively. The effective rate for 1993 reflects the impact of the restructuring charge which significantly lowered pre-tax income. Such lower level of pre-tax income caused investment tax credit amortization to more significantly influence the effective tax rate in that year. A reconciliation of the statutory Federal income tax rates to these effective tax rates is provided in Note L. A discussion of the adoption of SFAS No. 109, \"Accounting for Income Taxes,\" also is included therein.\nOPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS\nREGULATORY ENVIRONMENT. In providing telecommunications services, BellSouth Telecommunications is subject to regulation by both state and federal regulators with respect to rates, services and other issues. Other than in North Carolina and South Carolina, where it is subject to traditional rate of return regulation, BellSouth Telecommunications is operating under some form of incentive regulation plan at the state and federal levels whereby earnings above certain levels within a given range must be shared with customers in the form of credits, refunds or prospective rate reductions. These plans provide incentives to reduce costs and retain a portion of earnings above the sharing point, and in some cases, all earnings above the top of the range must be returned to customers. Since BellSouth Telecommunications' earnings fell close to or within the sharing range in its incentive plans during 1994, its ability to increase its earnings over the long run under these plans, even through productivity enhancements, is constrained. At December 31, 1994, BellSouth Telecommunications' estimated sharing obligation related to interstate access services was $141.6. Furthermore, its ability to change rates to more effectively respond to competition is limited under the current regulatory plans, which require, in general, that rates be charged as provided in tariff filings.\nAccordingly, BellSouth Telecommunications' primary regulatory focus is directed toward modifying the regulatory process to one that is more closely aligned with changing market conditions and overall public policy objectives. As an alternative to the current regulatory processes, BellSouth Telecommunications believes that price regulation, whereby prices of basic local exchange services are directly regulated, irrespective of rate of return tests, and prices for other products and services are based on market factors, is a logical progression to competitive fairness and provides advantages for consumers. While no such local regulatory plan has been implemented in the nine-state service area, the Tennessee Public Service Commission, subject to certain governmental authorizations and the enactment of enabling legislation, adopted rules to allow local exchange competition, including a provision whereby BellSouth Telecommunications could elect to operate under a price regulation plan. In addition, proposed plans filed by BellSouth Telecommunications in Kentucky, Georgia, Mississippi and Alabama are currently under review by the respective commissions in those states. The Florida, Georgia, North Carolina and Tennessee legislatures are considering bills that would provide for or allow price regulation and\/or local exchange competition. A proposed plan filed with the Louisiana Public Service Commission was rejected in November 1994. The FCC is reviewing its regulatory plan; any changes to the plan are not expected to be effective until mid-1995. BellSouth Telecommunications will continue to pursue implementation of price regulation plans in Louisiana, other states and at the federal level through filings with regulatory commissions and through legislative initiatives.\nECONOMY. The nation's gross domestic product grew 4% in 1994, which was the strongest annual growth of the current economic expansion. Employment in nonfarm businesses grew 2.6% during the year as the unemployment rate dropped to 5.6% by the fourth quarter. Growth in the nine-state region served by BellSouth Telecommunications was even stronger. The number of jobs in nonfarm businesses grew at a 3.0% annual rate, unemployment also dropped to 5.6% by the fourth quarter and real income expanded by an estimated 4.4%. Net in-migration added 450,000 to the region's population during 1994, with every state except Louisiana recording a gain. Four states, Florida, Georgia, North Carolina and Tennessee, were among the top ten nationally in 1994 numerical population gains. The demand for telecommunications services reflected the strength of the economic and population growth in the region. Higher interest rates in 1995 may dampen residential construction and durable goods manufacturing, but projected net in-migration near 400,000 would help to keep the regional demand for telecommunications services rising. However, increasing competition makes BellSouth Telecommunications' financial performance more susceptible to changes in the economy than previously, as its operations reflect the more competitive business environment and the greater elasticities for its products and services.\nCOMPETITION. Developments in the telecommunications marketplace continue to indicate that a technological convergence is occurring in the telephone, cable and broadcast television, computer, entertainment and information services industries. The technologies utilized and being developed in these industries are able to provide multiple and integrated communications offerings. A number of large companies, including AT&T Corp. and the other major interexchange carriers, other Bell Holding Companies and cable and other video entertainment companies, have completed acquisitions and entered into business alliances that will ultimately intensify and expand competition for local and toll communications and other services currently provided over BellSouth Telecommunications' networks. Other competitors have announced plans to build, and in certain locations have begun construction of, local phone connections and private networks that would permit business and residential customers to bypass the facilities of local telephone companies, including those of BellSouth Telecommunications in certain cities in its service territory. Legislative, regulatory and judicial developments will further facilitate competition in local, long distance and video markets.\nNotwithstanding the risks associated with increased competition, BellSouth and BellSouth Telecommunications will have opportunities in new business markets. BellSouth believes that in order to remain competitive in the future, it must aggressively pursue a corporate strategy of expanding its offerings beyond its traditional businesses, which may include information services, interactive communications and cable television and other entertainment services. As a part of this strategy, BellSouth has been granted permission by the FCC to conduct a trial of video dial tone services; acquired in auction one of the nationwide narrowband Personal Communications Services (PCS) licenses; participated in the ongoing FCC auction for broadband PCS licenses in the Carolinas and eastern Tennessee; and formed business alliances and partnerships, both domestically and internationally, related to the provision of interactive and traditional video programming services as well as wireless and wireline communications services. As another part of its competitive strategy, BellSouth Telecommunications has undertaken a plan to streamline its telephone operations and to improve its overall cost structure (see \"Other Matters -- Restructuring of Telephone Operations\"). Coincident with the existing restructuring plan, BellSouth Telecommunications is continuing to seek additional ways to better enhance customer service and productivity and to further improve its cost structure. As a result of these ongoing efforts, additional changes to fundamental business processes and work activities, as well as further employee reductions, are expected.\nACCOUNTING UNDER SFAS NO. 71. BellSouth Telecommunications continues to account for the economic effects of regulation under SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" Where appropriate, the provisions of SFAS No. 71 give recognition to the effect of actions of regulators, which can provide reasonable assurance of the existence of an asset, reduce or eliminate the value of an asset or impose or eliminate a liability of a regulated entity. As a result of such actions by regulators, BellSouth Telecommunications' balance sheet at December 31, 1994 reflects net deferred charges (regulatory assets) of $186.5 related primarily to compensated absences and unamortized issuance costs for debt that has been refinanced, and net deferred credits (regulatory liabilities) of $304.0 related to income tax issues. Virtually all of the current regulatory assets and liabilities arose in connection with the incorporation of new accounting standards into the ratemaking process, and are transitory in nature. The magnitude of the regulatory assets and liabilities is decreasing over time due to the ongoing amortization prescribed as a part of the adoption in 1988 of the FCC's current Uniform System of Accounts. Additional regulatory assets and liabilities may arise in the future as long as BellSouth Telecommunications remains subject to the provisions of SFAS No. 71.\nVarious forms of earnings-based regulation remain in effect at the federal level and in all nine states served by BellSouth Telecommunications. However, recent legislative and regulatory initiatives suggest that fully competitive markets for telecommunications services will eventually be established. During 1994, the United States Congress considered legislation designed specifically to open all telecommunications services to full competition. Although no such legislation was enacted into law, Congress is again considering legislation of this type, and similar initiatives are also emerging at the state level. Furthermore, in the regulatory arena, BellSouth Telecommunications continues to pursue modification of the existing regulatory framework. Price regulation plans, whereby prices of basic local exchange service are directly regulated and prices for other telecommunications products and services are based on market factors, have been proposed for implementation and are under review in several states in the service area and by the FCC.\nBellSouth Telecommunications would be required to discontinue accounting under SFAS No. 71 if the existing and anticipated levels of competition no longer allow for service and product pricing\nthat provides for the recovery of costs. Additionally, SFAS No. 71 would no longer apply if BellSouth Telecommunications is successful in altering the existing regulatory framework and achieving price regulation since such plans do not provide for the recovery of specific costs. While accounting under SFAS No. 71 is currently appropriate, it is increasingly likely that BellSouth Telecommunications will discontinue accounting under SFAS No. 71 due to the effect of one or both of these conditions. In that event, the impact on BellSouth Telecommunications' financial position and results of operations would be material. Under such circumstances, BellSouth Telecommunications would be required to reduce the recorded value for telephone plant and equipment in recognition of amounts that would not be recoverable or that would be overstated due to longer regulator-prescribed asset lives. BellSouth Telecommunications' overall depreciation reserve at December 31, 1994 was approximately 44% of its total depreciable plant. Broad industry analysis of other telecommunications companies who have recently discontinued accounting under SFAS No. 71 indicates that unregulated telecommunications enterprises similar to BellSouth Telecommunications have an overall depreciation reserve ratio that approximates 52% to 57% of total depreciable plant. If BellSouth Telecommunications were required to discontinue SFAS No. 71 and to revalue its telephone plant using similar assumptions and methodology, the net recorded book value of its telephone plant would be reduced by about $4,000 to $6,000. In addition, BellSouth Telecommunications would be required to eliminate its regulatory assets and liabilities, adjust the level of its unamortized investment tax credits and fully adopt issue basis accounting for its directory publishing fees. Specific financial impacts of discontinuing SFAS No. 71 would depend on the timing and magnitude of changes, both in the marketplace and in the overall regulatory framework.\nOTHER MATTERS\nRESTRUCTURING OF TELEPHONE OPERATIONS. As previously reported, during 1993 BellSouth Telecommunications recognized a $1,136.4 restructuring charge in connection with a plan to redesign, consolidate and streamline the fundamental processes and work activities in its telephone operations. The restructuring is being undertaken in response to an increasingly competitive business environment. Upon completion, restructuring of the telephone operations is expected to improve overall responsiveness to customer needs and reduce costs.\nAs a part of the restructuring, BellSouth Telecommunications is consolidating and centralizing its existing operations. BellSouth Telecommunications is establishing a single point of contact and accountability for the receipt, analysis and resolution of customer installation, repair activities and service activation. The efforts involve redesign of key work processes and designing new processes that facilitate the consolidation of service functions and the reduction of 10,200 employees.\nThe projected costs by year for each component of the charge were as follows:\nThrough December 31, 1994, BellSouth Telecommunications was substantially on plan with respect to projected expenditures and employee reductions. See \"PROGRESS UNDER THE PLAN.\"\nCONSOLIDATION AND ELIMINATION OF OPERATIONS. Approximately $342.8 of the charge consisted of costs associated with consolidating and eliminating operations as a result of re-engineering the way service is delivered to customers. During the restructuring period, 288 existing operations centers are being consolidated into 73 locations. Data management centers used to support company operations are being reduced from 11 to 6. Comptrollers offices are being reduced from 48 to 11. Collection process improvements are being made to reduce operating costs and uncollectibles. Redundancies are being eliminated and the number of steps decreased in the product planning and provisioning process. In addition, customer service processes and systems are being designed to provide one-number access, specific appointment times, on-line and real-time access to customer records and immediate service activation where facilities are already in place.\nSYSTEMS. Approximately $425.4 of the charge was for systems development. The information management systems in use prior to the restructuring effort were inadequate to deal with increased competition and changing technology. Accordingly, as an integral part of the restructuring plan, a major redesign of information systems throughout the company is being undertaken to attain a systems framework that both facilitates the targeted employee reductions and correlates to the increasingly competitive business environment. This effort entails significant changes to the overall computing platform, architecture and corporate systems structure.\nEMPLOYEE SEPARATION. Approximately $368.2 of the charge was for separation costs for employees leaving BellSouth Telecommunications through 1996 and for relocation of certain employees. BellSouth Telecommunications' targeted employee reduction of 10,200 employees by the end of the restructuring period will result in future cost savings and, as a result, is expected to improve BellSouth Telecommunications' competitive position.\nThe projected work force reductions by year under the plan were as follows:\nEmployee separation costs include severance payments, health care coverage, education benefits, and costs of relocating employees to new job locations, as well as net curtailment expenses. The severance payments, health care coverage and education benefits costs for management employees are paid under the provisions of current BellSouth management separation plans. The severance payments, health care coverage and education benefit costs for craft employees are paid under the provisions of collective bargaining agreements. Relocation costs are the costs to move personnel to different locations as a result of work center consolidations. These charges are paid under BellSouth Telecommunications' relocation guidelines and the terms of collective bargaining agreements. Net curtailment expenses are charged in accordance with the provisions of accounting pronouncements SFAS Nos. 88 and 106.\nPROGRESS UNDER THE PLAN. Since inception of the restructuring plan in fourth quarter 1993, cumulative employee reductions were 5,200 (1,300 in 1993 and 3,900 in 1994) and total amounts charged against the restructuring liability were $521.7.\nA summary of the costs incurred through December 31, 1994 under the plan is as follows:\nFor the year ended December 31, 1994, cash expenditures related to the ongoing implementation of the restructuring plan were approximately $390.2. Non-cash expenses were primarily comprised of pension curtailments and charges related to elimination of certain business operations of subsidiaries. Capital expenditures for 1994 related to restructuring were approximately $203.6; such expenditures are not reflected in the above tables.\nThe remaining restructuring liability at December 31, 1994 was approximately $614.7, all of which was classified as current. During 1995, BellSouth Telecommunications plans to accelerate restructuring activities such that employee reductions and expenditures as originally projected under the plan will be substantially completed by the end of 1995. Accordingly, employee reductions in 1995 under the plan are projected to be approximately 5,000 and capital expenditures, which are not reflected in the above tables, are projected to be about $300.\nThe cumulative reduction in employees as of December 31, 1994 resulted in an estimated $100 reduction in 1994 operating expenses and is currently projected to result in about a $300 to $400 reduction in 1995 operating expenses. Once the restructuring plan is completed, annual cost savings are expected to be approximately $600 due primarily to reduced employee-related expenses.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF MANAGEMENT\nThese financial statements have been prepared in conformity with generally accepted accounting principles and have been audited by Coopers & Lybrand L.L.P., independent accountants, whose report is contained herein.\nThe integrity and objectivity of the data in these financial statements, including estimates and judgments relating to matters not concluded by the end of the year, are the responsibility of the management of BellSouth Telecommunications. Management has also prepared all other information included in this Annual Report unless indicated otherwise.\nManagement maintains a system of internal accounting controls which is continuously reviewed and evaluated. However, there are inherent limitations that should be recognized in considering the assurances provided by any system of internal accounting controls. The concept of reasonable assurance recognizes that the cost of a system of internal accounting controls should not exceed, in management's judgment, the benefits to be derived. Management believes that BellSouth Telecommunications' system does provide reasonable assurance that the transactions are executed in accordance with management's general or specific authorizations and are recorded properly to maintain accountability for assets and to permit the preparation of financial statements in conformity with generally accepted accounting principles. Management also believes that this system provides reasonable assurance that access to assets is permitted only in accordance with management's authorizations, that the recorded accountability for assets is compared with the existing assets at reasonable intervals and that appropriate action is taken with respect to any differences. Management also seeks to assure the objectivity and integrity of its financial data by the 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, standards and managerial authorities are understood throughout the organization. Management is also aware that changes in operating strategy and organizational structure can give rise to disruptions in internal controls. Special attention is given to controls while the changes are being implemented.\nManagement maintains a strong internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. In addition, as part of its audit of these financial statements, Coopers & Lybrand L.L.P. completed a review of the accounting controls to establish a basis for reliance thereon in determining the nature, timing and extent of audit tests to be applied. Management has considered the internal auditor's and Coopers & Lybrand L.L.P.'s recommendations concerning the system of internal control and has taken actions that we believe are cost-effective in the circumstances to respond appropriately to these recommendations. Management believes that as of December 31, 1994, the system of internal controls was adequate to accomplish the objectives discussed herein.\nManagement also recognizes its responsibility for fostering a strong ethical climate so that BellSouth Telecommunications' affairs are conducted according to the highest standards of personal and corporate conduct. This responsibility is communicated to all employees through policies and guidelines addressing such issues as conflict of interest, safeguarding of BellSouth Telecommunications' real and intellectual properties, providing equal employment opportunities and ethical relations with customers, suppliers and governmental representatives. BellSouth Telecommunications maintains a program to assess compliance with these policies.\n\/s\/ Jere A. Drummond \/s\/ Patrick H. Casey PRESIDENT AND CHIEF EXECUTIVE OFFICER VICE PRESIDENT AND COMPTROLLER\nFebruary 3, 1995\nAUDIT COMMITTEE CHAIRMAN'S LETTER\nThe Audit Committee of the Board of Directors consists of three members who are neither officers nor employees of BellSouth Telecommunications. The Audit Committee met four times during 1994 and reviewed with the Chief Corporate Auditor, Coopers & Lybrand L.L.P., and management current audit activities, plans and the results of selected internal audits. The Audit Committee also reviewed the objectivity of the financial reporting process and the adequacy of internal controls. The Audit Committee recommended the appointment of the independent accountants and considered factors relating to their independence. The Chief Corporate Auditor and Coopers & Lybrand L.L.P. each met privately with the Audit Committee on occasion to encourage confidential discussions as to any auditing matters.\n\/s\/ Harry M. Lightsey, Jr. CHAIRMAN, AUDIT COMMITTEE February 3, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nBellSouth Telecommunications, Inc. Atlanta, Georgia\nWe have audited the accompanying consolidated balance sheets of BellSouth Telecommunications, Inc. 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. 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 BellSouth Telecommunications, 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 Notes H and L to the consolidated financial statements, BellSouth Telecommunications changed its method of accounting for postretirement benefits other than pensions, postemployment benefits, and income taxes in 1993.\n\/s\/ Coopers & Lybrand L.L.P. Atlanta, Georgia February 3, 1995\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the registration statement of BellSouth Telecommunications, Inc. on Form S-3 (File No. 33-49991) of our report dated February 3, 1995, on our audits of the consolidated financial statements of BellSouth Telecommunications, Inc. listed in Item 14(a) of this Form 10-K.\n\/s\/ Coopers & Lybrand L.L.P. Atlanta, Georgia March 6, 1995\nBELLSOUTH TELECOMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS (IN MILLIONS)\nThe accompanying notes are an integral part of these financial statements.\nBELLSOUTH TELECOMMUNICATIONS, INC. CONSOLIDATED BALANCE SHEETS (IN MILLIONS)\nThe accompanying notes are an integral part of these financial statements.\nBELLSOUTH TELECOMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN MILLIONS)\nThe accompanying notes are an integral part of these financial statements.\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN MILLIONS)\nNOTE A -- ACCOUNTING POLICIES\nBASIS OF PRESENTATION. The consolidated financial statements include the accounts of BellSouth Telecommunications, Inc. (BellSouth Telecommunications) and subsidiaries in which it has a controlling financial interest. BellSouth Telecommunications is a wholly-owned subsidiary of BellSouth Corporation (BellSouth). BellSouth Telecommunications maintains substantially all of its accounts and records in accordance with the Uniform System of Accounts prescribed by the Federal Communications Commission (FCC) and makes certain adjustments necessary to present the accompanying financial statements in accordance with generally accepted accounting principles applicable to regulated entities. Such principles differ in certain respects from those used by unregulated entities, but are required to appropriately reflect the financial and economic effects of regulation and the rate-making process. Significant differences resulting from the application of these principles are disclosed elsewhere in these Notes to Consolidated Financial Statements where appropriate.\nBASIS OF ACCOUNTING. BellSouth Telecommunications' consolidated financial statements have been prepared in accordance with generally accepted accounting principles, including the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" Where appropriate, SFAS No. 71 gives accounting recognition to the actions of regulators. Such actions can provide reasonable assurance of the existence of an asset, reduce or eliminate the value of an asset or impose or eliminate a liability of a regulated entity.\nAs a result of such actions by regulators, the consolidated balance sheets at December 31, 1994 and 1993 reflect net deferred charges (regulatory assets) of $186.5 and $235.9, respectively, related primarily to compensated absences and unamortized issuance costs for debt that has been refinanced. Net deferred credits (regulatory liabilities) included in the consolidated balance sheets were $304.0 and $378.9, respectively, related to income tax issues.\nTelephone plant and equipment has been depreciated using regulator-prescribed asset lives. Other telecommunications companies have recently discontinued accounting under SFAS No. 71 and have revalued their telephone plant. If BellSouth Telecommunications were to revalue its telephone plant using similar assumptions and methodology, the net recorded book value of its telephone plant would be reduced by approximately $4,000 to $6,000.\nCASH AND CASH EQUIVALENTS. BellSouth Telecommunications considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.\nMATERIAL AND SUPPLIES. New and reusable material is carried in inventory, principally at average original cost, except that specific costs are used in the case of large individual items. Nonreusable material is carried at estimated salvage value.\nPROPERTY, PLANT AND EQUIPMENT. The investment in property, plant and equipment is stated at original cost. For plant dedicated to providing regulated telecommunications services, depreciation is based on the remaining life method of depreciation and straight-line composite rates determined on the basis of equal life groups of certain categories of telephone plant acquired in a given year. Depreciation expense also includes amortization of certain classes of telephone plant and identified depreciation reserve deficiencies over periods allowed by regulatory authorities. When such plant is disposed of, the original cost less net salvage value is charged to accumulated depreciation. Other depreciable plant is depreciated using either straight-line or accelerated methods over the estimated useful lives of the assets. Gains and losses on disposal of other depreciable plant are recognized in the year of disposition as an element of other non-operating income.\nREVENUE RECOGNITION. Revenues are recognized when earned. Certain revenues derived from local telephone services are billed monthly in advance and are recognized the following month when\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE A -- ACCOUNTING POLICIES (CONTINUED) services are provided. Revenues derived from other telecommunications services, principally network access and toll, are recognized monthly as services are provided. Directory publishing fees are recognized over the life of the related directories, published by an affiliated company, which is generally one year.\nMAINTENANCE AND REPAIRS. The cost of maintenance and repairs of plant, including the cost of replacing minor items not effecting substantial betterments, is charged to operating expenses.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION. Regulatory authorities allow BellSouth Telecommunications to recognize the cost of capital (debt and equity components) associated with the construction of certain plant as income. Such income is not realized in cash currently but will be realized over the service life of the related plant as the resulting higher depreciation expense and plant investment are recovered in the form of increased revenues.\nINCOME TAXES. Effective January 1, 1993, BellSouth Telecommunications adopted SFAS No. 109, \"Accounting for Income Taxes.\" In accordance with the standard, the balance sheet reflects deferred tax balances associated with the anticipated tax impact of future income or deductions implicit in the balance sheet in the form of temporary differences. Temporary differences primarily result from the use of accelerated methods and shorter lives in computing depreciation for tax purposes. Prior to 1993, BellSouth Telecommunications accounted for income taxes under the provisions of Accounting Principles Board Opinion No. 11.\nFor financial reporting purposes, BellSouth Telecommunications is amortizing deferred investment tax credits earned prior to the 1986 repeal of the investment tax credit and also some transitional credits earned after the repeal. The credits are being amortized as a reduction to the provision for income taxes over the estimated useful lives of the assets to which the credits relate.\nNOTE B -- INVESTMENTS IN AND ADVANCES TO AFFILIATES Investments In and Advances to Affiliates consists primarily of 3,766,199 shares of BellSouth common stock. During 1993, grantor trusts established by BellSouth Telecommunications purchased for $199.9 such BellSouth common stock to provide partial funding for the benefits payable under certain non-qualified benefit plans. Dividend income earned from the BellSouth shares, included as a component of Other Income, net, was $10.4 and $7.6 for 1994 and 1993, respectively.\nNOTE C -- PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is summarized as follows at December 31:\nDepreciation of telephone plant and equipment as a percentage of average depreciable telephone plant was 7.20%, 7.51% and 7.67% for 1994, 1993 and 1992, respectively.\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE D -- OTHER CURRENT LIABILITIES Other current liabilities are summarized as follows at December 31:\nNOTE E -- DEBT\nDEBT MATURING WITHIN ONE YEAR: Debt maturing within one year is included as debt in BellSouth Telecommunications' computation of debt ratios and consisted of the following at December 31:\nBellSouth Telecommunications has committed credit lines aggregating $1,271.4 with various banks. There were no borrowings under the committed lines at December 31, 1994. BellSouth Telecommunications does not have any uncommitted lines of credit at December 31, 1994. There are no significant commitment fees or requirements for compensating balances associated with any lines of credit.\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE E -- DEBT (CONTINUED) LONG-TERM: Long-term debt is summarized as follows at December 31:\nMaturities of long-term debt outstanding (face amounts) at December 31, 1994 are summarized below:\nDuring 1993 and 1992, BellSouth Telecommunications refinanced certain long-term debt issues at more favorable interest rates. As a result of the early extinguishment of these issues, charges of $86.6, net of taxes of $58.8, and $40.7, net of taxes of $30.0, were recognized as extraordinary losses in 1993 and 1992, respectively.\nAt December 31, 1994, a shelf registration statement had been filed with the Securities and Exchange Commission by BellSouth Telecommunications under which $725.0 of debt securities could be offered.\nNOTE F -- OTHER LIABILITIES AND DEFERRED CREDITS Other liabilities and deferred credits is summarized as follows at December 31:\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE G -- TRANSACTIONS WITH AFFILIATES BellSouth Telecommunications has a contractual agreement with BellSouth Advertising & Publishing Corporation (BAPCO), an affiliated company, wherein BAPCO publishes certain telephone directories and in return pays BellSouth Telecommunications a publishing rights fee in its franchise area. For the years ended December 31, 1994, 1993 and 1992, these fees, included in Other operating revenue, were $638.1, $616.3 and $598.2, respectively.\nAt December 31, 1994 and 1993, amounts receivable from affiliated companies were $21.4 and $20.2, respectively. Amounts payable to affiliated companies at December 31, 1994 and 1993, both short and long-term, were $432.3 and $465.8, respectively.\nNOTE H -- EMPLOYEE BENEFITS\nPENSION PLANS. Substantially all employees of BellSouth Telecommunications are covered by noncontributory defined benefit pension plans sponsored by BellSouth. Principal plans are discussed below; other plans are not significant individually or in the aggregate.\nThe plan covering non-represented employees is a cash balance plan which provides pension benefits determined by a combination of compensation-based service and additional credits and individual account-based interest credits. The cash balance plan is subject to a minimum benefit determined under a plan in existence for non-represented employees prior to July 1, 1993 which provided benefits based upon credited service and employees' average compensation for a specified period. The minimum benefit under the prior plan is applicable to employees retiring through 2005. Both the 1994 and 1993 projected benefit obligations assume interest and additional credits greater than the minimum levels specified in the written plan. Pension benefits provided for represented employees are based on specified benefit amounts and years of service and includes the projected effect of future bargained-for improvements.\nBellSouth's funding policy is to make contributions to trust funds with the objective of accumulating sufficient assets to pay all pension benefits for which BellSouth is liable. Contributions are actuarially determined using the aggregate cost method, subject to ERISA and Internal Revenue Service limitations. Pension plan assets consist primarily of equity securities and fixed income investments.\nEffective January 1, 1994, the non-represented cash balance plan was divided from one into four cash balance plans which allowed for costs to be accounted for more precisely based upon specific company demographic information. The plan division had no material impact on BellSouth Telecommunications' 1994 costs.\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE H -- EMPLOYEE BENEFITS (CONTINUED) The components of net periodic pension cost for the non-represented plan are summarized below:\nPrior to 1994, BellSouth Telecommunications was allocated a portion of the expenses for both the non-represented and represented plans' pension expense. Pension cost allocated to BellSouth Telecommunications in 1994 for the represented plan was $63.6, and for both non-represented and represented plans in 1993, and 1992 was $113.4, and $155.3, respectively. The decrease in 1994 pension expense is primarily the result of a reduction in assumed benefit levels partially offset by the decrease in the discount rate assumption. The consolidated net pension expense amounts reflected above are exclusive of curtailment gains reflected in the restructuring activities discussed below.\nSFAS No. 87, \"Employers' Accounting for Pensions,\" requires certain disclosures to be made with respect to the components of net periodic pension cost for the period and a reconciliation of the funded status of the plan with amounts reported in the balance sheets. Such disclosures are not presented in 1994 for the represented plan and for years prior to 1994 for both non-represented and represented plans because the structure of the BellSouth plans does not permit disaggregation of relevant plan information on an individual company basis.\nThe significant actuarial assumptions at December 31, 1994 and 1993 were as follows:\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS. Substantially all non-represented and represented employees of BellSouth Telecommunications participate in BellSouth's postretirement health and life insurance welfare plans. Effective January 1, 1993, BellSouth adopted SFAS No. 106, \"Employers'\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE H -- EMPLOYEE BENEFITS (CONTINUED) Accounting for Postretirement Benefits Other Than Pensions,\" to account for these plans. BellSouth's transition benefit obligation is being amortized over 15 years, the average remaining service period of active plan participants at adoption. The accounting for the health care plan does not anticipate future adjustments to the cost-sharing arrangements provided for in the written plan for employees retiring after December 31, 1991.\nBellSouth's funding policy is to make contributions to trust funds with the objective of accumulating sufficient assets to pay all health and life benefits for which BellSouth is liable. Contributions are actuarially determined using the aggregate cost method, subject to ERISA and Internal Revenue Service limitations. Assets in the health and life plans consist primarily of equity securities and fixed income investments.\nPostretirement benefit cost allocated to BellSouth Telecommunications was $288.5 and $243.7 for 1994 and 1993. The consolidated net postretirement benefit cost amounts reflected above are exclusive of curtailment losses reflected in the restructuring activities discussed below. Prior to 1993, BellSouth Telecommunications recognized the cost of providing postretirement benefits based on funded amounts. The cost of providing health and life benefits for both active and retired employees was $524.1 for 1992. SFAS No. 106 requires certain disclosures to be made with respect to the components of net periodic postretirement benefit cost for the period and a reconciliation of the funded status of the plan with amounts reported in the balance sheets. Such disclosures are not presented because the structure of the BellSouth plan does not permit disaggregation of relevant plan information on an individual company basis.\nThe significant actuarial assumptions at December 31, 1994 and 1993 were as follows:\nThe health care cost trend rate assumption affects the amounts reported. A one-percentage-point increase in the assumed health care cost trend rates for each future year would increase BellSouth's accumulated postretirement benefit obligation by $108 at December 31, 1994 and the estimated aggregate service and interest cost components of the 1994 postretirement benefit cost by $14.\nMost regulatory jurisdictions have accepted BellSouth Telecommunications' SFAS No. 106 implementation plan. However, two states are requiring a 20-year and 30-year amortization of the transition benefit obligation, the impact of which is not material to BellSouth.\nEFFECT OF RESTRUCTURING ON PENSIONS AND POSTRETIREMENT BENEFITS. As a part of the restructuring charge in 1993 (see Note J), BellSouth Telecommunications recorded a liability of $88 for estimated net curtailment losses expected to impact BellSouth Telecommunications' pension and postretirement benefit plans. Of the amount recognized, $32 and $16 were realized and charged against the restructuring liability in 1994 and 1993, respectively.\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE H -- EMPLOYEE BENEFITS (CONTINUED) DEFINED CONTRIBUTION PLANS. BellSouth maintains contributory savings plans which cover substantially all employees of BellSouth Telecommunications. Employees' eligible contributions are matched with BellSouth common stock based on defined percentages determined annually by the Board of Directors. BellSouth Telecommunications recognized compensation expense of $113.4, $107.3 and $112.6 in 1994, 1993 and 1992, respectively, related to these plans.\nPOSTEMPLOYMENT BENEFITS. Effective January 1, 1993, BellSouth Telecommunications adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" SFAS No. 112 requires employers to accrue the cost of postemployment benefits provided to former or inactive employees after employment but before retirement, including but not limited to workers' compensation, disability, and continuation of health care benefits. Previously, BellSouth Telecommunications used the cash method to account for such costs. A one-time charge of $64.8, net of a deferred tax benefit of $40.8, related to adoption of this statement was recognized as a change in accounting principle. The effect of the change on BellSouth Telecommunications' 1993 operating results was not material.\nNOTE I -- LEASES BellSouth Telecommunications has entered into operating leases for facilities and equipment used in operations. Rental expenses under operating leases were $239.9, $228.6 and $258.7 for 1994, 1993 and 1992, respectively. Capital leases currently in effect are not significant.\nThe following table summarizes the approximate future minimum rentals under non-cancelable operating leases in effect at December 31, 1994:\nNOTE J -- RESTRUCTURING CHARGE The results of operations for the year ended December 31, 1993 include a $1,136.4 restructuring charge which reduced net income by $696.6. The restructuring is being undertaken to redesign and streamline the fundamental processes and work activities in the telephone operations to better respond to an increasingly competitive business environment. The restructuring is expected to improve overall responsiveness to customer needs and reduce costs.\nThe material components of the charge related to the reduction of the workforce by 10,200 employees. Through December 31, 1994, cumulative employee reductions related to the restructuring plan were 5,200, consisting of 1,300 in 1993 and 3,900 in 1994. The components of the charge consisted of provisions of $368.2 for separation payments and relocations of remaining employees, $342.8 for consolidation and elimination of certain operations facilities and $425.4 for enabling changes to information systems, primarily those used to provide services to existing customers.\nAt December 31, 1994, the remaining liability associated with the restructuring plan was $614.7, all of which was current.\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE K -- ADDITIONAL INCOME STATEMENT DATA\nInterest and dividend income for 1992 includes $56.6 relating to the settlement of an Internal Revenue Service summary assessment for the tax years 1979 and 1980.\nRevenues from services provided to AT&T Corp., BellSouth Telecommunications' largest customer, were approximately 13%, 16% and 16% of consolidated operating revenues for 1994, 1993 and 1992, respectively.\nNOTE L -- INCOME TAXES Effective January 1, 1993, BellSouth Telecommunications adopted SFAS No. 109, \"Accounting for Income Taxes,\" which applies a balance sheet approach to income tax accounting. In accordance with the new standard, the balance sheet reflects the anticipated tax impact of future taxable income or deductions implicit in the balance sheet in the form of temporary differences. These temporary differences reflect the difference between the basis in assets and liabilities as measured in the financial statements and as measured by tax laws using enacted tax rates. The cumulative effect of the adoption of SFAS No. 109 was not material.\nIn accordance with the provisions of SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" BellSouth Telecommunications has, for its regulated operations, only reflected the balance sheet impact of the adoption of SFAS No. 109. Specifically, BellSouth Telecommunications in 1993 recorded a net regulatory liability of $538.0 to correspond to the net reduction in deferred tax liabilities; the reduction resulted from changes in tax rates and from temporary differences which were previously flowed through. The balance of such net liability at December 31, 1994, included in Other Liabilities and Deferred Credits, was $304.0. This net regulatory liability is adjusted as the related temporary differences reverse.\nBellSouth Telecommunications is included in the consolidated Federal income tax return filed by BellSouth. Consolidated tax expense is allocated among the separate members of the group in accordance with the applicable sections of the Internal Revenue Code.\nGenerally, under this method each company calculates its current tax expense as if it filed a separate return. The sum of the separate company liabilities is compared to the consolidated return liability. The resulting difference, the benefit of consolidation, is allocated to companies contributing benefits (operating losses, excess credits and capital losses) in proportion to the amounts contributed. Deferred taxes are not allocated among the members of the group.\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE L -- INCOME TAXES (CONTINUED) The provision for income taxes is summarized as follows:\nTemporary differences and carryforwards which gave rise to deferred tax assets and (liabilities) at December 31 were as follows:\nOf the Net Deferred Tax Liability at December 31, 1994 and 1993, $260.5 and $199.6, respectively, was current and $(2,992.1) and $(2,831.4), respectively, was noncurrent.\nPrior to 1993, deferred tax expense resulted from timing differences in the recognition of revenue and expense items for tax and financial reporting purposes, as follows:\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE L -- INCOME TAXES (CONTINUED) A reconciliation of the Federal statutory income tax rate to BellSouth Telecommunications' effective tax rate follows:\nNOTE M -- SUPPLEMENTAL CASH FLOW INFORMATION The following supplemental information is presented in accordance with the provisions of SFAS No. 95, \"Statement of Cash Flows\":\nNOTE N -- FINANCIAL INSTRUMENTS The following disclosure of the estimated fair value of financial instruments is presented in accordance with the provisions of SFAS No. 107, \"Disclosures about Fair Value of Financial Instruments.\" The estimated fair value amounts have been determined using available market information described below. Since judgment is required to develop the estimates, the estimated amounts presented herein may not be indicative of the amounts that BellSouth Telecommunications could realize in a current market exchange.\nCASH AND CASH EQUIVALENTS. At December 31, 1994 and 1993, the recorded amount for Cash and cash equivalents approximates fair value due to the short-term nature of these instruments.\nMARKETABLE SECURITIES. The fair value of Marketable securities (representing BellSouth Common Stock), included as a component of Investments in and Advances to Affiliates, is based on the quoted market prices at December 31, 1994 and 1993, respectively (see Note B).\nBELLSOUTH TELECOMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS)\nNOTE N -- FINANCIAL INSTRUMENTS (CONTINUED) DEBT. At December 31, 1994 and 1993, the recorded amount for Commercial paper approximates the fair value due to the short-term nature of the liability. The estimates of fair value for Debentures and Notes are based on the closing market prices for each issue at December 31, 1994 and 1993, respectively (see Note E).\nCONCENTRATIONS OF CREDIT RISK. Financial instruments which potentially subject BellSouth Telecommunications to credit risk consist principally of trade accounts receivable. Concentrations of credit risk with respect to these receivables are limited due to the composition of the customer base, which includes a large number of individuals and businesses. At December 31, 1994, approximately $448 of trade accounts receivable were from interexchange carriers.\nNOTE O -- QUARTERLY FINANCIAL INFORMATION (UNAUDITED) In the following summary of quarterly financial information, all adjustments necessary for a fair presentation of each period were included. The results for first quarter 1993 were restated to reflect the one-time, non-cash charge for retroactive adoption of SFAS No. 112. The results for fourth quarter 1993 include a restructuring charge of $1,136.4, which reduced net income by $696.6.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNo change in accountants or disagreements on the adoption of appropriate accounting standards or financial disclosure have occurred during the periods included in 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\na. Documents filed as a part of the report:\n(2) Financial statement schedules have been omitted because the required information is contained in the financial statements and notes thereto or because such schedules are not required or applicable.\n(3) Exhibits: Exhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto.\nb. Reports on Form 8-K: None.\nSIGNATURES\nPursuant to the requirements of Section13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBELLSOUTH TELECOMMUNICATIONS, INC.\n\/s\/ PATRICK H. CASEY -------------------------------------- Patrick H. Casey VICE PRESIDENT AND COMPTROLLER 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 date indicated.\nPRINCIPAL EXECUTIVE OFFICER: Jere A. Drummond* President and Chief Executive Officer\nPRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER: Patrick H. Casey* Vice President and Comptroller\nDIRECTORS:\nIrving W. Bailey II* Robert H. Boh* Edward E. Crutchfield, Jr.* Frank R. Day* Jere A. Drummond* Lloyd C. Elam*\nJohn W. Harris* Mark C. Hollis* Harry M. Lightsey, Jr.* Thomas H. Meeker* Joe M. Rodgers* Charles J. Zwick*\n*By: \/s\/ PATRICK H. CASEY ---------------------------------- Patrick H. Casey (INDIVIDUALLY AND AS ATTORNEY-IN-FACT) March 6, 1995","section_15":""}
{"filename":"822816_1994.txt","cik":"822816","year":"1994","section_1":"ITEM 1. BUSINESS.\nGeneral IDS\/Shurgard Income Growth Partners L.P. was organized under the laws of the State of Washington on September 29, 1987. The General Partner is Shurgard Associates L.P. 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 1988 and purchased seven existing storage centers and one development site. The offering was closed in March 1989 with total proceeds raised through the sale of limited partnership interest of approximately $37 million.\nThe Partnership is also a partner and 70% equity owner in Shurgard Joint Partners II (\"SJP II\"), organized in the State of Washington. SJP II purchased four existing storage centers during 1988. The remaining 30% interest was originally owned by Shurgard Income Properties - Fund 18. On March 1, 1994, Shurgard Income Properties - Fund 18 Limited Partnership was merged into Shurgard Storage Centers, Inc. (\"SSCI\") as part of the consolidation of 17 Shurgard-sponsored limited partnerships. As a result of the merger, SSCI succeeded to all of Shurgard 18's interest in Shurgard Joint Partners II, and assumed its obligation as a partner. The Partnership consented to SSCI's admission as a successor partner in Shurgard Joint Partners II.\nFor 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 areas they serve, the acquisition or completion date, and the square foot occupancy at the beginning and end of the year.\nAll of the properties were purchased from unaffiliated sellers and are held in fee by the Partnership or Shurgard Joint Partners II.\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, 1995, there was one general partner and approximately 5,700 limited partners in the Partnership.\n(c) Distributions. During the fiscal years ended December 31, 1993 and 1994, the Partnership distributed $15.16 and $17.03 respectively, per $250 unit of limited partnership interest. In February 1995, the Partnership distributed $4.69 per unit of limited partnership interest. As of December 31, 1994, total distributions of $14,486,597 are greater than total earnings on a basis consistent with generally accepted accounting principles by $5,405,185. 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., a Washington limited partnership. Shurgard Associates L.P. 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. 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 operation 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. and the executive officers, directors and certain key personnel of Shurgard General Partner, Inc., and Shurgard Incorporated are as follows:\nOn March 24, 1995, Shurgard Incorporated was merged into Shurgard Storage Centers, Inc. 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:\nName Age Positions and Offices With the Company --------------- --- --------------------------------------------------- Charles K. Barbo 53 Chairman of the Board, President and Chief Executive Officer Harrell L. Beck 38 Director, Senior Vice President, Chief Financial Officer and Treasurer Dan Kourkoumelis 43 Director Donald W. Lusk 66 Director Wendell J. Smith 61 Director David K. Grant 41 Executive Vice President Michael Rowe 38 Executive Vice President Kristin H. Stred 36 Senior Vice President, Secretary and General Counsel\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 the Partnership 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 ----------- ---------------- ----------------\n1 General Partner 133,000*\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 .003%. 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.\n(a) Security ownership of certain beneficial owners as of February 6, 1995:\nNone owning more than 5% of the Partnership's voting securities.\n(b) Security ownership of management as of February 6, 1995:\nSecurity ownership in Shurgard Associates L.P. 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 Incorporated 3,4 40.0% IDS Partnership Services Corporation 3 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. 3 Owner is a Limited Partner of Shurgard Associates L.P. 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 merged into 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 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 $359,655 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 D at page 10 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) --------------- -------------------------- ---------- --------- Charles 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. and Shurgard Joint Partners II are incorporated by reference in Part II and are filed as Exhibit 13:\nCombined balance sheets -- December 31, 1994 and 1993 Combined statements of earnings -- Three years ended December 31, Combined statements of partners' equity (deficit) -- Three years ended December 31, 1994 Combined statements of cash flows -- Three years ended December 31, 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.\nBy: Shurgard Associates L.P., 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- Filed as Exhibit 3 to Form S-11 for laws Registration No. 33-17556 (a) Agreement of Limited Partnership 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. 33-17556 13. Annual report to security holders Filed as Exhibit 13 to Form 10K for Registration No. 33-17556 21.Subsidiaries of the registrant See Item 1 of this Form 10-K\n27.Financial Data Schedule Filed as Exhibit 27 to Form 10K for Registration No. 33-17556","section_15":""}
{"filename":"105839_1994.txt","cik":"105839","year":"1994","section_1":"ITEM 1. BUSINESS\nAllegheny Power System, Inc. (APS), incorporated in Maryland in 1925, is an electric utility holding company which owns various subsidiaries (collectively, the APS System). APS derives substantially all of its income from the electric utility operations of its direct and indirect subsidiaries, Monongahela Power Company (Monongahela), The Potomac Edison Company (Potomac Edison), West Penn Power Company (West Penn), and Allegheny Generating Company (AGC) (collectively, the Subsidiaries). The properties of the Subsidiaries are located in Maryland, Ohio, Pennsylvania, Virginia, and West Virginia, are interconnected, and are operated as a single integrated electric utility system (System), which is interconnected with all neighboring utility systems. The three electric utility operating Subsidiaries are Monongahela, Potomac Edison, and West Penn (Operating Subsidiaries). APS has no employees. Its officers are employed by Allegheny Power Service Corporation (APSC), a wholly-owned subsidiary of APS. On December 31, 1994, the APS System had 6,061 employees.\nMonongahela, incorporated in Ohio in 1924, operates in northern West Virginia and an adjacent portion of Ohio. It also owns generating capacity in Pennsylvania. Monongahela serves about 343,900 customers in a service area of about 11,900 square miles with a population of about 710,000. The seven largest communities served have populations ranging from 10,900 to 33,900. On December 31, 1994, Monongahela had 1,982 employees. Its service area has navigable waterways and substantial deposits of bituminous coal, glass sand, natural gas, rock salt, and other natural resources. Its service area's principal industries produce coal, chemicals, iron and steel, fabricated products, wood products, and glass. There are two municipal electric distribution systems and two rural electric cooperative associations in its service area. Except for one of the cooperatives, they purchase all of their power from Monongahela.\nPotomac Edison, incorporated in Maryland in 1923 and in Virginia in 1974, operates in portions of Maryland, Virginia, and West Virginia. It also owns generating capacity in Pennsylvania. Potomac Edison serves about 361,400 customers in a service area of about 7,300 square miles with a population of about 782,000. The six largest communities served have populations ranging from 11,900 to 40,100. On December 31, 1994, Potomac Edison had 1,137 employees. Its service area is generally rural. Its service area's principal industries produce aluminum, cement, fabricated products, rubber products, sand, stone, and gravel. There are four municipal electric distribution systems in its service area, all of which purchase power from Potomac Edison, and six rural electric\ncooperatives, one of which purchases power from Potomac Edison. There are also several large federal government installations served by Potomac Edison.\nWest Penn, incorporated in Pennsylvania in 1916, operates in southwestern and north and south central Pennsylvania. It also owns generating capacity in West Virginia. West Penn serves about 653,000 customers in a service area of about 9,900 square miles with a population of about 1,399,000. The 10 largest communities served have populations ranging from 11,200 to 38,900. On December 31, 1994, West Penn had 2,053 employees. Its service area has navigable waterways and substantial deposits of bituminous coal, limestone, and other natural resources. Its service area's principal industries produce steel, coal, fabricated products, and glass. There are two municipal electric distribution systems in its service area, which purchase their power requirements from West Penn, and five rural electric cooperative associations, located partly within the area, which purchase virtually all of their power through a pool supplied by West Penn and other nonaffiliated utilities.\nAGC, organized in 1981 under the laws of Virginia, is jointly owned by the Operating Subsidiaries as follows: Monongahela, 27%; Potomac Edison, 28%; and West Penn, 45%. AGC has no employees, and its only asset is a 40% undivided interest in the Bath County (Virginia) pumped-storage hydroelectric station, which was placed in commercial operation in December 1985, and its connecting transmission facilities. AGC's 840-megawatt (MW) share of capacity of the station is sold to its three parents. The remaining 60% interest in the Bath County Station is owned by Virginia Electric and Power Company (Virginia Power).\nAYP Capital, Inc. (AYP Capital), incorporated in Delaware in 1994, is an unregulated, wholly-owned nonutility subsidiary of APS. AYP Capital was formed in an effort to meet the challenges of the new competitive environment in the industry. APS has been authorized by the Securities and Exchange Commission to purchase common stock of and make capital contributions to AYP Capital in the amount of $3 million. AYP Capital has no employees. Its officers are employed by APSC. APSC is providing certain services to AYP Capital pursuant to a service agreement.\nThe Subsidiaries in the past have experienced and in the future may experience some of the more significant problems common to electric utilities in general. These include increases in operating and other expenses, difficulties in obtaining adequate and timely rate relief, restrictions on construction and operation of facilities due to regulatory requirements and environmental and health considerations, including the requirements of the Clean Air Act Amendments of 1990 (CAAA), which among other things, require a substantial annual reduction in emissions of sulfur dioxides (SO2) and nitrogen oxides (NOx).\nAdditional concerns include proposals to restructure and, to some extent, deregulate portions of the industry and increase competition. (See ITEM 1. COMPETITION.) Further concerns of the industry include possible restrictions on carbon dioxide emissions, uncertainties in demand due to economic conditions, energy\nconservation, market competition, weather, and interruptions in fuel supply because of weather. (See ITEM 1. CONSTRUCTION AND FINANCING, RATE MATTERS, and ENVIRONMENTAL MATTERS for information concerning the effect on the Subsidiaries of the CAAA.)\nCOMPETITION\nFollowing the steps of other previously regulated industries such as airlines, telecommunications and gas, there is a movement to deregulate or at least allow competition, limited or otherwise, in the electric utility industry. The passage of the National Energy Policy Act of 1992 (EPACT) has permitted an increase in competition by allowing the formation of Exempt Wholesale Generators (EWGs), with the approval of the Federal Energy Regulatory Commission (FERC), and by providing for mandatory access to the interconnected electric grid for wholesale transactions. It further provides for expansion of the grid where constraints are determined to exist, providing necessary authority to construct such facilities can be obtained and the requestor's rate for such transmission service reflects expansion costs. EPACT permits utility generation facilities to qualify as EWGs and allows sales to nonaffiliated and to affiliated utilities provided state commissions approve such transactions. (See ITEM 1. SALES and REGULATION for a further discussion of the impact of EPACT.)\nMaryland, Ohio, and Pennsylvania have initiated investigations concerning competition in the retail electric utility industry and promoting increased competitive options. (See ITEM 1. REGULATION for a further discussion of the states' initiatives.)\nTo meet the challenges of the new competitive environment in the industry, AYP Capital was formed in 1994. It is intended that AYP Capital operate as an innovative and flexible organization, pursuing and developing new opportunities in unregulated markets that will strengthen the long-term competitiveness and profitability of APS. The business opportunities which are pursued by AYP Capital will be directly related to the core utility business of APS. Management may consider establishing or acquiring its own EWGs or other nonregulated generation facilities, if feasible, and management continues to evaluate other nonregulated opportunities to meet the competitive challenge.\nTo further meet the challenges of the new competitive environment in the industry, management has begun to simplify the structure of the APS System to increase efficient operation. In addition, APS, along with the other registered electric public utility holding companies under the Public Utility Holding Company Act of 1935 (PUHCA), is advocating repeal of PUHCA which is an impediment to allowing the APS System to compete on a level playing field in the new era of competition. In the alternative, restructuring of the APS System to reduce or eliminate the effect of PUHCA is being considered.\nIn addition, management continues to explore methods of marketing and pricing its core product - electric energy and the transmission thereof - in new and competitive ways, such as bulk\nsales to power marketers, incentive pricing to traditional utility customers, and repackaging of services in nontraditional ways. It is also attempting to reduce costs, particularly capital expenditures, in order to position the APS System in a more competitive mode. The feasibility of maintaining these reduced levels in the future will depend upon, among other things, (1) the ability to maintain adequate levels of reliable service, (2) the avoidance of unexpected major equipment failures and (3) no changes in the timing or requirements for regulatory compliance measures.\nSALES\nIn 1994, consolidated kilowatt-hour (kWh) sales to the Operating Subsidiaries' retail customers increased 2.8% from those of 1993 as a result of increases of .9%, 2.2% and 4.4% in residential, commercial and industrial sales, respectively. The increased kWh sales in 1994 reflect both growth in number of customers and higher use. Consolidated revenues from residential, commercial, and industrial sales increased 5.5%, 6.8%, and 8.1%, respectively, primarily because of rate increases (See ITEM 1. RATE MATTERS), increases in fuel and energy cost adjustment clause revenues, and increased kWh sales. Consolidated kWh sales to and revenues from nonaffiliated utilities decreased 20.0% and 4.4%, respectively, due to increased native load, decreased demand, and price competition.\nThe System's all-time peak load of 7,280 MW, which was higher than the forecast, occurred on February 6, 1995. The peak load in 1994 and 1993 was 7,153 MW and 6,678 MW, respectively. The increased 1994 peak would have been higher except for voluntary conservation efforts by the Operating Subsidiaries' customers. The average System load (yearly net power supply divided by number of hours in the year) was 4,776 MW and 4,674 MW in 1994 and 1993, respectively. More information concerning sales may be found in the statistical sections and ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nConsolidated electric operating revenues for 1994 were derived as follows: Pennsylvania, 44.5%; West Virginia, 28.0%; Maryland, 20.5%; Virginia, 5.4%; Ohio, 1.6% (residential, 35.2%; commercial, 18.8%; industrial, 29.7%; nonaffiliated utilities, 13.5%; and other, 2.8%). The following percentages of such revenues were derived from these industries: iron and steel, 6.0%; chemicals, 3.4%; fabricated products,3.4%; aluminum and other nonferrous metals, 3.3%; coal mines, 3.2%; cement, 1.9%; and all other industries, 8.5%. Revenues from each of 17 industrial customers exceeded $5 million, including one coal customer of both Monongahela and West Penn with total revenues exceeding $22 million, three steel customers with revenues exceeding $27 million each, and one aluminum customer with revenues exceeding $68 million.\nDuring 1994, Monongahela's kWh sales to retail customers increased 3.2% as a net result of increases of 1.2% and 6.1% in commercial and industrial sales, respectively, and a decrease of\n.6% in residential sales. Revenues from residential, commercial and industrial customers increased 3.1%, 4.9% and 7.7%, respectively, and revenues from kWh sales to affiliated and nonaffiliated utilities increased 6.8%. Monongahela's all-time peak load of 1,694 MW occurred on July 20, 1994.\nMonongahela's electric operating revenues were derived as follows: West Virginia, 94.3% and Ohio, 5.7% (residential, 28.1%; commercial, 17.1%; industrial, 29.7%; nonaffiliated utilities, 11.7%; and other, 13.4%). Revenues from each of five industrial customers exceeded $10 million, including one coal customer with revenues exceeding $19 million and one steel customer with revenues exceeding $27 million.\nDuring 1994, Potomac Edison's kWh sales to retail customers increased 2.3% as a result of increases of 1.7%, 2.1%, and 2.8% in residential, commercial, and industrial sales, respectively. Revenues from such customers increased 7.9%, 9.0%, and 10.9%, respectively, and revenues from kWh sales to affiliated and nonaffiliated utilities decreased 1.0%. Potomac Edison's all-time peak load of 2,595 MW occurred on January 19, 1994.\nPotomac Edison's electric operating revenues were derived as follows: Maryland, 66.6%; Virginia 16.8% and West Virginia, 16.6%; (residential, 39.0%; commercial, 17.9%; industrial, 25.7%; nonaffiliated utilities, 14.1%; and other, 3.3%). Revenues from one industrial customer, the Eastalco aluminum reduction plant near Frederick, Maryland, amounted to $68 million (9.0% of total electric operating revenues). Minimum annual charges to Eastalco under an electric service agreement which continues through March 31, 2000, with automatic extensions thereafter unless terminated on notice by either party, were $19.7 million in 1994. Said agreement may be cancelled before the year 2000 upon 90 days notice of a governmental decision resulting in a material modification of the agreement.\nDuring 1994, West Penn's kWh sales to retail customers increased 2.9% as a result of increases of 1.1%, 2.9% and 4.4% in residential, commercial, and industrial sales, respectively. Revenues from residential, commercial, and industrial customers increased 5.0%, 6.4%, and 6.7%, respectively, and revenues from kWh sales to affiliated and nonaffiliated utilities decreased 5.7%. West Penn's all-time peak load of 3,179 MW occurred on February 6, 1995.\nWest Penn's electric operating revenues were derived as follows: Pennsylvania, 100% (residential, 33.4%; commercial, 18.4%; industrial, 29.3%; nonaffiliated utilities, 12.8%; and other, 6.1%). Revenues from each of four industrial customers exceeded $10 million, including two steel customers with revenues exceeding $32 million each.\nOn average, the Operating Subsidiaries are the lowest or among the lowest cost suppliers of electricity in their respective states with fixed costs being extremely low and incremental costs being about average. Therefore, the Operating Subsidiaries' delivered power prices should compete favorably with those of potential alternate suppliers who use cost-based pricing. However,\nthe Operating Subsidiaries face increased competition from utilities with excess generation that are willing to sell at prices intended only to cover variable costs. At the same time, the Operating Subsidiaries are experiencing cost increases due to compliance with the CAAA and purchases from Public Utility Regulatory Policies Act of 1978 (PURPA) projects. (See page 7 for a discussion of PURPA projects, and ITEM 3. LEGAL PROCEEDINGS for a description of litigation and regulatory proceedings concerning PURPA capacity.)\nIn 1994, the Operating Subsidiaries provided approximately 10.5 billion kWh of energy to nonaffiliated utility companies, of which 1.1 billion kWh were generated by the Subsidiaries and the rest were transmitted from electric systems located primarily to the west. These sales included a long-term transaction under which the Operating Subsidiaries purchased 450 MW of firm capacity and its associated energy from Ohio Edison Company for resale to Potomac Electric Power Company, both nonaffiliated utilities. The transaction began in mid-1987 and will continue through 2005, unless terminated earlier.\nSales to nonaffiliated utility companies vary with the needs of those companies for imported power; the availability of System generating facilities and excess power, fuel, and regional transmission facilities; and the availability and price of competitive sources of power. Sales of system generated power decreased in 1994 relative to 1993 primarily because of continued decreased demand, increased Operating Subsidiaries' native load, and increased willingness of other suppliers to make sales at lower prices. Further decreases in sales of system generated power to nonaffiliated utilities are expected in 1995 and beyond. Substantially all of the revenues from kWh sales to nonaffiliated utilities are passed on to retail customers and as a result have little effect on net income.\nPursuant to a peak diversity exchange arrangement with Virginia Power which is projected to continue through February 2008, the Operating Subsidiaries annually supply Virginia Power with 200 MW during each June, July, and August and in return Virginia Power supplies the Operating Subsidiaries with 200 MW during each December, January, and February, at least through February 1998. Thereafter, specific amounts of annual diversity exchanges beyond those currently established are to be mutually determined no less than 34 months prior to each year for which an exchange is to take place. The total number of megawatt-hours (MWh) to be delivered by each utility to the other over the term of the arrangement is expected to be the same.\nPursuant to an exchange arrangement with Duquesne Light Company (Duquesne) which will continue through February 1996 and may be extended through 1999 and beyond, the Operating Subsidiaries supply Duquesne with up to 200 MW for a specified number of weeks, generally during each March, April, May, September, October, and November. In return, Duquesne supplies the Operating Subsidiaries with up to 100 MW, generally during each December, January, and February. The total number of MWh to be delivered by each utility to the other over the term of the arrangement is expected to be the same.\nWest Penn supplies power to the Borough of Tarentum (Tarentum) using in part leased distribution facilities from Tarentum under a 30 year lease agreement terminating in 1996. In June 1993, Tarentum, which in that year had a load of 6.5 MW and revenues of $1.8 million, notified West Penn of its intention to exercise its option to end the lease agreement. The termination of the lease agreement and resulting transfer and sale of electric facilities will result in Tarentum becoming a municipal customer which will purchase electricity on a wholesale basis from West Penn or another supplier. The sale of electric facilities will require Pennsylvania Public Utility Commission (Pennsylvania PUC) approval.\nThe Operating Subsidiaries provide wholesale transmission services under their FERC-approved Standard Transmission Service tariff. The tariff provides that such service is subordinate in priority to native load and reliability requirements of interconnected systems to avoid adverse effects on regional and Operating Subsidiaries' reliability. (See ITEM 1. ELECTRIC FACILITIES for a discussion of stress on the System's transmission system.) Transmission services requiring special arrangements or long-term commitments have been and continue to be negotiated through mutually acceptable bilateral agreements. Substantially all of the revenues from transmission service sales are passed on to retail customers and as a result have little effect on net income. In addition, the Operating Subsidiaries have pending before the FERC a Standard Generation Service Rate Schedule tariff under which the Operating Subsidiaries will make available bundled, non-firm generation services with associated System transmission services to any customer who executes an agreement under such tariff. Sales subject to refund under the proposed tariff have been initiated.\nEPACT permits wholesale generators, utility-owned and otherwise, and wholesale consumers to request from owners of bulk power transmission facilities a commitment to supply transmission services. The FERC recently completed a generic investigation into the pricing of such requested transmission services. The FERC has chosen to maintain existing methods while offering limited opportunities to implement new methodologies which transmitting companies may wish to use if they find those methods to be beneficial. The potential for FERC's new pricing guidelines to be beneficial or detrimental to the Operating Subsidiaries cannot be predicted at this time. In addition, the FERC is continuing to develop new policies and procedures to further implement EPACT, including seeking comments to a Notice of Proposed Rulemaking on stranded costs and an Inquiry concerning alternative power pooling arrangements and in a recent case, has expanded the definition of nondiscriminatory service to require a utility to provide transmission service comparable to the service it provides itself. (See ITEM 3. LEGAL PROCEEDINGS for a discussion of the FERC proceeding wherein Duquesne has requested firm transmission service over the System's transmission facilities).\nUnder EPACT, consumers of wholesale power including small electric systems owned by municipalities and rural electric cooperative associations may purchase power from any available source and may seek an order from the FERC for transmission service from any utility. Small electric wholesale customers in the\nOperating Subsidiaries' service areas which do not have long term contracts may choose to avail themselves of this option. The Operating Subsidiaries will attempt to retain these customers.\nUnder PURPA, certain municipalities and private developers have installed, are installing or are proposing to install hydroelectric and other generating facilities at various locations in or near the Operating Subsidiaries' service areas with the intent of selling some or all of the electric capacity and energy to the Operating Subsidiaries at rates provided under PURPA and ordered by appropriate state commissions. The System's total generation capacity includes a maximum 299 MW of on-line PURPA capacity. Payments for PURPA capacity and energy in 1994 totaled approximately $134 million at an average cost to the System of 5.8 cents\/kWh as compared to System cost of about 3 cents\/kWh. The Operating Subsidiaries anticipate an additional 260 MW of PURPA capacity to come on-line in future years, up from 180 MW. This increase is due to a litigated PURPA project which had lapsed being reincluded in the planning process although litigation is ongoing. In addition, lapsed purchase agreements totaling 123 MW and other PURPA complaints totaling 520 MW are the subject of ongoing litigation and are not included in the System's current planning strategy. (See ITEM 3. LEGAL PROCEEDINGS for a description of litigation and regulatory proceedings in Pennsylvania and West Virginia.)\nELECTRIC FACILITIES\nThe following table shows the System's December 31, 1994 generating capacity, based on the maximum monthly normal seasonal operating capacity of each unit. The System-owned capacity totaled 8,070 MW, of which 7,090 MW (88%) are coal-fired, 840 MW (10%) are pumped-storage, 82 MW (1%) are oil-fired, and 58 MW (1%) are hydroelectric. The term \"pumped-storage\" refers to the Bath County station which stores energy for use principally during peak load hours by pumping water from a lower to an upper reservoir, using the most economic available electricity, generally during off-peak hours. During the generating cycle, power is produced by water falling from the upper to the lower reservoir through turbine generators.\nThe weighted average age of the System-owned coal-fired stations shown on the following page, based on generating capacity at December 31, 1994, was about 24.6 years. In 1994, their average heat rate was 9,927 Btu's\/kWh, and their availability factor was 82.1%, down from 87% in 1993 due, in part, to planned outages for installation of pollution control equipment for compliance with the CAAA.\nSYSTEM MAP\nThe Allegheny Power System Map (System Map), which has been omitted, provides a broad illustration of the names and approximate locations of the System's major generation and transmission facilities, both existing and under construction, in a five state region which includes portions of Pennsylvania, Ohio, West Virginia, Maryland and Virginia. Additionally, Extra High Voltage substations are displayed. By use of shading, the System Map also provides a general representation of the service areas of Monongahela (portions of West Virginia and Ohio), Potomac Edison (portions of Maryland, Virginia and West Virginia), and West Penn (portions of Pennsylvania).\nPower Stations shown on the System Map which appear within the Monongahela service area are Willow Island, Pleasants, Harrison, Rivesville, Albright, and Fort Martin. The single Power Station appearing within the Potomac Edison service area is R. Paul Smith. The Bath County Power Station appears on the map just south of the westernmost portion of Potomac Edison's service area formed by the borders of Virginia and West Virginia. Power Stations appearing within the West Penn service area are Armstrong, Mitchell, Hatfield's Ferry, Springdale and Lake Lynn.\nThe System Map also depicts transmission facilities which are (i) owned solely by the Operating Subsidiaries; (ii) owned by the Operating Subsidiaries in conjunction with other utilities; or (iii) owned solely by other utilities. The transmission facilities portrayed range in capacity from 138kV to 765kV. Additionally, interconnections with other utilities are displayed.\nThe following table sets forth the existing miles of tower and pole transmission and distribution lines and the number of substations of the Subsidiaries as of December 31, 1994:\nThe System has 11 extra-high-voltage (345 kV and above) (EHV) and 29 lower-voltage interconnections with neighboring utility systems. The interregional EHV transmission system, including System facilities, historically has been negatively affected by frequent periods of heavy loading, predominantly in a west-to-east direction. In 1994, the west-to-east flows decreased from prior years due to lower interregional power transfers. However, increases in customer load, power transfers by the Operating Subsidiaries and nonaffiliated entities, and parallel flows may contribute to a possible resumption of the heavy west-to-east power flows. If power transfers return to the levels experienced during the late 1980s and early 1990s, the interregional EHV transmission facilities may operate at times at their reliability limit and therefore, despite recently installed reactive power sources, restrictions on transfers may again become necessary.\nUnder certain provisions of EPACT, wholesale generators, and wholesale customers, may seek from owners of bulk power transmission facilities a commitment to supply transmission services. (See discussion under ITEM 1. SALES and REGULATION.) Such demand on the System's transmission facilities may add periodically to heavy power flows on the System's facilities.\nThe Operating Subsidiaries have, to date, provided managed contractual access to the System's transmission facilities via the provisions of their Standard Transmission Service tariff, or the terms and conditions of bilateral contracts.\nRESEARCH AND DEVELOPMENT\nThe Operating Subsidiaries spent $7.7 million, $4.6 million, and $2.7 million in 1994, 1993 and 1992, respectively, for research programs. Of these amounts, $5.9 million, $3.2 million and $0.6 million were for Electric Power Research Institute (EPRI) dues in 1994, 1993 and 1992, respectively. EPRI is an industry-sponsored research and development institution. The Operating Subsidiaries plan to spend approximately $9.7 million for research in 1995, with EPRI dues representing $6.2 million of that total.\nIndependent research conducted by Operating Subsidiaries concentrated on environmental protection (CAAA and permit mandates), generating unit performance, future generating technologies, delivery systems, and customer-related research. Clean power technology focused on power quality and load management devices and techniques for customer and delivery equipment.\nTwo U.S. Department of Energy Clean Coal Technology NOx control projects, which the Operating Subsidiaries cofounded, have recently been completed. Based upon the results of one of the projects, retrofitting of low NOx cell burners on Hatfield Power Station units has been undertaken at much lower costs than would otherwise have been possible.\nResearch is also being directed to help address major issues facing the Operating Subsidiaries including electric and magnetic field (EMF) assessment, waste disposal, greenhouse gas, client- server information system prospects, renewable resources, fuel cells, new combustion turbines and other cogeneration technologies. In addition, there is continuing evaluation of technical proposals from outside sources and monitoring of developments in literature, law, litigation and standards.\nElectric vehicle (EV) research included participation in the Ford Ecostar Demonstration Program, EV America and the Electric Transportation Coalition, as well as the development of appropriate wiring and building code standards to accommodate electric vehicles.\nWith reference to alleged global climate change, a Memorandum of Understanding was signed on behalf of all Edison Electric Institute (EEI) companies by EEI and the Department of Energy (DOE) which contains Initiatives directed toward voluntary programs to reduce greenhouse gas emissions. In early February 1995, an individual agreement will be entered into on behalf of the Operating Subsidiaries and the DOE.\nThe Operating Subsidiaries, in cooperation with the Pennsylvania Department of Environmental Resources and the West Virginia Division of Environmental Protection, are researching the feasibility and cost-effectiveness of injecting fly ash from the Operating Subsidiaries' power stations into abandoned underground\nmine sites in Pennsylvania and West Virginia to reduce acid mine drainage and mine surface subsidence. The project cost is anticipated to be shared with EPRI as part of a Tailored Collaboration Agreement with the Institute.\nThe Operating Subsidiaries also made research grants to regional colleges and universities to encourage the development of technical resources related to current and future utility problems.\nCONSTRUCTION AND FINANCING\nConstruction expenditures by the Subsidiaries in 1994 amounted to $508 million and for 1995 and 1996 are expected to aggregate $341 million and $284 million, respectively. In 1994, these expenditures included $153 million for compliance with the CAAA. The 1995 and 1996 estimated expenditures include $61 million and $7 million, respectively, to cover the costs of compliance with the CAAA. Allowance for funds used during construction (AFUDC) (shown below) has been reduced for carrying charges on CAAA expenditures that are being collected through currently approved surcharges or in base rates.\nThese construction expenditures include major capital projects at existing generating stations, including the construction of flue-gas desulfurization equipment (scrubbers) at the Harrison Power Station, upgrading distribution lines and substations, and the strengthening of the transmission and subtransmission systems. The Harrison scrubber project was completed on schedule and the scrubbers were declared available for service on November 16, 1994. The final cost is expected to be $555 million, which is approximately 24% below the original budget. Primary factors that contributed to the reduced cost were: a) the absence of any major construction problems; b) financing and material and equipment costs lower than expected; and c) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC.\nOn a collective basis for the Operating Subsidiaries, total expenditures for 1994, 1995, and 1996 include $190 million, $101\nmillion, and $52 million, respectively, for construction of environmental control technology. Outages for construction, CAAA compliance work and other environmental work is and will continue to be coordinated with planned outages.\nThe Operating Subsidiaries continue to study ways to reduce or meet future increases in customer demand, including aggressive demand- side management programs, new and efficient electric technologies, construction of various types and sizes of generating units and increasing the efficiency and availability of System generating facilities, reducing company electrical use and transmission and distribution losses, and where feasible and economical, acquisition of reliable, long-term capacity from other electric systems and from nonutility developers.\nThe Operating Subsidiaries are implementing demand-side management activities. Potomac Edison and West Penn are engaged in state commission supported or ordered evaluations of demand-side management programs. (See ITEM 1. REGULATION for a further discussion of these programs.) Several jurisdictions have adopted mechanisms which provide for recovery of the costs of such activities, some return on the related investment, the associated revenue reductions and a performance incentive, either on a current basis or through deferral to a base rate case.\nCurrent forecasts, which reflect demand-side management efforts and other considerations and assume normal weather conditions, project both average annual winter and summer peak load growth rates of 1.59% in the period 1995-2005. After considering the reactivation of West Penn capacity in cold reserve (see page 10), peak diversity exchange arrangements described in ITEM 1. SALES above, demand-side management and conservation programs, and contracted PURPA capacity, it is anticipated that new System-owned generating capacity will not be required until the year 2000 or beyond. If future customer demand materially exceeds that forecast, anticipated supply-side resources do not become available, demand-side management efforts do not succeed, or in the event of extremely adverse weather conditions, the Operating Subsidiaries may be unable at times to meet all of their customers' requirements for electric service.\nIn connection with their construction and demand-side management programs, the Operating Subsidiaries must make estimates of the availability and cost of capital as well as the future demands of their customers that are necessarily subject to regional, national, and international developments, changing business conditions, and other factors. The construction of facilities and their cost are affected by laws and regulations, lead times in manufacturing, availability of labor, materials and supplies, inflation, interest rates, and licensing, rate, environmental, and other proceedings before regulatory authorities. As a result, future plans of the Operating Subsidiaries are subject to continuing review and substantial change.\nThe Subsidiaries have financed their construction programs through internally generated funds, first mortgage bond, debenture,\nmedium-term note and preferred stock issues, pollution control and solid waste disposal notes, installment loans, long-term lease arrangements, equity investments by APS (or, in the case of AGC, by the Operating Subsidiaries), and, where necessary, interim short-term debt. Effective January 1994, the Operating Subsidiaries also have available a $300 million multi-year credit facility. The future ability of the Subsidiaries to finance their construction programs by these means depends on many factors, including creditworthiness, rate levels sufficient to provide internally generated funds and adequate revenues to produce a satisfactory return on the common equity portion of the Subsidiaries' capital structures and to support their issuance of senior and other securities. The creditworthiness of the Operating Subsidiaries in the future may be affected by increased concern of rating agencies that purchased power contracts are a risk factor deserving consideration. APS obtains most of the funds for equity investments in the Operating Subsidiaries through the issuance and sale of its common stock publicly and through its Dividend Reinvestment and Stock Purchase Plan and its Employee Stock Ownership and Savings Plan.\nIn 1994, the Subsidiaries issued $225.3 million of securities having interest rates between 6.75% and 8.125%. In May 1994, Monongahela issued 500,000 shares of cumulative preferred stock (par value $100 per share) with a dividend rate of $7.73. In June 1994, Potomac Edison issued $75 million of 8% first mortgage bonds due 2024. In August 1994, West Penn issued $65 million of 8.125% first mortgage bonds due 2024, and Monongahela, Potomac Edison, and West Penn issued $8.825 million, $11.560 million, and $14.910 million, respectively, in solid waste disposal notes to Harrison County, West Virginia. Harrison County in turn issued $35.295 million of 6-3\/4% tax-exempt 30-year solid waste disposal revenue bonds. The Operating Subsidiaries are using the proceeds from the issuance of their solid waste disposal notes to finance certain solid waste disposal facilities which comprise a portion of the scrubbers located at the Harrison Power Station.\nIn 1994, APS sold 1,629,372 shares of its common stock for $35 million through its Dividend Reinvestment and Stock Purchase Plan and its Employee Stock Ownership and Savings Plan.\nIn October 1994, West Penn issued and sold to APS 2,000,000 additional shares of common stock at a price of $20 per share.\nDuring 1994, the rate for West Penn's 400,000 shares of market auction preferred stock, par value $100 per share, reset approximately every 90 days at 2.52%, 3.09%, 3.59% and 4.28%. The rate set at auction on January 13, 1995, was 4.75%.\nAt December 31, 1994, APS had $90.25 million outstanding in short-term debt, Monongahela had $39.5 million outstanding in short- term debt and notes payable to affiliates, and AGC had $41.74 million outstanding in commercial paper, while Potomac Edison and West Penn had notes receivable from an affiliate of $1.9 million and $1.0 million, respectively.\nThe Subsidiaries' ratios of earnings to fixed charges for the year ended December 31, 1994, were as follows: Monongahela, 3.33; Potomac Edison, 3.46; West Penn, 3.40; and AGC, 3.50.\nAPS and the Subsidiaries' consolidated capitalization ratios as of December 31, 1994, were: common equity, 45.1%; preferred stock, 7.2%; and long-term debt, 47.7%. APS and the Subsidiaries' long-term objective is to maintain the common equity portion above 45%, reduce the long-term debt portion toward 45%, and maintain the preferred stock ratio for the balance of the capital structure.\nIn January 1994, the Operating Subsidiaries jointly entered into an aggregate $300 million multi-year credit agreement with eighteen lenders. Each Operating Subsidiary's borrowings under the agreement are limited to its pro rata share of the stock of AGC, which stock was pledged to secure the credit agreement. The Operating Subsidiaries' percentage ownership of AGC and resulting borrowing limitations are: Monongahela 27%, $81,000,000; Potomac Edison 28%, $84,000,000; and West Penn 45%, $135,000,000. The agreement may be used as a supplement to or in lieu of public financings and short-term debt programs.\nDuring 1995, the Operating Subsidiaries anticipate meeting their capital requirements through a combination of internally generated funds, cash on hand, and short-term borrowing as necessary. The Operating Subsidiaries may engage in tax-exempt solid waste disposal financings during 1995 to the extent funds are available to Harrison County from the West Virginia cap allocation. APS plans to sell common stock through its Dividend Reinvestment and Stock Purchase Plan and Employee Stock Ownership and Savings Plan.\nThe Operating Subsidiaries, if economic and market conditions make it desirable, may refund during 1995 up to $565 million of first mortgage bonds, up to $140 million of preferred stock, and up to $78 million of pollution control revenue notes through optional redemptions.\nFUEL SUPPLY\nSystem-operated stations burned approximately 15.8 million tons of coal in 1994. Of that amount, 69% was either cleaned (7.2 million tons) or used in stations equipped with scrubbers (3.6 million tons). Use of desulfurization equipment and cleaning and blending of coal make burning local higher-sulfur coal practical, and in 1994 about 97% of the coal received at System stations came from mines in West Virginia, Pennsylvania, Maryland, and Ohio. The Operating Subsidiaries do not mine or clean any coal. All raw, clean or washed coal is purchased from various suppliers as necessary to meet station requirements.\nLong-term arrangements, subject to price change, are in effect and will provide for approximately 12 million tons of coal in 1995. The Operating Subsidiaries will depend on short-term arrangements and spot purchases for their remaining requirements. Through the year 1999, the total coal requirements of present System-operated stations\nare expected to be met with coal acquired under existing contracts or from known suppliers. The Operating Subsidiaries signed two 10-year lime supply agreements during 1994 which will provide for the long-term lime requirements of the System's scrubbers.\nThe Operating Subsidiaries renegotiated several long-term coal contracts with Consolidation Coal Company effective January 1, 1995, resulting in reduced prices, the benefit of which will, for the most part, accrue to the Operating Subsidiaries' customers.\nFor each of the years 1990 through 1993, the average cost per ton of coal burned was $35.97, $36.74, $36.31 and $36.19, respectively. For the year 1994, the cost per ton decreased to $35.88.\nIn addition to using ash in various power plant applications such as sludge stabilization at Harrison and Mitchell Power Stations, the Operating Subsidiaries continue their efforts to market fly ash and bottom ash for beneficial uses and thereby reduce landfill requirements. (See ITEM 1. RESEARCH AND DEVELOPMENT.) In 1994, the Operating Subsidiaries received approximately $236,000 for the sale of 85,998 tons of fly ash and 64,511 tons of bottom ash for various uses including cement replacement, mine grouting, oil well grouting, soil extenders and anti-skid material.\nThe Operating Subsidiaries own coal reserves estimated to contain about 125 million tons of high-sulfur coal recoverable by deep mining. There are no present plans to mine these reserves and, in view of economic conditions now prevailing in the coal market, the Operating Subsidiaries plan to hold the reserves as a long-term resource.\nRATE MATTERS\nRate case decisions in almost all jurisdictions were issued for the Operating Subsidiaries in 1994.\nWest Penn\nOn March 31, 1994, West Penn filed an application with the Pennsylvania PUC for a base rate increase designed to produce $80.1 million in additional annual revenues from its retail customers. This request included recovery of the remaining carrying charges on investment, depreciation, and all operating costs required to comply with Phase I of the CAAA, and other increasing levels of expense. West Penn filed a petition on January 12, 1994 with the Pennsylvania PUC requesting authorization to accrue post in-service carrying charges on the Harrison scrubbers and to defer related depreciation and operating and maintenance expenses until they were recognized in rates. This request was approved by the Pennsylvania PUC on May 4, 1994. By Pennsylvania PUC order adopted December 15, 1994, an annual increase of $55.5 million for West Penn's retail customers was authorized to become effective December 31, 1994. Included in this amount was an authorized return on equity (ROE) of 11.5%.\nMonongahela\nOn January 18, 1994, Monongahela filed an application with the Public Service Commission of West Virginia (West Virginia PSC) for a base rate increase designed to produce $61.3 million in additional annual revenues which includes recovery of the remaining carrying charges on investment, depreciation, and all operating costs required to comply with Phase I of the CAAA, and other increasing levels of expense. The West Virginia PSC, on November 9, 1994 affirmed the recommended decision of the Administrative Law Judge (ALJ) providing for a rate increase to be effective November 16, 1994 of $23.5 million of new money. This amount was in addition to $6.9 million of CAAA recovery granted effective July 1, 1994 to be transferred from fuel clause recovery to base rates. The $6.9 million was included in Monongahela's $61.3 million request. The decision reflects an ROE of 10.85%. The West Virginia PSC's order stated that it was affirming the ALJ's recommendation because of time constraints and invited all parties to file petitions for reconsideration. All parties have filed petitions and a decision from the West Virginia PSC is pending. In the meantime, Monongahela is collecting the new rates, which are not subject to refund. Monongahela cannot predict the outcome of the request for reconsideration.\nBecause of procedural requirements of Ohio law, a rate case in Ohio in 1994 to request recovery of the cost of the Harrison scrubbers was not deemed practical. On January 31, 1995, Monongahela filed an application with the Public Utilities Commission of Ohio (Ohio PUC) for a base rate increase designed to produce $7.0 million in additional annual revenues which includes recovery of carrying charges on investment, depreciation, and all operating costs required to comply with Phase I of the CAAA, and other increasing levels of expense. The Ohio PUC approved Monongahela's petition of January 11, 1994 requesting authorization to accrue post in-service carrying charges on the Harrison scrubbers until its investment in such scrubbers is recognized in rates. That order also allows Monongahela to defer depreciation and operating and maintenance expenses, including property taxes (but not including fuel costs), with respect to the scrubbers. This accrual is included in the rate case filing. It is expected that the new rates will become effective in late 1995.\nPotomac Edison\nThe Maryland Public Service Commission (Maryland PSC) issued a final order on September 20, 1994 approving a settlement agreement in Potomac Edison's base rate case authorizing an annual increase of $19.6 million effective November 11, 1994. The rate case filed by Potomac Edison on April 15, 1994 originally requested a $30.9 million increase. The authorized $19.6 million increase is in addition to $2.7 million of demand-side management costs which were included in Potomac Edison's original request but which were granted as a separate surcharge. The rate case increase includes recovery of the remaining carrying charges\non investment, depreciation, and all operating costs required to comply with Phase I of the CAAA, and other increasing levels of expense.\nOn April 30, 1993 and June 22, 1994, Potomac Edison filed two rate cases with the Virginia State Corporation Commission (Virginia SCC) seeking a total increase of $12.5 million. The Virginia SCC granted an increase of $4.5 million effective September 28, 1993, based on the case filed April 30, 1993. In the case filed June 22, 1994, a settlement agreement was filed with the Hearing Examiner reflecting an additional increase of $3 million effective November 20, 1994. The settlement agreement has been accepted by the now pending before the Virginia SCC.\nOn November 9, 1994, the West Virginia PSC affirmed the recommended decision of the ALJ providing for a rate increase effective November 11, 1994. The increase of $1.5 million is in addition to $1.9 million of CAAA recovery granted effective July 1, 1994 which was included in Potomac Edison's original request for $12.2 million filed January 14, 1994. The request included recovery of the appropriate costs to comply with Phase I of the CAAA as well as other increasing levels of expense. The decision reflects an ROE of 10.85%. The West Virginia PSC's order stated that it was affirming the ALJ's recommendation because of time constraints and invited all parties to file petitions for reconsideration. All parties have filed petitions and a decision from the West Virginia PSC is pending. In the meantime, Potomac Edison is collecting the new rates, which are not subject to refund. Potomac Edison cannot predict the outcome of the request for reconsideration.\nAGC\nThrough February 29, 1992, AGC's ROE was adjusted annually pursuant to a settlement agreement approved by the FERC. In December 1991, AGC filed for a continuation of the existing ROE of 11.53% and other parties filed to reduce the ROE to 10%. Hearings were completed in June 1992, and a recommendation was issued by an ALJ on December 21, 1993, for an ROE of 10.83%, which the other parties argued should be further adjusted to reflect changes in capital market conditions since the hearings. Exceptions to this recommendation were filed by all parties for consideration by the FERC. On January 28, 1994, the Consumer Advocate Division of the West Virginia PSC, Maryland People's Counsel, and Pennsylvania Office of Consumer Advocate filed a joint complaint with the FERC against AGC claiming that both the existing ROE of 11.53% and the ROE recommended by the ALJ of 10.83% were unjust and unreasonable. This new complaint requested an ROE of 8.53% with rates subject to refund beginning April 1, 1994. Hearings were completed in November 1994 and a recommendation was issued by an ALJ on December 22, 1994 dismissing the Joint Consumer Advocates' complaint. A settlement agreement for both cases is currently pending, which would reduce AGC's ROE to 11.13% for the period from March 1, 1992 through December 31, 1994, and increase AGC's ROE to 11.20% for the period from January 1, 1995 through December 31, 1995. During 1995, the parties have agreed\nto negotiate in good faith to approve a mechanism for setting ROE in the future. This settlement is subject to FERC approval. If approved, this settlement will require a refund to customers for the period through December 31, 1994, of about $4.42 million for which adequate reserves have been provided.\nThrough a filing completed on October 31, 1994, AGC sought to add a prior tax payment of approximately $12 million to rate base which will produce about $1.4 million in additional annual revenues. On December 30, 1994, the FERC accepted AGC's filing, ordered that the increase in rates go into effect on June 1, 1995, subject to refund, and set AGC's ROE for hearing in 1995. A settlement agreement is currently pending. This settlement is subject to FERC approval.\nFERC\nIn 1994, West Penn and Monongahela implemented settlement agreements covering wholesale rates in effect for their municipal, co- op, and borderline agreement customers subject to the jurisdiction of the FERC. Each included recovery of the remaining carrying charges on investment, depreciation, as well as all operating costs required to comply with Phase I of the CAAA, and other increasing levels of expense. The amounts of the increases were $2.1 million for West Penn and $300,000 for Monongahela, both effective December 1, 1994.\nOn October 14, 1994, as supplemented on November 25, 1994, Potomac Edison filed a petition for a $3.8 million increase with the FERC. The request includes recovery of the remaining carrying charges on investment, depreciation, and all operating costs required to comply with Phase I of the CAAA, and other increasing levels of expense. By order dated January 18, 1995, the FERC accepted Potomac Edison's filing and set the matter for hearing. FERC also granted a request for summary disposition of one item which reduced Potomac Edison's request to $3.65 million. These new rates will go into effect on June 25, 1995, subject to refund. Potomac Edison cannot predict the outcome of this proceeding.\nENVIRONMENTAL MATTERS\nThe operations of the Subsidiaries are subject to regulation as to air and water quality, hazardous and solid waste disposal, and other environmental matters by various federal, state, and local authorities.\nMeeting known environmental standards is estimated to cost the Subsidiaries about $217 million in capital expenditures over the next three years. Additional legislation or regulatory control requirements, if enacted, may require modifying, supplementing, or replacing equipment at existing stations at substantial additional cost.\nAir Standards\nThe Operating Subsidiaries meet applicable standards as to particulates and opacity at major stations with high-efficiency electrostatic precipitators, cleaned coal, flue-gas conditioning, and, at times, reduction of output. From time to time minor excursions of opacity normal to fossil fuel operations are experienced and are accommodated by the regulatory process. The West Virginia Division of Environmental Protection (WVDEP), Office of Air Quality (OAQ), issued Notices of Violation (NOVs) for opacity exceedances for the fourth quarter of 1993 and first quarter of 1994 at the Albright, Fort Martin, and Harrison Power Stations. An NOV was issued by OAQ for visual opacity exceedances on March 23, 1994 at Pleasants Power Station. The Operating Subsidiaries have submitted written responses to OAQ regarding the opacity exceedances and are awaiting a response.\nBecause of the stringent 10% opacity limit in West Virginia which led to the above-mentioned NOVs, Monongahela and other West Virginia electric utilities petitioned the OAQ in 1994 to revise the opacity limit from 10% to 20% in order to be consistent with surrounding states and the federal New Source Performance Standards (NSPS). The OAQ on October 21, 1994 published a proposed revision to Title 45, Regulation 2 to increase the opacity limit to 20%. The final rule should be submitted to the state legislature in West Virginia for approval in 1995.\nThe Operating Subsidiaries meet current emission standards as to SO2 by the use of scrubbers, the burning of low-sulfur coal, the purchase of cleaned coal to lower the sulfur content and the blending of low-sulfur with higher sulfur coal.\nThe CAAA, among other things, require an annual reduction in total utility emissions within the United States of 10 million tons of SO2 and two million tons of NOx from 1980 emission levels, to be completed in two phases, Phase I and Phase II. Five coal-fired System plants are affected in Phase I and the remaining plants or units reactivated in the future will be affected in Phase II. Installation of scrubbers at the Harrison Power Station was the strategy undertaken by the Operating Subsidiaries to meet the required SO2 emission reductions for Phase I (1995-1999). Continuing studies will determine the compliance strategy for Phase II (2000 and beyond). It is expected that burner modifications at possibly all System stations will satisfy the NOx emission reduction requirements for the acid rain (Title IV) provisions of the CAAA. Additional post-combustion controls may be mandated in Maryland and Pennsylvania for ozone nonattainment (Title I) reasons. Continuous emission monitoring equipment has been installed on all Phase I and Phase II units. Studies to evaluate cost effective options to comply with Phase II, including those which may be available from the use of Operating Subsidiaries' banked emission allowances and from the emission allowance trading market, are continuing.\nIn a case brought by the electric utility industry which disputed the EPA's inclusion of overfire air equipment as well as low NOx burners\nin its definition of \"low NOx burner technology,\" the District of Columbia Circuit Court of Appeals on November 29, 1994 vacated and remanded to the EPA the Title IV NOx rule. As a result, the January 1, 1995 Phase I NOx compliance deadline under Title IV is no longer applicable. It is uncertain when a revised rule will be issued, whether the emission limits will be revised, and what the compliance deadline will be.\nPursuant to an option in the CAAA and in order to avoid the potential for more stringent NOx limits in Phase II, the Operating Subsidiaries chose to treat Phase II Group 1 boilers (tangential and wall-fired) as Phase I affected units as of January 1, 1995. This was accomplished by activation of substitution unit plans for the seven Phase II Group 1 boilers. As a result of being Phase I affected, these units will also be required to comply with the Phase I SO2 limits. Phase I NOx and SO2 compliance for these units should not require additional capital or operating expenditures.\nTitle I of the CAAA established an ozone transport region consisting of the District of Columbia and 11 northeast states including Maryland and Pennsylvania. Sources within the region will be required to reduce NOx emissions, a precursor of ozone, to a level conducive to attainment of the ozone national ambient air quality standard (NAAQS). The installation of reasonably available control technology (RACT) (overfire air equipment and\/or low NOx burners) at all Pennsylvania and Maryland stations is expected to be completed by May 31, 1995. This is essentially compatible with Title IV NOx reduction requirements, prior to their remand.\nThe Ozone Transport Commission (OTC) has determined that the Operating Subsidiaries may be required to make additional NOx reductions beyond RACT in order for the ozone transport region to meet the ozone NAAQS. Under terms of a Memorandum of Understanding (MOU), the Operating Subsidiaries' power stations located in Maryland and Pennsylvania will be required to reduce NOx emissions by 55% from the 1990 baseline emissions, with a compliance date of May 1999. Further reductions of 75% from the 1990 baseline may be required by May 2003, unless the results of modeling studies due to be completed by 1998, indicate otherwise. Both Maryland and Pennsylvania must promulgate regulations to implement the terms of the MOU.\nIn an effort to introduce market forces into pollution control, the CAAA created SO2 emission allowances. An allowance is defined as an authorization to emit one ton of SO2 into the atmosphere. Subject to regulatory limitations, allowances (including bonus and extension allowances) may be sold or \"banked\" for future use or sale. Through an industry allowance pooling agreement, the Operating Subsidiaries will receive a total of approximately 554,000 bonus and extension allowances during Phase I. These allowances are in addition to the Table A allowances of approximately 356,000 per year during the Phase I years. Ownership of these allowances permits the Operating Subsidiaries to operate in compliance with Phase I, as well as postpone a decision on their compliance strategy for Phase II. As part of their compliance strategy, the Operating Subsidiaries continue to study the allowance\nmarket to determine whether sales or purchases of allowances are appropriate.\nIn 1989, the West Virginia Air Pollution Control Commission approved the construction of a third-party cogeneration facility in the vicinity of Rivesville, West Virginia. Emissions impact modeling for that facility raised concerns about the compliance status of Monongahela's Rivesville Station with the NAAQS for SO2. Pursuant to a consent order, Monongahela agreed to collect on-site meteorological data and conduct additional dispersion modeling in order to demonstrate compliance. The modeling study and a compliance strategy recommending construction of a new \"good engineering practices\" (GEP) stack were submitted to the WVDEP in June 1993. Costs associated with the GEP stack are approximately $20 million. Monongahela is awaiting action by the WVDEP.\nUnder an EPA-approved consent order with Pennsylvania, West Penn completed construction of a GEP stack at the Armstrong Power Station in 1982 at a cost of over $13 million with the expectation that EPA's reclassification of Armstrong County to \"attainment status\" under NAAQS for SO2 would follow. As a result of the 1985 revision of its stack height rules, EPA refused to reclassify the area to attainment status. Subsequently, West Penn filed an appeal with the U.S. Court of Appeals for the Third Circuit for review of that decision as well as a petition for reconsideration with EPA. In 1988, the Court dismissed West Penn's appeal stating it could not decide a case while West Penn's request for reconsideration before EPA was pending. West Penn cannot predict the outcome of this proceeding.\nWater Standards\nUnder the National Pollutant Discharge Elimination System (NPDES), permits for all System-owned stations and disposal sites are in place. However, NPDES permit renewals for several West Virginia disposal sites contain what the Operating Subsidiaries believe are overly stringent discharge limitations. The WVDEP has temporarily stayed the stringent permit limitations while the Operating Subsidiaries continue to work with WVDEP and EPA in order to scientifically justify less stringent limits. Where this is not possible, installation of wastewater treatment facilities may become necessary. The cost of such facilities, if required, cannot be predicted at this time.\nThe EPA and state agencies have implemented stormwater runoff regulations for controlling discharges from industrial and municipal sources as well as construction sites. Stormwater discharges have been identified and included in NPDES permit renewals, but controls have not yet been required. Since the current round of permit renewals began in 1993, monitoring requirements have been imposed, with pollution reduction plans and additional control of some discharges anticipated.\nThe Clean Water Act deadline of October 1, 1994 for compliance with Phase II of the stormwater program passed without EPA promulgating\nregulations specifying which additional stormwater sources require NPDES permits. Affected System-owned facilities could include office buildings, parking lots, substations and rights-of-way. In the interim, the EPA has issued a policy memorandum specifying that its stormwater compliance enforcement strategy does not apply to Phase II sources. The Subsidiaries cannot predict the effect of EPA's regulations when promulgated.\nPursuant to the National Groundwater Protection Strategy, West Virginia adopted a Groundwater Protection Act in 1991. This law establishes a statewide antidegradation policy which could require the Operating Subsidiaries to undertake reconstruction of existing landfills and surface impoundments as well as groundwater remediation, and may affect herbicide use for right-of-way maintenance in West Virginia. Groundwater protection standards were approved and implemented in 1993 (based on EPA drinking water criteria) which established compliance limits. Pursuant to the groundwater protection standards variance provision, on October 26, 1994 the Operating Subsidiaries jointly filed with American Electric Power and Virginia Power, a Notice of Intent (NOI) to request class or source variances from the groundwater standards for steam electric operating facilities in West Virginia. Additionally, each of the companies filed individual NOIs. Technical and socio-economic justification to support the variance requests are being developed and the costs shared by the Operating Subsidiaries under a contract with EPRI. While the justification for the variance requests is being developed, the Operating Subsidiaries are protected from any enforcement action. Because variance requests must ultimately be approved by the West Virginia legislature, it is not possible to predict the outcome.\nThe Pennsylvania Department of Environmental Resources (PADER) developed a Groundwater Quality Protection Strategy which established a goal of nondegradation of groundwater quality. However, the strategy recognizes that there are technical and economic limitations to immediately achieving the goal and further recognizes that some groundwaters need greater protection than others. PADER is beginning to implement the strategy by promulgating changes to the existing rules that heretofore did not consider the nondegradation goal. The full extent of the impact of the strategy on the Operating Subsidiaries cannot be predicted.\nIn 1994, the Operating Subsidiaries received two NOVs from PADER and one NOV from WVDEP, all of which have been resolved. A chronic NPDES compliance problem at the closed Springdale Ash Area was resolved recently with the negotiation of a compliance agreement with PADER. The agreement specified the payment of a penalty for past permit exceedances, required payment of additional penalties for any future exceedances and provided for the installation of innovative constructed wetland treatment technology. The first stage has been installed and is operating in compliance with current NPDES permit effluent limitations.\nHazardous and Solid Wastes\nPursuant to the Resource Conservation and Recovery Act of 1976 (RCRA) and the Hazardous and Solid Waste Management Amendments of 1984, EPA regulates the disposal of hazardous and solid waste materials. Maryland, Pennsylvania, Ohio, Virginia and West Virginia have also enacted hazardous and solid waste management regulations that are as stringent as or more stringent than the corresponding EPA regulations.\nThe Operating Subsidiaries are in a continual process of either permitting new or re-permitting existing disposal capacity to meet future disposal needs. All disposal areas are currently operating in compliance with their permits.\nIt is anticipated that additional disposal capacity will be required for Armstrong Power Station. A small extension to the existing permitted disposal site and the permitting of a new site, are being actively pursued with PADER. A permit for an extension of the existing disposal site is anticipated to be granted by the end of 1995 for construction and use in 1996. Siting of a new disposal area will be a much longer process. If the Operating Subsidiaries fail to obtain either disposal permit, it could have an adverse impact on the operation of the Armstrong Power Station.\nSignificant costs were incurred during 1994 for expansion of existing coal combustion by-product disposal sites due to requirements for installation of liners on new sites and assessment of groundwater impacts through routine groundwater monitoring and specific hydrogeological studies. Existing sites may not meet the current regulatory criteria and groundwater remediation may be required at some of the Operating Subsidiaries' facilities. The Operating Subsidiaries continue to work with regulatory agencies to resolve outstanding issues. Additional and substantial costs may be incurred by the Operating Subsidiaries if remediation of existing sites is necessary.\nPotomac Edison received a notice from the Maryland Department of the Environment (MDE) in 1990 regarding a remediation ordered under Maryland law at a facility previously owned by Potomac Edison. The MDE has identified Potomac Edison as a potentially responsible party under Maryland law. Remediation is being implemented by the current owner of the facility which is located in Frederick. It is not anticipated that Potomac Edison's share of remediation costs, if any, will be substantial.\nOn March 4, 1994, the Operating Subsidiaries received notice that the EPA had identified them as potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, with respect to the Jack's Creek\/Sitkin Smelting Superfund Site. (See ITEM 3. LITIGATION for a further discussion of this case.)\nEmerging Environmental Issues\nTitle III of the CAAA requires EPA to conduct studies of toxic air pollutants from electric utility plants to determine if emission controls are necessary. EPA's reports are expected to be submitted to Congress in late 1995. If air toxic emission controls are recommended by EPA, final regulations are not likely to be promulgated prior to the year 2000. The impact of Title III on the Operating Subsidiaries is unknown at this time.\nReauthorization of the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act of 1980 and the RCRA are currently pending. When reauthorization does occur, it is anticipated that EPA will likely continue to regulate coal combustion by-product wastes and their leachates as nonhazardous.\nPursuant to RCRA, EPA will begin reviewing the electric utility industry's disposal practices of pyrites and pyritic material in 1995. Concerns over the production of low pH waters from pyrites may cause reclassification of ash or flue-gas desulfurization sludge disposal areas containing pyrites to that of special handling waste, or even possibly hazardous waste. Any change in classification would result in substantially increased costs for either retrofitting existing disposal sites or designing new disposal sites. A final determination is scheduled for 1998.\nAn additional issue which could impact the Operating Subsidiaries and which is undergoing intense study, is the health effect, if any, of electric and magnetic fields. The financial impact of this issue on the Operating Subsidiaries, if any, cannot be assessed at this time.\nIn connection with President Clinton's Climate Change Action Plan concerning greenhouse gases, the Operating Subsidiaries expressed by letter to the Department of Energy (DOE) in August 1993, their willingness to work with the DOE on implementing voluntary, cost- effective courses of action that reduce or avoid emission of greenhouse gases. Such courses of action must take into account the unique circumstances of each participating company, such as growth requirements, fuel mix and other circumstances. Furthermore, they must be consistent with the Operating Subsidiaries' integrated resource planning process and must not have an adverse effect on competitive position in terms of costs and rates or be unacceptable to their regulators. Some 63 other electric utility systems submitted similar letters.\nOn April 27, 1994, the DOE and the Edison Electric Institute, on behalf of member utilities, signed the Climate Challenge Program Memorandum of Understanding which establishes the principles DOE and utilities will operate under to reduce or avoid emission of greenhouse gases. A company-specific agreement is to be entered into on behalf of the Operating Subsidiaries and DOE in early February 1995.\nREGULATION\nAPS and the Subsidiaries are subject to the broad jurisdiction of the Securities and Exchange Commission (SEC) under the Public Utility Holding Company Act of 1935 (PUHCA). APS is also subject to the jurisdiction of the Maryland PSC as to certain of its activities. The Subsidiaries are regulated as to substantially all of their operations by regulatory commissions in the states in which they operate and also by the DOE and the FERC. In addition, they are subject to numerous other city, county, state, and federal laws, regulations, and rules.\nIn November 1994, the SEC published a release requesting comments from regulated public utility holding company systems and other interested parties on modernizing PUHCA by internal changes in rules and regulations. Comments are due in early February 1995. APS, along with all of the other registered electric public utility holding companies, is advocating repeal of PUHCA. However, APS cannot predict what changes, if any, will be made to PUHCA.\nThe National Energy Policy Act of 1992 (EPACT), among other things, amends PUHCA to permit utilities subject to PUHCA to compete in the wholesale generation business with other wholesale generators not subject to PUHCA; to ease restrictions on financing for that purpose; and to permit investment in foreign utilities. EPACT also amends the Federal Power Act to permit the FERC to order, under specified circumstances, access to transmission systems (including those of the System) so long as it would not unreasonably impair reliability nor adversely affect its existing wholesale, retail and transmission customers. It also amends PURPA to encourage states to study and regulate various matters, including the capital structures of EWGs, integrated resource planning, and the amount of purchased power that electric utilities should have in their generation mix. In addition it sets forth waste disposal standards, new nuclear licensing procedures, and contains provisions promoting alternate transportation fuels, research on environmental issues, and increased energy from renewables (See discussion of EPACT in ITEM 1. BUSINESS, SALES and ELECTRIC FACILITIES).\nSection 111 of EPACT requires the state utility commissions to institute proceedings to investigate and determine the feasibility of adopting proposed federal standards regarding three regulatory policy issues related to integrated resource planning, rate recovery methods for investments in demand-side management programs, and rates to encourage investments in cost-effective energy efficiency improvements to generation, transmission and distribution facilities. Maryland, Pennsylvania, Virginia, and West Virginia initiated investigations to determine whether to adopt the federal standards, while Ohio summarily issued a final order without an investigation. The Operating Subsidiaries submitted comments in the Maryland, Pennsylvania, and West Virginia proceedings and will file comments in 1995 in Virginia. To date, Maryland, Ohio, and West Virginia have issued final orders. All three states declined to adopt the federal standards, concluding that existing state regulations adequately address the issues. The outcome in the remaining jurisdictions cannot be predicted.\nThe Operating Subsidiaries founded and continue to participate in, along with other utilities, an organization whose primary purpose\nis to develop a mutually acceptable method of resolving the inequities imposed on transmission network owners by parallel power flows.\nIn July 1993, the Pennsylvania PUC directed the Bureau of Conservation, Economics and Energy Planning to develop competitive bidding regulations to replace, at least in part, the existing state PURPA regulations. The Pennsylvania PUC has instituted a proposed rulemaking regarding competitive bidding regulations. In collaboration with other Pennsylvania Electric Association companies, West Penn filed comments to the proposed competitive bidding rulemaking in October 1994. The Pennsylvania PUC has not issued a final order in connection with the proposed competitive bidding rulemaking. West Penn cannot predict the outcome of this proceeding. In November 1993, while awaiting the new competitive bidding regulations, West Penn filed a petition with the Pennsylvania PUC requesting an order that, pending the adoption of new state regulations requiring competitive bidding for PURPA, any proceedings or orders regarding purchase by West Penn of capacity from a qualifying facility under PURPA shall be based on competitive bidding. On June 3, 1994, the Pennsylvania PUC granted the West Penn petition. However, the Pennsylvania PUC reserved judgment on the applicability of the competitive bidding process to the South River project and provided that the question would be addressed in the South River complaint proceeding. Various aspects of the Pennsylvania PUC's decision have been appealed to the Pennsylvania Commonwealth Court by South River, West Penn, and Shannopin. This proceeding has been stayed pending the outcome of an appeal in an unrelated case. (See ITEM 3. LEGAL PROCEEDINGS for a description of the South River complaint, the Shannopin Project, and events that have taken place in Pennsylvania Commonwealth Court.)\nOn October 8, 1993, the West Virginia PSC issued proposed regulations concerning bidding procedures for capacity additions for electric utilities and invited comment by December 7, 1993. A number of interested parties, including Monongahela and Potomac Edison, filed comments. In May 1994, the West Virginia PSC held hearings on the proposed regulations. The West Virginia PSC has yet to issue an opinion.\nOn December 17, 1992, the Ohio PUC issued proposed rules concerning competitive bidding for supply-side resources, transmission access for winning bidders and incentives for the recovery of the cost of purchased power. The Ohio PUC invited comments by March 3, 1993 and reply comments by March 24, 1993. A number of interested parties, including Monongahela, submitted comments. The Ohio PUC has taken no further action following the filing of comments.\nMaryland and Virginia have not mandated compulsory competitive bidding as of this date.\nOn September 20, 1994, the Maryland PSC issued an order which instituted a proceeding for the purpose of examining regulatory and competitive issues affecting electric service in Maryland. On November 1, 1994, the Maryland PSC staff distributed a discussion paper describing the issues which they believe warrant analysis and comment by the utilities and interested persons. Potomac Edison submitted initial comments in response to the staff paper in January 1995. Legislative hearings are currently scheduled for March 1995.\nThe Ohio PUC has initiated informal roundtable discussions \"on issues concerning competition in the electric utility industry and promoting increased competitive options for Ohio businesses that do not unduly harm the interests of utility company shareholders or ratepayers\". These discussions are being undertaken pursuant to an Ohio Energy Strategy issued in April 1994. The first two roundtable discussions, attended by representatives of electric utilities, including Monongahela, businesses, residential consumers, environmental groups, and other interested persons or organizations were held on October 17 and December 8, 1994. The Ohio PUC will continue to hold roundtable meetings at approximately six-week intervals.\nThe Pennsylvania PUC instituted an investigation into electric power competition on May 10, 1994, requesting responses from interested persons on several broad areas of inquiry, such as retail wheeling, treatment of stranded investments, consumer protection and utility financial health. Comments were filed on November 10, 1994 and reply comments were filed on January 10, 1995. The Pennsylvania PUC has set a deadline of May 10, 1995 to conclude the investigation.\nIn August 1994, the Pennsylvania PUC instituted a proposed rulemaking relating to Pennsylvania PUC review of siting and construction of electric transmission lines. In an order in connection with the proposed rulemaking, the Pennsylvania PUC propounded a list of questions, including questions regarding electric and magnetic fields. In December 1994, West Penn filed responses to the questions. West Penn cannot predict the outcome of this proposed rulemaking.\nIn October 1990, the Pennsylvania PUC ordered Pennsylvania's major electric utilities, including West Penn, to file programs for demand-side management designed to reduce customer demand for electricity and to reduce the need for additional generating capacity. The Pennsylvania PUC also instituted a proceeding to formalize incentive ratemaking treatment for successful demand-side management activities. On December 13, 1993 the Pennsylvania PUC entered an order allowing Pennsylvania utilities to recover the costs of demand-side management activities, to recover revenues lost as a result of the activities, and to recover a performance incentive for successful activities. A group of industrial customers appealed the order of the Pennsylvania PUC to the Pennsylvania Commonwealth Court. On January 9, 1995, the Court held that utilities could recover demand-side management expenditures, but held that the Pennsylvania PUC had incorrectly allowed recovery of lost revenues and performance incentives. On January 23, 1995, the Pennsylvania PUC requested reargument of the case before the Commonwealth Court, and that request is pending.\nDuring 1994, Potomac Edison continued its participation in the Collaborative Process for demand-side management in Maryland with the Maryland PSC Staff, Office of People's Counsel, the Department of Natural Resources, Maryland Energy Administration, and Potomac Edison's largest industrial customer. Potomac Edison had received the Maryland PSC's approval to implement the Commercial and Industrial Lighting Rebate Program and the Power Saver\/Comfort Home Program for new residential construction as of July 1, 1993. Through December 31, 1994 Potomac Edison had approved applications for $16.1 million in rebates related to the commercial lighting program and $1.2 million in rebates related to the residential new construction program. The peak demand\nreductions from these two programs through the end of 1994 should reduce future generation requirements by about 26.0 and 1.9 MW, respectively. Program costs (including rebates) which are being amortized over a seven-year period, lost revenues, and a performance- based shared savings incentive (shareholder bonus) are being recovered through an Energy Conservation Surcharge.\nWest Penn implemented a Low Income Payment and Usage Reduction Program in 1994. This pilot program will run for two years and will assist up to 2,000 low income customers. The program allows a customer to enter into a payment agreement with West Penn which results in a reduced monthly payment based on income. The difference between the amount of the actual bill and the customer's payment is paid by Federal Assistance Grants and West Penn. The program is administered by the Dollar Energy Fund, a non-profit, charitable organization.\nWest Penn also implemented a Customer Assistance and Referral Evaluation Service Program in 1994 for customers with special needs. West Penn representatives work with customers who are experiencing temporary hardship in an attempt to solve their problems and maximize their ability to pay their bills. West Penn representatives utilize a variety of internal and external resources to address the needs of such customers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSubstantially all of the properties of the Operating Subsidiaries are held subject to the lien securing each Operating Subsidiary's first mortgage bonds and, in many cases, subject to certain reservations, minor encumbrances, and title defects which do not materially interfere with their use. Some properties are also subject to a second lien securing certain solid waste disposal and pollution control notes. The indenture under which AGC's unsecured debentures and medium-term notes are issued, prohibits AGC, with certain limited exceptions, from incurring or permitting liens to exist on any of its properties or assets unless the debentures and medium-term notes are contemporaneously secured equally and ratably with all other indebtedness secured by such lien. Transmission and distribution lines, in substantial part, some substations and switching stations, and some ancillary facilities at power stations are on lands of others, in some cases by sufferance, but in most instances pursuant to leases, easements, permits or other arrangements, many of which have not been recorded and some of which are not evidenced by formal grants. In some cases no examination of titles has been made as to lands on which transmission and distribution lines and substations are located. Each of the Operating Subsidiaries possesses the power of eminent domain with respect to its public utility operations. (See also ITEM 1. BUSINESS and SYSTEM MAP.)\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn September 16, 1994, Duquesne initiated a proceeding before the FERC by filing a request for an order requiring the System to provide 300 MW of transmission service at parity with native load customers from interconnection points within the System to the System's points of interconnection with the Pennsylvania-New Jersey-Maryland Interconnection (PJM). Duquesne is seeking to transmit primarily its\nown baseload generation for sales within and beyond the PJM system. The Operating Subsidiaries responded on October 24, 1994 requesting that the FERC order the parties back to negotiations to resolve, through a bilateral contract, outstanding issues concerning the transmission services. The FERC has yet to issue an order in this proceeding.\nIn 1979, National Steel Corporation (National Steel) filed suit against certain Subsidiaries in the Circuit Court of Hancock County, West Virginia, alleging damages of approximately $7.9 million as a result of an order issued by the West Virginia PSC requiring curtailment of National Steel's use of electric power during the United Mine Workers' strike of 1977-8. A jury verdict in favor of the Subsidiaries was rendered in June 1991. National Steel has filed a motion for a new trial, which is still pending before the Circuit Court of Hancock County. The Subsidiaries believe the motion is without merit; however, they cannot predict the outcome of this case.\nIn 1987, West Penn entered into separate agreements with developers of three PURPA projects: Milesburg (43 MW), Burgettstown (80 MW), and Shannopin (80 MW). The agreements provided for the purchase of each project's power over 30 years or more at rates generally approximating West Penn's avoided cost at the time the agreements were negotiated. Each agreement was subject to prior Pennsylvania PUC approval. In 1987 and 1988, West Penn filed a separate petition with the Pennsylvania PUC for approval of each agreement. Since that time, all three agreements have been, in varying degrees, the subject of complex and continuing regulatory and judicial proceedings. On various dates in 1994, West Penn and its two largest industrial customers, ARMCO and Allegheny Ludlum, filed joint petitions with the U.S. Supreme Court for writs of certiorari (Cert) in the Milesburg, Burgettstown, and Shannopin cases. On October 11, 1994, the U.S. Supreme Court denied these requests for appeal.\nAfter denial of Cert, the Pennsylvania PUC acted upon a pending petition of Shannopin and on December 1, 1994 refused to answer termination issues regarding Shannopin and ordered that the project be paid capacity costs. West Penn and its two largest industrial customers have appealed this order to the Pennsylvania Commonwealth Court. West Penn cannot predict the outcome of this proceeding.\nThere has been no further action on the Milesburg case since the denial of Cert. West Penn cannot predict the outcome of this matter.\nAs a result of the denial of Cert by the U.S. Supreme Court, the Pennsylvania PUC orders that recalculated rates and adjusted milestone dates for Burgettstown became final and non-appealable as of November 8, 1994.\nIn November 1994, West Penn filed a complaint with the Pennsylvania PUC regarding Burgettstown, Shannopin, and Milesburg, requesting the Pennsylvania PUC to cancel its orders regarding these projects because they are no longer in the public interest. On December 16, 1994, the Pennsylvania PUC dismissed the complaint. West Penn has appealed the order to the Pennsylvania Commonwealth Court. West Penn cannot predict the outcome of this proceeding.\nIn November 1994, Burgettstown filed a complaint against West Penn in the Court of Common Pleas of Washington County, Pennsylvania. The complaint requests equitable relief in the form of specific performance, declaratory and injunctive relief, and also seeks monetary damages for breach of contract and for tortious interference with Burgettstown's contractual relations with others. The Court has set April 3, 1995 as the trial date for the specific performance remedy only. West Penn cannot predict the outcome of this proceeding.\nOn March 19, 1995, West Penn filed a petition for issuance of a declaratory order with FERC (Petition). This Petition seeks a declaration that the orders of the Pennsylvania PUC requiring West Penn to purchase capacity from Burgettstown violate PURPA and FERC's PURPA regulations and thus West Penn has no obligation to purchase capacity from Burgettstown. West Penn cannot predict the outcome of this proceeding.\nIn October 1993, South River Power Partners, L.P. (South River) filed a complaint against West Penn with the Pennsylvania PUC. The complaint seeks to require West Penn to purchase 240 MW from a proposed coal-fired PURPA project to be built in Fayette County, Pennsylvania. West Penn is opposing this complaint as the power is not needed and the price proposed by South River is in excess of avoided cost. The Pennsylvania Consumer Advocate, the Small Business Advocate, the Pennsylvania PUC Trial Staff and various industrial customers intervened in opposition to the complaint. In August 1994, the Pennsylvania PUC granted West Penn's request to stay proceedings pending resolution of issues in a related matter concerning competitive bidding currently on appeal to the Pennsylvania Commonwealth Court. (See ITEM 1. REGULATION for a discussion of West Penn's competitive bidding petition.) West Penn cannot predict the outcome of this proceeding.\nTwo previously reported complaints had been filed with the West Virginia PSC by developers of cogeneration projects pursuant to PURPA in Marshall and Barbour Counties, West Virginia, seeking to require Monongahela and Potomac Edison to purchase capacity from the projects. These two cases were consolidated. The West Virginia PSC on March 5, 1993 found that: Monongahela had no need for additional capacity; Potomac Edison will need new combustion turbine generating capacity beginning in 1996; and Potomac Edison's avoided cost estimate, which is substantially below the costs sought by the developers of the projects, is reasonable. The developers subsequently asked the West Virginia PSC to consider issues which were not resolved in the March 5, 1993 order. On June 25, 1993 the West Virginia PSC found that Potomac Edison had a PURPA obligation to purchase power from qualifying facilities properly interconnected to the System in Monongahela's service territory and ordered negotiations by Monongahela and Potomac Edison with the two PURPA developers. On August 9, 1993, the West Virginia PSC deconsolidated the two cases. Following the West Virginia Supreme Court's denial of a petition for review of the June 25, 1993 order, both developers requested the start of negotiations. In February 1994, Potomac Edison and Monongahela met with the developer of the Barbour County Project to begin negotiation of issues not resolved in the March 1993 order. There have been no further developments in the Barbour County project since that time. In September 1994, Potomac Edison received a new proposal concerning the Marshall County site from its developer, pursuant to which the developer proposes to sell capacity to Potomac Edison. Potomac Edison replied to the proposal in October 1994. On January 10, 1995, the developer filed a motion with the West Virginia PSC to compel Potomac Edison to enter into an Electric Energy Purchase Agreement. Monongahela and Potomac Edison cannot predict the outcome of these proceedings.\nAs previously reported, effective March 1, 1989, West Virginia enacted a new method for calculating the Business and Occupation Tax\n(B & O Tax) on electricity generated in that state, which disproportionately increased the B & O Tax on shipments of electricity to other states. In 1989, West Penn, the Pennsylvania Consumer Advocate, and several West Penn industrial customers filed a joint complaint in the Circuit Court of Kanawha County, West Virginia seeking to have the B & O Tax declared illegal and unconstitutional on the grounds that it violates the Interstate Commerce Clause and the Equal Protection Clause of the federal Constitution and certain provisions of federal law that bar the states from imposing or assessing taxes on the generation or transmission of electricity that discriminate against out-of-state entities. In 1991, West Penn amended the complaint to include a 1990 increase in the rate of the B & O Tax. The trial was held in July 1993 and briefs have been filed. West Penn cannot predict the outcome of this litigation.\nAs of December 1994, Monongahela has been named as a defendant along with multiple other defendants in 1,625 pending asbestos cases involving one or more plaintiffs and Monongahela, Potomac Edison and West Penn have been named as defendants along with multiple other defendants in an additional 716 cases by one or more plaintiffs. Because these cases are filed by \"shot-gun\" complaints naming many plaintiffs and many defendants, it is presently impossible to determine the actual number of claims against the Operating Subsidiaries. However, based on past experience and data available to date, it is estimated that less than 500 cases actually involve claims against any or all of the Operating Subsidiaries. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at stations operated by the Operating Subsidiaries were employed by third-party contractors, with the exception of three known plaintiffs who claim to have been employees of Monongahela. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to an additional $1 million. Therefore, because of the multiple defendants, the Operating Subsidiaries believe their potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by Monongahela for an amount substantially less than the anticipated cost of defense. While the Operating Subsidiaries believe that all of these cases are without merit, they cannot predict the outcome of these cases or whether other cases will be filed.\nOn June 10, 1994, APS and all of its subsidiaries filed a declaratory judgment action in the Superior Court of New Jersey against their historic comprehensive general liability (CGL) insurers. This suit seeks a declaration that the CGL insurers have a duty to defend and indemnify the Operating Subsidiaries in the asbestos cases, as well as in certain environmental actions. To date, one insurer has settled. All other parties have answered the complaint. On January 27, 1995, the Court granted the CGL insurers' motion which dismissed the complaint, without prejudice, on procedural grounds. On the same day, APS and all of its subsidiaries recommenced the action in the Court of Common Pleas of Westmoreland County, Pennsylvania. The outcome of this proceeding cannot be predicted.\nOn March 4, 1994, the Operating Subsidiaries received notice that the EPA had identified them as potentially responsible parties (\"PRPs\") under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, with respect to the Jack's Creek\/Sitkin Smelting Superfund Site (Site). There are approximately 875 other PRPs involved. A Remedial Investigation\/Feasibility Study prepared by the EPA indicates remedial alternatives which range as high as $113 million, to be shared by all responsible parties. The EPA has not yet selected which remedial alternatives it will use, nor has it issued a Proposed Plan and Record of Decision. The Operating Subsidiaries believe they have defenses to allegations of liability and intend to vigorously defend this matter. The Operating Subsidiaries cannot predict the outcome of this proceeding.\nAfter protracted litigation concerning the Operating Subsidiaries' application for a license to build a 1,000-MW energy- storage facility near Davis, West Virginia, in 1988 the U.S. District Court reversed the U.S. Army Corps of Engineers' (Corps) denial of a dredge and fill permit on the grounds that, among other things, the Operating Subsidiaries were denied an opportunity to review and comment upon written materials and other communications used by the Corps in making its decision. As a result, the Court remanded the matter to the Corps for further proceedings. This decision has been appealed and negotiations are ongoing to settle this matter. The Operating Subsidiaries cannot predict the outcome of this proceeding.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNeither APS, Monongahela, Potomac Edison, West Penn nor AGC submitted any matters to a vote of shareholders during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAPS.\nAYP is the trading symbol of the common stock of APS on the New York, Chicago, and Pacific Stock Exchanges. The stock is also traded on the Amsterdam (Netherlands) and other stock exchanges. As of December 31, 1994, there were 66,818 holders of record of APS' common stock.\nThe tables below show the dividends paid and the high and low sale prices of the common stock for the periods indicated:\nThe high and low prices through February 2, 1995 were 24 and 21-1\/2. The last reported sale on that date was at 23-5\/8.\nMonongahela, Potomac Edison, and West Penn. The information required by this Item is not applicable as all the common stock of the Operating Subsidiaries is held by APS.\nAGC. The information required by this Item is not applicable as all the common stock of AGC is held by Monongahela, Potomac Edison, and West Penn.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nPage No.\nAPS D-1 Monongahela D-3 Potomac Edison D-5 West Penn D-7 AGC D-9\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPage No.\nAPS M-1 Monongahela M-5 Potomac Edison M-13 West Penn M-21 AGC M-30\nM-1 APS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCONSOLIDATED NET INCOME\nEarnings per share were $2.23 in 1994, including $.37 of non-recurring income from the cumulative effect of an accounting change to record unbilled revenues. The 1994 results also reflect the write-off ($.05 per share) of previously accumulated costs related to future facilities no longer considered meaningful in the industry's more competitive environment. Earnings per share were $1.88 and $1.83 in 1993 and 1992, respectively. Consolidated net income was $263.2 million including the $43.4 million non-recurring cumulative effect of an accounting change and net of the $5.3 million asset write-off described above. Consolidated net income was $215.8 million and $203.5 million in 1993 and 1992, respectively. The 1994 and 1993 increases in consolidated net income resulted primarily from kWh sales and retail rate increases. These revenue increases, in both years, were offset in part by higher expenses.\nThe subject of competition for customers, particularly industrial customers, has been receiving a lot of attention. In 1994 the Maryland, Ohio, and Pennsylvania commissions started proceedings described as inquiries into the subject, which are still in progress. The inquiries are not expected to result in immediately meaningful changes in current relations with our customers. All customers, except wholesale customers regulated by the Federal Energy Regulatory Commission (FERC), continue to be required to purchase their electricity requirements from the utility in whose franchised territory they reside. This is not to say that competition does not exist. Utilities continue to compete for the siting of new industrial and commercial customers, to retain existing customers in the franchised territory, and, for those businesses with multiple plants in multiple territories, to maintain or shift their production to local facilities. As in the past, electric utilities continue to compete with suppliers of other forms of energy. Because the subsidiaries are the lowest or among the lowest cost suppliers of electricity in their regions, they should not experience the competitive concerns of other utilities who use cost-based pricing. However, the subsidiaries continue to face competition from utilities with excess generation that are willing to sell at prices intended only to recover variable costs.\nSALES AND REVENUES\nKWh sales to and revenues from residential, commercial, and industrial customers are shown on page 35. Such kWh sales increased 2.8% and 3.3% in 1994 and 1993, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following: Increase from Prior Year 1994 1993 (Millions of Dollars)\nIncreased kWh sales $ 23.6 $ 46.6 Fuel and energy cost adjustment clauses* 48.3 57.0 Rate increases: Pennsylvania 22.7 25.2 Maryland 11.9 12.7 West Virginia 9.7 5.3 Virginia 8.5 2.5 Ohio 2.1 52.8 47.8 Other 4.3 6.2 $129.0 $157.6\n* Changes in revenues from fuel and energy cost adjustment clauses have little effect on consolidated net income.\nThe increased kWh sales in 1994 reflect growth in both residential and commercial customers and higher use by commercial customers. The 1994 residential use was down slightly from 1993 levels reflecting a decrease in both heating and cooling degree days. The increased kWh sales to residential and commercial customers in 1993 reflect both growth in number of customers and higher use. While 1993 heating degree days showed only a slight increase over 1992, and were approximately normal, cooling degree days increased 69% over 1992 and were 25% over normal, contributing to the 1993 kWh sales increases.\nRate case decisions in almost all jurisdictions, representing revenue increases in excess of $120 million on an annual basis, were issued for the subsidiaries in 1994. These included recovery of the remaining carrying charges on investment, depreciation, and all operating costs required to comply with Phase I of the Clean Air Act Amendments of 1990 (CAAA), and other increasing levels of expense. See Rate Matters on pages 7-9 for further information on rate changes.\nKWh sales to industrial customers increased 4.4% in 1994 and .3% in 1993. The 1994 increase occurred in almost all industrial groups, particularly coal mining (142 gigawatt-hours [GWh], 9.2%); paper, printing and publishing (130 GWh, 24.9%); iron and steel (130 GWh, 3.8%); and chemical customers (112 GWh, 5.0%). The relatively flat industrial sales growth in 1993 included one particular group, coal mines staffed by union personnel, which recorded reduced usage because of selective work stoppages by the United Mine Workers of America (UMWA) for most of the year prior to the settling of the dispute in December 1993. KWh sales to and revenues from nonaffiliated utilities are comprised of the following items: 1994 1993 1992 KWh sales (in billions): From subsidiaries' generation 1.1 1.2 3.2 From purchased power 8.8 11.2 14.6 9.9 12.4 17.8 Revenues (in millions): From subsidiaries'generation $ 29.0 $ 28.5 $ 91.7 From sales of purchased power 302.6 318.2 373.8 $331.6 $346.7 $465.5\nM-2\nDecreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by subsidiaries' generation in 1994 continued at less than 15% of 1988 levels because of continuing growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the subsidiaries' ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents per MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989--a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated. About 95% of the aggregate benefits from sales to nonaffiliated utilities is passed on to retail customers and has little effect on consolidated net income.\nThe increase in other revenues in 1994 resulted from increased revenues from wholesale customers. The decrease in other revenues in 1993 resulted from an agreement with the FERC to record in 1993 about $14 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years. About $46 million of other revenues in 1994 were derived from wholesale customers regulated by the FERC who have the ability to obtain their electricity requirements from other suppliers. In 1994, customers representing about 40% of these revenues signed seven-year contracts to remain as customers. In the event that the other customers were to select another supplier, the subsidiaries would retain transmission revenues with the result that any net income loss would not be significant.\nOPERATING EXPENSES\nFuel expenses increased .5% in 1994 and decreased 4% in 1993, both primarily due to changes in kWh generated. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the consolidated financial statements, with the result that changes in fuel expenses have little effect on consolidated net income.\n\"Purchased power and exchanges, net\" represents power purchases from and exchanges with other utilities and qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA) and is comprised of the following items: 1994 1993 1992 (Millions of Dollars)\nPurchased power: For resale to other utilities $267.1 $280.9 $344.0 From PURPA generation 134.0 105.2 94.0 Other 40.4 33.8 12.7 Total power purchased 441.5 419.9 450.7 Power exchanges, net (.6) (2.5) .7 $440.9 $417.4 $451.4\nThe amount of power purchased from other utilities for use by subsidiaries and for resale to other utilities depends upon the availability of the subsidiaries' generating equipment, transmission capacity, and fuel, and their cost of generation and the cost of operations of other utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to other utilities is described under SALES AND REVENUES above. The cost of power purchased for use by the subsidiaries, including power from PURPA generation, is mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the subsidiaries' regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on consolidated net income. The increases in purchases from PURPA generation reflect additional generation from new PURPA projects. None of the subsidiaries' purchased power contracts is capitalized since there are no minimum payment requirements absent associated kWh generation. The 1993 increase in other purchased power reflects efforts to conserve coal during the UMWA dispute. Other purchased power continued to increase in 1994 because of increased sales to retail customers combined with generating unit outages in the first quarter of 1994.\nThe increase in other operation expense in 1994 resulted primarily from a decision to increase the allowances for uncollectible accounts ($9 million), increases in salaries and wages ($5 million) and employee benefit costs, primarily pension expense ($6 million) and other postretirement benefits ($3 million), and provisions for environmental liabilities ($3 million). Allowances for uncollectible accounts were increased due to an increase in aged outstanding receivables caused by customers taking advantage of rate regulations which make it difficult if not impossible to curtail service to non-paying customers during the winter months. In a continuing effort to control salary and wage expenses and to improve the overall efficiency of the Company in a competitive environment, the Company has an ongoing program to consolidate various related functions within the subsidiaries. The increase in pension expense occurred because the subsidiaries in 1994 discontinued the practice of deferring SFAS No. 87 pension expense in Pennsylvania and West Virginia to reflect recent rate case decisions in those states. Pension expense in 1994 also includes a charge of $3.1 million for write-off of prior SFAS No. 87 deferrals in West Virginia because recovery of those deferrals was denied in the most recent rate cases.\nDuring 1992, the subsidiaries implemented significant changes to their benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future post-retirement medical benefit costs to be capped at two times 1993 levels. Approximately $1 million of the $3 million increase in postretirement benefit expenses for 1994 was due to the 1993 cost cap being greater than actuarily projected.\nThe adoption of SFAS No. 106 in 1993 increased 1993 postretirement benefit expense by approximately $5 million. The increase in other operation expense for 1993 resulted primarily from increases in employee benefit costs and salaries and wages.\nAnother FASB standard, SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\", effective in 1994, requires companies to accrue for other postemployment benefits such as disability benefits, health care benefits\nM-3\nfor disabled employees, severance pay, and workers' compensation claims. The subsidiaries currently accrue for workers' compensation claims, and the estimated liability for the other benefits is not material.\nMaintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. The subsidiaries are also experiencing, and expect to continue to experience, increased expenditures due to the aging of their power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA. Maintenance expense in 1993 includes the effects of an ice storm and blizzard in March 1993.\nDepreciation expense increases resulted primarily from additions to electric plant. On November 16, 1994, the subsidiaries declared the Harrison scrubbers available for service and started depreciation on them amounting to $32 million annually.\nTaxes other than income increased $4 million in 1994 primarily due to increases in gross receipts taxes resulting from higher revenues from retail customers. The 1993 increase ($4 million) resulted from increases in gross receipts taxes ($5 million) and increased property taxes ($2 million) offset by decreased West Virginia Business and Occupation taxes due to decreased generation in that state.\nThe net increase of $2 million in federal and state income taxes in 1994 resulted primarily from an increase in income before taxes. The net increase in 1993 of $13 million resulted primarily from an increase in income before taxes ($9 million) and an increase in the tax due to the Revenue Reconciliation Act of 1993 ($3 million). Note B to the consolidated financial statements provides a further analysis of income tax expenses.\nThe 1994 combined decrease of $2 million in allowances for funds used during construction (AFUDC), as well as the 1993 combined increase of $4 million, reflect variations in construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to decrease upon substantial completion of Phase I of the CAAA compliance program. Other income and deductions in 1994 reflect the write-off of $5.3 million net of income taxes of previously accumulated costs related to future facilities which are no longer considered meaningful in the industry's more competitive environment. Fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the levels of short-term debt maintained by the companies throughout the year, as well as the associated interest rates.\nThe increase in dividends on preferred stock of the subsidiaries reflects the issuance in May 1994 of $50 million of preferred stock with a dividend rate of $7.73 per share.\nLIQUIDITY AND CAPITAL RESOURCES\nSEC regulations define \"liquidity\" as \"the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash\". System companies need cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stocks, and for their construction programs. To meet these needs, the companies have used internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, installment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the companies' cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.\nCAPITAL REQUIREMENTS\nConstruction expenditures for 1994 were $508 million and for 1995 and 1996 are estimated at $341 million and $284 million, respectively. These estimates include $61 million and $7 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA discussed under ENVIRONMENTAL MATTERS on page 10. Annual construction expenditures through 1998 are not expected to significantly exceed 1995 estimated levels. Construction expenditure levels in 1999 and beyond will depend upon the strategy eventually selected for complying with Phase II of the CAAA, as well as future generation requirements.\nThe Harrison Scrubber Project was completed on schedule and the final cost was approximately 24% below the original budget. Primary factors contributing to the reduced cost include: (1) the absence of any major construction problems, (2) financing and material and equipment costs lower than expected, and (3) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. The possibility of new legislation which could restrict or discourage carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The subsidiaries have additional capital requirements of an annual preferred stock sinking fund ($1.2 million) and debt maturities (see Note H to the consolidated financial statements).\nIn a further effort to meet the challenges of the new competitive environment in the industry, AYP Capital, Inc., an unregulated wholly-owned subsidiary of the Company, was formed. It is intended that AYP Capital operate as an innovative and flexible organization, pursuing and developing new opportunities in unregulated markets that will strengthen the long-term competitiveness and profitability of the System. The Company has been authorized by the SEC to purchase common stock of and make capital contributions to AYP Capital in the amount of $3 million.\nINTERNAL CASH FLOWS\nInternal generation of cash, consisting of cash flows from operations reduced by dividends, was $246 million in 1994 compared with $270 million in 1993. In 1994 the subsidiaries financed approximately 48% of their capital expenditure program through internal cash generation. Based upon the new rate case authorizations received in 1994, it is expected that close to 100% of the capital expenditure program can be financed through internal cash generation in 1995.\nThe increase in other investments reflects the 1994 cash surrender values for secured benefit plans and a related prepayment. Materials and supplies, primarily fuel, constituted a significant use of cash in 1994 ($21 million). A new five-year National Bituminous Coal Wage Agreement was signed with the union in December 1993.\nM-4\nSystem coal inventory declined during the renegotiations due to selective mine shutdowns, and has returned to a more appropriate level. December 1992 levels reflected increases to provide for an adequate coal supply in the event of a strike.\nFINANCINGS\nDuring 1994, the Company issued 1,629,372 shares of common stock under its Dividend Reinvestment and Stock Purchase Plan (DRISP), and Employee Stock Ownership and Savings Plan (ESOSP) for $35.0 million. During 1994, the subsidiaries issued an aggregate of $140 million of first mortgage bonds having interest rates of 8% to 8.125%, an aggregate of $35 million of tax-exempt solid waste disposal notes to Harrison County, West Virginia, and $50 million of $7.73 preferred stock. Debt redemption costs are amortized over the life of the associated new bonds. Due to the significant number of refinancings which have occurred over the past three years, this balance is now about $41 million. Reduced future interest expense will more than offset these expenses.\nShort-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long-term securities. Short-term debt decreased $3.8 million to $126.8 million in 1994. In 1992, the Company and its subsidiaries established an internal money pool whereby surplus funds of the Company and certain subsidiaries may be borrowed on a short-term basis by the Company's subsidiaries. This has contributed to the continued low temporary cash investment amounts.\nAt December 31, 1994, unused lines of credit with banks were $202 million. In addition, a multi-year credit program established in January 1994 provides the subsidiaries with the ability to borrow on a standby revolving credit basis up to $300 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. There were no borrowings under this facility in 1994. During 1995, the subsidiaries have no current plans to issue new securities; however, if economic and market conditions make it desirable, they may refinance up to $783 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The subsidiaries may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds and qualified properties are available. The Company plans to continue DRISP\/ESOSP common stock sales.\nThe subsidiaries anticipate that they will be able to meet their future cash needs through internal cash generation and external financings, as they have in the past, and possibly through alternative financing procedures.\nENVIRONMENTAL MATTERS AND OTHER CONTINGENCIES\nIn the normal course of business, the subsidiaries are subject to various contingencies and uncertainties relating to their operations and construction programs, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note J to the consolidated financial statements. The subsidiaries previously reported that the Environmental Protection Agency (EPA) had identified them and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. A Remedial Investigation\/Feasibility Study prepared by the EPA indicates remedial alternatives which range as high as $113 million, to be shared by all responsible parties. The EPA has not yet selected which remedial alternatives it will use. The subsidiaries believe they have defenses to allegations of liability and intend to vigorously defend this matter. Although it is not possible at this time to determine what costs, if any, the subsidiaries may incur, they have recorded provisions for liabilities based on the range of remediation cost estimates and their relative participation, along with the approximately 875 others. The subsidiaries believe that provisions for liabilities and insurance recoveries are such that final resolution of this matter will not have a material effect on their financial position.\nMonongahela has been named as a defendant along with multiple other defendants in 1,625 pending asbestos cases involving one or more plaintiffs; Monongahela, Potomac Edison, and West Penn have been named as defendants along with multiple other defendants in an additional 716 cases by one or more plaintiffs. Because these cases are filed by \"shotgun\" complaints naming many plaintiffs and many defendants, it is currently impossible to determine the actual number of claims against the subsidiaries. However, based on past experience and data available to date, it is estimated that less than 500 cases actually involve claims against any or all of the subsidiaries. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at subsidiary-operated stations were employed by third-party contractors, with the exception of three known plaintiffs who claim to have been employees of Monongahela. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to an additional $1 million. Because of the multiple defendants, the subsidiaries believe their potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by Monongahela for an amount substantially less than the anticipated cost of defense.\nThe subsidiaries believe that the remaining cases involving them are without merit and that provisions for liabilities and insurance recoveries are such that these suits will not have a material effect on their financial position.\nM-5 Monongahela\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net Income Net income was $67.9 million in 1994, including $7.9 million of non-recurring income from the cumulative effect of an accounting change to record unbilled revenues. Net income was $61.7 million and $58.3 million in 1993 and 1992, respectively. Net income in 1994 and 1993 continue to reflect increases in revenues from retail customers resulting from increased kWh sales and retail rate increases. The decrease in 1994 income before the accounting change resulted primarily from higher expenses, including taxes, pension expense, and depreciation. The subject of competition for customers, particularly industrial customers, has been receiving a lot of attention. In 1994 the Ohio commission started a proceeding described as an informal roundtable discussion into the subject, which is still in progress. This process is not expected to result in immediately meaningful changes in current relations with our customers. All customers, except wholesale customers regulated by the Federal Energy Regulatory Commission (FERC), continue to be required to purchase their electricity requirements from the utility in whose franchised territory they reside. This is not to say that competition does not exist. Utilities continue to compete for the siting of new industrial and commercial customers, to retain existing customers in the franchised territory, and, for those businesses with multiple plants in multiple territories, to maintain or shift their production to local facilities. As in the past, electric utilities continue to compete with suppliers of other forms of energy. Because the Company is among the lowest cost suppliers of electricity in its region, it should not experience the competitive concerns of other utilities who use cost-based pricing. However, the Company continues to face competition from utilities with excess generation that are willing to sell at prices intended only to recover variable costs.\nSales and Revenues KWh sales to and revenues from residential, commercial, and industrial customers are shown on pages 16 and 17. Such kWh sales increased 3.2% and .3% in 1994 and 1993, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following:\nIncrease from Prior Year\n1994 1993 (Millions of Dollars) Increased kWh sales $ 3.8 $ 6.6 Fuel and energy cost adjustment clauses* 13.0 11.8 Rate increases: West Virginia 7.9 4.1 Ohio 2.1 7.9 6.2 Other 1.0 .2 $25.7 $24.8\n* Changes in revenues from fuel and energy cost adjustment clauses have little effect on net income.\nM-6\nThe increased kWh sales in 1994 reflect growth in both residential and commercial customers. The 1994 residential use was down slightly from 1993 levels reflecting a decrease in both heating and cooling degree days. The increased kWh sales to residential and commercial customers in 1993 reflect both growth in number of customers and higher use. While 1993 heating degree days showed only a slight increase over 1992, and were only 6% above normal, cooling degree days increased 54% over 1992, contributing to the 1993 kWh sales increase.\nRate case decisions in West Virginia and by the FERC for wholesale customers, representing revenue increases in excess of $30 million on an annual basis, were issued for the Company in 1994. These included recovery of the remaining carrying charges on investment, depreciation, and all operating costs required to comply with Phase I of the Clean Air Act Amendments of 1990 (CAAA), and other increasing levels of expense. KWh sales to industrial customers increased 6.1% in 1994 and decreased 4.4% in 1993. The 1994 increase occurred primarily from coal mining (128 gigawatt-hours [GWh], 16.1%); chemical (91 GWh, 5.3%); and primary metals customers (77 GWh, 8.3%). The increase in sales to primary metals customers was due in part to the discontinuance of one customer's use of its own generation, which contributed to 1993 decreased sales. The 1993 decrease also reflects a decline in sales to coal customers. Coal mines staffed by union personnel recorded reduced usage because of selective work stoppages by the United Mine Workers of America (UMWA) for most of the year prior to the settling of the dispute in December 1993. KWh sales to and revenues from nonaffiliated utilities are comprised of the following items:\n1994 1993 1992 KWh sales (in billions): From Company generation .3 .3 1.0 From purchased power 2.1 2.8 3.6 2.4 3.1 4.6 Revenues (in millions): From Company generation $ 7.7 $ 8.4 $ 26.7 From sales of purchased power 72.0 77.6 92.9 $79.7 $86.0 $119.6\nDecreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by the Company's generation in 1994 continued at less than 15% of 1988 levels because of growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the Company's ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents per MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989 a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated.\nM-7\nThe increase in other revenues in 1994 and 1993 resulted from continued increases in sales of capacity, energy, and spinning reserve to other affiliated companies because of additional capacity and energy available from qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA). This increase was offset in part in 1993 by an agreement with the FERC to record in 1993 about $3 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years. About 90% of the aggregate benefits from sales to affiliated and nonaffiliated utilities is passed on to retail customers and has little effect on net income. About $4 million of other revenues in 1994 were derived from wholesale customers regulated by the FERC who have the ability to obtain their electricity requirements from other suppliers. In the event that these customers were to select another supplier, the Company would retain transmission revenues with the result that any net income loss would not be significant.\nOperating Expenses Fuel expenses increased 4% in 1994 and decreased 3% in 1993, both primarily due to changes in kWh generated. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the financial statements, with the result that changes in fuel expenses have little effect on net income. \"Purchased power and exchanges, net\" represents power purchases from and exchanges with nonaffiliated utilities and qualified facilities under PURPA, capacity charges paid to Allegheny Generating Company (AGC), and other transactions with affiliates made pursuant to a power supply agreement whereby each company uses the most economical generation available in the System at any given time, and is comprised of the following items:\n1994 1993 1992 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other utilities $ 63.7 $ 68.6 $ 85.5 From PURPA generation 68.3 55.7 37.4 Other 9.4 8.1 3.1 Power exchanges, net (.2) (.6) .3 Affiliated transactions: AGC capacity charges 20.1 23.3 24.2 Energy and spinning reserve charges .5 .5 2.8 $161.8 $155.6 $153.3\nThe amount of power purchased from nonaffiliated utilities for use by the Company and for resale to nonaffiliated utilities depends upon the availability of the Company's generating equipment, transmission capacity, and fuel, and its cost of generation and the cost of operations of nonaffiliated utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated utilities is described under Sales and Revenues above. The cost of power and capacity purchased for use by the Company, including power from PURPA generation and affiliated transactions, is mostly recovered from customers currently through the regular fuel and\nM-8\nenergy cost recovery procedures followed by the Company's regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on net income. The increases in purchases from PURPA generation reflects additional generation from new PURPA projects. None of the Company's purchased power contracts is capitalized since there are no minimum payment requirements absent associated kWh generation. The 1993 increase in other purchased power reflects efforts to conserve coal during the UMWA dispute. Other purchased power continued to increase in 1994 because of increased sales to retail customers combined with generating unit outages in the first quarter of 1994. Energy and spinning reserve charges decreased in 1993 primarily because of additional generation available from PURPA projects. The increase in other operation expense in 1994 resulted primarily from increases in pension expense ($4 million), allowance for uncollectible accounts ($1 million), and salaries and wages ($1 million). The increase in pension expense occurred because the Company in 1994 discontinued the practice of deferring SFAS No. 87 pension expense in West Virginia to reflect the recent rate case decision. Pension expense in 1994 also includes a charge of $2.5 million for write-off of prior SFAS No. 87 deferrals in West Virginia because recovery of those deferrals was denied in the most recent rate case. In a continuing effort to control salary and wage expenses and to improve the overall efficiency of the Company in a competitive environment, the Allegheny Power System has an ongoing program to consolidate various related functions within the System. The increase in other operation expense for 1993 resulted primarily from increases in salaries and wages and employee benefit costs. During 1992, the Company implemented significant changes to its benefits plans, including cost caps, in an effort to both control and reduce employee benefit costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. The adoption of SFAS No. 106 in 1993 increased 1993 postretirement benefit expense by approximately $2 million. Another FASB standard, SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\", effective in 1994, requires companies to accrue for other postemployment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The Company currently accrues for workers' compensation claims, and the estimated liability for the other benefits is not material. Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment\nM-9\nand rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. In early January 1994, the Company experienced the worst storm in its history. The expenses were deferred and are being amortized over a five-year period beginning in November 1994, concurrent with recovery from customers. The Company is also experiencing, and expects to continue to experience, increased expenditures due to the aging of its power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA. Depreciation expense increases resulted primarily from additions to electric plant. On November 16, 1994, the Company declared the Harrison scrubbers available for service and started depreciation on them amounting to $8 million annually. The 1994 depreciation expense increase was offset in part by a decrease in depreciation rates in West Virginia of about $7 million annually effective in November 1994, concurrent with the base rate increase. A further reduction of about $4 million annually effective in January 1996, will result in depreciation rates for the Company which are comparable to those of other electric utilities, particularly those providing service in West Virginia. Taxes other than income increased $6 million in 1994 primarily due to an increase in West Virginia Business and Occupation taxes resulting from prior period adjustments recorded in 1993 and 1992. The 1993 increase ($1 million) was due primarily to increases in gross receipts taxes resulting from higher revenues from retail customers. The net decrease of $3 million in federal and state income taxes in 1994 resulted primarily from a decrease in income before taxes ($2 million) and the reversal of a provision for prior years which is no longer needed ($2 million). The net increase in 1993 of $6 million resulted primarily from an increase in income before taxes ($4 million), and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($1 million). Note B to the financial statements provides a further analysis of income tax expenses. The 1994 combined decrease of $3 million in allowances for funds used during construction (AFUDC), as well as the 1993 combined increase of $2 million, reflect variations in construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to decrease upon substantial completion of Phase I of the CAAA compliance program. The changes in other income, net, in 1994 and 1993 resulted primarily from the Company's share of earnings of AGC (see Note D to the financial statements). Other fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the levels of short-term debt maintained by the Company throughout the year, as well as the associated interest rates.\nLiquidity and Capital Resources SEC regulations define \"liquidity\" as \"the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash\". The Company needs cash for operating expenses, the payment of interest and dividends, retirement of debt, and for its construction program. To meet these needs, the Company has used internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, installment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the Company's cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.\nCapital Requirements\nConstruction expenditures for 1994 were $104 million and for 1995 and 1996 are estimated at $74 million and $70 million, respectively. These estimates include $11 million and $2 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA. Annual construction expenditures through 1998, on average, are not expected to significantly exceed 1995 estimated levels. Construction expenditure levels in 1999 and beyond will depend upon the strategy eventually selected for complying with Phase II of the CAAA, as well as future generation requirements. The Harrison Scrubber Project was completed on schedule and the final cost was approximately 24% below the original budget. Primary factors contributing to the reduced cost include: (1) the absence of any major construction problems, (2) financing and material and equipment costs lower than expected, and (3) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. The possibility of new legislation which could restrict or discourage carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The Company has additional capital requirements of debt maturities (see Note I to the financial statements).\nInternal Cash Flows Internal generation of cash, consisting of cash flows from operations reduced by dividends, was $67 million in 1994 compared with $69 million in 1993. In 1994 the Company financed\nM-10\napproximately 64% of its capital expenditure program through internal cash generation. Based upon the new rate case authorizations received in 1994 and an Ohio rate case filed in January 1995, it is expected that close to 100% of the capital expenditure program can be financed through internal cash generation in 1995. Materials and supplies, primarily fuel, constituted a significant use of cash in 1994 ($6 million). A new five-year National Bituminous Coal Wage Agreement was signed with the union in December 1993. System coal inventory declined during the renegotiations due to selective mine shutdowns, and has returned to a more appropriate level. December 1992 levels reflected increases to provide for an adequate coal supply in the event of a strike.\nFinancings\nDuring 1994, the Company issued $50 million of $7.73 preferred stock and $8.83 million of tax-exempt solid waste disposal notes to Harrison County, West Virginia. Due to the significant number of refinancings which have occurred over the past three years, the balance of debt redemption costs is now about $11 million. These costs are being amortized over the life of the associated new bonds. Reduced future interest expense will more than offset these expenses. Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long-term securities. Short-term debt, including notes payable to affiliates under the money pool, decreased $23.6 million to $39.5 million in 1994. In 1992, the Company and its affiliates established an internal money pool as a facility to accommodate intercompany short-term borrowing needs, to the extent that certain of the companies have funds available. The internal money pool has contributed to the continued low temporary cash investment amounts. At December 31, 1994, the Company had SEC authorization to issue up to $100 million of short-term debt. In addition, a multi-year credit program established in January 1994 provides the Company with the ability to borrow on a standby revolving credit basis up to $81 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. There were no borrowings under this facility in 1994. During 1995, the Company has no current plans to issue new securities; however, if economic and market conditions make it desirable, it may refinance up to $300 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The Company may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds and qualified properties are available.\nM-11\nThe Company anticipates that it will be able to meet its future cash needs through internal cash generation and external financings, as it has in the past, and possibly through alternative financing procedures.\nEnvironmental Matters and Other Contingencies In the normal course of business, the Company is subject to various contingencies and uncertainties relating to its operations and construction programs, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note K to the financial statements. The Company previously reported that the Environmental Protection Agency (EPA) had identified it and its affiliates and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. A Remedial Investigation\/Feasibility Study prepared by the EPA indicates remedial alternatives which range as high as $113 million, to be shared by all responsible parties. The EPA has not yet selected which remedial alternatives it will use. The Company believes it has defenses to allegations of liability and intends to vigorously defend this matter. Although it is not possible at this time to determine what costs, if any, the Company may incur, it has recorded provisions for liabilities based on the range of remediation cost estimates and its relative participation, along with the approximately 875 others. The Company believes that provisions for liabilities and insurance recoveries are such that final resolution of this matter will not have a material effect on its financial position. The Company has been named as a defendant along with multiple other defendants in 1,625 pending asbestos cases involving one or more plaintiffs, and the Company and its affiliates have been named as defendants along with multiple other defendants in an additional 716 cases by one or more plaintiffs. Because these cases are filed by \"shotgun\" complaints naming many plaintiffs and many defendants, it is currently impossible to determine the actual number of claims against the Company and its affiliates. However, based on past experience and data available to date, it is estimated that less than 500 cases actually involve claims against the Company or its affiliates. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at\nM-12\nSystem-operated stations were employed by third-party contractors, with the exception of three known plaintiffs who claim to have been employees of the Company. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to an additional $1 million. Because of the multiple defendants, the Company believes its potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by the Company for an amount substantially less than the anticipated cost of defense. The Company believes that the remaining cases involving it are also without merit and that provisions for liabilities and insurance recoveries are such that these suits will not have a material effect on its financial position.\nM-13\nPotomac Edison\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net Income Net income was $98.5 million in 1994, including $16.5 million of non-recurring income from the cumulative effect of an accounting change to record unbilled revenues. Net income was $73.5 million and $67.5 million in 1993 and 1992, respectively. The 1994 and 1993 increases in net income resulted primarily from kWh sales and retail rate increases. These revenue increases, in both years, were offset in part by higher expenses. The subject of competition for customers, particularly industrial customers, has been receiving a lot of attention. In 1994 the Maryland commission started a proceeding described as an inquiry into the subject, which is still in progress. The inquiry is not expected to result in immediately meaningful changes in current relations with our customers. All customers, except wholesale customers regulated by the Federal Energy Regulatory Commission (FERC), continue to be required to purchase their electricity requirements from the utility in whose franchised territory they reside. This is not to say that competition does not exist. Utilities continue to compete for the siting of new industrial and commercial customers, to retain existing customers in the franchised territory, and, for those businesses with multiple plants in multiple territories, to maintain or shift their production to local facilities. As in the past, electric utilities continue to compete with suppliers of other forms of energy. Because the Company is the lowest or among the lowest cost suppliers of electricity in its region, it should not experience the competitive concerns of other utilities who use cost-based pricing. However, the Company continues to face competition from utilities with excess generation that are willing to sell at prices intended only to recover variable costs.\nSales and Revenues KWh sales to and revenues from residential, commercial, and industrial customers are shown on pages 16 and 17. Such kWh sales increased 2.3% and 6.3% in 1994 and 1993, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following: Increase from Prior Year 1994 1993 (Millions of Dollars) Increased kWh sales $10.3 $24.4 Fuel and energy cost adjustment clauses* 18.6 19.1 Rate increases: Maryland 11.9 12.7 Virginia 8.5 2.5 West Virginia 1.9 1.1 22.3 16.3 Other 1.0 2.9 $52.2 $62.7 * Changes in revenues from fuel and energy cost adjustment clauses have little effect on net income.\nM-14\nThe increased kWh sales in 1994 reflect growth in the number of customers and higher use by industrial customers. The 1994 residential use was down slightly from 1993 levels reflecting a decrease in both heating and cooling degree days. The increased kWh sales to residential and commercial customers in 1993 reflect both higher use and growth in number of customers. While 1993 heating degree days showed only a slight increase over 1992, and were only 7% above normal, cooling degree days increased 82% over 1992 and were 12% over normal, contributing to the 1993 kWh sales increases. Rate case decisions in all retail jurisdictions, representing revenue increases in excess of $33 million on an annual basis, were issued for the Company in 1994. These included recovery of the remaining carrying charges on investment, depreciation, and all operating costs required to comply with Phase I of the Clean Air Act Amendments of 1990 (CAAA), and other increasing levels of expense. KWh sales to industrial customers increased 2.8% in 1994 and 4.3% in 1993. The increase in both years occurred in almost all industrial groups, the most significant of which in 1994 was from rubber and plastics customers (61 gigawatt-hours [GWh], 22%) and in 1993 was from cement customers (59 GWh, 12%). KWh sales to and revenues from nonaffiliated utilities are comprised of the following items:\n1994 1993 1992 KWh sales (in billions): From Company generation .3 .4 1.0 From purchased power 2.9 3.5 4.4 3.2 3.9 5.4 Revenues (in millions): From Company generation $ 8.9 $ 8.6 $ 27.5 From sales of purchased power 98.1 99.5 113.6 $107.0 $108.1 $141.1\nDecreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by the Company's generation in 1994 continued at less than 15% of 1988 levels because of continuing growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the Company's ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989 - a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated. About 95% of the aggregate benefits from sales to nonaffiliated utilities is passed on to retail customers and has little effect on net income.\nM-15\nThe decrease in other revenues in 1994 resulted from provisions for rate refunds recorded in 1994 for the 1993 and 1994 Virginia base rate increase requests, collected from customers subject to refund. A final order for the 1993 case has been received and refunds will be made to customers in early 1995. Commission approval of a settlement agreement for the 1994 request is pending. About $23 million of other revenues in 1994 were derived from wholesale customers regulated by the FERC who have the ability to obtain their electricity requirements from other suppliers. In the event that these customers were to select another supplier, the Company would retain transmission service revenues. The decrease in other revenues in 1993 resulted from an agreement with the FERC to record in 1993 about $4 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years.\nOperating Expenses Fuel expenses increased 1% in 1994 and decreased 4% in 1993, both primarily due to changes in kWh generated. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the financial statements, with the result that changes in fuel expenses have little effect on net income. \"Purchased power and exchanges, net\" represents power purchases from and exchanges with nonaffiliated utilities, capacity charges paid to Allegheny Generating Company (AGC), and other transactions with affiliates made pursuant to a power supply agreement whereby each company uses the most economical generation available in the System at any given time, and is comprised of the following items: 1994 1993 1992 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other utilities $ 86.5 $ 87.9 $104.6 Other 12.7 10.5 3.7 Power exchanges, net (.2) (.8) .2 Affiliated transactions: AGC capacity charges 29.4 28.0 29.6 Other affiliated capacity charges 37.6 28.4 21.9 Energy and spinning reserve charges 51.1 51.1 41.2 $217.1 $205.1 $201.2\nThe amount of power purchased from nonaffiliated utilities for use by the Company and for resale to nonaffiliated utilities depends upon the availability of the Company's generating equipment, transmission capacity, and fuel, and its cost of generation and the cost of operations of nonaffiliated utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated utilities is described under Sales and Revenues above. The cost of power purchased from nonaffiliates for use by the Company, AGC capacity charges in West Virginia, and affiliated energy and spinning reserve charges are mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the Company's regulatory commissions and is primarily\nM-16\nsubject to deferred power cost procedures with the result that changes in such costs have little effect on net income. The 1993 increase in other purchased power reflects efforts to conserve coal because of selective work stoppages by the United Mine Workers of America for most of the year. Other purchased power continued to increase in 1994 because of increased sales to retail customers combined with generating unit outages in the first quarter of 1994. While the Company does not currently purchase generation from qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA), several projects have been proposed, and an agreement has been reached with one facility to commence purchasing generation in 1999. This project and others may significantly increase the cost of power purchases passed on to customers. The increase in affiliated capacity in 1994 and 1993 and energy and spinning reserve charges in 1993 was due to growth of kWh sales to retail customers and an increase in affiliated energy available because of energy purchased by an affiliate from PURPA projects. The increase in other operation expense in 1994 resulted primarily from demand-side management program costs ($1 million) and cogeneration project expenses ($1 million), both of which are being recovered from customers, provisions for environmental liabilities ($1 million), and increases in affiliated company charges for transmission service ($2 million), salaries and wages ($1 million), and employee benefit costs ($1 million), primarily pension expense and other postretirement benefits. In a continuing effort to control salary and wage expenses and to improve the overall efficiency of the Company in a competitive environment, the Allegheny Power System has an ongoing program to consolidate various related functions within the System. The increase in pension expense occurred because the Company in 1994 discontinued the practice of deferring SFAS No. 87 pension expense in West Virginia to reflect a recent rate case decision. Pension expense in 1994 also includes a charge of $.9 million for write-off of prior SFAS No. 87 deferrals in Virginia and West Virginia because recovery of those deferrals was denied in the most recent rate cases. During 1992, the Company implemented significant changes to its benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. Approximately $.6 million of the increase in postretirement benefit expenses for 1994 was due to the 1993 cost cap being greater than actuarily projected. The adoption of SFAS No. 106 in 1993 increased 1993 postretirement benefit expense by approximately $1.5 million. The increase in other operation expense for 1993 resulted primarily from increases in employee benefit costs and salaries and wages. Another FASB standard, SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\", effective in 1994, requires companies to accrue for other postemployment benefits such as disability benefits, healthcare benefits for disabled employees, severance\nM-17\npay, and workers' compensation claims. The Company currently accrues for workers' compensation claims, and the estimated liability for the other benefits is not material. Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. The Company is also experiencing, and expects to continue to experience, increased expenditures due to the aging of its power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA. Depreciation expense increases resulted primarily from additions to electric plant. On November 16, 1994, the Company declared the Harrison scrubbers available for service and started depreciation on them amounting to $10 million annually. Taxes other than income increased $1 million in 1993 due to increases in gross receipts taxes resulting from higher revenues from retail customers ($1 million) and increased property taxes ($1 million), offset by decreased West Virginia Business and Occupation taxes due to decreased generation in that state ($1 million). The net increase of $3 million in federal and state income taxes in 1994 resulted primarily from an increase in income before taxes. The net increase in 1993 of $2 million in federal and state income taxes resulted primarily from an increase in income before taxes ($3 million) and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($1 million), offset by plant removal tax deductions for which deferred taxes were not provided ($1 million). Note B to the financial statements provides a further analysis of income tax expenses. The 1994 combined decrease of $1 million in allowances for funds used during construction (AFUDC), as well as the 1993 combined increase of $2 million, reflect variations in construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to decrease upon substantial completion of Phase I of the CAAA compliance program. The changes in other income, net, in 1994 and 1993 resulted primarily from the Company's share of earnings of AGC (see Note D to the financial statements) and in 1994 also from lost revenue and interest income for demand-side management programs. Other fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the levels of short-term debt maintained by the Company throughout the year, as well as the associated interest rates.\nM-18\nLiquidity and Capital Resources SEC regulations define \"liquidity\" as \"the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash\". The Company needs cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stock, and for its construction program. To meet these needs, the Company has used internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, installment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the Company's cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds. During 1994, the Company continued its participation in the Collaborative Process for Demand-Side Management in Maryland. Through December 31, 1994, the Company had received applications for $16.1 million in rebates related to the commercial lighting program. Program costs, including rebates and lost revenues, are deferred and are to be recovered through an energy conservation surcharge over a seven-year period.\nCapital Requirements Construction expenditures for 1994 were $143 million and for 1995 and 1996 are estimated at $92 million and $98 million, respectively. These estimates include $12 million and $5 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA. Annual construction expenditures through 1998, on average, are not expected to significantly exceed 1995 estimated levels. Construction expenditure levels in 1999 and beyond will depend upon the strategy eventually selected for complying with Phase II of the CAAA, as well as future generation requirements. The Harrison Scrubber Project was completed on schedule and the final cost was approximately 24% below the original budget. Primary factors contributing to the reduced cost include: (1) the absence of any major construction problems, (2) financing and material and equipment costs lower than expected, and (3) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. The possibility of new legislation which could restrict or discourage carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The Company has additional annual capital requirements of an annual preferred stock sinking fund ($1.2 million) and debt maturities (see Note I to the financial statements).\nM-19\nInternal Cash Flows Internal generation of cash, consisting of cash flows from operations reduced by dividends, was $67 million in 1994 compared with $75 million in 1993. In 1994 the Company financed approximately 47% of its capital expenditure program through internal cash generation. Based upon the new rate case authorizations received in 1994, it is expected that close to 100% of the capital expenditure program can be financed through internal cash generation in 1995.\nMaterials and supplies, primarily fuel, constituted a significant use of cash in 1994 ($5 million). A new five-year National Bituminous Coal Wage Agreement was signed with the union in December 1993. System coal inventory declined during the renegotiations due to selective mine shutdowns, and has returned to a more appropriate level. December 1992 levels reflected increases to provide for an adequate coal supply in the event of a strike.\nFinancings During 1994, the Company issued $75 million of 8% first mortgage bonds and $11.56 million of tax-exempt solid waste disposal notes to Harrison County, West Virginia. Due to the significant number of refinancings which have occurred over the past three years, the balance of debt redemption costs is now about $8 million. These costs are being amortized over the life of the associated new bonds. Reduced future interest expense will more than offset these expenses. Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long-term securities. In 1992, the Company and its affiliates established an internal money pool as a facility to accommodate intercompany short-term borrowing needs, to the extent that certain of the companies have funds available. The internal money pool has contributed to the continued low temporary cash investment amounts. At December 31, 1994, the Company had SEC authorization to issue up to $115 million of short-term debt. In addition, a multi-year credit program established in January 1994 provides the Company with the ability to borrow on a standby revolving credit basis up to $84 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. There were no borrowings under this facility in 1994. During 1995, the Company has no current plans to issue new securities; however, if economic and market conditions make it desirable, it may refinance up to $231 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The Company may also engage in addi- tional Harrison County tax-exempt solid waste disposal financings to the extent that funds and qualified properties are available. The Company anticipates that it will be able to meet its future cash needs through internal cash generation and external financings, as it has in the past, and possibly through alternative financing procedures.\nM-20\nEnvironmental Matters and Other Contingencies In the normal course of business, the Company is subject to various contingencies and uncertainties relating to its operations and construction programs, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note K to the financial statements. The Company previously reported that the Environmental Protection Agency (EPA) had identified it and its affiliates and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. A Remedial Investigation\/Feasibility Study prepared by the EPA indicates remedial alternatives which range as high as $113 million, to be shared by all responsible parties. The EPA has not yet selected which remedial alternatives it will use. The Company believes it has defenses to allegations of liability and intends to vigorously defend this matter. Although it is not possible at this time to determine what costs, if any, the Company may incur, it has recorded provisions for liabilities based on the range of remediation cost estimates and its relative participation, along with the approximately 875 others. The Company believes that provisions for liabilities and insurance recoveries are such that final resolution of this matter will not have a material effect on its financial position. Monongahela Power Company (MP), an affiliated company, has been named as a defendant along with multiple other defendants in 1,625 pending asbestos cases involving one or more plaintiffs, and the Company and its affiliates have been named as defendants along with multiple other defendants in an additional 716 cases by one or more plaintiffs. Because these cases are filed by \"shotgun\" complaints naming many plaintiffs and many defendants, it is currently impossible to determine the actual number of claims against the Company and its affiliates. However, based on past experience and data available to date, it is estimated that less than 500 cases actually involve claims against the Company or its affiliates. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at System-operated stations were employed by third-party contractors, with the exception of three known plaintiffs who claim to have been employees of MP. The Company is joint owner with MP in five generating plants, including four operated by MP in West Virginia. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to an additional $1 million. Because of the multiple defendants, the Company believes its potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by MP for an amount substantially less than the anticipated cost of defense. The Company believes that the remaining cases involving it are also without merit and that provisions for liabilities and insurance recoveries are such that these suits will not have a material effect on its financial position.\nM-21\nWest Penn\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nConsolidated Net Income Consolidated net income was $120.0 million in 1994, including $19.0 million of non-recurring income from the cumulative effect of an accounting change to record unbilled revenues. The 1994 results also reflect the write-off ($5.2 million after tax) of previously accumulated costs related to future facilities no longer considered meaningful in the industry's more competitive environment. Consolidated net income was $102.1 million and $98.2 million in 1993 and 1992, respectively. The 1994 and 1993 increases in consolidated net income resulted primarily from kWh sales and retail rate increases. These revenue increases, in both years, were offset in part by higher expenses. The subject of competition for customers, particularly industrial customers, has been receiving a lot of attention. In 1994 the Pennsylvania commission initiated an investigation into the subject, which is still in progress. The inquiry is not expected to result in immediately meaningful changes in current relations with our customers. All customers, except wholesale customers regulated by the Federal Energy Regulatory Commission (FERC), continue to be required to purchase their electricity requirements from the utility in whose franchised territory they reside. This is not to say that competition does not exist. Utilities continue to compete for the siting of new industrial and commercial customers, to retain existing customers in the franchised territory, and, for those businesses with multiple plants in multiple territories, to maintain or shift their production to local facilities. As in the past, electric utilities continue to compete with suppliers of other forms of energy. Because the Company is the lowest or among the lowest cost suppliers of electricity in its region, it should not experience the competitive concerns of other utilities who use cost-based pricing. However, the Company continues to face competition from utilities with excess generation that are willing to sell at prices intended only to recover variable costs.\nSales and Revenues KWh sales to and revenues from residential, commercial, and industrial customers are shown on pages 16 and 17. Such kWh sales increased 2.9% and 3.1% in 1994 and 1993, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following:\nIncrease from Prior Year 1994 1993 (Millions of Dollars) Increased kWh sales $ 9.4 $15.5 Fuel and energy cost adjustment clauses* 16.8 26.2 Rate increases 22.7 25.2 Other 2.3 3.1 $51.2 $70.0\n* Changes in revenues from fuel and energy cost adjustment clauses have little effect on consolidated net income.\nM-22\nThe increased kWh sales to residential and commercial customers in 1994 and 1993 reflect growth in number of customers and higher commercial use. Residential usage increased in 1994 despite a decrease in both heating and cooling degree days. While 1993 heating degree days remained about the same as 1992, and were only 6% below normal, cooling degree days increased 70% over 1992 and were 46% over normal, contributing to the 1993 kWh sales increases. Rate case decisions in all jurisdictions, representing revenue increases in excess of $57 million on an annual basis, were issued for the Company in 1994. These included recovery of the remaining carrying charges on investment, depreciation, and all operating costs required to comply with Phase I of the Clean Air Act Amendments of 1990 (CAAA), and other increasing levels of expenses. Rate increases also include a $61.6 million annual base rate increase in Pennsylvania effective May 18, 1993, including $26.1 million for recovery of carrying charges on CAAA compliance costs. KWh sales to industrial customers increased 4.4% in 1994 and .8% in 1993. The 1994 increase occurred in almost all industrial groups, particularly paper, printing and publishing (118 gigawatt-hours [GWh], 47.4%); fabricated metals (72 GWh, 6.9%); and iron and steel customers (53 GWh, 2.1%). The relatively flat industrial sales growth in 1993 included one particular group, coal mines staffed by union personnel, which recorded reduced usage because of selective work stoppages by the United Mine Workers of America (UMWA) for most of the year prior to the settling of the dispute in December 1993. KWh sales to and revenues from nonaffiliated utilities are comprised of the following items: 1994 1993 1992 KWh sales (in billions): From Company generation .5 .4 1.3 From purchased power 3.8 5.0 6.5 4.3 5.4 7.8 Revenues (in millions): From Company generation $ 12.3 $ 11.5 $ 37.5 From sales of purchased power 132.5 141.0 167.2 $144.8 $152.5 $204.7\nDecreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by the Company's generation in 1994 continued at less than 15% of 1988 levels because of continuing growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the Company's ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents per MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989 - a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated.\nM-23\nThe decrease in other revenues in 1994 and 1993 resulted from continued decreases in sales of energy and spinning reserve to an affiliated company because of additional energy available to it from qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA). The 1993 decrease was also due in part to an agreement with the FERC to record in 1993 about $6 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years. Most of the aggregate benefits from sales to affiliated and nonaffiliated utilities is passed on to retail customers and has little effect on consolidated net income. About $19 million of other revenues in 1994 were derived from wholesale customers regulated by the FERC who have the ability to obtain their electricity requirements from other suppliers. In 1994, these customers signed seven-year contracts to remain as customers.\nOperating Expenses Fuel expenses decreased 2% in 1994 and 4% in 1993 primarily due to decreases in kWh generated. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the consolidated financial statements, with the result that changes in fuel expenses have little effect on consolidated net income. \"Purchased power and exchanges, net\" represents power purchases from and exchanges with nonaffiliated utilities and qualified facilities under PURPA, capacity charges paid to AGC, and other transactions with affiliates made pursuant to a power supply agreement whereby each company uses the most economical generation available in the System at any given time, and is comprised of the following items:\n1994 1993 1992 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other utilities $116.9 $124.5 $153.9 From PURPA generation 65.7 49.6 56.5 Other 18.3 15.2 5.9 Power exchanges, net (.2) (1.2) .3 Affiliated transactions: AGC capacity charges 37.2 42.3 43.5 Energy and spinning reserve charges 8.6 4.7 3.5 Other affiliated capacity charges .7 .7 .6 $247.2 $235.8 $264.2\nThe amount of power purchased from nonaffiliated utilities for use by the Company and for resale to nonaffiliated utilities depends upon the availability of the Company's generating equipment, transmission capacity, and fuel, and its cost of generation and the cost of operations of nonaffiliated utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated utilities is described under Sales and Revenues above. The cost of power and capacity purchased for use by the Company, including power from PURPA generation and affiliated transactions, is mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the Company's\nM-24\nregulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on consolidated net income. The decrease in purchases from PURPA generation in 1993 was due to a planned generating outage at one PURPA project. None of the Company's purchased power contracts is capitalized since there are no minimum payment requirements absent associated kWh generation. The 1993 increase in other purchased power reflects efforts to conserve coal during the UMWA dispute. Other purchased power continued to increase in 1994 because of increased sales to retail customers combined with generating unit outages in the first quarter of 1994. The increase in other operation expense in 1994 resulted primarily from a decision to increase the allowances for uncollectible accounts ($8 million), increases in salaries and wages ($2 million) and employee benefit costs, primarily pension expense ($1 million) and other postretirement benefits ($2 million), and provisions for environmental liabilities ($1 million). Allowances for uncollectible accounts were increased due to an increase in aged outstanding receivables caused by customers taking advantage of rate regulations which make it difficult if not impossible to curtail service to non-paying customers during the winter months. In a continuing effort to control salary and wage expenses and to improve the overall efficiency of the Company in a competitive environment, the Allegheny Power System has an ongoing program to consolidate various related functions within the System. The increase in pension expense occurred because the Company in 1994 discontinued the practice of deferring SFAS No. 87 pension expense to reflect a recent rate case decision. During 1992, the Company implemented significant changes to its benefits plans, including cost caps, in an effort to both control and reduce employee benefit costs. The cost caps provide for future post-retirement medical benefit costs to be capped at two times 1993 levels. Approximately $.3 million of the increase in postretirement benefit expenses for 1994 was due to the 1993 cost cap being greater than actuarily projected. The adoption of SFAS No. 106 in 1993 increased 1993 postretirement benefit expenses by approximately $3 million. The increase in other operation expense for 1993 resulted primarily from increases in salaries and wages and employee benefit costs. Another FASB standard, SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\", effective in 1994, requires companies to accrue for other postemployment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The Company currently accrues for workers' compensation claims, and the estimated liability for the other benefits is not material. Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned\nM-25\nexpenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. The Company is also experiencing, and expects to continue to experience, increased expenditures due to the aging of its power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA. Maintenance expense in 1993 includes the effects of an ice storm and blizzard in March 1993. Depreciation expense increases resulted primarily from additions to electric plant and from a change in depreciation rates and net salvage amortization in May 1993. On November 16, 1994, the Company declared the Harrison scrubbers available for service and started depreciation on them amounting to $14 million annually. Taxes other than income decreased $2 million in 1994 primarily due to a decrease in West Virginia Business and Occupation taxes (B&O taxes) ($3 million), offset in part by an increase in gross receipts taxes resulting from higher revenues from retail customers ($2 million). The 1993 increase ($2 million) was primarily due to increases in gross receipts taxes ($3 million) offset by decreased West Virginia B&O taxes ($2 million). The net decrease of $1 million in federal and state income taxes in 1994 resulted primarily from plant removal cost tax deductions for which deferred taxes were not provided. The net increase in 1993 of $7 million resulted primarily from an increase in income before taxes ($6 million), and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($1 million). Note B to the consolidated financial statements provides a further analysis of income tax expenses. The 1994 combined increase of $2 million in allowances for funds used during construction (AFUDC), reflects increased construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to decrease upon substantial completion of Phase I of the CAAA compliance program. Other income and deductions in 1994 reflect the write-off of $5.2 million net of income taxes of previously accumulated costs related to future facilities which are no longer considered meaningful in the industry's more competitive environment. The changes in other income, net, in 1994 and 1993 resulted primarily from the Company's share of earnings of AGC (see Note D to the consolidated financial statements). Other fluctuations in other income, net, were individually insignificant. Other interest expense reflects change in the levels of short-term debt maintained by the Company throughout the year, as well as the associated interest rates.\nM-26\nLiquidity and Capital Resources SEC regulations define \"liquidity\" as \"the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash\". The Company needs cash for operating expenses, the payment of interest and dividends, retirement of debt, and for its construction program. To meet these needs, the Company has used internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, installment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the Company's cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.\nCapital Requirements\nConstruction expenditures for 1994 were $260 million and for 1995 and 1996 are estimated at $172 million and $115 million, respectively. These estimates include $38 million and $1 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA. Annual construction expenditures through 1998, on average, are not expected to significantly vary from 1995 estimated levels. Construction expenditure levels in 1999 and beyond will depend upon the strategy eventually selected for complying with Phase II of the CAAA, as well as future generation requirements. The Harrison Scrubber Project was completed on schedule and the final cost was approximately 24% below the original budget. Primary factors contributing to the reduced cost include: (1) the absence of any major construction problems, (2) financing and material and equipment costs lower than expected, and (3) favorable ruling of the Pennsylvania PUC allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. The possibility of new legislation which could restrict or discourage carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The Company has additional capital requirements of debt maturities (see Note I to the consolidated financial statements).\nInternal Cash Flows Internal generation of cash, consisting of cash flows from operations reduced by dividends, was $109 million in 1994 compared with $119 million in 1993. In 1994 the Company financed approximately 42% of its capital expenditure program through internal cash generation. Based upon the new rate case authorizations received in 1994, it is expected that close to 100% of the capital expenditure program can be financed through internal cash generation in 1995.\nM-27\nMaterials and supplies, primarily fuel, constituted a significant use of cash in 1994 ($9 million). A new five-year National Bituminous Coal Wage Agreement was signed with the union in December 1993. System coal inventory declined during the renegotiations due to selective mine shutdowns, and has returned to a more appropriate level. December 1992 levels reflected increases to provide for an adequate coal supply in the event of a strike.\nFinancings During 1994 the Company issued $65 million of 8-1\/8% first mortgage bonds and $14.91 million of tax-exempt solid waste disposal notes to Harrison County, West Virginia. Due to the significant number of refinancings which have occurred over the past three years, the balance of debt redemption costs is now about $10 million. These costs are being amortized over the life of the associated new bonds. Reduced future interest expense will more than offset these expenses. Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long-term securities. In 1992, the Company and its affiliates established an internal money pool as a facility to accommodate intercompany short-term borrowing needs, to the extent that certain of the companies have funds available. The internal money pool has contributed to the continued low temporary cash investment amounts. At December 31, 1994, the Company had SEC authorization to issue up to $170 million of short-term debt. In addition, a multi-year credit program established in January 1994 provides the Company with the ability to borrow on a standby revolving credit basis up to $135 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. There were no borrowings under this facility in 1994. During 1995, the Company has no current plans to issue new securities; however, if economic and market conditions make it desirable, it may refinance up to $251.5 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The Company may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds and qualified properties are available. The Company anticipates that it will be able to meet its future cash needs through internal cash generation and external financings, as it has in the past, and possibly through alternative financing procedures.\nEnvironmental Matters and Other Contingencies In the normal course of business, the Company is subject to various contingencies and uncertainties relating to its operations and construction programs, including cost recovery in\nM-28\nthe regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note K to the consolidated financial statements. The Company previously reported that the Environmental Protection Agency (EPA) had identified it and its affiliates and approximately 875 others as potentially responsible parties in a Superfund site subject to cleanup. A Remedial Investigation\/Feasibility Study prepared by the EPA indicates remedial alternatives which range as high as $113 million, to be shared by all responsible parties. The EPA has not yet selected which remedial alternatives it will use. The Company believes it has defenses to allegations of liability and intends to vigorously defend this matter. Although it is not possible at this time to determine what costs, if any, the Company may incur, it has recorded provisions for liabilities based on the range of remediation cost estimates and its relative participation, along with the approximately 875 others. The Company believes that provisions for liabilities and insurance recoveries are such that final resolution of this matter will not have a material effect on its financial position. Monongahela Power Company (MP), an affiliated company, has been named as a defendant along with multiple other defendants in 1,625 pending asbestos cases involving one or more plaintiffs, and the Company and its affiliates have been named as defendants along with multiple other defendants in an additional 716 cases by one or more plaintiffs. Because these cases are filed by \"shotgun\" complaints naming many plaintiffs and many defendants, it is currently impossible to determine the actual number of claims against the Company and its affiliates. However, based on past experience and data available to date, it is estimated that less than 500 cases actually involve claims against the Company or its affiliates. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at System-operated stations were employed by third-party contractors, with the exception of three known plaintiffs who claim to have been employees of MP. The Company is joint owner with MP in four generating plants, including three operated by MP in West Virginia. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally\nM-29\nsought against all defendants in an amount of up to an additional $1 million. Because of the multiple defendants, the Company believes its potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by MP for an amount substantially less than the anticipated cost of defense. The Company believes that the remaining cases involving it are also without merit and that provisions for liabilities and insurance recoveries are such that these suits will not have a material effect on its financial position.\nM-30 AGC\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations As described under Liquidity and Capital Resources, revenues are determined under a cost of service formula rate schedule. Therefore, if all other factors remain equal, revenues are expected to decrease each year due to a normal continuing reduction in the Company's net investment in the Bath County station and its connecting transmission facilities upon which the return on investment is determined. The net investment (primarily net plant less deferred income taxes) decreases to the extent that provisions for depreciation and deferred income taxes exceed net plant additions. Revenues for 1994 increased primarily because of the return on equity settlement which resulted in an adjustment of prior period provisions for rate refunds. Revenues for 1993 decreased due to a reduction in interest charges and net investment, and reduced operating expenses which are described below. Additionally, revenues for 1993 were reduced by the recording of estimated liabilities for possible refunds pending final Federal Energy Regulatory Commission (FERC) decisions in rate case proceedings (see Liquidity and Capital Resources). The increase in operating expenses in 1994 resulted primarily from an increase in federal income taxes due to an increase in income before taxes ($1.5 million). The decrease in operating expenses in 1993 resulted from a decrease in federal income taxes due to a decrease in income before taxes ($1.9 million) offset by an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($.5 million), partially offset by an increase in operation and maintenance expense. The decreases in interest on long-term debt in 1994 and 1993 were the combined result of decreases in the average amount of and interest rates on long-term debt outstanding. The increase in other interest in 1994 was due to amortization of the premium paid to refund debentures in 1993. Liquidity and Capital Resources SEC regulations define \"liquidity\" as \"the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash\". The Company's only operating assets are an undivided 40% interest in the Bath County (Virginia) pumped-storage hydroelectric station and its connecting transmission facilities. The Company has no present plans for construction of any other major facilities. Pursuant to an agreement, the Parents buy all of the Company's capacity in the station priced under a \"cost of service formula\" wholesale rate schedule approved by the FERC. Under this arrangement, the Company recovers in revenues all of its operation and maintenance expenses, depreciation, taxes, and a return on its investment.\nM-31\nThrough February 29, 1992, the Company's return on equity (ROE) was adjusted annually pursuant to a settlement agreement approved by the FERC. In December 1991, the Company filed for a continuation of the existing ROE of 11.53% and other parties (the Consumer Advocate Division of the Public Service Commission of West Virginia, Maryland People's Counsel, and Pennsylvania Office of Consumer Advocate, collectively referred to as the joint consumer advocates or JCA) filed to reduce the ROE to 10%. Hearings were completed in June 1992, and a recommendation was issued by an Administrative Law Judge (ALJ) on December 21, 1993, for an ROE of 10.83%, which the JCA argues should be further adjusted to reflect changes in capital market conditions since the hearings. Exceptions to this recommendation were filed by all parties for consideration by the FERC. On January 28, 1994, the JCA filed a joint complaint with the FERC against the Company claiming that both the existing ROE of 11.53% and the ROE recommended by the ALJ of 10.83% were unjust and unreasonable. This new complaint requested an ROE of 8.53% with rates subject to refund beginning April 1, 1994. Hearings were completed in November 1994 and a recommendation was issued by an ALJ on December 22, 1994, dismissing the JCA's complaint. A settlement agreement for both cases is currently pending, which would reduce the Company's ROE to 11.13% for the period from March 1, 1992, through December 31, 1994, and increase the Company's ROE to 11.20% for the period from January 1, 1995, through December 31, 1995. During 1995, the parties have agreed to negotiate in good faith to approve a mechanism for setting ROE in the future. This settlement is subject to FERC approval. If approved, this settlement will require a refund to customers for the period through December 31, 1994, of about $4.42 million for which adequate reserves have been provided. Through a filing completed on October 31, 1994, the Company sought to add a prior tax payment of approximately $12 million to rate base which will produce about $1.4 million in additional annual revenues. On December 30, 1994, the FERC accepted the Company's filing, ordered that the increase in rates go into effect on June 1, 1995, subject to refund, and set the Company's ROE for hearing in 1995. A settlement agreement is currently pending. This settlement is subject to FERC approval. An internal money pool accommodates intercompany short-term borrowing needs, to the extent that certain of the Company's affiliates have funds available.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of Allegheny Power System, Inc.\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Allegheny Power System, 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 Notes A, B and E to the consolidated financial statements, the Company changed its method of accounting for revenue recognition in 1994 and for income taxes and postretirement benefits other than pensions in 1993.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 2, 1995\nAPS\nCONSOLIDATED STATEMENT OF INCOME Year ended December 31 (Dollar amounts in thousands except for per share data) 1994 1993 1992 Electric Operating Revenues: Residential $ 863 725 $ 818 400 $ 734 874 Commercial 459 303 430 202 391 912 Industrial 728 009 673 418 637 656 Nonaffiliated utilities 331 557 346 705 465 491 Other 69 090 62 801 76 725 TOTAL OPERATING REVENUES 2 451 684 2 331 526 2 306 658 Operating Expenses: Operation: Fuel 547 241 544 659 567 833 Purchased power and exchanges, net 440 880 417 449 451 408 Deferred power costs, net (Note A) 11 805 (11 462) 89 Other 285 010 257 732 232 672 Maintenance 241 913 231 163 210 878 Depreciation 223 883 210 428 197 763 Taxes other than income taxes 183 060 178 788 174 578 Federal and state income taxes (Note B) 129 751 128 130 115 373 TOTAL OPERATING EXPENSES 2 063 543 1 956 887 1 950 594 OPERATING INCOME 388 141 374 639 356 064 Other Income and Deductions: Allowance for other than borrowed funds used during construction (Note A) 11 966 12 499 10 221 Asset write-off, net (Note A) (5 338) Other income, net 1 510 (6) 1 265 TOTAL OTHER INCOME AND DEDUCTIONS 8 138 12 493 11 486 INCOME BEFORE INTEREST CHARGES AND PREFERRED DIVIDENDS 396 279 387 132 367 550 Interest Charges and Preferred Dividends: Interest on long-term debt 153 668 157 449 147 427 Other interest 10 394 5 812 5 672 Allowance for borrowed funds used during construction (Note A) (7 630) (8 983) (7 331) Dividends on preferred stock of subsidiaries 20 096 17 098 18 235 TOTAL INTEREST CHARGES AND PREFERRED DIVIDENDS 176 528 171 376 164 003 Consolidated Income Before Cumulative Effect of Accounting Change 219 751 215 756 203 547 Cumulative Effect of Accounting Change, net (Note A) 43 446 Consolidated Net Income $ 263 197 $ 215 756 $ 203 547 Common Stock Shares Outstanding (average) (Note G) 118 272 373 114 937 032 111 226 318 Earnings Per Average Share (Note G): Consolidated income before cumulative effect of accounting change $1.86 $1.88 $1.83 Cumulative effect of accounting change, net (Note A) .37 Consolidated net income $2.23 $1.88 $1.83 See accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (These notes are an integral part of the consolidated financial statements.)\nNOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The Company and its subsidiaries (companies) are subject to regulation by the Securities and Exchange Commission. The regulated subsidiaries are subject to regulation by various state bodies having jurisdiction and by the Federal Energy Regulatory Commission (FERC). Significant accounting policies of the Company and its subsidiaries are summarized below.\nCONSOLIDATION: The Company owns all of the outstanding common stock of its subsidiaries. The consolidated financial statements include the accounts of the Company and all subsidiary companies after elimination of intercompany transactions.\nREVENUES: Beginning in 1994, revenues, including amounts resulting from the application of fuel and energy cost adjustment clauses, are recognized in the same period in which the related electric services are provided to customers, by recording an estimate for unbilled revenues for services provided from the meter reading date to the end of the accounting period. In 1993 and 1992, revenues were recorded for billings rendered to customers, except for a portion of unbilled revenues in West Virginia.\nDEFERRED POWER COSTS, NET: The costs of fuel, purchased power, and certain other costs, and revenues from sales and transmission services to other utilities, are deferred until they are either recovered from or credited to customers under fuel and energy cost recovery procedures.\nPROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment are stated at original cost, less contributions in aid of construction, except for capital leases which are recorded at present value. Cost includes direct labor and material, allowance for funds used during construction (AFUDC) on property for which construction work in progress is not included in rate base, and such indirect costs as administration, maintenance, and depreciation of transportation and construction equipment, and pensions, taxes, and other fringe benefits related to employees engaged in construction. The cost of depreciable property units retired, plus removal costs less salvage, are charged to accumulated depreciation.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION: AFUDC, an item that does not represent current cash income, is defined in applicable regulatory systems of accounts as including \"the net cost for the period of construction of borrowed funds used for construction purposes and a reasonable rate on other funds when so used\". AFUDC is recognized as a cost of property, plant, and equipment with offsetting credits to other income and interest charges. Rates used by the subsidiaries for computing AFUDC in 1994, 1993, and 1992 averaged 9.00%, 9.37%, and 9.19%, respectively. AFUDC is not included in the cost of such construction when the cost of financing the construction is being recovered through rates.\nDEPRECIATION AND MAINTENANCE: Provisions for depreciation are determined generally on a straight-line method based on estimated service lives of depreciable properties and amounted to approximately 3.3% of average depreciable property in 1994, 3.4% in 1993, and 3.3% in 1992. The cost of maintenance and of certain replacements of property, plant, and equipment is charged principally to operating expenses.\nINVESTMENTS: The investment in subsidiaries consolidated represents the excess of acquisition cost over book equity (goodwill) prior to 1966. Goodwill is not being amortized because, in management's opinion, there has been no reduction in its value. Other investments primarily represent the estimated cash surrender values and prepayments of purchased life insurance contracts on certain qualifying management employees under an executive life insurance plan and a supplemental executive retirement plan (Secured Benefit Plan). Payment of future premiums will fully fund these benefits.\nINCOME TAXES: Financial accounting income before income taxes differs from taxable income principally because certain income and deductions for tax purposes are recorded in the financial income statement in another period. Differences between income tax expense computed on the basis of financial accounting income and taxes payable based on taxable income are accounted for substantially in accordance with the accounting procedures followed for ratemaking purposes. Deferred tax assets and liabilities recorded in accordance with the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", represent the tax effect of temporary differences between the financial statement and tax basis of assets and liabilities computed utilizing the most current tax rates. Provisions for federal income tax were reduced in previous years by investment credits, and amounts equivalent to such credits were charged to income with concurrent credits to a deferred account, balances of which are being amortized over estimated service lives of the related properties.\nPOSTRETIREMENT BENEFITS: The subsidiaries have a noncontributory, defined benefit pension plan covering substantially all employees, including officers. Benefits are based on the employee's years of service and compensation. The funding policy is to contribute annually at least the minimum amount required under the Employee Retirement Income Security Act and not more than can be deducted for federal income tax purposes.\nThe subsidiaries also provide partially contributory medical and life insurance plans for eligible retirees and dependents. Medical benefits, which comprise the largest component of the plans, are based upon an age and years-of-service vesting schedule and other plan provisions. The funding plan for these costs is to contribute to Voluntary Employee Beneficiary Association (VEBA) trust funds an amount equal to the annual cost as determined by SFAS No. 106 (described below). Medical benefits are self-insured; the life insurance plan is paid through insurance premiums. The FASB has prescribed the determination of annual pension and other postretirement benefits expenses in SFAS No. 87, \"Employers' Accounting for Pensions\", and SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", respectively. The subsidiaries record annual pension expense in accordance with SFAS No. 87. Prior to 1994, regulatory deferrals of these benefit expenses were recorded pursuant to SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation\", for those jurisdictions which reflected as net expense the funding of pensions and cash payments of other benefits in the ratemaking process. Regulatory deferrals of SFAS No. 106 benefits expenses were recorded for those jurisdictions in which SFAS No. 106 costs were not yet included in rates.\nASSET WRITE-OFF: In 1994, the subsidiaries wrote off $9.2 million ($5.3 million net of income taxes) of previously accumulated costs related to a potential future power plant site and a proposed transmission line. In the industry's more competitive environment, it is no longer reasonable to assume future recovery of these costs in rates.\nACCOUNTING CHANGES: Effective January 1, 1994, the subsidiaries changed their revenue recognition method to include the accrual of estimated unbilled revenues for electric services. This change results in a better matching of revenues and expenses, and is consistent with predominant utility industry practice. Previously, in accordance with ratemaking procedures followed in West Virginia, Monongahela Power Company had recorded a portion of revenues for service rendered but unbilled at year-end. The cumulative effect of this accounting change for years prior to 1994, which is shown separately in the consolidated statement of income for 1994, resulted in a benefit of $43.4 million (after related income taxes of $28.9 million), or $.37 per share of common stock. The effect of the change on the current year's consolidated income before the cumulative effect of accounting change, as well as on 1993 and 1992 consolidated net income, is not material. Effective January 1, 1993, the subsidiaries adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". Prior to 1993, medical expenses and life insurance premiums paid for retired employees and their dependents were recorded as expense in the period they were paid. Also effective January 1, 1993,\nthe subsidiaries adopted SFAS No. 109, \"Accounting for Income Taxes\". This standard mandated a change from the previous income-based deferral approach to a balance sheet-based liability approach for computing deferred income taxes.\nNOTE B--INCOME TAXES: Details of federal and state income tax provisions are: 1994 1993 1992 (Thousands of Dollars) Income taxes--current: Federal $114 263 $110 815 $ 92 937 State 15 633 20 732 4 144 Total 129 896 131 547 97 081 Income taxes--deferred, net of amortization 33 994 6 034 28 318 Investment credit disallowed (404) Amortization of deferred investment credit (8 310) (8 422) (8 335) Total income taxes 155 580 129 159 116 660 Income taxes--credited (charged) to other income and deductions 3 058 (1 029) (1 287) Income taxes--charged to accounting change (including state income taxes) (28 887) Income taxes--charged to operating income $129 751 $128 130 $115 373\nThe total provision for income taxes is different than the amount produced by applying the federal income statutory tax rate to financial accounting income, as set forth below: 1994 1993 1992 (Thousands of Dollars) Financial accounting income before cumulative effect of accounting change, preferred dividends, and income taxes $369 598 $360 984 $337 155 Amount so produced $129 400 $126 300 $114 600 Increased (decreased) for: Tax deductions for which deferred tax was not provided: Lower tax depreciation 8 000 8 800 7 600 Plant removal costs (5 600) (6 000) (6 500) State income tax, net of federal income tax benefit 11 600 15 000 12 600 Amortization of deferred investment credit (8 310) (8 422) (8 335) Other, net (5 339) (7 548) (4 592) Total $129 751 $128 130 $115 373\nFederal income tax returns through 1991 have been examined and substantially settled. In adopting SFAS No. 109, the subsidiaries recognized a significant increase in both deferred tax assets and liabilities. At December 31, the deferred tax assets and liabilities were comprised of the following: 1994 1993 (Thousands of Dollars) Deferred tax assets: Unamortized investment tax credit $ 99 821 $ 105 289 Unbilled revenue 13 043 38 363 Tax interest capitalized 33 773 22 236 Contributions in aid of construction 18 742 17 176 State tax loss carryback\/carryforward 8 256 14 560 Other 40 927 21 658 214 562 219 282\nDeferred tax liabilities: Book vs. tax plant basis differences, net 1 123 763 1 051 500 Other 51 996 42 122 1 175 759 1 093 622 Total net deferred tax liabilities 961 197 874 340 Add portion above included in current assets (liabilities) 10 916 (645) Total long-term net deferred tax liabilities $ 972 113 $ 873 695\nIt is expected that regulatory commissions will allow recovery of the deferred tax liabilities in future years as they are paid, and accordingly, the subsidiaries have recorded regulatory assets of $605 million which offset the increase in deferred tax liabilities. Regulatory liabilities of $105 million have been recorded which offset the increase in deferred tax assets in order to reflect the subsidiaries' obligation to pass such tax benefits on to their customers as the benefits are realized in cash in future years.\nNOTE C--DIVIDEND RESTRICTION: Supplemental indentures relating to most outstanding bonds of the subsidiaries contain dividend restrictions under the most restrictive of which $461,539,000 of consolidated retained earnings at December 31, 1994, is not available for cash dividends on their common stocks, except that a portion thereof may be paid as cash dividends where concurrently an equivalent amount of cash is received by a subsidiary as a capital contribution or as the proceeds of the issue and sale of shares of such subsidiary's common stock.\nNOTE D--PENSION BENEFITS: Net pension costs, a portion of which (about 25% to 30%) was charged to plant construction, included the following components: 1994 1993 1992 (Thousands of Dollars) Service cost--benefits earned $14 940 $13 361 $12 402 Interest cost on projected benefit obligation 38 630 37 387 36 049 Actual return on plan assets (61) (89 680) (65 641) Net amortization and deferral (48 983) 43 653 21 344 SFAS No. 87 pension cost 4 526 4 721 4 154 Regulatory reversal (deferral) 6 681 (1 509) (3 862) Net pension cost $11 207 $ 3 212 $ 292\nThe benefits earned to date and funded status at December 31 using a measurement date of September 30 were as follows: 1994 1993 (Thousands of Dollars) Actuarial present value of accumulated benefit obligation earned to date (including vested benefit of $403,610,000 and $401,986,000) $429 998 $429 360 Funded status: Actuarial present value of projected benefit obligation $529 411 $546 776 Plan assets at market value, primarily common stocks and fixed income securities 573 122 602 194 Plan assets in excess of projected benefit obligation (43 711) (55 418) Add: Unrecognized cumulative net gain from past experience different from that assumed 52 078 58 402 Unamortized transition asset, being amortized over 14 years beginning January 1, 1987 18 882 22 028 Less unrecognized prior service cost due to plan amendments 10 650 12 939 Pension cost liability at September 30 16 599 12 073 Fourth quarter contributions 7 800 -- Pension liability at December 31 $ 8 799 $ 12 073\nIn determining the actuarial present value of the projected benefit obligation at September 30, 1994, 1993, and 1992, the discount rates used were 7.75%, 7.25%, and 7.75%, and the rates of increase in future compensation levels were 4.75%, 4.75%, and 5.25%, respectively. The expected long-term rate of return on assets was 9% in each of the years 1994, 1993, and 1992.\nNOTE E--POSTRETIREMENT BENEFITS OTHER THAN PENSIONS: The subsidiaries adopted SFAS No. 106 as of January 1, 1993, which requires accrual of postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents during the years the employees render the necessary service to receive such benefits. Prior to 1993, medical expenses and life insurance premiums paid by the subsidiaries for retired employees and their dependents were recorded in expense in the period in which they were paid ($6,553,000 in 1992). SFAS No. 106 postretirement cost in 1994 and 1993, a portion of which (about 25% to 30%) was charged to plant construction, included the following components: 1994 1993 (Thousands of Dollars) Service cost--benefits earned $ 3 058 $ 2 000 Interest cost on accumulated postretirement benefit obligation 13 732 11 300 Actual loss (return) on plan assets 135 (24) Amortization of unrecognized transition obligation 7 300 7 300 Other net amortization and deferral 206 24 SFAS No. 106 postretirement cost 24 431 20 600 Regulatory deferral (3 908) (4 790) Net postretirement cost $20 523 $15 810\nThe benefits earned to date and funded status at December 31 using a measurement date of September 30 were as follows: 1994 1993 (Thousands of Dollars) Accumulated postretirement benefit obligation: Retirees $118 518 $115 019 Fully eligible employees 24 791 24 135 Other employees 52 914 55 255 Total obligation 196 223 194 409 Plan assets at market value 19 791 4 646 Accumulated postretirement benefit obligation in excess of plan assets 176 432 189 763 Less: Unrecognized cumulative net loss from past experience different from that assumed 34 190 41 450 Unrecognized transition obligation, being amortized over 20 years beginning January 1, 1993 130 900 138 200 Postretirement benefit liability at September 30 11 342 10 113 Fourth quarter contributions and benefit payments 5 826 4 549 Postretirement benefit liability at December 31 $ 5 516 $ 5 564\nThe plan assets at market value are comprised of fixed income securities, common stocks, and a short-term investment fund in 1994; and a short-term investment fund in 1993. The unfunded accumulated postretirement benefit obligation (APBO) at January 1, 1993, of $145,500,000 (transition obligation) is being amortized prospectively over 20 years as permitted by SFAS No. 106. In determining the APBO at September 30, 1994, 1993, and 1992, the discount rates used were 7.75%, 7.25%, and 8%, and the rates of increase in future compensation levels were 4.75%, 4.75%, and 5.5%, respectively. The 1994 expected long-term rate of return on assets was 8.25% net of tax. For measurement purposes, a health care trend rate of 9% for 1995, declining 1% each year thereafter to 6.75% in the year 1998 and beyond, and plan provisions which limit future medical and life insurance benefits, were assumed. Increasing the assumed health care trend rate by 1% in each year would increase the APBO at December 31, 1994, by $13.5 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1994 by $1.3 million. The subsidiaries have been authorized recovery of approximately 90% of SFAS No. 106 expenses in rates.\nNOTE F--FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying amounts and estimated fair value of financial instruments at December 31, 1994 and 1993 were as follows:\nThe carrying amount of temporary cash investments, as well as short-term debt, approximates the fair value because of the short maturity of those instruments. The fair value of mandatorily redeemable preferred stock was estimated based on quoted market prices. The fair value of long-term debt was estimated based on actual market prices or market prices of similar issues. The fair value of the life insurance contracts in Note A was estimated based on cash surrender value. The Company does not have any financial instruments held or issued for trading purposes.\nFor purposes of the consolidated statement of cash flows, temporary cash investments with original maturities of three months or less, generally in the form of commercial paper, certificates of deposit, and repurchase agreements, are considered to be the equivalent of cash.\nNOTE G--STOCKHOLDERS' EQUITY: COMMON STOCK: In November 1993, the common shareholders approved a two-for-one split of the Company's common stock effective November 4, 1993. The stock split reduced the par value of the common stock from $2.50 per share to $1.25 per share and increased the number of authorized shares of common stock from 130,000,000 to 260,000,000. The number of common stock shares outstanding and per share information for all periods reflect the two-for-one split.\nPREFERRED STOCK: In May 1994, Monongahela issued 500,000 shares of Series L, $7.73 preferred stock with par value of $100 per share. This Series is not redeemable prior to August 1, 2004. All of the preferred stock is entitled on voluntary liquidation to its then current call price and on involuntary liquidation to $100 a share. The holders of West Penn Power Company's market auction preferred stock are entitled to dividends at a rate determined by an auction held the business day preceding each quarterly dividend payment date.\nMANDATORILY REDEEMABLE PREFERRED STOCK: The Potomac Edison Company's $7.16 preferred stock is entitled to a cumulative sinking fund sufficient to retire 12,000 shares each year at $100 a share plus accrued dividends. That subsidiary has the noncumulative option in each year to retire up to an additional 12,000 shares at the same price. The call price declines in future years.\nNOTE H--LONG-TERM DEBT: Maturities for long-term debt for the next five years are: 1995, $28,000,000; 1996, $43,575,000; 1997, $26,900,000; 1998, $227,136,000; and 1999, $5,300,000. Substantially all of the properties of the subsidiaries are held subject to the lien securing each subsidiary's first mortgage bonds. Some properties are also subject to a second lien securing certain pollution control and solid waste disposal notes. Commercial paper borrowings issuable by Allegheny Generating Company are backed by a revolving credit agreement with a group of seven banks which provides for loans of up to $50 million at any one time outstanding through 1998. Each bank has the option to discontinue its loans after 1998 upon three years' prior written notice. Without such notice, the loans are automatically extended for one year. However, to the extent that funds are available from the companies, Allegheny Generating Company borrowings are made through an internal money pool as described in Note I.\nNOTE I--SHORT-TERM DEBT: To provide interim financing and support for outstanding commercial paper, lines of credit have been established with several banks. The companies have fee arrangements on all of their lines of credit and no compensating balance requirements. At December 31, 1994, unused lines of credit with banks were $202,150,000. In addition to bank lines of credit, an internal money pool accommodates intercompany short-term borrowing needs, to the extent that certain of the companies have funds available. In January 1994, a multi-year credit program was established which provides that the subsidiaries may borrow up to $300 million on a standby revolving credit basis. Short-term debt outstanding for 1994 and 1993 consisted of: 1994 1993 (Thousands of Dollars) Balance at end of year: Commercial Paper $103,968 -- 6.06% $54,811 -- 3.31% Notes Payable to Banks 22,850 -- 5.92% 75,825 -- 3.45% Average amount outstanding during the year: Commercial Paper 67,290 -- 4.25% 21,567 -- 3.24% Notes Payable to Banks 33,273 -- 4.17% 25,597 -- 3.19%\nNOTE J--COMMITMENTS AND CONTINGENCIES: CONSTRUCTION PROGRAM: The subsidiaries have entered into commitments for their construction programs, for which expenditures are estimated to be $341 million for 1995 and $284 million for 1996. These estimates include expenditures for the program of complying with the Clean Air Act Amendments of 1990 (CAAA) as discussed below. ENVIRONMENTAL MATTERS: The companies are subject to various laws, regulations, and uncertainties as to environmental matters. Compliance may require them to incur substantial additional costs to modify or replace existing and proposed equipment and facilities and may affect adversely the lead time, size, and siting of future generating stations, increase the complexity and cost of pollution control equipment, and otherwise add to the cost of future operations. Construction estimates for 1995 and 1996 include $61 million and $7 million, respectively, for compliance with Phase I of the CAAA. Through 1998, annual construction expenditures are not expected to significantly exceed 1995 estimated levels. Construction expenditure levels in 1999 and beyond will depend upon the strategy eventually selected for complying with Phase II of the CAAA, as well as future generation requirements.\nLITIGATION: In the normal course of business, the companies become involved in various legal proceedings. The companies do not believe that the ultimate outcome of these proceedings will have a material effect on their financial position.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of Monongahela Power Company\nIn our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Monongahela Power Company (a subsidiary of Allegheny Power System, Inc.) 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 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 A, B and F to the financial statements, the Company changed its method of accounting for revenue recognition in 1994 and for income taxes and postretirement benefits other than pensions in 1993.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 2, 1995\nBALANCE SHEET DECEMBER 31 1994 1993 (Thousands of Dollars)\nASSETS Property, Plant, and Equipment: At original cost, including $35,856,000 and $144,621,000 under construction $1 763 533 $1 684 322 Accumulated depreciation (701 271) (664 947) 1 062 262 1 019 375 Investments: Allegheny Generating Company-common stock at equity (Note D) 60 137 61 698 Other 509 595 60 646 62 293 Current Assets: Cash 132 135 Accounts receivable: Electric service, net of $1,912,000 and $1,084,000 uncollectible allowance (Note A) 62 631 48 995 Affiliated and other 9 483 14 596 Materials and supplies-at average cost: Operating and construction 24 563 22 393 Fuel 23 678 19 904 Prepaid taxes 17 599 19 788 Deferred power costs (Note A) 1 852 10 823 Other 5 328 3 772 145 266 140 406 Deferred Charges: Regulatory assets (Note B) 186 109 162 842 Unamortized loss on reacquired debt 11 500 12 229 Other 10 700 10 308 208 309 185 379 Total $1 476 483 $1 407 453\nCAPITALIZATION AND LIABILITIES Capitalization: Common stock, other paid-in capital, and retained earnings (Notes C and H) $ 495 693 $ 483 030 Preferred stock, not subject to mandatory redemption (Note H) 114 000 64 000 Long-term debt (Note I) 470 131 460 129 1 079 824 1 007 159 Current Liabilities: Short-term debt (Note J) 36 570 63 100 Notes payable to affiliates (Note J) 2 900 Accounts payable 31 871 31 752 Accounts payable to affiliates 6 021 8 184 Taxes accrued: Federal and state income 118 Other 20 193 21 261 Interest accrued 10 927 10 641 Other 16 455 18 994 125 055 153 932 Deferred Credits and Other Liabilities: Unamortized investment credit 24 734 26 883 Deferred income taxes 216 264 192 466 Regulatory liabilities (Note B) 19 974 19 179 Other 10 632 7 834 271 604 246 362 Commitments and Contingencies (Note K) Total $1 476 483 $1 407 453 See accompanying notes to financial statements.\nNOTES TO FINANCIAL STATEMENTS (These notes are an integral part of the financial statements.)\nNote A-Summary of Significant Accounting Policies: The Company is a wholly-owned subsidiary of Allegheny Power System, Inc. and is a part of the Allegheny Power integrated electric utility system (the System). The Company is subject to regulation by the Securities and Exchange Commission (SEC), by various state bodies having jurisdiction, and by the Federal Energy Regulatory Commission (FERC). Significant accounting policies of the Company are summarized below.\nREVENUES: Revenues, including amounts resulting from the application of fuel and energy cost adjustment clauses, are recognized in the same period in which the related electric services are provided to customers by recording an estimate for unbilled revenues for services provided from the meter reading date to the end of the accounting period. This procedure has been utilized for a number of years in West Virginia, as required by the Public Service Commission of West Virginia, and was adopted for all revenues beginning in 1994.\nDEFERRED POWER COSTS, NET: The costs of fuel, purchased power, and certain other costs, and revenues from sales and transmission services to other utilities, are deferred until they are either recovered from or credited to customers under fuel and energy cost recovery procedures.\nPROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment, including facilities owned with affiliates in the System, are stated at original cost, less contributions in aid of construction, except for capital leases which are recorded at present value. Cost includes direct labor and material, allowance for funds used during construction (AFUDC) on property for which construction work in progress is not included in rate base, and such indirect costs as administration, maintenance, and depreciation of transportation and construction equipment, and pensions, taxes, and other fringe benefits related to employees engaged in construction. The cost of depreciable property units retired, plus removal costs less salvage, are charged to accumulated depreciation.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION: AFUDC, an item that does not represent current cash income, is defined in applicable regulatory systems of accounts as including \"the net cost for the period of construction of borrowed funds used for construction purposes and a reasonable rate on other\nfunds when so used\". AFUDC is recognized as a cost of property, plant, and equipment with offsetting credits to other income and interest charges. Rates used for computing AFUDC in 1994, 1993, and 1992 were 8.16%, 8.69%, and 8.23%, respectively. AFUDC is not included in the cost of such construction when the cost of financing the construction is being recovered through rates.\nDEPRECIATION AND MAINTENANCE: Provisions for depreciation are determined generally on a straight-line method based on estimated service lives of depreciable properties and amounted to approximately 3.6% of average depreciable property in 1994 and 3.8% in each of the years 1993 and 1992. The cost of maintenance and of certain replacements of property, plant, and equipment is charged principally to operating expenses.\nINCOME TAXES: The Company joins with its parent and affiliates in filing a consolidated federal income tax return. The consolidated tax liability is allocated among the participants generally in proportion to the taxable income of each participant, except that no subsidiary pays tax in excess of its separate return tax liability. Financial accounting income before income taxes differs from taxable income principally because certain income and deductions for tax purposes are recorded in the financial income statement in another period. Differences between income tax expense computed on the basis of financial accounting income and taxes payable based on taxable income are accounted for substantially in accordance with the accounting procedures followed for ratemaking purposes. Deferred tax assets and liabilities recorded in accordance with the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", represent the tax effect of temporary differences between the financial statement and tax basis of assets and liabilities computed utilizing the most current tax rates. Provisions for federal income tax were reduced in previous years by investment credits, and amounts equivalent to such credits were charged to income with concurrent credits to a deferred account, balances of which are being amortized over estimated service lives of the related properties.\nPOSTRETIREMENT BENEFITS: The Company participates with affiliated companies in the System in a noncontributory, defined benefit pension plan covering substantially all employees, including officers. Benefits are based on the employee's years of service and compensation. The funding policy is to contribute annually at least the minimum amount required under the Employee Retirement Income Security Act and not more than can be deducted for federal income tax purposes.\nThe Company also provides partially contributory medical and life insurance plans for eligible retirees and dependents. Medical benefits, which comprise the largest component of the plans, are based upon an age and years-of-service vesting schedule and other plan provisions. The funding plan for these costs is to contribute to Voluntary Employee Beneficiary Association (VEBA) trust funds an amount equal to the annual cost as determined by SFAS No. 106 (described below). Medical benefits are self-insured; the life insurance plan is paid through insurance premiums. The FASB has prescribed the determination of annual pension and other postretirement benefits expenses in SFAS No. 87, \"Employers' Accounting for Pensions\", and SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", respectively. The Company records annual pension expense in accordance with SFAS No. 87. Prior to 1994, regulatory deferrals of these benefit expenses were recorded pursuant to SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation\", for West Virginia and Ohio jurisdictions. These jurisdictions reflected as net expense the funding of pensions and cash payments of other benefits in the ratemaking process. Regulatory deferrals of SFAS No. 106 benefits expenses were recorded for Ohio and West Virginia jurisdictions in which SFAS No. 106 costs were not yet included in rates.\nACCOUNTING CHANGES: Effective January 1, 1994, the Company changed its revenue recognition method for revenues to include the accrual of estimated unbilled revenues for electric services. This change results in a better matching of revenues and expenses, and is consistent with predominant utility industry practice and the practice used in West Virginia for a number of years. The cumulative effect of this accounting change for the years prior to the adoption of this practice, including West Virginia, is shown separately in the statement of income for 1994, and resulted in a benefit of $7.9 million (after related income taxes of $5.4 million). The effect of the change on the current year's income before the cumulative effect of accounting change, as well as on 1993 and 1992 net income, is not material. Effective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". Prior to 1993, medical expenses and life insurance premiums paid for retired employees and their dependents were recorded as expense in the period they were paid. Also effective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\". This standard mandated a change from the previous income-based deferral approach to a balance sheet-based liability approach for computing deferred income taxes.\nNote B-Income Taxes: Details of federal and state income tax provisions are: 1994 1993 1992 (Thousands of Dollars)\nIncome taxes-current: Federal $27 793 $25 618 $20 365 State 4 841 1 692 830 Total 32 634 27 310 21 195 Income taxes-deferred, net of amortization 5 499 8 517 9 364 Investment credit disallowed (207) Amortization of deferred investment credit (2 149) (2 165) (2 175) Total income taxes 35 984 33 662 28 177 Income taxes-credited (charged) to other income 63 (50) (258) Income taxes-charged to accounting change (including state income taxes) (5 335) Income taxes-charged to operating income $30 712 $33 612 $27 919\nThe total provision for income taxes is different than the amount produced by applying the federal income statutory tax rate to financial accounting income as set forth below:\n1994 1993 1992 (Thousands of Dollars) Financial accounting income before cumulative effect of accounting change and income taxes $90 648 $95 310 $86 263 Amount so produced $31 700 $33 400 $29 300 Increased (decreased) for: Tax deductions for which deferred tax was not provided: Lower tax depreciation 5 400 5 700 4 900 Plant removal costs (2 100) (3 000) (2 600) State income tax, net of federal income tax benefit 3 500 3 800 3 800 Amortization of deferred investment credit (2 149) (2 165) (2 175) Equity in earnings of subsidiaries (2 800) (2 500) (2 800) Adjustments of provisions for prior years (1 900) 400 (100) Other, net (939) (2 023) (2 406) Total $30 712 $33 612 $27 919\nFederal income tax returns through 1991 have been examined and substantially settled.\nIn adopting SFAS No. 109, the Company recognized a significant increase in both deferred tax assets and liabilities. At December 31, the deferred tax assets and liabilities were comprised of the following:\nIt is expected that regulatory commissions will allow recovery of the deferred tax liabilities in future years as they are paid, and accordingly, the Company has recorded regulatory assets of $174 million which offset the increase in deferred tax liabilities. Regulatory liabilities of $20 million have been recorded which offset the increase in deferred tax assets in order to reflect the Company's obligation to pass such tax benefits on to its customers as the benefits are realized in cash in future years.\nNote C-Dividend Restriction: Supplemental indentures relating to most outstanding bonds of the Company contain dividend restrictions under the most restrictive of which $103,482,000 of retained earnings at December 31, 1994, is not available for cash dividends on common stock, except that a portion thereof may be paid as cash dividends where concurrently an equivalent amount of cash is received by the Company as a capital contribution or as the proceeds of the issue and sale of shares of its common stock.\nNote D-Allegheny Generating Company: The Company owns 27% of the common stock of Allegheny Generating Company (AGC), and affiliates of the Company own the remainder. AGC owns an undivided 40% interest, 840 MW, in the 2,100-MW pumped-storage hydroelectric station in Bath County, Virginia operated by the 60% owner, Virginia Power Company, a nonaffiliated utility. AGC recovers from the Company and its affiliates all of its operation and maintenance expenses, depreciation, taxes, and a return on its investment under a wholesale rate schedule approved by the FERC. Through February 29, 1992, AGC's return on equity (ROE) was adjusted annually pursuant to a settlement agreement approved by the FERC.\nIn December 1991, AGC filed for a continuation of the existing ROE of 11.53% and other parties (the Consumer Advocate Division of the West Virginia PSC, Maryland People's Counsel, and Pennsylvania Office of Consumer Advocate, collectively referred to as the joint consumer advocates or JCA) filed to reduce the ROE to 10%. Hearings were completed in June 1992, and a recommendation was issued by an Administrative Law Judge (ALJ) on December 21, 1993, for an ROE of 10.83%, which the JCA argues should be further adjusted to reflect changes in capital market conditions since the hearings. Exceptions to this recommendation were filed by all parties for consideration by the FERC. On January 28, 1994, the JCA filed a joint complaint with the FERC against AGC claiming that both the existing ROE of 11.53% and the ROE recommended by the ALJ of 10.83% were unjust and unreasonable. This new complaint requested an ROE of 8.53% with rates subject to refund beginning April 1, 1994. Hearings were completed in November 1994 and a recommendation was issued by an ALJ on December 22, 1994, dismissing the JCA's complaint. A settlement agreement for both cases is currently pending, which would reduce AGC's ROE to 11.13% for the period from March 1, 1992, through December 31, 1994, and increase AGC's ROE to 11.20% for the period from January 1, 1995, through December 31, 1995. Following is a summary of financial information for AGC:\nResults for 1994 reflect the effect of the pending settlement agreement. The Company's share of the equity in earnings above was $8.0 million, $7.3 million, and $8.3 million for 1994, 1993, and 1992, respectively, and is included in other income, net, on the Statement of Income.\nNote E-Pension Benefits: The Company's share of net pension costs under the System's pension plan, a portion of which (about 25% to 30%) was charged to plant construction, included the following components:\nThe benefits earned to date and funded status of the Company's share of the System plan at December 31 using a measurement date of September 30 were as follows:\n1994 1993 (Thousands of Dollars) Actuarial present value of accumulated benefit obligation earned to date (including vested benefit of $92,823,000 and $91,750,000) $ 99 605 $ 98 898 Funded status: Actuarial present value of projected benefit obligation $123 935 $128 201 Plan assets at market value, primarily common stocks and fixed income securities 134 166 141 195 Plan assets in excess of projected benefit obligation (10 231) (12 994) Add: Unrecognized cumulative net gain from past experience different from that assumed 13 969 15 187 Unamortized transition asset, being amortized over 14 years beginning January 1, 1987 3 988 4 711 Less unrecognized prior service cost due to plan amendments 2 471 2 891 Pension cost liability at September 30 5 255 4 013 Fourth quarter contributions 1 829 - Pension liability at December 31 $3 426 $4 013\nThe foregoing includes the Company's portion of amounts applicable to employees at power stations which are owned jointly with affiliates. In determining the actuarial present value of the projected benefit obligation at September 30, 1994, 1993, and 1992, the discount rates used were 7.75%, 7.25%, and 7.75%, and the rates of increase in future compensation levels were 4.75%, 4.75%, and 5.25%, respectively. The expected long-term rate of return on assets was 9% in each of the years 1994, 1993, and 1992.\nNote F-Postretirement Benefits Other Than Pensions: The Company adopted SFAS No. 106 as of January 1, 1993, which requires accrual of postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents during the years the employees render the necessary service to receive such benefits. Prior to 1993, medical expenses and life insurance premiums paid by the Company for retired employees and their dependents were recorded in expense in the period in which they were paid ($2,390,000 in 1992). SFAS No. 106 postretirement cost in 1994 and 1993, a portion of which (about 25% to 30%) was charged to plant construction, included the following components:\n1994 1993 (Thousands of Dollars) Service cost - benefits earned $ 764 $ 478 Interest cost on accumulated postretirement benefit obligation 3 655 2 819 Actual loss (return) on plan assets 38 (5) Amortization of unrecognized transition obligation 1 783 1 772 Other net amortization and deferral 50 5 SFAS No. 106 postretirement cost 6 290 5 069 Regulatory deferral (3 450) (1 981) Net postretirement cost $2 840 $3 088\nThe benefits earned to date and funded status of the Company's share of the System plan at December 31 using a measurement date of September 30 were as follows:\n1994 1993 (Thousands of Dollars) Accumulated postretirement benefit obligation: Retirees $33 528 $32 469 Fully eligible employees 4 947 4 348 Other employees 14 458 14 664 Total obligation 52 933 51 481 Plan assets at market value 5 338 1 230 Accumulated postretirement benefit obligation in excess of plan assets 47 595 50 251 Less: Unrecognized cumulative net loss from past experience different from that assumed 12 752 14 161 Unrecognized transition obligation, being amortized over 20 years beginning January 1, 1993 32 368 34 059 Postretirement benefit liability at September 30 2 475 2 031 Fourth quarter contributions and benefit payments 1 437 997 Postretirement benefit liability at December 31 $1 038 $1 034\nThe plan assets at market value are comprised of fixed income securities, common stocks, and a short-term investment fund in 1994; and a short-term investment fund in 1993. The unfunded accumulated postretirement benefit obligation (APBO) at January 1, 1993, of $35,800,000 (transition obligation), is being amortized prospectively over 20 years as permitted by SFAS No. 106. In determining the APBO at September 30, 1994, 1993, and 1992, the discount rates used were 7.75%, 7.25%, and 8%, and the rates of increase in future compensation levels were 4.75%, 4.75%, and 5.5%, respectively. The 1994 expected long-term rate of return on assets was 8.25% net of tax. For measurement purposes, a health care trend rate of 9% for 1995, declining 1% each year thereafter to 6.75% in the year 1998 and beyond, and plan provisions which limit future medical and life insurance benefits, were assumed. Increasing the assumed health care trend rate by 1% in each year would increase the APBO at December 31, 1994, by $3.6 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1994 by $.3 million.\nNote G-Fair Value of Financial Instruments: The carrying amounts and estimated fair value of financial instruments at December 31, 1994 and 1993 were as follows:\nThe carrying amount of short-term debt approximates the fair value because of the short maturity of those instruments. The fair value of long-term debt was estimated based on actual market prices or market prices of similar issues. The Company does not have any financial instruments held or issued for trading purposes. For purposes of the statement of cash flows, temporary cash investments with original maturities of three months or less, generally in the form of commercial paper, certificates of deposit, and repurchase agreements, are considered to be the equivalent of cash.\nNote H-Stockholders' Equity: COMMON STOCK AND OTHER PAID-IN CAPITAL: In September 1992, the Company issued and sold to its parent, 800,000 shares of its common stock at $50 per share. Other paid-in capital decreased $477,000 in 1994 as a result of underwriting fees and commissions associated with the Company's\nsale of $50 million of preferred stock. Other paid-in capital decreased $4,000 in 1992 as a result of a preferred stock redemption. PREFERRED STOCK: In May 1994, the Company issued 500,000 shares of Series L, $7.73 cumulative preferred stock with par value of $100 per share. This Series is not redeemable prior to August 1, 2004. All of the preferred stock is entitled on voluntary liquidation to its then current call price and on involuntary liquidation to $100 a share.\nNote I-Long-Term Debt: Maturities for long-term debt for the next five years are: 1995, none; 1996, $18,500,000; 1997, $15,500,000; 1998, $20,100,000; and 1999, $1,000,000. Substantially all of the properties of the Company are held subject to the lien securing its first mortgage bonds. Some properties are also subject to a second lien securing certain pollution control and solid waste disposal notes. Certain first mortgage bond series are not redeemable by certain refunding until dates established in the respective supplemental indentures.\nNote J-Short-Term Debt: To provide interim financing and support for outstanding commercial paper, the System companies have established lines of credit with several banks. The Company has SEC authorization for total short-term borrowings of $100 million including money pool borrowings described below. The Company has fee arrangements on all of its lines of credit and no compensating balance requirements. In addition to bank lines of credit, an internal money pool accommodates intercompany short-term borrowing needs, to the extent that certain of the companies have funds available. In January 1994, the Company and its affiliates jointly established an aggregate $300 million multi-year credit program which provides that the Company may borrow up to $81 million on a standby revolving credit basis. Short-term debt outstanding for 1994 and 1993 consisted of:\n1994 1993 (Thousands of Dollars) Balance at end of year: Commercial Paper $24,970-6.21% - Notes Payable to Banks 11,600-6.43% $63,100-3.45% Money Pool 2,900-5.49% - Average amount outstanding during the year: Commercial Paper 8,751-3.58% 3,467-3.19% Notes Payable to Banks 15,283-3.89% 10,627-3.20% Money Pool 11,363-4.51% 8,227-3.01%\nNote K-Commitments and Contingencies: CONSTRUCTION PROGRAM: The Company has entered into commitments for its construction program, for which expenditures are estimated to be $74 million for 1995 and $70 million for 1996. These estimates include expenditures for the program of complying with the Clean Air Act Amendments of 1990 (CAAA) as discussed below.\nENVIRONMENTAL MATTERS: System companies are subject to various laws, regulations, and uncertainties as to environmental matters. Compliance may require them to incur substantial additional costs to modify or replace existing and proposed equipment and facilities and may affect adversely the lead time, size, and siting of future generating stations, increase the complexity and cost of pollution control equipment, and otherwise add to the cost of future operations.\nConstruction estimates for 1995 and 1996 include $11 million and $2 million, respectively, for compliance with Phase I of the CAAA. Through 1998, annual construction expenditures, on average, are not expected to significantly exceed 1995 estimated levels. Construction expenditure levels in 1999 and beyond will depend upon the strategy eventually selected for complying with Phase II of the CAAA, as well as future generation requirements.\nLITIGATION AND OTHER: In the normal course of business, the Company becomes involved in various legal proceedings. The Company does not believe that the ultimate outcome of these proceedings will have a material effect on its financial position. The Company is guarantor as to 27% of a $50 million revolving credit agreement of AGC, which in 1994 was used by AGC solely as support for its indebtedness for commercial paper outstanding.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of The Potomac Edison Company\nIn our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of The Potomac Edison Company (a subsidiary of Allegheny Power System, Inc.) 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 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 A, B and F to the financial statements, the Company changed its method of accounting for revenue recognition in 1994 and for income taxes and postretirement benefits other than pensions in 1993.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 2, 1995\nBALANCE SHEET DECEMBER 31 1994 1993 (Thousands of Dollars)\nASSETS Property, Plant, and Equipment: At original cost, including $76,365,000 and $208,308,000 under construction $1 978 396 $1 857 961 Accumulated depreciation (673 853) (632 269) 1 304 543 1 225 692 Investments and Other Assets: Allegheny Generating Company - common stock at equity (Note D) 62 364 63 983 Other 938 819 63 302 64 802 Current Assets: Cash 2 196 1 489 Accounts receivable: Electric service, net of $1,177,000 and $1,207,000 uncollectible allowance (Note A) 68 714 44 575 Affiliated and other 2 403 6 383 Notes receivable from affiliates (Note J) 1 900 4 600 Materials and supplies at average cost: Operating and construction 27 800 26 153 Fuel 22 316 18 596 Prepaid taxes 13 168 12 523 Other 5 000 4 000 143 497 118 319 Deferred Charges: Regulatory assets (Note B) 88 758 76 962 Unamortized loss on reacquired debt 8 344 9 188 Other 21 091 24 800 118 193 110 950 Total $1 629 535 $1 519 763\nCAPITALIZATION AND LIABILITIES Capitalization: Common stock, other paid-in capital, and retained earnings (Notes C and H) $658 146 $626 467 Preferred stock (Note H) 61 578 62 778 Long-term debt (Note I) 604 749 517 910 1 324 473 1 207 155 Current Liabilities: Long-term debt and preferred stock due within one year (Notes H and I) 1 200 17 200 Accounts payable 37 126 41 986 Accounts payable to affiliates 10 485 15 606 Taxes accrued: Federal and state income 3 565 2 970 Other 11 874 13 552 Interest accrued 9 195 8 632 Other 17 399 22 445 90 844 122 391 Deferred Credits and Other Liabilities: Unamortized investment credit 28 041 30 308 Deferred income taxes 149 299 133 027 Regulatory liabilities (Note B) 16 957 18 490 Other 19 921 8 392 214 218 190 217 Commitments and Contingencies (Note K) Total $1 629 535 $1 519 763\nSee accompanying notes to financial statements.\nThe Potomac Edison Company\nNOTES TO FINANCIAL STATEMENTS (These notes are an integral part of the financial statements.)\nNote A Summary of Significant Accounting Policies: The Company is a wholly-owned subsidiary of Allegheny Power System, Inc. and is a part of the Allegheny Power integrated electric utility system (the System). The Company is subject to regulation by the Securities and Exchange Commission (SEC), by various state bodies having jurisdiction, and by the Federal Energy Regulatory Commission (FERC). Significant accounting policies of the Company are summarized below.\nREVENUES: Beginning in 1994, revenues, generally including amounts resulting from the application of fuel and energy cost adjustment clauses, are recognized in the same period in which the related electric services are provided to customers by recording an estimate for unbilled revenues for services provided from the meter reading date to the end of the accounting period. In 1993 and 1992, revenues were recorded for billings rendered to customers. Revenues of $68.0 million from one industrial customer, Eastalco Aluminum Company, were 9% of total electric operating revenues in 1994.\nDEFERRED POWER COSTS, NET: The costs of fuel, purchased power, and certain other costs, and revenues from sales and transmission services to other utilities, are deferred until they are either recovered from or credited to customers under fuel and energy cost recovery procedures.\nPROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment, including facilities owned with affiliates in the System, are stated at original cost, less contributions in aid of construction. Cost includes direct labor and material, allowance for funds used during construction (AFUDC) on property for which construction work in progress is not included in rate base, and such indirect costs as administration, maintenance, and depreciation of transportation and construction equipment, and pensions, taxes, and other fringe benefits related to employees engaged in construction. The cost of depreciable property units retired, plus removal costs less salvage, are charged to accumulated depreciation.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION: AFUDC, an item that does not represent current cash income, is defined in applicable regulatory systems of accounts as including \"the net cost for the period of construction of borrowed funds used for construction purposes and a reasonable rate on other funds when so used\". AFUDC is recognized as a cost of property, plant, and equipment with offsetting credits to other income and interest charges. Rates used for computing AFUDC in 1994, 1993,\nand 1992 were 9.73%, 9.97%, and 9.92%, respectively. AFUDC is not included in the cost of such construction when the cost of financing the construction is being recovered through rates. AFUDC is not recorded for construction applicable to the state of Virginia, where construction work in progress is included in rate base.\nDEPRECIATION AND MAINTENANCE: Provisions for depreciation are determined generally on a straight-line method based on estimated service lives of depreciable properties and amounted to approximately 3.4% of average depreciable property in 1994 and 3.6% in each of the years 1993 and 1992. The cost of maintenance and of certain replacements of property, plant, and equipment is charged principally to operating expenses.\nINCOME TAXES: The Company joins with its parent and affiliates in filing a consolidated federal income tax return. The consolidated tax liability is allocated among the participants generally in proportion to the taxable income of each participant, except that no subsidiary pays tax in excess of its separate return tax liability. Financial accounting income before income taxes differs from taxable income principally because certain income and deductions for tax purposes are recorded in the financial income statement in another period. Differences between income tax expense computed on the basis of financial accounting income and taxes payable based on taxable income are accounted for substantially in accordance with the accounting procedures followed for ratemaking purposes. Deferred tax assets and liabilities recorded in accordance with the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", represent the tax effect of temporary differences between the financial statement and tax basis of assets and liabilities computed utilizing the most current tax rates. Provisions for federal income tax were reduced in previous years by investment credits, and amounts equivalent to such credits were charged to income with concurrent credits to a deferred account, balances of which are being amortized over estimated service lives of the related properties.\nPOSTRETIREMENT BENEFITS: The Company participates with affiliated companies in the System in a noncontributory, defined benefit pension plan covering substantially all employees, including officers. Benefits are based on the employee's years of service and compensation. The funding policy is to contribute annually at least the minimum amount required under the Employee Retirement Income Security Act and not more than can be deducted for federal income tax purposes.\nThe Company also provides partially contributory medical and life insurance plans for eligible retirees and dependents. Medical benefits, which comprise the largest component of the plans, are based upon an age and years-of-service vesting schedule and other plan provisions. The funding plan for these costs is to contribute to Voluntary Employee Beneficiary Association (VEBA) trust funds an amount equal to the annual cost as determined by SFAS No. 106 (described below). Medical benefits are self-insured; the life insurance plan is paid through insurance premiums. The FASB has prescribed the determination of annual pension and other postretirement benefits expenses in SFAS No. 87, \"Employers' Accounting for Pensions\", and SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", respectively. The Company records annual pension expense in accordance with SFAS No. 87. Prior to 1994, regulatory deferrals of these benefit expenses were recorded pursuant to SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation\", for West Virginia and Virginia jurisdictions. These jurisdictions reflected as net expense the funding of pensions and cash payments of other benefits in the ratemaking process. Regulatory deferrals of SFAS No. 106 benefits expenses were recorded for the West Virginia jurisdiction in which SFAS No. 106 costs were not yet included in rates.\nACCOUNTING CHANGES: Effective January 1, 1994, the Company changed its revenue recognition method to include the accrual of estimated unbilled revenues for electric services. This change results in a better matching of revenues and expenses, and is consistent with predominant utility industry practice. The cumulative effect of this accounting change for years prior to 1994, which is shown separately in the statement of income for 1994, resulted in a benefit of $16.5 million (after related income taxes of $9.7 million). The effect of the change on the current year's income before the cumulative effect of accounting change, as well as on 1993 and 1992 net income, is not material. Effective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". Prior to 1993, medical expenses and life insurance premiums paid for retired employees and their dependents were recorded as expense in the period they were paid. Also effective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\". This standard mandated a change from the previous income-based deferral approach to a balance sheet-based liability approach for computing deferred income taxes. Note B\nIncome Taxes: Details of federal and state income tax provisions are: 1994 1993 1992 (Thousands of Dollars) Income taxes-current: Federal $34 193 $29 758 $26 366 State (2 849) 3 991 (2 635) Total 31 344 33 749 23 731 Income taxes-deferred, net of amortization 14 955 (770) 7 634 Investment credit disallowed (196) Amortization of deferred investment credit (2 267) (2 349) (2 246) Total income taxes 44 032 30 630 28 923 Income taxes-charged to other income (1 176) (544) (501) Income taxes-charged to accounting change (including state income taxes) (9 693) Income taxes-charged to operating income $33 163 $30 086 $28 422\nThe total provision for income taxes is less than the amount produced by applying the federal income statutory tax rate to financial accounting income as set forth below:\n1994 1993 1992 (Thousands of Dollars)\nFinancial accounting income before cumulative effect of accounting change and income taxes $115 146 $103 553 $ 95 898 Amount so produced $ 40 300 $ 36 200 $ 32 600 Increased (decreased) for: Tax deductions for which deferred tax was not provided: Lower tax depreciation 100 2 300 2 300 Plant removal costs (1 700) (2 100) (1 500) State income tax, net of federal income tax benefit 1 300 1 600 1 200 Amortization of deferred investment credit (2 267) (2 349) (2 246) Equity in earnings of subsidiaries (2 900) (2 600) (2 900) Other, net (1 670) (2 965) (1 032) Total $33 163 $30 086 $28 422\nFederal income tax returns through 1991 have been examined and substantially settled.\nIn adopting SFAS No. 109, the Company recognized a significant increase in both deferred tax assets and liabilities. At December 31, the deferred tax assets and liabilities were comprised of the following: 1994 1993 (Thousands of Dollars)\nDeferred tax assets: Unamortized investment tax credit $16 497 $17 922 Unbilled revenue 3 504 12 556 Tax interest capitalized 12 701 9 056 Contributions in aid of construction 11 653 10 530 State tax loss carryback\/carryforward 2 721 5 770 Advances for construction 1 338 1 303 Other 5 800 3 279 54 214 60 416 Deferred tax liabilities: Book vs. tax plant basis differences, net 192 862 183 892 Other 13 367 10 122 206 229 194 014 Total net deferred tax liabilities 152 015 133 598 Less portion above included in current liabilities 2 716 571 Total long-term net deferred tax liabilities $149 299 $133 027\nIt is expected that regulatory commissions will allow recovery of the deferred tax liabilities in future years as they are paid, and accordingly, the Company has recorded regulatory assets of $76 million which offset the increase in deferred tax liabilities. Regulatory liabilities of $17 million have been recorded which offset the increase in deferred tax assets in order to reflect the Company's obligation to pass such tax benefits on to its customers as the benefits are realized in cash in future years.\nNote C-Dividend Restriction: Supplemental indentures relating to most outstanding bonds of the Company contain dividend restrictions under the most restrictive of which $103,730,000 of retained earnings at December 31, 1994, is not available for cash dividends on common stock, except that a portion thereof may be paid as cash dividends where concurrently an equivalent amount of cash is received by the Company as a capital contribution or as the proceeds of the issue and sale of shares of its common stock.\nNote D-Allegheny Generating Company: The Company owns 28% of the common stock of Allegheny Generating Company (AGC), and affiliates of the Company own the remainder. AGC owns an undivided 40% interest, 840 MW, in the 2,100-MW pumped-storage hydroelectric station in Bath County, Virginia operated by the 60% owner, Virginia Power Company, a nonaffiliated utility. AGC recovers from the Company and its affiliates all of its operation and maintenance expenses, depreciation, taxes, and a return on its investment under a wholesale rate schedule approved by the FERC. Through February 29, 1992, AGC's return on equity\n(ROE) was adjusted annually pursuant to a settlement agreement approved by the FERC. In December 1991, AGC filed for a continua- tion of the existing ROE of 11.53% and other parties (the Consumer Advocate Division of the West Virginia PSC, Maryland People's Counsel, and Pennsylvania Office of Consumer Advocate, collectively referred to as the joint consumer advocates or JCA) filed to reduce the ROE to 10%. Hearings were completed in June 1992, and a recommendation was issued by an Administrative Law Judge (ALJ) on December 21, 1993, for an ROE of 10.83%, which the JCA argues should be further adjusted to reflect changes in capital market conditions since the hearings. Exceptions to this recommendation were filed by all parties for consideration by the FERC. On January 28, 1994, the JCA filed a joint complaint with the FERC against AGC claiming that both the existing ROE of 11.53% and the ROE recommended by the ALJ of 10.83% were unjust and unreasonable. This new complaint requested an ROE of 8.53% with rates subject to refund beginning April 1, 1994. Hearings were completed in November 1994 and a recommendation was issued by an ALJ on December 22, 1994, dismissing the JCA's complaint. A settlement agreement for both cases is currently pending, which would reduce AGC's ROE to 11.13% for the period from March 1, 1992, through December 31, 1994, and increase AGC's ROE to 11.20% for the period from January 1, 1995, through December 31, 1995. Following is a summary of financial information for AGC:\nDecember 31 1994 1993 (Thousands of Dollars)\nBalance sheet information: Property, plant, and equipment $680 749 $696 529 Current assets 5 991 11 063 Deferred charges 27 496 28 337 Total assets $714 236 $735 929 Total capitalization $489 894 $505 708 Current liabilities 6 484 21 891 Deferred credits 217 858 208 330 Total capitalization and liabilities $714 236 $735 929\nYear Ended December 31 1994 1993 1992 (Thousands of Dollars)\nIncome statement information: Electric operating revenues $91 022 $90 606 $96 147 Operation and maintenance expense 6 695 6 609 6 094 Depreciation 16 852 16 899 16 827 Taxes other than income taxes 5 223 5 347 5 236 Federal income taxes 14 737 13 262 14 702 Interest charges 17 809 21 635 22 585 Other income, net (11) (328) (21) Net income $29 717 $27 182 $30 724\nResults for 1994 reflect the effect of the pending settlement agreement. The Company's share of the equity in earnings above was $8.3 million, $7.6 million, and $8.6 million for 1994, 1993, and 1992, respectively, and is included in other income, net, on the Statement of Income.\nNote E-Pension Benefits: The Company's share of net pension costs under the System's pension plan, a portion of which (about 30% to 35%) was charged to plant construction, included the following components:\nThe benefits earned to date and funded status of the Company's share of the System plan at December 31 using a measurement date of September 30 were as follows: 1994 1993 (Thousands of Dollars) Actuarial present value of accumulated benefit obligation earned to date (including vested benefit of $103,546,000 and $102,917,000) $110 577 $110 278 Funded status: Actuarial present value of projected benefit obligation $135 060 $139 320 Plan assets at market value, primarily common stocks and fixed income securities 146 211 153 440 Plan assets in excess of projected benefit obligation (11 151) (14 120) Add: Unrecognized cumulative net gain from past experience different from that assumed 13 165 14 927 Unamortized transition asset, being amortized over 14 years beginning January 1, 1987 4 183 4 951 Less unrecognized prior service cost due to plan amendments 2 732 3 218 Pension cost liability at September 30 3 465 2 540 Fourth quarter contributions 1 989 Pension liability at December 31 $1 476 $2 540\nThe foregoing includes the Company's portion of amounts applicable to employees at power stations which are owned jointly with affiliates. In determining the actuarial present value of the projected benefit obligation at September 30, 1994, 1993, and 1992, the discount rates used were 7.75%, 7.25%, and 7.75%, and the rates of increase in future compensation levels were 4.75%, 4.75%, and 5.25%, respectively. The expected long-term rate of return on assets was 9% in each of the years 1994, 1993, and 1992.\nNote F-Postretirement Benefits Other Than Pensions: The Company adopted SFAS No. 106 as of January 1, 1993, which requires accrual of postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents during the years the employees render the necessary service to receive such benefits. Prior to 1993, medical expenses and life insurance premiums paid by the Company for retired employees and their dependents were recorded in expense in the period in which they were paid ($1,790,000 in 1992). SFAS No. 106 postretirement cost in 1994 and 1993, a portion of which (about 30% to 35%) was charged to plant construction, included the following components: 1994 1993 (Thousands of Dollars)\nService cost-benefits earned $ 696 $ 383 Interest cost on accumulated postretirement benefit obligation 4 047 3 042 Actual loss (return) on plan assets 47 (7) Amortization of unrecognized transition obligation 1 976 1 986 Other net amortization and deferral 53 7 SFAS No. 106 postretirement cost 6 819 5 411 Regulatory deferral (457) (846) Net postretirement cost $6 362 $4 565\nThe benefits earned to date and funded status of the Company's share of the System plan at December 31 using a measurement date of September 30 were as follows: 1994 1993 (Thousands of Dollars) Accumulated postretirement benefit obligation: Retirees $36 927 $35 189 Fully eligible employees 8 152 7 741 Other employees 14 035 14 635 Total obligation 59 114 57 565 Plan assets at market value 5 962 1 375 Accumulated postretirement benefit obligation in excess of plan assets 53 152 56 190 Less: Unrecognized cumulative net loss from past experience different from that assumed 14 223 15 695 Unrecognized transition obligation, being amortized over 20 years beginning January 1, 1993 35 928 37 995 Postretirement benefit liability at September 30 3 001 2 500 Fourth quarter contributions and benefit payments 1 634 1 132 Postretirement benefit liability at December 31 $1 367 $1 368\nThe plan assets at market value are comprised of fixed income securities, common stocks, and a short-term investment fund in 1994; and a short-term investment fund in 1993. The unfunded accumulated postretirement benefit obligation (APBO) at January 1, 1993, of $40,000,000 (transition obligation) is being amortized prospectively over 20 years as permitted by SFAS No. 106. In determining the APBO at September 30, 1994, 1993, and 1992, the discount rates used were 7.75%, 7.25%, and 8%, and the rates of increase in future compensation levels were 4.75%, 4.75%, and 5.5%, respectively. The 1994 expected long-term rate of return on assets was 8.25% net of tax. For measurement purposes, a health care trend rate of 9% for 1995, declining 1% each year thereafter to 6.75% in the year 1998 and beyond, and plan provisions which limit future medical and life insurance benefits, were assumed. Increasing the assumed health care trend rate by 1% in each year would increase the APBO at December 31, 1994, by $4.1 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1994 by $.4 million.\nNote G-Fair Value of Financial Instruments: The carrying amounts and estimated fair value of financial instruments at December 31, 1994 and 1993 were as follows:\nThe fair value of mandatorily redeemable preferred stock was estimated based on quoted market prices. The fair value of long-term debt was estimated based on actual market prices or market prices of similar issues. The Company does not have any financial instruments held or issued for trading purposes. For purposes of the statement of cash flows, temporary cash investments with original maturities of three months or less, generally in the form of commercial paper, certificates of deposit, and repurchase agreements, are considered to be the equivalent of cash.\nNote H-Stockholders' Equity: COMMON STOCK AND OTHER PAID-IN CAPITAL: The Company issued and sold common stock to its parent, at $20 per share, 2,500,000 shares in October 1993 and 4,000,000 shares in September 1992. Other paid-in capital increased $10,000 in 1994 and decreased $2,000 in 1992 as a result of preferred stock transactions.\nPREFERRED STOCK: All of the preferred stock is entitled on voluntary liquidation to its then current call price and on involuntary liquidation to $100 a share.\nMANDATORILY REDEEMABLE PREFERRED STOCK: The Company's $7.16 preferred stock is entitled to a cumulative sinking fund sufficient to retire 12,000 shares each year at $100 a share plus accrued dividends. The Company has the noncumulative option in each year to retire up to an additional 12,000 shares at the same price. The call price declines in future years.\nNote I-Long-Term Debt: Maturities for long-term debt for the next five years are: 1995, none; 1996, $18,700,000; 1997, $800,000; 1998, $1,800,000; and 1999, $1,800,000. Substantially all of the properties of the Company are held subject to the lien securing its first mortgage bonds. Some properties are also subject to a second lien securing certain pollution control and solid waste disposal notes. Certain first mortgage bond series are not redeemable by certain refunding until dates established in the respective supplemental indentures.\nNote J-Short-Term Financing: To provide interim financing and support for outstanding commercial paper, the System companies have established lines of credit with several banks. The Company has SEC authorization for total short-term borrowings of $115 million, including money pool borrowings described below. The Company has fee arrangements on all of its lines of credit and no compensating balance requirements. In addition to bank lines of credit, an internal money pool accommodates intercompany short-term borrowing needs, to the extent that certain of the companies have funds available. In January 1994, the Company and its affiliates jointly established an aggregate $300 million multi-year credit program which provides that the Company may borrow up to $84 million on a standby revolving credit basis. There was no short-term debt outstanding at the end of 1994 or 1993. Average short-term debt outstanding during the year for 1994 and 1993 consisted of:\n1994 1993 (Thousands of Dollars) Average amount outstanding during the year: Commercial Paper $1,021-3.96% $ 36-2.97% Notes Payable to Banks 2,499-3.96% 1,112-3.24% Money Pool 87-4.10% -\nNote K-Commitments and Contingencies: CONSTRUCTION PROGRAM: The Company has entered into commitments for its construction program, for which expenditures are estimated to be $92 million for 1995 and $98 million for 1996. These estimates include expenditures for the program of complying with the Clean Air Act Amendments of 1990 (CAAA) as discussed below.\nENVIRONMENTAL MATTERS: System companies are subject to various laws, regulations, and uncertainties as to environmental matters. Compliance may require them to incur substantial additional costs to modify or replace existing and proposed equipment and facilities and may affect adversely the lead time, size, and siting of future generating stations, increase the complexity and cost of pollution control equipment, and otherwise add to the cost of future operations. Construction estimates for 1995 and 1996 include $12 million and $5 million, respectively, for compliance with Phase I of the CAAA. Through 1998, annual construction expenditures, on average, are not expected to significantly exceed 1995 estimated levels. Construction expenditure levels in 1999 and beyond will depend upon the strategy eventually selected for complying with Phase II of the CAAA, as well as future generation requirements.\nLITIGATION AND OTHER: In the normal course of business, the Company becomes involved in various legal proceedings. The Company does not believe that the ultimate outcome of these proceedings will have a material effect on its financial position. The Company is guarantor as to 28% of a $50 million revolving credit agreement of AGC, which in 1994 was used by AGC solely as support for its indebtedness for commercial paper outstanding.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of West Penn Power Company\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of West Penn Power Company (a subsidiary of Allegheny Power System, Inc.) 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 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 A, B and F to the consolidated financial statements, the Company changed its method of accounting for revenue recognition in 1994 and for income taxes and postretirement benefits other than pensions in 1993.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 2, 1995\nCONSOLIDATED STATEMENT OF INCOME YEAR ENDED DECEMBER 31 1994 1993 1992 (Thousands of Dollars)\nElectric Operating Revenues: Residential $ 376 776 $ 358 900 $ 321 871 Commercial 207 165 194 773 177 697 Industrial 330 739 309 847 293 910 Nonaffiliated utilities 144 829 152 541 204 743 Other, including affiliates 68 733 68 916 78 620 Total Operating Revenues 1 128 242 1 084 977 1 076 841 Operating Expenses: Operation: Fuel 252 108 256 664 268 395 Purchased power and exchanges, net 247 194 235 772 264 208 Deferred power costs, net (Note A) 2 880 979 (1 527) Other 145 781 131 854 116 913 Maintenance 111 841 96 706 93 067 Depreciation 88 935 80 872 73 469 Taxes other than income taxes 87 224 89 249 87 300 Federal and state income taxes (Note B) 50 385 51 529 44 078 Total Operating Expenses 986 348 943 625 945 903 Operating Income 141 894 141 352 130 938 Other Income and Deductions: Allowance for other than borrowed funds used during construction (Note A) 6 729 5 077 5 010 Asset write-off, net (Note A) (5 179) Other income, net 13 797 12 728 14 534 Total Other Income and Deductions 15 347 17 805 19 544 Income Before Interest Charges 157 241 159 157 150 482 Interest Charges: Interest on long-term debt 58 102 58 857 53 768 Other interest 2 172 1 728 1 824 Allowance for borrowed funds used during construction (Note A) (4 048) (3 489) (3 266) Total Interest Charges 56 226 157 096 52 326 Consolidated Income Before Cumulative Effect of Accounting Change 101 015 102 061 98 156 Cumulative Effect of Accounting Change, net (Note A) 19 031 Consolidated Net Income $120 046 $102 061 $ 98 156\nCONSOLIDATED STATEMENT OF RETAINED EARNINGS\nBalance at January 1 $412 288 $400 515 $392 331\nAdd: Consolidated net income 120 046 102 061 98 156 532 334 502 576 490 487 Deduct: Dividends on capital stock of the Company: Preferred stock 8 504 8 206 7 331 Common stock 90 029 82 082 82 641 Total Deductions 98 533 90 288 89 972 Balance at December 31 (Note C) $433 801 $412 288 $400 515\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31 1994 1993 1992 (Thousands of Dollars) Cash Flows from Operations: Consolidated net income $120 046 $102 061 $98 156 Depreciation 88 935 80 872 73 469 Deferred investment credit and income taxes, net 699 (10 115) 809 Deferred power costs, net 2 880 979 (1 527) Unconsolidated subsidiaries' dividends in excess of earnings 2 773 3 311 4 287 Allowance for other than borrowed funds used during construction (6 729) (5 077) (5 010) Cumulative effect of accounting change before income taxes (Note A) (32 891) Asset write-off before income taxes (Note A) 8 919\nChanges in certain current assets and liabilities: Accounts receivable, net, excluding cumulative effect of accounting change (Note A) 18 951 (5 947) 8 799 Materials and supplies (9 205) 26 889 (15 593) Accounts payable (675) 3 196 3 877 Taxes accrued (4 502) 9 198 1 875 Interest accrued 2 620 (5 146) 3 534 Other, net 16 100 8 878 (8 989) 207 921 209 099 163 687\nCash Flows from Investing: Construction expenditures (260 366) (251 017) (204 409) Allowance for other than borrowed funds used during construction 6 729 5 077 5 010 (253 637) (245 940) (199 399)\nCash Flows from Financing: Sale of common stock 40 000 100 000 Sale of preferred stock 39 450 Issuance of long-term debt 80 129 268 766 181 843 Retirement of long-term debt (251 414) (158 500) Deposit with trustee for redemption of long-term debt 68 354 Notes receivable from affiliates 23 900 (4 000) (20 900)\nDividends on capital stock: Preferred stock (8 504) (8 206) (7 331) Common stock (90 029) (82 082) (82 641) 45 496 23 064 20 275 Net Change in Cash and Temporary Cash Investments (Note G) (220) (13 777) (15 437) Cash and Temporary Cash Investments at January 1 565 14 342 29 779 Cash and Temporary Cash Investments at December 31 $ 345 $ 565 $ 14 342\nSupplemental cash flow information Cash paid during the year for: Interest (net of amount capitalized) $ 51 745 $ 61 329 $ 48 135 Income taxes 54 958 55 111 45 868\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEET\nDECEMBER 31 1994 1993 (Thousands of Dollars)\nASSETS Property, Plant, and Equipment: At original cost, including $103,514,000 and $283,779,000 under construction $3 013 777 $2 803 811 Accumulated depreciation (1 009 565) (962 623) 2 004 212 1 841 188 Investments and Other Assets: Allegheny Generating Company-common stock at equity (Note D) 100 228 102 830 Other 1 474 1 537 101 702 104 367\nCurrent Assets: Cash and temporary cash investments (Note G) 345 565\nAccounts receivable: Electric service, net of $8,267,000 and $1,126,000 uncollectible allowance (Note A) 119 020 94 570 Affiliated and other 11 862 22 372 Notes receivable from affiliates (Note J) 1 000 24 900\nMaterials and supplies-at average cost: Operating and construction 39 922 36 030 Fuel 38 205 32 892 Deferred income taxes 12 538 1 974 Prepaid and other 12 525 15 980 235 417 229 283\nDeferred Charges: Regulatory assets (Note B) 364 473 331 755 Unamortized loss on reacquired debt 10 494 11 645 Other 15 560 26 525 390 527 369 925 Total $2 731 858 $2 544 763\nCAPITALIZATION AND LIABILITIES Capitalization: Common stock, other paid-in capital, and retained earnings (Notes C and H) $ 955 482 $ 893 969 Preferred stock, not subject to mandatory redemption (Note H) 149 708 149 708 Long-term debt (Note I) 836 426 782 369 1 941 616 1 826 046\nCurrent Liabilities: Long-term debt due within one year (Note I) 27 000 Accounts payable 107 792 105 493 Accounts payable to affiliates 6 477 9 451\nTaxes accrued: Federal and state income 9 217 11 533 Other 20 637 22 823 Interest accrued 16 475 13 855 Other 24 028 20 954 211 626 184 109\nDeferred Credits and Other Liabilities: Unamortized investment credit 52 946 55 524 Deferred income taxes 471 515 424 000 Regulatory liabilities (Note B) 39 881 40 834 Other 14 274 14 250 578 616 534 608 Commitments and Contingencies (Note K) Total $2 731 858 $2 544 763\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (These notes are an integral part of the consolidated financial statements.)\nNote A-Summary of Significant Accounting Policies: The Company is a wholly-owned subsidiary of Allegheny Power System, Inc. and is a part of the Allegheny Power integrated electric utility system (the System). The Company is subject to regulation by the Securities and Exchange Commission (SEC), by various state bodies having jurisdiction, and by the Federal Energy Regulatory Commission (FERC). Significant accounting policies of the Company are summarized below.\nCONSOLIDATION: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries (the companies).\nREVENUES: Beginning in 1994, revenues, including amounts resulting from the application of fuel and energy cost adjustment clauses, are recognized in the same period in which the related electric services are provided to customers by recording an estimate for unbilled revenues for services provided from the meter reading date to the end of the accounting period. In 1993 and 1992, revenues were recorded for billings rendered to customers.\nDEFERRED POWER COSTS, NET: The costs of fuel, purchased power, and certain other costs, and revenues from sales and transmission services to other utilities, are deferred until they are either recovered from or credited to customers under fuel and energy cost recovery procedures.\nPROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment, including facilities owned with affiliates in the System, are stated at original cost, less contributions in aid of construction, except for capital leases which are recorded at present value. Cost includes direct labor and material, allowance for funds used during construction (AFUDC) on property for which construction work in progress is not included in rate base, and such indirect costs as administration, maintenance, and depreciation of transportation and construction equipment, and pensions, taxes, and other fringe benefits related to employees engaged in construction. The cost of depreciable property units retired, plus removal costs less salvage, are charged to accumulated depreciation.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION: AFUDC, an item that does not represent current cash income, is defined in applicable regulatory systems of accounts as including \"the net cost for the period of construction of borrowed funds\nused for construction purposes and a reasonable rate on other funds when so used\". AFUDC is recognized as a cost of property, plant, and equipment with offsetting credits to other income and interest charges. Rates used for computing AFUDC in 1994, 1993, and 1992 were 8.88%, 9.40%, and 9.25%, respectively. AFUDC is not included in the cost of such construction when the cost of financing the construction is being recovered through rates.\nDEPRECIATION AND MAINTENANCE: Provisions for depreciation are determined generally on a straight-line method based on estimated service lives of depreciable properties and amounted to approximately 3.5%, 3.4%, and 3.3% of average depreciable property in 1994, 1993, and 1992, respectively. The cost of maintenance and of certain replacements of property, plant, and equipment is charged principally to operating expenses.\nINCOME TAXES: The companies join with the parent and affiliates in filing a consolidated federal income tax return. The consolidated tax liability is allocated among the participants generally in proportion to the taxable income of each participant, except that no subsidiary pays tax in excess of its separate return tax liability. Financial accounting income before income taxes differs from taxable income principally because certain income and deductions for tax purposes are recorded in the financial income statement in another period. Differences between income tax expense computed on the basis of financial accounting income and taxes payable based on taxable income are accounted for substantially in accordance with the accounting procedures followed for ratemaking purposes. Deferred tax assets and liabilities recorded in accordance with the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", represent the tax effect of temporary differences between the financial statement and tax basis of assets and liabilities computed utilizing the most current tax rates. Provisions for federal income tax were reduced in previous years by investment credits, and amounts equivalent to such credits were charged to income with concurrent credits to a deferred account, balances of which are being amortized over estimated service lives of the related properties.\nPOSTRETIREMENT BENEFITS: The Company participates with affiliated companies in the System in a noncontributory, defined benefit pension plan covering substantially all employees, including officers. Benefits are based on the employee's years of service and compensation. The funding policy is to contribute annually at least the minimum amount required under the Employee Retirement Income Security Act and not more than can be deducted for federal income tax purposes.\nThe Company also provides partially contributory medical and life insurance plans for eligible\nretirees and dependents. Medical benefits, which comprise the largest component of the plans, are based upon an age and years-of-service vesting schedule and other plan provisions. The funding plan for these costs is to contribute to Voluntary Employee Beneficiary Association (VEBA) trust funds an amount equal to the annual cost as determined by SFAS No. 106 (described below). Medical benefits are self-insured; the life insurance plan is paid through insurance premiums.\nThe FASB has prescribed the determination of annual pension and other postretirement benefits expenses in SFAS No. 87, \"Employers' Accounting for Pensions\", and SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", respectively. The Company records annual pension expense in accordance with SFAS No. 87. Prior to 1994, regulatory deferrals of these benefit expenses were recorded pursuant to SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation\", for its Pennsylvania jurisdiction which reflected as net expense the funding of pensions and cash payments of other benefits in the ratemaking process.\nASSET WRITE-OFF: In 1994, the Company wroteoff $8.9 million ($5.2 million net of income taxes) of previously accumulated costs related to a potential future power plant site and a proposed transmission line. In the industry's more competitive environment, it is no longer reasonable to assume future recovery of these costs in rates.\nACCOUNTING CHANGES: Effective January 1, 1994, the Company changed its revenue recognition method to include the accrual of estimated unbilled revenues for electric services. This change results in a better matching of revenues and expenses, and is consistent with predominant utility industry practice. The cumulative effect of this accounting change for years prior to 1994, which is shown separately in the consolidated statement of income for 1994, resulted in a benefit of $19.0 million (after related income taxes of $13.9 million). The effect of the change on the current year's consolidated income before the cumulative effect of accounting change, as well as on 1993 and 1992 consolidated net income, is not material. Effective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". Prior to 1993, medical expenses and life insurance premiums paid for retired employees and their dependents were recorded as expense in the period they were paid. Also effective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\". This standard mandated a change from the previous income-based deferral approach to a balance sheet-based liability approach for computing deferred income taxes.\nIn adopting SFAS No. 109, the Company recognized a significant increase in both deferred tax assets and liabilities. At December 31, the deferred tax assets and liabilities were comprised of the following:\n1994 1993 (Thousands of Dollars) Deferred tax assets: Unamortized investment tax credit $ 38 560 $ 40 455 Unbilled revenue 9 539 21 626 Tax interest capitalized 16 165 10 750 State tax loss carryback\/carryforward 5 535 8 790 Contributions in aid of construction 4 866 4 588 Other 18 905 7 416 93 570 93 625\nDeferred tax liabilities: Book vs. tax plant basis differences, net 536 343 507 214 Other 16 204 8 437 552 547 515 651 Total net deferred tax liabilities 458 977 422 026 Add portion above included in current assets 12 538 1 974 Total long-term net deferred tax liabilities $471 515 $424 000\nIt is expected that regulatory commissions will allow recovery of the deferred tax liabilities in future years as they are paid, and accordingly, the Company has recorded regulatory assets of $351 million which offset the increase in deferred tax liabilities. Regulatory liabilities of $39 million have been recorded which offset the increase in deferred tax assets in order to reflect the Company's obligation to pass such tax benefits on to its customers as the benefits are realized in cash in future years.\nNote C-Dividend Restriction: Supplemental indentures relating to most outstanding bonds of the Company contain dividend restrictions under the most restrictive of which $285,914,000 of consolidated retained earnings at December 31, 1994, is not available for cash dividends on common stock, except that a portion thereof may be paid as cash dividends where concurrently an equivalent amount of cash is received by the Company as a capital contribution or as the proceeds of the issue and sale of shares of its common stock.\nNote D-Allegheny Generating Company: The Company owns 45% of the common stock of Allegheny Generating Company (AGC), and affiliates of the Company own the remainder. AGC owns an undivided 40% interest, 840 MW, in the 2,100-MW pumped-storage hydroelectric station in Bath County, Virginia, operated by the 60% owner, Virginia Power Company, a nonaffiliated utility. AGC recovers from the Company and its affiliates all of its operation and maintenance expenses, depreciation, taxes, and a return on its investment under a wholesale rate schedule approved by the FERC. Through February 29, 1992, AGC's return on equity\n(ROE) was adjusted annually pursuant to a settlement agreement approved by the FERC. In December 1991, AGC filed for a continuation of the existing ROE of 11.53% and other parties (the Consumer Advocate Division of the Public Service Commission of West Virginia, Maryland People's Counsel, and Pennsylvania Office of Consumer Advocate, collectively referred to as the joint consumer advocates or JCA) filed to reduce the ROE to 10%. Hearings were completed in June 1992, and a recommendation was issued by an Administrative Law Judge (ALJ) on December 21, 1993, for an ROE of 10.83%, which the JCA argues should be further adjusted to reflect changes in capital market conditions since the hearings. Exceptions to this recommendation were filed by all parties for consideration by the FERC. On January 28, 1994, the JCA filed a joint complaint with the FERC against AGC claiming that both the existing ROE of 11.53% and the ROE recommended by the ALJ of 10.83% were unjust and unreasonable. This new complaint requested an ROE of 8.53% with rates subject to refund beginning April 1, 1994. Hearings were completed in November 1994 and a recommendation was issued by an ALJ on December 22, 1994, dismissing the JCA's complaint. A settlement agreement for both cases is currently pending, which would reduce AGC's ROE to 11.13% for the period from March 1, 1992, through December 31, 1994, and increase AGC's ROE to 11.20% for the period from January 1, 1995, through December 31, 1995.\nFollowing is a summary of financial information for AGC:\nDecember 31 1994 1993 (Thousands of Dollars) Balance sheet information: Property, plant, and equipment $680 749 $696 529 Current assets 5 991 11 063 Deferred charges 27 496 28 337 Total assets $714 236 $735 929 Total capitalization $489 894 $505 708 Current liabilities 6 484 21 891 Deferred credits 217 858 208 330 Total capitalization and liabilities $714 236 $735 929\nResults for 1994 reflect the effect of the pending settlement agreement. The Company's share of the equity in earnings above was $13.4 million, $12.2 million, and $13.8 million for 1994, 1993, and 1992, respectively, and is included in other income, net, on the Consolidated Statement of Income.\nNote E-Pension Benefits: The Company's share of net pension costs under the System's pension plan, a portion of which (about 25% to 30%) was charged to plant construction, included the following components:\nRegulatory deferrals amounting to $3,039,000 will be amortized to operating expenses over the four-year period 1995 through 1998 in accordance with authorized rate recovery. An additional $833,000 regulatory deferral was charged to plant construction in 1994. The benefits earned to date and funded status of the Company's share of the System plan at December 31 using a measurement date of September 30 were as follows:\n1994 1993 (Thousands of Dollars) Actuarial present value of accumulated benefit obligation earned to date (including vested benefit of $150,168,000 and $151,394,000) $158 578 $160 097\nFunded status: Actuarial present value of projected benefit obligation $191 787 $199 414 Plan assets at market value, primarily common stocks and fixed income securities 207 623 219 625 Plan assets in excess of projected benefit obligation (15 836) (20 211)\nAdd: Unrecognized cumulative net gain from past experience different from that assumed 15 103 17 586 Unamortized transition asset, being amortized over 14 years beginning January 1, 1987 8 427 9 678 Less unrecognized prior service cost due to plan amendments 4 999 5 678 Pension cost liability at September 30 2 695 1 375 Fourth quarter contributions 2 843 - Pension (prepayment) liability at December 31 $ (148) $ 1 375\nThe foregoing includes the Company's portion of amounts applicable to employees at power stations which are owned jointly with affiliates. In determining the actuarial present value of the projected benefit obligation at September 30, 1994, 1993, and 1992, the discount rates used were 7.75%, 7.25%, and 7.75%, and the rates of increase in future compensation levels were 4.75%, 4.75%, and\n5.25%, respectively. The expected long-term rate of return on assets was 9% in each of the years 1994, 1993, and 1992.\nNote F-Postretirement Benefits Other Than Pensions: The Company adopted SFAS No. 106 as of January 1, 1993, which requires accrual of postretirement benefits other than pensions (principally health care and life insurance) for employees and covered dependents during the years the employees render the necessary service to receive such benefits. Prior to 1993, medical expenses and life insurance premiums paid by the Company for retired employees and their dependents were recorded in expense in the period in which they were paid ($1,907,000 in 1992). SFAS No. 106 postretirement cost in 1994 and 1993, a portion of which (about 25% to 30%) was charged to plant construction, included the following components:\n1994 1993 (Thousands of Dollars) Service cost - benefits earned $1 154 $ 939 Interest cost on accumulated postretirement benefit obligation 4 461 4 389 Actual loss (return) on plan assets 31 (9) Amortization of unrecognized transition obligation 2 817 2 817 Other net amortization and deferral 83 9 SFAS No. 106 postretirement cost 8 546 8 145 Regulatory deferral - (1 963) Net postretirement cost $8 546 $6 182\nThe benefits earned to date and funded status of the Company's share of the System plan at December 31 using a measurement date of September 30 were as follows:\n1994 1993 (Thousands of Dollars) Accumulated postretirement benefit obligation: Retirees $35 895 $35 748 Fully eligible employees 8 290 9 030 Other employees 17 013 18 378 Total obligation 61 198 63 156 Plan assets at market value 6 173 1 510 Accumulated postretirement benefit obligation in excess of plan assets 55 025 61 646 Less: Unrecognized cumulative net (gain) loss from past experience different from that assumed (543) 3 362 Unrecognized transition obligation, being amortized over 20 years beginning January 1, 1993 50 929 53 746 Postretirement benefit liability at September 30 4 639 4 538 Fourth quarter contributions and benefit payments 2 113 1 960 Postretirement benefit liability at December 31 $2 526 $2 578\nThe plan assets at market value are comprised of fixed income securities, common stocks, and a short-term investment fund in 1994; and a short-term investment fund in 1993. The unfunded accumulated postretirement benefit obligation (APBO) at January 1, 1993, of $56,600,000 (transition obligation) is being amortized prospectively over 20 years as permitted by SFAS No. 106. In determining the APBO at September 30, 1994, 1993, and 1992, the discount rates used were 7.75%, 7.25%, and 8%, and the rates of increase in future compensation levels were 4.75%, 4.75%, and 5.5%, respectively. The 1994 expected long-term rate of return on assets was 8.25% net of tax. For measurement purposes, a health care trend rate of 9% for 1995, declining 1% each year thereafter to 6.75% in the year 1998 and beyond, and plan provisions which limit future medical and life insurance benefits, were assumed. Increasing the assumed health care trend rate by 1% in each year would increase the APBO at December 31, 1994, by $4.2 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1994 by $.4 million. The Company has been authorized recovery of SFAS No. 106 expenses in rates.\nNote G-Fair Value of Financial Instruments: The carrying amounts and estimated fair value of financial instruments at December 31, 1994 and 1993 were as follows:\nThe carrying amount of temporary cash investments approximates the fair value because of the short maturity of those instruments. The fair value of long-term debt was estimated based on actual market prices or market prices of similar issues. The Company does not have any financial instruments held or issued for trading purposes. For purposes of the consolidated statement of cash flows, temporary cash investments with original maturities of three months or less, generally in the form of commercial paper, certificates of deposit, and repurchase agreements, are considered to be the equivalent of cash.\nNote H-Stockholders' Equity: COMMON STOCK AND OTHER PAID-IN CAPITAL: The Company issued and sold common stock to its parent, at $20 per share, 2,000,000 shares in October 1994 and 5,000,000 shares in October 1993. Other paid-in capital decreased $145,000 in 1993 and $550,000 in 1992 as a result of the underwriting fees and commissions and miscellaneous expenses associated with the Company's sale of $40 million of preferred stock in 1992.\nPREFERRED STOCK: All of the preferred stock is entitled on voluntary liquidation to its then current call price and on involuntary liquidation to $100 per share. The holders of the Company's market auction preferred stock are entitled to dividends at a rate determined by an auction held the business day preceding each quarterly dividend payment date.\nNote I-Long-Term Debt: Maturities for long-term debt for the next five years are: 1995, $27,000,000; 1996 and 1997, none; 1998, $103,500,000; and 1999, $2,500,000. Substantially all of the properties of the Company are held subject to the lien securing its first mortgage bonds. Some properties are also subject to a second lien securing certain pollution control and solid waste disposal notes. Certain first mortgage bond series are not redeemable by certain refunding until dates established in the respective supplemental indentures.\nNote J-Short-Term Financing: To provide interim financing and support for outstanding commercial paper, the System companies have established lines of credit with several banks. The Company has SEC authorization for total short-term borrowings of $170 million, including money pool borrowings described below. The Company has fee arrangements on all of its lines of credit and no compensating balance requirements. In addition to bank lines of credit, an internal money pool accommodates intercompany short-term borrowing needs, to the extent that certain of the companies have funds available. In January 1994, the Company and its affiliates jointly established an aggregate $300 million multi-year credit program which provides that the Company may borrow up to $135 million on a standby revolving credit basis. There was no short-term debt outstanding at the end of 1994 or 1993. Average short-term debt outstanding during the year for 1994 and 1993 consisted of:\n1994 1993 (Thousands of Dollars) Average amount outstanding during the year: Commercial Paper $2,216-4.38% - Notes Payable to Banks 2,379-4.37% $9,081-3.18% Money Pool 521-4.24% 1,166-3.01%\nNote K-Commitments and Contingencies: CONSTRUCTION PROGRAM: The Company has entered into commitments for its construction program, for which expenditures are estimated to be $172 million for 1995 and $115 million for 1996. These estimates include expenditures for the program of complying with the Clean Air Act Amendments of 1990 (CAAA) as discussed below.\nENVIRONMENTAL MATTERS: System companies are subject to various laws, regulations, and uncertainties as to environmental matters. Compliance may require them to incur substantial additional costs to modify or replace existing and proposed equipment and facilities and may affect adversely the lead time, size, and siting of future generating stations, increase the complexity and cost of pollution control equipment, and otherwise add to the cost of future operations. Construction estimates for 1995 and 1996 include $38 million and $1 million, respectively, for compliance with Phase I of the CAAA. Through 1998, annual construction expenditures, on average, are not expected to significantly vary from 1995 estimated levels. Construction expenditure levels in 1999 and beyond will depend upon the strategy eventually selected for complying with Phase II of the CAAA, as well as future generation requirements.\nLITIGATION AND OTHER: In the normal course of business, the Company becomes involved in various legal proceedings. The Company does not believe that the ultimate outcome of these proceedings will have a material effect on its financial position. The Company is guarantor as to 45% of a $50 million revolving credit agreement of AGC, which in 1994 was used by AGC solely as support for its indebtedness for commercial paper outstanding.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of Allegheny Generating Company\nIn our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Allegheny Generating Company (an Allegheny Power System, Inc. affiliate) 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 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 A and B to the financial statements, the Company changed its method of accounting for income taxes in 1993.\nPRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nNew York, New York February 2, 1995\nBALANCE SHEET DECEMBER 31 1994 1993 (Thousands of Dollars)\nASSETS Property, Plant, and Equipment: At original cost, including $21,000 and $2,212,000 under construction $824 714 $824 904 Accumulated depreciation (143 965) (128 375) 680 749 696 529\nCurrent Assets: Cash 45 15 Accounts receivable from parents 1 516 8 615 Materials and supplies - at average cost 2 193 2 191 Other 2 237 242 5 991 11 063\nDeferred Charges: Regulatory assets (Note B) 4 449 4 489 Unamortized loss on reacquired debt 10 653 11 374 Other 12 394 12 474 27 496 28 337 Total $714 236 $735 929\nCAPITALIZATION AND LIABILITIES\nCapitalization: Common stock - $1.00 par value per share, authorized 5,000 shares, outstanding 1,000 shares $ 1 $ 1 Other paid-in capital 209 999 209 999 Retained earnings 12 729 18 512 222 729 228 512 Long-term debt (Note D) 267 165 277 196 489 894 505 708\nCurrent Liabilities: Long-term debt due within one year (Note D) 1 000 10 000 Accounts payable 48 11 Interest accrued 4 900 5 100 Taxes accrued 33 249 Other 503 6 531 6 484 21 891\nDeferred Credits: Unamortized investment credit 52 297 53 613 Deferred income taxes 137 297 125 848 Regulatory liabilities (Note B) 28 264 28 869 217 858 208 330 Total $714 236 $735 929\nSee accompanying notes to financial statements.\nNOTES TO FINANCIAL STATEMENTS (These notes are an integral part of the financial statements.)\nNote A Summary of Significant Accounting Policies: The Company was incorporated in Virginia in 1981. Its common stock is owned by Monongahela Power Company - 27%, The Potomac Edison Company - 28%, and West Penn Power Company - 45% (the Parents). The Parents are wholly-owned subsidiaries of Allegheny Power System, Inc. and are a part of the Allegheny Power integrated electric utility system. The Company is subject to regulation by the Securities and Exchange Commission (SEC) and by the Federal Energy Regulatory Commission (FERC). Significant accounting policies of the Company are summarized below.\nPROPERTY, PLANT, AND EQUIPMENT: Property, plant, and equipment are stated at original cost, and consist of a 40% undivided interest in the Bath County pumped-storage hydroelectric station and its connecting transmission facilities. The cost of depreciable property units retired plus removal costs less salvage are charged to accumulated depreciation.\nDEPRECIATION AND MAINTENANCE: Provisions for depreciation are determined on a straight-line method based on estimated service lives of depreciable properties and amounted to approximately 2.1% of average depreciable property in each of the years 1994, 1993, and 1992. The cost of maintenance and of certain replacements of property, plant, and equipment is charged to operating expenses.\nINCOME TAXES: The Company joins with its parents and affiliates in filing a consolidated federal income tax return. The consolidated tax liability is allocated among the participants generally in proportion to the taxable income of each participant, except that no subsidiary pays tax in excess of its separate return tax liability. Financial accounting income before income taxes differs from taxable income principally because certain income and deductions for tax purposes are recorded in the financial income statement in another period. Differences between income tax expense computed on the basis of financial accounting income and taxes payable based on taxable income are deferred. Deferred tax assets and liabilities recorded in accordance with the Financial Accounting Standards Board Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", represent the tax effect of temporary differences between the financial statement and tax basis of assets and liabilities computed utilizing the most current tax rates. Prior to 1987, provisions for federal income tax were reduced by investment credits, and amounts equivalent to such credits were charged to income with concurrent credits to a deferred\naccount, balances of which are being amortized over estimated service lives of the related properties.\nACCOUNTING CHANGE: Effective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\". This standard mandated a change from the previous income-based deferral approach to a balance sheet-based liability approach for computing deferred income taxes.\nNote B Income Taxes: Details of federal income tax provisions are:\nIn 1994, the total provision for income taxes ($14,737,000) was less than the amount produced by applying the federal income tax statutory rate to financial accounting income before income taxes ($15,559,000), due primarily to amortization of deferred investment credit ($1,316,000).\nFederal income tax returns through 1991 have been examined and substantially settled.\nIn adopting SFAS No. 109, the Company recognized a significant increase in both deferred tax assets and liabilities. At December 31, the deferred tax assets and liabilities were comprised of the following: 1994 1993 (Thousands of Dollars) Deferred tax assets: Unamortized investment tax credit $ 28 160 $ 28 869 Other 104 28 264 28 869 Deferred tax liabilities: Book vs. tax plant basis differences, net 165 561 154 565 Other 152 165 561 154 717 Total net deferred tax liabilities $137 297 $125 848\nIt is expected the FERC will allow recovery of the deferred tax liabilities in future years as they are paid, and accordingly, the Company has recorded regulatory assets of $4 million which offset the increase in deferred tax liabilities. Regulatory liabilities of $28 million have been recorded which offset the increase in deferred tax assets in order to reflect the Company's obligation to pass such tax benefits on to its customers as the benefits are realized in cash in future years.\nNote C Fair Value of Financial Instruments: The carrying amounts and estimated fair value of financial instruments at December 31, 1994 and 1993 were as follows:\nThe carrying amount of debentures and medium-term notes was based on actual market prices or market prices of similar issues. The carrying amount of commercial paper and notes payable to affiliates approximates the fair value because of the short maturity of those instruments. The Company does not have any financial instruments held or issued for trading purposes.\nNote D Long-Term Debt: The Company had long-term debt outstanding as follows:\nInterest December 31 Rate - % 1994 1993 (Thousands of Dollars) Debentures due: September 1, 2003 5.625 $ 50 000 $ 50 000 September 1, 2023 6.875 100 000 100 000 Commercial paper 6.25 (1) 41 736 21 362 Medium-term notes due 1994-1998 6.37 (1) 77 975 87 975 Notes payable to affiliates 2.85 (2) 29 500 Unamortized debt discount (1 546) (1 641) Total $268 165 $287 196 Less current maturities 1 000 10 000 Total $267 165 $277 196\n(1) Weighted average interest rate at December 31, 1994. (2) Weighted average interest rate at December 31, 1993.\nThe Company has a revolving credit agreement with a group of seven banks which provides for loans of up to $50 million at any one time outstanding through 1998. Each bank has the option to discontinue its loans after 1998 upon three years' prior written notice. Without such notice, the loans are automatically extended for one year. Amounts borrowed are guaranteed by the Parents in proportion to their equity interest. Interest rates are determined at the time of each borrowing. The revolving credit agreement serves as support for the Company's commercial paper. In addition to bank lines of credit, an internal money pool accommodates intercompany short-term borrowing needs, to the extent that certain of the Company's affiliates have funds available. At the end of 1993, the Company had outstanding $29,500,000 of money pool borrowings from affiliates. Maturities for long-term debt for the next five years are: 1995, $1,000,000; 1996, $6,375,000; 1997, $10,600,000; 1998, $101,736,000; and 1999, none.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nFor APS and the Subsidiaries, none.\nEmployment Contracts\nIn February 1995, APS entered into employment contracts with certain of the APS System executive officers (Agreements). Each Agreement sets forth (i) the severance benefits that will be provided to the employee in the event the employee is terminated subsequent to a Change in Control of APS (as defined in the Agreements), and (ii) the employee's obligation to continue his or her employment after the occurrence of certain circumstances that could lead to a Change in Control. The Agreements provide generally that unless employment is terminated by APS for Cause, Disability or Retirement or by the employee for Good Reason (each as defined in the Agreements), severance benefits will consist of a cash payment equal to 2.99 times the employee's annualized compensation together with APS maintaining existing benefits for the employee and the employee's dependents for a period of three years. Each Agreement initially expires on December 31, 1997 but will be automatically extended for one year periods thereafter unless either APS or the employee gives notice otherwise. Notwithstanding the delivery of such notice, the Agreements will continue in effect for twenty-four months after a Change in Control.\nCompensation of Directors\nIn 1994, APS directors who were not officers or employees of System companies received for all services to System companies (a) $16,000 in retainer fees, (b) $800 for each committee meeting attended, except Executive Committee meetings which are $200, and (c) $250 for each Board meeting of each company attended. Under an unfunded deferred compensation plan, a director may elect to defer receipt of all or part of his or her director's fees for succeeding calendar years to be payable with accumulated interest when the director ceases to be such, in equal annual installments, or, upon authorization by the Board of Directors, in a lump sum.\nEffective January 1, 1995, in addition to the fees mentioned above, the Chairperson of each of the Audit, Finance, Management Review, and New Business Committees will receive a further fee of $4,000 per year, and the retainer fee paid outside directors will be increased by 200 shares of APS common stock pursuant to the Restricted Stock Plan for Outside Directors which was adopted, subject to SEC approval, effective January 1, 1995. Also adopted effective January 1, 1995 was a Directors' Retirement Plan which will provide an annual pension equal to the retainer fee paid to the outside director at the time of his or her retirement, provided the director has at least five (5) years of service and, except under special circumstances described in the Plan, serves until age 65.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor APS and the Subsidiaries, none.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1)(2) The financial statements and financial statement schedules filed as part of this Report are set forth under 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":"740670_1994.txt","cik":"740670","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nMichaels Stores, Inc. (\"Michaels\" or the \"Company\") is the largest nationwide specialty retailer of arts, crafts and decorative items, operating a chain of 254 stores (as of April 15, 1994) located in 32 states and one Canadian province. Michaels stores offer a wide selection of competitively priced items including general crafts, wearable art, silk and dried flowers, picture framing materials and services, art and hobby supplies, and party, seasonal and holiday merchandise. The average sale is approximately $13.75. The Company's primary customers are women aged 25 to 54 with above average median household incomes, and the Company believes repeat customers account for a substantial portion of its sales. The Company was incorporated in 1983 as the successor to a Colorado corporation which commenced operations in 1962.\nMERCHANDISING\nPRODUCT SELECTION\nMichaels' merchandising strategy is to provide a broad selection of products in an appealing store environment with superior customer service. The commitment to customer service is evidenced through in-store \"how to\" demonstrations, project samples displayed throughout the store, and instructional classes for adults and children. The typical Michaels store offers an assortment of over 30,000 stock keeping units (\"SKUs\"). In general, each store offers products from ten departments. Nine of the departments offer essentially the same type of merchandise throughout the year, although the products may vary from season to season. The merchandise offered by these nine departments is as follows:\n- General craft materials, including those for stenciling, doll making, jewelry making, woodworking, wall decor, and tole painting;\n- Wearable art, including adult's and children's garments, fabric paints, embellishments, jewels and sequins, transfers and appliques;\n- Silk flowers, dried flowers and artificial plants sold separately or in ready-made and custom floral arrangements, all accessories needed for floral arranging, wedding millinery and floral items, and other items for personalizing home decor, such as wreaths, containers, baskets, candles, and potpourri;\n- Picture framing materials and services, including ready-made frames and custom framing, mat boards, glass, backing materials and related supplies, framed art and photo albums;\n- Fine art materials, representing a number of major brand lines and including items such as pastels, water colors, oil paints, acrylics, easels, brushes, paper and canvas;\n- Hobby items, including doll houses and miniature furniture, wooden and plastic model kits and related supplies, and paint-by-number kits;\n- Party needs, including paper party goods, gift wrap, candy making and cake decorating supplies, invitations, greeting cards, balloons and candy;\n- Needlecraft items, including stitchery supplies, knitting yarns, needles, canvas and related supplies for needlepoint, embroidery and cross stitching, knitting, crochet, and rug making, and quilts and afghans sold separately or in kits;\n- Ribbon, including satins, laces, florals and other styles sold both in bolts and by the yard.\nIn addition to the nine departments described above, the Company regularly features seasonal merchandise. Seasonal merchandise is ordered for several holiday periods, including Valentine's Day, Easter, Mother's Day, Halloween and Thanksgiving, in addition to the Christmas season. For example,\nseasonal merchandise for the Christmas season includes trees, wreaths, candles, lights and ornaments. Included in the seasonal department is promotional merchandise that is offered with the intention of generating customer traffic.\nThe following table shows sales by the largest departments as a percent of total sales for fiscal 1993, 1992 and 1991:\nDuring the Christmas selling season, up to 25% of floor and shelf space in a typical store is devoted to Christmas decorating and gift making merchandise. Because of the project-oriented nature of these products, the Company's peak Christmas selling season extends from October through December. Accordingly, a fully developed seasonal merchandising program, including inventory, merchandise layout and instructional ideas, is implemented in each store beginning in July of each year. This program requires additional inventory accumulation so that each store is fully stocked during the peak season. Sales of all merchandise typically increase during the Christmas selling season because of increased customer traffic. The Company believes that merchandise centered around other traditional holidays, such as Valentine's Day, Easter and Halloween, is becoming more popular and is a growing contributor to sales.\nMichaels' selling floor strategy is developed centrally and implemented at the store level through the use of \"planograms\" which provide store managers with detailed descriptions and illustrations with respect to store layout and merchandise presentation. Planograms are also used to cluster various products which can be combined to create individual projects.\nCUSTOMER SERVICE\nMichaels believes that customer service is critically important to its merchandising strategy. Many of the craft supplies sold in Michaels stores can be assembled into unique end-products. Accordingly, Michaels has hundreds of displays in every store in an effort to stimulate new project ideas, and supplies project sheets with detailed instructions on how to assemble the product. In addition, many sales associates are craft enthusiasts with the experience to help customers with ideas and instructions. The Company also offers free demonstrations and inexpensive classes in stores as a means of promoting new craft ideas. The Company creates additional shopper loyalty and enthusiasm through publication of the \"Michaels Arts & Crafts\" magazine, which reaches over 200,000 households six times per year, and sponsorship of the \"Michaels Kids Club\" for over 250,000 children nationwide. Michaels believes that the in-store \"how-to\" demonstrations, instructional classes, knowledgeable sales associates, and customer focus groups have allowed the Company to better understand and serve its customers. In addition, the Company measures its customer service in each store at least four times a year through a \"mystery shopper\" program.\nPURCHASING AND DISTRIBUTION\nThe Company's purchasing strategy is to negotiate centrally with its vendors in order to take advantage of volume purchasing discounts and improve control over product mix and inventory. Approximately 90% of the merchandise is acquired by the stores from vendors on the Company's \"approved list.\" Of this merchandise, approximately one-half is received from the Company's distribution centers and one-half is received directly from vendors. In addition, each store has the flexibility\nto purchase approximately 10% of its merchandise directly from local vendors, which allows the store managers to tailor the products offered in their stores to local tastes and trends. All store purchases are monitored by district and regional managers.\nThe Company currently operates three distribution centers which supply the stores with certain merchandise, including substantially all seasonal and promotional items. The Company's distribution centers are located in Irving, Texas, Buena Park, California and Lexington, Kentucky. The Company also operates a warehouse in Phoenix, Arizona, which allows the Company to store bulk purchases of seasonal and promotional merchandise prior to distribution. Michaels stores receive deliveries from the distribution centers generally once a week through an internal distribution network using leased trucks.\nSubstantially all of the products sold in Michaels stores are manufactured in the United States, the Far East and Mexico. Goods manufactured in the Far East generally require long lead times and are ordered four to six months in advance of delivery. Such products are either imported directly by the Company or acquired from distributors based in the United States. In all cases, purchases are denominated in U.S. dollars (or Canadian dollars for purchases of certain items delivered directly to stores in Canada).\nADVERTISING\nThe Company believes that its advertising promotes craft and hobby project ideas among its customers. The Company focuses on circular and newspaper advertising. The Company has found circular advertising, primarily as an insert to newspapers but also through direct mail or on display within its stores, to be the most effective medium of advertising. Such circulars advertise numerous products in order to emphasize the wide selection of products available at Michaels stores. The Company believes that its ability to advertise through circulars and newspapers approximately once a week in each of its markets provides the Company with an advantage over its smaller competitors. In the past the Company generally limited television advertising to those major markets in which it has clusters of stores or in which it was adding new stores. In the future, the Company will conduct advertising campaigns on targeted cable television networks reaching a nationwide audience. This effort may also be complemented with network television advertising in select markets.\nSTORE OPERATIONS\nThe Company's stores average approximately 15,500 square feet of selling space, although newer stores average approximately 17,000 square feet of selling space. Net sales for fiscal 1993 averaged approximately $3,180,000 per store (for stores open the entire fiscal year) and $218 per square foot of selling space. Store sites are selected based upon meeting certain economic, demographic and traffic criteria or for clustering stores in markets where certain operating efficiencies can be achieved. The Michaels stores currently in operation are located primarily in strip shopping centers in areas with easy access and ample parking.\nTypically, a Michaels store is managed by a store manager and one to three assistant store managers, depending on the sales volume of the store. The Company's vice president of store operations, four regional managers and twenty-three district managers are responsible for the supervision and operation of the stores. The Company believes this organizational structure enhances the communication among the individual stores and between the stores and corporate headquarters. In addition, the Company believes that the training and experience of its managers and assistant managers are vital to the success of its stores, and therefore has implemented extensive training programs for such personnel.\nNEW STORE EXPANSION\nMichaels currently anticipates adding approximately 70 to 75 stores in the United States and Canada during fiscal 1994, of which 34 have already opened or been acquired. Michaels' expansion strategy is to give priority to adding stores in existing markets in order to enhance economies of scale\nassociated with advertising, transportation, field supervision, and other regional expenses. Management believes that few of its existing markets are saturated. The Company also believes that many attractive new markets available to the Company exist. The anticipated development of Michaels stores in 1994 and the rate at which stores are developed thereafter will depend upon a number of factors, including the success of existing Michaels stores, the availability of suitable store sites, the availability of suitable acquisition candidates, and the ability to hire and train qualified managers.\nIn February 1994 the Company acquired Treasure House Stores, Inc., an arts and crafts chain of nine stores operating primarily in the Seattle market. In April 1994 the Company acquired a group of companies operating eight stores (primarily in Portland, Oregon) under the Oregon Craft and Floral Supply Co. name and eight stores (in southern California) under the H & H Craft and Floral Supply Co. name. All of these acquired stores will be operated in the future as Michaels stores. These acquisitions have created a dominant position for the Company in Oregon and Washington and further strengthened the Company's position in southern California. The Company intends to continue to review acquisition opportunities in existing and new markets.\nIn October 1993 the Company opened its first Michaels Craft and Floral Warehouse store (\"CFW\") using a newly-developed \"warehouse superstore\" format. It is anticipated that each store following the CFW format will occupy up to 40,000 square feet of selling space, carry a wider selection of certain categories of merchandise than the typical store, and generally offer merchandise at \"everyday\" discounted retail prices. In order to maintain a lower cost structure than the typical store, the CFW store utilizes new computer systems that provide full point-of-sale scanning, automated receiving of merchandise, and allow the elimination of retail price marking of individual product. The Company plans to open four or five additional CFW stores during 1994, and may accelerate the opening of such stores in the future if the format continues to be favorably received by the consumer.\nMichaels has developed a standardized procedure which enables the Company to efficiently open new stores and integrate them into its information and distribution systems. The Company develops the floor plan and inventory layout, and organizes the advertising and promotions in connection with the opening of each new store. In addition, Michaels maintains an experienced store opening staff to provide new store personnel with in-store training. The Company generally opens new stores during the period from February through October because new store personnel require significant in-store training prior to the first Christmas selling season.\nINVENTORY CONTROL\/MANAGEMENT INFORMATION SYSTEMS\nMichaels' management information systems include automated point-of-sale, merchandising, distribution and financial applications. All orders from the stores to the Company's distribution centers are processed electronically to ensure timely delivery of warehouse-sourced inventory. The Company's point-of-sale system generally captures sales information by department. Due to the large number of inexpensive items in the stores, the non-fashion nature of the merchandise, and the long lead times involved for ordering seasonal goods (up to nine months), the Company does not currently capture item-level sales information, inventory or margin electronically in all stores. Sales trend tracking combines item level point-of-sale scanning data from the CFW store with point-of-sale department-level sales from all other stores, weekly test counts of certain SKUs in 40 selected stores, and regular communication from store managers through the district and regional managers. Inventory and margins are monitored on a perpetual basis in the distribution centers and in the stores via physical inventories at least quarterly in groups of 30 to 40 stores and a year-end complete physical count in most stores. The Company believes that these procedures and automated systems, together with its other control processes, allow Michaels to manage and monitor its inventory levels and margin performance while it implements new SKU management systems.\nIn conjunction with the centralization of certain merchandising, financial and operational functions in 1991, the Company developed a Five-Year Information Technology Plan designed to satisfy the Company's growing management information needs. The enhancements provided for in this Plan\nthat have been implemented include improved ordering capabilities in the stores using radio frequency and bar-code scanning technologies, item-level scanning and automated receiving for the CFW store, the implementation of electronic data interchange with key vendors, and additional automation in the distribution centers also using radio frequency and bar-code scanning technologies. Additional near-term enhancements will include the implementation of more sophisticated warehouse replenishment, merchandise assortment planning, and \"planogramming\" capabilities.\nCOMPETITION\nMichaels is the largest nationwide specialty retailer dedicated to serving the arts and crafts marketplace. The specialty retail business is highly competitive. Michaels competes primarily with other nationwide retailers of craft items and related merchandise, regional and local merchants that tend to specialize in particular aspects of arts and crafts, and mass merchandisers that typically dedicate a portion of their selling space to a limited selection of arts, crafts, picture framing and seasonal products. The Company believes that its stores compete based on price, quality and variety of merchandise assortment, and customer service, such as instructional demonstrations. Michaels believes the combination of its broad selection of products, emphasis on customer service, loyal customer base, and capacity to advertise frequently in all of its markets provides the Company with a competitive advantage.\nSERVICE MARKS\nThe name \"Michaels\" and the Michaels logo are both federally registered service marks held by a trust of which a wholly-owned subsidiary of the Company is beneficiary.\nFRANCHISES\nThe Company has granted to Dupey Management Corporation the right to open royalty-free, licensed Michaels stores in an eight-county area in north Texas which includes the Dallas-Fort Worth area. In addition, a majority-owned subsidiary of the Company has the right to operate licensed Michaels stores in Canada, in return for which such subsidiary pays royalty fees.\nEMPLOYEES\nAs of March 27, 1994, approximately 10,040 persons were employed by the Company, approximately 5,830 of whom were employed on a part-time basis. The number of part-time employees is substantially increased during the Christmas selling season. Of the Company's full-time employees, 640 are engaged in various executive, operating, training and administrative functions in the Company's corporate office, distribution centers and bulk warehouse, and the remainder are engaged in store operations.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nMr. Sam Wyly became a director of the Company in July 1984 and was elected Chairman of the Board in October 1984. In 1963, Mr. Wyly founded University Computing Company, a computer software and services company, and served as President or Chairman from 1963 until February 1979. Mr. Wyly co-founded Earth Resources Company, an oil refining and silver and gold mining company,\nand served as its Executive Committee chairman from 1968 to 1980. Mr. Wyly and his brother, Charles J. Wyly, Jr., bought the 20 restaurant Bonanza Steakhouse chain in 1967. It grew to approximately 600 restaurants by 1989, during which time he served as Chairman. Mr. Wyly currently serves as Chairman of Sterling Software, Inc., a computer software company which he co-founded in 1981, and as President of Maverick Capital, Ltd., an investment fund management company. Sam Wyly is the father of Evan A. Wyly, a director of the Company.\nMr. Charles J. Wyly, Jr. became a director of the Company in October 1984 and Vice Chairman of the Board of Directors in February 1985. Mr. Wyly served as an officer and director of University Computing Company from 1964 to 1975, including President from 1969 to 1973. Mr. Wyly and his brother, Sam Wyly, founded Earth Resources Company, and Charles J. Wyly, Jr. served as Chairman of the Board from 1968 to 1980. Mr. Wyly served as Vice Chairman of the Bonanza Steakhouse chain from 1967 to 1989. Mr. Wyly is a co-founder and currently serves as Vice Chairman of the Board of Directors of Sterling Software, Inc. and as Chairman of Maverick Capital, Ltd. Charles J. Wyly, Jr. is the father-in-law of Donald R. Miller, Jr., a director and Vice President -- Market Development of the Company.\nMr. Bush became a director of the Company and was elected President and Chief Operating Officer in August 1991. Prior to joining the Company, Mr. Bush was Executive Vice President -- Operations and Stores for Ames Department Stores, Inc. Before joining Ames in 1990, Mr. Bush was President, Chief Operating Officer and a director of Rose's Stores, Inc., a discount store chain. From 1980 to 1985, he served as Vice President -- Southern Zone Manager for Zayre Corporation. Previously, Mr. Bush spent 22 years with J.C. Penney Company, where he held a variety of executive positions in merchandising, operations, marketing, strategic planning, specialty businesses, discount stores and business development.\nMr. Morris became Executive Vice President and Chief Financial Officer of the Company in August 1990. From January 1990 until August 1990 he was Senior Vice President -- Finance and Chief Financial Officer. From April 1988 until January 1990, Mr. Morris was a director, President and Chief Executive Officer of Frostcollection, Inc. Prior to April 1988, Mr. Morris was Partner-In-Charge of the Accounting and Audit and the Merger and Acquisition Departments of the Dallas, Texas office of Arthur Young & Company.\nMr. Sullivan became Executive Vice President of the Company in August 1990. From March 1988 until August 1990 he was Senior Vice President -- Real Estate. Prior to his joining the Company, Mr. Sullivan had served with Family Dollar Stores, Inc. for 11 years, most recently as Vice President -- Real Estate.\nMr. Rudman became Senior Vice President -- Merchandising and Marketing of the Company in October 1991. From October 1990 until October 1991 he was Director of Merchandising for Best Products, a catalog showroom retailer. From September 1989 until October 1990 Mr. Rudman was Senior Vice President -- Merchandising\/Marketing and Distribution for Silk Greenhouse, Inc., a chain of retail silk floral and accessory stores which filed a petition under federal bankruptcy laws in November 1990. From May 1988 until September 1989 he served as Vice President -- Non-Foods Merchandise for Pace Membership Club, prior to which time he was Vice President and Divisional Merchandise Manager of McCrory's, a chain of variety stores.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's stores generally are situated in strip shopping centers located near malls and on well-traveled roads. Almost all stores are in leased premises with lease terms generally ranging from five to twenty years. The base rental rates generally range from $75,000 to $175,000 per year. Rental expense for stores open during the full 12-month period of fiscal 1993 averaged $137,000. The leases are generally renewable, with increases in rental rates for renewal terms. A majority of the existing\nleases contain provisions pursuant to which the lessor has provided leasehold improvements to prepare for opening. However, the Company has been paying and anticipates continuing to pay for a larger portion of future improvements directly as opposed to financing them through the lessor.\nDuring 1993 the Company purchased a total of seven properties (consisting of six parcels of land and seven buildings) at a cost of $8.8 million, generally acquiring such properties by bidding for them in reorganization proceedings of other retail companies. Four of the properties have been or are in the process of being sold, generally in transactions pursuant to which the Company will lease the property back for a specified period of time. It is the Company's present intention to acquire land and\/or buildings only in unusual circumstances where the economics of the transactions appear favorable to the Company and the locations involved fit into the Company's expansion strategy.\nThe following table indicates the number of the Company's stores located in each state or province:\nThe Company leases a 210,000 square foot building in Irving, Texas for use as a distribution center and as the Company's corporate headquarters, and leases two nearby facilities for supplemental warehouse and office space. The Company also leases a 400,000 square foot building in Buena Park,\nCalifornia for use as a distribution center and leases a 350,000 square foot building in Lexington, Kentucky for the same purpose. In addition, the Company leases a 160,000 square foot building in Phoenix, Arizona for use as a bulk warehouse facility.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is a defendant from time to time in routine lawsuits incidental to its business. The Company believes that none of such current proceedings, individually or in the aggragate, will have a materially adverse effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nThe Company did not submit any matter to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.\nThe Company's Common Stock is quoted through the NASDAQ National Market System under the symbol \"MIKE.\" The following table sets forth the high and low sales prices of the Company's Common Stock for each quarterly period within the two most recent fiscal years.\nOn April 26, 1994, the last reported sale price of the Common Stock on the NASDAQ National Market System was $42.25, and as of such date there were approximately 1,044 holders of record of the Common Stock.\nThe Company's present plan is to retain earnings for the foreseeable future for use in the Company's business and the financing of its growth. The Company did not pay any dividends on its Common Stock during fiscal 1992 and 1993.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe selected financial information required by this item is included in the Company's 1993 Annual Report to Shareholders (the \"1993 Annual Report\") on page 1 under the heading \"Financial Highlights.\" Such 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 is included in the Company's 1993 Annual Report on pages 20 through 22 under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" Such information is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements and supplementary data required by this item are included in this Annual Report on Form 10-K, or are included in the Company's 1993 Annual Report and are incorporated herein by reference, as indicated in the following Index to Financial Statements and Financial Statement Schedules:\nAll other schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedules, or because the information required is included in the consolidated financial statements and notes thereto.\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 concerning the directors of the company is set forth in the Proxy Statement to be delivered to shareholders in connection with the Company's Annual Meeting of Shareholders to be held on May 24, 1994 (the \"Proxy Statement\") under the heading \"Proposal I -- Election of Directors,\" which information is incorporated herein by reference. The name, age and position of each executive officer of the Company is set forth under the heading: \"Executive Officers of the Registrant\" in Item 1 of this report, which information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information concerning executive compensation is set forth in the Proxy Statement under the heading \"Management Compensation,\" which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information concerning security ownership of certain beneficial owners and management is set forth in the Proxy Statement under the heading \"Principal Shareholders and Management Ownership,\" which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information concerning certain relationships and related transactions is set forth in the Proxy Statement under the headings \"Certain Transactions\" and \"Management Compensation -- Compensation and Stock Option Committee Interlocks and Insider Participation,\" which information is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K:\n(a) The following documents are filed as a part of this Annual Report on Form 10-K:\n(1) Financial Statements:\nThe financial statements filed as a part of this report are listed in the \"Index to Financial Statements and Financial Statement Schedules\" at Item 8.\n(2) Financial Statement Schedules:\nThe financial statement schedules filed as a part of this report are listed in the \"Index to Financial Statements and Financial Statement Schedules\" at Item 8.\n(3) Exhibits:\nThe exhibits filed as a part of this report are listed under \"Exhibits\" at subsection (c) of this Item 14.\n(b) Reports on Form 8-K:\nNo report on Form 8-K was filed on behalf of the Registrant during the last quarter of the period covered by this report.\n(c) Exhibits:\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMICHAELS STORES, INC.\nDate: April 28, 1994 By: ___________\/s\/_SAM WYLY___________ Sam Wyly 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.\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Michaels Stores, Inc.\nWe have audited the consolidated financial statements of Michaels Stores, Inc. as of January 30, 1994 and January 31, 1993, and for each of the three years in the period ended January 30, 1994, and have issued our report thereon dated February 28, 1994. Our audits also included the financial statement schedules listed in item 14(b). 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\nDallas, Texas February 28, 1994\nSCHEDULE I\nMICHAELS STORES, INC. MARKETABLE SECURITIES -- OTHER INVESTMENTS JANUARY 30, 1994 (IN THOUSANDS EXCEPT SHARE OR UNIT DATA)\nSCHEDULE IX\nMICHAELS STORES, INC. SHORT-TERM BORROWINGS (DOLLARS IN THOUSANDS)\nSCHEDULE X\nMICHAELS STORES, INC. SUPPLEMENTARY INCOME STATEMENT INFORMATION (IN THOUSANDS)\nAPPENDIX A\nA DESCRIPTION OF GRAPHIC MATERIAL CONTAINED IN THE COMPANY'S FORM OF COMMON STOCK CERTIFICATE IS CONTAINED IN EXHIBIT 4.1.\nEXHIBIT INDEX","section_15":""}
{"filename":"96879_1994.txt","cik":"96879","year":"1994","section_1":"Item 1. Business.\nTektronix is an Oregon corporation organized in 1946. Its principal executive offices are located at 26600 S.W. Parkway Avenue, Wilsonville, Oregon 97070, approximately 18 miles south of Portland. Its telephone number is (503) 627-7111. References herein to \"Tektronix\" or the \"Company\" are to Tektronix, Inc. and its wholly-owned subsidiaries unless the context indicates otherwise.\nTektronix' products cover a wide range of electronic equipment. The Company's products may be grouped into four classes of similar products as follows: (i) measurement business products, (ii) color printing and imaging products, (iii) video systems products, and (iv) network displays products. Measurement business products include digital and analog oscilloscopes, general purpose test instruments, television waveform monitors, vectorscopes, signal generators, automated test equipment, logic analyzers, card-modular test instruments, spectrum analyzers, cable testers, optical fiber testers, cameras, probes and related products. Color printing and imaging products include color printers and related products and supplies. Video systems products include studio production equipment, signal processing and distribution equipment, transmission systems and related products. Network displays products include graphics terminals and related products.\nProducts ________\nThe table below sets forth the contribution to total net sales of the Company's product groupings for the last three fiscal years (in thousands of dollars).\nMeasurement Business Products _____________________________\nBecause of their wide range of capabilities, measurement business products are used in a variety of applications, including research, design, testing, installation, manufacturing and service in the computer, military, commercial aerospace, telecommunications, television, process control and automotive industries.\nTektronix pioneered the development of high precision oscilloscopes over 45 years ago, and the oscilloscope is the Company's primary measurement product. Oscilloscopes are used by engineers and technicians when an electrical signal needs to be viewed, measured, tested or calibrated. Oscilloscopes are used extensively in the computer, communications, aerospace and other industries for design, manufacturing and maintenance. In addition to electrical signals, oscilloscopes can be adapted to measure mechanical motion (vibration), sound, light, heat, pressure, strain and velocity.\nOscilloscopes produce graphic representations of electrical signals on a cathode ray tube or other display device. Normally, the display shows the signal as a graph of its amplitude over a certain period of time, which may range from minutes to less than a billionth of a second. Oscilloscopes provide a convenient way to visually monitor and interpret analog electrical fluctuations, mechanical motion and sound.\nThe development of the microprocessor and associated growth in microprocessor-based devices stimulated both the existing analog markets and new digital markets. In addition, the microprocessor made possible significant improvements in oscilloscope design and performance. Most of the oscilloscopes and other measurement products manufactured by Tektronix feature digital storage and conversion functions, programmable operations, the ability to work in conjunction with personal computers and workstations and combinations of these capabilities. In addition, trends toward smaller microelectronic devices have opened new segments for specialized measurement equipment probes and other related equipment, such as connectors, adapters and cards, and cameras and plotters to record displayed waveforms.\nRecently, Tektronix redesigned a substantial portion of its oscilloscope product line to provide a consistent \"architecture\" across products and to enhance ease of use. Because the Company manufactures oscilloscopes in a wide range of configurations, bandwidths and other performance characteristics and in sizes ranging from hand-held to large laboratory units, this redesign provides customers with reduced learning time and higher productivity. The redesign also reduces the time required by the Company to develop new products because many essential\nuser interface aspects have been standardized. Some elements of this redesign also have been patented and provide the Company with certain competitive advantages.\nThe Company also offers modular instruments delivered on printed circuit cards that can be mixed and matched by customers and plugged directly into the backplane of industry-standard VXI-based card cages. These are controlled by personal computers or workstations to form complete instrument systems tailored to customers' particular requirements. A number of measurement products are now available in the VXI standard, which products are used primarily in manufacturing applications. Tektronix has been instrumental in the development of VXI-based hardware and software industry standards.\nMeasurement business products also include television test products, formerly reported as Television Systems products. Television test products include vectorscopes, waveform monitors, signal generators, automated test equipment, demodulators, aural modulation monitors and synchronizers which are used primarily by the television industry to test and display the quality of video and audio signals. The resolution of images and the fidelity of sounds, as well as the stability of the signals that carry them, are essential to program quality. Tektronix' television test products excel at the many forms of test and measurement vital to creating and maintaining signals of the highest quality.\nMarket changes are driving the development of new categories of products from Tektronix. The proliferation of electronic technology is requiring technicians and craftspeople to use smart electronic tools for electronic problem detection in areas such as automotive and electrical equipment repair and maintenance. TekTools(tm), Tektronix' new line of handheld, smart and rugged products, are designed specifically for these markets. Under the TekTools brand are a number of products such as a family of Digital Multimeters and a new line of products, the TekMeter(tm) family, that combine the functionality of a multimeter and oscilloscope into one product, and a number of accessories. An automotive version of the TekMeter has been developed for automotive electronic troubleshooting and repair and is being distributed to automotive service centers through third party distributors that specialize in distribution to the automotive market. Currently, the TekTools product family includes products priced from below $100 up to about $2,000.\nWhile TekTools are battery powered portable products, the Company also markets a line of lower priced benchtop basic instruments such as frequency counters, multimeters, power supplies and oscilloscopes. Applications include education, light manufacturing, electronic trouble shooting and basic electronic design.\nOther measurement business products include logic analyzers, spectrum analyzers and cable and fiber optic testers.\nLogic analyzers are a principal tool for electronic designers, engineers and technicians in testing and trouble-shooting computers, computer peripheral devices and digital electronic systems and instruments. Logic analyzers capture, display and examine streams of data coded as binary digits (bits), which are transmitted simultaneously over many channels. The Company's Digital Analysis System (DAS), a broad application logic analyzer, combines logic analysis and pattern generation by using card modular plug-in units to permit a range of performance in one system. The DAS is also used by software engineers in the development and optimization of microprocessor based designs.\nSpectum analyzers are used in communications and other industries to display and measure signal amplitude versus frequency rather than amplitude versus time (the latter being what an oscilloscope displays). It is an essential tool used to design, check and adjust communications transmitting and receiving equipment.\nProducts designed for the telecommunications industry play an increasingly important role in the Company's measurement business portfolio. Tektronix is a leading supplier of a broad range of test solutions for emerging networks, designed for ensuring integrity and optimizing performance of networks, and verifying design and assuring quality of communications equipment. Cable testers and fiber optic testers use time-domain- reflectometry techniques to locate faults in metallic and fiber optic cables. Essentially, these instruments send signals from one end of a cable and then measure the reflection time of the signals to determine the location of the fault. Cable testers and fiber optic testers are widely used in the telecommunication and cable television industries. The Company also has developed a series of products for SDH or SONET transmission testing in the telecommunications industry.\nOther measurement business products include digitizers, signal sources, curve tracers and modular lines of general purpose test instruments.\nColor Printing and Imaging Products ___________________________________\nTektronix' color printing and imaging products include color printers and related products and supplies.\nColor printers produce full color hard copies of images produced by personal computers, workstations and terminals. Most of the Company's printers are compatible with the Postscript industry standard page description language, which specifies how an image is transferred to hard copy. By adopting the Postscript\nstandard, color printers can be used in conjunction with a wide range of third-party graphics software. Tektronix produces color printers using thermal wax, phase change ink jet and dye sublimation color transfer technologies. The printers are controlled by software designed and implemented by the Company. Tektronix has developed proprietary technology that uses solid sticks of ink, of the Company's own formulation, that are melted and then jetted onto the paper. This technology produces vivid and stable images, allows printing on plain rather than coated paper and can be applied to a wide range of sizes and gauges of paper.\nThe use of color in computing and printing has been stimulated by enhancements in the underlying microprocessor technology of personal computers and workstations, by increasingly larger system and peripheral storage capabilities, and by enhancements in computer display capability. As personal computers increasingly become capable of displaying images (instead of just characters), there has been an accompanying growth in demand for printers that can print such images in color. This demand has been especially strong in certain scientific and engineering segments and in the graphic arts segment, where color has typically been a strong element of the way information is conveyed. The Company's printers are used in a number of environments, including office, graphic arts and engineering applications.\nThe purchase of a printer has typically been the second largest dollar expense of a personal computer user, second only to the basic computer system. While a substantial majority of the spending on printers has been directed to black and white (monochrome) printers, color printers have been a rapidly growing segment of the total printer market. As color printer technology advances and as prices for color printers approach the costs of higher performance monochrome printers, the market for color printers can be expected to show continued growth. In the past, there have been two significant areas of application for color printers. The first type of application is characterized by high quality output and higher prices, and color printers in this application are used to produce very high quality images that approach the quality of four-color offset printing. The second type of application is characterized by color text and images approaching the resolution of monochrome ink jet and laser printers and lower user costs. Tektronix participates primarily in the second application area, with products that range in price from approximately $3,000 (suggested list price) up to approximately $15,000. Products in the first application area typically sell for three to ten times more than the prices of the products in the second application area.\nWhile the market for color printers is currently growing rapidly, it is still much smaller than the market for\nmonochrome printers. Moreover, it is characterized by intense and increasing competition, resulting in a competitive pricing environment. Because the market for color hard copy is still small compared to the market for monochrome printers, distribution of products from manufacturer to end user is less efficient. The Company expects distribution channels to expand as color hard copy becomes a more prominent feature in computer applications.\nAlso included in color printing and imaging products are supplies for use with the Company's color printers, including inks, ribbons and paper. These supplies are a very significant source of ongoing color printing and imaging revenue.\nVideo Systems Products ______________________\nThe increasing use of television to communicate a broad array of information and entertainment has created markets for a number of products that support the development of \"content\" for distribution by television signals. As television distribution systems become more powerful, there is greater potential for increased usage via integration of computer applications with television. Those trends, coupled with the increasing use of cable and satellite to distribute content, are expanding the market for Tektronix' video systems products. These trends may result in increased demand for lower cost production products based on industry standard platforms and for systems that support the development and distribution of new forms of content, such as multimedia products.\nMost video systems products are from The Grass Valley Group, Inc. (\"Grass Valley\"), a wholly-owned subsidiary of the Company based in California that manufactures products used by the television industry for program production and distribution. Grass Valley products include studio production equipment, signal processing and distribution equipment and transmission systems. Studio production equipment is used in the creative process of television program production and assembly. Production equipment products include production switchers, special effects devices and editing controllers. Production switchers allow an operator to select signals from various sources, such as cameras, video tape recorders and network or remote transmissions, and to combine these signals into the continuous program seen by the viewing audience. Grass Valley also manufactures electronic graphics systems which are used to create video titles and graphics for use in television program production. Signal processing and distribution equipment is used in the process of moving signals within a television production facility or between facilities. Such equipment includes routing switchers, amplifiers, timing systems and signal conversion devices. Transmission systems are used in the process of transporting\nsignals between facilities. Transmission system products include fiber optic video transmitter\/receiver systems, digital video coders\/decoders, cross-connect switches and interactive conferencing systems including distance learning systems. Grass Valley's customers include the television networks, local television stations, post-production houses (which assemble commercials and television programs from recorded footage), telephone and cable companies and corporate and educational users.\nOther video systems products include the Company's new Profile (tm) product which is a disk-based, multi-channel video storage and playback system for use by television broadcasters in video library systems.\nNetwork Displays Products _________________________\nThe Company's major network displays product line is its X terminals, which are standards-based graphics terminals that also provide multiple windowing and networking capability. The Company's X terminals connect users with a host computer and other devices, such as a printer, that make up a computing system. Many X terminal applications involve a central \"server\" (containing applications and data) connected to multiple terminals, thereby allowing a number of users to access those applications and data. The Company no longer manufactures its older line of proprietary graphics terminals, but it still has a service business for its installed base for such products. This service business has continually declined as the installed base of these proprietary graphics terminals declines.\nX terminal products are based on standard architecture originally developed by the Massachusetts Institute of Technology. As a result, it is difficult for any manufacturer to develop a proprietary advantage in either the underlying hardware or in elements of the operating system. As a result, competition in the X terminals market is intense. The Company's graphics terminals have historically been used in technical applications such as mechanical engineering design, drafting and mapping. As a result, the Company has enjoyed a strong position in the technical and scientific segments of the market. Recently, the market has expanded and shifted to commercial applications from scientific and engineering applications. In accordance with this trend, recent additions to the Company's X terminal product line focus on new commercial and business applications, as well as engineering applications. Commercial customers now account for a major portion of the Company's X terminal revenues.\nManufacturing _____________\nDuring 1994, the Company sold its integrated circuits operation to Maxim Integrated Products, Inc. and transferred its hybrid circuits operation to a joint venture with Maxim, and in early 1995 completed the sale of approximately 65% of the stock of its printed circuit board operation in the initial public offering of Merix Corporation. As a result of these activities and other recent component operation divestitures, the Company's manufacturing operations are no longer highly integrated. The Company has entered into supply agreements with each of the companies now operating the respective component operations and, as a result, believes that the Company will be able to acquire the required components as needed. Other companies also manufacture special components for Tektronix.\nTektronix also purchases raw materials, components, data processing equipment and computer peripheral devices for use in its products and systems. Such purchased materials and components are generally available to Tektronix as needed. Although shortages of such items have been experienced from time to time, Tektronix believes that such shortages will not have a material adverse effect on the Company.\nTektronix owns substantially all of its manufacturing facilities. Its primary manufacturing facilities are located in or near the Portland, Oregon metropolitan area. Some of Tektronix' products, components and accessories are manufactured in Heerenveen, The Netherlands and in Hong Kong. Tektronix recently announced that it plans to transform its Heerenveen plant from a manufacturing operation to a logistics center. Grass Valley's products are manufactured near Grass Valley, California. See Item 2, \"Properties\" for a more detailed description of the Company's manufacturing facilities.\nCertain Tektronix products are assembled for the Japanese market at plants in Tokyo and Gotemba, Japan by Sony\/Tektronix Corporation, a Japanese corporation equally owned by Tektronix and Sony Corporation. Sony\/Tektronix also designs and manufactures small, lightweight portable oscilloscopes, benchtop semiconductor testers and digitizers in Japan for sale worldwide.\nSales and Distribution ______________________\nTektronix maintains its own worldwide sales engineering and field maintenance organization, staffed with technically trained personnel. Sales in the United States, Canada, Brazil, the United Kingdom, Germany, France, Italy, Spain, The Netherlands, Belgium, Sweden, Denmark, Norway, Finland, Switzerland, The Republic of Ireland, Australia, Austria, Hong Kong, Taiwan and Mexico are made primarily through field offices\nof the Company and its subsidiaries located in principal market areas. Sales in the Peoples Republic of China are made through liaison offices of a Hong Kong subsidiary of the Company. Except for Grass Valley products, sales in Japan are made by Sony\/Tektronix Corporation. Sales in India are made by Hinditron Tektronix Instruments, Ltd., an Indian company which is 40% owned by Tektronix. Many of the Company's products are sold in whole or in part through independent distributors throughout the United States and in some other countries. Certain of the Company's independent distributors also sell products manufactured by the Company's competitors. In some countries, all sales are made either directly by Tektronix or by independent representatives to whom Tektronix provides direct technical and administrative assistance. A number of the Tektronix field offices also perform major maintenance and reconditioning operations.\nTektronix' principal customers are electronic and computer equipment manufacturers, private industrial concerns engaged in commercial or governmental projects, military and nonmilitary agencies of the United States and of foreign countries, public utilities, educational institutions, radio and television stations and networks, graphics arts companies and users of sophisticated office products. Certain products are sold both to equipment users and to original equipment manufacturers.\nDuring the last fiscal year, United States Government agencies accounted directly for approximately three percent of Tektronix' consolidated sales as compared with approximately four percent for the prior year. During the last five years, direct sales to United States Government agencies ranged from three to six percent. The balance of sales during each year was distributed among several thousand other customers, with no other single customer accounting for as much as three percent. The Company believes that sales directly related to United States Government expenditures (excluding sales to the United States Government) were approximately four percent of Tektronix' consolidated sales for the last fiscal year. Contracts involving the United States Government are subject, as is customary, to termination by the Government at its convenience.\nMost Tektronix product sales are sold as standard catalog items. Tektronix attempts to fill its orders as promptly as possible. At May 28, 1994, Tektronix' unfilled product orders amounted to approximately $108 million, as compared to approximately $107 million at May 29, 1993. Tektronix expects that substantially all unfilled product orders at May 28, 1994 will be filled during its current fiscal year. Orders received by the Company are subject to cancellation by the customer.\nInternational Sales ___________________\nThe following table sets forth the breakdown between U.S. and international sales, based upon purchaser location, for each of the last three fiscal years (in thousands of dollars):\nSee \"Business Segments\" in the Notes to Consolidated Financial Statements at page 20 of the Company's 1994 Annual Report to Shareholders, containing information on sales, operating income and assets by geographic area based upon the location of the seller, which is hereby incorporated by reference.\nTektronix products are sold worldwide. European sales are made principally in Germany, France, the United Kingdom, Switzerland, Italy, Spain, Sweden, The Netherlands and Austria. Other international sales are principally in Japan, Canada and Australia. International sales include both export sales from the United States and sales by foreign subsidiaries. Fluctuating exchange rates and other factors beyond the control of Tektronix, such as the stability of international monetary conditions, tariff and trade policies and domestic and foreign tax and economic policies, affect the level and profitability of international sales. The Company is unable to predict the effect of these factors on its business. The Company hedges against certain currency exposures in order to minimize their impact.\nResearch and Development ________________________\nTektronix operates in an industry characterized by rapid technological change and research and development are important elements in its business. Expenditures during fiscal years ended May 30, 1992, May 29, 1993 and May 28, 1994 for research and development amounted to approximately $169,183,000, $157,068,000 and $153,148,000, respectively. Almost all of these funds were Company-generated.\nResearch and development activities are conducted by central research and design groups and specialized product development groups. These activities include: (i) research on basic devices and techniques (ii) the design and development of products and components and specialized equipment and (iii) the development of processes needed for production. Most of Tektronix' research and development is devoted to enhancing and developing its own products.\nPatents _______\nIt is Tektronix' policy to seek patents in the United States and appropriate foreign countries for its significant patentable developments. However, electronic equipment as complex as most Tektronix products is generally not patentable in its entirety. The Company believes that its business is not dependent to any material extent upon any particular patent or group of patents or upon any licensing arrangement.\nCompetition ___________\nThe electronics industry continues to become more competitive, both in the United States and abroad. Primary competitive factors are product performance, technology, customer service, product availability and price. Tektronix believes that its reputation in the marketplace is also a significant positive competitive factor. With respect to many of its products, the Company competes with companies that have substantially larger resources.\nTektronix is the world's largest manufacturer of oscilloscopes and no single competitor offers as complete a line. Tektronix is the leading manufacturer of test and measurement equipment for the television industry.\nTektronix has competed for a number of years in the market for logic analyzers with several companies. While a competitor has a larger market share in logic analyzers, Tektronix is the only other significant manufacturer in this relatively small segment of the instrumentation market.\nTektronix competes with a number of companies in specialized areas of other test and measurement products, and it competes with one large company that sells a broad line of test and measurement products.\nA large number of manufacturers, including computer manufacturers, compete with Tektronix in the markets for color printers and X terminals. Tektronix is a leader in the market for workgroup color printers and the leader in dye sublimation, Phase-change and thermal wax color printers. Tektronix is the fastest growing major supplier of X terminals and it now ranks third in unit sales.\nTektronix competes with a number of electronics firms that manufacture specialized equipment for the television industry, both with respect to its television test and measurement products and the products of Grass Valley. Grass Valley is the leading manufacturer of high-performance production switchers, a leading manufacturer of high-performance\ndistribution\/processing equipment and a significant factor in its other markets.\nEmployees _________\nAt May 28, 1994, Tektronix had 8,468 employees, of whom 1,390 were located in foreign countries. Tektronix' employees in the United States and most foreign countries are not covered by collective bargaining agreements. The Company believes that relations with its employees are good.\nEnvironment ___________\nThe Company's facilities are subject to numerous laws and regulations concerning the discharge of materials into the environment, or otherwise relating to protection of the environment. Compliance with these laws has not had and is not expected to have a material effect upon the capital expenditures, earnings or competitive position of the Company.\nExecutive Officers of the Company _________________________________\nThe following are the executive officers of the Company:\nThe executive officers are elected by the board of directors of the Company at its annual meeting. Executive officers hold their positions until the next annual meeting or until their successors are elected, or until such tenure is terminated by death, resignation or removal in the manner provided in the bylaws. There are no arrangements or understandings between executive officers or any other person pursuant to which the executive officers were elected and none of the executive officers are related.\nAll of the executive officers named have been employed by Tektronix in management positions for the last five years except: Mr. Jerome J. Meyer who joined Tektronix in 1990 and prior to that time served as President of the industrial business of Honeywell, Inc. (\"Honeywell\") (from 1988 to 1990), President and Chief Executive Officer of Honeywell Bull, Inc., now known as Bull HN Information Systems, Inc. (from 1987 to 1988) and a Vice President of Honeywell (from 1986 to 1987); Mr. John W. Vold who joined Tektronix in 1991 and from 1987 to 1991 was Executive Vice President of Bull HN Information Systems, Inc., and prior to that time was Vice President of the Airborne Products Division of Unisys Corporation; Mr. Timothy E. Thorsteinson who joined Tektronix in 1991 and from 1990 to 1991 was Director of Quality Performance of National Semiconductor Corporation (\"National Semiconductor\") and prior to that time held a number of management positions in human resources management at National\nSemiconductor; Mr. John P. Karalis who joined Tektronix in 1992 and prior to that time was with the law firm of Brown and Bain (from 1989 to 1992) and Vice President and General Counsel of Apple Computer, Inc. (from 1987 to 1989); Mr. Carl W. Neun who joined Tektronix in 1993 and prior to that time served as Senior Vice President of Administration and Chief Financial Officer of Conner Peripherals, Inc., (from 1987 to 1993); Mr. Delbert W. Yocam who joined Tektronix in 1992 and prior to that was an independent consultant (from 1990 to 1992) and was President of Apple Pacific (from 1988 to 1989) and Executive Vice President and Chief Operating Officer of Apple Computer, Inc. (from 1986 to 1988); Mr. Daniel Terpack who joined Tektronix in 1992 and prior to that was General Manager of Hewlett-Packard Company's Corvallis, Oregon Division, responsible for portable computation products; and Mr. William D. Walker, who is not an employee of the Company and has been a director of the Company since 1980.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nA brief description of the location and general characteristics of the significant properties occupied by Tektronix in August of 1994 is set forth below. Tektronix believes that its operations are in compliance in all material respects with requirements relating to environmental quality and energy conservation.\nTektronix owns a 265-acre industrial park (the \"Howard Vollum Park\") near Beaverton, Oregon. The Howard Vollum Park includes 23 buildings arranged in a campus-like setting and containing an aggregate of approximately 2.6 million gross square feet of enclosed floorspace. Most of the Company's central research and development and a substantial portion of its product manufacturing and administrative activities are located at Howard Vollum Park. The Company's measurement business products and television test equipment products are manufactured primarily at Howard Vollum Park. The Company leases certain excess space at the Howard Vollum Park to other corporations.\nMeasurement business operations are also conducted at three buildings, containing approximately 414,000 square feet, at the Company's 48-acre site near Aloha, Oregon, approximately five miles west of Howard Vollum Park. The Company intends to consolidate these operations with operations at Howard Vollum Park and the property is currently offered for sale as surplus.\nThe Company's Color Printing and Imaging Division, Network Displays Division and corporate headquarters occupy three buildings containing approximately 592,000 square feet on a 167-acre tract owned by the Company in Wilsonville, Oregon, approximately 16 miles south of Howard Vollum Park. An additional 192,000 square foot building on the Company's Wilsonville property is leased to another corporation.\nAll of the buildings described above were constructed after 1957 and are maintained in good condition. Warehouses, production facilities and other critical operations are protected by fire sprinkler installations. Most manufacturing, office and engineering areas are air-conditioned. The Company believes that its facilities described above are adequate for their intended uses. Capacity utilization within the Company varies between product area but, in general, the Company has the capacity to increase production substantially without adding significant plant capacity.\nTektronix owns a 240-acre site six miles east of Vancouver, Washington (Vancouver is across the Columbia River from Portland, Oregon.). The Company has leased the 488,000-square foot manufacturing facility that is situated on the site to another corporation. The property is surplus and the Company is attempting to sell it.\nTektronix owns 61 acres within an industrial park in Redmond, Oregon, about 150 miles east of Portland; 136 acres in Fairview, Oregon, about 15 miles east of Portland; and 75 acres adjacent to and west of Howard Vollum Park. At the present time, the Company is attempting to sell these parcels of undeveloped land.\nGrass Valley's operating facilities are primarily housed in ten buildings containing a total of approximately 190,000 square feet of floorspace on a 320-acre site owned by Grass Valley near Grass Valley, California, and three buildings containing a total of approximately 149,000 square feet on Grass Valley's 116-acre tract of land in the neighboring town of Nevada City.\nA 109,000-square-foot plant owned by Tektronix is located on 23 acres of land in Heerenveen, The Netherlands.\nTektronix also owns a seven-acre site in Hoddesdon, England, with manufacturing buildings containing about 47,000 square feet which is leased to another corporation. Tektronix is attempting to sell this facility.\nDomestic field offices in Santa Clara and Irvine, California; Chicago, Illinois; and Philadelphia, Pennsylvania are owned by Tektronix. Together they comprise approximately 214,000 square feet. All other Tektronix U.S. field offices, aggregating approximately 190,000 square feet, are leased.\nField offices near Cologne (101,000 square feet), London (83,000 square feet), and Sydney, Australia (23,000 square feet) are located in buildings owned by the Company. Field offices in other foreign countries occupy leased premises.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nMr. Jerome J. Lemelson has advised the Company that he believes Tektronix is infringing certain of his patents which allegedly cover such equipment or processes as bar code systems, machine vision, beam processing and IC manufacturing techniques. Mr. Lemelson's claims of infringement are primarily based on general allegations that all manufacturers, including Tektronix, which operate in certain industries must by the nature of their activities be infringing Mr. Lemelson's patents. Tektronix has had ongoing communications with Mr. Lemelson's representatives in an effort to obtain more specific information regarding the activities Mr. Lemelson believes are infringing. The Company is still investigating Mr. Lemelson's claims to determine if they may relate to any of the Company's equipment, products or processes. The Company believes that ultimate resolution of these claims will not have a material adverse effect on its financial position or results of operation.\nThere are no other material pending legal proceedings.\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.\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 included on page 26 of the Company's 1994 Annual Report to Shareholders and is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information required by this item is included on page 27 of the Company's 1994 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 by this item is included on pages 10 through 13 of the Company's 1994 Annual Report to Shareholders 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 included on pages 14 through 26 of the Company's 1994 Annual Report to Shareholders and is incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe information required by this item regarding Directors is included under \"Board of Directors\" and \"Election of Directors\" on pages 3 to 7 of the Company's Proxy Statement dated August 3, 1994.\nThe information required by this item regarding officers is contained under \"Executive Officers of the Company\" in Item 1 of Part I hereof.\nThe information required by Item 405 of Regulation S-K is included under \"Compliance with Section 16(a) of the Exchange Act\" on page 26 of the Company's Proxy Statement dated August 3, 1994.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information required by this item is included under \"Directors' Compensation\" and \"Executive Compensation\" on pages 7 to 13 of the Company's Proxy Statement dated August 3, 1994.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information required by this item is included under \"Ownership of Shares\" and \"Election of Directors\" on page 2 and 4 to 7 of the Company's Proxy Statement dated August 3, 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) Financial Statements. ____________________\nThe following documents are included in the Company's 1994 Annual Report to Shareholders at the pages indicated and are incorporated herein by reference:\n(2) Financial Statement Schedules. _____________________________\nThe following schedules and independent auditors' consent and report are filed herewith:\nSchedule II -- Amounts Receivable from Related Parties Schedule V -- Property, Plant and Equipment Schedule VI -- Accumulated Depreciation and Amortization of Property, Plant and Equipment Schedule IX -- Short-Term Borrowings Schedule X -- Supplementary Income Statement Information Independent Auditors' Consent and Report on Schedules All other schedules are omitted as the required information is inapplicable or is presented in the financial statements or related notes thereto.\nSeparate financial statements for the registrant have been omitted because the registrant is primarily an operating company and the subsidiaries included in the consolidated financial statements are substantially totally held. All subsidiaries of the registrant are included in the consolidated financial statements. Summarized financial information for 50 percent or less owned persons in which the registrant has an interest is included in the Notes to Consolidated Financial Statements appearing in the Company's Annual Report to Shareholders.\n(3) Exhibits:\n(3)(i) Restated Articles of Incorporation, as amended. Incorporated by reference to Exhibit (3) of Form 10-Q dated September 28, 1990, SEC File No. 1-4837.\n(ii) Bylaws, as amended.\n(4)(i) Indenture dated as of November 16, 1987, as amended by First Supplemental Indenture dated as of July 13, 1993, covering the registrant's 7-1\/2% notes due August 1, 2003. Indenture incorporated by reference\nto Exhibit 4(i) of Form 10-K dated August 22, 1990, SEC File No. 1-4837.\n(ii) Pursuant to Item 601(b)(4)(iii) of Regulation S-K, the registrant agrees to furnish to the Commission upon request copies of agreements relating to other indebtedness.\n(10)(i) Restated Operating Performance Incentive Plan, as amended. Incorporated by reference to Exhibit (10)(i) of Form 10-Q dated April 15, 1988, SEC File No. 1-4837.\n(ii) 1982 Stock Option Plan, as amended. Incorporated by reference to Exhibit 10(iii) of Form 10-K dated August 22, 1989, SEC File No. 1-4837.\n(iii) Stock Incentive Plan, as amended. Incorporated by reference to Exhibit 10(ii) of Form 10-Q dated April 9, 1993, SEC File No. 1-4837.\n(iv) Restated Annual Performance Improvement Plan. Incorporated by reference to Exhibit 10(i) of Form 10-Q dated April 9, 1993, SEC File No. 1-4837.\n(v) Restated Deferred Compensation Plan. Incorporated by reference to Exhibit 10(i) of Form 10-Q dated December 20, 1984, SEC File No. 1-4837.\n(vi) Retirement Equalization Plan, as amended. Incorporated by reference to Exhibit 10(vii) of Form 10-K dated August 18, 1993, SEC File No. 1-4837.\n(vii) Severance Agreement entered into between the Company and its named officers. Incorporated by reference to Exhibit 10(viii)of Form 10-K dated August 18, 1993, SEC File No. 1-4837.\n(viii) Indemnity Agreement entered into between the Company and its named officers and directors. Incorporated by reference to Exhibit 10(ix) of Form 10-K dated August 18, 1993, SEC File No. 1-4837.\n(ix) Executive Severance Agreement.\n(x) Retention Incentive Agreement.\n(xi) Executive Compensation and Benefits Agreement dated as of October 24, 1990. Incorporated by reference to Exhibit (10)(ii) of Form 10-Q dated December 21, 1990, SEC File No. 1-4837.\n(xii) Executive Compensation and Benefits Agreement dated as of October 1, 1992. Incorporated by reference to Exhibit (10)(iii) of Form 10-Q dated January 8, 1993, SEC File No. 1-4837.\n(xiii) Employment Letter Agreement dated September 1, 1992.\n(xiv) Executive Compensation and Benefits Agreement dated as of March 29, 1993.\n(xv) Rights Agreement dated as of August 16, 1990. Incorporated by reference to Exhibit 1 of Form 8-K dated August 27, 1990, SEC File No. 1-4837.\n(xvi) Non-Employee Directors' Deferred Compensation Plan.\n(13) Portions of the 1994 Annual Report to Shareholders that are incorporated herein by reference.\n(21) Subsidiaries of the registrant.\n(24) Powers of Attorney.\n(b) No reports on Form 8-K have been filed during the last quarter of the period covered by this Report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTEKTRONIX, INC.\nBy \/s\/ Carl W. Neun _______________________________ Carl W. Neun Vice President and Chief Financial Officer\nDated: August 11, 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' CONSENT AND REPORT ON SCHEDULES\nWe consent to the incorporation by reference in Registration Statements No. 33-33496 and 33-30648 of Tektronix, Inc. on Form S-8 and Registration Statements No. 33-18658 and 33-59648 of Tektronix, Inc. on Form S-3 of our reports dated June 23, 1994 (which expresses an unqualified opinion and includes an explanatory paragraph relating to a change in method of accounting for other postretirement benefits and income taxes in the year ended May 29, 1993), incorporated by reference in this Annual Report on Form 10-K of Tektronix, Inc. for the year ended May 28, 1994.\nOur audits of the financial statements referred to in our aforementioned report also included the financial statement schedules of Tektronix, Inc. listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE\nPortland, Oregon June 23, 1994\nSCHEDULE II\nThe balance at the beginning of 1992 included two promissory notes guaranteed by Stephen H. Vollum. The notes were paid in full in the fiscal year ended May 30, 1992.\nSCHEDULE V\nSCHEDULE VI\nSCHEDULE IX\nThe average borrowings were determined based on the amounts outstanding at each accounting period-end. Average interest rates were computed using interest rates and amounts outstanding at accounting period-ends.\nSCHEDULE X\nEXHIBIT LIST\n(3)(i) Restated Articles of Incorporation, as amended. Incorporated by reference to Exhibit (3) of Form 10-Q dated September 28, 1990, SEC File No. 1-4837.\n(ii) Bylaws, as amended.\n(4)(i) Indenture dated as of November 16, 1987, as amended by First Supplemental Indenture dated as of July 13, 1993, covering the registrant's 7-1\/2% notes due August 1, 2003. Indenture incorporated by reference to Exhibit 4(i) of Form 10-K dated August 22, 1990, SEC File No. 1-4837.\n(ii) Pursuant to Item 601(b)(4)(iii) of Regulation S-K, the registrant agrees to furnish to the Commission upon request copies of agreements relating to other indebtedness.\n(10)(i) Restated Operating Performance Incentive Plan, as amended. Incorporated by reference to Exhibit (10)(i) of Form 10-Q dated April 15, 1988, SEC File No. 1-4837.\n(ii) 1982 Stock Option Plan, as amended. Incorporated by reference to Exhibit 10(iii) of Form 10-K dated August 22, 1989, SEC File No. 1-4837.\n(iii) Stock Incentive Plan, as amended. Incorporated by reference to Exhibit 10(ii) of Form 10-Q dated April 9, 1993, SEC File No. 1-4837.\n(iv) Restated Annual Performance Improvement Plan. Incorporated by reference to Exhibit 10(i) of Form 10-Q dated April 9, 1993, SEC File No. 1-4837.\n(v) Restated Deferred Compensation Plan. Incorporated by reference to Exhibit 10(i) of Form 10-Q dated December 20, 1984, SEC File No. 1-4837.\n(vi) Retirement Equalization Plan, as amended. Incorporated by reference to Exhibit 10(vii) of Form 10-K dated August 18, 1993, SEC File No. 1-4837.\n(vii) Severance Agreement entered into between the Company and its named officers. Incorporated by reference to Exhibit 10(viii)of Form 10-K dated August 18, 1993, SEC File No. 1-4837.\n(viii) Indemnity Agreement entered into between the Company and its named officers and directors. Incorporated by reference to Exhibit 10(ix) of Form 10-K dated August 18, 1993, SEC File No. 1-4837.\n(ix) Executive Severance Agreement.\n(x) Retention Incentive Agreement.\n(xi) Executive Compensation and Benefits Agreement dated as of October 24, 1990. Incorporated by reference to Exhibit (10)(ii) of Form 10-Q dated December 21, 1990, SEC File No. 1-4837.\n(xii) Executive Compensation and Benefits Agreement dated as of October 1, 1992. Incorporated by reference to Exhibit (10)(iii) of Form 10-Q dated January 8, 1993, SEC File No. 1-4837.\n(xiii) Employment Letter Agreement dated September 1, 1992.\n(xiv) Executive Compensation and Benefits Agreement dated as of March 29, 1993.\n(xv) Rights Agreement dated as of August 16, 1990. Incorporated by reference to Exhibit 1 of Form 8-K dated August 27, 1990, SEC File No. 1-4837.\n(xvi) Non-Employee Directors' Deferred Compensation Plan.\n(13) Portions of the 1994 Annual Report to Shareholders that are incorporated herein by reference.\n(21) Subsidiaries of the registrant.\n(24) Powers of Attorney.","section_15":""}
{"filename":"277638_1994.txt","cik":"277638","year":"1994","section_1":"ITEM 1. BUSINESS ------ ------ -------- GENERAL. The Davey Tree Expert Company, which was incorporated in 1909, and its subsidiaries (the \"Registrant\") are in the business of providing horticultural services to a variety of residential, corporate, institutional and governmental customers. Horticultural services include the treatment, preservation, maintenance, cultivation, planting and removal of trees, shrubs and other plant life and also include the practices of landscaping, tree surgery, tree feeding, tree spraying, interior plant installation and maintenance, line clearing for public utilities, and related consultation services. Horticultural services also involve the application of scientifically formulated fertilizers, herbicides and insecticides with hydraulic spray equipment on residential and commercial lawns.\nCOMPETITION AND CUSTOMERS. The Registrant is one of the largest national organizations in the private horticultural services industry. The Registrant competes with other national and local firms with respect to its services, although the Registrant believes that no other firm, whether national or local, offers the range of services that it offers.\nCompetition in private horticultural services is generally localized but very active and widespread. The principal methods of competition are advertising, customer service, image, performance and reputation. The Registrant's program to meet its competition stresses the necessity for its employees to have and project to the customers a thorough knowledge of horticulture and utilization of modern, well-maintained equipment. Pricing is not always a critical factor in a customer's decision. Pricing is, however, the principal method of competition in providing horticultural services to utility customers, although in most instances consideration is given to reputation and past production performance.\nThe Registrant provides a wide range of horticultural services to private companies, public utilities, local, state and Federal agencies, and a variety of industrial, commercial and residential customers. During 1994, the Registrant had sales of approximately $27,000,000 (13% of total sales) to Pacific Gas & Electric Company, and approximately $24,000,000 (11% of total sales) to Allegheny Power Company.\nREGULATION AND ENVIRONMENT. The Registrant's facilities and operations, in common with those of the industry generally, are subject to governmental regulations designed to protect the environment. This is particularly important with respect to the Registrant's services regarding insect and disease control, because these services involve to a considerable degree the blending and application of spray materials, which require formal licensing in most areas. The constant changes in environmental conditions, environmental awareness, technology and social attitudes make it necessary for the Registrant to maintain a high degree of awareness of the impact such changes have on the market for its services. The Registrant believes that it is in compliance with existing Federal, state and local laws regulating the use of materials in its spraying operations as well as the other aspects of its business that are subject to any such regulation. Sequential page 3 of 38\nMARKETING. The Registrant solicits business from residential and commercial customers principally through direct mail programs and to a lesser extent through the placement of advertisements in national magazines and trade journals and in local newspapers and \"yellow pages\" telephone directories. Business from utility customers is obtained principally through negotiated contracts and competitive bidding. All sales and services are carried out through personnel who are direct employees. The Registrant does not use agents and does not franchise its name or business.\nSEASONALITY. The Registrant's business is highly seasonal, primarily due to extreme fluctuations in horticultural services provided to residential and commercial customers. Because of this seasonality, the Registrant has historically incurred losses in the first quarter, while sales and earnings are generally highest in the second and third quarters of the calendar year. Consequently, this has created heavy demands for additional working capital at various times throughout the year. The Registrant borrows primarily against bank commitments in the form of lines of credit and a revolving credit agreement, as well as several term notes, to provide the necessary funds.\nOTHER FACTORS. Rapid changes in equipment technology require a constant updating of equipment and processes to ensure competitive services to the Registrant's clients. Also, the Registrant must continue to assure its compliance with the Occupational Safety and Health Act. In keeping with these requirements, and to equip the Registrant for continued growth, capital expenditures in 1994 and 1993 were approximately $8,598,000 and $15,887,000, respectively.\nThe Registrant owns several trademarks including \"Davey\", \"Davey and design\", \"Arbor Green\", \"Davey Tree and design\", \"Davey Expert Co. and design\" and \"Davey and design (Canada)\". Through substantial advertising and use, the Registrant is of the opinion that these trademarks have become of value in the identification and acceptance of its products and services.\nEMPLOYEES. The Registrant employs between 4,800 and 5,200 persons, depending upon the season, and considers its employee relations to be good.\nFOREIGN AND DOMESTIC OPERATIONS. The Registrant and its Canadian subsidiaries sell the Registrant's service to customers in the United States and Canada.\nThe Registrant does not consider its foreign operations to be material and considers the risks attendant to its business with foreign customers, other than currency exchange risks, to be not materially different from those attendant to business with its domestic customers.\nSequential page 4 of 38\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table lists certain information with respect to major properties owned by the Registrant and used in connection with its operations.\nThe Registrant also rents approximately 40 other premises for office, warehouse and storage use. The Registrant believes that all of these properties have been adequately maintained and are suitable and adequate for its business as presently conducted.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. ------ ----------------- There are no legal proceedings, other than ordinary routine litigation incidental to the business, to which the Registrant or any of its subsidiaries is a party or of which any of their property is the subject. This routine litigation is not material to the Registrant. Sequential page 5 of 38\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, through the solicitation of proxies or otherwise.\nExecutive Officers of the Registrant (included pursuant to Instruction 3 to paragraph (b) of Item 401 of Regulation S-K). The executive officers of the Registrant and their present positions and ages are as follows:\nSequential page 6 of 38\nMr. Cowan was elected President and Chief Executive Officer in May 1988 and prior to that time served as President and Chief Operating Officer.\nMr. Adante was elected Executive Vice President, Chief Financial Officer and Secretary-Treasurer in May 1993. He served as Vice President, Chief Financial Officer and Secretary-Treasurer from July 1992 to June 1993. Prior to that time, he served as Vice President, Chief Financial Officer and Secretary since before 1990.\nMr. Warnke was elected Executive Vice President and General Manager-Utility Services in May 1993. Prior to that time, he served as Vice President and General Manager-Utility Services since before 1990.\nMr. Bowles was elected Vice President and General Manager of Davey Tree Surgery Company in January 1992. From that date and since before 1990, he served as Vice President and Co-General Manager.\nMr. Celmer was elected Vice President and General Manager - Residential Services in January, 1995. He served as Vice President-Eastern Operations, Residential and Commercial Services from January 1992 to January 1995. Prior to that time, he served as Vice President-Operations, Residential and Commercial Services since before 1990.\nMr. Comport was elected Corporate Controller in May 1990. Prior to that time and since before 1990, he served as Vice President-Finance and Administration for G & R Felpauch Company, a comparable-size retail supermarket chain.\nDr. Funk was elected Vice President-Human Technical Resources in January 1984.\nMs. Nicholas was elected Assistant Secretary in May 1982.\nMr. Ober was elected Vice President-New Ventures in March 1986.\nMr. Ramsey was elected Vice President and General Manager-Commercial Services in January, 1995. He served as Vice President-Western Operations, Residential and Commercial Services from January 1992 to January 1995. Prior to that time, he served as Vice President and Co- General Manager of Davey Tree Surgery Company since before 1990.\nMr. Shope was elected Vice President and General Manager-Residential and Commercial Services in January 1984. He retired effective December 24, 1994.\nMr. Parker was elected Vice President - Northern Operations, Utility Services in May, 1994. Prior to that time and since before 1990, he served in several positions in utility operations.\nOfficers of the Registrant serve for a term of office from the date of their election to the next organizational meeting of the Board of Directors and until their respective successors are elected. Sequential page 7 of 38\nPART II ------- ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. ------- ----------------------------------------------------------------------\nAt December 31, 1994, 1993, and 1992 the number of Common Shares issued were 4,364,220 for each date. At those respective dates, the number of shares in the treasury were 1,921,217, 1,852,050 and 1,816,307.\nThe Registrant's Common Shares are not listed or traded on an established public trading market and market prices are, therefore, not available. Semi-annually, for purposes of the Registrant's Employee Stock Ownership Trust (\"ESOT\"), the fair market value of the Registrant's Common Shares, based upon the Registrant's performance and financial condition, is determined by an independent financial consulting firm.\nAs of March 22, 1995, there were 1,632 record holders of the Registrant's Common Shares. During the years ended December 31, 1994, December 31, 1993 and December 31, 1992, the Registrant paid dividends of $.13, $.12, and $.11, respectively, per share in each of the four quarters. The Registrant's agreements with its lenders provide that the payment of cash dividends during any year may not exceed the lesser of (a) 30% of the average of annual net earnings (as defined) for the prior three years or (b) 10% of consolidated net worth (as defined) as at the first day of that year. (See Note 4 to the Financial Statements on page of this Annual Report on Form 10-K.)\nItem 6.","section_6":"Item 6. Selected Financial Data. ------- -----------------------\nSequential page 8 of 38\nNet earnings and net earnings per common share presented for 1991 include both the cumulative effect on prior years of changing to the new standard of accounting for income taxes and the change to the 150% declining balance method of depreciation. The cumulative effect increased net earnings by $606,000 and net earnings per common share by $.22. The change in depreciation method increased net earnings by $253,000 and net earnings per share by $.09.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ------- ---------------------------------------------------------------- RESULTS OF OPERATIONS. ---------------------\nLIQUIDITY AND CAPITAL RESOURCES ------------------------------- In fiscal 1994, operating activities generated $16,205,000 in cash, a decrease of $1,897,000 when compared with the $18,102,000 generated in 1993. The decrease was primarily attributable to lower net earnings.\nNet earnings declined $2,017,000 to $4,039,000 mainly due to budget reductions on existing utility operations and discontinued utility operations experienced in the ordinary course of competitive bidding. The decrease in utility revenues was partially recovered through revenue increases in Residential, Commercial and other services. Despite these partial recoveries in revenues, the Registrant's profit margins on several utility contracts retained during the competitive bidding process have narrowed in comparison to previous contracts. Accordingly, revenues and earnings were lower than in 1993. Subsequent to December 31, 1994, the Registrant was successful in renewing an expiring three year contract with a major utility customer. The new four year contract is anticipated to generate $15,400,000 in revenues on an annualized basis.\nAccounts receivable increased $1,025,000, which was $2,178,000 lower than the $3,203,000 increase experienced in 1993. The increase in accounts receivable, coupled with the decline in revenues, caused average days outstanding to rise 2.3 days to 54.5 days. Efforts by the Registrant to reduce both days and dollars to a more acceptable level were hindered in part due to organizational and administrative changes which commenced in 1993 at several utility customers, as well as slower payment cycles initiated by some commercial and residential customers. At February 28, 1995, the Registrant's accounts receivable declined $3,058,000 to $26,255,000 and days outstanding dropped slightly to 53.7 days, still 1.4 days higher than in February, 1994, but .8 days lower than the level at December 31, 1994. The Registrant is not concerned as to the collectibility of accounts, and therefore, considers no allowance necessary; however, it will continue to focus its efforts to attain permanent reductions in both days and dollars outstanding. Sequential page 9 of 38\nAccounts payable and accrued liabilities increased $962,000, a $1,584,000 change from last year's decrease of $622,000. This was primarily due to an increase in the current portion of self-insured workers' compensation reserves, partially offset by a reduction in accounts payable. Overall, workers' compensation reserves increased as a result of changes in estimated claims costs, and the Registrant's continued movement into self insurance in most states. These factors, as well as accruals related to the Registrant's retrospectively rated policies, also contributed to the $1,839,000 increase in insurance liabilities in 1994. (See Note 1 to the Financial Statements on page of the Annual Report on Form 10-K.) The decrease in accounts payable was primarily attributable to equipment purchases entered into during the fourth quarter of 1993 which, due to capital budget reductions, did not occur in the current year.\nOther liabilities declined $879,000, a change of $1,236,000 when compared to the increase of $357,000 in 1993. This change was primarily due to a decrease in income taxes payable, the result of lower earnings.\nInvesting activities used $9,408,000, a decrease of $6,188,000 when compared to the $15,596,000 used in the prior year. The decrease was primarily attributable to a $7,289,000 reduction in the Registrant's 1994 capital expenditures, due to the changes experienced on some of its utility contracts. This reduction was partially offset by a deposit paid for the acquisition of the B. D. Wilhelm Company, a residential and commercial tree and lawn care company in Denver, Colorado. The Registrant expects that this acquisition will be consummated during 1995. Despite the reduction in 1994 capital expenditures, the Registrant believes the budget of approximately $12,000,000 for 1995 remains consistent with its plan to expand other services, maintain equipment on existing operations, and provide for the ongoing purchase of land and branch office facilities.\nDuring 1994, the Registrant's financing activities used $6,846,000, an increase of $4,675,000 over 1993. The major item contributing to this change was a net reduction of the Registrant's long-term debt, principally the amount due under its revolving credit agreement. To a lesser extent, the increase in cash used in financing activities was impacted by additional funds required to repurchase common shares of the Registrant.\nAt December 31, 1994, the Registrant's principal source of liquidity consisted of $973,000 in cash and cash equivalents; short term lines of credit and amounts available to be borrowed from banks via notes payable totaling $12,285,000, of which $9,000,000 had been drawn at December 31, 1994; and a revolving credit agreement with a bank in the amount of $15,000,000, of which $2,700,000 had been drawn at December 31, 1994. Including the term note agreement of $12,000,000, the Registrant's credit facilities now total $39,285,000. The Registrant believes its available credit will exceed credit requirements, and that its liquidity is adequate.\nLiquidity Measurements\nManagement uses these measurements to gauge the Registrant's ability to meet current working capital requirements and the extent by which capital expenditures are funded by internally generated \"cash flow\". Sequential page 10 of 38\nLeverage Measurements ---------------------\nThese ratios measure the extent to which the Registrant has been financed by debt, or, put another way, the proportion of the total assets employed in the business that have been provided by creditors as compared to shareholders. Debt is defined as total liabilities.\nAt the end of 1994 these measurements improved slightly relative to 1993 and 1992. Those two years were affected by the additional borrowings incurred in 1992 to fund capital expenditures required by new utility contracts, in contrast with lower long-term debt resulting from reductions in those expenditures in 1994.\nCommon Share Measurements -------------------------\nThese measurements assist shareholders in assessing the Registrant's earnings performance, dividend payout and equity position as related to their shareholdings.\nSequential page 11 of 38\nEarnings per share measurements are shown as if all outstanding stock options had been exercised at December 31 of the years presented. Dividends were again increased in 1994. In 1994, they were increased $.04 per share or 8% over 1993, compared to an increase in 1993 of $.04 per share and 9% over 1992. It is the Registrant's objective to provide a fair return on investment to its shareholders through improved dividends as long as the Registrant can financially justify this policy. The fact that dividends have increased each year since 1979 reflects that objective.\nAsset Utilization Measurements ------------------------------\nManagement uses these measurements to evaluate its efficiency in employing assets to generate revenues and returns.\nAsset turnover decreased slightly to 2.1 from 2.3 in 1993 and 2.5 in 1992. Although Management anticipated that the return on average assets would remain lower than desired in the intermediate term because of a continuing commitment to acquire facilities for its Residental\/Commercial operations, discontinued utility operations and particularly due to the investment required in 1992 for the new utility contracts, the Registrant's long term goal remains that of achieving an asset turnover rate of at least 3.0 and improving the net earnings percentage to provide a return on assets of between 12% and 15%.\nRESULTS OF OPERATIONS ---------------------\nRevenues of $212,669,000 in 1994 decreased $8,949,000 or 4.0%, compared to a 6.1% and 11.5% increase in revenues in 1993 and 1992, respectively. Utility revenues decreased $16,788,000, offset by a $7,839,000 sales increase in Residential, Commercial and other services. Utility revenues were affected primarily by the contracts lost in the ordinary course of competitive bidding, and other discontinued contracts cited earlier in this discussion. Residential, Commercial, and other revenues improved as a result of heightened sales efforts and improved economic conditions generally. The Registrant anticipates that 1995 revenues will approximate levels attained in 1993.\nOperating costs of $145,108,000 declined $5,311,000 when compared to 1993, but as a percentage of revenues increased .3% to 68.2%. The percentage increase in operating costs was driven in part by equipment transportation and repair costs incurred in relocating equipment to alternate utility customer sites. Also, an increase in materials costs associated with additional commercial landscape contracts, as well as pricing concessions without commensurate labor concessions on certain utility contracts, contributed to the higher percentage costs. The Registrant does not anticipate that these costs will reoccur in 1995; accordingly, it expects that 1995 operating costs will be slightly lower as a percentage of sales then in 1994. Sequential page 12 of 38\nSelling costs increased 1.3% as a percentage of revenues to 12.9%, or $1,783,000 to $27,431,000. The increase was primarily attributable to higher branch office, relocation, and supervision expenses.\nGeneral and Administrative expenses of $17,436,000 declined $1,748,000 or .4% to 8.2% as a percentage of revenues. The decrease was accomplished primarily through corporate cost reductions, and to a lesser extent lower administrative incentives, the result of lower earnings.\nDepreciation and amortization expense of $13,354,000 was $398,000 lower than last year, but as a percentage of revenues increased .1% to 6.3%. The year-to-date percentage increase is primarily attributable to equipment idled during the interim period between the loss of certain utility contracts and the start of replacement contracts. The Registrant anticipates that depreciation expense will approximate $13,500,000 in 1995.\nInterest expense increased $205,000 to $2,752,000, or .1% to 1.3% as a percentage of sales. The increase is primarily a function of higher overall effective interest rates.\nAs a result of the above factors, earnings before income taxes were $6,788,000 or 3.2% of revenues, compared to $10,031,000 or 4.5%, and $8,302,000 or 4.0%, in 1993 and 1992, respectively.\nEffective income tax rates of 40.5%, 39.6%, and 39.2% were used to compute tax provisions for 1994, 1993, and 1992, respectively.\nAccordingly, net earnings for the year of $4,039,000 were $2,017,000 lower than in 1993, and as a percentage of revenues declined to 1.9% compared to 2.7% in the previous year.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. ------- ---------------------------------------------------------\nThe independent auditors' report, the audited consolidated financial statements, and the notes to the audited consolidated financial statements required by this Item 8 appear on pages through 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. ---------------------\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 Part I of this Report for information as to executive officers of the Registrant.\nThe information regarding directors of the Registrant appearing under the heading \"Election of Directors\" in the Registrant's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders is hereby incorporated by reference. Sequential page 13 of 38\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. ------- ----------------------\nThe information regarding compensation of the Registrant's executive officers appearing under the heading \"Remuneration of Executive Officers\" in the Registrant's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders is hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. -------- --------------------------------------------------------------\nThe information regarding the security ownership of certain beneficial owners and management appearing under the heading \"Ownership of Common Shares\" in the Registrant's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. -------- -----------------------------------------------\nThe information regarding certain relationships and related transactions appearing under the headings \"Election of Directors\" and \"Indebtedness of Management\" in the Registrant's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders is hereby incorporated by reference.\nPART IV ------- ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. -------- -----------------------------------------------------------------\n(a) (1) and (a) (2) Financial Statements and Schedules. See the Index to Financial Statements and Financial Statement Schedules on page of this Annual Report on Form 10-K.\n(a) (3) Exhibits. See the Index to Exhibits on sequentially numbered page 15 of this Annual Report on Form 10-K.\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 Annual Report on Form 10-K. Sequential page 14 of 38\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 Annual Report on Form 10-K to be signed on its behalf by the undersigned thereunto duly authorized.\nTHE DAVEY TREE EXPERT COMPANY\nBy:\/s\/ R. D. Cowan --------------------------- R. D. Cowan, President and Chief Executive Officer\nMarch 30, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 30, 1995.\n\/s\/ J. W. JOY \/s\/ JAMES H. MILLER -------------------------------- ------------------------------- J. W. JOY, Director and JAMES H. MILLER, Director Chairman of the Board\n\/s\/ R. DOUGLAS COWAN \/s\/ THOMAS G. MURDOUGH, JR. -------------------------------- ------------------------------- R. DOUGLAS COWAN, Director; THOMAS G. MURDOUGH, JR., Director President and Chief Executive Officer (Principal Executive \/s\/ JAMES H. POHL, Director and Operating Officer) ------------------------------- JAMES H. POHL, Director\n\/s\/ R. CARY BLAIR \/s\/ J MAURICE STRUCHEN -------------------------------- ------------------------------- R. CARY BLAIR, Director J MAURICE STRUCHEN, Director\n\/s\/ RICHARD E. DUNN \/s\/ DAVID E. ADANTE -------------------------------- ------------------------------- RICHARD E. DUNN, Director DAVID E. ADANTE, Executive Vice President, Chief Financial Officer and Secretary-Treasurer (Principal Financial Officer) \/s\/ WILLIAM D. GINN -------------------------------- WILLIAM D. GINN, Director\n\/s\/ RICHARD S. GRAY \/s\/ BRADLEY L COMPORT -------------------------------- ------------------------------- RICHARD S. GRAY, Director BRADLEY L COMPORT, Corporate Controller (Principal Accounting Officer) \/s\/ EUGENE W. HAUPT -------------------------------- EUGENE W. HAUPT, Director Sequential page 15 of 38\nINDEX OF EXHIBITS ----------------- [ITEM 14(a) (3)]\nSequential page 16 of 38\nThe documents listed as Exhibits 10(a), 10(b), and 10(c) constitute management contracts or compensatory plans or arrangements. Sequential page 17 of 38\nEXHIBIT 21\nSUBSIDIARIES OF THE REGISTRANT\nThe Registrant has three wholly-owned subsidiaries, Davey Tree Surgery Company (incorporated in California), Plantasia, Inc., (incorporated in Ohio), and Davey Tree Expert Co. of Canada, Limited (incorporated in Canada), each of which does business under its corporate name.\nSequential page 18 of 38\nExhibit 23 ----------\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Registration Statement Nos. 2-73052, as amended, 2-77353, 33-5755 and 33-21072 on Forms S-8 relating to The Davey Tree Expert Company 1980 Employee Stock Option Plan, The Davey Tree Expert Company 1982 Employee Stock Option Plan, The Davey Tree Expert Company 1985 Incentive Stock Option Plan and The Davey Tree Expert Company 1987 Incentive Stock Option Plan and in Registration Statement No. 33-30970 on Form S-2 relating to The Davey Tree Expert Company 1989 Stock Subscription Plan and in the related Prospectuses, of our report dated February 17, 1995, appearing in this Annual Report on Form 10-K of The Davey Tree Expert Company for the year ended December 31, 1994.\n\/s\/ DELOITTE & TOUCHE LLP Akron, Ohio March 27, 1995 Sequential page 19 of 38\nSequential page 20 of 38\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors The Davey Tree Expert Company Kent, Ohio\nWe have audited the accompanying consolidated balance sheets of The Davey Tree Expert Company and subsidiary companies as of December 31, 1994, 1993, and 1992, and the related consolidated statements of net earnings, 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 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, such consolidated financial statements present fairly, in all material respects, the financial position of The Davey Tree Expert Company and subsidiary companies as of 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.\n\/s\/ Deloitte & Touche LLP Deloitte & Touche LLP Akron, Ohio February 17, 1995\nSequential page 21 of 38\nTHE DAVEY TREE EXPERT COMPANY AND SUBSIDIARY COMPANIES\nCONSOLIDATED BALANCE SHEETS --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nSequential page 22 of 38\nSequential page 23 of 38\nSee notes to consolidated financial statements.\nSequential page 24 of 38\nSee notes to consolidated financial statements.\nSequential page 25 of 38\nSequential page 26 of 38\nSee notes to consolidated financial statements.\nSequential page 27 of 38\nTHE DAVEY TREE EXPERT COMPANY AND SUBSIDIARY COMPANIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 31,1994 ________________________________________________________________________________\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of The Davey Tree Expert Company and its wholly owned subsidiary companies.\nFISCAL YEAR - The Company's fiscal year ends on the Saturday closest to December 31; 1994 and 1993 were fiscal years comprised of 52 weeks ended December 31, 1994 and January 1, 1994, respectively, while 1992 was a 53 week year ended January 2, 1993. For presentation purposes, all years were presumed to have ended on December 31.\nCASH AND CASH EQUIVALENTS, ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE - Carrying amounts approximate fair value due to the short maturity of these instruments. Cash equivalents are highly liquid investments with maturities of three months or less when purchased.\nACCOUNTS RECEIVABLE - No allowance was considered necessary for any of the years presented.\nINTANGIBLE ASSETS represent goodwill, employment contracts, client lists and similar assets resulting from business acquisitions and are being amortized on a straight-line basis over their estimated useful lives ranging from 3 to 20 years.\nPROPERTY AND EQUIPMENT - The Company records property and equipment at cost. Generally, land improvements, leasehold improvements and buildings are depreciated by the straight-line method while the declining balance method is used for equipment. The estimated useful lives used in computing depreciation are: land improvements, 5-20 years; buildings and leasehold improvements, 5-40 years; equipment, 3-10 years.\nINSURANCE - The Company manages its casualty liability exposures primarily by utilizing two funding methods. For workers' compensation it is substantially self-insured. For auto, general liability, and some workers' compensation it is insured under policies which require payment of premiums that are subject to retrospective adjustment by the insurance company. The premiums are affected by several factors, including the safety record and experience of both the Company and the industry, and economic conditions. Under both methods, the Company generally retains the first $350,000 in loss per occurrence and carries excess insurance above that amount. With respect to workers' compensation, the Company's risk of exposure to loss per occurrence may be less than $350,000 depending on the nature of the claim and the statutes in effect by state.\nUnder both funding methods, insurance liabilities are determined using actuarial methods and assumptions to estimate ultimate costs. These liabilities include a large number of claims for which the ultimate costs will develop over a period of several years. Accordingly, the estimates can change as claims mature. Changes in estimates of claim costs resulting from new information received will be recognized in income in the period in which the estimates are changed. Expenses that are unallocable to specific claims are recognized as costs in the year incurred.\nSequential page 28 of 38\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nThe gross liability for the self-insured workers' compensation reserves and the net accrual for retrospectively rated premiums was approximately $9,785,000 at December 31, 1994, and $6,635,000 at December 31, 1993. The change in funding methods was the principal factor contributing to the increase. The present value of those liabilities, which is discounted at 5 1\/2% and 4% respectively, was $8,393,000 and $6,046,000. The change in the discount rate reduced insurance costs by $300,000 in 1994. The discounted self-insurance reserves and accruals related to the retrospectively rated policies have been combined and are classified as current and noncurrent liabilities and assets in the accompanying balance sheets based on the timing of future estimated cash payments and receipts.\nRECLASSIFICATIONS have been made to the prior-year financial statements to conform to the current year presentation.\n2. COMMON AND PREFERRED SHARES\nThe Company has authorized a class of 4,000,000 preferred shares, no par value, of which none were issued.\nThe number of common shares authorized is 12,000,000, par value $1.00. At December 31, 1994, 1993 and 1992, the number of common shares issued was 4,364,220, and the number of shares in the treasury were 1,921,217, 1,852,050 and 1,816,307, respectively.\nThe Company's stock is not listed or traded on an active stock market and market prices are, therefore, not available. Semi-annually, an independent financial consulting firm determines the fair market value based upon the Company's performance and financial condition.\nSince 1979, the Company has provided an \"internal market\" for all shareholders through its' purchase of their common shares. In 1991, shareholders approved uniform restrictions on the transfer of the Company's common shares. These restrictions generally give the Company or the trust of the Company's Employee Stock Ownership Plan the right to purchase the common shares whenever a shareholder proposes to transfer the shares to anyone, other than transfers to a current employee of the Company or transfers by a current or former employee to members of their immediate family.\nOMNIBUS STOCK PLAN - On May 17, 1994, shareholders approved adoption of the 1994 Omnibus Stock Plan, which consolidates into a single plan provisions for the grant of stock options and other stock based incentives and maintenance of the employee stock purchase plan. Other than director options, the grant of awards is at the discretion of the compensation committee of the board of directors. The aggregate number of common shares available for grant and the maximum number of shares granted annually are based on formulas defined in the plan. Each non-employee director elected or appointed, and re-elected or re-appointed, will receive a director option that gives the right to purchase, for six years, 1,000 common shares at the fair market value per share at date of grant. The maximum number of shares that may be issued upon exercise of stock options, other than director options, is 400,000 during the ten year term of the plan.\nShares available for grant at December 31, 1994 were 63,941, which were based on the number available upon ratification of the plan less the director options granted and shares purchased in 1994 under the stock purchase plan. On May 17, 1994 the non-employee directors were granted options to purchase 10,000 common shares at $29.63 per share, expiring in 2000.\nSequential page 29 of 38\n2. COMMON AND PREFERRED SHARES (Continued)\nSTOCK PURCHASE PLAN - The Company has an employee stock purchase plan that provides the opportunity for all full-time employees with one year of service to purchase shares through payroll deductions. The purchase price for the shares offered under the plan is 85% of the fair value of the shares. The Company had reserved 760,000 shares prior to adopting the 1994 Omnibus Stock Plan. Availability of shares is determined in accordance with provisions of the Omnibus Stock Plan.\nPurchases under the plan have been as follows:\nSTOCK OPTION PLANS - Prior to adoption of the 1994 Omnibus Stock Plan, the Company had two qualified stock option plans available for officers and management employees. The status of these plans are as follows at December 31, 1994:\nSTOCK SUBSCRIPTION OFFERING - In 1989, the Company made a stock subscription offering to employees and directors whereby they could subscribe to purchase stock for $15.86 per share. Employees could purchase the Company's common shares by making a 10% cash down payment and financing the remainder of the balance with seven-year promissory notes payable to the Company through monthly payroll deductions or annual installments commencing in September, 1989. The notes bear interest at a rate of 8% per annum and are reflected as subscriptions receivable in shareholders' equity. A total of 141 participants subscribed for 228,876 common shares of the Company.\nSequential page 30 of 38\n3. ACCRUED LIABILITIES\nAccrued liabilities consisted of:\n4. NOTES PAYABLE, BANK AND LONG-TERM DEBT\nNotes Payable, Bank ------------------- The Company has a bank operating loan which is repayable on demand and charges interest at the bank's prime rate. Additionally, the Company has unused short-term lines of credit with five banks totaling $3,285,000, generally at the banks' prime rate, which was 7.75% at December 31, 1994.\nLong-term Debt --------------\nThe total annual installments required to be paid on long-term debt in years 1995 to 1999 are as follows: 1995, $3,844,000; 1996, $2,673,000; 1997, $2,525,000; 1998, $2,446,000; 1999, $2,780,000. Excluded from these installments are the revolving credit agreement and notes payable which are classified as long-term debt since it is expected that these amounts will be outstanding throughout the ensuing year.\nRevolving Credit Agreement -------------------------- The Revolving Credit Agreement (\"Revolver\") permits the Company to borrow up to $15,000,000. The Revolver provides for interest on any borrowings at prime, plus a commitment fee of 3\/16 of 1% on the unborrowed commitment. Borrowings under the Revolver may be converted, at the Company's option, to five-year loans.\nSequential page 31 of 38\n4. NOTES PAYABLE, BANK AND LONG-TERM DEBT (Continued)\nUnder the most restrictive covenants of the Revolver and the Term Note Agreement (\"Term Note\") below, dividend payments could not exceed $1,697,000 in 1994, and the Company is obligated to maintain a minimum shareholders' equity, as defined, of $28,000,000 plus 25% of annual consolidated earnings from December 31, 1992; a minimum ratio of shareholders' equity to total liabilities, as defined, of .70 to 1 at December 31, 1993 and .75 to 1 at December 31 of each year thereafter; a minimum current ratio of 1 to 1; and a fixed charge coverage ratio of not less than 2.25 to 1.0.\nTerm Note Agreement ------------------- In 1992 the Company borrowed $12,000,000 under the Term Note which provides for twenty consecutive quarterly principal installments of $600,000 commencing January 1, 1995 plus interest at either the London Interbank Offered Rate (LIBOR) plus 1-5\/16% or prime plus 1\/4%. The average adjusted LIBOR rate during 1994 was 4.42%; LIBOR was 6.50%, 3.375% and 3.4375% at December 31, 1994, 1993 and 1992, respectively.\nNotes Payable ------------- Notes payable totaling $8,000,000 consist of borrowings from banks for periods of up to six months at rates based either on the London Interbank Offered Rate (LIBOR), or at a money market option rate, which are generally less than U.S. prime rate. The Company intends to refinance these obligations either through continued uninterrupted renewal of the notes or borrowing under the Revolver.\nCorporate Center Financing -------------------------- Corporate Center financing consisted of industrial development bonds which were repaid on February 1, 1994, and a $250,000 Community Development Block Grant, at 3% interest, which was repaid on August 1, 1994.\nLong-Term Debt of ESOT ---------------------- Commencing March 31, 1992, the agreement provided for twenty equal quarterly installments of $24,098 plus interest of 8.4% with the final installment due December 31, 1996. Prior to a refinancing on March 20, 1992, the quarterly installments were $15,061 plus interest of 8.4%.\nSubordinated Notes ------------------ In 1992, 1990 and 1988 the Company redeemed shares of its common stock from shareholders for cash and five-year subordinated promissory notes bearing interest at a rate equal to the average of the prime rate and the prevailing local bank basic savings rate. There were 16,800 shares redeemed in 1992 for cash of $223,830 and notes of $193,986. In 1990, 32,937 shares were redeemed for cash of $179,730 and notes of $478,022. In 1988, 40,744 shares were redeemed for cash of $274,320 and notes of $346,619.\nTerm Loans and Other -------------------- The weighted average interest on the term loans approximates 8.9% and the amounts outstanding are being repaid primarily in equal monthly installments through 1999.\nInterest on Debt ---------------- The Company made cash payments for interest on all debt of $2,487,000, $2,579,000, and $2,056,000 in 1994, 1993, and 1992, respectively.\nSequential page 32 of 38\n5. FINANCIAL INSTRUMENTS\nThe Company uses interest rate swap agreements (swaps) with its principal bank to reduce the impact of changes in interest rates on its borrowings under the Term Note. Management's authority to utilize these agreements is restricted by the Board of Directors, and they are not used for trading purposes. At December 31, 1994 and 1993, two of the outstanding swaps had a total notional amount of $12,000,000, which effectively changed the interest rate exposure on the Term Note to a fixed 7.22% over the same maturity period. On December 16, 1993, a \"reverse\" swap was entered into on a notional amount of $6,000,000, which effectively changed this fixed interest rate on one- half of the term note to a variable rate for two years.\nAmounts receivable or payable under the swaps are settled by the parties on a quarterly basis, and are accrued over the related periods of the swaps. These amounts are included in the consolidated balance sheets on a net basis as accrued liabilities and are treated either as an increase or decrease in interest expense. Interest expense was increased by $216,000, $295,000, and $25,000 in 1994, 1993 and 1992 respectively from these accruals.\nThe fair value of the swaps is the quoted amount that the Company would receive or pay to terminate the swap agreements as provided by the bank, taking into account current interest rates. Had these agreements been terminated as of December 31, 1994, the Company would have received $345,000. Had the same agreements been terminated at December 31, 1993, the Company would have paid $432,000.\nThe fair value of the Company's long-term debt is estimated based on the quoted market prices for similar issues or by discounting expected cash flows at the rates currently offered to the Company for debt of the same remaining maturities, as advised by the Company's principal bank. At December 31, 1994 and 1993, the carrying value of the Company's long-term debt was $24,968,000 and $28,428,000 respectively. At those dates, the fair value was $24,488,000 and $27,993,000 respectively.\n6. EMPLOYEE STOCK OWNERSHIP PLAN\nOn March 15, 1979, the Company consummated a plan which transferred control of the Company to its employees. As a part of this plan, the Company sold 1,440,000 Common Shares to the Company's new Employee Stock Ownership Trust (ESOT) for $2,700,000.\nThe Employee Stock Ownership Plan, in conjunction with the related trust (ESOT), provides for the grant to certain employees of certain ownership rights in, but not possession of, the Common Shares held by the trustee of the Trust. Annual allocations of shares are made to individual accounts established for the benefit of the participants.\nThe Employee Stock Ownership Plan includes as participants, all nonbargaining employees of the parent company and its domestic subsidiaries who have attained age 21 and completed one year of service.\nSOP 93-6 \"Employers Accounting for Employee Stock Ownership Plans\" requires the employer to recognize compensation expense equal to the fair value of the shares committed to be released; however, it allows an employer with an ESOP holding shares purchased prior to December 31, 1992 to continue their existing accounting treatment. Accordingly, the Company has elected to maintain its existing accounting treatment.\nSequential page 33 of 38\n6. EMPLOYEE STOCK OWNERSHIP PLAN (Continued)\nThe number of shares released from collateral and available for allocation to ESOP participants is determined by dividing the sum of the current year loan principal and interest payments by the sum of the current and future years' loan principal and interest payments. The Company makes annual cash contributions to the ESOP, net of dividends paid on the shares held as collateral, sufficient to pay the principal and interest on the ESOT debt; such contributions are reflected as an expense of the Company. Dividends on allocated shares are credited to participants' accounts and charged against retained earnings. ESOP shares that have been released and committed to be released are considered outstanding for purposes of computing earnings per share.\nThe contributions to the ESOT were:\n7. PENSION PLANS\nDescription of Plans -------------------- Substantially all of the Company's employees are covered by two defined benefit pension plans. One of these plans is for non-bargaining unit employees and is non-contributory with respect to annual compensation up to a defined level with voluntary contributions beyond the specified compensation levels, and employee contributions. The other plan is for bargaining unit employees not covered by union pension plans, is non-contributory, and provides benefits at a fixed monthly amount based upon length of service.\nFunding Policy -------------- The Company's funding policy is to make the annual contributions necessary to fund the plans within the range permitted by applicable regulations. The plans' assets are invested by outside asset managers in marketable debt and equity securities.\nSequential page 34 of 38\n7. PENSION PLANS (Continued)\nExpense Recognition ------------------- Pension expense (income) was calculated as follows:\nThe funded status of pension plans at December 31 were as follows:\nThe projected benefit obligation was determined using an assumed discount rate of 8.25% in 1994, 7.5% in 1993, and 8% in 1992. The assumed long-term compensation rate increase was 5.0% in 1994 and 1993, and 5.5% in 1992. The assumed long-term rate of return on plan assets was 7.5% in 1994 and 1993, and 8% in 1992.\nThe projected benefit obligation, which includes the effect of annual compensation rate increases, is based on an accumulated benefit obligation of $9,411,000, $8,837,000, and $8,329,000 at December 31, 1994, 1993 and 1992, respectively. It includes vested benefits of $9,231,000, $8,666,000, and $8,194,000, respectively.\nMultiemployer Plans ------------------- The Company also contributes to several multiemployer plans which provide defined benefits to unionized workers who do not participate in the Company sponsored bargaining unit plan. Amounts charged to pension cost and contributed to the plans in 1994, 1993 and 1992 totaled $380,000, $567,000, and $664,000, respectively.\nSequential page 35 of 38\n8. INCOME TAXES\nThe approximate tax effect of each type of temporary difference that gave rise to the Company's deferred tax assets (no valuation allowance was considered necessary) and liabilities at December 31, were as follows:\nSignificant components of income tax expense includes:\nSequential page 36 of 38\n8. INCOME TAXES (Continued)\nThe differences between the U.S. Federal statutory tax rate and the effective tax rate are as follows:\nEarnings before income taxes by country are as follows:\nThe Company made cash payments for income taxes of $3,638,000, $2,635,000, and $3,729,000 in 1994, 1993 and 1992, respectively.\n9. CUSTOMERS\nThe Company provides a broad line of horticultural services to corporate, institutional and residential customers throughout most of the United States and Canada. The Company's major service line, utility line clearance, represented approximately 64% of the outstanding accounts receivable at December 31, 1994, 1993 and 1992. The Company had revenues from one utility customer under multiple long-term contracts aggregating approximately $27,000,000 in 1994, $36,000,000 in 1993, and $33,000,000 in 1992. The Company had revenues from a second utility customer under multiple year contracts of approximately $24,000,000 in 1994, $23,000,000 in 1993, and $19,000,000 in 1992. The Company performs ongoing credit evaluations of its customers' financial conditions and generally requires no collateral.\n10. OPERATING LEASES\nThe Company primarily leases facilities which are used for district office and warehouse operations. These leases extend for varying periods of time up to four years and, in some cases, contain renewal options. Total rental expenses under such operating leases amounted to approximately $1,394,000, $1,245,000, and $1,030,000 for 1994, 1993 and 1992, respectively. As of December 31, 1994, future minimum rental payments, including taxes and other operating costs, for all operating leases having noncancelable lease terms in excess of one year, totaled $2,464,000, and are expendable as follows: 1995, $1,098,000; 1996, $668,000; 1997, $513,000; 1998, $156,000 and 1999, $29,000.\nSequential page 37 of 38\n11. COMMITMENTS AND CONTINGENCIES\nThe Company is party to a number of lawsuits, threatened lawsuits and other claims arising out of the normal course of business. Management is of the opinion that liabilities which may result are adequately covered by insurance, or to the extent not covered by insurance or accrued, would not be material in relation to the financial statements.\nAt December 31, 1994, the Company was contingently liable to its principal bank in the amount of $7,197,000 for outstanding letters of credit for insurance coverage and guarantees of debt for one of its subsidiaries.","section_15":""}
{"filename":"821472_1994.txt","cik":"821472","year":"1994","section_1":"Item 1. Business.\nFormation\nWestford Technology Ventures, L.P. (the \"Partnership\") is a Delaware limited partnership formed on September 3, 1987. WTVI Co., L.P., the managing general partner of the Partnership (the \"Managing General Partner\"), and four individuals (the \"Individual General Partners\") are the general partners of the Partnership. Hamilton Capital Management Inc. (the \"Management Company\") is the general partner of the Managing General Partner and the management company of the Partnership. The Partnership began its principal operations on December 1, 1988.\nThe Partnership operates as a business development company under the Investment Company Act of 1940. The Partnership's investment objective is to achieve long-term capital appreciation by making venture capital investments in new and developing companies and other special investment situations. The Partnership considers this activity to constitute the single industry segment of venture capital investing.\nIn 1988 and 1989, the Partnership publicly offered, through The Stuart-James Company, Incorporated (the \"Selling Agent\"), 35,000 units of limited partnership interest (\"Units\") at $1,000 per Unit. The Units were registered under the Securities Act of 1933 pursuant to a Registration Statement on Form N-2 (File No. 33-16891) which was declared effective on May 12, 1988. The Partnership held its initial and final closings on November 25, 1988 and January 31, 1989, respectively. A total of 11,217 Units were sold to limited partners (the \"Limited Partners\"). Gross capital contributions to the Partnership total $11,333,170; $11,217,000 from the Limited Partners, $112,170 from the Managing General Partner and $4,000 from the Individual General Partners.\nThe Partnership is scheduled to 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 if they determine that such extensions are in the best interest of the Partnership. The Partnership will terminate no later than December 31, 2002.\nThe Venture Capital Investments\nDuring the year ended December 31, 1994, the Partnership invested $1.5 million in four existing portfolio companies. From its inception to December 31, 1994, the Partnership had invested $9.2 million in eight portfolio investments, or approximately 90% of the original net proceeds of $10.2 million available for investment in venture situations. At December 31, 1994, the Partnership has investments in six portfolio companies with an aggregate cost of $7.7 million and a fair value of $7.5 million. The Partnership has fully or partially liquidated investments with an aggregate cost of $1.5 million. These liquidated investments returned $385,000 to the Partnership. As a result, as of December 31, 1994, the Partnership had a cumulative net realized loss from its venture capital investments of $1.1 million.\nThe Partnership's $3.4 million investment in Spectrix Corporation was valued at $3.8 million at December 31, 1994. This investment represented 44.4% of the total cost and 51.2% of the total fair value of the Partnership's investment portfolio at December 31, 1994.\nThe descriptions of the Partnership's follow-on investments in Spectrix Corporation and Thunderbird Technologies, Inc. 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 is incorporated herein by reference.\nThe description of the Partnership's follow-on investments in Spectrix 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 Spectrix Corporation, Cybernetics Systems International Corp. and Inn-Room Systems, Inc. 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 October and November 1994, the Partnership purchased 8% promissory notes of Spectrix Corporation aggregating $100,000 in face value and warrants to purchase 100,000 shares of the company at $.50 per share for $100,000. In December 1994, the Partnership purchased 62,500 preferred shares of Spectrix for $250,000 and converted its promissory notes totaling $500,000 and accrued interest of $18,940 into 129,735 preferred shares of the company. Additionally, in connection with these transactions, the Partnership received warrants to purchase 76,894 shares of Spectrix common stock at $.50 per share and a warrant to purchase 25,000 shares of Spectrix common stock at $5 per share.\nOn November 22, 1994, the Partnership purchased 214,800 shares of Inn-Room Systems, Inc. common stock for $107,400.\nDuring December 1994, the Partnership converted its demand notes due from Cybernetics Systems International Corp. totaling $170,000 and $15,267 of accrued interest into 840 preferred shares of the company. Additionally, in connection with the note conversion, the Partnership received a warrant to purchase 70,795 shares of the company's common stock at $.52 per share.\nCompetition\nThe Partnership encounters competition from other entities having similar investment objectives. Primary competition for venture capital investments has been from venture capital partnerships and corporations, venture capital affiliates of large industrial and financial companies, small business investment companies and wealthy individuals. Competition also may develop from foreign investors and from large industrial and financial companies investing directly rather than through venture capital affiliates. The Partnership has been a co-investor with other professional venture capital investors and these relationships have generally expanded the Partnership's access to investment opportunities.\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 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 Stockholder Matters.\nThere is no established public trading market for the Units and it is not anticipated that any public market for the Units will develop. Consequently, Limited Partners cannot easily liquidate their investment in the event of emergency or for other reasons. Several independent broker\/dealers provide an informal secondary market for limited partnership interests. Units of limited partnership interest of the Partnership have traded through this market on a limited basis. Transfers of Units are subject to certain restrictions in the Partnership Agreement and also may be affected by restrictions on resale imposed by the laws of certain states. The approximate number of holders of Units as of March 17, 1995 is 1,850. The Managing General Partner and the four Individual General Partners of the Partnership also hold interests in the Partnership. See Item 12 of this report \"Security Ownership of Certain Beneficial Owners and Management\".\nThe Partnership did not make any distributions to its Partners in 1994, 1993 or 1992.\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 $779,000 in cash and short-term investments: $498,000 in short-term securities with maturities of less than one year and $281,000 in an interest-bearing cash account. The Partnership earned $53,000, $89,000 and $191,000 of interest from such investments for the years ended December 31, 1994, 1993 and 1992, 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 invested $1.5 in four existing portfolio companies. From its inception to December 31, 1994, the Partnership had invested $9.2 million in 8 venture capital investments, representing 90% of the $10.2 million of original net proceeds to the Partnership.\nFunds needed to cover the Partnership's future follow-on investments and operating expenses will be obtained from existing cash reserves, interest and other income from portfolio investments 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 $679,000, $269,000 and $834,000, 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 - In June 1994, the Partnership realized a $384,000 loss from the sale of its investment in Eidetics Incorporated. The Partnership sold its Eidetics holdings, along with other former owners of Eidetics, as part of a management buyout of the company. The Partnership received a $4,190 cash down payment and potential future payments to be determined by the actual cash receipts of the new company for five years from the buyout date. At the time of the buyout, such future payments were estimated to aggregate $354,000 over the five year period.\nThe Partnership had no realized gains or losses from portfolio investments for the year ended December 31, 1993.\nFor the year ended December 31, 1992, the Partnership had a $700,000 net realized loss from portfolio investments. In November 1992, Softstrip, Inc. filed for protection under Chapter 11 of the federal Bankruptcy Code. As a result, the Partnership wrote-off its $500,000 investment in the company. In September 1992, Picture Productions, L.P. (\"PPLP\") acquired the assets of Visicon, Inc. The Partnership sold its Visicon holdings for a limited partnership interest in PPLP valued at $10,000, resulting in a $200,000 loss on its $210,000 investment in Visicon.\nInvestment Income and Expenses - Net investment loss for the years ended December 31, 1994, 1993 and 1992 was $295,000, $269,000 and $134,000, respectively. The $26,000 increase in net investment loss for 1994 compared to 1993 was the result of an $80,000 decrease in investment income for 1994 which was only partially offset by a $54,000 reduction in operating expenses for 1994. Interest earned from short-term investments declined $36,000 for 1994, from $89,000 in 1993 to $53,000 in 1994. This decrease primarily was the result of a reduction in the amount of funds invested in such securities during 1994 compared to 1993. Interest and other income from portfolio investments declined $45,000 for the 1994 period, from $86,000 in 1993 to $41,000 in 1994. This decrease primarily was due to the reversal, during 1994, of $30,000 of accrued interest due from Eidetics. This receivable was written-off in connection with the sale of the Partnership's investment in Eidetics, as discussed above. The $54,000 decline in operating expenses for 1994 compared to 1993, primarily is attributable to $61,000 of amortization expense included in the 1993 period. Organizational costs of $332,000 were amortized over a five year period which was completed on December 1, 1993.\nThe $134,000 increase in net investment loss for 1993 compared to 1992 primarily was due to a $165,000 decline in investment income for 1993. Interest earned from short-term investments declined $102,000 for 1993 compared to 1992, primarily due to a reduction in the amount of funds invested in such securities and a decline in short-term interest rates during 1993. Interest and other income from portfolio investments declined $62,000 for 1993 compared to 1992, primarily due to the conversion of debt securities into equity securities of Spectrix during 1993. This $165,000 decline in investment income was partially offset by a $30,000 decline in operating expenses for 1993 compared to 1992, primarily due to a reduced management fee for the 1993 period, as discussed below.\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 (net of selling commissions and organizational expenses paid by the Partnership), reduced by capital distributed and realized losses, with a minimum annual fee of $200,000. The management fee for the years ended December 31, 1994, 1993 and 1992 was $226,000, $234,000 and $248,000, respectively. To the extent possible, the management fee and other expenses incurred by the Partnership are paid with funds provided from operations. Funds provided from operations for the periods discussed, primarily were obtained from interest received from short-term investments and interest and other income earned from portfolio investments.\nUnrealized Gains and Losses and Changes in Unrealized Appreciation of Portfolio Investments - For the year ended December 31, 1994, the Partnership had a $45,000 net unrealized loss primarily resulting from a decrease in the public market price of Cincinnati Bell Inc.'s common stock. Additionally during 1994, $225,000 was transferred from unrealized loss to realized loss due to the sale of the Partnership's investment in Eidetics, as discussed above. The $225,000 transfer from unrealized loss to realized loss less the $45,000 unrealized loss resulted in a $180,000 increase in net unrealized appreciation of investments for 1994.\nFor the year ended December 31, 1993, the Partnership had a $95,000 net unrealized gain from its portfolio investments resulting from the net upward revaluation of certain portfolio investments.\nFor the year ended December 31, 1992, the Partnership had a net unrealized loss of $410,000 from its portfolio investments, primarily resulting from the downward revaluation of its investments in Inn-Room Systems, Inc. and Cincinnati Bell Inc. Additionally during 1992, the Partnership transferred $375,000 from unrealized loss to realized loss relating to the write-off of its investment in Softstrip, as discussed above. The $410,000 unrealized loss, offset by the $375,000 transfer from unrealized loss to realized loss, resulted in a $35,000 decrease in the Partnership's unrealized appreciation of investments for 1992.\nNet Assets - Changes to net assets resulting from operations are comprised of 1) net realized gain or loss from operations and 2) changes in net unrealized appreciation or depreciation of portfolio investments. For the years ended December 31, 1994, 1993 and 1992, Partnership had a net decrease in net assets resulting from operations of $500,000, $173,000 and $869,000, respectively.\nAt December 31, 1994, the Partnership's net assets were $8.4 million, down $500,000 from $8.9 million at December 31, 1993. The $500,000 decrease was comprised of the $679,000 net realized loss from operations offset by the $180,000 unrealized appreciation of investments for 1994.\nAt December 31, 1993, the Partnership's net assets were $8.9 million, down $173,000 from $9.1 million at December 31, 1992. This decrease was comprised of the $269,000 net realized loss from operations offset by the $95,000 unrealized appreciation of investments for 1993.\nAt December 31, 1992, the Partnership's net assets were $9.1 million, down $869,000 from $10 million at December 31, 1991. The $869,000 decrease was comprised of the $834,000 net realized loss from operations and the $35,000 unrealized depreciation of investments for 1992.\nGains and 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 (\"Unit\"), net unrealized depreciation of investments has been included as if the net 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 $744, $788 and $803, respectively.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nWESTFORD TECHNOLOGY VENTURES, L.P. INDEX\nReport of Independent Certified Public Accountants - BDO Seidman Independent Auditors' Report - Deloitte & Touche LLP\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 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.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nWestford Technology Ventures, L.P.\nWe have audited the accompanying balance sheet of Westford Technology Ventures, L.P. (the \"Partnership\"), including the schedule of portfolio investments, as of December 31, 1994, and the related statements of operations, cash flows and changes in partners' capital for the year 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, the financial statements referred to above present fairly, in all material respects, the financial position of Westford Technology Ventures, L.P. at 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.\nAs explained in Note 2, the financial statements include investments valued at $6,725,325, representing 80% of partners' capital as of December 31, 1994 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 estimates of value of such investments 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 and a ready market for the investments existed, and the differences could be material.\nBDO Seidman\nNew York, New York February 14, 1995\nINDEPENDENT AUDITORS' REPORT\nWestford Technology Ventures, L.P.\nWe have audited the accompanying balance sheet of Westford Technology Ventures, L.P. (the \"Partnership\"), including the schedule of portfolio investments, as of December 31, 1993, and the related statements of operations, cash flows, and changes in partners' capital for each of the two years in the period ended December 31, 1993. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned at December 31, 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 Westford Technology Ventures, L.P. at December 31, 1993, and the results of its operations, its cash flows and changes in its partners' capital for each of the two years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs explained in Note 2, the financial statements include securities valued at $5,682,293 at December 31, 1993 representing 64% of net assets, 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 February 22, 1995\nWESTFORD TECHNOLOGY VENTURES, L.P. BALANCE SHEETS December 31,\nSee notes to financial statements.\nWESTFORD TECHNOLOGY VENTURES, L.P. SCHEDULE OF PORTFOLIO INVESTMENTS December 31, 1994\n(A) Public company\n(B) In January 1995, the Partnership sold 20,000 common shares of Cincinnati Bell Inc. for $389,000, realizing a loss of $4,000.\nWESTFORD TECHNOLOGY VENTURES, L.P. SCHEDULE OF PORTFOLIO INVESTMENTS - continued December 31, 1994\n(C) During December 1994, the Partnership converted demand notes totaling $170,000 and $15,267 of accrued interest due from Cybernetics Systems International Corp. into 840 preferred shares of the company. Additionally, in connection with the note conversion, the Partnership received a warrant to purchase 70,795 shares of the company's common stock at $.52 per share. Also in December 1994, the company effected a 100-for-1 split of its common stock. As a result, the Partnership exchanged its 1,000 common shares of Cybernetics and warrant to purchase 75 common shares at $52.13 per share for 100,000 common shares and a warrant to purchase 7,500 common shares of the company at $.52 per share.\n(D) During 1994, the Partnership purchased promissory notes with a face value totaling $500,000 and warrants to purchase 260,000 shares of common stock of Spectrix Corporation for $500,000. In 1994, the Partnership also purchased 62,500 preferred shares of Spectrix for $250,000 and converted the $500,000 of promissory notes and accrued interest of $18,940 into 129,735 preferred shares of the company. Additionally, in connection with these transactions, the Partnership received warrants to purchase 76,894 shares of Spectrix common stock at $.50 per share and warrants to purchase 25,000 common shares at $5.00 per share.\n(E) In April 1994, Eidetics Incorporated was sold in a management buyout for a $4,190 cash down payment and potential future payments to be determined by the actual cash receipts of the acquiring company for five years from the buyout date. The Partnership recorded a $251,000 receivable related to such expected future payments. The Partnership realized a $384,000 loss from this transaction in 1994.\n* May be deemed an affiliated person of the Partnership as defined in the Investment Company Act of 1940.\nSee notes to financial statements.\nWESTFORD TECHNOLOGY VENTURES, L.P. SCHEDULE OF PORTFOLIO INVESTMENTS December 31, 1993\n(A) Public company\n* May be deemed an affiliated person of the Partnership as defined in the Investment Company Act of 1940.\nSee notes to financial statements.\nWESTFORD TECHNOLOGY VENTURES, L.P. STATEMENTS OF OPERATIONS For the Years Ended December 31,\nSee notes to financial statements.\nWESTFORD TECHNOLOGY VENTURES, L.P. STATEMENTS OF CASH FLOWS For the Years Ended December 31,\nSee notes to financial statements.\nWESTFORD TECHNOLOGY VENTURES, L.P. 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 depreciation of investments, was $803, $788 and $744 at December 31, 1992, 1993 and 1994, respectively.\nSee notes to financial statements.\nWESTFORD TECHNOLOGY VENTURES, L.P. NOTES TO FINANCIAL STATEMENTS\n1. Organization and Purpose\nWestford Technology Ventures, L.P. (the \"Partnership\") is a Delaware limited partnership formed on September 3, 1987. WTVI Co., L.P., the managing general partner of the Partnership (the \"Managing General Partner\") and four individuals (the \"Individual General Partners\") are the general partners of the Partnership. Hamilton Capital Management Inc. (the \"Management Company\") is the general partner of the Managing General Partner and the management company of the Partnership. The Partnership began its principal operations on December 1, 1988.\nThe Partnership's objective is to achieve long-term capital appreciation by making venture capital investments in new and developing companies and other special investment situations. The Partnership will 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 fair value of publicly-held portfolio securities is adjusted to the average closing public market price for the last five trading days of each quarter discounted by a factor of 0% to 50% for sales restrictions. Factors considered in the determination of an appropriate discount include, underwriter lock-up or Rule 144 trading restrictions, insider status where the Partnership either has a representative serving on the Board of Directors or is greater than a 10% shareholder, and other liquidity factors such as the size of the Partnership's position in a given company compared to the trading history of the public security. Privately-held portfolio securities are carried at cost until significant developments affecting the portfolio company 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.\nWESTFORD TECHNOLOGY VENTURES, L.P. NOTES TO FINANCIAL STATEMENTS\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 income tax returns. The Partnership's net assets for financial reporting purposes differ from its net assets for tax purposes. Net unrealized depreciation of $226,634 at December 31, 1994, which was recorded for financial statement purposes, was not recognized for tax purposes. Additionally, from inception to December 31, 1994, timing differences relating to realized losses totaling $382,000 have been deducted on the Partnership's financial statements and syndication costs relating to the selling of Units totaling $1.2 million were charged to partners' capital on the financial statements. These amounts have not been deducted or charged against partners' capital for tax purposes.\nStatements of Cash Flows - The Partnership considers cash held in its interest bearing cash account to be cash equivalents.\nOrganizational Costs - Organizational costs of $331,596 were amortized over a sixty-month period which commenced on December 1, 1988.\n3. Allocation of Partnership Profits and Losses\nThe Partnership Agreement provides that the Managing General Partner will be allocated, on a cumulative basis over the life of the Partnership, 20% of the Partnership's aggregate investment income and net realized gains from venture capital investments, provided that such amount is positive. All other gains and losses of the Partnership are allocated among all the Partners, including the Managing General Partner, in proportion to their respective capital contributions to the Partnership.\n4. Related Party Transactions\nThe Management Company provides, or arranges for others to provide, the management and administrative services necessary for the operation of the Partnership. For these services, the Management Company receives a management fee at an annual rate of 2.5% of the gross capital contributions to the Partnership (net of selling commissions and organizational expenses paid by the Partnership), reduced by capital distributed and realized losses, with a minimum fee of $200,000 per annum. Such fee is determined quarterly and paid monthly.\n5. Independent General Partners' Fees\nAs compensation for services rendered to the Partnership, each of the three Independent General Partners receives $10,000 annually in quarterly installments and $1,000 for each meeting of the Independent General Partners attended, plus out-of-pocket expenses.\nWESTFORD TECHNOLOGY VENTURES, L.P. NOTES TO FINANCIAL STATEMENTS\n6. Commitments\nThe Partnership and other investors of Inn-Room Systems, Inc. have guaranteed a bank loan payable by the company. The Partnership's portion of the guarantee is $72,000.\n7. Short-Term Investments\nAt December 31, 1994 and 1993, the Partnership had investments in short-term securities as detailed below.\n8. Subsequent Event\nIn February 1995, the Partnership sold 20,000 shares of Cincinnati Bell Inc. common stock for $389,000. At December 31, 1994, these shares were valued at $350,000, using the Partnership's standard valuation policy for publicly-traded securities.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nOn September 12, 1994, the Partnership received a letter from Deloitte & Touche LLP confirming that the client-auditor relationship between them had ceased. The principal reason for terminating the relationship was that the relatively small size of the Partnership had made it increasingly difficult for Deloitte & Touche LLP to serve as auditor on a cost-effective basis. The Deloitte & Touche LLP reports on the financial statements of the Partnership for the years ended December 31, 1993 and 1992 did not contain an adverse opinion or a disclaimer of opinion, nor were such reports qualified or modified as to uncertainty, audit scope, or accounting principles.\nDuring the two years ended December 31, 1993 and through September 12, 1994, the date the relationship ceased, there were no \"disagreements\" between the Partnership and Deloitte & Touche LLP or \"reportable events\" as defined in Item 304 of Regulation S-K.\nOn December 1, 1994, the Partnership appointed BDO Seidman as independent accountants of the Partnership, commencing with the year ending December 31, 1994.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nThe Partnership\nThe information set forth under the caption \"Election of General Partners\" in the Annual Meeting Proxy Statement is incorporated herein by reference.\nThe Management Company\nThe Management Company performs, or arranges for others to perform, the management and administrative services necessary for the operation of the Partnership pursuant to the Management Agreement between the Partnership and the Management Company. At March 17, 1995, the directors and executive officers of the Management Company are:\nName and Age Position Held Date Elected as a Director\nThe directors of the Management Company will serve as directors until the next annual meeting of stockholders and until their successors are elected and qualified. 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 qualified.\nThe information with respect to Mr. Hamilton, the sole shareholder of the Management Company, set forth under the subcaption \"Election of Individual General Partners\" in the Annual Meeting Proxy Statement is incorporated herein by reference.\nThere are no family relationships among any of the Individual General Partners of the Partnership. Jeffrey T. Hamilton and Louise M. Hamilton, President, Secretary and Chairman of the Board of Directors and Director of the Management Company, respectively, are husband and wife.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information with respect to the compensation of the Individual General Partners set forth under the subcaption \"Election of Individual General Partners\" in the Annual Meeting Proxy Statement is incorporated herein by reference.\nThe information with respect to the allocation and distribution of the Partnership's profits and losses to the Managing General Partner set forth under the subcaption \"Election of Managing General Partner\" in the Annual Meeting Proxy Statement is incorporated herein by reference.\nThe information with respect to the management fee payable to the Management Company set forth under the caption \"The Terms of the Current Management Agreement and the Proposed Management Agreement\" in the Annual Meeting Proxy Statement is incorporated herein by reference.\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 under the subcaption \"Election of Individual General Partners\" in the Annual Meeting Proxy Statement is incorporated herein by reference.\nAs 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. Mr. Ames, an Individual General Partner of the Partnership, owns 10 Units and Ms. Trammell, the Treasurer and Director of the Management Company, owns 3 Units. The Individual General Partners and the directors and officers of the Management Company as a group own thirteen Units or less than one percent of the total Units outstanding.\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.\nNot applicable.\nPART IV\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) 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 the 24th day of March 1995.\nWESTFORD TECHNOLOGY VENTURES, L.P.\nBy: WTVI Co., L.P. its managing general partner\nBy: Hamilton Capital Management Inc. its general partner\nExhibit Index\nExhibits Page\n3.1 Amended and Restated Certificate of Limited Partnership of the Registrant (filed as Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 and incorporated herein by reference).\n16.1 Letter from Deloitte & Touche LLP pursuant to Item 304(a)(3) of Regulation S-K (filed as Exhibit 16 to Form 8-K dated September 12, 1994 and incorporated herein by reference).\n27 Financial Data Schedule.","section_14":"","section_15":""}
{"filename":"99189_1994.txt","cik":"99189","year":"1994","section_1":"Item 1. Business ................................................. 3 Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe executive offices of Transamerica Corporation are located in the Transamerica Pyramid in San Francisco, California, a 48-story office building owned by a subsidiary of Transamerica. In 1986 the subsidiary borrowed $85,000,000, secured by a deed of trust on the property for ten years. Approximately 17% of the 450,000 square feet of rentable space is occupied by Transamerica and its subsidiaries.\nTransamerica Life Companies own the Transamerica Center in Los Angeles, California, which consists of a 32-story building, an 11-story building and a 10-story building. Transamerica Center is the home office of Transamerica Life Companies, Transamerica Finance Group and certain other subsidiaries of Transamerica. Approximately 71% of the 1,295,000 square feet of rentable space is occupied by Transamerica subsidiaries.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nVarious pending or threatened legal proceedings by or against the Corporation or one or more of its subsidiaries involve tax matters, alleged breaches of contract, torts, employment discrimination, violations of antitrust laws and miscellaneous other causes of action arising in the course of their businesses. Some of these proceedings involve claims for punitive or treble damages in addition to other specific relief.\nBased upon information presently available, and in light of legal and other defenses and insurance coverage available to the Corporation and its subsidiaries, contingent liabilities arising from threatened and pending litigation, income taxes and other matters are not expected to have a material effect on the consolidated financial position or results of operations of the Corporation and its subsidiaries.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS\nNot applicable.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nSee Item 10 in Part III of this Report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe following information in the Transamerica Corporation 1994 Annual Report is incorporated herein by reference:\nMarkets on which the Corporation's common stock is traded--\"Common Stock Listed and Traded,\" page 88.\nHigh and low sale prices for the Corporation's common stock for each quarter in 1994 and 1993--\"Supplementary Financial Information,\" page 81.\nFrequency and amount of cash dividends declared during 1994 and 1993--\"Selected Eleven-Year Financial Data--Note E,\" page 82.\nThere were approximately 53,200 common stockholders of record as of the close of business on February 28, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following items for each of the five years in the period ended December 31, 1994, included in \"Selected Eleven-Year Financial Data\" on pages 82 and 83 of the Transamerica Corporation 1994 Annual Report, are incorporated herein by reference:\nRevenues Income from continuing operations Earnings per share of common stock--Income from continuing operations Dividends declared per share of common stock Total assets Notes and loans payable: Long-term debt\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe textual information set forth under the caption \"Financial Review\" on pages 44 through 61, together with the tables under the headings \"Operating Income by Line of Business\" on page 45 and \"Unallocated Interest and Other Expenses\" on page 58 of the Transamerica Corporation 1994 Annual Report, are incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements and supplementary financial information of the Corporation and its subsidiaries in the Transamerica Corporation 1994 Annual Report are incorporated herein by reference:\nConsolidated Balance Sheet--December 31, 1994 and 1993--pages 62 and 63.\nConsolidated Statement of Income--Years ended December 31, 1994, 1993 and 1992--page 64.\nConsolidated Statement of Cash Flows--Years ended December 31, 1994, 1993 and 1992--page 65.\nConsolidated Statement of Shareholders' Equity--Years ended December 31, 1994, 1993 and 1992--page 66.\nNotes to Financial Statements--December 31, 1994--pages 67 through 79.\nSupplementary Financial Information--Years ended December 31, 1994 and 1993--page 81.\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 \"(1) Election of Directors\" in the Proxy Statement of Transamerica Corporation dated March 17, 1995 is incorporated herein by reference.\nThe officers of the Corporation are listed below. Executive officers are designated by an asterisk.\nMr. Herringer was elected Chief Executive Officer in 1991. He has been President of the Corporation since 1986.\nMr. Carpenter was elected Executive Vice President of the Corporation in 1993. He was Group Vice President of the Corporation from 1990 to 1993. He has been Chairman and Chief Executive Officer of Transamerica Occidental Life Insurance Company since 1985.\nMr. Finn was elected Executive Vice President of the Corporation in 1993. He was Group Vice President of the Corporation from 1990 to 1993. He has been President of Transamerica Finance Group, Inc. since 1988 and was elected its Chief Executive Officer in 1990.\nMr. Grubb was elected Secretary of the Corporation in 1995. He was elected Executive Vice President and Chief Financial Officer of the Corporation in 1993. He was Senior Vice President of the Corporation from 1989 to 1993.\nMr. Cusack was elected Senior Vice President of the Corporation in 1993. He was Vice President--Corporate Development of the Corporation from 1989 to 1993.\nMr. Latzer was elected Senior Vice President and Chief Investment Officer of the Corporation in 1988. Since 1988, he has been President and Chief Executive Officer of Transamerica Investment Services, Inc.\nMs. Breakiron-Evans was elected Vice President and General Auditor of the Corporation in 1994. She was with Arthur Andersen & Co. from 1980 to 1994 where she served as an Audit Partner in the San Francisco office from 1990 to 1994.\nMr. Broome was elected Vice President and Controller of the Corporation in 1979.\nMr. Colwell was elected Vice President--Real Estate Services of the Corporation in 1977. Since 1972, he has been President of Transamerica Realty Services, Inc., a subsidiary of the Corporation.\nMr. Dox was elected Vice President--Taxes of the Corporation in 1993. He was a Tax Partner with Ernst & Young LLP from 1977 to 1993, serving in the Los Angeles office from 1983 to 1993.\nMr. Hawkins was elected Vice President of the Corporation in 1993. He has been Senior Vice President and Treasurer of Transamerica Finance Group, Inc. since 1989.\nMr. Lindberg was elected Vice President and Treasurer of the Corporation in 1987.\nMr. Lockhart was elected Vice President--Public Affairs of the Corporation in 1979.\nMr. McClave was elected Vice President--Corporate Communications of the Corporation in 1981.\nMr. Olsen was elected Vice President--Corporate Relations of the Corporation in 1981.\nMs. Pehrson was elected Vice President--Human Resources of the Corporation in 1989.\nMr. Peirano was elected Vice President of the Corporation in 1993. He was Vice President--Taxes of the Corporation from 1983 to 1993.\nMr. Petrunoff was elected Vice President--Investor Relations of the Corporation in 1994. He held a number of positions within the commercial lending operation between 1990 and 1994, most recently serving as managing director of the European operations of commercial lending's inventory finance unit. He was a marketing manager for GE Capital Corporation from 1989 to 1990.\nMr. Sundby was elected Vice President--Financial Planning and Analysis in 1995. He was Assistant Controller and Director of Accounting of the Corporation from 1989 to 1995. He continues to serve as Assistant Controller.\nMs. Tornese was elected Vice President--Risk Management of the Corporation in 1987.\nThere is no family relationship among any of the foregoing officers or between any of the foregoing officers and any director of the Corporation.\nThe information set forth under the caption \"Securities Exchange Act of 1934\" in the Proxy Statement of Transamerica Corporation dated March 17, 1995 is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the captions \"Director Compensation and Benefits\" and \"Executive Compensation and Other Information\" in the Proxy Statement of Transamerica Corporation dated March 17, 1995 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 captions \"Principal Stockholders\" and \"Stockholdings of Directors and Executive Officers\" in the Proxy Statement of Transamerica Corporation dated March 17, 1995 is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe textual information set forth under the captions \"Director Compensation and Benefits,\" \"Compensation Committee Interlocks and Insider Participation\" and \"Certain Transactions\" in the Proxy Statement of Transamerica Corporation dated March 17, 1995 is incorporated herein by reference. PART 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(3) List of Exhibits:\nEX-3(i) Transamerica Corporation Certificate of Incorporation, as amended (incorporated by reference to Exhibit 4.5 of the Registrant's Registration Statement on Form S-3 (File No. 33-43921) as filed with the Commission on November 13, 1991 and to Exhibits 3 and 4 contained in Form 8-A filed January 21, 1992, as amended by Form 8 filed January 27, 1992).\nEX-3(ii) Transamerica Corporation By-Laws, as amended (incorporated by reference to Exhibit 3 of the Registrant's Quarterly Report on Form 10-Q (File No. 1-2964) for the quarter ended June 30, 1992).\nEX-4.1 Stock Purchase Rights Agreement dated as of July 17, 1986 together with Amendment dated January 24, 1991 (incorporated by reference to Exhibit 4.1 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1991).\nEX-4.2*\nEX-10.1 Form of Non-Qualified Stock Option Agreement under the Registrant's 1971 and 1979 Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.4 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1988).\nEX-10.2 Executive Benefit Plan for Transamerica Corporation and Affiliates, as amended (incorporated by reference to Exhibit EX-10.2 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1992).\nEX-10.3 Form of Amended and Restated Consulting Agreement effective January 1, 1994 between Transamerica Airlines, Inc. and Glenn A. Cramer (incorporated by reference to Exhibit EX-10.3 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1993).\nEX-10.4 Form of Consulting Agreement dated November 30, 1992, between Transamerica Corporation and James R. Harvey (incorporated by reference to Exhibit EX-10.4 of the Registrant's Annual Report on Form 10-K (File No. 1- 2964) for the year ending December 31, 1992).\n_________ *Neither the Corporation nor its subsidiaries are parties to any instrument with respect to long-term debt for which securities authorized thereunder exceed 10% of the total assets of the Corporation and its subsidiaries on a consolidated basis. Copies of instruments with respect to long-term debt of lesser amounts will be provided to the Commission upon request.\nEX-10.5 Form of Amended and Restated Consulting Agreement dated January 31, 1994 between Transamerica Corporation and James R. Harvey (incorporated by reference to Exhibit EX-10.5 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1993).\nEX-10.6 1993 Bonus Plan (incorporated by reference to Exhibit EX-10.7 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1992).\nEX-10.7 1994 Bonus Plan (incorporated by reference to Exhibit EX-10.1 of the Registrant's Quarterly Report on Form 10-Q (File No. 1-2964) for the quarter ended March 31, 1994).\nEX-10.8 1995 Bonus Plan.\nEX-10.9 1985 Stock Option and Award Plan, as amended, (including Amendments No. 1 through 6) (incorporated by reference to Exhibit EX-10.5 of the Registrant's Quarterly Report on Form 10-Q (File No. 1-2964) for the quarter ended March 31, 1994, to Post-Effective Amendment No. 3 of the Registrant's Registration Statement on Form S-8 (File No. 33-26317) as filed with the Commission on March 30, 1990, and to Exhibit 10.11 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1990).\nEX-10.10 Form of Non-Qualified Stock Option Agreement under the Registrant's 1985 Stock Option and Award Plan (incorporated by reference to Exhibit EX-10.3 of the Registrant's Quarterly Report on Form 10-Q (File No. 1-2964) for the quarter ended March 31, 1994).\nEX-10.11 Form of Incentive Stock Option Agreement under the Registrant's 1985 Stock Option and Award Plan (incorporated by reference to Exhibit 10.9 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1990).\nEX-10.12 Form of Restricted Stock Award Agreement under the 1985 Stock Option and Award Plan (incorporated by reference to Exhibit EX-10.11 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1993).\nEX-10.13 Form of Non-Qualified Stock Option Agreement for Nonemployee Directors under the 1985 Stock Option and Award Plan (incorporated by reference to Exhibit EX- 10.4 of the Registrant's Quarterly Report on Form 10-Q (File No. 1-2964) for the quarter ended March 31, 1994).\nEX-10.14 Deferred Compensation Policy for Transamerica Corporation and Affiliates effective January 1, 1987 (incorporated by reference to Exhibit 10.12 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1991).\nEX-10.15 Deferred Compensation Policy for Transamerica Corporation and Affiliates effective January 1, 1988 (incorporated by reference to Exhibit EX-10.14 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1992).\nEX-10.16 Deferred Compensation Policy for Transamerica Corporation and Affiliates effective January 1, 1989 (incorporated by reference to Exhibit 10.17 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1989).\nEX-10.17 Deferred Compensation Policy for Transamerica Corporation and Affiliates effective January 1, 1990 (incorporated by reference to Exhibit 10.18 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1989).\nEX-10.18 Deferred Compensation Policy for Transamerica Corporation and Affiliates effective July 1, 1992 (incorporated by reference to Exhibit EX-10.17 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1992).\nEX-10.19 Deferred Compensation Policy for Transamerica Corporation and Affiliates effective January 1, 1994 (incorporated by reference to Exhibit EX-10.18 of the Registrant's Annual Report on Form 10-K (File No. 1- 2964) for the year ended December 31, 1993).\nEX-10.20 Deferred Compensation Policy for Transamerica Corporation and Affiliates effective January 1, 1995.\nEX-10.21 1971 Non-Qualified Stock Option Plan of Transamerica Corporation, as amended (including Amendment Nos. 1 and 2) (incorporated by reference to Exhibit EX-10.20 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1992).\nEX-10.22 1979 Stock Option Plan of Transamerica Corporation, as amended (including Amendment Nos. 1 and 2) (incorporated by reference to Exhibit EX-10.21 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1992).\nEX-10.23 Form of Termination Agreement between Transamerica Corporation and certain of its executive officers (incorporated by reference to Exhibit 10.23 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1989).\nEX-10.24 Form of Termination Agreement between Transamerica Corporation and certain officers of certain of its subsidiaries (incorporated by reference to Exhibit 10.24 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1989).\nEX-10.25 Form of Termination Agreement between Transamerica Corporation and certain of its officers and of its subsidiaries.\nEX-10.26 Public Offering Agreement (and Exhibits thereto) dated January 28, 1993 by and among the Registrant, TIG Holdings, Inc., and Jon W. Rotenstreich (incorporated by reference to Exhibits 10.1, 10.2, 10.3, 10.4, 10.5 and 10.6 of the Registration Statement on Form S-1 (File No. 33-58122) as filed with the Commission on February 10, 1993).\nEX-10.27 Separation Agreement (and Exhibits thereto) dated January 28, 1993 by and among the Registrant, TIG Holdings, Inc., and Transamerica Insurance Group (incorporated by reference to Exhibits 3.3, 3.4 and 10.2 of the Registration Statement on Form S-1 (File No. 33-58122) as filed with the Commission on February 10, 1993).\nEX-10.28 Reinsurance Agreement dated December 31, 1992 by and between ARC Reinsurance Corporation and Transamerica Insurance Company, as amended (incorporated by reference to Exhibit EX-10.26 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1992).\nEX-10.29 Letter dated December 31, 1992 from the Registrant to Transamerica Insurance Company regarding ARC Reinsurance Corporation (incorporated by reference to Exhibit EX-10.27 of the Registrant's Annual Report on Form 10-K (File No. 1-2964) for the year ended December 31, 1992).\nEX-10.30 Transamerica Corporation 1995 Performance Stock Option Plan.\nEX-10.31 Transamerica Corporation Value Added Incentive Plan (incorporated by reference to Exhibit EX-10.2 of the Registrant's Quarterly Report on Form 10-Q (File No. 1-1964) for the quarter ended March 31, 1994).\nEX-11 Statement Re: Computation of Per Share Earnings.\nEX-12 Ratio of Earnings to Fixed Charges Calculation.\nEX-13 Portions of the Transamerica Corporation 1994 Annual Report (to the extent such portions are expressly incorporated herein).\nEX-21 List of Subsidiaries of Transamerica Corporation.\nEX-23 Consent of Ernst & Young LLP to the incorporation by reference of their report dated February 15, 1995 in the Registrant's Registration Statements on Form S-8 (File Nos. 2-80934, 2-83724, 33-3722, 33-12324, 33-13389, 33-18911, 33-26317, 33-38267, 33-43927 and 33-55587) and on Form S-3 (File Nos. 33-32419, 33-37889, 33-41008 and 33-55047).\nEX-24 Power of Attorney executed by the directors of the Registrant.\nEX-27 Financial Data Schedule.\nExhibits will be furnished to shareholders of the Corporation upon written request and, with the exception of Exhibit EX-13, upon payment of a fee of 30 cents per page, which fee covers the Corporation's reasonable expenses in furnishing such exhibits.\n(b) Reports on Form 8-K filed in the fourth quarter of 1994: During the quarter ended December 31, 1994, the Registrant filed a Report on Form 8-K, dated October 27, 1994, announcing its results for the quarter and nine month periods ending September 30, 1994. In addition, the 8-K announced that the Registrant had initiated a tender offer to purchase up to 6.4 million depositary shares representing interests in its 8.5% Preferred Stock, Series D.\n(c) Exhibits: Certain of the exhibits listed in Item (a)(3) above have been submitted under separate filings, as indicated.\n(d) Financial Statement Schedules: The response to this portion of Item 14 is submitted as a separate section of this report.\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nTRANSAMERICA CORPORATION Registrant\nBurton E. Broome Vice President and Controller\nDate: March 27, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 27, 1995 by the following persons on behalf of the registrant and in the capacities indicated.\nSignature Title\nPrincipal Executive Officer:\nFRANK C. HERRINGER* President and Chief Executive Officer\nPrincipal Financial Officer:\nEdgar H. Grubb Executive Vice President, Chief Financial Officer and Secretary\nPrincipal Accounting Officer:\nBurton E. Broome Vice President and Controller\nDirectors:\nSAMUEL L. GINN* Director JAMES R. HARVEY* Chairman of the Board and Director FRANK C. HERRINGER* Director GORDON E. MOORE* Director RAYMOND F. O'BRIEN* Director TONI REMBE* Director CONDOLEEZZA RICE* Director FORREST N. SHUMWAY* Director PETER V. UEBERROTH* Director\n*Robert D. Myers Attorney-in-Fact\nA majority of the members of the Board of Directors.\nANNUAL REPORT ON FORM 10-K\nITEM 14(a)(1) and (2) and ITEM 14(d)\nLIST OF FINANCIAL STATEMENTS AND\nFINANCIAL STATEMENT SCHEDULES\nand\nFINANCIAL STATEMENT SCHEDULES\nYear Ended December 31, 1994\nTRANSAMERICA CORPORATION AND SUBSIDIARIES\nSAN FRANCISCO, CALIFORNIA\nFORM 10-K--ITEM 14(a)(1) AND (2)\nTRANSAMERICA CORPORATION AND SUBSIDIARIES\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nFinancial Statements:\nThe following consolidated financial statements of Transamerica Corpora- tion and subsidiaries, included in the Transamerica Corporation 1994 Annual Report, are incorporated by reference in Item 8:\nConsolidated Balance Sheet--December 31, 1994 and 1993\nConsolidated Statement of Income--Years ended December 31, 1994, 1993 and 1992\nConsolidated Statement of Cash Flows--Years ended December 31, 1994, 1993 and 1992\nConsolidated Statement of Shareholders' Equity--Years ended December 31, 1994, 1993 and 1992\nNotes to Financial Statements--December 31, 1994\nFinancial Statement Schedules:\nThe following consolidated financial statement schedules of Transamerica Corporation and subsidiaries are included in Item 14(d).\nI--Summary of Investments Other Than Investments in Related Parties--December 31, 1994\nII--Condensed Financial Information of Registrant--December 31, 1994 and 1993, and years ended December 31, 1994, 1993 and\nIII--Supplementary Insurance Information--Years ended December 31, 1994, 1993 and 1992\nIV--Reinsurance--Years ended December 31, 1994, 1993 and 1992\nV--Valuation and Qualifying Accounts--Years ended December 31, 1994, 1993 and 1992\nAll other schedules provided for in the applicable accounting regulation of the Securities and Exchange Commission pertain to items which do not appear in the financial statements of Transamerica Corporation and subsidiaries or to items which are not significant or to items as to which the required disclos- ures have been made elsewhere in the financial statements and supplementary notes, and such schedules have therefore been omitted.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nBoard of Directors and Shareholders Transamerica Corporation\nWe have audited the consolidated financial statements of Transamerica Corporation and subsidiaries listed in Item 14(a)(1) and (2) of the Annual Report on Form 10-K of Transamerica Corporation for the year ended December 31, 1994. Our audits also included the financial statement schedules listed in the index at Item 14(a)(1) and (2). These financial statements and schedules are the responsibility of Transamerica 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 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 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 Transamerica 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 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 A to the consolidated financial statements, Transamerica Corporation changed its method of accounting for certain debt securities effective January 1, 1994.\nErnst & Young LLP\nSan Francisco, California February 15, 1995\nDifferences Between the Circulated Document and the Electronically Filed Document\n1. The document which is filed with the New York and Pacific Stock Exchanges will be a printed copy of the electronic document. However, the document which will be mass produced for general distribution will have different page numbering and page breaks than the electronically filed document.","section_15":""}
{"filename":"4977_1994.txt","cik":"4977","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL DESCRIPTION\nAFLAC Incorporated (the \"Parent Company\") was incorporated in 1973 under the laws of the State of Georgia and acts as a general business holding company. The Parent Company is a management company principally engaged, through its insurance subsidiaries, in providing supplemental health insurance products in the United States and Japan. In addition, the Parent Company, through subsidiaries and a general partnership with American Family Life Assurance Company of Columbus (\"AFLAC\"), operates in television broadcasting. In 1992, AFLAC transferred its minor United Kingdom insurance subsidiary and, in 1994, its minor Canadian insurance subsidiary to the Parent Company. As a management company, the Parent Company oversees the operations of its subsidiaries and provides capital and management services.\nAFLAC Incorporated and its subsidiaries (\"the Company\") have only one significant industry segment - insurance. For financial information relating to the Company's foreign and U.S. operations, see Exhibit 13, pages 13-5 to 13-18 and page 13-27 (Note 2 of Notes to the Consolidated Financial Statements), which are incorporated herein by reference.\nThe Parent Company's principal operating subsidiary is AFLAC, which has both U.S. and foreign operations (principally in Japan). AFLAC is a specialty insurer whose dominant business is individual supplemental health insurance with emphasis on cancer expense insurance plans. Management believes AFLAC is the world's leading writer of cancer expense insurance. In recent years, AFLAC has diversified its product offerings to include other types of supplemental health products in both the United States and Japan. The Japan Branch (\"AFLAC Japan\") also sells long-term care plans (\"Super Care\") and supplemental general medical expense plans. The United States operation (\"AFLAC U.S.\"), in addition to cancer expense plans, also sells other types of supplemental health insurance, including hospital intensive care, accident and disability, hospital indemnity, long-term care, short-term disability and Medicare supplement plans. AFLAC U.S. also offers several life insurance plans.\nThe Company is authorized to conduct insurance business in all 50 states, the District of Columbia, American Samoa, Guam, Puerto Rico, the U.S. Virgin Islands, the Commonwealth of the Northern Mariana Islands and several foreign countries. The Company's only significant foreign operation is AFLAC Japan, which accounted for 83.9% of the Company's total revenues in 1994.\nInsurance premiums and investment income from insurance operations are the major sources of revenues. The Company's consolidated premium income was $5.2 billion for 1994, $4.2 billion for 1993 and $3.4 billion for 1992.\nI-1\nThe following table lists, for each of the last three years, the percentage of consolidated premiums contributed by each class of insurance sold: Percentage of Insurance Class Consolidated Premium Income - ---------------------- ----------------------------------- 1994 1993 1992 ------ ------ ------ Health insurance 99.7% 99.6% 99.2% Life and other insurance .3 .4 .8\nThe following table sets forth consolidated earned premiums by class and information with respect to the health insurance plans, primarily cancer, offered by AFLAC principally in Japan and the United States for the three years ended December 31.\n(In thousands) 1994 1993 1992 ---------- ---------- ---------- Earned premiums: Health insurance $ 5,164,665 $ 4,205,637 $ 3,342,439 Life and other insurance 16,067 19,753 26,762 ---------- ---------- ---------- Total earned premiums $ 5,180,732 $ 4,225,390 $ 3,369,201 ========== ========== ==========\nHealth insurance plans: No. of policies issued 2,252,414 1,954,417 1,923,232 No. of policies terminated 1,169,990 1,122,952 1,002,020 No. of policies in force at year-end 16,560,892 15,478,468 14,647,003\nINVESTMENTS AND INVESTMENT RESULTS FOR U.S. AND JAPAN\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, issued by the Financial Accounting Standards Board. Under the provisions of SFAS No. 115, fixed-maturity securities available for sale are carried at fair value. Previously, fixed-maturity securities were carried at amortized cost. Prior year numbers have not been restated. The fair value of fixed-maturity securities available for sale exceeded amortized cost by $820.9 million at December 31, 1994. For additional information regarding SFAS No. 115, see Exhibit 13, page 13-25 (Note 1 of Notes to the Consolidated Financial Statements).\nThe Company's investments (including cash) amounted to $16.0 billion at December 31, 1994. Since December 31, 1993, total invested assets, including the effect of SFAS No. 115, have increased $3.5 billion, or 28.3%. AFLAC Japan investments increased $3.4 billion (29.5%), while AFLAC U.S. investments increased $162.2 million (14.8%). Since December 31, 1993, total invested assets, excluding the effect of SFAS No. 115, have increased $2.7 billion, or 21.7%. AFLAC Japan investments increased $2.5 billion (21.9%), while AFLAC U.S. investments increased $211.7 million (19.4%). Net investment income of $838.8 million in 1994 continues to be a growing source of revenues and earnings for the Company, increasing $149.6 million in 1994\nI-2\nover 1993 and $156.1 million in 1993 over 1992. It is generally AFLAC's policy to invest in high-grade investments, principally in high-quality government, public utility and corporate bonds.\nAFLAC primarily operates within the investment environments of the United States and Japan. Although aspects of these two financial markets are slowly converging, they remain fundamentally different. For example, differences in asset selection, liquidity, credit quality, accounting practices, insurance regulations and taxation affect the way the Company invests and purchases securities. The challenge is to integrate the varied market characteristics of Japan and the United States into a unified and coherent set of investment strategies. The Company has streamlined and integrated the organizational structure of the investment department into a single functional unit and has set specific worldwide criteria regarding credit quality, liquidity, compliance with regulatory requirements and conformance to product needs.\nDuring 1994, 88% of AFLAC Japan's yen cash flow available for investments was allocated to yen-denominated securities, while the remaining 12% was invested in dollar-denominated securities. Of the total amount invested in 1994, 10.5% was invested in Japanese government bonds at a yield of 4.73%, 53.3% was invested in the longer-dated private sector at a rate of 5.12%, 10.0% was invested in municipal bonds at a rate of 4.30%, and the remainder was invested in yen in assorted sectors at an average rate of 4.37%.\nAt year-end 1994, Japanese government bonds accounted for 35.8% of AFLAC Japan's total invested assets (including cash). Twenty-year government bonds made up the majority of AFLAC Japan's government bond holdings. AFLAC Japan continued to use longer-dated corporate instruments in 1994, which help maintain a favorable asset\/liability match, accounting for 19.6% of our total invested assets in Japan at year-end. At the end of the year, municipal securities represented 5.5% of the invested assets, while utility bonds represented 18.5%. Other assorted sectors accounted for 14.2%, and dollar- denominated securities represented the balance of AFLAC Japan's invested assets. In January 1995, there was a major earthquake in Kobe, Japan. The Company's fixed-maturity portfolio includes securities issued by governmental units and public utilities located in that region. The amortized cost of these securities is approximately $541 million. These securities account for less than 4% of AFLAC Japan's fixed-maturities. While the earthquake may temporarily disrupt general business conditions, management does not expect any change in the credit quality of these bonds.\nThe Company continued to avoid the Japanese equity and investment real estate markets in 1994. AFLAC Japan's equity portfolio accounted for only .1% of invested assets at year-end, and the Company does not expect this portion to increase in 1995. The Company also does not anticipate any change in the current level of mortgage loans on Japanese real estate, which was less than .1% of invested assets at year-end.\nThe Company increased its commitment to the dollar-denominated portfolio of AFLAC Japan's invested assets during 1994. AFLAC Japan added $303.6 million to this portfolio at an average yield of 7.39%. AFLAC Japan's dollar-denominated portfolio represented 6.4% of invested assets in Japan, or $951.3 million at the end of 1994, compared with $627.9 million at the end of 1993. This portfolio carries certain tax and yield advantages that make it attractive; however, the Company is careful to balance yield enhancement with\nI-3\nits corporate goal of increasing profit repatriation from AFLAC Japan to AFLAC U.S. and to the Parent.\nProfits repatriated from AFLAC Japan to AFLAC U.S. totaled $132.9 million in 1994, up from $97.9 million in 1993. Of the $132.9 million in 1994, $51.9 million was transferred to the Parent Company and used primarily to pay down debt. The balance was invested by AFLAC U.S. in dollar- denominated fixed-maturity securities at an average yield to maturity of 7.86%. Repatriation benefits consolidated operations because higher investment yields can be earned on funds invested in the United States. Also, income tax expense is presently lower on investment income earned in the United States. The Company expects profit repatriation to continue to have a positive impact on its consolidated net earnings in the future.\nThe Company's portfolio allocation in the United States continued to emphasize investment-grade corporate bonds, which accounted for 56.5% of new money purchases in 1994, at an average yield of 7.62%. AFLAC U.S. maintained its overall investment quality throughout the year, with more than 51% of the fixed-income portfolio rated \"AA\" or better at the end of the year.\nThe equity portion of the U.S. portfolio was $66.5 million, compared with $55.8 million in 1993. Equity investments accounted for 5.7% of U.S. invested assets in 1994. Mortgage loans on real estate remained immaterial.\nFor information on the composition of the Company's investment portfolio and investment results, see Part IV, Schedule I, and Exhibit 13, pages 13-14 to 13-15, 13-18 (discussions relating to Balance Sheet and Cash Flow) and pages 13-29 to 13-35 (Notes 3 and 4 of Notes to the Consolidated Financial Statements), which are incorporated herein by reference.\nI-4\nINSURANCE - JAPAN\nThe following table sets forth AFLAC Japan's earned premiums by product line for the last three years ended December 31.\n(In thousands) Earned premiums: 1994 1993 1992 ---------- ---------- ---------- Health insurance, principally Cancer expense $ 4,073,400 $ 3,275,915 $ 2,545,055 Super Care and other insurance 297,691 208,345 137,265 ---------- ---------- ---------- Total earned premiums $ 4,371,091 $ 3,484,260 $ 2,682,320 ========== ========== ==========\nThe following table sets forth the reconciliation of annualized premiums in force for AFLAC Japan for the years ended December 31:\n(In thousands) 1994 1993 1992 ---------- ---------- ---------- Annualized premiums in force, at beginning of year $ 3,672,594 $ 2,914,428 $ 2,503,500 New issues 767,289 594,171 508,756 Lapses and surrenders (182,115) (163,441) (115,088) Foreign currency translation adjustment 461,015 327,436 17,260 ---------- ---------- ---------- Annualized premiums in force, at end of year $ 4,718,783 $ 3,672,594 $ 2,914,428 ========== ========== ==========\nINSURANCE PLANS - JAPAN\nAFLAC's insurance is supplemental in nature and is designed to provide insurance to cover the medical and nonmedical costs that are not reimbursed by other forms of Japanese health coverage.\nThe cancer expense insurance plans offered in Japan are basically daily indemnity plans, providing a fixed amount for each day the insured is hospitalized for the treatment of cancer. The plans differ from the AFLAC U.S. cancer plans (described on pages I-9 and I-10) in that the Japanese policies also provide death benefits and cash surrender values (the Company estimates that approximately 28% of the premiums earned are associated with these benefits).\nDuring 1990, AFLAC introduced the Super Cancer Plan. The Super Cancer Plan includes, for the first time in Japan, first occurrence and outpatient benefits in addition to the benefits of the previous cancer coverages. Sales of new policies and conversions of existing policies resulted in 58.2% of all cancer units in force being Super Cancer Plans as of December 31, 1994.\nIn 1992, AFLAC broadened its product line with the introduction of a new care product, \"Super Care\". Super Care provides periodic benefits to those who become bedridden, demented or seriously disabled due to illness or accident. The new plan is offered with several riders, providing death\nI-5\nbenefits or additional care benefits, to enhance coverage. Prior to the introduction of the \"Super Care\" plan, AFLAC marketed a plan that primarily provided dementia care benefits.\nThe Ministry of Finance (MOF) in Japan recently permitted insurance companies to increase the premiums on new policy issues in response to the lower investment yields available in the Japanese market. AFLAC Japan increased the premiums on Super Cancer new issues by an average of 16% in July 1994. AFLAC Japan also increased the premiums on Super Care new issues by an average of 10% effective November 1993. The Company anticipates implementing a similar increase to the Super Care policies in the fourth quarter of 1995. Since the premium increases apply to new policies only, management does not expect any adverse impact on persistency of existing policies.\nThe Company has filed two new products for approval and introduction in 1995. The first product is a medical expense policy similar to a U.S. hospital indemnity policy. It provides benefits for daily hospital confinement and surgery, as well as a death benefit. The second product is a life insurance product with living benefit features. Management believes these products will fill another niche in the supplemental insurance marketplace for consumers and AFLAC.\nAGENCY FORCE - JAPAN\nThe development of a \"Corporate Agency\" system has been important to the growth of AFLAC Japan. This distribution method permits Japanese companies to form insurance agencies as subsidiaries that offer our insurance plans to the total affiliated group's employees, suppliers and customers. About 95% of all companies listed on the Tokyo Stock Exchange have either a corporate agency or allow payroll deduction of premiums for AFLAC's products. AFLAC has no ownership interest in these corporate agencies.\nAFLAC products are also sold through independent agencies that are not affiliated with large corporations and through agencies formed by individuals. At December 31, 1994, there were 4,961 agencies in Japan with 19,270 licensed agents. Agents' activities are principally limited to insurance sales, with policyholder service functions handled by the main office in Tokyo and 66 sales offices located throughout Japan.\nCOMPETITION - JAPAN\nIn 1974, AFLAC became the second foreign (non-Japanese) life insurance company to gain direct access to the Japanese insurance market by obtaining a license to do business in Japan. Through 1981, AFLAC was the only company in Japan authorized to issue a cancer expense insurance policy. Since that time, several other life companies have been permitted to offer cancer insurance. However, AFLAC remains the leading issuer of cancer expense insurance coverage in Japan, principally due to its lead time in the market, its unique marketing system (see \"Agency Force\"), its low-cost operations and its product expertise developed in the United States. AFLAC has been very successful in the sale of cancer expense policies in Japan, with over 11.8 million cancer policies in force at December 31, 1994.\nI-6\nThe Japanese government is continuing the discussions begun in 1991 with the insurance industry and other groups to explore various long-term deregulation approaches for the financial services businesses in Japan. The principles upon which deregulation of the Japanese insurance industry is based are: (1) to promote competition and to enhance efficiency through deregulation and liberalization; (2) to preserve soundness; and (3) to secure fairness and equity in business operations. This project is still in a preliminary stage and the ultimate changes and their effects are not presently determinable. Due to the Company's unique marketing distribution system in Japan, management believes that deregulation will not have an immediate material effect on the Company.\nAFLAC's strategy for future growth in Japan centers on the expansion of the Company's product line. Although the basic plan for growth is the same in Japan as in the United States, management has had to formulate a strategy specifically tailored for the Japanese insurance marketplace, which is very different from the U.S. system. There are only 31 life insurance companies in Japan, compared with more than 2,000 life insurers in the United States. In Japan, insurers have traditionally been restricted in the types of policies they could offer. However, as Japan begins deregulating the insurance industry, the marketplace should become more competitive, with insurers able to offer more types of products as they do in the United States.\nDuring 1994, Japan held a series of trade talks with the United States. The U.S.-Japan Framework Agreement negotiations looked at the possibility of opening various Japanese market sectors, including insurance, to expanded foreign competition. During the discussions, the Japanese government agreed to avoid any radical changes in the third sector of the insurance market until a substantial portion of the life and non-life insurance sectors are deregulated. AFLAC and other foreign-owned insurers, as well as some small to medium-sized companies, operate in the third sector. As a result, AFLAC should not be directly affected by deregulation in Japan in the immediate future. However, by building on the Company's strengths, management has prepared for increased competition.\nREGULATION AND REMITTANCE OF FUNDS - JAPAN\nAnnual payments are made from AFLAC Japan for management fees to the Parent Company, and allocated expenses and remittances of earnings to AFLAC U.S. These payments totaled $167.9 million in 1994, $133.4 million in 1993 and $65.5 million in 1992. Management fees paid to the Parent Company are largely based on expense allocations. It is expected that profit remittances will continue in future years, based on projected annual earnings of AFLAC Japan as computed on a Japanese regulatory accounting basis. Japanese earnings available for profit remittance reflect investments generally valued at the lower of market value or cost. Also, AFLAC Japan's statutory earnings reflect foreign exchange gains and losses on the translation of its U.S. dollar-denominated investments. Therefore, changes in interest rate levels, yen\/dollar exchange rates and other factors that affect market values of investment securities can cause wide fluctuations from year to year in the amounts of regulatory earnings in Japan and, therefore, profit remittances to AFLAC U.S.\nAs part of the deregulation process, the Japanese Ministry of Finance (\"MOF\") is developing new solvency regulations and standards that represent\nI-7\na form of risk-based capital requirements. AFLAC Japan must meet these requirements to continue profit transfers to AFLAC U.S. At this time, AFLAC Japan is in compliance with the proposed new standards, and management does not expect these requirements would adversely affect the repatriation of funds from Japan for the next several years.\nThe insurance business in Japan, which is conducted as a branch office of AFLAC, is subject to regulation by the MOF, similar to the regulation and supervision in the United States as described on page I-12 under \"Regulation - -U.S.\" AFLAC Japan files annual reports and financial statements for the Japanese insurance operations based on a March 31 year-end, prepared in accordance with Japanese regulatory accounting practices prescribed or permitted by the MOF. Also, financial and other affairs of AFLAC Japan are subject to examination by the MOF.\nReconciliations of AFLAC Japan net assets on a GAAP basis to net assets determined on a Japanese regulatory accounting basis as of December 31 are as follows: (In thousands - unaudited) 1994 1993 ---------- ---------- Net assets on GAAP basis $ 1,564,938 $ 1,099,712 Elimination of deferred policy acquisition costs (1,951,549) (1,537,128) Reduction in carrying value of fixed- maturity investments for market value and foreign exchange adjustments (978,855) (113,349) Adjustment to liability for future policy benefits 500,952 40,943 Elimination of deferred income taxes and adjustment to prepaid Japan taxes 1,223,368 791,268 Reduction in premiums receivable (227,270) (83,064) Other, net 97,041 (14,010) ---------- --------- Net assets on Japanese regulatory accounting basis $ 228,625 $ 184,372 ========== =========\nFor additional information regarding AFLAC Japan's operations, see Exhibit 13, pages 13-8 to 13-11 and pages 13-27 and 13-45 (Notes 2 and 10 of Notes to the Consolidated Financial Statements), which are incorporated herein by reference.\nEMPLOYEES - JAPAN\nAFLAC Japan employed 1,527 full-time and 178 part-time employees at December 31, 1994. AFLAC Japan considers its employee relations to be excellent.\nI-8\nINSURANCE - U.S.\nThe following table sets forth AFLAC U.S. earned premiums by product line for the last three years ended December 31.\nEarned premiums (in thousands): 1994 1993 1992 -------- -------- --------\nCancer expense $ 384,943 $ 369,256 $ 356,732 Other accident and health 392,371 338,743 288,643 Life insurance 15,149 14,488 14,641 -------- -------- -------- Total AFLAC U.S. earned premiums $ 792,463 $ 722,487 $ 660,016 ======== ======== ========\nHEALTH INSURANCE PLANS - U.S.\nAFLAC's insurance is supplemental in nature and is designed for persons who have major medical coverage. All of AFLAC's supplemental health insurance plans are guaranteed renewable for the lifetime of the policyholder. Guaranteed-renewable coverage may not be cancelled by the insurer, but premium rates on existing and future policies may be increased by class of policy in response to claims experience higher than originally expected (subject to federal and state loss-ratio guidelines) on a uniform, nondiscriminatory, state-wide basis subject to state regulatory approval.\nAFLAC's cancer plans are designed to provide insurance benefits for medical and nonmedical costs that are generally not reimbursed by major medical insurance. AFLAC currently offers a series of five different cancer plans in the United States that vary by benefit amounts and type. All five plans provide a first occurrence benefit that pays an initial amount when internal cancer is first diagnosed, a fixed amount for each day an insured is hospitalized for cancer treatment, and benefits for medical, radiation, chemotherapy, nursing, blood, plasma, physician, transportation, prosthesis and ambulance expenses. Some of the plans currently offered contain benefits that reimburse the insured for anesthesia and surgical expenses incurred in connection with cancer treatment, as well as benefits for a second surgical opinion and a \"wellness\" benefit applicable toward certain diagnostic tests such as pap smears and mammograms. AFLAC also issues several riders that may be purchased, including one that increases the amount of the first occurrence benefit for each month until age 65 that the coverage remains in force. AFLAC periodically introduces new forms of coverage, revising benefits and related premiums based upon the anticipated needs of the policyholders and AFLAC's claims experience.\nAFLAC currently markets five of the Medicare Supplement Standardized Plans, with the majority of sales being for Plans F and C. The plans are priced on an issue-age basis. Under this method, rates are revised due to changes in the Medicare program and medical inflation. There is no automatic rate increase due to the aging of the insured. Premium rates are determined based on zip code groupings, which are adjusted for increases in costs for each area. The benefits provided range from the basic plan, covering Part A and B coinsurance, to plans with more extensive coverage, including Part A\nI-9\nand B deductibles, skilled nursing coinsurance, Part B excess and other benefits. AFLAC U.S. does not market the standardized plans covering prescription drug benefits.\nAFLAC also issues other supplemental health insurance, such as intensive care, which is a low-premium policy that provides protection against the high cost of intensive care facilities during hospital confinement, regardless of reimbursements from other insurers. Other types of health insurance issued by AFLAC include a long-term convalescent care policy, an accident and disability protection policy, long- and short-term disability and a hospital confinement indemnity policy.\nLIFE INSURANCE PLANS - U.S.\nAFLAC issues various life insurance policies including whole life, limited pay life, voluntary group term life and term life coverage. LifeCare policies, which constitute the majority of life insurance sales, are written under master policies issued through several employer trusts. LifeCare policies are marketed in a manner similar to AFLAC's health plans, as described below.\nAGENCY FORCE AND MARKETING - U.S.\nAFLAC's sales agents are licensed to sell accident and health insurance, and many are also licensed to sell life insurance. Most agents' efforts are directed toward selling supplemental health insurance. The 1994 monthly average number of U.S. agents and brokers actively producing business was 5,692, compared with 5,437 in 1993 and 4,960 in 1992.\nAgents' activities are principally limited to sales, with all policyholder service functions, including issuance of policies, premium collection, payment notices and claims, handled by the staff at headquarters. Agents are paid commissions based on first-year and renewal premiums from their sales of health and life insurance products. AFLAC's State, Regional and District Sales Coordinators, who are independent contractors, are compensated by override commissions.\nAFLAC has concentrated on the development of \"payroll marketing\" in marketing its policies. Payroll marketing offers policies to individuals through common media such as trade and other associations or place of employment. This manner of marketing is distinct from \"group\" insurance sales in that each individual insured is directly contacted by the sales associate. Policies are individually underwritten and issued to the insured, and most employers do not contribute to the payment of premiums. Additionally, individuals may retain their full insurance coverage upon separation from employment or such affiliation, generally at the same premium. A major portion of premiums on such sales are collected through payroll deduction or other forms of group billings. Group-billed plans normally result in a lower average age of the insured at the time of policy issuance, and also result in certain savings in administrative costs, a portion of which are passed on to the policyholder in the form of reduced premiums. Management believes that payroll marketing enables the agency force to reach a greater number of prospective policyholders than individual solicitation and that such sales lower distribution costs.\nI-10\nAnother valuable marketing and sales tool is the flexible benefits program, or cafeteria plan, which allows an employee to pay for medical insurance using pretax dollars. These programs help achieve increased penetration as agents are required to present the program to all employees. They also help improve overall persistency levels due to the limited changes allowed during the plan year. The U.S. Congress continues to address possible changes to the U.S. health care system. Some of the 1994 proposals included provisions that would have eliminated cafeteria plans. However, no action on health care reform was taken in 1994.\nDuring 1994 and 1993, AFLAC continued to develop marketing arrangements with insurance brokers. Also, AFLAC has signed joint-marketing agreements with several large companies within and outside of the insurance industry. The core of the Company's distribution network will remain independent agents. The Company has improved its access to large payroll groups through insurance brokers and joint marketing alliances.\nIn 1994, AFLAC's U.S. premiums collected were $787.4 million, 7.3% of which was collected in Florida, 6.9% in Georgia, 6.8% in Texas, 5.5% in North Carolina and 5.1% in Tennessee. Premiums collected in all other states were individually less than 5% of AFLAC's U.S. premiums.\nCOMPETITION - U.S.\nThe accident and health and life insurance industry in the United States is highly competitive. AFLAC competes with a large number of other insurers, some of which have been in business for a longer period of time or have greater financial resources. In the United States, there are more than 2,000 life and accident and health insurance companies, most of which compete in the states AFLAC conducts business.\nPrivate insurers and voluntary and cooperative plans, such as Blue Cross and Blue Shield, provide insurance for meeting basic hospitalization and medical expenses. Much of this insurance is sold on a group basis. The federal and state governments also pay substantial costs of medical treatment through Medicare and Medicaid programs. Such major medical insurance generally covers a substantial amount of the medical (but not nonmedical) expenses incurred by an insured as a result of cancer or other major illnesses. AFLAC's policies are designed to provide coverage that is supplemental to coverage provided by major medical insurance. AFLAC's benefits may also be used to defray nonmedical expenses.\nSince other insurers generally do not provide full coverage of medical expenses or any coverage of nonmedical expenses, AFLAC's supplemental insurance is not an alternative to major medical insurance, but is sold to complement major medical insurance by covering the gap between major medical insurance reimbursements and the total costs of an individual's health care. AFLAC thus competes only indirectly with major medical insurers in terms of premium rates and similar factors. However, the scope of the major medical coverage offered by other insurers does represent a limitation on the market for AFLAC's products. Accordingly, expansion of coverage by other insurers or governmental programs could adversely affect AFLAC's business opportunities.\nI-11\nAFLAC competes directly with other insurers offering supplemental health insurance and believes that its current policies and premium rates are generally competitive with those offered by other companies selling similar types of insurance.\nFor additional information regarding U.S. insurance operations, see Exhibit 13, page 13-11 to 13-13, which is incorporated herein by reference.\nREGULATION - U.S.\nThe Parent Company and its insurance subsidiaries are subject to state regulations in the United States as an insurance holding company system. Such regulations generally provide that transactions between companies within the holding company system must be fair and equitable. In addition, transfer of assets among such affiliated companies, certain dividend payments from insurance subsidiaries and material transactions between companies within the system are subject to prior notice to, or approval by, state regulatory authorities.\nAFLAC and its insurance subsidiaries, in common with all U.S. insurance companies, are subject to regulation and supervision in the states and other jurisdictions in which they do business. In general, the insurance laws of the various jurisdictions establish supervisory agencies with broad administrative powers relating to, among other things: granting and revoking licenses to transact business, regulating trade practices, licensing agents, prior approval of forms of policies and premium rate increases, standards of solvency and maintenance of specified policy benefit reserves and minimum loss ratio requirements, capital for the protection of policyholders, limitations on dividends to shareholders, the nature of and limitations on investments, deposits of securities for the benefit of policyholders, filing of annual reports and financial statements prepared in accordance with statutory insurance accounting practices prescribed or permitted by the regulatory authorities, and periodic examinations of the financial and other affairs of insurance companies.\nFor further information concerning state regulatory and dividend restrictions, see Exhibit 13, page 13-45 (Note 10 - Statutory Accounting and Dividend Restrictions of Notes to the Consolidated Financial Statements), incorporated herein by reference.\nA risk-based capital formula was adopted by the National Association of Insurance Commissioners (\"NAIC\") in 1992 for U.S. life insurance companies that established capital requirements relating to insurance risk, business risk, asset risk and interest rate risk. These requirements are intended to facilitate identification by insurance regulators of inadequately capitalized insurance companies based upon the types and mixtures of risks inherent in the insurer's operations. The formulas for determining the amount of risk- based capital specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of the company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level risk-based capital, as defined by the NAIC. Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. The levels are company action, regulatory action, authorized control and mandatory control.\nI-12\nCompanies that have triggered a company action level event are required to submit a detailed comprehensive financial plan to the domiciliary state insurance department. In the regulatory action level, in addition to submitting the comprehensive financial plan, a company may be subjected to a detailed regulatory investigation. The domiciliary state insurance department is permitted, but not required, to place the insurance company under regulatory control when it falls to the authorized control level; regulatory control is required in the mandatory control level.\nAFLAC's NAIC risk-based capital ratio continues to reflect a very strong statutory capital and surplus position. Also, there are several ongoing regulatory initiatives being developed by the NAIC relating to investments, reinsurance, dividend restrictions, revision of the risk-based capital formula as it pertains to health organizations and other accounting requirements.\nCurrently, four states have laws, regulations or regulatory practices that either prohibit the sale of specific disease insurance, such as AFLAC's cancer expense insurance, or make its sale impractical. These states are Connecticut, Massachusetts, New Jersey and New York. The remainder of the states do not impose prohibitions or restrictions that prevent AFLAC from marketing cancer expense insurance. AFLAC U.S. is marketing several of its other products in these states, directly or through a subsidiary.\nUnder insurance guaranty fund laws in most states in the United States, insurance companies doing business therein can be assessed up to prescribed limits for policyholder losses incurred by insolvent companies with similar lines of business. Such assessments have not been material to the Company in recent years. The Company believes that future assessments relating to companies currently involved in insolvency proceedings will not materially impact the consolidated financial statements.\nThe Company continues to monitor developments in the U.S. Congress concerning possible changes to the U.S. health care system. No action on health care reform was taken in 1994; however, some of the 1994 proposals included provisions that could have unfavorably affected the Company's tax expense, product design and marketing techniques in the United States. Management believes that a more limited approach to health care reform will be on the legislative calendar in 1995. The future of health care reform and its impact on AFLAC U.S. cannot be readily predicted at this time.\nDespite the movement toward managed care in the U.S. health care system, management believes that opportunities for marketing high-quality, affordable supplemental insurance policies in the United States will continue. The Company believes that a reformed health care system will require individuals to assume responsibility for larger portions of their total health care expenses, which should increase the demand for supplemental insurance products.\nEMPLOYEES - U.S.\nIn its U.S. insurance operations, the Company employed 1,627 full-time and 33 part-time employees at December 31, 1994. The Company considers its employee relations to be excellent.\nI-13\nOTHER OPERATIONS\nAt December 31, 1994, the AFLAC Broadcast Division owned seven network- affiliated television stations with total assets of $152.1 million. The Broadcast Division employed 539 full-time and 108 part-time employees at December 31, 1994. The Broadcast Group considers its employee relations to be excellent.\nThe Broadcast Division produced increased revenues and earnings during 1994 as compared with 1993. Revenues increased 12.5%, to $77.0 million. Pretax earnings before interest expense rose 28.1%, to $17.2 million. Stations benefited from advertising related to the off-year political elections, an improved U.S. economy and strengthened cost controls.\nThe Broadcast Division has succeeded despite significant changes in the industry. With the emergence of new cable networks and stations, there are more outlets for advertising dollars than ever before. Despite the segmentation of television entertainment and news, network-affiliated stations continue to effectively deliver mass audiences to advertisers. As a result, the AFLAC Broadcast Division is able to successfully compete in a crowded, competitive marketplace.\nFor additional information regarding broadcast operations, see Exhibit 13, page 13-14, which is incorporated herein by reference.\nThe Company's other operations employed 307 full-time and 2 part-time employees at December 31, 1994; employee relations are considered to be excellent.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAFLAC owns an 18-story office building, which is the worldwide headquarters of the Parent Company and AFLAC, along with a six-story parking garage. These structures are located on approximately 14 acres of land in Columbus, Georgia. In addition, AFLAC Real Estate Holdings, Inc. (AREH), a wholly owned subsidiary of the Parent Company, owns a two-story building located on the same property. AFLAC also owns an administrative office building located nearby. The Parent Company, AFLAC and AREH also own and lease office space and warehouse facilities at other locations in the United States.\nIn Tokyo, Japan, AFLAC owns a new 11-story administrative office building which was completed in April 1994. AFLAC also leases office space in Tokyo, along with regional sales offices located throughout the country, and owns a training and computer facility in Tokyo. For further information concerning the new building in Japan, see Exhibit 13, pages 13-18, (discussion concerning cash flow) and 13-36 (Note 5 of Notes to the Consolidated Financial Statements), which are incorporated herein by reference. Other foreign affiliates of the Company also have leased office space.\nThe Broadcast Division owns and leases land, buildings, transmission towers and other broadcast equipment in the cities where its seven television stations are located.\nI-14\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a defendant in various litigation considered to be in the normal course of business. Management does not believe the outcome of any pending litigation in which it is a defendant will have a material effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to the security holders for a vote in the fourth quarter ended December 31, 1994.\nI-15\nITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY NAME PRINCIPAL OCCUPATION (*) AGE ___________________ _____________________________________ ___ Paul S. Amos Chairman of the Board of the Company 68 and AFLAC since August 1990; Vice Chairman of the Company and AFLAC until August 1990\nDaniel P. Amos Chief Executive Officer of the 43 Company and AFLAC, Vice Chairman of the Company, since August 1990; President of the Company since August 1991; President of AFLAC and Deputy Chief Executive Officer of the Company, until August 1990; Chief Operating Officer of AFLAC, until August 1990\nWilliam J. Bugg, Jr. Senior Vice President, Corporate 55 Actuary of AFLAC\nMonthon Chuaychoo Vice President, Financial Services, of 51 the Company and AFLAC since September 1993; Second Vice President, Assistant Controller of the Company and AFLAC from June 1991 to September 1993; Second Vice President of AFLAC until June 1991\nKriss Cloninger III Executive Vice President, Chief 47 Financial Officer and Treasurer of the Company, and Executive Vice President, Chief Financial Officer of AFLAC since March 1993; Senior Vice President, Chief Financial Officer and Treasurer of the Company, and Senior Vice President, Chief Financial Officer of AFLAC from March 1992 until March 1993; Principal, KPMG Peat Marwick LLP, Atlanta, GA, until March 1992\nMartin A. Durant, III Senior Vice President, Corporate Services, 46 of the Company and AFLAC since August 1993; Vice President and Controller of the Company, from 1990 to August 1993, and of AFLAC from June 1991 to August 1993; President of Rebuilding Service, Inc., until 1990\nI-16\nNorman P. Foster Executive Vice President, Corporate 59 Finance, of the Company and AFLAC since March 1992; Senior Vice President, Chief Financial Officer and Treasurer of the Company, and Senior Vice President and Chief Financial Officer of AFLAC until March 1992\nDavid Halmrast Senior Vice President, Corporate 55 Development, of AFLAC since December 1993; Senior Vice President, Corporate Development of the Company from April 1993 to December 1993; Senior Vice President and Chief Financial Officer of Colonial Companies, Inc. until July\nKerry W. Hand Senior Vice President, Home Office 42 Administration, of AFLAC\nKenneth S. Janke Jr. Senior Vice President, Investor 36 Relations, of the Company since August 1993; Vice President, Investor Relations, of the Company, since 1990; Second Vice President, Investor Relations, of the Company until 1990\nAkitoshi Kan Vice President, AFLAC Japan, Accounting 47 Department, since 1992; Manager, AFLAC Japan, Accounting Department, until\nKyoichi Kasuya Vice President, AFLAC Japan, Actuary, 57 since 1992; General Manager, AFLAC Japan, Actuarial Department, until\nJoseph P. Kuechenmeister Senior Vice President, Director 53 of Marketing of AFLAC, since December 1990; Vice President, Agency Director of AFLAC, October 1990 until December 1990; Second Vice President, Director of Direct Product and Sales Development of AFLAC until October 1990\nI-17\nJoey M. Loudermilk Senior Vice President, General Counsel 41 and Corporate Secretary of the Company, and Senior Vice President, General Counsel and Director, Legal and Governmental Relations and Corporate Secretary of AFLAC since May 1992; Senior Vice President, Corporate Counsel and Assistant Secretary of the Company and AFLAC and Director, Legal and Governmental Affairs of AFLAC, from 1990 until May 1992; Senior Vice President, Corporate Counsel and Assistant Secretary of the Company and Senior Vice President, Director, Legal and Governmental Affairs of AFLAC, from August 1989 until 1990; Vice President of the Company, and Vice President, Legal and Regulatory Department of AFLAC, until August 1989\nHidefumi Matsui Executive Vice President of AFLAC Japan, 50 since January 1992; Senior Vice President, Director of Marketing of AFLAC Japan, from January 1990 until January 1992; Senior Vice President of AFLAC Japan, until January 1990\nMinoru Nakai President of AFLAC International, Inc., 53 since October 1991; Senior Vice President, U.S.-Japan Operations, of AFLAC, until October 1991\nYoshiki Otake President of AFLAC Japan; Vice 55 Chairman of AFLAC International, Inc., since October 1991; Executive Vice President of AFLAC from January 1991 until October 1991\nThomas L. Paul President of AFLAC Broadcast Group, Inc.; 65 Vice President, Corporate Development, of the Company until 1993\nE. Stephen Purdom Executive Vice President of AFLAC since 47 October 1994; Senior Vice President, Medical Director of AFLAC until October\nI-18\nJoseph W. Smith, Jr. Chief Investment Officer of the Company 41 and AFLAC since August 1991; Senior Vice President, Investments of AFLAC, until August 1991\nGary L. Stegman Senior Vice President, Assistant Chief 45 Financial Officer of the Company and AFLAC since June 1991; Senior Vice President, Treasurer of AFLAC until June 1991\n(*) Unless specifically noted, the respective executive officer has held the occupation(s) set forth in the table for at least five years. Each executive officer is appointed annually by the board of directors and serves until his successor is chosen and qualified, or until his death, resignation or removal.\nI-19\nPART II\nPursuant to General Instruction G to Form 10-K, Items 5 through 8 are incorporated by reference from the Company's 1994 Annual Report to Shareholders, the appropriate sections of which are included herein as Exhibit 13. The page numbers of the selected information from the Annual Report (as well as the Annual Report) containing the required information are set forth below:\nRefer To Refer To Exhibit 13 Annual Report Pages Pages __________ _____________\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON 13-1; 13-2; 1; 24; 46 (Note EQUITY AND RELATED SHAREHOLDER 13-43 9); and 50 MATTERS (Note 9)\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA 13-3; 13-4 32 - 33\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND 13-5 to 25 - 31 ANALYSIS OF FINANCIAL CONDITION 13-18 AND RESULTS OF OPERATIONS\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND 13-19.1 to 34 - 50 SUPPLEMENTARY DATA 13-52\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS None None WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nII-1\nPART III\nPursuant to General Instruction G to Form 10-K, Items 10 through 13 are incorporated by reference to the Company's definitive Proxy Statement relating to the Company's 1995 Annual Meeting of Shareholders, which was filed with the Securities and Exchange Commission on March 10, 1995, pursuant to Regulation 14A under the Securities Exchange Act of 1934.\nRefer to the Information Refer to Contained in the Proxy Printed Statement under Captions Proxy (filed electronically) Statement Pages ________________________ _________\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE Security Ownership of 3 - 7 OFFICERS OF THE COMPANY Management. 1. Election Directors of Directors Executive Officers - see Part I, Item 4A herein\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION Board and Committee 8 - 18 Meetings and Directors Compensation; Summary Compensation Table; De- fined Benefit Pension Plan; Retirement Plans for Key Executives; Employment Contracts and Termination of Employ- ment Arrangements\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF Voting Securities and 2 - 7 CERTAIN BENEFICIAL Principal Holders OWNERS AND Thereof. Security Owner- MANAGEMENT ship of Management. 1. Election of Directors\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS Certain Transactions 19 AND RELATED and Relationships TRANSACTIONS\nIII-1\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. FINANCIAL STATEMENTS Refer to Page(s)\nIncluded in Part II of this report and incorporated by reference to the following pages of Exhibit 13: AFLAC Incorporated and Subsidiaries: Consolidated Statements of Earnings, for 13-19.1 - each of the years in the three-year 13-19.2 period ended December 31, 1994 Consolidated Balance Sheets, at December 13-20.1 - 31, 1994 and 1993 13-20.2 Consolidated Statements of Shareholders' 13-21.1 - Equity, for each of the years in the 13-21.2 three-year period ended December 31, Consolidated Statements of Cash Flows, 13-22.1 - for each of the years in the three-year 13-22.2 period ended December 31, 1994 Notes to the Consolidated Financial 13-23 to Statements 13-49 Report of Independent Auditors 13-51\n2. FINANCIAL STATEMENT SCHEDULES\nIncluded in Part IV of this report: Auditors' Report on Financial Statement Schedules IV-5 Schedule I - Summary of Investments - Other IV-6 Than Investments in Related Parties, at December 31, 1994 Schedule II - Condensed Financial Information of IV-7 - Registrant, at December 31, 1994 IV-12 and 1993 and for each of the years in the three-year period ended December 31, 1994 Schedule IV - Reinsurance, for each of the IV-13 years in the three-year period ended December 31, 1994\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.\nIV-1\n3. EXHIBITS\n3.0 - Articles of Incorporation, as amended - incorporated by reference from 1991 Form 10-K, Commission file number 1-7434, Exhibit 3.0; and Bylaws of the Company, as amended - incorporated by reference from 1992 Form 10-K, Commission file number 1-7434, Exhibit 3.0. 4.0 - The registrant is not filing one instrument evidencing indebtedness since the total amount of securities authorized under any single instrument does not exceed 10% of the total assets of the registrant and its subsidiaries on a consolidated basis. Copies of such instruments will be furnished to the Securities and Exchange Commission upon request. 10.0* - American Family Corporation Incentive Stock Option Plan (1982) - incorporated by reference from Registration Statement No. 33-44720 on Form S-8 with respect to the AFLAC Incorporated (Formerly American Family Corporation) Incentive Stock Option Plan (1982) and Stock Option Plan (1985). 10.1* - American Family Corporation Stock Option Plan (1985) - incorporated by reference from Registration Statement No. 33-44720 on Form S-8 with respect to the AFLAC Incorporated (Formerly American Family Corporation) Incentive Stock Option Plan (1982) and Stock Option Plan (1985). 10.1.1* - AFLAC Incorporated Amended 1985 Stock Option Plan - incorporated by reference from 1994 Shareholders' Proxy Statement, Commission file number 1-7434, Accession No. 0000004977-94-000003, Exhibit A. 10.2* - American Family Corporation Retirement Plan for Senior Officers, as amended and restated October 1, 1989 - incorporated by reference from 1993 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-94-000006, Exhibit 10.2. 10.3* - American Family Corporation Supplemental Executive Retirement Plan - incorporated by reference from 1989 Form 10-K, Commission file number 1-7434, Exhibit 10.9. 10.3.1* - AFLAC Incorporated Supplemental Executive Retirement Plan, as amended, effective September 1, 1993. 10.4* - AFLAC Incorporated Employment Agreement with Daniel P. Amos, dated August 1, 1993 - incorporated by reference from 1993 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-94-000006, Exhibit 10.4. 10.5* - American Family Life Assurance Company of Columbus Employment Agreement with Yoshiki Otake, dated January 1, 1995. 10.6* - AFLAC Incorporated Employment Agreement with Kriss Cloninger, III, dated February 14, 1992, and as amended November 12, 1993 - incorporated by reference from 1993 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-94-000006, Exhibit 10.6. 10.7* - AFLAC Incorporated Management Incentive Plan - incorporated by reference from 1994 Shareholders' Proxy Statement, Commission file number 1-7434, Accession No. 0000004977-94-000003, Exhibit B.\nIV-2\n10.8* - American Family Life Assurance Company of Columbus Employment Agreement with Hidefumi Matsui, dated January 1, 1995. 10.9* - American Family Life Assurance Company of Columbus Employment Agreement with Dr. E. Stephen Purdom, dated October 25, 1994. 13.0 - Selected information from the AFLAC Incorporated Annual Report to Shareholders for 1994. 21.0 - Subsidiaries. 23.0 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-8 Registration Statement No. 33-44720 with respect to the AFLAC Incorporated (Formerly American Family Corporation) Incentive Stock Option Plan (1982) and Stock Option Plan (1985). 23.1 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-3 Registration Statement No. 33-41926 with respect to the AFLAC Associate Stock Bonus Plan. 23.2 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-8 Registration Statement No. 33-41552 with respect to the AFLAC Incorporated 401(K) Retirement Plan. 27.0 - Financial Data Schedule (electronic filing only). 28.0* - AFLAC Incorporated 401(K) Retirement Plan incorporated by reference from 1992 Form 10-K, Commission file number 1-7434, Exhibit 28.0.\n(b) REPORTS ON FORM 8-K\nThere were no reports filed on Form 8-K for the quarter ended December 31, 1994.\nIV-3\n(c) EXHIBITS FILED WITH CURRENT FORM 10-K\n10.3.1* - AFLAC Incorporated Supplemental Executive Retirement Plan, as amended, effective September 1, 1993. 10.5* - American Family Life Assurance Company of Columbus Employment Agreement with Yoshiki Otake, dated January 1, 1995. 10.8* - American Family Life Assurance Company of Columbus Employment Agreement with Hidefumi Matsui, dated January 1, 1995. 10.9* - American Family Life Assurance Company of Columbus Employment Agreement with Dr. E. Stephen Purdom, dated October 25, 1994. 13.0 - Selected information from the AFLAC Incorporated Annual Report to Shareholders for 1994. 21.0 - Subsidiaries. 23.0 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-8 Registration Statement No. 33-44720 with respect to the AFLAC Incorporated (Formerly American Family Corporation) Incentive Stock Option Plan (1982) and Stock Option Plan (1985). 23.1 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-3 Registration Statement No. 33-41926 with respect to the AFLAC Associate Stock Bonus Plan. 23.2 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-8 Registration Statement No. 33-41552 with respect to the AFLAC Incorporated 401(K) Retirement Plan. 27.0 - Financial Data Schedule (electronic filing only).\n* Management contract or compensatory plan or arrangement.\nIV-4\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES\nThe Shareholders and Board of Directors AFLAC Incorporated:\nUnder date of January 30, 1995, we reported on the consolidated balance sheets of AFLAC Incorporated and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 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 schedules as listed in Item 14. 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\nAtlanta, Georgia January 30, 1995\nIV-5\nSCHEDULE I AFLAC INCORPORATED AND SUBSIDIARIES Summary of Investments - Other than Investments in Related Parties December 31, 1994\n(In thousands) Amount in Fair Balance Type of Investment Cost Value Sheet ----------- ---------- ---------\nFixed maturities available for sale: Bonds: United States Government and government agencies and authorities $ 373,215 $ 355,406 $ 355,406 States, municipalities and political subdivisions 806,036 839,346 839,346 Foreign governments 6,200,319 6,724,439 6,724,439 Public utilities 2,878,286 3,108,117 3,108,117 Convertibles 25,053 26,804 26,804 All other corporate bonds 4,426,911 4,476,582 4,476,582 ---------- ---------- ---------- Total fixed maturities available for sale 14,709,820 15,530,694 15,530,694 ---------- ---------- ---------- Equity securities: Common stocks: Public utilities 1,540 1,829 1,829 Banks, trusts and insurance companies 3,295 4,830 4,830 Industrial, miscellaneous and all other 66,750 77,714 77,714 ---------- ---------- ---------- Total equity securities 71,585 84,373 84,373 ---------- ---------- ---------- Total securities available for sale 14,781,405 15,615,067 15,615,067\nMortgage loans on real estate 25,104 29,104 25,104 Policy loans 1,202 1,202 1,202 Other long-term investments 3,836 3,836 3,836 Short-term investments 330,916 330,916 330,916 ---------- ---------- ---------- Total investments $15,142,463 $15,980,125 $15,976,125 ========== ========== ==========\nIV-6\nSCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCondensed Balance Sheets AFLAC Incorporated (Parent Only) (In thousands) December 31, 1994 1993 ---------- ---------- Assets: Investments: Investments in subsidiaries* $ 1,988,329 $ 1,489,961 Other investments: Money market funds 2,489 20,823 Mortgage loans and other 2,468 3,132 ---------- ---------- Total investments 1,993,286 1,513,916 Due from subsidiaries* 9,574 6,674 Other receivables 4,851 6,472 Property and equipment, net 8,961 10,107 Other 267 1,924 ---------- ---------- Total assets 2,016,939 1,539,093 ========== ========== Liabilities and Shareholders' Equity: Liabilities: Cash overdraft 82 59 Due to subsidiaries* 714 3,145 Notes payable (note A) 111,970 54,511 Employee and beneficiary benefit plans 117,145 84,445 Income taxes, primarily deferred 25,399 25,977 Other 9,862 5,332 Commitments and contingencies (note B) ---------- --------- Total liabilities 265,172 173,469 ---------- --------- Shareholders' equity: Common stock of $.10 par value: Authorized 175,000; issued 104,000 shares in 1994 and 103,710 shares in 1993 10,400 10,371 Additional paid-in capital 198,099 195,730 Unrealized foreign currency translation 174,091 123,294 Unrealized gains on equity securities 228,844 14,811 Retained earnings (note D) 1,277,487 1,029,625 Treasury stock (135,776) (6,568) Notes receivable for stock purchases (1,378) (1,639) ---------- ---------- Total shareholders' equity 1,751,767 1,365,624 ---------- ---------- Total liabilities and shareholders' equity $ 2,016,939 $ 1,539,093 ========== ========== * Eliminated in consolidation. See the accompanying Notes to Condensed Financial Statements.\nIV-7\nSCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCondensed Statements of Earnings AFLAC Incorporated (Parent Only) (In thousands)\nYears ended December 31, 1994 1993 1992 ---------- ---------- ---------- Revenues: Dividends from subsidiaries* $ 109,533 $ 71,268 $ 46,657 Management and service fees from subsidiaries* 26,391 30,357 28,227 Other income from subsidiaries, principally rental and interest* 683 992 828 Other income 1,327 (620) 693 --------- --------- --------- Total revenues 137,934 101,997 76,405 --------- --------- --------- Operating expenses: Interest expense - subsidiaries* 22 162 293 Interest expense - others 6,070 3,362 2,743 Capitalized interest (2,419) (3,250) (1,333) Other operating expense 65,635 53,595 48,760 --------- --------- --------- Total operating expenses 69,308 53,869 50,463 --------- --------- --------- Earnings before income taxes, equity in undistributed earnings of subsidiaries and cumulative effect of accounting changes 68,626 48,128 25,942\nIncome tax expense (note C) 874 1,063 1,103 --------- --------- --------- Earnings before equity in undistributed earnings of subsidiaries and cumulative effect of accounting changes 67,752 47,065 24,839\nEquity in undistributed earnings of subsidiaries 225,038 196,824 158,528 --------- --------- --------- Earnings before cumulative effect of accounting changes 292,790 243,889 183,367\nCumulative affect on prior years of accounting changes (including a $46,100 credit related to subsidiaries) (note F) - 11,438 - --------- --------- --------- Net earnings $ 292,790 $ 255,327 $ 183,367 ========= ========= =========\n* Eliminated in consolidation. See the accompanying Notes to Condensed Financial Statements.\nIV-8\nSCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT Condensed Statements of Cash Flows AFLAC Incorporated (Parent Only) (In thousands) Years ended December 31, 1994 1993 1992 ---------- ---------- ---------- Cash flows from operating activities: Net earnings $ 292,790 $ 255,327 $ 183,367 Adjustments to reconcile net earnings to net cash provided from operating activities: Cumulative effect on prior years of accounting changes - (11,438) - Equity in undistributed earnings of subsidiaries (225,038) (196,824) (158,528) Deferred income taxes (578) (300) 1,103 Employee and beneficiary benefit plans 32,700 18,195 12,659 Other, net 4,307 190 8,020 --------- --------- --------- Net cash provided by operating activities 104,181 65,150 46,621 --------- --------- --------- Cash flows from investing activities: Additions to property and equipment, net - (75) (1,368) Cost of other investments 18,998 (14,703) (9,301) Additional capitalization of subsidiaries (3,592) - (10,430) --------- --------- --------- Net cash used by investing activities 15,406 (14,778) (21,099) --------- --------- --------- Cash flows from financing activities: Proceeds from borrowings\/assumption of subsidiary debt 84,000 - 11,300 Proceeds from exercise of stock options 2,163 6,975 7,534 Principal payments under debt obligations (26,541) (11,419) (3,598) Dividends paid to shareholders (44,928) (40,057) (35,283) Net increase in amount due to\/from subsidiaries (5,331) (3,866) (2,338) Purchases of treasury stock (131,734) (1,325) (3,067) Treasury stock reissued 2,761 - - Other, net - (1,072) --------- --------- --------- Net cash used by financing activities (119,610) (50,764) (25,452) --------- --------- --------- Net change in cash (23) (392) 70 Cash (overdraft) at beginning of year (59) 333 263 --------- --------- --------- Cash (overdraft) at end of year $ (82) $ (59) $ 333 ========= ========= ========= See the accompanying Notes to Condensed Financial Statements. IV-9\nSCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nNotes to Condensed Financial Statements AFLAC Incorporated (Parent Only)\nThe accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of AFLAC Incorporated and Subsidiaries (see Part II - Item 8).\n(A) NOTES PAYABLE\nA summary of notes payable serviced by the Parent Company at December 31, 1994 and 1993 follows:\n(In thousands) 1994 1993 -------- --------\n6.63% short-term note payable to bank under unsecured line of credit, due January 13, 1995. $ 9,000 $ - Unsecured note payable to bank under revolving credit and term-loan agreement, variable interest rate, due in quarterly installments, beginning June 1995 through March 2000......... 50,000 - 5.965% unsecured note payable to banks, due in semiannual installments beginning October 1995 through 1997...................... 49,000 49,000 8.3% note payable, due in monthly installments through 1997, secured by equipment........................... 3,970 5,511 ------- -------\nTotal notes payable $111,970 $ 54,511 ======= =======\nThe aggregate maturities of the notes payable for each of the five years after December 31, 1994, are as follows:\n(In thousands)\n1995............................................ $ 28,007 1996............................................ 31,485 1997............................................ 29,978 1998............................................ 10,000 1999............................................ 10,000 Thereafter...................................... 2,500\nIV-10\n(B) CONTINGENCIES\nIn prior years, the Parent Company executed promissory notes to banks and transferred the proceeds to its broadcast subsidiaries for the acquisition of television broadcasting stations. The outstanding balances on these notes assumed by a partnership formed by the Broadcast Group and AFLAC were $32,277,779 as of December 31, 1994, and are not included in the accompanying condensed balance sheet.\nIn addition, the Parent Company has also guaranteed repayment of bank borrowings by its subsidiary, AFLAC. The related outstanding loan balance at December 31, 1994, was $1,400,000. The Company has also guaranteed to AFLAC repayment of intercompany borrowings from affiliates, which approximated $650,198 at December 31, 1994.\n(C) INCOME TAXES\nThe Company and its eligible U.S. subsidiaries file a consolidated U.S. federal income tax return. Income tax liabilities or benefits are recorded by each principal subsidiary based upon separate return calculations, and any difference between the consolidated provision and the aggregate amounts recorded by the subsidiaries is reflected in the Parent Company financial statements.\nThe Internal Revenue Service has proposed adjustments to the Company's U.S. consolidated federal income tax returns for the years 1989 through 1991. The proposed adjustments relate primarily to the computation of foreign- source income for purposes of the foreign tax credit that, if upheld, would have a significant effect on the Company's operating results. Management does not agree with the proposed tax issues and is vigorously contesting them. Although the final outcome is uncertain, the Company believes its position will prevail and that the ultimate liability will not materially impact the consolidated financial statements.\nFor further information on income taxes, see Exhibit 13, page 13-40, Note 8 of the Notes to the Consolidated Financial Statements.\n(D) DIVIDEND RESTRICTIONS\nSee Exhibit 13, pages 13-45 and 13-46 (Note 10, Statutory Accounting and Dividend Restrictions, of Notes to the Consolidated Financial Statements) for information regarding dividend restrictions.\n(E) SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION\n(In thousands) 1994 1993 1992 -------- -------- -------- Cash payments during the year for: Interest on debt obligations $ 6,302 $ 3,588 $ 2,781 Income taxes 400 - 139\nIn 1993, non-cash investing activities included issuance of common stock for purchase of a company amounting to $8,730,381. For further information see Note 9, Other, page 13-43 of Exhibit 13.\nIV-11\n(F) ACCOUNTING CHANGES\nFor information concerning the cumulative affect of new accounting standards adopted in 1994 and 1993, see page 13-25 of Exhibit 13, Note 1, section on Accounting Changes Adopted, of Notes to the Consolidated Financial Statements.\nIV-12\nIV-13\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAFLAC Incorporated\nDate MARCH 28, 1995 By \/s\/ PAUL S. AMOS ------------------------ ----------------------------- (Paul S. Amos) 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\/ DANIEL P. AMOS Chief Executive Officer, MARCH 28, 1995 - ------------------------ President and Vice ----------------- (Daniel P. Amos) Chairman Board of Directors\n\/s\/ KRISS CLONINGER, III Executive Vice President, MARCH 28, 1995 - ------------------------ Chief Financial Officer ----------------- (Kriss Cloninger, III) and Treasurer\n\/s\/ NORMAN P. FOSTER Executive Vice President, MARCH 28, 1995 - ------------------------ Corporate Finance ----------------- (Norman P. Foster)\nIV-14\n\/s\/ J. SHELBY AMOS, II Director MARCH 28, 1995 - ------------------------------ ----------------- (J. Shelby Amos, II)\nDirector March 28, 1995 - ------------------------------ ----------------- (Michael H. Armacost)\n\/s\/ M. DELMAR EDWARDS, M.D. Director MARCH 28, 1995 - ------------------------------ ----------------- (M. Delmar Edwards, M.D.)\n\/s\/ GEORGE W. FORD, JR. Director MARCH 28, 1995 - ------------------------------ ----------------- (George W. Ford, Jr.)\n\/s\/ CESAR E. GARCIA Director MARCH 28, 1995 - ------------------------------ ----------------- (Cesar E. Garcia)\n\/s\/ JOE FRANK HARRIS Director MARCH 28, 1995 - ------------------------------ ----------------- (Joe Frank Harris)\nDirector MARCH 28, 1995 - ------------------------------ ----------------- (Elizabeth J. Hudson)\n\/s\/ KENNETH S. JANKE, SR. Director MARCH 28, 1995 - ------------------------------ ----------------- (Kenneth S. Janke, Sr.)\nIV-15\n\/s\/ CHARLES B. KNAPP Director MARCH 28, 1995 - ------------------------------ ----------------- (Charles B. Knapp)\n\/s\/ HISAO KOBAYASHI Director MARCH 28, 1995 - ------------------------------ ----------------- (Hisao Kobayashi)\n\/s\/ PETER D. MORROW Director MARCH 28, 1995 - ------------------------------ ----------------- (Peter D. Morrow)\nDirector MARCH 28, 1995 - ------------------------------ ----------------- (Yoshiki Otake)\n\/s\/ JOHN M. POPE Director MARCH 28, 1995 - ------------------------------ ----------------- (John M. Pope)\n\/s\/ E. STEPHEN PURDOM, M.D. Director MARCH 28, 1995 - ------------------------------ ----------------- (E. Stephen Purdom, M.D.)\n\/s\/ HENRY C. SCHWOB Director MARCH 28, 1995 - ------------------------------ ----------------- (Henry C. Schwob)\n\/s\/ J. KYLE SPENCER Director MARCH 28, 1995 - ------------------------------ ----------------- (J. Kyle Spencer)\n\/s\/ GLENN VAUGHN, JR. Director MARCH 28, 1995 - ------------------------------ ----------------- (Glenn Vaughn, Jr.)\nIV-16\nExhibit Index\n3.0 - Articles of Incorporation, as amended - incorporated by reference from 1991 Form 10-K, Commission file number 1-7434, Exhibit 3.0; and Bylaws of the Company, as amended - incorporated by reference from 1992 Form 10-K, Commission file number 1-7434, Exhibit 3.0. 4.0 - The registrant is not filing one instrument evidencing indebtedness since the total amount of securities authorized under any single instrument does not exceed 10% of the total assets of the registrant and its subsidiaries on a consolidated basis. Copies of such instruments will be furnished to the Securities and Exchange Commission upon request. 10.0* - American Family Corporation Incentive Stock Option Plan (1982) - incorporated by reference from Registration Statement No. 33-44720 on Form S-8 with respect to the AFLAC Incorporated (Formerly American Family Corporation) Incentive Stock Option Plan (1982) and Stock Option Plan (1985). 10.1* - American Family Corporation Stock Option Plan (1985) - incorporated by reference from Registration Statement No. 33-44720 on Form S-8 with respect to the AFLAC Incorporated (Formerly American Family Corporation) Incentive Stock Option Plan (1982) and Stock Option Plan (1985). 10.1.1* - AFLAC Incorporated Amended 1985 Stock Option Plan - incorporated by reference from 1994 Shareholders' Proxy Statement, Commission file number 1-7434, Accession No. 0000004977-94-000003, Exhibit A. 10.2* - American Family Corporation Retirement Plan for Senior Officers, as amended and restated October 1, 1989 - incorporated by reference from 1993 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-94-000006, Exhibit 10.2. 10.3* - American Family Corporation Supplemental Executive Retirement Plan - incorporated by reference from 1989 Form 10-K, Commission file number 1-7434, Exhibit 10.9. 10.3.1* - AFLAC Incorporated Supplemental Executive Retirement Plan, as amended, effective September 1, 1993. 10.4* - AFLAC Incorporated Employment Agreement with Daniel P. Amos, dated August 1, 1993 - incorporated by reference from 1993 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-94-000006, Exhibit 10.4. 10.5* - American Family Life Assurance Company of Columbus Employment Agreement with Yoshiki Otake, dated January 1, 1995. 10.6* - AFLAC Incorporated Employment Agreement with Kriss Cloninger, III, dated February 14, 1992, and as amended November 12, 1993 - incorporated by reference from 1993 Form 10-K, Commission file number 1-7434, Accession No. 0000004977-94-000006, Exhibit 10.6. 10.7* - AFLAC Incorporated Management Incentive Plan - incorporated by reference from 1994 Shareholders' Proxy Statement, Commission file number 1-7434, Accession No. 0000004977-94-000003, Exhibit B.\n(i)\n10.8* - American Family Life Assurance Company of Columbus Employment Agreement with Hidefumi Matsui, dated January 1, 1995. 10.9* - American Family Life Assurance Company of Columbus Employment Agreement with Dr. E. Stephen Purdom, dated October 25, 1994. 13.0 - Selected information from the AFLAC Incorporated Annual Report to Shareholders for 1994. 21.0 - Subsidiaries. 23.0 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-8 Registration Statement No. 33-44720 with respect to the AFLAC Incorporated (Formerly American Family Corporation) Incentive Stock Option Plan (1982) and Stock Option Plan (1985). 23.1 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-3 Registration Statement No. 33-41926 with respect to the AFLAC Associate Stock Bonus Plan. 23.2 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-8 Registration Statement No. 33-41552 with respect to the AFLAC Incorporated 401(K) Retirement Plan. 27.0 - Financial Data Schedule (electronic filing only). 28.0* - AFLAC Incorporated 401(K) Retirement Plan incorporated by reference from 1992 Form 10-K, Commission file number 1-7434, Exhibit 28.0.\nExhibits Filed with Current Form 10-K:\n10.3.1* - AFLAC Incorporated Supplemental Executive Retirement Plan, as amended, effective September 1, 1993. 10.5* - American Family Life Assurance Company of Columbus Employment Agreement with Yoshiki Otake, dated January 1, 1995. 10.8* - American Family Life Assurance Company of Columbus Employment Agreement with Hidefumi Matsui, dated January 1, 1995. 10.9* - American Family Life Assurance Company of Columbus Employment Agreement with Dr. E. Stephen Purdom, dated October 25, 1994. 13.0 - Selected information from the AFLAC Incorporated Annual Report to Shareholders for 1994. 21.0 - Subsidiaries. 23.0 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-8 Registration Statement No. 33-44720 with respect to the AFLAC Incorporated (Formerly American Family Corporation) Incentive Stock Option Plan (1982) and Stock Option Plan (1985). 23.1 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-3 Registration Statement No. 33-41926 with respect to the AFLAC Associate Stock Bonus Plan. 23.2 - Consent of independent auditor, KPMG Peat Marwick LLP, to Form S-8 Registration Statement No. 33-41552 with respect to the AFLAC Incorporated 401(K) Retirement Plan. 27.0 - Financial Data Schedule (electronic filing only).\n* Management contract or compensatory plan or agreement.\n(ii)","section_15":""}
{"filename":"909832_1994.txt","cik":"909832","year":"1994","section_1":"ITEM 1 -- BUSINESS\nDESCRIPTION OF THE MERGER\nOn October 21, 1993, the shareholders of both The Price Company (\"Price\") and Costco Wholesale Corporation (\"Costco\") approved the mergers of Price and Costco with and into separate, wholly owned subsidiaries of Price\/Costco, Inc. (\"PriceCostco\" or the \"Company\"). The mergers are hereinafter called the \"Merger.\" PriceCostco was formed to effect the Merger. Pursuant to the Merger, Price and Costco each became a wholly owned subsidiary of PriceCostco. In the Merger, shareholders of Price received 2.13 shares of PriceCostco common stock for each share of Price common stock and shareholders of Costco received one share of PriceCostco common stock for each share of Costco common stock.\nThe Merger qualified as a \"pooling-of-interests\" for accounting and financial reporting purposes. The pooling-of-interests method of accounting presents as a single interest two or more common shareholder interests which were previously independent. The pooling-of-interests method of accounting treats the combining companies as if they had been a single business entity from inception. Consequently, the historical financial statements for periods prior to the consummation of the Merger have been restated as though the companies had been combined. The financial statements have also been adjusted to conform the accounting policies and interim reporting periods of the separate companies.\nThe fees and expenses related to the Merger and to the consolidation and restructuring of the combining companies (approximately $120 million, or $80 million after tax) were expensed as required under the pooling-of-interests accounting method and were reflected in the consolidated statement of income of PriceCostco in the first quarter of fiscal 1994, the period in which the Merger occurred. Such fees and expenses include direct transaction costs, expenses related to consolidating and restructuring certain functions, costs of the closing of certain excess facilities and sales of related properties, costs of severance and relocation and write-offs of certain redundant capitalized costs and other assets (See \"Notes to Consolidated Financial Statements -- Note 2 -- Merger of Price and Costco\" for an analysis of the provision for merger and restructuring).\nGENERAL\nPriceCostco operates cash and carry membership warehouses based on the concept that offering members very low prices on a limited selection of nationally branded and selected private label products in a wide range of merchandise categories will produce rapid inventory turnover and high sales volumes. This rapid inventory turnover, when combined with the operating efficiencies achieved by volume purchasing, efficient distribution and reduced handling of merchandise in no-frills, self-service warehouse facilities, enables PriceCostco to operate profitably at significantly lower gross margins than traditional wholesalers, discount retailers and supermarkets.\nPriceCostco buys virtually all of its merchandise directly from manufacturers for shipment either directly to PriceCostco's selling warehouses or to a consolidation point where various shipments are combined so as to minimize freight and handling costs. As a result, PriceCostco eliminates many of the costs associated with multiple step distribution channels, which include purchasing from distributors as opposed to manufacturers, use of central receiving, storing and distributing warehouses and storage of merchandise in locations off the sales floor. By providing this more cost effective means of distributing goods, PriceCostco meets the needs of business customers who otherwise would pay a premium for small purchases and for the distribution services of traditional wholesalers, and who cannot otherwise obtain the full range of their product requirements from any single source. In addition, these business members will often combine personal shopping with their business purchases. Individuals shopping for their personal needs are primarily motivated by the cost savings on brand name merchandise. PriceCostco's merchandise selection is designed to appeal to both the business and consumer requirements of its members by offering a wide range of nationally branded and selected private label products, often in case, carton or multiple-pack quantities, at attractively low prices.\nBecause of its high sales volume and rapid inventory turnover, PriceCostco generally has the opportunity to receive cash from the sale of a substantial portion of its inventory at mature warehouse operations before it is required to pay all its merchandise vendors, even though PriceCostco takes advantage of early payment terms to obtain payment discounts. As sales in a given warehouse increase and inventory turnover becomes more rapid, a greater percentage of the inventory is financed through payment terms provided by vendors rather than by working capital.\nPriceCostco's typical warehouse format averages approximately 120,000 square feet. Floor plans are designed for economy and efficiency in the use of selling space, in the handling of merchandise and in the control of inventory. Because shoppers are attracted principally by the availability of low prices on brand name and selected private label goods, PriceCostco's warehouses need not be located on prime commercial real estate sites or have elaborate facilities.\nBy strictly controlling the entrances and exits of its warehouses and by limiting membership to selected groups and businesses, PriceCostco has been able to limit inventory losses to less than one-half of one percent of net sales, well below those of typical discount retail operations. Problems associated with dishonored checks have also been insignificant, since individual memberships are limited primarily to members of qualifying groups, and bank information from business members is verified prior to establishing a check purchase limit. Memberships are invalidated at the point of sale for those members who have issued dishonored checks to PriceCostco.\nPriceCostco's policy is generally to limit advertising and promotional expenses to new warehouse openings and occasional direct mail advertisements to prospective new members. These practices result in very low marketing expenses as compared to typical discount retailers and supermarkets. In connection with new warehouse openings, PriceCostco's marketing teams personally contact businesses in the area who are potential wholesale members. These contacts are supported by direct mailings during the period immediately prior to opening. Potential Gold Star (individual) members are contacted by direct mail generally distributed through credit unions, employee associations and other entities representing the individuals who are eligible for Gold Star membership. After a membership base is established in an area, most new memberships result from word of mouth advertising, follow-up contact by direct mail distributed through regular payroll or other organizational communications to employee groups, and ongoing direct solicitations of prospective wholesale members.\nPriceCostco's warehouses generally operate on a seven-day, 68-hour week, and are open somewhat longer during the holiday season. Generally, warehouses are open weekdays between 10:00 a.m. and 8:30 p.m. Because these hours of operation are shorter than those of the traditional discount or grocery retailer, labor costs are lower relative to the volume of sales. Merchandise is generally stored on racks above the sales floor and displayed on pallets containing large quantities of each item, thereby reducing labor required for handling and stocking. In addition, sales are processed through an efficient centralized check-out facility. Items are not individually price marked, but are keyed or scanned into PriceCostco's electronic cash registers by an identifying item number, thereby allowing price changes without remarking merchandise. Substantially all manufacturers provide special, larger package sizes and merchandise pre-marked with the item numbers.\nPriceCostco's merchandising strategy is to provide the customer with a broad range of high quality merchandise at prices consistently lower than could be obtained through traditional wholesalers, discount retailers or supermarkets. An important element of this strategy is to carry only those products on which PriceCostco can provide its members significant cost savings. Consequently, items which members may request but which cannot be purchased at prices sufficiently low enough to pass along meaningful cost savings to members are often not carried. PriceCostco seeks to limit specific items in each product line to fast selling models, sizes and colors and therefore carries only an average of approximately 3,500 to 4,000 active stockkeeping units (\"SKU's\") per warehouse as opposed to full-line discount retailers which normally stock 40,000 to 60,000 SKU's or more. These practices are consistent with PriceCostco's membership policies of satisfying both the business and personal shopping needs of its wholesale members, thereby encouraging high volume shopping. Many consumable\nproducts are offered for sale in case, carton or multiple-pack quantities only. Appliances, equipment and tools often feature commercial and professional models. PriceCostco's policy is to accept returns of merchandise within a reasonable time after purchase.\nThe following table indicates the approximate percentage of sales accounted for by each major category of items sold by PriceCostco during fiscal 1994, 1993 and 1992:\nPriceCostco has direct buying relationships with many producers of national brand name merchandise. No significant portion of merchandise is obtained by PriceCostco from any one of these or other suppliers. PriceCostco has not experienced any difficulty in obtaining sufficient quantities of merchandise, and believes that if one or more of its current sources of supply became unavailable, it would be able to obtain alternative sources without experiencing a substantial disruption of its business. Also, PriceCostco purchases on a competitive cost basis, stocking different national brand name or selected private label merchandise of the same product, as long as quality and customer demand are comparable.\nPriceCostco is incorporated in the State of Delaware, and reports on a 52\/53 week fiscal year, consisting of 13 four-week periods and ending on the Sunday nearest the end of August. The first, second and third quarters consist of three periods each, and the fourth quarter consists of four periods (five weeks in the thirteenth period in a 53-week year). There is no material seasonal impact on PriceCostco's operations, except an increased level of sales and earnings during the Christmas holiday season.\nMEMBERSHIP POLICY\nPriceCostco's membership format is designed to reinforce customer loyalty and also to provide a continuing source of membership fee revenue. PriceCostco has two primary types of members: Business and Gold Star (individual members).\nBusinesses, including individuals with a business license, retail sales license or other evidence of business existence, may become Business members. PriceCostco promotes Business membership through its merchandise selection and its membership marketing programs. Business members generally pay an annual membership fee of $35 for the primary membership card with additional membership cards available for an annual fee of from $10 to $15.\nIndividual memberships are available to employees of federal, state and local governments, financial institutions, corporations, utility and transportation companies, public and private educational institutions, and other selected organizations. Individual members generally pay an annual membership fee of $35 which includes a second membership card.\nAs of August 28, 1994, PriceCostco had approximately 3.4 million Business memberships and approximately 6.4 million Gold Star memberships. Members can utilize their memberships at any Price Club or Costco Wholesale location.\nLABOR\nAs of August 28, 1994, PriceCostco had approximately 47,000 employees, about 50% of which were part time. Substantially all of Price's hourly employees in California, Connecticut, Maryland, Massachusetts, New Jersey, New York and one Price Club warehouse in Virginia are represented by the International Brotherhood of Teamsters. Nearly all other employees are non-union. PriceCostco considers its employee relations to be good.\nCOMPETITION\nThe Company operates in the rapidly changing and highly competitive merchandising industry. When Price pioneered the membership warehouse club concept in 1976, the dominant companies selling comparable lines of merchandise were department stores, grocery stores and traditional wholesalers. Since then, new merchandising concepts and aggressive marketing techniques have led to a more intense and focused competitive environment. Wal-Mart and Kmart have become the largest retailers in the United States and have recently expanded into food merchandising. Target has also emerged as a significant retail competitor. Approximately 800 warehouse clubs exist across the U.S. and Canada, including the 221 warehouses operated by the Company, and every major metropolitan area has some, if not several, club operations. Low cost operators selling a single category or narrow range of merchandise, such as Home Depot, Office Depot, Petsmart, Toys-R-Us, Circuit City and Barnes & Noble Books, have gained major market share in their respective categories. New forms of retailing involving modern technology are boosting sales in stores such as The Sharper Image, while home shopping is becoming increasingly popular. Likewise, in the food business, a competitor like Smart & Final, which operates in Arizona and California, is capturing an increasingly greater share of the institutional food business from wholesale operators and others; and many supermarkets now offer food lines in bulk sizes and at prices comparable to those offered by the Company. This factor, among others, has caused comparable warehouse sales to decline during fiscal 1994 resulting in lower average sales and earnings per location (see \"Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations\").\nREGULATION\nCertain state laws require that the Company apply minimum markups to its selling prices for specific goods, such as tobacco products and alcoholic beverages, and prohibit the sale of specific goods, such as tobacco and alcoholic beverages, at different prices in one location. While compliance with such laws may cause the Company to charge somewhat higher prices than it otherwise would charge, other mass merchandisers are also typically governed by the same restrictions, and the Company believes that compliance with such laws does not have a material adverse effect on its operations.\nIt is the policy of the Company to sell at lower than manufacturers' suggested retail prices. Some manufacturers attempt to maintain the resale price of their products by refusing to sell to the Company or to other purchasers that do not adhere to suggested retail prices. To date, the Company believes that it has not been materially affected by its inability to purchase directly from such manufacturers. Both federal and state legislation is proposed from time to time which, if enacted, would restrict the Company's ability to purchase goods or extend the application of laws enabling the establishment of minimum prices. The Company cannot predict the effect on its business of the enactment of such federal or state legislation.\nDESCRIPTION OF THE EXCHANGE TRANSACTION\nOn July 28, 1994, PriceCostco entered into an Agreement of Transfer and Plan of Exchange (as amended and restated, the \"Transfer and Exchange Agreement\") with Price Enterprises, Inc., (\"Price Enterprises\"). Price Enterprises is a Delaware corporation and an indirect, wholly owned subsidiary of the Company. The transactions contemplated by the Transfer and Exchange Agreement are hereinafter referred to as the \"Exchange Transaction.\"\nPursuant to the Transfer and Exchange Agreement and upon the terms and subject to the conditions set forth in an Offering Circular\/Prospectus and related Letter of Transmittal (which will be mailed to stock holders of record of the Company's common stock), the Company will offer to\nexchange one share of common stock of Price Enterprises for each share of common stock of the Company, up to a maximum of 27 million shares of Price Enterprises common stock (constituting all of the outstanding shares of Price Enterprises common stock) (the \"Exchange Offer\"). The Company currently anticipates that the Exchange Offer will be commenced prior to the end of November 1994. In connection therewith, the Offering Circular\/Prospectus and the Letter of Transmittal, which will describe the Exchange Transaction in detail, will be mailed to such holders. If more than 27 million shares of the Company's common stock are validly tendered and not withdrawn in the Exchange Offer prior to the expiration thereof, then, upon the terms and subject to the conditions set forth in such Offering Circular\/Prospectus and such related Letter of Transmittal, the Company will accept 27 million shares for exchange on a pro rata basis, and shares of Price Enterprises common stock will be exchanged therefor.\nIf the number of shares of the Company's common stock validly tendered in the Exchange Offer by holders of the Company's common stock is less than 21.6 million, the Company will accept such validly tendered shares for exchange and will distribute the remaining shares of Price Enterprises common stock pro rata to the Company's stockholders. If the number of shares of the Company's common stock validly tendered in the Exchange Offer is greater than 21.6 million, but less than 27 million, the Company will accept such validly tendered shares for exchange and will, at its option, either (i) distribute the remaining shares of Price Enterprises common stock pro rata to the Company's stockholders or (ii) sell such remaining shares to Price Enterprises in exchange for a promissory note.\nPursuant to the Transfer and Exchange Agreement, as of August 28, 1994, the Company caused to be transferred, or, in certain cases, will cause to be transferred, to Price Enterprises certain assets, including the following:\n(a) certain commercial real estate specified in the Transfer and Exchange Agreement that was not integral to the Company's merchandising operations (the \"Commercial Properties\");\n(b) real estate comprising four of the Company's warehouse club facilities (which are adjacent to existing Commercial Properties) that are being leased back to the Company effective August 29, 1994 at collective annual rentals of approximately $8.6 million;\n(c) commercial real estate known as 4455 and 4649 Morena Boulevard, San Diego, California;\n(d) 51% of the outstanding capital stock of each of Price Global and Price Quest (as defined and described below);\n(e) a note in the principal amount of $41 million made by Atlas Hotels, Inc., secured by hotel and convention center property in San Diego, California (\"Atlas Note\"); and\n(f) notes receivable with an aggregate book value of approximately $32 million, which were originally made and delivered by various governmental agencies in connection with the financing and development of certain warehouse club and adjacent real estate sites.\nThe Company and Price Enterprises have caused to be formed a limited liability company, Mexico Clubs, L.L.C. (\"Mexico Clubs\") of which the Company and Price Enterprises own 49% and 51% interests, respectively. The Company has caused to be formed two corporations, Price Global Trading, Inc. (\"Price Global\") and Price Quest, Inc. (\"Price Quest\" which, together with Mexico Clubs comprise the \"Subsidiary Corporations\". The Company has caused to be transferred and delivered to:\n(a) Mexico Clubs: (i) all shares of capital stock of Price Venture Mexico owned, directly or indirectly, by the Company; (ii) all other noncurrent assets of the Company and its subsidiaries specifically related to the conduct of business in Mexico; and (iii) certain other assets (collectively, the \"Mexico Assets\"); provided, however, that the term \"Mexico Assets\" does not include (A) the\nAgreement between Price, Price Venture Mexico and Controladora Comercial Mexicana, S.A. de C.V. to form a Corporate Joint Venture dated June 21, 1991, (B) any right, title or interest in or to the names \"Price Club,\" \"Price Club Costco\" or \"PriceCostco\" and (C) any computer software.\n(b) Price Global: (i) the right to develop a Club Business in certain international areas specified in the Transfer and Exchange Agreement (the \"Specified Geographical Areas\"); (ii) all shares of capital stock of Club Merchandising, Inc. owned, directly or indirectly, by the Company; (iii) all right, title and interest to, or, in certain cases, a long-term license to use, the names \"Price Club,\" \"Price Club Costco\" and \"Price Costco\" in each of the Specified Geographical Areas (other than Mexico); and (iv) all other noncurrent assets of the Company and its subsidiaries (other than those included in Club Merchandising, Inc.) specifically related to the conduct of business in the Specified Geographical Areas (collectively, the \"International Assets\"); and\n(c) Price Quest: (i) all of the noncurrent assets of the Company or any of its subsidiaries specifically related to the business and operations then conducted by the Company through its Quest interactive electronic shopping business, together with Price Club Travel, Price Club Realty and the Price Club automobile advertising\/referral business; (ii) all right, title and interest, if any, of the Company or any of its subsidiaries to, or, in certain cases, a long-term license to use, the names \"Price Club Quest\" and \"Quest\"; and (iii) certain other assets (collectively, the \"Quest Assets\").\nAs used herein, the term \"Club Business\" refers to any merchandising activity utilizing 70,000 square feet or more in a single location operating with membership and selling food and non-food items through a central check-out.\nEach of Price Global and Price Quest issued 100 shares of its common stock to Price, which constitutes all of the outstanding capital stock of each such Subsidiary Corporation. As of August 28, 1994, the Company caused to be transferred to Price Enterprises 51 shares of common stock of each of Price Global and Price Quest, representing 51% of the outstanding capital stock of each such Subsidiary Corporation.\nAs part of the Exchange Transaction, the Company and Price, on the one hand, and Price Enterprises and each of the Subsidiary Corporations, on the other, have entered into Operating Agreements to clarify the ongoing business relationship between the Company and the respective Subsidiary Corporations. The Company and Price, on the one hand, have also entered into Stockholders Agreements with Price Enterprises and each of Price Global and Price Quest, on the other, to clarify certain rights and obligations of the Company and Price Enterprises as stockholders of Price Global and Price Quest.\nPrice and Price Enterprises have entered into a Limited Liability Company Agreement with respect to Mexico Clubs which sets forth the rights and obligations of each of Price and Price Enterprises with respect to its membership interest in Mexico Clubs.\nAlso in connection with the Exchange Transaction, the Company and Price Enterprises entered into an unsecured revolving credit agreement, dated as of August 28, 1994 (the \"Advance Agreement\"), pursuant to which the Company has agreed to advance to Price Enterprises up to a maximum principal amount of $85 million (reduced by an amount equal to the net proceeds from the sale of any of the Commercial Properties between August 28, 1994 and the date of the closing of the Exchange Transaction (the \"Closing Date\")) from time to time during the period from August 28, 1994 until six months following the earlier of (A) the Closing Date and (B) the date on which Price Enterprises stock is distributed to stockholders of the Company. The interest rate under the Advance Agreement is the weighted average commercial paper rate on borrowings by the Company during each four-week period (including, without limitation, amortization of lender commitment fees and other costs associated with the backup line of credit and all miscellaneous costs and fees), or if commercial paper is unavailable under the Company's commercial paper program, the bank rate on borrowings by the Company pursuant to its working capital credit facility (including, without limitation, amortization of lender commitment fees and other costs associated with such credit facility and all miscellaneous costs and fees).\nPursuant to the Transfer and Exchange Agreement, upon the earlier to occur of the Closing Date and the date that shares of Price Enterprises common stock are distributed to holders of the Company's common stock, the Bylaws of the Company will be amended to delete the corporate governance provisions that were enacted as part of the Merger to require that the Board of Directors of the Company and certain committees of the Board be comprised of an equal number of Price Designees and Costco Designees (as such terms are hereinafter defined). The form of such Bylaws, as amended, is filed as an Exhibit to this Annual Report on Form 10-K. In addition, at the Closing Date, without any further action on behalf of the Company or Price Enterprises, the resignations of all of the Price Designees from the Board of Directors of the Company, other than Richard M. Libenson and Duane Nelles (which resignations were submitted to the Board of Directors of the Company on July 28, 1994), will become effective. Pursuant to the Transfer and Exchange Agreement, unless removed for cause, each of Messrs. Libenson and Nelles shall serve on the Board of Directors of the Company until the earlier of (i) the date two years following the Closing Date and (ii) such time as Sol Price and Robert Price and their affiliates in the aggregate cease to beneficially own at least two million shares of PriceCostco Common Stock (including any such shares owned by charitable trusts established by either of them).\nAs used in the Bylaws of the Company, \"Price Designees\" means those persons specified by Price as initial members of the Board of Directors of the Company as of the effective time of the Merger, or their direct or indirect replacements. The current Price Designees are J. Paul Kinloch, Richard M. Libenson, Mitchell G. Lynn, Duane Nelles (who was elected to the Board on July 28, 1994 following the resignation of Joseph K. Kornwasser), Paul A. Peterson and Robert E. Price. As used in the Bylaws of the Company, \"Costco Designees\" means those persons specified by Costco as initial members of the Board of Directors of the Company as of the effective time of the Merger, or their direct or indirect replacements. The current Costco Designees are Jeffrey H. Brotman, Daniel Bernard, Richard D. DiCerchio, Hamilton E. James, John W. Meisenbach and James D. Sinegal.\nFUTURE OPERATIONS Expansion plans for the United States and Canada during fiscal 1995 are to open 30-35 new warehouse clubs. The Company also expects to continue expansion of its international operations. The Company opened two warehouses in the United Kingdom through a 60%-owned subsidiary, with a third location due to open in June 1995. In October 1994, under a licensing agreement with PriceCostco, a Price Club opened in Seoul, Korea. Other markets are being assessed, particularly in the Pacific Rim. As a result of the Exchange Transaction, the Company's 50% ownership interest in the Mexican joint venture was transferred to Mexico Clubs in which the Company owns a 49% interest. See \"Part I -- Business - -- Description of the Exchange Transaction.\" As of August 28, 1994, there were 8 Price Clubs operating in Mexico through such joint venture. As of October 31, 1994, there were 10 Price Clubs operating in Mexico through such joint venture with one more scheduled to open prior to December 31, 1994.\nWhile there can be no assurance that current expectations will be realized and plans are subject to change upon further review, it is management's current intention to spend an aggregate of approximately $600 million to $700 million during fiscal 1995: for real estate, building and equipment for warehouse clubs and related operations (including remodels and expansions) in the United States and Canada; for international expansion, including additional investment in the United Kingdom and other potential ventures; and for activities such as business delivery and ancillary business operations.\nWhile the availability of capital resources cannot be predicted with certainty and is dependent upon a number of factors, including factors outside of the Company's control, management believes that the Company's earnings, cash flow, and financing capacity should be adequate to fund ongoing operations, proposed expansion and other planned development efforts.\nAs a result of the Exchange Transaction, the Company will own a 49% interest in each of the Mexico Assets, the International Assets and the Quest Assets. See \"Description of the Exchange Transaction\" above.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 -- PROPERTIES\nWAREHOUSE PROPERTIES\nAt August 28, 1994, PriceCostco operated warehouse clubs in 21 states, 7 Canadian provinces and the United Kingdom under the \"Price Club\" and \"Costco Wholesale\" names. The following is a summary of owned and leased warehouses by state and province:\nNUMBER OF WAREHOUSES\nThe following schedule shows warehouse openings (net of warehouse closings) by region for the past five fiscal years and expected openings (net of closings) through December 31, 1994:\nThe Company's home offices and headquarters are located in Kirkland, Washington and San Diego, California. Following consumation of the Exchange Transaction, the Company will no longer maintain a home office and headquarters in San Diego, California. Additionally, the Company maintains regional buying and administrative offices, operates regional cross-docking facilities for the consolidation and distribution of certain shipments to the warehouses and operates various processing and packaging facilities to support ancillary businesses.\nDISCONTINUED OPERATIONS -- NON-CLUB REAL ESTATE SEGMENT\nAs a result of the Exchange Transaction, the Company's business consists primarily of its warehouse club operations in the United States, Canada and the United Kingdom, and the Company has ceased to have any significant real estate activities that are not directly related to its warehouse club business.\nITEM 3","section_3":"ITEM 3 -- LEGAL PROCEEDINGS\nOn April 6, 1992, Price was served with a complaint in an action entitled FECHT ET AL. V. THE PRICE COMPANY ET AL., Case No. 92-497, United States District Court, Southern District of California (the \"Court\"). Subsequently, on April 22, 1992, Price was served with a first amended complaint in the action. The case was dismissed without prejudice by the Court on September 21, 1992, on the grounds the plaintiffs had failed to state a sufficient claim against defendants.\nSubsequently, plaintiffs filed a Second Amended Complaint which, in the opinion of the Company's counsel, alleged substantially the same facts as the prior complaint. The case was dismissed with prejudice by the Court on March 9, 1993, on grounds the plaintiffs had failed to state a sufficient claim against defendants. Plaintiffs have filed an Appeal in the Ninth Circuit Court of Appeals, which was argued on October 4, 1994. The Company is currently awaiting a Ninth Circuit Court of Appeals decision. If the Ninth Circuit Court of Appeals renders a decision that is adverse to the Company, the Company will continue its vigorous defense of the suit. The Company does not believe that the ultimate outcome of such litigation will have a material adverse effect on the Company's financial position or results of operations.\nThe Company is involved from time to time in claims, proceedings and litigation arising from its business and property ownership. The Company does not believe that any such claim, proceeding or litigation, either alone or in the aggregate, will 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\nThe Company's annual meeting is scheduled for 10:00 a.m. on January 27, 1995 at the Bellevue Inn in Bellevue, Washington. Matters to be voted on will be included in the Company's proxy statement to be filed with the Securities and Exchange Commission and distributed to stockholders prior to the meeting.\nITEM 4A -- EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following is a list of the names, ages and positions of the executive officers of the registrant.\nRobert E. Price has been the Chairman of the Board of PriceCostco since the Merger, although he has tendered his resignation effective as of the earlier of (i) the Closing Date and (ii) the date on which shares of Price Enterprises common stock are distributed to stockholders of PriceCostco (see \"Description of the Exchange Transaction\"). He was Chief Executive Officer and a director of Price since 1976, and was Chairman of the Board of Price since January 1989. Mr. Price was President of Price from 1976 until December 1990.\nJames D. Sinegal has been the President, Chief Executive Officer and a director of PriceCostco since the Merger. He was President and Chief Operating Officer of Costco since its inception and was elected Chief Executive Officer in August 1988. Mr. Sinegal is a co-founder of Costco and a director of Price Enterprises.\nJeffrey H. Brotman is a native of the Pacific Northwest and is a 1967 graduate of the University of Washington Law School. Mr. Brotman has been the Vice Chairman of the Board of PriceCostco since the Merger. He is a founder of Costco and a number of other specialty retail chains. Mr. Brotman is a director of Seafirst Bank; Carrefour, U.S.; Starbucks Corp.; The Sweet Factory and Garden Botanika.\nMitchell G. Lynn served as Senior Executive Vice President of PriceCostco from the Merger until mid July 1994 and has been a director of PriceCostco since the Merger, although he has tendered his resignation effective as of the earlier of (i) the Closing Date and (ii) the date on which shares of Price Enterprises common stock are distributed to stockholders of PriceCostco (see \"Description of the\nExchange Transaction\"). He has been President of Price since December 1990 and a director of Price since January 1991, although he has tendered his resignation as an officer and director of Price effective as of the earlier of (i) the Closing Date and (ii) the date on which shares of Price Enterprises common stock are distributed to stockholders of PriceCostco. Mr. Lynn joined Price as Controller in September 1979 and became a Vice President in 1984. From August 1989 to December 1990 Mr. Lynn was an Executive Vice President of Price and President of Price Club Industries, a division of Price.\nRichard D. DiCerchio has been Executive Vice President -- Merchandising, Distribution, Construction and Marketing of PriceCostco since the Merger and, until mid August 1994 also served as Executive Vice President, Chief Operating Officer -- Northern Division. He was elected Chief Operating Officer -- Western Region of Costco in August 1992 and was elected Executive Vice President and Director of Costco in April 1986. From June 1985 to April 1986, he was Senior Vice President, Merchandising of Costco. He joined Costco as Vice President, Operations in May 1983.\nRichard A. Galanti has been Executive Vice President and Chief Financial Officer of PriceCostco since the Merger. He was Senior Vice President, Chief Financial Officer and Treasurer of Costco since January 1985, having joined Costco as Vice President -- Finance in March 1985. From 1978 to February 1984, Mr. Galanti was an Associate with Donaldson, Lufkin & Jenrette Securities Corporation.\nFranz E. Lazarus has been Executive Vice President, Chief Operating Officer - -- Northern Division of PriceCostco since August 1994 and had previously served as Executive Vice President, Chief Operating Officer -- Eastern Division since the Merger. He was named Executive Vice President, Chief Operating Officer -- East Coast Operations of Costco in August 1992. Mr. Lazarus joined Costco in November 1983 and has held various positions prior to his current position.\nDavid B. Loge has been an Executive Vice President -- PriceCostco Industries since August 1994. Mr. Loge joined Price as a Director of Price Club Industries in March 1989 and became Vice President of Price and President of Price Club Industries in December 1990. Prior to joining Price, he served as Vice President of Operations of Sundale Beverage in Belmont, California.\nEdward B. Maron has been Executive Vice President, Chief Operating Officer - -- Canadian Division of PriceCostco since the Merger. He had been Senior Vice President, Canadian Division of Costco since April 1990. He previously held various management positions since joining Costco in June 1985.\nJoseph P. Portera has been Executive Vice President, Chief Operating Officer - -- Eastern Division of Price Costco since August, 1994. He was Senior Vice President-Operations, Northern California Region from October, 1993 to August 1994. From August 1991 to October 1993 he was Senior Vice President Merchandising -- Non Foods of Costco, and held various management positions since joining Costco in April 1984.\nSteven A. Velazquez was Executive Vice President -- Quest of PriceCostco from the Merger through early November 1994, overseeing the development of the Quest business. He is currently an Executive Vice President of Price Enterprises. He joined Price as a buyer in July 1981, became Vice President in February 1989, and became Executive Vice President of Merchandising in April 1990. Prior to joining Price, Mr. Velazquez was a buyer for Safeway Stores, San Diego Division.\nTheodore Wallace was Executive Vice President -- International of PriceCostco from the Merger through early November 1994, overseeing international expansion into the Pacific rim and other markets. He is currently an Executive Vice President of Price Enterprises. Mr. Wallace became an Executive Vice President of Price in 1984 and, from 1988 until Fall 1992, he was Chief Operating Officer (East Coast) of Price. He was a director of Price from October 1988 to October 1993. He joined Price as a warehouse manager in September 1977 and was its Vice President of Operations from 1983 to 1988.\nDennis R. Zook has been Executive Vice President, Chief Operating Officer -- Southern Division of PriceCostco since the Merger. He was Executive Vice President of Price since February 1989. Mr. Zook became Vice President of West Coast Operations of Price in October 1988. He joined Price as a warehouse manager in October 1982.\nPART II\nITEM 5","section_5":"ITEM 5 -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nIn the Merger, which occurred on October 21, 1993, each share of common stock, par value $.10 per share, of Price (\"Price Common Stock\") was exchanged for 2.13 shares of PriceCostco Common Stock and each share of common stock, par value $.0033 per share, of Costco (\"Costco Common Stock\") was exchanged for one share of PriceCostco Common Stock.\nPrior to October 21, 1993, Price Common Stock was quoted on The Nasdaq Stock Market's National Market under the symbol \"PCLB\" and Costco Common Stock was quoted on The Nasdaq Stock Market's National Market under the symbol \"COST.\" Trading in PriceCostco Common Stock commenced on October 22, 1993. PriceCostco Common Stock is quoted on The Nasdaq Stock Market's National Market under the symbol \"PCCW.\"\nThe following table sets forth the high and low sales prices of PriceCostco Common Stock for the period October 22, 1993 through October 31, 1994, and Price Common Stock and Costco Common Stock for the periods indicated. The quotations are as reported in published financial sources.\nAll Costco common share data has been adjusted to reflect a two-for-one stock split effected April 30, 1991 and a three-for-two stock split effected March 6, 1992. All Price common share data has been adjusted to reflect the 2.13 exchange ratio in the Merger.\nOn October 31, 1994, the last reported sales price per share of PriceCostco Common Stock was $15.75. On October 31, 1994, the Company had approximately 13,811 stockholders of record.\nDIVIDEND POLICY\nPriceCostco does not pay regular dividends and does not anticipate the declaration of a cash dividend in the forseeable future. Under its two revolving credit agreements, PriceCostco is generally permitted to pay dividends in any fiscal year up to an amount equal to 50% of its consolidated net income for that fiscal year.\nITEM 6","section_6":"ITEM 6 -- SELECTED FINANCIAL DATA\nSELECTED FINANCIAL AND OPERATING DATA\nThe following tables set forth selected financial and operating data for the ten fiscal years in the period ended August 28, 1994 for PriceCostco, giving effect to the Merger using the pooling-of-interests method of accounting and treating the non-club real estate segment as a discontinued operation. This selected financial and operating data should be read in conjunction with \"Item 7","section_7":"ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCOMPARISON OF FISCAL 1994 (52 WEEKS) AND FISCAL 1993 (52 WEEKS): (DOLLARS IN THOUSANDS, EXCEPT EARNINGS PER SHARE)\nNet operating results for fiscal 1994 reflect a net loss of $112,368 or $.51 per share (fully diluted), as compared to fiscal 1993 net income of $223,247 or $1.00 per share (fully diluted). This loss includes the previously announced provision for merger and restructuring costs of $120,000 pre-tax ($80,000 or $.36 per share after tax) related to the Merger. The Merger was approved by Price and Costco shareholders on October 21, 1993. The fiscal 1994 net loss includes a $40,766 or $.19 per share loss from discontinued operations, compared to income of $20,404 or $.08 per share in fiscal 1993. The fiscal 1994 loss from discontinued operations includes a provision of $80,500 pre-tax ($47,500 or $.22 per share after tax) arising from a change in accounting estimates caused by the Exchange Transaction. In addition, the fiscal 1994 net loss includes a charge of $182,500, or $.83 per share, reflecting the estimated loss on disposal of the discontinued non-club real estate operations.\nCONTINUING OPERATIONS\nIncome from continuing operations for fiscal 1994 was $110,898 or $.51 per share, compared to income from continuing operations for fiscal 1993 of $202,843 or $.92 per share. Excluding the $120,000 pre-tax merger and restructuring charge, income from continuing operations for fiscal 1994 would have been $190,898 or $.87 per share.\nNet sales increased 6.6% to $16,160,911 in fiscal 1994 from $15,154,685 in fiscal 1993. This increase was due to: (i) first year sales at the 29 new warehouses opened during fiscal 1994, which increase was partially offset by 8 warehouses closed during fiscal 1994 that were in operation during fiscal 1993; and (ii) increased sales at thirty-seven warehouses that were opened in 1993 and that were in operation for the entire 1994 fiscal year, which increase was partially offset by lower sales at existing locations opened prior to fiscal 1993. Changes in prices did not materially impact sales levels.\nComparable sales, that is sales in warehouses open for at least a year, were a negative 3% annual rate in fiscal 1994 -- similar to the negative 3% annual rate during fiscal 1993. The negative rate of comparable sales was attributed to several factors, including the following: the effect of sales cannibalization by opening additional warehouses in existing markets; increased competition in several markets; deflation in several merchandise categories; a generally poor economic environment, especially in California; and a weak Canadian dollar where the Company derived 16% and 15% of net sales in fiscal 1994 and 1993, respectively.\nMembership fees and other revenue increased 3.4% from $309,129, or 2.04% of net sales, in fiscal 1993 to $319,732, or 1.98% of net sales in fiscal 1994. This increase reflects membership signups at the twenty-nine new warehouses and the partial year effect of membership fee increases implemented in January 1994. As anticipated, the Company experienced a decline in membership renewals at existing warehouses due to overlapping memberships and offering Price and Costco members reciprocal member privileges effective November 1, 1993. The negative impact of the reciprocal member privileges on membership fee revenue is expected to be a less significant factor after November 1994.\nGross margin (defined as net sales minus merchandise costs) increased 6.7% from $1,403,532, or 9.26% of net sales in fiscal 1993 to $1,498,020, or 9.27% of net sales in fiscal 1994. The gross margin figures reflect accounting for merchandise inventory costs on the last-in, first-out (LIFO) method. For fiscal 1994 there was a $2,600 LIFO benefit or $.01 per share (fully diluted) to increase income after tax due to the use of the LIFO method compared to the first-in, first-out (FIFO) method. This compares to a $5,350 LIFO benefit or $.01 per share (fully diluted) in fiscal 1993.\nSelling, general and administrative expenses as a percent of net sales increased from 8.67% during fiscal 1993 to 8.82% during fiscal 1994, reflecting a combination of comparable unit sales decreases in the 200 warehouses in operation during both fiscal periods; higher expense ratios at the\n29 units opened during fiscal 1994 (newer units generally operate at significantly lower annual sales volumes than mature units and, therefore, incur higher expense ratios than mature units); and higher expense factors associated with certain ancillary operations.\nPreopening expenses totaled $24,564 or 0.15% of net sales during fiscal 1994 and $28,172 or 0.19% of net sales during fiscal 1993. During fiscal 1994, the Company opened 29 new warehouses compared to opening 37 new warehouses during fiscal 1993.\nThe Company recorded a pre-tax provision for warehouse closing costs of $7,500 or $.02 per share on an after-tax basis (fully diluted). The provision includes $5,750 (pre-tax) related to settlement of a lease dispute and additional closing costs related to warehouse clubs closed in prior years, and $1,750 (pre-tax) related to the estimated closing costs of six warehouses which were or will be replaced by new warehouses by December 31, 1994. This compares to $5,000 (pre-tax) or .01 per share in fiscal 1993.\nInterest expense totaled $46,116 in fiscal 1993 and $50,472 in fiscal 1994. In both fiscal years interest expense was incurred as a result of the interest on the convertible subordinated debentures and interest on borrowings on the Company's bank lines and commercial paper programs.\nInterest income and other totaled $17,750 in fiscal 1993, and $13,888 in fiscal 1994. This decrease was primarily due to lower average investment balances and lower interest rates.\nThe effective income tax rate (excluding the merger and restructuring charge and loss on disposal of the discontinued operations) on earnings in fiscal 1994 was 41.0%, compared to 39.7% in the prior year. The Company's effective income tax rate increased due to a higher federal statutory rate implemented in the Company's fourth quarter of fiscal 1993 and by changes in the impact of foreign operations on the effective tax rate.\nDISCONTINUED OPERATIONS\nThe loss on discontinued real estate operations (net of operating expenses and taxes) includes the results of income producing properties, gains on sale of property, interest income and a provision of $90,200 pre-tax of which $80,500 pre-tax ($47,500 after tax or or $.22 per share) relates to a change in calculating estimated losses for assets which are considered to be economically impaired. This change in accounting estimates results from the spin-off of the real estate segment assets into Price Enterprises, and Price Enterprises' decision to pursue business plans and operating strategies as a stand-alone entity which are significantly different than the strategies of the Company. Specifically, Price Enterprises' management believes that as a separate operating business it will not have the same access to capital as the Company or generate internal funds from operations to the same extent as the Company.\nPriceCostco's accounting policies with respect to estimating the amount of impairments on individual real estate properties and related assets such that impairment losses if the carrying amount of the asset could not be recovered from estimated future cash flows on an undiscounted basis. Price Enterprises management believes that in view of its strategies with respect to the number and nature of properties that would be selected for potential disposition, it would be more appropriate to estimate impairment losses based on fair values of the real estate properties as determined by appraisals and\/or a risk-adjusted discounted cash flow approach. In determining impairment losses, individual real estate assets were reduced to estimated fair value, if lower than historical cost. For those assets which have an estimated fair value in excess of cost, the asset continues to be recorded at cost. The impairment losses recorded as a result of this change in accounting estimates reduced the book basis of certain of the real estate and related assets.\nThe loss on disposal of the discontinued real estate operations of $182,500 or $.83 per share, reflected in the fourth quarter of fiscal 1994, relates to the transfer of the Company's commercial real estate operations, together with certain other assets, to Price Enterprises as part of the Exchange Transaction. For a description of the Exchange Transaction, see \"Part I -- Business -- Description of\nthe Exchange Transaction.\" The estimated loss on disposal is a non-recurring special charge calculated as the difference between the aggregate book value of the net assets being spun-off of $579,000 and the estimated market value of 27 million shares of Price Enterprises common stock of $411,750 plus direct transaction costs of approximately $15,250. The Exchange Transaction is expected to close before the end of the calendar year, at which time the estimated loss on disposal will be adjusted to actual. For a more detailed discussion of the estimated loss on disposal and the factors that will affect the amount of any adjustment to the loss after the Transaction is completed, see Note 3 -- Spin off of Price Enterprises, Inc. and Discontinued Operations.\nCOMPARISON OF FISCAL 1993 (52 WEEKS) AND FISCAL 1992 (52 WEEKS): (DOLLARS IN THOUSANDS, EXCEPT EARNINGS PER SHARE)\nNet income during fiscal 1993 decreased 8% to $223,247, or $1.00 per share (fully diluted), as compared to fiscal 1992 net income of $242,407 or $1.06 per share (fully diluted).\nCONTINUING OPERATIONS\nIncome from continuing operations for fiscal 1993 was $202,843 or $.92 per share, compared to fiscal 1992 income from continuing operations of $223,022 or $.98 per share.\nNet sales increased 10% to $15,154,685 in fiscal 1993 from $13,820,380 in fiscal 1992. This increase was due to: (i) first year sales at the thirty-seven new warehouses opened during fiscal 1993; and (ii) increased sales at thirty-one warehouses that were opened in 1992 and that were in operation for the entire fiscal year, which increase was partially offset by lower sales at existing locations opened prior to fiscal 1992. Changes in prices did not materially affect sales levels.\nComparable sales, that is sales in warehouses open for at least a year, trended downward in fiscal 1993 -- from a positive 6% annual rate during fiscal 1992, to a negative 3% annual rate during fiscal 1993. The declining rate of comparable sales was attributed to several factors, including the following: the effect of sales cannibalization by opening additional warehouses in existing markets; increased competition in several markets; deflation in several merchandise categories; a generally poor economic environment, especially in California; and a weak Canadian dollar where the Company derived 15% and 14% of net sales in fiscal 1993 and 1992, respectively.\nMembership fees and other revenue increased 12% from $276,998, or 2.00% of net sales, in fiscal 1992 to $309,129, or 2.04% of net sales in fiscal 1993. This increase reflects a continued strong membership base at existing warehouses, membership signups at the thirty-seven new warehouses and annualized effect of membership fee increases in certain markets implemented in fiscal 1992.\nGross margin (defined as net sales minus merchandise costs) increased 12% from $1,254,917, or 9.08% of net sales in fiscal 1992 to $1,403,532, or 9.26% of net sales in fiscal 1993. The increased gross margin reflects improved shrinkage control and improved buying and distribution techniques afforded by the Company's increased sales volume, as well as increased levels of sales from ancillary businesses (pharmacy, one-hour photo, print shop, optical and food services), which carry a higher than average gross margin. The gross margin figures reflect accounting for merchandise inventory costs on the last-in, first-out (LIFO) method. For fiscal 1993 there was a $5,350 LIFO benefit or $.01 per share (fully diluted) to increase income after tax due to the use of the LIFO method compared to the first-in, first-out (FIFO) method. This compares to a $300 LIFO provision in fiscal 1992.\nSelling, general and administrative expenses as a percent of net sales increased from 8.17% during fiscal 1992 to 8.67% during fiscal 1993, reflecting a combination of comparable unit sales decreases in the 170 warehouses in operation during both fiscal periods; higher expense ratios at the 37 units opened during fiscal 1993 (newer units generally operate at significantly lower annual sales volumes than mature units and, therefore, incur higher expense ratios than mature units); and higher expense factors associated with certain ancillary operations.\nPreopening expenses totaled $25,595 or 0.19% of net sales during fiscal 1992 and $28,172 or 0.19% of net sales during fiscal 1993. During fiscal 1993, the Company opened 37 new warehouses. The Company opened 31 new warehouses during fiscal 1992.\nDuring fiscal 1993, the Company announced and closed four warehouses and completed the closing and relocation of three warehouses announced in fiscal 1992. The costs associated with closing the four warehouses announced in fiscal 1993 will be approximately $5,000, or $.01 per share (fully diluted), and this amount was recognized as anticipated warehouse closing costs in the fourth quarter of fiscal 1993. This compares to $2,000 in fiscal 1992, when the Company announced the closing of two warehouses, relocated one warehouse and announced the planned relocation of another warehouse.\nInterest expense totaled $35,525 in fiscal 1992 and $46,116 in fiscal 1993. In fiscal 1992 interest expense was incurred as a result of the interest on the convertible subordinated debentures and interest on borrowings on the Company's bank lines. Fiscal 1993 includes a full year of interest expense on the $300,000 5 3\/4% convertible subordinated debentures which accounted for the increase in interest expense compared to fiscal 1992.\nInterest income and other totaled $28,958 in fiscal 1992, and $17,750 in fiscal 1993. This decrease was primarily due to lower average investment balances and lower interest rates.\nThe effective income tax rate on earnings in fiscal 1993 was 39.7%, compared to 39.5% the prior year. The Company's effective income tax rate increased due to a higher federal statutory rate implemented in the Company's fourth quarter of 1993 offset by changes in state and foreign effective rates.\nDISCONTINUED OPERATIONS\nDiscontinued real estate operations (net of operating expenses and taxes) includes the results of income producing properties as well as gains (losses) on sales of property. Income from discontinued real estate operations, net of income taxes, increased 5% from $19,385 or $0.08 per share in fiscal 1992 to $20,404 or $0.08 per share in fiscal 1993. The increase primarily represents nonrecurring gains recognized on sale of properties of $21,500 in fiscal 1993 as compared to $15,600 in fiscal 1992.\nRECENT SALES RESULTS\nPriceCostco's net sales for the eight-week period ended October 23, 1994 were approximately $2,520,000 an increase of 11% from approximately $2,280,000 for the same eight-week period of the prior fiscal year. Comparable warehouse sales (sales in warehouses open for at least a year) increased by one percent during the eight-week period.\nLIQUIDITY AND CAPITAL RESOURCES (DOLLARS IN THOUSANDS)\nPriceCostco's primary requirement for capital is the financing of the land, building and equipment costs for new warehouses plus the costs of initial warehouse operations and working capital requirements. PriceCostco does not expect to make significant investments in non-club real estate in the future. Additional capital will be required for international expansion through investments in foreign subsidiaries and joint ventures.\nIn fiscal 1994, cash provided from operations was approximately $248,000. These funds, combined with beginning fiscal year balances of cash, cash equivalents and short-term investments, along with borrowings under the Company's commercial paper program were used to finance additions to property, equipment for warehouse clubs and related operations of $475,000 and net inventory investment (merchandise inventories less accounts payable) of $66,000 and other investing activities related primarily to non-club real estate investments and investments in foreign joint ventures, which together totaled $125,000.\nExpansion plans for the United States and Canada during fiscal 1995 are to open 30-35 new warehouse clubs. The Company also expects to continue expansion of its international operations.\nThe Company opened two warehouses in the United Kingdom through a 60%-owned subsidiary, with a third location due to open in June, 1995. In October 1994, under a licensing agreement with PriceCostco, a Price Club opened in Seoul, Korea. Other markets are being assessed, particularly in the Pacific Rim. As a result of the Exchange Transaction, the Company's 50% ownership interest in the Mexican joint venture was transferred to Mexico Clubs in which the Company owns a 49% interest. See \"Part I -- Business -- Description of the Exchange Transaction.\" As of August 28, 1994, there were 8 Price Clubs operating in Mexico through such joint venture. As of October 31, 1994, there are 10 Price Clubs operating in Mexico through such joint venture with one more scheduled to open prior to December 31, 1994.\nWhile there can be no assurance that current expectations will be realized and plans are subject to change upon further review, it is management's current intention to spend an aggregate of approximately $500,000 to $600,000 during fiscal 1995 in the United States and Canada for real estate, construction, remodeling and equipment for warehouse clubs and related operations; and approximately $50,000 to $100,000 for international expansion, including the United Kingdom and other potential ventures. These expenditures will be financed with a combination of cash provided from operations, the use of cash, cash equivalents and short-term investments, which totaled $63,000 at August 28, 1994; short-term borrowings under revolving credit facilities and\/or commercial paper facilities; issuance of long-term debt; and other financing sources as required.\nThe Company has a domestic multiple option loan facility with a group of 14 banks which provides for borrowings of up to $500,000 or for standby support for a $500,000 commercial paper program. Of this amount, $250,000 expires on January 30, 1995, and $250,000 expires on January 30, 1998. The interest rate on bank borrowings is based on LIBOR or rates bid at auction by the participating banks. At August 28, 1994, in the amount outstanding under the Company's commercial paper program was $149,340. The Company expects to renew the $250,000 portion of the loan facility expiring on January 30, 1995, at substantially the same terms.\nIn addition, the Company's wholly-owned Canadian subsidiary has a $65,800 line of credit with a group of three Canadian banks of which $29,200 expires on December 1, 1994 (the short-term portion) and $36,600 expires in various amounts through December 1, 1996 (the long-term portion). The interest rate on borrowings is based on the prime rate or the \"Bankers' Acceptance\" rate. At August 28, 1994, no amounts were outstanding under these programs. The Company expects to renew the $29,200 short-term portion of the line of credit expiring on December 1, 1994, at substantially the same terms.\nThe Company has separate letter of credit facilities (for commercial and standby letters of credit), totaling approximately $193,000. The outstanding commitments under these facilities at August 28, 1994 was approximately $118,000, including approximately $53,000 in standby letters for workers' compensation requirements.\nDue to rapid inventory turnover, the Company's operations provide a higher level of supplier trade payables than generally encountered in other forms of retailing. When combined with other current liabilities, the resulting amount typically approaches the current assets needed to operate the business (e.g., merchandise inventories, accounts receivable and other current assets). At August 28, 1994, the working capital (deficit) totaled ($113,000) compared to working capital of $127,000 at August 29, 1993. This change is primarily related to a reduction in cash and cash equivalents of $67,000, a decrease in short-term investments and restricted cash of $81,000 and an increase in notes payable of $126,000 offset by other increases of $34,000, as working capital was used to finance expansion and merger expenses during fiscal 1994.\nIn fiscal 1992, cash provided from operations was $296,000. These funds combined with proceeds from issuance of $300,000 5 3\/4% convertible subordinated debentures in May 1992 and approximately $144,000 generated from the sale of certain properties were used to finance additions to property and\nequipment for warehouse clubs and related operations of $533,000; other investing activities related primarily to non-club real estate development, and investment in foreign joint ventures, which together totaled $83,000.\nITEM 8","section_7A":"","section_8":"ITEM 8 -- FINANCIAL STATEMENTS\nThe following financial statements of PriceCostco are as follows:\nITEM 9","section_9":"ITEM 9 -- CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nFor information with respect to the executive officers of the Registrant, see Item 4A -- \"Executive Officers of the Registrant\" at the end of Part I of this report. The information required by this Item concerning the Directors and nominees for Director of the Company is incorporated herein by reference to PriceCostco's Proxy Statement for its Annual Meeting of Stockholders, to be held on January 27, 1995, to be filed with the Commission pursuant to Regulation 14A.\nITEM 11","section_11":"ITEM 11 -- EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated herein by reference to PriceCostco's Proxy Statement for its Annual Meeting of Stockholders, to be held on January 27, 1995, to be filed with the Commission pursuant to Regulation 14A.\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 PriceCostco's Proxy Statement for its Annual Meeting of Stockholders to be held on January 27, 1995, to be filed with the Commission pursuant to Regulation 14A.\nITEM 13","section_13":"ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated herein by reference to PriceCostco's Proxy Statement for its Annual Meeting of Stockholders, to be held on January 27, 1995, to be filed with the Commission pursuant to Regulation 14A.\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 are as follows:\n1. Financial Statements:\nSee listing of Financial Statements included as a part of this Form 10-K on Item 8 of Part II.\n2. Financial Statements Schedules:\n(b) Current Report on Form 8-K filed on August 5, 1994.\n3. Exhibits\nThe following exhibits are filed as part of this Annual Report on Form 10-K or are incorporated herein by reference. Where an exhibit is incorporated by reference, the number which follows the description of the exhibit indicates the document to which cross reference is made (see page 22 for listing of cross reference documents).\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.\nNovember 16, 1994\nPRICE\/COSTCO, INC.\n(Registrant)\nBy \/s\/ RICHARD A. GALANTI\n-------------------------------------- Richard A. Galanti EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Price\/Costco, Inc.:\nWe have audited the accompanying consolidated balance sheets of Price\/Costco, Inc. (a Delaware corporation) and subsidiaries (PriceCostco) as of August 28, 1994 and August 29, 1993, and the related statements of operations, stockholders' equity and cash flows for the 52-week periods ended August 28, 1994, August 29, 1993 and August 30, 1992. These financial statements are the responsibility of PriceCostco's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe did not audit the financial statements of The Price Company and subsidiaries (Price), which statements reflect total assets of 52% of the consolidated totals as of August 29, 1993 and total revenues of 51% and 53% of the consolidated totals for the 52-week periods ended August 29, 1993 and August 30, 1992, respectively. Those statements were audited by other auditors whose report thereon has been furnished to us and our opinion expressed herein, insofar as it relates to the amounts included for Price, 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 are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 PriceCostco as of August 28, 1994 and August 29, 1993, and the results of its operations and its cash flows for the 52-week periods ended August 28, 1994, August 29, 1993 and August 30, 1992 in conformity with generally accepted accounting principles.\nArthur Andersen LLP\nSeattle, Washington November 14, 1994\nPRICE\/COSTCO, INC. CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS) ASSETS\nThe accompanying notes are an integral part of these balance sheets.\nPRICE\/COSTCO, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these statements.\nPRICE\/COSTCO, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE 52 WEEKS ENDED AUGUST 28, 1994, AUGUST 29, 1993, AND AUGUST 30, 1992 (IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nPRICE\/COSTCO, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of Price\/Costco, Inc., a Delaware corporation, and its subsidiaries (PriceCostco or the Company). PriceCostco is a holding company which operates primarily through its major subsidiaries, The Price Company and subsidiaries (Price), and Costco Wholesale Corporation and subsidiaries (Costco). As described more fully in Note 2 -- Merger of Price and Costco, on October 21, 1993, Price and Costco became wholly-owned subsidiaries of PriceCostco.\nAs described more fully in \"Note 3 -- Spin-off of Price Enterprises, Inc. and Discontinued Operations\" the Company has treated the spin-off of its real estate operations as discontinued operations in the fourth quarter of fiscal 1994.\nThe Company's investment in the Mexico joint venture and in real estate joint ventures that are less than majority owned are accounted for under the equity method.\nBUSINESS\nThe Company has operated in two reporting business segments, a cash and carry merchandising operation and as of July 1994 has discontinued its non-club real estate operations. The Company reports on a 52\/53 week basis and ends on the Sunday nearest August 31st. Fiscal years 1994, 1993 and 1992 were each 52 weeks.\nCASH AND CASH EQUIVALENTS\nThe Company considers all investments in highly liquid debt instruments maturing within 90 days when purchased as cash equivalents unless amounts are held in escrow for future property purchases or restricted by agreements.\nSHORT-TERM INVESTMENTS AND RESTRICTED CASH\nShort-term investments include highly liquid investments in United States and Canadian government obligations, along with other investment vehicles, some of which have maturities of three months or less at the time of purchase. The Company's policy is to classify these investments as short-term investments rather than cash equivalents if they are acquired and disposed of through its investment trading account, held for future property purchases, or restricted by agreement.\nMERCHANDISE INVENTORIES\nMerchandise inventories are valued at the lower of cost or market as determined primarily by the retail inventory method, and are stated using the last-in, first-out (LIFO) method for U.S. merchandise inventories. The Company believes the LIFO method more fairly presents the results of operations by more closely matching current costs with current revenues. If all merchandise inventories had been valued using the first-in, first-out (FIFO) method, inventories would have been higher by $6,650 at August 28, 1994, $9,250 at August 29, 1993 and $14,600 at August 30, 1992.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company provides for estimated inventory losses between physical inventory counts on the basis of a standard percentage of sales. This provision is adjusted periodically to reflect the actual shrinkage results of the physical inventory counts which generally occur in the second and fourth quarters of the Company's fiscal year.\nWhen required in the normal course of business, the Company enters into agreements securing vendor interests in inventories.\nRECEIVABLES\nCurrent receivables consist of vendor rebates and other miscellaneous amounts due to the Company, and are net of allowance for doubtful accounts of $3,045 at August 28, 1994 and $1,567 at August 29, 1993.\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. Depreciation and amortization expenses are computed using the straight-line method for financial reporting purposes and by accelerated methods for tax purposes. Buildings are depreciated over twenty-five to thirty-five years; equipment and fixtures are depreciated over three to ten years; and land rights and leasehold improvements are amortized over the initial term of the lease.\nInterest costs incurred on property and equipment during the construction period are capitalized. The amount of interest costs capitalized related to continuing operations was approximately $7,170 in fiscal 1994, $9,483 in fiscal 1993 and $8,487 in fiscal 1992.\nGOODWILL\nGoodwill included in other assets totaled $38,761 at August 28, 1994 and $41,725 at August 29, 1993 resulted from certain previous business combinations. Goodwill is being amortized over 5 to 40 years using the straight-line method. Accumulated amortization was $5,986 at August 28, 1994 and $5,575 at August 29, 1993.\nNET INCOME PER COMMON AND COMMON EQUIVALENT SHARE\nThe calculation of net income per common and common equivalent share for each period presented prior to the Merger reflects the issuance of 2.13 shares of PriceCostco Common Stock for each share of Price Common Stock used in such calculation and one share of PriceCostco Common Stock for each share of Costco Common Stock used in such calculation. For fiscal 1993 and 1992, this calculation eliminates interest expense, net of income taxes, on the 5 1\/2% convertible subordinated debentures (primary and fully diluted) and the 6 3\/4% convertible subordinated debentures (fully diluted only), and includes the additional shares issuable upon conversion of these debentures. For fiscal 1994, the 6 3\/4% and 5 1\/2% convertible subordinated debentures were not dilutive for either primary or fully diluted purposes. For all periods presented, the 5 3\/4% convertible subordinated debentures were not dilutive for either primary or fully diluted purposes. The weighted average number of common and common equivalent shares outstanding for primary and fully diluted share calculations for fiscal 1994, 1993 and 1992 were as follows (in thousands):\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PREOPENING EXPENSES\nPreopening expenses related to new warehouses, regional offices and other startup operations are expensed as incurred.\nMEMBERSHIP FEES\nMembership fee revenue represents annual membership fees paid by substantially all of the Company's members. In accordance with industry practice, annual membership fees are recognized as income when received.\nFOREIGN CURRENCY TRANSLATION\nThe accumulated foreign currency translation relates to the Company's consolidated foreign operations and its investment in the Price Club Mexico joint venture and is determined by application of the current rate method and included in the determination of consolidated stockholders' equity at the respective balance sheet dates.\nINCOME TAXES\nThe Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" That standard requires companies to account for deferred income taxes using the asset and liability method.\nRECLASSIFICATIONS\nCertain reclassifications of expenses between merchandise costs and selling, general and administrative expenses have been reflected in the financial statements in order to conform the presentations of the combined entities.\nNOTE 2 -- MERGER OF PRICE AND COSTCO On October 21, 1993, the shareholders of both Price and Costco approved the mergers of Price and Costco into subsidiaries of PriceCostco (the Merger). Pursuant to the Merger, Price and Costco became subsidiaries of PriceCostco. Shareholders of Price received 2.13 shares of PriceCostco common stock for each share of Price common stock and shareholders of Costco received one share of PriceCostco common stock for each share of Costco.\nThe Merger qualified as a \"pooling-of-interests\" for accounting and financial reporting purposes. The pooling-of-interests method of accounting is intended to present as a single interest two or more common shareholder interests which were previously independent. Consequently, the historical financial statements for periods prior to the consummation of the combination were restated as though the companies had been combined. The restated financial statements were adjusted to conform the accounting policies of the separate companies.\nAll fees and expenses related to the Merger and to the consolidation and restructuring of the combined companies were expensed as required under the pooling-of-interests accounting method. In the first quarter of fiscal 1994, the Company recorded a provision for merger and restructuring costs of $120,000 pre-tax ($80,000 after tax) related to the Merger.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 2 -- MERGER OF PRICE AND COSTCO (CONTINUED) Components of the $120,000 provision for merger and restructuring expenses, including amounts expended in Fiscal 1994 and the remaining accrual related to completing the merger and restructuring effort at August 28, 1994, are as follows:\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 2 -- MERGER OF PRICE AND COSTCO (CONTINUED) The following summarizes amounts reported by Price and Costco prior to the Merger for fiscal 1994, 1993 and 1992.\nNOTE 3 -- SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS\nSPIN-OFF OF PRICE ENTERPRISES, INC.\nOn July 28, 1994, PriceCostco entered into an Agreement of Transfer and Plan of Exchange (as amended and restated, the Transfer and Exchange Agreement) with Price Enterprises, Inc. (Price Enterprises). Price Enterprises is an indirect, wholly-owned subsidiary of PriceCostco, formed in July 1994. The transactions contemplated by the Transfer and Exchange Agreement are referred to herein as the \"Exchange Transaction.\"\nPursuant to the Transfer and Exchange Agreement, PriceCostco will offer to exchange one share of Price Enterprises Common Stock for each share of PriceCostco Common Stock, up to a maximum of 27 million shares of Price Enterprises Common Stock (the Exchange Offer). If more than 27 million shares of PriceCostco Common Stock are validly tendered and not withdrawn in the Exchange Offer prior to the expiration thereof, then PriceCostco will accept 27 million shares on a pro rata basis and shares of Price Enterprises Common Stock will be exchanged therefor. If the number of shares of PriceCostco Common Stock validly tendered in the Exchange Offer by holders of PriceCostco Common Stock is less than 21.6 million, PriceCostco will accept such validly tendered shares for exchange and will distribute the remaining shares of Price Enterprises Common Stock pro rata to PriceCostco\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 3 -- SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS (CONTINUED) stockholders. If the number of shares of PriceCostco Common Stock validly tendered in the Exchange Offer by holders of PriceCostco Common Stock is greater than 21.6 million, but less than 27 million, PriceCostco will accept such validly tendered shares for exchange and will, at its option, either (i) distribute the remaining shares of Price Enterprises Common Stock pro rata to PriceCostco stockholders or (ii) sell such remaining shares to Price Enterprises in exchange for a promissory note.\nThe following real estate related assets have been or will be transferred to Price Enterprises:\n- Substantially all of the real estate properties which historically formed the non-club real estate segment of PriceCostco.\n- Four existing Price Club warehouses (\"Warehouse Properties\") which are adjacent to existing non-club real estate properties which are being leased back to PriceCostco effective August 29, 1994, at initial collective annual rentals of approximately $8,600.\n- Notes receivable from various municipalities and agencies (\"City Notes\").\n- Note receivable in the principal amount of $41,000 made by Atlas Hotels, Inc., secured by a hotel and convention center property located in San Diego, California (\"Atlas Note\").\nIn addition, PriceCostco agreed to transfer to Price Enterprises 51% of the outstanding capital stock of two newly formed, wholly owned subsidiaries of the Company: Price Quest, Inc. (Price Quest) and Price Global Trading, Inc. (Price Global), Price and Price Enterprises also own 49% and 51% interests, respectively, in Mexico Clubs, L.L.C., a limited liability company (Mexico Clubs, which together with Price Quest and Price Global comprise the Subsidiary Corporations).\nMexico Clubs will own the Company's 50% interest in Price Club de Mexico and affiliates (Price Club Mexico), a 50-50 joint venture with Controladora Comercial Mexicana S.A. de C.V., which develops, owns and operates Price Clubs in Mexico. The investment in Price Club Mexico is accounted for under the equity method. At August 28, 1994, eight Price Clubs were in operation in Mexico. The Company owns a 49% interest in Mexico Clubs.\nPrice Quest will continue to operate the Quest interactive electronic shopping business of PriceCostco. The Quest business includes electronic shopping through kiosks located in certain PriceCostco club warehouses; Price Club Travel, which offers discount airline tickets and travel packages to PriceCostco members; Price Club Realty, a real estate brokerage business for PriceCostco members; and the Price Club automobile referral\/advertising program, which publishes advertisements for automobile dealers who provide discount purchasing programs to PriceCostco members in the vicinity of certain PriceCostco warehouse clubs. The Company owns 49% of the capital stock of Price Quest.\nPrice Global has the rights to develop club businesses in certain geographical areas specified in the Transfer and Exchange Agreement and owns 100% of the outstanding shares of Club Merchandising, Inc. (CMI), which was acquired by the Company in March 1992. The Company owns 49% of the capital stock of Price Global.\nFor purposes of governing the ongoing relationships between PriceCostco, Price Enterprises, and the Subsidiary Corporations, PriceCostco and Price, on the one hand, and Price Enterprises and the Subsidiary Corporations, on the other, have entered into operating agreements. PriceCostco and Price, on the one hand, and Price Enterprises and each of Price Global and Price Quest, on the other, have entered into stockholders agreements to clarify certain rights and obligation of PriceCostco and Price Enterprises as stockholders of Price Global and Price Quest. Price and Price Enterprises have\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 3 -- SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS (CONTINUED) entered into a Limited Liability Company Agreement with respect to Mexico Clubs that sets forth the rights and obligations of each of Price and Price Enterprises with respect to its membership interest in Mexico Clubs. PriceCostco and Price Enterprises have entered into an unsecured revolving credit agreement under which PriceCostco has agreed to advance Price Enterprises up to a maximum principal amount of $85 million (reduced by the net proceeds from the sale of certain commercial properties).\nDISCONTINUED OPERATIONS\nHistorically, the Company has treated non-club real estate investments as a separate reportable business segment. The primary assets generating operating income for the segment have been non-club real estate properties, consisting of property owned directly and property owned by real estate joint venture partnerships in which the Company has a controlling interest. Real estate joint ventures relate to real estate partnerships that are less than majority owned. In fiscal 1994, the Atlas Note was purchased and the related interest income has been included in the non-club real estate segment.\nAdditionally, the Warehouse Properties, and City Notes transferred to Price Enterprises as of August 28, 1994 have been included in the net assets of the discontinued operations as of August 28, 1994 and August 29, 1993, in the accompanying consolidated balance sheets. However, the operating expenses of the Warehouse Properties and the interest income on the City Notes have not been included in the real estate segment operating results because historically these amounts have been included as part of merchandising operations and other income. The operating results and net assets of the Subsidiary Corporations transferred to Price Enterprises are included in continuing operations because they were not related to the discontinued real estate operations.\nDISCONTINUED OPERATIONS -- NET ASSETS\nNet assets related to discontinued real estate operations as shown on the consolidated balance sheets at August 28, 1994 and August 29, 1993 consist of the following:\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 3 -- SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS (CONTINUED) INCOME (LOSS) FROM DISCONTINUED OPERATIONS\nComponents of net income (loss) from discontinued operations for fiscal 1994, 1993 and 1992 were as follows:\nPROVISION FOR ASSET IMPAIRMENTS\nThe loss on discontinued real estate operations includes a provision of $90,200 of which $80,500 ($47,500 after tax) relates to a change in calculating estimated losses for assets which are economically impaired. This change in accounting estimates results from the spin-off of the real estate segment assets into Price Enterprises and Price Enterprises' decision to pursue business plans and operating strategies as a stand-alone entity which are significantly different than the previous strategies of the Company. Price Enterprises' management believes that as a separate operating business it will not have the same access to capital as the Company or generate internal funds from operations to the same extent as the Company.\nPriceCostco's accounting policies with respect to estimating the amount of impairments on individual real estate properties and related assets were such that impairment losses would be recorded if the carrying amount of the asset could not be recovered from estimated future cash flows on an undiscounted basis. Price Enterprises' management believes that in view of its strategies with respect to the number and nature of properties that would be selected for disposition, it would be more appropriate to estimate impairment losses based on fair values of the real estate properties as determined by appraisals and\/or a risk-adjusted discounted cash flow approach. In determining impairment losses, individual real estate assets were reduced to estimated fair value, if lower than historical cost. For those assets which have an estimated fair value in excess of cost, the asset continues to be recorded at cost. The impairment losses recorded as a result of this change in accounting estimates reduced the book basis of certain of the real estate and related assets.\nUnder the previous policy, PriceCostco and Price Enterprise had determined that a provision for asset impairments of approximately $9,700 was required relating to four properties which were under contract or in final negotiations for sale.\nGAINS ON SALE OF NON-CLUB REAL ESTATE PROPERTIES\nDuring fiscal 1994, the Company entered into a transaction with The Price REIT, Inc. (REIT). On October 1, 1993, the Company sold a single shopping center and adjacent Price Club (which is being leased back to the Company) for $28,200. The Company recorded a $4,210 pre-tax gain in connection with this sale.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 3 -- SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS (CONTINUED) During fiscal 1993, the Company entered into two transactions with the REIT:\n(a) On December 18, 1992, the Company sold a former Price Club property for $14,350. The Company recorded a pre-tax gain of $6,710 in connection with this sale.\n(b) On August 12, 1993, the Company sold three shopping centers and adjacent Price Clubs (which are being leased back to the Company) and its 49.6% interest in a joint venture which owns five shopping centers, for which the Company received proceeds of approximately $117,000 and recognized a $14,320 pre-tax gain.\nDuring fiscal 1992, the Company entered into two transactions with the REIT:\n(a) On December 1, 1991 the Company entered into a sale and leaseback transaction, under which four Price Clubs were sold to the REIT for $26,700 and leased back for annual rentals of $2,470, increasing $27 each year. The master lease has an initial term of 15 years with seven five-year renewal options. Additionally, the Company sold a 50.4% interest in five shopping centers, four of which are adjacent to the Price Clubs involved in the sale-leaseback. The Company agreed, for a specified period, to subordinate its portion of the operational cash flow of the joint venture to allow the REIT shareholders to receive a specified return on their investment (9% the first year, increasing to 9.5% in year five). The Company recorded a pretax gain of $4,400 in connection with this sale.\n(b) On April 29, 1992, the Company sold two shopping centers and one Price Club adjacent to one of the shopping centers for $62,500. The Price Club is being leased back from the REIT for annual rentals of $370, increasing $4 per year, with an initial term of 15 years and seven five-year renewal options. The Company recorded a pre-tax gain of $11,200 in connection with this sale.\nFor the real estate transactions referred to above, no gains were recognized for the portion of the sales involving Price Club warehouses which are being leased back.\nESTIMATED LOSS ON DISPOSAL AND SUBSEQUENT ADJUSTMENT\nIn the fourth quarter of fiscal 1994, the Company recorded an estimated loss on disposal of its discontinued operations (the non-club real estate segment) as a result of entering into the Transfer and Exchange Agreement. While the Exchange Transaction is not expected to be completed until December 1994, the Company determined that the Exchange Transaction will, in all likelihood, result in a significant loss for financial reporting purposes and that there is a reasonable basis for estimating the loss. The actual loss for financial reporting purposes will be determined following consummation of the Exchange Transaction. Such loss will be the product of: (a) the difference between the book value per share of the assets transferred to Price Enterprises (at historical cost), and the fair market value per share; and (b) the actual number of shares exchanged. The loss also includes the direct expenses related to the Exchange Transaction. For purposes of recording such estimated loss, the Company assumed that (i) the Exchange Offer would be fully subscribed, (ii) a per share price of Price Enterprises Common Stock of $15.25 (the closing sales price of PriceCostco Common Stock on October 24, 1994) and (iii) direct expenses and other costs related to the Exchange Transaction of approximately $15,250.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 3 -- SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS (CONTINUED) The following table explains how the estimated loss was computed:\nThe book value of the assets transferred to Price Enterprises (approximately $21 per share of Price Enterprises stock), reflects a provision for asset impairments of $80,500 recorded as a change in accounting estimate in the fourth quarter of fiscal 1994.\nThe approximate $6 per share difference between the $21 book value per share of Price Enterprises and the assumed per share price of Price Enterprises is attributable to a combination of factors. These factors include an expectation that Price Enterprises' stock may trade at a discount from its book value (although the prices at which shares of Price Enterprises will trade cannot be predicted).\nIn making its determination to approve the Exchange Transaction, one of the factors considered by the Board of Directors of the Company was a range of illustrative high and low per share values for Price Enterprises and the implied per share premium in the Exchange Offer based on such illustrative values as compared to the per share price of PriceCostco common stock at July 14, 1994 of $14.75 (assuming 27 million shares of Price Enterprises common stock outstanding and a one-for-one exchange ratio). While believing that some premium to tendering stockholders is included in the exchange ratio, the Board did not quantify any such premium, recognizing that it could not quantify any such premium since the range of prices at which Price Enterprises Common Stock may trade cannot be predicted. If any such premium could be objectively measured, it would be accounted for as a cost of the treasury shares to be acquired by the Company. Since any premium cannot be objectively measured, the Company believes that it is appropriate in the circumstances to include any premium as part of the estimated loss on the disposal of the non-club real estate segment, recognizing that the amount of the loss is subject to revision after the Exchange Offer closes.\nAs indicated above, the estimated loss was determined assuming that the Exchange Offer would be fully subscribed. Any subsequent adjustment to the estimated loss will be affected by the extent to which the Exchange Offer is subscribed. If the Exchange Offer is at least 80% subscribed and PriceCostco elects to sell the unsubscribed shares to Price Enterprises for a note, the loss on the Transaction will be the same as if it were fully subscribed. Any unsubscribed shares distributed to stockholders pro rata will be excluded from the loss determination and accounted for as a dividend. The dividend will be measured by the book value per share of Price Enterprises shares distributed and will be is charged directly to retained earnings. Furthermore, to the extent that the Price Enterprises' fair market value per share differs from the estimated share price used above, the per share difference times the number of shares exchanged will be reclassified from the loss on disposal reflected in the income statement and included in the cost of the Company's treasury shares acquired. In measuring the actual loss on the Exchange Transaction, PriceCostco expects to measure the fair market value of Price Enterprises' stock based on the average closing sales price of Price Enterprises Common Stock during the 20 trading days commencing on the sixth trading day following the closing of the Exchange Offer. However, other factors may also need to be considered in making the final determination.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 3 -- SPIN-OFF OF PRICE ENTERPRISES, INC. AND DISCONTINUED OPERATIONS (CONTINUED) If the Exchange Offer is at least 80% subscribed and PriceCostco decides to sell the unsubscribed shares to Price Enterprises in exchange for a note, the loss on the Transaction will be the same as if it were fully subscribed. Otherwise, the actual loss will be reduced by approximately $6 per share. The actual loss determination will also be affected by the fair market price of Price Enterprises stock. The fair market value of Price Enterprises stock will be used to measure the cost per share of each PriceCostco share acquired in the Exchange Offer. For each dollar per share difference in Price Enterprises' stock value from the $15.25 amount used for purposes of estimating the loss, the actual loss will change by one dollar for every share exchanged. An increase in Price Enterprises' stock value would reduce the amount of the loss, while a decrease in Price Enterprises' stock value would cause the loss to be greater.\nDetermination of the actual loss will not affect PriceCostco's pro forma balance sheet, because any change in the amount of the loss on disposal, as it is ultimately measured, will result in an offsetting change in stockholders' equity, either as dividends, as an adjustment to the cost of treasury shares being acquired, or both.\nUNAUDITED PRO FORMA CONDENSED INFORMATION\nThe following unaudited pro forma condensed balance sheet of PriceCostco as of August 28, 1994 reflects the unaudited pro forma adjustments of the Exchange Transaction as if it had occurred on August 28, 1994 regardless of the ultimate treatment of the estimated loss on disposal as discussed above:\nPro forma net income from continuing operations was reduced by $2,580 or $.01 per share for the net effect of assets transferred in the Exchange Transaction which were not accounted for as part of discontinued operations. This net effect was caused by rent expense on the Warehouse Properties, income on the City Notes, and equity in earnings of Price Club Mexico, which was offset by the losses on certain merchandising operations.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 4 -- DEBT\nBANK LINES OF CREDIT\nThe company has a domestic multiple option loan facility with a group of 14 banks which provides for borrowings of up to $500,000 or for standby support for a $500,000 commercial paper program. Of this amount, $250,000 expires on January 30, 1995, and $250,000 expires on January 30, 1998. The interest rate on bank borrowings is based on LIBOR or rates bid at auction by the participating banks. Notes payable at August 28, 1994, in the accompanying balance sheet consist of amounts outstanding under the Company's commercial paper program. The Company expects to renew the $250,000 portion of the loan facility expiring on January 30, 1995, at substantially the same terms.\nIn addition, the Company's wholly-owned Canadian subsidiary has a $65,800 line of credit with a group of three Canadian banks of which $29,200 expires on December 1, 1994 (the short-term portion) and $36,600 expires in various amounts through December 1, 1996 (the long-term portion). The interest rate on borrowings is based on the prime rate or the \"Bankers' Acceptance\" rate. At August 28, 1994, no amounts were outstanding under these programs. The Company expects to renew the $29,200 short-term portion of the line of credit expiring on December 1, 1994, at substantially the same terms.\nThe Company has separate letter of credit facilities (for commercial and standby letters of credit), totaling approximately $193,000. The outstanding commitments under these facilities at August 28, 1994 were approximately $118,000 including approximately $53,000 in standby letters for workers' compensation requirements.\nLONG-TERM DEBT\nLong-term debt at August 28, 1994 and August 29, 1993 consists of:\nEffective upon consummation of the Merger, PriceCostco became a co-obligor under each of the convertible subordinated debentures originally issued by Price and Costco. These debentures are convertible into shares of PriceCostco. Conversion rates of Price subordinated debentures have been adjusted for the exchange ratio pursuant to the Merger.\nDuring the fourth quarter of fiscal 1992, Costco completed an offering of $300,000 5 3\/4% convertible subordinated debentures due 2002, which are convertible at any time prior to maturity, unless previously redeemed, into shares of PriceCostco common stock at a conversion price of $41.25 per share, subject to adjustment in certain events. Interest on the debentures is payable semiannually on November 15 and May 15. Commencing on June 1, 1995, these debentures are redeemable at the option of the Company, in whole or in part, at certain redemption prices.\nIn fiscal 1991, Price issued $287,500 6 3\/4% convertible subordinated debentures, which are convertible into shares of PriceCostco common stock at any time on or before March 1, 2001, unless\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 4 -- DEBT (CONTINUED) previously redeemed, at a conversion price of $22.54 per share, subject to adjustment in certain events. The 6 3\/4% debentures are unsecured and interest is payable semiannually on March 1 and September 1. The debentures are redeemable at the option of the Company after March 1, 1994 at certain redemption prices. On November 4, 1993 notice was given to the 6 3\/4% convertible debenture holders that their option to redeem the debentures, for cash equal to the principal amount plus accrued interest, in the event of a change of control of Price was effective as a result of the Merger and that holders had until December 6, 1993 to exercise such options. Approximately $2,421 of debentures were purchased at their face value subsequent to November 21, 1993.\nPriceCostco also has outstanding 5 1\/2% convertible subordinated debentures are convertible into shares of PriceCostco common stock at a conversion price of $23.77 per share, subject to adjustment in certain events. The 5 1\/2% debentures provide for payments to an annual sinking fund in the amount of 5% of the original principal amount ($10,000), commencing February 28, 1998, calculated to retire 70% of the principal amount prior to maturity. During fiscal 1990, the Company repurchased $20,597 of the debentures for a total cost of $17,507, resulting in a gain of approximately $2,900 and will apply this purchase to the initial sinking fund payments. The debentures are unsecured and interest is payable semiannually on February 28 and August 31.\nDue to the Exchange Offer, the possibility exists for a downward adjustment in the conversion price of each of the debentures. Such adjustment could occur in the event that (i) less than 21.6 million shares of PriceCostco common stock are validly tendered in the Exchange Offer and the Company distributes the remaining Price Enterprises shares pro rata to all PriceCostco stockholders or (ii) at least 21.6 million shares of PriceCostco common stock, but less than 27 million shares, are validly tendered, and the Company elects to make a pro rata distribution of the remaining shares to all PriceCostco stockholders.\nAt August 28, 1994, the fair values of the 5 3\/4%, 6 3\/4% and 5 1\/2% convertible subordinated debentures, based on current market quotes, were approximately $255,000, $278,000 and $154,000 respectively. Early retirement of these debentures would result in the Company paying a call premium.\nMaturities of long-term debt during the next five fiscal years and thereafter are as follows:\nNOTE 5 -- LEASES The Company leases land and\/or warehouse buildings at 47 warehouses open at August 28, 1994 and certain other office and distribution facilities under operating leases with remaining terms ranging from 2 to 30 years. These leases generally contain one or more of the following options which the Company can exercise at the end of the initial lease term: (a) renewal of the lease for a defined number of years at the then fair market rental rate; (b) purchase of the property at the then fair market value; (c) right of first refusal in the event of a third party purchase offer. Certain leases provide for periodic rental increases based on the price indices and some of the leases provide for rents based on the greater of minimum guaranteed amounts or sales volume. Contingent rents have not\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 5 -- LEASES (CONTINUED) been material. Additionally, the Company leases certain equipment and fixtures under short-term operating leases which permit the Company to either renew for a series of one-year terms or to purchase the equipment at the then fair market value.\nAggregate rental expense for fiscal 1994, 1993 and 1992 was $44,900, $38,700 and $33,680, respectively. Future minimum payments (including annual rents on the four Warehouse Properties discussed in Note 3) during the next five fiscal years and thereafter under noncancelable leases with terms in excess of one year, at August 28, 1994, were as follows:\nNOTE 6 -- STOCK OPTIONS AND WARRANTS Prior to the Merger, Price and Costco adopted various incentive and non-qualified stock option plans which allowed certain key employees and directors to purchase or be granted common stock of Price and Costco (collectively the Old Stock Option Plans). Options were granted for a maximum term of ten years, and were exercisable as they vest. Options granted under these plans generally vest ratably over five to nine years. Subsequent to the Merger, new grants of options are not being made under the Old Stock Option Plans.\nStock option transactions relating to the Old Stock Option Plans are summarized below:\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 6 -- STOCK OPTIONS AND WARRANTS (CONTINUED) The PriceCostco 1993 Combined Stock Grant and Stock Option Plan (the New Stock Option Plan) provides for the issuance of up to 10 million shares of the Company's common stock pursuant to the exercise of stock options or up to 1,666,666 through stock grants. Stock option and grant transactions relating to the New Stock Option Plan are summarized below:\nIn 1986 and 1987, Price granted warrants to purchase a total of 1,065,000 shares of common stock at $17.37 per share to a joint venture partner. The warrants granted in 1987 vested over a five year period from the date of issuance and are exercisable up to eight years and one month from the grant date. A total of 532,500 warrants have been exercised.\nNOTE 7 -- RETIREMENT PLANS The Company has a defined contribution retirement plan for all United States employees of Price except California union employees on whose behalf contributions are made to the Western Conference of Teamsters Pension Trust Fund. Contributions to such retirement plan totaled $11,018, $10,665 and $9,375 for fiscal 1994, 1993 and 1992, respectively. Contributions to the Teamsters Pension Trust Fund were $11,293, $11,588 and $11,196 for fiscal 1994, 1993 and 1992, respectively. During fiscal 1992, a 401(k) Plan was established for all Price employees eligible for the retirement plan. The Company matches 50% of eligible employee contributions up to a maximum Company contribution per employee per year. Contributions to the 401(k) Plan were $971, $752 and $650 in fiscal 1994, 1993 and 1992, respectively. The Company has a defined contribution plan for Canadian Price employees and contributes a percentage of each employee's salary. Contributions were $1,884, $1,640 and $1,331 in fiscal 1994, 1993 and 1992, respectively.\nThe Company has a 401(k) retirement plan for the benefit of all Costco employees. After one year of service, an employee is eligible to participate in this plan. Employee contributions are matched 10% by the Company until the employee has completed five years of service, at which time the matching contribution increases to 25%. Contributions were $2,677, $1,964 and $1,515 in fiscal 1994, 1993 and 1992, respectively.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 8 -- INCOME TAXES The provisions for income taxes from continuing operations for fiscal 1994, 1993 and 1992 are as follows:\nA reconciliation between the statutory tax rate and the effective rate from continuing operations for fiscal 1994, 1993 and 1992 is as follows:\nThe components of the deferred tax assets and liabilities related to continuing operations are as follows:\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 8 -- INCOME TAXES (CONTINUED) The net deferred tax liabilities at August 28, 1994 and August 29, 1993 include current deferred income tax assets of $54,717 and $34,901, respectively, and non-current deferred income tax liabilities of $65,679 and $51,540, respectively.\nNOTE 9 -- COMMITMENTS AND CONTINGENCIES\nLEGAL PROCEEDINGS\nOn April 6, 1992, Price was served with a complaint in an action entitled FECHT ET AL. V. THE PRICE COMPANY ET AL., Case No. 92-497, United States District Court, Southern District of California (the Court). Subsequently on April 22, 1992, Price was served with a first amended complaint in the action. The case was dismissed without prejudice by the Court on September 21, 1992, on the grounds the plaintiffs had failed to state a sufficient claim against defendants. Subsequently, plaintiffs filed a Second Amended Complaint which, in the opinion of Price's counsel, alleged substantially the same facts as the prior complaint. The case was dismissed with prejudice by the Court on March 9, 1993, on grounds the plaintiffs had failed to state a sufficient claim against defendants. Plaintiffs have filed a Notice of Appeal in the Ninth Circuit Court of Appeals, which was argued on October 4, 1994. The Company is currently awaiting a Ninth Circuit Court of Appeals decision. If the Ninth Circuit Court of Appeals renders a decision that is adverse to the Company, the Company intends to vigorously defend the suit. The Company does not believe that the ultimate outcome of such litigation will have a material adverse effect on the Company's financial position or results of operations.\nThe Company is involved from time to time in claims, proceedings and litigation arising from its business and property ownership. The Company does not believe that any such claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Company's financial position or results of operations.\nNOTE 10 -- RELATED PARTY TRANSACTIONS Joseph Kornwasser, a director of PriceCostco until July 28, 1994, is a general partner and has a two-thirds ownership interest in Kornwasser and Friedman Shopping Center Properties (K & F). K & F was a partner with Price in two partnerships. As of August 28, 1994, Price's total capital contributions to the partnerships were $83,000. Aggregate cumulative distributions from these partnerships were $14,300 at August 28, 1994. Price had also entered into a Development Agreement with K & F for the development of four additional properties. As of August 28, 1994, Price's total capital expenditures for these properties were $58,000. Aggregate cumulative distributions from these properties were $4,500 at August 28, 1994. Both partnership agreements and the Development Agreement provided for a preferred return to Price on a varying scale from 9% to 10% on its invested capital after which operating cash flows or profits are distributed 75% to Price and 25% to K & F. On August 12, 1993, Mr. Kornwasser became Chief Executive Officer and director of the REIT. On that date, the REIT also obtained the right to acquire certain of the partnership interests of K & F described above. On August 28, 1994, the Company purchased both K & F's interests in the two partnerships and its rights under the Development Agreement for a total of $2.5 million.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNOTE 11 -- GEOGRAPHIC INFORMATION The following table indicates the relative amounts of total revenue, operating income and identifiable assets for the Company during fiscal 1994, 1993 and 1992:\nNOTE 12 -- QUARTERLY FINANCIAL DATA (UNAUDITED) The tables on the next two pages reflect the unaudited quarterly results of operations for fiscal 1994 and 1993.\nAll information has been restated for discontinued real estate operations and various reclassifications have been made to conform Price and Costco's classification of merchandise costs and selling, general and administrative expenses. Shares used in the earnings per share calculation fluctuate by quarter depending primarily upon whether convertible subordinated debentures are dilutive during the respective period.\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nPRICE\/COSTCO, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Price\/Costco, Inc.:\nWe have audited, in accordance with generally accepted auditing standards, the financial statements included in Price\/Costco, Inc.'s annual report to stockholders included in this Form 10-K, and have issued our report thereon dated November 14, 1994. As noted in our report to the accompanying financial statements, The Price Company and subsidiaries (Price) have been audited by other auditors whose report thereon has been forwarded to us and our opinion expressed herein, insofar as it relates to the amounts included in the accompanying schedules related to Price for fiscal 1993 and 1992, is based solely on the report of the other auditors. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules of Price\/Costco, Inc. listed in Part IV, Item 14 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\nSeattle, Washington November 14, 1994\nSCHEDULE I\nPRICE\/COSTCO, INC. MARKETABLE SECURITIES--OTHER INVESTMENTS FOR THE PERIODS ENDED AUGUST 28, 1994, AUGUST 29, 1993 AND AUGUST 30, 1992 (DOLLARS IN THOUSANDS)\nSCHEDULE II\nPRICE\/COSTCO, INC.\nAMOUNTS RECEIVABLE FROM RELATED PARTIES FOR THE 52-WEEK PERIODS ENDED AUGUST 28, 1994, AUGUST 29, 1993 AND AUGUST 30, (DOLLARS IN THOUSANDS)\nSCHEDULE V\nPRICE\/COSTCO, INC.\nPROPERTY, PLANT AND EQUIPMENT FOR THE 52-WEEK PERIODS ENDED AUGUST 28, 1994, AUGUST 29, 1993 AND AUGUST 30, (DOLLARS IN THOUSANDS)\nSCHEDULE VI PRICE\/COSTCO, INC. ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE 52-WEEK PERIODS ENDED AUGUST 28, 1994, AUGUST 29, 1993 AND AUGUST 30, (DOLLARS IN THOUSANDS)\nSCHEDULE IX PRICE\/COSTCO, INC. SHORT-TERM BORROWINGS FOR THE 52-WEEK PERIODS ENDED AUGUST 28, 1994, AUGUST 29, 1993 AND AUGUST 30, (DOLLARS IN THOUSANDS)\nEXHIBIT INDEX","section_15":""}
{"filename":"225615_1994.txt","cik":"225615","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. LEGAL PROCEEDINGS\nDue to the nature of its business, the Delaware Company 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 the Delaware Company.\nFor a discussion of the Delaware Company's potential liability for non-employee products liability asbestos claims, see Item 1F and Note 1 to the consolidated financial statements.\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.\nPART I I\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nAs a result of the plan of reorganization announced by the Delaware Company on October 28, 1982 and completed on March 15, 1983, all of the Delaware Company's outstanding Common Stock is owned by International and, consequently, there is no market for the Delaware Company's Common Stock. For restrictions on the Delaware Company's present or future ability to pay dividends, see Note 6 to notes to the consolidated financial statements.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nIn fiscal year 1994, Net Income (Loss) includes a cumulative effect of 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 $240,042,000 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 Delta Catalytic Corporation and Note 14 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 the Delaware Company'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).\nAll of the Common Stock of the Delaware Company is owned by International and, therefore, no per share data is shown above.\nItem 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 $92,978,000 to $1,613,954,000. 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 $11,018,000 to $57,527,000. The decrease was primarily due to lower volume and margins from 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 16 to the consolidated financial statements).\nPower Generation Systems and Equipment's equity in income of investees increased $2,457,000 to $8,635,000 due primarily to improved results in three domestic joint ventures which own and operate a cogeneration plant and two small power plants.\nBacklog for this segment at March 31, 1994 was $2,398,285,000 compared to $2,614,709,000 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 yet 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 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 utilities have already purchased equipment to comply with Phase I of the Clean Air Act,\nand 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 increased $183,073,000 to $632,242,000 primarily due to the acquisition of DCC. This increase was partially offset by lower volume in fabrication and engineering operations, and procured materials.\nMarine Construction Services' segment operating income increased $5,029,000 to $8,445,000, primarily due to the acquisition of DCC, improved margins on fabrication operations, and the accelerated depreciation and write-off of certain fabrication facilities and marine construction equipment in the prior year. These increases were partially offset by lower volume in fabrication and engineering operations.\nBacklog for this segment at March 31, 1994 was $430,338,000 (including $233,299,000 from DCC). Excluding DCC, this was down from backlog of $305,390,000 at March 31, 1993. This segment's markets are expected to be at a low level in the U.S. during 1995. The overcapacity of marine equipment will continue to result in a competitive environment and put pressure on profit margins.\nInterest expense decreased $21,275,000 to $53,870,000, 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.\nOther-net expense increased $6,829,000 to $9,066,000. The increase was primarily due to the inclusion of DCC's minority interest expense in the current period and gains on the sale of interests in two commercial nuclear joint ventures (See Note 3 to the consolidated financial statements), all in the prior period.\nProvision for (benefit from) income taxes increased $6,473,000 to a provision of $915,000 from a benefit of $5,558,000 while loss before the provision for (benefit from) income taxes, extraordinary items and cumulative effect of accounting changes decreased $7,236,000 to $25,401,000. The increase in the provision for income taxes is due primarily to the increase in income from foreign operations.\nNet loss decreased $146,759,000 to $127,066,000 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 $240,042,000 in the prior year, in addition to the other items described above.\nFISCAL YEAR 1993 VS FISCAL YEAR 1992\nPower Generation Systems and Equipment's revenues decreased $70,489,000 to $1,520,976,000. 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 joint ventures 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 $35,740,000 to $68,545,000. 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, 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 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 $274,243,000 to $449,169,000 due to lower volume in fabrication and offshore operations. Segment operating income decreased $1,655,000 to $3,416,000 primarily due to the lower volume in fabrication and offshore operations and lower margins on fabrication operations. These were partially offset by improved margins on offshore operations and reduced general and administrative expenses. There were also higher equipment writedowns and a contract loss provision in 1992.\nEquity in income of investees decreased $4,598,000 to $6,655,000. This decrease principally resulted from equity income of $5,179,000 from the commercial nuclear services joint venture in 1992.\nInterest expense increased $1,389,000 to $75,145,000. This increase resulted from changes in debt obligations and interest rates prevailing thereon, which was partially offset by a reduction in the provision for interest on proposed income tax deficiencies and lower interest expense resulting from interest rate swap agreements.\nOther-net decreased $48,256,000 to expense of $2,237,000 from income of $46,019,000. The 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.) In addition, income from management fees and services applicable to the two commercial nuclear joint ventures of $8,446,000 was recorded in 1992.\nProvision for (benefit from) income taxes decreased $34,253,000 to a benefit of $5,558,000 from a provision of $28,695,000, while income (loss) from continuing operations before provision for (benefit from) income taxes, extraordinary items and cumulative effect of\naccounting changes decreased $91,189,000 to a loss of $32,637,000 from income of $58,552,000. The decrease in the provision for income taxes is due primarily to a decrease in income from continuing operations.\nNet Income (Loss) decreased $300,314,000 to a loss of $273,825,000 from income of $26,489,000, reflecting the cumulative effect of the adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" of $240,042,000, in addition to other items described above.\nEffect of Inflation and Changing Prices\nThe Delaware Company'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.\nThe management of the Delaware Company 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, the Delaware Company's cash and cash equivalents decreased $24,185,000 to $47,364,000 and total debt decreased $79,815,000 to $606,060,000. During the same period, the Delaware Company provided cash of $21,020,000 from operating activities and used cash of $28,249,000 for the acquisition of Delta Catalytic Corporation (\"DCC\"), $207,646,000 for repayment of long-term debt, and $15,719,000 for cash dividends on the Delaware Company's preferred stocks. The Delaware Company provided cash of $92,841,000 from the issuance of long-term debt and received cash of $100,000,000 as a capital contribution from International. Also, during the third quarter of fiscal year 1994, the Delaware Company received a capital contribution from International of $132,283,000 comprised of long-term investments of $129,930,000 (market value $130,214,000), primarily corporate bonds, and the accrued interest thereon of $2,353,000. Lower net contracts in progress and advance billings reflect the timing of billings on certain foreign Power Generation Systems and Equipment segment contracts.\nPursuant to an agreement with the majority of its principal insurers, the Delaware Company 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 this process, reimbursement is usually delayed for three months or more. The Delaware Company 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 consolidated financial statements). Settlement of the estimated liability of $135,053,000 at March 31, 1994 for\nfuture costs relating to insolvent insurers and policy year 1979 is expected to occur over the next 30 years. The Delaware Company'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 upon the Delaware Company's liquidity, and management believes, based on information currently available, that they will not have a material adverse effect on liquidity in the future.\nThe Delaware Company's expenditures for property, plant and equipment increased $4,983,000 to $62,650,000 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 a new combustion and emission test facility at its Alliance, Ohio research center. The Delaware Company has committed to make capital expenditures of approximately $52,964,000 during fiscal year 1995. In addition to maintaining the Delaware Company's existing facilities, these expenditures include $38,560,000 for a new concept steam generator 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 8 to the consolidated financial statements).\nAt March 31, 1994 and 1993, the Delaware Company had available to it various uncommitted short-term lines of credit from banks totalling $204,699,000 and $114,136,000, respectively. Borrowings outstanding against these facilities at March 31, 1994 were $15,519,000. There were no borrowings against these facilities at March 31, 1993. The Babcock & Wilcox Company has 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, and 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 or 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.\nThe Delaware Company is restricted, as a result of covenants in certain agreements, in its\nability 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. At March 31, 1994, the most restrictive of these covenants with respect to the payment of dividends by the Delaware Company would prohibit the payment of dividends other than current dividends on existing preferred stock.\nEffective February 1, 1989, the Delaware Company and a subsidiary of International, McDermott International Investments Co., Inc. (\"MIICO\"), entered into a reverse repurchase agreement whereby either party acting as a \"buyer\" would purchase for cash certain U. S. Government obligations owned by the other party acting as a \"seller\", and, at the date of purchase, the \"seller\" would agree to repurchase the same securities at a set price (including accrued interest) at a future specified date. At March 31, 1994, MIICO had repurchased all government obligations purchased by the Delaware Company under this agreement.\nThe Delaware Company and MIICO are parties to an agreement pursuant to which the Delaware Company may borrow up to $150,000,000 from MIICO at interest rates computed at the applicable federal rate determined by the IRS. There were no borrowings against this agreement at March 31, 1994 or 1993.\nWorking capital increased to $146,797,000 at March 31, 1994 from $41,215,000 at March 31, 1993. During 1995, the Delaware Company 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 the Delaware Company's liquidity nor capital resources.\nThe 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 the same in 1994 and 1993.\nThe Delaware Company 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.\nThe Delaware Company has provided a valuation allowance ($10,239,000 at March 31, 1994) primarily for certain state and local deferred tax assets which cannot be realized through carrybacks and future reversals of existing taxable temporary differences. Management believes that remaining deferred tax assets ($351,666,000 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\nThe Delaware Company adopted SFAS No. 106 effective April 1, 1992 for all domestic plans. The Delaware Company 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 the Delaware Company. The new standard does not have any impact on the cash requirements of any domestic or foreign postretirement health and welfare plan.\nIn 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 the Delaware Company.\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, the Delaware Company will report its investments at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholder's equity. The initial impact of the new standard will not have a material effect on the consolidated financial statements of the Delaware Company.\nItem 8.","section_7A":"","section_8":"Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders McDermott Incorporated\nWe have audited the accompanying consolidated balance sheet of McDermott Incorporated as of March 31, 1994 and 1993, and the related consolidated statements of income (loss) and retained earnings 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 Incorporated 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\nMCDERMOTT INCORPORATED CONSOLIDATED BALANCE SHEET MARCH 31, 1994 AND 1993\nSee accompanying notes to consolidated financial statements.\nMcDERMOTT INCORPORATED CONSOLIDATED STATEMENT OF INCOME (LOSS) AND RETAINED EARNINGS (DEFICIT) FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1994\nSee accompanying notes to consolidated financial statements. Significant related party transactions are disclosed in Note 5.\nMcDERMOTT INCORPORATED CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1994 INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\nContinued\nINCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\nSee accompanying notes to consolidated financial statements.\nMCDERMOTT INCORPORATED 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 include the accounts of McDermott Incorporated and all subsidiaries. Investments in joint venture and other entities in which McDermott Incorporated 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 consolidated financial statements are presented on the basis of continuing operations, unless otherwise stated.\nUnless the context otherwise requires, hereinafter, the \"Delaware Company\" will be used to mean McDermott Incorporated and its consolidated subsidiaries (including Babcock & Wilcox Investment Company and its principal subsidiary, The Babcock & Wilcox Company), and \"International\" will be used to mean McDermott International, Inc., a Panamanian corporation. International is the parent company of the Delaware Company.\nChanges in Accounting Policies\nProducts Liabilities - 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 the Delaware Company'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, the Delaware Company 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. The Delaware Company 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 the Delaware Company'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. The Delaware Company'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 liabilities and costs allocable to insolvent insurers and the policy year 1979 was $135,053,000. Inherent in the estimate of such future costs are expected trends in claim\nseverity 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) in fiscal year 1994. The adoption of this provision of EITF Issue No. 93-5 resulted in a decrease in Loss before Cumulative Effect of Accounting Change of $19,947,000 in fiscal year 1994, as costs that would have been recognized under the Delaware Company'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, the Delaware Company 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 cost of providing health and welfare benefits and expanded postretirement health and welfare plan disclosures. In accordance with the Statement, the Delaware Company elected immediate recognition of its transition obligation and recorded $240,042,000 (net of income tax benefit of $136,228,000) 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 $4,460,000. 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 $24,696,000 in fiscal year 1992.\nIncome Taxes - Effective April 1, 1992, the Delaware Company 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 the Delaware Company 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. Other than the cumulative effect, the accounting change had no material effect on fiscal year 1993.\nForeign 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:\nForeign currency transaction adjustments are reported in income. Included in Other Income (Expense) are transaction gains (losses) of $1,695,000, ($47,000), and ($411,000) for fiscal years 1994, 1993 and 1992, respectively.\nContracts 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 $51,337,000 and $41,658,000 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.\nThe Delaware Company is usually entitled to financial settlements relative to the individual circumstances of deferrals or cancellations of Power Generation Systems and Equipment contracts. The Delaware Company does not recognize such settlements or claims for additional compensation until final settlement is reached.\nIncluded in accounts receivable - trade are amounts representing retainages on contracts as follows:\nOf its long-term retainages at March 31, 1994, the Delaware Company anticipates collection as follows: $18,704,000 in fiscal year 1996, $17,452,000 in fiscal year 1997, and $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 22% 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 as follows:\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.\nEnvironmental Clean-up Costs\nThe Delaware Company 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 $19,583,000, $18,914,000 and $20,900,000 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 the Delaware Company.\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.\nCapitalization of Interest Cost\nIn fiscal years 1994, 1993 and 1992, total interest cost incurred was $55,187,000, $76,808,000 and $76,286,000, respectively, of which $1,317,000, $1,663,000 and $2,530,000, respectively, was capitalized.\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 held as long term investments (primarily corporate bonds) are carried at amortized cost. At March 31, 1994, the market and face values of the investments (including $989,000 of short-term investments carried at amortized cost) were $129,630,000 and $131,110,000, 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\nThe Delaware Company 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, the Delaware Company has forward exchange contracts to purchase $300,302,000 in foreign currencies (primarily Canadian Dollars), and to sell $233,425,000 in foreign currencies (primarily Canadian dollars and Japanese Yen), at varying maturities from fiscal year 1995 through 1998.\nNOTE 2 - ACQUISITION OF DELTA CATALYTIC CORPORATION\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 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 the Delaware Company. Results of DCC's operations from the date of acquisition to March 31, 1994 are included in the Delaware Company'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. The following pro forma income statement information for the Delaware Company is presented as though the acquisition of 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 acquisition of DCC been consummated as of the above dates, nor are they necessarily indicative of future operating results.\nThe acquisition was accounted for under the purchase method and the excess of cost over fair value of net assets of the purchased business is being amortized over a period of 10 years. The\npurchase price has been allocated to the underlying assets and liabilities based on fair values at the date of acquisition. A summary of the purchase price allocation is as follows:\nNOTE 3 - INVESTMENTS IN JOINT VENTURES AND OTHER ENTITIES\nDuring December 1991, the Delaware Company 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. The Delaware Company retained a 25% interest in BWFC and BWNSC. Both joint ventures were accounted for on a cost basis after the sale as the Delaware Company no longer exercised significant influence over these joint ventures. Prior to the sale BWFC was part of the Delaware Company'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, the Delaware Company 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, the Delaware Company sold its remaining interests in BWFC and BWNSC to the same parties for $10,150,000 and $32,440,000, respectively, and the loans of $33,820,000 were repaid.\nIncluded in the Consolidated Statement of Income (Loss) and Retained Earnings (Deficit) were 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.\nThe Delaware Company's investments in entities which are accounted for on the equity method were $27,695,000 and $21,703,000 at March 31, 1994 and 1993, respectively. Transactions with entities for which investments are accounted for on the equity method included sales to ($5,443,000, $5,909,000 and $8,368,000 in fiscal years 1994, 1993 and 1992, respectively) and purchases from ($3,510,000, $330,000 and $11,452,000 in fiscal years 1994, 1993 and 1992, respectively) these entities.\nSummarized combined balance sheet and income statement information based on the most recent financial information for the Delaware Company's equity investments in joint ventures and other entities are presented below:\nNOTE 4 - INCOME TAXES\nDeferred 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:\nIncome (loss) from continuing operations before provision for (benefit from) income taxes, extraordinary items and cumulative effect of accounting changes was as follows:\nThe provision for (benefit from) income taxes consists of:\nThe effective income tax rate on continuing operations is reconciled to the statutory federal income tax rate as follows:\nUndistributed earnings of consolidated foreign subsidiaries amounted to approximately $40,700,000 at March 31, 1994. These earnings are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state and local income taxes has been provided. Upon distribution of those earnings, the Delaware Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the foreign jurisdictions. The unrecognized deferred income tax liability is estimated to be approximately $15,800,000. Withholding taxes of $3,700,000 would be payable upon remittance of all previously unremitted earnings at March 31, 1994.\nDuring 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 amount 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.\nNOTE 5 - RELATED PARTY TRANSACTIONS\nThe Delaware Company has material transactions with International and its other subsidiaries occurring in the normal course of operations. Transactions which are included in the Delaware Company's revenues include the sales of engineering and design services and fabrication services ($7,415,000, $45,832,000, and $106,492,000 in fiscal years 1994, 1993 and 1992 respectively) and the leasing of equipment ($16,107,000, $25,195,000 and $23,343,000, in fiscal years 1994, 1993 and 1992, respectively). Other transactions include the allocation of general and administrative and other costs to International ($8,491,000, $8,304,000 and $6,458,000 in fiscal years 1994, 1993 and 1992, respectively), placing certain insurance coverage (at prices determined on an annual basis of $24,582,000, $18,096,000, and $47,478,000 in fiscal years 1994, 1993 and 1992, respectively, including discontinued operations) through commercial insurance carriers which in turn substantially reinsure such exposure to a wholly-owned subsidiary of International, and the management of certain of the investments of the Delaware Company and its pension plans by a wholly-owned subsidiary of International for which the Delaware Company paid fees of $2,528,000, $2,451,000 and $2,220,000 in fiscal years 1994, 1993 and 1992, respectively.\nEffective February 1, 1989, the Delaware Company and a subsidiary of International, McDermott International Investments Co., Inc., (\"MIICO\"), entered into a reverse repurchase agreement whereby either party acting as a \"buyer\" would purchase for cash certain U. S. Government obligations owned by the other party acting as a \"seller\", and, at the date of purchase, the \"seller\" would agree to repurchase the same securities at a set price (including accrued interest) at a future specified date. At March 31, 1993, the Delaware Company held securities which it had purchased with aggregate principal amounts of $78,860,000 under this agreement. At March 31, 1994, MIICO had repurchased all government obligations purchased by the Delaware Company under the agreement. Included in Interest income is interest resulting from these reverse repurchase agreements of $560,000, $3,545,000 and $1,161,000 for fiscal years 1994, 1993 and 1992, respectively.\nThe Delaware Company and MIICO are parties to an agreement pursuant to which the Delaware Company may borrow up to $150,000,000. There were no borrowings against this agreement at March 31, 1994 or 1993.\nAt March 31, 1994, property, plant and equipment and accumulated depreciation included $376,266,000 ($397,002,000 at March 31, 1993) and $270,813,000 ($275,923,000 at March 31, 1993), respectively, of marine equipment which is leased by the Delaware Company to International.\nUnder a reorganization during the fiscal year ended March 31, 1983, International became the parent of the McDermott group of companies, which includes the Delaware Company which prior to the reorganization was the parent company. The Delaware Company's investment in International represents its right to the undistributed earnings of International existing at the time of the reorganization less subsequent distributions by International to the Delaware Company. In order to preserve the Delaware Company's right to the undistributed earnings and provide for the distribution of such earnings to the Delaware Company should either the Delaware Company or International elect not to keep these earnings invested with International, the Delaware Company retained its ownership of 100,000 shares of International Common Stock, received 100,000 shares of International Series A Participating Preferred Stock and 100,000 shares of International Series B Non-Voting Preferred Stock, and entered into a stock purchase and sale agreement with International (the \"Intercompany Agreement\"). Both Series A and Series B Preferred Stocks have certain rights in the event of liquidation of International. Series B Preferred Stock is currently callable by International at $275 per share and 10,000 shares are to be redeemed by International each year at $250. Such redemption began in November 1992. The Series A and Series B Preferred Stocks are entitled to annual per share dividends of $10 (but no more than ten times the amount of per share dividends paid by International on its Common Stock) and $20, respectively, and such dividends are cumulative to the extent not paid. Shares of Series A Preferred Stock are also entitled to additional dividends whenever dividends in excess of $3 per International Common Share are declared in any fiscal year. Dividends and proceeds from redemption of Series B Preferred Stock received from International have been accounted for as a reduction of the Delaware Company's investment in International.\nPursuant to 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 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. If a unit is sold to International upon the Delaware Company's exercise of its right to sell under the Intercompany Agreement, the purchase price of such unit will be 90% of the then current value of the unit (the \"current unit value\"). If a unit is sold to International pursuant to an exercise by International of its right to purchase under the Intercompany Agreement, the purchase price of such unit will be 110% of the current unit value. 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. Both parties intend to preserve the Delaware Company's right to the undistributed earnings by not exercising any rights under the Intercompany Agreement that would result in a loss to the Delaware Company. The net proceeds to the Delaware Company from the exercise of any rights under the Intercompany Agreement\nwould 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.\nThe Delaware Company maintains the Thrift Plan for Employees of McDermott Incorporated and Participating Subsidiary and Affiliated Companies (the \"Thrift Plan\"), which is a defined contribution plan that includes a cash or deferred arrangement. Monthly employer contributions are equal to 50% of the first 6% of compensation (as defined in the plan) contributed by participants, and may be made, at the discretion of the Delaware Company, in cash or in common stock of International. When monthly employer contributions are made in stock, the Delaware Company pays cash to International and shares of common stock are issued to the Thrift Plan from the authorized but unissued share capital of International. The number of such shares is determined based on the closing price on the last business day of the month as reported on the New York Stock Exchange Composite Tape with fractional shares paid in cash. During fiscal years 1994, 1993 and 1992, respectively, 300,391, 347,054 and 115,787 shares were purchased by the Delaware Company for $7,984,000, $7,989,000 and $2,347,000.\nCertain officers and employees of the Delaware Company participate in certain benefit plans which involve the issuance of International Common Stock.\nNOTE 6 - LONG-TERM DEBT AND NOTES PAYABLE\nAs 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, the Delaware Company provided for the loss associated with the redemption and subsequent extinguishment of its 12.25% Senior Subordinated Notes due 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, the Delaware Company has 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 agreements. 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 in interest expense of $4,435,000 and $6,961,000 in fiscal years 1994 and 1993, respectively.\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. At March 31, 1994, the most restrictive of these covenants with respect to the payment of dividends by the Delaware Company would prohibit the payment of dividends other than the current dividends on existing preferred stock.\nMaturities of long-term debt during the five fiscal years subsequent to March 31, 1994 are as follows: 1995 - $6,009,000; 1996 - $155,426,000; 1997 - $5,173,000; 1998 - $46,418,000; 1999 - $27,165,000.\nAt March 31, 1994 and 1993, the Delaware Company had available to it various uncommitted short-term lines of credit from banks totalling $204,699,000 and $114,136,000, respectively. Borrowings outstanding against these facilities at March 31, 1994 were $15,519,000. There were no borrowings against these facilities at March 31, 1993. 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, and it is a condition to borrowing under the revolving credit facility\nthat the borrower's consolidated net tangible assets exceed a certain level. There were no borrowings against this facility at March 31, 1994 or 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.\nNOTE 7 - PENSION PLANS AND POSTRETIREMENT BENEFITS\nPension Plans - The Delaware Company 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. The Delaware Company'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\nNet periodic pension 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 included 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 reameasurement of net periodic pension cost increased pre-tax income from continuing operations by $2,074,000.\nThe following table sets forth the plans' funded status and amounts recognized in the Delaware Company's consolidated financial statements:\nThe assumptions used in determining the funded status of the U.S. plans were:\nThe 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 $101,681,000 due to the change in discount rate and a decrease of $15,076,000 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,\" the Delaware Company recorded, during fiscal years 1994 and 1993, an additional minimum liability for certain of its plans of $7,669,000 and $10,810,000 respectively. These liabilities resulted in recognition of intangible assets of $7,022,000 and $10,803,000 and reductions in stockholder's equity of $620,000 and $5,000, respectively, in fiscal years 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 cost for fiscal years 1994, 1993, and 1992 included the following components:\nThe following table sets forth the plans' funded status (assets exceed accumulated benefits) and amounts recognized in the Delaware Company'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 $12,727,000 due to the change in discount rate and a decrease of $4,307,000 due to the change in the rate of increase in future compensation levels.\nMultiemployer Plans - One of the Delaware Company'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 - The Delaware Company 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 retirees 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. The Delaware Company 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. The Delaware Company 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 $400,698,000 and $354,743,000 for the Delaware Company's health care plans and $41,337,000 and $33,791,000 for the Delaware Company'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.\nNet 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 $26,370,000 and the aggregate of the service cost and interest cost components of net periodic postretirement benefit costs for fiscal years 1994 by $2,335,000.\nEmployees of the Delaware Company who are not U. S. citizens and located in certain foreign countries are covered by various foreign postretirement benefit arrangements. The Delaware Company 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 the Delaware Company.\nPostemployment Benefits - See Management's Discussion and Analysis of Financial Condition and Results of Operations regarding future adoption of SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\"\nNOTE 8 - 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 9 - 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, respectively, of Series B Preferred Stock 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. 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\nof Series A Preferred Stock have been converted to date and the Delaware Company owned 1,575,505 shares of Series A Preferred Stock.\nNOTE 10 - CAPITAL STOCK\nChanges in Common Stock during the three years ended March 31, 1994 are summarized as follows:\nCommon shares outstanding at March 31, 1994 consisted of 3,000 voting shares entitled to 12,000 votes per share and 600 non-voting shares.\nNOTE 11 - CONTINGENCIES AND COMMITMENTS\nLitigation - The Delaware Company 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 the Delaware Company.\nProducts Liabilities - See Note 1 regarding products liabilities.\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 - $17,688,000; 1996 - $13,804,000; 1997 - $12,842,000; 1998 - $12,049,000; 1999 - $11,758,000; and thereafter - $34,590,000. Future minimum lease payments and leased property under capital leases are not material. Total rental expense for fiscal years 1994, 1993 and 1992 was $64,515,000, $62,959,000 and $66,314,000, respectively. These expense figures include contingent rentals and are net of sublease income, both of which are not material.\nOther - The Delaware Company 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.\nThe Delaware Company maintains liability and property insurance that it considers normal in the industry. However, certain risks are either not insurable or insurance is available at rates which the Delaware Company considers uneconomical.\nThe Delaware Company has been identified as a potentially responsible party at various cleanup sites under the Comprehensive Environmental Response, Compensation and Liability Act, as amended. Whereas, the Delaware Company has not been determined to be a major contributor of wastes to these sites, each potentially responsible party or contributor of may face assertions of joint and several liability. Based on its relative contribution of wastes to the various sites, of which a determination has not yet been made, the Delaware Company'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 the Delaware Company'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 position of the Delaware Company.\nCommitments for capital expenditures amounted to approximately $53,121,000 (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 $52,964,000 relates to fiscal year 1995.\nThe Delaware Company is contingently liable under standby letters of credit totaling $197,413,000 at March 31, 1994, issued in the normal course of business.\nNOTE 12 - FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK\nThe Delaware Company's Power Generation Systems and Equipment customers are principally the electric utility 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. The principal customers of the Marine Construction Services segment are the large oil and gas companies and the U. S. and other governments. These concentrations of customers may impact the Delaware Company'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, the Delaware Company'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.\nThe Delaware Company 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 $6,427 000 and $3,713,000, respectively.\nNOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used by the Delaware Company 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.\nInvestments under reverse repurchase agreement: The fair value of investments in government obligations under reverse repurchase agreement with an affiliate was estimated based on quoted market prices (including accrued interest) of the securities underlying the agreement.\nInvestment securities: The fair value 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 the Delaware Company's debt instruments are based on quoted market prices or, where quoted prices are not available, 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 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, the Delaware Company had forward exchange contracts outstanding to purchase and sell foreign currencies with a net notional value of $66,877,000 and $253,996,000 and a fair value of $55,202,000 and $250,549,000, respectively.\nThe estimated fair values of the Delaware Company's financial instruments at March 31, 1994 and 1993 follow:\nNOTE 14 - DISCONTINUED OPERATIONS\nWelded Tubular Line of Business\nIn fiscal year 1992, the Delaware Company 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 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, the Delaware Company 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.\nNOTE 15 - SEGMENT REPORTING\nThe Delaware Company operates in two industry segments - Power Generation Systems and Equipment, and Marine Construction Services.\nPower Generation Systems and Equipment's 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 services for the offshore oil, natural gas and hydrocarbon processing industries, and to other marine construction companies. These services, which are supplied primarily in North America, 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 the Delaware Company's operations in each segment. Corporate assets are principally cash and cash equivalents, short-term investments, marketable securities and prepaid pension costs.\nIn fiscal years 1994, 1993 and 1992, the U. S. Government accounted for approximately 17%, 21%, and 23%, respectively, of the Delaware Company's total revenues. These revenues are principally included in the Power Generation Systems and Equipment segment.\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 $6,549,000. This included a decrease of $3,753,000 in the Power Generation Systems and Equipment segment and a decrease of $2,796,000 in the Marine Construction Services segment.\nSegment Information For the Three Fiscal Years Ended March 31, 1994.\n1. Information about the Delaware Company's Operations in Different Industry Segments.\n(2) See Note 3 regarding the deconsolidation of BWFC to a cost method investment and the change of BWNSC from an equity method to a cost method investment during fiscal year 1992. (3) See Note 2 regarding the acquisition of DCC during fiscal year 1994.\n2. Information about the Delaware Company's Operations in Different Geographic Areas.\n(1) Includes property, plant and equipment of $14,887,000 of DCC in fiscal year 1994 (See Note 2) and the purchase of a fabrication yard in Nueces County, Texas financed by a note payable of $16,250,000. (2) Net of inter-geographic area revenues in fiscal year 1994 as follows: United States -$20,702,000, Canada - $8,167,000, and Other Foreign - $281,000. Inter-geographic eliminations for fiscal years 1993 and 1992 are immaterial.\nNOTE 16 - 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). The restatement decreased income before cumulative effect of accounting changes and net income by $467,000 and $101,217,000, 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 for the quarter ending September 30, 1993.\nPretax results for the quarter ended June 30, 1993 include a favorable warranty reserve adjustment of $11,000,000. Results for the March 1994 quarter include a provision of approximately $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.\nPretax results for the December 1992 quarter 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 $6,966,000. Results for the March 31, 1993 quarter include a gain on the sale of the remaining interests in two commercial nuclear joint ventures of $23,968,000.\nItem 9.","section_9":"Item 9. DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART I I I\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 arrangement or understanding between himself and any other person.\nInformation required by this item is incorporated by reference to the material appearing under the heading \"Election of Directors\" in the Information Statement for action to be taken without a meeting of shareholders on August 9, 1994.\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 Information Statement for action to be taken without a meeting of shareholders on August 9, 1994.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by this item is incorporated by reference to the material appearing under the heading \"Election of Directors\" in the Information Statement for action to be taken without a meeting of shareholders on August 9, 1994.\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 Information Statement for action to be taken without a meeting of shareholders on August 9, 1994.\nPART I V\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nFORM 8-K REPORTS\nThere were no current reports on Form 8-K filed during the three months ended March 31, 1994.\nEXHIBIT 22\nMCDERMOTT INCORPORATED 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.\nEXHIBIT 24\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-3 No. 33-54940) of McDermott Incorporated and in the related Prospectus of our report dated May 9, 1994 with respect to the consolidated financial statements of McDermott Incorporated, included in this Annual Report (Form 10-K) for the year ended March 31, 1994.\nERNST & YOUNG\nNew Orleans, Louisiana May 12, 1994\nSIGNATURES 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 INCORPORATED (REGISTRANT)\nBy: \/s\/ Robert E. Howson Robert E. Howson Chairman of the Board and Chief Executive Officer\n\/s\/ Brock A. Hattox Brock A. Hattox Senior Vice President and Chief Financial Officer\n\/s\/ Daniel R. Gaubert Daniel R. Gaubert Vice President and Controller\nSIGNATURES 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\/ Robert E. Howson Robert E. Howson Chairman of the Board and Chief Executive Officer, and Director\n\/s\/ Brock A. Hattox Brock A. Hattox Senior Vice President and Chief Financial Officer, and Director\n\/s\/ Lawrence R. Purtell Lawrence R. Purtell Senior Vice President and General Counsel and Corporate Secretary, and Director","section_15":""}
{"filename":"813762_1994.txt","cik":"813762","year":"1994","section_1":"Item 1. Business. --------\nIntroduction ------------\nAmerican Real Estate Partners, L.P. (\"AREP\") was formed in Delaware on February 17, 1987. Pursuant to an exchange offer (the \"Exchange Offer\") which was consummated on July 1, 1987, AREP acquired the real estate and other assets, subject to the liabilities, of thirteen limited partnerships (the \"Predecessor Partnerships\"). The Predecessor Partnerships acquired such assets between 1972 and 1985. A registration statement on Form S-4 relating to the Exchange Offer (Registration No. 33-13943) was filed with the Securities and Exchange Commission (the \"SEC\") and declared effective May 18, 1987.\nAREP's general partner is American Property Investors, Inc. (the \"General Partner\"), a Delaware corporation which is wholly owned by Carl C. Icahn (\"Icahn\"). The General Partner's principal business address is 90 South Bedford Road, Mt. Kisco, New York 10549. AREP's business is conducted through a subsidiary limited partnership, American Real Estate Holdings Limited Partnership (the \"Subsidiary\"), in which AREP owns a 99% limited partnership interest. The General Partner also acts as the general partner for the Subsidiary. The General Partner has a 1% general partnership interest in each of AREP and the Subsidiary. References to AREP herein include the Subsidiary, unless the context otherwise requires.\nDuring the end of March and early April 1995, AREP anticipates completing a rights offering (the \"Rights Offering\"), pursuant to which it will raise approximately $109,000,000, net of related expenses. High Coast Limited Partnership, a Delaware limited partnership which is controlled by Icahn, has acted as guarantor of the offering (the \"Guarantor\"). Through the Guarantor, Icahn will exercise certain subscription rights and an over-subscription privilege to acquire additional depositary units representing limited partner interests (the \"Depositary Units\") and 5% cumulative pay-in-kind redeemable preferred units representing limited partner interests (the \"Preferred Units\"). As of March 17, 1995, Icahn, through the Guarantor, beneficially owned 9.89% of the Depositary Units then outstanding prior to giving effect to the Rights Offering. In addition, as a result of the Guarantor's participation in the Rights Offering, AREP expects that Icahn will increase his percentage ownership in AREP and obtain a substantial portion of the Preferred Units being offered. A registration statement on Form S-3 relating to the Rights Offering (Registration No. 33-54767) was filed with the SEC and declared effective February 23, 1995. See \"Business -- Rights Offering\" and ITEM 12 -- \"Security Ownership of Certain Beneficial Owners and Management.\"\nI-1\nDescription of Business -----------------------\nAREP is in the business of acquiring and managing real estate and activities related thereto. Historically, the properties owned by AREP have been primarily office, retail, industrial, residential and hotel properties. Most of the real estate assets currently owned by AREP were acquired from the Predecessor Partnerships and such assets are generally net-leased to single, corporate tenants. As of March 17, 1995, AREP owned 249 separate real estate assets primarily consisting of fee and leasehold interests in 35 states and Canada (one property). As discussed below, AREP is seeking to acquire new investments to take advantage of investment opportunities it believes exist in the current real estate market to further diversify its portfolio and to mitigate against lease expirations.\nFor each of the years ended December 31, 1994, 1993 and 1992, no single real estate asset or series of assets leased to the same lessee accounted for more than 10% of the gross revenues of AREP. However, at December 31, 1994 and 1993, Portland General Electric Company (\"PGEC\") occupied a property (the \"PGEC Property\") which represented more than 10% of AREP's total assets. See ITEM 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties. ----------\nAs of March 17, 1995, AREP owned 249 separate real estate assets (primarily consisting of fee and leasehold interests and, to a limited extent, interests in real estate mortgages) in 35 states and Canada (one property). These properties are generally net-leased to single corporate tenants. Approximately 98% of AREP's properties are currently net-leased. See Note 8 to the Financial Statements contained herein for information on mortgages payable.\nThe following table summarizes the type, location and average net effective rent per square foot of AREP's properties:\nLocation Number of Property of Properties ----------- -------------\nUS: Southeast 109 Northeast 54 South Central 11 Southwest 20 North Central 46 Northwest 8\nCanada: 1\nFrom January 1, 1994 through March 17, 1995, AREP sold or otherwise disposed of 34 properties. In connection with such sales and dispositions, AREP received an aggregate of approximately $16,000,000 in cash, net of amounts utilized to\nI-13\nsatisfy mortgage indebtedness which encumbered such properties. As of December 31, 1994, AREP owned four properties that were being actively marketed for sale. The aggregate net realizable value of such properties is estimated to be approximately $413,000.\nFurthermore, AREP has executed a contract for the sale of a property located in Taylor, Michigan which is tenanted by Pace Membership Warehouse, Inc. AREP expects to complete the sale by the end of March 1995. The sales price is $9,300,000 and AREP expects to record a gain of approximately $3,300,000 in the three months ended March 31, 1995. The property is encumbered by a nonrecourse mortgage payable of approximately $4,346,000, which the purchaser will assume. In addition, the purchaser is obligated to pay AREP $50,000 should it default on its obligations under the contract.\nFor each of the years ended December 31, 1994, 1993 and 1992, no single real estate asset or series of assets leased to the same lessee accounted for more than 10% of the gross revenues of AREP. However, at December 31, 1994 and 1993, PGEC occupied a property, which represented more than 10% of AREP's total assets. PGEC is an electric utility engaged in the generation, purchase, transmission, distribution and sale of electricity, whose shares are traded on the New York Stock Exchange, Inc. (the \"NYSE\").\nThe PGEC Property is an office complex consisting of three buildings containing an aggregate of approximately 803,000 square feet on an approximate 2.7 acre parcel of land located in Portland, Oregon. The Predecessor Partnership originally purchased the PGEC Property on September 11, 1978 for a price of approximately $57,143,000.\nThe PGEC Property is subject to two underlying mortgages, which in the aggregate as of December 31, 1994, had an outstanding principal balance of $36,190,135. The first mortgage bears interest at 8.5% per annum, provides for aggregate annual debt service of $2,856,960 and matures on October 1, 2002, at which time a balloon payment of $19,304,091 will be due and payable. By its terms, this mortgage is prepayable at any time subject to certain restrictions. The second mortgage bears interest at 10% per annum, provides for interest-only payments during its term (an aggregate of $1,000,000 per annum) and matures in October 1996, at which time a balloon payment of $10,000,000 will be due and payable. By its terms, this second mortgage was not prepayable until September 1989, and then only with a 6% penalty, which penalty decreases by .5% each year thereafter.\nThe PGEC Property is net-leased to a wholly owned subsidiary of PGEC for forty (40) years, with two ten-year and one five-year renewal options. The annual rental is $5,137,309 until 2003, $4,973,098 until 2018 and $2,486,549 during each renewal option. PGEC has guaranteed the performance of its subsidiary's obligations under the lease. The lessee has an option to purchase the PGEC\nI-14\nProperty in September of 2003, 2008, 2013 and 2018 at a price equal to the fair market value of the PGEC Property determined in accordance with the lease and is required to make a rejectable offer to purchase the PGEC Property in September 2018 for a price of $15,000,000. A rejection of such offer will have no effect on the lease obligations or the renewal and purchase options.\nIn June 1994, AREP entered into two joint ventures with unaffiliated co-venturers for the purpose of developing luxury garden apartment complexes. See ITEM 1 -- \"Business -- Recent Acquisitions\" above.\nAREP's most significant acquisition in 1993 was the purchase of two non-performing mortgage loans for a combined price of $13,000,000. AREP foreclosed on these loans in 1993 and 1994, and now holds title to the underlying properties. On July 25, 1994, AREP obtained financing on these two properties. See ITEM 1 -- \"Business -- Financing Activities.\"\nAREP is continuing to seek opportunities to refinance upon favorable terms and sell certain of its properties to generate proceeds for future investments, in addition to the proceeds anticipated from the Rights Offering. In the current real estate environment, management continues to seek to improve the long- term value of AREP's portfolio by, among other means, using the proceeds of the Rights Offering and reinvesting capital transaction proceeds to maximize capital appreciation and diversification of the portfolio. AREP believes that the continuing weakness in the real estate market presents opportunities to acquire significantly undervalued properties, including commercial properties, residential development projects and non-performing loans, thereby enhancing AREP's portfolio and its return on investments. In selecting investments, AREP intends to focus on assets that it believes are undervalued in the current real estate market, such as development properties and non-performing loans, which the General Partner believes have the potential to diversify and enhance the long-term value of AREP's portfolio. Such investments may require active management which could result in higher operating expenses for AREP. The cash flow generated by an asset will be a consideration, but AREP may acquire assets that are not generating positive cash flow. While this may impact cash flow in the near term and there can be no assurance that any property acquired by AREP will increase in value or generate positive cash flow, management intends to focus on assets that it believes may provide opportunities for long- term growth and diversification of its portfolio.\nItem 3.","section_3":"Item 3. Legal Proceedings. -----------------\nUnitholder Litigation ---------------------\nOn August 15 and 16, 1994, AREP was served with two class action complaints, both filed with the Delaware Court of Chancery,\nI-15\nNew Castle County, in connection with the Rights Offering, Steven Yavers v. American Real Estate Partners, L.P., American Property Investors, Inc., and Carl C. Icahn, C.A. No. 13682, and Allan Haymes, I.R.A. v. American Real Estate Partners, L.P., American Property Investors, Inc., and Carl C. Icahn, C.A. No. 13687. An additional complaint relating to the Rights Offering was filed with the Delaware Court of Chancery, New Castle County, and all three have been consolidated into one action (the \"Consolidated Action\").\nPlaintiffs in the Consolidated Action claim that defendants have breached fiduciary and common law duties owed to plaintiffs and plaintiffs' putative class by engaging in self-dealing and by failing to disclose all relevant facts regarding the Rights Offering. Plaintiffs seek declaratory and injunctive relief declaring the action properly maintainable as a class action, declaring that defendants breached their fiduciary and other duties, enjoining the Rights Offering, ordering defendants to account for all damages suffered by the class as a result of the alleged acts and awarding further relief as the court deems appropriate.\nBy agreement among AREP and the above mentioned plaintiffs, AREP's time to respond to the consolidated complaint has been extended to April 7, 1995. AREP believes the allegations are without merit and intends to vigorously defend the Consolidated Action. The allegations in the consolidated complaint relate to previous superseded terms of the Rights Offering and, hence, AREP believes they are moot.\nDefaulted Mortgages -------------------\nAs of December 31, 1994, AREP held a mortgage note receivable in the principal amount of approximately $463,000. The mortgage encumbers four properties together with a collateral assignment of ground leases and rents. The properties are tenanted by Gino's and Foodarama. The mortgage had been taken back by a Predecessor Partnership in connection with the sale of these properties. The tenants remained current in their lease obligations.\nThe terms of the mortgage called for a balloon payment of $1,100,000 on January 1, 1992, which was not received. On January 9, 1992, AREP gave written notice of default to Sheldon Lowe and Joseph T. Comras, the mortgagors and the current owners of the properties. As of December 31, 1994, AREP is in the process of foreclosing on the four properties. See Note 12(d) to the Financial Statements contained herein.\nProperty Litigation -------------------\nSimultaneously with the acquisition of property in East Syracuse, New York, AREP entered into a general construction\nI-16\ncontract (the \"GC Agreement\") pursuant to which the seller was required to construct the property for a guaranteed maximum amount of $2,327,802. However, the construction of the BJ's Warehouse Store was subject to delays and the seller did not meet all of its construction obligations under the GC Agreement and failed to cure such defaults. AREP sent a notice, dated February 19, 1993, terminating the GC Agreement. AREP contacted the surety of the GC Agreement to make a claim pursuant to the terms of the surety bond and was unsuccessful. AREP has determined at this point that it will not pursue any potential claims that it may have against the surety, because after due inquiry, it believes that such claims will not be able to be satisfied. Additionally, in connection with certain alleged agreements between related entities and principals of the seller, and a brokerage company, the broker filed an action in the amount of $250,000. AREP did not agree to assume the obligation to pay such commission and is defending such action. Furthermore, another broker has instituted an action against AREP and certain other co-defendants regarding a $224,500 brokerage claim with respect to such property, as well as punitive damages of $1,000,000; this action was settled in January 1995 with dismissal of the action with prejudice and with a reservation of AREP's rights against its co- defendants.\nEnvironmental Litigation ------------------------\nOn September 16, 1991, AREP brought suit against Alco Standard Corporation and its affiliates, a former tenant of an industrial facility located in Rome, Georgia whose lease expired in October 1990. The action was brought against the defendants in the United States District Court for the Northern District of Georgia, Rome Division, for reimbursement of costs that could be incurred for clean-up of hazardous materials on the site and certain deferred maintenance. In July 1994, this litigation was settled and the property was sold for $525,000. A gain of approximately $100,000 was recognized in the third quarter of 1994. In addition, Alco reimbursed AREP for $150,000 of expenses incurred and indemnified AREP against any future liability in connection with any site contamination.\nLockheed, a tenant of AREP's leasehold property in Palo Alto, California, has entered into a consent decree with the California Department of Toxic Substances (\"CDTS\") to undertake certain environmental remediation at this property. Lockheed has estimated that the environmental remediation costs may be up to approximately $14,000,000. In a non-binding determination by CDTS, Lockheed was found responsible for approximately 75% of such costs and the balance was allocated to other parties. AREP was allocated no responsibility for any such costs.\nLockheed has served a notice that it may exercise its statutory right to have its liability reassessed in a binding arbitration proceeding. In this notice of arbitration, Lockheed stated that it will attempt to have allocated to AREP and to AREP's ground-lessor (which may claim a right of indemnity against AREP)\nI-17\napproximately 9% and 17%, respectively, of the total remediation costs. AREP believes that it has no liability for any of such costs and, in any proceeding in which such liability is asserted against AREP, AREP intends to contest such liability vigorously. In the event any of such liability is allocated to AREP, AREP intends to seek indemnification for any such liability from Lockheed in accordance with its lease.\nBankruptcies ------------\nAREP is aware that eleven of its present and former tenants have been or are currently involved in some type of bankruptcy or reorganization during the three-year period ended December 31, 1994, affecting a total of forty-one of AREP's properties. See also Notes 7(c), (d), (e), (g) and 12(a), (c), (d), (e) and 16(a) to the Financial Statements contained herein describing various tenant and mortgagor bankruptcies for which AREP has filed claims.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. ---------------------------------------------------\nNone.\nI-18\nPART II\nItem 5.","section_5":"Item 5. Market for AREP's Common Equity and Related Security Holder Matters. -----------------------------------\nMarket Information ------------------\nAREP's Depositary Units are traded on the NYSE under the symbol \"ACP.\" Trading on the NYSE commenced July 23, 1987, and the range of high and low market prices for the Depositary Units on the New York Stock Exchange Composite Tape (as reported by The Wall Street Journal) from January 1, 1993 through December 31, 1994 is as follows:\nHigh Low ---- ---\nQuarter ended: March 31, 1993 $ 9.38 $6.63 June 30, 1993 8.25 7.50 September 30, 1993 9.00 8.00 December 31, 1993 9.50 7.00\nMarch 31, 1994 $ 8.375 $7.375 June 30, 1994 8.50 7.375 September 30, 1994 8.625 7.375 December 31, 1994 8.00 7.25\nOn March 17, 1995, the last sales price of the Depositary Units, as reported by the New York Stock Exchange Composite Tape (as reported by The Wall Street Journal) was $7.375.\nAs of March 17, 1995, there were approximately 23,400 record holders of the Depositary Units.\nII-1\nTrading in the Preferred Units on the NYSE under the symbol \"ACP PR\" is expected to commence on March 31, 1995 on a when issued basis.\nDistributions -------------\nAfter evaluating the contingencies facing AREP, its anticipated cash flows, liquidity needs, maturing debt obligations and capital expenditure requirements, the Board of Directors of the General Partner reduced the quarterly distributions in 1993 from $.25 to $.125 per quarter. This reduction permitted management to continue to establish reserves for AREP's maturing debt obligations and other contingencies. In 1994, the General Partner determined that it was necessary for AREP to conserve cash and increase reserves from time to time in order to meet capital expenditures and maturing debt obligations. As a result, distributions to Unitholders were suspended. On March 16, 1995, the Board of Directors of the General Partner announced that a distribution for the fiscal quarter ended March 31, 1995 would not be made. In making its announcement, AREP noted that, consistent with previously announced estimates, net operating cash flow in 1994 was only break-even, after payment of periodic principal payments and maturing debt obligations, capital expenditures and the creation of additional cash reserves. AREP also noted that cash reserves had been set aside for its scheduled approximately $11.3 million principal payment due in May 1995 on its Senior Unsecured Debt and for the repayment of approximately $3.6 million of balloon mortgages coming due by May 1995. See ITEM 7 -- \"Management's Discussion and Analysis of the Financial Condition and Results of Operations -- Capital Resources and Liquidity.\" Following the Rights Offering, a substantial portion of the proceeds from the Rights Offering will be used to fund the acquisition of additional properties by AREP, which the General Partner believes have the potential to diversify and enhance the long-term value of AREP's investment portfolio. Each Unitholder will be taxed on the Unitholder's allocable share of AREP's taxable income and gains and accrued guaranteed payments, whether or not any cash is distributed to the Unitholder.\nRepurchase of Depositary Units ------------------------------\nAREP announced in 1987 its intention to purchase up to one million Depositary Units. On June 16, 1993, AREP increased the amount of shares authorized to be repurchased to 1,250,000 Depositary Units. As of March 17, 1995, AREP had purchased 1,037,200 Depositary Units at an aggregate cost of approximately $11,184,000. In light of the existing cash needs of the Partnership, management recently has not been acquiring Depositary Units for AREP, although AREP may from time to time acquire additional Depositary Units. Under the terms of the Note Agreements for the Senior Unsecured Debt, distributions and the amounts used to repurchase Depositary Units cannot exceed net cash flow, as defined therein, plus $15,000,000. See ITEM 7 -- \"Management's Discussion and Analysis of the Financial Condition and Results of Operations -- Capital Resources and Liquidity.\" To\nII-2\ndate this restriction has not impaired the ability of AREP to make distributions.\nItem 6.","section_6":"Item 6. Selected Financial Data. -----------------------\n* To the extent financial information pertaining to AREP is reflected, such information is consolidated for AREP and its Subsidiary.\nII-3\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of the Financial Condition and Results of Operations. ---------------------------------------------\nGeneral -------\nHistorically, substantially all of AREP's real estate assets have been net-leased to single corporate tenants under long-term leases. With certain exceptions, these tenants are required to pay all expenses relating to the leased property and therefore AREP is not typically responsible for payment of expenses, such as maintenance, utilities, taxes and insurance associated with such properties. AREP has experienced an increase in its property expenses in recent years, due principally to tenant bankruptcies and defaults as well as the acquisition of operating properties. Management expects that AREP's property ownership and management expenses will continue to be higher for the next several years as properties vacated by tenants are re-leased or held for sale and development and operating properties are acquired. Moreover, as AREP's various debt obligations come due, including the Senior Unsecured Debt, there will be increasing demands on cash flow.\nBy the end of the year 2000, net leases representing approximately 26% of AREP's net annual rentals from its portfolio will be due for renewal, and by the end of the year 2002, net leases representing approximately 40% of AREP's net annual rentals will be due for renewal. In many of these leases, the tenant has an option to renew at the same rents they are currently paying and in many of these leases the tenant also has an option to purchase. AREP believes that tenants acting in their best interest may be expected to renew those leases which will be at below market rents and to permit leases for properties that are less marketable (either as a result of the condition of such property or its location) or provide for renewal at above-market rents to expire. Since most of AREP's properties are net- leased to single, corporate tenants, it is expected that it may be difficult and time-consuming to re-lease or sell those properties that existing tenants decline to re-let or purchase and AREP may be required to incur expenditures to renovate such properties for new tenants. In addition, AREP may become responsible for the payment of certain operating expenses, including maintenance, utilities, taxes, insurance and environmental compliance costs associated with such properties, which are presently the responsibility of the tenant. As a result, AREP could experience an adverse impact on net cash flow from such properties in the next decade.\nIn the past AREP has generated cash flow from operations, primarily through net-lease transactions, for the purpose of making distributions to Unitholders; however, the recession and real estate downturn that occurred in the early 1990's led the General Partner to re-examine AREP's cash needs and investment opportunities. As a result of tenant defaults, including the bankruptcy of a number of tenants, and lease expirations, AREP's property management and operating expenses increased, as well as\nII-4\nits expenditures relating to the re-leasing of properties (such expenditures including capital expenditures necessary to refurbish vacated properties and to build out properties to meet the specifications of new tenants) and rental revenues decreased. In addition, the availability of acceptable financing to re-finance maturing mortgage debt and AREP's Senior Unsecured Debt became increasingly scarce. Consequently, the General Partner determined that it was necessary to conserve cash and establish reserves from time to time in order to meet capital expenditures and maturing debt obligations. As a result, there was insufficient cash flow from operations to pay distributions to Unitholders and such distributions were reduced and finally suspended. As of December 31, 1994, AREP had approximately $13,000,000 in cash reserves.\nAt the same time that the recession was imposing cash flow constraints on AREP, it was also creating what the General Partner perceived as significant investment opportunities to acquire undervalued properties. As discussed under ITEM 1 -- \"Business -- Rights Offering,\" during the next decade AREP expects net leases representing approximately 40% of its net annual rentals to expire and it is possible that AREP's investment portfolio will become stagnant. In order to enhance AREP's investment portfolio (and ultimately its asset values and cash flow prospects), AREP is seeking to acquire investments in undervalued properties. The General Partner believes that because of overdevelopment in certain real estate markets and the desire of certain real estate holders, including financial institutions, to dispose of real estate assets, there are assets available which are performing at a level, or may be available at a price, which may be substantially below their potential value (due to management weaknesses or temporary market conditions such as oversupply of comparable space or stagnant or recessionary local regional economies). Such properties may not be generating a positive cash flow in the near term; however, the General Partner believes that the acquisition of properties requiring some degree of management or development activity have the greatest potential for growth, both in terms of capital appreciation and the generation of cash flow. With the implementation of improved asset management, debt restructuring and capital improvements, for example, AREP would seek to maximize the performance and value of any such undervalued properties. Where opportunities exist, AREP may acquire such properties with proceeds of the Rights Offering or, as has been the case with acquisitions made by AREP over the last several years, sale or refinancing proceeds which AREP retains for reinvestment (rather than for distribution to Unitholders). The General Partner believes the acquisition of such investments is consistent with AREP's historical objectives of reinvesting proceeds of sales and refinancings in properties that offer greater growth potential and diversification. In addition, to the extent such investments enhance AREP's portfolio, AREP may be able to reinstate distributions to holders of Depositary Units, although there can be no assurances thereof.\nII-5\nAs a consequence of the foregoing, AREP decided to raise funds through the Rights Offering to increase its assets available for investment so that it will be in a better position to take further advantage of the investment opportunities in the real estate market and to further diversify its portfolio and mitigate against the impact of potential lease expirations. See ITEM 1 -- \"Business -- Rights Offering\" for a further discussion of the Rights Offering.\nDuring 1994 AREP had approximately $10,000,000 in maturing balloon mortgages due, approximately $6,700,000 of which have been repaid and approximately $3,300,000 of which have been refinanced. Approximately $5,700,000 and $16,000,000 of balloon mortgages are due in 1995 and 1996, respectively. During the period 1997 through 1998, approximately $9,100,000 in maturing balloon mortgages come due. AREP will seek to refinance a portion of these maturing mortgages, although it does not expect to be able to refinance all of them and may be required to repay them from cash flow and reserves created from time to time, thereby reducing cash flow otherwise available for other uses. AREP also has significant maturing debt requirements under the note agreements. In particular, AREP is required to make semi-annual interest payments and annual principal payments. In May 1994, AREP repaid $10,000,000 of the outstanding principal balance under the Note Agreements. Prior to 1994, AREP was only required to make payments of interest on such debt. Principal payments of approximately $11,308,000 are due under such agreements annually from 1995 through 1998. See ITEM 1 -- \"Business -- Financing Activities\" and ITEM 2 -- \"Properties.\"\nExpenses relating to environmental clean-up have not had a material effect on the earnings, capital expenditures, or competitive position of AREP. Management believes that substantially all such costs would be the responsibility of the tenants pursuant to lease terms. While most tenants have assumed responsibility for the environmental conditions existing on their leased property, there can be no assurance that AREP will not be deemed to be a responsible party or that the tenant will bear the costs of remediation. In addition, environmental clean-up costs could become the responsibility of AREP to the extent that tenants file for bankruptcy or otherwise fail to fulfill their lease obligations. See ITEM 1 -- \"Business -- Environmental Matters.\" Environmental problems may also delay or impair AREP's ability to sell, refinance or re-lease particular properties, resulting in decreased income and increased costs to AREP. In addition, as AREP acquires more operating properties, its exposure to environmental clean-up costs may increase. In light of the potential impact of environmental clean-up costs, AREP recently has undertaken to have certain properties (approximately 81) in its portfolio which were not inspected at the time of acquisition to be subjected to Phase I Environmental Site Assessment by a third-party consultant. Based on the results of these Phase I Environmental Site Assessments, the environmental consultant has recommended that limited Phase II Environmental Site Investigations be conducted for approximately 29 of the\nII-6\nsites in order to ascertain whether there are any environmental conditions and the anticipated cost of any remediation. At the conclusion of AREP's environmental site investigations, AREP will seek to coordinate with the tenants to attempt to ensure that they undertake any required remediation. As no Phase II Environmental Site Investigations have been conducted by the consultant, there can be no accurate estimation of the need for or extent of any required remediation, or the cost thereof. See also the discussion of the Lockheed property in ITEM 3 -- \"Legal Proceedings.\"\nResults of Operations ---------------------\nCALENDAR YEAR 1994 COMPARED TO CALENDAR YEAR 1993. Gross revenues increased by approximately $1,394,000, or 2.3%, during calendar year 1994 as compared to calendar year 1993. This increase reflects approximate increases of $3,393,000, or 21.6%, in rental income and $405,000, or 4.8%, in hotel operating income, partially offset by decreases of approximately $861,000, or 2.6%, in financing lease income, $571,000, or 28.4%, in other interest income, and $972,000, or 84.1%, in other income. The increase in rental income is primarily attributable to the two apartment complexes in Lexington, Kentucky acquired in 1993, increases in rents from a property formerly occupied by Amdura and rents received from BJ's Warehouse Store. The hotel operating revenues were generated by two hotels formerly leased to Integra. AREP has been operating these hotel properties through a third- party management company since August 7, 1992. The decrease in financing lease income is primarily attributable to normal amortization of financing leases partially offset by increased income from the Toy's \"R\" Us properties reacquired as a result of foreclosure on defaulted purchase money mortgages. The decrease in other interest income is primarily attributable to less interest received on defaulted purchase money mortgages and payments of balloon balances due. The decrease in other income related primarily to the settlement of the Days Inn bankruptcy claim, most of which was recognized in 1993.\nExpenses increased by approximately $196,000, or .5%, during calendar year 1994 compared to calendar year 1993. This increase reflects increases of approximately $1,833,000, or 71.1%, in property expenses, $600,000, or 13.8%, in depreciation and amortization and $336,000, or 13.7%, in general and administrative expenses, offset by decreases of approximately $2,392,000, or 9.5%, in interest expense and $181,000, or 2.5%, in hotel operating expenses. The increase in property expenses is primarily attributable to costs associated with the newly acquired operating properties mentioned previously, as well as the former Days Inn and Amdura properties now operated by the Company. The decrease in interest expense is primarily attributable to normal loan amortization and reductions due to certain loan refinancings and the repayments of maturing balloon debt obligations, including the Senior Unsecured Debt.\nII-7\nEarnings before property transactions increased during the calendar year 1994 by approximately $1,198,000, or 6.5%, from calendar year 1993.\nGain on property transactions decreased by approximately $586,000 during the calendar year 1994 as compared to calendar year 1993, due to differences in the size and number of transactions.\nDuring calendar year 1994, AREP recorded a provision for loss on real estate of $582,000 as compared to $462,000 in 1993.\nNet earnings for the calendar year 1994 increased by approximately $492,000, or 2.2%, as compared to net earnings for the calendar year 1993. This increase is attributable to the approximate $1,198,000 increase in earnings before property transactions, offset by the decrease in gain on sales of real estate and the increase in provision for loss on real estate.\nCALENDAR YEAR 1993 COMPARED TO CALENDAR YEAR 1992. Gross revenues, including revenues from hotel operating properties, increased by approximately $2,375,000, or 4.1%, during calendar year 1993 as compared to calendar year 1992. This increase reflects approximate increases of $4,745,000, or 128.1%, in hotel operating revenues and $498,000, or 75.8%, in other income, partially offset by decreases of approximately $1,270,000, or 3.7%, in financing lease income, $1,373,000, or 8.0%, in rental income, and $224,000, or 10.0%, in other interest income. The hotel operating revenues were generated by two hotels formerly leased to Integra and accounted for as financing leases. AREP has been operating these hotel properties through a third-party management company since August 7, 1992. The other income reflects partial settlements of bankruptcy claims against Days Inn and National Convenience Stores. See Note 7 to the Financial Statements contained herein. The decrease in financing lease income was primarily attributable to normal amortization of financing leases and the reclassification of rent from Integra and certain National Convenience Stores due to the filings by such tenants of voluntary petitions for reorganization pursuant to the provisions of Chapter 11 of the Bankruptcy Code, which leases were subsequently rejected in 1992. As a result of lease rejections, financing lease income decreased by approximately $740,000. The decrease in other interest income was primarily attributable to less interest received on two purchase money mortgages due to defaults and payments of balloon balances due. The decrease in rental income was primarily attributable to the loss of income resulting from property sales (approximately $1,200,000), the rejection of its lease by Days Inn, the Occidental lease expiration and decreases caused by re-letting properties at lower rentals, partially offset by increases primarily attributable to rents received from BJ's Warehouse Store and the Stoney Falls apartment complex in Lexington, Kentucky, both newly acquired operating properties in 1993. As a result of lease rejections, AREP's rental income decreased by approximately $480,000.\nII-8\nExpenses increased by approximately $4,578,000, or 12.3%, during calendar year 1993 compared to calendar year 1992. This increase reflects an increase of approximately $4,344,000, or 149.3%, in hotel operating expenses, $802,000, or 45.1%, in property expenses and $136,000, or 5.9%, in general and administrative expenses, partially offset by a decrease of approximately $731,000, or 2.8%, in interest expense. The hotel operating expenses were generated by the two hotels mentioned previously. The increase in property expenses is primarily attributable to expenses from several properties, including the former Days Inn and Amdura properties, AREP is now operating through third-party management companies, as well as off-lease properties and the newly acquired apartment complex in Lexington, Kentucky. The decrease in interest expense is primarily attributable to normal loan amortization, reductions due to certain loan refinancings and repayments, and the capitalization of interest in connection with the construction of the BJ's Warehouse Store, partially offset by increases in mortgage interest due to the foreclosure of properties tenanted by Toys R Us.\nEarnings before property transactions decreased during the calendar year 1993 by approximately $2,202,000, or 10.7%, from calendar year 1992.\nGain on property transactions increased by approximately $4,418,000 during the calendar year 1993 as compared to calendar year 1992, due to differences in the size and number of transactions.\nDuring calendar year 1993, AREP recorded a provision for loss on real estate of $462,000 as compared to approximately $8,847,000 in 1992.\nDuring calendar year 1992, a loss from early extinguishment of debt was incurred of approximately $785,000. No such loss was incurred during calendar year 1993.\nNet earnings for the calendar year 1993 increased by approximately $11,385,000, or 100.8%, as compared to net earnings for the calendar year 1992. This increase is attributable to the approximately $4,418,000 increase in gain on property transactions and the decreases of approximately $8,385,000 and $785,000 in provision for loss on real estate and loss from early extinguishment of debt, respectively, partially offset by the decrease in earnings before property transactions of approximately $2,202,000.\nCapital Resources and Liquidity -------------------------------\nGenerally, the cash needs of AREP for day-to-day operations have been satisfied from cash flow generated from current operations. The cash flow generated from day-to-day operations (before payment of maturing debt\nII-9\nobligations) has decreased in recent years, although it improved in 1994 due to the acquisition and foreclosure of certain operating properties and the repayment of debt. Cash flow has been negatively impacted by a reduction in operating cash flow caused by, among other things, tenant defaults and the termination of existing leases (due to expiration, rejection in bankruptcy or otherwise). Furthermore, AREP has experienced an increase in operating expenses with respect to vacated properties and has been required to perform maintenance and repair work in order to re-let such properties. AREP also has had to apply a larger portion of its cash flow to the repayment of maturing debt obligations. Cash flow from day-to-day operations represents net cash provided by operating activities (excluding working capital changes and non-recurring other income) plus principal payments received on financing leases, as well as principal receipts on mortgages receivable reduced by periodic principal payments on mortgage debt.\nAs a result of tenant bankruptcies, AREP has incurred and expects -- at least in the near term -- to continue to incur certain property expenses and other related costs. Thus far, these costs have consisted largely of legal fees, real estate taxes and property operating expenses. As of December 31, 1994, the total of such expenses relating to tenants who rejected their leases during the three-year period then ended was approximately $1,400,000 net of rent received from re-let properties. Of AREP's eleven present and former tenants involved in bankruptcy proceedings or reorganization, eight have rejected their leases, affecting 27 properties, all of which have been vacated. During 1992, AREP began operating some of these properties through third-party management companies. The rejections have had an adverse impact on annual cash flow (including both the decrease in revenues from lost rents, as well as increased operating expenses). The aggregate annual rent lost from tenants who rejected their leases during the three-year period ended December 31, 1994 was approximately $4,000,000. See Notes 7(c), (d), (e), (g) and 12(a), (c), (d), (e) and 16(a) to the Financial Statements contained herein. Currently AREP has one tenant in bankruptcy which occupies eight of AREP's properties.\nIn 1994, fourteen leases covering fourteen properties and representing approximately $810,000 in annual rental income expired. Seven of these fourteen leases originally representing approximately $513,000 in annual rental income were renewed or re-let for approximately $593,000 in annual rental income. One property, which had an approximate annual rental income of $112,000, has been renewed at $175,000, which amount has been determined by a market value appraisal. Three properties, with an approximate annual rental income of $69,000, are currently being marketed for sale or lease. Three properties, with an approximate annual rental of $116,000, were sold in 1994.\nIn 1995, 24 leases covering 24 properties and representing approximately $832,000 in annual rentals are scheduled to expire. AREP anticipates that eleven of these 24 leases originally representing\nII-10\napproximately $492,000 in annual rental income have been or will be re-let or renewed for approximately $507,000 in annual rentals. Thirteen leases, with an approximate annual rental income of $340,000, will be marketed for sale or lease when the current lease terms expire.\nAREP may not be able to re-let certain of its properties at current rentals. As discussed above, net leases representing approximately 40% of AREP's net annual rentals will be due for renewal by the end of the year 2002. Moreover, it is expected that it may be difficult and time consuming to re-lease or sell those properties that existing tenants decline to re-let or purchase and AREP may be required to incur expenditures to renovate such properties for new tenants. In addition, AREP will become responsible for the payment of certain operating expenses, including maintenance, utilities, taxes, insurance and environmental compliance costs, associated with such properties which are presently the responsibility of the tenant. As a result, AREP could experience an adverse impact on net cash flow from such properties in the next decade. There are also certain below-market leases with renewal options which are likely to be exercised.\nDuring 1994, AREP generated approximately $22 million in cash flow from day-to-day operations and approximately $200,000 from the Days Inn bankruptcy claim settlement. During the comparable period in 1993, AREP generated approximately $19 million in cash flow from day-to-day operations and approximately $1,200,000 from the Days Inn and SNG bankruptcy claims' settlements. During the comparable period of 1992, AREP generated approximately $23.5 million in cash flow from day-to-day operations and approximately $700,000 from the settlement of the Amdura Corp. bankruptcy claim. See Note 7(d) to the Financial Statements contained herein.\nCapital expenditures for real estate, excluding new acquisitions, were approximately $2,300,000 during 1994. During 1993, such expenditures, excluding new acquisitions, totalled approximately $2,500,000. During 1992, such expenditures totalled approximately $200,000.\nDuring 1994, AREP had approximately $10,000,000 in maturing balloon mortgages due, approximately $6,700,000 of which have been repaid and approximately $3,300,000 of which have been refinanced. Repayment of balloon mortgages out of AREP's cash flow totalled approximately $3,800,000 in 1993 and $1,100,000 in 1992, net of refinancings and exclusive of debt placement costs. Approximately $5,700,000 and $16,000,000 of maturing balloon mortgages are due in 1995 and 1996, respectively, and during the period 1997 through 1998 approximately $9,100,000 in maturing balloon mortgages come due. AREP will seek to refinance a portion of these maturing mortgages, although it does not expect to be able to refinance all of them and may be required to repay them from cash flow and increase reserves from time to time, thereby reducing cash flow otherwise available for other uses.\nII-11\nAREP also has significant maturing debt requirements under the Note Agreements. As of December 31, 1994, AREP had $45,231,106 of Senior Unsecured Debt outstanding. Pursuant to the Note Agreements, AREP is required to make semi-annual interest payments and annual principal payments. The interest rate charged on the Senior Unsecured Debt is 9.6% per annum. Under the terms of the Note Agreements, AREP deferred and capitalized 2% annually of its interest payment through May 1993. In May 1994, AREP repaid $10 million of its outstanding Senior Unsecured Debt under the Note Agreements and principal payments of approximately $11,308,000 are due annually from 1995 through the final payment date of May 27, 1998. As of December 31, 1994, AREP was in compliance with the terms of the Note Agreements.\nThe Note Agreements contain certain covenants restricting the activities of AREP. Under the Note Agreements, AREP must maintain a specified level of net annual rentals from unencumbered properties (as defined in the Note Agreements) and is restricted, in certain respects, in its ability to create liens and incur debts. Investment by AREP in certain types of assets that may be regarded as non-income producing, such as land or non-performing loans, is restricted under the Note Agreements. The holders of the Senior Unsecured Debt have agreed, however, to waive this restriction with respect to any additional capital raised by AREP in the Rights Offering. While the restrictions in the Note Agreements generally have not adversely affected AREP's operations in any material manner, if AREP encountered severe operating difficulties, certain options that management might otherwise elect, such as seeking additional secured financing, might be limited or prohibited.\nThe Note Agreements contain certain prepayment penalties which AREP would be required to pay if it extinguishes any portion of the outstanding principal prior to its annual due date. The Note Agreements require that such prepayment consist of 100% of the principal amount to be prepaid plus a premium based on a formula described therein. As of March 17, 1995 the premium required in order to prepay the Note Agreement in full would have been approximately $2,600,000. Subject to negotiating terms favorable to AREP, the Senior Unsecured Debt may be prepaid in full with a portion from the proceeds of the Rights Offering. Prepayment would release AREP from certain covenants which restrict its operating and investment activities, including, among others, covenants relating to the level of net annual rentals from unencumbered properties and the ability to create liens and incur additional debt. AREP believes that this prepayment and the resulting release from the covenants in the Note Agreements could further permit it to take advantage of the investment opportunities that exist in the real estate market.\nAfter evaluating the contingencies facing AREP, its anticipated cash flows, liquidity needs, maturing debt obligations and capital expenditure requirements, the Board of Directors of the General Partner reduced the quarterly distributions in 1993 from $.25 to $.125 per quarter. This reduction permitted management to continue to establish reserves for AREP's\nII-12\nmaturing debt obligations and other contingencies. In 1994, the General Partner determined that it was necessary for AREP to conserve cash and increase reserves from time to time in order to meet capital expenditures and maturing debt obligations. As a result, distributions to Unitholders were reduced and finally suspended. On March 16, 1995, the Board of Directors of the General Partner announced that a distribution for the fiscal quarter ended March 31, 1995 would not be made. In making its announcement, AREP noted that, consistent with previously announced estimates, net operating cash flow in 1994 was only breakeven, after payment of periodic principal payments and maturing debt obligations, capital expenditures and the creation of additional cash reserves. AREP also noted that cash reserves had been set aside for its scheduled approximately $11.3 million principal payment due in May 1995 on its Senior Unsecured Debt and for the repayment of approximately $3.6 million of balloon mortgages coming due by May 1995.\nThere were no distributions due to Unitholders for the year ended December 31, 1994. Distributions paid during 1994 totalled approximately $1,869,000, representing distributions due to Unitholders for the fourth quarter of 1993 and to Unitholders who exchanged their limited partner interests during 1994. Distributions due to Unitholders for the year ended December 31, 1993 were approximately $7.1 million. Distributions paid during the year ended December 31, 1993 totalled approximately $9.3 million, representing distributions due to Unitholders for the fourth quarter of 1992 and the first three quarters of 1993 and to Unitholders who exchanged their limited partner interests during 1993. Distributions due to Unitholders for the year ended December 31, 1992 were approximately $14.3 million. Distributions paid during 1992 totalled approximately $18.8 million, representing distributions due to Unitholders for the fourth quarter of 1991 and the first three quarters of 1992 and to Unitholders who exchanged their limited partner interests during 1992.\nThe proceeds from the Rights Offering are anticipated to be approximately $109,000,000 after the payment of offering expenses of approximately $1,000,000. The net proceeds of the Rights Offering will be used to further diversify and expand AREP's investment portfolio and, subject to negotiating terms favorable to AREP, the balance may be used to prepay its Senior Unsecured Debt. If the Senior Unsecured Debt is not prepaid, such funds will be used for additional portfolio investments. See ITEM 1 -- \"Investment Opportunities and Strategies.\"\nSales proceeds from the sale or disposal of portfolio properties totalled approximately $12.6 million, including $1.4 million of net proceeds from balloon payments of mortgages receivable in 1994. During the comparable period of 1993, sales proceeds totalled approximately $14 million, including $2.4 million of net proceeds from balloon payments of mortgages receivable. AREP entered into two joint ventures with unaffiliated co-venturers in June 1994 for the purpose of developing luxury garden apartment complexes in Hoover, Alabama, and Cary, North Carolina. In\nII-13\nthe year ended December 31, 1994, AREP invested approximately $5,500,000 in these joint ventures. In May 1993, AREP completed the construction of the BJ's Warehouse in Syracuse, New York for an aggregate cost of approximately $7,900,000, and an approximate $1.2 million cost for the adjacent parcel. In June 1993 AREP also acquired two non-performing mortgage loans on two residential apartment complexes located in Lexington, Kentucky for approximately $13 million. AREP foreclosed on each of these loans (one in 1993 and one in 1994) and now holds title to the underlying properties. See Notes 7(h) and (l) of the Financial Statements contained herein.\nII-14 ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS\nINDEPENDENT AUDITORS' REPORT\nThe Partners American Real Estate Partners, L.P.:\nWe have audited the accompanying consolidated balance sheets of American Real Estate Partners, L.P. and subsidiary as of December 31, 1994 and 1993, and the related consolidated statements of earnings, partners' 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 also have audited the 1994 financial statement schedule as listed in the Index at Item 14 (a) 2. These consolidated financial statements and the financial statement schedule are the responsibility of the Partnership'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 American Real Estate Partners, L.P. and subsidiary 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 New York, New York March 16, 1995\nII-15\nII-16\nII-17\nII-18\nII-19\nII-20\nAMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY ________________________________________\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 _____________________________________________\n1. ORGANIZATION AND BASIS OF PRESENTATION\nOn July 1, 1987, American Real Estate Holdings Limited Partnership (the \"Subsidiary\"), in connection with an exchange offer (the \"Exchange\"), entered into merger agreements with American Real Estate Partners, L.P. (the \"Company\") and each of American Property Investors, L.P., American Property Investors II, L.P., American Property Investors III, L.P., American Property Investors IV, L.P., American Property Investors V, L.P., American Property Investors VI, L.P., American Property Investors VII, L.P., American Property Investors VIII, L.P., American Property Investors IX, L.P., American Property Investors X, L.P., American Property Investors XI, L.P., American Property Investors 82, L.P. and American Property Investors 83, L.P. (collectively, the\"Predecessor Partnerships\"), pursuant to which the Subsidiary acquired all the assets, subject to the liabilities (known and unknown) of the Predecessor Partnerships.\nThe limited partners of the Predecessor Partnerships received limited partner interests in the Subsidiary. The number of such limited partner interests received by a limited partner was determined based upon his percentage ownership interest in the Predecessor Partnerships, the value of the Predecessor Partnerships' net assets and the number of limited partner interests allocable to the Predecessor Partnerships' general partners and their affiliates. The limited partner interests in the Subsidiary were contributed to the Company in exchange for limited partner interests therein. Limited partnership interests were allocable to the Predecessor Partnerships' general partners and their affiliates as a result of their rights: (i) to receive a portion of the cash flow of the Predecessor Partnerships by virtue of their ownership of interests in such partnerships and their entitlement to receive management fees and nonaccountable expense reimbursements and (ii) to share in the proceeds from the sale or liquidation of the assets of the Predecessor Partnerships and to receive real estate commissions with respect to the sale of properties by the Predecessor Partnerships. These rights of the Predecessor Partnerships' general partners and their affiliates were valued in connection with the Exchange. As a result of such valuation, and the assignment of the interests receivable by the corporate affiliates to American Property Investors, Inc. (the \"General Partner\"), an aggregate of 1,254,280 units and a 1% general partner interest in the Company were issued to the General Partner and 5,679 units were issued to noncorporate affiliates of the Predecessor Partnerships' general partners. In addition, the General Partner also received a 1% general partner interest in the Subsidiary.\nBy virtue of the Exchange, the Subsidiary owns the assets, subject to the liabilities, of the Predecessor Partnerships. The Company owns a 99% limited partner interest in the Subsidiary. The General Partner owns a 1% general partner interest in both the Subsidiary and the Company representing an aggregate 1.99% general partner interest in the Company and the Subsidiary.\nII-21\nThe participation in the transaction by a Predecessor Partnership was conditioned upon obtaining the approval of a majority-in-interest of the limited partners in such Predecessor Partnership. Such approvals were obtained with respect to each of the Predecessor Partnerships prior to July 1, 1987.\nDuring 1989, Integrated Resources, Inc. (\"Integrated\"), the former parent of the General Partner, experienced serious financial difficulties and, on February 13, 1990, it filed in the Bankruptcy Court for the Southern District of New York a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code (the \"Filing\"). The General Partner was a separate entity and neither the General Partner nor any other subsidiary of Integrated was included in the Filing.\nOn September 13, 1990, in connection with its voluntary petition for reorganization pursuant to Chapter 11 of the Bankruptcy Code, Integrated entered into an agreement whereby it agreed to sell all of its stock in the General Partner to Meadowstar Holding Company, Inc. (\"Meadowstar\"). Neither the Company nor the General Partner was a party to such agreement. The sale of the stock of the General Partner to Meadowstar was approved by the Bankruptcy Court on October 22, 1990. On November 15, 1990, pursuant to the terms of the Acquisition Agreement, Meadowstar purchased all of the outstanding shares of Common Stock of the General Partner. In May 1993, Carl C. Icahn acquired all of Meadowstar's interest in the General Partner.\nII-22\n2. SIGNIFICANT ACCOUNTING POLICIES\nFINANCIAL STATEMENTS AND PRINCIPLES OF CONSOLIDATION - The consolidated financial statements are prepared on the accrual basis of accounting and include only those assets, liabilities and results of operations which relate to the Company and the Subsidiary. All material intercompany accounts and transactions have been eliminated in consolidation.\nREGISTRATION COSTS AND EXPENSES OF THE EXCHANGE - Registration costs of the Predecessor Partnerships were charged against partners' equity upon the closing of the public offerings in accordance with prevalent industry practice. Expenses of the Exchange were charged against partners' equity upon consummation of the Exchange.\nNET EARNINGS AND DISTRIBUTIONS PER LIMITED PARTNERSHIP UNIT - For financial reporting purposes, the weighted average number of units assumed outstanding for the years ended December 31, 1994, 1993 and 1992 was 13,812,800, 13,889,667 and 14,058,153, respectively. There were no distributions in 1994. Distributions were $.50 per unit in 1993 and $1.00 per unit in 1992.\nUNIT OPTION PLAN - The Company adopted a Nonqualified Unit Option Plan (the \"Plan\") in 1987, which was further amended in 1989, under which options to purchase an aggregate of 1,416,910 Units may be granted to officers and key employees of the General Partner and the Company who provide services to the Company. To date, no options have been granted under the Plan.\nCASH AND CASH EQUIVALENTS - The Company considers short-term investments, which are highly liquid with original maturities of three months or less from date of issuance, to be cash equivalents.\nIncluded in cash and cash equivalents at December 31, 1994 and 1993 are investments in government backed securities of approximately $17,155,000 and $13,772,000, respectively.\nINCOME TAXES - No provision has been made for Federal, state or local income taxes since the Company is a partnership and, accordingly, such taxes are the responsibility of the partners.\nLEASES - The Company leases to others substantially all its real property under long-term net leases and accounts for these leases in accordance with the provisions of Financial Accounting Standards Board Statement No. 13, \"Accounting for Leases,\" as amended. This Statement sets forth specific criteria for determining whether a lease is to be accounted for as a financing lease or operating lease.\na. FINANCING METHOD - Under this method, minimum lease payments to be received plus the estimated value of the property at the end of the lease are considered the gross investment in the lease. Unearned income, representing the difference between gross investment and actual cost of the leased property, is amortized to income over the lease term so as to produce a constant periodic rate of return on the net investment in the lease.\nb. OPERATING METHOD - Under this method, revenue is recognized as rentals become due and expenses (including depreciation) are charged to operations as incurred.\nII-23\nPROPERTIES - Properties, other than those accounted for under the financing method, are carried at cost less accumulated depreciation unless declines in the values of the properties are considered other than temporary.\nFor each of the years ended December 31, 1994, 1993 and 1992 no individual real estate or series of assets leased to the same lessee accounted for more than 10% of the gross revenues of the Company. At December 31, 1994 and 1993, Portland General Electric Company occupied a property, consisting of corporate offices, which represented more than 10% of the Company's total assets.\nDEPRECIATION - Depreciation on properties accounted for under the operating method is computed using the straight-line method over the estimated useful life of the particular property or property components, which range from 5 to 45 years. When properties are sold or otherwise disposed of, the cost and accumulated depreciation are removed from the property account and the accumulated depreciation account, and any gain or loss on such sale or disposal is generally credited or charged to income (see Note 7).\nDEBT PLACEMENT COSTS - Debt placement costs are amortized on a straight-line basis over the term of the respective indebtedness.\nAssets Held for Sale - Assets held for sale are carried at the lower of cost or net realizable value.\nII-24\n3. CONFLICTS OF INTEREST AND TRANSACTIONS WITH RELATED PARTIES\na. The General Partner and its affiliates may realize substantial fees, commissions and other income from transactions involving the purchase, operation, management, financing and sale of the Partnership's properties, subject to certain limitations relating to properties acquired from the Predecessor Partnerships in the Exchange. Some of such amounts may be paid regardless of the overall profitability of the Partnership and whether any distributions have been made to Unitholders. As new properties are acquired, developed, constructed, operated, leased, financed and sold, the General Partner or its affiliates may perform acquisition functions, development and construction oversight and other land development services, property management and leasing services, either on a day-to-day basis or on an asset management basis, and other services and be entitled to fees and reimbursement of expenses relating thereto, including the Reinvestment Incentive Fee, property management fees, real estate brokerage and leasing commissions, fees for financing either provided or arranged by the General Partner and its affiliates, development fees, general contracting fees and construction management fees. The terms of any transactions between the Company and the General Partner or its affiliates must be fair and reasonable to the Company and customary to the industry.\nReinvestment incentive fees as payment for services rendered in connection with the acquisition of properties from July 1, 1987 through July 1, 1997 were 1% of the purchase price for the first five years and are 1\/2% for the second five years.\nReinvestment incentive fees are only payable on an annual basis if the sum of (x), the sales price of all Predecessor Partnerships' properties (net of associated debt which encumbered such properties at the consummation of the Exchange) sold through the end of such year, and (y), the appraised value of all Predecessor Partnerships' properties which have been financed or refinanced (and not subsequently sold), net of the amount of any refinanced debt, through the end of such year determined at the time of such financings or refinancings, exceeds the aggregate values assigned to such Predecessor Partnerships' properties for purposes of the Exchange. If the subordination provisions are not satisfied in any year, payment of reinvestment incentive fees for such year will be deferred. At the end of each year, a new determination will be made with respect to subordination requirements (reflecting all sales, financings and refinancings from the consummation of the Exchange through the end of such year) in order to ascertain whether reinvestment incentive fees for that year and for any prior year, which have been deferred, may be paid.\nFrom the commencement of the Exchange through December 31, 1994, the Company (i) sold or disposed of an aggregate of 126 properties of the Predecessor Partnerships for an aggregate of approximately $56,879,000, net of associated indebtedness which encumbered such properties at the consummation of the Exchange and (ii) refinanced 25 Predecessor Partnership properties with an aggregate appraised value, net of the amount of the refinanced debt, of approximately $44,431,000 for a sum total of approximately $101,310,000. Aggregate appraised values attributable to such properties for purposes of the Exchange were approximately $88,322,000. Fifteen properties have been acquired since the commencement of the Exchange, including two joint ventures entered into in 1994, for aggregate purchase prices of approximately $52,000,000. Reinvestment incentive fees of approximately $354,000 have previously been paid to the General Partner, and approximately $113,000 are payable to the General Partner for the 1994 acquisitions. The property acquired in 1992 was subject to a\nII-25\nconditional sale agreement (see Note 7); therefore, no reinvestment incentive fee was due at December 31, 1992.\nb. The Company entered into a lease, effective June 1, 1991, for approximately 6,900 square feet of office space with an affiliate of the General Partner. The lease is for a ten year term and provides for initial monthly rent (inclusive of charges for utilities) of $11,642, which amount increased to $12,936 on June 1, 1994 and increases to $14,804 on June 1, 1997. The terms of the lease agreement were reviewed for fairness by the Audit Committee of the Board of Directors of the General Partner which determined that the terms of such transaction were fair and reasonable to the Company. In evaluating the transaction, the Audit Committee consulted with an independent appraiser regarding the terms of the lease. For the year ended December 31, 1992, the Company paid $139,704 in rent.\nOn December 29, 1992, the affiliate of the General Partner assigned its interest in the lease to an unaffiliated third party.\nII-26\n4. REAL ESTATE LEASED TO OTHERS ACCOUNTED FOR UNDER THE FINANCING METHOD\nReal estate leased to others accounted for under the financing method is summarized as follows:\nDecember 31, -------------------------------- 1994 1993 --------------- --------------- Minimum lease payments receivable $446,943,110 $497,100,936 Unguaranteed residual value 171,636,874 175,214,737 ------------ ------------- 618,579,984 672,315,673 Less unearned income 304,319,198 344,845,351 ------------ ------------- $314,260,786 $327,470,322 ============ =============\nThe following is a summary of the anticipated future receipts of the minimum lease payments receivable at December 31, 1994:\nYear ending December 31, Amount -------------------- --------------- 1995 $ 38,439,834 1996 38,397,613 1997 38,366,876 1998 38,293,967 1999 37,214,924 Thereafter 256,229,896 -------------- $ 446,943,110 ==============\nAt December 31, 1994, approximately $244,463,000 of the net investment in financing leases was pledged to collateralize the payment of nonrecourse mortgages payable.\nII-27\n5. REAL ESTATE LEASED TO OTHERS ACCOUNTED FOR UNDER THE OPERATING METHOD\nReal estate leased to others accounted for under the operating method is summarized as follows:\nDecember 31, ---------------------------- 1994 1993 ------------- -------------\nLand $ 57,411,117 $ 53,446,863 Commercial building 112,762,861 107,809,870 ------------- -------------- $170,173,978 $ 161,256,733 Less accumulated depreciation 46,735,534 44,317,402 ------------- -------------- $123,438,444 $ 116,939,331 ============= ==============\nAs of December 31, 1994 and 1993, accumulated depreciation on the hotel operating properties (not included above) amounted to approximately $1,499,000 and $723,000, respectively (see Note 7).\nThe following is a summary of the anticipated future receipts of minimum lease payments under noncancelable leases at December 31, 1994:\nYear ending December 31, Amount ------------ ----------- 1995 $14,413,774 1996 13,554,598 1997 11,872,170 1998 10,650,677 1999 9,174,571 Thereafter 36,548,268 ------------ $96,214,058 ============\nAt December 31, 1994, approximately $91,029,000 of real estate leased to others was pledged to collateralize the payment of nonrecourse mortgages payable.\nII-28\n6. MORTGAGES RECEIVABLE\n(a) See Note 7.\n(b) 5.75% is paid currently and 3.25% is deferred. The principal and deferred interest is payable in monthly installments from March 1999 until November 2005.\n(c) 4.5% is paid currently and 4.5% is deferred until maturity.\n(d) Payments (with interest only at 9%) are $46,931 through November 1, 1996 and $54,276 through September 1, 2001 (See Note 12a).\n(e) Interest only will accrue until December 1, 2010; commencing January 1, 2011, monthly payments of $39,035 will be due, which will self-amortize the outstanding principal and current and deferred interest, with the final payment due December 1, 2019. Increased rentals on the property, if any, during the renewal term of the underlying lease will be applied against accrued interest and then the outstanding principal.\n(f) On January 16, 1992, the purchase money mortgage was amended. The maturity date was extended to November 1994 and the monthly payments decreased to $27,800 commencing February 1, 1992. Under the terms of the amendment, the maturity date has been further extended to February 1997 to coincide with Easco's renewal of its lease for an additional ten years.\nThe Company has generally not recognized any profit in connection with the property sales in which the above purchase money mortgages receivable were taken back. Such profits are being deferred and will be recognized when the principal balances on the purchase money mortgages are received.\nII-29\n7. SIGNIFICANT PROPERTY TRANSACTIONS\nInformation on significant property transactions during the three-year period ended December 31, 1994 is as follows:\na. On March 27, 1991, The Public Building Commission of Chicago (\"Public Building Commission\") commenced a condemnation proceeding against a property leased by The TJX Companies, Inc. The condemnation proceeding was settled on March 12, 1993 when the Company received approximately $4,305,000 from the tenant who purchased the property in accordance with their lease obligations. A net gain of approximately $1,575,000 was recognized on this transaction in the year ended December 31, 1993.\nb. The lease on a property formerly tenanted by Occidental Petroleum Corp. initially expired June 30, 1992 and was extended to March 1993 on a month-to-month basis. Based on existing conditions, the Company believed the carrying value at December 31, 1992 to be substantially in excess of the property's value, and as a result, wrote the asset down to its recoverable value by incurring a provision for loss on real estate in the amount of $1,400,000 for the year then ended. This asset has a carrying value of approximately $2,242,000 and is encumbered by a nonrecourse mortgage payable of approximately $2,182,000 as of December 31, 1994.\nThe Company has obtained zoning approval which will enable the re-development of the site into a 67,000 square foot retail center with two out parcels totaling 11,000 square feet of rentable area.\nc. On April 2, 1990, Amdura Corp., formerly American Hoist and Derrick Co., and certain of its subsidiaries, including Amdura National Distribution Company, a tenant of a property owned by the Company, filed voluntary petitions for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. The Company and the tenant previously executed an agreement which permitted the tenant to assume the lease and pursue assignment of said lease, subject to the Company's approval, during a specified time period. The tenant was unsuccessful in assigning the lease and, as a result, the lease was terminated and the Company took possession of the premises effective August 1, 1992. In accordance with this agreement, the Company was entitled to and recognized approximately $657,000 of income in full settlement of all claims against the tenant. This was included in \"Other income\" for the year ended December 31, 1992. The lease termination initially adversely impacted day-to-day operating cash flow by approximately $35,000 per month. During the year ended December 31, 1994, operating rental income exceeded expenses by approximately $575,000. During the year ended December 31, 1993, operating expenses exceeded rental income by approximately $280,000. As of December 31, 1994, the property is 100% leased. The property has a carrying value of approximately $3,699,000 and is encumbered by a nonrecourse mortgage payable of approximately $1,554,000 as of December 31, 1994. Based on current circumstances, the Company believes that the carrying value of the asset\nII-30\nis fairly stated. The Company engaged and continues to use a management company to perform supervisory management and leasing services, including the leasing of any vacant portions of the premises.\nd. On September 27, 1991, Days Inn of America, Inc. (\"Days Inn\"), a tenant of a property owned by the Company, located in Atlanta, Georgia, filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. The tenant, by order of the Bankruptcy Court, rejected the lease effective July 31, 1992. As of December 31, 1992, the tenant was in arrears by approximately $250,000 in rent and real estate taxes, both of which were pre-petition obligations. Subsequent to the filing, the tenant was current in its lease obligations. The Company previously wrote the asset down to what it believed was the recoverable value by incurring a provision for loss on real estate in the amount of approximately $4,252,000 for the year ended December 31, 1991. The asset whose carrying value at December 31, 1994 is approximately $4,537,000 is unencumbered by any mortgage.\nThe Company submitted a claim to the Bankruptcy Court and in August 1993, it reached a settlement of this claim against Days Inn, now known as Buckhead America Corporation (\"Buckhead\"). As a result, the Company has received cash in the amounts of approximately $184,000 and $730,000 in the years ended December 31, 1994 and 1993, respectively. In addition, stock in Buckhead valued at approximately $305,000 was received in the year ended December 31, 1993. These amounts of approximately $184,000 and $1,035,000 have been included in \"Other income\" for the years ended December 31, 1994 and 1993, respectively. The Buckhead stock was disposed of in 1994 with a nominal gain.\nEffective August 1, 1992 the Company engaged a management company to perform on-site and supervisory management services. The lease rejection has adversely impacted operating cash flow by approximately $110,000 per month. In addition, the Company expects to incur costs of approximately $3,200,000, as leases are executed, to renovate, build-out and re-lease the property.\ne. On July 14, 1992, Integra, A Hotel and Restaurant Company (\"Integra\"), which leased two hotel properties located in Miami, Florida and Phoenix, Arizona filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Bankruptcy Code. The tenant's petition, previously filed with the Bankruptcy Court, to reject the aforementioned leases, was approved on August 7, 1992 and the Company assumed operation of the properties on that date. As of December 31, 1992, the tenant was in arrears by approximately $720,000 for which an allowance of approximately $543,000 was provided in the year then ended. In addition, real estate taxes representing a pre-petition obligation were paid or accrued in the amount of approximately $425,000. These taxes were included in \"Property expenses\" for the year ended December 31, 1992. The Company has submitted a claim to the Bankruptcy Court.\nAt December 31, 1994, the property located in Miami, Florida has a carrying value of approximately $5,774,000 and is encumbered by nonrecourse mortgages payable of approximately $46,000. This property is subject to a ground lease. Based on current conditions, management\nII-31\nbelieves the carrying value of the Miami property is reasonably stated.\nBased on existing conditions and discussions with certain operators and managers of hotels, management believed the recoverable value of the Phoenix property to be substantially less than its carrying value. As a result, the Company wrote the property down by incurring a provision for loss on real estate in the amount of $4,538,000 in the year ended December 31, 1992. At December 31, 1994, this property has a carrying value of approximately $7,880,000 and is encumbered by a nonrecourse mortgage payable of approximately $3,286,000.\nThis mortgage was refinanced during the year ended December 31, 1994 (see Note 8).\nDuring the year ended December 31, 1993, the Company completed major renovations at the Miami and Phoenix Holiday Inns with capital expenditures totalling approximately $1,700,000 and $400,000, respectively. In connection with these renovations, approximately $250,000 of nonrecurring maintenance expenses were incurred at the Miami location. These expenses were included in hotel operating expenses for the year ended December 31, 1993. During the year ended December 31, 1994, additional capital expenditures of approximately $190,000 and $240,000 were incurred at the Miami and Phoenix Holiday Inns, respectively.\nThe Company has entered into a management agreement for the operation of the hotels with a national management organization. Since August 7, 1992, the hotels have been classified as Hotel Operating Properties and their revenues and expenses separately disclosed in the Consolidated Statements of Earnings. From August 7 through December 31, 1992, net hotel operations (hotel operating revenues less hotel operating expenses) totalled approximately $795,000. This was $100,000 less than the rent would have been from the rejected leases for the same period. Net hotel operations totalled approximately $1,781,000 and $1,195,000 for the years ended December 31, 1994 and 1993, respectively. This was approximately $379,000 and $965,000 less than the rent would have been from the rejected leases for the years then ended, respectively. Hotel operating expenses include all expenses except for approximately $215,000 of depreciation and $322,000 of interest expense for the period commencing August 7, 1992 through year end and approximately $776,000 and $509,000 of depreciation and $456,000 and $742,000 of interest expense for the years ended December 31, 1994 and 1993, respectively. These amounts are included in their respective captions in the Consolidated Statements of Earnings. The results for the year ended December 31, 1994 are not necessarily indicative of future operating results.\nf. During 1992, leases on two properties formerly tenanted by Petrolane, Inc. located in Belle Chasse, LA and Nisku, Alberta, Canada, expired and were re-let at rents substantially less than the previous leases. The new lease on the former location expires April 1996 and includes a purchase option for $575,000. The latter location's new lease expires March 1995. After evaluating the existing market conditions and the\nII-32\npotential use of the facilities, the Company believed the Belle Chasse property's carrying value at September 30, 1992 of approximately $1,267,000 to exceed the recoverable value in the amount of $517,000 and the Nisku property's carrying value at September 30, 1992 of approximately $1,020,000 to exceed the recoverable value in the amount of $270,000. As a result, the Company recorded a provision for loss on real estate in the amount of $787,000 for the year ended December 31, 1992. In addition, after further evaluation and review, the Company believed the Belle Chasse property's carrying value at June 30, 1994 to exceed the recoverable value in the amount of $237,000. As a result, the Company recorded a provision for loss on real estate in the amount of $237,000 for the year ended December 31, 1994.\ng. On December 9, 1991, Stop N Go Markets of Texas, Inc. (National Convenience Stores, Inc.) filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Bankruptcy Code. The tenant, who previously leased twenty-three locations, filed a motion with the Bankruptcy Court to assume four leases and reject the remaining leases. Pursuant to a stipulation by the Bankruptcy Court on February 4, 1993, the tenant's motion was approved effective as of August 31, 1992. The tenant was in arrears in the approximate amount of $6,000 rent and $34,000 of real estate taxes as of December 31, 1992. On March 19, 1993, the Company filed a proof of claim with the Bankruptcy Court. In November 1993, the Company received stock of the debtor valued at approximately $123,000 in partial settlement of its claim. This total has been included in \"Other income\" for the year ended December 31, 1993. In May of 1994 additional stock of the debtor was received. The total value of the stock at December 31, 1994 of $102,000 is based on the lower of cost or market.\nIn 1994, all four of the leased locations were sold. The remaining nineteen properties, whose rents totaled approximately $217,000 per year, were actively marketed for sale by the Company. Based on existing market conditions, the Company believed the carrying value of approximately $1,781,000 at December 31, 1992 to exceed the estimated net realizable value by $780,000, for which a provision for loss on real estate was recorded during the year then ended. During the years ended December 31, 1994 and 1993, the Company sold ten and nine of these locations, respectively. A nominal gain was recognized on the disposal of all twenty-three properties.\nh. On November 2, 1992, the Company purchased approximately fifteen acres of land in East Syracuse, New York for approximately $3,500,000 and contracted to build a 116,000 square foot BJ's Warehouse Store (\"BJ's\") upon the site. The Company has entered into a twenty year lease with Waban, Inc. (\"Waban\"), the parent company of BJ's Warehouse Club. Construction was substantially completed on May 22, 1993 and Waban took possession of the premises, which is situated on approximately ten acres of land, and commenced rental payments on that date. The lease provides for an initial annual net rental of $659,262 with CPI increases every five years, not to exceed 8.77%. Under the lease, Waban is responsible for any required structural repairs. Of the remaining five acres of adjacent land approximately 3.6 acres is available for future development by the Company.\nII-33\nSimultaneously with the acquisition of the property, the Company entered into a general construction contract with the seller (the \"GC Agreement\") pursuant to which the seller (the \"Seller\") was required to construct BJ's in accordance with the terms and conditions of the lease for a guaranteed maximum amount of $2,327,802. However, the construction of BJ's was subject to delays and the Seller did not meet all of its construction obligations under the GC Agreement and failed to cure such defaults. The Company sent a notice, dated February 19, 1993, terminating the GC Agreement and assumed the construction obligations. The Company contacted the surety of the GC Agreement pertaining to the site work. The surety was not responsive to the Company. The Company has determined at this point to not pursue any potential claims it may have because after further investigation, it believes such claims will not be able to be satisfied.\nAt December 31, 1994, the BJ's land, including related improvements, cost a total of approximately $4,996,000 and the building cost a total of approximately $3,105,000. The adjacent land available for future development, including related improvements, cost a total of approximately $1,256,000. Approximately $268,000 of interest was capitalized which included $210,000 and $58,000 during the years ended December 31, 1993 and 1992, respectively.\nA reinvestment incentive fee was paid to the General Partner of approximately $45,000 pertaining to this acquisition and development.\nThe Company received permanent financing of $4,000,000 on the BJ's parcel and improvements. (see Note 8).\ni. At December 31, 1992, the Company owned fifteen properties tenanted by Nationsbank, formerly NCNB National Bank of South Carolina. The leases on fourteen of these properties expired in December 1992 and one expired in March 1993; however, nine leases were extended to March 1993 in connection with an executed agreement (the \"Agreement\") entered into between the Company and the tenant to purchase and\/or lease any one or more of ten locations, including the property whose lease expired in March 1993. The tenant elected to purchase four and lease six properties in accordance with the Agreement. The four properties which were sold on March 26, 1993 had a carrying value of approximately $4,357,000 and were unencumbered by any mortgage at December 31, 1992. Since the contracted selling price of approximately $5,300,000 exceeded the carrying value, the Company believed the assets were fairly stated. The six leased locations were re-let at an annual rental of approximately $214,000, a reduction of approximately $196,000 from the previous rent. As a result, the Company believed the carrying value at December 31, 1992 exceeded the recoverable value and wrote the properties down by incurring a provision for loss on real estate in the amount of $1,000,000 for the year then ended. At December 31, 1994, these properties have a carrying value of approximately $2,081,000 and are unencumbered by any mortgage.\nOf the remaining five properties whose leases were not extended, one was sold on January 20, 1993. The property had a carrying value at December 31, 1992 of\nII-34\napproximately $261,000 that exceeded the net realizable value and therefore the Company wrote the property down by incurring a provision for loss on real estate in the amount of $192,165 for the year then ended. This asset was unencumbered by any mortgage at December 31, 1992.\nAnother property, whose carrying value at December 31, 1992 was $357,000 was written down by incurring a provision for loss on real estate in the amount of $182,000 in the three months ended March 31, 1993 and subsequently sold on April 15, 1993. The other three properties were sold during the year ended December 31, 1994.\nj. On July 31, 1993, the Company held a nonrecourse mortgage in the amount of approximately $3,456,000 secured by four properties tenanted by Toys \"R\" Us, Inc. The mortgage had been taken back by a Predecessor Partnership in connection with the sale of such properties. The tenant remained current in its obligations under the lease. The terms of the mortgage called for a balloon payment of approximately $3,456,000 on January 1, 1993 which was not received. The Company reacquired these properties in satisfaction of such mortgage and as of August 1, 1993 real estate with a carrying value of approximately $5,883,000 and a nonrecourse mortgage payable with a balance of approximately $2,904,000 were recorded. No gain or loss resulted upon foreclosure because the estimated fair value of the properties exceeds their carrying value. These properties have a carrying value of approximately $5,799,000 and are encumbered by a nonrecourse mortgage payable of approximately $3,354,000 at December 31, 1994. See Note 8 concerning the mortgage refinancing in 1994.\nk. On December 31, 1992, the Company held four nonrecourse wrap-around mortgages in the amount of approximately $7,689,000 secured by four properties tenanted by The Wickes Corp. The mortgages had been taken back by a Predecessor Partnership in connection with the sale of such properties. The tenant remained current in its obligations under the lease. However, the Company did not receive monthly debt service payments on these mortgages from the purchaser. Additionally, the terms of mortgages called for balloon payments of approximately $7,689,000 on January 1, 1993 which were not received. However, the tenant had previously purchased one property from the debtor and in January 1993, the tenant paid the balloon mortgage due on the property net of the underlying first mortgage, which it assumed. A gain of approximately $1,371,000 was recognized on this transaction in the year ended December 31, 1993.\nIn addition, the debtor paid the balloon mortgage due on one property, net of the underlying first mortgage in August of 1993. A gain of approximately $784,000 was recognized in the year ended December 31, 1993.\nIn January 1994, the debtor paid the balloon mortgage due, net of the underlying first mortgage, on one Wickes property and a gain of approximately $1,238,000 was recognized in the year ended December 31, 1994. In addition, the Company foreclosed on the remaining Wickes\nII-35\nproperty in January 1994 and real estate with a carrying value of approximately $643,000 was recorded in the year ended December 31, 1994. No gain or loss was incurred upon foreclosure because the estimated fair value of the property is equal to its carrying value. The mortgage balance on this remaining property is approximately $544,000 at December 31, 1994.\nl. On June 17, 1993, the Company purchased two non- performing mortgage loans for a combined price of $13,000,000. Each loan was collateralized by a residential apartment complex located in Lexington, Kentucky. The face value of the non-performing loans was approximately $21,188,000.\nThe first non-performing loan, purchased for $6,990,000, was collateralized by a 396 unit multi-family complex. The Company foreclosed on this property (\"Stoney Falls\"), and received the deed on October 11, 1993. The Company has entered into a management agreement for the operation of this property with a national management organization which began operating the property effective September 1, 1993. Subsequent to the acquisition, the Company received distributions from the receiver and cash flow from the property pertaining to the period prior to formal foreclosure, net of expenditures incurred by the Company, which have been applied as a reduction to the initial cost of the loan. This net cash flow, subsequent to the acquisition, totalled approximately $94,000. During the year ended December 31, 1994, the Company completed major renovations which totalled approximately $1,360,000. In connection with these renovations, approximately $350,000 of non recurring maintenance expenses were incurred. These expenses are included in \"property expenses\" for the year ended December 31, 1994. This asset has a carrying value of approximately $8,078,000 at December 31, 1994.\nThe second non-performing loan, purchased for $6,010,000, is collateralized by a 232-unit apartment complex. Foreclosure proceedings were initiated in April 1993 resulting in the debtor filing for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. The Company executed an agreement with the borrower, which was approved by the Bankruptcy Court, and foreclosed on this property (\"Stoney Brooke\") and received the deed on February 11, 1994. Subsequent to the acquisition, the Company received distributions from the seller of the note and began to receive cash flow from the property pertaining to the period prior to formal foreclosure, net of expenditures incurred by the Company, which have been applied as a reduction to the initial cost of the loan. This cash flow, net of expenditures incurred by the Company, totalled approximately $735,000. This property at December 31, 1994 has a carrying value of approximately $5,144,000.\nA reinvestment incentive fee of approximately $65,000 was paid the General Partner (See Note 3).\nSee Note 8 in connection with the mortgage financing of these two properties in 1994.\nm. In March 1994, the Company foreclosed on the property tenanted by Webcraft Technologies and KSS Transportation.\nII-36\nAs a result, real estate with a carrying value of approximately $626,000 was recorded in the year ended December 31, 1994. No gain or loss was incurred upon foreclosure because the estimated fair value of the property is believed to exceed its carrying value.\nn. In June 1994, the Company sold a property to the tenant, Lockheed Sanders, Inc. The property, which was located in Plainfield, N.J., was subject to a purchase option which was exercised. The selling price was $5,625,000 and a gain of approximately $1,961,000 was recognized in the year ended December 31, 1994. The property was unencumbered by any mortgage.\no. The Company entered into two joint ventures in June 1994 with unaffiliated co-venturers for the purpose of developing luxury garden apartment complexes. Both of these joint ventures have been consolidated in the accompanying financial statements.\n1. The first joint venture, formed as an Alabama Limited Liability Company, will develop a 240 unit multi-family project situated on approximately twenty acres, currently owned by the joint venture, located in Hoover, Alabama, a suburb of Birmingham. The Company, which owns a seventy percent (70%) majority interest in the joint venture, contributed $1,750,000 in June 1994 and the co-venturer contributed $250,000. As of December 31, 1994 $250,000 representing the minority interest of the co-venturer has been included in \"Accounts payable, accrued expenses, and other liabilities\" in the accompanying financial statements. The Company has no further funding commitment. Distributions will be made in proportion to ownership interests. Construction financing has been obtained by the joint venture in the amount of $8,760,000 and is guaranteed by the co-venturer and personally by its principals. The development costs are expected to total approximately $11,350,000. As of December 31, 1994, approximately $5,529,000 of development costs have been incurred, including the acquisition of land valued at approximately $1,138,000. Construction loan funding at December 31, 1994 was approximately $2,400,000. The first units were completed and available for occupancy in February 1995 and project completion is scheduled for August 1995. An affiliate of the Company's co-venturer will manage the property.\nA reinvestment incentive fee of approximately $40,000 will be due the General Partner upon completion of the project (see Note 3).\n2. The second joint venture, a Delaware limited partnership, will develop a 288-unit multi-family project situated on approximately thirty-three acres in Cary, North Carolina (Raleigh-Durham area). The Company, which owns a ninety percent (90%) majority interest in the partnership, has contributed approximately $3,744,000 as of December 31, 1994 and is a limited partner. The co-venturer\nII-37\nis the general partner and has a limited partner interest. The Company is entitled to a cumulative annual preferred return of 12% on its investment before cash distributions are made in proportion to ownership interests. The Company has made its final contribution which totalled approximately $278,000 in January 1995. Construction financing has been obtained by the joint venture in the amount of $12,205,000 and is guaranteed by the joint venture general partner and personally by its principals. The development costs are expected to total approximately $16,100,000. As of December 31, 1994, approximately $3,891,000 of development costs have been incurred, including the acquisition of land valued at $1,600,000. The first units are expected to be available for occupancy on or about July 1995 and project completion is scheduled for February 1996. An affiliate of the Company's co- venturer will manage the property.\nA reinvestment incentive fee of approximately $70,000 will be due the Company's General Partner upon completion of the project (see Note 3).\nII-38\n8. MORTGAGES PAYABLE\nAt December 31, 1994, mortgages payable, all of which are nonrecourse to the Company, are summarized as follows:\nThe following is a summary of the anticipated future principal payments of the mortgages:\nYear ending December 31, Amount -------------- -------------- 1995 $ 13,556,295 1996 25,230,486 1997 14,461,679 1998 8,917,349 1999 21,818,304 2000-2004 61,154,049 2005-2009 24,523,090 2010-2014 4,377,923 2015-2017 56,522 -------------- $ 174,095,697 ==============\na. On November 5, 1992, the Company closed a nonrecourse mortgage on the property located in Broomal, PA. The mortgage is in the amount of $3,000,000, bears interest at 9.125%, and matures October 15, 1997. Monthly debt service is approximately $38,000. Debt placement costs totaled approximately $145,000. The new mortgage replaces a previous wrap-around mortgage, which bore interest at 9 1\/2%, that was prepaid at a discount in December 1991.\nb. On April 15, 1992, the Company refinanced a nonrecourse mortgage loan which had an outstanding principal balance of approximately $4,677,000. The mortgage encumbered a property tenanted by The Rouse Company and bore interest at 8.625%. The original maturity date was April 1, 1999; however, in 1991 the lender called the mortgage as provided for under the terms of the loan. The new nonrecourse mortgage loan, which is in the principal amount of $5,000,000, bears interest at 9.5%, matures May 1, 2004 and is self-liquidating. Debt placement costs of approximately $153,000 were incurred. No gain or loss was incurred as a result of this transaction.\nII-39\nc. On May 1, 1992, the Company refinanced a nonrecourse mortgage loan which had an outstanding principal balance of approximately $11,803,000. This mortgage encumbered fifteen properties tenanted by the Louisiana Power and Light Company. It was scheduled to mature on November 1, 2000 and bore interest at 13.5%. The new mortgage loan was obtained at an interest rate of 8.79%, in the principal amount of $13,000,000, matures November 15, 2000 and is self-liquidating. Debt placement costs of approximately $390,000 were incurred. Prepayment penalties in connection with the extinguishment of the former debt totaled approximately $785,000. As a result, an extraordinary loss of the same amount was recorded during the year ended December 31, 1992. The monthly debt service of approximately $180,000 reflects a decrease of $14,000.\nd. As of June 1, 1992, the Company consummated a modification and extension of a nonrecourse mortgage loan which had an outstanding principal balance of approximately $4,713,000. This mortgage encumbers a property tenanted by Forte Hotels, Inc. It matured June 1, 1992 and bore interest at 9% per annum. In accordance with the modified terms, approximately $2,357,000 of the outstanding principal balance was repaid on June 1, 1992. The remaining principal balance matures June 1, 1998, bears interest at 10.75%, and is self-liquidating with monthly payments of approximately $45,000. An extension fee of approximately $24,000 was incurred in connection with this transaction.\ne. On October 18, 1993, the Company obtained permanent financing on the BJ's property in East Syracuse, New York. The nonrecourse loan is in the principal amount of $4,000,000, bears interest at 8.25% per annum, and matures October 31, 1998 at which time the Company has the option to extend the loan for one to five years, providing certain conditions are met. The monthly debt service is approximately $34,000. Debt placement costs of approximately $156,000 have been incurred.\nf. On December 13, 1993, the Company prepaid a mortgage with an outstanding balance of $3,038,346 that encumbered a property tenanted by the Lockheed Corporation, located in Burbank, CA. This mortgage was scheduled to mature on February 1, 1996 and bore interest at 16%. Prepayment penalties of approximately $91,000 were incurred.\ng. On December 22, 1993, the Company refinanced a nonrecourse mortgage loan which had an outstanding principal balance of approximately $7,613,000. This mortgage encumbered a property tenanted by Super Foods Services, Inc. It was scheduled to mature on October 1, 2010 and bore interest at 11.076%. The new mortgage loan which is self-liquidating is in the principal amount of $7,650,000, bears interest at 8.25% per annum, and matures August 1, 2010. Debt placement costs of approximately $333,000 and prepayment penalties of approximately $76,000 were incurred. The new annual debt service of approximately $846,000 reflects a decrease of $156,000 and initial interest savings of approximately $215,000 in 1994.\nII-40\nh. On March 4, 1994, the Company paid off one nonrecourse mortgage loan and refinanced two nonrecourse mortgage loans that encumbered a total of seven properties tenanted by Toys \"R\" Us. The loan paid off, which encumbered one property, had an outstanding principal balance of approximately $616,000, bore interest at 10.375%, and was callable at the lender's option in 1994. The two loans refinanced had outstanding principal balances of approximately $1,550,000 and $2,863,000, bore interest at 9.25% and 9.55%, were self-liquidating, and were callable at the lender's option in 1995 and 1996, respectively. The two new mortgage loans, in the principal amounts of approximately $1,464,000 and $3,636,000, bear interest at 7.08%, are self-liquidating and mature January 15, 2012. Debt placement costs of approximately $226,000 have been incurred. The new annual debt service of approximately $532,000 reflects a decrease of approximately $89,000.\ni. A balloon payment of approximately $6,266,000 was originally due June 1, 1994 on a nonrecourse mortgage which encumbered the Holiday Inn in Phoenix, Arizona; however, the Company paid off approximately $2,966,000 on that date and was granted an extension on the remaining balance. The interest rate was 10.75%. On June 27, 1994 the Company refinanced the remaining balance with a nonrecourse mortgage loan in the amount of $3,300,000. The new mortgage loan matures July 27, 1999, bears interest at 10.35% and has a balloon payment due at maturity of approximately $3,120,000. Debt placement costs of approximately $143,000 were incurred. The new annual debt service is approximately $370,000.\nj. On July 25, 1994 the Company obtained financing on the two apartment complexes located in Lexington, Kentucky. The two nonrecourse mortgage loans in the amount of $5,500,000 and $4,500,000 for Stoney Falls and Stoney Brooke Apartments, respectively, bear interest at 8.375% and mature in ten years when balloon payments totaling approximately $8,150,000 will be due. Under the terms of the loans, $100,000 was initially funded on each loan with the balance funded in January 1995. Debt placement costs of approximately $250,000 have been incurred. Annual debt service on the two loans is approximately $956,000.\nk. On December 9 and 23, 1994, the Company prepaid the first and second mortgages, respectively, with aggregrate outstanding balances of approximately $3,364,000 which encumbered a property tenanted by Chomerics, Inc. located in Woburn, Massachusetts. The first and second mortgages were scheduled to mature August 1, 2011 and February 1, 2005, respectively, and both bore interest at 13.875%. The first mortgage was callable August 1, 1996.\nII-41\n9. SENIOR INDEBTEDNESS\nOn May 27, 1988, the Company closed a $50,000,000, 10-year senior unsecured debt financing. The notes bear interest at 9.6%, payable semiannually, 2% of which may be deferred and added to the principal at the Company's option during the first five years. During 1993 and 1992, $546,842 and $1,077,496, respectively, were added to the principal of the note. In May 1994, the Company repaid $10,000,000 of the outstanding principal balance of the notes. The Company is required to make principal repayments of approximately $11,308,000 in each of the years 1995 through 1998.\nThe note agreements also place limitations on the Company with respect to, among other things, additional debt and the use of proceeds from property sales. In addition, distributions and the amounts used to purchase partnership interests cannot exceed cash flow, as defined in the agreements, plus $15,000,000. The Company is also required to maintain, among other things, specified levels of (i) net annual rentals, as defined in the agreements, on properties unencumbered by mortgage financing and (ii) net cash flow.\nII-42\n10. RECONCILIATION OF NET EARNINGS PER FINANCIAL STATEMENTS TO TAX REPORTING\n1994 1993 1992 ------------ ------------ ------------ Net earnings per financial statements $ 23,168,564 $ 22,676,754 $ 11,291,877 Minimum lease payments 6,708,644 6,066,011 5,592,462 received, net of income earned on leases accounted for under the financing method Gain on real estate 1,325,735 228,436 119,712 transactions for tax purposes in excess of that for financial statement purposes Provision for loss for 582,000 462,000 8,847,165 financial statement purposes Difference attributed to (29,367) (25,094) (4,243) joint ventures and minority interest Difference between expense (256,431) 584,286 1,768,031 accruals, net of income accruals, at beginning of year and end of year Depreciation and (9,532,694) (9,818,998) (10,124,573) amortization for tax purposes in excess of that for financial statement purposes due to leases accounted for under the financing method Other (26,218) (26,218) (26,218) ------------ ------------ ----------- Taxable income $ 21,940,233 $ 20,147,177 $17,464,213 ============ ============ ===========\nII-43\n11. QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS, EXCEPT PER UNIT DATA)\nThree Months Ended --------------------------------------------- March 31, June 30, ---------------------- ---------------------- 1994 1993 1994 1993 -------- --------- --------- --------\nRevenues $15,943 $15,787 $15,156 $14,342 ======== ========= ========= ======== Earnings before property transactions $ 5,231 $ 5,375 $ 5,030 $ 4,093 Provision for loss on real estate (75) (182) (237) (196) Gains on property transactions 1,364 3,806 2,236 34 -------- -------- --------- -------- Net earnings $ 6,520 $ 8,999 $ 7,029 $ 3,931 ======== ======== ========= ======== Net earnings per limited partnership unit $.46 $.63 $.50 $.28 ======== ======== ========= ========\nThree Months Ended --------------------------------------------- September 30, December 31, --------------------- --------------------- 1994 1993 1994 1993 --------- --------- --------- ---------- Revenues $14,750 $14,952 $15,702 $15,076 ========== ========= ========= ========== Earnings before property transactions $ 4,411 $ 4,592 $ 4,905 $ 4,319 Provision for loss on real estate (75) - (195) (84) Gains on property transactions 238 899 336 21 ---------- --------- ---------- --------- Net earnings $ 4,574 $ 5,491 $ 5,046 $ 4,256 ========== ========= ========== ========= Net earnings per limited partnership unit $ .32 $ .39 $ .36 $ .30 ========== ========= ========== =========\nNet earnings per unit is computed separately for each period and, therefore, the sum of such quarterly per unit amounts may differ from the total for the year.\nII-44\n12. COMMITMENTS AND CONTINGENCIES\na. On January 4, 1991, Best Products Co., Inc., a tenant in a property owned by the Company, filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. On June 14, 1994 the tenant came out of bankruptcy and affirmed the leases. The tenant has remained and is current in its obligations under the lease. As of December 31, 1994, the property had a carrying value of approximately $3,742,000 and is encumbered by a nonrecourse mortgage payable of approximately $256,000.\nb. On September 16, 1991, the Company brought suit against Alco Standard Corporation and its affiliates, a former tenant of an industrial facility located in Rome, Georgia whose lease expired in October 1990. The action was brought against the defendants in the United States District Court Northern District of Georgia, Rome Division for reimbursement of costs that could be incurred for clean-up of hazardous materials on the site and certain deferred maintenance. In July 1994, this litigation was settled and the property was sold for $525,000. A gain of approximately $100,000 was recognized in the year ended December 31, 1994. In addition, Alco reimbursed the Company for $150,000 of expenses incurred and indemnified the Company against any future liability in connection with any site contamination. The expense reimbursement has been included in \"Property expenses\" in the financial statements for the year ended December 31, 1994.\nc. On July 31, 1992, Chipwich, Inc. (\"Chipwich\"), parent of Peltz Food Corporation, a tenant in a property owned by the Company, filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. Chipwich then filed a motion for rejection of the lease and, pursuant to an order of the Bankruptcy Court, the lease was rejected on September 29, 1992. There is a guarantor of the lease and the Company is currently proceeding to enforce all obligations under such guaranty including settlement of an unsecured proof of claim filed by the Company. At December 31, 1994, the property has a carrying value of approximately $937,000 and is encumbered by a nonrecourse mortgage payable of approximately $314,000. Based on the existence of the guaranty, the Company believes that the carrying value of the asset is fairly stated at December 31, 1994.\nd. On December 31, 1994, the Company held a mortgage note receivable in the principal amount of $462,712. The mortgage encumbers four properties together with a collateral assignment of ground leases and rents. The properties are tenanted by Gino's and Foodarama. The mortgage had been taken back by a Predecessor Partnership in connection with the sale of these properties. The tenants remained current in their lease obligations.\nThe terms of the mortgage called for a balloon payment of $1,100,000 on January 1, 1992 which was not received. On January 9, 1992, the Company gave written notice of default to Sheldon Lowe and Joseph T. Comras, the mortgagors and the current owners of the properties. As\nII-45\nof December 31, 1994, the Company has commenced foreclosure actions on the four properties as follows: two each in Pennsylvania and New Jersey. The Company foreclosed on the property in Michigan on October 7, 1993 and real estate with carrying value of approximately $70,000 was recorded in the year ended December 31, 1993. On February 25, 1994 the Company foreclosed on the previously encumbered property formerly tenanted by Lionel Leisure located in Pennsylvania. In September 1994, this property was sold and no gain or loss was incurred upon disposition. In October 1994, the Company foreclosed on two properties located in Massachusetts and real estate with a carrying value of approximately $102,000 was recorded in the year ended December 31, 1994. No gain or loss was incurred or is anticipated upon foreclosure because the estimated fair value of the properties exceeds their carrying value.\ne. On January 26, 1993, Be-Mac Transport Company, Inc. (\"Be- Mac\"), a tenant in a property owned by the Company, filed a voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. Be-Mac then filed a motion for rejection of the lease and, pursuant to an order of the Bankruptcy Court, the lease was rejected on February 24, 1993. There is a guarantor of the lease and the Company is currently proceeding to enforce all obligations under such guaranty including settlement of an unsecured proof of claim filed by the Company. The rejected lease contains a purchase option exercisable by the guarantor. Based on the purchase option price, the Company wrote the property down by incurring a provision for loss on real estate in the amount of $196,000 in the year ended December 31, 1993. At December 31, 1994, the property has a carrying value of approximately $948,000 and is unencumbered by any mortgage. The Company has re-let the property effective March 1, 1994 at an annual rental of $120,000.\nf. Lockheed Missile and Space Company, Inc. (\"Lockheed\"), a tenant of the Company's leasehold property in Palo Alto, California, has entered into a consent decree with the California Department of Toxic Substances Control (\"CDTS\") to undertake certain environmental remediation at this property. Lockheed has estimated that the environmental remediation costs may be up to approximately $14,000,000. In a non-binding determination by the CDTS, Lockheed was found responsible for approximately 75% of such costs and the balance was allocated to other parties. The Company was allocated no responsibility for any such costs.\nLockheed has served a notice that it may exercise its statutory right to have its liability reassessed in a binding arbitration proceeding. In connection with this notice, Lockheed has stated that it will attempt to have allocated to the Company and to the Company's ground- lessor (which may claim a right of indemnity against the Company) approximately 9% and 17%, respectively, of the total remediation costs. The Company believes that it has no liability for any of such costs, and in any proceeding in which such liability is asserted against it, the Company will vigorously contest such liability. In the event any of such liability is allocated to the Company, it will seek indemnification from Lockheed in accordance with its lease.\nII-46\n13. PROPERTY HELD FOR SALE\nAt December 31, 1994, the Company owned four properties that were being actively marketed for sale. At December 31, 1994, these properties have been stated at the lower of their carrying value or net realizable value. The aggregate value of the properties is estimated to be approximately $413,000, after incurring a provision for loss on real estate in the amount of $85,000 in the year ended December 31, 1994. At December 31, 1993, the aggregate value of the properties was estimated to be approximately $2,327,000 after incurring a provision for loss on real estate in the amount of approximately $84,000 in the year then ended.\nII-47\n14. FAIR VALUE OF FINANCIAL INSTRUMENTS\nCash and Cash Equivalents, Accounts Receivable, and Accounts ------------------------------------------------------------ Payable and Accrued Expenses ----------------------------\nThe carrying amount of cash and cash equivalents, accounts receivable, and accounts payable and accrued expenses approximates fair value because of the short maturity of these instruments.\nMortgages Receivable --------------------\nThe fair values of the mortgages receivable past due, in process of foreclosure, or for which foreclosure proceedings are pending, are based on the discounted cash flows of the underlying lease. The fair values of the mortgages receivable satisfied subsequent to year end are based on the amount of the net proceeds received.\nThe fair values of the mortgages receivable which are current are based on the discounted cash flows of their respective payment streams.\nThe approximate estimated fair values of the mortgages receivable held as of December 31, 1994 are summarized as follows:\nAt December 31, 1994 ------------------------- Collateralized by Net Estimated Property Tenanted by Investment Fair Value -------------------- ----------- ----------- Gino's, Inc., and Foodarama Supermarkets, Inc. $ 293,000 $ 334,000 Hardee's Food Systems, Inc. 51,000 186,000 Bank of Virginia 342,000 400,000 Best Products Co., Inc. 249,000 253,000 Data 100 Corp. 807,000 1,028,000 Easco Corp. 972,000 3,482,000 Winchester Partnership 2,086,000 2,023,000\nThe net investment at December 31, 1994 is equal to the carrying amount of the mortgage receivable less any deferred income recorded.\nSenior Indebtedness\nThe approximate fair value and carrying value of the Company's senior indebtedness at December 31, 1994 is $47,653,000 and $45,231,000, respectively. The estimated fair value is based on the amount of future cash flows associated with the instrument discounted using the rate at which the Company believes it could currently replace the senior indebtedness.\nII-48\nLimitations\nFair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.\nII-49\n15. DISTRIBUTIONS PAYABLE\nDistributions payable represent amounts accrued and unpaid due to non-consenting investors (\"Non-consents\"). Non-consents are those investors who have not yet exchanged their limited partnership interest in the various Predecessor Partnerships for limited partnership units of American Real Estate Partners, L.P.\nII-50\n16. SUBSEQUENT EVENTS\na. On January 25, 1995, the Grand Union Company, a tenant leasing eight properties owned by the Company, filed a prepackaged voluntary petition for reorganization pursuant to the provisions of Chapter 11 of the Federal Bankruptcy Code. These eight properties' annual rentals total approximately $1,450,000 (including two properties which are sub-let, representing approximately $58,000 in annual rentals). The tenant has not yet determined whether it will exercise its right to reject or affirm the leases which will require an order of the Bankruptcy Court. The tenant is current in its obligations under the leases.\nb. During the end of March and early April 1995 the Company anticipates completing the Rights Offering through which it will raise approximately $109,000,000 net of related expenses. Pursuant to the terms of the Rights Offering, holders of depositary units representing limited partner interests (the \"Depositary Units\") on the record date received one transferable subscription right (each a \"Right\") for each seven Depositary Units held. Each Right was exercisable for a combination of securities consisting of six Depositary Units and one 5% cumulative pay-in-kind redeemable preferred unit representing limited partner interests (the \"Preferred Units\"). High Coast Limited Partnership, a Delaware Limited Partnership which is controlled by Carl C. Icahn (\"Icahn\"), has acted as guarantor of the offering (the \"Guarantor\"). Through the Guarantor, Icahn will exercise certain subscription rights and an over-subscription privilege to acquire additional Depositary Units and Preferred Units. A registration statement on Form S-3 relating to the Rights Offering (Registration No. 33- 54767) was filed with the Securities and Exchange Commission and declared effective February 23, 1995.\nc. On February 1, 1995, the Penske Corp. exercised its purchase option on three properties leased from the Company (two in New Jersey and one in New York). The selling price was approximately $4,535,000 and a gain of approximately $1,030,000 will be recognized in the three months ended March 31, 1995. Each property was encumbered by first and second mortgages which totalled approximately $1,162,000 and which were paid from the sales proceeds.\nd. The Company has executed a contract for the sale of the property tenanted by Pace Membership Warehouse, Inc. In addition, the purchaser is obligated to pay the Company $50,000 should it default on its obligations under the contract. The Company expects to complete the sale by the end of March 1995. The sale price is $9,300,000 and the Company expects to record a gain of approximately $3,300,000 in the three months ended March 31, 1995. The property is encumbered by a nonrecourse mortgage payable of approximately $4,346,000, which the purchaser will assume.\nII-51\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. ---------------------------------------------\nNone.\nII-52\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of AREP. ----------------------------------------\nThe names, offices held and the ages of the directors and executive officers of the General Partner are as follows:\nName Age Office ---- --- ------\nCarl C. Icahn 59 Chairman of the Board\nAlfred D. Kingsley 52 Director\nMark H. Rachesky 36 Director and Vice President\nWilliam A. Leidesdorf 49 Director\nJack G. Wasserman 58 Director\nJohn P. Saldarelli 53 Vice President, Secretary and Treasurer\nCarl C. Icahn has been Chairman of the Board of the General Partner since November 15, 1990. He was Chief Executive Officer and Member of the Office of the Chairman of Trans World Airlines, Inc. (\"TWA\") from November 8, 1988 to January 8, 1993; Chairman of the Board of Directors of TWA from January 3, 1986 to January 8, 1993 and Director of TWA from September 27, 1985 to January 8, 1993. He is also Chairman of the Board of Directors and President of Icahn & Co., Inc. since 1968. Icahn & Co., Inc. is a registered broker-dealer and a member of The New York Stock Exchange, Inc. Mr. Icahn has also been Chairman of the Board of Directors of ACF since October 29, 1984 and a Director of ACF since June 29, 1984. ACF is a railroad freight and tank car leasing, sales and manufacturing company. In 1979, Mr. Icahn acquired control and presently serves as Chairman of the Board of Directors of Bayswater Realty & Capital Corp., which is a real estate investment and development company. ACF, Icahn & Co., Inc. and Bayswater Realty & Capital Corp. are deemed to be directly or indirectly owned and controlled by Carl C. Icahn. Mr. Icahn also has substantial equity interests in and controls various partnerships and corporations which invest in publicly traded securities.\nAlfred D. Kingsley has served as Director of the General Partner since November 15, 1990. He was also Vice Chairman of the Board of Directors of TWA from February 1, 1989 to January 8, 1993 and a Member of the Office of the Chairman from November 8, 1988 to January 8, 1993. Mr. Kingsley was a Director of TWA from September 27, 1985 to January 8, 1993. He also was a Director and Executive Officer and Director of Research at Icahn & Co., Inc. and related entities from 1968 until December 1994. He also has been Vice Chairman of the Board of Directors of ACF since October 29, 1984 and a Director of ACF\nIII-1\nsince June 29, 1984. Mr. Kingsley has also been a Senior Managing Director of Greenway Partners, L.P. since May 1993, which invests in publicly traded securities.\nMark H. Rachesky has served as Director of the General Partner since November 15, 1990 and as Vice President since November 29, 1990. Since February 1, 1990, Mr. Rachesky has been employed at Icahn & Co., Inc., where he is involved in the finance and investments areas. Mr. Rachesky was formerly with Robert M. Bass Group, Inc., where he also was involved in financing and investment activities. Prior thereto, Mr. Rachesky was employed at Goldman, Sachs & Co.\nWilliam A. Leidesdorf has served as Director of the General Partner since March 26, 1991. Since January 1, 1994, Mr. Leidesdorf has been Managing Director of RFG Financial, Inc., a commercial mortgage company. From September 30, 1991 to December 31, 1993, Mr. Leidesdorf was Senior Vice President of Palmieri Asset Management Group. From May 1, 1990 to September 30, 1991, Mr. Leidesdorf was Senior Vice President of Lowe Associates, Inc., a real estate development company, where he was involved in the acquisition of real estate and the asset management workout and disposition of business areas. He also acted as the Northeast Regional Director for Lowe Associates, Inc. From June 1985 to January 30, 1990, Mr. Leidesdorf was Senior Vice President and stockholder of Eastdil Realty, Inc., a real estate company, where he was involved in the asset management workout, disposition of business and financing areas. During the interim period from January 30, 1990 through May 1, 1990, Mr. Leidesdorf was an independent contractor for Eastdil Realty, Inc. on real estate matters.\nJack G. Wasserman has served as a Director of the General Partner since December 3, 1993. Mr. Wasserman is an attorney and a member of the New York State Bar and has been with the New York based law firm of Wasserman, Schneider & Babb since 1966, where he is currently a senior partner.\nJohn P. Saldarelli has served as Vice President, Secretary and Treasurer of the General Partner since March 18, 1991. Mr. Saldarelli was also President of Bayswater Realty Brokerage Corp. from June 1987 until November 19, 1993 and Vice President of Bayswater Realty & Capital Corp. from September 1979 until April 15, 1993, both of which are deemed to be directly or indirectly owned and controlled by Carl C. Icahn.\nWilliam Leidesdorf and Jack G. Wasserman are on the Audit Committee of the Board of Directors of the General Partner.\nEach of Messrs. Icahn and Kingsley served on the Board of Directors of TWA. On January 31, 1992, TWA filed a petition for bankruptcy in the U.S. Bankruptcy Court in Delaware, seeking reorganization under Chapter 11 of the Bankruptcy Code. In connection therewith, the Pension Benefit Guaranty\nIII-2\nCorporation asserted that there existed in the TWA defined benefit plans an underfunding deficiency, and that if the Plans were terminated, TWA and all members of the controlled group of which TWA was a member, including the General Partner, would be liable, jointly and severally, for approximately $1.2 billion. On January 8, 1993, TWA, the Pension Benefit Guaranty Corporation, Mr. Icahn and the members of the controlled group, among others, settled all claims and potential claims which they had against each other.\nEach executive officer and director will hold office until the next annual meeting of the General Partner and until his or her successor is elected and qualified. Effective June 15, 1993, directors who are not employed by AREP or certain affiliates, receive fees of $3,000 for attendance at each quarterly meeting of the Board of Directors. Mr. Kingsley, Mr. Leidesdorf and Mr. Wasserman each received $12,000 for attendance at meetings in 1994.\nEach of the executive officers of the General Partner, other than John P. Saldarelli, performs services for other affiliates of the General Partner.\nThere are no family relationships between or among any of the directors and\/or executive officers of the General Partner.\nIf distributions (which are payable in kind) are not made to the holders of Preferred Units on any two Payment Dates (which need not be consecutive), the holders of more than 50% of all outstanding Preferred Units, including the General Partner and its affiliates, voting as a class, shall be entitled to appoint two nominees for the Board of Directors of the General Partner. Holders of Preferred Units owning at least 10% of all outstanding Preferred Units, including the General Partner and its affiliates to the extent that they are holders of Preferred Units, may call a meeting of the holders of Preferred Units to elect such nominees. Once elected, the nominees will be appointed to the Board of Directors of the General Partner by Icahn. As directors, the nominees will, in addition to their other duties as directors, be specifically charged with reviewing all future distributions to the holders of the Preferred Units. Such additional directors shall serve until the full distributions accumulated on all outstanding Preferred Units have been declared and paid or set apart for payment. If and when all accumulated distributions on the Preferred Units have been declared and paid or set aside for payment in full, the holders of Preferred Units shall be divested of the special voting rights provided by the failure to pay such distributions, subject to revesting in the event of each and every subsequent default. Upon termination of such special voting rights attributable to all holders of Preferred Units with respect to payment of distributions, the term of office of each director nominated by the holders of Preferred Units (the \"Preferred Unit Directors\") pursuant to such special voting rights shall terminate and the number of directors constituting the entire Board of Directors shall be reduced by the number of Preferred Unit Directors. The holders of the Preferred Units will have no\nIII-3\nother rights to participate in the management of AREP and will not be entitled to vote on any matters submitted to a vote of the holders of Depositary Units.\nIII-4\nIII-5\nAREP has adopted a Nonqualified Unit Option Plan (the \"Plan\") pursuant to which options to purchase an aggregate of 1,416,910 Depositary Units at an option price equal to the market price on the date of grant may be granted to officers and key employees of the General Partner and AREP who provide services to AREP. To date, no options have been granted under the Plan.\nIn February 1993, AREP adopted a 401K plan pursuant to which AREP will make a matching contribution to an employee's individual plan account in the amount of one-third (1\/3) of the first six (6%) percent of gross salary contributed by the employee.\nItem 12. Security Ownership of Certain Beneficial Owners and Management. --------------------------------\nAs discussed below, effective February 22, 1995 the General Partner and its affiliates contributed all of their Depositary Units to the Guarantor in exchange for a general partner interest in the Guarantor. As a result, as of February 22, 1995, the Guarantor owned 1,365,768 Depositary Units, or approximately 9.89% of the outstanding Depositary Units then outstanding, prior to giving effect to the Rights Offering. There were no outstanding Preferred Units on that date. The foregoing is exclusive of a 1.99% ownership interest in AREP which the General Partner held by virtue of its 1% General Partner interest in each of AREP and the Subsidiary. Prior to May 1993, Icahn's ownership of the General Partner was through his affiliate, Meadowstar Holding Company, Inc. (\"Meadowstar\"). Meadowstar had originally purchased all of the outstanding shares of common stock of (i) the General Partner and (ii) API Nominee Corp., a Delaware corporation (\"Nominee\"), pursuant to an Acquisition Agreement, dated as of September 13, 1990 (the \"Acquisition Agreement\") between Meadowstar and Integrated Resources, Inc. In May 1993, Icahn purchased all of the outstanding shares of the General Partner from Meadowstar. As a result, Icahn became the beneficial owner of the 1,254,280 Depositary Units owned by the General Partner. Icahn may also be deemed to be the beneficial owner of the 159,894 Depositary Units owned of record by Nominee (the Units owned by Nominee are Depositary Units of holders who have not yet exchanged their limited partner interests); however, Icahn disclaims such beneficial ownership.\nIn connection with the Rights Offering, the Guarantor was formed. The general partner of the Guarantor is the General Partner. The limited partners of the Guarantor are ACF Industries, Incorporated (\"ACF\"), a New Jersey corporation, and Tortoise Corp. (\"Tortoise\"), a New York corporation. Both ACF and Tortoise are controlled by Icahn. Each of the General Partner, ACF and Tortoise contributed to the Guarantor all Depositary Units and related rights, privileges and benefits owned by them or their affiliates, including the right to receive the Rights Offering. As a result of the above transactions, the Guarantor received 1,365,768 Depositary Units (which includes 76,088 Depositary Units Icahn acquired\nIII-6\nthrough participation in AREP's Dividend Reinvestment Plan which is available to all Unitholders, and 35,400 Depositary Units which were originally owned by Unicorn Associates Corporation, an affiliate of Icahn), representing approximately 9.89% of the outstanding Depositary Units prior to the Rights Offering which entitled the Guarantor to receive 195,110 Rights in the Offering.\nPursuant to the terms of the Rights Offering and a subscription guaranty agreement entered into in connection with the Rights Offering, the Guarantor agreed to subscribe for and purchased (i) 1,176,660 Depositary Units and 195,110 Preferred Units through the exercise of its Rights and (ii) all of the available Depositary Units and Preferred Units pursuant to the exercise of an over-subscription privilege. The Guarantor received certain registration rights with respect to its Depositary Units and Preferred Units for providing the subscription guaranty but was not otherwise compensated. As a result of the Guarantor's participation in the Rights Offering, AREP expects that Icahn will increase his percentage ownership in the Partnership and obtain a substantial portion of the Preferred Units being offered.\nThe affirmative vote of Unitholders holding more than 75% of the total number of all Units then outstanding, including Depositary Units held by the General Partner and its affiliates, is required to remove the General Partner. Thus, if Icahn, through the Guarantor, holds 25% or more of the Depositary Units outstanding after giving effect to the Rights Offering, the General Partner will not be able to be removed pursuant to the terms of the Partnership Agreement without Icahn's consent. Moreover, under the Partnership Agreement, the affirmative vote of the General Partner and Unitholders owning more than 50% of the total number of all outstanding Depositary Units then held by Unitholders, including the Guarantor, is required to approve, among other things, selling or otherwise disposing of all or substantially all of AREP's assets in a single sale or in a related series of multiple sales, dissolving AREP or electing to continue AREP in certain instances, electing a successor general partner, making certain amendments to the Partnership Agreement or causing AREP, in its capacity as sole limited partner of the Subsidiary, to consent to certain proposals submitted for the approval of the limited partners of the Subsidiary. Accordingly, if Icahn, through the Guarantor, holds 50% or more of the Depositary Units outstanding after giving effect to the Rights Offering, Icahn, through the Guarantor, will have effective control over such approval rights.\nAs of March 17, 1995, to the best knowledge of AREP, Tweedy, Browne Company L.P., a Delaware limited partnership, TBK Partners L.P., a Delaware limited partnership and Vanderbilt Partners, L.P., a Delaware limited partnership, who collectively filed an amended Form 13-D on November 30, 1993, owned 945,010 Depositary Units, or approximately 6.83% of the outstanding Depositary Units.\nThe following table provides information, as of March 17, 1995, as to the beneficial ownership of the Depositary Units of AREP for each\nIII-7\ndirector of the General Partner, and all directors and executive officers of the General Partner as a group.\nIII-8\nItem 13. Certain Relationships and Related Transactions. ----------------------------------------------\nRelated Transactions with the General Partner and its Affiliates ----------------------------------------------------------------\nIn November 1993 AREP replaced a letter of credit obtained by Meadowstar for the benefit of AREP in 1990 (the \"Letter of Credit\") with respect to AREP's Lockheed Electronics property in New Jersey relating to environmental clean-up costs, with a self-guaranty by AREP (the \"Guaranty\"). The Audit Committee approved the replacement of the Letter of Credit with the Guaranty as permitted under New Jersey law. The clean-up costs are the tenant's responsibility.\nFor the year ended December 31, 1994, AREP made no payments with respect to the Depositary Units owned by the General Partner. For the year ended December 31, 1993, AREP paid the General Partner (i) $641,360 ($0.50 per Unit) with respect to the Depositary Units owned by the General Partner (see ITEM 12) and (ii) $140,848 with respect to the aggregate 1.99% general partner interest of the General Partner in AREP. Based on distributions payable in respect of 1993, the General Partner acquired 76,088 Depositary Units through participation in the DRIP. In addition, AREP paid Unicorn Associates Corporation $17,700 ($0.50 per Unit) with respect to the 35,400 Depositary Units owned by it.\nAREP entered into a lease, effective June 1, 1991, for approximately 6,900 square feet of office space with Riverdale Investors Corp., Inc., an affiliate of the General Partner (the \"Lessor\"). The terms of this lease were reviewed for fairness by the Audit Committee, which determined that the terms of such transaction were fair and reasonable to AREP. In evaluating the transaction, the Audit Committee consulted with an independent appraiser regarding the terms of the lease. The lease is for a ten-year term and provides for initial monthly rent (inclusive of charges for utilities) of $11,642, which amount increases to $12,936 on June 1, 1994 and $14,804 on June 1, 1997. For the year ended December 31, 1992, AREP paid $139,704 in rent to the Lessor. On December 29, 1992, the Lessor assigned its rights in the lease to an unaffiliated third party.\nProperty Management and Other Related Transactions --------------------------------------------------\nThe General Partner and its affiliates benefited from the Rights Offering because, in their capacity as Exercising Rights Holders, they were entitled to the same right to increase their investment in AREP as other Unitholders, including acquiring additional Depositary Units. The Guarantor also received certain registration rights with respect to its Depositary Units and Preferred Units for providing the Subscription Guaranty.\nThe General Partner and its affiliates may receive fees in connection with the acquisition, sale, financing, development and management of new properties acquired by AREP. As development and other\nIII-9\nnew properties are acquired, developed, constructed, operated, leased and financed, the General Partner or its affiliates may perform acquisition functions, including the review, verification and analysis of data and documentation with respect to potential acquisitions, and perform development and construction oversight and other land development services, property management and leasing services, either on a day-to-day basis or on an asset management basis, and may perform other services and be entitled to fees and reimbursement of expenses relating thereto, provided the terms of such transactions are fair and reasonable to AREP in accordance with AREP Agreement and customary to the industry. It is not possible to state precisely what role, if any, the General Partner or any of its affiliates may have in the acquisition, development or management of any new investments. Consequently, it is not possible to state the amount of the income, fees or commissions the General Partner or its affiliates might be paid in connection with the investment of the Rights Offering proceeds since the amount thereof is dependent upon the specific circumstances of each investment, including the nature of the services provided, the location of the investment and the amount customarily paid in such locality for such services. However, investors may expect that, subject to the specific circumstances surrounding each transaction and the overall fairness and reasonableness thereof to AREP, the fees charged by the General Partner and its affiliates for the services described below generally will be within the ranges set forth below:\n-- Property Management and Asset Management Services. To the extent that AREP acquires any properties requiring active management (e.g., operating properties that are not net leased) or asset management services, including on-site services, it may enter into management or other arrangements with the General Partner or its affiliates. Generally, it is contemplated that under property management arrangements, the entity managing the property would receive a property management fee (generally 3% to 6% of gross rentals for direct management, depending upon the location) and under asset management arrangements, the entity managing the asset would receive an asset management fee (generally .5% to 1% of the appraised value of the asset for asset management services, depending upon the location) in payment for its services and reimbursement for costs incurred.\n-- Brokerage and Leasing Commissions. AREP also may pay affiliates of the General Partner real estate brokerage and leasing commissions (which generally may range from 2% to 6% of the purchase price or rentals depending on location; this range may be somewhat higher for problem properties or lesser-valued properties).\n-- Lending Arrangements. The General Partner or its affiliates may lend money to, or arrange loans for, AREP. Fees payable to the General Partner or its affiliates in connection with such activities include mortgage brokerage fees (generally .5% to 3% of the loan amount), mortgage origination\nIII-10\nfees (generally .5% to 1.5% of the loan amount) and loan servicing fees (generally .10% to .12% of the loan amount), as well as interest on any amounts loaned by the General Partner or its affiliates to AREP.\n-- Development and Construction Services. The General Partner or its affiliates may also receive fees for development services, generally 1% to 4% of development costs, and general contracting services or construction management services, generally 4% to 6% of construction costs.\n-- Reinvestment Incentive Fees. Subject to the limitations described below, the General Partner is entitled to receive a reinvestment incentive fee (a \"Reinvestment Incentive Fee\") for performing acquisition services equal to a percentage of the purchase price (whether paid in cash, Depositary Units, other securities and\/or with mortgage financing) of properties (other than Predecessor Properties) acquired from July 1, 1987 through July 1, 1997. This percentage is 1% for the first five years and 1\/2% for the second five years. Although a Reinvestment Incentive Fee accrues each time a property is acquired, Reinvestment Incentive Fees are only payable on an annual basis, within 45 days after the end of each calendar year, if the following subordination provisions are satisfied. Reinvestment Incentive Fees accrued in any year will only be payable if the sum of (x) the sales price of all Predecessor Properties (net of associated debt which encumbered these Properties at the consummation of the Exchange) sold through the end of that year and (y) the appraised value of all Predecessor Properties which have been financed or refinanced (and not subsequently sold), net of the amount of any refinanced debt through the end of that year determined at the time of such financings or refinancings, exceeds the aggregate values assigned to those Predecessor Properties for purposes of the Exchange. If the subordination provisions are not satisfied in any year, payment of Reinvestment Incentive Fees for that year will be deferred. At the end of each year a new determination will be made with respect to subordination requirements (reflecting all sales, financings and refinancings from the consummation of the Exchange through the end of that year) in order to ascertain whether Reinvestment Incentive Fees may be payable irrespective of whether distributions have been made or are projected to be made to Unitholders. Through December 31, 1994, an aggregate of (i) 126 Predecessor Properties were sold or disposed of for an aggregate of approximately $56,879,000 net of associated indebtedness which encumbered these Properties at the consummation of the Exchange and (ii) 25 Predecessor Properties were refinanced at an aggregate appraised value, net of the amount of the refinanced debt, of approximately $44,431,000 for a sum total of approximately $101,310,000. Aggregate appraised values attributable to these Predecessor Properties for purposes of the Exchange were approximately $88,322,000. Accordingly, through December 31, 1994, AREP satisfied the subordination requirements detailed above.\nIII-11\nNonqualified Unit Option Plan -----------------------------\nAREP has adopted the Plan, under which options to purchase an aggregate of 1,416,910 Depositary Units may be granted to officers and key employees of the General Partner and AREP who provides services to AREP. To date, no options have been granted under the Plan. See ITEM 11","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 following financial statements of American Real Estate Partners, L.P. are included in Part II, ITEM 8:\nPage Number ------\nIndependent Auditors' Report II-15\nConsolidated Balance Sheets -- II-16 December 31, 1994 and 1993\nConsolidated Statements of Earnings -- II-17 Years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Partners' Equity -- II-18 Years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows -- II-19-20 Years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements II-21-51\n(a) (2) Financial Statement Schedules: -----------------------------\nSchedule III - Real Estate Owned and Revenues IV-4-22 Earned (by tenant or guarantor as applicable)\nAll other Financial Statement schedules have been omitted because the required financial information is not applicable or the information is shown in the Financial Statements or Notes thereto.\n(a) (3) Exhibits: --------\n3.1 Certificate of Limited Partnership of AREP, dated February 17, 1987 (filed as Exhibit No. 3.1 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n3.2 Amended and Restated Agreement of Limited Partnership of AREP, dated as of May 12, 1987 (filed as Exhibit No. 3.2 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n3.3 Amendment No. 1 to the Partnership Agreement.\nIV-1\n3.4 Certificate of Limited Partnership of American Real Estate Holdings Limited Partnership (the \"Subsidiary\"), dated February 17, 1987 and amendment thereto, dated March 12, 1987 (filed as Exhibit No. 3.3 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n3.5 Amended Restated Agreement of Limited Partnership of the Subsidiary, dated as of July 1, 1987 (filed as Exhibit No. 3.4 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n4.1 Depositary Agreement among AREP, the General Partner and Registrar and Transfer Company, dated as of July 1, 1987 (filed as Exhibit No. 4.1 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n4.2 Amendment No. 1 to the Depositary Agreement.\n4.3 Specimen Depositary Receipt (filed as Exhibit No. 4.2 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n4.4 Form of Transfer Application (filed as Exhibit No. 4.3 to AREP's Annual Report on Form 10-K for the year ended\nDecember 31, 1987 and incorporated herein by reference).\n4.5 Form of Certificate representing Preferred Units.\n10.1 Nonqualified Unit Option Plan (filed as Exhibit No. 10.2 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n10.2 Distribution Reinvestment Plan (filed as Exhibit No. 10.3 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n10.3 Note Purchase Agreements, dated as of May 27, 1988 among AREP, the Subsidiary and The Prudential Insurance Company of America (the \"Note Agreements\") (filed as Exhibit Nos. 2a and 2b to AREP's Current Report on Form 8-K dated May 27, 1988 and incorporated herein by reference).\n10.4 Amendment No. 1 to the Note Agreements dated November 17, 1988 (filed as Exhibit No. 10.2 to AREP's\nIV-2\nRegistration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.5 Amendment No. 2 to the Note Agreements dated November 17, 1988 (filed as Exhibit No. 10.3 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.6 Amendment No. 3 to the Note Agreements dated as of June 21, 1994 (filed as Exhibit No. 10.4 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.7 Amendment No. 4 to the Note Agreements dated as of August 12, 1994 (filed as Exhibit No. 10.5 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.8 9.6% Senior Promissory Note of AREP and the Subsidiary due May 27, 1998 payable to The Prudential Insurance Company of America (filed as Exhibit No. 2c to AREP's Current Report on Form 8-K dated May 27, 1988 and incorporated herein by reference).\n10.9 9.6% Senior Promissory Note of AREP and the Subsidiary due May 27, 1998 payable to Prudential Property and Casualty Insurance Company (filed as Exhibit No. 2d to AREP's Current Report on Form 8-K dated May 27, 1988 and incorporated herein by reference).\n10.10 Subscription Guaranty Agreement between AREP and High Coast Limited Partnership (the \"Guarantor\").\n10.11 Registration Rights Agreement between AREP and the Guarantor.\n16 Letter dated September 27, 1991 of Deloitte & Touche regarding change in accountants (filed as Exhibit No. A to AREP's Current Report on Form 8-K dated October 3, 1991 and incorporated herein by reference).\n22 List of Subsidiaries (filed as Exhibit No. 22 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n(b) Reports on Form 8-K: ------------------- AREP filed a Current Report on Form 8-K (the \"Form 8-K\") with the Securities and Exchange Commission on March 17, 1995. Pursuant to Item 5 of the Form 8-K, AREP release its earnings for the fourth quarter and fiscal year ended December 31, 1994 and also announced that no distribution would be made for the fiscal quarter ending March 31, 1995.\nIV-3\nIV-4\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY -------------------------------------------------- REAL ESTATE OWNED AND REVENUES EARNED YEAR ENDED DECEMBER 31, 1994 -----------------------------------------------------------------------------\n1a. A reconciliation of the total amount at which real estate owned, accounted for under the operating method and hotel operating properties, was carried at the beginning of the period, with the total at the close of the period, is shown below:\nBalance - January 1, 1994 $ 176,050,393 Additions during period 12,496,354 Write downs (322,000) Reclassifications during period to assets held for sale (1,340,935) Disposals during period (1,556,204) -------------- Balance - December 31, 1994 $ 185,327,608 ==============\nb. A reconciliation of the total amount of accumulated depreciation at the beginning of the period, with the total at the close of the period, is shown below:\nBalance - January 1, 1994 $ 45,040,784 Depreciation during period 4,501,318 Disposals during period (709,930) Reclassifications during period to property held for sale (597,450) -------------- Balance - December 31, 1994 $ 48,234,722 ==============\nIV-11\n(continued)\nDepreciation on properties accounted for under the operating method is computed using the straight-line method over the estimated useful life of the particular property or property components, which range from 5 to 45 years.\n2. A reconciliation of the total amount at which real estate owned, accounted for under the financing method, was carried at the beginning of the period, with the total at the close of the period, is shown below:\nBalance - January 1, 1994 $ 327,470,322 Additions during period 41,256 Write downs (110,000) Disposals during period (6,432,148) Amortization of unearned income 31,990,262 Minimum lease rentals received (38,698,906) ------------ Balance - December 31, 1994 $314,260,786 ============\n3. The aggregate cost of real estate owned for federal income tax purposes is $402,624,341.\n4. Net income applicable to the period in Schedule III is reconciled with net earnings as follows:\nNet income applicable to financing and operating leases $ 26,648,827 Add interest income - other 1,438,491 ------------ 28,087,318 ------------ Deduct expenses not allocated: General and administrative expenses 2,791,123 Nonmortgage interest expense 4,731,517 Other 987,979 ------------ 8,510,619 ------------ Earnings before gain on property transactions 19,576,699 Provision for loss on property (582,000) Gain on sales of real estate 4,173,865 ------------ Net earnings $ 23,168,564 ============\nIV-12\n(Continued)\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY -------------------------------------------------- REAL ESTATE OWNED AND REVENUES EARNED YEAR ENDED DECEMBER 31, 1993 -------------------------------------------------------------------------------\n1a. A reconciliation of the total amount at which real estate owned, accounted for under the operating method and hotel operating properties, was carried at the beginning of the period, with the total at the close of the period, is shown below:\nBalance - January 1, 1993 $162,201,694 Additions during period 20,347,239 Write downs (247,000) Reclassifications during period from financing leases 800,429 Reclassifications during period to assets held for sale (2,212,215) Disposals during period (4,839,754) ------------ Balance - December 31, 1993 $176,050,393 ============\nb. A reconciliation of the total amount of accumulated depreciation at the beginning of the period, with the total at the close of the period, is shown below:\nBalance - January 1, 1993 $ 44,105,825 Depreciation during period 3,992,036 Disposals during period (1,896,524) Reclassifications during period to assets held for sale (1,160,553) ----------- Balance - December 31, 1993 $45,040,784 ===========\nDepreciation on properties accounted for under the operating method is computed using the straight-line method over the estimated useful life of the particular property or property components, which range from 5 to 45 years.\nIV-13 (continued)\n2. A reconciliation of the total amount at which real estate owned, accounted for under the financing method, was carried at the beginning of the period, with the total at the close of the period, is shown below:\nBalance - January 1, 1993 $330,322,814 Additions during period 4,130,942 Reclassifications during period (800,429) Disposals during period (116,994) Amortization of unearned income 32,851,135 Minimum lease rentals received (38,917,146) ------------ Balance - December 31, 1993 $327,470,322 ============\n3. The aggregate cost of real estate owned for federal income tax purposes is $398,245,532.\n4. Net income applicable to the period in Schedule III is reconciled with net earnings as follows:\nNet income applicable to financing and operating leases $ 24,390,249 Add interest income - other 2,009,598 ------------ 26,399,847 ============ Deduct expenses not allocated: General and administrative expenses 2,454,786 Nonmortgage interest expense 5,070,729 Other 495,561 ------------ 8,021,076 ============\nEarnings before gain on property transactions 18,378,771 Provision for loss on property (462,000) Gain on sales of real estate 4,759,983 ------------ Net earnings $22,676,754 ============\nIV-14\n(Continued)\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY -------------------------------------------------- REAL ESTATE OWNED AND REVENUES EARNED YEAR ENDED DECEMBER 31, 1992 -----------------------------------------------------------------------------\n1a. A reconciliation of the total amount at which real estate owned, accounted for under the operating method and hotel operating properties was carried at the beginning of the period, with the total at the close of the period, is shown below:\nBalance - January 1, 1992 $159,169,561 Additions during period 160,748 Write downs (8,847,165) Reclassifications during period from financing leases 21,902,382 Reclassifications during period to assets held for sale (9,090,374) Disposals during period (1,093,458) ------------ Balance - December 31, 1992 $162,201,694 ============\nb. A reconciliation of the total amount of accumulated depreciation at the beginning of the period, with the total at the close of the period, is shown below:\nBalance - January 1, 1992 $ 42,315,717 Depreciation during period 4,073,691 Disposals during period (385,164) Reclassifications during period to assets held for sale (1,898,419) ------------ Balance - December 31, 1992 $ 44,105,825 ============\nDepreciation on properties accounted for under the operating method is computed using the straight-line method over the estimated useful life of the particular property or property components, which range from 5 to 45 years.\nIV-15\n(continued)\n2. A reconciliation of the total amount at which real estate owned, accounted for under the financing method, was carried at the beginning of the period, with the total at the close of the period, is shown below:\nBalance - January 1, 1992 $358,005,265 Additions during period - Reclassifications during period (21,902,382) Disposals during period (187,607) Amortization of unearned income 34,121,308 Minimum lease rentals received (39,713,770) ------------ Balance - December 31, 1992 $330,322,814 ============\n3. The aggregate cost of real estate owned for federal income tax purposes is $382,975,157.\n4. Net income applicable to the period in Schedule III is reconciled with net earnings as follows:\nNet income applicable to financing and operating leases $ 26,101,004 Add interest income - other 2,234,035 ------------ 28,335,039 ============ Deduct expenses not allocated: General and administrative expenses 2,318,856 Nonmortgage interest expense 5,142,818 Other 292,155 ------------ 7,753,829 ============ Earnings before gain on property transactions and extraordinary item 20,581,210 Provision for loss on property (8,847,165) Gain on sales of real estate 342,372 ------------ Extraordinary item, gain from early extinguishment of debt (784,540) ------------ Net earnings $11,291,877 ============\nIV-16 (Continued)\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY -------------------------------------------------- REAL ESTATE OWNED BY STATE (ACCOUNTED FOR UNDER THE FINANCING METHOD) DECEMBER 31, 1994 -----------------------------------------------------------------------------\nNet State Investment ------ -------------------------- Alabama $ 10,774,730 California 14,865,499 Colorado 403,433 Connecticut 24,956,415 Florida 26,193,440 Georgia 6,611,153 Illinois 5,752,708 Indiana 673,807 Iowa 1,472,651 Kentucky 226,439 Louisiana 20,516,823 Maryland 6,868,375 Massachusetts 29,728,840 Michigan 14,742,376 Minnesota 1,907,837 Missouri 5,605,609 Nevada 903,509 New Hampshire 4,817,099 New Jersey 17,144,885 New York 15,551,206 North Carolina 7,045,840 Ohio 9,184,634 Oklahoma 129,943 Oregon 54,039,101 Pennsylvania 14,088,469 Rhode Island 1,102,181 South Carolina 325,975 Texas 3,391,052 Virginia 9,543,506 West Virginia 3,636,597 Wisconsin 2,056,654 ------------------- $314,260,786 ===================\nIV-17 (Continued)\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY -------------------------------------------------- REAL ESTATE OWNED AND RESERVE FOR DEPRECIATION BY STATE (ACCOUNTED FOR UNDER THE OPERATING METHOD) DECEMBER 31, 1994 -----------------------------------------------------------------------------\nAmount at which Carried at Reserve for State Close of Year Depreciation --------- ---------------- ------------- Alabama $ 1,707,913 $ - Arizona 8,661,230 780,739 California 13,574,684 3,702,517 Connecticut 1,549,805 1,027,553 Florida 14,474,746 5,007,024 Georgia 8,219,782 612,349 Illinois 8,849,567 2,836,885 Indiana 8,635,584 2,645,196 Kansas 460,490 - Kentucky 14,470,363 691,180 Louisiana 12,638,536 2,975,581 Maryland 1,864,304 518,658 Massachusetts 2,916,915 1,349,837 Michigan 19,225,223 3,394,696 Minnesota 7,072,018 1,474,020 Missouri 1,946,471 289,549 New Jersey 4,293,403 1,471,681 New York 22,393,357 5,858,402 North Carolina 3,191,685 1,030,096 Ohio 3,635,192 299,308 Oregon 298,451 - Pennsylvania 10,273,909 5,843,239 South Carolina 3,101,170 857,047 Tennessee 335,368 196,998 Texas 4,302,872 2,730,561 Virginia 1,986,638 948,210 Washington 4,190,632 1,337,294 Canada 1,057,300 356,102 ------------ ----------- $185,327,608 $48,234,722 ============ ===========\nIV-18 (Continued)\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY -------------------------------------------------- REAL ESTATE OWNED BY STATE (ACCOUNTED FOR UNDER THE FINANCING METHOD) DECEMBER 31, 1993 --------------------------------------------------------------------------\nNet State Investment --------- ----------- Alabama $ 11,067,060 California 17,888,934 Colorado 544,251 Connecticut 25,308,131 Florida 26,800,208 Georgia 6,769,438 Illinois 5,905,143 Indiana 233,369 Iowa 1,501,626 Kentucky 233,369 Louisiana 21,056,026 Maryland 7,009,645 Massachusetts 30,296,481 Michigan 14,950,167 Minnesota 1,943,843 Missouri 5,568,962 Nevada 921,680 New Hampshire 4,935,607 New Jersey 21,248,834 New York 16,253,711 North Carolina 7,355,915 Ohio 9,415,352 Oklahoma 133,802 Oregon 54,546,141 Pennsylvania 14,491,751 Rhode Island 1,121,598 South Carolina 342,233 Texas 3,534,796 Virginia 9,807,705 West Virginia 3,742,187 Wisconsin 2,094,811 ------------ $327,470,322 ============\nIV-19 (Continued)\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY -------------------------------------------------- REAL ESTATE OWNED AND RESERVE FOR DEPRECIATION BY STATE (ACCOUNTED FOR UNDER THE OPERATING METHOD) DECEMBER 31, 1993 -----------------------------------------------------------------------------\nAmount at which Carried at Reserve for State Close of Year Depreciation ------- ---------------- ------------- Alabama $ 736,694 $ 87,325 Arizona 8,419,901 432,415 California 12,931,574 3,463,370 Connecticut 1,549,805 965,696 Florida 14,636,201 4,438,112 Georgia 9,238,378 1,029,031 Illinois 8,850,494 2,604,653 Indiana 8,635,584 2,410,912 Kansas 460,490 - Kentucky 7,860,177 389,534 Louisiana 13,125,806 2,884,385 Maryland 1,238,325 474,818 Massachusetts 2,814,867 1,270,340 Michigan 19,225,223 3,044,807 Minnesota 6,776,010 1,243,786 Missouri 2,335,344 455,296 New Jersey 4,293,403 1,434,545 New York 21,711,796 5,430,334 North Carolina 1,591,685 1,008,960 Ohio 3,876,312 351,221 Oregon 298,451 - Pennsylvania 10,274,362 5,531,108 South Carolina 3,101,170 806,722 Tennessee 449,753 248,129 Texas 4,384,018 2,650,621 Virginia 1,986,638 920,929 Washington 4,190,632 1,129,111 Canada 1,057,300 334,624 --------------- -------------- $176,050,393 $45,040,784 =============== ==============\nIV-20 (Continued)\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY -------------------------------------------------- REAL ESTATE OWNED BY STATE (ACCOUNTED FOR UNDER THE FINANCING METHOD) DECEMBER 31, 1992 ---------------------------------------------------------------------\nNet State Investment ----------- ----------- Alabama $11,323,580 California 18,426,291 Colorado 571,985 Connecticut 25,629,109 Florida 27,350,648 Georgia 6,912,260 Illinois 5,123,971 Indiana 696,217 Iowa 1,528,040 Kentucky 239,682 Louisiana 21,534,147 Maryland 7,139,145 Massachusetts 30,013,085 Michigan 15,133,474 Minnesota 1,977,036 Missouri 6,273,577 Nevada 938,304 New Hampshire 5,044,563 New Jersey 21,672,020 New York 15,515,259 North Carolina 7,638,332 Ohio 9,620,021 Oklahoma 137,321 Oregon 55,011,975 Pennsylvania 14,862,614 Rhode Island 1,140,167 South Carolina 357,160 Texas 2,464,953 Virginia 10,079,084 West Virginia 3,838,951 Wisconsin 2,129,843 ----------- $330,322,814 ============\nIV-21 (Continued)\nSCHEDULE III AMERICAN REAL ESTATE PARTNERS, L.P. AND SUBSIDIARY -------------------------------------------------- REAL ESTATE OWNED AND RESERVE FOR DEPRECIATION BY STATE (ACCOUNTED FOR UNDER THE OPERATING METHOD) DECEMBER 31, 1992 -----------------------------------------------------------------------\nAmount at which Carried at Reserve for State Close of Year Depreciation ------- ---------------- ------------- Alabama $ 736,694 $ 81,154 Arizona 8,009,897 133,108 California 13,694,521 3,671,678 Connecticut 1,549,805 903,840 Florida 12,909,626 3,958,440 Georgia 8,819,331 832,671 Illinois 13,270,355 4,227,516 Indiana 8,635,584 2,201,628 Kansas 460,490 - Kentucky 929,261 330,093 Louisiana 13,125,806 2,674,988 Maryland 1,238,325 452,663 Massachusetts 2,484,262 1,190,844 Michigan 19,154,063 2,658,874 Minnesota 6,776,010 991,465 Missouri 1,806,775 428,289 New Jersey 4,293,404 1,390,643 New York 12,174,966 5,047,805 North Carolina 1,591,685 987,823 Ohio 4,108,388 410,445 Oregon 298,451 - Pennsylvania 10,273,909 5,218,974 South Carolina 3,101,170 756,396 Tennessee 987,111 434,167 Texas 3,966,086 2,570,682 Virginia 2,557,787 1,222,566 Washington 4,190,632 1,015,928 Canada 1,057,300 313,145 --------------- -------------- $162,201,694 $44,105,825 =============== ==============\nIV-22\nEXHIBIT INDEX -------------\nExhibit Page No. ------- --------\n3.1 Certificate of Limited Partnership of AREP, dated February 17, 1987 (filed as Exhibit No. 3.1 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n3.2 Amended and Restated Agreement of Limited Partnership of AREP, dated as of May 12, 1987 (filed as Exhibit No. 3.2 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n3.3 Amendment No. 1 to the Partnership Agreement.\n3.4 Certificate of Limited Partnership of American Real Estate Holdings Limited Partnership (the \"Subsidiary\"), dated February 17, 1987 and amendment thereto, dated March 12, 1987 (filed as Exhibit No. 3.3 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n3.5 Amended Restated Agreement of Limited Partnership of the Subsidiary, dated as of July 1, 1987 (filed as Exhibit No. 3.4 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n4.1 Depositary Agreement among AREP, the General Partner and Registrar and Transfer Company, dated as of July 1, 1987 (filed as Exhibit No. 4.1 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n4.2 Amendment No. 1 to the Depositary Agreement.\n4.3 Specimen Depositary Receipt (filed as Exhibit No. 4.2 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\nExhibit Page No. ------- --------\n4.4 Form of Transfer Application (filed as Exhibit No. 4.3 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n4.5 Specimen of Certificate representing Preferred Units (filed as Exhibit No. 4.9 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.1 Nonqualified Unit Option Plan (filed as Exhibit No. 10.1 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n10.2 Distribution Reinvestment Plan (filed as Exhibit No. 10.3 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n10.3 Note Purchase Agreements, dated as of May 27, 1988 among AREP, the Subsidiary and The Prudential Insurance Company of America (the \"Note Agreements\") (filed as Exhibit Nos. 2a and 2b to AREP's Current Report on Form 8-K dated May 27, 1988 and incorporated herein by reference).\n10.4 Amendment No. 1 to the Note Agreements dated November 17, 1988 (filed as Exhibit No. 10.2 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.5 Amendment No. 2 to the Note Agreements dated November 17, 1988 (filed as Exhibit No. 10.3 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.6 Amendment No. 3 to the Note Agreements dated as of June 21, 1994 (filed as Exhibit No. 10.4 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\nExhibit Page No. ------- --------\n10.7 Amendment No. 4 to the Note Agreements dated as of August 12, 1994 (filed as Exhibit No. 10.5 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.8 9.6% Senior Promissory Note of AREP and the Subsidiary due May 27, 1998 payable to The Prudential Insurance Company of America (filed as Exhibit No. 2c to AREP's Current Report on Form 8-K dated May 27, 1988 and incorporated herein by reference).\n10.9 9.6% Senior Promissory Note of AREP and the Subsidiary due May 27, 1998 payable to Prudential Property and Casualty Insurance Company (filed as Exhibit No. 2d to AREP's Current Report on Form 8-K dated May 27, 1988 and incorporated herein by reference).\n10.10 Subscription Guaranty Agreement between AREP and High Coast Limited Partnership (the \"Guarantor\") (filed as Exhibit No. 4.10 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.11 Registration Rights Agreement between AREP and the Guarantor (filed as Exhibit No. 4.11 to AREP's Registration Statement on Form S-3 (Registration No. 33-54767) and incorporated herein by reference).\n10.12 Amended and Restated Agency Agreement.\n10.13 Subscription Agent Agreement.\n16 Letter dated September 27, 1991 of Deloitte & Touche regarding change in accountants (filed as Exhibit No. A to AREP's Current Report on Form 8-K dated October 3, 1991 and incorporated herein by reference).\n22 List of Subsidiaries (filed as Exhibit No. 22 to AREP's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference).\n27 Financial Data Schedule\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(a) of the Securities Exchange Act of 1934, AREP has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 31st day of March, 1995.\nAMERICAN REAL ESTATE PARTNERS, L.P.\nBy: AMERICAN PROPERTY INVESTORS, INC. General Partner\nBy: \/s\/ Carl C. Icahn --------------------------------- Carl C. Icahn 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 AREP and in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/Carl C. Icahn Chairman of the Board March 31, 1995 ----------------------- (Principal Executive Carl C. Icahn Officer)\n\/s\/Alfred Kingsley Director March 31, 1995 ----------------------- Alfred Kingsley\n\/s\/Mark Rachesky Director March 31, 1995 ----------------------- Mark Rachesky\n\/s\/William A. Leidesdorf Director March 31, 1995 ------------------------ William A. Leidesdorf\n\/s\/Jack G. Wasserman Director March 31, 1995 ------------------------ Jack G. Wasserman\n\/s\/John P. Saldarelli Treasurer March 31, 1995 ------------------------ (Principal Financial John P. Saldarelli Officer and Principal Accounting Officer)","section_15":""}
{"filename":"352789_1994.txt","cik":"352789","year":"1994","section_1":"ITEM 1. BUSINESS:\nIomega Corporation (\"Iomega\" or the \"Company\") designs, manufactures and markets removable data storage devices, including magnetic disk drives based on Bernoulli Technology (registered trademark) , tape backup drives based on the industry standard QIC (quarter inch tape) format, and Zip (trademark) removable cartridge drives. The Company also markets a removable hard disk cartridge which is compatible with certain drives manufactured by SyQuest Technology, Inc. (\"SyQuest\") and utilizes rigid media, and Floptical (registered trademark) disk drives. The Company also designs, manufactures and markets subsystems and removable disks and cartridges for use with drives marketed by the Company. The Company was incorporated in Delaware in April 1980.\nProducts\nIomega's product lines include Bernoulli disk drives and related removable media disks, Ditto (trademark) QIC tape drives and related tape media, Zip removable cartridge disk drives and media cartridges, Floptical disk drives and related media disks and SyQuest-compatible removable hard disk cartridges. Following is a description of the Company's principal products:\nBernoulli Products: These 5.25-inch half-height drives are removable storage devices based on the Company's Bernoulli Technology, which allows spinning flexible media to be precisely stabilized next to a read\/write head with aerodynamic contours. The Company's Bernoulli drives are designed to combine the high capacity and rapid access generally associated with rigid \"Winchester\" disk drives with the media removability and expandable storage capacity generally associated with floppy disk drives and tape drives. The Company's Bernoulli drives and the associated disks are sold both in the form of a complete storage subsystem for IBM PC-compatible personal, laptop and notebook computers, Apple Macintosh personal and notebook computers, and SUN and other leading workstation products, and in the form of components for integration into larger systems by original equipment manufacturers (OEMs) or value added resellers (VARs). The Bernoulli drives use advanced Reed-Solomon error correction and come in 230, 150, 90, 44, and 20 megabyte (MB) disk drive capacities. They also come in external, internal and transportable versions.\nDuring 1994, the majority of the Company's Bernoulli sales came from the Bernoulli 150 drive and media cartridges. The Bernoulli MultiDisk 150 drive began shipping in October 1992 and was Iomega's first drive to use multiple capacity disks - 35, 65, 105 and 150MB. It is also capable of reading and writing to 90MB disks and reading 44MB disks of previous Bernoulli drives. The product has self-cleaning heads, which are designed to improve user convenience during operation. The Company began shipping the Bernoulli 230 drive in September 1994 and expects the Bernoulli 230 to account for a significant portion of 1995 Bernoulli sales. The Bernoulli 230 drive is capable of reading and writing 150 and 90MB disks and reading 44MB disks of previous Bernoulli drives.\n_________________________\nIomega, Bernoulli, and Bernoulli Technology are registered trademarks of, and the Iomega logo, Ditto, Zip, MultiDisk and Tape 250 are trademarks of Iomega Corporation. Floptical is a registered trademark of Insite Peripherals, Inc. All other company and product names mentioned are trademarks of their respective companies.\nTape Products: The Iomega Tape 250 (now known as Ditto 250) drives were the industry's first commercially available QIC-standard, 1-inch high tape drives. These drives have a capacity of 250MB with data compression and are dual speed (500\/1,000 kilobytes per second (Kbps)). Tape products are attached to the standard floppy interface in IBM PC-compatible computers. The parallel port Ditto 250 attaches to the printer parallel port on IBM PC compatible computers. The drives are shipped with application software for both Microsoft DOS and Microsoft Windows. The Company began shipping these products in June 1992. A significant portion of the Company's sales in 1994 were derived from tape products. In March 1995, the Company renamed and expanded its tape family, which is now known as the Ditto family of tape products. In late 1994, the Company began shipping Ditto 420. In March 1995, the Company announced and began to ship the Ditto 850 and 1700. The Company expects tape products to account for a significant portion of sales in 1995.\nZip Products: Iomega started shipping 100MB Zip drives in March 1995. Two versions of the drive are currently offered: a parallel port version for use with IBM PC-compatible computers and a SCSI version for use with Apple Macintosh computers or IBM PC-compatible computers which have a SCSI adapter board. 100MB media cartridges are currently offered with a 25MB version planned. Also offered is a line of accessories. Zip is an external drive with a unique industrial design and color. It features a window to allow visibility of the cartridge being used, rubber feet for standing either flat or on its side, indicator lights and a finger slot for easy cartridge insertion. The parallel port version features printer pass through to allow normal operation of a printer which is often attached to the parallel port of the computer. The SCSI version has two connectors to allow it to be used in a daisy chained set-up with other SCSI devices. The drive's performance is such that application programs can be run directly from the Zip drive. The Zip drive comes with software to help users organize and copy their data. Software read\/write protect is another feature for users to secure and protect their data.\nFloptical Products: Iomega's Floptical 3.5-inch, 21MB drives are read and write compatible with standard 720 kilobytes (KB) and 1.44MB floppy disk drives. The Company began shipping this product in October 1992. The Company has discontinued the development and manufacture of Floptical disk drives. However, the Company will continue to sell its remaining inventory and retains distribution rights to future generation Floptical drives.\nSubsystems: The Company provides an entire line of subsystems and software drivers for its Bernoulli and tape products. The subsystems are designed to work with multiple computer types, enabling users to move their storage device from machine to machine as their needs change. Models are available in single drive, dual drive, PC powered, and internal configurations. Software drivers are supplied to simplify the integration of the drive into the computer system. Drivers are supplied for leading operating systems including DOS 6.x, Microsoft Windows 3.x, Apple's Macintosh System 6.x and 7.x, and IBM's OS\/2.\nMedia: The Company manufactures removable disks using purchased media and sells them in multiple versions for use with its Bernoulli subsystems and drives. The Company has a five-year limited warranty on the disks used in its 230, 150, 90, 44, and 20MB Bernoulli drives. In addition, the Company provides tape cartridges manufactured for the Company to be used with its Ditto 250, 420, 720 and 1700 drives with a two-year limited warranty. The Company assembles Zip cartridges to be used with its Zip drive with a one- year limited warranty.\nThe Company has distribution rights for removable hard disk cartridges manufactured by Nomai, S.A. in France. The cartridges are compatible with certain SyQuest 5.25\" drives and utilize rigid media manufactured by IBM. The products come with a five-year limited warranty.\nProduct Technology and Features\nMagnetic and optical storage drives such as rigid disk drives, tape drives, and floppy disk drives, are used as mass memory devices in computer systems to store and retrieve digital information. These devices are used to access data while the computer is in operation, provide storage backup for other memory devices, store data for archival purposes, and transport data between systems.\nBernoulli Products: Disk drives store data on media which has either a rigid or flexible substrate coating with a thin layer of magnetic material which permits the recording, erasing and re-recording of data. As the media disk rotates in the disk drive, read\/write heads record data on the disk or retrieve stored data from the disk. Flexible disk drives use thin plastic disks (flexible substrate) that are protected by a lightweight envelope and are removable from the drive mechanism. Rigid disk drives, known as fixed, hard or \"Winchester\" drives, use rigid aluminum disks that are either fixed permanently in the drive mechanism or contained in a removable sealed cartridge.\nThe Company's Bernoulli drives differ from both floppy and Winchester disk drives in basic design and technology. The Company has applied Bernoulli principles of fluid mechanics to provide an aerodynamic coupling between the flexible media and recording head. The patented head contour creates a vacuum between the head and media to create a stable and intimate contact at the read\/write gap, thus achieving very high linear densities. Because the Bernoulli head\/disk interface is aerodynamically \"soft\", a particle of contamination can flow through the interface without permanent damage to the media or head. Similarly, shock and vibration, which can disable a rigid disk drive, may cause a recoverable error but little or no damage to the media or head in the Company's disk drives.\nTape Products: Iomega's tape drives and subsystems are primarily designed to back-up and protect against loss of data stored on hard disk drives in IBM PC-compatible computers. The Iomega tape drives have a beltless design which the Company believes improves reliability. Tape drives are believed to be superior to floppy disk drives as backup devices due to the much higher capacity of the minicartridge used in tape drives to distribute, store and transfer software and data. The storage media used by Iomega's tape products is the industry-standard QIC-compatible series minicartridges.\nZip Products: Iomega's Zip drives are designed for multiple uses: data transport, data back-up and hard drive expansion. The Zip drive utilizes high capacity flexible media and removability technologies developed in the Company's original Bernoulli products. It uses Winchester style nanoslide heads with a special airbearing surface combined with a unique linear voice coil motor. The drive reads and writes both the 3.5\" 25MB and 100MB Zip cartridges.\nFloptical Products: Iomega's Floptical drives are based on technology licensed by the Company on a non-exclusive basis from Insite Peripherals, Inc. The Floptical drive utilizes the same read\/write technology found in standard 3.5-inch floppy drives and is able to read and write to standard 3.5-inch floppy disks. Floptical disks are similar to standard floppy disks with the addition of an optical pattern on one surface. This pattern may be created either by stamping or by laser etching. The Company has developed a laser etching production process.\nSyQuest Compatible Disks: These removable hard disk cartridges are designed to be compatible with certain 5.25\" disk drives marketed by SyQuest Technology, Inc. (\"SyQuest\"). The removable hard disk cartridges are manufactured for the Company by Nomai, S.A. in France.\nNew Products and Product Development\nThe Company operates in an industry that is subject to rapid technological change, and its ability to compete successfully depends upon, among other factors, its ability to anticipate such change. Accordingly, the Company continues to seek to improve its current lines of product offerings and to pursue the development of new products. In particular, there are projects underway to develop higher capacity tape products and to develop high capacity, high performance removable storage devices. During 1994, 1993 and 1992, the Company's research and development expenses were $15,438,000, $18,972,000, and $21,959,000, respectively (or 10.9%, 12.9%, and 15.8%, respectively, of sales).\nIn October 1994, the Company announced its ZIP product, a 25MB and 100MB removable cartridge disk drive. The product capitalizes on the Company's core technical competencies: high capacity flexible media, heads with unique air bearing surfaces, and removability. The Company has applied for and is in the process of applying for a number of patents and copyrights in connection with the Zip product.\nThe ZIP drive is intended for the consumer\/mass market. Also, the Company is continuing development of product(s) for the high performance market currently served by its Bernoulli products. A 230MB version of the Bernoulli product family was introduced to the market in September 1994.\nIn August 1991, the Company entered into a joint development agreement with AIWA Company, Ltd., Japan (AIWA) to develop a very high capacity 4 millimeter (MM) Helico-scanning device based on DAT technology. The Company sold its rights to AIWA in July 1994.\nIn January 1992, the Company acquired certain assets, including intellectual property, of Springer Technologies, Inc., of Fremont, California. These assets were being used by the Company in the development of proprietary thin film head technology for possible application in future mass storage products. In February 1994, the Company sold this development operation to AIWA Research and Development, Inc., a subsidiary of AIWA. The Company has retained rights to purchase thin film heads from AIWA.\nIn April 1990, the Company established a division located in San Diego, California, to develop magnetic tape drive products. The Company began shipping its Tape 250 products in June 1992 and the Tape 420 in November 1994. In March 1995, the Company renamed its tape product line Ditto and introduced the Ditto 850 and Ditto 1700 which the Company began shipping in March 1995.\nIn January 1989, the Company entered into a technology licensing agreement with Insite Peripherals, Inc. (\"Insite\") for rights to use Insite's Floptical data recording technology. Under the licensing agreement, the Company has the nonexclusive option to manufacture and sell Floptical products developed by Insite and to participate in the development, manufacture, and sale of new products based on Floptical technology. The Company began shipping a 21MB laser Floptical drive in October 1992. In March 1994, the Company discontinued the development and manufacturing of Floptical disk drives, but retains the rights to manufacture and distribute in the future.\nThe Company expects to continue to invest in the development of new drives and disks as well as the expansion of its family of products to include other technologies. Such product expansion may be accomplished through internal development, the acquisition of businesses or technologies, or the use of other companies' products in subsystems. The Company also expects to invest in cost reduction efforts for the manufacture of its existing products in 1995.\nMarketing\nThe Company markets and sells storage subsystems, system components and media through several distribution channels.\nThe Company sells its products primarily through distributors and OEMs located throughout the United States, Canada, South America, the Far East and Europe. Domestically, the Company's distributors sell storage subsystems to dealers, national retail chains, superstores, mail order companies, value added resellers (VARs), and franchisees for resale to end users, and sell the Company's drives to OEMs. OEMs and VARs incorporate the Company's drives and drive subsystems into systems and microcomputers designed for a wide range of applications. In addition, the Company is increasing its sales presence in the retail channels to sell its new Zip and Ditto product lines. These retail channels include computer superstores, mail order catalogs, office supply superstores, consumer electronics superstores, and specialty computer stores who sell directly to end users.\nThe Company's Federal Systems Group addresses Federal government requirements through sales to Federal systems integrators and Federal resellers.\nThe Company sells its products outside of North America primarily through international distributors, which accounted for approximately 37% of the total Company's sales in 1994. The Company has increased its sales efforts in the European market in the past several years. Sales are accomplished primarily through sales offices located in Germany, Belgium, Spain, Norway, the United Kingdom, Italy, and France. The Company began invoicing in foreign currencies in January 1992.\nThe Company has contracts with certain of its customers which, in the event of a price decrease, allow those customers, subject to certain limitations, credit equal to the difference between the price originally paid and the new decreased price on units in the customers' inventories on the date of the price decrease. When a price decrease is anticipated, the Company establishes reserves for amounts estimated to be reimbursed to qualifying customers.\nAs of December 31, 1994, the Company's sales, marketing and service organization consisted of 147 salespersons, sales support and service personnel worldwide.\nManufacturing\nBernoulli Products: The Company manufactures its Bernoulli drives by assembling various components, subcomponents and prefabricated parts manufactured by it or outside vendors. The Company manufactures its disk drive mechanism and the media cartridge used with its products. In manufacturing its disks, the Company processes flexible media obtained from outside vendors by placing a magnetic pattern on the media for head positioning and then inserting the media into a protective shell, which is manufactured by a vendor to the Company's specifications. The Company's Bernoulli drives and subsystems are currently manufactured as standard products with standard configurations.\nTape Products: The Company manufactures its tape drives by assembling various components, subcomponents and prefabricated parts manufactured by the Company or outside suppliers. The Company tests these products to meet applicable industry standards. The Company packages its tape drives for sale to both end users and OEMs.\nZip Products: The drive has been designed to be easily manufactured. The Company manufactures its Zip drives and cartridges by assembling various components, subcomponents and prefabricated assemblies manufactured for it by outside suppliers. The Company uses its servowriting technology to place a magnetic pattern on the flexible media to allow the drive to accurately find and follow the \"tracks\" which are used to magnetically store the customer's data.\nThe Company depends on the continued and reliable supply of integrated circuits, media and other components and certain manufacturing equipment from several key vendors. The Company currently purchases media, read\/write positioning assemblies, read\/write heads, certain custom integrated circuits, actuator subassemblies, motors and certain other mechanical devices and assemblies from single manufacturers. The read\/write positioning assemblies used in the Company's Bernoulli drives are purchased from SKF Textilmaschinen- Komponenten GmbH pursuant to a supply agreement which expires on September 30, 1997. The Company purchases other material from single source suppliers on a purchase order basis. Any failure or delay by its vendors to supply required items could have an adverse material effect on the Company's business.\nThe Company has not experienced disruptions in its supply of critical components, other than disruptions in the ordinary course of business that have not had a material effect on the Company's business or operations.\nCompetition\nThe data storage industry is highly competitive. The Company competes with a number of companies that have financial, manufacturing and marketing resources greater than those of the Company and may also compete with licensees of the Company's products.\nBernoulli Products: The Company's Bernoulli drives compete with other data storage devices that are available to personal computer users, primarily Winchester drives (including fixed, removable drive, removable disk and card-mounted versions), and 3.5\" and 5.25\" Magneto-Optical (MO) products. The Company's drives compete in the end user market with internal and external storage subsystems, primarily with subsystems based on removable Winchester drives and disks and 3.5\" Magneto-Optical products. The Company's Bernoulli products compete in the market with a full range of storage products, including Winchester drives, removable Winchester drives, and high performance tape drives.\nTape Products: The Company's Ditto tape drives compete with other QIC and DC2000-type products (which includes QIC and Irwin) in the entry level tape back-up market. The Company believes that this is a growing segment of the market due to the greater need for backups resulting from increased Winchester drive capacities. The data transfer rate for this class of tape drives is relatively slow and since tapes do not provide random access their usage is normally restricted to back-up applications. The Company sees the tape and Bernoulli markets as complementary markets with price and performance segmentation between these product families.\nThe Company competes in the end user market with several internal and external tape products, including parallel port interface products. DC2000-type products currently offer capacities up to 1.7GB with compression. The tape market is considered a commodity market and, therefore, is very price competitive.\nZIP Products: The Company's newly introduced ZIP products have many of the same competitors as its Bernoulli products and tape products. In addition, there are emerging technologies that are considered as competitive with the ZIP products. These emerging technologies include MD-Data, high capacity Floptical, and several recordable CD-ROM technologies.\nFloptical Products: The Company's Floptical drives compete with standard and high density floppy disk drives. The Company's Floptical drives also compete with floptical drives manufactured by Insite.\nSyQuest Compatible Disks: The removable hard disk cartridges directly compete with SyQuest's own removable cartridges and cartridges from other companies. The product is dependent on the drive manufacturer's success in developing an installed base in the market.\nBecause the market in which the Company competes may be defined in a variety of different ways, both broadly (e.g., data storage) and narrowly (e.g., removable disk drive storage devices for personal computers), the Company believes that any attempt to identify the companies that it considers to be dominant in its industry would be both difficult and possibly misleading. However, the Company does believe that it faced more direct competition from removable storage devices for personal computers in 1994 than in any previous year and the Company expects that direct competition to continue and possibly increase in 1995. In the tape market, there are two major competitors -- Conner Periphials, Inc. and Colorado Memory Systems, a division of Hewlett Packard Company.\nThe Company believes that most purchasers of its products distinguish among competitive products on the basis of some or all of the following criteria: price (cost per unit and cost per megabyte of storage capacity), performance (speed and capacity), functionality (reliability, product size and removability) and security of data.\nAn additional competitive consideration, particularly in the OEM market, is the size (form factor) of the drive. Winchester and floppy drives are available in 8-inch, 5.25-inch, 3.5-inch, 2.5-inch and 1.8-inch form factors. The most common form factor for Winchester drives is 3.5-inches. The Company currently offers 5.25-inch Bernoulli drives, 3.5-inch Tape, 3.5- inch Floptical drives, and external 3.5-inch ZIP drives.\nThe data storage industry is characterized by rapid technological development. The introduction by a competitor of products with superior performance or substantially lower prices would adversely affect the Company's business.\nPatents\nThe Company owns 38 United States and 17 foreign patents, and has filed 39 U.S. and 3 foreign patents pending. Although the Company believes that its patents and patent applications have significant value, the Company also relies on copyrights and trade secrets to protect its technology. In addition, rapidly changing industry technology makes the Company's future success dependent primarily upon the technical competence and creative skill of its personnel. The Company has licensed from Insite certain rights relating to the Company's Floptical drives and related media. The Company also believes that it will be necessary or desirable for it to obtain licenses in connection with one or more of its future products, and believes, based on industry practice, that such licenses should be generally obtainable.\nThe Company does not believe that the manufacture or sale of its current products infringes any patents or other intellectual property rights or requires any license from others.\nPrincipal Customers\nDuring the year ended December 31, 1994, sales to Ingram Micro D, Inc., a major distributor, accounted for 11% of sales.\nBacklog\nPurchasers of the Company's products do not generally provide the Company with long-term delivery schedules. Accordingly, backlog is generally not material to an understanding of the Company's business, and the Company's backlog at any time is not generally indicative of future levels of sales.\nGovernment Contracts\nNo material portion of the Company's business is subject to renegotiation of profits or termination of contracts at the election of the United States government.\nEnvironmental Matters\nCompliance with federal, state and local environmental protection laws had no material effect on the Company in 1994 and is not expected to have a material effect in 1995.\nEmployees\nAs of December 31, 1994, the Company employed 886 persons (749 full-time and 137 part-time), including 94 in research and development, 560 in manufacturing, 110 in sales, marketing and service, 70 in general management and administration, and 52 in the European operations. During 1994, the Company completed restructuring actions which resulted in the elimination of approximately 200 positions from all levels of the organization.\nForeign Sales\nPrior to July 1992, the Company's sales to foreign customers were primarily export sales. In July 1992, the Company's German subsidiary began to ship and invoice the majority of the Company's European sales. The Company still exports to areas outside of Europe. Export sales (excluding European sales subsequent to July 1992) for the years ended December 31, 1994, 1993 and 1992 were $6,133,000, $7,534,000, and $21,041,000, respectively. Export sales represented 4% of total sales in 1994, 5% in 1993, and 15% in 1992. Foreign sales of the German subsidiary represented another 33% of total sales in 1994, 23% in 1993, and 10% in 1992. For the details of geographic regions, see \"Note 10, Operations By Geographic Region\", to the Company's audited financial statements for the year ended December 31, 1994. Sales to foreign customers were primarily to customers located in Europe. The Company began billing in foreign currencies in January 1992, therefore increasing its exposure to changes in exchange rates. However, the Company is hedging its cash flows by utilizing forward exchange contracts.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES:\nThe Company also has rented a 20,000 square foot facility in Freiburg, Germany for use as its European headquarters.\nIn addition, the Company leases a total of approximately 10,000 square feet for small sales offices, typically on a short-term basis, in Pleasanton, California; Dedham, Massachusetts; Dallas, Texas; Atlanta, Georgia; Vienna, Virginia; Costa Mesa, California; Hoffman Estate, Illinois; Toronto, Canada; Brussels, Belgium; Middlesex, Great Britain; Oslo, Norway; Milano, Italy; Madrid, Spain; and Cretail, France.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS:\nThere are no legal proceedings, other than ordinary routine litigation incidental to its business, to which the Company or its subsidiaries is a party or of which any of their property is the subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:\nNo matters were submitted to a vote of the Company's security holders during the quarter ended December 31, 1994.\nEXECUTIVE OFFICERS OF THE COMPANY\nKim B. Edwards, 47, joined the Company as President and Chief Executive Officer on January 1, 1994. Mr. Edwards served as President and Chief Executive Officer of Gates Energy Products, Inc., a manufacturer of rechargeable batteries and the successor of General Electric Battery Division, from March 1993 to December 1993, and previously served in various other executive positions after joining Gates Energy Products, Inc. in January 1987.\nLeonard C. Purkis, 46, joined the Company as Senior Vice President and Chief Financial Officer on March 1, 1995. Mr. Purkis joined Iomega following 12 years at General Electric Co., where his most recent assignment was as Senior Vice President of Finance at GE Capital Fleet Services. He also held positions in the Financial Services, Lighting and Plastics businesses, with assignments in Europe and the U.S.\nSrini Nageshwar, 53, was promoted to Senior Vice President - European Operations in April 1991. Mr. Nageshwar joined the Company in January 1991 as Vice President - European Operations. Prior to joining the Company, Mr. Nageshwar was Executive Vice President for Marketing, Sales and Operations of OAZ Communications, a network fax server company, from February 1990 to December 1990. Prior to that, he was President and Chief Operating Officer of Cumulus Corporation, a memory peripherals manufacturing company, from January 1989 to February 1990. Prior to that, Mr. Nageshwar spent 24 years in marketing and general management positions with Hewlett-Packard Company, most recently as Value-Added Business Manager.\nAnton J. Radman, Jr., 42, is Senior Vice President - Sales and Marketing. Previously, he served as Senior Vice President - Corporate Development and Floptical Product Line Manager from January 1993 to June 1993. He also served as Senior Vice President - Corporate Development from December 1989 to January 1993. Mr. Radman was also President of the Bernoulli Optical Systems Co. (BOSCO) subsidiary of Iomega from April 1990 to January 1993. Mr. Radman joined the Company in April 1980 and his previous positions with the Company have included Vice President - Research and Development, Vice President - OEM Products and Sales Manager, and Senior Vice President - Micro Bernoulli Division from April 1988 until December 1989.\nLeon J. Staciokas, 67, is Senior Vice President and Chief Internal Operations Officer. Mr. Staciokas joined the Company in August 1987 as Senior Vice President - Operations. He served as acting Chief Executive Officer of the Company from October 1993 until January 1994.\nJohn G. Thompson, 54, was promoted to Vice President - Corporate Manufacturing in January 1993. Prior to that, Mr. Thompson was Vice President -Materials, Procurement and Engineering Services from March 1988 to January 1992. Mr. Thompson was Vice President\/Controller of the Company from January 1988 until March 1988.\nDonald R. Sterling, 58, was promoted to Vice President, Corporate Counsel and Secretary in April 1994. Prior to that, he was Vice President for Legal Affairs and Secretary from August 1993 to March 1994. Mr. Sterling joined the Company in September 1988.\nExecutive officers are elected on an annual basis and serve at the discretion of the Board of Directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS:\nThe information required by this item is found in the section entitled \"Securities\" of the Company's 1994 Annual Report, which section is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA:\nThe information required by this item is found in the tables entitled \"Trends in Operations\" and \"Financial Conditions and Trends\" of the Company's 1994 Annual Report, which tables 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 found in the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" of the Company's 1994 Annual Report, which section 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 section entitled \"Financial and Operating Highlights\" of the Company's 1994 Annual Report, which section is incorporated herein by reference, and in the financial statements and schedules referred to in the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules, filed as a 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:\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 appears in the section entitled \"ELECTION OF DIRECTORS - Nominees\" of the Company's Proxy Statement for its 1995 annual meeting of stockholders and the section of such Proxy Statement entitled \"ELECTION OF DIRECTORS - Board and Committee Meetings\", which sections are incorporated herein by reference. Information regarding executive officers of the Company is furnished in Part I of this Annual Report on Form 10-K under the heading \"Executive Officers of the Company.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION:\nThe information required by this item appears in the sections entitled \"ELECTION OF DIRECTORS -- Director's Compensation\", \"ELECTION OF DIRECTORS -- Executive Compensation\", \"ELECTION OF DIRECTORS -- Employment and Severance Agreements\" and \"ELECTION OF DIRECTORS -- Certain Business Relationships\" of the Company's Proxy Statement for its 1995 annual meeting of stockholders, which sections 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 contained in the section entitled \"Beneficial Ownership of Common Stock\" of the Company's Proxy Statement for its 1995 annual meeting of stockholders, which section is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:\nThe information required by this item is contained in the sections entitled \"ELECTION OF DIRECTORS -- Employment and Severance Agreements\" and \"ELECTION OF DIRECTORS -- Certain Business Relationships\" of the Company's Proxy Statement for its 1995 annual meeting of stockholders, which sections 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) The following documents are filed as part of or are included in this Annual Report on Form 10-K:\n1. The financial statements listed in the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules, filed as a part of this Annual Report on Form 10-K.\n2. The financial statement schedule listed in the Index to Consolidated Financial Statements and Consolidated Financial Statement Schedules, filed as a part of this Annual Report on Form 10-K.\n3. The exhibits listed in the Exhibit Index filed as a part of this Annual Report on Form 10-K.\n(b) Reports on Form 8-K: No reports on Form 8-K were filed by the Company 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.\nIOMEGA CORPORATION\nBy: Kim B. Edwards 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.\nName Title Date --------------- --------------------------- ----- Chief Executive Officer and Kim B. Edwards Director (Principal executive officer)\nSenior Vice President-Finance, Leonard C. Purkis Chief Financial Officer and Treasurer (Principal financial and accounting officer)\nDavid J. Dunn Chairman of Board of Directors March 29, 1995\nWillem H.J. Andersen Director\nRobert P. Berkowitz Director\nAnthony L. Craig Director\nMichael J. Kucha Director\nJohn R. Myers Director\nJohn E. Nolan Director\nThe Honorable Director John E. Sheehan\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements appear in the Company's 1994 Annual Report to Stockholders and are incorporated herein by reference:\nDescription ------------- Report of Independent Public Accountants\nConsolidated Balance Sheets at December 31, 1994 and 1993\nConsolidated Statements of Operations 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\nThe following schedules are included in this Annual Report on Form 10-K:\nDescription ------------\nReport of Independent Public Accountants on Consolidated Financial Statement Schedules\nII - Valuation and Qualifying Accounts\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON CONSOLIDATED FINANCIAL STATEMENT SCHEDULES\nTo Iomega Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Iomega Corporation's annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 25, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index 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 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\nSalt Lake City, Utah January 25, 1995\nEXHIBIT 23.1\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports included or incorporated by reference in this Form 10-K, into the Company's previously filed Registration Statements on Form S-8, File Nos. 2-87671, 33-13083, 33-20432, 33-23822, 33-41083, and 33-54438.\nARTHUR ANDERSEN LLP\nSalt Lake City, Utah March 29, 1995","section_15":""}
{"filename":"700949_1994.txt","cik":"700949","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 - XII (the \"Partnership\"), is a limited partnership formed in late 1981 and currently governed by the Revised Uniform Limited Partnership Act of the State of Illinois to invest in improved income-producing commercial and residential real property. The Partnership sold $160,000,000 in Limited Partnership Interests (the \"Interests\"), to the public pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933 (Registration No. 2-76443). A total of 160,000 Interests have been sold to the public at $1,000 per Interest. The offering closed on April 19, 1983. No Limited Partner has made any additional capital contribution after such date. The Limited Partners of the Partnership share in their portion of the benefits of ownership of the Partnership's real property investments according to the number of Interests held.\nThe Partnership is engaged solely in the business of the acquisition, operation and sale and disposition of equity real estate investments. Such equity investments are held by fee title, leasehold estates and\/or through joint venture partnership interests. The Partnership's real property investments are located throughout the nation and it has no real estate investments located outside of the United States. A presentation of information about industry segments, geographic regions, raw materials or seasonality is not applicable and would not be material to an understanding of the Partnership's business taken as a whole. Pursuant to the Partnership Agreement, the Partnership is required to terminate on or before December 31, 2032. Accordingly, the Partnership intends to hold the real properties it acquires for investment purposes until such time as sale or other disposition appears to be advantageous. Unless otherwise described, the Partnership expects to hold its properties for long-term investment where, due to current market conditions, it is impossible to forecast the expected holding period. At sale of a particular property, the proceeds, if any, are generally distributed or reinvested in existing properties rather than invested in acquiring additional properties.\nThe Partnership has made the real property investments set forth in the following table:\nThe Partnership's real property investments are subject to competition from similar types of properties (including in certain areas properties owned or advised by affiliates of the General Partners) in the respective vicinities in which they are located. Such competition is generally for the retention of existing tenants. Additionally, the Partnership is in competition for new tenants in markets where significant vacancies are present. Reference is made to Item 7 below for a discussion of competitive conditions and future renovation and capital improvement plans of the Partnership and certain of its significant investment properties. Approximate occupancy levels for the properties are set forth in the table set forth in Item 2","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is not subject to any pending material legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of security holders during 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 16,456 record holders of Interests of the Partnership. There is no public market for Interests and it is not anticipated that a public market for Interests will develop. Upon request, the Corporate General Partner may provide information relating to a prospective transfer of Interests to an investor desiring to transfer his Interests. The price to be paid for the Interests, as well as any other economic aspects of the transaction, will be subject to negotiation by the investor.\nReference is made to Item 6","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nOn June 21, 1982, the Partnership commenced an offering of $160,000,000 pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. All Interests were subscribed and issued between June 21, 1982 and April 19, 1983 from which the Partnership received gross proceeds of $160,000,000.\nAfter deducting selling expenses and other offering costs, the Part- nership had approximately $141,004,000 with which to make investments in income-producing commercial and residential real property, to pay legal fees and other costs (including acquisition fees) related to such invest- ments 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 $30,504,000. Such funds and short-term investments of approximately $1,945,000 are available for capital improvements, future distributions to partners, and for working capital requirements, including capital improvements and leasing costs currently being incurred at the National City Center Office Building. Certain of the Partnership's investment properties currently operate in overbuilt markets which are characterized by lower occupancies and\/or reduced rent levels. The Partnership currently has adequate cash and cash equivalents to maintain the operations of the Partnership. The Partnership has taken steps to preserve its working capital by deciding to suspend distributions from operations to the Limited and General Partners effective as of the first quarter of 1992. The Partnership had also deferred cash distributions and partnership management fees, payable to the Corporate General Partner related to the third and fourth quarters of 1991. In addition, the General Partners and their affiliates had deferred payment of certain property management and leasing fees. In December 1994, the Partnership paid the Corporate General Partner the previously deferred cash distributions, partnership management fees and property management and leasing fees in the amount of $19,666, $33,334 and $3,798,155, respectively, as more fully described in Note 9. In February 1995, the Partnership paid a sales distribution of $23,200,725 ($145 per Interest) to the Limited Partners and $234,351 to the General Partners related to the sale of the Partnership's interest in the First Interstate Center (Notes 7 and 10).\nThe Partnership and its consolidated ventures have currently budgeted for 1995 approximately $1,216,000 for tenant improvements and other capital expenditures. The Partnership's share of such items in 1995 is currently budgeted to be approximately $1,130,000. Included in this amount is the roof and parking lot at the Permian Mall which are currently in need of repair. To fund the Permian Mall improvements, the Partnership intends to initiate discussions with the mortgage lender regarding a modification to the loan. There can be no assurance that a loan modification can be obtained. Actual amounts expended in 1995 may vary depending on a number of factors including actual leasing activity, results of operations, liquidity considerations and other market conditions over the course of the year. The source of capital for such items and for both short-term and long-term future liquidity and distributions is expected to be through cash generated by the Partnership's investment properties and through the sale of such investments. Due to the Permian Mall improvements and considerations on other properties as discussed below, only the National City Center Office Building is considered to be a significant source of future long-term operational cash generated. In addition, the Partnership does not consider the remaining mortgage note receivable (related to San Mateo Fashion Island) to be a source of future liquidity. Reference is made to Note 7(b). 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.\nSTONYBROOK APARTMENTS\nThe mortgages on Stonybrook Apartments II matured October 1, 1994 (Stonybrook Apartments I is not subject to a mortgage loan) with an outstanding balance of approximately $4,807,000 at September 30, 1994. The Partnership refinanced the $4,152,600 first mortgage loan which has been extended to October 1, 1999 at an interest rate of 9.175% per annum. The loan requires monthly interest and principal payments of approximately $35,000 with a balloon payment due at maturity. The Partnership remitted a $40,000 principal payment to the lender, reducing the amount refinanced to $4,112,600. Concurrently, the Partnership paid in full the second mortgage note secured by the property in the amount of $654,800. Accrued and unpaid interest in the amount of $325,485 was forgiven by the lender and is included in extraordinary refinancing loss, net of gain in the accompanying consolidated financial statements. Reference is made to Note 4. The Partnership is currently marketing both phases of the property for sale.\nCARRARA\nIn December 1994, the Partnership redeemed its interest in Carrara Place Limited to the venture for $750,000 in cash at closing (Note 7). As a result of the redemption, the Partnership recognized a gain of $5,404,577 in the accompanying consolidated financial statements. The market and property conditions that preceded the redemption are discussed below.\nThe lease for Carrara Place Office Building's major tenant, which represented 46% of the building's leasable area and provided for rental payments that were significantly greater than current market rental rates, expired in December 1992. The Denver, Colorado region had been adversely affected by increased competition for tenants as a result of overbuilding in the area. As a result of the current market rental rates, the cash flow generated by the property would have been significantly less than the payments required under the original mortgage note even if the space was re-leased. Further, re-leasing the space required significant re-leasing costs. Additionally, the lease for a tenant occupying approximately 17% of the building's leasable area was scheduled to expire in June 1994. The venture reached an agreement with the tenant to extend their lease for an additional five years. The venture also reached an agreement with a new tenant to occupy approximately 21% of the building's leasable area, with the lease scheduled to expire in August 2004. The Carrara venture initiated discussions with the mortgage lender regarding a modification to the mortgage loan and in September 1993 reached an agreement to modify the loan retroactive to January 1, 1993. Under the modification, the maturity date was extended from June 30, 1994 until January 1, 1998. Interest continued to accrue at 9.875% from January 1, 1993 until January 1, 1998. Effective January 1, 1993, the net cash flow of the property, subject to certain reserves, was paid to the lender and applied toward the payment of accrued and unpaid interest, current interest and principal balance of the loan, respectively. Any capital costs, including re-leasing costs, were to be funded by the lender, subject to their approval, and such costs added to the principal balance of the loan. Approximately $2,699,000 had been funded by the lender as of the date of the redemption.\nConcurrent with the modification, the Carrara venture was reorganized such that the Partnership became the sole general partner of the venture, with its venture partner becoming a limited partner of the venture. In addition, the property manager (an affiliate of the unaffiliated venture partner) was replaced effective September 1993. Based upon an analysis of anticipated market conditions, the Partnership had decided not to commit additional funds to the Carrara Place Office Building. There had to be a significant improvement in market and property conditions in order for the value of the property to be greater than the mortgage payoff amount at any point in time, including accrued interest. Therefore, it was unlikely that any significant proceeds would be received by the Partnership in the event the property were sold or refinanced.\nIn conjunction with the modification, the Carrara venture had agreed to transfer title to the lender if the venture failed to pay the loan in full on the earlier of the extended maturity date or an acceleration of the loan as a result of the occurrence of an event of default (as defined). Such a decision would have resulted in a gain for financial reporting and Federal income tax purposes with no corresponding distributable proceeds.\nNATIONAL CITY CENTER\nAt the National City Center Office Building located in Cleveland, Ohio, a major tenant (Baker & Hostetler) extended its lease term to 2001, but reduced its space leased by approximately 18,000 square feet as of January 1993. The extended lease requires tenant improvement costs of approximately $92,000 per year through the expiration of the lease with an additional amount to be paid in 1996 of approximately $730,000. These tenant improvement costs will result in the property incurring a slight deficit for 1994. In 1993, the Venture received a lease termination fee of approximately $1,100,000 from another tenant (KPMG Peat Marwick LLP) for vacating approximately 19,700 square feet (which was subsequently leased to National City Bank).\nIn January 1994, the debt service payments under the existing mortgage increased from 9-5\/8% to 11-7\/8% until the scheduled maturity of the loan in December 1995. The Venture 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 on April 20, 2001. In addition, the Venture paid a prepayment penalty of $580,586 based upon the outstanding loan balance at the time of refinancing. The lender required an escrow account of $612,000 to be established at the time of the refinancing for future tenant improvements at the property. The escrowed funds are to be released to the venture upon lender approval of such costs. The lender also required an escrow of the tenant improvement costs related to the Baker & Hostetler lease (as discussed above). The Venture is required to escrow approximately $313,000 per year in 1994 through 1996 and approximately $236,000 per year in 1997 and 1998. The $1,163,524 refundable loan commitment fee paid by the Partnership in 1993 was applied to accrued interest and the prepayment penalty, with the balance of $238,215 refunded to the Partnership in 1994. The Partnership's share of extraordinary loss on extinguishment of debt ($1,000,547) consisting of the prepayment penalty, the unamortized loan discount and unamortized loan fees at the time of refinancing is recorded in the accompanying consolidated financial statements. Real estate taxes payable in 1994 increased due to the expiration of a 25% reduction of a real estate tax abatement that was received when the property was purchased. The remaining 25% abatement expires in 1998 for taxes payable in 1999.\nCARLYLE SEATTLE\nIn May 1994, Carlyle Seattle executed an agreement which issued an option to sell its interest in First Interstate to the unaffiliated venture partner. The agreement provided for the purchase of 49.95% of Carlyle Seattle's interest by October 17, 1994 (for which Carlyle Seattle received a non-refundable deposit of $500,000 on June 30, 1994 and which was subsequently extended until December 22, 1994 with the receipt of an additional $500,000 on September 22, 1994) with an option for the unaffiliated venture partner to purchase the remaining 50.05% Carlyle Seattle interest between one year and two years after the initial sale closing. On December 1, 1994 (initial sale transaction closing) Carlyle Seattle received (from the unaffiliated joint venture partner) $20,276,000 in cash (less non-refundable deposits as described above) for 49.95% of its interest as explained above. The unaffiliated venture partner paid $5,000,000 in cash for the option of the unaffiliated venture partner to purchase the remaining 50.05% of Carlyle Seattle's interest in First Interstate. Additionally, the unaffiliated venture partner loaned Carlyle Seattle $15,000,000 (bearing interest at a rate of 9% per annum with accrued interest and unpaid principal due on January 1, 1997) which is secured by Carlyle Seattle's remaining 50.05% interest. The exercise price for the remaining 50.05% interest is $21,350,000 if the purchase option is exercised one year from the initial closing, increasing up to $22,850,000 at the termination of the option period. The $5,000,000 option purchase price and the balance of unpaid principal and accrued interest on the $15,000,000 Carlyle Seattle loan can be applied toward the exercise price. There can be no assurance that such option will be exercised. At December 31, 1994, Carlyle Seattle has recorded a note payable to the unaffiliated venture partner in the amount of $15,000,000 plus accrued interest and a deferred gain of $5,000,000 for the cash option payment. In connection with the sale transaction, the First Interstate joint venture agreement was amended to cause the joint venture to be converted to a limited partnership in which Carlyle Seattle is the sole limited partner and the unaffiliated venture partner is the sole general partner. The Partnership's share of proceeds from this transaction was approximately $29,522,000 and its share of gain on sale and restructuring was approximately $25,210,000 in 1994.\nPERMIAN MALL\nThe property produced cash flow from operations in 1994, however, significant funds will be required in the near future for major roof and parking lot repairs. In 1995, 15% of the tenant leases are scheduled to expire for which the Partnership is currently seeking renewal of existing leases or replacement tenants. In anticipation of the necessary major repairs and potential re-leasing costs the Partnership has initiated discussions with the mortgage lender regarding a modification to the loan. There can be no assurance that such modification will be obtained.\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 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.\nBy conserving working capital, the Partnership will be in a better position to meet future needs of its properties without having to rely on external financing sources.\nDue to the factors discussed above and the general lack of buyers of real estate today, it is likely that the Partnership may hold some of its investment properties longer than originally anticipated in order to maximize the return to the Limited Partners. Also, in light of the current severely depressed real estate markets, it currently appears that the Partnership's goal of capital appreciation will not be achieved. Although the Partnership expects to distribute from sale proceeds some portion of the Limited Partners' original capital, without a dramatic improvement in market conditions the Limited Partners will receive significantly less than their original investment. In addition, in connection with sales or other dispositions (including transfers to lenders) of properties (or interests therein) owned by the Partnership or its joint venture, the Limited Partners may be allocated substantial gain for Federal income tax purposes.\nRESULTS OF OPERATIONS\nThe increase in cash and cash equivalents and short-term investments in the aggregate as of December 31, 1994 as compared to December 31, 1993 is primarily due to (i) the Partnership's share of proceeds from the sale of the First Interstate transaction (such proceeds were substantially distributed in February 1995, Note 10) as discussed above and (ii) the Partnership's suspension of cash distributions from operations effective with the first quarter of 1992 as discussed above.\nThe decrease in loan commitment fee as of December 31, 1994 as compared to December 31, 1993 is due to the application of the loan commitment fee to accrued interest and prepayment penalty related to the April, 1994 refinancing of the mortgage loan at the National City Center Office Building (see Note 4(d)).\nThe increase in escrow deposits as of December 31, 1994 as compared to December 31, 1993 is primarily due to the April, 1994 refinancing of the National City Center Office Building mortgage loan (see Note 4(d)).\nThe decrease in investment properties net of accumulated depreciation and deferred expenses as of December 31, 1994 as compared to December 31, 1993 is primarily due to the transactions related to Carrara Place Limited and First Interstate in December, 1994 as discussed above. Such transactions, the payoff of the Stonybrook I mortgage note and the refinancing of the Stonybrook II mortgage note also resulted in the decrease of the current portion and long term debt as of December 31, 1994 as compared to December 31, 1993.\nThe decreases in accrued rents receivable, accounts payable and other liabilities as of December 31, 1994 as compared to December 31, 1993 is primarily due to the First Interstate transaction.\nThe decrease in accrued interest at December 31, 1994 as compared to December 31, 1993 is due primarily to the transaction related to Carrara Place Limited (note 7).\nThe decrease in due to affiliates as of December 31, 1994 as compared to December 31, 1993 is primarily due to the payment of deferred management and leasing fees in December, 1994 (see Note 9).\nThe note payable and deferred gain at December 31, 1994 relate to the sale and financing of Carlyle Seattle's remaining interest in First Interstate (see Note 7(d)).\nThe decrease in rental income and mortgage and other interest and property operating expenses for the year ended December 31, 1994 as compared to the year ended December 31, 1993 is primarily due to the second mortgage lender's realization upon its security represented by the Country Square apartments in February, 1993, the sale of the Sierra Pines and Crossing Apartments in July 1993 (see Note 7) and to the change to the equity method of accounting for First Interstate effective December 1, 1994 (see Note 1). In addition, rental income decreased due to a $1,100,000 termination fee received in January 1993 at the National City Center Office Building and due to decreased rental income at the First Interstate Center resulting from decreased rental rates. The decrease in rental income, mortgage and other interest, and property operating expenses for the year ended December 31, 1993 compared to the year ended December 31, 1992 is primarily due to the second mortgage lender's realization upon its security represented by the Country Square apartments and the sale of the Sierra Pines and Crossing Apartments in July 1993 and decreased occupancy at the Carrara Place Office Building. The decrease in rental income is partially offset by the lease termination fee received in 1993 at the National City Center Office building, as discussed above.\nThe increase in interest income for the year ended December 31, 1994 compared to the year ended December 31, 1993 is primarily due to the increases in the rate of interest earned on and an increased average balance of U.S. Government obligations. The decrease in interest income for the year ended December 31, 1993 compared to the year ended December 31, 1992 is primarily due to a decrease in the interest income recognized on the mortgage note receivable for San Mateo Fashion Island.\nThe decrease in depreciation for the year ended December 31, 1994 compared to the year ended December 31, 1993 is primarily due to the second mortgage lender's realization upon its security represented by the Country Square apartments in February, 1993 and the sale of the Sierra Pines and Crossing Apartments in July 1993 and to the change to the equity method of accounting for First Interstate effective December 1, 1994 (see Note 7).\nThe increase in Partnership's share of operations of unconsolidated venture for the year ended December 31, 1993 as compared to December 31, 1992 is due to the transfer of title to the property to the lender of the Yerba Buena West Office Building in June 1992.\nThe provision for value impairment for the year ended December 31, 1992 is due to the Partnership recording a provision to reduce the net carrying value of the Sierra Pines Apartments, based upon a proposed sales price.\nThe decrease in venture partners' share of ventures' operations for the year ended December 31, 1994 compared to the year ended December 31, 1993 and the corresponding decrease in venture partners' deficits in ventures for the year ended December 31, 1994 compared to the year ended December 31, 1993 is primarily due to the sale of the Partnership's interest in Carrara Place Limited and the First Interstate transaction as discussed above.\nThe gain on sale or dispositions, net of venture partners' share for the year ended December 31, 1994 is due to the redemption of the Partnership's interest in Carrara Place Limited and partial sale and restructuring of First Interstate (see Note 7). The gain on the sale or disposition of investment properties for the year ended December 31, 1993 is due to the second mortgage lender's realization upon its security represented by the Country Square apartments in February 1993 and the gain on sale of the Sierra Pines and Crossing Apartments in July 1993. The gain on the sale or disposition of investment properties for the year ended December 31, 1992 is due to the transfer of title to the property to the lender of the Yerba Buena West Office Building in June 1992. In addition, the lenders of Arbor Town Apartments - I and Arbor Town Apartments - II realized upon their security and took title to the properties in December 1992.\nThe extraordinary loss for the year ended December 31, 1994 is primarily due to the discount and deferred mortgage expense write-offs and the prepayment penalty related to the National City Center mortgage refinancing. These losses are netted against the forgiveness of accrued interest associated with the Stonybrook Apartments II refinancing (see Note 4).\nINFLATION\nDue to the decrease in the level of inflation in recent years, inflation generally has not had a material effect on rental income or property operating expenses.\nTo the extent that inflation in future periods does have an adverse impact on property operating expenses, the effect will generally be offset by amounts recovered from tenants, as many of the long-term leases at the Partnership's commercial properties have escalation clauses covering increases in the cost of operating and maintaining the properties as well as real estate taxes. Therefore, there should be little effect on operating earnings if the properties remain substantially occupied. In addition, substantially all of the leases at the Partnership's shopping center investment contain provisions which entitle the Partnership to participate in gross receipts of tenants above fixed minimum amounts.\nFuture inflation may also cause capital appreciation of the Partnership's investment properties over a period of time to the extent that rental rates and replacement costs of properties increase.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nINDEX\nIndependent Auditors' Report\nConsolidated Balance Sheets, December 31, 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 consolidated financial statements or related notes.\nINDEPENDENT AUDITORS' REPORT\nThe Partners CARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII:\nWe have audited the consolidated financial statements of Carlyle Real Estate Limited Partnership - XII (a limited partnership) and consolidated ventures as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement 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 - XII 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 27, 1995\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (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 its ventures Carlyle Seattle Associates (\"Carlyle Seattle\") (note 7), Stonybrook Partners Limited Partnership (\"Stonybrook\"), Carrara Place Limited (\"Carrara\") (note 7), Carlyle Carrollton Associates (\"Carlyle Carrollton\") (note 7), and Carlyle\/National City Associates (\"Carlyle\/National City\"), Carlyle Seattle's venture, Wright-Carlyle Seattle (\"First Interstate\") (note 7) and Carlyle Carrollton's venture, Country Square, Ltd. (\"Country Square\") (note 7). The effect of all transactions between the Partnership and the ventures has been eliminated.\nThe equity method of accounting has been applied in the accompanying consolidated financial statements with respect to the Partnership's interest in Carlyle Yerba Buena Limited Partnership (\"Yerba Buena\"), through the date of its disposition (note 3(c)) and First Interstate, effective December 1, 1994, due to the sale of 49.95% of Carlyle Seattle's interest (note 7). Accordingly, the accompanying consolidated financial statements do not include the accounts of entities accounted for under the equity method.\nThe Partnership records are maintained on the accrual basis of accounting as adjusted for Federal income tax reporting purposes. The accompanying consolidated financial statements have been prepared from such records after making appropriate adjustments to present the Partnership's accounts in accordance with generally accepted accounting principles (\"GAAP\") and to consolidate the accounts of the ventures as described above. Such adjustments are not recorded on the records of the Partnership. The net effect of these items is summarized as follows:\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe net earnings (loss) per limited partnership interest is based upon the limited partnership interests outstanding at the end of each year (160,005). Deficit capital accounts will result, through the duration of the Partnership, in net gain for financial reporting and income tax purposes.\nStatement of Financial Accounting Standards No. 95 requires the Partnership to present a statement which classifies receipts and payments according to whether they stem from operating, investing or financing activities. The required information has been segregated and accumulated according to the classifications specified in the pronouncement. Partnership distributions from unconsolidated ventures are considered cash flow from operating activities only to the extent of the Partnership's cumulative share of net earnings. In addition, the Partnership records amounts held in U.S. Government obligations and certificates of deposit at cost which approximates market. Therefore, for the purposes of these statements, the Partnership's policy is to consider all such amounts held with original maturities of three months or less ($30,086,428 and none held at December 31, 1994 and 1993, respectively) as cash equivalents with any remaining amounts reflected as short-term investments being held to maturity.\nDeferred expenses are comprised principally of deferred leasing commissions and deferred lease assumption costs which are amortized over the lives of the related leases and deferred mortgage costs which are amortized over the term of the related notes.\nAlthough certain leases of the Partnership provide for tenant occupancy during periods for which no rent is due and\/or increases in minimum lease payments over the term of the lease, the Partnership accrues rental income for the full period of occupancy on a straight-line basis.\nStatement of Financial Accounting Standards No. 107, (\"SFAS 107\"),\"Disclosures about Fair Value of Financial Instruments\", requires entities with total assets exceeding $150 million at December 31, 1992 to disclose the SFAS 107 value of all financial assets and liabilities for which it is practicable to estimate. Value is defined in the Statement as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Partnership believes the carrying amount of its financial instruments classified as current assets and liabilities (excluding current portion of long-term debt) approximates SFAS 107 value due to the relatively short maturity of these instruments. There is no quoted market value available for any of the Partnership's other instruments. The debt, with a carrying balance of $79,735,096, has been calculated to have an SFAS 107 value of $69,365,789 by discounting the scheduled loan payments to maturity. Due to restrictions on transferability and prepayment, and the inability to obtain comparable financing due to previously modified debt terms or other property specific competitive conditions, the Partnership would be unable to refinance these properties to obtain such calculated debt amounts reported. (See note 4.) The Partnership has no other significant financial instruments.\nDuring 1992, the Partnership entered into a contract (that was subsequently terminated) to sell the Sierra Pines Apartments subject to certain contingencies. Based upon the proposed sales price, the Partnership would not have recovered the net carrying value of the investment property. The Partnership, therefore, as a matter of prudent accounting practice, made a provision for value impairment on such investment property of $2,682,822. Such provision was recorded in September 1992, to effectively reduce the net carrying value of the investment property, based upon the proposed sale price. The Sierra Pines Apartments was sold in July 1993 (note 7(c)).\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nNo provision for State or Federal income taxes has been made as the liability for such taxes is that of the Partners rather than the Partnership. However, in certain instances, the Partnership has been required under applicable law to remit directly to the taxing authorities amounts representing withholding from distributions paid to partners.\n(2) INVESTMENT PROPERTIES\nThe Partnership has acquired, either directly or through joint ventures, ten apartment complexes, four office buildings, and two enclosed shopping malls. During 1984, the Partnership sold its interest in the Arbor Town Apartments-I and the Arbor Town Apartments-II complexes. Subsequently, in 1992, the lenders on the Arbor Town Apartments-I and Arbor Town Apartments-II complexes realized upon their security and obtained title to the properties resulting in the Partnership no longer having a security interest in the properties (note 4(d)). In 1986, the Partnership conveyed its interest in the Presidio West Apartments-II and sold its interest in the San Mateo shopping center. In 1990, the Partnership disposed of its interest in the Timberline Apartments and sold its interest in the Meadows Southwest Apartments. In 1991, the Partnership, through its joint venture, disposed of its interest in the Summerfield\/Oakridge Apartments. In 1992, the Yerba Buena venture transferred title to the property to the lender (note 3(c)). In 1993, the Partnership sold its interest in the Sierra Pines Apartments and The Crossing Apartments, and disposed of its interest in the Country Square Apartments (note 7). In 1994, the Partnership redeemed its interest in Carrara Place Limited (note 7). Also in 1994, Carlyle Seattle sold 49.95% of its interest in and issued an option to sell its remaining 50.05% interest in the First Interstate venture (note 7). The four properties owned at December 31, 1994 were completed and in operation.\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 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.\nProvisions for value impairment are recorded with respect to the investment properties whenever the estimated future cash flows from a property's operations and projected sale are less than the property's net carrying value.\n(3) VENTURE AGREEMENTS\n(a) General\nThe Partnership, at December 31, 1994, is a party to three operating joint venture agreements. Pursuant to such agreements, the Partnership made aggregate capital contributions of $101,530,662 (including Carrara Place Limited in which the Partnership redeemed its interest in 1994). In general, the 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\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nthe Partnership's interest, which is determined by arm's-length negotiations. Under certain circumstances, either pursuant to the venture agreements or due to the Partnership's obligations as a general partner, the Partnership may be required to make additional cash contributions to the ventures.\nThe Partnership has acquired, through the above ventures, one apartment complex and two office buildings. In some instances, the properties were acquired (as completed) for a fixed purchase price. In other instances, properties were developed by the ventures and, in those instances, the contributions of the Partnership were generally fixed. The joint venture partners (who were primarily responsible for constructing the properties) contributed any excess of cost over the aggregate amount available from Partnership contributions and financing and, to the extent such funds exceeded the aggregate costs, were to retain such excess. The venture properties have been financed under various long-term debt arrangements as described in note 4.\nTwo of the ventures' properties produced net cash receipts during 1994, one in 1993. In general, operating profits and losses are shared in the same ratio as net cash receipts. If there are no net cash receipts, substantially all profits or losses are allocated in accordance with the partners' respective economic interests. The Partnership generally has preferred positions (related to the Partnership's cash investment in the ventures) with respect to distribution of sale or refinancing proceeds from the ventures.\nThere are certain risks associated with the Partnership's investments made through joint ventures including the possibility that the Partnership's joint venture partners in an investment might become unable or unwilling to fulfill their financial or other obligations, or that such joint venture partners may have economic or business interests or goals that are inconsistent with those of the Partnership.\n(b) First Interstate Center\nOn December 1, 1994, Carlyle Seattle sold 49.95% of its interest in First Interstate (note 7(d)).\nDuring 1982, the Partnership acquired, through a joint venture (\"First Interstate\") between an affiliated joint venture (\"Carlyle Seattle\") described below and the developer, a fee ownership of improvements and a leasehold interest in an office building in Seattle, Washington. Carlyle Seattle is a joint venture between the Partnership and Carlyle Real Estate Limited Partnership-X (\"C-X\"), an affiliated partnership sponsored by the Corporate General Partner of the Partnership. Under the terms of the First Interstate venture agreement, Carlyle Seattle made initial cash contributions aggregating $30,000,000.\nThe terms of the Carlyle Seattle venture agreement provide that all the capital contributions will be made in the proportion of 73.3% by the Partnership and 26.7% by C-X. The initial required contribution by the Partnership to the Carlyle Seattle venture was $22,000,000. The Carlyle Seattle venture agreement further provides that all of the venture's share of First Interstate's annual cash flow, sale or refinancing proceeds, operating profits and losses, and tax items will be allocated 73.3% to the Partnership and 26.7% to C-X.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nPrior to the sale transaction, Carlyle Seattle was generally entitled to receive a preferred distribution (on a cumulative basis) of annual cash flow equal to 8% of its capital contributions to First Interstate. venture. Cash flow in excess of this preferred distribution was distributable to the First Interstate joint venture partner up to the next $400,000 and any remaining annual cash flow was distributable 50% to Carlyle Seattle and 50% to the First Interstate joint venture partner. Operating deficits, if any, were shared 50% by Carlyle Seattle and 50% by the First Interstate joint venture partner. Operating profits or losses of the First Interstate joint venture generally were allocated in the same ratio as the allocation of annual cash flow, however, the joint venture partner was to be allocated not less than 25% of such profits and losses.\nIn connection with the transaction, the First Interstate Venture Agreement has been amended to convert Carlyle Seattle's remaining general partnership interest to a limited partnership interest. Additionally, the amendment states that no profits, income or gain shall be allocable to Carlyle Seattle except to the extent that Carlyle Seattle receives distributions from First Interstate and operating losses shall be allocated to the extent of Carlyle Seattle's positive capital account balance and thereafter at 25.025%. The amended Venture Agreement provides that any distributions to Carlyle Seattle are subordinate to the joint venture partner's preferred return (as defined). It is not anticipated that any distributions will be made to Carlyle Seattle from operations subsequent to the initial sale transaction. Immediately after the execution of the amendment to the Venture Agreement, the unaffiliated venture partner conveyed its general partnership interest to its affiliate and First Interstate was recapitalized. The recapitalization involved the refinancing and replacement of the first mortgage loan. The replacement debt is payable in monthly installments of interest only at a rate of 7.88% per annum, and matures on December 1, 2001 when all unpaid principal and accrued interest becomes due. Additionally, effective December 1, 1994, the equity method of accounting has been applied with respect to Carlyle Seattle's interest in First Interstate as Carlyle Seattle's interest has decreased to less than 50% and converted to a limited partnership interest.\nThe office building is managed by an affiliate of the First Interstate joint venture partner for a fee computed at 2% of base and percentage rents.\n(c) Yerba Buena West Office Building\nIn June 1992, Carlyle Yerba Buena Limited Partnership (\"Yerba Buena\") transferred title to the property to the lender in return for an opportunity to share in future sale or refinancing proceeds above certain levels. In order for the joint venture to share in future sale or refinancing proceeds, however, 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, through June 1998, the joint venture has right of first opportunity to purchase the property if the lender chooses to sell. An affiliate of the Partnership's Corporate General Partner had been managing and leasing the property for the lender. In December 1994, the affiliate was replaced as manager and leasing agent for the property. 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 of $2,261,223 and $1,350,845 in 1992 for financial reporting and Federal income tax purposes, respectively, with no corresponding distributable proceeds.\n(d) Carrara\nIn December 1994, the Partnership redeemed its interest in Carrara Place Limited to the venture (note 7(e)).\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe Carrara joint venture agreement provided that operating profits and losses of the venture were to be allocated 50% to the venture and 50% to the venture partner. Commencing July 1, 1994, operating profits or losses were allocated 100% to the Partnership. Gain arising from the sale or other disposition of the property would be allocated to the venture partner or partners then having a deficit balance in its or their respective capital accounts in accordance with the terms of the venture agreement. Any additional gain would be allocated in accordance with the distribution of sales proceeds. The lease for Carrara Place Office Building's major tenant, which represented 46% of the building's leasable area and provided for rental payments that were significantly greater than current market rental rates, expired in December 1992 and the tenant vacated. The Carrara venture initiated discussions with the mortgage lender regarding a modification to the mortgage loan.\nConcurrent with the modification (note 4(b)), the Carrara venture reorganized such that the Partnership became the sole general partner of the venture, with its venture partner becoming a limited partner of the venture. In addition, the property manager (an affiliate of the unaffiliated venture partner) was replaced effective September 1993. Based upon an analysis of current and anticipated market conditions, the Partnership had decided not to commit additional funds to the Carrara Place Office Building. There had to be a significant improvement in market and property conditions in order for the value of the property to be greater than the mortgage pay off amount at any point in time, including accrued interest. Therefore, it was unlikely that any significant proceeds would be received by the Partnership from a sale of the property or that the mortgage loan could be refinanced when it became due.\nIn conjunction with the modification, the venture had agreed to transfer title to the lender if the venture failed to pay the loan in full on the earlier of the extended maturity date or an acceleration of the loan as a result of the occurrence of an event of default (as defined).\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nIncluded in the above total long-term debt is $2,055,549 at December 31, 1993 which represents mortgage interest accrued but not currently payable pursuant to the terms of the notes (as modified).\nFive year maturities of long-term debt (exclusive of amortization of discount) are as follows:\n1995 . . . . . . . . . . $1,683,440 1996 . . . . . . . . . . 1,843,475 1997 . . . . . . . . . . 2,018,223 1998 . . . . . . . . . . 2,204,089 1999 . . . . . . . . . . 6,285,213 ==========\n(b) Debt Modifications\nThe Partnership modified the $5,800,000 second mortgage note secured by the Country Square apartment complex in Carrollton, Texas effective June 1, 1989. The pay rate was raised from 4% per annum to 5% per annum (payable in monthly installments of interest only) through December 1, 1992. Interest accrued and was deferred at a rate of 11% per annum from June 1, 1989 through December 31, 1990 and 12% per annum from January 1, 1991 through December 31, 1992; payable each April 30 to the extent of any annual cash flow (as defined) or upon the earlier of subsequent sale of the property or the January 1, 1993 maturity of the note. The lender notified the Partnership that it would not modify the existing terms of the second mortgage. The Partnership was unable to secure new or additional modifications or extensions to the loan. On February 2, 1993, the second mortgage lender concluded proceedings to realize upon its security and took title to the property. As a result, the Partnership recognized a gain for financial reporting purposes of $1,520,734 and a gain for Federal income tax purposes of $5,633,431 in 1993 with no corresponding distributable proceeds.\nEffective January 1, 1993, the mortgage note secured by the Carrara Place Office Building was modified. Under the modification, the maturity date was extended from June 30, 1994 until January 1, 1998. Interest continued to accrue at 9.875% from January 1, 1993 until maturity. Effective January 1, 1993, the net cash flow of the property (after the required minimum interest payments of $8,333 monthly or $100,000 annually), subject to certain reserves including a $350,000 operating reserve to fund deficits, was to be paid to the lender and applied toward the payment of accrued and unpaid interest, current interest and principal balance of the loan, respectively. Any capital costs, including re-leasing costs, were to be funded by the lender, (subject to their approval) and added to the principal balance of the loan.\nIn conjunction with the modification, the venture had agreed to transfer title to the lender if the venture failed to pay the loan in full on the earlier of the extended maturity date or an acceleration of the loan as a result of the occurrence of an event of default (as defined) (note 7(e)). CARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(c) Sierra Pines and Crossings Apartments\nEffective December 27, 1990, the Partnership obtained replacement loans from an institutional lender to retire in full satisfaction, at an aggregated discount, the previously modified existing long-term mortgage notes secured by the Sierra Pines Apartments and the Crossings Apartments. The new lender required the establishment of escrow accounts, of approximately $253,000 and $291,000, to be used toward the purchase of capital items at the Sierra Pines Apartments and the Crossings Apartments, respectively. As of the date of sale (see note 7(c)) approximately $62,000 and $6,000 were used for such purposes for the respective properties. The new mortgage loans, which were cross-collateralized, required interest only payments at 9.5% plus contingent interest (as defined) until January 1, 1999, when the remaining balance was payable. In 1993 and 1992, $176,334 and $145,029 were paid for 1992 and 1991 contingent interest, respectively for the properties. $107,945 was paid in 1993 for 1993 contingent interest for both properties through the date of sale. In the event that these properties were sold before the maturity date of the loan, the lender was to receive additional interest of 6% of the mortgage principal and, in general, the higher of 65% of the sale proceeds (as defined) or ten times the highest contingent interest (as defined) amount in any of the three full fiscal years preceding the sale. In 1993, the Partnership sold its interest in the Sierra Pines Apartments and The Crossing Apartments (see note 7(c)).\n(d) National City Center Office Building\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 on April 10, 2001. Carlyle\/National City paid a refundable loan commitment fee of $1,163,524 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 escrowed funds are to be released to the venture upon lender approval of such costs. The lender also required an escrow of the tenant improvement costs related to the Baker & Hostetler lease (as discussed above). The Venture is required to escrow approximately $313,000 per year in 1994 through 1996 and approximately $236,000 per year in 1997 and 1998. The Partnership's share of extraordinary loss on extinguishment of debt ($1,000,547) consisting of the prepayment penalty, the unamortized loan discount and unamortized loan fees at the time of refinancing is recorded in the accompanying consolidated financial statements.\n(e) Stonybrook Apartments\nThe mortgages on Stonybrook Apartments II matured October 1, 1994 (Stonybrook Apartments I is not subject to a mortgage loan) with an outstanding balance of approximately $4,807,000 at September 30, 1994. The Partnership refinanced the $4,152,600 first mortgage loan and extended the maturity date to October 1, 1999 at an interest rate of 9.175% per annum. The loan requires monthly interest and principal payments of approximately\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n$35,000 with a balloon payment due at maturity. The Partnership remitted a $40,000 principal payment to the lender, reducing the amount refinanced to $4,112,600. Concurrently, the Partnership paid in full the second mortgage note secured by the property in the amount of $654,800. Accrued and unpaid interest in the amount of $325,485 was forgiven by the lender and is reflected as an extraordinary item in the accompanying consolidated financial statements.\n(5) PARTNERSHIP AGREEMENT\nPursuant to the terms of the Partnership Agreement, net profits and losses of the Partnership from operations are allocated 96% to the Limited Partners and 4% to the General Partners. Profits from the sale or other disposition of investment properties will be allocated first to the General Partners in an amount equal to the greater of the amount distributable to the General Partners as sale or refinancing proceeds from sale or other disposition of investment properties (as described below) or 1% of the profits from the sale or refinancing. Losses from the sale or other disposition of investment properties will be allocated 1% to the General Partners. The remaining sale or other disposition of investment properties profits and losses will be allocated to the Limited Partners.\nAn amendment to the Partnership Agreement, effective January 1, 1991, generally provides that notwithstanding any allocation contained in the Agreement, if at any time profits are realized by the Partnership, any current or anticipated event that would cause the deficit balance in absolute amount in the Capital Account of the General Partners to be greater than their share of the Partnership's indebtedness (as defined) after such event, then the allocation of Profits to the General Partners shall be increased to the extent necessary to cause the deficit balance in the Capital Account of the General Partners to be no less than their respective shares of the Partnership's indebtedness (as defined) after such event. In general, the effect of this amendment is to allow the deferral of the recognition of taxable gain to the Limited Partners.\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 will be allocated 90% to the Limited Partners and 10% to the General Partners (of which 6.25% constitutes a management fee to the Corporate General Partner for services in managing the Partnership). Distributions of \"sale proceeds\" and \"financing proceeds\" are to be allocated 99% to the Limited Partners and 1% to the General Partners until receipt by the Limited Partners of their initial contributed capital plus a stipulated return thereon. Thereafter, distributions of \"sale proceeds\" and \"financing proceeds\" are to be allocated to the General Partners until the General Partners have received an amount equal to 3% of the gross sales prices of any properties sold, then the balance 85% to the Limited Partners and 15% to the General Partners.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(6) MANAGEMENT AGREEMENTS\nThe Partnership has entered into agreements with sellers or affiliates of the sellers for the operation and management of several properties. Such agreements provided that, during the term of these agreements, the managers paid all expenses of the properties and retained the excess, if any, of cash revenues from operations over costs and expenses, as defined, as a management fee. Upon termination of the agreements, an affiliate of the General Partners assumed management under agreements providing for management fees calculated at a percentage of the gross income from the properties. In December 1994, one of the affiliated property managers sold substantially all of its assets 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 is acting as the property manager of the National City Center Office Building and Stonybrook Apartments.\n(7) SALE OF INVESTMENT PROPERTIES\n(a) Arbor Town Apartments-I and Arbor Town Apartments-II\nDuring November 1984, the Partnership concurrently sold the land and related improvements of the Arbor Town Apartments-I and Arbor Town Apartments-II located in Arlington, Texas for $15,500,000, consisting of $3,100,000 in cash and $12,400,000 of wrap-around notes receivable. The purchase wrap-around notes were subject to existing mortgage notes.\nThe sale was accounted for by the installment method whereby the gain on sale of $2,724,491 (net of discount on the notes receivable of $890,413) was recognized as collections of principal were received. Beginning with 1987, the Partnership adopted the cost recovery method. No profit was recognized by the Partnership in 1992 and 1991.\nThe Partnership did not receive the scheduled interest only payments of approximately $2,000,000 on the wrap-around notes receivable from January 1988 through May 1989 and, therefore, the Partnership did not make the corresponding scheduled monthly payments on the underlying indebtedness. The buyer voluntarily filed for protection under Chapter 11 of the United States Bankruptcy Code in May 1988. In April 1989, the United States Bankruptcy Court approved a plan of reorganization, whereby scheduled payments on the wrap-around notes receivable and related underlying mortgage notes payable were allowed to be modified by the buyer.\nUnder the terms of the Bankruptcy Reorganization Plan, the Partnership's wrap-around notes receivable and underlying non-recourse mortgage notes payable remained outstanding. The buyer subsequently negotiated the modification of the underlying non-recourse mortgage notes payable directly with the lenders while the wrap-around notes receivable had been modified to the extent the Partnership had agreed that the buyer make payments directly to the lender. These modifications modified the terms of the original underlying loan agreements resulting in permanent interest expense reductions. For financial reporting purposes, these interest expense reductions had been offset by adjustments to the wrap-around notes receivable. No reserve for collectibility had been established previously due to the existence of deferred gain exceeding the net equity in the wrap- around notes receivable, with the underlying indebtedness being non- recourse to the Partnership. The Partnership recognized interest income on the wrap-around notes receivable only to the extent interest had been paid\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nby the buyer on the modified underlying indebtedness. In December 1992, the lenders concluded proceedings to realize upon their security and obtained title to the properties resulting in the Partnership no longer having a security interest in the properties. Although the Partnership received no cash proceeds from the transfer of its security interest; it did, however, recognize a gain for financial reporting purposes and a loss for Federal income tax purposes in 1992 of $1,556,577 and $275,509, respectively.\n(b) San Mateo Fashion Island\nOn December 31, 1986, the Partnership sold its right, title and interest in the land, leasehold interest and related improvements of the San Mateo Fashion Island shopping center for $44,202,559 and recognized profit in full of $9,528,813. The sale price consisted of $950,000 in cash at closing, the assumption of the existing mortgage note having an unpaid principal balance of $39,302,559 (for financial reporting purposes the principal balance was $28,895,264) and an additional promissory note in the amount of $3,950,000 ($950,000 paid in March 1988) secured by a subordinated deed of trust on the property. In addition to the sale price, the Partnership received $7,600,000 from the venture partner during 1986 under the terms of the venture agreement.\nDuring the first quarter of 1992, the Partnership was advised by the buyer (in which the Corporate General Partner has an interest) that it had initiated discussions directly with the first mortgage lender regarding a modification to the first mortgage note. The buyer is currently making reduced payments to the first mortgage lender and had discontinued making payments to the Partnership as of March 1992. Due to uncertainty regarding the value of the underlying collateral, the Partnership reserved for the entire outstanding principal balance and accrued interest ($3,720,000) on the note receivable as of December 31, 1994 and 1993 in the accompanying consolidated financial statements. In addition, the entire outstanding principal balance and accrued interest was written off for Federal income tax purposes in 1992.\n(c) Sierra Pines and Crossing Apartments\nOn July 29, 1993, the Partnership sold the land, buildings, related improvements and personal property of the Sierra Pines and Crossing Apartments located in Houston, Texas. The purchaser is not affiliated with the Partnership or its General Partners and the sale price was determined by arm's-length negotiations. The sale prices of the land, buildings, related improvements and personal property for Sierra Pines and Crossing Apartments were $4,880,000 and $9,535,000, respectively. A portion of the cash proceeds was utilized to retire the first mortgage notes with outstanding balances of $4,380,000 and $7,600,000, respectively, secured by the properties. The Partnership paid additional interest of $1,230,923 in the aggregate in connection with the retirement of the mortgage notes. The Partnership received in connection with these sales, after additional interest and normal costs of sale, a net amount of cash of approximately $950,000 (including $288,000 in advisory fees) in the aggregate. As a result of these sales, the Partnership recognized gains for financial reporting purposes in 1993 of $44,030 and $2,526,916, respectively, and recognized a gain for Federal income tax purposes in 1993 of $1,510,727 and $6,164,118, respectively.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(d) First Interstate\nIn May 1994, Carlyle Seattle executed an agreement which issued an option to sell its interest in First Interstate to the unaffiliated venture partner. The agreement provided for the purchase of 49.95% of Carlyle Seattle's interest by October 17, 1994 (for which Carlyle Seattle received a non-refundable deposit of $500,000 on June 30, 1994 and which was subsequently extended until December 22, 1994 with the receipt of an additional $500,000 on September 22, 1994) with an option for the unaffiliated venture partner to purchase the remaining 50.05% Carlyle Seattle interest between one year and two years after the initial sale closing. On December 1, 1994 (initial sale transaction closing), Carlyle Seattle received (from the unaffiliated joint venture partner) $20,276,000 cash (less non-refundable deposits as described above) for 49.95% of its interest as explained above. The unaffiliated venture partner paid, $5,000,000 cash for the option of the unaffiliated venture partner to purchase the remaining 50.05% of Carlyle Seattle's interest in the First Interstate. Additionally, the unaffiliated venture partner loaned $15,000,000 (bearing interest at a rate of 9% per annum with accrued interest and unpaid principal due on January 1, 1997) and is secured by Carlyle Seattle's remaining 50.05% interest. The exercise price for the remaining 50.05% interest is $21,350,000 if the purchase option is exercised one year from the initial closing, increasing up to $22,850,000 at the termination of the option period. The $5,000,000 option purchase price paid at the initial closing and the balance of unpaid principal and accrued interest on the $15,000,000 Carlyle Seattle loan can be applied toward the exercise price. There can be no assurance that such option will be exercised. At December 31, 1994, Carlyle Seattle has recorded a note payable to the unaffiliated venture partner in the amount of $15,000,000 plus accrued interest and a deferred gain of $5,000,000 for the cash option payment. See note 3(b) for a discussion of the restructuring of the First Interstate joint venture. The Partnership's share of proceeds from this transaction was approximately $29,522,000. Carlyle Seattle recognized a gain of $34,583,869 (of which the Partnership's share is $25,210,324) for financial reporting purposes in 1994 and a gain of $83,565,440 (of which the Partnership's share is $61,224,798) for Federal income tax purposes in 1994.\n(e) Carrara\nIn December 1994, the Partnership redeemed its interest in Carrara Place Limited for $750,000 in cash at closing. As a result of the redemption, the Partnership recognized a gain of $5,404,577 for financial reporting purposes and $12,141,105 for Federal income tax purposes in 1994.\n(8) LEASES\n(a) As Property Lessor\nAt December 31, 1994 the Partnership and its consolidated ventures' principal assets are one apartment complex, one enclosed shopping mall and two office buildings. The Partnership has determined that all leases relating to these properties are properly classified as operating leases; therefore, rental income is reported when earned and the cost of each of the properties, excluding cost of land, is depreciated over the estimated useful life.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nLeases with commercial tenants range in term from one to thirty years and provide for fixed minimum rent and partial reimbursement of operating costs. In addition, leases with shopping center tenants provide additional rent based upon percentages of tenants' sales volumes. With respect to the Partnership's shopping center investment, a substantial portion of the ability of retail tenants to honor their leases is dependent upon the retail economic sector. Apartment complex leases in effect at December 31, 1994 are generally for a term of one year or less and provide for annual rents of approximately $1,956,000.\nCost and accumulated depreciation of the leased assets are summarized as follows at December 31, 1994:\nShopping mall: Cost. . . . . . . . . . . . $ 24,767,200 Accumulated depreciation. . (8,401,619) ------------ 16,365,581 ------------ Office buildings: Cost. . . . . . . . . . . . 89,472,492 Accumulated depreciation. . (27,206,294) ------------ 62,266,198 ------------ Apartment complex: Cost. . . . . . . . . . . . 8,060,815 Accumulated depreciation. . (3,738,289) ------------ 4,322,526 ------------ Total. . . . . . . . . . $ 82,954,305 ============\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 . . . . . . . . . . . $ 13,645,829 1996 . . . . . . . . . . . 11,609,375 1997 . . . . . . . . . . . 10,791,221 1998 . . . . . . . . . . . 10,356,002 1999 . . . . . . . . . . . 10,193,636 Thereafter . . . . . . . . 54,675,218 ------------ Total. . . . . . . . . $111,271,281 ============\n(b) As Property Lessee\nFirst Interstate owned a net leasehold interest (which was scheduled to expire in 2052) in the land underlying the Seattle, Washington office building, subject to a 20-year extension. The lease provided for an annual rent of $670,000 and has been determined to be an operating lease (note 7(d)).\nConcurrent with the sale transaction, an affiliate of the new general partner in First Interstate purchased the land underlying the office building and terminated the related ground lease.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(9) TRANSACTIONS WITH AFFILIATES\nFees, commissions and other expenses required to be paid by the Partnership to the General Partners and their affiliates as of December 31, 1994 and for the years ended December 31, 1994, 1993 and 1992 are as follows:\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONCLUDED\nThe General Partners and their affiliates had deferred through June 30, 1988 payment of certain property management and leasing fees. In addition, the Partnership deferred the General Partners' cash distribution and management fee of $19,666 and $33,334, respectively, for the third and fourth quarters of 1991. In December 1994 the Partnership paid deferred property management and leasing fees, cash distributions and management fees of $3,798,155, $19,666 and $33,334, respectively.\n(10) SUBSEQUENT EVENT - Distributions\nIn February 1995, the Partnership paid a sales distribution of $23,200,725 ($145 per Interest) to the Limited Partners and $234,351 to the General Partners.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no changes of or disagreements with accountants during fiscal year 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, as the Corporate General Partner, has responsibility for all aspects of the Partnership's operations, subject to the requirement that sales of real property must be approved by the Associate General Partner of the Partnership, Realty Associates-XII, L.P., an Illinois limited partnership with JMB as the sole general partner. The Associate General Partner shall be directed by a majority in interest of its limited partners (who are generally officers, directors and affiliates of JMB or its affiliates) as to whether to provide its approval of any sale of real property (or any interest therein) of the Partnership. The Partnership is subject to certain conflicts of interest arising out of its relationships with the General Partners and their affiliates as well as the fact that the General Partners and their affiliates are engaged in a range of real estate activities. Certain services have been and may in the future be provided to the Partnership or its investment properties by affiliates of the General Partners, including property management services and insurance brokerage services. In general, such services are to be provided on terms no less favorable to the Partnership than could be obtained from independent third parties and are otherwise subject to conditions and restrictions contained in the Partnership Agreement. The Partnership Agreement permits the General Partners and their affiliates to provide services to, and otherwise deal and do business with, persons who may be engaged in transactions with the Partnership, and permits the Partnership to borrow from, purchase goods and services from, and otherwise to do business with, persons doing business with the General Partners or their affiliates. The General Partners and their affiliates may be in competition with the Partnership under certain circumstances, including, in certain geographical markets, for tenants for properties and\/or for the sale of properties. Because the timing and amount of cash distributions and profits and losses of the Partnership may be affected by various determinations by the General Partners under the Partnership Agreement, including whether and when to sell or refinance a property, the establishment and maintenance of reasonable reserves, the timing of expenditures and the allocation of certain tax items under the Partnership Agreement, the General Partners may have a conflict of interest with respect to such determinations.\nThe names, positions held and length of service therein of each director and executive officer and certain officers of the Corporate General Partner are as follows:\nSERVED IN NAME OFFICE OFFICE SINCE ---- ------ ------------\nJudd D. Malkin Chairman 5\/03\/71 Director 5\/03\/71 Neil G. Bluhm President 5\/03\/71 Director 5\/03\/71 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\nSERVED IN NAME OFFICE OFFICE SINCE ---- ------ ------------\nH. Rigel Barber Chief Executive Officer and 8\/01\/93 Executive Vice President 1\/02\/87 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 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-XI (\"Carlyle-XI\"), Carlyle Real Estate Limited Partnership-XIII (\"Carlyle-XIII\"), Carlyle Real Estate Limited Partnership-XIV (\"Carlyle-XIV\"), Carlyle Real Estate Limited Partnership-XV (\"Carlyle-XV\"), Carlyle Real Estate Limited Partnership-XVI (\"Carlyle-XVI\"), Carlyle Real Estate Limited Partnership-XVII (\"Carlyle- XVII\"), JMB Mortgage Partners, Ltd. (\"Mortgage Partners\"), JMB Mortgage Partners, Ltd.-II (\"Mortgage Partners-II\"), JMB Mortgage Partners, Ltd.-III (\"Mortgage Partners-III\"), JMB Mortgage Partners, Ltd.-IV (\"Mortgage Partners-IV\"), Carlyle Income Plus, Ltd. (\"Carlyle Income Plus\") and Carlyle Income Plus, Ltd.-II (\"Carlyle Income Plus-II\") and the managing general partner of JMB Income Properties, Ltd.-IV (\"JMB Income-IV\"), JMB Income Properties, Ltd.-V (\"JMB Income-V\"), JMB Income Properties, Ltd.-VI (\"JMB Income-VI\"), JMB Income Properties, Ltd.-VII (\"JMB Income-VII\"), JMB Income Properties, Ltd.-VIII (\"JMB Income-VIII\"), JMB Income Properties, Ltd.-IX (\"JMB Income-IX\"), JMB Income Properties, Ltd.-X (\"JMB Income-X\"), JMB Income Properties, Ltd.-XI (\"JMB Income-XI\"), JMB Income Properties, Ltd.-XII (\"JMB Income-XII\") and JMB Income Properties, Ltd.-XIII (\"JMB Income-XIII\"). Most of the foregoing directors and officers are also officers and\/or directors of various affiliated companies of JMB including Arvida\/JMB Managers, Inc. (the general partner of Arvida\/JMB Partners, L.P. (\"Arvida\")), Arvida\/JMB Managers-II, Inc. (the general partner of Arvida\/JMB Partners, L.P.-II (\"Arvida-II\")) and Income Growth Managers, Inc. (the corporate general partner of IDS\/JMB Balanced Income Growth, Ltd. (\"IDS\/BIG\")). Most of such directors and officers are also partners of certain partnerships which are associate general partners in the following real estate limited partnerships: Carlyle-VII, Carlyle-IX, Carlyle-X, Carlyle-XI, Carlyle-XIII, Carlyle-XIV, Carlyle-XV, Carlyle-XVI, Carlyle- XVII, JMB Income-VI, JMB Income-VII, JMB Income-VIII, JMB Income-IX, JMB Income-X, JMB Income-XI, JMB Income-XII, JMB Income-XIII, Mortgage Partners, Mortgage Partners-II, Mortgage Partners-III, Mortgage Partners-IV, Carlyle Income Plus, Carlyle Income Plus-II and IDS\/BIG.\nThe business experience during the past five years of each such director and officer of the Corporate General Partner of the Partnership in addition to that described above is as follows:\nJudd D. Malkin (age 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 is 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. 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) is Executive Vice President of JMB. Mr. Cameron has been associated with JMB since April, 1977. Prior to joining JMB, 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.\nITEM 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 in Notes 5 and 9. The Partnership deferred the General Partner's cash distribution and deferred management fees related to the third and fourth quarters of 1991. In December 1994, the Partnership paid the General Partner the previously deferred cash distribution and management fees. The General Partners received a share of the Partnership's long-term capital gain for tax purposes aggregating $5,250,527 in 1994. In addition, the General Partners received a share of the Partnership's operating losses aggregating $539,886. Such losses may benefit the General Partners to the extent that such losses may be offset against taxable income from the Partnership or other sources.\nThe Partnership is permitted to engage in various transactions involving affiliates of the Corporate General Partner of the Partnership. The relationship of the Corporate General Partner (and its directors and officers) to its affiliates is set forth above in Item 10.\nJMB Properties Company, an affiliate of the Corporate General Partner, provided property management services to the Partnership for all or part of 1994 for the Stonybrook Apartments - I & II in Tucson, Arizona, the Permian Mall in Odessa, Texas and National City Center Office Building in Cleveland, Ohio at fees calculated at a percentage of gross income from the properties. In 1994, such affiliate earned property management fees amounting to $1,251,080 for such services, all of which were paid as of 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 specified in the Prospectus), and such agreements must be terminable by either party thereto, without penalty, upon 60 days' notice.\nJMB Insurance Agency, Inc., an affiliate of the Corporate General Partner, earned insurance brokerage commissions in 1994 aggregating approximately $39,097, all of which were paid in 1994 in connection with the providing of insurance coverage for certain of the real property investments of the Partnership. Such commissions are at rates set by insurance companies for the classes of coverage provided.\nThe General Partners of the Partnership or their affiliates may be reimbursed for their direct expenses or out-of-pocket expenses relating to the administration of the Partnership and the operation of the Partnership's real property investments. In 1994, the Corporate General Partner of the Partnership was due reimbursement for such out-of-pocket expenses in the amount of $85,037, of which $1,833 was unpaid as of December 31, 1994.\nAdditionally, the General Partners may be reimbursed for salaries and direct expenses of officers and employees of the Corporate General Partner and its affiliates while directly engaged in the administration of the Partnership and in the operation of the Partnership's real property investments. In 1994, such costs were $159,099. The General Partners earned no disbursement agent fees in 1993.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the Corporate General Partner, affiliates or their management other than those described in Items 10 and 11 above (see Note 3(c) to the accompanying Notes to Consolidated Financial Statements).\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements (See Index to Financial Statements filed with this annual report).\n(2) Exhibits.\n3-A. The Prospectus of the Partnership dated June 21, 1982, as supplemented on August 24, 1982, October 21, 1982, November 1, 1982, December 22, 1982 and February 18, 1983, as filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Copies of pages 6-14, 137-139, A-6 to A-11 and A-13 to A-19 are incorporated by reference to the Partnership's Registration Statement on Form S-11 (File No. 2-76443) dated June 21, 1982.\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, is incorporated by reference to the Partnership's Registration Statement on Form S-11 (File No. 2-76443) dated June 21, 1982.\n4-A. Mortgage loan agreement between Wright-Carlyle Seattle and The Prudential Insurance Company dated October 16, 1985, relating to the First Interstate Center is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0- 12433) dated March 19, 1993.\n4-B. Mortgage loan agreement between Carlyle\/National City Associates and New York Life Insurance Company dated November 15, 1983, relating to the National City Center Office Building is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n10-A.Acquisition documents including the venture agreement relating to the purchase by the Partnership of an interest in the First Interstate Center in Seattle, Washington are hereby incorporated by reference to the Partnership's prospectus on Form S-11 (File No. 2-76443), dated June 21, 1982.\n10-B.Acquisition documents including the venture agreement relating to the purchase by the Partnership of an interest in the National City Center Office Building in Cleveland, Ohio are hereby incorporated by reference to the Partnership's Report on Form 8-K, dated August 8, 1983.\n10-C.Bargain and Sale Deed relating to the Partnership's disposition of the Timberline Apartments in Denver, Colorado, dated July 25, 1990 is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n10-D.Sale documents and exhibits thereto relating to the Partnership's sale of the Meadows Southwest Apartments in Houston, Texas are hereby incorporated herein by reference to the Partnership's Report on Form 8-K (File No. 0-12433), dated January 11, 1991 by reference.\n10-E.Non-Merger Quit Claim Deeds relating to the Partnership's disposition of the Summerfield\/ Oakridge Apartments in Aurora, Colorado, dated January 7, 1991 are hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n21. List of Subsidiaries.\n24. Powers of Attorney.\n27. Financial Data Schedule.\n99.1.The Partnership's Report on Form 8-K (File No. 0- 12433) describing the sale transaction of First Interstate Center dated December 14, 1994 is filed herewith.\n99.2.The Partnership's Report on Form 8-K (File No. 0- 12433) describing the sale of the Partnership's interest in Carrara Place Limited dated December 22, 1994 is filed herewith.\n___________\nAlthough certain additional long-term debt instruments of the Registrant have been excluded from Exhibit 4 above, pursuant to Rule 601(b)(4)(iii), the Registrant commits to provide copies of such agreements to the SEC upon request.\n(b) The following reports on Form 8-K were filed since the beginning of the last quarter of the period covered by this report.\n(i) The Partnership's report on Form 8-K dated December 14, 1994 for December 1, 1994 (describing the sale transaction of First Interstate) was filed.\n(ii) The Partnership's report on Form 8-K dated December 22, 1994 for December 8, 1994 (describing the sale of the Partnership's interest in Carrara Place Limited) was filed.\nNo annual report for the year 1994 or proxy material has been sent to the Partners of the Partnership. An annual report will be sent to the Partners subsequent to this filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII\nBy: JMB Realty Corporation Corporate General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: March 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 - XII\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------ ----\n3-A. Pages 6-14, 137-139, A-6 to A-11 and A-13 to A-19 of the Prospectus of the Partnership dated June 21, 1982, as supplemented on August 24, 1982, October 21, 1982, November 1, 1982, December 22,1982 and February 28, 1983Yes\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus Yes\n4-A. Mortgage loan agreement related to the First Interstate Center Yes\n4-B. Mortgage loan agreement related to the National City Center Office Building Yes\n10-A. Acquisition documents related to First Interstate Center Yes\n10-B. Acquisition documents related to National City Center Office Building Yes\n10-C. Bargain and Sale Deed related to Timberline Apartments Yes\n10-D. Sale documents related to the Meadows Southwest Apartments Yes\n10-E. Non-Merger Quit Claim Deeds related to the Summerfield\/Oakridge Apartments Yes\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No\n99.1. Form 8-K for First Interstate Center No\n99.2. Form 8-K for Carrara Place Office Building No","section_12":"","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the Corporate General Partner, affiliates or their management other than those described in Items 10 and 11 above (see Note 3(c) to the accompanying Notes to Consolidated Financial Statements).\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements (See Index to Financial Statements filed with this annual report).\n(2) Exhibits.\n3-A. The Prospectus of the Partnership dated June 21, 1982, as supplemented on August 24, 1982, October 21, 1982, November 1, 1982, December 22, 1982 and February 18, 1983, as filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Copies of pages 6-14, 137-139, A-6 to A-11 and A-13 to A-19 are incorporated by reference to the Partnership's Registration Statement on Form S-11 (File No. 2-76443) dated June 21, 1982.\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, is incorporated by reference to the Partnership's Registration Statement on Form S-11 (File No. 2-76443) dated June 21, 1982.\n4-A. Mortgage loan agreement between Wright-Carlyle Seattle and The Prudential Insurance Company dated October 16, 1985, relating to the First Interstate Center is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0- 12433) dated March 19, 1993.\n4-B. Mortgage loan agreement between Carlyle\/National City Associates and New York Life Insurance Company dated November 15, 1983, relating to the National City Center Office Building is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n10-A.Acquisition documents including the venture agreement relating to the purchase by the Partnership of an interest in the First Interstate Center in Seattle, Washington are hereby incorporated by reference to the Partnership's prospectus on Form S-11 (File No. 2-76443), dated June 21, 1982.\n10-B.Acquisition documents including the venture agreement relating to the purchase by the Partnership of an interest in the National City Center Office Building in Cleveland, Ohio are hereby incorporated by reference to the Partnership's Report on Form 8-K, dated August 8, 1983.\n10-C.Bargain and Sale Deed relating to the Partnership's disposition of the Timberline Apartments in Denver, Colorado, dated July 25, 1990 is hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n10-D.Sale documents and exhibits thereto relating to the Partnership's sale of the Meadows Southwest Apartments in Houston, Texas are hereby incorporated herein by reference to the Partnership's Report on Form 8-K (File No. 0-12433), dated January 11, 1991 by reference.\n10-E.Non-Merger Quit Claim Deeds relating to the Partnership's disposition of the Summerfield\/ Oakridge Apartments in Aurora, Colorado, dated January 7, 1991 are hereby incorporated by reference to the Partnership's report for December 31, 1992 on Form 10-K (File No. 0-12433) dated March 19, 1993.\n21. List of Subsidiaries.\n24. Powers of Attorney.\n27. Financial Data Schedule.\n99.1.The Partnership's Report on Form 8-K (File No. 0- 12433) describing the sale transaction of First Interstate Center dated December 14, 1994 is filed herewith.\n99.2.The Partnership's Report on Form 8-K (File No. 0- 12433) describing the sale of the Partnership's interest in Carrara Place Limited dated December 22, 1994 is filed herewith.\n___________\nAlthough certain additional long-term debt instruments of the Registrant have been excluded from Exhibit 4 above, pursuant to Rule 601(b)(4)(iii), the Registrant commits to provide copies of such agreements to the SEC upon request.\n(b) The following reports on Form 8-K were filed since the beginning of the last quarter of the period covered by this report.\n(i) The Partnership's report on Form 8-K dated December 14, 1994 for December 1, 1994 (describing the sale transaction of First Interstate) was filed.\n(ii) The Partnership's report on Form 8-K dated December 22, 1994 for December 8, 1994 (describing the sale of the Partnership's interest in Carrara Place Limited) was filed.\nNo annual report for the year 1994 or proxy material has been sent to the Partners of the Partnership. An annual report will be sent to the Partners subsequent to this filing.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Partnership has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XII\nBy: JMB Realty Corporation Corporate General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: March 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 - XII\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------ ----\n3-A. Pages 6-14, 137-139, A-6 to A-11 and A-13 to A-19 of the Prospectus of the Partnership dated June 21, 1982, as supplemented on August 24, 1982, October 21, 1982, November 1, 1982, December 22,1982 and February 28, 1983Yes\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus Yes\n4-A. Mortgage loan agreement related to the First Interstate Center Yes\n4-B. Mortgage loan agreement related to the National City Center Office Building Yes\n10-A. Acquisition documents related to First Interstate Center Yes\n10-B. Acquisition documents related to National City Center Office Building Yes\n10-C. Bargain and Sale Deed related to Timberline Apartments Yes\n10-D. Sale documents related to the Meadows Southwest Apartments Yes\n10-E. Non-Merger Quit Claim Deeds related to the Summerfield\/Oakridge Apartments Yes\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No\n99.1. Form 8-K for First Interstate Center No\n99.2. Form 8-K for Carrara Place Office Building No","section_15":""}
{"filename":"31348_1994.txt","cik":"31348","year":"1994","section_1":"ITEM 1. BUSINESS - -----------------\nEchlin Inc. was incorporated in the state of Connecticut in 1959 and is engaged in only one business segment as a worldwide supplier of products to maintain or improve the efficiency and safety of motor vehicles. During the past fiscal year, Echlin Inc. and its subsidiaries (\"Echlin\" or the \"company\") continued to conduct its business in a manner consistent with prior years.\nThe company's principal products can be classified into the following categories: brake system, engine system, other vehicle parts and non-vehicular products. Brake system parts include hydraulic brake master cylinders, push rods for master cylinders, brake shoes, drums, brake cables, hardware and wheel cylinders for drum brake systems, disc pads, rotors and calipers for disc brake systems, repair kits for hydraulic brakes, hoses and controllers for electrical brakes. In addition, wheel oil seals, compressors, air dryers, valves, power boosters, pressure converters, air brake actuating products, antilock brake systems, spring brakes, brake block, remanufactured brake shoes, pneumatic and electrical connectors and slack adjustors are manufactured for the heavy duty brake market. Engine system parts include condensers, contacts, complete distributors, distributor caps, ignition coils, rotors, control modules, sensors, electronic voltage regulators, wire and cable products, carburetor and emission control parts, fuel pumps, starter drives, solenoids, electronic fuel injection systems, oxygen sensors, EGR valves, LPG carburetion parts and PCV valves. Other vehicle parts include new and remanufactured clutches, bell housings, automatic transmission parts, timing gears and chains, U-joints, engine mounts, airhorns, mirrors, water pumps, power steering pumps, oil pumps and steering and suspension system components, heavy duty windshield wiper systems and shifters, traction bars, gaskets and accessories for the high performance market. Non-vehicular products include small engine parts and security access control products.\nSales by product class for the last three fiscal years ended August 31 were as follows:\n(In millions of dollars)\nThe company's products are sold primarily as replacement products for use by professional mechanics and by car and truck owners. Sales are made to automotive warehouse distributors, heavy duty distributors, retailers, other parts manufacturers and parts remanufacturers. The company also sells its products to original equipment manufacturers in both the automotive and heavy duty markets.\nRaw Materials - -------------\nEchlin's principal requirements for raw materials consist of copper, brass, steel, plastic, paperboard, rubber, resin, iron, zinc and aluminum. Echlin is not dependent on any one source for the raw materials essential to its business, and during the last year encountered no difficulties in obtaining raw materials.\nPatents and Licenses - --------------------\nEchlin holds a number of patents on its air brake system parts, hydraulic brake system parts, engine system parts and security access control products. The loss or expiration of any of these patents would not, however, have a significant effect on Echlin's operations.\nSeasonal Effects - ----------------\nEchlin's business does not have material seasonal characteristics.\nWorking Capital Items - ---------------------\nInventories are kept at a sufficient level to service customer orders but are not disproportionate to Echlin's sales. Echlin grants customers the right to return goods where the conditions of Echlin's obsolescence and return policies are met. This practice has not had materially adverse effects on its business.\nCustomers - ---------\nMembers of the National Automotive Parts Association (NAPA) represent the company's largest group of customers and accounted for 10.3% of consolidated net sales for the year ended August 31, 1994. Included in this number are sales to Genuine Parts Company and its affiliates, the largest member of NAPA, which accounted for 10.2% of consolidated net sales in fiscal 1994. This long-standing relationship with NAPA started in 1928. Products identified by the trademarks \"NAPA Echlin\" and \"NAPA United\" are sold exclusively in the United States to NAPA distribution centers. Echlin believes its relationship with NAPA and its members are good, however, the loss of the NAPA members as customers would have a materially adverse effect on its business.\nBacklog - -------\nMost of Echlin's sales are from its inventory so that the amount of backlog is not material to an understanding of its business.\nGovernment Contracts - --------------------\nGovernment contracts are not material to Echlin's business.\nCompetitive Conditions - ----------------------\nAs Echlin sells different product lines in various markets, there is no one company which serves as its major competitor. There are a number of major independent manufacturers of parts and supplies and the leading original equipment manufacturers also supply virtually every part sold by Echlin. In addition, the company faces competition in domestic markets from foreign manufacturers.\nCompetition in all markets served by Echlin is based on product quality, delivery, warranty, customer service and price. Echlin believes that its products command good acceptance, and that it is one of the leading manufacturers in the industry.\nEnvironmental Regulations - -------------------------\nEchlin does not believe that compliance with federal, state or 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 will have a material effect on capital expenditures, earnings or its competitive position.\nEmployees - ---------\nEchlin employs approximately 20,600 people worldwide. The company believes that relations with its employees are satisfactory.\nResearch and Development - ------------------------\nEchlin's basic parts and supplies business does not require it to make substantial expenditures on research and development activities. However, Echlin has developed several new products and continues to make expenditures for the modification and improvement of existing products and services. For the years ended August 31, 1994, 1993 and 1992, Echlin spent approximately $22,535,000, $18,442,000 and $15,222,000, respectively, on research and developmental efforts, substantially all of which was sponsored by Echlin.\nFinancial Information About Foreign and Domestic Operations and Export Sales - ----------------------------------------------------------------------------\nFor information relating to Echlin's foreign and domestic operations for fiscal 1994, 1993 and 1992, see Note 9 to the consolidated financial statements appearing on pages 44 and 45 of Echlin's 1994 Annual Report to Shareholders, which pages are incorporated herein by reference. Export sales represent less than 10% of the company's consolidated trade sales.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - -------------------\nThe following table sets forth a summary description of Echlin's principal physical properties as of November 1, 1994:\n*Leased facility\nIn addition to the properties listed above, Echlin owns or leases other smaller facilities both in the United States and abroad. Echlin believes it will be able to renew all leases upon expiration. Inability to do so, however, would not have a materially adverse effect on Echlin's operations.\nIn the opinion of Echlin's management, its properties are in good condition and provide adequate capacity for its current operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ---------------------------\nThe company and its consolidated subsidiaries are parties to various legal proceedings arising in the normal course of business including administrative and judicial proceedings in connection with environmental matters that involve claims for damages and\/or potential monetary sanctions. In management's opinion, based on the advice of counsel, the outcome of such proceedings will not in the aggregate have a materially 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 security holders during the fourth quarter of the fiscal year covered by this report.\nEXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------\nOfficers are elected to hold their offices until their respective successors are duly elected or until their earlier resignation or removal. There is no family relationship between the executive officers.\nListed below is the name, age, position and business experience of each officer of the company during the past five years:\nFrederick J. Mancheski (age 68) Chairman of the Board and Chief Executive - ---------------------- Officer since 1969; a Director since 1963.\nC. Scott Greer (age 44) President since September 1990; various managerial - -------------- positions within Echlin's International Group from 1980 through 1990; a Director since October 1990.\nJon P. Leckerling (age 46) Vice President, General Counsel and Corporate - ----------------- Secretary since 1990; Managing Director of Long Wharf Capital Partners Inc. from 1988 to 1990.\nMilton J. Makoski (age 48) Vice President-Human Resources since 1986. - -----------------\nJoseph A. Onorato (age 45) Vice President and Treasurer since May 1994; - ----------------- Treasurer from 1990 to 1994; Assistant Treasurer from 1985 to 1990.\nRobert F. Tobey (age 49) Vice President Corporate Development since April - --------------- 1994; various managerial positions within Echlin's International Group from 1991 to 1994; Vice President Corporate Development from 1985 to 1991.\nRichard A. Wisot (age 48) Vice President and Controller since July 1990; - ---------------- Treasurer from 1981 to 1990.\nKenneth T. Flynn Jr. (age 45) Assistant Corporate Controller since 1985. - --------------------\nCharles W. O'Connor (age 64) Assistant General Counsel and Assistant Secretary - ------------------- since 1990; Attorney and Assistant Secretary from 1980 to 1990.\nEdward C. Shalagan (age 42) Assistant Treasurer since 1988. - ------------------\nEdward D. Toole Jr. (age 64) Associate General Counsel and Assistant Secretary - ------------------- since 1990; Vice President, Secretary and General Counsel from 1986 to 1990.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED - -------------------------------------------------------------- SECURITY HOLDER MATTERS - -----------------------\nEchlin's common stock is listed on the New York Stock Exchange, the Pacific Stock Exchange and the International Stock Exchange in London. Options on Echlin's stock are also traded on the Pacific Stock Exchange. The number of record holders of common stock on November 4, 1994 was 4,162. The quarterly market price and dividend data appearing on page 48 of Echlin's 1994 Annual Report to Shareholders is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - ---------------------------------\nThe presentation under \"Historical Data\" on pages 46 and 47 of Echlin'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 - ---------------------\n\"Review of Operations and Financial Condition\" on pages 5 and 6 of Echlin'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 Statements of Income, Consolidated Balance Sheets, Consolidated Statements of Cash Flows, Consolidated Statements of Changes in Shareholders' Equity, Notes to Consolidated Financial Statements, Quarterly Financial Data and the Report of Independent Accountants as set forth on pages 33 through 45 of Echlin'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 - --------------------\nThere have been no changes in independent accountants or disagreements on accounting and financial disclosure.\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------------------------------------------------------------\nInformation relating to Directors is set forth under the caption \"Election of Directors\" on pages 2 through 8 in Echlin's 1994 Annual Proxy Statement and is incorporated herein by reference. Certain information regarding Executive Officers of the Registrant is contained in Item 4 of Part I of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - ---------------------------------\nInformation relating to Executive Compensation is set forth under the captions \"Compensation of Directors\" and \"Executive Compensation\" on pages 5 through 8 and 8 through 17, respectively, in Echlin's 1994 Annual Proxy Statement and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------------------------------------------------------------------------\nInformation relating to Security Ownership of Certain Beneficial Owners and Management is set forth under the caption \"Beneficial Ownership\" on pages 5 through 7 in Echlin's 1994 Annual Proxy Statement and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ---------------------------------------------------------\nInformation relating to Certain Relationships and Related Transactions is set forth under the caption \"Election of Directors\" in Echlin's 1994 Annual Proxy Statement on pages 2 through 8 and page 12 are incorporated herein by reference.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - ---------------------------------------------------------------------------\n14. (a) Document List -------------\n1. Financial Statements --------------------\nAmong the responses to this Item 14 (a) are the following financial statements which are incorporated herein by reference in Item 8 above:\n(i) Consolidated Statements of Income for the three years ended August 31, 1994, 1993 and 1992 (ii) Consolidated Balance Sheets at August 31, 1994 and 1993 (iii) Consolidated Statements of Cash Flows for the three years ended August 31, 1994, 1993 and 1992 (iv) Consolidated Statements of Changes in Shareholders' Equity for the three years ended August 31, 1994, 1993 and 1992 (v) Notes to Consolidated Financial Statements (vi) Report of Independent Accountants\n2. Financial Statement Schedules -----------------------------\nAll other schedules are omitted because they are not required, are inapplicable, or the information is otherwise shown in the financial statements or notes thereto.\n3. Exhibits Required by Item 601 of Securities and Exchange Commission ------------------------------------------------------------------- Regulation S-K. --------------\n(3)(i) By-Laws, as amended on December 22, 1987, June 21, 1988, October 30, 1991, and June 29, 1994 is being filed as an Exhibit.\n(ii) Certificate of Incorporation, filed as Exhibit 3 (3)(ii) to the Annual Report on Form 10-K for the fiscal year ended August 31, 1987, is incorporated herein by reference.\n(iii) Certificate of Amendment amending the Certificate of Incorporation to Establish Series A Cumulative Participating Preferred Stock, filed as Exhibit 3 (3)(iii) to the Annual Report on Form 10-K for the fiscal year ended August 31, 1989, is incorporated herein by reference.\n(iv) Certificate of Amendment, amending the Certificate of Incorporation, to limit the liability of directors for monetary damages under certain circumstances, filed as Item 2 to the 1989 Annual Proxy Statement, is incorporated herein by reference.\n(4)(i) Specimen of Common Stock Certificate, filed as Exhibit 2(1) to Registration No. 2-63494, is incorporated herein by reference.\n(ii) Rights Agreement, dated as of June 21, 1989, between Echlin Inc. and The Connecticut Bank and Trust Company, N.A., as Rights Agent, which includes the form of Amendment to the company's Certificate of Incorporation as Exhibit A, the form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Stock as Exhibit C, filed as Exhibit 1 to the Current Report on Form 8-K dated June 21, 1989 is incorporated herein by reference.\n(iii) Successor Rights Agent Agreement between Echlin Inc. and The First National Bank of Boston appointing The First National Bank of Boston as successor Rights Agent to replace The Connecticut Bank and Trust Company, N.A. as Rights Agent, filed as Exhibit 3(3)(iv) to the Annual Report on Form 10-K for the fiscal year ended August 31, 1990, is incorporated herein by reference.\n(10)(i) (a) Deferred Compensation Plan filed as Exhibits (10)(c)(i) to the Annual Report on Form 10-K for the fiscal year ended August 31, 1981, is incorporated herein by reference; (b) information set forth under the caption \"Executive Bonus Plan\" in the 1992 Annual Proxy Statement is incorporated herein by reference; (c) the Echlin Inc. 1992 Stock Option Plan, filed as Appendix A to the 1992 Annual Proxy Statement, is incorporated herein by reference; (d) Supplemental Executive Retirement Plan dated as of December 19, 1990, as amended, filed as Exhibit 3(10)(ii) to the Annual Report on Form 10-K for the fiscal year ended August 31, 1991, is incorporated herein by reference; (e) Change in Control Severance Policy dated as of December 19, 1990, as amended, filed as Exhibit 3(10)(ii) to the Annual Report on Form 10-K for the fiscal year ended August 31, 1991, is incorporated herein by reference; (f) the Echlin Inc. Performance Unit Plan, filed as Appendix A to the 1994 Annual Proxy Statement, is incorporated herein by reference.\n(13) The financial section of Echlin's 1994 Annual Report to Shareholders, which contains the information incorporated by reference in this Annual Report on Form 10-K, is being filed as an Exhibit.\n(22) List of Subsidiaries of Echlin Inc. is being filed as an Exhibit.\n(27) Financial Data Schedule is being filed as an Exhibit.\nAll other exhibits are omitted because they are not applicable.\n14 (b) Reports on Form 8-K - ---------------------------\nNo Current Report on Form 8-K was required to be filed for the three months ended August 31, 1994.\nSIGNATURES ----------\nPursuant to the requirements of Section l3 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nEchlin Inc.\nBy: \/s\/Frederick J. Mancheski ---------------------------- Frederick J. Mancheski Chairman of the Board and Chief Executive Officer Date: November 15, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities* indicated on November 15, 1994.\n\/s\/Frederick J. Mancheski - ------------------------- Frederick J. Mancheski, Chairman of the Board and Chief Executive Officer\n\/s\/C. Scott Greer - ------------------------- C. Scott Greer, President and Director\n\/s\/Richard A. Wisot - ------------------------- Richard A. Wisot, Vice President and Controller, Chief Accounting Officer\n\/s\/D. Allan Bromley - ------------------------- D. Allan Bromley, Director\n\/s\/John F. Creamer Jr. - ----------------------- John F. Creamer Jr., Director\n\/s\/Milton P. DeVane - ------------------------- Milton P. DeVane, Director\n\/s\/John E. Echlin Jr. - ------------------------ John E. Echlin Jr., Director\n\/s\/John F. Gustafson - ------------------------- John F. Gustafson, Director\n\/s\/Donald C. Jensen - ------------------- Donald C. Jensen, Director\n\/s\/Trevor O. Jones - ------------------ Trevor O. Jones, Director\n\/s\/Phillip S. Myers - ------------------------- Phillip S. Myers, Director\n\/s\/Frank R. O'Keefe Jr. - ------------------------ Frank R. O'Keefe Jr., Director\n\/s\/Jerome G. Rivard - ------------------- Jerome G. Rivard, Director\n*The position of Chief Financial Officer of the company is presently vacant.\nREPORT OF INDEPENDENT ACCOUNTANTS --------------------------------- ON FINANCIAL STATEMENT SCHEDULES --------------------------------\nTo the Board of Directors of Echlin Inc.\nOur audits of the consolidated financial statements referred to in our report dated September 23, 1994 appearing on page 33 of the 1994 Annual Report to Shareholders of Echlin Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in Item 14(a) of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/s\/ Price Waterhouse LLP - ----------------------------- Price Waterhouse LLP\nStamford, Connecticut September 23, 1994\nCONSENT OF INDEPENDENT ACCOUNTANTS ----------------------------------\nWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 33-66422, No. 33-15813, No. 2-92426, and No. 33- 15814) of Echlin Inc. of our report dated September 23, 1994 appearing on page 33 of the 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 Schedules, which appears above.\n\/s\/ Price Waterhouse LLP - ----------------------------- Price Waterhouse LLP\nStamford, Connecticut November 15, 1994\nECHLIN INC. SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992\n(a) Represents normal cash purchases of machinery and equipment.\n(b) Includes additions from business acquisitions in the amounts of $98,516,000, $25,793,000 and $14,021,000 for fiscal years ended August 31, 1994, 1993 and 1992, respectively. The remaining portion primarily represents translation adjustments on property, plant and equipment located in foreign countries.\n(c) Restated to include property, plant and equipment for Sprague Devices, Inc. and Frictiontech Inc. due to the pooling of interests transactions.\nECHLIN INC. SCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992\n(a) Primarily represents translation adjustments on property, plant and equipment located in foreign countries.\n(b) Restated to include accumulated depreciation of property, plant and equipment for Sprague Devices, Inc. and Frictiontech Inc. due to the pooling of interests transactions.\nECHLIN INC. SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992\n(a) Restated to include the valuation accounts for Sprague Devices, Inc. and Frictiontech Inc. due to the pooling of interests transactions.\n(b) Includes translation adjustments on allowance for doubtful account balances of non-U.S. divisions.\nECHLIN INC. SCHEDULE IX - SHORT-TERM BORROWINGS FOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992\n(a) Year-end borrowing levels and interest rates represent borrowings by foreign units in international money markets. Interest rate averages may be impacted by rates charged in highly inflationary economies.\n(b) Domestic notes payable mature generally within 30 days from their date of issue. Domestic notes payable have been classified as long-term because of the company's intent to refinance this debt on a long-term basis and the availability of such financing under the terms of a noncancellable Revolving Credit Agreement (RCA).\n(c) Commercial paper matures generally within 30 days from its date of issue. All commercial paper has been classified as long-term because of the company's intent to refinance this debt on a long-term basis and the availability of such financing under the terms of a noncancellable RCA.\nECHLIN INC. SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992\nAmounts for amortization of intangible assets, pre-operating costs and similar deferrals, taxes other than payroll and income taxes, and royalties are not presented as such amounts are less than 1% of total sales during each of the above years.","section_15":""}
{"filename":"40461_1994.txt","cik":"40461","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT AND DESCRIPTION OF BUSINESS AND SEGMENT INFORMATION\nGeneral Binding Corporation, incorporated in 1947, and its subsidiaries (herein referred to as \"GBC\" or \"Company\") are engaged predominantly in one line of business, namely the design, manufacture and distribution of a broad line of business machines and related supplies. This broad line includes system applications in the areas of binding, laminating, shredding, and security identification. These products are manufactured in eighteen plants in the United States and abroad. GBC products are sold through a network of direct sales and telemarketing personnel, dealers, distributors and wholesale stationers. The Company provides maintenance and repairs on the machines it sells through a trained field service organization and through trained dealers. The following table illustrates the ratio of revenue contribution of business machines, supplies and service for the last three fiscal years: ------------------------------------------------------------\n------------------------------------------------------------ * Includes the ringmetal business\nOn August 26, 1994, the Company completed its acquisition of the Sickinger Company located in Auburn Hills, Michigan. Sickinger manufactures paper punching machines as well as wire and plastic coil binding supplies. The total consideration paid for the Sickinger Company was $4.9 million. On July 29, 1993, the Company finalized the purchase of the business and certain assets of Bates Manufacturing Company located in Hackettstown, New Jersey. Bates manufactures and distributes staplers, numbering systems, card files and other office products through a large network of dealers and wholesalers. The total consideration paid for the Bates Manufacturing Company was $5.0 million. Additional information related to the Company's acquisitions is included in Note 13 to the Consolidated Financial Statements.\nCustomers The Company's machines and supplies are sold worldwide to users in the business, education, graphic arts, health, recreation and government markets. With this broad base of customers, GBC is not dependent upon any single customer for a significant portion of its business.\nCompetition Although there is active competition with respect to each GBC product, GBC is not aware of any major company competing in all its products. The Company believes that it has a leadership position for its binding and laminating products and a strong market share for most of its other products. To maintain its competitive position, GBC relies primarily on product quality, marketing strength and customer service.\nBacklog and Seasonal Variations Backlog of orders is not considered a material factor in GBC's business, nor is the business seasonal in any material respect.\nMaterials Materials and parts used in the manufacture of GBC's products are available from a number of sources. In general, the Company has not experienced any shortages in materials or parts. During 1994 a worldwide shortage of polyester developed. Polyester is used in the manufacture of the Company's film products. Due to the volume of the Company's purchases of polyester and its strong relationships with suppliers; the Company believes that it will continue to be able to purchase adequate volumes of polyester to meet demand.\nPatents and Trademarks Many of the equipment and supply products manufactured and\/or sold by the Company and certain application methods related to such products are covered by United States and foreign patents. The Company's U.S. patent on the basic hot-knife plastic VeloBind strip binding element expires in the year 2000 and the proprietary nature of that product is important to the Company's ability to effectively compete in its markets. Although the other patents owned by the Company are also highly important to its business, the Company does not consider its business dependent on any of those patents. The Company has registered the GBC, VeloBind and Bates trademarks in the United States and numerous foreign countries and considers those trademarks material to its business. The Company has also registered numerous other trademarks related to specific products in the United States and many foreign countries.\nEnvironment Although the Company has no known operations which have a significant impact upon the environment, GBC continuously takes active steps to ensure that all of its operations comply with local, state and federal regulations relating to environmental protection and occupational safety hazards. These steps have not had a material effect upon operating results or the Company's competitive position.\nResearch and Development Research and development expenditures amounted to approximately $5,069,000 in 1994, $4,949,000 in 1993 and $3,521,000 in 1992. All research is Company funded.\nEmployees As of December 31, 1994, GBC employed 3,226 people worldwide. Employee relations are considered to be excellent.\nGeographical Information Financial information by geographical area is included in Note 11 to the Consolidated Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES In addition to the manufacturing locations listed below, the Company operates sales and service offices throughout the world, seven regional warehouses in the United States, and a 60,000 sq. ft. world headquarters building in Northbrook, Illinois. Management believes that the Company's manufacturing facilities are suitable and adequate for its operations and are maintained in a good state of repair. Major manufacturing is conducted at the following plant locations:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material pending legal proceedings, and neither the Company nor any of its officers or directors are aware of any material contemplated proceeding.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS DURING THE FOURTH QUARTER OF 1994 None.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nPRINCIPAL MARKET AND PRICE RANGE The following table shows the range of closing prices for the common stock in the NASDAQ National Market System for the calendar quarters indicated below: ------------------------------------------------------------\nDIVIDENDS The following table represents dividends paid per share during the calendar quarters indicated below: ------------------------------------------------------------\nCash dividends have been paid each quarter commencing with the fourth quarter of 1975. The future payment of dividends and any increases therein are within the discretion of the Company's Board of Directors and will depend, among other factors, on working capital requirements, capital expenditures and earnings growth of the Company. On March 20, 1995, the Company paid a quarterly dividend of $.105 per share.\nApproximate Number of Equity Security Holders ------------------------------------------------------------\n------------------------------------------------------------ *Per latest report of Transfer Agent. Each security dealer holding shares in a street name for one or more individuals is counted as only one record holder.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n(000 omitted, except per share and ratio data) --------------------------------------------------------------------------------\n-------------------------------------------------------------------------------- (1) The Company adopted SFAS No. 109, \"Accounting for Income Taxes\", in 1993 by restating financial statements beginning in 1990.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSales The Company's 1994 sales exceeded the $400 million mark for the first time reaching a new record of $420 million. Sales increased $44 million or 12% over 1993 as compared to an increase of $7 million or 2% over 1992. Results for both years were impacted by acquisitions. Sales in 1994 were positively impacted by the acquisitions of Sickinger Company in August of 1994 and the business of Bates Manufacturing Company in July of 1993, while 1993 sales were positively impacted by the acquisition of the Bates business. Excluding the impact of acquisitions, 1994 sales increased 8% while 1993 sales were relatively flat. Increases in sales for 1994 were recorded in all major channels of distribution with the exception of the ringmetals business which experienced relatively flat sales. The most significant factors contributing to growth were increases in the Company's: a) worldwide film products operations; b) domestic office products division; and c) international subsidiaries' distributor\/dealer operations. Additionally, another factor contributing to the increase was higher sales in the domestic direct\/telemarketing operation which partially resulted from increased market penetration in the graphic products business coupled with sales of a new high capacity punch product, the AP-1. Sales in 1993 compared to 1992 were favorably impacted by a 24% increase in the Company's worldwide film products division. This increase was partially offset by lower sales in the Company's international operations, ringmetals, and domestic OEM businesses. The lower sales recorded in 1993 in the Company's international operations were significantly impacted by weaker foreign currencies and ongoing recessionary conditions. On a worldwide basis, sales of the Company's equipment product lines increased 17% in 1994 over 1993 as compared to a 5% increase in 1993 over 1992. Worldwide sales of supplies and service product lines (which for discussion purposes, include the Company's ringmetals business) increased 10% in 1994 over 1993 versus a 1% increase in sales in 1993 over 1992. Without the impact of acquisitions, equipment sales increased 9% in 1994 and remained flat in 1993, while supply and service sales increased 8% in 1994 and remained flat in 1993.\nGross Margins, Cost and Expenses Gross profit margins decreased 1 percentage point from 1993 to 1994 and decreased 2.5 points from 1992 to 1993. Excluding the impact of acquisitions, margins remained relatively flat from 1993 to 1994 and decreased 2 points from 1992 to 1993. An erosion in margins experienced by the Company's international and domestic core operations during 1994 was partially offset by an improvement in margins in the ringmetals business. Worldwide competitive pressures, an increase in certain raw material costs, and a mix change towards the Company's growth in lower margin film and dealer businesses had a negative effect on margins. The decline in margins from 1992 to 1993 was attributed to ongoing recessionary conditions, worldwide competitive pressures in the Company's international operations, and weaker foreign currencies coupled with a mix change towards the Company's growth in lower margin film and dealer businesses. Also contributing to the decline were higher research and development expenses which increased 41% over 1992. Selling, service, and administrative expenses increased 7% in 1994 and decreased 2% in 1993. Without the impact of acquisitions, 1994 expenses increased approximately 5% while 1993 expenses decreased 4%. These expenses as a percentage of total sales have declined over the past two years and were 35.1% , 36.6%, and 38.2%, respectively, in 1994, 1993, and 1992. The 1994 increase in expenses primarily resulted from increased sales in the Company's worldwide operations. Additional expenses were incurred to consolidate several of the Company's distribution operations, increase its marketing and advertising expenditures, and expand its support for its export businesses. The 1993 decrease in expenses predominantly resulted from the effect of weaker foreign currencies, the consolidation of a number of domestic direct branch sales operations and a reduction in Corporate support expenses. Partially offsetting these decreases were higher expenses resulting from higher sales in the Company's film products and domestic office products divisions and the adoption of SFAS 106, \"Accounting for Postretirement Benefits Other Than Pensions.\" A pretax restructuring charge of $4.0 million was recorded in 1994. See Note 14 to the Consolidated Financial Statements for additional information.\n-\nInterest expense increased by 5% in 1994 over 1993 compared to a 10% increase in 1993 over 1992. The primary reason for the 1994 increase was higher average debt levels. The higher debt levels resulted primarily from significantly higher inventory and receivable levels along with the financing of the Sickinger and Bates acquisitions. This increase was partially offset by the expiration of several of the Company's interest rate swaps in the fourth quarter of 1993 and lower debt levels in the Company's Mexican subsidiary. The increase in interest expense in 1993 was primarily due to: a) a reduction in the capitalization of interest due to the completion of the Company's film products plant expansion; b) an increase in interest expense in the Company's international operations due to higher borrowing levels as a result of lower overall earnings and dividends paid in late 1992; and c) higher domestic borrowing levels during the second half of 1993 resulting from the financing of the Bates acquisition. Other income and expense in 1994 was $1,842,000 of expense compared to $1,210,000 of expense in 1993. The most significant factors affecting the unfavorable change were higher currency losses of $174,000 primarily resulting from the devaluation of the Mexican peso and losses on sales of fixed assets of $161,000. Other income and expense in 1993 was $1,210,000 of expense compared to $1,339,000 of expense in 1992. The favorable change was primarily due to higher income of $384,000 from investments in joint ventures and a decrease of $281,000 in amortization expense for a non-compete note, goodwill and patents. Partially offsetting this was higher currency losses of $192,000 and lower interest income of $164,000.\nIncome Taxes The Company's effective tax rate increased slightly to 38.9% from 38.3% in 1993. The 1993 rate declined 1.8 points from the 1992 rate of 40.1% primarily due to a decrease in foreign earnings which were subject to higher income taxes coupled with an increase in the tax benefit received from a tax allocation agreement between the Company and Lane Industries, Inc. Partially offsetting this was an increase in the statutory Federal income tax rate as a result of the enactment of the Omnibus Budget Reconciliation Act of 1993 in August of 1993. Numerous other items enter into the development of the Company's effective tax rate. Additional information is included in Note 10 to the Consolidated Financial Statements.\nNet Income The Company's net income per share increased 5% or $.05 to $1.00 in 1994 compared to 1993 net income per share of $.95. The increase was primarily attributed to continued growth in the worldwide film products operations and international and domestic core businesses along with improved performance in the Company's ringmetals division. This increase was partially offset by an after-tax restructuring charge of $2,504,000 or $.16 per share. Additional information is included in Note 14 to the Consolidated Financial Statements. The Company's 1993 net income per share decreased 9% or $.09 to $.95 compared to 1992 net income per share of $1.04. The decrease was primarily attributable to a 43% decrease in earnings in the Company's international operations due to ongoing recessionary conditions and continuing competitive pressures. Also contributing to the decrease were higher research and development expenses relating to new product development. These unfavorable items were partially offset by increases in income in the Company's domestic direct branch\/telemarketing operations, domestic office products division and film products division along with a lower effective tax rate.\nOther Events During December 1994 the Mexican peso was devalued. The value of the Mexican peso compared to the U.S. dollar has continued to weaken since the devaluation. The effect of the devaluation on the Company's results of operations for the year ended December 31, 1994 was not material. Translation of the assets and liabilities of the Company's Mexican operations into U.S. dollars resulted in an unfavorable adjustment of $2,053,000. In accordance with SFAS No. 52, \"Foreign Currency Translation,\" this adjustment is reflected in the Company's equity section of the balance sheet. Continued weakening of the Mexican peso will have an unfavorable impact on the Company's future results of operations. The unfavorable impact will result from: a) an anticipated weakening of the Mexican economy; b) higher costs associated with importing inventory and materials into Mexico; and c) losses associated with obligations denominated in U.S. dollars and other foreign currencies. The extent of the impact of these conditions on the Company's results of operations is not known.\nLiquidity and Capital Resources Cash provided by operating activities decreased to $5.2 million in 1994 compared with $15.0 million in 1993 and $17.1 million in 1992. The decline in cash flow in 1994 was primarily due to an increase in inventory and accounts receivable levels while the decline in 1993 was mainly due to an increase in accounts receivable levels coupled with an increase in income tax payments.\nCapital expenditures were $12.8 million in 1994 compared to $10.6 million in 1993 and $9.8 million in 1992. Major projects in 1994 included the completion of a European production facility for the film products division and the construction of a ringmetals manufacturing operation in Costa Rica. Capital expenditures for 1993 included the expansion of the plant and production capacity of the Company's graphic operations, the expansion of the film products division into Europe, tooling for new products, and the renovation and remodeling of the Company's research and development facility in Northbrook. Expenditures for 1992 included the expansion of the Company's film products division domestic plant and production capacity. Capital expenditures for 1995 are expected to be approximately $17.9 million and include the purchase and implementation of a company-wide business enterprise information system along with the upgrading of various domestic and international manufacturing capabilities. Cash dividends paid in 1994 increased to $.405 per share compared to $.40 per share in 1993 and $.37 per share in 1992. The Company had access to $62.5 million in short-term credit lines and as of December 31, 1994 had $23.8 million in outstanding borrowings against these lines. During 1994, the Company also had access to a $62.5 million credit agreement to fund both working capital and acquisition requirements. At the end of 1994, the Company had $36.0 million in borrowings against this agreement classified as long-term debt on the Company's balance sheet. Additional information is included in Note 6 to the Consolidated Financial Statements. The Company believes that funds generated from operations combined with existing credit facilities are more than sufficient to meet currently anticipated capital needs along with any foreseeable acquisition requirements.\nAcquisitions The Company acquired Sickinger Company in 1994 and the business and certain assets of Bates Manufacturing Company in 1993. See Note 13 to the Consolidated Financial Statements for additional information.\n-\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAll other schedules have been omitted because they are not applicable, are not required, or the information is included in the consolidated financial statements or notes thereto.\nCONSOLIDATED STATEMENTS OF INCOME General Binding Corporation and Subsidiaries\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nCONSOLIDATED BALANCE SHEETS General Binding Corporation and Subsidiaries\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS General Binding Corporation and Subsidiaries\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY General Binding Corporation and Subsidiaries\n* Includes Class B Common Stock for the years ended December 31, 1991 through 1994 -- Shares 2,398,275, Amount $300,000 ** The Company adopted SFAS No. 109, \"Accounting for Income Taxes\", in 1993 by restating financial statements beginning in 1990.\n-\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(A) Consolidation The consolidated financial statements include the accounts of the Company and its domestic and international subsidiaries. All of these international subsidiaries have November 30 fiscal year-ends except for Canada and Mexico. Intercompany accounts and transactions have been eliminated in consolidation. Investments in significant companies which are 20% to 50% owned are treated as equity investments and the Company's share of earnings is included in income.\n(B) Cash and Cash Equivalents The Company considers temporary cash investments with an original maturity of three months or less to be cash equivalents.\n(C) Inventory Valuation Inventories are valued at the lower of cost or market on a first-in, first-out basis. Inventory costs include labor, material and factory overhead.\n(D) Depreciation of Plant and Equipment Depreciation of plant and equipment is computed using principally the straight-line method over the following estimated lives: -------------------------------------------------------------------------------- Buildings 25 - 50 years Machinery and equipment 1 - 20 years Leasehold improvements Term of lease -------------------------------------------------------------------------------- The cost and accumulated depreciation of items sold or retired are removed from the asset accounts and the resulting gain or loss is recognized in income.\n(E) Amortization of Intangibles Cost in excess of fair value of assets of acquired companies is amortized on the straight-line basis over estimated periods of benefit ranging up to 40 years.\n(F) Compensated Absences The Company follows the policy of accruing vacation pay for all employees.\n(G) Income Taxes Since 1986, the Company's policy for earnings from its international subsidiaries has been to provide appropriate income taxes on the earnings expected to be distributed to the Company. In 1992, 1993 and 1994, current earnings of all international subsidiaries other than GBC Canada and Mexico were considered remitted to the United States for the purpose of determining income tax expense for the year. In addition, in 1988, the Company implemented a balance sheet hedging strategy for its international operations and as a result provided appropriate income taxes on approximately $4,449,000 of pre-1986 earnings of its international subsidiaries. Approximately $1,835,000 of these earnings were remitted in the years 1988 through 1994, and the balance is expected to be remitted in future years. As of December 31, 1994, the cumulative amount of undistributed earnings of international subsidiaries upon which income taxes have not been provided was approximately $12.9 million. In the opinion of management, this amount remains indefinitely reinvested by the international subsidiaries.\n(H) Net Income per Common Share Net income per common share is based on the weighted average number of common shares outstanding for each year. Assuming exercise of all outstanding stock options, net income per common share would not be materially different from net income per common share as reported.\n(I) Stock Option Compensation Stock option compensation cost applicable to the non-qualified restricted plans is valued at the date of the grant and recorded as compensation expense as the options become exercisable.\n(J) Deferred Service Income Income under maintenance agreements is deferred and recognized over the term (primarily 1 to 2 years) of the agreements on a straight-line basis.\n2. FOREIGN CURRENCY EXCHANGE AND TRANSLATION Foreign currency translation adjustments, except for those adjustments relating to Mexican operations during 1992 (a hyperinflated economy), have been excluded from the Consolidated Statements of Income and are recorded in a cumulative translation adjustment account as a separate component of stockholders' equity. Beginning in January of 1993, Mexico is no longer being accounted for as a hyperinflated economy and accordingly its foreign currency translation adjustments are recorded in the cumulative translation adjustment account.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\nThe accompanying Consolidated Statements of Income include net gains and losses on foreign currency transactions and net gains and losses resulting from translation of the Mexican balance sheet into U.S. dollars during 1992. Such amounts are reported as part of cost of sales and other income\/expense and are summarized as follows (000 omitted): -------------------------------------------------------------------------------\n(a) Foreign currency transaction gains\/losses are subject to income taxes at the respective country's effective tax rate.\n(b) Relates to operations in Mexico, a hyperinflationary economy in 1992.\n3. INVENTORIES Inventories are summarized as follows (000 omitted): -------------------------------------------------------------------------------\n4. PROFIT-SHARING AND PENSION PLANS Under the provisions of a defined contribution profit sharing plan covering substantially all full-time domestic employees (excluding U.S. RingBinder union employees and Sickinger employees), the Company is required to make annual contributions, as defined, to a trust fund. The Company may make additional contributions for any year and has done so annually, except in 1968, since establishment of the plan. Contributions charged to expense were $2,092,000 in 1994, $2,122,000 in 1993 and $1,937,000 in 1992. Employee participation in the plan is optional. Participating employees must contribute 2%, but cannot contribute more than 12% of total compensation. The Company has two separate active domestic defined benefit pension plans and one frozen domestic defined benefit pension plan. The Company has a Guaranteed Retirement Income Plan (GRIP) for its domestic employees participating in the profit sharing plan. The plan provides benefits that are based on the employee's years of credited service and a percentage of the employee's compensation offset by a percentage of the employee's social security benefits. Furthermore, benefits from the GRIP Plan are reduced by the actuarial equivalent of the participant's profit sharing account. U.S. RingBinder also has a pension plan covering substantially all of its union member employees. The plan provides benefits that are based on the employee's years of credited service. As of September 30, 1994, the Company froze the defined benefit plan for the non-union employees at U.S. RingBinder and these employees became eligible for the Company's defined contribution profit sharing plan. The Company's funding policy towards all domestic plans is to fund the plans annually in accordance with ERISA and Federal tax regulations. All domestic plans utilize the entry age normal funding actuarial method to calculate the annual normal cost. The plans' assets consist of cash and cash equivalents, debt, equity and government securities. VeloBind was acquired by the Company on November 1, 1991. On this date, all of VeloBind's full-time employees became eligible for the same profit sharing and pension plans as the Company's domestic employees. Prior to acquisition, VeloBind maintained a 401(K) Savings Incentive Plan. Upon acquisition, this plan was frozen with all Company and employee contributions suspended. Distributions from the Savings Incentive Plan are made upon retirement, death or disability, termination of employment or exercise of the limited withdrawal rights provided under the Savings Incentive Plan. The Company's international subsidiaries have adopted a variety of defined benefit and defined contribution plans. These plans provide benefits that are based upon the employee's years of credited service. The benefits payable under these plans, for the most part, are provided by the establishment of trust funds or the purchase of insurance annuity contracts. Net periodic pension expense for the pension plans for the years 1994, 1993 and 1992 was as follows (000 omitted): -------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\nThe following rates were used in determining the actuarial present value of accumulated plan benefits for the Company's pension plans. --------------------------------------------------------------------------------\nNet periodic pension expense\/(income) for 1994, 1993 and 1992 includes the following components (000 omitted): --------------------------------------------------------------------------------\nThe following table sets forth the plans' funded status at December 31, 1994 and 1993 (000 omitted): --------------------------------------------------------------------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\n5. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Company currently provides certain health care benefits for eligible domestic retired employees. Employees may become eligible for those benefits if they have fulfilled specific age and service requirements. In 1993, the Company adopted the Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". This statement requires companies to accrue the cost of postretirement benefits during the service lives of employees. The Company elected to amortize over a twenty year period the accumulated liability, measured as of December 31, 1992, of $1,905,000. Prior to adopting this standard, the Company recognized these costs as the benefits were paid and retiree health care benefits expense in 1992 was approximately $280,000. Net periodic postretirement benefit expense consisted of the following components (000 omitted): ------------------------------------------------------------\nThe projected liabilities which are not funded are as follows (000 omitted): ------------------------------------------------------------\nThe following assumptions used in determining the expense and obligation are listed below: ------------------------------------------------------------\nThe rate of increase in the per capita cost of covered health benefits was assumed to be 9% in 1995, decreasing gradually to 6% by the year 2000 and remaining at that level thereafter. The effect of a 1% increase in the medical trend assumption would increase the accumulated postretirement benefit obligation as of December 31,1994 by $116,000 and increase the net periodic cost by $17,000. The Company monitors the cost of the plan and has periodically changed the benefits provided under this plan. The Company reserves the right to make additional changes or terminate these benefits in the future. Any changes in the plan or revisions of the assumptions affecting expected future benefits may have a significant effect on the amount of the obligation and annual expense.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\n6. DEBT AND CREDIT ARRANGEMENTS Information regarding short-term debt for the three years ended December 31, 1994, 1993, and 1992, is as follows (000 omitted): --------------------------------------------------------------------------------\n(A) Notes payable by the Company's foreign subsidiaries were $9,443,000 in 1994, $9,625,000 in 1993 and $11,787,000 in 1992.\n(B) The rate for 1994, 1993 and 1992 includes Mexican borrowings at a rate which is influenced by the rate of inflation in that country. The weighted average interest rate for notes payable to banks, excluding such borrowings, for the years ended December 31, 1994, 1993 and 1992 would be 6.3%, 8.2% and 8.1%, respectively. The weighted average interest rate is computed by dividing the annualized interest expense for the short-term debt outstanding by the short-term debt outstanding at December 31.\n(C) The composition of the Company's short-term debt will vary by category at any point in time during the year.\n(D) Average amount outstanding during the year is computed by dividing the total daily outstanding principal balances by 365 days.\n(E) The weighted average interest rate during the year for notes payable to banks excluding Mexican borrowings, for the three years ended December 31, 1994, 1993 and 1992 would be 6.1%, 7.4% and 8.8%, respectively. The weighted average interest rate during the year is computed by dividing the actual short-term interest expense by the average short-term debt outstanding.\nLong-term debt consists of the following at December 31, 1994 and 1993 (000 omitted): --------------------------------------------------------------------------------\nThe Company has short-term lines of credit aggregating $62.5 million from various banks worldwide, of which $34.5 million are with foreign banks or foreign branches of banks. Interest rates on these lines of credit are primarily at the prime rate or the lender's cost of funds plus margin. These arrangements are reviewed annually for renewal. The Company has access to a $62.5 million revolving credit agreement to fund both working capital and acquisition requirements. Under the terms of the agreement, which was entered into with a group of lenders, the Company can borrow up to $62.5 million under a bid option facility at any time until December 1995. The Company may convert the revolving credit loan into a five year term loan on the last day of any quarter during the life of the agreement and on the termination date of the agreement. Interest is payable at varying rates provided for in the loan agreement. The Company agreed to pay an annual facility fee of 15\/100 of one percent on the total commitment amount of $62.5 million.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\nThe revolving credit agreement contains, among other things, certain restrictive covenants. Under the most restrictive of the covenants, the Company and its subsidiaries must maintain minimum working capital of $40.0 million, a debt to tangible net worth ratio not more than 1.15 to 1.0, and an interest coverage ratio of at least 2.0 to 1.0. The Company was in compliance with these covenants at December 31, 1994. As of December 31, 1994, the Company had $36.0 million in borrowings against this agreement classified as long-term borrowings on the Company's balance sheet. Although the Company has the ability to convert the revolving credit agreement to a term loan in 1995, it is the Company's intention to enter into a new agreement. The scheduled maturities of long-term debt for each of the five years subsequent to December 31, 1994, are as follows (000 omitted):\n7. FINANCIAL INSTRUMENTS Many of the Company's financial instruments (including cash and cash equivalents, accounts and notes receivable, notes payable and other accrued liabilities) carry short-term maturities. As such instruments have short-term maturities their fair values approximate the carrying values. Substantially all of the Company's long-term obligations, including current maturities of long-term obligations have floating interest rates. The fair value of these instruments also approximates the carrying values.\nInterest Rate Swaps and Caps The Company enters into interest rate swap and interest rate cap agreements to hedge interest rate exposure on floating rate debt. At December 31, 1994, the Company had outstanding five interest rate swaps with commercial banks (\"counterparties\"), having a total notional principal amount of $22 million (no exchange of principal was involved). Two of the swaps with notional principal amounts totaling $7 million mature in October 1995. Under these agreements, the Company is obligated at a fixed rate of 6.31% with payments due quarterly until maturity. The floating rate from the counterparties is based on the three month U.S. dollar LIBOR rate (6.5% at December 31, 1994). The remainder of the swaps with notional principal amounts totaling $15 million have various maturity dates through September 1998. Under these agreements, the Company is obligated at a weighted average interest rate of 6.99% with payments due quarterly until maturity. The floating rate from the counterparties is based on the three month U.S. dollar LIBOR rate. The Company accounts for its swaps by accruing the differential to be paid or received as interest rates change over the life of the agreements. At December 31, 1994, the fair value of the interest rate swaps was $427,000 and represents the amounts the counterparties would pay the Company if the agreements were terminated. At December 31, 1993, the fair value of the interest rate swaps was ($775,000) and represented the amounts the Company would have had to pay to terminate the agreements. During 1994, the Company entered into three interest rate cap agreements with commercial banks having a total notional principal amount of $15 million. The beginning effective date for these agreements was September 30, 1994 with various maturity dates through September 1998. The Company was required to pay a one-time fee in exchange for the counterparties' obligation to pay the Company the difference between the three month U.S. dollar LIBOR interest rate and 7.5% in the event that the LIBOR interest rate exceeds 7.5%. Fees for interest rate caps are capitalized and amortized over the life of the cap agreement. At December 31, 1994, the carrying value in the Company's balance sheet for interest rate caps was $218,000. The related fair value of the interest rate caps was $345,000 and represents the amounts the counterparties would pay the Company if the agreements were terminated. The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap and cap agreements, however the Company believes that the risk of loss is remote.\n-\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\nForeign Exchange Contracts The Company also enters into foreign exchange contracts to hedge foreign currency exchange risk. These contracts primarily hedge inventory purchases, royalties and management fees. The Company enters into hedges for identifiable transactions where the foreign currency commitment is firm. The hedged transactions are recorded based upon the nature of the transaction (e.g., costs related to inventory purchases are recorded to inventory and recognized in cost of sales). At December 31, 1994, the Company had foreign exchange contracts with various dates of maturity through December 31, 1995 to purchase $31.2 million in U.S. dollars. The fair market value of the contracts at the year end spot rate was approximately $400,000 greater than the contracted amount. At December 31, 1993, the Company had foreign exchange contracts with various dates of maturity through December 31, 1994 to purchase $2.3 million in various foreign currencies and $15.0 million in U.S. dollars. The difference between the contracted amount and the fair market value of the contracts at the 1993 year end spot rate was immaterial.\n8. RENTS AND LEASES Following is a schedule summarizing, by year, the future minimum rental payments and guaranteed residual payments required for all noncancelable lease terms in excess of one year as of December 31, 1994 (000 omitted): ------------------------------------------------------------\nTotal rental expense for the years ended December 31, 1994, 1993 and 1992 was $7,693,000, $7,442,000 and $8,129,000, respectively.\n9. COMMON STOCK AND STOCK OPTIONS The Company's Certificate of Incorporation provides for 20,000,000 authorized shares of common stock, $.125 par value per share and 2,398,275 shares of Class B common stock, $.125 par value per share. Each Class B share is entitled to 15 votes and is to be automatically converted into one share of common stock upon transfer thereof. All of the Class B shares are owned by Lane Industries, Inc., the Company's majority stockholder. The Company has two non-qualified stock option plans adopted in 1980 and 1989 for officers, including officers who are directors, and other key employees of the Company. The 1980 plan terminated in 1990, however the options granted under this plan may be exercised at various times until January, 1998. Under both plans, options may be granted during a ten year period at a purchase price of not less than 85% of the fair market value on the date of the grant. Options granted may be exercised in four equal parts over a period not to exceed eight years from the date of grant, except that no part of an option may be exercised until at least one year from the date of grant has elapsed. In addition, the 1989 plan also provides that any option granted under the 1989 plan may include a grant of stock appreciation rights simultaneously with the grant of the option or any time within six months thereafter prior to the exercise, termination or expiration of such option. The Company did not grant any stock appreciation rights during 1994 or 1993. The Company reserved 1,050,000 shares of its common stock for subsequent issuance pursuant to the 1989 plan. At December 31, 1994, 203,100 shares and 78,255 shares, respectively, were available for purchase pursuant to the 1989 and 1980 plans.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\nA summary of the stock option activity under the 1980 and 1989 plans is as follows: ------------------------------------------------------------\nUpon the exercise of options, the proceeds are credited to the treasury stock and additional paid-in capital accounts. Compensation costs previously accrued are credited to additional paid-in capital upon the exercise of non-qualified options.\n10. INCOME TAXES Effective January 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". The provisions of SFAS 109 were applied retroactively to January 1, 1990. SFAS 109 requires the recognition of deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. In addition, the accounting standard requires the recognition of future tax benefits, such as net operating loss carryforwards, to the extent that realization of such benefits is more likely than not. The adoption of SFAS 109 resulted in a cumulative effect charge of $1,134,000 or $.07 per common share at January 1, 1990. The 1992 financial statements were restated to reflect the adoption of SFAS 109. As a result of the change in accounting for income taxes, 1992 net income decreased by $324,000.\nThe provision for income taxes was as follows (000 omitted): ------------------------------------------------------------\nThe Omnibus Budget Reconciliation Act of 1993 changed the Company's prevailing Federal income tax rate from 34% to 35% effective January 1, 1993. The Company's effective income tax rate varies from the statutory Federal income tax rate as a result of the following factors: ------------------------------------------------------------\n* The benefit results from a tax allocation agreement between the Company and Lane Industries, Inc. entered into in 1978. Under the terms of the agreement, Lane Industries, Inc. has agreed to share with the Company a portion of the Federal income tax savings, if any, resulting from filing consolidated income tax returns. Lane Industries, Inc. is the Company's majority stockholder.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\nIncome before taxes was as follows (000 omitted): ------------------------------------------------------------\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 are as follows (000 omitted): ------------------------------------------------------------\nA valuation allowance is provided to reduce the deferred tax assets to a level which, more likely than not, will be realized. The net deferred tax assets reflects management's estimate of the amount which will be realized from future profitability which can be predicted with reasonable accuracy. The Company provides U.S. income taxes on the earnings expected to be distributed by its foreign subsidiaries. Under the current remitter concept, the Company has excess foreign tax credits available to reduce Federal income taxes in future years. The Company has established a valuation allowance for the foreign tax credits that the Company anticipates will expire unutilized five years after cash dividends are actually paid. At December 31, 1994, the Company has $2,200,000 of net operating loss carryforwards available to reduce future taxable income of certain international subsidiaries. These loss carryforwards expire in the years 1997 through 2001 or have an unlimited carryover period. A valuation allowance has been provided for a portion of the deferred tax assets related to those loss carryforwards which will most likely expire unutilized.\n11. BUSINESS SEGMENTS AND FOREIGN OPERATIONS The Company is engaged predominantly in one line of business, namely the design, manufacture and distribution of a broad line of business machines and related supplies. This broad line includes system applications in the areas of binding, laminating, shredding and security identification. The products are manufactured in eighteen plants worldwide. GBC products are sold through a common network of direct sales and telemarketing personnel, dealers, distributors and wholesale stationers. The Company provides maintenance and repairs on the machines it sells through a trained field service organization and through trained dealers. Financial information for the three years ended December 31, 1994, 1993 and 1992, by geographical area is summarized below. Sales between geographic areas are made at market value less allowances for additional manufacturing, marketing and administrative costs to be incurred by the affiliated company. For purposes of complying with Statement of Financial Accounting Standards No. 14, export sales to foreign customers ($12,773,000 in 1994, $11,163,000 in 1993 and $11,957,000 in 1992) have been classified in the following tables as part of the United States sales.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\n--------------------------------------------------------------------------------\n--------------------------------------------------------------------------------\n* Operating income for the United States, Europe and Other International includes restructuring charges of $3.4 million, $.2 million and $.4 million, respectively, for the year ended December 31, 1994. ** Other income (expense) is comprised principally of foreign currency transaction and translation gains and losses, interest income, dividend and royalty income, gains and losses on the disposal of capital assets, amortization of goodwill, patents and a non-compete note and other transactions.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\nAll subsidiaries were 100% owned during the three year period, except for Grupo GBC, S.A. de C.V. (Grupo GBC) which was not 100% owned until August of 1992. In prior years, a majority of the issued shares of the capital stock of Grupo GBC were controlled by Mexican nationals and were essentially equivalent to preferred stock having fixed dividend rights and fixed rights upon any subsequent liquidation of the subsidiary. In view of the nature of the rights prescribed, the operations of the subsidiary were consolidated for financial reporting purposes. The following table illustrates the ratio of revenue contribution of business machines, supplies and service for the last three fiscal years: -------------------------------------------------------------------------------\n* Includes the ringmetal business.\n12. QUARTERLY FINANCIAL DATA (UNAUDITED) Summarized quarterly financial data for 1994 and 1993 was as follows (000 omitted, except per share data): --------------------------------------------------------------------------------\n13. ACQUISITIONS On August 26, 1994, the Company completed the purchase of the Sickinger Company, headquartered in Auburn Hills, Michigan. Sickinger manufactures paper punching machines as well as wire and plastic coil binding supplies. The total consideration paid for the Sickinger Company was $4.9 million. The acquisition has been accounted for as a purchase transaction with the results of operations included in the consolidated financial statements since the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired is estimated to be $1.2 million. On July 29, 1993, the Company finalized the purchase of the business and certain assets of Bates Manufacturing Company. Bates Manufacturing Company, located in Hackettstown, New Jersey, manufactures and distributes staplers, numbering systems, card files and other office products through a large network of dealers and wholesalers. The total consideration paid for the Bates Manufacturing Company was $5.0 million. The acquisition has been accounted for as a purchase transaction with the results of operations included in the consolidated financial statements since the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired was $1.3 million.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS General Binding Corporation and Subsidiaries\n14. RESTRUCTURING CHARGE\nA restructuring charge of $4.0 million ($2.5 million after-tax) was recorded in 1994. The charge reflected costs associated with discontinuing manufacturing in certain locations along with an overall downsizing of the Company's infrastructure. The restructuring charge consisted primarily of the following: a) write-down of properties to their estimated net realizable values; b) costs associated with freezing a defined benefit pension plan; and c) termination benefits paid and payable to certain former employees. The liability established for the termination benefits, which is not material to the Company's financial statements, reflects the costs associated with providing benefits to former employees that were terminated and notified of their benefit arrangement prior to December 31, 1994. All benefits will be paid to the group of former employees by December 31, 1995. The Company does not believe that the activities that will not be continued are significant to the Company's revenue or operating results.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF GENERAL BINDING CORPORATION: We have audited the accompanying consolidated balance sheets of General Binding 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 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. 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 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. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of General Binding 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. As explained in Note 5 to the consolidated financial statements, in 1993 the Company changed its method of accounting for postretirement benefits and, as explained in Note 10, in 1993 the Company gave retroactive effect to the change in accounting for income taxes.\nArthur Andersen LLP Chicago, Illinois February 21, 1995\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS General Binding Corporation and Subsidiaries\nALLOWANCES FOR DOUBTFUL ACCOUNTS AND SALES RETURNS Changes in the allowances for doubtful accounts and sales returns were as follows (000 omitted): --------------------------------------------------------------------------------\n*Amounts primarily relate to the effects of foreign currency exchange rate changes, the acquisition of Sickinger in 1994 and final purchase accounting adjustments for VeloBind in 1992.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in General Binding Corporation's 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 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 Chicago, Illinois February 21, 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\nInformation required under this Item is contained in the Registrant's 1995 Definitive Proxy Statement, which is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required under this Item is contained in the Registrant's 1995 Definitive Proxy Statement, which is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required under this Item is contained in the Registrant's 1995 Definitive Proxy Statement, which is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required under this Item is contained in the Registrant's 1995 Definitive Proxy Statement, which 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) 1. Financial Statements. See Index to Financial Statements and Supplementary Data.\n2. Financial Statement Schedule. See Index to Financial Statements and Supplementary Data.\n3. Exhibits\n3. Certificate of Incorporation, as amended May 11, 1988. Incorporated by reference to Exhibit 3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.\n4. Consent agreement to provide the Commission upon written request a copy of the Registrant's long-term debt agreements.\n21. Subsidiaries of the Registrant\n27. Financial Data Schedule\n(b) Reports on Form 8-K No reports on Form 8-K were filed by the registrant during the last 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.\nGENERAL BINDING CORPORATION\nBy: \/s\/ GOVI C. REDDY --------------------------------------- Govi C. Reddy President and Chief Executive Officer\nBy: \/s\/ EDWARD J. MCNULTY --------------------------------------- Edward J. McNulty Vice President and Chief Financial Officer\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.","section_15":""}
{"filename":"27425_1994.txt","cik":"27425","year":"1994","section_1":"ITEM 1 - BUSINESS - - ----------------- Amcast Industrial Corporation, an Ohio corporation organized in 1869, and its subsidiaries (called collectively \"Amcast\" or the \"company\") are engaged in the business of producing fabricated metal products, valves and controls, and cast and tubular metal products, in a variety of shapes, sizes, and metals for sale to end users directly and through sales representatives and distributor organizations and to original equipment manufacturers. Manufacturing facilities are located in five states, primarily in the eastern half of the United States. The company's business operations are conducted through three divisions and nine wholly-owned subsidiaries. Its subsidiaries include Amcast Industrial Ltd., an Ontario, Canada corporation; Elkhart Products Corporation (Elkhart), an Indiana corporation; WheelTek, Inc. (WheelTek), an Indiana corporation; Amcast Industrial Investment Corporation, a Delaware corporation; Amcast Automotive, Inc. (formerly Midwest Marketing Services Corporation), a Michigan corporation; Amcast Industrial Financial Services, Inc., an Ohio corporation; Amcast Industrial Sales Corporation, a U.S. Virgin Islands corporation; Amcast Casting Technologies, Inc., an Indiana Corporation and Amcast Precision Products, Inc., a California corporation. During fiscal 1992, Amcast and Izumi Industries, Ltd. of Japan, formed a joint venture, Casting Technology Corporation. Amcast owns 60% of the joint venture. In 1994, the joint venture was converted to a partnership, Casting Technology Company.\nDuring the fourth quarter of 1993, the company elected early adoption, effective September 1, 1992, of the Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". This statement requires companies to record a liability for employees' accumulated postretirement benefit costs and to recognize on-going expenses on an accrual basis. The company recognized a $6,159 pretax cumulative effect of the change in accounting principle, which represents the accumulated postretirement benefit obligation as of September 1, 1992. The effect on net income and shareholders' equity was $3,942, or $.47 per share. The impact on fiscal year 1993 operating results, due to the adoption of SFAS 106, was not material. See Postretirement Health Care and Life Insurance footnote of the company's Annual Report to Shareholders for the year ended August 31, 1994, Exhibit 13.1, page 52 herein.\nEffective August 31, 1992, the company's Board of Directors approved a plan to divest Stanley G. Flagg & Co. (Flagg), a manufacturer of iron and brass pipe fittings, previously reported as part of the Flow Control Products segment. This action was prompted by unprofitable operations that were plagued by industry overcapacity and weak demand in the iron pipe fittings product line. The company made a pretax provision of $22 million based on the expected proceeds of this divestiture. A significant portion of the Flagg assets, relating to the iron and pole line hardware businesses, have been sold and, although operating losses, until disposition, are greater than originally estimated, the loss on the sale of assets and estimated liabilities are expected to be less than the amounts initially provided. Annual sales and results of the remaining brass business are not material to the company. At August 31, 1994, the company believes that it has provided adequately for the effect of the disposal of the remaining assets of Flagg and the operating losses through the date of disposal. See Discontinued Operation footnote of the company's Annual Report to Shareholders for the year ended August 31, 1994, Exhibit 13.1, page 42 herein.\nThe company operates in two business segments--1) Flow Control Products and (2) Engineered Components. Information concerning the net sales, operating profit and identifiable assets of each segment for fiscal years 1992 through 1994 appears under \"Business Segments\" in the Notes to Consolidated Financial Statements in the company's Annual Report to Shareholders for the year ended August 31, 1994, Exhibit 13.1, page 56 herein. Amcast has no foreign manufacturing operations and export sales to customers in foreign countries are not material.\nITEM 1 - BUSINESS (cont'd) - - ----------------- FLOW CONTROL PRODUCTS - - --------------------- The Flow Control Products segment (Flow Control) includes the business of the Superior Valve division (Superior Valve), the Elkhart subsidiary, and Amcast Industrial Ltd. Superior Valve, acquired in October 1986, manufactures valves and accessories used in air conditioning and refrigeration systems, and compressed gas cylinder valves for the welding, specialty, carbonic, and medical gas industries. Elkhart, acquired in July 1983, produces wrot copper fittings for use in residential and commercial water systems and markets bronze pipe fittings and valves. Amcast Industrial Ltd. is the common Canadian marketing arm for Amcast's Flow Control segment manufacturing units.\nThe company's Flow Control business is a leading supplier of pipe fittings for the industrial, commercial, and residential construction markets, valves utilized in air-conditioning and refrigeration systems, and industrial compressed gas applications. These products are sold through distributors and wholesalers. Shipments are made by truck from company locations directly to customers. The competition is comprised of a number of manufacturers of parts for air conditioning, refrigeration, and plumbing systems, gas meters, and valves and controls. The company believes that competition in this segment is based on a number of factors including product quality, service, delivery, and value.\nMost of the Flow Control business is based on customer purchase orders for their current product requirements and such orders are filled from company inventory. Orders are not considered firm beyond a 90-day period.\nSee Properties at Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES - - -------------------\nThe following table provides certain information relating to the company's principal facilities as of October 14, 1994:\nITEM 2 - PROPERTIES (cont'd) - - -------------------\nThe land and building in Rancho Cucamonga, California, are leased under a 5-year lease, with a requirement that Amcast purchase the property at the fair market price at the lease expiration in 1997. The land and building in Burlington, Ontario, are leased under a 5-year lease expiring in 1995, with an option to renew the lease for two successive 5-year terms. The land in Richmond and Gas City, Indiana is leased under 99 year leases, expiring in 2091. The Corporate offices are being leased for five years expiring in 1998. The Amcast Automotive offices are being leased for five years expiring in the year 2000, with an option for a five year renewal. All other properties are owned by the company. The lease at the former Miami, Florida facility was terminated during fiscal year 1994 and operations were transferred to the Rancho Cucamonga, California facility.\nA portion of the land and building at Fayetteville, Arkansas is subject to a mortgage in favor of Bank One, Dayton, NA, to secure the payment of a $5,050,000 bond issue dated December 1, 1991, and maturing December 1, 2004.\nThe company's operating facilities are in good condition and are suitable for the company's purposes. Utilization of capacity is dependent upon customer demand. During fiscal 1994, productive capacity utilization by division ranged from 58% to 90%, and averaged 78% of the company's total capacity.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS - - -------------------------- The company is subject to a range of federal, state and local laws and regulations governing the discharge of material into the environment or otherwise relating to the protection of the environment. The company periodically makes capital expenditures to meet the requirements of these laws and regulations; however, the company believes that the anticipated expenditures for such purposes in the foreseeable future will not be material to its financial position or its competitive position.\nThe company, as is normal for the industry in which it operates, is subject to periodic environmental site investigations and inquiries. The company has been identified as a potentially responsible party by various state agencies and by the United States Environmental Protection Agency (U.S. EPA) under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, for costs associated with eight U.S. EPA led multi-party \"superfund\" sites and three state environmental agency led remediation sites. While the company could be found jointly and severally liable at a number of these sites, the company, in each case, is contesting any responsibility or believes that its liability will not be material because of the nature of the waste involved or the limited amount of waste generated by the company which was allegedly disposed of at these sites. With respect to one such site located in Ironton, Ohio, another potentially responsible party has brought an action entitled ALLIED-SIGNAL, INC., V. AMCAST INDUSTRIAL CORPORATION, in the U.S. District Court for the Southern District of Ohio, Western Division, Case No. C-3-92-013, seeking contribution from the company for a portion of the total response and remediation costs, which the plaintiff has claimed may exceed $20 million. The company believes that its ultimate equitable share, if any, of any liability for cleanup costs at this site will not be material.\nThe company also is a defendant in a lawsuit entitled PUBLIC INTEREST RESEARCH GROUP, INC., ET AL. V. STANLEY G. FLAGG & CO., ET AL., in the U.S. District Court for the Eastern District of Pennsylvania, Case No. 89-2137, which alleges that the content of zinc and other minerals in the waste water discharged at the company's Stowe, Pennsylvania, facility exceeded the levels allowed under the applicable permit during the period from October 1984 through October 1988. The suit seeks the assessment of penalties; however, the company believes that penalties, if any, should not be material because the discharge currently is in compliance with the permit.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - - ------------------------------------------------------------ None\nITEM 4A - EXECUTIVE OFFICERS OF REGISTRANT - - ------------------------------------------\nLeo W. Ladehoff, age 62, has been a Director since 1978, Chairman of the Board of the company since December 1980, Chief Executive Officer since May 1979, and President of the company from September 1990 to December 1993. Mr. Ladehoff was also President of the company from December 1978 until November 1986.\nJohn H. Shuey, age 48, has been President and Chief Operating Officer since December 1993 and a Director since March 1994. He was Executive Vice President from February 1991 to December 1993. From 1986 to 1991, Mr. Shuey was Senior Vice President, Finance and Chief Financial Officer at AM International (producer of business graphics equipment used in preparation and reproduction of information).\nDennis A. Bertram, age 57, has been President and General Manager of the Automotive Products Group since May 1992. From May 1989 to May 1992 he was Vice President and General Manager of the WheelTek Division. From July 1986 to May 1989 he was Vice President of Operations for WheelTek.\nJ. Randall Caraway, age 43, has been President of Amcast Precision Products, Inc. since March 1991. From August 1990 to March 1991 he was Vice President\/General Manager of the Ontario Division. From 1988 to 1990 Mr. Caraway was President of Coastcast in California. Prior to his role of President he was Vice President of Operations of Coastcast.\nDavid L. Ewing, age 46, has been President of the Flow Control Products Group since January 1994 and Vice President\/General Manager of Elkhart Products Corporation, Plumbing Division since April 1990. From May 1989 to April 1990 Mr. Ewing was President of Sensus Technologies. From September 1987 to May 1989 he was President of the coupling division of Rockwell International in TexarKana, Arkansas.\nMichael N. Powell, age 47, has been Vice President\/General Manager of Superior Valve Company since April 1994. Mr. Powell was President and Chief Operating Officer of Versa Technologies, Inc. in Racine, Wisconsin from May 1991 to December 1993. Prior to that he was a Senior Vice President for Mark Controls Corporation in Skokie, Illinois.\nDouglas D. Watts, age 49, has been Vice President, Finance since August 1994. From 1987 to August 1994 Mr. Watts held various financial management positions with General Cable Corporation, of which the most recent post was Vice President and Controller. From 1985 to 1987 he was Vice President, Finance and Chief Financial Officer of LCP Chemicals and Plastics, Inc., Edison, New Jersey.\nWilliam L. Bown, age 48, has been Vice President and Controller since June 1992. From November 1983 to May 1992 Mr. Bown was Controller of Worthington Industries, Inc. in Columbus, Ohio.\nDenis G. Daly, age 52, has been Vice President, Legal Affairs and Secretary, since January 1990. From January 1988 to December 1989 he worked in private practice at the law firm of Thompson, Hine, and Flory. From August 1982 to January 1988 he was Vice President, General Counsel, and Secretary at Day International (Dayco) in Dayton.\nWilliam J. Durbin, age 49, has been Vice President, Human Resources, since July 1984. Mr. Durbin was Director of Personnel and Director of Management Resources of Carrier Transicold Co., Carrier North American Operations, and Carrier International Corp. from 1978 to 1984.\nMyron E. Frye, age 55, has been Vice President of Purchasing since November 1992. From March 1983 to November 1992 he was President of Purchasing \/ Materials Group, Inc. in Naperville, Illinois.\nITEM 4A - EXECUTIVE OFFICERS OF REGISTRANT (cont'd) - - ------------------------------------------ Robert P. Hensley, age 63, has been Assistant Vice President of Risk Management\/ Assistant Secretary, since March 1989. From January 1987 to March 1989 he was Director of Risk Management\/Assistant Secretary.\nMichael R. Higgins, age 48, has been Treasurer since January 1987.\nYeshwant P. Telang, age 69, has been Senior Vice President, Technology and Competitive Manufacturing, since November 1991. He was Vice President, Technology from January 1985 to November 1991.\nOfficers of Amcast are elected at the Board of Directors' first meeting following the annual meeting of shareholders and hold office until the first meeting of the board following the next Annual Meeting of Shareholders.\nPART II -------\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED - - -------------------------------------------------------------- STOCKHOLDER MATTERS -------------------\nAmcast common stock is listed on the New York Stock Exchange, ticker symbol AIZ. As of August 31, 1994, there were 8,457,896 of the Company's common shares outstanding, and there were approximately 7,000 shareholders of Amcast's common stock, including shareholders of record and the company's estimate of beneficial holders.\nSee Long-Term Debt and Credit Arrangement footnote of the company's Annual Report to Shareholders for the year ended August 31, 1994, Exhibit 13.1, page 45 herein for other information required by this item.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA - - -------------------------------- See \"Selected Data\" of the company's Annual Report to Shareholders for the year ended August 31, 1994, Exhibit 13.1, page 35 herein.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL - - ---------------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS ----------------------------------- See \"Results of Continuing Operations\", \"Liquidity\", and \"Capital Resources\" of the company's Annual Report to Shareholders for the year ended August 31, 1994, Exhibit 13.1, pages 30-34 herein.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - - ---------------------------------------------------- See \"Financial Statements and Notes\", together with the report thereon of Ernst & Young LLP and \"Quarterly Financial Data (Unaudited)\" of the company's Annual Report to Shareholders for the year ended August 31, 1994, Exhibit 13.1, pages 36-57 herein.\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 required by this item relating to directors of the company is incorporated herein by reference to that part of the information under \"Election of Directors\" beginning on page 2 of the company's Proxy Statement for its Annual Meeting of Shareholders to be held on December 14, 1994. Information concerning executive officers of the company appears under \"Executive Officers of Registrant\" at Part I, page 8, of this Report.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION - - -------------------------------- The information required by this item is incorporated herein by reference to \"Executive Compensation\" on pages 6 through 12 of the company's Proxy Statement for its Annual Meeting of Shareholders to be held on December 14, 1994.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND - - ------------------------------------------------------------- MANAGEMENT ---------- The information required by this item is incorporated herein by reference to \"Security Ownership of Directors, Nominees and Officers\" on page 5 and \"Security Ownership of Certain Beneficial Owners\" on page 15 of the company's Proxy Statement for its Annual Meeting of Shareholders to be held on December 14, 1994.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - - -------------------------------------------------------- The information required by this item is contained on pages 12 and 13 in the company's Proxy Statement for its Annual Meeting of Shareholders to be held on December 14, 1994, which is incorporated herein by reference.\nPART IV -------\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS - - -------------------------------------------------------------- ON FORM 8-K ----------- (a) Documents filed as part of this report.\n1. Financial statements:\nThe following financial statements of Amcast Industrial Corporation and subsidiaries, included in the Annual Report to Shareholders for the year ended August 31, 1994, are incorporated by reference at Item 8 of this report.\nConsolidated Statements of Operations - Years Ended August 31, 1994, 1993, and 1992.\nConsolidated Statements of Financial Condition - August 31, 1994 and 1993.\nConsolidated Statements of Shareholders' Equity - Years Ended August 31, 1994, 1993 and 1992.\nConsolidated Statements of Cash Flows - Years Ended August 31, 1994, 1993, and 1992.\nNotes to Consolidated Financial Statements\n2. Consolidated financial statement schedules:\nAll other financial statement schedules are omitted because they are not applicable or because the required information is shown in the financial statements and notes.\n3. Exhibits - See Index to Exhibits (page 19 hereof).\n4. Form 8-K - During the quarter ended August 31, 1994, the company did not file any reports on Form 8-K.\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 29th day of November 1994.\nAMCAST INDUSTRIAL CORPORATION (Registrant)\nBy \/s\/Leo W. Ladehoff ---------------------------------- Leo W. Ladehoff 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 indicated.\nSignature Title Date - - ------------------- ------------------------- -----------------\n\/s\/Leo W. Ladehoff Chairman of the Board and November 29, 1994 - - ------------------- Leo W. Ladehoff Chief Executive Officer, Director\n\/s\/John H. Shuey President and Chief November 29, 1994 - - ------------------- John H. Shuey Operating Officer, Director\n\/s\/Douglas D. Watts Vice President, Finance November 29, 1994 - - ------------------- Douglas D. Watts\n\/s\/William L. Bown Vice President and Controller November 29, 1994 - - ------------------- William L. Bown\n*James K. Baker Director November 29, 1994 *Walter E. Blankley Director November 29, 1994 *Peter H. Forster Director November 29, 1994 *Ivan W. Gorr Director November 29, 1994 *Earl T. O'Loughlin Director November 29, 1994 *William G. Roth Director November 29, 1994 *R. William Van Sant Director November 29, 1994\n*The undersigned Leo W. Ladehoff, by signing his name hereto, does sign and execute this annual report on Form 10-K on behalf of each of the above-named directors of the registrant pursuant to powers of attorney executed by each such director and filed with the Securities and Exchange Commission as an exhibit to this report.\nBy \/s\/Leo W. Ladehoff ------------------------- Leo W. Ladehoff Attorney in Fact\nSCHEDULE V and VI - PROPERTY, PLANT AND EQUIPMENT (A) (Thousands of dollars)\nAMCAST INDUSTRIAL CORPORATION AND SUBSIDIARIES\nYears Ended August 31\n______________________________________________________________________________\nNotes to Schedules V and VI:\n(1) Represents normal additions. (2) Reclassification from Construction in Progress to specific asset accounts. (3) Reclassification among fixed asset accounts. (4) Reclassification between Other Assets and fixed asset accounts. (5) Reclassification to net assets of discontinued operation. (6) Write-down in carrying value of equipment and\/or disposal of equipment previously written down. (7) Property not used in ongoing operations - reclassified to Other Assets. (8) Adjustment due to foreign currency translation. (9) Reclassification between inventory and fixed asset accounts.\n(A) The principal lives and depreciation methods used for the above asset classifications are:","section_15":""}
{"filename":"786156_1994.txt","cik":"786156","year":"1994","section_1":"Item 1. Business\nGeneral\nSummit Tax Exempt Bond Fund, L.P. (the ``Registrant''), a Delaware limited partnership, was formed on December 18, 1985 and will terminate on December 31, 2020 unless terminated sooner under the provisions of the Agreement of Limited Partnership (the ``Partnership Agreement''). The Registrant was formed to invest in tax-exempt participating first mortgage revenue bonds (``First Mortgage Bonds'' or ``FMBs'') issued by various state or local governments or their agencies or authorities. These investments were made with proceeds from the initial sale of 7,906,234 Beneficial Unit Certificates (``BUC$''). The FMBs are secured by participating first mortgage loans (``Mortgage Loans'') on multi-family residential apartment properties (``Properties'') developed by unaffiliated developers. The Properties are garden apartment projects diversified nationwide. The Registrant's fiscal year for book and tax purposes ends on December 31.\nThe Registrant is engaged solely in the business of investing in FMBs; therefore, presentation of industry segment information is not applicable.\nGeneral Partners\nThe general partners of the Registrant are Prudential-Bache Properties, Inc. (``PBP'') and Related Tax Exempt Bond Associates, Inc. (the ``Related General Partner'') (collectively, the ``General Partners''). Related BUC$ Associates, Inc. (the ``Assignor Limited Partner''), which acquired and holds limited partnership interests on behalf of those persons who purchase BUC$, has assigned to those persons substantially all of its rights and interest in and under such limited partnership interests. The Related General Partner and the Assignor Limited Partner are under similar ownership.\nCompetition\nThe General Partners and\/or their affiliates have formed, and may continue to form, various entities to engage in businesses which may be competitive with the Registrant.\nThe Registrant's business is affected by competition to the extent that the underlying Properties from which it derives interest and, ultimately, principal payments, may be subject to competition relating to rental rates and amenities from comparable neighboring properties.\nStructure of First Mortgage Bonds\nThe principal and interest payments on each FMB are payable only from the cash flows, including proceeds in the event of a sale, from the Properties underlying the FMBs. None of these FMBs constitute a general obligation of any state or local government, agency or authority. The FMBs are secured by the Mortgage Loans on the underlying Properties and the structure of each Mortgage Loan mirrors the structure of the corresponding FMB.\nUnless otherwise modified, the principal of the FMBs will not be amortized during their respective terms (which range from 17 to 24 years) and will be required to be repaid in lump sum ``balloon'' payments at the expiration of the respective terms or at such earlier times as the Registrant may require pursuant to the terms of the bond documents. The Registrant has a right to require redemption of the FMBs approximately twelve years after their issuance. The Registrant anticipates holding the FMBs for approximately 12 to 15 years from the date of issuance; however, it can and may elect to hold until maturity.\nIn addition to the stated base interest rates ranging from 5.23% to 8.5% per annum, each of the FMBs which have not been modified provides for ``contingent interest'' consisting of (a) an amount equal to 50% to 100% of net property cash flow and 50% to 100% of net sale or refinancing proceeds until the borrower has paid, during the post-construction period, annually compounded interest at a rate ranging from 8.875% to 9.34% on a cumulative basis, and thereafter (b) an amount equal to 25% to 50% of the remaining net property cash flow and 25% to 50% of remaining net sale or refinancing proceeds until the borrower has paid interest at a simple annual rate of 16% over the term of the FMB. Both the stated and contingent\ninterest are exempt from federal income taxation. The Registrant has not received any contingent interest to date.\nIn order to protect the tax-exempt status of the FMBs, the owners of the Properties are required to enter into certain agreements to own, manage and operate such Properties in accordance with the requirements of the Internal Revenue Code.\nBond Modifications\/Forbearance Agreements\nThe following table lists the FMBs that the Registrant owns, together with the occupancy and current rental rates of the underlying properties:\nA provision for loss on impairment of assets of $1,350,000 was recorded during the year ended December 31, 1994 to record the estimated impairment of FMBs based upon an analysis of estimated cash flows from the individual properties securing the FMBs.\nOn April 1, 1994, Mansion Apartment Project Investors, Inc. (``MAPI''), an affiliate of the Related General Partner who replaced the original developer of The Mansion property, sold the ownership interest in the property to an unrelated third party for $700,000 in cash and the assumption of the obligation under the Registrant's $19,450,000 FMB as well as a $400,000 second mortgage note payable to a lender affiliated with the Related General Partner taken by assignment from the seller. Notwithstanding the assumption of the FMB, the General Partners agreed to forbear on the Registrant's rights and remedies in declaring an interest payment default under the FMB loan documents provided the new borrower made minimum monthly interest payments to the Registrant equal to approximately $81,000 per month (5% per annum) together with payments to a replacement reserve escrow account of approximately $4,500 per month and complied with all other covenants and obligations.\nEffective October 18, 1994, The Mansion FMB was modified. The modification provides for a base pay rate of 5.23%. In addition, the contingent interest feature has been changed. Under the modified FMB, an additional .386% per year (primary contingent interest) is due and payable from 100% of cash flow above the base pay rate. If not paid, the difference between the minimum pay rate and the primary contingent interest rate is deferred and is payable from future cash flow and sale or refinancing proceeds. Remaining cash flow and sale or refinancing proceeds, if any, are paid to the Registrant in an amount equal to 35% of net cash flow until the borrower receives a 12.5% cumulative return on its investment together with the return of the initial investment. Then, the Registrant is entitled to 50% of remaining cash flow and net sale or refinancing proceeds until the owner has paid interest at a cumulative annual rate of 16%. Notwithstanding The Mansion owner's obligation to pay amounts due as primary contingent interest, the Registrant has agreed, until 1998, the obligation to pay such amounts will be considered satisfied subject to those amounts being contributed by The Mansion's owner toward certain designated repairs to the property. The Mansion's owner will nevertheless be obligated to pay amounts due from remaining cash flow if available above the primary contingent interest rate.\nAs a result of the cash equity investment, The Mansion (which had previously been classified in the financial statements as an Asset Held for Sale) was reinstated as an FMB. The net cash proceeds from the sale of approximately $105,000 (net of a $400,000 escrow for certain repairs, a $50,000 second mortgage note principal payment, and closing costs), paid to the Registrant to reduce accrued and unpaid interest, was recorded by the Registrant as deferred income and is being amortized as interest income over the remaining life of The Mansion FMB. The balance of the deferred income relating to The Mansion FMB was approximately $101,000 at December 31, 1994. All other accrued and unpaid interest on The Mansion FMB which previously had been reserved for financial statement purposes was forgiven.\nIn June 1992, the Registrant made a $320,000 second mortgage loan to the owner of the property underlying the Cypress Run FMB for the payment of 1991 property taxes. This loan required monthly interest only payments at a rate of 8.5% per annum with the principal due on July 1, 1994. Interest payments on the loan as well as the FMB were current through June 1994; however, due to bankruptcy, the loan remains outstanding and the borrower has been notified of the default (see below for discussion of borrower's bankruptcy filing). An allowance for possible loss was recorded for this loan in 1993.\nAs a result of the failure to pay 1992 and 1993 real estate taxes, the Registrant initiated steps to enforce its rights and remedies on the Cypress Run property in July 1994. These remedies include acceleration of the loan and a $350,000 draw on an irrevocable letter of credit issued on behalf of the owner of Cypress Run as security relating to obligations under the Rental Performance Agreement. Pursuant to the terms of the bond documents, approximately $348,000 of the proceeds received from the draw on the letter of credit has been recorded as a reduction of the FMB with the balance applied as interest. In response, on July 15, 1994, the owner of the property filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code and continued to operate the property as a debtor-in-possession. The bankruptcy filing operated as a stay against the enforcement of the Registrant's remedies which include foreclosure. At the initial hearing, the court consented, among other things, to allow the Registrant to receive the monthly net cash flow generated by the property as its debt service payments for at least the initial 120 days of the proceedings.\nOn November 10, 1994, an Order Modifying Stay together with a Settlement Stipulation was entered by the Court which granted the Registrant relief from the Automatic Stay. This order became effective on March 31, 1995 unless a sale of the property, subject to the Registrant's approval, was closed beforehand. The Registrant continues to receive the monthly net cash flow generated by the property.\nOn March 31, 1995, pursuant to the Court Order, ownership of the Cypress Run property was transferred to an affiliate of the Related General Partner. The affiliate has not made an equity investment in the underlying property; however, it will assume the day-to-day responsibilities and obligations of operating the property.\nDue to the failure to pay 1990 and 1991 property taxes and interest from March to August 1992, the Registrant instituted foreclosure proceedings against Greenway Manor. On July 20, 1992, the Greenway partnership filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. Pursuant to a 1992 court order, the receiver paid the Registrant the cash flow remaining after paying past due taxes, property operating costs and escrowing for 1992 taxes. On June 30, 1993, the court dismissed the bankruptcy proceeding at which time the owner of the property and obligor under the FMB agreed to transfer the deed-in-lieu of foreclosure to an affiliate of the Related General Partner.\nFor several properties collateralizing FMBs (High Pointe Club, securing an $8,900,000 FMB; Greenway Manor, securing a $12,850,000 FMB and Cedar Creek, securing an $8,100,000 FMB) the original owners of the underlying properties and obligors of the FMBs were replaced by affiliates of the Related General Partner who have not made equity investments in the underlying properties. These entities have assumed the day-to-day responsibilities and obligations of operating the underlying properties. Buyers are being sought who would make equity investments in the underlying properties and assume the nonrecourse obligations for the FMBs. Although these properties are not producing sufficient cash flow to fully service the debt, the\nRegistrant has no present intention to declare a default on these FMBs. These FMBs are classified as ``Assets Held for Sale'' in the financial statements in the Registrant's Annual Report.\nOn May 31, 1992, Clarendon Hills Investors Inc. (``CHI''), an affiliate of the Related General Partner who had replaced the developer of the Clarendon Hills property, sold its ownership interest in the property to an unrelated third party (the ``Purchaser'') for $26,200,000. The Purchaser paid $2,000,000 in cash, assumed the $17,600,000 obligation of the Registrant's FMB and issued to CHI a $6,600,000 promissory note which in turn, was assigned to the Registrant. The $6,600,000 promissory note bears interest at the rate of 8.0% per annum payable in equal monthly installments until December 2003 at which time the entire unpaid principal and interest will be due and payable. The $1,441,209 in net cash proceeds of the sale (net of certain closing costs), paid by CHI to the Registrant to reduce accrued and unpaid interest, was recorded by the Registrant as deferred income and is being amortized as interest income from FMBs over the remaining life of the Clarendon Hills FMB. The balance of the deferred income relating to the Clarendon Hills FMB was approximately $1,117,000 at December 31, 1994.\nIn connection with the sale of the Clarendon Hills property by CHI, the FMB collateralized by the property was modified to provide for, among other things: the discharge of all accrued and unpaid interest relating to a previous owner (which for financial statement purposes had been fully reserved); a reduction of the base interest rate to 5.52% per annum on the $17,600,000 FMB; and a further reduction of the base interest during the first four years from closing of an amount equal to 50% of the increase in property taxes (if any) over the fiscal 1992 property tax bill resulting solely from this sale (limited to $35,000 per annum). In addition, the contingent interest feature was modified to assign annual cash flow as follows: (1) to pay the Registrant its 5.52% base rate on the FMB and to pay the 8.0% interest owed on the promissory note; (2) to assign the Purchaser the next $220,000 representing return on its investment; and then (3) to pay the Registrant 65% of cash flow until the Registrant receives an interest rate equal to 8.25% per annum on $24,200,000 ($17,600,000 FMB and $6,600,000 promissory note) for each respective year on a non-cumulative basis. Any remaining cash flow is then shared 65% by the Purchaser and 35% by the Registrant.\nThe FMBs for the East Ridge and Martin's Creek properties were modified in 1990 when the equity interest in the properties and the related obligations of the FMBs were sold by an affiliate of the Related General Partner to an unrelated third party. The modifications provide for minimum pay rate increases from 6.0% per annum in 1990 to 7.5% per annum in March 1996. These FMBs provide for a fluctuation in the interest rate in any one year to defray certain rehabilitation or extraordinary costs. Beginning in March 1997, the pay rate will be 8.25% per annum. The difference between the minimum interest rate and the original stated rate is payable out of available future cash flow. In addition, the contingent interest feature was changed. Under the modified terms of the FMBs, after the Registrant receives the minimum rate of interest, the borrower will receive all cash flow until it receives a 10% simple cumulative annual return on the borrower's cumulative investment. The Registrant will then be entitled to receive all previously accrued but unpaid contingent interest (0.84% per annum) and then 25% of all remaining cash flow, if any, in excess of an amount necessary to increase the borrower's return to 12% per annum on a cumulative, compounded basis.\nDuring 1991, forbearance agreements were finalized with the owners of the North Glen and Thomas Lake properties. The General Partners further modified the North Glen forbearance agreement in April 1993 to allow the owner to make debt payments at a pay rate of 6.0% per annum through December 1995 at which time the rate is scheduled to increase to the stated rate of 8.5% per annum. The pay rate for the Thomas Lake property is scheduled to increase in annual increments to the original stated rate of 8.5% per annum in December 1996.\nDuring 1992, a forbearance agreement was finalized with the owner of the Sunset Terrace property. Terms of the agreement call for a reduced pay rate of 7.0% per annum through May 1993 with scheduled annual increments to the original stated rate of 8.0% in May 1996. With respect to all of these FMBs, the difference between the pay rate and the original stated rate is deferred and payable out of available future cash flow or ultimately from sales or refinancing proceeds.\nThe determination as to whether it is in the best interest of the Registrant to enter into forbearance agreements on the FMBs or, alternatively, to pursue its remedies under the loan documents, including foreclosure, is based upon several factors. These factors include, but are not limited to, property performance, owner cooperation and projected legal costs.\nThe following FMB's interest income exceeded 15% of the Registrant's total revenue for one or more of the three years in the period ended December 31, 1994:\n* FMB's interest income was less than 15% of the Registrant's total revenue for the year.\nCredit Facility\nOn January 15, 1993, the Registrant entered into a loan agreement with an unaffiliated lender for a $15,000,000 credit facility with a maturity date of January 14, 1998 and an option to extend for two years for an additional fee. The debt service requirements include monthly interest only payments with a variable interest rate equal to the 30-day commercial paper interest rate (5.90% at December 31, 1994) plus 4.05% with principal due at maturity. The facility is collateralized by a pledge of the FMBs and associated collateral of East Ridge, Martin's Creek, The Mansion, Thomas Lake and Sunset Terrace. The initial proceeds from this facility were used to repay a $10,000,000 credit facility guaranteed by the Registrant, to repay a $3,000,000 noninterest-bearing working capital loan made to the Registrant from the Related General Partner and to pay associated closing costs. The $10,000,000 credit facility had been used to pay for costs incurred to complete construction of the properties securing the High Pointe Club and Clarendon Hills FMBs and to fund a loan toward the payment of property taxes on the Thomas Lake property. The $3,000,000 working capital loan was used to supplement distributions commencing with the fourth quarter 1988 distribution. The unused portion of the Registrant's $15,000,000 credit facility is to be used for future working capital requirements and contingencies of the Registrant, as necessary, subject to approval of the lender.\nIn conjunction with the Registrant's credit facility and the repayment of the previously existing $10,000,000 credit facility, the Registrant was assigned nonrecourse notes in the amount of $6,600,000, $3,180,000 and $220,000 from the Clarendon Hills, High Pointe Club and Thomas Lake properties, respectively. The Clarendon Hills promissory note, secured by a deed of trust, requires monthly interest only payments of 8.0% per annum with the principal due on December 1, 2003. The unsecured High Pointe Club note also requires monthly interest only payments of 8.0% per annum with the principal due on December 31, 2003. Since the High Pointe Club property is paying interest on a cash flow basis, interest on the promissory note is only recorded when cash flow is received in excess of the stated rate. No interest on the High Pointe Club promissory note has been received or recorded through December 31, 1994. The assigned High Pointe Club note is subordinate to the High Pointe Club FMB; therefore, the promissory note has been fully reserved. The Thomas Lake note, secured by a second mortgage on the property, requires monthly interest only payments based on the Citibank, N.A. prime rate (8.5% at December 31, 1994) plus 2.0% per annum with the principal due on April 5, 1995. The Registrant intends to extend Thomas Lake loan. Proposed terms call for a fixed interest rate of 8.5% with principal amortization over a 36 month period. Clarendon Hills and Thomas Lake are current on their interest payments.\nEmployees\nThe Registrant has no employees. Management and administrative services for the Registrant are performed by the General Partners and their affiliates pursuant to the Partnership Agreement. See Notes B and G to the financial statements of the Registrant's Annual Report which is filed as an exhibit hereto.\nOther Information\nOn October 27, 1994, an affiliate of PBP, Prudential Securities Incorporated (``PSI''), entered into cooperation and deferred prosecution agreements (the ``Agreements'') with the Office of the United States Attorney\nfor the Southern District of New York (the ``U.S. Attorney''). The Agreements resolved a grand jury investigation that had been conducted by the U.S. Attorney into PSI's sale during the 1980's of the Prudential-Bache Energy Income Fund oil and gas limited partnerships (the ``Income Funds''). In connection with the Agreements, the U.S. Attorney filed a complaint charging PSI with a criminal violation of the securities laws. In its request for a deferred prosecution, PSI acknowledged to having made certain misstatements in connection with the sale of the Income Funds. Pursuant to the Agreements, the U.S. Attorney will defer any prosecution of the charge in the complaint for a period of three years, provided that PSI complies with certain conditions during the three-year period. These include conditions that PSI not violate any criminal laws; that PSI contribute an additional $330 million to a pre-existing settlement fund; that PSI cooperate with the government in any future inquiries; and that PSI comply with various compliance-related provisions. If, at the end of the three-year period, PSI has complied with the terms of the Agreements, the U.S. Attorney will be barred from prosecuting PSI on the charges set forth in the complaint. If, on the other hand, during the course of the three-year period, PSI violates the terms of the Agreements, the U.S. Attorney can elect to pursue such charges.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Registrant does not own or lease any property.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThis information is incorporated by reference to Note H to the financial statements in the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of BUC$holders\nNone\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's BUC$ and Related BUC$holder Matters\nAs of March 1, 1995, there were 7,358 holders of record owning 7,906,234 BUC$. The Registrant's BUC$ are listed on the American Stock Exchange under the SUA symbol; however, the limited partner interests themselves are not listed.\nThe high and low stock prices for each quarterly period of the last two years for which the BUC$ were traded are as follows:\nQuarterly cash distributions per BUC paid during 1994 and 1993 were as follows:\nThere are no material restrictions upon the Registrant's present or future ability to make distributions in accordance with the provisions of the Partnership Agreement. Cash distributions paid in 1994 and 1993 were funded from adjusted cash flow from operations. In addition, the cash distributions paid in 1993 were supplemented by previously undistributed cash flow from operations. Approximately $1,069,000 of the $6,641,000 and $2,588,000 of the $6,641,000 paid to BUC$holders in 1994 and 1993, respectively, represent a return of capital on a generally accepted accounting principles (GAAP) basis (The return of\ncapital on a GAAP basis is calculated as BUC$holder distributions less net income allocated to BUC$holders). The Registrant currently expects that cash distributions will be paid in the foreseeable future from adjusted cash flow from operations. For discussion of other factors that may affect the amount of future distributions, see Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 17 through 20 of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table presents selected financial data of the Registrant. This data should be read in conjunction with the financial statements of the Registrant and the notes thereto on pages 2 through 16 of the Registrant's Annual Report which is filed as an exhibit hereto.\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 17 through 20 of the Registrant's Annual Report which is filed as an exhibit hereto.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data are incorporated by reference to pages 2 through 16 of the Registrant's Annual Report which is filed as an exhibit hereto.\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 are no directors or executive officers of the Registrant. The Registrant is managed by the General Partners.\nThe Registrant, the Registrant's General Partners and their directors and executive officers, and any persons holding more than ten percent of the Registrant's BUC$ are required to report their initial ownership of such BUC$ and any subsequent changes in that ownership to the Securities and Exchange Commission on Forms 3, 4 and 5. Each executive officer, director and BUC$holder who owns greater than ten percent of\nthe Registrant's BUC$ are required by Securities and Exchange Commission regulations to furnish the Registrant with copies of all Forms 3, 4 or 5 they file. All of these filing requirements were satisfied on a timely basis. In making these disclosures, the Registrant has relied solely on written representations of the General Partners' directors and executive officers and BUC$holders who own greater than ten percent of the Registrant's BUC$ or copies of the reports they have filed with the Securities and Exchange Commission during and with respect to its most recent fiscal year.\nPrudential-Bache Properties, Inc.\nThe directors and executive officers of PBP and their positions with regard to managing the Registrant are as follows:\nName Position James M. Kelso President, Chief Executive Officer, Chairman of the Board of Directors and Director Barbara J. Brooks Vice President--Finance and Chief Financial Officer Robert J. Alexander Vice President and Chief Accounting Officer Chester A. Piskorowski Vice President Frank W. Giordano Director Nathalie P. Maio Director\nJAMES M. KELSO, age 40, is the President, Chief Executive Officer, Chairman of the Board of Directors and a Director of PBP. He is a Senior Vice President of PSI. Mr. Kelso also serves in various capacities for other affiliated companies. Mr. Kelso joined PSI in July 1981.\nBARBARA J. BROOKS, age 46, is the Vice President-Finance and Chief Financial Officer of PBP. She is a Senior Vice President of PSI. Ms. Brooks also serves in various capacities for other affiliated companies. She has held several positions within PSI since 1983. Ms. Brooks is a certified public accountant.\nROBERT J. ALEXANDER, age 33, is a Vice President of PBP. He is a First Vice President of PSI. Mr. Alexander also serves in various capacities for other affiliated companies. Prior to joining PSI in July 1992, he was with Price Waterhouse for nine years. Mr. Alexander is a certified public accountant.\nCHESTER A. PISKOROWSKI, age 51, is a Vice President of PBP. He is a Senior Vice President of PSI and is the Senior Manager of the Specialty Finance Asset Management area. Mr. Piskorowski has held several positions within PSI since April 1972. Mr. Piskorowski is a member of the New York and Federal Bars.\nFRANK W. GIORDANO, age 52, is a Director of PBP. He is a Senior Vice President of PSI and General Counsel of Prudential Mutual Fund Management, Inc., an affiliate of PSI. Mr. Giordano also serves in various capacities for other affiliated companies. He has been with PSI since July 1967.\nNATHALIE P. MAIO, age 44, is a Director of PBP. She is a Senior Vice President and Deputy General Counsel of PSI and supervises non-litigation legal work for PSI. She joined PSI's Law Department in 1983; presently, she also serves in various capacities for other affiliated companies.\nThere are no family relationships among any of the foregoing directors or executive officers. All of the foregoing directors and executive officers have indefinite terms.\nRelated Tax Exempt Bond Associates, Inc.\nThe directors and executive officers of the Related Tax Exempt Bond Associates, Inc. are as follows:\nName Position J. Michael Fried President and Director Stuart J. Boesky Vice President Alan P. Hirmes Vice President Lawrence J. Lipton Treasurer Stephen M. Ross Director Lynn A. McMahon Secretary\nJ. MICHAEL FRIED, 50, is President and a Director of the Related General Partner. Mr. Fried is President, a Director and a principal shareholder of Related Capital Company (``Capital''), a real estate finance and acquisition affiliate of the Related General Partner. In that capacity, he is the chief executive officer of Capital, and is responsible for initiating and directing all of Capital's syndication, finance, acquisition and investor reporting activities. Mr. Fried practiced corporate law in New York City with the law firm of Proskauer, Rose, Goetz & Mendelsohn from 1974 until he joined Capital in 1979. Mr. Fried graduated from Brooklyn Law School with a Juris Doctor degree, magna cum laude; from Long Island University Graduate School with a Master of Science degree in Psychology; and from Michigan State University with a Bachelor of Arts degree in History.\nSTUART J. BOESKY, 39, is Vice President of the Related General Partner. Mr. Boesky practiced real estate and tax law in New York City with the law firm of Shipley & Rothstein from 1984 until February 1986 when he joined Capital. From 1983 to 1984 Mr. Boesky practiced law with the Boston law firm of Kaye, Fialkow, Richard & Rothstein and from 1978 to 1980 was a consultant specializing in real estate at the accounting firm of Laventhol & Horwath. Mr. Boesky graduated from Michigan State University with a Bachelor of Arts degree and from Wayne State School of Law with a Juris Doctor degree. He then received a Master of Law degree in Taxation from Boston University School of Law.\nALAN P. HIRMES, 40, is a Vice President of the Related General Partner. Mr. Hirmes has been a Certified Public Accountant in New York since 1978. Mr. Hirmes is a Vice President of Capital. Prior to joining Capital in October 1983, Mr. Hirmes was employed by Weiner & Co., certified public accountants. Mr. Hirmes graduated from Hofstra University with a Bachelor of Arts degree.\nLAWRENCE J. LIPTON, 38, is a Controller of the Related General Partner. Mr. Lipton has been a Certified Public Accountant in New York since 1989. Prior to joining Capital, Mr. Lipton was employed by Deloitte & Touche from 1987 to 1991. Mr. Lipton graduated from Rutgers College with a Bachelor of Arts degree and from Baruch College with a Masters of Business Administration degree.\nSTEPHEN M. ROSS, 54, is a Director of the Related General Partner. Mr. Ross is President of The Related Companies, L.P. He graduated from The University of Michigan with a Bachelor of Business Administration degree and from Wayne State University School of Law. Mr. Ross then received a Master of Law degree in taxation from New York University School of Law. He joined the accounting firm of Coopers & Lybrand in Detroit as a tax specialist and later moved to New York, where he worked for two large Wall Street investment banking firms in their real estate and corporate finance departments. Mr. Ross formed The Related Companies, Inc. in 1972, to develop, manage, finance and acquire subsidized and conventional apartment developments. To date, The Related Companies, Inc. has developed multi-family properties totalling in excess of 25,000 units, all of which it manages.\nLYNN A. McMAHON, 39, is Secretary of the Related General Partner. Since 1983, she has served as Assistant to the President of Capital. From 1978 to 1983 she was employed at Sony Corporation of America in the Government Relations Department.\nThere are no family relationships among any of the foregoing directors or executive officers. All of the foregoing directors and executive officers serve indefinite terms.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Registrant does not pay or accrue any fees, salaries or any other form of compensation to directors and officers of the General Partners for their services. Certain officers and directors of the General Partners receive compensation from affiliates of the General Partners, not from the Registrant, for services performed for various affiliated entities, which may include services performed for the Registrant; however, the General Partners believe that any compensation attributable to services performed for the Registrant is immaterial. See Item 13 Certain Relationships and Related Transactions for information regarding compensation to the General Partners.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 1, 1995, the directors and officers of the Related General Partner directly own 99.97% of the voting securities of the Related General Partner; however, no director or officer of either General Partner owns directly or beneficially any interest in the voting securities of PBP.\nAs of March 1, 1995, directors and officers of the Related General Partner own directly or beneficially BUC$ issued by the Registrant as follows:\n- ------------------ * Less than 1% of the BUC$ issued by the Registrant.\nAs of March 1, 1995, no director or officer of PBP owns directly or beneficially any BUC$ issued by the Registrant.\nAs of March 1, 1995, one BUC$holder beneficially owns more than five percent (5%) of the BUC$ issued by the Registrant as follows:\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe Registrant has, and will continue to have, certain relationships with the General Partners and their affiliates. However, there have been no direct financial transactions between the Registrant and the directors or officers of the General Partners.\nReference is made to Notes B and G to the financial statements in the Registrant's Annual Report which is filed as an exhibit hereto, which identify the related parties and discuss the services provided by these parties and the amounts paid or payable for their services.\nPART IV\nPage in Annual Report\nItem 14(a) Exhibits, Financial Statement Schedules and Reports on Form 8-K 1. Financial Statements and Independent Auditors' Report-Incorporated by reference to the Registrant's Annual Report which is filed as an exhibit hereto Independent Auditors' Report 2 Financial Statements: Statements of Financial Condition--December 31, 1994 and 1993 3 Statements of Operations--Three years ended December 31, 1994 4 Statements of Changes in Partners' Capital--Three years ended December 31, 1994 5 Statements of Cash Flows--Three years ended December 31, 1994 6 Notes to Financial Statements 7 2. Financial Statement Schedule and Independent Auditors' Report on Schedule Independent Auditors' Report on Schedule Schedule: II-Valuation and Qualifying Accounts and Reserves--Three years ended December 31, All other schedules have been omitted because they are not applicable or the required information is included in the financial statements and the notes thereto. 3. Exhibits Description:\n3 Partnership Agreement, incorporated by and reference to Exhibit A to the Prospectus 4 of Registrant, dated February 19, 1986, filed pursuant to Rule 424(b) under the Securities Act of 1933, File No. 33-2421 Amended and Restated Certificate of Limited Partnership (incorporated by reference to Exhibit 4 to Registration Statement on Form S-11, File No. 33-2421)\n10(a) First Mortgage Bond, dated May 13, 1986, with respect to The Mansion project, in the principal amount of $19,450,000 (incorporated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated May 13, 1986)\n10(b) First Mortgage Bond, dated May 20, 1986, with respect to the Martin's Creek project, in the principal amount of $7,300,000 (incorporated by reference to Exhibit 10(c) in Registrant's Current Report on Form 8-K dated May 20, 1986)\n10(c) First Mortgage Bond, dated May 20, 1986, with respect to the East Ridge project, in the principal amount of $8,700,000 (incorporated by reference to Exhibit 10(b) in Registrant's Current Report on Form 8-K dated May 20, 1986)\n10(d) First Mortgage Bond, dated July 29, 1986, with respect to the High Pointe Club project (formerly named Greenhill), in the principal amount of $8,900,000 (incorpo- rated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated July 29, 1986)\n10(e) First Mortgage Bond, dated August 14, 1986, with respect to the Cypress Run project at Tampa Palms, in the principal amount of $15,750,000 (incorporated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated August 14, 1986)\n10(f) First Mortgage Bond, dated September 2, 1986, with respect to the Thomas Lake Place Apartments project, in the principal amount of $12,975,000 (incorporated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated Sep- tember 2, 1986)\n10(g) First Mortgage Bond, dated September 30, 1986, with respect to the North Glen Apartments project (formerly named Tempo Northridge), in the principal amount of $12,400,000 (incorporated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated September 30, 1986)\n10(h) First Mortgage Bond, dated October 9, 1986, with respect to the Greenway Manor project, in the principal amount of $12,850,000 (incorporated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated October 9, 1986)\n10(i) First Mortgage Bond, dated December 8, 1986, with respect to the Clarendon Hills Apartments project, in the principal amount of $17,600,000 (incorporated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated December 8, 1986)\n10(j) First Mortgage Bond, dated December 29, 1986, with respect to the Cedar Creek Village Apartments project, in the principal amount of $8,100,000 (incorporated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated December 29, 1986)\n10(k) First Mortgage Bond, dated February 12, 1987, with respect to the Sunset Terrace project, in the principal amount of $10,350,000 (incorporated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated February 12, 1987)\n10(l) Loan Agreement dated September 19, 1990 between River Bank America and the Registrant (incorporated by reference to Exhibit 10(a) in Registrant's Current Report on Form 8-K dated September 19, 1990)\n10(m) Note dated September 19, 1990 from the Registrant to River Bank America (incor- porated by reference to Exhibit 10(b) in Registrant's Current Report on Form 8-K dated September 19, 1990)\nPledge Agreement dated September 19, 1990 between River Bank America and the 10(n) Registrant (incorporated by reference to Exhibit 10(c) in Registrant's Current Report on Form 8-K dated September 19, 1990)\nIndemnity and Reimbursement Agreement 10(o) dated September 19, 1990 between Stephen M. Ross and the Registrant (incorporated by reference to Exhibit 10(d) in Registrant's Current Report on Form 8-K dated September 19, 1990)\nSettlement Agreement for the North Glen 10(p) First Mortgage Bond dated December 3, 1990 (incorporated by reference to Exhibit 10(p) in Registrant's Annual Report on Form 10-K dated December 31, 1991)\nSettlement Agreement for the Thomas Lake 10(q) First Mortgage Bond dated July 11, 1991 (incorporated by reference to Exhibit 10(q) in Registrant's Annual Report on Form 10-K dated December 31, 1991)\nSettlement Agreement for the Sunset 10(r) Terrace First Mortgage Bond dated July 10, 1992 (incorporated by reference to Exhibit 10(r) in the Registrant's Annual Report on Form 10-K dated December 31, 1992)\nAssignment and Assumption Agreement for 10(s) the Clarendon Hills First Mortgage Bond dated May 1, 1992 (incorporated by reference to Exhibit 10(s) in the Regis- trant's Annual Report on Form 10-K dated December 31, 1992)\nFirst Supplemental Indenture between City of Hayward and Seattle-First National Bank relating to the Clarendon Hills First 10(t) Mortgage Bond dated May 1, 1992 (incorporated by reference to Exhibit 10(t) in the Registrant's Annual Report on Form 10-K dated December 31, 1992)\nLoan Agreement dated as of January 14, 10(u) 1993 between the Registrant and U.S. West Financial Services, Inc. (incorporated by reference to Exhibit 10(u) in the Registrant's Quarterly Report on Form 10-Q dated June 30, 1993)\nPledge and Security Agreement dated as of 10(v) January 14, 1993 between the Registrant and U.S. West Financial Services, Inc. (incorporated by reference to Exhibit 10(v) in the Registrant's Quarterly Report on Form 10-Q dated June 30, 1993)\nSecured Promissory Note dated January 14, 10(w) 1993 between the Registrant and U.S. West Financial Services, Inc. (incorporated by reference to Exhibit 10(w) in the Registrant's Quarterly Report on Form 10-Q dated June 30, 1993)\nPromissory Note dated January 15, 1993 between the Registrant and RHA Inc. 10(x) (incorporated by reference to Exhibit 10(x) in the Registrant's Quarterly Report on Form 10-Q dated June 30, 1993)\n10(y) Nonrecourse Promissory Note Secured by Deed of Trust dated January 28, 1993 between Stephen P. Diamond and Clarendon Hills Investors, Inc. assigned to the Registrant (incorporated by reference to Exhibit 10(y) in the Registrant's Quarterly Report on Form 10-Q dated June 30, 1993)\nAssignment Agreement dated January 15, 1993 between Summit Tax Exempt Funding 10(z) Corporation and the Registrant (incorporated by reference to Exhibit 10(z) in the Registrant's Quarterly Report on Form 10-Q dated June 30, 1993)\nAmended Settlement Agreement for the North 10(aa) Glen First Mortgage Bond dated June 1, 1993 (incorporated by reference to Exhibit 10(aa) in the Registrant's Annual Report on Form 10-K dated December 31, 1993)\nSale-Purchase Agreement between Mansion Apartment Project Investors, Inc., Seller and Independence Apartments Associates, 10(ab) L.P., Purchaser dated November 30, 1993 (incorporated by reference to Exhibit 10(ab) in the Registrant's Quarterly Report on Form 10-Q dated March 31, 1994)\nAddendum to Sale-Purchase Agreement between Mansion Apartment Project In- vestors, Inc., Seller and Independence 10(ac) Apartments Associates, L.P., Purchaser dated March 31, 1994 (incorporated by reference to Exhibit 10(ac) in the Regis- trant's Quarterly Report dated March 31, 1994)\nFirst Supplemental Indenture, dated as of 10(ad) October 18, 1994, between The Industrial Development Authority of the City of Independence, Missouri and Boatman's First National Bank of Kansas City relating to The Mansion project (filed herewith)\nFirst Mortgage Bond, dated May 13, 1986 and revised as of October 18, 1994 with 10(ae) respect to The Mansion project, in the principal amount of $19,450,000 (filed herewith)\nRegistrant's 1994 Annual Report (with the exception of the information and data incorporated by reference in Items 3, 7 13 and 8 of this Annual Report on Form 10-K, no other information or data appearing in the Registrant's 1994 Annual Report is deemed filed as part of this report) (filed herewith)\n27 Financial Data Schedule (filed herewith)\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.\n(LOGO)\nTwo World Financial Center Telephone: (212) 436-2000 New York, NY 10281-1424 Facsimile: (212) 436-5000\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Summit Tax Exempt Bond Fund, L.P. New York, New York\nWe have audited the financial statements of Summit Tax Exempt Bond Fund, L.P. (a Delaware Limited Partnership) 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 12, 1995; 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 schedule of Summit Tax Exempt Bond Fund L.P., listed in Item 14(a)2. This financial statement schedule is the responsibility of the General Partners. 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.\n\/s\/ Deloitte & Touche - --------------------------- April 12, 1995\n(LOGO)\nSUMMIT TAX EXEMPT BOND FUND, L.P. (a limited partnership) SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\nValuation allowance for first mortgage bonds\nValuation allowance for uncollectible receivables\nValuation allowance for promissory notes\nValuation allowance for assets held for sale\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSummit Tax Exempt Bond Fund, L.P.\nBy: Prudential-Bache Properties, Inc. A Delaware corporation, General Partner By: \/s\/ Robert J. Alexander Date: April 17, 1995 --------------------------------------------- Robert J. Alexander Vice President and Chief Accounting Officer By: Related Tax Exempt Bond Associates, Inc. A Delaware corporation, General Partner By: \/s\/ Alan P. Hirmes Date: April 17, 1995 --------------------------------------------- Alan P. Hirmes 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 (with respect to the General Partners) and on the dates indicated.\nBy: Prudential-Bache Properties, Inc. A Delaware corporation, General Partner By: \/s\/ James M. Kelso Date: April 17, 1995 --------------------------------------------- James M. Kelso President, Chief Executive Officer, Chairman of the Board of Directors and Director By: \/s\/ Barbara J. Brooks Date: April 17, 1995 --------------------------------------------- Barbara J. Brooks Vice President - Finance and Chief Financial Officer By: \/s\/ Robert J. Alexander Date: April 17, 1995 --------------------------------------------- Robert J. Alexander Vice President By: \/s\/ Frank W. Giordano Date: April 17, 1995 --------------------------------------------- Frank W. Giordano Director By: \/s\/ Nathalie P. Maio Date: April 17, 1995 --------------------------------------------- Nathalie P. Maio Director\nBy: Related Tax Exempt Bond Associates, Inc. A Delaware corporation, General Partner\nBy: \/s\/ J. Michael Fried Date: April 17, 1995\n--------------------------------------------- J. Michael Fried President and Director (Principal Executive Officer) By: \/s\/ Alan P. Hirmes Date: April 17, 1995 --------------------------------------------- Alan P. Hirmes Vice President (Principal Financial and Accounting Officer) By: \/s\/ Lawrence J. Lipton Date: April 17, 1995 --------------------------------------------- Lawrence J. Lipton Treasurer By: Stephen M. Ross Date: April 17, 1995 --------------------------------------------- Stephen M. Ross Director","section_14":"","section_15":""}
{"filename":"311995_1994.txt","cik":"311995","year":"1994","section_1":"ITEM 1 - BUSINESS\nExcept for a discussion of competition, information required by this item is incorporated by reference from portions of Mitchell Energy & Development Corp.'s Annual Report to Stockholders for the fiscal year ended January 31, 1994 furnished to the Commission pursuant to Rule 14a-3(b) under the Securities Exchange Act of 1934 (Annual Report to Stockholders).\nCompetition\nThe Registrant is a holding company which conducts all of its operations through its subsidiaries, collectively referred to as \"the Company.\" The Company is one of the nation's largest independent oil and gas producers and is a leading real estate developer in the Houston-Galveston area. Its energy-related operations include the exploration for and production of natural gas and crude oil, production of natural gas liquids (NGLs) and the operation of intrastate pipelines. The Company has substantial real estate holdings, mostly within a 50-mile radius of Houston, Texas.\nWithin its energy businesses, the Company competes with many companies that have substantially larger financial and other resources or whose operations are more fully integrated than the Company's. The oil and gas industry is highly competitive. There is competition within the industry and also with other industries in supplying the fuel and energy needs of commerce, industry and individuals. Due to relatively higher domestic finding costs and continued unfavorable price levels for oil and gas, many energy companies have chosen in recent years to focus on international activities and to reduce or eliminate their U.S. operations. However, the Company intends to retain its domestic focus and hopes to benefit from lessened competition for prospects and the availability of opportunities for producing property acquisitions. From a competitive standpoint, those focusing on international activities have chosen to seek potentially more prolific opportunities in areas where operations generally are subject to much greater political risk and other uncertainties. Alternatively, the Company has chosen to limit these risks by continuing to operate only in the U.S. Also, the Company's operations and cash flows benefit from the fact that almost one-half of its natural gas production is sold under a long-term contract at prices well above those that are available currently for market-sensitive production.\nThe Company owns or has interests in over 60 natural gas processing plants located in Texas, Oklahoma and New Mexico, and it ranked 13th in daily domestic NGL production in calendar 1992. The Company also has fractionating equipment at several of its processing plants and owns a 38.75% interest in a large fractionating plant near Mont Belvieu on the upper Texas Gulf Coast. After being fractionated into ethane, propane, butanes and natural gasoline, the NGLs are used by others in the production of plastics, paints, solvents, synthetic rubber, gasoline and a wide variety of other products. Propane also is widely used as a fuel in rural areas for cooking, home heating and crop drying. The Company has entered the downstream business through its one-third interest in a partnership which is constructing a plant at Mont Belvieu, Texas, to produce MTBE, an oxygenate used in the production of environmentally cleaner gasoline. The plant, which has a design capacity of 12,500 barrels per day, is expected to begin production during the summer of 1994.\nThe Company owns or has interests in intrastate natural gas pipeline systems located in Texas with an aggregate length of over 4,000 miles. The Company's pipeline systems tend to be regional gathering systems which operate in highly competitive local markets. These pipelines intersect with numerous other pipelines, enabling the Company to buy, sell, transport and exchange gas with other pipeline operators. In the fall of 1992, the Company commenced limited operations of its Spindletop Gas Storage Facility, which is expected to improve the Company's competitive position in the petrochemical and industrial markets of Southeast Texas.\nThe Company's largest real estate development project--The Woodlands--is a 25,000-acre master-planned community with a population approaching 39,000. During each of the last four years, The Woodlands ranked first among Houston's residential communities in lot sales, new home sales and housing starts. The Woodlands Mall is under construction and is projected to open in October 1994 with four major anchor department stores. The Company believes the new mall will be a catalyst for additional commercial land sales and will enhance residential and commercial land values in The Woodlands. The number of residential communities competing for new home buyers in the Houston area is expected to increase, resulting in a reduced market share (based on the percentage of new homes sold) for the master-planned communities. However, with the related expansion in the size of the overall market, the Company anticipates that it will be able to maintain its residential unit sales volume near the level achieved in recent years. Several of the Houston area master-planned communities are owned by companies having substantially greater financial resources than the Company.\nThe Company's operations have been and may be in the future affected from time to time in varying degree by general economic conditions and by laws and regulations, including restrictions on production, price controls, tax increases and environmental regulations. The Company's energy price realizations are often volatile and generally are affected by world supply and demand conditions. Real estate sales, on the other hand, may be affected by available disposable income, interest rates, availability of financing and numerous other factors.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nInformation required by this item is incorporated by reference from portions of the Annual Report to Stockholders.\nOTHER OIL AND GAS RELATED DATA\nThe following information is required by Sections 3, 5 and 6 of the Securities Act Industry Guide 2, Disclosure of Oil and Gas Operations.\nAVERAGE PRODUCTION COST IN EQUIVALENT UNITS(a)\n(a) Includes equity partnership interests. (b) Expressed in equivalent units of production with barrels of oil converted to cubic feet of gas based on relative sales value.\nUNDEVELOPED ACREAGE At January 31, 1994\n- ---------------- (a) Expiring leases may be renewed if conditions warrant. (b) Percentage of the state's net acres located in the indicated areas of concentration. (c) Includes Alabama, Arkansas, California, Kansas, Louisiana, Mississippi, Montana, Nebraska, New York, Oklahoma, Pennsylvania and West Virginia.\nDRILLING ACTIVITY (a) For the year ended January 31\n___________________________ (a) Excludes service wells; includes equity partnership interests. (b) Mississippi, New York, Ohio and Pennsylvania. (c) An additional 50 wells (41.7 net wells) were in the process of being drilled or completed on January 31, 1994.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nA settlement was reached in January 1994 for the previously reported litigation brought against two 45%-owned partnerships by a pipeline purchaser related to three contracts covering natural gas sales in Burleson County, Texas. The settlement agreement provided for new contracts and for no payment of damages by the partnership. While near-term revenues under the new contracts will likely be lower, the Company estimates that total revenues over the terms of these contracts will at least equal those which would have been received under the previous agreements.\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 security holders, either through the solicitation of proxies or otherwise.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following is a list of the executive officers of the Company as of April 1, 1994.\nAll of the executive officers, except Mr. Stevens, were elected at a Board of Directors meeting held on June 30, 1993 for a term of one year, or until their respective successors are qualified. Mr. Stevens was elected to the new position of President and Chief Operating Officer at the Board of Directors meeting held on December 10, 1993. His term of office began January 3, 1994 and will extend until the meeting of the Board following the next annual meeting of stockholders or until his successor is duly qualified.\nThere are no significant family relationships among the officers of the Company, either by blood, marriage or adoption.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nExcept for the approximate number of holders of record of common stock securities, information required by this item is incorporated by reference from portions of the Annual Report to Stockholders.\nThe numbers of holders of Class A Common Stock and of Class B Common Stock at March 31, 1994 were 2,668 and 2,644, respectively. Including those whose shares are carried in street names, the Registrant estimates that there are approximately 9,000 holders of each class of its common stock.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nInformation required by this item is incorporated by reference from pages 67 and 68 of the Annual Report to Stockholders under the caption \"Historical Summary.\" Incorporation by reference from these pages is restricted to the information provided under the captions: Revenues, net earnings, net earnings per common share, cash dividends per common share, ratio of earnings to fixed charges, total assets and long-term debt for the fiscal years 1990 through 1994.\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 from pages 29 through 42 of the Annual Report to Stockholders.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nInformation required by this item is incorporated by reference from portions of the Annual Report to Stockholders.\nITEM 9","section_9":"ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNo Form 8-K's were filed by the Registrant during its fiscal years ended January 31, 1993 and 1994 or any subsequent period reporting a change of accountants or any disagreement 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\nInformation required by this item is incorporated by reference from portions of the Registrant's definitive Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after January 31, 1994 pursuant to Regulation 14A under the Securities Exchange Act of 1934 (Proxy Statement), under the caption \"Election of Directors.\" See page 6 of this Form 10-K for information regarding Executive Officers of the Registrant.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nInformation required by this item is incorporated by reference from portions of the Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after January 31, 1994, under the captions \"Executive Compensation\" and \"Compensation Committee Interlocks and Insider Participation.\"\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by this item is incorporated by reference from portions of the Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after January 31, 1994, under the caption \"Voting Securities and Principal Holders Thereof.\"\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by this item is incorporated by reference from portions of the Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after January 31, 1994, under the caption \"Certain Transactions.\"\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nFINANCIAL STATEMENTS AND SUPPLEMENTAL DATA\nFINANCIAL STATEMENT SCHEDULES\nSchedules not listed above are omitted as the information required to be set forth therein is included in the consolidated financial statements or the footnotes thereto, or the schedules are not applicable.\nEXHIBITS\nThe following exhibits 10(b) through 10(n) filed under paragraph 10 of Item 601 of Regulation S-K are the Company's management contracts and compensation plans or arrangements.\nREPORTS FILED ON FORM 8-K\nOn January 18, 1994, Mitchell Energy & Development Corp. filed a Form 8-K reporting its intention to (1) issue $250 million of 6 3\/4% Senior Notes Due 2004 pursuant to the terms of a Senior Debt Indenture dated January 1, 1993, as supplemented by a First Supplemental Indenture dated January 15, 1994, between Mitchell Energy & Development Corp. and NationsBank of Texas, National Association, as trustee and (2) redeem, with the proceeds from such issuance, its $200 million 11 1\/4% Senior Notes Due 1999 at 103.21% of their principal amount.\nOn January 20, 1994, Mitchell Energy & Development Corp. filed a Form 8-K reporting its intention to (1) issue $100 million of 5.10% Senior Notes Due 2004 pursuant to the terms of the Senior Debt Indenture identified in the preceding paragraph and (2) repay floating-rate borrowings under revolving credit agreements of its primary energy and real estate 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.\nMitchell Energy & Development Corp.\n\/s\/ GEORGE P. MITCHELL April 18, 1994 _________________________________________ George P. Mitchell, 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 date indicated.\n\/s\/ GEORGE P. MITCHELL April 18, 1994 _________________________________________ George P. Mitchell, Chairman and Chief Executive Officer\n\/s\/ BERNARD F. CLARK April 18, 1994 _________________________________________ Bernard F. Clark, Vice Chairman\n\/s\/ W. D. STEVENS April 18, 1994 _________________________________________ W. D. Stevens, Director, President and Chief Operating Officer\n\/s\/ PHILIP S. SMITH April 18, 1994 _________________________________________ Philip S. Smith, Senior Vice President - Administration, Chief Financial Officer and Principal Accounting Officer\n\/s\/ ROBERT W. BALDWIN April 18, 1994 _________________________________________ Robert W. Baldwin, Director\n\/s\/ WILLIAM D. EBERLE April 18, 1994 _________________________________________ William D. Eberle, Director\nSIGNATURES (continued)\n\/s\/ SHAKER A. KHAYATT April 18, 1994 _________________________________________ Shaker A. Khayatt, Director\n\/s\/ BEN F. LOVE April 18, 1994 _________________________________________ Ben F. Love, Director\n\/s\/ WALTER A. LUBANKO April 18, 1994 _________________________________________ Walter A. Lubanko, Director\n\/s\/ J. TODD MITCHELL April 18, 1994 _________________________________________ J. Todd Mitchell, Director\n\/s\/ M. KENT MITCHELL April 18, 1994 _________________________________________ M. Kent Mitchell, Director\n\/s\/ MICHAEL B. MORRIS April 18, 1994 _________________________________________ Michael B. Morris, Director\n_________________________________________ Raymond L. Watson, Director\n\/s\/ BENJAMIN N. WOODSON April 18, 1994 _________________________________________ Benjamin N. Woodson, Director\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Mitchell Energy & Development Corp.:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Mitchell Energy & Development Corp.'s Annual Report to Stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated April 18, 1994. Our 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 on page 9 are the responsibility of the Company's management and are presented for purposes of complying with rules of the Securities and Exchange Commission, and are not part of the basic financial statements. These financial statement schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nHouston, Texas April 18, 1994\nS-1 Mitchell Energy & Development Corp. and Subsidiaries SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDER- WRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES FOR THE YEARS ENDED JANUARY 31, 1994, 1993 AND 1992 (in thousands)\n___________________________ This receivable, which arose in conjunction with the acquisition of a pipeline company of which Mr. Wilshusen was formerly an owner, bears interest at prime and is secured by a second lien on certain real estate. This loan has been fully reserved.\nS-2 Mitchell Energy & Development Corp. and Subsidiaries SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT -- PAGE 1 OF 4\n================================================================================\nMitchell Energy & Development Corp. CONDENSED BALANCE SHEETS January 31, 1994 and 1993 (in thousands)\n===============================================================================\nMitchell Energy & Development Corp. CONDENSED STATEMENTS OF EARNINGS For the Years Ended January 31, 1994, 1993 and 1992 (in thousands except per share amounts)\n___________________________ The accompanying notes are an integral part of these condensed financial statements.\nS-3 Mitchell Energy & Development Corp. and Subsidiaries SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT -- PAGE 2 OF 4\n================================================================================\nMitchell Energy & Development Corp. CONDENSED STATEMENTS OF CASH FLOWS For the Years Ended January 31, 1994, 1993 and 1992\n(in thousands)\n___________________________ The accompanying notes are an integral part of these condensed financial statements.\nS-4 Mitchell Energy & Development Corp. and Subsidiaries SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT -- PAGE 3 OF 4\n================================================================================\nMitchell Energy & Development Corp. NOTES TO CONDENSED FINANCIAL STATEMENTS JANUARY 31, 1994, 1993 AND 1992\n(A) General. The accompanying condensed financial statements of Mitchell Energy & Development Corp. (MEDC) should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report to Stockholders of Mitchell Energy & Development Corp. and subsidiaries (the Company) for fiscal 1994, which is filed as an exhibit to this annual report on Form 10-K. For information regarding the components of and an analysis of the activity in stockholders' equity, refer to the Consolidated Statements of Stockholders' Equity included in the Company's Annual Report to Stockholders. For information regarding the issuance of Class B shares in fiscal 1994, the reclassification of MEDC's common stock in fiscal 1993 and the Company's stock option and bonus unit plans, see Notes 7 and 10 of Notes to Consolidated Financial Statements included in the Company's Annual Report to Stockholders. Also, see Note 4 for information regarding extraordinary losses from early debt retirements recorded in fiscal 1994 and fiscal 1993 and Note 11 for the cumulative effect of a change in accounting methods for postretirement benefits recorded in fiscal 1993. These charges reduced the reported equity in net earnings of subsidiaries for fiscal 1994 by $5,426,000 and for fiscal 1993 by $7,251,000 and $10,551,000, respectively.\n(B) Income Taxes. MEDC is included in the consolidated tax return of the Company. As the parent company, MEDC allocates to its subsidiaries amounts equal to the income taxes that the subsidiaries would pay or receive as a refund if separate returns were filed. MEDC's income tax benefit in fiscal 1992 arose when certain tax carryforwards were estimated to be utilizable that previously had been expected to expire.\n(C) Long-term Debt. A summary of outstanding long-term debt at January 31, 1994 and 1993 follows (in thousands):\nDuring January 1994, MEDC called for redemption on February 25, 1994 its $200,000,000 of 11 1\/4% Senior Notes Due 1999. This early redemption was completed at a price of 103.21% of principal, and the expensing of this premium and related unamortized debt issuance costs resulted in an extraordinary charge of $5,426,000 (after tax benefit of $2,921,000). This charge was recorded in fiscal 1994 since the loss was incurred when the debt was called in January 1994. Because all proceeds of senior note borrowings are advanced to the operating subsidiaries and all the costs of such indebtedness are rebilled to the subsidiaries, the extraordinary charge was allocated to MEDC's subsidiaries.\nDuring January 1994, MEDC issued $250,000,000 of 6 3\/4% Senior Notes Due 2004 and $100,000,000 of 5.10% Senior Notes Due 1997. Initially, the loan proceeds were advanced to MEDC's subsidiaries, which used them to pay down borrowings under their commercial paper and bank revolving credit agreements. In February 1994, the subsidiaries reborrowed a portion of the amounts temporarily paid down and advanced such funds to MEDC to fund the debt redemption mentioned in the preceding paragraph.\nS-5 Mitchell Energy & Development Corp. and Subsidiaries SCHEDULE III - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT -- PAGE 4 OF 4 ================================================================================\nOn April 13, 1992, MEDC redeemed its $250,000,000 of 11 1\/4% Senior Notes Due 1997 using the proceeds of a March 1992 offering of $250,000,000 of 9 1\/4% Senior Notes Due 2002. This early redemption was completed at a price of 103.21% of principal, and the expensing of this premium and related unamortized debt issuance costs resulted in an extraordinary charge of $7,251,000 (after tax benefit of $3,736,000), which was allocated to MEDC's subsidiaries as previously discussed.\nDuring July 1992, MEDC issued $100,000,000 of 8% Senior Notes Due 1999. The proceeds of this financing were advanced to MEDC's subsidiaries, which used them to pay down borrowings under their bank revolving credit agreements.\nExcept for the notes which were redeemed in February 1994, the Company's senior notes have no sinking fund requirements and are not redeemable prior to their respective maturity dates. The senior note indentures contain certain restrictions which, among other things, limit cash dividend payments and additional borrowings, restrict the sale or lease of certain assets and limit MEDC's right to consolidate or merge with other companies. Retained earnings available for the payment of cash dividends totaled $351,954,000 at January 31, 1994.\nCertain loan agreements of MEDC's subsidiaries limit the amount of cash advances and dividends that can be paid to MEDC. At January 31, 1994, transfers to MEDC of approximately $1,240,000,000 were available under these agreements.\n(D) Debt Guarantees. At January 31, 1994, MEDC was contingently liable for the repayment of approximately $80,000,000 in outstanding debt of subsidiaries and certain of their equity investees. Also, MEDC had contingent liabilities at that date totaling approximately $6,000,000, consisting principally of debt guarantees for nonprofit institutions located in The Woodlands.\n(E) General and Administrative Expense Allocation. General and administrative expense in the Condensed Statements of Earnings is net of amounts charged to subsidiaries of $43,222,000; $41,398,000 and $38,184,000 in fiscal 1994, 1993 and 1992. Such costs are allocated based on estimates of time spent and benefits derived by the subsidiaries from the services provided.\n(F) Statements of Cash Flows. Short-term investments with a maturity of three months or less are considered to be cash equivalents. Bank revolving credit agreement borrowings with terms of three months or less are excluded from the amounts reported as debt proceeds and repayments. Interest paid totaled $53,625,000; $52,754,000 and $52,032,000 during the years ended January 31, 1994, 1993 and 1992. Income taxes of $12,240,000; $5,935,000 and $11,233,000 were paid during these same periods. There were no significant non-cash investing or financing activities during the three-year period ended January 31, 1994.\n(G) Fair Value of Financial Instruments. The following table summarizes the carrying amounts and estimated fair values of MEDC's financial instruments for which it is practicable to estimate that value at January 31, 1994 (in thousands):\nThe estimated fair values for cash and cash equivalents are assumed to equal their carrying values because of the short maturities of these instruments. Estimated fair values of long-term debt are based on quoted market prices for these instruments. Estimated fair values of financial guarantees and commitments are based on the estimated costs of obtaining letters of credit to relieve MEDC of its obligations under such agreements.\nS-6 Mitchell Energy & Development Corp. and Subsidiaries SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED JANUARY 31, 1994, 1993 AND 1992 (in thousands)\n___________________________ * \"Other changes\" include transfers between asset categories and differences between the Company's equity in earnings (losses) of and distributions from equity investees, the investments in which are included in property, plant and equipment.\nS-7 Mitchell Energy & Development Corp. and Subsidiaries SCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED JANUARY 31, 1994, 1993 AND 1992 (in thousands)\n- ------------------------- * \"Other changes\" for gas gathering and transmission for fiscal 1992 consist primarily of reductions related to assets that were contributed to a 45% owned partnership.\nS-8 MITCHELL ENERGY & DEVELOPMENT CORP. AND SUBSIDIARIES INDEX TO EXHIBITS\nINDEX TO EXHIBITS (Continued)\nINDEX TO EXHIBITS (Continued)","section_15":""}
{"filename":"11975_1994.txt","cik":"11975","year":"1994","section_1":"Item 1 - Business\nThe term \"Corporation\" refers to BIC Corporation, a New York corporation which was incorporated in 1958, and its subsidiaries, unless the context indicates otherwise.\nThe Corporation's primary focus is the manufacture and sale of high-quality, low-cost consumer products. These products include stationery products, lighters and shavers. The Corporation also distributes sailboards which are purchased from a foreign affiliate. While most of the Corporation's operations are conducted in the United States, operations are also conducted at other locations in North and Central America. Societe BIC, S.A. is the Corporation's majority shareholder.\nThe following table sets forth the net sales and income (loss) before income taxes, extraordinary credit and cumulative effect of change in accounting principle for each of the Corporation's principal products for the periods indicated:\nProducts\nThe principal products of the Corporation are as follows:\nStationery Products\nThe Corporation is the largest manufacturer and distributor of ball pen writing instruments in North America. Based on market research studies and other public information, the number of ball pens sold by the Corporation in 1993 represents approximately 40% of the office products market in the United States and close to 60% of the over-the-counter market. These pens, which are marketed under trademarks owned by the Corporation, are available in both non- retractable, non-refillable models and retractable, refillable models. The pens are available in various ink and barrel colors and point sizes. In addition to ball pens, the Corporation manufactures highlighting markers, roller pens and correction fluids and distributes mechanical pencils.\nStationery Products (Continued)\nIn 1992, the Corporation acquired Wite-Out Products, Inc., the second largest manufacturer of correction fluid in the United States. During the fourth quarter of 1993, the Corporation introduced four performance-based correction fluids formulated to meet the specific needs of individual consumers: For Everything(R) Quick Dry, For Everything Extra Coverage, For Everything Super Smooth and Water Base. This line contains no chemicals known to deplete the ozone layer. With this introduction, BIC(R) Wite-Out(R) Formula 109(R), BIC Wite-Out For Copies, and BIC Wite-Out for Pen & Ink have been discontinued. The new Wite-Out line will be supported with special consumer and trade promotions during 1994.\nDuring 1993, the Corporation expanded its line of Soft Feel(R) pens to include Soft Feel Stic. Soft Feel pens have rubberized barrels for greater writing comfort. The Corporation also introduced six new BIC Wavelengths(R) designs in 1993, which include Clear Clics(TM), clear clic pens with fashion tinted bodies; and Hot-Lites(TM), highlighters with heat sensitive barrels that change color when held. The other new designs are Art Attacks(TM), Flats(TM), Spaz(TM) and Glow Stics(TM). BIC Wavelengths is a line of fashionable pens and mechanical pencils featuring a variety of colorful designs, images and ink colors. The Corporation will continue to expand its BIC Wavelengths line in 1994.\nLighters\nThe Corporation is the leading manufacturer and distributor of disposable butane lighters in North America. Based on market research studies and other public information, BIC lighters continue to maintain their market leadership position despite the importation of low-quality, inexpensive lighters from the Far East.\nDuring the second quarter of 1992, the Corporation introduced to the market its BIC Lighter with Child Guard(R). This new model, which has a lever that makes it even more difficult for children to light, exceeds the United States Consumer Product Safety Commission standard that will go into effect on July 12, 1994.\nThe Corporation continues to expand its Limited Edition line to include new fashions and designs. During the first quarter of 1993, BIC introduced Country Western and Flowers. The Country Western series offers five full-color illustrations of scenes from the American West; the Flowers series consists of five floral designs in a variety of rich colors.\nShavers\nOne-piece shavers, the only type sold by the Corporation, account for over 60% of the wet-shave market. In the one-piece shaver market, which consists of over 1.2 billion units annually, the Corporation continues to share the number one position. These statistics are based on market research studies and other public information.\nIn 1992, the Corporation introduced a new line of twin-blade shavers: BIC Twin Select(R) Normal Skin, BIC Twin Select(R) Sensitive Skin and BIC Twin Pastel(TM) for women. The BIC twin-blade shaver features precise twin-blade orientation for different skin types, a slimmer shaver head, a long and tapered handle and a reusable guard. During 1993, the Corporation supported this line with special promotions and television advertising, and will continue to do so in 1994. The promotions will primarily be account specific in 1994, whereas in 1993, the promotions were directed towards the mass market.\nSport\nThe principal sport product distributed by the Corporation is the BIC Sailboard. These sailboards are purchased from a foreign affiliate.\nSales\/Marketing\nThe Corporation's principal products are sold through the Corporation's sales force and manufacturer representative groups to approximately 18,500 accounts, which include food, drug, wholesale club, superstore, variety and retail outlets, as well as tobacco, drug and stationery wholesalers, who in turn distribute the products to retail outlets. Sales to commercial customers are generated both by the Corporation's own sales force and by selected manufacturer representative groups who sell to office supply distributors and retailers. Stationery products, lighters and shavers carrying the purchaser's name, trademark, corporate symbol or other imprint are sold to customers for advertising specialty or premium purposes by the Corporation's Special Markets Division.\nThe Corporation relies upon advertising on national television networks, in national publications with broad circulation and in publications for specialized audiences. In addition, the Corporation maintains a cooperative advertising program pursuant to which it shares the cost of certain advertising with retailers. The Corporation also provides a wide variety of product displays, seasonal sales promotion materials and other advertising and merchandising aids to retail outlets.\nInternational Operations\nThe Corporation's international operations consist of the operations of its subsidiaries in Canada, Mexico, Guatemala and Puerto Rico. Sales by foreign subsidiaries were approximately 15% of consolidated net sales in 1993 and 16% in 1992 and 1991.\nInternational operations are subject to certain risks, including changes in currency exchange rates and imposition of foreign exchange controls. During 1992, the Corporation's Mexican subsidiaries' economy ceased to be considered highly inflationary, and the Mexican peso became the subsidiaries' functional currency. The operations in Guatemala and Mexico showed slight improvements in sales for 1993.\nCompetition\nAlthough the Corporation is the leading domestic manufacturer of ball pen writing instruments and disposable butane lighters, it is subject to intense competition in all areas of its business. Competitors include both smaller specialized firms and larger diversified companies, some of which have broader product lines and substantially greater financial resources than the Corporation. The Corporation's major competitor in stationery products is Gillette Company. Major competitors in lighters are Scripto Tokai Corporation, Swedish Match Corporation and importers of low-quality, inexpensive lighters from the Far East. In shavers, major competitors are Gillette Company and the Schick Division of Warner Lambert Company.\nTrademarks\nThe Corporation owns a number of trademarks relating to its products which are the subject of intensive advertising and marketing programs. The principal registered trademarks, which the Corporation believes are important to its business, are BIC, (Logo of BIC), \"Flick My BIC\", (Logo of BIC Wavelengths), and (Logo of BIC Wite-Out).\nEmployee Relations\nAt January 2, 1994, the Corporation had approximately 2,500 employees, of whom approximately 590 were unionized personnel at the Corporation's facility in Milford, Connecticut. These unionized personnel are represented under a collective bargaining agreement which expires on November 29, 1997. The Corporation considers its employee relations to be good.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 - Properties\nAt January 26, 1994, the Corporation owned and operated manufacturing plants in the United States, Mexico, Canada and Guatemala. Manufacturing areas, including related office and service areas of the Corporation, are as follows:\nIn January 1993, the Corporation's Special Markets Division began leasing a 30,500 square foot building in Clearwater, Florida for additional office and warehouse space. During 1993, the Corporation expanded its Duncan (formerly Spartanburg), South Carolina; Fountain Inn, South Carolina; Clearwater, Florida and Cuautitlan, Mexico facilities. The Corporation recently relocated its Wite-Out operation from a leased facility in Beltsville, Maryland to its Fountain Inn, South Carolina facility.\nThe Corporation leases sales offices and warehouse space at various other locations and owns or leases such machinery and equipment as is necessary for the operation of its business. In general, the machinery and plants are in good condition, adequately meet the Corporation's needs and operate at reasonable levels of production capacity.\nItem 3","section_3":"Item 3 - Legal Proceedings\nThe Corporation has significant contingent liabilities with respect to pending litigation, claims and disputes, principally relating to its lighters, which arise in the ordinary course of its business.\nIn 1985, the United States District Court, Southern District of New York (the \"District Court\"), in connection with pending patent actions between BIC Sport U.S.A. Inc. and Windsurfing International, ruled that Windsurfing's sailboard patent was valid and was infringed by BIC boards. The patent in question expired in January 1987. By decision dated April 8, 1991, the District Court awarded damages of lost profits to Windsurfing International based upon a market share theory. BIC appealed the decision and on August 4, 1993, the United States Court of Appeal for the Federal Circuit reversed the District Court's award based on lost profits and remanded the case to the District Court for a determination of damages based upon a reasonable royalty. As of January 2, 1994, BIC has provided for this liability in its consolidated financial statements.\nItem 3 - Legal Proceedings (Continued)\nIn November 1992, a state court jury in Creek County, Oklahoma, in a 9 to 3 verdict, awarded $11,000,000 in actual damages and $11,000,000 in punitive damages against the Corporation in connection with a product liability action. Management is vigorously appealing the verdict on a number of grounds. It is the opinion of management, based on advice of legal counsel, that it is probable that the verdict will be overturned on appeal.\nBIC has been named a Potentially Responsible Party at a superfund site. Refer to Part II, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations for further discussion.\nWhile the ultimate liability with respect to the above matters, including any additional liability not provided for, is not presently determinable, it is the opinion of management, after consultation with counsel to the Corporation, that any liabilities resulting therefrom will not have a material adverse effect on the Corporation's consolidated financial position or on its results of operations if such operations continue at the present level.\nItem 4","section_4":"Item 4 - Submission of Matters to a Vote of Security Holders\nNo matters were submitted during the fourth quarter of fiscal year 1993 to a vote of security holders through solicitation of proxies or otherwise.\nPART II\nItem 5","section_5":"Item 5 - Market for Registrant's Common Shares and Related Shareholder Matters\nOn October 6, 1992, the Corporation began trading its common shares on the New York Stock Exchange. The shares previously traded on the American Stock Exchange.\nSet forth below is the range of sales prices of the Corporation's common shares for each quarter during 1993 and 1992.\n\/1\/ Per share amounts have been retroactively restated to reflect the 1992 share split effected in the form of a 100% share dividend.\nThe Corporation paid quarterly cash dividends which totaled $0.72 in 1993 and $1.06 in 1992. The 1992 cash dividends included a special cash dividend of $0.50 per share. During the first quarter of 1994, the Board of Directors voted an increase in the regular quarterly dividend from $0.18 per share to $0.20 per share, effective with the dividend paid on January 31, 1994, to shareholders of record on January 17, 1994.\nIn 1993, the Corporation amended its Certificate of Incorporation to increase the number of authorized common shares, $1 par value, from 25,000,000 to 50,000,000.\nItem 5 - Market for Registrant's Common Shares and Related Shareholder Matters (Continued)\nAs of January 26, 1994, there were approximately 1,400 shareholders of record of the Corporation's Common Shares.\nItem 6","section_6":"Item 6 - Selected Financial Data\nThe following selected consolidated financial data for the five fiscal years ended January 2, 1994, insofar as it relates to the 1993, 1992 and 1991 fiscal years, should be read in conjunction with the Corporation's consolidated financial statements included herein.\n\/1\/ Cash dividends per share represent the total dividends paid each year. Per share amounts have been retroactively restated to reflect the 1992 share split effected in the form of a 100% share dividend.\nItem 7","section_7":"Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nThe cash required by the Corporation for working capital, capital expenditures and dividend payments was generated from operations and, to a lesser extent, short-term borrowings. The Corporation expects to continue to satisfy most of its cash requirements through internally generated funds. The Corporation's current ratio was 1.87 in 1993 and 1.79 in 1992, reflecting the Corporation's highly liquid position and ability to finance its current operations without significant short-term borrowings.\nAllowance for doubtful accounts decreased by $1.0 million to $4.1 million in 1993 and increased by $2.7 million to $5.1 million in 1992. These fluctuations are related to an increase in bad debt expense in 1992 and an increase in amounts written-off in 1993. Both of these increases are related to Phar Mor Stores Inc. filing for bankruptcy during the third quarter of 1992.\nInventories increased by $1.3 million in 1993 and by $10.9 million in 1992. These increases were associated with higher production levels to support sales increases. Average inventory turnover was 4.0 times in 1993 and 4.3 times in 1992.\nLiquidity and Capital Resources (Continued)\nBank borrowings were $6.7 million at January 2, 1994 and $7.7 million at January 3, 1993 which primarily reflect borrowings by the Corporation's United States operations. Information concerning the Corporation's bank borrowings is contained in Note 6 of Notes to Consolidated Financial Statements.\nAccounts payable and accrued expenses decreased by $2.8 million in 1993 and increased by $5.5 million in 1992. The 1993 decrease is primarily due to the timing of income tax payments by the Corporation's Canadian subsidiary. The 1992 fluctuation primarily reflected a $7.7 million increase in the provision for insurance associated with general liability and workers' compensation, partially offset by a $2.9 million decrease in the payroll liability mainly due to the timing of bonus payments.\nCapital spending decreased in 1993 and increased in 1992. Purchases of property, plant and equipment were $41.2 million in 1993 and $44.9 million in 1992. Spending in 1993 included purchases of machinery and equipment for productivity increases and quality improvements in stationery products and lighters; capacity increases in stationery products and new stationery products; expansions of the Duncan, South Carolina; Fountain Inn, South Carolina; Clearwater, Florida and Cuautitlan, Mexico facilities and building improvements for the Gaffney, South Carolina facility. Spending in 1992 was principally for productivity increases and quality improvements in stationery products, lighters and shavers, which included the purchase of approximately 60 new molding machines; capacity increases in stationery products and the purchase of two facilities in South Carolina. 1994 capital spending for all of the Corporation's locations is expected to be lower than the 1993 level.\nIn July 1993, the U.S. Environmental Protection Agency (\"EPA\") issued its final volumetric ranking of Potentially Responsible Parties (\"PRPs\") for the Solvents Recovery Service of New England (\"SRSNE\") Superfund Site in Southington, Connecticut. The Corporation has been notified that it is a PRP at the Site and has been ranked, by the EPA, number 192 of a total of 1,659 PRPs named. This ranking represents less than 1% of the total volume of waste disposed at the SRSNE Site with the first 191 PRPs representing 90% of the total volume.\nThe Corporation cannot predict with certainty the total costs of cleanup, the Corporation's share of the total costs or the extent to which contributions will be available from other parties, the amount of time necessary to complete the cleanup, or the availability of insurance coverage. Based on currently available information, the Corporation believes that its share of the ultimate cleanup costs at this Site will not have a material adverse impact on the Corporation's financial position or on its results of operations if such operations continue at the present level.\nAt January 2, 1994 and January 3, 1993, the Corporation carried no long-term debt. At January 2, 1994, unused lines of credit were $99.7 million and stand-by letters of credit were $35.5 million, which management believes is more than adequate to meet the Corporation's current or future requirements.\nDuring the first quarter of 1994, the Board of Directors voted an 11.1% increase in the regular quarterly cash dividend from $0.18 per share to a new rate of $0.20 per share, effective with the dividend paid on January 31, 1994 to shareholders of record on January 17, 1994.\nLiquidity and Capital Resources (Continued)\nIn 1993, the Corporation amended its Certificate of Incorporation to increase the number of authorized common shares, $1 par value, from 25,000,000 to 50,000,000.\nDuring the first quarter of 1992, the Corporation paid a special cash dividend of $0.50 per share, which was in addition to the regular quarterly cash dividend of $0.14 per share.\nIn January 1994, the Corporation concluded negotiations with its unionized employees, local utilities and local taxing authorities. Concessions received through these negotiations will result in a modest, but important, reduction in future operating costs at its Milford, Connecticut facility. In addition, the State of Connecticut has offered the Corporation a $9 million grant and loan package to offset capital spending for its Milford, Connecticut facility.\nConsistent with common practice, the Corporation self-insures to a degree against certain types of risk. The Corporation also has in place risk management programs other than insurance to minimize exposure to loss. The programs remained relatively unchanged from the prior year. Management believes its overall risk management and insurance programs are adequate to protect its assets and earnings against significant loss.\nResults of Operations\nIn 1993, the Corporation's net sales increased by $21.9 million to $439.3 million due to increased sales of stationery products of $17.1 million, lighters of $1.3 million and shavers of $4.0 million, partially offset by a decline in sport products of $0.5 million. The increase in stationery products primarily represents an increase in average selling prices of approximately 9% by its North American operations. The increase in lighters primarily reflects an increase in units sold of approximately 3% by its United States operations. The shaver increase is attributable to higher average selling prices of approximately 10% in North America. This shaver increase is partially offset by a slight decline in units sold.\nIn 1992, the Corporation's net sales increased by $48.2 million to $417.4 million due to increased sales of stationery products of $31.5 million, lighters of $4.9 million and shavers of $12.5 million, partially offset by a decline in sport products of $0.7 million. The increase in stationery products, which included the incremental sales of Wite-Out products, reflected increased units sold of approximately 11% and higher average selling prices in the United States. One of the Corporation's Mexican subsidiaries also showed improvements in units sold and higher average selling prices. The increase in lighters was primarily attributable to increased units sold of approximately 4% in North America. The shaver increase was largely the result of the incremental sales of twin-blade shavers.\nNet sales of sport products decreased by $0.5 million in 1993 and by $0.7 million in 1992. These reductions reflect a decrease in the number of units sold of approximately 11% in 1993 and 5% in 1992, and lower average selling prices. Income before income taxes, extraordinary credit and cumulative effect of change in accounting principle was $1.6 million in 1993 and $0.2 million in 1992 for sport products. The increase in 1993 is related to a reduction in the provision related to sailboard litigation which is discussed further in Part I, Item 3 - Legal Proceedings.\nForeign sales remained relatively flat in 1993, while increasing by approximately 13% in 1992. The increase in 1992 primarily reflected increased sales of stationery products by one of the Corporation's Mexican subsidiaries.\nResults of Operations (Continued)\nThe Corporation's purchases from Societe BIC, S.A., the Corporation's majority shareholder, and from other affiliated companies, decreased by $1.8 million to $42.2 million in 1993 and increased by $2.4 million to $44.0 million in 1992. The 1993 decrease primarily represents lower inventory purchases from Societe BIC, S.A. The 1992 increase reflects higher inventory purchases from Societe BIC, S.A., partially offset by favorable foreign exchange rates. The Corporation purchases from Societe BIC, S.A. and other affiliated companies, products that it does not presently manufacture, certain component parts and machinery and equipment. Information concerning the Corporation's transactions and balances with Societe BIC, S.A. and other related parties is contained in Note 15 of Notes to Consolidated Financial Statements.\nGross profit, as a percentage of net sales, increased by 0.4% in 1993 and by 2.7% in 1992. The 1992 increase primarily reflected improvements in the United States and Canadian operations. The improvements in the United States were principally due to favorable foreign exchange rates associated with imports, and higher average selling prices in shavers resulting from the incremental sales of twin-blade shavers. The improvements in the Canadian operations reflected higher average selling prices in shavers and BIC Wavelengths, and favorable foreign exchange rates associated with imports.\nAdvertising, selling, general and administrative, marketing and research and development expenses increased by $7.3 million to $133.7 million in 1993 and by $12.2 million to $126.4 million in 1992. The 1993 increase reflects higher selling expenses and an 18% increase in marketing expenses. These increases are partially offset by an 8% decrease in general and administrative expenses. The increase in selling expense is attributable to higher sales levels. The increase in marketing is related to the costs associated with the promotion of the Corporation's line of twin-blade shavers. The decrease in general and administrative expenses reflects a decrease in the provision for general liability and workers' compensation insurance, relocation costs and bad debt expense. These decreases are partially offset by an increase in the amortization of intangibles associated with the purchase of Wite-Out Products, Inc. The 1992 increase included a 23% increase in general and administrative expenses and a 20% increase in marketing and advertising. The general and administrative expense reflected the increase in the provision for general liability and workers' compensation insurance, relocation costs attributable to the relocation of the marker division, higher bad debt expense and the amortization of the intangible assets acquired in the purchase of Wite-Out Products, Inc. The increase in marketing and advertising included the promotional costs associated with the introduction of the Corporation's line of twin-blade shavers. One of the Corporation's Mexican subsidiaries incurred higher advertising costs, in order to mitigate the effects of increased competition resulting from the removal of price controls and the easing of restrictions on foreign imports.\nOther income - net increased by $2.0 million to $4.2 million in 1993 and by $0.8 million to $2.2 million in 1992. The 1993 fluctuation is due to an increase in net foreign currency gains and to a reduction in the provision related to the sailboard litigation which is discussed further in Part I, Item 3 - Legal Proceedings. These fluctuations are partially offset by lower interest income and higher interest expense. The 1992 fluctuation was primarily due to decreases in several miscellaneous expense items, none of which was individually significant. These decreases were partially offset by lower interest income in the United States.\nResults of Operations (Continued)\nThe effective tax rate has varied each year as follows: 39.5% in 1993, 40.6% in 1992 and 42.1% in 1991. During 1991, the Corporation utilized the tax benefit of a foreign net tax operating loss carryforward of $1.1 million which was shown as an extraordinary credit in the Statement of Consolidated Income.\nIncome before extraordinary credit and cumulative effect of change in accounting principle increased by $4.8 million and by $12.9 million in 1993 and 1992, respectively. These increases were primarily due to improvements in core operations (stationery products, lighters and shavers) in the United States.\nIn 1993, net income included a $9.8 million cumulative effect of a change in accounting principle which was entirely related to the adoption of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Refer to New Accounting Standards below for further discussion.\nNew Accounting Standards\nEffective January 4, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 106 (\"SFAS 106\"), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The Corporation elected to recognize the cumulative effects of this obligation on the immediate recognition basis. The cumulative effects as of January 4, 1993 of adopting SFAS 106 were an increase in accrued postretirement costs of $16.2 million and a decrease in net earnings of $9.8 million, or $0.42 per share. The adoption of SFAS 106 had no effect on the Corporation's cash flow.\nEffective January 4, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes.\" Under SFAS 109, the deferred tax provision is determined under the liability method. Under this method, deferred tax assets and liabilities are recognized based on differences between financial statement and tax bases of assets and liabilities using presently enacted tax rates. There was no material cumulative effect on the Corporation's financial position or on its results of operations by adopting SFAS 109.\nThe Corporation is required to adopt Statement of Financial Accounting Standards No. 112 (\"SFAS 112\"), \"Employers' Accounting for Postemployment Benefits,\" by fiscal 1994. The adoption of SFAS 112 will not have a significant effect on the Corporation's consolidated financial position or on its results of operations if such operations continue at the present level.\nItem 8","section_7A":"","section_8":"Item 8 - Financial Statements and Supplementary Data\nThe consolidated financial statements and supplementary data are set forth beginning on page 13 of this Annual Report.\nItem 9","section_9":"Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThere were no changes in accountants, or disagreements with accountants on 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*\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*Responses to Items 10 through 13 are omitted since the Corporation will, no later than 120 days after January 2, 1994, the close of its most recent fiscal year, file a definitive proxy statement pursuant to Regulation 14(a) of the General Rules and Regulations under the Securities Exchange Act of 1934.\nPART IV\nItem 14","section_14":"Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. Financial Statements: See the attached Index to Consolidated Financial Statements and Financial Statement Schedules. 2. Financial Statement Schedules: See the attached Index to Consolidated Financial Statements and Financial Statement Schedules. 3. Exhibits: 3. a. Restated Certificate of Incorporation, as filed May 5, 1993. b. By-Laws, as amended.\/1\/ 4. Instruments relating to long-term debt are not filed, but the Registrant agrees to file a copy of such instruments, upon the request of the Securities and Exchange Commission. 9. a. Voting Trust Agreement, dated February 5, 1991, by and among Societe BIC, S.A., Marcel L. Bich, Neil A. Polio, Bruno Bich, Francois Bich and BIC Corporation, as amended February 3, 1992, for the purpose of naming Alexander Alexiades as successor voting trustee.\/2\/ b. Amendment to Voting Trust Agreement, dated July 5, 1993. 10. a. Selected Executive Retirement Plan, as amended. b. Agreement, dated July 1, 1971, including amendments, between Societe BIC, S.A. and BIC Pen Corporation.\/2\/ 21. Subsidiaries of the Registrant. 23. Consent of Independent Auditors. - ------------------------- \/1\/ Incorporated by reference to the Corporation's Annual Report on Form 10-K for its fiscal year ended January 3, 1993.\n\/2\/ Incorporated by reference to the Corporation's Annual Report on Form 10-K for its fiscal year ended December 30, 1990.\nShareholders may obtain a copy of any exhibit not contained herein by writing to the Secretary, BIC Corporation, 500 BIC Drive, Milford, CT 06460. A charge of $.50 per page to cover the cost of copying and handling will be imposed.\n(b) No reports on Form 8-K were filed by the Corporation during the last quarter of its fiscal year ended January 2, 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.\nBIC CORPORATION By: BRUNO BICH Bruno Bich, Chairman and Chief Executive Officer\nDate: March 9, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSIGNATURE AND TITLE DATE - -------------------------------------------------------------------------------\nBRUNO BICH March 9, 1994 - ------------------------------------------------------------ (Bruno Bich) Chairman and Chief Executive Officer and Director (Chief Executive Officer)\nRAYMOND WINTER March 9, 1994 - ------------------------------------------------------------ (Raymond Winter) President and Chief Operating Officer and Director (Chief Operating Officer)\nROBERT L. MACDONALD March 9, 1994 - ------------------------------------------------------------ (Robert L. Macdonald) Vice President-Finance and Treasurer (Principal Financial and Accounting Officer)\nALEXANDER ALEXIADES March 9, 1994 - ------------------------------------------------------------ (Alexander Alexiades) Director\nROBERT E. ALLEN March 9, 1994 - ------------------------------------------------------------ (Robert E. Allen) Director\nDAVID W. HELENIAK March 9, 1994 - ------------------------------------------------------------ (David W. Heleniak) Director\nANTOINE G. TREUILLE March 9, 1994 - ------------------------------------------------------------ (Antoine G. Treuille) Director - -------------------------------------------------------------------------------\nBIC CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nAll other financial statement schedules have been omitted because the conditions requiring the filing thereof do not exist or because the required information is shown in the consolidated financial statements or notes thereto.\n(Logo of Deloitte & Touche)\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareholders of BIC Corporation:\nWe have audited the accompanying consolidated financial statements and related financial statement schedules of BIC Corporation and its subsidiaries (the \"Corporation\") listed in the preceding Index to Consolidated Financial Statements and Financial Statement Schedules of the Annual Report on Form 10-K of the Corporation for the year ended January 2, 1994. These consolidated financial statements and financial statement schedules are the responsibility of the Corporation's management. Our responsibility is to express an opinion on the 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, such consolidated financial statements present fairly, in all material respects, the financial position of BIC Corporation and its subsidiaries at January 2, 1994 and January 3, 1993 and the consolidated results of their operations and their cash flows for each of the three fiscal years in the period ended January 2, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs described in Note 1 to the consolidated financial statements, in 1993, the Corporation changed its methods of accounting for income taxes and postretirement benefits other than pensions.\nDELOITTE & TOUCHE\nNew Haven, Connecticut\nJanuary 28, 1994\nBIC CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS JANUARY 2, 1994 and JANUARY 3, 1993\nSee Notes to Consolidated Financial Statements.\nBIC CORPORATION AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED INCOME FOR THE 1993, 1992 AND 1991 FISCAL YEARS\nSTATEMENTS OF CONSOLIDATED RETAINED EARNINGS FOR THE 1993, 1992 AND 1991 FISCAL YEARS\nSee Notes to Consolidated Financial Statements.\nBIC CORPORATION AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED CASH FLOWS FOR THE 1993, 1992 AND 1991 FISCAL YEARS\nSee Notes to Consolidated Financial Statements.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nA summary of significant accounting policies for BIC Corporation and its subsidiaries (the \"Corporation\"), manufacturers and distributors of high- quality, low-cost consumer products, is as follows:\nConsolidation\nThe consolidated financial statements include the accounts of BIC Corporation and its subsidiaries. An investment in an affiliated company is accounted for on the equity method. All significant intercompany balances and transactions have been eliminated.\nInventories\nInventories are valued at the lower of cost (determined on the first-in, first-out basis) or market.\nProperty, Plant and Equipment\nProperty, plant and equipment is recorded at cost. Depreciation, principally on the declining balance method, is provided over the estimated useful lives of the assets as follows:\nBuildings and improvements 10-50 years Machinery and equipment 3-12 years\nExpenditures for maintenance and repairs are charged to operations as incurred. Expenditures for betterments and major renewals are capitalized. Costs of assets sold or retired and the related amounts of accumulated depreciation are eliminated from the accounts in the year of disposal and any resulting gains or losses are included in income.\nIntangibles\nCosts pertaining to goodwill and patents are amortized on the straight-line method over five to seventeen years. Trademarks are amortized over five to forty years.\nAccrued Expenses - Insurance\nAccrued expenses - insurance represents the estimated costs of known and anticipated claims under the Corporation's product liability (principally relating to its lighters) and workers' compensation insurance policies. For each claim, the Corporation maintains self-insurance up to the estimated amount of the probable claim or the amount of the deductible, whichever is lower. At each financial reporting date, probable claim amounts, individually or in aggregate, were not expected to materially exceed the deductible. Claims are generally settled within five years of origination.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nEmployee Benefit Plans\nSubstantially all employees in the United States and Canada are covered by defined benefit pension plans. The plans are noncontributory and provide for pension benefits based on average pay and years of service to the Corporation. Funding for the pension plans is based on a review of the specific requirements and an evaluation of the assets and liabilities of each plan.\nThe Corporation has a share purchase plan for substantially all full-time United States unionized employees who elect to participate. Effective July 1992, a 401(k) Savings and Investment Plan was established, which constitutes a replacement of the BIC Corporation Employees Share Purchase Plan for non- unionized employees. The plans provide that the Corporation match a portion of participant contributions.\nThe Corporation provides certain postretirement medical and life insurance benefits for qualifying retired and active unionized and non-unionized employees in the United States. Most retirees outside the United States are covered by government sponsored and administered programs.\nIn 1993, the Corporation adopted Statement of Financial Accounting Standards No. 106 (\"SFAS 106\"), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The Corporation elected to recognize the cumulative effects of this obligation on the immediate recognition basis. The cumulative effects as of January 4, 1993 of adopting SFAS 106 were an increase in accrued postretirement costs of $16.2 million and a decrease in net earnings of $9.8 million, or $0.42 per share. Aside from the one-time effect of the cumulative adjustments, adoption of SFAS 106 was not material to the Corporation's 1993, 1992 and 1991 consolidated results of operations.\nThe Corporation is required to adopt Statement of Financial Accounting Standards No. 112 (\"SFAS 112\"), \"Employers' Accounting for Postemployment Benefits,\" by fiscal year 1994. The adoption of SFAS 112 will not have a significant effect on the Corporation's consolidated financial position or its results of operations if such operations continue at the present level.\nForeign Currency\nAssets and liabilities of certain foreign subsidiaries, whose local currency is the functional currency, are translated at exchange rates in effect at the balance sheet date. During 1992, the Corporation's Mexican subsidiaries' economy ceased to be considered highly inflationary and the Mexican peso became the subsidiaries' functional currency. Translation gains and losses are not included in the Statements of Consolidated Income, but are accumulated in a separate component of shareholders' equity. Gains and losses from foreign currency transactions are included in the Statements of Consolidated Income.\nThe Corporation enters into forward exchange contracts denominated in foreign currencies providing protection from currency fluctuations affecting certain inventory and equipment purchase commitments denominated in foreign currencies. Gains and losses associated with these transactions are deferred and included in the determination of the cost of the assets acquired.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nIncome Taxes\nEffective January 4, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes.\" Under SFAS 109, the deferred tax provision is determined under the liability method. Under this method, deferred tax assets and liabilities are recognized based on differences between financial statement and tax bases of assets and liabilities using presently enacted tax rates. There was no material effect on the Corporation's financial position or results of operations by adopting SFAS 109.\nThe Corporation does not provide for Federal or state income taxes on the accumulated earnings and profits of its foreign subsidiaries to the extent that the current intention of the Corporation is to allow its foreign subsidiaries to reinvest these earnings or to the extent that any Federal or state taxes attributable to the repatriation of such earnings would be substantially offset by foreign tax credits.\nEarnings Per Common Share\nEarnings per common share are based on the weighted average number of shares outstanding in each year. The weighted average number of shares outstanding was 23,559,244 during 1993 and 1992, and 24,082,368 during 1991 after giving retroactive effect to the 1992 share split effected in the form of a 100% share dividend.\nFiscal Year\nThe Corporation's fiscal year is the 52 or 53 weeks ending on the Sunday closest to December 31.\nReclassifications\nThe consolidated financial statements for years prior to 1993 have been reclassified to conform with the 1993 financial statement presentation.\n2. CASH AND CASH EQUIVALENTS:\nCash and cash equivalents consist of the following:\nThe Corporation's cash management policy is to invest in highly liquid, short- term financial instruments. The interest-bearing certificates of deposit have maturity dates of less than three months when purchased and, accordingly, have been classified as cash and cash equivalents.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n3. INVENTORIES:\nInventories consist of the following:\n4. PROPERTY, PLANT AND EQUIPMENT - NET:\nProperty, plant and equipment - net consists of the following:\n5. OTHER ASSETS:\nOther assets consist of the following:\nIn 1992, the Corporation acquired Wite-Out Products, Inc. for $19,848,000, which was accounted for by the purchase method of accounting. Accordingly, the excess of cost over the fair value of net tangible assets acquired, approximately $16,900,000, was allocated to intangibles.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n6. BANK BORROWINGS:\nInformation with respect to the Corporation's bank borrowings is as follows:\n7. OTHER CURRENT LIABILITIES:\nOther current liabilities consist of the following:\n8. EMPLOYEE BENEFIT PLANS:\nThe Corporation's net periodic pension cost for 1993, 1992 and 1991 is summarized as follows:\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n8. EMPLOYEE BENEFIT PLANS (Continued):\nThe following table sets forth the funded status at January 2, 1994 and January 3, 1993 of the Corporation's defined benefit pension plans:\nPrior service costs primarily relate to plan amendments which retroactively increase benefits to plan participants. These costs are recognized in net periodic pension cost over appropriate periods.\nThe following assumptions were used in developing the above benefit obligation amounts:\nContributions under the employees share purchase plans and the 401(k) Savings and Investment Plan were approximately $728,000, $406,000 and $123,000 in 1993,1992 and 1991, respectively.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n9. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS:\nThe Corporation provides certain postretirement medical and life insurance benefits for qualifying retired and active unionized and non-unionized employees in the United States. Most retirees outside the United States are covered by government sponsored and administered programs. Postretirement benefits are non pre-funded and are paid by the Corporation as incurred.\nThe Corporation's net periodic postretirement benefit cost included the following components:\nThe following table sets forth the status of postretirement benefits:\nFor measurement purposes, a 14.0% annual rate of increase in the per capita cost was assumed for 1993. The rate was assumed to decrease gradually to 5.5% through the year 2009 and remain at that level thereafter. The discount rate used in determining the accumulated postretirement benefit obligation was 8.5% at January 4, 1993, and 7.0% at January 2, 1994. The unamortized net loss represents a change in actuarial assumptions (discount rate) that will be amortized over future periods.\nA 1% increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation as of January 2, 1994 by $2.6 million and the net periodic postretirement benefit cost by $368,000.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n10. SHAREHOLDERS' EQUITY:\nOn November 18, 1992, the Corporation's Board of Directors canceled the Corporation's 745,506 shares of common stock held as treasury shares. These shares were restored to the status of authorized but unissued shares in accordance with Section 515(e) of the New York Business Corporation Law. The excess of cost over par value ($13,687,381) was allocated to additional paid-in capital.\nOn November 18, 1992, the Corporation's Board of Directors declared a two- for-one share split effected in the form of a 100% share dividend of 11,779,622 authorized common shares, $1 par value, distributed on December 15, 1992, to shareholders of record on December 1, 1992. In connection therewith, approximately $1,302,000 and $10,478,000 was transferred from additional paid- in capital and retained earnings, respectively, to common shares. 1992 and 1991 per share data has been restated to reflect the share split.\nThe following represents a summary of the above transactions, other than the reduction in retained earnings shown in the Statements of Consolidated Retained Earnings:\nThe Corporation declared and paid cash dividends of $0.72 per share in 1993 and $1.06 per share in 1992. The 1992 amount included a special dividend of $0.50 per share. The Corporation increased its regular quarterly dividend from $0.18 per share to $0.20 per share effective with the dividend payable on January 31, 1994 to shareholders of record on January 17, 1994.\nIn 1993, the Corporation amended its Certificate of Incorporation to increase the number of authorized common shares, $1 par value, from 25,000,000 to 50,000,000 shares.\nForeign currency translation adjustments included in shareholders' equity were $(680,000), $(1,111,000) and $(33,000) for the fiscal years 1993, 1992 and 1991, respectively.\n11. OTHER INCOME - NET:\nOther income - net consists of the following:\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n12. SUPPLEMENTARY INCOME STATEMENT INFORMATION:\nThe following items were charged to expenses in the Statements of Consolidated Income:\n13. INCOME TAXES:\nThe provision (credit) for income taxes consists of the following:\nThe total income tax provision shown in the Statements of Consolidated Income differed from the total income tax expense as computed by applying the statutory United States Federal (\"Federal\") income tax rate to income before income taxes, extraordinary credit and cumulative effect of change in accounting principle as follows:\nFederal income taxes have not been provided for on cumulative unremitted earnings of foreign subsidiaries of approximately $16,076,000 at January 2, 1994, $14,051,000 at January 3, 1993 and $11,955,000 at December 29, 1991.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n13. INCOME TAXES (Continued):\nThe provision for deferred Federal income taxes consists of the following:\nDuring 1991, the Corporation utilized the tax benefit of a foreign net tax operating loss carryforward of $1,050,000 which was shown as an extraordinary credit in the Statement of Consolidated Income.\nThe provision for deferred foreign income taxes consists primarily of temporary differences related to inventory.\nDeferred income taxes at January 2, 1994 and January 3, 1993 consist of the following:\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n13. INCOME TAXES (Continued):\nAt January 2, 1994, current deferred tax assets of $16.8 million and current deferred tax liabilities of $2.1 million were included in Deferred Income Taxes and Accrued Expenses - Other, respectively. In addition, non- current deferred tax assets of $1.4 million were included in Other Assets.\n14. CONTINGENCIES AND COMMITMENTS:\nThe Corporation has significant contingent liabilities with respect to pending litigation, claims and disputes, principally relating to its lighters, which arise in the ordinary course of its business.\nIn July 1993, the U.S. Environmental Protection Agency (\"EPA\") issued its final volumetric ranking of Potentially Responsible Parties (\"PRPs\") for the Solvents Recovery Service of New England (\"SRSNE\") Superfund Site in Southington, Connecticut. The Corporation has been notified that it is a PRP at the Site and has been ranked, by the EPA, number 192 of a total of 1,659 PRPs named. This ranking represents less than 1% of the total volume of waste disposed at the SRSNE Site with the first 191 PRPs representing 90% of the total volume.\nThe Corporation cannot predict with certainty the total costs of cleanup, the Corporation's share of the total costs or the extent to which contributions will be available from other parties, the amount of time necessary to complete the cleanup, or the availability of insurance coverage. Based on currently available information, the Corporation believes that its share of the ultimate cleanup costs at this Site will not have a material adverse impact on the Corporation's financial position or on its results of operations if such operations continue at the present level.\nIn November 1992, a state court jury in Creek County, Oklahoma, in a 9 to 3 verdict, awarded $11,000,000 in actual damages and $11,000,000 in punitive damages against the Corporation in connection with a product liability action. Management is vigorously appealing the verdict on a number of grounds. It is the opinion of management, based on advice of legal counsel, that it is probable that the verdict will be overturned on appeal.\nWhile the ultimate liability with respect to the above matters, including any additional liability not provided for, is not presently determinable, it is the opinion of management, after consultation with counsel to the Corporation, that any liabilities resulting therefrom will not have a material adverse effect on the Corporation's consolidated financial position or on its results of operations if such operations continue at the present level.\nAt January 2, 1994, the Corporation had outstanding approximately $23,165,000 of forward exchange contracts, under which the Corporation is required to purchase French francs at an average contract rate of approximately 6.04 French francs to the dollar during 1994. See Note 1 - Foreign Currency.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED STATEMENTS (Continued)\n15. RELATED PARTY TRANSACTIONS AND BALANCES:\nMaterial transactions and balances with the Corporation's majority shareholder, Societe BIC, S.A. and with other related parties are as follows:\n16. FINANCIAL INSTRUMENTS:\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, \"Disclosure about Fair Value of Financial Instruments.\" The estimated fair value amounts have been determined by the Corporation, 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 Corporation could realize in a current market exchange.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued):\n16. FINANCIAL INSTRUMENTS (Continued):\nCash and Cash Equivalents\nThe Corporation compared the certificates of deposit interest rates at the contract dates to the prevailing interest rates at January 2, 1994 and January 3, 1993 and determined that there were no significant differences. Therefore, the carrying amounts of these items are a reasonable estimate of their fair value.\nBank Borrowings\nDue to the relatively short period of time between the origination of the bank borrowings and their repayments, the carrying amounts approximate their estimated fair value.\nForward Foreign Currency Contracts\nThe fair value of foreign currency contracts is the amount as of January 2, 1994 and January 3, 1993 at which contracts with the same date of maturity as existing contracts could be purchased, based on estimates obtained from dealers.\nUnused Lines of Credit and Stand-By Letters of Credit\nThere is no annual cost of maintaining the unused lines of credit. The annual cost of maintaining stand-by letters of credit is estimated based on fees of 1\/4% to 3\/4% of the amount of the letter of credit, which would be currently charged for similar arrangements.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\n17. FOREIGN OPERATIONS:\nA summary of information about the Corporation's operations in different geographic areas is as follows (see Note 15 for sales to affiliated companies):\n\/1\/ Transfers between geographic areas are generally accounted for at a range of cost to cost plus 10%.\nBIC CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued):\n18. SELECTED QUARTERLY FINANCIAL DATA (Unaudited):\n\/1\/ The quarter ended April 4, 1993 includes a decrease in net earnings for the cumulative effect of a change in accounting for postretirement benefits other than pensions of $9,816 or $0.42 per share.\n\/2\/ 1992 quarterly per share amounts have been retroactively restated to reflect the share split effected in the form of a 100% share dividend.\nSCHEDULE II\nBIC CORPORATION AND SUBSIDIARIES\nSCHEDULE OF AMOUNTS RECEIVABLE FROM EMPLOYEES FOR THE FISCAL YEARS ENDED JANUARY 2, 1994, JANUARY 3, 1993 AND DECEMBER 29, 1991\nSCHEDULE V\nBIC CORPORATION AND SUBSIDIARIES\nCONSOLIDATED PROPERTY, PLANT AND EQUIPMENT FOR THE FISCAL YEARS ENDED JANUARY 2, 1994, JANUARY 3, 1993 AND DECEMBER 29, 1991\n\/1\/ Transferred to appropriate classification upon completion of construction.\nSCHEDULE VI\nBIC CORPORATION AND SUBSIDIARIES\nCONSOLIDATED ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE FISCAL YEARS ENDED JANUARY 2, 1994, JANUARY 3, 1993 AND DECEMBER 29, 1991\nSCHEDULE VIII\nBIC CORPORATION AND SUBSIDIARIES\nCONSOLIDATED VALUATION ACCOUNTS FOR THE FISCAL YEARS ENDED JANUARY 2, 1994, JANUARY 3, 1993 AND DECEMBER 29, 1991\n\/1\/ Principally accounts written-off, less recoveries.\nFORM 10K\nFor the fiscal year ended Commission File No. 1-6832 January 2, 1994\nBIC CORPORATION\nEXHIBIT INDEX -------------\nExhibit No. - -----------\n3. a. Restated Certificate of Incorporation, as filed May 5, 1993.\nb. By-Laws, as amended.\/1\/\n4. Instruments relating to long-term debt are not filed, but the Registrant agrees to file a copy of such instruments, upon request of the Securities and Exchange Commission.\n9. a. Voting Trust Agreement, dated February 5, 1991, by and among Societe BIC, S.A., Marcel L. Bich, Neil A. Pollio, Bruno Bich, Francois Bich and BIC Corporation, as amended February 3, 1992, for the purpose of naming Alexander Alexiades as successor voting trustee.\/2\/\nb. Amendment to Voting Trust Agreement, dated July 5, 1993.\n10. a. Selected Executive Retirement Plan, as amended.\nb. Agreement, dated July 1, 1971, including amendments, between Societe BIC, S.A. and BIC Pen Corporation.\/2\/\n21. Subsidiaries of the Registrant.\n23. Consent of Independent Auditors.\n- --------------------------\n\/1\/ Incorporated by reference to the Corporation's Annual Report on Form 10-K for its fiscal year ended January 3, 1993.\n\/2\/ Incorporated by reference to the Corporation's Annual Report on Form 10-K for its fiscal year ended December 30, 1990.","section_15":""}
{"filename":"48174_1994.txt","cik":"48174","year":"1994","section_1":"ITEM 1. Business\nHOME BENEFICIAL CORPORATION\nHome Beneficial Corporation (\"the Corporation\") was incorporated in Virginia on March 5, 1970, for the purpose of becoming a holding company for Home Beneficial Life Insurance Company (\"the Life Company\"), which originated in 1899. On December 31, 1970, pursuant to a Plan of Reorganization proposed by the Board of Directors and approved by the stockholders of the Life Company, the Corporation acquired all of the issued and outstanding capital stock of the Life Company by merger of the Life Company into a wholly-owned subsidiary of the Corporation, the name of which was immediately changed to Home Beneficial Life Insurance Company. At the present time, the Life Company, which is engaged in the life and accident and health insurance business, is the major subsidiary of the Corporation.\nThere was no material change in the nature of business done by the Corporation during 1994.\nBUSINESS OF THE LIFE COMPANY\nThe Life Company sells group life insurance and substantially all of the forms of ordinary insurance, including universal life, whole life, term, and annuities, together with accidental death and disability riders. The Life Company's business is concentrated in six Mid-Atlantic states and the District of Columbia, and its products are marketed through its own sales force of approximately 1,150 full-time personnel assigned to some 47 district offices located in principal cities and towns. In addition to the agency force, there were some 236 supervisory, administrative, clerical and other personnel employed in the home office.\nThe following table sets forth the geographic distribution of direct business premiums received during 1994:\nPremiums Jurisdiction (In 000's)\nDelaware $ 2,582 District of Columbia 2,971 Maryland 15,774 North Carolina 9,947 Tennessee 22,186 Virginia 40,246 West Virginia 1,190\nThe maximum amount of ordinary individual insurance presently retained by the Life Company without reinsurance is $200,000 plus an additional $75,000 coverage for accidental death. This maximum is scaled down according to the age and physical classification of the insured. The total amount of life insurance in force at December 31, 1994 reinsured by the Life Company with other companies aggregated $97 million representing less than 1% of the Life Company's life insurance in force on that date. The Life Company participates in several group life insurance programs as a reinsurer and also assumes reinsurance on a facultative (individual risk) basis from two other life insurance companies. Life insurance assumed relates principally to group life and represented approximately 17% of premium income and 55% of life insurance in force for 1994. Claims incurred under these group life insurance programs approximate the related premium income, and no significant assets or liabilities are required in the balance sheet. A contingent liability exists on insurance ceded to the reinsurer since the Life Company would be liable in the event that the reinsurer is unable to meet obligations assumed by it under the reinsurance agreement.\nAccident and health insurance premiums accounted for less than 8% of premium income for 1994. A significant proportion of the accident and health premium is attributable to medical benefit coverage provided for the Life Company's employees and their dependents under its Protection and Retirement Plan. The Life Company offers no health insurance coverage other than to its own employees. The Life Company writes individual accident policies with death and dismemberment benefits. These policies accounted for approximately 30% of total accident and health premiums for 1994.\nThe Life Company, as a legal reserve company, is required by the various laws of the states in which it is licensed to transact business to carry as liabilities aggregate policy reserves which are considered adequate to meet its obligations on insurance policies in force. Such required reserves are considered statutory reserves because the methods and assumptions used in their calculation are explicitly prescribed by the laws of the various states. The liabilities shown herein for all policies issued since 1948 are based on guidelines prescribed by the American Institute of Certified Public Accountants and have been calculated in accordance with generally accepted accounting principles. Such liabilities are calculated by the use of assumptions as to mortality rates, interest rates, withdrawal rates and expense rates in effect at the time the gross premiums were calculated. Liabilities on paid-up policies include a liability for future maintenance expenses which the Life Company expects to incur. See Revenues, Benefits, Claims and Expenses, Note 1 of the Notes to Consolidated Financial Statements, which is incorporated herein by reference from pages 11 and 12 of the 1994 Annual Report to Stockholders, for additional information relating to the Life Company's reserves.\nThe investment of the Life Company's funds and assets is determined by an Investment Committee. Generally, investments made must meet requirements established by the applicable investment statutes of the Commonwealth of Virginia governing the nature and quality of investments which may be made by life insurance companies.\nThe following table shows investments of the Life Company at December 31, 1994. Fixed maturities (bonds, notes and redeemable preferred stocks) and equity securities (nonredeemable preferred and common stocks) are stated at their estimated fair value; mortgage loans on real estate are stated at cost adjusted where appropriate for amortization of premium or discount; short-term investments are at cost; and policy loans are stated at unpaid balances.\nAsset Value Amount Percent (000's) of Total Fixed Maturities: Bonds and notes: United States government and govern- ment agencies and authorities $ 29,679 2.6% States, municipalities and political subdivisions 284,437 24.8 Foreign government 25,317 2.2 Public utilities 242,799 21.2 All other corporate 109,745 9.6 Total fixed maturities 691,977 60.4\nEquity Securities $ 24,230 2.1 Mortgage loans 338,458 29.6 Policy loans 53,426 4.7 Short-term investments 31,880 2.8 Other 5,168 .4 $1,145,139 100.0%\nThere were no principal and interest payments past due on fixed maturities at December 31, 1994.\nThe Life Company's mortgage portfolio consists of approximately 2400 conventional first mortgages on a wide range of residential and commercial properties located primarily in those Mid-Atlantic states in which the Life Company conducts its insurance business. At December 31, 1994 the aggregate carrying value of mortgage loans was $338,458,261, broken down by category as follows:\nResidential $168,476,605 Commercial 169,981,656\nCommercial loans include loans on apartments, shopping centers, office buildings and warehouses. Generally, commercial loans range from $250,000 to $3,500,000 in principal amount. The Life Company also makes some mortgage loans to churches. Every property is inspected by a staff underwriter prior to the issuance of a loan commitment. On commercial loans of more than $250,000, the property is inspected every two years after the loan is closed as long as the balance exceeds $250,000.\nThe Life Company's mortgage lending business is heavily concentrated in the states of Virginia and North Carolina. At December 31, 1994, approximately 76% of the Life Company's mortgages, constituting approxi- mately 74% of the total book value of the Life Company's mortgage port- folio, were on residential or commercial properties located in the State of Virginia. Additionally, at the same date approximately 14% of the Life Company's mortgages, constituting approximately 12% of the total book value of the Life Company's mortgage portfolio, were on properties in North Carolina. The relatively high percentage of mortgage loans made in these two states reflects the geographical concentration of the Life Company's insurance business activities in the same two states. Although the Life Company's mortgage loan portfolio is heavily concentrated in Virginia and North Carolina, the economies of those states are diversified, and the Life Company does not believe its mortgage loan portfolio reflects undue risk from the large percentage of its loans originated in those two states.\nAlthough the economic downturn during 1990 and 1991 was characterized by troubled real estate loans in the portfolios of many financial institutions operating in the Life Company's market, the Life Company's mortgage loan portfolio has not reflected the widely-publicized experience of other financial institutions. The Life Company presently holds two real estate parcels acquired through foreclosure with a carrying value in the financial statements of $650,000. Mortgage loans whose terms have been restructured over the past five years are immaterial, and no mortgage loans were in foreclosure proceedings at December 31, 1994. Except as indicated below, there were no mortgage loans otherwise not performing in accordance with the contractual terms.\nAt December 31, 1994, the aging schedule for delinquent mortgage loans in terms of past due days was as follows:\nPast due days 30-60 60-90 Over 90 Total\nPrincipal $5,547,6691 $1,863,551 $ -0- $7,411,220 Percent of total mortgage loans 1.6% .6% - 2.2%\n130-60 days past due includes a substantial amount of loan payments that have been received by the Life Company's brokers after their December, 1994 cut-off reporting date to the Life Company. These amounts will be included in their next remittance report.\nThe Life Company believes the quality of its loan portfolio is attributable to its relatively stringent underwriting standards which have been in force for many years. At the present time, and for a number of years, the Life Company's lending policies have restricted mortgage loans to a maximum loan to value ratio of 75%, based on the lower of cost or appraisal, except for purchase money mortgages and insured or guaranteed mortgages. The Life Company's policy is to place mortgage loans on non-accrual status where any mortgage payment is 90 days or more past due.\nDuring the period 1986-1994, the Life Company experienced only five foreclosures on real estate loans, one in each of the years 1986, 1989 and 1990, two in 1992 and none in 1993 and 1994. The total of the unpaid principal balances of loans in these five foreclosures was $986,477. The Life Company disposed of three properties acquired in foreclosure proceedings prior to 1994 without loss. The Corporation does not provide a provision for loan losses in its financial statements. Based upon the de minimis loss experience of the mortgage loan portfolio over many years and the continuing satisfactory performance of its portfolio, the Corporation's management does not feel that a provision is required.\nSee Investment Operations, Note 2 of Notes to Consolidated Financial Statements, which is incorporated herein by reference from pages 12, 13, and 14 of the 1994 Annual Report to Stockholders, and Schedule I included in Part IV elsewhere herein, for additional information concerning the Corporation's consolidated investment portfolio.\nThe Life Company, in common with other insurance companies, is subject to regulation and supervision in each of the states in which it does business. Such regulation is primarily for the benefit of the policy- holders of the Life Company rather than the stockholders. Although the extent of such regulation varies from state to state, in general, the insurance laws of the respective states delegate broad administrative powers to supervisory agencies. These powers relate to the granting and revocation of licenses to transact business, the licensing of agents, the approval of the forms of policies used, reserve requirements, and the type and concentration of investments permitted. In addition, the supervisory agencies have power over the form and content of required financial statements and reports, including requirements regarding accounting practices to be employed in the presentation of such statements and reports. Certain of the required accounting practices vary from generally accepted accounting principles. See Notes 1 and 7 of the Notes to Consolidated Financial Statements, which Notes are incorporated herein by reference from pages 11, 12 and 17 of the 1994 Annual Report to Stockholders.\nSeveral jurisdictions in which the Life Company does business including its domiciliary state of Virginia, have enacted legislation providing for specific regulation of the relationship between licensed insurers and their holding companies and among affiliated members of a holding company group. These statutes vary in substance from state to state, but generally speaking, vest administrative control in the insurance regulatory authority. Among the provisions found in these statutes are provisions for the filing of registration statements by insurers which are members of a holding company group, provisions that the holding company will be subject to reporting requirements and to visitation by the insurance regulatory authorities, standards as to transactions between insurers and their holding companies or between members of a holding company group, and control over the payment of extraordinary dividends. See Stockholders' Equity and Restrictions, Note 7 of the Notes to Consolidated Financial Statements, which is incorporated herein by reference from page 17 of the 1994 Annual Report to Stockholders for additional information concerning transactions between the Life Company and its affiliates.\nThe life insurance business is intensely competitive and the Life Company competes with many other companies, both stock and mutual, in the states in which it is licensed. The American Council of Life Insurance in its \"1994 Fact Book\", estimates that of the 1,886 life insurance companies doing business in the United States at mid-year 1993, 1,777 were stock companies.\nAccording to figures reported in the September 1994 issue of Best's Review, Life\/Health Edition, calculated on a statutory accounting basis, the Life Company ranks in the top 11% of all life insurance companies in the United States based on total admitted assets as of December 31, 1993.\nNo material portion of the business of the Life Company is dependent upon a single customer or a very few customers. The group life insurance sold by the Life Company consists largely of reinsurance participations described on page 4.\nThe Corporation's only industry segment is the business of the Life Company, and its operations have contributed over 98% of the total consolidated revenues and income before income taxes for each of the past three years.\nNeither the Corporation nor any of its subsidiaries engage in material operations outside of the United States, or derives material business from customers outside the United States.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe principal office of the Corporation is located at 3901 West Broad Street, Richmond, Virginia 23230, which also serves as the home office premises of the Life Company. The home office building, which contains approximately 110,000 square feet of office space, was originally completed in 1950 with a 30,000 square foot addition completed in 1990. The building is used solely for company purposes.\nThe Life Company presently leases space for 54 district and detached offices in Delaware, Maryland, the District of Columbia, West Virginia, Virginia, Tennessee and North Carolina. The termination dates on these leases range from 1995 to 2003; all of the longer term leases being for district office purposes. The maximum annual rent paid under any lease is $28,775. The annualized rent under all leases in effect on December 31, 1994 was approximately $760,000.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nAs of the date of this report, neither the Corporation nor any of its subsidiaries was a party to any material pending 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 the Corporation's security holders during the fourth quarter of its fiscal year ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nIncorporated herein by reference from the 1994 Annual Report to Stockholders, page 21.\nITEM 6.","section_6":"ITEM 6. Selected Consolidated Financial Data\nIncorporated herein by reference from the 1994 Annual Report to Stockholders, page 22.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nIncorporated herein by reference from the 1994 Annual Report to Stockholders, pages 19 and 20.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nConsolidated financial statements of the Corporation at December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994 and the auditor's report thereon and the Corporation's unaudited quarterly financial data for the two year period ended December 31, 1994 are incorporated herein by reference from the 1994 Annual Report to Stockholders, pages 6 through 18 and 21.\nITEM 9.","section_9":"ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. Directors and Executive Officers of the Registrant\n(a) and (b) The following table gives the name and age of each of the directors (all of whom, except C. M. Glenn, Jr., L. W. Richardson, and Dianne N. Collins are executive officers of the Corporation and the Life Company) and their positions and offices with the Corporation and the Life Company and the dates first elected to those positions with the Corporation.\nPosition and Offices with the Corporation and the Life Company and Date Elected to Name Age Corporation Officer Position\nDianne N. Collins 49 Director of the Life Company and the Corporation and Community Volunteer\nH. D. Garnett 52 Vice President (since 1979), Controller (since 1974) and a director of the Corporation and the Life Company\nC. M. Glenn, Jr. 78 Retired Vice President-Treasurer and a director of the Corporation and the Life Company\nW. G. Hancock 44 Counsel (since 1984) and a director of the Corporation and the Life Company\nG. T. Richardson 42 Vice President (since 1983) and a director of the Corporation and the Life Company\nL. W. Richardson 75 Retired Vice President and a director of the Corporation and the Life Company\nJ. M. Wiltshire, Jr. 69 Vice President (since 1972), Counsel (since 1982), Secretary (since 1994) and a director of the Corporation and the Life Company\nR. W. Wiltshire 73 Chairman of the Board (since 1983) and a director of the Corporation and the Life Company\nR. W. Wiltshire, Jr. 49 President (since 1988), Chief Executive Officer (since 1992) and a director of the Corporation and the Life Company\nW. B. Wiltshire 46 Vice President (since 1983) and a director of the Corporation and the Life Company\nMrs. Collins was first elected to the Board of Directors of the Corporation on February 15, 1994, Messrs. Garnett, Hancock, G. T. Richardson, and W. B. Wiltshire were first elected to the Board in 1983, and Messrs. R. W. Wiltshire, Jr. and J. M. Wiltshire, Jr. were first elected to the Board in 1976 and 1971, respectively, all to fill then existing vacancies on the Board. The remaining persons named in the foregoing table have served as directors of the Corporation since its organization in 1970.\nAll of the above persons serve one year terms as both executive officers and directors, or in the case of Messrs. Glenn and Richardson and Mrs. Collins, as directors only, which expire April 4, 1995. There are no executive officers of the Corporation who are not directors.\n(c) Not applicable.\n(d) C. M. Glenn, Jr. is the uncle of W. G. Hancock. L. W. Richardson is the father of G. T. Richardson and the first cousin of R. W. Wiltshire. R. W. Wiltshire is the father of R. W. Wiltshire, Jr. and W. B. Wiltshire and the first cousin of J. M. Wiltshire, Jr.\n(e)(1) Except as set forth below, each of the persons named in (a) and (b) above has been principally employed by the Corporation and the Life Company in the present position for more than the past five years. Dianne N. Collins has been a Trustee of the 1984 Voting Trust described in Item 12 below since January 4, 1994 and a volunteer in the Richmond, Virginia community for more than the past five years. C. M. Glenn, Jr. and L. W. Richardson retired at the end of 1986 and 1987, respectively, each having served in the office shown for more than five years immediately prior to his retirement. W. G. Hancock has been a partner of the law firm of Mays & Valentine, Richmond, Virginia since 1981 specializing in real estate and mortgage lending, insurance company regulation and general business matters. He was designated as Counsel to the Corporation and the Life Company effective June 13, 1984. J. M. Wiltshire, Jr. was elected to the additional office of Secretary of the Corporation and Life Company effective January 18, 1994. Effective April 7, 1992, R. W. Wiltshire, Jr. was elected Chief Executive Officer of the Life Company and the Corporation to succeed R. W. Wiltshire who had served in that office for more than five years immediately prior thereto. Prior to his election as Chief Executive Officer, R. W. Wiltshire, Jr. was responsible for the general management of the operations of the Corporation and the Life Company. R. W. Wiltshire retired as an employee and salaried officer of the Corporation and the Life Company effective September 6, 1993.\n(e)(2) Not applicable.\n(f) Not applicable.\n(g) Not applicable.\n(h) The Corporation's directors and executive officers are required to file reports with the Securities and Exchange Commission (the \"Commission\") concerning their initial ownership of shares of the Corporation's Class A and Class B Common Stock and any subsequent changes in that ownership, and the Corporation traditionally has assisted its directors and executive officers in the filing of these reports. In making these reports, the Corporation has relied on written representations of its directors and executive officers and copies of the reports that they have filed with the Commission. The Corporation believes that these filing requirements were satisfied in 1994.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\n(a) and (b) Summary Compensation Table\nThe following Summary Compensation Table sets forth certain information concerning cash compensation paid to or contributed for the benefit of the five individuals named below for services rendered to the Corporation and its subsidiaries as executive officers during each of the three years in the period ended December 31, 1994.\nSUMMARY COMPENSATION TABLE\nName and Principal Annual All Other Position (1) Year Compensation-Salary (2) Compensation(3)\nR. W. Wiltshire, Jr. 1994 $139,312 $4,179 President and Chief 1993 118,512 3,555 Executive Officer(4) 1992 108,528 2,171\nJ. M. Wiltshire, Jr. 1994 132,134 3,964 Vice President, 1993 125,434 3,763 Secretary and 1992 121,201 2,424 Counsel\nH. D. Garnett 1994 119,122 3,574 Vice President and 1993 112,422 3,373 Controller 1992 107,937 2,159\nW. B. Wiltshire 1994 117,294 3,519 Vice President 1993 105,403 3,162 1992 99,986 2,000\nG. T. Richardson 1994 117,074 3,512 Vice President 1993 105,174 -- 1992 98,991 1,980\n(1) Offices shown are of both the Corporation and the Life Company. (2) The amounts shown include employee contributions to the Thrift Plan. (3) All of the amounts shown reflect matching contributions by the Corporation and the Life Company to the Thrift Plan. The Thrift Plan is a defined contribution plan available to substantially all salaried employees. Participants may make thrift contributions to the plan in any whole percentage of 2-14% of their compensation, and the Corporation and the Life Company will make a matching contribution to the plan in an amount equal to three-fourths of the first 4% of each eligible employee's compensation so contributed for the year. All matching amounts shown for each executive officer are fully vested. Benefits under the Thrift Plan are payable at death, retirement or other termination of employment (or at January of the calendar year of age 70 1\/2, if earlier). (4) Effective April 7, 1992, R. W. Wiltshire, Jr. was elected Chief Executive Officer of the Corporation and the Life Company.\n(c) Not applicable\n(d) Not applicable\n(e) Not applicable\n(f) Pension and Postretirement Medical Benefits Plans\nThe Corporation's Retirement Plan, a defined benefit pension plan, covers substantially all employees of the Corporation and the Life Company with the requisite length of service, which was reduced from six months to two months of service commencing January 1, 1995. The Plan provides a retirement annuity, payable by the Life Company as the insurer under the Plan, to each employee who is credited with five years of service, who attains his normal retirement age (which is age 65 or, if the employee becomes a participant at or after age 60, his fifth anniversary of becoming a participant) while employed by the Corporation or the Life Company, or who is totally and permanently disabled while an employee. The retirement annuity is earned in the form of a single life annuity for the life of the employee, commencing at the employee's normal retirement age, and is equal to the sum of retirement annuity credits earned by the employee for each calendar year he is credited with a year of service. Retirement annuity benefits under the plan can be paid as early as age 55 if the employee retires with at least ten years of service (or at disability retirement, if earlier) and must be paid starting in January of the calendar year the employee reaches age 70 1\/2, even though he has not then retired. The annuity is payable monthly and is subject to actuarial reduction in the event the employee commences to receive his retirement annuity prior to his normal retirement age (other than as a result of disability retirement) or receives his retirement annuity in a joint and survivor rather than a single life annuity form of payment. A survivor annuity benefit is provided to the employee's spouse in certain cases if the employee dies before his retirement annuity payments begin.\nThe annual annuity credit for years after 1988 is equal to 2% of the first $10,000 of the employee's compensation for the year, plus 2.5% of the employee's compensation for the year in excess of $10,000. Once an employee is credited with 35 years of service, whether before or after 1989, the annual annuity credit after 1988 becomes 2.5% of the employee's compensation for the year. Prior to 1989, several different benefit formulas were applied, and employees who were participants before 1989 will retain their annuity credits as determined through December 31, 1988 based on those earlier formulas. Covered compensation for purposes of the Plan is aggregate cash compensation up to $150,000 per year for years after 1993 ($200,000 per year for 1992 and 1993), as adjusted from time to time under the Internal Revenue Code of 1986, as amended, which in the case of each executive officer is identical to the amount shown as salary in the Summary Compensation Table appearing in Item 11(a) and (b). The estimated annual benefits payable under the Plan for each of the individuals listed in the Summary Compensation Table are as follows: R. W. Wiltshire, Jr. - $85,790, J. M. Wiltshire, Jr. - $44,552, , H. D. Garnett - $71,137, W. B. Wiltshire - $83,372, and G. T. Richardson - $92,032. The benefits as shown are estimated on the basis that the persons named will continue to receive, until the end of the calendar year in which they reach age 65 or, if already age 65, until the end of the current calendar year, salaries at the same rates in effect during 1994 and will then retire and elect a single life rather than a joint and survivor annuity form of payment.\nAmounts payable under the Plan are not subject to deduction for social security benefits under the Federal Social Security Act.\nIn addition to the Corporation's defined benefit pension plan, the Corporation has a postretirement medical benefits plan consisting of defined benefit medical coverage for pre-1993 retirees and defined contribution medical coverage for post-1992 retirees who were active employees on December 31, 1992. The pre-1993 retiree program covers all employees who had retired under the Corporation's pension plan as of December 31, 1992. The post-1992 retiree program covers all full time active employees as of December 31, 1992 who retire under the Corporation's pension plan thereafter. Employees who joined the Corporation after December 31, 1992 are not eligible for participation in either program under the postretirement medical benefits plan.\nThe pre-1993 retiree program reimburses its participants for actual covered costs subject to specified deductibles and coinsurance. The pre- 1993 retiree program is contributory and participant contribution requirements may be increased from time to time and benefits may be modified or terminated by the Corporation. The post-1992 retiree program is noncontributory and reimburses its participants for the cost of health insurance and other health care coverage premiums up to a maximum benefit amount (stated in terms of health care spending credits) determined in accordance with the plan based on years of service as of December 31, 1992. The unused maximum benefit amount, initially determined as of December 31, 1992, is increased thereafter only for interest from January 1, 1993 until it is fully expended.\nAll current salaried executive officers of the Corporation, upon their retirement, will be covered under the post-1992 retiree program. The spending account credit balances determined as of December 31, 1994 (without interest to be credited thereafter) for each of them are as follows: R. W. Wiltshire, Jr. - $28,058, J. M. Wiltshire, Jr. - $30,796, H. D. Garnett - $26,005, W. B. Wiltshire - $28,743 and G. T. Richardson -$26,005.\nThe Corporation is self insured with respect to benefits under the postretirement medical benefits plan.\n(g) Compensation of Directors\nAll directors of the Corporation (other than Messrs. Glenn, L. W. Richardson, R. W. Wiltshire, Hancock and Mrs. Collins) are salaried executive officers. Messrs. Glenn, L. W. Richardson and R. W. Wiltshire have retired as salaried executive officers of the Corporation and the Life Company. Upon his retirement on December 31, 1986 after more than 48 years of service, Mr. Glenn was asked to serve at the pleasure of the Board of Directors as a Consultant to the Corporation and its subsidiaries for which he receives $30,000 per year in addition to his normal retirement benefit of $26,495 under the Corporation's Retirement Plan. Under the terms of the contract, Mr. Glenn has agreed to perform such services of a consulting and advisory nature as may be requested of him from time to time by the Chairman of the Board of the Corporation. Messrs. Richardson and Wiltshire retired on December 31, 1987, and September 6, 1993, respectively, and in consideration of their past services to the Corporation and the Life Company over a continuous period of more than 42 years in the case of Mr. Richardson and 47 years in the case of Mr. Wiltshire, the Corporation agreed to pay Mr. Richardson $30,000 per year and Mr. Wiltshire $90,000 per year in addition to their respective pension benefits of $34,109 and $55,002 under the Retirement Plan. The Corporation's agreements with each of Messrs. Glenn, Richardson and Wiltshire provide that they will not compete with the Corporation or its subsidiaries, directly or indirectly, on a full time or a part time or on a consulting or advisory basis. Messrs. Glenn and Richardson also are participants in the pre-1993 retiree program under the Corporation's postretirement medical benefits plan. Mr. Wiltshire is a participant in the post-1992 retiree program under the plan and has a spending account credit balance as of December 31, 1994, after reimbursement to him of premiums paid subsequent to his retirement, of $42,591. (See \"Pension and Postretirement Medical Benefits Plan\" in Item 11(f)). Mr. Hancock is a partner in the law firm of Mays & Valentine. The amount of legal fees paid to that firm by the Corporation and its subsidiaries and affiliates in 1994, including amounts for legal services provided by Mr. Hancock, did not exceed 5% of the firm's gross revenues for its last fiscal year. No director of the Corporation receives any additional compensation in the form of directors' fees or otherwise for attendance at meetings of the Board or committees thereof, or other services performed solely in his or her capacity as a director.\n(h) Employment Contracts and Termination of Employment and Change-in- Control Arrangements\n(1) Not applicable\n(2) Not applicable\n(i) Not applicable\n(j) Board of Director Interlocks and Insider Participation\nThe Corporation has no formal compensation committee, and all final decisions as to executive officer compensation are made by the entire Board of Directors. All members of the Board of Directors, except Mrs. Collins, are present or retired officers of the Corporation. Messrs. R. W. Wiltshire, Jr., J. M. Wiltshire, Jr., Garnett, W. B. Wiltshire, and G. T. Richardson are salaried executive officers of the Corporation. R. W. Wiltshire has retired as an employee of the Corporation and now serves as an unsalaried executive officer in the capacity of Chairman of the Board. Messrs. Glenn and L. W. Richardson are retired executive officers of the Corporation. Mr. Hancock is an unsalaried executive officer of the Corporation and a partner in the law firm of Mays & Valentine which is general counsel to the Corporation.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\n(a) and (b) As of March 10, 1995, 5,401,024 shares of Class A Common Stock of the Corporation, constituting 63.7% of the 8,476,576 shares then outstanding, were held by trustees under a voting trust agreement dated as of May 1, 1984, which, by virtue of a voting trust extension agreement dated as of May 1, 1987, continues in force until May 11, 1997 (1984 Voting Trust). The Voting Trustees, each of whom is a director of the Corporation and the Life Company are R. W. Wiltshire, L. W. Richardson, R. W. Wiltshire, Jr., G. T. Richardson, and Dianne N. Collins (as the current successor to M. D. Nunnally, Jr. one of the original Voting Trustees, who died several years ago) (together, the Trustees). Their mailing address is 3901 West Broad Street, Richmond, Virginia 23230. The Trustees are given exclusive voting power of the Class A Common Stock subject to the 1984 Voting Trust, but must vote or execute consents in accordance with the instructions of the holders of voting trust certificates with respect to any action submitted to a vote of the holders of Class A Common Stock as to which a majority of the Trustees then in office favor an affirmative vote, where such action, if approved by the holders of Class A Common Stock in accordance with and to the extent required by law and the Corporation's Articles of Incorporation, would result in: (a) the increase or decrease of the authorized number of shares of Class A Common Stock; (b) an exchange, reclassification, or cancellation of all or part of the shares of Class A Common Stock; (c) an exchange, or right of exchange, of all or any part of the shares of another class into the shares of Class A Common Stock; (d) any change that may be adverse to the designations, preferences, limitations, voting rights or relative to other rights of any nature of the shares of Class A Common Stock; (e) any change of the shares of Class A Common Stock into a different number of shares of the same class or into the same or a different number of shares, either with or without par value, of other classes of stock; (f) the creation of a new class of stock, or change of a class with subordinate and inferior rights into a class having rights and preferences prior and superior to shares of Class A Common Stock, or any increase of the rights and preferences of any class having rights and preferences prior or superior to shares of Class A Common Stock; (g) any limitation or denial of preemptive rights of shares of Class A Common Stock; (h) the sale, lease, exchange, mortgage, pledge or other disposition of all, or substantially all, the property and assets of the Corporation; (i) the merger or consolidation of the Corporation with or into any other corporation, or of any other corporation with or into the Corporation; or (j) the dissolution of the Corporation. If a majority of the Trustees shall oppose any such matter, the Trustees need not solicit, obtain or follow directions from the holders of the voting trust certificates, and such majority of Trustees opposing any such proposal are authorized and empowered to vote all the shares of Class A Common Stock held by the Trustees under the 1984 Voting Trust against such proposal. A majority vote of the Trustees controls actions to be taken by them; they may vote in person or by proxy to another Trustee with or without direction how to vote. They may vote for themselves as directors and officers of the Corporation and fix their compensation provided it be commensurate with the duties and responsibilities of the office or position held. They may name successor trustees in event of death, resignation, removal from the Commonwealth of Virginia or incapacity of any Trustee. They receive no compensation for their services as Trustees. In the event that by virtue of a stock dividend, stock split, reclassification of stock or subscription, the Trustees receive further Class A Common Stock, it is to be held by them subject to all of the provisions of the 1984 Voting Trust. In the event that as a result of any merger, consolidation, sale of assets or property, exchange or other cause, the shares of Class A Common Stock of the Corporation held by the Trustees should be converted into and become shares of another corporation, the 1984 Voting Trust shall be terminated automatically unless the amount of voting stock in such other corporation received as a result of the conversion would thereafter represent more than one-third of the issued and outstanding voting stock of such other corporation if it has no class of stock registered under the Securities Exchange Act of 1934, or more than one-twentieth of the issued and outstanding voting stock of such other corporation if it has a class of stock so registered, in either of which cases the 1984 Voting Trust shall continue in force according to its terms.\nClass B Common Stock, which has no vote on most matters, is publicly traded in the over-the-counter market and is not subject to the 1984 Voting Trust.\nDue to the substantial number of shares of Class A Common Stock held subject to the 1984 Voting Trust, the Trustees individually and collectively may be deemed to be \"control persons\" of the Corporation under rules and regulations of the Securities and Exchange Commission.\nAs of March 10, 1995, the Trustees under the 1984 Voting Trust beneficially owned, directly or indirectly, voting trust certificates evidencing an aggregate of 827,646 shares of Class A Common Stock subject thereto, as well as another 270,673 shares of Class A Common Stock that are not subject to the 1984 Voting Trust.\nThe following table shows as of March 10, 1995, the beneficial owner- ship of all Class A and Class B Common Stock by each director of the Corporation, and the beneficial ownership of the Corporation's Class A Common Stock by any other person or entity known to the Corporation to own more than 5% of the outstanding shares of such class. The Corporation has no executive officers who are not directors. The amounts shown for Class A Common Stock include beneficial ownership evidenced by voting trust certificates of the 1984 Voting Trust, but exclude Class A shares held by the Trustees thereunder.\nDirectors\nAmount Title of Beneficially Percent of Name of Director Class Owned(1) Class(2)\nDianne N. Collins Class A 13,536(3)(4)(5) * Class B 7,264(4) * H. D. Garnett Class A - - Class B 2,600 (6) * C. M. Glenn, Jr. Class A 327,826 (5)(7)(8)(9) 3.87 Class B 80,711 (7)(8)(9) * W. G. Hancock Class A 89,560 (9)(10)(11) 1.06 Class B 4 * G. T. Richardson Class A 52,784 (3)(5) * Class B 10,274 * L. W. Richardson Class A 262,161 (3)(5)(9)(12) 3.09 Class B 89,179 (9)(12) * J. M. Wiltshire, Jr. Class A - - Class B 6,000 * R. W. Wiltshire Class A 741,492 (3)(5)(9)(13) 8.75 Class B 47,920 (13) * R. W. Wiltshire, Jr. Class A 28,346 (3)(5)(13) * Class B 41,443 (9)(13) * W. B. Wiltshire Class A 28,186 (5)(13) * Class B 30,550 (9)(13) *\n5% Class A Stockholders (Other Than Directors and Trustees) Amount Name and Address of Beneficially Percent of 5% Class A Stockholder Owned (1) Class\nDixie Company 2,561,336 (5)(14) 30.22 Richmond, Virginia\nDoris G. Hancock 449,574 (8)(15) 5.30 Richmond, Virginia\nEstate of Mary Morton Parsons 1,174,427 (5)(16) 13.85 Richmond, Virginia\nGeorge L. Richardson 599,680 (5) 7.07 Richmond, Virginia\n(1) Beneficial ownership has been determined in accordance with Rule 13d- 3 under the Securities Exchange Act of 1934. (2) Where an asterisk is shown, the percentage is less than 1%. (3) 5,401,024 shares of Class A Common Stock constituting 63.7% of the 8,476,576 shares outstanding are held by R. W. Wiltshire, L. W. Richardson, R. W. Wiltshire, Jr., G. T. Richardson and Dianne N. Collins, as Trustees under the 1984 Voting Trust. (4) All of the voting trust certificates for Class A shares and the Class B shares are held of record by Dixie Company and may be acquired by Mrs. Collins pursuant to her power to revoke an inter vivos trust. Such voting trust certificates are also included in the table for Dixie Company.\n(5) Some portion or all of the Class A shares shown for each of the indicated directors or stockholders are subject to the 1984 Voting Trust, and their beneficial ownership as to those shares is evidenced by voting trust certificates that have been issued to them thereunder. The number of Class A shares deposited in the 1984 Voting Trust by each of them is as follows: Dianne N. Collins - 13,536; C. M. Glenn, Jr. - 150,164; G. T. Richardson - 22,510; L. W. Richardson - 250,708; R. W. Wiltshire - 539,016; R. W. Wiltshire, Jr. - 1,876; W. B. Wiltshire - 1,728; Dixie Company - 2,423,800; Estate of Mary Morton Parsons - 1,174,427; and George L. Richardson - 404,600. (6) All of the Class B shares shown for Mr. Garnett are owned jointly with his wife. (7) Includes 165,520 shares of Class A (of which 90,000 shares are evidenced by voting trust certificates of the 1984 Voting Trust) and 23,280 shares of Class B Common Stock held in trust by Crestar Bank as trustee for the benefit of Mr. Glenn during his lifetime, with remainder to his issue. (8) Includes 80,822 shares of Class A and, in the case of Mr. Glenn, 3,644 shares of Class B Common Stock, held by Mr. Glenn and his sister, Doris G. Hancock, and another sister, as trustees under the will of Hazel C. Glenn for the benefit of his daughter. (9) Includes an aggregate of 7,560 shares of Class A (of which 2,696 shares are evidenced by voting trust certificates of the 1984 Voting Trust) and 12,750 shares of Class B Common Stock held by directors as trustees or custodians for the benefit of children (that are not described in other footnotes to this table), or by their wives, and with respect to which beneficial ownership is or will be disclaimed by individual directors in ownership reports filed with the Securities and Exchange Commission. (10) The ownership shown for Mr. Hancock excludes 188,800 shares of Class A Common Stock held in trust by Crestar Bank for the benefit of his mother, Doris G. Hancock, with remainder to Mrs. Hancock's issue, in which Mr. Hancock has a vested one-third beneficial interest subject to partial divestment upon any further children of Mrs. Hancock. (11) Includes 2,400 shares of Class A Common Stock held by Mr. Hancock and his brother and sister as trustees under inter vivos trusts created by their mother for the benefit of her six grandchildren, three of whom are children of Mr. Hancock. (12) Includes 25,538 shares of Class A Common Stock evidenced by voting trust certificates of the 1984 Voting Trust and 36,912 shares of Class B Common Stock held by Mr. Richardson, as trustee with sole voting and shared investment power, for the benefit of a member of his immediate family. (13) 141,804 shares of Class A Common Stock, voting trust certificates for 94,976 shares of Class A Common Stock subject to the 1984 Voting Trust and 660 shares of Class B Common Stock are held by the Estate of Essie Lee Wiltshire for the life of R. W. Wiltshire with a vested remainder interest in the children of R. W. Wiltshire. R. W. Wiltshire is the sole executor of the Estate of Essie Lee Wiltshire. During the life of R. W. Wiltshire the income from the foregoing shares is paid to the children of R. W. Wiltshire. In addition, R. W. Wiltshire has a life estate in voting trust certificates evidencing 403,264 shares of Class A Common Stock subject to the 1984 Voting Trust and 47,260 shares of Class B Common Stock, with remainder to the children of R. W. Wiltshire. R. W. Wiltshire, Jr. and W. B. Wiltshire have vested one-fourth beneficial interests in all the foregoing shares, subject to partial divestment upon any further children of R. W. Wiltshire. The ownership shown includes such shares for R. W. Wiltshire and excludes all such shares for R. W. Wiltshire, Jr. and W. B. Wiltshire. Both R. W. Wiltshire, Jr. and W. B. Wiltshire also have the same vested one-fourth remainder interests subject to partial divestment in another 140,836 shares of Class B Common Stock in which various children and grandchildren of R. W. Wiltshire residing in other households have an interest for his life. The ownership shown for R. W. Wiltshire, R. W. Wiltshire, Jr. and W. B. Wiltshire does not reflect any of such shares, except in the case of R. W. Wiltshire, Jr. for 26,445 shares held by him as custodian for his minor children and another 8,764 shares held for his own benefit and in the case of W. B. Wiltshire for 17,630 shares held by him as custodian for his minor children and another 8,764 shares held for his own benefit.\n(14) Dixie Company is the nominee of Jefferson National Bank which holds 137,536 Class A shares and voting trust certificates for another 2,423,800 Class A shares in a number of fiduciary accounts that it administers (including voting trust certificates for 13,536 Class A shares previously reported in the table for Mrs. Collins). (15) Includes 188,800 shares of Class A Common Stock held in trust by Crestar Bank as trustee for the benefit of Mrs. Hancock during her lifetime with remainder to her issue. Also includes 18,205 Class A shares held by Mrs. Hancock's husband. (16) Clinton Webb and NationsBank of Virginia, N.A. are the co-executors of the Estate of Mary Morton Parsons.\nAs of March 10, 1995, executive officers and directors of the Corporation as a group beneficially owned 1,543,891 shares or 18.2% of the Class A (including beneficial ownership evidenced by voting trust certificates of, but exclusive of shares held by the Trustees under, the 1984 Voting Trust) and 315,945 shares or 3.5% of the Class B Common Stock of the Corporation, respectively.\n(c) The Corporation has no knowledge of any contractual arrangement which may at a subsequent date result in a change of control of the Corporation, except that the 1984 Voting Trust is scheduled to expire on May 11, 1997. Upon its expiration, the shares of Class A Common Stock of the Corporation now held by the Trustees under the 1984 Voting Trust will be held by persons presently holding voting trust certificates representing those shares.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\n(a) Not applicable.\n(b) W. G. Hancock is a partner in the law firm of Mays & Valentine which provided legal services as general counsel to the Corporation and its subsidiaries and affiliates during 1994, and is expected to serve in the same capacity in 1995. The amount of legal fees paid to that firm by the Corporation and its subsidiaries and affiliates for 1994 did not exceed 5% of the firm's gross revenues for its last full fiscal year.\n(c) Not applicable.\n(d) Not applicable.\nPart IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. and 2. Financial Statements and Financial Statement Schedules\nThe financial statements and financial statement schedules listed in the accompanying Index to Financial Statements and Financial Statement Schedules on page 23 are filed as part of this annual report.\n3. Exhibits\nThe exhibits listed in the accompanying Index to Exhibits are filed as part of this annual report.\n(b) Reports on Form 8-K\nNone\nHOME BENEFICIAL CORPORATION and Financial Statement Schedules (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 financial statements and notes thereto.\nThe consolidated financial statements and supplementary information listed in the above index, which are included in the Annual Report to Stockholders for Home Beneficial Corporation for the year ended December 31, 1994, are incorporated herein by reference.\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report(Form 10-K) of Home Beneficial Corporation of our report dated February 10, 1995, included in the 1994 Annual Report to Stockholders of Home Beneficial Corporation.\nOur audits also included the financial statement schedules of Home Beneficial Corporation listed in Item 14(a). These schedules are the responsibility of the Corporation'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\nRichmond, Virginia February 10, 1995\n(*) See Notes 6 and 7 to Consolidated Financial Statements\n(*) Short-term investments, which consist of investments with maturities of 30 days or less, are considered cash equivalents\nSIGNATURES\nPursuant to the requirements of Section 12 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.\nHOME BENEFICIAL CORPORATION Registrant\nBy: H. D. Garnett Vice President and Controller, 3\/21\/95\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:\nR. W. Wiltshire Chairman of the Board and Director, 3\/21\/95\nC. M. Glenn, Jr. Retired Vice President, Treasurer and Director, 3\/21\/95\nL. W. Richardson Retired Vice President and Director, 3\/21\/95\nR. W. Wiltshire, Jr. President, Chief Executive Officer and Director, 3\/21\/95\nJ. M. Wiltshire, Jr. Vice President, Counsel, Secretary and Director, 3\/21\/95\nW. B. Wiltshire Vice President and Director, 3\/21\/95\nH. D. Garnett Vice President, Controller and Director, 3\/21\/95\nG. T. Richardson Vice President and Director, 3\/21\/95\nW. G. Hancock Counsel and Director, 3\/21\/95\nDianne N. Collins Director, 3\/21\/95","section_15":""}
{"filename":"200245_1994.txt","cik":"200245","year":"1994","section_1":"Item 1.Business\nSalomon Inc (\"the Company\") was incorporated in 1960 under the laws of the State of Delaware. At December 31, 1994, its full time equivalent number of employees was 9,077. Information concerning the business of Salomon Inc under the following captions in Exhibit 13, \"Salomon Inc 1994 Annual Report Financial Information,\" is deemed part of this Annual Report on Form 10-K and is hereby incorporated herein by reference:\nSalomon Inc - Overview of 1994 (on pages 14 through 19)\nSalomon Brothers - Description of Business (on pages 21 through 22)\nPhibro Division - Description of Business (on page 27)\nPhibro USA - Description of Business (on pages 28 through 30)\nNote 1 Revenues by Business Unit (on pages 67 through 70)\nNote 2 Industry Segment and Geographic Data (on pages 71 through 72)\nNote 10 Net Capital (on page 78)\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2.Properties\nSince 1991, the Company's headquarters has been Seven World Trade Center, located in lower Manhattan, New York. In 1993, a subsidiary of Salomon Brothers purchased two long-term leasehold interests in property located in London that was previously leased on a short-term basis. Salomon Brothers' 132,000-square-foot operational support facility in Tampa, Florida was completed and became fully operational in 1992. The Tampa facility provides clearing and operational support services primarily for Salomon Brothers' New York-based sales, trading and investment banking activities.\nFurther information concerning the Company's properties under the following captions in Exhibit 13, \"Salomon Inc 1994 Annual Report Financial Information,\" is deemed part of this Annual Report on Form 10-K and is hereby incorporated herein by reference:\nPhibro Division - Description of Business (on page 27)\nPhibro USA - Description of Business (on pages 28 through 30)\nNote 4 Property, Plant and Equipment (on page 73)\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn August 9, 1991, the Company announced that it had uncovered irregularities by certain employees of its indirect wholly owned subsidiary\nSalomon Brothers Inc (\"SBI\") in connection with certain auctions of U.S. Treasury securities. During the 1991 third quarter the Company recorded a pretax charge of $200 million to establish a reserve for estimated monetary damages, settlement costs, fines, penalties, legal expenses and other related costs expected to be incurred in connection with the private actions and investigations by certain U.S. governmental authorities, state agencies and self-regulatory authorities arising out of this matter. In a settlement with U.S. governmental authorities announced on May 20, 1992, the Company and SBI consented to various sanctions including the payment of $190 million, the establishment of an additional $100 million private civil claims fund, the issuance of an injunction and the adoption of an administrative order, and in connection with this matter SBI was also temporarily suspended from dealing directly with the Federal Reserve Bank and from executing customer transactions in Treasury auctions. As a result of the settlement, the Company recorded an additional pretax charge of $185 million in the 1992 second quarter. The settlement did not resolve the Antitrust Division of the U.S. Department of Justice's charges concerning possible collusion by primary dealers and others in bidding at U.S. Treasury auctions. In January and February of 1993, the Company and SBI made payments of approximately $4 million to settle claims with 42 states and the District of Columbia arising out of the U.S. Treasury auction and related matters.\nOver 50 private actions were commenced against the Company, SBI or certain present and former directors, officers and employees of the Company or SBI with respect to the U.S. Treasury auction and related matters. These actions can be grouped into three categories: securities litigation (brought on behalf of purchasers of the Company's securities), Treasury litigation (brought on behalf of purchasers of U.S. Treasury securities) and derivative litigation.\nForty-two of the actions were class and derivative actions which were consolidated for pre-trial or discovery purposes into three actions in the United States District Court for the Southern District of New York (the \"Southern District of New York\") before The Honorable Robert P. Patterson, Jr. Amended consolidated complaints were filed in each of the three consolidated groups of class actions.\nThe securities litigation and Treasury litigation (with the exception of the Three Crown action discussed below) are the subject of settlement agreements. In June 1994, the court approved settlement of the consolidated securities action and the Company has paid $54.5 million to the plaintiff class out of the $100 million private civil claims fund described above. The court also awarded plaintiffs' attorneys' fees and expenses in the amount of $9.6 million, which has been paid by the Company. In July 1994, the court approved settlement of the consolidated Treasury litigation and the Company and SBI have paid $66 million to the plaintiff class. Plaintiffs' attorneys' fees and expenses related to claims against the Company awarded by the court were included in this amount. The Company and SBI expect that almost two-thirds of this payment will be reimbursed to the Company out of the $100 million private civil claims fund. The settlements described above have exhausted all but a relatively small portion of the fund.\nPlaintiffs in Three Crown Limited Partnership, et al. v. Salomon Brothers Inc, et al., 92 Civ. 3142, opted out of the Treasury litigation settlement and have continued actively to pursue claims against SBI and other defendants. This action, which is pending in the Southern District of New York, alleges, among other things, that SBI and one of its former employees violated provisions of the Federal securities laws, the Racketeer Influenced and Corrupt Organization Act (\"RICO\") and the antitrust laws, in some instances in collusion with others, by repeatedly purchasing quantities of U.S. Treasury securities in excess of Federal regulatory limits and manipulating the market in U.S. Treasury securities. The action seeks compensatory damages of approximately $25 million and trebling of that amount pursuant to the antitrust and RICO laws, as well as costs, interest and other relief.\nIn re Salomon Inc Shareholders' Derivative Litigation, 91 Civ. 5500 (S.D.N.Y., consolidated August 30, 1991), consolidated for all pre-trial purposes 16 actions which asserted derivative claims purportedly on behalf of the Company against members of the Company's Board of Directors and others. The actions claim, among other things, that SBI employees violated U.S. Treasury and Federal Reserve Board regulations governing the purchase of U.S. Treasury securities at auctions by repeatedly purchasing quantities of U.S. Treasury securities in excess of Federal regulatory limits and submitting bids for those securities in the names of persons who had not authorized such bids. The claims, as originally filed, further asserted that the director defendants breached their fiduciary obligations to the Company by engaging in or recklessly disregarding these allegedly illegal practices, thereby exposing the Company to potential liabilities and adverse business consequences. The actions seek to require the individual defendants to recompense the Company for all damages caused by them, to return compensation received by them and to pay punitive damages, as well as costs, interest and other relief. The Company moved to dismiss the complaint on the grounds that plaintiffs had failed to make a demand on the Company's Board of Directors. In January 1994, the derivative plaintiffs amended their complaint, among other things, to dismiss without prejudice their complaint against all defendants other than those who ceased to be officers or directors of the Company following the announcement of irregularities in August 1991.\nOn September 28, 1994, the United States District Court of the Southern District of New York granted the motion of the individual defendants to stay trial of the action and compel arbitration, subject to determination by the New York Stock Exchange as to whether the claims are arbitrable and whether the New York Stock Exchange would exercise jurisdiction over the claims. The New York Stock Exchange declined to exercise jurisdiction on December 22, 1994. Individual defendants have appealed that decision to the New York Stock Exchange Board. The determination of the motion by the Board is currently pending.\nA New York Stock Exchange arbitration panel on May 13, 1994 denied in their entirety the employment-related compensation claims for John Gutfreund who sought to recover $55.3 million. On August 12, 1994, Mr. Gutfreund filed a petition in the Supreme Court of New York for New York County seeking to vacate the arbitration panel's decision and require a new arbitration. On December 31, 1994, the Court dismissed Mr. Gutfreund's petition and confirmed the arbitration panel's decision denying Mr. Gutfreund's claims. Mr. Gutfreund has appealed the decision.\nAs part of the May 1992 settlement of the U.S. Treasury auction matters with the U.S. governmental authorities, the Company and SBI consented to an injunction against violating\ncertain record keeping and anti-fraud provisions of the Federal securities laws based on allegations that transactions in certain securities during 1984 and 1986 were pre-arranged to accelerate the recognition of losses for Federal income tax purposes. In connection with audits of the Company's Federal income tax returns, the Internal Revenue Service indicated it was contemplating claims for civil penalties in connection with such transactions during 1984 and 1986. The transactions as to which penalties were contemplated were apparently effected solely by employees who have left the Company and were in violation of Company policy. The principal impact of such transactions was deferral of taxes. Promptly after it discovered the transactions, the Company informed the Internal Revenue Service and paid the taxes due and interest. The Company and the Internal Revenue Service have entered into a settlement agreement that resolves the scope of claims for civil penalties, which civil penalties shall be payable by the Company to the Internal Revenue Service in an amount to be determined in accordance with the terms of the settlement agreement.\nSBI has been named as a defendant in a purported class action brought in May 1988 in the Delaware Chancery Court for New Castle County (Shields and Van De Walle v. L.F. Rothchild, Unterberg, Towbin Holdings, Inc., et al.). The defendants include L.F. Rothchild, Unterberg, Towbin Holdings, Inc. (\"Holdings\"), certain of its officers and directors, certain selling shareholders and controlling persons and the lead underwriters for Holdings' March 1986 public offering of 7,676,325 shares of Common Stock at $20.50 per share. Plaintiffs purport to represent a class of all persons who purchased stock pursuant to that offer. Together with Shearson Lehman Brothers Incorporated and L.F. Rothchild Incorporated (\"L.F. Rothchild\"), SBI acted as one of the lead underwriters with a participation of 1,074,441 shares. In general, the complaint alleges that the prospectus prepared in connection with the offering contained untrue statements of material fact and omitted to state material facts in violation of the Federal securities laws. The complaint seeks, among other things, compensation and punitive damages in unspecified amounts as well as the costs of the action. Both Holdings and L.F. Rothchild have been reorganized in bankruptcy proceedings and SBI no longer has any outstanding claims for indemnity or contribution against them. In February 1990, the court determined that the action should be stayed as to all defendants pending resolution of a class proof of claim filed by the Shields and Van De Walle plaintiffs in the Holdings bankruptcy proceeding that alleges the same claims contained in the Shields and Van De Walle complaint. That proof of claim was withdrawn, and with the completion of the reorganization of Holdings, the stay has been lifted and pre-trial proceedings have resumed.\nIn September 1992, Harris Trust and Savings Bank (as trustee for Ameritech Pension Trust (\"APT\")), Ameritech Corporation, and an officer of Ameritech filed suit against SBI and Salomon Brothers Realty Corporation (\"SBRC\") in the United States District Court for the Northern District of\nIllinois. The second amended complaint alleges that three purchases by APT from Salomon of participation interests in net cash flow or resale proceeds of three portfolios of motels owned by Motels of American, Inc. (\"MOA\"), as well as a fourth purchase by APT of a similar participation interest with respect to a portfolio of motels owned by Best Inns, Inc. (\"Best\"), violated the Employee Retirement Income Security Act (\"ERISA\"), and that the purchase of the participation interests for the third MOA portfolio and for the Best portfolio violated RICO and state law. SBI had acquired the participation interests in transactions in which it purchased as principal mortgage notes issued by MOA and Best to finance purchases of motel portfolios; 95% of three such interests and 100% of one such interest were sold to APT for purchase prices aggregating approximately $20.9 million. Plaintiffs' second amended complaint seeks (i) a judgment on the ERISA claims in the amount\nof the purchase prices of the four participation interests (approximately $20.9 million), for rescission and for disgorgement of profits, as well as other relief, and (ii) a judgment on the claims brought under RICO and state law in the amount of $12.3 million, with damages trebled to $37 million on the RICO claims and punitive damages in excess of $37 million on certain of the state law claims as well as other relief. SBI and SBRC answered the second amended complaint in part, moved to dismiss in part and asserted counterclaims against plaintiff Ameritech Corp. On August 16, 1993 the court (i) dismissed the RICO claims as well as plaintiffs' claims for breach of contract and unjust enrichment; (ii) denied SBI's motion to dismiss one of the ERISA claims (which alleges that SBI participated in a fiduciary's breach); and (iii) denied Ameritech's motion to dismiss SBI's counterclaims. Discovery with respect to the remaining claims is ongoing. Each of the Department of Labor and the Internal Revenue Service had advised SBI that it was reviewing the transactions in which APT acquired such participation interests. The Department of Labor, however, has advised Salomon that its investigation has been concluded. With respect to the Internal Revenue Service investigation, SBI and Salomon Brothers Realty Corp. have consented to extensions of time for the assessment of excise taxes which may be claimed to be due with respect to the transactions for the year 1987.\nGolder, Thoma, Cressey Fund III Limited Partnership, et al. v. Salomon Brothers Inc., is a lawsuit brought by Golder, Thoma, Cressey Fund III Limited Partnership and three individuals purporting to represent eleven members of senior management of Health Care and Retirement Corporation of America (\"HCRA\"), in the Circuit Court of Cook County, Illinois on July 10, 1992 against SBI in connection with SBI's performance in providing financial advisory services for the proposed acquisition by the plaintiffs of HCRA in 1991. An amended complaint was filed on November 14, 1994 that added Salomon Brothers Realty Corp. as a defendant and certain lower-level members of management of HRCA as plaintiffs. The lawsuit asserts claims for negligence, breach of fiduciary duty, negligent misrepresentation and breach of contract. Plaintiffs seek to recover damages purported to exceed $190 million due to their alleged inability to complete the acquisition at an advantageous price, $6 million of alleged fees and expenses, punitive damages and attorneys' fees, as well as costs and other relief. Discovery is ongoing in this case.\nBetween May 1994 and the present, SBI, along with a number of other broker-dealers, was named as a defendant in approximately 25 federal court lawsuits and one state court lawsuit, principally alleging that companies that make markets in securities traded on Nasdaq violated the federal antitrust laws by conspiring to maintain a minimum spread of $.25 between the price bid and the price asked for certain securities. The federal lawsuits were consolidated for pretrial purposes in the Southern District of New York in the fall of 1994 under the caption In re Nasdaq Market-Makers Antitrust Litigation, United States District Court, Southern District of New York No. 94-CIV-3996 (RWS); M.D.L. No. 1023. The state court suit, Lawrence A. Abel v. Merrill Lynch & Co., Inc. et al., Superior Court of San Diego No. 677313, has been stayed.\nIn the federal suits, the plaintiffs purport to represent the class of persons who bought what they currently estimate to be approximately 1650 securities on Nasdaq between May 1, 1989 and May 27, 1994. They seek unspecified monetary damages, which would be trebled under the antitrust laws. The plaintiffs also seek injunctive relief, as well as attorneys' fees and the costs of the action. (The state case, brought under California law, seeks similar relief.) Plaintiffs filed a consolidated amended complaint on December 16, 1994. Defendants filed a motion to dismiss that complaint on February 2, 1995. A hearing on the motion is scheduled\nfor April 26, 1995. By order of the court, discovery, other than third party discovery, is stayed pending that hearing.\nThe Antitrust Division of the Department of Justice is conducting an industry-wide investigation into the Nasdaq market. It has issued civil investigative demands to Salomon seeking interrogatory responses and the production of documents relating to Salomon's role as a market maker in Nasdaq stocks. The Securities and Exchange Commission is also conducting an industry-wide investigation of various Nasdaq market practices. SBI has received various subpoenas for documents relating to the Nasdaq market as part of the Securities and Exchange Commission investigation.\nDuring 1994, a number of customers of SBI's Private Investment Department in Hong Kong asserted claims against SBI arising primarily from alleged inappropriate sales practices with respect to transactions involving principally collateralized mortgage obligations. Certain of these customers have filed for arbitrations of these claims with the National Association of Securities Dealers, Inc. and the American Arbitration Association. Salomon has resolved almost all of these asserted claims, the cost of which was reflected in 1994 results. Salomon announced the closing of the Private Investment Department in early 1995.\nUnder the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), under certain circumstances, a potentially responsible party (\"PRP\"), may be held jointly and severally liable, without regard to fault, for response costs at a CERCLA site. A PRP's ultimate cost at a site generally depends on its involvement with the site and the nature and extent of contamination, the remedy selected, the role of other PRPs in creating the alleged contamination and the availability of contribution from\nthose PRPs, as well as any insurance or indemnification agreements which may apply. In most cases, both the resolution of the complex issues involved and any necessary remediation expenditures occur over a number of years.\nIn 1988, a subsidiary of Salomon Inc, The S.W. Shattuck Chemical Company, Inc. (\"Shattuck\"), along with over 350 industrial, municipal and other entities, was named by the federal Environmental Protection Agency (\"EPA\") as a PRP subject to liability under CERCLA at a site, Section 6 of the Lowry Landfill in Arapaho County, Colorado (\"Lowry\"), owned by the city and county of Denver (\"Denver\"). Shattuck was named a PRP based on disposal of its wastes at Lowry. Along with several other waste generator PRPs, Shattuck entered into two Administrative Consent Orders with the EPA pursuant to which certain site investigations and studies were conducted. In March 1994, EPA selected a remedy for Lowry, estimated to cost approximately $94 million. In December 1991, Denver filed suit under CERCLA and state common law in the United States District Court for the District of Colorado against Salomon Inc, Shattuck and 38 other PRPs seeking a declaration of their liability for, and recovery of, response costs expended and to be incurred at Lowry. In February 1992, Waste Management of Colorado, Inc. and Chemical Waste Management Inc., both PRPs at Lowry, commenced a similar action in the same court against Salomon Inc and Shattuck. In May 1993, the Company and Shattuck settled both actions with the plaintiffs. Under the settlement and based on current EPA estimates, the Company's ultimate share of remediation costs is not expected to exceed $13 million of which approximately 60% has been paid into a trust fund.\nIn August 1992, the EPA issued a Unilateral Administrative Order (\"the Order\") for remedial design\/remedial action to be performed by Shattuck under CERCLA at a site\n(Bannock Street), which includes property owned by, and a metal processing plant previously operated by, Shattuck in Denver, Colorado. The Order provides that, in the course of performing the remedial design\/remedial action, Shattuck shall demonstrate financial assurance in an amount not less that $26.6 million. Effective August 31, 1992, Shattuck served notice to EPA of its intent to comply with the Order. Shattuck has performed significant remediation activities at the site in accordance with the Order. In May 1994, Denver issued a Cease and Desist Order (\"CD Order\") to Shattuck to stop work under the Order. In August 1994, EPA filed suit in the Federal District Court in Colorado seeking to set aside the CD Order. Pending resolution of this suit, Shattuck is complying with the CD Order. EPA has also demanded payment by Shattuck of past response costs purportedly relating to the site alleged to be approximately $3 million. The extent of Shattuck's liability for these costs cannot be determined at this time, because Shattuck is actively contesting the factual and legal bases for EPA's claim.\nIn May 1993, the National Zinc site in Bartlesville, Oklahoma was proposed for listing as a superfund site on EPA's National Priorities List under CERCLA. Final listing remains subject to EPA's determination. In May 1993, both Salomon Inc and a current subsidiary received notices from EPA of designation as PRPs with respect to National Zinc. The National Zinc site was defined by EPA to\ninclude a smelter facility which had been owned by a former subsidiary of the Company and an eight square mile area surrounding such facility. The Company and its current subsidiary have formally opposed the PRP designations. In October 1993, the Company received notice from EPA of a planned removal response by EPA at the National Zinc site estimated by EPA to cost approximately $15.2 million. The Company and two other parties were designated by EPA as PRPs with respect to this removal action. In November 1993, EPA notified the Company and the same two other PRPs of its intent to conduct a remedial investigation, feasibility study and remedial design (\"RI\/FS\/RD\") for the site on a schedule which would result in selecting a remedy by December 1994, and offered the PRPs the opportunity to do this work. EPA also stated its willingness to consider a State Delegation Pilot Project whereunder PRPs, including the Company, could conduct the RI\/FS\/RD pursuant to an Administrative Order of Consent with the State of Oklahoma, with limited oversight by EPA. In February 1994, EPA issued to the Company and two other PRPs a Unilateral Administrative Order (\"UAO\") with respect to the removal action described above. The Company and one other PRP served notice to EPA of their intention to comply with the UAO. In April 1994, the Company, one other PRP and the City of Bartlesville entered into a Consent Agreement and Final Order (\"CAFO\") with the Oklahoma Department of Environmental Quality (\"ODEQ\") to conduct the RI\/FS\/RD. The work required under the UAO and the CAFO has been timely completed to date. The Company estimates that its cost to perform the removal action pursuant to the UAO and to participate in performing the RI\/FS\/RD will be approximately $7.5 million. In December 1994, ODEQ issued a Record of Decision selecting a remedy for Operable Unit 1, relating to protection of human health, covering the area at the National Zinc site surrounding the smelter facility. The selected remedy is estimated to cost approximately $24.3 million. Under the terms of the CAFO, the Company and the other PRPs have agreed to negotiate with ODEQ in good faith regarding what role, if any, they will have in the implementation of the selected remedy. While the Company and the other PRPs have advised ODEQ that they are preparing to initiate such negotiations, the Company's future costs, if any, related to implementation of the selected remedy at the site cannot be determined at this time.\nIn February 1994, Horseheads Industries, Inc. D\/B\/A Zinc Corporation of America (\"ZCA\"), the current owner of the smelter facility at the National Zinc site, filed suit in the United States District Court for the Northern District of Oklahoma against the Company, St. Joe Minerals Company (\"St. Joe\"), Fluor Corporation (\"Fluor\") and Cyprus Amax Minerals Company (\"Cyprus\") alleging that the defendants are liable to it for response costs incurred in connection with the smelter facility under CERCLA because of the release of hazardous substances during periods of ownership or operation by them or their affiliates or predecessors in interest. In August 1994, a settlement agreement was entered into between ZCA, Fluor\/St. Joe and the Company (but not Cyprus), providing for an allocation as between the settling parties as to both past and future response costs. With respect to future remediation (the determination and implementation of which is expected to take several years) and the costs thereof, the settlement agreement established a management committee comprised of representatives of the settling parties to oversee study and clean-up of the facility and the costs associated therewith. Pursuant to the settlement, the Company and Fluor have taken over ZCA's role in the litigation including defense\nof ZCA against a pending counterclaim of Cyprus, and pursuit of claims against Cyprus. The Company's future costs related to the remediation of the smelter facility cannot be determined at this time, because the timing, nature and extent of any such remediation are still under study.\nIn March 1990, Salomon Inc and a subsidiary were notified by the Tennessee Department of Health and Environment (\"TDHE\") that they were responsible for remedial costs under the Tennessee Hazardous Waste Management Act, as prior owners and operators, at Roane Alloys, a ferro-alloy plant in Rockwood, Tennessee. In 1992, Salomon Inc's subsidiary, together with another prior owner and the current owner of the site, received a determination from the TDHE selecting a site remediation plan under which management believes that Salomon Inc's and the subsidiary's costs will total approximately $1 million. Remediation activities have been substantially completed at the site.\nIn addition to the matters discussed above, liability under CERCLA is currently asserted against Salomon Inc and\/or its subsidiaries by EPA relating to the following sites: Erda, Utah (Micronutrients International) and Granite City, Illinois (NL\/Taracorp). Additionally, a subsidiary has been named as a third-party defendant in a suit filed by the EPA in the United States District Court for the Western District of Pennsylvania to recover response costs allegedly expended at a CERCLA site in Pulaski, Pennsylvania (Metcoa). In each case, Salomon Inc, or the subsidiary, has been identified as a PRP based upon the alleged shipment of relatively small volumes of material to the site, and management believes that Salomon Inc's, or the subsidiary's share of remediation costs will be immaterial.\nIn July 1994, a lawsuit was filed in the Federal Court in Texas against Phibro Energy USA, Inc., (\"Phibro USA\") a subsidiary of the Company, by the Friends of the Earth, Inc. The action is a citizen's suit brought under Section 505 of the Federal Water Pollution Control Act alleging violations by Phibro USA of the monitoring, record keeping and discharge limitations of its Houston refinery wastewater discharge permit during the period from September 1989 to the date of the suit. Subsequent to the filing of this lawsuit, the EPA filed an Administrative Complaint against Phibro USA, alleging substantially the same violations under the Clean Water Act and implementing regulations. Phibro USA has settled the EPA's claim. The extent of Phibro USA's liability with respect to the claim alleged in the lawsuit cannot be determined at this time.\nIn June 1994, the Company's subsidiary, Philipp Brothers, Inc., received from the Attorney General of Texas a Notice of Potential Liability, under the Texas Solid Waste Disposal Act and CERCLA, with respect to the Industrial Road\/Industrial Metals Site (the \"Site\") in Corpus Christi, Texas. The State of Texas (the \"State\") has estimated that complete remediation of the Site and post-closure care will cost approximately $7.2 million. The State has claimed that Philipp Brothers, Inc.'s share of such cost is approximately $487,000. Philipp Brothers, Inc. has advised the State that it has been incorrectly identified as a PRP at the Site. The extent of Philipp Brothers, Inc.'s liability with respect to the State's claim cannot be determined at this time.\nIn addition, other legal proceedings are pending against or involve the Company and its subsidiaries. Based on information currently available and established reserves, the Company believes the ultimate resolution of pending legal proceedings will not result in any material adverse impact on the Company's consolidated financial condition; however, such resolution could have a material adverse impact on operating results in future periods depending in part on the results for such 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 security holders during the fourth quarter of 1994.\nExecutive Officers of the Registrant\nName and Age Office ------------ ------ Jerome H. Bailey (42) Chief Financial Officer since June 1993; previously employed at Morgan Stanley in various executive capacities for more than five years\nRobert E. Denham (49)* Chairman and Chief Executive Officer since June 1992; previously General Counsel from September 1991; previously a partner in the law firm of Munger, Tolles & Olson, Los Angeles, California, for more than four years\nGedale B. Horowitz (62)* Executive Vice President since 1981\nJohn G. Macfarlane (40) Treasurer since 1989; Treasurer of Salomon Brothers Inc since 1989; previously employed by Salomon Brothers Inc in various executive capacities from 1979\nKenneth K. Marshall (52) Acting Controller since March 1, 1995; employed by Salomon Brothers Inc since October 1993; previously employed by Coopers & Lybrand in various executive capacities for more than five years\nDeryck C. Maughan (47)* Executive Vice President since May 1993; Chairman and Chief Executive Officer of Salomon Brothers Inc since May 1992; previously Chief Operating Officer of Salomon Brothers Inc from August 1991; Vice Chairman of Salomon Brothers Inc from January 1991 to August 1991; Chairman of Salomon Brothers Asia Limited from 1986 to 1991\nRobert H. Mundheim (62) Executive Vice President and General Counsel since December 1993; General Counsel since September 1992; previously co-chairman of the law firm Fried, Frank, Harris, Shriver and Jacobson, New York, from March\n1990 after having served as Dean of the University of Pennsylvania Law School for more than seven years\n* Also a Director of Salomon Inc\nOfficers of the Registrant are elected annually at the May meeting of the Company's Board of Directors that follows the Annual Meeting of Stockholders.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nInformation concerning the market for the Registrant's common equity and related stockholder matters in Exhibit 13, \"Salomon Inc 1994 Annual Report Financial Information,\" under the caption \"Common Stock Data\" on page 95, is deemed part of this Annual Report on Form 10-K and is hereby incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected financial data in Exhibit 13, \"Salomon Inc 1994 Annual Report Financial Information,\" under the caption \"Five Year Summary of Selected Financial Information\" on page 96, is deemed part of this Annual Report on Form 10-K and is hereby 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 contained under the following captions in Exhibit 13, \"Salomon Inc 1994 Annual Report Financial Information,\" is deemed part of this Annual Report on Form 10-K and is hereby incorporated herein by reference:\nFinancial Highlights (page 1) Overview of 1994 (on pages 14 through 19) Segment Information (on pages 20 through 31) Derivative Instruments (on pages 32 through 36) Capital and Liquidity Management (on pages 37 through 44) Risk Management (on pages 45 through 53)\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Consolidated Financial Statements of the Company and subsidiaries, together with the Summary of Options and Contractual Commitments, the Summary of Accounting Policies, the Notes to Consolidated Financial Statements and the Report of Independent Public Accountants, contained in Exhibit 13, \"Salomon Inc 1994 Annual Report Financial Information\" on pages 56 through 93, and the information appearing under the caption \"Selected Quarterly Financial Data (Unaudited)\" on page 94 of such Exhibit are deemed part of this Annual Report on Form 10-K and are hereby incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nThere were no changes in or disagreements with accountants reportable herein.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\n(a) Directors -\nInformation concerning directors of the Registrant is contained under the caption \"Election of Directors\" in the Proxy Statement for the 1995 Annual Meeting of Stockholders, which information is hereby incorporated herein by reference.\n(b) Executive Officers -\nInformation concerning executive officers of the Registrant is presented in Part I of this Annual Report on Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation concerning executive compensation is contained under the captions \"Election of Directors - Executive Compensation\" and \"Election of Directors - Board of Directors' Role, Meetings, Committees and Fees\" in the Proxy Statement for the 1995 Annual Meeting of Stockholders, which information is hereby incorporated herein by reference.\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 contained under the caption \"Election of Directors - Information as to Certain Stockholdings\" in the Proxy Statement for the 1995 Annual Meeting of Stockholders, which information is hereby incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation concerning certain relationships and related transactions is contained under the caption \"Election of Directors - Certain Transactions\" in the Proxy Statement for the 1995 Annual Meeting of Stockholders, which information is hereby incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Financial Statements and Schedules\n(1) Financial Statements\nThe Consolidated Financial Statements of the Company and subsidiaries, together with the Summary of Accounting Policies, the Notes to Consolidated Financial Statements and the Report of Independent Public Accountants, dated February 26, 1995, are contained in Exhibit 13, \"Salomon Inc 1994 Annual Report Financial Information,\" and are hereby incorporated herein by reference.\n(2) Schedules\n(Schedules are omitted because the required information either is not applicable or is included in the financial statements or the notes thereto.)\n(3) Exhibits\n3.a Certificate of Incorporation of the Company, as amended (incorporated by reference to Exhibits 3 to Quarterly Reports on Form 10-Q for the quarters ended June 30, 1987 and June 30, 1986, Exhibit 4(a) to Registration Statement Number 2-84733 on Form S-3 filed June 30, 1983, Exhibit 4 to Quarterly Report on Form 10-Q for the quarter ended September 30, 1987, Exhibit A to Exhibit 1 to Registration Statement on Form 8-A filed February 11, 1988, Exhibit 3 to Current Report on Form 8-K dated June 13, 1991, and Exhibit 4(a) to Current Report on Form 8-K dated February 22, 1993)\n3.b* By-laws of the Company, as amended February 26, 1995\n4.a Certificate of Incorporation of the Company. See Exhibit 3(a) above.\n4.b Rights Agreement dated as of February 8, 1988 between Salomon Brothers Inc and Morgan Shareholders Services Trust Company and related letter dated February 9, 1988 from Berkshire Hathaway Inc. (incorporated by reference to Exhibit 28 to Annual Report on Form 10-K for the year ended December 31, 1987)\nItem 14. (continued)\n(c) Exhibits (continued)\n4.c First Amendment dated December 7, 1988 to Rights Agreement dated as of February 8, 1988 between Salomon Inc and Morgan Shareholder Services Trust Company (incorporated by reference to Exhibit 28 to Annual Report on Form 10-K for the year ended December 31, 1988)\n4.d Contract dated September 27, 1987 between Berkshire Hathaway Inc. and Salomon Inc and letter dated September 28, 1987 amending said contract (incorporated by reference to Exhibit 10(c) to Annual Report on Form 10-K for the year ended December 31, 1987)\n4.e The Company 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 Company and its consolidated subsidiaries that does not exceed 10 percent of the total consolidated assets of the Company.\n10.a Lease between 7 World Trade Center Company and Salomon Inc dated November 23, 1988 (incorporated by reference to Exhibit 10(a) to the Annual Report on Form 10-K, as amended, for the year ended December 31, 1991)\n10.b Foundation Agreement for the creation of the Joint Enterprise \"White Nights\" between Varyeganneftegaz Production Association, Phibro Energy Production, Inc. and Anglo-Suisse (U.S.S.R.) L.P. dated November 1, 1990 (incorporated by reference to Exhibit 10(b) to the Annual Report on Form 10-K, as amended, for the year ended December 31, 1991)\n10.c Charter of the Joint Enterprise \"White Nights\" (incorporated by reference to Exhibit 10(c) to the Annual Report on Form 10-K, as amended, for the year ended December 31, 1991)\n10.d Non-Qualified Stock Option Plan of 1984 (incorporated by reference to Exhibit A to the Proxy Statement for the 1988 Annual Meeting of the Stockholders)\n12.a* Calculation of Ratio of Earnings to Fixed Charges\n12.b* Calculation of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends\n13* Salomon Inc 1994 Annual Report Financial Information (furnished for the information of the Securities and Exchange Commission and not deemed \"filed\" as part of this Report except for those portions which are expressly incorporated by reference)\n21* Subsidiaries of the Registrant\n23* Consent of Independent Public Accountants\n24* Powers of Attorney\n27* Financial Data Schedule\nItem 14. (continued)\n(c) Exhibits (continued)\n99.a Copies of the settlement documents relating to the resolution of certain governmental investigations with respect to the U.S. Treasury auction and related matters (incorporated by reference to Exhibit 28(a) to the Annual Report on Form 10-K for the year ended December 31, 1992)\n99.b Copies of the amended consolidated complaints filed in connection with In re Salomon Inc Securities Litigation, In re Salomon Brothers Treasury Litigation and In re Salomon Inc Shareholders' Derivative Litigation (incorporated by reference to Exhibit 28(b) to the Annual Report on Form 10-K for the year ended December 31, 1992)\n99.c Summaries of the complaints filed against the Company, SBI and certain present and former directors, officers and employees of the Company and\nSBI in the six individual actions named in Item 3 with respect to the U.S. Treasury auction and related matters (incorporated by reference to Exhibit 28(c) to the Annual Report on Form 10-K for the year ended December 31, 1992)\n99.d Copies of the six complaints summarized in Exhibit 28(c) which were filed against the Company, SBI or certain present and former directors, officers and employees of the Company and SBI with respect to the U.S. Treasury auction and related matters (incorporated by reference to Exhibit 28(c) to the Company's Annual Report on Form 10-K, as amended, for the year ended December 31, 1991; Exhibit 28(h) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991; Exhibit 28(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992; Exhibit 28(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992; Exhibit 28(f) to the Company's Current Report on Form 8-K dated September 16, 1991 and Exhibits 28(b) and (c) to the Company's Current Report on Form 8-K dated July 28, 1992).\n* Filed herewith\nItem 14. (continued)\n(b) Reports on Form 8-K\nThe Company filed a Current Report on Form 8-K dated February 2, 1995, reporting under Item 5 (\"Other Events:\") and Item 7 (\"Financial Statements, Pro Forma Financial Information and Exhibits\") the issuance of a press release.\nThe Company filed a Current Report on Form 8-K dated February 27, 1995, reporting under Item 5 (\"Other Events:\") and Item 7 (\"Financial Statements, Pro Forma Financial Information and Exhibits\") the issuance of a press release.\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, on the 30th day of March, 1995.\nSALOMON INC By \/s\/ Arnold S. Olshin (Registrant) (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.\nRobert E. Denham Chief Executive Officer March 30, 1995 and Director\nJerome H. Bailey Chief Financial Officer March 30, 1995 and Chief Accounting Officer\nDwayne O. Andreas* Director March 30, 1995\nWarren E. Buffett* Director March 30, 1995\nClaire M. Fagin* Director March 30, 1995\nGedale B. Horowitz* Director March 30, 1995\nDeryck C. Maughan* Director March 30, 1995\nWilliam F. May* Director March 30, 1995\nCharles T. Munger* Director March 30, 1995\nLouis A. Simpson* Director March 30, 1995\nRobert G. Zeller* Director March 30, 1995\n*The undersigned, by signing his or her name hereto, does hereby sign this report on behalf of each of the above-indicated directors of the Registrant pursuant to powers of attorney, executed on behalf of each such director, on the 30th day of March, 1995.\nBy \/s\/ Arnold S. Olshin (Attorney-In-Fact)\nSALOMON INC FORM 10-K EXHIBIT INDEX\nCertain exhibits to this Form 10-K have been incorporated by reference in Part IV Item 14. The following exhibits are being filed herewith:\nExhibit Number Description -------------- ----------- 3.b By-Laws\n12.a Calculation of Ratio of Earnings to Fixed Charges\n12.b Calculation of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends\n13 Salomon Inc 1994 Annual Report Financial Information\n21 Subsidiaries of the Registrant\n23 Consent of Independent Public Accountants\n24 Powers of Attorney\n27 Financial Data Schedule","section_15":""}
{"filename":"79636_1994.txt","cik":"79636","year":"1994","section_1":"Item 1. Business\nPortland General Corporation - Holding Company\nPortland General Corporation (Portland General), an electric utility holding company, was organized in December 1985. Portland General Electric Company (PGE or the Company), an electric utility company and Portland General's principal operating subsidiary, accounts for substantially all of Portland General's assets, revenues and net income. Portland General is also the parent company of Portland General Holdings, Inc. (Holdings), which provides organizational separation for Portland General's nonutility businesses (see page 16). Portland General is exempt from regulation under the Public Utility Holding Company Act of 1935, except Section 9(a)(2) thereof relating to the acquisition of securities of other public utility companies.\nAs of December 31, 1994, Portland General and its subsidiaries had 2,536 regular employees compared to 2,618 and 3,253 at December 31, 1993 and 1992, respectively.\nPortland General Electric Company - Electric Utility\nGeneral\nPGE, incorporated in 1930, is an electric utility engaged in the generation, purchase, transmission, distribution, and sale of electricity in the State of Oregon. PGE also sells energy in the wholesale market to other utilities, primarily in the State of California. PGE's Oregon service area is 3,170 square miles, including 54 incorporated cities of which Portland and Salem are the largest, within a state-approved service area allocation of 4,070 square miles. PGE estimates that at the end of 1994 its service-area population was approximately 1.35 million, constituting approximately 45% of the state's population. At December 31, 1994 PGE served over 637,000 customers.\nIn early 1993 PGE ceased commercial operation of the Trojan Nuclear Plant (Trojan) of which it is a 67.5% owner. PGE is seeking to recover its investment in Trojan and the plant decommissioning costs in its electric rates. See Oregon Regulatory Matters below and Note 5, Trojan Nuclear Plant, in the Notes to Financial Statements for further discussion.\nPortland General Electric Company\nOperating Revenues\nPGE's operating revenues from customers peak during the winter season. The following table summarizes operating revenues and kWh sales for the years ended December 31:\nPortland General Electric Company\nRegulation\nPGE is subject to regulation by the Oregon Public Utility Commission (PUC), which consists of a three-member commission appointed by the Governor. The PUC approves PGE's retail rates and establishes conditions of utility service. The PUC ensures that prices are fair and equitable and provides PGE an opportunity to earn a fair return on its investment. In addition, the PUC regulates the issuance of securities and prescribes the system of accounts to be kept by Oregon utilities. PGE is also subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC) with regard to the transmission and sale of wholesale electric energy, licensing of hydroelectric projects and certain other matters.\nConstruction of new generating facilities requires a permit from the Energy Facility Siting Council (EFSC).\nThe Nuclear Regulatory Commission (NRC) regulates the licensing and decommissioning of nuclear power plants. In 1993 the NRC issued a possession-only license amendment to PGE's Trojan operating license. Trojan will be subject to NRC regulation until Trojan is fully decommissioned, all nuclear fuel is removed from the site and the license is terminated. The Oregon Department of Energy also monitors Trojan.\nOregon Regulatory Matters\nGeneral Rate Filing\nOn November 8, 1993 PGE filed a general rate case with the PUC requesting an increase in electric prices by an average of 5.1% beginning January 1, 1995. PGE's request included a return on equity of 11.5% and 11.8% for the years 1995 and 1996, respectively, down from the prior authorized return of 12.5%, and full recovery of the Trojan investment and decommissioning costs.\nIn mid-1994 PGE and the PUC Staff reached settlement on the majority of non-Trojan issues.\nIn July 1994 PGE agreed to delay a final order addressing all rate case matters to no later than March 31, 1995 in return for approval of a first quarter 1995 power cost deferral. Recovery of\npower cost deferrals is addressed in separate rate proceedings (see discussion below).\nOn November 11, 1994 PGE and the PUC Staff stipulated to a joint recommendation to the PUC on all outstanding cost of capital issues including an 11.6% return on equity for 1995 and 1996.\nThe PUC Staff recommended that PGE be allowed to recover 100% of Trojan decommissioning and transition costs and 85.9% of the remaining Trojan investment. Hearings were held in January 1995 and PGE expects a rate order no later than March 31, 1995. See General Rate Filing discussion in Management's Discussion and Analysis of Financial Condition and Results of Operations for further details.\nTrojan Replacement Power Cost Deferrals\nPGE operates without a power cost adjustment provision which necessitates separate filings with the PUC to recover increases in power costs not reflected in current rates. The PUC authorized PGE to defer, for later collection, 80% of the incremental power costs incurred from December 4, 1992 to March 31, 1993 to replace power no longer generated by Trojan. The PUC authorized PGE to start collecting this power cost deferral over a three year period beginning in April 1994.\nThe PUC authorized PGE to defer, for later collection, 50% of the incremental power costs incurred from July 1, 1993 to March 31, 1994, subject to a review of PGE earnings.\nThe first quarter 1995 power cost deferral (see General Rate Filing discussion above) authorizes PGE to defer, for later collection, 40% of the incremental power costs incurred from January 1, 1995 to March 31, 1995, subject to a review of PGE earnings. PGE will file for recovery of this and its prior power cost deferral on June 30, 1995.\n1993 Residential and Small Farm Customer Price Increase\nUnder provisions of the Regional Power Act (RPA), PGE exchanges with BPA higher-cost power for lower-cost federal hydroelectric power and passes the benefits to residential and small farm customers.\nIn September 1993 the PUC approved PGE's request to raise its electricity prices to residential and small farm customers an average of 7.8%, or approximately $29 million in annual revenues, effective October 1, 1993. This allowed PGE to\nPortland General Electric Company\npass through the BPA's nearly 16% price increase which reduced the power exchange credit to PGE's residential and small farm customers.\n1992 Temporary Rate Increase\nThe PUC authorized PGE to recover a portion of the incremental power costs it incurred during Trojan's 1991 extended outage. PGE was allowed to recover 90% of the excess power costs incurred from November 1, 1991 until Trojan returned to service in early March 1992. Revenue collections started on January 1, 1992, with commercial and industrial rates increasing 4.8% and residential rates increasing 0.6%. On April 7, 1992, the PUC approved the Company's request to decrease the rate at which it was recovering excess power costs. Residential rates decreased by 0.5% while commercial and industrial rates decreased by 3.3%. Revenue collections were completed in June 1993. The PUC's temporary rate increase order has been challenged by the Utility Reform Project. See Item 3, Legal Proceedings.\nEnergy Efficiency\nPGE and the PUC work together to provide the appropriate financial incentives for PGE's energy efficiency programs. PGE is allowed a return of and a return on energy efficiency program expenditures. PGE and the PUC also developed the Share All Value Equitably (SAVE) program to remove a financial disincentive and encourage PGE to aggressively pursue cost- effective energy efficiency measures. SAVE consisted of a lost revenue component, an energy efficiency investment true-up mechanism, and a shared savings incentive that rewards PGE with additional revenues for a portion of the difference between the equivalent cost of new generation and the cost of the energy efficiency measures. The shared savings component of the SAVE tariff can result in a penalty if the amount of energy savings falls short of the established benchmark levels. During the four years of the program, PGE exceeded benchmarks set by the PUC, and qualified programs achieved an annualized 55 average megawatts of saved energy.\nSAVE, which began as a three-year tariff in 1991, was extended for 1994. A program for 1995 and beyond is being discussed with the PUC.\nLitigation Settlement\nIn July 1990, PGE reached an out-of-court settlement with the PUC on two of three rate matters being litigated. PGE had sought judicial review of the three rate matters related to a 1987 general rate order.\nThe settlement did not resolve the issue related to the gain on PGE's sale of a portion of the Boardman Coal Plant (Boardman) and the Pacific Northwest Intertie transmission line (Intertie). PGE's position is that 28% of the gain should be allocated to customers. The 1987 rate order allocated 77% of the gain to customers over a 27-year period. In accordance with the 1987 rate order the unamortized gain, $119 million before taxes, at December 31, 1994, is being distributed as a reduction of customer revenue requirements.\nOn January 23, 1995 the Marion County Circuit Court affirmed the PUC's decision in the 1987 rate order discussed above. PGE has sixty days from the date of the decision to appeal.\nLeast Cost Energy Planning\nThe PUC adopted Least Cost Energy Planning for all energy utilities in Oregon with the goal of selecting the mix of options that yields an adequate and reliable supply of energy at the least cost to the utilities and customers. \"Demand side\" options (e.g., conservation and load management) as well as traditional \"supply side\" options (e.g., generation and purchase of power) are evaluated. Although utility management continues to be fully responsible for decision-making, the process allows the PUC and the public to participate in resource\nPortland General Electric Company\nplanning. Ratemaking decisions are not made in the planning process. However, participation by the PUC and the public may reduce the uncertainty regarding the ratemaking treatment of the acquisition of new resources. PGE will file its next Least Cost Plan (LCP) in 1995.\nCompetition and Marketing\nThe passage of the Energy Policy Act of 1992 (Energy Act) fostered increased competition in the electric utility industry. Currently, wholesale markets are reflecting the greatest competitive challenges. The Energy Act created new entrants in the wholesale market by facilitating the ownership and operation of generating facilities by exempt wholesale generators (which may include independent power producers as well as affiliates of electric utilities). The Energy Act also authorized FERC to require a utility to provide transmission service for other entities generating electric energy for sale or resale. In addition, the Energy Act granted states the authority to adopt retail wheeling, the transmission by an electric utility of electric power from another supplier to a customer located within the utilities service area. Certain states, including California, are considering proposals which would allow customers to select their electricity provider. The Oregon PUC has not yet considered similar measures.\nRetail Competition and Marketing\nPGE operates within a state-approved service area and is substantially free from direct retail competition with other electric utilities. However, a local natural gas utility competes with PGE for residential and commercial customers' space and water heating. Additionally, industrial and commercial customers have become more aggressive in managing their energy costs.\nPGE is working to be the energy expert and utility of choice for its retail customers. A key initiative is PGE's Power Smart Program which is targeted at residential and commercial customers. It includes a program which offers home buyers high energy efficiency homes built with the use of construction techniques and materials specifically designed to minimize the impact of construction on the environment, programs to influence market growth through high value electrical applications and managing capacity demand through load shaping, an Energy Resource Center to provide customers with technical assistance and training for energy-related business issues, and a joint program with the Oregon Superintendent of Public Instruction and other utilities to develop a curriculum to encourage teachers, students, and parents to use energy more efficiently in their homes.\nWholesale Competition and Marketing\nPGE's generating resources, coupled with its transmission rights on the Pacific Northwest Intertie (Intertie) provides the Company with flexibility to buy and sell power in California, the desert Southwest, the Northwest and Canada.\nThe ability to make wholesale energy sales depends on the availability and price of surplus power, access to transmission systems, changing prices of fossil fuels, competition from alternative suppliers, and the demand for power by other parties.\nThe Intertie is a transmission line with a total capacity of 4,800 megawatts that links winter-peaking northwest utilities with summer-peaking wholesale customers in the South. PGE has scheduling capability for 850 megawatts on the Intertie and 100 megawatts of scheduling capability on BPA's DC Intertie.\nThe federal Energy Act established competition in bulk power generation as national policy. FERC can now order wholesale transmission of electric power, called wholesale wheeling. Wholesale wheeling allows independent power producers, utilities, and brokers with little or no generating capacity to market power over wide geographic areas. Ownership of 950 megawatts of transmission rights secures the Company's presence in the increasingly competitive wholesale market by providing access to power and wholesale customers beyond PGE's service territory.\nPower Supply\nPGE's decision in January 1993 to immediately cease operation of Trojan (see Note 5, Trojan Nuclear Plant in the Notes to Financial Statements) ended 17 years of operation during which the plant provided 745 megawatts of capacity, and supplied about one quarter of PGE's annual energy requirements.\nPGE is replacing this output and meeting new load growth with a mix of energy purchases, new generating resources and demand-side programs.\nPortland General Electric Company\nGenerating Capability\nPGE's existing hydroelectric, coal-fired and gas-fired plants are key economic resources for the Company providing 1,911 megawatts of generating capability. PGE's lowest-cost producers are its eight hydroelectric projects on the Clackamas, Sandy, Deschutes, and Willamette rivers in Oregon.\nThe gas-fired Beaver Combustion Turbine Plant (Beaver) set operating records in 1994, providing 13% of PGE's energy requirements at a cost competitive with the Company's spot market purchases. The Boardman Coal-Fired Plant (Boardman) also set records in 1994, operating at an 86% capacity factor.\nPurchased Power\nPGE relies on long-term power contracts with four hydro projects on the mid-Columbia River which provide PGE with 667 megawatts. PGE also purchases surplus energy, primarily hydro-generated, from other Pacific Northwest utilities with firm contracts for 1,377 megawatts ranging in term from one to 22 years. In addition, PGE has long-term exchange contracts with summer-peaking California utilities to help meet its winter- peaking requirements.\nPGE has a total of 2,299 megawatts of firm capacity to serve PGE's peak loads. PGE also has access to surplus energy in the spot market, called secondary energy, which is utilized to meet customers' needs when it is economical to do so, and to provide replacement energy during plant outages.\nReserve Margin\nReserve margin is the amount of firm resource capacity in excess of customer demand during a period of peak loads. Based on its generating plants and firm purchased power contracts in place as of December 31, 1994, capacity available to PGE compared with historical peak loads is:\nYear in Review\nPGE generated 47% of its load requirements in 1994 compared with 42% in 1993. Firm and secondary purchases met the remaining load.\nBelow average precipitation in some parts of the Columbia River basin reduced the availability of inexpensive hydro power on the secondary market in 1994. Regional water conditions were about 71% of normal. However, mild weather, increased thermal-unit production, and lower gas prices mitigated the effect of poor water conditions.\nPortland General Electric Company\n1995 Outlook\nThe early predictions of water conditions indicate they will be about 95% of normal. While this should improve PGE hydro generation, efforts to restore salmon runs on the Columbia and Snake Rivers may affect the supply and price of purchased power (see the Restoration of Salmon Runs discussion below).\nCommercial operation of The Coyote Springs Generation Project (Coyote Springs), a 220 megawatt cogeneration facility being constructed\nnear Boardman, Oregon is planned for late 1995. See Item 3, Legal Proceedings for discussion of legal challenges to the development of Coyote Springs.\nEven with the addition of Coyote Springs, PGE will continue to purchase power in 1995 and beyond. Price and supply of power purchases will continue to be of particular importance. Adequate supplies of secondary energy are expected to be available to meet customer demand. The Company will proceed with obtaining required site permits for potential new generating resources but does not anticipate new construction in the foreseeable future.\nRestoration of Salmon Runs - Several species of Snake River salmon are protected as threatened under the Endangered Species Act (ESA). In an attempt to save the endangered fish the federal government has taken emergency actions that have reduced the amount of electricity generated at the Columbia and Snake River dams. In January 1995 the National Marine Fisheries Service (NMFS) released, for public comment, a draft plan calling for altering the management of federal dams and reservoirs in the Columbia River basin in order to protect dwindling salmon stocks. The plan proposes to boost river flows while young salmon are migrating which reduces the water available for hydropower generation. NMFS is empowered by the ESA to require salmon- protection measures by the Bureau of Reclamation and the Army Corps of Engineers, the agencies which operate the federal dams on the river.\nThe Columbia river and its tributaries produce nearly two thirds of the electricity used in the region. PGE purchases power from many sources, including the mid-Columbia dams. Reductions in the amount of water allowed to flow through the dams' turbines reduces generation and increases the cost of power available to purchase on a non-contract or secondary basis. The attempt to improve fish passage by releasing more water from the reservoirs in the spring and summer could mean less water available in the fall and winter, when the demand for electricity in the Pacific Northwest is the highest. This could lead to higher power costs.\nBy utilizing its transmission system to increase seasonal power exchanges with California and the Southwest PGE could partially offset the cost of reduced hydro generation on the Columbia and Snake Rivers. California energy demand peaks in\nPortland General Electric Company\nthe summer, while the Pacific Northwest demand peaks in winter. Furthermore, PGE is less vulnerable to operational changes on the Columbia and Snake Rivers' hydro projects because of its base of thermal generating resources.\nPGE's fish biologists are working with state and federal agencies to ensure that PGE's hydro operations located on several Columbia River tributaries are compatible with the survival of wild salmon and other wildlife. PGE does not expect the ESA process to significantly impact its own hydro generation.\nFuel Supply\nCoal\nBoardman. PGE has an agreement to supply coal to Boardman through the year 2000. The agreement does not require a minimum amount of coal to be purchased. PGE did not take deliveries under this agreement during 1994 but utilized several short and medium term contracts to supply coal for Boardman generation. Coal purchased in 1994 contained less than 0.5% of sulfur by weight and emitted less than the EPA allowable limit of 1.2 pounds of sulfur dioxide per million British thermal units (MMBtu) when burned. The coal is from both surface mining operations and underground operations, each subject to federal, state, and local regulations. Coal is delivered to Boardman by railroad.\nColstrip. Coal for Units 3 and 4, located in southeastern Montana, is provided under contract with Western Energy Company, a wholly-owned subsidiary of Montana Power Company. The contract provides that the coal delivered will not exceed a maximum sulfur content of 1.5% by weight. The Colstrip plant has sulfur dioxide removal equipment to allow operation in compliance with EPA's source performance emission standards.\nCentralia. Coal for Units 1 and 2, located in southwestern Washington, is provided under contract with PacifiCorp doing business as PacifiCorp Electric Operations. Most of Centralia's coal requirements are expected to be provided under this contract.\nAbout one quarter of PGE's firm resources comes from coal-fired plants:\nNatural Gas\nIn addition to the agreements discussed below the Company utilizes short-term agreements and spot-market purchases to secure transportation capacity and gas supplies sufficient to fuel plant operations.\nBeaver. PGE owns 90% of a pipeline which directly connects Beaver to Northwest Pipeline (NWP), an interstate gas pipeline operating between British Columbia and New Mexico. PGE presently has access to 30,000 MMBtu per day of firm capacity on NWP or enough to operate Beaver at approximately a 30% capacity. The contracted firm capacity on NWP increases to 76,000 MMBtu per day in late 1995 or enough to operate Beaver at approximately 70% capacity.\nCoyote Springs. During 1994 PGE took assignment of existing firm transportation capacity on the interconnected systems of various suppliers sufficient to deliver 41,000 MMBtu per day of natural gas from Alberta, Canada to Coyote Springs. This service should be sufficient to fuel 100% of plant operations and will start in late 1995 when the plant is expected to come on-line. In late 1995 PGE will begin purchasing under two-year contracts for the supply of natural gas to Coyote Springs at a 75 percent load factor.\nPortland General Electric Company\nEnvironmental Matters\nPGE operates in a state recognized for environmental leadership. PGE's environmental stewardship policy emphasizes minimizing waste in its operations, minimizing environmental risk and promoting energy efficiency.\nEnvironmental Regulation\nPGE is subject to regulation by federal, state, and local authorities with regard to air and water quality, noise, waste disposal and other environmental issues. PGE is also subject to the Rivers and Harbors Act of 1899 and similar Oregon laws under which it must obtain permits from the U.S. Army Corps of Engineers or the Oregon Division of State Lands to construct facilities or perform activities in navigable waters or in waters of the State. The EPA regulates the proper use, transportation, clean up and disposal of polychlorinated biphenyls (PCBs). State agencies or departments which have direct jurisdiction over environmental matters include the Environmental Quality Commission, the Department of Environmental Quality (DEQ), the Oregon Department of Energy, and the Energy Facility Siting Council. Environmental matters regulated by these agencies include the siting and operation of generating facilities and the accumulation, clean-up and disposal of toxic and hazardous wastes.\nAir\/Water Quality\nCongress passed amendments to the Clean Air Act (Act) in 1990 that will renew and intensify national efforts to reduce air pollution. Significant reductions in emissions of sulfur dioxide, nitrogen oxide and other contaminants will be required over the next several years. Coal-fired plant operations will be affected by these emission limitations.\nFederal implementing standards under the Act are being drafted at the present time. State governments are also charged with monitoring and administering certain portions of the Act. Each state is required to set guidelines that at least equal the federal standards.\nIn 1993, the EPA issued its final allocation of emission allowances. Boardman was assigned sufficient allowances to operate after the year 2000 at a 60 to 67% capacity factor without having to further reduce emissions or to buy additional credits. Centralia will be required to reduce emissions by the year 2000 and the owners are examining several options such as installing scrubbers, converting to lower-sulfur coal or natural gas, or purchasing emission allowances. It is not anticipated that Colstrip will be required to reduce emissions because it utilizes scrubbers. However, future legislation, if adopted, could affect plant operations and increase operating costs or reduce coal-fired capacity.\nBoardman's air contaminant discharge permit, issued by the DEQ, has no restrictions on plant operations. This permit expired in 1994 and is being renewed in 1995. Plant operations have not been affected as a result of this routine renewal process.\nThe water pollution control facilities permit for Boardman expired in May 1991. The DEQ is processing the permit application and renewal is expected. In the interim, Boardman is permitted to continue operating under the terms of the original permit. The waste- water discharge permit for Beaver was approved in 1994.\nDEQ air contaminant discharge permits for the combustion turbine generators at Bethel expire in 1995 but are expected to be replaced by new permits during the year. The current permits allow unrestricted plant operations during the day. Due to noise limitations only one unit may operate at night. The combustion turbines are allowed to operate on either natural gas or oil.\nPGE has developed an emergency oil spill response plan for the fuel oil storage tanks and unloading dock at Beaver. This plan has been submitted to the Coast Guard, EPA and DEQ in compliance with new federal and state oil spill regulations. The plan includes employee training and the acquisition of clean up equipment.\nEnvironmental Clean Up\nPGE is involved with others in environmental clean up of PCB contaminants at various sites as a potentially responsible party (PRP). The clean up effort is considered complete by the PRP's at several sites which are awaiting consent orders from the appropriate regulatory agencies. Future clean-up costs associated with these sites are not expected to be material.\nPortland General Electric Company\nHuman Resources\nAs of December 31, 1994, PGE had 2,502 regular employees, including 164 employees at Trojan. This compares to 2,577 and 3,157 regular PGE employees at December 31, 1993 and 1992, respectively.\nPortland General Holdings, Inc. - Nonutility Businesses\nGeneral\nPortland General Holdings, Inc. (Holdings) is a wholly-owned subsidiary of Portland General and is the parent company of Portland General's subsidiaries presently engaged in leveraged leasing and administrative services for electric futures trading. Holdings has provided organizational separation from PGE and financial flexibility and support for the operation of non-utility businesses. The assets and businesses of Holdings are its investments in its subsidiaries.\nLeasing\nColumbia Willamette Leasing\nColumbia Willamette Leasing (CWL) acquires and leases capital equipment on a leveraged basis. During 1994 and 1993, CWL made no new investments in leveraged leases. CWL's investment portfolio consists of six commercial aircraft, two container ships, 5,500 containers, coal, tank, and hopper railroad cars, a truck assembly plant, an acid treatment facility, and a wood chipping facility, totaling $153 million of net investment. No new investments are expected or planned for the foreseeable future.\nElectricity Trading Administrative Services\nTule Hub Services Company (Tule)\nTule, incorporated in Oregon during 1994, was created to provide administrative services to facilitate the trading of electric futures at the California-Oregon border. Tule is modeled after similar companies in the crude oil and natural gas industries which evolved as a result of deregulation and trading of related futures contracts.\nIndependent Power\nInvestment in Bonneville Pacific Corporation\nIn October 1990, Holdings purchased 20% of the common stock of Bonneville Pacific, an independent power producer headquartered in Salt\nLake City, Utah. Over the next six months, Holdings purchased additional shares of Bonneville Pacific common stock, increasing its investment to 46% of the outstanding stock. Holdings also has outstanding loans of $28 million to Bonneville Pacific and its subsidiaries. In November 1991, Portland General announced that it was halting further investments, and Holdings wrote off its equity investment in and loans to Bonneville Pacific. In addition, Holdings' representatives resigned from Bonneville Pacific's board of directors. These decisions were based in part on Bonneville Pacific underperforming expectations, the impairment of the investment in Bonneville Pacific and the inability of Bonneville Pacific to meet project sell-down commitments under the original purchase agreement. Bonneville Pacific has filed for protection under Chapter 11 of the Federal Bankruptcy\nCode. Holdings has instituted legal proceedings with regard to its investment in Bonneville Pacific. Numerous lawsuits have been filed in this matter by Bonneville Pacific and other parties since late 1991. See Note 13, Legal Matters, in the Notes to the Financial Statements and Item 3. Legal Proceedings for more information.\nReal Estate\nColumbia Willamette Development Company\nThe process of liquidating real estate projects was substantially completed during 1994. See Note 2, Real Estate - Discontinued Operations, in Notes to the Financial Statements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nPortland General Corporation\nDiscussion regarding nonutility properties is included in the previous section.\nPortland General Electric Company\nGenerating facilities owned by PGE are set forth in the following table:\nPGE holds licenses under the Federal Power Act (which expire during the years 2001 to 2006) for all of its hydroelectric generating plants and state licenses covering all or portions of certain plants. Following the 1993 closure, PGE has been granted a possession-only license amendment for Trojan by the NRC. In addition, in early 1995 PGE filed its Trojan decommissioning plan with the NRC.\nPGE's principal plants and appurtenant generating facilities and storage reservoirs are situated on land owned by PGE in fee or land under the control of PGE pursuant to valid existing leases, federal or state licenses, easements, or other agreements. In some cases meters and transformers are located upon the premises of customers. The Indenture securing PGE's first mortgage bonds constitutes a direct first mortgage lien on substantially all utility property and franchises, other than expressly excepted property.\nLeased Properties\nCombustion turbine generators at Bethel and Beaver are leased by PGE. These leases expire in 1999. PGE leases its headquarters complex in downtown Portland and the coal-handling facilities and certain railroad cars for Boardman.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNonutility\nGerhard W. Gohler, IRA, et al v. Robert L. Wood et al, U.S. District Court for the District of Utah\nThis case was originally filed on August 31, 1992 as the consolidation of various class actions filed on behalf of certain purchasers of Bonneville Pacific Corporation common (Bonneville Pacific) shares and subordinated debentures. In April 1994 the Court dismissed certain of the plaintiffs' claims and thereafter plaintiffs filed a second amended consolidated class action complaint. The defendants in the action are certain Bonneville Pacific insiders and other individuals associated with Bonneville Pacific, Portland General Corporation (Portland General), Portland General Holdings, Inc. (Holdings), certain Portland General individuals, Deloitte & Touche (Bonneville Pacific's independent auditors) and one of its partners, Mayer, Brown & Platt, a law firm used by Bonneville Pacific, and two partners of that firm, three underwriters of a Bonneville Pacific offerings of convertible subordinated debentures (Kidder, Peabody & Co., Piper Jaffray & Hopwood Incorporated, and Hanifen, Imhoff Inc.), and Norwest Bank, Minnesota, N.A., indenture trustee on a Bonneville Pacific's offering of convertible subordinated debentures. The amount of damages sought is not specified.\nThe claims asserted against Portland General, Holdings, and the Portland General individuals allege violations of federal and Utah state securities laws and of the Racketeer Influenced and Corrupt Organizations Act (RICO).\nFurther motions to dismiss have been filed in response to the amended complaint, however hearing on the motions of Portland General, Holdings, and the Portland General individuals has been deferred pending ongoing settlement discussions between those parties and the plaintiffs.\nRoger G. Segal, as the Chapter 11 Trustee for Bonneville Pacific Corporation v. Portland General Corporation, Portland General Holdings, Inc. et al, U.S. District Court for the District of Utah\nThis action was originally filed on April 24, 1992 by Bonneville Pacific against Portland General, Holdings, and certain individuals affiliated with Portland General or Holdings alleging breach of fiduciary duty, tortious interference, breach of contract, and other actionable wrongs related to Holdings' investment in Bonneville Pacific.\nOn August 2, 1993 an amended complaint was filed by the Bonneville Pacific bankruptcy trustee against Portland General, Holdings, certain individuals affiliated with Portland General or Holdings and over 50 other defendants unrelated to Portland General or Holdings. This complaint and another subsequent amended version were dismissed by the Court in whole or in part. The Trustee has currently on file his Fifth Amended Complaint. The complaint includes allegations of RICO violations and RICO conspiracy, collusive tort, civil conspiracy, common law fraud, negligent misrepresentation, breach of fiduciary duty, liability as a partner for the debts of partnership, and other actionable wrongs. Although the amount of damages sought is not specified in the Complaint, the Trustee has filed a damage disclosure calculation which purports to compute damages in amounts ranging from $340 million to $1 billion - subject to possible increase based on various factors. The Portland General parties have again filed motions to dismiss. Arguments were heard in December, 1994, and the motions are awaiting decision by the Court.\nPortland General Holdings, Inc. v. Deloitte & Touche, et al, Third Judicial District Court for Salt Lake County\nOn January 22, 1992, Holdings filed a complaint alleging Deloitte & Touche and certain individuals associated with Bonneville Pacific misrepresented the financial condition of Bonneville Pacific. The complaint alleges that Holdings relied on fraudulent statements and omissions by Deloitte & Touche and the individual defendants in acquiring a 46% interest in and making loans to Bonneville Pacific starting in September 1990. Holdings alleges, among other things, the existence of transactions in which generation projects developed or purchased by Bonneville Pacific were transferred at exaggerated valuations or artificially inflated prices to Bonneville Pacific's affiliated entities, Bonneville Pacific related parties or third parties. The suit claims that Bonneville Pacific's books, as audited by Deloitte & Touche, led Holdings to conclude wrongly that Bonneville Pacific's management was effective and could\nachieve the profitable sale of certain assets, as called for in Holdings purchase agreement with Bonneville Pacific. Holdings is seeking approximately $228 million in damages.\nThis case has been consolidated for all purposes with Portland General Holdings, Inc. v. Bonneville Group and Raymond L. Hixson noted below. Some of the defendants in the consolidated case have asserted counterclaims against Holdings. Certain counterclaims do not presently specify an amount of damages. The remaining counterclaims, taken together, seek approximately $80 million in specified and punitive damages. The Company believes the counterclaims have little merit.\nPortland General Holdings, Inc. v. The Bonneville Group and Raymond L. Hixson, Third Judicial District Court for Salt Lake County\nOn June 1, 1993 Holdings filed a complaint alleging The Bonneville Group and Raymond L. Hixson misrepresented the financial condition of Bonneville Pacific. The complaint contains substantially the same allegations against these defendants as claimed in Portland General Holdings, Inc. v. Deloitte & Touche, et al and seeks the same damages.\nUtility\nBPA v. WPPSS (WPPSS v. 88 Participants), U.S. District Court for the Western District of Washington\nCost Sharing Litigation On October 26, 1982 the Washington Public Power Supply System filed suit against Portland General Electric Company (PGE) and other entities that are participants in Supply System Units 1, 3, 4 and 5 (the Participants), and the Morgan Guaranty Trust Company of New York seeking a declaration of the respective rights and obligations of the parties for the proper allocation of shared costs between and among the various Supply System Units (the Cost-Sharing Litigation).\nWhile the Cost-Sharing Litigation was pending, the Supply System ceased work on Unit 3, the unit owned by PGE, Puget, PacifiCorp, and other investor owned utilities (IOUs) in common with the Supply System. In August 1983 PGE and two IOUs filed counterclaims, cross-claims, third-party claims and a motion for a preliminary injunction against the Supply System, BPA, and certain of the Participants.\nPGE and the IOUs also sought a declaratory judgment against the Supply System, PacifiCorp and the Unit 4 and 5 Participants requiring costs between Units 3 and 5 to be allocated in accordance with a 1976 Policy Statement or if the Policy Statement was found to be non-binding, damages from the Supply System and others for misrepresentations and omissions. Following decisions by the Washington Supreme Court that certain of the Unit 4 and 5 Participants were not responsible for Unit 4 and 5 costs, Chemical Bank, as trustee for the Unit 4 and 5 bondholders, intervened in this litigation.\nOn February 25, 1992 the Ninth Circuit Court of Appeals ruled in support of PGE and the IOUs. A trial remains necessary to assure that the allocations were properly performed.\nPGE has agreed to a tentative settlement in the case which would result in a $1 million payment by the Company. Any final settlement will require court approval.\nPGE v. Ronald Eachus, Myron Katz, Nancy Ryles (Oregon Public Utility Commissioners) and the Oregon Public Utility Commission, Marion County Circuit Court\nIn July 1990 PGE reached an out-of-court settlement with the Oregon Public Utility Commission (PUC) on two of three matters arising from the 1987 rate case. The settlement resolved the dispute regarding the treatment of certain investment tax credits and the 1986-1987 interim relief. The settlement did not resolve the issue related to the gain on PGE's sale of a portion of Boardman and the Intertie. On January 23, 1995, the judge affirmed the PUC decision allocating 77% of the gain to customers over a 27 year period. See Note 12, Regulatory Matters, in the Notes to the Financial Statements for more details. PGE has sixty days to appeal from the date of the decision.\nUtility Reform Project v. Oregon Public Utility Commission, Multnomah County Circuit Court\nOn February 18, 1992 the Utility Reform Project (URP) filed a complaint in Multnomah County Oregon Circuit Court asking the PUC to set aside and rescind PUC Order No. 91-1781 that authorized PGE a temporary rate increase to recover a portion of the excess power costs incurred during the 1991 Trojan outage. URP and the PUC agreed to stay the case pending PUC hearings on the PUC order. On February 22, 1992\nthe PUC issued an order approving the rate increase. The case is currently under a stay. PGE has not intervened in this case.\nPacificorp v. PGE, Columbia Steel Casting Co., Inc., and Public Utility Commission of Oregon, U.S. District Court for the District of Oregon\nIn 1972, PGE and PacifiCorp, dba Pacific Power & Light Company (PP&L) entered into an agreement (Agreement) subsequently approved by the PUC and the City of Portland, which PGE and the PUC believe created exclusive service territory for PGE and PP&L in defined areas within the City of Portland. Columbia Steel Casting Co. (Columbia Steel), an industrial customer of PGE located inside the area allocated to PGE, requested that PP&L provide it with electric service.\nOn May 31, 1990 PP&L filed a complaint for declaratory judgment in the US District Court for the District of Oregon seeking a determination of the respective rights and responsibilities of the parties under the Agreement and the Sherman Antitrust Act with regard to Columbia Steel's request. On June 19, 1990, Columbia Steel also filed a complaint in US District Court for the District of Oregon with regard to the allocation of the service territories between PGE and PP&L. (See Columbia Steel Casting Co., Inc. v. PGE, et al below.) These two cases were consolidated.\nOn July 2, 1990 PGE requested the PUC, the governmental agency charged with allocating the service territories among utilities, to affirm the exclusive territories allocated under the 1972 Agreement. Columbia Steel intervened.\nOn May 2, 1991 PGE and PP&L entered into an agreement to settle the District Court litigation filed by PP&L. The settlement provided, among other things, that the parties would file a joint application to the PUC for exclusive territories within the City of Portland and that PP&L would serve Columbia Steel in exchange for certain assets. On April 16, 1992 the PUC issued an order which corrected and affirmed the 1972 Order, approved the Agreement, and the 1992 territorial allocation agreement between PGE and PP&L.\nColumbia Steel requested reconsideration by the PUC of the 1992 Order, which the PUC denied on August 7, 1992.\nColumbia Steel Casting Co., Inc. v. PGE, Pacificorp, and Myron Katz, Nancy Ryles and Ronald Eachus, Ninth Circuit Court of Appeals\nOn June 19, 1990 Columbia Steel filed a complaint for declaratory judgment, injunctive relief and damages in U.S. District Court for the District of Oregon contending that the 1972 territory allocation agreement (Agreement) (see above case for background information) does not give PGE the exclusive right to serve them nor does it allow PP&L to deny service to them. Columbia Steel is seeking an unspecified amount in damages amounting to three times the excess power costs paid over a ten year period.\nOn July 3, 1991 the Court ruled that the Agreement did not allocate customers for the provision of exclusive services and that the 1972 order of the PUC approving the Agreement did not order the allocation of territories and customers.\nOn August 19, 1993 the Court ruled that Columbia Steel was entitled to receive from PGE approximately $1.3 million in damages which represented the additional costs incurred by Columbia Steel for electric service from July 1990 to July 1991, trebled, plus costs and attorney's fees. Both PGE and Columbia Steel have appealed the ruling.\nPortland General Electric Company v. Westinghouse Electric Corporation, U.S. District Court for the Western District of Pennsylvania\nOn February 17, 1993 PGE filed a complaint against Westinghouse Electric Corporation (Westinghouse), the manufacturer of Trojan's steam generators, alleging breach of contract, negligence, fraud, negligent misrepresentation and violation of federal and state racketeering statutes relating to Westinghouse's design, manufacture and installation of the steam generators.\nOn June 28, 1993 the Court dismissed PGE's claims of negligence and negligent misrepresentation. A Trial date has not been set.\nIn the Matter of Portland General Electric Company, U.S. Environmental Protection Agency\nPGE and the U.S. Environmental Protection Agency (EPA) have settled a civil complaint against PGE, for a nominal amount. The complaint alleged violations of environmental standard with\nrespect to storage of materials and related recordkeeping at a transmission substation.\nSouthern California Edison Company v. PGE, U.S. District Court for the District of Oregon\nOn August 3, 1994, Southern California Edison (SCE) filed a complaint in Multnomah County Circuit Court in Portland, Oregon claiming PGE's decision to close Trojan violated the terms of a long-term firm power sales and exchange agreement entered into in 1986. The 25-year contract is for 75 megawatts of firm energy and capacity plus a 225 megawatt seasonal exchange. Under the agreement SCE is obligated to pay to PGE a reservation fee for system capacity, seasonal exchange and other services equal to $16.9 million annually.\nSCE is seeking termination of the agreement and damages including a return of payments made to PGE from the date of PGE's alleged default (approximately $34 million).\nPGE has filed a petition with FERC asking FERC to assume jurisdiction and seeking a Declaratory Order and Motion for Summary Disposition. PGE also removed the case from the State court to federal court. Subsequent to removal, SCE filed a motion for remand to the state court. The motion was granted. PGE's motion for the state court to stay or dismiss the case pending a decision by FERC was denied. Trial in the state court has been set for October 1995.\nThe Company will vigorously defend itself and believes it will succeed in the defense of these claims.\nUtility Reform Project and Don't Waste Oregon Council v. Energy Facility Siting Council, Portland General Electric Company and Oregon Department of Fish and Wildlife, Supreme Court of the State of Oregon\nOn November 16, 1994 and November 17, 1994, Utility Reform Project (URP) and Don't Waste Oregon Council (DWOC), respectively, filed Petitions for Judicial Review of the order of the Energy Facility Siting Council (EFSC) granting a site certificate for the Coyote Springs Generation Plant. The Petitions have been consolidated. URP and DWOC seek to have the order remanded to EFSC for reconsideration. They allege that EFSC did not adequately address standards related to the need for power and financial assurances, and erred in its treatment of certain confidential information. Briefs have been filed and argument is set for early March.\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\nPortland General Corporation\nPortland General's common stock is publicly held and traded on the New York and Pacific Stock Exchanges. The table below reflects the dividends on Portland General's common stock and the stock price ranges as reported by The Wall Street Journal for 1994 and 1993.\nThe approximate number of shareholders of record as of December 31, l994 was 45,152.\nPortland General Electric Company\nPGE is a wholly owned subsidiary of Portland General. PGE's common stock is not publicly traded. Aggregate cash dividends declared on common stock were as follows (thousands of dollars):\nPGE is restricted, without prior PUC approval, from making any dividend distributions to Portland General that would reduce PGE's common equity capital below 36% of total capitalization.\nItem 6.","section_6":"Item 6. Selected Financial Data\nPortland General Corporation\nPortland General Electric Company\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Condition and Results of Operations\nGeneral\nResults of Operations\nPortland General Corporation (Portland General) reported 1994 earnings of $100 million or $1.99 per share. Portland General Electric (PGE or the Company), an electric utility company and Portland General's principal operating subsidiary, performed well, contributing $95 million to Portland General's earnings.\n1994 Compared to 1993\nPGE accounts for substantially all of Portland General's assets, revenues and net income. The following discussion focuses on utility operations, unless noted.\nPortland General's 1994 earnings of $100 million, $1.99 per share, compared favorably to 1993 earnings of $89 million, $1.88 per share. In 1994 previously recorded real estate reserves of $6 million, after tax, or $.13 per share, were restored to income as a result of the substantial completion of divestiture of real estate investments. Income from continuing operations was $93 million compared to $89 million in 1993.\nCustomer growth and increased wholesale activity resulted in strong energy sales for the year. Kilowatt-hour (kWh) sales increased 8% over the prior year, adding $60 million to revenues. Weather adjusted retail load grew approximately 2.5% with the addition of nearly 13,700 retail customers. Wholesale kWh sales escalated 69% reflecting the availability of low cost\npower for resale and the Company's active wholesale marketing of energy throughout the Western United States.\nAccrued revenues of $19 million, relating to power cost deferrals, were down substantially from the $67 million in 1993. PGE deferred for later collection a portion of incremental Trojan Nuclear Plant (Trojan) replacement power costs for nine months during 1993. Nuclear cost savings allowed PGE to operate the last nine months of 1994 without the need for additional power cost deferrals.\nAn 8% increase in total sales combined with a 14% decline in PGE's hydro generation contributed to a $35 million increase in variable power costs. Strong performance at PGE's thermal generating facilities allowed PGE to generate 47% of its total system load compared to 42% in 1993. Generation at coal fired plants increased 20%, with all plants producing above last year's levels. Despite the increased generation at its thermal plants, average fuel costs decreased by 4% due to low natural gas prices. These factors contributed to a reduction in total average variable power costs to 19.1 mills\/Kwh from 19.4 mills\/Kwh (10 mills = 1 cent) in 1993.\nOperating expenses (excluding variable power costs, depreciation, decommissioning and amortization) decreased by $24 million. Continued emphasis on cost reductions at Trojan resulted in $30 million in decreased nuclear operating expenses. Since plant closure in 1993, the number of PGE nuclear employees has dropped from 984 to 166 and correspondingly, annual nuclear operating expenses have declined from\napproximately $96 million to $15 million. Increases in operating costs on PGE's distribution system partially offset nuclear cost savings.\nThe $4 million increase in other income reflects an increase in accrued interest on deferred power costs and a gain on the sale of non-utility property, partially offset by provisions for litigation costs.\nAllowance for funds used during construction increased $4 million primarily due to the level of construction expenditures at the Coyote Springs Generation Project (Coyote Springs) in 1994, which helped offset increased interest costs on short-term borrowings.\n1993 Compared to 1992\nPortland General reported 1993 earnings of $89 million, $1.88 per share, compared to $90 million, $1.93 per share, in 1992. In 1992, upon approval from the Oregon Public Utility Commission (PUC), PGE applied capital treatment to $18 million of Trojan steam generator repair costs which were incurred in 1991. As a result, $11 million, after tax, was restored to 1992 earnings. Excluding this event, 1992 earnings would have been $79 million. Regulatory action, continued customer growth and cost reductions were the major contributors to the 1993 results.\nOperating revenues increased $64 million over 1992. In August 1993, the PUC authorized PGE to defer, for later collection, 50% of the incremental Trojan replacement power costs incurred from July 1, 1993, through March 31, 1994. This authorization, coupled with the 80% deferral in place for the period from December 4, 1992, to March 31, 1993, (see the Power Cost Recovery discussion in the Financial and Operating Outlook section below) allowed the Company to record $67 million of revenues related to the future recovery of replacement power costs.\nRetail load growth of 2.6% and cooler weather during the early part of the year increased Kwh sales 5% for 1993. Wholesale revenue declined $30 million due to the lack of low-cost power for resale.\nOperating expenses (excluding variable power costs, depreciation, decommissioning and amortization) declined 14% for 1993 due to a $53 million decline in nuclear expenses from closing Trojan. Nuclear operating expenses for 1993 reflect the amortization of Trojan miscellaneous closure and transition costs (which were accrued and capitalized at December 31, 1992). These costs are amortized as payments are made. During 1993 the Company amortized $45 million to nuclear operating expenses.\nVariable power costs increased $90 million in 1993. The average variable power cost increased from 15 mills per kWh in 1992 to 19 mills per Kwh in 1993. Trojan generated 16% of the Company's 1992 power needs at an average fuel cost of 4 mills per Kwh. This generation was primarily replaced by power purchases at an average price of 24 mills per Kwh. However, good performance at PGE's generating plants helped control the increase of variable power costs. PGE's Beaver plant operated well in 1993, generating 13% more power than in 1992. Company-owned hydro production rose 21%. Additional maintenance outage time caused generation at Units 3 and 4 of the Colstrip Coal Plant (Colstrip) to decline which slightly reduced the Company's 1993 thermal generation from the 1992 level (excluding Trojan). Fuel cost increased from 9 mills per Kwh to 10 mills per Kwh driving 1993 fuel expense up $5 million.\nDepreciation, decommissioning and amortization increased $24 million in 1993. The 1992 amount includes a credit of $18 million associated with the capitalization of 1991 Trojan steam generator repair costs discussed above. The remaining increase reflects depreciation charges for new plant placed in service.\nOther income increased slightly reflecting accrued interest on deferred charges and declining interest costs, partially offset by an increase in charitable contributions of approximately $4 million.\nCash Flow\nPortland General Corporation\nPortland General requires cash to pay dividends to its common stockholders, to provide funds to its subsidiaries, to meet debt service obligations and for day to day operations. Sources of cash are dividends from PGE, asset sales, leasing rentals, short- and intermediate-term borrowing, and the sale of Portland General's common stock.\nIn 1994 Portland General replaced its expiring committed borrowing facilities with a $15 million committed borrowing facility.\nPortland General received $62 million in dividends from PGE. In February 1994 Portland General issued 2.3 million shares of common stock. The $41 million of proceeds were used to purchase additional shares of PGE common stock. In addition, Portland General received $9 million in proceeds from the issuance of shares of common stock under its Dividend Reinvestment and Optional Cash Payment Plan.\nPortland General Electric Company\nCash Provided by Operations is the primary source of cash used for day to day operating needs of PGE. The Company also obtains cash from external borrowings, as needed.\nA significant portion of cash from operations comes from depreciation and amortization of utility plant, charges which are recovered in customer revenues but require no current cash outlay. Cash provided by operations increased primarily due to growth in operating revenues which were comprised of fewer non-cash revenues. This was partially offset by a related increase in tax payments and a $20 million prepayment made to the IRS (see below). Cash provided by operations increased slightly in 1993 as compared to 1992 reflecting lower income tax payments.\nFuture cash requirements may be affected by the ultimate outcome of the IRS audit of PGE's 1985 WNP-3 abandonment loss deduction. The IRS has issued a statutory notice of tax deficiency, which PGE is contesting. In September 1994, PGE made a $20 million prepayment to the IRS to mitigate the interest cost exposure, if any, related to the alleged tax deficiency. The prepayment is refundable with interest should PGE prevail. See Notes 4 and 4A, Income Taxes, in the Notes to Financial Statements for further information.\nInvesting Activities are primarily for generation, transmission and distribution facilities and energy efficiency improvements at PGE. PGE's capital expenditures for 1994 of $247 million were primarily for new generating resources and expansion and upgrade of its transmission and distribution system. PGE's capital expenditures for 1995 are expected to be at similar levels.\nCapital expenditures for distribution, system improvements and energy efficiency investmentsare expected to be approximately $180 million in 1996 . At this time the Company will proceed with obtaining required site permits for potential new generating resources but does not anticipate new construction in the foreseeable future.\nPGE pays $11 million per year into an external trust for the future costs of Trojan decommissioning.\nFinancing Activities provide supplemental cash for day-to-day operations and PGE's capital requirements. Internal funding will cover the majority of the Company's 1995 capital expenditures. PGE anticipates continued access to capital markets to finance the remainder.\nThe maturities of intermediate and long-term debt are chosen to match expected asset lives and maintain a balanced maturity schedule. Short-term debt, which includes commercial paper and lines of credit, is used for day- to-day operations.\nPGE has committed borrowing facilities of $120 million and $80 millon which are used primarily as backup for PGE's $200 million commercial paper facility.\nThe issuance of additional preferred stock and First Mortgage Bonds requires PGE to meet earnings coverage and security provisions set forth in the Articles of Incorporation and the Indenture securing its First Mortgage Bonds. As of December 31, 1994, PGE could issue $370 million of preferred stock and $430 million of additional First Mortgage Bonds.\nDuring 1994 PGE received proceeds of $41 million from the issuance of 2.3 million shares of $3.75 par value common stock to Portland General. PGE redeemed 200,000 shares of its $100 par value 8.10% preferred stock series.\nIn late 1994, the Company issued $30 million of three year notes and $45 million of seven year notes. PGE also borrowed $22 million against the assets of its Corporate Owned Life Insurance (COLI) program at variable rates. Proceeds from these activities were used to fund PGE's construction program.\nThe Company has engaged in the limited use of derivative financial instruments as a means of managing its exposure to interest rate fluctuations. The Company does not use these financial instruments for speculative purposes.\nIn November 1994, PGE entered into two $25 million interest rate swap agreements to hedge the cost of new long-term debt expected to be issued in mid-1995. See Note 8, Long-Term Debt in the Notes to Financial Statements for further discussion.\nFinancial and Operating Outlook\nGeneral Rate Filing\nIn late 1993, PGE filed a general rate case with the PUC requesting an increase in electric rates by an average of 5.1% to take effect January 1, 1995. PGE's request included a return on equity of 11.5% and 11.8% for the years 1995 and 1996 respectively, down from the current authorized return of 12.5%, and full recovery of the Trojan investment and decommissioning costs.\nIn early 1994 PGE and the PUC staff reached settlement on the majority of non-Trojan issues.\nIn July 1994, PGE agreed to the PUC staff's request to delay a final order addressing all rate case matters to no later than March 31, 1995 in return for approval of a first quarter 1995 power cost deferral. Recovery of power cost deferrals is addressed in separate rate proceedings, not in the general rate case (see the discussion of Power Cost Recovery below).\nIn early November 1994, PGE and the PUC staff entered into a stipulation jointly recommending to the PUC a settlement on all outstanding cost of capital issues which included an 11.6% return on equity for the years 1995 and 1996.\nThe PUC staff recommended that PGE be allowed to recover 100% of Trojan decommissioning and transition costs and 85.9% of the remaining Trojan investment. If the PUC staff's recommendation on Trojan were the ultimate outcome of the regulatory process, PGE estimates that it could record a loss of up to approximately $39 million. Hearings were held in January 1995 and PGE expects a rate order no later than March 31, 1995.\nTrojan Related Issues\nPlant Shutdown and Transition Costs - In early 1993, PGE ceased commercial operation of Trojan.\nSince plant closure PGE has committed itself to a safe and economical transition toward a decommissioned plant.\nTransition costs associated with operating and maintaining the spent fuel pool and securing the plant until dismantlement begins are estimated at $51 million for the period 1995 through 1998 inclusive. These costs are paid from current operating funds.\nInvestment Recovery - PGE's pending general rate case addresses recovery of Trojan plant costs (see General Rate Filing discussion above), including decommissioning. In the interim, the PUC authorized PGE to continue recovery of depreciation and decommissioning costs at previously approved rates.\nPGE made the decision to permanently cease commercial operation of Trojan as part of its least cost planning process. Management determined that continued operation of Trojan was not cost effective. Least cost analysis assumed that recovery of the Trojan plant investment, including future decommissioning costs, would be granted by the PUC. Regarding the authority of the PUC to grant recovery, the Oregon Department of Justice (Attorney General) issued an opinion that the PUC may allow rate recovery of total plant costs, including operating expenses, taxes, decommissioning costs, return of capital invested in the plant and return on the undepreciated investment. While the Attorney General's opinion does not guarantee recovery of costs associated with the shutdown, it does clarify that under current law the PUC has authority to allow recovery of such costs in rates.\nPGE asked the PUC to resolve certain legal and policy questions regarding the statutory framework for future ratemaking proceedings related to the recovery of the Trojan investment and decommissioning costs. In 1993, the PUC issued a declaratory ruling agreeing with the Attorney General's opinion discussed above. The ruling also stated that the PUC will favorably consider allowing PGE to recover in rates some or all of its return on and return of its undepreciated investment in Trojan, including decommissioning costs, if PGE meets certain conditions. PGE believes that its general rate filing provides evidence that satisfies the conditions established by the PUC.\nManagement believes that the PUC will grant future revenues to cover all, or substantially all, of Trojan plant costs with an appropriate return. However, recovery of the Trojan plant investment and decommissioning costs requires PUC approval in a public regulatory process. Although the PUC has allowed PGE to continue, on an interim basis, collection of these costs in the same manner as prescribed in its last general rate proceeding, the PUC has not previously addressed recovery of costs related to a prematurely retired plant when the decision to close the plant was based upon a least cost planning process. While the PUC Staff has recommended recovery of 85.9% of the Trojan investment and full recovery of decommissioning costs, the ultimate decision will be made by the PUC. Due to uncertainties inherent in a public process, management cannot predict, with certainty, whether the PUC will allow recovery of all, or substantially all, of the $342 million Trojan plant investment and $339 million of decommissioning costs. Management believes the ultimate outcome of this public regulatory process will not have a material adverse effect on the financial condition, liquidity or capital resources of Portland General. However, it may have a material impact on the results of operations for a future reporting period.\nPortland General's independent accountants are satisfied that management's assessment regarding the ultimate outcome of the regulatory process is reasonable. Due to the inherent uncertainties in the regulatory process discussed above, the magnitude of the amounts involved and the possible impact on the results of operations for a future reporting period, the independent accountants have added a paragraph to their audit report to give emphasis to this matter.\nDecommissioning - In January 1995 PGE submitted a decommissioning plan to the Nuclear Regulatory Commission (NRC) and Energy Facility Siting Council of Oregon (EFSC). PGE estimates the cost to decommission its share of Trojan is $351 million in nominal dollars (actual dollars expected to be spent in each year). The decommissioning cost estimate reflects expected cost savings from PGE's plan for the early removal of some of Trojan's large components. Since the large component removal project (LCRP) will be completed prior to NRC and EFSC approval of PGE's decommissioning plan, specific approval of the LCRP was obtained from EFSC in November 1994.\nThe decommissioning estimate represents a site specific decommissioning cost estimate performed for Trojan by an experienced decommissioning engineering firm. This cost estimate assumes that the majority of decommissioning activities will occur between 1997 and 2001, beginning with the removal of certain large plant components while\nconstruction of a temporary dry spent fuel storage facility is taking place. The plan anticipates final site restoration activities will begin in 2018 after PGE completes shipment of spent fuel to a United States Department of Energy (USDOE) facility. The federal repository which was originally scheduled to begin operations in 1998 is now estimated to commence no earlier than 2010. On-site storage capacity is able to accommodate fuel until the federal facilities are available.\nPGE collects revenues from customers for decommissioning costs and deposits them into an external trust fund. PGE expects any future changes in estimated decommissioning costs to be incorporated in revenues to be collected from customers.\nSCE Complaint - Southern California Edison (SCE) filed a complaint claiming PGE's decision to close Trojan violated the terms of a long-term firm power sales and exchange agreement under which SCE is obligated to pay to PGE a reservation fee equal to $16.9 million annually, through 2010. SCE is seeking termination of the agreement and damages.\nCompetition\nThe Energy Policy Act of 1992 and the California Public Utility Commission Industry Restructuring Proposal (Restructuring Proposal) have caused utilities to address their competitive environment. The 1994 Restructuring Proposal outlines an electric services industry in which consumers are gradually allowed direct access to generation suppliers, marketers, brokers and other service providers in the competitive marketplace for energy services.\nAlthough presently operating in a cost-based regulated environment, PGE expects increasing competition from other forms of energy and other suppliers of electricity. PGE's ownership of 950 megawatts of transmission rights on the Pacific Northwest Intertie (Intertie) provides it access to power and wholesale customers beyond its service territory.\nCustomer Growth and Revenues\nPGE's customer base grew by 13,700 retail customers in 1994, which led to a 2.5% increase in weather-adjusted retail Kwh sales. In 1994, 11,900 residential customers were added to the system\ncompared to 9,300 in 1993. The Company estimates retail load growth in 1995 to be approximately the same level as 1994. In addition, PGE plans to actively market wholesale energy throughout the Western United States.\nPower Cost Recovery\nPGE operates without a power cost adjustment tariff, therefore adjustments for power costs above or below those used in existing general tariffs are not automatically reflected in customers' rates. As a result, PGE has obtained PUC approval to defer incremental replacement power costs related to the closure of Trojan. The following table sets out the amounts deferred and the collection status of the 1993 and 1994 deferrals. In accordance with Oregon law, collection of the deferrals is subject to PUC review of PGE's reported earnings, adjusted for the regulatory treatment of unusual and\/or non- recurring items, as well as the determination of an appropriate rate of return on equity for a given review period.\nPower Supply\nPGE expects to generate approximately 50% of its 1995 load requirements from company owned resources. Coyote Springs, a 220 megawatt cogeneration facility under construction near Boardman, Oregon is expected to be completed and on-line in late 1995. PGE expects to purchase the remainder of its 1995 load requirement. Although early predictions of 1995 water conditions indicate they will be about 95% of normal, efforts to restore salmon runs on the Columbia and Snake Rivers may affect the supply and price of purchased power. Additional factors that could affect purchased power include weather conditions in the Northwest during winter months and in California and the Southwest during the summer months, and the performance of major generating facilities in those regions.\nRestoration of Salmon Runs - Several species of Snake River salmon are protected as threatened under the Endangered Species Act (ESA). The federal government has taken emergency actions that have reduced the amount of electricity generated at the Columbia and Snake River dams in an attempt to save the endangered fish. In January 1995 the National Marine Fisheries Service (NMFS) released a draft plan calling for altering the management of federal dams and reservoirs in the Columbia River basin in order to protect dwindling salmon stocks. The plan takes steps to boost river flows while young salmon are migrating and further reduces the water available for generation. NMFS is empowered by the ESA to require salmon protection measures by the Bureau of Reclamation and the Army Corps of Engineers, which operate the federal dams.\nThe Columbia river and its tributaries produce nearly two thirds of the electricity used in the region. PGE purchases power from many sources, including the mid-Columbia dams. Reductions in the amount of water allowed to flow through the dams' turbines reduces generation and increases the cost of power available to purchase on a non-contract or secondary basis. The attempt to improve fish passage by releasing more water from the reservoirs in the spring and summer could mean less water available in the fall and winter, when the demand for electricity in the Pacific Northwest is the highest. This could lead to higher power costs.\nHydro Relicensing - PGE's licenses for its hydroelectric generating plants under the Federal Power Act will expire during the years 2001 to 2006. PGE is actively pursuing relicensing of these low-cost power resources.\nFuel Supply\nNatural Gas - In addition to the agreements discussed below the Company utilizes short-term agreements and spot-market purchases to secure transportation capacity and gas supplies sufficient to fuel plant operations.\nPGE seeks to manage a portion of market risk associated with the fluctuations in the price of natural gas through its hedging program. PGE entered into hedge agreements to fix the price of a portion of the natural gas purchased to fuel operations at its Beaver plant during October 1994 through February 1995. Additional natural gas hedging activity is expected in 1995. The Company does not enter into natural gas hedging agreements for speculative purposes. See Note 9, Commitments in Notes to Financial Statements for further discussion.\nBeaver - PGE owns 90% of a pipeline which directly connects Beaver Beaver to Northwest Pipeline (NWP), an interstate gas pipeline operating between British Columbia and New Mexico. PGE presently has access to 30,000 MMBtu per day of firm capacity on NWP or enough to operate Beaver at approximately 30% of capacity. The contracted firm capacity on NWP increases in late 1995 to 76,000 MMBtu per day or enough to operate Beaver at approximately 70% capacity.\nCoyote Springs - During 1994 PGE took assignment of existing firm transportation capacity\non the interconnected systems of various shippers sufficient to deliver 41,000 MMBtu per day of natural gas from Alberta, Canada to Coyote Springs. This service should be sufficient to fuel 100% of plant operations and will start in late 1995 when the plant is expected to come on-line. In late 1995 PGE will begin purchasing under two-year contracts for the supply of natural gas to Coyote Springs at a 75% load factor.\nNonutility\nBonneville Pacific Litigation - Portland General, Portland General Holdings, Inc. (Holdings), and certain affiliated individuals, along with others, have been named as defendants in a class action by investors in Bonneville Pacific Corporation (Bonneville Pacific) and in a suit filed by the bankruptcy trustee for Bonneville Pacific. The class action includes allegations of various violations of federal and Utah securities laws and of the Racketeer Influenced and Corrupt Organizations Act (RICO). The suit by the bankruptcy trustee for Bonneville Pacific alleges RICO violations and RICO conspiracy, collusive tort, civil conspiracy, common law fraud, negligent misrepresentation, breach of fiduciary duty, liability as a partner for the debts of a partnership and other actionable wrongs.\nHoldings has filed a complaint seeking approximately $228 million in damages against Deloitte & Touche and certain parties associated with Bonneville Pacific alleging that it relied on fraudulent and negligent statements and omissions when it acquired a 46% interest in and made loans to Bonneville Pacific.\nA detailed report released in June 1992, by a U.S. Bankruptcy examiner outlined a number of questionable transactions that resulted in gross exaggeration of Bonneville Pacific's assets prior to Holdings' investment. This report includes the examiner's opinion that there was significant mismanagement and very likely fraud at Bonneville Pacific.\nFor background information and further details, see Note 13, Legal Matters in the Notes to Financial Statements.\nAppendix (Electronic Filing Only)\nOmitted graphic material:\nPage 8 Retail Price v. Inflation graph comparing PGE retail price (cents per KWh) to Portland CPI:\nRetail Price CPI 1985 5.12 106.7 1986 5.0 108.2 1987 4.93 110.9 1988 4.77 114.7 1989 4.69 120.3 1990 4.57 127.4 1991 4.69 134 1992 4.78 140 1993 4.86 143.6 1994 4.97 147.7\nPage 10 1994 Actual Power Sources pie chart: (megawatt hours)\nPGE Hydro: 10% (2,022,000) Coal: 24% (4,918,000) Secondary Purchases: 20% (4,036,000) Firm Purchases: 33% (6,905,000) Combustion Turbines: 13% (2,766,000)\nPage 11 1995 Forecasted Power Sources pie chart: (megawatt hours)\nPGE Hydro: 12% (2,356,000) Coal: 24% (4,810,000) Secondary Purchases: 16% (3,173,000) Firm Purchases: 34% (6,784,000) Combustion Turbines: 14% (2,912,000)\nPage 11 Loads v. Firm Resources graph: (average MW) Loads Firm Resources 1990 1973 2078 1991 2018 2071 1992 2138 2225 1993 2195 2022 1994 2350 1887 1995 2398 2068 1996 2431 2073 1997 2481 2017 1998 2531 2049 1999 2583 2038\nPage 24 Operating Revenue and Net Income (Loss) graph: ($ Millions): Operating Net Revenue Income 1990 852 100 1991 890 -50 1992 883 90 1993 947 89 1994 959 100\nPage 24 PGE Electricity Sales graph: (Billions of KWh)\n1990 Residential 6.4 Commercial 5.5 Industrial 3.6 Wholesale 4.3\n1991 Residential 6.5 Commercial 5.6 Industrial 3.6 Wholesale 3.9\n1992 Residential 6.3 Commercial 5.8 Industrial 3.6 Wholesale 2.7\n1993 Residential 6.8 Commercial 6.0 Industrial 3.8 Wholesale 1.6\n1994 Residential 6.7 Commercial 6.2 Industrial 3.9 Wholesale 2.7\nPage 25 Retail Revenues and Power Costs Graph: (Mills\/KWh)\nNet Variable Retail Power Revenues 1990 8 50 1991 10 52 1992 11 53 1993 17 56 1994 16 53\nPage 25 Operating Expenses graph: ($ Millions)\n1990 Operating Costs 302 Variable Power 200 Depreciation 90\n1991 Operating Costs 361 Variable Power 226 Depreciation 112\n1992 Operating Costs 327 Variable Power 222 Depreciation 99\n1993 Operating Costs 283 Variable Power 311 Depreciation 122\n1994 Operating Costs 262 Variable Power 347 Depreciation 124\nPage 26 Utility Capital Expenditures graph: ($ Millions)\n1990 115 1991 150 1992 159 1993 149 1994 247\nPage 27 Capitalization graph: ($ Millions)\n1990 Long-term Debt 763 Common Equity 771 Preferred Stock 152\n1991 Long-term Debt 913 Common Equity 679 Preferred Stock 150\n1992 Long-term Debt 874 Common Equity 724 Preferred Stock 152\n1993 Long-term Debt 803 Common Equity 744 Preferred Stock 140\n1994 Long-term Debt 806 Common Equity 834 Preferred Stock 120\nPage 29 Residential Customers graph: (Thousands) 1984 454732 1985 461076 1986 470136 1987 476481 1988 484293 1989 496165 1990 512913 1991 526699 1992 536111 1993 545410 1994 557338\nManagement's Statement of Responsibility\nPortland General Corporation's management is responsible for the preparation and presentation of the consolidated financial statements in this report. Management is also responsible for the integrity and objectivity of the statements. Generally accepted accounting principles have been used to prepare the statements, and in certain cases informed estimates have been used that are based on the best judgment of management.\nManagement has established, and maintains, a system of internal accounting controls. The controls provide reasonable assurance that assets are safeguarded, transactions receive appropriate authorization, and financial records are reliable.\nAccounting controls are supported by written policies and procedures, an operations planning and budget process designed to achieve corporate objectives, and internal audits of operating activities.\nPortland General's Board of Directors includes an Audit Committee composed entirely of outside directors. It reviews with management, internal auditors and independent auditors, the adequacy of internal controls, financial reporting, and other audit matters.\nArthur Andersen LLP is Portland General's independent public accountant. As a part of its annual audit, selected internal accounting controls are reviewed\nin order to determine the nature, timing and extent of audit tests to be performed. All of the corporation's financial records and related data are made available to Arthur Andersen LLP. Management has also endeavored to ensure that all representations to Arthur\nAndersen LLP were valid and appropriate.\nJoseph M. Hirko Vice President Finance, Chief Financial Officer, Chief Accounting Officer and Treasurer\nReport of Independent Public Accountants\nTo the Board of Directors and Shareholders of Portland General Corporation:\nWe have audited the accompanying consolidated balance sheets and statements of capitalization of Portland General Corporation and subsidiaries 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 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 more fully discussed in Note 5 to the consolidated financial statements, the realization of assets related to the abandoned Trojan Nuclear Plant in the amount of $681 million is dependent upon the ratemaking treatment as determined by the Public Utility Commission of Oregon.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Portland General 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.\nArthur Andersen LLP Portland, Oregon, February 7, 1995\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPortland General Corporation and Subsidiaries Notes to Financial Statements\nNote 1\nSummary of Significant Accounting Policies\nConsolidation Principles\nThe consolidated financial statements include the accounts of Portland General Corporation (Portland General) and all of its majority-owned subsidiaries. Significant intercompany balances and transactions have been eliminated.\nBasis of Accounting\nPortland General and its subsidiaries' financial statements conform to generally accepted accounting principles. In addition, Portland General Electric Company's (PGE or the Company) accounting policies are in accordance with the requirements and the ratemaking practices of regulatory authorities having jurisdiction.\nRevenues\nPGE accrues estimated unbilled revenues for services provided from the meter read date to month-end.\nPurchased Power\nPGE credits purchased power costs for the net amount of benefits received through a power purchase and sale contract with the Bonneville Power Administration (BPA). Reductions in purchased power costs that result from this exchange are passed directly to PGE's residential and small farm customers in the form of lower prices.\nDepreciation\nPGE's depreciation is computed on the straight-line method based on the estimated average service lives of the various classes of plant in service. Excluding the Trojan Nuclear Plant (Trojan), depreciation expense as a percent of the related average depreciable plant in service was approximately 3.8% in 1994, 3.9% in 1993 and 3.8% in 1992.\nThe cost of renewal and replacement of property units is charged to plant, and repairs and maintenance are charged to expense as incurred. The cost of utility property units retired, other than land, is charged to accumulated depreciation.\nAllowance for Funds Used During Construction (AFDC)\nAFDC represents the pretax cost of borrowed funds used for construction purposes and a reasonable rate for equity funds. AFDC is capitalized as part of the cost of plant and is credited to income but does not represent current cash earnings. The average rates used by PGE were 4.65%, 3.52%, and 4.72% for the years 1994, 1993 and 1992, respectively.\nIncome Taxes\nPortland General files a consolidated federal income tax return. Portland General's policy is to collect for tax liabilities from subsidiaries that generate taxable income and to reimburse subsidiaries for tax benefits utilized in its tax return.\nIncome tax provisions are adjusted, when appropriate, for potential tax adjustments. Deferred income taxes are provided for temporary differences between financial and income tax reporting. See Notes 4 and 4A, Income Taxes, for more details.\nAmounts recorded for Investment Tax Credits (ITC) have been deferred and are being amortized to income over the approximate lives of the related properties, not to exceed 25 years.\nNuclear Fuel\nAmortization of nuclear fuel (reflected only in 1992 expenses) was based on the quantity of heat produced for the generation of electric energy.\nInvestment in Leases\nColumbia Willamette Leasing (CWL), a subsidiary of Portland General Holdings, Inc. (Holdings), acquires and leases capital equipment. Leases that qualify as direct financing leases and are substantially financed with nonrecourse debt at lease inception are accounted for as leveraged leases. Recorded investment in leases is the sum of the net contracts receivable and the estimated residual value, less unearned income and deferred ITC. Unearned income and deferred ITC are amortized to income over the life of the leases to provide a level rate of return on net equity invested.\nThe components of CWL's net investment in leases as of December 31, 1994 and 1993, are as follows (thousands of dollars):\nCash and Cash Equivalents\nHighly liquid investments with original maturities of three months or less are classified as cash equivalents.\nWNP-3 Settlement Exchange Agreement\nThe Washington Public Power Supply System Unit 3 (WNP-3) Settlement Exchange Agreement, which has been excluded from PGE's rate base, is carried at present value and amortized on a constant return basis.\nRegulatory Assets\nPGE defers, or accrues revenue for, certain costs which would otherwise be charged to expense, if it is probable that future rates will permit recovery of such costs. These costs are reflected as deferred charges or accrued revenues in the financial statements and are amortized over the period in which revenues are collected. Trojan plant and decommissioning costs are currently covered in customer rates. Of the remaining regulatory assets of approximately $500 million, 78% have been treated by the Oregon Public Utility Commission (PUC) as allowable cost of service items in PGE's most recent rate processes. The remaining amounts, primarily comprised of power cost deferrals, are subject to regulatory confirmation in future ratemaking proceedings.\nHedge Accounting\nPGE may use derivative products to hedge against exposures to interest rate and commodity price risks. The objective is to mitigate risks due to market fluctuations associated with external financings or the purchase of natural gas, electricity and related products. PGE's hedging programs are intended to reduce such risks.\nGains and losses from derivatives that reduce commodity price risks are recognized as fuel or purchased power expense. Gains and losses from derivatives that reduce interest rate risk of future debt issuances are deferred and amortized over the life of the related debt.\nReclassifications\nCertain amounts in prior years have been reclassified for comparative purposes.\nNote 2\nReal Estate - Discontinued Operations\nPortland General has substantially completed divestiture of its real estate operations in Columbia Willamette Development Company (CWDC). In June 1994, CWDC sold the largest remaining property in its real estate holdings for\n$16 million. As a result, the real estate reserve was liquidated.\nNote 3\nEmployee Benefits\nPension Plan\nPortland General has a non-contributory pension plan (the Plan) covering substantially all of its employees. Benefits under the Plan are based on years of service, final average pay and covered compensation. Portland General's policy is to contribute annually to the Plan 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 Plan's assets are held in a trust and consist primarily of investments in common stocks, corporate bonds and US government issues.\nPortland General determines net periodic pension expense according to the principles of SFAS No. 87, Employers' Accounting for Pensions. Differences between the actual and expected return on plan assets is included in net amortization and deferral and is considered in the determination of future pension expense.\nThe following table sets forth the Plan's funded status and amounts recognized in Portland General's financial statements (thousands of dollars):\nNet pension expense for 1994, 1993 and 1992 included the following components (thousands of dollars):\nOther Post-Retirement Benefit Plans Portland General accrues for health, medical and life insurance costs during the employees' service years, per SFAS No. 106. PGE receives recovery for the annual provision in customer rates. Employees are covered under a Defined Dollar Medical Benefit Plan which limits Portland General's obligation by establishing a maximum contribution per employee. The accumulated benefit obligation for postretirement health and life insurance benefits at December 31, 1994 was $27 million, for which there were $25 million of assets held in trust. The benefit obligation for postretirement health and life insurance benefits at December 31, 1993 was $31 million.\nPortland General also provides senior officers with additional benefits under an unfunded Supplemental Executive Retirement Plan (SERP). Projected benefit obligations for the SERP are $15 million and $16 million at December 31, 1994 and 1993, respectively.\nDeferred Compensation\nPortland General provides certain employees with benefits under an unfunded Management Deferred Compensation Plan (MDCP). Obligations for the MDCP are $21 million and $18 million at December 31, 1994 and 1993, respectively.\nEmployee Stock Ownership Plan\nPortland General has an Employee Stock Ownership Plan (ESOP) which is a part of its 401(k) retirement savings plan. Employee contributions up to 6% of base pay are matched by employer contributions in the form of ESOP common stock. Shares of common stock to be used to match contributions of PGE employees were purchased from a $36 million loan from PGE to the ESOP trust in late 1990. This loan is presented in the common equity section as unearned compensation. Cash contributions from PGE and dividends on shares held in the trust are used to pay the debt service on PGE's loan. As the loan is retired, an equivalent amount of stock is allocated to employee accounts. In 1994, total contributions to the ESOP of $5 million combined with dividends on unallocated shares of $1 million were used to pay debt service and interest on PGE's loan. Shares of common stock used to match contributions by employees of Portland General and its subsidiaries are purchased on the open market.\nNote 4\nNote 5\nTrojan Nuclear Plant\nPlant Shutdown and Transition Costs - PGE is the 67.5% owner of Trojan. In early 1993 PGE ceased commercial operation of Trojan. Since plant closure PGE has committed itself to a safe and economical transition toward a decommissioned plant.\nTransition costs associated with operating and maintaining the spent fuel pool and securing the plant until dismantlement begins are estimated at $51 million for the period 1995 through 1998 inclusive. These costs are recorded as part of the Trojan decommissioning reserve and transition costs on the Company's balance sheet. Unlike decommissioning costs which will utilize funds from PGE's Nuclear Decommissioning Trust (NDT), transition costs are paid from current operating funds.\nDecommissioning - In January 1995 PGE submitted a decommissioning plan to the Nuclear Regulatory Commission (NRC) and Energy Facility Siting Council of Oregon (EFSC). The plan estimates PGE's cost to decommission Trojan at $351 million reflected in nominal dollars (actual dollars expected to be spent in each year). The decommissioning estimate represents a site specific decommissioning cost estimate performed for Trojan by an experienced decommissioning engineering firm. This cost estimate assumes that the majority of decommissioning activities will occur between 1997 and 2001, beginning with the removal of certain large plant components while construction of a temporary dry spent fuel storage facility is taking place. The plan anticipates final site restoration activities will begin in 2018 after PGE completes shipment of spent fuel to a United States Department of Energy (USDOE) facility (see the Nuclear Fuel Disposal discussion below).\nAs noted above, the decommissioning plan reflects PGE's current efforts to remove some of Trojan's large components which is expected to result in overall decommissioning cost savings. Since the Trojan large component removal project (LCRP) will be completed prior to NRC and EFSC approval of PGE's formal decommissioning plan, specific approval of the LCRP was obtained from EFSC in November 1994.\nDecommissioning activities reflected in the cost estimate include the cost of\ndecommissioning planning, removal and disposal of radioactively contaminated equipment and facilities as required by the NRC; building demolition; nonradiological site remediation; and extended fuel management costs including licensing and surveillance through the year 2018.\nThe Trojan decommissioning plan filed with the NRC was the culmination of a two-year process undertaken by PGE to evaluate the most economical way to safely decommission Trojan in a regulated environment. Both the 1994 update and the 1993 site specific cost estimates are reflected in the financial statements in nominal dollars (actual dollars expected to be spent in each year). The $17 million difference between the 1993 $334 million estimate and the 1994 $351 million estimate, stated in nominal dollars, is due to refinement of the timing and scope of certain dismantlement activities. Stated in 1994 dollars the current estimate of $234 million is not significantly changed from the previous estimate of $230 million.\nFollowing is a reconciliation of the decommissioning cost estimate from December 31, 1992 to December 31, 1994 (thousands of dollars):\nPGE expects any future changes in estimated decommissioning costs to be incorporated in future revenues to be collected from customers. PGE collects revenues from customers for decommissioning costs and deposits them into an\nexternal trust fund. Earnings on the trust fund will be used to adjust the amount of decommissioning costs to be collected from customers.\nTrojan decommissioning trust assets are invested primarily in investment grade tax- exempt bonds which are available for sale. Year-end balances are valued at market which approximates cost. For the year ended December 31, 1994 and 1993 the trust reflected the following activity (thousands of dollars):\nInvestment Recovery - PGE filed a general rate case on November 8, 1993 which addresses recovery of Trojan plant costs, including decommissioning. In late February 1993 the PUC granted PGE accounting authorization to continue using previously approved depreciation and decommissioning rates and lives for its Trojan investment.\nPGE made the decision to permanently cease commercial operation of Trojan as part of its least cost planning process. Management determined that continued operation of Trojan was not cost effective. Least cost analysis assumed that recovery of the Trojan plant investment, including future decommissioning costs, would be granted by the PUC. Regarding the authority of the PUC to grant recovery, the Oregon Department of Justice (Attorney General) issued an opinion that the PUC may allow rate recovery of total plant costs, including operating expenses, taxes, decommissioning costs, return of capital invested in the plant and return on the undepreciated investment. While the Attorney General's opinion does not guarantee recovery of costs associated with the shutdown, it does clarify that under current law the PUC has authority to allow recovery of such costs in rates.\nPGE asked the PUC to resolve certain legal and policy questions regarding the statutory framework for future ratemaking proceedings related to the recovery of the Trojan investment and decommissioning costs. On August 9, 1993, the PUC issued a declaratory ruling agreeing with the Attorney General's opinion discussed above. The ruling also stated that the PUC will favorably consider allowing PGE to recover in rates some or all of its return on and return of its undepreciated investment in Trojan, including decommissioning costs, if PGE meets certain conditions. PGE believes that its general rate filing provides evidence that satisfies the conditions established by the PUC.\nManagement believes that the PUC will grant future revenues to cover all, or substantially all, of Trojan plant costs with an appropriate return. However, recovery of the Trojan plant investment and decommissioning costs requires PUC approval in a public regulatory process. Although the PUC has allowed PGE to continue, on an interim basis, collection of these costs in the same manner as prescribed in its last general rate proceeding, the PUC has not previously addressed recovery of costs related to a prematurely retired plant when the decision to close the plant was based upon a least cost planning process. While the PUC Staff has recommended recovery of 85.9% of the Trojan investment and full recovery of decommissioning costs, the ultimate decision will be made by the PUC. If the PUC staff's recommendation on Trojan were the ultimate outcome of the regulatory process, PGE estimates that it could record a loss of up to approximately $39 million. Due to uncertainties inherent in a public process, management cannot predict, with certainty, whether the PUC will allow recovery of all, or substantially all, of the $342 million Trojan plant investment and $339 million of decommissioning costs. Management believes the ultimate outcome of this public regulatory process will not have a material adverse effect on the financial condition, liquidity or capital resources of Portland General. However, it may have a material impact on the results of operations for a future reporting period.\nPortland General's independent accountants are satisfied that management's assessment regarding the ultimate outcome of the regulatory process is reasonable. Due to the inherent uncertainties in the regulatory process discussed above, the magnitude of the amounts involved and the possible impact on the results of operations for a future reporting period, the independent accountants have added a paragraph to their audit report to give emphasis to this matter.\nNuclear Fuel Disposal and Clean up of Federal Plants - PGE contracted with the USDOE for permanent disposal of its spent nuclear fuel in USDOE facilities at a cost of .1 cent per net kilowatt-hour sold at Trojan which PGE pre- paid during the period of Trojan's operations. Significant\ndelays are expected in the USDOE acceptance schedule of spent nuclear fuel from domestic utilities. The federal repository which was originally scheduled to begin operations in 1998 is now estimated to commence no earlier than 2010. Based on this projection, PGE anticipates the possibility of difficulties in disposing of its high-level radioactive waste by 2018. However, on-site storage capacity is able to accommodate fuel until the federal facilities are available.\nThe Energy Policy Act of 1992 provided for the creation of a Decontamination and Decommissioning Fund (DDF) to provide for the clean up of the USDOE gas diffusion plants. The DDF is to be funded by domestic nuclear utilities and the Federal Government. The legislation provided that each utility pays based on the ratio of the amount of enrichment services the utility purchased to\nthe total amount of enrichment services purchased by all domestic utilities prior to the enactment of the legislation. Based on Trojan's 1.1% usage of total industry enrichment services, PGE's portion of the funding requirement is approximately $17.3 million. Amounts are funded over 15 years beginning with the USDOE's fiscal year 1993. Since enactment PGE has made the first three of the 15 annual payments with the first annual payment made in September 1993.\nNuclear Insurance - The Price-Anderson Amendment of 1988 limits public liability claims that could arise from a nuclear incident to a maximum of $9.0 billion per incident. PGE has purchased the maximum primary insurance coverage currently available of $200 million. The remaining $8.8 billion is covered by secondary financial protection required by the NRC. This secondary coverage provides for loss sharing among all owners of nuclear reactor licenses.\nIn the event of an incident at any nuclear plant in which the amount of the loss exceeds $200 million, PGE could be assessed retrospective premiums of up to $53.5 million per incident, limited to a maximum of $6.75 million per incident in any one year under the secondary financial protection coverage.\nBased upon Trojan's permanently defueled condition and following the NRC and other regulators' approval, PGE and co-owners carry property insurance coverage on the Trojan plant in the amount of $155 million and self- insure for on-site decontamination.\nNote 6\nCommon Stock As of December 31, 1994, Portland General had reserved 2,872,476 authorized but unissued common shares for issuance under its dividend reinvestment plan. In addition, new shares of common stock are issued under an employee stock purchase plan.\nCumulative Preferred Stock of Subsidiary No dividends may be paid on common stock or any class of stock over which the preferred stock has priority unless all amounts required to be paid for dividends and sinking\nfund payments have been paid or set aside, respectively.\nThe 7.75% Series preferred stock has an annual sinking fund requirement which requires the redemption of 15,000 shares at $100 per share beginning in 2002. At its option, PGE may redeem, through the sinking fund, an additional 15,000 shares each year. All remaining shares shall be mandatorily redeemed by sinking fund in 2007. This Series is only redeemable by operation of the sinking fund.\nThe 8.10% Series preferred stock has an annual sinking fund requirement which requires the redemption of 100,000 shares at $100 per share which began in 1994. At its option, PGE may redeem, through the sinking fund, an additional 100,000 shares each year. This Series is redeemable at the option of PGE at $102 per share to April 14, 1995 and at reduced amounts thereafter.\nCommon Dividend Restriction of Subsidiary PGE is restricted from paying dividends or making other distributions to Portland General, without prior PUC approval, to the extent such payment or distribution would reduce PGE's common stock equity capital below 36% of its total capitalization. At December 31, 1994, PGE's common stock equity capital was 47% of its total capitalization.\nStock Compensation Plans Portland General has a plan under which 2.3 million shares of Portland General common stock are available for stock-based incentives. Upon termination, expiration or lapse of certain types of awards, any shares remaining subject to the award are again available for grant under the plan. As of December 31, 1994, stock options for 835,300 shares of common stock were outstanding. Options for 15,000 shares are currently exercisable: 2,500 at $17.375 per share; 7,500 at $14.75 per share and 5,000 shares at $17.125 per share. The options for the remaining 820,300 shares are exercisable beginning in 1995 through 1999 at prices ranging from $13 to $22.25 per share.\nDuring 1994, Portland General issued 60,882 restricted common shares for officers and selected employees of both Portland General and PGE. As of December 31, 1994, 120,882 restricted common shares under the plan were outstanding for officers and employees.\nNote 7\nShort-Term Borrowings\nAt December 31, 1994, Portland General had total committed lines of credit of $215 million. Portland General has a $15 million committed facility expiring in July 1995. PGE has committed facilities of $120 million expiring in July 1997 and $80 million expiring in July 1995. These lines of credit have annual fees ranging from 0.125% to 0.15% and do not require compensating cash balances. The facilities are used primarily as backup for both commercial paper and borrowings from commercial banks under uncommitted lines of credit. At December 31, 1994, there were no outstanding borrowings under the committed facilities.\nPGE has a $200 million commercial paper facility. Unused committed lines of credit must be at least equal to the amount of PGE's commercial paper outstanding.\nCommercial paper and lines of credit borrowings are at rates reflecting current market conditions and, generally, are substantially below the prime commercial rate.\nShort-term borrowings and related interest rates were as follows (thousands of dollars):\nNote 8\nInterest Rate Swap Agreements\nIn November 1994, PGE entered into two 10 year forward interest rate swap agreements, each with a notional amount of $25 million. The agreements are used to hedge against interest rate movements on long-term debt which PGE anticipates issuing in mid- 1995. PGE is committed to terminate the agreements on or before May 15, 1995.\nPGE is exposed to credit risks in the event of nonperformance by the counterparties to these interest rate swap agreements. PGE anticipates that the counterparties will be able to fully satisfy their obligations.\nNote 9\nCommitments\nNatural Gas Agreements PGE has two long-term agreements for transmission of natural gas from domestic and Canadian sources to PGE's existing and proposed natural gas-fired generating facilities. One agreement provides PGE firm pipeline capacity beginning June, 1993 and increased pipeline capacity in November 1995. The second agreement will give PGE capacity on a second interstate gas pipeline. Under the terms of these two agreements, PGE is committed to paying capacity charges of approximately $5 million during 1995, $14 million annually in 1996 through 1999, and $140 million over the remaining years of the contract which expires in 2015. Under these agreements PGE has the right to assign unused capacity to other parties. In addition, PGE will make a capital contribution for pipeline construction of approximately $3 million in 1995.\nFor the period of October 1994 through February 1995, PGE hedged an average of 38,000 MMBtus per day of physical gas purchases which represented approximately 40% of gas usage for the period. The effect of these agreements was to fix the prices of gas.\nRailroad Service Agreement\nIn October 1993, PGE entered into a railroad service agreement to deliver coal from Wyoming to the Boardman Coal Plant (Boardman) and is required to contribute $7 million over the 5 years remaining in the contract.\nPurchase Commitments\nOther purchase commitments outstanding (principally construction at PGE) totaled approximately $69 million at December 31, 1994. Cancellation of these purchase agreements could result in cancellation charges.\nPurchased Power\nPGE has long-term power purchase contracts with certain public utility districts in the state of Washington and with the City of Portland, Oregon. PGE is required to pay its proportionate share of the operating and debt service costs of the hydro projects whether or not they are operable.\nSelected information is summarized as follows (thousands of dollars):\nPGE's share of debt service costs, excluding interest, will be approximately $6 million for 1995 and 1996, $7 million for 1997, and $6 million for 1998 and 1999. The minimum payments through the remainder of the contracts are estimated to total $97 million.\nPGE has entered into long-term contracts to purchase power from other utilities in the west. These contracts will require fixed payments of up to $67 million in 1995, $32 million in 1996, and $22 million in 1997. After that date, capacity contract charges will be up to $25 million annually until 2001. From 2001 until 2016 capacity charges total $19 million annually.\nLeases\nPGE has operating and capital leasing arrangements for its headquarters complex, combustion turbines and the coal-handling facilities and certain railroad cars for Boardman. PGE's aggregate rental payments charged to expense amounted to $22 million in 1994 and 1993, and $20 million in 1992. PGE has capitalized its combustion turbine leases. However, these leases are considered operating leases for ratemaking purposes.\nIncluded in the future minimum operating lease payments schedule above is approximately $135 million for PGE's headquarters complex.\nNote 10\nWNP-3 Settlement Exchange Agreement\nPGE is selling energy received under a WNP-3 Settlement Exchange Agreement (WSA) to the Western Area Power Administration (WAPA) for 25 years, which began October 1990. Revenues from the WAPA sales contract are expected to be sufficient to support the carrying value of PGE's investment.\nThe energy received by PGE under WSA is the result of a settlement related to litigation surrounding the abandonment of WNP-3. PGE receives about 65 average annual megawatts for approximately 30 years from BPA under the WSA. In exchange PGE will make available to BPA energy from its combustion turbines or from other available resources at an agreed- to price.\nNote 11\nJointly-Owned Plant\nAt December 31, 1994, PGE had the following investments in jointly-owned generating plants (thousands of dollars):\nNote 12\nRegulatory Matters\nPublic Utility Commission of Oregon PGE had sought judicial review of three rate matters related to a 1987 general rate case. In July 1990 PGE reached an out-of-court settlement with the PUC on two of the three rate matter issues being litigated. The settlement resolved the dispute with the PUC regarding treatment of accelerated amortization of certain investment tax credits and 1986-1987 interim relief.\nThe settlement, however, did not resolve the issue related to the gain on PGE's sale of a portion of Boardman and the Intertie. PGE's position is that 28% of the gain should be allocated to customers. The 1987 rate order allocated 77% of the gain to customers over a 27-year period. In accordance with the 1987 rate order, the unamortized gain, $119 million at December 31, 1994, is being distributed as a reduction of customer revenue requirements .\nOn January 23, 1995 the Marion County Circuit Court affirmed the PUC's decision in the 1987 rate order discussed above. PGE has sixty days from the date of the decision to appeal.\nNote 13\nLegal Matters\nWNP Cost Sharing PGE and three other investor-owned utilities (IOUs) are involved in litigation surrounding the proper allocation of shared costs between Washington Public Power Supply System (Supply System) Units 1 and 3 and Units 4 and 5. A court ruling, issued in May 1989, stated that Bond Resolution No. 890, adopted by the Supply System, controlled disbursement of proceeds from bonds issued for the construction of Unit 5, including the method for allocation of shared costs. It is the IOUs' contention that at the time the project commenced there was agreement among the parties as to the allocation of shared costs and that this agreement and the Bond Resolution are consistent, such that the allocation under the agreement is not prohibited by the Bond Resolution.\nIn February 1992, the Court of Appeals ruled that shared costs between Units 3 and 5 should be allocated in proportion to benefits under the equitable method supported by PGE and the IOUs. A trial remains necessary to assure that the allocations are properly performed.\nPGE has agreed to a tentative settlement in the case which would result in a $1 million payment by the Company. Any final settlement will require court approval.\nBonneville Pacific Class Action and Lawsuit A complaint was originally filed on August 31, 1992 as the consolidation of various class actions filed on behalf of certain purchasers of Bonneville Pacific Corporation common shares and subordinated debentures. In April 1994 the Court dismissed certain of the plaintiffs' claims and thereafter plaintiffs filed a second amended consolidated class action complaint. The defendants in the action are certain Bonneville Pacific Corporation insiders and other individuals associated with Bonneville Pacific, Portland General Corporation (Portland General), Portland General Holdings, Inc. (Holdings), certain Portland General individuals, Deloitte & Touche (Bonneville's independent auditors) and one of its partners, Mayer, Brown & Platt, a law firm used by Bonneville, and two partners of that firm, three underwriters of a Bonneville offering of convertible subordinated debentures (Kidder, Peabody & Co., Piper Jaffray & Hopwood Incorporated, and Hanifen, Imhoff Inc.), and Norwest Bank, Minnesota, N.A., indenture trustee on a Bonneville Pacific's offering of convertible subordinated debentures. The amount of damages sought is not specified.\nThe claims asserted against Portland General, Holdings, and the Portland General individuals allege violations of federal and Utah state securities laws and of Racketeer Influenced and Corrupt Organizations Act (RICO).\nFurther motions to dismiss have been filed in response to the amended complaint, however hearing on the motions of Portland General, Holdings, and the Portland General individuals has been deferred pending ongoing settlement discussions between those parties and the plaintiffs.\nA separate legal action was filed on April 24, 1992 by Bonneville Pacific Corporation against Portland General, Holdings, and certain individuals affiliated with Portland General or Holdings alleging breach of fiduciary duty, tortious\ninterference, breach of contract, and other actionable wrongs related to Holdings' investment in Bonneville Pacific. On August 2, 1993 an amended complaint was filed by the Bonneville Pacific bankruptcy trustee against Portland General or Holdings and over 50 other defendants unrelated to Portland General or Holdings. This complaint and another subsequent amended version were dismissed by the Court in whole or in part. The Trustee has currently on file his Fifth Amended Complaint. The complaint includes allegations of RICO violations and RICO conspiracy, collusive tort, civil conspiracy, common law fraud, negligent misrepresentation, breach of fiduciary duty, liability as a partner for the debts of a partnership, and other actionable wrongs. Although the amount of damages sought is not specified in the Complaint, the Trustee has filed a damage disclosure calculation which purports to compute damages in amounts ranging from $340 million to $1 billion - subject to possible increase based on various factors. The Portland General parties have again filed motions to dismiss. Arguments were heard in December, 1994, and the motions are awaiting decision by the Court.\nOther Legal Matters Portland General and certain of its subsidiaries are party to various other claims, legal actions and complaints arising in the ordinary course of business. These claims are not considered material.\nSummary While the ultimate disposition of these matters may have an impact on the results of operations for a future reporting period, management believes, based on discussion of the underlying facts and circumstances with legal counsel, that these matters will not have a material adverse effect on the financial condition of Portland General.\nOther Bonneville Pacific Related Litigation Holdings filed complaints seeking approximately $228 million in damages in the Third Judicial District Court for Salt Lake County (Utah) against Deloitte & Touche and certain other parties associated with Bonneville Pacific alleging that it relied on fraudulent and negligent statements and omissions by Deloitte & Touche and the other defendants when it acquired a 46% interest in and made loans to Bonneville Pacific starting in September 1990.\nNote 14\nFair 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\nThe carrying amount of cash and cash equivalents approximates fair value because of the short maturity of those instruments.\nOther investments\nOther investments approximate market value.\nRedeemable preferred stock\nThe fair value of redeemable preferred stock is based on quoted market prices.\nLong-term debt\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 Portland General for debt of similar remaining maturities.\nInterest Rate\/Natural Gas Hedging\nThe fair value of interest rate and natural gas derivatives is the estimated amount that the Company would receive or pay to terminate the agreements at the reporting date, taking into account current market rates. At year-end 1994 this amount was not material.\nThe estimated fair values of financial instruments are as follows (thousands of dollars):\nPortland General Electric Company\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPart III\nItems 10-13 Information Regarding Directors and Executive Officers of the Registrant\nPortland General Corporation\nPart IV\nItem 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.\nPortland General Corporation\nMarch 2, 1995 By \/s\/ Ken L. Harrison\nKen L. Harrison\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.\nChairman of the Board and \/s\/ Ken L. Harrison Chief Executive Officer March 2, 1995 Ken L. Harrison\nVice President Finance, Chief Financial Officer, Chief Accounting Officer \/s\/ Joseph M. Hirko and Treasurer March 2, 1995 Joseph M. Hirko\n*Gwyneth Gamble Booth *Peter J. Brix *Carolyn S. Chambers *John W. Creighton, Jr. *Ken L. Harrison *Jerry E. Hudson Directors March 2, 1995 *Warren E. McCain *Jerome J. Meyer *Randolph L. Miller *Richard G. Reiten *Bruce G. Willison\n*By \/s\/ Joseph E. Feltz (Joseph E. Feltz, 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.\nPortland General Electric Company\nMarch 2, 1995 By \/s\/ Ken L. Harrison Ken L. Harrison\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.\nChairman of the Board and \/s\/ Ken L. Harrison Chief Executive Officer March 2, 1995 Ken L. Harrison\nVice President Finance Chief Financial Officer, Chief Accounting Officer \/s\/ Joseph M. Hirko and Treasurer March 2, 1995 Joseph M. Hirko\n*Gwyneth Gamble Booth *Peter J. Brix *Carolyn S. Chambers *John W. Creighton, Jr. *Ken L. Harrison *Jerry E. Hudson Directors March 2, 1995 *Warren E. McCain *Jerome J. Meyer *Randolph L. Miller *Bruce G. Willison\n*By \/s\/ Joseph E. Feltz (Joseph E. Feltz, Attorney-in-Fact)\nNote: Although the Exhibits furnished to the Securities and Exchange Commission with the Form 10-K have been omitted herein, they will be supplied upon written request and payment of a reasonable fee for reproduction costs. Requests should be sent to:\nJoseph M. Hirko Vice President Finance, Chief Financial Officer, Chief Accounting Officer and Treasurer\nPortland General Corporation 121 SW Salmon Street Portland, OR 97204\nAPPENDIX\nPORTLAND GENERAL ELECTRIC COMPANY\nPART II\nPage\nItem 8. Financial Statements and Notes . . . . . . 67\nItem 8. Financial Statements and Supplementary Data\nNote 4A\nIncome Taxes\nThe following table shows the detail of taxes on income and the items used in computing the differences between the statutory federal income tax rate and Portland General Electric Company's (PGE) effective tax rate (thousands of dollars):\nAs of December 31, 1994 and 1993, the significant components of PGE's deferred income tax assets and liabilities were as follows (thousands of dollars):\nAs a result of implementing SFAS No. 109, PGE has recorded deferred tax assets and liabilities for all temporary differences between the financial statement bases and tax bases of assets and liabilities.\nThe IRS completed its examination of Portland General Corporation's (Portland General) tax returns for the years 1985 to 1987 and has issued a statutory notice of tax deficiency which Portland General is contesting. As part of this audit, the IRS has proposed to disallow PGE's 1985 WNP-3 abandonment loss deduction on the premise that it is a taxable exchange. PGE disagrees with this position and will take appropriate action to defend its deduction. Management believes that it has appropriately provided for probable tax adjustments and is of the opinion that the ultimate disposition of this matter will not have a material adverse impact on the financial condition of PGE.\nNote 6A\nCommon Stock\nCommon Stock\nPortland General is the sole shareholder of PGE common stock. PGE is restricted, without prior Oregon Public Utility Commission (PUC) approval, from paying dividends or making other distributions to Portland General to the extent such payment or distribution would reduce PGE's common stock equity capital below 36% of total capitalization. At December 31, 1994, PGE's common stock equity capital was 47% of its total capitalization.\nNote 7A\nShort-Term Borrowings","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\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPortland General Corporation\nMarch 2, 1995 By \/s\/ Ken L. Harrison\nKen L. Harrison\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.\nChairman of the Board and \/s\/ Ken L. Harrison Chief Executive Officer March 2, 1995 Ken L. Harrison\nVice President Finance, Chief Financial Officer, Chief Accounting Officer \/s\/ Joseph M. Hirko and Treasurer March 2, 1995 Joseph M. Hirko\n*Gwyneth Gamble Booth *Peter J. Brix *Carolyn S. Chambers *John W. Creighton, Jr. *Ken L. Harrison *Jerry E. Hudson Directors March 2, 1995 *Warren E. McCain *Jerome J. Meyer *Randolph L. Miller *Richard G. Reiten *Bruce G. Willison\n*By \/s\/ Joseph E. Feltz (Joseph E. Feltz, 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.\nPortland General Electric Company\nMarch 2, 1995 By \/s\/ Ken L. Harrison Ken L. Harrison\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.\nChairman of the Board and \/s\/ Ken L. Harrison Chief Executive Officer March 2, 1995 Ken L. Harrison\nVice President Finance Chief Financial Officer, Chief Accounting Officer \/s\/ Joseph M. Hirko and Treasurer March 2, 1995 Joseph M. Hirko\n*Gwyneth Gamble Booth *Peter J. Brix *Carolyn S. Chambers *John W. Creighton, Jr. *Ken L. Harrison *Jerry E. Hudson Directors March 2, 1995 *Warren E. McCain *Jerome J. Meyer *Randolph L. Miller *Bruce G. Willison\n*By \/s\/ Joseph E. Feltz (Joseph E. Feltz, Attorney-in-Fact)\nNote: Although the Exhibits furnished to the Securities and Exchange Commission with the Form 10-K have been omitted herein, they will be supplied upon written request and payment of a reasonable fee for reproduction costs. Requests should be sent to:\nJoseph M. Hirko Vice President Finance, Chief Financial Officer, Chief Accounting Officer and Treasurer\nPortland General Corporation 121 SW Salmon Street Portland, OR 97204\nAPPENDIX\nPORTLAND GENERAL ELECTRIC COMPANY\nPART II\nPage\nItem 8. Financial Statements and Notes . . . . . . 67\nItem 8. Financial Statements and Supplementary Data\nNote 4A\nIncome Taxes\nThe following table shows the detail of taxes on income and the items used in computing the differences between the statutory federal income tax rate and Portland General Electric Company's (PGE) effective tax rate (thousands of dollars):\nAs of December 31, 1994 and 1993, the significant components of PGE's deferred income tax assets and liabilities were as follows (thousands of dollars):\nAs a result of implementing SFAS No. 109, PGE has recorded deferred tax assets and liabilities for all temporary differences between the financial statement bases and tax bases of assets and liabilities.\nThe IRS completed its examination of Portland General Corporation's (Portland General) tax returns for the years 1985 to 1987 and has issued a statutory notice of tax deficiency which Portland General is contesting. As part of this audit, the IRS has proposed to disallow PGE's 1985 WNP-3 abandonment loss deduction on the premise that it is a taxable exchange. PGE disagrees with this position and will take appropriate action to defend its deduction. Management believes that it has appropriately provided for probable tax adjustments and is of the opinion that the ultimate disposition of this matter will not have a material adverse impact on the financial condition of PGE.\nNote 6A\nCommon Stock\nCommon Stock\nPortland General is the sole shareholder of PGE common stock. PGE is restricted, without prior Oregon Public Utility Commission (PUC) approval, from paying dividends or making other distributions to Portland General to the extent such payment or distribution would reduce PGE's common stock equity capital below 36% of total capitalization. At December 31, 1994, PGE's common stock equity capital was 47% of its total capitalization.\nNote 7A\nShort-Term Borrowings","section_15":""}
{"filename":"73313_1994.txt","cik":"73313","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL Capsure Holdings Corp. and its subsidiaries (\"Capsure\" or the \"Company\") are engaged in the property and casualty insurance business. Capsure's principal property and casualty insurance entities are Western Surety Company (\"Western Surety\"), acquired in August 1992, United Capitol Insurance Company (\"United Capitol\"), acquired in February 1990, and Universal Surety of America (\"Universal Surety\"), acquired on September 22, 1994. Western Surety writes small fidelity and noncontract surety bonds, referred to as \"miscellaneous\" bonds, and errors and omissions (\"E&O\") liability insurance, as a licensed insurer in all 50 states and the District of Columbia. United Capitol writes specialty property and casualty insurance, primarily as an excess and surplus (\"E&S\") lines insurer. United Capitol is licensed in Wisconsin and Arizona and conducts business on a nonadmitted basis in all other states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. Universal Surety specializes in the underwriting of small contract and miscellaneous surety bonds. Universal Surety is licensed in 16 states with most of its business generated in Texas.\nThe Company's business strategy with respect to its existing insurance operations is to emphasize the underwriting of risks where reasonable expectations of underwriting profits exist. At Western Surety, whose business is relatively low risk and relatively insensitive to industry pricing cycles, delivery of excellent service to its vast network of agents is emphasized. At Universal Surety, whose business includes both miscellaneous surety and the comparatively more risky contract surety, responsiveness to agents coupled with sound conservative underwriting are the guiding principles. Contract bonds are more affected by prevailing market and general economic conditions than are noncontract bonds. At United Capitol, whose business is relatively high risk and extremely cyclical, strict underwriting discipline is the critical factor in effecting underwriting profitability during soft market periods.\nThe Company's primary growth strategy is to expand its operations in the specialty insurance and financial services industries by capitalizing on Western Surety's licenses, distribution system and A+ rating by A.M. Best Company, Inc. (\"A.M. Best\") and United Capitol's underwriting expertise and management resources, and by acquiring profitable, well-managed businesses with established market positions in the insurance or financial services industry. The September 22, 1994 acquisition of Universal Surety is an example of this philosophy. Universal Surety has been a highly successful regional underwriter of miscellaneous and small- to medium-sized contract surety bonds in Texas (75% of 1994 gross written premiums) and adjacent southern states. Universal Surety's preacquisition financial results have been exceptional. Gross written premiums have grown from $5.1 million for the year ended December 31, 1990 to $15.3 million for the year ended December 31, 1994 (including results prior to acquisition). A weighted average combined ratio below 80% was maintained over this same period. These results compare favorably to national contract surety bond insurers. Universal Surety's overall growth in gross written premiums and underwriting income during this period was attributable to its product specialization, underwriting expertise and the strong economy in its geographic region. Such growth was restricted by Universal Surety's ability to attract qualified underwriting and claims personnel and maintain distinctive service to its agents. The planned expansion of Universal Surety's contract surety business through Western Surety's broad distribution network will be similarly controlled. There can be no assurance, however, that Universal Surety's preacquisition results will be indicative of future operating results under the ownership and management of Capsure.\nIn addition, in 1993 the Company acquired Fischer Underwriting Group, Incorporated (\"Fischer\"), a managing general agency engaged in producing and underwriting specialty directors' and officers' (\"D&O\") and miscellaneous professional liability insurance. Formerly acting on behalf of Lloyds' of London and other insurers, Fischer commenced producing and underwriting on behalf of United Capitol in December 1993.\nSUMMARY OF INSURANCE OPERATIONS Capsure's insurance companies operate in two principal markets within the property and casualty insurance industry - surety and fidelity and excess and surplus lines. The principal lines of business of Western Surety and Universal Surety are surety and fidelity. United Capitol underwrites principally other liability, product liability and commercial property, primarily on an E&S basis.\nOn August 14, 1992, the Company acquired Western Surety. Founded in 1900, Western Surety is one of the largest writers of miscellaneous bonds in the United States. Bonds underwritten by Western Surety are relatively low-risk, low-premium products where prompt service, easy-to-use forms and availability of an extensive array of bond products are emphasized. Western Surety's success is attributable to its product specialization, underwriting expertise and broad distribution network. Substantially all of Western Surety's bonds are mandated by various state statutes and local ordinances.\nOn September 22, 1994, the Company acquired Universal Surety. Founded in 1984, Universal Surety specializes in writing miscellaneous and small- to medium-sized contract surety bonds in the southern United States. Contract bonds underwritten by Universal Surety are primarily contractor performance and payment bonds in amounts under $3.0 million for which underwriting expertise and distinctive service to agents are emphasized. Universal Surety underwrites primarily standard and some specialty accounts for which it will utilize supplemental collateral arrangements and excess rates for contractors not qualified for standard surety rates. Universal Surety also reduces its exposure through participation in the Small Business Administration (\"SBA\") Surety Bond Guarantee Program. Under this program, the SBA will generally reimburse Universal Surety for 80% of losses and loss adjustment expenses incurred on any SBA guaranteed bond in exchange for 20% of the premium. In addition, a significant portion of the Company's premiums consist of miscellaneous bonds underwritten in the same geographic area.\nOn February 20, 1990, the Company acquired United Capitol, a specialty property and casualty insurer. United Capitol provides principally general liability insurance, including D&O liability, product liability and other liability, to businesses which have hazardous, unique or unusual risk characteristics and which require individual risk underwriting and pricing expertise. Policies underwritten by United Capitol are relatively high- risk, high-premium products. Since its founding in 1986, United Capitol has been able to consistently achieve its primary objective of generating underwriting profits by adhering to a strategy of strict underwriting discipline. The Company believes this strategy is a critical factor affecting underwriting profitability during soft market conditions, which have prevailed in the property and casualty industry since 1987. United Capitol has experienced significant declines in premium volume since 1987 as it has exercised underwriting discipline and has declined to write what it believes to be underpriced business.\nA.M. BEST RATINGS Western Surety, Universal Surety and United Capitol are currently rated A+ (Superior), A (Excellent) and A (Excellent), respectively, by A.M. Best. A.M. Best's letter ratings range from A++ (Superior) to C- (Fair) with A++ being highest. An A+ (Superior) rating is assigned to those companies which A.M. Best believes have achieved superior overall performance when compared to the norms of the property and casualty insurance industry. A+ (Superior) rated insurers have been shown to be among the strongest in ability to meet policyholder and other contractual obligations. A rating of A (Excellent) is assigned to those companies which A.M. Best believes have achieved excellent overall performance when compared to the norms of the property and casualty insurance industry and generally have demonstrated a strong ability to meet their respective policyholder and other contractual obligations. A.M. Best reviews its ratings at least annually and reaffirmed each company's rating in June 1994. There can be no assurance that these ratings will continue to be reaffirmed.\nSURETY AND FIDELITY BOND OPERATIONS According to 1993 statistics published by the Surety Association of America (\"SAA\"), the surety and fidelity bond market had direct written premiums of approximately $2.7 billion, of which the miscellaneous bond segment accounted for approximately $724 million. Western Surety targets a subset of the miscellaneous bond segment of the surety and fidelity market because of its favorable risk characteristics. Universal Surety targets both the miscellaneous bond and small contract surety bond segments of the market.\nPRODUCTS AND POLICIES Surety and fidelity bonds differ in some respects from conventional insurance policies. A surety bond is a three-party arrangement wherein the issuer of the bond (the surety) guarantees to a third party (the obligee) an obligation made by another entity (the principal). The surety is the party who guarantees fulfillment of the principal's obligation to the obligee. In addition, sureties are generally entitled to recover from the principal any losses and expenses paid to third parties. The surety's responsibility is to evaluate the risk and determine if the principal meets the underwriting requirements for the bond. Accordingly, surety bond premiums primarily reflect the type and class of risk and related costs associated with both processing the bond transaction and investigating the applicant including, if necessary, an analysis of the applicant's creditworthiness and ability to perform.\nWestern Surety issues thousands of different noncontract bond forms representing the many types of bonds available in each of the jurisdictions in which it operates. Universal Surety issues both contract and noncontract surety bonds. The terms of such bonds in many cases are prescribed by federal, state and local laws or regulations. The principal types of surety and fidelity bonds underwritten are as follows:\nLicense and Permit - Bonds required by statutes or ordinances for a number of purposes including guaranteeing the payment of certain taxes and fees and providing consumer protection as a condition to granting licenses related to selling real estate or motor vehicles and contracting services.\nJudicial and Fiduciary - Bonds required by statutes, courts or legal documents for the protection of those on whose behalf a fiduciary acts. Examples of such fiduciaries include executors and administrators of estates, and guardians of minors and incompetents.\nFidelity - Bonds which cover losses arising from employee dishonesty. Examples of purchasers of fidelity bonds are law firms, insurance agencies and janitorial service companies.\nPublic Official - Bonds required by statutes and ordinances to guarantee the lawful and faithful performance of the duties of office by public officials.\nNotary Public - Bonds required by statutes to protect against losses resulting from the improper actions of notaries public.\nContract - Bonds which secure the payment and\/or performance of an obligation under a written contract.\nEach company also writes E&O policies for two classes of insureds: notaries public and tax preparers. The notary public E&O policy is marketed as a companion product to the notary public bond and the tax preparer E&O policy is marketed to small tax return preparation firms. In addition, Western Surety introduced an Insurance Agents & Brokers E&O Insurance product in 1994.\nThe following tables set forth, for each principal class of bonds, combined Western Surety and Universal Surety gross written premiums, net written premiums, net earned premiums and number of bonds and policies in force in 1994, 1993 and 1992 and the respective percentages of the total. All tables in this section contain information reflecting the operations of both Western Surety and Universal Surety prior to their respective acquisitions by Capsure. As such, the financial information is not necessarily indicative of the financial results that would have occurred under the ownership and management of Capsure (amounts in thousands, except percentages and average bond amounts):\nMARKETING Western Surety enjoys broad national distribution of its products, which are marketed through approximately 37,000 of the approximately 45,000 independent property and casualty insurance agencies in the United States. These independent agencies are paid an average commission of approximately 30% of a miscellaneous bond's premium. Western Surety also employs approximately 60 full-time salaried marketing representatives whose principal duties are to continually service their producer network on a local basis.\nSince miscellaneous fidelity and surety bonds typically account for a small portion of an independent agency's revenues and are generally applied for under rush circumstances, Western Surety emphasizes one-day response service, easy-to-use forms and an extensive array of miscellaneous bond products. In addition, independent agents are provided pre-executed bond forms and powers of attorney that allow them to issue many standard bonds in their offices.\nWestern Surety's marketing strategy is concentrated on increasing its share of the miscellaneous bond market. In addition, Western Surety devotes considerable time and effort educating legislators as to the need for and value of miscellaneous bonds and challenging attempts to repeal certain bonding requirements.\nUniversal Surety markets its products through approximately 1,000 independent property and casualty insurance agencies through its headquarters in Houston, Texas and branch offices in Austin, Dallas, Kansas City and San Antonio. Universal Surety emphasizes innovative, flexible underwriting, product specialization and distinctive agent service backed by highly qualified, experienced employees.\nUniversal Surety's preacquisition results have been exceptional as gross written premiums grew from $5.1 million in 1990 to $15.3 million in 1994, while maintaining a combined ratio below 80%. In addition, according to 1993 SAA statistics, Universal Surety ranked number one in volume of bonds written in Texas and number three in terms of direct written premiums. Of Universal Surety's gross written premiums in 1994, 68% related to contract bonds, including 12% that qualified for the SBA guarantee. The remaining 32% related to noncontract bonds, including 11% for notary public bonds.\nUniversal Surety has concentrated its marketing efforts in expanding its share of the small contract bond market. Contract bonds underwritten by Universal Surety are primarily contractor performance and payment bonds in amounts under $3.0 million. Universal Surety underwrites principally standard accounts and some specialty accounts for which it will utilize supplemental collateral arrangements and excess rates or SBA guarantees for contractors not generally considered standard risks. The Company intends to utilize Western Surety's existing diverse agency relationships to expand the geographic and agency distribution of Universal Surety's contract surety business. The Company has initially targeted marketing activities towards Western Surety agents in 13 southern states, including Texas. Western Surety will generally cede 100% of each such contract surety bond written on Western paper to Universal Surety pursuant to a Surety Bond Quota Reinsurance Agreement. In 1994, these activities were not material.\nIn addition, Western Surety is gradually expanding its product line by offering Insurance Agents & Brokers E&O Insurance directly to a majority of its vast agency force. Western Surety cedes 90% of each policy to a reinsurer pursuant to a treaty reinsurance arrangement. In 1994, these activities were not material.\nUNDERWRITING Western Surety and Universal Surety target various products in the surety and fidelity bond market which are characterized by relatively low-risk exposure and small bond amounts. Its underwriting criteria, including the extent of bonding authority granted to independent agents, vary depending on the class of business and the type of bond. For example, relatively little underwriting information is required of certain low-exposure risks such as notary bonds. Other bonds, such as fiduciary or probate bonds, are subjected to greater individual risk scrutiny, including verification of the credit history and financial resources of an applicant. Contract bonds underwritten by Universal Surety, which have higher bond amounts and inherent risk, are subject to stringent financial analysis and credit review. Both companies grant authority to independent agents to issue certain low-risk bonds subject to underwriting guidelines.\nCOMPETITION The surety and fidelity market is highly competitive. The largest market shares are held by large diversified insurance companies; however, the single largest writer nationally in 1993, according to the SAA, controlled only 6% of the $2.7 billion market. The small fidelity and noncontract surety or miscellaneous segment of this market is competitive on the basis of service, price, and commissions paid to producers. No single competitor has a significant market position in the broad geographic range and lines of business in which Western Surety conducts its operations. Certain of Western Surety's existing and potential competitors are larger and have greater financial and other resources than Western Surety. The Company believes that Western Surety's principal competitive strengths include its expertise in writing miscellaneous bonds, distribution network of independent agencies, timely customer response and service, and admitted status in every state and the District of Columbia.\nThe market in which Universal Surety competes, primarily small contract bonds, has seen additional competition as both large and small insurance companies are competing and expanding in this area. Certain of Universal Surety's existing and potential competitors are larger and have greater financial resources than Universal Surety. Universal Surety believes that its principal competitive strengths include its underwriting expertise in both contract and miscellaneous bonds, its distinctive service and its strong relationship with its agents.\nEXCESS AND SURPLUS LINES OPERATIONS For regulatory purposes, the commercial property and casualty insurance market is essentially divided into three segments: the admitted or licensed market, commonly referred to as the \"standard\" market; the alternate risk mechanism market, which includes captive insurance companies, risk retention groups and risk purchasing groups; and, the E&S market. The largest provider group is the licensed or admitted insurers. The alternate risk market may operate on an admitted or E&S basis.\nThe E&S segment was created to provide a source of insurance to those insureds who are unable to purchase coverage in the standard market. Admitted insurers are subject to extensive state regulation of rates, policy forms and operational conduct, are required to participate in assigned risk pools and must pay premium taxes and other state assessments. These companies, however, exert a dominant influence over pricing in the commercial market. By contrast, E&S insurers are subject to comparatively less state regulation, affording them more pricing and form flexibility and lower operating expenses. E&S insurers may only insure those risks which the standard market cannot or chooses not to insure.\nThe commercial property and casualty insurance market is highly cyclical and intensely competitive as to price and terms. The size and composition of the E&S market historically have fluctuated with industry cycles. The cycles have been characterized by conditions known as hard markets and soft markets. Hard markets have been characterized by varying periods of relatively higher premiums and more restrictive coverages. As more insurers have been attracted to those conditions, competition has intensified. Over time, this has resulted in depressed premiums, broader coverages and underwriting losses in the industry, which are referred to as soft markets, and have been characterized by an oversupply of underwriting capacity. E&S insurers are generally more vulnerable to these cycles, which is reflected by their volatile writings, since E&S insurers typically only underwrite classes of risks which standard market insurers cannot or choose not to insure. The commercial property and casualty insurance market has been operating under soft market conditions since 1987 and there can be no assurance as to the timing or extent of hard market conditions returning to the property and casualty insurance industry.\nPRODUCTS AND POLICIES The following tables set forth for each of United Capitol's principal lines of business, gross written premiums, net written premiums and net earned premiums in 1994, 1993 and 1992 (dollars in thousands):\nPRODUCT LIABILITY AND OTHER PRIMARY GENERAL LIABILITY United Capitol provides primary general liability insurance, including product liability coverage, on both a claims-made and an occurrence basis to hazardous, unique or unusual classes of commercial insureds that require specialized underwriting. These policies provide coverage to the insured against third-party claims of bodily injury or property damage arising from negligent acts of the insured. Except as discussed below, claims for bodily injury or property damage caused by exposure to asbestos are excluded from product liability and other primary general liability policies sold by United Capitol.\nMany of United Capitol's general liability policies specifically provide product liability coverage for liabilities arising from the manufacture and\/or distribution of goods by an insured. Classes of insureds include manufacturers and distributors of industrial machinery, equipment and chemicals, sporting goods, toys and trailers; bridge building, pile driving and other artisan contractors; operators of carnivals, circuses, water and amusement parks; and fireworks exhibitors.\nMost of United Capitol's non-asbestos primary general liability policies have been issued on the occurrence form (63% in 1994, 66% in 1993 and 71% in 1992); however, classes considered to be particularly susceptible to late reporting (\"long tail\" classes) are generally written on a claims-made form. Examples of these classes include pharmaceuticals and chemicals manufacturers and distributors, and hazardous waste remediation contractors.\nIn 1992, United Capitol commenced offering pollution liability coverage, on a claims-made only basis, to contractors involved in the remediation of preexisting pollution. United Capitol does not provide pollution coverage to those parties who are likely to create or be the source of pollution. United Capitol's gross limit of liability for this coverage is generally $1.0 million, but higher limits are available through the use of reinsurance. Total gross written premiums for this coverage were $0.5 million, $0.6 million and $0.2 million in 1994, 1993 and 1992, respectively.\nFor the primary general liability insurance line of business, United Capitol generally offers gross limits of liability of approximately $1.0 million to $3.0 million. United Capitol's average gross annual premium per policy\nin 1994, 1993 and 1992 was approximately $116,000, $98,000 and $105,000, respectively, and the average gross limits of liability were $2.0 million, $1.8 million and $1.8 million, respectively.\nD&O AND MISCELLANEOUS PROFESSIONAL LIABILITY In December 1993, United Capitol commenced writing specialty D&O and miscellaneous professional liability insurance on a claims-made basis through Fischer. D&O insurance is designed to protect directors and officers from liabilities arising while acting in their official capacities and typically covers both liabilities of the officer or director and reimbursement of a corporation that has lawfully agreed to indemnify their officers or directors. Miscellaneous professional liability insurance, also known as E&O, covers claims by third parties who allege damage as a result of negligent actions by insured professionals. The gross limit of liability for these policies is generally $1.0 million, though gross limits up to $5.0 million are available through the use of reinsurance. The average gross annual premium per policy for these classes of business was $11,000 in 1994 and $9,000 in 1993. United Capitol targets businesses with hard-to-place D&O risks such as new companies, research and development companies, and companies with past bankruptcies as well as not-for-profit businesses. Types of entities considered for professional liability coverage by United Capitol include insurance agents, real estate brokers, title agents, and collection agents and certain legal professionals. Fischer, to a lesser degree, also places certain D&O and E&O insurance with insurers other than United Capitol and receives commissions for such services. This business placed with other insurers was not material to the Company.\nASBESTOS ABATEMENT United Capitol provides general liability insurance for asbestos abatement contractors, as well as professional liability insurance for architects, engineers and others in their capacity as asbestos abatement or environmental consultants. Asbestos abatement generally involves removal or containment of asbestos and asbestos-containing materials from buildings and other structures. United Capitol's asbestos abatement policy forms exclude coverage for employees of an insured and others required to be in the area during the asbestos abatement process.\nUnited Capitol generally provides gross limits of liability of $1.0 million to $3.0 million to asbestos abatement contractors and professional liability coverage to asbestos abatement and environmental consultants. Higher gross limits can be provided through the use of reinsurance. In 1994, 1993 and 1992, the average gross annual premium per policy for this class of business was approximately $76,000, $76,000 and $67,000, respectively. The average gross limit of liability was $2.8 million in 1994, $2.5 million in 1993 and $2.0 million in 1992.\nFrom 1986 through 1990, substantially all of United Capitol's general liability policies for asbestos abatement contractors and environmental consultants were written on a claims-made basis. Because of highly favorable loss experience with the product, and in response to changing market conditions as more insurers have entered the market, United Capitol commenced writing these policies on an occurrence basis in late 1990. In 1994, 1993 and 1992, asbestos abatement general liability policies written on an occurrence basis increased to approximately 79%, 69% and 60% of the total, respectively. Since 1989, United Capitol has experienced a significant decline in asbestos abatement-related insurance premiums in absolute terms as well as relative to its total business because of intense competition for this product. Management anticipates a continuing decline in this business.\nPROPERTY, SURETY AND OTHER BUSINESS United Capitol writes commercial property and inland marine insurance, generally offering up to $5.0 million of gross limits per location or per policy. The average gross annual premium per policy was $18,000 in 1994, $25,000 in 1993 and $23,000 in 1992. In 1993, United Capitol's agency subsidiary, United Capitol Managers, Inc. (\"Managers\"), entered into an agreement under which it acts as commercial property underwriting manager for Westport Insurance Corporation (\"Westport\"), a member company of the Employers Reinsurance Group. Westport is rated A++ (Superior) by A.M. Best and is an admitted insurer in the majority of jurisdictions. Managers earns a commission for business underwritten on behalf of Westport and United Capitol assumes up to $500,000 net per risk on business produced by Managers. In 1994, Managers produced $4.3 million of gross premiums for Westport of which $0.3 million was retroceded to United Capitol.\nUnited Capitol also writes a small amount of surety bonds for asbestos abatement and hazardous waste remediation contractors.\nPOLICY FORMS United Capitol uses both claims-made and occurrence forms for its liability lines of business, both of which are generally more restrictive than standard industry policy forms. Since inception, approximately 90% of United Capitol's claims-made and occurrence liability policies have provided for an aggregate limit for all claims in a policy year. Further, all liability policies issued since early 1987 have provided for an aggregate limit for all claims in a policy year. In approximately 98% of United Capitol's liability policies, defense costs and other loss adjustment expenses are either included within the policy limits or subject to a dollar cap. Virtually all of United Capitol's liability policies are written subject to a self-insured retention or deductible. These underwriting standards and percentages have remained essentially unchanged since 1986. Except as described above, United Capitol's liability policies exclude coverage for the insured's liability for claims related to pollution. United Capitol's liability policies generally exclude coverage for the insured's liability for punitive or exemplary damages.\nFor its property and surety lines of business, United Capitol generally uses standard industry policy forms which it may modify in some respects.\nMARKETING United Capitol principally markets its insurance through approximately 250 wholesale and retail insurance brokerage firms throughout the country whose employees are specially licensed by insurance regulatory authorities as E&S insurance brokers. These brokers submit risk proposals to United Capitol for its review and underwriting analysis. No brokers have the authority to bind United Capitol and United Capitol does not delegate underwriting or claims management authority to nonaffiliated managing general agents or other independent agents or brokers. Due to the specialized nature of United Capitol's business, policy writings tend to be concentrated among a small group of brokerage firms committed to United Capitol's products. For the years ended December 31, 1994, 1993 and 1992, United Capitol's top ten brokerage firms generated approximately 42%, 49% and 45%, respectively, of gross written premiums in those periods. In 1994, 1993 and 1992, United Capitol's top brokerage firm produced 12%, 14% and 12%, respectively, of its gross written premiums.\nUNDERWRITING All underwriting and pricing decisions are made by United Capitol or its subsidiaries' employees and reviewed by senior management. Given the hazardous, unique or unusual nature of the risks United Capitol insures, its underwriters carefully analyze the risks associated with each application for insurance. United Capitol's underwriters evaluate the prior loss history, the inherent risk characteristics and the financial condition of the applicant where appropriate. For asbestos abatement contractors, the underwriting process also includes evaluation of the contractor's qualifications, experience and operating procedures. For all liability coverages, and particularly when determining whether liability coverage will be offered on an occurrence form, United Capitol's underwriting analysis includes evaluation of the likely \"tail\" period between an insured occurrence and the time a claim is likely to be made.\nCOMPETITION The excess and surplus lines market is significantly affected by conditions in the commercial property and casualty market, which are highly cyclical and intensely competitive as to price and terms. Many of United Capitol's existing or potential competitors are larger, have considerably greater financial and other resources, have greater experience in the insurance industry, have longer relationships with their brokers and insureds and offer a broader line of insurance products than United Capitol. United Capitol competes with other excess and surplus lines insurers, other forms of insurance organizations such as risk retention groups and other alternative risk mechanisms. United Capitol also competes with admitted insurers since a risk may not be offered to an excess and surplus lines insurer if an admitted insurer is willing to insure the risk. The property and casualty industry is particularly competitive with respect to price and terms, and United Capitol will compete on that basis only when there remains reasonable expectation of underwriting profits. United Capitol believes its competitive strengths are its underwriting discipline, quality service and effective claims administration.\nREINSURANCE The Company's insurance subsidiaries, in the ordinary course of business, cede reinsurance to other insurance companies to limit their exposure to loss and to provide greater diversification of risk. The reinsurance coverages and terms are tailored to the specific risk characteristics of the underlying product line. Reinsurance contracts do not relieve the Company of its primary obligations to claimants. A contingent liability exists with respect to reinsurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under the reinsurance agreements. Capsure places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claim settlement performance. At December 31, 1994, Capsure's largest reinsurance receivable, including prepaid reinsurance premiums of $1.3 million and estimated ceded incurred but not reported (\"IBNR\") losses of $12.0 million, was approximately $18.9 million with Generali - U.S. Branch. Generali - U.S. Branch is rated A (Excellent), XV by A.M. Best. No other receivable from a single reinsurer exceeded 10% of total reinsurance receivables.\nUNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES The liability for unpaid losses and loss adjustment expenses (\"LAE\") is based on estimates of (a) the ultimate settlement value of reported claims, (b) IBNR claims, (c) future expenses to be incurred in the settlement of claims and (d) claim recoveries. These estimates are determined based on Company and industry loss experience as well as consideration of current trends and conditions. The liability for unpaid losses and LAE is an accounting estimate and, similar to other accounting estimates, there is the potential that actual future loss payments will differ from the initial estimate. The methods of determining such estimates and the resulting estimated liability are continually reviewed and updated. Changes in the estimated liability are reflected in operating income in the year in which such changes are determined.\nEach of Capsure's insurance subsidiaries employs prudent reserving approaches in establishing the estimated liability for unpaid loss and LAE due to the inherent difficulty and variability in the estimation process. In addition, Capsure utilizes independent actuarial firms of national standing to conduct periodic reviews of claim procedures and loss reserving practices, and annually obtains actuarial certification as to the reasonableness of actuarial assumptions used and the sufficiency of year-end reserves for each of its principal insurance subsidiaries.\nA table is included in both Management's Discussion and Analysis and Note 7 to the Consolidated Financial Statements which presents a reconciliation of beginning and ending consolidated loss reserve balances for the three years ended December 31, 1994. Such tables highlight the impact of favorable revisions to the estimated liability established in prior years.\nA reconciliation of the consolidated loss reserves reported in accordance with generally accepted accounting principles (\"GAAP\"), and the reserves reported to state insurance regulatory authorities in accordance with statutory accounting principles (\"SAP\") follows (dollars in thousands):\nThe following table presents the development under GAAP of combined balance sheet reserves for 1985 through 1994, including periods prior to Capsure's ownership. The top line of the table shows the combined reserves at the balance sheet date for each of the indicated periods. The amount of the reserves represents the estimated amount of losses and LAE arising in all prior years that are unpaid at the balance sheet date, including IBNR reserves. The upper portion of the table shows the reestimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimates change as more information becomes known about the frequency and severity of claims\nfor individual periods. The cumulative redundancy (deficiency) represents the aggregate change in the estimates over all prior years. It should be noted that the table presents a \"run off\" of balance sheet reserves rather than accident or policy year loss development. Therefore, each amount in the table includes the effects of changes in reserves for all prior years (dollars in thousands):\nREGULATION Capsure's insurance subsidiaries are subject to varying degrees of regulation and supervision in the jurisdictions in which they transact business under statutes which delegate regulatory, supervisory and administrative powers to state insurance regulators. In general, an insurer's state of domicile has principal responsibility for such regulation which is designed generally to protect policyholders rather than investors and relates to matters such as the standards of solvency which must be maintained; the licensing of insurers and their agents; the examination of the affairs of insurance companies, including periodic financial and market conduct examinations; the filing of annual and other reports, prepared on a statutory basis, on the financial condition of insurers or for other purposes; establishment and maintenance of reserves for unearned premiums and losses; and requirements regarding numerous other matters. Licensed or admitted insurers generally must file with the insurance regulators of such states, or have filed on its behalf, the premium rates and bond and policy forms used within each state. In some states, approval of such rates and forms must be received from the insurance regulators in advance of their use.\nWestern Surety is domiciled in South Dakota and licensed in all other states and the District of Columbia. Universal Surety is domiciled in Texas and licensed in 15 other states. United Capitol is domiciled in Wisconsin, licensed in Arizona and approved, or not disapproved, as a nonadmitted insurer in all other states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. Nonadmitted insurers are generally permitted to operate with a greater degree of freedom from various regulations. In the future, it is likely that more extensive regulatory requirements or restrictions may be imposed upon nonadmitted insurers, which may increase operating costs associated with compliance.\nInsurance regulations generally also require registration and periodic disclosure of certain information concerning ownership, financial condition, capital structure, general business operations and any material transactions or agreements by or among affiliates. Such regulation also typically restricts the ability of any one person to acquire 10% or more,\neither directly or indirectly, of a company's stock without prior approval of the applicable insurance regulatory authority. In addition, dividends and other distributions to stockholders generally may be paid only out of unreserved and unrestricted statutory earned surplus. Such distributions may be subject to prior regulatory approval, including a review of the implication on Risk-Based Capital requirements. A discussion of Risk-Based Capital requirements for property\/casualty insurance companies is included in both Management's Discussion and Analysis and Note 10 to the Consolidated Financial Statements. Without prior regulatory approval in 1995, Capsure's insurance subsidiaries may pay stockholder dividends of $19.3 million in the aggregate. In 1994, 1993 and 1992, Capsure received $21.0 million (including $5.0 million of dividends requiring prior approval), $11.8 million, and $29.0 million (including $15.1 million of dividends requiring prior approval), respectively, in dividends from its insurance subsidiaries.\nCapsure's insurance subsidiaries are subject to periodic financial and market conduct examinations. These examinations are generally performed by the domiciliary state insurance regulatory authorities. The South Dakota Department of Commerce and Regulation - Division of Insurance conducted its last triennial examination of Western Surety as of December 31, 1991. This examination covered both financial and market conduct procedures. The Texas Department of Insurance conducted its triennial examination of Universal Surety as of September 30, 1992. This examination included both financial and market conduct procedures. The Insurance Department of the State of Wisconsin conducted a financial examination of United Capitol as of December 31, 1992. There were no significant issues noted which required corrective action by any of Capsure's insurance companies.\nCertain states in which Capsure conducts its business require insurers to join a guaranty association. Guaranty associations provide protection to policyholders of insurers licensed in such states against the insolvency of those insurers. In order to provide the associations with funds to pay certain claims under policies issued by insolvent insurers, the guaranty associations charge members assessments based on the amount of direct premiums written in that state. To date, such assessments have not been material to Capsure's results of operations.\nWestern Surety, United Capitol and Universal Surety each qualifies as an acceptable surety for federal and other public works project bonds pursuant to U.S. Department of Treasury regulations. The underwriting limitations of Western Surety, Universal Surety and United Capitol, based on each insurer's statutory surplus, are currently $3.5 million, $0.6 million and $6.7 million, respectively.\nManagement believes that, going forward, regulation of its business will increase rather than decrease both on a federal and state level, thereby increasing the costs associated with compliance.\nINVESTMENTS Insurance company investment practices must comply with insurance laws and regulations and must also comply with certain covenants under Capsure's $135 million revolving credit facility. Generally, insurance laws and regulations prescribe the nature and quality of and set limits on the various types of investments which may be made by Capsure's insurance companies. Capsure's insurance companies invest funds provided by operations predominantly in high-quality, taxable, fixed income securities.\nManagement believes that its investment strategy is conservative, with preservation of capital being the foremost objective. Its investment strategy is also influenced by the terms of the insurance coverages written, its expectations as to the timing of claim payments, debt service requirements, and tax considerations, in particular the existence of the Company's net operating tax loss carryforwards (\"NOLs\"), as described below.\nA separate investment committee of the Board of Directors of each insurance company establishes investment policy and oversees the management of each portfolio. A professional independent investment adviser is engaged to assist in the management of each company's investment portfolio pursuant to established investment committee guidelines. The insurance companies pay an advisory fee based on the net asset value of the assets under management.\nNET OPERATING TAX LOSS CARRYFORWARDS In July 1986, the Company emerged from voluntary bankruptcy proceedings under Chapter 11 of the United States Bankruptcy Code. Prior to its emergence, the Company was primarily involved in oil and gas exploration and development and providing supplies to the oil and gas industry. Due to a significant downturn in the oil and gas industry in the early 1980s, the Company generated significant losses and was unable to meet its obligations, resulting in its voluntary bankruptcy filing. Upon the emergence from bankruptcy, the Company had oil and gas interests and approximately $300 million in NOLs. Approximately $226 million of these NOLs are available at December 31, 1994 to reduce the Company's future federal taxable income.\nEMPLOYEES As of December 31, 1994, the Company employed approximately 600 persons. Since its emergence from bankruptcy in 1986, the Company has not experienced any work stoppages and believes its relations with its employees are good. The Company's current operations are in newly acquired businesses unrelated to its pre-1986 oil and gas operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company subleases its executive offices for an annual rent of approximately $0.1 million from Equity Group Investments, Inc. (\"EGI\"), a company affiliated with certain directors, officers, and stockholders of the Company. The executive offices are located at Two North Riverside Plaza, Chicago, Illinois 60606. Western Surety leases office space for its executive offices at 101 South Phillips Avenue, Sioux Falls, South Dakota 57102, under a lease expiring in 2002. Western Surety's office space, consisting of approximately 81,600 square feet, is leased from a partnership in which Western Surety owns a 50% interest. The annual rent, which is subject to annual adjustments, was $1.5 million as of December 31, 1994. Western Surety also leases a 14,760 square foot branch office in Dallas, Texas. Annual rent for the branch office was $0.2 million and the lease expires in 1996. United Capitol leases office space for its executive offices at 1400 Lake Hearn Drive, Atlanta, Georgia 30319, under a lease terminating June 30, 1997 with an annual rent of $0.2 million. Universal Surety leases office space for its executive offices at 950 Echo Lane, Suite 250, Houston, Texas 77478, under a lease terminating October 31, 1997 with an annual rent of $0.1 million. Universal Surety also leases space for branch offices in Austin, Dallas and San Antonio, Texas and Overland Park, Kansas for an additional annual rent of approximately $0.1 million.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are parties to numerous lawsuits arising in the normal course of business, some seeking material damages. The Company believes the resolution of these lawsuits will not have a material adverse effect on its 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 EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock (\"Common Stock\") trades on the New York Stock Exchange under the symbol CSH. Prior to June 16, 1993, the stock traded on the over-the-counter market through NASDAQ under the symbol NUCO. Such over-the-counter market quotations reflected inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. On March 24, 1995, the last reported sale price for the Common Stock was $12.63 per share. The following table shows the range of high and low sales prices for shares of the Common Stock as reported on the New York Stock Exchange (or as reported on NASDAQ for the periods presented prior to June 16, 1993) for each calendar quarter from the first quarter of 1993 through the fourth quarter of 1994:\nThe number of stockholders of record of Common Stock on March 24, 1995 was approximately 2,400.\nThe Company has not paid dividends on its Common Stock and does not anticipate declaring any dividends on its Common Stock in the near future. The Company's intention is to utilize its available cash to fund acquisitions to meet its growth objectives.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following financial information has been derived from the audited Consolidated Financial Statements and notes thereto which appear elsewhere in this or previously issued Annual Reports on Form 10-K and should be read in conjunction with such financial statements and related notes thereto.\nThe Company acquired United Capitol in February 1990, Western Surety in August 1992 and Universal Surety in September 1994. The inclusion of the results of United Capitol, Western Surety and Universal Surety from their respective dates of acquisition affects the comparability of financial information. Such results are not necessarily indicative of future results. Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standard (\"SFAS\") No. 115. In 1993, the Company adopted SFAS No. 109 and No. 113 and has restated prior years' financial information. For a more detailed description of these transactions and their effects on the Company's financial data, see the audited Consolidated Financial Statements and related notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in this or previously issued Annual Reports on Form 10-K.\nThe following information for the Company is as of and for the years ended December 31, 1994, 1993, 1992, 1991 and 1990 (amounts in thousands, except per share data):\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL The following is a discussion and analysis of Capsure Holdings Corp. and its subsidiaries' (\"Capsure\" or the \"Company\") operating results, financial condition, liquidity and capital resources. This discussion should be read in conjunction with the consolidated financial statements and related notes thereto, which contain additional information regarding the Company's operating results and financial condition.\nOn July 31, 1986, the Company emerged from voluntary bankruptcy proceedings under Chapter 11 of the United States Bankruptcy Code. As a result of operating losses from oil and gas operations prior to the Company's bankruptcy, the Company emerged from bankruptcy with approximately $300 million in net operating tax loss carryforwards (\"NOLs\"). Approximately $226 million of these NOLs are available at December 31, 1994 to reduce the Company's future federal taxable income. The Company believes that an analysis of results of operation and financial condition should include an analysis of the Company's ability to reduce its income tax payments through the utilization of NOLs.\nThe Company's operations have been focused in the property and casualty insurance business since 1990. Capsure's principal property and casualty insurance entities are Western Surety Company (\"Western Surety\"), acquired in August 1992, United Capitol Insurance Company (\"United Capitol\"), acquired in February 1990, and Universal Surety of America (\"Universal Surety\"), acquired on September 22, 1994.\nSince 1987, soft market conditions characterized by intense competition on rate and contract terms have prevailed in the property and casualty insurance industry. The industry continues to be relatively well-capitalized and underleveraged on an operating basis which exerts continued pressure on rates and terms. Although the industry has sustained unprecedented losses from catastrophes in 1992 through 1994, as well as the adverse impact of rising interest rates in 1994, there has not been a meaningful improvement in market conditions. Due to the nature of its business, these market conditions have had little impact on Western Surety; however, United Capitol has been significantly affected by prevailing market conditions. United Capitol has responded to these difficult market conditions by maintaining a disciplined underwriting approach and electing to decline business that may result in unacceptable or inadequately compensated risk. Management believes prevailing market conditions are likely to persist for the near and possibly long-term. Capsure will continue to focus its resources in lines of business where it has or can acquire the requisite underwriting and business processing experience and for which consistent long-term underwriting profits can reasonably be expected. The September 22, 1994 acquisition of Universal Surety, as described below, is an example of this philosophy.\nWestern Surety specializes in writing small fidelity and noncontract surety bonds, referred to as \"miscellaneous\" bonds, and errors and omissions (\"E&O\") liability insurance and is licensed to write fidelity, surety and casualty insurance in all 50 states and the District of Columbia. Western Surety is rated A+ (Superior) by A.M. Best Company, Inc. (\"A.M. Best\"). Bonds underwritten by Western Surety are relatively low-risk, low-premium products where prompt service, easy-to-use forms and availability of an extensive array of bond products are emphasized. One of the largest writers of miscellaneous bonds in the United States, Western Surety has experienced overall growth in gross written premiums since 1990 in spite of the soft market. This growth is attributable to its product specialization, underwriting expertise and broad distribution network as well as to legislatively mandated bond limit increases, and to bonding requirements legislated by various states and municipalities. Substantially all of Western Surety's bonds are mandated by various state statutes and local ordinances. Such factors have largely insulated Western Surety from the effects of prevailing market conditions in the broader commercial property and casualty insurance industry. Management believes, with respect to Western Surety's products, that the Company's results of operations will not be significantly affected by new miscellaneous bond requirements or by the repeal of any existing legislated bonding requirements.\nUniversal Surety specializes in the underwriting of small contract and miscellaneous surety bonds. Universal Surety is rated A (Excellent) by A.M. Best and is licensed in 16 southern states with most of its business generated in Texas (75% of 1994 gross written premiums). Contract bonds underwritten by Universal Surety are primarily contractor performance and payment bonds in amounts under $3.0 million for which underwriting expertise and distinctive service to agents are emphasized. Universal Surety underwrites primarily standard accounts and some specialty accounts for\nwhich it will utilize supplemental collateral arrangements and excess rates for contractors not qualified for standard surety rates. Universal Surety also reduces its exposure through participation in the Small Business Administration (\"SBA\") Surety Bond Guarantee Program. Under this program, the SBA will generally reimburse Universal Surety for 80% of losses and loss adjustment expenses incurred on any SBA guaranteed bond in exchange for 20% of the premium. Contract bonds are more affected by prevailing market and general economic conditions than noncontract bonds.\nUniversal Surety's preacquisition financial results have been exceptional. Gross written premiums have grown from $5.1 million for the year ended December 31, 1990 to $15.3 million for the twelve months (including results prior to acquisition) ended December 31, 1994. A weighted average combined ratio below 80.0% was maintained over this same period. These results compare favorably to national contract surety bond insurers. Universal Surety's overall growth in gross written premiums and underwriting income during this period was attributable to its product specialization, underwriting expertise and the strong economy in its geographic region. Such growth was also characterized by measured expansion restricted by its ability to attract qualified underwriting and claims personnel and maintain distinctive service to its agents. The planned expansion of Universal Surety's small contract surety products through Western Surety's broad distribution network will be similarly controlled. However, there can be no assurance that Universal Surety's preacquisition results will be indicative of future operating results under the ownership and management of Capsure.\nUnited Capitol writes specialty property and casualty insurance primarily as an excess and surplus lines insurer. United Capitol is rated A (Excellent) by A.M. Best. United Capitol provides principally general liability insurance, including directors' and officers' liability (\"D&O\"), product liability and other liability coverages, to businesses which have hazardous, unique or unusual risks. Policies underwritten by United Capitol are relatively high-risk, high-premium products which require individual risk underwriting and pricing expertise. United Capitol has experienced significant declines in gross written premiums as it has adhered to its strategy of strict underwriting discipline and has declined to write what it believes to be underpriced business.\nRESULTS OF OPERATIONS The components of income for each of the past three years are summarized as follows (dollars in thousands):\nINSURANCE UNDERWRITING Underwriting results for the past three years are summarized in the following table (dollars in thousands):\nSurety and fidelity represents the combined results of Western Surety, since its acquisition in August 1992, and Universal Surety, since its September 22, 1994 acquisition. Surety and fidelity are the principal lines of business of Western Surety and Universal Surety. Excess and surplus lines represents the results of United Capitol. United Capitol's principal lines of business are other liability, product liability and commercial property primarily written on an excess and surplus lines basis.\nGross written premiums increased $1.6 million for the year ended December 31, 1994. Western Surety experienced a 1.1% decrease in gross written premiums, mainly due to a decline in public official bond premiums as compared to 1993. This decline, which was expected, was caused by the cyclical nature of these bonds. Writings for this product typically increase every other year, following the November elections. Universal Surety contributed $4.0 million of gross written premiums since its acquisition in September 1994. United Capitol's gross written premiums decreased 5.8%, or $1.7 million in 1994. Significant declines in the asbestos abatement and other primary casualty business were partially offset by the addition of $5.7 million in gross written premiums of D&O business produced by the Company's Fischer Underwriting Group, Incorporated (\"Fischer\") which was acquired in November 1993 by a subsidiary of United Capitol. United Capitol's premium volume, particularly in the increasingly competitive asbestos abatement line, continued to be significantly affected by prolonged soft market conditions.\nNet earned premiums increased $6.5 million for the year ended December 31, 1994. Western Surety's net earned premiums increased 1.9% in 1994 compared to 1993. Universal Surety contributed net earned premiums of $4.0 million in 1994. United Capitol's net earned premiums increased 6.3%, or $1.1 million in 1994, primarily as a result of the recognition of $2.5 million of contingent reinsurance premiums related to an excess of loss reinsurance treaty. Excluding the recognition of the contingent premiums, net earned premiums decreased 7.5% at United Capitol.\nGross written premiums increased $50.7 million for the year ended December 31, 1993, principally due to the inclusion of Western Surety results for a full year. United Capitol's gross written premiums increased $1.6 million, or 6.1%, primarily due to increases in the property and non-asbestos general liability insurance lines of business combined with the addition of D&O insurance more than offsetting the decline in the asbestos abatement liability business.\nNet earned premiums increased $44.8 million for the year ended December 31, 1993, primarily due to the inclusion of a full year of operating results of Western Surety. United Capitol's net earned premiums increased 12.0%, or $1.9 million in 1993, reflecting the increase in net written premiums in prior years.\nUnderwriting income for the year ended December 31, 1994 was virtually unchanged as compared to the prior year despite increased net earned premiums. The consolidated combined ratio increased to 83.5% in 1994 from 82.3% in 1993. The consolidated loss ratio increased to 25.2% in 1994 from 23.2% in 1993, reflecting less favorable development of prior years' loss reserves at United Capitol than was experienced in 1993. United Capitol's loss ratio increased to 61.1% in 1994 from 47.5% in 1993. Excluding the effects of favorable development, United Capitol would have reported loss ratios of 98.3% and 110.3% in 1994 and 1993, respectively. The surety and fidelity loss ratio decreased to 15.8% in 1994 from 16.7% in 1993, primarily due to favorable development of prior years' loss reserves and increased salvage recoveries at Western Surety.\nThe consolidated expense ratio decreased to 58.3% in 1994, compared to 59.1% in 1993. The surety and fidelity expense ratio decreased to 67.7% in 1994 from 69.1% in 1993. Net commissions, brokerage and other underwriting expenses incurred at Western Surety were effectively controlled during 1994, offsetting increased costs associated with enhancing Western Surety's computer systems. United Capitol's expense ratio increased to 22.5% in 1994 compared to 21.6% in 1993.\nUnderwriting income for the year ended December 31, 1993 increased $5.3 million as compared to the prior year, principally due to the inclusion of Western Surety results for a full year. The consolidated combined ratio increased to 82.3% in 1993 from 75.9% in 1992. The consolidated loss ratio decreased to 23.2% in 1993 from 25.8% in 1992, largely due to the inclusion of Western Surety for a full year partially offset by increased losses at United Capitol. The surety and fidelity loss ratio increased to 16.7% in 1993 from 14.6% in 1992, mainly due to increased losses on certain motor vehicle dealer bonds. United Capitol's loss ratio increased to 47.5% in 1993 from 43.4% in 1992, reflecting the impact of competitive market conditions. Excluding the effects of favorable development, United Capitol would have reported loss ratios of 110.3% and 86.2% in 1993 and 1992, respectively.\nThe consolidated expense ratio increased to 59.1% in 1993 from 50.1% in 1992, reflecting the inclusion of full year results of operations for Western Surety. The surety and fidelity expense ratio was 69.1% in both 1993 and 1992. United Capitol's expense ratio increased slightly to 21.6% in 1993 from 20.5% in 1992.\nINVESTMENT INCOME Net investment income for the years ended December 31, 1994, 1993 and 1992 was $19.1 million, $19.8 million and $15.5 million, respectively. Investment results for each year were negatively impacted by declining interest rates through the end of 1993. The $4.3 million increase in net investment income in 1993 over 1992 reflects the inclusion of a full year of Western Surety's investing activity which more than offset the impact of declining investment yields. The average pretax yields of the portfolio for the years ended December 31, 1994, 1993 and 1992 were 6.5%, 6.8% and 7.6%, respectively.\nCapsure's insurance companies invest funds provided by operations predominantly in high-quality, short-duration, taxable fixed income securities. Beginning in 1994, the Investment Committees of the Board of Directors of the Company and its insurance subsidiaries have approved the investment of up to $26 million in the aggregate by the insurance subsidiaries and at the parent company level in publicly traded nonaffiliated real estate investment trust (\"REIT\") equity securities. At December 31, 1994, the carrying value of the Company's REIT portfolio was approximately $24.3 million. The preservation of capital and utilization of the Company's available NOLs are Capsure's principal investment objectives.\nANALYSIS OF OTHER OPERATIONS Net investment gains were $0.9 million, $2.1 million and $0.4 million for the years ended December 31, 1994, 1993 and 1992, respectively. Net investment gains of $1.9 million in 1994 and $3.1 million in 1993 resulted from the sale of equity securities in the investment portfolio at the parent company level which more than offset net investment losses of $0.4 million and $1.0 million, respectively, from the insurance operations. There were no parent company level net investment gains recognized in 1992. Included in 1994 net investment gains were $0.5 million of net unrealized investment losses on the trading securities portfolio held at the parent company level. The net investment losses from the insurance operations in 1993 were primarily due to a $2.5 million write-down to fair value of two interest-only securities reflecting lower future expected cash flows of these securities as a result of an accelerated level of mortgage prepayments, partially offset by $1.5 million of net investment gains from the sale of other securities.\nAmortization expense was $3.4 million for the years ended December 31, 1994 and 1993 and $1.6 million in 1992. Amortization expense in 1994, 1993 and 1992 included $1.3 million, $1.8 million and $0.6 million, respectively, of amortization of intangible assets and $2.1 million, $1.6 million and $1.0 million, respectively, of amortization of excess cost over net assets acquired related to the acquisitions of Western Surety, Universal Surety, United Capitol and Fischer. Excess cost over net assets acquired is amortized substantially over 40 years. Other intangible assets are amortized over periods ranging from three to 20 years.\nInterest expense decreased 24.7%, or $1.6 million for the year ended December 31, 1994, reflecting the effect of reduced debt. The Company's average debt outstanding for the twelve months ended December 31, 1994 was approximately $74.0 million compared to $96.0 million in 1993. In connection with the early retirement of the Company's bank term loans, the Company incurred a $1.6 million write-off of unamortized deferred loan fees in the year ended December 31, 1994. Interest expense increased 29.8%, or $1.4 million for the year ended December 31, 1993. The increase was attributable to increased borrowings in connection with the acquisition of Western Surety which more than offset the effects of lower average interest rates.\nINCOME TAXES Income taxes were $9.4 million, $9.2 million and $6.8 million for the years ended December 31, 1994, 1993 and 1992, respectively. The effective income tax rates were 39.5%, 36.2% and 38.8%, respectively. The increase in the 1994 effective tax rate over prior years was attributable to an increased level of nondeductible goodwill amortization in connection with the acquisitions of Universal Surety and Fischer as well as certain delayed provisions of the Revenue Reconciliation Act of 1993. The Company's income tax expense does not approximate\nactual taxes paid, primarily due to the utilization of the Company's NOLs. Actual income taxes paid were $0.6 million for the years ended December 31, 1994 and 1993, respectively, and $0.7 million for the year ended December 31, 1992.\nLIQUIDITY AND CAPITAL RESOURCES The Company's insurance subsidiaries are highly liquid. The insurance operations derive liquidity from net premium collections, reinsurance recoveries and investment earnings and use these funds to pay claims and operating expenses. The operations of an insurance company generally result in cash being collected from customers in the form of premiums in advance of cash outlays for claims. Each insurance company invests its collected premiums, generating investment income, until such time cash is needed to pay claims and associated expenses.\nThe Company believes total invested assets, including cash and short-term investments, are sufficient in the aggregate and have suitably scheduled maturities to satisfy all policy claims and other operating liabilities, including anticipated income tax sharing payments of its insurance operations. Management believes the duration of each insurance subsidiary's portfolio is properly matched with the expected duration of its liabilities. At December 31, 1994, the carrying value of the Company's invested assets of the insurance operations was comprised of $246.6 million of fixed maturities (at fair value), $20.6 million of equity securities, $17.5 million of short-term investments, $4.1 million of other investments and $3.8 million of cash. At December 31, 1993, the carrying value of the Company's invested assets of the insurance operations was comprised of $229.5 million of fixed maturities (at amortized cost), $48.4 million of short-term investments, $5.5 million of other investments and $2.2 million of cash and $0.8 million of equity securities.\nCash flow at the parent company level is derived principally from dividend and tax sharing payments from its insurance subsidiaries. The principal obligations at the parent company level are to service debt and pay operating expenses. At December 31, 1994, the carrying value of the Company's invested assets of the non-insurance operations, principally at the parent company level, was comprised of $7.6 million of equity securities, $4.6 million of short-term investments, $0.8 million of other investments and $0.3 million of cash. At December 31, 1993, the carrying value of the Company's non-insurance operations invested assets, principally at the parent company level, was comprised of $20.8 million of short-term investments, $8.7 million of equity securities and $1.1 million of cash.\nThe Company's consolidated net cash flow provided by operating activities was $29.3 million, $32.1 million and $18.7 million for the years ended December 31, 1994, 1993 and 1992, respectively. Consolidated operating cash flow (pretax income excluding the write-off of deferred loan fees, net investment gains and amortization of goodwill and intangibles) for the year ended December 31, 1994, was $27.8 million as compared to $26.9 million in 1993 and $18.7 million in 1992.\nOn March 29, 1994, the Company formed a direct, wholly owned subsidiary, Capsure Financial Group, Inc. (\"CFG\"), to which Capsure contributed substantially all its assets and liabilities. Concurrently, CFG entered into a senior reducing revolving credit agreement with a syndicate of banks for $135 million (the \"Credit Facility\"). At closing, $68 million of funds drawn under the Credit Facility, together with a portion of the Company's cash, were used to repay $84.6 million of previously existing bank term debt. Paydowns of $25 million and borrowings of $28 million for the acquisition of Universal Surety have occurred since then. The remaining availability under the Credit Facility of $64 million may be used to finance future acquisitions and for general corporate purposes.\nPrincipal and interest payments required under the Credit Facility are funded principally by dividend and intercompany tax sharing payments received from Capsure's insurance subsidiaries.\nCapsure's insurance subsidiaries are subject to regulation and supervision by the various state insurance regulatory authorities in which they conduct business, including regulations with respect to the payment of dividends. Without prior regulatory approval in 1995, Capsure's insurance subsidiaries may pay stockholder dividends of $19.3 million in the aggregate. In 1994, 1993 and 1992 Capsure received $21.0 million (including $5.0 million of dividends requiring prior approval), $11.8 million, and $29.0 million (including $15.1 million of dividends requiring prior approval), respectively, in dividends from its insurance subsidiaries.\nIntercompany tax sharing agreements between Capsure and its subsidiaries provide that income taxes shall be allocated based upon separate return calculations in accordance with the Internal Revenue Code of 1986, as amended. Intercompany tax payments are remitted at such times as estimated tax payments would be required to be made to the Internal Revenue Service. Capsure received tax sharing payments from its subsidiaries of $12.3 million, $13.0 million and $9.0 million in 1994, 1993 and 1992, respectively.\nOn September 22, 1994, Capsure, through its wholly owned subsidiary, CFG, acquired all of the outstanding common stock of Universal Surety Holding Corp. (\"USHC\"). USHC is the holding company of Universal Surety. Capsure paid $28 million in cash and $4 million in Capsure stock for USHC, pursuant to a Stock Purchase Agreement dated as of July 26, 1994. The cash portion of the purchase price was financed with borrowings under Capsure's $135 million Credit Facility.\nThe Company continues to pursue acquisitions of financial services businesses with a particular focus on the insurance industry. Although the emphasis is on financial services and insurance, the Company may consider other investments that would further enhance the Company's value.\nFINANCIAL CONDITION A significant factor affecting the Company's financial condition is the Company's policy with respect to investing insurance-related funds. The Company's policy is to invest a substantial portion of such funds in high-quality, short-duration mortgage pass-through instruments, collateralized mortgage obligations (\"CMOs\") and other asset-backed securities. CMOs differ from traditional fixed maturities in that they may expose the investor to yield variability and even principal risk due to such factors as high mortgage prepayment rates and defaults and delinquencies in the underlying asset pool. Management believes it has reduced prepayment variability by investing only in short tranches and by owning a substantial amount of planned amortization class (\"PAC\") tranches which are structured largely to insulate the investor from prepayment risk. A PAC tranche is structured to amortize in a predictable manner and, therefore, the risk of prepayment of the underlying collateral is shifted to other tranches, whose owners are willing to accept such risk. Further, management believes it has minimized credit risk primarily by purchasing only securities rated A or better on the date of acquisition and which are collateralized or guaranteed by U.S. Government agencies or have substantial credit enhancement in the form of financial guarantees, mortgage insurance, letters of credit, over- collateralization, subordinated structures and excess servicing spreads. Management monitors the investment portfolio of the insurance subsidiaries and the current rating of each security owned on a monthly basis. Beginning in 1994, the Investment Committees of the Board of Directors of the Company and its insurance subsidiaries have approved the investment of up to $26 million in the aggregate by the insurance subsidiaries and at the parent company level in publicly traded nonaffiliated REIT equity securities. At December 31, 1994, the carrying value of the Company's REIT portfolio was approximately $24.3 million.\nThe following table sets forth the composition by ratings assigned by The Standard & Poors Corporation (\"S&P\") or Moody's Investor Services, Inc. (\"Moody's\") of the fixed income portfolio of the Company as of December 31, 1994 (dollars in thousands):\nAnother critical factor affecting the Company's financial condition is the Company's policies with respect to loss and loss adjustment expense reserves. Each of Capsure's insurance subsidiaries employs prudent reserving approaches in establishing the estimated liability for unpaid loss and loss adjustment expenses due to the inherent difficulty and variability in the estimation process. The liability for unpaid losses and loss adjustment expenses is based on estimates of (a) the ultimate settlement value of reported claims, (b) incurred but not reported (\"IBNR\") claims, (c) future expenses to be incurred in the settlement of claims and (d) claim recoveries. The liability for unpaid losses and loss adjustment expenses is an accounting estimate and, similar to other accounting estimates, there is the potential that actual future loss payments will differ from the initial estimate. The methods of determining such estimates and the resulting estimated liability are continually reviewed and updated. Changes in the estimated liability are reflected in operating income in the year in which such changes are determined.\nThe following table presents selected loss and loss adjustment expense information (gross of reinsurance) and highlights the impact of revisions to the estimated liability established in prior years (dollars in thousands):\nAs a result of favorable claim settlements and changes in estimates of insured events in prior years, the provision for losses and loss adjustment expenses decreased by $14.5 million ($8.3 million, net of reinsurance) in 1994, $15.0 million ($11.3 million, net of reinsurance) in 1993 and $9.9 million ($7.5 million, net of reinsurance) in 1992.\nThe National Association of Insurance Commissioners (\"NAIC\") has promulgated Risk-Based Capital (\"RBC\") requirements for property\/casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy, and other business factors. The RBC information will be used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio (the \"Ratio\") of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Generally, a Ratio in excess of 200% of authorized control level RBC requires no corrective actions on the behalf of the company or regulators. As of December 31, 1994, each of Capsure's insurance subsidiaries had a Ratio that was substantially in excess of the minimum RBC requirements.\nCapsure's insurance subsidiaries require capital to support premium writings. In accordance with industry and regulatory guidelines, the net written premiums to surplus ratio of a property and casualty insurer should not exceed 3 to 1 (the terms of the Credit Facility limit this ratio further to 2.75 to 1 for Western Surety and Universal Surety and 2 to 1 for United Capitol). On December 31, 1994, Western Surety's statutory surplus was $37.1 million and its net written premiums to surplus ratio was 2 to 1. On December 31, 1994, Universal Surety's statutory surplus was $7.6 million and its net written premiums to surplus ratio was 1.9 to 1. On December 31, 1994, United Capitol's statutory surplus was $61.8 million and its net written premiums to surplus ratio was 0.3 to 1. The Company believes that each insurance company's statutory surplus is sufficient to support its current and anticipated premium levels.\nThe Internal Revenue Service has not examined the Company's tax returns for the years in which the Company reported net operating losses. Under Section 382 of the Internal Revenue Code, certain restrictions on the utilization of NOLs will apply if there is an ownership change of a corporation entitled to use such carryovers. The Company believes that there is currently no restriction on the ability of the Company to utilize its NOLs. It is possible that future transactions involving the common stock or rights to acquire such stock could cause an ownership change of the Company resulting in restrictions of the Company's ability to utilize the NOLs during all taxable periods after the date of such ownership change. The Company has adopted provisions in its Certificate of Incorporation designed to facilitate the Company's ability to preserve and utilize its NOLs.\nENVIRONMENTAL LIABILITIES The Company was engaged in oil and gas production, exploration and development until mid-1993. In connection with the sale of substantially all of the Company's oil and gas properties, the buyers assumed all material environmental liabilities.\nUnited Capitol, in the ordinary course of business, chooses to underwrite accounts which have hazardous, unique or unusual risk characteristics and applies a strict and specialized underwriting discipline to such risks. Since United Capitol's organization in 1986, its liability policies have included an absolute pollution coverage exclusion (except for policies offering pollution liability coverage to contractors involved in the remediation of preexisting pollution). In addition, except as discussed below, United Capitol's product liability and other primary general liability policies contain exclusions, which management believes are enforceable, for coverage of claims for bodily injury or property damage caused by exposure to asbestos.\nUnited Capitol provides coverage to asbestos abatement contractors against third parties who have alleged bodily injury or property damage as a result of exposure to asbestos. Employees of the insured contractor and others required to be in the abatement area are not intended to be covered by United Capitol's policies and management believes such coverage exclusions are enforceable. Through the date hereof, there have been no valid claims against United Capitol's asbestos abatement liability policies alleging bodily injury arising from exposure to asbestos. Management believes that none of the other insurance products offered by Capsure's insurance subsidiaries creates any potential material environmental exposure.\nManagement believes that Capsure is adequately reserved for risks associated with environmental liabilities although there can be no assurance that legal or other developments will not increase the Company's exposure to environmental liabilities.\nIMPACT OF ADOPTING STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS (\"SFAS\") As discussed in Note 2 to the consolidated financial statements, the Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" effective January 1, 1994 and SFAS No. 109, \"Accounting for Income Taxes\" and SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-duration and Long-duration Contracts\" effective January 1, 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAll other schedules and historical information are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.\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 Company will file a definitive proxy statement with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 (the \"Proxy Statement\") relating to the Company's Annual Meeting of Stockholders to be held on May 24, 1995, not later than 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. Information required by Items 10 through 13 will appear in the Proxy Statement and 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\nAll other schedules and historical information are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nWe have audited the accompanying consolidated financial statements and financial statement schedules of Capsure Holdings Corp. and Subsidiaries listed in the index on page 27 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 the 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 Capsure Holdings Corp. 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 relations 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 Company has changed its methods of accounting for investments in 1994, and income taxes and reinsurance in 1993.\nCOOPERS & LYBRAND L.L.P. Chicago, Illinois February 24, 1995\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of these financial statements.\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these financial statements.\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of these financial statements.\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)\nThe accompanying notes are an integral part of these financial statements.\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Capsure Holdings Corp. and all significant majority-owned subsidiaries (\"Capsure\" or the \"Company\"). Capsure is engaged principally in the property and casualty insurance business. The Company's principal insurance operating entities are Western Surety Company (\"Western Surety\"), United Capitol Insurance Company (\"United Capitol\") and Universal Surety of America (\"Universal Surety\"). All significant intercompany accounts and transactions have been eliminated in consolidation.\nBASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles. 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. Certain balances in the prior years' financial statements have been reclassified to conform to current presentation.\nINVESTMENTS Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The Company has the ability to hold all debt securities to maturity. However, the Company may dispose of securities prior to their scheduled maturity due to changes in interest rates, prepayments, tax and credit considerations, liquidity or regulatory capital requirements, or other similar factors. As a result, the Company considers substantially all of its debt (bonds and redeemable preferred stocks) and equity securities as available-for-sale. Certain equity securities at the parent company level that are held principally for the purpose of selling them in the near term are considered trading securities. Certain debt securities, principally deposited with state insurance regulatory authorities, are considered held to maturity since the Company has both the positive intent and ability to hold these securities to maturity. The accounting policies for each category are as follows:\nAvailable-for-Sale Securities -- These securities are reported at fair value, with unrealized gains and losses, net of deferred income taxes, reported as a separate component of stockholders' equity until realized. Cash flows from purchases, sales and maturities are reported gross in the investing activities section of the cash flow statement.\nTrading Securities -- These securities are reported on the balance sheet at fair value, with any unrealized gains and losses included in earnings. Cash flows from purchases, sales and maturities are included in the operating activities section of the cash flow statement.\nHeld-to-Maturity Securities -- These securities are reported at amortized cost on the balance sheet. Cash flows from purchases, sales and maturities are reported gross in the investing activities section of the cash flow statement.\nPreviously, all debt securities were carried at amortized cost and all equity securities reported at fair value, with unrealized gains and losses, net of deferred income taxes, reflected in stockholders' equity.\nThe amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. For mortgage-backed and certain asset-backed securities, Capsure recognizes income using a constant effective yield based on estimated cash flows including anticipated prepayments. Significant variances in actual cash flows from expected cash flows are accounted for prospectively. Any related adjustment is reflected in investment income. Investment gains or losses are determined using the specific\nidentification method. Investments with an other than temporary decline in value are written down to fair value, resulting in losses that are included in investment gains and losses.\nShort-term investments are carried at amortized cost which approximates fair value.\nDEFERRED POLICY ACQUISITION COSTS Policy acquisition costs, consisting of commissions and other underwriting expenses which vary with, and are directly related to, the production of business, net of reinsurance commission income, are deferred and amortized to income as the related premiums are earned. Deferred policy acquisition costs are subject to a limitation representing the excess of anticipated net earned premiums over anticipated losses, loss adjustment expenses and maintenance costs. The ultimate recoverability of policy acquisition costs is determined without regard to investment income.\nEXCESS COST OVER NET ASSETS ACQUIRED AND INTANGIBLE ASSETS The excess cost over the fair value of the net assets acquired is amortized substantially over 40 years. Other intangible assets are amortized over periods ranging from three to 20 years, a substantial portion of which is amortized over three years. Other intangible assets primarily relate to the estimated value of the acquired insurance in force and the producing agency force as of the acquisition date. Excess cost over net assets acquired is reported net of accumulated amortization of $5.4 million and $3.4 million at December 31, 1994 and 1993, respectively. Intangible assets are reported net of accumulated amortization of $23.3 million and $19.5 million at December 31, 1994 and 1993, respectively.\nUNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES The liability for unpaid losses and loss adjustment expenses is based on estimates of (a) the ultimate settlement value of reported claims, (b) incurred but not reported (\"IBNR\") claims, (c) future expenses to be incurred in the settlement of claims and (d) claim recoveries. These estimates are determined based on Company and industry loss experience as well as consideration of current trends and conditions. The liability for unpaid losses and loss adjustment expenses is an accounting estimate and, similar to other accounting estimates, there is the potential that actual future loss payments will differ from the initial estimate. The methods of determining such estimates and the resulting estimated liability are continually reviewed and updated. Changes in the estimated liability are reflected in operating income in the year in which such changes are determined.\nINSURANCE PREMIUMS Insurance premiums are recognized as revenue ratably over the terms of the related policies. Unearned premiums represent the portion of premiums written applicable to the unexpired terms of policies in force calculated on a daily pro rata basis. Premium revenues are reported net of amounts ceded to reinsurers.\nREINSURANCE Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy and are reported as reinsurance receivable rather than netted against the liability for unpaid losses and loss adjustment expenses. Losses and loss adjustment expenses incurred are reported net of estimated recoveries under reinsurance contracts.\nINCOME TAXES The provision for income taxes includes deferred taxes resulting from temporary differences between the financial reporting and tax bases of assets and liabilities, using the asset and liability method required by SFAS No. 109, \"Accounting for Income Taxes.\" Under the asset and liability method, deferred income taxes are established for the future tax effects of temporary differences between the tax and financial reporting bases of assets and liabilities using currently enacted tax rates. Such temporary differences primarily relate to net operating loss carryforwards (\"NOLs\"), loss reserve discounting, deferred policy acquisition costs and intangible assets. The measurement of deferred tax assets is subject to a valuation allowance based upon the expectation of future realization. Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period of enactment.\nREORGANIZATION PROCEEDINGS On July 31, 1986, the Company emerged from voluntary bankruptcy proceedings under Chapter 11 of the United States Bankruptcy Code (the \"Bankruptcy Code\"). After the requisite acceptances were obtained and the Bankruptcy Court determined that the Second Amended Joint Plan of Reorganization, as amended (the \"Plan of Reorganization\"), satisfied applicable requirements of the Bankruptcy Code, the Bankruptcy Court confirmed the Plan of Reorganization on December 20, 1985, and the Plan of Reorganization was consummated on July 31, 1986 (the \"Reorganization Date\"). The Company emerged from bankruptcy with approximately $300 million of NOLs resulting from oil and gas operations prior to the reorganization.\nIn accordance with accounting principles applicable to reorganizations, the net assets of the Company were adjusted to fair value, the accumulated deficit in retained earnings at the date of reorganization was eliminated and the excess of the fair values of the net assets over the stated value of outstanding capital stock was assigned to additional paid-in capital. In the 1992 financial statements as restated under SFAS No. 109, the Company established a deferred tax asset, net of a valuation allowance, with a corresponding credit to additional paid-in capital equal to the amount of available NOLs for which future realization is expected. Tax benefits resulting from the future utilization of such NOLs will reduce the net deferred tax asset established in accordance with SFAS No. 109.\nEARNINGS PER SHARE Earnings per share of common and common equivalent shares outstanding are computed using the treasury stock method. Weighted average shares outstanding including additive common equivalent shares (assuming full dilution) for 1994, 1993 and 1992 were 15.2 million, 15.0 million and 12.2 million, respectively.\n2. ADOPTION OF NEW ACCOUNTING STANDARDS\nINVESTMENTS Effective January 1, 1994, the Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Although Capsure has the ability to hold all debt securities to maturity, the Company may dispose of securities prior to their scheduled maturity. Accordingly, the Company has classified substantially all of its debt and equity securities as securities available-for-sale. These securities are reported at fair value, with unrealized gains and losses, net of deferred income taxes, reported as a separate component of stockholders' equity until realized. In addition, certain equity securities at the parent company level were classified as trading securities in accordance with SFAS No. 115. Previously all debt securities were considered held-to-maturity and carried at amortized cost, and all equity securities were reported at fair value, with unrealized gains and losses, net of deferred income taxes, reflected in stockholders' equity.\nAt January 1, 1994, net unrealized gains on investments which were classified as securities available-for-sale were approximately $7.0 million ($4.6 million, net of deferred income taxes). Approximately $4.9 million of the $7.0 million net unrealized gains on available-for-sale securities related to fixed maturities which were carried at amortized cost at December 31, 1993. At January 1, 1994, unrealized gains and losses on the trading securities were not material to the Company's results of operations.\nINCOME TAXES Effective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 requires the asset and liability method of accounting for income taxes rather than the deferred method, as specified by Accounting Principles Board (\"APB\") No. 11. The adoption of SFAS No. 109 permitted the Company to recognize as a deferred tax asset the benefits of certain NOLs that were previously prohibited under APB No. 11. Under the new standard, deferred tax assets are valued based upon the expectation of future realization on a \"more likely than not\" basis. Upon adoption of SFAS No. 109, the Company restated its 1992 financial statements. As of January 1, 1992, a deferred tax asset of $60.2 million, net of a valuation allowance of $45.2 million, with a corresponding credit to additional paid-in capital was recorded related to available NOLs for which future realization is expected. Such restatement did not have a material effect on the Company's 1992 results of operations.\nIn addition, the adoption of SFAS No. 109 also resulted in: (i) certain assets and liabilities previously recorded net of tax in connection with purchase accounting to be recorded on a gross basis, resulting in increases in the balance of certain assets and liabilities with a corresponding increase in deferred tax assets and liabilities; (ii) an increase in certain revenues and expenses (primarily the amortization of intangible assets) which were previously recorded net of tax; and (iii) a more normalized effective tax rate, reflecting the tax-effecting of certain revenues and expenses which had previously been shown net of tax.\nREINSURANCE Effective January 1, 1993, the Company adopted SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-duration and Long-duration Contracts\" and restated its prior years' balance sheets in accordance with SFAS No. 113. SFAS No. 113 requires reinsurance receivables on paid and unpaid losses and loss adjustment expenses and prepaid reinsurance premiums to be reported as assets rather than netted against the corresponding liability for such items on the balance sheet.\n3. ACQUISITIONS\nOn September 22, 1994, Capsure, through its wholly owned subsidiary, Capsure Financial Group, Inc. (\"CFG\"), acquired all of the outstanding common stock of Universal Surety Holding Corp. (\"USHC\"). USHC is the holding company of Universal Surety. Universal Surety specializes in the underwriting of small contract and miscellaneous surety bonds and is licensed to write fidelity, surety and casualty insurance in 16 states. Capsure paid $28 million in cash and $4 million in Capsure common stock for USHC, pursuant to a Stock Purchase Agreement dated as of July 26, 1994. The cash portion of the purchase price was financed with borrowings under Capsure's $135 million revolving credit facility.\nOn August 14, 1992, Capsure acquired all of the outstanding common stock of Surewest Financial Corp. (\"Surewest\"). Surewest is the holding company for Western Surety. Western Surety specializes in writing small fidelity and noncontract surety bonds and is licensed to write fidelity, surety and casualty insurance in all 50 states and the District of Columbia. The aggregate purchase price for the stock of Surewest was approximately $103.5 million, consisting of $99 million in cash and $1 million in Capsure common stock, plus $3.5 million of acquisition costs and $14.4 million of additional capital contributed to pay down Surewest's existing indebtedness. Funding for the acquisition was derived in part from a $65.0 million bank term loan. The remaining funds were derived from available cash of the Company obtained principally through the offering of 3.4 million shares of Capsure common stock, dividends paid by United Capitol and through the exercise of warrants.\nEach acquisition has been accounted for as a purchase and, accordingly, the acquired assets and liabilities have been recorded at their estimated fair values. The operating results of USHC are included in the consolidated statements of income and cash flows from the September 22, 1994 acquisition date. The operating results of Surewest are included in the consolidated statements of income and cash flows from the August 14, 1992 acquisition date. The excess of the purchase price over the fair value of net assets acquired is recorded as excess cost over net assets acquired in the consolidated balance sheets.\nThe USHC Stock Purchase Agreement provides for a contingent payment to certain of the selling shareholders. Such payment shall be in cash or an equivalent amount of Capsure common stock, at the Company's option, in the year 2000, equal to twenty percent of the excess of the after-tax fair market value of Universal Surety at December 31, 1999, over an assumed fifteen percent return, compounded annually, on Capsure's invested capital. The contingent consideration, if any, shall be allocated to excess cost over net assets acquired when the additional consideration is payable and amortized prospectively over its remaining useful life.\nThe following table of unaudited pro forma information has been prepared as if the acquisition of USHC had been consummated on January 1, 1993 and the acquisition of Surewest had been consummated on January 1, 1991, at the same purchase price, with adjustments to the consolidated results of operations for the effects of the acquisition in the same manner as subsequent to the acquisition. Such adjustments include: (i) decreased net investment income and realized investment gains at USHC and Surewest; (ii) decreased corporate investment income; (iii) decreased operating\nexpenses at USHC and Surewest; and (iv) increased interest and amortization expense. In management's opinion, the pro forma financial information is not indicative of consolidated results of operations that may have occurred had the acquisitions taken place on January 1 of each respective year, or of future results of operations of the combined companies under the ownership and operation of Capsure. In the following table, the dollars are in thousands, except per share amounts:\nOn November 10, 1993, the Company acquired all of the outstanding common stock of Fischer Underwriting Group, Incorporated (\"Fischer\") for an aggregate purchase price of $3.5 million. Fischer is a managing general agency engaged in producing and underwriting specialty directors' and officers' and miscellaneous professional liability insurance. The acquisition of Fischer was not material to the Company's financial condition or results of operations for the year ended December 31, 1993 and, therefore, is not included in the 1993 and 1992 pro forma financial information above.\n4. INVESTMENTS\nThe cost and estimated fair values of investments in debt and equity securities as of December 31, 1994 were as follows (dollars in thousands):\nThe cost and estimated fair values of investments in debt and equity securities as of December 31, 1993 were as follows (dollars in thousands):\nAs of December 31, 1994, 99% of the Company's debt securities were considered investment grade by The Standard & Poors Corporation or Moody's Investor Services, Inc., and 91% were rated at least AA by those agencies. In addition, the Company's investments in debt securities did not contain any significant geographic or industry concentration of credit risk.\nThe U.S. Treasury notes and mortgage pass-through securities are backed by the full faith and credit of the U.S. Government. The U.S. Government collateralized mortgage obligations consist of securities collateralized by first mortgages issued by the Federal National Mortgage Association, and the Federal Home Loan Mortgage Corporation, or guaranteed by the Government National Mortgage Association.\nThe Company's insurance subsidiaries, as required by state law, deposit certain securities with state insurance regulatory authorities. At December 31, 1994, fixed maturities on deposit had an aggregate carrying value of $11.0 million.\nDuring 1994, the Company shifted a portion of its available-for-sale portfolio to equity securities, principally higher yielding nonaffiliated real estate investment trusts (\"REITs\"). At December 31, 1994, the carrying value of the Company's REIT portfolio was $24.3 million.\nShort-term investments are comprised of U.S. Treasury notes, maturing corporate notes, money market and mutual funds, and investment grade commercial paper equivalents.\nThe amortized cost and estimated fair value of debt securities at December 31, 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (dollars in thousands):\nMajor categories of net investment income and net investment gains were as follows (dollars in thousands):\nNet unrealized gain (loss) on securities included in stockholders' equity for December 31, 1994 and 1993 was as follows (dollars in thousands):\nAt December 31, 1994 and 1993, the carrying value of debt securities on non-accrual status was $1.9 million and $2.6 million, respectively, related to two interest-only U.S. Government collateralized mortgage obligations. The gross realized investment losses on fixed maturities in 1993 were primarily due to a $2.5 million write-down to fair value on these two interest-only securities, reflecting lower future expected cash flows of these securities as a result of an accelerated level of mortgage prepayments.\nA majority of the realized investment gains and losses on equity securities resulted from sales of securities held at the parent company level. For 1994, investment activity for the equity trading portfolio held at the parent company level included gross realized investment gains of $1.5 million and gross realized investment losses of $1.0 million.\n5. DEFERRED POLICY ACQUISITION COSTS\nPolicy acquisition costs deferred and the related amortization charged to income were as follows (dollars in thousands):\n6. REINSURANCE\nThe Company's insurance subsidiaries, in the ordinary course of business, cede reinsurance to other insurance companies to limit their exposure to loss and to provide greater diversification of risk. Reinsurance contracts do not relieve the Company of its primary obligations to claimants. A contingent liability exists with respect to reinsurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under the reinsurance agreements. The Company evaluates the financial condition of its reinsurers, establishes allowances for uncollectible amounts and monitors concentrations of credit risk. At December 31, 1994, Capsure's largest reinsurance receivable, including prepaid reinsurance premiums of $1.3 million and estimated ceded IBNR of $12.0 million, was approximately $18.9 million with Generali - U.S. Branch. Generali - U.S. Branch is rated A (Excellent), XV by A.M. Best Company, Inc. No other receivable from a single reinsurer exceeded 10% of total reinsurance receivables.\nThe effect of reinsurance on premiums written and earned for the years ended December 31, 1994, 1993 and 1992 was as follows (dollars in thousands):\nThe effect of reinsurance on losses and loss adjustment expenses incurred for the years ended December 31, 1994, 1993 and 1992 was as follows (dollars in thousands):\n7. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES\nActivity in the liability for unpaid losses and loss adjustment expenses was as follows (dollars in thousands):\nAs a result of favorable claim settlements and changes in estimates of insured events in prior years, the provision for losses and loss adjustment expenses decreased by $14.5 million ($8.3 million, net of reinsurance) in 1994, $15.0 million ($11.3 million, net of reinsurance) in 1993 and $9.9 million ($7.5 million, net of reinsurance) in 1992.\n8. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following table summarizes disclosure of fair value information of 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 may be based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. Accordingly, the estimates presented herein are subjective in nature and are not necessarily indicative of the amounts that Capsure could realize in a current market exchange. This information excludes certain financial instruments and all nonfinancial instruments such as insurance contracts from fair value disclosure. Thus, the following fair value amounts cannot be aggregated to determine the underlying economic value of Capsure.\nThe carrying amounts and estimated fair values of financial instruments for the years ended December 31, 1994 and 1993 were as follows (dollars in thousands):\nThe following methods and assumptions were used by Capsure in estimating fair values of financial instruments:\nInvestment Securities -- The estimated fair values for debt securities (including redeemable preferred stock) are based upon quoted market prices, where available. For debt securities not actively traded, the estimated fair values are determined 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 the yield, credit quality and maturity of the investments. The estimated fair values for equity securities are based on quoted market prices.\nCash, Short-Term Investments and Other Investments -- The carrying amount for these instruments approximates their estimated fair value.\nLong-Term Debt -- The estimated fair value of Capsure's long-term debt is 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.\n9. LONG-TERM DEBT\nOn March 29, 1994, the Company formed a direct, wholly owned subsidiary, CFG, to which Capsure contributed substantially all its assets and liabilities. Concurrently, CFG entered into a senior reducing revolving credit agreement with a syndicate of banks for $135 million (the \"Credit Facility\"). The common stock of substantially all of Capsure's subsidiaries and substantially all assets of Capsure's non-insurance operations have been pledged under the Credit Facility. As of December 31, 1994, $71 million was outstanding under the Credit Facility. The remaining availability under the Credit Facility may be used to finance future acquisitions and for general corporate purposes.\nThe interest rate on borrowings under the Credit Facility may be fixed, at the Company's option, for a period of one to six months and is based on a margin over either the London Interbank Offered Rate (\"LIBOR\") or the greatest of the agent bank's prime rate, certificate of deposit rate plus 1.0% and the Federal Funds Effective Rate plus 0.5%. The margin varies based on a leverage ratio and ranges from 0.75% to 1.75% on LIBOR borrowings and 0.0% to 0.75% on non-LIBOR borrowings. The Credit Facility provides for a commitment fee on the unused availability which also varies based on leverage. At December 31, 1994, the weighted average interest rate on outstanding borrowings was 7.125% and the applicable commitment fee was 0.375%.\nThe Credit Facility limits the Company with respect to the incurrence of additional indebtedness and the payment of dividends, imposes certain restrictions on investments and requires the maintenance of certain financial ratios and levels of Risk-Based Capital (\"RBC\"). As of December 31, 1994, the Company was in compliance with all material restrictions or covenants contained in the Credit Facility agreement. The use of the Credit Facility for acquisition purposes is subject to certain conditions with respect to the business and historical financial results of the target company, the maintenance of certain financial ratios on a prospective and pro forma basis, and the structure of the acquisition transaction.\nTotal borrowings available under the Credit Facility reduce semi-annually commencing March 31, 1996 by the following amounts (dollars in thousands):\nPrincipal and interest payments required under the Credit Facility are funded principally by dividend and intercompany tax sharing payments received from Capsure's insurance subsidiaries.\n10. STATUTORY FINANCIAL DATA\nCapsure's insurance subsidiaries file annual financial statements prepared in accordance with statutory accounting practices prescribed or permitted by applicable insurance regulatory authorities. Prescribed statutory accounting practices include state laws, regulations and general administrative rules, as well as guidance provided in a variety of publications of the National Association of Insurance Commissioners (\"NAIC\"). Permitted statutory accounting practices encompass all accounting practices that are not prescribed. Such practices may differ from state to state, may differ from company to company within a state, and may change in the future. The permitted statutory accounting practices of Capsure's insurance subsidiaries did not have a material effect on reported statutory surplus. The principal differences between statutory financial statements and financial statements prepared in accordance with generally accepted accounting principles are that statutory financial statements do not reflect deferred policy acquisition costs and deferred income taxes and debt securities are generally carried at amortized cost in statutory financial statements.\nThe NAIC has promulgated RBC requirements for property\/casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy, and other business factors. The RBC information will be used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio (the \"Ratio\") of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Generally, a Ratio in excess of 200% of authorized control level RBC requires no corrective actions on the behalf of the company or regulators. As of December 31, 1994, each of Capsure's insurance subsidiaries had a Ratio that was substantially in excess of the minimum RBC requirements.\nCapsure's insurance subsidiaries are subject to regulation and supervision by the various state insurance regulatory authorities in which they conduct business. Such regulation is generally designed to protect policyholders and includes such matters as maintenance of minimum statutory surplus and restrictions on the payments of dividends. Generally, statutory surplus of each insurance subsidiary in excess of statutorily prescribed minimum is available for transfer to the parent company. However, such distributions as dividends may be subject to prior regulatory approval, including a review of the implication on RBC. Without prior regulatory approval in 1995, Capsure's insurance subsidiaries may pay stockholder dividends of $19.3 million in the aggregate. In 1994, 1993 and 1992, Capsure received $21.0 million (including $5.0 million of dividends requiring prior approval), $11.8 million, and $29.0 million (including $15.1 million of dividends requiring prior approval), respectively, in dividends from its insurance subsidiaries.\nCombined statutory surplus and net income for insurance operations, including preacquisition results, as reported to regulatory authorities were as follows (dollars in thousands):\n11. INCOME TAXES\nThe components of deferred income taxes as of December 31, 1994 and 1993 were as follows (dollars in thousands):\nCapsure and its subsidiaries file a consolidated federal income tax return. As of December 31, 1994, based upon the Company's consolidated federal income tax returns, approximately $226.0 million of consolidated NOLs were available to offset future taxable income of the Company and its subsidiaries. The majority of such carryforwards expire in 1997, 1998 and 1999. Although realization is not assured, management believes that it is more likely than not that Capsure will generate sufficient taxable income to utilize at least $48.3 million of tax benefits from its available NOLs at December 31, 1994. Such estimate is based upon the earnings history of each of its insurance subsidiaries and projections of future taxable income. The reduction in the valuation allowance for deferred tax assets of $10.0 million in 1994 related primarily to the September 22, 1994, acquisition of Universal Surety and projections of future taxable income of this newly acquired entity.\nThe income tax provisions consisted of the following (dollars in thousands):\nReconciliations from the federal statutory tax rate to the effective tax rate are as follows:\nIntercompany tax sharing agreements between Capsure and its subsidiaries provide that income taxes shall be allocated based upon separate return calculations in accordance with the Internal Revenue Code of 1986, as amended (the \"Code\"). Intercompany tax payments are remitted at such times as estimated tax payments would be required to be made to the Internal Revenue Service. Capsure received tax sharing payments from its subsidiaries of $12.3 million, $13.0 million and $9.0 million in 1994, 1993 and 1992, respectively.\nThe Internal Revenue Service has not examined the Company's tax returns for the years in which the Company reported net operating losses. Under Section 382 of the Code, certain restrictions on the utilization of NOLs will apply if there is an ownership change of a corporation entitled to use such carryovers. The Company believes that there is currently no restriction on the ability of the Company to utilize its NOLs. It is possible that future transactions involving the Company's common stock or rights to acquire such stock could cause an ownership change of the Company resulting in restrictions of the Company's ability to utilize the NOLs during all taxable periods after the date of such ownership change. The Company has adopted provisions in its Certificate of Incorporation designed to facilitate the Company's ability to preserve and utilize its NOLs.\n12. COMMITMENTS AND CONTINGENCIES\nOn November 8, 1988, California voters enacted Proposition 103, an initiative which required a rollback in insurance rates for products written or renewed after November 8, 1988, and provided that rate changes must thereafter be submitted for approval to the Department of Insurance prior to implementation. While the proposition had the most significant impact on automobile insurance, its provisions were written broadly and may also apply to other property and casualty insurance, including surety bonds. The applicability of Proposition 103 to surety bonds has been litigated in the California courts and is currently under review by the California Supreme Court. Management believes that an unfavorable resolution of this matter would not have a material adverse impact on the Company's results of operations or financial position.\nThe Company was engaged in oil and gas production, exploration and development until mid-1993. In connection with the sale of substantially all of the Company's oil and gas properties, the buyers assumed all material environmental liabilities.\nUnited Capitol, in the ordinary course of business, chooses to underwrite accounts which have hazardous, unique or unusual risk characteristics and applies a strict and specialized underwriting discipline to such risks. Since United Capitol's organization in 1986, its liability policies have included an absolute pollution coverage exclusion (except for policies offering pollution liability coverage to contractors involved in the remediation of preexisting pollution). In addition, except as discussed below, United Capitol's product liability and other general liability policies contain exclusions, which management believes are enforceable, for coverage of claims for bodily injury or property damage caused by exposure to asbestos.\nUnited Capitol provides coverage to asbestos abatement contractors against third parties who have alleged bodily injury or property damage as a result of exposure to asbestos. Employees of the insured contractor and others required to be in the abatement area are not intended to be covered by United Capitol's policies and management believes such coverage exclusions are enforceable. Through the date hereof, there have been no valid claims against United Capitol's\nasbestos abatement liability policies alleging bodily injury arising from exposure to asbestos. Management believes that none of the other insurance products offered by Capsure's insurance subsidiaries creates any potential material environmental exposure.\nManagement believes that Capsure is adequately reserved for risks associated with environmental liabilities although there can be no assurance that legal or other developments will not increase the Company's exposure to environmental liabilities.\nCapsure and its subsidiaries are subject to litigation in the ordinary course of business. In the opinion of management, the outcome of such litigation will not have a material effect on the results of operations or financial position of Capsure.\n13. WARRANTS\nIn January 1989, the Company distributed warrants to purchase shares of its common stock to its stockholders of record on January 9, 1989, whereby for each share of common stock held on such date, one Series A Warrant, one Series B Warrant and one Series C Warrant (\"ABC Warrants\") were distributed. Each Series A Warrant, each Series B Warrant and each two Series C Warrants entitled the holder to purchase one share of the Company's common stock. In the aggregate, 9,825,378 ABC Warrants were distributed to purchase 8,187,815 shares of the Company's common stock. The original exercise price per share of common stock, issuable upon exercise of any ABC Warrant, was $5.50 per share. The Company utilized substantially all of the proceeds received from the exercise of ABC Warrants in 1992 to purchase the capital stock of Surewest. The Company also issued 8,580 warrants to directors of the Company to purchase a like number of shares of common stock for $5.60 per share (\"Other Warrants\"). In conjunction with the financing of the 1990 acquisition of United Capitol, the Company issued 44,444 warrants to a bank to purchase a like number of shares of Common Stock at $0.05 per share (\"Bank Warrants\"). All warrants had stated exercise and expiration periods. As of December 31, 1994, there were no warrants of any series outstanding.\nWarrant activity for the years ended December 31, 1994, 1993 and 1992 was as follows (dollars in thousands):\n14. STOCK OPTIONS\nThe Company has reserved 1,500,000 shares of its common stock for issuance to directors, officers, key employees and consultants of the Company through incentive stock options, nonqualified stock options and stock appreciation rights to be granted under the Company's 1990 Stock Option Plan (the \"Plan\"). On March 2, 1994, the Board of Directors of the Company approved an amendment to the Plan to increase by 500,000 the aggregate number of shares available for which options may be granted under the Plan to 1,500,000 shares. This amendment was approved by the stockholders at the Annual Meeting held on May 19, 1994. The Plan is administered by the Compensation Committee (the \"Committee\"), consisting of certain members of the Board of Directors. The option price is determined by the Committee, but cannot be less than the fair market value of the common stock of the Company at the date of grant for incentive stock options, and cannot be less than the par value of the common stock of the Company for non-qualified stock options.\nThe Plan provides for the granting of incentive options as defined under the Code. Under the Plan, all nonqualified stock options and incentive stock options expire ten years after the date of grant. All options in 1993 and 1994 were granted at an option price equal to fair market value at the date of grant. In 1992, all options were granted at an option price equal to fair market value, except for 2,500 nonqualified stock options which were granted at $8.50.\nStock option activity for the three years ended December 31, 1994 was as follows:\nAs of December 31, 1994, 858,973 shares were exercisable under the Plan. The number of shares available for granting of options under the Plan were 277,126 and 67,500 at December 31, 1994 and 1993, respectively.\n15. RELATED PARTY TRANSACTIONS\nEquity Group Investments, Inc. (\"EGI\"), a company affiliated with certain directors, officers and stockholders of the Company; other affiliated entities; and individuals affiliated with certain directors and officers of the Company perform or provide services to the Company and its subsidiaries. These services relate to acquisition consulting, financial planning, legal and tax advice, and investor relations, as well as leasing office space and providing certain computer equipment, operations and maintenance services to the Company. Related party agreements are generally for a term of one year and are approved by the independent members of the Board of Directors. The Company's corporate office space is leased pursuant to a facilities sharing agreement with EGI.\nThe Company paid rent, administrative services, and office facility services to EGI or its affiliates of $0.1 million in 1994, 1993 and 1992. The Company paid $0.2 million in 1994 and 1993 and $0.1 million in 1992 for financial planning, tax, accounting, investor relations and computer support and maintenance to EGI or its affiliates. The Company paid $0.2 million, $0.1 million and $0.4 million in fees for legal services to a law firm affiliated with EGI in 1994, 1993 and 1992, respectively. The Company received reimbursement from affiliates of EGI for financial management services provided by employees of the Company amounting to $0.1 million in 1994 and 1993 and $0.2 million in 1992.\n16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following is a summary of the unaudited results of operations for the years ended December 31, 1994 and 1993. The Company acquired Universal Surety in September 1994 and the consolidated results of operations shown below include the operating results of Universal Surety from the date of acquisition, which affects the comparability of the financial information (dollars in thousands, except per share data):\nSCHEDULE I\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES AS OF DECEMBER 31, 1994 (AMOUNTS IN THOUSANDS)\nSCHEDULE III\nCAPSURE HOLDINGS CORP. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) BALANCE SHEETS (AMOUNTS IN THOUSANDS)\nSee Notes to Condensed Financial Information and Notes to Consolidated Financial Statements\nSCHEDULE III\nCAPSURE HOLDINGS CORP. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) - (CONTINUED) STATEMENTS OF INCOME (AMOUNTS IN THOUSANDS)\nSee Notes to Condensed Financial Information and Notes to Consolidated Financial Statements\nSCHEDULE III\nCAPSURE HOLDINGS CORP. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) - (CONTINUED) STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS)\nSee Notes to Condensed Financial Information and Notes to Consolidated Financial Statements\nSCHEDULE III\nCAPSURE HOLDINGS CORP. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) - (CONTINUED) NOTES TO CONDENSED FINANCIAL INFORMATION\n1. BASIS OF PRESENTATION\nThe condensed financial information of the parent company includes the accounts of Capsure Holdings Corp. (\"Capsure\"). On March 29, 1994, Capsure formed Capsure Financial Group, Inc., a direct wholly owned subsidiary, to which Capsure contributed substantially all its assets and liabilities, including its investments in SI Acquisition Corp., NI Acquisition Corp. and Pin Oak Petroleum, Inc.\nSCHEDULE V\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES SUPPLEMENTAL INSURANCE INFORMATION AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (AMOUNTS IN THOUSANDS)\nSCHEDULE VI\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES REINSURANCE FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (AMOUNTS IN THOUSANDS)\nSCHEDULE VIII\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (AMOUNTS IN THOUSANDS)\n- --------------- (1) Accounts charged against allowance. (2) Includes balance at acquisition date of Universal Surety of $52.\nSCHEDULE X\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (AMOUNTS IN THOUSANDS)\n(A)(3) EXHIBITS\nExhibit Number Description\n2 Not applicable.\n3(i) The Certificate of Incorporation of Nucorp, Inc. dated May 6, 1988 together with the Certificate of Merger of Nucorp Energy, Inc. with and into Nucorp, Inc. dated August 12, 1988 (filed on August 15, 1988 as Exhibit 3.1 to Nucorp, Inc.'s Quarterly Report on Form 10-Q for the Period March 31, 1988 through June 30, 1988, and incorporated herein by reference).\n3(ii) Bylaws of Nucorp, Inc. (filed on August 15, 1988 as Exhibit 3.2 to Nucorp, Inc.'s Quarterly Report on Form 10-Q for the Period March 31, 1988 through June 30, 1988, and incorporated herein by reference).\n4 Specimen of Capsure Holdings Corp. Common Stock Certificate.\n9 Not applicable.\n10(1) Employment Agreement dated as of February 20, 1990 among Nucorp, Inc., United Capitol Holding Company, United Capitol Insurance Company, Equity Holdings and Bruce A. Esselborn (filed on August 2, 1990 as Exhibit 10.7 to Post-Effective Amendment No. 1 to Nucorp, Inc.'s Registration Statement on Form S-1, and incorporated herein by reference).\n10(2) Employment Agreement dated as of February 20, 1990 among Nucorp, Inc., United Capitol Holding Company, United Capitol Insurance Company and Mary Jane Robertson (filed on July 16, 1992 as Exhibit 10(iii)(A)(2) to Amendment No. 1 to Nucorp, Inc.'s Registration Statement on Form S-2, and incorporated herein by reference).\n10(3) Employment Agreement dated as of February 20, 1990 among Nucorp, Inc., United Capitol Holding Company, United Capitol Insurance Company and Steven S. Zeitman (filed on July 16, 1992 as Exhibit 10(iii)(A)(3) to Amendment No. 1 to Nucorp, Inc.'s Registration Statement on Form S-2, and incorporated herein by reference).\n10(4) Employment Agreement dated as of February 20, 1995 by and between Capsure Holdings Corp., a Delaware corporation, and Bruce A. Esselborn, an individual.\n10(5) Employment Agreement dated as of February 20, 1995 by and among Capsure Holdings Corp., a Delaware corporation, United Capitol Insurance Company, a Wisconsin corporation, and Mary Jane Robertson, an individual.\n10(6) Employment Agreement dated as of February 20, 1995 by and between Capsure Holdings Corp., a Delaware corporation, and Steven S. Zeitman, an individual.\n10(7) Executive Employment Agreement dated as of August 14, 1992 by and among Nucorp, Inc., a Delaware corporation, Surewest Financial Corp., a South Dakota corporation, SI Acquisition Corp., a Texas corporation, Western Surety Company, a South Dakota corporation, Equity Holdings, an Illinois partnership, and Dan L. Kirby.\n10(8) Executive Employment Agreement dated as of August 14, 1992 by and among Nucorp, Inc., a Delaware corporation, SI Acquisition Corp., a Texas corporation, Surewest Financial Corp., a South Dakota corporation, Western Surety Company, a South Dakota corporation, Equity Holdings, an Illinois partnership, and Joe P. Kirby.\nExhibit Number Description\n10(9) Purchase Agreement dated as of December 21, 1989 among Nucorp, Inc. and Bruce A. Esselborn (filed on August 2, 1990 as Exhibit 10.8 to Post-Effective Amendment No. 1 to Nucorp's Registration Statement on Form S-1, and incorporated herein by reference).\n10(10) Purchase Agreement dated as of December 22, 1989 among Nucorp, Inc. and CIP Limited Partnership (filed on September 26, 1990 as Exhibit 10.10 to Amendment No. 1 to Nucorp's Registration Statement on Form S-1, and incorporated herein by reference).\n10(11) Common Stock Purchase Warrant dated as of February 20, 1990, of Nucorp, Inc. to Continental Bank N.A. (filed on March 2, 1993 as Exhibit 28(e) to Nucorp, Inc.'s Registration Statement on Form S-3, and incorporated herein by reference).\n10(12) Registration Agreement dated as of February 20, 1990, between Nucorp, Inc. and Continental Bank N.A. (filed on March 2, 1993 as Exhibit 28(f) to Nucorp, Inc.'s Registration Statement on Form S-3, and incorporated herein by reference).\n10(13) Purchase Agreement dated as of March 25, 1992 among Nucorp, Inc., SI Acquisition Corp. and Surewest Financial Corp. (filed on March 27, 1992, as Exhibit 2 on Form 8-K, and incorporated herein by reference).\n10(14) Stock Purchase Agreement between Nucorp, Inc.; SI Acquisition Corp.; Surewest Financial Corp.; Joe P. Kirby; Dan L. Kirby; Kevin T. Kirby; Steven T. Kirby; First Bank of South Dakota, N.A., as Trustee of the Dan L. Kirby Trust; First Bank of South Dakota, N.A., as Trustee of the Kevin T. Kirby Trust; Norwest Bank South Dakota, N.A., as Trustee of the Joe P. Kirby Trust; and Norwest Bank South Dakota, N.A., as Trustee of the Steven T. Kirby Trust, dated March 25, 1992 and schedules thereto (filed on March 25, 1992 as Exhibit 2 on Nucorp, Inc.'s Form 8-K, and incorporated herein by reference).\n10(15) Credit Agreement dated August 14, 1992, among SI Acquisition Corp., and Continental Bank N.A. (filed on March 2, 1993 as Exhibit 28(c) to Nucorp, Inc.'s Registration Statement on Form S-3, and incorporated herein by reference).\n10(16) Compensation Agreement dated August 14, 1992 among SI Acquisition Corp. and Continental Bank N.A. (filed on March 26, 1993 as Exhibit 10.15 on Nucorp, Inc.'s Form 10-K, and incorporated herein by reference).\n10(17) Credit Agreement dated as of March 29, 1994 among Capsure Financial Group, Inc., Capsure Holdings Corp., the Lenders named therein and Chemical Bank, as Administrative Agent.\n10(18) Stock Purchase Agreement among John Knox, Jr., Universal Surety Holding Corp., Capsure Financial Group, Inc. and Capsure Holdings Corp. dated July 26, 1994 (filed on October 6, 1994 as Exhibit 2 to Capsure Holdings Corp. Current Report on Form 8-K, and incorporated herein by reference).\n10(19) 1990 Stock Option Plan of Nucorp, Inc. (filed on April 19, 1990 as Exhibit A to Nucorp, Inc.'s Proxy Statement for the Annual Meeting of Shareholders on May 9, 1990, and incorporated herein by reference).\n10(20) First Amendment to the Nucorp, Inc. 1990 Stock Option Plan (filed on April 27, 1992 as part of Nucorp, Inc.'s Proxy Statement for the Annual Meeting of Shareholders on June 9, 1992, and incorporated herein by reference).\n10(21) Managing General Agency Agreement between Western Surety Company and United Capitol Managers, Inc. (filed on March 2, 1993 as Exhibit 28(a) to Nucorp, Inc.'s Registration Statement on Form S-3, and incorporated herein by reference).\nExhibit Number Description\n10(22) Surety Bond Quota Share Reinsurance Agreement between Western Surety Company and United Capitol Insurance Company (filed on March 2, 1993 as Exhibit 28(b) to Nucorp, Inc.'s Registration Statement on Form S-3, and incorporated herein by reference).\n10(23) Contract Surety Bond Reinsurance Agreement dated as of September 22, 1994 between Western Surety Company, a South Dakota corporation, and Universal Surety of America, a Texas corporation.\n10(24) Co-Employee Agreement dated as of September 22, 1994 between Western Surety Company and Universal Surety of America.\n11 Earnings per share computation.\n12 Not applicable.\n13 Not applicable.\n16 Not applicable.\n18 Not applicable.\n21 Subsidiaries of the Registrant.\n22 Not applicable.\n23 Consent of Coopers & Lybrand dated March 29, 1995.\n24(1) Power of Attorney for Herbert A. Denton dated March 27, 1995.\n24(2) Power of Attorney for Bradbury Dyer, III dated March 17, 1995.\n24(3) Power of Attorney for Talton R. Embry dated March 17, 1995.\n24(4) Power of Attorney for Dan L. Kirby dated March 21, 1995.\n24(5) Power of Attorney for Joe P. Kirby dated March 22, 1995.\n24(6) Power of Attorney for L.G. Schafran dated March 20, 1995.\n27 Financial Data Schedule.\n28 Information from reports furnished to state insurance regulatory authorities - Schedule P from 1994 Combined Annual Statement of Capsure Holdings Corp.\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.\nCAPSURE HOLDINGS CORP.\n\/s\/ Bruce A. Esselborn Bruce A. Esselborn President (Principal Executive Officer)\n\/s\/ Mary Jane Robertson Mary Jane Robertson Senior Vice President and Chief Financial Officer (Principal Financial Officer)\n\/s\/ John S. Heneghan John S. Heneghan Controller (Principal Accounting Officer)\nDated: March 29, 1995\n(CONTINUED)\nCAPSURE HOLDINGS CORP. - SIGNATURES - (CONTINUED)\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nCAPSURE HOLDINGS CORP. AND SUBSIDIARIES\nEXHIBIT INDEX\nEXHIBIT INDEX (CONTINUED)","section_15":""}
{"filename":"811516_1994.txt","cik":"811516","year":"1994","section_1":"ITEM 1. BUSINESS.\nMetropolitan Realty Corporation (the \"Company\") is a real estate investment trust (\"REIT\") under the Internal Revenue Code of 1986, as amended (the \"Tax Code\"). The Company was incorporated under Michigan law on November 13, 1986. In November 1988, the Company issued 4,512,169 shares of common stock in an initial public offering and received net proceeds of $43,200,851.\nAs a REIT, the Company is required to invest most of its assets in real estate assets, cash and government securities. The Company intends to invest substantially all of its assets in mortgage loans to real estate projects located in southeastern Michigan in the counties of Wayne and Macomb. At December 31, 1994, the Company's total mortgage loan portfolio is invested 74% in projects located in the City of Detroit, 11% in projects located in the County of Macomb, and 15% in projects located in the County of Wayne outside of the City of Detroit.\nThe Company's mortgage loans include financing for industrial and mixed-use facilities, office buildings, and retail and residential centers. The Company has favored investments that will provide a competitive return and permanent financing for projects which were constructed with union labor. All mortgage loans to date are collateralized by a first lien on real property. At December 31, 1994, the Company's largest loan approximates 10% of its total assets and the carrying value of all mortgage loans approximates 62% of its total assets.\nFunds that have not yet been invested in mortgage loans are primarily invested in marketable mortgage-backed securities until needed for the Company's operations or investments in mortgage loans. As of December 31, 1994, approximately 26% of the Company's net assets remained invested in marketable mortgage-backed securities. The Company believes that its mortgage loans and marketable mortgage-backed securities will provide a competitive economic return to its shareholders while protecting their capital.\nThe Company continues to evaluate real estate projects and intends to liquidate its remaining marketable securities to make additional mortgage loans to qualified projects located in southeastern Michigan. Although the Company has competed and is competing with financial institutions such as banks, insurance companies, savings and loan associations, mortgage bankers, pension funds and other real estate investment vehicles with investment objectives similar to those of the Company, the Company believes it has targeted a market niche which is underserved.\nDuring 1994, the Company had one full-time administrative employee. The day-to-day operations of the Company are administered by the Executive Vice President who serves on a part- time basis under the direction of the President and the Executive Committee. Members of the Board of Directors serve without pay as officers and committee members and devote a considerable amount of time to the administration and operations of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's executive offices are located at Suite 748, 535 Griswold, Detroit, Michigan 48226. The Company rents this office space under a month-to-month lease which provides for a monthly rental of approximately $1,426, which is comparable to prevailing rentals for similar facilities. The Company's offices are suitable and adequate for the current operations of the Company.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material legal proceedings pending or, to the knowledge of the Company, threatened, to which the Company is a party or by which its property may be bound.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNo matters were submitted to a vote of the Company's shareholders since the Annual Meeting of Shareholders held June 10, 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 American Stock Exchange (the \"Exchange\"). The Company is listed for trading on the Exchange under the symbol \"MET\". The following table sets forth the high and low sales prices on the Exchange and dividends paid per share during each quarter of the years ended December 31, 1994 and 1993:\nAs of March 15, 1995, 4,532,169 shares of common stock were issued and outstanding and the number of shareholders of record was 53.\nThe Company intends to continue to pay cash dividends to shareholders on a quarterly basis in aggregate amounts sufficient to distribute at least 95% of its \"real estate investment trust taxable income\" in order to maintain its status as a REIT under the Tax Code. The Company will continue to furnish annually to each shareholder a statement setting forth distributions paid during the preceding year and their characterization as ordinary income, return of capital or capital gain.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table sets forth selected financial data as of December 31, 1994, 1993, 1992, 1991 and 1990 and for the years then ended:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nResults of Operations\nDuring fiscal year 1994, one of the Company's mortgage loans with an outstanding principal balance of $3,300,000 matured and was repaid. In addition, one of the Company's mortgage loans with an outstanding principal balance of approximately $1,200,000 was prepaid with prepayment penalties approximating $114,000. The Company's net investment in mortgage loans to real estate projects represented 62% of its assets, or $25,393,979, at December 31, 1994 and 71% of its assets, or $29,587,662, at December 31, 1993. The yields on the Company's outstanding mortgage loans range from 8% to 12.25%. The weighted average yield of earning mortgage loans is 10.58% at December 31, 1994, as compared to 10.33% at December 31, 1993. The weighted average term of outstanding mortgage loans is 9.1 years. At December 31, 1994, the Company had no outstanding loan commitments. The amount of foreclosed property held for sale, net of valuation allowance, represents 2% of the Company's assets, or $900,000, at December 31, 1994 and 5% of its assets, or $1,960,000, at December 31, 1993. The amount of marketable mortgage-backed (Federal National Mortgage Association and Federal Home Loan Mortgage Corporation) securities held by the Company during 1994 averaged $8,164,000 and earned an average yield of 4.6%, as compared to average marketable mortgage-backed security holdings of $8,101,000 which earned an average yield of 5.1% during 1993. The average yield on all performing interest earning assets was 8.9% for the year ended December 31, 1994 and 9.1% for the year ended December 31, 1993.\nInvestment income from marketable mortgage-backed securities decreased $51,851 to $370,725 for the year ended December 31, 1994 from $422,576 for the year ended December 31, 1993. Of the decrease, $9,508 was the result of a decrease in the average amount invested in marketable securities and $42,343 was the result of a decrease in the average yield earned.\nInvestment income from mortgage loans decreased $40,646 to $3,073,230 for the year ended December 31, 1994 from $3,113,876 for the year ended December 31, 1993. Of the decrease, $210,745 was the result of a decrease in average mortgage loans offset by a $45,326 increase in the stated average yield on all mortgage loans, and a $124,773 increase in interest income from loans which were non-earning at December 31, 1993.\nOperating expenses increased 25% to $1,270,478 for the year ended December 31, 1994 from $1,015,087 for the year ended December 31, 1993. The majority of this increase is due to a $957,717 increase in net loss from foreclosed property held for sale, which was largely attributable to an increase in the provision for valuation allowance, offset by a $461,500 decrease in the allowance for loan losses. Other operating expenses decreased $240,826 to $436,562 for the year ended December 31, 1994 from $677,388 for the year ended December 31, 1993. This decrease is due to a $147,363 reduction in general and administrative expenses, primarily as a result of decreased professional service fees, and a $93,463 reduction in amortization of organization costs, which became fully amortized in 1993.\nTwo mortgage loans with net carrying values aggregating $3,709,891 at December 31, 1994, collateralized by shopping centers in Detroit, Michigan and personal guarantees aggregating approximately $498,000, were in default at December 31, 1991 for nonpayment of principal, interest and late charges. The mortgagors are affiliated through a common borrower. In 1991, the Company established a loan loss reserve to reduce the carrying value of these loans to their estimated net realizable value. During 1992, the Company entered into loan modification agreements with these borrowers, pursuant to which the borrowers agreed to bring the loans current by December 31, 1992 and agreed to have the deeds to the properties placed in escrow. The Company also exercised its right to receive rental payments directly from the tenants. All events of default were cured on February 1, 1993 and the loans are now current. The Company continues to exercise its right to receive assigned rents directly from the tenants and the deeds to the properties remain in escrow. Both of these notes are classified as earning at December 31, 1994. An allowance has been provided to reduce the carrying value of these loans to their estimated net realizable value.\nA mortgage loan with a carrying amount of $1,369,349 at December 31, 1994, collateralized by an apartment building located in Detroit, Michigan, was in default at December 31, 1992 for nonpayment of principal, interest and late charges. During 1993, the Company entered into a loan modification agreement with the borrower which cured the events of default. Pursuant to this agreement the interest rate has been reduced, effective April 1, 1993, from 11.125% to 8% through April 1, 1995 and to 9.5% thereafter until maturity. This agreement also deferred payments until November 1993, when monthly installments of interest only commenced and continued through April 1994. Commencing May 1994, varying installments of principal and interest are due monthly until maturity, at which time the remaining unpaid principal and accrued interest is due. This agreement also includes personal guarantees aggregating approximately $570,000 at December 31, 1994. This loan is now current and is classified as earning at December 31, 1994. An allowance has been provided to reduce the carrying amount of the loan to its estimated net realizable value. The Company also has three additional loans, which are carried at an aggregate value of approximately $1.9 million at December 31, 1994, to entities affiliated with this borrower through common ownership which are all current and are classified as mortgage notes, earning at December 31, 1994.\nManagement reviews, on a regular basis, factors which may adversely affect its mortgage loans, including occupancy levels, rental rates and property values. It is possible that economic conditions in southeastern Michigan and the nation in general may adversely affect certain of the Company's other loans. The Company believes that the allowance for loan losses of $1,000,000 at December 31, 1994 is adequate to reflect mortgage loans at their estimated net realizable value.\nAt December 23, 1992, the Company obtained an apartment building located in Detroit, Michigan through a foreclosure sale. This property was the collateral for a construction loan under which the borrower defaulted during 1992. Under Michigan law, title passed to the Company on June 23, 1993 at the expiration of a six month redemption period. The carrying value of the property was written down to its estimated fair value at the time of foreclosure of $2,100,000, which resulted in a $639,000 writeoff against the allowance for loan losses. The fair value was determined based upon a July 1992 independent appraisal of the property. A valuation allowance of $140,000 was also established at the time of foreclosure for the estimated costs to sell the property. At December 31, 1994, the carrying value of the property has been reduced to $900,000 to reflect an updated property valuation based on the results of the Company's marketing efforts to locate a buyer for the property. The Company intends to continue to actively market this property for sale during 1995.\nDuring 1994, the Company reached settlements with the guarantors of the foreclosed loan aggregating $320,000. These settlements are payable over four to eight years, with interest rates ranging from non-interest bearing to 7.5%. Income from settlements is recorded as miscellaneous income when received and totalled $43,000 for the year ended December 31, 1994. The property's operating income and expenses from the date of foreclosure are reflected in the statement of operations as net loss from foreclosed property held for sale and total $1,295,416 for the year ended December 31, 1994.\nNet investment income decreased by 4% to $2,587,550, or $.57 per share, for the year ended December 31, 1994 from $2,700,898, or $.60 per share, for the year ended December 31, 1993. The decrease is attributable to a $957,717 increase in net loss from foreclosed property held for sale, offset by a $461,500 reduction in the allowance for loan losses, a $147,363 reduction of general and administrative costs, a $93,463 reduction in amortization of organization costs, and a $142,043 increase in total income.\nInvestment income from FNMA marketable securities decreased $245,920 to $422,576 for the year ended December 31, 1993 from $668,496 for the year ended December 31, 1992. Of the decrease, $134,519 was the result of a decrease in the average amount invested in marketable securities and $111,401 was the result of a decrease in the average yield earned.\nInvestment income from mortgage loans increased $105,192 to $3,113,876 for the year ended December 31, 1993 from $3,008,684 for the year ended December 31, 1992. Of the increase, $354,411 was the result of an increase in average mortgage loans offset by a $38,918 decrease in the stated average yield on all mortgage loans, a $54,381 decrease in interest income due to property received in foreclosure and a $155,920 decrease in interest income due to the Company's decision to discontinue accruing interest on certain loans.\nOperating expenses decreased 41% to $1,015,087 for the year ended December 31, 1993 from $1,716,288 for the year ended December 31, 1992. The majority of this decrease is due to a $900,000 decrease in the allowance for loan losses offset by a $337,699 net loss from foreclosed property held for sale. Other operating expenses, consisting primarily of general and administrative expenses, decreased $138,900 as a result of decreased professional fees.\nNet investment income increased by approximately 28% to $2,700,898, or $.60 per share, for the year ended December 31, 1993 from $2,112,662, or $.47 per share, for the year ended December 31, 1992. The increase in net investment income from 1992 to 1993 is primarily attributable to a $900,000 decrease in the allowance for loan losses expense offset by a $112,965 decline in total income.\nInvestment income from marketable securities decreased $480,229 to $668,496 for the year ended December 31, 1992 from $1,148,725 for the year ended December 31, 1991. Of the decrease, $275,932 was the result of a decrease in the average amount invested in marketable securities and $204,297 was the result of a decrease in the average yield earned.\nInvestment income from mortgage loans increased $341,369 to $3,008,684 for the year ended December 31, 1992 from $2,667,315 for the year ended December 31, 1991. Of the increase, $390,501 was the result of an increase in average investment in mortgage loans and $50,074 was the result of an increase in average yield offset by a $99,206 decrease in average yield due to the Company's decision to discontinue accruing interest on loans in default.\nDuring 1992, the Company increased its allowance for loan losses by $900,000. Operating expenses other than the allowance for loan losses decreased 3.7% from $846,733 for the year ended December 31, 1991 to $816,288 for the year ended December 31, 1992. Operating expenses other than the allowance for loan losses during both 1992 and 1991 consisted primarily of general and administrative expenses.\nNet investment income increased by approximately 9% to $2,112,662, or $.47 per share, for the year ended December 31, 1992 from $1,934,853, or $.43 per share, for the year ended December 31, 1991. The increase in net investment income from 1991 to 1992 was primarily attributable to a $440,500 decrease in the allowance for loan losses expense offset by a $306,236 decline in total income.\nThe Company intends to continue to invest its available funds at competitive market rates in mortgage loans to real estate projects located in southeastern Michigan. Cycles in the local and national economy have affected and could continue to affect the Company's ability to invest its remaining funds in mortgage loans and the yields attainable on such investments. Decreases in market interest rates may result in lower returns on future mortgage loans than on the mortgage loans closed to date. The Company expects to have the balance of its available assets fully invested in mortgage loans by the end of 1995.\nLiquidity and Capital Resources\nFunds that have not yet been invested in mortgage loans are primarily invested in marketable mortgage-backed securities until needed for the Company's operations or investments in mortgage loans. Income and principal received with respect to the Company's investments in mortgage loans are also invested in marketable mortgage backed securities pending distribution to shareholders in the form of dividends or reinvestment in mortgage loans. At December 31, 1994, the Company had $26,393,979 invested in mortgage loans, $2,034,134 invested in real estate owned, $10,783,048 invested in marketable mortgage-backed securities and approximately $3,298,886 invested in money market funds.\nAt December 31, 1994, the Company had no outstanding loan commitments. The Company anticipates that its sources of cash are more than adequate to meet its liquidity needs.\nOn March 14, 1995, the Company's Board of Directors announced its preliminary approval for the private placement of asset-backed bonds through a wholly owned subsidiary to be formed. The Company expects to generate proceeds of approximately $50 million. At December 31, 1994, $131,000 of professional fees have been incurred and deferred in connection with this transaction.\nNet cash generated by operating activities during 1994 aggregated $2,957,011 including $3,087,188 in net investment income adjusted for noncash depreciation and amortization expense, the valuation provisions for mortgage loans and foreclosed property held for sale, and amortization of net loan origination fees.\nNet cash provided by investing activities during 1994 aggregated $1,090,650 and consisted primarily of loan repayments and collections of principal from marketable securities offset by loan disbursements and purchases of marketable securities. The Company collected $4,876,191 of loan repayments and net commitment fees and purchased $4,767,232 of marketable securities with the proceeds. Collections of principal from marketable securities totalled $1,093,691. Loan disbursements of $150,000 represent a final disbursement to a current borrower.\nFinancing activities in 1994 consisted of dividend payments to shareholders of $2,855,266 which represented $.63 per outstanding share.\nThe Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Debt and Equity Securities\" (SFAS 115), on January 1, 1994. Under SFAS No. 115, marketable securities available for sale are carried at market value and unrealized gains and losses are included in a separate component of shareholders' equity. At December 31, 1994, shareholders' equity includes net unrealized holding losses on marketable securities of $356,949. In accordance with SFAS No. 115, prior period financial statements have not been restated to reflect the change in accounting principle.\nThe Financial Accounting Standards Board (\"FASB\") has issued Statement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments,\" and SFAS 114, \"Accounting by Creditors for Impairment of a Loan\", which was amended by SFAS 118, \"Accounting by Creditors for Impairment of Loan Income Recognition and Disclosures\". These pronouncements require the disclosure of the fair value of financial instruments along with the valuation method and significant assumptions used, and the measurement of the impairment of a loan based on the present value of expected future cash flows discounted at the loan's effective interest rate, respectively. The FASB requires adoption of these pronouncements in 1995. Based on current information available, management does not believe these pronouncements will have a significant impact on the Company's financial statements.\nThe Company's policy is to declare and pay cash dividends on a quarterly basis. The Company declared and paid dividends aggregating $.63 per share during the year ended December 31, 1994, compared to $.54 per share during the year ended December 31, 1993 and $.70 per share during the year ended December 31, 1992. The Company declared a dividend of $.13 per share of common stock to its shareholders of record on March 21, 1995 which will be paid on March 31, 1995 from the Company's money market funds.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements of the Company, consisting of balance sheet, statement of operations, statement of shareholders' equity, statement of cash flows and the notes to financial statements, are set forth in the separate financial section which begins on page and 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 the Company's independent public accountants during the past two fiscal years and the Company does not disagree with such 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 required by this Item 10 has been omitted as the Company intends to file with the Securities and Exchange Commission (the \"SEC\") not later than 120 days after the Company's year ended December 31, 1994, pursuant to Regulation 14A, a proxy statement which will relate to the election of directors and other matters. The information which will be included in such definitive proxy statement under the captions \"Election of Directors\" and \"Executive Officers and Executive Compensation\" is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this Item 11 has been omitted as the Company intends to file with the SEC not later than 120 days after the Company's year ended December 31, 1994, pursuant to Regulation 14A, a proxy statement which will relate to the election of directors and other matters. The information which will be included in such definitive proxy statement under the caption \"Executive Officers and 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 12 has been omitted as the Company intends to file with the SEC not later than 120 days after the Company's year ended December 31, 1994, pursuant to Regulation 14A, a proxy statement which will relate to the election of directors and other matters. The information which will be included in such definitive proxy statement under the caption \"Principal Shareholders\" is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by this Item 13 has been omitted as the Company intends to file with the SEC not later than 120 days after the Company's year ended December 31, 1994, pursuant to Regulation 14A, a proxy statement which will relate to the election of directors and other matters. The information which will be included in such definitive proxy statement under the caption \"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.\na. Documents Filed as part of Report. The following documents are filed as part of this Report.\n1. A list of the financial statements required to be filed as part of this Form 10-K are shown in the \"Index to the Financial Statements and Schedule\" filed herewith.\n2. The financial statement schedule required to be filed as a part of this Form 10-K is shown in the \"Index to the Financial Statements and Schedule\" filed herewith.\n3. A list of the exhibits required by Item 601 of the Regulation S-K to be filed as a part of this Form 10-K are shown in the \"Index to Exhibits\" filed herewith.\nb. Reports on Form 8-K. The Company did not file any reports on Form 8-K 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.\nDated: March 25, 1995 METROPOLITAN REALTY CORPORATION\nBy: \/s\/ Jay B. Rising ---------------------------------- Jay B. Rising, President (Principal Executive Officer and Principal Financial Officer)\nAnd By: \/s\/ Russell P. Flynn ----------------------------------\nPursuant to the requirements of the 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\/ Jay B. Rising Attorney-In-Fact March 25, 1995 -------------------------- *Jay B. Rising\n* Director March 25, 1995 -------------------------- Daniel L. Boone\n* Director March 25, 1995 -------------------------- David M. Diegel\n* Director March 25, 1995 -------------------------- Wayne S. Doran\n* Director March 25, 1995 -------------------------- Russell P. Flynn\n* Director March 25, 1995 -------------------------- David B. Hanson\n* Director March 25, 1995 -------------------------- Kenneth L. Hollowell\n* Director March 25, 1995 -------------------------- Robert G. Jackson\n* Director March 25, 1995 -------------------------- Richard P. Kughn\n* Director March 25, 1995 -------------------------- F. Thomas Lewand\n* Director March 25, 1995 -------------------------- Ernest Lofton\n* Director March 25, 1995 -------------------------- Daniel F. McNamara\n* Director March 25, 1995 -------------------------- Robert H. Naftaly\n* Director March 25, 1995 -------------------------- Timothy L. Nichols\nDirector March 25, 1995 -------------------------- Joel A. Schwartz\n* Director March 25, 1995 -------------------------- Oliver H. Smith\nSignature Title Date --------- ----- ----\n* Director March 25, 1995 -------------------------- Frank D. Stella\n* Director March 25, 1995 -------------------------- Marc Stepp\nDirector March 25, 1995 -------------------------- James M. Tervo\n* Director March 25, 1995 -------------------------- Samuel H. Thomas, Jr.\n* Director March 25, 1995 -------------------------- R. Douglas Trezise\n* Director March 25, 1995 -------------------------- Ronald C. Yee\nINDEX TO THE FINANCIAL STATEMENTS AND SCHEDULE ____________\nPAGES\nREPORT OF INDEPENDENT ACCOUNTANTS\nBALANCE SHEET, DECEMBER 31, 1994 AND 1993\nSTATEMENT OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSTATEMENT OF 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 -\nFINANCIAL STATEMENT SCHEDULE:\nSchedule II - Valuation and Qualifying Accounts\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Metropolitan Realty Corporation:\nWe have audited the financial statements and the financial statement schedule of Metropolitan Realty Corporation listed on page 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 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 Metropolitan Realty Corporation 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.\nCoopers & Lybrand L.L.P.\nDetroit, Michigan March 10, 1995\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS ____________\n1. ORGANIZATION:\nMetropolitan Realty Corporation (the \"Company\"), incorporated November 13, 1986, was organized to qualify as a real estate investment trust under the provisions of the Internal Revenue Code.\n2. ACCOUNTING POLICIES:\nCash Equivalents\nThe Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nMarketable Securities\nThe 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, marketable securities available for sale are carried at market value and unrealized gains and losses are included in a separate component of shareholders' equity. Shareholders' equity at December 31, 1994 includes net unrealized holding losses on marketable securities of $356,949. In accordance with the provisions of SFAS No. 115, prior period financial statements have not been restated to reflect the change in accounting principle. The cumulative effect of adopting the provisions of SFAS No. 115 was not significant. Prior to January 1, 1994, marketable securities were carried at the lower of cost or market. Marketable securities at December 31, 1994 and 1993 consist of Federal National Mortgage Association and Federal Home Loan Mortgage Corporation mortgage backed securities. Realized gains or losses on sales of securities are determined based upon specific identification. The realized net loss on marketable securities, included in investment income in the accompanying statement of operations, resulted from called securities and aggregated $16,557 for the year ended December 31, 1994 and $24,223 for the year ended December 31, 1993. At December 31, 1994, all marketable securities are considered available for sale.\nAllowance for Loan Losses\nThe Company provides for possible losses on its portfolio of mortgage notes receivable based on an evaluation of each mortgage note. In determining the allowance for possible losses, the Company has considered various indicators of value, including market evaluations of the underlying collateral, the cost of money, operating cash flow from the property during the projected holding period and expected capitalization rates applied to the stabilized net operating income of the specified property.\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n2. ACCOUNTING POLICIES, continued:\nThe allowance is based upon management's estimates and ultimate losses may vary from the current estimates. These estimates are periodically reviewed, and as adjustments become necessary, they are reported in the statement of operations in the period in which they become known.\nForeclosed Property Held for Sale\nProperty acquired through loan foreclosure is initially recorded at the lesser of mortgage loan balance or fair value at the date of foreclosure. Losses, if any, attributable to the excess of the recorded investment including accrued interest over fair value are charged to the allowance for loan losses on mortgage loans at the time of foreclosure. A valuation allowance is also established at the time of foreclosure for the estimated costs to sell the property as the Company is dependent on the liquidation of the property for the recovery of its investment in foreclosed real estate. Subsequent to foreclosure, the property is carried at the lower of cost or fair value less estimated costs to sell. The property's operating income and expenses from the date of foreclosure are reflected in the statement of operations. Depreciation of the property commences one year from the date of foreclosure. Income from guarantor settlements is recognized when received.\nOrganization Costs\nCertain costs related to the organization of the Company were capitalized at cost and amortized on a straight-line basis over 60 months. Organization costs became fully amortized in fiscal 1993.\nIncome Taxes\nThe Company intends to operate at all times to qualify as a real estate investment trust under the provisions of the Internal Revenue Code. In general, each year qualification is met, income is not subject to federal income tax at the Company level to the extent distributed to shareholders.\nRevenue Recognition\nLoan origination fees received from the borrower, in excess of loan origination costs paid, are amortized to interest income using the effective interest method over the life of the mortgage loan.\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n2. ACCOUNTING POLICIES, continued:\nInterest income is accrued when earned. The Company discontinues the accrual of interest income when circumstances exist which cause the collection of interest to be doubtful. The determination to discontinue accruing interest is made after a review by the Company's management of all relevant facts, including delinquency of principal and\/or interest, and financial stability of the borrower. Loans classified as nonearning are loans on which the accrual of interest has been discontinued.\nOther\nCertain prior year accounts have been reclassified to conform with current year presentations.\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n3. MORTGAGE NOTES RECEIVABLE:\nMortgage notes receivable as of dates indicated are summarized as follows:\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n3. MORTGAGE NOTES RECEIVABLE, Continued:\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n3. MORTGAGE NOTES RECEIVABLE, Continued:\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n3. MORTGAGE NOTES RECEIVABLE, Continued:\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n3. MORTGAGE NOTES RECEIVABLE, Continued:\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n3. MORTGAGE NOTES RECEIVABLE, Continued:\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n3. MORTGAGE NOTES RECEIVABLE, Continued:\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n3. MORTGAGE NOTES RECEIVABLE, continued:\nA reconciliation of the carrying value of mortgage notes receivable for the years ended December 31, 1994, 1993 and 1992 is as follows:\nDuring the year ended December 31, 1994, the Company earned approximately $395,000 or 10.2% of its total income on one mortgage note with a carrying value of approximately $4,238,000.\nTwo mortgage notes carried at an aggregate carrying value of approximately $3,700,000 and four mortgage notes carried at an aggregate carrying value of approximately $3,200,000 at December 31, 1994 made with entities affiliated through common ownership earned the Company $448,941 and $321,079, respectively, during the year ended December 31, 1994.\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n3. MORTGAGE NOTES RECEIVABLE, continued:\nTwo mortgage loans with net carrying values aggregating $3,709,891 at December 31, 1994, collateralized by shopping centers in Detroit, Michigan and personal guarantees aggregating approximately $498,000, were in default at December 31, 1991 for nonpayment of principal, interest and late charges. The mortgagors are affiliated through a common borrower. In 1991, the Company established a loan loss reserve to reduce the carrying value of these loans to their estimated net realizable value. During 1992, the Company entered into loan modification agreements with these borrowers, pursuant to which the borrowers agreed to bring the loans current by December 31, 1992 and agreed to have the deeds to the properties placed in escrow. The Company also exercised its right to receive rental payments directly from the tenants. All events of default were cured on February 1, 1993 and the loans are now current. The Company continues to exercise its right to receive assigned rents directly from the tenants and the deeds to the properties remain in escrow. Both of these notes are classified as earning at December 31, 1994. An allowance has been provided to reduce the carrying value of these loans to their estimated net realizable value.\nA mortgage loan with a carrying amount of $1,369,349 at December 31, 1994, collateralized by an apartment building located in Detroit, Michigan, was in default at December 31, 1992 for nonpayment of principal, interest and late charges. During 1993, the Company entered into a loan modification agreement with the borrower which cured the events of default. Pursuant to this agreement the interest rate has been reduced, effective April 1, 1993, from 11.125% to 8% through April 1, 1995 and to 9.5% thereafter until maturity. This agreement also deferred payments until November 1993, when monthly installments of interest only commenced and continued through April 1994. Commencing May 1994, varying installments of principal and interest are due monthly until maturity, at which time the remaining unpaid principal and accrued interest is due. This agreement also includes personal guarantees aggregating approximately $570,000 at December 31, 1994. This loan is now current and is classified as earning at December 31, 1994. An allowance has been provided to reduce the carrying amount of the loan to its estimated net realizable value. The Company also has three additional loans, which are carried at an aggregate value of approximately $1.9 million at December 31, 1994, to entities affiliated with this borrower through common ownership which are all current and are classified as mortgage notes, earning at December 31, 1994.\nThe Company evaluates its portfolio of mortgage loans on an individual basis, comparing the amount at which the investment is carried to its estimated net realizable value. In making its evaluations, the Company has assumed that it will be able to acquire property collateralizing mortgage loans by foreclosure, if deemed appropriate, and hold and dispose of such assets and real estate currently owned in the ordinary course of business to maximize the return to the Company. The evaluations and related assumptions are dependent upon current estimates of future operations, proceeds, costs, events and general market and economic conditions all of which are influenced by many unpredictable factors. Accordingly, the ultimate realizations of the Company's investments, including future income, may differ from amounts presently estimated. The Company believes that the allowance for loan losses of $1,000,000 at December 31, 1994 is adequate to properly reflect the portfolio of mortgage loans at estimated net realizable value.\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n4. REAL ESTATE OWNED:\nAt December 23, 1992, the Company obtained an apartment building located in Detroit, Michigan through a foreclosure sale. This property was the collateral for a construction loan under which the borrower defaulted during 1992. Under Michigan law, title passed to the Company on June 23, 1993, at the expiration of a six month redemption period. The carrying value of the property was written down to its estimated fair value at the time of foreclosure of $2,100,000, which resulted in a $639,000 writeoff against the allowance for loan losses. The fair value was determined based upon a July 1992 independent appraisal. A valuation allowance of $140,000 was also established at the time of foreclosure for the estimated costs to sell the property. At December 31, 1994, the carrying value of the property has been reduced to $900,000 to reflect an updated property valuation based on the results of the Company's marketing efforts to locate a buyer for the property.\nDuring 1994, the Company reached settlements with the guarantors of the foreclosed loan aggregating $320,000. These settlements are payable over four to eight years, with interest rates ranging from non-interest bearing to 7.5%. The settlements bear interest at an average rate of 6%. Income from the settlements is recognized by the Company when received and is recorded as miscellaneous income on the statement of operations. Settlement income totalled $43,000 for the year ended December 31, 1994.\nThe property's operating income and expenses from the date of foreclosure are reflected in the statement of operations. The net loss from foreclosed property held for sale, totalling $1,295,416 for the year ended December 31, 1994 and $337,699 for the year ended December 31, 1993, consisted of the following:\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n5. FEDERAL INCOME TAX:\nA real estate investment trust is not subject to federal income tax on taxable income distributed to its shareholders during its fiscal year and subsequent year, but prior to filing its federal tax return. If, however, the real estate investment trust has retained income within the limits allowed under the federal tax laws, it must pay tax at corporate rates on its undistributed income. Furthermore, if the real estate investment trust fails to distribute, during the fiscal year, an amount equal to 85% of its taxable income for that year, it is subject to a 4% excise tax on the shortfall. The excise tax is not deductible for federal income tax purposes. Income for tax and financial reporting purposes is reconciled as follows:\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n6. RELATED PARTY TRANSACTIONS:\nThe Company was involved in various transactions with affiliates as follows:\no One of the Company's legal counselors is also a member of the Company's Board of Directors. Fees for legal services provided by the director's law firm amount to $153,296, of which $70,076 are deferred by the Company (see Note 8), $57,599 and $186,285 for the years ended December 31, 1994, 1993 and 1992, respectively. Accrued legal fees of $22,524 and $3,087 are included in accounts payable in the accompanying balance sheet at December 31, 1994 and 1993, respectively.\no Fees aggregating $19,831, $19,261 and $23,176 for the years ended December 31, 1994, 1993 and 1992, respectively, were earned by a shareholder of the Company for providing various investment and other services to the Company.\no Consulting fees under a contractual agreement aggregating $42,400, $40,000 and $56,442 were earned by an officer of the Company in 1994, 1993 and 1992 respectively. Accrued consulting fees of $1,667 are included in accounts payable in the accompanying balance sheet at December 31, 1993.\n7. DIVIDEND DECLARATION:\nUnder pertinent provisions of the Internal Revenue Code, a real estate investment trust may consider a dividend declared in a subsequent year to be a distribution of income of the immediately prior year and thus reduce income subject to income tax. On March 10, 1995, the Board of Directors of the Company declared a cash dividend of $.13 per share of common stock to its shareholders of record on March 21, 1995, payable on March 31, 1995. Of this dividend, $.06 will be paid from income earned by the Company in 1994. This dividend will be taxable to shareholders as ordinary income.\n8. SUBSEQUENT EVENT:\nOn March 14, 1995, the Company's Board of Directors announced its preliminary approval for the private placement of asset-backed bonds through a wholly-owned subsidiary to be formed. The Company expects to generate proceeds of approximately $50 million. At December 31, 1994 $131,000 of professional fees have been incurred and deferred in connection with this transaction.\nContinued\nMETROPOLITAN REALTY CORPORATION\nNOTES TO FINANCIAL STATEMENTS, Continued\n9. INTERIM FINANCIAL INFORMATION (unaudited):\nContinued\nContinued\nINDEX TO EXHIBITS\nPage Exhibit Incorporated Herein Filed Number No. Description by Reference to Herewith Herein ------------------------------------------------------------------------------- 3.1 Second Restated Exhibit 3.1 to the Articles of Company's Form 10-K for Incorporation the fiscal year ended December 31, 1988 ------------------------------------------------------------------------------- 3.2 Amendments to ByLaws Exhibit 3.2 to 1991 10-K adopted May 17, 1991 ------------------------------------------------------------------------------- 3.3 Restated ByLaws adopted Exhibit 3.3 to 1991 10-K July 19, 1989, as amended October 27, 1989, May 15, 1990 and May 17, 1991 ------------------------------------------------------------------------------- 10.1 Investment Management Exhibit 10.2 to 1988 Service Agreement 10-K dated February 15, 1989 between the Company and NBD Bank, N.A. (formerly National Bank of Detroit) ------------------------------------------------------------------------------- 10.2 Agency and Consulting Exhibit 10.2 to 1990 Agreement dated as of 10-K November 15, 1989 between the Company and Walters & Associates, Inc. ------------------------------------------------------------------------------- 10.3 Letter agreement dated Exhibit 10.1 to 1990 July 1990 between the 10-K Company and Acquest Capital Management, Inc. ------------------------------------------------------------------------------- 10.4 Buhl Building Lease Exhibit 10.4 to 1991 dated April 25, 1991 10-K between the Company and Buhl Realty Company ------------------------------------------------------------------------------- 10.5 Agency and Consulting Exhibit 10.5 to 1992 Agreement dated as of 10-K February 4, 1993 between the Company and Mattar Consulting Services, Inc. ------------------------------------------------------------------------------- 10.6 First lease amendment Exhibit 10.6 to 1992 to Buhl Building Lease 10-K dated May 14, 1992 between the Company and Buhl Realty Company ------------------------------------------------------------------------------- 10.7 Letter agreement dated Exhibit 10.7 to 1993 March 8, 1994 between 10-K the Company and Mattar Consulting Services, Inc. ------------------------------------------------------------------------------- 10.8 Second lease amendment Exhibit 10.8 to 1993 to Buhl Building Lease 10-K dated May 14, 1992 between the Company and Buhl Realty Company ------------------------------------------------------------------------------- 10.9 Minutes of Executive Committee of the Board of Directors meeting dated X E-2 March 3, 1995 modifying Agency and Consulting Agreement dated as of February 4, 1993 between the Company and Mattar Consulting Services, Inc. ------------------------------------------------------------------------------- 25 Powers of Attorney X E-3 -------------------------------------------------------------------------------\nE-1","section_15":""}
{"filename":"850693_1994.txt","cik":"850693","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS\nAllergan, Inc. (\"Allergan\" or the \"Company\") is a leading provider of specialty therapeutic eye care products throughout the world with niche pharmaceutical products in skin care and neural care. Its worldwide consolidated revenues are principally generated by prescription and non-prescription pharmaceutical products in the areas of ophthalmology and skin care, intraocular lenses and other ophthalmic surgical products, and contact lens care products.\nAllergan was incorporated in California in 1948 and reincorporated in Delaware in 1977. In 1980, the Company was acquired by SmithKline Beckman Corporation (then known as \"SmithKline Corporation\" and herein \"SmithKline\"). The Company operated as a wholly-owned subsidiary of SmithKline from 1980 until 1989 when Allergan again became a stand-alone public company through a spin-off distribution by SmithKline.\nDuring the fourth quarter of 1991, the Company divested its computer-based ophthalmic diagnostic instrument business, Allergan Humphrey. In November 1992, the Company sold its contact lens business in North and South America. In August 1993, the Company sold its contact lens business outside of the Americas.\nALLERGAN BUSINESSES\nThe following table sets forth, for the periods indicated, the net sales from continuing operations for each of the Company's specialty therapeutics businesses and product lines:\nThe foregoing table does not include sales of discontinued operations. See Note 11 of Notes to Consolidated Financial Statements on page 41 of the 1994 Annual Report for further information concerning foreign and domestic operations.\nOphthalmic Pharmaceuticals Business\nAllergan develops, manufactures and markets a broad range of prescription and non-prescription products designed to treat diseases and disorders of the eye, including glaucoma,\ninflammation, infection and allergy. In addition, the specialty over-the-counter product line consists of products designed to treat ocular surface disease, including artificial tears and ocular decongestants.\nThe largest segment of the market for ophthalmic prescription drugs is for the treatment of glaucoma, a sight-threatening disease characterized by elevated intraocular pressure. Allergan's largest selling pharmaceutical product is Betagan(R) ophthalmic solution, a beta blocker used in the initial treatment of glaucoma. Allergan also markets and sells Propine(R) ophthalmic solution, which is used alone or in combination with other drugs when initial drug therapy for glaucoma becomes inadequate. Patent protection for both products expired in the United States in 1991. In 1993, in anticipation of generic competition, Allergan entered into an agreement with Schein Pharmaceutical, Inc. (\"Schein\") whereby Schein will market generic versions of certain Allergan products that are off-patent in the United States. During 1994, Bausch & Lomb and Alcon Laboratories separately announced receipt of marketing approval from the FDA for a generic version of Betagan(R) and Propine(R), respectively. In each instance, Schein began marketing a generic version of the corresponding Allergan product immediately after each announcement.\nThe Company also markets several leading ophthalmic products to treat ocular inflammation and infection. Allergan holds a major share of the U.S. market for ophthalmic corticosteroids. Pred Forte(R) and FML(R) Liquifilm(R) suspensions are leading products in the ocular corticosteroid inflammation market. Allergan's major products in the anti-infective market are Blephamide(R) suspension, a topical anti-inflammatory and anti-infective, Polytrim(R) solution, a synthetic antimicrobial which treats surface ocular bacterial infections and Ocuflox(R) solution, a fluroquinolone which treats bacterial conjunctivitis. Ocuflox(R) solution was first marketed in the U.S. in August 1993. It is also marketed in many countries internationally and is awaiting approval in Spain and Canada.\nIn 1993, Allergan entered into a strategic alliance with Fisons Corporation to co-promote certain ophthalmic pharmaceuticals in the United States. The alliance currently involves Allergan's Acular(R)1 ophthalmic solution for the relief of itch associated with seasonal allergic conjunctivitis. Later, under the terms of the alliance, co-promotion is planned to expand to include Fisons' Opticrom(R)2 ophthalmic solution and nedocromil sodium ophthalmic solution.\nOphthalmic Surgical Business\nAllergan's surgical business (known as Allergan Medical Optics or \"AMO\") develops, manufactures and markets intraocular lenses (\"IOLs\"), surgically related pharmaceuticals, phacoemulsification equipment and other ophthalmic surgical products.\nThe largest segment of the surgical market is for the treatment of cataracts. Cataracts are a condition, usually age related, in which the natural lens of the eye becomes progressively clouded. This clouding obstructs the passage of light and can lead to blindness. Most patients blinded by cataracts can be surgically cured by removing the clouded lens and replacing it with an IOL. AMO currently offers a full line of products used in the performance of cataract surgery, including rigid multi-piece, single-piece and small incision design IOLs. Sales of all models of the Company's IOLs represented 9.7%, 9.1% and 10% of total Company sales in 1992, 1993 and 1994, respectively. Intraocular lenses marketed by Allergan for small incision cataract surgery __________________________________\n1 Acular(R) is a registered trademark, which is licensed from Syntex (U.S.A.) Inc.\n2 Opticrom(R) is a registered trademark of Fisons Corporation.\ninclude the AMO(R)Phacoflex(R) small incision IOL, introduced in 1989, the AMO(R)Foldable Phacoflex(R)II SI-30NB(TM) small incision IOL, introduced in April 1993, and the AMO(R)DuraLens(TM) IOL which was introduced in various European countries during 1994. AMO(R)Array(R) multifocal IOL is also available in several European countries including Germany, France and Spain and is currently undergoing clinical trials in the U. S. Sales growth of IOLs in the U.S. has been adversely impacted by price erosion resulting from competitive pressures and government pricing policies.\nSmall incision IOLs continue to grow in popularity along with increasing use of phacoemulsification, a method of cataract extraction that uses ultrasound waves to break the natural lens into small fragments that can be removed through a hollow needle. Phacoemulsification requires only a 3 to 4 millimeter incision, compared to incisions of up to 12 millimeters for other techniques. Phacoemulsification accounts for more than 80 percent of cataract procedures in the United States. In 1993 Allergan introduced the AMO(R)Prestige(TM) phacoemulsification machine. AMO(R)Prestige(TM) makes small-incision cataract surgery easier than other phacoemulsification machines by using a sophisticated microprocessor that monitors vacuum and fluid in the eye. Allergan also markets AMO(R)Vitrax(R), a viscoelastic used to maintain the anterior chamber and protect endothelial cells during cataract surgery.\nIn September 1994, Allergan acquired the worldwide IOL business of Ioptex Research Inc., formerly a division of Smith & Nephew. In January 1995, Allergan acquired Optical Micro Systems (\"OMS\"). OMS develops and manufactures phacoemulsification equipment. These two acquisitions provide the Company with additional IOL and phacoemulsification equipment product offerings and the capability to manufacture phacoemulsification equipment.\nOptical Business\nThe Company has been in the contact lens care market since 1960. It develops, manufactures and markets a broad range of products worldwide for use with every available type of contact lens. These products include disinfecting solutions to destroy harmful microorganisms on the surface of contact lenses; daily cleaners to remove undesirable film and deposits from contact lenses; and enzymatic cleaners to remove protein deposits from contact lenses. The Company offers products that can be used in each of the three disinfecting systems now available: hydrogen peroxide systems, convenient chemical systems and heat systems. UltraCare(R) neutralizer\/disinfectant, Allergan's one-step hydrogen peroxide disinfection system, was approved by the FDA in March 1992 for general marketing in the United States. In the third quarter of 1994, Allergan received U.S. marketing approval for UltraCare(R) with a new color indicator. The new system, which had been previously launched in Germany, relies on a Vitamin B-12 color indicator which turns the solution pink to indicate complete neutralization of the peroxide. Allergan's Complete(R) brand Multi-Purpose convenient chemical disinfection system for soft contact lenses was launched in Australia, Canada, China Germany and Italy during 1993 and in the United States, the United Kingdom and Mexico in 1994.\nSales of the Company's proprietary enzymatic cleaners represented 11%, 11% and 10% of total Company sales in 1992, 1993 and 1994, respectively, and sales of the Company's hydrogen peroxide disinfection systems represented 13%, 14% and 14% of total Company sales in 1992, 1993 and 1994, respectively.\nSkin Care Business\nBuilding upon its strength in marketing to medical specialties and taking advantage of synergies in research and development, Allergan's skin care business (known as Allergan\nHerbert) develops, manufactures and markets a line of therapeutic skin care products primarily to dermatologists in the United States. Its product line includes Gris-Peg(R) tablets, a systemic anti-fungal product, Elimite(R) cream for the treatment of scabies and Naftin(R), a topical anti-fungal gel and cream.\nBotox(R)\/Neuromuscular Business\nAllergan's Botox(R) (Botulinum Toxin Type A) purified neurotoxin complex is used in the treatment of certain neuromuscular disorders which are characterized by involuntary muscle contractions or spasms. Botox(R) purified neurotoxin complex is marketed in the United States, Canada, Germany, France, Italy, New Zealand and a number of other countries for the treatment of blepharospasm (the uncontrollable abnormal contraction of the eyelid muscles which can force the eye closed) and strabismus (misalignment of the eyes) in people 12 years of age and over. In May 1994, Botox(R) purified neurotoxin complex was approved in the United Kingdom for blepharospasm and hemifacial spasm. In March 1991, an application was filed with the FDA for approval of a nonophthalmic claim for an indication related to a neck and shoulder neuromuscular disorder known as cervical dystonia (torticollis). Allergan has been asked to provide supplemental clinical data to support the torticollis filing. Botox(R) has been approved in several European countries for the treatment of cervical dystonia.\nEMPLOYEE RELATIONS\nAt December 31, 1994, the Company employed approximately 4,900 persons throughout the world, including approximately 2,220 in the United States. None of the Company's U.S.-based employees are represented by unions. The Company considers that its relations with its employees are, in general, very good.\nINTERNATIONAL OPERATIONS\nThe Company believes that international markets represent a significant opportunity for continued growth. International sales have represented approximately 52.1%, 52.5% and 52.7% of total sales for the years ended December 31, 1992, 1993 and 1994, respectively. Allergan believes that its well-established international market presence provides it with a competitive advantage, enabling the Company to maximize the return on its investment in research, product development and manufacturing.\nAllergan established its first foreign subsidiary in 1964 and currently sells products in approximately 100 countries. Marketing activities are coordinated on a worldwide basis and resident management teams provide leadership and infrastructure for customer focused rapid introduction of new products in their local markets.\nIn Japan, the second largest eye care market in the world, certain of Allergan's eye care pharmaceutical products are licensed to Santen Pharmaceuticals (the largest eye care pharmaceutical manufacturer in Japan), and Allergan's contact lens care products are sold through a joint venture between Santen and Allergan. IOLs and other eye care surgical products are sold directly in Japan. In 1994, Allergan and Nicholas Piramal India Limited formed a joint venture to manufacture and market eye care products in India. Also in 1994, fifteen ophthalmic pharmaceutical products and Botox(R) purified neurotoxin complex were approved for sale in India. In October 1994, Allergan launched its first two prescription products, Propine(R) and Betagan(R) solutions, in the Peoples' Republic of China. This followed the earlier introduction of its Complete(R) system in 1993. The Company is scheduled to begin construction of a new manufacturing facility in Hangzhou in 1995.\nSALES AND MARKETING\nAllergan maintains global marketing and regional sales organizations. Supplementing the sales efforts and promotional activities aimed at eye and skin care professionals, as well as neurologists outside the U.S., who use, prescribe and recommend its products, Allergan has been shifting its resources increasingly toward managed care providers. In addition, Allergan advertises in professional journals and has an extensive direct mail program of descriptive product literature and scientific information to specialists in the ophthalmic and dermatological fields. The Company's specialty therapeutic products are sold to drug wholesalers, independent and chain drug stores, commercial optical chains, mass merchandisers, food stores, hospitals, ambulatory surgery centers and medical practitioners, including neurologists. At December 31, 1994, the Company employed approximately 820 sales representatives throughout the world.\nRESEARCH AND DEVELOPMENT\nThe Company's global research and development efforts focus on eye care, skin care and neuromuscular products that are safe, effective, convenient and have an economic benefit. The Company's own research and development activities are supplemented by a commitment to identifying and obtaining new technologies through in-licensing, joint ventures and acquisition efforts including the establishment of research relationships with academic institutions and individual researchers.\nResearch and development efforts for the ophthalmic pharmaceuticals business focus primarily on new therapeutic products for glaucoma, inflammation, dry eye, allergy and new anti-infective pharmaceuticals for eye care. The Company is conducting research on new compounds that control intraocular pressure by either reducing the inflow or production, or improving the outflow of aqueous humor. Alpha2 agonists are a new class of glaucoma treatments currently being tested. They may be used by patients who cannot use beta-blockers or as an adjunct therapy. Allergan's lead compound in this category is brimonidine, which has completed Phase III clinical trials for the control of post-surgical intraocular pressure elevation and is currently undergoing Phase III trials for ocular hypertension and glaucoma. During the third quarter of 1994, Allergan filed a drug approval application with the FDA on brimonidine for acute post-surgical elevated pressure in the eye following argon laser trabeculoplasty. The Company is also conducting research and clinical trials on a class of compounds called prostaglandins. Unlike beta-blockers and alpha2 agonists that decrease the inflow or production of aqueous humor, prostaglandins reduce intraocular pressure by improving its outflow. The Company is also developing topical cyclosporine A for the treatment of severe dry eye.\nResearch and development activities for the surgical business concentrate on improved cataract surgical systems, implantation instruments and methods, and new IOL materials and designs, including the AMO(R)Array(R) multifocal IOL, designed to allow patients to see well over a range of distances.\nResearch and development in the optical business is aimed at contact lens care systems which are effective and more convenient for patients to use, thus lead to a higher rate of compliance with recommended lens care procedures. Improved compliance can enhance safety and extend the time a patient will be a contact lens wearer. The Company believes that continued development and commercialization of disinfection systems that are both easy-to-use and efficacious will be important for the future success of this part of the Company's business.\nDuring the first quarter of 1993, Allergan began Phase III clinical trials with its proprietary topical retinoid tazarotene (previously known as AGN190168) for both acne and psoriasis. In July 1994, the Company released initial Phase III clinical trial results for\ntazarotene for psoriasis, which met expectations based on results of earlier clinical studies. By mid-1995, the Company intends to file with the FDA an application for marketing approval for tazarotene in the treatment of psoriasis and acne, based on the results of this initial trial and six additional trials with more than 2,000 patients. Also, during the first quarter of 1994, an application was filed with the FDA seeking approval to market Azelex(TM) (azelaic acid) cream in the U.S. for the treatment of acne.\nDuring 1992, the Company entered into a joint venture (\"Joint Venture\") with Ligand Pharmaceuticals Incorporated (\"Ligand\") to combine Ligand's knowledge of intracellular receptor technology with the Company's experience in receptor-selective retinoids for topical use. The Joint Venture filed an Investigational New Drug Application (\"IND\") with the FDA in November 1993 for the use of 9-cis Retinoic acid (LGD1057) to be given orally for cancer therapy. In March 1994, the Joint Venture filed an IND for the topical use of LGD 1057 for cancers involving the skin.\nIn December 1994, the Company and Ligand announced the formation of a new research and development company, Allergan Ligand Retinoid Therapeutics, Inc. (\"ALRT\"), to devote $100 million to the accelerated research and development of retinoid products. Allergan and Ligand will fund ALRT in part through a public offering of $32.5 million of ALRT units through a rights offering to their respective shareholders. ALRT will be the successor to the Joint Venture which will be dissolved immediately prior to the consummation of the offering. Allergan and Ligand will contribute all Joint Venture technology and assets to ALRT. Upon consummation of the transaction, Allergan and Ligand will make cash payments to ARLT of $50 million and $17.5 million, respectively, and expense these cash payments as a one-time charge to earnings. A registration statement relating to the units has been filed with the SEC but has not yet become effective. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This disclosure shall not constitute an offer to sell or the solicitation of an offer to buy, nor shall there be any sale of these securities in any state in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state.\nThe continuing introduction of new products supplied by the Company's research and development efforts and in-licensing opportunities is critical to the success of the Company. Delays or failures in one or more significant research projects could have a material adverse impact on the future operations of the Company. At December 31, 1994, there were an aggregate of approximately 650 people involved in the Company's research and development efforts. The Company's research and development expenditures associated with continuing operations for 1992, 1993 and 1994 were $89.5 million, $102.5 million and $111.5 million, respectively.\nCOMPETITION\nAllergan faces strong competition in all of its markets worldwide. Numerous companies are engaged in the development, manufacture and marketing of health care products competitive with those manufactured by Allergan, although these companies do not necessarily compete in all of Allergan's product lines. Major eye care competitors include Alcon Laboratories (a subsidiary of Nestle), Bausch & Lomb, Ciba Vision Corp. (a subsidiary of Ciba-Geigy), IOLab (a subsidiary of Johnson & Johnson), Merck, Pharmacia Ophthalmics (a subsidiary of Kabi Pharmacia), and Sola\/Barnes-Hind (a subsidiary of Pilkington plc). These competitors have equivalent or greater resources than Allergan. The Company's skin care business competes against a number of companies, including, among others, Schering-Plough, Johnson & Johnson and Hoffman LaRoche, which have greater resources than Allergan. In marketing its products to health care professionals, the Company competes primarily on the basis of product technology, service and price. The Company believes that it competes favorably in its product markets.\nGOVERNMENT REGULATION\nDrugs, biologics and medical devices, including IOLs and contact lens care products, are subject to regulation by the FDA, state agencies and, in varying degrees, by foreign health agencies. Government regulation of many of the Company's products generally requires extensive testing of new products and filing applications for approval by the FDA prior to sale in the United States and by foreign health agencies prior to sale in many international markets. The FDA and foreign health agencies review these applications and determine whether the product is safe and effective. The process of developing data to support a pre-market application and governmental review can be costly and take many years to complete.\nIn general, manufacturers of drugs, medical devices and biologics are operating in an increasingly more rigorous regulatory environment than has been the case in previous years. The total cost of providing health care services has been and will continue to be subject to review by governmental agencies and legislative bodies in the major world markets, including the United States, which are faced with significant pressure to lower health care costs. Prices for some of the Company's products, specifically IOLs and pharmaceutical products, accounting for approximately 52% of the Company's 1994 worldwide sales, are expected to come under increased pressure as governments and managed care providers generally increase their efforts to contain health care costs.\nSeveral legislative and administrative measures to strengthen government regulation of medical devices and drugs have recently been implemented in the United States, such as the Safe Medical Devices Act of 1990, which among other things, increased reporting requirements of adverse events associated with medical devices, and the Prescription Drug User Fee Act of 1992, which requires payment of substantial fees to the FDA for the review of new drug applications. The United States Congress is expected to consider mandating the application of user fees to medical device applications as well. Other measures are pending or have been proposed. In addition, there has been increased scrutiny of drug and device manufacturers by the FDA as a result of a scandal in the generic drug industry and controversies surrounding the safety of certain medical devices. While the Company is not primarily involved in these areas of business, the impact of increased FDA scrutiny is felt by all companies in the drug and device industries. Moreover, in Europe and other major Allergan markets, the regulation of drugs and medical devices is likewise increasing. The Company is working to ensure that its operations remain in compliance with the regulatory requirements of the FDA, its foreign counterparts, and other governmental agencies.\nIn the United States, a significant percentage of the patients who receive the Company's IOLs are covered by the federal Medicare program. When a cataract extraction with IOL implantation is performed in an ambulatory surgery center (\"ASC\"), Medicare provides the ASC with a fixed $150 allowance to cover the cost of the IOL. When the procedure is performed in a hospital outpatient department, the hospital's reimbursement is determined using a complex formula that blends the hospital's costs with the $150 allowance paid to ASCs. This $150 IOL payment could be subject to reduced levels by Congress through various legislative actions: health care reform; deficit reduction legislation; or implementation of a balanced budget amendment. The Medicare Technical Corrections Bill of 1994 directed the U.S. Health Care Financing Administration (\"HCFA\") to establish a system through which the agency would pay ASCs and hospitals a rate above $150 for \"advanced technology IOLs\". HCFA is not expected to consider applications from manufacturers for preferential \"advanced technology\" status before 1996. In November 1990, HCFA issued proposed regulations under which Medicare would not recognize hospitals' expenditures for IOLs implanted during outpatient cataract surgery to the extent that those expenditures exceed the ASC allowance of $150. The Company cannot predict whether HCFA will promulgate a final regulation imposing this limitation, or whether limits on IOL payment will be incorporated within a more broadly sweeping reform of the Medicare outpatient hospital reimbursement system.\nThe cost of prescription drugs is likely to receive some continuing attention in the United States Congress. Legislation enacted in 1990, and amended and strengthened in 1992, requires pharmaceutical manufacturers to rebate to the government a portion of their revenues from drugs furnished to Medicaid patients. In 1992, legislation was enacted that extends these requirements to covered outpatient pharmaceuticals, and also mandates a reduction in pharmaceutical prices charged to certain federally-funded facilities as well as to certain hospitals serving a disproportionate share of low-income patients. A provision of the Omnibus Budget Reconciliation Act of 1993 limits tax benefits currently realized by U.S. manufacturers as a result of the manufacture of certain products in Puerto Rico, beginning in 1994. It is likely that some Congressional attention will continue to focus on the costs of drugs generally, and particularly on increases in drug prices in excess of the rate of inflation.\nThe United States Congress also devoted significant attention in 1994 and in prior years to proposed amendments to the Orphan Drug Act. Under one proposal, once cumulative sales of an orphan drug exceed a designated dollar amount the FDA would be authorized to approve competitors' marketing applications. The Company currently markets one orphan drug product, Botox(R) purified neurotoxin complex. While legislation was not enacted in 1994, it is expected that Congress will consider further amendments to the Orphan Drug Act in 1995.\nAs a result of the change in its leadership, the Unites States Congress may reexamine the regulatory burdens imposed on drug and medical device manufacturers by the FDA. Congress will also consider less sweeping health care reform legislation. In Europe, on both a European Union level and at the local national level, governments have implemented legislation directed at, among other things, cost containment in the form of reference pricing (i.e., setting a fixed level of reimbursement by drug category), removing various categories of drugs from reimbursement programs, and encouraging generic prescribing.\nThe Company cannot predict the likelihood of any significant legislative action in these areas, nor can it predict whether or in what form health care legislation being formulated by various governments will be passed. The Company also cannot predict exactly what effect such governmental measures would have if they were ultimately enacted into law. However, in general, the Company believes that such legislative activity will likely continue and the adoption of such measures can be expected to have some adverse impact on the Company's business.\nPATENTS, TRADEMARKS AND LICENSES\nAllergan owns or is licensed under numerous patents relating to its products, product uses and manufacturing processes. It now has numerous patents issued in the United States and corresponding foreign patents issued in the major countries in which it does business. Allergan believes that its patents and licenses are important to its business, but that with the exception of those relating to hydrogen peroxide disinfection systems, no one patent or license is currently of material importance in relation to its business as a whole. Allergan markets its products under various trademarks and considers these trademarks to be valuable because of their contribution to the market identification of the various products.\nENVIRONMENTAL MATTERS\nThe Company is subject to federal, state, local and foreign environmental laws and regulations. The Company believes that its operations comply in all material respects with applicable environmental laws and regulations in each country where the Company has a business presence. Although Allergan continues to make capital expenditures for environmental protection, it does not anticipate any significant expenditures in order to comply with such laws and regulations which would have a material impact on the Company's capital expenditures,\nearnings or competitive position. The Company is not aware of any pending litigation or significant financial obligations arising from current or past environmental practices. There can be no assurance, however, that environmental problems relating to properties owned or operated by the Company will not develop in the future, and the Company cannot predict whether any such problems, if they were to develop, could require significant expenditures on the part of the Company. In addition, the Company is unable to predict what legislation or regulations may be adopted or enacted in the future with respect to environmental protection and waste disposal.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAllergan's operations are conducted in owned and leased facilities located throughout the world. Its primary administrative and research facilities are located in Irvine, California. The following table describes the general character of the major existing facilities as of March 6, 1995:\nThe Company believes its present facilities are adequate for its current needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are involved in various litigation and claims arising in the normal course of business which Allergan considers to be normal in view of the size and nature of its business. Although the ultimate outcome of pending litigation cannot be precisely ascertained at this time, Allergan believes that any liability resulting from the aggregate amount of uninsured damages for outstanding lawsuits and claims will not have a material adverse effect on its consolidated financial position. However, in view of the unpredictable nature of litigation, no assurances can be given in this regard.\nThe Company, in cooperation with regulatory authorities in Puerto Rico, is evaluating and implementing operational improvements to the wastewater treatment system at the Company's Hormigueros facility. These improvements, which will reduce the ecological impacts of the Company's operations, will not have a material adverse impact of the Company's business.\nIn October 1993, the Company disclosed to the U.S. Department of Commerce Office of Export Enforcement (the \"Commerce Department\") that it had been shipping its medicine, Botox(R) purified neurotoxin complex, under general license authority to various foreign countries in the period since July 15, 1992, when the active ingredient in Botox(R), an attenuated form of botulinum toxin, was reclassified to require validated export licensing. It is the Company's position that the reclassification did not and could not apply to medicines, such as Botox(R), that are exempt from validated export licensing by statute and that have no potential application as biological warfare agents or other undesired uses. After conducting a field investigation, in which the Company cooperated, the Commerce Department advised the Company in the first quarter of 1995 that it did not agree with the Company's position regarding the export classification of Botox(R) and that it had referred the case to the office of the U.S. Attorney in order to determine whether criminal charges might be warranted. The Company does not believe that the filing of criminal charges would be warranted.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company did not submit any matter 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.\nITEM I-A. EXECUTIVE OFFICERS OF ALLERGAN, INC.\nThe executive officers of the Company and their ages as of March 6, 1995 are as follows:\nOfficers are appointed by and hold office at the pleasure of the Board of Directors.\nDr. Anido has been Corporate Vice President and President, Americas Region since 1993. Prior thereto, he had 18 years of experience with pharmaceutical companies. Dr. Anido was Vice President, Business Management of the U.S. Prescription Products Division of Marion Merrell Dow, Inc. from 1991 to 1993, President and General Manager (1990-1991) and Vice President, Sales & Marketing (1989-1990) of Nordic Laboratories, Inc. He also held various management positions with Marion Laboratories, Inc.\nMr. D'Eliscu has been Corporate Vice President, Corporate Communications since 1992 and was Vice President, Investor Relations and Public Communications from 1991. Mr. D'Eliscu had been Senior Director, Investor Relations of the Company from 1989 to 1991 and prior thereto, he had been Director of Business Development from 1988 and Senior Product Manager from 1985. Mr. D'Eliscu first joined the Company in 1979.\nMr. Donohoe has been Corporate Vice President and President, Europe Region since 1992. Prior thereto, he was Corporate Vice President and President, Optical, Consumer\/OTC Group from 1991. Mr. Donohoe was Senior Vice President and General Manager, Contact Lenses from 1990 to 1991 and Area Vice President, Northern Europe from 1989 to 1990. Mr. Donohoe held the position of Senior Vice President, Worldwide Marketing for the Optical Division from 1988 to 1989 and was Vice President, International Marketing from 1987 to 1988. Mr. Donohoe first joined the Company in 1987.\nMr. Haugen has been Executive Vice President and Chief Operating Officer since April 1992 and had been Corporate Vice President of the Company and President, Worldwide Eye Marketing and Sales & Operations since January 1992. Prior thereto, Mr. Haugen was Corporate Vice President and President, Americas Region in 1991 and had been President of Allergan Optical and Senior Vice President of the Company from 1989 to 1991. Prior thereto he was Senior Vice President and President of Allergan Pharmaceuticals from 1988 to 1989 and was Senior Vice President, Planning and Business Development since 1987. Mr. Haugen first joined the Company in 1976.\nMr. Hilles has been Corporate Vice President, Human Resources since 1991 and prior thereto was Senior Vice President, Human Resources from 1986 to 1991. He was Vice President, Human\nResources from 1981 to 1986. Mr. Hilles first joined SmithKline Beckman Corporation in 1965.\nDr. Kaplan has been Corporate Vice President, Research and Development since 1992. He had been Senior Vice President, Pharmaceutical Research and Development since 1991, Senior Vice President, Research and Development since 1989 and Vice President since 1988. Dr. Kaplan had served as Senior Director in Group Research and Development from 1986 to 1988 and as Associate Director, Discovery Research from 1984 to 1986. Dr. Kaplan first joined the Company in 1983.\nMr. Reichardt has been Corporate Vice President, Optical since 1992. Prior thereto, he was Senior Vice President, Marketing\/Business Development, Optical-Europe from 1991 and Senior Vice President, Northern Europe from 1983. Mr. Reichardt first joined the Company in 1972.\nMs. Schiavo has been Corporate Vice President, Worldwide Operations since 1992. She was Senior Vice President, Operations from 1991 and Vice President, Operations from 1989. Prior thereto, she was Senior Director, Operations from 1988 to 1989. Ms. Schiavo first joined the Company in 1980.\nMr. Shepherd has been President and Chief Executive Officer of the Company since 1992 and prior thereto had been President and Chief Operating Officer from 1984 to 1991. Prior to 1984, Mr. Shepherd was President of Allergan U.S., Senior Vice President, U.S. Operations and Vice President, Operations. Mr. Shepherd first joined the Company in 1966.\nMr. Tunney has been Corporate Vice President, General Counsel and Secretary of the Company since 1991 and prior thereto was Senior Vice President, General Counsel and Secretary from 1989 through 1991. Mr. Tunney had served as Vice President, General Counsel and Assistant Secretary of the Company since 1986, and as Associate General Counsel of the Company since 1985. Prior thereto he was Senior International Attorney for SmithKline Beckman Corporation which he joined in 1979.\nMr. Yoder has been Vice President and Controller of the Company since 1990. Prior thereto, Mr. Yoder held various management positions with Del Taco, Inc. from 1983 to 1989, including Vice President, Finance of Del Taco\/Naugles Restaurants and Vice President, Controller of Del Taco, Inc. Mr. Yoder first joined the Company in 1990.\nThe information required by Item 405 of Regulation S-K is included on page 7 of the Proxy Statement and is incorporated herein by reference.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe section entitled \"Market Prices of Common Stock and Dividends\" on the inside back cover of the Annual Report is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe table entitled \"Selected Financial Data\" on page 46 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 section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations for the Three Year Period Ended December 31, 1994\" on pages 23-28 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, including the notes thereto, together with the sections entitled \"Independent Auditors' Report\" and \"Quarterly Results (Unaudited)\" of the Annual Report included on pages 44 and 45, respectively, are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe section entitled \"Independent Auditors\" on page 20 of the Proxy Statement is incorporated herein by reference.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF ALLERGAN, INC.\nInformation under this Item is included on pages 2-5 of the Proxy Statement and such information is incorporated herein by reference. Information with respect to executive officers is included on pages 10-12 of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe section entitled \"Executive Compensation,\" and the subsection entitled \"Director Compensation\" included in the Proxy Statement on pages 11-12, and page 6, respectively, are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe common stock information in the section entitled \"Security Ownership of Certain Beneficial Owners and Management\" on pages 8-10 of the Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe subsection entitled \"Other Matters\" and the section entitled \"Compensation Committee Interlocks and Insider Participation\" on pages 7 and 19 of the Proxy Statement are incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n* Incorporated by reference from the indicated pages of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994 (and except for these pages, the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994, is not deemed filed as part of this report).\nAll other schedules have been omitted for the reason that the required information is presented in financial statements or notes thereto, the amounts involved are not significant or the schedules are not applicable.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the last quarter of 1994.\n(c) Item 601 Exhibits\nReference is made to the Index of Exhibits beginning at page 18 of this report.\n(d) Other Financial Statements\nThere are no financial statements required to be filed by Regulation S-X which are excluded from the annual report to shareholders by Rule 14 a-3(b)(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.\nDate: March 22, 1995 ALLERGAN, INC.\nBy \/S\/ WILLIAM C. SHEPHERD ------------------------------------- William C. Shepherd 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.\nINDEX OF EXHIBITS\nINDEX OF EXHIBITS\nINDEX OF EXHIBITS\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders and Board of Directors of Allergan, Inc.:\nUnder date of January 23, 1995, we reported on the consolidated balance sheets of Allergan, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings 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 audit of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule in the Form 10-K. 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, this 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 6 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1992 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" As discussed in note 8 to the consolidated financial statement, the Company also adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions,\" in 1992.\nKPMG PEAT MARWICK LLP\nCosta Mesa, California January 23, 1995\nSCHEDULE VIII\nALLERGAN, INC.\nAllowance for Doubtful Accounts\nYears Ended December 31, 1994, 1993 and 1992\n(Dollars in millions)\n_________________________\n(a) Provision charged to earnings. (b) Accounts written off. (c) Allowance of business sold.\nS-4","section_15":""}
{"filename":"8960_1994.txt","cik":"8960","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":"812094_1994.txt","cik":"812094","year":"1994","section_1":"Item 1. Business - ----------------\nOutlet Centre Partners (the \"Registrant\") is a limited partnership formed in March 1987 under the laws of the State of Illinois, which raised $30,000,000 from sales of Limited Partnership Interests. The Registrant owns (through subsidiaries) the Factory Outlet Centre (the \"Centre\") located in Bristol, Wisconsin as described under \"Property\" (Item 2). 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.\nIn June 1994, the Registrant completed the refinancing of the Centre's first mortgage loan. See Note 3 of Notes to Financial Statements for further information.\nThe Centre is subject to certain competitive conditions in the market in which the property 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 Partners-XXII, 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. Property - ----------------\nAs of December 31, 1994, the Registrant owns the Factory Outlet Centre, a regional enclosed mall containing approximately 310,000 square feet located on approximately 33 acres in Bristol, Wisconsin.\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 the property.\nSee Notes to Financial Statements for other information regarding the property investment.\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 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, following.\nAs of December 31, 1994, the number of record holders of Limited Partnership Interests of the Registrant was 2,046.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ----------\nTotal income $ 5,500,853 $ 5,066,152 $ 5,654,459 $ 6,131,744 $ 5,798,949 Net (loss) income (118,837) (446,805) (217,234) 708,302 504,302 Net (loss) income per Limited Partnership Interest (3.92) (14.74) (7.17) 23.37 16.64 Total assets 24,143,296 23,433,874 24,772,417 26,234,651 27,023,973 Mortgage note payable 12,692,502 11,543,885 11,664,937 11,771,694 11,876,774 Distributions per Limited Partnership Interest None 27.625 44.20 44.20 44.20\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nSummary of Operations - ---------------------\nThe Centre's operations have stabilized and begun to improve due to renovations and leasing efforts undertaken during the past two years. As a result, the net loss decreased during 1994 as compared to 1993. Lower average occupancy, rental rates and percentage rent collections during 1993 caused an increase in the net loss during 1993 as compared to 1992. Further discussion of Outlet Centre Partners' (the \"Partnership\") operations is summarized below.\nOperations - ----------\n1994 Compared to 1993 - ---------------------\nThe Partnership receives rents from certain tenants based on a percentage of their gross sales in excess of stipulated minimums. Higher sales for some tenants at the Centre and higher average occupancy have caused an increase in percentage and base rents, resulting in an increase in rental income during 1994 as compared to 1993.\nThe Partnership bills tenants on a monthly basis for common area maintenance, advertising costs and other operating expenses of the Centre based on estimates. Adjustments are periodically made to these billings once the Partnership has determined the actual amounts due. The billings during 1994 also reflect additional income from the reimbursement of property management fees, which are now billable to tenants. The periodic adjustment of billings, combined with the increase in the amount billable to tenants in 1994, have resulted in an increase in service income during 1994 as compared to 1993.\nAn increase in the principal balance and interest rate on the Centre's mortgage loan due to the June 1994 refinancing caused an increase in interest expense on the mortgage note payable during 1994 as compared to 1993.\nAdditional capitalized improvements at the Centre resulted in an increase in depreciation expense during 1994 as compared to 1993.\nDuring the first half of 1993, advertising and other promotional expenses were incurred in order to promote the Centre. During 1994, lower advertising costs were partially offset by higher insurance expense, resulting in a decrease in property operating expense during 1994 as compared to 1993.\nAs a result of repair upgrades to the Centre's heating and air conditioning system, maintenance and repairs increased during 1994 as compared to 1993.\nA lower assessed value levied by the local taxing authority resulted in a decrease in real estate taxes during 1994 as compared to 1993.\nHigher portfolio management, legal and accounting fees caused an increase in administrative expenses during 1994 as compared to 1993.\n1993 Compared to 1992 - ---------------------\nDuring the second half of 1992 and throughout 1993, the Centre experienced a high rate of lease expirations causing average occupancy to decrease from 1992 to 1993. In order to retain or attract quality tenants, some new leases reflected reductions in rental rates and rental concessions. The weak market conditions depressed gross sales for certain tenants at the Centre resulting in lower percentage rents, and many of the tenants with new or renewed leases received an increase in their stipulated percentage rent minimums causing a further decrease in the receipt of such rents by the Partnership. The combined effect of these events resulted in a decrease in rental income and property management fees during 1993 as compared to 1992.\nThe Partnership bills tenants on a monthly basis for common area maintenance, advertising costs and other operating expenses of the Centre based on estimates. Adjustments are periodically made to these billings once the Partnership has determined the actual amounts due. Also, since the Centre receives reimbursement based upon the tenants' pro rata share of rentable space, the decrease in average occupancy at the Centre has caused a reduction in the total amount billable for these items. The combined effect of these events resulted in a decrease in service income during 1993 as compared to 1992.\nThe Partnership used cash reserves to fund costs incurred in connection with the renovation of the Centre, tenant improvements related to the leasing of space and quarterly distributions to Limited Partners. This reduction in funds available for investment combined with lower interest rates in 1993 resulted in a decrease in interest income on short-term investments during 1993 as compared to 1992.\nDuring the latter part of 1992, significant advertising and other promotional expenses were incurred in order to promote the completion of the Centre's renovation in late 1992. The media campaign continued into 1993, but the spending level was lowered, resulting in a decrease in property operating expense during 1993 as compared to 1992.\nPainting costs and asphalt repairs incurred in 1992 in connection with the Centre's renovation resulted in a decrease in maintenance and repairs during 1993 as compared to 1992.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership increased as of December 31, 1994 when compared to December 31, 1993. The cash flow provided by the Partnership's operating activities reflects operations of the Centre plus interest income generated by short-term investments, partially offset by administrative expenses of the Partnership. Investing activities consisted of improvements to the Centre. Financing activities consisted of principal payments on the mortgage note payable, and the net proceeds from the Centre's mortgage loan refinancing, which were used along with other cash reserves, to fund capital improvement escrows and financing fees.\nIn June 1994, the Partnership completed the refinancing of the Centre's first mortgage loan. See Note 3 of Notes to Financial Statements for additional information.\nThe costs incurred in connection with the programs and strategies for the Centre described herein have been funded with cash flow as well as the cash reserves of the Partnership. Based upon the decline in prior years of the Partnership's cash reserves and in anticipation of working capital deemed necessary for refinancing the Centre's mortgage note payable and funding leasing costs, the General Partner suspended distributions to Limited Partners beginning with the fourth quarter 1993 distribution which would have been made in January 1994. The Partnership made four regular distributions totaling $27.625 and $44.20 per Interest in 1993 and 1992, respectively. See Financial Statements, Statements of Partners' Capital for further information. To date, investors have received distributions of Net Cash Receipts of $266.315 and Net Cash Proceeds of $263.08, totaling $529.395 per $1,000 Interest.\nThe August 1991 opening of the 2.4 million square foot Gurnee Mills outlet center in Gurnee, Illinois, resulted in additional competition for the Centre. However, upon completion of the Centre's major renovation in late 1992, gross sales at the Centre stabilized and began to rise. In addition, during the second half of 1992 and throughout 1993, the Centre experienced a high rate of lease expirations. Through successful leasing strategies and efforts, many tenant leases were renewed, and several new tenant leases were signed. These leasing strategies and efforts are continuing as additional tenant leases expire. As of December 31, 1994, the Centre was 91% occupied. The Centre has also continued its media and marketing campaign. In addition, continued repairs and upgrades are required in order for the Centre to remain attractive to tenants and shoppers. The success of this media campaign and the leasing and repair programs will impact the level of future cash flow generated by the Centre, as well as the future sale price which may be obtained by the Partnership. At the present time, the General Partner's goal is to improve cash flow and rebuild Partnership cash reserves before reinstating distributions to Limited Partners. During 1993 and 1994, the Centre generated positive cash flow which is defined as an amount equal to the property's revenue receipts less property related expenses, which include debt service payments.\nA 400,000 square foot outlet mall is being constructed in Huntley, Illinois, which is approximately 50 miles southwest of the Centre. Approximately 192,000 square feet has recently been completed and was opened to shoppers in August 1994. The remainder is expected to be completed in two phases by 1996. The General Partner currently believes that this mall is unlikely to have a significant impact on the operations at the Centre based upon its location relative to the Centre.\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\nprovided by independent third parties. Additionally, Allegiance Realty Group, Inc., which has provided property management services to the Centre, 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.\nComparison of Actual Operations and the Financial Forecast - ----------------------------------------------------------\nThe Financial Forecast and Supplemental Projections included in the Partnership's Prospectus forecasted the operations of the Partnership for a ten year period beginning January 1, 1988 and ending December 31, 1997. The Partnership incurred a net loss of $118,837 during the year ended December 31, 1994, whereas net income of approximately $1,086,000 was originally forecasted for this period. The difference was primarily a result of lower than forecasted rental income and additional expenditures related to the ongoing media and marketing campaign and various improvements at the Centre. The General Partner anticipates that the actual operations for 1995 will also be significantly lower than the forecasted operations for 1995 in the Prospectus due to lower than originally forecasted rental collections. In addition, the Centre expects to continue its media and marketing campaign, and leasing and tenant improvement costs are expected to be incurred in retaining existing tenants as well as attracting new ones. The expenditures associated with these programs are designed to help the Centre remain competitive throughout the remainder of the 1990's. Although these expenditures reduce cash flow from operations, they are intended to help provide for the long-term stability of the Centre.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------\nSee Index to Financial Statements 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 $24,143,296 $28,071,202 $23,433,874 $27,038,736 Partners' capital (deficit): General Partner (1,153,068) (523,491) (1,151,880) (527,156) Limited Partners 11,756,873 15,055,201 11,874,522 15,036,681 Net (loss) income: General Partner (1,188) 3,665 (4,468) (8,266) Limited Partners (117,649) 18,520 (442,337) (446,457) Per Limited Partner- ship Interest (3.92) 0.60 (14.74) (14.84)\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and - -----------------------------------------------------------------------\nFinancial 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-XXII, 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 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 6 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 Limited Partnership Interests of the Registrant.\n(b) Neither Balcor Partners-XXII nor its partners and officers own any Limited Partnership Interests of the Registrant.\nRelatives and affiliates of the partners and officers of the General Partner own five Limited Partnership 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 6 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 and Reports on Form 8-K - -----------------------------------------\n(a) (1 & 2) See Index to Financial Statements 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. 1 to Registrant's Registration Statement on Form S-11 dated April 2, 1987 (Registration No. 33-13097), is hereby incorporated herein by reference.\n(4) Form of Subscription Agreement previously filed as Exhibit No. 4.1 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated April 2, 1987 (Registration No. 33-13097) 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. 0-16717) 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.\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.\nOUTLET CENTRE PARTNERS\nBy: \/s\/Allan Wood ------------------------- Allan Wood Executive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XXII, 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 - ---------------------- ------------------------------- ------------ President and Chief Executive Officer (Principal Executive Officer) of Balcor Partners-XXII, \/s\/Thomas E. Meador the General Partner March 23, 1995 - -------------------- -------------- Thomas E. Meador\nExecutive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XXII, \/s\/Allan Wood the General Partner March 23, 1994 - -------------------- -------------- Allan Wood\nReport of Independent Public Accountants\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\nSchedules:\nSchedules are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo The Partners of Outlet Centre Partners:\nWe have audited the accompanying balance sheets of OUTLET CENTRE PARTNERS (an Illinois Limited Partnership -- see Note 2) 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. 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, the financial statements referred to above present fairly, in all material respects, the financial position of OUTLET CENTRE PARTNERS 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\nChicago, Illinois February 10, 1995\nOUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1994 and 1993\nASSETS\n1994 1993 ------------ ------------ Cash and cash equivalents $ 1,819,294 $ 1,308,812 Accounts and accrued interest receivable 74,981 118,110 Escrow deposits 929,674 Deferred expenses, net of accumulated amortization of $41,563 in 1994 and $476,668 in 1993 374,062 43,332 ------------ ------------ 3,198,011 1,470,254 ------------ ------------ Investment in real estate at cost: Land 2,871,183 2,871,183 Buildings and improvements 27,299,367 27,037,691 ------------ ------------ 30,170,550 29,908,874 Less accumulated depreciation 9,225,265 7,945,254 ------------ ------------ Investment in real estate, net of accumulated depreciation 20,945,285 21,963,620 ------------ ------------ $24,143,296 $23,433,874 ============ ============\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable $ 204,154 $ 347,663 Due to affiliates 47,693 35,255 Accrued real estate taxes payable 545,840 719,102 Security deposits 49,302 65,327 Mortgage note payable 12,692,502 11,543,885 ------------ ------------ Total liabilities 13,539,491 12,711,232\nPartners' capital (30,000 Limited Partnership Interests issued and outstanding) 10,603,805 10,722,642 ------------ ------------ $24,143,296 $23,433,874 ============ ============\nThe accompanying notes are an integral part of the financial statements.\nOUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL for the years ended December 31, 1994, 1993 and 1992\nPartners' Capital (Deficit) Accounts ----------------------------------------- General Limited Total Partner Partners ------------- ------------ ------------\nBalance at December 31, 1991 $ 13,541,431 $(1,145,240) $14,686,671\nCash distributions to Limited Partners (A) (1,326,000) (1,326,000) Net loss for the year ended December 31, 1992 (217,234) (2,172) (215,062) ------------- ------------ ------------ Balance at December 31, 1992 11,998,197 (1,147,412) 13,145,609\nCash distributions to Limited Partners (A) (828,750) (828,750) Net loss for the year ended December 31, 1993 (446,805) (4,468) (442,337) ------------- ------------ ------------ Balance at December 31, 1993 10,722,642 (1,151,880) 11,874,522\nNet loss for the year ended December 31, 1994 (118,837) (1,188) (117,649) ------------- ------------ ------------ Balance at December 31, 1994 $ 10,603,805 $(1,153,068) $11,756,873 ============= ============ ============\n(A) Summary of cash distributions paid per Limited Partnership Interest:\n1994 1993 1992 ------------- ------------ ------------\nFirst Quarter None $ 11.05 $ 11.05 Second Quarter None 5.525 11.05 Third Quarter None 5.525 11.05 Fourth Quarter None 5.525 11.05\nThe accompanying notes are an integral part of the financial statements.\nOUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1994, 1993 and 1992\n1994 1993 1992 ------------- ------------ ------------ Income: Rental $ 3,136,357 $ 2,848,289 $ 3,239,873 Service 2,319,857 2,180,945 2,320,859 Interest on short-term investments 44,639 36,918 93,727 ------------- ------------ ------------ Total income 5,500,853 5,066,152 5,654,459 ------------- ------------ ------------\nExpenses: Interest on mortgage note payable 1,223,270 1,131,748 1,146,043 Depreciation 1,280,011 1,196,548 1,124,878 Amortization 84,895 74,286 74,286 Property operating 1,700,641 1,760,061 1,891,816 Maintenance and repairs 195,594 147,380 380,070 Real estate taxes 545,840 719,102 746,240 Property management fees 244,587 234,499 251,379 Administrative 344,852 249,333 256,981 ------------- ------------ ------------ Total expenses 5,619,690 5,512,957 5,871,693 ------------- ------------ ------------ Net loss $ (118,837) $ (446,805) $ (217,234) ============= ============ ============ Net loss allocated to General Partner $ (1,188) $ (4,468) $ (2,172) ============= ============ ============ Net loss allocated to Limited Partners $ (117,649) $ (442,337) $ (215,062) ============= ============ ============ Net loss per Limited Partnership Interest (30,000 issued and outstanding) $ (3.92) $ (14.74) $ (7.17) ============= ============ ============\nThe accompanying notes are an integral part of the financial statements.\nOUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1994, 1993 and 1992\n1994 1993 1992 ------------- ------------ ------------ Operating activities: Net loss $ (118,837) $ (446,805) $ (217,234) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation of property 1,280,011 1,196,548 1,124,878 Amortization of deferred expenses 84,895 74,286 74,286 Net change in: Accounts and accrued interest receivable 43,129 (13,014) (84,096) Escrow deposits (14,949) Accounts payable (143,509) 88,966 116,785 Due to affiliates 12,438 3,090 (2,918) Accrued real estate taxes (173,262) (27,138) 85,801 Security deposits (16,025) (6,854) (11,911) ------------- ------------ ------------ Net cash provided by operating activities 953,891 869,079 1,085,591 ------------- ------------ ------------\nInvesting activity: Improvements to property (261,676) (426,216) (579,793) ------------- ------------ ------------ Cash used in investing activity (261,676) (426,216) (579,793) ------------- ------------ ------------ Financing activities: Distributions to Limited Partners (828,750) (1,326,000) Proceeds from refinancing of mortgage note payable 12,750,000 Repayment of mortgage note payable (11,468,631) Principal payments on mortgage note payable (132,752) (121,052) (106,757) Funding of capital improvement escrows (914,725) Payment of deferred expenses (415,625) ------------- ------------ ------------ Net cash used in financing activities (181,733) (949,802) (1,432,757) ------------- ------------ ------------\nNet change in cash and cash equivalents 510,482 (506,939) (926,959) Cash and cash equivalents at beginning of year 1,308,812 1,815,751 2,742,710 ------------- ------------ ------------ Cash and cash equivalents at end of year $ 1,819,294 $ 1,308,812 $ 1,815,751 ============= ============ ============\nThe accompanying notes are an integral part of the financial statements.\nOUTLET CENTRE PARTNERS (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Accounting Policies:\n(a) The financial statements represent the consolidated assets, liabilities and capital of Outlet Centre Partners (the \"Partnership\") and its subsidiaries as of December 31, 1994 and 1993 and the consolidated operating results for each of the three years in the period ended December 31, 1994.\n(b) 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 18 - 25 Furniture and fixtures 5\nDepreciation expense for capitalized tenant improvements is computed using a straight-line method over the term of the lease.\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\nThe Partnership records its investment in real estate at cost, and periodically assesses possible impairment to the value of its property. 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(c) Deferred expenses consist of financing fees which are amortized over the term of the loan agreement.\n(d) Cash equivalents include all highly liquid investments with a maturity of three months or less when purchased.\n(e) The Partnership is not liable for Federal income taxes as each partner is required to recognize 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(f) A reclassification has been made to the previously reported 1993 statements in order to provide comparability with the 1994 statements. This reclassification has not changed the 1993 results.\n2. Partnership Agreement:\nThe Partnership was organized on March 13, 1987. The Partnership Agreement provides for Balcor Partners-XXII to be the General Partner and for the admission of Limited Partners through the sale of up to 30,000 Limited Partnership Interests at $1,000 per Interest. The Partnership commenced the offering of Limited Partnership Interests to the public on July 2, 1987 and completed its minimum offering on August 13, 1987 after certain minimum sales of Limited Partnership Interests had been achieved. The offering was terminated on March 9, 1988, after the sale of 30,000 Limited Partnership Interests.\nThe Partnership and its subsidiaries own the Factory Outlet Centre (the \"Centre\") located in Bristol, Wisconsin. The Partnership Agreement provides that profits and losses will be allocated 1% to the General Partner and 99% to the Limited Partners.\nNet Cash Receipts of the Partnership available for distribution will be distributed 90% to Limited Partners and 10% to the General Partner provided, however, that 100% of the General Partner's share of Net Cash Receipts will be subordinated to the prior receipt by Limited Partners of a Preferential Distribution of 7% for each of the first five 12-month periods following the termination of the offering and 8% for each 12-month period thereafter. For each period during which the Preferential Distribution is not attained, the General Partner's share of Net Cash Receipts will be deferred to the extent of any such deficiency and such deferred portion will be paid to the General Partner from future distributed Net Cash Receipts or from Net Cash Proceeds after required subordination levels are attained. A deficiency in the Preferential Distribution for a particular year will not by itself cause the subordination of the General Partner's share of Net Cash Receipts in later years. Net Cash Receipts will be computed after the deduction of the Partnership expenses.\nNet Cash Proceeds of the Partnership which are available for distribution will be distributed to Limited Partners until they have received an amount equal to their Original Capital plus a Cumulative Distribution of 12% per annum. Thereafter, Net Cash Proceeds will be distributed to pay the General Partner an amount equal to its subordinated and unpaid share of Net Cash Receipts, and then 85% to the Limited Partners and 15% to the General Partner. Upon the dissolution and liquidation of the Partnership, Net Cash Proceeds will be distributed in accordance with the Partners' respective ending capital account balances.\n3. Mortgage Note Payable:\nIn June 1994, the Centre's first mortgage loan was refinanced. The interest rate increased from 9.75% to 10.14%, the maturity date was extended from August 1994 to July 1999 and the monthly payments of principal and interest increased from $104,400 to $117,120. A portion of the proceeds from the new $12,750,000 first mortgage loan were used to repay the existing first mortgage loan of $11,468,631.\nFuture maturities of the above note are approximately as follows:\n1995 $ 124,000 1996 137,000 1997 152,000 1998 168,000 1999 12,112,000\nDuring the years ended December 31, 1994, 1993 and 1992, the Partnership incurred and paid interest expense on the mortgage notes payable of $1,223,270, $1,131,748 and $1,146,043, respectively.\n4. Management Agreement:\nAs of December 31, 1994, the Centre is under a management agreement with a third-party management company. This management agreement provides for a fee of 5% of all rental and certain service receipts collected.\n5. Tax Accounting:\nThe Partnership maintains 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. For 1994, the net effect of these accounting differences resulted in a net loss in the financial statements compared to net income for tax reporting purposes; the difference of which is $141,022.\nThe aggregate cost of land for federal income tax purposes is $2,871,183 and the aggregate cost of buildings and improvements for Federal income tax purposes is $27,352,632. The total cost of the above mentioned is $30,223,815.\n6. 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 $225,117 None $230,289 $23,799 $251,610 $19,589 Reimbursement of expenses to the General Partner, at cost: Accounting 44,324 $16,613 30,090 2,483 30,998 2,474 Data processing 14,181 3,089 9,210 1,979 9,954 796 Investor communica- tions 18,104 6,960 18,333 1,513 5,904 471 Legal 16,205 4,073 6,001 495 14,761 1,178 Portfolio management 35,774 13,117 24,833 2,049 32,474 2,592 Other 17,421 3,841 35,591 2,937 63,471 5,065\nAllegiance Realty Group, Inc. an affiliate of the General Partner, managed the Centre 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 $27,307, $18,499 and $17,321 for 1994, 1993 and 1992, respectively.\n7. Rentals under Operating Leases:\nThe Partnership receives rental income from the leasing of retail shopping center space under operating leases. The minimum future rentals (excluding amounts representing executory costs such as taxes, maintenance and insurance) based on operating leases held at December 31, 1994 are approximately as follows:\n1995 $ 2,645,000 1996 2,437,000 1997 1,837,000 1998 1,312,000 1999 919,000 Thereafter 1,260,000\nMinimum future rentals do not include amounts which may be received from certain tenants based upon a percentage of their gross sales in excess of stipulated minimums. Percentage rentals totalled approximately $221,000 for 1994, $98,000 for 1993 and $192,000 for 1992.\nThe Partnership is subject to the usual business risks regarding the collection of the above-mentioned rentals.","section_15":""}
{"filename":"216430_1994.txt","cik":"216430","year":"1994","section_1":"Item 1. Business:\nGENERAL DEVELOPMENT OF BUSINESS - Liqui-Box Corporation and its subsidiaries (\"Liqui-Box\" or the \"Company\") is one of the largest companies in the world specializing in the research, development and manufacture of bag-in-box flexible liquid packaging systems. The Company was incorporated in January, 1962 in the state of Ohio. Its principal offices are located at 6950 Worthington-Galena Road, Worthington, Ohio.\nLiqui-Box is a major producer of bag-in-box flexible packaging and related filling equipment systems for the beverage, processed foods, dairy, detergent, wine and other specialty products industries. The Company is also the leading supplier of containers and dispensing systems to the bottled water industry.\nThe Company and its subsidiaries operate 14 manufacturing plants in the United States and Europe. Through licensees, agents and direct exporters, Liqui-Box serves markets in many countries worldwide.\nIn August, 1993, Liqui-Box purchased the assets of the Liquid Packaging Divisions of Sonoco Products Company and its wholly-owned subsidiary Sonoco Limited (Sonoco), which have production facilities in Romiley, England, and Elk Grove, California. The two production facilities manufacture plastic bags for the wine, aseptic food and other miscellaneous markets. The Company believes the acquisition broadens its access to European markets and will contribute meaningfully to the Company's growth in future years. Further discussion can be found on Pages 16 [Management's Discussion and Analysis] and 29 [Note 8 of the Notes to Consolidated Financial Statements] of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994 (the \"1994 Annual Report\"), which information is herein incorporated by reference.\nDESCRIPTION OF PRINCIPAL PRODUCTS - The principal product of the Company is plastic packaging. Such packaging includes specialty plastic bags and plastic blow molded containers and equipment for filling such packaging products (less than 2% of total net sales), injection molded plastic products used in liquid packaging and a variety of industrial and commercial plastic packaging films. These products are marketed nationwide primarily to the edible products industries principally through a direct sales force. These products are also marketed internationally through a direct sales force, licensees, agents and the Company's own export operations.\nIn 1994, the Company maintained a strong sales momentum in its principal markets of beverage, processed foods and specialty industrial products. In addition, the two premium drinking water products under the Alaskan Falls label, introduced in 1991, showed improvement in sales and continue to be introduced onto retail shelves in selected Midwestern states. Sales from our European subsidiary also showed increased unit growth during the year.\nCOMPETITION - The plastic packaging market is large and highly fragmented. There are numerous competitors and the major markets in which the Company sells its products are very competitive. These products are in competition with similar products produced by other manufacturers, and in some instances, with products produced by other industries from other raw materials.\nThe plastic packaging industry is, therefore, highly price competitive. A substantial number of manufacturers compete in the national and international markets. None are considered to be dominant. According to information in the public domain, Liqui-Box supplies less than one percent of the total plastic packaging market in the United States.\nWhile Liqui-Box's product and customer mix is generally diverse, The Perrier Group of America constitutes a buying group of customers that is a material part of the Company's business to the extent that loss of this buying group, with which the Company has a good relationship, would have a material effect on the Company's business. The risk associated with such a potential loss is mitigated by an exclusive 10 year supply agreement between the Company and The Perrier Group of America. Sales to this customer constituted 15%, 13% and 13% of total sales in 1994, 1993 and 1992, respectively.\nRESEARCH AND DEVELOPMENT - Liqui-Box emphasizes applied research and development as a vital aspect of meeting the needs of its customers for plastic packaging. Thus, the Company's research activities focus on the development of new plastic packaging products and packaging systems to increase quality, improve production efficiency and\/or reduce costs to its customers and to the ultimate consumer. The Company also devotes significant efforts to the research, development and improvement of plastic packaging machinery and equipment for use by its customers and in its own production operations.\nR & D expenditures in 1994, 1993 and 1992 were $2,151,000, $1,954,000 and $1,487,000, respectively. All such activities were entirely Company funded from operations. It should also be noted that the funding levels only represent costs directly charged to research and development. The amounts do not represent the commitment and work of all employees of Liqui-Box to improving existing products and processes and to developing new products and processes. Many employees who are not part of the research and development organization of the Company spend part of their efforts on developing new products and processes.\nInformation on research and development can also be found on Pages 16 and 17 [Management's Discussion and Analysis] and on Page 24 [Note 1, Accounting Policies, of the Notes to Consolidated Financial Statements] of the 1994 Annual Report and is incorporated herein by reference.\nPATENTS AND LICENSES - Liqui-Box holds and maintains patents for packaging design, fitments and packaging equipment which are used by the Company in its production and which are also licensed to other manufacturers. Revenues from royalties from these patents and licenses are not material to the total revenues of the Company.\nENVIRONMENT - Consumer recognition of environmental friendliness of liquid plastic packaging systems is growing. Compared to a conventional 5- gallon plastic pail, the 5-gallon plastic bag-in-box reduces total plastic use by 90 percent. An empty, collapsed 5-gallon bag requires a small fraction of the disposal space a comparable number of No. 10 cans, five wide-mouth one gallon jars or one 5-gallon pail occupy. The corrugated box used to transport and store packaged liquids is completely recyclable. Liqui-Box utilizes proper recycling codes on all of its products for quick identification in community recycling programs.\nThe bag-in-box design is increasingly seen as a major part of the solution to the problem of environmental waste, storage and disposal. In addition, Liqui-Box is asking its suppliers to experiment in the use of reprocessed material in the products furnished to the Company and several promising applications are being actively explored. The Company has also committed to zero scrap in the waste stream of its plant operations through sorting and recycling for use in shipping bags and other nonfood applications. This commitment represents the elimination of more than one million pounds of waste annually.\nAs a major player in the solution of societal environmental problems, the Company supports such conscientiousness and is not aware of any federal, state or local statutory or regulatory provisions concerning environmental protection or the discharge of materials into the environment that will have any material effect on the capital expenditures, sales, earnings or competitive position of the Company in the future.\nRAW MATERIALS - The primary raw material essential to the Company's business is plastic resin. There are a number of suppliers for this material and the market is highly competitive. The Company is confident that its sources of supply of resin are adequate for its needs in the foreseeable future.\nSEASONALITY OF BUSINESS - The demand for some applications of certain plastic packaging products is seasonal in nature. A mild summer, for example, can reduce the Company's sales to the beverage industry. However, experience over the years has shown that these variations generally offset each other and tend to level the total demand for the Company's products throughout the year. As a result, the Company usually experiences only minor variations in sales volume attributable to seasonal demands.\nBACKLOG OF ORDERS - Sales of the Company's packaging products generally are closely coordinated with the product production of its customers. Typically, orders are filled within 30 days. Therefore, the backlog of orders is not significant.\nEMPLOYEES - Liqui-Box employed 818 individuals in its operations throughout the United States and in Europe on December 31, 1994. Approximately 14% of these employees are members of collective bargaining units. The Company considers itself an industry leader in participative management of its human resources, placing a premium value on innovation, creativity and attentiveness to solving customers' problems in packaging. Accordingly, the Company believes its relations with its employee group to be an asset.\nFOREIGN OPERATIONS AND SALES - The Company's European operations constituted 12% of consolidated net sales, less than 10% of consolidated income before taxes and 18% of consolidated identifiable assets as of and for the year ended December 31, 1994. European operations constituted less than 10% of net sales and income before taxes for the year ended January 1, 1994 and 19% of identifiable assets as of January 1, 1994.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties:\nAt December 31, 1994, the Company owned or leased property at eighteen (18) locations for manufacturing, warehousing, and offices with a total of approximately 670,000 square feet of floor space. The following table summarizes the properties owned or leased.\nThe Company believes that its properties, plant, and equipment are all in good operating condition and are adequate for its expected needs. Certain of the leases contain renewal options which the Company expects to exercise to maintain its operations at the facilities.\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\nExecutive Officers of the Registrant: -------------------------------------\nThe names, ages, and positions of all of the executive officers of Liqui-Box, as of February 28, 1995, are listed below along with their business experience during the past five years. Executive officers are appointed annually by the Board of Directors at the annual meeting of directors immediately following the annual meeting of shareholders. There are no arrangements or understandings between any executive officer and any other person pursuant to which the executive officer was selected.\nPART II\nPages -------------- The following items are incorporated herein by reference from the indicated pages of the 1994 Annual Report:\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 3\nItem 6.","section_6":"Item 6. Selected Financial Data 3\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 16-17\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data 18-31\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure N\/A\nPART III\nThe following items are incorporated herein by reference from the indicated pages of the Registrant's definitive Proxy Statement for its 1995 Annual Meeting filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant 4 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\". 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 7 - 10 Neither the Report of the Board of Directors and Stock Option Committee on executive compensation, nor the performance graph included in the Registrant's definitive Proxy Statement for its 1995 Annual Meeting, are incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners 2 - 3 and Management\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions 11\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K:\n(a) (1) The following consolidated financial statements of Liqui-Box Corporation and Subsidiaries, included in the Registrant's 1994 Annual Report, are incorporated by reference in Item 8 and filed as Exhibit 13 to this report. The page numbers indicate the location of the consolidated financial statements in the Registrant's 1994 Annual Report.\nConsolidated Balance Sheets --December 31, 1994 and January 1, 1994 18-19\nConsolidated Statements of Income --Fifty-two weeks ended December 31, 1994, Fifty-two weeks ended January 1, 1994 and Fifty-two weeks ended January 2, 1993 20\nConsolidated Statements of Cash Flows --Fifty-two weeks ended December 31, 1994, Fifty-two weeks ended January 1, 1994 and Fifty-two weeks ended January 2, 1993 21\nConsolidated Statements of Stockholders' Equity --Fifty-two weeks ended December 31, 1994, Fifty-two weeks ended January 1, 1994 and Fifty-two weeks ended January 2, 1993 22-23\nNotes to Consolidated Financial Statements 24-30\nReport of Independent Auditors 31\n(a) (2) The following consolidated financial statement schedules of Liqui-Box Corporation and Subsidiaries are included in Item 14(d). The page number indicates the location in this Form 10-K.\nII - Valuation and Qualifying Accounts 10\nSchedules other than those listed above are omitted because they are not required or are not applicable.\nItem 14. (continued)\n(b) No report on Form 8-K was filed during the fourteen weeks ended December 31, 1994. N\/A\n(c) Exhibits filed with this Annual Report on Form 10-K are attached hereto. See Index to Exhibits at page 53.\n(d) Financial Statement Schedules -- See Item 14.(a)(2)","section_15":""}
{"filename":"68622_1994.txt","cik":"68622","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral\nU S WEST Communications, Inc. (the \"Company\") is incorporated under the laws of the State of Colorado and has its principal offices at 1801 California Street, Denver, Colorado, 80202, telephone number (303) 896-3099. The Company is an indirect, wholly owned subsidiary of U S WEST, Inc. (\"U S WEST\").\nThe Company was formed January 1, 1991, when Northwestern Bell Telephone Company (\"Northwestern Bell\") and Pacific Northwest Bell Telephone Company (\"Pacific Northwest Bell\") were merged into The Mountain States Telephone and Telegraph Company (\"Mountain Bell\"), which simultaneously changed its name to U S WEST Communications, Inc. U S WEST acquired ownership of Mountain Bell, Northwestern Bell and Pacific Northwest Bell on January 1, 1984, when American Telephone and Telegraph Company (\"AT&T\") transferred its ownership interests in these three wholly-owned operating telephone companies to U S WEST. This divestiture was made pursuant to a court approved consent decree entitled the Modification of Final Judgment (\"MFJ\"), which arose out of an antitrust action brought by the United States Department of Justice against AT&T.\nCompany Operations\nThe Company provides telecommunications services in the states of Arizona, Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Utah, Washington and Wyoming (the \"14 state region\"). The Company serves approximately 80% of the population in these states and approximately 40% of the land area. At December 31, 1994, the Company had approximately 14,336,000 telephone network access lines in service, a 3.6% increase over year end 1993. (4.0% growth excluding the effects of the sale of 60,000 lines in rural telephone exchanges.)\nUnder the terms of the MFJ, the 14 state region was divided into 29 geographical areas called local access and transport areas (\"LATAs\") with each LATA generally centered on a metropolitan area or other identifiable community of interest. The principal types of telecommunications services offered by the Company are (i) local service, (ii) intraLATA long-distance service and (iii) exchange access service (which connects customers to the facilities of interLATA service providers). For the year ended December 31, 1994, local service, exchange access service and intraLATA long distance service accounted for 45%, 33% and 15%, respectively, of the sales and other revenues of the Company. In 1994, revenues from a single customer, AT&T, accounted for approximately 13% of the Company's sales and other revenues.\nResearch and Development\nThe Company recognized $23, $42 and $55 for research and development expense in 1994, 1993 and 1992, respectively. Approximately half of this activity was conducted at Bell Communications Research, Inc., one-seventh of which is owned by Company.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART I\nITEM 1. BUSINESS (continued)\nRegulation\nThe Company is subject to varying degrees of regulation by state commissions with respect to intrastate rates and service, and access charge tariffs. Under traditional rate of return regulation, intrastate rates are generally set on the basis of the amount of revenues needed to produce an authorized rate of return (refer to page 9 of Management's Discussion).\nThe Company has sought alternative forms of regulation (\"AFOR\") plans which provide for competitive parity, enhanced pricing flexibility and improved capability in bringing to market new products and services. In a number of states where AFOR plans have been adopted, such actions have been accompanied by requirements to refund revenues, reduce existing rates or upgrade service, any of which could have adverse short-term effects on earnings. Similar agreements may have resulted under traditional rate of return regulation (refer to page 18 of Management's Discussion).\nThe Company is also subject to the jurisdiction of the Federal Communications Commission (\"FCC\") with respect to interstate access tariffs (that specify the charges for the origination and termination of interstate communications) and other matters. The Company's interstate services have been subject to price cap regulation since January 1991. Price caps are a form of incentive regulation and, ostensibly, limit prices rather than profits. However, the FCC's price cap plan includes sharing of earnings in excess of authorized levels with interexchange carriers. The Company believes that competition will ultimately be the determining factor in pricing telecom- munications services. In January 1994, the FCC announced that it will begin reviewing its current form of regulation.\nCompetition\nHistorically, communications, entertainment and information services were provided by different companies in different industries. The convergence of these technologies is changing both the competitive environment and the way the Company does business. This convergence, which is being fueled by techno- logical advances, will lead to more intense competition from companies with which the Company has not historically competed.\nThe Company's principal current competitors are competitive access providers (\"CAPs\"). Competition from CAPs is currently limited to providing large business customers (with high-volume traffic) private line access to the facilities of interexchange carriers. AT&T's entrance into the cellular communications market through its acquisition of McCaw Cellular Communications, Inc. may create increased competition in local exchange as well as cellular services. The loss of local exchange customers to competitors would affect multiple revenue streams, including those related to local and access services, and long distance network services, and could have a material, adverse effect on the Company's operations.\nIn addition to CAPs and providers of wireless services, a major potential source of future competition includes cable television companies which may offer telecommunications and other information services in addition to existing video services.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART I\nITEM 1. BUSINESS (continued)\nCompetition (continued)\nCompetition from long distance companies continues to erode the Company's market share of intraLATA long distance services such as WATS and \"800.\" These revenues have declined over the last several years as customers have migrated to interexchange carriers that have the ability to offer these services on both an intraLATA and interLATA basis. The Company is prohibited from providing interLATA long distance services.\nThe actions of state and federal public policymakers will play an important role in determining how increased competition affects the Company. The Company is working with regulators and legislators to help ensure that public policies keep pace with our rapidly changing industry and allow the Company to bring new services to the marketplace.\nThe Company supports regulatory reform. It is increasingly apparent that the legal and regulatory framework under which the Company operates, which includes restrictions on equipment manufacturing, prohibitions on cross-ownership of cable television by telephone companies and restrictions on the transport of communications, entertainment and information across LATA boundaries, limits both competition and consumer choice. The Company believes that it is in the public interest to lift these restrictions and to place all competitors under the same rules to ensure the industry's technological develop- ment and long-term financial health.\nCompetitive Strategy\nThe Company intends to implement its competitive strategy by focusing on three key objectives: 1) business growth through the development of broadband networks; 2) customer loyalty through continuous improvement in customer service; and 3) improved productivity through systems re-engineering and other cost controls.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART I\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe properties of the Company do not lend themselves to description by character and location of principal units. At December 31, 1994, the percentage distribution of total net telephone plant by major category for the Company was as follows:\nAt December 31, 1994, substantially all of the installations of central office equipment were located in buildings owned by the Company situated on land which it owns in fee, while many garages, and administrative and business offices were in leased quarters.\nTotal investment in telephone plant increased to $29.4 billion at December 31, 1994, from $28.0 billion at December 31, 1993, after giving effect to retirements, but before deducting accumulated depreciation. The Company's 1994 capital expenditures of $2.5 billion were substantially devoted to the continued modernization of telephone plant, including investments in fiber optic cable, to improve customer services and network productivity. 1995 capital expenditures are anticipated to be $2.1 billion and the majority of these are expected to be financed through internally generated funds.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART I\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nWith respect to lawsuits, proceedings and other claims pending at year-end, it is the opinion of management that after final disposition, any monetary liability or financial impact to the Company beyond that provided at year-end, would not be material to the consolidated financial position of the Company.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nThe Company's volume growth resulted in a normalized increase in net income of $101 or 9.9% for the year ended December 31, 1994, compared with the same period last year. Net income in 1994 was normalized for a gain of $51 on the sale of certain rural telephone exchanges. For 1993, normalizing items include the restructuring charge of $534 (after tax), the federally mandated income tax increase of $54 and the 1993 extraordinary charges of $3,041 for the discontinuance of Statement of Financial Accounting Standards (\"SFAS\") No. 71, and $77 for the early extinguishment of debt.\nVolume growth also resulted in a 7.4 percent increase in earnings before interest, taxes, depreciation and amortization and other (\"EBITDA\"), also excluding the 1993 restructuring charge. The Company believes EBITDA is an important indicator of the operational strength of the business.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nOPERATING REVENUES\nTotal operating revenues were $8,998, a $342 or 4.0% increase over the prior year. In the tables below, price changes primarily represent the aggregate effects of price changes resulting from regulatory proceedings and growth represents increased market penetration (through increased access lines and additional sales of products and services to existing customers). Different regulatory commissions govern the interstate and intrastate jurisdictions, resulting in varying price and refund impacts.\nLocal service revenues include local telephone exchange, local private line and public telephone services. The increase in local service revenues was primarily attributable to access line growth, which exceeded 5 percent in the states of Arizona, Colorado, Idaho and Utah.\nAccess Charges\nAccess charges are collected primarily from the interexchange carriers for their use of the local exchange network. For interstate access services, there is also a fee collected directly from telephone customers. Approximately 35 percent of access revenues and 13 percent of total revenues are derived from providing access service to AT&T.\nAn increase of 7.8 percent in interstate billed access minutes of use more than offset the effects of price decreases. Interstate price reductions have been phased in by the Federal Communications Commission (\"FCC\") over a number of years. In response to competitive pressure and FCC orders, the Company reduced its annual interstate access prices by approximately $40 during 1994, in addition to $60, effective July 1, 1993. The Company believes access prices will continue to decline, whether mandated by the FCC or as a result of an increasingly competitive market for access services.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nOPERATING REVENUES (Continued)\nIntrastate access charges increased primarily as a result of higher demand. Intrastate minutes of use grew by 13 percent in 1994. Demand for private line services, for which revenues are generally not usage-sensitive, also increased.\nLong-distance network service (\"long-distance\") revenues are derived from calls made within the Company's service area boundaries, commonly referred to as \"LATAs.\" The effects of competition continue to impact long-distance revenues. Long-distance revenues decreased principally due to the effects of multiple toll carrier plans implemented in Oregon and Washington in May and July 1994, respectively. These regulatory arrangements allow independent telephone companies to act as toll carriers. The impact in 1994 was a decrease in long-distance revenue of $68, partially offset by an increase of $10 in intrastate access revenue and a decrease of $48 in access fees (otherwise paid to independent companies). These regulatory arrangements decreased net income by approximately $6 in 1994 and will decrease 1995 net income by $10 to $12.\nOther Services\nOther services revenues are derived from billing and collection services provided to interexchange carriers, and new services such as voice messaging. The 8.6 percent increase in 1994 was due to higher revenue from these billing and collection services, and continued market penetration of new service offerings.\nOPERATING EXPENSES\nTotal operating expenses were $6,848, a $146 or 2.2% increase over the same period last year, excluding the 1993 restructuring charge.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nOPERATING EXPENSES (continued)\nEmployee-related costs include basic salaries and wages, overtime, contract labor, benefits (including pension and health care) and payroll taxes. Higher costs of approximately $90 were a result of additional overtime payments, contract labor, and basic salaries and wages, all related to the implementation of customer service and streamlining initiatives. A pension credit reduction of $66 resulted from a change in actuarial assumptions, including decreases in the discount rate and the expected long-term rate of return on plan assets. Partially offsetting these increases were the effects of employees leaving the Company under the restructuring program, lower health-care benefit costs including a reduction in the accrual for post- retirement benefits and lower incentive compensation payments to employees.\nDuring the summer of 1994, increased customer demand put additional stress on current processes and systems, and affected the quality of service in certain markets. The pace of the Company's restructuring program also contributed to quality of service issues. However, the issues pertaining to quality of service underscore the need to re-engineer the business. The Company achieved target levels of service at year end by implementing customer service initiatives and slowing the pace of its restructuring program. To continue improving upon the level of service quality achieved by year-end 1994, the Company will incur additional near-term costs for temporary employees, overtime and contract labor. The Company will also stretch out its 1993 restructuring plan an additional year, to 1997. As a result of these actions, the annual benefits related to restructuring will not be fully realized until 1998 (see \"Restructuring Charges\").\nOther operating expenses include access charges, network software expenses, cost of services and products provided by affiliates, and other administrative expenses. Contributing to the increase in other operating expenses were additional network software expenses and advertising costs incurred for the increased deployment of new products and expansion of markets for existing products. The increase was partially offset by the $48 reduction in access expense related to the effects of the multiple toll carrier plan (see \"Long-Distance Network Service\").\nThe increase in depreciation and amortization expense was primarily a result of a higher depreciable asset base and increased depreciation rates. The Company's discontinuance of SFAS No. 71 in September 1993 has resulted in the use of shorter asset lives to more closely reflect the economic lives of telephone plant. The Company continues to pursue improved capital recovery within the regulated environment.\nINTEREST AND OTHER\nInterest expense decreased in 1994 due to the effects of a debt refinancing program in 1993 and a reclassification of capitalized interest. Pursuant to the discontinuance of SFAS No. 71, interest capitalized as a component of telephone plant construction is now being reflected as an offset to interest expense, rather than as an income component of other income (expense).\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nINTEREST AND OTHER (continued)\nOther expense increased over the same period last year due to the reclassification of capitalized interest to interest expense in 1994.\nPROVISION FOR INCOME TAXES\nThe increase in the effective tax rate resulted primarily from the effects of discontinuing SFAS No. 71, an increase in 1994 income before income taxes and the 1993 restructuring charge. Partially offsetting these increases is the cumulative effect on deferred income taxes from the 1993 federally mandated increase in income taxes.\nRESTRUCTURING CHARGES\nThe Company's 1993 results reflect an $880 million restructuring charge (pretax). The related restructuring plan (the \"Plan\") is designed to provide faster, more responsive customer services while reducing the costs of providing these services. As part of the Plan, the Company is developing new systems that will enable it to monitor networks to reduce the risk of service interruptions, activate telephone service on demand, provide automated inventory systems and centralize its service centers so that customers can have their telecommunications needs resolved with one phone call. The Company is consolidating its existing 560 customer service centers into 26 centers in 10 cities and reducing its total work force by approximately 9,000 employees (including the remaining employee reductions pursuant to the restructuring plan announced in 1991).\nImplementation of the Plan is expected to extend into 1997, rather than being completed in 1996 as originally scheduled. Implementation schedules are driven by customer demand and related service issues, concerns with system stability as major customer impacting systems are integrated, and staffing agreements negotiated with the Company's unions. These changes do not alter the Company's plan to fundamentally re-engineer the way it conducts business in the emerging competitive environment. The total cash expenditures of $880 under the Plan remain unchanged.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nRESTRUCTURING CHARGES (continued)\nEmployee separation costs include severance payments, health- care coverage and postemployment education benefits. Systems development costs include the replacement of existing, single- purpose systems with new systems designed to provide integrated, end-to-end customer service. The work-force reductions would not be possible without the development and installation of the new systems, which will eliminate the current, labor-intensive interfaces between existing processes. Real estate costs include preparation costs for the new service centers. The relocation and retraining costs are related to moving employees to the new service centers and retraining employees on the methods and systems required in the new, restructured mode of operation.\nThe Company estimates that full implementation of the Plan will reduce employee-related expenses by approximately $400 per year. These savings are expected to be offset by the effects of inflation.\nThe following estimates of employee separations and related amounts reflect the extension of employee reductions into 1997.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nAs a result of extending the plan into 1997, employee reductions and separations amounts shown above have been reduced by 1,519 and $41 in 1995, and 175 and $14 in 1996, respectively, and increased by 2,445 and $73, respectively, in 1997.\nSystems Development\nThe Company's existing information management systems were largely developed to support analog technology in a monopoly environment. These systems are increasingly inadequate due to the effects of increased competition, new forms of regulation and changing technology that have driven consumer demand for new services that can be delivered quickly, reliably and economically. The sequential systems currently in place are slow, labor-intensive and costly to maintain, and often cannot be adapted to support new product and service offerings, including future multimedia services envisioned by U S WEST.\nThe systems re-engineering program in place involves development of new systems for the following core processes:\nService delivery - to support service on demand for all products and services, including repair. These systems will permit one customer service representative to handle all facets of a customer's requirements as contrasted to the numerous points of customer interface required today.\nService assurance - for performance monitoring from one location and remote testing in the new environment, including identification and resolution of faults prior to customer impact, and one-system dispatch environment.\nCapacity provisioning - for integrated planning of future network capacity, including the installation of software controllable service components.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nRESTRUCTURING CHARGES (continued)\nSystems Development (continued)\nThe direct, incremental and nonrecurring systems development costs contained in the Plan are comprised of the following amounts:\nOriginal estimates of system expenditures in 1995 and 1996 were $140 and $115, respectively. Though current estimates in total are not materially different, the timing and amount of expenditures by category has changed.\nThe majority of systems development labor will be supplied through the use of temporary employees, contractors and new employees with special skills. While it is likely that a small number of the new employees will be retained after completion of the Plan due to their specialized skills, it is planned that any related increase in headcount will be offset through other employee reductions.\nSystems expenses charged to current operations consist of all costs associated with the information management function, including planning, developing, testing and maintaining data bases for general purpose computers, in addition to systems costs related to maintenance of telephone network applications. The key related administrative (i.e. general purpose) systems include customer service, order entry, billing and collection, accounts payable, payroll, human resources and property records. Ongoing systems costs comprised approximately six percent of total operating expenses in 1994, 1993 and 1992. The Company expects systems costs charged to current operations as a percent of total operating expenses to approximate the current level throughout the life of the Plan. However, systems costs could increase relative to other operating costs as the business becomes more technology dependent.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nRESTRUCTURING CHARGES (continued)\nProgress Under the Plan\nFollowing is a schedule of progress achieved under the Plan in 1994:\nThe Company anticipated Plan expenditures of approximately $421 in 1994. However, the Company slowed the pace of its re-engineering implementation to address issues pertaining to the quality of service.\nThe Company's 1991 restructuring plan included a pretax charge of $240 due to planned work-force reductions of approximately 6,000 employees. All expenditures and work-force reductions associated with the 1991 plan were completed by the end of 1994.\nOTHER ITEMS\nFederal Regulatory Issues\nIn January 1995, the 9th U.S. Circuit Court of Appeals in San Francisco upheld the June 15, 1994, Seattle Federal District Court ruling that affirmed U S WEST's challenge to the constitutionality of the telephone company video programming restriction in the 1984 Cable Act. The act prevents telephone companies from providing video programming within their regions. U S WEST argued, and the courts agreed, that the restriction violates its First Amendment right to free speech. The decision would allow the Company to provide video programming directly to its regional telephone subscribers. The Federal Government can appeal to the U.S. Supreme Court. The Company is evaluating its options in light of this ruling. In January 1995, the FCC instituted a proceeding to modify and promulgate rules on the provision of video programming.\nIn January 1995, the U.S. Circuit Court of Appeals for the District of Columbia overruled the FCC's \"range-of-rates\" decision. This FCC decision permitted non-dominant carriers to file ranges for rates, rather than specific price points. The Court of Appeals held that the Communications Act requires all carriers to specify prices on their tariffs. The effect of this decision will be to require non-dominant carriers (like MCI, or Time Warner's Full Service Network) to file tariffs with considerably more price detail.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nOTHER ITEMS (continued)\nFederal Regulatory Issues (continued)\nIn October 1994, the 9th U.S. Circuit Court of Appeals overruled the FCC's Computer III non-structural separation decision for the provision of enhanced services on an integrated basis. The effect of the decision is to return to the provision of such service through a separate subsidiary, which could make it more difficult for local exchange carriers to offer enhanced services. In January 1995, the FCC granted a waiver for the continued provision of enhanced services, pending further proceedings by the FCC.\nIn August 1994, the U.S. Circuit Court of Appeals for the District of Columbia upheld an FCC ruling that neither telephone companies nor customer programmers need to obtain a franchise from local governments to provide Video Dial Tone (\"VDT\") service. The decision means that local telephone companies will avoid additional franchise fees related to the provisioning of VDT services.\nIn June 1994, the U.S. Circuit Court of Appeals for the District of Columbia overturned the FCC's requirement that local telephone companies allow physical collocation by third parties (competitive access providers), within their central offices, for the installation and operation of equipment that connects to the local telephone network. The decision essentially affirms the private property rights of corporations. The court also ordered the FCC to reconsider its requirement that allows competitors to interconnect equipment to the local network from a point outside a central office. In light of the rulings, the Company is evaluating how it can provide future inter- connection services.\nOn June 20, 1994, the seven regional Bell operating companies (\"RBOCs\") asked the divestiture court for a waiver of the Court's restriction on the RBOCs' provision of wireless long- distance services. The consent decree restricts the RBOCs from providing long-distance services as well as manufacturing. The request for a waiver closely follows a recommendation by the Department of Justice that the RBOCs be allowed to provide wireless long-distance services.\nThe FCC has adopted a regulatory structure known as \"Open Network Architecture\" (\"ONA\"), under which the Company is required to unbundle its telephone network services in a manner that will accommodate the service needs of the growing number of information service providers. Under ONA, the number of local exchange service competitors could increase significantly.\nThe Company's interstate services have been subject to price cap regulation since January 1991. Price caps are a form of incentive regulation designed to limit prices rather than profits. The price cap plan is currently under review by the FCC.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II MANAGEMENT'S DISCUSSION. (Dollars in millions)\nOTHER ITEMS (continued)\nState Regulatory Issues\nThe Company has sought alternative forms of regulation (\"AFOR\") plans that provide for competitive parity, enhanced pricing flexibility and improved capability in bringing to market new products and services. In a number of states where AFOR plans have been adopted, such actions have been accompanied by agreements to refund revenues, reduce existing rates or upgrade service, any of which could have adverse short-term effects on earnings. Similar results may have occurred under traditional rate of return regulation. In addition to the FCC price cap plan, the Company has AFOR plans in the states of Colorado, Idaho, Minnesota, Nebraska, North Dakota, Oregon and South Dakota.\nThere are pending regulatory actions in local regulatory jurisdictions that call for price decreases, refunds or both. In one such instance, the Utah Supreme Court has remanded a Utah Public Service Commission (\"PSC\") order to the PSC for reconsideration, thereby establishing certain exceptions to the rule against retroactive ratemaking: 1) unforeseen and extraordinary events, and 2) misconduct. The PSC's initial order denied a refund request from an interexchange carrier and other parties that relates to the Tax Reform Act of 1986. This case is still in the discovery process. If a formal filing -- made in accordance with the remand from the Supreme Court -- alleges that the exceptions apply, the range of possible risk is $0 to $140.\nInterest Rate Risk Management\nThe Company is exposed to market risks arising from changes in interest rates. Derivative financial instruments are used by the Company to manage these risks. The objective of the Company's interest rate risk management program is to minimize the total cost of debt. To meet this objective the Company uses risk-reducing and risk-adjusting strategies. Interest rate forward contracts were used in 1993 to reduce the debt issuance risks associated with interest rate fluctuations. Interest rate swaps are used to adjust the risks of the debt portfolio on a consolidated basis by varying the ratio of fixed- to floating- rate debt. The market value of the debt portfolio and its risk-adjusting derivative instruments are monitored and compared to predetermined benchmarks to evaluate the effectiveness of the risk management program.\nIn 1993, the Company refinanced $2.7 billion of callable debt with new lower-cost fixed-rate debt. The Company achieved an annual interest expense reduction of approximately $35 as a result of this refinancing. In conjunction with the refinancing, the Company executed forward contracts to sell U.S. Treasury securities to reduce debt issuance risks and to lock in the cost of $1.5 billion of the future debt issue. At December 31, 1994, deferred credits of $8 and deferred charges of $51 on closed interest rate forward contracts are included as part of the carrying value of the underlying debt. The deferred credits and charges are being recognized as a yield adjustment over the life of the debt, which matures at various dates through 2043. The net deferred charge is directly offset by the lower coupon rate achieved on the new debt.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART II\nMANAGEMENT'S DISCUSSION. (Dollars in millions)\nOTHER ITEMS (continued)\nInterest Rate Risk Management (continued)\nNotional amounts on interest rate swaps outstanding at December 31, 1994, were $781 with various maturities that extend to 1999. The estimated effect of the Company's interest rate derivative transactions was to adjust the level of fixed-rate debt from 73.8 percent to 86.2 percent of the total debt portfolio.\nITEM 8.","section_4":"","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareowner and Board of Directors of U S WEST Communications, Inc.\nWe have audited the consolidated financial statements and the consolidated financial statement schedules of U S WEST Communications, Inc. listed in the index on page 38 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 U S WEST Communications, Inc. as of 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. 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 6 of the Notes to Consolidated 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,\" in 1993. As discussed in Note 13 of the Notes to Consolidated Financial Statements, the Company changed its method of accounting for postretirement benefits other than pensions and other postemployment benefits in 1992.\n\/s\/ COOPERS & LYBRAND L.L.P.\nCoopers & Lybrand L.L.P. Denver, Colorado January 18, 1995\nU S WEST COMMUNICATIONS, INC.\nU S WEST COMMUNICATIONS, INC.\nU S WEST COMMUNICATIONS, INC.\nU S WEST COMMUNICATIONS, INC.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION: The Consolidated Financial Statements include the accounts of U S WEST Communications, Inc. and its wholly-owned subsidiaries (the \"Company\"). The Company is an indirect, wholly owned subsidiary of U S WEST, Inc. The Company was formed as a result of the January 1, 1991, merger of The Mountain States Telephone and Telegraph Company, Northwestern Bell Telephone Company and Pacific Northwest Bell Telephone Company. The merger was accounted for as a transfer of assets among entities under common control similar to that of a pooling- of-interests.\nIn the third quarter of 1993, the Company discontinued accounting for its operations under Statement of Financial Accounting Standards (\"SFAS\") No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" Refer to Note 6 of the Notes to Consolidated Financial Statements.\nCertain reclassifications within the Consolidated Financial Statements have been made to conform to the current year presentation.\nCASH AND CASH EQUIVALENTS: Cash and cash equivalents include highly liquid investments with original maturities of three months or less which are readily convertible into cash and which are not subject to significant risk resulting from changes in interest rates.\nMATERIALS AND SUPPLIES: New and reusable materials are carried principally at average cost, except for significant individual items which are valued based on specific costs. Non-reusable material is carried at its estimated salvage value.\nPROPERTY, PLANT AND EQUIPMENT: The investment in property, plant and equipment is carried at cost less accumulated depreciation. Additions, replacements and substantial betterments are capitalized. Capitalized costs include applicable salaries and employee benefits, materials, taxes and certain other items. The cost of repairs and maintenance for property, plant and equipment is charged to expense as incurred.\nThe Company's provision for depreciation of property, plant and equipment is based on various straight-line group methods using remaining useful (economic) lives based on industry-wide studies. Prior to discontinuing SFAS No. 71, depreciation was based on lives specified by regulatory commissions. When depreciable property, plant and equipment is retired or sold, the original cost less the net salvage value is generally charged to accumulated depreciation.\nThe Company capitalizes interest related to qualifying construction projects and amortizes this cost over the remaining service lives of the related assets. Capitalized interest is recorded as a reduction of interest expense. Prior to the Company's discontinuance of SFAS No. 71, capitalized interest was recorded as an element of other expense. Total amounts capitalized by the Company were $36, $19 and $23 in 1994, 1993 and 1992, respectively.\nREVENUE RECOGNITION: Local telephone service revenues are generally billed monthly in advance. These revenues are recognized when services are provided. Nonrecurring and usage sensitive revenues derived from installation, exchange access and long distance services are billed and recognized monthly as services are provided.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\nFINANCIAL INSTRUMENTS: Net interest income or expense on interest rate swaps is recognized over the life of the swaps as an adjustment to interest expense. Gains and losses on forward contracts, designated as hedges of interest rate exposure on debt refinancings, are deferred and recognized as an adjustment to interest expense over the life of the underlying debt.\nCOMPUTER SOFTWARE: The cost of computer software, whether purchased or developed internally, is charged to expense with two exceptions. Initial operating system software is capitalized and amortized over the life of the related hardware, and initial network applications software is capitalized and amortized over three years. Subsequent upgrades to capitalized software are expensed. Capitalized computer software of $146 and $148 at December 31, 1994 and 1993, respectively is recorded in property, plant and equipment. The Company amortized capitalized computer software costs of $86, $51 and $24 in 1994, 1993 and 1992, respectively.\nINCOME TAXES: The provision for income taxes consists of an amount for taxes currently payable and an amount for tax consequences deferred to future periods in accordance with SFAS No. 109. The Company implemented SFAS No. 109, \"Accounting for Income Taxes,\" in 1993. Adoption of the new standard did not have a material effect on the financial position or results of operations, primarily because of the Company's earlier adoption of SFAS No. 96.\nFor financial statement purposes, investment tax credits are being amortized over the economic lives of the related property, plant and equipment in accordance with the deferred method of accounting for such credits.\nNOTE 2: MAJOR CUSTOMER\nThe Company provides network access services to interexchange carriers, the largest volume of which is provided to AT&T. During 1994, 1993 and 1992, billings for all services to AT&T approximated $1,130, $1,159 and $1,191, respectively. The decreases are primarily due to price decreases prescribed by the Federal Communications Commission (\"FCC\"). Related accounts receivable at December 31, 1994 and 1993, totaled $98 and $97, respectively.\nNOTE 3: CONTINGENCIES\nThere are pending regulatory actions in local regulatory jurisdictions that call for price decreases, refunds or both. In one such instance, the Utah Supreme Court has remanded a Utah Public Service Commission (\"PSC\") order to the PSC for reconsideration, thereby establishing certain exceptions to the rule against retroactive ratemaking: 1) unforeseen and extraordinary events, and 2) misconduct. The PSC's initial order denied a refund request from an interexchange carrier and other parties that relates to the Tax Reform Act of 1986. This case is still in the discovery process. If a formal filing -- made in accordance with the remand from the Supreme Court -- alleges that the exceptions apply, the range of possible risk is $0 to $140.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 4: RELATED PARTY TRANSACTIONS\nThe Company purchases various services, as noted, from affiliated companies. The amount paid by the Company for these services is determined in accordance with FCC and state cost allocation rules, which prescribe various cost allocation methodologies that are dependent upon the service provided. Management believes that such cost allocation methods are reasonable. The costs of those services are billed to the regulated company.\nIt is not practicable to provide a detailed estimate of the expenses which would be recognized on a stand-alone basis. However, the Company believes that corporate services, including those related to shareholder relations, procurement, tax, legal and human resources, are obtained more economically through affiliates than they would be on a stand-alone basis, since the Company absorbs only a portion of the total costs. Additionally, through its 1\/7 ownership interest in Bellcore (see footnote 1 below), the Company obtains benefits associated with research and development activities which exceed the Company's share of the total costs.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 5: RESTRUCTURING CHARGES\nThe Company's 1993 results reflect an $880 million restructuring charge (pretax). The related restructuring plan (the \"Plan\") is designed to provide faster, more responsive customer services while reducing the costs of providing these services. As part of the Plan, the Company is developing new systems that will enable it to monitor networks to reduce the risk of service interruptions, activate telephone service on demand, provide automated inventory systems and centralize its service centers so that customers can have their telecommunications needs resolved with one phone call. The Company is consolidating its existing 560 customer service centers into 26 centers in 10 cities and reducing its total work force by approximately 9,000 employees (including the remaining employee reductions associated with the restructuring plan announced in 1991). The Plan provides for the reduction of 2,450 management and 6,550 occupational employees.\nEmployee separation costs include severance payments, health-care coverage and postemployment education benefits. Systems development costs include the replacement of existing, single- purpose systems with new systems designed to provide integrated, end-to-end customer service. The work-force reductions would not be possible without the development and installation of the new systems, which will eliminate the current, labor-intensive interfaces between existing processes. Real estate costs include preparation costs for the new service centers. The relocation and retraining costs are related to moving employees to the sites of the new service centers and retraining employees on the new methods and systems required in the new, restructured mode of operation.\nThe Company's 1991 restructuring plan included a pretax charge of $240 due to planned work-force reductions of approximately 6,000 employees. The balance of the unused reserve at December 31, 1993, was $56. All expenditures and work-force reductions under the 1991 plan were completed by the end of 1994.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 6: DISCONTINUANCE OF SFAS NO. 71\nThe Company incurred a non-cash, extraordinary charge of $3 billion, net of an income tax benefit of $2.3 billion, in conjunction with its decision to discontinue accounting for its operations in accordance with SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" as of September 30, 1993. SFAS No. 71 generally applies to regulated companies that meet certain requirements, including a requirement that a company be able to recover its costs, competition notwithstanding, by charging its customers at prices established by its regulators. The Company's decision to discontinue the application of SFAS No. 71 was based on the belief that competition, market conditions and the development of broadband technology, more than prices established by regulators, will determine the future cost recovery by the Company. As a result of this change, the remaining asset lives of the Company's telephone plant have been shortened to more closely reflect the useful (economic) lives of such plant.\nFollowing is a list of the major categories of property, plant and equipment and the manner in which lives were affected by the discontinuance of SFAS No. 71:\nThe Company employed two methods to determine the amount of the extraordinary charge. The \"economic life\" method assumed that a portion of the plant-related effect is a regulatory asset that was created by the under-depreciation of plant under regulation. This method yielded the plant-related adjustment that was confirmed by the second method, a discounted cash flows analysis.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 7: PROPERTY, PLANT AND EQUIPMENT\nIn 1994, the Company sold certain rural telephone exchanges with a cost basis of $122. The Company received consideration for the sales of $93 in cash and $81 in replacement property. The Company will receive an additional $30 of replacement property in 1995.\nNOTE 8: LEASE COMMITMENTS\nThe Company has entered into operating leases for office facilities, equipment and real estate. Total commitments under non-cancelable operating leases at December 31, 1994, follow:\nRent expense under operating leases was $194 in 1994, $184 in 1993 and $185 in 1992.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 9: DEBT\nThe weighted average interest rate on commercial paper was 5.92 percent and 2.73 percent at December 31, 1994 and 1993, respectively.\nUnder formal lines of credit with major banks, the Company is permitted to borrow up to $600, all of which was available at December 31, 1994.\nInterest rates and maturities on long-term debt follow:\nInterest payments (net of amounts capitalized) were $344, $386 and $406, respectively, for 1994, 1993 and 1992.\nDuring 1993, the Company refinanced debt issues aggregating $2.7 billion in principal amount to take advantage of favorable interest rates. The refinancing resulted in an extraordinary charge to income of $77, net of a tax benefit of $48.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 10: FAIR VALUES OF FINANCIAL INSTRUMENTS\nFair values of cash equivalents, other current amounts receivable and payable, and short-term debt, approximate the carrying amount due to their short-term nature.\nThe fair value of long-term debt is based on quoted market prices where available or, if not available, is based on discounting future cash flows using current interest rates. The fair values of interest rate swaps approximate their recorded value.\nAs of December 31, 1994 and 1993, the carrying amount of the Company's debt was $5,727 and $5,352, respectively, and the fair value was $5,200 and $5,500, respectively.\nNOTE 11: DERIVATIVE FINANCIAL INSTRUMENTS\nThe Company enters into interest rate swap agreements to manage its market exposure to fluctuations in interest rates. Swap agreements are primarily used to effectively convert existing commercial paper to fixed rate debt. This allows the Company to achieve interest savings over issuing fixed rate debt directly.\nUnder an interest rate swap, the Company agrees with another party to exchange interest payments at specified intervals over a defined term. Interest payments are calculated by reference to the notional amount based on the fixed and variable rate terms of the swap agreements. The net interest received or paid as part of the interest rate swap is accounted for as an adjustment to interest expense.\nThe Company also entered into a currency swap to convert Swiss franc-denominated debt to dollar-denominated debt. This allowed the Company to achieve interest savings over issuing fixed rate dollar-denominated debt. Under the currency swap, the Company agreed with another party to exchange dollars for francs within the terms of the loan which include periodic interest payments and principal upon origination and maturity. The currency swap and foreign currency debt are combined and accounted for as if dollar-denominated debt were issued directly.\nThe following table summarizes terms of swaps as of December 31, 1994. Variable rates are primarily indexed to the 30 day commercial paper rate.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 11: DERIVATIVE FINANCIAL INSTRUMENTS (continued)\nIn 1993, the Company executed forward contracts to sell U.S. Treasury Securities to reduce debt issuance risks by allowing the Company to lock in the treasury rate component of the future debt issue. At December 31, 1994, deferred credits of $8 and deferred charges of $51 on closed interest rate forward contracts are included as part of the carrying value of the underlying debt. The deferred credits and charges are being recognized as a yield adjustment over the life of the debt, which matures at various dates through 2043. The net deferred charge is directly offset by the lower coupon rate achieved on the debt issuance. At December 31, 1994, there were no open forward contracts on interest rates.\nThe counterparties to these derivative contracts are major financial institutions. The Company is exposed to credit loss in the event of non-performance by these counterparties. The Company manages this exposure by monitoring the credit standing of the counterparty and establishing dollar and term limitations which correspond to the respective credit rating of each counterparty. The Company does not have significant exposure to an individual counterparty and does not anticipate non-performance by any counterparty.\nNOTE 12: COMMON SHAREOWNER'S EQUITY\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 13: EMPLOYEE BENEFITS\nPension Plans\nThe Company is a participant in a defined benefit pension plan administered by U S WEST, which covers substantially all management and occupational employees. Prior to 1993, the Company was a participant in two defined benefit pension plans administered by U S WEST, which were merged into one plan effective January 1, 1993. Benefits for management employees are based upon a final pay formula, while occupational benefits are based upon a flat benefit formula. The projected unit credit method is used for financial reporting purposes and the aggregate cost method for funding purposes. No funding was required in 1994, 1993 or 1992. Net pension credits for 1994, 1993 and 1992 were $0, $66 and $102, respectively.\nPostretirement Benefits Other Than Pensions\nThe Company provides certain health care and life insurance benefits for retired employees. Effective January 1, 1992, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS No. 106 mandates that employers reflect in their current expenses an accrual for the cost of providing retirement medical and life insurance benefits to current and future retirees. Prior to 1992, the Company recognized these costs as they were paid. Adoption of SFAS No. 106 resulted in a one-time, non-cash charge against 1992 earnings of $1,675, net of a deferred tax benefit of $1,022, for the prior service of active and retired employees. The effect upon 1992 income before change in accounting principle of adopting SFAS No. 106 was approximately $36.\nIn conjunction with the adoption of SFAS No. 106, for financial reporting purposes, the Company elected to immediately recognize the accumulated postretirement benefit obligation for current and future retirees, net of the fair value of plan assets.\nThe Company used the projected unit credit method for the determination of postretirement medical costs for financial reporting purposes. Net postretirement benefit costs for 1994, 1993 and 1992 were $220, $248 and $258, respectively. The amount funded by the Company will generally follow the amount of expense allowed in regulatory jurisdictions.\nOther Postemployment Benefits\nThe Company also adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" effective January 1, 1992. SFAS No. 112 requires that employers accrue for the estimated costs of benefits, such as workers' compensation and disability, provided to former or inactive employees who are not eligible for retirement. Adoption of SFAS No. 112 resulted in a one-time, non-cash charge against 1992 earnings of $49, net of a deferred tax benefit of $30.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 14: INCOME TAXES\nThe Company is included in the consolidated tax return of U S WEST. Under an agreement with U S WEST, the Company recognizes income taxes on a separate return basis. At December 31, 1994 and 1993, the Company had outstanding taxes payable to U S WEST of $29 and $96, respectively.\nFor financial statement purposes, investment tax credits are being amortized over the economic lives of the related property, plant and equipment in accordance with the deferred method of accounting for such credits.\nThe unamortized balance of investment tax credits were $231 and $280 at December 31, 1994 and 1993, respectively.\nAmounts paid for income taxes were $551, $338, and $465 respectively, for 1994, 1993 and 1992.\nU S WEST COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in millions)\nNOTE 14: INCOME TAXES (Continued)\nThe current portion of the deferred tax asset was $280 and $292 at December 31, 1994 and 1993, respectively, resulting primarily from restructuring charges and compensation-related items.\nOn August 10, 1993, federal legislation was enacted that increased the corporate tax rate from 34 percent to 35 percent retroactive to January 1, 1993. The cumulative effect on deferred taxes of the 1993 increase in income tax rates was $54.\nU S WEST COMMUNICATIONS, INC. SUPPLEMENTARY FINANCIAL DATA (Dollars in millions)\nQUARTERLY FINANCIAL DATA (Unaudited)\nFirst, second and fourth quarters' net income in 1994 includes gains on sales of certain rural exchanges of $15, $16 and $20, respectively.\nSecond quarter 1993 net income reflects the costs associated with the refinancing of debt in the amount of $50.\nThird quarter 1993 operating loss reflects the restructuring charge of $880 ($534 after-tax) described in Note 5 of the Notes to Consolidated Financial Statements.\nThird quarter 1993 net loss includes, in addition to the effects of the restructuring charge, the impacts of discontinuing the application of SFAS No. 71 of $3,041, the cumulative effect of a federally mandated increase in income taxes of $54 and the early extinguishment of debt of $27.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART IV\nFinancial statement schedules other than those listed above have been omitted because the required information is contained in the Consolidated Financial Statements and notes thereto, or because such schedules are not required or applicable.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\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(b) Reports on Form 8-K:\nNo filings on Form 8-K were made in 1994.\n(c) Exhibits\nExhibits identified in parentheses below, on file with the Securities and Exchange Commission (\"SEC\"), are incorporated herein by reference as exhibits hereto.\nU S WEST COMMUNICATIONS, INC. FORM 10-K\nPART IV\nItem 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, in the City of Denver, State of Colorado, on March 28, 1995.\nU S WEST COMMUNICATIONS, INC.\n\/s\/ DAVID R. LAUBE By --------------------------- David R. Laube Vice President, Controller 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 date indicated.\nPrincipal Executive Officer: A. Gary Ames, President and Chief Executive Officer\nPrincipal Financial Officer: James T. Helwig, Vice President and Chief Financial Officer\nPrincipal Accounting Officer: David R. Laube, Vice President, Controller and Treasurer\nDirectors:\n\/s\/ A. GARY AMES \/s\/ JAMES T. HELWIG \/s\/ JAMES M. OSTERHOFF\n\/s\/ DAVID R. LAUBE By ------------------------ David R. Laube (for himself and as Attorney-in-Fact)\nDated: March 28, 1995\nU S WEST COMMUNICATIONS, INC. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (Dollars in millions)","section_15":""}
{"filename":"29854_1994.txt","cik":"29854","year":"1994","section_1":"Item 1. Business\nDouglas & Lomason Company (the \"Company\" or the \"Registrant\") is a major supplier of original equipment parts to the North American automotive industry. Automotive products, which have accounted for approximately 94% of the Company's total sales during each of the last three years, include fully trimmed seating, seating components and mechanisms, and decorative and functional body trim parts. These products are manufactured primarily for the three major U.S. automotive manufacturers and other original equipment suppliers.\nThe Company also manufactures material handling systems and custom truck bodies and trailers. These products have accounted for approximately 6% of the Company's total sales during each of the last three years.\nThe Registrant classifies its business into two segments: automotive products and industrial and commercial products. Exclusive of automotive products, no segment accounts for 10 percent or more of consolidated revenues or profits. A summary of certain segment information appears in note (6) of notes to consolidated financial statements on page 20 of the 1994 Annual Report to Shareholders and is incorporated herein by reference.\nAUTOMOTIVE PRODUCTS\nSeating\nSeating systems and components account for the principal portion of the Company's automotive business. The Company is one of the major independent manufacturers and assemblers of seating systems and components for the North American automotive industry. Seat assemblies produced by the Company satisfy the seat requirements of a full range of vehicles. The Company currently supplies complete seats to customer assembly plants on a \"just-in-time\" (JIT) \"sequenced parts delivery\" (SPD) basis for passenger cars and vans.\nThe Company's seat frame business has grown significantly over the 48 years it has been supplying seating systems and components to the North American automotive industry. The Company believes it is currently one of the largest independent manufacturers of seat frames in North America. The seat frames manufactured by the Company are incorporated by it into complete seats and sold to vehicle assembly plants and are also sold separately to other seat assemblers. The Company believes that it is recognized as one of the most vertically integrated independent seat manufacturers in North America. The Company is capable of producing seat frames, manual seat mechanisms, foam, covers, suspension systems, and plastic seat trim at its manufacturing facilities.\nThe Company believes that opportunities for growth may emerge in foreign transplant operations in North America and from the expanding trend toward seat assembly outsourcing in Europe. The Company has established technical and business relationships with three Japanese partners to facilitate the exchange of technical information and to establish business relationships with foreign automakers. In 1988, the Company formed a\n50\/50 joint venture company with Namba Press Works Co., Ltd. of Japan. This company, named Bloomington-Normal Seating Company, is located in Normal, Illinois and manufactures seating systems for Diamond-Star Motors, a subsidiary of Mitsubishi Motors Corporation. The Company also has a license agreement with Imasen Electric of Japan for the manufacture of manual seat adjuster mechanisms.\nBody Trim Components\nThe Company has been supplying decorative body trim components to the automotive industry since 1902. These products include body side, wheel opening and structural B-pillar moldings, head and tail lamp bezels, bumpers, including those back filled with Azdel, and window and door sealing systems. The Company has the capability of processing large quantities of metal, plastic and composite material parts through injection molding, pressing, rolling, laminating and extruding systems and finishing parts through anodizing and painting.\nThe Company produces a variety of injection molded and extruded plastic moldings including bi-laminate body side and deck lid moldings. These moldings can be finished in a variety of ways such as with a high gloss, in body colors including metallics, or with encapsulated colorful graphics.\nProduct Engineering\nThe Company pursues new products and processes through a 180 person product engineering staff. This staff is customer-focused in that all new projects must be based on a customer's requirements. This facilitates the development of products in shorter lead time and matches products more closely to consumer requirements.\nSales and Customers\nSales coverage by the Company of the North American automotive industry is maintained by an experienced direct sales staff consisting of 24 account managers, divided into separate and distinct customer-focused groups. The sales group is supported by fully developed program management teams incorporating simultaneous engineering techniques.\nThe percent of sales to total automotive sales of seating systems and body trim components to the three major automotive manufacturers during the past three years is as follows:\nSales percentages include sales to other seat assemblers for ultimate sale to the above customers.\nINDUSTRIAL AND COMMERCIAL PRODUCTS\nThis segment of the Company's business accounted for approximately 6% of total Company sales in each of the three years ended December 31, 1994.\nIndustrial and commercial products include:\nMaterial Handling Equipment. The Company designs and manufactures material handling equipment such as conveyors, bagging and packaging machines, pulleys and rollers. The Company also produces related equipment such as elevators, bag flatteners, automatic palletizers and bag placers. These products are sold to the agriculture, mining and transportation industries among others.\nCustom Truck Bodies and Trailers. The Company serves the food and beverage industry through the design and manufacture of delivery truck bodies and trailers for soft drinks, beer, bottled water, bakery products, milk and ice cream, meats, frozen foods and other products. These units include side-loading aluminum bodies and trailers, and steel, aluminum or reinforced fiberglass refrigerated truck bodies and trailers.\nCompetition\nThe Company is one of the three major independent seat suppliers to the North American automotive industry. The Company's primary independent competitors are Johnson Controls Inc.'s Automotive Products Group and Lear Seating Inc. The Company also competes with captive seating suppliers, namely: Delphi Interior and Lighting Systems of General Motors Corporation and the Plastic Trim Products Division of Ford Motor Company.\nThe Company's body trim business competes with a significant number of major competitors. There are 10 to 12 with a full range of material, process and product capabilities similar to the Company's and several competitors with specialized niche products.\nGENERAL\nRaw materials purchased by the Registrant consisting of carbon steel, aluminum, stainless steel, plastics, and fabric are generally available from numerous independent sources. Management believes that the trend in its material costs is upward.\nWhile the Registrant owns several patents and patent rights, patent protection is not materially significant to its business.\nTo the best of the Registrant's knowledge, its permits are in compliance with all federal, state and local environmental protection provisions.\nThe number of persons employed by the Registrant at December 31, 1994 was 6,039.\nThe Registrant does not consider its business seasonal except to the extent that automotive changeovers to new models affect business conditions.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe corporate offices of the Company and the product engineering staff are located in Farmington Hills, Michigan in three buildings containing approximately 96,000 square feet. Information as to the Company's 18 principal facilities in operation as of December 31, 1994 is set forth below:\nThe Company believes that substantially all of its property and equipment is in good condition and adequate for its present requirements.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are no material legal proceedings pending against the Registrant or its subsidiaries.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable\nExecutive Officers of the Registrant\nThe names and ages of all executive officers of the Registrant are as follows:\nOfficers of the Registrant are elected each year at the Annual Meeting of the Board of Directors to serve for the ensuing year or until their successors are elected and qualified.\nAll of the executive officers of the Registrant named above have held various executive positions with the Registrant for more than five years except: Mr. Nicholson who has been President and Chief Executive Officer of PVS Chemicals, Inc. and a Director of the Company for more than five years; Mr. Bruck who joined the Company in 1993 after having served as Vice President, Product Engineering Group at RCO the preceding five years; Mr. Pniewski who joined the Company in January 1994 after serving in various positions with Ford Motor Company for more than twenty years, the most recent of which was Vehicle Seat Systems Engineering Manager in the Plastics and Trim Products Division; and Mr. Hampton who has been a partner with the law firm of Dickinson, Wright, Moon, Van Dusen and Freeman for more than five years.\nThere is no family relationship between any of the foregoing persons.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters\nThe information set forth under the caption \"Shareholder Information\" on page 26 the 1994 Annual Report of the Registrant is incorporated by reference herein. As of December 31, 1994, there were 757 holders of record of the Registrant's Common Stock.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information set forth under the caption \"Selected Financial and Other Data\" on pages 24 and 25 the 1994 Annual Report of the Registrant is incorporated by reference herein.\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 Condition and Results of Operations\" on pages 12 and 13 of the 1994 Annual Report of the Registrant is incorporated by reference herein.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information set forth on pages 14 through 25 of the 1994 Annual Report of the Registrant is incorporated by reference 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\nThe information set forth under the caption \"Information About Directors and Nominees for Directors\" on pages 3 and 4 of the definitive Proxy Statement of the Registrant dated March 31, 1995 filed with the Securities and Exchange Commission pursuant to Regulation 14A is incorporated by reference herein for information as to directors of the Registrant.\nReference is made to Part I of this Report for information as to executive officers of the Registrant.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information set forth under the caption \"Executive Compensation\" on pages 7, 8 and 9 of the definitive Proxy Statement of the Registrant dated March 31, 1995 filed with the Securities and Exchange Commission pursuant to Regulation 14A is incorporated by reference herein.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information set forth under the caption \"Security Ownership\" on pages 1 and 2 of the definitive Proxy Statement of the Registrant dated March 31, 1995 filed with the Securities and Exchange Commission pursuant to Regulation 14A is incorporated by reference herein.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\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 a part of this report:\n1. Financial Statements\nThe following consolidated financial statements of Douglas & Lomason Company and subsidiaries included in the Douglas & Lomason Company 1994 Annual Report to its Shareholders for the year ended December 31, 1994, are incorporated herein by reference:\nConsolidated Balance Sheets at December 31, 1994 and 1993.\nConsolidated Statements of Earnings for each of the years in the three year period ended December 31, 1994.\nConsolidated Statements of Shareholders' Equity for each of the years in the three year period ended December 31, 1994.\nConsolidated Statements of Cash Flows for each of the years in the three year period ended December 31, 1994.\nNotes to Consolidated Financial Statements.\nThe consolidated financial information for the years ended December 31, 1994, 1993, and 1992 set forth under \"Index to Consolidated Financial Statements and Schedules.\"\nEXHIBITS\n(The Exhibit marked with one asterisk below was filed as an Exhibit to the Form 10-K Report of the Registrant for the fiscal year ended December 31, 1983; the Exhibit marked with two asterisks below was filed as an Exhibit to the Form 10-Q Report of the Registrant for the quarter ended June 30, 1988; the Exhibit marked with three asterisks below was filed as an Exhibit to the Form 10-K Report of the Registrant for the fiscal year ended December 31, 1989; the Exhibits marked with four asterisks below were filed as Exhibits to the Form 10-K Report of the Registrant for the fiscal year ended December 31, 1991; the Exhibit marked with five asterisks below was filed as an Exhibit to the Form 10-K Report of the Registrant for the fiscal year ended December 31, 1992, the Exhibits marked with six asterisks were filed as\nExhibits to the Form 10-K Report of the Registrant for the fiscal year ended December 31, 1993, and the Exhibit marked with seven asterisks below was filed as an Exhibit to the Form 10-Q Report of the Registrant for the quarter ended June 30, 1994, and are incorporated herein by reference, the Exhibit numbers in brackets being those in such Form 10-K or 10-Q Reports).\n(3)(a)****** Restated Articles of Incorporation of Registrant.[(3)(a)]\n(3)(b)****** By-Laws of the Registrant. [(3)(b)]\n(4)(a)** Term Loan Agreement dated as of May 20, 1988 between Registrant and the Banks named in Section 2.1 thereof [1].\n(4)(a)(1)**** Amendments to Term Loan Agreement Agreement dated as of May 20, 1988. [(4)(a)(1)]\n(4)(b)**** Term Loan Agreement dated as of December 19, 1991 between Registrant and NBD Bank, N.A. and Manufacturers Bank, N.A., as amended. [(4)(b)]\n(4)(c)******* Amended and Restated Credit Agreement dated as of June 24, 1994, between Registrant and the banks named in Section 2.1 thereof. [4]\n(10)(a)* 1982 Incentive Stock Option Plan of the Registrant [10](#)\n(10)(b)*** 1990 Stock Option Plan of the Registrant [(10)(b)](#)\n(10)(c)**** Joint Venture Agreement dated as of July 25, 1986 between Registrant and Namba Press Works Co., Ltd. [(10)(c)]\n(13) Portions of 1994 Annual Report of Registrant.\n(21)***** Subsidiaries of the Registrant. [(22)]\n(23) Consent of KPMG Peat Marwick LLP.\n(27) Financial Data Schedule\n(b) Reports on Form 8-K.\nThe Registrant has not filed any reports on Form 8-K during the last quarter of the period covered by this report.\n(#) This document is a management contract or compensatory plan.\nSIGNATURES\nPursuant to the requirements of the Section 13 or 15 (d) of the 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 29th day of March, 1995.\nDOUGLAS & LOMASON COMPANY\nBy: \/s\/ H. A. Lomason II ---------------------------- H. A. Lomason II Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)\nBy: \/s\/ James J. Hoey ---------------------------- James J. Hoey Senior Vice President and Chief Financial Officer (Principal Financial Officer)\nBy: \/s\/ Melynn M. Zylka ---------------------------- Melynn M. Zylka Treasurer (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 indicated on March 29th, 1995.\nSignature Title\n\/s\/ James E. George Director -------------------------- James E. George\n\/s\/ Verne C. Hampton II Director -------------------------- Verne C. Hampton II\n\/s\/ H. A. Lomason II Director -------------------------- H. A. Lomason II\n\/s\/ Dale A. Johnson Director -------------------------- Dale A. Johnson\n\/s\/ Charles R. Moon Director -------------------------- Charles R. Moon\n\/s\/ James B. Nicholson Director -------------------------- James B. Nicholson\n\/s\/ Gary T. Walther Director -------------------------- Gary T. Walther\nDOUGLAS & LOMASON COMPANY AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nThe consolidated balance sheets of the Company and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1994 together with the related notes and the report of KPMG Peat Marwick LLP, independent certified public accountants, all contained in the Company's 1994 annual report to shareholders, are incorporated herein by reference.\nThe following additional financial data should be read in conjunction with the financial statements in the 1994 annual report to shareholders. All other schedules are omitted, as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes. Financial statements and related schedules of the Registrant have been omitted because the Registrant is primarily an operating company and the subsidiaries included in the consolidated financial statements are totally held.\nIndex\nPage ---- Independent Auditors' Report\nSchedule VIII - Valuation and Qualifying Accounts\nIndependent Auditors' Report\nThe Board of Directors and Shareholders Douglas & Lomason Company:\nUnder date of January 31, 1995, we reported on the consolidated balance sheets of Douglas & Lomason Company and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 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 have 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 8 to the consolidated financial statements, the Company changed its method of accounting for income taxes and postretirement benefits other than pensions in 1993.\n\/s\/ KPMG Peat Marwick LLP\nDetroit, Michigan January 31, 1995\nSchedule VIII","section_15":""}
{"filename":"319201_1994.txt","cik":"319201","year":"1994","section_1":"Item 1. DESCRIPTION OF BUSINESS\nTHE COMPANY AND ITS PRODUCTS\nThe Company was incorporated under the laws of the State of Delaware in July 1975. The Company's headquarters are located at 160 Rio Robles, San Jose, California, 95134, telephone (408) 434-4200. Unless the text requires otherwise, the \"Company\" or \"KLA\" refers to KLA Instruments Corporation and its subsidiaries.\nKLA is the leader in design, manufacture, marketing and service of yield management and process monitoring systems for the semiconductor industry. KLA believes that it is the world's largest supplier to the wafer, reticle and metrology inspection equipment markets. The Company sells to virtually all of the world's semiconductor manufacturers and has achieved very high market shares in its principal businesses. KLA's systems are used to analyze product and process quality at critical steps in the manufacture of integrated circuits, providing feedback so that fabrication problems can be identified, addressed and contained. This understanding of defect sources and how to contain them enables semiconductor manufacturers to increase yields. Quickly attaining and then maintaining high yields is one of the most important determinants of profitability in the semiconductor industry. The Company believes that its customers typically experience rapid paybacks on their investments in the Company's systems.\nThe growing complexity of semiconductor devices, including shrinking feature dimensions, has substantially increased the cost to manufacture semiconductors, making yield loss more expensive. This trend has increased semiconductor manufacturers' demand for systems which permit the detection and containment of process problems. The sensitivity of fabrication yields to defect densities increases as devices become more complex. Further, the escalating capital investments necessary for the construction of semiconductor fabrication facilities heighten manufacturers' need for yield enhancing systems which can leverage their returns on these investments.\nSeveral years ago, the Company recognized the industry's need for in-line monitoring to provide real-time process management capability. In response, the Company devoted substantial resources to developing systems with the throughput, reliability and associated data analysis capabilities for in-process inspection. During the past several years, customers' use of the Company's wafer inspection systems began evolving from single system, off-line engineering analysis applications to multiple systems monitoring critical steps directly on advanced fabrication lines. Positive customer evaluation of the Company's in-line production monitoring systems led to record order levels for the Company's 1993 and 1994 fiscal years . The Company believes that the potential market for in-line monitoring systems is several times larger than its traditional market for engineering analysis systems.\nYIELD MANAGEMENT\nMaximizing yields, or the number of good die per wafer, is a key goal of modern semiconductor manufacturing. Higher yields increase the revenue a manufacturer can obtain for each semiconductor wafer processed. As line width geometries decrease, yields become more sensitive to the size and density of defects. Semiconductor manufacturers use yield management and process monitoring systems to improve yields by identifying defects, by analyzing them to determine process problems, and, after corrective action has been taken, by monitoring subsequent results to ensure that the problem has been contained. Monitoring and analysis may take place at many points in the fabrication process as wafers move through a production cycle consisting of hundreds of separate process steps.\nSemiconductor factories are increasingly expensive to build and equip. Yield management and process monitoring systems, which typically represent a fraction of the total investment required to build and equip a fabrication facility, enable integrated circuit manufacturers to leverage these expensive facilities and improve their returns on investment.\nThe most significant opportunities for yield improvement generally occur when production is started at new factories and when new products are first built. Equipment that helps a manufacturer to increase yields quickly when products are new enables the manufacturer to offer products in volume at the time when they are likely to generate the greatest profits.\nThe following are some of the methods used to manage yield; they all require the capture and analysis of data gathered through many measurements:\no Engineering analysis is performed off the manufacturing line to identify and analyze defect sources. Engineering analysis equipment operates with very high sensitivity to enable comprehensive analysis of wafers. Because they operate off-line, engineering analysis systems do not require high speeds of operation.\no In-line monitoring is used to review the status of circuits during production steps. Information generated is used to determine whether the fabrication process steps are within required tolerances and to make any necessary process adjustments in real-time before wafer lots move to subsequent process stations. Because the information is needed quickly to be of greatest value, in-line monitoring requires both high throughput and high sensitivity.\no Pass\/fail tests are used at several steps in the manufacturing process to evaluate products. For example, a pass\/fail test is used to determine whether reticles used in photolithography are defect-free; electrical pass\/fail testing is performed at the end of the manufacturing process to determine whether products meet performance specifications.\nKLA STRATEGY\nKLA is the premier supplier of yield management and process monitoring systems to the semiconductor manufacturing industry. Key elements of KLA's strategy are as follows:\no Leadership in Yield Management. The Company believes that yield management requires both the ability to identify defects and the ability to use defect data: (i) to recognize patterns which reveal process problems; and (ii) to resolve and contain process flaws which are causing reduced yields. The Company has developed yield management solutions that consist of sophisticated defect detection sensors located at key steps in the production process, as well as analysis stations with relational database software that enable isolation of defect sources, identification of problem causes and implementation of corrective action.\nThe Company believes that its world-wide organization of more than 50 applications engineers provides an important competitive advantage. These applications engineers serve\nas yield management consultants to the Company's customers, assisting in applying KLA's systems to accelerate yield improvement and achieve real-time process control.\no Development of In-Line Monitoring Market. KLA has introduced a family of wafer inspection systems with the wafer throughput and sensitivity necessary for in-line monitoring. Prior to the introduction of KLA's 2100 series, no suppliers' products were capable of both the speed and the sensitivity needed for in-line inspection for all defect types at critical process steps. In-line inspection is a critical yield enhancement and cost reduction technique because it allows defect detection in real-time rather than waiting until after final test results become available to discover problems that have a significant yield impact. As a result of these advantages, the Company believes that its customers will install multiple systems directly monitoring critical steps in the integrated circuit manufacturing process.\no Technology Leadership. The Company believes that it is the technological leader in integrated circuit yield management and process control monitoring. To maintain its leadership position, KLA is committed to state-of-the-art multidisciplinary technologies. See \"-Technology\" on page 8.\nThe Company's long range objective is to develop an integrated yield management network which spans the semiconductor fabrication process.\nYIELD MANAGEMENT AND PROCESS MONITORING SYSTEMS\nKLA's systems are developed to work together to offer its customers not just tools, but integrated yield management solutions. KLA offers inspection systems for key steps in the semiconductor manufacturing process and analysis systems comprised of database management hardware and software to translate raw inspection data into patterns which reveal process problems. The Company's wafer inspection and metrology systems are used for engineering analysis and in-line monitoring, and its reticle inspection systems and wafer probers are used for pass\/fail tests.\nWISARD - Wafer Inspection Systems. KLA's WISARD business unit created the market for automated inspection of semiconductor wafers with the introduction of the KLA 2000 series over nine years ago. KLA continues to have a predominant market share with its current generation of wafer inspection systems, the 2100 series.\nKLA's 2100 series, combined with a dedicated defect data gathering and analysis workstation, the KLA 2551, and an off-line Review Station, the KLA 2608, provide semiconductor manufacturers with a yield management system sensitive enough for engineering analysis and fast enough for in-line monitoring of the semiconductor manufacturing process. The 2100 series of inspection systems offers an increase in inspection speed of up to 2,000 times over that of KLA's original wafer inspection system. This marked increase in speed and sensitivity allows customers to obtain very prompt feedback on process status by placing wafer inspection systems on the production line.\nThe selection of the technology architecture for the 2100 series was made to allow the base unit to support a family of products capable of performance enhancements through upgrades of various subsystems. The first model, the KLA 2110, was introduced in 1991 with sufficient speed and sensitivity to enable in-line inspection of repeating arrays typical in memory devices. One year later, in 1992, KLA introduced a new repeating array model, the KLA 2111, which operates at up to five times the speed of the KLA 2110 and has improved sensitivity.\nShortly thereafter in 1992, KLA introduced the KLA 2130 which is capable of \"all pattern\" inspection required for microprocessors and other logic devices as well as both the logic and repeating array portions of memory devices. In late 1993, KLA introduced the new 2131 model for all pattern inspection which operates at up to twice the speed of the KLA 2130 and with higher\nsensitivity. The Company believes that there are further opportunities to expand the 2100 series family of systems and has several new models under development.\nTo manage defect data, KLA offers the KLA 2551 Analysis Station, a multi-user work station using a relational database for storing defect coordinates and digitized images. Defect analysis and image review operates through a WindowsTM -based interface. The KLA 2551 incorporates an open architecture which consolidates data from inspection systems, review stations, wafer sort electrical testers, host computers, and scanning electron microscopes (SEMs). The data analysis software provides statistical process control reports, defect source analysis, and automated correlation of in-line process defects to bit failures. The graphical software combines both data and image to produce wafer maps, trend charts, and video review. When coupled with an optional remote terminal, the KLA 2551 permits process engineers in remote locations to link to the database of defect records and images to perform further analyses or compare data from different wafer fabrication facilities.\nThe KLA 2608 Review Station provides a platform for reviewing and classifying defects detected on KLA and non-KLA wafer inspection systems. An operator may append classification codes to the defect record, a record which also includes wafer number, die coordinates, defect location, and defect size.\nThe average selling prices of KLA's 2100 series of wafer inspection systems range from approximately $1 million to approximately $2 million.\nRAPID - Reticle Inspection Systems. RAPID, KLA's first business unit, created the market for automated inspection of reticles and photomasks for the semiconductor manufacturing industry over 16 years ago, and continues to have a predominant market share. KLA has delivered over 700 reticle and photomask inspection systems worldwide.\nDuring photolithography, a stepper projects a circuit pattern from a reticle onto a wafer. Error-free reticles are the first step in ensuring high yields in the manufacturing process because defects in reticles can translate into millions of ruined die.\nIn 1992, KLA introduced its new generation of reticle inspection systems, the 300 series. The KLA 301 Reticle Inspection System and the KLA 30 Reference Data Computer together form the KLA 331 Inspection System which represents a major advance in speed, sensitivity and flexibility. The KLA 331 offers the highest inspection sensitivity available in the market place, which the Company believes is vital to meet reticle inspection requirements for today's more complex microprocessors and larger DRAMs.\nDuring fiscal 1993 and 1994, delays in completing all features of the KLA 331 systems caused a decline in RAPID's business as many customers waited for the new model. Certain ease-of-use and performance enhancements to the KLA 331 which are yet to be completed will be required before some customers will order systems.\nThe average selling prices of KLA's 331 inspection systems range from approximately $1.7 million to approximately $2.6 million.\nMetrology - Overlay and Critical Dimension Measurement Systems. Lithography for sub-micron semiconductor fabrication requires increasingly stringent overlay and critical dimension tolerances. In particular, decreasing line widths, larger die sizes, and additional layers have made overlay mis-registration errors a crucial cause of yield loss. To address these challenges, KLA offers the KLA 5000 series metrology systems: the 5100 for overlay; and the 5015 for both overlay and critical dimension measurement. KLA estimates that during its fiscal 1993 and 1994, it had the leading share in the worldwide market for overlay registration systems.\nThe KLA 5000 series uses a patented coherence probe microscopy technology which permits fast autofocus and precision critical dimension measurements. Applying its expertise in digital image processing, KLA has developed sophisticated measurement algorithms that are tolerant of process variations. With coherence probe microscopy, the system scans the image-forming coherence region through the wafer plane, only gathering information from in-focus surfaces. As a result, measurements are more tolerant of process and substrate reflectivity variations than those from ordinary optical systems.\nThe precision measurements from the KLA 5000 series identify the magnitude and direction of overlay mis-registration errors arising from the stepping process and from optical distortion inherent in the stepper lens. Based upon these measurements, users can fine-tune the stepper program to compensate for these errors, and improve process yield.\nThe average selling prices of KLA's metrology systems for the semiconductor industry range from approximately $300,000 to approximately $550,000.\nThe disk drive manufacturing industry is an emerging market for KLA's metrology systems. Disk drive manufacturers use a semiconductor photolithography process to produce thin film heads. The Company's coherence probe technology is particularly well-suited to handle the complex topography characteristics encountered in the thin film head process. The Company believes that its solution to these requirements has allowed it to achieve the major share of the thin film head metrology market.\nWafer Probing Systems. The ATS division sells and services a family of automated wafer probers and network controllers which position individual semiconductor devices still in wafer form under electrical test probes. The probers work in conjunction with electronic parametric and functional testers to perform fully automated tests of the performance of completed die before the wafers are diced and packaged. The electrical test procedure also identifies failed die, classifies die by performance and generates a database of test results for use in process control.\nKLA develops, manufactures and markets these products in cooperation with Tokyo Electron, Limited (\"TEL\"), the leading distributor of semiconductor equipment in Japan. KLA develops and manufactures the prober's image processing electronics and optical subsystems. TEL manufactures the prober's mechanical chassis and incorporates the KLA electronics and subsystems. The ATS division sells the integrated prober systems in the United States and Europe with its own control software and custom interfaces. TEL sells and services the integrated prober systems in Japan and the rest of Asia.\nThe WATCHER business unit develops the image processing subsystems used in ATS' and TEL's wafer prober systems. This image processing computer performs a number of steps: (i) optical character recognition (OCR) to identify the wafer; (ii) precise wafer alignment and positioning to the probe head; and (iii) probe process inspection to monitor prober performance.\nThe average selling prices of KLA's basic wafer prober systems range from approximately $150,000 to approximately $350,000.\nPRISM-Software Productivity and Analysis Systems. The PRISM division was formed in June 1994 to enter the software market with a family of standard software packages for the global semiconductor industry. PRISM, which stands for PRocess Information SysteMs, has adopted a charter to offer software products that enhance yield and maximize factory productivity.\nPRISM's first products to market are a set of probe floor networking products that provide an open architecture for prober and tester automation. These were originally developed within the ATS division as an enhancement to ATS prober systems. Within PRISM they have been integrated into an architecture called CIMA, or Control and Information Management\nArchitecture, and are being marketed as an open architecture probe floor product suite that will integrate with most any prober and tester regardless of manufacturer.\nSEMSpec-Scanning Electron Microscope Inspection Systems. As feature sizes of semiconductor circuits continue to decrease for leading edge semiconductor products, the Company believes that conventional optical technologies ultimately will begin to reach physical limits imposed by the wavelength of light and fail to provide the necessary inspection resolution. Working closely with those customers with the most advanced inspection requirements, KLA has developed the world's only fully automatic electron beam inspection systems. These systems, comprised of the world's fastest scanning electron-optical column and a high speed image computer, are used for reticle and wafer inspection. The development of these systems was funded in part by customer-sponsored research and development programs. KLA has sold four of these systems to customers. KLA expects the market for these inspection systems to emerge slowly.\nKLA Acrotec Ltd. The Company has an 8% equity investment in KLA Acrotec, a Japanese company that develops optical systems that inspect flat panel displays utilizing technology developed by the Company. The Company has a research and development agreement with KLA Acrotec to provide research, development and engineering, on a best efforts cost reimbursement basis. The Company believes that KLA Acrotec is the leading supplier of flat screen inspection systems.\nCUSTOMERS AND APPLICATIONS\nThe Company believes that it is one of the few suppliers which sells its systems to virtually all of the world's semiconductor manufacturers. In fiscal 1992 and 1994, no single customer accounted for more than 10% of the Company's revenues. During fiscal 1993, Motorola accounted for approximately 11% of the Company's revenues.\nSALES, SERVICE AND MARKETING\nThe Company sells products through a combination of direct sales and distribution channels. The Company believes that the size and location of its field sales, service and applications engineering organization represents a significant competitive advantage in its served markets. In the United States and Europe, the Company has a direct sales force located in major geographical markets. Sales, service and applications facilities throughout the world employ over 400 sales, service and applications engineers.\nIn Japan, the Company sells systems for the semiconductor market through TEL. TEL has been the Company's distributor to the Japanese semiconductor market since 1978. The sales effort in Japan is supported by KLA Japan, which provides marketing, applications support, technical support and service to Japanese customers. Over the last two years, the Company significantly increased its customer service organization in Japan in order to assume service and support responsibilities from TEL. KLA Japan has over 100 local employees and occupies facilities at Tachikawa, Osaka and Fukuoka.\nIn Singapore and Taiwan, the Company sells its systems through local sales representatives. In Korea, the Company will convert, in October 1994, from a local sales representative to a direct sales force.\nKLA maintains an export compliance program that fully meets the requirements of the U.S. Department of Commerce. KLA has never been denied approval to ship against a purchase order.\nFor information regarding the Company's revenues from foreign operations for the Company's last three fiscal years, see Note 3 on page 20 of the 1994 Annual Report to Stockholders, incorporated herein by reference.\nTECHNOLOGY\nKLA's inspection and metrology systems precisely capture trillions of features on wafers and reticles that are as small as 10 millionths of an inch on a side and analyze each of these features for possible defects through the use of the following technologies:\nImage Acquisition. KLA's systems acquire images of sub-micron features on wafers and reticles. The quality and brightness of the images greatly influence the speed and sensitivity of the final inspection system. KLA has developed a wide range of optical imaging systems, such as laser scanners, interference microscope systems, and conventional white light and deep UV optical systems. To satisfy the future sensitivity requirements of advanced lithography, KLA has already developed an electron beam system which incorporates the world's fastest scanning electron-optical column.\nImage Conversion. The Company's equipment converts the photon or electron image to an electronic digital format. KLA has pioneered the use of time-delay-integration sensors that convert as many as 100 million pixels (picture elements) to 256-level gray scale images each second. KLA also utilizes other image conversion technologies such as avalanche diode detectors, photo multiplier systems, and fixed frame pickups.\nPrecision Mechanics. In the most common configuration of an inspection system, the reticle or the wafer is moved at a constant speed through the field of the imaging system. Since areas of interest are as small as 5 millionths of an inch, and vibrations in the scanning system of one-tenth of the area of interest can degrade system performance, the mechanical stage must be extremely smooth and precise. To address these requirements, KLA has eight years experience in the design and manufacture of air-bearing linear drive stages.\nProprietary Algorithms. To perform the inspection or measurement task, the Company's equipment examines the properties of the digitized images using a set of logical steps (algorithms) which measure the desired image property. KLA's engineers develop sets of algorithms that are specifically tailored to obtain optimum performance for its wafer, reticle and metrology systems. These algorithms are largely responsible for the state-of-the-art performance of KLA's systems.\nImage Computers. The combination of proprietary algorithms and special purpose computers allows KLA's equipment to have a high performance to cost ratio. While general purpose computers are capable of executing KLA's algorithms, very few computer architectures can sustain the computing speed that is required in KLA's systems (as high as 72,000 MIPS). To address this requirement, KLA develops and builds special purpose image computers designed to execute its algorithms.\nDatabase Analysis. Many of the inspections that KLA reticle inspection systems perform require a digital image representation of the ideal pattern obtained from the data used to manufacture the reticle. This capability allows inspection systems to compare the actual circuit with its design specifications. KLA has been developing database systems for over 14 years to satisfy this objective. Its present generation of special purpose database computers is capable of generating simulated images at the same high speeds at which KLA's image conversion systems generate the digital image from the actual reticle.\nStatistical Process Control. Integrated circuit yield management and process monitoring systems generate hundreds of thousands of data items each day. To enhance the utility of these data, KLA has a team of software engineers who build systems containing statistical process control software to simplify data and present these data in a useful manner. KLA is continuing to work on new software to enhance its statistical process control systems.\nRESEARCH AND DEVELOPMENT\nThe market for yield management and process monitoring systems is characterized by rapid technological development and product innovation. The Company believes that continued and timely development of new products and enhancements to existing products are necessary to maintain its competitive position. Accordingly, the Company devotes a significant portion of its personnel and financial resources to research and development programs and seeks to maintain close relationships with customers to remain responsive to their needs.\nIn order to meet continuing developments in the semiconductor industry and to broaden the applications for its image processing technology, the Company is committed to significant engineering efforts for product improvement and new product development. Approximately 18% of the Company's workforce is engaged in engineering, research and development. For information regarding the Company's research and development expense during the last three fiscal years, see page 18 and 21 of the 1994 Annual Report to Stockholders herein incorporated by reference.\nKLA typically receives some external funding from customers, from industry groups, and from government sources to augment its engineering, research and development efforts. In addition, KLA capitalizes some software development costs. Although the timing and the level of these external funds cannot be predicted, the level of such funding and capitalization has been approximately 4%, 4% and 2% of sales for fiscal 1992, 1993 and 1994, respectively. The Company reports engineering, research and development expense net of this funding and capitalization. Thus, recorded amounts for engineering, research and development expense were 17%, 10% and 9% of sales in fiscal 1992, 1993 and 1994, respectively.\nMANUFACTURING\nThe Company's principal manufacturing activities take place in San Jose, California; Bevaix, Switzerland; and Migdal Ha'Emek, Israel; and consist primarily of assembling and testing components and subassemblies which are acquired from third party vendors and then integrated into the Company's finished products. Subsequent to June 30, 1994, the Company began planning the construction of one or two additional buildings on undeveloped land at its San Jose campus facility. The Company is also cross-training personnel, so that it can respond to changes in product mix by reallocating personnel in addition to hiring.\nThe Company has been working with key vendors to improve inventory management. Volume purchase agreements and just-in-time delivery schedules have reduced both inventory levels and costs. The Company's manufacturing engineers, in conjunction with key vendors, are improving the manufacturability and reliability of the new wafer and reticle inspection systems.\nMany of the components and subassemblies are standard products, although certain items are made to Company specifications. Certain of the components and subassemblies included in the Company's systems are obtained from a single source or a limited group of suppliers. Those parts subject to single or limited source supply are routinely monitored by management and the Company endeavors to ensure that adequate supplies are available to maintain manufacturing schedules, should supply for any part be interrupted. Although the Company seeks to reduce its dependence on sole and limited source suppliers, in some cases the partial or complete loss of certain of these sources could have at least a temporary adverse effect on the Company's results of operations and damage customer relationships.\nCOMPETITION\nThe market for yield management and process control systems is highly competitive. In each of the markets it serves, the Company faces competition from established and potential competitors, some of which may have greater financial, engineering, manufacturing and marketing resources than the Company. Significant competitive factors in the market for yield\nmanagement and process control systems include system performance, ease of use, reliability, installed base and technical service and support.\nThe Company believes that, while price and delivery are important competitive factors, the customers' overriding requirement is for systems which easily and effectively incorporate automated, highly accurate inspection capabilities into their existing manufacturing processes, thereby enhancing productivity. The Company's yield management and process control systems for the semiconductor industry are generally higher priced than those of its present competitors and are intended to compete based upon performance and technical capabilities. These systems also compete with less expensive, more labor-intensive manual inspection devices.\nThe Company's wafer and reticle inspection systems have a predominant share of their markets. The Company is the leading provider of overlay registration systems. The Company believes it is the second largest supplier of wafer prober systems in the U.S. and Europe.\nMany of the Company's competitors are investing in the development of new products aimed at applications currently served by the Company. The Company's competitors in each product area can be expected to continue to improve the design and performance of their products and to introduce new products with competitive price\/performance characteristics. Competitive pressures often necessitate price reductions which can adversely affect operating results. Although the Company believes that it has certain technical and other advantages over its competitors, maintaining such advantages will require a continued high level of investment by the Company in research and development and sales and marketing. There can be no assurance that the Company will have sufficient resources to continue to make such investments or that the Company will be able to make the technological advances necessary to maintain these competitive advantages.\nThe yield management and process control industry is characterized by rapidly changing technology and a high rate of technological obsolescence. Development of new technologies that have price\/performance characteristics superior to the Company's technologies could adversely affect the Company's results of operations. In order to remain competitive, the Company believes that it will be necessary to expend substantial effort on continuing product improvement and new product development. There can be no assurance that the Company will be able to develop and market new products successfully or that the products introduced by others will not render the Company's products or technologies non-competitive or obsolete.\nPATENTS AND OTHER PROPRIETARY RIGHTS\nThe Company believes that, due to the rapid pace of innovation within the yield management and process control systems industry, the Company's protection of patent and other intellectual property rights is less important than factors such as its technological expertise, continuing development of new systems, market penetration and installed base and the ability to provide comprehensive support and service to customers.\nThe Company protects its proprietary technology through a variety of intellectual property laws including patents, copyrights and trade secrets. The Company's source code is protected as a trade secret and as an unpublished copyright work. The Company has a number of United States and foreign patents and patent applications. The Company's effort to protect its intellectual property rights through trade secret and copyright protection may be impaired if third parties are able to copy or otherwise obtain and use the Company's technology without authorization. Effective intellectual property protection may be unavailable or limited in certain foreign countries. In addition, the semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. No assurance can be given that any patent held by the Company will be sufficient to protect the Company.\nBACKLOG\nBacklog orders for systems were $125 million as of June 30, 1994, with 99% shippable in one year, as compared with $52 million as of June 30, 1993, with 98% shippable in one year. The Company generally ships systems within six months after receipt of a customer's purchase order.\nEMPLOYEES\nAs of August 31, 1994, KLA employed a total of approximately 1,135 persons. None of KLA's employees is represented by a labor union. KLA has experienced no work stoppages and believes that its employee relations are excellent.\nCompetition in the recruiting of personnel in the semiconductor and semiconductor equipment industry is intense. KLA believes that its future success will depend in part on its continued ability to hire and retain qualified management, marketing and technical employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nKLA owns a corporate facility which houses engineering, manufacturing and administrative functions in San Jose, California, occupying approximately 232,000 square feet. The Company purchased this facility in 1990 at a total cost of approximately $30 million, including improvements. The Company leases additional office space for manufacturing, engineering, sales and service activities, including seven locations in the U.S., four in Europe, three in Japan, and one each in Malaysia, Korea, Taiwan and Israel. Subsequent to June 30, 1994, the Company entered into two leases, for two year terms commencing August 10, 1994 and November 1, 1994, for two buildings adjacent to its campus facility, consisting of an aggregate of approximately 73,000 square feet. Capital expenditures for fiscal 1995 are expected to approximate depreciation; however, this assessment could change if demand continues to exceed estimates and additional manufacturing capacity is required. No estimate can be made of the size or cost of any such additional capacity. In addition, subsequent to June 30, 1994, the Company began planning the construction of one or two additional buildings on undeveloped land at its campus facility .\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn June 1990, the Company filed a lawsuit in the U.S. Federal District Court in San Jose, California, against Orbot Systems Ltd. and Orbot, Inc., now Orbotech (\"Orbot\") for patent infringement. Orbot has since counter-sued for interference with normal business. If the Company were to lose, Orbot would be allowed to continue to sell products using its present illuminator. The Company believes that the outcome of this suit will most likely be determined based upon the validity of KLA's patent, U.S. Patent No. 4,877,326. The case is scheduled to go to trial in early 1995. Management believes the results of this lawsuit will not have a significant adverse effect on the Company.\nIn November 1993 KLA filed suit, in U.S. District Court in San Jose, CA, against Orbot Instruments Inc. for infringing a KLA patent on die- to-database inspection. Orbot Instruments filed a cross-complaint alleging interference with business. This case is in the early phase of discovery.\nThe Company is also the defendant in three suits resulting from the discontinuance of the printed circuit inspection business. In one case the trial court denied the plaintiff's demand for damages. This case is under appeal. The other two cases are in early discovery. Management does not believe that these suits will have a significant adverse effect on the Company.\nBeginning in August 1992 Jerome Lemelson, an independent inventor, filed suit in U.S. District Court in Reno, NV, against the three U.S. automobile companies, Motorola and several Mitsubishi subsidiaries for the infringement of Lemelson's patents on machine vision. Recently Motorola settled with Lemelson. However, Lemelson has put other semiconductor companies on\nnotice . In the event that Lemelson prevails in his suit against other semiconductor companies, KLA may be liable as a potential indemnitor.\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\n\"Common Stock\" on page 24 of the 1994 Annual Report to Stockholders is incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\n\"Selected Financial Data\" on page 14 of the 1994 Annual Report to Stockholders is incorporated herein by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\n\"Management's Financial Commentary\" on pages 12 and 13 of the 1994 Annual Report to Stockholders is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements, together with the report thereon of Price Waterhouse LLP dated July 26, 1994, appearing on pages 14 through 24 of the aforementioned 1994 Annual Report to Stockholders are incorporated herein by reference in this Form 10-K Annual Report. With the exception of the information incorporated by reference in Items 1, 5, 6, 7 and 8, the 1994 Annual Report to Stockholders is not to be deemed filed as part of this Form 10-K Annual Report.\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\nDIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Set forth below are the names of the present executive officers of the Company, their ages and positions held with the Company.\nMr. Levy co-founded the Company in July 1975 and served as President and Chief Executive Officer and a Director of the Company until November 1991, when he became Chairman of the Board of Directors and Chief Executive Officer. Since May 1993, Mr. Levy has been a Director of Ultratech Stepper, Inc., a manufacturer of photolithography equipment, and since April 1993 a director of Network Peripherals, Inc., a supplier of high-performance client-server networking solutions.\nMr. Schroeder rejoined the Company in November 1991 as President, Chief Operating Officer and Director. Mr. Schroeder had worked previously at KLA from 1979 through 1987, during which time he held the positions of Vice President of Operations (1979); Vice President and General Manager, RAPID (1982); Vice President and General Manager, WISARD (1983); and Senior Vice President (1985). In July 1988, he became President and Chief Executive Officer of Photon Dynamics, Inc., a manufacturer of electro-optic test equipment. In mid-1989, he was appointed President, Chief Operating Officer, and Director of Genus, Inc., a manufacturer of CVD chemical vapor deposition and ion implant equipment. He left Genus in October 1991, to rejoin KLA Instruments Corporation.\nMr. Boehlke joined the Company in April 1983 as Vice President and General Manager of the RAPID Division. Subsequently, he was General Manager of several divisions and groups of divisions at KLA. In June 1985, Mr. Boehlke was elected to Senior Vice President and to Executive Vice President in January 1989, and to Chief Operating Officer in August 1989 until July 1990, when he became Chief Financial Officer.\nDr. Tsai joined the Company in June 1984 as a member of the WISARD Technical Staff and was promoted to Manager of Algorithm Development for the WISARD Division. From August 1989 until September 1990 he served as Director of Engineering for WISARD. In October 1990, he\nwas promoted to Vice President of Engineering for KLA Acrotec, and in July 1994 he was elected Vice President of the Company and promoted to Chief Technical Officer.\nMr. Dickerson joined KLA in January 1986 as a Senior Applications Engineer in the Wafer Inspection Division. In July 1987 he was promoted to Manager of Applications Engineering for the Wafer Inspection Division, followed by Manager of Product Planning in July 1989, Director of Marketing in July 1990, and Vice President of Marketing in July 1992. In July 1993, he was promoted to Vice President and Director of the Wafer Inspection Business Unit. In July 1994, he was elected to Vice President of the Company.\nMr. McCarver joined the Company in October 1985 as Vice President of Sales for the RAPID Division, was promoted to General Manager in July 1987, and was additionally elected to Vice President of the Company in August 1989. In August 1993, he became Vice President of Corporate Sales.\nDr. Richardson joined KLA in June 1993 as Vice President and General Manager of the Metrology Division, and was elected Vice President of the Company in July 1994. He served as Vice President and General Manager of Diagnostic Systems Group of Schlumberger Technologies from September 1985 to November 1991, and was the Corporate Technology Adviser for Schlumberger Ltd., a manufacturer of electronic test equipment, from November 1991 to May 1993.\nMr. Ryde joined KLA in June 1980 as Production Control Manager. In May 1981 he was promoted to Materials Manager, followed by Production Manager in January 1982 and Manager, Advance Manufacturing - KLA208 in May 1984. In March 1985 he became Product Marketing Manager for the RAPID Division. In December 1988, after leaving KLA for 6 months to pursue other interests, he returned as Director of EMMI Business within the ATS Division. In January 1989 he was promoted to Director of Operations - Europe, and in March 1991 became Vice President of Operations for the ATS Division. He was promoted to Vice President and General Manager of the Customer Support Division in July 1992 and was elected to Vice President of the Company in July 1994.\nMr. Schnitzer joined the Company in July 1978 as Software Engineering Manager and was promoted to Director of Engineering of the RAPID Division in July 1982, and was promoted to Vice President in July 1983. He became Vice President of Technology and Marketing of RAPID in May 1987, and Vice President of Advanced Inspection in January 1989. In October 1989, he was promoted to General Manager of the WISARD Division and, additionally, was elected to Vice President of the Company in July 1990. In July 1993, he became Group Vice President of the Wafer and Reticle Inspection Group (\"WRInG\"), composed of the former RAPID and WISARD divisions.\nMr. Turner joined the Company in September 1983 as a Corporate Financial Analyst, transferred to be the Field Service Financial Administrator of the RAPID Division in August 1984, was promoted to RAPID Division Controller in February 1986, transferred to International Division Controller in July 1988, was promoted to Corporate Controller in December 1989, and was elected Vice President of the Company in July 1990.\nMs. DeMars joined KLA in 1988 as Director of Human Resources after a 13 year career in Employee Relations at Monolithic Memories, Inc. and Advanced Micro Devices. In November 1991, KLA promoted Ms. DeMars to Vice President of Human Resources, worldwide.\nMr. Stoddart joined the Company in December 1991 as Treasurer. Prior to joining the Company, Mr. Stoddart was Treasurer of General Cellular Corporation, a cellular telephone service provider, from October 1989 to September 1991 and previously with The Cooper Companies, Inc., a manufacturer of pharmaceuticals and medical equipment and implant equipment, as Assistant Treasurer from August 1986 to July 1988, and then Treasurer from July 1988 to September 1989.\nMr. Chamberlain has served as a Director of the Company since 1982. He has served as a Director of Octel Communications Corporation, a manufacturer of high performance voice processing systems since March 1989.\nMr. Lorenzini has served as a Director of the Company since 1976. He has served since January 1993 as Chairman of SunPower Corporation, a manufacturer of optoelectronic devices, and from October 1988 to January 1993, he served as President and Chief Executive Officer. Since July 1993, he has also been a Principal in Dalton Partners, a turn-around management company. He was a founder and, until December 1986, Chairman of the Board of Siltec Corporation, a manufacturer of semiconductor materials and manufacturing equipment. Since October 1986, Mr. Lorenzini has also served as a Director of FSI International, a semiconductor process equipment manufacturer.\nMr. Nishi has served as a Director of the Company since 1989. He is the Director of ULSI Research Laboratory, Hewlett-Packard Laboratories, and also a consultant professor in the Stanford University Department of Electrical Engineering.\nMr. Rubinovitz previously served as a Director of the Company from October 1979 to January 1989, and rejoined the Company as a Director in 1990. From April 1989 through December 1993, he served as Executive Vice President of EG&G, Inc., a diversified manufacturer of scientific instruments and electronic, optical and mechanical equipment, and previously as Senior Vice President of EG&G, Inc. between April 1986 and April 1989. Since April 1989, Mr. Rubinovitz has served as a Director of EG&G. Since October 1984, he has served as Director of Richardson Electronics, Inc., a manufacturer and distributor of electron tubes and semiconductors and, since October 1986, Director of Kronos, Inc., a manufacturer of electronic time keeping systems.\nMr. Tellefsen has served as a Director of the Company since 1978. He is General Partner of the investment manager of Glenwood Ventures I and II, venture capital funds. Since January 1983, he has served as a Director of Iwerks Entertainment, a producer of movie-based specialty theaters, and since 1982, as a director of Octel Communications Corporation.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe information regarding Executive Compensation as it appears 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 regarding Security Ownership of Certain Beneficial Owners and Management as it appears in the Proxy Statement is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information regarding Certain Relationships and Related Transactions as it appears in the Proxy Statement is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORT ON FORM 8-K\n(a) (1) Financial Statements: See Index to Financial Statements, page 19.\n(2) Financial Statement Schedules: See Index to Financial Statement Schedules, page 19. (3) Exhibits: See Index to Exhibits, pages 23, 24 and 25.\n(b) No reports on Form 8-K were filed during the quarter ended June 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 City of San Jose, State of California, on the 27th day of September 1994.\nKLA INSTRUMENTS CORPORATION\nBy WILLIAM TURNER ----------------------------------- William Turner Vice President\/Corporate 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 this registrant and in the capacities and on the dates indicated.\nKLA INSTRUMENTS CORPORATION AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENT SCHEDULES\n*Incorporated by reference from the indicated pages of the 1994 Annual Report to Stockholders.\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.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of KLA Instruments Corporation\nOur audits of the consolidated financial statements referred to in our report dated July 26, 1994, appearing on page 24 of the 1994 Annual Report to Stockholders of KLA Instruments Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in the index on page 19 of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPrice Waterhouse LLP\nSan Jose, California July 26, 1994\nSCHEDULE VIII\nKLA INSTRUMENTS CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS\nSCHEDULE IX\nKLA INSTRUMENTS CORPORATION SHORT TERM BORROWINGS\n_________________\n1The average borrowings were determined based on the amounts outstanding at each month-end.\n2The weighted average interest rate during the year was computed by dividing the interest expense on these borrowings by the average short-term borrowings outstanding during the year.\n3Short-term borrowings at June 30, 1992 include $1.3 million local currency borrowings by one of the Company's foreign subsidiaries under the Company's $15 million multicurrency line of credit and $3.7 million of local currency borrowings by certain of the Company's foreign subsidiaries.\n4Short-term borrowings at June 30, 1993 include $1.2 million local currency borrowings by one of the Company's foreign subsidiaries under the Company's $15 million multicurrency line of credit and $1.4 million of local currency borrowings by certain of the Company's foreign subsidiaries.\n5Short-term borrowings at June 30, 1994 include $4.2 million local currency borrowings by one of the Company's foreign subsidiaries under the Company's $10 million multicurrency line of credit and $0.5 million of local currency borrowings by certain of the Company's foreign subsidiaries.\nINDEX TO EXHIBITS\n(I) EXHIBITS INCORPORATED BY REFERENCE: 3.1 Certificate of Incorporation, as amended11 3.2 Bylaws, as amended8 4.3 Rights Agreement dated as of March 15, 1989, between the Company and First National Bank of Boston, as Rights Agent. The Rights Agreement includes as Exhibit A, the form of Right Certificate, and as Exhibit B, the form of Summary of Rights to Purchase Common Stock2 10.15 Statement of Partnership to Triangle Partners dated April 12, 19833 10.16 Lease Agreement and Addendum thereto dated January 10, 1983, between BBK Partnership and the Company3 10.18 Purchase and Sale Agreement dated January 10, 1983, between BBK Partnership, Triangle Partners and the Company3 10.23 Research and Development Agreement, Cross License and Technology Transfer Agreement and Agreement for Option to License and Purchase Resulting Technology, all dated February 21, 1985, by and between KLA Development No. 3, Ltd., and the Company4 10.24 Research and Development Agreement dated February 21, 1985, by and between KLA Development No. 3, Ltd., and the Company4 10.25 Agreement for Option to License and Purchase Resulting Technology dated February 21, 1985, by and between KLA Development No. 3, Ltd., and the Company4 10.33 (Research and Development) Agreement dated as of February 1, 1987, by and between IBM Corporation and the Company5 10.35 Research and Development Agreement, Cross License and Technology Transfer Agreement and Agreement for Option to License and Purchase Resulting Technology, all dated September 30, 1986 and between KLA Development No. 4, Ltd., and the Company5 10.43 Amendment to the Exclusive Marketing Agreement dated February 23, 1989, by and between Micrion Limited Partnership and the Company6 10.44 Bank Loan Guarantee dated June 29, 1989, by the Company in favor of The First National Bank of Boston for the Micrion Limited Partnership6 10.45 Distribution Agreement, dated July 1990, by and between Tokyo Electron Limited, a Japanese Corporation, and the Company7 10.46 Principal facility Purchase Agreement dated July 1990, including all exhibits and amendments; Lease Agreement, Termination of Lease, Lot line adjustment, rights of first refusal, Deeds of Trust7 10.47 Joint Venture Agreement between the Company and Nippon Mining Company, Limited, dated September 18, 19908 10.48 Exercise of Option to Purchase Technology made effective as of September 30, 1989, by and between KLA Development No. 3, and the Company8 10.49 Exercise of Option to Purchase Technology made effective as of January 1, 1990, by and between KLA Development No. 4, and the Company8 10.51 Guarantee Agreement between First National Bank of Boston and the Company, dated June 29, 19898 10.52 Amendment to the Guarantee Agreement between First National Bank of Boston and the Company, dated April 19, 19918 10.53 Secured Installment Note between Micrion and First National Bank of Boston, dated April 19, 19918 10.54 Micrion Corporation Series E Preferred Stock Purchase Agreement, dated September 13, 19918 10.55 Micrion Corporation Guaranty and Warrant Agreement, dated December 8, 10.57 Stock repurchase and option grant agreement between Bob Boehlke and the Company, dated April 22, 19918 10.58 Purchase Agreement between the Company and Ono Sokki Co., Ltd., dated October 18, 1991 with\ncertain portions for which confidential treatment has been requested, excise9 10.59 Credit Agreement between Bank of America NT & SA and the Company, dated November 15, 1991, as amended July 29, 19929 10.60 Employment agreement between the Company and Kenneth L. Schroeder dated October 4, 19919 10.61 Amendment of Credit Agreement between Bank of America NT & SA and theCompany, dated October 28, 199210 10.62 Amendment of Credit Agreement between Bank of America NT & SA and the Company, dated December 31, 199210 10.63 Amendment of Credit Agreement between Bank of America NT & SA and the Company, dated February 28, 199310 10.64 Amendment of Credit Agreement between Bank of America NT & SA and the Company, dated March 31, 199310 10.65 Amendment of Credit Agreement between Bank of America NT & SA and the Company, dated June 1, 199310 10.69 1982 Stock Option Plan, as amended by the Board of Directors on July 20, 199012 10.70 1981 Employee Stock Purchase Plan, as amended by the Board of Directors on July 20, 199013 10.71 1990 Outside Directors Stock Option Plan14 10.72 1993 Employee Stock Purchase Plan, as amended by the Board of Directors on September 14, 1992.15\n(II) EXHIBITS INCLUDED HEREWITH:\n10.66 Amendment of Credit Agreement between Bank of America NT & SA and the Company, dated December 31, 1993 10.67 Amendment of Credit Agreement between Bank of America NT & SA and the Company, dated March 31, 1994 10.68 Credit Agreement between Bank of America NT & SA and the Company, dated April 30, 1994 13 1994 Annual Report to Stockholders. This Annual Report shall not be deemed to be filed except to the extent that the information is specifically incorporated by reference 21 List of Subsidiaries of KLA Instruments Corporation 23.1 Consent of Independent Accountants\n____________________________________________________________ 1Filed as the same exhibit number as set forth herein to Form S-8, File No. 33-15784, effective August 2, 1987 2Filed as exhibit number 1 to Form 8-A, filed effective March 23, 1989 3Filed as the same exhibit number as set forth herein to Registrant's Form 10-K for the year ended June 30, 1983 4Filed as the same exhibit number as set forth herein to Registrant's Form 10-K for the year ended June 30, 1985 5Filed as the same exhibit number as set forth herein to Registrant's Form 10-K for the year ended June 30, 1987 6Filed as the same exhibit number as set forth herein to Registrant's Form 10-K for the year ended June 30, 1989 7Filed as the same exhibit number as set forth herein to Registrant's Form 10-K for the year ended June 30, 1990 8Filed as the same exhibit number as set forth herein to Registrant's Form 10-K for the year ended June 30, 1991 9Filed as the same exhibit number as set forth herein to Registrant's Form 10-K for the year ended June 30, 1992 10Filed as the same exhibit number as set forth herein to Registrant's Form 10-K for the year ended June 30, 1993\n11Filed as the same exhibit number to Registrant's registration statement no. 33-51819 on Form S-3, dated February 2, 1994 12Filed as exhibit number 4.4 as set forth herein to Registrant's Form 10-K for the year ended June 30, 1990 13Filed as exhibit number 4.5 as set forth herein to Registrant's Form 10-K for the year ended June 30, 1990 14Filed as exhibit number 4.6 as set forth herein to Registrant's Form 10-K for the year ended June 30, 1991 15Filed as exhibit number 4.7 as set forth herein to Registrant's Form 10-K for the year ended June 30, 1993","section_15":""}
{"filename":"764542_1994.txt","cik":"764542","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nMAXXAM Group Inc. and its wholly owned subsidiaries are collectively referred to herein as the \"Company\" or \"MGI\" unless otherwise indicated or the context indicates otherwise. The Company is a wholly owned subsidiary of MAXXAM Inc. (\"MAXXAM\"). The Company engages almost exclusively in forest products operations through its 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\"). 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 (which cannot efficiently process them in its own mills).\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 (\"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.\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.\"\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\nof 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.\nPacific Lumber 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. 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. 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 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.\nCommon 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. 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 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 With 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 Pacific Lumber. 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 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. 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 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\nrevenues in 1994. Pacific Lumber markets its products through its own sales staff which focuses primarily on domestic sales.\nPacific Lumber 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, Pacific Lumber believes that it has a strong degree of customer loyalty.\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 With 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 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 the SPHC's possession and reasonably necessary for the operation and maintenance of the SPHC Timberlands containing the SPHC Timber. In particular, Pacific Lumber is required to regenerate SPHC Timber, prevent and control loss of the 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 the SPHC Timber and comply with environmental laws and regulations, including measures with respect to waterways, habitat, hatcheries and endangered species. Pacific Lumber also is 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 Pacific Lumber, 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 Services 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 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 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 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 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 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 and, thus, the purchase price 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, a wholly owned subsidiary of Pacific Lumber (\"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 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.\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\na 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 With 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. 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. 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\nresults. 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. 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 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,\nincluding 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, 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.\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 seek 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\n7722) (\"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, MAXXAM, and Pacific Lumber, approximately $14.8 million was paid by Pacific Lumber and the balance was paid by 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 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 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, the 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, relates 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.\nThe Company's management believes that the matters described above are unlikely to have a material adverse effect on the Company's consolidated financial position or results of operations. See Item 1. \"Business--Regulatory and Environmental Factors\" above for a general description of regulatory and similar matters which could affect Pacific Lumber's timber harvesting practices and future operating results.\nZERO COUPON NOTE LITIGATION In April 1989, an action was filed against the Company, MAXXAM, MAXXAM Properties Inc. (\"MPI,\" a wholly owned subsidiary of MGI) and certain of MAXXAM's directors in the Court of Chancery of the State\nof Delaware, entitled Progressive United Corporation v. MAXXAM Inc., et al., Civil Action No. 10785. Plaintiff purports to bring this action as a stockholder of MAXXAM derivatively on behalf of MAXXAM 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 to a Put and Call Agreement between MPI and Mr. Charles Hurwitz (Chairman of the Board of the Company, MAXXAM 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 MAXXAM into which they were converted) for $10.3 million. In July 1989, Mr. Hurwitz exercised the Call and acquired 990,400 shares of MAXXAM'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 MAXXAM, that the Put and Call Agreement constituted an alleged waste of corporate assets of MAXXAM 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.\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 REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is held entirely by 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 cash dividends on its common stock of $20.0 million in 1993. No dividends were declared or paid in 1994. As of December 31, 1994, approximately $4.9 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 5 to the Consolidated Financial Statements appearing in Item 8.\nThe 11-1\/4% Senior Secured Notes due 2003 (the \"MGI Senior Notes\") and the 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\") are secured by the Company's pledge of 100% of the common stock of Pacific Lumber, Britt and MPI, and by a pledge of 28 million common shares of Kaiser Aluminum Corporation (\"Kaiser\") that are owned by MAXXAM. See Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Financial Condition and Investing and Financing Activities\" and Note 5 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\nAs a result of the Forest Products Group Formation (as discussed in Note 1 to the Consolidated Financial Statements), the Company's financial statements have been restated to present the historical results of operations relating to the net assets transferred to MAXXAM pursuant to the Forest Products Group Formation. Such restatement has been made with respect to all periods presented in this Report in a manner similar to that which would be presented if the Company had discontinued the operations relating to such net assets.\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 Stockholder and Board of Directors of MAXXAM Group Inc.:\nWe have audited the accompanying consolidated balance sheets of MAXXAM Group Inc. (a Delaware corporation and a wholly owned subsidiary of MAXXAM Inc.) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows and stockholder's equity (deficit) 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 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 MAXXAM 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 three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs explained in Notes 6 and 7 to the financial statements, effective January 1, 1993, the Company changed its method 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 consolidated financial statements taken as a whole. The schedule listed in Item 14(a)(2) of this Form 10-K 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\nSan Francisco, California January 27, 1995\nCONSOLIDATED BALANCE SHEET\nCONSOLIDATED STATEMENT OF OPERATIONS\nCONSOLIDATED STATEMENT OF CASH FLOWS\nCONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)\n1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of MAXXAM Group Inc. (\"MGI\") and its subsidiaries, collectively referred to herein as the \"Company.\" The Company is a wholly owned subsidiary of MAXXAM Inc. (\"MAXXAM\").\nThe Company conducts its business primarily through the operations of its subsidiaries. Prior to the Forest Products Group Formation (as defined below), the Company operated in three industries: aluminum, through its majority owned subsidiary, Kaiser Aluminum Corporation (\"Kaiser\"), a fully integrated aluminum producer; forest products, through The Pacific Lumber Company (\"Pacific Lumber\") and Britt Lumber Co., Inc. (\"Britt\"), each a wholly owned subsidiary; and real estate management and development, through the Palmas del Mar development located in Puerto Rico (\"Palmas\") which was owned by the Company's subsidiary, MAXXAM Properties Inc. (\"MPI\"). On August 4, 1993, contemporaneously with the consummation of the sale of the MGI Notes (as defined in Note 5), the Company (i) transferred to MAXXAM 50 million common shares of Kaiser held by a subsidiary of the Company, representing the Company's (and MAXXAM's) entire interest in Kaiser's common stock, (ii) transferred to MAXXAM 60,075 shares of MAXXAM common stock held by a subsidiary of the Company, (iii) transferred to MAXXAM certain notes receivable, long-term investments, and other assets, each net of related liabilities, collectively having a carrying value to the Company of approximately $1,100 and (iv) exchanged with MAXXAM 2,132,950 Depositary Shares, acquired from Kaiser on June 30, 1993 for $15,000, such exchange being in satisfaction of a $15,000 promissory note evidencing a cash loan made by MAXXAM to the Company in January 1993. On the same day, MAXXAM assumed approximately $17,500 of certain liabilities of the Company that were unrelated to the Company's forest products operations or were related to operations which have been disposed of by the Company. Additionally, on September 28, 1993, the Company transferred to MAXXAM its interest in Palmas. The foregoing transactions are collectively referred to as the \"Forest Products Group Formation.\"\nAs a result of the Forest Products Group Formation, the Company restated its Consolidated Financial Statements to present the net assets transferred to MAXXAM pursuant to the Forest Products Group Formation (including certain allocated costs from MAXXAM for general and administrative expenses unrelated to the Company's forest products operations). Such restatement has been made with respect to all periods presented in a manner similar to that which would have been presented if the Company had discontinued the operations relating to such net assets. See Note 2.\nAs a result of the Forest Products Group Formation, the Company's business is substantially limited to forest products operations which consists of 100% of the outstanding common stock of Pacific Lumber and 100% of the outstanding common stock of Britt. Pacific Lumber is engaged in all principal aspects of the lumber industry, including the growing and harvesting of redwood and Douglas-fir timber, the milling of logs into lumber and the production of manufactured lumber products. Britt mills logs to produce a variety of fencing and decking products.\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 - net unrealized holding losses of $1,094 and net realized gains of $2,763; 1993 - net realized gains of $3,510, the recovery of $2,063 of net unrealized losses and net unrealized gains of $841; and 1992 - net realized losses of $5,003 and net unrealized losses of $371. 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. Cost is primarily 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 estimated 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 5. 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 5) 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\n$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 5). 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.\nStockholder's Equity (Deficit) Adjustments to the Company's additional capital for the years ended December 31, 1992 and 1993 resulted from transactions relating to Kaiser's common stock prior to the Forest Products Group Formation. Pursuant to the terms of an amended compensation plan, Kaiser issued 77,279 and 4,228 shares to certain members of its management in 1992 and 1993, respectively. As a result of these transactions, the Company's equity in Kaiser's net assets differed from the Company's historical cost. The Company accounted for these differences as adjustments to additional capital.\nInvestment, Interest and Other Income In February 1994, Pacific Lumber 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, Pacific Lumber 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, Pacific Lumber 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, the 10-1\/2% Senior Notes due 2003 (the \"Pacific Lumber Senior Notes\"), the 11-1\/4% Senior Secured Notes due 2003 (the \"MGI Senior Notes\") and the 12-1\/4% Senior Secured Discount Notes due 2003 (the \"MGI Discount Notes\"), and on the current rates offered for borrowings similar to the other debt. The Timber Notes, the Pacific Lumber Senior Notes, the MGI Senior Notes and the MGI Discount 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. NET ASSETS TRANSFERRED TO MAXXAM\nAs a result of the Forest Products Group Formation (as described in Note 1), the Company transferred all of its interest in Kaiser's common stock, the assets and related liabilities of Palmas, and certain other net assets that were unrelated to the Company's forest products operations, to MAXXAM. The Company did not incur any gain or loss relating to the transfer of such assets and liabilities to MAXXAM.\nThe net income (loss) from net assets transferred to MAXXAM is as follows:\nNet assets transferred to MAXXAM are as follows as of the date of transfer:\n3. INVENTORIES\nInventories consist of the following:\nDuring 1993 and 1992, Pacific Lumber's inventory quantities were reduced. These reductions resulted in the liquidation of Pacific Lumber's 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.\n4. PROPERTY, PLANT AND EQUIPMENT\nThe major classes of property, plant and equipment are as follows:\nOn March 23, 1993, Pacific Lumber issued $235,000 of the Pacific Lumber Senior Notes and its newly-formed wholly owned subsidiary, Scotia Pacific Holding Company (\"SPHC\"), issued $385,000 of the Timber Notes. Pacific Lumber and SPHC used the net proceeds from the sale of the Pacific Lumber Senior Notes and the Timber Notes, together with Pacific Lumber's cash and marketable securities, to (i) retire (a) $163,784 aggregate principal amount of Pacific Lumber's 12% Series A Senior Notes due July 1, 1996 (the \"Series A Notes\"), (b) $299,725 aggregate principal amount of Pacific Lumber's 12.2% Series B Senior Notes due July 1, 1996 (the \"Series B Notes\") and (c) $41,750 aggregate principal amount of Pacific Lumber's 12-1\/2% Senior Subordinated Debentures due July 1, 1998 (the \"Debentures;\" the Series A Notes, the Series B Notes and the Debentures are referred to collectively as the \"Old Pacific Lumber Securities\"); (ii) pay accrued interest on the Old Pacific Lumber Securities through the date of redemption thereof; (iii) pay the applicable redemption premiums on the Old Pacific Lumber Securities; (iv) repay Pacific Lumber's $28,867 cogeneration facility loan; (v) fund the initial deposit of $35,000 to the Liquidity Account; and (vi) pay a $25,000 dividend to a subsidiary of the Company. These transactions resulted in a pre-tax extraordinary loss of $16,368, consisting primarily of the payment of premiums and the write-off of unamortized deferred financing costs on the Old Pacific Lumber Securities.\nThe indenture governing the Timber Notes (the \"Timber Note Indenture\") prohibits SPHC from incurring any additional indebtedness for borrowed money and limits the business activities of SPHC to the ownership and operation of its timber and timberlands. The Timber Notes are senior secured obligations of SPHC and are not obligations of, or guaranteed by, Pacific Lumber or any other person. The Timber Notes are secured by a lien on (i) SPHC's timber and timberlands (representing $192,445 of the Company's consolidated balance at December 31, 1994), (ii) substantially all of SPHC's property and equipment, (iii) SPHC's contract rights and certain other assets and (iv) the funds deposited in the Payment Account and the Liquidity Account.\nThe Timber Notes are structured to link, to the extent of cash available, the deemed depletion of SPHC's timber (through the harvest and sale of logs) to required amortization of the Timber Notes. The required amount of amortization due on any Timber Note payment date is determined by various mathematical formulas set forth in the Timber Note Indenture. The minimum amount of principal which SPHC must pay (on a cumulative basis) through any Timber Note payment date in order to avoid an Event of Default (as defined in the Timber Note Indenture) is referred to as rated amortization (\"Rated Amortization\"). If all payments of principal are made in accordance with Rated Amortization, the payment date on which SPHC will pay the final installment of principal is July 20, 2015. The amount of principal which SPHC must pay through each Timber Note payment date in order to avoid payment of prepayment or deficiency premiums is referred to as scheduled amortization (\"Scheduled Amortization\"). If all payments of principal are made in accordance with Scheduled Amortization, the payment date on which SPHC will pay the final installment of principal is July 20, 2009.\nSubstantially all of the Company's consolidated assets are owned by Pacific Lumber and a significant portion of Pacific Lumber's assets are owned by SPHC. The Company expects that Pacific Lumber will provide a major portion of the Company's future operating cash flow. Pacific Lumber is dependent upon SPHC for a significant portion of its operating cash flow. The holders of the Timber Notes have priority over the claims of creditors of Pacific Lumber with respect to the assets and cash flow of SPHC, and the holders of the Pacific Lumber Senior Notes have priority over the claims and creditors of the Company with respect to the assets and cash flows of Pacific Lumber. Under the terms of the Timber Note Indenture, SPHC will not have available cash for distribution to Pacific Lumber unless SPHC's cash flow from operations exceeds the amounts required by the Timber Note Indenture to be reserved for the payment of current debt service (including interest, principal and premiums) on the Timber Notes, capital expenditures and certain other operating expenses.\nPrincipal and interest on the Timber Notes is payable semi- annually on January 20 and July 20. The Timber Notes are redeemable at the option of SPHC, in whole but not in part, at any time. The redemption price of the Timber Notes is equal to the sum of the principal amount, accrued interest and a prepayment premium calculated based upon the yield of like term Treasury securities plus 50 basis points.\nInterest on the Pacific Lumber Senior Notes is payable semi- annually on March 1 and September 1. The Pacific Lumber Senior Notes are redeemable at the option of Pacific Lumber, in whole or in part, on or after March 1, 1998 at a price of 103% of the principal amount plus accrued interest. The redemption price is reduced annually until March 1, 2000, after which time the Pacific Lumber Senior Notes are redeemable at par.\nPacific Lumber has a revolving credit agreement with a bank (the \"Revolving Credit Agreement\") which expires on May 31, 1997. Borrowings under the Revolving Credit Agreement are secured by Pacific Lumber's trade receivables and inventories, with interest computed at the bank's reference rate plus 1-1\/4% or the bank's offshore rate plus 2-1\/4%. The Revolving Credit Agreement provides for borrowings of up to $30,000, of which\n$15,000 may be used for standby letters of credit. As of December 31, 1994, $19,742 of borrowings was available under the Revolving Credit Agreement, of which $4,742 was available for letters of credit. No borrowings were outstanding as of December 31, 1994, and letters of credit outstanding amounted to $10,258.\nThe indentures governing the Pacific Lumber Senior Notes and the Timber Notes and Pacific Lumber's Revolving Credit Agreement contain various covenants which, among other things, limit the payment of dividends and restrict transactions between Pacific Lumber and its affiliates. As of December 31, 1994, under the most restrictive of these covenants, approximately $20,800 of dividends could be paid by Pacific Lumber.\nOn August 4, 1993, the Company issued $100,000 aggregate principal amount of the MGI Senior Notes and $126,720 aggregate principal amount (approximately $70,000 net of original issue discount) of 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 the Company's pledge of 100% of the common stock of Pacific Lumber, Britt and MPI, and by MAXXAM's pledge of 28 million shares of Kaiser's common stock it received as a result of the Forest Products Group Formation. The indenture governing the MGI Notes, among other things, restricts the ability of the Company to incur additional indebtedness, engage in transactions with affiliates, pay dividends and make investments. As of December 31, 1994, under the most restrictive of these covenants, approximately $4,900 of dividends could be paid by the Company. The MGI Notes are senior indebtedness of the Company; however, they are effectively subordinate to the liabilities of the Company's subsidiaries, which include the Timber Notes and the Pacific Lumber Senior Notes. The MGI Discount Notes are net of discount of $43,941 and $53,221 at December 31, 1994 and 1993, respectively.\nThe MGI Senior Notes pay interest semi-annually on February 1 and August 1 of each year. The MGI Discount Notes will not pay any interest until February 1, 1999, at which time semi-annual interest payments will become due on each February 1 and August 1 thereafter.\nThe Company used a portion of the net proceeds from the sale of the MGI Notes to retire the entire outstanding balance of its 12-3\/4% Notes at 101% of their principal amount, plus accrued interest through November 14, 1993. The Company used the remaining portion of the net proceeds from the sale of the MGI Notes, together with a portion of its existing cash resources, to pay a $20,000 dividend to MAXXAM. MAXXAM used such proceeds to redeem, on August 20, 1993, $20,000 aggregate principal amount of its 14% Senior Subordinated Reset Notes due 2000 at 100% of their principal amount plus accrued interest thereon.\nThe Company incurred a pre-tax extraordinary loss associated with the early retirement of the 12-3\/4% Notes of $9,677 consisting of net interest cost of $3,763, the write-off of $3,472 of unamortized deferred financing costs, a premium of $1,500 and the write-off of $942 of unamortized original issue discount.\nMaturities The following table of scheduled maturities of long-term debt outstanding at December 31, 1994 reflects Scheduled Amortization with respect to the Timber Notes:\nRestricted Net Assets of Subsidiaries At December 31, 1994, certain debt instruments restricted the ability of Pacific Lumber to transfer assets, make loans and advances and pay dividends to the Company. The restricted net assets of Pacific Lumber totaled approximately $10,000 at December 31, 1994.\n6. CREDIT (PROVISION) IN LIEU OF INCOME TAXES\nThe Company and its subsidiaries are members of MAXXAM's consolidated return group for federal income tax purposes. Prior to August 4, 1993, the Company and each of its subsidiaries computed their tax liabilities or tax benefits on a separate company basis (except as discussed in the following paragraph), in accordance with their respective tax allocation agreements with MAXXAM.\nEffective on March 23, 1993, MAXXAM, Pacific Lumber, SPHC and Salmon Creek Corporation (\"Salmon Creek\") entered into a tax allocation agreement that, among other things, amended the tax calculations with respect to Pacific Lumber (the \"Amended PL Tax Allocation Agreement\"). Under the terms of the Amended PL Tax Allocation Agreement, Pacific Lumber is liable to MAXXAM for the federal consolidated income tax liability of Pacific Lumber, SPHC and certain other subsidiaries of Pacific Lumber (but excluding Salmon Creek) (collectively, the \"PL Subgroup\") computed as if the PL Subgroup was a separate affiliated group of corporations which was never connected with MAXXAM. The Amended PL Tax Allocation Agreement further provides that Salmon Creek is liable to MAXXAM for its federal income tax liability computed on a separate company basis as if it was never connected with MAXXAM. The remaining subsidiaries of MGI are each liable to MAXXAM for their respective income tax liabilities computed on a separate company basis as if they were never connected with MAXXAM, pursuant to their respective tax allocation agreements.\nMGI's tax allocation agreement with MAXXAM, as amended on August 4, 1993 (the \"Amended Tax Allocation Agreement\"), provides that the Company's federal income tax liability is computed as if MGI files a consolidated tax return with all of its subsidiaries except Salmon Creek, and that such corporations were never connected with MAXXAM (the \"MGI Consolidated Tax Liability\"). The federal income tax liability of MGI is the difference between (i) the MGI Consolidated Tax Liability and (ii) the sum of the separate tax liabilities for the Company's subsidiaries (computed as discussed above), but excluding Salmon Creek. To the extent that\nthe MGI Consolidated Tax Liability is less than the aggregate amounts in (ii), MAXXAM is obligated to pay the amount of such difference to MGI.\nThe credit (provision) in lieu of income taxes on income (loss) from continuing operations before income taxes, extraordinary items and cumulative effect of changes in accounting principles consists of the following:\nThe 1994 deferred federal credit in lieu of income taxes of $2,366 includes a credit relating to reserves the Company no longer believes are necessary. The 1993 deferred federal credit in lieu of income taxes of $4,825 includes $2,601 for the benefit of operating loss carryforwards generated in 1993 and 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) from continuing operations 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 the Company's acquisition of Pacific Lumber (see Note 9). 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 $8,856 which approximated the federal statutory income tax rate in effect on the dates the transactions 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 $14,916. 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 acquisitions of Pacific Lumber in 1986 and Britt in 1990. As a result of restating these assets and liabilities, the loss from continuing operations before income taxes, extraordinary item and cumulative effect of changes in accounting principles for the year ended December 31, 1993 was decreased by $377.\nThe components of the Company's net deferred income tax assets (liabilities) are as follows:\nThe valuation allowances listed above relate primarily to loss and credit carryforwards. As of December 31, 1994, approximately $37,209 of the net deferred income tax assets listed above relate 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. Also included in net deferred income tax assets as of December 31, 1994 is approximately $35,263 which relates to the benefit of loss and credit carryforwards, net of valuation allowances. 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 $44,351 and $42,752 at December 31, 1994 and 1993, respectively, which are recorded pursuant to the tax allocation agreements with MAXXAM.\nThe following table presents the estimated tax attributes for federal income tax purposes for the Company and its subsidiaries as of December 31, 1994, under the terms of the respective tax allocation agreements. The utilization of certain of these attributes is subject to limitations.\n7. EMPLOYEE BENEFIT PLANS\nThe Company has a defined benefit plan which covers all employees of Pacific Lumber. 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 Pacific Lumber and the employee's compensation for that year. Pacific Lumber'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 assumptions used in accounting for the defined benefit plan were as follows:\nThe Company has an unfunded defined benefit plan for certain postretirement and other benefits which covers substantially all employees of Pacific Lumber. 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 from continuing operations 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, Pacific Lumber'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, Pacific Lumber'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.\nPacific Lumber 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 $4,069, $3,776 and $3,288 for the years ended December 31, 1994, 1993 and 1992, respectively.\n8. RELATED PARTY TRANSACTIONS\nMAXXAM provides the Company and certain of the Company's subsidiaries with accounting and data processing services. In addition, MAXXAM provides the Company with office space and various office personnel, insurance, legal, operating, financial and certain other services. MAXXAM's expenses incurred on behalf of the Company are reimbursed by the Company through payments consisting of (i) an allocation of the lease expense for the office space utilized by or on behalf of the Company and (ii) a reimbursement of actual out-of-pocket expenses incurred by MAXXAM, including, but not limited to, labor costs (including costs\nassociated with phantom share and stock appreciation rights) of MAXXAM personnel rendering services to the Company. Charges by MAXXAM for such services included in continuing operations were $2,254, $3,347 and $3,735 for the years ended December 31, 1994, 1993 and 1992, respectively. The Company believes that the services being rendered are on terms not less favorable to the Company than those which would be obtainable from unaffiliated third parties.\nIn 1994, in connection with the litigation settlement described in Note 9, Pacific Lumber paid approximately $3,185 to a law firm in which a director of Pacific Lumber is also a partner. In 1993, Pacific Lumber paid approximately $1,931 in connection with the offering of the Pacific Lumber Senior Notes and the Timber Notes to this same law firm.\n9. LOSS ON LITIGATION SETTLEMENT AND CONTINGENCIES\nDuring 1994, MAXXAM, Pacific Lumber and others agreed to a settlement, subsequently approved by the Court, of class and related individual claims brought by former stockholders of Pacific Lumber against MAXXAM, the Company, Pacific Lumber, former directors of Pacific Lumber and others concerning the Company's acquisition of Pacific Lumber. Of the approximately $52,000 settlement, approximately $33,000 was paid by insurance carriers of MAXXAM and Pacific Lumber, approximately $14,800 was paid by Pacific Lumber 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 Pacific Lumber'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.\n10. 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\nThe consolidated financial statements and notes thereto of Kaiser Aluminum Corporation and The Pacific Lumber Company are incorporated herein by reference and included as Exhibits 99.1 and 99.2 hereto, respectively.\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 51), which index is incorporated herein by reference.\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nBALANCE SHEET (UNCONSOLIDATED)\nSTATEMENT OF OPERATIONS (UNCONSOLIDATED)\nSTATEMENT OF CASH FLOWS (UNCONSOLIDATED)\nNOTES TO FINANCIAL STATEMENTS\nA. BASIS OF PRESENTATION\nAs described in Note 1 to the Company's Consolidated Financial Statements (contained in Item 8), the Forest Products Group Formation required the Company to restate its historical financial statements with respect to the net assets transferred to MAXXAM. Such restatement has been made with respect to all periods presented in a manner similar to that which would have been presented if the Company had discontinued the operations relating to such net assets.\nB. LONG-TERM DEBT\nThe Forest Products Group Formation was done contemporaneously with the issuance of the MGI Notes and the retirement of the 12-3\/4% Notes as described in Note 5 to the Consolidated Financial Statements. The MGI Notes are secured by the Company's pledge of 100% of the common stock of Pacific Lumber, Britt and MPI and by MAXXAM's pledge of 28 million shares of Kaiser's common stock it received as a result of the Forest Products Group Formation.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMAXXAM GROUP INC.\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 (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: March 24, 1995 By: CHARLES E. HURWITZ Charles E. Hurwitz Chairman of the Board, President and Chief Executive Officer\nDate: March 24, 1995 By: PAUL N. SCHWARTZ Paul N. Schwartz Vice President, Chief Financial Officer and Director\nDate: March 24, 1995 By: JOHN A. CAMPBELL John A. Campbell Vice President and Director\nDate: March 24, 1995 By: JOHN T. LA DUC John T. La Duc Vice President and 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 and Director\nMAXXAM GROUP INC.\nINDEX OF EXHIBITS\nExhibit Number Description\n3.1 Certificate of Incorporation of MAXXAM Group Inc. (the \"Company\" or \"MGI\") (incorporated herein by reference to Exhibit 3.1E to the Company's definitive proxy statement dated October 24, 1984)\n3.2 Certificate of Amendment of Certificate of Incorporation of the Company dated as of September 28, 1988 (incorporated herein by reference to Exhibit 3(b) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988)\n3.3 Certificate of Amendment of Certificate of Incorporation of the Company dated as of June 1, 1989 (incorporated herein by reference to Exhibit 3(c) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989)\n3.4 By-laws of the Company (incorporated herein by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K dated July 10, 1986)\n4.1 Indenture between the Company and Shawmut Bank, N.A., Trustee, regarding the Company's 12-3\/4 Senior Secured Discount Notes due 2003 and 11-1\/4% Senior Secured 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 The Pacific Lumber Company (\"Pacific Lumber\") 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 Annual Report on Form 10-K of Pacific Lumber for the fiscal year ended December 31, 1993, File No. 1-9204)\n4.3 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, File No. 55538; the \"SPHC 1993 Form 10-K\")\n4.4 Revolving Credit Agreement dated as of June 23, 1993 between Pacific Lumber and Bank of America National Trust and Savings Association (incorporated herein by reference to Exhibit 4.19 to Amendment No. 6 to the Company's Registration Statement on Form S-2, Registration No. 33-64042; the \"MGI Registration Statement\")\n4.5 Letter Amendment to the Revolving Credit Agreement, dated October 5, 1993 (incorporated herein by reference to Exhibit 4.1 to Pacific Lumber's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, File No. 1-9204)\n4.6 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 Tax Allocation Agreement between the Company and MAXXAM Inc. dated August 4, 1993 (incorporated herein by reference to Exhibit 10.6 to the MGI Registration Statement)\n10.2 Tax Allocation Agreement dated as of May 21, 1988 among MAXXAM Inc., the Company, Pacific Lumber and the corporations signatory thereto (incorporated herein by reference to Exhibit 10.8 to Pacific Lumber's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-9204)\n10.3 Tax Allocation Agreement among Pacific Lumber, 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)\n10.4 Tax Allocation Agreement between MAXXAM Inc. and Britt Lumber Co., Inc., dated as of July 3, 1990 (incorporated herein by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993)\n10.5 Agreement dated December 20, 1985 between Pacific Lumber and General Electric Company (incorporated herein by reference to Exhibit 10(m) to Pacific Lumber's Registration Statement on Form S-1, Registration No. 33-5549; the \"1985 GE Agreement\")\n10.6 Amendment No. 1 to Agreement between Pacific Lumber 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, File No. 1-9204)\n10.7 Power Purchase Agreement dated January 17, 1986 between Pacific Lumber and Pacific Gas and Electric Company (incorporated herein by reference to Exhibit 10(n) to Pacific Lumber's Registration Statement on Form S-1, Registration No. 33-5549)\n10.8 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)\n10.9 Master Purchase Agreement between Pacific Lumber and SPHC (incorporated herein by reference to Exhibit 10.1 to the SPHC 1993 Form 10-K)\n10.10 Services Agreement between Pacific Lumber and SPHC (incorporated herein by reference to Exhibit 10.2 to the SPHC 1993 Form 10-K)\n10.11 Additional Services Agreement between Pacific Lumber and SPHC (incorporated herein by reference to Exhibit 10.3 to the SPHC 1993 Form 10-K)\n10.12 Reciprocal Rights Agreement among Pacific Lumber, SPHC and Salmon Creek Corporation (incorporated herein by reference to Exhibit 10.4 to the SPHC 1993 Form 10-K)\n10.13 Environmental Indemnification Agreement between Pacific Lumber and SPHC (incorporated herein by reference to Exhibit 10.5 to the SPHC 1993 Form 10-K)\n10.14 Purchase and Services Agreement between Pacific Lumber 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)\n10.15 Put and Call Agreement dated November 16, 1987 between Charles E. Hurwitz and MPI (incorporated herein by reference to Exhibit C to Schedule 13D dated November 24, 1987, filed by the Company with respect to MAXXAM Inc.'s common stock; the \"Put and Call Agreement\")\n10.16 Amendment to Put and Call Agreement, dated May 18, 1988 (incorporated herein by reference to Exhibit D to the Final Amendment to Schedule 13D dated May 20, 1988, filed by the Company relating to MAXXAM Inc.'s common stock)\n10.17 Amendment to Put and Call Agreement, dated as of February 17, 1989 (incorporated herein by reference to Exhibit 10.35 to MAXXAM Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-3924)\n10.18 Unconditional Guarantee of Payment and Performance dated June 17, 1991, by the Company and MAXXAM Inc. to and for the benefit of General Electric Capital Corporation (\"GECC\") (incorporated herein by reference to Exhibit 10(ee) to Amendment No. 4 to MGI's Registration Statement on Form S-4 on Form S-2, Registration No. 33-42300)\n10.19 First Renewal, Extension and Modification Agreement, dated as of June 17, 1992 among GECC, MXM Mortgage Corp. and the Company (incorporated herein by reference to Exhibit 4.3 to MAXXAM Inc.'s Quarterly Report on Form 10-Q for the quarter ended September 30, 1993, File No. 1-3924)\n10.20 Loan Increase, Extension and Modification Agreement, dated as of December 30, 1992, among GECC, MXM Mortgage Corp. and MAXXAM Inc.(incorporated herein by reference to Exhibit 4.23 to MAXXAM Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 1-3924)\n10.21 Consent and Assumption Agreement, dated as of December 10, 1993, among GECC, MXM Mortgage Corp., MXM Mortgage L.P., the Company and MAXXAM Inc. (incorporated herein by reference to MAXXAM Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File No. 1-3924)\n10.22 Release and Termination of Unconditional Guarantee of Payment and Performance, dated as of December 30, 1993, executed by GECC (incorporated herein by reference to MAXXAM Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File No. 1-3924)\n10.23 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 MGI Registration)\n10.24 Undertaking, dated August 4, 1993, executed by MAXXAM in favor of the Company\n*27 Financial Data Schedule\n*99.1 The consolidated financial statements and notes thereto of Kaiser Aluminum Corporation for the fiscal year ended December 31, 1994\n*99.2 The consolidated financial statements and notes thereto of The Pacific Lumber Company for the fiscal year ended December 31, 1994\n* Included with this filing.","section_15":""}
{"filename":"276780_1994.txt","cik":"276780","year":"1994","section_1":"Item 1. BUSINESS\nGeneral\nColor Tile, Inc. (collectively, with its subsidiaries, the \"Company\") , a Delaware corporation, is a nation-wide specialty retailer of floor covering products, principally serving the do-it-yourself, buy-it-yourself residential remodeling market and, to a lesser extent, the small contractor or commercial customer. Management believes that the Company is the largest specialty retailer of floor covering products in the United States based on sales. At January 2, 1994, the Company sold its line of products through 800 domestic Color Tile Stores (collectively \"Color Tile Stores\", whether Company owned (\"Company Stores\") or franchisee owned (\"Franchised Stores\")).\nThe Company offers a broad selection of quality floor covering, wall covering and related products and accessories accompanied by a high level of customer service and support at prices competitive with other floor and wall covering retailers. The Company's product lines include glazed ceramic tile for floor and wall covering, resilient flooring (consisting of vinyl tile and sheet vinyl), carpeting, hardwood flooring (consisting of strip and plank flooring and parquet tile), window treatments and wall coverings. The Company also sells a full line of installation and maintenance materials (including adhesives, grouts, caulks, waxes, polishes and sealers) and tools for use in installing or maintaining the Company's principal products, and arranges professional installation for most of its products through local independent contractors.\nManagement believes that the Company's most important competitive advantages are its nationwide store network, nationally recognized \"Color Tile\" and \"ColorCarpet\" trademarks and strong vendor relationships. The Company's strategy is to increase sales by expanding its product offerings, opening new Color Tile Stores and adding new channels of distribution, including direct- response retailing. The Company has expanded its special-order programs in order to offer the consumer a wider selection of products in each of the principal product categories sold in its stores. These special-order programs generally do not require significant additional investment in inventory.\nSince its founding in 1953, the Company has sold a broad selection of hard- surface flooring products. Ceramic tile is offered in a variety of sizes, colors, textures and finishes. Resilient flooring represents the Company's other principal hard-surface floor covering product line. Vinyl tile, the traditional do-it-yourself floor covering product, typically costs less per square foot and is easier to install than other types and styles of floor covering. In addition, the Company also sells a broad selection of wood flooring products. The Company sells it hard-surface flooring products primarily from in-stock supplies, supplemented by special-order programs.\nSince 1989, the Company has offered a full line of carpeting on a nation- wide basis using the trade name \"ColorCarpet\". The principal features of the\nCompany's carpet program are the marketing of carpet by color, rather than by style, and marketing of a broad assortment of carpets on a cut-to-order basis.\nIn response to its successful introduction of carpeting, the Company has developed additional retail formats to increase further its penetration of the carpeting segment of the floor covering market. In 1992, the Company began developing two new retailing formats: Floors A Plenty, a \"super-store\" format, and ColorCarpet, a small specialty store format.\nFloors A Plenty is a free-standing \"super-store\" that targets customers who tend to be more value-conscious than Color Tile's existing customers and who perceive the super-store format as offering increased value. This format also targets small contractors and other commercial customers. The Company opened its first Floors A Plenty store in the Dallas-Fort Worth area in late 1992 and opened its second Floors A Plenty store in Cincinnati, Ohio during the first quarter of 1994. Floors A Plenty stores offer approximately 20,000 SKU's, of which approximately 10,000 are carpet SKU's.\nThe Company developed a format of smaller, principally franchised specialty carpet stores operating under Color Tile's \"ColorCarpet\" trade name. During 1993, the Company opened the first two ColorCarpet stores in the Dallas-Fort Worth area. In the first quarter of 1994, the Company opened one additional ColorCarpet Store in the Dallas-Fort Worth area. ColorCarpet stores offer approximately 12,000 SKU's of carpeting in approximately 3,500 square feet of retail space. Carpeting represents approximately 80% of ColorCarpet store's total SKU's. A limited selection of hard-surface flooring products is also available.\nA typical Color Tile Store currently offers for sale approximately 17,000 SKU's, approximately 14,000 of which are devoted to special-order products (approximately 10,000 of which relate to carpet and approximately 4,000 of which relate to other products). The Company's special-order programs have grown significantly over the past four years, principally through the introduction of carpet in 1989. In 1990, the Company began selling window treatments on a special-order basis.\nThe Company recently acquired the assets (the \"ABF Assets\") of American Blind Factory, Inc. (\"ABF\") and certain related entities and assumed certain liabilities in connection therewith through its new wholly-owned subsidiary, American Blind and Wallpaper Factory, Inc. (\"ABWF\"). ABF was a Detroit based direct-response marketing company engaged in the sale, on a special-order basis, of name-brand and private-label window treatments (blinds and similar products), and wall coverings at significant discounts from average retail prices.\nThe Company's fiscal year ends on the Sunday nearest to December 31. All references herein to \"1993\", \"1992\" and \"1991\" refer to the 52 week or 53 week fiscal years ended January 2, 1994, January 3, 1993 and December 29, 1991, respectively. The fiscal year ended January 3, 1993 was comprised of 53 weeks.\nProducts\nThe Company's principal product lines are ceramic tile, resilient flooring, carpeting and installation, and installation materials and tools. The table below indicates the approximate percentages of Company sales derived from each of these classes of products, and all other classes of products offered by the Company (including product installation) during the periods shown.\nClass of Products 1993 1992 1991 ----------------- ---- ---- ----\nCeramic Tile 24% 25% 25% Resilient Flooring 25 26 26 Carpet and Installation 26 26 23 Installation Materials and Tools 14 14 16 Other(1) 11 9 10 --- ---- ---- 100% 100% 100% ==== ==== ==== ______________________\n(1) Includes sales of window treatments, wallcoverings, wood flooring and sales by ABWF since November 1, 1993.\nCeramic Tile\nSince its founding, the Company has sold a broad selection of glazed ceramic tile used for floor covering and wall covering in a variety of sizes, colors, textures and finishes. In addition, the Company offers ceramic tile accent pieces and accessories to complement its basic ceramic tile products. Color Tile Stores sell ceramic tile primarily from in-stock supplies, supplemented by a special-order service for certain ceramic tile, marble and granite products that are targeted at a more affluent segment of the market than its in-stock ceramic tile products.\nThe Company merchandises its ceramic tile products by offering its customers a high level of assistance in the selection and installation of its ceramic tile products, including advice from trained sales personnel (including \"how to\" clinics) and printed instructional materials for installation of the products.\nDuring 1993, approximately 19% of the ceramic tile products sold by the Company were manufactured at the Company's tile manufacturing facility located in Cleveland, Mississippi (the \"Tile Facility\"). See \"Manufacturing.\" Approximately 29% of the ceramic tile products sold by the Company during this period were purchased from domestic suppliers and approximately 52% were imported from suppliers in Italy, Spain, Brazil and countries in the Far East, including Japan, Thailand and Korea.\nResilient Flooring\nResilient flooring represents the Company's other traditional line of floor covering products and is available in either vinyl tile or sheet vinyl. Vinyl tile is the traditional do-it-yourself floor covering. Vinyl tile typically costs less per square foot and is easier to install than other types and styles of floor covering. Most of the Company's vinyl tile sales are made from a broad selection of patterns that are maintained in stock. Color Tile Stores also stock a limited assortment of sheet vinyl supplied by nationally recognized manufacturers. A more extensive selection of vinyl tile and sheet vinyl is available by special order.\nCarpet and Installation\nColor Tile Stores offer a full line of carpeting under the \"ColorCarpet\" trade name. Approximately 10,000 different styles and colors of carpet are offered at a broad range of prices. The Company's sales personnel sell carpet principally by color rather than price. See \"Advertising, Marketing and Merchandising.\" The Company does not inventory carpet, but orders directly from its suppliers on a \"cut-to-order\" basis upon receipt of a customer order and a deposit on the purchase price. Payment in full is due at the time of installation. The Company provides installation for its carpeting and other product lines through local independent contractors.\nWindow Treatments and Wallcoverings\nColor Tile Stores. Color Tile Stores also sell window treatments under the \"WindowColors\" trade name. Window treatments consist of window shades, blinds, wooden window coverings and related products. Window treatments are stocked on a limited basis by Color Tile Stores and are generally purchased from domestic suppliers upon receipt of customer orders and are shipped directly to the customer. Color Tile stores also offer a selection of brand name wallpaper.\nABWF. ABWF's principal product lines include horizontal, vertical, pleated and wood blinds and wallpaper. ABWF features a broad range of name brands of vertical, horizontal, pleated and wood blinds, as well as a complete line of private-label blinds. Private-label blinds are manufactured by the brand-name product vendors and are of like quality. ABWF also features a broad selection of major name brands of wallpaper. Wallpaper is ordered by specific pattern number and book name and is available both directly from manufacturers or through various wholesale distributors. ABWF maintains a database of more than 30,000 wallpaper patterns, the majority of which have multiple vendor sources. The two-tiered distribution system for wallpaper provides ABWF with the opportunity to offer its customers a broad selection at a competitive cost.\nInstallation Materials and Tools\nColor Tile Stores generally carry a full line of tools, kits, installation materials and product care materials for use primarily in the installation and maintenance of floor covering and wall covering products. These products are generally sold in conjunction with the Company's principal floor and wall covering products.\nOver 90% of the installation and maintenance items sold in 1993, including adhesives, grouts, caulks, waxes, polishes and sealers, were manufactured at the Company's adhesives facility located in West Chicago, Illinois (the \"Adhesives Facility\"). See \"Manufacturing.\" Other accessories, including brushes, rollers and other tools for product application or installation, are made to the Company's specifications and are generally sold under the Color Tile brand name.\nWood Flooring\nA broad selection of wood flooring (both strip and plank flooring and parquet tile) is offered by Color Tile in a variety of colors, widths and finishes. These products are generally targeted to a more affluent segment of the market than the Company's other floor covering products. During 1993, the Company obtained a substantial majority of the parquet tile and strip and plank wood flooring sold by the Company from its formerly owned Wood Plant located in Melbourne, Arkansas. The Company sold the Wood Plant in May 1992 and entered into a Supply Agreement with the purchaser pursuant to which the Company, subject to certain exceptions and minimum annual purchase requirements, agreed to purchase virtually all of its hardwood flooring requirements, and the purchaser agreed to supply the Company with such requirements, through 1998. See \"Suppliers.\"\nFranchising\nThe Company's franchising program is designed to allow the Company to expand its network of Color Tile Stores geographically without substantial increases in its capital spending and working capital requirements. The Company's franchising program is focused generally in less populous markets\n(e.g., 100,000 or less population) which historically would not support multiple locations and, therefore, do not enable the Company to achieve satisfactory operating, administrative and advertising efficiencies. In these smaller markets, the Company may either convert existing Company Stores to Franchised Stores or open new Franchised Stores, thus reducing the Company's capital investment while allowing the Company to receive the franchise fees and royalties provided by the sales and operation of such Franchised Stores.\nAt January 2, 1994, 86 Franchised Stores were in operation (excluding nine Franchised Stores operating under the name \"Factory Carpet\" in Canada). During 1993, 56 Franchised Stores (excluding the nine Franchised Stores in Canada) were opened (including 26 Franchised Stores that were previously Company Stores), two Franchised Stores were closed and three Franchised Stores were reacquired by the Company and are currently operated as Company Stores. In April 1993, the Company introduced a new franchise program to offer prospective franchisees the opportunity to open a \"ColorCarpet\" store, which devotes substantially more of its sales area to sales and marketing of carpeting than a full line Color Tile Store.\nThe typical Franchised Store is substantially identical to a Company Store. The Company generally obtains a lease for the Franchised Store, which it then subleases to the franchisee. The franchisee purchases leasehold improvements, fixtures and inventory. The Company provides its expertise in site selection, interior design, training, marketing and certain financing and accounting functions in return for an initial fee of $22,500. Thereafter, the Company receives royalties and an advertising fee based on gross sales of the Franchised Store.\nAdvertising, Marketing and Merchandising\nSales promotions and advertising are developed centrally by the Company's in-house advertising department for use on a national basis. The Company creates and produces most of its own print advertising. An independent advertising firm produces television advertisements for the Company. The Company's advertising program includes network television, radio, print advertising and in-store displays.\nExpenditures for advertising and promotion purposes were approximately 7.2%, 8.0%, and 7.4% of net sales for 1993, 1992 and 1991, respectively. The Company also receives cooperative advertising contributions from certain of its suppliers of resilient flooring, carpet and other product categories.\nEach Color Tile Store is arranged to provide a broad selection of SKU's for each product line. In ceramic tile, the Company has developed a display format known as the \"Great Wall of Tile\" that presents many of the wall tile products sold in Color Tile Stores in a space-saving, easy-to-view display arranged by color. The Company has also developed a similar merchandising approach for carpeting through in-store displays of samples of its \"ColorCarpet\" product lines arranged by color group. By utilizing this approach, Color Tile Stores are able to offer carpeting customers a wider range of carpeting products than would be possible if the Company were to offer carpeting for sale from in-stock inventory.\nABWF's primary means of generating new customers for blinds and wallpaper is through advertisements in women's and home-related magazines. Based on ABWF's high rates of repeat and referral business, ABWF continually analyzes its advertising program and sources of customers to optimize the cost benefit of its advertising. In addition, ABWF continually tests new magazines to increase consumer awareness of ABWF.\nRetail Operations\nStore Operations. The Company operates a network of stores throughout the continental United States. The Company generally seeks to locate Color Tile Stores on heavily traveled streets in locations where homes are at least five years old, the age at which the Company believes the first renovations or remodeling of homes often occurs. In selecting locations for Color Tile Stores, the Company also attempts to obtain locations that are in proximity to other nationally recognized, high-volume retailers, which tend to generate substantial customer traffic for the shopping centers in which they are located. The Company also seeks to cluster Company Stores in populated areas to allow for greater operational, administrative and advertising efficiencies. The Company also operates 37 stores in seven provinces of Canada pending their disposition.\nThe Company operates Color Tile stores in each of 49 states of the United States. At January 2, 1994, their geographic distribution was as follows:\nNumber of Color Tile Stores (including Franchised Stores)\nAlabama . . . . . . 7 Nevada . . . . . 4 Arizona . . . . . . 12 New Hampshire . . . 5 Arkansas . . . . . 4 New Jersey . . . 28 California . . . . 87 New Mexico . . . . 3 Colorado . . . . . 18 New York . . . . . 42 Connecticut . . . . 15 North Carolina . . 14 Delaware . . . . . 5 North Dakota . . . 2 Florida . . . . . . 46 Ohio . . . . . . . 42 Georgia . . . . . . 17 Oklahoma . . . . . 6 Hawaii . . . . . . 1 Oregon . . . . . . 10 Idaho . . . . . . . 3 Pennsylvania . . . 49 Illinois . . . . . 44 Rhode Island . . . 4 Indiana . . . . . . 22 South Carolina . . 8 Iowa . . . . . . . 10 South Dakota . . . 1 Kansas . . . . . . 6 Tennessee . . . . . 15 Kentucky . . . . . 11 Texas . . . . . . . 62 Louisiana . . . . . 10 Utah . . . . . . . 5 Maine . . . . . . . 4 Vermont . . . . . . 1 Maryland . . . . . 19 Virginia . . . . . 21 Massachusetts . . . 20 Washington . . . . 20 Michigan . . . . . 36 West Virginia . . . 3 Minnesota . . . . . 14 Wisconsin . . . . . 15 Mississippi . . . . 2 Wyoming . . . . . . 1 Missouri . . . 19 --- Montana . . . . . . 4 TOTAL 800 Nebraska . . . . . 3 ===\nA summary of Color Tile's Store openings and closings is provided below:\nHistorical Store Openings and Closings --------------------------------------\n1993 1992 1991 ---- ---- ----\nCompany Stores:(1)(2) --------------\nBeginning of period 731 733 731 Opened 25 13 11 Converted from Franchised Stores 3 1 --- Converted to Franchised Stores (26) (13) (3) Closed (19) (3) (6) ---- ---- ---- End of period 714 731 733 === === === Franchised Stores: (2) -----------------\nBeginning of period 35 13 4 Opened 30 10 7 Converted from Company Stores 26 13 3 Converted to Company Stores (3) (1) -- Closed (2) -- (1) --- -- --- End of period 86 35 13 == == ==\nTotal Color Tile Stores: (2) -----------------------\nBeginning of period 766 746 735 Opened 55 23 18 Closed (21) (3) (7) ---- ---- ---- End of period 800 766 746 === === ===\n(1) Includes owned stores operated under the names Color Tile, Floors A Plenty or ColorCarpet. (2) Excludes Factory Carpet stores operated in Canada. The Company intends to operate these stores pending their disposition.\n______________________________\nColor Tile Store Operations. The typical Color Tile Store consists of approximately 5,000 square feet, has approximately 20 parking spaces and is located in a strip shopping center or is a free-standing store. The Company frequently updates the product displays and placement of products within Color Tile Stores. Each year the Company also identifies Company Stores for renovation and remodeling. A typical Color Tile Store currently offers\napproximately 17,000 SKU's, approximately 14,000 of which are devoted to special-order products (approximately 10,000 of which relate to carpet and approximately 4,000 of which relate to other products).\nEach Company Store typically employs approximately five people, including a store manager. Thirty-two regional managers supervise the store managers and three divisional vice presidents supervise the regional managers. Sales personnel are compensated on a commission basis, with compensation for regional managers and divisional vice presidents determined on the basis of sales development and profitability of the stores for which they are responsible.\nABWF Direct-Response Operations. Prospective customers contact ABWF by dialing toll-free 1-800-735-5300 and are greeted by a trained sales representative who follows a scripted dialogue to determine what item and specifications the customer desires. The sales representative keys the critical information (color, size, book number, pattern number, etc.) into a computer which generates a price quote for the item ordered and, where applicable, identifies the lowest cost vendor to ABWF for a particular brand name product based on size, quantity and special vendor discounts and promotions. ABWF offers over 100,000 SKU's to its customers.\nCompleted orders are transmitted to the manufacturer or distributor. Orders are shipped directly to the customer by United Parcel Service or similar carrier, and arrive three to seven working days after shipment.\nABWF's internally developed proprietary software utilizes the most recent vendor pricing in quotes given to customers and ensures that orders are accurately transmitted to the appropriate lowest cost vendor. The system currently tracks more than 30,000 individual wallpaper patterns and more than 300 blind products, each of which has a matrix of prices based on dimensions. Increasingly, ABWF is utilizing electronic data interchange to transmit orders and confirm shipment with vendors.\nFloors A Plenty. Floors A Plenty is a free-standing \"super-store\" developed to capitalize on the Company's success in the carpet product line in a larger, higher volume retail outlet. This format targets customers who tend to be more value-conscious than Color Tile's existing customers and who perceive the super-store format as offering increased value. This format also targets small contractors and other commercial customers. The Company opened its first Floors A Plenty store in the Dallas-Fort Worth area in late 1992 and opened its second Floors A Plenty store in Cincinnati, Ohio during the first quarter of 1994. Floors A Plenty stores offer approximately 20,000 SKU's, of which approximately 10,000 are carpet SKU's. The Company intends to locate its Floors A Plenty stores adjacent to other super-store retailers, such as Price Club, Sam's, Home Depot and Builders Square.\nColorCarpet. To capitalize on the success of the ColorCarpet trade name, the Company developed a chain of smaller, principally franchised specialty\ncarpet stores operating under the \"ColorCarpet\" trade name. During 1993, the Company opened the first two ColorCarpet stores in the Dallas-Fort Worth area. During the first quarter of 1994, the Company opened one additional ColorCarpet store in the Dallas-Fort Worth area. ColorCarpet stores offer approximately 12,000 SKU's of carpet in approximately 3,500 square feet of retail space. Carpeting represents approximately 80% of a ColorCarpet store's total SKU's. A limited selection of hard-surface flooring products is also available. The Company intends to locate ColorCarpet franchises in smaller markets where the demographics would not typically support a full-line Color Tile Store. The Company intends to locate ColorCarpet stores principally in strip malls and small retailing centers adjacent to residential areas.\nCanadian Stores. Effective for the quarter ended October 3, 1993, the Company decided to dispose of its Canadian operations. In conjunction with this anticipated disposition, the Company recorded a loss of $9,500,000, which included operating losses of $849,000 for 1993. As of March 31, 1994, the Company had not disposed of these operations. The Canadian stores were acquired by the Company in 1990. The viability of the Canadian operations was adversely affected by certain significant events that occurred subsequent to the acquisition, including (i) a severe Canadian recession that continued into 1993, (ii) the imposition, beginning in 1992, of a retaliatory \"anti-dumping\" tariff on carpets imported into Canada from the United States, (iii) imposition of a value-added tax (the G.S.T.) on all manufactured and imported goods sold into Canada, and (iv) a significant devaluation of the Canadian dollar during 1992 and 1993. The Company is in the process of negotiating the sale of the Canadian operations.\nSuppliers\nThe Company believes that one of its competitive advantages is its strong relationship with its vendors. The Company continues to have good relationships with suppliers.\nDuring 1993, the Company manufactured approximately 15% of the products sold in Color Tile Stores, with the balance supplied by unaffiliated domestic (approximately 72%) and foreign (approximately 13%) manufacturers. See \"Manufacturing.\" Approximately 48% of the Company's products are manufactured for the Company by third-party vendors under the \"Color Tile\" or other Company-owned names. Three unaffiliated suppliers, in the aggregate, accounted for approximately 30% of the products purchased by the Company during 1993.\nThe Company has no long-term purchase commitments other than a supply agreement for wood flooring between the Company and the purchaser of the Wood Plant. This agreement provides for the Company, subject to certain exceptions and a minimum annual purchase requirement, to purchase virtually all of its requirements for hardwood flooring from the purchaser of the Wood Plant through May 1998. The purchase prices for such products are subject to annual negotiation and adjustment starting in May 1994. The Company has completed such negotiations for the 1994 contract year.\nManagement believes that the Company could find alternative sources of supply should any of the Company's major suppliers cease doing business with it or should the Company be restricted by governmental action from purchasing products manufactured in other countries. The principal materials utilized by the Company in its manufacturing operations include sand, petrochemicals and clay, all of which are available from a variety of sources.\nDistribution\nThe Company has four regional distribution centers located as follows:\nDistribution Center Square Footage ------------------- --------------\nSan Bernardino, California 116,000 Houston, Texas 82,000 University Park, Illinois 187,000 Baltimore, Maryland 138,000 ------- Total Square Footage 523,000 =======\nThe Company seeks to locate its distribution centers in areas that maximize transportation and organizational efficiencies and minimize freight and other costs of supplying Color Tile Stores.\nThe Company typically supplies Color Tile Stores from its distribution centers weekly or bi-weekly using both Company-operated vehicles and outside contract carriers. The Company seeks to maintain inventory levels and a distribution network permitting it to supply customers with merchandise purchased in the Color Tile Stores either immediately from in-stock goods or within 10 working days following the order.\nManufacturing\nApproximately 15% of the products sold in Color Tile Stores during 1993 were manufactured by the Company at its Tile Facility in Cleveland, Mississippi and its Adhesives Facility in West Chicago, Illinois. The Company believes that its manufacturing facilities are generally adequate for their intended purposes and are in good condition. The Adhesives Facility has capacity in excess of that necessary to supply Color Tile Stores and sells its products to outside distributors under private label and \"North American\" brand names. The Tile Facility also has limited capacity in excess of that necessary to supply Color Tile Stores and sells its products to unaffiliated entities. During 1993 the Company sold approximately 33% and 18%, respectively, of the products manufactured at the Adhesives Facility and the Tile Facility to unaffiliated entities.\nThe Adhesives Facility. The Adhesives Facility was built to the Company's specifications and completed in 1982. The Company designed and constructed the\nAdhesives Facility for the purpose of formulating products for use in connection with installation and maintenance of other product lines sold by the Company. In 1993, this facility produced approximately 94% of the Company's adhesives, grouts and other surface-preparation products, which collectively represented approximately 10% of the Company's total product sales. During 1993, the Adhesives Facility on average operated at approximately 50% of capacity.\nThe Adhesives Facility is situated on approximately 9.2 acres of land and contains approximately 163,000 square feet of production, warehouse, office and research laboratory space. The Company also produces color coordinating grouts at the Adhesives Facility to add a design element to this product category.\nThe Tile Facility. In August 1980, the Company acquired the Tile Facility, which is situated on a 15-acre tract of land and contains approximately 115,000 square feet of production, office and warehouse space. Since the acquisition of the Tile Facility, the Company has made various renovations and equipment installations to increase production and operating efficiency. Tile produced at this facility accounted for approximately 19% of the sales of ceramic tile by Color Tile Stores and approximately 5% of total product sales during 1993. The Company also manufactures trim pieces and decorated tiles at this facility. The Tile Facility on average operated at approximately 85% of capacity during 1993.\nTrademarks and Copyrights\nThe Company owns a number of trademarks and copyrights relating to the operation of its business. These have been of value to the Company in the past and are expected to be of value in the future. The loss of a single trademark or copyright, other than the \"Color Tile\" and \"ColorCarpet\" trademarks and logos, would not, in the opinion of management, have a material effect on the conduct of its business. The Company has granted a security interest in its trademarks and copyrights to secure its indebtedness under the Company's credit agreement dated November 27, 1991, as amended, with a group of commercial banks and other institutional lenders (the \"Senior Credit Agreement\").\nCompetition\nThe Company competes with general merchandise and discount stores, home improvement centers and specialty retailers operating on a local, regional or national basis. Many of such competitors sell a considerably broader variety of products than the Company within each of the Company's product lines and certain of such competitors have substantially greater financial resources than the Company. The Company believes its principal chain store competitors for certain of its product lines in some markets are regional home improvement centers (such as Hechinger's, Home Depot, Payless Cashways and Lowe's), regional specialty chains (such as New York Carpetworld, Carpeteria, Carpetland USA and Carpet Exchange and regional tile chains in certain metropolitan markets) and national department stores and specialty retailers (such as Sears, JC Penney\nand Sherwin Williams).\nExpansion by certain regional home improvement center chains has led to increased price competition for certain of the Company's products in some markets. In addition, the existence of certain regional specialty chains, with established market shares in residential carpet sales, has also led to increased price competition for carpet in the markets where these competitors operate.\nEmployees\nAt January 2, 1994, the Company employed approximately 4,000 persons, including approximately 300 employees of ABWF and approximately 200 employees of the Company's Canadian subsidiary. Substantially all of these employees are employed on a full-time basis. The Company believes that its working relationship with its employees is good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nAt January 2, 1994, 138 of the 800 Color Tile Stores were owned by the Company and 662 were leased by the Company. Of the leased Company Stores, 44 are leased from the Color Tile Employees Investment Plan (the \"Investment Plan\"). Pursuant to the Senior Credit Agreement, substantially all of the Company-owned properties are mortgaged to secure the indebtedness incurred thereunder.\nStore leases, other than those entered into in connection with sale and leaseback transactions, normally have initial terms ranging from 10 to 20 years. Many of these leases have renewal options at increased rents. Leases under the Company's sale and leaseback transactions have initial terms ranging principally from 20 to 25 years, generally with renewal options at increased rents. Of the 196 leases expiring within the next three fiscal years, 143 have renewal options. Leases generally are \"triple-net\", which obligates the Company to pay real estate taxes, insurance and common area maintenance and other operating and maintenance costs in addition to a specified rental amount. Leases for approximately 75% of the leased Company Stores provide for periodic rental increases based on increases in cost of living indices or other mechanisms and\/or contingent rentals payable generally on the basis of a percentage of gross sales in excess of stipulated amounts.\nThe Company currently operates two manufacturing facilities. See \"Manufacturing.\" The Company distributes merchandise to Color Tile Stores through four distribution centers. See \"Distribution.\"\nThe total space owned and leased by the Company as of January 2, 1994 was as follows:\nApproximate Square Footage(1)\nOwned Leased Total ----- ------ -----\nRetail, net of subleases 685,000(1) 2,703,000(2) 3,388,000 Manufacturing 163,000 115,000 278,000 Distribution Centers -- 523,000 523,000 Office -- 129,000 129,000 -------- ---------- --------- Totals 848,000 3,470,000 4,318,000 ======== ========== ========= _________________________\n(1) Excludes Factory Carpet stores operated in Canada which the Company intends to operate pending their disposition. As of January 2, 1994, Factory Carpet leased 331,000 square feet.\n(2) The Company was subleasing approximately 898,000 square feet of retail space to franchisees and other tenants as of such date.\nDuring fiscal 1993, aggregate rental payments were approximately $30,600,000 (exclusive of sublease rental income for such space of approximately $7,300,000).\nThe Company's executive offices and principal administrative offices are located in Fort Worth, Texas, in a leased office building containing approximately 100,000 square feet. The lease for such space expires in October 1997.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company is a party to various legal proceedings. Management believes that the outcome of all pending legal proceedings will not, in the aggregate, have 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\nNone\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAll of the common stock of the Company is owned by Color Tile Holdings, Inc. (\"Holdings\"). There is no established public trading market for the common stock of the Company. Cash dividends have not been paid on the common stock of the Company since 1978 when its predecessor was incorporated.\nThe Senior Credit Agreement contains covenants generally restricting the ability of the Company to pay dividends on its capital stock in the future, except for certain permitted payments on the Company's preferred stock. The Company may however pay dividends or make other distributions on its common stock to Holdings in amounts equal to the amounts (i) required for Holdings to pay franchise taxes and other fees required to maintain its corporate existence and provide for other operating costs of up to $100,000 per fiscal year, (ii) required for Holdings to pay Federal, state and local income taxes to the extent such income taxes are attributable to the income of the Company and its subsidiaries, or (iii) expended by Holdings, up to an aggregate amount of $1,500,000 in any fiscal year of the Company, to repurchase capital stock of the Company or Holdings owned by former employees of the Company or its subsidiaries or their assigns, estates and heirs.\nThe terms of the Company's Class B, Series A Senior Increasing Rate Preferred Stock (the \"Series A Shares\") also generally restrict payment of dividends on the Company's common stock so long as shares of such Series A Stock are outstanding on generally the same terms as contained in the Senior Credit Agreement.\nOn December 17, 1993, the Company issued (the \"Senior Notes Offering\") $200 million in principal amount of 10-3\/4% Senior Notes, due 2001 (the \"Senior Notes\"). The Senior Notes were issued pursuant to an indenture which restricts the payment of dividends, the repurchase of capital stock and the making of other Restricted Payments (as defined), subject to certain exceptions similar to those contained in the Senior Credit Agreement.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe selected financial data presented in the table below for the Company for the fiscal years ended January 2, 1994, January 3, 1993, December 29, 1991 and December 30, 1990, and for the Predecessor Company for the fiscal year ended December 31, 1989, have been derived from the Company's and the Predecessor Company's audited consolidated financial statements. The Company operates on a 52-53 week fiscal year ending on the Sunday closest to December 31 each year. The acquisition of the Predecessor Company by Holdings occurred on December 28, 1989, and was accounted for as a purchase. Accordingly, the assets and liabilities of the Company were revalued and significant adjustments to the assets and liabilities acquired were made to reflect their estimated fair value\nat such date. For financial reporting purposes, the effective date of the acquisition and related transactions is January 1, 1990. This information should be read in conjunction with, and is qualified in its entirety by, the Company's audited consolidated financial statements included elsewhere herein.\n- ---------------------- (a) The special charges for the year ended January 3, 1993 relate to the provision for restructuring, store closures and conversion of certain Company Stores to Franchised Stores and the write-down of certain property, plant and equipment and intangible assets (See Note 12 of the Notes to Consolidated Financial Statements).\n(b) Effective October 3, 1993, the Company determined to dispose of its Canadian retail operations resulting in a $9,500 charge based on expected losses from those operations prior to disposal and the estimated loss on disposal of the related assets and the business. The sales, costs and related expenses of the Factory Carpet's operations have been eliminated\nfrom the individual line items of the selected financial data for 1993 and the operating losses of this line of business of $849 have been included on a one-line basis in the $9,500 loss from disposal of a line of business. Factory Carpet sales of $23,661 have been eliminated from the summary financial data for 1993.\nThe gain on disposal of a line of business for 1992 relates to the sale of the Company's formerly owned wood manufacturing facility located in Melbourne, Arkansas (the \"Wood Plant\") (see Note 13 of the Notes to Consolidated Financial Statements).\n(c) The extraordinary items for 1993, 1992, and 1991 relate to the gains (losses) on the early extinguishment of certain long-term debt (See Note 7 of the Notes to Consolidated Financials Statements).\n(d) The cumulative effect of changes in accounting methods for 1989 related to the Company's change in method of accounting for layaways and deposits. The Company also changed its method for accounting for deferred income taxes to conform to new interpretations of Statement of Financial Accounting Standards No. 96 related to the deferred income tax effects of amortization of certain intangibles.\nPredecessor Company -------\nJan. 2, Jan. 3, Dec. 29, Dec. 30, Dec. 31, 1994 1993 1991 1990 1989 -------- ------- -------- -------- --------\nBalance Sheet Data: (Amounts in Thousands) ------------------\nCurrent assets $108,084 $ 94,085 $ 88,999 $ 92,351 $124,302 Current liabilities 103,712 82,831 87,593 89,334 80,793 Working capital 4,372 11,254 1,406 3,017 43,509 Total assets 565,343 462,992 504,984 525,338 402,482 Long-term debt (inc. current portion) 353,357 254,762 305,735 369,452 300,213 Redeemable preferred stock 86,838 82,596 26,556 23,576 20,597 Common stockholder's equity (deficiency) $ 21,738 $ 48,789 $ 77,941 $ 24,824 $(23,537)\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nFiscal Year Ended January 2, 1994 (52 weeks) Compared to Fiscal Year Ended January 3, 1993 (53 weeks).\nEffective October 3, 1993, the Company determined to dispose of its 37 store Canadian operations. The sales, costs and expenses of the Canadian operations have been eliminated in the consolidated statement of operations for 1993 but are included in the results of operations for prior periods.\nSystemwide Sales. Systemwide sales include retail sales of all Company Stores (excluding Canadian operations in 1993), retail sales of all Franchised Stores, sales of ABWF and outside sales of manufactured products to third parties. Systemwide sales for the Company's U.S. operations increased 2.4% during 1993 as compared to the comparable prior-year period.\nNet Sales. Total net sales of the Company declined as a result of the elimination from net sales of $23,661,000 of retail sales of the Canadian retail operations for 1993. Total net sales for 1992 include $31,085,000 of retail sales of the Canadian operations. Net sales for the Company's domestic operations increased $5,827,000, or 1.1%, for 1993 as compared to net sales for the comparable prior-year period. The improvement in sales resulted from (a) increases in (i) sales of carpet and related installation services, (ii) franchising fees and royalties and (iii) sales of merchandise to franchisees and (b) the addition of the sales of ABWF. These increases were partially offset by decreases in sales resulting from (i) the conversion of 26 Company Stores (excluding 9 Company stores in Canada) to Franchised Stores, (ii) decreased sales of other product lines and (iii) the loss of sales of products manufactured at the Wood Plant to third parties following the sale of the facility in fiscal 1992.\nNet sales for domestic Company Stores open over one year decreased 3.4% for 1993 compared to the comparable prior-year period. The Company believes that the factors affecting retail sales in 1993 include (i) the severe winter weather during March, the Company's peak selling period, (ii) a continued decline in consumer confidence during the first three quarters of 1993, (iii) generally weak economic conditions, and (iv) the extremely soft retail climate in California and the Northeast. As part of its continuing efforts to reduce expenses in this difficult retail environment, management reduced domestic advertising expenditures by approximately $4,304,000, or 9.7%, for 1993 compared to the prior year, which reductions management believes also contributed to the decline in net sales.\nAt January 2, 1994, there were 800 Color Tile Stores (excluding the 37 Canadian stores) in operation, 86 of which were Franchised Stores. During 1993, 25 new Company Stores were opened, 19 Company Stores were closed, 56 new Franchised Stores were opened (including the 26 Company Stores converted to Franchised Stores), two Franchised Stores were closed and three Franchised Stores were reacquired by the Company and are currently operated as Company Stores (excluding the Canadian Stores). In addition, as of January 2, 1994, there were 58 signed franchise agreements for additional Franchised Stores that the Company expects will open within the next 12 to 18 months.\nCost of Sales. Cost of sales decreased by $1,840,000, or 0.6%, for 1993, due principally to the elimination of the Canadian operation's cost of sales, which decreased cost of sales by $14,485,000, and also due to lower overall domestic retail sales. As a percentage of net sales, cost of sales increased to 55.8% for 1993 as compared to 53.6% for the comparable prior-year period. This increase in cost of sales as a percentage of net sales resulted principally from a sales mix shift caused by (i) increased sales of carpet and related installation services, (ii) increased sales of merchandise to franchisees, (iii) decreased sales of hard-surface flooring products and (iv) the addition of the sales by ABWF since its acquisition.\nOperating Expenses. Selling, general and administrative expenses decreased as a percentage of sales to 34.5% for 1993 as compared to 36.0% for the comparable prior-year period as the Company continued its concerted efforts to reduce operating and administrative expenses throughout the Company. Such expenses decreased in aggregate dollar amount by $17,345,000 for 1993 as compared to the comparable prior-year period primarily due to (i) decreases in payroll, (ii) reductions in advertising expenditures discussed previously, (iii) lower insurance costs due to favorable claims experience and (iv) elimination of $9,542,000 of operating expenses of the Canadian operations.\nGain (Loss) on Disposal of a Line of Business. During the third quarter of 1993, the Company determined to dispose of its Canadian operations. The 37 retail stores comprising the Canadian operations, including 9 Franchised Stores, operate under the Factory Carpet name, and were acquired by the Company during 1990. The viability of the Factory Carpet chain was adversely affected by certain significant events that occurred subsequent to the Company's acquisition of the chain, including (i) a severe Canadian recession that has continued into 1993, (ii) the imposition, beginning in 1992, of a retaliatory \"anti-dumping\" tariff on carpets imported into Canada from the United States, (iii) imposition of a value-added tax (the G.S.T.) on all manufactured and imported goods sold in Canada and (iv) a significant devaluation of the Canadian dollar during 1992 and 1993.\nAs a result of the effect of these events on the Canadian operations, the Company has elected to exit the Canadian market and to sell the assets and business of its Canadian operations. As of March 31, 1994, the Company was in the process of negotiating the sale of the Canadian operations. In conjunction with this anticipated disposition, the Company recorded a loss of $9,500,000, which included operating losses of $849,000 for 1993.\nDuring May 1992, the Company sold its Wood Plant and realized a gain of $4,007,000.\nInterest Expense, Net. Interest expense decreased $5,317,000 for 1993 as compared to the comparable prior-year period. The lower interest expense resulted from the redemption during the second and third quarters of 1992 of the remaining $101,045,000 in aggregate principal amount of the Company's debt securities with the proceeds of borrowings under the Senior Credit Agreement and proceeds from the issuance of the Series A Shares in August 1992. Borrowings under the Senior Credit Agreement bear interest at fluctuating rates, which\napproximated 6.3% per annum during 1993. These rates were substantially below the applicable rates on the redeemed debt securities, which had interest rates ranging from 12 3\/8% to 13 3\/4% per annum. See \"Liquidity and Capital Resources.\"\nPre-Tax Income (Loss). Pre-tax loss for 1993 was $1,278,000 as compared to pre-tax loss of $20,152,000 for the comparable prior-year period. Before the expected loss on disposal of the Canadian business of $9,500,000, pre-tax income would have been $8,222,000 for 1993. Excluding the 1992 gain on the sale of the Wood Plant of $4,007,000 and the $30,000,000 Special Charges, pre-tax income for 1992 would have been $5,841,000. This improvement in pre-tax income resulted from lower interest expense in 1993.\nIncome Taxes. Income tax expense was $641,000 for 1993 compared to $931,000 in the comparable prior-year period, due to higher state income taxes in 1992 on the gain on the sale of the Wood Plant.\nExtraordinary Item. In 1993 the Company recognized a $12,603,000 extraordinary loss on the early extinguishment of debt. During 1992, the Company reported an extraordinary loss on the early extinguishment of debt of $601,000.\nNet Loss. Net loss for 1993 was $14,522,000 after the $9,500,000 loss on the Canadian operations and the $12,603,000 extraordinary loss on the early extinguishment of debt. This loss compares to net loss in the prior year of $21,993,000, which included $4,007,000 pre-tax gain on sale of the Wood Plant and the $30,000,000 Special Charges. Excluding the extraordinary losses in both years, the loss on disposal of the Canadian operations during 1993 and the gain on sale of the Wood Plant and the Special Charges during 1992, net income would have been $7,581,000 for 1993 as compared to net income of $4,910,000 for the comparable prior-year period.\nFiscal Year Ended January 3, 1993 (53 Weeks), Compared to Fiscal Year Ended December 29, 1991 (52 Weeks).\nThe discussion that follows includes the Canadian stores then in operation. Accordingly, the terms \"Color Tile Stores\" and \"Company Stores,\" as used in this section, include both domestic and Canadian stores.\nNet Sales. Net sales for 1992 increased $36,070,000, or 6.6%, compared to the prior fiscal year. The increase in sales resulted primarily from increased sales of carpet and related installation services and increased sales of ceramic tile and resilient flooring, and increases in franchise fees and royalties.\nNet sales for Company Stores opened over one year increased 5.6% in 1992 compared to the prior year. At January 3, 1993, there were 806 Color Tile Stores in operation, 35 of which were Franchised Stores. During 1992, 16 Company Stores were opened, 13 Company Stores were converted to Franchised\nStores and four Company Stores were closed. In addition, 23 Franchised Stores were opened, including the 13 Franchised Stores which were previously Company Stores, and one Franchised Store was reacquired by the Company and currently operates as a Company Store.\nCost of Sales. Cost of sales increased by $18,851,000, or 6.4%, in 1992 compared to the prior period. As a percentage of net sales, cost of sales declined to 53.6% during 1992 as compared to 53.7% for the prior year. This reduction in cost of sales as a percentage of net sales resulted principally from improved gross margins in carpet and related installation services, as well as increased franchise fees and royalties.\nOperating Expenses. Selling, general and administrative expenses for 1992 decreased as a percentage of sales to 36.0% from 37.0% in the prior year as the Company continued to control its operating costs and administrative expenses. Such expenses increased in aggregate dollar amount by $7,559,000, or 3.8%, primarily due to an increase in advertising expenditures of approximately $6,000,000 and, to a lesser extent, due to increased commission-based payroll resulting from increased sales.\nSpecial Charges. In early 1993, the Company undertook a detailed study of its operations. As a result of this study, which was completed in late March 1993, the Company recorded a write-down in 1992 of (i) certain property, plant and equipment and (ii) certain intangible assets, and established provisions for restructuring of operations, store closures and conversion of certain Company Stores to Franchised Stores. As a result of these write-downs and provisions, the Company recorded special charges in the amount of $30,000,000 during the fourth quarter of 1992.\nThe Company anticipates improved operating results in future periods as a result of the special charges due to (i) lower depreciation and amortization expense for certain intangibles and fixed assets which were either written off or written down to net realizable value and (ii) reduced operating losses on stores to be sold, closed or franchised. The Company does not believe there will be any significant impact on liquidity or sources and uses of capital resources as a result of the special charges.\nGain on Sale of Assets. On May 15, 1992, the Company completed the sale of the Wood Plant and realized a pre-tax gain of $4,007,000. The proceeds of the sale, before fees and expenses, included $11,809,000 in cash and the buyer's assumption of certain liabilities, including an agreement to defease an industrial revenue bond related to the Wood Plant, with an outstanding principal amount of approximately $2,600,000. The Company used a portion of the proceeds to prepay $10,000,000 of scheduled principal payments on the term loan portion of the Senior Credit Agreement due in 1992.\nInterest Expense, Net. Interest expense decreased $26,289,000, or 50.6%, in 1992 as compared to the prior year. The lower interest expense resulted from the repurchase during fiscal 1991 and fiscal 1992 of $260,080,000 in aggregate principal amount of the Company's debt securities with the proceeds of\nborrowings under the Senior Credit Agreement, which borrowings bear interest at rates substantially below the applicable rates on the repurchased debt securities, and with net proceeds of approximately $51,000,000 from the placement of the 2,200,000 Series A Shares.\nLoss Before Income Taxes and Extraordinary Item. Pre-tax loss for 1992 was $20,152,000 (after the $30,000,000 of Special Charges) as compared to a pre-tax loss of $30,627,000 for the prior year. The improvement in the pre-tax loss resulted primarily from the $26,289,000 reduction in interest expense and improvement in operations (before the Special Charges taken in the fourth quarter of 1992). Excluding the Special Charges recorded in 1992, pre-tax income would have been $9,848,000, as compared to the $30,627,000 pre-tax loss in 1991.\nIncome Tax Expense (Benefit). Income tax expense for 1992 was $1,240,000 as compared to a $2,133,000 tax benefit in the prior year due to higher state income taxes and alternative minimum tax on 1992 earnings.\nExtraordinary Item. In 1992 the Company recognized a $910,000 pre-tax extraordinary loss on the early extinguishment of debt. This extraordinary loss resulted from the redemption of the remaining outstanding 12-3\/8% Senior Notes at a premium on October 15, 1992. During 1991, the Company recorded a pre-tax extraordinary gain on the early extinguishment of debt of $7,403,000 before applicable income taxes of $2,517,000.\nNet Loss. Net loss for 1992 was $21,993,000 as compared to a net loss in the prior year of $23,608,000. The improvement in the net loss over the prior year resulted primarily from lower interest expense.\nLiquidity and Capital Resources\nCommencing in November 1991, the Company implemented a recapitalization plan to reduce the Company's interest expense and to provide the Company additional liquidity and financial flexibility. In connection with this plan, the Company issued additional common stock of the Company to Color Tile Holdings, Inc. (\"Holdings\") and the Series A Shares in a private placement and entered into the Senior Credit Agreement. The Company utilized the proceeds of these financings to refinance the Company's existing bank debt, to repurchase all of its outstanding debt securities and to provide working capital for its operations.\nAt January 2, 1994, the Company had $126,600,000 in outstanding borrowings under the Senior Credit Agreement, which bear interest at fluctuating rates. At January 2, 1994, the average fluctuating interest rate on such borrowings approximated 6.2% per annum. The Company was in compliance as of January 2, 1994 with all restrictive covenants contained in the Senior Credit Agreement.\nUpon the application of net proceeds from the Senior Notes Offering, the Company prepaid $86,500,000 of indebtedness under the term loan portion of its Senior Credit Agreement, which reduced the Company's mandatory debt repayment obligations on currently outstanding debt over the next five years. After giving effect to the use of net proceeds from the Senior Notes Offering, the next scheduled principal payment on the term loan portion of the Senior Credit Agreement will be $3,026,000 due in March 1996. Approximately $8,000,000 of total cash dividends on the Series A Shares will be payable during 1994. In 1995, the Company's Redeemable Senior Preferred Stock will begin to accrue cash dividends of approximately $5,200,000 each year.\nCapital expenditures for 1993 were $14,031,000 as compared to $13,938,000 for 1992. These capital expenditures for new store openings, remodeling of existing stores, new fixtures and capitalized repairs have been funded through cash flow from operations and the revolving credit portion of the Senior Credit Agreement. In 1994, the Company anticipates total capital expenditures of approximately $18,000,000 to $20,000,000.\nThe Company believes that funds generated from operations, the revolving line of credit portion of the Senior Credit Agreement, lease financings and purchase money mortgages will provide sufficient resources through 1994 to permit it to meet its working capital requirements, to make all principal and interest payments due and payable on the Senior Notes and its other existing indebtedness, to pay all cash dividend payments payable on its Series A Shares and to finance planned capital expenditures. At March 31, 1994 there was approximately $10,000,000 of availability under the Senior Credit Agreement.\nIn order to consummate the Senior Notes Offering and apply the net proceeds therefrom as described herein, the Company entered into an amendment to its Senior Credit Agreement that became fully effective upon the consummation of the Senior Notes Offering. Such amendment modifies the Senior Credit Agreement to, among other things, permit the Senior Notes Offering, lower the interest coverage tests governing the payment of dividends on its Series A Shares and Redeemable Senior Preferred Stock and permit the acquisition of the ABF Assets. In addition to permitting the use of the proceeds from the Senior Notes Offering as described herein, this amendment also increases the level of capital expenditures permitted under the Senior Credit Agreement, provides the Company with increased flexibility under its financial and other covenants and permits the disposition of the Company's Canadian operations and certain retail stores acquired from the former owner of the ABF Assets.\nImpact of Inflation and Changing Prices; Seasonality\nInflation and changing prices have not historically had a material effect on the Company's overall operations. Generally, the Company has been able to offset the effect of increases in product costs through a combination of price increases, modifications in promotional strategies and the implementation of operating efficiencies.\nThe Company's business shows some seasonal variation, with lower sales levels generally occurring during the winter months.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements required by this item are set forth on pages through and the related financial schedules are set forth on pages S-1 through S-4.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nCertain information with respect to the directors and executive officers of the Company is set forth below:\nName Age Position ---- --- --------\nEddie M. Lesok 45 Chairman of the Board, Chief Executive Officer and Director N. Laurence Nagle 65 President, Chief Operating Officer and Director Daniel J. Gilmartin 49 Senior Vice President, Treasurer, Chief Financial Officer and Director Alan J. Bethscheider 35 Vice President-Legal, Secretary and General Counsel Paul W. Soldatos 44 Director Walter F. Loeb 69 Director\nEddie M. Lesok has been Chairman of the Board since January 1989, Chief Executive Officer of the Company since January 1988 and a director of the Company since November 1981. He was President and Chief Operating Officer of the Company from December 1986 through December 1988. Mr. Lesok has been a director of Texas Commerce Bank, a commercial bank, since November 1988. Mr. Lesok has been with the Company since 1972.\nN. Laurence Nagle has been President and Chief Operating Officer of the Company since January 1989 and a director of the Company since December 1989. He was Executive Vice President of the Company from January 1988 through December 1988. Mr. Nagle was a managing director and Vice President of \"21\" Holdings, Inc. (formerly known as Knoll International Holdings, Inc.), from May 1987 to January 1988, during which time he also served as a consultant to the Company.\nDaniel J. Gilmartin has been Vice President, Treasurer, Chief Financial Officer and a director of the Company since September 1991 and Senior Vice President since January 1994. Prior to joining the Company, Mr. Gilmartin was President and Chief Operating Officer of Frank's Nursery and Crafts, Inc., a wholly-owned subsidiary of General Host Corporation, from October 1988 to August 1991. He was Director of Planning of General Host Corporation from February 1982 to October 1988.\nAlan J. Bethscheider has been the Secretary of the Company since January 1992 and Vice President-Legal and General Counsel since February 1992. Previously, Mr. Bethscheider was associated with the law firm of Gibson, Dunn &\nCrutcher from June 1984 to February 1992 and acted as outside counsel to the Company from January 1990 to February 1992.\nPaul W. Soldatos has been a director of the Company since 1989 and an executive of Investcorp S.A., its predecessor or one or more of its wholly-owned subsidiaries since March 1988.\nWalter F. Loeb has been a director of the Company since August 1991. Since February 1990, Mr. Loeb has been President of Loeb Associates, Inc., a New York based domestic and international retail consulting firm. In addition, he is the publisher of the \"Loeb Retail Letter\". From 1984 to 1990 Mr. Loeb was Senior Retail Analyst and a Principal of Morgan Stanley & Co. Incorporated.\nHoldings has agreed to elect Mr. Lesok and Mr. Nagle to the Company's Board of Directors as long as they are employed by the Company. In connection with his employment, the Company appointed Mr. Gilmartin to the Company's Board of Directors. All directors serve until their respective successors are elected at the next annual meeting of stockholders, and all executive officers serve at the discretion of the Board of Directors.\nDirector Compensation\nMr. Loeb receives a director's fee of $20,000 annually and a fee of $2,000 for each meeting attended. The Company pays no additional remuneration to its employees or to executives of INVESTCORP S.A. (\"Investcorp\") or any of its wholly-owned subsidiaries for serving as directors. Pursuant to the terms of their employment agreements, Mr. Lesok and Mr. Nagle are to serve as executive officers of the Company. (See \"Employment Contracts; Termination and Change-in Control Agreements.\") There are no family relationships among any of the directors or executive officers.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe following table sets forth all cash compensation earned in fiscal 1993 by the Company's Chief Executive Officer and each of the other three most highly compensated executive officers, whose remuneration exceeded $100,000.\nSummary Compensation Table --------------------------\nLong Term Compen- Annual Compensation sation Other Awards\n(a) (b) (c) (d) (e) (g) (i)\nOther All Annual Other Name Compen- Compen and Salary sation Holdings -sation Principal ($) Bonus ($) Options ($) Position Year (B) ($) (C,D) (#)(E) (C,F,G) (A)\nEddie M. Lesok 1993 358,100 - - - 4,497 Chief Executive 1992 358,100 296,000 - - 4,364 Officer 1991 358,100 - - - -\nN. Laurence Nagle 1993 282,500 - - - 4,497 President 1992 282,500 256,000 - - 4,364 1991 282,500 - - - -\nDaniel J. 1993 207,500 50,000 - - 4,497 Gilmartin 1992 207,500 192,000 - - 26,696 Chief Financial 1991 107,836 - - 4,240 - Officer\nAlan J. 1993 132,200 - - - 4,260 Bethscheider 1992 115,053 65,262 - 6,375 - Vice President- Legal ___________________\n(A) Mr. Gilmartin joined the Company in September 1991. Mr. Bethscheider joined the Company in February 1992.\n(B) Salary for fiscal 1991 for Messrs. Lesok and Nagle includes $39,942 and $30,673, respectively, for payments made in 1992 as retroactive salary adjustments for fiscal 1991.\n(C) Information for years ended prior to December 15, 1992 is not required to be disclosed in columns (e) and (i).\n(D) Non-cash personal benefits payable to executive officers during fiscal 1993 did not exceed, in the aggregate, the lesser of $50,000 or 10% of the cash compensation of any individual officer.\n(E) All of the Company's issued and outstanding common stock is owned by Holdings. All references to common stock in the Executive Compensation tables and discussion contained in this Item 11 refer to common stock of Holdings.\n(F) See Employment Contracts; Termination and Change-in-Control Arrangements.\"\n(G) The amounts shown in this column for 1993 and 1992, respectively, are derived from the following figures: (i) Mr. Lesok, $4,497 and $4,364, respectively, Company payments to the Investment Plan ($4,497 and $4,364 of which is vested), and (ii) Mr. Nagle, $4,497 and $4,364, respectively, Company payments to the Investment Plan ($4,497 and $4,364 of which is vested), (iii) Mr. Gilmartin, $4,497 and $1,696, respectively, Company payments to the Investment Plan ($1,799 and $678 of which are vested), and $25,000 relocation allowance for 1992 and (iv) Mr. Bethscheider, $4,260 Company payment during 1993 to the Investment Plan ($852 of which is vested).\nOption Exercises and Value Table - Fiscal 1993\nAggregated Option Exercises in Fiscal 1993, and FY-End Option Value (a) (b) (c) (d) (e)\nValue of Un- exercised \"In- Number of the-Money\" Unexercised Holdings Holdings Holdings Options at FY- Shares Options at End Acquired on Value FY-End ($) Name Exercise (#) Realized (#) Exercisable\/ ($) Exercisable\/ Unexercisable Unexercisable (A)\nEddie M. - - 7,091.8\/28,367.2 - Lesok\nN. Laurence - - 3,636.8\/14,627.2 - Nagle\nDaniel J. - - 848\/3,392 - Gilmartin\nAlan J. - - 1,275\/5,100 - Bethscheider\n_______________________\n(A) Underlying shares are not publicly traded and are subject to repurchase by Holdings at the employee's cost or at the then current value of the underlying shares as determined by the Company's Board of Directors upon the termination of the employee's employment with the Company; therefore, options have not been categorized as \"in-the- money.\" The Company has not established any recent valuations for such shares.\nEmployment Contracts; Termination and Change-in-Control Agreements\nIn connection with the acquisition of the Company by Holdings (the \"1989 Merger\"), the Company entered into an employment agreement with Eddie M. Lesok to serve as Chairman of the Board and Chief Executive Officer and an employment agreement with N. Laurence Nagle to serve as President and Chief Operating Officer. In January 1994, these agreements were amended to, among other things,\nextend their terms until the end of the Company's 1998 fiscal year. The agreements entitle Mr. Lesok and Mr. Nagle to participate in the fringe benefit programs maintained by the Company and made available to its executive officers generally. Mr. Lesok will receive, under his agreement, an annual base salary of $450,000 (subject to upward adjustment) during the term of the agreement. Mr. Nagle will receive, under his agreement, an annual base salary of $375,000 (subject to upward adjustment) during the term of his employment. If the employment of Mr. Lesok or Mr. Nagle is terminated as a result of death or Permanent Disability (as defined in the respective agreements), Mr. Lesok or Mr. Nagle (or their respective estates), as the case may be, will be entitled to receive a lump sum amount equal to two times his annual base salary. If the employment of either such executive is terminated by the Company other than for Cause (as defined in the respective agreements) or by such executive for Good Reason (as defined in the respective agreements), such executive will be entitled to an amount equal to his annual base salary, payable over the lesser of two years or the remaining stated term of his employment.\nThe Company has agreed that if, prior to December 31, 1994, Mr. Gilmartin's employment is terminated on a non-voluntary basis without cause or, in certain cases, upon a change of control of the Company, Mr. Gilmartin will be entitled to up to one year's base salary. Mr. Gilmartin's current base salary is $200,000. Additionally, the Company has agreed that if Mr. Bethscheider's employment is terminated, in certain cases, upon a change of control of the Company, Mr. Bethscheider will be entitled to twelve months' base salary. Mr. Bethscheider's current base salary is $150,000.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nHoldings owns all of the Company's issued and outstanding shares of common stock. Holdings has pledged all such shares to secure the Company's obligations under its Senior Credit Agreement. See \"Capital Structure\". The mailing address of Holdings is 280 Park Avenue, 37th Floor, New York, New York 10017.\nHoldings' Principal Stockholders\nClass D Stock, par value $.01 per share, is the only class of Holdings' stock that currently possesses voting rights. At January 2, 1994, there were 5,000 shares of Holdings' Class D Stock issued and outstanding. Members of the Company's management own Class C Stock, par value $.01 per share, which stock has no voting rights except in certain limited circumstances. The following tables set forth as of January 2, 1994 the number of such shares beneficially owned and the percentage of such shares of the total issued and outstanding shares of Class D Stock and Class C Stock of Holdings owned (i) by each person or entity known to the Company to beneficially own five percent or more of the outstanding shares of such stock and (ii) by the directors and executive officers of the Company:\nClass D Voting Stock:\nPercent of Outstanding Shares Number of of Shares of Holdings' Holdings' Class D Class D Name and Address Voting Stock Voting Stock of Beneficial Owner Beneficially Owned(1) Beneficially Owned(1) ------------------- --------------------- ---------------------\nINVESTCORP S.A.(2)(3) 2,600 52% 37 rue Notre-Dame Luxembourg\nCIP Limited(4) 2,600 52% P. O. Box 1111 West Wind Building George Town, Grand Cayman Cayman Islands, B.W.I.\nCorporate Equity Limited(4)(5) 350 7% P. O. Box 1111 West Wind Building George Town, Grand Cayman Cayman Islands, B.W.I.\nAcquisition Equity Limited(4)(6) 350 7% P. O. Box 1111 West Wind Building George Town, Grand Cayman Cayman Islands, B.W.I.\nFunding Equity Limited(4)(7) 350 7% P. O. Box 1111 West Wind Building George Town, Grand Cayman Cayman Islands, B.W.I.\nPlanning Equity Limited(4)(8) 350 7% P. O. Box 1111 West Wind Building George Town, Grand Cayman Cayman Islands, B.W.I.\nElias N. Hallack(9) 1,200 24% Tile Capital Limited P. O. Box 1111 West Wind Building George Town, Grand Cayman Cayman Islands, B.W.I.\nNemir A. Kirdar(3) 1,200 24% Tile Equity Limited P. O. Box 1111 West Wind Building George Town, Grand Cayman Cayman Islands, B.W.I.\nMichael L. Merritt(10) 1,200 24% Tile International Limited P. O. Box 1111 West Wind Building George Town, Grand Cayman Cayman Islands, B.W.I. ___________________________\n(1) As used in this table, beneficial ownership means the sole or shared power to vote, or direct the voting of a security, or the sole or shared power to dispose, or direct the disposition of, a security.\n(2) Investcorp owns no stock in any of Corporate Equity Limited, Acquisition Equity Limited, Funding Equity Limited, Planning Equity Limited, or the beneficial owners of these entities (see (5)-(8) below). Investcorp may be deemed to be the beneficial owner of the shares of voting stock held by such entities because the beneficial owners of each of those entities have entered into revocable management agreements with a wholly-owned subsidiary of Investcorp pursuant to which these shareholders have granted such subsidiary the authority to direct the disposition of the stock owned by such entities for so long as such agreements are in effect. Investcorp is a Luxembourg corporation, with its registered address at 37 rue Notre-Dame, Luxembourg.\n(3) Mr. Kirdar, the President and Chief Executive Officer of Investcorp, owns more than 99% of the stock of Tile Equity Limited, a Cayman Islands corporation. Its registered office is P. O. Box 1111, West Wind Building, George Town, Grand Cayman, Cayman Islands, British West Indies. Mr. Kirdar has granted a revocable proxy in Tile Equity Limited to Investcorp. Mr. Kirdar's address of record is INVESTCORP BANK E.C., Investcorp House, P. O. Box 5240, Manama Bahrain.\n(4) CIP Limited (\"CIP\") is a less than 1% indirect beneficial owner of stock of Corporate Equity Limited, Acquisition Equity Limited, Funding Equity Limited, Planning Equity Limited. CIP may be deemed to be the beneficial owner of the shares of voting stock held by such entities because the ultimate beneficial shareholders of each of those entities have granted to CIP revocable proxies in companies that own those entities' stock. CIP also may be deemed to indirectly control Investcorp through proxies that it holds. The address of CIP Limited is P. O. Box 1111, West Wind Building, George Town, Grand Cayman, Cayman Islands, British West Indies.\n(5) Corporate Equity Limited is a Cayman Islands corporation.\n(6) Acquisition Equity Limited is a Cayman Islands corporation.\n(7) Funding Equity Limited is a Cayman Islands corporation.\n(8) Planning Equity Limited is a Cayman Islands corporation.\n(9) Mr. Hallack, the Co-Chief Operating Officer of Investcorp, owns more than 99% of Tile Capital Limited, a Cayman Islands corporation. Its registered office is P. O. Box 1111, West Wind Building, George Town, Grand Cayman, Cayman Islands, British West Indies. Mr. Hallack's address of record is INVESTCORP BANK E.C., Investcorp House, P. O. Box 5240, Manama Bahrain.\n(10) Mr. Merritt, the Co-Chief Operating Officer of Investcorp, owns more than 99% of Tile International Limited, a Cayman Islands corporation. Its registered office is P. O. Box 1111, West Wind Building, George Town, Grand Cayman, Cayman Islands, British West Indies. Mr. Merritt's address of record is INVESTCORP BANK E.C., Investcorp House, P. O. Box 5240, Manama Bahrain.\nClass C Non-Voting Stock:\nPercent of Number of Outstanding Shares of Shares of Holdings' Holdings' Class C Class C Name and Address Non-Voting Stock Non-Voting Stock of Beneficial Owner Beneficially Owned (1) Beneficially Owned (1) ------------------- ---------------------- ----------------------\nAll directors and 66,357 25.2% executive officers of the Company as a group (16 persons)\nEddie M. Lesok 38,198 14.5% c\/o Color Tile, Inc. 515 Houston Street Fort Worth, TX 76102\nN. Laurence Nagle 18,729 7.1% c\/o Color Tile, Inc. 515 Houston Street Fort Worth, TX 76102\nDaniel J. Gilmartin 848 0.3% c\/o Color Tile, Inc. 515 Houston Street Fort Worth, TX 76102\nAlan J. Bethscheider 850 0.3% c\/o Color Tile, Inc. 515 Houston Street Fort Worth, TX 76102 ___________________________\n(1) As used in this table, beneficial ownership means the sole or shared power to vote, or direct the voting of a security, or the sole or shared power to dispose, or direct the disposition of, a security.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nHoldings acquired the Company in a merger transaction in 1989 (the \"1989 Merger\") pursuant to an Agreement of Merger, dated as of October 16, 1989, as amended as of December 17, 1989 (the \"Merger Agreement\"), by and among Holdings, CT Acquisition Corp. (\"CTA\"), the Company, Knoll International Holdings, Inc. (\"KIHI\") and NEAC, Inc. (\"NEAC\") (the sole common and junior cumulative preferred stockholder of the Company immediately prior to the 1989 Merger). Holdings was formed to acquire the Company by\naffiliates of Investcorp, other international investors and members of the Company's management. No entity participating in the 1989 Merger or any affiliates thereof own any of the Series A Shares.\nIn connection with the 1989 Merger, the Company has an agreement for management advisory and consulting services with Investcorp International, Inc. (\"International\") pursuant to which the Company has agreed to pay International $500,000 per annum for a five-year term.\nDuring 1991 and 1990, the Company incurred interest expense on the $60 million Junior Subordinated Notes (the \"Junior Notes\") totaling approximately $10,291,000 and $10,342,000, respectively, of which approximately $6,860,000 and $3,825,000, respectively, was deferred. On November 27, 1991, Holdings contributed to the Company additional common equity of $79,704,110. These funds were utilized by the Company to redeem $60,000,000 aggregate principal amount of the Junior Notes, together with deferred interest of $10,684,500 plus accrued interest of $3,431,210, at a premium of $5,588,400.\nDuring 1991, the Company paid International $3,750,000 for financing advisory fees for its assistance in arranging the Company's Senior Credit Agreement and a $50,000,000 senior subordinated debt commitment with a commercial bank. Additionally, an affiliate of Investcorp was paid $6,000,000 in connection with the repurchase of debt securities of the Company. These transactions were reviewed by the independent member of the Company's Board of Directors, and an independent, nationally known investment banking firm, who determined that the terms and conditions associated with these transactions were as favorable to the Company as the Company could have reasonably obtained from an independent third party.\nIn April 1992, prior to the termination of a commitment by the Company's principal lender under its Senior Credit Agreement to provide up to $50,000,000 of subordinated debt (the \"Senior Subordinated Loan Commitment\") in connection with the issuance of the Series A Shares, the Company agreed to reduce the lender's commitment under the Senior Subordinated Loan Commitment from $50,000,000 to $25,000,000. At that time, an affiliate of Investcorp entered into a standby commitment to subscribe for $25,000,000 of a new class of preferred stock (the \"Preferred Stock Commitment\"). Neither Investcorp nor its affiliate received any separate fees or other compensation in connection with the Preferred Stock Commitment. Upon completion of the placement of Series A Shares on August 13, 1992, the commitments of the lender pursuant to the Senior Subordinated Loan Commitment and the Investcorp affiliate pursuant to the Preferred Stock Commitment terminated.\nDuring 1993, the Company paid the Investment Plan aggregate rentals of approximately $3,500,000 with respect to 44 properties leased to the Company by the Investment Plan. During 1992 and 1991, the Company paid the Investment Plan aggregate rentals of approximately $3,100,000 with respect to 43 properties and approximately $3,100,000 with respect to 43 properties, respectively. These leases were originally between\nthe Company and third parties and reflect arm's-length terms.\nOn October 5, 1993, ABF Acquisition Corp. (\"ABF Acquisition\"), an affiliate of Investcorp, entered into an agreement (the \"ABF Acquisition Agreement\") to acquire the ABF Assets and assume certain liabilities in connection therewith. ABF Acquisition agreed to acquire the ABF Assets to facilitate the acquisition of such assets by the Company pending the receipt of proceeds from the Senior Notes Offering, the execution of an amendment to the Senior Credit Agreement permitting, among other things, the acquisition of the ABF Assets, and the receipt of certain required governmental consents. The ABF Acquisition Agreement provided for the acquisition of the ABF Assets and certain related entities in exchange for the assumption of certain specified liabilities and the payment of a cash purchase price of approximately $73,000,000 net of the anticipated effect of certain adjustments pursuant to the ABF Acquisition Agreement. In connection with such acquisition, affiliates of Investcorp received approximately $4,300,000 from ABF Acquisition in respect of a bridge loan commitment, a guarantee of the bridge loan provided by Chemical Bank to finance the acquisition of the ABF Assets by ABF Acquisition and the payment of fees for merger advisory services. A portion of the fees payable to affiliates of Investcorp was intended to compensate such affiliates for committing to provide additional funds in the event that the Company was unable to consummate the acquisition of the ABF Assets as described below.\nThe Company entered into an option (the \"Option Agreement\") to acquire the ABF Assets and assumed the liabilities associated therewith from ABF Acquisition at a price of approximately $80,000,000, including fees and expenses of $6,500,000, which reflects the same price paid by ABF Acquisition for the ABF Assets, adjusted to reflect amounts payable to certain Investcorp affiliates, as described above, and the reimbursement of transaction costs incurred in connection with such acquisition. The Company exercised its option and acquired the ABF Assets contemporaneously with the completion of the Senior Notes Offering on December 17, 1993.\nIn connection with the Option Agreement, the Company and ABF Acquisition entered into a Management Services Agreement dated November 4, 1993 pursuant to which the Company agreed to provide management services to ABF Acquisition until the earlier to occur of the closing of the exercise of the Company's option to purchase the assets of ABF Acquisition under the Option Agreement or November 4, 1994. The Management Services Agreement provides for the Company to receive a fee for such services. Pursuant to this agreement, the Company has received a fee of approximately $2,000 and does not expect to receive any additional compensation.\nPursuant to the ABF Acquisition Agreement, the parties made customary representations, warranties and covenants typically contained in agreements of this type and entered into customary indemnities for breaches of such representations, warranties and covenants set forth in the ABF Acquisition Agreement. Upon the acquisition of the ABF Assets, ABF Acquisition assigned all its rights under the ABF Acquisition Agreement to the Company.\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 reports: ----------------------------------\n1. Financial Statements included under Item 8:\nSee Index to Consolidated Financial Statements included on page .\n2. Financial Statement Schedules filed herewith:\nSee Index to Consolidated Financial Statements Schedules included on page.\nAll other schedules are omitted either because they are not required or because the required information is included in the financial statements and notes thereto included herein. See \"Index to Consolidated Financial Statements.\"\n3. List of Exhibits\nEach management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K is identified with an asterisk (\"*\") below.\n3(a) Certificate of Incorporation of the Company (filed as Exhibit 3(a) to the Registration Statement (No. 33-13428) on Form S-1 filed by the Company on April 14, 1987 (the \"Registration Statement\") and incorporated herein by reference)\n3(b) Certificate of Amendment of Certificate of Incorporation of the Company (filed as Exhibit 4(f) to the Company's Current Report on Form 8-K dated December 28, 1989 (the \"December 28, 1989 Form 8-K\") and incorporated herein by reference)\n3(c) Amended and Restated Bylaws of the Company (filed as Exhibit 3(b) to the Registration Statement and incorporated herein by reference)\n3(d) Certificate of Amendment of Certificate of Incorporation of the Company (filed as Exhibit 3(d) to the Company's Current Report on Form 10-K dated March 28, 1991 and incorporated herein by reference)\n3(e) Certificate of Designations, Preferences, and Relative, Participating, Optional, and Other Special Rights of Preferred Stock and Qualifications, Limitations and Restrictions thereof for the Registrant's Series A Senior Increasing Rate Preferred Stock (filed as Exhibit 4.1 to the Company's current report on Form 8-K dated August 28, 1992 (the \"August 28, 1992 Form 8-K\") and incorporated herein by reference)\n3(f) Certificate of Designations, Preferences, and Relative, Participating, Optional, and Other Special Rights of Preferred Stock and Qualifications, Limitations and Restrictions thereof for the Registrant's Series B Senior Increasing Rate Preferred Stock (filed as Exhibit 4.2 to the August 28, 1992 Form 8-K and incorporated herein by reference)\n3(g) Certificate of Amendment to the Certificate of Incorporation of the Registrant (filed as Exhibit 4.5 to the August 28, 1992 Form 8-K and incorporated herein by reference)\n4(a) Securities Purchase Agreement, dated as of October 20, 1986, among GFICT and each of the Purchasers referred to therein (filed as Exhibit 4(a) to the Registration Statement and incorporated herein by reference)\n4(b) Registration Rights Agreement, dated as of October 20, 1986, among GFICT and each of the Purchasers referred to therein relating to the Securities (filed as Exhibit 4(b) to the Registration Statement and incorporated herein by reference)\n4(c) Specimen Certificate of the Company's Senior Preferred Stock (filed as Exhibit 4(m) to the Registration Statement and incorporated herein by reference)\n4(d) Agreement, dated as of December 28, 1989, among Color Tile Holdings, Inc., CT Acquisition Corp., Color Tile, Inc., Knoll International Holdings, Inc. and NEAC, INC. (filed as Exhibit 4(f) to the December 28, 1989 Form 8-K)\n4(d) Securities Purchase Agreement by and among the Registrant and each of the Purchasers referred to therein, dated as of August 13, 1992 (filed as Exhibit 4.3 to the August 28, 1992 Form 8-K)\n4(e) Exchange and Registration Rights Agreement by and among the Registrant and each of the Purchasers referred to therein, dated as of August 13, 1992 (filed as Exhibit 4(m) to the August 28, 1992 Form 8-K)\n4(f) Form of Indenture for Color Tile, Inc. 10-3\/4% Senior Notes Due 2001 (filed as exhibit 4(g) to the Company's Form S-1 Registration Statement filed November, 1993 and incorporated herein by reference).\n10(a) Lease and Agreement, dated as of August 1, 1979, between the City of Melbourne, Arkansas (\"Melbourne\") and the Company (filed as Exhibit 10(a) to the Registration Statement and incorporated herein by reference)\n10(b) First Supplemental Lease and Agreement, dated as of February 1, 1981, between Melbourne and the Company (filed as Exhibit 10(b) to the Registration Statement and incorporated herein by reference)\n10(c) Trust Indenture, dated as of August 1, 1979, by and between Melbourne and TCB, as Trustee, relating to the 7- 1\/8% Industrial Development Revenue Bond - Color Tile Project, Series 1979 (the \"Melbourne Bonds\") (filed as Exhibit 10(c) to the Registration Statement and incorporated herein by reference)\n10(d) First Supplemental Trust Indenture, dated as of February 1, 1981, by and between Melbourne and TCB, as Trustee, relating to the Melbourne Bonds (filed as Exhibit 10(d) to the Registration Statement and incorporated herein by reference)\n10(e) Guaranty Agreement, dated as of August 1, 1979, between the Company and TCB relating to the Melbourne Bonds (filed as Exhibit 10(e) to the Registration Statement and incorporated herein by reference)\n10(f) First Supplemental Guaranty Agreement, dated as of February 1, 1981, between the Company and TCB relating to the Melbourne Bonds (filed as Exhibit 10(f) to the Registration Statement and incorporated herein by reference)\n10(g) Lease Agreement, dated January 1, 1981, between the Village of Park Forest South (\"Park Forest\") and the Company (filed as Exhibit 10(g) to the Registration Statement and incorporated herein by reference).\n10(h) Indenture of Mortgage and Deed of Trust, dated January 1, 1981, from Park Forest to Texas Commerce Bank National Association (\"TCB\") and Edward Mogee, as Trustees, relating to the 9.375% Industrial Revenue Bonds (Color Tile, Inc. Project), Series A, due December 15, 2000 (the \"Park Forest Bonds\") (filed as Exhibit 10(h) to the Registration Statement and incorporated herein by reference)\n10(i) Guarantee and Indemnification Agreement, dated January 1, 1981, between the Company and TCB, as Trustee, relating to the Park Forest Bonds (filed as Exhibit 10(i) to the Registration Statement and incorporated herein by reference)\n10(j) Lease Agreement, dated January 1, 1981, between the City of Cleveland, Mississippi (\"Cleveland\") and the Company (filed as Exhibit 10(j) to the Registration Statement and incorporated herein by reference)\n10(k) Indenture of Mortgage and Deed of Trust, dated January 1, 1981, from Cleveland to TCB, as Trustee, relating to the 10% Industrial Development Revenue Bonds (Color Tile, Inc. Project), Series A, due January 15, 2001 (the \"Cleveland Bonds\") (filed as Exhibit 10(k) to the Registration Statement and incorporated herein by reference)\n10(l) Guarantee and Indemnification Agreement, dated January 1, 1981, between the Company and TCB, as Trustee, relating to the Cleveland Bonds (filed as Exhibit 10(l) to the Registration Statement and incorporated herein by reference)\n10(m) Lease Agreement, dated October 1, 1981, between City of West Chicago (\"West Chicago\") and the Company (filed as Exhibit 10(m) to the Registration Statement and incorporated herein by reference)\n10(n) Indenture of Mortgage and Deed of Trust, dated October 1, 1981, from West Chicago to TCB and Albert V. O'Neal, as Trustees, relating to the 9.80% Indenture Development Revenue Bonds (Color Tile, Inc. Project), Series A, due 1983-1997 (the \"West Chicago Bonds\") (filed as Exhibit 10(n) to the Registration Statement and incorporated herein by reference)\n10(o) Guarantee and Indemnification Agreement, dated October 1, 1981, between the Company and TCB, as Trustee, relating to the West Chicago Bonds (filed as Exhibit 10(o) to the Registration Statement and incorporated herein by reference)\n*10(p) Profit Sharing Plan (filed as Exhibit 10(r) to the Registration Statement and incorporated herein by reference)\n10(q) Agreement of Merger, dated as of October 16, 1989, among Color Tile Holdings, Inc., CT Acquisition Corp., Color Tile, Inc. , Knoll International Holdings, Inc. and NEAC, INC. (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended October 1, 1989 and incorporated by reference)\n10(r) Amendment to Agreement of Merger, dated as of December 17, 1989, among Color Tile Holdings, Inc., CT Acquisition Corp., Color Tile, Inc., Knoll International Holdings, Inc. and NEAC, INC. (filed as Exhibit 2(b) to the December 28, 1989 Form 8-K and incorporated herein by reference)\n*10(s) Amendment to Employment Agreement dated January 3, 1994, between the Company and Eddie M. Lesok\n*10(t) Amendment to Employment Agreement dated January 3, 1994, between the Company and N. Laurence Nagle\n10(u) Agreement for Management Advisory and Consulting Services between INVESTCORP International Inc. and CT Acquisition Corp. dated December 22, 1989 (filed as Exhibit 10(aa) to the December 31, 1989 Form 10-K and incorporated herein by reference)\n10(v) Credit Agreement dated as of November 27, 1991, as amended through April 2, 1992, among the Company, the lenders party thereto and Manufacturers Hanover Trust Company as agent (filed as Exhibit 10(ff) to the December 29, 1991 Form 10-K and incorporated herein by reference)\n10(x) Amendment, Acknowledgement and Consent, dated July 30, 1992, among the Registrant, Chemical Bank, as agent, and certain banks listed therein, amending certain provisions of the Credit Agreement, dated as of November 27, 1991 as amended through April 2, 1992, and the Senior Subordinated Loan Agreement, dated as of November 27, 1991 as amended through April 2, 1992 (each of which were previously filed as Exhibits 10(ff) and 10(gg) to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 29, 1991) (filed as Exhibit 28.1 to the August 28, 1992 Form 8-K)\n10(y) Amendment No. 3, dated as of November 1, 1993, to the Credit Agreement, dated as of November 27, 1991, as amended April 2, 1992, among the Company, the lenders party thereto and Chemical Bank as agent (filed an Exhibit 10(r) to Registration Statement (No. 33-50599) filed by the Company on October 14, 1993 and incorporated herein by reference).\n18 Letter regarding Change in Accounting Principles (filed as Exhibit 18 to the December 31, 1989 Form 10-K and incorporated herein by reference)\n21(a) Press Release of the Registrant concerning the Placement, dated August 13, 1992 (filed as Exhibit 21.2 to the August 28, 1992 Form 8-K)\n22 Subsidiaries of the Company\n(b) Reports on Form 8-K: -------------------\nThe following Reports on Form 8-K were filed during the last quarter of time period covered by this Report on Form 10-K:\nNone\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCOLOR TILE, INC.\nBy: \/s\/ Eddie M. Lesok ---------------------------------------- Eddie M. Lesok, Chief Executive Officer DATED: April 1, 1994\nPursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and on the date indicated.\n\/s\/ Eddie M. Lesok - ----------------------------------------- Eddie M. Lesok, Chairman of the Board, April 1, 1994 Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ N. Laurence Nagle - ------------------------------------------ N. Laurence Nagle, Director April 1, 1994\n\/s\/ Daniel J. Gilmartin - ----------------------------------------- Daniel J. Gilmartin, Director April 1, 1994 (Principal Financial Officer)\n\/s\/ Paul W. Soldatos - ----------------------------------------- Paul W. Soldatos, Director April 1, 1994\n\/s\/ Walter F. Loeb - ----------------------------------------- Walter F. Loeb, Director April 1, 1994\nCOLOR TILE, INC. Annual Report on Form 10-K Year Ended January 2, 1994\nEXHIBITS INDEX Sequentially Exhibit Numbered No. Description Page - ------- --------------------------------------------------- ------------\nReport of Independent Accountants\nConsolidated Financial Statements:\nConsolidated Balance Sheet as of January 2, 1994 and January 3, 1993 Consolidated Statement of Operations for the years ended January 2, 1994, January 3, 1993 and December 29, 1991 Consolidated Statement of Common Stockholder's Equity for the years ended January 2, 1994, January 3, 1993, and December 29, 1991 Consolidated Statement of Cash Flows for the years ended January 2, 1994, January 3, 1993 and December 29, 1991 Notes to Consolidated Financial Statements\nFinancial Statement Schedules:\nSchedule V - Property, Plant and Equipment\nSchedule VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment\nSchedule VIII - Valuation and Qualifying Accounts\nSchedule X - Supplementary Income Statement Information\n10(s) Employment Agreement - Eddie M. Lesok\n10(t) Employment Agreement - N. Laurence Nagle\n22 Subsidiaries of Company\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nPage ------\nReport of Independent Accountants F - 2\nConsolidated Financial Statements:\nConsolidated Balance Sheet as of January 2, 1994 and January 3, 1993 F - 3\nConsolidated Statement of Operations for the years ended January 2, 1994, January 3, 1993 and December 29, 1991 F - 4\nConsolidated Statement of Common Stockholder's Equity for the years ended January 2, 1994, January 3, 1993 and December 29, 1991 F - 5\nConsolidated Statement of Cash Flows for the years ended January 2, 1994, January 3, 1993 and December 29, 1991 F - 6\nNotes to Consolidated Financial Statements F - 7\nConsolidated Financial Statement Schedules for the years ended January 2, 1994, January 3, 1993 and December 29, 1991:\nSchedule V - Property, Plant and Equipment S - 1\nSchedule VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment S - 2\nSchedule VIII - Valuation and Qualifying Accounts S - 3\nSchedule X - Supplementary Income Statement Information S - 4\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nBoard of Directors Color Tile, Inc.\nWe have audited the consolidated financial statements and the financial statement schedules of Color Tile, Inc. listed 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 Color Tile, Inc. as of January 2, 1994 and January 3, 1993 and the consolidated results of its operations and cash flows for each of the three years in the period ended January 2, 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\nFort Worth, Texas March 28, 1994\nCOLOR TILE, INC. Consolidated Balance Sheet January 2, 1994 and January 3, 1993 (Amounts in Thousands, except share amounts)\nASSETS\nJanuary 2, January 3, --------- --------- 1994 1993 --------- ---------\nCurrent Assets: Cash and cash equivalents $ 4,522 $\nAccounts and notes receivable, net of allowance for bad debts of $369 and $415 13,860 12,643 Inventories 83,552 74,045 Deferred income taxes 1,078 3,830 Other current assets 5,072 3,567 ------- -------\nTotal Current Assets 108,084 94,085 ------- -------\nProperty, plant and equipment, net 119,993 121,949\nGoodwill, net 269,824 173,847 Other intangible assets, net 40,696 45,377 Deferred financing costs, net 6,464 13,891 Deferred income taxes 13,078 10,322 Other assets 7,204 3,521 -------- -------\nTotal Assets $565,343 $462,992 ======== ========\nLIABILITIES AND STOCKHOLDERS' EQUITY\nCurrent Liabilities: Current portion of long-term debt $ 5,790 $15,073 Accounts payable 60,941 38,803 Accrued expenses and other current liabilities 36,981 28,955 ------- -------\nTotal Current Liabilities 103,712 82,831 ------- -------\nLong-term debt 347,567 239,689\nOther noncurrent liabilities 5,488 9,087 ------- -------\nTotal Liabilities 456,767 331,607 ------- -------\nCommitments and contingencies (Notes 8 and 10)\nRedeemable preferred stock, $90,784 liquidation value at January 2, 1994 86,838 82,596\nCommon Stockholder's Equity: Common stock, $.01 par value, 1,000,000 shares authorized, 101 shares issued and outstanding Additional paid-in capital 105,230 117,522 Accumulated deficit (83,492) (68,733) -------- -------\nTotal Common Stockholder's Equity 21,738 48,789 ------- -------\nTotal Liabilities and Stockholders' Equity $565,343 $462,992 ======== =======\nThe accompanying notes are an integral part of the consolidated financial statements.\nCOLOR TILE, INC. Consolidated Statement of Operations for the years ended January 2, 1994, January 3, 1993 and December 29, 1991\n(Amounts in Thousands)\nJanuary 2, January 3, December 29, 1994 1993 1991 --------- --------- ---------\nSystemwide Sales (Note 1) $568,314 $586,007 $546,761 ======== ======== ========\nNet Sales $555,127 $580,385 $544,315 -------- -------- --------\nCosts and Expenses:\nCost of sales 309,528 311,368 292,517 Selling, general and administrative expenses 191,451 208,796 201,237 Depreciation and amortization 25,546 28,683 29,202 Special charges 30,000 --------- ------- --------- Total Costs and Expenses 526,525 578,847 522,956 -------- -------- --------\nOperating income 28,602 1,538 21,359\nGain (loss) on disposal of a line of business (9,500) 4,007 Interest expense (net of interest income of $163, $102, and $540) (20,380) (25,697) (51,986) -------- -------- --------\nLoss before income taxes and extraordinary item (1,278) (20,152) (30,627)\nProvision (benefit) for Income Taxes 641 1,240 (2,133) -------- -------- -------\nLoss before extraordinary item (1,919) (21,392) (28,494)\nExtraordinary gain (loss) on early extinguishment of debt, net of tax (12,603) (601) 4,886 -------- -------- -------\nNet Loss $(14,522) $(21,993) $(23,608) ======== ======== ========\nThe accompanying notes are an integral part of the consolidated financial statements.\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in Thousands, except share amounts)\n1. Summary of Significant Accounting Policies: -------------------------------------------\nBasis of Presentation ---------------------\nColor Tile, Inc. (\"Color Tile\") has been a wholly-owned subsidiary of Color Tile Holdings, Inc. (\"Holdings\"), an affiliate of INVESTCORP, S.A. (\"Investcorp\"), since Holdings' acquisition of all outstanding common stock of Color Tile, Inc. on December 28, 1989 (the \"1989 Merger\").\nOn December 17, 1993, Color Tile, Inc. through its wholly-owned subsidiary, American Blind and Wallpaper Factory, Inc. (\"ABWF\"), acquired the operating assets (the \"ABF Assets\") of American Blind Factory, Inc., (\"ABF\") (see note 2 - Acquisitions) from ABF Acquisition Corp. (\"ABF Acquisition \"), a Delaware corporation and affiliate of Investcorp (see note 15 - Transactions with Related Parties). ABF Acquisition acquired the ABF Assets and assumed certain liabilities in connection therewith on November 4, 1993 to facilitate the acquisition of such assets by Color Tile, Inc. pending the receipt of proceeds from the consummation of the $200 million 10 3\/4% Senior Notes (the \"Senior Notes\") Offering (the \"Senior Notes Offering\"). For financial reporting purposes, the results of operations of ABWF are combined with the operating results of Color Tile, Inc., and its subsidiaries (collectively, the \"Company\") from the effective date of the acquisition of the ABF Assets by ABF Acquisition, November 1, 1993.\nPrinciples of Consolidation ---------------------------\nThe accompanying consolidated financial statements include the accounts of Color Tile, Inc. and its subsidiaries after elimination of significant intercompany accounts and transactions.\nForeign Currency Translation ----------------------------\nFor foreign operations, whose functional currency is not U. S. dollars, the balance sheet is translated at the year end exchange rate. Resulting translation adjustments are made to Accumulated Deficit. Operating statement transactions are translated at the average exchange rate for the year. Any exchange gain or loss is credited or charged to operations.\nAccounting Period -----------------\nThe fiscal year of the Company ends on the Sunday nearest to December 31. All references herein to \"1993\", \"1992\" and \"1991\" mean the 52 week or 53 week fiscal years ended January 2, 1994, January 3, 1993 and December 29, 1991, respectively. The year ended January 3, 1993 was comprised of 53 weeks. The years ended January 2, 1994 and December 29, 1991 were each comprised of 52 weeks.\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in Thousands, except share amounts)\n1. Summary of Significant Accounting Policies (Continued): ------------------------------------------------------\nInventories -----------\nInventories are stated at the lower of cost or market. Cost of sales is determined principally by the first-in, first-out (\"FIFO\") method.\nProperty, Plant and Equipment -----------------------------\nProperty, plant and equipment, including assets under capital leases, are stated at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets.\nBetterments, renewals and repairs that extend the lives of assets are capitalized; other repairs and maintenance are expensed as incurred. Upon retirement or other disposal, the asset cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to operations.\nGoodwill and Other Intangible Assets ------------------------------------\nGoodwill and other intangible assets are amortized primarily on a straight-line basis over the estimated useful lives of the assets or the terms of the leases. At each balance sheet date, management assesses whether there has been a permanent impairment in the value of goodwill and other intangible assets by considering factors such as expected future operating income, current operating results, and other economic factors. Management believes no impairment has occurred.\nSoftware Development Costs --------------------------\nSignificant internal software development costs are being capitalized and amortized over their estimated useful lives, principally five years, commencing when the software is installed and available for use.\nDeferred Financing Costs ------------------------\nDeferred financing costs are amortized over the term of the related debt.\nIncome Taxes ------------\nThe Company has adopted the liability method of accounting for income taxes in accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109) as of December 31, 1990 (see note 9 - Income Taxes). Deferred income taxes are recognized for temporary differences between financial statement and income tax bases of assets and liabilities and net operating loss carryforwards for which income tax benefits will be realized in future years.\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n1. Summary of Significant Accounting Policies (Continued): -------------------------------------------------------\nSystemwide Sales ----------------\nSystemwide sales include retail sales of all Company Stores, sales of ABWF since the date of acquisition, retail sales of all Franchised Stores and sales of manufactured products to outside third parties.\nFranchise Revenue Recognition -----------------------------\nInitial franchise fees are recognized as income when the Company has substantially performed all of its material obligations under the franchise agreement. Franchise royalty fees and advertising contributions are recognized as income based on a percentage of franchise sales. Sales of inventories to franchisees are recognized as sales when shipped to the franchisee.\nCash and Cash Equivalents -------------------------\nFor purposes of reporting cash flows, the Company considers short-term investments with maturities of three months or less when purchased to be cash equivalents. Cash equivalents are stated at cost, which approximates market value.\nReclassification ---------------- Certain balances for the years ended January 3, 1993 and December 29, 1991 have been reclassified to conform to the presentation adopted for the year ended January 2, 1994. These reclassifications did not result in a change in net loss or common stockholder's equity.\n2. Acquisitions: -------------\nOn December 17, 1993, the Company completed its acquisition of the ABF Assets. ABF was a Detroit, Michigan based direct response marketing organization, engaged in the sale of name-brand and private-label horizontal, vertical, pleated and wood blinds and name-brand wallcovering. Also included in the acquisition were 24 retail stores previously operated by the former owner of ABF in metropolitan Detroit and Chicago of which five stores were converted to Color Tile stores and the remainder were subsequently closed.\nThe purchase price of approximately $80 million, including fees and expenses of approximately $6.5 million, was provided from proceeds of the Senior Notes Offering which was consummated on December 17, 1993.\nThe acquisition was accounted for as a purchase and the results of operations of ABWF have been included in the accompanying consolidated financial statements since November 1, 1993, the effective date of the acquisition of the ABF Assets by ABF Acquisition (see note 15 - Transactions with Related Parties).\nThe cost of the acquisition has been allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed. The allocation resulted in goodwill of\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n2. Acquisitions (Continued): ------------------------\napproximately $101 million, which is being amortized over 40 years. The allocation of purchase price will be finalized during 1994.\nThe following unaudited proforma results of operations assumes the acquisition of the ABF Assets occurred at the beginning of 1993 and 1992 after including the impact of certain adjustments, such as: amortization of intangibles, increased interest expense on the acquisition debt, elimination of prior owner's compensation and the related income tax effect. These proforma results are prepared for informational purposes only and are not necessarily indicative of future results of operations, nor the historical results of operations that would have occurred had the acquisition been consummated as of the assumed dates.\n1993 1992 -------- --------\n(unaudited) Net sales $624,241 $644,469 Gross profit 260,990 285,121 Loss before extraordinary item (5,132) (25,091) Net loss (17,735) (25,692)\n3. Inventories: ------------\nInventories at January 2, 1994 and January 3, 1993 are summarized as follows:\n1993 1992 ---- ---- Finished goods $81,381 $71,994 Work in progress 656 557 Raw materials 1,515 1,494 -------- ----- $83,552 $74,045 ======= ======\n4. Property, Plant and Equipment: -----------------------------\nProperty, plant and equipment and estimated useful lives at January 2, 1994 and January 3, 1993 consist of the following:\nLife 1993 1992 ---- ---- ----\nLand $26,790 $26,790 Buildings 35 years 26,007 26,363 Assets under capital leases 3-35 53,934 51,121 Leasehold improvements 5-10 29,253 27,772 Fixtures and equipment 2-15 48,153 44,630\nConstruction in progress 1,621 884 ----- ----- 185,758 177,560 Less: accumulated depreciation (65,765) (55,611) ------ ------ $119,993 $121,949 ======= =======\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n4. Property, Plant and Equipment (Continued): -----------------------------------------\nDepreciation expense was $15,626, $17,336 and $16,970 for 1993, 1992 and 1991, respectively.\n5. Goodwill and Other Intangible Assets: ------------------------------------\nGoodwill and other intangible assets and related amortization periods at January 2, 1994 and January 3, 1993 consist of the following:\nAmortization 1993 1992 Period ---- ---- -------- Goodwill 40 years $289,668 $188,585 Less: accumulated amortization (19,844) (14,738) ------ ------ Goodwill, net 269,824 173,847\nOther intangible assets\nFavorable operating leases and lease options Lease term 44,316 44,316 Other 5 - 40 years 29,868 32,058 ----- ------ 74,184 76,374\nLess: accumulated amortization (33,488) (30,997) ------ ------ Other intangible assets, net 40,696 45,377 ------ ------ $310,520 $219,224 ======= =======\n6. Accrued Expenses and Other Current Liabilities: ----------------------------------------------\nAccrued expenses and other current liabilities at January 2, 1994 and January 3, 1993:\n1993 1992 ---- ---- Employee compensation $4,867 $6,581 Accrued payroll, property and sales tax 4,757 5,173 Accrued interest 1,111 225 Other accrued expenses 20,238 10,890 Layaways and deposits 6,008 6,086 -------- ------ $36,981 $28,955 ======== ======\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n7. Long-term Debt: --------------\nLong-term debt at January 2, 1994 and January 3, 1993 consists of the following:\n1993 1992 ---- ---- 10 3\/4% Senior notes $200,000 Term loan 46,000 $140,000 Revolving line of credit 80,600 85,300 Mortgage loans on real estate 3,447 4,127 Obligations under capital leases 23,310 25,335 ------- ------- Total long-term debt 353,357 254,762 Less Current portion (5,790) (15,073) -------- -------- $347,567 $239,689 ======== ========\nThe 10 3\/4% Senior Notes due December 15, 2001 (the \"Senior Notes\"), were issued on December 17, 1993. The Senior Notes are redeemable at the Company's option, in whole or in part, at any time or from time to time on or after December 15, 1997, initially at 104.61% of their principal amount and thereafter at prices declining to 100% of the principal amount at December 15, 2000, in each case together with accrued and unpaid interest through the redemption date. In addition, if the Company or Holdings consummates one or more public offerings of its common stock prior to December 15, 1996, the Company may redeem up to 35% of the initially outstanding principal amount of the Senior Notes with the net proceeds of any such public offering available to the Company at a price of 110% of their principal amount, together with accrued and unpaid interest, if any; provided, however, that following such redemption at least 65% of the aggregate principal amount of the Senior Notes originally issued remains outstanding. The Senior Notes are not subject to any sinking fund requirement. The Senior Notes are uncollateralized obligations of the Company.\nThe Company has a Senior Credit Agreement with a group of commercial banks and other institutional investors which provides for a $46,000 term loan facility, originally $150,000, due in varying amounts through 1998 and a $100,000 revolving line of credit facility expiring in 1998. The term loan facility was used to repurchase certain outstanding debt securities and for payment of fees and expenses related to the repurchase of those debt securities. The entire $100,000 revolving line of credit can be used to fund working capital requirements. The Senior Credit Agreement contains certain covenants that may affect the operations of the Company. These covenants, among other things, restrict, subject to certain limitations, the Company's ability to incur additional indebtedness or issue redeemable preferred stock, enter into transactions with affiliates, make payments in respect of its capital stock, make capital expenditures, sell assets and purchase subordinated debt. At January 2, 1994, in accordance with these covenants, the Company was restricted from paying dividends on its\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n7. Long-term Debt (Continued): --------------------------\ncommon stock. Such covenants also require the Company to maintain certain financial ratios.\nTrade and certain standby letters of credit, which amounted to $10,657 at January 2, 1994, reduce the amounts available for additional borrowings and letters of credit under the revolving line of credit by a like amount. At January 2, 1994, the Company had approximately $8,700 available under the revolving line of credit facility for additional working capital borrowings.\nThe outstanding borrowings under the Senior Credit Agreement accrue interest at the higher of the bank's announced reference rate or 1\/2 % above the federal funds rate, in each case plus 1-1\/2 % (7-1\/2% at January 2, 1994). Outstanding borrowings can be converted to Eurodollar loans which accrue interest at LIBOR plus 2-3\/4 %. In accordance with terms of the Senior Credit Agreement, certain borrowings have been converted to Eurodollar loans which accrued interest at rates from 6.00% to 6.25% at January 2, 1994. Commercial letter of credit fees are 3\/4% of the stated amount and standby letter of credit fees are 2-1\/2% per annum. In addition, the Company is required to pay commitment fees of 1\/2% per annum on available lines of credit. The Company paid commitment fees of approximately $106 and $124 for the years ended January 2, 1994 and January 3, 1993, respectively. The Senior Credit Agreement, which expires on December 31, 1998, is collateralized by substantially all of the assets of the Company.\nIn conjunction with the Senior Notes Offering, the Company and its lenders substantially modified the Senior Credit Agreement to, among other things, permit the Senior Notes Offering, the purchase of ABF Assets, and the disposal of the Company's Canadian operations and certain retail stores acquired from the former owner of ABF. The amendment also increases the level of permitted capital expenditures, reduces the interest coverage ratio and other financial covenants required to be maintained under the agreement and significantly modifies both the timing and amounts of the minimum future repayments of borrowings under the term loan portion of the Senior Credit Agreement.\nDuring 1993, the Company prepaid $86,500 of borrowings under the term loan portion of the Senior Credit Agreement with proceeds of the Senior Notes Offering. In conjunction with this early extinguishment of debt and substantial modifications to the Senior Credit Agreement, the Company has recorded an extraordinary loss of $12,603 on the write-off of related deferred financing costs in the consolidated statement of operations.\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n7. Long-term Debt (Continued): --------------------------\nDuring 1992 and 1991, the Company repurchased all of the aggregate principal amount of the 12 3\/8% Senior Notes, 13% Senior Subordinated Notes and 13 3\/4% Subordinated Debentures with proceeds from the Company's term loan, line of credit facility and the proceeds of the private placement of the Class B, Series A Senior Increasing Rate Preferred Stock in August 1992. In conjunction with these early extinguishments of debt, the Company recorded a pretax loss of $910 in 1992 and pretax gain of $7,403 in 1991, which after an income tax benefit of $309 and a tax provision of $2,517, respectively, were recorded as extraordinary items in the consolidated statement of operations.\nAt Janaury 2, 1994, the fair value of the Senior Notes, excluding accrued interest, was determined to be $203,000, based on quoted prices for the issue. The estimated fair value of the Company's remaining long-term debt approximates the carrying amount based on discounted cash flows and book values.\nMortgage loans on real estate have interest rates ranging from 9.25% to 9.75% and are payable monthly in arrears.\nFuture minimum payments of long-term debt are as follows:\n1994 $5,790 1995 4,830 1996 15,923 1997 17,952 1998 102,403 Thereafter 206,459 -------- $353,357 ========\n8. Capital and Other Leases: ------------------------\nRetail operations of Company Stores are conducted in 662 leased and 138 owned facilities. Under the lease agreements for leased facilities, initial terms normally range from ten to twenty-five years, most of which include renewal options. Leases are generally triple net and provide that the Company will pay real estate taxes, insurance, common area maintenance and other operating costs in addition to specified rental amounts. Certain leases contain rental escalation provisions and\/or contingent rentals based on sales.\nThe building portion of minimum rentals which meet the criteria of capital leases are capitalized, and the related assets and obligations are recorded using the rate implicit\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n8. Capital and Other Leases (Continued): ------------------------------------\nin the lease. The asset is amortized on a straight-line basis over the lesser of the useful life of the building or the lease term.\nAssets under capital leases at January 2, 1994 and January 3, 1993 consist of the following: 1993 1992 ---- ---- Buildings (manufacturing and distribution facilities) $5,612 $5,612 Buildings (retail stores) 37,470 37,470 Fixtures and equipment 10,852 8,039 ------- ------\n53,934 51,121 Less: accumulated amortization (25,564) (18,480) -------- --------\n$28,370 $32,641 ======== ========\nCertain other noncancellable leases and the land portion of the minimum rentals under building capital leases are accounted for as operating leases. Total rental expense was as follows:\n1993 1992 ---- ---- Minimum rentals $29,906 $27,367 Contingent rentals 696 754 Less: sublease rentals (7,315) (4,547) -------- -------- $23,287 $23,574 ========= ========\nMinimum rental commitments are summarized as follows:\nCapital Operating Leases Leases ------ ------ 1994 $7,310 $22,393 1995 5,811 20,328 1996 4,385 19,172 1997 3,669 17,699 1998 2,796 16,083 Thereafter 8,174 66,630 -------- --------- Total minimum lease payments 32,145 $162,305 ======== Less: amount representing interest (8,835) -------- Present value of net minimum lease payments $23,310 ========\nMinimum payments for capital and operating leases have not been reduced by minimum sublease rentals of approximately $2,104 for capital leases and $27,608 for operating leases which are due in the future under noncancellable subleases.\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n8. Capital and Other Leases (Continued): ------------------------------------\nIn addition, minimum payments do not include contingent rentals which may be paid under certain store leases on the basis of a percentage of sales in excess of stipulated amounts or future rental increases as periodically determined.\n9. Income Taxes: ------------\nThe Company has been included in the consolidated federal income tax return of its parent company, Holdings, beginning with the income tax return filed of 1990. Income taxes are presented by the Company as if it filed a separate federal income tax return.\nThe provision (benefit) for income taxes consists of the following:\n1993 1992 1991 ---- ---- ---- Current: Federal $544 ($2,517) State $660 574 384 Foreign (19) 122 ---- ---- --------- Provision (benefit) for income taxes 641 1,240 (2,133)\nProvision for current taxes included in extraordinary item (309) 2,517 ---- ------ -------- 641 931 384 ---- ------ -------- Deferred: Federal\n---- ------ -------- Provision for income taxes $641 $931 $384 ==== ====== ========\nThe following is a reconciliation of income taxes at the Federal statutory rate with income taxes recorded by the Company:\n1993 1992 1991 ---- ---- ---- Tax (benefit) at $( 447) $(6,850) $(10,413) federal statutory rates Extraordinary item (4,411) (309) 2,517 State income taxes, net of federal tax benefit 429 379 253 Foreign income taxes (19) 122 Losses providing no tax benefit 3,298 5,948 6,387 Amortization of goodwill 1,791 1,406 1,640 Alternative minimum tax 235 --------- ------ --------\nProvision for income taxes $ 641 $ 931 $ 384 ======== ====== ========\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n9. Income Taxes (Continued): ------------------------\nThe components of the net deferred tax asset recognized as of January 2, 1994 and January 3, 1993 are as follows:\n1993 1992 ---- ----\nDeferred tax liability: Depreciation ($3,928) ($4,355) ------ ------ Deferred tax asset: Tax net operating loss carryforward 37,121 30,086 Other, net 16,286 20,307 ------ ------ 53,407 50,393 Less: Valuation allowance (35,323) (31,886) ------ ------ Deferred tax asset, net of Valuation allowance 18,084 18,507 ------ ------ Net deferred tax asset $14,156 $14,152 ======= =======\nAs of January 2, 1994, the Company has net operating loss carryforwards of approximately $106,335 and $82,558 for federal income tax and alternative minimum tax purposes, respectively. These carryforwards will expire from 2001 through 2006. Subsequently recognized tax benefits of the valuation allowance will reduce goodwill in the amount of $6,001.\n10. Commitments and Contingencies: -----------------------------\nThere are various claims and pending actions incident to the business operations of the Company. In the opinion of management, the Company's potential liability in all pending actions and claims, in the aggregate, is not material.\n11. Redeemable Preferred Stock: --------------------------\nRedeemable preferred stock at January 2, 1994 and January 3, 1993 is comprised of the following:\n1993 1992 ---- ---- Class B, Series A Senior Increasing Rate Preferred Stock,$57,825 liquidation value at January 2, 1994 $54,306 $53,035 Senior Cumulative Preferred Stock, $32,959 liquidation value at January 2, 1994 32,532 29,561 ------- ------- Redeemable preferred stock $86,838 $82,596 ======= =======\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n11. Redeemable Preferred Stock (Continued): --------------------------------------\nThe Company had 2,200,000 shares of Class B, Series A Senior Increasing Rate Preferred stock, $1 par value, $25 liquidation value (the \"Series A Shares\") issued and outstanding at January 2, 1994 and January 3, 1993. The Series A Shares provide for the payment of cumulative quarterly cash dividends equal to $.8125 per share at issuance.\nThe quarterly dividend which applied to quarters that commenced on October 15, 1992 and April 15, 1993 was equal to $.84375 per Series A Share. This quarterly dividend will increase by $.03125 per share over the previously prevailing quarterly dividend on each July 15 and January 15, commencing with the quarterly dividend payable for the quarter beginning on January 15, 1994, up to a maximum quarterly dividend of $1.0625 per share. Quarterly dividends payable in excess of $.9375 per share may, at the option of the Company, be paid to holders of the shares in whole or in part by the issuance of additional shares at the rate of one additional share for each $25.00 of such dividends not paid in cash. The difference between the ultimate redemption value and the initial carrying value is being accreted over the redemption period.\nThe Series A Shares are subject to mandatory redemption at $25.00 per share, plus accrued but unpaid dividends on January 15, 2003. The Series A Shares may be redeemed, in whole or in part, on or after July 15, 1993 at prices beginning at $25.25 on January 15, 1993 and increasing to $26.00 per share on July 15, 1995 and then subsequently declining to $25.00 at July 15, 1998 and thereafter. As of January 2, 1994 and January 3, 1993, the carrying amount of the Series A Shares has been increased $3,357 and $1,854, respectively, for undeclared and unpaid cash dividends.\nThe Company had 200,000 shares of Senior Cumulative Preferred Stock, $1 par value, $100 liquidation value issued and outstanding at January 2, 1994 and January 3, 1993. From July 15, 1989 through January 15, 1995, the Senior Cumulative Preferred Stock provides for the accrual, on a quarterly basis, of cumulative dividends in the form of additional shares of Senior Cumulative Preferred Stock at the annual rate of .1450 shares per share of Senior Cumulative Preferred Stock payable January 15, 1995. Such accrued dividends do not compound additional dividends. Commencing January 15, 1995, the Senior Cumulative Preferred Stock provides for cumulative dividends at the annual rate of 14.50% per share payable quarterly after January 15, 1995. Dividends which are due and unpaid accrue additional dividends, compounding on a quarterly basis, at the rate of $14.50 per share per annum. The difference between the ultimate redemption value and the initial carrying value is being accreted over the redemption period.\nThe Senior Cumulative Preferred Stock is subject to mandatory redemption in an amount equal to 50% of the outstanding shares on October 15, 1998 and the remaining 50% of such outstanding shares on October 15, 1999. Certain features of the Senior Cumulative Preferred Stock were modified in connection with the 1989 Merger. As of January 2,\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n11. Redeemable Preferred Stock (Continued): --------------------------------------\n1994 and January 3, 1993 the carrying amounts of the Senior Cumulative Preferred Stock have been increased by approximately $12,962 and $10,067, respectively, representing cumulative dividends not currently declared or paid, but which are payable under the mandatory redemption features.\nAt January 2, 1994, the fair value of the Series A Shares was determined to be $57,200 based on quoted prices for the issue, excluding accrued but undeclared dividends. The estimated fair value, including accrued but undeclared dividends, of the Senior Cumulative Preferred Stock approximates the carrying amount based upon discounted cash flows and book values.\n12. Special Charges: ---------------\nDuring the fourth quarter of fiscal 1992, following a detailed study of its operations, the Company recorded a write-down of certain property, plant, equipment and intangible assets, and established provisions for restructuring of operations, store closures and conversion of certain stores to Franchised Stores. These write-downs and provisions aggregated $30,000 and are reflected as a Special Charge in the Consolidated Statement of Operations.\n13. Gain (Loss) on Disposal of a Line of Business: ----------------------------------------------\nEffective October 3, 1993, the Company decided to dispose of its wholly owned Canadian subsidiary, Factory Carpet, which operates 37 retail stores in Canada (including 9 Franchised stores). The Company is in the process of negotiating the sale of the Canadian operations. In connection with the disposition of Factory Carpet, the Company recorded a charge to continuing operations of $8,651. The sales, costs and related expenses of Factory Carpet's operations have been eliminated from the individual line items of the 1993 Consolidated Statement of Operations and the operating losses of this line of business have been included on a one-line basis in the loss from disposal of a line of business as follows:\n---- Net sales $23,661 ========\nOperating loss (849) Estimated loss on disposal (8,651) ------- Loss on disposal of a line of business $(9,500) ========\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n13. Gain (Loss) on Disposal of a Line of Business (Continued): ----------------------------------------------------------\nEffective May 15, 1992, the Company completed the sale of its hardwood flooring manufacturing plant (the \"Wood Plant\") located in Melbourne, Arkansas and realized a pre-tax gain of $4,007. The proceeds of the sale, before fees and related expenses, included $11,809 in cash and the buyer's assumption of certain liabilities, including an agreement to defease $2,600 of industrial revenue bonds related to the Wood Plant.\n14. Supplemental Cash Flow Information: ----------------------------------\n1993 1992 1991 ---- ---- ---- Supplemental disclosure of cash flow informations: Interest paid $18,192 $28,320 $55,950 Income taxes paid $444 $1,281 $450 Non-cash investing and financing activities: Capital lease obligations incurred for property, plant and equipment $2,096 $3,400 Senior Increasing Rate Preferred Stock unpaid dividends $1,503 $1,854 Senior Cumulative Preferred Stock dividends in kind $2,895 $2,923 $2,900\n15. Transactions With Related Parties: ---------------------------------\nDuring the year ended December 29, 1991 the Company incurred interest expense on the Junior Subordinated Notes totaling $10,291 of which $6,860 was deferred. On November 27, 1991, Holdings purchased one additional share of the Company's common stock for $79,704. With these funds, the Company redeemed the $60,000 of the Junior Subordinated Notes, related deferred interest of $10,685 and accrued interest of $3,431, at a premium of $5,588.\nIn conjunction with the refinancing of the Company's debt in 1991, $3,750 was paid to INVESTCORP International, Inc. (\"International\"), an affiliate, for financing advisory fees for its assistance in arranging the Senior Credit Agreement. Additionally, an affiliate of INVESTCORP was paid $6,000 in connection with the repurchase of certain outstanding debt securities of the Company. These transactions have been reviewed by the independent member of the Board of Directors who determined that, and the Company has received a letter from an independent nationally known investment banking firm which concluded that, the terms and conditions associated with these transactions were as favorable to the Company as the Company could have reasonably obtained from an independent third party.\nOn October 5, 1993, ABF Acquisition, an affiliate of Investcorp, entered into an agreement (the \"ABF Acquisition Agreement\") to acquire the ABF Assets and assume certain liabilities in connection therewith. ABF Acquisition agreed to acquire the ABF\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n15. Transactions with Related Parties (Continued): ---------------------------------------------\nAssets to facilitate the acquisition of such assets by the Company pending (i) the receipt of proceeds from the Senior Notes Offering, (ii) the execution of an amendment to the Senior Credit Agreement permitting, among other things, the acquisition of the ABF Assets, and (iii) the receipt of certain required governmental consents. The ABF Acquisition Agreement provided for the acquisition of the ABF Assets and certain related entities in exchange for the assumption of certain specified liabilities and the payment of a purchase price of approximately $73,000 net of the anticipated effect of certain adjustments pursuant to the ABF Acquisition Agreement. In connection with such acquisition, affiliates of Investcorp received approximately $4,300 from ABF Acquisition in respect of a bridge loan commitment, a guarantee of the bridge loan provided by Chemical Bank to finance the acquisition of the ABF Assets by ABF Acquisition and the payment of fees for merger advisory services. A portion of the fees payable to affiliates of Investcorp was intended to compensate such affiliates for committing to provide additional funds in the event that the Company was unable to consummate the acquisition of the ABF Assets as described below.\nThe Company entered into an option (the \"Option Agreement\") to acquire the ABF Assets and assume the liabilities associated therewith from ABF Acquisition at a price approximately $80,000, including fees and expenses of $6,500, which reflects the same price paid by ABF Acquisition for the ABF Assets, adjusted to reflect amounts payable to certain Investcorp affiliates, as described above, and the reimbursement of transaction costs incurred in connection with such acquisition. The Company exercised its rights under the Option Agreement and acquired the ABF Assets contemporaneously with the completion of the Senior Notes Offering on December 17, 1993.\nIn connection with the Option Agreement, the Company and ABF Acquisition entered into a Management Services Agreement dated November 4, 1993 pursuant to which the Company agreed to provide management services to ABF Acquisition until the earlier to occur of the closing of the exercise of the Company's option to purchase the ABF Assets from ABF Acquisition pursuant to the Option Agreement, or November 4, 1994. The Management Services Agreement provides for the Company to receive a fee for such services. Pursuant to this agreement, the Company has received a fee of approximately $2 and does not expect to receive any additional compensation.\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n15. Transactions with Related Parties (Continued): ---------------------------------------------\nPursuant to the ABF Acquisition Agreement, the parties made customary representations, warranties and covenants typically contained in agreements of this type and entered into customary indemnities for breaches of such representations, warranties and covenants set forth in the ABF Acquisition Agreement. Upon the acquisition of the ABF Assets, ABF Acquisition assigned all its rights under the ABF Acquisition Agreement to the Company.\nThe Company paid International $500 for management fees during each of the fiscal years 1993, 1992 and 1991.\nThe Color Tile Employees Investment Plan (\"Investment Plan\"), which is under the direct control of Company management, owns 44 properties leased by the Company. During 1993, 1992 and 1991 the Company paid approximately $3,460, $3,085 and $3,113, respectively, in rentals to the Investment Plan for these properties.\n16. Employee Benefit Plans: ----------------------\nThe Investment Plan is a defined contribution plan open to all employees upon completing certain periods of service with the Company. This plan requires the Company to make contributions to the plan equal to a certain percentage of the employee's contribution rate during the year. The Company's contributions to the Investment Plan were $829, $846 and $715, respectively, for 1993, 1992 and 1991.\nUnder the Color Tile Family Security Plan (\"Family Security Plan\"), salaried and certain other employees who have three years of service with the Company are eligible to become participants in the Family Security Plan. The Family Security Plan provides that in the event of the death of a participant who is an employee, who is on authorized leave of absence or who is under an approved disability, the participant's beneficiary will receive approximately one-half the participant's Family Security Plan salary on a monthly basis for a defined period of time. The Company provides a noncontributory benefit for a period of 10 years; employees may also obtain, on a contributory basis, the same benefit until the employee would have attained age 65. The Family Security Plan is administered through a Voluntary Employees' Beneficiary Association (\"VEBA\") qualified under Section 501(c)(9) of the Internal Revenue Code of 1986. The Family Security Plan is funded by life insurance owned by the VEBA. A participant's Family Security Plan salary approximates the total compensation paid to the participant by the Company during the plan year.\nCOLOR TILE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued (Amounts in Thousands, except share amounts)\n16. Employee Benefit Plans (Continued): ----------------------------------\nOfficers and director employees participate in the Family Security Plan on the same terms as other employees. For 1993, 1992 and 1991 the Company contributed $261, $228 and $237, respectively, to the Family Security Plan.\n17. Supplemental Selected Quarterly Financial Data (Unaudited): ----------------------------------------------------------\nUnaudited summarized financial data by quarter for 1993, 1992 and 1991 is as follows:\nQuarter Ended Year ended ------------------------------------------- January 2, 1994: April 4 July 3 October 3 January 2 --------------- ------- ------ --------- --------- Net sales $134,680 $131,596 $135,287 $153,564 Cost of sales 71,566 72,636 74,430 90,896 Selling, general and administrative expenses 47,585 46,610 48,065 49,191 Depreciation and amortization 6,126 5,930 5,979 7,511 -------- -------- -------- -------- Operating income 9,403 6,420 6,813 5,966\nLoss on disposal of a line of business (346) (434) (8,720) Interest expense, net (4,855) (4,818) (4,740) (5,967) Income taxes (300) (223) (101) (17) Extraordinary loss on early extinguishment of debt, net (12,603) -------- -------- --------- -------- Net income (loss) $3,902 $945 $(6,748) $(12,621) ====== ======= ======== ========\nQuarter Ended Year ended -------------------------------------------- January 3, 1993: March 29 June 28 September 27 January 3 --------------- -------- ------- ------------ --------- Net sales $139,864 $150,193 $146,772 $143,556 Cost of sales 73,552 79,169 79,965 78,682 Selling, general and administrative expenses 53,036 55,342 51,304 49,114 Depreciation and amortization 7,107 6,821 6,830 7,925 Special charges 30,000 -------- -------- --------- --------- Operating income 6,169 8,861 8,673 (22,165) (loss) Gain on sale of assets 4,007 Interest expense, net (7,928) (6,808) (5,930) (5,031) Income taxes (123) (339) (547) (231) Extraordinary loss on early extinguishment of debt, net (601) -------- -------- ------ -------- Net income (loss) $(1,882) $ 5,721 $1,595 $(27,427) ======= ======= ====== =======\n17. Supplemental Selected Quarterly Financial Data (Unaudited) (Continued): ----------------------------------------------------------------------\nIn conjunction with the recognition of the loss on the disposal of the Canadian operations, the sales, costs and related expenses of Factory Carpet's operations have been excluded from the individual line items of the 1993 Selected Quarterly Financial data and the operating losses of this line of business have been included on a one-line basis in the loss on disposal of a line of business for each quarter of 1993 (see note 13 - Gain (Loss) on Disposal of a Line of Business).\nSCHEDULE V\n(a) Additions for 1993 include the ABF Assets acquired effective November 1, 1993.\n(b) Includes $2,532 of fixed asset write-offs related to the disposal of Canadian operations during 1993.\n(c) Represents transfers of assets from construction in progress to other assets for 1993, 1992 and 1991.\n(d) Represents transfer of capital lease assets purchased and foreign currency translation adjustments associated with Factory Carpet for the 1992.\n(e) Represents $625 of fixed asset write-offs related to the Special Charges at January 3, 1993.\nS-1\nSCHEDULE VI\nCOLOR TILE, INC. ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (Amounts in Thousands)\n(a) Includes $12,417 of expense related to Special Charges at January 3, 1993.\n(b) Includes $1,235 of retirements related to the disposition of Canadian operations.\n(c) Represents transfers of capital lease assets purchased and foreign currency translation adjustments associated with Factory Carpet for the year ended January 3, 1993.\nS-2\nSCHEDULE VIII\nCOLOR TILE, INC. VALUATION AND QUALIFYING ACCOUNTS (Amounts in Thousands)","section_15":""}
{"filename":"772572_1994.txt","cik":"772572","year":"1994","section_1":"ITEM 1. BUSINESS. ---------\nGeneral -------\nEdac Technologies Corporation (\"Edac\") was formed in 1985 for the purpose of acquiring Gros-Ite Industries, Incorporated (which had three operating divisions: Time Engineering, Gros-Ite and Spectrum). In the past six years Edac has sold the assets of its other operations and now operates only the Gros-Ite division (\"Gros-Ite\").\nProducts --------\nEdac currently offers design and manufacturing services for the aerospace industry in areas such as special tooling, equipment and gauges, and components used in the manufacture, assembly and inspec-tion of jet engines. Edac also offers design and manufacturing services for the medical instruments industry in such areas as components used in the manufacture of medical instruments and special tooling. Edac also designs and manufactures specialized machines for a variety of other applications.\nEdac maintains manufacturing facilities with computerized numerically controlled machining centers, and grinding, welding, and sheet metal fabrication, painting and assembly capabilities. Items manufactured by Edac include precision rings, and other components for jet engines, components for medical instruments, as well as industrial spindles, environmental test chambers and specialized machinery designed by Edac or others and other assemblies requiring close tolerances.\nPatents and Trademarks ----------------------\nEdac currently holds no patents or registered trademarks, tradenames or similiar intellectual property. The Company believes that the nature of its business presently does not require the development of patentable products or registered tradenames or trademarks to maintain market growth.\nMarketing and Competition -------------------------\nEdac has numerous competitors both in design and manufacturing. Many of the independent design firms with which it competes are smaller than Edac and do not provide the variety of services that Edac provides. Edac also competes with its customers' in-house design and technical services capabilities. Edac believes that it is able to compete effectively with independent design firms and in-house design staffs because of its experience and the timeliness and competitive pricing of its services.\nMany firms also compete with Edac's manufacturing operations. However, Edac believes that it will be able to compete effectively with these firms on price, ability to meet customer deadlines and the stringent quality control standards it employs. Edac also believes that its integration of design and manufacturing capabilities offers a competitive advantage.\nEdac's manufactured products are sold primarily through individual purchase orders on a quotation or bid basis. Its sales personnel and management maintain contacts with purchasing sources to keep informed as to manufacturing projects available for quotation. Edac occasionally enters into annual manufacturing contracts on specific components.\nFor its fiscal year ended December 31, 1994, approximately 69% of Edac's net sales were derived from sales to United Technologies Corporation.\nApproximately 70% of Edac's design business is done on a time and material basis based on hourly rates established annually. Most of Edac's manufacturing is done on a firm quotation basis. Less than 10% of Edac's net sales are attributed to government contracts subject to termination or renegotiation at the option of the U.S. Government. United Technologies Corporation annually negotiates hourly billing rates for design work and is free to audit costs actually charged.\nBacklog -------\nEdac's backlog as of December 31, 1994, was approximately $24,487,000 compared to $20,860,000 as of December 31, 1993. Backlog consists of accepted purchase orders that are cancellable by the customer without penalty, except for payment of costs incurred, and may involve delivery times that extend over periods as long as two or three years. Edac presently expects to complete approximately $15,900,000 of its December 31, 1994 backlog within the next 12 months.\nEmployees ---------\nAs of March 19, 1995 Edac had approximately 152 employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. ------------\nThe Company anticipates adding 20,000 additional square feet in 1995. (See Management's Discussion and Analysis).\n(1) Property subject to mortgage securing certain corporate indebtedness.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. ------------------\nNone\nITEM 4.","section_4":"ITEM 4. SUBMISSION TO A VOTE OF SECURITY HOLDERS. -----------------------------------------\nNo matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED ------------------------------------------------- STOCKHOLDERS MATTERS. ---------------------\nInformation in response to this item is incorporated herein by reference to \"Market Information\" on page 3 of the Registrant's 1994 Annual Report to Shareholders\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. ------------------------\nInformation in response to this item is incorporated herein by reference to \"Selected Financial Information\" on page 3 of the Registrant's 1994 Annual Report to Shareholders.\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 to \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on page 4 through 7 of the Registrant's 1994 Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. --------------------------------------------\nInformation in response to this item is incorporated herein by reference to pages 8 through 20 of the Registrant's 1994 Annual Report to Shareholders.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ------------------------------------------------ ACCOUNTING AND FINANCIAL DISCLOSURE. ------------------------------------\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. ---------------------------------------------------\nInformation in response to this item is incorporated herein by reference to \"Election of Directors\" in the Registrant's definitive Information Statement for its 1995 Annual Meeting of Shareholders, which will be filed within 120 days after the end of the Registrant's fiscal year ended December 31, 1994.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. -----------------------\nInformation in response to this item is incorporated herein by reference to \"Executive Compensation\" in the 1995 Information 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 to \"Principal Security Holders and Security Holdings of Management\" in the 1995 Information Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. -----------------------------------------------\nInformation in response to this item is incorporated herein by reference to \"Certain Transactions\" in the 1995 Information Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON ------------------------------------------------------- FORM 8-K. ---------\n(a) Documents filed: ---------------\n1. Financial Statements.\nThe financial statements required to be filed by Item 8 hereof have been incorporated by reference to the Registrant's 1994 Annual Report to Shareholders and consist of the following:\nReport of Independent Public Acountants\nConsolidated Statements of Operations--Years ended December 31, 1994, 1993 and 1992\nConsolidated Balance Sheets--December 31, 1994 and 1993.\nConsolidated Statements of Changes in 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 financial statement schedule of Edac is included in Item 14(d) hereof:\nReport of Independent Public Accountants on Schedule\nSchedule II: Valuation and qualifying accounts\nAll other schedules for which provisions are 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(b) Reports on Form 8-K -------------------\nNone.\n(c) Exhibits: --------\nSee Exhibit Index included as the last part of this Report, which Index is incorporated herein by this reference.\n(d) Financial Statements and Schedules ----------------------------------\nRefer to Item 14a above for listing of financial statements and schedules.\nLETTERHEAD OF ARTHUR ANDERSEN LLP\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE ----------------------------------------------------\nTo the Shareholders and Board of Directors of\nEdac Technologies Corporation:\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in Edac Technologies Corporation's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated March 3, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule presented on page 9 of this Form 10-K 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 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\nHartford, Connecticut March 3, 1995\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS EDAC TECHNOLOGIES CORPORATION AND SUBSIDIARIES\n(1) Represents write-off of specific accounts receivable.\nSIGNATURES\nPursuant to the requirements of section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nEDAC TECHNOLOGIES CORPORATION\nBY \/s\/ Robert T. Whitty . ---------------------------- Robert T. Whitty, Chief Executive Officer\nBY \/s\/ Glenn L. Purple . -------------------------- Glenn L. Purple Vice President-Finance (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 and on the dates indicated.\n(1) Exhibit incorporated by reference to the Company's registration statement on Form S-1 dated August 6, 1985, commission File No. 2-99491, as amended.\n(2) Exhibit incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1989.\n(3) Exhibit incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1991.\n(4) Exhibit incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n(5) Exhibit incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1993.","section_15":""}
{"filename":"70502_1994.txt","cik":"70502","year":"1994","section_1":"ITEM 1. BUSINESS.\nNational Rural Utilities Cooperative Finance Corporation (the \"Company\" or \"CFC\") was incorporated as a private, not-for-profit cooperative association under the laws of the District of Columbia in April 1969. The principal purpose of CFC is to provide its members with a source of financing to supplement the loan programs of the Rural Electrification Administration (\"REA\") of the United States Department of Agriculture. CFC makes loans primarily to its rural utility system members (\"Utility Members\") to enable them to acquire, construct and operate electric distribution, generation, transmission and related facilities. Most CFC long-term loans to Utility Members have been made in conjunction with concurrent loans from REA and are secured equally and ratably with REA's loans by a single mortgage. CFC also provides guarantees for tax-exempt financings of pollution control facilities and other properties constructed or acquired by its members, and, in addition, provides guarantees of taxable debt in connection with certain lease and other transactions of its members.\nCFC's 1,039 members as of May 31, 1994, included 899 rural electric Utility Members, virtually all of which are consumer-owned cooperatives, 71 service members and 69 associate members. The Utility Members included 833 distribution systems and 66 generation and transmission (\"Power Supply\") systems operating in 46 states and U.S. territories. At December 31, 1992, CFC's member rural electric systems provided service to about 70% of the contiguous continental land territory of the United States, serving approximately 12.2 million consumers representing an estimated 28.8 million ultimate users of electricity and owned approximately $60.8 billion (before depreciation of $16.4 billion) in total utility plant.\nRural Telephone Finance Cooperative (\"RTFC\") was incorporated as a taxable cooperative association in the state of South Dakota in September 1987. RTFC is a controlled affiliate of CFC and was created for the purpose of providing financing to its rural telecommunication members and affiliates. RTFC's bylaws require that the majority of RTFC's Board of Directors be elected from individuals designated by CFC. CFC is the sole source of funding for RTFC. See Note 1 to Combined Financial Statements for summary financial information relating to RTFC at May 31, 1994. As of that date, RTFC had 352 members.\nGuaranty Funding Cooperative (\"GFC\") was organized in December 1991 as a taxable cooperative Association owned by its member rural electric systems and CFC to provide a source of funds for members to refinance their REA guaranteed debt previously held by the Federal Financing Bank of the United States Treasury (\"FFB\"). GFC is a controlled affiliate of CFC (the majority of its directors are appointed by CFC). All loans from GFC are guaranteed by REA. CFC is the sole source of funding for GFC. See Note 1 to Combined Financial Statements for summary financial information relating to GFC at May 31, 1994. As of May 31, 1994, GFC had four members.\nExcept as indicated, financial information presented herein includes CFC, RTFC and GFC on a combined basis.\nNational Cooperative Services Corporation (\"NCSC\") was organized in 1981 as a taxable cooperative, owned and operated by its member rural electric distribution systems, to provide specialized financing and services to the cooperative rural electric industry that CFC could not otherwise provide due to competitive, regulatory or other reasons. NCSC has an independent Board of Directors, with CFC providing all management services through a contractual arrangement. CFC is the source for essentially all of NCSC's financing capabilities through direct loans or, predominantly, providing credit enhancements (guarantees) of debt issued by NCSC in the public and private credit markets. NCSC's financial statements are not combined or consolidated with CFC's.\nMEMBERS\nCFC currently has five classes of members: Class A -- cooperative or nonprofit distribution systems; Class B -- cooperative or nonprofit power supply systems which are federations of Class A or other Class B members; Class C -- statewide and regional associations which are wholly-owned or controlled by Class A or\nClass B members; Class D -- national associations of cooperatives; and Associate Members -- nonprofit groups or entities organized on a cooperative basis which are owned, controlled or operated by Class A, B or C members and which provide nonelectric services primarily for the benefit of ultimate consumers. Associate Members are not entitled to vote at any meeting of the members and are not eligible to be represented on CFC's Board of Directors.\nMembership in RTFC is limited to CFC and commercial or cooperative corporations eligible to receive loans or other assistance from REA and which are engaged (or plan to be engaged) in providing telephone or telecommunication services to ultimate users and affiliates of such corporations.\nMembership in GFC is limited to CFC and cooperative or nonprofit Utility Member systems who have refinanced all or a portion of their FFB debt through CFC.\nSet forth below is a table showing by state or U.S. territory, at May 31, 1994, the total number of CFC, RTFC and GFC members (memberships in each other have been eliminated and corporations which belong to more than one of CFC, RTFC and GFC have been counted only once), the percentage of loans and the percentage of loans and guarantees outstanding.\nLOANS AND GUARANTEES\nGENERAL\nCFC provides its Utility Members with a source of financing to supplement the loan programs of REA. CFC provides the majority of total non-REA direct funding and guarantees obtained by members. CFC's\ninterest rates on loans to its members are set to reflect the cost of its funds allocated to such loans, operating and other expenses and a reasonable margin (see \"Loan and Guarantee Policies\").\nSubstantially all long-term and some intermediate-term loans are secured, while most short-term loans are unsecured. Long-term loans generally have maturities of up to 35 years. Fixed rate long-term loans generally provide for a fixed interest rate for terms of one to 30 years (but not beyond the maturity of the loan). Upon expiration of the term, the borrower may select another fixed rate term of one to 30 years or a variable rate. Variable rate long-term loans have an interest rate which varies monthly as determined by CFC. Intermediate- and short-term loans are made for terms not exceeding 60 months. CFC adjusts the rate monthly on outstanding short-and intermediate-term loans. On notification to borrowers, CFC may adjust the rate semimonthly. Telecommunication loans are secured long-term fixed or variable rate loans with maturities generally not exceeding 15 years and short-term unsecured loans. CFC has also provided guarantees for tax-exempt financings of pollution control facilities and utility properties constructed or acquired by its members and for members' obligations under certain lease transactions (see \"Loan and Guarantee Policies\").\nSet forth below is a table showing loans outstanding to borrowers as of May 31, 1994, 1993 and 1992, and the weighted average interest rates thereon and loans committed but unadvanced to borrowers at May 31, 1994.\n- - --------------- (A) The interest rates in effect at August 1, 1994, were 8.15% for long-term loans with a seven-year fixed rate term, 5.15% on variable rate long-term loans and 5.40% on intermediate-and short-term loans. The rates in effect at August 1, 1994, on loans to associate members were 8.15% for long-term loans with a seven-year fixed rate term, 4.90% on long-term variable rate loans and 5.40% on short-term loans. The rates in effect at August 1, 1994, on loans to telecommunication organizations were 8.75% for long-term loans with a seven-year fixed rate term requiring a 10% equity investment, 8.60% for long-term loans with a seven-year fixed rate term requiring a 5% equity investment, 5.35% on long-term variable rate loans requiring a 10% equity investment, 5.20% on longterm variable rate loans requiring a 5% equity investment, 5.60% on intermediate-term loans and 6.15% on short-term loans.\n(B) Unadvanced commitments include loans approved by CFC for which loan contracts have not yet been executed or for which loan contracts have been executed, but funds have not been advanced.\n(C) During calendar year 1995, $141.8 million of such outstanding fixed rate loans, which currently have a weighted average interest rate of 7.99% per annum, will become subject to rate adjustment. During the first quarter of calendar year 1994, long-term fixed rate loans totaling $52.9 million had their interest rates adjusted. These loans will be eligible to readjust their interest rate again during the first quarter of calendar year 1995 to the lowest long-term fixed rate offered during 1994 for the term selected. At January 1 and May 31, 1994, the seven-year long-term fixed rate was 6.55% and 8.00%, respectively.\n(D) CFC had loans outstanding to NCSC in each of the periods shown. Long-term fixed rate loans outstanding to NCSC as of May 31, 1994, 1993 and 1992, were $47.8 million, $49.0 million and $50.2 million, respectively. In addition, as of May 31, 1994, CFC had unadvanced long-term fixed rate and long-term variable rate loan commitments to NCSC in the amounts of $5.0 million and $9.7 million, respectively.\n(E) Included in long-term variable rate secured loans are $3.5 million, $2.5 million and $2.6 million in unsecured loans to one borrower at May 31, 1994, 1993 and 1992.\n(F) All short-term loans are unsecured, except for $18.2 million, $31.6 million and $23.2 million in loans outstanding at May 31, 1994, 1993 and 1992 that are secured.\n(G) The rates on nonperforming loans are the weighted average of the stated rates on such loans as of the dates shown and do not necessarily relate to the interest recognized by CFC from such loans.\n(H) The rates on restructured loans are the weighted average of the effective rates (based on the present value of scheduled future cashflows) as of the dates shown and do not necessarily relate to the interest recognized by CFC on such loans.\nSet forth below are the weighted average interest rates earned by CFC (recognized in the case of nonperforming and restructured loans) on all loans outstanding during the fiscal years ended May 31.\nINTEREST RATES EARNED ON LOANS\nAt May 31, 1994, CFC's ten largest borrowers, which were all Power Supply members, had outstanding loans from CFC totaling $461.6 million (excluding $394.1 million of loans guaranteed by REA), which represented approximately 7.5% of CFC's total loans outstanding. As of May 31, 1994, outstanding CFC guarantees for these same ten largest borrowers totaled $2,117.7 million which represented 79.2% of CFC's total guarantees outstanding, including guarantees of the maximum amounts of lease obligations at such date. On that date, no member had outstanding loans and guarantees in excess of 10% of the aggregate amount of CFC's outstanding loans and guarantees; however, one of the ten largest borrowers, Deseret Generation & Transmission Co-operative (\"Deseret\"), was in financial difficulty (see Note 10 to Combined Financial Statements). At May 31, 1994, loans outstanding to Deseret (excluding loans guaranteed by REA) accounted for 1.8% of total loans outstanding and guarantees outstanding to Deseret accounted for 12.6% of total guarantees outstanding. Total loans and guarantees outstanding to Deseret equaled 26.8% of total Members' Equity, Members' Subordinated Certificates and the allowance for loan and guarantee losses.\nSet forth below is a table showing CFC's guarantees as of the dates indicated. Substantially all guarantees have been provided on behalf of Power Supply members.\nCFC MEMBER GUARANTEES\n- - ---------------\n* Includes $1,214.6 million, $1,120.8 million and $1,068.0 million at May 31, 1994, 1993 and 1992, respectively, of adjustable rate pollution control bonds which can be tendered for purchase at specified times at the option of the holders (in the case of $382.9 million, $358.6 million and $361.4 million of such bonds outstanding at May 31, 1994, 1993 and 1992, respectively, at any time on seven days' notice, in the case of $289.5 million, $233.2 million and $236.3 million outstanding at May 31, 1994, 1993 and 1992, respectively, at any time on a minimum of one day's notice and in the case of the remainder on a five-week or semiannual\nbasis). CFC has agreed to purchase any such bonds that cannot be remarketed. Since the inception of the program CFC has not been required to purchase any such bonds.\nLoan Contingencies\nCFC maintains a loan and guarantee loss allowance to cover losses that may be incurred in the course of lending or extending credit enhancements. The allowance is periodically evaluated by management with the Board of Directors.\nCFC classifies a loan as nonperforming if interest or principal payments are contractually past due 90 days or more, repayment in accordance with the original terms is not expected due to court order or ultimate repayment is otherwise not expected. Loans in which the original terms have been modified as a result of a borrower's financial difficulties are classified as restructured. Interest income on nonperforming loans is recognized on a cash basis as long as CFC believes the collateral value supports the outstanding principal balance.\nLOAN AND GUARANTEE POLICIES\nLong-Term Loans to Utility Members\nCFC makes long-term loans to both distribution and power supply members. CFC's financial tests for determining the eligibility of a Utility Member initially to receive a long-term loan from CFC historically included two ratios, the Times Interest Earned Ratio (\"TIER\") and the Debt Coverage Ratio (\"DSC\"). TIER is the ratio of (x) net margins and patronage capital as defined under \"The Rural Electric Systems -- Financial Information\" plus interest on longterm debt (including all interest charged to construction) to (y) interest on long-term debt (including all interest charged to construction). DSC is the ratio of (x) net margins and patronage capital plus interest on long-term debt (including all interest charged to construction) plus depreciation and amortization expense to (y) long-term debt service obligations. In applying the tests, obligations under contracts providing for payment whether or not the purchaser in fact receives electric power from the seller, guarantees and other contingent obligations are not considered debt, nor is interest on the proposed CFC loan given effect. In determining the eligibility of a member for a longterm loan, each of the above ratios is averaged for the best two of three calendar years preceding the date of determination, resulting in the \"Average TIER\" and \"Average DSC\".\nUnder CFC's historical lending policy, a member distribution system with an Average TIER and an Average DSC of at least 1.50 and 1.25, respectively, was generally eligible for a long-term mortgage loan from CFC. Under new lending criteria, established in early 1994, distribution systems must instead generally achieve an Average Modified DSC (as described herein) of 1.35. The new DSC (also called the \"Modified DSC\" or \"MDSC\") calculation is the ratio of (x) operating margins and patronage capital plus interest on long-term debt (including all interest charged to construction) plus depreciation and amortization expense plus Non-operating Margins-Interest plus cash received in respect of generation and transmission and other capital credits to (y) longterm debt service obligations. The distribution systems will also be required to have achieved a 20% ratio of equity to total assets at the end of the preceding calendar year (the \"Equity\" test). The average MDSC is computed using the average of the best two of three calendar years' ratios preceding the date of determination. The borrower is required to maintain these ratios at or above the minimum loan eligibility requirements as long as there is a balance outstanding on the loan.\nUnder present REA policy, a system which meets the REA concurrent mortgage requirement for Average TIER and Average DSC, 1.50 and 1.25, respectively, will generally be required to borrow a portion of its financial requirements from a supplemental lender. The extent of the supplemental loan required generally reflects the revenue productivity of the borrower's investment in plant, as measured by the ratio of its investment in plant to its operating revenues (the \"plant-revenue ratio\"). REA regulations, however, permit borrowers which meet certain rate disparity, consumer income or extremely high rate tests to qualify for 100% REA loans. Further, the Administrator of REA has the authority to approve 100% REA loans according to new qualifications established in 1993, or at his\/her discretion on a case-by-case basis.\nIt is anticipated that many CFC loans to distribution systems will continue to be made in conjunction with loans by REA. However, in addition to making concurrent loans, CFC's loan policy permits it to make 100% loans to member systems which meet the applicable minimum borrowing requirements. As of May 31, 1994, CFC had a total of $407.7 million in long-term loans committed and outstanding to 26 Utility Members which did not have long-term REA loans outstanding. These systems have either prepaid their REA loans or have never incurred any REA debt.\nUnder CFC policy, a member Power Supply system having Average TIER and Average DSC of at least 1.0 in each case is eligible for a long-term loan from CFC. Loans have been made both for additions to or acquisition of existing power supply facilities and in connection with the construction of new power supply projects. Loans have also been made in connection with the termination costs associated with certain plant construction for cancelled power supply projects. However, most loans to CFC member Power Supply systems for new generating plants and transmission facilities have been made by other lenders (principally the FFB, which has typically offered rates lower than CFC's) under repayment guarantees from REA, with REA's rights as guarantor secured by a mortgage on the system's properties.\nUnder the REA mortgage, borrowers are required to design their rates to cover all operating expenses, including all payments in respect of principal and interest on notes when due, provide and maintain reasonable working capital and to maintain a TIER of not less than 1.5 and a DSC of not less than 1.25.\nCFC has made and may continue to approve long-term loans to borrowers which fall below CFC's loan eligibility requirements. Such loans are made on a case-by-case basis, based upon the submission by the borrower of, among other things, a long-range financial forecast which indicates that the borrower will, in future years, meet the applicable minimum borrowing requirements. During the past five years, such loans accounted for 3.5% of the total dollar amount of loans approved.\nThe rate charged for long-term fixed rate mortgage loans is designed to reflect CFC's estimated overall cost of fixed rate capital allocated to its fixed rate mortgage loans (including Capital Term and other Subordinated Certificates, Collateral Trust Bonds, Medium-Term Notes, variable rate borrowings supported by Interest Rate Exchange Agreements and Members' Equity) plus increments estimated to cover general and administrative expenses, a provision for loan and guarantee losses and a reasonable margin.\nLong-term fixed rate loans provide for a fixed interest rate of periods for one to 30 years. Upon expiration of the interest rate period, the borrower may select another fixed rate term of one to 30 years (but not beyond the maturity of the loan) or in certain instances may repay the loan or convert to another interest rate program.\nCFC also makes long-term loans with variable interest rates. Such loans are funded primarily from available short-term sources, and the rate is adjusted monthly to reflect CFC's cost of capital raised to fund these loans plus increments estimated to cover general and administrative expenses, a provision for loan and guarantee losses and the maintenance of a reasonable margin.\nA borrower may convert a long-term loan from the variable rate to a fixed rate at any time with no fee. Some fixed rate loans may be converted to variable rate loans at any time, subject to the payment of a conversion fee and in certain cases regulatory approval.\nPrepayment of concurrent loans, where permitted by CFC and REA, or otherwise agreed to by CFC and REA, will be apportioned pro-rata between REA and CFC based on the respective balances of their concurrent loans outstanding as of the date of prepayment. Prior to January 1, 1994, no fee was required on the prepayment of a standard seven-year fixed rate loan that was prepaid during a repricing cycle. Now all prepayments except those required to maintain the original REA\/CFC concurrent loan proportions will be subject to a prepayment fee.\nUntil December 1993, most long-term borrowers were required to purchase from CFC subordinated loan capital term certificates in an amount up to 7% of the loan amount. These certificates amortize along with the loan. For all loans advanced after December 1993, distribution systems may be required to purchase subordinated loan capital term certificates in an amount up to 3% of the loan amount or may not be required to\npurchase any certificates depending upon the borrower's leverage ratio with CFC (the ratio of the outstanding and available loan funds to subordinated certificates and allocated but unretired patronage capital), including the new loan. Power supply members are required to purchase the certificates in amounts up to 12% of the loan amount.\nBeginning with loan applications received after May 31, 1984, the initial interest rate for all advances is fixed when loan funds are first advanced. Initial rates for loans approved prior to such date were fixed at the time of CFC's approval, which generally preceded the first advance by at least a year. Beginning with loans approved after December 31, 1987, each advance made under a long-term fixed rate loan commitment bears the fixed interest rate in effect at the time of the advance.\nCFC long-term loans made in conjunction with concurrent REA loans are generally for terms of 35 years and under present policy are payable, after a short period during which interest only is payable, in level quarterly installments which include both accrued interest and a portion of the principal. Substantially all of CFC's present long-term mortgage loans to Utility Members are secured by a first mortgage lien upon all property (other than office equipment and vehicles) at any time owned by the borrower and future revenue. In the case of members whose property is already subject to a mortgage to REA, REA approval of the loan is required, even in the case of a 100% CFC loan, in order to accommodate REA's mortgage lien so that CFC may share ratably in the security provided by the mortgaged property. CFC and REA are then mortgagees in common, entitled to the security in proportion to the unpaid principal amounts of their respective loans. Mortgages do not require that the value of the mortgaged property be equal to the obligations secured thereby.\nEvents of default under the long-term mortgages include default in the payment of the mortgage notes, default (continuing after grace periods in some cases) in the performance of the covenants in the loan agreements or the mortgages, and events of bankruptcy and insolvency. Under common mortgages securing long-term CFC loans to distribution system members, REA has the sole right to exercise remedies on behalf of all holders of mortgage notes for 30 days after default. If REA does not act within 30 days or if REA is not legally entitled to act on behalf of all noteholders, CFC may exercise remedies. Under common mortgages securing long-term CFC loans to, or guarantee reimbursement obligations of, power supply members, REA retains substantial control over the exercise of mortgage remedies.\nIntermediate-Term Loans to Utility Members\nIntermediate-term loans are made to members for terms of up to five years. The interest rates on intermediate-term loans are adjusted monthly (and may be adjusted semimonthly) to cover CFC's cost of capital raised to fund these loans plus increments estimated to cover general and administrative expenses, a provision for loan and guarantee losses and the maintenance of a reasonable margin. Intermediate-term loans that are classified as secured are secured by a first mortgage lien upon all property (other than office equipment and vehicles) at any time owned by the borrower and future revenue. Borrowers are generally not required to purchase additional subordinated certificates in CFC in conjunction with an intermediate-term loan.\nShort-Term Loans to Utility Members\nCFC makes short-term line of credit loans to its member distribution systems in amounts based on the system's monthly operation and maintenance expenses and prior year's additions to plant. Power supply systems are eligible for lines of credit in amounts up to a maximum of $50 million, based on the system's quarterly operation and maintenance expenses. Loans made to distribution and power supply systems under such lines of credit are generally unsecured; are for a term not exceeding 12 months for power supply systems and not exceeding 60 months for distribution systems; and may be prepaid without premium and reborrowed in whole or in part during such term. Short-term loans with terms greater than 12 months are required to be paid down to a zero balance for five consecutive business days during each 12 month period.\nThe interest rates on short-term line of credit loans are adjusted monthly (and may be adjusted semimonthly) to cover CFC's cost of capital raised to fund these loans plus increments estimated to cover general and administrative expenses, a provision for loan and guarantee losses and the maintenance of a\nreasonable margin. Borrowers are not required to purchase additional subordinated certificates in CFC in conjunction with a short-term loan.\nLoans to Telecommunication Borrowers\nRTFC makes long-term loans to rural telecommunication companies for the acquisition of telecommunication systems and the construction of telephone, cellular and cable television systems.\nUnder RTFC policy, a telephone system with an Average DSC and an Average TIER of 1.25 and 1.50, respectively, is eligible for a long-term mortgage loan from RTFC. A cable television system with an Average DSC of 1.25 is eligible for a long-term mortgage loan. A cellular telephone system is eligible for an initial long-term mortgage loan if it can demonstrate the ability to achieve an Average DSC of 1.10 prior to the fifth year of operations, and maintain that requirement annually thereafter.\nSecurity for RTFC long-term loans made to REA borrowers will consist of a first mortgage lien on the assets and revenues of the system on a pari passu basis with REA. Security from non-REA borrowers is considered on a case by case basis but generally a loan will not exceed 80% of the estimated initial value of the collateral. Long-term loans are made to RTFC borrowers for terms generally up to 15 years and amortized quarterly over the life of the loan. Long-term borrowers are required to purchase subordinated certificates from RTFC in amounts equal to 5% or 10% of the long-term loan amount depending on the borrower.\nThe interest rate on long-term loans can be fixed for the full term of the loan or for a predetermined period. Alternatively, the borrower may elect a variable rate which is adjusted monthly (and may be adjusted semimonthly). A long-term variable rate loan may be converted to a fixed rate at any time. A long-term fixed rate loan may be converted to a variable rate only on a rate adjustment date.\nRTFC provides intermediate-term equipment financing for periods up to five years. These loans are provided on an unsecured basis and are used to finance the purchase price and installation costs of central office equipment, support assets and other communication products. Intermediate-term equipment financing loans are generally made to operating telephone companies with an equity level of at least 25% of total assets and which have achieved a DSC ratio for each of the previous two calendar years of at least 1.75.\nRTFC also provides short-term financing to telecommunication systems for periods up to 60 months. These short-term loans are typically in the form of a revolving line of credit which requires the borrower to pay off the balance for five consecutive business days at least once during each 12 month period. These loans are provided on an unsecured basis and are used primarily for normal operating expenses. Lines of credit are available to telecommunication systems generally in amounts not to exceed the greater of five percent of total assets or 25% of equity in excess of 35% of total assets. Borrowers are not required to purchase subordinated certificates in RTFC as a condition to receiving a line of credit.\nRTFC interest rates on all loans are set to cover the cost of funds, plus an increment estimated to cover general and administrative expenses, a provision for loan losses and the maintenance of a reasonable margin.\nRTFC obtains funding for its loans through back-to-back borrowing from CFC, which in turn has a security interest in all RTFC's loans.\nLoans to Associate Members\nCFC also makes loans to Associate Members, which are non-profit or cooperative organizations owned, controlled or operated by a CFC Class A, B or C Member or by CFC (sponsor) and engaged primarily in furnishing nonelectric services within the sponsor's service area. Long-term loans are available to Associate Members for periods of one to 35 years and are secured by the assets financed or by a guarantee from a Utility Member, or both. The rate on these loans, to the extent funding sources are available, may be fixed for the full term of the loan or for a predetermined period. Alternatively, the borrower may elect a variable rate which is adjusted monthly (and may be adjusted semimonthly). Borrowers are required to purchase a subordinated certificate equal to 10% of the loan amount.\nCFC also provides short-term loans to Associate Members for periods of up to 60 months. The short-term loans are generally revolving lines of credit which may require the borrower to pay off the balance for five consecutive business days during each 12 month period. Borrowers are not required to purchase a subordinated certificate as a condition to receiving a short-term loan. Short-term interest rates are set monthly (and may be adjusted semimonthly). These loans are generally unsecured but are guaranteed by an operating distribution or power supply member of CFC.\nAssociate Member interest rates are set to cover the cost of funds plus an increment estimated to cover general and administrative expenses, a provision for loan losses and a reasonable margin.\nREA Guaranteed Loans\nIn connection with legislation which allowed certain systems to prepay existing borrowings from FFB without prepayment penalties or fees, CFC established a program under which it made long-term loans to members for the purpose of prepaying these loans. Each note evidencing such a loan was issued to a trust which in turn issued certificates evidencing its ownership to CFC. The principal and interest on these notes are 100% guaranteed by REA. Under REA regulations, the note rate may not exceed the rate borne by the system's prepaid borrowings from the FFB adjusted to reflect savings accrued since prepayment of the note compared with the rate on the prepaid borrowing. The systems are required to pay service fees to CFC in connection with these transactions. Most of these loans that have not been sold in public offerings have been transferred to GFC. In addition, CFC services $589.1 million of these loans held in trust which have been sold in public offerings.\nGuarantees of Pollution Control Facility and Utility Property Financings\nCFC has guaranteed debt issued in connection with the construction or acquisition by CFC members of pollution control, solid waste disposal, industrial development and electric distribution facilities. Such debt is issued by governmental authorities and the interest thereon is exempt from Federal income taxation. The proceeds of the offering are made available to the member system, which in turn is obligated to pay the governmental authority amounts sufficient to service the debt. The debt, which is guaranteed by CFC, may include short-and long-term obligations.\nIn the event of a default by a system for nonpayment of debt service, CFC is obligated to pay any required amounts under its guarantee and the bond issue will not be accelerated so long as CFC performs under its guarantee. The system is required to repay, on demand, any amount advanced by CFC pursuant to its guarantee. This repayment obligation is secured by a common mortgage with REA on all the system's assets, but CFC may not exercise remedies thereunder for up to two years following default. However, if the debt is accelerated because of a determination that the interest thereon is not tax-exempt, the system's obligation to reimburse CFC for any guarantee payments will be treated as a long-term loan.\nIn connection with these transactions, the systems generally must purchase from CFC unsecured subordinated certificates in an amount up to 12% of the principal amount guaranteed and maturing at the final maturity of the related debt (but not less than 20 years). These certificates generally bear interest at the greater of the 34-year FFB interest rate, the interest rate on the longest maturity of the debt being guaranteed or 90% of the rate on the loan from CFC used to purchase the certificate. In addition, if a debt service reserve fund is created by CFC to secure the debt being issued, the system buys an additional subordinated certificate, maturing at the time of the final maturity of the debt, in the amount of such reserve. No interest is paid on such certificate, but any earnings from investments held by the trustee of such debt service reserve funds will be credited against the system's debt service obligations. The system is also required to pay to CFC initial and\/or on-going servicing fees in connection with these transactions.\nCertain guaranteed long-term debt bears interest at variable rates which are adjusted at intervals of one to 270 days, weekly, each five weeks or semiannually to a level expected to permit their resale or auction at par. At the option of the member on whose behalf it is issued and provided funding sources are available, rates on such debt may be fixed until maturity. Holders have the right to tender for purchase at par the debt when it bears interest at a variable rate and CFC has committed to purchase debt so tendered if it cannot otherwise be\nremarketed. While CFC holds the securities, the cooperative will pay interest to CFC at its intermediate-term loan rate.\nGuarantees of Lease Transactions\nCFC has a program of lending to or guaranteeing debt issued by NCSC in connection with leveraged lease transactions. In such transactions, NCSC has lent money to an industrial or financial company (a \"Lessor\") for the purchase of a power plant (or an undivided interest therein) or utility equipment which was then leased to a CFC member (\"the Lessee\") under a lease requiring the Lessee to pay amounts sufficient to permit the owner of the property to service the loan. The loans were made on a non-recourse basis to the Lessor but were secured by the property leased and the owner's rights as Lessor. NCSC borrowed the funds it lent either under a CFC guarantee or on an interim basis directly from CFC and purchased from CFC a subordinated certificate in an amount up to 12% of the amount CFC guaranteed or lent. The subordinated certificates generally bear interest at a rate equal to the FFB rate for 34-year loans or 90% of CFC's loan rate and are repaid proportionally as the amount guaranteed decreases. NCSC is also obligated to pay administrative and\/or guarantee fees to CFC in connection with these transactions. Such fees are reimbursed to NCSC by the Lessee in each transaction.\nGuarantees of Tax Indemnifications\nCFC has also guaranteed members' obligations to indemnify against loss of tax benefits in certain tax benefit transfers. A member's obligation to reimburse CFC for any guarantee payments would be treated as a long-term loan, secured on a pari passu basis with REA by a first lien on substantially all the member's property to the extent of any cash received by the member at the outset of the transaction. The remainder would be treated as an intermediate-term loan secured by a subordinated mortgage on substantially all of the member's property. Due to changes in Federal tax law, no further guarantees of this nature are anticipated. In connection with these transactions, the members purchased from CFC an unsecured subordinated certificate in an amount up to 12% of the amount guaranteed.\nOther\nCFC may provide other loans and guarantees as requested by its members. Such loans and guarantees will generally be made on a secured basis with interest rates and guarantee fees set to cover CFC's cost of capital, general and administrative expenses, a provision for loan and guarantee losses and maintenance of a reasonable margin. In connection with these transactions, the system generally must purchase from CFC an unsecured subordinated certificate in an amount up to 12% of the amount guaranteed or lent.\nCFC FINANCING FACTORS\nFunding for the Company's loan programs are derived from Members' Equity (net margins, retained as allocated but unreturned patronage capital), from the sale of its Subordinated Certificates (see Note 3 to Combined Financial Statements), Collateral Trust Bonds, Medium-Term Notes, Commercial Paper and Bank Bid Notes. CFC's ability to obtain short-and long-term funds from external sources as needed depends on such factors as its reputation in the investment community, its financial condition and that of its members, the depth and liquidity of the markets in which it participates, its ability to conduct its operations to meet or exceed the financial standards of performance expected by the investment markets and the credit rating agencies and the continued support of its members.\nEach year CFC allocates its net margins (operating margin plus nonoperating income) among its members in proportion to interest earned by CFC from such members within various loan pools. These allocations are evidenced by Patronage Capital Certificates which bear no interest or dividends and have no stated maturity. These amounts are available for use in CFC's operations pending their retirement. CFC's current policy is to retire Patronage Capital Certificates representing 50% of the prior year's allocation during the following year and the remaining 50% after 15 years, if permitted by CFC's contractual obligations and to the extent that the Board of Directors in its discretion may determine from time to time that the financial\ncondition of CFC will not be impaired as a result. The six years of unretired allocations that are currently held by CFC will be retired over the next 15 years starting with the retirement to be made in August 1994. RTFC's current policy is to retire 50% of current year's margins within 8 1\/2 months of the end of the fiscal year with the remainder to be retired at the discretion of RTFC's Board of Directors. GFC's current policy is to retire 100% of current year's margins shortly after the end of the fiscal year.\nAs a condition of membership, CFC members have subscribed to Capital Term Certificates, which like CFC's other Subordinated Certificates are unsecured subordinated obligations of CFC. They generally mature 100 years after issuance and bear interest at the rate of 5% per annum. The purchase of Subordinated Certificates may also be required as a condition of each long-term loan and certain intermediate-term loans made by CFC to its members (Subordinated Certificates issued in connection with loans made prior to June 1, 1983, earn 3% annually, and Subordinated Certificates for loans approved on or after that date are noninterest-bearing). Subordinated Certificates, bearing interest at various rates, are also required to be purchased in connection with CFC guarantees of member debt. The maturity of Subordinated Certificates purchased in connection with loans and guarantees generally coincides with the maturity of the related loan or guaranteed debt. Membership certificates and loan and guarantee certificates represented 52% and 48%, respectively, of total Subordinated Certificates outstanding at May 31, 1994.\nTo fund a portion of its long-term fixed rate loan program, CFC issues intermediate-and long-term senior secured Collateral Trust Bonds and senior unsecured Medium-Term Notes with differing maturities, interest rates and redemption provisions. The Collateral Trust Bonds are secured by pledges of eligible mortgage notes with a principal amount at least equal to the total amount of bonds outstanding. If certain minimum eligibility ratios are not maintained, the mortgage notes affected must be replaced with other eligible collateral. In addition, Commercial Paper supported by an equal amount of interest rate exchange agreements is used to fund long-term fixed rate loans (see Note 5 to Combined Financial Statements).\nThe Company issues Commercial Paper through dealers and directly to members and other eligible nonmember investors to provide funds for short-, intermediate-and long-term variable rate loans to members, including REA guaranteed loans, and temporarily to fund long-term fixed rate loans to members prior to funding with long-term debt. Commercial Paper could also be used to fund purchases of tax-exempt securities which CFC may be obligated to purchase pursuant to its commitment to act as standby purchaser. In addition, CFC may issue Commercial Paper in excess of its own funding needs in order to provide its members an investment vehicle for their excess funds; CFC uses the proceeds from such issuances to purchase short-term obligations of other issuers. Commercial Paper outstanding at May 31, 1994, 1993 and 1992, net of discount related to the issuance of dealer commercial paper, was approximately $3,429.0 million, $2,198.6 million and $2,043.8 million, respectively. The outstanding commercial paper at May 31, 1994, 1993 and 1992 had average maturities of 36 days, 46 days and 44 days, respectively. The amount of such outstanding Commercial Paper sold directly by CFC to its members and eligible nonmembers as a percentage of total outstanding Commercial Paper was 31% as of May 31, 1994 versus 54% at May 31, 1993.\nCFC also issues short-term Bank Bid Notes to fund its variable rate loans. These bid notes are unsecured loan obligations. Bid note facilities are uncommitted lines of credit for which CFC does not pay a fee. The amount of Bank Bid Notes outstanding as of May 31, 1994, 1993 and 1992 was $209.0 million, $335.0 million and $100.0 million, respectively.\nAs of May 31, 1994, CFC had two revolving credit agreements totaling $2,900.0 million with 52 banks, including Morgan Guaranty Trust Company of New York as Administrative Agent and Arranger and the Bank of Nova Scotia as Managing Agent. These credit facilities were arranged principally to provide liquidity support for CFC's outstanding Commercial Paper and the adjustable or floating\/fixed rate bonds which CFC has guaranteed for the benefit of its members.\nUnder the respective revolving credit agreements, CFC can borrow up to $2,030.0 million until June 3, 1996 (the \"three-year facility\"), and an additional $870.0 million until May 26, 1995 (the \"364-day facility\"). Any amounts outstanding will be due on those dates. In connection with the three-year facility, CFC pays a per annum facility\/commitment fee of .225 of 1%. The per annum facility fee for the 364-day facility is .15 of\n1%. If CFC's short-term ratings decline, these fees may be increased by no more than .2125 of 1%. Borrowings under both agreements will be at one or more rates as defined in the agreements, as selected by CFC.\nThe revolving credit agreements require CFC among other things to maintain Members' Equity and Members' Subordinated Certificates of at least $1,334.4 million (increased each fiscal year by 90% of net margins not distributed to members) and an average fixed charge coverage ratio over the six most recent fiscal quarters of at least 1.025 and prohibit the retirement of patronage capital unless CFC has achieved a fixed charge coverage ratio of 1.05 for the preceding fiscal year. The credit agreements prohibit CFC from incurring senior debt (including guarantees but excluding indebtedness incurred to fund REA guaranteed loans) in an amount in excess of ten times the sum of Members' Equity and subordinated debt and restrict, with certain exceptions, the creation by CFC of liens on its assets and contain certain other conditions to borrowing. The agreements also prohibit CFC from pledging collateral in excess of 150% of the principal amount of Collateral Trust Bonds outstanding. Provided that CFC is in compliance with these financial covenants (including that CFC has no material contingent or other liability or material litigation that was not disclosed by or reserved against in its most recent annual financial statements) and is not in default, CFC may borrow under the agreements until the termination date. As of May 31, 1994 CFC was in compliance with all covenants and conditions.\nAs of May 31, 1994 there were no borrowings outstanding under the revolving credit agreements. On the basis of the three-year facility, at May 31, 1994, CFC classified $2,030.0 million of its notes payable outstanding as long-term debt. CFC expects to maintain more than $2,030.0 million of notes payable outstanding during the next 12 months. If necessary, CFC can refinance such notes payable on a long-term basis by borrowing under the three-year facility, subject to the conditions therein.\nIn addition to the revolving credit facilities at May 31, 1994, CFC also had $610.0 million in separately negotiated 364-day lines of credit, documented by a uniform line of credit agreement for which a commitment fee of .10 of 1% is paid. The line of credit agreement contains the same financial covenants as the revolving credit agreements and may be terminated upon 30 days notice by either party. After such notice, the bank would not be obligated to lend.\nInterest rates charged on loans by CFC include the cost of funds incurred by CFC plus increments estimated to cover general and administrative expenses, a provision for loan and guarantee losses and to provide margins in amounts considered by CFC to be consistent with sound financial practice. While interest rates are set to cover estimated costs and to provide reasonable margins, CFC does not always match the maturity of its borrowings to those of its loans. CFC generally finances its long-term loans to members through borrowings having shorter maturities than the loans; however, CFC generally finances its fixed rate loans with funds whose maturities coincide with, or exceed, the rate adjustment cycle of the loan.\nSet forth below is a table showing CFC's outstanding borrowings and the weighted average interest rates thereon as of the dates shown:\nCFC BORROWINGS\n- - --------------- (A) Net of $0.2 million, $1.5 million and $30.7 million principal amount of bonds held in Treasury at May 31, 1994, 1993 and 1992, respectively, of which $0.2 million, $1.5 million and $1.8 million, respectively, was purchased in connection with CFC's deferred compensation program.\n(B) Series N Collateral Trust Bonds were called July 2, 1992. Series P Collateral Trust Bonds matured November 1, 1992. Series F Collateral Trust Bonds were called September 3, 1992, at a premium of 4.07%. Series Q Collateral Trust Bonds were called on June 16, 1993, at par. Series R Collateral Trust Bonds were called on February 2, 1994, at par. Series S Collateral Trust Bonds were called on April 18, 1994, at par.\n(C) Excludes $2,030.0 million, $2,030.0 million and $1,750.0 million of Commercial Paper classified as long-term debt as of May 31, 1994, 1993 and 1992, respectively (see Note 4 to Combined Financial Statements).\n(D) Total long-and intermediate-term debt includes $200.8 million which will be due or is expected to be redeemed, during fiscal year 1995.\n(E) Excluding $107.1 million, $116.5 million and $128.0 million of Debt Service Reserve Certificates, and $29.3 million, $32.4 million and $36.2 million of subscribed but unissued Subordinated Certificates as of May 31, 1994, 1993 and 1992, respectively, since such funds are not generally available for investing in earning assets.\n(F) Net of discount; includes $2,030.0 million, $2,030.0 million and $1,750.0 million of Commercial Paper classified as long-term debt as of May 31, 1994, 1993 and 1992, respectively. Includes $209.0 million, $335.0 million and $100.0 million of Bank Bid Notes at May 31, 1994, 1993 and 1992, respectively (see Note 4 to Combined Financial Statements).\n(G) Average interest rates are weighted on the basis of amounts of outstanding borrowings without adjustment for bank credit compensation arrangements for short-term borrowings.\nSet forth below are the weighted average costs incurred by CFC on its short-term borrowings (Commercial Paper and Bank Bid Notes) and on its long-term borrowings (Collateral Trust Bonds, Medium-Term Notes and interest rate swaps) for the period shown.\nINTEREST COSTS ON CFC BORROWINGS\nTAX STATUS\nIn 1969, CFC obtained a ruling from the Internal Revenue Service (\"IRS\") recognizing CFC's exemption from the payment of Federal income taxes under Section 501(c)(4) of the Internal Revenue Code. Such exempt status could be removed as a result of changes in legislation or in administrative policy or as a result of changes in CFC's business. CFC believes that its operations have not changed materially from those described to the IRS. CFC's affiliates RTFC and GFC are taxable Subchapter T corporations.\nINVESTMENT POLICY\nSurplus funds are invested pursuant to policies adopted by CFC's Board of Directors. Under present policy, surplus funds may be invested in direct obligations of or obligations guaranteed by the United States or agencies thereof, the World Bank, or certain high quality commercial paper, obligations of foreign governments, Eurodollar deposits, bankers' acceptances, bank letters of credit, certificates of deposit or working capital acceptances. The policy also permits investments in certain types of repurchase agreements with highly rated financial institutions, whereby the assets consist of eligible securities listed above set aside in a segregated account. CFC typically has two types of funds available for investment: (1) the debt service reserve funds held by the collateral trust bond trustee under the Collateral Trust Bond Indenture between CFC and Manufacturer Hanover Trust Company (\"1972 Indenture\"), used to make bond interest and sinking fund payments; and (2) member loan payments and commercial paper investments in excess of the daily cash funding requirements. Debt service reserve funds are invested with maturities scheduled to coincide with interest and sinking fund payment dates.\nOTHER SOURCES OF LOANS TO CFC MEMBERS\nIn addition to CFC, there are other lending sources which supplement REA financing, some of whose lending rates may be lower than CFC's. At May 31, 1994, CFC had 5,443 long-term mortgage loans committed or outstanding to distribution systems totaling approximately $4,965.5 million, and to CFC's knowledge other lenders, excluding REA, had 407 such loans at May 31, 1994, totaling approximately $475.0 million. At May 31, 1994, CFC had 118 committed or outstanding long-term mortgage loans for power supply projects totaling approximately $1,161.5 million and to CFC's knowledge other lenders, excluding REA and FFB, had such loans committed or outstanding for power supply projects in a total amount of approximately $2,750.0 million.\nEMPLOYEES\nAt May 31, 1994, CFC had 157 employees, including engineering, financial and legal personnel, management specialists, loan examiners, accountants and support staff. CFC believes that its relations with its employees are good.\nTHE RURAL ELECTRIC AND TELEPHONE SYSTEMS\nGENERAL\nCFC's 899 rural electric Utility Members as of May 31, 1994, were drawn from the approximately 937 (at December 31, 1992) rural electric utility systems (the \"systems\") which were eligible for REA loans. A large proportion of the eligible systems are members of CFC and information regarding these systems is available in the Annual Statistical Reports of REA (\"REA Reports\"), therefore commentary in this section is based on information about the systems generally, rather than CFC members alone (see Note on page 19). However, the Composite Financial Statements on pages 20 to 24 relate only to CFC Utility Members. At December 31, 1992 and for the year then ended, CFC's members accounted for approximately 96% of the total utility plant, 91% of the total equity, 92% of the net margins and 92% of the total number of systems covered by REA Reports, and CFC believes that its members are representative of the systems as a whole.\nAlthough generally stable retail rates have been the historical pattern for REA borrowers, in the 1970's and early 1980's rising costs of fuel, material, labor, capital and wholesale power required rate increases by most of the distribution systems. Increases in costs have also resulted in rate increases by the power supply systems. Virtually all power contracts between power supply systems and their member distribution systems provide for rate increases to cover increased costs of supplying power, although in certain cases such increases must be approved by regulatory agencies. During the last five years, costs and rates have generally been stable.\nTHE REA PROGRAM\nSince the enactment of the Rural Electrification Act in 1936, REA has financed the construction of electric generating plants, transmission facilities and distribution systems in order to provide electricity to persons in rural areas who were without central station service. Principally through the organization of systems under the REA loan program in 46 states and U.S. territories, the percentage of farms and residences in rural areas of the United States receiving central station electric service increased from 11% in 1934 to almost 99% currently. Rural electric systems serve 11% of all consumers of electricity in the United States and its territories. They account for approximately 8% of total sales of electricity and about 6% of energy generation and generating capacity.\nIn 1949, the Act was amended to allow REA to lend for the purpose of furnishing and improving rural telephone service. At December 31, 1992, 899 of REA's 957 telephone borrowers provided service to 6.1 million subscribers throughout the United States and its territories (reporting information was not available for the remaining 58 borrowers).\nThe Rural Electrification Act provides for REA to make insured loans and to provide other forms of financial assistance to borrowers. REA is authorized to make direct loans, at below market rates, to systems which are eligible to borrow from it. REA is also authorized to guarantee loans which have been used mainly to provide financing for construction of Bulk Power Supply Projects. Guaranteed loans bear interest at a rate agreed upon by the borrower and the lender (which generally has been the FFB). For telephone borrowers, REA also provides financing through the Rural Telephone Bank (RTB). The RTB is a government corporation providing financing at rates reflecting its cost of capital. REA exercises a high degree of financial and technical supervision over borrowers' operations. Its loans and guarantees are generally secured by a mortgage on substantially all of the system's property and revenues.\nLegislation has been proposed which would provide funding of $675 million for the REA insured loan program for electric borrowers for FY 1995 and $498 million for the telephone borrowers through REA and the RTB. In addition, $300 million was proposed for the REA guaranteed electric loan program.\nLegislation has been enacted which allows REA electric borrowers to prepay their loans to REA at a discount based on the government's cost of funds at the time of prepayment. If a borrower chooses to prepay its notes, it becomes ineligible for future REA lending for a period of ten years, except in certain specified instances. Regulations regarding the note buy-out, relating to computation of discount and certain issues\nconcerning potential taxes on gains, were adopted on March 22, 1994. As of May 31, 1994, no borrowers have prepaid their REA loans under these rules.\nDISTRIBUTION SYSTEMS\nDistribution systems are local utilities distributing electric power, generally purchased from wholesale sources, to consumers in their service areas. Virtually all are locally-managed cooperative, non-profit associations, and most have been in operation for at least 40 years. At December 31, 1992, the approximate number of consumers served by REA electric borrowers was 12.2 million, representing an estimated 28.8 million ultimate users. Aggregate operating revenues of the distribution systems from sales of electric energy for the year ended December 31, 1992, totaled $14.0 billion, of which 65% was derived from the sales of electricity to residential consumers (farm and nonfarm), 31% from such sales to commercial and industrial consumers and the remainder from sales to various other consumers.\nThe composite TIER of CFC member distribution systems increased to 2.19 in 1992 from 2.11 in 1991. The composite DSC ratio fell from 2.13 in 1991 to 2.07 in 1992. Composite equity as a percent of total assets for member distribution systems increased from 38.18% at December 31, 1991 to 39.44% at December 31, 1992.\nThe cost of purchased wholesale power in 1992 amounted to 66.5% of the total revenues of the distribution systems. Information from REA concerning the amount of energy generated and purchased by REA borrowers including distribution systems during the 12 months ended December 31, 1992 (1993 data is not available) indicates that 18.4% was purchased from power companies including investor-owned utilities and industrial and manufacturing corporations, 55.5% from rural electric power supply systems and other distribution systems having generating facilities, 18.8% from Federal agencies and 7.3% from publicly-owned power suppliers, such as municipal systems.\nWholesale power supply contracts ordinarily guarantee neither an uninterrupted supply nor a constant cost of power. Contracts with REA-financed power supply systems (which generally require the distribution system to purchase all its power requirements from the power supply system) provide for rate increases to pass along increases in sellers' costs (subject in certain cases to regulatory approval). The wholesale power contracts permit the power supply system, subject to approval by REA and, in certain circumstances, regulatory agencies, to establish rates to its members so as to produce revenues sufficient, with revenues from all other sources, to meet the costs of operation and maintenance (including, without limitation, replacements, insurance, taxes and administrative and general overhead expenses) of all generating, transmission and related facilities, to pay the cost of any power and energy purchased for resale, to pay the costs of generation and transmission, to make all payments on account of all indebtedness and leases of the power supply system and to provide for the establishment and maintenance of reasonable reserves. The rates under the wholesale power contracts are required to be reviewed by the Board of Directors of the power supply system at least annually.\nPower contracts with investor-owned utilities, or power supply systems which do not borrow from REA generally have rates subject to regulation by the Federal Energy Regulatory Commission. Contracts with Federal agencies generally permit rate changes by the selling agency (subject, in some cases, to Federal regulatory approval). In the case of many distribution systems, only one power supplier is within a feasible distance to provide wholesale electricity.\nPOWER SUPPLY SYSTEMS\nPower supply systems are utilities which purchase and generate electric power and provide it wholesale to distribution systems for delivery to the ultimate retail consumer. Of the 62 operating power supply systems financed in whole or in part by REA or CFC at December 31, 1993, 61 were cooperatives owned directly or indirectly by groups of distribution systems and one was government owned. Of this number, 39 had generating capacity of at least 100,000 kilowatts, and eight had no generating capacity. Five of the eight systems with no generating capacity operated transmission lines to supply certain distribution systems, one has applied for REA financing for its first transmission facility and two are currently building their first transmission facilities. Certain other power supply systems had been formed but did not yet own generating or\ntransmission facilities. At December 31, 1992, the 58 power supply systems reporting to REA owned 145 generating plants with a total generating capacity of approximately 29,597,000 kilowatts, or approximately 4.3% of the nation's estimated electric generating capacity and served 700 REA distribution system borrowers (representing an average for the year of approximately 8.3 million consumers). Certain of the power supply systems which own generating plants lease these facilities to others and purchase their power requirements from the lessee-operators.\nOf the power supply systems' total generating capacity in place as of December 31, 1992, steam plants accounted for 94.2% (including nuclear capacity representing approximately 10.2% of such total generating capacity), internal combustion plants accounted for 5.5% and hydroelectric plants accounted for 0.3%. REA loans and loan guarantees as of December 31, 1992, have provided funds for the installation of over 34,031,000 kilowatts, of which nuclear is approximately 3,806,000 kilowatts, or 11.2% of the total, of which 979,000 kilowatts have officially been cancelled, or 2.9% of the total.\nThe high level of growth in demand for electricity experienced in the 1970's was not expected to decline in the 1980's and the power supply systems continued their construction programs in anticipation of continued growth in demand. During the 1980's, however, slower growth in power requirements of the systems reduced the need for additional generating capacity in most areas of the country. Thus, many areas are now experiencing a surplus of generating capacity and, as a result, some power supply systems have significant amounts of fixed costs for power plant investment not fully supported by increased revenues (see Note 10 to Combined Financial Statements for further information concerning certain CFC members experiencing this problem).\nWhile the level of funds needed for new generating units is expected to be low over the next few years, the need for transmission and capital additions will continue to generate substantial long-term capital requirements. The power supply systems are expected to continue to seek to satisfy these requirements primarily through the REA loan guarantee program.\nREGULATION AND COMPETITION\nThe degree of regulation of rural electric systems by state authorities varies from state to state. The retail rates of rural electric systems are regulated in 17 states (in which there are approximately 289 systems). Distribution systems in these states account for 34% of the total operating revenues and patronage capital of all distribution systems nationwide. State agencies, principally public utility commissions, of 20 states regulate those states' approximately 300 systems as to the issuance of long-term debt securities. In six states (in which there are approximately 100 systems) state agencies regulate, to varying degrees, the issuance of short-term debt securities. Since 1967, the Federal Power Commission and its successor, the Federal Energy Regulatory Commission (\"FERC\"), which regulates interstate sales of energy at wholesale, have taken the position that it lacks jurisdiction to regulate cooperative rural electric systems which are current borrowers from REA. However, rural electric cooperatives that pay off their REA debt or never incur REA debt may be regulated by FERC with respect to financing and\/or rates. To date, four power supply systems and one distribution system are regulated by FERC.\nVarying degrees of territorial protection against competing utility systems are provided to distribution systems in 41 states (in which over 92% of the distribution systems are located). Changes in administrative or legislative policy in several states, or Federal legislation may result in more or in less territorial protection for the distribution systems.\nIn addition to competition from other utility systems, some distribution systems have expressed increasing concern about the loss of desirable suburban service areas as a result of annexation by expanding municipal or franchised investor-owned utility systems, regardless of the degree of territorial protection otherwise provided by applicable law. The systems are also subject to competition from alternate sources of energy such as bottled gas, natural gas, fuel oil, diesel generation, wood stoves and self-generation.\nThe systems, in common with the electric power industry generally, may incur substantial capital expenditures and increases in operating costs in order to meet the requirements of both present and future\nFederal, state and local standards relating to safety and environmental quality control. These include possible requirements for burying distribution lines and meeting air and water quality standards.\nOn November 15, 1990, amendments to the Clean Air Act of 1970 (the \"Amendments\"), designed to cause utilities and others to reduce emissions, became law. The Amendments contain a range of compliance options and a phase-in period which will help mitigate the immediate costs of implementation. Many of CFC's member systems already comply with the provisions of the Amendments. CFC is currently monitoring the overall impact of the Amendments on individual member systems, which must implement compliance plans and operating or equipment modifications for Phase I of the Act (1995), and for those affected in Phase II of the Act (2000). Compliance plans for member systems with units affected in Phase I primarily involve fuel switching to low-sulfur coal. The trading of emission allowances may also be an economical alternative in Phase II. Some member systems originally believed to be affected by the Amendments have developed strategies designed to minimize the Amendment's impact. At this time, it is not anticipated that the Amendments will have a material adverse impact on the quality of CFC's loan portfolio.\nFINANCIAL INFORMATION\nThe systems differ from investor-owned utilities in that the vast majority are cooperative, non-profit organizations operating under policies which provide that rates should be established so as to minimize rates over the longterm. Revenues in excess of operating costs and expenses are referred to as \"net margins and patronage capital\" and are treated as equity capital furnished by the systems' consumers. This \"capital\" is transferred to a balance sheet account designated as \"patronage capital\", and is usually allocated to consumers in proportion to their patronage. Such capital is not refunded to them for a period of years during which time it is available to the system to be used for proper corporate purposes. Subject to their applicable contractual obligations, the systems may refund such capital to their members when doing so will not impair the systems' financial condition. In the terminology of the Uniform System of Accounts prescribed by REA for its borrowers, \"operating revenues and patronage capital\" refers to all utility operating income received during a given period.\nSimilar to the practice followed by investor-owned utilities pursuant to FERC procedures and as prescribed by REA, the systems capitalize as a cost of construction the interest charges on borrowed funds (\"interest charged to construction\") and the estimated unearned interest attributable to internally-generated funds (\"allowance for funds used during construction\") used in the construction of generation, and to a lesser extent transmission and distribution facilities. This accounting policy, which increases net margins by the amounts of these actual and imputed interest charges, is based on the premise that the cost of financing construction is an expenditure serving to increase the productive capacity and value of the utility's assets and thus should be included in the cost of the assets constructed and recovered over the life of the assets. In the case of power supply systems, REA has included in its direct loans and guarantees of loans amounts sufficient to meet the estimated interest charges during construction. If the foregoing accounting policy were not followed, utilities would presumably request regulatory permission, if applicable, to increase their rates to cover such costs. The amounts of interest charged to construction and allowance for funds used during construction capitalized by distribution systems are relatively insignificant. Because power supply systems generally expend substantial amounts on long-term construction projects, the application of this accounting policy may result in substantially lower interest expense and in substantially higher net margins for such systems during construction than would be the case if such a policy were not followed.\nOn the following pages are tables providing composite statements of revenues, expenses and patronage capital of the distribution systems which were members of CFC and the power supply systems which were members of CFC during the five years ended December 31, 1992, and their respective composite balance\nsheets at the end of each such year. The data for the year ended December 31, 1993 was not available from REA prior to the filing of this document. - - --------------- NOTE: Statistical information in the REA Reports has not been examined by CFC's independent public accountants, and the number and geographical dispersion of the systems have made impractical an independent investigation by CFC of the statistical information available from REA. The REA Reports are based upon financial statements submitted to REA, subject to year-end audit adjustments, by reporting REA borrowers and do not, with minor exceptions, take into account current data for certain systems, primarily those which are not active REA borrowers. As of December 31, 1992, 159 REA borrowers had repaid their REA loans in full and were accordingly not subject to REA reporting requirements.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION COMPOSITE STATEMENTS OF REVENUES, EXPENSES AND PATRONAGE CAPITAL AS REPORTED BY CFC MEMBER DISTRIBUTION SYSTEMS\nThe following are unaudited figures which are based upon financial statements submitted to REA or to CFC by CFC Member Distribution Systems\n- - --------------- (1) Includes cost of purchased power, power production and transmission expense, separately listed in the applicable REA Report.\n(2) Includes sales expenses, consumer accounts and customer service and informational expense as well as other administrative and general expenses, separately listed in the applicable REA Report.\n(3) Represents net margins of power supply systems and other associated organizations allocated to their member distribution systems and added in determining net margins and patronage capital of distribution systems under REA accounting practices. Cash distributions of this credit have rarely been made by the power supply systems and such other organizations to their members.\n(4) Interest on long-term debt is net of interest charged to construction, which is stated separately as a credit in REA Reports. For a description of the reasons for, and the effect on net margins and patronage capital of, the accounting policies governing interest charged to construction and allowance for funds used during construction, see \"Financial Information\". CFC believes that amounts incurred by distribution systems for interest charged to construction and allowance for funds used during construction are immaterial relative to their total interest on long-term debt and net margins and patronage capital.\n(5) Determined by adding interest on long-term debt (in each year including all interest charged to construction) and net margins and patronage capital and dividing the total by interest on long-term debt (in each year including all interest charged to construction).\n(6) The ratio of (x) net margins and patronage capital plus interest on long-term debt (including all interest charged to construction) plus depreciation and amortization to (y) long-term debt service obligations.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION COMPOSITE BALANCE SHEETS AS REPORTED BY CFC MEMBER DISTRIBUTION SYSTEMS\nTHE FOLLOWING ARE UNAUDITED FIGURES WHICH ARE BASED UPON FINANCIAL STATEMENTS SUBMITTED TO REA OR TO CFC BY CFC MEMBER DISTRIBUTION SYSTEMS\n- - --------------- (1) Includes investments in service organizations, power supply capital credits and investments in CFC.\n(2) Includes non-refundable donations or contributions in cash, services or property from states, municipalities, other government agencies, individuals and others for construction purposes separately listed in the applicable REA Report.\n(3) Principally debt to REA and includes $3,536,794,013, $3,435,994,499, $3,283,689,097, $3,018,608,279 and $2,714,809,274 for the years 1992, 1991, 1990, 1989 and 1988, respectively, due to CFC.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION COMPOSITE STATEMENTS OF REVENUES, EXPENSES AND PATRONAGE CAPITAL AS REPORTED BY CFC MEMBER POWER SUPPLY SYSTEMS\nTHE FOLLOWING ARE UNAUDITED FIGURES WHICH ARE BASED UPON FINANCIAL STATEMENTS SUBMITTED TO REA OR TO CFC BY CFC MEMBER POWER SUPPLY SYSTEMS\n- - --------------- (1) Includes cost of purchased power, power production and transmission expense, separately listed in the applicable REA Report.\n(2) Includes sales expenses and consumer accounts expense and consumer service and informational expense as well as other administrative and general expenses, separately listed in the applicable REA Report.\n(3) Certain power supply systems purchase wholesale power from other power supply systems of which they are members. Power supply capital credits represent net margins of power supply systems allocated to member power supply systems on the books of the selling power supply systems. This item has been added in determining net margins and patronage capital of the purchasing power supply systems under REA accounting practices. Cash distributions of this credit have rarely been made by the selling power supply systems to their members. This item also includes net margins of associated organizations allocated to CFC power supply members and added in determining net margins and patronage capital of the CFC member systems under REA accounting practices.\n(4) Interest on long-term debt is net of interest charged to construction. Allowance for funds used during construction has been included in non-operating margins. For a description of the reasons for, and the effect on net margins and patronage capital of, the accounting policies governing interest charged to construction and allowance for funds used during construction, see \"Financial Information\". According to\nunpublished information furnished by REA, interest charged to construction and allowance for funds used during construction for CFC power supply members in the years 1988-1992 were as follows:\n(5) Determined by adding interest on long-term debt (in each year including all interest charged to construction) and net margins and patronage capital and dividing the total by interest on long-term debt (in each year including all interest charged to construction). The TIER calculation includes the operating results of four financially troubled power supply systems, without which the composite TIER would have been 1.14, 1.14, 1.08, 1.09 and 1.06 for the years ended December 31, 1992, 1991, 1990, 1989 and 1988, respectively.\n(6) The ratio of (x) net margins and patronage capital plus interest on long-term debt (including all interest charged to construction) plus depreciation and amortization to (y) long-term debt service obligations. The DSC calculation includes the operating results of four power supply systems experiencing financial difficulties. Without these systems, the composite DSC would have been 1.23, 1.25, 1.22, 1.21 and 1.23 for the years ended December 31, 1992, 1991, 1990, 1989 and 1988, respectively.\n(7) Twelve CFC power supply system members are not required to report to REA since they are not currently borrowers from REA. These systems are either in developmental stages or act as coordinating agents for their members. Their inclusion would not have a material effect on this data. In addition, REA has determined not to include data for Wabash Valley Power Association (\"Wabash\") and Colorado-Ute in their composite statements due to Wabash's ongoing bankruptcy and the liquidation of Colorado-Ute (see Note 10 to Combined Financial Statements).\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION COMPOSITE BALANCE SHEETS AS REPORTED BY CFC MEMBER POWER SUPPLY SYSTEMS\nTHE FOLLOWING ARE UNAUDITED FIGURES WHICH ARE BASED UPON FINANCIAL STATEMENTS SUBMITTED TO REA OR TO CFC BY CFC MEMBER POWER SUPPLY SYSTEMS\n- - --------------- (1) Includes investments in service organizations, power supply capital credits and investments in CFC.\n(2) Principally debt to REA or debt guaranteed by REA and loaned by FFB.\n(3) Twelve CFC power supply system members are not required to report to REA since they are not currently borrowers from REA. These systems are either in developmental stages or act as coordinating agents for their members. Their inclusion would not have a material effect on these data.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nCFC owns and operates a headquarters facility in Fairfax County in the Commonwealth of Virginia. This facility consists of a six-story office building with separate parking garage situated on four acres of land. The company also owns an additional eight acres of unimproved land adjacent to the building. On April 11, 1994, CFC purchased an additional 23 1\/2 acres of unimproved land adjacent to the building. There are no plans at this time for future use of either parcel of land.\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.\nInapplicable.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following is a summary of selected financial data for each of the five years ended May 31, 1994.\n- - --------------- (A) During the years ended May 31, 1993, 1992 and 1991 CFC paid premiums totaling $3.2 million, $1.4 million, and $2.8 million respectively, in connection with the prepayment of Collateral Trust Bonds. Margins used to compute the fixed charge coverage ratio represent net margins before extraordinary loss plus fixed charges. The fixed charges used in the computation of the fixed charge coverage ratio consist of interest and amortization of bond discount and bond issuance expenses.\n(B) Includes commercial paper reclassified as long-term debt and excludes portion of long-term debt due within one year (see Note 5 to Combined Financial Statements).\n(C) Excludes $200.8 million, $286.8 million, $494.5 million, $109.6 million and $65.1 million in long-term debt that comes due, matures and\/or will be redeemed early during fiscal years 1995, 1994, 1993, 1992 and 1991, respectively.\n(D) In accordance with CFC's revolving credit agreements, the leverage ratio is calculated by dividing debt and guarantees outstanding, excluding debt used to fund loans guaranteed by the U.S. Government, by the total of Members' Subordinated Certificates and Members' Equity.\nCFC has had outstanding guarantees for its members' indebtedness in each of the fiscal years shown above. Members' interest expense on such indebtedness was approximately $124.3 million for the year ended May 31, 1994.\nThe Company does not have outstanding any common stock and does not pay dividends. CFC retires Patronage Capital Certificates, which represent allocations of CFC's net margins, 50% of an allocation during the next fiscal year and expects to retire the remaining 50% after 15 years with due regard for CFC's financial condition.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nOVERVIEW\nThe following discussion and analysis is designed to provide a better understanding of the Company's combined financial condition and results of operations and as such should be read in conjunction with the Combined Financial Statements, including the notes thereto.\nCFC was formed in 1969 by rural electric cooperatives to provide them with a source of funds to supplement the financing provided by REA. The Company was organized as a cooperative where each member receives one vote. Under CFC's bylaws, the Board of Directors must be comprised of 22 individuals who are either general managers or directors of the members. CFC was granted tax-exempt status under Section 501(c)(4) of the Internal Revenue Code.\nIn 1987, RTFC was formed by CFC to provide a source of funds for the rural telephone industry. Like CFC, RTFC is a cooperative. However, RTFC's bylaws and voting members' agreement require that the majority of RTFC's Board of Directors be elected from individuals designated by CFC. The remaining board positions are filled by individuals nominated by the other RTFC members. Because CFC has control of the RTFC Board, RTFC's financial condition and results of operations are combined with those of CFC. CFC is the sole source of funding for RTFC. (Unless stated otherwise, all references to CFC refer to the combined results of CFC, RTFC and all other CFC controlled affiliates.)\nThe principal concept of CFC is to provide a mechanism through which the rural electric cooperatives can achieve better access to the debt markets. Each rural electric cooperative which joins CFC agrees to purchase subordinated subscription certificates from CFC as described below.\nCFC's operations consist of providing loans, financial guarantees and other financial services to its rural electric, telephone and other related organizations. In connection with any long-term loan or guarantee made by CFC to or on behalf of one of its members, CFC generally requires that the member make an additional investment in CFC by purchasing loan or guarantee certificates. Like the original subscription certificates, the loan and guarantee certificates are unsecured and subordinate to other debt.\nThe subscription and loan and guarantee certificates (together, \"Subordinated Certificates\") along with related patronage capital provide CFC's base capitalization. On a regular basis, CFC obtains debt financing in the market by issuing long-term fixed rate or variable rate Collateral Trust Bonds, intermediate-term fixed or variable rate Medium-Term Notes, Commercial Paper and Bank Bid Notes. In addition, CFC obtains debt financing from its membership and other qualified investors through the direct sale of its Commercial Paper and Medium-Term Notes.\nCFC's primary objective as a cooperative is to provide its members with the lowest possible loan and guarantee rates. Therefore, CFC marks up its funding costs only to the extent necessary to cover its operating expenses and a provision for loan and guarantee losses and to provide for margins sufficient to preserve interest coverage in light of CFC's financing objectives. To the extent members contribute to CFC's base capital with Subordinated Certificates carrying below-market interest rates, CFC can offer proportionally lower interest rates on its loans to members.\nCFC is required by the cooperative laws under which it is incorporated to allocate its earnings to its members in proportion to the members' contributions to those earnings. CFC thus allocates its net margins based on each member's participation in loan programs during the year.\nCFC's strength is closely tied to the performance of its member rural electric and telephone utility systems due to the near 100% concentration of its loan and guarantee portfolio in those industries. The following provides an analysis of both CFC's performance and a discussion of the quality of CFC's loan and guarantee portfolio.\nFINANCIAL CONDITION\nAt May 31, 1994, CFC had $6.2 billion in total assets. Approximately $5.9 billion or 95% of these assets consisted of loans made to CFC's members. The remaining $0.3 billion consisted of other assets to support CFC's operations. Except as required for the debt service account and unless excess cash is invested overnight, CFC does not use funds to invest in debt or equity securities.\nAt May 31, 1994, 84% of CFC's loan portfolio consisted of 35-year long-term secured amortizing loans. The remaining 16% consisted of short-and intermediate-term secured and unsecured lines of credit and long-term loans guaranteed by the United States Government. Approximately 34.5% or $2.1 billion in long-term loans carry a fixed rate of interest. All other loans, including $3.0 billion in long-term loans, are subject to interest rate adjustment monthly or semimonthly.\nIn addition to its loans, CFC had provided approximately $2.7 billion in guarantees for its members at May 31, 1994. These guarantees relate primarily to tax-exempt financed pollution control equipment and to leveraged lease transactions for equipment and plant.\nAt May 31, 1994, CFC had also committed to lend approximately $5.2 billion to its members. Most unadvanced loan commitments contain a material adverse change clause. As many of these commitments are provided for operational backup liquidity, CFC does not anticipate funding the majority of the commitments outstanding.\nCFC funds its assets through the sale of Subordinated Certificates, retained equity and other debt instruments. As discussed previously, Subordinated Certificates include both original membership subscription certificates and loan and guarantee certificates, all of which are subordinate to other CFC debt. At May 31, 1994, subscription certificates totaled $640 million. These certificates generally mature in 70 to 100 years and generally pay interest at 5.0%. At May 31, 1994, loan certificates totaled $311 million and carried a weighted average interest rate of 1.2%. At May 31, 1994, guarantee certificates totaled $271 million and carried a weighted average interest rate of 5.1%. Both the loan certificates and guarantee certificates are long-term instruments which generally amortize at a rate equivalent to that of the loan or guarantee to which they relate. On a combined basis, Subordinated Certificates carried a weighted average interest rate of 4.5%. The issuance of zero percent loan certificates is expected to exceed the issuance of 5.0% subscription certificates. Therefore, management expects this average interest rate to decline over time.\nCFC's net margins are allocated each year to CFC's member borrowers. Prior to fiscal year 1994, CFC's policy was to retire net margins on a first-in, first-out seven year cycle. For fiscal years 1994 and beyond, net margins will be retired 50% in the next fiscal year and the remaining 50% held for 15 years. During the next 15 years, CFC will retire the existing six years of unretired allocations representing net margins for fiscal years 1988 to 1993. The unretired allocations (members' equity) do not earn interest and are junior to all debt instruments, including Subordinated Certificates. At May 31, 1994, CFC had $261 million in retained equity. Subordinated Certificates, in conjunction with retained members' equity, supply CFC's base capitalization.\nCFC enters the capital markets through the issuance of Collateral Trust Bonds, Medium-Term Notes, Commercial Paper and Bank Bid Notes. At May 31, 1994, CFC had $540 million in fixed rate long-term Collateral Trust Bonds outstanding. Under its Collateral Trust Bond Indentures, CFC must pledge as collateral mortgage notes from its borrowers evidencing loans equal in principal amount to at least 100% of the outstanding Bonds. At May 31, 1994, CFC had pledged $718 million in mortgage notes. During the year, CFC effected the early redemption of $350 million in Collateral Trust Bonds, at par. In February 1994, CFC had entered into a new Collateral Trust Bond Indenture, with First Bank National Association as trustee (\"1994 Indenture\"), under which future series of Collateral Trust Bonds will be issued. Virtually all Collateral Trust Bonds were offered to outside investors in underwritten public offerings.\nAt May 31, 1994, CFC had $472 million outstanding in Medium-Term Notes. Medium-Term Notes are issued for terms of 270 days to 30 years and are unsecured obligations of CFC. Medium-Term Notes outstanding to CFC's members totaled $234 million at May 31, 1994. The remaining $238 million were sold to outside investors.\nAt May 31, 1994, CFC had $3,429 million outstanding in Commercial Paper with a weighted average maturity of 36 days. Commercial Paper notes are issued with maturities up to 270 days and are unsecured obligations of CFC. Commercial Paper outstanding to CFC's members totaled $1,061 million at May 31, 1994. The remaining $2,368 million was sold to outside investors.\nIn addition CFC obtains funds from various banking institutions under Bank Bid Note arrangements, similar to bank lines of credit. The notes are issued for terms up to three months and are unsecured obligations of CFC. At May 31, 1994, CFC had $209 million outstanding in Bank Bid Notes.\nDuring the year, total assets increased $760 million. CFC continued to see an increase in net loan balances outstanding, with an increase of $809 million or 15.8%. Gross loans increased by a total of $824 million, partially offset by an increase in the allowance for loan and guarantee losses of $16 million, over the prior year. As a percentage of the portfolio, long-term loans (excluding loans guaranteed by REA) represented 84% at May 31, 1994, compared to 89% at May 31, 1993. The drop in percentage is due to the increase of $236 million in loans guaranteed by REA. Long-term fixed rate loans represented 41% and 44% of the total long-term loans at May 31, 1994 and 1993. Loans converting from the fixed rate to the variable rate or selecting a variable rate upon the expiration of the current fixed interest rate period totaled $257 million for the year ended May 31, 1994, approximately one-third of the $837 million of such conversions or repricings for the year ended May 31, 1993. The loans moving from the fixed rate to a variable rate were partially offset by $222 million and $371 million of variable rate loans that converted to a fixed rate for the years ended May 31, 1994 and 1993. This resulted in a net change of $35 million and $466 million from the fixed rate to the variable rate for the years ended May 31, 1994 and 1993, respectively.\nThe increase in total loans outstanding at May 31, 1994 was primarily due to an increase of $400 million in long-term variable rate loans, an increase of $236 million in loans guaranteed by REA and an increase in intermediate-and short-term loans of $221 million offset by a decrease of $15 million in long-term fixed rate loans and a decrease of $18 million in nonperforming and restructured loans. The increase in long-term variable rate loans was primarily due to an increase of $211 million to telecommunication systems for the acquisition of telecommunication properties and to an increase of $197 million to distributions systems for concurrent loan advances. The increase in REA guaranteed loans was the result of three new refinancings of FFB debt. The increase in intermediate-term loans was primarily due to an increase of $77 million to power supply systems for the financing of the premium charged in connection with the prepayment of their FFB loans. The increase in short-term loans was primarily due to an increase of $124 million to distribution systems for interim construction financing.\nThe increase in net loans outstanding was partially offset by decreases to cash on hand of $33 million and debt service investments of $12 million. CFC's cash management policy is to minimize cash on hand to the extent possible. The decrease in debt service investments was due to the redemptions of three Collateral Trust Bond series during the year, reducing the required debt service payments under the 1972 bond indenture. This amount will continue to decrease as the remaining series are redeemed or mature and no future issues are planned under the 1972 indenture. The 1994 Indenture, under which CFC plans to issue future Collateral Trust Bonds, does not require the maintenance of a debt service reserve fund. The decrease in other assets was primarily due to refinancings of tax-exempt bonds guaranteed by CFC during the year. CFC did not require a debt service reserve certificate to be purchased in connection with the new guarantees.\nDuring the year, CFC substantially increased its short-term debt outstanding to fund both the increase in variable rate loans outstanding and the early redemption of long-term debt. Notes Payable, which consists of Commercial Paper and Bank Bid Notes, increased $1,104 million. This increase was a result of CFC match-funding as to rate the additional variable rate loans originated and converted during the year. At May 31, 1994, CFC's short-term debt consisted of $2,368 million in dealer Commercial Paper, $1,000 million in Commercial paper issued to CFC's members, $61 million in Commercial Paper issued to certain nonmembers and $209 million in Bank Bid Notes. The Commercial Paper outstanding to CFC's members and nonmembers decreased by $116 million and the amount of Bank Bid Notes outstanding decreased by $126 million from the prior year. Commercial Paper sold through CFC's dealers increased by $1,347 million to fund the increase in loans outstanding, the decrease in long-term debt and the decreases in the other types of short-term debt.\nCFC's short-term debt has a weighted average maturity of 36 days at May 31, 1994, a decrease from 46 days at May 31, 1993. Long-term debt consists in part of Collateral Trust Bonds and Medium-Term Notes. As a result of the decrease in fixed rate loans, CFC retired three Collateral Trust Bond series, resulting in a net decrease in long-term debt of $340 million. As described in the footnotes to the combined financial statements, CFC reclassifies a portion of its short-term debt as long-term, as it has the ability (subject to certain conditions) to refinance this short-term debt on a long-term basis under its revolving credit agreements. CFC renegotiated its revolving credit agreements during the fourth quarter of fiscal year 1993 and was able to reclassify $2,030 million in short-term debt as long-term at May 31, 1994 and 1993. On May 27, 1994 CFC extended the 364-day agreement which will now mature on May 26, 1995. CFC also obtained an additional $610 million in separately negotiated 364-day lines of credit.\nIn addition to the $764 million net increase in debt outstanding, CFC also recorded a decrease in deferred income of $3 million. CFC collects a fee for any fixed to variable rate conversions allowed. Financial accounting standards require that this fee income be deferred and taken into income as interest on loans over the original remaining original fixed-rate maturity period of the converted loan. Due to the smaller volume of conversions experienced during the year, deferred conversion fee income decreased from $38 million at May 31, 1993 to $35 million at May 31, 1994.\nOff-balance sheet, CFC experienced an increase of $881 million in loan commitments. This increase was primarily due to a $410 million increase in short-term lines of credit and to an increase of $318 million in long-term commitments to Power Supply borrowers and $287 million in long-term commitments to telecommunication borrowers partially offset by a decrease of $104 million in intermediate-term loan commitments.\nCFC's leverage ratio increased during the year from 4.41 at May 31, 1993, to 4.63 at May 31, 1994. The ratio is calculated after excluding all debt associated with the funding of the REA guaranteed loans. Subordinated Certificates are treated as equity in the calculation of the leverage ratio. This increase was primarily due to an increase in loans outstanding to members financed by the issuance of short-term debt and medium-term notes. There were no other significant changes in CFC's financial condition. CFC contemplates that its leverage ratio will continue to increase to facilitate its members' financing requirements. CFC believes the leverage ratio will be maintained within a range comparable to that of finance companies which have received comparable ratings from major rating agencies.\nMARGIN ANALYSIS\nFiscal Year 1994 versus 1993 Results\nCFC uses an interest coverage ratio, instead of the dollar amount of gross or net margins as a primary performance indicator since CFC's net margins are subject to fluctuations as interest rates change. During the year ended May 31, 1994, CFC achieved a Times Interest Earned Ratio (\"TIER\") of 1.13. This was a decrease from the prior fiscal year when a TIER of 1.16 (calculated before extraordinary loss) was earned. Management has established a 1.10 TIER as its minimum operating objective.\nFor the year ended May 31, 1994, operating income totaled $324.7 million, a decrease of $11.7 million from the prior year. Operating income includes interest earned on loans and conversion fees. The decrease in operating income was due to the general decline in interest rates and CFC's passing on the resulting savings on to its members. The decrease was due to a negative rate variance of $37.0 million which was partially offset by a positive volume variance of $25.3 million.\nFor the year ended May 31, 1994, cost of funds totaled $263.2 million, a decrease of $2.2 million from the prior year. Included in cost of funds is interest expense on CFC's Subordinated Certificates and other debt instruments offset by interest earnings on debt service investments. The decrease in cost of funds was due to a negative rate variance of $8.4 million partially offset by a positive volume variance of $6.2 million.\nFor the year ended May 31, 1994, gross margins totaled $61.5 million. This represented a decrease from the prior fiscal year of $9.5 million or a reduction of 0.30% of average loans outstanding. This decrease was primarily a result of the general reduction in rates due to a lower interest rate environment.\nGeneral and administrative expenses decreased 5.4% during the fiscal year as compared to an increase of 0.2% incurred in the prior year. In addition, CFC added $15.6 million to its allowance for loan and guarantee losses, an increase of $0.6 million from the previous year.\nNonoperating income includes guarantee fee income and any other gains and losses. Nonoperating income increased $0.7 million, from $3.3 million for the year ended May 31, 1993 to $4.0 million for the year ended May 31, 1994.\nDuring the year ended May 31, 1994, CFC retired three Collateral Trust Bond series totaling $350.0 million, all at par.\nOverall, CFC's net margins decreased $5.3 million from $38.5 million for the year ended May 31, 1993 to $33.2 million for the year ended May 31, 1994. As described earlier, this decrease was a result of a declining interest rate environment partially offset by the reduction in operating expenses and the increase in nonoperating income. CFC's achieved TIER of 1.13 represents a decrease from the prior year's achieved TIER of 1.16. The decrease in achieved TIER was a result of a larger decrease to net margins than to the cost of funds which resulted from CFC's intentional reduction of the interest rate spread over cost charged on its loans.\nFiscal Year 1993 versus 1992 Results\nFor the year ended May 31, 1993, operating income totaled $336.4 million, a decrease of $65.9 million from the year ended May 31, 1992. The decrease was due to a negative rate variance of $67.1 million partially offset by a positive volume variance of $1.2 million.\nFor the year ended May 31, 1993, cost of funds totaled $265.4 million, a decrease of $49.5 million from the prior year. The decrease was due to a negative rate variance of $50.5 million partially offset by a positive volume variance of $1.0 million.\nFor the year ended May 31, 1993, gross margins totaled $71.0 million. This represented a decrease from the prior year of $16.4 million or a decrease of 0.33% of average loans outstanding. This decrease was a result of the lower interest rate environment. The margins necessary to meet a desired interest coverage ratio are lower in a declining interest rate environment.\nDuring the year ended May 31, 1993, general and administrative expenses increased by approximately 0.2%. In addition, CFC added $15 million to its allowance for loan and guarantee losses during the year, a decrease of $12 million from the prior year.\nDuring the year ended May 31, 1993, CFC retired three Collateral Trust Bond series. One such series required a prepayment premium of $3.2 million, recorded as an extraordinary loss. During the year ended May 31, 1993, CFC realized interest savings on the retirement sufficient to cover the prepayment premium.\nOverall, CFC's net margins decreased $5.7 million from $44.2 million for the year ended May 31, 1992 to $38.5 million for the year ended May 31, 1993. Again, this decrease was a result of a declining interest rate environment offset somewhat by the reduction in the provision for loan and guarantee losses. Although net margins decreased, CFC achieved a TIER of 1.16, an increase over the prior year's TIER of 1.14.\nThe following is a summary of CFC's operating results as a percentage of average loans outstanding for the last three fiscal years.\nINCOME STATEMENT AS A PERCENTAGE OF AVERAGE LOANS OUTSTANDING\n- - --------------- (1) Nonoperating income includes the extraordinary losses in FY 1993 and 1992 resulting from the prepayment of debt.\nLOAN AND GUARANTEE PORTFOLIO ASSESSMENT\nPortfolio Diversity\nCFC and its combined affiliates make loans and provide financial guarantees to their qualified members. The combined memberships include rural electric distribution systems, rural electric generation and transmission systems, telecommunication systems, statewide rural electric and telecommunication associations, and associate organizations.\nThe following chart summarizes loans and guarantees outstanding by member class at May 31, 1994, 1993 and 1992.\nLOANS AND GUARANTEES OUTSTANDING BY MEMBER CLASS\nCFC's members are distributed throughout the United States and its territories, including 46 states, the District of Columbia, Guam, Samoa and the U.S. Virgin Islands. At May 31, 1994, 1993 and 1992 no state or territory had over 8.2%, 8.8%, and 8.5%, respectively, of total loans and guarantees outstanding.\nCFC believes that the risk of lending to a single industry is mitigated somewhat by the fact that many of CFC's borrowers as utilities do not have immediate competition in the sale of their services and the fact that the services members provide are essential to the consumers.\nCredit Concentration\nIn addition to the geographic diversity of the portfolio, CFC limits its exposure to any one single borrower. The majority of the largest single exposures are concentrated in the Power Supply systems due to their large plant and equipment requirements. At May 31, 1994, the total exposure outstanding to any one\nborrower did not exceed 5.2% of total loans and guarantees outstanding and the total loans and guarantees outstanding to the members of any one state or territory did not exceed 8.2%. At May 31, 1994, CFC had $1,558 million in loans outstanding and $2,584 million in guarantees outstanding to its largest 40 borrowers, representing 25% of total loans outstanding and 97% of total guarantees outstanding. Credit exposure to the largest 40 borrowers represented 47% of total credit exposure at May 31, 1994, compared to 50% at May 31, 1993. CFC's largest ten credit exposures represented 29% and 31% of total exposure at May 31, 1994 and 1993, respectively.\nSecurity Provisions\nExcept when providing lines of credit, CFC typically lends to its members on a secured basis. At May 31, 1994, approximately 4.80% of CFC's total loans and guarantees were unsecured obligations of CFC borrowers. CFC's long-term loans are typically secured pro-rata with other secured lenders, if any (primarily REA), by all assets and future revenues of the borrower. Short-term loans are generally unsecured lines of credit. Guarantees are secured on a pro-rata basis with other secured creditors, by all assets and future revenues of the borrower or by the underlying financed asset. In addition to the collateral received, CFC also requires that its borrowers set rates designed to achieve certain financial ratios.\nPortfolio Quality\nThe following table summarizes the key composite operating results of CFC's two main borrower types, distribution and power supply systems, which together comprise 89.9% and 91.4% of CFC's total loan and guarantee portfolio at May 31, 1994 and 1993 (the table has not been weighted based on CFC's outstanding loans and guarantees to the borrowers):\nCFC DISTRIBUTION MEMBER BORROWERS COMPOSITE RESULTS\nCFC POWER SUPPLY MEMBER BORROWERS COMPOSITE RESULTS\n- - --------------- NOTE: The composite member data is as of December 31, of the year indicated. Data for December 31, 1993, was not available prior to the date of this filing. The power supply composite results have been presented without the operating results of four systems experiencing financial difficulties.\nMost CFC power supply borrowers sell the majority of their power under all-power-requirements contracts with their member distribution systems. These contracts allow, subject to regulatory requirements, for the recovery of all costs at the power supply level. Due to the contractual connection between the power supply and distribution systems, total combined system equity (power supply equity plus the equity at its affiliated distribution systems) has typically been maintained at the distribution level.\nAs with CFC, to the extent distribution systems can fund their assets with retained members' equity (i.e., unretired capital credits), overall funding costs for plant and equipment are reduced. Distribution systems can, in turn, pass these savings on to their member\/consumers in the form of lower utility rates.\nThe effectiveness of the all-power-requirements contract is dependent on the individual systems' right and ability to establish rates to cover all costs. The boards of directors of most of CFC's power supply and distribution members have the authority to establish binding rates for their consumer members. Some states regulate rate setting and can therefore override the system's internal rate setting procedures. However, most CFC members are not externally rate regulated. CFC has 833 distribution members of which 586 are not regulated. Of the remaining 247 distribution systems, 153 are regulated only on a streamlined basis. At the power supply level, 47 of 66 members are not rate regulated.\nDuring the past few years, power supply members have been increasing their equity levels. Under recently changed REA underwriting standards, in order to qualify for additional REA loan funds, power supply systems may be required to maintain, or demonstrate an ability to reach, a 20% of assets equity level or they must obtain guarantees from their affiliated distribution systems.\nNonperforming and Restructured Loans\nCFC classifies a borrower as nonperforming when any one of the following criteria are met: (1) principal or interest payments on any loan to the borrower are past due 90 days or more, (2) the borrower is operating under protection of the bankruptcy court, or (3) for some other reason, management does not expect the timely repayment of principal or interest. Once a borrower is classified as nonperforming, interest on its loans is recognized on a cash basis. Alternately, CFC may choose to apply all cash received to the reduction of principal, thereby forgoing interest income recognition. At May 31, 1994, nonperforming loans totaled $44.9 million, a decrease of $10.9 million over the prior year-end. The decrease was due to the reclassification of loans to two members totaling $8.9 million, (including $5.9 million reclassified as performing and $3.0 million reclassified as restructured). At May 31, 1994, nonperforming loans represented 0.5% of total loans and guarantees outstanding.\nLoans classified as restructured are loans for which agreements have been executed that change the original terms of the loan, generally a change to the originally scheduled cashflows. At May 31, 1994, restructured loans totaled $165.4 million, a decrease of $7.5 million from the prior year. Restructured loans in the amount of $111.5 million, $100.3 million and $81.2 million were not accruing interest income at May 31, 1994, 1993 and 1992, respectively.\nThe majority of CFC's problem loan situations occurred prior to the past five years as a result of excess capacity or cancelled capacity additions after the plant and equipment construction cycle of the mid-1980s. Since 1986, when power supply construction-in-progress represented 16.3% of total power supply plant, power supply members have reduced the level of plant additions. At the end of the calendar year 1992, construction-in-progress represented 2.8% of total power supply plant (see Note 10 to Combined Financial Statements for a more complete discussion of certain loan and guarantee contingencies).\nNONPERFORMING AND RESTRUCTURED ASSETS (DOLLAR AMOUNTS IN MILLIONS)\nAllowance for Loan and Guarantee Losses\nCFC maintains an allowance for potential loan and\/or guarantee losses which is periodically reviewed by management for adequacy. In performing this assessment, management considers various factors including an analysis of the financial strength of CFC's borrowers, delinquencies, loan charge-off history, underlying\ncollateral, and economic and industry conditions. At May 31, 1994, the allowance for loan and guarantee losses totaled $188.2 million, an increase of $15.6 million from the prior year-end. The allowance represented 238.6% of nonperforming loans and 2.1% of total loans and guarantees outstanding at year-end.\nSince its inception in 1969, CFC has charged off loan balances in the total amount of $28.4 million, net of recoveries.\nManagement believes that the allowance for loan and guarantee losses is adequate to cover any portfolio losses which have occurred or may occur.\nThe following chart presents a summary of the allowance for loan and guarantee losses at May 31, 1994, 1993 and 1992.\nALLOWANCE FOR LOAN AND GUARANTEE LOSSES (DOLLAR AMOUNTS IN THOUSANDS)\nASSET\/LIABILITY MANAGEMENT\nA key element of CFC's funding operations is the monitoring and management of interest rate and liquidity risk. This process involves controlling asset and liability volumes, repricing terms and maturity schedules to stabilize gross operating margins and retain liquidity.\nInterest Rate Risk\nCFC is subject to interest rate risk to the extent CFC's loans are subject to interest rate adjustment at different times than the liabilities which fund those assets. Therefore, CFC's interest rate risk management policy involves the close matching of asset and liability repricing terms within a range of 5% of gross assets (total assets plus the loan and guarantee loss allowance which is netted against gross loans on the balance sheet). CFC measures the matching of funds to assets by comparing the amount of fixed rate assets repricing or amortizing to the total fixed rate debt maturing over the next year. At May 31, 1994 CFC had $196 million in fixed rate assets amortizing or repricing and $55 million in fixed rate liabilities maturing during fiscal year 1995. The difference, $141 million represents the amount of CFC's assets that are not considered match-funded as to rate. CFC's difference of $141 million, at May 31, 1994 represents 2.2% of gross assets. CFC funds variable rate assets which reprice monthly with short-term liabilities, primarily Commercial Paper and Bank Bid Notes, both of which are primarily issued with original maturities under 90 days. CFC funds fixed rate loans with fixed rate Collateral Trust Bonds, Medium-Term Notes, Subordinated Certificates and Members' Equity. With the exception of Subordinated Certificates, which are generally issued at rates below CFC's long-term cost of funding and with extended maturities, CFC's liabilities have average maturities that closely match the repricing terms of CFC's fixed interest rate loans. CFC also uses Commercial Paper supported by interest rate exchange agreements to fund its fixed rate portfolio of loans.\nCertain of CFC's Collateral Trust Bonds and Medium-Term Notes were issued with early redemption provisions. To the extent borrowers are allowed to convert their fixed rate loans to a variable interest rate and to the extent it is beneficial, CFC takes advantage of these early redemption privileges. However, because\nconversions can take place at different intervals from early redemptions, CFC charges conversion fees designed to compensate for any additional interest rate risk assumed by the Company.\nLiquidity\nCFC is subject to liquidity risk to the extent cash repayments on its assets are insufficient to cover the cash requirements on maturing liabilities and other sources of funds with which to make debt repayments are not available. For the most part, CFC funds its long-term loans with much shorter term maturity debt instruments. As a result, CFC has to manage its liquidity risk by ensuring that other sources of funding are available to make debt maturity payments. CFC accomplishes this in four ways. First, CFC maintains revolving credit agreements which (subject to certain conditions) allow CFC to borrow funds on terms of up to three years. Second, CFC has maintained investment grade ratings, facilitating access to the capital markets. Third, CFC maintains shelf registrations for both Collateral Trust Bonds and Medium-Term Notes either of which (absent market disruptions and assuming CFC remains creditworthy) could be issued at fixed or variable rates in sufficient amounts to fund the next 18 to 24 months funding requirements. Fourth, CFC obtains much of its funding directly from its members and believes this funding is more stable than funding obtained from outside sources.\nCFC's long-and short-term debt and guarantees receive ratings from three of the major credit rating agencies, Moody's Investors Service (\"Moody's\"), Standard and Poor Corporation (\"S&P\") and Fitch Investors Service (\"Fitch\"). During May 1994, S&P and Fitch upgraded CFC's ratings on Collateral Trust Bonds from AA- to AA and the ratings on Medium-Term Notes, guaranteed lease debt and guaranteed bonds from A+ to AA-. CFC's short-term debt and guarantee ratings from these agencies were reaffirmed at the highest level A-1+ by S&P and+ by Fitch. Moody's reaffirmed CFC's current ratings, and lists CFC's ratings outlook as positive. The following table presents CFC's current credit ratings at year-end.\nThe ratings listed above have the meaning as defined by each of the respective rating agencies and are not recommendations to buy, sell or hold securities and are subject to revision or withdrawal at any time by the rating organizations.\nAt May 31, 1994 and 1993, CFC's members provided 44.3% and 52.0% of total capitalization as follows:\nMEMBERSHIP CONTRIBUTIONS TO TOTAL CAPITALIZATION (DOLLAR AMOUNTS IN THOUSANDS)\nThe total amount of member investments decreased by $71.9 million or 2.6%. The total member investment as a percentage of total capitalization decreased due to the increase in nonmember debt required to fund the increase in loans outstanding. Total capitalization at May 31, 1994 was $6,133.9 million, an increase of $774.1 million over the total capitalization of $5,359.8 million at May 31, 1993. When the loan and guarantee loss allowance is added to both membership contributions and to total capitalization the percentages are 46.0% and 53.5% at May 31, 1994 and 1993, respectively.\nHISTORICAL RESULTS\nThe following chart provides CFC's key operating results over the last six years.\nSELECTED KEY FINANCIAL DATA (DOLLAR AMOUNTS IN THOUSANDS)\n- - --------------- (1) The leverage ratio is calculated by dividing debt and guarantees outstanding, excluding debt used to fund loans guaranteed by REA, by the total of Members' Subordinated Certificates and Members' Equity.\n(2) The debt\/equity ratio is calculated by dividing debt outstanding, excluding debt used to fund loans guaranteed by REA, by the total of Members' Subordinated Certificates, Members' Equity and the loan and guarantee loss allowance.\n(3) TIER is calculated by dividing net margins before extraordinary items plus the cost of funds by the cost of funds.\nFINANCIAL AND INDUSTRY OUTLOOK\nDuring the coming year, management expects CFC's borrowers to continue to utilize the variable interest rate programs to a greater extent than the fixed interest rate program. This is due primarily to the positive\ninterest yield curve and due partly to CFC's borrowers diversifying the interest terms on their long-term debt. As the demand for variable interest rate loans increases, either through conversions from the fixed interest rate program or through new loan advances, CFC will continue to match fund these loans as to rate with variable interest rate debt instruments and will continue to redeem, to the extent possible and economically beneficial, its fixed interest rate debt instruments. These fixed rate loans at the borrower level typically represent a small portion of the borrower's overall capitalization.\nOn March 22, 1994 the final regulations regarding the prepayment of REA notes at a discount were adopted. As of May 31, 1994, no members had prepaid their loans under these regulations. During the first quarter of fiscal year 1995, CFC expects to advance approximately $142 million to five borrowers for the purpose of prepaying their REA loans. Future volume of REA prepayments will depend on a number of factors including interest rates, tax consequences and possible acquisition or other business opportunities available to the members. CFC does not expect large volumes of prepayment requests to be made at any one time, but believes that there will be a steady stream of activity.\nOver the last year, two large telecommunications companies, GTE and U.S. West, were in the process of divesting properties in various areas of the country. During fiscal year 1994, CFC extended approximately $400 million in loan commitments, through RTFC, to telecommunications members that had submitted bids on these properties. The increase in telephone loans outstanding as of May 31, 1994 was due to the advance of loans for the acquisition of these properties. To date a total of $302.1 million has been advanced to RTFC members that had their bids for property accepted by GTE, U.S. West and other independent telecommunication companies. Loan activity to telecommunications members should continue strong through the next fiscal year, as the remaining telecommunication properties are acquired. The level of growth experienced during fiscal year 1994 and expected in fiscal year 1995 is due to the telecommunication members taking advantage of specific opportunities and should not be seen as a continuing trend.\nAs discussed previously, REA has proposed to amend its lending requirements for power supply systems, requiring them to either increase their equity levels or obtain guarantees from their affiliated distribution systems. To the extent these systems require capital and this capital is unavailable from REA, some might be able to enter the public debt markets without the assistance of a financial intermediary. As a result, management believes that REA's new requirements may reduce CFC's potential lending and guarantee volume with CFC's larger, more creditworthy power supply members.\nThe amount of loan funds available from REA to its borrowers is dependent upon the size of the congressionally allocated subsidy for REA's revolving loan fund and the current interest rates. As interest rates rise, a larger portion of the subsidy is required to buydown the interest rate, reducing the total amount of funding available for new loans. As the level of loan funds available decreases, borrowers will be required to seek out additional sources for loan funds.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Combined Financial Statements, Auditors' Report and Combined Quarterly Financial Results are included on pages through (see Note 12 to Combined Financial Statements for a summary of the quarterly results of CFC's 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.\n(a) Identification of Directors\n(b) Identification of Executive Officers\nThe President, Vice President and Secretary-Treasurer are elected annually by the Board of Directors at its first meeting following CFC's annual membership meeting, each to serve a term of one year; the Governor serves at the pleasure of the Board of Directors; and the other Executive Officers serve at the pleasure of the Governor.\n(c) Identification of Certain Significant Employees.\nInapplicable.\n(d) Family Relationships.\nNo family relationship exists between any director or executive officer and any other director or executive officer of the registrant.\n(e) (1) and (2) Business Experience and Directorships.\nIn accordance with Article IV of CFC's Bylaws, each candidate for election to the Board of Directors must be a trustee, director or manager of a member of CFC.\nMr. McGinnis has been the General Manager of Denton County Electric Cooperative, Inc., Denton, TX since 1980. He was President of Texas Electric Cooperative, Inc., Austin, TX from 1984 to 1985.\nMr. Cariker has been General Manager of Cookson Hills Electric Cooperative, Stigler, OK, since 1982.\nMr. Bye has been General Manager of East Central Electric Association, Braham, MN, since 1985.\nMr. Anderson has been President and CEO of Southside Electric Cooperative, Crewe, VA and a Director of Old Dominion Electric Cooperative, Glen Allen, VA since 1982. He has been a member of the Virginia, Maryland & Delaware Association of Electric Cooperatives since 1982. He was Chairman of the NRECA Cooperative Research Committee from 1982 to February 1990. He was elected to the Board of Directors of Vedcorp, an economic development corporation, and elected to the Crewe, VA Industrial Development Committee, in May 1991. Mr. Anderson was appointed to the Southside Virginia Business and Education Commission in 1992.\nMr. Austin has been a Director of Blue Ridge EMC, Lenoir, NC since 1970. Since 1984 he has been President of Blue Ridge EMC, and held the office of Vice President prior to 1984. He has been a Director of North Carolina EMC (G&T), Raleigh, NC, since 1989 and serves on the Executive Committee. He served as a Director of NC Association of Electric Cooperatives, Raleigh, NC from 1970 until 1989, and served as President from March 1983 to March 1984. He has been a Director of First Union National Bank, Boone, NC since 1971. He has been owner and Manager of Reins-Sturdivant Funeral Directors, Boone, NC since 1975.\nMr. Bauman has been the General Manager of Butler County Rural Electric Cooperative, Allison, IA, since 1984. He is a member of the Corn Belt Power Cooperative Industrial Development Committee and the Iowa Association of Business and Industry's Economic Development Committee.\nMr. Bertram has been a farmer in Valley City, ND, since 1964. He has been a Director of North Dakota Association of Rural Electric Cooperatives, Mandan, ND, since 1988 and Secretary of Cass County Electric Cooperative, Inc., Kindred, ND, since 1986.\nMr. Dycus has been a partner and co-owner of Dycus, Bradley & Draves, P.C., a regional public accounting firm, since 1973. He has been a Director of Egyptian Electric Cooperative, Steeleville, IL, since 1976 and a Director of Southern Illinois Power Cooperative since 1981.\nMr. English has been Executive Vice President and General Manager of NRECA, Washington, DC since February 1994. He served in the House of Representatives from 1975 to 1994. He served on the House Agriculture Committee from 1975 to 1994, and was Chairman of the House Agricultural Subcommittee on Environment Credit and Rural Development in 1989.\nMr. Floyd has been Vice Chairman of Oconee Electric Membership Corporation, Dudley, GA, since 1970. He has been Vice President since 1968 and a Director since 1969 of The Four County Bank. He has been a Director of Oglethorpe Power Corporation, Tucker, GA, and President and Chairman of Twiggs Gin Inc., a cotton gin, since 1973.\nMrs. Griffin has been a Director of D.S.& O. Rural Electric Cooperative Association, Abilene, KS, since 1987. She is a member of the National Rural Electric Women's Association, and has been a Rural Electric Director for 15 years. She is presently serving as a member of the Board of Directors of the\nKansas City Board of Trade. She served as a member of the Kansas Wheat Commission and is a member of the Kansas Association of Wheat Growers. She has been a member of the KEPCo Executive Committee and a former chair on the KEPCo Power Supply Planning and Operation Committee. She has also been Director of both the Dickinson County Extension Council Executive Board, and the Dickinson County Historical Society Board.\nMr. Harmeyer has been a Director of the Indiana Statewide Association of Rural Electric Cooperatives, Indianapolis, IN since 1976. He has also been a Director for Decatur County REMC, Greensburg, IN since 1958. He is a past member of CFC's nominating committee. He was a Director of the Indiana Rural Cooperative Federal Credit Union from 1978 to 1981. He has been Chairman of Harmeyer Farms, Inc., since 1985. He is Chairman of the Napoleon State Bank and a past Board Chairman of the Ripley County Farm Bureau Co-op and the Ripley County Soil & Water Conservation Board. He is a past delegate for Milk Marketing, Inc.\nMr. Hudson has owned and operated the Leonard Paul Store, a general store, since 1978. He has sold real estate in the Priest Lake, ID area since 1989. He has been President of Northern Lights, Inc., Sandpoint, ID since 1984.\nMr. Kline has been a Director of Trico Electric Cooperative, Tucson, AZ since 1988. He has been Vice President of Grand Canyon State Electric Cooperative Association since 1992. He was a part-time Magistrate for the town of Marana, AZ, from 1983 to 1993.\nMr. Liess has been General Manager of Twin Valleys Rural Public Power District, Cambridge, NE since 1978. He has been an alternate Director of the Nebraska Rural Electric Association (\"NREA\") and the Nebraska Electric Generation and Transmission Cooperative, Inc., since 1979. He has been Chairman of the Nebraska ACRE Board since 1991 and vice-chairman of the NREA Credit Union Board since 1989. He is a member and one of five original founders of Five District Joint Venture, developers of Rural Power Manager Software. Mr. Liess has been a member of the Board of Governors of the Central Community College since 1989. He is a member of the Board of Directors of the Central Plains Technical and Business Development Center and Chairman of the Cambridge Economic Development Board.\nMr. Loveless has been the Executive Vice President and General Manager of Meriwether Lewis Electric Cooperative, Centerville, TN, since 1987. He served as Assistant General Manager of Meriwether Lewis Electric Cooperative from 1985 to 1987. He is a member of the Board of Directors and the Legislative and Tax Committee of the Tennessee Electric Cooperative Association.\nMr. Paolucci has been General Manager of Morrow Electric Cooperative, Inc., Mount Gilead, OH since 1977. In addition he is presently Chairman of the United Utility Supply Cooperative Corporation and has served as its Vice Chairman. He has also served as Trustee for Buckeye Power, Inc. since 1983.\nMr. Piper has been the General Manager of Pacific Northwest Generating Cooperative, Portland, OR, since 1979. He is a Director of the Pacific Northwest Utilities Conference Committee and was a member of the NRECA Water Power Committee from 1987 to 1991. He has been a member of the National Preference Customer Committee since 1983 and is presently President of the G&T Managers Association.\nMr. Pitchford has owned and operated a farm in Columbia, AL, since 1971. He has been a Director of Pea River Electric Cooperative, Ozark, AL, since 1987.\nMr. Roberts has been a Director of NRECA, Washington, DC since 1980 and President since February 1993. He has been a Director of Golden Spread Electric Cooperative, Amarillo, TX since 1984 and was Board Chairman from 1987 to 1988. He is a member and past president of the Bellville Industrial Foundation, and a past director of the First National Bank of Bellville and the Bellville Hospital Foundation.\nMr. Sloan has been a Director of Craighead Electric Cooperative, Jonesboro, AR, since 1962, and he was President from 1975 to 1989. He was a Director of Arkansas Electric Cooperative Corporation\nand Arkansas Electric Cooperatives, Inc., both of Little Rock, AR, from 1975 to 1989. He was a Director of Electric Research and Manufacturing Cooperative, Dyersburg, TN, from 1984 to 1989. He was a Director of Citizens National Bank, Walnut Ridge, AR, from 1968 to 1990. He has been a farmer and farm manager since 1956. He was a Director of SF Services, Inc., a farmers association, from 1967 to 1992, and was Chairman of the Board from 1986 to 1992. He has been a Director of Arkansas Blue Cross and Blue Shield since 1978.\nMr. Williams has been Executive Vice President and General Manager of York Electric Cooperative, York, SC since 1974. He has been a trustee for both the Saluda River Electric Cooperative, Laurens, SC and the Electric Cooperatives of South Carolina since 1974. He was a trustee for the South Carolina State Development Board from 1991 to 1993 and a trustee for the York Technical College Foundation Board from 1983 to 1991.\nMr. Gill joined the CFC staff in April 1972 as Borrowers Operations Officer. He served as Deputy Governor from 1978 to 1979 prior to being named Governor effective September 1979.\nMr. List joined CFC as a staff attorney in February 1972. He served as Corporate Counsel from June 1980 until 1991 and served as General Counsel until May 1992. He became Senior Vice President and General Counsel on June 1, 1992.\nMr. Bulman joined the CFC staff as Power Supply Officer in March 1980. He has served as Loan Officer since June 1, 1984. He became Senior Vice President and Loan Officer on June 1, 1992.\nMr. Salera joined CFC's staff as Controller in September 1975.\nMr. Petersen joined CFC in August 1983 as an Area Representative. He became the Director of Policy Development and Internal Audit in January 1990, then Director of Credit Analysis in November 1990 and Corporate Secretary on June 1, 1992. He became Assistant to the Governor on May 1, 1993. He became Assistant Governor and Acting Administrative Officer on June 1, 1994.\nMr. Lilly joined CFC as a Senior Financial Consultant in October 1983. He became Director of Special Finance in June 1985 and Director of Corporate Finance in June 1986. He became Treasurer and Principal Finance Officer on June 1, 1993. He became Senior Vice President and Chief Financial Officer on January 1, 1994.\n(f) Involvement in Certain Legal Proceedings.\nNone to the knowledge of CFC.\n(g) Promoters and control persons.\nInapplicable.\nITEM 405. COMPLIANCE WITH SECTION 16 (A) OF THE EXCHANGE ACT.\nInapplicable.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Summary Compensation Table below sets forth the aggregate renumeration for services in all capacities to CFC, on an accrual basis, for the three years ended May 31, 1994, 1993 and 1992 to the named executive officers. The named executive officers include the CEO and the next four most highly compensated executive officers serving at May 31, 1994, with salary and bonus for fiscal year 1994 in excess of $100,000.\nSUMMARY COMPENSATION TABLE\n- - --------------- (1) Reportable perquisites and other personal benefits do not exceed $50,000 or 10% of salary and bonus. All other items reportable under this column are not applicable to CFC.\n(2) Not applicable to CFC.\n(3) Amounts for fiscal years 1994 and 1993 include $90,292 and $63,750 related to an employment contract, $48,147 and $45,616 related to leave accruals and $5,980 and $5,697 related to CFC contributions to savings plan for Mr. Gill; $12,771 and $3,688 related to leave accruals and $3,344 and $3,081 related to CFC contributions to savings plan for Mr. Bulman; $7,213 and $6,724 related to leave accruals and $2,888 and $2,765 related to CFC contributions to savings plan for Mr. List; $6,682 and $5,901 related to leave accruals and $2,778 and $2,154 related to CFC contributions to savings plan for Mr. Lilly; and $4,980 and $8,915 related to leave accruals and $2,578 and $2,483 related to CFC contributions to savings plan for Mr. Walsh, respectively.\n(4) Mr. Walsh retired effective May 31, 1994.\nDEFINED BENEFIT OR ACTUARIAL PLAN DISCLOSURE\nNRECA also maintains the Retirement and Security Program entitling CFC employees to receive, under a 50% joint and surviving spouse annuity, 1.90% of the average of their five highest base salaries during their last ten years of employment, multiplied by the number of years of participation in the program. As of May 31, 1994, the number of years of service credited and the compensation covered under the program, respectively, for the officers listed above was as follows: Charles B. Gill -- 21 years 2 months, $260,834; Steven L. Lilly -- 10 years 8 months, $105,003; John Jay List -- 21 years 3 months, $129,650; Richard B. Bulman -- 14 years 2 months, $142,088; Nicholas J. Walsh -- 22 years 5 month, $117,868.\nPENSION PLAN TABLE\n- - --------------- * The Tax Reform Act of 1984 places a cap on maximum salary used to compute retirement benefits and maximum yearly benefit. For calendar year 1994, the salary cap is $150,000 (the cap represents the amount of salary for 1994 that may be used in the computation of the average base salary) and benefits cap is $118,800.\nThe Budget Reconciliation Act of 1993 has set a limit of $150,000 on the 1994 compensation to be used in the calculation of pension benefits. In order to restore potential lost benefits, CFC has set up a Pension Restoration Plan. Under the plan, the amount that NRECA invoices CFC will continue to be based on the full compensation paid to each employee. Upon the retirement of a covered employee, NRECA will calculate the retirement and security benefit to be paid with consideration of the compensation limits and will pay the maximum benefit thereunder. NRECA will also calculate the retirement and security benefit that would have been available without consideration of the compensation limits and CFC will pay the difference. NRECA will then give CFC a credit against future retirement and security contribution liabilities in the amount paid by CFC to the covered employee.\nCFC will pay such additional benefits to the covered employee through a Severance Pay Plan and a Deferred Pay Restoration Plan. Under the Severance Pay Plan, the employee is paid an amount equal to the lost pension benefits but not to exceed twice the employee's annual compensation for the prior year. The benefit must be paid within 24 months of termination of employment. To the extent that the Severance Pay Plan cannot pay all of the lost pension benefits, the remainder will be paid under a Deferred Compensation Plan, which will be paid out in a lump sum or in installments of up to 60 months.\nCOMPENSATION OF DIRECTORS\nNo director received any renumeration as an officer or director of CFC. Directors are reimbursed for travel expenses and received a daily per diem to cover meals and lodging for their attendance at all Board of Directors functions.\nEMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS\nUnder a supplemental benefit agreement entered into as of April 1, 1989, and amended as of April 1, 1993, CFC agreed to employ Mr. Gill, and Mr. Gill has agreed to remain as a CFC employee, for six years commencing April 1, 1989, and for future periods that may be agreed upon, at no less than his present compensation (as of April 1, 1993). Provided he does not earlier resign and is not discharged for cause, CFC has agreed to pay Mr. Gill, after his normal retirement date in 2000 or such earlier retirement dated as agreed to by the Board of Directors, or earlier death or disability, a sum ranging from $17,500 commencing in 1983 to $32,500 beginning in 1986 for each year he is employed by CFC (or in the case of death or disability, for each year he would have been so employed (since 1983) until such date, subject, in the case of disability, to certain offsets or other payments) with interest at the rate of 10% per annum until payment. The agreement also provides to Mr. Gill eight weeks of paid vacation per year, which will accrue and be paid if unused. Mr. Gill has informed CFC of his intention to retire as of April 1, 1995. The Board has agreed that this date will be treated as his normal retirement date under the supplemental benefit agreement.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nDuring the year ended May 31, 1994 the following directors and former directors of CFC served as members on the Operating Review and Audit Committee of the Board of Directors (which functions as the Board's compensation committee):\nBill McGinnis (President of CFC)\nJohn M. McBride (Former Director and Former Vice President of CFC)\nJohn B. Floyd, Jr.\nDavid E. Piper\nJ.E. Smith (Former Director and Former President of CFC)\nJ. Chris Cariker (Vice President of CFC)\nGarry Bye (Secretary-Treasurer of CFC)\nHarold I. Dycus\nRalph L. Loveless\nTerry Pitchford\nJohnnie R. Austin (Former Secretary-Treasurer of CFC)\nOther than those mentioned above, there were no compensation committee interlocks or insider participation related to executive compensation.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInapplicable.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\n(a), (b) and (c) At May 31, 1994, CFC had commitments for long-and intermediate-term loans aggregating $53 million and $205 million, respectively, and committed lines of credit aggregating $346 million, to member systems, excluding NCSC, RTFC and GFC, of which executive officers or directors of CFC are members, employees, officers or directors. At May 31, 1994, $193 million and $70 million of advances were outstanding with respect to such long-and intermediate-term loans, respectively, and $24 million was outstanding under such lines of credit. At May 31, 1994, CFC had guaranteed $246 million of contractual obligations of such members. CFC had commitments to NCSC for long-term loans of $15 million and CFC had outstanding guarantees of certain contractual obligations in the amount of $764 million at May 31, 1994, on behalf of NCSC. At May 31, 1994, advances outstanding with respect to such long-term loans were $48 million for NCSC. Such loans and guarantees were made in the ordinary course of CFC's business on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transaction with other members and did not involve more than normal risk of uncollectibility or present other unfavorable features. It is anticipated that, consistent with its loan and guarantee policies in effect from time to time, additional loans and guarantees will be made by CFC to member systems and trade and service organizations of which officers or directors of CFC are members, employees, officers or directors. In light of its cooperative nature, pursuant to which CFC was established for the very purpose of extending financing to its members (from whose ranks its directors must be drawn), CFC is of the view that no purpose would be served by including detailed information with respect to specific loans and guarantees to members with which any of its directors are affiliated.\n(d) Inapplicable.\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\nAll other schedules are omitted because they are not required or inapplicable or the information is included in the financial statements or notes thereto.\n3. EXHIBITS\n(B) REPORTS ON FORM 8-K.\nNo reports on Form 8-K were filed during the last quarter of fiscal 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, in the County of Fairfax, Commonwealth of Virginia, on the 5th day of August, 1994.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nBy: \/s\/ CHARLES B. GILL\n-------------------------------------- Charles B. Gill Governor 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.\nAugust 5, 1994\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors of NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION:\nWe have audited the accompanying combined balance sheets of National Rural Utilities Cooperative Finance Corporation (a not-for-profit corporation under the District of Columbia Cooperative Association Act) and other related entities as discussed in Note 1 as of May 31, 1994 and 1993, and the related combined statements of income, expenses and net margins, changes in members' equity and cash flows for each of the three years in the period ended May 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, the financial statements referred to above present fairly, in all material respects, the financial position of National Rural Utilities Cooperative Finance Corporation and other related entities as of May 31, 1994 and 1993, and the 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. ARTHUR ANDERSEN & CO.\nWashington, D.C. July 18, 1994\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nCOMBINED BALANCE SHEETS (DOLLAR AMOUNTS IN THOUSANDS) MAY 31, 1994 AND 1993\nASSETS\nThe accompanying notes are an integral part of these combined financial statements.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION COMBINED BALANCE SHEETS (DOLLAR AMOUNTS IN THOUSANDS) MAY 31, 1994 AND 1993\nLIABILITIES AND MEMBERS' EQUITY\nThe accompanying notes are an integral part of these combined financial statements.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION COMBINED STATEMENTS OF INCOME, EXPENSES AND NET MARGINS (DOLLAR AMOUNTS IN THOUSANDS) FOR THE YEARS ENDED MAY 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of these combined financial statements.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION COMBINED STATEMENTS OF CHANGES IN MEMBERS' EQUITY (DOLLAR AMOUNTS IN THOUSANDS) FOR THE YEARS ENDED MAY 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of these combined financial statements.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nCOMBINED STATEMENTS OF CASH FLOWS\n(DOLLAR AMOUNTS IN THOUSANDS)\nFOR THE YEARS ENDED MAY 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of these combined financial statements.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS\nMAY 31, 1994, 1993 AND 1992\n(1) GENERAL INFORMATION AND ACCOUNTING POLICIES\n(a) General Information\nNational Rural Utilities Cooperative Finance Corporation (the \"Company\" or \"CFC\") was incorporated as a private, not-for-profit cooperative association under the laws of the District of Columbia in April 1969. The principal purpose of CFC is to provide its members with a source of financing to supplement the loan programs of the Rural Electrification Administration (\"REA\") of the United States Department of Agriculture. CFC makes loans primarily to its rural utility system members (\"Utility Members\") to enable them to acquire, construct and operate electric distribution, generation, transmission and related facilities. Most CFC long-term loans to Utility Members are made in conjunction with concurrent loans from REA and are secured equally and ratably with REA's loans by a single mortgage. CFC also provides guarantees for tax-exempt financings of pollution control facilities and other properties constructed or acquired by its members and, in addition, provides guarantees of taxable debt in connection with certain lease and other transactions of its members. CFC is exempt from payment of Federal income taxes under Section 501(c)(4) of the Internal Revenue Code.\nCFC's 1,039 members as of May 31, 1994, included 899 Utility Members, virtually all of which are consumer-owned cooperatives, 71 service members and 69 associate members. The Utility Members included 833 distribution systems and 66 generation and transmission (\"Power Supply\") systems operating in 46 states and U.S. territories. At December 31, 1992, CFC's member systems served approximately 12.2 million consumers, representing service to an estimated 28.8 million ultimate users of electricity and owned approximately $60.8 billion (before depreciation of $16.4 billion) in total utility plant.\nRural Telephone Finance Cooperative (\"RTFC\") was incorporated as a private cooperative association in the state of South Dakota in September 1987. RTFC is a controlled affiliate of CFC and was created for the purpose of providing and\/or arranging financing for its rural telecommunication members and affiliates. RTFC's bylaws require that the majority of RTFC's Board of Directors be elected from individuals designated by CFC. CFC is the sole source of funding for RTFC. As of May 31, 1994, RTFC had 352 members. RTFC is a taxable entity under Subchapter T of the Internal Revenue Code and accordingly takes deductions for allocations of net margins to its patrons.\nGuaranty Funding Cooperative (\"GFC\") was incorporated as a private cooperative association in the state of South Dakota in December 1991. GFC is a controlled affiliate of CFC and was created for the purpose of providing a source of funds for its members to refinance their REA guaranteed debt previously held by the Federal Financing Bank. All trust certificates held by GFC were transferred to GFC by CFC and are guaranteed by the REA. CFC is the sole source of funding for GFC. GFC had four members other than CFC at May 31, 1994. GFC is a taxable entity under Subchapter T of the Internal Revenue Code and accordingly takes deductions for allocations of net margins to its patrons.\n(b) Principles of Combination\nThe accompanying financial statements include the combined accounts of CFC, RTFC and GFC, after elimination of all material intercompany accounts and transactions. CFC has a $1,000 membership interest in both RTFC and GFC. CFC exercises control over RTFC and GFC through majority representation on their Boards of Directors. CFC manages the affairs of RTFC through a long-term management agreement. CFC services the loans for GFC for which it collects a servicing fee.\nAs of May 31, 1994, CFC had committed to lend RTFC up to a total of $1.8 billion to fund loans to its members and their affiliates. As of the same date, RTFC had outstanding loans and unadvanced loan\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\ncommitments totaling $1,135.4 million. RTFC's net margins are allocated to RTFC borrowers. Summary financial information relating to RTFC included in the combined financial statements is presented below:\n- - ---------------\n(1) The transfer of RTFC equity is governed by the South Dakota Cooperative Association Act which provides that net margins shall be distributed and paid to patrons. However, reserves may be created and credited to patrons in proportion to total patronage. CFC has been the sole funding source for RTFC's loans to its members. As CFC is not a borrower of RTFC and is not expected to be in the foreseeable future, RTFC's net margins would not be available to CFC in the form of patronage capital.\n(2) RTFC's net margins for fiscal year 1994 will be adjusted for the allocation of patronage capital by CFC.\nAs of May 31, 1994, CFC had loaned GFC $524.1 million to fund the purchase of REA guaranteed trust certificates from CFC. Summary financial information relating to GFC included in the combined financial statements is presented below:\n- - ---------------\n(1) The transfer of GFC equity is governed by the South Dakota Cooperative Association Act which provides that net margins shall be distributed and paid to patrons. However, reserves may be created and credited to patrons in proportion to total patronage. CFC has been the sole funding source for GFC's loans to its members. As CFC is not a borrower of GFC and is not expected to be in the foreseeable future, GFC's net margins would not be available to CFC in the form of patronage capital.\nUnless stated otherwise, references to CFC relate to CFC, RTFC and GFC on a combined basis.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\n(c) Amortization of Bond Discount and Bond Issuance Costs\nBond discount and bond issuance costs are amortized using the effective interest method over the life of each bond issue.\n(d) Nonperforming Loans\nIt is CFC's policy to classify a loan as nonperforming when it meets any of the following criteria:\n(i) Interest or principal payments are contractually past due 90 days or more,\n(ii) As a result of court proceedings, repayment in accordance with the original terms is not anticipated, or\n(iii) For other reasons, timely repayment is not expected.\n(e) Allowance for Loan and Guarantee Losses\nCFC maintains an allowance for loan and guarantee losses at a level believed to be adequate in relation to the quality and size of its loans and guarantees outstanding. It is CFC's policy to review periodically its loans and guarantees and to make adjustments to the allowance as necessary. The allowance is based on estimates, and accordingly, actual loan and guarantee losses may differ from the allowance amount.\nActivity in the allowance account is summarized as follows for the years ended May 31:\n(f) Fixed Assets\nBuildings, aircraft, furniture and fixtures and related equipment are stated at cost less accumulated depreciation and amortization of $5.4 million and $4.2 million as of May 31, 1994 and 1993, respectively. Depreciation and amortization expenses ($1.6 million, $1.5 million and $1.2 million in fiscal years 1994, 1993 and 1992, respectively) are computed primarily on the straight-line method over estimated useful lives ranging from 3 to 40 years.\n(g) Recognition of Fee Income\nIn connection with its various loan, guarantee and other financing programs, CFC may be entitled to receive certain fees. Such fees are generally designed to compensate CFC for expenses associated with the related transactions. CFC recognizes the income from such fees periodically over the term during which it incurs the related expenses.\n(h) Financial Instruments with Off-Balance Sheet Risk\nIn the normal course of business, CFC is a party to financial instruments with off-balance sheet risk both to meet the financing needs of its member borrowers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, guarantees\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nof members' obligations and interest rate exchange agreements. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the combined balance sheets.\n(i) Accounting by Creditors for Impairment of a Loan\nIn May 1993, the Financial Accounting Standards Board released Statement No. 114 \"Accounting by Creditors for Impairment of a Loan.\" The statement requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, observable market value or the fair value of the collateral. The statement is required to be implemented in fiscal years beginning after December 15, 1994 and will apply to loans that are, or become impaired, based on the provisions of SFAS 114, or that have certain restructuring agreements executed on or after the implementation date. CFC has elected not to implement this statement early and management has not yet determined its impact on the financial statements.\n(j) Employers' Accounting for Postemployment Benefits\nIn November 1992, the Financial Accounting Standards Board released Statement No. 112 \"Employers' Accounting for Postemployment Benefits.\" This statement requires employers to recognize the obligation to provide postemployment benefits, if the obligation is attributable to employees' services already rendered, employees' rights to those benefits accumulate or vest, payment of the benefits is probable, and the amount of the benefits can be reasonably estimated. This statement is effective for fiscal years beginning after December 15, 1994. CFC has elected not to implement this statement early. However, management does not expect the implementation to have a material impact on the financial statements.\n(k) Accounting for Certain Investments in Debt and Equity Securities\nIn May 1993, the Financial Accounting Standards Board released Statement No. 115 \"Accounting for Certain Investments in Debt and Equity Securities.\" This statement requires that investments in debt and equity securities be recorded at fair value in the statement of financial condition unless the reporting enterprise has the positive intent and ability to hold the instrument to maturity. If there is positive intent and ability to hold to maturity, the instrument can be recognized using the amortized cost method. This statement is effective for fiscal years beginning after December 15, 1993. CFC has elected not to implement this statement early, and management has not yet determined its impact on the financial statements.\n(l) Memberships\nMembers are charged a one-time membership fee based on member class. CFC Distribution System members (Class A), Power Supply System members (Class B), NRECA (Class D) and Associate members (Class E) all pay a $1,000 membership fee. CFC Service Organization members (Class C) pay a $200 membership fee. RTFC voting members pay a $1,000 membership fee and non-voting members pay a $100 membership fee. All GFC members pay a $1,000 membership fee.\n(m) Reclassifications\nCertain reclassifications of prior year amounts have been made to conform with fiscal year 1994 presentation.\n(2) LOANS AND COMMITMENTS\nLoans to members bear interest at rates determined from time to time by the Board of Directors on the basis of CFC's cost of funds, operating expenses, provision for loan and guarantee losses and the maintenance of reasonable margin levels. In keeping with its not-for-profit, cooperative character, CFC's policy is to set\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\ninterest rates at the lowest levels it considers to be consistent with sound financial management. Loans outstanding to members, weighted average interest rates thereon and unadvanced commitments are summarized by loan type as follows as of May 31:\n- - ---------------\n(A) Unadvanced commitments include loans approved by CFC for which loan contracts have not yet been executed and for which loan contracts have been executed, but funds have not been advanced. CFC may\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nrequire additional information to assure itself that all conditions for advance of funds have been fully met and that there has been no material change in the member's condition as represented in the documents supplied CFC. Since commitments may expire without being fully drawn upon, the total amounts reported as commitments do not necessarily represent future cash requirements. Collateral and security requirements for lending on commitments are identical to those for advanced loans.\n(B) Generally, long-term fixed rate secured loans provide for a fixed interest rate for terms of one to 30 years. Upon expiration of the term, the borrower may select another fixed rate term of one to 30 years (but not beyond maturity of the loan) or a variable rate. The borrower may select either option or may repay to CFC the principal then outstanding together with interest due thereon and other sums, if required.\n(C) CFC had loans outstanding to National Cooperative Services Corporation (\"NCSC\") in each of the periods shown. Long-term fixed rate loans outstanding to NCSC as of May 31, 1994 and 1993, were $47.8 million and $49.0 million, respectively. In addition, as of May 31, 1994, CFC had unadvanced long-term fixed rate and variable rate loan commitments to NCSC in the amount of $5.0 million and $9.7 million, respectively.\n(D) Included in the long-term variable rate secured loans are $3.5 million and $2.5 million in unsecured loans to one borrower at May 31, 1994 and 1993.\n(E) All short-term loans are unsecured, except for $18.2 million and $31.6 million in loans outstanding at May 31, 1994 and 1993 that are secured.\n(F) The rates on nonperforming loans are the weighted average of the stated rates on such loans as of the dates shown and do not necessarily relate to the interest recognized by CFC from such loans.\n(G) The rates on restructured loans are the weighted average of the effective rates (based on present values of scheduled future cash flows) as of the dates shown and do not necessarily relate to the interest recognized by CFC from such loans.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nLoans outstanding, by state or U.S. territory, are summarized below:\nWeighted average interest rates earned (recognized in the case of nonperforming and restructured loans) on all loans outstanding are summarized below:\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nLong-term fixed rate loans outstanding at May 31, 1994 which will be subject to adjustment of their interest rates during the next five calendar years are summarized as follows (due to principal repayments, amounts subject to interest rate adjustment may be lower at the actual time of interest rate adjustment):\nDuring the first quarter of calendar year 1994, long-term fixed rate loans totaling $52.9 million had their interest rates adjusted. These loans will be eligible to readjust their interest rates again during the first quarter of calendar year 1995 to the lowest long-term fixed rate offered during 1994 for the term selected. At January 1 and May 31, 1994, the standard long-term fixed rates were 6.55% and 8.00%, respectively.\nOn most long-term secured loans, level quarterly payments are required with respect to principal and interest in amounts sufficient to repay the loan principal, generally over a period ending approximately 35 years from the date of the secured promissory note. Fiscal year 1995 repayments of principal on long-term loans outstanding are expected to be a relatively minor amount of such outstanding loans.\nCFC evaluates each borrower's creditworthiness on a case-by-case basis. It is generally CFC's policy to require collateral for all long-term and some intermediate-term loans. Such collateral usually consists of a first mortgage lien on the borrower's total system, including plant and equipment, and a pledge of future revenues. The loan and security documents also contain various provisions with respect to the mortgaging of the borrower's property, the maintenance of certain earnings and debt service coverage ratios, maintenance of adequate insurance coverage and certain other restrictive covenants.\nUnder common mortgages securing long-term CFC loans to Distribution System members, REA has the sole right to act within 30 days or, if REA is not legally entitled to act on behalf of all noteholders, CFC may exercise remedies. Under common mortgages securing long-term CFC loans to, or guarantee reimbursement obligations of, Power Supply members, REA retains substantial control over the exercise of mortgage remedies.\nAs of May 31, 1994 and 1993, mortgage notes representing approximately $717.8 million and $1,301.7 million, respectively, of outstanding long-term loans to members were pledged as collateral to secure CFC's Collateral Trust Bonds.\nCFC has received no guarantee of its loans from REA; however, \"Refinancing loans guaranteed by REA\" represents loans made by CFC and transferred to its affiliate GFC to fund the prepayment of members' Federal Financing Bank debt, effected through grantor trusts which each hold a note from the member, the repayment of which has been guaranteed by REA. Each trust issues Trust Certificates which represent an undivided interest in the trust assets. GFC, as holder of Trust Certificates, is financing these loans from funds provided by CFC at a variable rate until fixed rate funding is obtained through the public markets.\nCFC sets the variable interest rates monthly on outstanding short-and intermediate-term loans. On notification to borrowers, CFC may adjust the interest rate semimonthly. Under CFC policy, the maximum interest rate which may be charged on short-term loans is the prevailing bank prime rate plus 1% per annum;\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\non intermediate-term loans, the prevailing bank prime rate plus 1 1\/2% per annum; and on RTFC short-term loans, the prevailing bank prime rate plus 3% per annum.\nAt May 31, 1994, 1993 and 1992, nonperforming loans in the amount of $44.9 million, $55.8 million and $17.0 million, respectively, were on a nonaccrual basis with respect to recognition of interest income. The effect of not accruing interest on nonperforming loans was a decrease in interest income of $1.5 million, $1.1 million and $1.1 million for the years ended May 31, 1994, 1993 and 1992, respectively. Income recognized on these loans totaled $0.5 million, $0.5 million and $20.9 million, respectively.\nAt May 31, 1994, 1993 and 1992, the total amount of restructured debt was $165.4 million, $172.9 million and $145.6 million, respectively. CFC elected to apply all principal and interest payments received against outstanding amounts on restructured debt of $111.5 million, $100.3 million and $81.2 million, respectively. The interest income that would have been recorded under the original terms of the debt, assuming the debt had been outstanding for the period, was $8.4 million, $8.8 million and $10.5 million, for the years ended May 31, 1994, 1993 and 1992, respectively. The interest income actually recorded for restructured debt was $4.0 million, $2.9 million and $5.6 million, respectively. At May 31, 1994 and 1993, CFC had committed to lend $53.0 million and $26.5 million, respectively, to borrowers performing under restructured terms.\n(3) MEMBERS' SUBORDINATED CERTIFICATES\nMembership Subscription Certificates\nTo join CFC and to establish eligibility to borrow, CFC members (other than associate members and service organizations) are required to execute agreements to subscribe to certain Subordinated Certificates. Such certificates are interest-bearing, unsecured, subordinated debt of CFC. CFC is authorized to issue subscription certificates without limitation as to the total principal amount.\nGenerally, Membership Subscription Certificates mature in the years 2070 through 2090 and bear interest at 3% or 5% per annum.\nNew members joining CFC are required to purchase Membership Subscription Certificates in an amount equal to 5% of each loan advance up to a maximum amount based on their operating results. The maturity dates and interest rates payable on such Certificates vary in accordance with applicable CFC policy.\nIn certain cases, the Board of Directors has approved alternative deferred payment arrangements for purchase of subscription certificates. These deferred payments are evidenced by noninterest-bearing, unsecured notes from the member and are shown as receivables.\nLoan and Guarantee Certificates\nMembers obtaining long-term loans, certain intermediate-term loans or guarantees from CFC or RTFC are generally required to purchase additional Subordinated Certificates with each such loan or guarantee. These certificates are unsecured, subordinated debt of CFC and RTFC.\nCertificates currently purchased in conjunction with loans are noninterest-bearing and are generally repaid periodically over the life of the loan in relation to the loan principal balance outstanding. Such certificate purchase requirements, if any, range from 1% to 12% of the loan amount depending on the membership classification of the borrower and the borrower's leverage ratio, including the new loan, with CFC, for utility systems.\nThe maturity dates and the interest rates payable on certificates purchased in conjunction with CFC's guarantee program vary in accordance with applicable CFC policy. In addition, members may also be required to purchase noninterest-bearing Subordinated Certificates in connection with CFC's guarantee of long-term tax-exempt bonds (see Note 8). These certificates have varying maturities but none is greater than the longest\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nmaturity of the guaranteed obligation. Proceeds from the sale of such certificates are pledged by CFC to the debt service reserve fund established in connection with the bond issue, and any earnings from the investments of the fund inure solely to the benefit of the members for whose benefit the bonds are issued.\nInformation with respect to Members' Subordinated Certificates at May 31, is as follows:\nCFC estimates the amount of Subscription and Loan and Guarantee Certificates that will be repaid during the next five fiscal years will total approximately 2% of certificates outstanding. The weighted average interest rate paid on all subordinated certificates was 4.46%, 4.58% and 4.17% as of May 31, 1994, 1993 and 1992, respectively. These rates do not include $107.1 million, $116.5 million and $128.0 million of debt service reserve certificates and $29.3 million, $32.4 million and $36.2 million of subscribed but unissued subordinated certificates at May 31, 1994, 1993 and 1992, respectively.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\n(4) NOTES PAYABLE AND CREDIT ARRANGEMENTS\nNotes payable due within one year as of May 31, and weighted average interest rates thereon, are summarized as follows:\nOther information with regard to notes payable due within one year at May 31, is as follows:\nCFC issues short-term bid notes which are unsecured obligations of CFC and do not require back-up bank lines for liquidity purposes. Bid note facilities are uncommitted lines of credit for which CFC does not pay a fee. The commitments are generally subject to termination at the discretion of the individual banks.\nAs of May 31, 1994, CFC had two revolving credit agreements totaling $2,900.0 million with 52 banks, including Morgan Guaranty Trust Company of New York as Administrative Agent and Arranger and the Bank of Nova Scotia as Managing Agent. These credit facilities were arranged principally to provide liquidity support for CFC's outstanding commercial paper and the adjustable or floating\/fixed rate bonds which CFC has guaranteed and agreed to purchase for the benefit of its members (see Note 8).\nUnder the respective revolving credit agreements, CFC can borrow up to $2,030.0 million until June 3, 1996 (the \"three-year facility\"), and $870.0 million until May 26, 1995 (the \"364-day facility\"). Any\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\namounts outstanding will be due on those dates. In connection with the three-year facility, CFC pays a per annum facility\/commitment fee of .225 of 1%. The per annum facility fee for the 364-day facility is .15 of 1%. If CFC's short-term ratings decline, these fees may be increased by no more than .2125 of 1%. Borrowings under both agreements will be at one or more rates as defined in the agreements, as selected by CFC.\nThe revolving credit agreements require CFC among other things to maintain Members' Equity and Members' Subordinated Certificates of at least $1,334.4 million (increased each fiscal year by 90% of net margins not distributed to members) and an average fixed charge coverage ratio over the six most recent fiscal quarters of at least 1.025 and prohibits the retirement of patronage capital unless CFC has achieved a fixed charge coverage ratio of 1.05 for the preceding fiscal year. The credit agreements prohibit CFC from incurring senior debt (including guarantees but excluding indebtedness incurred to fund REA guaranteed loans) in an amount in excess of ten times the sum of Members' Equity and subordinated debt and restrict, with certain exceptions, the creation by CFC of liens on its assets and contain certain other conditions to borrowing. The agreement also prohibits CFC from pledging collateral in excess of 150% of the principal amount of Collateral Trust Bonds outstanding. Provided that CFC is in compliance with these financial covenants (including that CFC has no material contingent or other liability or material litigation not disclosed by or reserved against in its most recent annual financial statements) and is not in default, CFC may borrow under the agreements until the termination date. As of May 31, 1994, CFC was in compliance with all covenants and conditions.\nAs of May 31, 1994, there were no borrowings outstanding under the revolving credit agreements. At May 31, 1994, CFC classified $2,030.0 million of its notes payable outstanding as long-term debt. CFC expects to maintain more than $2,030.0 million of notes payable outstanding during the next 12 months. If necessary, CFC can refinance such notes payable on a long-term basis by borrowing under the three-year facility, subject to the conditions therein.\nIn addition to the revolving credit facilities at May 31, 1994, CFC also had $610.0 million in separately negotiated 364-day lines of credit, documented by a uniform line of credit agreement for which a commitment fee of .10 of 1% is paid. The line of credit agreement contains the same financial covenants as the revolving credit agreements and may be terminated upon 30 days notice by either party. After such notice the bank would not be obligated to lend.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\n(5) LONG-TERM DEBT\nThe following is a summary of long-term debt as of May 31:\nCFC redeemed Series Q Collateral Trust Bonds on June 16, 1994, Series R Collateral Trust Bonds on February 2, 1994, and Series S Collateral Trust Bonds on April 18, 1994, all at par.\nThe weighted average interest rate on Medium-Term Notes and Collateral Trust Bonds was 8.06%, 8.56% and 8.90% as of May 31, 1994, 1993 and 1992. These rates do not include notes payable supported by the revolving credit agreement.\nThe principal amount of Medium-Term Notes and Collateral Trust Bonds maturing (including any sinking fund requirements) in each of the five fiscal years following May 31, 1994, is as follows:\nUnder the 1972 Indenture for Collateral Trust Bonds, CFC is required to maintain funds in a debt service investment account equivalent to principal and interest payments due on the bonds over the next twelve months. At May 31, 1994 and 1993, CFC had $33.7 million and $45.6 million of such funds invested in bank certificates of deposit and marketable securities, respectively.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nThe outstanding Collateral Trust Bonds are secured by the pledge of mortgage notes taken by CFC in connection with long-term secured loans made to those members fulfilling specified criteria as set forth in the indenture. Medium-Term Notes are unsecured obligations of CFC.\nAs of May 31, 1994 and 1993, CFC had interest rate exchange agreements as follows:\nUnder these agreements, CFC pays a fixed rate of interest and receives interest based on a floating rate, the net result of which is included in the cost of funds. CFC is exposed to interest rate risk to the extent of nonperformance by the other parties to the agreements.\nCFC enters into interest rate swaps in managing its interest rate risk. In these swaps, CFC agrees with other parties to exchange, at specified intervals, the difference between fixed-and floating-interest amounts calculated on an agreed-upon notional principal amount. CFC uses interest rate swap agreements to hedge certain long-term fixed-rate interest-earning assets that have been funded by shorter-term variable interest-bearing liabilities. Interest rate swaps in which CFC pays the fixed and receives the floating rate are used to reduce the impact of market interest rate fluctuations on CFC's net margins.\nCFC is be exposed on these interest rate swap agreements to interest rate risk if the counterparty to the interest rate swap agreement does not perform to the agreement's terms. CFC does have a policy intended to limit counterparty credit risk by maintaining swap agreements only with financial institutions with at least a AA long-term credit rating.\n(6) EMPLOYEE BENEFITS\nCFC is a participant in the National Rural Electric Cooperative Association (\"NRECA\") Retirement and Security Program. This program is available to all qualified CFC employees. Under the program, participating employees are entitled to receive, under a 50% joint and surviving spouse annuity, 1.90% of the average of their five highest base salaries during their last ten years of employment, multiplied by the number of years of participation in the program. CFC funds pension costs accrued on a monthly basis. A moratorium on contributions has been in effect since July 1, 1987, when the plan reached the full funding limitation. This is a multi-employer plan, available to all member cooperatives of NRECA, and therefore, the projected benefit obligation and plan assets are not determined or allocated separately by individual employer.\nThe Budget Reconciliation Act of 1993 has set a limit of $150,000 on the 1994 compensation to be used in the calculation of pension benefits. In order to restore potential lost benefits, CFC has set up a Pension Restoration Plan. Under the plan, the amount that NRECA invoices CFC will continue to be based on the full compensation paid to each employee. Upon the retirement of a covered employee, NRECA will calculate the retirement and security benefit to be paid with consideration of the compensation limits and will pay the maximum benefit thereunder. NRECA will also calculate the retirement and security benefit that would have been available without consideration of the compensation limits and CFC will pay the difference. NRECA will then give CFC a credit against future retirement and security contribution liabilities in the amount paid by CFC to the covered employee.\nCFC will pay such additional benefits to the covered employee through a Severance Pay Plan and a Deferred Pay Restoration Plan. Under the Severance Pay Plan, the employee is paid an amount equal to the lost pension benefits but not to exceed twice the employee's annual compensation for the prior year. The\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nbenefit must be paid within 24 months of termination of employment. To the extent that the Severance Pay Plan cannot pay all of the lost pension benefits, the remainder will be paid under a Deferred Compensation Plan, which will be paid out in a lump sum or in installments of up to 60 months.\nCFC recognizes in current year margins any expected payouts for post retirement benefits (other than pensions) as a result of current service. Postretirement benefits include, but are not limited to, health and welfare benefits provided after retirement. While CFC allows retired employees to participate in its medical and life insurance plans, the retirees must do so at their own expense. Any liability which may be incurred by allowing retired employees to remain on CFC's medical and life insurance plans is not material to CFC's financial condition, results of operations or cashflows.\n(7) RETIREMENT OF PATRONAGE CAPITAL\nPatronage capital in the amount of $30.1 million was retired during fiscal year 1994. This amount consists of $28.0 million retired by CFC, $1.2 million retired by RTFC and $0.9 million retired by GFC.\nIn accordance with the CFC-only policy of retiring patronage capital, it is anticipated that patronage capital representing one-sixth of the fiscal years 1988, 1989 and 1990 allocations along with one-half of the fiscal year 1994 allocation will be retired in August 1994. Management anticipates that 50% of RTFC's margins for fiscal year 1994 will be retired in January 1995, and that 100% of GFC's margins for fiscal year 1994 will be retired in the second quarter of fiscal year 1995. Future retirements of patronage capital will be made as determined by the Companies' respective Boards of Directors with due regard for their individual financial conditions.\n(8) GUARANTEES\nAs of May 31, 1994 and 1993, CFC had outstanding guarantees of the following contractual obligations of its members (see Note 1(e) for a description of CFC's allowance for loan and guarantee losses and Note 3 for a discussion of requirements to purchase Members' Subordinated Certificates in connection with these guarantees):\n- - ---------------\n(A) CFC has unconditionally guaranteed to the holders or to trustees for the benefit of holders of these bonds the full principal, premium, if any, and interest on each bond when due. In addition, CFC has agreed to make up, at certain times, deficiencies in the debt service reserve funds for certain of these issues of bonds.\nIn the event of a default by a system for nonpayment of debt service, CFC is obligated to pay any required amounts under its guarantee, which will prevent the acceleration of the bond issue. The system is required to repay, on demand, any amount advanced by CFC pursuant to its guarantee. This repayment obligation is secured by a common mortgage with REA on all of the system's assets, but CFC may not exercise remedies thereunder for up to two years. However, if the debt is accelerated because of a determination that the interest thereon is not tax-exempt, the system's obligation to reimburse CFC for any guarantee payments will be treated as a long-term loan.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nOf the amounts shown, $1,214.6 million and $1,120.8 million as of May 31, 1994 and 1993, respectively, are adjustable or floating\/fixed rate bonds. The floating interest rate on such bonds may be converted to a fixed rate as specified in the indenture for each bond offering. During the variable rate period (including at the time of conversion to a fixed rate), CFC has unconditionally agreed to purchase bonds tendered or called for redemption if such bonds have not previously been sold to other purchasers by the remarketing agents.\n(B) CFC has guaranteed debt issued by NCSC in connection with leveraged lease transactions. The amounts shown represent loans from NCSC to a trust for the benefit of an industrial or financial company for the purchase of a power plant or utility equipment which was subsequently leased to a CFC member. The loans are secured by the property leased and the owner's rights as lessor. NCSC borrowed the funds for these loans either under a CFC guarantee or directly from CFC.\n(C) CFC has unconditionally guaranteed to lessors certain indemnity payments which may be required to be made by the lessees in connection with tax benefit transfers. The amount shown represent CFC's maximum potential liability at May 31, 1994 and 1993. However, the amounts of such guarantees vary over the lives of the leases. As of May 31, 1994 and 1993, the maximum amount of the guarantees when taken individually totaled $414.6 million and $437.0 million, respectively. A member's obligation to reimburse CFC for any guarantee payments would be treated as a long-term loan, secured pari passu with the REA by a first lien on substantially all of the member's property to the extent of any cash received by the member at the outset of the transaction. The remainder would be treated as an intermediate-term loan secured by a subordinated mortgage on substantially all of the member's property. Due to changes in Federal tax law, no further guarantees of this nature are anticipated.\n(D) At May 31, 1994 and 1993, CFC had unconditionally guaranteed commercial paper issued by NCSC in the amount of $34.8 million and $35.5 million, respectively.\nGuarantees outstanding, by state, are summarized as follows:\nCFC uses the same credit policies and monitoring procedures in providing guarantees as it does for loans and commitments.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\n(9) FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following disclosure of the estimated fair value of financial instruments is made in accordance with Statement of Financial Accounting Standards No. 107, \"Disclosure about Fair Value of Financial Instruments.\" Whenever possible, the estimated fair value amounts have been determined using quoted market information as of May 31, 1994, along with other valuation methodologies which are summarized below. However, the estimated fair value information presented is not necessarily indicative of amounts CFC could realize currently in a market sale as such amounts have not been revalued since year end. Therefore, current estimates of fair value may differ significantly from the amounts presented. With the exception of redeeming Collateral Trust Bonds under early redemption provisions and allowing borrowers to prepay their loans, CFC has held all financial instruments to maturity. Below is a summary of significant methodologies used in estimating fair value amounts and a schedule of fair values at May 31, 1994.\nDebt Service Investments\nThe fair value of debt service investments is estimated based on published bid prices or dealer quotes or is estimated using quoted market prices for similar securities when no market quote is available. Debt service investments purchased with original maturities of less than or equal to 90 days are estimated at the carrying value which is a reasonable estimate of fair value.\nLoans to Members\nFair values are estimated by discounting the 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. Loans with different risk characteristics, specifically nonperforming and restructured loans, are valued using a discount rate commensurate with the risk involved. Loans with original interest rate repricing maturities of less than or equal to 90 days are valued at cost which approximates fair value.\nDebt Service Reserve Funds\nFair value of debt service reserve funds is estimated at cost as all gains and losses on the underlying securities inure directly to the benefit or detriment of the CFC member and not to CFC.\nNotes Payable\nNotes payable consist of commercial paper and bank bid notes. The fair value of commercial paper and bid notes with maturities greater than 90 days is estimated based on quoted market rates with similar maturities for commercial paper and on bid prices from the various banking institutions for bid notes. The fair value of commercial paper and bank bid notes with maturities less than or equal to 90 days is estimated at carrying value which is a reasonable estimate of fair value.\nLong-Term Debt\nLong-term debt consists of Collateral Trust Bonds and Medium-Term Notes. The fair value of long-term debt is estimated based on published bid prices or dealer quotes or is estimated using quoted market prices for similar securities when no market quote is available.\nSubordinated Certificates\nAs it is impracticable to develop a discount rate that measures fair value, Subordinated Certificates have not been valued. Subordinated Certificates are extended long-term obligations to CFC; many have maturities of 70 to 100 years. These certificates are issued to CFC's members as a condition of membership or as a condition of obtaining loan funds or guarantees and are non-transferable. As these certificates were issued not\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nonly for their future payment stream but also as a condition to receiving future loan funds, there is no ready market from which to obtain fair value rates.\nInterest Rate Exchanged Agreements\nThe fair value is estimated as the amount CFC would receive or pay to terminate the agreement, taking into account the current market rate of interest and the current creditworthiness of the exchange counterparties.\nCommitments\nThe fair value is estimated as the carrying value, or zero. Extensions of credit under these commitments, if exercised, would result in loans priced at market rates.\nGuarantees\nCFC charges guarantee fees based on the specifics of each individual transaction. The demand for CFC guarantees has been small in the last few years. In addition, there is no other company that provides guarantees to rural electric utility companies with which to obtain market fee information. As a result, it is impracticable to supply fair value information related to guarantee fees.\nCarrying and fair values as of May 31, 1994 and 1993 are presented as follows:\n--------------------\n(1) Prior to reclassification of notes payable supported by the revolving credit agreements.\n(10) CONTINGENCIES\n(A) On May 23, 1985, Wabash Valley Power Association, Inc. (\"WVPA\") filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in connection with the cancelled Marble Hill plant construction.\nOn August 7, 1992, the Bankruptcy Court confirmed WVPA's reorganization plan pending approval of rates as contemplated in the plan. Depending on the final terms of a plan of reorganization, CFC could\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nbe obligated to pay REA a pro-rata amount (estimated at 78%) of the debt service payments plus interest made by WVPA on the $25 million in tax-exempt bonds since the bankruptcy petition date.\nOn June 22, 1994, the U.S. District Court affirmed (over REA's objection) the Wabash plan in reorganization. REA has until August 28, 1994, to appeal the decision to the U.S. Court of Appeals. Under the Wabash plan, CFC would realize an estimated total loss of approximately $12 million ($8.6 million of which has been written off to date), after the offset of subordinated capital term certificates (without taking into account interest since the petition date). The estimated loss under the Wabash plan does not include the amount CFC is obligated to pay to REA, representing REA's share of the debt service payments made by Wabash on the CFC guaranteed bonds, since the petition date.\nIn May 1993, CFC advanced $24.4 million in variable interest rate secured loans to WVPA, which was used to effect an early redemption of tax-exempt bonds guaranteed by CFC. As WVPA is in bankruptcy, CFC has classified this loan as nonperforming and, therefore, does not accrue interest income on the loans. As of May 31, 1994, CFC had $22.9 million in loans outstanding to Wabash.\nBased on WVPA's preliminary reorganization plan, management believes that CFC has adequately reserved for any potential loss.\n(B) Deseret Generation & Transmission Co-operative (\"Deseret\") and its major creditors entered into an Agreement Restructuring Obligations (\"ARO\") that restructured Deseret's debt obligations to REA, CFC and certain other creditors, including certain lease payments due on the Bonanza Power Plant. The ARO, which closed in January 1991 with an effective date of January 1, 1989, provides for the reduction of Deseret's debt service and rental obligations on the Bonanza Power Plant until 1996 when large sales of power were intended to commence.\nUnder the ARO assumptions, CFC expects to fund Deseret's cash flow shortfalls until at least 1996 under its various guarantees of debt obligations. Deseret's ability to generate enough cash flow to service its current debt and rental payments as well as to begin repayment of the shortfall funded by CFC thereafter depends on whether it is able to make the large power sales on which the ARO is premised. Due to changes in power demands of Deseret's distribution system members and the resulting reduction in power available for sale at higher prices to nonmembers, as well as an inability, so far, to complete the intended power sales, Deseret's cash flow projections have undergone revision since the closing of the ARO. As a result of these changes, Deseret is expected to be unable to satisfy its payment obligations under the ARO, and the ARO is expected to be amended some time in the future. Under the ARO, CFC expected to fund Deseret's cash flow shortfalls totaling $117 million and expected a maximum exposure of $439 million in 1996. At May 31, 1994, CFC had funded $93.8 million of the shortfall. CFC's current exposure of $447.7 million is greater than the expected maximum from the ARO because it loaned Deseret funds for the early redemption, at a premium, of two high interest rate bond issues. If the parties cannot agree on an amendment, the ARO could be terminated and Deseret's creditors would be free to pursue remedies on their defaulted obligations.\nOn April 25, 1994, Deseret announced that it had entered into an agreement with Tri-State G&T and PacifiCorp to study the possible acquisition of Deseret's assets. Deseret has also announced its intention to seek proposals from other parties regarding assets and\/or power purchases from Deseret.\nCFC has placed all loans to Deseret on a nonaccrual basis with respect to interest income recognition. CFC does not anticipate interest income recognition on the outstanding loans until such time that Deseret's power sales produce cash flows sufficient to service all debts.\nAs part of a separate agreement, in conjunction with the ARO, CFC will be obligated to repay out of payments by Deseret $25.9 million (plus interest) received from a party to the Bonanza Lease transaction to cover shortfalls in the July 1989, January 1990 and July 1990 lease payments which were\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\nfunded by that party. This amount would be repaid if the available annual cash flow were to exceed the debt repayment requirements as defined in the ARO (i.e., CFC was no longer required to fund a shortfall).\nAs of May 31, 1994, CFC had approximately $447.7 million in current credit exposure to Deseret consisting of $111.5 million in secured loans and $336.2 million in guarantees by CFC of various direct and indirect obligations of Deseret. CFC's guarantees include $9.3 million in tax-benefit indemnifications and $32.8 million relating to mining equipment for a coal supplier of Deseret. The remainder of CFC's guarantee is for semiannual debt service payments on $294.1 million of bonds issued in a $655 million leverage lease financing of a generating station in 1985. Under the ARO, CFC has also provided Deseret a $20.0 million five-year priority secured line of credit. At May 31, 1994, there was no balance outstanding under this line of credit.\nCFC believes that, given the underlying collateral value and the terms of the ARO, it has adequately reserved for any potential loss on its loans and guarantees to Dereset.\n(C) As a consequence of high costs associated with its involvement with the Clinton Nuclear Station, Soyland Power Cooperative (\"Soyland\") charged costs for wholesale power which resulted in its member's retail rates being uncompetitive. This situation resulted in revenues which were inadequate to service its debt. Soyland, REA and CFC entered into a debt restructuring agreement, dated as of December 15, 1993, which restructured Soyland's indebtedness to REA. As part of this agreement, CFC agreed to extend additional credit to Soyland in the form of a $30 million revolving credit facility and a $30 million loan for capital additions. The revolving credit loan and the capital additions loan have priority in payment over the existing REA loans and the prior CFC loan.\nAt May 31, 1994, CFC had $49.4 million in outstanding long-term loans to Soyland which were secured equally and ratably with the REA on all assets and future revenues of Soyland. In addition, CFC had $23.3 million in super secured lines of credit outstanding to Soyland. These lines of credit are to be paid before all other secured debt. CFC also had $384.7 million in loans to Soyland which are 100% guaranteed by the U.S. Government.\nCFC believes that, given the underlying collateral value of its secured loans to Soyland, it has adequately reserved for any potential loss on its loans.\n(D) At May 31, 1994, four other borrowers were in payment default to CFC on secured and unsecured loans totaling $22.0 million. At May 31, 1993, six borrowers were in payment default to CFC on secured and unsecured loans totaling $31.4 million, these six included the four that were in payment default at May 31, 1994.\n(11) EXTRAORDINARY LOSS\nDuring the year ended May 31, 1994, CFC did not incur any prepayment penalties related to the early retirement of Collateral Trust Bonds. During the years ended May 31, 1993 and 1992 CFC paid prepayment penalties of $3.2 million and $1.4 million, respectively, for the early retirement of Collateral Trust Bonds.\nNATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION\nNOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)\n(12) COMBINED QUARTERLY FINANCIAL RESULTS (UNAUDITED)\nSummarized results of operations for the four quarters of fiscal years 1994 and 1993 are as follows:\n- - ---------------\nNOTE: During fiscal year 1994, CFC made nine monthly provisions for loan and guarantee losses of $0.625 million and one special provisions of $10.0 million during the third quarter. During fiscal year 1993, CFC made regular monthly provisions for loan and guarantee losses of $1.25 million.\nEXHIBIT INDEX","section_15":""}
{"filename":"34257_1994.txt","cik":"34257","year":"1994","section_1":"ITEM 1. BUSINESS - -----------------\n(a) General Development of Business\nFairchild Industries, Inc. is incorporated in Delaware and is the successor corporation to Fairchild Industries, Inc., a corporation incorporated in Maryland in 1936, pursuant to a merger effective on May 4, 1987. As used herein, the term \"Company\" refers to Fairchild Industries, Inc. and its subsidiaries unless otherwise indicated. The Company is a subsidiary of RHI Holdings, Inc. (\"RHI\"), which is in turn a wholly-owned subsidiary of The Fairchild Corporation (\"TFC\").\nThe Company conducts its operations through its wholly-owned subsidiary, VSI Corporation (\"VSI\"), in three business segments: Aerospace Fasteners, Industrial Products and Communications Services. The Aerospace Fasteners segment designs, manufactures and markets high performance, specialty fastening systems, primarily for aerospace applications. The Industrial Products segment designs, manufactures and markets tooling and electronic control systems for the plastic injection molding and die casting industries. The Communications Services segment furnishes telecommunications services and equipment to tenants of commercial office buildings. For a comparison of the sales of each of the Company's three business segments for each of the last three fiscal years, see \"Management Discussion and Analysis of Results of Operations and Financial Condition\".\nFiscal 1994 Developments - ------------------------\nAerospace Fasteners Restructuring ---------------------------------\nIn recent years, the Company has undertaken measures designed to reduce costs and improve operating efficiencies, increase earnings, and maintain its market position in the Aerospace Fasteners segment. These measures have included closing and consolidating certain of the Aerospace Fasteners segment's facilities.\nAs a result of the sustained soft worldwide demand for aircraft, and the resulting decline in new order rates and prices for aerospace fasteners, in Fiscal 1994, the Company has undertaken further restructuring actions to downsize, reduce costs, reduce cycle times and improve margins. These restructuring efforts have included discontinuance of certain aircraft engine bolt product lines, increased cellularization of manufacturing processes, relocation of its New Jersey operations to California and re-engineering of certain manufacturing processes and methods to meet increased customer quality standards. In connection with these moves, in Fiscal 1994, the Company recorded restructuring charges of $18.9 million. The Company believes the reduction of the capacity of the Aerospace Fasteners segment, and the reorganization of its remaining manufacturing operations, will continue to improve operating efficiencies and reduce operating costs.\nThe foregoing measures represent a continuation of actions commenced in Fiscal 1992 and continued in Fiscal 1993, which included the consolidation of a major manufacturing facility, the elimination of over 410 manufacturing personnel and 100 other personnel of the Aerospace Fasteners segment, a wage and salary freeze and certain other actions to improve manufacturing efficiencies and streamline operations.\nThe Company also continues to examine its manufacturing, selling, general and administrative costs and expenses and intends to further reduce such costs and expenses in Fiscal 1995 and, to this end may incur additional restructuring costs related to the elimination of product lines and further personnel reductions.\n(b) Financial Information about Business Segments\nFinancial information regarding the Company's business segments are hereby incorporated by reference from Note 14 of the Company's consolidated financial statements included in Item 8 Financial Statements and Supplementary Data.\n(c) Narrative Description of Business Segments\nAerospace Fasteners - -------------------\nThe Company, through its Aerospace Fasteners segment, is a leading worldwide manufacturer and supplier of fastening systems used in the construction and maintenance of commercial and military aircraft. The Aerospace Fasteners segment accounted for 45.8% of total Company sales for the year ended June 30, 1994.\nProducts --------\nIn general, aerospace fasteners produced by the Company are used to join materials in applications which are not critical to flight. Products range from standard aerospace screws to more complex systems that fasten airframe structures, and sophisticated latching or quick disconnect mechanisms that allow efficient access to internal parts that need to be serviced regularly or monitored. The Aerospace Fasteners segment also manufactures and supplies fastening systems used in non-aerospace industrial and electronic niche applications. The Aerospace Fasteners segment produces and sells products under various trade names and trademarks including Voi-Shan (fasteners for aerospace structures), Screwcorp (standard externally threaded products for aerospace applications), RAM (custom designed mechanisms for aerospace applications), Camloc (components for the industrial, electronic, automotive and aerospace markets), Tridair and Rosan (fastening systems for highly- engineered aerospace, military and industrial applications). In addition to these manufacturing operations, the Aerospace Fasteners segment includes HARCO, which is a leading stocking distributor of self-locking nuts in the aerospace fasteners industry.\nPrincipal product lines of the Aerospace Fasteners segment include:\nStandard Aerospace Airframe Fasteners - These fasteners consist of standard externally threaded fasteners used in non-critical airframe applications on a wide variety of aircraft. These fasteners include Hi- Torque Speed Drive, Tri-Wing, Torq-Set, Phillips and Hex Heads.\nCommercial Aerospace Structural and Engine Fasteners - These fasteners consist of more highly engineered, permanent or semi-permanent fasteners used in non-critical but more sophisticated airframe and engine applications which could involve joining more than two materials. These fasteners are generally engineered to specific customer requirements or manufactured to specific customer specifications for special applications, often involving exacting standards. These fasteners include Hi-Lok, Veri-Lite, Eddie-Bolt2 and customer proprietary engine nuts.\nProprietary Products and Fastening Systems - These very highly engineered, proprietary fasteners are designed by the Company for specific customer applications and include high performance structural latches and hold down mechanisms. These fasteners are usually proprietary in nature and are primarily used in either commercial aerospace or military applications. These fasteners include Visu-Lok, Composi-Lok, Keen-serts, Mark IV, Flatbeam and Ringlock.\nHighly Engineered Fastening Systems for Industrial Applications - These highly engineered fasteners are designed by the Company for specific niche applications in the electronic, automotive and durable goods markets and are sold under the Camloc trade name.\nGas Springs for Automotive and Industrial\/Commercial Applications - These are designed to assist in the raising, lowering or moving of heavy loads such as the tailgate of a vehicle, sunbeds, printer canopies, acoustic hoods and like items.\nSales and Markets -----------------\nThe products of the Aerospace Fasteners segment are sold primarily to domestic and foreign original equipment manufacturers, the maintenance and repair market through distributors and the United States government. 78.9% of its sales are domestic. The products of the Aerospace Fasteners segment are marketed by a direct sales force and technical engineering support personnel who are responsible for identifying new product applications, obtaining the approval of new products and maintaining ongoing relationships with customers in order to meet their requirements. Major customers include Boeing, McDonnell Douglas, Airbus, Lockheed and Northrop and their subcontractors as well as major distributors such as Burbank Aircraft. No single customer accounts for more than 10% of consolidated sales.\nThe Company anticipates that non-aerospace and commercial aerospace applications as a percentage of sales will increase over time as the Company brings to market new products and military spending declines.\nResearch and Development ------------------------\nResearch and development and its engineering related support functions are an important part of the Company's strategy of providing its customers quality products, prompt service and overall value. Company sponsored research and development expense in the Aerospace Fasteners segment for the years ended June 30, 1994, 1993 and 1992 amounted to $1,435,000, $2,204,000 and $3,197,000, respectively.\nManufacturing and Production ----------------------------\nThe Aerospace Fasteners segment has seven major manufacturing facilities, of which four are located in the United States and three are located in Europe. Each facility has virtually complete production capability, and subcontracts only those orders which exceed capacity. Each plant is oriented to produce a specified product or group of products, depending on the production process involved.\nOn January 17, 1994, the Aerospace Fasteners' Chatsworth, California manufacturing facility suffered extensive damage from the Southern California earthquake. As a result, the Company relocated the Chatsworth manufacturing operations to its other Southern California facilities. See Note 11 of the Company's consolidated financial statements included in Item 8 Financial Statements and Supplementary Data.\nThe Company is continuing to extensively re-engineer the way it produces fasteners, shifting from a process orientation to a product orientation by forming focused discrete work groups with each having broader responsibilities.\nCompetition -----------\nThe Aerospace Fasteners segment's major competitors include Hi-Shear, Inc., Monogram, Inc., Air Industries, Inc., SPS, Inc., Kaynar, Valley Todeco, and Huck International, with regard to aerospace fasteners, and Southco, Inc., with regard to specialized industrial applications. In addition, competition comes from stocking distributors who may offer reduced lead times to customers as a result of their inventory investment.\nIndustrial Products - -------------------\nThe Industrial Products segment operates under the trade name D-M-E Company (\"DME\"), and Fairchild Data Corporation (\"Data\"). DME is a leading manufacturer and supplier of tooling and electronic control products for the plastic injection molding industry worldwide. The principal end-users of DME's products are the transportation, packaging, communications, housewares, commercial and industrial products, medical products, toy, appliance, furniture and building industries. The Company estimates that 77.5% of DME's sales for the year ended June 30, 1994, were in North America and 22.5% were attributable to sales outside North America.\nData is a supplier of modems for use in high-speed digitized voice and data communications. No single customer accounts for more than 10% of consolidated sales. The Industrial Products segment accounted for 37.5% of total Company sales for the year ended June 30, 1994.\nProducts --------\nDME provides an extensive line of standardized and special order products as well as electronic control systems. Principal product lines include:\nMold Bases - Mold bases are used to retain the cavity and core of a plastic mold. These products are individually stacked high alloy, precision-machined steel plates available either as a standard dimensioned catalog product or as a specially machined mold base made to customer specifications.\nMold Components - Mold components are utilized within a mold base to facilitate the mechanical action of the individual steel plates. These products include such items as leader pins and bushings to guide and align the plates, ejector pins and sleeves to eject the finished plastics product from the mold, and other specialized products such as collapsible cores to mold complex geometries involving difficult under-cuts and threads.\nMoldmaking Tools\/Supplies - Tooling and miscellaneous supplies allow the moldmaker to manufacture and \"finish\" the actual cavity and core of a plastic mold. These products range from ultrasonic polishing equipment and abrasives to specialized tooling for the milling and drilling of steel.\nRunnerless Molding\/Process Control - DME's internally and externally heated runnerless molding systems with thermal and\/or mechanical gate shut-off devices produce high quality plastic products while minimizing labor content and reducing scrap in the manufacturing process. DME's trademark runnerless molding systems are called The Hot One and The Cool One. DME also provides sensor and computer technology, allowing processors Statistical Process Control (SPC) of their entire molding cycle.\nCAD\/CAM - DME offers a unique line of Computer Aided Design (CAD) and Computer Aided Manufacturing (CAM) hardware and software for the plastics industry. DME sells computer hardware as a value-added reseller for some of the industry's best known computer suppliers. Additionally, DME has developed copyrighted software programs which are specific to the plastics industry. These systems enable mold designers to design mold bases utilizing a combination of most of the popular products offered by DME, including runnerless systems.\nData is a supplier of modems for use in high-speed digitized voice and data communications.\nSales and Markets -----------------\nDME's sales efforts in North America are led by direct field sales representatives and regional managers, who call directly on key mold makers, molders and designers. In addition, a telemarketing group supplements the sales representatives' efforts and reaches the smaller or low activity accounts. Additionally, DME utilizes distributors in key product market segments to focus on sales of items such as temperature controls. Sales of highly technical products, such as complete runnerless manifold systems, are aided by technical service people located in the sales regions.\nInternationally, sales are handled by direct sales representatives in England, France, Belgium and Germany. In a number of countries in Europe and Asia, joint venture partners sell DME products through both full-time sales people and secondary distribution outlets. DME utilizes stocking distributors to serve the rest of the world.\nManufacturing and Production ----------------------------\nLocal production facilities are a strategic advantage to sales in the custom mold base markets DME serves. Accordingly, DME maintains regional production facilities in North America and Europe to service customers of its custom-manufactured products. DME owns ten manufacturing facilities in the United States, Canada, Mexico, Belgium and Germany and licenses four other companies to manufacture products in Brazil, Hungary, Japan and Korea.\nCompetition -----------\nDME competes with different companies with respect to each of its major product categories. DME's competition principally consists of small privately-held manufacturers operating primarily in local markets.\nThe Company believes it is the leading manufacturer of mold bases. DME is one of six major competitors in North America and one of four major competitors in Europe in the runnerless molding\/process controls market. The Company believes the runnerless molding\/process controls market is a growth market with competition based primarily on product technology and service. A significant portion of DME's research and development is aimed at this market. DME faces competition from various companies with respect to each of the individual products in the other resale products category. Competition in this category is based primarily on price and delivery time.\nCommunications Services - -----------------------\nFairchild Communications Services Company provides telecommunications equipment and services to tenants of commercial office buildings, under the trade name Telecom 2000 Services. The Company believes it is the largest provider of comprehensive telecommunications services exclusively to multi- tenant office buildings in the United States. Fairchild Communications was founded as a start-up venture in 1985 and has grown rapidly through expansions and acquisitions. Sales have grown from $1.4 million in Fiscal 1986 to $74.2 million in Fiscal 1994. Approximately $48 million of such increase was attributable to acquisitions (determined on an annualized basis at the date of acquisition), primarily the acquisition of the telecommunication assets of Amerisystems. The Communications Services segment accounted for 16.7% of total Company sales for the year ended June 30, 1994.\nServices --------\nFairchild Communications negotiates long-term telecommunications franchises with owners or developers of office buildings, typically during the latter stages of building construction. Under these arrangements, Fairchild Communications installs switching equipment, cable and telephone equipment. Fairchild Communications then contracts directly with individual tenants in the buildings to provide multi-year, single point-of-contact telecommunications services. The services provided by Fairchild Communications include access to services provided by regulated communications companies, including local, long distance, international and \"800\" telephone services. In addition, Fairchild Communications provides telecommunications equipment as well as voice mail, telephone calling cards, local area networks and voice and data cable installation. Fairchild Communications also provides customized billing services to assist customers in controlling their telecommunications expense. Fairchild Communications typically provides telecommunications services at rates equal to or below those which a customer could otherwise obtain, in part due to discounts Fairchild Communications commands as a high volume purchaser of telephone services.\nCustomers ---------\nCustomers typically consist of small to medium size businesses and branches of larger organizations. As of June 30, 1994, Fairchild Communications served approximately 4,500 customers at 275 buildings located in 23 major metropolitan areas, providing approximately 62,000 full service lines and 9,000 long distance only lines. Contract terms typically provide for a lease of three to five years with an automatic renewal provision.\nCompetition -----------\nFairchild Communications competes with regulated major carriers that may provide a portion of the services that Fairchild Communications provides, but are typically not structured to provide all of a customer's telecommunications requirements. Fairchild Communications also competes with small independent operators serving local markets. In some cases Fairchild Communications competes with other communications services providers in order to secure franchises with office building owners for the provision of telecommunications services within their buildings. Principal competitors include Realcom and Shared Technologies, as well as smaller, more localized, companies. Once a franchise has been obtained, Fairchild Communications competes with equipment manufacturers and distributors for the provision of telephone and other telecommunications equipment and services to the building's tenants. Principal equipment competitors include manufacturers such as NEC, Intecom, AT&T and some of the local Bell operating companies acting as manufacturer's distributors, as well as numerous smaller equipment distributors.\nGrowth ------\nManagement believes that future growth in the Communications Services segment will come primarily from four sources: acquisitions of smaller companies operating in the same or related businesses; new customers as a result of increased occupancy of space currently vacant in office buildings already under franchise; additional franchise agreements with newly constructed office buildings; and additional services to the existing customer base.\nForeign Operations - ------------------\nThe Company's operations are located primarily in the United States and Europe. Inter-area sales are not significant to the total revenue of any geographic area. Export sales are made by U.S. subsidiaries and divisions to customers in non-U.S. countries, whereas foreign sales are made by the Company's non-U.S. subsidiaries. For the Company's sales results by geographic area and export sales, see Note 15 of the Company's consolidated financial statements included in Item 8 Financial Statements and Supplementary Data.\nMajor Customers - ---------------\nNo single customer accounted for more than 10% of consolidated sales in any of the Company's business segments for the year ended June 30, 1994.\nBacklog of Orders - -----------------\nBacklog is significant in the Company's Aerospace Fasteners segment due to long-term production requirements of its customers. Backlog of unfilled orders is not material in the Industrial Products segment, where most orders for products are placed and filled within a few weeks. Backlog is not applicable to the Communications Services segment.\nThe Company's backlog of orders as of June 30, 1994 in the Aerospace Fasteners and Industrial Products segments amounted to $113.4 million and $5.6 million, respectively. The Company anticipates that approximately 87.8% of the aggregate backlog at June 30, 1994 will be delivered by June 30, 1995.\nSuppliers - ---------\nThe Company does not consider itself to be materially dependent upon any one supplier, but is dependent upon a wide range of subcontractors, vendors and suppliers of materials to meet its commitments to its customers.\nResearch and Patents - --------------------\nThe Company's research and development activities have included: applied research; development of new products; testing and evaluation of, and improvements to, existing products; improvements in manufacturing techniques and processes; development of product innovations designed to meet government safety and environmental requirements; and development of technical services for manufacturing and marketing. The Company's sponsored research and development expenditures amounted to $3,940,000, $3,262,000 and $4,140,000 for the years ended June 30, 1994, 1993 and 1992, respectively. The Company owns patents relating to the design and manufacture of certain of its products and is a licensee of technology covered by the patents of other companies. The Company does not believe that any of its business segments are dependent upon any single patent or upon the rights and licenses it possesses under any single patent owned by others.\nPersonnel - ---------\nAs of June 30, 1994, the Company had approximately 3,500 employees. Approximately 4% of these employees were covered by collective bargaining agreements. The Company believes that its relations with its employees are good.\nEnvironmental Matters - ---------------------\nSee discussion of Environmental Matters under Item 3 \"Legal Proceedings\" below.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - --------------------\nAs of June 30, 1994, the Company owned or leased properties totalling approximately 1,698,000 square feet, approximately 1,084,000 square feet of which was owned and 614,000 square feet of which was leased. The Aerospace Fasteners segment's properties consisted of approximately 697,000 square feet, with principal operating facilities of approximately 454,000 square feet concentrated in southern California. The Industrial Products segment's properties consisted of approximately 722,000 square feet, with principal operating facilities of approximately 393,000 square feet located in Arizona, Michigan, Pennsylvania and Belgium.\nThe Company leases its corporate headquarters at Washington-Dulles International Airport from RHI.\nThe Company has several parcels of property which it is attempting to market, lease and\/or develop: (i) an 88 acre parcel located in Farmingdale, New York, (ii) a 12 acre parcel located in City of Commerce, California, (iii) a 6 acre parcel in Temple City, California, and (iv) an 8 acre parcel in Chatsworth, California. In addition to the above, certain other properties of the Company are being marketed.\nOn January 17, 1994, the Aerospace Fasteners' Chatsworth, California manufacturing facility suffered extensive damage from the Southern California earthquake. As a result, the Company relocated the Chatsworth manufacturing operations to its other Southern California facilities. See Note 11 of the Company's consolidated financial statements included in Item 8 Financial Statements and Supplementary Data.\nThe following table sets forth the location of the larger physical properties used in the continuing operations of the Company, their square footage, the business segment or groups they serve and their primary use. Each of the properties owned or leased by the Company is, in management's opinion, generally well maintained, is suitable to support the Company's business and is adequate for the Company's present needs. All of the Company's occupied properties are maintained and updated on a regular basis.\nInformation concerning long-term rental obligations of the Company at June 30, 1994 is set forth in Note 13 to the Company's consolidated financial statements included in Item 8 Financial Statements and Supplementary Data.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ---------------------------\nGovernment Claims - -----------------\nIn 1989, the Company learned through its own quality assurance procedures, and voluntarily disclosed to its customers and the Department of Defense, that certain units of VSI had not performed certain production lot tests mentioned in the military specifications for some limited product lines. The Company does not believe that VSI's level of testing resulted in shipment of unsafe products or that purchasers were otherwise damaged, and the government subsequently reduced certain test requirements. In May 1994, VSI settled this matter with the government by payment of $330,000.\nFollowing an investigation by the Inspector General of NASA, the civil division of the United States Department of Justice alleged improprieties in years 1982 and 1984 through 1986, in indirect costs rates and labor charging practices of a former subsidiary of the Company. The Company entered into settlement discussions with the Department of Justice to attempt to resolve these claims and has reached an agreement in principle with the government to settle this matter for $5,000,000, payable in six equal semi-annual installments, with interest at 6% per year. The unpaid balance will likely be collateralized by certain excess real estate. If the settlement is not consummated, the government may initiate suit under the False Claims Act, seeking treble damages and penalties, and under the Truth in Negotiation Act, seeking a price reduction on certain contracts and subcontracts.\nThe Corporate Administrative Contracting Officer (the \"ACO\"), based upon the advice of the United States Defense Contract Audit Agency, has made a determination that FII did not comply with Cost Accounting Standards in accounting for (i) the 1985 reversion to FII of certain assets of terminated defined benefit pension plans and (ii) pension costs upon the closing of segments of FII's business. The ACO has directed FII to prepare a cost impact proposal relating to such plan terminations and segment closings and, following receipt of such cost impact proposals, may seek adjustments to contract prices. The ACO alleges that substantial amounts will be due if such adjustments are made. The Company believes it has properly accounted for the asset reversions in accordance with applicable accounting standards. The Company has entered into discussions with the government to attempt to resolve these pension accounting issues.\nEnvironmental Matters - ---------------------\nThe Company and other aerospace fastener and industrial product manufacturers are subject to stringent Federal, state and local environmental laws and regulations concerning, among other things, the discharge of materials into the environment and the generation, handling, storage, transportation and disposal of waste and hazardous materials. To date, such laws and regulations have not had a material effect on the financial condition of the Company, although the Company has expended, and can be expected to expend in the future, significant amounts for investigation of environmental conditions and installation of environmental control facilities, remediation of environmental conditions and other similar matters, particularly in the Aerospace Fasteners segment.\nIn connection with its plans to dispose of certain real estate, the Company must investigate environmental conditions and may be required to take certain corrective action prior or pursuant to any such disposition. In addition, management has identified several areas of potential contamination at or from other facilities owned, or previously owned, by the Company, that may require the Company either to take corrective action or to contribute to a clean-up. The Company is also a defendant in certain lawsuits and proceedings seeking to require the Company to pay for investigation or remediation of environmental matters and has been alleged to be a potentially responsible party at various \"Superfund\" sites. Management of the Company believes that it has recorded adequate reserves in its financial statements to complete such investigation and take any necessary corrective actions or make any necessary contributions. No amounts have been recorded as due from third parties, including insurers, or set off against, any liability of the Company, unless such parties are contractually obligated to contribute and are not disputing such liability.\nOther Matters - -------------\nThe Company is involved in various other claims and lawsuits incidental to its business, some of which involve substantial amounts. The Company, either on its own or through its insurance carriers, is contesting these matters.\nIn the opinion of management, the ultimate resolution of the legal proceedings, including those discussed above, will not have a material adverse effect on the financial condition or the future operating results of the Company.\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 THE REGISTRANT'S COMMON EQUITY AND RELATED - --------------------------------------------------------------\nSTOCKHOLDER MATTERS -------------------\nAll of the Company's outstanding common stock is held by RHI, a wholly owned subsidiary of TFC. There is no established public trading market for this class of common stock. No dividends have been declared on this class of common stock since the date of issuance.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - --------------------------------\nITEM 7.","section_7":"ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF - ------------------------------------------------- RESULTS OF OPERATIONS AND FINANCIAL CONDITION ---------------------------------------------\nRECENT DEVELOPMENTS\nDuring the first quarter of Fiscal 1994, 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\", and elected to take one-time non-cash charges totaling $11.7 million, of which $.2 million was for postretirement benefits and $11.5 million for change in accounting for income taxes. These charges are reflected in the fiscal year ended June 30, 1994, and represent cumulative effects on prior years of the accounting changes. For the fiscal year ended June 30, 1994, the effect of the changes on pretax income from continuing operations was not material.\nRESULTS OF OPERATIONS\nThe Company currently operates in three principal business segments: Aerospace Fasteners, Industrial Products and Communication Services. Set forth below is a comparison of the results of the operations of the Company for the fiscal years ended June 30, 1994 (\"Fiscal 1994\"), June 30, 1993 (\"Fiscal 1993\") and June 30, 1992 (\"Fiscal 1992\"). This comparison relates solely to the continuing portions of the Company's business.\nFISCAL 1994 VERSUS FISCAL 1993\nGeneral - -------\nOverall sales declined by 4.2% for Fiscal 1994, compared to Fiscal 1993, primarily caused by price erosion due to excess capacity in the aerospace fasteners industry, reduced order rates from commercial and military aerospace customers in the Aerospace Fasteners segment and lower revenues due to the disruption caused by the earthquake. Reduced order rates were principally due to reductions in defense spending and reduced build rates of commercial airplane original equipment manufacturers due to conditions in the airline industry. The decline in sales at the Aerospace Fasteners segment was partially offset by significant sales increases at the Industrial Products and Communication Services segments in the Fiscal 1994 period. The Industrial Products segment included sales in the current period by Fairchild Data Corporation which had been classified as a discontinued operation in the prior periods.\nOperating income decreased by $19.8 million in Fiscal 1994, compared to Fiscal 1993. A restructuring charge of $18.9 million was recorded in Fiscal 1994 compared to $15.5 million in Fiscal 1993 to further implement the Aerospace Fasteners segment restructuring plan. A $4.0 million charge for earthquake damage and related business interruption also affected this segment in Fiscal 1994. Operating income was up in the Industrial Products and Communications Services business segments for Fiscal 1994, however, in the Aerospace Fasteners segment operating income declined $16.8 million for Fiscal 1994, compared to the prior year. Other corporate income also decreased in Fiscal 1994. (See discussion below.)\nAerospace Fasteners - -------------------\nSales in the Aerospace Fasteners segment decreased 17.7% in Fiscal 1994, compared to Fiscal 1993, primarily due to the reduced order rates. Ordering activity remained at low levels at original equipment manufacturers, and in the replacement markets. In addition, customers are rescheduling orders to take later delivery in line with reduced aircraft build rates.\nThe operating loss in the Aerospace Fasteners segment increased by $16.8 million in Fiscal 1994, compared to the Fiscal 1993 period. During the Fiscal 1994 period, as a result of the sustained soft worldwide demand for aircraft, aircraft engines and the resulting decline in new order rates and prices for aerospace fasteners, the Company has continued to undertake further restructuring actions to further downsize, reduce costs, reduce cycle times and improve margins. These restructuring efforts include discontinuance of certain aircraft engine bolt and other product lines, increased cellularization of manufacturing processes, relocation of its New Jersey operations into California and re-engineering certain manufacturing processes and methods to meet increased customer quality standards.\nThe Company recorded a pretax restructuring charge of $18.9 million in Fiscal 1994 to cover the cost of the above mentioned restructuring activities, including the write down of goodwill and surplus assets related to certain product lines, severance benefits and the nonrecurring costs associated with the cellularization and reengineering of manufacturing processes and methods. Depending on future demand and prices of aerospace fasteners, the Company may take further restructuring actions in the future and may record additional restructuring charges to cover the cost of these activities. The Fiscal 1993 period included a restructuring charge of $15.5 million relating to further downsizing fastener operations in Europe and California, and severance and early retirement benefits for terminated employees.\nOn January 17, 1994, the Company's Chatsworth, California Aerospace Fasteners manufacturing facility suffered extensive damage from the Southern California earthquake. As a result, the Company has relocated the Chatsworth manufacturing operations to its other Southern California facilities. This disruption has caused increased costs and reduced revenues in Fiscal 1994 and will likely negatively affect Fiscal 1995 as well. While the Company carries insurance for both business interruption and property damage caused by earthquakes, the policy has a 5% deductible. The Company has recorded an unusual pretax loss in Fiscal 1994 of $4.0 million to cover the currently estimated net cost of the damages and business interruption caused by the earthquake. Included in prepaids and other current assets is an insurance claim receivable of $5.9 million for recoverability of costs related to business interruption and property damage.\nOperating income in Fiscal 1994 was also affected by (1) reduced demand and price erosion; and (2) higher quality control costs resulting from customers' intensified quality requirements. A large customer's disapproval in the third quarter of Fiscal 1993, of the quality system at one of the Aerospace Fasteners segment's plants negatively affected sales and operating income in Fiscal 1994. The disapproval resulted in the plant being ineligible to receive new orders, delayed shipments due to on-site customer inspection of finished product, and increased quality costs. The segment has implemented a program to comply with the customer's quality requirements and the plant's quality system was requalified by the customer during the first quarter of Fiscal 1994. The quality improvement program requires that the plant reinspect its inventories and modify certain manufacturing processes and quality procedures at all major facilities. This program has resulted in one time start-up costs and increased recurring quality costs, each of which negatively affected the Fiscal 1994 operating results, and will likely negatively affect the future profit margins of this segment.\nIndustrial Products - -------------------\nSales in the Industrial Products segment increased 12.2% in Fiscal 1994 compared to Fiscal 1993. The inclusion of Fairchild Data Corporation sales in Fiscal 1994 accounted for 76.5% of the increased sales in this segment. The increase in sales in the current period reflects customer response to D-M-E Company's (\"DME\") fast delivery programs, new products, and growth of the domestic economy. Domestic demand for tooling for plastics has been strong while foreign demand has been sluggish in certain countries, reflecting the economic conditions abroad. However, expansion into selected foreign markets is being pursued and appears to have potential.\nOperating income in the Industrial Products segment increased 10.2% in Fiscal 1994, compared to Fiscal 1993. The inclusion of Fairchild Data Corporation operating income in Fiscal 1994 accounted for 48.9% of the increase in operating income in this segment. The improved results in the current period resulted from a higher sales volume and improved operating margins. In recent years the Industrial Products segment has implemented several cost savings steps, including overhead reduction and improved inventory management programs, which have contributed to the higher operating margins. The improvements in inventory management and delivery systems resulted in faster deliveries, reduction in inventory, and higher inventory turnover. In addition, DME has continued to implement improved manufacturing methods that have reduced cycle times and costs.\nCommunications Services - -----------------------\nSales in the Communications Services segment increased 9.0% in Fiscal 1994, compared to Fiscal 1993, primarily due to the inclusion of sales from acquisitions, the addition of telecommunications franchises in new office buildings, and growth at existing sites.\nOperating income in the Communications Services segment increased 12.2% in Fiscal 1994 compared to Fiscal 1993, primarily due to increased sales resulting from the reasons given above and related economies of scale. Operating income as a percent of sales in Fiscal 1994 was slightly higher than in Fiscal 1993.\nOther Expenses\/Income - ---------------------\nCorporate Administrative Expense - The Company's corporate staff performs work for several corporate entities including TFC, RHI, and the Company. Corporate administrative expense incurred by the Company is invoiced to RHI and to TFC on a monthly basis and represents the estimated cost of services performed on behalf of such companies by the Company. The estimated cost is based primarily on estimated hours spent by corporate employees on functions related to RHI and to TFC. Management believes that the corporate administrative expense of the Company would be higher if it operated as a separate independent entity. Corporate administrative expense increased by 11.6% in Fiscal 1994 as compared to Fiscal 1993, primarily due to non-recurring expense incurred for severance payouts. Excluding severance payouts, corporate administrative expense would have been relatively flat in Fiscal 1994 compared to Fiscal 1993.\nOther Corporate Income - Other corporate income decreased $6.3 million in Fiscal 1994 compared to Fiscal 1993, primarily due to (1) the absence of amortization of over accrued retiree health care expense in Fiscal 1994, (2) the write down of corporate real estate held for sale in Fiscal 1994, and (3) recording a favorable pension adjustment in Fiscal 1993.\nNet Interest Expense - Net interest expense decreased 6.2% in Fiscal 1994, compared to Fiscal 1993, primarily due to lower rates on intercompany borrowings in Fiscal 1994 compared to Fiscal 1993.\nInvestment Income - Investment income of $3.4 and $1.4 million was recorded in Fiscal 1994 and Fiscal 1993, respectively, resulting principally from dividends realized on participating pension annuity contracts.\nIncome Taxes - For Fiscal 1994, the Company recorded an income tax benefit of 17.7%. The benefit tax rate was lower than the statutory rate, largely due to the write off and amortization of goodwill, which is not deductible for tax purposes.\nAccounting Changes:\n1) Postretirement Benefits - Using the immediate recognition method, the charge to earnings representing the cumulative effect of this accounting change was immaterial. The unamortized portion of an overstated liability of $10.7 million for discontinued operations substantially offset the transition obligation of $10.9 million for active employees and retirees of continuing operations.\n2) Accounting for Income Taxes - The Company elected the immediate recognition method and recorded a $11.5 million charge representing the cumulative effect on prior years. This charge represents deferred taxes related primarily to differences between the tax basis and book basis of fixed assets, prepaid pension expense, and inventory.\nExtraordinary Item - Net - The extraordinary item in Fiscal 1993 represents the write-off of $1.3 million of deferred loan fees from the portion of the term loan prepaid, or $.8 million after tax.\nNet Earnings (Loss) - Net earnings decreased $21.7 million in Fiscal 1994 compared to Fiscal 1993, primarily due to the $19.8 million drop in operating income and the $11.7 million charge, net of tax, for the cumulative effect of accounting changes, offset partially by decreased net interest expense, increased investment income and the income taxes benefit due to the pretax loss.\nFISCAL 1993 VERSUS FISCAL 1992\nGeneral - -------\nOverall sales declined by 5.4% for Fiscal 1993, compared to Fiscal 1992, primarily caused by price erosion due to excess capacity in the aerospace fasteners industry and reduced order rates from commercial and military aerospace customers in the Aerospace Fasteners segment. The decline in sales at the Aerospace Fasteners segment was partially offset by significant sales increases at the Industrial Products and Communication Services segments in the Fiscal 1993 period. Operating income decreased 57.4% for Fiscal 1993, compared to Fiscal 1992. Operating income was up in the Industrial Products and Communications Services business segments for Fiscal 1993; however, in the Aerospace Fasteners segment, operating income declined $31.1 million for Fiscal 1993, compared to the prior year. Both twelve month periods ended June 30, 1993, and June 30, 1992, included restructuring charges in the Aerospace Fasteners segment. Other corporate income also improved in Fiscal 1993. (See discussion below.)\nAerospace Fasteners - -------------------\nSales in the Aerospace Fasteners segment decreased 17.4% in Fiscal 1993, compared to Fiscal 1992, primarily due to the reduced order rates mentioned above. Ordering activity remained at low levels at commercial airplane original equipment manufacturers, engine manufacturers, in defense related procurements, and in the replacement markets served by distributors. In addition, customers rescheduled orders to take later delivery in line with reduced aircraft build rates.\nOperating income in the Aerospace Fasteners segment decreased $31.1 million in Fiscal 1993, in relation to the comparable Fiscal 1992 period. During the Fiscal 1993 period, the Company continued to implement restructuring plans and included a restructuring charge of $15.5 million to further downsize fastener operations in Europe and California and close and consolidate its New Jersey operations into California. This resulted in severance costs, plant closing and relocation costs, and the write off of excess assets. The Fiscal 1992 period included a restructuring charge of $2.5 million related to severance and early retirement benefits for terminated employees. Operating income in Fiscal 1993 also was negatively affected by (1) reduced demand and price erosion; (2) higher quality control costs resulting from customers' intensified quality requirements; and (3) increased provisions for excess and slow moving inventory, which amounted to $7.4 million in Fiscal 1993 versus $5.1 million in Fiscal 1992.\nIndustrial Products - -------------------\nSales in the Industrial Products segment increased 12.3% in Fiscal 1993 compared to Fiscal 1992. The increase in sales in the current period reflected customer response to the D-M-E's fast delivery programs, new products, and moderation of the impact of the economic recession which adversely affected results in Fiscal 1992. Domestic demand for tooling for plastics was strong while foreign demand was weak.\nOperating income in the Industrial Products segment increased 25.1% in Fiscal 1993, compared to Fiscal 1992. The improved results in Fiscal 1993 resulted from a higher sales volume and improved operating margins. Early in Fiscal 1992, the Industrial Products segment implemented several cost savings steps, including overhead reduction and improved inventory management programs, which have contributed to the higher operating margins.\nCommunications Services - -----------------------\nSales in the Communications Services segment increased 16.8% in Fiscal 1993, compared to Fiscal 1992, primarily due to the inclusion of sales from acquisitions, the addition of telecommunications franchises in new office buildings, and growth at existing sites.\nOperating income in the Communications Services segment increased 9.6% in Fiscal 1993 compared to Fiscal 1992, primarily due to increased sales. Operating income as a percent of sales declined in Fiscal 1993 to 21.6% from 23.0% in Fiscal 1992. The decline was due to lower long distance margins partially offset by lower selling, general and administrative expenses as a percent of sales.\nOther Expenses\/Income - ---------------------\nCorporate Administrative Expense - Corporate administrative expense increased by $.9 million in Fiscal 1993 as compared to Fiscal 1992. This increase resulted from an increase in the Company's share of the total corporate administrative expense, primarily due to increased costs associated with the Company's compliance reporting requirements to its banks.\nOther Corporate Income - Other corporate income includes royalty income, rental income, and the reversal of excess reserves no longer deemed necessary. Other corporate income increased $.8 million in Fiscal 1993 compared to Fiscal 1992, primarily due to the adjustment of overstated health care liabilities of $2.7 million no longer deemed necessary in Fiscal 1993.\nNet Interest Expense - Net interest expense increased 19.2% in Fiscal 1993, compared to Fiscal 1992, primarily due to higher total borrowings and the higher interest rate on the new senior secured notes.\nInvestment Income - Investment income of $1.4 million and $7.1 million was recorded in Fiscal 1993 and Fiscal 1992, respectively, resulting principally from dividends realized on participating pension annuity contracts.\nIncome Taxes - For Fiscal 1993, the Company recorded a small income tax provision on a pretax loss. The effective tax rate was higher than the statutory rate largely due to permanent differences between financial reporting and tax accounting, the majority of which resulted from the acquisition of the Company by TFC in 1989. The most significant differences were depreciation related to the write-up to fair value of property, plant and equipment and amortization of goodwill, neither of which is deductible for tax purposes.\nNet Earnings (Loss) - Net earnings decreased $26.5 million in Fiscal 1993 compared to Fiscal 1992, primarily due to the $26.1 million drop in operating income, increased net interest expense of $5.2 million, and reduced investment income of $5.6 million, offset partially by lower income taxes due to the pretax loss.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nWorking capital at June 30, 1994, was $23.4 million which was $8.9 million lower than at June 30, 1993. The primary reasons for this reduction included a net increase in affiliated and external short term borrowings of $11.8 million and a $6.6 million decrease in inventories. Partially offsetting the effects of the working capital reductions mentioned above was an increase in accounts receivable of $4.6 million and an increase of $6.7 million in prepaids and other current assets primarily due to the earthquake insurance claim receivable.\nThe Company also expects to generate cash from the sale of certain assets. Net assets held for sale at June 30, 1994 had a book value of $34.5 million and included three parcels of real estate in California and an 88 acre parcel of real estate located in Farmingdale, New York, which the Company plans to sell, lease or develop, subject to the resolution of certain environmental matters and market conditions. In June 1994 the Chatsworth facility was classified as assets held for sale, as a result of the earthquake.\nThe Company's principal cash requirements include debt service, capital expenditures, acquisitions, payment of other liabilities and payment of dividends on preferred stock.\nThe level of the Company's capital expenditures varies from year to year, depending upon the timing of capital spending for new production equipment, periodic plant and facility expansion, acquisition of building telecommunications assets, as well as cost reduction and labor efficiency programs. For the twelve month period ended June 30, 1994, capital expenditures including the cost of acquisitions were $16.1 million. The Company anticipates that total capital expenditures including the cost of acquisitions for the fiscal year ending June 30, 1995, will be approximately $19.6 million.\nDuring Fiscal 1994, goodwill was reduced by $7.0 million as a result of the restructuring charge which included a write down of goodwill related to certain aerospace fasteners product lines which are in the process of being discontinued.\nOther liabilities that require the use of cash include post-employment benefits for retirees, environmental investigation and remediation obligations, litigation settlements and related costs.\nThe Company expects that cash generated from operations, borrowings, asset sales and the ability to refinance portions of its long-term debt will be adequate to satisfy cash requirements. If such sources are not adequate, the Company believes that additional capital resources would be available from RHI, via either new equity contributions or the assumption of certain of the Company's obligations. However, there can be no assurance that RHI would make these additional capital resources available to the Company.\nThe Company's Credit Agreement requires the Company to comply with certain financial covenants including, achieving cumulative earnings before interest, taxes, depreciation and amortization, (\"EBITDA Covenant\"), and maintaining certain coverage ratios. The Company was in compliance with the Credit Agreement as of the end of Fiscal 1994. The Company has negotiated an amendment to the Credit Agreement (i) to accommodate the unusual loss from the January 17, 1994 Southern California earthquake, and (ii) to reduce by $5.0 million the Company's minimum requirement under the EBITDA Covenant for the duration of the Credit Agreement. To comply with the minimum EBITDA Covenant requirements (as amended), the Company's subsidiary, VSI, must earn for the cumulative total of the trailing four quarters, EBITDA as follows: $68.6 million for the first quarter of Fiscal 1995, $70.4 million for the second quarter of Fiscal 1995, $72.1 million for the third quarter of Fiscal 1995, and $75.0 millon for the fourth quarter of Fiscal 1995. VSI's ability to meet the minimum requirement under the EBITDA covenant in Fiscal 1995 is uncertain, and there can be no assurance that the Company will be able in the future to comply with the minimum requirements under the EBITDA Covenant and other financial covenants under the Credit Agreement. Noncompliance with any of the financial covenants, without cure, or waiver would constitute an event of default under the Credit Agreement. An event of default resulting from a breach of a financial covenant may result, at the option of lenders holding a majority of the loans, in an acceleration of the principal and interest outstanding, and a termination of the revolving credit line. If necessary, management believes a waiver can be obtained.\nAny available cash may be paid as dividends to RHI if the purpose of such dividends is to provide TFC with funds necessary to meet its debt service requirements under specified notes and debentures. All other dividends to RHI are subject to certain limitations under the Credit Agreement. As of June 30, 1994, the Company was unable to provide dividends to RHI. The Credit Agreement also restricts all additional borrowings under the Credit Facilities for the payment of any dividends.\nIMPACT OF FUTURE ACCOUNTING CHANGES\nAccounting by Creditors for Impairment of a Loan - ------------------------------------------------\nOn July 1, 1994 the Company implemented SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\" (\"SFAS No. 114\"). SFAS No. 114 is a change in accounting principle that requires the Company, as a creditor, to evaluate for impairment (i) the collectibility of the contractual principal and interest of accounts receivable and notes receivable with terms longer than one year, and (ii) all loans restructured in a troubled debt restructuring. Accordingly, any loan impairment shall be recognized in the financial statements. The effect of implementing SFAS No. 114, by the Company, was not material.\nAccounting for Certain Investments and Debt and Equity Securities - -----------------------------------------------------------------\nOn July 1, 1994 the Company adopted SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\"). SFAS No. 115 provides new rules on accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. The effect of implementing SFAS No. 115, by the Company, was not material. ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------------------------------------------------------\nThe following consolidated financial statements of the Company and the report of the Company's independent public accountants with respect thereto, are set forth below. Page ----\nConsolidated Balance Sheets as of June 30, 1994 and 1993.... 27\nConsolidated Statements of Earnings - The three years ended June 30, 1994, 1993 and 1992............................. 29\nConsolidated Statements of Common Stockholder's Equity - The three years ended June 30, 1994, 1993 and 1992........ 30\nConsolidated Statements of Cash Flows - The three years ended June 30, 1994, 1993 and 1992........................ 31\nNotes to Consolidated Financial Statements.................. 33\nReport of Independent Public Accountants.................... 55\nSupplementary data regarding \"Quarterly Financial Information (Unaudited)\" is set forth under this Item 8 in Note 16 to the Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\nCorporate Structure: Fairchild Industries, Inc. is incorporated in the State of Delaware. As used herein, the term \"Company\" refers to Fairchild Industries, Inc. and its subsidiaries unless otherwise indicated. The Company is a subsidiary of RHI Holdings, Inc. (\"RHI\") which is in turn a wholly-owned subsidiary of The Fairchild Corporation (\"TFC\"). The Company conducts its operations through its wholly-owned subsidiary VSI Corporation (\"VSI\").\nFiscal Year: The fiscal year (\"Fiscal\") of the Company ends on June 30. All references herein to \"1994\", \"1993\", and \"1992\" mean the fiscal years ended June 30, 1994, 1993 and 1992, respectively.\nPrinciples of Consolidation: The consolidated financial statements are prepared in accordance with generally accepted accounting principles and include the accounts of the Company and its majority-owned subsidiaries. Investments in companies owned between 20 percent and 50 percent are recorded at cost, adjusted for equity in undistributed earnings or losses since the date of acquisition. All significant intercompany accounts and transactions have been eliminated in consolidation.\nStatements of Cash Flows: For purposes of these statements, the Company considers all temporary investments with original maturity dates of three months or less as cash equivalents. Total cash disbursements made by the Company for income taxes and interest were as follows:\nInventories: Inventories are valued at the lower of cost or market, with cost determined primarily on the last-in, first-out (LIFO) basis. Inventories from continuing operations are valued as follows:\nFor inventories valued on the LIFO method, the excess of current FIFO value over stated LIFO value was approximately $7,924,000 and $8,981,000 at June 30, 1994 and 1993, respectively. The LIFO decrement was immaterial for Fiscal 1994.\nProperties and Depreciation: Properties are stated at cost and depreciated over estimated useful lives, generally on a straight-line basis. For Federal income tax purposes, accelerated depreciation methods are used. No interest costs were capitalized in any of the years presented. Property, plant, and equipment consisted of the following:\nAmortization of Goodwill: The excess of cost of purchased businesses over the fair value of their net assets at acquisition dates (goodwill) is being amortized on a straight-line basis over 40 years.\nDeferred Loan Costs: Deferred loan costs associated with various debt issues are being amortized over the terms of the related debt, based on the amount of outstanding debt, using the effective interest method. Amortization expense for these loan costs was $2,201,000, $1,895,000 and $1,344,000 for Fiscal 1994, 1993 and 1992, respectively.\nImpairment of Long Lived Assets: The Company reviews its long lived assets, including property, plant and equipment, identifiable intangibles and goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. To determine recoverability of its long lived assets the Company evaluates the probability that undiscounted future net cash flows, without interest charges, will be less than the carrying amount of the assets.\nDespite two consecutive years of operating losses in the Company's Aerospace Fasteners Segment, the Company believes that future net cash flows from this segment will be sufficient to permit recovery of the segment's long lived assets, including the remaining goodwill, after a $7,000,000 reduction of goodwill in Fiscal 1994 relating to certain aerospace product lines which are in the process of being discontinued.\nForeign Currency Translation: All balance sheet accounts of foreign subsidiaries are translated at the current exchange rate as of the end of the accounting period. Income statement items are translated at average currency exchange rates. The resulting translation adjustment is recorded as a separate component of stockholders' equity. Transaction gains and losses included in other income were not significant.\nResearch and Development: Company-sponsored research and development expenditures are expensed as incurred.\nReclassifications: Certain amounts in prior years' financial statements have been reclassified to conform to the Fiscal 1994 presentation.\n2. ACQUISITIONS ------------\nWithin the last few years, Fairchild Communications Services Company (\"Fairchild Communications\"), a partnership whose partners are indirect subsidiaries of the Company, has completed the acquisition of several small companies involved in the sale of telecommunications services and equipment of tenants in commercial office buildings. In the third quarter of Fiscal 1993, Fairchild Communications acquired all the telecommunication assets of Office Networks, Inc., for approximately $7,300,000.\nThe cost of Fiscal 1992 acquisitions by Fairchild Communications totaled approximately $4,960,000. These purchases included: Bramtel, Inc. purchased August 1991 for $1,800,000; Hansen Communications purchased September 1991 for $160,000; certain assets of Telshare Associates Limited Partnership purchased April 1992 for approximately $1,100,000; and the stock of Teletech Resources Corporation purchased May 1992 for approximately $1,900,000, subject to certain adjustments.\n3. NET ASSETS HELD FOR SALE ------------------------\nThe Company has decided not to sell Fairchild Data Corporation (\"Data\") which previously was included in net assets held for sale. The Company is recording the current period's results from Data with the Company's Industrial Products Segment. Sales from Data formerly included in net assets held for sale, and not included in results of operations, were $15,432,000 and $13,624,000 for the twelve months ended June 30, 1993 and 1992, respectively. The impact of Data's earnings on the prior year periods was immaterial.\nNet assets held for sale at June 30, 1994 includes several parcels of real estate in California and an 88 acre parcel of real estate located in Farmingdale, New York, which the Company plans to sell, lease or develop, subject to the resolution of certain environmental matters and market conditions.\nNet assets held for sale are recorded at estimated net realizable values, which reflect anticipated sales proceeds and other carrying costs to be incurred during the holding period. Interest is not allocated to net assets held for sale.\n4. NOTES PAYABLE AND LONG-TERM DEBT --------------------------------\nAt June 30, 1994 and 1993, notes payable and long-term debt consisted of the following:\nThe Company maintains a credit agreement (the \"Credit Agreement\") with a consortium of banks, which provides a revolving credit facility and term loans (collectively the \"Credit Facilities\"). The Credit Facilities generally bear interest at 2.75% over the London Interbank Offer Rate (\"LIBOR\") for the revolving credit facility and Term Loan VII, and at 3.75% over LIBOR for Term Loan VIII, respectively. The commitment fee on the unused portion of the revolving credit facility was 0.5% at June 30, 1994. The Credit Facilities mature March 31, 1997 and are secured by substantially all the Company's assets.\nThe following table summarizes the Credit Facilities under the Credit Agreement.\nAt June 30, 1994, the Company had unused bank lines of credit aggregating $51,706,000 at interest rates approximating the prime rate. The Company has short-term lines of credit relating to foreign operations aggregating $12,147,000 against which the Company owed $3,592,000 at June 30, 1994.\nAt June 30, 1994, the Company had outstanding letters of credit of $7,794,000 which were supported by the Credit Agreement and other bank facilities on an unsecured basis.\nOn August 5, 1992, the Company completed a public offering and issued at par $125,000,000 of 12.25% Senior Secured Notes due 1999 (the \"Notes\"). The Notes are redeemable, in whole or in part, at the Company's option on or after August 1, 1997, at 102% of their aggregate principal amount, and thereafter, beginning August 1, 1998, at 100% of their aggregate principal amount plus accrued interest. The Notes are senior secured obligations of the Company, ranking \"pari passu\" with the Company's existing and future senior indebtedness. The proceeds from the sale of the Notes were used to (i) repay $55,000,000 of the Company's term loans under the Credit Agreement, (ii) repay $50,000,000 of loans under VSI's revolving credit facility under the Credit Agreement (which amounts will be available for future borrowings), including $30,000,000 which the Company paid as a portion of dividends (the \"Dividends\") to its parent, RHI, and (iii) as part of the Dividends, repay $20,000,000 of loans under RHI's revolving credit facility under the Credit Agreement.\nAs a result of the issuance of the Notes, certain amendments (the \"Bank Amendments\") to the Company's bank Credit Agreement became effective on August 5, 1992. As part of the Bank Amendments, (i) the lenders have extended to 1997 the maturity of $42,000,000 of term loans to the Company, (ii) the lenders have extended from 1994 to 1997 $50,250,000 of loans under VSI's revolving credit facility, (iii) the Company has repaid $55,000,000 of term loans from the proceeds of the Notes, (iv) the Company has repaid $50,000,000 of loans under its revolving credit facility, (v) the interest rate on loans outstanding to the Company and VSI under the Credit Agreement has been increased, and (vi) the Credit Agreement was amended in certain other respects to permit greater operating flexibility and to permit the payment of the Dividends under specified conditions.\nThe Credit Agreement contains certain covenants, including a material adverse change clause, and restrictions on dividends, capital expenditures, capital leases, operating leases, investments and indebtedness. It requires the Company to comply with certain financial covenants including achieving cumulative earnings before interest, taxes, depreciation and amortization (\"EBITDA Covenant\"), and maintaining certain coverage ratios. The Company was in compliance with the Credit Agreement at June 30, 1994.\nThe Company has negotiated an amendment to the Credit Agreement (i) to accommodate the unusual loss from the January 17, 1994 Southern California earthquake, and (ii) to reduce by $5,000,000 the Company's minimum requirement under the EBITDA Covenant for the duration of the Credit Agreement. To comply with the minimum EBITDA Covenant requirement (as amended), the Company's subsidiary, VSI, must earn for the cumulative total of the trailing four quarters, EBITDA as follows: $68,600,000 for the first quarter of Fiscal 1995, $70,360,000 for the second quarter of Fiscal 1995, $72,120,000 for the third quarter of Fiscal 1995 and $75,000,000 for the fourth quarter of Fiscal 1995. VSI's ability to meet the minimum requirement under the EBITDA Covenant in Fiscal 1995 is uncertain, and there can be no assurance that the Company will be able in the future to comply with the minimum requirement under the EBITDA Covenant and other financial covenants under the Credit Agreement. Noncompliance with any of the financial covenants, without cure, would constitute an event of default under the Credit Agreement. An event of default resulting from a breach of a financial covenant may result, at the option of lenders holding a majority of the loans, in an acceleration of the principal and interest outstanding, and a termination of the revolving credit line. If necessary, management believes a waiver can be obtained.\nAny available cash may be paid as dividends to RHI if the purpose of such dividends is to provide TFC with funds necessary to meet its debt service requirements under specified notes and debentures. All other dividends to RHI are subject to certain limitations under the Credit Agreement. As of June 30, 1994, the Company was unable to provide dividends to RHI. The Credit Agreement also restricts all additional borrowings under the Credit Facilities for the payment of any dividends.\nVSI's capital expenditures are limited during the remaining term of the Credit Agreement to the lower of (i) an annual ceiling of $25,200,000 to $26,500,000 per year, or (ii) 30% of the prior Fiscal year's earnings before interest, taxes, depreciation and amortization. Capital expenditure reductions can be offset by cash contributions from RHI. Capital expenditures can also be increased if cash proceeds are received from the sale of other property, subject to approval by the senior lenders under the Credit Agreement. The Company's sale of property, plant, and equipment is limited during the remaining term of the Credit Agreement.\nThe indenture, covering the Company's 9.75% subordinated debentures, places restrictions on payment of dividends and the creation of additional debt of equal priority with the debentures. The Company is in compliance with these restrictions at June 30, 1994.\nAnnual maturities of long-term debt obligations (exclusive of capital lease obligations) for each of the five years following June 30, 1994 are as follows: $6,957,000 for 1995, $8,728,000 for 1996, $86,506,000 for 1997, $1,000,000 for 1998, and $125,000,000 for 1999.\n5. PENSIONS AND POSTRETIREMENT BENEFITS -------------------------------------\nPensions --------\nThe Company has established defined benefit pension plans covering substantially all employees. Employees in foreign subsidiaries may participate in local pension plans which are in the aggregate insignificant and are not included in the following disclosures. The Company's funding policy for the plans is to contribute each year the minimum amount required under the Employee Retirement Income Security Act of 1974.\nThe following table provides a summary of the components of net periodic pension cost for the plans:\nThe following table sets forth the funded status and amounts recognized in the Company's statement of financial position at June 30, 1994 and 1993 for its defined benefit pension plans:\nAll of the Company's defined benefit plans have assets in excess of accumulated benefit obligations.\nPlan assets include Class A common stock of The Fairchild Corporation of $3,172,000 and $2,968,000 at June 30, 1994 and 1993, respectively. Substantially all of the plan assets are invested in listed stocks and bonds.\nPostretirement Health Care Benefits -----------------------------------\nEffective July 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (\"SFAS No. 106\"), \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". This new standard requires that the expected cost of postretirement benefits be accrued and charged to expense during the years the employees render the service. This is a significant change from the Company's previous policy of expensing these costs for active employees when paid.\nThe Company elected the immediate recognition method of adoption of SFAS No. 106. The unamortized portion of the overstated liability for discontinued operations was $10,652,000, net of tax, which substantially offset a $10,904,000, net of tax, charge relating to the transition obligation for active employees and retirees of continuing operations. The charge to net earnings from the cumulative effect of this accounting change was $252,000, net of tax.\nThe Company provides health care benefits for most retired employees. Postretirement health care expense from continuing operations totaled $1,948,000, $1,366,000 and $840,000 for the years ended June 30, 1994, 1993 and 1992, respectively. The Company has accrued approximately $33,397,000 as of June 30, 1994, for postretirement health care benefits related to discontinued operations. This represents the cumulative discounted value of the long-term obligation and includes interest expense of $2,849,000, $4,866,000 and $5,099,000 for the years ended June 30, 1994, 1993 and 1992, respectively. The components of expense for continuing operations and discontinued operations combined in 1994 are as follows:\nThe following table set forth the funded status for the Company's postretirement health care benefit plan:\nThe accumulated postretirement benefit obligation was determined using a discount rate of 8.5%, and a health care cost trend rate of 9.5% and 6.5% for pre-age-65 and post-age-65 employees, respectively, gradually decreasing to 4.5% and 5.0%, respectively, in the year 2003 and thereafter.\nIncreasing the assumed health care cost trend rates by 1% would increase the accumulated postretirement benefit obligation as of June 30, 1994, by approximately $2,093,000, and increase net periodic postretirement benefit cost by approximately $238,000 for Fiscal 1994.\n6. 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 Statement of Financial Accounting Standards No. 109 (\"SFAS No. 109\"), \"Accounting for Income Taxes\".\nUnder the liability 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 SFAS No. 109, income tax expense was determined using the deferred method. Deferred tax expense was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated.\nAs permitted under SFAS No. 109, prior years' financial statements have not been restated. The Company elected the immediate recognition method and recorded a $11,486,000 charge representing the prior years' cumulative effect. This charge represents deferred taxes that had to be recorded related primarily to fixed assets, prepaid pension expense, and inventory basis differences.\nThe provision for income taxes from continuing operations is summarized as follows:\nThe income tax provision for continuing operations differs from that computed using the statutory Federal income tax rate of 35.0% in 1994 and 34.0% in the 1993, and 1992 periods for the following reasons:\nThe following table is a summary of the significant components of the Company's deferred tax assets and liabilities as of June 30, 1994:\nFor years prior to the change in the method of accounting for taxes, the deferred income tax component of the income tax provision for continuing operations consists of the effect of timing differences related to:\nDomestic income taxes, less allowable credits, are provided on the unremitted income of foreign subsidiaries and affiliated companies, to the extent that such earnings are intended to be repatriated. No domestic income taxes or foreign withholding taxes are provided on the undistributed earnings of foreign subsidiaries and affiliates that are considered permanently invested, or which would be offset by allowable foreign tax credits. At June 30, 1994, the amount of domestic taxes payable upon distribution of such earnings is not significant.\nIn the opinion of management, adequate provision has been made for all income taxes and interest, and any tax liability that may arise for prior periods will not have a material effect on the financial condition or results of operations of the Company.\n7. REDEEMABLE PREFERRED STOCK --------------------------\nOn August 21, 1992, the Company closed on an offer to exchange (the \"Exchange Offer\") on a one-for-one basis, up to 90% of the outstanding shares of Series A Convertible Preferred Stock of the Company for shares of Series C Cumulative Preferred Stock of the Company. The Exchange Offer resulted in an increase in stockholders' equity of $25,126,000 (prior to fees and expenses) due to the Series C Preferred Stock not being mandatorily redeemable or convertible to cash. Approximately 56.8% of the outstanding shares of the Series A Preferred Stock were exchanged for shares of the Series C Preferred Stock. The Series C Preferred Stock has an annual dividend requirement of $4.25 per share through July 21, 1999, and $7.00 per share thereafter. The Company's requirement to redeem annually shares of Series A Preferred Stock has been reduced by the number of shares of Series A Preferred Stock exchanged for Series C Preferred Stock, i.e., by 558,360 shares. Both the Series A Preferred Stock and the Series C Preferred Stock are listed on the New York Stock Exchange.\nThe Series A Preferred Stock is subject to annual mandatory redemptions of 165,564 shares per annum at $45.00 per share, plus any dividend arrearages, commencing in 1989. In addition, the Company has the option of redeeming any or all shares at $45.00 per share. The Company announced on August 30, 1989, that the Board of Directors authorized expenditure of up to $25,000,000 for additional early redemption of these shares as market conditions permit. The Company purchased 146,892 shares of its Series A Preferred Stock in Fiscal 1992. The Company did not purchase any shares in Fiscal 1994 and 1993.\nHolders of the Series A Preferred Stock have general voting rights. Additionally, in the event of a cumulative arrearage equal to six quarterly dividends, all Series A Preferred stockholders have the right to elect separately, as a class, two members to the Board of Directors. No cash dividends can be declared or paid on any stock junior to the Series A Preferred Stock in the event of dividend arrearages or a default in the obligation to redeem such Series A Preferred Stock. Due to the merger of the Company with RHI in August 1989, holders of the Series A Preferred Stock are entitled, at their option, but subject to compliance with certain covenants under the Company's Credit Agreement, to redeem their shares for $27.18 in cash.\nAnnual maturity redemption requirements for redeemable preferred stock as of June 30, 1994, are as follows: $0 for 1995, $4,211,000 for 1996, $7,450,000 for 1997, and $7,450,000 for 1998.\n8. EQUITY SECURITIES -----------------\n3,000 shares of Series B Preferred Stock were authorized, 2,025 and 1,976 shares were issued and outstanding at June 30, 1994 and 1993. All of the Series B Preferred Stock is owned by the Company's parent, RHI.\n9. FAIR VALUE OF FINANCIAL INSTRUMENTS -----------------------------------\nStatement of Financial Accounting Standards No. 107 (\"SFAS No. 107\"), \"Disclosures about Fair Value of Financial Instruments,\" requires disclosures of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. 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 discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS No. 107 excludes certain financial instruments and all non-financial 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:\nCash and Cash Equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximates the fair value.\nInvestment Securities: Fair values for equity securities are based on quoted market prices, where available. For equity securities not actively traded, fair values are estimated by using quoted market prices of comparable instruments or, if there are no relevant comparables, on pricing models or formulas using current assumptions. The fair value of limited partnerships and other investments are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the investment.\nNotes Receivable: Fair values of notes receivable are estimated by using discounted cash flow analyses, using a current market rate applicable to the yield, credit quality, and maturity of the investment.\nShort-term Borrowings: The carrying amounts of the Company's short-term borrowings approximate their fair values.\nLong-term Borrowings and Notes Payable: The carrying amounts of borrowings under its bank credit agreement and current maturities of long- term debt approximate their fair value. The fair value of the Company's subordinated debentures and senior notes are based on quoted market prices, where available. For subordinated debentures not actively traded, fair values are estimated by using quoted market prices of comparable instruments. The fair value for the Company's other fixed rate long-term debt is estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.\nRedeemable Preferred Stock: The fair value for redeemable preferred stock is based on the quoted market price.\nOff-balance-sheet Instruments: Fair values for the Company's off- balance-sheet instruments (letters of credit, commitments to extend credit, and lease guarantees) are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counter parties' credit standing. The current period's fair value of the Company's off-balance-sheet instruments is not material.\nThe carrying amounts and fair values of the Company's financial instruments at June 30, 1994 and June 30, 1993 are as follows:\n10. RESTRUCTURING CHARGES ---------------------\nDuring the Fiscal 1994 period, as a result of the sustained soft worldwide demand for aircraft, aircraft engines and the resulting decline in new order rates and prices for aerospace fasteners, the Company has continued to undertake additional restructuring actions to further downsize, reduce costs, reduce cycle times and improve margins. These restructuring efforts include discontinuance of certain aircraft engine bolt and other product lines, increased cellularization of manufacturing processes, relocation of its New Jersey operations into California and re-engineering certain manufacturing processes and methods to meet increased customer quality standards.\nThe Company recorded a pretax restructuring charge of $18,860,000 in Fiscal 1994 to cover the cost of the above mentioned restructuring activities, including the write down of goodwill and surplus assets related to certain product lines, severance benefits and the nonrecurring costs associated with the cellularization and reengineering of manufacturing processes and methods. Depending on future demand and prices of aerospace fasteners, the Company may take further restructuring actions in the future and may record additional restructuring charges for the cost of these activities.\nThe Company recorded restructuring charges of $15,469,000 and $2,500,000 in Fiscal 1993 and 1992, respectively, relating to the downsizing of fastener operations in Europe and California, and severance and early retirement benefits for terminated employees.\n11. UNUSUAL ITEMS -------------\nOn January 17, 1994, the Company's Chatsworth, California Aerospace Fasteners manufacturing facility suffered extensive damage from the Southern California earthquake. As a result, the Company relocated the Chatsworth manufacturing operations to its other Southern California facilities. This disruption has caused increased costs and reduced revenues in the Fiscal 1994 third and fourth quarters. While the Company carries insurance for both business interruption and property damage caused by earthquakes, the policy has a 5% deductible. The Company has recorded an unusual pretax loss of $4,000,000 in Fiscal 1994 in the Aerospace Fasteners segment to cover the estimated net cost of the damages and related business interruption caused by the earthquake. An insurance claim of $5,900,000 has been recorded for recoverability of costs related to business interruption and property damage. In addition, the Company recorded a write down of $2,000,000 relating to this real estate which is now included in net assets held for sale.\n12. RELATED PARTY TRANSACTIONS --------------------------\nThe Company's corporate staff performs work for each of the three corporate entities. Corporate administrative expense incurred by the Company is invoiced to RHI and to TFC on a monthly basis and represents the estimated cost of services performed on behalf of such companies by the Company. The estimated cost is based primarily on estimated hours spent by corporate employees on functions related to RHI and to TFC.\nThe Company has entered into a tax sharing agreement with its parent whereby the Company is included in the consolidated federal income tax return of the parent. The Company makes payments to the parent based on the amounts of federal income taxes, if any, it would have paid had it filed a separate federal income tax return.\nThe Aerospace Fasteners segment had sales to Banner Aerospace, Inc. a 47.2% affiliate of RHI, of $5,680,000, $8,750,000 and $10,941,000 for the years ended June 30, 1994, 1993 and 1992, respectively.\n13. COMMITMENTS AND CONTINGENCIES -----------------------------\nLeases ------\nThe Company leases certain of its facilities and equipment under capital and operating leases. The following is an analysis of the assets under capital leases included in property, plant and equipment:\nRental expense under all leases amounted to $7,193,000, $9,575,000 and $10,410,000 for the years ended June 30, 1994, 1993 and 1992, respectively.\nIn connection with the sale of Metro Credit Corporation, the Company remained contingently liable as a guarantor of the payment and performance of obligations of third party lessees under aircraft leases, which call for aggregate annual base lease payments of approximately $3,454,000 in 1995, and approximately $11,397,000 over the remaining 5-year guaranty period. In each case, the Company has been indemnified by the purchasers and lessors from any losses related to such guaranties.\nGovernment Claims -----------------\nIn 1989, the Company learned through its own quality assurance procedures, and voluntarily disclosed to its customers and the Department of Defense, that certain units of VSI had not performed certain production lot tests mentioned in the military specifications for some limited product lines. The Company does not believe that VSI's level of testing resulted in shipment of unsafe products or that purchasers were otherwise damaged, and the government subsequently reduced certain test requirements. In May 1994, VSI settled this matter with the government by payment of $330,000.\nFollowing an investigation by the Inspector General of NASA, the civil division of the United States Department of Justice alleged improprieties in years 1982 and 1984 through 1986, in indirect costs rates and labor charging practices of a former subsidiary of the Company. The Company entered into settlement discussions with the Department of Justice to attempt to resolve these claims and has reached an agreement in principle with the government to settle this matter for $5,000,000, payable in six equal semi-annual installments, with interest at 6% per year. The unpaid balance will likely be collateralized by certain excess real estate. If the settlement is not consummated, the government may initiate suit under the False Claims Act, seeking treble damages and penalties, and under the Truth in Negotiation Act, seeking a price reduction on certain contracts and subcontracts.\nThe Corporate Administrative Contracting Officer (the \"ACO\"), based upon the advice of the United States Defense Contract Audit Agency, has made a determination that FII did not comply with Cost Accounting Standards in accounting for (i) the 1985 reversion to FII of certain assets of terminated defined benefit pension plans, and (ii) pension costs upon the closing of segments of FII's business. The ACO has directed FII to prepare a cost impact proposal relating to such plan terminations and segment closings and, following receipt of such cost impact proposals, may seek adjustments to contract prices. The ACO alleges that substantial amounts will be due if such adjustments are made. The Company believes it has properly accounted for the asset reversions in accordance with applicable accounting standards. The Company has entered into discussions with the government to attempt to resolve these pension accounting issues.\nEnvironmental Matters ---------------------\nThe Company and other aerospace fastener and industrial product manufacturers are subject to stringent Federal, state and local environmental laws and regulations concerning, among other things, the discharge of materials into the environment and the generation, handling, storage, transportation and disposal of waste and hazardous materials. To date, such laws and regulations have not had a material effect on the financial condition of the Company, although the Company has expended, and can be expected to expend in the future, significant amounts for investigation of environmental conditions and installation of environmental control facilities, remediation of environmental conditions and other similar matters, particularly in the Aerospace Fasteners segment.\nIn connection with its plans to dispose of certain real estate, the Company must investigate environmental conditions and may be required to take certain corrective action prior or pursuant to any such disposition. In addition, management has identified several areas of potential contamination at or from other facilities owned, or previously owned, by the Company, that may require the Company either to take corrective action or to contribute to a clean-up. The Company is also a defendant in certain lawsuits and proceedings seeking to require the Company to pay for investigation or remediation of environmental matters and has been alleged to be a potentially responsible party at various \"Superfund\" sites. Management of the Company believes that it has recorded adequate reserves in its financial statements to complete such investigation and take any necessary corrective actions or make any necessary contributions. No amounts have been recorded as due from third parties, including insurers, or set off against, any liability of the Company, unless such parties are contractually obligated to contribute and are not disputing such liability.\nOther Matters -------------\nThe Company is involved in various other claims and lawsuits incidental to its business, some of which involve substantial amounts. The Company, either on its own or through its insurance carriers, is contesting these matters.\nIn the opinion of management, the ultimate resolution of the legal proceedings, including those discussed above, will not have a material adverse effect on the financial condition or the future operating results of the Company.\n14. BUSINESS SEGMENTS -----------------\nThe Company's operations are conducted in three principal business segments. The Aerospace Fasteners segment includes the manufacture of high performance specialty fasteners and fastening systems. The Industrial Products segment is primarily engaged in the manufacture of tooling and injection control systems for the plastic injection molding and die casting industries and the supply of modems for use in high speed digitized voice and data communications. The Communications Services segment provides telecommunication services to office buildings. Intersegment sales are insignificant to the sales of any segment.\nIdentifiable assets represent assets that are used in the Company's operations in each segment at year end. Corporate assets are principally in cash and short-term investments, notes receivable, assets held for sale, and property maintained for general corporate purposes.\nThe Company's financial data by business segment is as follows:\n15. FOREIGN OPERATIONS AND EXPORT SALES -----------------------------------\nThe Company's operations are located primarily in the United States and Europe. Interarea sales are not significant to the total sales of any geographic area. The Company's financial data by geographic area is as follows:\nExport sales are defined as sales to customers in foreign countries by the Company's domestic operations. Export sales amounted to the following:\n16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) -------------------------------------------\nNet earnings (loss) from continuing operations includes charges to reflect the cost of restructuring the Company's Aerospace Fasteners Segment, of $9,903,000 and $8,957,000 in the second and fourth quarter of Fiscal 1994, respectively, and $1,500,000, $932,000 and $13,037,000 in the second, third and fourth quarters of Fiscal 1993, respectively. The Company recorded an unusual loss in the third and fourth quarters of Fiscal 1994 of $3,200,000 and $2,800,000, respectively, to cover the estimated net cost of the damages and related business interruption caused by an earthquake and the write down of real estate. The Fiscal 1993 first quarter also includes an extraordinary charge of $833,000, net of tax, from the write-off of deferred loan fees.\nThe Fiscal 1994 first and second quarter data presented vary from the amounts previously reported in Form 10-Q due to the Company's decision not to sell a division which was included in net assets held for sale, and not included in the results of operations. Sales from the division were $4,141,000 and $3,438,000 in the first and second quarters, respectively, of Fiscal 1994. Earnings from the division had no material effect during these periods. Report of Independent Public Accountants ----------------------------------------\nTo Fairchild Industries, Inc.:\nWe have audited the accompanying consolidated balance sheets of Fairchild Industries, Inc. (a Delaware corporation) and subsidiaries as of June 30, 1994 and 1993, and the related consolidated statements of earnings, common stockholder's equity and cash flows for the years ended June 30, 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 auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Fairchild Industries, Inc. and subsidiaries as of June 30, 1994 and 1993 and the results of their operations and their cash flows for the years ended June 30, 1994, 1993, and 1992, in conformity with generally accepted accounting principles.\nAs discussed in Notes 5 and 6 to the Consolidated Financial Statements, effective July 1, 1993, the Company changed its methods of accounting for postretirement benefits other than pensions, and income taxes.\nArthur Andersen LLP\nWashington, D.C. August 26, 1994\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 COMPANY - --------------------------------------------------------- INFORMATION CONCERNING DIRECTORS - --------------------------------\nName of Director, Number of Shares of Principal Occupations Preferred Stock During Past Five Years Director Beneficially Owned as of and Other Information Age Since August 31, 1994 - --------------------- --- -------- ------------------------\nSeries A Series C -------- --------\nAlcox, Michael T. 46 1989 -- -- Vice President and Chief Financial Officer of the Company; Director, Senior Vice President and Chief Financial Officer of The Fairchild Corporation; Vice President and Chief Financial Officer of RHI Holdings, Inc.; and Director of Banner Aerospace, Inc.(1)\nCaplin, Mortimer M. 78 1979 -- 3,240(2) Member, Caplin & Drysdale (Attorneys); Director of Presidential Realty Corporation, Danaher Corporation and Unigene Laboratories, Inc. (1)\nName of Director, Number of Shares of Principal Occupations Preferred Stock During Past Five Years Director Beneficially Owned as of and Other Information Age Since August 31, 1994 - --------------------- --- -------- ------------------------\nSeries A Series C -------- --------\nFlaherty, Thomas J. 56 1994 -- -- Chief Operating Officer of the Company; Director and Chief Operating Officer of The Fairchild Corporation; President and Chief Operating Officer of IMO Industries, Inc. from 1992 to April 1993; Chief Executive Officer & President of Transnational Industries, Inc. from 1990 to 1992; from 1977 to 1990, various executive positions with the Hamilton Standard and Pratt & Whitney units of United Technologies Corporation.\nRichey, Herbert S. 72 1992 -- -- President, Richey Coal Company (Coal Properties - Brokerage and Consulting) until December, 1993; Director of The Fairchild Corporation, Oglebay Norton Company and Sifco Industries, Inc.\nSteiner, Jeffrey J. 57 1989 6,100 (5) 500 Chairman of the Board, Chief Executive Officer and President of the Company, The Fairchild Corporation and RHI Holdings, Inc.; Director of Banner Aerospace, Inc., The Franklin Corporation, and The Copley Fund (1), (3), (4)\nName of Director, Number of Shares of Principal Occupations Preferred Stock During Past Five Years Director Beneficially Owned as of and Other Information Age Since August 31, 1994 - --------------------- --- -------- ------------------------\nSeries A Series C -------- --------\nSteiner Hercot, Natalia 29 1989 -- -- Presently a Graduate Student, Previously employed with The Fairchild Corporation as a Financial Analyst\n(1) Member of Executive Committee\n(2) Includes 1,440 shares owned by the Caplin Foundation, a non-profit corporation, beneficial ownership of which is disclaimed by Mr. Caplin. Mr. Caplin is President of this foundation. Mr. Caplin owns beneficially approximately 0.6% of the outstanding Series C Preferred Stock of the Company and has sole voting and investment power for all such shares.\n(3) The Fairchild Corporation, through RHI Holdings, Inc., has a significant direct or indirect equity position in Banner Aerospace, Inc.\n(4) Mr. Steiner beneficially owns shares having approximately 72% of the total voting power of outstanding voting stock of The Fairchild Corporation and may be deemed to control The Fairchild Corporation.\n(5) Includes 2,900 shares owned by Stinbes Limited, a corporation organized under the laws of the Caymen Islands, an indirect wholly- owned subsidiary of Bestin S.A., a Luxemborg joint stock company, whose shares are owned by Paske Investments Ltd., a corporation organized under the laws of Jersey, Channel Islands, a wholly- owned subsidiary of the Friday Trust, of which Mr. Steiner is the settlor and a beneficiary.\nEXECUTIVE OFFICERS OF THE COMPANY - ---------------------------------\nThe executive officers of the Company, as of September 2, 1994, are listed below:\nName (age) and Positions and Offices Held with Company Principal Occupation and Business (Year Elected) Experience (Past Five Years) - ---------------------------- ---------------------------------\nJeffrey J. Steiner (57) Chairman, Chief Executive Officer and Chairman, Chief Executive President since 1991; Chairman and Chief Officer and President (1991) Executive Officer since 1985 and President since 1991 of The Fairchild Corporation; Vice Chairman, Banner Aerospace since 1990.\nThomas J. Flaherty (56) Chief Operating Officer since April Chief Operating Officer (1993) 1993; President and Chief Operating Officer of IMO Industries, Inc. from 1992 to April 1993; Chief Executive Officer & President of Transnational Industries, Inc. from 1990 to 1992; from 1977 to 1990, various executive positions with the Hamilton Standard and Pratt & Whitney units of United Technologies Corporation.\nJohn D. Jackson (57) Senior Vice President, Administration Senior Vice President since 1989; Vice President 1986-1989; (1989) and Secretary since 1978. (1978)\nJohn L. Flynn (48) Vice President and Tax Counsel since Vice President and 1986. Tax Counsel (1986)\nHarold R. Johnson (71) Vice President, Business Development, Vice President (1988) since 1988; Founder, Chairman and President, Telebit Corp. 1983-1988.\nJerry Lirette (46) Vice President since 1988; President Vice President (1988) of D-M-E Company since 1984.\nMichael T. Alcox (46) Vice President and Chief Financial Vice President and Chief Officer since 1989; Senior Vice Financial Officer (1989) President and Chief Financial Officer of The Fairchild Corporation since 1987.\nName (age) and Positions and Offices Held with Company Principal Occupation and Business (Year Elected) Experience (Past Five Years) - ---------------------------- ---------------------------------\nChristopher Colavito (39) Vice President and Controller since Vice President and 1989; Assistant Controller 1987-1989. Controller (1989)\nKaren L. Schneckenburger (45) Treasurer since 1989; Director of Treasurer (1989) Finance 1986-1989.\nMelvin Borer (51) Vice President since 1991; President Vice President (1991) of Fairchild Communications Services Company since 1989; Vice President and General Manager of Fairchild Communications Services Company from 1987 to 1989.\nEric Steiner (32) Vice President since 1992; Director, Vice President (1992) Banner Aerospace\nDonald E. Miller (47) Vice President and General Counsel Vice President and since 1991; Principal, Temkin & Miller, General Counsel (1991) Ltd. from 1973 to 1990.\nTownsend Breeden (62) Vice President since 1992; General Vice President (1992) Manager, Keltec Florida, Inc. 1989 to 1992.\nRobert D. Busey (51) Vice President since 1993; Vice President (1993)\nRobert H. Kelley (46) Vice President since 1993; Vice President (1993)\nThere are no family relationships between any executive officers and directors, except that Natalia Steiner-Hercot, a Director of the Company, and Eric Steiner, Vice President of the Company, are children of Jeffrey Steiner, also a Director of the Company.\nRobert D. Busey, Vice President, filed a Form 3 late during the 1994 fiscal year. Robert H. Kelley, Vice President, filed a Form 3 late during the 1994 fiscal year. Eric Steiner, Vice President, filed a Form 4 late during the 1994 fiscal year.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - --------------------------------\nCOMPENSATION OF DIRECTORS - ------------------------- Retainer and Meeting Fees - -------------------------\nEach non-employee Director (excluding Directors who are employees of The Fairchild Corporation or any subsidiary thereof) receives a cash retainer of $18,000 per year and an additional $1,000 for each Board meeting attended. Members of each Board Committee receive $750 for each Committee meeting attended with the Chairman of each Committee receiving a $2,500 per year retainer. A separate fee is not paid for a Committee meeting held on the same day as another Committee meeting.\nCOMPENSATION OF EXECUTIVE OFFICERS AND OTHER INFORMATION - -------------------------------------------------------- Cash Compensation - -----------------\nThe information required by this section of Item 11 is set forth in the 1994 Proxy Statement of the Company's parent, The Fairchild Corporation (\"TFC\"), which TFC intends to file with the Securities and Exchange Commission within 120 days after June 30, 1994, and said information is incorporated herein by reference from TFC's 1994 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------------------------------------------------------------------------\nThe following table sets forth, as of September 2, 1994, the Company's common stock, Series A Preferred Stock, Series B Preferred Stock, and Series C Preferred Stock owned by any person known to the Corporation to be the beneficial owner of more than five (5%) percent of any class and beneficially owned by all Directors and Officers of the Company as a group:\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------\nThe information required by this section of Item 13 is set forth in the 1994 Proxy Statement of the Company's parent, The Fairchild Corporation (\"TFC\"), which TFC intends to file with the Securities and Exchange Commission within 120 days after June 30, 1994, and said information is incorporated herein by reference from TFC's 1994 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.\nAll financial statements of the registrant as set forth under Item 8 of this report on Form 10-K.\n(a) (2) Financial Statement Schedules and Report of Independent Public Accountants\nSchedule Number Description Page Number --------------- ----------- -----------\nV Property, Plant and Equipment 69\nVI Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment 69\nVIII Valuation and Qualifying Accounts 70\nIX Short-Term Borrowings 71\nX Supplementary Income Statement Information 71\nThe reports of the registrant's Independent Public Accountants with respect to the above-listed financial statements for Fiscal 1994 and Fiscal 1993, and the reports on the financial statement schedules for Fiscal 1994 and Fiscal 1993, appear on page 26 of this Report.\nAll other schedules are omitted because they are inapplicable, or not required, or the information is included in the consolidated financial statements or notes thereto.\nFinancial statements for unconsolidated affiliates, including joint ventures and general partnerships, accounted for by the equity method, have been omitted because no such affiliate constitutes a significant subsidiary.\nReport of Independent Public Accountants ----------------------------------------\nTo Fairchild Industries, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Fairchild Industries, Inc. and subsidiaries included in this Form 10-K and have issued our report thereon dated August 26, 1994. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index on page 63 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\nWashington, D.C. August 26, 1994\n(a) (3) Exhibits\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.\nExhibit Number - -------\n3(a) Certificate of Incorporation of Fairchild Industries, Inc. filed with the Secretary of State of Delaware on August 18, 1989 (incorporated by reference to Exhibit 3(a) of Form 10-K filed by the Registrant for the six months ended June 30, 1989, File No. 1-3102).\n3(b) Certificate of Designation, of Series B Preferred Stock of Fairchild Industries, Inc. filed with the Secretary of State of Delaware on August 18, 1989 (incorporated by reference to Exhibit 3(b) of Form 10-K filed by the Registrant for the six months ended June 30, 1989, File No. 1-3102).\n3(c) Certificate of Correction of Certificate of Incorporation of Fairchild Industries, Inc. filed with the Secretary of State of Delaware on October 18, 1989 (incorporated by reference to the 1990 10-K).\n3(d) Certificate of Increase of Fairchild Industries, Inc. of Series B Preferred Stock of Fairchild Industries, Inc. filed with the Secretary of State of Delaware on July 3, 1990 (incorporated by reference to the 1990 10-K).\n3(e) Certificate of Stock Designation of Series C Cumulative Preferred Stock filed August 20, 1992.\n3(f) Certificate of Correction of Certificate of Stock Designation of Series C Cumulative Preferred Stock filed September 14, 1992.\n3(g) Certificate of Amendment of Certificate of Incorporation of Fairchild Industries, Inc. filed May 26, 1993.\n3(h) Fairchild Industries, Inc. By-Laws (incorporated by reference to Form 10-K filed by the Registrant for year ended June 30, 1990 (the \"1990 10-K\")).\n4(a) Indenture, dated as of November 1, 1982, under which certain Debt Securities of the Company were issued (Exhibit 4 to Registration Statement No. 2-80009 on Form S-3 effective October 28, 1982, is incorporated herein by reference).\n4(b) Indenture, dated as of January 1, 1978, under which the 9 3\/4% Subordinated Debentures of the Company, due April 1, 1998, were issued (Exhibit 2-B to Registration Statement No. 2-60451 on Form S-7, effective January 12, 1978, is incorporated herein by reference).\n4(c) Indenture, dated as of August 1, 1992, under which the 12 1\/4% Senior Secured Notes of the Company, due 1999, were issued (Exhibit to Registration Statement No. 33-47341 on Form S-2, is incorporated herein by reference).\n10(a) Restated and Amended Credit Agreement dated as of July 27, 1992 (incorporated by reference to 1992 10-K).\n10(b) Amendment No. 1, dated as of June 30, 1993, to the Restated and Amended Credit Agreement dated as of July 27, 1992.\n10(c) Agreement and Plan of Merger dated May 7, 1989 among Fairchild Industries, Inc., Banner Industries, Inc., and Specialty Fastener Holdings, Inc. (incorporated by reference to Exhibit 2(a) of Form 10-K filed for the six months ended June 30, 1989, File No. 1-3102).\n10(d) Asset Purchase Agreement dated May 31, 1989 among Matra S.A., Aero Acquisitions Corp., Banner Industries, Inc. and Fairchild Acquisition Corp. (incorporated by reference to Exhibit 2(b) of Form 10-K filed by the Registrant for the six months ended June 30, 1989, File No. 1-3102).\n*10(e) Amendment No. 2, dated as of October 1, 1993, to the Restated and Amended Credit Agreement dated as of July 27, 1992.\n*10(f) Amendment No. 3, dated as of December 23, 1993, to the Restated and Amended Credit Agreement dated as of July 27, 1992.\n*10(g) Amendment No. 4, dated as of March 31, 1994, to the Restated and Amended Credit Agreement dated as of July 27, 1992.\n11 Computation of earnings per share (found at Note to Registrant's Consolidated Financial Statements for the fiscal year ended June 30, 1994).\n*22 Subsidiaries of the Fairchild Industries, Inc.\n*Filed herewith\nCertain instruments with respect to issues of long-term debt have not been filed as exhibits as the total amount of securities authorized under any one of such issues does not exceed 10% of the total assets of the registrant and its subsidiaries on a consolidated basis. The Registrant agrees to furnish to the Securities and Exchange Commission a copy of each such instrument upon its request.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the quarter ended June 30, 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.\nFAIRCHILD INDUSTRIES, INC.\nBy: Michael T. Alcox ------------------------ Director Vice President and Chief Financial Officer\nBy: Christopher Colavito ------------------------ Vice President and Controller\nDate: September 21, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nName, Title, Capacity Date --------------------- ----\nMichael T. Alcox September 21, 1994 ----------------------------- Director, Vice President and Chief Financial Officer\nChristopher Colavito September 21, 1994 ----------------------------- Vice President and Controller\nMortimer M. Caplin September 21, 1994 ----------------------------- Director\nThomas J. Flaherty September 21, 1994 ----------------------------- Director and Chief Operating Officer\nHerbert S. Richey September 21, 1994 ----------------------------- Director\nJeffrey J. Steiner September 21, 1994 ----------------------------- Director\nNatalia Steiner Hercot September 21, 1994 ----------------------------- Director\nOther changes include foreign currency translation adjustments, intercompany transfers, and transfers between property, plant and equipment and net assets held for sale.\nOther changes include foreign currency translation adjustments, intercompany transfers, and transfers between property, plant and equipment and net assets held for sale.","section_15":""}
{"filename":"883702_1994.txt","cik":"883702","year":"1994","section_1":"ITEM 1. BUSINESS\n(A) GENERAL DESCRIPTION OF BUSINESS\nAcme Metals Incorporated, based in Riverdale, Illinois, is the successor to the original Acme Steel Company which merged with the Interlake Iron Company in 1964 to form Interlake Steel Corporation. The Company's name was changed to Interlake, Inc. and was subsequently reincorporated in Delaware on December 19, 1969.\nAs a result of a reorganization in 1986, The Interlake Corporation (\"new Interlake\") became the parent company of Interlake, Inc. (\"old Interlake\"). Old Interlake transferred all but its iron, steel and domestic steel strapping assets and businesses to new Interlake. Old Interlake was again renamed Acme Steel Company, and pursuant to the reorganization, was spun off from new Interlake as a public company in May, 1986.\nAcme Steel Company undertook a further reorganization in May, 1992 when Acme Metals Incorporated (\"Company\") was formed and became the parent of Acme Steel Company (\"Acme\"), and Acme's former subsidiaries, Acme Packaging Corporation (\"Packaging\"), Alpha Tube Corporation (\"Alpha\"), and Universal Tool & Stamping Co., Inc. (\"Universal\"). The Company has been publicly traded on NASDAQ since 1986.\nThe principal business activities of the Company consist of two separate industry segments namely:\nSteel Making Segment Acme Steel Company - an integrated iron and steel producer\nSteel Fabricating Segment Acme Packaging Corporation - steel strapping and strapping products Alpha Tube Corporation - welded steel tube products Universal Tool & Stamping Co., Inc. - auto and light truck jack products.\n(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe Company reports its operations by two industry segments, Steel Making and Steel Fabricating. Financial information about the Company's industry segments is contained in the BUSINESS SEGMENTS section of the Notes to the Consolidated Financial Statements on page 51.\n(C) NARRATIVE DESCRIPTION OF BUSINESS\nSteel Making Segment Acme is a fully integrated producer of steel products. Acme's line of products is concentrated on the manufacture of flat-rolled steels, including sheet and strip steel. In the flat-rolled steel market Acme specializes in producing carbon steels, especially high carbon steels, alloy steels, and high strength steels. The principal markets served by Acme include the agricultural equipment, automotive components, industrial equipment, industrial fastener, pipe and tube, processor, and tool manufacturing industries. The Company's Steel Fabricating Segment consumes approximately 30 - 50 percent of Acme's steel production. Acme's focus on external customers is centered around customers whose demand levels and metallurgical requirements are for the small production quantities available from Acme's facilities. Acme's sales represented about 44, 41 and 37 percent of total Company sales in 1994, 1993 and 1992 respectively.\nAcme's facilities are located in Riverdale and Chicago, Illinois, and include the following plant facilities: coke ovens, blast furnaces, pigging machines, basic oxygen furnaces, rolling mill, a slab grinder, hot strip mills, pickle lines, cold mills, annealing furnaces, slitter lines, and cut-to-length lines.\nAcme is the smallest integrated steel producer in the U.S. with annual hot band shipping capability of approximately 720,000 tons. This compares with total U.S. shipments of all steel products of approximately 88 million tons.\nSteel Fabricating Segment Packaging, which was incorporated as a separate entity in December 1991, is one of the two major domestic producers of steel strapping and strapping tools in North America and, by management estimates, shares approximately 80 percent of the domestic market equally with its primary competitor. Strapping is currently produced at four plants located throughout the U.S. and represented approximately 32, 33 and 36 percent of the Company's sales in 1994, 1993 and 1992, respectively. Principal markets served by Packaging include the agricultural, automotive, brick, construction, fabricated and primary metals, forest products, paper and wholesale industries. Packaging receives all of its flat-rolled steel supply from Acme.\nPackaging currently manufactures its products in four steel strapping plants, located in Riverdale, Illinois; New Britain, Connecticut; Leeds, Alabama and Bay Point (formerly Pittsburg-West), California.\nAlpha, which was acquired in May 1989, is a leading producer of high quality welded carbon steel tubing used for furniture, recreational, contractors' and automotive applications. Alpha receives a significant portion of its flat-rolled steel supply from Acme. Alpha markets its products to the appliance, automotive, construction, heating and cooling equipment, household and leisure furniture, material handling, recreational products, and warehouse industries. Alpha's sales represented approximately 16 percent of total sales for the Company in each of the last three years.\nAlpha operates three facilities in Toledo, Ohio, including two manufacturing facilities equipped with rolling mills for the production of steel tube and pipe, and a plant for slitting steel.\nUniversal, acquired in May 1987, produces automotive and light truck jacks, tire wrenches and accessories for the original equipment manufacturer (\"OEM\") market in North America. Management estimates that it currently holds a 30 percent share of the OEM market for auto and light truck jacks in North America. Universal receives virtually all its flat-rolled steel supply from Acme. Universal markets its products to domestic and foreign transplant automotive manufacturers and the automotive aftermarket. Universal's sales were approximately 8, 10 and 11 percent of total Company sales in 1994, 1993 and 1992, respectively.\nUniversal's production facilities, located in Butler, Indiana, include a computer assisted design and manufacturing system, and automated stamping and assembly lines.\nEmployee Relations The Company has a work force of 2,748 employees, of which 659 are salaried and 2,089 are paid hourly. The unionized work force totals 1,943, or 71 percent of total employment. None of the salaried work force is unionized and the hourly work force at one site (Alpha) is non-union as well. The Company's relationships with the unions are good. There have been no strikes or work stoppages at any location since the Company's purchase of the plants in Connecticut, Alabama, California and Indiana. The last strike at the Riverdale and Chicago locations was in 1959 during a major steel industry work stoppage. In addition, the Company instituted Labor Management Participation Teams in 1982 as a vehicle for problem solving in a team environment and a Total Quality Improvement Program in 1991 to establish standards to achieve the highest quality product from the existing facilities. Union members participate extensively in these two programs.\nThe Company has a contract in place with the United Steelworkers covering approximately 1,500 employees at the Acme and Packaging operations in Chicago and Riverdale, Illinois. The contract expires in 1999, contains a no-strike provision, and a wage reopener in 1996 subject to binding arbitration.\nRaw Materials Acme's principal raw materials are iron ore and coal. Iron ore requirements are expected to continue to be satisfied through an equity interest in Wabush Mines in Newfoundland (Labrador) and Quebec, Canada and through term contracts and purchases on the open market. Acme is obligated to purchase iron ore from Wabush at the higher of production cost or market. Production cost currently approximates market; however, there can be no assurance that the mine's cost structure will not increase in the future in excess of world market prices. During 1994, Acme acquired approximately 53 percent of its iron ore needs from Wabush under this agreement with the balance of ore requirements at a competitive delivered cost. Coal\nrequirements are expected to be satisfied through term contracts and purchases on the open market. The Company believes Acme's sources of iron ore, coal and other raw materials are adequate to provide for its foreseeable needs.\nEnvironmental Compliance The operations of the Company and its subsidiary companies are subject to numerous Federal, state and local laws and regulations providing a comprehensive program of controlling the discharge of materials into the environment and remediation of certain waste disposal sites by responsible parties for the protection of public health and the environment. In addition, various Federal and state occupational safety and health laws and regulations apply to the work place environment. See ITEM 3, LEGAL PROCEEDINGS, (B) ENVIRONMENTAL for a complete discussion of environmental proceedings.\nBacklog; Trademarks; Patents None of the Company's subsidiaries had a significant amount of backlog at December 25, 1994 and neither the Company nor its subsidiaries hold any patents, trademarks, licenses or franchises which are deemed material to its overall business.\n(D) COMPETITIVE CONDITIONS IN THE STEEL INDUSTRY\nGeneral Steel Market The U.S. integrated steel industry has suffered economically in the past decade due to increased competition from mini-mills, lack of investment in newer steel making technologies, foreign competition (often government subsidized), increasing costs associated with government-mandated environmental regulations and high labor and benefit costs compared to its competition.\nU.S. domestic shipments for all steel products have averaged approximately 88 million tons per year for the last three years. While total U.S. shipments of steel have grown by an average of 2.4 percent per year since 1982, steel exports by U.S. producers have accounted for most of that growth. Domestic steel consumption has been essentially flat over the past ten years.\nThe industry has raw steel production capacity estimated to be 110 to 117 million tons. In addition, over 85 percent of current U.S. steel production is continuously cast. These two factors together with the industry's ongoing successful efforts to improve productivity and reduce costs have contributed to significant downward pressure on the price of steel in the marketplace. Real steel selling prices have fallen at an annual rate of 3.5 percent over the past decade although during 1993 and 1994, steel prices have increased on average. The Company believes the trend toward lower real steel prices will continue, although at a slower rate.\nOver the long-term, steel prices will be set by the lowest cost producers, and the lowest costs will be attained through the implementation of new technologies. The flat-rolled steel market provides strong evidence of this downward trend in real steel prices due to decreasing costs. Technological innovation is likely to continue in the steel industry and producers will be required to achieve significant, sustainable cost reductions to succeed.\nSpecial Grade Market This component of the flat-rolled market represents the medium carbon, high carbon, high strength low alloy (\"HSLA\") and alloy markets. The total annual specialty market is approximately 3 million tons, of which Acme's share is estimated to be 6 to 7 percent. However, in the portion of the market where Acme is not facility-limited (where customers can use narrow widths and have no continuous cast requirement), it holds an approximately 30 percent share. Acme's principal customer markets are agricultural equipment, industrial fasteners, hand and power tools, rerollers, automotive components and construction.\nLow Carbon Flat-rolled Market Flat-rolled products comprise approximately 50 percent of the U.S. steel market, or about 40-45 million tons per year, of which the majority is in low carbon sheet and strip. Acme's share is estimated to be less than 1 percent. The key end users are automotive OEMs, automotive stampers, can and container manufacturers, the construction industry, appliance makers, tubing manufacturers and steel service centers.\nAcme's Competitive Position For commercial sales to unaffiliated customers, Acme currently competes principally in the mid- and high-carbon and alloy steel markets. Acme has numerous competitors composed principally of steel service centers and, to a lesser extent, smaller integrated mills.\nAcme faces the same challenges as the rest of the steel industry. While Acme has reported operating losses in one of its last 3 years, it has generally outperformed the industry on average. Because of Acme's high overall cost structure resulting from its outmoded steel finishing process and the competitive forces affecting the entire steel industry, steel making has proven to be only marginally profitable even at the upper end of the business cycles. Management believes that Acme, and the U.S. steel industry as a whole, benefitted during 1993 and 1994 from an upturn in the business cycle and increases in steel prices on average over the past two years. There can be no assurance that this upturn in the business cycle will continue or that the industry will be successful in maintaining current price levels.\n(E) THE MODERNIZATION AND EXPANSION PROJECT\nAcme's existing rolling mill facilities cannot produce a coil which is large and wide (more than 30 inches) enough to satisfy the needs of many users of flat-rolled steel. In addition, the existing physical limitations of the mill facilities do not allow Acme to fully utilize its existing raw steel manufacturing capability. Further, large users increasingly demand continuously cast materials, and many other users prefer such materials.\nSince 1982, a number of U.S. steel mills have constructed conventional thick slab continuous casting production facilities. Currently, about 90 percent of U.S. Steel Mills producing sheet, sheet strip, and plate utilize conventional thick slab casting.\nThe conventional thick slab facilities are a technological step behind the new continuous thin slab casting facilities, which eliminate the extra heating and rolling necessary to flatten thick slabs to an appropriate dimension. At present there are 2 operating thin slab casting facilities in North America, which have a combined estimated capacity of 4 million tons per year. In addition, thin slab casting facilities are under construction with an estimated combined capacity of 5.5 million tons. Three other sites are also currently under consideration. Of the companies currently using or planning to construct continuous thin slab casters, none have or will have the facilities to use basic oxygen furnace steel. Instead, these new installations will use scrap steel as their raw material.\nIn response to these and other competitive concerns, in July 1992, the Company announced it was conducting a feasibility study of a new continuous thin slab caster\/hot strip rolling mill complex (the \"Modernization and Expansion Project\") at the Company's Riverdale, Illinois plant. The study concluded that successful implementation of the Modernization and Expansion Project should result in significantly more favorable financial results for the Company beginning in 1997 than those it would achieve if it continued its steel making business with its existing facilities. This improved financial performance would result from increased sales due to increased production capability and product range, higher yields, lower costs, increased efficiency, and more consistent product quality.\nThe Board of Directors of the Company decided to proceed with the Modernization and Expansion Project in August 1994 coincident with the completion of the financing. The final cost, including equipment, ancillary facilities and construction, is expected to be approximately $392 million excluding capitalized interest costs and certain internal costs directly related to the Modernization and Expansion Project. See LIQUIDITY AND CAPITAL RESOURCES in MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe Modernization and Expansion Project will include facilities for both the continuous casting of thin steel slabs (approximately 2\" in thickness and 60\" in width) (\"Caster\") and the hot rolling of those slabs into steel strip (\"Mill\") and is being constructed in a new building on a site adjacent to Acme's current steel making facilities. Steel production at Acme's existing facilities will continue during construction without disruption or reduction of product available for supply to customers. When fully operational, the Modernization and Expansion Project should be capable of producing Acme's anticipated product mix.\nThe Modernization and Expansion Project will involve substantial costs in addition to those for the construction of the facility itself. The new Caster and Mill will eliminate several labor-intensive operations Acme now must employ. The efficiencies resulting from the elimination of these operations will result in a reduction of Acme's workforce of between 250 and 300 people. The Company has taken a $2.3 million charge to income in 1994 to account for the contractual employee reduction costs associated with the project. The Company also took a $7.2 million charge to income in 1994 to reflect an impairment of the existing steel finishing facilities which will be replaced by the Modernization and Expansion Project. The charges were reflected in the Company's third quarter results. Further, during the Modernization and Expansion Project's final completion phase, including initial testing, the Company anticipates incurring approximately $15 million of start-up related costs, some of which may be capitalized as part of the Modernization and Expansion Project. In addition, the Company will be required to capitalize the interest expenses associated with the Modernization and Expansion Project during the construction period. These capitalized expenses are estimated to be approximately $70-75 million, which will be added to the cost of the Modernization and Expansion Project during the construction period and amortized over the lives of the related assets.\nDuring construction of the Modernization and Expansion Project, the Company believes Acme's existing steel manufacturing operations will continue during construction with minimal disruption. The Modernization and Expansion Project and the activities of the general contractor will be monitored by a project management team composed primarily of existing officers and employees. In the event there are significant problems with the construction of the Modernization and Expansion Project, senior management may have to devote substantial time to those problems and, as a result, may devote substantially less time than is normal to existing operations. See LIQUIDITY AND CAPITAL RESOURCES in MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for a discussion of the financing for the Modernization and Expansion Project.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company, through its subsidiaries, has facilities throughout the United States.\nAcme's principal properties consist of an iron-producing plant in Chicago, Illinois and a steel producing plant in Riverdale, Illinois. These facilities include blast furnaces, coke ovens, pigging machines for the production of molten iron and pig iron, basic oxygen furnaces and rolling mills for the production of flat-rolled steel. Acme also owns equity interests in raw material mining ventures in Newfoundland (Labrador) and Quebec, Canada (iron ore). In addition, Acme owns land adjacent to its steel producing plant in Riverdale, Illinois on which it is constructing the Modernization and Expansion Project.\nPackaging's principal properties consist of steel strapping plants, which include slitting and painting equipment, in Riverdale, Illinois; New Britain, Connecticut; and Leeds, Alabama; and a steel strapping plant in Bay Point (formerly Pittsburg-West), California.\nAlpha's three facilities are located in the Toledo, Ohio metropolitan area. Alpha's facilities include two manufacturing and office buildings and rolling mills for the production of welded steel tubing. Alpha has a third plant at which steel is slit.\nUniversal's facilities are located in Butler, Indiana. Universal's facilities include a manufacturing and office building, a computer assisted design and manufacturing system, and automated forming and assembly lines.\nAll of these plants are owned in fee except for the Alpha facilities which are leased through 1999, and are renewable at the option of the Company.\nIn the opinion of management, the manufacturing facilities of the Company's subsidiaries are properly maintained and their productive capacity is adequate to meet its requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n(A) GENERAL\nPursuant to an Agreement and Plan of Reorganization as of March 5, 1986, the Company (prior to the Company's 1992 reorganization, the Company was Acme Steel Company, now a subsidiary and formerly called Interlake, Inc. hereinafter referred to as the \"Company\") and Interlake, its former parent company, entered into a Tax Indemnification Agreement (\"TIA\"). The TIA generally provides for Interlake to indemnify the Company for certain tax matters. Per the TIA, Interlake is solely responsible for any additional income taxes it is assessed related to adjustments relating to all tax years prior to 1982. With respect to any additional income taxes that are finally determined to be due with respect to the tax years beginning in 1982 through the date of the \"Spin-Off\" (as said term is identified in the Reorganization documents), the Company is responsible for taxes relating to \"Timing Differences\" related to the Company's \"Continuing Operations.\" A \"Timing Difference\" is defined generally as an adjustment to income, deductions or credits which is required to be reported in a tax year beginning subsequent to 1981 through the Spin-Off, but which will reverse in a subsequent year. \"Continuing Operations\" is defined generally as any business and operations conducted by the Company as of the Spin-Off date. Interlake is principally responsible for any additional income taxes the Company is assessed relating to all other adjustments prior to the Spin-Off.\nWhile certain issues have been negotiated and settled between the Company, Interlake and the Internal Revenue Service for the tax years beginning 1982 through the date of the Spin-Off, certain significant issues for the tax years beginning 1985 through the Spin-Off remain unresolved; and on March 17, 1994, the Company received a Statutory Notice of Deficiency (\"Notice\") in the amount of $16.9 million in tax as a result of the Internal Revenue Service's examination of the 1982 through 1984 tax years. Interlake has been principally responsible, pursuant to the TIA, for representing the Company before the Internal Revenue Service for the 1982 through 1984 tax years. Should the government sustain its position as proposed for those unresolved issues and those contained in the Notice, substantial interest would also be due (potentially in an amount greater than the tax claimed). The taxes claimed relate principally to adjustments for which the Company is indemnified by Interlake pursuant to the TIA. The Company has adequate reserves to cover that portion of the tax for which it believes it may be responsible per the TIA. The Company is contesting the unresolved issues and the Notice.\nTo date, Interlake has met its obligations under the TIA with respect to all covered matters. In the event, Interlake, for any reason, is unable to fulfill its obligations under the TIA, the Company could have increased future obligations.\nThe Company's subsidiaries also have various litigation matters pending which arise out of the ordinary course of their businesses. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the financial position of the Company.\n(B) ENVIRONMENTAL\nIn addition to the general matters noted above, the operations of the Company and its subsidiary companies are subject to numerous Federal, state and local laws and regulations providing a comprehensive program of controlling the discharge of materials into the environment and remediation of certain waste disposal sites by responsible parties for the protection of public health and the environment. In addition, various Federal and state occupational safety and health laws and regulations apply to the work place environment.\nThe current environmental control requirements are comprehensive and reflect a long-term trend towards increasing stringency as these laws and regulations are subject to periodic renewal and revision. The\nCompany expects these requirements will continue to become even more stringent in future years. The 1990 Federal Clean Air Act amendment, for example, imposed significant additional environmental control requirements upon Acme's coke plant facilities.\nIn prior years, the Company has made substantial capital investments in environmental control facilities to achieve compliance with these laws, incurring expenditures of $7.7 million for environmental projects in the period from 1992 through 1994. The Company anticipates making further capital expenditures of approximately $6.2 million for environmental projects during 1995 and $1 million in 1996 to maintain compliance with these laws (exclusive of any such expenditures related to the continuous thin slab caster and hot strip mill project). In addition, maintenance, depreciation and operating expenses attributable to installed environmental control facilities are having, and will continue to have, an adverse effect upon the Company's earnings. Although all of the Company's subsidiary operating companies are affected by these laws and regulations, similar to other steel manufacturing operations, they have had, and are expected to continue to have, a greater impact upon the Company's steel manufacturing subsidiary than on the Company's other operating subsidiaries.\nThe Company, principally through its operating subsidiaries, is and, from time to time, in the future will be involved in administrative proceedings involving the issuance, or renewal, of environmental permits relating to the conduct of its business. The final issuance of these permits are generally resolved on terms satisfactory to the Company. In the future, the Company expects such permits will be similarly resolved on satisfactory terms; however, from time to time, the Company is required to pursue administrative and\/or judicial appeals prior to achieving a resolution of the terms of such permits.\nThe Company, from time to time, may be involved in administrative or judicial proceedings with various regulatory agencies or private parties in connection with claims the Company's operations have violated certain environmental laws, conditions of existing permits or with respect to the disposal of materials at waste disposal sites. The resolution of such matters may involve the payment of civil penalties, damages, remediation expenses and\/or the expenditure of funds to add or modify pollution control equipment.\nWaste Remediation Matters Pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986, 42 U.S.C., Section 9601 et seq. (\"Superfund\") and similar state statutes, liability for remediation of property, including waste disposal sites, contaminated by hazardous materials may be imposed on present and former owners or operators of such property and generators or transporters of such materials to a waste disposal site (i.e., Potentially Responsible Parties, \"PRPs\"). The Company and its operating subsidiaries have been named as PRPs with respect to several such sites. In each instance, the Company's investigation has evidenced either, i) the Company had not disposed of waste materials at the site and was not properly named as a PRP; or, ii) the Company's proportion of materials disposed of at such sites is of sufficiently small volume to qualify the Company as a DE MINIMIS contributor of waste material at such sites. This DE MINIMIS status has been confirmed at essentially all of the applicable sites.\nAlthough no assurances can be given that new information will not be uncovered which would cause the Company and its subsidiaries to lose their DE MINIMIS status at these sites, or, that the Company, or its subsidiary companies, would not be named as PRPs at additional sites, the Company presently believes its total costs for the sites named above will not be material.\nIn addition to the foregoing Superfund sites, the following waste remediation matters relating to the Company's subsidiary companies are currently pending:\nLEEDS, ALABAMA - ELEVATED LEVELS OF LEAD. In September 1992, Packaging hired a consulting engineering firm for the purpose of providing soil sampling and analysis in connection with an application for a storm water permit for its Leeds, Alabama, plant. Pursuant to an investigation conducted by the consultant, elevated levels of lead were discovered on the property, including one area of the property wherein buried drums were discovered containing lead.\nIn January 1993, Packaging advised the seller of this plant site that the sampling program was initiated in conjunction with filing a Notice of Intent for the plant for coverage under the Alabama Department of Environmental Management's General Storm Water Discharge Permit. The seller was advised that the results of the sampling program showed runoff from the west parking lot area contained elevated concentrations of lead in the samples. Pursuant to Packaging's investigation, Packaging advised the seller that all evidence indicated these conditions were present on the property at the time the seller owned the property and were present at the time the Leeds, Alabama, facility was sold to the Company on March 29, 1989; and, pursuant to the terms of the purchase and sale agreements relating to this property, the seller is responsible for remediating any lead or other contaminants located on this property. Without admitting or denying its liability, the seller has retained a consultant to conduct a full investigation, sampling and analysis of the property.\nPackaging is cooperating with the seller regarding the investigation of the contamination of this property by lead, and\/or other substances; however, Packaging intends to vigorously pursue its remedies under the purchase and sale agreements with the seller.\nAdministrative and Litigation Matters The Company, or its operating subsidiaries are currently involved in the following matters relating to administrative regulations which affect, or may affect, the operations, the permits or the issuance of permits; or litigation relating to the Company:\nACME STEEL COMPANY - NPDES PERMIT. In 1991, the Illinois Environmental Protection Agency (\"IEPA\"), issued Acme a permit, pursuant to the National Pollution Discharge Elimination System (\"NPDES\") regulating non-contact water discharges to the Calumet River from Acme's coke and blast furnace plant facilities. The NPDES permit contains strict temperature and storm water discharge limitations. Acme filed an appeal of certain conditions of the permit with the Illinois Pollution Control Board (\"IPCB\"). Acme is proceeding to resolve this matter through the administrative proceedings which allow for the filing of a Petition for an Adjusted Standard and a request that the IPCB grant Acme an adjusted standard and relief from the temperature limitations. Further, through modification of certain provisions in the permit and the implementation of best management practices, Acme anticipates achieving control of the Acme's storm water discharge to an the extent that it will achieve compliance with other permit conditions.\nIn the event these matters are not resolved through the administrative process as outlined above, Acme will petition the IPCB for a variance from the General Use Water Quality Standards. If issued, a variance will provide temporary relief. Future compliance with permit conditions would be achieved at an estimated capital expenditure of approximately $4 million and operating expenses would be incurred at an annual rate of approximately $650,000. In the event Acme's Petition for an Adjusted Standard is denied and a variance is denied, Acme may be subject to penalties until compliance is achieved.\nThe Company believes Acme has demonstrated it is entitled to the issuance of an Adjusted Standard, or absent an Adjusted Standard, a Variance allowing the Company sufficient time to install additional capital equipment to achieve compliance, however, there are no assurances the same will be granted. If such relief is not granted, and penalties are assessed, the Company does not have sufficient information to estimate its liabilities for such penalties, if any, which may be assessed.\nREMOVAL CREDITS AND PRETREATMENT. The Metropolitan Water Reclamation District of Greater Chicago (\"MWRD\") is a publicly owned treatment works (\"POTW\"). The MWRD applied to the U.S. Environmental Protection Agency (\"U.S. EPA\") for authority to revise categorical pretreatment standards to reflect the actual treatment provided by the MWRD for waste water discharged to the MWRD's POTW by industrial users (\"Removal Credits\"). These revised categorical standards, reflecting Removal Credits are essential for Acme to avoid expenditures for control of 4AAP phenol found in discharges from its coke by-products plant and for control of certain other pollutants. In 1987, the MWRD's application was denied by the U.S. EPA and the denial was upheld by the United States Court of Appeals for the Seventh Circuit. The U.S. EPA maintained that under the Clean Water Act and decisions of U.S. District Courts, that it could not approve Removal Credits until it promulgated \"sludge criteria.\"\nIn 1993, the U.S. EPA promulgated sludge criteria which included the possibility of granting Removal Credits for phenols only in certain circumstances. Acme petitioned the MWRD for Removal Credits. Following this petition, the MWRD again applied to the U.S. EPA for authority to grant Removal Credits. While this application was denied, the U.S. EPA stated that if the Agency amends its regulations with respect to phenol 4AAP either as a result of the petition filed by the MWRD or independently, that the MWRD may then resubmit its application.\nAcme, together with a similarly situated steel company, filed Comments and a Request for Reconsideration and Clarification concerning the 4AAP phenol component of U.S. EPA's Standards for Disposal of Sludges with the U.S. EPA and filed a Petition for Review of the U.S. EPA's decision with the Court of Appeals for the DC Circuit. Both the Comments and Request for Reconsideration and the Petition for Review are pending. The steel companies filed a motion with the DC Circuit Court to stay the appeal pending U.S. EPA's consideration of the Comments and Administrative Request for Reconsideration and Clarifications. The Court granted this Motion on September 14, 1994. While Acme continues to challenge the U.S. EPA's denial of the Removal Credits application and is pursuing administrative and legal remedies, Acme could be subject to allegations it is in violation of currently applicable pretreatment standards and could be required to negotiate appropriate resolutions with the U.S. EPA and the MWRD which could result in the payment of penalties. In the event Acme is unsuccessful in its challenge of U.S. EPA's actions, capital expenditures required to bring its discharges to the MWRD into compliance with the current applicable pretreatment standards are estimated at approximately $6 million.\nAlthough Acme is vigorously pursuing its administrative and judicial remedies and would vigorously contest any action to assess civil penalties against Acme, the Company does not have sufficient information to estimate its potential liability, if any, if Acme's efforts to obtain such relief, or contest such penalty assessments, are not successful.\nILLINOIS STATE IMPLEMENTATION PLAN FOR PARTICULATES. Acme, together with other Illinois steel companies, engaged in extensive discussions with the IEPA leading to the development of regulations governing the emissions of particulate matter from various steel manufacturing facilities operated by Acme and others. These regulations were submitted to the U.S. EPA for approval as part of IEPA's State Implementation Plan (\"SIP\").\nOn November 18, 1994, the U.S. EPA conditionally approved these regulations. The conditions imposed by the U.S. EPA for this SIP approval required a commitment by the IEPA to adopt more stringent rules for various sources at Acme and other steel companies. Acme, together with other steel companies, filed a Petition for Review of U.S. EPA's action in the U.S. Court of Appeals for the Seventh Circuit on January 4, 1995 (Docket No. 95-1025).\nThe steel companies, including Acme, are engaged in discussions with the U.S. EPA and the IEPA regarding the need for these more stringent rules and what additional particulate emission controls, if any, may be appropriate or required under Federal law. These discussions and the Petition for Review are pending and no estimate can be made whether additional emission controls will be required or the cost of such controls at this time.\nOther Matters ACME STEEL COMPANY - MELT SHOP DESULFURIZATION FUGITIVE EMISSIONS. Following internal reviews of current desulfurization requirements, Acme determined that existing environmental controls for desulfurizing molten iron at its Riverdale, Illinois, melt shop were not sufficient to control fugitive emissions from this process. The higher percentage of molten iron needing desulfurization is a result of increased market place demands for lower sulfur content in finished steel goods sold by Acme.\nAcme, after completion of its internal review and preliminary engineering evaluation, requested a meeting and began discussions with the U.S. EPA and IEPA in August 1994 regarding an improved fugitive emission control program. During these discussions, concerns were raised regarding fugitive emissions from the iron transfer station and Acme will include this operation in its new emission control system. The cost of this emission control system, which will be completed in 1995, is currently estimated to be $2.5 million.\nDiscussions are ongoing with the environmental agencies towards a final agreement on this new control system. U.S. EPA has indicated it may seek penalties for past violations and for any economic benefit which may have accrued to Acme by reason of a delay in achieving compliance with fugitive emission regulations for the iron desulfurization and transfer operations under U.S. EPA's civil penalties policies. The Company does not believe Acme incurred any economic benefits from delayed compliance with respect to these emissions and intends to vigorously oppose any efforts to assess such penalties against Acme.\nMETROPOLITAN WATER RECLAMATION DISTRICT OF GREATER CHICAGO (MWRD) - CEASE AND DESIST ORDERS (C&D ORDER). Cease and Desist Order No. 32453. On March 24, 1994, the MWRD issued C&D Order No. 32453 relating to Acme's self-reported discharges of total cyanide to the MWRD's sanitary sewer system in quantities in excess of the limits authorized by the MWRD's Sewage and Waste Control Ordinance at its Chicago, Illinois Coke Plant. Following extensive investigation of the cause and evaluation and testing of appropriate treatment methodologies, Acme selected a treatment system and submitted a proposed construction schedule to the MWRD for review. The cost of this treatment system will be approximately $1.1 million. In the interim, the MWRD has agreed to extend the date for demonstrating compliance at this source to March 23, 1995, and based on reasonable progress towards achieving compliance, further extensions of this deadline.\nCease and Desist Order No. 38357. On July 13, 1994, the MWRD issued C&D Order No. 38357 relating to Acme's self-reported discharges of lead, mercury, iron and pH in quantities in excess of, or out of the range of, the limits authorized by the MWRD's Sewage and Waste Control Ordinance. Following investigation and corrective action, these violations were corrected for all parameters except lead. Acme is continuing its investigation of the potential source(s) of the excess lead discharges and whether modifications will be necessary for the treatment system at this source at its Riverdale, Illinois plant. Pending the completion of these investigations and evaluations, the Company is unable to determine the cost to demonstrate compliance at this source. Acme intends to seek an extension from the MWRD of the date for demonstrating compliance with the lead limitations. If the MWRD does not grant an extension, Acme may be subject to penalties until compliance is achieved.\n1986 REORGANIZATION MATTERS. Pursuant to an Agreement and Plan of Reorganization dated as of March 5, 1986, (the \"Reorganization\") between the Company and Interlake entered into a Cross-Indemnification Agreement, dated May 29, 1986, (the \"Agreement\") more specifically described in Exhibit 10.2 to the Company's Annual Report\/Form 10-K filed with the U.S. Securities Exchange Commission for the fiscal year 1992.\nPursuant to the terms of this Agreement, for a period of ten (10) years following the date of the Spin-Off (as said term is identified in the Reorganization documents), the Company undertook to defend, indemnify and hold Interlake and its affiliates harmless from and against any and all Claims, as that term is defined in the Agreement, occurring either before or after the date of the Reorganization and which arose out of or are related to the Acme Business. The Acme Business is more specifically defined in the Agreement as the iron and steel and domestic U.S. steel strapping business as conducted by the Company on or about May 29, 1986. The indemnification by the Company of Interlake with respect to any claims includes, but is not limited to, all claims asserted in connection with the Company's interests or obligations with respect to: Wabush Iron Company, Ltd.; Wabush Mines; Erie Mining Company; Olga Coal Company; assets and liabilities related to qualified welfare and benefit plans with respect to retired, current and future employees of the Company; certain environmental matters relating to the Acme Business, whether brought by a governmental agency or a private entity; workers' compensation matters and occupational safety, health and administration matters; and product liability and general liability matters related to the Acme Businesses. The Agreement designated certain mineral property interests retained by the Company, including land held for the account of the Company by Syracuse Mining Company, a subsidiary of Pickands Mather and Company; stock of Tilden Iron Mining Company; and, lands in Bruce County, Ontario, Canada, being within the scope of the indemnification.\nSimilarly, and for the same period of time, Interlake undertook to defend, indemnify and hold the Company and its affiliates harmless from and against all Claims, as that term is defined in the Agreement,\noccurring either before or after the date of the Reorganization related to the operation of all businesses and properties currently owned, directly or indirectly, by Interlake or any subsidiary of Interlake (other than the Company and its affiliates) and relating to the Transferred Property, as that term is defined in the Reorganization Agreement (but excluding the Acme Business), and, any business and properties discontinued or sold by Interlake Inc. prior to May 29, 1986, including any discontinued or sold businesses or property which, if continued, would be part of the Acme Business. The indemnification by Interlake with respect to any Claims incurred in connection with or arising out of or related to the Interlake Business, as that term is defined more specifically in the Agreement, includes but is not limited to: those claims asserted in connection with certain stock options, rights, awards and programs; certain deferred compensation matters; certain matters arising under qualified welfare and benefit plans and post-retirement income plans; and, environmental matters relating to the Interlake Businesses whether brought by governmental agencies or private entities. These environmental matters include, without limitation, the lawsuit captioned People of the State of Illinois v. Waste Management of Illinois, Interlake, Inc. and First National Bank of Western Springs, Circuit Court of Cook County, Illinois (No. 85 L 30162); the disposal of materials at the landfill operated by Conservation Chemical located at Gary, Indiana, to the extent such materials originated at the plant of Gary Steel Company; and, operation of facilities by predecessors of Interlake, Inc. at Duluth, Minnesota; workers' compensation, occupational safety and health matters relating to the Interlake Business; general products liability and general litigation matters related to the Interlake Business; and, the matters arising from Lake Mining Company, Mauthe Mining Company, Odanah Iron Company, Vermillion Mining Company and Western Mining Company.\nPursuant to this Agreement, Interlake has provided the defense and paid all costs in the matter of City of Toledo v. Beazer Materials and Services, Inc., successor-in-interest to Koppers Company, Inc., Toledo Coke Corporation, the Interlake Corporation, successor-in-interest to Interlake, Inc., The Interlake Companies, Inc., successor-in-interest to Interlake, Inc., Acme Steel Company, Successor-in-interest to Interlake, Inc., United States District Court, Northern District of Ohio, Western Division, Case No. 3:90 CV 7344, which is an action for declaratory and injunctive relief by the City of Toledo (the \"City\") to recover its past and future costs and damages associated with the presence of and release of hazardous substances, hazardous wastes, solid waste, industrial waste and other waste at or about property located on Front Street in Toledo, Ohio. The City seeks relief pursuant to the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\"), the Resource Conservation Recovery Act (\"RCRA\") and on the basis of nuisance. City claims that the defendants owned and\/or operated facilities located on Front Street in Toledo, Ohio which generated, transported and\/or treated, stored or disposed of hazardous substances, hazardous wastes, solid wastes and industrial wastes or other wastes which were released at and from the facility by defendants or successors-in-interest to the entities which owned, operated, generated, transported and\/or treated, stored or disposed of said substances. The trial of the Phase I issues (RCRA claims) in this case was concluded in late 1994; however, the Court has not rendered a decision on the Phase I claims.\nInterlake also has and continues to provide indemnification to the Company for the Duluth, Minnesota, facility which has been designated as a Superfund Site pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986, 42 U.S.C. Section 9601, et seq. Interlake's estimate, obtained from publicly filed documents, of the potential remediation costs of contaminated soils, under alternatives Interlake deems appropriate and which it indicates are consistent with U.S. EPA's policy guidance and the Minnesota environmental agency (\"MPCA\"), range from $3 to $4 million. Other remediation plans for the contaminated soils which contemplate the continued industrial use of the property could cost as much as $20 million. However, Interlake believes that the risks and other assumptions associated with these plans may be overstated. The MPCA also requested Interlake to investigate and evaluate remediation alternatives for the underwater sediments at the Duluth site; however, Interlake indicates it is unable to provide meaningful estimates of the potential cost estimates of such remediation, if any is deemed appropriate, until the investigation is complete and remediation alternatives are reviewed with the MPCA.\nTo date, Interlake has met its obligations under the Cross-Indemnification Agreement with respect to all matters covered therein affecting the Company, including those matters related to litigation and environmental matters. The Company does not have sufficient information to determine the potential liability of the Company, if any, for the matters covered by the Agreement in the event Interlake fails to meet its obligations thereunder in the future. In the event Interlake, for any reason, was unable to fulfill its obligations under the Cross-Indemnification Agreement, the Company could have increased future obligations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of the Company's security holders during the last quarter of the last fiscal year.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nThe information relating to the market for the Company's common stock and related shareholder matters appears in the note to consolidated financial statements titled Long-term Debt and Revolving Credit Agreement, page 46, and on page 1 under the captions Stock Market Information and Dividend Policy which is incorporated by reference in this Form 10-K Annual Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nTEN YEARS IN REVIEW (dollars in thousands except for per share data)\nCertain amounts have been reclassified to conform with the 1994 presentation. A ten-year presentation is provided. Acme Metals Incorporated, formerly Acme Steel Company, became a public company in 1986 when, following the reorganiza- tion of Interlake, Inc., the shares of the company were distributed to shareholders of The Interlake Corporation, pursuant to a reorganization of Interlake, Inc. Financial data for 1985 has been reconstructed.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThe following table sets forth for the periods indicated the percentage relationship that items in the Statements of Operations bear to net sales.\nFISCAL 1994 AS COMPARED TO FISCAL 1993\nNET SALES. In 1994, the Company continued to enjoy an improvement both in order volume and prices that benefitted the steel industry and the national economy as a whole. Order rates for all of the Company's products increased as sales volume improved 13 percent during the year. As a result of the improving economy and price increases, the Company experienced the highest quarterly net sales in its history in 1994's fourth quarter achieving sales of $143.3 million. Consolidated net sales of $522.9 million for the year ended December 25, 1994 were $65.4 million, or 13 percent higher than net sales in 1993. Higher shipment volume represented a $37.7 million increase in sales supplemented by a 6 percent increase in average selling prices over last year's comparable period. The increased selling prices had a $27.7 million favorable impact on sales in comparison to 1993.\nSTEEL MAKING SEGMENT. Net sales for the Steel Making Segment advanced to $349.4 million in 1994, a $45.6 million, or 15 percent, improvement over last year's comparable period. Sales to unaffiliated customers increased 23 percent to $231.2 million while intersegment sales of $118.2 million were 2 percent higher than in 1993. The increase in the Steel Making Segment's net sales was the result of the phase in of two separate 2 percent price increases in average selling prices as well as the full year impact of 1993's price increases and a 15,694 ton increase in shipments of flat-rolled products.\nSTEEL FABRICATING SEGMENT. Steel Fabricating Segment net sales of $293.5 million in 1994 were $21.9 million, or 8 percent, higher than the comparable period in the prior year. An increase in average selling prices accounted for $15.9 million of the sales improvement while increased shipments generated the remainder of the increase over last year.\nSales of steel strapping and strapping tools totaled $166.8 million in 1994, a $12.7 million, or 8 percent, increase over a year earlier. Increased volume accounted for $8.6 million, or 68 percent, of the improvement over last year's results. Average selling prices were 3 percent higher than last year's levels with all of the increase coming in the latter part of the year.\nSteel tube sales for 1994 reached $82.8 million, up 11 percent from the prior year. The $8.6 million improvement in sales was due entirely to increased average selling prices. Selling prices rose 18 percent during the year while shipments fell 7 percent due to on-going rationalization of customer base towards higher margin accounts.\nSales of jacks and lifting tools for cars and light trucks totaled $43.9 million, 2 percent higher than the prior year. The improvement in sales was due entirely to increased selling prices, which, on average, were slightly above the previous year's levels.\nCOMPARATIVE SALES BY SEGMENT. The table below presents the percentage make-up of the products comprising the Company's business segments, for the past three years.\nGROSS PROFIT. The gross profit for the year ended December 25, 1994 of $76.3 million was $31.1 million higher than the gross profit recorded during last year's comparable period. The increase in gross profit was due to higher average selling prices for the Company's products and increased shipment volume. Operating costs, however, were higher in 1994. Higher material costs and higher retiree insurance and pension costs were the primary reasons for the increased operating costs. The gross profit, as a percentage of net sales, was 14.6 percent in 1994 versus 9.9 percent in last year's comparable period.\nSELLING AND ADMINISTRATIVE EXPENSE. Selling and administrative expense totaled $33.2 million (6.4 percent of net sales) and $30.6 million (6.7 percent of net sales) for the years ended 1994 and 1993, respectively. While expenses increased principally due to the increased sales activity, as a percentage of sales they decreased.\nOPERATING INCOME. Operating income for the Company for the year ended December 25, 1994 was $33.6 million as compared to operating income of $12.7 million for the year ended December 26, 1993.\nSTEEL MAKING SEGMENT. Operating income for the Steel Making Segment totaled $14.5 million, a significant improvement over operating income of $0.7 million recorded in 1993. The Operating income in 1994 was reduced by a $9.5 million non-cash, nonrecurring charge recorded to recognize the impairment of existing steel making facilities and contractual employee reduction costs related to the decision to proceed with the Modernization and Expansion Project. The earnings improvement was driven by increased shipments and higher average selling prices. Shipments to external customers in 1994 increased 62,000 tons over\nthe prior year while shipments to the Steel Fabricating Segment were 13,200 tons lower than in 1993. Approximately 65 percent of 1994's shipments and gross margin was attributable to external customers while the remaining 35 percent of gross margin was generated by shipments to the Steel Fabricating Segment. In 1993, the Steel Making Segment shipped 60 percent of its products to external customers which generated approximately 60 percent of its margin while shipments to the Fabricating Segment produced the remaining 40 percent of gross margin. The increased percentage of shipments to external customers in 1994 is consistent with the Company's two-pronged strategy to obtain the highest possible margin on flat-rolled steel and obtain the highest earnings for the Company as a whole. In total, the increased shipments generated $8.1 million in increased revenue while a 4 percent increase in average selling prices contributed $11.4 million to the improvement over last year's results. Partially offsetting the Steel Making Segment's sales related gains were increased material costs, retiree and active medical costs, increased pension expense, higher major maintenance spending, and increased selling expenses.\nSTEEL FABRICATING SEGMENT. Operating income for the Steel Fabricating Segment of $19.0 million in 1994 was $7.1 million higher than the results recorded in 1993. The segment benefitted from the strong economy and increased average selling prices in 1994. Packaging, which sells steel strapping used to secure various finished products to pallets or within shipping containers during transportation, was helped by higher demand for its products in connection with increases in the domestic construction and forest products markets. Alpha's results advanced due to increased average selling prices resulting from a shift from commodity markets to specialty value added tubing products. Alpha's business also benefitted from higher margins due to increased demand for its more technologically advanced products and gains in product quality and manufacturing productivity. Downward pressure on its selling prices in 1994 left Universal's operating income just slightly lower than that of the prior year. Partially offsetting the Steel Fabricating Segment's sales and productivity related gains were increased raw material costs in the form of higher flat- rolled steel prices.\nINTEREST EXPENSE. Interest expense increased significantly over the prior year. The increase in interest expense of $8.6 million resulted from the issuance of $255 million and the retirement of $50 million of long-term debt in the third quarter of 1994. See LIQUIDITY AND CAPITAL RESOURCES AND LONG-TERM DEBT AND REVOLVING CREDIT AGREEMENT IN THE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS.\nINTEREST INCOME. Interest income was $6.1 million higher than in 1993 due mainly to additional interest income earned on the net proceeds received from the issuance of debt and equity during the year.\nOTHER NON-OPERATING INCOME. Non-operating income in 1994 was $1.1 million higher than last year's comparable period due primarily to a refund of prior years' utility costs recorded in the current year.\nINCOME TAX EXPENSE. The income tax expense in 1994 totaled $9.9 million based on a 34.6 percent effective tax rate as compared to the $4.2 million expense in 1993, based on a 40 percent effective rate. The reduction in the effective tax rate was due primarily to the significant level of interest income related to tax-free investments during the year.\nNET INCOME. The Company recorded earnings of $17.0 million, or $2.16 per share in 1994 versus the $6.3 million, or $1.15 per share, recorded in 1993. In 1994, net income per share was reduced by an extraordinary expense item of $1.8 million, net of tax, or 22 cents per share related to the early extinguishment of debt in the third quarter.\nFISCAL 1993 AS COMPARED TO FISCAL 1992\nNET SALES. In 1993, the Company benefited from the strengthening economy in terms of increased shipments and higher average selling prices. For the year, consolidated net sales totaled $457.4 million, up $65.8 million, or 17 percent, over 1992 sales. Shipments of products were strong, representing a $57.5 million increase from last year's shipment volume levels. Average selling prices were 2 percent higher than in 1992 with all of the increase coming in the second half of the year. The improvement in selling prices added $8.3 million to 1993 net sales.\nSTEEL MAKING SEGMENT. Total net sales for the Steel Making Segment advanced to $303.8 million in 1993, a $43.7 million, or 17 percent, improvement over the prior year. Sales to unaffiliated customers\nincreased 29 percent to $187.8 million while intersegment sales of $116.1 million were 1 percent higher than in 1992. The increase in total net sales was principally the result of a 13 percent jump in shipments. Steel selling prices, on average, were 3 percent higher than the prior year. Nearly all of the price increases materialized in the second half of the year as the Steel Making Segment began to benefit from two $20 per ton (5 percent) increases initiated in the second and third quarters of 1993.\nSales of sheet and strip steel, which accounted for 94 percent of the Steel Making Segment's sales in 1993, advanced $41.8 million, or 17 percent, over the prior year. Semi-finished steel sales increased $3.3 million, or 45 percent, over the prior year, while sales of iron products fell $1.5 million, or 18 percent, as compared to a year earlier.\nSTEEL FABRICATING SEGMENT. Steel Fabricating Segment net sales of $271.5 million were $24.6 million, or 10 percent, higher than the prior year. Higher shipments accounted for $20 million of the improvement while a 2 percent increase in average selling prices generated the remainder of the increase over a year earlier.\nSales of steel strapping and strapping tools totaled $154.1 million in 1993, an $11.7 million, or 8 percent, increase over a year earlier. Increased shipping volume accounted for $9.4 million, or 80 percent, of the improvement over the prior year's results. Average selling prices were 2 percent higher than the prior year's levels with all of the increase coming in the latter part of the year.\nSteel tube sales for 1993 reached $74.3 million, up 17 percent from the prior year. The $10.8 million improvement in sales was due mainly to increased shipping volume. Selling prices rose 4 percent during the year with most of the increase in the last half of 1993.\nSales of jacks and lifting tools for cars and light trucks totaled $43.1 million, 5 percent higher than the prior year. The improvement in sales was due entirely to increased shipping volume as selling prices, on average, were slightly below the prior year's levels.\nGROSS PROFIT. Gross profit as a percent of consolidated net sales in 1993 was 9.9 percent, the highest percentage since 1989. The gross profit percentage in 1992 was 7.5 percent. Increased sales volume and higher average selling prices were the primary determinants for the significant increase in gross profit over last year. Operating costs, however, were higher in 1993. Labor costs increased due to a combination of higher overtime premiums and incentive bonuses, a negotiated bonus payment to Acme's and Packaging's union workers at the Riverdale facilities for ratifying the one year labor contract that ended August, 1993 of $0.8 million and a union signing bonus and lump sum payments negotiated as part of the current labor contract resulting in charges of $0.3 million during the year. Unplanned expenditures to repair Acme's basic oxygen furnace and primary rolling mill also reduced gross profit in 1993. Pension expense was $1.5 million higher than in 1992 as the Company recorded a $0.3 million expense in 1993 versus a $1.2 million pension benefit in the prior year. Depreciation increased $0.5 million over the last year due partially to a major relining of Acme's blast furnace in 1990.\nSELLING AND ADMINISTRATIVE EXPENSE. Selling and administrative expenses in 1993 were $1.7 million higher than the prior year. However, on a percentage of sales basis, selling and administrative expenses improved over the prior year as expenses totaled 6.7 percent of sales in 1993 versus 7.4 percent in 1992. The Company began to benefit from lower labor costs resulting from a program, initiated in the 1992 third quarter and substantially completed by year end, to reduce the Company's salaried employee work-force by 10 percent. The 1993 savings from this program were sufficient to offset higher medical costs for selling and administrative employees.\nRESTRUCTURING CHARGE. During 1992, the Company recorded a $2.7 million restructuring charge in connection with its 10 percent salaried work force reduction which was completed during 1993. This charge covered additional pension liability and extra vacation pay as part of an early retirement offer and severance payments for involuntary separations. See RESTRUCTURING CHARGE in the NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS for further specific components of the charge.\nNONRECURRING CHARGE. The Company recorded a $1.9 million non-recurring charge in 1993 in connection with the $1.3 million write-off of Acme's No. 3 Hot Strip Mill and Billet Mill and a $0.6 million expense to close Packaging's Pittsburg-East facility in California and write off a strapping line at its New Britain, Connecticut, facility.\nOPERATING INCOME. Operating income for the Company was $12.7 million in 1993 as compared to an operating loss of $2.1 million in 1992.\nSTEEL MAKING SEGMENT. Operating income for the Steel Making Segment totaled $0.7 million, a significant improvement over the $9.3 million loss from operations recorded in 1992. The earnings improvement was driven by increased shipments and higher average selling prices. Shipments to external customers in 1993 increased 87,000 tons over the prior year while shipments to the Steel Fabricating Segment were 5,600 tons lower than in 1992. Approximately 60 percent of 1993's shipments and gross profit was attributable to external customers while the remaining 40 percent of gross profit was generated by shipments to the Steel Fabricating Segment. In 1992, the Steel Making Segment shipped 55 percent of its products to external customers which generated 52 percent of its gross profit while shipments to the Steel Fabricating Segment produced the remaining 48 percent of gross profit. The increased percentage of shipments to external customers in 1993 is consistent with the Company's two-pronged strategy to obtain the highest possible margin on flat-rolled steel and obtain the highest earnings for the Company as a whole. In total, the increased shipments generated $8.6 million in increased revenue while a 3 percent increase in average selling prices contributed $5.9 million to the improvement over the prior year's results. Partially offsetting the Steel Making Segment's sales related gains were increased labor costs in connection with overtime and union negotiated payments, unexpected repairs to its basic oxygen furnace and primary rolling mill and a $1.3 million write-off of the No. 3 Hot Strip Mill recorded in the fourth quarter.\nSTEEL FABRICATING SEGMENT. Operating income for the Steel Fabricating Segment of $11.9 million in 1993 was $4.6 million higher than the results recorded in 1992. The Steel Fabricating Segment benefited from the improving economy and increased average selling prices in 1993.\nPartially offsetting the Steel Fabricating Segment's sales and productivity related gains were increased raw material costs in the form of higher flat-rolled steel prices and a $0.6 million expense to close Packaging's Pittsburg-East facility in California and the write-off of a strapping line at its New Britain, Connecticut facility. Packaging, which sells steel strapping used to secure various finished products to pallets or within shipping containers during transportation, was helped by higher demand for its products in connection with increased U.S. industrial output.\nAlpha's results advanced due to the improvement in the housing and recreational product markets. Alpha Tube's business also benefited from higher margins due to increased demand for its more technologically advanced products and gains in product quality and manufacturing productivity.\nDespite downward pressure on its selling prices in 1993, Universal's business achieved record results due to improved manufacturing productivity.\nINTEREST EXPENSE AND INCOME. Interest expense was slightly lower than the prior year. The decrease resulted from a reduced balance on the Company's long-term debt as the result of a $3.5 million principal payment in May 1993. Interest income was $0.1 million lower than in 1992 due mainly to reduced returns on cash balances.\nNON-OPERATING INCOME. In 1993, the Company recorded a $1.2 million pre-tax gain as the result of a settlement of prior claims against LTV Steel Company (LTV) by Wabush Iron, in an iron ore mine equity interest held by Acme, pursuant to the finalization of LTV's plan of reorganization. The sale of all of the Company's interests in a coal producing property located in West Virginia added approximately $1 million to pre-tax income in 1992.\nINCOME TAX EXPENSE. The income tax expense for 1993 equaled $4.2 million based on a 40 percent effective tax rate. Because of a loss in 1992, the Company recognized income tax benefits of $1.7 million in 1992, based on a 37 percent effective tax rate.\nNET INCOME. For 1993, the Company registered net income of $6.3 million, or $1.15 per share. In 1992, the Company incurred a net loss of $2.8 million, or 53 cents per share, before the cumulative effect of changes in accounting principles. The improvement in net income was due primarily to increased shipments, and to a lesser extent, higher average selling prices for steel, steel strapping and welded steel tube.\nIn 1992, the Company adopted both FAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions and FAS No. 109, Accounting for Income Taxes. The cumulative effect of adopting FAS No. 106 resulted in a $42.2 million after-tax charge to 1992 earnings. The cumulative effect of the adoption of FAS No. 109 increased the 1992 net loss by $8.1 million.\nFISCAL 1992 AS COMPARED TO FISCAL 1991\nNET SALES. As a result of the modest economic recovery that began in 1992, consolidated net sales of $391.6 million were $14.6 million, or 4 percent, higher than prior year consolidated net sales. Shipments of products rebounded, representing a $22 million increase from 1991 levels. However, selling prices on average declined 2 percent from the prior year's prices. The weakness in selling prices, particularly for steel and steel strapping products, had a $7.4 million negative effect on 1992 sales.\nSTEEL MAKING SEGMENT. Sales for the Steel Making Segment of $260.1 million in 1992 were up modestly (4 percent) over the year earlier due entirely to increased shipments as average selling prices were 2 percent lower than 1991 price levels. Sales to unaffiliated customers increased 3 percent to $145.6 million while inter segment sales of $114.5 million were 4 percent higher than in 1991.\nSTEEL FABRICATING SEGMENT. Steel Fabricating Segment sales of $247.0 million in 1992 were $10.9 million, or 5 percent, higher than the prior year. Steel strapping sales of $142.3 million in 1992 were unchanged. Sales of steel tubing amounted to $63.5 million in 1992, up 4 percent from a year earlier while auto and truck jack sales of $41.2 million increased 20 percent over the 1991 levels.\nGROSS PROFIT. Gross profit as a percent of consolidated net sales equaled 7.5 percent in 1992, an improvement over the 7.4 percent registered in 1991. The improvement in the 1992 gross profit over the prior year was the result of reduced material costs and lower expenditures in connection with the Company's aggressive cost control efforts. These cost reduction measures were more than enough to overcome a combination of unfavorable margin impacts resulting from lower average selling prices for most of the Company's products, a 12 percent jump in costs associated with medical and life insurance coverage for the Company's active and retired employees, increased property and franchise taxes and expenses for a feasibility study of options for building a new continuous thin slab caster\/hot strip mill complex at Acme's Riverdale facility. The Company's gross profit margin benefited from a $1 million pension benefit in 1992, compared to no benefit in 1991. Depreciation expense increased $0.5 million in 1992 over the prior years' expense partially due to the major relining of the Company's blast furnace in 1990.\nSELLING AND ADMINISTRATIVE EXPENSE. Selling and administrative expenses in 1992 were approximately the same as in 1991. As a percent of sales, selling and administrative expenses were 7.4 and 7.8 percent in 1992 and 1991, respectively. The Company began to benefit from lower labor costs resulting from a program, initiated in the 1992 third quarter and substantially completed by year end, to reduce its salaried employee work-force by 10 percent. The 1992 savings from this program were sufficient to offset higher medical costs for selling and administrative employees. Expenses associated with the reorganization of the Company, completed in June 1992, added about $0.4 million to selling and administrative costs in 1991.\nRESTRUCTURING CHARGE. During 1992, the Company recorded a $2.7 million restructuring charge in connection with its 10 percent salaried work force reduction. This charge covered additional pension liability and extra vacation pay as part of an early retirement offer as well as severance payments in conjunction with involuntary separations.\nOPERATING INCOME (LOSS). The operating loss for the Company was $2.1 million in 1992 as compared to a $1.5 million loss recorded in 1991.\nSTEEL MAKING SEGMENT. The Steel Making Segment incurred a $9.4 million operating loss in 1992 as compared to a $4.4 million loss in 1991. The $5 million decline in the Steel Making Segment's results was primarily due to a combination of a two percent decline in average selling prices for sheet, strip and\nsemifinished steel which decreased sales by $4.8 million partially offset ($2.9 million) by a 9 percent increase in steel shipments, a $2.2 million reduction in operating income due to a $6 million decline in iron sales as the result of a one-time spot sale of molten iron to LTV Steel Company, Inc. in 1991 and a $2.7 million restructuring charge in connection with a 10 percent salaried work force reduction plan. Operating costs, however, were lower than in 1992 due to reduced material costs and lower expenditures.\nSTEEL FABRICATING SEGMENT. Operating income for the Steel Fabricating Segment of $7.1 million in 1992 was $4.6 million higher than the results recorded in 1991. Packaging's 1992 results were $0.1 million, or 3 percent, lower than the prior year due almost entirely to a 3 percent drop in average selling prices. Alpha's results in 1992 were $2.8 million higher than in 1991 as the result of lower raw material costs and more efficient operations. Universal's operating income jumped $1.9 million due to a 19 percent increase in shipments.\nINTEREST EXPENSE AND INCOME. Interest expense remained constant from 1991 to 1992. Interest income grew $0.4 million primarily because of higher cash balances during the year.\nNON-OPERATING INCOME. The sale of all of the Company's interests in a coal producing property located in West Virginia added approximately $1 million to pre-tax income in 1992. In 1991, pre-tax income benefited from a one-time gain of $1.2 million in connection with the assignment to a third party of the Company's rights in claims allowed in the LTV Steel Company, Inc Bankruptcy. Other non-operating income dropped by $1 million from a year earlier stemming principally from lower royalty income from coal properties and a $0.4 million loss on disposal of fixed assets recorded in 1992.\nINCOME TAX EXPENSE. Because of the Company's losses in 1992 and 1991, the Company recognized income tax benefits of $1.7 million in 1992, based on a 37 percent effective tax rate, and $0.7 million in 1991, based on a 24 percent effective tax rate. The Company adopted FAS No. 109, Accounting for Income Taxes in 1992. The impact of the adoption of this pronouncement on 1992's results was to increase the credit for taxes by $0.9 million.\nNET (LOSS). For 1992, the Company suffered a net loss of $2.8 million, or 53 cents per share, before the cumulative effect of changes in accounting principles. In 1991, the Company incurred a net loss of $2.3 million, equal to 43 cents per share. The decline in operating earnings was due primarily to weaker selling prices for steel and steel strapping.\nThe Company was required to change its accounting for retiree health care and life insurance to conform with FAS No. 106, Employers' Accounting for Postretirement Benefits other than Pensions. The Company chose to adopt this accounting standard effective December 30, 1991, the first day of the Company's 1992 fiscal year. The transition effect of adopting FAS No. 106 resulted in a $67.6 million charge to 1992 earning, partially offset by $25.4 million in income tax effects.\nThe Company also elected to adopt FAS No. 109, Accounting for Income Taxes in 1992. This accounting standard prescribes a new method of accounting for deferred income taxes and requires the restatement of prior year deferred income taxes. The cumulative effect of the adoption of this pronouncement increased the 1992 net loss by $8.1 million.\nLIQUIDITY AND CAPITAL RESOURCES\nAs of December 25, 1994, the Company's long-term indebtedness was $265 million. The Company also currently has an unused $80 million Working Capital Facility with an initial term of three years from the date of consummation of the Note Offering. At December 25, 1994, the Company's ratio of debt to total capitalization was .54 to 1.\nOn March 28, 1994, the Company sold special warrants on a private placement basis exclusively in Canada and Europe. On August 11, 1994, the special warrants were exercised on a one-for-one basis for 5,600,000 shares of the Company's Common Stock. Furthermore, the Company sold 375,000 shares of it's common stock to Raytheon Engineers & Constructors, Inc. (\"Raytheon\") for $24 per share less issuance costs. The total net proceeds from the equity issued during the year was $119.3 million.\nThe Company's cash and cash equivalents balance at December 25, 1994 was $76.6 million. The Company historically has financed its operating and investing activities principally with cash from operations and expects to continue to do so in the next few years except for expenditures related to the Modernization and Expansion Project. Net cash provided by operations was $47.4 million, $16.0 million and $24.0 million for 1994, 1993 and 1992, respectively. At December 25, 1994, the Company had total cash and cash equivalents, short-term investments and restricted cash and investments of $354.4 million. These funds are all invested in compliance with the Company's bond indenture which restricts the type, quality and maturity of investments.\nCapital expenditures totaled $56.3 million, $11.7 million and $7.6 million in 1994, 1993 and 1992, respectively. Of the $75.6 million spent on capital expenditures from 1992 through 1994, approximately $7.7 million or 10 percent, was attributable to compliance with environmental regulations. The majority of the remainder of the capital project expenditures was for replacement and rehabilitation of production facilities throughout the Company and payments to Raytheon and capitalized interest related to the construction of the Modernization and Expansion Project. Based on the turnkey contract price now estimated to be $377 million, without taking into account financing costs, internally generated costs related directly to the project or additional changes that may be requested by Acme during construction, management estimates that the cost of the Modernization and Expansion Project, including equipment, ancillary facilities, construction, general contractor fees, and certain other project costs which will be paid by the Company, will not exceed $392 million. The increase in the turnkey contract price is related to the assumption of the foreign exchange risk on the equipment contract in exchange for an acceleration of the completion date of the new facility. In addition, the Company has decided to add a roll grinding shop to the facility which accounts for the majority of the remaining increase. The Company currently has sufficient cash and investments resulting from the issuance of the notes, term loan and equity which, when combined with funds that will be generated from operations in the future, will enable the Company to complete construction of the Modernization and Expansion Project and meet the working capital needs of the Company. In addition, the Company has an available $80 million working capital facility which the Company expects to remain undrawn. The Company also plans to spend approximately $24 million in 1998 related to the relining and upgrading of Acme's A blast furnace at its Chicago facilities, and the Company is continually evaluating opportunities for incremental capital expenditures which meet certain financial return criteria.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe response to Item 8 is submitted in a separate section of this Annual Report on Form 10-K. See the audited Consolidated Financial Statements and Financial Statement Schedules of Acme Metals Incorporated attached hereto and listed in the index on page 32 of this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nInformation with respect to directors of the Company is incorporated herein by reference from the proxy statement for the Annual Meeting of Shareholders of the Company to be held on April 27, 1995 under the caption ELECTION OF DIRECTORS.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following table sets forth, as of March 15, 1995, with respect to each executive officer of the Company, his name and all positions held during the last five years. Executive officers are elected annually by the Board of Directors of the Company to serve for a term of office of one year and until their successors are elected.\nAs a result of a Reorganization effected May 25, 1992, Acme Steel Company became and continues to be a subsidiary of the Company. Prior to the Reorganization the executive officers listed below were executive officers of Acme Steel Company and, at the time of the reorganization, were elected to similar positions within the Company.\n* Note that Gerald Shope's appointment will be effective April 1, 1995. ** Note that Richard Stefan is retiring as of March 31, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to executive compensation is incorporated herein by reference from the proxy statement for the Annual Meeting of Shareholders of the Company to be held on April 27, 1995 under the caption Executive Compensation.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation relating to security ownership of certain beneficial owners and management is incorporated herein by reference from the proxy statement for the Annual Meeting of Shareholders of the Company to be held on April 27, 1995 under the caption SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n(1) Financial Statements:\nThe response to this portion of Item 14 is submitted in a separate section of this report. See the audited Consolidated Financial Statements and Schedules of Acme Metals Incorporated attached hereto and listed on the index on page 32 of this report.\n(2) Financial Statement Schedules:\nThe response to this portion of Item 14 is submitted in a separate section of this report. See the audited Consolidated Financial Statements and Schedules of Acme Metals Incorporated attached hereto and listed on the index on page 32 of this report.\n(3) Exhibits\n* Filed herewith. (1) Filed pursuant to Item 14 of Form 10-K. (2) Also see Amendment and Assignment Agreement filed with Exhibit 10.13 to the 1992 10-K.\n* Filed herewith. (1) Filed pursuant to Item 14 of Form 10-K. (2) Also see Amendment and Assignment Agreement filed with Exhibit 10.13 to the 1992 10-K.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed in the fourth quarter of 1994.\nNo financial statements were filed.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nACME METALS INCORPORATED\nSIGNATURES (continued)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nACME METALS INCORPORATED FORM 10-K -- ITEM 8 AND ITEMS 14 (A) (1) AND 14 (A) (2)\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following Consolidated Financial Statements of Acme Metals Incorporated and the related Report of Independent Accountants are included in Item 8 and Item 14 (a) (1):\nThe following Consolidated Financial Statement Schedule of Acme Metals Incorporated is included in Item 14 (a) (2):\nAll other schedules have been omitted because they are not applicable, or not required, or because the required information is shown in the consolidated financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Acme Metals Incorporated\nIn our opinion, the accompanying consolidated financial statements listed in the index appearing on page 32 present fairly, in all material respects, the financial position of Acme Metals Incorporated and its subsidiaries at December 25, 1994 and December 26, 1993 and the results of their operations and their cash flows for each of the three years in the period ended December 25, 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 financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in the Notes to Consolidated Financial Statements, Acme Metals Incorporated changed its method of accounting for postretirement benefits other than pensions and income taxes in 1992.\n\/s\/ Price Waterhouse LLP Price Waterhouse LLP March 17, 1995 Chicago, Illinois\nREPORT OF MANAGEMENT\nThe management of Acme Metals Incorporated has prepared and is responsible for the consolidated financial statements and other financial information included in this Form 10-K Annual Report. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include amounts that are based upon informed judgments and estimates by management. The other financial information in this annual report is consistent with the consolidated financial statements.\nThe Company maintains a system of internal accounting controls. Management believes the internal accounting controls provide reasonable assurance that transactions are executed and recorded in accordance with Company policy and procedures and that the accounting records may be relied on as a basis for preparation of the consolidated financial statements and other financial information.\nThe financial statements have been audited by Price Waterhouse LLP, the Company's independent accountants, whose report is included herein. In addition, the Company has a professional staff of internal auditors who coordinate their financial audits with the procedures performed by the independent accountants and conduct operational and special audits.\nThe Audit Review Committee of the Board of Directors, composed of directors who are not employees of the Company, meets periodically with management, the internal auditors and the independent accountants to discuss the adequacy of internal accounting controls and the quality of financial reporting. Both the independent accountants and internal auditors have full and free access to the Audit Review Committee.\nACME METALS INCORPORATED\nCONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of this financial statement.\nACME METALS INCORPORATED\nCONSOLIDATED BALANCE SHEETS (IN THOUSANDS)\nThe accompanying notes are an integral part of this financial statement.\nACME METALS INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\nThe accompanying notes are an integral part of this financial statement.\nACME METALS INCORPORATED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS)\nThe accompanying notes are an integral part of this financial statement.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Acme Metals Incorporated (the Company) and its majority-owned subsidiaries. Investments in mining ventures are accounted for by the equity method. All intercompany transactions have been eliminated.\nThe Company's fiscal year ends on the last Sunday in December.\nCASH AND CASH EQUIVALENTS\nCash and cash equivalents include cash balances and highly liquid investments with a maturity of three months or less. The funds are invested in compliance with the Company's bond indenture which restricts the type, quality and maturity of investments.\nSHORT-TERM INVESTMENTS\nShort-term investments have a maturity of more than three months and less than 1 year. These investments are stated at cost as it is the intent of the Company to hold these securities until maturity. The funds are invested in compliance with the Company's bond indenture which restricts the type, quality and maturity of investments.\nINVENTORIES\nInventories are stated at the lower of cost or market. The primary method used to determine inventory costs is the last-in, first-out (LIFO) method.\nRESTRICTED CASH AND INVESTMENTS\nRestricted cash and investments consists of cash and investments held in trust and committed for the construction of the continuous thin slab caster\/hot strip mill complex and payment of the related debt service according to the Company's bond indenture. These investments are stated at cost as it is the intent of the Company to hold these securities until maturity. The funds are invested in compliance with the Company's bond indenture which restricts the type, quality and maturity of investments.\nPROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION\nProperty, plant and equipment are stated at cost. Depreciation of plant and equipment is computed principally on a straight-line basis over the estimated useful lives of the assets. Expenditures for maintenance, repairs and minor renewals and betterments are charged to expense as incurred. Furnace relines and major renewals and betterments are capitalized.\nUpon disposition of property, plant and equipment, the cost and related accumulated depreciation are removed from the accounts, and the resulting gain or loss is recognized.\nThe Company regularly reviews the carrying value of certain of its long-term assets and recognizes impairments when the discounted present value of future net cash flows is less than the carrying value.\nCONSTRUCTION IN PROGRESS\nConstruction in progress includes all costs, including capitalized interest, associated with the construction of the Company's continuous thin slab caster\/hot strip mill complex at its Riverdale, Illinois steelmaking facility. Also included in construction in progress are other capital projects not completed at the end of the reporting period.\nRETIREMENT BENEFIT PLANS\nPension costs include service cost, interest cost, return on plan assets and amortization of the unrecognized initial net asset. The Company's policy is to fund not less than the minimum funding required under ERISA.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company has unfunded postretirement health care and life insurance plans. Provisions for postretirement costs in 1994, 1993 and 1992 were determined pursuant to the provisions of Financial Accounting Standards (FAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Under this standard, the annual expense represents a combination of interest and service cost provisions of the annual accrual. The postretirement benefits are not funded.\nINCOME TAXES\nThe credits for deferred income taxes in 1994, 1993 and 1992 were determined pursuant to the provisions of FAS No. 109, \"Accounting for Income Taxes.\" Under this standard, the provision for deferred income taxes represents the tax effect of temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities.\nPER SHARE DATA\nAmounts per common share are based on the weighted average number of common and dilutive common equivalent shares outstanding during the year; 7,872,642 in 1994, 5,439,784 in 1993 and 5,396,311 in 1992.\nRECLASSIFICATIONS\nCertain prior year amounts have been reclassified to conform to the current year presentation.\nCONTINUOUS THIN SLAB CASTER\/HOT STRIP MILL PROJECT:\nOn August 11, 1994, the Company completed the financing for its $392 million (exclusive of capitalized interest and internally generated project costs directly related to the Modernization and Expansion Project) continuous thin slab caster\/hot strip mill project (Modernization and Expansion Project). The Company recorded a nonrecurring charge and an extraordinary expense item related to this transaction. See NONRECURRING CHARGE AND LONG TERM DEBT AND REVOLVING CREDIT AGREEMENT in the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nNONRECURRING CHARGE:\nDuring 1994, the Company completed financing for its Modernization and Expansion Project. As a result of the decision to commence with this project, the Company recorded a $9.5 million (pre-tax) nonrecurring charge. The nonrecurring charge was recorded to address the impairment of the existing steelmaking facilities and contractual employee reduction costs related to the construction and commissioning of the Modernization and Expansion Project.\nThe Company recorded a $1.9 million nonrecurring charge in 1993 including $1.3 million in connection with a decision made during the year to permanently idle Acme Steel's No. 3 Hot Strip Mill and Billet Mill; a $0.6 million charge to close Acme Packaging's Pittsburg-East facility in California; and, the elimination of a strapping line at its New Britain, Connecticut facility following a determination made during the year to consolidate production facilities and eliminate unprofitable lines.\nRESTRUCTURING CHARGE:\nDuring 1993, the Company completed its program to reduce its salaried work force by 10 percent. The pre-tax reserve of $2.7 million established by the Company included $1.1 million related to increased pension benefits and acceleration of the payment of pension benefits, a special postretirement termination charge of $1.3 million, a postretirement plan curtailment gain of $0.4 million and $0.7 million related to increased vacation benefits, severance pay and a reserve for contingencies related to the program.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nUNUSUAL INCOME ITEM:\nIn 1993, the Company recorded a benefit in connection with its investment in Wabush Iron Company (WabIron). As a result of the finalization of a plan of reorganization for LTV Steel Company, a former participant in WabIron, Acme was awarded $1.2 million (market value) of LTV securities in a settlement of a bankruptcy claim filed by all of the participants in the Wabush Mines Project joint venture.\nDuring 1992, the Company sold all of its interests in certain coal producing property located in West Virginia. This transaction added approximately $1 million of pre-tax income to 1992 results.\nINVENTORIES:\nInventories are summarized as follows:\nOn December 25, 1994 and December 26, 1993, inventories valued on the LIFO method were less than the current costs of such inventories by $58.3 million and $57.4 million, respectively.\nIn 1994, inventory quantities decreased from the prior year which resulted in liquidation of LIFO inventory quantities carried at the lower cost that prevailed in prior years, the effect of which decreased cost of products sold and increased income before income taxes and extraordinary item by $0.7 million.\nPROPERTY, PLANT AND EQUIPMENT:\nProperty, plant and equipment consisted of the following:\nThe difference between depreciation expense presented in the Consolidated Statements of Cash Flows and the Consolidated Statements of Operations represents that portion of depreciation expense that is classified in selling and administrative expense on the Consolidated Statements of Operations.\nThe Company capitalized expenditures related to the construction of the Modernization and Expansion Project totaling $44.7 million as of December 25, 1994. The capitalized expenditures are comprised of a $42.0 million payment to Raytheon Engineers & Constructors, Inc., the general contractor, for the construction project, $2.0 million of related capitalized interest, and $0.7 million of other costs directly related to the construction of the Modernization and Expansion Project.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nRETIREMENT BENEFIT PLANS:\nThe Company has various retirement benefit plans covering substantially all salaried and hourly employees. Certain salaried employees with one full calendar quarter of service are eligible to participate in the Company's defined contribution plan and employee stock ownership plan (ESOP). Company contributions to the defined contribution plan and employee stock ownership plan are based upon 7.5 and 3.5 percent (the ESOP contribution was reduced from 6.5 to 3.5 percent in the second quarter of 1993), respectively, of eligible compensation. Amounts charged to operations under these plans were $3.5 million in 1994, $3.4 million in 1993 and $4.1 million in 1992.\nSalaried employees who joined the Company prior to December 31, 1981 and certain hourly employees participate in defined benefit retirement plans which provide benefits based upon either years of service and final average pay or fixed amounts for each year of service.\nThe net defined benefit pension credit (expense) included the following components:\nPension plan curtailment losses of $1.1 million are included in the 1992 restructuring charge.\nActuarial assumptions used for the Company's pensions plans were as follows:\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe following table sets forth the funded status of the Company's defined benefit retirement plans and amounts recognized in the balance sheet.\nIn accordance with FAS No. 87, \"Employer's Accounting for Pensions,\" the Company has recorded an adjustment, net of applicable income taxes, as shown in the table above, to recognize a minimum pension liability relating to certain under-funded pension plans.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS:\nThe Company and its subsidiaries sponsor several unfunded defined benefit postretirement plans that provide medical, dental, and life insurance for retirees and eligible dependents.\nIn 1994, 1993, and 1992, the cost for all plans, calculated pursuant to FAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" amounted to $9.1 million, $7.9 million and $7.8 million, respectively.\nThe net periodic postretirement benefit cost for 1994, 1993 and 1992, net of retiree contributions of approximately 10 percent of costs, included the following components:\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe following table sets forth the plans' combined status at December 25, 1994 and December 26, 1993:\nThe accrued postretirement obligation was determined by application of the terms of medical, dental, and life insurance plans, together with relevant actuarial assumptions and health care cost trend rates projected at annual rates ranging ratably from 12 percent in 1992 to 5 percent through 1999 and beyond. The effect of a 1 percent annual increase in these assumed cost trend rates would increase the accumulated postretirement benefit obligation by approximately $11.2 million; the net periodic postretirement benefit costs would increase by approximately $2.1 million. The obligation for postretirement benefits as of December 25, 1994 was determined using an 8.5 percent discount rate, as compared to the 7.5 percent discount rate used for the year ended December 26, 1993.\nThe increase in the discount rate contributed to a net decrease in the obligations of approximately $9.2 million. As the measurement of net periodic postretirement benefits cost is based on beginning of the year assumptions, the lower revalued obligation at the end of fiscal 1994 did not have any impact on the expense recorded for 1994.\nACCRUED EXPENSES:\nIncluded in the Consolidated Balance Sheets caption Accrued Expenses are the following:\nINVESTMENTS IN ASSOCIATED COMPANIES:\nThe Company has a 31.7 percent interest in an iron ore mining venture. In 1994, 1993 and 1992, the Company made iron ore purchases of $20.7 million, $18.3 million, and $21.7 million, respectively from the venture. At December 25, 1994, $5.6 million was owed to the venture for iron ore purchases; amounts owed to the venture for such ore purchases were $4.2 million at December 26, 1993.\nThe Company has a 37 percent interest in Olga Coal Company. In 1987, Olga Coal Company filed for protection under Chapter 11 of the U.S. Bankruptcy Act and the coal mining operation was idled. The coal mining investment is carried at no value in the Consolidated Balance Sheets.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nINCOME TAXES:\nThe provision (credit) for taxes consisted of the following:\nThe effective income tax rates for 1994, 1993 and 1992 are reconciled to the Federal statutory tax rate in the following table:\nAs of the beginning of 1992, the Company adopted FAS No. 109, Accounting for Income Taxes. The cumulative effect of the change in accounting for income taxes increased the 1992 net loss by $8.1 million or $1.50 per share. The change in accounting for income taxes increased the credit for taxes in 1992 by $0.9 million.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSignificant components of the Company's deferred tax liabilities and assets at December 25, 1994 and December 26, 1993 are summarized below:\nIn 1994 and 1993, the change in the deferred income tax liability primarily represents the effect of changes in the amounts of temporary differences from the prior year. In addition, based on the Company's expected future profitability, the net deferred tax asset was increased in 1994 recognizing the effect of legislation enacted during 1993 which increased the maximum corporate tax rate from 34 to 35 percent.\nThe Company believes it is more likely than not to realize the net deferred tax asset and accordingly no valuation allowance has been provided. This conclusion is based on, (i) reversing deductible temporary differences (excluding postretirement amounts) being offset by reversing taxable temporary differences, (ii) the extremely long period that is available to realize the future tax benefits associated with the postretirement related deductible temporary differences and, (iii) the Company's expected future profitability.\nThe Company's Federal tax liability is the greater of its regular tax or alternative minimum tax. At December 25, 1994, the Company had no alternative minimum tax credits available to be carried forward.\nIn 1994, cash flows were reduced by $12.3 million resulting from net income tax payments. In 1993, cash flows were reduced by $4.5 million resulting from income tax payments of $5.0 million and income tax refunds of $0.5 million in connection with net operating loss carryback claims. In 1992, cash flows were increased by $4.8 million resulting from $6.0 million of income tax refunds in connection with net operating loss carryback claims and income tax payments of $1.2 million.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nLONG-TERM DEBT AND REVOLVING CREDIT AGREEMENT:\nThe Company's long-term debt at December 25, 1994 and December 26, 1993 is summarized as follows:\nDuring 1994, the Company issued long-term debt in the form of Senior Secured Notes, Senior Secured Discount Notes and a Term Loan for gross cash proceeds of $255 million in connection with the financing of the construction of the Modernization and Expansion Project. The gross proceeds were reduced by debt issuance costs of $14.3 million which is being amortized over the lives of the respective bond issues and the term loan.\nCoincident with issuance of new debt, the Company prepaid the total principal remaining on the previously existing Senior Notes of $50 million and incurred approximately $3 million ($1.8 million after-tax) in prepayment penalties which are shown as an extraordinary expense item net of taxes in the Consolidated Statements of Operations.\nSENIOR SECURED NOTES\nThe Senior Secured Notes were issued for $125 million, bearing 12.5 percent interest due in 2002. The Senior Secured Notes may be redeemed at the option of the Company, in whole, or in part on or after August 1, 1998 at fixed redemption prices, together with accrued and unpaid interest to the redemption date.\nSENIOR SECURED DISCOUNT NOTES\nThe Senior Secured Discount Notes provided gross proceeds of $80 million and mature in 2004, which will yield 13.5 percent and accrete to an aggregate principal amount of $117.9 million on August 1, 1997. During 1994, the Senior Secured Discount Notes accreted to a value of $84.1 million. The Senior Secured Discount Notes may be redeemed at the option of the Company in whole or in part, on or after August 1, 1999, at fixed redemption prices, together with accrued and unpaid interest to the redemption date.\nTERM LOAN\nThe Term Loan provided gross proceeds of $50 million and matures on a graduated schedule beginning in 1998, and may be redeemed at par, in whole or in part, by the Company on the last day of any quarterly interest period. The Term Loan bears interest at 400 basis points above three month LIBOR. At December 25, 1994, the interest rate in effect was 10.375 percent.\nWORKING CAPITAL FACILITY\nThe Company has a Working Capital Facility agreement with a group of banks which provides aggregate commitments of $80 million secured by the inventories and accounts receivable of the Company's subsidiaries. During 1993 and 1992, the Company had a $60 million revolving credit agreement with a group of banks. At December 25, 1994 and December 26, 1993, no amounts were outstanding under either credit agreement. The Company pays an annual commitment fee of one-half percent on the unused portion of the credit line.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company's obligations under the Senior Notes and Term Loan are secured by a pledge of all capital stock of the Company's direct subsidiaries. The guarantee of the Notes and Term Loan by Acme Steel is secured by a first property lien on substantially all existing and future real property and equipment of Acme Steel, including all of the assets required in connection with the Modernization and Expansion Project. The guarantee of the Notes and Term Loan by Acme Packaging are secured by a pledge of all of the capital stock of its subsidiaries.\nThe maturities during the five years ending December 26, 1999 are $4.3 million in 1998 and $15.2 million in 1999. Cash flows from operating activities were reduced by cash paid for interest on debt by $5.3 million in 1994 and $5.2 million in 1993 and $5.6 million in 1992.\nThe Senior Notes, Term Loan and Working Capital Facility contain certain restrictive covenants that limit the Company's ability to incur additional indebtedness, create liens, pay dividends, repurchase capital stock, engage in transactions with affiliates, sell assets, engage in sale or leaseback transactions and engage in mergers or consolidations.\nFAIR VALUE OF FINANCIAL INSTRUMENTS:\nCASH AND CASH EQUIVALENTS, SHORT-TERM INVESTMENTS AND RESTRICTED CASH AND INVESTMENTS\nThe carrying value of cash and cash equivalents, short-term investments and restricted cash and investments approximates the current value.\nLONG-TERM DEBT\nThe fair value of the Company's Senior Secured Notes and Senior Secured Discount Notes is determined by using the quoted market price at the end of the reporting period.\nThe fair value of the Term Loan and Note Payable is estimated by calculating the present value of the remaining interest and principal payments on the debt to maturity. The present value of the Term Loan uses a discount rate equal to the three month LIBOR rate plus 400 basis points at the end of the reporting period. The Note Payable present value computation uses a discount rate equal to the prime rate at the end of the reporting period plus or minus the spread between the prime rate and the rate negotiated on the debt at the inception of the loan.\nThe following table presents information on the Company's financial instruments:\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nISSUANCE OF COMMON STOCK:\nOn August 11, 1994, the Company issued 5.6 million shares of $1 par value common stock in exchange for 5.6 million special warrants sold on March 2, 1994. The issue price of the special warrants was $21 providing gross proceeds to the Company of $117.6 million. The gross proceeds were reduced by related equity issuance costs of $6.8 million providing net equity proceeds of $110.8 million.\nIn addition, on September 23, 1994, Raytheon entered into an agreement with the Company to purchase 375,000 shares of its common stock for $24 per common share. The gross proceeds of $9 million was reduced by the related issuance costs of $0.5 million. The sale closed on October 7, 1994. These common shares have not been registered.\nCOMMON STOCK:\nThe Company has a stock incentive program which provides, among other benefits, for the granting of stock options and stock awards to officers and key employees. Stock options for the Company's common stock are granted at prices not less than the market price at date of grant and no option may be exercised more than ten years from the grant date. Information regarding stock options is summarized below:\nAt December 25, 1994, 394,450 options were exercisable; 490,850 options were exercisable at December 26, 1993. Options vest over a two year period.\nStock awards granted in 1994 totaled 13,000 shares at a value of either $23.19 or $22.88 per share depending on the grant date. Stock awards granted in 1993 totaled 15,400 shares at a value of either $16.00 or $16.75 per share depending on the grant date. Stock awards granted in 1992 totaled 18,650 shares at a value of either $15.00 or $18.75 per share depending on the grant date. The compensation expense for the value of stock awards granted is recognized ratably over the vesting period of 5 years.\nCOMMITMENTS AND CONTINGENCIES:\nThe Company's interest in an iron ore mining joint venture requires payment of its proportionate share of all fixed operating costs, regardless of the quantity of ore received, plus the variable operating costs of minimum ore production for the Company's account. Normally, the Company reimburses the joint venture for these costs through its purchase of ore at the higher of cost or market prices. During 1994, the Company obtained approximately 56 percent of its iron ore needs from the joint venture and purchases generally approximated market prices.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company has entered into a turnkey contract with Raytheon Engineers & Constructors, Inc. (\"Raytheon\") to build the Modernization and Expansion Project at its steelmaking facilities located in Riverdale, Illinois. A significant portion of Raytheon's subcontract with the key equipment vendor is denominated in German Deutsche Marks, DM133 million ($83.2 millions at the inception of the contract). The Company agreed to assume the DM foreign exchange costs in return for an acceleration of the final completion date of the facility. At this time, approximately DM42.5 million of this foreign exchange exposure remain unhedged.\nThe Company is subject to various Federal, state and local environmental statutes and regulations which provide a comprehensive program for controlling the release of materials into the environment and require responsible parties to remediate certain waste disposal sites. In addition, various health and safety statutes and regulations apply to the work-place environment. Administrative, civil and criminal penalties may be applicable for failure to comply with these laws. These environmental laws and regulations are subject to periodic revision and modification. The United States Congress, for example, has recently completed a major overhaul of the Federal Clean Air Act which is a major component of the Federal environmental statutes affecting the Company's operations.\nFrom time to time, the Company is also involved in administrative proceedings involving the issuance, or renewal, of environmental permits relating to the conduct of its business. The final issuance of these permits have been resolved on terms satisfactory to the Company; and, in the future, the Company expects such permits will similarly be resolved on satisfactory terms.\nAlthough management believes it will be required to make further substantial expenditures for pollution abatement facilities in future years, because of the continuous revision of these regulatory and statutory requirements, the Company is not able to reasonably estimate the specific pollution abatement requirements, the amount or timing of such expenditures to maintain compliance with these environmental laws. While such expenditures in future years may be substantial, management does not presently expect they will have a material adverse effect on the Company's future ability to compete within its markets.\nIn those cases where the Company has been identified as a Potentially Responsible Party (\"PRP\") or is otherwise made aware of a possible exposure to incur costs associated with an environmental matter, management determines (i) whether, in fact, the Company has been properly named or is otherwise obligated, (ii) the extent to which the Company may be responsible for costs associated with the site in question, (iii) an assessment as to whether another party may be responsible under various indemnification agreements or insurance policies the Company is a party to, and (iv) an estimate, if one can be made, of the costs associated with the clean-up efforts or settlement costs. It is the Company's policy to make provisions for environmental clean-up costs at the time that a reasonable estimate can be made. At December 31, 1994, the Company had recorded reserves of less than $0.3 million for environmental clean-up matters. While it is not possible to predict the ultimate costs of resolving environmental related issues facing the Company, based upon information currently available, they are not expected to have a material effect on the consolidated financial condition or results of operations of the Company.\nIn connection with the Spin-Off from The Interlake Corporation (\"Interlake\") on May 29, 1986, Acme Steel Company (a subsidiary of the Company) entered into certain indemnification agreements with Interlake. Pursuant to the terms of the indemnification agreements, Interlake undertook to defend, indemnify and hold Acme Steel Company harmless from any claims, as defined, relating to Acme Steel Company operations or predecessor operations occurring before May 29, 1986, the inception of Acme Steel Company. The indemnification agreements cover certain environmental matters including certain litigation and Superfund sites in Duluth, Minnesota and Gary, Indiana for which either Interlake or Acme Steel Company's predecessor operations have been named as defendants or PRP's, as applicable. To date, Interlake has met its obligations under the indemnification agreements and has provided the defense and paid all costs\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) related to these environmental matters. The Company does not have sufficient information to determine the potential liability, if any, for the matters covered by the indemnification agreements in the event Interlake fails to meet its obligations thereunder in the future. In the event that Interlake, for any reason, was unable to fulfill its obligations under the indemnification agreements, the Company could have increased future obligations which could be significant.\nAlso in connection with the Spin-Off from Interlake, Acme Steel Company entered into a Tax Indemnification Agreement (\"TIA\") which generally provides for Interlake to indemnify Acme Steel Company for certain tax matters. While certain issues have been negotiated and settled between the Company, Interlake and the Internal Revenue Service, certain significant issues for the tax years beginning in 1982 through 1986 remain unresolved.\nOn March 17, 1994, Acme Steel Company received a Statutory Notice of Deficiency (\"Notice\") in the amount of $16.9 million in tax as a result of the Internal Revenue Service's examination of the 1982-1984 tax years. The Company is contesting the unresolved issues and the Notice. Should the government sustain its position as proposed for those unresolved issues and those contained in the Notice, substantial interest would also be due (potentially in an amount greater than the tax claimed). The taxes claimed relate principally to adjustments for which Acme Steel Company is indemnified by Interlake pursuant to the TIA. The Company has adequate reserves to cover that portion for which it believes it may be responsible per the TIA. To date, Interlake has met its obligations under the TIA with respect to all covered matters. In the event that Interlake, for any reason, were unable to fulfill its obligations under the TIA, the Company could have increased future obligations.\nThe Company's subsidiaries also have various litigation matters pending which arise out of the ordinary course of their businesses. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the financial position of the Company.\nBUSINESS SEGMENTS:\nThe Company presents its operations in two segments, Steel Making and Steel Fabricating.\nSteel Making operations include the manufacture of sheet, strip and semifinished steel in low-, mid-, and high-carbon alloy and specialty grades. Principal markets include agricultural, automotive, industrial equipment, industrial fasteners, welded steel tubing, processor and tool manufacturing industries.\nThe Steel Fabricating Segment processes and distributes steel strapping, strapping tools and industrial packaging (Acme Packaging Corporation), welded steel tube (Alpha Tube Corporation) and auto and light truck jacks (Universal Tool & Stamping Co., Inc.). The Steel Fabricating Segment sells to a number of markets.\nAll sales between segments are recorded at current market prices. Income from operations consists of total sales less operating expenses. Operating expenses include an allocation of expenses incurred at the Corporate Office that are considered by the Company to be operating expenses of the segments rather than general corporate expenses. Income (loss) from operations does not include other non-operating income or expense, interest income or expense, the cumulative effect of changes in accounting principles, or income taxes. Identifiable assets are those that are associated with each business segment. Corporate assets are principally investments in cash equivalents and deferred income taxes.\nThe products and services of the Steel Making and Steel Fabricating Segments are distributed through their own respective sales organizations which have sales offices at various locations in the United States. Export sales are insignificant for the years presented.\nACME METALS INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nSEGMENT INFORMATION (IN THOUSANDS)\n(1) Includes a $9.5 million nonrecurring charge to recognize asset impairment costs and contractual employee reduction cost related to construction of the Modernization and Expansion Project. (2) Includes a $1.3 million write off of Acme Steel Company's No. 3 Hot Strip Mill and Billet Mill. (3) Includes a $0.6 million expense to close Acme Packaging's Pittsburg-East facility in California and the write-off of a strapping line at its New Britain, Connecticut facility. (4) Includes a $2.1 million restructuring charge in connection with a 10 percent salaried work force reduction plan. (5) Includes a $0.3 million restructuring charge in connection with a 10 percent salaried work force reduction plan.\nSUBSEQUENT EVENT:\nOn December 30, 1994, the Company sold its interest in the LAS Virginia Properties. A gain on sale of the properties, net of the adjusted cost basis, will be recognized in the amount of $1.6 million, in fiscal 1995.\nACME METALS INCORPORATED\nQUARTERLY RESULTS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe third quarter of 1994 includes a $9.5 million nonrecurring charge to address the impairment of existing steelmaking facilities and contractual employee costs related to construction and commissioning of the Modernization and Expansion Project. In addition, the third quarter also includes a $1.8 million extraordinary expense item resulting from prepayment of previously existing senior notes.\nThe fourth quarter of 1993 includes a $1.2 million benefit related to Acme's investment in Wabush Mines, a $1.3 million expense to write-off the Steel subsidiary's No. 3 Hot Strip Mill and Billet Mill, $0.6 million of expense associated with the closure of the Packaging subsidiary's Pittsburg-East facility in California and the write-off of a strapping line at the Packaging subsidiary's New Britain, Connecticut facility.\nThe third quarter of 1992 includes a $3.1 million restructuring charge in connection with the Company's work force reduction plan.\nThe fourth quarter of 1992 includes a $1 million gain on the sale of all the Company's interests in a coal producing property in West Virginia, and a postretirement plan curtailment gain of $0.4 million related to the restructuring charge was included in fourth quarter results.\nACME METALS INCORPORATED\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\n(IN THOUSANDS)","section_15":""}
{"filename":"861439_1994.txt","cik":"861439","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":"82231_1994.txt","cik":"82231","year":"1994","section_1":"Item 1. Business\n(a) The Company (as used herein the term \"Raymond\" refers to The Raymond Corporation alone, and the term \"Company\" refers to The Raymond Corporation and its subsidiaries, both consolidated and unconsolidated, and direct and indirect) operates predominately in one business segment, that being the design, manufacture, sale, leasing and short-term rental of materials handling equipment. Revenues are realized predominately through its North American Dealer Network although the Company has expanded in both the domestic and international markets with minimal capital investment through distribution and O.E.M. (Original Equipment Manufacturer) supply agreements.\nRaymond was organized in 1840 as Lyon Iron Works, in Greene, New York, and in 1922 George G. Raymond, Sr. purchased it. Raymond produced its first materials handling product in 1930 under the Lyon Iron Works name. In 1941, Raymond was renamed Lyon-Raymond Corporation, and in 1951, was renamed The Raymond Corporation. Shares were first offered to the public in 1956.\nThe major components of the Company's international operations are Raymond Industrial Equipment, Limited, a wholly-owned Canadian manufacturing subsidiary, and G.N. Johnston Equipment Co. Ltd., the exclusive Canadian distributor that is 45% owned by R.H.E. Ltd., a wholly-owned Canadian subsidiary of Raymond. Foreign exchange exposure on international operations is limited primarily to the Canadian dollar and is minimized through the purchase of foreign currency exchange contracts.\nIn 1991, Raymond and Mitsubishi Caterpillar Forklift America Inc. (\"MCFA\") signed an agreement to create a joint venture company. The joint venture company, known as Material Handling Associates, Inc. (\"MHA\"), is a separate enterprise which designs, develops, and sells products to be manufactured exclusively by the Company and distributed exclusively through MHA dealers using Caterpillar trademarks. This venture is intended to expand distribution of products manufactured by the Company and to provide additional opportunities for the sale of replacement parts and accessories.\nDuring 1992, Raymond entered into an agreement with B.T. Industries AB (\"BT\") of Mjolby, Sweden, a European manufacturer and distributor of lift trucks. Under the agreement, the Company manufactures a European version of the SWING-REACH\/R\/ truck for distribution by BT. In addition, the agreement grants BT the non-exclusive right to distribute this product in other markets in which the Company currently does not participate.\nIn 1994, Raymond and MCFA signed an agreement to purchase for resale battery powered, electric low lift pallet trucks known as walkies, similar to those currently manufactured by the Company for MHA. MCFA markets the walkies under the Mitsubishi trademark throughout the United States, Canada, Mexico, Central and South America. Also in 1994, Raymond and MCFA signed an agreement whereby the Company manufactures a sit-down counterbalanced electric forklift truck exclusively for sale to MCFA.\nIn 1994, Raymond entered into an agreement with Jungheinrich A.G. (\"Jungheinrich\") of Hamburg, Germany, the second largest manufacturer of lift trucks in Europe. Under the agreement, the Company manufactures a European version of the EASi orderpicker truck for distribution by Jungheinrich. In addition, the agreement grants Jungheinrich the non-exclusive right to distribute this product in other markets in which the Company currently does not participate.\nDuring 1994, Raymond and Remstar International Inc. (\"Remstar\"), of Westbrook, Maine, signed an agreement whereby the Company manufactures horizontal carousels and parts for distribution by Remstar. Pursuant to the agreement, the Company agrees to use Remstar as its exclusive distributor in the United States, Canada and Mexico but retains the right to sell parts, accessories and equipment in the United States, Canada and Mexico for use with the Company's horizontal carousels sold prior to this agreement.\nIn 1994, the Company expanded its Dealer Network into Columbia and Costa Rica. Existing markets in Mexico were expanded to include additional sales territories.\nThe Company has equity investments in certain members of the Company's Dealer Network and, in 1994, increased equity investments in dealerships with principal offices in Missouri and Utah.\nDuring 1994, Raymond formed Dockstocker Corporation, a New York corporation, owned by Raymond Sales Corporation, a 100% owned subsidiary of Raymond. Dockstocker Corporation will market and sell a stand-up end control counterbalanced forklift truck featuring flexible dockstance operator configuration designed to maximize loading productivity in the dock environment.\n(b) Financial Information about Industry Segments\n\"Note M-Business Segment Information\" on Page 36 of the Annual Report to Shareholders for the year ended December 31, 1994 is incorporated herein by reference.\n(c) Narrative Description of Business\n(i) Principal Products and Services\nThe Company's products are marketed principally under the RAYMOND\/R\/ trademark, and fall into the category of unit load and case pick load handling.\nThe Company's unit load and case pick load products are operator-controlled machines used to move a load from point A to point B. The unit load and case pick load product line includes orderpickers, walkies, sideloaders, straddle, SWING-REACH\/R\/ trucks, and REACH-FORK\/R\/ trucks for narrow aisle and very narrow aisle operation, and counterbalanced PACER\/TM\/ trucks.\nIn 1990, a new line of orderpickers with advanced microprocessor control was introduced by the Company. The orderpickers significantly reduce the high costs and time involved to pick orders. Total programmability, through the intellidrive\/R\/ control system, allows truck performance to be tailored to each user's needs to optimize productivity. The intellidrive system utilizes microchip technology developed by the Company and is designed to replace control systems based on hydraulic and mechanical technologies commonly utilized in the industry. The intellidrive system enhances the trucks' performance characteristics and productivity and has allowed the Company to reduce manufacturing costs through reduced material and labor expense.\nIn 1991, the Company introduced a series of products known as EASi products - Ergonomically Advanced Systems with intellidrive. This new line of trucks is designed for greater operator comfort and enhanced productivity. The trucks included in this series are the operator-up SWING-REACH truck, the orderpicker and the narrow aisle REACH-FORK truck. The new EASi REACH-FORK truck has unequaled capacity at elevated heights and provides greater space utilization and increased productivity.\nAlso in 1991, five new walkies were introduced featuring a top-mounted operator's steering handle and other innovations.\nIn 1992, the Company introduced a new base model version of the orderpicker and REACH-FORK truck.\nIn 1993, a new generation of the EASi REACH-FORK truck and EASi Orderpicker were introduced, designed for greater operator comfort and productivity. The Company also introduced regenerative braking to allow recycling of energy back into the battery, improving overall efficiency while extending component life. The REACH-FORK truck also has an innovative motor impeller design, ensuring a superior air flow system which improves component life and further enhances operator comfort.\nAlso in 1993, the Company introduced an option on the EASi REACH-FORK truck and EASi Orderpicker with the SMARTi\/TM\/ information system. The SMARTi information system enables the customer to easily obtain reports on the truck's activities by shift, day or week to help evaluate productivity.\nIn addition, two new walkies were introduced in 1993. The 8,000 pound capacity walkie and the transistor-controlled 4,000 pound capacity walkie are designed to increase productivity.\nIn 1994, the Company introduced a new walkie handle design to provide greater operator comfort, convenience and productivity. The design difference can make repeated movements more comfortable.\nAlso in 1994, two new products were added to the EASi REACH-FORK\/R\/ line featuring upgradeability from 24 volt operation, and an optional dockstance operator compartment. In addition, the EASi REACH-FORK family was expanded to include a four directional truck for use in handling both standard pallets and long loads, and additional mast selections for very tall single and double deep reach applications.\nAll of these vehicles, controls and systems are sold through a network of dealerships, which have multiple full service facilities across their trading area and are supported by a repair and replacement parts service. The Company's replacement parts and accessories business supports the base of the Company's lift trucks in service and provides new parts and service to customers who have service needs for non-Company equipment. In addition, the Company rebuilds and sells electric motors and other components for replacement use, offering its customers a cost-effective alternative to purchasing a new component for both Company and non-Company equipment.\nRaymond Leasing Corporation, a wholly-owned subsidiary of the Company, offers lease financing, short-term rentals and sales of used equipment and serves as a marketing vehicle for the Company's products by providing the Company's Dealer Network with flexible leasing programs.\nThe Company presently manufactures lift truck masts for two original equipment manufacturer (O.E.M.) customers.\nThe product and service categories of the Company's business segment are shown with percentage of revenues contributed in \"Note M-Business Segment Information\" on page 36 of the Annual Report to Shareholders for the year ended December 31, l994, which is incorporated herein by reference.\n(ii) Status of Announced Products Not Yet Introduced\nThe Company has not made a public announcement about any new products or industry segments that will require a material investment of assets or that are otherwise material. However, as in prior years, the Company expects to introduce new and enhanced models through its normal research and development activities.\n(iii) Sources and Availability of Raw Materials\nThe Company procures components from the best available sources of supply, which include a broad range of internal manufacturing capabilities. Certain components of its products are fabricated from bar, strip, rod and plate steel. Individual decisions to make or buy are based upon numerous factors, the more significant being quality, cost, lead time, and technological sensitivity.\nThe Company has no significant long-term commitments with any supplier and believes its supply arrangements are adequate for current and presently foreseeable needs. Certain electric motors, forks, castings, hydraulic and electronic components are made to Company specifications and are purchased from single sources. Many single sources are backed up by agreements to allow manufacture by alternate sources or by the availability of similar standard components from alternate sources.\nContinued effort is made by the Company's Engineering and Purchasing Departments to establish and improve the strong working relationships between the Company and its suppliers.\nThe Company's products vary in capacity, function, and load capability; thus, specifications for a particular order require that many of the components are only made to orders booked. Commonly used parts are manufactured or purchased and stocked to minimize production time. Finished products are normally assembled only to orders booked. Every effort is made to keep inventories low, while meeting competitive delivery commitments.\n(iv) Patents, Trademarks, Licenses, Franchises and Concessions Held\nThe Company has numerous registered patents in the United States, Canada and several European countries with respect to various inventions, including the intellidrive\/R\/ control system. Although the Company considers that, taken as a whole, the rights under these patents, which expire from time to time, are a valuable asset, it does not regard its business as being materially dependent upon any single patent or any group of patents.\nThe Company also has a number of registered and common law trademarks and service marks for its products. The trade and service marks, taken as a whole, are considered by the Company to be important to its business.\n(v) Seasonality of Business\nThe Company does not recognize its business segment or any of its products or services as seasonal.\n(vi) Working Capital Practices\nThe Company pursues and the industry demands no special business practices with respect to working capital items.\n(vii) Customers\nThe Company distributes its products principally through its Dealer Network. These Dealers sell the Company's products to the end users, which represent a broad cross-section of industry. They include public and private businesses engaged in the manufacture, storage and\/or distribution, both wholesale and retail, of a wide variety of products which include: materials, food, textiles, paper, steel, rubber, electrical components, equipment and machinery.\nIn 1992, the Company established its National Accounts Program, which offers selected large customers a single purchasing and financing source for their materials handling equipment and service needs. Delivery, installation and after-sale service are provided by the Company's Dealer Network. The program focuses on fleet users of lift trucks with facilities in several areas of the country.\nNo single customer (end user) of the Company accounts for 10% or more of the Company's total consolidated revenues.\n(viii) Backlog\nAs of December 31, 1994, the backlog of orders aggregated approximately $78,119,000 compared with a backlog of approximately $52,297,000 on December 31, 1993. No assurance can be given that the backlog will continue at any particular level. The Company reasonably expects to fill the backlog of orders within the current fiscal year, unless a longer production lead time has been requested by the customer. The Company believes that its current backlog can generally be considered firm; no significant cancellations are expected.\n(ix) Contracts Subject to Termination or Renegotiation\nThere is no material portion of the business that is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government.\n(x) Competition\nWhile competitive conditions vary from product to product, all of the Company's products are marketed in the highly competitive manufacturing and warehousing materials handling systems markets. Historically, Raymond's strength has been in providing superior application, specific product performance, service and reliability.\nThe Company is a major competitor in all market segments in which it participates, generally competing with other major national and international manufacturers. Many small manufacturers compete with a few major manufacturers in a highly fragmented market. In addition to these direct competitors, a number of other products compete indirectly for the industrial consumer's materials handling dollars. The Company believes it is the only North American manufacturer which designs and manufactures its own vehicle controls. This allows the Company to be a leader in developing and applying new control technologies, responding more quickly to user demands and trends, and differentiating its products with respect to key competitive factors such as productivity and ergonomics.\nThe Company believes it is the only company offering its comprehensive array of materials handling systems, products and services to the markets it serves.\nBecause of the Company's broad product mix, it has no one single competitor but rather various competitors across the unit load and case pick load handling category.\nIn recent years, the Company has introduced a new enhanced line of orderpickers, reach trucks, turret trucks and walkies which have solidified the Company's position in the unit load and case pick load handling category. Over time, several manufacturers have emerged as key competitors in this category, including U.S.-based Crown Equipment Corporation, Clark Material Handling Company, a wholly-owned subsidiary of Terex Corporation, and the Yale Industrial and Hyster subsidiaries of North American Coal Company.\nThe Company no longer considers itself a competitor in the automated storage and retrieval market since its business activity is now limited to the manufacture of horizontal carousels for a single original equipment manufacturer (O.E.M.) customer\n(xi) Research and Development\nThe cost of the Company's research and development program amounted to $3,958,000 in 1994 compared to $4,251,000 in 1993, and $2,557,000 in 1992. The Company works closely with customers in the development of product application to fulfill a particular materials handling requirement.\n(xii) Compliance with Environmental Laws and Regulations\nThe Company's production facilities and operations are subject to a variety of federal, state and local environmental and job safety laws and regulations, including various federal, state and local laws, ordinances and regulations pursuant to which an owner of real property may become liable for the costs of removal or remediation of certain hazardous or toxic substances located on or in such property. Environmental laws often impose liability without regard to whether the owner knew of, or was responsible for, the presence of such hazardous or toxic substances. The presence of such substances, or the failure to remediate the presence of such substances properly, may adversely affect the owner's ability to sell such real estate or to borrow using such real estate as collateral. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") imposes joint and several liability for clean-up and enforcement costs, without regard to fault or to the legality of the original conduct, on current or predecessor owners or operators of a site. Under CERCLA, an owner or operator of the site may be liable for all or part of the costs to clean up sites at which waste has been released by the owners, the owner's lessees, or by predecessor or successor owners. In addition, liability extends to persons\/companies which generated the hazardous substances located on the property, or arranged for disposal of such substances. The Company believes that it is in compliance in all material respects with all relevant federal, state and local rules and regulations and regulations regarding hazardous or toxic substances. No assurances, however, can be given that the Company is aware of all potential environmental liabilities, or that there are not material environmental liabilities of which the Company is not aware.\n(xiii) Employees\nThe Company had 1,498 employees on December 31, 1994.\n(d) Financial Information about Foreign and Domestic Operations and Export Sales\n(1) \"Note M-Business Segment Information\" on Page 36 of the Annual Report to Shareholders for the Year ended December 31, 1994 is incorporated herein by reference.\n(2) The Company has no extraordinary risks attendant to its foreign operations.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's corporate headquarters and main manufacturing facility are located in an approximately 70,000 square foot office building and approximately 325,000 square foot adjacent plant in Greene, New York, both of which are owned by the Company.\nExpansion has recently been completed on a modern 138,000 square foot steel and masonry manufacturing and office building the Company owns in Brantford, Ontario, Canada.\nThe Company owns a modern one-story facility located in East Syracuse, New York which houses the Company's Parts Distribution Center and a Raymond dealership. The facility, made of steel and masonry construction, contains approximately 61,000 square feet of warehouse and office space. Approximately 9,300 square feet of the warehouse is presently occupied by Raymond Leasing Corporation's rental department and truck repair facility.\nThe Company currently leases approximately 10,301 square feet of space from The Greene Central School District in Greene, New York for use as a training center. The lease, for a five year period, expires December, 1995.\nAll of the Company's properties and machinery are believed to be well maintained and in good condition. The Company estimates that its production capacity is adequate for the business anticipated during the next three or four years.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is currently defending approximately 70 products liability and similar lawsuits involving industrial accidents. Management believes that none of these will individually have a material adverse effect on the Company. Taken as a whole, the damages claimed would have a material adverse effect on the Company but actual costs of judgments, settlements and costs of defense have not had such an effect to date. The Company views these actions, and related expenses of administration, litigation and insurance, as part of the ordinary course of its business. The Company uses a combination of self-insured retention and insurance, paid for in part by its dealers, to manage these risks and believes that the insurance coverage and reserves established for self-insured risks are adequate. The Company's dealers contribute to the funding of the Company's products liability program and, in turn, the Company indemnifies the dealers against products liability expense and manages products liability claims. The Company has a policy of aggressively defending these lawsuits which generally take several years to ultimately resolve.\nThe Company is also one of sixteen remaining defendants in a private environmental lawsuit. The five plaintiffs in the case are Cooper Industries, Inc., Keystone Consolidated Industries, Inc., The Monarch Machine Tool Co., Niagara Mohawk Power Corporation and Overhead Door Corporation. Plaintiffs have been ordered by the United States Environmental Protection Agency to perform a Remedial Investigation\/Feasibility Study with respect to a 20 acre site located in Cortland, New York and are seeking contribution from each of the defendants. Plaintiffs have alleged that each defendant is a \"Potentially Responsible Party\" as that term is defined in environmental statutes. Pretrial discovery is expected to continue through the Fall of 1995. The site involved in the litigation was a manufacturing site for many decades prior to 1971. From 1971 to 1985, a scrap metal processing operation was conducted at the site. From 1975 to 1982, the owners of the scrap metal processing operation purchased scrap metal from the Company. The plaintiffs have alleged that the scrap metal purchased from the Company was coated with certain solvents and\/or cutting oils. Plaintiffs have the burden of proving the nature and extent of the Company's contribution to the site, as well as the burden of proving what portion of the material delivered to the site was \"hazardous\" as that term is defined in the environmental statutes. The Company is aggressively defending the claim and does not believe it is likely to have a material adverse effect on the Company.\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 security holders.\nADDITIONAL INFORMATION REQUIRED IN PART I:\nExecutive Officers of the Registrant\nThe names, ages and positions of all the Executive Officers of the Company, as of March 10, 1995, are listed below together 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 or any Director or Executive Officer of the Company, nor any arrangement or understanding between any officer and any other person pursuant to which the officer was elected.\nPART II\nItem 5.","section_5":"Item 5. Market for the Company's Common Stock and Related Security Holder Matters\nCommon Stock Market Prices and Dividends and related securities matters, as discussed on Pages 7, 9, 10, 14, 29, 38 and 42 of the Annual Report to Shareholders for the year ended December 31, 1994, included in this Form 10-K Annual Report as Exhibit 13 are incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected Financial Data of The Raymond Corporation and consolidated subsidiaries, reported on Pages 9 and 10 of the Annual Report to Shareholders for the year ended December 31, 1994, included in this Form 10-K Annual Report as Exhibit 13 are 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 11 through 15 of the Annual Report to Shareholders for the year ended December 31, 1994, included in this Form 10-K Annual Report as Exhibit 13 are incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe consolidated Financial Statements of The Raymond Corporation included on Pages 16 through 38 of the Annual Report to Shareholders for the year ended December 31, 1994, included in this Form 10-K Annual Report as Exhibit 13 are incorporated herein by reference.\nQuarterly Results of Operations on Page 38, Note M and Supplemental Information on Changing Price Levels on Page 14 of the Annual Report to Shareholders for the year ended December 31, 1994, included in this Form 10-K Annual Report as Exhibit 13 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 regarding Directors required by Items 401 and 405 of Regulation S-K is disclosed under the captions \"Nominees for Election as Directors\" and \"Directors Continuing in Office\" in the Proxy Statement for the Annual Meeting of Shareholders to be held April 29, 1995 included as Exhibit 99 hereto, and is incorporated herein by reference. Information regarding Executive Officers is included in Part I of this Form 10-K and incorporated herein by reference thereto.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation regarding compensation of Directors and Executive Officers is disclosed under the captions \"Directors Remuneration; Attendance\" and \"Executive Compensation\" of the Proxy Statement for the Annual Meeting of Shareholders to be held April 29, 1995, included as Exhibit 99 hereto, and is incorporated herein by reference thereto.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThis information is disclosed under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" in the Proxy Statement for the Annual Meeting of Shareholders to be held on April 29, 1995 included as Exhibit 99 hereto, and is incorporated herein by reference thereto.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThis information is disclosed in the 1995 Proxy Statement for the Annual Meeting of Shareholders in the section captioned \"Certain Relationships and Related Transactions\" included as Exhibit 99 hereto, and is incorporated herein by reference thereto.\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. The following financial statements of the Registrant and its subsidiaries, presented on pages 16 to 38 of the Registrant's 1994 Annual Report to Shareholders, which is filed with this Form 10-K Annual Report as Exhibit 13, are incorporated herein by reference.\n2. The following Consolidated Financial Statement Schedules of The Raymond Corporation and Subsidiaries are required by Item 14(d):\nAll other schedules for which provision is made in Regulation S-X of the Securities and Exchange Commission have been omitted because they are not applicable or not required under the related instructions or because the information has been furnished elsewhere in the financial statements.\n3. See Exhibit Index at pages 17-19 of this Form 10-K.\n(b) No report on Form 8-K was filed by the registrant during the fourth quarter of its fiscal year ending December 31, 1994.\nEXHIBIT INDEX -------------\nExhibit # Description ------- ----------- 3.1 Restated and Amended Certificate of Incorporation of The Raymond Corporation. Filed as Exhibit 3.1 to the 1991 Form 10-K Annual Report of the Company and incorporated herein by reference.\n3.2 Bylaws of the Company, as amended, dated January 1, 1993. Filed as Exhibit 3.2 to the 1992 Form 10-K Annual Report of the Company and incorporated herein by reference.\n4.2 Form of Indenture between the Company and The Chase Manhatten Bank, N.A., as Trustee, and the 6.50% Convertible Subordinated Debenture due 2003, incorporated herein by reference to Registration Statement on Form S-3, Registration No. 33-71480, effective November 12, 1993.\n10.1 Joint Venture Agreement dated August 1, 1991 between Caterpillar Industrial Inc., and The Raymond Corporation. Filed as Exhibit 10.18 to the 1991 Form 10-K Annual Report of the Company and incorporated herein by reference.\n10.2 First Amendment to Joint Venture Agreement dated August 1, 1991 between Caterpillar Industrial Inc. and The Raymond Corporation dated October 22, 1992. Filed as Exhibit 10.18 to the 1992 Form 10-K Annual Report of the Company and incorporated herein by reference.\n10.3 Second Amendment to Joint Venture Agreement dated August 1, 1991 between Caterpillar Industrial Inc. and The Raymond Corporation.\n10.4 Third Amendment to Joint Venture Agreement dated August 1, 1991 between Caterpillar Industrial Inc. and The Raymond Corporation.\n10.5 Revolving Credit and Term Loan Agreement dated December 21, 1994 among The Raymond Corporation, Raymond Leasing Corporation and Chemical Bank.\n10.6 Revolving Credit and Term Loan Agreement dated February 14, 1995 among The Raymond Corporation, Raymond Leasing Corporation and The Chase Manhattan Bank, N.A.\n10.7 Raymond Leasing Corporation Senior Note Agreement dated as of March 1, 1987. Filed as Exhibit 10.6 to the 1993 Form 10-K Annual Report of the Company and incorporated herein by reference.\n10.8 Raymond Leasing Corporation Revolving Line of Credit dated April 30, 1992. Filed as Exhibit 10.7 to the 1993 Form 10-K Annual Report of the Company and incorporated herein by reference.\n10.9 Raymond Leasing Corporation Senior Note Agreement dated as of November 1, 1991. Filed as Exhibit 10.22 to the 1992 Form 10-K Annual Report of the Company and incorporated herein by reference.\nEXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS ---------------------------------------------\nExhibit # Description ------- ----------- 10.10 Consulting Agreement effective as of January 1, 1995 between Lee J. Wolf and The Raymond Corporation.\n10.11 Consulting Agreement effective as of January 1, 1995 between George G. Raymond, Jr. and The Raymond Corporation.\n10.12 Employment Agreement dated as of November 3, 1987 between Ross K. Colquhoun and The Raymond Corporation. Filed as Exhibit 10.10 to the 1990 Form 10-K Annual Report of the Company and incorporated herein by reference.\n10.13 Amendment #1 to Employment Agreement effective January 1, 1994 between Ross K. Colquhoun and The Raymond Corporation.\n10.14 Sample form of Employment Agreement between The Raymond Corporation and Company Vice Presidents. Filed as Exhibit 10.8 to the 1991 Form 10-K Annual Report of the Company and incorporated herein by reference.\n10.15 The Raymond Corporation Retirement Benefits Equalization Plan.\n10.16 The Raymond Corporation Stock Option Plan (1991).\n10.17 The Raymond Corporation Savings Plan effective January 1, 1986, amended and restated as of January 1, 1993. Filed as Exhibit 10.20 to the 1993 Form 10-K Annual Report of the Company and incorporated herein by reference.\n10.18 The Raymond Corporation Deferred Compensation Plan for Exempt Employees restated as of September 1, 1994.\n10.19 The Raymond Corporation Officer Performance Bonus Plan Formula. Filed as Exhibit 10.15 to the 1992 Form 10-K Annual Report of the Company and incorporated herein by reference.\n10.20 Profit Sharing Retirement Plan of The Raymond Corporation, Plan A, dated January 1, 1976, revised July 23, 1993. Filed as Exhibit 10.23 to the 1993 Form 10-K Annual Report of the Company and incorporated herein by reference.\n10.21 Profit Sharing Retirement Plan for Salaried Employees of The Raymond Corporation, Plan B, dated January 1, 1976, revised July 23, 1993. Filed as Exhibit 10.24 to the 1993 Form 10-K Report of the Company and incorporated herein by reference\n10.22 The Raymond Corporation Pension Plan.\nExhibit # Description ------- ----------- 11. Statement re: computation of per share earnings.\n13. Annual Report to Shareholders for the year ended December 31, 1994.\n18. Letter dated February 7, 1992 from Ernst & Young re: change in accounting principles. Filed as Exhibit 18 to the 1991 Form 10-K Annual Report of the Company and incorporated herein by reference.\n19. Filed Form 8 Report dated September 11, 1992. Filed as Exhibit 19 to the 1992 Form 10-K Annual Report of the Company and incorporated herein by reference.\n21. Subsidiaries (Direct and Indirect) of The Raymond Corporation for the year ending December 31, 1994.\n23. Consent of Independent Auditors dated March 27, 1995.\n24. Power of Attorney of Directors dated March 4, 1995.\n27. Financial Data Schedule.\n99. The Company's 1995 Proxy Statement for the Annual Meeting of Shareholders to be held on April 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.\nDate: March 29, 1995 THE RAYMOND CORPORATION ------------------------ (Registrant)\nBy: \/s\/ Ross K. Colquhoun --------------------------- Ross K. Colquhoun 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 and in the capacities and on the date indicated.\nBy: \/s\/ Ross K. Colquhoun By: \/s\/ William B. Lynn ------------------------ --------------------------- Ross K. Colquhoun William B. Lynn President, Chief Executive Executive Vice President Officer and Director Principal Financial Officer\nDate: 03\/29\/95 Date: 03\/29\/95\nBy: \/s\/ John F. Everts ------------------------- John F. Everts Corporate Controller Date: 03\/29\/95\nBy: \/s\/ George G. Raymond, Jr. By: \/s\/ Arthur M. Richardson --------------------------- -------------------------- George G. Raymond, Jr., Chairman Arthur M. Richardson, Director Date: 03\/29\/95 Date: 03\/29\/95\nBy: \/s\/ James F. Matthews By: \/s\/ M. Richard Rose --------------------------- -------------------------- James F. Matthews, Director M. Richard Rose, Director Date: 03\/29\/95 Date: 03\/29\/95\nBy: \/s\/ John E. Mott By: \/s\/ Daniel F. Senecal -------------------------- ---------------------------- John E. Mott, Director Daniel F. Senecal, Director Date: 03\/29\/95 Date: 03\/29\/95\nBy: \/s\/ Michael R. Porter -------------------------- Michael R. Porter, Director Date: 03\/29\/95\nBy: \/s\/ Lee J. Wolf --------------------- Lee J. Wolf, Director\nDate: 03\/29\/95\nTHE RAYMOND CORPORATION AND SUBSIDIARIES\nSCHEDULE I -- Condensed Financial Information of Registrant -- The Raymond Corporation\nYears ended December 31, 1994, 1993 and 1992\nCondensed Balance Sheets\nThe accompanying notes are a part of the financial statements.\nTHE RAYMOND CORPORATION AND SUBSIDIARIES\nSCHEDULE I -- Condensed Financial Information of Registrant -- The Raymond Corporation\nYears ended December 31, 1994, 1993 and 1992\nCondensed Balance Sheets\nThe accompanying notes are a part of the financial statements.\nTHE RAYMOND CORPORATION AND SUBSIDIARIES\nSCHEDULE I -- Condensed Financial Information of Registrant -- The Raymond Corporation\nYears ended December 31, 1994, 1993 and 1992\nCondensed Statements of Income\nThe accompanying notes are a part of the financial statements.\nTHE RAYMOND CORPORATION AND SUBSIDIARIES\nSCHEDULE I -- Condensed Financial Information of Registrant -- The Raymond Corporation\nYears ended December 31, 1994, 1993 and 1992\nCondensed Statements of Cash Flow\nThe accompanying notes are part of the financial statements.\nTHE RAYMOND CORPORATION AND SUBSIDIARIES\nSCHEDULE I -- Condensed Financial Information of Registrant -- The Raymond Corporation\nYears ended December 31, 1994, 1993 and 1992\nNotes to Condensed Financial Statements\nNOTE A - Basis of Presentation\nIn the parent company-only financial statements, the Company's investment in subsidiaries and unconsolidated investees is stated at cost plus equity in undistributed earnings of the subsidiaries and unconsolidated investees since the date of acquisition. Parent company-only financial statements should be read in conjunction with the Company's consolidated financial statements.\nNOTE B - Long-Term Debt\nThe 6.5% convertible subordinated debentures are convertible into shares of common stock at a rate adjusted for the 1994 5% stock dividend of approximately 56.47 shares for each $1,000 principal amount of debentures. These debentures are redeemable at prices ranging from 103.5% of principal to par depending upon the redemption date. The debentures are convertible at any time prior to maturity and are redeemable any time on or after December 15, 1996, in whole or in part, at the option of the Company.\nTHE RAYMOND CORPORATION AND SUBSIDIARIES\nSCHEDULE I -- Condensed Financial Information of Registrant -- The Raymond Corporation\nYears ended December 31, 1994, 1993 and 1992\nNotes to Condensed Financial Statements (cont'd)\nNOTE C -- Guarantee\nRaymond Leasing Corporation, a wholly-owned subsidiary of the Company, has a $12,000,000 long-term debt obligation outstanding at December 31, 1994. Under terms of the debt agreement, the Company has guaranteed the payment of all principal and interest.\nNOTE D -- Dividends from Subsidiaries and Investees\nCash dividends paid to The Raymond Corporation from unconsolidated investees accounted for under the equity method were $107,969 in 1994, $682,208 in 1993, and $1,478,658 in 1992. Cash dividends paid to The Raymond Corporation by subsidiaries were $0 in 1994, $334,000 in 1993, and $0 for 1992.\nTHE RAYMOND CORPORATION AND SUBSIDIARIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nYear Ending December 31, 1994\nA - Warranty & maintenance costs charged against reserve.\nB - Bad debt write-offs charged against reserve.\nC - Insurance costs charged against reserve.\nTHE RAYMOND CORPORATION AND SUBSIDIARIES\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nYear Ending December 31, 1993\nA -- Warranty & maintenance costs charged against reserve.\nB -- Bad debt write-offs charged against reserve.\nC -- Insurance costs charged against reserve, including for the first time the activity of self-insured retention for workers' compensation.\nTHE RAYMOND CORPORATION AND SUBSIDIARIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nYear Ending December 31, 1992\nA -- Warranty & maintenance costs charged against reserve.\nB -- Bad debt write-offs charged against reserve.\nC -- Insurance costs charged against reserve.","section_15":""}
{"filename":"63754_1994.txt","cik":"63754","year":"1994","section_1":"Item 1. Business\nThe Registrant, a diversified specialty food company, is principally engaged in the manufacture of spices, seasonings, flavorings and other specialty food products and sells such products to the retail food market, the foodservice market and to industrial food processors throughout the world. The Registrant also, through subsidiary corporations, manufactures and markets plastic packaging products for the food, cosmetic and health care industries.\nThe Registrant's Annual Report to Stockholders for 1994, which is enclosed as Exhibit 13, contains a description of the general development, during the last fiscal year, of the business of the Registrant, which was formed in 1915 under Maryland law as the successor to a business established in 1889. Pages 9 through 21 of that Report are incorporated by reference. The Registrant's net sales increased 8.9% in 1994 to $1,694,772,000 due to both sales price and volume changes.\nThe Registrant operates in one business segment and has disclosed in Note 10 of the Notes to Consolidated Financial Statements on page 35 of its Annual Report to Stockholders for 1994, which Note is incorporated by reference, the financial information about the business segment required by this Item.\nSPECIALTY FOOD BUSINESS\nThe Registrant's Annual Report to Stockholders for 1994 sets forth a description of the business conducted by the Registrant on pages 9 through 11. Those pages of the Registrant's Annual Report are incorporated by reference.\nPrincipal Products\/Marketing\nSpices, seasonings, flavorings, and other specialty food products are the Registrant's principal products. Spices, seasonings, flavorings, and other specialty food products accounted for approximately 90% of net sales on a consolidated basis during the three fiscal years ended November 30, 1994. No other product or class of similar products or services contributed as much as 10% to consolidated net sales during the last three fiscal years. The Registrant's efforts will continue to be directed primarily in the area of spices, seasonings, flavorings, and other specialty food products.\nThe Registrant markets its consumer and foodservice products through its own sales organization, food brokers and distributors. In the industrial market, sales are made mostly through the Registrant's own sales force.\nProducts\/Industry Segments\nThe Registrant has not announced or made public information about a new product or industry segment that would require the investment of a material amount of the assets of the Registrant or that otherwise is material.\nRaw Materials Many of the spices and herbs purchased by the Registrant are imported into the United States from the country of origin, although substantial quantities of particular materials, such as paprika, dehydrated vegetables, onion and garlic, and substantially all of the specialty food ingredients other than spices and herbs, originate in the United States. Some of the imported materials are purchased from dealers in the United States. The Registrant is a direct importer of certain raw materials, mainly black pepper, vanilla beans, cinnamon, herbs and seeds from the countries of origin. The principal purpose of such purchases is to satisfy the Registrant's own needs. The Registrant also sells imported raw materials to other food processors.\nThe raw materials most important to the Registrant are onion, garlic and capsicums (paprika and chili peppers), which are produced in the United States, black pepper, most of which originates in India, Indonesia, Malaysia and Brazil, and vanilla beans, a large proportion of which the Registrant obtains from the Malagasy Republic and Indonesia.\nTrademarks, Licenses and Patents\nThe Registrant owns a number of registered trademarks, which in the aggregate may be material to the Registrant's business. However, the loss of any one of those trademarks, with the exception of the Registrant's \"McCormick\" and \"Schilling\" trademarks, would not have a material adverse impact on the Registrant's business. The \"McCormick\" and \"Schilling\" trademarks are extensively used by the Registrant in connection with the sale of a substantial number of the Registrant's products in the United States. The \"McCormick\" and \"Schilling\" trademarks are registered and used in various foreign countries as well. The terms of the trademark registrations are as prescribed by law and the registrations will be renewed for as long as the Registrant deems them to be useful.\nThe Registrant has entered into a number of license agreements authorizing the use of its trademarks by persons in foreign countries. In the aggregate, the loss of those license agreements would not have a material adverse impact on the Registrant's business. The terms of the license agreements are generally 3 to 5 years or until such time as either party terminates the agreement. Those agreements with specific terms are renewable upon agreement of the parties.\nThe Registrant owns various patents, but they are not viewed as material to the Registrant's business.\nSeasonal Nature of Business\nHistorically, the Registrant's sales and profits are lower in the first two quarters of the fiscal year and increase in the third and fourth quarters.\nWorking Capital\nIn order to meet increased demand for its products during its fourth quarter, the Registrant usually builds its inventories during the second and third quarters. In common with other companies, the Registrant generally finances working capital items (inventory and receivables) through short-term borrowings, which include the use of lines of credit and the issuance of commercial paper.\nCustomers\nThe Registrant has a large number of customers for its products. No single customer accounted for as much as 10% of consolidated net sales in 1994. In the same year, sales to the five largest customers represented approximately 20% of consolidated net sales.\nBacklog Orders\nThe dollar amount of backlog orders of the Registrant's specialty food business is not material to an understanding of the Registrant's business, taken as a whole.\nGovernment Contracts\nNo material portion of the Registrant's business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.\nCompetition\nAlthough the Registrant is a leader in sales of certain spices and seasoning and flavoring products, and is the largest producer and distributor of dehydrated onions and garlic in the United States, its business is highly competitive. For further discussion, see pages 13 and 17 of the Registrant's Annual Report to Stockholders for 1994, which pages are incorporated by reference.\nResearch and Quality Control\nThe Registrant has emphasized quality and innovation in the development, production and packaging of its products. Many of the Registrant's products are prepared from confidential formulae developed by its research laboratories and product development departments. The long experience of the Registrant in its field contributes substantially to the quality of the products offered for sale. Quality specifications exist for the Registrant's products,and continuing quality control inspections and testing are performed. Total expenditures for these and other related activities during fiscal years 1994, 1993 and 1992 were approximately $39,562,000, $38,226,000, and $35,968,000 respectively. Of these amounts, expenditures for research and development amounted to $12,999,000 in 1994, $12,259,000 in 1993, and $11,844,000 in 1992. The amount spent on customer-sponsored research activities is not material.\nEnvironmental Regulations\nCompliance with Federal, State and local provisions related to protection of the environment has had no material effect on the Registrant's business. No material capital expenditures for environmental control facilities are expected to be made during this fiscal year or the next.\nEmployees\nThe Registrant had on average approximately 8,900 employees during fiscal year 1994.\nForeign Operations\nInternational businesses have made significant contributions to the Registrant's growth and profits. In common with other companies with foreign operations, the Registrant is subject in varying degrees to certain risks typically associated with doing business abroad, such as local economic and market conditions, exchange and price controls, restrictions on investment, royalties and dividends and exchange rate fluctuations.\nNote 10 of the Notes to Consolidated Financial Statements on page 35 of the Registrant's Annual Report to Stockholders for 1994, and page 13 of the Registrant's Annual Report to Stockholders for 1994 contain the information required by subsection (d) of Item 101 of Regulation S-K, which pages are incorporated by reference.\nPackaging Operations\nThe Registrant's Annual Report to Stockholders for 1994 sets forth a description of the Registrant's packaging group on page 11, which page is incorporated by reference. Setco, Inc. and Tubed Products, Inc., which comprise Registrant's packaging group, are wholly owned subsidiaries of the Registrant and are, respectively, manufacturers of plastic bottles and plastic squeeze tubes.\nSubstantially all of the raw materials used in the packaging business originate in the United States. The market for plastic packaging is highly competitive. The Registrant is the largest single customer of the packaging group. All intracompany sales have been eliminated from the Registrant's consolidated financial statements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe location and general character of the Registrant's principal plants and other materially important physical properties are as follows:\n(a) Consumer Products\nA plant is located in Hunt Valley, Maryland on approximately 52 acres in the Hunt Valley Business Community. This plant, which contains approximately 540,000 square feet, is owned in fee and is used for processing and distributing spices and other food products. A plant of approximately 475,000 square feet located in Salinas, California is owned in fee and is used for milling, processing, packaging, and distributing spices and other food products.\n(b) Industrial Products\n(i)A plant complex is located in Gilroy, California consisting of connected and adjacent buildings owned in fee and providing approximately 894,000 square feet of space for milling, dehydrating, packaging, warehousing and distributing onion, garlic and capsicums. Adjacent to this plant is a 4.3 acre cogeneration facility which supplies steam to the dehydration business as well as electricity to Pacific Gas & Electric Company. The cogeneration facility was financed with an installment note secured by the property and equipment. This note is non-recourse to the Registrant.\n(ii)The Registrant has two principal plants devoted to industrial flavoring products in the United States. A plant of 102,000 square feet is located in Hunt Valley, Maryland and is owned in fee. A plant of 102,400 square feet is located in Dallas, Texas and is owned in fee.\n(c) Spice Milling\nLocated adjacent to the consumer products plant in Hunt Valley is a spice milling and cleaning plant which is owned in fee by the Registrant and contains approximately 185,000 square feet. This plant services all food product groups of the Registrant. Much of the milling and grinding of raw materials for Registrant's seasoning products is done in this facility.\n(d) Packaging Products\nThe Registrant has four principal plants which are devoted to the production of plastic containers. The facilities are located in California, Massachusetts, New York and New Jersey, and range in size from 178,000 to 280,000 square feet. The plants in New York and New Jersey are leased.\n(e) International\nThe Registrant has a plant in London, Ontario which is devoted to the processing, packaging and distribution of food products. This facility is approximately 145,000 square feet and is owned in fee.\n(f) Research and Development\nThe Registrant has a facility in Hunt Valley , Maryland which houses the research and development laboratories and the technical capabilities of the industrial division. The facility is approximately 109,000 square feet and is owned in fee.\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 to which any of their property is subject.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matter was submitted during the fourth quarter of Registrant's fiscal year 1994 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 Registrant has disclosed at page 19 of its Annual Report to Stockholders for 1994, which page is incorporated by reference, the information relating to the market, market quotations, and dividends paid on Registrant's common stocks required by this Item.\nThe approximate number of holders of common stock of the Registrant based on record ownership as of January 31, 1995 was as follows:\nApproximate Number Title of Class of Record Holders\nCommon Stock, no par value 2,086 Common Stock Non-Voting, 10,880 no par value\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe Registrant has disclosed the information required by this Item in the Historical Financial Summary of its Annual Report to Stockholders for 1994 at pages 20 and 21, which pages are incorporated by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe Registrant's Annual Report to Stockholders for 1994 at pages 12 through 19 contains a discussion and analysis of the Company's financial condition and results of operations for the three fiscal years ended November 30, 1994. Said pages are incorporated by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data for McCormick & Company, Incorporated are included on pages 23 through 36 of the Annual Report to Stockholders for 1994, which pages are incorporated by reference. The report of independent auditors from Ernst & Young on such financial statements is included on page 37 of the Annual Report to Stockholders for 1994; the supplemental schedule for 1992, 1993 and 1994 is included on page 14 of this Report on Form 10-K.\nThe unaudited quarterly data required by Item 302 of Regulation S-K is included in Note 11 of the Notes to Consolidated Financial Statements at page 36 of the Registrant's Annual Report to Stockholders for 1994, which Note is incorporated by reference.\nItem 9.","section_9":"Item 9. Changes in and None. Disagreements with Accountants on Accounting and Financial Disclosure.\nPART III Item 10.","section_9A":"","section_9B":"","section_10":"","section_11":"Item 11.Executive Registrant's Proxy Compensation. Statement dated February 15, 1995\/Pages 9-18.\nItem 12.","section_12":"Item 12.Security Ownership Registrant's Proxy of Certain Statement dated February Owners and Management.15, 1995\/Pages 4-7.\nItem 13.","section_13":"Item 13.Certain Relationships Registrant's Proxy and Related Statement dated February Transactions. 15, 1995\/Page 7.\nPART IV Item 14.","section_14":"","section_15":""}
{"filename":"808450_1994.txt","cik":"808450","year":"1994","section_1":"ITEM 1. BUSINESS\nNavistar International Corporation is a holding company and its principal operating subsidiary is Navistar International Transportation Corp. referred to as \"Transportation\". As used hereafter, \"Navistar\" or \"Company\" refers to Navistar International Corporation and its subsidiaries and \"Parent Company\" refers to Navistar International Corporation alone.\nNavistar, through its wholly-owned subsidiary Transportation, operates in one principal business segment, the manufacture and marketing of Class 5 through 8 diesel trucks, including school bus chassis, mid- range diesel engines and service parts in the United States and Canada and in selected export markets. Transportation is the industry market share leader in the combined Class 5 through 8 truck market in the United States and Canada, offering a full line of diesel-powered products in the common carrier, private carrier, government\/service, leasing, construction, energy\/petroleum and student transportation markets. Transportation also produces mid-range diesel engines for use in its Class 5, 6 and 7 medium trucks and for sale to original equipment manufacturers. Transportation markets its products through an extensive distribution network which includes 951 dealer and distribution outlets in the United States and Canada. Service and customer support are also supplied at these outlets. As a further extension of its business, Transportation provides financing and insurance for its dealers, distributors and retail customers through its wholly-owned subsidiary, Navistar Financial Corporation, referred to as \"Navistar Financial\". See \"Important Supporting Operations\".\nTHE MEDIUM AND HEAVY TRUCK INDUSTRY\nThe market in which Navistar competes is subject to considerable volatility as it moves in response to cycles in the overall business environment and is particularly sensitive to the industrial sector which generates a significant portion of the freight tonnage hauled. Government regulation has impacted and will continue to impact trucking operations and efficiency and the specifications of equipment.\nThe following table shows retail deliveries in the combined United States and Canadian markets for the five years ended October 31, 1994, in thousands of units. YEARS ENDED OCTOBER 31, -----------------------\n1994 1993 1992 1991 1990 ---- ---- ---- ---- ---- Class 5, 6 and 7 medium trucks and school bus chassis ..... 134.2 122.5 118.3 120.1 149.8 Class 8 heavy trucks ......... 205.4 166.4 125.2 109.0 139.0 ----- ----- ----- ----- ----- Total ...................... 339.6 288.9 243.5 229.1 288.8 ===== ===== ===== ===== =====\nSource: Based upon monthly data by the American Automobile Manufacturers Associations (AAMA) in the United States and Canada and other sources.\nThe truck market in the United States and Canada is highly competitive. Major domestic competitors include PACCAR, Ford and General Motors, as well as foreign-controlled manufacturers, such as Freightliner, Mack and Volvo GM. In addition, manufacturers from Japan (Hino, Isuzu, Nissan and Mitsubishi) are competing in the United States and Canadian markets. The intensity of this competitiveness, which is expected to continue, results in price discounting and margin pressures throughout the industry. In addition to the influence of price, market position is driven by product quality, engineering, styling and utility and a comprehensive distribution system.\nTRANSPORTATION MARKET SHARE\nTransportation delivered 91,600 Class 5 through 8 trucks in the United States and Canada in fiscal 1994, a 15% increase from the 79,800 in 1993. Navistar's combined share of the Class 5 through 8 truck market in 1994 was 27%. Transportation has been the leader in combined market share for Class 5 through 8 trucks, including school bus chassis, in the United States and Canada in each of its last 14 fiscal years.\nPRODUCTS AND SERVICES\nThe following table illustrates the percentage of Transportation's sales by class of product based on dollar amount:\nYEARS ENDED OCTOBER 31, --------------------------\nPRODUCT CLASS 1994 1993 1992 - ------------- ---- ---- ----\nClass 5, 6 and 7 medium trucks and school bus chassis ..... 32% 31% 36% Class 8 heavy trucks ......... 42 44 39 Service parts ................ 14 14 15 Engines ...................... 12 11 10 ---- ---- ---- Total ...................... 100% 100% 100% ==== ==== ====\nTransportation offers a full line of Class 5 through 8 trucks, with the objective of serving the customer better and more effectively by addressing requirements for increased performance and value. Transportation has made continuing improvements in its Class 8 heavy truck image. In 1994, new products were introduced including integrated sleeper cabs (Pro Sleeper) in four sizes, anti-lock brakes as standard equipment on 9000 series conventionals and cabovers, and changes in the 5000 series of trucks (Paystar) which improve weight distribution. In addition, the new T444E diesel engine was introduced in 1994 as the first fully electronic mid-range diesel engine produced. This engine will further enhance Class 5, 6 and 7 medium truck operating performance and life.\nTransportation was recognized at the industry's largest trade show of the year by winning the award for the \"Most Significant Powered Vehicle\" for the 9200 Premium Conventional tractor with the all-new 51\" Hi-Rise Pro Sleeper. According to a recent survey conducted by J. D. Power and Associates on 1994 Medium-Duty Truck Customer Satisfaction, Navistar ranked number one in customer satisfaction in product and service for Class 5, 6 and 7 medium conventional trucks for the second consecutive year.\nFor over two decades, Transportation has been the leading supplier of school bus chassis in the United States. Chassis are sold through dealers and national account managers for delivery to the ultimate customers: school districts and contractors. Transportation manufactures chassis for conventional school buses, as well as chassis for use in small capacity buses designed to meet the needs of disabled students. In addition to its traditional chassis business, Transportation has invested in American Transportation Corporation (AmTran), a manufacturer of school bus bodies. Through its relationship with AmTran, Transportation participates in the trend toward the integrated design and manufacture of school buses, which offers the potential for improved production and marketing efficiencies and a reduction in the school bus order cycle.\nTransportation offers only diesel-powered trucks and buses because of their improved fuel economy, ease of serviceability and greater durability over gasoline-powered vehicles. Transportation's Class 8 heavy trucks generally use diesel engines purchased from outside suppliers however, in 1994, it began offering the new T444E engine for use in its heavy trucks. Class 5, 6 and 7 medium trucks are powered by diesel engines manufactured by Transportation. In 1993, Transportation launched its all new world class series of in-line six cylinder diesel engines for bus and Class 5 through 8 truck models. Transportation is the leading supplier of mid- range diesel engines in the 150-300 horsepower range according to data supplied by a private research firm, Power Systems Research of Minneapolis, Minnesota. Based upon information published by R.L. Polk & Company, diesel-powered Class 5, 6 and 7 medium truck shipments represented 81% of all medium truck shipments for fiscal year 1994 in the United States and Canada.\nTransportation's truck manufacturing operations in the United States and Canada consist principally of the assembly of components manufactured by its suppliers, although Transportation produces its own mid-range diesel truck engines, sheet metal components (including cabs) and miscellaneous other parts.\nThe following is a summary of Transportation's truck manufacturing capacity utilization for the five years ended October 31, 1994.\nYEARS ENDED OCTOBER 31, -----------------------\n1994 1993 1992 1991 1990 ------ ------ ------ ------ ------ Production units ............ 94,993 88,274 73,901 70,502 80,737 Total production capacity ... 112,966 106,032 106,088 106,762 114,402 Capacity utilization ........ 84.1% 83.3% 69.7% 66.0% 70.6%\nTotal production capacity varies as a result of changes in the number of days of production during a year as well as changes in production constraints.\nENGINE & FOUNDRY\nTransportation builds diesel engines for use in its Class 5, 6 and 7 medium trucks, school buses, selected Class 8 heavy truck models and for sale to original equipment manufacturers. Production in 1994 totalled 192,400 units, an increase of 9.7% from the 175,500 units produced in 1993.\nTransportation has completed a major capital investment in its engine products and facilities to manufacture a new generation of mid-range diesel engines in both the in-line six cylinder and V-8 configurations. This new generation of engines is designed to respond to customer demands for engines that have more power, improved fuel economy, longer life, and meet current emission requirements through 1997. The engines are offered in a wider horsepower range than previously offered, which will give Transportation an opportunity to expand the number of applications for its engines and broaden its customer base. Transportation believes that its family of diesel engines, each designed to provide superior performance in customer applications, offers both the lowest cost of ownership and excellent value to its customers.\nIn September 1993, Transportation introduced three new in-line six cylinder engines that replaced its long-standing DT family of engines in International Class 5, 6 and 7 medium trucks. These new engines, the DT 466 [175-230 HP], DT 466 High Torque [195-250 HP] and the International 530 [250-300 HP] offer displacements of 466 and 530 cubic inches. These in-line six cylinder products feature 20 percent longer life as a result of larger main and rod bearings, stronger crankshafts, and gear driven accessories. In 1995, full electronic control of the fuel system will be incorporated into three new six-cylinder engine models, the DT 466E, DT 466E High Torque and International 530E. These electronically controlled engines will offer the customer a flexible array of features such as cruise control, self diagnostics and an engine protection system.\nTransportation is the first to offer a totally electronic mid-range diesel engine family which meets emissions standards without the use of catalytic converters. With the introduction of the 8.7 Liter 530 and 530E engines, Transportation offers to customers who, in the past have only been able to purchase larger 10 Liter class engines, a lighter-weight, more cost-effective product.\nIn February 1994, Transportation replaced the 7.3 Liter V-8 diesel engine with an entirely new product. The T444E is a 444 cubic inch V-8 engine with an electronically controlled fuel injection system. This new diesel engine offers significant customer advantages, with a 10 to 15 percent improvement in fuel economy, 30 to 40 percent enhancement in durability, and improved power and torque when compared to Transportation's 7.3 Liter V-8 product. The new V-8 also meets current emissions requirements cost-effectively and includes such optional features as electronic cruise control, electronically controlled power take-off and diagnostic capabilities.\nBased on U.S. registrations published by R.L. Polk & Company, the T444E electronically controlled diesel engine is the leading engine of its class. In addition to its strong contribution to the market position of Transportation's medium trucks, a light truck version, marketed as the 7.3 Liter Direct Injection Diesel, has had significant external sales. Transportation has entered into an agreement to supply this new V-8 product to a major automotive company through the year 2000 for use in all of its diesel-powered light trucks and vans. Sales of this engine to the automotive company currently accounts for approximately 88% of Navistar's 444E sales. Shipments to all original equipment manufacturers totalled a record 130,600 units in 1994, an increase of 11% from the 118,200 units shipped in 1993.\nThe following is a summary of Transportation's engine capacity utilization for the five years ended October 31, 1994.\nYEARS ENDED OCTOBER 31, -----------------------\n1994 1993 1992 1991 1990 ------- ------- ------- ------- ------- Engine production units ..... 192,446 175,464 148,991 126,103 160,434 Total production capacity ... 188,000 166,260 166,260 166,720 166,720 Capacity utilization ........ 102.4% 105.5% 89.6% 75.6% 96.2%\nTotal production capacity varies as a result of changes in product mix.\nTransportation is exploring the development of alternative fuel engines, including engines powered by compressed natural gas. Transportation has entered into an agreement with Detroit Diesel Corporation to develop a natural gas engine based on Transportation's new V-8 engine and Detroit Diesel's electronic alternative fuel technology.\nSERVICE PARTS\nThe service parts business is a significant contributor to Transportation's sales and gross margin and to the maintenance of its Class 5 through 8 truck and engine customer base. In the United States and Canada, Transportation operates seven regional parts distribution centers, which allows it to offer 24-hour availability and same day shipment of the parts most frequently requested by customers. Transportation is undertaking initiatives to increase parts sales outside of the United States and Canada. As customers have explored ways to reduce their costs and improve efficiency, Transportation and its dealers have established programs to help them manage the parts and maintenance aspects of their businesses more efficiently. Transportation also offers a \"Fleet Charge\" program, which allows participating customers to purchase parts on credit at all of its dealer locations at consistent and competitive prices. In 1994, service parts sales increased as a result of higher net selling prices, export business expansion and growth in dealer and national accounts.\nMARKETING AND DISTRIBUTION\nUnited States and Canadian Operations. Transportation's truck products are distributed in virtually all key markets in the United States and Canada through the largest retail organization specializing in medium and heavy trucks. As part of its continuing program to adapt to changing market conditions, Transportation has been assisting dealers to expand their operations to better serve their customer base. Transportation's truck distribution and service network in the United States and Canada was composed of 951, 950 and 952 dealers and retail outlets at October 31, 1994, 1993 and 1992, respectively. Included in these totals were 473, 467 and 460 secondary and associate locations at October 31, 1994, 1993 and 1992, respectively.\nRetail dealer activity is supported by 5 regional operations in the United States and a general office in Canada. A national account sales group is responsible for 155 major national account customers.\nTransportation's 10 retail and 4 wholesale used truck centers in the United States and Canada provide sales and trade-in benefits to its dealers and retail customers.\nInternational Operations. Transportation exports trucks, components and service parts, both wholesale and retail, to more than 70 countries around the world. In 1994, 5,100 trucks were exported while 5,300 trucks were exported in 1993. Cumulatively, from 1986 through 1994, Transportation was the leading North American exporter of Class 6-8 trucks, according to data provided by the AAMA.\nIn Mexico, Transportation has an agreement with DINA Camiones, S.A. (DINA) to supply product technology, components and technical services for assembly of DINA trucks and buses. In 1994, Transportation exported almost 10,000 engines to DINA, bringing the total engines shipped to approximately 30,000 over the past three years. Transportation also has initiated sales of the in-line six cylinder family of mid-range diesel engines to Perkins Group, Ltd., of Peterborough, England, for worldwide distribution and to Detroit Diesel Corporation, the North American distributor of Perkins.\nNAVISTAR FINANCIAL CORPORATION\nNavistar Financial is engaged in the wholesale, retail and to a lesser extent lease financing of new and used trucks sold by Transportation and its dealers in the United States. Navistar Financial also finances wholesale accounts and selected retail accounts receivable of Transportation. Sales of new products (including trailers) of other manufacturers are also financed regardless of whether designed or customarily sold for use with Transportation's truck products. During fiscal 1994 and 1993, Navistar Financial provided wholesale financing for 93% and 90%, respectively, of the new truck units sold by Transportation to its dealers and distributors in the United States. Navistar Financial also provided retail financing in fiscal 1994 for approximately 15% of the new truck units sold by Transportation and its dealers and distributors in the United States, unchanged from fiscal 1993.\nNavistar Financial's wholly-owned insurance subsidiary, Harco National Insurance Company, provides commercial physical damage and liability insurance coverage to Transportation's dealers and retail customers and to the general public through an independent insurance agency system.\nIMPORTANT SUPPORTING OPERATIONS\nThird Party Sales Financing Agreements. In the United States, Transportation has an agreement with Associates Commercial Corporation (Associates) to provide wholesale financing to certain of its truck dealers and retail financing to their customers. During fiscal 1994 and 1993, Associates provided 7% and 10%, respectively, of the wholesale financing utilized by Transportation's dealers and distributors.\nNavistar International Corporation Canada has an agreement with a subsidiary of General Electric Canadian Holdings Limited to provide financing for Canadian dealers and customers.\nForeign Insurance Subsidiaries. Harbour Assurance Company of Bermuda Limited offers a variety of programs to the Company, including general liability insurance, ocean cargo coverage for shipments to and from foreign distributors and reinsurance coverage for various Transportation policies. The company writes minimal third party coverage and provides a variety of insurance programs to Transportation, its dealers, distributors and customers.\nCAPITAL EXPENDITURES AND RESEARCH AND DEVELOPMENT\nTransportation designs and manufactures its trucks and diesel engines to meet or exceed specific industry requirements. New products are introduced and improvements are made, in accordance with operating plans and market requirements and not on a predetermined cycle.\nDuring 1994, capital expenditures totalled $87 million. Major program expenditures included continued investment in machinery and equipment at the Melrose Park, Illinois and Indianapolis, Indiana engine facilities to manufacture mid-range diesel engines used in trucks and school bus chassis manufactured by the Company and also sold to original equipment manufacturers. Other expenditures were made for truck product improvements, modernization of facilities and compliance with environmental regulations.\nDuring 1993, capital expenditures totalled $110 million. Major product program expenditures included investment at the Melrose Park, Illinois and Indianapolis, Indiana engine facilities to manufacture a new series of mid-range diesel engines for use within the Company's truck products and for sale to original equipment manufactures. Other expenditures were made for truck product improvements, modernization of facilities and compliance with environmental regulations. In 1992, capital expenditures were $55 million.\nProduct development is an ongoing process at Transportation. Research and development activities are directed toward the introduction of new products and improvements of existing products and processes used in their manufacture. Spending for company-sponsored activities totalled $95 million in 1994 and 1993 and $90 million in 1992.\nBACKLOG\nThe backlog of unfilled truck orders (subject to cancellation or return in certain events) was as follows:\nAT OCTOBER 31 MILLIONS OF DOLLARS UNITS ------------- ------------------- ------\n1994 ...... $ 4,197 64,841 1993 ...... $ 1,353 23,939 1992 ...... $ 1,124 20,456\nAlthough the backlog of unfilled orders is one of many indicators of market demand, many factors may affect point-in-time comparisons such as changes in production rates, available capacity, new product introductions and competitive pricing actions.\nEMPLOYEES\nThe following table summarizes employment levels as of the end of fiscal years 1992 through 1994:\nTOTAL AT OCTOBER 31 EMPLOYMENT ------------- ----------\n1994 ....................... 14,910 1993 ....................... 13,612 1992 ....................... 13,945\nTo meet the increased customer demand, additional production workers were employed at the Chatham, Ontario and Springfield, Ohio Truck Facilities and at the Melrose Park, Illinois and Indianapolis, Indiana Engine Facilities.\nLABOR RELATIONS\nAt October 31, 1994, the United Automobile, Aerospace and Agricultural Implement Workers of America (UAW) represented 8,278 of the Company's active employees in the United States, and the Canadian Auto Workers (CAW) represented 1,873 of the Company's active employees in Canada. Other unions represented 1,015 of the Company's active employees in the United States and Canada. The Company entered into collective bargaining agreements with the UAW and CAW in 1993 which expire on October 1, 1995 and October 24, 1996, respectively.\nPATENTS AND TRADEMARKS\nTransportation continuously obtains patents on its inventions and thus owns a significant patent portfolio. Additionally, many of the components which Transportation purchases for its products are protected by patents that are owned or controlled by the component manufacturer. Transportation has licenses under third party patents relating to its products and their manufacture, and Transportation grants licenses under its patents. The royalties paid or received under these licenses are not significant. No particular patent or group of patents is considered by Transportation to be essential to its business as a whole.\nLike all businesses which offer well-known products or services, Transportation's primary trademarks symbolize the Company's goodwill and provide instant identification of its products and services in the marketplace and thus, are an important part of its worldwide sales and marketing efforts. To support these efforts, Transportation maintains, or has pending, registrations of its primary trademarks in those countries in which it does business or expects to do business.\nRAW MATERIALS AND ENERGY SUPPLIES\nTransportation purchases raw materials, parts and components from numerous outside suppliers but relies upon some suppliers for a substantial number of components for its truck products. Transportation's purchasing strategies have been designed to improve access to the lowest cost, highest quality sources of raw materials, parts and components, and to reduce inventory carrying requirements. A portion of Transportation's requirements for raw materials and supplies is filled by single source suppliers.\nThe impact of an interruption in supply will vary by commodity. Some parts are generic to the industry while others are of a proprietary design requiring unique tooling which would require time to recreate. However, the Company's exposure to a disruption in production as a result of an interruption of raw materials and supplies is no greater than the industry as a whole. In order to remedy any losses resulting from an interruption in supply, the Company maintains contingent business interruption insurance for storms, fire and water damage. In 1994, as a result of industry-wide growth and demand, several suppliers experienced capacity constraints which created interruptions in the flow of supplies to the Company.\nIMPACT OF GOVERNMENT REGULATION\nTruck and engine manufacturers continue to face increasing governmental regulation of their products, especially in the areas of environment and safety. The Company believes its products comply with all applicable environmental and safety regulations.\nAs a diesel engine manufacturer, the Company has incurred significant research and tooling costs to totally redesign its engine product lines to meet United States Environmental Protection Agency (U.S. EPA) and California Air Resources Board (CARB) emission standards effective in the 1994 model year. The Company faces significant additional outlays through 1998 to meet further tightening of these standards. The Company expects that its diesel engines will be able to meet all of these standards in the required time-frame. However, compliance with California's 1998 Ultra- Low-Emission Vehicle (ULEV) standards for medium-size vehicles (which includes vehicles up to 14,000 lbs. Gross Vehicle Weight Rating - GVWR) will require the use of alternative fuels. The Company expects to have products available to meet these standards prior to 1998.\nEmissions regulations in Canada and Mexico are similar, but not identical, to the U.S. federal regulations. Although Canada's regulations impose standards equivalent only to the U.S. standards for the 1990 model year, diesel engine manufacturers, including the Company, have voluntarily signed several memorandums of understanding with the Canadian federal government, agreeing to sell only engines meeting the 1994 U.S. emission standards in model years 1995 to 1997. Mexico has adopted the U.S. heavy diesel engine emission standards as of the 1994 model year but has conditioned compliance on the availability of low-sulfur diesel fuel. The Mexican government is expected to complete the conversion of diesel fuel supplies nationwide to low-sulfur fuel in mid-1995.\nTruck manufacturers are also subject to various noise standards imposed by federal, state and local regulations. The engine is one of a truck's primary noise sources, and the Company therefore works closely with original equipment manufacturers to develop strategies to reduce engine noise. The Company is also subject to the National Traffic and Motor Vehicle Safety Act (Safety Act) and Federal Motor Vehicle Safety Standards (Safety Standards) promulgated by the National Highway Traffic Safety Administration. The Company believes it is in compliance with the Safety Act and the Safety Standards.\nExpenditures to comply with various environmental regulations relating to the control of air, water and land pollution at production facilities and to control noise levels and emissions from Transportation's products have not been material except for the Wisconsin Steel and Solar Turbine sites.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nTransportation has 7 manufacturing and assembly plants in the United States and 1 in Canada. All plants are owned by Transportation. The aggregate floor space of these 8 plants is approximately 8 million square feet.\nTransportation also owns or leases other significant properties in the United States and Canada, including a paint facility, a small component fabrication plant, vehicle and parts distribution centers, sales offices, engineering centers and its headquarters in Chicago.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nENVIRONMENTAL MATTERS - ---------------------\nBeginning in March 1984, Transportation received several enforcement notices from the U.S. EPA, all of which relate to Transportation's painting activities at its Springfield, Ohio assembly and body plants. The notices alleged that these painting activities violated the Federal Clean Air Act because the paint contained volatile organic compounds (VOC) in greater quantities than permitted under applicable Ohio regulations (the VOC Regulations). In an administrative action instituted under Section 120 of the Clean Air Act, begun in September 1984, U.S. EPA sought to recover a noncompliance penalty, measured as the costs allegedly saved by Transportation by not complying with the VOC Regulations at the assembly plant.\nIn a court action instituted under Section 113(b) of the Clean Air Act, the United States filed civil complaints pertaining to the assembly plant (filed on April 30, 1985) and the body plant (filed on November 3, 1986) in the U.S. District Court in the Southern District of Ohio. These complaints asked the judge to impose fines of up to $25,000 per violation of the VOC Regulations per day since December 31, 1982. In November 1994, Transportation and U.S. EPA concluded a settlement of both the administrative action and the court action. The settlement included a payment of $2.7 million by Transportation.\nOTHER MATTERS - -------------\nIn May 1993, a jury issued a verdict in favor of Vernon Klein Truck & Equipment, Inc. and against Transportation in the amount of $10.8 million in compensatory damages and $15 million in punitive damages. The Company appealed the verdict and in order to do so was required to post a bond collateralized with $30 million in cash. In November 1994, the Court of Appeals of the State of Oklahoma reversed the verdict and entered judgement in favor of Transportation on virtually all aspects of the case. The bond and related collateral will be released when the order of the Court of Appeals is filed.\nTransportation and the Economic Development Administration (EDA), a division of the U.S. Department of Commerce reached an agreement in the fourth quarter of 1994 in settlement of commercial and environmental disputes related to the Wisconsin Steel property. EDA and Transportation became 90% and 10% beneficiaries, respectively, of a trust which was created after the party that purchased Wisconsin Steel filed for bankruptcy. At the time of bankruptcy, EDA had guaranteed repayment of 90% and Transportation of 10% of loans made to Wisconsin Steel. The settlement provides that EDA transfer its interest in the trust to Transportation, which in turn will assume responsibility for completing the investigation of the environmental condition at the site and for any cleanup work that may be necessary. Transportation has agreed to pay EDA $11 million to settle various commercial issues as well as reimburse them for a portion of environmental response costs spent by EDA. The Department of Justice must approve the final settlement before the interest in the trust, or the property, is transferred to Transportation.\nThe Company and its subsidiaries are subject to various other claims arising in the ordinary course of business, and are parties to various legal proceedings which constitute ordinary routine litigation incidental to the business of the Company and its subsidiaries. In the opinion of the Company's management, none of these proceedings or claims are material to the business or the financial condition of the Company.\nEXECUTIVE OFFICERS\nThe following selected information for each of the Company's current executive officers was prepared as of November 4, 1994.\nOFFICERS AND POSITIONS WITH NAME AGE NAVISTAR AND OTHER INFORMATION ---- --- ----------------------------------\nJames C. Cotting ....... 61 Chairman and Chief Executive Officer since 1987 and a Director since 1983. Mr. Cotting also is Chairman and Chief Executive Officer of Transportation since 1990 and a Director since 1987. Prior to this, Mr. Cotting served as Vice Chairman and Chief Financial Officer, 1983-1987.\nJohn R. Horne .......... 56 President and Chief Operating Officer and a Director since 1990. Mr. Horne also is President and Chief Operating Officer of Transportation since 1990 and a Director since 1987. Prior to this, Mr. Horne served as Group Vice President and General Manager, Engine and Foundry, 1990 and Vice President and General Manager, Engine and Foundry, 1983-1990.\nRobert C. Lannert ...... 54 Executive Vice President and Chief Financial Officer and a Director since 1990. Mr. Lannert also is Executive Vice President and Chief Financial Officer of Transportation since 1990 and a Director since 1987. Prior to this, Mr. Lannert served as Vice President and Treasurer, 1987-1990 and Vice President and Treasurer of Transportation, 1979-1990.\nRobert A. Boardman ...... 47 Senior Vice President and General Counsel since 1990. Mr. Boardman also is Senior Vice President and General Counsel of Transportation since 1990. Prior to this, Mr. Boardman served as Vice President of Manville Corporation, 1988-1990 and Corporate Secretary, 1983-1990.\nThomas M. Hough ......... 49 Vice President and Treasurer since 1992. Mr. Hough also is Vice President and Treasurer of Transportation since 1992. Prior to this, Mr. Hough served as Assistant Treasurer 1987-1992, and Assistant Treasurer of Transportation, 1987-1992. Mr. Hough also served as Assistant Controller, Accounting and Financial Systems, 1987 and Controller of Navistar Financial Corporation, 1982-1987.\nRobert I. Morrison ...... 56 Vice President and Controller since 1987. Mr. Morrison also is a Vice President and Controller of Transportation since 1985. Prior to this, Mr. Morrison served as Assistant Treasurer and Vice President, Finance and Planning, International Group, 1983-1985.\nSteven K. Covey ......... 43 Corporate Secretary since 1990. Mr. Covey is Associate General Counsel of Transportation since November 1992. Prior to this, Mr. Covey served as General Attorney, Finance and Securities of Transportation, 1989-1992, Senior Counsel, Finance and Securities, 1986-1989 and Senior Attorney, Corporate Operations 1984-1986.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot Applicable\nPART II\nThe information required by Items 5-8 is incorporated herein by reference from the 1994 Annual Report to Shareowners, filed as Exhibit 13 to this Form 10-K as follows: Annual Report Page ------ ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ......... 65\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ................. 63\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION ................. 4\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA .................. 19\nWith the exception of the aforementioned information (Part II; Items 5-8) and the information specified under Items 1 and 14 of this report, the 1994 Annual Report to Shareowners is not to be deemed filed as part of this report.\n---------------------------------------\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nPART III\nITEMS 10, 11, 12 AND 13\nInformation required by Part III (Items 10, 11, 12 and 13) of this Form is incorporated herein by reference from Navistar's definitive Proxy Statement for the March 15, 1995 Annual Meeting of Shareowners.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nInformation required by Part IV (Item 14) of this form is incorporated herein by reference from Navistar International Corporation's 1994 Annual Report to Shareowners, filed as Exhibit 13 to this Form 10-K as follows:\nAnnual Report Page ------ Financial Statements - --------------------\nStatement of Income (Loss) for the years ended October 31, 1994, 1993 and 1992 ................ 19 Statement of Financial Condition as of October 31, 1994 and 1993 ...................... 21 Statement of Cash Flow for the years ended October 31, 1994, 1993 and 1992 ................ 23 Statement of Non-Redeemable Preferred, Preference and Common Shareowners' Equity for the years ended October 31, 1994, 1993 and 1992 .......... 25 Notes to Financial Statements .................... 27\nForm 10-K Schedules Page - --------- ----\nVIII - Valuation and Qualifying Accounts and Reserves .........................\nAll other schedules are omitted because of the absence of the conditions under which they are required or because information called for is shown in the financial statements and notes thereto in the 1994 Annual Report to Shareowners.\nFinance and Insurance Subsidiaries:\nThe financial statements of Navistar Financial Corporation for the years ended October 31, 1994, 1993 and 1992 appearing on pages 9 through 11 in Annual Report on Form 10-K for Navistar Financial Corporation for the fiscal year ended October 31, 1994, Commission No. 1-4146-1, are incorporated herein by reference and filed as Exhibit 28 to this Form 10-K.\nFinancial information regarding all Navistar subsidiaries engaged in finance and insurance operations, including Navistar Financial Corporation, appears as supplemental information to the Financial Statements in the Navistar 1994 Annual Report to Shareowners and is incorporated herein by reference.\nExhibits, Including those Incorporated by Reference Form 10-K Page - --------------------------------------------------- --------------\n(3) Articles of Incorporation and By-Laws ..... E-1 (4) Instruments Defining the Rights of Security Holders, including Indentures E-2 (10) Material Contracts ....................... E-3 (11) Computation of Net Income (Loss) Per Common Share ....................... E-5 (13) Navistar International Corporation 1994 Annual Report to Shareowners ...... N\/A (22) Subsidiaries of the Registrant ........... E-6 (23) Independent Auditors' Consent ............ 21 (24) Power of Attorney ........................ 19 (28) Navistar Financial Corporation Annual Report on Form 10-K for the fiscal year ended October 31, 1994 ............ N\/A\nAll exhibits other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information called for is shown in the financial statements and notes thereto in the 1994 Annual Report to Shareowners.\nReports on Form 8-K - -------------------\nNo reports on Form 8-K were filed for the three months ended October 31, 1994.\nSIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n----------------------------------\nSIGNATURE\nPursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNAVISTAR INTERNATIONAL CORPORATION - ---------------------------------- (Registrant)\n\/s\/ Robert I. Morrison - ---------------------------------- Robert I. Morrison January 27, 1995 Vice President and Controller (Principal Accounting Officer)\nSIGNATURE EXHIBIT 24 NAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n----------------------------------\nPOWER OF ATTORNEY\nEach person whose signature appears below does hereby make, constitute and appoint James C. Cotting and Robert I. Morrison and each of them acting individually, true and lawful attorneys-in-fact and agents with power to act without the other and with full power of substitution, to execute, deliver and file, for and on such person's behalf, and in such person's name and capacity or capacities as stated below, any amendment, exhibit or supplement to the Form 10-K Report making such changes in the report as such attorney-in-fact deems appropriate.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nSignature Title Date - ----------------------- ----------------------------- ----------------\n\/s\/ James C. Cotting - ----------------------- James C. Cotting Chairman of the Board, January 27, 1995 and Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Robert I. Morrison - ----------------------- Robert I. Morrison Vice President and Controller January 27, 1995 (Principal Accounting Officer)\n\/s\/ Jack R. Anderson - ----------------------- Jack R. Anderson Director January 27, 1995\n\/s\/ William F. Andrews - ------------------------ William F. Andrews Director January 27, 1995\n\/s\/ Wallace W. Booth - ------------------------ Wallace W. Booth Director January 27, 1995\n\/s\/ Andrew F. Brimmer - ------------------------ Andrew F. Brimmer Director January 27, 1995\n\/s\/ Bill Casstevens - ------------------------ Bill Casstevens Director January 27, 1995\nSIGNATURE EXHIBIT 24 (CONTINUED)\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n----------------------------------\nSIGNATURES (Continued)\n\/s\/Richard F. Celeste - ------------------------ Richard F. Celeste Director January 27, 1995\n\/s\/John D. Correnti - ------------------------ John D. Correnti Director January 27, 1995\n\/s\/William Craig - ------------------------ William Craig Director January 27, 1995\n\/s\/Jerry E. Dempsey - ------------------------ Jerry E. Dempsey Director January 27, 1995\n\/s\/Mary Garst - ------------------------ Mary Garst Director January 27, 1995\n\/s\/ Arthur G. Hansen - ------------------------ Arthur G. Hansen Director January 27, 1995\n\/s\/ John R. Horne - ------------------------ John R. Horne Director January 27, 1995\n\/s\/Robert C. Lannert - ------------------------ Robert C. Lannert Director January 27, 1995\n\/s\/ Donald D. Lennox - ------------------------ Donald D. Lennox Director January 27, 1995\n\/s\/ Elmo R. Zumwalt, Jr. - ------------------------ Elmo R. Zumwalt, Jr. Director January 27, 1995\nSIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES ----------------------------------\nINDEPENDENT AUDITORS' REPORT\nNavistar International Corporation:\nWe have audited the Statement of Financial Condition of Navistar International Corporation and Consolidated Subsidiaries as of October 31, 1994 and 1993, and the related Statement of Income (Loss), of Cash Flow, and of Non-Redeemable Preferred, Preference and Common Shareowners' Equity for each of the three years in the period ended October 31, 1994, and have issued our report thereon dated December 12, 1994 (which includes an explanatory paragraph relating to the change in methods of accounting for postretirement benefits other than pensions and for income taxes as required by Statements of Financial Accounting Standards No. 106 and No. 109); such consolidated financial statements and report are included in your 1994 Annual Report to Shareowners and are incorporated herein by reference. Our audits also included the financial statement schedule of Navistar International Corporation and Consolidated 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 December 12, 1994 Chicago, Illinois\n----------------------------------\nEXHIBIT 23\nINDEPENDENT AUDITORS' CONSENT\nNavistar International Corporation:\nWe consent to the incorporation by reference in Post-Effective Amendment No. 1 to Registration No. 2-70979 on Form S-8 and in Post- Effective Amendment No. 6 to Registration No. 2-55544 on Form S-8 and in Post-Effective Amendment No. 1 to Registration No. 2-9604 on Form S-8 of our reports dated December 12, 1994, appearing and incorporated by reference in this Annual Report on Form 10-K of Navistar International Corporation for the year ended October 31, 1994.\nDeloitte & Touche LLP January 27, 1995 Chicago, Illinois","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nInformation required by Part IV (Item 14) of this form is incorporated herein by reference from Navistar International Corporation's 1994 Annual Report to Shareowners, filed as Exhibit 13 to this Form 10-K as follows:\nAnnual Report Page ------ Financial Statements - --------------------\nStatement of Income (Loss) for the years ended October 31, 1994, 1993 and 1992 ................ 19 Statement of Financial Condition as of October 31, 1994 and 1993 ...................... 21 Statement of Cash Flow for the years ended October 31, 1994, 1993 and 1992 ................ 23 Statement of Non-Redeemable Preferred, Preference and Common Shareowners' Equity for the years ended October 31, 1994, 1993 and 1992 .......... 25 Notes to Financial Statements .................... 27\nForm 10-K Schedules Page - --------- ----\nVIII - Valuation and Qualifying Accounts and Reserves .........................\nAll other schedules are omitted because of the absence of the conditions under which they are required or because information called for is shown in the financial statements and notes thereto in the 1994 Annual Report to Shareowners.\nFinance and Insurance Subsidiaries:\nThe financial statements of Navistar Financial Corporation for the years ended October 31, 1994, 1993 and 1992 appearing on pages 9 through 11 in Annual Report on Form 10-K for Navistar Financial Corporation for the fiscal year ended October 31, 1994, Commission No. 1-4146-1, are incorporated herein by reference and filed as Exhibit 28 to this Form 10-K.\nFinancial information regarding all Navistar subsidiaries engaged in finance and insurance operations, including Navistar Financial Corporation, appears as supplemental information to the Financial Statements in the Navistar 1994 Annual Report to Shareowners and is incorporated herein by reference.\nExhibits, Including those Incorporated by Reference Form 10-K Page - --------------------------------------------------- --------------\n(3) Articles of Incorporation and By-Laws ..... E-1 (4) Instruments Defining the Rights of Security Holders, including Indentures E-2 (10) Material Contracts ....................... E-3 (11) Computation of Net Income (Loss) Per Common Share ....................... E-5 (13) Navistar International Corporation 1994 Annual Report to Shareowners ...... N\/A (22) Subsidiaries of the Registrant ........... E-6 (23) Independent Auditors' Consent ............ 21 (24) Power of Attorney ........................ 19 (28) Navistar Financial Corporation Annual Report on Form 10-K for the fiscal year ended October 31, 1994 ............ N\/A\nAll exhibits other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information called for is shown in the financial statements and notes thereto in the 1994 Annual Report to Shareowners.\nReports on Form 8-K - -------------------\nNo reports on Form 8-K were filed for the three months ended October 31, 1994.\nSIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n----------------------------------\nSIGNATURE\nPursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nNAVISTAR INTERNATIONAL CORPORATION - ---------------------------------- (Registrant)\n\/s\/ Robert I. Morrison - ---------------------------------- Robert I. Morrison January 27, 1995 Vice President and Controller (Principal Accounting Officer)\nSIGNATURE EXHIBIT 24 NAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n----------------------------------\nPOWER OF ATTORNEY\nEach person whose signature appears below does hereby make, constitute and appoint James C. Cotting and Robert I. Morrison and each of them acting individually, true and lawful attorneys-in-fact and agents with power to act without the other and with full power of substitution, to execute, deliver and file, for and on such person's behalf, and in such person's name and capacity or capacities as stated below, any amendment, exhibit or supplement to the Form 10-K Report making such changes in the report as such attorney-in-fact deems appropriate.\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:\nSignature Title Date - ----------------------- ----------------------------- ----------------\n\/s\/ James C. Cotting - ----------------------- James C. Cotting Chairman of the Board, January 27, 1995 and Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ Robert I. Morrison - ----------------------- Robert I. Morrison Vice President and Controller January 27, 1995 (Principal Accounting Officer)\n\/s\/ Jack R. Anderson - ----------------------- Jack R. Anderson Director January 27, 1995\n\/s\/ William F. Andrews - ------------------------ William F. Andrews Director January 27, 1995\n\/s\/ Wallace W. Booth - ------------------------ Wallace W. Booth Director January 27, 1995\n\/s\/ Andrew F. Brimmer - ------------------------ Andrew F. Brimmer Director January 27, 1995\n\/s\/ Bill Casstevens - ------------------------ Bill Casstevens Director January 27, 1995\nSIGNATURE EXHIBIT 24 (CONTINUED)\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES\n----------------------------------\nSIGNATURES (Continued)\n\/s\/Richard F. Celeste - ------------------------ Richard F. Celeste Director January 27, 1995\n\/s\/John D. Correnti - ------------------------ John D. Correnti Director January 27, 1995\n\/s\/William Craig - ------------------------ William Craig Director January 27, 1995\n\/s\/Jerry E. Dempsey - ------------------------ Jerry E. Dempsey Director January 27, 1995\n\/s\/Mary Garst - ------------------------ Mary Garst Director January 27, 1995\n\/s\/ Arthur G. Hansen - ------------------------ Arthur G. Hansen Director January 27, 1995\n\/s\/ John R. Horne - ------------------------ John R. Horne Director January 27, 1995\n\/s\/Robert C. Lannert - ------------------------ Robert C. Lannert Director January 27, 1995\n\/s\/ Donald D. Lennox - ------------------------ Donald D. Lennox Director January 27, 1995\n\/s\/ Elmo R. Zumwalt, Jr. - ------------------------ Elmo R. Zumwalt, Jr. Director January 27, 1995\nSIGNATURE\nNAVISTAR INTERNATIONAL CORPORATION AND SUBSIDIARIES ----------------------------------\nINDEPENDENT AUDITORS' REPORT\nNavistar International Corporation:\nWe have audited the Statement of Financial Condition of Navistar International Corporation and Consolidated Subsidiaries as of October 31, 1994 and 1993, and the related Statement of Income (Loss), of Cash Flow, and of Non-Redeemable Preferred, Preference and Common Shareowners' Equity for each of the three years in the period ended October 31, 1994, and have issued our report thereon dated December 12, 1994 (which includes an explanatory paragraph relating to the change in methods of accounting for postretirement benefits other than pensions and for income taxes as required by Statements of Financial Accounting Standards No. 106 and No. 109); such consolidated financial statements and report are included in your 1994 Annual Report to Shareowners and are incorporated herein by reference. Our audits also included the financial statement schedule of Navistar International Corporation and Consolidated 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 December 12, 1994 Chicago, Illinois\n----------------------------------\nEXHIBIT 23\nINDEPENDENT AUDITORS' CONSENT\nNavistar International Corporation:\nWe consent to the incorporation by reference in Post-Effective Amendment No. 1 to Registration No. 2-70979 on Form S-8 and in Post- Effective Amendment No. 6 to Registration No. 2-55544 on Form S-8 and in Post-Effective Amendment No. 1 to Registration No. 2-9604 on Form S-8 of our reports dated December 12, 1994, appearing and incorporated by reference in this Annual Report on Form 10-K of Navistar International Corporation for the year ended October 31, 1994.\nDeloitte & Touche LLP January 27, 1995 Chicago, Illinois","section_15":""}
{"filename":"759831_1994.txt","cik":"759831","year":"1994","section_1":"Item 1. Business ----------------\nBalcor Realty Investors 85-Series II 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 $83,936,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of real property, and all financial information included in this report relates to this industry segment.\nThe Registrant utilized the net offering proceeds to acquire thirteen real property investments and a minority joint venture interest in one additional property. The Registrant has since disposed of five of these properties. As of December 31, 1994, the Registrant owned the eight properties and the minority joint venture interest described under Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ------------------\nAs of December 31, 1994 the Registrant owns the eight properties described below:\nLocation Description of Property -------- -----------------------\nFort Worth, Texas Chestnut Ridge Apartments - Phase I (formerly Cottonwood Apartments - Phase I): a 192-unit apartment complex located on approximately 7 acres.\nMemphis, Tennessee Country Oaks Apartments: a 200-unit apartment complex located on approximately 10 acres.\nArlington, Texas Forest Ridge Apartments - Phase II: a 328-unit apartment complex located on approximately 15 acres.\nSt. Louis County, Missouri Hunter's Glen Apartments: a 192-unit apartment complex located on approximately 10 acres.\nHillsborough County, Florida Marbrisa Apartments: a 224-unit apartment complex located on approximately 37 acres.\nGwinnett County, Georgia Park Crossing Apartments: a 280-unit apartment complex located on approximately 21 acres.\nLexington-Fayette, Kentucky Steeplechase Apartments: a 296-unit apartment complex located on approximately 16 acres.\nEast Baton Rouge Parish, Willow Bend Lake Apartments: a 360-unit Louisiana apartment complex located on approximately 22 acres.\nEach of the above properties is held subject to various forms of financing.\nThe Registrant also holds a 38.38% minority joint venture interest in Rosehill Pointe Apartments located in Lenexa, Kansas.\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. The Registrant has not made distributions to date to investors. For additional information, see Item 7. 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 7,393.\nItem 6.","section_6":"Item 6. Selected Financial Data ------------------------------- Year ended December 31, ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ---------- Total income $12,889,004 $13,196,684 $14,216,484 $13,083,391 $14,198,997 Loss before gain on sale of property (2,019,363) (2,299,675) (2,647,166) (3,666,743) (4,885,957) Net (loss) income (2,019,363) 1,348,884 (2,647,166) (3,666,743) (1,615,755) Net (loss) income per Limited Partnership Interest (23.82) 15.91 (31.22) (43.25) (19.06) Total assets 52,186,795 54,690,993 65,783,386 70,528,914 73,611,604 Mortgage notes payable 53,346,903 57,225,506 65,457,125 66,975,920 67,140,599\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and ----------------------------------------------------------------------- Results of Operations ---------------------\nSummary of Operations ---------------------\nDuring 1993, Balcor Realty Investors 85-Series II (the \"Partnership\") recognized a gain in connection with the sale of the Playa Palms Apartments. This caused the Partnership to recognize net income during 1993 as compared to a net loss during 1994 and 1992. In addition, aggregate property operations for the remaining properties improved from 1992 to 1993 and 1993 to 1994.\nOperations ----------\n1994 Compared to 1993 ---------------------\nThe July 1993 sale of Playa Palms Apartments caused decreases in rental and service income, interest expense on mortgage notes payable, depreciation expense, amortization expense, property operating expense, maintenance and repairs, real estate taxes and property management fees during 1994 as compared to 1993. These decreases were offset by, or were in addition to, other activity as described below.\nThe Partnership was able to achieve higher occupancy levels and\/or rental rates at all of the Partnership's eight remaining properties. As a result, rental and service income, as well as the related property management fees, increased at these properties during 1994, which partially offset the decreases due to the sale of Playa Palms Apartments.\nDuring the latter half of 1993, restricted investments of $1,995,000 were released and the proceeds were used to repay the respective loans from the General Partner relating to these cash collateral pledges. As a result of these funds no longer being available for short-term investments, interest income on short-term investments decreased during 1994 as compared to 1993.\nDuring 1993, the Partnership reached a settlement with one of the defendants in the litigation related to the Park Crossing Apartments and recognized settlement income of $113,870 in connection with this transaction. The Partnership reached a settlement with the remaining defendants during 1994 and received $300,000 in settlement of all claims due to the Partnership.\nIn connection with the 1994 refinancings of the properties' mortgage loans, the Partnership retired and replaced $4,215,546 of affiliated mortgage notes payable related to the Chestnut Ridge - Phase I and Forest Ridge - Phase II apartment complexes with General Partner loans. As a result, interest expense on mortgage notes payable decreased and interest expense on short-term loans from affiliates increased during 1994 as compared to 1993. Also contributing to the decrease in interest expense on mortgage notes payable were lower interest rates due to the Chestnut Ridge - Phase I refinancing in 1994 and the Hunter's Glen, Marbrisa, Park Crossing and Steeplechase refinancings in 1993.\nDue to the 1994 refinancings of the Chestnut Ridge - Phase I and Forest Ridge - Phase II mortgage loans, deferred expenses related to the previous loans were fully amortized. As a result, amortization of deferred expenses increased during 1994 as compared to 1993.\nIncreased insurance premiums at all of the Partnership's properties during 1994 offset the decrease in property operating expense due to the sale of Playa Palms Apartments.\nDuring 1994, the Partnership incurred significantly higher maintenance and\nrepairs expenses at the Marbrisa Apartments in connection with exterior painting and wood replacement as required by the 1993 mortgage refinancing. These expenses were partially offset by the Playa Palms sale and exterior painting and parking lot repairs during 1993 at the Hunter's Glen Apartments.\nReal estate tax rates increased during 1994 at Park Crossing and Willow Bend Lake apartment complexes and the assessed value of Park Crossing Apartments also increased during 1994. This resulted in an increase in real estate tax expense at these properties, during 1994 as compared to 1993, which partially offset the decrease in real estate tax expense due to the Playa Palms sale.\nHigher legal fees incurred due to the Park Crossing Apartments settlement along with higher accounting, data processing and portfolio management expenses during 1994 resulted in an increase in administrative expenses during 1994 as compared to 1993.\nThe Partnership holds a minority joint venture interest in the Rosehill Pointe Apartments, which realized a decrease in interest expense during 1994 due to a reduction of the interest rate on the property's first mortgage loan during the third quarter of 1993. This decrease was partially offset by increased expenditures for insurance, utilities, payroll and advertising during 1994 as compared to 1993. As a result of the combined effect of these events, participation in loss of joint venture with an affiliate decreased during 1994 as compared to 1993.\nThe Partnership recognized a gain on sale of property of $3,648,559 during 1993 in connection with the sale of Playa Palms Apartments.\n1993 Compared to 1992 ---------------------\nThe July 1993 sale of Playa Palms Apartments caused decreases in rental and service income, interest expense on mortgage notes payable, depreciation expense, amortization expense, property operating expense, real estate taxes and property management fees during 1993 as compared to 1992. These decreases were offset by, or were in addition to, other activity as described below. The Partnership also recognized a gain on sale of property during 1993.\nThe Partnership was able to achieve higher occupancy levels and\/or rental rates at seven of the Partnership's eight remaining properties, most significantly at the Marbrisa and Park Crossing apartment complexes. As a result, rental and service income increased at these properties for 1993 and partially offset the decreases in rental and service income discussed above.\nAs a result of the payoff of restricted investments described above and due to interest rates being lower in 1993 than in 1992, interest income on short-term investments decreased during 1993 as compared to 1992.\nDuring 1992, the Partnership reached a settlement with the seller of the Forest Ridge - Phase II and Highpoint - Phase I apartment complexes and recognized settlement income of $486,000 in connection with this transaction.\nLower interest rates on short-term loans, as well as a reduction in the amount of debt outstanding during 1993 as compared to 1992, resulted in a decrease in interest expense on short-term loans from the General Partner during 1993 as compared to 1992.\nAs a result of the refinancing of the Hunter's Glen, Marbrisa, Park Crossing, Steeplechase and Willow Bend Lake apartment complexes mortgage loans during 1993, deferred expenses related to the previous loans were fully amortized. In addition, the Partnership recognized amortization expense during 1993 on the new mortgage loans. As a result, amortization of deferred expenses increased during 1993 as compared to 1992, fully offsetting the decrease discussed above.\nThe Partnership incurred increased parking lot repairs and exterior painting\ncosts at the Hunter's Glen Apartments and increased roof repairs and parking lot repairs at the Steeplechase Apartments. As a result, maintenance and repair expenses increased during 1993 as compared to 1992. These increases were partially offset by the sale of the Playa Palms Apartments and the absence of exterior painting costs at the Chestnut Ridge - Phase I Apartments in 1993.\nDuring 1992, the Partnership reached a settlement with the seller of the Pleasant Lake Village and Playa Palms apartment complexes. The Partnership recognized a loss of $221,827 as a result of the write-off of the remaining portion of the receivable from the seller which was forgiven as part of the settlement.\nThe Partnership holds a minority joint venture interest in the Rosehill Pointe Apartments, which realized increased rental and service income at the property due to increases in rental rates and\/or occupancy levels during 1993 and a decrease in interest expense due to a reduction of the interest rate on the property's first mortgage loan. Additionally, the property also incurred increased payroll expenditures during 1993. As a result of these events, the Partnership recognized a decrease in its participation in the loss from the joint venture with an affiliate during 1993 as compared to 1992.\nLiquidity and Capital Resources -------------------------------\nThe cash position of the Partnership decreased as of December 31, 1994 when compared to December 31, 1993. The Partnership's operating activities consisted primarily of cash flow generated from property operations, which was partially offset by the payment of administrative expenses, short-term interest expense and deferred interest expense upon the refinancing of the Chestnut Ridge - Phase I and Forest Ridge - Phase II mortgage loans. The Partnership's financing activities included the refinancing of these mortgage loans. From the proceeds of the new first mortgage loans, the Partnership repaid the previous first mortgage loans and a portion of the loans payable from affiliates relating to each property. The Partnership also funded required repair escrows and paid related financing costs. Additional financing activities included payment of principal on mortgage notes payable.\nThe Partnership owes approximately $12,296,000 to the General Partner at December 31, 1994 in connection with the funding of operating deficits and other working capital requirements. These loans are expected to be repaid from available cash flow from future property operations, or from proceeds received from the disposition of the Partnership's real estate investments prior to any distributions to Limited Partners.\nAlthough affiliates of the General Partner have, in certain circumstances, provided mortgage loans for certain properties of the Partnership, there can be no assurance that loans of this type will be available from either affiliates or the General Partner in the future. The General Partner may continue to provide additional short-term loans to the Partnership 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 from the General Partner 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 through the General Partner, its affiliates or third parties, the Partnership may be required to dispose of some of its properties in order to satisfy Partnership obligations.\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\nproperty'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, six of the Partnership's eight remaining properties generated positive cash flow compared to five properties for the same period in 1993. In addition, the property in which the Partnership holds a minority joint venture interest generated positive cash flow during 1994 and 1993. The Hunter's Glen and Forest Ridge - Phase II apartment complexes generated positive cash flow during 1994 as compared to a marginal deficit during 1993 due to decreased expenditures for parking lot repairs, and the absence of expenditures for exterior painting and higher rental income, respectively. The Chestnut Ridge - Phase I Apartments operated at a marginal cash flow deficit during 1994 and 1993. The Marbrisa Apartments, which generated positive cash flow during 1993, operated at a marginal deficit during 1994 primarily due to higher repairs and maintenance 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 90% to 97%. 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.\nDuring 1994, the Chestnut Ridge - Phase I and Forest Ridge - Phase II mortgage loans were refinanced. See Note 3 of Notes to Financial Statements for additional information.\nIn October 1994, the Partnership reached a settlement with the remaining defendants in litigation on the Park Crossing Apartments and received $300,000 in settlement of all claims due to the Partnership. See Note 4 of Notes to Financial Statements for additional information.\nThe Partnership's properties are owned through the use of third-party and affiliate mortgage loan financings 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, the Country Oaks Apartments mortgage loan of approximately $5,462,000 matures. The General Partner expects to refinance this loan prior to maturity. No mortgage loans mature during 1996. In certain instances it may be difficult for the Partnership to refinance a property in an amount sufficient to retire in full the current third-party mortgage financing with respect to the property. In the event negotiations with the existing lender for a loan modification or with new lenders for a refinancing are unsuccessful, the Partnership may sell the collateral property or other properties to satisfy an obligation or may relinquish title to the collateral property in satisfaction of the outstanding mortgage loan balance.\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 property, 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.\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.\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 $52,186,795 $41,006,290 $54,690,993 $44,800,981 Partners' deficit: General Partner (906,714) (14,549,350) (886,520) (13,969,240) Limited Partners (14,763,734) (14,363,891) (12,764,565) (11,271,553) Net (loss) income: General Partner (20,194) (580,110) 13,489 535,554 Limited Partners (1,999,169) (3,092,338) 1,335,395 3,429,757 Per Limited Part- nership Interest (23.82) (36.84) 15.91 40.86\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-XVII, its General Partner, has a Board of Directors.\n(b, c & e) The names, ages and business experiences 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 11 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-XVII 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 -------------- ------------- ---------------- Limited Partnership Interests 1,235 1.47%\nRelatives and affiliates of the partners and officers and partners of the General Partner own 21 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 11 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 set forth as Exhibit 3 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated March 12, 1985 (Registration No. 2-95000) is incorporated herein by reference.\n(4) Subscription Agreement set forth as Exhibit 4.1 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated March 12, 1985 (Registration No. 2-95000) and 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. 0-14351) are incorporated herein by reference.\n(10) Agreement of Sale and attachments thereto relating to the sale of Playa Palms Apartments, previously filed as Exhibit (2) to the Registrant's Report on Form 8-K dated June 2, 1993, is 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 85-SERIES II 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-XVII, the General Partner\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.\nSignature Title Date ---------------------- ------------------------------- ------------\nPresident and Chief Executive Officer (Principal Executive Officer) of Balcor Partners-XVII, \/s\/Thomas E. Meador the General Partner March 29, 1995 -------------------- -------------- Thomas E. Meador\nExecutive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor \/s\/Allan Wood Partners XVII, the General Partner March 29, 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 85-Series II A Real Estate Limited Partnership:\nWe have audited the financial statements and the financial statement schedule of Balcor Realty Investors 85-Series II 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 85-Series II 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 10, 1995\nBALCOR REALTY INVESTORS 85-SERIES II A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1994 and 1993\nASSETS\n1994 1993 ------------- ------------- Cash and cash equivalents $ 600,949 $ 1,192,138 Restricted investments 480,000 480,000 Escrow deposits 1,041,462 937,213 Accounts and accrued interest receivable 183,575 349,385 Deferred expenses, principally loan financing fees, net of accumulated amortization of $323,605 in 1994 and $283,373 in 1993 1,070,071 1,035,536 ------------- ------------- 3,376,057 3,994,272 ------------- ------------- Investment in real estate, at cost: Land 10,525,187 10,525,187 Buildings and improvements 62,537,549 62,537,549 ------------- ------------- 73,062,736 73,062,736 Less accumulated depreciation 24,251,998 22,366,015 ------------- ------------- Investment in real estate, net of accumulated depreciation 48,810,738 50,696,721 ------------- ------------- $ 52,186,795 $ 54,690,993 ============= =============\nLIABILITIES AND PARTNERS' DEFICIT\nLoans payable - affiliate $ 12,295,605 $ 8,752,085 Accounts payable 243,758 93,233 Due to affiliates 216,455 108,865 Accrued liabilities, principally interest and real estate taxes 423,967 919,487 Security deposits 228,573 245,973 Loss in excess of investment in joint venture with an affiliate 1,101,982 996,929 Mortgage notes payable - affiliates 1,673,215 7,481,299 Mortgage notes payable 51,673,688 49,744,207 ------------- ------------- Total liabilities 67,857,243 68,342,078\nPartners' deficit (83,936 Limited Partnership Interests issued and outstanding) (15,670,448) (13,651,085) ------------- ------------- $ 52,186,795 $ 54,690,993 ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES II 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 $ (12,352,803) $ (873,537) $(11,479,266)\nNet loss for the year ended December 31, 1992 (2,647,166) (26,472) (2,620,694) -------------- ------------- ------------- Balance at December 31, 1992 (14,999,969) (900,009) (14,099,960)\nNet income for the year ended December 31, 1993 1,348,884 13,489 1,335,395 -------------- ------------- ------------- Balance at December 31, 1993 (13,651,085) (886,520) (12,764,565)\nNet loss for the year ended December 31, 1994 (2,019,363) (20,194) (1,999,169) -------------- ------------- ------------- Balance at December 31, 1994 $ (15,670,448) $ (906,714) $(14,763,734) ============== ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES II 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 $ 12,521,580 $ 12,994,337 $ 13,541,677 Interest on short-term investments 67,424 88,477 188,807 Settlement income 300,000 113,870 486,000 -------------- ------------- ------------- Total income 12,889,004 13,196,684 14,216,484 -------------- ------------- -------------\nExpenses:\nInterest on mortgage notes payable 5,138,352 6,142,371 6,920,675 Interest on short-term loans from affiliate 572,915 370,180 511,571 Depreciation 1,885,983 2,051,056 2,263,897 Amortization of deferred expenses 274,282 187,999 146,738 Property operating 3,203,292 3,180,653 3,185,322 Maintenance and repairs 1,513,263 1,319,906 1,250,681 Real estate taxes 1,039,756 1,061,532 1,101,842 Property management fees 626,989 657,359 675,541 Administrative 641,949 471,856 505,340 Write-off of receivables from seller 221,827 Participation in loss of joint venture with an affiliate 11,586 53,447 80,216 -------------- ------------- ------------- Total expenses 14,908,367 15,496,359 16,863,650 -------------- ------------- ------------- Loss before gain on sale of property (2,019,363) (2,299,675) (2,647,166) Gain on sale of property 3,648,559 -------------- ------------- ------------- Net (loss) income $ (2,019,363) $ 1,348,884 $ (2,647,166) ============== ============= ============= Net (loss) income allocated to General Partner $ (20,194) $ 13,489 $ (26,472) ============== ============= ============= Net (loss) income allocated to Limited Partners $ (1,999,169) $ 1,335,395 $ (2,620,694) ============== ============= ============= Net (loss) income per Limited Partnership Interest (83,936 issued and outstanding) $ (23.82) $ 15.91 $ (31.22) ============== ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES II 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: Net (loss) income $ (2,019,363) $ 1,348,884 $ (2,647,166) Adjustments to reconcile net (loss) income to net cash provided by or used in operating activities: Gain on sale of property (3,648,559) Participation in loss of joint venture with an affiliate 11,586 53,447 80,216 Depreciation of properties 1,885,983 2,051,056 2,263,897 Amortization of deferred expenses 274,282 187,999 146,738 Deferred interest expense 196,599 306,255 522,677 Payment of deferred interest expense (681,731) (1,392,348) Write-off of receivables from seller 221,827 Collection of proceeds from settlement 569,477 Net change in: Escrow deposits 178,438 (246,022) (160,281) Accounts and accrued interest receivable 165,810 (27,516) (217,357) Accounts payable 150,525 (76,283) (320,879) Due to affiliates 107,590 3,613 (33,974) Accrued liabilities (10,388) (83,557) (4,744) Security deposits (17,400) (61,414) 7,998 -------------- ------------- ------------- Net cash provided by or used in operating activities 241,931 (1,584,445) 428,429 -------------- ------------- -------------\nInvesting activities: Redemption of restricted investments 1,995,000 2,038,000 Distributions from joint venture with an affiliate 93,467 30,848 70,967 Proceeds from sale of property 13,200,000 Payment of selling costs (109,559) Additions to properties (140,468) -------------- ------------- ------------- Net cash provided by investing activities 93,467 14,975,821 2,108,967 -------------- ------------- ------------- Financing activities:\nProceeds from issuance of $ 11,664,000 $ 34,916,121 $ 3,053,400 mortgage notes payable Repayment of loans payable - affiliate (1,499,140) (4,505,372) (2,875,532) Proceeds from loans payable - affiliate 827,114 1,515,153 2,641,461 Repayment of mortgage notes\npayable - affiliates (1,592,538) (1,027,935) (3,053,400) Repayment of mortgage notes payable (9,389,731) (41,842,846) Principal payments on mortgage notes payable (344,788) (255,910) (2,186,552) Funding of repair escrows (287,150) (549,045) Releases from repair escrows 4,463 348,833 Payment of deferred expenses (308,817) (981,606) (77,491) -------------- ------------- ------------- Net cash used in financing activities (926,587) (12,382,607) (2,498,114) -------------- ------------- -------------\nNet change in cash and cash equivalents (591,189) 1,008,769 39,282 Cash and cash equivalents at beginning of year 1,192,138 183,369 144,087 -------------- ------------- ------------- Cash and cash equivalents at end of year $ 600,949 $ 1,192,138 $ 183,369 ============== ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 85-SERIES II 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 method. Rates used in the determination of depreciation are based upon the following estimated useful lives:\nYears -----\nBuildings and improvements 30 Furniture and fixtures 5\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\nWhen properties are sold, the related costs and accumulated depreciation are removed from the respective accounts. Any gain or loss on disposition will be recognized in accordance with generally accepted accounting principles.\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 principally of loan financing fees which are being amortized over the terms of the respective agreements.\n(c) Investment in joint venture with an affiliate represents the recording of the Partnership's 38.38% interest, under the equity method of accounting, in a joint venture with an affiliated partnership. Under the equity method of accounting, the Partnership records its initial investment at cost and adjusts its investment account for additional capital contributions, distributions and its share of joint venture income or loss. Depreciation recognized in connection with the ownership of real estate by the joint venture has resulted in the Partnership's share of cumulative losses exceeding the net amounts invested in the joint venture. This has resulted in the classification of the investment as \"Loss in excess of investment in joint venture with an affiliate\" in the accompanying financial statements.\n(d) Cash equivalents include all highly liquid investments with a maturity of three months or less when purchased.\n(e) 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.\n2. Partnership Agreement:\nThe Partnership was organized in October 1984. The Partnership Agreement provides for Balcor Partners-XVII to be the General Partner and for the admission of Limited Partners through the sale of up to 84,000 Limited Partnership Interests at $1,000 per Interest, 83,936 of which were sold through August 22, 1985, the termination date of the offering.\nThe Partnership Agreement generally provides that the General Partner will be allocated 1% and the Limited Partners will be allocated 99% of the profits and losses from operations. One hundred percent of Net Cash Receipts available for distribution shall be distributed to the holders of Interests in proportion to\ntheir 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 as a part of the General Partner's share of Net Cash Proceeds. Under certain circumstances, the General Partner may participate in the Net Cash Proceeds from the sale or refinancing of Partnership properties. The General Partner's participation is equal to 15% of further Net Cash Proceeds distributed after holders of Interests have received a return of Original Capital plus any deficiency in a Cumulative Distribution of 6% on Adjusted Original Capital, as defined in 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 -------------- ---------- ---------- ------ ------ ------- ---------- Mortgage Notes Payable - Nonaffiliates Apartment Complexes\nChestnut Ridge I(a)$3,675,362 $3,031,806 9.02% 2001 $29,776 $3,460,000 Country Oaks(b) 5,502,374 5,551,286 10.00% 1995 50,153 5,462,000 Forest Ridge II(c) 7,948,748 6,360,000 9.188% 2001 65,209 7,479,000 Hunter's Glen(d) 4,602,507 4,634,883 9.13% 2001 37,851 4,302,000 Marbrisa(e) 5,452,288 5,496,454 8.23% 2000 41,242 5,102,000 Park Crossing(f) 7,251,725 7,309,578 8.54% 1998 56,655 7,012,000 Steeplechase(g) 7,369,371 7,421,637 9.13% 2001 60,643 6,893,000 Willow Bend Lake(h) 9,871,313 9,938,563 9.33% 2001 82,641 9,253,000 ----------- ----------- Subtotal 51,673,688 49,744,207 ----------- ----------- Mortgage Notes Payable - Affiliates Apartment Complexes\nChestnut Ridge I(a) 1,673,215 3,533,299 10.50% 2002 (a) 1,673,000 Forest Ridge II(c) 3,948,000 ----------- ----------- Subtotal 1,673,215 7,481,299 ----------- ----------- Total $53,346,903 $57,225,506 ========== ===========\n(a) In March 1994, the Partnership completed the refinancing of these mortgage loans. The original loans consisted of a $3,029,731 first mortgage loan from an unaffiliated lender and a junior mortgage loan and an unsecured loan from affiliates of the Partnership totaling $3,983,484, including deferred interest of $450,185. The proceeds from the new first mortgage loan of $3,694,000 from an unaffiliated lender were used to repay the previous first mortgage loan, the deferred interest on the affiliated loans and a portion of the outstanding loans from affiliates. The new first mortgage loan interest rate decreased from 9.75% to 9.02%, the maturity date was changed from February 2002 to April 2001 and the monthly payments increased from $25,667 to $29,776. As required by the unaffiliated lender, $1,646,000 of the remaining balance of the affiliate loans was retired and replaced with a General Partner loan and the remainder was recharacterized as a subordinate non-recourse loan of $1,473,215 and a preferred limited partnership interest of $200,000 in the subsidiary partnership which holds title to the property, both of which are included in mortgage notes payable - affiliates in the balance sheet. The contract interest rate on the subordinate non-recourse loan remains unchanged at 10.50%, which is the rate of return earned on the preferred limited partnership interest as well. The interest pay rate on the subordinate non-recourse loan is the lower of the contract rate or the net cash from the property after payment of debt service on the first mortgage. The Limited Partners' position is unaffected by this conversion of a portion of the affiliated loan to an equity position, as Limited Partners' equity is subordinate to the preferred interest just as it was subordinated to the affiliate loans prior to the recharacterization.\nThe affiliate loan and preferred equity interest are subordinate to the Partnership's receipt of sale or refinancing proceeds in the amount of $1,646,000.\n(b) The General Partner expects to be able to refinance this loan prior to maturity.\n(c) In July 1994, the Partnership completed the refinancing of these mortgage loans. The original loans consisted of a $6,360,000 first mortgage loan from an unaffiliated lender and an unsecured loan from an affiliate of the Partnership totaling $4,179,546, including deferred interest of $231,546. The proceeds from the new first mortgage loan of $7,970,000 from an unaffiliated lender were used to repay the previous first mortgage loan, the deferred interest on the affiliate loan and a portion of the outstanding affiliate loan. The interest rate on the new first mortgage loan increased from 9.025% to 9.188%, the maturity date was extended from December 1994 to August 2001 and the monthly payments increased from $47,833 to $65,209. As required by the unaffiliated lender, the remaining $2,569,546 balance of the affiliate loan was retired and replaced with a General Partner loan.\n(d) In June 1993, this loan was refinanced. The interest rate decreased from 9.875% to 9.13%, the maturity date was extended from October 1993 to July 2001 and the monthly payments decreased from $37,882 to $37,851. A portion of the proceeds from the new $4,650,000 first mortgage loan were used to repay the existing first mortgage loan of $4,255,145.\n(e) In November 1993, this loan was refinanced. The interest rate decreased from 9.75% to 8.23%, the maturity date was extended from October 1993 to December 2000 and the monthly payments decreased from $46,769 to $41,242. A portion of the proceeds from the new $5,500,000 first mortgage loan were used to repay the existing first mortgage loan of $5,291,523.\n(f) In May 1993, this loan was refinanced. The interest rate decreased from 10.0% to 8.54%, the maturity date was extended from October 1993 to June 1998 and the monthly payments decreased from $61,977 to $56,655. A portion of the proceeds from the new $7,341,121 first mortgage loan were used to repay the existing first mortgage loan of $6,897,113.\n(g) In May 1993, this loan was refinanced. The interest rate decreased from 11.0% to 9.13%, the maturity date was extended from August 1993 to June 2001 and the monthly payments increased from $60,235 to $60,643. A portion of the proceeds from the new $7,450,000 first mortgage loan were used to repay the existing first mortgage loan of $5,996,274.\n(h) In May 1993, this loan was refinanced. The interest rate decreased from 10.5% to 9.33%, the maturity date was extended from November 1994 to June 2001 and the monthly payments increased from an average of $69,259 to $82,641. A portion of the proceeds from the new $9,975,000 first mortgage loan were used to repay the existing first mortgage loan of $7,807,308.\nThe Partnership's loans described above require current monthly payments of principal and interest except for the Chestnut Ridge - Phase I mortgage note payable-affiliate which requires payments based on the cash flow of the property.\nSee Note 7 of Notes to Financial Statements for additional information on cash collateral pledges and letters of credit.\nApproximate principal maturities of the above mortgage notes payable during each of the next five years are as follows:\n1995 $ 5,861,000 1996 382,000 1997 439,000 1998 7,433,000 1999 424,000\nDuring the year ended December 31, 1994, 1993 and 1992, the Partnership incurred interest expense on non-affiliated mortgage notes payable of $4,680,137, $5,281,113 and $5,960,181 and paid interest expense of $4,680,137, $6,239,776 and $5,734,467, respectively.\n4. Settlement Income:\n(a) The Partnership had ongoing litigation with the seller and certain of its principals and affiliates on claims under terms of the original management and guarantee agreement on the Park Crossing Apartments. During July 1993, the Partnership settled with one minor defendant and received $113,870, and during 1994 the Partnership accepted $300,000 as settlement in full on all remaining amounts owed to the Partnership. In addition, $139,946 which had been held in an escrow, was released to the Partnership.\n(b) In June 1992, the Partnership reached a settlement with the seller of the Forest Ridge - Phase II and Highpoint - Phase I apartment complexes. Prorations due from the seller pursuant to the original management and guarantee agreements on these properties were previously written off due to uncertain collectibility. Under the terms of the settlement, the Partnership received cash of $486,000, which was recorded as settlement income, and the Partnership and seller released all claims and causes of action against one another.\n5. Write-off of Receivables from Seller:\nIn May 1992, the Partnership reached a settlement with the seller of the Pleasant Lake Village and Playa Palms apartment complexes for proration amounts the seller owed the Partnership pursuant to the original management and guarantee agreements. The Partnership received $130,603 from the seller during 1992 and also received a payment of $438,874 in August 1992 from the General Partner, who voluntarily agreed to reimburse the Partnership for a portion of the seller's obligations. The Partnership wrote off receivables from the seller of $221,827 in connection with this transaction.\n6. Property Sale:\nDuring 1993, the Partnership sold the Playa Palms Apartments in an all cash sale for $13,200,000. From the proceeds of the sale the Partnership paid $12,701,189 in full satisfaction of the property's first mortgage loan, which included $1,117,006 of accrued interest, and a second mortgage loan of $32,349 was repaid at a discount of $21,049. The basis of the property was $9,462,931, net of accumulated depreciation of $4,353,876. For financial statement purposes, the Partnership recognized a gain of $3,648,559 during 1993. The remaining proceeds from the sale were used to repay a portion of the loans from the General Partner.\n7. Restricted Investments:\nAs of January 1, 1993, the Partnership had outstanding cash pledges totaling $2,475,000 as collateral for letters of credit relating to the mortgage loans on the Country Oaks and Marbrisa apartment complexes. In 1993 cash collateral pledges totaling $1,995,000 were released and used to reduce the principal balance of the Partnership's loans outstanding with the General Partner. As of December 31, 1994, a restricted investment of $480,000, partially collateralizing the Country Oaks mortgage loan, remained outstanding. This investment is recorded at cost which approximates market value. The amount pledged as collateral is invested in short-term instruments pursuant to the terms of the pledge agreement with the lending institution. Interest earned on the investment accumulates to the benefit of the Partnership and is payable upon expiration or termination of the letter of credit or earlier at the sole discretion of the lending institution.\n8. Management Agreements:\nAs of December 31, 1994, all of the properties owned by the Partnership, including the property in which the Partnership holds a minority joint venture interest, are under management agreements with a third-party management company. These management agreements provide for annual fees of 5% of gross operating receipts.\n9. Investment in Joint Venture with an Affiliate:\nThe Partnership owns a 38.38% joint venture interest in the Rosehill Pointe Apartments. The joint venturer is an affiliate of the General Partner. During 1994, the Partnership received distributions totaling $93,467.\n10. 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 $1,653,085 less than the tax loss of the Partnership for the same period.\n11. 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 $572,620 None $663,957 $50,530 $672,841 $57,128 Reimbursement of expenses to the General Partner at cost: Accounting 70,337 25,737 66,172 5,468 64,199 4,750 Data processing 54,271 15,312 31,524 5,786 34,889 2,890 Investor communica- tions 19,725 5,681 18,544 1,532 10,559 781 Legal 14,649 8,055 11,713 968 15,900 1,177 Portfolio management 40,873 25,281 47,486 4,314 27,153 2,009 Other 17,062 4,912 14,582 1,205 18,088 1,339\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed all of the Partnership's properties, including the property in which the Partnership holds a minority joint venture interest, until the affiliate was sold to a third party in November 1994.\nIn July 1993 and July 1994, the Partnership repaid loans to Balcor Real Estate Holding, Inc. (\"BREHI\"), an affiliate of the General Partner, on the Hunter's Glen and Forest Ridge - Phase II apartment complexes, respectively. In March 1994, the Partnership partially repaid and refinanced the balance of the Chestnut Ridge - Phase I Apartments affiliated mortgage loans. See Note 3 of Notes to Financial Statements for additional information on these loans.\nDuring 1994, 1993 and 1992, the Partnership incurred interest expense on the BREHI loans of $458,215, $861,258 and $960,494 and paid interest expense of $943,347, $991,101 and $663,532, respectively. As of December 31, 1994 and 1993, interest expense of $30,498 and $515,630, respectively, was payable and is included in accrued liabilities on the balance sheet.\nAs of December 31, 1994, the Partnership owes $12,295,605 to the General Partner in connection with the funding of additional working capital and other Partnership obligations. This amount included $480,000 which was borrowed to pledge as collateral relating to the Country Oaks mortgage loan. During 1994, the Partnership retired and replaced $1,646,000 and $2,569,546 of BREHI loans related to the Chestnut Ridge - Phase I and Forest Ridge - Phase II apartment complexes, respectively, with General Partner loans in connection with the 1994 refinancings of the properties' mortgage loans. The Partnership also made a net paydown of $672,026 during this period on the General Partner loans. In connection with the loans from the General Partner, the Partnership incurred interest expense of $572,915, $370,180 and $511,571 and paid interest expense\nof $480,500, $366,296 and $533,620 during 1994, 1993 and 1992, respectively. As of December 31, 1994 and 1993, interest expense of $131,477 and $39,062, respectively, was payable. 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 6.562%.\nThe General Partner may continue to make arrangements with an affiliate 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 from affiliates 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 affiliates of the General Partner or third parties, the Partnership may be required to dispose of some of its properties earlier than intended in order to satisfy Partnership 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 $120,176, $80,248 and $73,683 for 1994, 1993 and 1992, respectively.\nBALCOR REALTY INVESTORS 85-SERIES II A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS 85-SERIES II A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS 85-SERIES II 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) 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(c) The aggregate cost of land for Federal income tax purposes is $10,794,040 and the aggregate cost of buildings and improvements for Federal income tax purposes is $25,119,265. The total of the above-mentioned is $35,913,305.\n(d) Reconciliation of Real Estate -----------------------------\n1994 1993 1992 ---------- ---------- ----------\nBalance at beginning of year $73,062,736 $86,739,075 $86,739,075\nAdditions during year: Improvements None 140,468 None\nCost of real estate sold None (13,816,807) None ----------- ----------- ----------- Balance at end of year $73,062,736 $73,062,736 $86,739,075 =========== =========== ===========\nReconciliation of Accumulated Depreciation ------------------------------------------\n1994 1993 1992 ---------- ---------- ----------\nBalance at beginning of year $22,366,015 $24,668,835 $22,404,938 Depreciation expense for the year 1,885,983 2,051,056 2,263,897 Accumulated depreciation of real estate sold None (4,353,876) None ---------- ---------- ----------\nBalance at end of year $24,251,998 $22,366,015 $24,668,835 =========== =========== ===========\n(e) See description of Mortgage Notes Payable in Note 3 of Notes to Financial Statements.\n(f) Depreciation expense is computed based upon the following estimated useful lives:\nYears -----\nBuildings and improvements 30 Furniture and fixtures 5","section_15":""}
{"filename":"80424_1994.txt","cik":"80424","year":"1994","section_1":"Item 1. Business. --------- General Development of Business ----------------------------------- The Procter & Gamble Company is primarily a manufacturer and distributor of household products. Its products are sold throughout the United States and abroad. The Company was incorporated in Ohio in 1905 and was the outgrowth of a business founded in 1837 by William Procter and James Gamble.\nUnless the context indicates otherwise, the term the \"Company\" as used herein refers to The Procter & Gamble Company (the registrant) and its subsidiaries.\nAdditional information required by this item is incorporated by reference to the letter to shareholders which appears on pages 1-5 of the Annual Report to Shareholders for the fiscal year ended June 30, 1994.\nFinancial Information About Industry Segments ------------------------------------------------- The information required by this item is incorporated by reference to Note 10. Segment Information which appears on pages 30 and 31 of the Annual Report to Shareholders for the fiscal year ended June 30, 1994.\nNarrative Description of Business ------------------------------------- The products of Laundry and Cleaning, Personal Care and Food and Beverage segments are distributed primarily through grocery stores and other retail outlets. The products of the Pulp and Chemicals segment are sold direct and through jobbers. In March 1992 the Company established a plan to divest its commercial pulp business. The sale of the timberlands in July 1994 completed this plan. The class of products information required by this item is incorporated by reference to Note 10. Segment Information which appears on pages 30 and 31 of the Annual Report to Shareholders for the fiscal year ended June 30, 1994.\nAmong the well-known names under which the Company's products are sold are: Ace, Always, Ariel, Attends, Bold, Bounce, Bounty, Camay, Cascade, Charmin, Cheer, Cover Girl, Crest, Crisco, Dash, Dawn, Downy, Duncan Hines, Era, Fairy, Flash, Folgers, Gain, Hawaiian Punch, Head and Shoulders, Ivory, Jif, Lenor, Luvs, Max Factor, Mr. Proper, Olay, Old Spice, Pampers, Pantene, Pert, Pringles, Punica, Rejoice, Safeguard, Scope, Secret, Sunny Delight, Tide, Vicks, Vidal Sassoon, Whisper, and Zest.\nThe Company's business, represented by the aggregate of the four segments, is essentially homogeneous. For the most part, the factors necessary for an understanding of these four segments are essentially identical. The markets in which the Company's products are sold are highly competitive. The products of the Company's business segments compete with many large and small companies and there is no dominant competitor or competitors. Advertising is used in conjunction with an extensive sales force because the Company believes this combination provides the most efficient method of marketing these types of products. Product quality, performance, value and packaging are also important competitive factors.\nThe creation of new products and the development of new performance benefits for consumers on the Company's existing products are vital ingredients in its continuing progress in the highly competitive markets in which it does business. Basic research and product development activities continued to carry a high priority during the past fiscal year. The Company spent $1,059 million in fiscal year 1994, $956 million in 1993 and $861 million in 1992 on such activities. While many of the benefits from these efforts will not be realized until future years, the Company believes these activities demonstrate its commitment to future growth.\nThe Company has registered trademarks and owns or has licenses under patents which are used in connection with its business in all segments. Some of these patents or licenses cover significant product formulation and processing of the Company's products. The trade names of all major products in each segment are registered trademarks. In part, the Company's success can be attributed to the existence of these trademarks, patents and licenses.\nMost of the raw materials used by the Company are purchased from others. The Company purchases a substantial variety of raw materials, no one of which is material to the Company's business taken as a whole. The price volatility of agricultural commodities is, at particular periods, of importance to the products manufactured and sold in the Food and Beverage products segment.\nExpenditures in fiscal year 1994 for compliance with Federal, State and local environmental laws and regulations were not materially different from such expenditures in the prior year, and no material increase is expected in fiscal year 1995.\nInternational operations are generally characterized by the same conditions discussed in the description of the business above and may also be affected by additional elements including changing currency values and different rates of inflation and rates of economic growth. The effect of these additional elements is more significant in the Laundry and Cleaning and Personal Care products segments which comprise most of the Company's international business.\nThe Company has approximately 96,500 employees.\nThe Company provides an Employee Stock Ownership Plan (\"ESOP\") which is part of The Procter & Gamble Profit Sharing Trust and Employee Stock Ownership Plan. Convertible preferred stock of the Company and other assets owned by the ESOP are held through a trust (the \"ESOP Trust\"). The ESOP Trust has issued certain debt securities to the public. The Company has fully, unconditionally and irrevocably guaranteed payment of principal and interest on these debt securities. Holders of these debt securities have no recourse against the assets of the ESOP Trust except with respect to cash contributions made by the Company to the ESOP Trust, and earnings attributable to such contributions. Such cash contributions are made by the Company only to the extent that dividends on the convertible preferred stock are inadequate to fund repayment of the debt securities. Any such contributions and subsequent payments to holders are made on a same-day basis and such contributions would therefore not be held by the ESOP Trust unless there was a default in payment on the debt securities by the ESOP Trust after having received such contributions\nfrom the Company. Such a default is not likely to occur and there is therefore little likelihood that there would be assets available to satisfy the claims of any holders of the debt securities. A summary description of the liabilities of the ESOP Trust and of the dividends paid by the Company on the convertible preferred stock and cash payments from the Company to the ESOP Trust for the three years ended June 30, 1994 are incorporated by reference to Note 8 of \"Notes to Consolidated Financial Statements\" on pages 26-28 of the 1994 Annual Report to Shareholders.\nAdditional information required by this item is incorporated by reference to the letter to shareholders which appears on pages 1-5 and Financial Condition which appears on page 35 and 36 of the Annual Report to Shareholders for the fiscal year ended June 30, 1994.\nFinancial Information About Foreign and Domestic Operations ------------------------------------------------------------ The information required by this item is incorporated by reference to Note 10. Segment Information which appears on pages 30 and 31 of the Annual Report to Shareholders for the fiscal year ended June 30, 1994.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. ----------- In the United States, the Company owns and operates manufacturing facilities at 45 locations in 22 states. In addition, it owns and operates 89 manufacturing facilities in 39 other countries. Laundry and Cleaning products are produced at 39 of these locations; Personal Care products at 90; and Food and Beverage products at 20. Pulp and Chemicals are produced at 18 locations. The management considers that the Company's production facilities are adequate to support the business efficiently, and that the properties and equipment have been well maintained.\nItem 3.","section_3":"Item 3. Legal Proceedings. ------------------ The Company is involved in clean-up efforts at off-site Superfund locations, many of which are in the preliminary stages of investigation. The amount accrued at June 30, 1994 representing the Company's probable future costs that can be reasonably estimated was $8 million.\nThe Company is also involved in certain other environmental proceedings. No such proceeding is expected to result in material monetary or other sanctions being imposed by any governmental entity, or in other material liabilities. However, the Company has agreed to participate in the Toxic Substances Control Act (\"TSCA\") Section 8(e) Compliance Audit Program of the United States Environmental Protection Agency (\"EPA\"). As a participant, the Company has agreed to audit its files for materials which under current EPA guidelines would be subject to notification under Section 8(e) of TSCA and to pay stipulated penalties for each report submitted under this program. It is anticipated that the Company's liability under the Program will be $1,000,000. No administrative proceeding is pending; however the Company anticipates being required to enter an Administrative Order on Consent pursuant to this Program in late 1995. In addition, the EPA issued to a subsidiary of the Company a Finding and Notice of Violation (NOV\") dated June 16, 1994, based on Section 113(a) of the Clean Air Act (as amended), for alleged violations of the California State Implementation Plan by the subsidiary's manufacturing plant in Sacramento, California. The violations relate to 1) a plant expansion project that was implemented on the basis of calculated emission data that later proved to be\ninaccurate, with the result that the project allegedly failed to observe the federal construction ban and certain \"new source review\" provisions; and 2) the subsequent installation of a material recovery unit that is now alleged to be pollution control equipment for which a permit was required. The NOV does not specify the relief that will be sought by EPA, but any penalties are not expected to be material to the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. ---------------------------------------------------- Not applicable.\nExecutive Officers of the Registrant --------------------------------------\nThe names, ages and positions held by the executive officers of the Company on August 12, 1994 are:\nElected to Present Name Position Age Position - - ------------- -------------------- --- ----------- Edwin L. Artzt Chairman of the Board and 64 1989 Chief Executive. Director from 1972-75 and since October 14, 1980.\nJohn E. Pepper President. 56 1986 Director since June 12, 1984.\nDurk I. Jager Executive Vice President. 51 1989 Director since December 12, 1989.\nMichael J. Allen Group Vice President. 56 1991\nWolfgang C. Berndt Group Vice President. 51 1986\nBenjamin L. Bethell Senior Vice President. 54 1991\nRobert T. Blanchard Group Vice President. 49 1991\nGordon F. Brunner Senior Vice President. 55 1987 Director since March 1, 1991.\nBruce L. Byrnes Group Vice President. 46 1991\nLarry G. Dare Group Vice President. 54 1989\nElected to Present Name Position Age Position - - ------------- -------------------- --- --------- Stephen P. Donovan, Jr. Group Vice President. 53 1986\nHarald Einsmann Group Vice President. 60 1984 Director since June 10, 1991.\nRobert J. Herbold Senior Vice President. 52 1990\nJames J. Johnson Senior Vice President 47 1992 and General Counsel.\nJeffrey D. Jones Group Vice President. 41 1992\nAlan G. Lafley Group Vice President. 47 1992\nGary T. Martin Senior Vice President. 49 1991\nLawrence D. Milligan Senior Vice President. 58 1990\nJorge P. Montoya Group Vice President. 48 1991\nThomas A. Moore Group Vice President. 43 1992\nErik G. Nelson Senior Vice President. 54 1993\nRobert L. Wehling Senior Vice President. 55 1994\nEdwin H. Eaton, Jr. Vice President and 56 1987 Comptroller.\nTodd A. Garrett Vice President, Procter 52 1992 & Gamble Worldwide.\nAll of the above Executive officers are members of the Executive Committee of The Procter & Gamble Company and have been employed by the Company over five years.\nPART II ----------\nItem 5.","section_5":"Item 5. Market for the Common Stock and Related Stockholder Matters -----------------------------------------------------------\nThe stock exchanges on which the common stock is listed, the quarterly price range and dividends for the past two years and the number of common shareholders are incorporated by reference to page 42 of the Annual Report to Shareholders for the fiscal year ended June 30, 1994.\nItem 6.","section_6":"Item 6. Selected Financial Data -----------------------\nIn 1993 the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions\" and Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\". The effect of these accounting changes was to reduce net earnings by $988 million ($1.45 per share).\nDuring 1993 the Company announced one-time charges of $2,402 million for manufacturing consolidations and organizational restructuring and $303 million related to the divestiture of the 100% juice business. The after- tax effect of these provisions is $1,746 million or $2.57 per share.\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 the Analysis and Discussion and Financial Condition shown on pages 32-36 and the letter to shareholders on pages 1-5 of the Annual Report to Shareholders for the fiscal year ended June 30, 1994.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplemental Data ------------------------------------------\nThe financial statements and supplemental data are incorporated by reference to pages 16-31 of the Annual Report to Shareholders for the fiscal year ended June 30, 1994.\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 -------------------------------- The information required by this item is incorporated by reference to pages 3-5 and 17-18 of the proxy statement filed since the close of the fiscal year ended June 30, 1994, pursuant to Regulation 14A which involved the election of directors. Pursuant to Item 401(b) of Regulation S-K, Executive Officers of the Registrant are reported in Part I of this report.\nItem 11.","section_11":"Item 11. Executive Compensation ---------------------- The information required by this item is incorporated by reference to pages 7-14 of the proxy statement filed since the close of the fiscal year ended June 30, 1994, pursuant to Regulation 14A which involved the election of directors.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management -------------------------------------------------------------- The information required by this item is incorporated by reference to pages 15-17 of the proxy statement filed since the close of the fiscal year ended June 30, 1994, pursuant to Regulation 14A which involved the election of directors.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions ---------------------------------------------- The information required by this item is incorporated by reference to page 18 of the proxy statement filed since the close of the fiscal year ended June 30, 1994, pursuant to Regulation 14A which involved the election of directors.\nPART IV --------- Item 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K -----------------------------------------------------------------\nA. 1. Financial Statements:\nThe following consolidated financial statements of The Procter & Gamble Company and subsidiaries and the report of independent accountants are incorporated by reference in Part II, Item 8.\n- Report of independent accountants\n- Consolidated statement of earnings -- for years ended June 30, 1994, 1993 and 1992\n- Consolidated balance sheet -- as of June 30, 1994 and\n- Consolidated statement of retained earnings -- for years ended June 30, 1994, 1993 and 1992 - Consolidated statement of cash flows -- for years ended June 30, 1994, 1993 and 1992\n- Notes to consolidated financial statements\n2. Financial Statement Schedules:\nSchedule V -- Property, plant, and equipment - page 15\nSchedule VI -- Accumulated depreciation - page 16\nSchedule IX -- Short-term borrowings - page 17\nSchedule X -- Supplementary income statement information - page 18\nThe schedules other than those listed above are omitted because of the absence of the conditions under which they are required, or because the information is set forth in the financial statements or notes thereto.\n3. Exhibits:\nExhibit (3-1) -- Amended Articles of Incorporation (Incorporated by reference to Exhibit (3-1) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(3-2) -- Regulations (Incorporated by reference to Exhibit (3-2) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\nExhibit (4) -- Registrant agrees to file a copy of documents defining the rights of holders of long-term debt upon request of the Commission.\nExhibit (10-1) -- The Procter & Gamble 1992 Stock Plan (as amended December 14, 1993) which was adopted by the shareholders at the annual meeting on October 13, 1992.\n(10-2) -- The Procter & Gamble 1983 Stock Plan (as amended May 11, 1993) which was adopted by the shareholders at the annual meeting on October 11, 1983 (Incorporated by reference to Exhibit (10-2) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-3) -- The Procter & Gamble Executive Group Life Insurance Policy (each executive officer is covered for an amount equal to annual salary plus bonus) (Incorporated by reference to Exhibit (10-3) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-4) -- Additional Remuneration Plan (as amended June 12, 1990) which was adopted by the Board of Directors on April 12, 1949 (Incorporated by reference to Exhibit (10-4) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-5) -- The Procter & Gamble Deferred Compensation Plan for Directors which was adopted by the Board of Directors on September 9, 1980 (Incorporated by reference to Exhibit (10-5) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\nExhibit (10-6) -- The Procter & Gamble Retirement Plan for Directors which was adopted by the Board of Directors on December 12, 1989 (Incorporated by reference to Exhibit (10-6) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-7) -- The Procter & Gamble Board of Directors Charitable Gifts Program which was adopted by the Board of Directors on November 12, 1991 (Incorporated by Reference to Exhibit (10-7) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-8) -- The Procter & Gamble 1993 Non-Employee Directors' Stock Plan which was on November 9, 1993, approved by the Board of Directors for submission to the Shareholders on October 11, 1994 (Incorporated by reference to Appendix A of the proxy statement filed since the close of the fiscal year ended June 30, 1994).\n(10-9) -- Richardson-Vicks Inc. Special Stock Equivalent Incentive Plan which was authorized by the Board of Directors of The Procter & Gamble Company and adopted by the Board of Directors of Richardson-Vicks Inc. on December 31, 1985.\nExhibit (11) -- Computation of earnings per share.\nExhibit (12) -- Computation of ratio of earnings to fixed charges.\nExhibit (13) -- Annual Report to shareholders. (Pages 1-5, 16-36, and 42)\nExhibit (21) -- Subsidiaries of the registrant.\nExhibit (23) -- Consent of Deloitte & Touche LLP.\nExhibit (27) -- Financial Data Schedule.\nExhibit (99-1) -- Directors and Officers Liability Policy (the \"Policy Period\" has been extended to 6\/30\/97).\n(99-2) -- Directors and Officers (First) Excess Liability Policy (the \"Policy Period\" has been extended to 6\/30\/95).\n(99-3) -- Directors and Officers (Second) Excess Liability Policy (the \"Policy Period\" has been extended to 6\/30\/95).\n(99-4) -- Fiduciary Responsibility Insurance Policy (the \"Policy Period\" has been extended to 6\/30\/95).\nThe exhibits listed are filed with the Securities and Exchange Commission but are not included in this booklet. Copies of these exhibits may be obtained by sending a request to: Linda D. Rohrer, Assistant Secretary, The Procter & Gamble Company, P. O. Box 599, Cincinnati, Ohio 45201\nB. Reports on Form 8-K:\nAn 8-K Report containing an exhibit under Item 7 entitled \"Press Release Issued by Registrant on April 12, 1994\" was filed on April 13, 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 in the city of Cincinnati, State of Ohio.\nTHE PROCTER & GAMBLE COMPANY\nBy \/s\/EDWIN L. ARTZT --------------------------- Edwin L. Artzt Chairman of the Board and Chief Executive\nSeptember 13, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.\nSignature Title Date - - --------- ----- ----- _______ \/s\/EDWIN L. ARTZT Chairman of the Board and | - - -------------------- Chief Executive and Director | (Edwin L. Artzt) (Principal Executive Officer) | | \/s\/ERIK G. NELSON Senior Vice President | - - -------------------- (Principal Financial Officer) | (Erik G. Nelson) September 13, 1994 | \/s\/EDWIN H. EATON, JR. Vice President and Comptroller | - - -------------------- (Principal Accounting Officer) | (Edwin H. Eaton, Jr.) | | \/s\/DAVID M. ABSHIRE | - - -------------------- Director | (David M. Abshire) | | \/s\/NORMAN R. AUGUSTINE | - - -------------------- Director | (Norman R. Augustine) ___________|\nSignature Title Date - - --------- ------ ---- __________ | \/s\/DONALD R. BEALL | - - -------------------- Director | (Donald R. Beall) | | \/s\/GORDON F. BRUNNER | - - -------------------- Director | Gordon F. Brunner) | | \/s\/RICHARD B. CHENEY | - - -------------------- Director | (Richard B. Cheney) | | \/s\/HARALD EINSMANN | - - -------------------- Director | (Harald Einsmann) | | | - - -------------------- Director | (Richard J. Ferris) | | \/s\/JOSEPH T. GORMAN | - - -------------------- Director September 13, 1994 (Joseph T. Gorman) | | \/s\/ROBERT A. HANSON | - - -------------------- Director | \/s\/(Robert A. Hanson) | | \/s\/DURK I. JAGER | - - -------------------- Director | (Durk I. Jager) | | \/s\/JERRY R. JUNKINS | - - -------------------- Director | (Jerry R. Junkins) | | \/s\/JOSHUA LEDERBERG | - - -------------------- Director | (Joshua Lederberg) | | \/s\/CHARLES R. LEE | - - -------------------- Director | (Charles R. Lee) | __________\nSignature Title Date - - --------- ------ ----- _________ \/s\/JOHN E. PEPPER | - - ------------------- Director | (John E. Pepper) | | \/s\/JOHN G. SMALE | - - ------------------- Director | (John G. Smale) September 13, 1994 | \/s\/ROBERT D. STOREY | - - ------------------- Director | (Robert D. Storey) | | \/s\/MARINA v.N. WHITMAN | - - ------------------- Director | (Marina v.N. Whitman) _______|\nDELOITTE & TOUCHE LLP\n250 East Fifth Street Post Office Box 5340 Cincinnati, Ohio 45201 (513) 784-7100\nREPORT OF INDEPENDENT ACCOUNTANTS - - --------------------------------------------------------------\nThe Procter & Gamble Company:\nWe have audited the consolidated financial statements of The Procter & Gamble Company and subsidiaries as of June 30, 1994 and 1993, and for each of the three years in the period ended June 30, 1994, and have issued our report thereon dated August 10, 1994 (expressing an unqualified opinion and including an explanatory paragraph regarding the changes in accounting for other post retirement benefits and income taxes effective July 1, 1992); 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 The Procter & Gamble Company and subsidiaries, listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE LLP August 10, 1994\nRates for Depreciation of Properties for financial accounting purposes are generally as follows:\nBuildings 1.5% to 10% Machinery & Equipment 3% to 33.3%\nEXHIBIT INDEX --------------\nExhibit (3-1) -- Amended Articles of Incorporation (Incorporated by reference to Exhibit (3-1) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(3-2) -- Regulations (Incorporated by reference to Exhibit (3-2) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\nExhibit (4) -- Registrant agrees to file a copy of documents defining the rights of holders of long-term debt upon request of the Commission.\nExhibit (10-1) -- The Procter & Gamble 1992 Stock Plan (as amended December 14, 1993) which was adopted by the shareholders at the annual meeting on October 13, 1992.\n(10-2) -- The Procter & Gamble 1983 Stock Plan (as amended May 11, 1993) which was adopted by the shareholders at the annual meeting on October 11, 1983 (Incorporated by reference to Exhibit (10-2) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-3) -- The Procter & Gamble Executive Group Life Insurance Policy (each executive officer is covered for an amount equal to annual salary plus bonus) (Incorporated by reference to Exhibit (10-3) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-4) -- Additional Remuneration Plan (as amended June 12, 1990) which was adopted by the Board of Directors on April 12, 1949 (Incorporated by reference to Exhibit (10-4) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-5) -- The Procter & Gamble Deferred Compensation Plan for Directors which was adopted by the Board of Directors on September 9, 1980 (Incorporated by reference to Exhibit (10-5) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-6) -- The Procter & Gamble Retirement Plan for Directors which was adopted by the Board of Directors on December 12, 1989 (Incorporated by reference to Exhibit (10-6) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\nExhibit (10-7) -- The Procter & Gamble Board of Directors Charitable Gifts Program which was adopted by the Board of Directors on November 12, 1991 (Incorporated by Reference to Exhibit (10-7) of the Company's Annual Report on Form 10-K for the year ended June 30, 1993).\n(10-8) -- The Procter & Gamble 1993 Non-Employee Directors' Stock Plan which was on November 9, 1993, approved by the Board of Directors for submission to the Shareholders on October 11, 1994 (Incorporated by reference to Appendix A of the proxy statement filed since the close of the fiscal year ended June 30, 1994).\n(10-9) -- Richardson-Vicks Inc. Special Stock Equivalent Incentive Plan which was authorized by the Board of Directors of the Procter & Gamble Company and adopted by the Board of Directors of Richardson-Vicks Inc. on December 31, 1985.\nExhibit (11) -- Computation of earnings per share.\nExhibit (12) -- Computation of ratio of earnings to fixed charges.\nExhibit (13) -- Annual Report to shareholders. (Pages 1-5, 16-36, and 42)\nExhibit (21) -- Subsidiaries of the registrant.\nExhibit (23) -- Consent of Deloitte & Touche LLP.\nExhibit (27) -- Financial Data Schedule.\nExhibit (99-1) -- Directors and Officers Liability Policy (the \"Policy Period\" has been extended to 6\/30\/97).\n(99-2) -- Directors and Officers (First) Excess Liability Policy (the \"Policy Period\" has been extended to 6\/30\/95).\n(99-3) -- Directors and Officers (Second) Excess Liability Policy (the \"Policy Period\" has been extended to 6\/30\/95).\n(99-4) -- Fiduciary Responsibility Insurance Policy (the \"Policy Period\" has been extended to 6\/30\/95).","section_15":""}
{"filename":"355429_1994.txt","cik":"355429","year":"1994","section_1":"ITEM 1. BUSINESS\nProtective Life Corporation is an insurance holding company, whose subsidiaries provide financial services through the production, distribution, and administration of insurance and investment products. Founded in 1907, Protective Life Insurance Company (\"Protective Life\") is the Company's principal operating subsidiary. Unless the context otherwise requires, the \"Company\" refers to the consolidated group of Protective Life Corporation and its subsidiaries. The Company has six operating divisions: Acquisitions, Financial Institutions, Group, Guaranteed Investment Contracts, Individual Life, and Investment Products. The Company also has an additional business segment which is described herein as Corporate and Other.\nAdditional information concerning the Company's divisions may be found in \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - RESULTS OF OPERATIONS\" and Note J to Consolidated Financial Statements in the Company's 1994 Annual Report to Stockholders, which are incorporated herein by reference.\nACQUISITIONS DIVISION\nThe Company actively seeks to acquire blocks of insurance policies. These acquisitions may be accomplished through acquisitions of companies or through the assumption or reinsurance of policies. Most acquisitions do not include the Company's acquisition of an active sales force, but some do. Blocks of policies acquired through the Acquisitions Division are usually administered as \"closed\" blocks; i.e., no new policies are sold. Therefore, the amount of insurance in force for a particular acquisition is expected to decline with time due to lapses and deaths of the insureds. The experience of the Company has been that acquired or reinsured business can be administered more efficiently by the Company than by previous management.\nMore than twenty separate transactions were made between 1970 and 1987. From 1987 through 1989, the Company encountered more competition concerning acquisitions; however, it did not change its strategy concerning the margins it sought from acquisitions. Consequently, no material transactions were entered into from 1987 to 1989.\nThe environment for acquisitions has become more favorable since 1989 and management believes that this favorable environment likely will continue into the immediate future. Insurance companies are facing heightened regulatory and market pressure to increase statutory capital and thus may seek to increase capital by selling blocks of policies. Insurance companies also appear to be selling blocks of policies in conjunction with programs to narrow strategic focus. In addition, smaller companies may face difficulties in marketing and thus may seek to be acquired.\nSeveral states have enacted statutes that decreased the attractiveness of assumption reinsurance transactions and increased the attractiveness of coinsurance transactions, which has caused sellers to place more emphasis on the financial condition and acquisition experience of the purchaser. Management believes this trend will favorably impact the Company's competitive position. However, it appears that other companies are entering this market; therefore, the Company may face increased competition for future acquisitions.\nTotal revenues and income before income tax from the Acquisitions Division are expected to decline with time unless new acquisitions are made. Therefore, the Division's revenues and earnings may fluctuate from year-to-year depending upon the level of acquisition activity.\nIn the fourth quarter of 1990, Protective Life reinsured two separate blocks of insurance. In the first quarter of 1992, Employers National Life Insurance Company, a small Texas insurance company, was purchased and merged into Protective Life. In the third quarter of 1993, Protective Life acquired Wisconsin National Life Insurance Company and coinsured a small block of universal life policies. In the second quarter of 1994, the Company coinsured a small block of payroll deduction policies. In the fourth quarter of 1994, the Company acquired through coinsurance a block of 130,000 policies.\nFINANCIAL INSTITUTIONS DIVISION\nThe Financial Institutions Division specializes in marketing insurance products through commercial banks, savings and loan associations, and mortgage bankers. The Division markets an array of life and health products, the majority of which cover consumer and mortgage loans made by financial institutions located primarily in the southeastern United States. The Division also markets life and health products through the consumer finance industry and through automobile dealerships. The Division markets through employee field representatives, independent brokers, and a wholly-owned subsidiary. The Division also offers certain products through direct mail solicitation to customers of financial institutions. The demand for credit life and credit health insurance is related to the level of loan demand.\nIn July 1992, in a major expansion of the Division, the Company acquired the credit insurance business of Durham Life Insurance Company (\"Durham\") which more than doubled the reserves the Company then held for its existing credit insurance activities. The acquisition provided significant market share in the southeastern states not previously covered by the Company. The larger size of the Division has allowed it to achieve economies of scale.\nGROUP DIVISION\nThe Group Division manufactures, distributes, and services group, payroll deduction, cancer, and dental insurance products. The Division offers substantially all forms of group insurance customary in the industry, making available complete packages of life and accident and health insurance to employers. The life and accident and health insurance packages offered by this Division include hospital and medical coverages as well as dental and disability coverages. To address rising health care costs, the Division provides cost containment services such as utilization review and catastrophic case management.\nThe Division markets its group insurance products primarily in the southeastern and southwestern United States using the services of brokers who specialize in group products. Sales offices in Alabama, Florida, Georgia, Illinois, Missouri, North Carolina, Ohio, Oklahoma, Tennessee, and Texas are maintained to serve these brokers. Group policies are directed primarily at employers and associations with between 25 and 1,000 employees. The Division also markets group insurance to small employers through a marketing organization affiliated with\nan insurer, and reinsures the business produced by the marketing organization. The Division receives a ceding commission from these arrangements.\nGroup accident and health insurance is generally considered to be cyclical. Profits rise or fall as competitive forces allow or prevent rate increases to keep pace with changes in group health medical costs. The Company is placing marketing emphasis on other health insurance products which have not been as subject to medical cost inflation as traditional group health products. These products include dental insurance policies and hospital indemnity policies which are distributed nationally through the Division's existing distribution system, as well as through joint marketing arrangements with independent marketing organizations, and through reinsurance contracts with other insurers. These products also include an individual cancer insurance policy marketed through a nationwide network of agents. It is anticipated that a significant part of the growth in the Company's health insurance premium income in the next several years will be from products like dental and individual cancer insurance.\nIn 1993 the Division established a special marketing unit to sell dental plans through mail and telephone solicitations. Additionally, the Company has recently acquired National Health Care Systems of Florida, Inc., known as \"DentiCare\", a Florida-based dental health maintenance organization. DentiCare has over 260,000 members in the southeastern United States.\nGUARANTEED INVESTMENT CONTRACTS DIVISION\nIn November 1989, the Company began selling guaranteed investment contracts (\"GICs\"). The Company's GICs are contracts, generally issued to a 401(k) or other retirement savings plan, which guarantee a fixed return on deposits for a specified period and often provide flexibility for withdrawals, in keeping with the benefits provided by the plan. The Company also offers a related product which is purchased primarily as a temporary investment vehicle by the trustees of escrowed municipal bond proceeds. GICs are sold to customers through a network of specialized GIC managers, consultants, and brokers.\nThe Company entered the GIC business in 1989 through a joint venture. The joint venture arrangement was ended in 1991.\nLife insurer credit concerns and a demand shift to non-traditional GIC alternatives have generally caused the GIC market to contract somewhat. Management believes that maintenance of strong claims-paying and financial strength ratings is necessary for success in this market.\nThe Division's total revenues and income before income tax have significantly increased each year since 1990 as GIC account balances have increased. The rate of growth in GIC account balances will most likely significantly decrease as the number of maturing contracts increases.\nINDIVIDUAL LIFE DIVISION\nSince 1983, the Individual Life Division (formerly, the Agency Division) has utilized a distribution system based on experienced independent personal producing general agents who are recruited by regional sales managers. At December 31, 1994, there were 25 regional sales managers located throughout the United States. Honors Club members, agents who produce at\nleast $30 thousand of new premium per year, totalled 253 at December 31, 1994. Honors Club members represent approximately 46% of the Division's new premium. In 1993, the Division began distributing insurance products through stock brokers. The Division also distributes insurance products through the payroll deduction market.\nMarketing efforts in the Individual Life Division are directed toward the Company's various universal life products and products designed to compete in the term marketplace. Universal life products combine traditional life insurance protection with the ability to tailor a more flexible payment schedule to the individual's needs, provide an accumulation of cash values on which income taxes are deferred, and permit the Company to change interest rates credited on policy cash values to reflect current market rates. The Company currently emphasizes back-end loaded universal life policies which reward the continuing policyholder and which should maintain the persistency of its universal life business. The products designed to compete in the term marketplace are term-like policies with guaranteed level premiums for the first 10, 15, or 20 years which provide a competitive net cost to the insured.\nThe Division is developing new ventures including a special program for parents and guardians of persons with disabilities, a special product for owners of privately-held companies, and the sale of policies in the life insurance brokerage market.\nThe Division recently changed its name to describe more accurately its functions of manufacturing, distributing, and servicing the Company's individual life insurance products.\nINVESTMENT PRODUCTS DIVISION\nThe Investment Products Division manufactures, sells, and supports annuity products. These products are sold through stock brokers, financial institutions, and the Individual Life Division.\nIn April 1990, the Company began sales of modified guaranteed annuity products (\"MGA products\") which guarantee a compounded interest rate for a fixed term. Because contract values are \"market-value adjusted\" upon surrender prior to maturity, the MGA products afford the Company a measure of protection from changes in interest rates.\nIn late 1992, the Division ceased most new sales of single premium deferred annuities. In 1994, the Division introduced a variable annuity product to broaden the Division's product line.\nThe Division also includes ProEquities, Inc. (\"PES\"), formerly, Protective Equity Services, Inc., an affiliated securities broker-dealer. Through PES, members of the Company's field force who are licensed to sell securities can sell stocks, bonds, mutual funds, and investment products that may be manufactured or issued by companies other than the Company. Some of the Company's annuity products are also sold through PES. On January 1, 1995, management responsibility for PES was transferred to the Individual Life Division, and PES's financial results will be included in the Individual Life Division beginning in 1995.\nCORPORATE AND OTHER\nThe Corporate and Other segment consists of several small insurance lines of business, net investment income and expenses not attributable to the business segments described above (including interest on substantially all debt), and the operations of several small noninsurance subsidiaries. The earnings of this segment may fluctuate from year to year.\nIn 1988, the Company acquired convertible preferred stock of Southeast Health Plan, Inc. (\"SEHP\"), a Birmingham-based health maintenance organization. In August 1991, the Company converted the preferred stock into 80% of the common stock of SEHP. In August 1993, the Company sold its interest in SEHP.\nIn 1994, the Company entered into a joint venture arrangement with the Lippo Group to enter the Hong Kong insurance market. The Company and the Lippo Group jointly own a Hong Kong insurer which commenced business in early 1995. Most of the Hong Kong insurer's products are similar to those currently being offered by the Company. Management believes that this joint venture will position the Company to market life insurance in mainland China when that opportunity unfolds.\nINSURANCE IN FORCE\nThe Company's total consolidated life insurance in force at December 31, 1994 was $49.9 billion. The following table shows sales by face amount and insurance in force for the Company's business segments.\nThe ratio of voluntary terminations of individual life insurance to mean individual life insurance in force, which is determined by dividing the amount of insurance terminated due to surrenders and lapses during the year by the mean of the insurance in force at the\nbeginning and end of the year, adjusted for the timing of major acquisitions and assumptions was:\nNet terminations reflect voluntary lapses and cash surrenders, some of which may be due to the replacement of the Company's products with competitors' products. Also, a higher percentage of voluntary lapses typically occurs in the first 15 months of a policy, and accordingly, lapses will tend to increase or decrease in proportion to the change in new insurance written during the immediately preceding periods.\nThe amount of investment products in force is measured by account balances. The following table shows guaranteed investment contract and annuity account balances.\nUNDERWRITING\nThe underwriting policies of the Company's insurance subsidiaries are established by management. With respect to individual insurance, the subsidiaries use information from the application and, in some cases, inspection reports, attending physician statements, or medical examinations to determine whether a policy should be issued as applied for, rated, or rejected. Medical examinations of applicants are required for individual life insurance in excess of certain prescribed amounts (which vary based on the type of insurance) and for most ordinary insurance applied for by applicants over age 50. In the case of \"simplified issue\" policies, which are issued primarily through the Financial Institutions Division and the payroll deduction market, coverage is rejected if the responses to certain health questions contained in the application indicate adverse health of the applicant. For other than \"simplified issue\" policies, medical examinations are requested of any applicant, regardless of age and amount of requested coverage, if an examination is deemed necessary to underwrite the risk. Substandard risks may be referred to reinsurers for full or partial reinsurance of the substandard risk.\nThe Company's insurance subsidiaries require blood samples to be drawn with ordinary insurance applications for coverage over $100,000 (ages 16-50) or $150,000 (age 51 and above). Blood samples are tested for a wide range of chemical values and are screened for antibodies\nto the HIV virus. Applications also contain questions permitted by law regarding the HIV virus which must be answered by the proposed insureds.\nGroup insurance underwriting policies are administered by experienced group underwriters. The underwriting policies are designed for single employer groups. Initial premium rates are based on prior claim experience and manual premium rates with relative weights depending on the size of the group and the nature of the benefits.\nINVESTMENTS\nThe types of assets in which the Company may invest are influenced by state laws which prescribe qualified investment assets. Within the parameters of these laws, the Company invests its assets giving consideration to such factors as liquidity needs, investment quality, investment return, matching of assets and liabilities, and the composition of the investment portfolio by asset type and credit exposure. Because liquidity is important, the Company continually balances maturity against yield and quality considerations in selecting new investments.\nThe Company's asset\/liability matching practices involve monitoring of asset and liability durations for various product lines, cash flow testing under various interest rate scenarios, and rebalancing of assets and liabilities with respect to yield, risk, and cash-flow characteristics.\nIn accordance with generally accepted accounting principles, the Company's fixed maturities, equity securities, and short-term investments are valued at market. Mortgage loans, investment real estate, policy loans, and other long- term investments are valued at amortized cost. The following table shows the Company's investments at December 31, 1994, valued on the basis of generally accepted accounting principles.\nA significant portion of the Company's bond portfolio is invested in mortgage-backed securities. Mortgage-backed securities are constructed from pools of residential mortgages, and may have cash flow volatility as a result of changes in the rate at which prepayments of principal occur with respect to the underlying loans. Prepayments of principal on the underlying residential loans can be expected to accelerate with decreases in interest rates and diminish with increases in interest rates.\nIn management's view, the overall quality of the Company's investment portfolio continues to be strong. The Company obtains ratings of its fixed maturities from Moody's Investor Service, Inc. (\"Moody's\") and Standard & Poor's Corporation (\"S&P\"). If a bond is not rated by Moody's or S&P, the Company uses ratings from the Securities Valuation Office of the National Association of Insurance Commissioners (\"NAIC\"), or the Company rates the bond based upon a comparison of the unrated issue to rated issues of the same issuer or rated issues of other issuers with similar risk characteristics. At December 31, 1994, approximately 98% of bonds were rated by Moody's, S&P, or the NAIC.\nThe following table shows the approximate percentage distribution of the Company's fixed maturities by rating category, utilizing S&P's rating categories, at December 31, 1994:\nAt December 31, 1994, approximately $3,160.3 million of the Company's $3,242.8 million bond portfolio was invested in U.S. Government-backed securities or investment grade corporate bonds and only approximately $82.5 million of its bond portfolio was rated less than investment grade. Approximately $269 million of bonds are not publicly traded.\nRisks associated with investments in less than investment grade debt obligations may be significantly higher than risks associated with investments in debt securities rated investment grade. Risk of loss upon default by the borrower is significantly greater with respect to such debt obligations than with other debt securities because these obligations may be unsecured or subordinated to other creditors. Additionally, there is often a thinly traded market for such securities and current market quotations are frequently not available for some of these securities. Issuers of less than investment grade debt obligations usually have higher levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than investment-grade issuers.\nThe Company also invests in bank loan participations. Generally, such investments constitute the most senior debt incurred by the borrower in highly leveraged transactions. They are generally unrated by the credit rating agencies. Of the $244.9 million of bank loan participations owned by the Company at December 31, 1994, $195.1 million were classified by the Company as less than investment grade.\nThe Company also invests a significant portion of its portfolio in mortgage loans. Results for these investments have been excellent due to careful management and a focus on a specialized segment of the market. The Company generally does not lend on speculative properties and has specialized in making loans on either credit-oriented commercial properties, or credit-anchored strip shopping centers.\nThe following table shows a breakdown of the Company's mortgage loan portfolio by property type:\nCredit-anchored strip shopping center loans are generally on strip shopping centers located in smaller towns and anchored by one or more strong regional or national retail stores. The anchor tenants enter into long-term leases with the Company's borrowers. These centers provide the basic necessities of life, such as food, pharmaceuticals, and clothing, and have been relatively insensitive to changes in economic conditions. The following are some of the largest anchor tenants (measured by the Company's exposure) in the strip shopping centers at December 31, 1994:\nThe Company's mortgage lending criteria generally require that the loan-to- value ratio on each mortgage be at or under 75% at the time of origination, although in certain circumstances the Company will lend on the basis of an 85% loan-to-value ratio. Projected rental payments from credit anchors (i.e., excluding rental payments from smaller local tenants) generally exceed 70% of the property's projected operating expenses and debt service. The average size mortgage loan in the Company's portfolio is approximately $1.5 million. The largest single loan amount is $11.9 million.\nMany of the Company's mortgage loans have call or interest rate reset provisions after five to seven years. However, if interest rates were to significantly increase, the Company may be unable to increase the interest rates on its existing mortgage loans commensurate with the significantly increased market rates, or call the loans.\nAt December 31, 1994, $24.0 million or 1.6% of the mortgage loan portfolio was nonperforming. It is the Company's policy to cease to carry accrued interest on loans that are over 90 days delinquent. For loans less than 90 days delinquent, interest is accrued unless it is determined that the accrued interest is not collectible. If a loan becomes over 90 days\ndelinquent, it is the Company's general policy to initiate foreclosure proceedings unless a workout arrangement to bring the loan current is in place.\nAs a general rule, the Company does not invest directly in real estate. The investment real estate held by the Company consists largely of properties obtained through foreclosures or the acquisition of other insurance companies. At foreclosure, a new appraisal is obtained, and the value of real estate acquired through foreclosure is valued at the lesser of the mortgage loan balance plus costs of foreclosure or appraised value. In the Company's experience, the appraised value of foreclosed properties often equals or exceeds the mortgage loan balance on the property plus costs of foreclosure. Also, foreclosed properties often generate a positive cash flow enabling the Company to hold and manage the property until the property can be profitably sold.\nThe Company has established an allowance for uncollectible amounts on investments. This allowance was $35.9 million at December 31, 1994.\nA combination of futures contracts and options on treasury notes is currently being used in connection with a hedging program which is designed to hedge against rising interest rates for asset\/liability management of certain investments, primarily mortgage loans on real estate, and liabilities arising from interest sensitive products such as GICs and individual annuities. Realized investment gains and losses on such contracts are deferred and amortized over the life of the hedged asset. The Company also uses interest rate swap contracts to effectively convert certain investments from a variable to a fixed rate of interest.\nFor further discussion regarding the Company's investments and the maturity of and the concentration of risk among the Company's invested assets, see Note C to the Consolidated Financial Statements.\nThe following table shows the investment results of the Company for the years 1990 through 1994:\nSee \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - LIQUIDITY AND CAPITAL RESOURCES\" in the Company's 1994 Annual Report to Stockholders for certain information relating to the Company's investments and liquidity.\nINDEMNITY REINSURANCE\nAs is customary in the insurance industry, the Company's insurance subsidiaries cede insurance to other insurance companies. The ceding insurance company remains contingently liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it. The Company sets a limit on the amount of insurance retained on the life of any one person. In the individual lines it will not retain more than $500,000, including accidental death benefits, on any one life. Certain of the term-like plans of the Company have a retention of $50,000 per life. For group insurance, the maximum amount retained on any one life is $100,000. At December 31, 1994, the Company had insurance in force of $49.9 billion of which approximately $8.6 billion was ceded to reinsurers.\nRESERVES\nThe applicable insurance laws under which the Company's insurance subsidiaries operate require that each insurance company report policy reserves as liabilities to meet future obligations on the outstanding policies. These reserves are the amounts which, with the additional premiums to be received and interest thereon compounded annually at certain assumed rates, are calculated in accordance with applicable law 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 named mortality tables and interest rates.\nThe reserves carried in the Company's financial reports (presented on the basis of generally accepted accounting principles) differ from those specified by the laws of the various states and carried in the insurance subsidiaries' statutory financial statements (presented on the basis of statutory accounting principles mandated by state insurance regulation). For policy reserves other than those for universal life policies, annuity contracts, and GICs, these differences arise from the use of mortality and morbidity tables and interest rate assumptions which are deemed under generally accepted accounting principles to be more appropriate for financial reporting purposes than those required for statutory accounting purposes; from the introduction of lapse assumptions into the reserve calculation; and from the use of the net level premium reserve method on all business. Policy reserves for universal life policies, annuity contracts, and GICs are carried in the Company's financial reports at the account value of the policy or contract.\nFEDERAL INCOME TAX CONSEQUENCES\nThe Company's 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 noninsurance 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.\nUnder pre-1984 tax law, certain income of the Company was not taxed currently, but was accumulated in the \"Policyholders' Surplus Account\" for each insurance company subsidiary to be taxed only when such income was distributed to the stockholders or when certain limits on accumulated amounts were exceeded. Consistent with current tax law, amounts accumulated in the Policyholders' Surplus Account have been carried forward, although no accumulated income\nmay be added to these accounts. As of December 31, 1994, the combined Policyholders' Surplus Accounts for the life insurance subsidiaries of the Company and the estimated tax which would become payable on these amounts if distributed to stockholders were $50.7 million and $17.7 million, respectively. The Company does not anticipate any of its life insurance subsidiaries exceeding applicable limits on amounts accumulated in these accounts and, therefore, does not expect to involuntarily pay tax on the amounts held therein.\nCOMPETITION\nThe Company operates in a highly competitive industry. In connection with the development and sale of its products, the Company encounters significant competition from other insurance companies, many of which have financial resources greater than those of the Company, as well as from other investment alternatives available to its customers. The operating results of companies in the insurance industry have historically been subject to significant fluctuations due to competition, economic conditions, interest rates, investment performance, maintenance of insurance ratings, and other factors. Management believes that the Company's ability to compete is dependent upon, among other things, its ability to attract and retain agents to market its insurance products, its ability to develop competitive and profitable products, and its maintenance of a high rating from rating agencies.\nNontraditional sources of health care coverages, such as health maintenance organizations and preferred provider organizations, are developing rapidly in the Company's operating territory and provide competitive alternatives to the Company's group health products.\nBanks, by offering bank investment contracts currently guaranteed by the FDIC, provide competitive alternatives to GICs. Banks may also compete by selling annuity products provided by other insurance companies. Also, in the future banks and other financial institutions may be granted approval to underwrite and sell annuities or other insurance products that compete directly with the Company.\nREGULATION\nThe Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including rates, policy forms and capital adequacy, and is concerned primarily with the protection of policyholders rather than stockholders. The Company's management does not believe that the regulatory initiatives currently under consideration would have a material adverse impact on the Company or its insurance subsidiaries; however, the Company cannot predict the form of any future proposals or regulation.\nThe Company's insurance subsidiaries are required to file detailed annual reports with the supervisory agencies in each of the jurisdictions in which they do business and their business and accounts are subject to examination by such agencies at any time. Under the rules of the NAIC, insurance companies are examined periodically (generally every three to five years) by one or more of the supervisory agencies on behalf of the states in which they do business. To date, no such insurance department examinations have produced any significant adverse findings regarding any insurance subsidiary of the Company.\nA life insurance company's statutory capital is computed according to rules prescribed by the NAIC as modified by the insurance company's state of domicile. Statutory accounting rules are different from generally accepted accounting principles and are intended to reflect a more conservative view. The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. These risk-based capital requirements are intended to allow insurance regulators to identify inadequately capitalized insurance companies based upon the types and mixtures of risks inherent in the insurer's operations. The formula includes components for asset risk, liability risk, interest rate exposure, and other factors. Based upon the December 31, 1994 statutory financial reports, management believes that the Company's insurance subsidiaries are adequately capitalized under the formula.\nIndividual state guaranty associations assess insurance companies to pay benefits to policyholders of insolvent or failed insurance companies. The Company's insurance subsidiaries were assessed immaterial amounts in 1994, which will be partially offset by credits against future state premium taxes. The Company cannot predict the amount of any future assessments; however, most insurance guaranty fund laws currently provide that an assessment may be excused or deferred if it would threaten an insurer's financial strength.\nIn addition, many states, including the states in which the Company's insurance subsidiaries are domiciled, have enacted legislation or adopted regulations regarding insurance holding company systems. These laws require registration of and periodic reporting by insurance companies domiciled within the jurisdiction which control or are controlled by other corporations or persons so as to constitute an insurance holding company system. These laws also affect the acquisition of control of insurance companies as well as transactions between insurance companies and companies controlling them. Most states, including Tennessee, where Protective Life is domiciled, require administrative approval of the acquisition of control of an insurance company domiciled in the state or the acquisition of control of an insurance holding company whose insurance subsidiary is incorporated in the state. In Tennessee, the acquisition of 10% of the voting securities of a person is generally deemed to be the acquisition of control for the purpose of the insurance holding company statute and requires not only the filing of detailed information concerning the acquiring parties and the plan of acquisition, but also administrative approval prior to the acquisition.\nThe Company's insurance subsidiaries are subject to various state statutory and regulatory restrictions, applicable to insurance companies generally, that limit the amount of cash dividends, loans and advances that those subsidiaries may pay to the Company. The restrictions are generally based on certain levels of surplus, investment income and operating income, as determined under statutory insurance accounting practices. In general, dividends up to specified levels are considered ordinary and may be paid thirty days after written notice to the insurance commissioner of the state of domicile unless such commissioner objects to the dividend prior to the expiration of such period. Dividends in larger amounts are considered extraordinary and are subject to affirmative prior approval by such commissioner. The maximum amount that would qualify as ordinary dividends to the Company by its insurance subsidiaries in 1995 is estimated to be $62 million as of December 31, 1994. No assurance can be given that more stringent restrictions will not be adopted from time to time by states in which the Company's insurance subsidiaries are domiciled, which restrictions could have the effect, under certain circumstances,\nof significantly reducing dividends or other amounts payable to the Company by such subsidiaries without affirmative prior approval by state regulatory authorities.\nThe Company's insurance subsidiaries act as fiduciaries and are subject to regulation by the Department of Labor (\"DOL\") when providing a variety of products and services to employee benefit plans governed by the Employee Retirement Income Security Act of 1974 (\"ERISA\"). Severe penalties are imposed by ERISA on fiduciaries which violate ERISA's prohibited transaction provisions by breaching their duties to ERISA covered plans. In a case decided by the United States Supreme Court in December, 1993 (JOHN HANCOCK MUTUAL LIFE INSURANCE COMPANY V. HARRIS TRUST AND SAVINGS BANK) the Court concluded that an insurance company general account contract that had been issued to a pension plan should be divided into its guaranteed and nonguaranteed components and that certain ERISA fiduciary obligations applied with respect to the assets underlying the nonguaranteed components. Although the Company's insurance subsidiaries have not issued contracts identical to the one involved in HARRIS TRUST, some of its policies relating to ERISA-covered plans may be deemed to have nonguaranteed components subject to the principles announced by the Court.\nThe full extent to which HARRIS TRUST makes the fiduciary standards and prohibited transaction provisions of ERISA applicable to all or part of insurance company general account assets, however, cannot be determined at this time. The Supreme Court's opinion did not resolve whether the assets at issue in the case may be subject to ERISA for some purposes and not others. The life insurance industry is currently discussing with the DOL the possibility of exemptions from the prohibited transaction provisions of ERISA in view of HARRIS TRUST. In August of 1994, the DOL published a notice of a proposed class exemption which, if adopted in final form, would exempt from the prohibited transaction rules, prospectively and retroactively to January 1, 1995, certain transactions engaged in by insurance company general accounts in which employer benefit plans have an interest. The proposed exemption would not cover all such transactions, and the insurance industry is seeking further relief. Until these and other matters are clarified, the Company is unable to determine whether the decision will result in any liability and, if so, its nature and scope.\nExisting federal laws and regulations affect the taxation of life insurance products and companies or their contractholders or policyowners and the relative desirability of various personal investment vehicles. Congress has from time to time considered proposals that, if enacted, would have had an adverse impact on the federal income tax treatment of certain individual annuity and life insurance policies offered by the Company's life insurance subsidiaries. If these proposals were to be adopted, they would adversely affect the ability of the Company's life insurance subsidiaries to sell such products and could result in the surrender of existing contracts and policies. Although it cannot be predicted whether future legislation will contain provisions that alter the treatment of these products, such provisions are not part of any tax legislation currently under active consideration in Congress.\nThe Federal Government has advocated changes to the current health care delivery system which will address both affordability and availability issues. The ultimate scope and effective date of any health care reform proposals are unknown at this time and are likely to be modified as they are considered for enactment by Congress. It is anticipated that these proposals may adversely affect certain products in the Company's group health insurance business. In addition to the federal initiatives, a number of states are considering legislative programs that\nare intended to affect the accessibility and affordability of health care. Some states have recently enacted health care reform legislation. These various state programs (which could be preempted by any federal program) may also adversely affect the Company's group health insurance business. However, in light of the small relative proportion of the Company's earnings attributable to group health insurance, management does not expect that either the federal or state proposals will have a material adverse effect on the Company's earnings.\nAdditional issues related to regulation of the Company and its insurance subsidiaries are discussed in \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - LIQUIDITY AND CAPITAL RESOURCES\" in the Company's 1994 Annual Report to Stockholders.\nEMPLOYEES\nThe Company had 1,094 full-time employees, including 919 in the Home Office in Birmingham, Alabama at December 31, 1994. These employees are covered by contributory major medical insurance, group life, and long-term disability insurance plans. The cost of these benefits in 1994 amounted to approximately $2.4 million for the Company. In addition, substantially all of the employees are covered by a pension plan. The Company also matches employee contributions to its 401(k) Plan. See Note K to Consolidated Financial Statements.\nRECENT DEVELOPMENTS\nThe President and Congress are considering repealing the Glass-Steagall Act, which would allow banks to diversify into securities and other businesses including insurance. The ultimate scope and effective date of any proposals are unknown at this time and are likely to be modified as they are considered for enactment by Congress. It is anticipated that these proposals may increase competition and, therefore, may adversely affect the Company.\nIn March 1995, the Company completed its previously announced acquisition of National Health Care Systems of Florida, Inc. The purchase price, determined at closing, was $38.3 million. In connection with the acquisition, the Company will reissue approximately 658,000 shares of Company Common Stock now held as treasury shares.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's Home Office building is located at 2801 Highway 280 South, Birmingham, Alabama. This building includes the original 142,000 square-foot building which was completed in 1976 and a second contiguous 220,000 square-foot building which was completed in 1985. In addition, parking is provided for approximately 1,000 vehicles.\nThe Company leases administrative space in 6 cities, substantially all under leases for periods of three to five years. The aggregate monthly rent is approximately $72 thousand.\nMarketing offices are leased in 16 cities, substantially all under leases for periods of three to five years with only three leases running longer than five years. The aggregate monthly rent is approximately $35 thousand.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings, other than ordinary routine litigation incidental to the business of the Company, to which the Company or any of its subsidiaries is a party or of which any of the Company's properties is the subject. See also \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - LIQUIDITY AND CAPITAL RESOURCES\" in the Company's 1994 Annual Report to Stockholders for certain information relating to litigation involving the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted during the fourth quarter of 1994 to a vote of security holders of the Company.\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 and principally traded on the New York Stock Exchange (NYSE symbol: PL). Through October 1, 1993, the Company's Common Stock was traded on the over-the-counter market (NASDAQ symbol: PROT) and was quoted on the NASDAQ National Market System. The following table sets forth the highest and lowest closing prices of the Company's Common Stock, $0.50 par value, as reported by the New York Stock Exchange and the NASDAQ during the periods indicated, along with the dividends paid per share of Common Stock during the same periods.\nAt February 14, 1995, there were approximately 2,100 holders of record of Company Common Stock.\nThe Company (or its predecessor) has paid cash dividends each year since 1926 and each quarter since 1934. The Company expects to continue to pay cash dividends, subject to the earnings and financial condition of the Company and other relevant factors. The ability of the Company to pay cash dividends is dependent in part on cash dividends received by the Company from its life insurance subsidiaries. See Item 7 - \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - LIQUIDITY AND CAPITAL RESOURCES\" in the Company's 1994 Annual Report to Stockholders. Such subsidiary dividends are restricted by the various insurance laws of the states in which the subsidiaries are incorporated. See Item 1 - \"BUSINESS - REGULATION\".\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\nInformation regarding the Company's financial condition and results of operations is included under the caption \"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\" in the Company's 1994 Annual Report to Stockholders and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data for the Company and its subsidiaries, which are included under the caption \"CONSOLIDATED FINANCIAL STATEMENTS\" in the Company's 1994 Annual Report to Stockholders, are incorporated herein by reference.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Directors and Stockholders Protective Life Corporation Birmingham, Alabama\nOur report on the consolidated financial statements of Protective Life Corporation and Subsidiaries has been incorporated by reference in this Form 10- K from page 59 of the 1994 Annual Report to Stockholders of Protective Life Corporation. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page 26 of this Form 10-K.\nIn our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n\/s\/ Coopers & Lybrand L.L.P.\nBirmingham, Alabama February 13, 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\nExcept for the information concerning executive officers of the Company set forth below, the information called for by this Item 10 is incorporated herein by reference to the section entitled \"ELECTION OF DIRECTORS AND INFORMATION ABOUT NOMINEES\" in the Company's definitive proxy statement for the Annual Meeting of Stockholders, May 1, 1995, to be filed with the Securities and Exchange Commission by the Company pursuant to Regulation 14A within 120 days after the end of its 1994 fiscal year.\nThe executive officers of the Company are as follows:\nName Age Position ---- --- --------\nDrayton Nabers, Jr. 54 Chairman of the Board, President and Chief Executive Officer and a Director\nR. Stephen Briggs 45 Executive Vice President\nJohn D. Johns 42 Executive Vice President and Chief Financial Officer\nOrmond L. Bentley 59 Senior Vice President, Group\nDeborah J. Long 41 Senior Vice President and General Counsel\nJim E. Massengale 52 Senior Vice President\nSteven A. Schultz 41 Senior Vice President, Financial Institutions\nWayne E. Stuenkel 41 Senior Vice President and Chief Actuary\nA. S. Williams III 58 Senior Vice President, Investments and Treasurer\nJudy Wilson 36 Senior Vice President, Guaranteed Investment Contracts\nName Age Position ---- --- --------\nJerry W. DeFoor 42 Vice President and Controller, and Chief Accounting Officer\nAll executive officers are elected annually and serve at the pleasure of the Board of Directors. None is related to any director of the Company or to any other executive officer.\nMr. Nabers has been Chairman of the Board, President and Chief Executive Officer and a Director since May 1994. From May 1992 to May 1994, he was President and Chief Executive Officer and a Director. Mr. Nabers was President and Chief Operating Officer and a Director from August 1982 until May 1992. From July 1981 to August 1982, he was Senior Vice President of the Company. Since August 1982, he has also been President of Protective Life and had been its Senior Vice President from September 1981 to August 1982. From February 1980 to September 1981, he served as Senior Vice President, Operations of Protective Life. From 1979 to February 1980, he was Senior Vice President, Operations and General Counsel of Protective Life. From February 1980 to March 1983, he served as President of Empire General Life Insurance Company, a subsidiary, and from March 1983 to December 31, 1984, he was Chairman of the Executive Committee of Empire General. He is also a director of Energen Corporation and National Bank of Commerce of Birmingham.\nMr. Briggs has been Executive Vice President of the Company and of Protective Life since October 1993. From January 1993 to October 1993, he was Senior Vice President, Life Insurance and Investment Products of the Company and of Protective Life. Mr. Briggs had been Senior Vice President, Ordinary Marketing of the Company since August 1988 and of Protective Life since April 1986. From July 1983 to April 1986, he was President of First Protective Insurance Group, Inc.\nMr. Johns has been Executive Vice President and Chief Financial Officer of the Company and of Protective Life since October 1993. From August 1988 to October 1993, he served as Vice President and General Counsel of Sonat, Inc. He is a director of National Bank of Commerce of Birmingham and Parisian Services, Inc.\nMr. Bentley has been Senior Vice President, Group of the Company since August 1988 and of Protective Life since December 1978. Mr. Bentley has been employed by Protective Life since October 1965.\nMs. Long has been Senior Vice President and General Counsel of the Company and of Protective Life since February 1, 1994. From August 2, 1993 to January 31, 1994, Ms. Long served as General Counsel of the Company and from February 1984 to January 31, 1994 she practiced law with the law firm of Maynard, Cooper & Gale, P.C.\nMr. Massengale has been Senior Vice President of the Company and of Protective Life since May 1992. From May 1989 to May 1992, he was Senior Vice President, Operations and Systems of the Company and Protective Life. From January 1983 to May 1989, he served as Senior Vice President, Corporate Systems of the Company and Protective Life.\nMr. Schultz has been Senior Vice President, Financial Institutions of the Company and of Protective Life since March 1993. Mr. Schultz served as Vice President, Financial Institutions of the Company from February 1993 to March 1993 and of Protective Life from February 1989 to March 1993. From June 1977 through January 1989, he was employed by and served in a number of capacities with The Minnesota Mutual Life Insurance Company, finally serving as Director, Group Sales.\nMr. Stuenkel has been Senior Vice President and Chief Actuary of the Company and of Protective Life since March 1987. Mr. Stuenkel is a Fellow of the Society of Actuaries and has been employed by Protective Life since September 1978.\nMr. Williams has been Senior Vice President, Investments and Treasurer of the Company since July 1981. Mr. Williams also serves as Senior Vice President, Investments and Treasurer of Protective Life. Mr. Williams has been employed by Protective Life since November 1964.\nMs. Wilson has been Senior Vice President, Guaranteed Investment Contracts of the Company and of Protective Life since January 1, 1995. From July 1991 to December 31, 1994, she served as Vice President, Guaranteed Investment Contracts of Protective Life. From October 1989 through July 1991, Ms. Wilson was employed by an affiliated insurer who reinsured a percentage of each guaranteed investment contract written through Protective Life.\nMr. DeFoor has been Vice President and Controller, and Chief Accounting Officer of the Company and Protective Life since April 1989. Mr. DeFoor is a certified public accountant and has been employed by Protective Life since August 1982.\nCertain of these executive officers also serve as executive officers and\/or directors of various other Company subsidiaries.\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 called for by Items 11 through 13 is incorporated herein by reference from the Company's definitive proxy statement for the Annual Meeting of Stockholders, May 1, 1995, to be filed with the Securities and Exchange Commission by the Company pursuant to Regulation 14A within 120 days after the end of its 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 part of this report:\n1. Financial Statements:\nThe following financial statements set forth in the Company's 1994 Annual Report to Stockholders as indicated on the following table are incorporated by reference (See Exhibit 13). PAGE Report of Independent Accountants. . . . . . . . . . . . . . . . 59 Consolidated Statements of Income for the years ended December 31, 1994, 1993, and 1992. . . . . . . . . . . . 39 Consolidated Balance Sheets as of December 31, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . 40 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1994, 1993, and 1992 . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993, and 1992 . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Notes to Consolidated Financial Statements . . . . . . . . . . . 44\n2. Financial Statement Schedules:\nThe Report of Independent Accountants which covers the financial statement schedules appears on page 22 of this report. The following schedules are located in this report on the pages indicated. PAGE Schedule I - Summary of Investments - Other Than Investments in Related Parties. . . . . . . . . . . 33 Schedule II - Condensed Financial Information of Registrant. . . . . . . . . . . . . . . . . . . . . . . . . 34 Schedule III - Supplementary Insurance Information . . . . . . . 38 Schedule IV - Reinsurance. . . . . . . . . . . . . . . . . . . . 39\nAll other schedules to the consolidated financial statements required by Article 7 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted.\n3. Exhibits:\nIncluded as exhibits are the items listed below. The Company will furnish a copy of any of the exhibits listed upon the payment of $5.00 per exhibit to cover the cost of the Company in furnishing the exhibit.\nITEM NUMBER DOCUMENT\n*3(a) 1985 Restated Certificate of Incorporation of the Company filed as Exhibit 3(a) to the Company's Form 10-K Annual Report for the year ended December 31,\n*3(a)(1) Certificate of Amendment of 1985 Restated Certificate of Incorporation of the Company filed as Exhibit 3(a)(1) to the Company's Form 10-K Annual Report for the year ended December 31, 1993\n*3(a)(2) Certificate of Designation of Junior Participating Cumulative Preferred Stock of the Company filed with the Secretary of State of Delaware on July 14, 1987 and filed as Exhibit A to the Company's Form 8-K Report filed July 15, 1987\n*3(a)(3) Certificate of Correction of Certificate of Designation of Junior Participating Cumulative Preferred Stock of the Company filed with the Secretary of State of Delaware on July 27, 1987 and filed as Exhibit 3(a)(4) to the Company's Form 10-K Annual Report for the year ended December 31, 1987\n*3(a)(4) Certificate of Amendment of 1985 Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on May 5, 1994 and filed as Exhibit 3(a)(5) to the Company's Form 10-Q Quarterly Report for the period ended March 31, 1994\n*3(b) By-laws of the Company filed as Exhibit C to the Company's Form 10 Registration Statement filed September 4, 1981\n*3(b)(1) Amended By-laws of the Company filed as Exhibit B to the Company's Form 8-K Report filed May 18, 1983\n*4(a) 1985 Restated Certificate of Incorporation of the Company filed as Exhibit 3(a) to the Company's Form 10-K Annual Report for the year ended December 31,\n*4(a)(1) Certificate of Amendment of 1985 Restated Certificate of Incorporation of the Company filed as Exhibit 3(a)(1) to the Company's Form 10-K Annual Report for the year ended December 31, 1993\n______________________ *incorporated by reference\n*4(a)(2) Certificate of Designation of Junior Participating Cumulative Preferred Stock of the Company filed with the Secretary of State of Delaware on July 14, 1987 and filed as Exhibit A to the Company's Form 8-K Report filed July 15, 1987\n*4(a)(3) Certificate of Correction of Certificate of Designation of Junior Participating Cumulative Preferred Stock of the Company filed with the Secretary of State of Delaware on July 27, 1987 and filed as Exhibit 3(a)(4) to the Company's Form 10-K Annual Report for the year ended December 31, 1987\n*4(a)(4) Certificate of Amendment of 1985 Restated Certificate of Incorporation of the Company filed with the Secretary of State of Delaware on May 5, 1994 and filed as Exhibit 3(a)(5) to the Company's Form 10-Q Quarterly Report for the period ended March 31, 1994\n*4(c) Certificate of Formation of PLC Capital L.L.C. (\"PLC Capital\") filed as Exhibit 4(c) to the Company and PLC Capital's Registration Statement No. 33-52831\n*4(d) Amended and Restated Limited Liability Company Agreement of PLC Capital L.L.C. filed as Exhibit 4(d) to the Company and PLC Capital's Registration Statement No. 33-52831\n*4(e) Form of Action establishing series of Preferred Securities (included as Annex A to Exhibit 4(d))\n*4(f) Specimen Preferred Security Certificate (included as Annex B to Exhibit 4(d))\n*4(n) Rights Agreement, dated as of July 13, 1987, between the Company and AmSouth Bank, as Rights Agent filed as Exhibit 1 to the Company's Form 8-A filed July 15, 1987\n*10(a) Management Incentive Plan filed as Exhibit 10(a) to the Company's Form 10-K Annual Report for the year ended December 31, 1984\n*10(a)(1) Amendment to the Company's Management Incentive Plan renamed as the Company's Annual Incentive Plan filed as Exhibit 10(a)(1) to the Company's Form 10-Q Report filed May 14, 1990\n__________________________ *incorporated by reference\n*10(b) Performance Share Plan filed as Exhibit G to the Company's Form 10 Registration Statement filed September 4, 1981 (expired as to new grants)\n*10(b)(1) 1983 Performance Share Plan filed as Exhibit C to the Company's Form 8-K Report filed May 18, 1983\n*10(b)(2) The Company's 1983 Performance Share Plan (as amended March 19, 1990) filed as Exhibit 10(b)(2) to the Company's Form 10-Q Report filed May 14, 1990\n*10(b)(3) The Company's 1992 Performance Share Plan filed as Exhibit 10(b)(3) to the Company's Form 10-Q filed May 15, 1992\n*10(c) Excess Benefit Plan filed as Exhibit 10(c) to the Company's Form 10-K Annual Report for the year ended December 31, 1984\n*10(c)(1) Excess Benefit Plan amended and restated as of January 1, 1989 filed as Exhibit 10(c)(1) to the Company's Form 10-K Annual Report for the year ended December 31, 1991\n*10(d) Bond Purchase Agreement filed as Exhibit 10(d) to the Company's Form 10-K Annual Report for the year ended December 31, 1991\n*10(d)(1) Escrow Agreement filed as Exhibit 10(d)(1) to the Company's Form 10-K Annual Report for the year ended December 31, 1991\n*10(e) Indemnity Agreements filed as Exhibits to the Company's Form 10-Q Report, filed August 14, 1986\n*10(f) Preferred Share Purchase Rights Plan filed as Exhibit 1 to the Company's Form 8-A Report filed July 15, 1987, as amended July 23 and July 29, 1987\n*10(i) Form of Severance Compensation Agreement filed as Exhibit 10(i) to the Company's Form 10-K Annual Report for the year ended December 31, 1991\n*10(i)(1) Form of First Amendment to Severance Compensation Agreement filed as Exhibit 10(i)(1) to the Company's Form 10-K Annual Report for the year ended December 31, 1991\n__________________________ *incorporated by reference\n*10(iii)(A)(1) The Company's Deferred Compensation Plan for Directors who are not Employees of the Company filed as Exhibit 4 to the Company's Form S-8 filed August 27, 1993\n*10(iii)(A)(2) The Company's Deferred Compensation Plan for Officers filed as Exhibit 4 to the Company's Form S- 8 filed January 13, 1994\n13 1994 Annual Report To Stockholders\n21 Organization Chart of the Company and Affiliates\n23 Consent of Coopers & Lybrand L.L.P.\n24 Power of Attorney\n27 Financial Data Schedule\nThe following is a list of each management contract or compensatory plan or arrangement required to be filed as an exhibit to this form pursuant to Item 14(c) of this Form 10-K: Exhibit Item Numbers 10(a), 10(a)(1), 10(b), 10(b)(1), 10(b)(2), 10(b)(3), 10(c), 10(c)(1), 10(i), 10(i)(1), 10(iii)(A)(1), and 10(iii)(A)(2).\n(b) Reports on Form 8-K:\n(1) Form 8-K, dated February 14, 1994 - Item 5\n(2) Form 8-K, dated April 26, 1994 - Item 5\n(3) Form 8-K, dated June 17, 1994 - Item 7\n(4) Form 8-K\/A, dated June 20, 1994 - Item 7\n(5) Form 8-K, dated July 1, 1994 - Item 7\n(6) Form 8-K, dated July 27, 1994 - Item 5\n(7) Form 8-K, dated October 25, 1994 - Item 5\n(8) Form 8-K, dated November 14, 1994 - Item 5 __________________________ *incorporated by reference\nSIGNATURES\nPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPROTECTIVE LIFE CORPORATION\nBy:\/s\/Drayton Nabers, Jr. --------------------------------- Drayton Nabers, Jr. Chairman of the Board, President and Chief Executive Officer 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 Company and in the capacities and on the dates indicated.\nSIGNATURE CAPACITY IN WHICH SIGNED DATE --------- ------------------------ ----\n\/s\/Drayton Nabers, Jr. Chairman of the Board, March 24, 1995 ------------------------- President and Chief Executive DRAYTON NABERS, JR. Officer (Principal Executive Officer) and Director\n\/s\/John D. Johns Executive Vice President and March 24, 1995 ------------------------- Chief Financial Officer JOHN D. JOHNS (Principal Financial Officer)\n\/s\/Jerry W. DeFoor Vice President and Controller, March 24, 1995 ------------------------- and Chief Accounting Officer JERRY W. DEFOOR (Principal Accounting Officer)\n* ------------------------- Chairman Emeritus and March 24, 1995 WILLIAM J. RUSHTON III Director\n* ------------------------- Director March 24, 1995 JOHN W. WOODS\n* Director March 24, 1995 ------------------------- CRAWFORD T. JOHNSON III\n* Director March 24, 1995 ------------------------- WILLIAM J. CABANISS, JR.\n* Director March 24, 1995 ------------------------- H. G. PATTILLO\n* Director March 24, 1995 ------------------------- EDWARD L. ADDISON\n* Director March 24, 1995 ------------------------- JOHN J. MCMAHON, JR.\n* Director March 24, 1995 ------------------------- A. W. DAHLBERG\n* Director March 24, 1995 ------------------------- JOHN W. ROUSE, JR.\n* Director March 24, 1995 ------------------------- ROBERT T. DAVID\n* Director March 24, 1995 ------------------------- RONALD L. KUEHN, JR.\n* Director March 24, 1995 ------------------------- HERBERT A. SKLENAR\n______________\n*Drayton Nabers, Jr., by signing his name hereto, does sign this document on behalf of each of the persons indicated above pursuant to powers of attorney duly executed by such persons and filed with the Securities and Exchange Commission.\nBy:\/s\/Drayton Nabers, Jr. -------------------------------- DRAYTON NABERS, JR. Attorney-in-fact\nSCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES PROTECTIVE LIFE CORPORATION AND SUBSIDIARIES DECEMBER 31, 1994 (in thousands)\nCOL. A COL. B COL. C COL. D ------ ------ ------ ------ AMOUNT AT WHICH SHOWN IN BALANCE TYPE OF INVESTMENT COST VALUE SHEET ------------------ ---------- ----------- -----------\nFixed maturities: Bonds: Mortgage-backed securities $2,002,842 $1,898,321 $1,898,321 United States Government and government agencies and authorities 90,468 81,881 81,881 States, municipalities, and political subdivisions 10,902 9,677 9,677 Public utilities 414,011 378,120 378,120 Convertibles and bonds with warrants attached 687 385 385 All other corporate bonds 927,779 874,428 874,428 Bank loan participations 244,881 244,881 244,881 Redeemable preferred stocks 6,800 5,953 5,953 ---------- ---------- ---------- Total fixed maturities 3,698,370 3,493,646 3,493,646 ---------- ---------- ---------- Equity securities: Common stocks - industrial, miscellaneous, and all other 22,768 24,797 24,797 Nonredeemable preferred stocks 23,190 20,208 20,208 ---------- ---------- ---------- Total equity securities 45,958 45,005 45,005 ---------- ---------- ----------\nMortgage loans on real estate 1,487,795 ******** 1,487,795 Investment real estate 20,303 ******** 20,303 Policy loans 147,608 ******** 147,608 Other long-term investments 48,013 ******** 48,013 Short-term investments 59,541 ******** 59,541 ---------- ----------\nTotal investments $5,507,588 ******** $5,301,911 ---------- ---------- ---------- ----------\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF INCOME PROTECTIVE LIFE CORPORATION (PARENT COMPANY) YEARS ENDED DECEMBER 31, 1994, 1993, AND 1992 (in thousands)\nSee notes to condensed financial statements.\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS PROTECTIVE LIFE CORPORATION (PARENT COMPANY) (in thousands)\nSee notes to condensed financial statements.\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS PROTECTIVE LIFE CORPORATION (PARENT COMPANY) YEARS ENDED DECEMBER 31, 1994, 1993, AND 1992 (in thousands)\nSee notes to condensed financial statements.\nSCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT PROTECTIVE LIFE CORPORATION (PARENT COMPANY)\nNOTES TO CONDENSED FINANCIAL STATEMENTS\nThe Company publishes consolidated financial statements that are its primary financial statements. Therefore, these parent company condensed financial statements are not intended to be the primary financial statements of the Company, and should be read in conjunction with the consolidated financial statements and notes thereto of Protective Life Corporation and subsidiaries.\nNOTE 1 - DEBT\nAt December 31, 1994, the Company had borrowed $23.0 million of its $60 million revolving line of credit. Borrowings under the revolving line of credit become due in 1997. In addition, $75 million of Senior Notes due 2004 and $69.6 million of subordinated debentures due 2024 were outstanding at December 31, 1994. The subordinated debentures were issued to PLC Capital L.L.C., an affiliate, in connection with the issuance of Monthly Income Preferred Securities by PLC Capital L.L.C.\nNOTE 2 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION\nNOTE 3 - SUBSIDIARY SURPLUS DEBENTURES\nProtective Life Insurance Company (\"Protective Life\") has issued surplus debentures to the Company in order to finance acquisitions and growth. At December 31, 1994, the balance of the surplus debentures was $39.4 million. The surplus debentures are included in receivables from subsidiaries. Protective Life must obtain the approval of the Commissioner of Insurance before it may repay any portion of the surplus debenture.\nNOTE 4 - SALE OF SUBSIDIARY\nOn January 27, 1993, Protective Life contributed (in the form of a dividend) its 80% ownership interest in the common stock of Southeast Health Plan, Inc. (\"SEHP\"). Because SEHP was in a deficit position, the transaction was recorded as a \"negative\" dividend by the Company. On August 6, 1993, the Company sold its ownership interest in SEHP.\n_____________________________ *Eliminated in consolidation.\nSCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION PROTECTIVE LIFE CORPORATION AND SUBSIDIARIES (in thousands)\nSCHEDULE IV - REINSURANCE PROTECTIVE LIFE CORPORATION AND SUBSIDIARIES (dollars in thousands)\nEXHIBITS TO FORM 10-K OF PROTECTIVE LIFE CORPORATION FOR THE FISCAL YEAR ENDED DECEMBER 31, 1994\nINDEX TO EXHIBITS\nPAGE\n13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .","section_15":""}
{"filename":"856465_1994.txt","cik":"856465","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is a party to ordinary routine litigation incidental to its business. There is also hereby incorporated by reference the information under the headings \"Regulatory, Environmental, and Other Matters Affecting Refining and Marketing\" and \"Regulation and Other Factors Affecting Exploration and Production\" in Items 1 and 2, the discussions contained in Item 7, and the information regarding contingencies in Note 14 to the Consolidated Financial Statements in Item 8.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nExecutive Officers of the Registrant.\nExecutive Officer Name Age Position Since ---- --- -------- --------- James E. Acridge 54 President and Chief October 1989 Executive Officer\nA. Wayne Davenport 46 Vice President and May 1994 Corporate Controller\nFredric L. Holliger 47 Executive Vice President October 1989 and Chief Operating Officer\nJames W. Griffitts 49 Vice President September 1990 Information Systems\nMorgan Gust 47 Vice President and August 1990 General Counsel, Vice President Administration, and Secretary\nGary L. Nielsen 52 Vice President Finance, October 1989 Treasurer and Assistant Secretary\nThe officers of the Company are elected annually by the Board of Directors and each officer serves until his successor is chosen and qualified or until his earlier resignation or removal. There are no family relationships among the officers of the Company.\nJames E. Acridge has served as Chairman of the Board of Directors, President and Chief Executive Officer of the Company since October 1989. Mr. Acridge also serves as Chairman of the Nominating Committee. Mr. Acridge is Chairman of the Board of Directors, President and Chief Executive Officer of Giant Arizona and Chairman of the Board of Directors of Giant E&P. Mr. Acridge founded Giant Arizona in 1969 and has served continuously as its Chairman of the Board of Directors, President and Chief Executive Officer.\nA. Wayne Davenport has served as Vice President and Corporate Controller since May 1994. He also serves in such positions for Giant and Giant E&P. Prior to joining the Company in March 1994, Mr. Davenport was an investor in crude oil and natural gas properties and a consultant to the industry. From February 1987 to September 1992, he served in various positions, the last being Executive Vice President and Chief Financial Officer, with Hondo Oil & Gas Company, a company engaged in refining, marketing, exploration and production. Mr. Davenport was an audit partner for the accounting firm of Ernst & Young from May 1982 until February 1987.\nFredric L. Holliger has served as a director, Executive Vice President and Chief Operating Officer of the Company since October 1989. Mr. Holliger joined Giant Arizona as Senior Vice President and President of the Giant Arizona refining division in February 1989 and continues to serve as a director, Executive Vice President and Chief Operating Officer of Giant Arizona. Since May 1993, he has also served as a director and President and Chief Executive Officer of Giant E&P. Before joining Giant Arizona, he served for two years as President of Northern Natural Gas Company, a division of Enron Corp., Omaha, Nebraska (\"Northern Natural\") and prior thereto was employed by Northern Natural for 14 years, serving in a variety of marketing, supply, operations and petroleum engineering capacities.\nJames W. Griffitts has served as Vice President Information Systems since May 1994. He also serves in such positions for Giant Arizona and Giant E&P. He served as Vice President Accounting and Information Services from December 1991 to May 1994 and as Vice President, Information Systems for the Company from September 1990 until December 1991. Prior to September 1990, he served first Giant Arizona and then the Company as Director of Information Systems. Mr. Griffitts joined Giant Arizona in January 1977 and since that date has served in a variety of positions in the areas of personnel, accounting and systems.\nMorgan Gust has served as Secretary and General Counsel of the Company since August 1990 and as Vice President since September 1990. In addition, he has served as Vice President Administration since October 1992. He also serves in such capacities and as a director of Giant Arizona and Giant E&P. Before joining the Company, Mr. Gust was President of Tucson Resources, Inc., an investment and financial services company, where he served first in the capacity of Vice President and General Counsel and later as Executive Vice President. From September 1975 to July 1988, Mr. Gust was a partner in the law firm of Gust, Rosenfeld and Henderson.\nGary L. Nielsen has served as Treasurer and Assistant Secretary of the Company since October 1989, Vice President since September 1990, and Vice President Finance since September 1992. He also serves in such capacities for both Giant Arizona and Giant E&P. Mr. Nielsen joined Giant Arizona as its Treasurer in October 1986. Before joining Giant Arizona, he was senior Vice President and Chief Financial Officer of the casino hotel division of Del Webb Corporation from April 1978 to March 1986, and Chief Financial Officer of the Crescent Hotel Group from March 1986 to October 1986.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe principal United States market on which the Company's Common Stock is traded is the New York Stock Exchange. The high and low sales prices for the Common Stock for each full quarterly period as reported on the New York Stock Exchange Composite Tape for the last two fiscal years is as follows:\nQuarter Ended High Low ------------------ ------ ------ December 31, 1994 9 1\/4 6 3\/4 September 30, 1994 8 7\/8 7 1\/8 June 30, 1994 9 7\/8 7 3\/8 March 31, 1994 10 3\/4 8 5\/8\nDecember 31, 1993 12 3\/4 10 September 30, 1993 13 3\/8 9 1\/4 June 30, 1993 10 1\/2 7 3\/8 March 31, 1993 7 3\/4 5 1\/8\nThe Company did not declare a dividend in any quarter in 1994 or 1993. On January 9, 1995, the Company's Board of Directors declared a common stock dividend of $0.05 per share payable to stockholders of record on January 23, 1995. This dividend was paid on February 3, 1995. On March 2, 1995, the Company's Board of Directors declared another common stock dividend of $0.05 per share payable to stockholders of record on April 24, 1995, with payment to be made May 5, 1995. Any future dividends are subject to the results of the Company's operations, declarations by the Board of Directors and existing debt covenants, as described below.\nOn November 29, 1993, the Company issued $100,000,000 of 9 3\/4% Senior Subordinated Notes (\"Notes\"). The Notes were issued pursuant to an Indenture dated November 29, 1993 (the \"Indenture\") among the Company, its Subsidiaries, as guarantors, and NBD Bank, National Association, as trustee. The Indenture contains a number of covenants, which, among other provisions, place restrictions on the payment of dividends. A similar provision is contained in the agreement governing the Company's 10.91% senior unsecured note. At December 31, 1994, retained earnings available for dividends under the terms of the Indenture was approximately $13,800,000. The Indenture includes the payment of dividends in its definition of \"Restricted Payments\" which are subject to limitations, the most significant of which are summarized as follows:\nThe Company will not, and will not permit any of its Restricted Subsidiaries to, directly or indirectly, make any Restricted Payment, unless:\n(a) no Default or Event of Default shall have occurred and be continuing at the time of or immediately after giving effect to such Restricted Payment;\n(b) at the time of and immediately after giving effect to such Restricted Payment, the Company would be able to incur at least $1.00 of additional Indebtedness pursuant to the first paragraph of the covenant captioned \"Limitation on Incurrence of Additional Indebtedness\"; and\n(c) immediately after giving effect to such Restricted Payment, the aggregate amount of all Restricted Payments declared or made after the Issue Date does not exceed the sum of (A) 50% of the Consolidated Net Income of the Company and its Restricted Subsidiaries (or in the event such Consolidated Net Income shall be a deficit, minus 100% of such deficit) during the period (treated as one accounting period) subsequent to September 30, 1993 and ending on the last day of the fiscal quarter immediately preceding the date of such Restricted Payment and (B) $15 million. Consolidated Net Income excludes, among other things, any full cost ceiling limitation writedown.\nAlso see the \"Capital Structure\" discussion in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included in Item 7 hereof.\nCapitalized items used but not defined above have the meaning assigned to them in the Indenture.\nThere were 337 holders of record of Common Stock on March 1, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table summarizes recent financial information of the Company. This selected financial data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations at Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nCOMPARISON OF THE YEARS ENDED DECEMBER 31, 1994 AND DECEMBER 31, 1993 --------------------------------------------------------------------- The primary factors affecting the comparative results of the Company's 1994 and 1993 operations are the writedown of the Company's proved oil and gas properties in 1993 compared to 1994, a decline in refining margins, the acquisition of nine retail units, an increase in interest costs, a decline in refinery sourced sales volumes and higher operating expenses and grain costs.\nEARNINGS BEFORE INCOME TAXES AND EXTRAORDINARY ITEM --------------------------------------------------- Earnings before income taxes and extraordinary item were $5.8 million for the year ended December 31, 1994, a decrease of $4.2 million or 42% from $10.0 million for the year ended December 31, 1993. The decrease is primarily the result of a 16% decline in average refinery margins, a 6% decrease in refinery sourced finished product sales volumes, higher ethanol plant grain costs and higher interest and operating expenses. These factors were partially offset by a $12.1 million decrease in the writedown in the carrying value of oil and gas properties due to \"ceiling test\" calculations in 1994 compared to 1993 and a 19% increase in finished product sales volumes and a 31% increase in merchandise sales from the Company's retail units.\nFor the years ended December 31, 1994 and 1993, the Company's exploration and production operations (\"Giant E&P\") recorded losses of $4.3 million and $17.1 million, respectively, including the \"ceiling test\" writedowns. The 1994 writedown was primarily due to low crude oil and natural gas prices at September 30, 1994, impairment of certain unproved properties and downward revisions of certain reserves. The 1993 writedown was primarily due to downward revisions of oil and gas reserves and low crude oil prices at December 31, 1993. Exclusive of the \"ceiling test\" writedowns, the 1994 period reflected a smaller loss compared to the same 1993 period due primarily to lower production costs relative to declines in crude oil and natural gas production and selling prices.\nREVENUES -------- Revenues for the year ended December 31, 1994, decreased $22.3 million or 7% to $293.5 million from $315.8 million in the comparable 1993 period. The decrease is primarily due to an 11% decline in refinery weighted average selling prices, a 6% decrease in refinery sourced finished product sales volumes and a 1% decline in retail selling prices. Offsetting these decreases was a 19% increase in the volume of finished products sold from the retail units along with a 31% increase in merchandise sales. Also included in 1994 revenues is a $0.5 million gain resulting from the settlement of property damage claims relating to the accident at the refinery in July.\nThe decline in refinery sourced finished product sales volumes was primarily due to a scheduled major maintenance turnaround started in March and completed in April and an accident at the refinery in mid-July which damaged the alkylation unit and curtailed production for a period of approximately sixty days. The increase in retail finished product and merchandise sales is the result of increased same store volumes and the acquisition of nine units in the Company's primary market area.\nVolumes of refined products sold through retail outlets increased approximately 19% from 1993 levels primarily due to a 30% increase in volumes sold from the service stations offset in part by a 6% decrease in travel center volumes, 5% at the Giant Travel Center and 11% at the Giant Express which was sold on November 2, 1994.\nRevenues from Giant E&P, including intercompany revenues of $4.1 million in 1994 and $4.8 million in 1993, totaled $6.0 million for the year ended December 31, 1994, a decrease of $1.4 million or 20% from the $7.4 million reported for the comparable 1993 period. This decrease is due to an 8% decline in crude oil production, a 7% decline in average crude oil selling prices, a 16% decline in natural gas production and a 15% decline in natural gas selling prices. The decline in natural gas production is due to a 1993 year end adjustment of coal seam gas reserves sold in 1992, determined pursuant to an annual redetermination clause contained in the 1992 purchase and sale agreement.\nCOST OF PRODUCTS SOLD --------------------- For the year ended December 31, 1994, cost of products sold decreased $14.4 million or 7% to $193.4 million from $207.8 million for the corresponding 1993 period. A 6% decline in average crude oil costs and a 6% decline in the volume of finished products sold from the refinery accounts for most of the decrease. These decreases were partially offset by an increase in costs relating to increased merchandise sales from the retail units and a $1.8 million increase in average grain costs due to forward grain purchase contracts and higher costs resulting from the effects of the poor grain harvest of 1993. Also included in 1994 cost of products sold is $1.4 million of preliminary estimates of reimbursements for losses under the Company's business interruption insurance policies relating to the refinery accident in July.\nCost of products sold by Giant E&P decreased approximately 30% for the year ended December 31, 1994, compared to the same 1993 period. The decline is primarily related to a decrease in production.\nOPERATING EXPENSES ------------------ For the year ended December 31, 1994, operating expenses increased $5.0 million or 10% to $53.9 million from $48.9 million in the corresponding 1993 period. The increase is primarily due to operating expenses of the nine retail units acquired, an increase in payroll and related costs for other operations and increases in repairs and maintenance and utility costs at the refinery. Partially offsetting these increases was a decrease in refinery purchased fuel costs.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES -------------------------------------------- For the year ended December 31, 1994, selling, general and administrative expenses decreased $1.7 million or 13% to $11.9 million from $13.6 million for the year ended December 31, 1993. The decline is primarily due to a decrease in the management incentive bonus accrual and the recording of a $1.0 million insurance settlement in the first quarter of 1994 relating to environmental costs incurred in prior years. Partially offsetting these decreases were increases in payroll and related costs and a reduction in 1993 third quarter expenses by $0.9 million for a decrease in the estimated liability for self insured workmen's compensation claims.\nDEPRECIATION, DEPLETION AND AMORTIZATION ---------------------------------------- For the year ended December 31, 1994, depreciation, depletion and amortization (\"DD&A\") declined $0.6 million to $15.0 million from $15.6 million in the corresponding 1993 period. The decrease is primarily due to a decline in DD&A in the Company's exploration and production operations related to declines in production and the writedown of proved oil and gas properties. This decrease is partially offset by increases related to nine retail units acquired, the completion and start up of a diesel desulfurization unit at the refinery in September 1993 and amortization of costs relating to the major maintenance turnaround completed at the refinery in April 1994.\nINTEREST EXPENSE (INCOME) ------------------------- For the year ended December 31, 1994, interest expense increased $6.0 million or 105% to $11.8 million from $5.8 million in the same 1993 period. The increase is primarily due to the issuance of $100 million of 9 3\/4% senior subordinated notes in November 1993, the proceeds of which were partially used to retire existing debt with lower effective interest rates, but with significantly shorter maturities. In addition, the amortization of proceeds from a terminated interest rate swap were lower in the 1994 period.\nFor the year ended December 31, 1994, interest income increased $0.2 million or 17% to $1.7 million from $1.5 million in the comparable 1993 period primarily due to the investment of larger amounts of excess cash, in part from the issuance of the senior subordinated notes, at slightly higher interest rates.\nINCOME TAXES ------------ Income taxes for the years ended December 31, 1994 and 1993 were computed in accordance with Statement of Financial Accounting Standards No. 109 (\"SFAS No. 109\"), resulting in effective tax rates of approximately 22% and 38%, respectively. The difference in the two rates is primarily due to the relationship of relatively consistent amounts of alcohol fuel and coal seam gas tax credits in each year to varying amounts of annual income and the effect of the statutory rate increase in 1993 on deferred income taxes resulting from the enactment of the Revenue Reconciliation Act of 1993 which increased the statutory U.S. federal income tax rate to 35% from 34%.\nOUTLOOK ------- The Company's future results of operations, which continue to be determined by its principal business of refining and marketing of petroleum products, are primarily dependent on producing and selling sufficient quantities of refined products at margins sufficient to cover fixed and variable expenses.\nCOMPARISON OF THE YEARS ENDED DECEMBER 31, 1993 AND DECEMBER 31, 1992 --------------------------------------------------------------------- The primary factors affecting the comparative results of the Company's 1993 and 1992 operations are the significant improvement in 1993 in refining and retail margins, the writedown of the Company's proved oil and gas properties in both 1993 and 1992 and higher operating expenses incurred in 1993. The Company believes that the relatively higher margins were due to a general improvement in economic conditions in its market area, increased market demand and operating problems at other regional refineries during the first and second quarters of 1993 which resulted in decreased output. In the fourth quarter of 1993, the Company had an impairment in the carrying amount of its proved oil and gas properties. A similar writedown was made in the first quarter of 1992. In both years the impairment was partially due to downward revisions of oil and gas reserves, along with low crude oil prices at December 31, 1993 and low natural gas prices at March 31, 1992. Operating expenses increased in 1993 primarily due to the reinstatement of a management incentive bonus and higher payroll and related costs, primarily in retail operations.\nEARNINGS (LOSS) BEFORE INCOME TAXES AND EXTRAORDINARY ITEM ---------------------------------------------------------- Earnings before income taxes and extraordinary item increased $16.1 million from a loss of $6.1 million for the year ended December 31, 1992, to earnings of $10.0 million for the year ended December 31, 1993. The increase is primarily due to a 40% improvement in average refining margins, a 16% increase in retail refined product margins, increased merchandise sales through the service stations at slightly higher margins, a reduction in interest expense and an increase in interest income. Partially offsetting these positive factors were higher operating costs in 1993 and a $15.5 million charge in 1993 for a writedown in the carrying value of the Company's oil and gas properties compared to a similar charge of $13.8 million in 1992.\nFor the year ended December 31, 1993, the loss of Giant E&P compared to the year ended December 31, 1992, increased $2.9 million, including the $1.7 million increase in the writedown of the oil and gas properties. The remainder of the decline was primarily due to a decrease in crude oil and natural gas production and a decline in crude oil selling prices. These declines were partly offset by increases in natural gas selling prices.\nREVENUES -------- For the year ended December 31, 1993, revenues increased $10.9 million or 4% when compared to the corresponding 1992 period. The increase was primarily due to higher retail refined product selling prices and merchandise sales offset in part by a 1% decline in finished product volumes sold from the refinery. Weighted average refinery selling prices were less than 1% higher in 1993 than in 1992.\nFor the comparable periods, volumes of refined products sold through retail outlets increased approximately 1%. A 9% increase in service station volumes was partially offset by a 16% decline in travel center volumes. The decline in volumes at the Travel Center was due to a combination of factors including severe weather conditions along I-40 in the first quarter of 1993, increased price competition and the recent requirement that posted prices for diesel fuel in New Mexico include state excise taxes, resulting in the commercial truck customer having to pay these taxes at the time of purchase. Service station volumes increased primarily due to station maturity and the addition of nine stations in the fourth quarter of 1993 operated under a management agreement.\nRevenues, including intercompany revenues, for Giant E&P decreased $2.1 million for the year ended December 31, 1993, compared to the same 1992 period. The decrease was due to a 12% decline in crude oil production, a 13% decline in crude oil selling prices and a 32% decline in natural gas production, partially offset by an 18% increase in natural gas selling prices. Natural gas production has declined in part due to the sale of a portion of the Company's coal seam gas reserves in 1992.\nCOST OF PRODUCTS SOLD --------------------- Cost of products sold for the year ended December 31, 1993 decreased $9.0 million or 4% compared to the same 1992 period. The decrease is primarily the result of a 10% decline in crude oil costs, an 8% decline in average grain costs and a 1% decline in refined product sales from the refinery. Partially offsetting these decreases were higher costs relating to higher merchandise sales at the retail units.\nCost of products sold by Giant E&P decreased approximately 4% for the year ended December 31, 1993 compared to the corresponding 1992 period, primarily as a function of the decline in production.\nOPERATING EXPENSES ------------------ Operating expenses increased $4.8 million or 11% for the year ended December 31, 1993 compared to the corresponding 1992 period. Increases in payroll and related costs, higher repair and maintenance expenditures and increased purchased fuel and chemical costs accounted for substantially all of the increase.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES -------------------------------------------- Selling, general and administrative expenses increased $1.8 million or 15% for the year ended December 31, 1993 compared to the same 1992 period. Reinstatement of the management incentive bonus, offset by a $0.9 million adjustment to workmen's compensation expense resulting from a decrease in the estimated liability for self insured claims accounts for substantially all of the increase.\nDEPRECIATION, DEPLETION AND AMORTIZATION ---------------------------------------- Depreciation, depletion and amortization decreased $1.6 million or 9% for the year ended December 31, 1993 compared to the year ended December 31, 1992. The decrease is primarily due to the extension of the service lives of certain refinery equipment from 16 to 24 years, which was effective in the fourth quarter of 1992.\nINTEREST EXPENSE (INCOME) ------------------------- Interest expense declined $1.9 million or 25% in the twelve months ended December 31, 1993 compared to the same 1992 period. The decrease was primarily due to a reduction in the amount of long-term debt outstanding, a general decline in short-term interest rates, an interest rate management strategy utilizing an interest rate swap and interest capitalized in the 1993 period. The average amount of long- term debt outstanding in 1993 was $8.3 million lower than in 1992. The increase in interest income was due to the investment of excess cash in short-term investments and marketable securities.\nINCOME TAXES ------------ The provision for income taxes for the years ended December 31, 1993 and 1992, have been computed in accordance with Statement of Financial Accounting Standards No. 109 resulting in an effective tax rate of approximately 38% for the 1993 period and an effective tax benefit rate of approximately 60% for the 1992 period. The difference in the two rates is partially due to the enactment of the Revenue Reconciliation Act of 1993 which increased the statutory U.S. federal income tax rate to 35% for all of 1993. This increase includes an adjustment to current income taxes payable as well as to previously recorded deferred income taxes payable. In addition, the 1993 effective rate reflects relatively higher state income taxes due to state loss carryback provisions affecting 1992 and lower alcohol fuel and coal seam gas credits.\nEXTRAORDINARY LOSS ON EXTINGUISHMENT OF DEBT -------------------------------------------- The extraordinary loss of approximately $0.4 million in 1993 on the early extinguishment of debt resulted from the prepayment of certain long-term debt from the proceeds of the issuance of $100,000,000 in senior subordinated notes. The loss results primarily from the writeoff of deferred financing costs and prepayment penalties.\nLIQUIDITY AND CAPITAL RESOURCES\nCASH FLOW FROM OPERATIONS ------------------------- Net cash provided by operating activities totaled $12.4 million for the year ended December 31, 1994, compared to $37.6 million for the comparable 1993 period. Operating cash flows decreased primarily as the result of a decline in net earnings adjusted for non-cash items and net changes in working capital items, primarily increases in receivables and inventories.\nWORKING CAPITAL --------------- Working capital at December 31, 1994 consisted of current assets of $108.0 million and current liabilities of $42.4 million, or a current ratio of 2.55:1. At December 31, 1993, the current ratio was 2.71:1 with current assets of $102.0 million and current liabilities of $37.6 million.\nCurrent assets have increased since December 31, 1993, primarily due to an increase in inventories and receivables. Inventories have increased as a result of a 123% increase in raw material volumes on hand, partially resulting from the Company's decision to accumulate raw material inventory during periods of reduced production such as those resulting from the scheduled major maintenance turnaround in March and April and a refinery accident in July. Finished product inventory volumes were up slightly from 1993 year end levels. Receivables have increased due to higher trade receivables resulting from higher refinery sourced sales volumes and prices in December 1994 and an increase in other receivables because of insurance reimbursements accrued as a result of the refinery accident in July, excise tax reimbursements resulting from exchange sales and an increase in interest receivable on marketable security investments. In addition, income tax refunds have increased due to the overpayment of estimated income taxes. These increases are partially offset by a decrease in cash and cash equivalents and marketable securities, a decrease in prepaid expenses, principally deposits and prepaid insurance premiums, and a decrease in current deferred income tax assets.\nCurrent liabilities have increased due to an increase in accounts payable and the current portion of long-term debt. Accounts payable have increased primarily due to an increase in the purchase price and volumes of raw materials acquired in December 1994. Partially offsetting these increases is a decrease in accrued liabilities primarily due to a decrease in management incentive bonus accruals, the reclassification of deferred insurance refunds in part to a long-term reserve for environmental liabilities and in part as a recovery of previously incurred environmental expenditures and a decline in estimated income taxes payable. These decreases were offset in part by an increase in accrued interest payable.\nCAPITAL EXPENDITURES AND RESOURCES ---------------------------------- Net cash used in investing activities for the purchase of property, plant and equipment totaled approximately $21.0 million for the year 1994, including the cash portion of the acquisition of nine retail units and certain other assets from a privately-held retailer\/jobber; scheduled major maintenance turnaround costs; equipment replacement at the refinery due to an accident in July; costs incurred to secure a supplemental and standby power supply for the refinery and adjacent travel center; various other operational and environmental projects at the refinery; construction, rebuilding and remodeling of various retail units; oil and gas well drilling and leasehold costs and various other projects. In addition, as part of the Company's short-term cash management program there were net purchases of marketable securities.\nOn July 16, 1994, a propane treatment vessel associated with the refinery's alkylation unit failed, causing several units at the refinery to be temporarily shutdown and damaging the alkylation unit, necessitating extensive repairs. Repairs to the propane treatment vessel and adjacent equipment damaged in the incident were completed and the alkylation unit returned to full operation on September 16, 1994. The Company has settled all claims with its insurance companies relating to property damage coverage under its policies as the claims relate to this incident for approximately $0.7 million.\nOn November 2, 1994, the Company completed the sale of its Giant Express truck stop located in Winslow, Arizona for approximately $5.5 million. In addition to the cash purchase price, the agreement includes a 5 year product supply contract for the facility, which enables the Company to retain the outlet for a portion of its Ciniza Refinery's diesel fuel production. The sale of this facility will not have a material impact on the Company's future results of operations.\nThe Company has budgeted approximately $41.2 million for capital expenditures in 1995. Approximately $11.7 million is budgeted for non-discretionary projects that are required by law or regulation or to maintain the physical integrity of existing assets. These projects include, among others, operational and environmental projects at the refinery and exploration and production operations, multiple pump dispensers and card readers for the retail operations and informational system enhancements to improve all operations. The remaining budget of $29.5 million is for discretionary projects to sustain or enhance the current level of operations or to grow or increase earnings on existing or new business. The primary projects in this category include the acquisition and development of oil and gas properties, drilling and improvement of current exploration and production holdings and the acquisition, construction, rebuilding and remodeling of retail units.\nThe amount of these budgeted discretionary projects that are actually undertaken in 1995 will depend on, among other things, identifying acceptable acquisitions, general business conditions and results of operations. All of the budgeted capital projects undertaken are expected to be funded from working capital. Working capital, including that necessary for capital expenditures and debt service will be funded through cash generated from operating activities, existing cash and marketable securities balances and, if necessary, future borrowings. Future liquidity, both short and long-term, will continue to be primarily dependent on producing and selling sufficient quantities of refined products at margins sufficient to cover fixed and variable expenses.\nAlthough the Company is not currently aware of any pending circumstances which would change these capital budget expectations, changes in the tax laws, the imposition of any changes in federal and state clean air and clean fuel requirements and other changes in environmental laws and regulations may also increase future capital expenditure levels. Future capital expenditures are also subject to business conditions affecting the industry. In addition, the Company continues to investigate other strategic acquisitions, including the possibility of acquiring an additional refinery, and other capital improvements to its existing facilities. The Company is also actively pursuing the possible sale or exchange of non-strategic or underperforming assets.\nMuch of the capital currently planned to be spent by the Company for environmental compliance is integrally related to operations or to operationally required projects, and the Company does not specifically identify capital expenditures related to such projects on the basis of environmental as opposed to economic purposes. However, with respect to capital expenditures budgeted primarily to satisfy environmental regulations, it is estimated that approximately $0.6 million, $5.0 million and $6.6 million was spent in 1994, 1993 and 1992, respectively, and $1.3 million is expected to be spent in 1995. With respect to the Company's operating expenses for environmental compliance, while records are not kept specifically identifying or allocating such expenditures, management believes that the Company incurs significant operating expense for such purposes.\nCAPITAL STRUCTURE ----------------- At December 31, 1994, and December 31, 1993, the Company's long-term debt was 51% and 53% of total capital, respectively. The decrease is the result of an increase in retained earnings and a decrease in long-term debt.\nThe Company's capital structure includes $100 million of 10 year 9 3\/4% senior subordinated notes (\"Notes\"). Repayment of the Notes is jointly and severally guaranteed on an unconditional basis by the Company's direct and indirect wholly-owned subsidiaries, subject to a limitation designed to ensure that such guarantees do not constitute a fraudulent conveyance. Except as otherwise allowed in the Indenture pursuant to which the Notes were issued, there are no restrictions on the ability of such subsidiaries to transfer funds to the Company in the form of cash dividends, loans or advances. General provisions of applicable State law, however, may limit the ability of any subsidiary to pay dividends or make distributions to the Company in certain circumstances.\nThe Company has a $20.0 million uncommitted line of credit available to support the issuance of letters of credit in the ordinary course of business. At December 31, 1994, there were approximately $13.6 million in irrevocable letters of credit outstanding under this arrangement. This uncommitted line of credit is subject to a negative pledge on working capital.\nOn April 15, 1994, the Company's Board of Directors authorized the repurchase of up to 5% or approximately 600,000 shares of the Company's common stock. On October 5, 1994, the Board of Directors voted to increase the number of shares authorized to be repurchased to 1,000,000 shares, or approximately 8% of all outstanding shares. These purchases may be made over the next year from time to time as conditions permit. Shares may be repurchased through privately- negotiated transactions, block share purchases and open market transactions. Through the end of the year, the Company had repurchased 202,300 shares of its common stock for approximately $1.7 million at a weighted average cost of $8.16 per share, including commissions. As of February 28, 1995, the Company had repurchased an additional 276,200 shares at a weighted average cost of $8.30 per share, including commissions. These shares are being treated as treasury shares.\nAny repurchased shares would be available for a variety of corporate purposes. The number of shares actually repurchased will be dependent upon market conditions and there is no guarantee as to the exact number of shares to be repurchased by the Company. The Company may suspend or discontinue the program at any time without notice.\nOn January 9, 1995, the Company's Board of Directors declared a common stock dividend of $0.05 per share payable to stockholders of record on January 23, 1995. This dividend was paid on February 3, 1995. This was the first dividend paid since the Company suspended its regular quarterly dividend in November 1991. On March 2, 1995, the Company's Board of Directors declared another common stock dividend of $0.05 per share payable to stockholders of record on April 24, 1995, with payment to be made May 5, 1995. Future dividends, if any, are subject to the results of the Company's operations, existing debt covenants and declaration by the Company's Board of Directors.\nOTHER ----- Federal, state and local laws and regulations relating to health and the environment affect nearly all of the operations of the Company. As is the case with all companies engaged in similar industries, the Company faces significant exposure from actual or potential claims and lawsuits involving environmental matters. These matters involve alleged soil and water contamination, air pollution and personal injuries or property damage allegedly caused by exposure to hazardous materials manufactured, handled or used by the Company. Future expenditures related to health and environmental matters cannot be reasonably quantified in many circumstances due to the speculative nature of remediation and clean-up cost estimates and methods, the imprecise and conflicting data regarding the hazardous nature of various types of waste, the number of other potentially responsible parties involved, various defenses which may be available to the Company and changing environmental laws and interpretations of environmental laws.\nIt is expected that rules and regulations implementing federal, state and local laws relating to health and the environment will continue to affect the operations of the Company. The Company cannot predict what additional health or environmental legislation or regulations will be enacted or become effective in the future or how existing or future laws or regulations will be administered or enforced with respect to products or activities of the Company. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of the regulatory agencies, could have an adverse effect on the financial position and the results of operations of the Company and could require substantial expenditures by the Company for the installation and operation of pollution control systems and equipment not currently possessed by the Company.\nIn May 1991, the EPA notified the Company that it may be a potentially responsible party for the release, or threatened release, of hazardous substances, pollutants or contaminants at the Lee Acres Landfill, which is adjacent to the Company's Farmington refinery which was operated until 1982. At the present time, the Company is unable to determine the extent of its potential liability, if any, in the matter. In 1989, a consultant to the Company estimated, based on various assumptions, that the Company's share of potential liability could be approximately $1.2 million. This figure was based upon the consultant's evaluation of such factors as available clean-up technology, BLM's involvement at the site and the number of other entities that may have had involvement at the site. The consultant, however, did not conduct an analysis of the Company's potential legal defenses and arguments including possible setoff rights. Potentially responsible party liability is joint and several, such that a responsible party may be liable for all of the clean-up costs at a site even though the party was responsible for only a small part of such costs. Actual liability, if any, may differ significantly from the consultant's estimate. In addition, the Company is remediating a free-phase hydrocarbon plume that extends approximately 1,000 feet south of the Farmington refinery.\nIn 1994, the Company established an environmental liability accrual for approximately $1.4 million relating to ongoing environmental projects, including the remediation of the free-phase hydrocarbon plume described above. In late 1994, the Company accrued an additional $0.3 million relating to hydrocarbon contamination on 5.5 acres the Company owns in Bloomfield, New Mexico. At December 31, 1994, the balance of the accrual was approximately $1.6 million and was recorded in the current and long-term sections of the Company's consolidated balance sheet.\nThe Company is subject to audit on an ongoing basis of the various taxes that it pays to federal, state, local and Tribal agencies. These audits may result in additional assessments or refunds along with interest and penalties. In some cases the jurisdictional basis of the taxing authority is in dispute and is the subject of litigation or administrative appeals. In one such case, the Company has received several tax assessments from the Navajo Tribe, including a $1.8 million severance tax assessment issued to Giant Industries Arizona, Inc., a wholly-owned subsidiary of the Company, in November 1991 relating to crude oil removed from properties located outside the boundaries of the Navajo Indian Reservation in an area of disputed jurisdiction. It is the Company's position that it is in substantial compliance with laws applicable to the disputed area, and such assessments are or will be the subject of litigation or administrative appeals.\nThe Company uses the full cost method of accounting for oil and gas activities. Under this method, the Company is required to write down capitalized costs, adjusted for accumulated amortization and related deferred income taxes, if those costs exceed a \"cost ceiling.\" This \"cost ceiling\" is determined by calculating the value of the Company's estimated reserves utilizing, among other things, the price of crude oil and natural gas at the end of each quarter. During periods of declining prices and reserves, the Company may be required to write down these capitalized costs due to impairment in value. At December 31,1994, the Company's adjusted capitalized costs and the \"cost ceiling\" were approximately the same. Whether or not a writedown will be necessary in the future depends upon future prices and reserve volumes.\nThe Company is in the process of completing its insurance claims for reimbursement under its business interruption policies as the claims relate to the accident that occurred at the refinery in July 1994. The Company has accrued $1.4 million as a preliminary estimate of expected reimbursement under these policies. The Company expects to reach final settlement with the insurance companies during the second quarter of 1995.\nDue in part to a decision to accumulate raw material inventory during periods of reduced production such as those resulting from a major maintenance project at the refinery in early 1994 and an accident in July 1994, and due in part to better than forecasted receipts of crude oil from the field, the Company's inventories of crude oil have increased to approximately 763,000 barrels as of December 31, 1994. Based on projections of local crude oil availability from the field, current levels of usage of Alaska North Slope crude oil (\"ANS\"), and the Company's inventory levels, the Company believes an adequate crude oil supply will be available, without the use of additional supplemental supply alternatives, to sustain refinery operations at planned levels into the first quarter of 1996.\nBecause exploration and production activity has been at a relatively low level over the last few years, total crude oil production in the Four Corners area currently reflects the trend of normal depletion of reservoirs without the supplements of significant new discoveries. The Company believes that local crude oil supply currently approximates 95% of aggregate local crude oil demand. The Company is currently able to supplement local crude oil supplies with ANS and other alternate grades of crude oil through its gathering systems' interconnection with the Four Corners and Texas-New Mexico common carrier pipeline systems and by truck or rail. Generally, such crude oil is of lesser quality than locally available crude oils, and, with the exception of ANS, the Company believes such crude oil generally has a delivered cost greater than that of locally available crude oil.\nIn response to the decline in local crude oil production, the Company has evaluated, and will continue in the future to evaluate, supplemental crude oil supply alternatives on both a short-term and long-term basis. Among other alternatives, the Company has considered making equipment modifications to the refinery to increase its ability to use ANS crude oil from its current level of approximately 1,000 barrels per day and has considered the installation of additional rail facilities to enable the Company to provide the incremental crude oil to supplement local supply sources when required in the most cost effective manner available. In addition, the Company has considered, and has in fact entered into, additional long-term agreements with local crude oil suppliers to provide additional security for the Company's local supply sources.\nAs additional supplemental crude oil becomes necessary, the Company intends to implement one or more of these available alternatives as necessary and as is most advantageous under the then prevailing conditions. The Company currently believes that the most desirable strategy to supplement local crude oil supplies, on a long- term basis, is the delivery of supplemental crude oil from outside of the Four Corners area by pipeline. Implementation of supplemental supply alternatives will result in additional raw material costs, operating costs, capital costs, or a combination thereof in amounts which are not presently ascertainable by the Company but which will vary depending on factors such as the specific alternative implemented, the quantity of supplemental crude oil required, and the date of implementation. Implementation of some supply alternatives requires the consent or cooperation of third parties and other considerations beyond the control of the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Giant Industries, Inc. Scottsdale, Arizona\nWe have audited the accompanying consolidated balance sheets of Giant Industries, Inc. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Giant Industries, 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.\nDELOITTE & TOUCHE LLP\nPhoenix, Arizona March 6, 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.\nNoncash Investing and Financing Activities. For the year ended December 31, 1994, a portion of the acquisition price of nine retail units was seller financed for $2,917,000.\nThe accompanying notes are an integral part of these consolidated financial statements.\nGIANT INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:\nORGANIZATION\nGiant Industries, Inc. (\"Giant\" or the \"Company\") was organized to combine the refining and marketing business of Giant Industries Arizona, Inc. (\"Giant Arizona\") with the exploration and production business of Hixon Development Company (\"Hixon\") through a merger in December 1989 in which Giant Arizona and Hixon became wholly-owned subsidiaries of the Company. In conjunction with the merger, the Company completed its initial public offering. In 1990, Hixon was renamed Giant Exploration & Production Company (\"Giant E&P\").\nDESCRIPTION OF BUSINESS\nThe Company operates primarily as an independent refiner and marketer of petroleum products and also engages in the exploration for and the acquisition, development and production of crude oil, condensate and natural gas primarily in New Mexico, Kansas and Oklahoma. The Company has one operating refinery in New Mexico with a crude oil throughput capacity of 20,800 barrels per day and total capacity including natural gas liquids of 26,000 barrels per day.\nIts principal business is the refining of crude oil into petroleum products which are sold through branded retail outlets as well as through distributors, industrial\/commercial accounts and major oil companies. The Company also operates an ethanol production plant which supplies ethanol for blending at the Company's refinery as well as for sale to third party customers. As an adjunct to its retail outlets, the Company sells merchandise through stores.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Giant and all its subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nNET REVENUES\nRevenues are recognized from sales when product ownership is transferred to the customer. Excise and other similar taxes are excluded from net revenues.\nSTATEMENTS OF CASH FLOWS\nAll highly liquid instruments with an original maturity of three months or less are considered to be cash equivalents.\nFUTURES CONTRACTS\nThe Company periodically enters into futures contracts to hedge its exposure to price fluctuations on crude oil and refined products. Gains and losses on hedge contracts are deferred and reported as a component of the related transaction. For the purposes of the Statement of Cash Flows, hedging transactions are considered to be operating activities.\nINTEREST RATE SWAPS\nCommencing in 1991, interest rate management techniques such as swaps and caps were entered into in order to effectively manage and reduce net interest expense. Periodic net settlements on swap transactions are reported as an adjustment to net interest expense.\nMARKETABLE SECURITIES\nMarketable securities, all of which are available-for-sale, consisting of taxable corporate bonds, non-taxable municipal bonds and variable rate preferred stocks are stated at fair value. Fair value is estimated based on quoted market prices. Marketable securities are managed as part of the Company's short-term cash management program.\nCONCENTRATION OF CREDIT RISK\nCredit risk with respect to customer receivables is concentrated in a small geographic area in which the Company operates and relates to customers in the oil and gas industry. To minimize this risk, the Company performs ongoing credit evaluations of its customers' financial position and requires collateral, such as letters of credit, in certain circumstances.\nINVENTORIES\nInventories are stated at the lower of cost or market. Costs for crude oil and refined products produced by the refinery are determined by the last-in, first-out (\"LIFO\") method. Costs for exchange and terminal refined products and shop supplies are determined by the first-in, first-out (\"FIFO\") method. Costs for merchandise inventories are determined by the retail inventory method.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are stated at cost and, except for oil and gas properties, are depreciated on the straight-line method over their respective estimated useful lives. The estimated useful lives for the various categories of property, plant and equipment are:\nOil and gas properties Units of production Buildings and improvements 7-30 years Machinery and equipment 7-24 years Pipelines 30 years Furniture and fixtures 2-15 years Vehicles 3-7 years\nThe full cost method of accounting is followed for oil and gas properties. Under this method of accounting, the cost of unsuccessful as well as successful exploration and development activities are capitalized as oil and gas properties.\nThe sum of net capitalized costs and estimated future development and dismantlement costs is amortized over the production of proved reserves using the units of production method. Depreciation, depletion and amortization per equivalent barrel of production sold for the years ended December 31, 1994, 1993 and 1992 was $5.32, $7.50, and $6.31, respectively, excluding the effect of the Company's writedown of oil and gas properties. Excluded from amounts subject to amortization are costs associated with unevaluated properties of $1,551,000 and $2,973,000 at December 31, 1994 and 1993, respectively, until proved reserves associated with the properties have been determined or impairment occurs. Net capitalized costs exceeding the estimated present value of future cash inflows from proved oil and gas reserves reduced by estimated future operating expenses and development expenditures are charged to current operations. Gain or loss on the sale or other disposition of oil and gas properties is not recognized unless significant oil and gas reserves are involved.\nRoutine maintenance, repairs and replacement costs are charged against earnings as incurred. Turnaround costs, which consist of complete shutdown and inspection of significant units of the refinery at intervals of two or more years for necessary repairs and replacements, are deferred and amortized over the period until the next expected shutdown. Expenditures which materially increase values, expand capacities or extend useful lives are capitalized. Interest expense is capitalized as part of the cost of constructing major facilities and equipment.\nTREASURY STOCK\nIn 1994, the Company's Board of Directors authorized the repurchase of 1,000,000 shares of the Company's common stock, or approximately 8% of all outstanding shares. These purchases may be made over the next year from time to time as conditions permit. Shares may be repurchased through privately-negotiated transactions, block share purchases and open market transactions. Through the end of the year, the Company had repurchased 202,300 shares at a cost of approximately $1,652,000. These shares are being treated as treasury shares.\nENVIRONMENTAL EXPENDITURES\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.\nINCOME TAXES\nThe provision (benefit) for income taxes is based on earnings (loss) reported in the financial statements. Deferred income taxes are provided on temporary differences between reported earnings and taxable income.\nEARNINGS (LOSS) PER COMMON SHARE\nEarnings (loss) per common share is computed on the weighted average number of shares of common stock outstanding during each period. The exercise of outstanding stock options would not result in a material dilution of earnings per share.\nRECLASSIFICATIONS\nCertain reclassifications have been made to the 1993 and 1992 financial statements to conform to the statement classifications used in 1994, including selling, general and administrative expenses and depreciation, depletion and amortization previously included in cost of products sold and operating expenses.\nNOTE 2--MARKETABLE SECURITIES\nOn 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 the classification of securities at acquisition into one of three categories: held-to-maturity, available-for-sale, or trading--with different reporting requirements for each classification. All of the Company's marketable securities are classified as available-for-sale.\nSecurities that are being held for indefinite periods of time, including those securities which may be sold in response to needs for liquidity are classified as available-for-sale. At December 31, 1994, the Company's marketable securities had a fair value of $35,631,000. A valuation allowance of $654,000 was recorded in 1994 to reduce the carrying value of the portfolio to estimated fair value and the after- tax adjustment necessary to mark the securities to market reduced stockholders' equity by $398,000. This adjustment had no effect on the current results of operations. A summary of the Company's securities is as follows:\nContractual maturities of securities, other than equity securities, at December 31, 1994 are as follows:\nActual maturities may differ from contractual maturities because the borrowers have the right to call or prepay certain obligations, sometimes without call or prepayment penalties.\nAn analysis of the caption \"Unrealized loss on securities available- for-sale, net\" in the Consolidated Balance Sheet is as follows:\nIncluded in the Company's investment portfolio is $2,000,000 of Orange County, California Tax and Revenue Anticipation Notes due July 28, 1995. Orange County filed for bankruptcy on December 6, 1994. The Company has written this investment down by $200,000 as of December 31, 1994, to reflect an other than temporary impairment.\nIn recording gains and losses on the sale of marketable securities, cost is determined using specific identification. Such gains and losses are nominal for all years presented.\nNOTE 3--ACCOUNTING CHANGE:\nDuring the fourth quarter of 1992, the Company extended the service lives of certain refinery equipment from 16 to 24 years. The effect of this change in estimate was to increase net earnings by $1,164,000 or $0.10 per share for 1994 and 1993 and $270,000 or $0.02 per share for 1992.\nNOTE 4--INVENTORIES:\nInventories consist of the following:\nThe Company uses the LIFO method of inventory valuation. The portion of inventories valued on a LIFO basis totaled $21,717,000 and $12,699,000 at December 31, 1994 and 1993, respectively. The following data will facilitate comparison with operating results of companies using the FIFO method.\nIf inventories had been determined using the FIFO method at December 31, 1994, 1993 and 1992, net earnings and earnings per share for the years ended December 31, 1994, 1993 and 1992 would have been higher (lower) by $357,000 and $0.03, $237,000 and $0.02 and ($191,000) and ($0.02), respectively.\nNOTE 5--PROPERTY, PLANT AND EQUIPMENT:\nProperty, plant and equipment, at cost, consist of the following:\nNOTE 6--ACCRUED EXPENSES:\nAccrued expenses are comprised of the following:\nNOTE 7--LONG-TERM DEBT:\nLong-term debt consists of the following:\nThe Indenture supporting the 9 3\/4% senior subordinated notes (\"Notes\") contains certain covenants that, among other things, restrict the ability of the Company and its subsidiaries to create liens, incur or guarantee debt, pay dividends, sell certain assets or subsidiary stock, engage in certain mergers, engage in certain transactions with affiliates or alter the Company's current line of business. At December 31, 1994, the Company was in compliance with these covenants. In addition, the Company is, subject to certain conditions, obligated to offer to purchase a portion of the Notes at a price equal to 100% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of purchase, with the net cash proceeds of certain sales or other dispositions of assets. Upon a change of control, the Company will be required to offer to purchase all of the Notes at 101% of the principal amount thereof, plus accrued interest, if any, to the date of purchase. At December 31, 1994, retained earnings available for dividends under the terms of the Indenture was approximately $13,800,000.\nThe 10.91% senior unsecured note is due to The Prudential Insurance Company of America (\"Prudential\") and the related agreement includes certain covenants, determined on a FIFO inventory basis, that require the Company to maintain a minimum net worth and working capital; places certain restrictions on, while not precluding, the purchase or redemption of the Company's capital stock, payment of dividends and payments of subordinated debt and interest; limits the dollar amount of new operating leases; and specifies certain conditions for new long-term debt obligations. At December 31, 1994, the Company was in compliance with these covenants. The remaining balance is payable in nine semi-annual installments of $1,250,000 through 1999.\nOn March 1, 1994, the Company issued a $2,917,000, 8% promissory note as part of the purchase price of nine service stations. The principal is due in three equal annual installments with the first payment due on March 1, 1995. Interest is payable quarterly.\nAt December 31, 1994, there was a $20,000,000 uncommitted credit facility in place with a major bank to support the issuance of letters of credit. At that date, the Company had $13,621,000 of irrevocable letters of credit outstanding under this arrangement. This uncommitted line of credit is subject to a negative pledge on working capital.\nIn 1994 and 1993, the Company's interest expense was reduced by approximately $288,000 and $1,304,000, respectively, as a result of amortizing the proceeds received from a terminated interest rate swap agreement. At December 31, 1994, there was approximately $606,000 of deferred swap proceeds to be amortized over the remaining term of the 10.91% Prudential note.\nAggregate annual maturities of long-term debt as of December 31, 1994 are: 1995 - $4,107,000; 1996 - $4,178,000; 1997 - $4,257,000; 1998 - $3,153,000; 1999 - $3,346,000; and all years thereafter - $101,156,000.\nNOTE 8--FINANCIAL INSTRUMENTS AND HEDGING ACTIVITY:\nThe following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, \"Disclosures About Fair Value of Financial Instruments\" and SFAS No. 119, \"Disclosures about Derivative Financial Instruments and Fair Value of Financial Instruments.\" The estimated fair value amounts have been determined by the Company using available market information and 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 the Company could realize in a current market exchange. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.\nThe carrying amounts and estimated fair values of the Company's financial instruments are as follows:\nThe carrying values of cash and cash equivalents, receivables, accounts payable and accrued expenses approximate fair values due to the short-term maturities of these instruments. Variable rate long-term debt instruments are estimated to approximate fair values as rates are tied to short-term indices.\nMARKETABLE SECURITIES\nThe fair value of marketable securities was determined based on quoted market prices from various brokers. See Note 2.\nFIXED RATE LONG-TERM DEBT\nThe fair value of fixed rate long-term debt was estimated by discounting future cash flows using rates estimated to be currently available for debt of similar terms and remaining maturities.\nHEDGING ACTIVITIES\nThe Company purchases crude oil futures contracts to reduce price volatility and to lock-in margins in its refining and marketing operations. In addition, the Company uses forward grain purchase contracts and options to reduce price volatility on and to secure grain supplies for its ethanol production operations. These contracts permit settlement by delivery of commodities and, therefore, are not financial instruments, as defined by SFAS No. 105. The Company uses these contracts in its hedging activities. At December 31, 1994, the Company's hedging activities had futures contracts maturing in 1995 covering 168,000 barrels of crude oil and grain purchase contracts for approximately 190,000,000 pounds of grain, equating to approximately 90% of grain demand through September of 1995. In addition, options had been purchased on approximately 58,000,000 pounds of the contracted grain commitment. At December 31, 1993, the Company's hedging activities had futures contracts maturing in 1994 covering 395,000 barrels of crude oil and grain purchase contracts maturing in 1994 and 1995 for approximately 146,000,000 pounds of grain. The crude oil futures contracts qualify as hedges, and any gains or losses resulting from market changes will be offset by losses or gains on the Company's hedging contracts. The grain purchase contracts are forward purchase contracts and have the effect of locking-in the Company's grain cost. The options purchased will allow the Company to participate in the market if grain prices drop significantly. Gains and losses on hedging contracts are deferred and reported as a component of the related transaction. Net deferred gains (losses) for the Company's petroleum hedging activities were approximately $17,000 and $(476,000) at December 31, 1994 and 1993, respectively.\nThe Company is exposed to loss in the event of nonperformance by the other parties to these contracts. However, the Company does not anticipate nonperformance by the counterparties.\nNOTE 9--INCOME TAXES:\nThe provision (benefit) for income taxes is comprised of the following:\nIncome taxes paid in 1994, 1993 and 1992 were $5,379,000, $6,672,000 and $3,803,000, respectively.\nA reconciliation of the difference between the provision (benefit) for income taxes and income taxes at the statutory U.S. federal income tax rate is as follows:\nDeferred income taxes are provided to reflect temporary differences in the basis of net assets for income tax and financial reporting purposes. The tax effected temporary differences and credit carryforwards which comprise deferred taxes are as follows:\nAt December 31, 1994, the Company had a minimum tax credit carryforward of approximately $5,694,000 available to offset future income taxes payable to the extent regular income taxes payable exceeds alternative minimum taxes payable. Minimum tax credits can be carried forward indefinitely.\nAt December 31, 1994, the Company also had approximately $2,101,000 of general business credits available to offset future regular taxes payable. Pursuant to Federal income tax law, these carryover credits must be used before any minimum tax credit carry- forward can be used. Of the total general business credit available, $868,000 will expire in 2008 and $1,233,000 will expire in 2009.\nNOTE 10--EMPLOYEE STOCK OWNERSHIP PLAN:\nThe Company and its subsidiaries have an Employee Stock Ownership Plan (\"ESOP\") which is a noncontributory defined contribution plan established primarily to acquire shares of the Company's common stock for the benefit of all eligible employees. The ESOP's assets include 1,534,878 and 1,599,204 shares of the Company's common stock at December 31, 1994 and 1993, respectively. At December 31, 1994 and 1993, 1,460,322 and 1,403,711, respectively, of these shares had been allocated to participants and 74,556 and 195,493, respectively, remained unallocated. Shares are allocated to participants when principal payments are made on the loan discussed below. Allocations to participant accounts are made on a formula based on the ratio that each participant's compensation, during the Plan year, bears to the compensation of all such participants. The Company treats all ESOP shares as outstanding for earnings per share purposes.\nThe ESOP originally borrowed $6,500,000 from a bank and purchased shares of the Company's common stock from existing shareholders. The loan was purchased by the Company from the bank in 1993, when the loan had a principal balance of $1,347,000. The loan obligation of the ESOP bears interest at 80% of the prime rate. In 1994, the ESOP made a principal payment of $833,000 leaving a balance of $514,000 due and payable in September 1995. The loan obligation is considered unearned employee benefit expense and, as such, recorded as a reduction of the Company's stockholders' equity. Both the loan obligation and the unearned benefit expense are reduced by the amount of any loan repayments made by the ESOP. Contributions to the ESOP are made at the discretion of the Board of Directors. The Company made contributions of $900,000, $889,000 and $900,000 to the ESOP for 1994, 1993 and 1992, respectively.\nNOTE 11--STOCK INCENTIVE PLAN:\nThe Company established the 1989 Stock Incentive Plan under which 500,000 shares of the Company's common stock were authorized to be issued to deserving employees in the form of options and\/or restricted stock. The Plan is administered by the Compensation Committee of the Board of Directors.\nThe following summarizes stock option transactions under this plan:\nIn 1990, an additional 29,500 shares of restricted stock were granted under this plan of which 8,572 were forfeited in 1993 and 1,286 in 1994. At December 31, 1994, there were 163,801 shares available for future grants.\nPrior to adoption of the 1989 Stock Incentive Plan, the Company granted shares to employees under Restricted Stock Plans as follows:\nShares --------- 1989 124,097* 1988 214,447**\n*Net of 21,045 shares forfeited. **Net of 33,746 shares forfeited.\nAll of the options or restricted stock grants are subject to forfeiture with vesting ranging from 14% to 33% annually beginning one year after the date of grant for restricted stock and exercise dates of stock options. Compensation expense related to restricted stock grants is charged to earnings over the appropriate vesting period. All options were granted at fair market value at the date of grant and expire on the tenth anniversary of the grant date.\nNOTE 12--401(k) PLAN:\nIn 1993, the Company adopted a 401(k) retirement plan for its employees. This plan complements the Company's Employee Stock Ownership Plan by allowing the employees to invest on a pre-tax basis in non-Giant stock investments thus diversifying their retirement portfolios. For the year ended December 31, 1994 and 1993, the Company had expensed $189,000 and $109,000, respectively, for matching contributions under this plan.\nNOTE 13--INTEREST, OPERATING LEASES AND RENT EXPENSE:\nInterest paid and capitalized for 1994 was $11,644,000 and $0, for 1993 was $4,711,000 and $249,000, and for 1992 was $7,871,000 and $162,000, respectively.\nThe Company is committed to annual minimum rentals under noncancelable operating leases that have initial or remaining lease terms in excess of one year as of December 31, 1994 as follows:\nTotal rent expense was $1,890,000, $1,584,000 and $1,430,000 for 1994, 1993 and 1992, respectively.\nNOTE 14--COMMITMENTS AND CONTINGENCIES:\nThe Company and certain subsidiaries are defendants to various legal actions. Certain of these pending legal actions involve or may involve compensatory, punitive or other damages. Litigation is subject to many uncertainties and it is possible that some of the legal actions, proceedings or claims referred to above could be decided adversely. Although the amount of liability at December 31, 1994 with respect to these matters is not ascertainable, the Company believes that any resulting liability should not materially affect the Company's financial condition or results of operations.\nFederal, state and local laws and regulations relating to health and the environment affect nearly all of the operations of the Company. As is the case with all companies engaged in similar industries, the Company faces significant exposure from actual or potential claims and lawsuits involving environmental matters. These matters involve alleged soil and water contamination, air pollution and personal injuries or property damage allegedly caused by exposure to hazardous materials manufactured, handled or used by the Company. Future expenditures related to health and environmental matters cannot be reasonably quantified in many circumstances due to the speculative nature of remediation and clean-up cost estimates and methods, the imprecise and conflicting data regarding the hazardous nature of various types of waste, the number of other potentially responsible parties involved, various defenses which may be available to the Company and changing environmental laws and interpretations of environmental laws.\nThe United States Environmental Protection Agency notified the Company in May 1991 that it may be a potentially responsible party for the release or threatened release of hazardous substances, pollutants, or contaminants at the Lee Acres Landfill, which is owned by the United States Bureau of Land Management (\"BLM\") and which is adjacent to the Company's Farmington refinery which was operated until 1982. Potentially responsible party liability is joint and several, such that a responsible party may be liable for all of the clean-up costs at a site even though it was responsible for only a small part of such costs. At the present time, the Company is unable to determine the extent of potential liability, if any, in this matter and has made no provision therefore in its financial statements.\nIn 1994, the Company established an environmental liability accrual for approximately $1,400,000 relating to ongoing environmental projects, including the remediation of a free-phase hydrocarbon plume at the Company's Farmington Refinery. In late 1994, the Company accrued an additional $250,000 relating to hydrocarbon contamination on 5.5 acres the Company owns in Bloomfield, New Mexico. At December 31, 1994, the balance of the accrual was approximately $1,600,000, recorded in the current and long-term section of the Company's consolidated balance sheet.\nThe Company has received several tax notifications and assessments from the Navajo Tribe relating to crude oil and natural gas removed from properties located outside the boundaries of the Navajo Indian Reservation in an area of disputed jurisdiction, including a $1,800,000 severance tax assessment issued to Giant Arizona in November 1991. The Company has invoked its appeal rights with the Tribe's Tax Commission in connection with this assessment and intends to vigorously oppose the assessment. It is the Company's understanding that these appeals will be held in abeyance pending further judicial clarification of the Tribe's taxing authority by means of litigation involving other companies. It is possible, however, that the Company's assessments will have to be litigated by the Company before final resolution. The Company may receive further tax assessments before judicial resolution of the Tribe's taxing authority.\nNOTE 15--QUARTERLY FINANCIAL INFORMATION (UNAUDITED):\nNOTE 16--SUPPLEMENTARY FINANCIAL INFORMATION FOR OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED):\nThe following is historical information relating to the Company's oil and gas operations.\nExcluded from amounts subject to amortization as of December 31, 1994 and 1993 are $1,551,000 and $2,973,000, respectively, of costs associated with unevaluated properties. The majority of the evaluation activities are expected to be completed in five years.\nCOSTS EXCLUDED FROM AMORTIZATION\nCAPITALIZED COSTS\nThe Company's net investment in oil and gas properties was as follows:\nDuring 1994 and 1993, the Company recognized non-cash writedowns of its oil and gas properties of $3,395,000 and $15,511,000, respectively, for the excess of net capitalized costs over the estimated present value of net future cash inflows. These writedowns were recorded as increases to accumulated depreciation, depletion and amortization.\nCOSTS INCURRED\nCosts incurred (exclusive of general support facilities) in oil and gas exploration activities (all in the United States) were as follows:\nESTIMATED QUANTITIES (ALL IN THE UNITED STATES) OF PROVED OIL AND GAS RESERVES\nProved reserves are estimated quantities of crude oil, natural gas and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are those which are expected to be recovered through existing wells with existing equipment and operating methods. The Company's reserves are located primarily in the southwestern United States.\nThe following schedules set forth the Company's net proved and proved developed oil and gas reserves, as determined by independent consultants, along with a summary of the changes in the quantities of net proved reserves:\nRevisions are due to unsuccessful drilling efforts, downward revisions of well economic productivity and limitations in drilling for the replacement of reserves caused by reduced capital expenditures. In 1992, the Company sold a volume of reserves equal to approximately 50% of its then working interest in certain proved developed natural gas reserves along with a portion of the associated gathering system. The purchase and sale agreement associated with that transaction contains a provision whereby the ownership interest in the subject reserves is adjusted annually at December 31, 1993 through 1996, based on year-end reserve reports, so that the buyer receives a cumulative working interest estimated for the life of the reserves equal to the reserve volume purchased. In 1994, there was a positive gas revision for the Company equal to approximately 1,018 million cubic feet and in 1993, there was a negative gas revision of approximately 1,159 million cubic feet.\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 (\"Standardized Measure\") is a disclosure requirement under SFAS No. 69. The Standardized Measure does not purport to present the fair market value of a company's proved oil and gas reserves. This would require consideration of expected future economic and operating conditions, which are not taken into account in calculating the Standardized Measure.\nUnder the Standardized Measure, future cash inflows were estimated by applying year-end prices, adjusted for fixed and determinable escalations, to the estimated future production of year-end proved reserves. Prices tend to be volatile and have decreased significantly for natural gas and increased somewhat for crude oil since year-end. Future cash inflows were reduced by estimated future production and development costs to determine pre-tax cash inflows. Future income taxes were computed by applying the statutory tax rate to the excess of pre-tax cash inflows over the Company's tax basis in the associated proved oil and gas properties. Tax credits, including the federal coal seam gas credit, and permanent differences were also considered in the future income tax calculation. Future net cash inflows after income taxes were discounted using a 10% annual discount rate to arrive at the Standardized Measure.\nSet forth below is the Standardized Measure relating to proved oil and gas reserves:\nChanges in the Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves for 1994, 1993 and 1992:\nResults of operations for exploration and production activities (all in the United States):\nITEM 9.","section_9":"ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNot applicable.\nPART III\nCertain information required by Part III is omitted from this Report by virtue of the fact that the Registrant will file with the Securities and Exchange Commission a definitive proxy statement relating to the Company's Annual Meeting of Stockholders to be held May 18, 1995 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 to be included therein is incorporated herein by reference. The Company expects to disseminate the Proxy Statement to stockholders on or about March 30, 1995.\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 the information contained in the Proxy Statement under the caption \"Election of Directors.\"\nThe information concerning the Company's executive officers required by this Item is incorporated by reference to the section in Part I, Item 4 hereof entitled \"Executive Officers of the Registrant.\"\nThe information concerning compliance with Section 16(a) of the Exchange Act required by this Item is incorporated by reference to the information contained in the Proxy Statement under the caption \"Security Ownership of Certain Beneficial Owners and Management.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference to the information contained in the Proxy Statement under the captions \"Election of Directors,\" \"Executive Compensation,\" \"Compensation Committee Report on Executive Compensation\" and \"Compensation Committee Interlocks and Insider Participation.\"\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 information contained in the Proxy Statement under the captions \"Election of Directors\" and \"Security Ownership of Certain Beneficial Owners and Management.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated by reference to the information contained in the Proxy Statement under the captions \"Compensation Committee Interlocks and Insider Participation\" and \"Certain Transactions.\"\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 included in Item 8:\n(i) Independent Auditors' Report\n(ii) Consolidated Balance Sheets - December 31, 1994 and 1993\n(iii) Consolidated Statements of Operations - Years ended December 31, 1994, 1993 and 1992\n(iv) Consolidated Statements of Stockholders' Equity - Years ended December 31, 1994, 1993 and 1992\n(v) Consolidated Statements of Cash Flows - Years ended December 31, 1994, 1993 and 1992\n(vi) Notes to Consolidated Financial Statements\n(2) Financial Statement Schedule. The following financial statement schedule of Giant Industries, Inc. for the years ended December 31, 1994, 1993 and 1992 is filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Giant Industries, Inc.\nIndependent Auditors' Report on Schedule . . . . . S-1\nSchedule II - Valuation and Qualifying Accounts . . S-2\nSchedules not listed above have been omitted because they are not applicable or are not required or because the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto.\n(3) Exhibits. The Exhibits listed on the accompanying Index to Exhibits immediately following the financial statement schedule are filed as part of, or incorporated by reference into, this Report.\nContracts with management and any compensatory plans or arrangements relating to management are as follows:\nExhibit No. Description ------- ----------- 10.1 1989 Stock Incentive Plan of the Registrant. Incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 1-10398.\n10.3 ESOP Substitute Excess Deferred Compensation Benefit Plan. Incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 1-10398.\n10.6 Amended 1988 Restricted Stock Plan of Registrant. Incorporated by reference to Exhibit 10.3 to Form S-1.\n10.7 1989 Stock Option Plan of Registrant. Incorporated by reference to Exhibit 10.4 to Form S-1.\n10.30 Employment Agreement, dated as of November 16, 1989, between James E. Acridge and the Company. Incorporated by reference to Exhibit 10.52 to Amendment No. 2.\n10.31 Employment Agreement, dated as of November 16, 1989, between Fredric L. Holliger and the Company. Incorporated by reference to Exhibit 10.53 to Amendment No. 2.\n10.32 Employment Agreement, dated as of August 1, 1990 between Morgan Gust and the Company. Incorporated by reference to Exhibit 10.64 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.\n10.35 Giant Industries, Inc. and Affiliated Companies 401(k) Plan. Incorporated by reference to Exhibit 10.46 to Amendment No. 2 to the Form S-3 Registration Statement under the Securities Act of 1933 as filed November 12, 1993, File No. 33-69252. _________________________________\nForm S-1--Refers to the Form S-1 Registration Statement under the Securities Act of 1933 as filed October 16, 1989, File No. 33-31584.\nAmendment No. 2--Refers to the Amendment No. 2 to Form S-1 Registration Statement under the Securities Act of 1933 as filed November 20, 1989, File No. 33-31584.\n(b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during 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.\nGIANT INDUSTRIES, INC.\nBy: \/ s \/ James E. Acridge ------------------------------ James E. Acridge Chairman of the Board, President and Chief Executive Officer\nMarch 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 date indicated.\n\/s\/ James E. Acridge --------------------------------------- James E. Acridge, Chairman of the Board, President, Chief Executive Officer and Director\nMarch 30, 1995\n\/s\/ A. Wayne Davenport --------------------------------------- A. Wayne Davenport Vice President and Corporate Controller (Principal Accounting Officer)\nMarch 30, 1995\n\/s\/ Fredric L. Holliger --------------------------------------- Fredric L. Holliger, Executive Vice President, Chief Operating Officer and Director.\nMarch 30, 1995\n\/s\/ Gary L. Nielsen --------------------------------------- Gary L. Nielsen, Vice President Finance and Treasurer (Principal Financial Officer)\nMarch 30, 1995\n\/s\/ F. Michael Geddes --------------------------------------- F. Michael Geddes, Director\nMarch 30, 1995\n\/s\/ George C. Hixon --------------------------------------- George C. Hixon, Director\nMarch 30, 1995\n\/s\/ Harry S. Howard, Jr. --------------------------------------- Harry S. Howard, Jr., Director\nMarch 30, 1995\n\/s\/ Richard T. Kalen, Jr. --------------------------------------- Richard T. Kalen, Jr., Director\nMarch 30, 1995\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Giant Industries, Inc. Scottsdale, Arizona\nWe have audited the consolidated financial statements of Giant Industries, Inc. and subsidiaries (the \"Company\") 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 March 6, 1995. Our audits also included the financial statement schedule of the Company 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\nPhoenix, Arizona March 6, 1995\nS-1\nSCHEDULE II GIANT INDUSTRIES, INC. AND SUBSIDIARIES Valuation and Qualifying Accounts Three years ended December 31, 1994 (In thousands)\nCharged Balance at (credited) Balance beginning to costs Deduction at end of period and expenses (a) of period ---------- ------------ --------- ---------\nYear ended December 31, 1994: Allowance for doubtful accounts $429 $167 $ (50) $546 ==== ==== ===== ====\nYear ended December 31, 1993: Allowance for doubtful accounts $415 $133 $(119) $429 ==== ==== ===== ====\nYear ended December 31, 1992: Allowance for doubtful accounts $335 $127 $ (47) $415 ==== ==== ===== ====\n(a) Deductions are specific trade accounts determined to be uncollectible.\nS-2 \/TABLE\nGIANT INDUSTRIES, INC. ANNUAL REPORT ON FORM 10-K YEAR ENDED DECEMBER 31, 1994\nINDEX TO EXHIBITS\nDefinitions:\nForm S-1--Refers to the Form S-1 Registration Statement under the Securities Act of 1933 as filed October 16, 1989, File No. 33-31584.\nAmendment No. 1--Refers to the Amendment No. 1 to Form S-1 Registration Statement under the Securities Act of 1933 as filed October 27, 1989, File No. 33-31584.\nAmendment No. 2--Refers to the Amendment No. 2 to Form S-1 Registration Statement under the Securities Act of 1933 as filed November 20, 1989, File No. 33-31584.\nAmendment No. 3--Refers to the Amendment No. 3 to Form S-1 Registration Statement under the Securities Act of 1933 as filed December 12, 1989, File No. 33-31584.\nForm S-3--Refers to the Form S-3 Registration Statement under the Securities Act of 1933 as filed September 22, 1993, File No. 33-69252.\nExhibit No. Description ----------- ----------- 3.1 Restated Certificate of Incorporation of the Giant Industries, Inc., a Delaware corporation (the \"Company\"). Incorporated by reference to Exhibit 3.1 to Amendment No. 3.\n3.2 Bylaws of the Company, as amended. Incorporated by reference to Exhibit 3.2 to Amendment No. 3.\n3.3 Articles of Incorporation of Giant Exploration & Production Company, a Texas corporation (\"Giant Exploration\"), formerly Hixon Acquisition Corp. Incorporated by reference to Exhibit 2.1, Annex III to Form S-1.\n3.4 Bylaws of Giant Exploration. Incorporated by reference to Exhibit 2.1, Annex IV to Form S-1.\n3.5 Articles of Incorporation of Giant Industries Arizona, Inc., an Arizona corporation (\"Giant Arizona\") formerly Giant Acquisition Corp. Incorporated by reference to Exhibit 2.1, Annex V to Form S-1.\n3.6 Bylaws of Giant Arizona. Incorporated by reference to Exhibit 2.1, Annex VI to Form S-1.\n3.7 Articles of Incorporation of Ciniza Production Company. Incorporated by reference to Exhibit 3.7 to Form S-3.\n3.8 Bylaws of Ciniza Production Company. Incorporated by reference to Exhibit 3.8 to Form S-3.\n3.9 Articles of Incorporation of Giant Stop-N-Go of New Mexico, Inc. Incorporated by reference to Exhibit 3.9 to Form S-3.\n3.10 Bylaws of Giant Stop-N-Go of New Mexico, Inc. Incorporated by reference to Exhibit 3.10 to Form S-3.\n3.11 Articles of Incorporation of Giant Four Corners, Inc. Incorporated by reference to Exhibit 3.11 to Form S-3.\n3.12 Bylaws of Giant Four Corners, Inc. Incorporated by reference to Exhibit 3.12 to Form S-3.\n3.13*** Articles of Incorporation of Giant Mid-Continent, Inc.\n3.14*** Bylaws of Giant Mid-Continent, Inc.\n4.1 Amended and Restated Note Agreement, dated as of September 30, 1993, among the Prudential Insurance Company of America (\"Prudential\"), Pruco Life Insurance Company (\"Pruco\"), the Company and Giant Arizona, relating to $20,000,000 of 10.91% Senior Notes due March 31, 1999. Incorporated by reference to Exhibit 4.13 to Amendment No. 2 to the Form S-3 Registration Statement under the Securities Act of 1933 as filed November 12, 1993, File No. 33-69252.\n4.2*** Letter Amendment No. 1, dated December 31, 1994, to Amended and Restated Note Agreement, dated September 30, 1993, among Prudential, Pruco, the Company and Giant Arizona.\n4.3 Indenture, dated as of November 29, 1993 among the Company, as Issuer, the Subsidiary Guarantors, as guarantors, and NBD Bank, National Association, as Trustee, relating to $100,000,000 of 9 3\/4% Senior Subordinated Notes due 2003. Incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated November 29, 1993, File No. 1-10398.\n10.1 1989 Stock Incentive Plan of the Company. Incorporated by reference to Exhibit 10.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, File No. 1-10398.\n10.2 Employee Stock Ownership Plan and Trust Agreement of the Company, as amended. Incorporated by reference to Exhibit 10.1 of the Company's Report on Form 10-Q for the quarter ended September 30, 1994, File No. 1-10398.\n10.3 ESOP Substitute Excess Deferred Compensation Benefit Plan. Incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File 1-10398.\n10.4 Loan Agreement, dated December 20, 1991, between NBD Bank, National Association and Continental Bank, N.A. as trustee under the Employee Stock Ownership Plan and Trust Agreement of the Company. Incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for fiscal year ended December 31, 1991, File No. 1-10398.\n10.5 Term Note for $2,896,831.80, dated December 20, 1991, between NBD Bank, National Association and the Employee Stock Ownership Plan and Trust Agreement of the Company. Incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for fiscal year ended December 31, 1991, File No. 1-10398.\n10.6 Amended 1988 Restricted Stock Plan of the Company. Incorporated by reference to Exhibit 10.3 Form S-1.\n10.7 1989 Stock Option Plan of the Company. Incorporated by reference to Exhibit 10.4 to Form S-1.\n10.8 Form of Assignment of Oil & Gas and Mineral Leases between Mtrust Corp., N.A., Alexander P. Hixon and George C. Hixon, Trustees of the Elizabeth F. Hixon Trust, and Hixon Development Company. Incorporated by reference to Exhibit 10.12 to Form S-1.\n10.9 Form of Assignment of Overriding Royalty Interest between Mtrust Corp., N.A., Alexander P. Hixon and George C. Hixon, Trustees of the Elizabeth F. Hixon Trust, and Hixon Development Company. Incorporated by reference to Exhibit 10.13 to Form S-1.\n10.10 Purchase Agreement, dated November 29, 1990, between Giant Arizona and Prime Pinnacle Peak Properties Limited Partnership. Incorporated by reference to Exhibit 10.16 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.\n10.11 Escrow Instructions, dated January 7, 1991, between Prime Pinnacle Peak Properties Limited Partnership and Giant Arizona. Incorporated by reference to Exhibit 10.17 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.\n10.12 Agreement for Leasing of Service Station Site, dated March 1, 1991, between Giant Arizona and Prime Pinnacle Peak Properties Limited Partnership. Incorporated by reference to Exhibit 10.18 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.\n10.13 First Amendment to Agreement for Leasing of Service Station Site, dated March 1, 1991, between Giant Arizona and Prime Pinnacle Peak Properties Limited Partnership. Incorporated by reference to Exhibit 10.18 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File 1-10398.\n10.14 Purchase and Sale Agreement, dated as of May 7, 1991, between New Bank of New England N.A., Den Norske Bank, Kansallis--Osake--Pankki--and Portales Energy Company, Inc. and the Company. Incorporated by reference to Exhibit 10.4 to the Company's Report on Form 10-Q for the quarter ended June 30, 1991, File No. 1-10398.\n10.15 Aircraft Lease Purchase Agreement, dated as of June 21, 1991, between Metlife Capital Corporation and the Company. Incorporated by reference to Exhibit 10.1 to the Company's Report on Form 10-Q for the quarter ended June 30, 1991, File No. 1-10398.\n10.16 Promissory Note for $600,000, dated December 1, 1988, from JEA to Metlife Capital Corporation (\"Metlife\"). Incorporated by reference to Exhibit 10.38 to Form S-1.\n10.17 Promissory Note for $825,000, dated December 20, 1988, from JEA to Metlife. Incorporated by reference to Exhibit 10.39 to Form S-1.\n10.18 Promissory Note for $750,000, dated December 28, 1987, from JEA to Metlife. Incorporated by reference to Exhibit 10.40 to Form S-1.\n10.19 Promissory Note for $825,000, dated June 28, 1988, from JEA to Metlife. Incorporated by reference to Exhibit 10.41 to Form S-1.\n10.20 Promissory Note for $900,000, dated August 31, 1988, from JEA to Metlife. Incorporated by reference to Exhibit 10.42 to Form S-1.\n10.21 Promissory Note for $1,125,000, dated April 21, 1989, from JEA to Metlife. Incorporated by reference to Exhibit 10.43 to Form S-1.\n10.22 Promissory Note for $1,087,500, dated December 30, 1988, from JEA to Metlife. Incorporated by reference to Exhibit 10.44 to Form S-1.\n10.23 Promissory Note for $1,082,900, dated December 30, 1988, from JEA to Metlife. Incorporated by reference to Exhibit 10.45 to Form S-1.\n10.24* Sales Agreement, dated June 6, 1989, between Giant Arizona and Mobil Oil Corporation. Incorporated by reference to Exhibit 10.47 to Amendment No. 2.\n10.25* Amendment, dated April 20, 1990, to Sales Agreement, dated June 6, 1989, between Giant Arizona and Mobil Oil Corporation. Incorporated by reference to Exhibit 10.51 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.\n10.26* Sales Agreement, dated February 10, 1989, between Giant Arizona and Conoco Inc. Incorporated by reference to Exhibit 10.48 to Amendment No. 2.\n10.27** Crude Oil and Condensate Sales and Purchase Agreement, dated August 1, 1994, between Meridian Oil Trading Inc. (Seller) and Giant Refining Company, a division of Giant Industries Arizona, Inc. (Buyer).\n10.28** Natural Gas Liquids Sales and Purchase Agreement, dated October 27, 1994, between Meridian Oil Hydrocarbons Inc. and Giant Refining Company, a division of Giant Industries Arizona, Inc.\n10.29* Natural Gasoline Purchase and Sale Agreement, dated September 1, 1990, between Sunterra Gas Processing Company and Giant Arizona. Incorporated by reference to Exhibit 10.57 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.\n10.30 Employment Agreement, dated as of November 16, 1989, between James E. Acridge and the Company. Incorporated by reference to Exhibit 10.52 to Amendment No. 2.\n10.31 Employment Agreement, dated as of November 16, 1989, between Fredric L. Holliger and the Company. Incorporated by reference to Exhibit 10.53 to Amendment No. 2.\n10.32 Employment Agreement, dated as of August 1, 1990 between Morgan Gust and the Company. Incorporated by reference to Exhibit 10.64 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.\n10.33 Consulting Agreement, dated January 1, 1990, between the Company and Kalen and Associates. Incorporated by reference to Exhibit 10.66 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.\n10.34 Consulting Agreement, dated March 12, 1992, between the Company and Geddes and Company. Incorporated by reference to Exhibit 10.1 to the Company's Report on Form 10-Q for the quarter ended June 30, 1992, File No. 1-10398.\n10.35 Giant Industries, Inc. and Affiliated Companies 401(k) Plan. Incorporated by reference to Exhibit 10.46 to Amendment No. 2 to the Form S-3 Registration Statement under the Securities Act of 1933 as filed November 12, 1993, File No. 33-69252.\n11.1*** Statement regarding computation of earnings per share.\n18.1 Letter regarding change in accounting principles. Incorporated by reference to Exhibit 18.1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.\n21.1*** Subsidiaries of the Company.\n23.1*** Consent of Intera Information Technologies, Inc.\n23.2*** Consent of Deloitte & Touche LLP to incorporate reports in previously filed Registration Statement.\n27 *** Financial Data Schedule.\n99.1*** Information required by Rule 15d-21 under the Securities Act of 1934 for the year ended December 31, 1994 for the Giant Industries, Inc. and Affiliated Companies Employee Stock Ownership Plan.\n*Certain information contained in these documents has been afforded confidential treatment. **Incomplete versions filed; portions for which confidential treatment has been requested filed supplementary. ***Filed herewith.","section_15":""}
{"filename":"93410_1994.txt","cik":"93410","year":"1994","section_1":"ITEM 1. BUSINESS\n(a) GENERAL DEVELOPMENT OF BUSINESS\nSUMMARY DESCRIPTION OF CHEVRON ------------------------------ Chevron Corporation (1), a Delaware corporation, is a major international oil company. It provides administrative, financial and management support for, and manages its investments in, domestic and foreign subsidiaries and affiliates, which engage in fully integrated petroleum operations, chemical operations, real estate development and other mineral and energy related activities in the United States and approximately 100 other countries. Petroleum operations consist of exploring for, developing and producing crude oil and natural gas; transporting crude oil, natural gas and petroleum products by pipelines, marine vessels and motor equipment; refining crude oil into finished petroleum products; and marketing crude oil, natural gas and the many products derived from petroleum. Chemical operations include the manufacture and marketing of a wide range of chemicals for industrial uses.\nIncorporated in Delaware in 1926 as Standard Oil Company of California, the company adopted the name Chevron Corporation in 1984. Domestic integrated petroleum operations are conducted primarily through three divisions of the company's wholly owned Chevron U.S.A. Inc. subsidiary. Exploration and production (\"upstream\") operations in the United States are carried out through Chevron U.S.A. Production Company. U.S. refining and marketing (\"downstream\") activities are performed by Chevron U.S.A. Products Company. Warren Petroleum Company engages in all phases of the domestic natural gas liquids business. A list of the company's major subsidiaries is presented on page EX-2 of this Annual Report on Form 10-K. As of December 31, 1994, Chevron had 45,758 employees, 77 percent of whom were employed in U.S. operations.\nOVERVIEW OF PETROLEUM INDUSTRY ------------------------------ Petroleum industry operations and profitability are influenced by a large number of factors, over some of which individual oil and gas companies have little control. Governmental attitudes and policies, particularly in the areas of taxation, energy and the environment, have a significant impact on petroleum activities, regulating where and how companies conduct their operations and formulate their products and, in some cases, limiting their profits directly. Prices for crude oil and natural gas, petroleum products and petrochemicals are determined by supply and demand for these commodities. OPEC member countries are the world's swing producers of crude oil and their production levels are the primary driver in determining worldwide supply. Demand for crude oil and its products and natural gas is largely driven by the health of local, national and worldwide economies, although weather patterns and taxation relative to other energy sources also play a significant part. Natural gas is generally produced and consumed on a country or regional basis. Its largest use is for electrical generation, where it competes with other energy fuels.\nCURRENT OPERATING ENVIRONMENT ----------------------------- After starting the year at a five-year low, crude oil prices rebounded in the second quarter of 1994 on news of OPEC's decision at their March 1994 meeting to hold production at their current level of 24.5 million barrels per day for the balance of the year (subsequently extended through 1995) and concern of supply disruptions due to local disturbances in Nigeria. Crude oil prices began to fall in August and continued to trend downward through the end of the year due to ample crude supplies, settlement of the Nigerian oil\n------------------ (1) As used in this report, the term \"Chevron\" and such terms as \"the company,\" \"the corporation,\" \"our,\" \"we,\" and \"us\" may refer to Chevron Corporation, one or more of its consolidated subsidiaries, or to all of them taken as a whole, but unless the context clearly indicates otherwise, should not be read to include \"affiliates\" of Chevron (those companies owned approximately 50 percent or less).\nAs used in this report, the term \"Caltex\" may refer to the Caltex Group of companies, any one company of the group, any of their consolidated subsidiaries, or to all of them taken as a whole and also includes the \"affiliates\" of Caltex.\nAll of these terms are used for convenience only, and are not intended as a precise description of any of the separate companies, each of which manages its own affairs.\n- 1 -\nworker's strike in early September and an abnormally mild winter in most parts of the United States. The company's U.S. realizations declined 72 cents per barrel from the previous year, representing the fourth consecutive year average realizations have fallen.\nU.S. natural gas prices also trended downward throughout 1994 after having posted increases in the prior three years. Factors contributing to the decrease in natural gas prices included poor utility demand driven by the relatively mild summer and winter weather in many parts of the U.S., increased Canadian gas exports to the U.S., high gas storage levels and improved performance of nuclear power plants that experienced downtime in the previous year. In the United States, the Henry Hub, Louisiana spot price for natural gas, a common benchmark for natural gas prices, averaged $1.86 per thousand cubic feet (MCF) in 1994, a decrease of $.25 per MCF from 1993.\nThe company's average realization from U.S. crude oil production declined from $14.58 per barrel in 1993 to $13.86 per barrel in 1994 while average liquids realizations from international liftings, including equity affiliates, declined by $1.23 per barrel to $14.86 per barrel. Average U.S. natural gas realizations from production decreased to $1.77 per MCF in 1994 from $1.99 per MCF in 1993.\nThe following table compares the high, low and average Chevron posted prices for West Texas Intermediate (WTI), an industry benchmark light crude oil, for each of the quarters during 1994 and for the full years of 1994, 1993, and 1992:\n----------------------------------------------------------------------\nWEST TEXAS INTERMEDIATE CRUDE OIL CHEVRON POSTED PRICES (Dollars per Barrel)\n------------------------------------- 1ST Q 2ND Q 3RD Q 4TH Q YEAR 1993 1992 ----- ----- ----- ----- ----- ----- ----- High 15.00 19.75 19.50 18.00 19.75 20.25 21.75 Low 13.00 13.75 15.75 15.75 13.00 13.00 16.50 Average 13.80 16.71 17.48 16.68 16.18 17.68 19.71 ----------------------------------------------------------------------\nFor the first two months of 1995, average natural gas realizations for the company's U.S. operations were $1.43 per MCF. During this period, the company's posted price for WTI ranged from $16.50 per barrel to $18.00, with an average of $17.28. On March 20, 1995 the company's posted price for WTI was $17.50 per barrel.\nChevron's refining and marketing operations in the United States were adversely affected by scheduled and unscheduled refinery downtime and other refinery operating problems in the first half of 1994. These refinery problems increased the company's operating costs and caused the company to purchase more costly third-party products to supply the company's marketing system. This put additional pressure on the company's sales margins on refined products which were already depressed most of the year due to ample supplies in the marketplace. The company's average sales price per barrel of refined product declined for the fourth year in a row, falling to $24.37 per barrel in 1994 from $25.35 per barrel in 1993.\nThe company's chemical operations improved significantly in 1994 as improving worldwide economies, including the U.S., reduced industry overcapacity, resulting in higher sales volumes and stronger prices for the company's commodity chemicals. Sales and other operating revenues from the company's chemical operations, including sales to other Chevron companies, increased $431 million from the $3,296 million recorded in 1993.\n- 2 -\nCHEVRON STRATEGIC DIRECTION --------------------------- To improve financial performance and to compete more effectively, Chevron developed and implemented seven \"strategic intents\" in 1992 and added an eighth \"strategic intent\" in 1993. The company periodically reviews and modifies these \"strategic intents\" to reflect Chevron's current operating environment. The eight \"strategic intents\" for 1995 are:\n- BUILD A COMMITTED TEAM TO ACCOMPLISH THE CORPORATE MISSION. The company continues to believe the success of the other seven strategic intents is dependent on the commitment and dedication that Chevron employees bring to their jobs. For the past three years, Chevron has measured employees' attitudes about the company and diagnosed areas of employee concerns by the use of the Worldwide Employee Survey. Due in large part to employee responses to the surveys, the company has recently developed or revamped programs in the areas of skills development, job selection, and upward feedback, a process in which employees are given the opportunity to evaluate their immediate supervisor. In 1994, the company sought to articulate this \"strategic intent\" by issuing a vision statement that outlined the attributes of a committed team. Underlying the vision statement was the need to promote trust, respect, support and teamwork among and between its employees and supervisors. The company is encouraging informed risk taking and encouraging employees to take an active role in planning and decision making while also increasing their accountability. Due in part to this \"strategic intent,\" a greater number of cross-functional teams are being formed in the company to make decisions and manage projects, demonstrating a greater amount of teamwork and cooperation among its employees. In January 1995, the company announced a new program that will provide employees with a cash bonus if the company achieves certain financial goals. In 1995 the program, called \"Chevron Success Sharing,\" will be based on Chevron's adjusted Return on Capital Employed (ROCE). If the company achieves an ROCE of 10 percent or greater and its ROCE is among the top four of its major U.S. competitors, a cash bonus, varying from two to eight percent of an employee's annual salary depending on the company's relative ROCE ranking, will be paid to employees eligible to participate in the program.\n- FOCUS ON REDUCING COSTS ACROSS ALL ACTIVITIES. Operating expenses, adjusted for special items, declined $150 million in 1994 when compared to 1993, sustaining the prior year's cost reductions as well as offsetting inflation and mitigating expenses associated with refinery problems in the first half of 1994. When compared to 1991, the base measurement year established when Chevron undertook an extensive cost-cutting and work force reduction program in early 1992, operating expenses in 1994 have declined by over $1 billion. Although a portion of the cost reduction is related to discontinued operations, the company believes the majority is the result of a permanent reduction in the company's ongoing cost structure.\nThe company remains committed to further reductions in operating expense in 1995. Four \"breakthrough\" initiatives are currently in various stages of study or implementation that could result in large, permanent cost savings. These four \"breakthrough\" initiatives involve ways to reduce corporate energy costs; ways to reduce the cost of goods and services by working more efficiently with fewer suppliers; improvements to the project management process which is used to evaluate and administer large capital projects; and improvements in inventory management in order to avoid tying up working capital in excessive inventories.\n- CONTINUE UPSTREAM GROWTH IN INTERNATIONAL AREAS. The company continues to believe opportunities to discover and develop major new reserves in the United States are limited due to regulatory barriers and drilling prohibitions on many of the most promising areas of development. In 1994, international exploration and production (E&P) capital spending rose 3 percent to approximately 71 percent of total E&P capital spending, including affiliates. This same ratio of international versus total E&P spending is expected to continue in 1995. As recently as 1990, U.S. exploration and production capital spending was approximately 50 percent of the total. Since 1991, international oil and gas production has increased nearly 25 percent and oil and gas reserves have increased 80 percent.\n- 3 -\n- GENERATE GREATER THAN $800 MILLION IN CASH PER YEAR FROM U.S. UPSTREAM. Chevron is emphasizing a steady cash flow from a core group of approximately 400 oil and gas fields concentrated in California, Texas, the Rocky Mountains and the Gulf of Mexico. Net cash flow after capital and exploratory expenditures for U.S. exploration and production operations fell to $750 million in 1994 from $1.2 billion in 1993 due to weak crude oil and natural gas prices throughout most of the year.\nThe company modified this \"strategic intent\" in 1995 by lowering the annual cash generation amount from $1 billion to $800 million. This modification reflects the significant change in the outlook for both crude and U.S. natural gas prices since the original \"strategic intent\" was set in 1991 combined with the progress achieved in cost reduction.\nThe company continues to evaluate its current properties as well as evaluate and acquire new properties that the company believes will help it meet and sustain its cash generation goal. In 1994, the company acquired certain gas properties in West Texas by purchasing 100 percent of the stock of Pakenham, Inc., a subsidiary of Wes-Tex Drilling Company. The company believes these properties hold considerable development potential. Over the next five years, Chevron plans to drill about 150 wells on these properties at a cost of approximately $100 million and expects production to triple to 90 million cubic feet per day by 1999.\n- ACHIEVE TOP FINANCIAL PERFORMANCE IN U.S. DOWNSTREAM. Chevron is seeking to strengthen its competitive position by investing in core refineries, reducing the size of its refining system and concentrating on specific marketing regions. The company sold its Philadelphia, Pennsylvania, refinery to Sun Company, Inc. in August 1994 and its Port Arthur, Texas, refinery to Clark Refining and Marketing, Inc. in February 1995. These refineries no longer fit Chevron's plan to have a more focused U.S. refining operation and their sales eliminated large capital expenditures that would otherwise have been required to make the refineries more competitive and to meet the Clean Air Act Amendments of 1990.\n- GROW CALTEX IN ATTRACTIVE MARKETS WHILE ACHIEVING SUPERIOR COMPETITIVE FINANCIAL PERFORMANCE. Management believes that the demand for petroleum products will continue to grow in the Asia Pacific region. Chevron's 50 percent owned Caltex affiliate, a leading competitor in these areas, has and is continuing to make significant capital investments to expand and upgrade its refining capacity and its retail marketing systems. Refinery upgrade projects are continuing in Singapore and Korea, as well as the construction of a new refinery in Thailand. In 1994, Caltex opened representative offices in Ho Chi Minh City and Hanoi to develop and evaluate business opportunities in Vietnam. In China, Caltex is exploring technical and commercial aspects of developing a business relationship with Sinopec's Nanjing Refinery operated by Jinling Petrochemical Corporation. Caltex is also studying the feasibility of a joint venture with Shantou Ocean Enterprises to build a liquefied petroleum gas (LPG) terminal in Shantou, China.\n- IMPROVE COMPETITIVE FINANCIAL PERFORMANCE IN CHEMICALS WHILE DEVELOPING ATTRACTIVE OPPORTUNITIES FOR GROWTH. Financial results for the company's chemical operations improved significantly in 1994 as the chemical industry in general rebounded from a period of depressed earnings due to sluggish world economies and production overcapacity. Improving world economies resulted in increased demand for the company's commodity chemicals, which are used to package or manufacture numerous consumer goods. In addition, the company believes the restructuring and cost reduction plans that have been implemented in recent years positioned the company to take advantage of the improved industry conditions. In 1995, the company plans to continue its restructuring with the closing of its nitric acid and fertilizer plants in Richmond, California, while also investing in areas demonstrating growth potential. Chevron plans to invest about $200 million in its chemical operations in 1995, including plans to expand production capacity by 65 percent at its linear low density polyethylene (LLDPE) plant at Cedar Bayou, Texas. This expansion is expected to be completed in 1996.\n- 4 -\n- BE SELECTIVE IN NON-CORE BUSINESSES. Chevron operates four units that are outside the corporation's core focus. These four units are Chevron Canada Limited (CCL) and Gulf Oil Great Britain (GOGB) whose primary operations are the refining and marketing of petroleum products in Canada and the U.K., respectively, The Pittsburg & Midway Coal Mining Co. (P&M), operator of the company's mineral interests, and Chevron Land and Development Co. (CL&D), manager of the company's surplus fee production properties and other real estate operations in California. Chevron manages these four units for cash flow and profitability, and for growth when attractive opportunities exist. In 1994, GOGB expanded its service station network by approximately 7 percent to total about 500 service stations at year-end. P&M completed its planned sale of Chevron's non- coal interests in 1994 with the sale of its 50 percent interest in the Stillwater platinum and palladium mine in Montana and its 52.5 percent interest in some zinc-lead prospects in Ireland. CL&D generated over $140 million in sales of developed and undeveloped real estate properties in 1994.\nIn 1994, Chevron continued to dispose of other marginally performing or non-strategic assets, including the aforementioned refinery sales and the company's headquarters building located in San Francisco, California. Due to recent downsizing and restructuring of its operations, it was determined that employees currently located in the headquarters building could be accommodated in the company's other two San Francisco office buildings. Relocation of employees is expected to occur over the next 5 years.\nThe company is currently seeking prospective purchasers for its real estate development assets in California and is currently reviewing its oil and gas operations in western Canada.\n(b) INDUSTRY SEGMENT AND GEOGRAPHIC AREA INFORMATION\nThe company's primary business is its integrated petroleum operations. Secondary operations include chemicals and minerals. The petroleum activities of the company are widely distributed geographically, with major operations in the United States, Australia, United Kingdom, Canada, Nigeria, Angola, Congo, Papua New Guinea, China, Indonesia and Zaire. The company's Caltex affiliate, through its subsidiaries and affiliates, conducts exploration and production operations in Indonesia and refining and marketing activities in the Eastern Hemisphere, with major operations in Japan, Korea, Australia, the Philippines, Thailand and South Africa. Tengizchevroil (TCO), a 50\/50 joint venture with a subsidiary of the national oil company of the Republic of Kazakhstan conducts production activities in Kazakhstan, a former Soviet republic.\nThe company's and its affiliates' chemicals operations are concentrated in the United States, but include operating facilities in France, Japan and Brazil. The company's and its affiliates' principal minerals activities consist of coal operations in the United States.\nTabulations setting forth three years' identifiable assets, operating income, sales and other operating revenues for the company's three industry segments, by United States and International geographic areas, may be found in Note 9 to the Consolidated Financial Statements beginning on page FS-22 of this Annual Report on Form 10-K.\n(c) DESCRIPTION OF BUSINESS AND PROPERTIES\nThe petroleum industry is highly competitive in the United States and throughout most of the world. This industry also competes with other industries in supplying the energy needs of various types of consumers.\nThe company's operations can be affected significantly by changing economic, regulatory and political environments in the various countries, including the United States, in which it operates. The company evaluates the economic and political risk of initiating, maintaining or expanding operations in any geographical area.\n- 5 -\nIn the United States, environmental regulations and federal, state and local actions and policies concerning economic development, energy and taxation may have a significant effect on the company's operations.\nInternationally, the company continues to closely monitor the civil unrest in Angola and the political uncertainty in Nigeria and Zaire and the possible threat these may pose to the company's oil and gas exploration and production operations and the safety of the company's employees located in those countries.\nThe company attempts to avoid unnecessary involvement in partisan politics in the communities in which it operates but participates in the political process to safeguard its assets and to ensure that the community benefits from its operations and remains receptive to its continued presence.\nThe company utilizes various derivative instruments to manage its exposure to price risk stemming from its integrated petroleum activities. Some of the instruments may be settled by delivery of the underlying commodity, whereas others can only be settled by cash. All these instruments are commonly used in the global trade of petroleum products and are relatively straightforward, involve little complexity and are substantially of a short-term duration.\nThe company enters into forward exchange contracts as a hedge against some of its foreign currency exposures. Interest rate swaps are entered into as part of the company's overall strategy to manage the interest rate risk on its debt. The impact of the forward exchange contracts and interest rate swaps on the company's results of operations is not material.\nCAPITAL AND EXPLORATORY EXPENDITURES\nChevron's capital and exploratory expenditures during 1994 and 1993 are summarized in the following table:\n-------------------------------------------------------\nCAPITAL AND EXPLORATORY EXPENDITURES (Millions of Dollars) 1994 1993 ------ ------ Exploration and Production $2,586 $2,217 Refining, Marketing and Transportation 1,105 1,166 Chemicals 135 224 Coal and Other Minerals 44 42 All Others 103 90 ------ ------ Total Consolidated Companies 3,973 3,739 Equity in Affiliates 846 701 ------ ------ Total Including Affiliates $4,819 $4,440 ====== ====== -------------------------------------------------------\nTotal consolidated expenditures in 1994 increased 6 percent when compared to 1993, largely due to a $369 million increase in exploration and production (E&P) expenditures that was partially offset by decreases in chemical expenditures of $89 million and decreases in refining, marketing and transportation expenditures amounting to $61 million.\nConsolidated E&P expenditures amounted to 65 percent of the company's total consolidated expenditures in 1994, compared with 59 percent in 1993. The percentage increase was due solely to increased expenditures in international E&P as U.S. E&P expenditures, as a percentage of total consolidated expenditures, remained relatively unchanged from 1993. U.S. E&P expenditures in 1994 included the company's acquisition of certain natural gas operations in West Texas. Major international E&P expenditures in 1994 included the acquisition of exploration and development interests in the Republic of Congo and exploration and development activities associated with the Alba Field in the U.K. North Sea, the North West Shelf Project in Australia, the Hibernia Project offshore Newfoundland, the Duri Steamflood Project\n- 6 -\nin Indonesia, Areas B and C in Angola, the Niger Delta region in Nigeria and the Tengiz Project in Kazakhstan. Refining, marketing and transportation outlays in 1994 included expenditures for upgrading U.S. refineries to produce reformulated gasoline in order to comply with federal, state and local air quality regulations as well as other projects intended to upgrade and increase efficiencies at the refineries.\nThe company's share of capital and exploratory expenditures by its affiliates was $846 million in 1994, an increase of 21 percent from $701 million in 1993. This increase was primarily due to expenditures by the company's Caltex affiliate in the high growth Pacific Rim areas on refinery expansion\/upgrade projects in Korea and Singapore and the construction of a new refinery in Thailand.\nIn 1995, the company expects to spend approximately $5.1 billion, including its share of equity affiliates' expenditures, an increase of approximately 5 percent over 1994 levels. Consolidated expenditures in 1995 are expected to remain relatively flat at $3.9 billion while affiliate expenditures are expected to increase 37 percent to $1.2 billion. Worldwide E&P expenditures are expected to total $2.7 billion, of which approximately 70 percent will be for international projects such as the continued development of the Hibernia Field, expansion of the North West Shelf Project, enhanced recovery projects in Indonesia, development of the Tengiz Field in Kazakhstan, development of the Alba and Britannia fields in the North Sea, development of the N'Kossa and Kitina fields in Congo, and other development projects in West Africa. Worldwide refining, marketing and transportation expenditures are estimated at $1.9 billion, with U.S. expenditures of about $900 million. These U.S. expenditures are largely due to major capital programs to manufacture clean fuels at the Richmond and El Segundo, California, refineries as mandated by the California Air Resources Board regulations. Major international refining and marketing expenditures in 1995 include the continuation of refinery construction and expansion\/upgrade projects by the company's Caltex affiliate to meet growing product demand in the Pacific Rim areas. Chemical expenditures are also expected to rise in 1995 due to planned expansion of the linear low- density polyethylene manufacturing plant at the Cedar Bayou, Texas, chemical facility.\nThe actual expenditures for 1995 will depend on various conditions affecting the company's operations, including crude oil prices, and may differ significantly from the company's forecast.\nPETROLEUM - EXPLORATION\nThe following table summarizes the company's net interests in productive and dry exploratory wells completed in each of the last three years and the number of exploratory wells drilling at December 31, 1994. \"Exploratory wells\" include delineation wells, which are wells drilled to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir or to extend a known reservoir beyond the proved area. \"Wells drilling\" include wells temporarily suspended.\n----------------------------------------------------------------------------- EXPLORATORY WELL ACTIVITY\nNET WELLS COMPLETED (1) WELLS DRILLING --------------------------------------- AT 12\/31\/94 1994 1993 1992 ------------------- ----------- ---------- ----------- GROSS (2) NET (2) PROD. DRY PROD. DRY PROD. DRY --------- ------- ---- ---- ---- ---- ---- ---- United States 43 32 53 17 32 14 42 16 --------- ------- ---- ---- ---- ---- ---- ----\nAfrica 11 4 5 2 3 4 3 3 Other International 42 18 55 42 27 35 15 4 --------- ------- ---- ---- ---- ---- ---- ---- Total International 53 22 60 44 30 39 18 7 --------- ------- ---- ---- ---- ---- ---- ---- Total Consolidated Companies 96 54 113 61 62 53 60 23\nEquity in Affiliates 8 4 - 1 1 1 1 - --------- ------- ---- ---- ---- ---- ---- ---- Total Including Affiliates 104 58 113 62 63 54 61 23 ========= ======= ==== ==== ==== ==== ==== ====\n(1) Indicates the number of wells completed during the year regardless of when drilling was initiated. Completion refers to the installation of permanent equipment for the production of oil or gas or, in the case of a dry well, the reporting of abandonment to the appropriate agency.\n(2) Gross wells include the total number of wells in which the company has an interest. Net wells are the sum of the company's fractional interests in gross wells. ----------------------------------------------------------------------------- - 7 -\nAt December 31, 1994, the company owned or had under lease or similar agreements undeveloped and developed oil and gas properties located throughout the world. Undeveloped acreage includes undeveloped proved acreage. The geographical distribution of the company's acreage is shown in the next table.\n----------------------------------------------------------------------------- ACREAGE* AT DECEMBER 31, 1994 (Thousands of Acres) DEVELOPED UNDEVELOPED DEVELOPED AND UNDEVELOPED ---------------- -------------- ---------------- GROSS NET GROSS NET GROSS NET ------- ------ ----- ----- ------- ------ United States 4,301 2,854 6,059 2,558 10,360 5,412 ------- ------ ----- ----- ------- ------ Canada 18,325 10,514 615 395 18,940 10,909 Africa 26,589 18,143 139 55 26,728 18,198 Asia 42,809 19,296 45 16 42,854 19,312 Europe 3,060 1,362 62 14 3,122 1,376 Other International 10,191 3,671 54 15 10,245 3,686 ------- ------ ----- ----- ------- ------ Total International 100,974 52,986 915 495 101,889 53,481 ------- ------ ----- ----- ------- ------ Total Consolidated Companies 105,275 55,840 6,974 3,053 112,249 58,893 Equity in Affiliates 3,202 1,601 233 116 3,435 1,717 ------- ------ ----- ----- ------- ------ Total Including Affiliates 108,477 57,441 7,207 3,169 115,684 60,610 ======= ====== ===== ===== ======= ======\n* Gross acreage includes the total number of acres in all tracts in which the company has an interest. Net acreage is the sum of the company's fractional interests in gross acreage. -----------------------------------------------------------------------------\nThe company had $257 million of suspended exploratory wells included in properties, plant and equipment at year-end 1994. The wells are suspended pending drilling of additional wells to determine if commercially producible quantities of oil or gas reserves are present. The ultimate disposition of these well costs is dependent on the results of this future activity.\nDuring 1994, the company explored for oil and gas in the United States and about 21 other countries. The company's 1994 exploratory expenditures, including affiliated companies' expenditures but excluding unproved property acquisitions, were $526 million compared with $533 million in 1993. Domestic expenditures represented approximately 40 percent of the consolidated companies' worldwide exploration expenditures, a 5 percent increase from the prior year. Significant activities in Chevron's exploration program during 1994 include the following (number of wells are on a \"gross\" basis):\nUNITED STATES: Domestic exploratory expenditures, excluding unproved property acquisitions, were $209 million in 1994, compared to $183 million spent in 1993. In addition, the company incurred costs of $28 million for unproved property acquisitions in 1994. The company continued to focus its exploratory efforts in 1994 in the Gulf of Mexico, Texas, California, the Rocky Mountains and in other areas where it has existing production. Twelve wildcat exploratory wells were initiated in 1994 of which eleven were in new areas and one was in an existing core area. Including three wells commenced in late 1993, thirteen wells were completed in 1994, resulting in two discoveries in the Gulf of Mexico. The company's exploratory well in the Destin Dome Block 97, located 30 miles south of Pensacola, Florida in the Gulf of Mexico, resulted in a dry hole. Exploration efforts in high-potential areas, including Alaska's Arctic National Wildlife Refuge (ANWR) and parts of offshore Florida, California and North Carolina have been blocked by legal restrictions and drilling moratoria. Chevron and other oil companies have sued the Department of Interior to recover bonus payments, lease rentals and certain geophysical costs for federal offshore leases that remain undrilled due to state, federal, and private objections to drilling. The company is seeking to recover approximately $126 million, plus interest, spent on leases off Florida, North Carolina and Alaska. Currently all parties have filed Motions for Summary Judgment in this matter. Oral arguments were held on January 31, 1995 and a ruling is expected in 1995.\n- 8 -\nAFRICA: In Africa, the company spent $81 million during 1994 on exploratory efforts, excluding the acquisition of unproved properties, compared with $104 million in 1993. The company also acquired $19 million of unproved properties in 1994.\nIn Nigeria, the company's operations are managed by three subsidiaries. Chevron Nigeria Limited (CNL) operates and holds a 40 percent interest in concessions totaling 2.3 million acres in the onshore and offshore regions of the Niger Delta. Chevron Oil Company (Nigeria) Limited (COCNL) holds a 20 percent interest in six concessions covering 600,000 acres with six oil fields operated by a partner. Chevron Petroleum Nigeria Limited (CPNL) has a 30 percent interest in two deepwater Niger Delta blocks and three inland Benue Basin blocks and an additional sole interest, through a production sharing contract signed in October 1994 with the Nigerian National Petroleum Company (NNPC), in six other Benue Basin blocks. CNL drilled seven exploratory and appraisal wells in 1994 which resulted in three new field discoveries, two successful appraisal wells and two dry holes. CNL also acquired 3-D seismic data covering Nigerian acreage of 200 square miles. COCNL, through its operating partner, drilled one exploratory well in 1994 which discovered gas and gas condensate. CPNL will begin seismic studies in 1995 as part of a work program expected to span the next six years to explore for oil in six Benue Basin blocks, totaling approximately 5,600 square miles. The company will finance the exploration phase and offset its cost from any future crude oil production. This production sharing agreement is a departure from the joint venture agreements of the past in which cost and revenue were shared according to each party's interest in the venture.\nIn Angola, the company is the operator of a 2,700 square mile concession off the coast of Angola's Cabinda exclave. The concession is divided into Areas A, B, and C, with Area A generating the majority of 1994 production. Area B production commenced in November 1994 with the commissioning of installations in the Kokongo Field. Chevron has a 39 percent interest in the concession. Six exploratory wells were drilled in 1994, with three wells in Area A resulting in oil discoveries. Two of these wells will be developed by drilling from existing facilities while the third well will be appraised in 1995 for the appropriate installation facilities required for development. The other three exploratory wells were drilled in Areas B and C and resulted in the discoveries of the N'Sangui and Minzu fields. The current exploration license for Areas B and C expired in 1994. Negotiations are currently underway to renew this agreement for five additional years. In 1994, Chevron (operator with 31 percent interest) and its partners completed negotiations of a Production Sharing Agreement for Deepwater Block 14, located due west of Areas B and C. The Angolan government approved the agreement in December 1994 and signing occurred in February 1995. A seismic program is scheduled to begin in April 1995 followed by the first of four exploration obligation wells in early 1996.\nOffshore Congo, Chevron currently participates in two production licenses and two exploration licenses. The company has a 29 percent interest in the Kitina production license and the Marine VII exploration license operated by AGIP. Between October 1994 and March 1995 Chevron acquired a 30 percent interest in the N'Kossa production license and the Haute Mer exploration license operated by ELF Congo. The company and its partners plan to drill two wildcat wells in 1995, one in each of the two exploration areas. The company opened an office in Congo in January 1995 to facilitate its participation in the two joint ventures.\nIn Zaire, the company has a 50 percent interest in, and is the operator of, a 390 square mile concession off the coast of Zaire. Exploration activity in 1994 resulted in an oil discovery in the Tshiala East exploration well. An existing production well was also deepened in 1994 and a new reservoir underlying Mibale Field was discovered. An exploration well in the Mibale Field and the Tshiala West #1 well commenced in December 1994.\nOTHER INTERNATIONAL INCLUDING AFFILIATED COMPANIES: Exploration expenditures, excluding unproved property acquisitions, were $236 million in 1994, a decrease of $10 million from the 1993 amount of $246 million. In addition, unproved properties of $21 million were acquired in 1994.\nIn Europe, Chevron's exploration efforts were concentrated in the U.K. sector of the North Sea and off the coast of Wales where the company has conducted research and a joint environmental appraisal of the coast in order to allay local concern about the environmental impacts of exploration off the Pembrokeshire coast.\n- 9 -\nIn Ireland, the company converted three blocks in the Celtic Sea from seismic options to full exploration licenses in February 1995. In addition, the company filed an application for blocks in the deep water area west of Ireland during the Porcupine Basin Licensing Round.\nIn Canada, exploration efforts in 1994 continued to be concentrated in the western part of the country near existing infrastructures that would allow any reserves to be brought on production quickly. A total of 26 exploratory wells were drilled in 1994, resulting in 2 oil and 6 gas discoveries.\nIn Australia, Chevron and its partners in West Australia Petroleum Pty., Ltd. (WAPET) participated in two successful exploration wells resulting in an oil discovery in the Crest 1 well and a gas discovery in the Chrysaor 1 well. Both discoveries are located off the western coast of Australia. The company completed its 3D seismic surveys over the northern part of the Barrow Island oil field and over the onshore Dongara gas\/oil field in 1994. Permit WA-253-P, covering a 519,000 acre block north of Gorgon, was issued to WAPET on behalf of Chevron (50 percent) and a partner during 1994. In December 1994, Chevron signed an agreement to farm-in to WA-215-P in the area between Barrow and Thevenard Island. A farm-in well will be drilled late in the first half of 1995. In addition, the company and its partners in the North West Shelf Project continued their interpretative work on the East Dampier 3D seismic survey. As a result of this work, two exploration wells will be drilled in 1995. In March 1995, the company announced that one of these wells, Perseus-1, had discovered a natural gas and condensate deposit in the waters off northwest Australia, between the North Rankin and Goodwyn fields. The company withdrew from a permit it held with Shell in the Timor Sea in 1994.\nIn Papua New Guinea, Chevron and its partners' 1994 efforts were focused on the delineation of the Gobe Main oil field. In addition, two new exploratory wells commenced in 1994: the SE Mananda 2X well extended a previous oil discovery that may eventually be tied in with the Kutubu field's production and the TA-1X well was drilling at year-end on another prospect between the Gobe and Kutubu fields. In 1995, the company and its partners anticipate an active exploration program to follow up the prospect development work that was carried out in 1994. Exploratory efforts in 1995 are expected to focus on untested trends in the PPL-161 and PDL-2 licenses, where prospects with Kutubu-sized potential still remained to be tested. In the past, exploration efforts have largely concentrated on a single trend which included the Kutubu fields, the Gobe fields, and the SE Mananda discovery.\nIn China, Chevron completed seismic studies on Block 33\/08 in the East China Sea in 1994. The company was awarded sole interest in this block in late 1993. Two exploratory wells are planned for 1995, the first of which commenced in February. This wildcat well, designated Wenzhou 15-1-1, reached its targeted depth and was plugged and abandoned. The second well is scheduled to commence in late March 1995. A production sharing agreement, granting sole interest in Block 62\/23 in the South China Sea, was signed by the company and the Chinese National Offshore Oil Company in late February 1995. A natural gas exploratory well is planned for this block in 1996. Exploration obligations for the current phase of Contract area 16\/08 were fulfilled in 1994. Studies are planned in 1995 to determine the optimum program for the three marginal discoveries in this Contract area.\nIn Bolivia, Chevron at year-end was negotiating the final terms of a farm out of the Caipipendi Exploration Block which, if successful, will lead to a partner funded seismic program over prospects in the southern half of the block.\nIn Trinidad and Tobago, the first of four exploratory wells, Rocky Palace #1, was drilled and tested in 1994. Iguana River #1, the second exploratory well, was drilled in 1994 but encountered mechanical problems and was unable to reach the reservoir objectives. Ste. Croix #1, the third well in the program, has been approved for drilling in mid-1995.\nIn Colombia, two prospects were identified in the Rio Blanco Block using seismic data acquired in 1994. The company plans to drill an exploratory well on one of these prospects in mid-1995. Drill site permitting and road construction is currently underway.\n- 10 -\nPETROLEUM - OIL AND NATURAL GAS PRODUCTION\nThe following table summarizes the company's and its affiliates' 1994 net production of crude oil, natural gas liquids and natural gas.\n----------------------------------------------------------------------------- 1994 NET PRODUCTION* OF CRUDE OIL AND NATURAL GAS LIQUIDS AND NATURAL GAS\nCRUDE OIL & NATURAL GAS NATURAL GAS LIQUIDS (THOUSANDS OF (BARRELS PER DAY) CUBIC FEET PER DAY) ----------------- ------------------- United States -California 127,770 137,110 -Gulf of Mexico 118,370 1,109,390 -Texas 69,270 431,530 -Louisiana 4,470 38,010 -Wyoming 9,690 151,480 -Colorado 14,290 - -New Mexico 8,560 104,540 -Other States 16,220 112,610 ------- --------- Total United States 368,640 2,084,670 ------- ---------\nAfrica 237,600 - Canada 51,510 246,820 United Kingdom (North Sea) 70,720 30,400 Indonesia 20,310 560 Australia 20,570 199,140 Papua New Guinea 29,770 - China 8,250 - Other International 9,570 4,840 ------- --------- Total International 448,300 481,760 ------- --------- Total Consolidated Companies 816,940 2,566,430 ------- --------- Equity in Affiliates 175,570 64,140 ------- --------- Total Including Affiliates 992,510 2,630,570 ======= =========\n* Net production excludes royalties owned by others. -----------------------------------------------------------------------------\nPRODUCTION LEVELS: In 1994, net crude oil and natural gas liquids production, including affiliates, increased for the second year in a row, rising four percent to 992,510 barrels per day from 950,150 barrels per day in 1993. Production increases were noted in a number of countries. In the U.K., production from Alba Field, which went on stream in January 1994, and additional production from Ninian Field, as a result of the company's acquisition of an additional 6 percent equity interest in December 1993, caused U.K. production to increase 43 percent to 70,720 barrels of oil per day. Oil production in Africa increased 9 percent to 237,600 barrels per day primarily due to increased Nigerian production as a result of full year production from three fields placed on stream in late 1993, four new fields placed on stream in 1994 and higher production quotas in 1994, and Angolan production, which increased in 1994 due to new wells in the Takula, Numbi and N'Sano fields. Indonesian production, including the company's share of its affiliate's production, rose 6 percent to\n- 11 -\n173,250 barrels per day in 1994 as a result of the application of enhanced recovery methods in certain fields. In Kazakhstan, Chevron's net oil production doubled to 22,630 barrels per day in 1994 due to full year production and increased export quotas in the latter half of the year. These production increases were partially offset by production declines in the United States due to divestments of producing properties in late 1993, primarily Milne Point, and normal field declines.\nNet production of natural gas, including affiliates, increased 4 percent to 2,630,570 thousand cubic feet per day. Increases were noted in Australia due to initial production from the Roller, Skate and Crest fields, in Canada as a result of reduced re-injection requirements and the shallow gas program, which is designed to rapidly develop and produce gas from low-depth reserves, in the U.S. due primarily to new wells in the Laredo area of Texas and one month's production from the Pakenham, Inc. acquisition, and in Kazakhstan due to full year production.\nThe natural gas industry is undergoing rapid and significant changes that have squeezed margins and caused markets to become more competitive. In the United States, natural gas producers have traditionally sold their production to pipeline companies, who in turn distribute the product to their customers. As a result of FERC Order 636, producers now can sell directly to customers and provide many of the services previously provided by the pipeline companies. Chevron has concentrated its natural gas marketing efforts on the longer term contract market. These customers, which include local distribution companies and industrials, require premium bearing services and marketing arrangements that Chevron can fulfill. The company's sales to these customers have risen significantly, while sales to pipeline companies have correspondingly declined. Chevron has recently completed a detailed evaluation of its existing natural gas marketing efforts and, as a result, will be dedicating additional resources to the effort of marketing gas to targeted end-users. The company has developed and implemented a process that it believes will significantly reduce the cycle time associated with identifying, piloting, and capitalizing on new natural gas marketing opportunities. This new process should allow the company to more readily move natural gas out of mature, lower margin markets into emerging, high-growth premium markets.\nData on the company's average sales price per unit of oil and gas produced, as well as the average production cost per unit for 1994, 1993, and 1992 are reported in Table III on pages FS-32 and FS-33 of this Annual Report on Form 10-K. The following table summarizes the company's and its affiliates' gross and net productive wells at year-end 1994.\n-----------------------------------------------------------------------------\nPRODUCTIVE OIL AND GAS WELLS AT DECEMBER 31, 1994\nPRODUCTIVE (1) PRODUCTIVE (1) OIL WELLS GAS WELLS ------------------ ------------------- GROSS (2) NET(2) GROSS (2) NET (2) --------- ------ --------- ------- United States 27,898 14,180 3,992 1,715 --------- ------ --------- ------- Canada 1,818 963 301 168 Africa 861 335 5 2 United Kingdom (North Sea) 207 35 - - Other International 937 349 37 15 --------- ------ --------- ------- Total International 3,823 1,682 343 185 --------- ------ --------- ------- Total Consolidated Companies 31,721 15,862 4,335 1,900\nEquity in Affiliates 4,524 2,262 33 16 --------- ------ --------- ------- Total Including Affiliates 36,245 18,124 4,368 1,916 ========= ====== ========= ======= Multiple completion wells included above: 432 218 21 11\n(1) Includes wells producing or capable of producing and injection wells temporarily functioning as producing wells. Wells that produce both oil and gas are classified as oil wells. (2) Gross wells include the total number of wells in which the company has an interest. Net wells are the sum of the company's fractional interests in gross wells.\n-----------------------------------------------------------------------------\n- 12 -\nDEVELOPMENT ACTIVITIES: The company's development expenditures, including affiliated companies but excluding proved property acquisitions, were $1,508 million in 1994 and $1,451 million in 1993.\nThe table below summarizes the company's net interest in productive and dry development wells completed in each of the past three years and the status of the company's development wells drilling at December 31, 1994. (A \"development well\" is a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive. \"Wells drilling\" include wells temporarily suspended.)\n-----------------------------------------------------------------------------\nDEVELOPMENT WELL ACTIVITY\nNET WELLS COMPLETED (1) WELLS DRILLING -------------------------------------- AT 12\/31\/94 1994 1993 1992 ------------------- ----------- ---------- ----------- GROSS (2) NET (2) PROD. DRY PROD. DRY PROD. DRY --------- ------- ---- ---- ---- ---- ---- ---- United States 62 59 194 5 293 11 217 5 --------- ------- ---- ---- ---- ---- ---- ---- Africa 12 4 9 - 10 - 10 1 Other International 32 9 48 4 57 12 55 4 --------- ------- ---- ---- ---- ---- ---- ---- Total International 44 13 57 4 67 12 65 5 --------- ------- ---- ---- ---- ---- ---- ---- Total Consolidated Companies 106 72 251 9 360 23 282 10\nEquity in Affiliates 41 20 98 - 93 - 159 5 --------- ------- ---- ---- ---- ---- ---- ---- Total Including Affiliates 147 92 349 9 453 23 441 15 ========= ======= ==== ==== ==== ==== ==== ====\n(1) Indicates the number of wells completed during the year regardless of when drilling was initiated. Completion refers to the installation of permanent equipment for the production of oil or gas or, in the case of a dry well, the reporting of abandonment to the appropriate agency. (2) Gross wells include the total number of wells in which the company has an interest. Net wells are the sum of the company's fractional interests in gross wells. -----------------------------------------------------------------------------\nSignificant 1994 development activities include the following:\nUNITED STATES: Chevron's U.S. development expenditures were $416 million in 1994, a decrease of $59 million from the 1993 figure of $475 million. Expenditures for proved reserve acquisitions amounted to $95 million in 1994, primarily due to the company's acquisition of certain gas properties in West Texas from Wes-Tex Drilling Company, compared to $12 million in 1993. Additions to proved reserves during 1994 from extensions, discoveries and improved recovery, before revisions, were 57 million barrels of crude oil and natural gas liquids and 538 billion cubic feet of natural gas. Additions to proved reserves from acquisitions were approximately 1 million barrels of crude oil and natural gas liquids and 55 billion cubic feet of natural gas.\nChevron's development of its wholly owned San Joaquin Valley diatomite reserves in the Lost Hills Field in California continued with the drilling and completion of 37 new wells and the reworking of 42 older wells using reservoir fracturing techniques. A four year water injection project, initiated in 1992, to sustain reservoir pressure and further boost production continued into its third year with the drilling of 39 injection wells and the conversion of 7 producing wells to injection. When completed, the 520-acre project will have over 200 injectors with a total injection rate of 40,000 barrels of water per day. The combination of reservoir fracturing and water injection is expected to significantly increase both the production rate and the amount of oil ultimately recoverable from this resource.\nChevron owns approximately 25 percent of the Point Arguello project, offshore California, and operates two offshore platforms (Hermosa and Hidalgo), the onshore Gaviota oil and gas plant and the interconnecting pipelines. Chevron and its partners ceased double-hull tankering of oil from the project to the Los Angeles area on February 1, 1994 in compliance with the terms of the tankering permit granted by the California Coastal Commission. These terms required suspension of tankering if Chevron and its partners were unable to sign, by February 1, an agreement with a pipeline developer, who possessed the necessary discretionary permits needed for a new pipeline, that the developer could use for pipeline financing.\n- 13 -\nProduction from the project averaged 78,000 barrels of oil per day in 1994, somewhat below its full production capacity but at about the same level as under tankering. About a third of current production is delivered via pipeline to Los Angeles area refineries. However, due to a shortage of adequate transportation facilities to Los Angeles, the balance of production is shipped via pipeline to markets in the Midwest, resulting in increased transportation costs. In March 1994, the company announced that an agreement had been reached with a pipeline developer to build a 130-mile pipeline in Southern California that would carry Point Arguello oil production to Los Angeles. Chevron and certain other project partners will have a minority interest in the pipeline. The pipeline project is currently in the environmental review stage and is scheduled to be certified in October 1995. However, a property owner in the pipeline right of way is pushing for an alternate route, which may cause further delays. If the environmental review is certified in October 1995, the issuance of permits and the start of construction are expected in the first quarter of 1996. A workover and drilling program, designed to add proved reserves and abate the decline in production rate continued in 1994 with the drilling and completion of two new wells and one redrill during the year.\nIn 1994, Chevron completed an economic evaluation of the viability of developing the Green Canyon 205 Field located 2,600 feet below the ocean's surface in the Gulf of Mexico. Preliminary field development plans have been finalized; however, alternative development concepts will be considered through the first half of 1995, at which time a final selection will be made. Preliminary engineering work is expected to begin in early 1995. Initial production is planned for 1999 and is expected to exceed 50,000 barrels per day. Chevron has a 67 percent interest in this field.\nThe drilling phase at the company's Garden Banks 191 \"A\" platform in the Gulf of Mexico was completed in late 1994. Natural gas production from this block started in late 1993 and is currently producing at a daily rate of 200 million cubic feet of gas, exceeding original production estimates of 150 million cubic feet per day. Chevron is the operator and holds a 50 percent interest in this block.\nIn the Gulf of Mexico's Norphlet gas trend, which stretches some 80 miles from the Destin Dome area (offshore Florida) to the Mobile Block 861 area (offshore Mississippi), production from the Mobile Block 861 #8 well commenced in February 1994. Production from three additional wells drilled in 1994 is expected to start in 1996 with the completion of a processing facility currently being fabricated for the Mobile 861 Area. Production from three wells in the Mobile Block 916 Area offshore Alabama is expected to come on stream in April 1995 with a combined daily net rate of 50 million cubic feet of gas. Chevron's interest in various blocks in the Norphlet gas trend vary from 33 percent to 100 percent.\nNine of thirty-six prospects identified using the 3-D seismic survey of the Eugene Island 238 Field in the Gulf of Mexico have been drilled by the end of 1994. Seven wells were successful, resulting in four gas and three oil discoveries. A new production platform, added in 1994 to accommodate the oil discoveries, will increase production by 9,000 barrels per day. Three additional wells will be drilled and an additional satellite platform will be installed in 1995. By the end of 1995, daily total production for the field is forecasted to exceed 200 million cubic feet of gas and 15,000 barrels of oil. Chevron has a 100 percent interest in this field except for Block 229, where Chevron's interest is 70 percent.\nChevron continued to aggressively develop \"tight gas\" (gas which is produced from a tight, low-permeability formation) in the Laredo, Texas area. In 1994, twenty-five wells were drilled, adding proved reserves of 176 billion cubic feet of gas. Current net production averaged 165 million cubic feet of gas per day. The company acquired more than 12,000 new acres in 1994 for future development. Chevron's interest in the leases is 100 percent except for one lease in which the company's interest is 59 percent.\nIn 1994, the company purchased the stock of Pakenham, Inc., a subsidiary of Wes-Tex Drilling Company. Assets acquired in the purchase included 47 natural gas producing wells in West Texas, 52 billion cubic feet of net proved natural gas reserves and a gathering system that is currently used to transport natural gas to a pipeline owned by Valero Transmission Company. Warren Petroleum Company, Chevron's gas processing unit, is expanding its operations to include the Pakenham gas gathering and processing business. The company believes the field holds the potential to further increase the company's gas reserves and expects to add wells that will more than triple the current production of 25 million cubic feet per day to 90 million cubic feet per day by 1999.\n- 14 -\nAFRICA: Developmental expenditures in Africa were $276 million in 1994, compared to $239 million in 1993. Expenditures for proved reserve acquisitions amounted to $145 million in 1994. Additions to proved reserves from extensions, discoveries and improved recovery, before revisions, were 103 million barrels of crude oil and natural gas liquids. Additions to proved reserves from acquisitions were approximately 76 million barrels of crude oil and natural gas liquids. Acquisition expenditures and proved reserves from acquisitions in 1994 were both primarily related to the company's activities in the Congo.\nIn Angola, where Chevron's equity interest is 39 percent, 15 development wells were added in Area A fields in 1994. Production from the greater Takula Area fields increased in 1994 due to ongoing development of the N'Sano and Numbi Southeast fields and from infill programs in existing reservoirs. A new production platform and associated pipelines were installed in N'Sano Field during 1994 and development drilling commenced at mid-year. A decline in production from the greater Malongo Area fields was reversed in 1994 through a combination of production from new exploration discoveries and continued infill activity. One offshore processing platform in the Malongo South Field was revamped and modernized in 1994. The company expects to maintain production from Area A in future years through the combination of infill drilling, workovers, facility modernization, waterflood and gas injection.\nAreas B and C continued to be the major focus of 1994 development programs in Angola with the installation of two integrated drilling and production platforms in the Kokongo Field in Area B. The East Kokongo platform is designed as the hub for future phases of development for Areas B and C and includes a thirty-eight mile pipeline linking the platforms to onshore terminal facilities in Malongo. Drilling rigs were installed in the fourth quarter of 1994 which resulted in initial production being established in late November. By year-end, two wells had been completed and additional drilling is expected to continue into 1996. The Nemba Field in Area B is expected to operate as a satellite of East Kokongo. Contracts were awarded in 1994 for an early production system consisting of three subsea wells, a tanker for floating production service and related flowlines and pipelines. Production start-up is scheduled for the second half of 1995. Tenders were issued in 1994 for the construction of additional Area B facilities, consisting of two integrated platforms and associated pipelines, related to the development of Lomba Field and the southern portion of Nemba Field. Start-up is forecasted for 1997 at which time the early production system at Nemba will be de- commissioned and the three subsea wells tied-back to Nemba South for continued production. The Lomba installation will operate as a satellite of Nemba South. Contracts for the development of the Sanha and N'Dola fields in Area C were released in the fourth quarter of 1994 following resolution of partner financing issues. The development will consist of two integrated platforms and related pipelines and facilities which are currently being fabricated in South Africa. These fields will act as satellites of East Kokongo with start-up forecasted for early 1997.\nIn Nigeria, total production from the 26 CNL-operated fields averaged 369,200 barrels of oil per day, an increase of over 41,000 barrels of oil per day from 1993. This increase was the result of new field development programs, development drilling in existing fields, workover programs and increased commercial allowables. Four new fields, Abigborodo, Jokka, Kito and Benin River, were placed on production in 1994. Benin River production commenced in December 1994 from one well. Detailed engineering for the full development of Benin River will continue in 1995 with full production start-up planned for 1996. The platform upgrade program marked its second year in 1994. This program, intended to upgrade all existing platforms in order to extend the useful life and enhance the safety and environmental performance of these facilities, continued at Delta, Meren 1 and Okan fields. Engineering was completed for Utonana and is underway for Abiteye, Makaraba, Isan\/West Isan, Malu and two satellite platforms at Okan. Work on the Escravos Gas Project, Phase I, continued in 1994 with the completion of sand-filling at the onshore site for the Liquefied Petroleum Gas (LPG) extraction\/fractionation plant. In addition, 93 percent of the detailed design engineering work for Phase I of the project was completed in 1994. This first phase will utilize gas that is currently being flared in the Okan and Mefa fields. The project will include offshore gas compression facilities, an onshore LPG extraction plant, and a floating LPG storage unit anchored offshore. The project will sell gas under a long term contract to the Nigerian Gas Company in addition to producing approximately 15,000 barrels per day of hydrocarbon liquids for export. Start- up of the project is now expected in mid-1997.\n- 15 -\nIn the Congo, Chevron and its partners have begun developing the Kitina Field. Development consists of a drilling jacket with some topside facilities, tied via a pipeline to other onshore processing and export facilities at Djeno Terminal. Production is forecasted to begin in mid-1997 with peak production of 50,000 barrels per day by 1999. In late 1994 the company and its partners successfully drilled an appraisal well in the 1992 Kitina South discovery. The development of the N'Kossa Field started in 1993. Two producing platforms connected to a floating barge containing processing facilities will allow crude oil and LPG to be loaded onto tankers for direct export. Production is forecasted to commence in mid-1996 at a rate of 80,000 barrels per day, reaching peak production of about 120,000 barrels per day in 1998.\nIn Zaire, one development well, one re-drill, and five workovers were completed in 1994. Early production from the Tshiala East exploration discovery was developed by installation of a satellite production platform and tie-back to existing processing facilities. Additional development planning studies are underway to evaluate further development of this field.\nOTHER INTERNATIONAL INCLUDING AFFILIATED COMPANIES: Development expenditures in 1994 were $816 million compared to $737 million in 1993. Additions to proved reserves from extensions, discoveries and improved recoveries were 91 million barrels of crude oil and natural gas liquids and 708 billion cubic feet of natural gas.\nIn the United Kingdom the company has interests in over 50 blocks on the U.K. Continental Shelf which total approximately 1.7 million gross acres, including six producing fields in the North Sea where interests vary from 4.9 to 33.3 percent. At the Ninian Field in the North Sea, Chevron (24 percent interest) and its partners are paid a tariff for processing third-party oil and gas production using available processing capacity at the Ninian facilities. In 1994 third-party oil flowing through the Ninian Field's facilities increased with production from Columba and Dunbar Fields coming on stream. This follows production from Staffa Field which was brought on stream in 1992, Lyell Field (Chevron owns a 33.3 percent interest) in early 1993 and Strathspey Field at year-end 1993. Production from the first phase of a two-phase development plan for the North Sea's Alba Field, in which Chevron has a 33 percent interest, commenced in January 1994. Average daily gross oil production was 42,400 barrels, with a fourth quarter average of 62,900 barrels of oil per day. Plans for the second phase of Alba, which will develop the southern area of the reservoir, continued in 1994 with conceptual engineering studies to select a preferred development option. A decision is expected by late 1995 which should result in first production from the southern part of the field in 1996. The Britannia gas field development in the North Sea was approved by the United Kingdom Department of Trade and Industry at the end of 1994. Development will initially consist of a steel drilling, production and accommodation platform and a subsea well center, along with a gas offtake pipeline and onshore gas processing facilities. Condensate from the field will be transported ashore via the Forties pipeline system. Gas and gas liquids will be transported to and processed at the St. Fergus terminal in northeast Scotland. Peak production is expected to be approximately 740 million cubic feet of gas and 70,000 barrels of condensate per day. Initial production is expected to commence in late 1998. Agreements have been reached to sell gas to four purchasers. Chevron's share of production is just over 30 percent.\nIn Canada, the company continues to concentrate its development efforts in six core producing areas in Alberta and one in Manitoba where operating efficiencies and lower operating costs can be realized using existing infrastructure. In 1994, the company drilled 49 wells that were targeted at new reserves around existing fields along with 58 development wells. The company also continued its development of the late-1993 Simonette oil discovery with further delineation drilling and site construction activities in 1994.\nChevron has a 27 percent interest in the Hibernia Field, located approximately 200 miles offshore Newfoundland. In 1994, the Gravity Based Structure (GBS) was floated to a deep water construction site where final construction, including installation of the topside structures will be completed before mid- 1997, the date for its scheduled towing to the drilling site. Engineering cost and construction delays caused by the\n- 16 -\ncomplexity of the GBS have resulted in higher than projected pre-production costs for the project. The company is working very closely with the Hibernia Management Development Company and with partners to keep the project on schedule and to control construction costs. Initial production has been delayed and is now forecasted for 1998. Hibernia investment is projected to be slightly over $210 million in 1995, an increase of $17 million over 1994 levels. The company's capitalized investment in this project was $570 million at year-end 1994.\nIn Indonesia, Chevron's interests in 13 contract areas are managed by its 50 percent owned P.T. Caltex Pacific Indonesia and Amoseas Indonesia affiliates. The Duri Steamflood Project, begun in 1985 to assist the difficult production process for the relatively heavy, waxy Duri crude, is being completed in 12 stages (Areas 1-12). Development of Area 7 is currently underway and steaming began early in 1995. Area 8 is due to be on stream early in 1997. More than three billion additional barrels of oil are expected to be recovered from the Duri Field as a result of steamflooding. Total production at Duri averaged 300,000 barrels per day in 1994. A waterflood project involving 21 fields in Central Sumatra, including the Minas field, continued in 1994. Over the next 20 years, waterflood operations will be introduced or expanded at these fields.\nFirst steam from the Darajat geothermal field, located 115 miles southeast of Jakarta, was delivered to Prusahaan Listrik Negara (PLN), Indonesia's state electricity agency, in late 1994. The Darajat I plant was commissioned in late 1994 with initial production targeted for PLN's nearby 55-megawatt power plant. Negotiations with the Indonesian government on developing Darajat II is expected to commence in 1995. This future expansion will allow production to increase to 130 megawatts by 1999.\nIn Kazakhstan, the company formed a 50\/50 joint venture with Tengizmunaigaz, a subsidiary of Kazakhstanmunaigaz - the national oil company of the Republic of Kazakhstan - to develop the Tengiz and Korolev oil fields on the northeast coast of the Caspian Sea. This joint venture affiliate, Tengizchevroil (TCO), began operations in April 1993. TCO's total production capacity was 65,000 barrels per day for most of 1994. However, production in the early part of 1994 was limited to 35,000 barrels per day due to the amount of mercaptans, foul-smelling sulfur compounds, in the oil. The mercaptan problem was resolved at mid-year through the use of chemical scavengers and exports reached 65,000 barrels per day in the fourth quarter. Production capacity was increased to 95,000 barrels per day at year-end with the completion of a second processing plant. By the end of 1995, production capacity is scheduled to increase to 130,000 barrels per day and could reach 260,000 barrels per day by the late 1990's. However, the pace of further development beyond the 130,000 barrels per day is dependent on the availability of additional export capacity. Current production is restricted by the limited transportation facilities available to TCO to bring the oil to world markets. Tengiz crude oil production is currently exchanged for Russian crude which is then exported from Russia to world markets. Production levels have been and are continuing to be restricted by the monthly export quotas (currently 65,000 barrels per day) set by Russia under this agreement. The company has been in prolonged negotiations with the Caspian Pipeline Consortium, composed of the Republics of Russia and Kazakhstan and the Sultanate of Oman, to agree on terms for an export pipeline system that would enable the project to increase its production and sell its output directly to world markets. It is currently impossible to predict the eventual outcome of these negotiations or its impact on the joint venture.\nIn Australia, drilling commenced in October 1994 in the Goodwyn Field which is being developed as part of the North West Shelf Project in which Chevron holds a one-sixth interest. Production started in February 1995 with total initial production expected at around 10,000 barrels of condensate per day, rising to 80,000 barrels of condensate and 900 million cubic feet of natural gas per day at its peak in 1996. First production from the Wanaea and Cossack oil field development is expected late in 1995. Combined peak production from the two oilfields is forecasted at 115,000 barrels of oil per day and should occur in mid-1996. The liquids-rich gas from Wanaea will be combined with gas from the North Rankin and Goodwyn fields and processed at the onshore gas plant at Karratha, which is being modified to allow the export sale of LPG. In 1994, Chevron and its partners in West Australian Petroleum Pty., Ltd. (WAPET) continued to evaluate options for the commercialization of the Gorgon gas field. The North Gorgon 2 appraisal well was\n- 17 -\nsuccessful with combined tests from four sands of 175 million cubic feet of gas per day. Initial production from the Roller\/Skate oilfield development commenced in May 1994, averaging 40,000 barrels per day. Associated gas from the Roller\/Skate and Saladin fields is being piped to shore and either sold in the Perth market or stored in the Dongara field for future sales. The Crest discovery well was put on extended production tests in 1994 and was producing over 6,000 barrels of oil per day in December. Full field development will consist of drilling two more wells onshore Thevenard Island and tying them into existing facilities in mid-1995. Chevron's interest in WAPET projects varies from 26 to 50 percent.\nIn Papua New Guinea, Chevron (19 percent interest) and its partners are currently undertaking front-end engineering work on the Gobe fields in the southeastern portion of the PPL-161 license. This work is expected to lead to the submission of a Petroleum Development License application to the Papua New Guinea government in 1995. The Gobe fields consist of SE Gobe (discovered in 1991) and Gobe Main (discovered in 1993). A delineation program on Gobe Main was conducted in 1994 that defined the scope of the oil discovery and allowed planning for a joint development of the two fields to progress. If the government approves the development application in early 1996, initial oil production from the Gobe fields will commence in 1997. Chevron and its partners, as well as other competitor groups, have made significant gas discoveries in the Papuan Basin. Evaluations for the development of gas discoveries in the PPL-101 license (P'nyang and Juha gas fields) and the PDL-2 license (Hedinia field gas cap) are continuing. An active development drilling program designed to accelerate production and develop new reserves is scheduled for the Kutubu fields in early 1995. This program, which will contain both vertical and horizontal wells, is expected to allow production from the Kutubu fields to remain at a rate in excess of 100,000 barrels of oil per day throughout 1995.\nIn China, work continued in 1994 on projects to develop the HZ\/32-2 and HZ\/32-3 fields in the South China Sea. The plan includes two platforms, 12 additional wells and a tie-in to the existing production facility at the HZ\/21-1 Field. Initial production, expected to peak at 45,000 barrels per day, is scheduled for mid-1995. Chevron holds a 16 percent interest in the venture.\nIn Kuwait, the company signed a three-and-a-half year agreement with the Kuwait Oil Company in August 1994 to provide technical services to help develop the Burgan Field, the world's second largest oil field.\nPETROLEUM - NATURAL GAS LIQUIDS\nChevron's wholly owned Warren Petroleum Company is engaged in all phases of the domestic natural gas liquids (NGL's) business and is the largest U.S. wholesale marketer of natural gas liquids, selling to customers in 46 states. Warren also conducts Chevron's international liquefied petroleum gas (LPG) trading and sales activities. Sales in 1994 totaled 281,000 barrels per day (includes sales of 72,000 barrels per day to Chevron subsidiaries). Warren's business encompasses:\nEXTRACTION - Warren operates 18 gas processing plants in Oklahoma, Texas, Louisiana and New Mexico with a total processing capacity of 3.5 billion cubic feet of gas per day and holds equity interests in an additional 25 plants. Natural gas from Chevron's and other producers' wells is piped to these plants, where the various liquids are extracted. Warren's share of gas liquids production from these plants was 66,000 barrels per day in 1994.\nFRACTIONATION - Raw natural gas liquids are collected from Warren's processing plants, third-party purchases and Warren's gas liquids import facility on the Houston Ship Channel and transported via pipelines to Warren's fractionation plant at Mont Belvieu, Texas. The 220,000 barrel per day capacity facility fractionates raw NGL's into ethane, propane, normal butane, iso-butane and natural gasoline products. The Mont Belvieu complex includes a 45 million barrel capacity underground gas liquids storage facility.\n- 18 -\nDISTRIBUTION - Gas liquids are distributed to refineries, petrochemical manufacturers and independent distributors via terminals supplied by pipelines, barges, tank cars and trucks. NGL imports and exports are handled at Warren's marine terminal, the Warrengas Terminal, located on the Houston Ship Channel and linked to the Mont Belvieu complex by dedicated pipelines. Petrochemical manufacturers are the main purchasers of ethane while propane is sold to petrochemical manufacturers as well as residential and commercial users. Refineries are the major customers for the remaining types of NGL's.\nWarren's activities in international LPG business development included marketing LPG for other Chevron companies in Canada, West Africa, the U.K., and Australia. In 1994, the company also lent support to a Caltex study of LPG opportunities in China.\nIn 1994, Warren began construction of field gathering and compression facilities to support Chevron U.S.A. Production Company's Pakenham Field acquisition in West Texas. The company also converted an underutilized ethylene pipeline owned by Chevron Chemical Company to an isobutane pipeline in 1994, allowing Warren to utilize the excess fractionation capacity it had at its Mt. Belvieu, Texas plant to produce isobutane for transportation and sale in the Texas City, Texas market.\nThe company's total third-party natural gas liquids sales volumes over the last three years are reported in the following table.\n---------------------------------------------------\nNATURAL GAS LIQUIDS SALES VOLUMES (Thousands of barrels per day)\n1994 1993 1992 ---- ---- ---- United States - Warren 209 208 191 United States - Other 6 3 3 ---- ---- ---- Total United States 215 211 194 Canada 27 30 26 Other International 7 7 7 ---- ---- ---- Total Consolidated Companies 249 248 227 ==== ==== ====\n---------------------------------------------------\nPETROLEUM - RESERVES AND CONTRACT OBLIGATIONS\nTable IV on pages FS-33 and FS-34 of this Annual Report on Form 10-K sets forth the company's net proved oil and gas reserves, by geographic area, as of December 31, 1994, 1993, and 1992. During 1994, the company filed estimates of oil and gas reserves with the Department of Energy, Energy Information Agency. Those estimates were consistent with the reserve data reported on page FS-34 of this Annual Report on Form 10-K.\nThe company sells gas from its producing operations under a variety of contractual arrangements. Most contracts generally commit the company to sell quantities based on production from specified properties but certain gas sales contracts specify delivery of fixed and determinable quantities. In the United States, the quantities of natural gas the company is obligated to deliver in the future under existing contracts is not significant in relation to the quantities available from the production of the company's proved developed U.S. reserves in these areas. Outside the United States, the company replaced its single Western Australian domestic gas contract with six agreements, involving sales to five direct-end users. Those agreements commit the company to deliver approximately 258 billion cubic feet of natural gas through 2005. The company believes it can satisfy these contracts from quantities available from production of the company's proved developed Australian natural gas reserves.\n- 19 -\nPETROLEUM - REFINING\nThe daily refinery inputs over the last three years for the company's and its affiliate's refineries are shown in the following table.\n-----------------------------------------------------------------------------\nPETROLEUM REFINERIES: LOCATIONS, CAPACITIES AND INPUTS (Inputs and Capacities are in Thousands of Barrels Per Day)\nDECEMBER 31, 1994 ------------------ REFINERY INPUTS OPERABLE -------------------- LOCATIONS NUMBER CAPACITY 1994 1993 1992 ---------------------------- ------ -------- ---- ---- ---- Pascagoula, Mississippi 1 295 324 283 294 Port Arthur, Texas (1) 1 185 158 177 189 Richmond, California 1 230 220 228 228 El Segundo, California 1 230 227 233 235 Philadelphia, Pennsylvania (1) - - 94 184 164 Other (2) 6 261 190 202 201 -- ----- ----- ----- ----- Total United States 10 1,201 1,213 1,307 1,311 -- ----- ----- ----- -----\nBurnaby, B.C., Canada 1 50 47 43 41 Milford Haven, Wales United Kingdom 1 115 116 120 103 -- ----- ----- ----- ----- Total International 2 165 163 163 144 -- ----- ----- ----- ----- Total Consolidated Companies 12 1,366 1,376 1,470 1,455\nEquity in Various Affiliate Locations 14 492 460 435 399 -- ----- ----- ----- ----- Total Including Affiliate 26 1,858 1,836 1,905 1,854 == ===== ===== ===== =====\n(1) The company sold the Philadelphia, Pennsylvania refinery in August 1994 and the Port Arthur, Texas refinery in February 1995.\n(2) Refineries in El Paso, Texas; Barber's Point, Hawaii; Salt Lake City, Utah; Perth Amboy, New Jersey; Willbridge, Oregon; and Richmond Beach, Washington. Capacity and input amounts for El Paso represent Chevron's share.\n-----------------------------------------------------------------------------\nAt the end of 1994, Chevron had the largest U.S. refining capacity and ranked among the top ten in worldwide refining capacity including its share of affiliate's refining capacity. The company wholly owned and operated 10 refineries in the United States and one each in Canada and the United Kingdom. The company's Caltex Petroleum Corporation affiliate owns or has interests in 14 operating refineries in Japan (4), Korea, the Philippines, Australia, New Zealand, Bahrain, Singapore, Pakistan, Thailand, Kenya and South Africa.\nDistillation operating capacity utilization in 1994 averaged 93 percent in the United States and 94 percent worldwide (including affiliate), compared with 94 percent in the United States and 95 percent worldwide in 1993. Chevron's capacity utilization of its domestic cracking and coking facilities, which are the primary facilities used to convert heavier products to gasoline and other light products, averaged 90 percent in 1994, up 2 percent from 1993.\nIn 1994, the company continued work on various expansion\/upgrade projects, which are expected to cost over $1 billion when completed, at its Richmond and El Segundo, California, refineries. These projects are aimed at meeting regional clean air requirements and producing cleaner burning motor gasoline and diesel fuel as required by the California Air Resources Board and the Federal Clean Air Act Amendments of 1990. Projects to produce federal reformulated gasoline were completed at both refineries in 1994. In addition, a $300 million investment to upgrade key processing units to improve yields of high value light products is continuing at the Richmond refinery.\n- 20 -\nFor the last few years, the U.S. downstream industry has been going through massive recapitalization in order to meet the stringent new environmental requirements under the 1990 amendments to the Clean Air Act. As a result, in 1993, the company announced a major restructuring of the company's downstream operations which included the divestment of refineries in Philadelphia, Pennsylvania and Port Arthur, Texas. These refineries no longer fit in Chevron's long term plans to have a more strategically focused U.S. refining operation and the divestitures would reduce the capital expenditures that would have been required to meet the Clean Air Act amendments. The company sold its Philadelphia, Pennsylvania, refinery to Sun Company, Inc. in August 1994 and its Port Arthur, Texas, refinery to Clark Refining and Marketing, Inc. in February 1995.\nFederal regulations required that reformulated gasoline (RFG) be sold in nine mandated areas in the United States beginning January 1, 1995. In addition, certain states and other areas voluntarily opted for the RFG requirement. Some of these areas have subsequently withdrawn, or are considering withdrawing, from the voluntary requirement. Also, in some areas complaints have surfaced that an RFG ingredient, MTBE, is causing illness among users. The company is unable to predict the outcome of these developments on its operations and the industry. Chevron is selling RFG in a total of nine mandated and voluntary areas.\nIn 1994, Caltex and its partners continued construction of a grassroots, 130,000 barrels per day refinery in Thailand. Mechanical completion of the refinery is expected by the first quarter of 1996, with full production commencing by mid-1996. The anticipated fall 1995 completion of the Residuum Fluid Catalytic Cracking (RFCC) unit at the Singapore export refinery will mark the completion of that refinery's expansion\/upgrade project. The upgrade will increase refining capacity by 60,000 barrels per day, increase yield of light products by 33,000 barrels per day, and enable the refinery to produce oxygenated unleaded gasoline and low sulfur diesel fuel. At the Yocheon refinery in South Korea, construction of an RFCC unit is currently underway to position Caltex's Honam affiliate for Korea's shift to a higher-margin, lighter product mix.\nPETROLEUM - REFINED PRODUCTS MARKETING\nPRODUCT SALES: The company and its Caltex Petroleum Corporation affiliate markets petroleum products throughout much of the world. The principal trademarks for identifying these products are \"Chevron,\" \"Gulf\" (principally in the United Kingdom) and \"Caltex.\" U.S. sales volumes of refined products by the company during 1994 amounted to 1,314 thousand barrels per day, equivalent to approximately eight percent of total U.S. consumption. Worldwide sales volumes, including the company's share of affiliate's sales, averaged 2,248 thousand barrels per day in 1994, a decrease of about four percent over 1993. This decrease was largely due to the sale of the company's Philadelphia, Pennsylvania, refinery in August 1994, and refinery downtime in the first half of 1994.\n- 21 -\nThe following table shows the company's and its affiliate's refined product sales volumes, excluding intercompany sales, over the past three years.\n--------------------------------------------------------\nREFINED PRODUCTS SALES VOLUMES (Thousands of Barrels Per Day)\n1994 1993 1992 ----- ----- ----- UNITED STATES Gasolines 615 652 646 Gas Oils and Kerosene 277 325 347 Jet Fuel 260 247 252 Residual Fuel Oil 65 94 110 Other Petroleum Products* 97 105 115 ----- ----- ----- Total United States 1,314 1,423 1,470 ----- ----- -----\nINTERNATIONAL United Kingdom 118 111 108 Canada 56 50 39 Other International 140 168 147 ----- ----- ----- Total International 314 329 294 ----- ----- ----- Total Consolidated Companies 1,628 1,752 1,764\nEquity in Affiliate 620 594 565 ----- ----- ----- Total Including Affiliate 2,248 2,346 2,329 ===== ===== =====\n* Principally naphtha, lubes, asphalt and coke.\n--------------------------------------------------------\nThe company's Canadian sales volumes consist of refined product sales in British Columbia and Alberta by the company's Chevron Canada Ltd. subsidiary. In the United Kingdom, the sales volumes reported comprise a full range of product sales by the company's Gulf Oil (Great Britain) Ltd. subsidiary. The 1994 volumes reported for \"Other International\" relate primarily to international sales of aviation, marine fuels, and refined products in Latin America, the Far East and elsewhere. The equity in affiliate's sales in 1994 consists of the company's interest in Caltex Petroleum Corporation, which operates in 61 countries including Australia, the Philippines, New Zealand, South Africa and, through Caltex affiliates, in Japan and Korea.\nRETAIL OUTLETS: In the United States, the company supplies, directly or through jobbers, approximately 8,600 motor vehicle, aircraft and marine retail outlets, including more than 2,000 company-owned or -leased motor vehicle service stations. The company's gasoline market area is concentrated in the Southern, Southwestern and Western states. Chevron estimates it is the fourth largest seller of gasoline in the United States and is among the top three marketers in 15 states.\nChevron is continuing its efforts to increase non-fuel related revenues through its existing customer and asset base. In 1994, the company revised its credit terms for Chevron credit card holders and introduced a \"Gold\" tier to its Travel Club. The company is also gauging consumer interest in having McDonald's restaurants on the premises of company-owned service stations, with a number of test sites in Texas and Louisiana now in operation. Revenues from Direct Mail Marketing, introduced in 1993, continued to grow in 1994.\nThe company continued to expand its \"FastPay\" system by approximately 700 stations in 1994, increasing the total service stations with the system to over 2,000 nationwide. This automated system allows credit card customers to pay at the pump with credit approvals processed in about five seconds using satellite data transmission.\n- 22 -\nInternationally, the company's branded products are sold in 200 owned or leased stations in British Columbia, Canada and in 498 (233 owned or leased) stations in the United Kingdom.\nPETROLEUM - TRANSPORTATION\nTANKERS: Chevron's controlled seagoing fleet at December 31, 1994 is summarized in the following table. All controlled tankers were utilized in 1994.\n-----------------------------------------------------------------------------\nCONTROLLED TANKERS AT DECEMBER 31, 1994\nU.S. FLAG FOREIGN FLAG ----------------------------- ------------------------------ CARGO CAPACITY CARGO CAPACITY NUMBER (millions of barrels) NUMBER (millions of barrels) ------ --------------------- ------ --------------------- Owned 1 - 23 22 Bareboat Charter 6 2 7 12 Time-Charter - - 8 4 ---- ---- ---- ---- Total 7 2 38 38 ==== ==== ==== ====\n-----------------------------------------------------------------------------\nFederal law requires that cargo transported between domestic ports be carried in ships built and registered in the United States, owned and operated by U.S. entities and manned by U.S. crews. At year-end 1994, the company's U.S. flag fleet was engaged primarily in transporting crude oil from Alaska and California terminals to refineries on the West Coast and Hawaii, refined products between the Gulf Coast and East Coast, and refined products from California refineries to terminals on the West Coast, Alaska and Hawaii.\nAt year-end 1994, two of the company's controlled international flag vessels were being used for floating storage. The remaining international flag vessels were engaged primarily in transporting crude oil from the Middle East, Indonesia, Mexico, West Africa and the North Sea to ports in the United States, Europe, the United Kingdom, and Asia. Refined products also were transported worldwide.\nIn addition to the tanker fleet summarized in the table above, the company owns a one-sixth undivided interest in each of six liquefied natural gas (LNG) ships that are bareboat chartered to the Australian North West Shelf Project. One of the ships, the Northwest Stormpetrel, was delivered in late December 1994. These ships, along with two time-chartered LNG vessels, transport LNG from Australia primarily to various Japanese gas and electric utilities.\nChevron continued to upgrade and \"right-size\" its fleet of vessels in 1994 by taking delivery of two 1.1 million barrel capacity, double hull tankers and selling two 2.0 million, one 1.2 million and one .9 million barrel capacity tankers. The company also reduced its time-chartered fleet by a net one tanker and 1.0 million barrels of capacity during 1994.\nPage 28 of this Annual Report on Form 10-K contains a discussion of the effects of the Federal Oil Pollution Act on the company's shipping operations.\n- 23 -\nPIPELINES: Chevron owns and operates an extensive system of domestic crude oil, refined products and natural gas pipelines. The company also has direct or indirect interests in other domestic and international pipelines. The company's ownership interests in pipelines are summarized in the following table:\n----------------------------------------------------------- PIPELINE MILEAGE AT DECEMBER 31, 1994\nWHOLLY PARTIALLY OWNED OWNED (1) TOTAL ----- ----- ------ UNITED STATES: Crude oil (2) 5,150 620 5,770 Natural gas 413 32 445 Petroleum products 4,041 1,472 5,513 ----- ----- ------ Total United States 9,604 2,124 11,728 ----- ----- ------\nINTERNATIONAL: Crude oil (2) - 785 785 Natural gas - 205 205 Petroleum products 12 109 121 ----- ----- ------ Total International 12 1,099 1,111 ----- ----- ------ Worldwide 9,616 3,223 12,839 ===== ===== ======\n(1) Reflects equity interest in lines. (2) Includes gathering lines related to the transportation function. Excludes gathering lines related to the domestic production function.\n-----------------------------------------------------------\nThe company has signed an agreement with Pemex, the national oil company of Mexico, to build a $8.5 million, 19-mile pipeline from Chevron's El Paso, Texas, refinery to a Pemex storage terminal just south of Ciudad Juarez, Mexico. The pipeline will transport gasoline, diesel, and possibly kerosene and is expected to be in service in 1996, pending approval by various regulatory agencies.\nCHEMICALS\nThe company's chemical operation manufactures and markets commodity chemical products for industrial use and chemical additives for fuels and lubricants. After a period of ample supplies caused by industry production overcapacity, the petrochemical industry rebounded dramatically in 1994. The excess industry capacity of the last four years was rapidly eliminated as improved industrialized economies, particularly in the United States, raised demand for consumer goods, many of which are made from or packaged with plastics derived from commodity chemicals marketed by the company. The elimination of the industry's excess capacity tightened supplies, which led to higher margins for the company's products. The profitability of chemical operations in 1994 was further enhanced by the restructuring and cost reduction programs the company had undertaken in recent years which positioned the company to benefit from improved industry conditions.\nAt year-end 1994, Chevron Chemical Company owned and operated 20 U.S. manufacturing facilities in 10 states, owned manufacturing facilities in Brazil and France, and owned a majority interest in a manufacturing facility in Japan. The principal domestic plants are located at Cedar Bayou, Orange and Port Arthur, Texas; St. James and Belle Chasse, Louisiana; Marietta, Ohio; Pascagoula, Mississippi; St. Helens, Oregon; and Richmond, California. The company's three major operating divisions are \"Aromatics and Derivatives,\" which are marketed in 32 countries, \"Olefins and Derivatives,\" which are marketed in 45 countries and \"Oronite Additives,\" which are marketed in over 80 countries. The following table shows, by chemical division, 1994 revenues and the number of owned or majority owned chemical manufacturing facilities and combined operating capacities as of December 31, 1994.\n- 24 -\n----------------------------------------------------------------------------- CHEMICAL OPERATIONS\nMANUFACTURING FACILITIES 1994 ------------------- ANNUAL REVENUE (1) DIVISION U.S. INTERNATIONAL CAPACITY ($ Millions) --------------------- ---- ------------- ------------------- ------------ Olefins and Derivatives 11 - 7,050 million lbs. $1,186 Aromatics and Derivatives 5 - 5,210 million lbs. 944 Oronite Additives 2 3 160 million gal. 832 Other (including excise tax) 2 - (2) 119 -- - ------ Totals 20 3 $3,081 == = ======\n(1) Excludes intercompany sales. (2) No meaningful common measurement. -----------------------------------------------------------------------------\nThe company plans to expand its linear low density polyethylene (LLDPE) manufacturing facility at Cedar Bayou, Texas in 1995 with project completion expected in the first quarter of 1996. The expansion will increase the plant's production capacity of LLDPE by 340 million pounds per year. The plant is also capable of manufacturing high density polyethylene. These materials are used to produce a variety of products for the packaging industry.\nThe company is continuing with its previously announced plans to withdraw from its agricultural and consumer product businesses. Plans to shut down the company's nitric acid and fertilizer plants in Richmond, California by the end of July 1995 were announced by the company in late January 1995. Chevron sold the majority of its nitrogen fertilizer business to Unocal in 1991 and has operated the facilities since that time under contract with Unocal. The company's remaining fertilizer plant in St. Helens, Oregon is currently for sale.\nCOAL AND OTHER MINERALS\nCOAL: The company's wholly-owned coal mining and marketing subsidiary, The Pittsburg and Midway Coal Mining Co. (P&M), owned and operated four surface and three underground mines at year-end 1994. Three of the mines are located in New Mexico and one each in Alabama, Wyoming, Kentucky and Colorado. All of the mines produce steam coal used primarily for electric power generation. P&M's strategy is to focus on regional markets in the United States, capitalizing on major utility growth markets in the southwest and southeast.\nIn 1994, the company restructured its interest in the Black Beauty Coal Company by adding a new partner who contributed both cash and additional coal properties to the partnership. This restructuring reduced the company's interest in the partnership from 50 percent to 33 percent. The Black Beauty Coal Company's principal operations are in the Indiana\/Illinois coal market.\nSales of coal from P&M's wholly-owned mines and from its interest in the Black Beauty Coal Company were 20.4 million tons in 1994, a decrease of approximately 2 percent from 1993 sales of 20.8 million tons. However, 1994 production was at 94 percent of estimated capacity, a 2 percent increase over 1993. About 59 percent of 1994 sales came from two mines, the McKinley Mine in New Mexico and the Kemmerer Mine in Wyoming. The average selling price for coal from mines owned and operated by P&M was $24.39 per ton in 1994 compared to $24.62 per ton in 1993, contributing $414 million and $426 million to Chevron's consolidated sales and other operating revenues in 1994 and 1993, respectively. At year-end 1994, P&M controlled approximately 538 million tons of developed and undeveloped coal reserves.\nDemand growth for coal in the United States remains largely dependent on the demand for electric power, which in turn depends on regional and national economic conditions and on competition from other fuel sources. In 1994, the electric utility industry consumed over 80 percent of all coal produced in the United States.\n- 25 -\nApproximately 87 percent of P&M's coal sales are made to electric utilities. Of those sales, about 50 percent are under contracts longer than 10 years and 20 percent are under three to ten year contracts. As a result, P&M is not particularly exposed to short-term fluctuations in market prices. Generally, these contracts contain negotiated cost pass through and inflation adjustment provisions.\nP&M controls a significant inventory of low-sulfur coal reserves, and the company expects demand for this type of coal to grow as utilities implement their strategies to comply with the air quality emission standards of Phase I of the Clean Air Act Amendments of 1990, which began on January 1, 1995. In addition, P&M anticipates that the Energy Policy Act of 1992 will increase competition in the electric power market and will provide new market opportunities for low-cost coal producers.\nOTHER MINERALS: In 1994, the company completed its previously announced plan to exit the non-coal minerals business by selling its two remaining non-coal assets: the company's 50 percent interest in the Stillwater Mining Company, a Montana platinum-palladium mining operation, and the company's 52.5 percent holding in some zinc-lead prospects in Ireland.\nREAL ESTATE\nThe company's real estate activities are carried out primarily through its wholly owned subsidiaries, Chevron Land and Development Company and Huntington Beach Company (collectively, Chevron Land). Chevron Land's activities are predominantly handled by the company's offices in Newport Beach and San Francisco, California.\nReal estate operations have concentrated on converting Chevron's surplus fee production properties in California into residential and commercial real estate. After making major infrastructure improvements, the properties are sold to third parties or jointly developed. At the end of 1994, Chevron Land managed approximately 35,000 acres of real estate in California. The company also leases approximately 70,000 acres of irrigated farmland and 160,000 acres of rangeland to local growers and ranchers in California's San Joaquin Valley.\nChevron Land participates in residential developments through partnerships with home builders. During 1994, the company sold over 340 homes in California, more than doubling the 160 homes sold in 1993. The California economy is now beginning to show signs of renewed economic growth and the company is positioning itself to take advantage of the recovery by developing properties at a pace that meets market demand while preserving current real estate development entitlements.\nIn addition to its sales of residential real estate, the company also generated over $140 million in revenues from about 25 sales involving commercial, recreational or undeveloped real estate. The largest of these sales involved the sale of two undeveloped properties to Kaufman and Broad and the sale of two golf courses and related facilities to Club Corporation of America. These sales were made through the company's 80 percent interest in the Coto de Caza Partnership.\nThe company announced in March 1995 that it has established a marketing team for the possible sale of its real estate development assets. If a satisfactory price and other terms can be obtained, the company hopes to conclude the sale in 1995.\nRESEARCH AND ENVIRONMENTAL PROTECTION\nRESEARCH: The company's principal research laboratories are at Richmond and La Habra, California. The Richmond facility engages in research on new and improved refinery processes, develops petroleum and chemical products, and provides technical services for the company and its customers. The La Habra facility conducts research and provides technical support in geology, geophysics and other exploration science, as well as oil production methods such as hydraulics, assisted recovery programs and drilling, including offshore drilling. Employees in subsidiaries engaged primarily in research activities at year-end 1994 numbered approximately 2,000.\n- 26 -\nChevron's research and development expenses were $179 million, $206 million and $229 million for the years 1994, 1993 and 1992, respectively.\nIn 1994, the company developed a synthetic-based drilling mud for offshore use. Drilling mud is a liquid mixture that transports drill cuttings or small rock fragments out of the well. Conventional oil-based muds produce toxic oil- coated cuttings that are illegal to dispose of offshore. The new synthetic drilling mud meets all environmental requirements for discharge directly into the ocean, thereby eliminating the additional expense needed to transport and dispose of the cutting onshore.\nThe company signed an agreement in 1994 with Excel Paralubes, a joint venture of Conoco Inc. and Pennzoil Products Co., which licensed the company's Isodewaxing technology for a new lube oil manufacturing facility to be built at Conoco's Lake Charles refinery in Westlake, Louisiana. The Isodewaxing technology was also selected by Petro-Canada for a major expansion of their lube oil facilities in Mississauga, Ontario. Isodewaxing is a catalytic process that changes the characteristics of waxy molecules in crude feedstocks, resulting in a greater yield of high-quality base oils at a lower operating cost than conventional solvent based processing. The Petro-Canada facility is expected to come on stream in the fourth quarter 1996, followed by the Excel Paralube facility in 1997. The company also licensed, in 1994, its residuum desulfurization technology to Tohoku Oil Co. of Japan for its 100,000 barrel per day Sendai refinery and to Formosa Petrochemical Corporation for its 450,000 barrel per day refinery in Taiwan.\nLicenses under the company's patents are generally made available to others in the petroleum and chemical industries. However, the company's business is not dependent upon licensing patents.\nENVIRONMENTAL PROTECTION: One of Chevron's corporate strategies is to give high priority to environmental, public and governmental concerns. Chevron's revised corporate policy on Health, Environment and Safety was approved by the stockholders in 1991. In 1992, a comprehensive series of 102 management practices was approved by senior management to strengthen the implementation of the policy. The program is called \"Protecting People and the Environment\" and is modeled after the Chemical Manufacturers Associations' program called \"Responsible Care.\" It is also similar to the American Petroleum Institute's program called \"Strategies for Today's Environmental Partnership.\" In 1994, the company published an environmental, health and safety performance report named \"Measuring Progress - A Report on Chevron's Environmental Performance.\" This report describes the company's environmental performance since its last environmental report issued in 1990 and summarizes the company's policy and approach to environmental protection.\nThe company's oil and gas exploration activities, along with those of many other petroleum companies, have been hampered by drilling moratoria, imposed because of environmental concerns, in areas where the company has leasehold interests, particularly Alaska, offshore Florida and offshore California. Difficulties and delays in obtaining necessary permits, such as those experienced by Chevron and its partners in the Point Arguello Field offshore California, can delay or restrict oil and gas development projects. While events such as these can impact current and future earnings, either directly or through lost opportunities, the company does not believe they will have a material effect on the company's consolidated financial position, its liquidity, or its competitive position relative to other domestic or international petroleum concerns. The situation has, however, been a factor, among others, in the shift of the company's exploration efforts to areas outside of the United States.\nSince 1991, the company has spent about $1.2 billion in capital expenditures on air quality projects at its refining facilities, primarily in order to comply with federal and state clean air regulations and to provide consumers with fuels that reduce air pollution and air toxicity. The Clean Air Act Amendments of 1990 require that only reformulated gasoline (RFG) may be sold in the nine worst ozone areas in the United States beginning on January 1, 1995 while other areas may voluntarily opt into the RFG requirement. Chevron began selling RFG in nine areas in 1995. The California Air Resources Board requires a more stringent reformulated gasoline be sold statewide beginning in March 1996 and work is continuing at the company's Richmond and El Segundo, California, refineries to meet these requirements.\n- 27 -\nThe Federal Oil Pollution Act of 1990 (OPA) expanded federal authority to direct responses to oil spills to improve preparedness and response capabilities and to impose penalties on spillers for restoration costs and loss of use of the resources during restoration. Under OPA, the U.S. Coast Guard imposed new regulations on owners of vessels operating in U.S. waters after December 28, 1994 which required owners to meet strict guidelines for financial responsibility in the case of an oil spill. The company complied with the requirements by self-insurance and was issued a Certificate of Financial Responsibility for each of its vessels operating in U.S. waters prior to the December 28 deadline. OPA also requires the scheduled phase-out of single hull tankers for trading to U.S. ports, which has resulted in the utilization of more costly double hull tankers. Many of the coastal states have enacted or are preparing legislation in these same areas. In 1994, the company took delivery of two double hull tankers, the last of seven such vessels ordered in 1990. The company has been actively involved in the Marine Preservation Association, a non-profit organization that funds the Marine Spill Response Corporation (MSRC). MSRC owns the largest stockpile of oil spill response equipment in the nation and operates five strategically located U.S. coastal regional centers.\nThe company expects the enactment of additional federal and state regulations addressing the issue of waste management and disposal and effluent emission limitations for offshore oil and gas operations. While the costs of operating in an environmentally responsible manner and complying with existing and anticipated environmental legislation and regulations, including loss contingencies for prior operations, are expected to be significant, the company anticipates that these costs will not have a material impact on its consolidated financial position, its liquidity, or its competitive position in the industry.\nIn 1994, the company's U.S. capitalized environmental expenditures were $645 million, representing approximately 33 percent of the company's total consolidated U.S. capital and exploratory expenditures. The company's U.S. capitalized environmental expenditures were $620 million and $430 million in 1993 and 1992, respectively. These environmental expenditures include capital outlays to retrofit existing facilities, as well as those associated with new facilities. The expenditures are predominantly in the petroleum segment and relate mostly to air and water quality projects and activities at the company's refineries, oil and gas producing facilities and marketing facilities. For 1995, the company estimates that capital expenditures for environmental control facilities will be approximately $558 million. The actual expenditures for 1995 will depend on various conditions affecting the company's operations and may differ significantly from the company's forecast. The company is committed to protecting the environment wherever it operates, including strict compliance with all governmental regulations. The future annual capital costs of fulfilling this commitment are uncertain, but are expected to decrease after expenditures required to produce fuels that reduce air pollution and air toxicity reached their peak in 1994.\nUnder provisions of the Superfund law, Chevron has been designated as a potentially responsible party (PRP) for remediation of a portion of 238 hazardous waste sites. Since remediation costs will vary from site to site as well as the company's share of responsibility for each site, the number of sites in which the company has been identified as a PRP should not be used as a relevant measure of total liability. At year-end 1994, the company's environmental remediation reserve related to Superfund sites amounted to $61 million. Forecasted expenditures for the largest of these sites, located in California, amounts to approximately 20 percent of the reserve.\nThe company's 1994 environmental expenditures, remediation provisions and year-end environmental reserves are discussed on pages FS-2 through FS-4 of this Annual Report on Form 10-K. These pages also contain additional discussion of the company's liabilities and exposure under the Superfund law and additional discussion of the effects of the Clean Air Act Amendments of 1990.\n- 28 -\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe location and character of the company's oil and gas and minerals and real estate properties and its refining, marketing, transportation and chemical facilities are described above under Item 1. Business and Properties. Information in response to the Securities Exchange Act Industry Guide No. 2 (\"Disclosure of Oil and Gas Operations\") is also contained in Item 1 and in Tables I through VI on pages FS-30 to FS-35 of this Annual Report on Form 10-K. Note 12, \"Properties, Plant and Equipment,\" to the company's financial statements contained on page FS-25 of this Annual Report on Form 10-K presents information on the company's gross and net properties, plant and equipment, and related additions and depreciation expenses, by geographic area and industry segment for 1994, 1993 and 1992.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nA. CITIES SERVICE TENDER OFFER CASES. The complaint by Cities Service Co. (\"Cities Service\") and two individual plaintiffs was originally filed in August 1982 in Oklahoma state court in Tulsa. Prior proceedings have effectively eliminated the two individual plaintiffs as parties. The defendants were initially Gulf Oil Corporation and GOC Acquisition Corporation. Subsequent filings have identified Chevron U.S.A. Inc. as the successor in interest to Gulf Oil Corporation. In the original complaint Cities Service pleaded for damages of not less than $2.7 billion together with legal interest for breach of contract and misrepresentation. The great bulk of the damages were related to claims on behalf of shareholders of Cities Service. All of the claims by Cities Service shareholders have been dismissed.\nPlaintiff Cities Service filed its Second Amended Petition on April 25, 1994, adding Oxy U.S.A. as the successor to plaintiff Cities Service, adding Chevron U.S.A. Inc. as successor to Gulf Oil Corporation and adding Chevron Corporation as a new defendant. In addition to the existing claims for breach of contract and fraud, the amendments added the following causes of action: willful and malicious breach of contract, negligent misrepresentation, interference with prospective economic advantage in connection with the 1989 proposed Oxy-Cities Department of Energy (\"DOE\") settlement, and the claimed DOE liability as additional contract damages and as additional fraud damages. The amendment also added a claim for punitive damages based upon the alleged fraud, negligent misrepresentation, willful breach and interference claims and requested not less than $100 million on each of the several claims, together with pre-judgment interest and punitive damages. It also requested $12 million plus prejudgment interest for Cities' costs in defending against DOE proceedings since 1989, and an order entitling Cities Service to recover such \"restitutionary obligation\" amounts ultimately paid by Oxy U.S.A. to the DOE in excess of its proposed 1989 DOE settlement, and punitive damages.\nDefendants answered, in part, the plaintiff's Second Amended Petition and moved to dismiss the claims for negligent misrepresentation, malicious breach of contract and interference with prospective economic advantage. In addition, defendant Chevron Corporation moved to dismiss the petition for lack of subject matter jurisdiction.\nThe motion to dismiss the new tort claim and certain other claims was denied and an answer to these claims was timely filed. Chevron Corporation's motion to dismiss for lack of personal jurisdiction was granted on September 7, 1994. Plaintiff's motion to dismiss defendants' counterclaim was also granted.\nThe Oklahoma Supreme Court has denied defendants' petition for certiorari on the trial court's certified interlocutory order concerning the defenses based upon certain conditions in the contract and alleged misstatements by plaintiff concerning its potential DOE liability.\nPlaintiff's motion to bifurcate this case for two trials was granted by the trial court on January 23, 1995. The first trial will concern plaintiff's claims for alleged breach of contract, willful and malicious breach of contract, and negligent misrepresentation. The second trial will cover plaintiff's claims for alleged interference with prospective economic advantage in connection with the proposed 1989 DOE settlement, and the claimed DOE liability as additional damages under another claim of breach of contract.\nVarious discovery motions are pending. There is no discovery cut-off and no trial date has yet been set.\n- 29 -\nB. IN RE GULF PENSION LITIGATION. In two lawsuits, which were commenced on December 2, 1986 and April 24, 1987 and consolidated on July 17, 1987 in the U.S. District Court for the Southern District of Texas as IN RE GULF PENSION LITIGATION, former employees of Gulf Oil Corporation who were participants in the Gulf Pension Plan contended that a partial termination of the Gulf Pension Plan had occurred and they were entitled to immediate vesting and distribution of plan benefits and to distribution of alleged excess plan assets, which allegedly had been unlawfully seized by Gulf or Chevron. All aspects of this case have now been resolved except for plaintiffs' claim to entitlement to $620 million in surplus funds in the Gulf Pension Plan. This issue was decided adversely to plaintiffs by the District Court on April 10, 1991.\nOn October 21, 1994, the Fifth Circuit Court of Appeals affirmed the District Court's determination that the plaintiffs were not entitled to surplus assets of the Gulf Pension Plan. On November 18, 1994, plaintiffs filed a petition for rehearing and a suggestion for rehearing en banc with the Fifth Circuit. Both of these were denied on December 1, 1994.\nOn March 1, 1995, the plaintiffs filed a Petition for a Writ of Certiorari with the United States Supreme Court.\nC. PERTH AMBOY NEW SOURCE PERFORMANCE STANDARD PENALTY. The United States Environmental Protection Agency (EPA) claims that Chevron's Perth Amboy refinery violated various provisions of the Clean Air Act New Source Performance Standards (\"NSPS\") as a result of refinery modifications conducted in 1973 and 1983. The EPA issued a compliance order in November 1993 and in 1994 issued a formal determination that the NSPS applied to the refinery. This NSPS applicability determination has been appealed to the United States Circuit Court of Appeals for the Third Circuit. The EPA's penalty demand is $15.2 million. Chevron has made a counteroffer of $150,000.\nD. PREMANUFACTURE NOTIFICATION FOR DETERGENT ADDITIVES. On September 30,1993, the EPA instituted an administrative proceeding, assessing civil penalties of about $17 million for alleged violations of the Toxic Substances Control Act (TSCA). The EPA contends that the company was required to file Premanufacture Notifications (PMNs) with regard to six chemical substances manufactured or imported since 1990. The company believes that no PMNs were required because the chemicals were within the scope of existing TSCA inventory listings. Nevertheless, the company reported the situation to the EPA when it was advised by a third party that the EPA may, without public notice, have revised its interpretation of TSCA regulations to require PMNs to be filed in such circumstances. Thereafter, under protest, the company suspended the production and importation of the chemicals and filed PMNs for them, continuing the suspension for the 90-day period contemplated by TSCA. The detergents in question are very similar to common detergents and intermediates used in their production, and the EPA does not appear to claim that failure to file a PMN resulted in any health or safety risk. The EPA permitted the company to dispose of its current stocks of the chemicals during the period that the company suspended their production and importation. The company has challenged the penalty assessment through an administrative appeal.\nE. EL SEGUNDO REFINERY REFORMULATED GASOLINE PROJECT. On September 22, 1993, the EPA instituted an administrative proceeding contending that the company had not received a permit required under the Clean Air Act Amendments of 1990 (CAAA) for field activities at the El Segundo refinery relating to the production of reformulated gasolines, which was federally mandated by January 1, 1995 under other provisions of the CAAA. All company activities had been conducted in accordance with authorization by the South Coast Air Quality Management District (SCAQMD), the primary enforcing agency of the rule that the EPA contends the company violated. EPA efforts to cause the company to cease all construction activities were stayed by the Ninth Circuit Court of Appeals, and SCAQMD has since issued the company a formal permit to construct. The EPA also sought civil penalties from the company for activities conducted prior to the issuance of the permit. The company has declined to accept the EPA's penalty demand of $1.635 million and is in the process of formulating a counteroffer. The matter has been referred to the Department of Justice for enforcement.\n- 30 -\nF. PORT ARTHUR REFINERY ASSESSMENT. On August 3, 1994, the Environmental Protection Agency (EPA) issued a Notice of Violation and Civil Penalty Assessment against the Port Arthur Refinery, alleging exceedances of the refinery's water discharge permit on 24 occasions between 1989 and 1994. The EPA further alleged various violations of record- keeping and reporting requirements regarding monitoring of the wastewater effluent discharge pursuant to the permit. The EPA sought civil penalties in excess of $100,000. The refinery denied all allegations, many of which were subject to the \"upset\" defense available to dischargers during extraordinary weather events and temporary maintenance of wastewater treatment equipment. Without admitting liability, Chevron agreed to pay a fine of $124,000 and to implement various changes in recordkeeping procedures.\nG. CHEVRON PIPELINE COMPANY PENALTY ASSESSMENT. By letter dated December 13, 1994, the EPA alleged that Chevron has violated the New Source Performance Standards applicable to petroleum liquid storage vessels (\"Subpart Ka\") and thereby has violated section 111(e) of the Clean Air Act. More particularly, the EPA contends that one petroleum liquid storage vessel at Chevron's pipeline facility in La Mirada, California, has continuously operated in violation of one provision of Subpart Ka since 1979. The EPA has proposed a civil penalty of $306,000 for Chevron's alleged violation of the Act. Chevron has contacted EPA and will commence settlement negotiations with the EPA in the near future.\nOther previously reported legal proceedings have been settled or the issues resolved so as not to merit further reporting.\n- 31 -\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted during the fourth quarter of 1994 to a vote of security holders through the solicitation of proxies or otherwise.\nEXECUTIVE OFFICERS OF THE REGISTRANT AT MARCH 1, 1995\nMAJOR AREA OF NAME AND AGE EXECUTIVE OFFICE HELD RESPONSIBILITY ------------------- -------------------------------- ---------------------- K.T. Derr 58 Chairman of the Board since 1989 Chief Executive Director since 1981 Officer Executive Committee Member since 1986\nJ.D. Bonney 64 Vice-Chairman of the Board Worldwide Exploration since 1987 and Production Director and Executive Activities, Coal, Committee Member since 1986 Administrative Services, Aircraft Services\nJ.N. Sullivan 57 Vice-Chairman of the Board Worldwide Refining, since 1989 Marketing and Trans- Director since 1988 portation Activities, Executive Committee Member Chemicals, since 1986 Real Estate, Environmental, Human Resources, Research\nR.E. Galvin 63 Vice-President since 1988 U.S. Exploration President of Chevron U.S.A. and Production Production Company since 1992 Executive Committee Member since 1993\nD.J. O'Reilly 48 Vice-President since 1991 U.S. Refining, President of Chevron U.S.A. Marketing and Products Company since 1994 Supply Executive Committee Member since 1994\nM.R. Klitten 50 Vice-President and Chief Finance Financial Officer since 1989 Executive Committee Member since 1989\nR.H. Matzke 58 Vice-President since 1990 Overseas Exploration President of Chevron Overseas and Production Petroleum Inc. since 1989 Executive Committee Member since 1993\nJ.E. Peppercorn 57 Vice-President since 1990 Chemicals President of Chevron Chemical Company since 1989 Executive Committee Member since 1993\nH.D. Hinman 54 Vice-President and General Law Counsel since 1993 Executive Committee Member since 1993\n- 32 -\nThe Executive Officers of the Corporation consist of the Chairman of the Board, the Vice-Chairmen of the Board, and such other officers of the Corporation who are either Directors or members of the Executive Committee, or are chief executive officers of principal business units. Except as noted below, all of the Corporation's Executive Officers have held one or more of such positions for more than five years. Messrs. Galvin, O'Reilly, Matzke and Peppercorn are rotating members of the Executive Committee, with two serving at any one time.\nH.D. Hinman - Partner, Law Firm of Pillsbury Madison & Sutro - 1973 - Vice-President and General Counsel, Chevron Corporation - 1993\nM.R. Klitten - President, Chevron Information Technology Company - 1987 - Vice-President and Chief Financial Officer, Chevron Corporation - 1989\nR.H. Matzke - President, Chevron Canada Resources Limited - 1986 - President, Chevron Overseas Petroleum Inc. - 1989 - Vice-President, Chevron Corporation and President, Chevron Overseas Petroleum Inc. - 1990\nD.J. O'Reilly - General Manager of El Segundo Refinery, Chevron U.S.A. Inc. - 1986 - Senior Vice President, Chevron Chemical Company - 1989 - Vice President for Strategic Planning and Quality, Chevron Corporation - 1991 - Vice President, Chevron Corporation and President, Chevron U.S.A. Products Company - 1994\nJ.E. Peppercorn - Senior Vice-President, Chevron Chemical Company - 1986 - President, Chevron Chemical Company - 1989 - Vice-President, Chevron Corporation and President, Chevron Chemical Company - 1990\n- 33 -\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information on Chevron's common stock market prices, dividends, principal exchanges on which the stock is traded and number of stockholders of record is contained in the Quarterly Results and Stock Market Data tabulations, on page FS-12 of this Annual Report on Form 10-K.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data for years 1990 through 1994 are presented on page FS-36 of this Annual Report on Form 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND Results of Operations\nIndexes to Financial Statements, Supplementary Data and Management's Discussion and Analysis of Financial Condition and Results of Operations are presented on page 39 of this Annual Report on Form 10-K.\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 of Financial Condition and Results of Operations are presented on page 39 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 THE REGISTRANT\nThe information on Directors on pages 2 through 4 of the Notice of Annual Meeting of Stockholders and Proxy Statement dated March 24, 1995, is incorporated herein by reference in this Annual Report on Form 10-K. See Executive Officers of the Registrant on pages 32 and 33 of this Annual Report on Form 10-K for information about executive officers of the company.\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 on page 21 of the Notice of Annual Meeting of Stockholders and Proxy Statement dated March 24, 1995 and is incorporated herein by reference in this Annual report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information on pages 11 through 13 of the Notice of Annual Meeting of Stockholders and Proxy Statement dated March 24, 1995, is incorporated herein by reference in this Annual Report on Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information on page 5 of the Notice of Annual Meeting of Stockholders and Proxy Statement dated March 24, 1995, is incorporated herein by reference in this Annual Report on Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no relationships or related transactions requiring disclosure under Item 404 of Regulation S-K.\n- 34 -\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: PAGE (S) -------- Report of Independent Accountants FS-13\nConsolidated Statement of Income for the three years ended December 31, 1994 FS-14\nConsolidated Balance Sheet at December 31, 1994 and 1993 FS-15\nConsolidated Statement of Cash Flows for the three years ended December 31, 1994 FS-16\nConsolidated Statement of Stockholders' Equity for the three years ended December 31, 1994 FS-17\nNotes to Consolidated Financial Statements FS-18 to FS-29\n(2) FINANCIAL STATEMENT SCHEDULES:\nCaltex Group of Companies Combined Financial Statements and Schedules C-1 to C-20\nThe Combined Financial Statements and Schedules of the Caltex Group of Companies are filed as part of this report. All other schedules are omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto.\n(3) EXHIBITS:\nThe Exhibit Index on pages 37 and 38 of this Annual Report on Form 10-K lists the exhibits that are filed as part of this report.\n(b) REPORTS ON FORM 8-K:\nA Current Report on Form 8-K, dated January 24, 1995, was filed by the company on January 24, 1995. This report announced unaudited preliminary earnings for the quarter and the twelve months ended December 31, 1994.\nA Current Report on Form 8-K, dated February 27, 1995, was filed by the company on February 28, 1995. This report announced the sale of the Port Arthur, Texas, fuels refinery to Clark Refining and Marketing, Inc. and a $98 million increase to 1994 preliminary earnings as a result of the reversal of a previously established provision for the closure of the refinery.\nA Current Report on Form 8-K, dated March 10, 1995, was filed by the company on March 10, 1995. This report contained the Company's 1994 Financial Statements (audited) and Management's Discussion and Analysis of Financial Condition and Results of Operations.\nA Current Report on Form 8-K, dated March 10, 1995, was filed by the company on March 10, 1995. This report contained Summarized Financial Data for the three years ended December 31, 1994 for the company's Chevron Transport Corporation subsidiary.\n- 35 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 29th day of March 1995.\nChevron Corporation\nBy KENNETH T. DERR* ------------------------------------ Kenneth T. Derr, 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 on the 29th day of March 1995.\nPRINCIPAL EXECUTIVE OFFICERS DIRECTORS (AND DIRECTORS)\nKENNETH T. DERR* SAMUEL H. ARMACOST* ------------------------------------- -------------------------------------- Kenneth T. Derr, Samuel H. Armacost Chairman of the Board\nJ. DENNIS BONNEY* SAM GINN* ------------------------------------- -------------------------------------- J. Dennis Bonney, Sam Ginn Vice-Chairman of the Board\nJAMES N. SULLIVAN* CARLA A. HILLS* ------------------------------------- -------------------------------------- James N. Sullivan, Carla A. Hills Vice-Chairman of the Board\nCHARLES M. PIGOTT* -------------------------------------- PRINCIPAL FINANCIAL OFFICER Charles M. Pigott\nMARTIN R. KLITTEN* CONDOLEEZZA RICE* ------------------------------------- -------------------------------------- Martin R. Klitten, Condoleezza Rice Vice-President and Chief Financial Officer\nS. BRUCE SMART, JR.* -------------------------------------- S. Bruce Smart, Jr. PRINCIPAL ACCOUNTING OFFICER\nDONALD G. HENDERSON* JOHN A. YOUNG* ------------------------------------- -------------------------------------- Donald G. Henderson, John A. Young Vice-President and Comptroller\n*By: \/s\/ MALCOLM J. McAULEY GEORGE H. WEYERHAEUSER* -------------------------------- -------------------------------------- Malcolm J. McAuley, George H. Weyerhaeuser Attorney-in-Fact\n- 36 -\nEXHIBIT INDEX\nEXHIBIT NO. DESCRIPTION ------- -------------------------------------------------------------------- 3.1 Restated Certificate of Incorporation of Chevron Corporation, dated August 2, 1994, filed as Exhibit 3.1 to Chevron Corporation's Quarterly Report on Form 10-Q for the quarter and six month period ended June 30, 1994, and incorporated herein by reference.\n3.2 By-Laws of Chevron Corporation, as amended July 27, 1994, including provisions giving attorneys-in-fact authority to sign on behalf of officers of the corporation, filed as Exhibit 3.2 to Chevron Corporation's Quarterly Report on Form 10-Q for the quarter and six month period ended June 30, 1994, and incorporated herein by reference.\n4.1 Rights Agreement dated as of November 22, 1988 between Chevron Corporation and Manufacturers Hanover Trust Company of California, as Rights Agent, filed as Exhibit 4.0 to Chevron Corporation's Current Report on Form 8-K dated November 22, 1988, and incorporated herein by reference.\n4.2 Amendment No. 1 dated as of December 7, 1989 to Rights Agreement dated as of November 22, 1988 between Chevron Corporation and Manufacturers Hanover Trust Company of California, as Rights Agent, filed as Exhibit 4.0 to Chevron Corporation's Current Report on Form 8-K dated December 7, 1989, and incorporated herein by reference.\nPursuant to the Instructions to Exhibits, certain instruments defining the rights of holders of long-term debt securities of the corporation and its consolidated subsidiaries are not filed because the total amount of securities authorized under any such instrument does not exceed 10 percent of the total assets of the corporation and its subsidiaries on a consolidated basis. A copy of such instrument will be furnished to the Commission upon request.\n10.1 Management Incentive Plan of Chevron Corporation, as amended and restated effective January 1, 1990, filed as Exhibit 10.1 to Chevron Corporation's Annual Report on Form 10-K for 1990, and incorporated herein by reference.\n10.2 Management Contingent Incentive Plan of Chevron Corporation, as amended May 2, 1989, filed as Exhibit 10.2 to Chevron Corporation's Annual Report on Form 10-K for 1989, and incorporated herein by reference.\n10.3 Chevron Corporation Excess Benefit Plan, amended and restated as of July 1, 1990, filed as Exhibit 10.3 to Chevron Corporation's Annual Report on Form 10-K for 1990, and incorporated herein by reference.\n10.4 Supplemental Pension Plan of Gulf Oil Corporation, amended as of June 30, 1986, filed as Exhibit 10.4 to Chevron Corporation's Annual Report on Form 10-K for 1986 and incorporated herein by reference.\n10.5 Chevron Restricted Stock Plan for Non-Employee Directors, as amended and restated effective January 29, 1992, filed as Appendix A to Chevron Corporation's Notice of Annual Meeting of Stockholders and Proxy Statement dated March 16, 1992, and incorporated herein by reference.\n10.6 Chevron Corporation Long-Term Incentive Plan, filed as Appendix A to Chevron Corporation's Notice of Annual Meeting of Stockholders and Proxy Statement dated March 19, 1990, and incorporated herein by reference.\n12.1 Computation of Ratio of Earnings to Fixed Charges (page EX-1).\n21.1 Subsidiaries of Chevron Corporation (page EX-2).\n23.1 Consent of Price Waterhouse LLP (page EX-3).\n23.2 Consent of KPMG Peat Marwick LLP (page EX-4).\n- 37 -\nEXHIBIT INDEX (continued)\nEXHIBIT NO. DESCRIPTION ------- -------------------------------------------------------------------- 24.1 Powers of Attorney for directors and certain officers of Chevron to Corporation, authorizing the signing of the Annual Report on 24.13 Form 10-K on their behalf.\n99.1 Definitions of Selected Financial Terms (page EX-5).\nCopies of above exhibits not contained herein are available, at a fee of $2 per document, to any security holder upon written request to the Secretary's Department, Chevron Corporation, 225 Bush Street, San Francisco, California 94104.\n- 38 -\nINDEX TO MANAGEMENT'S DISCUSSION AND ANALYSIS, CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPAGE(S) -------------- Management's Discussion and Analysis . . . . . . . . . . . . . FS-1 to FS-12\nQuarterly Results and Stock Market Data . . . . . . . . . . . . FS-12\nReport of Management . . . . . . . . . . . . . . . . . . . . . FS-13\nReport of Independent Accountants . . . . . . . . . . . . . . . FS-13\nConsolidated Statement of Income . . . . . . . . . . . . . . . FS-14\nConsolidated Balance Sheet . . . . . . . . . . . . . . . . . . FS-15\nConsolidated Statement of Cash Flows . . . . . . . . . . . . . FS-16\nConsolidated Statement of Stockholder's Equity . . . . . . . . FS-17\nNotes to Consolidated Financial Statements . . . . . . . . . . FS-18 to FS-29\nSupplemental Information on Oil and Gas Producing Activities . FS-30 to FS-35\nFive-Year Financial Summary . . . . . . . . . . . . . . . . . . FS-36\n- 39 -\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nKEY FINANCIAL RESULTS MILLIONS OF DOLLARS, EXCEPT PER-SHARE AMOUNTS 1994 1993 1992 ------------------------------------------------------------------------------- Sales and Other Operating Revenues $35,130 $36,191 $38,212 Income Before Cumulative Effect of Changes in Accounting Principles $ 1,693 $ 1,265 $ 2,210 Cumulative Effect of Changes in Accounting Principles - - $ (641) Net Income $ 1,693 $ 1,265 $ 1,569 Special Credits (Charges) Included in Income* $ 22 $ (883) $ 651 Per Share: Income Before Cumulative Effect of Changes in Accounting Principles $ 2.60 $ 1.94 $ 3.26 Net Income $ 2.60 $ 1.94 $ 2.31 Dividends $ 1.85 $ 1.75 $ 1.65 Return On: Average Capital Employed 8.7% 6.8% 8.5% Average Stockholders' Equity 11.8% 9.1% 11.0% =============================================================================== * BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES.\nChevron's net income for 1994 was $1.693 billion, up 34 percent and 8 percent from 1993 and 1992, respectively. However, special items in all years, and the cumulative effect of adopting two new accounting standards in 1992, affected the comparability of the company's reported results. Special items, after related tax effects, increased earnings in 1994 by $22 million, decreased earnings in 1993 by $883 million and increased earnings in 1992 by $651 million. Also, the cumulative effect of adopting two new accounting standards reduced 1992 earnings $641 million. Excluding the effects of special items in all years and the 1992 accounting changes, 1994 earnings of $1.671 billion declined 22 percent from very strong operating earnings of $2.148 billion in 1993 and increased 7 percent from $1.559 billion in 1992.\nOPERATING ENVIRONMENT AND OUTLOOK. Worldwide petroleum industry conditions were weak throughout 1994. Crude oil prices were at a five-year low at the beginning of the year. Although prices recovered somewhat during the year, supplies remained plentiful. The company's U.S. realizations were, on average, 72 cents per barrel less than in the prior year, and its international realizations declined $1.23 per barrel. Average crude oil prices have declined for four consecutive years.\nU.S. natural gas prices, after increasing the past two years, began falling in 1994 and averaged 22 cents per thousand cubic feet less than in 1993, as ample supplies and mild weather held down prices. The company's international natural gas prices fell by about the same amount.\nSales margins on refined products were depressed much of the year. For example, in the United States, product prices averaged about $1 per barrel less than in the previous year as highly competitive markets, particularly in the East, held down prices. These market conditions tended to lengthen the time lag for product prices to reflect the gradually increasing crude oil costs during the year.\nOn the other hand, the chemicals industry experienced a dramatic turnaround from the excess capacity and weak demand of the past four years. Strengthening industrialized economies, particularly in the United States, resulted in strong demand and higher prices - and Chevron's chemicals earnings rebounded substantially.\nAll these industry conditions have continued into 1995. The company's posted price for West Texas Intermediate (WTI), a benchmark crude oil, was $16.75 per barrel at year-end 1994 and $17.50 at February 28, 1995. The Henry Hub natural gas spot price, an industry marker, was $1.61 per thousand cubic feet at year-end 1994 and $1.55 at February 28, 1995. U.S. refined products prices in January 1995 were about flat with December. Planned major maintenance shutdowns at two of the company's core refineries resulted in lower refinery utilization rates, lower sales volumes and increased product purchases in the early part of 1995. Chemicals operations remained strong.\nChevron began selling federally mandated reformulated gasoline January 1, 1995 in nine areas in the United States, accounting for about 20 percent of its January gasoline sales volumes. The increased cost of manufacturing reformulated gasoline has not yet been fully reflected in sales prices.\nThe company embarked on an aggressive program several years ago to increase its competitiveness and achieve superior returns for its stockholders. Businesses were restructured, marginal and non-core assets were divested and the company's cost structure was significantly reduced. At\nFS-1\nthe same time, the company has selectively pursued growth opportunities in its areas of strength.\nThe company continues to review and analyze its operations and may incur future charges related to the restructuring of its businesses and disposition of marginal or non-strategic assets. In particular, the company is currently reviewing its oil and gas operations in western Canada and options to maximize the value of certain real estate operations located in California.\nUNITED STATES REFINING AND MARKETING DEVELOPMENTS. In connection with the previously announced restructuring of its U.S. downstream operations, Chevron sold its Philadelphia refinery in August 1994 and its Port Arthur, Texas, refinery in February 1995. The two refineries had a combined capacity of about 350,000 barrels per day or about 25 percent of the company's total U.S. refining capacity prior to the sales. The Philadelphia refinery had been operated as a merchant refinery, with its 175,000 barrels per day output sold to independent petroleum marketers. Products for the company's marketing system that were previously supplied by the Port Arthur refinery will be obtained from other sources.\nThe restructuring reflected the company's strategy to focus its resources in the West, Southwest and those parts of the South where the company's marketing business is strongest. The smaller refinery organization is expected to be more efficient, with improved cash flow and return on capital employed. The disposition of the two refineries has also eliminated large capital investments that would have otherwise been required.\nIn connection with the Port Arthur refinery sale, the company retained certain environmental cleanup obligations. The company has accrued for presently anticipated costs of $282 million, most of which will be expended over approximately the next ten years. It is possible additional provisions may be necessary in the future. The expenditures will be funded by future cash flows from operations, with no material effect anticipated on the company's liquidity.\nINTERNATIONAL EXPLORATION AND PRODUCTION DEVELOPMENTS. Liquids production from 50 percent owned Tengizchevroil (TCO), a joint venture with the Republic of Kazakhstan, averaged about 46,000 barrels per day in 1994, up from 30,000 barrels per day in 1993. At year-end 1994 TCO was producing about 65,000 barrels per day. With the completion of a second processing plant in December 1994, production capacity increased to 95,000 barrels per day and is scheduled to increase to 130,000 barrels per day by the end of 1995. Beyond this, the pace of further field development is dependent on the availability of additional export capability. Production levels are dependent on monthly export quotas set by Russia, under a transportation\/exchange agreement, and are currently set at 65,000 barrels per day. Chevron has been in prolonged negotiations with the Caspian Pipeline Consortium, composed of the Republics of Russia and Kazakhstan and the Sultanate of Oman, to agree on terms for an export pipeline system that would enable the project to sell its output directly to world markets.\nAlthough the company's operations in Nigeria and the Angolan exclave of Cabinda have been generally unaffected by the political uncertainty and civil unrest that continues to exist in those countries, the company continues to closely monitor developments. Chevron has significant oil producing properties in both countries and has major development projects underway. In 1994, the company's net share of production in Nigeria averaged about 130,000 barrels per day, and in Angola about 100,000 barrels per day.\nChevron's partner in Nigeria, the government-owned Nigerian National Petroleum Corporation (NNPC) has fallen behind in paying its cash calls to Chevron, as well as to other oil companies operating in Nigeria. However, NNPC continues to make payments and the company believes all amounts owed it will ultimately be paid.\nThe Nigerian government effectively devalued its currency, the naira, in January 1995 by changing from a fixed exchange rate to a floating, free market rate. This devaluation did not have a significant effect on the financial position of the company's Nigerian subsidiary and is not expected to have a significant effect on its ongoing operations.\nENVIRONMENTAL MATTERS. Virtually all aspects of the businesses in which the company engages are subject to various federal, state and local environmental, health and safety laws and regulations. These regulatory requirements continue to increase in both number and complexity, and govern not only the manner in which the company conducts its operations, but also the products it sells. Most of the costs of complying with myriad laws and regulations pertaining to its operations and products are embedded in the normal costs of conducting its business.\nFS-2\nUsing definitions and guidelines established by the American Petroleum Institute, Chevron estimates its worldwide environmental spending in 1994 was about $1.5 billion for its consolidated companies. Included in these expenditures were $683 million of environmental capital expenditures, and $638 million of costs associated with the control and abatement of hazardous substances and pollutants from ongoing operations. The total amount also includes spending charged against reserves established for future environmental cleanup programs (but not non-cash provisions recorded during the year).\nIn addition to the costs for environmental protection associated with its ongoing operations and products, the company (as well as other companies engaged in the petroleum or chemicals industries) incurs expenses for corrective actions at various facilities and waste disposal sites. An obligation to take remedial action may be incurred as a result of the enactment of laws, such as the federal Superfund law, or the issuance of new regulations or as the result of the company's own policies in this area. Accidental leaks and spills requiring cleanup may occur in the ordinary course of business. In addition, an obligation may arise when operations are closed or sold. Most of the expenditures to fulfill these obligations relate to facilities and sites where past operations followed practices and procedures that were considered acceptable under standards existing at the time, but now require investigatory and\/or remedial work to meet current standards.\nDuring 1994, the company recorded $505 million of before-tax provisions to provide for environmental remediation efforts, including Superfund sites. Actual expenditures charged against these provisions and other previously established reserves amounted to $182 million in 1994. At year-end 1994, the company's environmental remediation reserve was $1.219 billion, including $61 million related to Superfund sites.\nUnder provisions of the Superfund law, the Environmental Protection Agency (EPA) has designated Chevron a potentially responsible party (PRP), or has otherwise involved it, in the remediation of 238 hazardous waste sites. At year-end 1994, the company's cumulative share of costs and settlements for approximately 168 of these sites, for which payments or provisions have been made in 1994 and prior years, was about $96 million, including a provision of $16 million made during 1994. No single site is expected to result in a material liability for the company at this time. For the remaining sites, investigations are not yet at a stage where the company is able to quantify a probable liability or determine a range of reasonably possible exposure. The Superfund law provides for joint and several liability. Any future actions by the EPA and other regulatory agencies to require Chevron to assume other responsible parties' costs at designated hazardous waste sites are not expected to have a material effect on the company's consolidated financial position or liquidity.\nGenerally, provisions are recorded for work at identified sites where an assessment or cleanup plan has been developed and for which costs can reasonably be estimated. In 1994, the company recorded environmental remediation provisions aggregating $223 million for its U.S. marketing sites where no specific contamination had yet been identified, using estimates based on its history of required remediation at other similar sites.\nIt is likely the company will continue to incur additional charges for environmental remediation relating to past operations. These future costs are indeterminable due to such factors as the unknown magnitude of possible contamination, the unknown 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. While the amounts of future costs may be material to the company's results of operations in the period in which they are recognized, the company does not expect these costs to have a material effect on its consolidated financial position or liquidity. Also, the company does not believe its obligations to make such expenditures have had or will have any significant impact on the company's competitive position relative to other domestic or international petroleum or chemicals concerns. Although environmental compliance costs are substantial, the company has no reason to believe they vary significantly from similar costs incurred by other companies engaged in similar businesses in similar areas. The company believes that such costs ultimately are reflected in the petroleum and chemicals industries' prices for products and services.\nThe petroleum industry is incurring major capital expenditures to meet clean-air regulations, such as the 1990 amendments to the Clean Air Act in the United States. For companies operating in California, where Chevron has a significant presence, the California Air Resources Board has imposed even stricter requirements. The company's worldwide capital expenditures related to air quality are believed to have peaked at $495 million in 1994. For 1995, total worldwide environ-\nFS-3\nmental capital expenditures are estimated at $622 million, of which $438 million are expected to be spent on air quality related measures. This is in addition to the ongoing costs of complying with other environmental regulations and the costs to remediate previously contaminated sites.\nIn addition to the reserves for environmental remediation discussed above, the company maintains reserves for dismantlement, abandonment and restoration of its worldwide oil and gas and coal properties at the end of their productive lives. Most such costs are environmentally related. Provisions are recognized on a unit-of-production basis as the properties are produced. The amount of these reserves at year-end 1994 was $1.520 billion and is included in accumulated depreciation, depletion and amortization in the company's consolidated balance sheet.\nFor the company's other ongoing operating assets, such as refineries, no provisions are made for exit or cleanup costs that may be required when such assets reach the end of their useful lives unless a decision to sell or otherwise abandon the facility has been made.\nOTHER CONTINGENCIES. At year-end 1994 the company had $257 million of suspended exploratory wells included in properties, plant and equipment. The wells are suspended pending the drilling of additional wells to determine if commercially producible quantities of oil and gas are present. These well costs will be capitalized or expensed depending on the results of this future drilling activity.\nThe company is the subject of various lawsuits and claims and other contingent liabilities. These are discussed in the notes to the accompanying consolidated financial statements. The company believes that the resolution of these matters will not materially affect its financial position or liquidity.\nThe company utilizes various derivative instruments to manage its exposure to price risk stemming from its integrated petroleum activities. Some of the instruments may be settled by delivery of the underlying commodity, whereas others can only be settled by cash. All these instruments are commonly used in the global trade of petroleum products and are relatively straightforward, involve little complexity and are substantially of a short-term duration. Most of the activity in these instruments is intended to hedge a physical transaction, hence gains and losses arising from these instruments offset, and are recognized concurrently with, gains and losses from the underlying commodities.\nNEW ACCOUNTING STANDARDS. In the 1994 first quarter, the company adopted two new accounting standards, Statement of Financial Accounting Standards (SFAS) No. 112, \"Employers Accounting for Postemployment Benefits\" and SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The adoption of these standards did not have a material effect on the company's consolidated financial statements and had no effect on its liquidity. The 1994 consolidated financial statements also include the disclosures required by SFAS 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,\" dealing with instruments that can only be settled in cash.\nSPECIAL ITEMS. Net income is affected by transactions that are unrelated to, or are not representative of, the company's ongoing operations for the periods presented. These transactions, defined by management and designated \"special items,\" can obscure the underlying results of operations for a year as well as affect comparability between years. The table below summarizes the gains (losses), on an after-tax basis, from special items included in the company's reported net income.\nMILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Prior-Year Tax Adjustments $ 344 $(130) $ 72 Asset Dispositions 48 122 757 Asset Write-Offs and Revaluations - (71) (133) Environmental Remediation Provisions (304) (90) (44) Restructurings and Reorganizations (45) (554) (40) LIFO Inventory Losses (10) (46) (26) Other (11) (114) 65 ------------------------------------------------------------------------------ Total Special Items $ 22 $(883) $651 ==============================================================================\nPRIOR-YEAR TAX ADJUSTMENTS are generally the result of the settlement of audit issues with taxing authorities or the re-evaluation by the company of its tax liabilities as a result of new developments. Also, adjustments are required for the effect on deferred income taxes of changes in statutory tax rates. In 1994, prior-year tax adjustments increased earnings $344 million, including the\nFS-4\nnet reversal of $301 million of tax and related interest reserves resulting from the company's global settlement with the Internal Revenue Service for issues relating to the years 1979 through 1987. Tax adjustments decreased earnings $130 million in 1993, which included the effect of a one percent increase in the U.S. corporate income tax rate, but increased earnings by $72 million in 1992.\nASSET DISPOSITIONS in 1994 consisted of the sale of the company's lead and zinc prospect in Ireland, generating an after-tax profit of $48 million. This sale completed the company's withdrawal from non-coal minerals activities. The Ortho lawn and garden products business was the major asset sold in 1993, generating a $130 million gain. In addition, oil and gas properties in the United States and Indonesia, undeveloped coal properties in the United States and marketing assets in Central America were sold in 1993 resulting in a net loss of $8 million. In 1992, assets sold included oil and gas properties in the United States, United Kingdom, Canada and Sudan; a fertilizer business in the United States; and a copper interest in Chile. In addition, the stock of a U.S. oil and gas subsidiary was exchanged for 31,500,000 shares of Chevron stock, a transaction valued at $1.1 billion. The combination of these and other smaller sales resulted in after-tax gains of $757 million in 1992.\nASSET WRITE-OFFS AND REVALUATIONS in 1993 were comprised of certain U.S. refinery assets, U.S. and Canadian production assets, and miscellaneous corporate assets. Asset write-offs in 1992 consisted of a $110 million write-down of the company's Beaufort Sea oil properties and a net $23 million charge related to certain U.S. refining, marketing and chemical fertilizer assets.\nENVIRONMENTAL REMEDIATION PROVISIONS pertain to estimated future costs for environmental cleanup programs at certain of the company's U.S. service stations, marketing terminals, refineries, chemical locations and oil and gas properties; divested operations in which Chevron has liability for future cleanup costs; and sites, commonly referred to as Superfund sites, for which the company has been designated a PRP by the EPA. In addition to environmental remediation and cleanup costs included in the 1994 and 1993 restructuring charges discussed below, provisions for environmental remediation amounted to $304 million in 1994, $90 million in 1993, and $44 million in 1992.\nRESTRUCTURINGS AND REORGANIZATIONS charges in 1994 were a net $45 million addition to the $543 million charge provided in 1993 to restructure the company's U.S. refining and marketing business. The 1994 adjustment included $6 million applicable to the effect of the restructuring on the company's chemicals operations. The adjustment also included the result of environmental remediation actions agreed to with regulatory agencies, and retained by the company, in connection with the terms of the sale of the Port Arthur refinery.\nThe 1993 charge was composed primarily of a write-down of the company's Philadelphia and Port Arthur refinery facilities and related inventories to their realizable values. In estimating the refineries' realizable values, the company took into account certain environmental cleanup obligations. The charges also included provisions for environmental site assessments and employee severance.\nThe Philadelphia refinery was sold in August 1994 and the Port Arthur refinery was sold in February 1995. At year-end 1994, the reserve balance of $715 million, before tax, was comprised of $491 million applicable to the loss on the Port Arthur facilities and inventories and $224 million for retained future Port Arthur environmental cleanup obligations. Additional Port Arthur environmental reserves had been established prior to the decision to sell the refinery.\nIn 1992, Chevron recorded a net charge of $40 million associated with restructuring and work-force reductions in connection with the company's enhanced early retirement program.\nLIFO INVENTORY LIQUIDATION LOSSES result from the reduction of inventories in certain inventory pools valued under the Last-In, First-Out (LIFO) accounting method. LIFO losses decreased net income in 1994, 1993 and 1992 by $10 million, $46 million and $26 million, respectively, as inventories were liquidated at higher than then-current costs. These amounts include the company's equity share of Caltex LIFO inventory effects. Chevron's consolidated petroleum inventories were 99 million barrels at year-end 1994 and 1993 and 105 million barrels at year-end 1992.\nOTHER SPECIAL ITEMS in 1994 included charges for litigation and regulatory settlements of $31 million, which were partially offset by a casualty insurance recovery of $20 million. In 1993, net additions of $70 million to reserves for various litigation and regulatory issues and a one-time cash bonus award to employees totaling $60 million, were partially offset by a favorable inventory adjustment of $16 million. In 1992, insurance recoveries and chemical products licensing agreements of $76 million were partially offset by $11 million of net additions to reserves for various litigation and regulatory issues.\nFS-5\nRESULTS OF OPERATIONS. Results for 1994 were depressed by lower average crude oil and natural gas prices and lower sales margins on refined products. Crude oil prices were especially low in the first quarter and U.S. refined products margins were very weak in the second quarter. In addition to these industry conditions, the company experienced unscheduled refinery downtime and other refinery operating problems in its U.S. operations, particularly in the first half of the year, that further reduced earnings. Chemicals operations, however, were very strong, benefiting from improved industry fundamentals and the restructuring and cost reduction programs undertaken in recent years.\nIn 1993, compared with 1992, strong worldwide refined product sales margins and high U.S. natural gas prices mitigated the effects of lower crude oil prices. Another contributing factor to the company's improved operating performance in 1993 was the large reduction in its operating and administrative costs. Also, lower interest and exploration expenses helped earnings. Chemicals operations were at depressed levels in both years, reflecting continued industry overcapacity and weak worldwide economies.\nSALES AND OTHER OPERATING REVENUES were $35.1 billion, down from $36.2 billion in 1993 and $38.2 billion in 1992. Revenues declined from 1993 and 1992 levels primarily due to lower prices for crude oil, natural gas and refined products together with lower refined product sales volumes. These factors also accounted for corresponding declines in PURCHASED CRUDE OIL AND PRODUCTS. The decline in total revenues was partially mitigated by higher chemicals revenues and gasoline excise tax collections.\nOTHER INCOME in all years included net gains resulting from the disposition of non-core assets, which caused other income to fluctuate from year to year.\nOPERATING, SELLING AND ADMINISTRATIVE EXPENSES, adjusted for special items, declined $150 million in 1994. Annual operating costs in 1994 were over $1 billion less than in 1991, the base measurement year set when the company launched its cost reduction program in early 1992. Operating expenses in 1994 included unanticipated costs associated with unscheduled refinery shutdowns and maintenance, as well as other refinery operating problems. Although a portion of the cost reduction is a result of operations disposed of over the years, the bulk of the decrease is due to a significant reduction to the company's ongoing cost structure. Reported selling, general and administrative expenses in 1994 included the reversal of $319 million of accrued interest reserves on federal income taxes payable resulting from the company's settlement with the IRS of nine open tax years, 1979 through 1987.\nMILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Reported Operating Expenses* $6,314 $6,267 $6,145 Reported Selling, General and Administrative Expenses 963 1,530 1,761 ------------------------------------------------------------------------------ Total Operational Costs 7,277 7,797 7,906 Eliminate Special Charges Before Tax (161) (531) (282) ------------------------------------------------------------------------------ Adjusted Ongoing Operational Costs $7,116 $7,266 $7,624 ============================================================================== * OPERATIONS ARE CHARGED AT MARKET RATES FOR CONSUMPTION OF THE COMPANY'S OWN FUEL. THESE \"COSTS\" ARE ELIMINATED IN THE CONSOLIDATED FINANCIAL STATEMENTS. FOR COST PERFORMANCE MEASUREMENT, SUCH COSTS ARE INCLUDED AND AMOUNTED TO $1,027, $1,017 AND $1,251 IN 1994, 1993 AND 1992, RESPECTIVELY.\nTAXES on income were $1.1 billion in 1994, $1.2 billion in 1993, and $1.3 billion in 1992, equating to effective income tax rates of 39.6 percent, 47.9 percent, and 36.2 percent for each of the three years, respectively. The lower effective tax rate for 1994 is attributable to the effect of favorable prior-year tax adjustments resulting from a global settlement with the Internal Revenue Service for the years 1979 through 1987, which included the reversal of excess interest reserves with little associated tax effect. The increase in the 1993 tax rate from 1992 levels is due primarily to unfavorable prior-year tax adjustments, including an increase in deferred income taxes resulting from the one percent increase in the U.S. corporate income tax rate. The 1992 rate included the effect of a tax-free exchange, which resulted in a large book gain with no associated tax cost.\nCURRENCY TRANSACTIONS decreased net income $64 million in 1994 compared with increases of $46 million in 1993 and $90 million in 1992. These amounts include the company's share of affiliates' currency transactions. The loss on currency transactions in 1994 resulted primarily from fluctuations in the value of the Australian and Philippine currencies relative to the U.S. dollar. In 1993, gains resulted from fluctuations in the currency of Nigeria. In 1992, gains resulted from fluctuations in the currencies of the United Kingdom, Canada, Australia and Nigeria.\nFS-6\nRESULTS BY MAJOR OPERATING AREAS MILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Exploration and Production United States $ 518 $ 566 $1,043 International 539 580 594 ------------------------------------------------------------------------------ Total Exploration and Production 1,057 1,146 1,637 ------------------------------------------------------------------------------ Refining, Marketing and Transportation United States 40 (170) 297 International 239 252 111 ------------------------------------------------------------------------------ Total Refining, Marketing and Transportation 279 82 408 ------------------------------------------------------------------------------ Total Petroleum 1,336 1,228 2,045 Chemicals 206 143 89 Coal and Other Minerals 111 44 198 Corporate and Other 40 (150) (122) ------------------------------------------------------------------------------ Income Before Cumulative Effect of Changes in Accounting Principles $1,693 $1,265 $2,210 Cumulative Effect of Changes in Accounting Principles - - (641) ------------------------------------------------------------------------------ Net Income $1,693 $1,265 $1,569 ==============================================================================\nSPECIAL ITEMS BY MAJOR OPERATING AREAS MILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Exploration and Production United States $ (66) $(136) $413 International 20 (61) 14 ------------------------------------------------------------------------------ Total Exploration and Production (46) (197) 427 ------------------------------------------------------------------------------ Refining, Marketing and Transportation United States (285) (725) (53) International (10) 1 (3) ------------------------------------------------------------------------------ Total Refining, Marketing and Transportation (295) (724) (56) ------------------------------------------------------------------------------ Total Petroleum (341) (921) 371 Chemicals (9) 112 53 Coal and Other Minerals 48 - 159 Corporate and Other 324 (74) 68 ------------------------------------------------------------------------------ Total Special Items Included in Net Income $ 22 $(883) $ 651 ==============================================================================\nU.S. EXPLORATION AND PRODUCTION earnings in 1994, excluding special items, were down 17 percent from 1993 levels and down 7 percent from 1992 results.\nMILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Earnings Excluding Special Items $584 $702 $ 630 ------------------------------------------------------------------------------ Prior-Year Tax Adjustments - (40) 5 Asset Dispositions - (54) 419 Asset Write-Offs and Revaluations - (13) - Environmental Remediation Provisions (51) (13) (2) Restructurings and Reorganizations - (2) (35) LIFO Inventory (Losses) Gains (4) 1 5 Other (11) (15) 21 ------------------------------------------------------------------------------ Total Special Items (66) (136) 413 ------------------------------------------------------------------------------ Reported Earnings $518 $566 $1,043 ==============================================================================\nOperationally, lower average crude oil and natural gas prices and lower crude oil production levels in 1994 contributed to the earnings decline from 1993. Crude prices were sharply lower in the last half of 1993, but recovered to the point that in December 1994, the company's average realizations were $3.12 per barrel higher than in December 1993. Overall, however, the company's average crude oil realization for 1994 decreased $.72 per barrel to $13.86. Natural gas prices fell throughout 1994, averaging $1.77 per thousand cubic feet for the year, down $.22 from the 1993 average price. Natural gas accounts for almost half of the company's U.S. oil and gas production volumes.\nCost cutting efforts and higher natural gas prices were the major factors in 1993's earnings improvement from 1992, offsetting lower crude oil prices and lower production levels.\nNet liquids production for 1994 averaged 369,000 barrels per day, down 6 percent from 394,000 in 1993 and down 15 percent from 432,000 barrels per day in 1992. Net natural gas pro-\nFS-7\nduction in 1994 averaged about 2.1 billion cubic feet per day, about the same level as 1993 but down from 2.3 billion cubic feet per day in 1992. The production declines resulted from producing property sales, in connection with the company's decision to concentrate its efforts on a core portfolio of about 400 producing properties, and from normal field declines.\nINTERNATIONAL EXPLORATION AND PRODUCTION earnings in 1994, excluding special items, were down 19 percent from 1993 levels and down 11 percent from 1992 results, due primarily to foreign currency effects. In 1994, foreign exchange losses were $28 million, whereas in 1993 and 1992, foreign exchange gains amounted to $57 million and $80 million, respectively.\nMILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Earnings Excluding Special Items $519 $641 $580 ------------------------------------------------------------------------------ Prior-Year Tax Adjustments 20 (63) (27) Asset Dispositions - 29 166 Asset Write-Offs and Revaluations - (19) (110) Restructurings and Reorganizations - (2) (9) LIFO Inventory Losses - (1) (1) Other - (5) (5) ------------------------------------------------------------------------------ Total Special Items 20 (61) 14 ------------------------------------------------------------------------------ Reported Earnings $539 $580 $594 ==============================================================================\nOperationally, higher production volumes did not fully offset the effect of lower average crude oil and natural gas prices in 1994. The company's average international liquids prices, including equity in affiliates, declined to $14.86 per barrel from $16.09 in 1993 and $17.93 in 1992. Average natural gas prices were $1.84 per thousand cubic feet in 1994 compared with $2.08 and $2.07 in 1993 and 1992, respectively. In 1994, net liquids production, including production from equity affiliates, increased 12 percent over 1993 to 624,000 barrels per day, and was up 22 percent from 1992 production levels. Net natural gas production volumes also increased in 1994, up 16 percent from 1993 to 546 million cubic feet per day and up 18 percent from 1992 levels. Production of crude oil and natural gas has been increasing steadily since the late 1980s, reflecting the company's strategy of growing its international operations.\nSELECTED OPERATING DATA 1994 1993 1992 ------------------------------------------------------------------------------- U.S. EXPLORATION AND PRODUCTION Net Crude Oil and Natural Gas Liquids Production (MBPD) 369 394 432 Net Natural Gas Production (MMCFPD) 2,085 2,056 2,313 Natural Gas Liquids Sales (MBPD) 215 211 194 Revenues from Net Production Crude Oil ($\/bbl.) $13.86 $14.58 $16.50 Natural Gas ($\/MCF) $ 1.77 $ 1.99 $ 1.70\nINTERNATIONAL EXPLORATION AND PRODUCTION (1) Net Crude Oil and Natural Gas Liquids Production (MBPD) 624 556 512 Net Natural Gas Production (MMCFPD) 546 469 463 Natural Gas Liquids Sales (MBPD) 34 37 33 Revenues from Liftings Liquids ($\/bbl.) $14.86 $16.09 $17.93 Natural Gas ($\/MCF) $ 1.84 $ 2.08 $ 2.07\nU.S. REFINING AND MARKETING Gasoline Sales (MBPD) 615 652 646 Other Refined Product Sales (MBPD) 699 771 824 Refinery Input (MBPD) 1,213 1,307 1,311 Average Refined Product Sales Price ($\/bbl.) $24.37 $25.35 $25.96\nINTERNATIONAL REFINING AND MARKETING (1) Refined Product Sales (MBPD) 934 923 859 Refinery Input (MBPD) 623 598 543\nCHEMICALS SALES AND OTHER OPERATING REVENUES (2) United States $3,079 $2,694 $2,929 International 648 602 566 ------------------------------ Worldwide $3,727 $3,296 $3,495 =============================================================================== (1) INCLUDES EQUITY IN AFFILIATES. REFINERY INPUT IN 1992 DOES NOT INCLUDE SOUTH AFRICA WHERE LOCAL GOVERNMENT RESTRICTIONS PROHIBITED DISCLOSURE OF REFINERY INPUT IN 1992 AND PRIOR YEARS. (2) MILLIONS OF DOLLARS. INCLUDES SALES TO OTHER CHEVRON COMPANIES.\nMBPD=thousand barrels per day; MMCFPD=million cubic feet per day; bbl.=barrel; MCF=thousand cubic feet\nFS-8\nU.S. REFINING AND MARKETING earnings, excluding special items, declined 41 percent from 1993's strong results and were down 7 percent from 1992 levels. Sales volumes in 1994 declined 8 percent from 1993 levels, largely due to the sale of the company's Philadelphia refinery in August.\nMILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Earnings Excluding Special Items $ 325 $ 555 $350 ------------------------------------------------------------------------------ Prior-Year Tax Adjustments - (38) 7 Asset Dispositions - (1) - Asset Write-Offs and Revaluations - (25) (31) Environmental Remediation Provisions (249) (77) (42) Restructurings and Reorganizations (39) (543) (1) LIFO Inventory Gains (Losses) 3 (44) (22) Other - 3 36 ------------------------------------------------------------------------------ Total Special Items (285) (725) (53) ------------------------------------------------------------------------------ Reported Earnings $ 40 $(170) $297 ==============================================================================\nSales margins were lower in 1994 compared with 1993. Refined products prices were weak as ample supplies created a highly competitive market. The company also experienced unscheduled refinery downtime and other refinery operating problems early in 1994 that increased operating expenses and required more expensive third-party product purchases to supply the company's marketing system.\nCompared with the previous year, the strong earnings in 1993 reflected lower crude oil prices and lower operating costs, resulting in higher average sales margins than in 1992. Total product sales volumes declined 3 percent from 1992 levels, although sales of higher-valued motor fuels increased about 1 percent.\nINTERNATIONAL REFINING AND MARKETING earnings include international marine operations and equity earnings of the company's Caltex Petroleum Corporation affiliate. Excluding special items, 1994 earnings were about level with 1993, but more than doubled from 1992.\nMILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Earnings Excluding Special Items $249 $251 $114 ------------------------------------------------------------------------------ Prior-Year Tax Adjustments - (4) 7 Asset Dispositions - 13 - Asset Write-Offs and Revaluations - (1) - Restructurings and Reorganizations - (1) (1) LIFO Inventory Losses (10) (3) (9) Other - (3) - ------------------------------------------------------------------------------ Total Special Items (10) 1 (3) ------------------------------------------------------------------------------ Reported Earnings $239 $252 $111 ==============================================================================\nEarnings in 1994 reflected lower results from the company's United Kingdom operations and several of the Caltex major areas of operations, particularly refining operations in Bahrain. United Kingdom operations were impacted by weak sales margins and the effects of an explosion and fire at the cracking facility that manufactures its gasoline. Shipping and trading earnings also declined. On the other hand, Canadian results improved on higher sales volumes and stronger markets. Results in 1992 reflected weak global economic conditions that held down product prices, shrinking sales margins in all the company's areas of operations.\nSales volumes for 1994 increased slightly over 1993 levels as a 5 percent increase in marketing sales was mostly offset by a decline in the company's trading sales volumes; however, 1994 volumes were up nearly 9 percent from 1992 due to continued demand growth in the Caltex areas of operations. Caltex volumes, excluding transactions with Chevron, increased 4 percent from 1993 and 6 percent from 1992 to 1993, continuing its growth of the past several years.\nEquity earnings of Caltex were $210 million, $227 million and $180 million for 1994, 1993, and 1992, respectively. Between 1994 and 1993, there was a favorable swing of $69 million resulting from inventory adjustments and an unfavorable impact of $43 million caused by foreign currency transactions. In 1994, Chevron's share of annual Caltex earnings benefited $17 million from upward adjustments to the carrying value of its petroleum inventories to reflect market values after a 1993 write-down of $52 million. Caltex foreign currency transactions were losses of $27 million in 1994 but were gains of $16 million and $21 million in 1993 and 1992, respectively.\nTotal international refining and marketing foreign currency transaction losses were $19 million in 1994, compared with gains of $2 million in 1993 and $13 million in 1992.\nFS-9\nCHEMICALS earnings, excluding special items, were up dramatically from 1993 and 1992 levels. The improving U.S. economy reduced industry overcapacity, resulting in higher sales volumes at stronger prices, and reversing 5 years of successively lower operating earnings caused by industry over-expansion just prior to a downturn in the U.S. economy. Restructurings and cost reduction programs undertaken in recent years positioned the company's chemicals businesses to benefit from the improved industry conditions. Operating results were strong in all the company's divisions - additives, aromatics and, especially, olefins. Olefins results would have been even higher had a major plant not been shut down for over a month because of damage caused by flooding in southeast Texas in mid-October. The shutdown resulted in lost earnings and higher operating and repair expenses.\nMILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Earnings Excluding Special Items $215 $ 31 $36 ------------------------------------------------------------------------------ Prior-Year Tax Adjustments - (5) (2) Asset Dispositions - 130 13 Asset Write-Offs and Revaluations - - 8 Environmental Remediation Provisions (4) - - Restructurings and Reorganizations (6) (5) (1) LIFO Inventory Gains 1 1 1 Other - (9) 34 ------------------------------------------------------------------------------ Total Special Items (9) 112 53 ------------------------------------------------------------------------------ Reported Earnings $206 $143 $89 ==============================================================================\nCOAL AND OTHER MINERALS earnings, excluding special items, increased 43 percent from 1993 and 62 percent from 1992 results. Operationally, earnings improved as coal sales margins were slightly higher. Sales tonnage, at 20.4 million tons, was down slightly from the prior year, but up from 16.5 million tons in 1992. Also, earnings benefited from the absence of 1993 and 1992 losses from non-coal minerals activities.\nMILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Earnings Excluding Special Items $ 63 $44 $ 39 ------------------------------------------------------------------------------ Prior-Year Tax Adjustments - (2) - Asset Dispositions 48 5 159 Other - (3) - ------------------------------------------------------------------------------ Total Special Items 48 - 159 ------------------------------------------------------------------------------ Reported Earnings $111 $44 $198 ==============================================================================\nCORPORATE AND OTHER activities include interest expense, interest income on cash and marketable securities, real estate and insurance operations, and corporate center costs.\nExcluding the effects of special items, corporate and other charges in 1994 were $284 million, compared with net charges of $76 million in 1993 and $190 million in 1992.\nMILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ Earnings Excluding Special Items $(284) $ (76) $(190) ------------------------------------------------------------------------------ Prior-Year Tax Adjustments 324 22 82 Asset Write-offs and Revaluations - (13) - Restructurings and Reorganizations - (1) 7 Other - (82) (21) ------------------------------------------------------------------------------ Total Special Items 324 (74) 68 ------------------------------------------------------------------------------ Reported Earnings $ 40 $(150) $(122) ==============================================================================\nIn 1994, the company changed its method of distributing certain corporate expenses to its business segments. As a result, corporate and other charges for 1994 included $190 million that, under the previous method, would have been allocated to the business segments. This change had no net income effect. Amounts that would have been allocated in 1994 to the company's major operating areas under the prior method are as follows: U.S. Exploration and Production - $34 million; U.S. Refining and Marketing - $32 million; International Exploration and Production - $63 million; International Refining and Marketing - $48 million; Chemicals - $10 million; and Coal and Other Minerals - $3 million.\nHigher interest costs in 1994 resulted from the combined effect of higher debt levels and higher interest rates than in 1993. The decline in 1993 costs relative to 1992 reflects an $84 million after-tax reduction in interest expense, due to lower interest rates and lower debt levels.\nLIQUIDITY AND CAPITAL RESOURCES. Cash, cash equivalents and marketable securities decreased $710 million to $1.3 billion at year-end 1994. Cash provided by operating activities decreased $1.3 billion in 1994 to $2.9 billion, compared with $4.2 billion in 1993 and $3.9 billion in 1992. The 1994 decrease reflects lower operational earnings, adjusted for non-cash charges, and increased working capital requirements, including the payment of $675 million to the Internal Revenue Service for the settlement of substantially all open tax issues for the nine\nFS-10\nyears 1979 through 1987. Cash from operations, proceeds from asset sales, an increase in overall debt levels and the draw-down of cash balances were used to fund the company's capital expenditures and dividend payments to stockholders.\nAT YEAR-END 1994, THE COMPANY CLASSIFIED $1.8 BILLION OF SHORT-TERM OBLIGATIONS AS LONG-TERM DEBT. Settlement of these obligations, consisting of commercial paper, is not expected to require the use of working capital in 1995 because the company has the intent and the ability, as evidenced by revolving credit arrangements, to refinance them on a long-term basis. The company's practice has been to continually refinance its commercial paper, maintaining levels it believes to be appropriate.\nON DECEMBER 31, 1994, CHEVRON HAD $4.4 BILLION IN COMMITTED CREDIT FACILITIES WITH VARIOUS MAJOR BANKS. These facilities support commercial paper borrowing and can also be used for general credit requirements. No borrowings were outstanding under these facilities during the year or at year-end 1994. In addition, Chevron and one of its subsidiaries each have existing \"shelf\" registrations on file with the Securities and Exchange Commission that together would permit registered offerings of up to approximately $700 million of debt securities.\nTHE COMPANY'S DEBT AND CAPITAL LEASE OBLIGATIONS TOTALED $8.142 BILLION AT DECEMBER 31, 1994, up $604 million from $7.538 billion at year-end 1993. The increase is primarily from $466 million of additional net short-term borrowings, largely the issuance of commercial paper, the issuance of $350 million of 7.45 percent notes due in the year 2004 and $65 million in capital lease obligations associated with the delivery of a new vessel. These increases were partially offset by the first quarter repayment of $200 million of 7.875 percent public debt originally due March 1, 1997. The company also retired $40 million of debt related to the Employee Stock Ownership Plan in January 1994.\nTHE COMPANY'S FUTURE DEBT LEVEL IS PRIMARILY DEPENDENT ON ITS CAPITAL SPENDING PROGRAM AND ITS BUSINESS OUTLOOK. While the company does not currently expect its debt level to increase significantly during 1995, it believes it has substantial borrowing capacity to meet unanticipated cash requirements.\nFINANCIAL RATIOS 1994 1993 1992 ------------------------------------------------------------------ Current Ratio 0.8 0.8 0.9 Interest Coverage Ratio 7.6 7.4 8.2 Total Debt\/Total Debt Plus Equity 35.8% 35.0% 36.4% ==================================================================\nThe CURRENT RATIO is the ratio of current assets to current liabilities at year-end. Two items affect the current ratio negatively, which in the company's opinion, do not affect its liquidity. Included in current assets in all years are inventories valued on a LIFO basis, which at year-end 1994 were lower than current costs by $684 million. Also the company's practice of continually refinancing its commercial paper, $3.2 billion classified as short-term at year-end 1994, results in a large portion of its short-term debt being outstanding indefinitely. Chevron's interest coverage ratio increased in 1994 due to higher income before tax. The INTEREST COVERAGE RATIO is defined as income before income tax expense, plus interest and debt expense and amortization of capitalized interest, divided by before-tax interest costs. The company's DEBT RATIO (total debt to total debt plus equity) increased slightly, as total debt increased more than equity did year-to-year.\nThe company's senior debt is rated AA by Standard & Poor's Corporation and Aa2 by Moody's Investors Service. Chevron's U.S. commercial paper is rated A-1$PL by Standard & Poor's and Prime-1 by Moody's, and Chevron's Canadian commercial paper is rated R-1 (middle) by Dominion Bond Rating Service. All these ratings denote high-quality, investment-grade securities.\nCAPITAL AND EXPLORATORY EXPENDITURES\nWORLDWIDE CAPITAL AND EXPLORATORY EXPENDITURES FOR 1994, INCLUDING THE COMPANY'S EQUITY SHARE OF AFFILIATES' EXPENDITURES, TOTALED $4.8 BILLION. Expenditures for exploration and production accounted for 57 percent of total outlays in 1994, 53 percent in 1993 and 51 percent in 1992. International exploration and production spending increased to 71 percent of worldwide exploration and production expenditures in 1994, up from 68 percent in 1993 and 65 percent in 1992, reflecting the company's increased focus on international exploration and production activities.\nFS-11\nTHE COMPANY PROJECTS 1995 CAPITAL AND EXPLORATORY EXPENDITURES AT APPROXIMATELY $5.1 BILLION, including Chevron's share of spending by affiliates. Excluding affiliates, spending will be essentially flat at $3.9 billion. The 1995 program provides $2.7 billion in exploration and production investments, of which about 70 percent are for international projects.\nThe company is participating in several significant oil and gas development projects. These include the development of the Hibernia field off the coast of Newfoundland; the Tengiz project in Kazakhstan; steam- and water-flood projects in Indonesia; expansion of the North West Shelf liquefied natural gas project in Australia; continued development of the Britannia natural gas field in the North Sea; expanded production projects in Angola; field development and expanded exploration in Congo; new field development in Papua New Guinea; and the Norphlet Trend natural gas development project in the Gulf of Mexico.\nRefining, marketing and transportation expenditures are estimated at about $1.9 billion, with about $900 million of that planned for the U.S., including upgrading U.S. refineries to produce reformulated gasolines needed to comply with the Clean Air Act and California Air Resources Board regulations. Most of the balance will be focused on high growth Asia Pacific Rim countries where the company's Caltex affiliate has several major refinery projects under way to meet rising demand, including continuing the construction of a new refinery in Thailand and capacity expansion projects in Japan and Korea.\nProjected spending also includes funds for the expansion of the linear low-density polyethylene manufacturing plant at the Cedar Bayou, Texas, chemicals facility.\nCAPITAL AND EXPLORATORY EXPENDITURES\nQUARTERLY RESULTS AND STOCK MARKET DATA Unaudited\nFS-12\nREPORT OF MANAGEMENT\nTO THE STOCKHOLDERS OF CHEVRON CORPORATION\nManagement of Chevron is responsible for preparing the accompanying financial statements and for assuring their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting principles and fairly represent the transactions and financial position of the company. The financial statements include amounts that are based on management's best estimates and judgments.\nThe company's statements have been audited by Price Waterhouse LLP, independent accountants, selected by the Audit Committee and approved by the stockholders. Management has made available to Price Waterhouse LLP all the company's financial records and related data, as well as the minutes of stockholders' and directors' meetings.\nManagement of the company has established and maintains a system of internal accounting controls that is designed to provide reasonable assurance that assets are safeguarded, transactions are properly recorded and executed in accordance with management's authorization, and the books and records accurately reflect the disposition of assets. The system of internal controls includes appropriate division of responsibility. The company maintains an internal audit department that conducts an extensive program of internal audits and independently assesses the effectiveness of the internal controls.\nThe Audit Committee is composed of directors who are not officers or employees of the company. It meets regularly with members of management, the internal auditors and the independent accountants to discuss the adequacy of the company's internal controls, financial statements and the nature, extent and results of the audit effort. Both the internal auditors and the independent accountants have free and direct access to the Audit Committee without the presence of management.\n\/s\/ K.T. Derr \/s\/ M.R. Klitten \/s\/ D.G. Henderson\nKenneth T. Derr Martin R. Klitten Donald G. Henderson Chairman of the Board Vice President, Finance Vice President and Chief Executive Officer and Chief Financial Officer and Comptroller\nFebruary 28, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE STOCKHOLDERS AND THE BOARD OF DIRECTORS OF CHEVRON CORPORATION\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, stockholders' equity and cash flows present fairly, in all material respects, the financial position of Chevron 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 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, effective January 1, 1992, the company changed its methods of accounting for postretirement benefits other than pensions and for income taxes.\n\/s\/ Price Waterhouse LLP\nSan Francisco, California February 28, 1995\nFS-13\nCONSOLIDATED STATEMENT OF INCOME\nYEAR ENDED DECEMBER 31 MILLIONS OF DOLLARS, ---------------------------------- EXCEPT PER-SHARE AMOUNTS 1994 1993 1992 ------------------------------------------------------------------------------ REVENUES Sales and other operating revenues (1) $35,130 $36,191 $38,212 Equity in net income of affiliated companies 440 440 406 Other income 284 451 1,059 ------------------------------------------------------------------------------ TOTAL REVENUES 35,854 37,082 39,677 ------------------------------------------------------------------------------ COSTS AND OTHER DEDUCTIONS Purchased crude oil and products 16,990 18,007 19,872 Operating expenses 6,314 6,267 6,145 Provision for U.S. refining and marketing restructuring 69 837 - Exploration expenses 379 360 507 Selling, general and administrative expenses 963 1,530 1,761 Depreciation, depletion and amortization 2,431 2,452 2,594 Taxes other than on income (1) 5,559 4,886 4,899 Interest and debt expense 346 317 436 ------------------------------------------------------------------------------ TOTAL COSTS AND OTHER DEDUCTIONS 33,051 34,656 36,214 ------------------------------------------------------------------------------ INCOME BEFORE INCOME TAX EXPENSE AND CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES 2,803 2,426 3,463 INCOME TAX EXPENSE 1,110 1,161 1,253 ============================================================================== INCOME BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES $ 1,693 $ 1,265 $ 2,210 CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES - - (641) ============================================================================== NET INCOME $ 1,693 $ 1,265 $ 1,569 ============================================================================== PER SHARE OF COMMON STOCK: (2) INCOME BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES $2.60 $1.94 $3.26 CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES - - (.95) ---------------------------------- NET INCOME PER SHARE OF COMMON STOCK $2.60 $1.94 $2.31\nWEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 651,672,238 650,957,752 677,954,828 ============================================================================== (1) INCLUDES CONSUMER EXCISE TAXES. $4,790 $4,068 $3,964 (2) SHARES AND PER-SHARE AMOUNTS REFLECT A TWO-FOR-ONE STOCK SPLIT IN MAY 1994.\nSee accompanying notes to consolidated financial statements.\nFS-14\nCONSOLIDATED BALANCE SHEET\nAT DECEMBER 31 -------------------------- MILLIONS OF DOLLARS 1994 1993 ------------------------------------------------------------------------------ ASSETS Cash and cash equivalents $ 413 $ 1,644 Marketable securities 893 372 Accounts and notes receivable (less allowance: 1994 - $62; 1993 - $66) 3,923 3,808 Inventories: Crude oil and petroleum products 1,036 1,108 Chemicals 391 423 Materials and supplies 263 252 Other merchandise 20 18 -------------------------- 1,710 1,801 Prepaid expenses and other current assets 652 1,057 ------------------------------------------------------------------------------ TOTAL CURRENT ASSETS 7,591 8,682 Long-term receivables 138 94 Investments and advances 3,991 3,623\nProperties, plant and equipment, at cost 46,810 44,807 Less: accumulated depreciation, depletion and amortization 24,637 22,942 -------------------------- 22,173 21,865 Deferred charges and other assets 514 472 ------------------------------------------------------------------------------ TOTAL ASSETS $34,407 $34,736 ==============================================================================\nLIABILITIES AND STOCKHOLDERS' EQUITY Short-term debt $ 4,014 $ 3,456 Accounts payable 2,990 3,325 Accrued liabilities 1,274 2,538 Federal and other taxes on income 624 782 Other taxes payable 490 505 ------------------------------------------------------------------------------ TOTAL CURRENT LIABILITIES 9,392 10,606 Long-term debt and capital lease obligations 4,128 4,082 Deferred credits and other non-current obligations 2,043 1,677 Non-current deferred income taxes 2,674 2,916 Reserves for employee benefit plans 1,574 1,458 ------------------------------------------------------------------------------ TOTAL LIABILITIES 19,811 20,739 ------------------------------------------------------------------------------ Preferred stock (authorized 100,000,000 shares, $1.00 par value, none issued) - - Common stock (authorized 1,000,000,000 shares, $1.50 par value, 712,487,068 shares issued) * 1,069 1,069 Capital in excess of par value 1,858 1,855 Deferred compensation - Employee Stock Ownership Plan (ESOP) (900) (920) Currency translation adjustment and other 175 108 Retained earnings 14,457 13,955 Treasury stock, at cost (1994 - 60,736,435 shares; 1993 - 61,008,858 shares) * (2,063) (2,070) ------------------------------------------------------------------------------ TOTAL STOCKHOLDERS' EQUITY 14,596 13,997 ------------------------------------------------------------------------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $34,407 $34,736 ==============================================================================\n* SHARES AND PAR VALUE AMOUNTS REFLECT A TWO-FOR-ONE STOCK SPLIT IN MAY 1994.\nSee accompanying notes to consolidated financial statements.\nFS-15\nCONSOLIDATED STATEMENT OF CASH FLOWS\nYEAR ENDED DECEMBER 31 ------------------------------ MILLIONS OF DOLLARS 1994 1993 1992 ------------------------------------------------------------------------------ OPERATING ACTIVITIES Net income $ 1,693 $ 1,265 $ 1,569 Adjustments Depreciation, depletion and amortization 2,431 2,452 2,594 Dry hole expense related to prior years' expenditures 53 29 57 Distributions less than equity in affiliates' income (55) (173) (144) Net before-tax (gains) losses on asset retirements and sales (83) 373 (568) Net currency translation losses (gains) 40 (27) (66) Deferred income tax provision 110 (160) (176) Cumulative effect of changes in accounting principles - - 641 Net (increase) decrease in operating working capital (1) (1,773) 463 82 Other (2) 480 (1) (75) ------------------------------------------------------------------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES (3) 2,896 4,221 3,914 ------------------------------------------------------------------------------ INVESTING ACTIVITIES Capital expenditures (3,405) (3,323) (3,352) Proceeds from asset sales 731 908 1,043 Net (purchases) sales of marketable securities (4) (545) 30 45 ------------------------------------------------------------------------------ NET CASH USED FOR INVESTING ACTIVITIES (3,219) (2,385) (2,264) ------------------------------------------------------------------------------ FINANCING ACTIVITIES Net borrowings of short-term obligations 466 293 1,333 Proceeds from issuance of long-term debt 436 199 23 Repayments of long-term debt and other financing obligations (588) (854) (1,260) Cash dividends paid (1,206) (1,139) (1,115) Purchases of treasury shares (5) (4) (382) ------------------------------------------------------------------------------ NET CASH USED FOR FINANCING ACTIVITIES (897) (1,505) (1,401) ------------------------------------------------------------------------------ EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS (11) 21 3 ------------------------------------------------------------------------------ NET CHANGE IN CASH AND CASH EQUIVALENTS (1,231) 352 252 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,644 1,292 1,040 ------------------------------------------------------------------------------ CASH AND CASH EQUIVALENTS AT YEAR-END $ 413 $ 1,644 $ 1,292 ============================================================================== (1) THE \"NET (INCREASE) DECREASE IN OPERATING WORKING CAPITAL\" IS COMPOSED OF THE FOLLOWING: (INCREASE) DECREASE IN ACCOUNTS AND NOTES RECEIVABLE $ (44) $ 187 $ 97 (INCREASE) DECREASE IN INVENTORIES (57) 288 292 DECREASE (INCREASE) IN PREPAID EXPENSES AND OTHER CURRENT ASSETS 4 (52) 85 (DECREASE) INCREASE IN ACCOUNTS PAYABLE AND ACCRUED LIABILITIES (1,510) 214 (567) (DECREASE) INCREASE IN INCOME AND OTHER TAXES PAYABLE (166) (174) 175 ------------------------------------------------------------------------------ NET (INCREASE) DECREASE IN OPERATING WORKING CAPITAL $(1,773) $ 463 $ 82 ============================================================================== (2) IN 1994, \"OTHER\" OPERATING ACTIVITIES WERE COMPRISED PRIMARILY OF INCREASES IN NON-CURRENT OBLIGATIONS WHICH INCLUDED, IN PART, NON-CASH PROVISIONS FOR ENVIRONMENTAL REMEDIATION. (3) \"NET CASH PROVIDED BY OPERATING ACTIVITIES\" INCLUDES THE FOLLOWING CASH PAYMENTS FOR INTEREST AND INCOME TAXES: INTEREST PAID ON DEBT (NET OF CAPITALIZED INTEREST) $ 310 $ 309 $ 392 INCOME TAXES PAID $ 1,147 $ 1,505 $ 1,236 ============================================================================== (4) \"NET (PURCHASES) SALES OF MARKETABLE SECURITIES\" CONSISTS OF THE FOLLOWING GROSS AMOUNTS: MARKETABLE SECURITIES PURCHASED $(1,943) $(1,855) $(2,633) MARKETABLE SECURITIES SOLD 1,398 1,885 2,678 ------------------------------------------------------------------------------ NET (PURCHASES) SALES OF MARKETABLE SECURITIES $ (545) $ 30 $ 45 ==============================================================================\nSee accompanying notes to consolidated financial statements.\nFS-16\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY*\nFS-17\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Millions of dollars\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Chevron Corporation and its consolidated subsidiaries (the company) employ accounting policies that are in accordance with generally accepted accounting principles in the United States.\nSUBSIDIARY AND AFFILIATED COMPANIES. The consolidated financial statements include the accounts of subsidiary companies more than 50 percent owned. Investments in and advances to affiliates in which the company has a substantial ownership interest of approximately 20 to 50 percent, or for which the company participates in policy decisions, are accounted for by the equity method. Under this accounting, remaining unamortized cost is increased or decreased by the company's share of earnings or losses after dividends.\nOIL AND GAS ACCOUNTING. The successful efforts method of accounting is used for oil and gas exploration and production activities.\nDERIVATIVES. Gains and losses on hedges of existing assets or liabilities are included in the carrying amounts of those assets or liabilities and are ultimately recognized in income as part of those carrying amounts. Gains and losses related to qualifying hedges of firm commitments or anticipated transactions also are deferred and are recognized in income or as adjustments of carrying amounts when the hedged transaction occurs. Gains and losses on derivatives contracts that do not qualify as hedges are recognized currently in \"Other income.\"\nSHORT-TERM INVESTMENTS. All short-term investments are classified as available-for-sale, and are in highly liquid debt securities. Those investments that are part of the company's cash management portfolio with original maturities of three months or less are reported as cash equivalents. The balance of the short-term investments is reported as marketable securities.\nINVENTORIES. Crude oil, petroleum products, chemicals and other merchandise are stated at cost, using a Last-In, First-Out (LIFO) method. In the aggregate, these costs are below market. Materials and supplies generally are stated at average cost.\nPROPERTIES, PLANT AND EQUIPMENT. All costs for development wells, related plant and equipment (including carbon dioxide and certain other injected materials used in enhanced recovery projects), and mineral interests in oil and gas properties are capitalized. Costs of exploratory wells are capitalized pending determination of whether the wells found proved reserves. Costs of wells that are assigned proved reserves remain capitalized. All other exploratory wells and costs are expensed.\nProved oil and gas properties are regularly assessed for possible impairment on an aggregate worldwide portfolio basis, applying the informal \"ceiling test\" of the Securities and Exchange Commission. Under this method, the possibility of an impairment may exist if the aggregate net book carrying value of these properties, net of applicable deferred income taxes, exceeds the aggregate undiscounted future cash flows, after tax, from the properties, as calculated in accordance with accounting rules for supplemental information on oil and gas producing activities. In addition, high-cost, long-lead-time oil and gas projects are individually assessed prior to production start-up by comparing the recorded investment in the project with its fair market or economic value, as appropriate. Economic values are generally based on management's expectations of discounted future after-tax cash flows from the project at the time of assessment.\nDepreciation and depletion (including provisions for future abandonment and restoration costs) of all capitalized costs of proved oil and gas producing properties, except mineral interests, are expensed using the unit-of-production method by individual fields as the proved developed reserves are produced. Depletion expenses for capitalized costs of proved mineral interests are recognized using the unit-of-production method by individual fields as the related proved reserves are produced. Periodic valuation provisions for impairment of capitalized costs of unproved mineral interests are expensed.\nDepreciation and depletion expenses for coal are determined using the unit-of-production method as the proved reserves are produced. The capitalized costs of all other plant and equipment are depreciated or amortized over estimated useful lives. In general, the declining-balance method is used to depreciate plant and equipment in the United States; the straight-line method generally is used to depreciate international plant and equipment and to amortize all capitalized leased assets.\nGains or losses are not recognized for normal retirements of properties, plant and equipment subject to composite group amortization or depreciation. Gains or losses from abnormal retirements or sales are included in income.\nExpenditures for maintenance, repairs and minor renewals to maintain facilities in operating condition are expensed. Major replacements and renewals are capitalized.\nENVIRONMENTAL EXPENDITURES. Environmental expenditures that relate to current ongoing operations or to conditions caused by past operations are expensed. Expenditures that create future benefits or contribute to future revenue generation are capitalized.\nLiabilities related to future remediation costs are recorded when environmental assessments and\/or cleanups are probable, and the costs can be reasonably estimated. Other than for assessments, the timing and magnitude of these accruals is generally based on the company's commitment to a formal plan of action, such as an approved remediation plan or the sale or disposal of an asset. For the company's domestic marketing facilities, the accrual is based on the probability that a future remediation commitment will be required. For oil and gas and coal producing properties, a provision is made through depreciation expense for anticipated abandonment and restoration costs at the end of the property's useful life.\nFor Superfund sites, the company records a liability for its share of costs when it has been named as a Potentially Responsible Party (PRP) and when an assessment or cleanup plan has been developed. This liability includes the company's own portion of the costs and also the company's portion of amounts for\nFS-18\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued\nother PRPs when it is probable that they will not be able to pay their share of the cleanup obligation.\nThe company records the gross amount of its liability based on its best estimate of future costs in current dollars and using currently available technology and applying current regulations as well as the company's own internal environmental policies. Future amounts are not discounted. Probable recoveries or reimbursements are recorded as an asset.\nCURRENCY TRANSLATION. The U.S. dollar is the functional currency for the company's consolidated operations as well as for substantially all operations of its equity method companies. For those operations, all gains or losses from currency transactions are included in income currently. The cumulative translation effects for the few equity affiliates using functional currencies other than the U.S. dollar are included in the currency translation adjustment in stockholders' equity.\nTAXES. Income taxes are accrued for retained earnings of international subsidiaries and corporate joint ventures intended to be remitted. Income taxes are not accrued for unremitted earnings of international operations that have been, or are intended to be, reinvested indefinitely.\nNOTE 2. ADOPTION OF STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS NO. 106, \"EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\" (SFAS 106) AND NO. 109, \"ACCOUNTING FOR INCOME TAXES\" (SFAS 109) Effective January 1, 1992, the company adopted SFAS 106 and SFAS 109, issued by the Financial Accounting Standards Board. The effects of these statements on 1992 net income included a charge of $641, or $.95 per share, attributable to the cumulative effect of adoption, including the company's share of equity affiliates. This net charge was composed of $833, after related tax benefits of $423, for the recognition of liabilities for retiree benefits (primarily health and life insurance), partially offset by a credit of $192 for deferred income tax benefits and other changes stipulated by the new income tax accounting rules.\nNOTE 3. SPECIAL ITEMS AND OTHER FINANCIAL INFORMATION Net income is affected by transactions that are unrelated to or are not representative of the company's ongoing operations for the periods presented. These transactions, defined by management and designated \"special items,\" can obscure the underlying results of operations for a year as well as affect comparability of results between years.\nListed below are categories of special items and their net increase (decrease) to net income, after related tax effects:\nYEAR ENDED DECEMBER 31 ------------------------------ 1994 1993 1992 ------------------------------------------------------------------------------ Asset dispositions, net Lead and zinc property in Ireland $ 48 $ - $ - Ortho lawn and garden products - 130 - Oil and gas properties - (25) 209 Stock exchange with Pennzoil Company - - 376 Copper interest in Chile - - 159 Other - 17 13 ------------------------------ 48 122 757 ------------------------------------------------------------------------------ Asset write-offs and revaluations Oil and gas properties - (31) (110) Refining and marketing assets - (24) (31) Other - (16) 8 ------------------------------ - (71) (133) ------------------------------------------------------------------------------ Prior-year tax adjustments 344 (130) 72 ------------------------------------------------------------------------------ Environmental remediation provisions (304) (90) (44) ------------------------------------------------------------------------------ Restructurings and reorganizations Work-force reductions, net - (11) (40) U.S. refining and marketing (39) (543) - Chemicals (6) - - ------------------------------ (45) (554) (40) ------------------------------------------------------------------------------ LIFO inventory losses (10) (46) (26) ------------------------------------------------------------------------------ Other, net Litigation and regulatory issues (31) (70) (11) One-time employee bonus - (60) - Chemicals products license agreements - - 32 Insurance gains and other adjustments 20 16 44 ------------------------------ (11) (114) 65 ------------------------------------------------------------------------------ Total special items, after tax $ 22 $(883) $651 ==============================================================================\nThe 1994 U.S. refining and marketing restructuring charge of $39 and the chemicals charge of $6 were net adjustments made to the 1993 charge of $543. The restructuring reserve was primarily composed of writedowns of two refineries and their related inventories to estimated realizable values. The estimated realizable value of the refineries took into account certain environmental cleanup obligations. Also included in the reserve were amounts for environmental site assessments and employee severance. The refineries are located in Philadelphia, Pennsylvania, and Port Arthur, Texas.\nThe Philadelphia refinery was sold in August 1994 and the Port Arthur refinery was sold in February 1995. The reserve was reduced by the amount of proceeds received from the sale of the Philadelphia refinery and adjustments were made to reflect the terms of the sales. These included adjustments to the realizable values of the assets, primarily inventories, and the recognition of certain environmental remediation obligations retained by the company. These adjustments resulted in a $45 net increase to the reserve. At year-end 1994, the reserve balance, before related tax effects, was composed of $491 for loss on the sale of the Port Arthur refinery and related inventories and $224 for Port Arthur environmental cleanup obligations.\nThe company does not expect the environmental cleanup expenditures, most of which will be made over an approximate\nFS-19\nNOTE 3. SPECIAL ITEMS AND OTHER FINANCIAL INFORMATION - Continued\nten-year period, to have any material effect on its liquidity. The costs will be funded through cash from future operations.\nOther financial information is as follows:\nYEAR ENDED DECEMBER 31 ------------------------------- 1994 1993 1992 ------------------------------------------------------------------------------ Total financing interest and debt costs $419 $371 $478 Less: capitalized interest 73 54 42 ------------------------------------------------------------------------------ Interest and debt expense 346 317 436 Research and development expenses 179 206 229 Currency transaction (losses) gains * $(64) $ 46 $ 90 ============================================================================== * INCLUDES $(24), $18 AND $24 IN 1994, 1993 AND 1992, RESPECTIVELY, FOR THE COMPANY'S SHARE OF AFFILIATES' CURRENCY TRANSACTION EFFECTS.\nThe excess of current cost (based on average acquisition costs for the year) over the carrying value of inventories for which the LIFO method is used was $684, $671 and $803 at December 31, 1994, 1993 and 1992, respectively.\nNOTE 4. INFORMATION RELATING TO THE CONSOLIDATED STATEMENT OF CASH FLOWS The Consolidated Statement of Cash Flows excludes the following non-cash transactions:\nIn 1994, the company took delivery of a new tanker under a capital lease arrangement. This asset was recorded as a $65 million addition to properties, plant and equipment and to capital lease obligations.\nThe company's Employee Stock Ownership Plan (ESOP) repaid $40 and $30 of matured debt guaranteed by Chevron Corporation in 1994 and 1993, respectively. The company reflected this payment as reductions in debt outstanding and in Deferred Compensation - ESOP.\nIn 1993, the company acquired a 50 percent interest in the Tengizchevroil joint venture (TCO) in the Republic of Kazakhstan through a series of cash and non-cash transactions. The company's interest in TCO is accounted for using the equity method of accounting and is recorded in \"Investments and advances\" in the consolidated balance sheet. The cash expended in connection with the formation of TCO and subsequent advances to TCO have been included in the consolidated statement of cash flows in \"Capital expenditures.\" The deferred payment portion of the TCO investment totaled $709 at December 31, 1993, and $466 at year-end 1994 and is recorded in \"Accrued liabilities\" and \"Deferred credits and other non-current obligations\" in the consolidated balance sheet. Payments in 1993 and 1994 related to the deferred portion of the TCO investment were classified as \"Repayments of long-term debt and other financing obligations\" in the consolidated statement of cash flows.\nThe company refinanced an aggregate amount of $334 and $57 in tax exempt long-term debt and capital lease obligations in 1993 and 1992, respectively. These refinancings are not reflected in the consolidated statement of cash flows.\nIn 1992, the company received 31,500,000 shares of its common stock held by a stockholder in exchange for the stock of a subsidiary owning certain U.S. oil and gas producing properties and related facilities, cash and other current assets and current liabilities. The value attributed to the treasury shares received was $1,100. The property exchanged consisted of properties, plant and equipment with a carrying value of $790 and, excluding cash, net current liabilities of $1. Cash of $57 was included as a reduction of proceeds from asset sales.\nIn 1992, the company acquired an additional ownership interest in an affiliate, accounted for under the equity method, in a non-cash transaction. This increase in ownership required the consolidation of the affiliate into the company's financial statements. The principal result of this consolidation was to increase non-current assets and liabilities by approximately $64.\nThere have been other non-cash transactions that have occurred during the years presented. These include the reissuance of treasury shares for management compensation plans; acquisitions of properties, plant and equipment through capital lease transactions; and changes in stockholders' equity, long-term debt and other liabilities resulting from the accounting for the company's ESOP. The amounts for these transactions have not been material in the aggregate in relation to the company's financial position.\nThe major components of \"Capital expenditures,\" and the reconciliation of this amount to the capital and exploratory expenditures, excluding equity in affiliates, presented in \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" are presented below:\nYEAR ENDED DECEMBER 31 ------------------------------- 1994 1993 1992 ------------------------------------------------------------------------------ Additions to properties, plant and equipment * $3,112 $3,214 $3,342 Additions to investments 284 179 47 Payments for other assets and (liabilities), net 9 (70) (37) ------------------------------------------------------------------------------ Capital expenditures 3,405 3,323 3,352 Expensed exploration expenditures 326 330 450 Payments of long-term debt and other financing obligations 242 86 - ------------------------------------------------------------------------------ Capital and exploratory expenditures, excluding equity companies $3,973 $3,739 $3,802 ============================================================================== * 1994 EXCLUDES NON-CASH CAPITAL LEASE ADDITION OF $65.\nNOTE 5. STOCKHOLDERS' EQUITY Retained earnings at December 31, 1994 and 1993, include $2,265 and $2,087, respectively, for the company's share of undistributed earnings of equity affiliates.\nAt the company's annual meeting on May 3, 1994, stockholders approved an increase in the authorized shares of common stock from 500 million to 1 billion and approved a two-for-one split of the company's issued common stock, effective May 11, 1994. All share and per-share amounts prior to that date have been restated to reflect the stock split.\nIn 1988, the company declared a dividend distribution of one Right for each outstanding share of common stock. The Rights will be exercisable, unless redeemed earlier by the company, if a person or group acquires, or obtains the right to acquire, 10 percent or more of the outstanding shares of common stock or commences a tender or exchange offer that would result in acquiring 10 percent or more of the outstanding shares of common stock, either event occurring without the prior consent of the company. Each Right entitles its holder to purchase stock having a value equal to two times the exercise price of the\nFS-20\nNOTE 5. STOCKHOLDERS' EQUITY - Continued\nRight. The person or group who had acquired 10 percent or more of the outstanding shares of common stock without the prior consent of the company would not be entitled to this purchase opportunity.\nThe Rights will expire in November 1998, or they may be redeemed by the company at 5 cents per share prior to that date. The Rights do not have voting or dividend rights and, until they become exercisable, have no dilutive effect on the earnings of the company. Twenty million shares of the company's preferred stock have been designated Series A participating preferred stock and reserved for issuance upon exercise of the Rights.\nNo event during 1994 made the Rights exercisable.\nNOTE 6. FINANCIAL INSTRUMENTS\nOFF BALANCE SHEET RISK. The company enters into forward exchange contracts, generally with terms of 90 days or less, as a hedge against some of its foreign currency exposures, primarily anticipated purchase transactions forecasted to occur within 90 days. At December 31, 1994 and 1993, the notional amounts were $60 and $114, respectively.\nThe company enters into interest rate swaps as part of its overall strategy to manage the interest rate risk on its debt. Under the terms of the swaps, net cash settlements, based on the difference between fixed-rate and floating-rate interest amounts calculated by reference to agreed notional principal amounts, are made either semi-annually or annually, and are recorded monthly as \"Interest and debt expense.\" At December 31, 1994, the notional principal amounts of the swaps held by the company totaled $850, and the contracts have remaining terms of between two to five years.\nThe impact of the swaps and forward exchange contracts on the company's results of operations is not material.\nThe company utilizes certain derivative financial instruments as hedges to manage a small portion of its exposure to price volatility stemming from its integrated petroleum activities. Relatively straightforward and involving little complexity, these instruments consist mainly of crude oil futures contracts traded on the International Petroleum Exchange and natural gas swap contracts, entered into principally with major financial institutions. The futures contracts hedge anticipated crude oil purchases and sales, generally forecasted to occur within a ninety-day period. Natural gas swaps are primarily used to hedge firmly committed sales, and the terms of the swap contracts held have an average maturity of twelve months, mirroring the terms of the committed sales. Gains and losses on the instruments offset, and are recognized concurrently with gains and losses associated with the underlying commodities.\nCONCENTRATIONS OF CREDIT RISK. The company's financial instruments that are exposed to concentrations of credit risk consist primarily of its cash equivalents, marketable securities, derivative financial instruments and trade receivables.\nThe company's short-term investments are placed with various foreign governments and a wide array of financial institutions with high credit ratings. This diversified investment policy limits the company's exposure both to credit risk and to concentration of credit risk. Similar standards of diversity and creditworthiness are applied to the company's counterparties in derivative financial instruments.\nThe trade receivable balances, reflecting the company's diversified sources of revenue, are dispersed among the company's broad customer base worldwide. As a consequence, concentrations of credit risk are limited. The company routinely assesses the financial strength of its customers. Letters of credit are the principal security obtained to support lines of credit or negotiated contracts when the financial strength of a customer is not considered sufficient.\nFAIR VALUE. At December 31, 1994, the company's long-term debt of $2,155 had an estimated fair value of $2,127. The fair value is based on quoted market prices at December 31, 1994, or the present value of expected cash flows when a quoted market price was not available.\nAt December 31, 1994, the company held crude oil futures contracts and natural gas swap contracts with approximate negative fair values totaling $(38).\nThe company holds cash equivalents and U.S. dollar marketable securities in domestic and offshore portfolios. Eurodollar bonds and floating rate notes are the primary instruments held. At December 31, 1994, cash equivalents and marketable securities had a fair value of $1,178. Of this balance, $285 classified as cash equivalents had average maturities under 90 days, while the remainder, classified as marketable securities, had an average maturity of 4 years.\nNOTE 7. SUMMARIZED FINANCIAL DATA - CHEVRON U.S.A. INC. At December 31, 1994, Chevron U.S.A. Inc. was Chevron Corporation's principal operating company, consisting primarily of the company's U.S. integrated petroleum operations (excluding most of the domestic pipeline operations). These operations are conducted by three divisions: Chevron U.S.A. Production Company, Chevron U.S.A. Products Company and Warren Petroleum Company. Summarized financial information for Chevron U.S.A. Inc. and its consolidated subsidiaries is presented below:\nYEAR ENDED DECEMBER 31 ------------------------------ 1994 1993 1992 ------------------------------------------------------------------------------ Sales and other operating revenues $25,833 $28,092 $29,454 Total costs and other deductions 25,367 27,588 28,410 Income before cumulative effect of changes in accounting principles 501 325 811 Cumulative effect of changes in accounting principles - - (573) Net income 501 325 238 ==============================================================================\nAT DECEMBER 31 ------------------ 1994 1993 ------------------------------------------------------------------------------ Current assets $ 3,341 $ 3,661 Other assets 14,136 14,099 Current liabilities 6,347 5,936 Other liabilities 5,599 5,738 Net equity 5,531 6,086 ==============================================================================\nFS-21\nNOTE 8. LITIGATION The company is a defendant in numerous lawsuits. Plaintiffs may seek to recover large and sometimes unspecified amounts, and some matters may remain unresolved for several years.\nA lawsuit brought against the company by OXY USA Inc., the successor in interest to Cities Service Company, remains pending in an Oklahoma state court. The suit involves claims for breach of contract and misrepresentation related to the termination of Gulf Oil Corporation's offer to purchase Cities' stock in 1982. (Gulf was acquired by Chevron in 1984.) OXY also asserts that the company improperly interfered with a proposed settlement of claims brought against OXY by the Department of Energy.\nManagement is of the opinion that resolution of the lawsuits will not result in any significant liability to the company in relation to its consolidated financial position or liquidity.\nNOTE 9. GEOGRAPHIC AND SEGMENT DATA The geographic and segment distributions of the company's identifiable assets, operating income and sales and other operating revenues are summarized in the following tables.\nAT DECEMBER 31 ------------------------------ 1994 1993 1992 ------------------------------------------------------------------------------ IDENTIFIABLE ASSETS United States Petroleum $15,540 $16,443 $18,508 Chemicals 1,992 2,045 2,165 Coal and Other Minerals 592 744 762 ------------------------------------------------------------------------------ Total United States 18,124 19,232 21,435 ------------------------------------------------------------------------------ International Petroleum 12,493 12,202 9,671 Chemicals 411 412 390 Coal and Other Minerals 45 13 10 ------------------------------------------------------------------------------ Total International 12,949 12,627 10,071 ------------------------------------------------------------------------------ TOTAL IDENTIFIABLE ASSETS 31,073 31,859 31,506 Corporate and Other 3,334 2,877 2,464 ------------------------------------------------------------------------------ TOTAL ASSETS $34,407 $34,736 $33,970 ==============================================================================\nYEAR ENDED DECEMBER 31 ------------------------------ 1994 1993 1992 ------------------------------------------------------------------------------ OPERATING INCOME United States Petroleum $ 831 $ 692 $ 1,693 Chemicals 241 162 46 Coal and Other Minerals 60 59 68 ------------------------------------------------------------------------------ Total United States 1,132 913 1,807 ------------------------------------------------------------------------------ International Petroleum 1,672 1,772 1,731 Chemicals 81 63 70 Coal and Other Minerals 79 (3) 177 ------------------------------------------------------------------------------ Total International 1,832 1,832 1,978 ------------------------------------------------------------------------------ TOTAL OPERATING INCOME 2,964 2,745 3,785 Corporate and Other (161) (319) (322) Income Tax Expense (1,110) (1,161) (1,253) ------------------------------------------------------------------------------ Income before cumulative effect of changes in accounting principles $ 1,693 $ 1,265 $ 2,210 Cumulative effect of changes in accounting principles - - (641) ------------------------------------------------------------------------------ NET INCOME $ 1,693 $ 1,265 $ 1,569 ==============================================================================\nYEAR ENDED DECEMBER 31 ------------------------------ 1994 1993 1992 ------------------------------------------------------------------------------ SALES AND OTHER OPERATING REVENUES United States Petroleum-Refined products $11,690 $13,169 $13,964 -Crude oil 3,466 4,086 5,138 -Natural gas 1,755 1,776 1,631 -Natural gas liquids 1,072 1,098 1,075 -Other petroleum revenues 637 682 700 -Excise taxes 2,977 2,554 2,458 -Intersegment 977 924 1,052 ------------------------------ Total Petroleum 22,574 24,289 26,018 ------------------------------ Chemicals-Products 2,528 2,211 2,409 -Intersegment 273 248 266 ------------------------------ Total Chemicals 2,801 2,459 2,675 ------------------------------ Coal and Other Minerals-Products 415 447 395 ------------------------------ Total United States 25,790 27,195 29,088 ------------------------------------------------------------------------------ International Petroleum-Refined products 2,638 2,920 2,857 -Crude oil 4,783 4,415 4,893 -Natural gas 383 380 364 -Natural gas liquids 108 137 115 -Other petroleum revenues 307 285 227 -Excise taxes 1,797 1,499 1,490 -Intersegment (2) 1 10 ------------------------------ Total Petroleum 10,014 9,637 9,956 ------------------------------ Chemicals-Products 537 497 463 -Excise taxes 16 15 16 -Intersegment 8 6 5 ------------------------------ Total Chemicals 561 518 484 ------------------------------ Coal and Other Minerals-Products 1 - 2 ------------------------------ Total International 10,576 10,155 10,442 ------------------------------------------------------------------------------ Intersegment sales elimination (1,256) (1,179) (1,333) ------------------------------------------------------------------------------ Corporate and Other 20 20 15 ------------------------------------------------------------------------------ TOTAL SALES AND OTHER OPERATING REVENUES $35,130 $36,191 $38,212 ============================================================================== Memo: Intergeographic Sales United States $ 512 $ 266 $ 309 International 1,803 4,418 3,823 ==============================================================================\nThe company's primary business is its integrated petroleum operations. Secondary operations include chemicals and coal. The company's real estate and insurance operations and worldwide cash management and financing activities are in \"Corporate and Other.\"\nBeginning January 1, 1994, the company no longer distributes certain corporate expenses to its business segments. Prior to 1994, these expenses were allocated on the basis of each segment's identifiable assets (including an allocation to \"Corporate and Other\"). Starting in 1994, segments are billed for direct corporate services; unbilled corporate expenses are included in \"Corporate and Other.\" The company believes this better reflects the current organizational and management structure of its business units and corporate departments.\nFS-22\nNOTE 9. GEOGRAPHIC AND SEGMENT DATA - Continued\nAs a result of the change, \"Corporate and Other\" in 1994 included $232 of before-tax expenses that, under the previous method, would have reduced segment operating income. There was no change in the net income of the company.\nAlso in connection with the change, the company no longer allocates certain corporate identifiable assets to the business segments. At December 31, 1994, \"Corporate and Other\" included $1,259 of identifiable assets that in previous years would have been included in the identifiable assets of the business segments.\nThese changes resulted in an increase to 1994 U.S. and International Petroleum operating income of $101 and $111, respectively. Identifiable assets at December 31, 1994 for U.S. and International Petroleum were reduced $630 and $506, respectively. The effect of these changes on 1994 operating income and year-end 1994 identifiable assets of the company's other segments and geographic areas was not material.\nIdentifiable assets for the business segments include all assets associated with operations in the indicated geographic areas, including investments in affiliates.\nSales and other operating revenues for the petroleum segment are derived from the production and sale of crude oil, natural gas and natural gas liquids, and from the refining and marketing of petroleum products. The company also obtains revenues from the transportation and trading of crude oil and refined products. Chemicals revenues result primarily from the sale of petrochemicals, plastic resins, and lube oil and fuel additives. Coal and other minerals revenues relate primarily to coal sales. During 1994, the company completed its withdrawal from non-coal minerals activities.\nSales and other operating revenues in the above table include both sales to unaffiliated customers and sales from the transfer of products between segments. Sales from the transfer of products between segments and geographic areas are generally at estimated market prices. Transfers between geographic areas are presented as memo items below the table.\nEquity in earnings of affiliated companies has been associated with the segments in which the affiliates operate. Sales to the Caltex Group are included in the \"International Petroleum\" segment. Information on the Caltex and Tengizchevroil affiliates is presented in Note 11. Other affiliates are either not material or not vertically integrated with a segment's operations.\nNOTE 10. LEASE COMMITMENTS Certain non-cancelable leases are classified as capital leases, and the leased assets are included as part of \"Properties, plant and equipment.\" Other leases are classified as operating leases and are not capitalized. Details of the capitalized leased assets are as follows:\nAT DECEMBER 31 ------------------ 1994 1993 ------------------------------------------------------------------------------ Petroleum Exploration and Production $ 45 $ 50 Refining, Marketing and Transportation 618 554 ----------------------------------------------------------------------------- 663 604 Less: accumulated amortization 398 409 ----------------------------------------------------------------------------- Net capitalized leased assets $265 $195 =============================================================================\nAt December 31, 1994, the future minimum lease payments under operating and capital leases are as follows:\nAT DECEMBER 31 ------------------- OPERATING CAPITAL YEAR LEASES LEASES ----------------------------------------------------------------------------- 1995 $158 $ 64 1996 144 60 1997 131 56 1998 114 52 1999 107 44 Thereafter 218 659 ----------------------------------------------------------------------------- Total $872 935 ------------------------------------------------------------------- Less: amounts representing interest and executory costs (456) ----------------------------------------------------------------------------- Net present value 479 Less: capital lease obligations included in short-term debt (306) ----------------------------------------------------------------------------- Long-term capital lease obligations $173 ============================================================================= Future sublease rental income $ 43 $ - =============================================================================\nRental expenses incurred for operating leases during 1994, 1993 and 1992 were as follows:\nYEAR ENDED DECEMBER 31 ---------------------------- 1994 1993 1992 ----------------------------------------------------------------------------- Minimum rentals $410 $452 $408 Contingent rentals 7 9 10 ----------------------------------------------------------------------------- Total 417 461 418 Less: sublease rental income 14 15 14 ----------------------------------------------------------------------------- Net rental expense $403 $446 $404 =============================================================================\nContingent rentals are based on factors other than the passage of time, principally sales volumes at leased service stations. Certain leases include escalation clauses for adjusting rentals to reflect changes in price indices, renewal options ranging from one to 25 years and\/or options to purchase the leased property during or at the end of the initial lease period for the fair market value at that time.\nFS-23\nNOTE 11. INVESTMENTS AND ADVANCES Investments in and advances to companies accounted for using the equity method, and other investments accounted for at or below cost, are as follows:\nAT DECEMBER 31 ------------------ 1994 1993 ------------------------------------------------------------------------------ Equity method affiliates Caltex Group $2,362 $2,147 Tengizchevroil 1,153 927 Other affiliates 346 426 ------------------------------------------------------------------------------ 3,861 3,500 Other, at or below cost 130 123 ------------------------------------------------------------------------------ Total investments and advances $3,991 $3,623 ==============================================================================\nChevron owns 50 percent each of P.T. Caltex Pacific Indonesia, an exploration and production company operating in Indonesia; Caltex Petroleum Corporation, which, through its subsidiaries and affiliates, conducts refining and marketing activities in Asia, Africa, Australia and New Zealand; and American Overseas Petroleum Limited, which, through its subsidiaries, manages certain of the company's exploration and production operations in Indonesia. These companies and their subsidiaries and affiliates are collectively called the Caltex Group.\nTengizchevroil (TCO) is a 50 percent owned joint venture formed in 1993 with the Republic of Kazakhstan to develop the Tengiz and Korolev oil fields over a 40-year period. The investment in TCO at December 31, 1994 and 1993 included a deferred payment portion of $466 and $709 respectively, $420 of which is payable to the Republic of Kazakhstan upon the attainment of a dedicated export system with the capability of the greater of 260,000 barrels of oil per day or TCO's production capacity. This portion of the investment was recorded upon formation of the venture as the company believed at the time, and continues to believe, that its payment is beyond a reasonable doubt given the original intent and continuing commitment of both parties to realizing the full potential of the venture over its 40-year life.\nEquity in earnings of companies accounted for by the equity method, together with dividends and similar distributions received from equity method companies for the years 1994, 1993 and 1992, are as follows:\nYEAR ENDED DECEMBER 31 ----------------------------------------------------- EQUITY IN EARNINGS DIVIDENDS ------------------------- ------------------------- 1994 1993 1992 1994 1993 1992 ------------------------------------------------------------------------------ Caltex Group $350 $361 $334* $239 $172 $183 Tengizchevroil (10) (1) - - - - Other affiliates 100 80 72 146 95 79 ------------------------------------------------------------------------------ Total $440 $440 $406 $385 $267 $262 ============================================================================== * BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES.\nThe company's transactions with affiliated companies, primarily for the purchase of Indonesian crude oil from P.T. Caltex Pacific Indonesia and the sale of crude oil and products to Caltex Petroleum Corporation's refining and marketing companies, are summarized in the adjacent table.\nAccounts and notes receivable in the consolidated balance sheet include $135 and $156 at December 31, 1994 and 1993, respectively, of amounts due from affiliated companies. Accounts payable include $46 and $35 at December 31, 1994 and 1993, respectively, of amounts due to affiliated companies.\nYEAR ENDED DECEMBER 31 ------------------------------ 1994 1993 1992 ------------------------------------------------------------------------------ Sales to Caltex Group $1,166 $1,739 $1,784 Sales to other affiliates 7 5 5 ------------------------------------------------------------------------------ Total sales to affiliates $1,173 $1,744 $1,789 ============================================================================== Purchases from Caltex Group $ 800 $ 842 $ 797 Purchases from other affiliates 52 101 56 ------------------------------------------------------------------------------ Total purchases from affiliates $ 852 $ 943 $ 853 ==============================================================================\nThe following tables summarize the combined financial information for the Caltex Group and substantially all of the other equity method companies together with Chevron's share. Amounts shown for the affiliates are 100 percent.\nFS-24\nNOTE 12. PROPERTIES, PLANT AND EQUIPMENT\nExpenses for maintenance and repairs were $928, $875 and $1,045 in 1994, 1993 and 1992, respectively.\nNOTE 13. TAXES\nYEAR ENDED DECEMBER 31 ------------------------------ 1994 1993 1992 ------------------------------------------------------------------------------ Taxes Other Than on Income United States Taxes on production $ 102 $ 135 $ 140 Import duties 21 21 18 Excise taxes on products and merchandise 2,978 2,554 2,458 Property and other miscellaneous taxes 374 380 416 Payroll taxes 112 122 141 ------------------------------------------------------------------------------ Total United States 3,587 3,212 3,173 ------------------------------------------------------------------------------ International Taxes on production 14 7 30 Import duties 11 22 55 Excise taxes on products and merchandise 1,812 1,514 1,506 Property and other miscellaneous taxes 116 112 114 Payroll taxes 19 19 21 ------------------------------------------------------------------------------ Total International 1,972 1,674 1,726 ------------------------------------------------------------------------------ Total taxes other than on income $5,559 $4,886 $4,899 ------------------------------------------------------------------------------\nU.S. federal income tax expense was reduced by $60, $57 and $49 in 1994, 1993 and 1992, respectively, for low-income housing and other business tax credits.\nIn 1994, before-tax income for U.S. operations was $1,194 compared with $687 in 1993 and $1,592 in 1992. Before-tax income for international operations was $1,609, $1,739 and $1,871 in 1994, 1993 and 1992, respectively.\nYEAR ENDED DECEMBER 31 ------------------------------ 1994 1993 1992 ------------------------------------------------------------------------------ Taxes on Income U.S. federal Current $ 175 $ 394 $ 329 Deferred 43 (241) (129) Deferred - Adjustment for enacted changes in tax laws\/rates - 54 - State and local 10 63 54 ------------------------------------------------------------------------------ Total United States 228 270 254 ------------------------------------------------------------------------------ International Current 815 864 1,046 Deferred 67 48 (47) Deferred - Adjustment for enacted changes in tax laws\/rates - (21) - ------------------------------------------------------------------------------ Total International 882 891 999 ------------------------------------------------------------------------------ Total taxes on income $1,110 $1,161 $1,253 ==============================================================================\nThe deferred income tax provisions included (costs) benefits of $(222), $98 and $163 related to properties, plant and equipment in 1994, 1993 and 1992, respectively. U.S. benefits were recorded in 1993 related to the U.S. refining and marketing restructuring provision.\nIn 1992, the tax related to the cumulative effect of adopting SFAS 106 (Note 2) was $423, representing deferred income tax benefits approximating the statutory tax rate.\nFS-25\nNOTE 13. TAXES - Continued\nThe company's effective income tax rate varied from the U.S. statutory federal income tax rate because of the following:\nYEAR ENDED DECEMBER 31 ------------------------------ 1994 1993 1992 ------------------------------------------------------------------------------ Statutory U.S. federal income tax rate 35.0% 35.0% 34.0% Effects of income taxes on international operations in excess of taxes at the U.S. statutory rate 18.5 15.6 15.2 Effects of asset dispositions - (0.6) (8.0) State and local taxes on income, net of U.S. federal income tax benefit 0.2 2.2 1.1 Prior-year tax adjustments (4.4) 3.0 (0.6) Effects of enacted changes in tax laws\/rates on deferred tax liabilities - 1.3 - Tax credits (2.1) (2.4) (1.4) All others (3.2) (0.9) (0.9) ------------------------------------------------------------------------------ Consolidated companies 44.0 53.2 39.4 Effect of recording equity in income of certain affiliated companies on an after-tax basis (4.4) (5.3) (3.2) ------------------------------------------------------------------------------ Effective tax rate 39.6% 47.9% 36.2% ==============================================================================\nThe company records its deferred taxes on a tax jurisdiction basis and classifies those net amounts as current or noncurrent based on the balance sheet classification of the related assets or liabilities.\nAt December 31, 1994 and 1993, deferred taxes were classified in the consolidated balance sheet, as follows:\nAT DECEMBER 31 ------------------ 1994 1993 ------------------------------------------------------------------------------ Prepaid expenses and other current assets $ (112) $ (495) Deferred charges and other assets (148) (146) Federal and other taxes on income 18 27 Non-current deferred income taxes 2,674 2,916 ------------------------------------------------------------------------------ Total deferred taxes, net $2,432 $2,302 ==============================================================================\nThe reported deferred tax balances are composed of the following deferred tax liabilities (assets):\nAT DECEMBER 31 ------------------ 1994 1993* ------------------------------------------------------------------------------ Properties, plant and equipment $4,451 $4,201 Inventory 240 293 Miscellaneous 254 237 ------------------------------------------------------------------------------ Deferred tax liabilities 4,945 4,731 ------------------------------------------------------------------------------ Abandonment\/environmental reserves (1,066) (910) Employee benefits (564) (535) AMT\/other tax credits (711) (486) Other accrued liabilities (299) (472) Miscellaneous (523) (523) ------------------------------------------------------------------------------ Deferred tax assets (3,163) (2,926) ------------------------------------------------------------------------------ Deferred tax assets valuation allowance 650 497 ------------------------------------------------------------------------------ Total deferred taxes, net $2,432 $2,302 ============================================================================== * CERTAIN 1993 AMOUNTS HAVE BEEN RECLASSIFIED TO CONFORM TO THE 1994 PRESENTATION.\nIt is the company's policy for subsidiaries included in the U.S. consolidated tax return to record income tax expense as though they filed separately, with the parent recording the adjustment to income tax expense for the effects of consolidation.\nUndistributed earnings of international consolidated subsidiaries and affiliates for which no deferred income tax provision has been made for possible future remittances totaled approximately $3,815 at December 31, 1994. Substantially all of this amount represents earnings reinvested as part of the company's ongoing business. It is not practical to estimate the amount of taxes that might be payable on the eventual remittance of such earnings. On remittance, certain countries impose withholding taxes that, subject to certain limitations, are then available for use as tax credits against a U.S. tax liability, if any. The company estimates withholding taxes of approximately $258 would be payable upon remittance of these earnings.\nNOTE 14. SHORT-TERM DEBT\nAT DECEMBER 31 ----------------- 1994 1993 ------------------------------------------------------------------------------ Commercial paper (1) $5,036 $4,391 Current maturities of long-term debt 134 167 Current maturities of long-term capital leases 33 23 Redeemable long-term obligations Long-term debt 315 297 Capital leases 273 255 Notes payable 23 203 ------------------------------------------------------------------------------ Subtotal (2) 5,814 5,336 Reclassified to long-term debt (1,800) (1,880) ------------------------------------------------------------------------------ Total short-term debt $4,014 $3,456 ============================================================================== (1) WEIGHTED AVERAGE INTEREST RATES AT DECEMBER 31, 1994 AND 1993 WERE 6.0% AND 3.3%, RESPECTIVELY. (2) WEIGHTED AVERAGE INTEREST RATES AT DECEMBER 31, 1994 AND 1993 WERE 5.8% AND 3.4%, RESPECTIVELY.\nRedeemable long-term obligations consist primarily of tax-exempt variable-rate put bonds that are included as current liabilities because they become redeemable at the option of the bondholders during the year following the balance sheet date.\nNOTE 15. LONG-TERM DEBT\nAT DECEMBER 31 ----------------- 1994 1993 ------------------------------------------------------------------------------ 8.11% amortizing notes due 2004 (1) $ 750 $ 750 7.45% notes due 2004 348 - 9.375% sinking-fund debentures due 2016 278 278 5.6% notes due 1998 190 190 9.75% sinking-fund debentures due 2017 180 179 4.625% 200 million Swiss franc issue due 1997 152 136 6.90% serial notes due 1994-1997 (1),(2) 150 190 7.875% notes due 1997 (3) - 200 Other long-term obligations (7.02%) (2) (less than $50 individually) 183 223 Other foreign currency obligations (5.45%) (2) 58 78 ------------------------------------------------------------------------------ Total including debt due within one year 2,289 2,224 Debt due within one year (134) (167) Reclassified from short-term debt (6.0%) (2) 1,800 1,880 ------------------------------------------------------------------------------ Total long-term debt $3,955 $3,937 ============================================================================== (1) GUARANTEE OF ESOP DEBT. (2) WEIGHTED AVERAGE INTEREST RATE AT DECEMBER 31, 1994. (3) DEBT RETIRED BEFORE MATURITY DATE.\nFS-26\nNOTE 15. LONG-TERM DEBT - Continued\nChevron and one of its wholly owned subsidiaries each have \"shelf\" registrations on file with the Securities and Exchange Commission (SEC) that together would permit the issuance of $700 of debt securities pursuant to Rule 415 of the Securities Act of 1933.\nAt year-end 1994, the company had $4,425 of committed credit facilities with banks worldwide, $1,800 of which had termination dates beyond one year. The facilities support the company's commercial paper borrowings. Interest on any borrowings under the agreements is based on either the London Interbank Offered Rate or the Reserve Adjusted Domestic Certificate of Deposit Rate. No amounts were outstanding under these credit agreements during the year nor at year-end.\nAt December 31, 1994 and 1993, the company classified $1,800 and $1,880, respectively, of short-term debt as long-term. Settlement of these obligations is not expected to require the use of working capital in 1995, as the company has both the intent and ability to refinance this debt on a long-term basis.\nConsolidated long-term debt maturing in each of the five years after December 31, 1994, is as follows: 1995-$134, 1996-$98, 1997-$246, 1998-$276 and 1999-$94.\nNOTE 16. EMPLOYEE BENEFIT PLANS\nPENSION PLANS. The company has defined benefit pension plans for most employees. The principal plans provide for automatic membership on a non-contributory basis. The retirement benefits provided by these plans are based primarily on years of service and on average career earnings or the highest consecutive three years' average earnings. The company's policy is to fund at least the minimum necessary to satisfy requirements of the Employee Retirement Income Security Act.\nThe net pension expense (credit) for all of the company's pension plans for the years 1994, 1993 and 1992 consisted of:\n1994 1993 1992 ------------------------------------------------------------------------------ Cost of benefits earned during the year $ 97 $103 $106 Interest cost on projected benefit obligations 263 276 302 Actual return on plan assets (62) (472) (309) Net amortization and deferral (294) 101 (134) ------------------------------------------------------------------------------ Net pension expense (credits) $ 4 $ 8 $(35) ==============================================================================\nSettlement gains in 1994, related to lump-sum payments, totaled $17. In addition to the net pension expense in 1993, the company recognized a net settlement loss of $63 and a curtailment loss of $4 reflecting the termination of a former Gulf pension plan and lump-sum payments from other company pension plans. In 1992, the company recorded charges of $65 and a curtailment loss of $7, offset by net lump-sum settlement gains of $101 related to an early retirement program offered to employees of its U.S. and certain Canadian subsidiaries.\nAt December 31, 1994 and 1993, the weighted average discount rates and long-term rates for compensation increases used for estimating the benefit obligations and the expected rates of return on plan assets were as follows:\n1994 1993 ------------------------------------------------------------------------------ Assumed discount rates 8.8% 7.4% Assumed rates for compensation increases 5.1% 5.1% Expected return on plan assets 10.1% 9.1% ==============================================================================\nThe pension plans' assets consist primarily of common stocks, bonds, cash equivalents and interests in real estate investment funds. The funded status for the company's combined plans at December 31, 1994 and 1993, was as follows:\nPLANS WITH PLANS WITH ASSETS ACCUMULATED IN EXCESS OF BENEFITS ACCUMULATED IN EXCESS OF BENEFITS PLAN ASSETS ----------------- ----------------- AT DECEMBER 31 1994 1993 1994 1993 ------------------------------------------------------------------------------ Actuarial present value of: Vested benefit obligations $(2,596) $(2,854) $ (186) $ (183) ============================================================================== Accumulated benefit obligations $(2,680) $(2,949) $ (194) $ (194) ============================================================================== Projected benefit obligations $(3,053) $(3,456) $ (222) $ (229) Plan assets at fair values 3,626 3,831 - 1 ------------------------------------------------------------------------------ Plan assets greater (less) than projected benefit obligations 573 375 (222) (228) Unrecognized net transition (assets) liabilities (294) (349) 18 20 Unrecognized net (gains) losses (178) 41 54 74 Unrecognized prior service costs 113 84 6 7 Minimum liability adjustment - - (80) (52) ------------------------------------------------------------------------------ Net pension cost prepaid (accrued) $ 214 $ 151 $ (224) $ (179) ==============================================================================\nThe net transition assets and liabilities generally are being amortized by the straight-line method over 15 years.\nPROFIT SHARING\/SAVINGS PLAN AND SAVINGS PLUS PLAN. Eligible employees of the company and certain of its subsidiaries who have completed one year of service may participate in the Profit Sharing\/Savings Plan and the Savings Plus Plan. Charges to expense for the profit sharing part of the Profit Sharing\/Savings Plan and the Savings Plus Plan were $75, $95 and $84 in 1994, 1993 and 1992, respectively.\nEMPLOYEE STOCK OWNERSHIP PLAN (ESOP). In December 1989, the company established an ESOP as part of the Profit Sharing\/Savings Plan. The ESOP Trust Fund borrowed $1,000 and purchased 28.2 million previously unissued shares of the company's common stock. The ESOP provides a partial pre-funding of the company's future commitments to the profit sharing part of the Plan, which will result in annual income tax savings for the company. The ESOP is expected to satisfy most of the company's obligations to the profit sharing part of the Plan during the next 10 years.\nFS-27\nNOTE 16. EMPLOYEE BENEFIT PLANS - Continued\nAs allowed by AICPA Statement of Position (SOP) 93-6, the company has elected to continue its current practices which are based on SOP 76-3 and subsequent consensuses of the Emerging Issues Task Force of the Financial Accounting Standards Board. Accordingly, the debt of the ESOP is recorded as debt and shares pledged as collateral are reported as deferred compensation in the consolidated balance sheet and statement of stockholders' equity. The company reports compensation expense equal to the ESOP debt principal repayments less dividends received by the ESOP. Interest incurred on the ESOP debt is recorded as interest expense. Dividends paid on ESOP shares are reflected as a reduction of retained earnings. All ESOP shares are considered outstanding for earnings-per-share computations.\nThe company recorded expense for the ESOP of $42, $60 and $50 in 1994, 1993 and 1992, respectively, including $71, $74 and $75 of interest expense related to the ESOP debt. All dividends paid on the shares held by the ESOP are used to service the ESOP debt. The dividends used were $50, $47 and $35 in 1994, 1993 and 1992, respectively.\nThe company made contributions to the ESOP of $63, $57 and $18 in 1994, 1993 and 1992, respectively, to satisfy ESOP debt service in excess of dividends received by the ESOP. The ESOP shares were pledged as collateral for its debt. Shares are released from a suspense account and allocated to profit sharing accounts of plan participants, based on the debt service deemed to be paid in the year in proportion to the total of current year and remaining debt service. Compensation expense was $(10), $(17) and $(35) in 1994, 1993 and 1992, respectively. The ESOP shares as of December 31 were as follows:\nTHOUSANDS 1994 1993 ------------------------------------------------------------------------------ Allocated shares 5,969 5,010 Unallocated shares 21,208 22,452 ------------------------------------------------------------------------------ Total ESOP shares 27,177 27,462 ==============================================================================\nMANAGEMENT INCENTIVE PLANS. The company has two incentive plans, the Management Incentive Plan (MIP) and the Long-Term Incentive Plan (LTIP) for officers and other regular salaried employees of the company and its subsidiaries who hold positions of significant responsibility. The MIP makes outright distributions of cash for services rendered or deferred awards in the form of stock units. Awards under LTIP may take the form of, but are not limited to, stock options, restricted stock, stock units and non-stock grants. Stock options become exercisable not earlier than one year and not later than 10 years from the date of grant.\nThe maximum number of shares of common stock that may be granted each year is 1 percent of the total outstanding shares of common stock as of January 1 of such year. As of December 31, 1994, 5,845,260 shares were under option at exercise prices ranging from $31.9375 to $43.875 per share. Stock option transactions for 1994 and 1993 are as follows:\nAT DECEMBER 31 ------------------ THOUSANDS OF SHARES 1994 1993 ------------------------------------------------------------------------------ Outstanding January 1 4,303 3,934 Granted 1,770 1,413 Exercised (140) (1,019) Forfeited (88) (25) ------------------------------------------------------------------------------ Outstanding December 31 5,845 4,303 ------------------------------------------------------------------------------ Exercisable December 31 4,152 2,912 ==============================================================================\nCharges to expense for the combined management incentive plans were $31, $36 and $20 in 1994, 1993 and 1992, respectively.\nOTHER BENEFIT PLANS. In addition to providing pension benefits, the company makes contributions toward certain health care and life insurance plans for active and qualifying retired employees. Substantially all employees in the United States and in certain international locations may become eligible for coverage under these benefit plans. The company's annual contributions for medical and dental benefits are limited to the lesser of actual medical and dental claims or a defined fixed per capita amount. Life insurance benefits are paid by the company and annual contributions are based on actual plan experience.\nNon-pension postretirement benefits are funded by the company when incurred. A reconciliation of the funded status of these benefit plans is as follows:\nAT DECEMBER 31, 1994 AT DECEMBER 31, 1993 -------------------------- -------------------------- HEALTH LIFE TOTAL HEALTH LIFE TOTAL ------------------------------------------------------------------------------ Accumulated postretirement benefit obligation (APBO) Retirees $(480) $(262) $ (742) $(593) $(320) $ (913) Fully eligible active participants (120) (57) (177) (139) (64) (203) Other active participants (190) (37) (227) (271) (56) (327) ------------------------------------------------------------------------------ Total APBO (790) (356) (1,146) (1,003) (440) (1,443) Fair value of plan assets - - - - - - ------------------------------------------------------------------------------ APBO (greater) than plan assets (790) (356) (1,146) (1,003) (440) (1,443) Unrecognized net (gain) loss (195) (66) (261) 63 25 88 ------------------------------------------------------------------------------ Accrued postretirement benefit costs $(985) $(422) $(1,407) $(940) $(415) $(1,355) ==============================================================================\nFS-28\nNOTE 16. EMPLOYEE BENEFIT PLANS - Continued\nThe company's net postretirement benefits expense was as follows:\n1994 1993 1992 ----------------- ----------------- ----------------- HEALTH LIFE TOTAL HEALTH LIFE TOTAL HEALTH LIFE TOTAL ------------------------------------------------------------------------------ Cost of benefits earned during the year $23 $ 4 $ 27 $23 $ 3 $ 26 $23 $ 4 $ 27 Interest cost on benefit obligation 71 31 102 76 30 106 70 30 100 ------------------------------------------------------------------------------ Net post-retirement benefits expense $94 $35 $129 $99 $33 $132 $93 $34 $127 ==============================================================================\nFor measurement purposes, separate health care cost-trend rates were utilized for pre-age 65 and post-age 65 retirees. The 1995 annual rates of increase were assumed to be 4.0 percent and 4.3 percent, respectively, increasing to 8.5 percent and 7.7 percent in 1996 and gradually decreasing thereafter to the average ultimate rates of 6.0 percent in 2000 for pre-age 65 and 5.0 percent in 2000 for post-age 65. An increase in the assumed health care cost-trend rates of 1 percent in each year would increase the aggregate of service and interest cost for the year 1994 by $13 and would increase the December 31, 1994 accumulated postretirement benefit obligation (APBO) by $105.\nAt December 31, 1994, the weighted average discount rate was 8.75 percent and the assumed rate of compensation increase related to the measurement of the life insurance benefit was 5.0 percent.\nNOTE 17. OTHER CONTINGENT LIABILITIES AND COMMITMENTS The U.S. federal income tax and California franchise tax liabilities of the company have been settled through 1976 and 1987, respectively. For federal income tax purposes, all issues other than the allocation of state income taxes and the creditability of taxes paid to the Government of Indonesia have been resolved through 1987. The Indonesia issue applies only to years after 1982. Settlement of open tax matters is not expected to have a material effect on the consolidated net assets or liquidity of the company and, in the opinion of management, adequate provision has been made for income and franchise taxes for all years either under examination or subject to future examination.\nAt December 31, 1994, the company and its subsidiaries, as direct or indirect guarantors, had contingent liabilities of $249 for notes of affiliated companies and $55 for notes of others.\nThe company and its subsidiaries have certain contingent liabilities with respect to long-term unconditional purchase obligations and commitments, throughput agreements and take-or-pay agreements, some of which relate to suppliers' financing arrangements. The aggregate amount of required payments under these various commitments are: 1995-$141; 1996-$137; 1997-$102; 1998-$89; 1999-$86; 2000 and after-$497. Total payments under the agreements were $154 in 1994, $142 in 1993 and $128 in 1992.\nIn March 1992, an agency within the Department of Energy (DOE) issued a Proposed Remedial Order (PRO) claiming Chevron failed to comply with DOE regulations in the course of its participation in the Tertiary Incentive Program. Although the DOE regulations involved were rescinded in March 1981, following decontrol of crude oil prices in January 1981, and the statute authorizing the regulations expired in September 1981, the PRO purports to be for the period April 1980 through April 1990. The PRO claimed the company overrecouped under the regulations by $125 during the period in question. Including interest through December 1994, the total claim amounted to $295. The DOE is seeking to increase the claim by an additional $42, plus interest, of alleged over-recovery. The company asserts that in fact it incurred a loss through participation in the DOE program. Discovery has been completed and evidentiary hearings are in progress before the Office of Hearings and Appeals.\nThe company is subject to loss contingencies pursuant to environmental laws and regulations that in the future may require the company to take action to correct or ameliorate the effects on the environment of prior disposal or release of chemical or petroleum substances by the company or other parties. Such contingencies may exist for various sites including, but not limited to: Superfund sites and refineries, oil fields, service stations, terminals and land development areas, whether operating, closed or sold. The amount of such future cost is indeterminable due to such factors as the unknown magnitude of possible contamination, the unknown 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. While the company provides for known environmental obligations that are probable and reasonably estimable, the amount of future costs may be material to results of operations in the period in which they are recognized.\nThe company's operations, particularly oil and gas exploration and production, can be affected by changing economic, regulatory and political environments in the various countries, including the United States, in which it operates. In certain locations, host governments have imposed restrictions, controls and taxes, and, in others, political conditions have existed that may threaten the safety of employees and the company's continued presence in those countries. Internal unrest or strained relations between a host government and the company or other governments may affect the company's operations. Those developments have, at times, significantly affected the company's related operations and results, and are carefully considered by management when evaluating the level of current and future activity in such countries.\nAreas in which the company has significant operations include the United States, Australia, United Kingdom, Canada, Nigeria, Angola, Congo, Papua New Guinea, China, Indonesia and Zaire. The company's Caltex affiliates have significant operations in Indonesia, Japan, Korea, Australia, the Philippines, Thailand and South Africa. The company's Tengizchevroil affiliate operates in Kazakhstan. FS-29\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES Unaudited\nIn accordance with Statement of Financial Accounting Standards No. 69, \"Disclosures about Oil and Gas Producing Activities\" (SFAS 69), this section provides supplemental information on oil and gas exploration and producing activities of the company in six separate tables. The first three tables provide historical cost information pertaining to costs incurred in exploration, property acquisitions and development; capitalized costs; and results of operations. Tables IV through VI present information on the company's estimated net proved reserve quantities, standardized measure of estimated discounted future net cash flows related to proved reserves, and changes in estimated discounted future net cash flows. The Africa geographic area includes activities in Nigeria, Angola, Zaire, Congo and other countries. The \"Other\" geographic category includes activities in Australia, the United Kingdom North Sea, Canada, Papua New Guinea and other countries. Amounts shown for affiliated companies are Chevron's 50 percent equity share in each of P.T. Caltex Pacific Indonesia (CPI), an exploration and production company operating in Indonesia, and Tengizchevroil (TCO), an exploration and production company operating in the Republic of Kazakhstan, which began operations in April 1993.\nTABLE I - COSTS INCURRED IN EXPLORATION, PROPERTY ACQUISITIONS AND DEVELOPMENT (1)\nFS-30\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - Continued Unaudited\nTABLE II - CAPITALIZED COSTS RELATING TO OIL AND GAS PRODUCING ACTIVITIES\nFS-31\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - Continued Unaudited\nTABLE III - RESULTS OF OPERATIONS FOR OIL AND GAS PRODUCING ACTIVITIES (1)\nThe company's results of operations from oil and gas producing activities for the years 1994, 1993 and 1992 are shown below.\nNet income from exploration and production activities as reported on page FS-7 reflects income taxes computed on an effective rate basis. In accordance with SFAS 69, income taxes below are based on statutory tax rates, reflecting allowable deductions and tax credits. Results reported below exclude any allocation of corporate overhead; net income for 1993 and 1992 reported on page FS-7 includes allocated corporate overhead, but 1994 does not. Interest expense is excluded from the results reported below and from the net income amounts on page FS-7.\nFS-32\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - Continued Unaudited\nTABLE III - RESULTS OF OPERATIONS FOR OIL AND GAS PRODUCING ACTIVITIES (1) - Continued\nTABLE IV - RESERVE QUANTITIES INFORMATION\nThe company's estimated net proved underground oil and gas reserves and changes thereto for the years 1994, 1993 and 1992 are shown in the following table. These quantities are estimated by the company's reserves engineers and reviewed by the company's Reserves Advisory Committee using reserve definitions prescribed by the Securities and Exchange Commission.\nProved reserves are the estimated quantities that geologic and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Due to the inherent uncertainties and the limited nature of reservoir data, estimates of underground reserves are subject to change over time as additional information becomes available.\nProved reserves do not include additional quantities recoverable beyond the term of lease or contract unless renewal is reasonably certain, or that may result from extensions of currently proved areas, or from application of secondary or tertiary recovery processes not yet tested and determined to be economic.\nProved developed reserves are the quantities expected to be recovered through existing wells with existing equipment and operating methods.\n\"Net\" reserves exclude royalties and interests owned by others and reflect contractual arrangements and royalty obligations in effect at the time of the estimate.\nProved reserves for Tengizchevroil (TCO), the company's 50 percent owned affiliate in Kazakhstan, do not include reserves that will be produced when a dedicated export system is in place.\nFS-33\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - Continued Unaudited\nTABLE IV - RESERVE QUANTITIES INFORMATION - Continued\nTABLE V - STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATED TO PROVED OIL AND GAS RESERVES\nThe standardized measure of discounted future net cash flows, related to the above proved oil and gas reserves, is calculated in accordance with the requirements of SFAS 69. Estimated future cash inflows from production are computed by applying year-end prices for oil and gas to year-end quantities of estimated net proved reserves. Future price changes are limited to those provided by contractual arrangements in existence at the end of each reporting year. Future development and production costs are those estimated future expenditures necessary to develop and produce year-end estimated proved reserves based on year-end cost indices, assuming continuation of year-end economic conditions. Estimated future income taxes are calculated by applying appropriate year-end statutory tax rates. These rates reflect allowable deductions and tax credits and are applied to estimated future pre-tax net cash flows, less the tax basis of related assets. Discounted future net cash flows are calculated using 10 percent midperiod discount factors. This discounting requires a year-by-year estimate of when the future expenditures will be incurred and when the reserves will be produced.\nThe information provided does not represent management's estimate of the company's expected future cash flows or value of proved oil and gas reserves. Estimates of proved reserve quantities are imprecise and change over time as new information becomes available. Moreover, probable and possible reserves, which may become proved in the future, are excluded from the calculations. The arbitrary valuation prescribed under SFAS 69 requires assumptions as to the timing of future production from proved reserves and the timing and amount of future development and production costs. The calculations are made as of December 31 each year and should not be relied upon as an indication of the company's future cash flows or value of its oil and gas reserves.\nFS-34\nSUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES - Continued Unaudited\nTABLE V - STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATED TO PROVED OIL AND GAS RESERVES - Continued\nTABLE VI - CHANGES IN THE STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS FROM PROVED RESERVES\nThe changes in present values between years, which can be significant, reflect changes in estimated proved reserve quantities and prices and assumptions used in forecasting production volumes and costs. Changes in the timing of production are included with \"Revisions of previous quantity estimates.\" The increase for 1994 reflected higher crude oil prices and natural gas reserve quantity increases, partially offset by lower natural gas prices. The decline from 1992 to 1993 was due primarily to lower crude oil prices.\nFS-35\nFIVE-YEAR FINANCIAL SUMMARY (1)\nFS-36\nCALTEX GROUP OF COMPANIES COMBINED FINANCIAL STATEMENTS\nDECEMBER 31, 1994\nC-1\nCALTEX GROUP OF COMPANIES COMBINED FINANCIAL STATEMENTS DECEMBER 31, 1994\nINDEX\nPAGE -------------\nGeneral Information C-3 to C-4\nIndependent Auditors' Report C-5\nCombined Balance Sheet C-6 to C-7\nCombined Statement of Income C-8\nCombined Statement of Retained Earnings C-9\nCombined Statement of Cash Flows C-9\nNotes to Combined Financial Statements C-10 to C-20\nNote: Financial statement schedules are omitted as permitted by Rule 4.03 and Rule 5.04 of Regulation S-X.\nC-2\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.\nC-3\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.\nC-4\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\nare 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.\"\n\/s\/ KPMG Peat Marwick LLP\nDallas, Texas February 14, 1995\nC-5\nCALTEX GROUP OF COMPANIES COMBINED BALANCE SHEET - DECEMBER 31, 1994 AND 1993 (MILLIONS OF DOLLARS)\nASSETS\n1994 1993 ------- ------- CURRENT ASSETS:\nCash and cash equivalents (including time deposits of $136 in 1994 and $64 in 1993) $ 251 $ 166\nNotes and accounts receivable, less allowance for doubtful accounts of $14 in 1994 and 1993: Trade 1,107 950 Other 187 155 Nonsubsidiary companies 88 112 ------- ------- 1,382 1,217 Inventories: Crude oil 132 148 Refined products 573 532 Materials and supplies 73 56 ------- ------- 778 736\nDeferred income taxes 10 4 ------- ------- Total current assets 2,421 2,123\nINVESTMENTS AND ADVANCES:\nNonsubsidiary companies at equity 2,370 1,796 Miscellaneous investments and long-term receivables, less allowance of $8 in 1994 and $7 in 1993 198 195 ------- ------- 2,568 1,991\nPROPERTY, PLANT AND EQUIPMENT, AT COST:\nProducing 3,284 3,027 Refining 1,787 1,483 Marketing 2,552 2,252 Marine 35 35 Capitalized leases 119 119 ------- ------- 7,777 6,916\nLess: Accumulated depreciation, depletion and amortization 3,165 2,878 ------- ------- 4,612 4,038 PREPAID AND DEFERRED CHARGES 209 237 ------- ------- Total assets $9,810 $8,389 ======= =======\nSee accompanying Notes to Combined Financial Statements.\nC-6\nCALTEX GROUP OF COMPANIES COMBINED BALANCE SHEET - DECEMBER 31, 1994 AND 1993 (MILLIONS OF DOLLARS)\nLIABILITIES AND STOCKHOLDERS' EQUITY\n1994 1993 ------- ------- CURRENT LIABILITIES:\nNotes payable to banks and other financial institutions $1,229 $ 966\nLong-term debt due within one year 157 51\nAccounts payable: Trade and other 1,240 967 Stockholder companies 77 87 Nonsubsidiary companies 123 149 ------- ------- 1,440 1,203\nAccrued liabilities 113 86\nEstimated income taxes 133 105 ------- ------- Total current liabilities 3,072 2,411\nLONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS 715 530\nACCRUED LIABILITY FOR EMPLOYEE BENEFITS 113 98\nDEFERRED CREDITS AND OTHER NON-CURRENT LIABILITIES 789 646\nDEFERRED INCOME TAXES 236 263\nMINORITY INTEREST IN SUBSIDIARY COMPANIES 152 146\nSTOCKHOLDERS' EQUITY:\nCommon stock 355 355 Additional paid-in capital 2 2 Retained earnings 3,898 3,688 Currency translation adjustment 399 250 Unrealized holding gain on investments 79 - ------- ------- Total stockholders' equity 4,733 4,295\nCOMMITMENTS AND CONTINGENT LIABILITIES ------- -------\nTotal liabilities and stockholders' equity $9,810 $8,389 ======= =======\nSee accompanying Notes to Combined Financial Statements.\nC-7\nCALTEX GROUP OF COMPANIES COMBINED STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (MILLIONS OF DOLLARS)\n1994 1993 1992 ------- ------- -------\nSALES AND OTHER OPERATING REVENUES (1) $14,751 $15,409 $17,281\nOPERATING CHARGES: Cost of sales and operating expenses (2) 12,801 13,431 15,348 Selling, general and administrative expenses 568 496 479 Depreciation, depletion and amortization 331 295 263 Maintenance and repairs 160 170 165 ------- ------- ------- 13,860 14,392 16,255\nOperating income 891 1,017 1,026\nOTHER INCOME (DEDUCTIONS): Equity in net income of nonsubsidiary companies 263 140 163 Dividends, interest and other income 134 99 83 Foreign exchange, net (73) 23 21 Interest expense (101) (93) (102) Minority interest in subsidiary companies (3) (8) (13) ------- ------- ------- 220 161 152 ------- ------- -------\nIncome before provision for income taxes and cumulative effects of changes in accounting principles 1,111 1,178 1,178 ------- ------- -------\nPROVISION FOR INCOME TAXES: Current 467 433 456 Deferred (45) 25 53 ------- ------- ------- Total provision for income taxes 422 458 509 ------- ------- -------\nIncome before cumulative effects of changes in accounting principles 689 720 669 Cumulative effects of changes in accounting principles - - 51 ------- ------- ------- Net income $ 689 $ 720 $ 720 ======= ======= ======= (1) Includes sales to: Stockholder companies $ 1,192 $ 907 $ 835 Nonsubsidiary companies $ 1,044 $ 944 $ 924\n(2) Includes purchases from: Stockholder companies $ 1,800 $ 3,333 $ 3,917 Nonsubsidiary companies $ 1,612 $ 1,385 $ 641\nSee accompanying Notes to Combined Financial Statements.\nC-8\nCALTEX GROUP OF COMPANIES COMBINED STATEMENT OF RETAINED EARNINGS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (MILLIONS OF DOLLARS)\n1994 1993 1992 ------- ------- ------- Balance at beginning of year $3,688 $3,310 $2,955 Net income 689 720 720 Cash dividends (479) (342) (365) ------- ------- ------- Balance at end of year $3,898 $3,688 $3,310 ======= ======= =======\nCOMBINED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (MILLIONS OF DOLLARS)\n1994 1993 1992\n------- ------- ------- OPERATING ACTIVITIES: Net income $689 $720 $720 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effects of changes in accounting principles - - (51) Depreciation, depletion and amortization 331 295 263 Dividends from nonsubsidiary companies, less than equity in net income (220) (103) (133) Net gains on asset sales (17) (4) (4) Deferred income taxes (45) 25 53 Prepaid charges and deferred credits 115 (41) 25 Changes in operating working capital 58 31 (58) Other 77 10 (46) ------- ------- ------- Net cash provided by operating activities 988 933 769 ------- ------- -------\nINVESTING ACTIVITIES: Capital expenditures (837) (763) (711) Investments in and advances to nonsubsidiary companies (131) (149) (17) Net purchases\/sales of investment instruments 14 (21) (11) Proceeds from asset sales 37 73 144 ------- ------- ------- Net cash used in investing activities (917) (860) (595)\nFINANCING ACTIVITIES: Proceeds from borrowings having original terms in excess of three months 1,257 745 831 Repayments of borrowings having original terms in excess of three months (880) (704) (857) Net increase in other borrowings 135 140 94 Dividends paid, including minority interest (482) (342) (365) ------- ------- ------- Net cash provided by (used in) financing activities 30 (161) (297) ------- ------- ------- Effect of exchange rate changes on cash and cash equivalents (16) 15 (8) ------- ------- ------- NET CHANGE IN CASH AND CASH EQUIVALENTS 85 (73) (131) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 166 239 370 ------- ------- ------- CASH AND CASH EQUIVALENTS AT END OF YEAR $251 $166 $239 ======= ======= =======\nSee accompanying Notes to Combined Financial Statements.\nC-9\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.\nC-10\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.\nC-11\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):\nEquity Share 1994 1993 ------------ ------- -------\nNippon Petroleum Refining Company, Ltd. 50% $ 997 $ 829 Koa Oil Company, Ltd. 50% 448 310 Honam Oil Refinery Company, Ltd. 50% 557 423 All other Various 368 234 ------- ------- $2,370 $1,796 ======= =======\nShown below is summarized combined financial information for these nonsubsidiary companies (in millions):\n100% Equity Share ------------------ ------------------ 1994 1993 1994 1993\n------- ------- ------- ------- Current assets $5,352 $4,680 $2,651 $2,316 Other assets 7,821 6,147 3,858 2,975\nCurrent liabilities 4,940 4,900 2,363 2,349 Other liabilities 3,504 2,306 1,776 1,146 Net worth 4,729 3,621 2,370 1,796\n100% Equity Share ------------------------- ------------------------- 1994 1993 1992 1994 1993 1992 ------------------------- ------------------------- Operating revenues $10,886 $10,679 $10,502 $5,418 $5,304 $5,216 Operating income 770 494 645 381 242 319 Net income 526 281 326 263 140 163\nC-12\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):\n1994 1993 ------- -------\nU.S. dollars: Variable interest rate term loans $233 $173 Fixed interest rate term loans with 7.6% average rate 206 220 Australian dollars: Debentures with interest rates at 12.5% due 1996 4 8 Promissory notes payable with 7.2% average rate 81 76 Fixed interest rate loan with 11.2% rate due 2001 132 - Commercial paper with 7.0% average rate 23 - Capital lease obligations 11 33 New Zealand dollars: Term loans with interest rates 6-6.35% due 1996-1997 16 14 Other 9 6 ------- ------- $715 $530 ======= =======\nC-13\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):\nAssets Exceed Accumulated Accumulated Benefits Funding Status Benefits Exceed Assets -------------- ------------- -------------\n1994 1993 1994 1993 ------ ------ ------ ------\nActuarial present value of: Vested benefit obligation $282 $280 $137 $117 Accumulated benefit obligation 317 309 161 137 Projected benefit obligation 493 484 225 195\nAmount of assets available for benefits: Funded assets at fair value $435 $450 $ 58 $ 39 Net pension (asset) liability recorded (8) (11) 136 128 ------ ------ ------ ------ Total assets $427 $439 $194 $167 ====== ====== ====== ======\nAssets less than projected benefit obligation $(66) $(45) $(31) $(28)\nConsisting of: Unrecognized transition net assets (liabilities) 16 31 (3) (2) Unrecognized net losses (55) (44) (25) (23) Unrecognized prior service costs (27) (32) (3) (3)\nWeighted average rate assumptions: Discount rate 9.7% 9.5% 6.6% 6.5% Rate of increase in compensation 7.2% 7.4% 4.6% 4.7% Expected return on plan assets 10.2% 10.3% 5.5% 5.5%\nC-14\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(7) EMPLOYEE BENEFITS - CONTINUED\nExpenses (Funded & Unfunded Combined) 1994 1993 1992 -------- ------ ------- ------- Cost of benefits earned during the year $27 $27 $26 Interest cost on projected benefit obligation 55 58 54 Actual return on plan assets (23) (59) (9) Net amortization and deferral (16) 16 (38) ------ ------- ------- $43 $42 $33 ====== ======= =======\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.\nC-15\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):\n1994 1993 ------- ------- Interest rate swaps - Pay Fixed, Receive Floating $363 $294 Interest rate swaps - Pay Floating, Receive Fixed $182 $ 50 Commitments to purchase foreign currencies $252 $244 Commitments to sell foreign currencies $274 $183\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.\nC-16\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):\n1994 1993 1992 ------- ------- ------- Taxes other than income taxes: Duties, import and excise taxes $2,384 $1,978 $1,891 Other 32 29 29 ------- ------- ------- Total taxes other than income taxes 2,416 2,007 1,920 Provision for income taxes 422 458 509 ------- ------- ------- $2,838 $2,465 $2,429 ======= ======= =======\nC-17\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:\n1994 1993 1992 ------- ------- ------- Computed \"expected\" tax expense 35.0% 35.0% 34.0%\nEffect of recording equity in net income of nonsubsidiary companies on an after tax basis (8.3) (4.2) (4.9)\nEffect of dividends received from subsidiary and nonsubsidiary companies 4.4 4.2 3.8\nForeign income subject to foreign taxes in excess of U.S. statutory tax rate 6.9 7.4 11.6\nIncrease\/(Decrease) in deferred tax asset valuation allowance .3 (3.1) (.4)\nOther (.3) (.4) (.9) ------- ------- ------- 38.0% 38.9% 43.2% ======= ======= =======\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):\nDeferred Deferred Tax Assets Tax Liabilities ---------------- --------------- 1994 1993 1994 1993 ------ ------ ------ ------ Inventory $ 17 $ 10 $ 12 $ 18 Depreciation - - 310 298 Retirement plans 34 33 2 3 Tax loss carryforwards 27 29 - - Investment allowances 40 8 - - Other 30 20 41 34 ------ ------ ------ ------ 148 100 365 353 Valuation allowance (9) (6) - - Total deferred taxes $139 $ 94 $365 $353 ====== ====== ====== ======\nC-18\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):\n1994 1993 1992 ------- ------- -------\nNotes and accounts receivable $(97) $ 82 $ (45) Inventories (37) 66 (114) Accounts payable 152 (147) 212 Accrued liabilities 16 16 (27) Estimated income taxes 24 14 (84) ------- ------- ------- Total $ 58 $ 31 $ (58) ======= ======= =======\n\"Net Cash Provided by Operating Activities\" includes the following cash payments for interest and income taxes (in millions):\n1994 1993 1992 ------- ------- ------- Interest paid (net of capitalized interest) $ 94 $ 92 $106\nIncome taxes paid $444 $391 $528\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.\nC-19\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.\nC-20","section_15":""}
{"filename":"63330_1994.txt","cik":"63330","year":"1994","section_1":"Item 1. Business (a) General Maui Land & Pineapple Company, Inc. is a Hawaii corporation, the successor to a business organized in 1909. The Company consists of a land- holding and operating parent company as well as its principal wholly-owned subsidiaries, Maui Pineapple Company, Ltd., Kapalua Land Company, Ltd., Kapalua Investment Corp., Kapalua Waste Treatment Company, Ltd., Kapalua Water Company, Ltd. and Honolua Plantation Land Company, Inc. Maui Pineapple Company, Ltd. and Kapalua Land Company, Ltd. are the major operating subsidiaries. The Company, as used herein, refers to the parent and all of its subsidiaries.\n(b) Financial Information About Industry Segments The information set forth under Note 16 to Consolidated Financial Statements on page 18 of the Maui Land & Pineapple Company, Inc. 1994 Annual Report to Stockholders is incorporated herein by reference.\n(c) Narrative Description of Business The Company's principal activities are Pineapple, Resort and Commercial & Property. (1) Pineapple In 1994 pineapple recorded an $867,000 operating loss. After allocations for interest and corporate expenses, the total loss was $4.4 million. This was a significant improvement over 1993 financial results and was primarily a result of severe cost cutting in operations. Due to the continuing worldwide oversupply of canned pineapple, the marketplace for canned pineapple did not improve. Imports of canned pineapple, although lower than in 1993, remained at high levels. This has put extreme downward pressure on the Company's case sales volume and pricing structure. Case sales volume was down 7% from 1993 and pricing was at the same low level as 1993. The retail and institutional categories are the areas of the business most seriously affected by imports. Case sales volume for fruit and juice was down 11% from 1993 and pricing was flat in both categories. Sales to the government, export sales and juice concentrate, however, recorded increases in case volume of 35%, 12% and 8%, respectively. Prices in government and export sales remained flat, while concentrate prices improved slightly from 1993 levels.\nOur Jet Fresh program to the U.S. mainland showed growth and made a positive income contribution for 1994. Case sales increased by 10% and total revenues grew 7% from 1993. Local fresh fruit sales posted a 7% increase in revenues. In June of 1994 Maui Pineapple Company, Ltd., along with the International Longshoremen's and Warehousemen's Union, filed an anti- dumping petition with the International Trade Commission. The petition alleged that Thai canned pineapple producers were breaking U.S. and international trade laws by selling in the U.S. below their production costs. This below cost pricing resulted in extremely low prices in 1993 and 1994, which greatly affected our Company, its employees, stockholders and the companies with whom we do business. Preliminary decisions in the Company's favor have been made by the International Trade Commission and the U.S. Department of Commerce for both injury and anti-dumping duties. By May of 1995 the Company expects to receive final decisions on injury and anti-dumping duties. Looking forward to 1995 we continue to see an extremely competitive market, regardless of the anti-dumping petition outcome. The Company has changed its strategic direction to further reduce its exposure to oversupply because of lower cost foreign producers. This change of strategy involves entry into new business segments, product line additions, strategic alliances, and improved customized product packaging capabilities to meet niche business opportunities in the marketplace where we enjoy a competitive advantage. In 1994 we made substantial progress in identifying these opportunities. We are preparing for entry into these new markets in 1995. Financial and volume objectives for these new business opportunities are modest in our 1995 plan. In 1994 we increased our emphasis on marketing. Our gaol is a transition from trade-oriented marketing to a trade and consumer-oriented marketing. Modest consumer advertising efforts were successful in 1994. We plan to expand consumer-oriented advertising in 1995. The focal point of all our marketing activities will be our \"100% Hawaiian U.S.A.\" message. Maui Pineapple Company, Ltd. is the operating subsidiary for pineapple. It owns and operates fully-integrated facilities for the production of pineapple products. Pineapple is cultivated on two company-operated plantations on Maui which provided approximately 75% of the fruit processed in 1994. The balance of fruit processed was purchased from independent growers, a substantial portion of which is from Wailuku Agribusiness Co., Inc. under\nlong-term contract. Two pineapple crops are normally harvested from each new planting. The first, or plant crop, is harvested approximately 18 to 23 months after planting, and the second, or ratoon crop, is harvested 12 to 14 months later. Harvested pineapple is processed at the Company's cannery in Kahului, Maui, where a full line of canned pineapple products is produced, including solid pineapple in various grades and styles, juice, and juice concentrates. The cannery operates most of the year; however, over 50% of production volume takes place during June, July and August. The metal containers used in canning pineapple are produced in the Company-owned can plant. Warehouses are maintained at the cannery site for inventory purposes. The Company sells pineapple products under buyers' labels principally to large grocery chains, other food processors, wholesale grocers, and to organizations offering a complete buyers' brand program to affiliated chains and wholesalers serving both retail and food service outlets. A substantial volume of its pineapple products is marketed through food brokers. Maui Pineapple Company, Ltd. is the sole supplier of private label, 100% Hawaiian canned pineapple products to United States supermarkets. In 1994, approximately 20 domestic customers accounted for about 51% of pineapple sales. Export sales, chiefly to Japan, Canada and Western Europe, amounted to approximately 6.2%, 5.2% and 7.1% of total pineapple sales in 1994, 1993 and 1992, respectively. Sales to the U.S. government amounted to approximately 11.8%, 8.5% and 8.7% of total pineapple sales in 1994, 1993 and 1992, respectively. The Company's pineapple sales office is in Concord, California. As a service to its customers, the Company maintains inventories of its products in public warehouses in the continental United States. The balance of its products are shipped directly from Hawaii to its customers. The Company sells its products in competition with both foreign and U.S. companies. Its principal competitors are two U.S. companies which produce sizable quantities of pineapple, a significant portion of which is produced in the Philippines. Producers in other foreign countries (particularly Thailand) are also a major source of competition. Although foreign production has the advantage of lower hourly labor costs, the Company is able to maintain its market position through other production and shipping cost advantages, and by producing high quality canned products. Other canned fruits and fruit juices are also a source of\ncompetition. Generally, the price of the Company's products is influenced by supply and demand of pineapple and other fruits and juices. To grow and harvest its crops and operate its cannery, the Company employed approximately 1,000 year-round employees and hired approximately 550 seasonal workers in 1994.\n(2) Resort Kapalua resort had a loss, before allocated interest and corporate expenses, of $2.2 million in 1994 compared to a loss of $1.6 million in 1993. Increased losses from development-related activities more than offset substantial profit improvement from Kapalua's on-going resort operations. Development activities, in total, showed a loss of $5 million in 1994 compared to a loss of $1.6 million the year before. Most of this increase was from Kaptel Associates, The Ritz-Carlton Kapalua hotel joint venture. The loss allocation increased in 1994 because there were no loss allocations to the Company until the last quarter of 1993. The Ritz- Carlton Kapalua reported significantly improved profits from operations in 1994 as compared to 1993; however, debt service continued to result in substantial losses and cash flow deficits. In February and March 1995, Kaptel was only able to make partial payment on its debt service. The lenders have notified Kaptel that partial payment constituted an event of default, but as of March 15, 1995, the lenders have not accelerated the loan. The Kaptel partners are presently attempting to work with the lenders to restructure the hotel financing. At this stage the resolution of this situation cannot be predicted. See Note 3 to Consolidated Financial Statements in Maui Land & Pineapple Company, Inc. 1994 Annual Report to shareholders. Resorts on-going operations posted a profit of $2.8 million for 1994, an increase of over $3 million from the loss in 1993. Cash flow from resort operations increased in 1994 to a positive $4.4 million. Improved financial performance in 1994 was helped only slightly by better market conditions in both the visitor industry and resort real estate markets. After three consecutive years of decline, the visitor industry reported a 5% increase in the number of total visitors to Hawaii with both the eastbound and westbound markets showing single digit growth. Average hotel occupancy for Hawaii increased 6% last year with Maui showing the strongest growth of any island. Both the visitor industry and real\nestate markets, however, are just beginning to recover and remain well below their peak levels of four years ago. Resort occupancy at Kapalua increased for the second consecutive year to just over 56%. This was well below the average occupancy for Maui, primarily because the resort is competing in the over-supplied luxury hotel market. Most of the 1994 profit improvement in operations came from internal efforts to reduce costs throughout the Company and to develop new revenues. More than half of this improvement came from recreation and retail activities with the largest single increase from the new resort membership program called The Kapalua Club. Revenues for golf, tennis and merchandise sales increased less than 2% in 1994. Unusually wet and windy weather during our busy season resulted in lower golf and tennis play. The Kapalua Villas, our short-term rental operations, produced its first profit from a 17% increase in gross revenues and a 22% increase in the number of villas in the rental program. Kapalua Realty had its best year since the downturn in the real estate market four years ago. Total resale volume more than doubled and the net loss was reduced by over $100,000. The Kapalua resort development is a destination resort community in West Maui. The resort borders the ocean and includes two hotels, 528 condominium units, three residential subdivisions, three championship golf courses, two ten-court tennis facilities, a 22,000 square foot commercial shopping center, restaurants, a water utility and a waste transmission utility. Kapalua Land Company, Ltd. is the developer of the Kapalua resort. It operates the golf and tennis facilities, the commercial shopping center, a short-term vacation rental program (The Kapalua Villas) and certain retail outlets in the resort. It is the provider of certain services to the resort including shuttle, security and the maintenance of common areas. Kapalua Land Company, Ltd. also receives rental income from the lease of certain properties to third parties. Kapalua Realty Company, Ltd. (a wholly-owned subsidiary of Kapalua Land Company, Ltd.) is a general brokerage real estate company located within the resort. Kapalua Water Company, Ltd. and Kapalua Waste Treatment Company, Ltd. (wholly-owned subsidiaries of the Company) are public utilities providing water and waste transmission services to the Kapalua resort.\nKapalua Land Company, Ltd. and Rolfing Partners formed a joint venture in November of 1988 to finance and develop the third 18-hole golf course and Plantation Estate Phase I and Phase II, two residential development projects at Kapalua. Five lots in Plantation Estates Phase I and allocated planning and offsite costs related to Plantation Estates Phase II, remain in inventory at December 31, 1994. Kapalua Investment Corp. (a wholly-owned subsidiary of the Company), Maui Hotels (a subsidiary of The Ritz-Carlton Hotel Company) and NI Hawaii Resort, Inc. (a subsidiary of Nissho Iwai Corp.) are the general partners of Kaptel Associates. The partnership is the owner of The Ritz-Carlton Kapalua hotel which opened in October of 1992. The partnership is leasing the 36-acre hotel site from the Company under a long-term lease. The Kapalua resort faces substantial competition from existing and planned resort developments throughout Hawaii and the world. Kapalua is adjacent to the Napili resort area and is approximately five miles from the Kaanapali resort area. The Company employed approximately 360 employees in its resort operations at December 31, 1994.\n(3) Commercial & Property The Company's commercial & property business segment produced substantially lower revenues and operating profits in 1994 compared to 1993. Revenues decreased from $13.6 million to $10.6 million in 1994 and operating profits decreased by $3.7 million from $9.1 million in 1993 to $5.4 million in 1994. The decreases result primarily from lower revenues from land sales and from proceeds of a condemnation which were included in revenues and operating profit for 1993. Revenues at Kaahumanu Center, the Company's largest commercial property, were up substantially in 1994, particularly in the fourth quarter of the year, compared to 1993. The increase in revenues was due to completion of the Center's renovation and expansion project and the installation of a number of new tenants. The operating profit contribution from Kaahumanu Center was slightly lower in 1994 than 1993, due in part to the construction activity. Napili Plaza, the Company's second largest commercial property, experienced slightly higher revenues in 1994 and contributed about the same level of operating profit as in 1993. In late October of 1994 the Company received final approval from the County of Maui to open the redeveloped Kaahumanu Center for business. The expanded and renovated Liberty House and Sears department stores and the\nnew J.C. Penney store were open for the Christmas season, together with a number of new tenants. Kaahumanu Center is currently over 90% leased. Our partner in the redevelopment project, the Employees' Retirement System of the State of Hawaii (ERS) was scheduled to convert its $30.6 million construction loan on this project into additional partnership equity upon completion of the construction period. It is now anticipated that the ERS will convert its loan in late March. Napili Plaza continues to experience a relatively high vacancy level due to highly competitive leasing conditions for commercial property in West Maui and the continued relatively low visitor count. Commercial & Property includes Kaahumanu Center, Napili Plaza and other non-resort property rentals and sales. Kaahumanu Center is a regional shopping mall and office building located in Kahului on the island of Maui. On December 31, 1994, 89% of the available gross leasable area was occupied by 112 tenants. The Center's primary competitor is the Maui Mall which is located within one mile of Kaahumanu Center. Napili Plaza is a 44,000 square foot retail and commercial office center located in West Maui. The first tenants in Napili Plaza began operation in January of 1992. As of December 31, 1994, 71% of the gross leasable area was occupied by 15 tenants. Napili Plaza faces competition from several other retail locations in the Napili area. In June of 1993 Kaahumanu Center Associates (KCA) was formed to finance the expansion of and to own and operate the Kaahumanu Center. KCA is a partnership between the Company as general partner and the Employees' Retirement System of the State of Hawaii as a limited partner. The renovation which was completed in November of 1994, expanded the Center from approximately 315,000 to 525,000 square feet of gross leasable area.\n(4) Other Information The Company engages in continuous research to develop techniques to reduce costs through crop production innovations. Improved production systems have resulted in increased productivity by the labor force. Research and development expenses approximated $285,000 in 1994, $416,000 in 1993 and $466,000 in 1992. The Company has reviewed its compliance with Federal, State and local provisions which regulate the discharge of materials into the environment. It does not expect any material financial impact as a result of compliance with these laws.\nThe Company's method of disposing of pineapple processing waste water utilizes underground injection wells. In recent years, such methods have come under the scrutiny of the regulatory agencies. The Company's capital expenditure budget for 1995 includes $2.2 million for a system which will totally replace the existing method of disposing of processing waste water. In total, the Company employed approximately 2,000 people in 1994.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales. Export sales only arise through the pineapple company. Export sales of pineapple products are made chiefly to Japan, Western Europe and Canada. For the last three years these sales did not exceed 10% of total consolidated revenues.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES The Company owns approximately 28,700 acres of land on the island of Maui. This land, most of which was acquired from 1911 to 1932, is carried at cost. The Company believes it has clear and unencumbered marketable title to all of the preceding property except for the following: (1) a $13,890,000 mortgage loan on Kaahumanu Center; *(2) a $35,000,000 second mortgage on Kaahumanu Center, securing the bank construction loan for the Kaahumanu Center renovation; and a $30,588,000 third mortgage to the Employees' Retirement System of the State of Hawaii. *(3) a mortgage on the fee and leasehold interest of the 36-acre Ritz- Carlton Kapalua Hotel site, which secures a loan to Kaptel Associates for $186,250,000; (4) a perpetual conservation easement granted to the State of Hawaii on a 13-acre parcel at Kapalua; (5) certain existing easements and rights-of-way that do not materially affect the Company's use of such property; *(6) a mortgage on the land underlying the Kapalua Bay Hotel, The Kapalua Shops, The Bay Club, approximately 12 acres of undeveloped land at Kapalua and the Napili Plaza, which secures the $30,588,000 loan from the Employees' Retirement System of the State of Hawaii. (7) a mortgage on the three golf courses at Kapalua, which secures the Company's $27.8 million revolving credit arrangement; (8) a permanent conservation easement granted to The Nature Conservancy, a non-profit corporation, covering approximately 8,600 acres; and\n(9) a small percentage of the Company's land in various locations on which multiple claims exist and for which the Company has initiated quiet title actions. *See Note 3 to Consolidated Financial Statements in the Maui Land & Pineapple Company, Inc. 1994 Annual Report to Shareholders. Approximately 22,400 acres of the Company's land are located in West Maui, approximately 6,200 acres are located at its Haliimaile plantation in central Maui, and approximately 60 acres are located in Kahului, Maui. The 22,800 acres in West Maui comprise a largely contiguous parcel which extends from the sea to an elevation of approximately 5,700 feet and includes nine miles of ocean frontage with approximately 3,300 lineal feet along sandy beaches, as well as agricultural and grazing lands, gulches, and heavily forested areas. The Haliimaile property is situated at elevations between 1,000 and 3,000 feet above sea level on the slopes of Haleakala. Approximately 6,500 acres of Company-owned land are used directly or indirectly in the pineapple operations and approximately 1,500 acres are designated for the Kapalua resort. The Kahului acreage includes offices, a can manufacturing plant and pineapple processing cannery, interconnected warehouses at the cannery site where finished product is stored and the Kaahumanu Center. The remaining land is primarily in pasture or forest reserve. Approximately 2,800 acres of leased land are used in the Company's pineapple operations. A major operating lease covers approximately 1,500 acres of land. The balance of the leased property is covered under eight leases expiring variously through 2006. The aggregate land rental for these leases was $398,000 in 1994.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS None.\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 REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER MATTERS The information set forth under the caption \"Common Stock\" on page 19 of the Maui Land & Pineapple Company, Inc. 1994 Annual Report to Stockholders is incorporated herein by reference.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA The information set forth under the caption \"Selected Financial Data\" on page 20 of the Maui Land & Pineapple Company, Inc. 1994 Annual Report to Stockholders is incorporated herein by reference.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on pages 21 through 23 of the Maui Land & Pineapple Company, Inc. 1994 Annual Report to Stockholders is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The \"Independent Auditors' Report,\" \"Consolidated Financial Statements,\" \"Notes to Consolidated Financial Statements\" on pages 7 through 18 of the Maui Land & Pineapple Company, Inc. 1994 Annual Report to Stockholders are incorporated herein by reference.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information set forth under the captions \"Compliance with Section 16(a) of the Exchange Act\" and \"Election of Directors\" on pages 6 through 8 of the Maui Land & Pineapple Company, Inc. Proxy Statement, dated March 31, 1995, is incorporated herein by reference.\nThe Company has the following executive officers: Principal Occupation Name During Last 5 Years\nJoseph W. Hartley, Jr. President & Chief Executive Officer (Age 61) since June 1992; Executive Vice President\/Pineapple from 1979 to 1992.\nGary L. Gifford Executive Vice President\/Resort (Age 47)\nPaul J. Meyer Executive Vice President\/Finance (Age 47)\nRichard H. Cameron (1) Vice President\/Property Management (Age 40) since 1990; Vice President\/Planning & Development of Kapalua Land Company, Ltd. from 1985 to 1990.\nDouglas R. Schenk Vice President\/Pineapple since 1993; (Age 42) Cannery Manager of Maui Pineapple Company, Ltd. since 1989.\n(1) Richard H. Cameron is the grandson of Frances B. Cameron, Director Emeritus, and the nephew of Mary C. Sanford, Chairman of the Board.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION The information set forth under the caption \"Executive Compensation\" on pages 9 through 13 of the Maui Land & Pineapple Company, Inc. Proxy Statement, dated March 31, 1995, is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under the caption \"Security Ownership of Certain Beneficial Owners and Management\" on pages 4 through 6 of the Maui Land & Pineapple Company, Inc. Proxy Statement, dated March 31, 1995, is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth under the caption \"Compensation Committee Interlocks and Insider Participation\" on page 13 of the Maui Land & Pineapple Company, Inc. Proxy Statement, dated 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 (a) 1. Financial Statements The following Financial Statements and Supplementary Data of Maui Land & Pineapple Company, Inc. and subsidiaries and the Independent Auditors' Report are included in Item 8 of this report: Consolidated Balance Sheets, December 31, 1994 and 1993 Consolidated Statements of Operations and Retained Earnings 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\n(a) 2. Financial Statement Schedules The Financial Statements of Kaptel Associates for the Years Ended December 31, 1994, 1993 and 1992 are filed as exhibits.\n(a) (3) Exhibits Exhibits are listed in the \"Index to Exhibits\" found on pages 16 to 17 of this Form 10-K.\n(b) (3) 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 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.\nMAUI LAND & PINEAPPLE COMPANY, INC.\nMarch 29, 1995 By \/s\/JOSEPH W. HARTLEY, JR. Joseph W. Hartley, Jr. 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.\nBy \/s\/MARY C. SANFORD Date March 29, 1995 Mary C. Sanford Chairman of the Board\nBy \/s\/PAUL J. MEYER Date March 29, 1995 Paul J. Meyer Executive Vice President\/Finance\nBy \/s\/TED PROCTOR Date March 29, 1995 Ted Proctor Controller & Assistant Treasurer\nBy \/s\/PETER D. BALDWIN Date March 29, 1995 Peter D. Baldwin Director\nBy \/s\/RICHARD H. CAMERON Date March 29, 1995 Richard H. Cameron Director\nBy \/s\/LANSING E. EBERLING Date March 29, 1995 Lansing E. Eberling Director\nBy \/s\/RANDOLPH G. MOORE Date March 29, 1995 Randolph G. Moore Director\nBy \/s\/FRED E. TROTTER III Date March 29, 1995 Fred E. Trotter III Director\nINDEX TO EXHIBITS\nThe exhibits designated by an asterisk (*) are filed herein. The exhibits not so designated are incorporated by reference to the indicated filing. All previous exhibits were filed with the Securities and Exchange Commission in Washington D. C. under file number 0-4674.\n3. Articles of Incorporation and By-laws 3(i) Articles of Incorporation (Amended as of 4\/19\/79). Exhibit 3 to Form 10-K for the year ended December 31, 1980. 3(ii) By Laws (Amended as of 2\/26\/88). Exhibit (3ii) to Form 10-Q for the quarter ended September 30, 1994.\n10. Material Contracts 10.1(i) Revolving and Term Loan Agreement, dated as of December 31, 1992. Exhibit (10)A to Form 10-K for the year ended December 31, 1992. (ii) First Loan Modification Agreement, dated and effective as of March 1, 1993. Exhibit (10)A to Form 10-Q for the quarter ended March 31, 1993. (iii) Second Loan Modification Agreement, dated September 8, 1993. Exhibit (10)B to Form 10-Q for the quarter ended September 30, 1993.\n(iv) Third Loan Modification Agreement, dated September 30, 1994. Exhibit (10)B to Form 10-K for the year ended December 31, 1993. (v) Fourth Loan Modification Agreement, dated March 8, 1994. Exhibit (10)A to Form 10-K for the year ended December 31, 1993. *(vi) Fifth Loan Modification Agreement, dated as of December 31, 1994. Attached.\n10.2(i) Limited Partnership Agreement of Kaahumanu Center Associates, dated June 18, 1993. Exhibit (10)A to Form 10-Q for the quarter ended June 30, 1993. (ii) Cost Overrun Guaranty Agreement, dated June 28, 1993. Exhibit (10)B of Form 10-Q for the quarter ended June 30, 1993. (iii) Environmental Indemnity Agreement, dated June 28, 1993. Exhibit (10)C to Form 10-Q for the quarter ended June 30, 1993. (iv) Indemnity Agreement, dated June 28, 1993. Exhibit (10)D to Form 10-Q for the quarter ended June 30, 1993. (v) Direct Liability Agreement, dated June 28, 1993. Exhibit (10)E to Form 10-Q for the quarter ended June 30, 1993.\n10.3(i) Note Purchase Agreement between John Hancock Mutual Life Insurance Company and Maui Land & Pineapple Company, Inc., dated September 9, 1993. Exhibit (10)A to Form 10-Q for the quarter ended September 30, 1993. (ii) First Amendment to Note Purchase Agreement dated as of March 30, 1994. Exhibit (10)A to Form 10-Q for the quarter ended March 31, 1994.\n10.4 The following relate to the Ritz-Carlton Kapalua Hotel: Partnership Agreement; Development Agreement; Operating Agreement; Hotel Ground Lease; Supplemental Agreement; Construction Loan Agreement; Promissory Note; Real Property Mortgage; Leasehold Mortgage. Exhibit (10)A-I to Form 10-Q for the quarter ended September 30, 1990.\n10.5 Partnership Agreement of Plantation Club Associates, dated November 10, 1988. Exhibit (10)A to Form 10-K for the year ended December 31, 1988.\n10.6 $15 million Promissory Note, dated March 31, 1986, for the acquisition of Kaahumanu Center. Exhibit (10)C to Form 10-K for the year ended December 31, 1986.\n10.7 Compensatory plans or arrangements (i) Executive Deferred Compensation Plan (revised as of 8\/16\/91). Exhibit (10)A to Form 10-Q for the quarter ended September 30, 1994. (ii) Executive Insurance Plan (Amended). Exhibit (10)A to Form 10-K for the year ended December 31, 1980. (iii) Remunerative agreement between Maui Land & Pineapple Company, Inc. and Paul J. Meyer, Executive Vice President\/Finance. Exhibit (10)A to Form 10-Q for the quarter ended June 30, 1984. (iv) Supplemental Executive Retirement Plan (effective as of January 1, 1988). Exhibit (10)B to Form 10-K for the year ended December 31, 1988.\n10.8 Hotel Ground Lease between Maui Land & Pineapple Company, Inc. and The KBH Company. Exhibit (10)B to Form 10-Q for the quarter ended September 30, 1985.\n11. Statement re computation of per share earnings: Net Income (Loss) divided by weighted Average Common Shares Outstanding equals Net Income (Loss) Per Common Share.\n13.* Annual Report to security holders. Maui Land & Pineapple Company, Inc. 1994 Annual Report.\n21. Subsidiaries of registrant: All of the following were incorporated in the State of Hawaii: Maui Pineapple Company, Ltd. Kapalua Land Company, Ltd. Kapalua Investment Corp. Kapalua Water Company, Ltd. Kapalua Waste Treatment Company, Ltd. Honolua Plantation Land Company, Ltd.\n27.* Financial Data Schedule.\n99. Additional Exhibits 99.1* Financial Statements of Kaptel Associates for the years ended December 31, 1994 and 1993.\n99.2* Maui Land & Pineapple Company, Inc. Proxy Statement dated March 31, 1995.","section_15":""}
{"filename":"33798_1994.txt","cik":"33798","year":"1994","section_1":"Item 1. BUSINESS\n(a) General Development of Business\nGrossman's Inc. (the \"Company\") was first incorporated in Michigan in 1919 as E.S. Evans and Co., Inc., then was reincorporated in Delaware in 1923. In 1931 the Company's name was changed to Evans Products Company. In 1986, in conjunction with the reorganization of the Company described herein, the Company adopted the name Grossman's Inc.\nOn March 11, 1985, Evans Products Company (\"Evans\") and certain of its subsidiaries filed voluntary petitions for relief under Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Florida. On November 19, 1986, the Company emerged from the Chapter 11 proceedings. Under a court approved Reorganization Plan, the following transactions took place in 1986. Substantially all of Evans' assets, other than those of the retail building materials business conducted by Evans' wholly-owned subsidiary, Grossman's Inc. (\"Old Grossman's\"), were transferred to Evans Asset Holding Company (\"EAHC\") and a trust (collectively \"AHC\"), each beneficially owned by the lenders to Evans and one of its subsidiaries (the \"Lenders\") for the purpose of liquidating such assets. Evans and its filing subsidiaries (including Old Grossman's) were discharged from substantially all of their pre-Chapter 11 petition indebtedness. All of Evans' outstanding shares of common stock and preferred stock were cancelled. Old Grossman's was then merged into Evans, which adopted the name Grossman's Inc. (the \"Company\"), and the Company distributed to its creditors or to a trust or reserve for unpaid and unliquidated claims, $60,000,000 of its 13% Debentures, which matured in 1991, $73,000,000 of its 14% Debentures due 1996, $105,200,000 face value of its Zero Coupon Notes, which matured and the final installment paid in January 1993, and 20,000,000 shares of its Common Stock (of which 1,859,852 shares were sold by the trust and the Company in a private placement in December, 1986).\nOn July 31, 1987, the Company completed a public offering of 11,000,000 shares of its Common Stock. Of the shares offered, 6,131,347 shares were sold by the Company, with the net proceeds of $45,092,000 used to purchase 13% and 14% Debentures. The remaining 4,868,653 shares sold in the offering were sold by stockholders.\nOn February 1, 1989, the Company announced that it had engaged Shearson Lehman Hutton Inc. as the Company's financial adviser to assist the Company in reviewing strategic alternatives to realize the values inherent in its business. As a result of this effort, on September 12, 1989, the Company sold the assets and business of its Moore's Division to Harcros Lumber & Building Supplies Inc., an indirect wholly-owned subsidiary of Harrisons & Crosfield plc of London, England. The Moore's Division consisted of 59 retail building materials stores and yards located in Maryland, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia and West Virginia.\nIndependent of the Shearson engagement, on August 25, 1989, the Company sold its Northwest Division, consisting of 28 retail building materials stores located in California to GNW Partners, L.P., a California limited partnership. Certain of the former management employees of the Northwest Division were partners in GNW.\nNet proceeds from the 1989 sales of the Moore's and Northwest Divisions totalled $105.7 million. Such proceeds were principally used for the retirement of long-term debt.\nIn September 1993, the Company announced plans to close 22 Eastern Division stores. In September 1994, the Company announced plans to close an additional 15 Eastern Division stores. The closings were completed in the respective fourth quarters.\n(b) Financial Information About Industry Segments\nThe Company's operations during the last three years have been entirely in the retail building materials industry.\n(c) Narrative Description of Business\nGrossman's is a retailer of lumber, building materials, and other home improvement products emphasizing sales to its target customers; contractors, remodelers and serious do-it-yourselfers. The Company operates 106 stores, under the names \"Grossman's\", \"Contractors' Warehouse\" and \"Mr. 2nd's Bargain Outlets\", as listed in Item 2","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's stores are generally located on or adjacent to major transportation arteries to be convenient to urban and suburban markets. The Company seeks to match the size of a store to market sales potential. The typical store in smaller markets contains 49,000 square feet of selling space, 24,000 square feet under roof and the remainder in a merchandised outdoor lumber yard. In larger markets, the Company's stores may have as much as 100,000 square feet of selling space, up to 60,000 square feet of which is enclosed and the remainder in an adjacent lumber yard. Most stores have an adjacent outdoor sales area with storage buildings to dispense lumber and other building materials.\nThe Company's dual yard stores, which cater to consumers, builders and contractors, are typically located on three or more acres of land and have approximately 45,000 square feet under roof, including showroom and warehouse space. Dual yards also have large outside selling and storage areas (40,000 to 60,000 square feet) to service the contractor business.\nBUILDER'S MART ______________\nMEXICO - ------ Monterrey\nThe Company owns 60 of its stores and leases 46 stores, of which 27 have leases that expire without renewal or purchase options within the next ten years. Historically, leases without renewal options have been actively negotiated and renewed by the Company prior to expiration.\nFour leases have options for the Company to purchase the stores from the lessors at various times at an aggregate purchase price estimated to be below aggregate current market value.\nDuring 1993 and 1994, a total of 38 Eastern Division stores were closed. Of the 21 owned stores within this group, one was sold in 1993, eight were sold in 1994, four are under agreement to be sold, and two were designated to be reopened as Mr. 2nd's Bargain Outlets, the first of which recently opened. Of the 17 leased properties within this group, 8 leases have been terminated and 4 leases are due to be terminated in 1995 upon sales of property under contract.\nIn addition to the Company's stores, the Company owns and operates two distribution centers, a data processing center and two office facilities, one of which includes the Company's corporate office.\nThe net book value of the Company's owned real properties as of December 31, 1994 is approximately $64.4 million. Mortgage debt of approximately $15.8 million is outstanding on nine of the Company's owned properties.\nThe Company's properties are considered well maintained and are in good condition. Since 1986, the Company has invested $126.1 million in capital assets in its Eastern and Contractors' Warehouse Division stores and distribution centers.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company is a party to litigation incidental to the conduct of its business, most of which is covered by insurance and none of which is expected to 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\nNo cash dividends have been paid on the Company's Common Stock since its initial issuance on November 19, 1986.\nItem 7.","section_5":"","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION\nGrossman's Inc. financial condition at December 31, 1994 reflects efforts to consolidate Eastern Division operations and redeploy capital assets toward the addition of new Contractors' Warehouse stores, modifications to Eastern Division stores with potential to improve operational performance and investment in other ventures with higher projected long-term returns. Significant 1994 events affecting year end financial condition are as follows:\n\/\/\/ Certain Eastern Division stores were closed, as current operating results and future expectations did not meet performance criteria. In 1994, 16 stores were closed, following 22 closings in 1993.\n\/\/\/ Capital from sales of closed store properties was redeployed into enhancements to Eastern Division stores and two Contractors' Warehouse store openings, one in 1994 and one shortly after year end. New business ventures included the first store opening by the Company's 50% owned Mexican joint venture and the development of Project-Pro's Inc., the Company's 80% owned installed sales subsidiary.\n\/\/\/ A $10.0 million non-cash increase to stockholders' investment was recorded to reflect improvement in the difference between the accumulated pension benefit obligation and the estimated value of pension assets. The adjustment resulted from an increase in the discount rate assumption used to compute actuarially the cost of the pension obligation.\nOther ongoing events which will have an effect on future liquidity are as follows:\n\/\/\/ In November 1994, site plan approval was given by the Town of Braintree Planning Board for the sale of the Company's 35-acre headquarters to Kmart Corporation. Completion of the transaction will greatly improve liquidity, add working capital and provide cash resources for additional investment in growth initiatives.\n\/\/\/ Modifications designed to attract professional sales are being made in all Grossman's stores in the East prior to the 1995 spring selling season. These modifications will focus primarily on merchandise mix changes.\n\/\/\/ Installation of Eastern Division point-of-sale register systems will be completed in 1995 in time for the spring selling season.\n\/\/\/ Subject to site availability, up to four new Contractors' Warehouse stores are planned to open in the Midwest during 1995. The first such store opened in Indianapolis in January.\n\/\/\/ The Company will continue to expand into international markets with a planned second store opening in the Monterrey, Mexico market by its joint venture and exploration of licensing arrangements with international partners.\nTriggered by lower than planned 1994 operating performance, in the third quarter the Company reviewed all Eastern Division stores to identify capital which could be redeployed to growth initiatives expected to\ngenerate more attractive long-term returns. These initiatives include the aggressive Midwest expansion of the Company's Contractors' Warehouse concept and the continued repositioning of Eastern Division stores to enhance their appeal to target customers. Consideration was given to past and future expectations of individual store and market operating performance, as well as the estimated real estate value of each location. Following this review, at the end of the third quarter, the Company closed 15 stores, nine owned and six leased. A $6.5 million pre-tax charge was recorded related to closing costs, lease expenses, inventory writedowns, other expenses and the expected net recovery of property, plant and equipment. The store closings were completed during the fourth quarter and proceeds from the liquidation of inventory were used to reduce related accounts payable and borrowings under the revolving credit agreement.\nDuring 1993 and 1994, a total of 38 Eastern Division stores were closed. Of the 21 owned stores within this group, one was sold in 1993, eight were sold in 1994, four are under agreement to be sold, and two were designated to be reopened as Mr. 2nd's Bargain Outlets, the first of which recently opened. Net proceeds from the disposal of these properties exceeded $13.6 million in 1994 and remaining unsold properties continue to be actively marketed. It is anticipated that sales of some or all of the remaining properties will occur over a period of years, resulting in a liquidity improvement at the time of each respective sale.\nCapital expenditures in 1994 totalled $4.8 million, as compared to $15.0 million in 1993, with $1.5 million related to Project-Pro's, the Company's 80% owned subsidiary which began operations in 1994, and the remainder principally related to Contractors' Warehouse store openings and Eastern Division point-of-sale register systems. Within the Contractors' Warehouse Division, its second Midwest store was opened in Dayton, Ohio in June 1994 and its third store, located in Indianapolis, Indiana, opened shortly after year end 1994. Subject to site availability and financing, up to three more Midwest stores are planned for openings in 1995 and additional stores are planned for future years. In the Eastern Division, the first of the two closed store properties designated for reopening as Mr. 2nd's Bargain Outlets opened in Woonsocket, Rhode Island in December 1994, and the second store is scheduled for a spring 1995 opening in Schenectady, New York.\nReflected in the year end balance sheet are two new ventures; Project-Pro's, an 80% owned consolidated subsidiary, and Construcentro, a 50% owned unconsolidated joint venture. Project-Pro's opened its first three home-improvement showrooms and began operations during 1994. Franchising of the concept to professional contractors began in the fourth quarter. Approximately $2.4 million has been invested in Construcentro, which opened its first store in May 1994 in Monterrey, Mexico, under the name Builder's Mart. The investment in Construcentro has been accounted for under the equity method of accounting. A second store in the Monterrey market is presently planned. Recent economic instability in Mexico, including significant devaluation of the peso, may result in market changes, insufficient sales or supply shortages, at which time expansion plans may be reassessed.\nAt December 31, 1994, the actuarial assumption for the discount rate used to value pension benefit obligations was changed from 7.0% to 8.5%, on par with current yields for appropriate high-quality debt instruments. As a result, a non-cash adjustment of $10.5 million was recorded reducing the minimum pension liability, the intangible pension asset was reduced by\n$552 thousand to equal unrecognized prior service cost, and the difference of $10.0 million was recorded as an increase to stockholders' investment. The minimum liability, intangible asset and adjustment to stockholders' investment will be measured annually and will change based upon interest rate assumptions, changes in the benefit obligation and changes in the value of plan assets.\nIn 1993, the Company announced an agreement to sell its 35-acre headquarters site in Braintree, Massachusetts to Kmart Corporation. The Town of Braintree Planning Board approved Kmart's site plan in November 1994. Under the terms of the Company's agreement with Kmart, the closing for this transaction is to occur by October 4, 1995, subject to a six- month extension option at Kmart's election. The Company is currently discussing a closing timetable with representatives of Kmart and is unable to predict when this transaction will be consummated. Financial reporting of the transaction will be deferred until sale consummation. Proceeds from the sale will initially be used to reduce borrowings under the revolving term note payable and, in the future, will be used for capital expenditures, operating needs and, if available, retirement of the $16.2 million of 14% Debentures due January 1996.\nInventory at December 31, 1994 totalled $116.6 million, a $5.2 million decrease from the prior year end. Inventory declines as a result of Eastern Division store closings were offset in part by inventory in newly opened Contractors' Warehouse stores. The Eastern Division's automated, integrated replenishment system, with virtually all lines of merchandise now being automatically replenished, contributed to more efficient inventory management in 1994. Also related to the inventory decrease, accounts payable declined by $1.2 million from the prior year end, offset in part due to timing of payments.\nDeclines in property, plant and equipment reflect the sale of closed store properties offset in part by the capital expenditures described above. The decline in long-term debt and capital lease obligations also reflect the property sales. Of the total $14.2 million in payments on long-term debt and capital lease obligations, $4.2 million was related to closed store properties. Also impacting capital lease obligations was a decline in capital intensive Eastern Division store renovations. Capital lease additions in 1994 totalled $813 thousand compared to $7.3 million in 1993. Reformatting of stores in 1995 to better serve professional customers is not expected to be capital intensive, due to most changes being related to inventory mix, as opposed to store renovations.\nThe Company believes that existing funds, funds generated from operations, proceeds to be received from the sale of properties and funds available under the $60 million loan and security agreement will be sufficient to satisfy debt service requirements, to pay other liabilities in the normal course of business and to finance planned capital expenditures.\nRESULTS OF OPERATIONS\n1994 Compared with 1993\nThe 1994 net loss of $1.9 million compared to a net loss of $68.3 million in 1993, with non-recurring items occurring in each year. The 1994 results include a $6.5 million provision for the closing of 15 Eastern Division stores. One additional store was closed earlier in the year. The 1993 results include a $34.3 million provision for the closing of 22 Eastern Division stores and a non-cash adjustment to the provision for income taxes of $30.2 million to record a valuation allowance against previously recorded deferred tax assets. Excluding these non-recurring items, operating income improved to $10.7 million in 1994 from $5.2 million in 1993. Negatively impacting the 1994 results were start up costs of the Company's 80% owned subsidiary, Project-Pro's, and the Company's 50% share of initial operating losses of its Mexican joint venture.\nTotal sales results were impacted by Eastern Division store closings and Contractors' Warehouse store openings in both 1993 and 1994.\nWithin Grossman's stores, comparable store sales results are indicative of the Company's strategy to strengthen the appeal of stores to target customers - contractors, remodelers and serious do-it-yourselfers. Comparable increases in professional sales have offset a decline in retail sales, reflective of increasingly competitive conditions. Contractors' Warehouse comparable store sales results in 1994 were impacted by division-wide promotional activities in March and June 1993, prior to and concurrent with three store openings, and throughout 1994 by a slowing economy in the Southern California market in which 8 of the division's 12 stores operate.\nGross profit declined by $25.8 million as the result of the sales decline and a decline in gross margin from 25.3% in 1993 to 24.6% in 1994. The decline in gross margin reflects the increase in sales mix toward professional sales, including Contractors' Warehouse, from 51.6% of total sales in 1993 to 56.1% in 1994. Overall gross margin reductions will continue as the sales mix continues to shift toward professional customers, who receive discounts from normal retail pricing, and as additional Contractors' Warehouse stores are opened. Contractors' Warehouse stores operate at higher per store sales volume with lower gross margins. Efforts are ongoing to improve margins on products sold to the growing professional sales base, by expanding the inventory product mix in all Grossman's stores prior to the spring selling season. Competitive market conditions and volatile lumber prices, expected to continue in the future, have also impacted retail margins. Competitive conditions continue to cause lumber margins to be below historical levels.\nSelling and administrative expenses declined in 1994 by $31.3 million, or 16.1%, reflecting reduced overhead as a result of closed stores and additional Eastern Division staff reductions which occurred in the latter periods of 1993. As a percent of sales, selling and administrative expenses declined from 23.0% in 1993 to 21.4% in 1994. Included in selling and administrative expenses is pension expense, which increased from $1.8 million in 1993 to $4.5 million in 1994 as the result of changes in assumptions used to actuarially determine the pension liability and expense. As a result of assumption changes at December 31, 1994 and a decline in workforce, pension expense in 1995 is expected to decline to $2.3 million. In 1995, additional expenses incurred in the first quarter related to Eastern Division store modifications are expected to be recovered during the balance of the year.\nAt the end of the third quarter in both 1993 and 1994, non-recurring charges for store closings were recorded to cover costs related to leases, severance and outplacement expenses, inventory writedowns, other anticipated expenses and the net unrecoverable amount of property, plant and equipment. In 1993, the Company closed 22 Eastern Division stores and $34.3 million was provided, and in 1994 15 Eastern Division stores were closed and $6.5 million was provided. One additional store was closed in early 1994. Sales from stores closed represented 20.3% and 5.4%, respectively, of total sales in 1993 and 1994.\nIncluded in operating expenses in 1994 are $5.3 million of expenses related to the development and start-up of Project-Pro's, the Company's 80% owned subsidiary, which opened its first three project centers in 1994. Development activities and expenses should significantly decline\nin the future, as franchising of Project-Pro's territories began in the 1994 fourth quarter. Store preopening expense, related to Contractors' Warehouse store openings, increased by $200 thousand due to continued openings.\nInterest expense declined from $8.4 million in 1993 to $7.4 million in 1994, reflecting a reduction in average borrowings, offset in part by an increase in the average interest rate. In 1995, rising interest rates and an increase in average borrowings until consummation of the Braintree property sale, will result in additional interest expense.\nReflected in the statement of operations in 1994 is a $490 thousand net loss on the operations of Construcentro, the Company's 50% unconsolidated joint venture, which opened its first store, located in Monterrey, Mexico, during the 1994 second quarter. Recent economic instability in the Mexican economy, including devaluation of the peso, may result in market changes, insufficient sales or supply shortages, impacting future results.\nIn 1993, based on unanticipated operating losses and a reassessment of future expectations, the Company established a valuation allowance to reduce the carrying value of the deferred tax assets to zero. Tax credits recorded earlier in 1993 were also reversed, resulting in a provision for income taxes of $30.2 million. In 1994, income taxes were insignificant.\nOther than the effects of unstable lumber prices, as previously discussed, the Company's business was not materially affected by inflation in any of the years presented.\n1993 Compared with 1992\nThe 1993 net loss of $68.3 million compared to net income of $6.2 million in 1992. The 1993 results included a $34.3 million provision for store closings and a non-cash adjustment of $30.2 million to deferred tax assets.\nIn both 1992 and 1993, the Company's strategy was to emphasize sales to the professional customer. In both years, comparable retail sales declines were offset by comparable professional sales increases. In 1993, Eastern Division retail sales declines; however, were not fully offset by professional sales increases. Sales in the first four months of 1993 were negatively affected by severe weather conditions and prolonged wet ground conditions, partially offset by sales improvements in subsequent months.\nGross margin declined from 26.8% in 1992 to 25.3% in 1993. Throughout 1993, margin declines occurred as the result of the increase in sales to professional customers, who receive discounts from normal retail pricing, and the growth in Contractors' Warehouse stores, which operate at higher per stores sales volume with lower gross margins. Margin declines were also due to competitive market conditions and rising lumber prices. Economic and competitive conditions did not fully allow these price increases to be passed on to customers. Gross profit declined from $223.4 million in 1992 to $212.9 million in 1993, reflecting the combination of the overall sales and gross margin declines.\nOperating losses during the first quarter, which are normal due to the seasonality of the Company's business, were higher in 1993 due to the severe weather conditions in the Northeast and West, the Company's two\nprincipal operating markets. In the first quarter of 1993, the operating loss was $11.3 million, compared to a $4.8 million loss in the comparable period of 1992. In the 1993 second quarter, as conditions improved, operating income of $11.7 million compared favorably to the 1992 level of $10.7 million.\nIn the 1993 third quarter, the Company's operating income prior to recognition of store closing expense was $2.9 million, as compared to $9.8 million for the same period in 1992. The decline in operating income was principally due to Eastern Division store results. Steps taken to react to diminishing store performance, including price reductions, inventory management, and promotional activities, did not counteract the declining operational results, particularly in those stores most greatly affected by competition. As the third quarter progressed, management performed a review of each Eastern Division store and a determination was made to close 22 marginally performing stores. Store closing expense of $34.3 million was provided at the end of the quarter to cover costs related to the leases of 11 of the stores to be closed, severance and outplacement expenses, inventory writedowns, other expenses and the expected net recovery of property, plant and equipment.\nSelling and administrative expenses in 1993 approximated the 1992 level, but varied significantly by quarter, with a first quarter increase of $3.6 million, a second quarter decrease of $2.6 million, a third quarter increase of $2.2 million and a fourth quarter decrease of $3.3 million. The first quarter increase was primarily due to activities in support of strategic initiatives. Expenses related to these activities were higher in the second quarter of 1992 than in the same period in 1993, the principal reason for the second quarter decline. At the end of the second quarter, the Company announced a restructuring of the Eastern Division, largely as a result of the continued implementation of the automated replenishment system. In the third quarter of 1993, staff reductions were effected and selling and administrative expenses included severance payments, outplacement services and other expenses related to the restructuring, resulting in the overall expense increase.\nDepreciation and amortization increased by $1.8 million in 1993, related to ongoing capital spending in support of strategic initiatives. Preopening expense, associated with the development, opening, expansion and modernization of stores, decreased from $3.5 million in 1992 to $630 thousand in 1993, as the result of a curtailment of the repositioning of Eastern Division stores. Interest expense remained relatively constant from 1992 to 1993. Interest expense savings related to the retirement of high-interest rate debt were offset by $1.3 million of interest expense on borrowings under the Company's revolving credit agreement. There were no revolving credit borrowings in 1992.\nAt September 30, 1993, based upon unanticipated operating losses and a reassessment of future expectations, the Company established a valuation allowance to reduce the carrying value of deferred tax assets to zero. Tax credits recorded earlier in 1993 were also reversed, resulting in a total provision for income taxes of $30.2 million.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nStockholders and Board of Directors Grossman's Inc.\nWe have audited the accompanying consolidated balance sheets of Grossman's Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, changes in stockholders' investment, and cash flows for each of the three years in the period ended December 31, 1994. Our audits included the financial statement schedule listed in the index of 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 Grossman's 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. 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 31, 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.\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe accompanying notes are an integral part of these consolidated financial statements.\nGROSSMAN'S INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation - --------------------------- The consolidated financial statements present the results of operations, financial position and cash flows of Grossman's Inc. and its subsidiaries (the \"Company\"). The investment in an unconsolidated affiliate is accounted for on the equity method. All significant intercompany balances and transactions have been eliminated.\nFiscal Periods - -------------- The Company's year end is December 31. The Company records activity in quarterly accounting periods of equal length ending on the last Saturday of each quarter. Differences in amounts presented and those which would have been presented using actual quarter-end dates are not material.\nFiscal years 1994 and 1992 contained 52 weeks while fiscal year 1993 contained 53 weeks. The additional week in 1993 was included in the fourth quarter.\nCash Equivalents - ---------------- All highly liquid investments, with a maturity of three months or less at date of purchase, are considered to be cash equivalents.\nAccounts Receivable - ------------------- Credit is extended on open account to qualified contractors and remodelers.\nFinance charge income, included in other income, amounted to $513.0 thousand, $587.4 thousand and $619.6 thousand in 1994, 1993 and 1992, respectively.\nInventories - ----------- Merchandise inventories are valued at the lower of cost, as determined by the average cost method, or market.\nProperty, Plant and Equipment - ----------------------------- Property, plant and equipment are stated at cost and are depreciated using the straight-line method over estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the improvements, which range up to 20 years. Ranges of useful lives by principal classification for property, plant and equipment are as follows:\nBuildings 20 - 33 years Machinery and equipment 3 - 7 years Furniture and fixtures 3 - 10 years\nNOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) - ----------------------------------------------------\nAccrued Insurance Claims - ------------------------ Insurance coverage is maintained for general liability and workers' compensation risks under contractual arrangements which retroactively adjust premiums for claims paid subject to specified limitations. Expenses associated with such risks are accrued as amounts required to cover incurred incidents can be estimated.\nLeases - ------ Capital leases, those leases which transfer substantially all benefits and risks of ownership, are accounted for as acquisitions of assets and incurrences of obligations. Capital lease amortization is included in depreciation and amortization expense, with the amortization period restricted to the lease term. Interest on the related obligation is recognized over the lease term at a constant periodic rate.\nIncome Taxes - ------------ Tax provisions and credits are recorded at statutory rates for taxable items included in the consolidated statements of operations regardless of the period for which such items are reported for tax purposes. Deferred income taxes are recognized for temporary differences between financial statement and income tax bases of assets and liabilities. Deferred tax assets are reduced by a valuation allowance when the determination cannot be made that it is more likely than not that some portion or all of the related tax asset will be realized.\nPension Plan - ------------ A noncontributory retirement plan is sponsored for the benefit of substantially all employees. Pension costs are funded in accordance with the Employee Retirement Income Security Act. Prior service costs, the unrecognized net transition asset, and gains and losses, whether realized or unrealized, are amortized over estimated average remaining service periods.\nPreopening Expense - ------------------ Expenses associated with the opening of new stores and facilities and the expansion or major remodeling of existing stores are expensed as incurred.\nStore Closing Expense - --------------------- Store closing costs, net of amounts expected to be recovered, are recorded when the decision to close a store is made. Store closing costs include estimated losses, lease payments, other expenses and the net unrecoverable amount from sales of property, plant and equipment.\nEarnings Per Common Share - ------------------------- Earnings per common share are computed based on the weighted average number of common shares outstanding, less shares in treasury, plus common share equivalents attributable to stock options, when dilutive.\nNOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) - ----------------------------------------------------\nBusiness Segment - ---------------- The Company operates in one business segment: the retail sale, distribution and installation of building materials and related products.\nClassification - -------------- Certain amounts in the consolidated financial statements for prior years have been reclassified to conform to the current year presentation. Such reclassifications had no effect on previously reported results of operations.\nNOTE 3 - REVOLVING TERM NOTE PAYABLE - ------------------------------------\nOn December 15, 1993, the Company entered into a loan and security agreement with BankAmerica Business Credit, Inc., which provides for borrowings up to $60 million, including letters of credit up to $15 million, under a formula based arrangement based on a percentage of qualified inventory and accounts receivable. Borrowings pursuant to this agreement are secured by inventories, receivables and certain other assets. At December 31, 1994, cash borrowings under this agreement totalled $29.9 million and outstanding standby letters of credit, issued in the normal course of business, principally to guaranty payment of insurance obligations, totalled $9.7 million. The agreement has a three-year term, with one-year renewal periods thereafter. Interest is payable monthly at 1% over Prime Rate (8.5% at December 31, 1994), with a Eurodollar option available for borrowings in excess of $5 million. The agreement also provides for a 1\/2% per annum commitment fee on the average daily unused amount under $50 million. The agreement grants the lender rights to seek to increase or decrease the percentages loaned upon, which\nNOTE 3 - REVOLVING TERM NOTE PAYABLE (CONTINUED) - ------------------------------------------------\nmay affect availability, and contains various covenants which, among other things, require minimum levels of net worth, establish minimum interest and fixed charge coverage ratios, and establish maximum levels of capital expenditures.\nThe maximum borrowings and letters of credit in 1993, under this agreement, were $23.2 million and $12.1 million, respectively. The maximum borrowings and letters of credit in 1994, under this agreement, were $39.3 million and $13.1 million, respectively. The weighted average annual interest rate on such borrowings in 1993 and 1994 was 7.0% and 7.5%, respectively.\nUpon entering into the loan and security agreement, the Company's prior revolving credit agreement with a group of banks was terminated. The maximum borrowings in 1993 under the prior revolving credit agreement was $36.0 million. The weighted average annual interest rate on such borrowings was 5.9%.\nInterest on the 14% Debentures is payable semi-annually on January 1 and July 1. At any time prior to maturity, upon 30 days notice, the Company may redeem the 14% Debentures, in whole or in part, on any interest payment date, at 100% of principal (in minimum amounts of $5 million), plus a yield maintenance premium based upon quoted Treasury Constant Maturity Series yields.\nMortgage notes bear interest at a weighted average rate of 10.0% and are secured by real estate and equipment with a net book value of $32.3 million at December 31, 1994. The 14% Debentures, mortgage notes and certain lease agreements contain various covenants which, among other things, restrict dividends and distributions on and repurchases of Common Stock; require specified levels of net worth; limit capital expenditures; restrict liens, the incurrence of indebtedness and lease obligations; and\nNOTE 4 - LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS (CONTINUED) - -----------------------------------------------------------------\nrestrict loans and investments. Under the most restrictive of these agreements, the Company had no retained earnings available for the payment of dividends at December 31, 1994.\nInterest paid during 1994, 1993 and 1992 amounted to (in thousands) $7,995, $7,639 and $8,286, respectively.\nNOTE 5 - LEASE COMMITMENTS (IN THOUSANDS) - -----------------------------------------\nLeases have been entered into for certain retail locations, office space, equipment and vehicles. The fixed terms of the leases range up to fourteen years and, in general, leases for retail locations contain multiple renewal options for various periods between one and ten years. Certain leases contain provisions which include additional payments based upon sales performance, operating and real estate tax escalations and purchase options.\nTotal rent expense charged to operations during 1994, 1993 and 1992 amounted to $5,698, $7,615 and $8,819, respectively. Total contingent rentals included in rent expense were $757, $923 and $999, respectively.\nIncluded in property, plant and equipment as of December 31, 1994 and 1993 is $32,158 and $36,359, respectively, of machinery and equipment under capital leases. The related accumulated amortization is $23,673 and $24,049, respectively. Capital lease additions for machinery and equipment totalled $813 in 1994, $7,238 in 1993 and $2,739 in 1992.\nNOTE 5 - LEASE COMMITMENTS (IN THOUSANDS) (Continued) - -----------------------------------------------------\nNOTE 6 - FAIR VALUE OF FINANCIAL INSTRUMENTS - --------------------------------------------\nFair values are estimated based on the following assumptions: cash and cash equivalents are reported in the balance sheet at amounts which approximate fair value; and the carrying values of long-term debt and revolving term note payable are estimated using discounted cash flow analyses, based upon the Company's current incremental borrowing rates for similar types of borrowing arrangements.\nNOTE 7 - SALE OF PROPERTY - -------------------------\nIn October 1993, the Company announced an agreement for the sale of its 35 acre headquarters site in Braintree, Massachusetts to Kmart Corporation. The Town of Braintree Planning Board approved Kmart's site plan in November 1994. Under the terms of the Company's agreement with Kmart, the closing for this transaction is to occur by October 4, 1995, subject to a six-month extension option at Kmart's election. The Company is currently discussing a closing timetable with representatives of Kmart and is unable to predict when this transaction will be consummated.\nNOTE 8 - STOCKHOLDERS' INVESTMENT - ---------------------------------\nThe Company's Restated Certificate of Incorporation contains certain provisions restricting accumulations of Common Stock. Under these provisions, as modified by the Board of Directors and currently in effect, no person may acquire shares of Common Stock on or prior to December 31, 1996 (or such later date as may be fixed by the Board of Directors) if the number of shares actually and constructively owned by such person, as defined, would exceed 5% of the outstanding Common Stock on any date. Attempted acquisitions of Common Stock in excess of these limits will be null and void and all shares purportedly acquired in excess of these limits will have no rights, except the right to receive out of the proceeds of resale thereof an amount not in excess of the amount paid for such excess shares plus brokers' commissions. Such restrictions may be waived by the Board of Directors and are not applicable to an acquisition of more than 50% of the outstanding shares of Common Stock for cash pursuant to a tender offer, merger or other business combination in which all holders of Common Stock are afforded an opportunity to sell all their shares.\nNOTE 9 - EMPLOYEE BENEFIT PLANS - -------------------------------\nA noncontributory defined benefit pension plan, the Grossman's Inc. Retirement Plan (the \"Retirement Plan\"), is sponsored covering substantially all employees. Employees are eligible to participate in the Retirement Plan at age 21 with one year of service. Benefits through 1990 are based upon years of service multiplied by a percentage of reference earnings. Beginning in 1991, the benefit is based upon annual reference earnings.\nNOTE 9 - EMPLOYEE BENEFIT PLANS (CONTINUED) - -------------------------------------------\nStatement of Financial Accounting Standards No. 87 (\"FAS 87\") requires the recognition of a minimum liability, to the extent that actuarially computed plan benefits exceed the fair value of plan assets, and the recognition of a related intangible asset, to the extent of any unfunded prior service cost. In 1993, the discount rate assumption was changed from 9.5% to 7.0%, resulting in a December 31, 1993 adjustment of $21,938 thousand, reducing the prepaid pension asset and establishing a minimum liability of $15,199 thousand. An intangible asset of $1,410 thousand was also recorded, equal to unrecognized prior service cost. The difference\nNOTE 9 - EMPLOYEE BENEFIT PLANS (CONTINUED) - ------------------------------------------- between the minimum pension liability adjustment and the intangible asset was charged to stockholders' investment. The increase in net periodic pension cost from 1993 to 1994 was principally attributable to the discount rate assumption decrease at year end 1993. As of December 31, 1994, in accordance with the guidelines of FAS 87, the discount rate assumption was reevaluated and changed to 8.5%. As a result, an adjustment of $10,504 thousand was recorded to reduce the minimum pension liability, the intangible asset was reduced by $552 thousand to equal unrecognized prior service cost, and the difference of $9,952 thousand was credited to stockholders' investment.\nA savings plan is also sponsored for the benefit of substantially all employees. The plan provides that employees may contribute up to 14% of their compensation, with a fully vested Company match of a portion of the contribution. The Company contributed $552 thousand in 1994, $574 thousand in 1993 and $555 thousand in 1992 to the plan.\nNOTE 10 - OTHER LIABILITIES - ---------------------------\nStandby letters of credit which guarantee general liability and workers' compensation insurance claims are outstanding under the Company's revolving term note payable.\nNOTE 11 - EMPLOYEE STOCK OPTION PLANS - -------------------------------------\nA nonqualified stock option plan covers officers and other key management employees (\"1986 Plan\"). The 1986 Plan provides for nonqualified options to purchase a total of 3,750,000 shares of Common Stock.\nA nonqualified stock option plan covers key management employees who are not officers (\"1993 Plan\"). The 1993 Plan provides for nonqualified options to purchase a total of 600,000 shares of Common Stock, with a maximum of 5,000 shares per employee. The maximum number of options which may be granted in any calendar year is 300,000.\nAll options granted are ten-year nonqualified options and were granted at market value. Of the options outstanding at December 31, 1994, 200,000 were exercisable when issued, and the balance become exercisable in either three or four equal annual installments following the respective dates of grant. All outstanding options become exercisable upon a change in control, as defined in the option agreements. At December 31, 1994, 4,056,250 shares of Common Stock were reserved for future issuance under the plans.\nNOTE 12 - INCOME TAXES - ----------------------\nIncome taxes are accounted for in accordance with statement of Financial Accounting Standards 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 financial statement and income tax bases of assets and liabilities and net operating loss carryforwards to the extent that management assesses the utilization of such net operating loss carryforwards to be more likely than not. The statement also requires deferred tax assets to be reduced by a valuation allowance if, based on the weight of available evidence, management cannot make a determination that it is more likely than not that some portion or all of the related tax benefits will be realized. Furthermore, the statement requires that a valuation allowance be established or adjusted if a change in circumstances causes a change in judgment about the future realizability of the deferred tax assets.\nAt December 31, 1992, deferred tax assets were recorded totalling $30.2 million, with no related valuation allowance, based upon management's assessment at that time that taxable income would more likely than not be sufficient to utilize fully the net operating loss carryforwards prior to their ultimate expiration in the year 2001. At September 30, 1993, based upon unanticipated 1993 operating results and a reassessment of future expectations, the Company established a valuation allowance to reduce the carrying value of deferred tax assets to zero.\nAt December 31, 1994, the Company has net operating loss carryforwards of $117 million, expiring as follows: 1998-$15 million, 1999-$28 million, 2000-$23 million, 2001-$15 million, 2008-$28 million and 2009-$8 million.\nNOTE 12 - INCOME TAXES (CONTINUED) - ----------------------------------\nThe Company's tax returns for years subsequent to 1982 have not been reviewed by the Internal Revenue Service (\"IRS\"). Availability of the net operating loss carryforwards might be challenged by the IRS upon review of such returns and may be limited under the Tax Reform Act of 1986 as a result of changes that may occur in the ownership of the Company's stock in the future, principally relating to a change in control.\nThe Company believes; however, that IRS challenges that would limit the utilization of available net operating loss carryforwards are unlikely, and that the adjustments to tax liability, if any, for years through 1994 will not have a material adverse effect on the Company's financial position.\nIncome and franchise taxes paid in 1994, 1993 and 1992 amounted to (in thousands) $423, $920 and $1,158, respectively.\nNOTE 13 - INVESTMENT IN UNCONSOLIDATED AFFILIATE - ------------------------------------------------\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\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item regarding Directors is hereby incorporated by reference to the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K. Information regarding the Company's Executive Officers is set forth above following Item 1 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 to the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.\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 to the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.\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 to the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.\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 Page Number in this Report\nConsolidated Balance Sheets December 31, 1994 and 1993................................... 27\nConsolidated Statements of Operations Years Ended December 31, 1994, 1993 and 1992................. 29\nConsolidated Statements of Cash Flows Years Ended December 31, 1994, 1993 and 1992................. 30\nConsolidated Statements of Changes in Stockholders' Investment Years Ended December 31, 1994, 1993 and 1992................. 31\nNotes to Consolidated Financial Statements..................... 32\n(a) 2 - Index to Financial Statement Schedules\nThe following consolidated financial statement schedules of Grossman's Inc. and Subsidiaries are included in Item 14(d) and filed herewith (page numbers refer to page numbers in this Form 10-K):\nSchedule II - Valuation and Qualifying Accounts................ 56\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(b) Reports on Form 8-K\nNone.\n(a) 3. and (c) - Exhibits\nExhibit Number\n2(e) Final Decree and Order Closing Cases, dated October 2, 1987, of the United States Bankruptcy Court for the Southern District of Florida, filed as Exhibit 2(e) to the Company's Form 10-Q for the quarter ended September 30, 1987, is incorporated herein by reference.\n2(f) Asset Purchase Agreement between GNW Partners, L.P. and Grossman's Inc., dated June 28, 1989, without exhibits, filed as Exhibit 2(f) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 (File 1-542), is incorporated herein by reference.\n2(g) Asset Purchase Agreement between Harcros Lumber & Building Supplies Inc. and Grossman's Inc., dated August 14, 1989, without exhibits, filed as Exhibit 2(a) to the Company's Form 8-K, dated September 12, 1989, is incorporated herein by reference.\n3(a) Restated Certificate of Incorporation of the Company, as in effect November 19, 1986, filed as Exhibit 3(a) to the Company's Form 8-K, dated November 19, 1986 (File No. 1-542), is incorporated herein by reference.\n3(a)-1 Resolutions adopted by the Company's Board of Directors on December 15, 1987, modifying and extending restrictions on acquisition of Common Stock under Article Ninth of Company's Restated Certificate of Incorporation, filed as Exhibit 3(a)-1 to the Company's Form 8-K, dated December 15, 1987 (File 1-542), is incorporated herein by reference.\n3(a)-2 Notice to Stockholders of modification and extension of restrictions on acquisition of Common Stock pursuant to Article Ninth of Company's Restated Certificate of Incorporation, filed as Exhibit 3(a)-2 to the Company's Form 8-K, dated December 15, 1987 (File 1-542), is incorporated herein by reference.\n3(a)-3 Certificate of Designation Relating to Certain Restrictions on the Acquisition of Common Stock pursuant to Article Ninth of the Company's Restated Certificate of Incorporation, filed as Exhibit 3(1)-2 to the Company's Form 8-K dated November 19, 1986 (File No. 1-542), is incorporated herein by reference.\n3(a)-4 Resolutions adopted by the Company's Board of Directors on October 23, 1990 extending restrictions on acquisition of Common Stock under Article Ninth of Company's Restated Certificate of Incorporation, filed as Exhibit 3(a)-4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990 (File No. 1-542), is incorporated herein by reference.\n3(a)-5 Notice to Stockholders of extension of restrictions on acquisition of Common Stock pursuant to Article Ninth of the Company's Restated Certificate of Incorporation, filed as Exhibit 3(a)-5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990 (File No. 1-542), is incorporated herein by reference.\n3(a)-6 Certificate of Designation Relating to Certain Restrictions on the Acquisition of Common Stock pursuant to Article Ninth of the Company's Restated Certificate of Incorporation, filed as Exhibit 3(a)-6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990 (File No. 1-542), is incorporated herein by reference.\n3(a)-7 Notice to Stockholders of extension of restrictions on acquisition of Common Stock pursuant to Article Ninth of the Company's Restated Certificate of Incorporation, is incorporated herein by reference.\n3(a)-8 Certificate of Designation Relating to Certain Restrictions on the Acquisition of Common Stock pursuant to Article Ninth of the Company's Restated Certificate of Incorporation, is incorporated herein by reference.\n3(b) By-Laws of the Company, as in effect November 19, 1986, filed as Exhibit 3(b) to the Company's Form 8-K, dated November 19, 1986 (File No. 1-542), is incorporated herein by reference.\n3(b)-1 Copy of the amendments to the Grossman's Inc. By-Laws as adopted by the Board of Directors of Grossman's Inc. on December 15, 1987, filed as Exhibit 3(b)-1 to the Company's Form 8-K, dated December 15, 1987 (File 1-542), is incorporated herein by reference.\n4(c) Indenture, dated January 1, 1986, from the Company to United States Trust Company of New York, as Trustee, with respect to the Company's 14% Debentures due 1996, filed as Exhibit 4(c) to the Company's Form 8-K, dated November 19, 1986 (File No. 1-542), is incorporated herein by reference.\n4(c)-1 First Supplemental Indenture, dated January 1, 1987, to Indenture, dated January 1, 1986 (Exhibit 4(c) above), for the Company's 14% Debentures due 1996, filed as Exhibit 4(h) to the Company's Registration Statement on Form S-1, No. 33-15107, is incorporated herein by reference.\n4(c)-2 Second Supplemental Indenture, dated March 15, 1987, to Indenture, dated January 1, 1986, for the Company's 14% Debentures due 1996 (Exhibit 4(c) above), filed as Exhibit 4(j) to the Company's Registration Statement on Form S-1, No. 33-15107, is incorporated herein by reference.\n4(c)-3 Third Supplemental Indenture, dated June 15, 1987, to Indenture, dated January 1, 1986, for the Company's 14% Debentures due 1996 (Exhibit 4(c) above), filed as Exhibit 4(c)-3 to the Company's Form 8-K, dated July 15, 1988 (File No. 1-542), is incorporated herein by reference.\n4(c)-4 Fourth Supplemental Indenture, dated June 15, 1987, to Indenture, dated January 1, 1986, for the Company's 14% Debentures due 1996 (Exhibit 4(c) above), filed as Exhibit 4(c)-4 to the Company's Form 8-K, dated July 15, 1988 (File No. 1-542), is incorporated herein by reference.\n4(c)-5 Form of Waiver dated December 21, 1988 of certain provisions of Section 5.11 to the Indenture, dated January 1, 1986, for the Company's 14% Debentures due 1996 (Exhibit 4(c) above), filed as Exhibit 4(c)-5 to the Company's Form 8-K, dated December 13, 1988, is incorporated herein by reference.\n4(c)-6 Fifth Supplemental Indenture, dated September 30, 1989, to Indenture, dated January 1, 1986, for the Company's 14% Debentures due 1996 (Exhibit 4(c) above), filed as Exhibit 4(c)-6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-542), is incorporated herein by reference.\n4(c)-7 Sixth Supplemental Indenture, dated March 1, 1990, to Indenture, dated January 1, 1986, for the Company's 14% Debentures due 1996 (Exhibit 4(c) above), filed as Exhibit 4(c)-7 to the Company's Form 10-Q for the quarter ended June 30, 1990, is incorporated herein by reference.\n4(c)-8 Seventh Supplemental Indenture, dated May 17, 1991, to Indenture, dated January 1, 1986, for the Company's 14% Debentures due 1996 (Exhibit 4(c) above), filed as Exhibit 4(c)-8 to the Company's Form 10-K for the year ended December 31, 1991 (File No. 1-542), is incorporated herein by reference.\n4(e)-1 Amended and Restated Registration Rights and Transfer Restriction Agreement, dated April 30, 1987, among the Company; the Common Holders, Debt Holders, Offering Committee and Custodian named therein; and Herzog, Heine Geduld Inc., filed as Exhibit 4(e)-1 to the Company's Registration Statement on Form S-1, No. 33-15107, is incorporated herein by reference.\n4(m) Term Loan and Security Agreement without Exhibits and Installment Note, dated October 15, 1991, between Grossman's Inc. and Sanwa Business Credit Corporation, filed as Exhibit 4(m) to the Company's Form 10-Q for the quarter ended September 30, 1991, is incorporated herein by reference.\n4(n) First Amendment, dated December 14, 1993, to Term Loan and Security Agreement between Grossman's Inc. and Sanwa Business Credit Corporation, dated October 15, 1991, is incorporated herein by reference.\n4(n)-1 Second Amendment, dated October 30, 1994, to Term Loan and Security Agreement between Grossman's Inc. and Sanwa Business Credit Corporation, dated October 15, 1991, filed as Exhibit 4(n)-1 to the Company's Form 10-Q for the quarter ended September 30, 1994 (File No. 1-542), is incorporated herein by reference.\n4(n)-2 Third Amendment, dated January 31, 1995, to Term Loan and Security Agreement between Grossman's Inc. and Sanwa Business Credit Corporation, dated October 15, 1991 (without exhibit), filed herewith.\n4(o) Loan and Security Agreement between Grossman's Inc. and BankAmerica Business Credit, Inc. dated December 15, 1993 (without exhibits), filed as Exhibit 4(o) to the Company's Form 10-K for the year ended December 31, 1993 (File No. 1-542), is incorporated herein by reference.\n4(o)-1 Waiver and Second Amendment, dated as of July 11, 1994, to the Loan and Security Agreement between Grossman's Inc. and BankAmerica Business Credit, Inc., dated December 15, 1993, filed herewith.\n10(iii)(g)-2 Separation Agreement, dated November 28, 1994, between Grossman's Inc. and Thomas R. Schwarz, filed herewith.\n10(iii)(h)-2 Employment Agreement, dated December 1, 1994 between Grossman's Inc and Sydney L. Katz, filed herewith.\n10(iii)(k) Amended and Restated Employment Agreement, dated July 1, 1991, between Grossman's Inc. and Robert L. Flowers, filed as Exhibit 10(iii)(k) to the Company's Annual Report on Form 10-K for year ended December 31, 1991 (File No. 1-542), is incorporated herein by reference.\n10(iii)(k)-1 Amendment No. 1, dated September 26, 1994, to Amended and Restated Employment Agreement dated as of July 1, 1991, between Grossman's Inc. and Robert L. Flowers, filed as Exhibit 10(iii)(k)-1 to the Company Form 10-Q for the quarter ended September 30, 1994 (File No. 1-542), is incorporated herein by reference.\n10(iii)(l) Amended and Restated Employment Agreement, dated July 1, 1991, between Grossman's Inc. and Richard E. Kent, filed as Exhibit 10(iii)(l) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-542), is incorporated herein by reference.\n10(iii)(l)-1 Amendment No. 1, dated September 26, 1994, to Amended and Restated Employment Agreement dated as of July 1, 1991, between Grossman's Inc. and Richard E. Kent, filed as Exhibit 10(iii)(l)-1 to the Company's Form 10-Q for the quarter ended September 30, 1994 (File No. 1-542), is incorporated herein by reference.\n10(iii)(m)-1 Severance Agreement, dated August 22, 1994, between Grossman's Inc. and Alan T. Kane, filed herewith.\n10(iii)(n) Employment Agreement, dated June 8, 1992, between Grossman's Inc. and David Krawczyk, filed herewith.\n10(iii)(n)-1 Amendment No. 1, dated September 26, 1994, to Employment Agreement dated as of June 8, 1992, between Grossman's Inc. and David Krawczyk, filed herewith.\n10(iii)(o) Employment Agreement, dated November 23, 1994, between Grossman's Inc. and Robert K. Swanson, filed herewith.\n10(b) Restated and Amended Grossman's Inc.\/Evans Asset Holding Company General Pension Plan, filed as Exhibit 10(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1986 (File No. 1-542), is incorporated herein by reference.\n10(c) Agreement Re General Pension Plan, dated November 18, 1986, among Evans Products Company, Grossman's Inc., Evans Financial Corp., Evans Transportation Company and Evans Asset Holding Company, filed as Exhibit 10(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1986 (File No. 1-542), is incorporated herein by reference.\n10(c)-1 Agreement Re Spin-off of General Pension Plan, dated January 1, 1987, among the Company, Evans Asset Holding Company, Evans Financial Corp. and Evans Transportation Company, filed as Exhibit 10(c)-1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987 (File No. 1-542), is incorporated herein by reference.\n10(c)-2 Letter, dated December 30, 1987, documenting certain understandings reached among the Company, Grossman's Inc. Retirement Plan, Evans Asset Holding Company and Evans Asset Holding Company\/Grossman's Inc. General Pension Plan, regarding the proper interpretation of the Agreement Re Spin-off of General Pension Plan (Exhibit 10(c)-1 above), filed as Exhibit 10(c)-2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987 (File No. 1-542), is incorporated herein by reference.\n10(c)-8 Grossman's Inc. Restated Retirement Plan, dated February 15, 1995, filed herewith.\n10(d) Claim Allocation Agreement, dated November 19, 1986, by and between Evans Asset Holding Company, EFC Mortgage Trust and Grossman's Inc., filed as Exhibit 10(d) to the Company's Annual Report on Form 10-K for the year ended December 31, 1986 (File No. 1-542), is incorporated herein by reference.\n10(e) EPC Asset Transfer Agreement, dated November 19, 1986, among Evans Products Company, Evans Asset Holding Company, EPC Properties Company, Minneapolis Electric Steel Castings Company, Racine Steel Castings Company, RSC Properties Company, Duluth Steel Castings Company, Aberdeen Forest Products Company and Evans Engineered Products Company, filed as Exhibit 10(e) to the Company's Annual Report on Form 10-K for the year ended December 31, 1986 (File No. 1-542), is incorporated herein by reference.\n10(f) EFC Asset Transfer Agreement, dated November 19, 1986, among Evans Financial Corp. and EFC Mortgage Trust, filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended December 31, 1986 (File No. 1-542), is incorporated herein by reference.\n10(g) Assumption Agreement, dated November 19, 1986, among Evans Asset Holding Company, EFC Mortgage Trust, Evans Products Company, Evans Financial Corp. and Bank of America National Trust and Savings Association, as agent, filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the year ended December 31, 1986 (File No. 1-542), is incorporated herein by reference.\n10(h) Grossman's Inc. 1986 Nonqualified Stock Option Plan, filed as Exhibit A to the Company's Proxy Statement for the 1987 Annual Meeting of Stockholders, dated September 28, 1987, is incorporated herein by reference.\n10(h)-1 Amendment, dated December 11, 1990, to 1986 Nonqualified Stock Option Plan, filed as Exhibit 10(h)-1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1990 (File No. 1-542), is incorporated herein by reference.\n10(h)-2 Amendment, dated January 28, 1992, to 1986 Nonqualified Stock Option Plan, filed as Exhibit 10(h)-2 to the Company's Form 10-Q for the quarter ended March 31, 1992 (File No. 1-542), is incorporated herein by reference.\n10(i)-3 Grossman's Inc. Restated Executive Severance Plan, dated December 14, 1994, filed herewith.\n10(m)-1 Grossman's Inc. Supplemental Executive Retirement Plan, dated January 1, 1992, filed as Exhibit 10(m)-1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 1-542), is incorporated herein by reference.\n10(n)-5 Grossman's Inc. Restated Savings and Profit Sharing Plan, dated February 15, 1995, filed herewith.\n10(o) Grossman's Inc. 1993 Key Employee Stock Option Plan, dated April 27, 1993, filed as Exhibit 10(o) to the Company's Form 10-K for the year ended December 31, 1993 (File No. 1-542) is incorporated herein by reference.\n11(a) Statement re computation of earnings per share, filed herewith.\n22 Subsidiaries of the Company, filed as Exhibit 22 to the Company's Annual Report on Form 10-Q for the quarter ended September 30, 1991 (File No. 1-542), is incorporated herein by reference.\n23 Consent of Ernst & Young LLP, Independent Auditors, filed herewith.\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.\nGROSSMAN'S INC. --------------- Company\nDate: March 16, 1995 By \/s\/ Steven L. Shapiro --------------------- Steven L. Shapiro 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 Company and in the capacities and on the dates indicated.","section_15":""}
{"filename":"73088_1994.txt","cik":"73088","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS\nNorthwestern Public Service Company (Company) is an electric and gas utility engaged in generating, transmitting, distributing, and selling electric energy in eastern South Dakota, where it furnishes electric service to 54,863 customers in more than 100 communities and adjacent rural areas. The Company also purchases, distributes, sells, and transports natural gas to 74,982 customers in four communities in Nebraska and 56 communities in eastern South Dakota. The Company, through its subsidiaries, is also engaged in certain nonutility operations as more fully discussed in the section entitled \"Nonutility Operations\". The Company was incorporated under the laws of the State of Delaware in 1923 and is qualified to do business in the states of South Dakota, Nebraska, Iowa, and North Dakota. The Company does not serve customers in North Dakota or Iowa. The Company has its principal office at 33 Third Street SE, Huron, South Dakota 57350-1318. Its telephone number is 605-352-8411.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe information required by this item 1(b) is incorporated by reference to Note 10 of the \"Notes to Consolidated Financial Statements\" on page 24 of the Company's 1994 Annual Report to Stockholders, filed as an Exhibit hereto.\nNARRATIVE DESCRIPTION OF BUSINESS\nPursuant to the South Dakota Public Utilities Act, the South Dakota Public Utilities Commission (PUC) assigned as the Company's electric service territory the communities and adjacent rural areas in which the Company provides electric service in South Dakota. The Company has the right to provide electric service to present and future electric customers in its assigned service territory for so long as the service provided is deemed adequate. Under the South Dakota Public Utilities Act, effective July 1, 1976, the Company is not required to obtain or renew municipal franchises to provide electric service within its assigned service territory.\nThe Company has nonexclusive municipal franchises to provide gas service in the Nebraska and South Dakota communities in which it provides such service. The maximum term permitted under Nebraska law for such franchises is 25 years while the maximum term permitted under South Dakota law is 20 years. The Company's policy is to seek renewal of a franchise in the last year of its term. The Company has never been denied the renewal of any of these franchises and does not anticipate that any future renewals would be withheld.\nELECTRIC BUSINESS\nELECTRIC SALES. On a fully consolidated basis, 46% of the Company's 1994 operating revenues were from the sale of electric energy. All of the Company's electric revenues are derived from customers in South Dakota.\nThe Company has relatively few large customers in its service territory. By customer category, 33% of 1994 total electric sales was from residential sales, 50% was from commercial and industrial sales, 2% was from street lighting and sales to public authorities, and 15% was from sales for resale.\nSales for resale primarily include power pool sales to other utilities. Power pool sales fluctuate from year to year depending on a number of factors including the Company's availability of excess short-term generation and the ability to sell the excess power to other utilities in the power pool. The Company also sells power and energy at wholesale to certain municipalities for resale and to various governmental agencies. In 1994, these sales accounted for less than 1% of total electric sales.\nCAPABILITY AND DEMAND. The Company shares in the ownership of the Big Stone Generating Plant (Big Stone), located near Big Stone City in northeastern South Dakota. In North Dakota, the Company maintains transmission facilities to interconnect with electric transmission lines of other utilities and shares in the ownership of the Coyote I Electric Generating Plant (Coyote), located near Beulah, North Dakota. In Iowa, the Company shares in the ownership of Neal Electric Generating Unit #4 (Neal), located near Sioux City.\nAt December 31, 1994, the aggregate net summer peaking capacity of all Company-owned electric generating units was 309,480 mw, consisting of 105,711 kw from Big Stone (the Company's 23.4% share), 42,600 kw from Coyote (the Company's 10.0% share), 54,169 kw from Neal (the Company's 8.7% share), and 107,000 kw from internal combustion turbine units and small diesel units, used primarily for peaking purposes.\nThe Company is a summer peaking utility. The 1994 peak demand of 229,922 occurred on July 18, 1994. Total system capability at the time of peak was 309,480 kw. The reserve margin for 1994 was 35%. The minimum reserve margin requirement as determined by the members of the Mid- Continent Area Power Pool (MAPP), of which the Company is a member, is 15%.\nMAPP is an area power pool arrangement consisting of utilities and power suppliers having transmission interconnections located in a 9-state area in the North Central region of the United States and in two Canadian provinces. The objective of MAPP is to accomplish coordination of planning and operation of generation and interconnecting transmission facilities to provide reliable and economical electric service to members' customers, consistent with reasonable utilization of natural resources and protection of the environment. While benefiting from the advantages of the planning, coordination, and operations of MAPP, each member has the right and obligation to own or otherwise provide the facilities to meet its own requirements. The terms and conditions of the MAPP agreement and transactions between MAPP members are subject to the jurisdiction of the FERC. The MAPP agreement was accepted for filing by the FERC effective 1972. The Company also has interconnections with the transmission facilities of Otter Tail Power Company, Montana-Dakota Utilities Co., Northern States Power Company, and WAPA; and has emergency interconnections with transmission facilities of East River Electric Cooperative, Inc. and West Central Electric Cooperative. These interconnections and pooling arrangements enable the Company to arrange purchases or sales of substantial quantities of electric power and energy with other pool members and to participate in the benefits of pool arrangements.\nThe Company is finalizing an integrated resource plan to identify how it will meet the energy needs of its customers. The plan includes estimates of customer usage and programs to provide for economic, reliable, and timely supplies of energy. The plan does not anticipate the need for additional baseload generating capacity for at least the next ten years.\nFUEL SUPPLY. Lignite and sub-bituminous coal were utilized by the Company as fuel for virtually all of the electric energy generated during 1994. North Dakota lignite is the primary fuel at Big Stone and Coyote I. During 1994, the average heating value of lignite burned was 6,049 BTU per pound at Big Stone and 6,922 BTU per pound at Coyote I. The sulfur content of this lignite is typically between 0.80% and 1.2%. Neal #4 burns Wyoming sub-bituminous coal which had an average heating value of 8,450 BTU per pound during 1994. Typically, the sulphur content of this coal is between 0.30% and 0.40%.\nThe Company's fuel costs have remained relatively stable. The average costs of fuels burned are shown below for the periods indicated:\nCost Per Million BTU % of 1994 Year Ended December 31 Megawatt Hours Fuel Type 1992 1993 1994 Generated --------- ---- ---- ---- --------------\nLignite - Big Stone $1.16 $1.12 $1.10 47% Lignite - Coyote I** .81 .84 .86 21% Sub-bituminous - Neal #4 .77 .76 .74 32% Natural Gas 2.62 2.37 2.21 * Oil 4.29 3.90 3.90 *\n*Less than one-half of one percent. **Includes pollution control reagent.\nDuring 1994, the average delivered cost per ton of lignite was $13.13 to Big Stone and $10.99 to Coyote I. The average cost for coal delivered to Neal #4 was $11.95 per ton for 1994. Such amounts include severance taxes imposed by the state of North Dakota on lignite and a production tax imposed by the state of Wyoming on other coal. While the effect on the Company's fuel costs of future changes in severance or production taxes cannot be predicted, any unforeseen changes in the Company's fuel costs may be passed on to its customers through the operation of the fuel adjustment clause. This feature of the Company's electric rates is more fully discussed in the section entitled \"Regulation\".\nThe continued delivery of lignite and sub-bituminous coal to the three large steam generating units in which the Company is part owner is reasonably assured by contracts covering various periods of the operating lives of these units. The Big Stone contract provides for adequate supplies of lignite through purchases under the primary contract, which expires in mid-1995. Following bid evaluations of coal supplies for the Big Stone Plant, a contract for Montana sub-bituminous coal was secured during 1994 for the period of mid-1995 through 1999. Further evaluations will be conducted during the contract term to select a coal supply for periods beyond 1999. The contract for delivery of lignite to the Coyote I plant, which expires in 2016, provides for an adequate fuel supply for the estimated economic life of that plant. Neal #4 receives Wyoming sub- bituminous coal under a long-term contract which expires in 1998. In the near future, the Company, along with the other owners of Neal #4, will begin to study options for the supply of coal for periods beyond the expiration date.\nFollowing test burns in 1990 and 1991, the owners of the Big Stone plant received approval from the South Dakota Department of Environment and Natural Resources to burn tire derived fuel (TDF) and refuse derived fuel (RDF). The quantity of TDF and RDF that was burned in 1994 and that is expected to be burned in 1995 is insignificant when compared to total coal consumption at the plant.\nThe fossil fuel supplies for the Big Stone and Neal #4 plants are delivered via unit trains belonging to the respective plants' owners and locomotives of the Burlington Northern Railroad and the Chicago and Northwestern Railroad, respectively. The lignite supply for Coyote I is delivered via conveyor at this \"mine-mouth\" plant.\nWhile the Company has no firm contract for diesel fuel for its other electric generating plants, it has been able to purchase its diesel fuel requirements in recent years from local suppliers and currently has in storage an amount adequate to satisfy its normal requirements for such fuel.\nAdditional information relating to jointly owned plants is incorporated by reference to Note 6 of the \"Notes to Consolidated Statements\" on page 22 of the Company's 1994 Annual Report to Stockholders filed as an Exhibit hereto.\nGAS BUSINESS\nGAS SALES AND DEMAND. On a fully consolidated basis, 40% of the Company's 1994 operating revenues were from the sale of gas energy. During 1994, the Company derived 56% of its gas revenues from South Dakota and 44% from Nebraska. The Company's peak daily sendout was 128,700 MMBTU.\nCAPABILITY AND SUPPLY. The Company owns and operates natural gas distribution systems serving 36,259 customers in eastern South Dakota, for which it purchases gas from various gas marketing firms under gas transportation service agreements with various gas marketing firms. These agreements provide for firm deliverable pipeline capacity of approximately 49,300 MMBTU per day in South Dakota. The Company has service agreements with Northern Natural Gas Company (NNG) providing for firm transportation of natural gas. While NNG has eliminated nearly all of its gas supply activities, the Company has supply contracts in place and peak shaving capacity to meet its peak day system needs.\nIn Nebraska, the Company owns and operates natural gas distribution systems serving 38,723 retail customers in the village of Alda and the cities of Grand Island, Kearney, and North Platte, Nebraska. The Company purchases much of its natural gas for these systems from KN Gas Supply Co. under a seven-year service agreement entered in 1993. The Company also purchases certain quantities of gas for its Nebraska customers from various gas marketing firms. These agreements provide for firm deliverable pipeline capacity of approximately 49,600 MMBTU per day in Nebraska.\nIn 1992, the Federal Energy Regulatory Commission (FERC) issued Order 636. Order 636 requires, among other provisions, that all companies with natural gas pipelines separate natural gas supply or production services from transportation service and storage businesses. This allows gas distribution companies, such as the Company, and individual customers to purchase gas directly from producers, third parties, and various gas marketing entities and transport it through the suppliers' pipelines. Both NNG and KN Interstate Gas Transmission Co. (KN) have completed restructuring proceedings with the FERC under Order 636 in which their transportation, sales, and storage services were changed. The Company has operated under the restructured environment during the past two years.\nTo supplement firm gas supplies, the Company also has contracts for underground natural gas storage services to meet the heating season and peak day requirements of its gas customers. In addition, the Company also owns and operates six propane-air plants with a total rated capacity of 18,000 MMBTU per day, or approximately 14% of peak day requirements. The propane-air plants provide an economic alternative to pipeline transportation charges to meet the extreme peaks caused by customer demand on extremely cold days.\nA few of the Company's industrial customers purchase their natural gas requirements directly from gas marketing firms for transportation and delivery through the Company's distribution system. The transportation rates have been designed to make the Company economically indifferent as to whether the Company sells and transports gas or only transports gas.\nCOMPETITION\nAlthough the Company's electric service territory is assigned according to the South Dakota Public Utilities Act, and the Company has the right to provide electric service to present and future electric customers in its assigned service area for so long as the service provided is deemed adequate, the energy industry in general has become increasingly competitive. Electric service also competes with other forms of energy and the degree of competition may vary from time to time depending on relative costs and supplies of other forms of energy.\nThe National Energy Policy Act of 1992 was designed to promote energy efficiency and increased competition in the electric wholesale markets. The Energy Act also allows the FERC to order wholesale wheeling by public utilities to provide utility and nonutility generators access to public utility transmission facilitates. The provision allows the FERC to set prices for wheeling, which will allow utilities to recover certain costs from the companies receiving the services, rather than the utilities' retail customers. Many states are currently considering retail wheeling, which aims to provide all customers with the right to choose their electricity supplier. No regulatory proposals have yet been formally introduced in South Dakota.\nFederal Energy Regulatory Commission Order 636 requires, among other provisions, that all companies with natural gas pipelines separate natural gas supply or production services from transportation service and storage businesses. This allows gas distribution companies, such as the Company, and individual customers to purchase gas directly from producers, third parties, and various gas marketing entities and transport it through the suppliers' pipelines. While Order 636 had positive aspects by providing for more diversified supply and storage options, it also required the Company to assume responsibility for the procurement, transportation, and storage of natural gas. The alternatives now available under Order 636 create additional pressure on all distribution companies to keep gas supply and transportation pricing competitive, particularly for large customers.\nREGULATION\nThe Company is a \"public utility\" within the meaning of the Federal Power Act and the South Dakota Public Utilities Act and, as such, is subject to the jurisdiction of, and regulation by, FERC with respect to issuance of securities, the PUC with respect to electric service territories, and both FERC and the PUC with respect to rates, service, accounting records, and in other respects. The State of Nebraska has no centralized regulatory agency which has jurisdiction over the Company's operations in that state; however, the Company's natural gas rates are subject to regulation by the municipalities in which it operates.\nUnder the South Dakota Public Utilities Act, enacted in 1975, a requested rate increase may be implemented by the Company 30 days after the date of its filing unless its effectiveness is suspended by the PUC and, in such event, can be implemented subject to refund with interest six months after the date of filing, unless sooner authorized by the PUC. The Company's electric rate schedules provide that it may pass along to all classes of customers qualified increases or decreases in the cost of fuel used in its generating stations and in the cost of fuel included in purchased power. A purchased gas adjustment provision in its gas rate schedules permits the company to pass along to gas customers increases or decreases in the cost of purchased gas.\nThe Company filed no electric rate cases in South Dakota during the three years ended December 31, 1994. On May 26, 1994, the Company filed for a $2.4 million increase in South Dakota natural gas revenues. As a result of a negotiated settlement with the South Dakota Public Utilities Commission, on November 15, 1994, the Company implemented rates which will produce additional annual natural gas revenues of $2.1 million, assuming normal weather, representing an overall increase of 6.2%. On December 30, 1994, the Company filed for increased rates applicable to the Nebraska natural gas service area. The proposal, which would increase overall revenues for a year with normal weather by $2.7 million or 9.6%, cannot become effective before April 1, 1995 based upon provisions of the Municipal Natural Gas Regulation Act passed in 1986.\nENVIRONMENTAL MATTERS\nThe Company is subject to regulation with regard to air and water quality, solid waste disposal, and other environmental considerations by Federal, state, and local governmental authorities. The application of governmental requirements to protect the environment involves or may involve review, certification, issuance of permits, or similar action by government agencies or authorities, including the United States Environmental Protection Agency (EPA), the South Dakota Department of Environment and Natural Resources (DENR), the North Dakota State Department of Health, and the Iowa Department of Environmental Quality, as well as compliance with decisions of the courts. Such requirements, particularly with regard to emissions into the air and water, may substantially increase the cost to the Company of construction and operation of electric generating facilities. Such requirements may also necessitate additional investments in new equipment at existing installations.\nCLEAN AIR ACT. The Clean Air Act Amendments of 1990 (the Clean Air Act) which stipulate limitations on sulfur dioxide and nitrogen oxide emissions from certain coal-fired power plants will require the purchase of additional emission allowances or a reduction in sulfur dioxide emissions beginning in the year 2000 from Big Stone. The Company believes Big Stone can most economically meet the sulfur dioxide emission requirements of the Clean Air Act by switching its fuel source from North Dakota lignite to low- sulfur western sub-bituminous coal available in the region. The Company's other baseload plants, Coyote I and Neal #4, are expected to comply with the sulfur dioxide emission limitations through the use of existing flue gas scrubbing and low sulfur coal without the need for additional emission allowances.\nWith regard to the Clean Air Act's nitrogen oxide emission requirements, the Neal #4 wall-fired boiler is expected to meet the emission limitations for such boilers. The Clean Air Act does not yet specify nitrogen oxide limitations for boilers with cyclone burners such as those used at Big Stone and Coyote I because practical low-nitrogen oxide cyclone burner technology does not exist. It requires the EPA to establish nitrogen oxide emission limitations before 1997 for cyclone boilers including consideration that the cost to accomplish such limits be comparable to retrofitting low-nitrogen oxide burner technology to other types of boilers. In addition, it also requires future studies to determine what controls, if any, should be imposed on coal-fired boilers to control emissions of certain air toxics other than sulfur and nitrogen oxides. Because of the uncertain nature of cyclone boiler nitrogen oxide and air toxic emission limits, the Company cannot now determine the additional costs, if any, it may incur due to these provisions of the Clean Air Act.\nPCBs. The Company has met or exceeded the removal and disposal requirements of equipment containing polychlorinated biphenyls (PCBs) as required by state and federal regulations. The Company will use some PCB- contaminated equipment for its remaining useful life, and dispose of the equipment according to pertinent regulations that govern that use and disposal of this equipment. PCB-contaminated oil is burned for energy recovery at a permitted facility.\nSTORAGE TANKS. The South Dakota DENR and the EPA adopted regulations imposing requirements upon the owners and operators of aboveground and underground storage tanks. The Company's fuel oil storage facilities at its generating plants in South Dakota are affected by the aboveground tank regulations, and the Company has instituted procedures for compliance.\nSITE REMEDIATION. The Company conducted an investigation of a manufactured gas plant (MGP) site and is taking remedial action to dispose of waste material found at such site. Recovery of remediation costs for such sites will be sought from insurance carriers and through the regulatory process although there is no assurance that such costs will be recovered.\nCOMPLIANCE. In addition to the Clean Air Act, the Company is also subject to other environmental regulations. The Company believes that it is in compliance with all presently applicable environmental protection requirements and regulations. However, the Company is unable to forecast the effect which future environmental regulations may ultimately have upon the cost of its facilities and operations. No administrative or judicial proceedings involving the company are now pending or known by the Company to be contemplated under presently effective environmental protection requirements.\nSITING. The states of South Dakota, North Dakota, and Iowa have enacted laws with respect to the siting of large electric generating plants and transmission lines. The South Dakota PUC, the North Dakota Public Service Commission, and the Iowa Utilities Board have been granted authority in their respective states to issue site permits for nonexempt facilities.\nCAPITAL SPENDING AND FINANCING\nThe Company's primary capital requirements include the funding of its utility construction and expansion programs, the funding of debt and preferred stock retirements and sinking fund requirements, and the funding of its corporate development and investment activities.\nThe emphasis of the Company's construction activities is to undertake those projects that most efficiently serve the expanding needs of its customer base, enhance energy delivery capabilities, expand its current customer base, and provide for the reliability of energy supply. Capital expenditure plans are subject to continual review and may be revised as a result of changing economic conditions, variations in sales, environmental requirements, investment opportunities, and other ongoing considerations.\nExpenditures for construction activities for 1994, 1993, and 1992 were $22.7 million, $20.0 million, and $18.5 million. Construction expenditures during the last three years included expenditures related to the installation of an additional 43 mw of internal peaking capacity, the expansion of the Company's natural gas system into 29 additional communities in eastern South Dakota, and to an operations center which will provide future cost savings and operating efficiencies through consolidation of activities. Construction expenditures for 1995 are estimated to be $19.3 million. The majority of the projected expenditures will be spent on enhancements of the electric and gas distribution systems and completion of the operations center. Estimated construction expenditures for the years 1995 through 1999 are expected to be $69 million.\nCapital requirements for the mandatory retirement of long-term debt and the mandatory preferred stock sinking fund redemption totaled $600,000, $180,000, and $513,000, for the years ended 1994, 1993, and 1992. It is expected that such mandatory retirements will be $600,000 in 1995, $1,080,000 in 1996, $570,000 in 1997, $20.6 million in 1998, and $13.5 million in 1999.\nThe Company anticipates that future capital requirements will be met by both internally generated cash flows and available external financing.\nThe Company will continue to evaluate and pursue opportunities to enhance shareholder return through nonregulated business investments. Nonregulated projects are expected to be financed from the existing investment portfolio and from other available financing options.\nInformation relating to capital resources and liquidity is incorporated by reference to \"Management's Discussion and Analysis\" on pages 12-14 of the Company's 1994 Annual Report to Stockholders, filed as an Exhibit hereto.\nNONUTILITY OPERATIONS\nGRANT, INC. Grant, Inc., which holds title to property not used in the Company's utility business, was incorporated in South Dakota in 1972.\nNORTHWESTERN GROWTH CORPORATION (NGC). NGC was incorporated under the laws of South Dakota in 1994 to pursue and manage nonutility investments and development activities. Although the primary focus of NGC's investment program will be to seek growth opportunities in the energy, energy equipment, and energy services industries, NGC will also continue to pursue opportunities in existing and emerging growth entities in nonenergy industries that meet return and capital gain requirements. Along with a portfolio of marketable securities, NGC's assets include the investments of two subsidiaries: Northwestern Networks, Inc. and Northwestern Systems, Inc.\nNORTHWESTERN NETWORKS, INC. (NNI). NNI was incorporated in South Dakota in 1986. NNI holds a common stock investment in LodgeNet Entertainment Corporation, a provider of television entertainment and information systems to hotels and motels.\nNORTHWESTERN SYSTEMS, INC. (NSI). NSI was incorporated in South Dakota in 1986. In December 1992, NSI acquired a 60% common stock ownership in Lucht, Inc., a firm that develops, manufactures, and markets multi-image photographic printers and other related equipment. On October 1, 1993, NSI acquired the remaining 40% common stock interest in that company.\nAdditional information relating to nonutility business is incorporated by reference to \"Management's Discussion and Analysis\" on pages 12-14 of the Company's 1994 Annual Report to Stockholders filed as an Exhibit hereto.\nEMPLOYEES\nAt December 31, 1994, the Company had 452 employees. A three-year collective bargaining agreement which expires June 30, 1995, covers 252 operating and clerical employees. The Company has never experienced a work stoppage or strike and considers its relationship with its employees to be very good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nELECTRIC PROPERTY\nThe Company's electric properties consist of an interconnected and integrated system. The Company, Otter Tail, and MDU jointly own Big Stone, a 455,783 kilowatt (kw) nameplate capacity lignite-fueled electric generating plant and related transmission facilities. Big Stone is operated by Otter Tail for the benefit of the owners. The Company owns 23.4% of the Big Stone Plant.\nThe Company is one of four power suppliers which jointly own Coyote I, a 455,783 kw nameplate capacity lignite-fueled electric generating plant and related transmission facilities located near Beulah, North Dakota. The Company has a 10% interest in Coyote I, which is operated by MDU for the benefit of the owners.\nThe Company is one of 14 power suppliers which jointly own Neal #4, a 639,999 kw nameplate capacity coal-fueled electric generating plant and related transmission facilities located near Sioux City, Iowa. Midwest Power Systems, Inc. is principal owner of Neal #4 and is the operator of the unit. The Company has an 8.7% interest in Neal #4.\nThe Company has an undivided interest in these jointly owned facilities and is responsible for its proportionate share of the capital and operating costs while being entitled to its proportionate share of the power generated. Each participant finances its own investment. The Company's interest in each plant is reflected in the Consolidated Balance Sheet on a pro rata basis, and its share of operating expenses is reflected in the Consolidated Statement of Income and Retained Earnings.\nIn addition to its interest in Big Stone, Coyote I, and Neal #4, the Company owns and operates 19 oil and gas-fired units for peaking and reserve capacity.\nAs of December 31, 1994, the aggregate nameplate capacity of all Company-owned electric generating units is 327,419 kw, with an aggregate net summer peaking capacity of 309,480 kw and a net winter peaking capacity of 327,542 kw. The Company's maximum peak hourly demand of 251,493 kw occurred on July 17, 1991. In 1994, the Company's peak hourly demand was 229,922 kw and occurred on July 18, 1994.\nThe Company's interconnected transmission system consists of 318.5 miles operating at 115 kilovolts (kv) and 896.7 miles operating at 69 kv and 34.5 kv. The Company also owns three segments of transmission line, which are not tied to its internal system, in connection with its joint ownership in the three large steam generating plants. These lines consist of 18.2 miles of 230 kv line from Big Stone, 25.4 miles of 345 kv line from Neal #4, and 23.1 miles of 345 kv line from Coyote I. In addition to these lines, the Company owns 1,717.2 miles of distribution lines serving customers in more than 100 communities and adjacent rural areas. The company owns 38 transmission substations with a total rated capacity of 1,111,417 kilovolt amperes (kva), two mobile substations with a total rated capacity of 5,500 kva and 78 distribution substations with a total rated capacity of 358,449 kva.\nGAS PROPERTY\nOn December 31, 1994, the Company owned 999 miles of distribution mains and appurtenant facilities in South Dakota. The Company also owns propane-air facilities in Aberdeen, Brookings, Huron, and Mitchell, South Dakota, having a total rated capacity of 15,280 MMBTU per day, which are operated for standby and peak shaving purposes only.\nOn December 31, 1994, the Company owned 649 miles of distribution mains and appurtenant facilities in Nebraska. The Company also owns propane-air facilities at Kearney and North Platte, Nebraska, having a total rated capacity of 9,380 MMBTU per day, which are operated for standby and peak shaving purposes only.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not currently involved in any pending major litigation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo issues were submitted to a vote of security holders during the last quarter of the period covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is listed on the New York Stock Exchange (NYSE) under the ticker symbol NPS. Common stock was registered in the names of 8,132 stockholders at December 31, 1994. The payment of dividends is subject to the restrictions described in Note 2 of the \"Notes to Consolidated Financial Statements\" on page 21 of the Company's 1994 Annual Report to Stockholders, filed as an Exhibit hereto.\nQUARTERLY COMMON STOCK INFORMATION\n1994 High Low Dividends ---- ---- --- --------- First $29 $26 $.415 Second 29 5\/8 26 .415 Third 29 3\/8 27 1\/2 .415 Fourth 28 7\/8 24 1\/2 .425\n1993 High Low Dividends ---- ---- --- --------- First $29 1\/2 $26 1\/4 $.405 Second 31 1\/2 28 3\/4 .405 Third 33 1\/2 29 1\/4 .405 Fourth 32 1\/2 28 1\/2 .415\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n1994 1993 1992 1991 1990 ---- ---- ---- ---- ---- (in thousands, except per share amounts)\nOperating Revenues $157,266 $153,257 $119,197 $122,900 $115,980 Net Income 15,440 15,191 13,721 14,815 17,506 Earnings Per Common Share 2.00 1.96 1.77 1.88 2.23 Dividends Per Common Share 1.670 1.630 1.590 1.535 1.475 Total Assets 359,066 343,574 308,194 297,761 283,073 Long-Term Debt 127,623 127,200 106,572 93,236 79,469 Redeemable Preferred Stock 40 70 100 2,990 3,185\nSelected financial data includes the operating results and balance sheet amounts for Lucht, Inc. effective December 1, 1992, the date of acquisition. Additional information relating to Lucht, Inc. is incorporated by reference to \"Management's Discussion and Analysis\" on pages 12-14 of the Company's 1994 Annual Report to Stockholders, filed as an Exhibit hereto.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATION\nThe information required by this Item 7 is incorporated by reference to \"Management's Discussion and Analysis\" on pages 12-14 of the Company's 1994 Annual Report to Stockholders, filed as an Exhibit hereto.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item 8 is incorporated by reference to the Company's financial statements and related footnotes on pages 16-24 of the Company's 1994 Annual Report to Stockholders, filed as an Exhibit hereto.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere have been no changes in accountants or disagreements on accounting principles or practices or financial statement disclosures.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n(a) IDENTIFICATION OF DIRECTORS\nThe information regarding directors required by this Item 10 and paragraphs (a) and (e) of Item 401 of Regulation S-K is incorporated by reference to the information under \"Election of Directors\" in the Company's definitive Proxy Statement dated March 24, 1995, and filed with the Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 within 120 days after the close of the Company's fiscal year ended December 31, 1994.\n(b) & (e) IDENTIFICATION AND BUSINESS EXPERIENCE OF EXECUTIVE OFFICERS\nR. A. Wilkens, Chairman of the Board, age 66\nChairman of the Board of Directors since February 1994. Formerly Chief Executive Officer from 1990-1994; formerly President from 1980-1994.\nM. D. Lewis, President and Chief Executive, age 47\nPresident and Chief Executive Officer since February 1994; formerly Executive Vice President-Corporate Services 1992-1994; formerly Vice President-Corporate Services 1987-1992; Assistant Vice President-Corporate Services 1985-1987.\nW. D. Craig, Vice President, age 58\nVice President since November 1994; formerly Vice President-Gas Operations September 1988-November 1994; Assistant Vice President-Gas Operations June, 1988-September 1988; Manager-Gas Operations March 1988-June 1988. Joined the Company in 1988. Formerly President & COO of Hoosier Gas Corporation 1987-1988. Formerly Director-Gas Operations of SIGECO 1985-1987.\nA. D. Dietrich, Vice President-Corporate Services, age 44\nVice President-Corporate Services since November 1994; Corporate Secretary since October 1989; formerly Vice President-Legal May 1990-November 1994; Assistant Corporate Secretary September 1989-October 1989; Corporate Attorney 1978-1989.\nA. R. Donnell, Vice President-Energy Operations, age 51\nVice President-Energy Operations since November 1994; formerly Vice President-Electric Operations July 1987-November 1994; Assistant Vice President-Electric Operations June 1987-July 1987; Manager-Electric Distribution 1985-June 1987; Manager-Special Projects 1977-1985.\nT. A. Gulbranson, Vice President, age 47\nVice President since November 1994; formerly Vice President-Corporate Services May 1993-November 1994; Vice President-Community Development 1988- 1993; formerly Division Manager-Webster 1983-1988.\nR. R. Hylland, Vice President-Finance and Corporate Development, age 34\nVice President-Finance and Corporate Development since November 1994; formerly Vice President-Finance and Corporate Development and Treasurer May 1993-November 1994; Vice President-Finance and Treasurer 1991-1994; Treasurer and Controller December 1990-April 1991; Controller and Assistant Treasurer November 1989-December 1990; Controller July 1989-November 1989. Joined the Company in July 1989. Formerly Senior Audit and Financial Consulting Manager with Arthur Andersen & Co. Mr. Hylland also serves as President and Chief Operating Officer of Northwestern Growth Corporation since November 1994.\nR. F. Leyendecker, Vice President-Energy Services, age 49\nVice President-Energy Services since November 1994; formerly Vice President- Rates & Regulation 1987-November 1994; Assistant Vice President-Rates & Regulation 1985-1987.\nW. K. Lotsberg, Vice President-Public Affairs, age 52\nVice President-Public Affairs since May 1994; formerly Vice President- Consumer Affairs March 1989-May 1994; Manager-Public Affairs from 1980 to 1989.\nD. C. Oberlander, Assistant Vice President, age 49\nAssistant Vice President since May 1994; formerly Controller April 1991-May 1994; Assistant Controller December 1990-April 1991; Manager-Information Systems 1979-1990.\nR. A. Thaden, Treasurer, age 43\nTreasurer since November 1994; formerly Manager-Corporate Accounting 1987- November 1994.\nAll of the executive officers of the registrant serve at the discretion of the Board and are elected annually by the Board of Directors following the Annual Meeting of Stockholders except for the positions of Controller, Assistant Treasurer and Assistant Corporate Secretary, which are appointed by the Board of Directors. No family relationships exist between any officers of the Company.\n(c) IDENTIFICATION OF CERTAIN SIGNIFICANT EMPLOYEES\nNone\n(d) FAMILY RELATIONSHIPS\nNone\n(f) INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS\nNone\n(g) PROMOTERS AND CONTROL PERSONS\nNone\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 is incorporated by reference to the information under \"Compensation of Directors and Executive Officers\" in the Company's definitive Proxy Statement dated March 24, 1995, and filed with the Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 within 120 days after the close of the Company's fiscal year ended December 31, 1994.\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 under \"Securities Ownership by Directors and Officers\" in the Company's definitive Proxy Statement dated March 24, 1995, and filed with the Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 within 120 days after the close of the Company's fiscal year ended December 31, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company has no relationships or transactions covered by this item.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) DOCUMENTS FILED AS PART OF THIS REPORT\n1. Financial Statements\nThe following items are included in this annual report by reference to the registrant's Annual Report to Stockholders for the year ended December 31, 1994: Page in Annual Report to Stockholders --------------- Financial Statements:\nConsolidated Statement of Operations and Retained Earnings for the Three Years Ended December 31, 1994 16\nConsolidated Statement of Cash Flows for the Three Years Ended December 31, 1994 17\nConsolidated Balance Sheet, December 31, 1994 and 1993 18\nConsolidated Statement of Capitalization, December 31, 1994 and 1993 19\nNotes to Consolidated Financial Statements 20-24\nQuarterly Unaudited Financial Data for the Two Years Ended December 31, 1994 24\nReport of Independent Public Accountants 15\n2. Financial Statement Schedules\nThe following supplemental financial data included herein should be read in conjunction with the financial statements referenced above:\nPage in Form 10-K ---------\nReport of Independent Public Accountants Following Signatures\nSchedule VIII - Valuation and Qualifying Accounts Following Report of Independent Public Accountants\nSchedules other than those 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 financial statements or the notes thereto.\n(b) REPORTS ON FORM 8-K\nNo reports on Form 8-K have been filed during the quarter ended December 31, 1994.\n(c) EXHIBITS\nSee Exhibit 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, thereunto duly authorized.\nNORTHWESTERN PUBLIC SERVICE COMPANY\n\/s\/ M. D. Lewis --------------------------------------- M. D. Lewis, Director and President and Chief Executive Officer 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.\n\/s\/ R. A. Wilkens --------------------------------------- R. A. Wilkens, Chairman of the Board of Directors\n\/s\/ M. D. Lewis --------------------------------------- M. D. Lewis, Director and President and Chief Executive Officer\n\/s\/ R. R. Hylland --------------------------------------- R. R. Hylland, Vice President-Finance & Corporate Development (Principal Financial Officer)\n\/s\/ Rogene A. Thaden --------------------------------------- Rogene A. Thaden, Treasurer (Principal Accounting Officer)\n\/s\/ Jerry W. Johnson --------------------------------------- Jerry W. Johnson, Director\n\/s\/ Aelred J. Kurtenbach --------------------------------------- Aelred J. Kurtenbach, Director\n\/s\/ Herman Lerdal --------------------------------------- Herman Lerdal, Director\n\/s\/ Larry F. Ness --------------------------------------- Larry F. Ness, Director\n\/s\/ Raymond M. Schutz --------------------------------------- Raymond M. Schutz, Director\n\/s\/ Bruce I. Smith --------------------------------------- Bruce I. Smith, Director\n\/s\/ W. W. Wood --------------------------------------- W. W. Wood, Director\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Northwestern Public Service Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Northwestern Public Service Company's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 27, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The supplemental financial information and schedule listed in the table of contents of financial statements 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. This information 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\nMinneapolis, Minnesota, January 27, 1995\nEXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K FOR YEAR ENDED DECEMBER 31, 1994\n(3) ARTICLES OF INCORPORATION AND BY-LAWS\n3(a)(1)\nRegistrant's Restated Certificate of Incorporation, dated February 7, 1990, is incorporated by reference to Exhibit 3(a)(1) to Form 10-K for the year ended December 31, 1989, Commission File No. 0-692.\n3(a)(2)\nCertificate of Retirement of Preferred Stocks, dated January 13, 1992, is incorporated by reference to Exhibit 3(a)(2) to Form 10-K for the year ended December 31, 1991, Commission File No. 0-692.\n3(b)\nRegistrant's By-Laws, as amended, dated December 1, 1990, are incorporated by reference to Exhibit 3(b) to Form 10-K for the year ended December 31, 1990, Commission File No. 0-692.\n(4) INDENTURES AND POLLUTION CONTROL FACILITY OBLIGATIONS\n4(a)(1)\nIndenture, dated August 1, 1940, executed by the Company to The Chase Manhattan Bank (N.A.) and J. J. O'Connell, as Trustees, and supplemental and amendatory indentures thereto are incorporated by reference to Exhibit 2 to Form 12-K for the year ended December 31, 1970, Commission File No. 2-4472.\n4(a)(2)\nSupplemental Indenture, dated August 1, 1972, executed by the Company to The Chase Manhattan Bank (N.A.) and J. J. O'Connell, as Trustees, is incorporated by reference to Exhibit 2 to Form 8-K for the month of August, 1972, Commission File No. 2-4472.\n4(a)(3)\nSupplemental Indenture, dated July 1, 1973, executed by the Company to The Chase Manhattan Bank (N.A.) and J. J. O'Connell, as Trustees, is incorporated by reference to Exhibit 1 to Form 8-K for the month of July, 1973, Commission File No. 2-4472.\n4(a)(4)\nSupplemental Indenture, dated November 14, 1974, executed by the Company to The Chase Manhattan Bank (N.A.) and J. J. O'Connell, as Trustees, is incorporated by reference to Exhibit 1 to Form 8-K for the month of November, 1974, Commission File No. 2-4472.\n4(a)(5)\nSupplemental Indenture, dated May 1, 1975, executed by the Company to The Chase Manhattan Bank (N.A.) and J. J. O'Connell, as Trustees, is incorporated by reference to Exhibit 2 to Form 8-K for the month of May, 1975, Commission File No. 2-4472.\n4(a)(6)\nSupplemental Indenture, dated June 1, 1977, executed by the Company to The Chase Manhattan Bank (N.A.) and J. J. O'Connell, as Trustees, is incorporated by reference to Exhibit 2(a)(34) to Registration Statement on Form S-7 (Reg. No. 2-58825).\n4(a)(7)\nSupplemental Indenture, dated July 1, 1978, executed by the Company to The Chase Manhattan Bank (N.A.) and J. J. O'Connell, as Trustees, is incorporated by reference to Exhibit 2(a)(43) to Registration Statement on Form S-7 (Reg. No. 2-63083).\n4(a)(8)\nSupplemental Indenture, dated December 1, 1978, executed by the Company to The Chase Manhattan Bank (N.A.) and J. J. O'Connell, as Trustees, is incorporated by reference to Exhibit 11 to Form 10-K for the year ended December 31, 1978, Commission File No. 0-692.\n4(a)(9)\nRegistrant's Supplemental Indenture, dated May 6, 1987, is incorporated by reference to Exhibit 3(a) to Form 10-Q for the quarter ended September 30, 1987, Commission File No. 0-692.\n4(a)(10)\nSupplemental Indenture, dated November 1, 1989, executed by the Company to the Chase Manhattan Bank (N.A.) and Vincent J. Marino, as Trustees, is incorporated by reference to Exhibit 4(a)(10) to Form 10-K for the year ended December 31, 1989, Commission File No. 0-692.\n4(a)(11)(i)\nSupplemental Indenture, dated July 15, 1991, executed by the Company to the Chase Manhattan Bank (N.A.) and C. J. Heinzelmann, as Trustees, is incorporated by reference to Exhibit 4(a)(11)(i) to Form 8-K, dated August 1, 1991, Commission File No. 0-692.\n4(a)(12)\nSupplemental Indenture, dated November 15, 1991, is incorporated by reference to Exhibit 4(a)(12) to Form 10-K for the year ended December 31, 1991, Commission File No. 0-692.\n4(a)(13)\nSupplemental Indenture, dated September 1, 1992, executed by the Company to the Chase Manhattan Bank (N.A.) and C. J. Heinzelmann, as Trustees, is incorporated by reference to Exhibit 4(a)(11)(i) to Form 8-K, dated September 18, 1992, Commission File No. 0-692.\n4(a)(14)\nUnderwriting Agreement dated August 16, 1993 among the Company, Morgan Stanley & Co. Incorporated, Lehman Brothers Inc. and NatWest Capital Markets Limited, is incorporated by reference to Exhibit 1 of Registrant's Report on Form 8-K, dated August 16, 1993, Commission File No. 0-692.\n4(a)(15)\nGeneral Mortgage Indenture and Deed of Trust dated as of August 1, 1993 from the Company to The Chase Manhattan Bank (National Association), as Trustee, is incorporated by reference to Exhibit 4(a) of Form 8-K, dated August 16, 1993, Commission File No. 0-692.\n4(a)(16)\nSupplemental Indenture dated as of August 15, 1993 to the General Mortgage Indenture and Deed of Trust dated as of August 1, 1993 executed by the Company to The Chase Manhattan Bank (National Association), as Trustee, is incorporated by reference to Exhibit 4(b) of Form 8-K, dated August 16, 1993, Commission File No. 0-692.\n4(a)(17)\nSupplemental Indenture dated August 15, 1993 to the Indenture dated August 1, 1940 from the Company to The Chase Manhattan Bank (National Association) and C. J. Heinzelmann, as successor Trustees, is incorporated by reference to Exhibit 4(c) of Form 8-K, dated August 16, 1993, Commission File No. 0-692.\n4(b)(1)\nCopy of Sale Agreement between Company and Mercer County, North Dakota, dated June 1, 1993, related to issuance of Pollution Control Refunding Revenue Bonds (Northwestern Public Service Company Project) Series 1993, is incorporated by reference to Exhibit 4(b)(1) of Registrant's report on Form 10-Q for the quarter ending June 30, 1993, Commission File No. 0-692.\n4(b)(2)\nCopy of Loan Agreement between Company and Grant County, South Dakota, dated June 1, 1993, related to issuance of Pollution Control Refunding Revenue Bonds (Northwestern Public Service Company Project) Series 1993A, is incorporated by reference to Exhibit 4(b)(2) of Registrant's report on Form 10-Q for the quarter ending June 30, 1993, Commission File No. 0-692.\n4(b)(3)\nCopy of Loan Agreement between Company and Grant County, South Dakota, dated June 1, 1993, related to issuance of Pollution Control Refunding Revenue Bonds (Northwestern Public Service Company Project) Series 1993B, is incorporated by reference to Exhibit 4(b)(3) of Registrant's report on Form 10-Q for the quarter ending June 30, 1993, Commission File No. 0-692.\n4(b)(4)\nCopy of Loan Agreement between Company and City of Salix, Iowa, dated June 1, 1993, related to issuance of Pollution Control Refunding Revenue Bonds (Northwestern Public Service Company Project) Series 1993, is incorporated by reference to Exhibit 4(b)(4) of Registrant's report on Form 10-Q for the quarter ending June 30, 1993, Commission File No. 0-692.\n(10) MATERIAL CONTRACTS\n10(a)(1)(i)\nCopy of Big Stone Plant Agreement, an agreement between Otter Tail Power Company, Montana-Dakota Utilities Co. and Northwestern Public Service Company for sharing ownership of generating plant, dated January 7, 1970, is incorporated by reference to Exhibit 6 to Form 12-K for the year ended December 31, 1971, Commission File No. 2-4472.\n10(a)(1)(ii)\nCopy of Supplemental Agreement No. 1 to Big Stone Plant Agreement, dated July 1, 1983, is incorporated by reference to Exhibit 10(a)(1)(ii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(a)(1)(iii)\nCopy of Supplemental Agreement No. 2 to Big Stone Plant Agreement, dated March 1, 1985, is incorporated by reference to Exhibit 10(a)(1)(iii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(a)(1)(iv)\nCopy of Supplemental Agreement No. 3 to Big Stone Plant Agreement, dated March 31, 1986, is incorporated by reference to Exhibit 10(a)(1)(iv) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(a)(2)(i)\nCopy of Big Stone Plant Coal Agreement between Otter Tail Power Company, Montana-Dakota Utilities Co., and Northwestern Public Service Company and Knife River Coal Mining Company, dated January 1, 1972, is incorporated by reference to Exhibit 5 to Form 10-K for the year ended December 31, 1980.\n10(a)(2)(ii)\nCopy of Amendment to Big Stone Plant Coal Agreement, dated June 25, 1992, is incorporated by reference to Exhibit 10(a)(2)(ii) to Form 10-K for the year ended December 31, 1992, commission File No. 0-692.\n10(a)(3)(i)\nCopy of Big Stone Plant Transmission Facilities Agreement between Otter Tail Power Company, Montana-Dakota Utilities Co., and Northwestern Public Service Company, dated April 3, 1972, is incorporated by reference to Exhibit 10(a)(3)(i) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(a)(3)(ii)\nCopy of Supplement No. 1 to Big Stone Plant Transmission Facilities Agreement, dated October 1, 1974, is incorporated by reference to Exhibit 10(a)(3)(ii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(a)(3)(iii)\nCopy of Supplement No. 2 to Big Stone Plant Transmission Facilities Agreement, dated June 10, 1976, is incorporated by reference to Exhibit 10(a)(3)(iii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(a)(3)(iv)\nCopy of Supplement No. 3 to Big Stone Plant Transmission Facilities Agreement, dated October 1, 1982, is incorporated by reference to Exhibit 10(a)(3)(iv) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(a)(3)(v)\nCopy of Supplement No. 4 to Big Stone Plant Transmission Facilities Agreement, dated October 1, 1982, is incorporated by reference to Exhibit 10(a)(3)(v) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(a)(3)(vi)\nCopy of Supplement No. 5 to Big Stone Plant Transmission Facilities Agreement, dated March 1, 1985, is incorporated by reference to Exhibit 10(a)(3)(vi) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(a)(3)(vii)\nCopy of Supplement No. 6 to Big Stone Plant Transmission Facilities Agreement, dated March 31, 1986, is incorporated by reference to Exhibit 10(a)(3)(vii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(b)(1)(i)\nCopy of Amendment to Ownership Agreement for George Neal Generating Station Unit 4, dated October 30, 1975, to reflect Registrant's ownership interest of 50,000 KW (8.681%), is incorporated by reference to Exhibit 10 to Form 12-K for the year ended December 31, 1975, Commission File No. 2-4472.\n10(b)(1)(ii)\nCopy of Second Amendment to Ownership Agreement for George Neal Generating Station Unit 4, dated October 30, 1975, is incorporated by reference to Exhibit 10(b)(1)(ii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(b)(1)(iii)\nCopy of Third Amendment to Ownership Agreement for George Neal Generating Station Unit 4, dated December 31, 1984, is incorporated by reference to Exhibit 10(b)(1)(iii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(b)(2)(i)\nCopy of Coal Sales and Purchase Agreement, between Iowa Public Service Company (as agent for the owners of the George Neal Generating Station Unit 4) and Carter Oil Company, dated September 29, 1977, is incorporated by reference to Exhibit 13 to Form 10-K for the year ended December 31, 1977, Commission File No. 0-692.\n10(b)(2)(ii)\nCopy of Notice of Election to Extend Coal Contract with Carter Oil Company, dated November 2, 1978, is incorporated by reference to Exhibit 10(b)(2)(ii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(b)(2)(iii)\nCopy of revised Exhibit \"A\", dated May 1, 1986 to Coal Sales and Purchase Agreement, dated September 29, 1977, is incorporated by reference to Exhibit 10(b)(2)(iii) to Form 10-K for the year ended December 31, 1990, Commission File No. 0-692.\n10(b)(3)(i)\nCopy of Transmission Facilities and Operating Agreement for George Neal Generating Station Unit 4, entered by and between Iowa Public Service Company, Northwestern Public Service Company, & other plant owners, dated October 24, 1984, is incorporated by reference to Exhibit 10(b)(3)(i) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(b)(3)(ii)\nCopy of First Amendment to Transmission Facilities and Operating Agreement for George Neal Generating Station Unit 4, dated December 31, 1984, is incorporated by reference to Exhibit 10(b)(3)(ii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(c)(1)(i)\nCopy of Agreement for Sharing Ownership of Generating Unit No. 1, Coyote Station, by and between Otter Tail Power Company, Minnkota Power Cooperative, Inc., Montana-Dakota Utilities Co., Minnesota Power & Light Company, & Northwestern Public Service Company, dated December 31, 1977, is incorporated by reference to Exhibit 15 to Form 10-K for the year ended December 31, 1978, Commission File No. 0-692.\n10(c)(1)(ii)\nCopy of Supplemental Agreement No. 1 to Agreement for Sharing Ownership of Generating Unit No. 1, Coyote Station, dated December 31, 1977, is incorporated by reference to Exhibit 16 to Form 10-K for the year ended December 31, 1978, Commission File No. 0-692.\n10(c)(1)(iii)\nCopy of Amendment No. 2 to Agreement for Sharing Ownership of Generating Unit No. 1, Coyote Station, Amendment No. 1 to Coyote 1 Station Transmission Facilities Agreement, and Amendment No. 2 to Coyote Plant Coal Agreement, dated March 1, 1981, is incorporated by reference to Exhibit 10(c)(1)(iii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(c)(1)(iv)\nCopy of Amendment No. 3 to Agreement for Sharing Ownership of Generating Unit No. 1, Coyote Station, Amendment No. 2 to Coyote 1 Station Transmission Facilities Agreement, and Amendment No. 5 to Coyote Plant Coal Agreement, dated September 5, 1985, is incorporated by reference to Exhibit 10(c)(1)(iv) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(c)(2)(i)\nCopy of Coyote Plant Coal Agreement, by and between Otter Tail Power Company, Minnkota Power Cooperative, Inc., Montana-Dakota Utilities Co., Minnesota Power & Light Company, & Northwestern Public Service Company and Knife River Coal Mining Company, and Addendum to Coyote Plant Coal Agreement, both dated January 1, 1978, are incorporated by reference to Exhibit 17 to Form 10-K for the year ended December 31, 1979, Commission File No. 0-692.\n10(c)(2)(ii)\nCopy of Addendum to Coyote Plant Coal Agreement, dated March 10, 1980, is incorporated by reference to Exhibit 10(c)(2)(ii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(c)(2)(iii)\nCopy of Amendment to Coyote Plant Coal Agreement, dated May 28, 1981, is incorporated by reference to Exhibit 10(c)(2)(iii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(c)(2)(iv)\nCopy of Fourth Amendment to Coyote Plant Coal Agreement, dated August 19, 1985, is incorporated by reference to Exhibit 10(c)(2)(iv) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(c)(3)(i)\nCopy of Coyote 1 Station Transmission Facilities Agreement, by and between Otter Tail Power Company, Minnkota Power Cooperative, Inc., Montana-Dakota Utilities Co., Minnesota Power Company, & Northwestern Public Service Company, dated November 30, 1978, is incorporated by reference to Exhibit 10(c)(3)(i) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(c)(3)(ii)\nCopy of Amendment No. 2 to Coyote Station Transmission Facilities Agreement, dated January 1, 1983, is incorporated by reference to Exhibit 10(c)(3)(ii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(c)(3)(iii)\nCopy of System Interconnection Agreement, by and between Otter Tail Power Company, Montana-Dakota Utilities Co., & Northwestern Public Service Company, dated September 26, 1988, is incorporated by reference to Exhibit 10(c)(3)(iii) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(d)\nMid-Continent Area Power Pool Agreement, dated March 31, 1972, as amended through January 1, 1991, is incorporated by reference to Exhibit 10(d) to Form 10-K for the year ended December 31, 1991, Commission File No. 0-692.\n10(e)(1)\nInterconnection Contract between Registrant and Western Area Power Administration, dated April 1, 1984, is incorporated by reference to Exhibit 4 to Form 10-K for the year ended December 31, 1984, Commission File No. 0-692.\n10(e)(2)\nSupplement No. 6 to Interconnection Contract between Registrant and Western Area Power Administration, dated February 5, 1987, is incorporated by reference to Exhibit 10(e)(2) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(e)(3)\nSupplement No. 5 to Interconnection Contract between Registrant and Western Area Power Administration, dated June 1, 1987, is incorporated by reference to Exhibit 10(e)(3) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(g)(1)\nSupplemental Income Security (Retirement) Plan for Directors, Officers and Managers, as amended July 1, 1986, is incorporated by reference to Exhibit 10(g)(1) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(g)(2)\nDeferred Compensation Plan for Non-employee Directors adopted November 6, 1985, is incorporated by reference to Exhibit 10(g)(2) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(g)(3)\nForm of Severance Agreement for Officers is incorporated by reference to Exhibit 5 to Form 10-Q for the quarter ended March 31, 1986, Commission File 0-692.\n10(g)(4)\nPension Equalization Plan, dated August 5, 1987, is incorporated by reference to Exhibit 10(g)(4) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692.\n10(g)(5)\nDirector Retirement Plan dated November 4, 1987, as amended February 2, 1994, is incorporated by reference to Exhibit 10(g)(5) to Form 10-K for the year ended December 31, 1993, Commission File No. 0-692.\n10(g)(6)\nAnnual Performance Incentive Plan for Officers, dated February 1, 1989, as amended February 2, 1994, is incorporated by reference to Exhibit 10(g)(6) to Form 10-K for the year ended December 31, 1993, Commission File No. 0- 692.\n10(g)(7)\nLong-term Incentive Compensation Plan (Phantom Stock Unit Plan) for Directors and Officers, dated February 1, 1989, as amended February 2, 1994, is incorporated by reference to Exhibit 10(g)(7) to Form 10-K for the year ended December 31, 1993, Commission File No. 0-692.\n10(g)(8)\nSupplemental Pension Agreement for W. D. Craig, dated May 3, 1989, is incorporated by reference to Exhibit 10(g)(9) to Form 10-K for the year ended December 31, 1989, Commission File No. 0-692.\n(13) REPORT FURNISHED TO SECURITY HOLDERS\n13(a)\nAnnual Report for fiscal year ended December 31, 1994, furnished to stockholders of record on March 1, 1995 (exhibit filed herewith).\n(21) SUBSIDIARIES OF REGISTRANT\n21(a)\nGrant, Inc., a South Dakota corporation, is a wholly owned subsidiary of Registrant which does business under the name of Grant, Inc.\n21(b)\nNorthwestern Growth, Inc., a South Dakota corporation, is a wholly owned subsidiary of Registrant which does business under the name of Northwestern Growth, Inc.\n21(c)\nNorthwestern Systems, Inc., a South Dakota corporation, is a wholly owned subsidiary of Registrant which does business under the name of Northwestern Systems, Inc.\n21(d)\nNorthwestern Networks, Inc., a South Dakota corporation, is a wholly owned subsidiary of Registrant which does business under the name of Northwestern Networks, Inc.\n(22) OTHER DOCUMENTS OR STATEMENTS TO SECURITY HOLDERS\n22(a)\nProxy materials dated March 24, 1995, furnished to common stockholders of record on March 6, 1995 (exhibit filed with SEC on March 27, 1995).\nFinancial Data Schedule","section_15":""}
{"filename":"771729_1994.txt","cik":"771729","year":"1994","section_1":"Item 1. Business.\nGENERAL\nPrecision Standard, Inc. (\"the Company\") is a diversified company composed of the following wholly-owned subsidiaries and divisions: (a) The Aeroplex Group of Pemco Aeroplex, Inc. (the \"Aeroplex\") which maintains and modifies large transport aircraft for the U.S. Government and foreign and commercial customers, (b) Pemco World Air Services, A\/S which maintains and modifies large transport aircraft for foreign and commercial customers, (c) Hayes Targets Division of Pemco Aeroplex, Inc. (the \"Targets Division\") which designs and manufactures aerial target systems for domestic and foreign military customers, (d) Space Vector Corporation (\"Space Vector\" or \"SVC\") which develops and manufactures rocket launch vehicles and guidance systems for the U.S. Government and foreign and commercial customers, (e) Pemco Engineers Aircraft Cargo Systems Division (the \"Aircraft Cargo Systems Division\") which designs and manufactures aircraft cargo handling systems, (f) Pemco Engineers Springs and Components Division which designs and manufactures precision springs and components, (g) Pemco Air Support Services, Inc. (\"PASS\") which sells parts for large transport aircraft and provides support of aircraft which have been converted or modified by its affiliates and (h) Pemco Nacelle Services, Inc. (\"Nacelle\") which maintains and overhauls engine nacelles and thrust-reversers for large jet transport aircraft.\nSIGNIFICANT DEVELOPMENTS\nAward of KC-135 Aircraft Contract\nThe United States Air Force awarded a contract in August of 1994 to the Aeroplex for the Programmed Depot Maintenance (PDM) of the KC-135 aircraft. The contract is expected to run for seven years and involve the maintenance of as many as 406 aircraft. The amount funded as of March, 1995 under the first year of the contract was $41.6 million. The total value of the contract over a seven year period, if fully funded, is expected to be over $254.0 million. The Company has performed Programmed Depot Maintenance on KC-135 aircraft since 1968 and has processed over 2,050 of the KC- 135 aircraft.\nPemco World Air Services, A\/S\nThe Company contracted with Sterling Airways of Copenhagen, Denmark in May of 1994 for the lease of Sterling's 180,000 square foot aircraft maintenance center at Copenhagen Airport. The Company's Copenhagen operation is registered as a Danish limited company and operates under the name Pemco World Air Services, A\/S (\"PWAS\"). The agreement with Sterling entitles PWAS to use of existing tools and equipment and appoints PWAS as Sterling's consignment distributor for all rotables, spares, consumables and raw materials. Additionally, the agreement grants PWAS an option to purchase the hangars which are situated on ground leased from the airport and entitles PWAS to use of all of Sterling's service data, manuals, technical materials and related information.\nThe wide-body facility in Copenhagen, which is approved by the Joint Aviation Authority of the European Community (\"JAA\") and the Federal Aviation Administration (\"FAA\") as a Part 145 repair station, offers the full range of quality products and services available at the Company's North American facilities. These products and services include maintenance checks, aging aircraft inspections and repairs, the repair and overhaul of aircraft components, passenger-to-Quick Change conversions and passenger-to- freighter conversions.\nRealignment of Operating Units\nIn September of 1994, the Company reallocated its management resources and realigned its operating units into four groupings: (a) the Commercial Aircraft Maintenance and Modification Group, which began operating under the name Pemco World Air Services in August of 1994 and includes the Dothan Division of the Aeroplex and Pemco World Air Services, A\/S; (b) the Government and Military Aircraft Services Group which operates as the Birmingham Division of the Aeroplex; (c) the Manufacturing and Overhaul Group which includes the Aircraft Cargo Systems and Springs and Components Divisions of Pemco Engineers, Pemco Nacelle Services, Inc., the Targets Division and Space Vector Corporation; and (d) the Aviation Support Services Group which operates as PASS.\nJoint Aviation Authority Approvals\nIn 1994 the Joint Aviation Authority of the European Community granted authority to the Aeroplex for the performance of maintenance and modification work on aircraft which are registered under JAA authority and operated throughout the world. JAA approval was also granted to the Company's Aircraft Cargo Systems Division for the manufacture of all aircraft cargo handling systems, laminated panels and related spares and to the Company's Pemco Nacelle Services subsidiary for the maintenance and overhaul of engine nacelles and thrust reversers for European-operated aircraft. The JAA approvals enhance the Company's expansion in the global marketplace allowing the Company to utilize full U.S. and European authority on all of the Company's aircraft maintenance, modification and manufacturing products and services.\nRelocation of Pemco Nacelle Services, Inc.\nThe Company anticipates relocating Pemco Nacelle Services, Inc. to its Clearwater facility in the second quarter of 1995 in order to accommodate the current and anticipated needs of Pemco Nacelle. The Clearwater facility also houses the PASS aircraft parts distribution center. Earlier, the Company suspended its aircraft maintenance operations at the facility to adjust its staffing to current work levels.\nPRINCIPAL PRODUCTS AND SERVICES\nAircraft Maintenance and Modification\nGeneral\nThe Aircraft Maintenance and Modification services offered by the Company provide a skilled work force and a large, permanent engineering, design and analysis staff. This comprehensive staff performs custom airframe design and modification functions and offers complete airframe maintenance and repair services together with technical publication and reprographic capabilities. The Company's work force and engineering staff are capable in all aspects of aerodynamics, propulsion, fluid mechanics, flight operations, fuel and induction systems, controls, communications, radar, instrumentation and support research and development functions. The Company's reprographic capability includes photographic enlargement, negative, mylar photomural and film positive products, xerographic reproduction, and such other support functions as fomecore mounting, binding, microfilming and video inventorying of aircraft input for production.\nThe principal services performed under contract are Programmed Depot Maintenance, commercial \"C\" and \"D\" checks, overhaul and modification of fixed and rotary wing aircraft, passenger-to- freighter conversions, passenger-to-Quick Change conversions, aircraft strip and paint, component overhaul, rewiring, military landing gear overhaul, parts fabrication and engineering support. The Company maintains its own hydraulic and sheet metal machine shops to satisfy all of its hydraulic test and assembly needs and to fabricate, repair and restore parts and components for aircraft structural modification. The Company also performs in-house, heat-treatment work on alloys used in aircraft modifications and repairs and has complete non-destructive testing capabilities and test laboratories.\nThe Company has produced quality maintenance and modification work on a wide variety of aircraft over the past 43 years, including C-130, KC-135, B-757, B-747, B-737, B-727, B-707, DC-8, DC-9, C-9, P-3, T-34, A-300, BAE-146 and U.S. Navy H-2 helicopters.\nC-130\nThe Company has performed Programmed Depot Maintenance on the U.S. Air Force C-130 Hercules aircraft continuously since 1965. The C-130 is a four engine, turboprop military cargo aircraft built by Lockheed since the mid 1950's. There are more that 700 C-130 aircraft in the U.S. military fleet and this aircraft is expected to remain an integral part of the U.S. Air Force transport fleet through the mid 2010's. In addition to the C-130 PDM contract, the Company has performed modification work for the U.S. Air Force under a C-130 wing retrofit contract. In total, the Company has processed over 3,100 C-130 aircraft.\nThe U.S. Air Force awarded a five year contract to the Company for the maintenance of C-130 aircraft in 1991. The contract expires in 1996 at which time the Company intends to vigorously pursue its re-award.\nKC-135\nThe Company first performed Programmed Depot Maintenance on the U.S. Air Force KC-135 aircraft in 1968, and has since processed over 2,050 of the aircraft. There are approximately 740 KC-135 aircraft in the U.S. military fleet, and this aircraft is expected to remain operational beyond the year 2020. In addition to the KC-135 PDM contract, the Company has performed major KC-135 aircraft modifications including wing re-skin, major rewire, corrosion prevention control, flight director, auto pilot, and fuel savings advisory system modifications.\nIn August of 1994, the United States Air Force awarded the Company a new contract for Programmed Depot Maintenance of KC-135 aircraft. The contract is expected to run for seven years and involve the maintenance of as many as 406 aircraft. In October of 1994, the Air Force awarded approximately $38.0 million of work for the first fiscal year under the contract. This annual award does not include amounts for \"drop-in\" aircraft or additional work of a non-routine nature which is funded on a case-by-case basis. The amount funded as of March, 1995 under the first year of the contract had increased to $41.6 million. The total value of the contract over a seven year period, if fully funded, is expected to be over $254.0 million.\nThe current contract follows a five year contract awarded in 1990. The total funding on the prior five year contract was approximately $261.0 million.\nMost major government aircraft maintenance and modification programs are awarded for a one year term with optional follow-on years. The awards are generally fixed price contracts which also provide the opportunity for additional work to be done on a time and materials cost basis. The Company aggressively pursues this market by remaining in close contact with the various planning and procurement agencies of the U.S. Government and foreign services and following new and revised programs from the early program definition stage through the final contract award. Potential commercial programs are followed in a similar manner through close and continued contact with airlines, cargo carriers and leasing companies.\nThe Aircraft Maintenance and Modification service is performed at the Birmingham and Dothan Divisions of the Aeroplex and at Pemco World Air Services, A\/S in Copenhagen, Denmark. Each of these facilities is an FAA and JAA approved Repair Station which employs Designated Engineering Representatives (\"DERs\"). DERs are design and engineering personnel certified by the FAA, thus permitting the Company to design certain systems without individual FAA approval.\nThe Company's principal customers for its Aircraft Maintenance and Modification service are the United States and foreign armed services, commercial air carriers (both domestic and foreign, passenger and cargo) and aircraft leasing companies. The Company markets its products and services in the United States, Europe, Scandinavia, Africa, the Middle East and the Commonwealth of Independent States (CIS).\nThe Company's competition in the United States consists mainly of other independent, unlimited repair stations and modifications centers. There are approximately 10-15 such facilities in the United States, ranging from $1 million to $150 million in revenue, which compete with the Company for business in this approximately $2.0 billion industry. However, most of the Company's domestic competitors tend to specialize in particular portions of the aircraft while the Company focuses on total airframe repair, maintenance and conversion. Outside of the United States, the majority of the Company's competitors are affiliated with an airline. The Company's competition for its conversion products resides in the United States and in Israel.\nThe Company considers its competitive strengths to be its engineering capability, trained labor force, substantial capacity and strong customer base. Additionally, the Company believes itself to be the first U.S. independent operator to have established a base in Europe. This will allow the Company to expand its relationships with aircraft leasing companies and to offer its conversion products and support capabilities to leasing companies' fleets on two continents simultaneously.\nSupersonic and Subsonic Aerial Tow Targets and Wing Tip Infrared Pods\nThe Company designs and manufactures supersonic and subsonic aerial tow targets and wing tip infrared pods. The family of low cost, high speed targets is known as the Hayes Universal Tow Target System (HUTTS). The targets can be flown from any commercial or military aircraft capable of carrying external stores as well as from most drone aircraft. The targets are available in various detection configurations: 1) visual smoke 2) visual light 3) infrared (simulates a jet aircraft engine) 4) radar and 5) visual fiber streamer. A maneuvering tow target and a low altitude sea-skimming target are also available in each of the above configurations. The various targets and equipment associated with the HUTTS are fully-developed and operational in the U.S. military services and in the services of many foreign countries.\nThe infrared wing tip pods are utilized on sub and full scale drones or droned excess military aircraft. Hayes Targets has supplied 100% of infrared augmentation for the U.S. Air Force for the last 20 years. Hayes Targets is presently designated as an Air Force \"Blue Ribbon Contractor\".\nThe targets and pods are produced by the Company's Targets Division at Leeds, Alabama. The principal markets for the targets are the U.S. armed forces as well as markets in Europe, the Middle East, Australia and South America. The Company's competition consists of one competitor on the west coast of the United States and two foreign entities. The Company considers its competitive strength in this market to be its innovative engineering capabilities and superior product performance.\nSpace Vehicles and Support Systems\nThe Company maintains a large research, development and engineering staff dedicated to the design and manufacture of space related systems such as sounding rockets, launch vehicles, guidance and control subsystems, vehicle structures and recovery systems. The staff serves in the capacity of a subcontractor in most large U.S. Government Department of Defense programs. The staff has prime contracts with NASA in support of space science and does a limited amount of commercial space work.\nThe Company's largest contract in this arena is the HERA program which will provide realistic ballistic targets for Theater Missile Defense (TMD) interceptor deployment. The HERA program, initiated in 1992, provides for twenty-five target vehicles to be utilized during interceptor testing of various TMD systems through the year 1997. Options to provide an additional fifty target vehicles to continue Army testing and to accommodate Air Force and Navy TMD missions through the year 2000 are part of the long-range HERA program. The initial demonstration flight test vehicle is scheduled for launch in April 1995 with the first target mission scheduled for July 1995. The HERA program is sponsored by the U.S. Army Space and Strategic Defense Command. Its contractor team is comprised of Coleman Research Corporation as the system prime contractor, Space Vector Corporation as the booster subcontractor, and Aerotherm Corporation as the ballistic reentry target subcontractor.\nThis product line is produced by the Company's Space Vector subsidiary, which is located at Chatsworth, California with a satellite office at Fountain Valley, California. The Company's principal markets for its space and missile products are the U.S. Government, prime contractors to the U.S. Government, and the scientific community in general. The Company's competition ranges from very small organizations for the component subsystems to major corporations for the design and manufacture of spacecraft and launch vehicles. The Company considers its competitive strength to be its technical and managerial competence. The Company's contracts are awarded in accordance with the government's competitive bidding practices.\nCargo Handling Systems\nThe Company designs and manufactures on-board cargo-handling systems for all types of large transport aircraft, including B-747, B-727, B-737, DC-8, DC-9\/C-9B, DC-10\/KC-10, L-1011, L-100 and L-188, and certain other military aircraft. Robotics and fully-computerized machinery are used to produce a wide variety of aircraft cargo handling systems as well as individual parts used in the Company's proprietary systems and in other systems. These cargo systems represent state-of-the-art technology in their design, efficient use of floor space and maximum strength, with a minimum of added weight. The systems meet all of the FAA and JAA Quality Assurance Standards, MIL-I and MIL-Q qualifications as required.\nThis product line is produced by the Company's Pemco Engineers Aircraft Cargo Systems Division located at Corona, California. The Company's principal markets for the cargo handling system are all major United States and foreign airlines and aircraft manufacturers. The Company has approximately eight competitors and considers its strength in this industry to be its innovation, quality and response time.\nPrecision Springs and Components\nThe Company manufactures precision springs and components and employs custom design, tooling and precision stamping in the production of these high tolerance parts. The springs and components are used in a variety of industrial, commercial and residential applications.\nThis product line is produced by the Company's Pemco Engineers Springs and Components Division. This division is also located at Corona, California and shares state-of-the-art equipment with Pemco Engineers Aircraft Cargo System Division. The Company markets its precision springs and components to a wide range of manufacturers in numerous industries. There are approximately 500 manufacturers of springs and components in the United States making it a $1 billion industry. The Company's competitors range in size from \"single-machine\" shops to companies with revenues exceeding $20 million. Most of the competitors, however, produce a broader mix of products while the Company focuses on the manufacture of precision springs and components.\nParts Support and Component Overhauls\nThe Company's Parts Support and Component Overhaul service provides a comprehensive source for aircraft spares and component overhauls. The Company uses its inventory and on-line tracking and sales system to provide support to the cargo conversion customers of Pemco World Air Services as well as to users and owners of a wide range of commercial and military aircraft. This service provides the Company's customers with the capability of locating spare parts virtually anywhere in the world, an inventory of critical spare parts for the Company's conversion programs and 24 hour \"Aircraft on Ground\" service.\nThis service is provided by Pemco Air Support Services, Inc. (\"PASS\"). PASS has three locations. PASS facilities at Birmingham, Alabama and Clearwater, Florida serve North and South America as well as the Pacific Rim. The PASS facility in Copenhagen, Denmark serves Europe, Africa, and the Middle East. The Company markets its parts support and component overhaul service to commercial carriers worldwide as well as to foreign armed services.\nIn the area of supporting and selling the Company's designed and manufactured parts, the Company often benefits from a captive market situation. In the second area of competition, which is the brokerage of non-proprietary parts, the industry is comprised of several large companies and as many as a thousand smaller companies. While the Company is still a small player in this market segment, its goal is to market quality products that interest the users of the Company's products, thus creating a sales synergy. To this end, the Company has obtained several European distributorships for U.S. based companies and expects to increase the number of distributorships to 15-20 over the next few years. Its future market strength will depend on the Company's ability to create innovative pricing structures, provide higher quality service and the acquisition of parts inventories or teaming arrangements upon beneficial terms.\nNacelle Overhaul and Repair\nThe Nacelle Overhaul and Repair service provides a comprehensive source for the overhaul, repair and modification to nacelles and thrust reversers for engines supplied by General Electric, Pratt & Whitney and Rolls-Royce.\nThis service is provided by Pemco Nacelle Services, Inc. which is located at Leeds, Alabama. The Company markets its nacelle overhaul and repair service to commercial carriers worldwide and supports turbofan-powered aircraft manufactured by Airbus, Boeing and McDonnell Douglas. There are approximately five competitors in the United States and abroad. The Company entered this line of business in March of 1993 and plans to build its competitive strength on turnaround time, the convenience of customer exchange in lieu of repair, quality, and price.\nSTATUS OF NEW PRODUCTS OR SERVICES\nB-737 Conversion Program\nIn June of 1991, the Company completed and received a Supplementary Type Certificate (STC) for the first after-market conversion of a factory-delivered Boeing 737-300 aircraft from passenger-to-freighter or passenger-to-Quick Change configurations. (Quick Change aircraft can be used to carry either passengers or freight, thus increasing aircraft utilization and revenues.) The Company had converted twenty-nine 737-300 aircraft as of December 31, 1994.\nThe Company also developed an amendment to the above STC in order to accomplish the conversion of a Boeing 737-200 aircraft from passenger-to-freighter or passenger-to-Quick Change configurations. The Company converted two 737-200 aircraft in 1994 and has eight option ships in its backlog.\nB-757 Conversion Program\nIn September of 1992, the Company entered into a data licensing agreement with Boeing to facilitate development by the Company of a STC for the after market conversion of Boeing B-757 aircraft from passenger-to-freighter or passenger-to-Quick Change configurations. The Company is continuing to seek a launch customer for this program.\nFormation of Joint Stock Company with British Russian Aviation Corporation (BRAVIA)\nThe Company agreed in June of 1993 to form a joint stock company in cooperation with British Russian Aviation Corporation (BRAVIA) for the conversion of TU-204 passenger aircraft to freighter, Quick Change (QC) and \"combi\" configurations and for stripping, cleaning and painting of the aircraft. The joint stock company is to include BRAVIA shareholders, Tupolev, Aviastar and Aviation Ventures, a subsidiary of Fleming Russian Investment Corporation. No constructive progress concerning the joint stock company was made in 1994 and the Company does not foresee the venture progressing substantially in 1995.\nRESEARCH AND DEVELOPMENT\nThe Company charged the cost it incurred for company sponsored research and development costs, which totalled $0.8 million in 1994, $0.4 million in 1993 and $0.8 million in 1992 directly to earnings. The research and development activities in 1994 were principally in support of the Targets and Aircraft programs. In 1995, research and development costs are expected to be in the $0.5 to $1.0 million range, again principally in support of the Targets and Aircraft programs. The Company is not engaged in any customer sponsored research and development efforts.\nSALES\nForeign and Domestic Operations and Export Sales\nThe majority of the Company's revenues were generated in the United States and the majority of the Company's assets are located in the United States. The Company has two foreign operations, Pemco World Air Services, A\/S which is registered as a Danish limited company and Pemco Air Support Services which is registered as a Danish branch of a U.S. company. These foreign operations contributed less than four percent of the Company's consolidated revenue in 1994 and own less than four percent of the Company's identifiable consolidated assets. The Company does not expect the growth rate of its foreign operations to substantially exceed the growth rate of the Company as a whole.\nThe Company provides maintenance and modification services to foreign-based aircraft owners and operators at its U.S. facilities and its Copenhagen, Denmark facility. The Company's Targets, Space Vector and Aircraft Cargo Systems Divisions also sell in export markets. The services and products sold at the Company's U.S. locations are payable only in U.S. dollars. The Company's Copenhagen locations accept payments in Danish kroner and U.S. dollars, as well as other foreign currencies.\nThe following table presents the percentages of total sales for each principal product and service rendered for the last three fiscal years and the percentage of export sales for the last three fiscal years. (See also footnote number 13 to the accompanying financial statements of the Company which are included under Item 8 hereof):\nMajor Customers\nBacklog\nFor the year ending December 31, 1994, 65% of the Company's backlog was for the U.S. Government versus 70% for the year ending December 31, 1993. The backlog for the U.S. Government decreased $8.5 million from 1993 to 1994, primarily due to performance of work in 1994 under the Company's HERA contract. The HERA contract is the Company's largest contract for its Space Vehicles and Support Systems. The HERA contract backlog at December 31, 1993 was approximately $17.4 million versus $12.7 million at December 31, 1994. The Company's U.S. Government backlog also decreased due to the completion of the Company's contract at the government- owned, company-operated facility at Bergstrom U.S. Air Force Base and due to a $4.6 million reduction in C-130 orders. Partially offsetting the reduction in U.S. Government backlog is an increase of $3.5 million in KC-135 orders. Commercial backlog increased $7.8 million primarily due to the additional scheduling of 727 cargo conversion aircraft.\nApproximately $27.2 million of 1994 commercial backlog, (compared to $25.4 million at December 31, 1993) included above may not be considered firm as it includes maintenance and modification work to be performed on optional aircraft. Approximately $28.9 million of 1994 U.S. Government backlog (compared to $27.0 million at December 31, 1993) included above are firm orders that have not yet been funded. Additionally, the Company has approximately $200.0 million of firm but unfunded backlog associated with the six follow-on years of the KC-135 contract and $6.5 million associated with the final year of the C-130 contract which is not included in the figures cited above. Approximately $115.7 million of the December 31, 1994 backlog is expected to be filled in 1995.\nRAW MATERIALS\nThe Company purchases a variety of raw materials including aluminum sheets and plates, extrusion, alloy steel and forgings. The Company experienced no significant shortages of raw material essential to its business during 1994 and does not anticipate any shortages of critical commodities over the longer term; although, this is difficult to assess because many factors causing such possible shortages are outside its control. The Company has experienced a noticeable increase in lead times from its vendors, particularly on aluminum and extrusion orders. This could culminate in an increase in the cost of the Company's raw material purchases in 1995.\nThe Company procures many components, parts and equipment items from various domestic companies. The Company faces some dependence on suppliers for certain types of parts involving highly technical processes; however, this risk has lessened in the past few years as additional high technology suppliers have entered the market. The Company does not believe this dependence has significance for its business as a whole; rather, any adverse consequence that might result from the failure of a sole supplier to provide a particular part would be felt on an individual contract basis.\nA significant portion of the equipment and components used by the Company in the fulfillment of its services under United States Government contracts is furnished without charge to the Company by the U.S. Government. The Company is dependent upon U.S. Government furnished material to meet delivery schedules, and untimely receipt of such material would adversely affect production schedules and contract profitability. The Company has encountered late delivery of Government-furnished material (GFM) in 1993 and 1994 and as a result, has experienced a disruption in scheduled work flow. The Company has submitted a request for Equitable Adjustment to the U.S. Government for the increased costs it has incurred attributable to untimely receipt of GFM. The Company has recorded a long-term receivable and revenue equal to $3.5 million associated with this request. The Company anticipates the late delivery of GFM by the U.S. Government to continue in 1995.\nPATENTS, TRADEMARKS, COPYRIGHTS AND STC'S\nThe Company holds 36 FAA-issued Supplementary Type Certificates (STCs) which authorize it to perform certain modifications to aircraft. These modifications include air-stair installation and the conversion of commercial aircraft from passenger-to-freighter or passenger-to-Quick Change configurations. The STCs are applicable to Boeing 707, 727, 737, Douglas DC-6, DC-8, DC-9, and Convair 580 Series Aircraft. The Company also holds 13 STCs related to its cargo handling systems for various types of large transport aircraft. STCs are not patentable but instead indicate an FAA acceptable procedure to perform a given air-worthiness modification.\nThe Company holds 24 FAA-issued Parts Manufacturing Approvals (PMAs) which give it authorization to manufacture parts of its own design or that of other manufacturers related to its cargo handling system. The Company holds numerous other PMAs which give the Company authority to manufacture certain parts used in the conversion of aircraft from passenger-to-freighter and passenger- to-Quick Change configurations. The Company has an intangible asset of approximately $0.2 million at December 31, 1994 related to the STCs and PMAs and will fully amortize this intangible asset over the next ten years.\nThe Company holds two active utility patents and three active design patents related to the target product line. Three of the patents (one utility expiring in 2001 and two designs expiring in 1998) concern infrared augmentation. The second utility patent is a British patent (expiring in 1997) and concerns visual augmentation. The remaining design patent (expiring in 1998) concerns a portable ground scoring unit developed for the purpose of scoring ground-based target emplacements on ground-to-air gunnery ranges. All of the patents except the British patent are U.S. patents. The Company does not believe that the expiration or invalidation of any or all of these patents would have a material adverse impact upon its financial condition.\nThe Company holds copyrights to the computer software developed in-house for the operation of the Power Drive Unit System and Cargo Door Electro-Mechanical System used in the conversion of commercial aircraft, as well as copyrights to the software for the development of the control computer codes for the TLX-1 sea-skimming, height-keeping tow target, and the TMX class maneuvering target. These copyrights are not registered and will begin to expire after the year 2028.\nENVIRONMENTAL COMPLIANCE\nThe Company has requirements to comply with environmental regulations at the federal, state and local levels. These requirements apply especially to the stripping, cleaning and painting of aircraft. The requirements to comply with environmental regulations have not had, and are not expected to have, a material effect on the Company's capital expenditures, earnings and competitive position.\nThe Company has been designated as a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act for contamination associated with a site near its Clearwater facility. It is difficult to estimate the total cleanup costs and to predict the method that will be used to allocate such costs among the responsible parties. However, based upon presently known facts, the Company does not believe that the resolution of this matter will have a material adverse effect on the Company's financial position, results of operations or cash flows.\nEMPLOYEES\nAt March 15, 1995, the Company employed approximately 2,414 persons, of whom approximately 1,686 were covered by collective bargaining agreements. Twenty-eight of the employees are employed on a part-time basis.\nThe two primary collective bargaining agreements are with the International Association of Machinists at the Company's Dothan, Alabama location and the United Auto Workers at the Company's Birmingham, Alabama and Leeds, Alabama locations.\nThe collective bargaining agreement with the International Association of Machinists was successfully negotiated without a work stoppage in August of 1992 and was extended for five years to August 1997. The collective bargaining agreement with the United Auto Workers was successfully negotiated without a work stoppage in July of 1993 and was extended for three years to July of 1996. Good relations continue between labor and management at each of the facilities.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAll of the Company's properties are generally well maintained and in good operating condition. All facilities were adequately utilized during 1994 except the Company's Clearwater, Florida facility. The Company suspended aircraft maintenance operations in Clearwater during the second quarter of 1994 in order to adjust its overall staffing to anticipated work levels. The Company continued, however, to operate the PASS aircraft parts distribution center at the Clearwater facility. In the second quarter of 1995, the Company anticipates relocating Pemco Nacelle Services to the Clearwater facility in an effort to accommodate the current and anticipated needs of Nacelle. The relocation of Nacelle to Clearwater is expected to increase the utilization of the Clearwater facility but not to bring it to a level of full utility in 1995. Pemco Nacelle Services is currently located in Leeds, Alabama and is subleasing an 8,700 square foot building from the Targets Division. This building will be utilized by the Targets Division subsequent to the relocation of Nacelle to Clearwater, Florida.\nPemco Aeroplex, Inc. - Birmingham, Alabama\nThe Birmingham Division of the Aeroplex is located at the Birmingham International Airport, at Birmingham, Alabama. The facility is located on 208 acres of land with approximately 1,935,000 square feet of production and administrative floor space. The facility includes ten flow-through bays, each 40 feet high, 160 feet wide and 725 feet long, permitting continual production line operation. The facility also includes a number of ancillary buildings such as a paint hangar, a shipping and receiving warehouse, a wing rehabilitation shop, a sheet metal shop and a 54,904 square foot general office building which houses Aeroplex administrative staff as well as PASS and the Precision Standard headquarters. Available ramp area exceeding 3,000,000 square feet is adjacent to the municipal airport runways. Additionally, the facility operates a control tower which supplements the FAA-managed municipal air control tower and a fire fighting unit which supplements fire fighting equipment operated by both the City of Birmingham and the Alabama Air National Guard.\nThe Birmingham facility is in every material respect a complete aircraft modification and maintenance center. The facility is an approved FAA and JAA Repair Station and maintains Department of Defense \"SECRET\" security clearance.\nThe facility is leased from the Birmingham Airport Authority under a lease agreement which expires on September 30, 1999.\nPemco Aeroplex, Inc. - Dothan, Alabama\nThe Dothan Division of the Aeroplex is located at the Dothan Municipal Airport, at Dothan, Alabama. The facility is located on 91.5 acres of land with approximately 521,000 square feet of production and administrative floor space. The facility includes 352,000 square feet of aircraft hangar space which is comprised of 13 bays and one wide-body aircraft hangar. The facility also includes four warehouses, two paint hangars, support shops and 26,000 square feet of administrative offices. The facility has 850,000 square feet of aircraft flight line and parking ramp space and is served by an airport consisting of two runways of 5,600 and 8,500 feet, a FAA Flight Service Station and a control tower.\nThe facility is leased from the Dothan\/Houston County Airport Authority under a lease agreement which, inclusive of a five year option period, expires in June of 2015.\nPemco World Air Services A\/S - Copenhagen, Denmark\nPemco World Air Services, A\/S is located at the Copenhagen Airport. The facility is located on 87 acres of land with approximately 252,000 square feet of production and administrative floor space. The facility was built in 1988 and has two large, modern hangars comprised of four bays. The hangars can accommodate DC10\/MD11-sized aircraft and are equipped with overhead work platforms. Each hangar also includes stockroom, backshop and office space. The JAA and FAA approved facility has 103,300 square feet of ramp space and is served by an airport consisting of three runways.\nThe facility is leased from the bankruptcy estate of Sterling Airways under a five year lease agreement that includes a purchase option at the end of the lease term. The five year lease expires in May of 1999.\nThe Clearwater Facility\nThe Company's Clearwater facility is located at the St. Petersburg\/Clearwater International Airport at Clearwater, Florida. The facility is located on 22 acres of land with approximately 133,000 square feet of production and administrative floor space. The facility includes 2 bays of approximately 92,000 square feet as well as supply and support shops and administrative offices. The facility has 782,000 square feet of ramp space and is served by airport facilities consisting of five runways (from 4,000 to 8,500 feet), a FAA Flight Service Station and a control tower.\nThe facility is leased from Pinellas County, a political subdivision of the State of Florida, under a lease agreement that expires in September of 1995, exclusive of five optional renewal periods of five years each which would extend the lease until 2029.\nThe Targets Division\nThe Targets Division is located at Leeds, Alabama. The facility is located on 4 acres of land and consists of one metal building with approximately 32,000 square feet of manufacturing and office floor space. The Targets Division occupies this building under a lease agreement which, inclusive of a twelve year option period, expires in December of 2006.\nPemco Nacelle Services, Inc.\nPemco Nacelle Services is currently located at Leeds, Alabama, adjacent to the Targets Division. The facility consists of one metal building of approximately 8,700 square feet. This facility is subleased from the Targets Division.\nSpace Vector Corporation\nSpace Vector Corporation is located at Chatsworth, California. The Company relocated its operations in February, 1994 due to irreparable earthquake damage to the buildings it had been leasing previously. The new location is in close proximity of its former Chatsworth location and consists of two industrial buildings of approximately 67,000 square feet. Space Vector Corporation occupies these buildings under a lease agreement which expires in April, 1999.\nSpace Vector also leases a 3,400 square foot research and development and administrative office in Fountain Valley, California. This lease expires in October of 1997.\nPemco Engineers Aircraft Cargo Systems and Springs and Components Divisions\nPemco Engineers is located at Corona, California. The facility consists of 28,000 square feet of production and administrative floor space. The facility is under a lease agreement which, inclusive of a five year option period, expires in December of 2001.\nPemco Air Support Services (PASS)\nPASS has three locations: administrative offices at the Birmingham facility, a warehouse at the Clearwater facility, and approximately 5,000 square feet of office and warehouse space at Copenhagen, Denmark. The Denmark facility is five kilometers from the Copenhagen Airport and is leased with the lease expiring, inclusive of a five year option period, in November of 2002.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nVarious claims of employment discrimination, including race, sex, age and disability, have been made against the Company's subsidiary, Pemco Aeroplex, Inc., in proceedings before the Equal Employment Opportunity Commission and, in some cases, in U.S. District Court in Alabama by several current and former employees at its Birmingham, Alabama and Dothan, Alabama facilities. The Company is also defending several workers compensation claims brought by employees in Alabama state court. The Company believes that these claims, no one of which is material to the Company as a whole, are more reflective of the general increase in employment related litigation in the U.S. and in Alabama than of any actual discriminatory employment practices by the Company. The Company believes that these claims have no merit and intends to vigorously defend itself in all litigation arising therefrom.\nThe Company has been designated as a potentially responsible party under The Comprehensive Environmental Response, Compensation and Liability Act for contamination associated with a site near its Clearwater facility. See Item 1. Business, Environmental Compliance, for further disclosure.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nThere were no matters submitted for a vote of the Company's shareholders in the fourth quarter of fiscal 1994.\nItem 5.","section_5":"Item 5. Market for Company's Common Equity and Related Stockholder Matters.\nThe Company's common stock trades on The NASDAQ National Market System under the symbol \"PCSN.\" Approximately 67% of the outstanding shares of the Company's common stock is held by Matthew L. Gold, the Company's Chairman, President and Chief Executive Officer.\nThe following table sets forth what the Company believes to be the range of high and low bid quotations for its common stock on a quarterly basis for each of the Company's last two fiscal years. Quotations represent prices between dealers, do not include retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions.\nOn December 31, 1994, there were 12,787,208 shares of common stock issued of which 105,657 shares are restricted shares that were issued in December of 1994. There are 12,344,291 shares outstanding held by 232 owners of record, which the Company believes were held by more than 500 beneficial owners.\nThe Company has never paid cash dividends on its common stock and currently intends to continue its policy of retaining all of its earnings for use in its business.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations.\nINTRODUCTION\nThe following discussion should be read in conjunction with the Company's consolidated financial statements and notes thereto included herein as Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplemental Data.\nThe following financial statements and financial statement schedules are submitted herewith:\nFinancial Statements:\nReports of Independent Accountants\nConsolidated Balance Sheets\nConsolidated Statements of Operations\nConsolidated Statements of Stockholder's Equity\nConsolidated Statements of Cash Flow\nNotes to Consolidated Financial Statements\nFinancial Statement Schedules:\nReport of Independent Accountants Schedule II - Amounts Receivable From Related Parties, and Underwriters, Promoters and Employees Other Than Related Parties\nSchedule II - Valuation and Qualifying Accounts\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders Precision Standard, Inc.\nWe have audited the accompanying consolidated balance sheets of Precision Standard, 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. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Precision Standard, 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 Notes 1, 8, and 10 to the consolidated financial statements, in 1993 the Company changed its methods of accounting for income taxes and for certain postretirement benefits.\nBirmingham, Alabama March 31, 1995, except for Note 6 as to which the date is April 14, 1995\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION, OPERATIONS, AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Operations - Precision Standard, Inc. (the Company) is primarily engaged in the maintenance and modification of large transport aircraft; the design, development, and manufacture of aerial target systems; the development and manufacture of rocket launch vehicles and guidance systems; the design and manufacture of cargo handling systems; and the manufacture of precision springs and components.\nPrinciples of Consolidation - The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated.\nContract Accounting - The Company recognizes revenue on aircraft and aerial target system programs principally under the percentage-of-completion method of accounting, using an output measure of progress, units of delivery for contracts with provisions for multiple deliveries, and an input measure by which the extent of progress is measured by the ratio of cost incurred to date to the estimated total cost of the contract (cost to cost) for contracts which the units of delivery method is not appropriate. The Company's contracts for its rocket launch vehicles and guidance systems are primarily cost reimbursement contracts. As such, revenues are recorded as costs are incurred and as fees are earned. Provision is made to recognize estimated losses in the period in which it is determined that the estimated total contract costs will exceed the estimated total contract revenues.\nInventories - Materials and supplies are stated at the lower of average cost or market (replacement cost). Work in process includes materials, direct labor, manufacturing overhead, and other indirect costs incurred under each contract, less progress payments, amounts in excess of estimated realizable value, and amounts charged to cost of goods sold on units delivered or progress completed. Inventoried costs on long- term commercial programs and U.S. Government fixed price contracts include direct engineering, production and tooling costs, and applicable overhead. In addition, inventoried costs on U.S. Government fixed price contracts include research and development and general and administrative expenses estimated to be recoverable. In accordance with industry practice, inventoried costs are classified as current assets and include amounts related to contracts having production cycles longer than one year.\nProperty, Plant, And Equipment - Depreciation and amortization are computed using the straight-line method over the following estimated useful lives:\nMaintenance and repairs are charged to expense as incurred, while major renewals and improvements are capitalized.\nThe cost and related accumulated depreciation of assets sold or otherwise disposed of are deducted from the related accounts and resulting gains or losses are reflected in operations.\nDepreciation charged to operations was $2,493,948, $2,336,694, and $2,159,919 for the years ended December 31, 1994, 1993, and 1992, respectively.\nIntangible Assets - Intangible assets are being amortized using the following methods and estimated useful lives:\nLeasehold interest costs represent below market rental rates on the leases obtained in the acquisition of a subsidiary. Supplemental type certificates are granted by the Federal Aviation Administration in order to allow certain modifications to be made to a particular model of aircraft for commercial use. All intangible assets associated with the acquisition of Hayes International Corporation have been reduced to zero in conjunction with the adoption of SFAS No. 109.\nIncome Taxes - In the first quarter of 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, ACCOUNTING FOR INCOME TAXES, which changed the Company's method of accounting for income taxes from the deferred method required under Accounting Principles Board Opinion No. 11 to the liability method. The principal difference between the liability method and the deferred method is that, under the liability method, deferred tax assets and liabilities are adjusted to reflect changes in the statutory tax rates resulting in income adjustments in the period such changes are enacted. Prior years' financial statements have not been restated for the accounting change (see Note 8).\nNonpension Postretirement Benefits - In the first quarter of 1993, the Company adopted SFAS No. 106, EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS. SFAS No. 106 requires the Company to accrue the estimated cost of retiree benefit payments, other than pensions, during employees' active service period. The Company previously expensed the cost of retiree health care benefits as claims were incurred. Prior years' financial statements have not been restated for the accounting change (see Note 10).\nProvision For Warranty Expenses - The Company warranties certain work performed for a given time period, in accordance with the terms of each specific contract. The Company provides for future warranty expenses based on actual warranty history, company practice and specific warranty terms. In 1994, the Company increased its warranty reserve by $1,268,236 to $1,518,679 in order to provide for future warranty expenses. This reserve is management's best estimate of anticipated costs related to aircraft that were under warranty at December 31, 1994.\nCash Equivalents - For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nEarnings Per Common Share - In 1994, the computation of primary and fully diluted earnings per share is based on the weighted average number of outstanding common shares including restricted shares and assuming the exercise of stock options. Stock warrants were treated as equity rather than debt, as this presentation was the most dilutive. The 1993 primary and fully diluted earnings per share is based on weighted average number of outstanding common shares assuming the exercise of certain stock options. Stock warrants were treated as debt rather than equity, as this presentation was the most dilutive. The 1992 earnings per share reflects the dilutive effect of the warrants, with both primary and fully diluted earnings per share being based on the weighted average number of common shares outstanding assuming the exercise of stock warrants; the inclusion of stock options would have been antidilutive. The shares used in the computations for the three years were as follows (in thousands):\nReclassifications - Certain prior year amounts have been reclassified to conform with the presentation used in 1994.\n2. TRADE ACCOUNTS RECEIVABLE\nRecoverable costs and accrued profit not billed consist principally of amounts of revenue recognized on contracts, for which billings had not been presented to the contract owners because the amounts were not billable at December 31, 1994 and 1993.\n3. INVENTORIES\nA portion of the above inventory balances relates to U.S. Government contracts. The Company receives progress payments on the majority of its government contracts. The title to all inventory on which the Company receives these payments is vested in the government to the extent of the progress payment balance.\nIncluded in work in process are unrecovered costs at the estimated recoverable value of $516,439 and $663,521 at December 31, 1994 and 1993, respectively. These costs relate primarily to certain over-and-above type work performed on government contracts. Recoverability of these costs is subject to future determination through negotiation or other procedures not complete at the balance sheet dates. These unrecovered costs relate to contracts under which all goods have been delivered at December 31, 1994 and 1993, respectively. All of the unrecovered costs at December 31, 1993 were settled during 1994. Management expects to recover the 1994 costs in accordance with past experience.\nAlso included in work in process is $3,160,586 and $4,047,575 of deferred production, initial tooling, and related nonrecurring costs (collectively referred to as deferred costs) at December 31, 1994 and 1993, respectively. The recovery of a significant portion of these deferred costs is dependent on the number of conversions performed and actual contract prices. Sales significantly under estimates or costs significantly over estimates could result in the realization of substantial losses. Realization of approximately $1,352,082 and $1,753,630 of deferred costs at December 31, 1994 and 1993, respectively, is dependent on the profitability of firm contracts. Recoverability of the remaining $1,808,504 and $2,293,945 of deferred costs at December 31, 1994 and 1993, respectively, is dependent upon the profitability of anticipated contracts. Based on studies by the Company, management believes there exists a sufficient market to enable the Company to recover these costs.\nDuring 1992, the Company reassessed the potential market for aircraft conversions under one of its current programs. This reassessment reduced cost of sales by approximately $477,000 in 1992.\nThe aggregate amounts of general and administrative costs incurred during 1994, 1993, and 1992 were $14,560,608, $15,684,055, and $14,606,944, respectively. The amounts of general and administrative costs remaining in inventories at December 31, 1994 and 1993 were $1,508,537 and $1,324,670, respectively, and are associated with government contracts.\n4. INTANGIBLE ASSETS\nAmortization charged to operations was $210,168, $1,283,366, and $1,606,495 for the years ended December 31, 1994, 1993, and 1992, respectively.\n5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES\n6. LONG-TERM DEBT\nThe rates of interest applicable under the Revolving and Term Credit facilities are variable, depending upon the general level of interest rates and the timing and nature of elections which the Company is entitled to make in respect to renewals of outstanding debt or increments of additional debt.\nFor the years ended December 31, 1994 and 1993, the effective interest rate for the Revolving Credit facility was 6.97 percent and 6.08 percent, respectively. For the years ended December 31, 1994 and 1993, the effective interest rate for the Term Credit facility was 6.99 percent and 6.22 percent, respectively.\nThe Company reached an agreement in March 1994 with its primary lender to extend the maturity date of both the Revolving Credit facility and Term Credit facility. Both of these instruments were previously due in September 1994. The restated credit agreement provides that the maturity date of the Revolving Credit facility is September 30, 1995. The agreement also provides that the maturity date of the Revolving Credit facility can be extended to March 31, 1996 pursuant to the payment of the extension fee specified in the agreement. The provisions of the Revolving Credit facility agreement require a commitment fee of one-half of one percent per annum on the unused portion. The restated Term Credit facility provides for six equal quarterly installments of $2.0 million beginning on March 31, 1994 and continuing through June 30, 1995 and a final payment of $7.0 million on September 30, 1995. The agreement provides that the maturity date of the Term Credit facility can be extended pursuant to the payment of the extension fee specified in the agreement. This extension would allow the Company to repay the balance in two installments of $2.0 million each on September 30 and December 31, 1995 and a final payment equal to the remaining unpaid balance on March 31, 1996. The Company has assumed this extension and, accordingly, the debt has been classified as long term in accordance with the agreement.\nThe Senior Subordinated Loan payable bears interest at 13.5 percent, with payments of interest only, due monthly. A $5,000,000 principal payment is due in September 1995 and 1996.\nThe above loans are collateralized by substantially all of the assets of the Company and have various covenants which limit the Company to incur or prohibit the Company from incurring additional indebtedness, dispose of assets, merge with other entities, declare dividends, or make capital expenditures in excess of certain amounts in any fiscal year. Additionally, the Company is required to maintain various financial ratios and minimum net worth amounts. At December 31, 1994, the Company was in violation of both of its leverage ratio and fixed charge coverage ratio requirements for the third and fourth quarter of 1994. In addition, the Company was in violation of certain nonfinancial covenants in the fourth quarter of 1994. On April 14, 1995 the Company's primary lender issued waivers regarding these covenants and modified certain financial covenants for the first six months of 1995. In addition, the primary lender issued a Sixth Amendment to the Amended and Restated Credit Agreement (the Amendment). The Amendment states that eighty percent of any proceeds received from the Request for Equitable Adjustment (Note 11) must first be applied to the noncurrent portion of the Senior and Term loans and upon liquidation of those loans, be applied to the Revolving Credit Facility.\nAt December 31, 1993, the Company had failed to assign certain leasehold interests to the bank. In addition, the Company was in violation of both of its tangible net worth requirements at December 31, 1993. Subsequently, the bank issued waivers regarding these covenants.\nIn connection with the Senior Subordinated Loan, the Company granted a warrant to the bank to purchase 4,215,753 shares of the Company's common stock at an exercise price of approximately $.24 per share. The warrant provides for mandatory repurchase periods between June 15 and December 14 during 1991, 1992, and 1993. Upon written notice from the warrant holder during the mandatory repurchase periods, the Company is required to repurchase the warrant for the per share difference between the then current appraised value of the Company's common stock and the exercise price of the warrant (put price). At December 31, 1994 and 1993, the estimated aggregate put price for all shares, pursuant to the warrant, of $4,200,000, is included in the mezzanine section of the Company's financial statements. The financial statements also included an intangible asset of $2,500,000 at December 31, 1992. This asset was being amortized to interest expense over the term of the bank credit facilities. The asset was reduced to $0 along with other noncurrent intangibles as a result of the utilization of purchased operating loss carryforwards (see Note 8).\nChanges in the estimated put price prior to the first put date (June 15, 1991) were accreted; changes in the estimated put price after the first put date were recorded directly to interest expense. The $2,300,000 and $200,000 accretion in 1993 and 1992, respectively, were recorded as increases to interest expense.\nDuring the periods January 15, 1993 through April 14, 1993 and January 15, 1994 through September 14, 1994, the Company had the option to repurchase the warrants for the then current put price, if the warrants had not been previously exercised or repurchased. Additionally, the warrant holders had rights to demand registration of the warrants under certain circumstances. The warrants expire in September 1998.\nThe warrant was neither put nor exercised by the lender as of December 31, 1993. On April 1, 1993, pursuant to the provisions of the warrant agreement, the Company called the warrant for repurchase. The call was rescindable and subject to negotiation pursuant to the terms of the warrant agreement. The amount included in the mezzanine section of the balance sheet represents management's estimate of the amount to be paid to the lender.\nAs one of the conditions to the granting of the 1994 waivers and the Amendment necessary to cure the debt covenant violations at September 30, 1994 and December 31, 1994, the primary lender required rescission of the Company's call of the warrant. The warrant otherwise remains as a binding and enforceable agreement between the Company and its primary lender. The Company intends to continue to negotiate the purchase of the warrant, and any purchase or change in the Company's intent may have an impact on the Company's financial position, earnings, and cash flows depending upon the action taken.\n7. ESTIMATED LOSSES ON CONTRACTS IN PROGRESS\nThe Company provides for losses on uncompleted contracts in the period in which it is determined that the estimated total contract costs will exceed the estimated total contract revenues. These estimates are reviewed periodically and any revisions are charged or credited to operations in the period in which the change is determined.\nIncluded in the allowance for future losses on uncompleted contracts is a provision of $690,788 and $495,333 at December 31, 1994 and 1993, respectively, for a certain contract. This is dependent upon the number of aircraft delivered to the Company prior to December 31, 1995, as specified in the contract. This represents management's best estimate of the anticipated losses on the ultimate number of deliveries. Deliveries greater than that estimated could result in the realization of losses in excess of the allowance provided.\nAlso included in the allowance for future losses on uncompleted contracts is a provision of $654,388 that relates to a certain contract on which the Company has agreed to perform additional work. This represents management's best estimate of the total cost to perform this additional work.\nThe provision for losses under one of the Company's U.S. Government contracts was increased by $120,000 in 1992. This change in estimate was recognized through a charge to operations. This contract was completed in 1992.\nDuring 1994, 1993, and 1992, a provision for estimated losses on contracts in progress in the amount of $849,843, $583,122 and $-0-, respectively, was recognized through a charge to operations to provide for reserves on specific contracts in progress at December 31, 1994, 1993, and 1992, respectively. 8. INCOME TAXES\nEffective January 1, 1993, the Company adopted SFAS No. 109, ACCOUNTING FOR INCOME TAXES, which changed the Company's method of accounting for income taxes from the deferred method required under Accounting Principles Board Opinion No. 11 to the liability method. The principal difference between the liability method and the deferred method is that, under the liability method, deferred tax assets and liabilities are adjusted to reflect changes in the statutory tax rates resulting in income adjustments in the period such changes are enacted. Prior years' financial statements have not been restated for the accounting change.\nSFAS No. 109 specifies that deferred tax assets are to be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has established valuation allowances primarily for certain state net operating loss carryforwards and foreign tax losses of which the realization is uncertain. Based on the Company's projected taxable income, management believes it is more likely than not that the Company will realize the benefit of the net deferred tax assets existing at December 31, 1994.\nDuring 1994, the Company reduced its valuation allowance resulting in an increase of net deferred tax assets and an increase in the benefit for income taxes of approximately $10.5 million. This reduction in the valuation allowance was attributable to the award of a significant seven-year governmental contract which was in negotiation at December 31, 1993. Upon receipt of this award, realization of certain deferred tax assets became, in the opinion of management, more likely than not.\nThe net change in the deferred tax asset of $2,804,104 in 1993 related to benefits arising from loss carryforwards. The deferred tax asset related to these carryforwards has been recognized as a current asset in the consolidated balance sheet at December 31, 1993. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.\nIn prior years, management estimated that the amount of preacquisition federal operating loss carryfowards associated with the acquisition of a subsidiary to be in the range of $15 million to $20 million. The carryforward amounts were audited by the Internal Revenue Service (IRS) during 1993 and the actual carryforwards were found to be approximately $20 million.\nIn 1993, the Company utilized approximately $10 million of these preacquisition loss carryforwards, and, in accordance with SFAS No. 109, the utilization of these carryforwards was first used to offset all of the unamortized intangible assets associated with the acquisition. This resulted in a $2,756,755 reduction in intangible assets. The remaining operating loss carryforwards utilized during the year ended December 31, 1993 were used to reduce tax expense.\nThe alternative minimum tax credit carryforwards of $690,851 included in the deferred tax assets above do not expire.\n9. STOCK OPTIONS AND RESTRICTED SHARE PLANS\nOn September 8, 1989, the stockholders approved an Incentive Stock Option and Appreciation Rights Plan and a Nonqualified Stock Option Plan, pursuant to which a maximum aggregate of 2,000,000 shares of common stock have been reserved for grant to key personnel. The plans expire by their terms on July 10, 1999 and September 8, 1999, respectively.\nUnder both plans, the option price may not be less than the fair market value of the stock at the time the options are granted. Generally, these options become exercisable over staggered periods but may not be exercised after ten years after the date of grant.\nDeferred Compensation - In December 1994, the Company adopted a Restricted Share Plan (the Plan) designed to attract, retain, and motivate executive officers of the Company. The Plan authorizes the issuance of 105,657 common shares of beneficial interest pursuant to restricted shares issued under the Plan. In connection with the grant of shares under the Plan, the Compensation Committee determines any vesting requirements. In December of 1994 the Company issued $175,000 of restricted shares which will be amortized over the period earned by the employee. In December 1994, the Company also established certain other unvested cash bonuses which will be amortized to compensation expense over the vesting period of two years.\n10. EMPLOYEE BENEFIT PLANS\nPension - The Company has a defined benefit pension plan in effect, which covers substantially all employees at its Birmingham, Dothan, and Leeds, Alabama facilities who meet minimum eligibility requirements. Benefits for nonunion employees are based on salary and years of service, while benefits for union employees are based upon a fixed benefit rate and years of service. The funding policy is consistent with the funding requirements of federal law and regulations concerning pensions. Pursuant to this practice, the Company made contributions of $1,271,740, $908,496, and $74,358 in 1994, 1993, and 1992, respectively. Plan assets consist primarily of stocks, bonds, and cash equivalents.\nPursuant to the requirements of SFAS No. 87, EMPLOYERS' ACCOUNTING FOR PENSIONS, an additional minimum pension liability of $14,444,846 and $9,839,673, representing the excess of the accumulated benefit obligation over plan assets plus prepaid pension cost, was recognized at December 31, 1994 and 1993, respectively. The additional liability has been offset by intangible assets to the extent of previously unrecognized prior service cost. Amounts in excess of previously unrecognized prior service cost are recorded as a reduction of stockholders' equity. The intangible asset and reduction of stockholders' equity are $4,750,776 and $7,748,850 (net of tax) and $5,094,011 and $4,745,662 (net of tax) at December 31, 1994 and 1993, respectively.\nAlthough the discount rate increased from 7.5 percent at December 31, 1993 to 8.75 percent at December 31, 1994 (which reduced the accumulated benefit obligation by $9,260,000), the additional minimum liability adjustment increased primarily due to lower than anticipated returns on plan assets attributable to rising interest rates.\nAt December 31, 1993, a minimum liability was required to be recognized primarily due to the decline in the discount rate from 8.5 percent at December 31, 1992 to 7.5 percent at December 31, 1993. The effect of the decline in the discount rate of approximately $8,000,000 was partially offset by changes made in other actuarial assumptions to more appropriately reflect actual and expected experience of the plan. The assumption changes decreased the accumulated benefit obligation (ABO) by approximately $4,600,000. The assumptions that were changed related to mortality, retirement ages, and termination rates.\nThe projected benefit obligation is the actuarial present value of that portion of the projected benefits attributable to employee service rendered to date. Service cost is the actuarial present value of the portion of the projected benefits attributable to employee service rendered during the year.\nIncreases in benefit obligations due to plan amendments are amortized over the average future service of active participants. Cumulative net actuarial gains and losses in excess of the 10 percent corridor amount are amortized over the average future service of active participants.\nNonpension Postretirment Benefits - Effective January 1, 1993, the Company adopted SFAS No. 106, EMPLOYER'S ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS. SFAS No. 106 requires the Company to accrue the estimated cost of retiree benefit payments, other than pensions, during employees' active service period. The Company previously expensed the cost of retiree health care benefits as claims were incurred.\nThe Company provides health care benefits to both salaried and hourly retired employees at its Birmingham, Leeds, and Dothan facilities. The retirees' spouse and eligible dependents are also entitled to coverage under this defined benefit plan, as long as the retiree remains eligible for benefits. To be eligible for coverage the retiree must have attained age 62 and the benefits cease once age 65 is reached.\nThe retirees pay premiums based on the full active coverage rates. These premiums are assumed to increase at the same rate as health care costs. Benefits under the plan are subject to certain deductibles, copayments, and yearly and lifetime maximums. Currently, the plan is unfunded.\nThe health care cost trend rate assumption has a significant effect on the amounts reported. Rates listed above represent assumed increases in per capita cost of covered health care benefits for 1994 and 1993, respectively. For future years the rate was assumed to decrease gradually and remain at the ultimate trend rate thereafter.\nThe weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 8.75 and 7.5 percent at December 31, 1994 and 1993, respectively. At January 1, 1994, the weighted average discount rate used was 7.5 percent. At January 1, 1993, the date of adoption of SFAS No. 106, the weighted average discount rate used was 8.5 percent. In addition to these changes in assumption, the mortality, retirement ages, and termination rates were also changed. These changes in assumptions were the primary cause of the $176,000 and $211,000 unrecognized gains at December 31, 1994 and 1993, respectively.\nThe Company recognized $91,000 and $120,000 of expense associated with the plan in 1994 and 1993, respectively.\nSelf-Insurance - It is generally the policy of the Company to act as a self-insurer for certain insurable risks consisting primarily of employee health insurance programs and workers' compensation. Losses and claims are accrued as incurred. The Company maintains a self-insured health insurance plan for the Birmingham, Leeds, and, effective October 1, 1992, its Dothan divisions of its Pemco Aeroplex subsidiary. The Company has reserves established in the amounts of $1,964,176 and $1,380,790 for reported and incurred but not reported claims at December 31, 1994 and 1993, respectively. Expense incurred for this plan was $8,121,138, $6,561,761, and $7,259,426 for 1994, 1993, and 1992, respectively.\nThe Company also has a self-insured workers' compensation program. The Company has a self-insured retention of $250,000 per occurrence. Claims in excess of this amount are covered by insurance. Included in deposits and other, at December 31, 1994 and 1993, is $850,000 that has been placed on deposit with the state of Alabama in connection with the Company's self-insured workers' compensation plan. Use of these funds is limited by the state. The Company has reserves of $4,780,716 and $4,429,322 for reported and incurred but not reported claims at December 31, 1994 and 1993, respectively. Expense incurred on this plan was $1,399,100, $3,351,608, and $2,665,270 for 1994, 1993, and 1992, respectively.\nDefined Contribution Plan - Effective November 1, 1990, the Company adopted a 401(k) savings plan for employees who are not covered by any collective bargaining agreement, have attained age 21, and have completed one year of service. Employee and Company matching contributions are discretionary. The Company made no matching contributions during 1994, 1993, or 1992. Company contributions vest as follows:\nEmployees are always 100 percent vested in their contributions.\n11. COMMITMENTS AND CONTINGENCIES\nOperating Leases - The Company's manufacturing and service operations are performed principally on leased premises owned by municipal units or authorities. Remaining lease terms range from two to eighteen years and provide for basic rentals, plus contingent rentals based upon a graduated percentage of sales. The Company also leases vehicles and equipment under various leasing arrangements.\nFuture minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1994 are as follows:\nTotal rent expense charged to operations for the years ended December 31, 1994, 1993, and 1992 amounted to $3,128,796, $3,116,118, and $2,323,143, respectively. Contingent rental amounts included in rent expense amounted to $1,196,481, $1,443,128, and $830,228 for the years ended December 31, 1994, 1993, and 1992, respectively.\nUnited States Government Contracts - The Company, as a U.S. Government contractor, is subject to audits, reviews, and investigations by the government related to its negotiation and performance of government contracts and its accounting for such contracts. Failure to comply with applicable U.S. Government standards by a contractor may result in suspension from eligibility for award of any new government contract and a guilty plea or conviction may result in debarment from eligibility for awards. The government may, in certain cases, also terminate existing contracts, recover damages, and impose other sanctions and penalties. The Company believes, based on all available information, that the outcome of the U.S. Government's audits, reviews, and investigations will not have a materially adverse effect on the Company's consolidated results of operation, financial position, or cash flows.\nU.S. Government Request For Equitable Adjustment (REA) - The Company has recorded revenue and a long-term unbilled receivable of approximately $3,500,000 in anticipation of settlement of a contract REA involving the KC-135 Programmed Depot Maintenance (PDM) contract.\nThe REA, which has been certified by the Company and submitted to the U.S. Government, is for equitable adjustment of the cost effect of late delivery of government-furnished materials (GFM). The disruption in scheduled work flow which occurred as a result of the late delivery of GFM began in the second quarter of 1993 and continues to impact ships in work at December 31, 1994. The Company has obtained an opinion from outside legal counsel specializing in government procurement law and from independent management consultants that there is a reasonable basis to support the REA. The Company feels strongly that the evidence in support of the REA is objective and verifiable, and the costs associated with the REA are reasonable in view of the work performed and are not the result of any deficiencies in the Company's performance. The Company has considered the cost impact of ships redeliverable to the government through December 31, 1994, and has recorded the claim net of reserves. The reserves are deemed necessary by the Company due to uncertainties in the process of receiving equitable adjustment related to such claims. At this time, the Company cannot estimate the length of time that will be required to resolve the claim. Should the Company not ultimately receive an equitable adjustment from the claim, which event the Company deems unlikely, the Company would realize a pre-tax reduction of revenue of approximately $3,500,000.\nLitigation - The Company is involved in various legal proceedings arising in the normal course of business. Management does not believe the ultimate outcome of such litigation will have a material adverse effect on the consolidated financial position, the results of operations of the Company, or cash flows of the Company.\n12. RELATED PARTY RECEIVABLE\nThe related party receivable reflected in the balance sheet consists of various notes receivables from Matthew L. Gold, who is an officer, director, and majority stockholder of the Company.\n13. GEOGRAPHIC SEGMENTS AND MAJOR CUSTOMERS\nThe Company's operations are primarily concentrated in one industry segment, the maintenance and modification of large transport aircraft. Aggregate sales to customers in foreign countries, principally in Europe, account for approximately 7 percent, 10 percent, and 15 percent of the Company's net sales for the years ended December 31, 1994, 1993, and 1992, respectively. Sales to major customers which accounted for 10 percent or more of the Company's net sales were as follows:\n14. CONCENTRATION OF CREDIT RISK\nThe Company provides aircraft modification and maintenance, as well as engineering services, primarily to the United States Government, various cargo companies, leasing companies, and commercial airlines. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains an adequate allowance for potential credit losses. When the Company grants credit, with the exception of the United States Government, it is primarily to customers whose ability to pay is dependent upon the economics prevailing in the air passenger and cargo traffic industries.\nThe Company invests its excess cash in deposits with major banks with strong credit ratings. These investments are typically overnight repurchase agreements and, therefore, bear minimal risk. The Company has not experienced any losses on these investments.\n15. EXTRAORDINARY ITEMS\nOn August 31, 1991, the Company's Dothan facility experienced a fire that destroyed one of its hangars, as well as a customer's plane. The property loss, as well as the business interruption claim, were covered by the Company's insurance carrier.\nAmounts reflected in the 1991 financial statements relating to the property loss and business interruption claims are outlined below:\nConstruction of the new hangar was completed in 1992. Final settlement of the claim occurred in 1993.\nIn June 1989, Rolando F. Sablon, a former stockholder and director of the Company, named the Company and other related defendants in a suit alleging theories of breach of contract, breach of fiduciary duty, common law fraud, violations of the Racketeer Influenced and Corrupt Organization Act, and violations of the Securities and Exchange Act of 1934, as well as corresponding violations of certain Florida state statutes. During 1993, this claim was settled out of court by the Company for $1.3 million. The Company's remaining indebtedness under this settlement is $-0- and $800,000 at December 31, 1994 and 1993, respectively (see Note 5). At December 31, 1993, the settlement was recorded as an extraordinary item and reduced net income by $1,274,000, net of the income tax benefit of $26,000.\n16. FOURTH QUARTER ADJUSTMENTS\nIn the fourth quarter of 1994, the Company recorded year-end adjustments to the Company's inventory and inventory reserves, uncollectible accounts receivable, warranty reserve, year-end bonuses, and deferred tax asset valuation allowance which, in the aggregate, increased net income for the quarter and year ending December 31, 1994 by approximately $9,916,900.\nIn the fourth quarter of 1993, the Company recorded year-end adjustments to the Company's self-insured workers' compensation reserve, common stock purchase warrant, inventory, and inventory reserves which, in the aggregate, increased net income for the quarter and year ending December 31, 1993 by approximately $700,000.\nIn the fourth quarter of 1992, the Company recorded a significant adjustment relating to a change in management's estimate as to the appropriate level of workers' compensation insurance reserves. This adjustment reduced net income by approximately $1,100,000 for the quarter and year ending December 31, 1992.\nREPORT OF INDEPENDENT ACCOUNTANTS ON SUPPLEMENTARY INFORMATION\nBoard of Directors and Stockholders Precision Standard, Inc.\nOur report on the consolidated financial statements of Precision Standard, Inc. and Subsidiaries is included on page of this Form 10-K. In connection with our audit of such financial statements, we have also audited the related financial statement schedules listed in the index on page 32 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.\nBirmingham, Alabama\nMarch 31, 1995, except for Note 6 as to which the date is April 14, 1995.\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANT\nWe consent to the incorporation by reference in the registration statement of Precision Standard, Inc. on Form S-8 ( File Nos. 33- 34206 and 33-79676) of our report dated March 31, 1995 except for Note 6 as to which the date is April 14, 1995, on our audits of the consolidated financial statements and financial statement schedules of Precision Standard, 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.\nBirmingham, Alabama\nMarch 31, 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 Company.\nInformation regarding the directors and executive officers of the Company is incorporated by reference from the \"ELECTION OF DIRECTORS\" section of the Company's definitive 1995 Proxy Statement.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation regarding management remuneration and transactions is incorporated by reference from the \"EXECUTIVE COMPENSATION\" section of the Company's definitive 1995 Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation regarding the security ownership of certain beneficial owners and management is incorporated by reference from the \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\" section of the Company's definitive 1995 Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation regarding certain relationships and related transactions is incorporated by reference from the \"TRANSACTIONS WITH MANAGEMENT AND OTHERS\" section of the Company's definitive 1995 Proxy Statement.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\nFinancial Statement Schedules. The Financial Statement Schedules listed below appear in Part II, Item 8 hereof.\na. Financial Statements: Report of Independent Accountants Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\nSchedule VIII. Valuation and Qualifying Accounts.\nSchedule X. Supplementary Income Statement Information.\nAll other financial statement schedules have been omitted, as the required information is inapplicable or the information is presented in the financial statements or the notes thereto.\nb. Reports on Form 8-K. No Reports on Form 8-K were filed with the Commission during the quarter ended December 31, 1994.\nc. Exhibits.\n2 Not applicable.\n3.1 Amended and First Restated Articles of Incorporation of the Company. (1)\n3.2 Amended and First Restated Bylaws of the Company. (1)\n3.3 Articles of Amendment to the Articles of Incorporation. (2)\n4.1 Asset Sales and Purchase Agreement dated July 19, 1984, among Monarch Equities, Inc., Pemco Engineers, Inc., Robert D. Lang, Georgia L. Lang and Monarch Aviation, Inc. (3)\n4.2 Promissory Note dated July 17, 1987, from Monarch Equities, Inc., to Pemco Engineers, Inc. (3)\n4.3 Credit Agreement among Precision Standard, Inc., the Lenders Named Herein and Bank of America National Trust and Savings Association, Agent, dated September 5, 1988. (1)\n4.4 Amended and Restated U.S. $10,000,000 Senior Subordinated Loan Agreement dated as of September 9, 1988, among Precision Standard, Inc., as Borrower, and the Financial Institutions listed on the Signature Pages hereof as Lender. (1)\n4.5 Amended and Restated Credit Agreement among Precision Standard, Inc., the Lenders Named Herein and Bank of America National Trust and Savings Association, Agent, dated November 30, 1988. (1)\n4.6 First Amendment to Amended and Restated Credit Agreement dated as of June 14, 1989. (1)\n4.7 First Amendment to Amended and Restated Senior Subordinated Loan Agreement dated June 14, 1989. (1)\n4.8 Specimen Certificate for Common Stock. (4)\nPursuant to Paragraph (b)(4)(iii) of Item 601 of Regulation S-K, the Company has not filed certain instruments with respect to other long-term debt of the Company or its consolidated subsidiaries. Copies of such documents will be furnished to the Commission upon request.\n9 Not applicable.\n10.1 Sale of Assets Agreement dated June 2, 1986 among Monarch Equities, Inc., Pemco Engineers, Inc., Monarch Aviation, Inc., Rolando Sablon and Matthew Gold. (3)\n10.2 Amendment to Sale of Assets Agreement and Closing Statement dated June 3, 1986, among Monarch Equities, Inc., Pemco Engineers, Inc., Monarch Aviation, Inc., and SG Trading Corp. (3)\n10.3 Assignment and Assumption Agreement executed July 30, 1987, effective June 4, 1986, between SG Trading Corp. and Matthew Gold. (3)\n10.4 Purchase Agreement dated December 31, 1986, between the Company and Matthew Gold. (3)\n10.5 Purchase Agreement executed August 6, 1987, effective April 30, 1987, between the Company and Matthew Gold. (3)\n10.6 Contract No. N68520-87-0007 between Monarch Aviation, Inc., and the United States Navy. (3)\n10.7 Novation Agreement between Monarch Aviation, Inc., and the Company dated August 6, 1987. (5)\n10.8 Lease dated November 1, 1986, between Monarch Properties and Pemco Engineers, Inc. (3)\n10.9 Amended and Restated Incentive Stock Option and Appreciation Rights Plan. (6)\n10.10 Amended and Restated Nonqualified Stock Option Plan. (6)\n10.11 Amended Executive Employment Agreement between the Company and Walter M. Moede effective June 1, 1993, as amended March 11, 1994. (7)\n10.12 Amended Executive Employment Agreement between the Company and Matthew L. Gold effective June 1, 1993, as amended March 11, 1994. (7)\n10.13 Executive Employment Agreement between the Company and C. Fredrik Groth effective June 1, 1993. (7)\n12 Not applicable.\n13 Not applicable.\n16 Not applicable.\n18 Not applicable.\n21 Subsidiaries of the Company. (7)\n22 Not applicable.\n23 Consent of Coopers & Lybrand to the incorporation by reference of their report in Company's Form S-8 Registration Statement (File No. 33-34206 and 33-79676).\n24 Not applicable.\n27 Financial Data Schedule - Electronic Data Gathering Analysis and Retrieval (EDGAR).\n28 Not applicable.\n29 Not applicable. ____________________\n(1) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, and incorporated by reference herein.\n(2) Filed as an exhibit to the Company's Registration Statement on Form S-8 dated June 1, 1994, and incorporated by reference herein.\n(3) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended April 30, 1987, and incorporated by reference herein.\n(4) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, and incorporated by reference herein.\n(5) Filed as an exhibit to the Company's Annual Report on Form 10- K for the fiscal year ended April 30, 1988, and incorporated by reference herein.\n(6) Filed as exhibits to the Company's Definitive Proxy Statement for the 1994 Annual Meeting of Shareholders, and incorporated by reference herein.\n(7) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, and incorporated by reference herein.\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.\nPRECISION STANDARD, INC.\nDated: 4-13-95 By: \/s\/Matthew L. Gold Matthew L. Gold, 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 Company and in the capacities and on the dates indicated.\nSignature Capacity Date\n\/s\/Matthew L. Gold Chairman, President 4-13-95 Matthew L. Gold Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/Walter M. Moede Executive Vice President 4-15-95 Walter M. Moede Chief Financial Officer, Secretary and Director (Principal Financial Officer)\n\/s\/Donald C. Hannah Director 3-31-95 Donald C. Hannah\n\/s\/George E.R. Kinnear II Director 3-31-95 George E. R. Kinnear II\n\/s\/Wesley L. McDonald Director 3-31-95 Wesley L. McDonald\n\/s\/Ben J. Shapiro, Jr. Director 3-31-95 Ben J. Shapiro, Jr.","section_15":""}
{"filename":"764403_1994.txt","cik":"764403","year":"1994","section_1":"ITEM\n1. Business............................................. 1 Organization........................................ 1 Service Area and Customers.......................... 1 Water Supply........................................ 2 Water Treatment Facilities and Water Quality Regulations...................... 3 Transmission and Distribution....................... 6 Energy Supply....................................... 7 Environmental Matters............................... 7 Franchises.......................................... 8 Employee Relations.................................. 8 Rate Matters........................................ 8 Real Estate Matters................................. 10\n2. Properties........................................... 12\n3. Legal Proceedings.................................... 12\n4. Submission of Matters to a Vote of Security Holders.................................... 12\nPART II\nITEM\n5. Market for the Corporation's Common Stock and Related Stockholder Matters......................... 12\n6. Selected Financial Data.............................. 13\n7. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations............................... 14\n8. Financial Statements and Supplementary Data.......... 22\n9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.............. 22\nPART III\nITEM PAGE\n10. Directors and Executive Officers of the Registrant... 22\n11. Executive Compensation............................... 22\n12. Security Ownership of Certain Beneficial Owners and Management.............................. 22\n13. Certain Relationships and Related Transactions....................................... 22\nPART IV\nITEM\n14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................ 22\nSIGNATURES................................................... 25\nAPPENDIX I\nElizabethtown Water Company and Subsidiary Consolidated Financial Statements for the Years Ended December 31, 1994, 1993 and 1992 and Independent Auditors' Report\nE'TOWN CORPORATION\nELIZABETHTOWN WATER COMPANY\nForm 10-K\nAnnual Report\nFor the year ended December 31, 1994\nPART I\nITEM 1. Business\nORGANIZATION\nE'town Corporation (E'town or Corporation) was incorporated under the laws of the State of New Jersey in 1985 to serve as a holding company for Elizabethtown Water Company, (Elizabethtown or Company) and its wholly owned subsidiary, The Mount Holly Water Company (Mount Holly). Elizabethtown and Mount Holly are regulated water utilities which, as a consolidated entity, are referred to herein as Elizabethtown Water Company (Elizabethtown Water Company). E'town Properties, Inc. (Properties) was incorporated in 1987 as a wholly owned and non-regulated subsidiary of E'town to acquire, develop and sell real estate holdings.\nElizabethtown and Mount Holly are engaged in the distribution of water for domestic, commercial, industrial and fire protection purposes and for resale by other water companies and public bodies.\nElizabethtown is a New Jersey corporation, one of whose predecessors was first incorporated in 1854. The present corporation was formed in 1961 as a result of a consolidation of Elizabethtown Water Company Consolidated and Plainfield-Union Water Company. Princeton and Somerville Water Companies were merged into Elizabethtown in 1973, and, as of January 1, 1977, Bound Brook Water Company was also merged into Elizabethtown. Elizabethtown owns all of the common stock of Mount Holly which contributed approximately 3% of the Company's consolidated operating revenues for 1994.\nSERVICE AREA AND CUSTOMERS\nAt December 31, 1994 Elizabethtown and Mount Holly furnished water service on a retail basis to general customers and to industrial customers served through 191,622 meters in 54 municipalities in the counties of Union, Middlesex, Somerset, Mercer, Hunterdon, Ocean, Morris and Burlington in the central part of New Jersey, serving a population of approximately 570,000. Elizabethtown also provides, on a wholesale basis, a portion of the water requirements of eight additional municipalities with their own retail water systems and of three other investor-owned water companies. Water for fire protection service is provided to 53 municipalities and also to commercial and industrial establishments.\nThe Company's operating revenues by major classifications for the twelve months ending December 31, 1994 are as follows:\nGeneral customers 61.7% Sales to other systems 17.7% Larger industrial customers 7.3% Fire protection service\/miscellaneous 13.3%\nThe systems are substantially all metered except for fire service.\nAdditional operating statistics appear on page 13.\nWATER SUPPLY\nThe water supply systems of Elizabethtown and Mount Holly are physically separate. During 1994, Elizabethtown's pumpage averaged 131.8 million gallons per day (MGD) and Mount Holly's pumpage averaged 3.5 MGD. Elizabethtown and Mount Holly believe they have sufficient water supply sources to meet the current needs of their customers. Mount Holly plans to construct additional facilities, as discussed below, to augment its water supplies.\nIn 1994, surface water sources supplied about 89% of Elizabethtown's supply with wells supplying the remaining 11%. All of Mount Holly's water is produced from wells.\nSubstantially all of Elizabethtown's surface water is purchased under a long-term contract with the New Jersey Water Supply Authority (NJWSA) which requires Elizabethtown to purchase (i) 32 MGD from the state-owned Delaware and Raritan Canal which transports water from the Delaware River Basin plus (ii) an average of 70 MGD from the Raritan River Basin which includes the state-owned Spruce Run-Round Valley Reservoir System. The safe yield of the Raritan River Basin and the Delaware and Raritan Canal is 225 MGD of which 151 MGD is presently allocated to Elizabethtown and others. Elizabethtown has available and, as needed to meet system demand, purchases water over and above its minimum purchase obligation.\nThe Company continues to analyze the potential effect of federal and state regulations on the long-term capacity of Elizabethtown's wells. Since 1985, wells with an aggregate capacity of 11 MGD have been withdrawn from service due to more stringent federal and state regulations and increased groundwater contamination at certain well sites. Under state and federal regulations now in effect, Elizabethtown owns and operates wells with an aggregate safe daily yield of approximately 18 MGD. If regulations governing radionuclides in drinking water proposed by the United States Environmental Protection Agency (USEPA) are adopted, Elizabethtown's well capacity will decrease to about 13 MGD.\nAll of Mount Holly's system delivery of 3.5 MGD in 1994 was supplied from wells. To ensure an adequate supply of quality water from an aquifer serving parts of southern New Jersey, state legislation will require Mount Holly, as well as other suppliers obtaining water from designated portions of this aquifer, to reduce pumpage from its wells by the earlier of: (i) the date a new regional system planned by another purveyor is completed or (ii) the date Mount Holly develops its own alternate sources. Mount Holly's pumpage for 1994 was 1,268 million gallons (MG) and, under the state legislation, Mount Holly must reduce its pumpage to 538 MG from its existing wells. Mount Holly has received preliminary approval from the New Jersey Department of Environmental Protection (NJDEP) for its conceptual plan to develop a new water supply, treatment and transmission system necessary to obtain water outside the designated portion of the aquifer and to treat such water and pump it into the Mount Holly system. The current estimate of the the cost of this project is $16.5 million, excluding an allowance for funds used during construction (AFUDC). The land for the supply and treatment facilities has been purchased and test wells have been drilled and evaluated. Mount Holly expects to file for a rate incre-ase, in two phases, in the second quarter of 1995 providing for rate relief for the entire project in the second phase.\nWATER TREATMENT FACILITIES AND WATER QUALITY REGULATIONS\nElizabethtown owns and operates a treatment plant at the confluence of the Raritan and Millstone Rivers adjacent to the Delaware and Raritan Canal to treat surface waters purchased from the NJWSA. The plant can withdraw water from any of these sources, which is an advantage in the event that one source becomes contaminated. The plant was placed in service in 1931 and has continually been upgraded since that time. Elizabethtown also operates smaller treatment facilities to treat groundwater produced by certain wells. Mount Holly operates similar groundwater treatment facilities.\nBoth the USEPA and the NJDEP regulate the operation of Elizabethtown's and Mount Holly's water treatment and distribution systems and the quality of the water Elizabethtown and Mount Holly deliver to their customers. Currently, Elizabethtown and Mount Holly believe they are in compliance with all present federal and state water quality standards, including all regulations promulgated to date by the USEPA pursuant to the Federal Safe Drinking Water Act, as amended (SDWA), and by the NJDEP pursuant to similar state legislation. However, Elizabethtown has included certain capital projects in its three-year capital expenditure plans which it anticipates will be necessary to comply with regulations that have been proposed by the USEPA and NJDEP. Recovery of the financing and operating costs of such improvements, plus those costs for any additional projects which cannot be foreseen at this time, will be requested in rates.\nElizabethtown has responded to recent water quality regulations promulgated by NJDEP and the USEPA by replacing groundwater supplies with increased withdrawals of surface water. Accordingly, the proportion of supply produced from surface water has increased from 85% in 1986 to 89% in 1994. The Company expects this trend to continue because it is preferable from the standpoint of operational efficiency and cost to modify treatment processes and facilities at one or two large plants than to attempt to constantly upgrade treatment facilities at multiple well sites.\nNew Surface Water Treatment Plant\nElizabethtown's capital program includes the construction of a new water treatment plant, the Canal Road Water Treatment Plant (Plant) to increase Elizabethtown's sustainable production capacity and provide the ability to continue to meet water quality regulations. In April 1994, the Company executed a lump-sum contract for the construction of the Plant, which will have an initial capacity of 40 MGD. Construction of the Plant is currently in progress. The current estimated cost of the Plant is approximately $100 million, excluding AFUDC. The Company has expended $38.4 million, excluding AFUDC of $2.0 million, as of December 31, 1994 on the Plant. The project is proceeding on schedule, the construction contract remains on budget and the project is expected to be completed in mid-1996.\nThe Plant has been designed by a joint venture of two engineering firms, who are nationally recognized as experts in the field. One of the partners of the joint venture which designed the Plant is also managing the construction.\nIn August 1993, the New Jersey Board of Public Utilities (BPU) approved a stipulation (1993 Plant Stipulation) signed by all parties to the Company's petition filed in connection with the Plant which states that the parties affirm the Plant is necessary and that the Company's estimate regarding the Plant's cost, at that time of $87 million, and construction period are reasonable. The 1993 Plant Stipulation also provides for a rate setting mechanism for the Plant during the construction period. In April 1994, Elizabethtown notified all parti-es to the 1993 Plant Stipulation that the estimated cost of the Plant had increased (See \"Rate Matters\").\nWater Quality Regulations\nAs required by the SDWA, the USEPA has established maximum contaminant levels (MCLs) for various substances found in drinking water. As authorized by similar state legislation, the NJDEP has set MCLs for certain substances which are more restrictive than the MCLs\nset by the USEPA. In certain cases, the USEPA and NJDEP have also mandated that certain treatment procedures be followed in addition to satisfying MCLs established for specific contaminants. The NJDEP is also the USEPA's agent for enforcing the SDWA in New Jersey and, in that capacity, monitors the activities of Elizabethtown and Mount Holly and reviews the results of water quality tests performed by Elizabethtown and Mount Holly for adherence to applicable regulations.\nRegulations generally applicable to water utilities, including Elizabethtown and Mount Holly, include the Lead and Copper Rule (LCR), the MCLs established for various volatile organic compounds (VOCs), the MCLs proposed for radionuclides and the Surface Water Treatment Rule (SWTR).\nLead and Copper Rule\nThe LCR requires Elizabethtown and Mount Holly to test the quantity of lead and copper in drinking water at the customer's tap and, if certain contaminant levels (action levels) are exceeded, to notify customers and initiate a public information campaign advising customers how to minimize exposure to lead and copper. The LCR also requires Elizabethtown to add corrosion inhibitors to water to minimize leaching of lead from piping, faucets and soldered joints into water consumed at the tap. Results from two separate tests completed during 1992 within Elizabethtown and Mount Holly's systems do not indicate lead and copper concentrations above the action levels. Accordingly, public notification and a public information campaign have not been required. Capital costs of corrosion inhibitor facilities of $2.9 million have been included in Elizabethtown's five-year capital projections. Elizabethtown will request that the costs of compliance be recovered in rates.\nVolatile Organic Compounds\nVOCs include various substances (primarily synthetic organic solvents) which have percolated into groundwater aquifers from surface sources. Elizabethtown has found VOCs in excess of the applicable MCLs in certain of its wells and has either suspended the use of such wells or constructed aeration towers which remove such contaminants from the water by venting them into the atmosphere. Because underground water flows are difficult to map, it is difficult to predict when and where contamination will occur in the future. To the extent that contamination in excess of applicable MCLs occurs at wells lacking aeration towers, Elizabethtown will consider building such facilities if feasible and cost effective, or closing such wells, thereby increasing its reliance on surface water. To date, Mount Holly has not been affected by VOC contamination.\nRadionuclides\nRadionuclides are naturally occurring radioactive substances (primarily radon) found in groundwater. Like VOCs, radon can be removed from groundwater using aeration towers. If the MCLs proposed for all radionuclides are finally adopted, Elizabethtown believes that it will abandon wells with aggregate production capacity of approximately 5 MGD, thereby further increasing Elizabethtown's reliance on surface water.\nSurface Water Treatment Rule\nThe operation of Elizabethtown's existing Raritan-Millstone treatment plant is subject to the SWTR. Elizabethtown has assessed the plant's sustainable production capacity, assuming operation consistent with the requirements of the SWTR, and determined that improvements to the existing plant are necessary.\nSpecifically, Elizabethtown has installed additional pumps to increase capacity and reliability at peak times and has constructed a new building to house offices and lab facilities. Also, Elizabethtown, will replace existing chlorine gas disinfection facilities with liquid sodium hypoclorite to improve community and employee safety, will install corrosion inhibitor facilities in conformance with the LCR, will construct facilities to handle waste materials generated from the treatment process (See \"Environmental Matters\"). Elizabethtown has included the capital costs of these facilities in its capital program and will request that the costs of these facilities be recovered in rates (See \"Capital Expenditures Program\" at Item 7).\nTRANSMISSION AND DISTRIBUTION\nAs of December 31, 1994, Elizabethtown Water Company's transmission and distribution system included 2,828 miles of transmission and distribution mains. Mains range in size up to 60 inches, substantially all of which are either ductile iron, cast iron or prestressed concrete pipe. Elizabethtown conducts an ongoing program costing approximately $1 million per year to clean and line its older cast iron mains. Such costs are capitalized and have been included in rate base in stipulations settling recent rate cases.\nAs of December 31, 1994, Elizabethtown also had in service pumping equipment having capacities of 283 MGD for low lift pumping capacity, 577 MGD for system supply pumping capacity and 194 MGD for transfer booster pumping capacity. Distribution storage facilities as of December 31, 1994 consisted of standpipes, elevated and ground storage tanks and reservoirs with an aggregate capacity of 82 MG. Such pumping, transmission and storage facilities are necessary to maintain adequate water pressures throughout the service territory. Failure to maintain pressures could adversely affect domestic service and impede local fire departments' efforts to fight fires, particularly during peak summer loads.\nOn an ongoing basis, Elizabethtown assesses the capacity of its system to maintain adequate pressures under all load conditions and initiates plans to construct pumping, transmission and storage facilities as needed.\nENERGY SUPPLY\nElizabethtown pumps substantially all of its water with electric power purchased from two major electric utilities. Elizabethtown also has diesel powered pumping and generating facilities at its major treatment plants and at certain transfer stations to provide basic service during possible electrical shortages. Elizabethtown has not, to date, experienced any shortage of electric energy or diesel fuel to operate its pumps and has cooperated with its electric suppliers during their peak periods by operating non-electrical pumping facilities upon request.\nENVIRONMENTAL MATTERS\nElizabethtown and Mount Holly are also subject to regulation by the NJDEP with respect to water supply plans and specifications for the construction, improvement, alteration and operation of public water supply systems and with respect to the quality of any effluent from treatment plants.\nAs a normal by-product of treating surface water, Elizabethtown's existing surface water treatment plant generates silt removed from untreated river water plus residue from chemicals used in the treatment process. Historically, Elizabethtown has disposed of this material in landfills. As a result of revised regulations governing landfills, Elizabethtown has been reusing this material on site. Due to limited on site storage capacity, Elizabethtown is designing a facility to dry the by-product for beneficial reuse. Estimated expenditures for this facility are included in the Company's capital program.\nDuring the late 1980's, Elizabethtown withdrew a well field from service because of increased groundwater contamination and more stringent water quality regulations. Subsequently, residents in the area have claimed that Elizabethtown's decision to withdraw such wells from service has caused the local water table to rise to the level where basement flooding occurs during periods of heavy rain. Elizabethtown commissioned an engineering firm to determine whether it is feasible and cost effective to install treatment facilities so that those wells not presently complying with current regulations can be returned to service. The study was also intended to evaluate whether the resumption of pumping would have any effect on the local water table. The study concluded that it is possible to treat the water at this location and resume pumping at a quality and yield that is satisfactory to Elizabethtown. Elizabethtown is evaluating the cost-effectiveness of this approach in connection with a possible governmental grant to the municipality involved, for such purpose. Preliminary cost estimates of treatment facilities necessa-ry to return certain wells in this area to service are included in the Company's capital program.\nUnder New Jersey law, environmental matters are addressed by the NJDEP before diversion allowances or other water supply projects are authorized. To date, Elizabethtown and Mount Holly have been able to construct all plant facilities and obtain all diversion authorizations necessary to maintain customer service.\nFRANCHISES\nThe property and franchises of Elizabethtown and Mount Holly are subject to rights of eminent domain of the State of New Jersey. These rights have been delegated by statutes now in effect to municipalities or groups of municipalities and have been or may be delegated to various public agencies. No such rights of eminent domain have been exercised since 1931.\nEMPLOYEE RELATIONS\nAs of December 31, 1994, the Corporation had a total of 386 full-time employees, of which 207 were covered by union contracts. The contracts between the Company and the Utility Workers Union of America (A.F.L.-C.I.O.), were renegotiated on February 1, 1993 and will expire on January 31, 1996.\nThe Company considers relations with both union and non-union employees to be satisfactory.\nRATE MATTERS\nElizabethtown and Mount Holly are subject to regulation by the BPU with respect to the issuance and sale of securities, rates and service, classification of accounts, mergers, and other matters. Elizabethtown and Mount Holly periodically seek rate relief to cover the cost of increased operating expenses, increases in financing expenses due to additional investments in utility plant, and other costs of doing business. Rate increases of approximately 30% in excess of current rates will be required by Elizabethtown during 1996, a major portion of which will be needed- to recover the expected costs of the Plant. In light of the approval by the BPU of the 1993 Plant Stipulation discussed below, and Elizabethtown's experience obtaining base rate relief, Elizabethtown expects the BPU to grant timely and adequate rate relief for the Plant, but cannot predict the ultimate outcome of any rate proceeding.\nAs mentioned previously, the 1993 Plant Stipulation, approved in August 1993, states that the Plant is necessary and that the Company's estimates regarding the Plant's cost, at that time of $87 million, and construction period are reasonable. In addition, the 1993 Plant Stipulation authorizes the Company to levy a rate surcharge if the Company's pre-tax interest coverage ratio for any 12-month historical period drops below 2.0 times. The surcharge would equal 20% of the Company's gross interest expense for the prior 12 months, adjusted for revenue taxes. The surcharge would go into effect at the same time as the Company's next base rate increase after the coverage ratio falls below 2.0 times. Also, the surcharge would remain in effect for\n12 months and could be extended by the BPU for up to six additional months. Based upon current conditions, Elizabethtown expects its pre-tax interest coverage will remain above the 2.0 times trigger level through the completion of the Plant's construction and that the surcharge will not be required. The 1993 Plant Stipulation also provides that the rate of return on common stockholder's equity used to calculate the rate for the equity component of the AFUDC for the Plant will be 1.5% less than the rate of return on common stockholder's equity established in the Company's most recent base rate case. The authorized rate of return on common stockholder's equity is currently 11.5%.\nAs indicated above under \"Water Supply\", Mount Holly expects to petition the BPU for a rate increase in the second quarter of 1995 requesting an increase in rates to take place in two phases. The first phase is necessary to recover costs to finance construction projects that were not reflected in rates last established in October 1986. The proposed increase will also seek recovery of increased costs for various operations and maintenance expenses since 1986. The second phase will seek recovery of the cost of the new water supply, treatment and transmission system discussed above.\nOn January 24, 1995, the BPU approved a stipulation (1995 Stipulation) for a rate increase for Elizabethtown of $5.3 million, effective February 1, 1995. The 1995 Stipulation provides for an authorized rate of return on common equity of 11.5%. It also provides for recovery of the current service cost portion of the obligation accrued under Statement of Financial Accounting Standards 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions,\" provided this amount is funded by the Company. The rate increase will cover the cost to finance $62.0 million of construction projects that were not reflected in the rates last established in March 1993. The increase will offset costs for power, labor and benefits, primarily medical. The 1995 Stipulation also provides for an increase in depreciation rates resulting in an increase in depreciation expense of approximately $.4 million. The 1995 Stipulation requires Elizabethtown to maintain an average ratio of common equity to total capitalization of at least 45.1% for the 12 months ended January 31, 1996. If a lessor ratio is maintained, the revenue requirement associated with such lesser ratio will offset the overall revenue requirement in the next base rate case.\nOn January 11, 1995, Elizabethtown filed with the BPU for a rate increase of $.9 million for a change in the Purchased Water Adjustment Clause (PWAC) rate based on a proposed change in the unit cost of water purchased from the NJWSA, to be effective July 1, 1995. This procedure, established by BPU Rules, allows Elizabethtown to reflect in rates the change in the cost of water purchased from the NJWSA without a complete rate case. Included in this request is the amortization of the anticipated balance, as of July 1, 1995, of the net under-recovery for the 1994 PWAC of $.4 million. The Company expects the BPU to render a decision prior to July 1, 1995.\nIn June 1994, the BPU approved a Stipulation for an increase in rates under a PWAC. The Stipulation resulted in an increase in rates, effective July 1, 1994, of $.3 million.\nREAL ESTATE MATTERS\nProperties and E'town currently own several parcels of land aggregating approximately 740 acres located in central New Jersey having an original acquisition cost of approximately $8 million. Approximately half of this acreage was purchased from a third party and the balance was land formerly owned by Elizabethtown and no longer needed for utility purposes. These holdings are owned in fee.\nThe Corporation has no plans to acquire additional real estate. Over the next several years, the Corporation expects to work with local and state officials to obtain various approvals to enhance the value and development potential of its real estate holdings while minimizing expenditures.\nIn January 1995, Properties entered into an agreement to sell a parcel of land to a developer. The agreement allowed either party to cancel such agreement by March 23, 1995 and has been extended to March 31, 1995 and allows the buyer until July 23, 1996 to obtain all approvals required by governmental agencies in order to develop the property. Other significant dates have been established during this period upon which either the buyer or Properties may cancel the agreement if certain criteria are not met. The ultimate sale price is depen-dent upon the number of buildable lots as allowed by the municipality.\nIn August 1993, E'town, Properties and Elizabethtown sold three parcels of land totalling 260 acres to the Somerset County Park Commission for $3.4 million. The sale produced an after-tax gain of approximately $1.1 million or $.21 per share.\nExecutive Officers of the Corporation and Elizabethtown\nName Age Positions Held\nRobert W. Kean, Jr. 72 Chairman and Chief Executive Officer of the Corporation since 1985 and Elizabethtown since 1973.\nHenry S. Patterson, II 72 President of the Corporation since March 1985 and its subsidiary, E'town Properties, Inc., since July 1987.\nThomas J. Cawley 64 President of Elizabethtown and its subsidiary, Mount Holly since August 1992. Executive Vice President of Elizabethtown since January 1987 and Vice President of Mount Holly since 1973. Previously, Vice President, Operations since 1975.\nAndrew M. Chapman 39 Served as Chief Financial Officer of the Corporation since August 1989 and Treasurer of the Corporation since November 1990 and since May 1994, Executive Vice President and Chief Financial Officer of Elizabethtown. He served as Senior Vice President of Elizabethtown from April 1993 to May 1994, Chief Financial Officer of Elizabethtown from November 1990 to May 1994 and Treasurer of Elizabethtown from August 1989 to May 1994. Prior to 1989, he was Director of the Office of Financial Management of the State of New Jersey, Department of Treasury and earlier, a Vice President at Shearson Lehman Brothers.\nAnne Evans Estabrook 50 Vice President of the Corporation since September 1987. Owner of the Elberon Development Co., (a real estate holding company) since 1984 and President of David O. Evans, Inc. (a construction company) since 1983.\nWalter M. Braswell 45 Secretary of the Corporation, Properties and Elizabethtown since December 1990 and Vice President and General Counsel and Assistant Secretary of Elizabethtown since August 1988. Previously, Assistant Secretary and General Attorney of Elizabethtown since May 1983.\nNorbert Wagner 59 Senior Vice President-Operations of Elizabethtown since May 1992. Vice President-Operations since March 1987, Chief Engineer since October 1978.\nEdward F. Cash 59 Vice President - Customer Services of Elizabethtown since 1977. Assistant Vice President Customer Services since 1973.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nAll principal plants and other materially important units of property of Elizabethtown and Mount Holly are owned in fee. The Company considers that the properties of Elizabethtown and Mount Holly are in good operating condition.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nAs reported during 1994, a developer asserted in a suit filed in 1991 against Elizabethtown that the Company failed to install facilities necessary to provide water service to a new development in a timely manner. The developer further asserted that this delay took place during a period of generally declining real estate values, thereby allegedly, preventing the developer from selling his lots at more favorable prices. The developer alleged that his economic losses from the decline in real estate -values were $4.0 million.\nIn November 1994, the Company settled this matter by paying the developer $1.7 million. The Company will seek recovery from its insurance carriers.\nSeveral lawsuits have been filed, initially in March 1991 in New Jersey Superior Court, against Elizabethtown and other parties in connection with a fire that occurred in a storage facility in December 1989 resulting in damage to property stored at that facility. The lawsuits allege that the water mains surrounding the industrial complex failed to provide an adequate flow of water necessary to fight the fire. The suits further allege that the Company was negligent in failing to ensure that sprinkler systems were operational prior to the fire, resulting in those sprinkler systems being without water at the time of the fire. Management cannot now predict the outcome of this litigation.\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 Corporation's Common Stock and Related Stockholder Matters\nThis information is included in Exhibit 13, filed herewith, and is incorporated herein by reference. All of the common stock of Elizabethtown Water Company is owned by E'town.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nE'town Corporation\nThis information is included in Exhibit 13, filed herewith, and is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations\nE'town Corporation\nThis information is included in Exhibit 13, filed herewith, and is incorporated herein by reference.\nElizabethtown Water Company and Subsidiary\nThe water utility operations of Elizabethtown Water Company (Elizabethtown or Company) and its subsidiary The Mount Holly Water Company (Mount Holly), the consolidated entity being referred to herein as Elizabethtown Water Company (Elizabethtown Water Company), presently constitute the major portion of E'town Corporation's (E'town) assets and earnings. Mount Holly contributed 3% of Elizabethtown Water Company's consolidated operating revenues for 1994. E'town, a New Jersey holding company, is the parent company of Elizabethtown Water Company and E'town Properties, Inc. The following analysis sets forth significant events affecting the financial condition at December 31, 1994 and 1993, and the results of operations for the years ended December 31, 1994, 1993 and 1992 for Elizabethtown Water Company.\nLIQUIDITY AND CAPITAL RESOURCES\nCapital Expenditures Program\nCapital expenditures were $70.0 million during 1994. Capital expenditures for the three-year period ending December 31, 1997, are estimated to be $169.4 million.\nElizabethtown\nElizabethtown's capital program includes the construction of a new water treatment plant, the Canal Road Water Treatment Plant (Plant), near Elizabethtown's existing plant. The Plant, which will have an initial rated production capacity of 40 million gallons per day and can be expanded to 200 million gallons per day, is necessary to meet existing and anticipated customer demands and to replace groundwater supplies withdrawn from service as a result of more restrictive water quality regulations and g-roundwater contamination. Elizabethtown's construction program also includes additional mains and storage facilities necessary to serve existing and future customers.\nIn April 1994, Elizabethtown executed a lump-sum contract for the construction of the Plant. The current estimated cost of the Plant is approximately $100 million, excluding an Allowance for Funds Used\nDuring Construction (AFUDC). The Company has expended $38.4 million, excluding AFUDC of $2.0 million, as of December 31, 1994 on the Plant. The project is proceeding on schedule, the construction contract remains on budget and the project is expected to be completed in mid-1996.\nIn August 1993, the New Jersey Board of Public Utilities (BPU) approved a stipulation (1993 Plant Stipulation) signed by the Department of Ratepayer Advocate, the BPU staff and several of Elizabethtown's major wholesale customers, all of whom typically participate in Elizabethtown's rate cases. The 1993 Plant Stipulation states the Plant is necessary and that the Company's estimate regarding the Plant's cost, at that time of $87 million, and construction period are reasonable. In April 1994, Elizabethtown notified all parties to the 1993 Plant Stipulation that the estimated cost of the Plant had increased. The 1993 Plant Stipulation authorizes Elizabethtown to levy a rate surcharge during the Plant's construction period if the Company's pre-tax interest coverage ratio for any 12-month historical period drops below 2.0 times. The surcharge would equal 20% of the Company's gross interest expense for the prior 12 months, adjusted for revenue taxes. The surcharge would go into effect at the same time as the Company's next base rate increase after the coverage ratio falls below 2.0 times. Also, the surcharge would remain in effect for 12 months and could be extended by the BPU for up to six additional months. The 1993 Plant Stipulation also provides that the rate of return on common stockholder's equity used to calculate the rate for the equity component of the AFUDC for the Plant will be 1.5% less than the rate of return on common stockholder's equity established in the Company's most recent base rate case. The authorized rate of return on common stockholder's equity is currently 11.5%.\nElizabethtown's pre-tax interest coverage ratio, calculated in accordance with the 1993 Plant Stipulation, for the twelve months ended December 31, 1994 was 2.8 times, which is in excess of the 2.0 times trigger level for the rate surcharge authorized by the 1993 Plant Stipulation. Based upon current conditions, the Company expects its pre-tax interest coverage will remain above the 2.0 times trigger level through the completion of the Plant's construction and that the surcharge will not be required-.\nMount Holly\nTo ensure an adequate supply of quality water from an aquifer serving parts of southern New Jersey, state legislation is requiring Mount Holly, as well as other suppliers obtaining water from designated portions of this aquifer, to reduce pumpage from its wells. Mount Holly has received preliminary approvals from the New Jersey Department of Environmental Protection for its conceptual plan to develop a new water supply and treatment and transmission system necessary to obtain water outside the desig-nated portion of the aquifer and to treat such water and pump it into the Mount Holly\nsystem. The current estimate of the cost of this project is $16.5 million. The land for the supply and treatment facilities has been purchased and test wells have been drilled and evaluated. Mount Holly expects to file for a rate increase, in two phases, in the second quarter of 1995 providing for rate relief for the entire project in the second phase.\nCapital Resources\nDuring 1994, Elizabethtown Water Company financed 24.1% of its capital expenditures from internally generated funds (after payment of common stock dividends). The balance was financed with a combination of proceeds from capital contributions from E'town (funded by sale of its Common Stock) and short-term borrowings under the revolving credit agreement discussed below.\nFor the three-year period ending December 31, 1997, Elizabethtown Water Company estimates that 30% of its capital expenditures will be financed with internally generated funds (after the payment of common stock dividends). The balance will be financed with a combination of capital contributions from E'town from the proceeds from the sale of E'town common stock, long-term debentures, proceeds of tax-exempt New Jersey Economic Development Authority (NJEDA) bonds and short-term borrowings under the revolving credit agreement discussed below. The NJEDA has granted preliminary approval for the financing of almost all of Elizabethtown's major projects over the next three years, including the Plant. Elizabethtown expects to pursue tax-exempt financing to the extent that final allocations are granted by the NJEDA. The Company's senior debt is rated A3 and A by Moody's and Standard and Poor's, respectively.\nIn May 1994, E'town issued 690,000 shares of common stock for net proceeds of $18.2 million. The net proceeds were used to fund an equity contribution to Elizabethtown of $16.0 million. This contribution has been used to partially fund Elizabethtown's construction program, the predominant portion of which relates to the Plant.\nIn March 1994, Elizabethtown issued 120,000 shares of $100 par value, $5.90 Cumulative Preferred Stock for proceeds of $12.0 million at an effective rate of 7.37%. The proceeds were used to redeem $12.0 million of the Company's $8.75 Cumulative Preferred Stock. The redemption premium of $1.0 million was paid from general Company funds.\nElizabethtown has executed a committed revolving credit agreement (Agreement) with an agent bank and five additional participating banks to replace its uncommitted lines of credit. The Agreement provides up to $60 million in revolving short-term financing which, together with internal funds, proceeds of future\nissuances of debt and preferred stock and capital contributions from E'town, is expected to be sufficient to finance Elizabethtown's and Mount Holly's capital needs through 1997. The Agre-ement allows Elizabethtown to borrow, repay and reborrow up to $60 million during the first three years, after which time Elizabethtown may convert any outstanding balances to a five-year fully amortizing term loan. The Agreement further provides that among other covenants, Elizabethtown must maintain a ratio of common and preferred equity to total capitalization of not less than 35% and a pre-tax interest coverage ratio of at least 1.5 to 1. As of December 31, 1994, Elizabethtown had borrowings outstanding of $23.0 million under the Agreement at interest rates from 5.6% to 6.4 %, at a weighted average rate of 6.1%.\nDuring 1994, 273,159 shares of common stock were issued for proceeds of $7.1 million under E'town's Dividend Reinvestment and Stock Purchase Plan (DRP). The proceeds are used on an ongoing basis to make capital contributions to Elizabethtown to partially fund its capital program.\nDuring 1995, E'town Corporation expects to issue approximately 500,000 shares of common stock through a public offering in order to finance additional equity contributions to Elizabethtown to fund the Company's capital program, the predominant portion of which is the Plant.\nAlso in 1995, Elizabethtown intends to issue approximately $30 million of tax-exempt debentures through the NJEDA to repay balances outstanding under the revolving credit agreement incurred for qualified capital expenditures.\n1993 and 1992\nIn May 1993, E'town issued 575,000 shares of common stock for net proceeds of $16.6 million. The net proceeds were used to fund equity contributions to Elizabethtown of $11.0 million in May 1993 and $2.8 million in September 1993. Elizabethtown used a portion of such contributions to repay $7.0 million of short-term bank debt incurred for construction expenditures and invested the balance on a short-term basis.\nDuring 1993, E'town raised $6.0 million from the sale of common stock under its DRP. Such proceeds were used to fund equity contributions to Elizabethtown, primarily for Elizabethtown's capital expenditures.\nIn August 1993, E'town, Properties and Elizabethtown sold three parcels of land totalling 260 acres to the Somerset County Park Commission for $3.4 million. Of the total proceeds, $2.2 million was used to fund an equity contribution to Elizabethtown.\nIn November 1993, Elizabethtown issued $50 million of 7 1\/4% Debentures due November 1, 2028. The proceeds of the issue were used to redeem $30 million of the Company's 8 5\/8% Debentures due 2007 and $20 million of the Company's 10 1\/8% Debentures due 2018. The aggregate redemption premiums of $2.7 million were paid from general Company funds.\nIn April 1992, E'town issued 500,000 shares of common stock for net proceeds of $12.7 million. Proceeds of the issue funded an $11.0 million capital contribution to Elizabethtown. Also, E'town funded additional equity contributions of $4.2 million to Elizabethtown from E'town's DRP.\nDuring 1992, Elizabethtown issued $15 million of 8% Debentures to repay short-term bank debt, of which, $9 million was incurred to repay Elizabethtown's 4 7\/8% Debentures due February 1, 1992, and the remainder was incurred to finance construction expenditures.\nRESULTS OF OPERATIONS\nEarnings Applicable to Common Stock for 1994 were $13.4 million as compared to $13.8 million for 1993. A return to more normal summer weather and water consumption patterns, a non-recurring charge related to litigation, an increase in both the debt and equity components of AFUDC and increases in operating and depreciation expenses since March 1993, when rates were last increased, all contributed to the overall decrease between 1993 and 1994.\nEarnings Applicable to Common Stock for 1993 were $13.8 million as compared to $11.1 million for 1992. The increase in earnings resulted from higher levels of outdoor water use due to abnormally hot and dry summer weather. Also, a rate increase received in March 1993 enabled Elizabethtown to cover higher levels of operating expenses in 1993 without adversely affecting earnings. Summer water use in excess of what management believed to be normal contributed approximately $1.8 million to the increase.\nOperating Revenues increased $2.0 million or 2.0% in 1994. Of this increase, $1.2 million relates to a rate increase, effective March 1993. Sales to retail customers decreased by $.9 million, primarily due to a return to more normal weather patterns during the spring and summer months of 1994 compared to 1993. However, despite the return to more normal weather patterns, sales to other water systems and to large industrial customers increased by $.6 million and $.7 million, respectively. Due to nor-mal growth within the service territory, fire service revenues increased by $.4 million.\nOperating Revenues increased $10.8 million or 12.1% in 1993. Of this increase, $4.8 million relates to the combined effect of the rate increases of $5.0 million and $4.0 million effective March 1993 and 1992, respectively. Also, sales to retail customers increased $3.8 million and sales to other water systems increased $1.2 million due to hot, dry summer weather.\nOperation Expenses increased by $2.2 million or 5.7%. The increase is due primarily to increased costs for labor, benefits, miscellaneous expenses and the unit cost of raw water purchased from the NJWSA, which is reflected in the PWAC (see Note 8 to the Notes to Consolidated Financial Statements) in addition to the cost of chemicals to treat such water. Benefit costs increased due, primarily, to an increase in the actuarially calculated pension expense.\nOperation Expenses increased by $3.5 million or 10.0% in 1993 primarily due to increases in the quantity of power and raw water purchased to meet higher than normal summer loads. Also, the unit costs of power and purchased water increased, as did labor costs and the cost of medical and other benefits.\nMaintenance Expenses increased by $.9 million or 15.9% due to the effects of unusually harsh winter weather in the first quarter of 1994 in addition to an increased level of preventive maintenance at various operating facilities throughout the Company.\nMaintenance Expenses increased by an insignificant amount in 1993.\nDepreciation Expense increased $.6 million or 7.9% in 1994 and $.6 million or 9.5% in 1993 due to additional depreciable plant being placed in service during those periods.\nRevenue Taxes increased $.2 million or 2.0% in 1994 and $1.4 million or 12.8% in 1993 due to additional taxes on the higher revenues discussed above.\nReal Estate, Payroll and Other Taxes increased by $.2 million or 8.1% in 1994 due to increased payroll taxes resulting from labor cost increases. Real estate, payroll and other taxes increased $.1 million in 1993 also due to increased payroll taxes.\nFederal Income Taxes decreased $.5 million or 6.3% in 1994 and increased $1.8 million or 31.2% in 1993 due to the changes in the components of taxable income discussed herein. The increase in 1993 also includes $.2 million due to a change in the federal statutory tax rate from 34% to 35%.\nOther Income decreased in total by less than $.1 million in 1994. Included in this net decrease is a litigation settlement of $.9 million (see Note 11 to the Notes to Consolidated Financial Statements). Also included in the net decrease is a an increase in the equity component of AFUDC of $.7 million resulting from increased construction expenditures, primarily related to the Plant. Other increases of $.3 million resulted from various miscellaneous items. Federal income taxes, as a result of all of the above, decreased less than $.1 million.\nOther Income increased in total by $.1 million in 1993. Other Income increased, primarily, due to a gain on the sale of land by Elizabethtown. A decrease in the equity component of AFUDC of $.2 million resulted from the timing of construction expenditures. Other increases of $.2 million resulted from various miscellaneous items. Federal income taxes, as a result of all of the above, increased $.1 million.\nTotal Interest Charges decreased $1.0 million or 9.1% in 1994 due primarily to savings from refinancing of long-term debt in 1993. Also, an increase in the debt component of AFUDC of $.5 million, resulted in a reduction of interest expense.\nTotal Interest Charges increased $.8 million or 7.7% in 1993, due primarily to an increase in interest for long-term debt issued in September 1992 and a reduction in earnings from NJEDA trust funds due to the use of trust fund balances for construction expenditures. These items were partially offset by lower interest on short-term debt due to reduced borrowings.\nPreferred Stock Dividends decreased $.2 million or 18.7% in 1994 as a result of savings from the refinancing of the $8.75 series preferred stock with $5.90 series preferred stock in March 1994.\nECONOMIC OUTLOOK\nCurrently, Elizabethtown and Mount Holly believe they are in compliance with all water quality standards. Looking forward, however, governmental water quality and service regulations will require Elizabethtown and Mount Holly to make significant investments in water supply, water treatment, transmission and storage facilities including, for Elizabethtown, the Plant, and for Mount Holly, a new water supply, treatment and transmission system to augment existing facilities. This capital program will require regular external financing and rate relief through 1996.\nThe timing and amount of rate increases obtained by Elizabethtown and Mount Holly, as well as various other factors which will always affect the financial performance of a water utility, such as weather, customer usage, the magnitude and timing of capital expenditures and the rate of growth of revenues and expenditures, will drive earnings going forward in 1995 and 1996. Once the new facilities, referred to above, are constructed and reflected in rates, Elizabethtown expects its internally generated -cash flow to increase and capital outlays to return to more normal levels. As a result, external financing and rate relief needs should become less frequent. Therefore, more than in recent years, management's ongoing efforts to grow unit sales and control operating costs will benefit the customer by reducing the frequency of rate increases, and will benefit shareholders by positively affecting earnings.\nThe BPU approved a $5.3 million, or 5.3%, rate increase (1995 Stipulation) effective February 1, 1995 which will favorably impact earnings in 1995. Among other provisions, the 1995 Stipulation requires Elizabethtown to maintain an average ratio of common equity to total capitalization of at least 45.1% for the twelve months ended January 31, 1996. If a lesser ratio is maintained, the revenue requirement associated with such lesser ratio will offset the overall revenue requirement in the next base rate case.\nThe Company expects to sustain an average ratio of common equity to total capitalization in excess of 45.1% for such 12-month period. Looking further forward, rate increases of approximately 30% in excess of current rates will be required by Elizabethtown during 1996, a major portion of which will be needed to recover the expected costs of the Plant. In light of the approval by the BPU of the 1993 Plant Stipulation, and Elizabethtown's experience obtaining base rate relief, Elizabethtown expects the BPU to gra-nt timely and adequate rate relief for the Plant, but cannot predict the ultimate outcome of any rate proceeding.\nRate increases of more than 100% in excess of current rates will be required by Mount Holly during the period 1995-1996, the predominant portion of which will be required to recover the expected costs of the new supply, treatment and transmission facilities. Mount Holly expects to file for a rate increase in two phases in the second quarter of 1995, providing for rate relief for the entire project in the second phase. Mount Holly expects the BPU to grant timely and adequate rate relief, but cannot predict the ultimate o-utcome at this time.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information for E'town is included in Exhibit 13, filed herewith, and is incorporated herein by reference.\nThe information for Elizabethtown Water Company is contained on pages 2 through 21 of Appendix I included 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\nInformation with respect to directors of E'town and Elizabethtown is included in E'town's Proxy Statement for the 1995 Annual Meeting of Stockholders, and is incorporated herein by reference.\nInformation regarding the executive officers of both E'town and Elizabethtown follows Item 1 in Part I of this Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nThis information for E'town and Elizabethtown is included in E'town's Proxy Statement for the 1995 Annual Meeting of Stockholders, and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThis information is included in E'town's Proxy Statement for the 1995 Annual Meeting of Stockholders, and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThis information for E'town and Elizabethtown is included in E'town's Proxy Statement for the 1995 Annual Meeting of Stockholders, 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 report:\n1. Financial Statements:\nElizabethtown Water Company\nStatements of Consolidated Income for the years ended December 31, 1994, 1993 and 1992.\nConsolidated Balance Sheets as of December 31, 1994 and 1993.\nStatements of Consolidated Capitalization as of December 31, 1994 and 1993.\nStatement of Consolidated Shareholder's Equity for the years ended December 31, 1994, 1993 and 1992.\nStatements of Consolidated Cash Flows for the years ended December 31, 1994, 1993 and 1992.\nNotes to Consolidated Financial Statements.\nE'town Corporation\nA portion of the 1994 Annual Report to Shareholders which includes Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations, Consolidated Financial Statements, Notes to Consolidated Financial Statements, Independent Auditors' Report and Other Financial and Statistical Data is filed herewith as Exhibit 13 and is herein incorporated by reference.\nElizabethtown Water Company\nElizabethtown Water Company's consolidated financial statements and notes thereto are included herein on pages 2 through 21 of Appendix I.\nE'town and Elizabethtown Water Company\nThe Independent Auditors' Reports for E'town and Elizabethtown Water Company appear on page 27 herein and page 1 of Appendix I, respectively.\n2. Financial Statement Schedules:\nAll financial schedules required to be filed contain the same data and amounts for both E'town and Elizabethtown Water Company, except for Supplemental Schedule of Property, Plant and Equipment, which includes property, plant and equipment for each company.\nSchedule II - Valuation and Qualifying Accounts for the Years Ended December 31, 1994, 1993 and 1992.\nSupplemental Schedule of Property, Plant and Equipment at December 31, 1994 and 1993.\nOther 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 the notes accompanying each company's financial statements.\n3. Exhibits\n(a) Exhibits for E'town and Elizabethtown Water Company are listed in the Exhibit Index.\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, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMarch 29, 1995 E'TOWN CORPORATION\nBy: \/s\/ Robert W. Kean, Jr. ------------------------- Chairman, 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 indicated on March 29, 1995.\nChairman, Chief Executive Officer and Director \/s\/ Robert W. Kean, Jr. -------------------------\nPresident and Director \/s\/ Henry S. Patterson II -------------------------\nVice President and Director \/s\/ Anne Evans Estabrook -------------------------\nChief Financial Officer and Treasurer \/s\/ Andrew M. Chapman (Principal Financial and Accounting Officer) -------------------------\nDirector \/s\/ Brendan T. Byrne -------------------------\nDirector \/s\/ Thomas J. Cawley -------------------------\nDirector \/s\/ John Kean -------------------------\nDirector \/s\/ Robert W. Kean III -------------------------\nDirector \/s\/ Arthur P. Morgan -------------------------\nDirector \/s\/ Barry T. Parker -------------------------\nDirector \/s\/ Hugo M. Pfaltz, Jr. -------------------------\nDirector \/s\/ Chester A. Ring III -------------------------\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the 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 29, 1995 ELIZABETHTOWN WATER COMPANY\nBy: \/s\/ Robert W. Kean, Jr. -------------------------- Chairman, 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 indicated on March 29, 1995.\nChairman, Chief Executive Officer and Director \/s\/ Robert W. Kean, Jr. --------------------------\nPresident and Director \/s\/ Thomas J. Cawley --------------------------\nChief Financial Officer and Treasurer \/s\/ Andrew M. Chapman (Principal Financial Officer) --------------------------\nController \/s\/ Dennis W. Doll (Principal Accounting Officer) --------------------------\nDirector \/s\/ Brendan T. Byrne --------------------------\nDirector \/s\/ Anne Evans Estabrook --------------------------\nDirector \/s\/ John Kean --------------------------\nDirector \/s\/ Robert W. Kean, III --------------------------\nDirector \/s\/ Arthur P. Morgan --------------------------\nDirector \/s\/ Barry T. Parker --------------------------\nDirector \/s\/ Henry S. Patterson, II --------------------------\nDirector \/s\/ Hugo M. Pfaltz, Jr. --------------------------\nDirector \/s\/ Chester A. Ring III --------------------------\nINDEPENDENT AUDITORS' REPORT\nE'TOWN CORPORATION:\nWe have audited the consolidated financial statements of E'town 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 February 17, 1995, except for the subsequent events discussed in Notes 3 and 11, as to which the dates are February 23, 1995 and March 9, 1995, respectively; 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 financial statement schedules of E'town Corporation and its subsidiaries, listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\n\/s\/ Deloitte & Touche LLP Parsippany, New Jersey\nFebruary 17, 1995, except for the subsequent events discussed in Notes 3 and 11, as to which the dates are February 23, 1995 and March 9, 1995, respectively\nE'TOWN CORPORATION SCHEDULE II ELIZABETHTOWN WATER COMPANY VALUATION AND QUALIFYING ACCOUNTS\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E\n________ ________ ________ ________ ________\nADDITIONS BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OF PERIOD\n______________ __________ ___________ __________ __________\nReserve for Uncollectible Accounts:\nYear Ended December 31, 1994 $434,000 $552,459 (A) $523,459 $463,000\nYear Ended December 31, 1993 $377,000 $571,116 (A) $514,116 $434,000\nYear Ended December 31, 1992 $281,800 $472,261 (A) $377,061 $377,000\n____________________________\n(A) Write-off of uncollectible accounts, net of recoveries.\n_______________________________________________________________________________\nSUPPLEMENTAL SCHEDULE E'TOWN CORPORATION ELIZABETHTOWN WATER COMPANY PROPERTY, PLANT AND EQUIPMENT AT DECEMBER 31, 1994 AND 1993\n1994 1993\n_________ _________ ELIZABETHTOWN WATER COMPANY:\n____________________________ UTILITY PLANT IN SERVICE: Intangible Plant $ 250,766 $ 250,766 Source of Supply Plant 9,739,125 8,616,493 Pumping Plant 43,658,801 41,570,388 Water Treatment Plant 46,008,913 44,492,959 Transmission & Distribution Plant 354,703,279 328,843,648 General Plant 14,068,349 13,567,318 Leasehold Improvements 110,954 69,264 Acquisition Adjustments 632,388 767,988\n____________ ____________ Utility Plant in Service 469,172,575 438,178,824 Construction Work in Progress 55,739,951 17,242,088\n____________ ____________ Total Utility Plant 524,912,526 455,420,912\nNON-UTILITY PROPERTY - net 85,690 87,582\n____________ ____________ TOTAL $524,998,216 $455,508,494\n____________ ____________\n____________ ____________ E'TOWN CORPORATION:\n___________________ UTILITY PLANT (as above) $524,912,526 $455,420,912\nNON-UTILITY PROPERTY - net 12,061,574 11,989,116\n____________ ____________ TOTAL $536,974,100 $467,410,028\n____________ ____________\n____________ ____________\nEXHIBIT INDEX\nCertain of the following exhibits, designated with an asterisk(*), are filed herewith. The exhibits not so designated have heretofore been filed with the Commission and are incorporated herein by reference to the documents indicated in brackets following the description of such exhibits.\nE'town Corporation\nExhibit No. Description\n3(a) - Certificate of Incorporation of E'town Corp. [Registration Statement No. 33-42509, Exhibit 4(a)]\n*3(b) - By-Laws of E'town Corp.\n3(c) - Certificate of Incorporation of E'town Properties, Inc. [Registration Statement No. 33-32143, Exhibit 4(j)]\n3(d) - By-Laws of E'town Properties, Inc. [Registration Statement No. 33-32143, Exhibit 4(n)]\n4(a) - Rights Agreement dated as of February 4, 1991 between E'town and the Rights Agent [Registration Statement No. 33-38566, Exhibit 4(n)]\n4(b) - Indenture dated as of January 1, 1987 from E'town Corporation to Boatmen's Trust, Trustee, relating to the 6 3\/4% Convertible Subordinated Debentures due 2012 [Registration Statement No. 33-32143, Exhibit 4(a)]\n10(a) - Incentive Stock Option Plan [Registration Statement No. 2-99602, Exhibit 28(a)]\n*10(b) - Savings and Investment Plan\n10(c) - Management Incentive Plan [Registration Statement No. 33-38566, Exhibit 10(i)]\n10(d) - E'town's 1987 Stock Option Plan [Registration Statement No. 33-42509, Exhibit 28]\n10(e) - E'town's 1990 Performance Stock Program [Registration Statement No. 33-46532, Exhibit 10(k)]\n10(f) - E'town's Dividend Reinvestment and Stock Purchase Plan [Registration No. 33-56013, Exhibit 4(e)]\n10(g) - Change of Control Agreement [Form 10-Q for the quarter ended March 31, 1994, Exhibit 10]\n*11 - Statement Regarding Computation of Per Share Earnings\n*13 - Portion of the 1994 Annual Report to Shareholders which includes Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations, Consolidated Financial Statements, Notes to Consolidated Financial Statements, Independent Auditors' Report and Other Financial and Statistical Data and is herein incorporated by reference.\n*23 - Consent of Deloitte & Touche LLP, Independent Auditors\n*27 - E'town Corporation - Financial Data Schedule\nEXHIBIT INDEX\nCertain of the following exhibits, designated with an asterisk(*), are filed herewith. The exhibits not so designated have heretofore been filed with the Commission and are incorporated herein by reference to the documents indicated in brackets following the description of such exhibits.\nElizabethtown Water Company\nExhibit No. Description\n3(a) - Form of Restated Certificate of Incorporation of Elizabethtown Water Company [Form 10-K for the year ended December 31, 1993, Exhibit 3(a)]\n3(b) - By-Laws of Elizabethtown Water Company\n4(a) - Indenture dated as of November 1, 1993 from Elizabethtown Water Company to The Bank of New York, Trustee, relating to the 7 1\/4% Debentures due 2028. [Form 10-K for year ended December 31, 1993, Exhibit 4(a)]\n4(b) - Indenture dated as of September 1, 1992 from Elizabethtown Water Company to The Bank of New York, Trustee, relating to the 8% Debentures due 2022 [Form 10-K for year ended December 31, 1992, Exhibit 4(a)]\n4(c) - Indenture dated as of October 1, 1991 from Elizabethtown Water Company to The Bank of New York, Trustee, relating to the 8 3\/4% Debentures due 2021 [Registration Statement No. 33-46532, Exhibit 4(f)]\n4(d) - Indenture dated as of August 1, 1991 from Elizabethtown Water Company to The Bank of New York, Trustee, relating to the 6.60% Debentures due 2021 [Registration Statement No. 33-46532, Exhibit 4(g)]\n4(e) - Indenture dated as of August 1, 1991 from Elizabethtown Water Company to The Bank of New York, Trustee, relating to the 6.70% Debentures due 2021 [Registration Statement No. 33-46532, Exhibit 4(h)]\n4(f) - Indenture dated as of October 1, 1990 from Elizabethtown Water Company to Citibank, N.A., Trustee, relating to the 7 1\/2% Debentures due 2020 [Registration Statement No. 33-38566, Exhibit 4(e)]\nExhibit No. Description\n4(g) - Indenture dated as of December 1, 1989 from Elizabethtown Water Company to Citibank, N.A., Trustee, relating to the 7.20% Debentures due 2019 [Registration Statement No. 33-38566, Exhibit 4(f)]\n10(a) - Contract for service to Middlesex Water Company. [Registration Statement No. 33-38566, Exhibit 10(a)]\n10(b) - Contract for service to Edison Township. [Registration Statement No. 2-58262, Exhibit 13(c)]\n10(c) - Contract for service to New Jersey-American Water Company. [Form 10-K for the year ended December 31, 1992, Exhibit 10(c)]\n10(d) - Contract for service to City of Elizabeth. [Form 10-K for the year ended December 31, 1992, Exhibit 10(d)]\n10(e) - Contract for service to Franklin Township. [Registration Statement No. 33-46532, Exhibit 10(e)]\n10(f) - Contract with the New Jersey Water Supply Authority for the purchase of water from the Raritan Basin. [Registration Statement No. 33-32143, Exhibit 10(e)]\n10(g) - Supplemental Executive Retirement Plan of Elizabethtown Water Company [Form 10-K for the year ended December 31, 1992 Exhibit 10(g)]\n10(h) - Medical Reimbursement Plan of Elizabethtown Water Company [Form 10-K for the year ended December 31, 1992 Exhibit 10(h)]\n*12(a) - Computation of Ratio of Earnings to Fixed Charges\n*12(b) - Computation of Ratio of Earnings to Fixed Charges and Preferred Dividends\n* 27 - Elizabethtown Water Company - Financial Data Schedule.\nAPPENDIX I\nELIZABETHTOWN WATER COMPANY AND SUBSIDIARY\nCONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 AND INDEPENDENT AUDITORS' REPORT\nAPPENDIX I\nELIZABETHTOWN WATER COMPANY AND SUBSIDIARY\n__________________________________________\n__________________________________________________________________________ PAGE\n____ INDEPENDENT AUDITORS' REPORT 1\nSTATEMENTS OF CONSOLIDATED INCOME FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 2\nCONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1994 AND 1993 3\nSTATEMENTS OF CONSOLIDATED CAPITALIZATION AS OF DECEMBER 31, 1994 AND 1993 5\nSTATEMENTS OF CONSOLIDATED SHAREHOLDER'S EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 6\nSTATEMENTS OF CONSOLIDATED CASH FLOWS FOR THE YEARS ENDED 7 DECEMBER 31, 1994, 1993 AND 1992\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8\n__________________________________________________________________________\nAPPENDIX I\nINDEPENDENT AUDITORS' REPORT\nTO THE SHAREHOLDER AND BOARD OF DIRECTORS OF ELIZABETHTOWN WATER COMPANY:\nWe have audited the accompanying consolidated balance sheets and statements of consolidated capitalization of Elizabethtown Water Company and its subsidiary 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 audits also included the financial statement schedules listed in the Index at Item 14. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on 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 Elizabethtown Water Company and its subsidiary 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.\n\/s\/ Deloitte & Touche LLP Parsippany, New Jersey\nFebruary 17, 1995\nElizabethtown Water Company and Subsidiary APPENDIX I\nStatements of Consolidated Income\nYear Ended December 31,\n_______________________________________ 1994 1993 1992\n_____________ ____________ ____________\nOperating Revenues $102,032,505 $99,996,120 $89,167,337\n____________ ____________ ____________\nOperating Expenses: Operation 40,722,980 38,529,149 35,041,222 Maintenance 6,623,772 5,716,157 5,704,843 Depreciation 7,860,180 7,285,309 6,654,986 Revenue taxes 12,748,161 12,501,804 11,086,349 Real estate, payroll and other taxes 2,717,067 2,513,891 2,429,446 Federal income taxes (Note 3) 7,176,396 7,658,770 5,836,464\n____________ ___________ ___________ Total operating expenses 77,848,556 74,205,080 66,753,310\n____________ ___________ ___________\nOperating Income 24,183,949 25,791,040 22,414,027\n____________ ___________ ___________\nOther Income: Litigation settlement (Note 11) (932,203) Gain on sale of land 122,400 Allowance for equity funds used during construction (Note 2) 1,178,133 445,339 599,443 Federal income taxes (Note 3) (237,599) (258,024) (185,000) Other-net 432,922 169,474 (55,326)\n____________ ___________ ___________ Total other income 441,253 479,189 359,117\n____________ ___________ ___________\n____________ ___________ ___________ Total Operating and Other Income 24,625,202 26,270,229 22,773,144\n____________ ___________ ___________\nInterest Charges: Interest on long-term debt 10,774,008 11,527,301 10,516,521 Other interest expense-net 175,507 77,921 514,122 Capitalized interest (Note 2) (867,101) (391,895) (616,473) Amortization of debt discount-net 319,646 224,383 209,631\n____________ ___________ ___________ Total interest charges 10,402,060 11,437,710 10,623,801\n____________ ___________ ___________\nIncome Before Preferred Stock Dividends 14,223,142 14,832,519 12,149,343 Preferred Stock Dividends 854,047 1,050,000 1,050,000\n____________ ___________ ___________\nEarnings Applicable to Common Stock $ 13,369,095 $13,782,519 $11,099,343\n____________ ___________ ___________\n____________ ___________ ___________\nSee Notes to Consolidated Financial Statements.\nElizabethtown Water Company and Subsidiary APPENDIX I\nConsolidated Balance Sheets\nDecember 31,\n___________________________ Assets 1994 1993\n____________ ____________\nUtility Plant-at Original Cost: Utility plant in service $469,172,575 $438,178,824 Construction work in progress 55,739,951 17,242,088\n____________ ____________ Total utility plant 524,912,526 455,420,912 Less accumulated depreciation and amortization 87,456,550 82,128,023\n____________ ____________ Utility plant-net 437,455,976 373,292,889\n____________ ____________\nNon-utility Property 85,690 87,582\n____________ ____________\nFunds Held by Trustee for Construction Expenditures (Note 2) 382,306\n____________\nCurrent Assets: Cash and cash equivalents 1,485,115 3,263,456 Customer and other accounts receivable (less reserve: 1993, $434,000; 1992, $377,000) 12,350,802 11,887,985 Unbilled revenues 7,161,483 7,248,322 Materials and supplies-at average cost 1,724,969 1,623,702 Prepaid insurance, taxes, other 1,410,401 1,603,955 Prepaid federal income taxes 1,344,630\n____________ ____________ Total current assets 25,477,400 25,627,420\n____________ ____________\nDeferred Charges (Note 7): Prepaid pension expense (Note 10) 926,142 1,003,145 Abandonments 76,049 152,097 Waste residual management 325,785 587,589 Unamortized debt and preferred stock expenses 8,902,271 8,025,677 Taxes recoverable through future rates (Note 3) 26,339,057 26,643,663 Postretirement benefit expense (Note 10) 2,077,051 1,004,556 Purchased water under recovery - net 314,128 Other unamortized expenses 868,365 598,179\n____________ ____________ Total deferred charges 39,828,848 38,014,906\n____________ ____________ Total $502,847,914 $437,405,103\n____________ ____________\n____________ ____________\nSee Notes to Consolidated Financial Statements.\nElizabethtown Water Company and Subsidiary APPENDIX I\nConsolidated Balance Sheets\nDecember 31,\n____________________________ Capitalization and Liabilities 1994 1993\n____________ ____________\nCapitalization (Notes 4 and 5): Common shareholder's equity $151,624,255 $125,764,979 Cumulative preferred stock 12,000,000 12,000,000 Long-term debt-net 141,908,430 141,909,533\n____________ ____________ Total capitalization 305,532,685 279,674,512\n____________ ____________\nCurrent Liabilities: Notes payable-banks (Note 5) 23,000,000 0 Long-term debt-current portion (Note 4) 42,000 42,000 Accounts payable and other liabilities 18,165,522 9,589,716 Customers' deposits 278,895 276,497 Municipal and state taxes accrued 12,831,524 12,569,445 Federal income taxes accrued 704,771 Interest accrued 2,828,464 2,699,483 Preferred stock dividends accrued 59,000 89,178\n____________ ____________ Total current liabilities 57,205,405 25,971,090\n____________ ____________\nDeferred Credits: Customer advances for construction 45,554,476 45,149,522 Federal income taxes (Note 3) 60,109,244 55,955,366 Unamortized investment tax credits 8,650,537 8,852,487 Emergency water projects 127,704 Accumulated postretirement benefits (Note 10) 2,077,051 1,004,556\n____________ ____________ Total deferred credits 116,391,308 111,089,635\n____________ ____________\nContributions in Aid of Construction 23,718,516 20,669,866\n____________ ____________\nCommitments and Contingent Liabilities (Note 9)\n____________ ____________ Total $502,847,914 $437,405,103\n____________ ____________\n____________ ____________\nSee Notes to Consolidated Financial Statements.\nElizabethtown Water Company and Subsidiary APPENDIX I\nStatements of Consolidated Capitalization\nDecember 31,\n____________________________ 1994 1993\n____________ ____________\nCommon Shareholder's Equity (Notes 4 and 5): Common stock without par value, authorized, 10,000,000 shares; issued 1994 and 1993, 1,974,902 shares $ 15,740,602 $ 15,740,602 Paid-in capital 88,868,632 63,522,594 Capital stock expense (484,702) (484,702) Retained earnings 47,499,723 46,986,485\n____________ ____________ Total common shareholder's equity 151,624,255 125,764,979\n____________ ____________\nCumulative Preferred Stock (Note 4): $100 par value, authorized, 200,000 shares; $5.90 series, issued and outstanding, 120,000 shares 12,000,000\n____________\nCumulative Preferred Stock-Redeemable (Note 4): $100 par value, authorized, 200,000 shares; $8.75 series, issued and outstanding, 120,000 shares 12,000,000\n____________\nCumulative Preferred Stock: $25 par value, authorized, 500,000 shares; none issued\nElizabethtown Water Company: 7.20% Debentures, due 2019 10,000,000 10,000,000 7 1\/2% Debentures, due 2020 15,000,000 15,000,000 6.60% Debentures, due 2021 10,500,000 10,500,000 6.70% Debentures, due 2021 15,000,000 15,000,000 8 3\/4% Debentures, due 2021 27,500,000 27,500,000 8% Debentures, due 2022 15,000,000 15,000,000 7 1\/4% Debentures, due 2028 50,000,000 50,000,000\nThe Mount Holly Water Company: Notes Payable (due serially through 2000) 144,300 186,300\n____________ ____________ Total long-term debt 143,144,300 143,186,300 Unamortized discount-net (1,235,870) (1,276,767)\n____________ ____________ Total long-term debt-net 141,908,430 141,909,533\n____________ ____________ Total capitalization $305,532,685 $279,674,512\n____________ ____________\n____________ ____________\nSee Notes to Consolidated Financial Statements.\nElizabethtown Water Company and Subsidiary APPENDIX I\nStatements of Consolidated Shareholder's Equity\nYear Ended December 31,\n_______________________________________ 1994 1993 1992\n____________ ___________ ___________\nCommon Stock: $ 15,740,602 $ 15,740,602 $ 15,740,602\n____________ ____________ ____________\nPaid-in Capital: Balance at Beginning of Year 63,522,594 43,713,297 28,381,584 Capital contributed by parent company 25,346,038 19,809,297 15,331,713\n____________ ____________ ____________ Balance at End of Year 88,868,632 63,522,594 43,713,297\n____________ ____________ ____________\nCapital Stock Expense: (484,702) (484,702) (484,702)\n____________ ____________ ____________\nRetained Earnings: Balance at Beginning of Year 46,986,485 44,054,327 42,239,144 Income Before Preferred Stock Dividends 14,223,142 14,832,519 12,149,343 Dividends on Common Stock (12,855,857) (10,850,361) (9,284,160) Preferred Stock Dividends (854,047) (1,050,000) (1,050,000)\n____________ ____________ ____________ Balance at End of Year 47,499,723 46,986,485 44,054,327\n____________ ____________ ____________\nTotal Common Shareholder's Equity $151,624,255 $125,764,979 $103,023,524\n____________ ____________ ____________\n____________ ____________ ____________\nSee Notes to Consolidated Financial Statements.\nElizabethtown Water Company and Subsidiary APPENDIX I\nStatements of Consolidated Cash Flows Year Ended December 31,\n_____________________________________ 1994 1993 1992\n___________ ___________ ____________ Cash Provided by Operating Activities: Income Before Preferred Stock Dividends $ 14,223,142 $ 14,832,519 $ 12,149,343 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 7,860,180 7,285,309 6,654,986 Gain on sale of land (122,400) (Increase) decrease in deferred charges (1,046,053) (2,878,971) 92,070 Deferred income taxes and investment tax credits-net 4,256,534 3,332,558 2,685,426 Allowance for debt and equity funds used during construction (AFUDC) (2,045,234) (837,234) (1,215,916) Other operating activities-net (130,902) (449,792) (182,669) Change in current assets and liabilities excluding cash, short-term investments and current portion of debt: Customer and other accounts receivable (462,817) (840,485) 1,308,263 Unbilled revenues 86,839 (688,601) (164,241) Accounts payable and other liabilities 8,548,026 669,078 (934,312) Accrued\/prepaid interest and taxes (1,464,787) 232,741 678,208 Other (101,266) (6,870) 3,473\n____________ ____________ ____________ Net cash provided by operating activities 29,723,662 20,527,852 21,074,631\n____________ ____________ ____________ Cash Provided by Financing Activities: Decrease in funds held by Trustee for construction expenditures 382,306 8,519,877 12,390,518 Proceeds from issuance of debentures 50,000,000 15,000,000 Proceeds from issuance of preferred stock 12,000,000 Redemption of preferred stock (12,000,000) Capital contributed by parent company 25,346,038 19,809,297 15,331,713 Repayment of long-term debt (42,000) (50,042,000) (9,042,000) Contributions and advances for construction-net 3,453,604 1,909,905 3,066,832 Net increase (decrease) in notes payable-banks 23,000,000 (5,500,000) (13,000,000) Dividends paid on common and preferred stock (13,661,332) (11,900,361) (10,334,160)\n____________ ____________ ____________ Net cash provided by financing activities 38,478,616 12,796,718 13,412,903\n____________ ____________ ____________ Cash Used for Investing Activities: Utility plant expenditures (excluding AFUDC) (69,980,619) (32,501,865) (33,292,602) Proceeds from sale of land 131,000\n____________ ____________ ____________ Net cash used for investing activities (69,980,619) (32,370,865) (33,292,602)\n____________ ____________ ____________ Net Increase (Decrease) in Cash and Cash Equivalents (1,778,341) 953,705 1,194,932 Cash and Cash Equivalents at Beginning of Year 3,263,456 2,309,751 1,114,819\n____________ ____________ ____________ Cash and Cash Equivalents at End of Year$ 1,485,115 $ 3,263,456 $ 2,309,751\n____________ ____________ ____________\n____________ ____________ ____________\nSupplemental Disclosures of Cash Flow Information: Cash paid during the year for: Interest (net of amount capitalized) $ 9,952,838 $ 11,837,347 $ 10,970,625 Income taxes 6,771,254 5,881,008 3,875,774 Preferred stock dividends $ 805,475 $ 1,050,000 $ 1,050,000\nSee Notes to Consolidated Financial Statements.\nELIZABETHTOWN WATER COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ORGANIZATION\nElizabethtown Water Company (Elizabethtown or Company) and its wholly owned subsidiary, The Mount Holly Water Company (Mount Holly), the consolidated entity referred to herein as Elizabethtown Water Company, is a wholly owned subsidiary of E'town Corporation (E'town or Corporation). E'town, a New Jersey holding company, is the parent company of Elizabethtown Water Company and E'town Properties, Inc.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Consolidation\nThe consolidated financial statements include Elizabethtown and its subsidiary, Mount Holly. Significant intercompany accounts and transactions have been eliminated. Elizabethtown and Mount Holly are regulated water utilities and follow the Uniform System of Accounts, as adopted by the New Jersey Board of Public Utilities (BPU).\nUtility Plant and Depreciation\nIncome is charged with the cost of labor, materials and other expenses incurred in making repairs and minor replacements and in maintaining the properties. Utility plant accounts are charged with the cost of improvements and major replacements of property. When depreciable property is retired or otherwise disposed of, the cost thereof, plus the cost of removal net of salvage, is charged to accumulated depreciation. Depreciation generally is computed on a straight-line basis at functional rates for various classes of assets. The provision for depreciation, as a percentage of average depreciable property, was 1.75% for 1994, 1.74% for 1993 and 1.72% for 1992.\nAllowance for Funds Used During Construction\nElizabethtown capitalizes, as an appropriate cost of utility plant, an Allowance for Funds Used During Construction (AFUDC), which represents the cost of financing major projects during construction. AFUDC is added to the construction cost of the project and included in rate base and then recovered in rates during the project's useful life. AFUDC is comprised of a debt component (credited to Interest Charges), and an equity component (credited to Other Income) in the Statements of Consolidated Income (See Note 8). The equity component considers the increased reliance on equity contributions to Elizabethtown from E'town's stock sales. Such equity contributions have become an integral part of the financing of Elizabethtown's construction program. AFUDC totaled $2,045,234, $837,234 and $1,215,916 for 1994, 1993 and 1992, respectively.\nRevenues\nRevenues are recorded based on the amounts of water delivered to customers through the end of each accounting period. This includes an accrual for unbilled revenues for water delivered from the time meters were last read to the end of the respective accounting periods.\nFederal Income Taxes\nElizabethtown Water Company files a consolidated federal tax return with E'town and E'town Properties, Inc. Deferred income taxes are provided for timing differences in the recognition of revenues and expenses for tax and financial statement purposes to the extent permitted by the BPU. Elizabethtown and Mount Holly account for prior years' investment tax credits by the deferral method, which amortizes the credits over the lives of the respective assets.\nCustomer Advances for Construction and Contributions in Aid of Construction\nCustomer Advances for Construction and Contributions in Aid of Construction represent capital provided by developers for main extensions to new real estate developments. Some portion of Customer Advances for Construction is refunded based upon the revenues that the new developments generate. Contributions in Aid of Construction are Customer Advances for Construction that are no longer subject to refund.\nPreferred Stock Dividends\nThe amortization of a premium of $1,050,000, paid in March 1994, on the redemption of Elizabethtown's $8.75 Cumulative Preferred Stock, is recorded as Preferred Stock Dividends in the Statements of Consolidated Income. The premium is being amortized over 10 years for ratemaking purposes (See Note 4).\nFunds Held by Trustee for Construction Expenditures\nProceeds from New Jersey Ecomomic Development Authority financings were held in trust until such time as qualified project expenditures were incurred. Income received from the investment of the trust fund assets was recorded as an offset to the related interest expense.\nCash Equivalents\nElizabethtown Water Company considers all highly liquid debt instruments purchased with maturities of three months or less to be cash equivalents.\nReclassification\nCertain prior year amounts have been reclassified to conform to the current year's presentation.\n3. FEDERAL INCOME TAXES\nThe computation of federal income taxes and the reconciliation of the tax provision computed at the federal statutory rate (35% in 1994 and 1993 and 34% in 1992) with the amount reported in the Statements of Consolidated Income follow:\n1994 1993 1992 ---------------------- (Thousands of Dollars)\nTax expense at statutory rate ........ $7,573 $7,962 $6,178 Items for which deferred taxes are not provided: Capitalized interest ............... (2) (2) (3) Difference between book and tax depreciation ..................... 92 81 66 Investment tax credits.............. (209) (208) (210) Other............................... (40) 84 (10) ------ ------ ------ Provision for federal income taxes.... $7,414 $7,917 $6,021 ====== ====== ====== The provision for federal income taxes is composed of the following: Current .............................. $5,087 $5,926 $5,318 Tax collected on main extensions ..... (1,931) (1,341) (1,982) Deferred: Tax depreciation.................... 3,366 3,222 2,980 Alternative minimum tax............. (412) Capitalized interest................ 384 72 118 Main cleaning and lining............ 396 323 271 Other............................... 314 (91) (70) Investment tax credits-net............ (202) (194) (202) ------ ------ ------ Total provision ...................... $7,414 $7,917 $6,021 ====== ====== ======\nEffective January 1, 1993, Elizabethtown Water Company adopted Statement of Financial Accounting Standards (SFAS) 109, \"Accounting for Income Taxes.\" SFAS 109 established accounting rules that change the manner in which income tax expense is determined for accounting purposes. SFAS 109 utilizes a liability method under which deferred taxes are provided at the enacted statutory rate for all temporary differences between financial statement earnings amounts and the tax basis of existing assets or liabilities.\nIn connection with the adoption of SFAS 109, Elizabethtown Water Company and Mount Holly recorded additional deferred taxes for water utility temporary differences not previously recognized. The increased deferred tax liability was offset by a corresponding asset representing the future revenue expected to be recovered through rates based on established regulatory practice permitting such recovery.\nIn accordance with SFAS 109, deferred tax balances have been reflected at E'town's current consolidated federal income tax rate, which is 35%. The increase in the statutory tax rate from 34% to 35% in 1993 resulted in the recognition of additional federal income tax expense of $168,798 and an additional deferred federal income tax liability of $100,744 in 1993. The net deferred income tax liability as of December 31, 1994 and 1993 is comprised of the following: 1994 1993 ---------------------- (Thousands of Dollars)\nDeferred tax assets $ 3,585 $ 3,804 Deferred tax liabilities (63,694) (59,759) -------- -------- Net deferred income tax liabilities $(60,109) $(55,955) ======== ========\nThe tax effect of significant temporary differences representing deferred income tax assets and liabilities as of December 31, 1994 and 1993 is as follows:\n1994 1993 ---------------------- (Thousands of Dollars)\nWater utility plant--net $(53,517) $(49,582) Taxes recoverable through future rates (9,219) (9,326) Investment tax credit 3,028 3,098 Prepaid pension expense (324) (351) Other assets 557 706 Other liabilities (634) (500) -------- -------- Net deferred income tax liabilities $(60,109) $(55,955) ======== ========\n4. CAPITALIZATION\nIn May 1994, E'town issued 690,000 shares of common stock for net proceeds of $18,218,471. The net proceeds were used to fund an equity contribution to Elizabethtown of $16,000,000. This contribution has been used to partially fund Elizabethtown's construction program, the predominant portion of which relates to the Canal Road Water Treatment Plant (Plant) (See Note 9).\nE'town routinely makes an equity contribution to Elizabethtown which represents the proceeds of common stock issued under E'town's Dividend Reinvestment and Stock Purchase Plan (DRP). Amounts contributed for 1994 and 1993 were $7,146,038 and $6,009,298, respectively.\nIn May 1993, E'town issued 575,000 shares of common stock for net proceeds of $16,591,927. The net proceeds were used to fund equity contributions to Elizabethtown of $11,000,000 in May 1993 and $2,800,000 in September 1993. Elizabethtown used a portion of such contributions to repay $7,000,000 of short-term bank debt incurred for construction expenditures.\nCumulative Preferred Stock\nIn March 1994, Elizabethtown issued 120,000 shares of $100 par value, $5.90 Cumulative Preferred Stock for proceeds of $12,000,000 at an effective rate of 7.37%. The proceeds were used to redeem $12,000,000 of the Company's $8.75 Cumulative Preferred Stock. The redemption premium of $1,050,000 was paid from general Company funds and is being amortized over 10 years for ratemaking purposes (See Note 2).\nThe $5.90 Cumulative Preferred Stock is not redeemable at the option of Elizabethtown. Elizabethtown is required to redeem all 120,000 shares of the Preferred Stock on March 1, 2004 at $100 per share.\nLong-term Debt\nElizabethtown's long-term debt indentures restrict the amount of retained earnings available to Elizabethtown to pay cash dividends (which is the primary source of funds available to the Corporation for payment of dividends on its common stock) or acquire Elizabethtown's common stock, all of which is held by E'town. At December 31, 1994, $7,816,323 of Elizabethtown's retained earnings were restricted under the most restrictive indenture provision. Therefore, $39,683,400 of retained earnings were unrestricted.\nIn November 1993, Elizabethtown issued $50,000,000 of 7 1\/4% Debentures due November 1, 2028. The proceeds of the issue were used to redeem $30,000,000 of the Company's 8 5\/8% Debentures due 2007 and $20,000,000 of the Company's 10 1\/8% Debentures due 2018. The aggregate redemption premiums of $2,681,000 were paid from general Company funds.\n5. LINES OF CREDIT\nElizabethtown has executed a committed revolving credit agreement (Agreement) with an agent bank and five additional banks which replaces its uncommitted lines of credit. The Agreement provides up to $60,000,000 in revolving short-term financing which, together with internal funds, proceeds of future issuances of debt and preferred stock by Elizabethtown and capital contributions from E'town, is expected to be sufficient to finance Elizabethtown's and Mount Holly's capital needs, which are estimated to be $169.4 million through 1997. At December 31, 1994, Elizabethtown had borrowings outstanding of $23,000,000 under the Agreement at interest rates from 5.6% to 6.4%, at a weighted average rate of 6.1%.\nThe Agreement allows Elizabethtown to borrow, repay and reborrow up to $60,000,000 during the first three years, after which time Elizabethtown may convert any outstanding balances to a five-year, fully amortizing term loan. The Agreement further provides that, among other covenants, Elizabethtown must maintain\na ratio of common and preferred equity to total capitalization of not less than 35% and a pre-tax interest coverage ratio of at least 1.5 to 1.\nElizabethtown has $15,000,000 of uncommitted lines of credit with several banks in addition to the lines under the Agreement.\nInformation relating to bank borrowings for 1994, other than under the Agreement, and borrowings for 1993 and 1992, is as follows: 1994 1993 1992 ------------------------ (Thousands of Dollars)\nMaximum amount outstanding.......... $10,000 $7,000 $27,500 Average monthly amount outstanding.. $ 583 $2,062 $15,457 Average interest rate at year end... (A) (A) 4.1% Compensating balances at year end... $ 0 $ 195 $ 205 Weighted average interest rate based on average daily balances.......... 4.4% 3.8% 4.6% (A) No outstanding bank borrowings at year end.\n6. FINANCIAL INSTRUMENTS\nThe carrying amounts and the estimated fair values, as of December 31, 1994 and 1993 of financial instruments issued or held by Elizabethtown Water Company, are as follows:\n1994 1993 ---------------------- (Thousands of Dollars) Cumulative preferred stock (1): Carrying amount $ 12,000 $ 12,000 Estimated fair value 10,860 13,020\nLong-term debt (1): Carrying amount $141,908 $141,910 Estimated fair value 129,355 155,097\n(1) Estimated fair values are based upon quoted market prices for these or similar securities.\n7. DEFERRED CHARGES AND CREDITS\nAbandonments\nThe abandonment cost of a small filter plant has been deferred and is being amortized for ratemaking purposes over a 10-year period ending in 1995.\nWaste Residual Management\nThe costs of the waste residual management programs are being amortized over three-year periods for ratemaking purposes.\nPurchased Water Under Recovery-Net\nAs discussed in Note 8, in June 1994, the BPU approved a Purchased Water Adjustment Clause (PWAC) which allows Elizabethtown to reflect in rates the effect of differences in consumption billed for the PWAC and the volume of water purchased by Elizabethtown from the New Jersey Water Supply Authority (NJWSA) since the Company's last base rate case. A deferral of $314,128 has been recorded which represents an amount not yet recovered in rates under the PWAC.\nNo return is being earned on the above deferred charge balances.\nUnamortized Debt and Preferred Stock Expenses\nCosts incurred in connection with the issuance or redemption of long-term debt have been deferred and are being amortized over the lives of respective issues for ratemaking purposes. Costs incurred in connection with the issuance and redemption of preferred stock have been deferred and are being amortized over a 10-year period for ratemaking purposes (See Note 2).\n8. REGULATORY MATTERS\nRates\nOn January 24, 1995 the BPU approved a stipulation (1995 Stipulation) for a rate increase of $5,300,000, or 5.34%, effective February 1, 1995. The 1995 Stipulation provides for an authorized rate of return on common equity of 11.5%. It also provides for recovery of the current service cost portion of the obligation accrued under SFAS 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions,\" provided this amount is funded by the Company (See Note 10). The rate increase will cover the cost to finance $62,000,000 of construction projects that were not reflected in the rates last established in March 1993. These projects include treatment, transmission and storage facilities needed to ensure that Elizabethtown continues to meet the Safe Drinking Water Act regulations on water quality and service. The increase will offset costs for power, labor and benefits, primarily medical. The 1995 Stipulation provides for an increase in depreciation rates resulting in an increase in depreciation expense of approximately $469,000. The 1995 Stipulation also requires Elizabethtown to maintain an average ratio of common equity to total capitalization of at least 45.1% for the twelve months ended January 31, 1996. If a lesser ratio is maintained, the revenue requirement associated with such lesser ratio will offset the overall revenue requirement in the next base rate case. The Company expects to sustain an average of common equity to total capitalization in excess of 45.1% for such 12-month period.\nOn January 11, 1995, Elizabethtown filed with the BPU for a rate increase of $886,166 for a change in the Purchased Water Adjustment Clause (PWAC) rate based on a proposed change in the unit cost of water purchased from the NJWSA, to be effective July 1, 1995. This procedure, established by BPU rules, allows Elizabethtown to reflect in rates the change in the cost of water purchased from the NJWSA without a complete rate case. Included in this request is the amortization of the anticipated balance, as of July 1, 1995, of the net under-recovery from the 1994 PWAC of $440,526. A decision is expected by the BPU prior to July 1, 1995 (See Note 9).\nIn June 1994, the BPU approved a Stipulation for an increase in rates under a PWAC. The Stipulation resulted in an increase in rates, effective July 1, 1994, of $334,611.\nIn the second quarter of 1995, Mount Holly expects to petition the BPU for an increase in rates to take place in two phases. The first phase is necessary to recover costs to finance construction projects that were not reflected in rates last established in October 1986. The proposed increase will also seek recovery of increased costs for various operations and maintenance expenses since 1986. The second phase includes a new water supply, treatment and transmission system necessary to obtain water outside a designated portion of an aquifer currently used by Mount Holly to supply a substantial portion of its customers. This project is deemed to be the most cost-effective alternative available to Mount Holly as a result of state legislation which restricts the amount of water that can be withdrawn from the aquifer in certain areas of Southern New Jersey. The project is currently estimated to cost $16,500,000. A decision by the BPU on Mount Holly's petition would be expected by the end of 1995.\nIn August 1993, the BPU approved a stipulation (1993 Plant Stipulation) signed by the parties to the Company's petition relating to the Canal Road Water Treatment Plant (Plant). The 1993 Plant Stipulation states that the Plant is necessary and that the Company's estimates regarding the Plant's cost, at that time of $87,000,000, and construction period are reasonable (See Note 9). The 1993 Plant Stipulation authorizes the Company to levy a rate surcharge if the Company's pre-tax interest coverage ratio for any 12-month historical period drops below 2.0 times. The surcharge would equal 20% of the Company's gross interest expense for the prior 12 months, adjusted for revenue taxes. The surcharge would go into effect at the same time as the Company's next base rate increase after the coverage ratio falls below 2.0 times. Also, the surcharge would remain in effect for 12 months and could be extended by the BPU for up to six additional months. The 1993 Plant Stipulation also provides that the rate of return on common stockholder's equity used to calculate the rate for the equity component of the AFUDC for the Plant will be 1.5% less than the rate of return on common stockholder's equity established in the Company's most recent base rate case. The authorized rate of return on common stockholder's equity is currently 11.5%.\nIn March 1993, the BPU approved a stipulation for a rate increase of $5,000,000, effective as of that date.\nMain Extension Refunds\nIn a case captioned Van Holten, et al v. Elizabethtown Water Company, (Van Holten) several developers petitioned the BPU in 1984 and 1985 seeking an Order which would require Elizabethtown to refund to the\ndevelopers all of their on-site and off-site customer advances for construction. For on-site mains, Elizabethtown received a final BPU decision in September 1987, requiring refunds in accordance with the BPU's suggested refund formula, which was less than the amounts requested by the developers. For the off-site mains, the developers were denied any refund. The developers appealed the BPU decision to the Appellate Division of the New Jersey Superior Court (Appellate Division), which in October 1988 upheld the decision of the BPU.\nSince 1986, additional petitions dealing with this issue have been filed by other developers. In these additional proceedings, all parties have agreed to abide by the final decision of the New Jersey Supreme Court in the Van Holten case. For all customer advances, Elizabethtown has and will continue to make the refunds in accordance with the BPU's suggested refund formula.\nIn response to an appeal of the 1988 Appellate Division decision, in August 1990, the New Jersey Supreme Court (Court) rendered a decision upholding the BPU's authority to implement what the BPU had established as an appropriate refund formula in the Van Holten case.\nThe BPU's suggested formula provides for a refund of 2 1\/2 times the annual revenues for each metered connection. Although the Court ruled that the BPU has the jurisdiction to determine what is an appropriate refund formula, it remanded the case to the BPU to further develop the record on why the BPU deemed the 2 1\/2 times formula to be appropriate in the Van Holten case.\nIn June 1991, the BPU issued an Order on Remand reaffirming the 2 1\/2 times annual revenue formula. Addressing the reasonableness of this formula, the BPU indicated in its decision that the 2 1\/2 times formula fairly allocates the costs of the main extensions among the developers, Elizabethtown and the rate payers. Again, developers appealed the Order on Remand to the Appellate Division, and in December 1992, the Appellate Division remanded the matter to the BPU for more complete findings and statements of reasons in support of its decision.\nBy Order on Remand dated January 19, 1994, the BPU again deemed the 2 1\/2 times formula to be appropriate in the Van Holten case. In addition to the previous rationale it gave for employing this formula in this case, the BPU indicated that on a per-customer basis, the initial cost of the extension was, in most instances, far higher than Elizabethtown's average cost of plant invested for existing customers at the time petitions were filed in 1984. Therefore, a full refund would clearly result in a significant subsidization of the developers by Elizabethtown's existing customers. The BPU concluded that such a subsidization would be unjust and unreasonable.\nOn February 23, 1994, the developers appealed the January 19, 1994 BPU Order on Remand to the Appellate Division. On February 1, 1995, the Appellate Division affirmed the BPU Remand dated January 19, 1994. On February 14, 1995, the developers appealed the decision to the New Jersey Supreme Court.\nThe maximum potential refund for the Van Holten case, and all subsequently filed cases, is approximately $2,500,000, which would be capitalized and, therefore, would not have a material adverse effect on earnings. Management believes the final outcome of this matter will be favorable and no additional refunds will be necessary.\n9. COMMITMENTS\nElizabethtown is obligated, under a contract that expires in 2013, to purchase from the NJWSA a minimum of 37 billion gallons of water annually. The Company purchases additional water from the NJWSA on an as-needed basis. Effective July 1, 1995, the annual cost under the contract will be $8,857,389. The total cost of water purchased from the NJWSA, including additional water purchased on an as-needed basis, was $8,987,472, $8,819,212 and $7,827,058 for 1994, 1993 and 1992, respectively.\nThe following is a schedule by years of future minimum rental payments required under noncancelable operating leases with terms in excess of one year at December 31, 1994: ---------------------- (Thousands of Dollars)\n1995 $ 886 1996 907 1997 869 1998 12 1999 0 ------ Total $2,674 ======\nRent expense totaled $829,562, $789,636 and $719,624 for 1994, 1993 and 1992, respectively.\nCapital expenditures through 1997 are estimated to be $169.4 million for Elizabethtown's and Mount Holly's utility plant.\nCanal Road Water Treatment Plant\nIn April 1994, following a competitive bidding process, Elizabethtown executed a lump-sum contract for the construction of the Canal Road Water Treatment Plant. The project is currently estimated to cost $100,000,000, excluding AFUDC. The Company has expended $38,393,301, excluding AFUDC of $2,018,698, as of December 31, 1994. Construction is expected to be completed in mid-1996.\n10. PENSION PLAN AND OTHER POSTRETIREMENT BENEFITS Elizabethtown has a trusteed, noncontributory Retirement Plan (Plan), which covers most employees. Under the Company's funding policy, the Company makes contributions that meet the minimum funding requirements of the Employee Retirement Income Security Act of 1974. The components of the net pension costs (credits) are as follows:\n1994 1993 1992 --------------------------- (Thousands of Dollars)\nService cost-benefits earned during the year ............................. $1,052 $ 899 $ 843 Interest cost on projected benefit obligation ........................... 1,946 1,973 1,836 Return on Plan assets ................. 939 (1,409) (970) Net amortization and deferral ......... (3,860) (1,658) (2,235) ------ ------ ------ Net pension costs (credits) ........... $ 77 $ (195) $ (526) ====== ====== ======\nPlan assets are invested in publicly traded debt and equity securities. The reconciliations of the funded status of the Plan to the amounts recognized in the Consolidated Balance Sheets are presented below:\n1994 1993 ---------------------- (Thousands of Dollars)\nMarket value of Plan assets ..................... $30,810 $33,032 ------- ------- Actuarial present value of Plan benefits: Vested benefits ............................... 20,776 20,708 Non-vested benefits ........................... 157 227 ------- ------- Accumulated benefit obligation ................ 20,933 20,935 Projected increases in compensation levels .... 5,642 6,541 ------- ------- Projected benefit obligation .................... 26,575 27,476 ------- ------- Excess of Plan assets over projected benefit obligation ..................................... 4,235 5,556 Unrecognized net gain ........................... (1,337) (2,403) Unrecognized prior service cost ................. 451 539 Unrecognized transition asset ................... (2,423) (2,689) ------- ------- Prepaid pension expense.......................... $ 926 $ 1,003 ======= =======\nThe assumed rates used in determining the actuarial present value of the projected benefit obligations were as follows: 1994 1993 ------------------\nDiscount rate ................................... 8.00% 7.00% Compensation increase ........................... 5.50% 5.50% Rate of return on Plan assets ................... 8.50% 8.50%\nElizabethtown and Mount Holly provide certain health care and life insurance benefits for substantially all of their retired employees.\nEffective January 1, 1993, Elizabethtown Water Company adopted SFAS 106. Under SFAS 106, the cost of postretirement benefits are accrued for each year the employee renders service, based on the expected cost of providing such benefits to the employee and the employee's beneficiaries and covered dependents rather than expensing these benefits on a pay-as-you-go basis for retired employees.\nBased upon an independent actuarial study, the transition obligation, calculated under SFAS 106, which Elizabethtown Water Company has not funded, was $7,214,736 as of January 1, 1993. The transition obligation is being amortized over 20 years. The following table details the unfunded postretirement benefit obligation at December 31, 1994 and 1993:\n1994 1993 ---------------------- (Thousands of Dollars)\nRetirees $2,457 $3,133 Fully eligible plan participants 5,080 5,403 ------ ------ Accumulated postretirement benefit obligation 7,537 8,536 Plan assets at fair value 0 0 Unrecognized net gain 1,033 (677) Unrecognized transition obligation (6,493) (6,854) ------ ------ Accrued postretirement benefit obligation $2,077 $1,005 ====== ======\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation as of De-cember 31, 1994, and for 1994, was 12%. This rate decreases linearly each successive year until it reaches 5% in 2003, after which the rate remains constant. The assumed discount rate used in determining the accumulated postretirement benefit obligation at December 31, 1994 and 1993 and for the years 1994 and 1993 was 8.0%, 7.0%, 7.0% and 8.5%, respectively. A single 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 net postretirement service and interest cost by approximately $2,280,000 and $138,000, respectively.\nBased upon the independent actuarial study referred to above, the annual postretirement cost calculated under SFAS 106 for 1994 and 1993 is as follows: 1994 1993 ---------------------- (Thousands of Dollars) Service cost - benefits earned during the year $ 369 $ 249 Interest cost on accumulated postretirement benefit obligation 592 602 Amortization of transition obligation 361 361 ------ ------ Total 1,322 1,212 Deferred amount for pending recovery (1,072) (1,005) ------ ------ Net postretirement benefit expense $ 250 $ 207 ====== ======\nThe rate increase for the 1995 Stipulation includes as an allowable expense the pay-as-you-go portion of postretirement benefits as well as the current service cost, and requires that the current service cost be funded. The 1995 Stipulation allows Elizabethtown to defer the amount accrued in excess of these amounts for consideration in future rate cases. Mount Holly currently has BPU approval to defer the amount accrued in excess of the pay-as-you-go portion of its expenses calculated under SFAS 106. Generally accepted accounting principles permit this regulatory treatment, provided deferrals are not accumulated for a period of more than five years. As of December 31, 1994, the amount that has been deferred is $2,077,051.\nRecovery of deferred postretirement costs will be requested in Elizabethtown's and Mount Holly's next base rate cases. Management believes that Elizabethtown and Mount Holly will recover the deferred postretirement costs in future rates.\n11. LEGAL MATTERS\nAs reported during 1994, a developer asserted in a suit filed in 1991 against Elizabethtown that the Company failed to install facilities necessary to provide water service to a new development in a timely manner. The developer further asserted that this delay took place during a period of generally declining real estate values, thereby allegedly preventing the developer from selling his lots at more favorable prices. The developer alleged that his economic losses from the decline in real estate values were $4,000,000.\nIn November 1994, the Company settled this matter by paying the developer $1,750,000. As part of the settlement, the developer agreed that part of this payment represented a refund of funds deposited under a main extension loan agreement for the construction of the facilities. In addition, the Company has applied a portion of the settlement against an insurance reserve. The effect on earnings is $932,203 or $605,932 net of federal income taxes. The Company will seek recovery from its insurance carriers.\nSeveral lawsuits have been filed against Elizabethtown and other parties in connection with a fire that occurred in a storage facility in December 1989 resulting in damage to property stored at that facility. The lawsuits allege that the water mains surrounding the industrial complex failed to provide an adequate flow of water necessary to fight the fire. The suits further allege that the Company was negligent in failing to ensure that sprinkler systems were operational prior to the fire, resulting in those sprinkler systems being without water at the time of the fire. Management cannot now predict the outcome of this litigation.\n12. RELATED PARTY TRANSACTIONS\nThe Company enters into various transactions with E'town and E'town Properties, Inc. Elizabethtown provides administrative and accounting services to these affiliates which are billed on a monthly basis; effective in 1994, Elizabethtown is billed for financial services by E'town.\nThe total of all intercompany billings was $426,944, $278,191 and $270,439 for 1994, 1993 and 1992, respectively. In addition, various expenditures are made to vendors which are common to the entities. Each entity absorbs its proportionate share of the costs.\n13. QUARTERLY FINANCIAL DATA (Unaudited)\nA summary of financial data for each quarter of 1994 and 1993 follows:\nIncome Before Earnings Operating Operating Preferred Applicable to Quarter Revenues Income Stock Dividends Common Stock ---------------------------------------------------------------- (Thousands of Dollars Except Per Share Amounts)\n1st $ 24,657 $ 5,579 $ 3,082 $ 2,832 2nd 25,208 5,945 3,484 3,281 3rd 27,370 6,976 4,093 3,890 4th 24,798 5,684 3,564 3,366 -------- ------- ------- ------- Total $102,033 $24,184 $14,223 $13,369 ======== ======= ======= =======\n1st $ 22,136 $ 5,465 $ 2,637 $ 2,374 2nd 24,865 6,715 3,916 3,654 3rd 28,947 8,169 5,527 5,264 4th 24,048 5,442 2,753 2,491 -------- ------- ------- ------- Total $ 99,996 $25,791 $14,833 $13,783 ======== ======= ======= =======\nWater utility revenues are subject to a seasonal fluctuation due to normal increased consumption during the third quarter of each year.","section_15":""}
{"filename":"18651_1994.txt","cik":"18651","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":"860192_1994.txt","cik":"860192","year":"1994","section_1":"ITEM 1. BUSINESS.\nBACKGROUND\nGeneva Steel Company (the \"Company\" or \"Geneva\") owns and operates the only integrated steel mill operating west of the Mississippi River. The Company's mill manufactures hot-rolled sheet, plate and pipe products for sale primarily in the western and central United States.\nThe steel mill is located 45 miles south of Salt Lake City, Utah on approximately 1,400 acres. The steel mill's facilities include four coke oven batteries, three blast furnaces, two Q-BOP furnaces, a continuous casting facility, a combination continuous rolling mill and various finishing facilities. The Company's coke ovens produce coke from a blend of various grades of metallurgical coal. Coke is used as the principal fuel for the Company's blast furnaces, which convert iron ore into liquid iron. The liquid iron is then blended with scrap metal and metallic alloys and further refined in the Q-BOP furnaces to produce liquid steel. With the completion of the continuous casting facility and related improvements, the liquid steel is now continuously cast into slabs. The Company intends to process the majority of its liquid steel through the caster facility, and in November 1994 more than 92% of the Company's steel slabs were processed through the caster. Alternatively, liquid steel can be poured into ingot molds, with the ingots being subsequently rolled into slabs. Steel slabs are either direct rolled or allowed to cool and then reheated prior to rolling. Slabs are rolled into hot-rolled steel products (sheet, plate and pipe) in the Company's rolling and finishing mills.\nThe Company acquired the steel mill and related facilities from USX Corporation (\"USX\") on August 31, 1987 at a price of approximately $44.1 million plus the assumption of certain liabilities. USX had operated the mill from 1944 until 1986, when it placed the mill on hot-idle status. Pursuant to the acquisition agreement between USX and the Company, USX retained liability for retiree life insurance, health care and pension benefits relating to employee service prior to the acquisition. USX also indemnified the Company for costs due to any environmental condition existing on the Company's real property as of the acquisition date that is determined to be in violation of environmental laws or otherwise results in the imposition of environmental liability, subject to the Company's sharing the first $20 million of certain clean-up costs on an equal basis. See \"-- Environmental Matters.\" Since the Company began operations, its strategy has been to be a low-cost producer and to optimize its product quality and mix.\nCAPITAL PROJECTS\nOverview\nIn February 1990, the Company announced a major modernization program intended to strengthen its competitive position. The modernization program was undertaken to reduce operating costs, broaden the Company's product line, improve product quality and increase throughput capacity of finished flat-rolled steel products from approximately 1.4 to 1.9 million tons per year. The modernization program provides for improvements principally to the Company's steelmaking, casting, rolling and finishing facilities. Management believes that the modernization program has enabled the Company to produce the widest continuously cast steel slabs in the world and is positioning the Company for additional market penetration, particularly with respect to plate products.\nThe Company has spent approximately $67 million, $83 million and $165 million on capital projects during the fiscal years ended September 30, 1992, 1993 and 1994, respectively. These expenditures were made primarily in connection with the Company's ongoing modernization efforts. Management believes that the modernization projects completed to date have resulted in certain reduced production costs, increased throughput capacity and improved product quality and yield. However, production inefficiencies and other transition costs associated with completion and implementation of various capital projects had a negative impact on the Company's operations during fiscal year 1994. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe Company's capital projects, including its modernization efforts, are planned from the outset to be flexible and are managed accordingly. The Company revises its capital projects from time to time in response to various technological, financial, market and other operating considerations.\nModernization Projects\nSince announcing the modernization program, the Company has (i) completed a new continuous casting facility and related improvements, (ii) installed two Q-BOP furnaces, (iii) completed a direct rolling and large coil project, including installation of a coilbox and an in-line steel slab conditioning or \"scarfing\" facility, (iv) installed various environmental projects, including a biological wastewater treatment facility, benzene mitigation equipment, coke oven gas desulfurization facility and other projects, (v) completed the first phase of the wide plate coiler project, and (vi) completed various other projects, including the conversion of the Company's broadside mill to a re-powered and upgraded reversing mill. The following discussion highlights the major components of projects that were completed during fiscal year 1994 or which remain to be completed.\nContinuous Casting Facility and Related Improvements. The Company completed construction of its continuous caster in April 1994. The continuous casting facility substantially replaces the Company's ingot mold operations. The caster project includes a ladle metallurgy furnace, which allows the Company to control more precisely the temperature and metallurgy of its liquid steel. The Company has situated its caster and related improvements to feed slabs directly into its rolling mill to minimize the cost of handling and reheating slabs. The Company believes that the continuous caster and related improvements have improved the mill's finished product yield, reduced certain production costs, increased throughput capacity and improved the metallurgical and surface quality of its products. The Company is nearing completion of the start-up period of the project and the second phase of the wide plate coiler project described below. Upon completion of these projects, the Company expects to achieve a 1.9 million ton annual production rate, realize additional operating cost savings, increase its percentage of plate products sold and realize other operational benefits.\nWide Plate Coiler and Related Plate Processing Facilities. The wide coiled plate project will allow the Company to produce plate in coil form up to 126 inches in width and 1 inch in thickness. The wide coils can either be shipped directly to customers or uncoiled, sheared and leveled on the Company's new cut-to-length line. Geneva has divided the project into two phases, the first of which allows Geneva to coil plate up to 96 inches in width and to uncoil, shear and level plate up to 126 inches wide. Geneva began rolling wide coiled plate in July 1994. In connection with completion of the first phase, the Company also converted its broadside mill to a reversing mill as described above. The second phase of the project includes improvements designed to coil plate up to 126 inches in width and 1 inch in thickness. This phase is currently expected to be completed in early calendar year 1995. The Company believes that the capability to produce and process wide plate in coil form will be a significant competitive advantage.\nRolling Mill Finishing Stand Improvements. The Company has a six-stand 132-inch combination continuous rolling mill, the widest of its type in the world, which gives the Company the flexibility to alter its mix of sheet and plate products in response to customer demands and changing market conditions. The final phase of the rolling mill modernization includes hydraulic gauge control, roll bending and automatic roll change. These improvements are designed to enhance the shape and gauge of the Company's products and to increase throughput capacity. In light of favorable steel market conditions and the Company's improved competitive position resulting from the continuous caster and other modernization projects, the Company has elected to defer completion of the finishing stand improvements. The Company currently anticipates completing the improvements in the Spring of 1996.\nAdditional Capital Projects\nAdditional Slab Heating Capacity. As part of its modernization efforts, the Company modified its soaking pit furnaces to hold hot slabs taken from the continuous caster and increase the temperature of the slabs in preparation for rolling. As the continuous caster and other related capital projects were implemented, the Company encountered difficulties in achieving sufficient heating capacity from the soaking pits. Consequently, the Company is using both the soaking pits and its existing reheat furnaces to heat slabs. Utilization of both facilities has\nprevented the Company from realizing approximately $8 to $10 per ton of the estimated operating cost savings previously associated with the Company's modernization program. The Company is, therefore, investigating various facilities designed to increase its slab heating capacity and achieve the estimated operating cost savings. The Company's preliminary cost estimate for the additional slab heating capacity is approximately $30 million.\nIronmaking Facility. The Company has recently commenced construction of a plasma-fired cupola ironmaking facility. The cupola functions similar to a blast furnace although it utilizes only a fraction of the coke required by the blast furnace to produce liquid iron. The cupola can utilize scrap steel, directly reduced iron or other metallic inputs. The cupola utilizes electric plasma technology as a secondary fuel source to further reduce coke requirements and substantially increase throughput. The technology represents a means of meeting short-term ironmaking needs while providing a broader flexibility of inputs and decreasing coke requirements. The cupola was originally constructed by a steel company in Texas, but was never operated. Geneva purchased the cupola and is in the process of having the facility dismantled and shipped to the Company's mill. The estimated cost of the cupola is approximately $29 million.\nDevelopment Venture\nThe Company, together with Air Products and Chemicals, Inc. and Centerior Energy Corporation, has jointly agreed to pursue a unique project at Geneva intended to demonstrate the commercial viability of an energy efficient, environmentally sound process for producing hot metal and electricity. This project, known as Clean Power from Integrated Coal\/Ore Reduction (CPICOR(TM)), was selected under the United States Department of Energy's Clean Coal Technology Demonstration Program. The project includes construction and operation of a 3,000 ton per day COREX(R) cokeless ironmaking unit. Potential advantages of the project for the Company include additional ironmaking capacity, decreased dependence on coke, increased energy production and various environmental benefits. The project, which includes up to $150 million in cost share funding from the Department of Energy, is not anticipated to startup until 1999 and is still subject to a number of contingencies.\nProject Management\nThe Company's capital projects are under continuous review, and it is possible that the Company may in the future elect to make further changes in the design and timing of, and amounts budgeted for, its capital projects and improvements. Geneva plans to manage the construction and completion of the modernization and additional capital projects as justified by future operating results, availability of funds, market conditions and other factors.\nThere can be no assurance that the projected benefits of the modernization and other capital projects will be fully achieved, sufficient product demand will exist for the Company's additional throughput capacity, or recent declines in production interruptions and other transition costs will continue, or the planned capital projects can be completed in a timely manner or for the amounts budgeted. The Company anticipates that, in any event, it may incur significant start-up and transition costs as planned capital projects are implemented. Notwithstanding completion of the modernization program and other capital projects discussed above, management believes that the Company will continue to require future improvements and additional capital projects that are critical to the Company's long-term ability to compete and that will require substantial capital expenditures.\nPRODUCTS\nThe Company's principal product lines are hot-rolled sheet, plate and pipe products. The Company also sells semi-finished slabs from time to time, as well as non-steel materials that are by-products of its steelmaking operations.\nThe Company has a 132-inch combination continuous rolling mill, the widest of its type in the world, which gives the Company the flexibility to alter its mix of sheet and plate products in response to customer demands and changing market conditions and the opportunity to maximize utilization of the facilities. Generally, the Company manufactures products in response to specific customer orders. During fiscal year 1994, the Company increased its percentage of sheet products sold. This shift was due primarily to the Company's suspension of certain plate\nproduction while upgrades to various processing equipment were being implemented and to favorable pricing associated with sheet products. Product mix shifts are also determined by Geneva's product mix optimization efforts. These efforts generally allow Geneva to focus on products with the highest margin contribution based on throughput efficiency. The Company's product sales mix for fiscal years 1990 through 1994 is shown below:\nSheet. The mill produces hot-rolled sheet steel which is sold in sheet or coil form in thicknesses of .06 to .230 of an inch and widths of 40 to 74 inches. Maximum widths vary according to thickness. Included in the sheet products made by the Company are cut length sheet, hot-rolled bands and tempered coil. Sheet is used in a variety of applications such as storage tanks, light structural components and supports, and welded tubing.\nPlate. The Company's plate products consist of hot rolled carbon and high-strength low alloy steel plate in coil form, cut to length and flat rolled in widths varying from 48 to 126 inches and in thicknesses varying from .1875 of an inch to 3 inches. The Company produces both strip mill plate and flat plate. Plate can be used for heavy steel structures such as storage tanks, railroad cars, ships and bridges.\nPipe. The Company produces electric resistance welded pipe (\"ERW pipe\") ranging from approximately 7 to 16 inches in diameter. ERW pipe is manufactured by heating and fusing the edges of the steel to form the pipe. The Company's ERW pipe is used primarily in pipelines, including water, natural gas and oil transmission and distribution systems, and in standard and structural pipe applications.\nSlabs and Non-Steel. The Company occasionally sells steel slabs when excess capacity is available and market conditions are favorable. The Company also sells products produced by its foundry operation and various by-products resulting from its steelmaking activities.\nMARKETING; PRINCIPAL CUSTOMERS\nThe Company sells its sheet and plate products primarily to steel service centers and distributors, which in recent years have become one of the largest customer groups in the domestic steel industry. Service centers and distributors accounted for approximately 80% of the Company's sales in fiscal 1994. The Company also sells its products to steel processors and various end-users, including manufacturers of welded tubing, highway guardrail, storage tanks, railcars, ships and agricultural and industrial equipment. The Company believes that sales of its products, either directly or through service centers or distributors, to automotive or appliance manufacturers have been immaterial. The Company has developed a broad customer base. In fiscal year 1994, the Company sold its products domestically to approximately 230 customers in 41 states and abroad through exporters to several customers in Canada and Mexico.\nThe Company sells its ERW pipe to end-users and through distributors primarily in the western and central United States where demand for pipe fluctuates in partial response to oil and gas industry cycles. The Company also sells products in the export market. Export sales, which generally have lower margins than domestic sales, accounted for approximately 5.9%, 1.9% and 0.3% of the Company's net sales during fiscal years 1992, 1993 and 1994, respectively. Export sales have decreased as a result of the Company's involvement in certain trade cases in Canada and Mexico and improved domestic market conditions.\nThe Company's principal direct marketing efforts are in the western and central United States. Five sales representatives are employed in the western market, two of whom are located in the greater Los Angeles area, the\nlargest single market for steel in the western United States. Based on industry information and the Company's own estimates, the Company believes that it sells a significant portion of the hot-rolled sheet and plate purchased in the eleven western states.\nIn the central United States, the Company currently has a small share of the market. Management believes, however, that there are attractive opportunities for revenue growth in this market. Substantially all of Geneva's sales in the central United States are made through a sales arrangement with Mannesmann Pipe and Steel Corporation (\"Mannesmann\"), the United States steel marketing subsidiary of Mannesmann A.G., a major German industrial company. The sales arrangement entitles Mannesmann to sell the Company's products in 15 central states and to certain of the Company's customers in the eastern United States, and to receive a variable commission on its sales. Mannesmann has an exclusive right to sell the Company's products in these areas, except that the Company is entitled to make direct sales subject to a commission payable to Mannesmann on certain sales. Within the 15 central states mentioned above, Mannesmann is prohibited from selling products that compete with the Company's products. The payment terms provide that Mannesmann make a production prepayment of up to $10 million. The Company is currently considering amending its agreement with Mannesmann to increase the amount of the production prepayment to $20 million. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\" The prepayment is recorded as a production prepayment until the product is shipped, at which time the sale is recorded. The arrangement may be terminated upon six month's notice by either Mannesmann or the Company in December 1995 and at three-year intervals thereafter. Mannesmann accounted for approximately 41% and 42% of the Company's net sales in fiscal years 1993 and 1994, respectively. Any termination or disruption of the Company's arrangements with Mannesmann could have a material adverse effect on the Company's results of operations and financial condition.\nThe Company's strategy is to maintain its core market in the western United States, where its market position is the strongest, and to increase growth in the midwest and eastern regions, while focusing on profit maximization. The Company believes that service centers and distributors account for a substantially larger proportion of its sales than of sales for the industry as a whole. In addition, demand from this customer group historically has experienced wide fluctuations due to substantial changes in the group's inventory levels. In view of these factors, the Company intends to develop a more diverse customer base, including steel processors and various end-users, while retaining strong relationships with service center and distributor customers. The Company expects its modernization efforts to play a critical role in the implementation of these strategies by enabling the Company to provide higher quality products and to gain access to a wider range of customers than previously permitted.\nThe Company generally produces steel in response to specific orders. As of November 30, 1994, the Company had estimated total orders on hand for approximately 257,000 tons compared to approximately 307,000 tons as of November 30, 1993. The Company does not believe that its orders on hand are necessarily indicative of future operating results.\nEMPLOYEES; LABOR AGREEMENT\nThe Company has a workforce of approximately 2,680 full-time employees, of whom approximately 540 are salaried and approximately 2,140 are hourly. The Company's 194 operating management personnel generally have had considerable experience in the steel industry. Almost half have more than 20 years of industry experience, with most of the remaining managers ranging in experience from 10 to 20 years. The Company's senior operating managers have an average of over 25 years of industry experience.\nSubstantially all of the Company's hourly employees are represented by the United Steelworkers of America under a collective bargaining agreement that expires in February 1995. The Company believes that its labor agreement is an important competitive advantage. Although the Company's wage rates under the agreement are high by local standards and comparable to regional competitors, its total hourly labor costs are substantially below recent industry averages compiled by the American Iron and Steel Institute. Unlike labor agreements negotiated by many other domestic integrated steel producers, the Company's labor agreement does not contain traditional work rules, limits the Company's financial pension obligations to a defined contribution plan, entitles the Company to reduce its profit sharing obligations by an amount equal to a portion of its capital expenditures, and does not require\nthe Company to pay any retiree medical expenses. The Company did not assume any pension obligations or retiree medical obligations related to workers' service while the plant was owned by USX.\nThe Company's labor agreement also contains a performance dividend plan designed to reward employees for increased shipments of steel products. Compensation under the plan includes a monthly guarantee of $.33 per hour for all represented workers. The guaranteed payment is based on an annualized shipment rate of 1.5 million tons. As shipments increase above this level, compensation under the plan also increases.\nGeneva has also implemented a performance dividend plan for all non-union employees that provides additional compensation as shipment levels increase. Unlike the union plan, however, there are no guaranteed payments.\nThe Company's profit sharing obligations under the labor agreement are based on earnings before taxes, extraordinary items and profit sharing. Unlike the profit sharing arrangements of many major domestic integrated steel producers, the Company's profit sharing obligations are reduced by an amount equal to a portion of its capital expenditures. The Company is required to contribute each year to the profit sharing pool 10% of earnings before taxes, extraordinary items and profit sharing after deducting 25% of the first $50 million of capital expenditures and 30% of all additional capital expenditures in such year (including, in each case, capital maintenance). All payments made to workers under the union performance dividend plan are deducted from any profit sharing obligations otherwise required.\nGiven the expiration of the labor agreement in February 1995, the Company will commence negotiations with the United Steelworkers of America in the near-term. There can be no assurance regarding the effect of future labor negotiations or the outcome thereof.\nRAW MATERIALS AND RELATED SERVICES\nThe Company is strategically located near major deposits of several of the principal raw materials used to make steel, including iron ore, high volatile coal, limestone and natural gas. The Company believes that, in certain instances, this proximity, together with the Company's importance as a customer to suppliers of these materials, enhances its ability to obtain competitive terms for these raw materials. As the Company evaluates emerging technologies for the production of iron and steel, it intends to focus on those technologies that allow increased utilization of resources available in the western United States.\nIron Ore. The Company's steelmaking process can use both iron ore and iron ore pellets. In recent years, the Company has used a higher percentage of iron ore pellets in an effort to maximize operating efficiencies of its blast furnaces in response to increased production needs. Iron ore pellets are generally purchased from USX as discussed below and also purchased in the spot market. As the Company increases production levels, it may continue to use a higher percentage of iron ore pellets. The Company obtains its iron ore from deposits at mines in Utah. The ore is mined by an independent contractor under claims owned by the Company and transported by railroad to the steel mill. The Company expects future costs of recovery of this ore to increase gradually as the reserves are depleted.\nThe Company has historically purchased iron ore pellets from USX pursuant to a contract that expired in August 1994 under which USX was obligated to supply, and the Company was obligated to purchase, 58% of the Company's iron unit requirements. The Company believes USX agreed to a new contract that includes higher pellet prices; nevertheless, USX has recently attempted to reopen contract negotiations in an effort to obtain even more favorable pricing terms. The Company is currently attempting to resolve the matter with USX.\nCoal and Coke. The coke batteries operated by the Company require a blend of various grades of metallurgical coal. The Company currently obtains high volatile coal from a mine in western Colorado owned by Pacific Basin Resources under a contract that expires in March 1997. The Company also purchases various grades of coal under short-term contracts from sources in the eastern United States. Although the Company\nbelieves that such coal is available from several alternative eastern suppliers, the Company is subject to price volatility resulting from fluctuations in the spot market. In the future, the Company may purchase eastern coal under longer-term contracts. There can be no assurance that the Company's blend of coal will not change or that its overall cost of coal will not increase.\nThe Company is currently purchasing coke as a result of its increasing steel production and decreasing capacity to produce its own coke. The ability of other domestic integrated steel mills to produce coke is also decreasing, thereby increasing the demand for purchased coke in the United States. The Company purchases coke from sources in Japan and China pursuant to two separate agreements. As the Company's consumption of purchased coke increases, the Company's average cost of coke used in the manufacturing process will be higher.\nEnergy. The Company's steel operations consume large amounts of oxygen, electricity and natural gas. The Company purchases oxygen under a contract with Big Three Industries, Inc. expiring in calendar year 1998. The oxygen is delivered from an air separation plant located on the Company's premises but owned by the supplier. In July 1990, the Company entered into an agreement with Praxair, Inc. (\"Praxair\") to construct, own and operate a facility (the \"Oxygen Facility\") at the steel mill for the production, compression, storage and vaporization of additional oxygen, as well as nitrogen and argon. The contract expires in 2006 and specifies that the cost associated with the construction and operation of the Oxygen Facility be borne by Praxair. The Company is required to pay a monthly charge for the right to receive 100% of the production of the Oxygen Facility. Management anticipates that additional oxygen capacity will be necessary as a result of the Company's efforts to increase production levels.\nThe Company generates a substantial portion of its electrical requirements using a 50 megawatt rated generator located at the steel mill and currently purchases the remainder of its electrical requirements from Utah Power & Light Company (\"UP&L\") under a 90 megawatt interruptible power contract expiring in 1999. The contract provides for price increases tied to the cost of energy used by the utility to produce electricity. The Company has also entered into a firm power contract expiring in 1999 with UP&L under which the Company is entitled to purchase additional electrical needs. The firm contract provides for energy charges and price increases similar to the interruptible contract but also includes a significantly higher capacity charge.\nNatural gas is purchased at the wellhead in the Rocky Mountain region and is transported to the steel mill by pipeline. The Rocky Mountain region has substantial deposits of natural gas.\nOther. The Company's mill is served by both the Southern Pacific Transportation Company and the Union Pacific Railroad Company. The Company believes that it is one of the largest western customers of each railroad. The Company's location in the western United States facilitates backhauling, which reduces freight costs. The Company has negotiated various reductions in its transportation rates. The Company also owns mining claims in a limestone quarry located approximately 30 miles from the Company's plant. The limestone is mined by the Company and transported by railroad to the mill.\nThe Company uses scrap metal obtained from its own operations and external sources in its steelmaking process. As the Company increases its production volume, improves yield or implements additional ironmaking processes, such as the plasma-fired cupola, that utilize scrap, management anticipates that increased amounts of scrap will be purchased.\nThe cost of the Company's raw materials, including energy, has been susceptible in the past to fluctuations in price and availability and is expected to increase over time. Worldwide competition in the steel industry has frequently limited the ability of steel producers to raise finished product prices to recover higher raw material costs. The Company's future profitability will be adversely affected to the extent it is unable to pass on higher raw material costs to its customers.\nCOMPETITION AND OTHER MARKET FACTORS\nThe Company competes with domestic and foreign steel producers on the basis of price, quality and service. Many of the Company's competitors are larger, have greater capital resources, more modern technology and larger sales organizations than the Company. Intense worldwide sales competition exists for all the Company's products. Both the industry and the Company face increasing competition from producers of certain materials such as aluminum, composites, plastics and concrete which compete with steel in many markets.\nThe Company believes that certain of its raw material arrangements, particularly with respect to energy, and its current labor contract are favorable in relation to those of the domestic steel industry as a whole. The Company believes that its geographic location enhances its ability to compete in the western United States. Although product quality has improved significantly as a result of the continuous caster and other capital improvements, the Company is presently at a competitive disadvantage with respect to certain product quality factors, particularly with respect to sheet products. The Company believes, however, that its ongoing modernization efforts will continue to enhance the competitiveness of its products. Nevertheless, standards of quality in the steel industry are rising as buyers continually expect higher quality products. Foreign and domestic producers continue to invest heavily to achieve increased production efficiencies and product quality.\nThe steel industry is cyclical in nature and highly competitive. Moreover, overall throughput capacity and competition are increasing due primarily to construction of mini-mills and improvements in production efficiencies. The Company, like other steel producers, is highly sensitive to price and production volume changes. Consequently, any downward movement could have an adverse effect on the Company given its high fixed costs of operations.\nForeign competition is a significant factor in the steel industry and has adversely affected product prices in the United States and tonnage sold by domestic producers. The intensity of foreign competition is substantially affected by fluctuations in the value of the United States dollar against several other currencies. Despite a substantial decline in the value of the United States dollar relative to certain foreign currencies, steel imports have recently increased significantly due to the strength of the United States economy, higher domestic prices for steel products and other factors. Although foreign economies and currency exchange rates are subject to substantial fluctuations, there can be no assurance that this condition will not continue. In addition, many foreign steel producers are controlled or subsidized by foreign governments whose decisions concerning production and exports may be influenced in part by political and social policy considerations as well as by prevailing market conditions and profit opportunities. Existing trade laws and regulations may be inadequate to prevent unfair trade practices whereby imports could pose increasing problems for the domestic steel industry and the Company.\nIn June 1992, the Company joined with other domestic steel producers in filing cases with the United States Department of Commerce and International Trade Commission (the \"ITC\") alleging that producers in certain foreign countries had engaged in unlawful subsidization and dumping practices. In July 1993, the ITC issued final injury determinations in the flat-rolled steel cases. As a result, anti-dumping and countervailing duties are now collected on all imports covered by the affirmative ITC determinations, including cut-to-length plate, a product produced by the Company. The domestic producers and many of the foreign producers appealed the ITC determinations. The appeal of the Canadian producers was heard by the NAFTA Binational Panel which issued its opinion and order on October 31, 1994. The order does not appear to require any material change to the existing duties applicable to the cut- to-length plate products of such Canadian producers. If the remaining appeals result in a significant reduction or complete lifting of existing duties, it could have an adverse effect on prevailing prices for the Company's cut-to-length plate products.\nDuring the past three years, steel producers in Canada and Mexico have filed trade cases in their respective countries against domestic steel producers, including the Company. The Canadian cases have been concluded and the Mexican cases are at various stages of resolution. Because the Company's exports into these countries have been immaterial over the past two years, these cases have not had a material effect on the Company.\nIntegrated steel producers are facing increasing competitive pressures from mini-mills. Mini-mills are generally smaller volume steel producers which use ferrous scrap metal as their basic raw material and serve\nregional markets. These operations generally produce lower margin, commodity type steel goods such as bars, rods and structural products. A number of mini-mills also produce plate and pipe products that compete directly with the Company's products. In addition, three mini-mills have announced intentions to construct facilities that will produce wide plate in coil form, thereby potentially competing with products produced by the Company. Recently developed thin slab\/direct rolling techniques have allowed mini-mills to produce the types of sheet products that have traditionally been supplied by integrated producers. Two mini-mills located in the midwestern United States produce these types of sheet products. Moreover, several competitors have announced or expressed an intention to construct new sheet product facilities that, if constructed, are expected to significantly increase domestic steel production and thereby further increase competition.\nENVIRONMENTAL MATTERS\nCompliance with environmental laws and regulations is a significant factor in the Company's business. The Company is subject to federal, state and local environmental laws and regulations concerning, among other things, air emissions, wastewater discharge, and solid and hazardous waste disposal. The Company believes that it is in compliance in all material respects with all currently applicable environmental regulations.\nThe Company has incurred substantial capital expenditures for environmental control facilities, including the Q-BOP furnaces, the wastewater treatment facility, the benzene mitigation equipment, the coke oven gas desulfurization facility and other projects. The Company has budgeted a total of approximately $2.2 million for environmental capital improvements in fiscal years 1995 and 1996. Such improvements include potential upgrades to the Company's coking operation ($2.0 million) and a wastewater diffuser system ($0.2 million). Environmental legislation and regulations have changed rapidly in recent years and it is likely that the Company will be subject to increasingly stringent environmental standards in the future. Although the Company has budgeted capital expenditures for environmental matters, it is not possible at this time to predict the amount of capital expenditures that may ultimately be required to comply with all environmental laws and regulations.\nUnder the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), the U.S. Environmental Protection Agency and the states have authority to impose liability on waste generators, site owners and operators and others regardless of fault or the legality of the original disposal activity. Other environmental laws and regulations may also impose liability on the Company for conditions existing prior to the Company's acquisition of the steel mill.\nAt the time of the Company's acquisition of the steel mill, the Company and USX identified certain hazardous and solid waste sites and other environmental conditions which existed prior to the acquisition. USX has agreed to indemnify the Company (subject to the sharing arrangements described below) for any fines, penalties, costs (including costs of clean-up, required studies, and reasonable attorneys' fees), or other liabilities for which the Company becomes liable due to any environmental condition existing on the Company's real property as of the acquisition date that is determined to be in violation of any environmental law, is otherwise required by applicable judicial or administrative action, or is determined to trigger civil liability (the \"Pre-existing Environmental Liabilities\"). The Company has provided a similar indemnity (but without any similar sharing arrangement) to USX for conditions that may arise after the acquisition. Although the Company has not completed a comprehensive analysis of the extent of the Pre-existing Environmental Liabilities, such liabilities could be material.\nUnder the acquisition agreement between the two parties, the Company and USX agreed to share on an equal basis the first $20 million of costs incurred by either party to satisfy any government demand for studies, closure, monitoring, or remediation at specified waste sites or facilities or for other claims under CERCLA or the Resource Conservation and Recovery Act. The Company is not obligated to contribute more than $10 million for the clean-up of wastes generated prior to the acquisition. The Company believes that it has paid the full $10 million necessary to satisfy its obligations under the cost-sharing arrangement. USX has recently advised the Company, however, of its position that a portion of the amount paid by the Company may not be properly credited against Geneva's obligations. Although the Company believes that USX's position is without merit, there can be no assurance that this matter will be resolved without litigation. Moreover, the Company's ability to obtain indemnification from USX in the future will depend on factors which may be beyond the Company's control and may also be subject to dispute.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's principal properties consist of the approximately 1,400-acre site on which the steel mill and related facilities are located, the Company's iron ore mines in southern Utah and the limestone quarry near the steel mill. The Company also leases from the State of Utah, under a lease expiring in 2016, a 300-acre site which includes a retention pond. The retention pond is a significant part of the Company's water pollution control facilities. Although the Company's facilities are generally suitable to its needs, the Company believes that such facilities will continue to require future improvements and additional modernization projects in order to remain competitive. See Item 1. \"Business--Capital Projects\" and \"--Competition and Other Market Factors.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIn addition to the matters described under Item 1. \"Business--Competition and Other Market Factors,\" the Company is a party to routine legal proceedings incident to its business. In the opinion of management, none of the proceedings to which the Company is currently a party are expected to have a material adverse effect on the Company's business 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 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 STOCKHOLDER MATTERS.\nThe Company's Class A Common Stock is listed and traded on the New York Stock Exchange (\"NYSE\") and the Pacific Stock Exchange under the symbol \"GNV.\" The following table sets forth, for the periods indicated, the high and low sales prices for the Class A Common Stock as reported on the NYSE Composite Tape.\nAs of November 30, 1994, the Company had 13,113,488 shares of Class A Common Stock outstanding, held by 587 stockholders of record, and 20,639,688 shares of Class B Common Stock outstanding, held by five stockholders of record. Shares of Class B Common Stock are convertible into shares of Class A Common Stock at the rate of ten shares of Class B Common Stock for one share of Class A Common Stock. There is no public market for the Class B Common Stock.\nThe Company currently anticipates that it will retain all available funds to finance its capital expenditures and other business activities, and it does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. In addition, the Company's revolving credit facility and senior notes restrict the amount of dividends that the Company may pay. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\" and Note 2 of Notes to Financial Statements included in this Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by this Item is incorporated by reference to page 15 of the Company's Annual Report to Shareholders for the fiscal year ended September 30, 1994.\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 16 through 21 of the Company's Annual Report to Shareholders for the fiscal year ended September 30, 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 pages 22 through 36 of the Company's Annual Report to Shareholders for the fiscal year ended September 30, 1994.\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 the sections entitled \"Election of Directors -- Nominees for Election as Directors\" and \"Executive Officers\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on March 28, 1995. The definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after September 30, 1994, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this Item is incorporated by reference to the sections entitled \"Election of Directors -- Director Compensation\" and \"Executive Compensation\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on March 28, 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 section entitled \"Principal Holders of Voting Securities\" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on March 28, 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) Documents Filed:\n1. Financial Statements. The following Financial Statements of the Company and Report of Independent Public Accountants included in the Company's Annual Report to Shareholders for the fiscal year ended September 30, 1994 are incorporated by reference in Item 8 of this Report:\n- Report of Independent Public Accountants\n- Balance Sheets at September 30, 1994 and 1993\n- Statements of Operations for the years ended September 30, 1994, 1993 and 1992\n- Statements of Stockholders' Equity for the years ended September 30, 1994, 1993 and 1992\n- Statements of Cash Flows for the years ended September 30, 1994, 1993 and 1992\n- Notes to Financial Statements\n2. Financial Statement Schedules. The following Financial Statement Schedules of the Company for the years ended September 30, 1994, 1993 and 1992 are filed as part of this Report and should be read in conjunction with the Company's Financial Statements and Notes thereto:\nFinancial statements and schedules 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, or contained in this Report.\n(b) Reports on Form 8-K\nNone.\n(c) Exhibits\n------------- * Management contract or compensatory plan or arrangement.\n(1) Incorporated by reference to the Registration Statement on Form S-1 dated March 27, 1990, File No. 33-33319.\n(2) Incorporated by reference to the Registration Statement on Form S-3 dated June 16, 1993, File No. 33-64548.\n(3) Incorporated by reference to the Registration Statement on Form S-4 dated April 15, 1993, File No. 33-61072.\n(4) Incorporated by reference to the Registration Statement on Form S-4 dated August 9, 1993, File No. 33-61072.\n(5) Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended September 30, 1991.\n(6) Incorporated by reference to the Current Report on Form 8-K dated May 22, 1992.\n(7) Incorporated by reference to the Registration Statement on Form S-1 dated November 5, 1990, File No. 33-37238.\n(8) Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended September 30, 1992.\n(9) Incorporated by reference to the Current Report on Form 8-K dated December 2, 1993.\n(10) Incorporated by reference to the Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 1993.\n(11) Incorporated by reference to the Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994.\n(12) Incorporated by reference to the Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1994.\n(d) Financial Statement Schedules See pages 18 through 23 herein.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Geneva Steel Company:\nWe have audited in accordance with generally accepted auditing standards, the financial statements incorporated by reference in Item 8 of this Form 10-K, and have issued our report thereon dated October 28, 1994 (except with respect to the matters discussed in Note 2 and Note 9 as to which the date is November 30, 1994). Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The 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\nSalt Lake City, Utah October 28, 1994\nGENEVA STEEL COMPANY\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (Dollars in Thousands)\nGENEVA STEEL COMPANY\nSCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (Dollars in Thousands)\nGENEVA STEEL COMPANY\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (Dollars in Thousands)\nGENEVA STEEL COMPANY\nSCHEDULE IX - SHORT-TERM BORROWINGS FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (Dollars in Thousands)\nAmounts payable to a syndicate of banks for borrowings represent obligations under a revolving credit facility.\n______________________ (1) Average amount outstanding during the year has been calculated by averaging the month end outstanding balances.\n(2) Weighted average interest rate has been calculated based on the average monthly interest rate charged on daily outstanding balances.\nGENEVA STEEL COMPANY\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (Dollars in Thousands)\nOther information required by Rule 12-11 has been omitted because the item did not exceed 1% of net sales as presented in the Company's financial statements and accompanying notes included 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, on December 28, 1994.\nGENEVA STEEL COMPANY\nBy: Joseph A. Cannon __________________________ Joseph A. Cannon, Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nEXHIBIT INDEX\n------------- * Management contract or compensatory plan or arrangement.\n(1) Incorporated by reference to the Registration Statement on Form S-1 dated March 27, 1990, File No. 33-33319.\n(2) Incorporated by reference to the Registration Statement on Form S-3 dated June 16, 1993, File No. 33-64548.\n(3) Incorporated by reference to the Registration Statement on Form S-4 dated April 15, 1993, File No. 33-61072.\n(4) Incorporated by reference to the Registration Statement on Form S-4 dated August 9, 1993, File No. 33-61072.\n(5) Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended September 30, 1991.\n(6) Incorporated by reference to the Current Report on Form 8-K dated May 22, 1992.\n(7) Incorporated by reference to the Registration Statement on Form S-1 dated November 5, 1990, File No. 33-37238.\n(8) Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended September 30, 1992.\n(9) Incorporated by reference to the Current Report on Form 8-K dated December 2, 1993.\n(10) Incorporated by reference to the Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 1993.\n(11) Incorporated by reference to the Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994.\n(12) Incorporated by reference to the Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 1994.","section_15":""}
{"filename":"29915_1994.txt","cik":"29915","year":"1994","section_1":"ITEM 1. BUSINESS THE COMPANY\nThe Dow Chemical Company was incorporated in 1947 under Delaware law and is the successor to a Michigan corporation, of the same name, organized in 1897. The Company is engaged in the manufacture and sale of chemicals, plastic materials, pharmaceuticals, agricultural and consumer products and other specialized products. Its principal executive offices are located at 2030 Dow Center, Midland, Michigan 48674, telephone 517-636-1000. Except as otherwise indicated by the context, the terms \"Company\" or \"Dow\" as used herein mean The Dow Chemical Company and its consolidated subsidiaries.\nBUSINESS AND PRODUCTS\nProducts and Services Dow was organized in 1897 to extract chemicals from the native brine deposits of central Michigan. From an initial concentration on products derived from these chemicals, the Company has expanded its activities into four industry segments. Aggregation of products is generally made on the basis of process technology, end-use markets and channels of distribution. Key products and services include:\nChemicals and Performance Products Dow's wide range of products are used primarily as raw materials in the manufacture of customer products, or they aid in the processing of customer products and services. Industries served include adhesives, aerosols, aerospace, automotive, chemical processing, metalworking, oil and gas, pulp and paper, personal care, pharmaceuticals, processed foods, utilities and water treatment. Chemicals and Metals: Acetone, alkanolamines, caustic soda, chlorinated solvents, chlorine, ethyleneamines, ethylene dichloride, ethylene glycols, glycerine, hydrochloric acid, hydrogen chloride, magnesium metal, methyl chloride, phenol, propylene glycols, propylene oxide and vinyl chloride monomer. Performance Products: Acetylsalicylic acid (aspirin), acrylamide monomer, air separation and gas treating products and services, antimicrobials, aqueous and semi-aqueous cleaners, brake fluids, compressor lubricants, Dowanol glycol ethers, Dowex ion exchange resins, Dowfax surfactants; Dowfrost, Dowtherm and Syltherm heat transfer fluids; Drytech superabsorbents, FilmTec membranes, Invert solvents, latex coatings and binders, magnesium hydroxide, Methocel and Ethocel cellulosic products, Peladow, Liquidow and Dowflake calcium chloride; plastic lined piping products, polyglycols, specialty monomers (DVB, VBC) and Versene chelating agents.\nPlastic Products Dow ranks among the world leaders in the production of plastics, offering the broadest range of thermoplastic and thermoset materials of any manufacturer. Dow plastics and plastic fabricated products are used in a wide variety of industries, such as appliances, automotive, building and construction, electronics, flooring, furniture, health care, housewares, packaging and recreation. Thermoplastics: Affinity polyolefin plastomers, Aim advanced styrenic resins, Aspun fiber-grade resins, Attane ultra low density polyethylene copolymers, Calibre polycarbonate resins, Dowlex linear low density polyethylene, Engage polyolefin elastomers, Insite technology polymers, Isoplast polyurethane engineering thermoplastic resins, low and high density polyethylene, Magnum ABS resins, Pellethane TPU elastoplastic polymers, Prevail thermoplastic resins, Primacor adhesive copolymers, Pulse engineering resins, Sabre engineering resins, Saran PVDC, Styron polystyrene, Tyril SAN resins and Tyrin CPE elastomers and resins. Thermosets: Cyclotene advanced electronics resins, D.E.H. curing agents, D.E.N. epoxy novolacs, D.E.R. liquid and solid epoxy resins, Derakane epoxy vinyl ester resins, Isonate pure and modified MDI (methylene diphenyl diisocyanate), Papi polymeric MDI, Specflex systems, Spectrim reaction moldable products, Tactix performance polymers, The Enhancer carpet backing, Voranate T-80 TDI (toluene diisocyanate) and Voranol polyether polyols and copolymer polyols. Fabricated Products: DAF adhesive films, DWF window films, Ethafoam plastic foams, Opticite label films, Saranex plastic films, Styrofoam brand plastic foams, Trycite plastic films, Trymer rigid foam billets and Zetabon plastic clad metals.\nHydrocarbons and Energy Dow is the world leader in the production of olefins, styrene and aromatics. This segment encompasses procurement of fuels and petroleum-based raw materials as well as the production of olefins, aromatics, styrene and cogenerated power and steam for use in the Company's operations. Hydrocarbons: Benzene, ethylene, propylene and styrene.\nHydrocarbons and Energy (Continued) Energy: Power and steam production plus fuels procurement and natural gas pipelines. Includes independent power producer Destec Energy, Inc., a Dow subsidiary, which develops independent power projects and sells electrical and thermal energy.\nConsumer Specialties This segment is comprised of three businesses primarily operated by Dow affiliates: Agricultural Products, Pharmaceuticals and Consumer Products. Agricultural Products (DowElanco) are used in crop protection and production, and for industrial pest control. The Pharmaceuticals business (Marion Merrell Dow) includes prescription drugs and over-the-counter health care products. The Consumer Products business (DowBrands) includes household and personal care products. Agricultural Products: Broadstrike, Garlon, Lontrel, Sonalan, Starane, Tordon, Treflan and phenoxy herbicides; Dursban and Lorsban insecticides; Beam, Rubigan and Trimidal fungicides; N-Serve nitrogen stabilizer, Telone soil fumigant, Vikane gas fumigant, Sentricon termite colony elimination system, and hybrid seeds. Pharmaceuticals: Prescription Products: Carafate antiulcer, Cardizem antianginal, Cardizem SR antihypertensive, Cardizem CD antianginal\/antihypertensive, Cardizem Injectable for atrial fibrillation or atrial flutter, Nicorette (outside the U.S.) and Nicoderm smoking cessation aids, Sabril anticonvulsant, Seldane antihistamine, Seldane-D antihistamine-decongestant combination and Targocid antibiotic. Pharmaceuticals: Over-the-Counter Products: (now marketed in the U.S. by SmithKline Beecham Consumer Healthcare, a partnership between Marion Merrell Dow and SmithKline Beecham) Cepastat sore throat lozenges, Citrucel bulk-fiber laxative, Debrox ear care product, Gaviscon antacid, Gly-Oxide oral antiseptic, Nicorette (in the U.S.), Novahistine cough\/cold\/allergy products and OsCal calcium supplements. Consumer Products: Household Products: Dow bathroom cleaner with Scrubbing Bubbles, Fantastik all purpose cleaner, Glass Plus multi- surface cleaner, Handi-Wrap plastic film, Saran Wrap plastic film, Smart Scrub soft scouring cleanser, Spray'N Wash tough laundry stain remover, ultra Vivid color safe bleach, ultra Yes laundry detergent and Ziploc plastic bags. Consumer Products: Personal Care: Apple Pectin, Nucleic A, PermaSoft, Salon Style, and Style hair care products.\nUnallocated This segment encompasses Dow's businesses that are not reported elsewhere, including the consolidated insurance and finance companies, and Ventures businesses such as Dow Environmental and advanced electronics materials. This segment includes activities and overhead cost variances not allocated to other segments.\nIndustry Segment and Geographic Area Results See Note S to the Financial Statements for a discussion of sales, operating income and identifiable assets by industry segment and geographic area. A product segment sales analysis follows.\nPRODUCT SEGMENT SALES ANALYSIS\nIn millions (Unaudited) 1994 1993 1992 - ---------------------------------------------------------------------- Sales of Principal Products and Services - ---------------------------------------------------------------------- Chemicals and Performance Products Chemicals and Metals $2,762 $2,625 $2,807 Performance Products 1,774 1,643 1,664 -------------------------------------------------------------------- Total Chemicals and Performance Products 4,536 4,268 4,471 - ---------------------------------------------------------------------- Plastic Products Thermoplastics 3,887 3,203 3,332 Thermosets 2,679 2,414 2,485 Fabricated Products 910 842 898 -------------------------------------------------------------------- Total Plastic Products 7,476 6,459 6,715 - ---------------------------------------------------------------------- Hydrocarbons and Energy Hydrocarbons and Energy 2,043 1,797 1,734 - ---------------------------------------------------------------------- Consumer Specialties Agricultural Products 1,735 1,604 1,580 Pharmaceuticals 3,274 3,007 3,478 Consumer Products 845 846 919 -------------------------------------------------------------------- Total Consumer Specialties 5,854 5,457 5,977 - ---------------------------------------------------------------------- Unallocated Miscellaneous 106 79 74 - ---------------------------------------------------------------------- Net Sales $20,015 $18,060 $18,971 - ----------------------------------------------------------------------\nRaw Materials The Company has, and expects to continue to have, adequate supplies of raw materials during 1995 and subsequent years.\nChemicals and Performance Products The most important raw materials for the Chemicals and Performance Products segment are ammonia, benzene, butadiene, caustic soda, cellulose, chlorine, ethylene, limestone, natural gas and natural gas liquids, natural brines, naphtha, organic acid, propylene, propylene oxide, salt and styrene. Ocean water from the Gulf of Mexico is the principal raw material for magnesium. The Company owns salt deposits in Louisiana, Michigan and Texas, U.S.; Alberta, Canada; Brazil; and Germany. The Company also owns natural brine deposits in Michigan and limestone deposits in Texas. These deposits are expected to last in excess of 100 years. The Company produces essentially all of its internal requirements of brine, propylene oxide, caustic soda, chlorine and styrene; and most of its internal requirements of butadiene and ethylene.\nPlastic Products Major raw materials for the Plastic Products segment are styrene, ethylene, benzene, acrylonitrile, octene, aniline, propylene oxide, bisphenol, epichlorohydrin, and vinylidene chloride. With the exception of ethylene, acrylonitrile, octene and aniline, the Company produces essentially all of the major raw materials that it consumes.\nHydrocarbons and Energy Major raw materials such as liquefied petroleum gases, crude oil, naphtha, natural gas, benzene, propylene, fuel oil and coal are purchased by the Company both on long-term contracts and as they become available on the market. The Company, and its subsidiary Destec Energy, Inc., own the rights to substantial deposits of lignite in Texas and Louisiana. About 89 percent of the output of a 1.6 billion pounds-per-year ethylene plant and 40 percent of the output of a 1.8 billion pounds-per-year ethylene plant, both owned by Novacor Chemicals Ltd., at Joffre, Alberta, Canada, are under long-term supply contracts to Dow Chemical Canada, Inc. This commitment is further described in Note Q to the Financial Statements. The purchased ethylene is used for feedstock at Dow Canada's manufacturing complex at Fort Saskatchewan and at other Dow locations. About 33 percent of the capacity of a 1.3 billion pounds-per-year ethylene plant, owned by BASF in Antwerp, Belgium is under a long- term contract to convert Dow's naphtha into ethylene and its by-products. The ethylene and by-products will be used for feedstock at Dow Benelux's manufacturing facility in Terneuzen, the Netherlands.\nConsumer Specialties The Consumer Specialties segment raw materials are primarily chlorine, 1,3 dichloropropene, dexylamine succinate, phenol, polyethylene, and vinylidene chloride, which are manufactured by the Company. Other raw materials such as pyridine, propionic acid, organo-phosphate based derivatives, sugar, alcohol, quinine, sulphate, lactulose, sucralfate, and codeine, are purchased under contracts.\nMethod of Distribution All products and services are marketed primarily through the Company's sales force, although in some foreign markets more emphasis is placed upon sale through distributors. No significant portion of the business of any industry segment is dependent upon a single customer.\nCompetition The Company experiences substantial competition in each of its industry segments. During 1994, the Company was the second largest chemical company in the United States in terms of sales and will likely be in the top five in terms of sales worldwide in 1994. The chemical industry has been historically competitive and this condition is expected to continue. The chemical divisions of the major international oil companies also provide substantial competition both in the U.S. and abroad. The Company competes worldwide on the basis of price, quality and customer service.\nPatents, Licenses and Trademarks The Company consistently applies for and obtains United States and foreign patents and the Company and its consolidated subsidiaries now own approximately 4,900* active United States patents and approximately 14,100* active foreign patents, which can be identified to industry segments as follows: Chemicals and Performance Products, 1,400 U.S. and 2,600 foreign; Plastic Products, 1,300 U.S. and 3,400 foreign; Hydrocarbons and Energy, 100 U.S. and 200 foreign; Consumer Specialties, 1,300* U.S. and 6,400* foreign; Ventures, 500 U.S. and 1,200 foreign, and Unallocated, 300 U.S. and 300 foreign. Dow is also party to a substantial number of patent licenses and other technology agreements. Dow's primary purpose in obtaining its patents is to protect the results of its own research effort for use in its own operations. The Company had patent and technology royalty income of $25 million in 1994, $26 million in 1993 and $21 million in 1992,\nPatents, Licenses and Trademarks (Continued) and paid royalties to others of $40 million in 1994, $44 million in 1993, and $34 million in 1992. Dow also has a substantial number of trademarks and trademark registrations in the United States and in other countries, including the \"Dow in Diamond\" trademark. Although the Company considers that, in the aggregate, its patents, licenses and trademarks constitute valuable assets, it does not regard its business as being materially dependent upon any single patent, license or trademark.\n*Includes approximately 700 Marion Merrell Dow, Inc. and 500 DowElanco patents in the U.S., and approximately 4,000 Marion Merrell Dow, Inc. and 2,200 DowElanco foreign patents.\nResearch and Development The Company is engaged in a continuous program of basic and applied research to develop new products and processes, to improve and refine existing products and processes and to develop new applications for existing products. Research and Development expenses were $1,261 million in 1994 compared to $1,256 million in 1993 and $1,289 million in 1992. The Company employs approximately 7,700 people in various kinds of research and development activities.\nOther Activities Dow owns, through its Liana Limited subsidiary, 100 percent of the stock of Dorinco Reinsurance Company, a Michigan stock property and casualty company which engages in the insurance and reinsurance business. In addition, the Company effectively owns 100 percent of the stock of two Bermuda insurance companies.\nPrincipal Partly Owned Companies Principal companies in which Dow owns a 50 percent interest include Dow Corning Corporation, a manufacturer of silicone and silicone products; Dow-United Technologies Composite Products, Inc., a manufacturer of composite products; and Gurit-Essex, A.G., a Swiss company, which supplies European automobile manufacturers with proprietary specialty products. In addition, Dow has a 45 percent interest in Total Raffinaderij Nederland N.V., which provides feedstocks for Dow's major petrochemical site at Terneuzen, the Netherlands, and also services the Benelux and nearby markets.\nProtection of the Environment Matters pertaining to the environment are discussed in Legal Proceedings, Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes A and Q to the Financial Statements.\nFinancial Information About Foreign and Domestic Operations and Export Sales In 1994, the Company derived 50 percent of its sales and had 46 percent of its plant investment outside the United States. While the Company's international operations may be subject to a number of additional risks, such as changes in currency exchange rates, the Company does not regard its foreign operations, on the whole, to carry any greater risk than its operations in the United States. Information on sales, operating income and identifiable assets by geographic area for each of the last three years appears in Note S to the Financial Statements.\nNumber of Products Dow manufactures and supplies more than 2,500 product families and services and no single one accounted for more than 5 percent of the Company's consolidated sales in 1994. No significant portion of the business of any industry segment is dependent upon a single customer.\nEmployees The personnel count at December 31, 1994 was 53,730 versus 55,436 at the end of 1993 and 61,353 at the end of 1992. The 12 percent reduction in personnel from the end of 1992 to the end of 1994 reflected rationalization and work process improvements throughout the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The Company operates 130 manufacturing sites in 30 countries. The Company considers that its properties are in good operating condition and that its machinery and equipment have been well maintained. The Company's Chemicals and Plastics production facilities and plants operated at approximately 92 percent of capacity during 1994. On a global basis, Dow operates 14 major production plants, the locations of which are as follows:\nUnited States: Midland, Michigan; Freeport, Texas; Pittsburg, California; Plaquemine, Louisiana; Cincinnati, Ohio; Kansas City, Missouri. Canada: Sarnia, Ontario; Fort Saskatchewan, Alberta. Germany: Stade; Rheinmuenster. France: Drusenheim The Netherlands: Terneuzen. Spain: Tarragona. Brazil: Aratu.\nIncluding the major production facilities, the Company has plants and holdings in the following geographic areas:\nUnited States: 50 manufacturing locations in 16 states and the Commonwealth of Puerto Rico. Canada: 9 manufacturing locations in 3 provinces. Europe: 39 manufacturing locations in 14 countries. Latin America: 19 manufacturing locations in 6 countries. Pacific: 13 manufacturing locations in 7 countries.\nAll of the above Dow plants are owned in fee, subject to certain easements of other persons which, in the opinion of Dow, do not substantially interfere with the continued use of such properties or materially affect their value.\nA summary of plant properties, classified by type, is contained in Note G to the Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nBreast Implant Matters The Company and Corning Incorporated (\"Corning\") are each 50 percent shareholders in Dow Corning Corporation (\"Dow Corning\"). Dow Corning, and in many cases the Company and Corning as well, have been sued in a number of individual and class actions by plaintiffs seeking damages, punitive damages and injunctive relief in connection with injuries purportedly resulting from alleged defects in silicone breast implants. In addition, certain shareholders of the Company have filed separate consolidated class action complaints alleging that the Company, Dow Corning or some of their respective Directors violated duties imposed by the federal securities laws regarding disclosure of alleged defects in silicone breast implants. The Company and one of its former officers have also been sued in two separate class action complaints alleging that the defendants violated duties imposed by the federal securities laws regarding disclosure of information material to a reasonable investor's assessment of the magnitude of the Company's exposure to direct liability in silicone breast implant litigation. In a separate action, a Corning shareholder has sued certain Dow Corning Directors (including three current Company Directors and two former Company Directors) alleging breaches of state law duties relating to the manufacture and marketing of silicone breast implants and seeking to recover unquantified money damages derivatively on Corning's behalf. Two separate derivative actions have been brought in the federal court, Southern District of New York, by Company shareholders purportedly on the Company's behalf. In Kas, et al. v. Butler, et al., two Company shareholders brought suit in 1992, naming as defendants all persons who were serving the Company as Directors on December 31, 1990, certain Dow Corning Directors, Dow Corning, Corning and certain Dow Corning officers, seeking derivatively on the Company's behalf unquantified money damages. In Rubinstein, et al. v. Ludington, et al., four Company shareholders brought suit in 1992, naming as defendants Dow Corning's Directors (Messrs. Falla, Popoff and Stavropoulos) who were also Company Directors and three former Company Directors, also seeking derivatively on the Company's behalf unquantified money damages. Plaintiffs in both cases subsequently made demands that the Company's Board bring suit on behalf of the Company. After the Board rejected those demands, the plaintiffs refiled their complaints alleging that the demands were wrongfully rejected. It is impossible to predict the outcome of each of the above described legal actions. However, it is the opinion of the Company's management that the possibility that these actions will have a material adverse impact on the Company's consolidated financial statements is remote, subject to the effects described below.\nBreast Implant Matters (Continued) In September 1993, Dow Corning announced the possibility of a global settlement concerning the silicone breast implant matter. In January 1994, Dow Corning announced a pretax charge of $640 million ($415 million after tax) for the fourth quarter of 1993. In January 1995, Dow Corning announced a pretax charge of $241 million ($152 million after tax) for the fourth quarter of 1994. These charges included Dow Corning's best estimate of its potential liability for breast implant litigation based on the Settlement Agreement (defined below); litigation and claims outside the Settlement Agreement; and provisions for legal, administrative and research costs related to breast implants. The charges for 1993 and 1994 included pretax amounts of $1,240 million and $441 million, respectively, less expected insurance recoveries of $600 million and $200 million, respectively. The 1993 amounts reported by Dow Corning were determined on a present value basis. On an undiscounted basis, the estimated liability above for 1993 was $2,300 million less expected insurance recoveries of $1,200 million. As a result of the Dow Corning actions, the Company recorded its 50 percent share of the charges, net of tax benefits available to the Company. The impact on the Company's net income was a charge of $192 million for 1993 and a charge of $70 million for 1994. On March 23, 1994, Dow Corning, along with other defendants and representatives of breast implant litigation plaintiffs, signed a Breast Implant Litigation Settlement Agreement (the \"Settlement Agreement\"). The Settlement Agreement was approved by Dow Corning's Board of Directors on March 28, 1994. Under the Settlement Agreement, industry participants (the \"Funding Participants\") would contribute up to approximately $4.2 billion over a period of more than thirty years to establish several special purpose funds. The Company is not a Funding Participant and is not required to contribute to the settlement. The Settlement Agreement, if implemented, provides for a claims-based structured resolution of claims arising out of silicone breast implants and defines periods during which breast implant plaintiffs may \"opt out\" of the class subject to the settlement by electing not to settle their claims by way of the Settlement Agreement and instead continuing their individual breast implant litigation against manufacturers and other defendants, including the Company. In certain circumstances, if any defendant who is a Funding Participant considers the number of plaintiffs who have opted out and maintained lawsuits against such defendant to be excessive, such defendant may withdraw from participation in the Settlement Agreement. Pursuant to the Settlement Agreement, any plaintiff who participates in the settlement releases the Company from any breast implant related liability. On April 1, 1994, the U.S. District Court for the Northern District of Alabama (the \"Court\") preliminarily approved the Settlement Agreement. A Court-supervised fairness review process of the Settlement Agreement was completed on August 22, 1994. The Settlement Agreement received final approval by the Court on September 1, 1994. The Court's final approval of the Settlement Agreement has been appealed to the U.S. Court of Appeals for the Eleventh Circuit. Various preliminary estimates of the aggregate number of plaintiffs who have indicated an intent to opt out of the settlement (the \"Opt Out Plaintiffs\") have been made public. Dow Corning has reported that since July 1, 1994, many initial Opt Out Plaintiffs with claims against Dow Corning have rejoined the settlement. The Court is continuing to collect information relating to the number of Opt Out Plaintiffs. Dow Corning will continue to evaluate the nature and scope of the current or potential future claims of these Opt Out Plaintiffs. Opt Out Plaintiffs were able to rejoin the settlement until the March 1, 1995 date established by the Court. The date by which Dow Corning was required to decide whether to remain as a participant in or to exercise the first of its options to withdraw from the Settlement Agreement was extended to September 9, 1994. On September 8, 1994, Dow Corning's Board of Directors approved Dow Corning's continued participation in the Settlement Agreement. Initial claims were required to be filed with the Court by September 16, 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 contributions to the settlement are sufficient to pay validated claims. The date by which this process will be completed is uncertain. If contributions are not sufficient, claimants with validated claims may have the ability to become Opt Out Plaintiffs during another specified period. In that event, if any defendant who is a Funding Participant considers the number of new Opt Out Plaintiffs to be excessive, such defendant may decide to exercise a second option to withdraw from participation in the Settlement Agreement. There can be no assurance that Dow Corning will not withdraw from participation in the Settlement Agreement. Dow Corning has reported that, as additional facts and circumstances develop, the estimate of its potential liability 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. Any future charge by Dow Corning resulting from a revision or provision, if required, could have a material adverse impact on the Company's net income for the period in which it is recorded by Dow Corning, but would not have a material adverse impact on the Company's consolidated cash flows or financial position. As to breast implant product liability claims that continue to be asserted against Dow Corning (as opposed to the Company), any loss to the Company would be limited to the diminution in the value of the Company's investment in Dow Corning, which totaled $337 million as of December 31, 1994, that would be caused by charges taken against income by Dow Corning in connection with these claims. The Company believes that Dow Corning is defending these claims vigorously.\nBreast Implant Matters (Continued) The Company is separately named as a defendant in a total of 12,395 breast implant product liability cases. In these situations, plaintiffs have alleged that the Company should be liable for Dow Corning's alleged torts based on the Company's 50 percent stock ownership in Dow Corning and that the Company should be liable by virtue of alleged \"direct participation\" by the Company or its agents in Dow Corning's breast implant business. These latter, direct participation claims include counts sounding in fraud, aiding and abetting, conspiracy and negligence. On December 1, 1993, Federal District Court Judge Sam C. Pointer, Jr., dismissed the Company from more than 3,000 (4,945 as of February 28, 1995) federal product liability cases involving silicone breast implants. The Opt Out Plaintiffs who have sued in federal courts are bound by this decision unless it is later vacated. Judge Pointer had been appointed by the Federal Judicial Panel on Multidistrict Litigation to oversee all of the silicone breast implant cases filed in the U.S. federal courts. In his ruling, Judge Pointer stated that the Company is a separate, independent company and has no legal responsibility for Dow Corning's breast implant business activities. He further held that the Company is not liable for any actions allegedly taken independent of its role as a shareholder of Dow Corning. Judge Pointer stated that there was \"no evidence\" to indicate the Company \"had any special knowledge about the alleged risks and hazards of silicone\" or that the Company did anything improper. Judge Pointer also held that he would reconsider his ruling if new facts emerge or if the law changes in one or more states. Certain new facts have emerged since Judge Pointer's ruling. Plaintiffs have asked the Court to vacate its ruling based on those facts. The Company does not believe these facts are material and has asked that the Court's December 1, 1993 ruling be made final. In separate similar rulings, the Company has been dismissed from 4,076 cases brought in the state courts of California, Indiana, Michigan, New Jersey, New York and Pennsylvania as to all claims against it. The California ruling has been appealed. The Company remains a defendant in 3,374 product liability cases brought in state courts and continues to be named as a defendant as additional cases are filed in various courts. On November 3, 1994, Judge Michael Schneider, presiding in the consolidated breast implant cases in Harris County, Texas, granted in part and denied in part the Company's motion for summary judgment. Judge Schneider granted the Company's motion as to (i) all claims based on the Company's status as a shareholder of Dow Corning, (ii) the claim that the Company was liable in negligence for failing to supervise Dow Corning, and (iii) the plaintiffs' licensor-licensee claim. Judge Schneider denied the Company's motion with regard to plaintiffs' claims sounding in fraud, aiding and abetting, conspiracy, certain negligence claims and a claim brought under the Texas Deceptive Trade Practices Act. As a result, the Company remains a defendant as to such claims in 2,331 cases pending in Harris County litigation. In those cases, the Company has filed cross-claims against Dow Corning on the ground that if the Company and Dow Corning are found jointly and severally liable, Dow Corning should bear appropriate responsibility for the injuries caused by its product. In addition, the Company has filed claims with its insurance carriers to recover in the event it is held liable in the Harris County (or any other) breast implant litigation. The first of the Harris County cases went to trial in November 1994, and the jury returned a verdict on February 15, 1995. At the conclusion of the presentation of the evidence, plaintiffs voluntarily withdrew their fraud and Deceptive Trade Practices Act claims against the Company. The jury reached a verdict dismissing the Company from all liability with respect to one plaintiff. As to the second plaintiff, the jury found for the Company in plaintiff's conspiracy, concert of action and negligence counts. The jury also found the Company jointly and severally liable with Dow Corning in the amount of $5.23 million for having given Dow Corning \"substantial encouragement or assistance\" in marketing breast implants that had not been first adequately tested. The jury allocated the Company's responsibility for plaintiff's damages at 20%. The Company has filed a motion with Judge Schneider requesting a judgment notwithstanding the verdict and will appeal any unfavorable ruling. It is impossible to predict the outcome or to estimate the cost to the Company of resolving this action or any of the other cases in Harris County. In an order dated December 1, 1994, Judge Frank Andrews, presiding in the consolidated breast implant cases in Dallas County, Texas, indicated that he had granted the Company's motion for summary judgment \"on all causes of action other than conspiracy and strict liability as a component parts supplier.\" As a result, the Company remains a defendant as to such claims in 116 cases pending in Dallas County. It is impossible to predict the outcome or to estimate the cost to the Company of resolving these actions. It is the opinion of the Company's management that the possibility that plaintiffs will prevail on the theory that the Company should be liable in the breast implant litigation because of its shareholder relationship with Dow Corning is remote. It is further the opinion of the Company's management that the possibility that a resolution of plaintiffs' direct participation claims would materially impact the Company's consolidated financial statements is remote. The Company was informed by Dow Corning that it had 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 states that the Boston Regional Office is conducting an informal investigation which \"concerns Dow Corning, its subsidiary Dow Corning Wright ('DCW'), and parent corporations Dow Chemical Co. and Corning Inc.\"\nSeldane In July 1992, two class actions lawsuits were filed in the United States District Court for the Western District of Missouri alleging that Marion Merrell Dow Inc. (\"MMD\"), a subsidiary of the Company, violated the federal securities laws as a result of alleged false statements and omission regarding the drug Seldane. The suits, which were brought by purchasers of MMD stock and sought unquantified damages, also named the Company as a defendant, principally because of its status as an alleged \"controlling person\" of MMD. In addition to seeking recovery against MMD and the Company, the suits named as defendants a variety of entities and individuals including certain Directors of MMD (some of whom are also Directors of the Company) and certain underwriters of a 1992 offering of MMD stock. Subsequently, plaintiffs filed a consolidated amended class action complaint in the same court consolidating the two previously filed complaints and captioned In re Marion Merrell Dow Securities Litigation. The consolidated amended class action complaint does not name the Company as a defendant but reserves the right to name the Company in the future should discovery disclose a basis for doing so. In December 1992, plaintiffs and the Company entered into an agreement conditionally tolling the statute of limitations as to any action against the Company. In addition, in July 1992, a derivative suit captioned Harris J. Sklar v. Ewing M. Kauffman, et al. was filed in the Court of Chancery of the State of Delaware against MMD (as nominal defendant) and certain past and present Directors of MMD, including Messrs. Falla, Lyons, Popoff and Stavropoulos, who are also Directors of the Company. The suit sought unquantified damages allegedly suffered by MMD as a result of alleged breaches of fiduciary duty and waste of corporate assets by its Directors in connection with the marketing of Seldane and alleged disclosures and omissions regarding Seldane made to consumers and to the investing public. On February 28, 1993, the Court entered an order dismissing without prejudice the complaint as against all defendants. Management believes that the above actions are without merit. Furthermore, it is the opinion of the Company's management that the possibility that litigation of these claims would materially impact the Company's consolidated financial statements is remote.\nEnvironmental Matters The Company has agreed to participate in the Toxic Substances Control Act, Section 8(e) compliance audit program and expects to pay a civil penalty of $1 million sometime during the first half of 1995. On September 27, 1993, February 23, 1994, and October 31, 1994, the U.S. Environmental Protection Agency filed actions against the Company alleging violations of the boiler and industrial furnace regulations. The Company agreed to pay a total of $151,729 in settlement of $319,230 of proposed fines with respect to two Company sites. Proposed civil fines for three additional Company sites total $1,286,764. On May 31, 1994, the U.S. Environmental Protection Agency filed an action against the Company alleging violations of the Clean Water Act at the Company's Ludington, Michigan site. Proposed civil fines total $125,000. On July 1, 1994, the Louisiana Department of Environmental Quality served a Penalty Notice on the Company alleging three spills which violated the Louisiana Clean Water Act, seeking proposed civil fines totaling $120,740, including administrative expenses. DowElanco, a general partnership 60 percent owned by the Company, received a letter dated November 30, 1994 from the U.S. Environmental Protection Agency regarding incident reporting under Section 6(a)(2) of the Federal Insecticide, Fungicide and Rodenticide Act. Settlement negotiations have been initiated to resolve any possible fines which may exceed $100,000. On December 19, 1994, the Texas Natural Resource Conservation Commission sent a proposed order to the Company seeking administrative civil penalties of $519,350 for alleged violations of the Texas Clean Air Act.\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.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below is information related to the Company's executive officers as of March 13, 1995.\nEnrique C. Falla, 55, Dow Executive Vice President and Chief Financial Officer. Director Since 1985. Employee of Dow since 1967. Commercial Vice President of Dow Latin America 1979-80. President of Dow Latin America 1980-84. Dow Financial Vice President 1984-91. Treasurer 1986-87. Chief Financial Officer 1987 to date. Executive Vice President 1991 to date. Director of Dow Corning Corporation,* Marion Merrell Dow Inc.,* Kmart Corporation and the University of Miami. Mr. Falla is a cousin of Mr. Sosa's wife.\nEXECUTIVE OFFICERS OF THE REGISTRANT (Continued)\nFrank P. Popoff, 59, Chairman of the Dow Board of Directors and Chief Executive Officer. Director since 1982. Employee of Dow since 1959. Executive Vice President of Dow Europe S.A.* 1980-81. President of Dow Europe S.A.* 1981-85. Dow Executive Vice President 1985-87. President and Chief Operating Officer 1987. President 1987-93. Chief Executive Officer 1987 to date. Chairman of the Board December 1992 to date. Director of Dow Corning Corporation,* Marion Merrell Dow Inc.* and DowElanco.* Director of American Express Company, U S WEST, Inc. and Chemical Financial Corporation. Serves on the Policy Committee of The Business Roundtable, The Business Council and The Conference Board. Member of the American Chemical Society, the National LEAD Council and the Michigan Business Partnership.\nEnrique J. Sosa, 54, Dow Senior Vice President and President of Dow North America. Director since 1990. Employee of Dow since 1964. Director of Marketing for the Plastics Department 1980-82. General Manager of Dow Brazil 1982-84. President of Dow Brazil 1984-85. Commercial Vice President for Specialty Chemicals 1985-87. Group Vice President for Chemicals and Performance Products 1987-90. Director of Corporate Product Department 1990-93. President of Dow North America 1993 to date. Dow Vice President 1990-91. Senior Vice President 1991 to date. Director of Destec Energy, Inc.* and Dow Corning Corporation.* Director of the National Association of Manufacturers and National Action Council for Minorities in Engineering, Inc. Member, Board of Trustees, Northwood University, and Executive Committee, Michigan First, Inc. Mr. Sosa's wife is a cousin of Mr. Falla.\nWilliam S. Stavropoulos, 55, Dow President and Chief Operating Officer. Director since 1990. Employee of Dow since 1967. President of Dow Latin America 1984-85. Commercial Vice President for Dow U.S.A., Basics and Hydrocarbons 1985-87. Group Vice President for Plastics and Hydrocarbons 1987-90. Chairman of Essex Specialty Products, Inc.* 1988-92. President of Dow U.S.A. 1990-93. Dow Vice President 1990-91. Senior Vice President 1991-93. Dow President and Chief Operating Officer 1993 to date. Director of Dow Corning Corporation* and Marion Merrell Dow Inc.* Chairman of the Board of the American Plastics Council. Board member of the Chemical Manufacturers Association, Citizens Research Council, U.S. Council for International Business and Midland Community Center. Member of the Society of Chemical Industry, American Chemical Society, University of Notre Dame Science Advisory Council and Joint Automotive Suppliers Governmental Action Council. Director of Chemical Financial Corporation and Chemical Bank and Trust Company.\nEach of these executive officers was elected by the Board of Directors to hold office until the next annual election of officers. As provided by the Bylaws of the Company, the Board of Directors elects the officers at its first meeting after each annual meeting of the stockholders.\n* A number of Company entities are referred to in the biographies and are defined as follows. (Some of these entities have had various names over the years and the names and relationships to the Company, unless otherwise indicated, are stated as they existed as of March 13, 1995.) Dow Corning Corporation, a corporation 50 percent-owned by Dow; DowElanco, a general partnership 60 percent-owned by Dow; Destec Energy, Inc. and Marion Merrell Dow Inc., both majority-owned subsidiaries of Dow; Dow Europe S.A. and Essex Specialty Products, Inc., wholly owned subsidiaries of Dow. Ownership by Dow described above may be either direct or indirect.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe principal market for the Company's common stock is the New York Stock Exchange. On February 9, 1995, the Company declared a cash dividend of 65 cents per share, payable April 28, 1995, to stockholders of record on March 31, 1995. This will be the 333rd consecutive quarterly dividend since 1912. There were 96,697 common stockholders of record as of March 13, 1995. Quarterly market and dividend information can be found in Part II, Item 8 (Supplementary Data) on page 50.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations Sales were $20.0, $18.1 and $19.0 billion for 1994, 1993 and 1992, respectively. Operating income for the same periods was $2.3, $1.4 and $1.3 billion, which included pretax special charges of $180 million in 1993 and $433 million in 1992 as discussed in Note B to the Financial Statements. The 1993 charge was taken by Marion Merrell Dow Inc., Dow's pharmaceutical subsidiary (71 percent owned), to cover expenses related to realignment of the company and other cost-management efforts to position the business for long-term success. Dow took a special charge in 1992 that reflected write-offs and write-downs, plant shutdowns, divestitures and the consolidation of a variety of business activities globally. Volume gains, price recovery and improved productivity contributed to higher operating income in 1994 compared to 1993 and 1992. Volume improved 8 percent in 1994 versus the previous year, and prices increased 2 percent after having declined since 1990. Through work process improvements, cost of sales adjusted for volume was down more than 2 percent despite an increase of almost 1 percent in the hydrocarbons and energy purchase price index.\nCHEMICALS AND PERFORMANCE PRODUCTS Chemicals and Performance Products had a 6 percent gain in sales in 1994 compared to the previous year, reporting $4.5 billion in sales versus $4.3 billion. In 1992, sales were $4.5 billion. Operating income continued to increase, rising to $592 million in 1994 from $350 million in 1993 and $269 million in 1992. The segment's operating income was affected by a special charge of $115 million in 1992.\nChemicals and Metals Sales for Chemicals and Metals were up 5 percent in 1994 compared to the previous year and down 2 percent versus 1992. Sales were $2.8, $2.6 and $2.8 billion for 1994, 1993 and 1992, respectively. The sales gain in 1994 resulted from 4 percent increases in both prices and volume compared to the previous year. Besides price recovery, lower costs and expenses resulted in improved margins. Price increases and higher volume for vinyl chloride monomer made the greatest contribution to the sales gain in this business and helped offset lower prices for caustic soda. An upturn in construction activity led to the stronger demand. Ethylene glycol was also a significant contributor to the improved results, with higher prices and volume. Propylene oxide demand improved in 1994, resulting in very tight supply. Because demand is expected to continue growing, Dow is authorizing incremental expansions of propylene oxide capacity in the U.S., Germany and Brazil. Dow has identified more than 500 million pounds of incremental capacity that can be added beginning in late 1995 or early 1996 with little added capital. Capacity was also increased for Dow with the start-up of its Zhejiang Pacific Chemical Company joint venture propylene oxide plant in Ningbo, People's Republic of China. Following a dramatic volume decline for magnesium, Dow adjusted its capacity in 1994 by permanently closing a production facility in Freeport, Texas. The facility had previously been idled when product exported from Russia and China saturated world markets. As supply and demand balances have become more favorable, price recovery is underway. Prices for chlorinated organics remained steady while volume continued to decline. The phaseout is underway for methyl chloroform and other applications of chlorinated organics which are of environmental concern. This phaseout will not have a material impact on Chemicals and Performance Products.\nPerformance Products In 1994, Performance Products had record sales of $1.8 billion, up 8 percent from the previous year. Sales were $1.6 and $1.7 billion in 1993 and 1992, respectively. Volume grew 8 percent in 1994 compared to 1993 while prices remained flat. In 1993, prices declined 6 percent compared to 1992, resulting in the sales decline that year. Improving economic conditions created greater demand for latex coated paper around the world, resulting in higher sales and profits for emulsion polymers. Demand and prices also improved for carpet and specialty applications. Dow responded to the increased demand for styrene butadiene latex by achieving an incremental increase in capacity from its existing facilities globally. Dow achieved higher sales for Methocel methyl cellulose as demand and prices strengthened. In anticipation of greater demand, Dow plans to add capacity in 1995 through debottlenecking. Sales declined for separation systems in 1994 due to the loss of patent protection for FilmTec membranes. The resulting increase in competition had little impact on volume, but prices were down significantly versus 1993. The loss of patent protection did not materially impact the results of Chemicals and Performance Products. Competitive pressures also resulted in a sales decline for ion exchange resins, but prices appear to have stabilized and volume is improving. Drytech superabsorbents experienced price attrition in 1994 in the face of new competition. However, volume remained strong. Sales of oxygenated solvents, chelants, antimicrobials, polyglycols, heat transfer fluids and other specialty chemicals continued to grow with gains in prices and volume.\nOutlook for Chemicals and Performance Products Prices of caustic soda began to recover in the second half of 1994. This recovery is expected to accelerate in 1995 as contract renewals bring higher prices. The improvement for caustic, coupled with strong demand and higher prices for most products in Chemicals and Metals, should result in further growth in sales and operating income in 1995. Performance Products is likely to better the record sales it attained in 1994, as volume and prices are expected to rise. Leading the return to more attractive margins will be the emulsion polymers business, where price recovery is expected to continue as global economic conditions improve.\nPLASTIC PRODUCTS Plastics reported record sales in 1994 of $7.5 billion, an increase of 16 percent versus the previous year. Sales were $6.5 billion in 1993 and $6.7 billion in 1992. The higher sales resulted from volume and price gains of 11 percent and 3 percent, respectively. Operating income continued to improve in 1994 on the strength of price recovery and cost and expense reductions. Operating income in 1994 was $1.1 billion, up from $380 million in 1993 and $94 million in 1992. Operating income in 1992 included a special charge of $184 million.\nThermoplastics Sales increased 21 percent to $3.9 billion in 1994 compared to $3.2 billion in 1993. Sales were $3.3 billion in 1992. Polyolefins and elastomers had significantly improved sales and margins due to the strong global pricing environment, higher volume in all geographic areas and continued cost reductions. As overall economic conditions improved, Dow's volume increased 11 percent, in line with industry growth rates. In meeting this strong demand, the business set production records for polyethylene and chlorinated polyethylene. Start-up of a new plant for Dowlex polyethylene at Fort Saskatchewan, Alberta, was completed in a safe manner, within budget and ahead of schedule in September 1994. The global commercialization of Insite technology has accelerated as more than 25 commercial applications of Affinity plastomers and Engage elastomers have been developed. A second production unit was converted in late 1994 to satisfy growing demand for Insite technology polymers. In January 1995, Dow and DuPont signed a letter of intent to form an enterprise that would include a broad portfolio of general purpose and specialty elastomer products. Combined global elastomer sales for the two companies currently are about $1 billion. The new enterprise has the potential to grow at more than twice the industry rate, leading to total revenues of $2 billion within five years. Specialty polyolefins posted record profitability in 1994, resulting primarily from strong volume growth and lower costs. Price was the single largest contributor to sales and profit improvement for Styron polystyrene, with significant increases in all geographic areas. Coupled with double-digit reductions in cost, the sales gain brought a dramatic improvement in margins. Dow responded to high levels of demand by increasing the capacity of existing plants in the U.S. and Canada. In November 1994, Styron Asia Ltd., a Dow joint venture with Asahi Chemical Industry Co., was formed. Based in Hong Kong, Styron Asia Ltd. will engage in the marketing, sales and service for polystyrene to the consumer and business electronics industries outside of Japan. Engineering thermoplastics had significantly improved performance in 1994 due to cost reductions and volume gains. While prices were down 3 percent, volume increased, resulting in higher sales. Volume improved in the Pacific area as the result of general industrial growth and in North America due to increased demand from the automotive and construction industries. Magnum ABS, Calibre polycarbonate and Pulse polycarbonate blends had the strongest improvement. Start-up of the Sumitomo-Dow Ltd. joint venture polycarbonate compounding operation was completed in September 1994, with the polymerization step scheduled to start up in February 1995. Demand for polycarbonate accelerated worldwide in 1994 and was exceptionally strong in the Pacific. Dow, in cooperation with Idemitsu Petrochemical Ltd., has moved into the development phase of new, semi-crystalline engineering resins.\nThermosets Thermosets had record sales of $2.7 billion in 1994, up from $2.4 billion the previous year and $2.5 billion in 1992. The sales increase in 1994 versus 1993 resulted from a 9 percent gain in volume, which offset a 1 percent decline in prices. Polyurethanes enjoyed record sales in 1994 based on strong demand. The global polyurethanes industry had exceptional growth rates in 1994, including a 12 percent increase in the U.S. Much of Dow's growth came from the Pacific, where the company has expanded its polyurethanes manufacturing presence in recent years.\nThermosets (Continued) In 1994, Dow started up its joint venture polyol facility in Ningbo, People's Republic of China, and completed a 300 million pound capacity expansion for polyols at its facility in Freeport, Texas. In February 1995, Dow announced plans to construct a new world-scale toluene diisocyanate (TDI) plant in Freeport. Dow's capacity expansions for TDI, polyols and propylene oxide (discussed under Chemicals and Metals) will provide the feedstocks needed to continue meeting the growing demand for polyurethanes globally. Productivity improvements are helping the polyurethanes business retain its low-cost-to-serve position, which is of primary importance for this industry. In 1994, costs were reduced and production records set. For epoxy products, supply tightened globally, supporting an upward trend in prices. Volume improved in 1994 and cost reductions contributed to better margins than in 1993. Operating rates also improved and were at high levels. In 1994, Dow started up a 120 million pound per year incremental expansion of epichlorohydrin, one of the basic products in the epoxy products chain. The expansion came in response to growing global demand that has outpaced supply. Bisphenol, another raw material for epoxy products, moved from a balanced to a tight supply situation in 1994.\nFabricated Products Fabricated Products had record sales of $910 million in 1994, up from $842 million in 1993 and $898 million in 1992. The business also achieved record profits in 1994 as a result of strong volume growth, price increases and cost reductions. Volume for Styrofoam brand products improved as economic conditions provided an increase in construction activity. In line with the company's plans to expand geographically, Dow will start up a new plant in Turkey for Styrofoam brand products in late 1995. Films and engineered laminates had higher sales due to the improvement in overall economic conditions and penetration of new applications. Price increases initiated across all of films during the last four months of 1994 will have their full effect in 1995 and demand is expected to remain strong.\nOutlook for Plastic Products Thermoplastics will benefit from strong demand and tight supply for ethylene- and styrene-based products. Dow's capacity expansions are well timed to capture this growth. The epoxy and polyurethanes businesses should continue to grow, although at a lesser rate than during the past few years. Dow believes that its Thermosets business will grow faster than the overall economy. The Fabricated Products business is expected to benefit from growing demand in the construction, electronics and telecommunications sectors, which are driven by expansion outside the U.S.\nHYDROCARBONS AND ENERGY Hydrocarbons and Energy had sales of $2.0 billion, up 14 percent from $1.8 billion in 1993 and 18 percent compared to $1.7 billion in 1992. Operating income increased 72 percent to $74 million in 1994 from $43 million in 1993. Hydrocarbons and Energy had an operating loss of $183 million in 1992, which included the unfavorable impact of a special charge of $113 million. Although operating income was not affected, Dow's 1994 earnings included a gain on its investment in Magma Power Company, primarily as a result of the merger agreement between Magma and California Energy Company, Inc. In 1993, earnings included gains from the sale of portions of the company's equity interests in Magma and Crestar Energy Inc. (see Note C to the Financial Statements). Ethylene production for Dow continued at high operating rates that were above the industry average. Ethylene market values rose substantially worldwide, driven by strong demand. This growth is expected to continue and capacity was expanded through the start-up of crackers in Fort Saskatchewan, Alberta, in the second half of 1994 and Freeport, Texas, in early 1995. Demand strengthened for styrene in the second half of 1994, leading to tight supply conditions and significant price increases. Feedstock costs for Hydrocarbons and Energy were up 1 percent in 1994 compared to the previous year.\nDestec Energy, Inc. Independent power producer Destec Energy, Inc., a publicly traded Dow subsidiary (76 percent owned), reported revenues for 1994 of $727 million, up from $674 million in 1993 and $508 million in 1992. The percentage of Destec's revenues sourced from Dow was 19 percent in 1994 and 1993, and 23 percent in 1992. Destec's results were favorably affected by an increase in equity earnings from the company's power facility partnerships, financing of the 123 megawatt Michigan Power CoGen project in Ludington, Michigan, and settlements concerning the development of two other projects. In 1994, Destec added 936 megawatts of new capacity and improved the operations and ownership structures at several existing facilities. The company presently has seven projects in construction or advanced development, representing additional equivalent capacity of more than 1,200 megawatts.\nOutlook for Hydrocarbons and Energy Ethylene and styrene will begin the year in a favorable supply and demand situation for Dow, but new ethylene capacity being added around the world could lead to a weaker market in the second half of 1995. Styrene demand is expected to remain strong throughout the year. Destec implemented a major corporate restructuring in 1994 aimed at realigning its development strategy, streamlining its organizational profile and reducing costs. In 1995, Destec plans to focus on its restructured business strategies. Two of Destec's Texas power marketing contracts expired during 1994 and the remaining contract expires in April 1995. As these contracts expire, Destec is selling its excess capacity at prevailing tariff prices and attempting to negotiate new contracts, but these expirations could substantially reduce Destec's revenues and gross margin in 1995 and beyond. In 1994, these contracts and operations from the related facilities accounted for 30 percent of Destec's total revenues and 78 percent of its gross margin.\nCONSUMER SPECIALTIES Consumer Specialties had sales of $5.9 billion in 1994, up 7 percent compared to 1993, but down 2 percent versus 1992. Operating income in 1994 was $762 million, a 1 percent decrease from $772 million in 1993 when excluding a Marion Merrell Dow Inc. special charge of $180 million that year. Including the impact of the charge, operating income in 1993 was $592 million. Operating income was $1.1 billion in 1992, which included the impact of an $11 million special charge. The declines in operating income, when excluding the charges, primarily reflect the shift to lower margin generic products for Pharmaceuticals.\nAgricultural Products Dow had a record $1.7 billion in sales of Agricultural Products through DowElanco, which is a global joint venture between Dow and Eli Lilly and Company, with Dow holding a 60 percent share. Sales for Agricultural Products were $1.6 billion in both 1993 and 1992. U.S. sales remained strong in specialty products, with notable increases in termite control, vegetation management and technical products. Lorsban 15G, the leading U.S. corn soil insecticide, yielded steady performance. Sales of other previously registered crop protection products were augmented by Broadstrike weed control systems in their first year of introduction. On a global basis, European sales stabilized despite government- sponsored farm acreage reduction programs and lack of financing for sales to the former Soviet Union. In Latin America and the Pacific, sales increased significantly, due to strong performance across product lines and added revenue from the introduction of flumetsulam, the active ingredient of Broadstrike. DowElanco also formed joint ventures with IPiCi to serve the global dinitroanaline market and with Nocil for the manufacture and sale of chlorpyrifos in India. Additionally, European operations were streamlined with new formulation and packaging operations. In 1995, DowElanco is commercializing the newly registered Sentricon system featuring Recruit termite bait. In 1997, pending EPA approvals, DowElanco plans to launch a new line of Naturalyte insecticides based on fermentation technology, initially targeted at the cotton and vegetable markets.\nPharmaceuticals Sales for Pharmaceuticals were $3.3 billion in 1994, up from $3.0 billion in 1993 but down from $3.5 billion in 1992. This business includes Marion Merrell Dow Inc., a Dow subsidiary (71 percent owned), and Dow's wholly owned pharmaceutical subsidiaries in Latin America. Marion Merrell Dow Inc. reported higher sales in 1994. Sales were $3.1 billion in 1994, an increase of 9 percent from 1993 sales of $2.8 billion. The growth in sales resulted primarily from acquisitions in the U.S. and Japan, along with strong North American sales of Cardizem CD once-a-day treatment for hypertension and angina. Sales of the Cardizem (diltiazem HCl) family of cardiovascular medications were $933 million in 1994, an increase of 2 percent over 1993. Sales were aided by the strength of Cardizem CD, which posted record sales of $708 million in 1994, up 30 percent. The Seldane (terfenadine) family of anti-allergy products recorded 1994 sales of $698 million, down 7 percent. Sales in North America and Europe were lower due to competitive pressures, while the Pacific region continued to show solid growth. Included in global sales for the brand in 1994 were $563 million for Seldane tablets, down 7 percent, and $135 million for Seldane-D (terfenadine and pseudoephedrine HCl), down 5 percent. Carafate (sucralfate), a unique anti-ulcer medication, faced continued pressure in 1994, with sales of $147 million, down 17 percent.\nConsumer Products Dow's Consumer Products affiliate, DowBrands, had sales of $845, $846 and $919 million in 1994, 1993 and 1992, respectively. In North America Household Products, a gain in sales for food protection products was offset by declines in the hard surface cleaner and laundry product businesses caused by aggressive competitive activity. Ziploc brand bags had a significant market share gain in 1994. Contributing to this gain were the recent new product introductions of Ziploc vegetable bags and Ziploc snack bags. The new manufacturing and distribution center in Urbana, Ohio, began shipping product in the fourth quarter. Brands such as Dow bathroom cleaner, Fantastik all purpose cleaner, Glass Plus multi-surface cleaner and Spray'N Wash tough laundry stain remover were reintroduced to the marketplace with new ergonomically designed bottles, more effective formulations and improved trigger sprayers that are intended to build consumer preference for the products. DowBrands also introduced Smart Scrub soft scouring cleaner with 100 percent water-soluble baking soda, which eliminates lengthy rinsing and gritty residue. Smart Scrub achieved a strong market share during its introduction, and will be followed by Smart Scrub with bleach in the first half of 1995.\nOutlook for Consumer Specialties DowElanco expects accelerating momentum from new product sales combined with steady earnings from older products to continue in the coming year. While two of Marion Merrell Dow's key products, Seldane and Seldane-D, face vigorous competition from other brands, the products have yet to experience generic competition in the U.S. Following the April 1994 expiration of one U.S. patent relating to Seldane, Marion Merrell Dow is defending the company's intellectual property rights related to certain other patents but cannot predict when, or if, U.S. generic competition might begin. In addition, the Cardizem brand faces increasing competition from generic and brand name products. DowBrands is likely to have improved profitability in 1995 as a result of the pending sale of its Personal Care business. This will allow the company to focus resources on the global expansion of its Home Food Management products, introduce new products and restore growth in cleaning and laundry products.\nUNALLOCATED The operating results of the consolidated insurance and finance subsidiaries, and Ventures businesses such as Dow Environmental and advanced electronics materials, are grouped in this segment together with activities and overhead cost variances not allocated to other business segments. This segment had an operating loss of $214 million in 1994 versus income of $75 million in 1993 and a loss of $6 million in 1992. The primary components of the 1994 operating loss were severance costs of $124 million, research and other expenses related to new developmental activities in the Ventures businesses of $91 million, and asset write-offs and provisions for environmental remediation not assigned to Dow's other industry segments of $38 million. These costs were partially offset by pretax income from the insurance and finance company operations of $40 million. This segment's 1993 operating income was comprised primarily of pretax income from the insurance and finance company operations of $98 million and favorable variances resulting from resource use reduction of $60 million which were partially offset by expenses related to new developmental activities in the Ventures businesses of $70 million. In 1992, casualty losses from Hurricane Andrew, a fire in Terneuzen, the Netherlands, and a decrease in investment income, all contributed to the lower operating results of the insurance and finance companies.\nCOMPANY SUMMARY Net sales for 1994 of $20.0 billion were up 11 percent from $18.1 billion in 1993 and 6 percent from $19.0 billion in 1992. This result reflected improved economic conditions globally which led to higher selling prices and stronger volumes as illustrated in the Sales Price and Volume table on the following page. All geographic areas and all industry segments had higher sales versus 1993 with Rest of World sales up 21 percent. Plastic Products led Dow's industry segments with sales increasing 16 percent compared to a year ago. Volume was up 8 percent versus 1993 and up across all geographic areas. Volume was up 6 percent in the United States, 7 percent in Europe and 18 percent in Rest of World. Selling prices were up 2 percent globally with Europe and Rest of World recording increases of 3 percent and the United States an increase of 1 percent versus 1993. Sales in the United States accounted for 50 percent of the total sales in 1994, 51 percent in 1993 and 50 percent in 1992. Sales details by industry segment and geographic area are provided in Note S to the Financial Statements and in the Product Segment Sales Analysis on page 5.\nSales Price and Volume 1994 1993 1992 Percentage changes ------------------ ------------------ ------------------ from prior year(1) Price Volume Total Price Volume Total Price Volume Total - -------------------------------------------------------------------------------- Geographic Areas: United States 1% 6% 7% - (3)% (3)% (1)% 6% 5% Europe 3 7 10 (13)% (1) (14) (6) 1 (5) Rest of World 3 18 21 (1) 4 3 (3) 3 - - -------------------------------------------------------------------------------- Total 2% 8% 11% (4)% (1)% (5)% (3)% 4% 1% - -------------------------------------------------------------------------------- Industry Segments: Chemicals and Performance Products 1% 5% 6% (4)% (1)% (5)% (3)% 2% (1)% Plastic Products 4 12 16 (6) 2 (4) (6) 4 (2) Hydrocarbons and Energy 6 8 14 (5) 9 4 (7) (3) (10) Consumer Specialties (1) 8 7 - (9) (9) 3 6 9 - -------------------------------------------------------------------------------- Total 2% 8% 11% (4)% (1)% (5)% (3)% 4% 1% - -------------------------------------------------------------------------------- (1)Not intended to add.\nOperating Income Operating income was $2.3 billion in 1994, up 63 percent from $1.4 billion in 1993 and 82 percent from $1.3 billion in 1992. As discussed in Note B to the Financial Statements, 1993 and 1992 included special charges against income of $180 million and $433 million, respectively. Gross margin improved $931 million versus 1993, primarily as a result of higher selling prices and increased sales volumes. Research and development, promotion and advertising, and selling and administrative expenses increased by a total of $158 million or 4 percent compared to 1993, primarily as a result of increased selling expenses and new product launch costs in the Consumer Specialties segment, and variable compensation expenses linked to improved company earnings. Management's continued focus on resource use reduction resulted in structural costs being reduced $174 million or 4 percent versus 1993 levels. The ratio of operating income to sales was 12 percent in 1994, versus 8 percent in 1993 and 7 percent in 1992. Price and volume increases in the Chemicals and Performance Products, Plastic Products, and Hydrocarbons and Energy segments coupled with the favorable impact of reduced structural costs led to the improved 1994 results. Operating income for Plastic Products nearly tripled to $1.1 billion compared to 1993, on the strength of both price and volume increases. Prices for the company began to show noticeable improvement in the latter half of 1994, contributing to the improved operating results. Higher prices are expected in 1995 versus 1994 with caustic prices improving significantly as contracts are renewed. Sales volumes are expected to be higher in 1995 as well. The United States contributed 55 percent of the total operating income in 1994 compared to 72 percent in 1993 and 90 percent in 1992. The United States portion of the total declined as a result of operating income improvements in Europe and Rest of World. Operating income in Europe was $273 million in 1994 versus a $1 million loss in 1993 and a $90 million loss in 1992. Operating income from Dow's other geographic areas continued to show improvement, increasing to $779 million in 1994 from $405 million in 1993 and $221 million in 1992.\nOperating Costs and Expenses\nCost Components as a Percent of Total: 1994 1993 1992 - ------------------------------------------------------------------- Hydrocarbons and energy 22% 21% 21% Wages, salaries and employee benefits 23 25 24 Maintenance 6 6 7 Depreciation 7 8 7 Supplies, services and other raw materials 42 40 41 - ------------------------------------------------------------------- Total 100% 100% 100% - -------------------------------------------------------------------\nDow's global plant operating rate for its chemicals and plastics businesses was 92 percent of capacity in 1994 compared to 85 percent in 1993 and 84 percent in 1992. The higher operating rate is attributed to sales volume growth which increased 8 percent over 1993. Overall manufacturing costs for chemicals and plastics, after adjusting for volume and special charges, were down 4 percent from 1993. This reduction was primarily the result of a continued focus on cost and resource use reduction in manufacturing, including lower maintenance spending. Depreciation expense was $1.3 billion in 1994, 1993 and 1992. Research and Development expenses were $1.3 billion, flat with 1993 and down 2 percent from 1992.\nOperating Income (Continued) Promotion and Advertising expenses are of a discretionary nature and are most directly related to sales in Consumer Specialties. In 1994, Promotion and Advertising expenses were $658 million, down 3 percent from $678 million in 1993 and 17 percent from $795 million in 1992. These 1994 expenses were reduced primarily in Pharmaceuticals as a result of a product mix more heavily weighted by generics. Selling and Administrative expenses for 1994 were $2.4 billion, up 8 percent from $2.2 billion in 1993 and 3 percent from $2.3 billion in 1992. The increase in 1994 was primarily the result of variable compensation accruals based on improved company earnings and increased spending in Pharmaceuticals due to the inclusion of the full-year results of The Rugby Group, Inc. and Kodama Ltd. Rugby and Kodama, two Marion Merrell Dow Inc. pharmaceutical acquisitions, were consolidated for the first time in the fourth quarter of 1993 and first quarter of 1994, respectively. Selling and Administrative expenses represented 12 percent of sales in each of 1994, 1993 and 1992. The personnel count at December 31, 1994 was 53,730 versus 55,436 at the end of 1993 and 61,353 at the end of 1992. The 12 percent reduction in personnel from the end of 1992 to the end of 1994 reflected rationalization and work process improvements throughout the company. Excluding the acquisitions of Kodama in 1994 and Rugby in 1993, the personnel counts would have been 52,314 and 54,626 at the end of 1994 and 1993, respectively, a 15 percent reduction from year- end 1992 to year-end 1994.\nNet Income Net income available for common stockholders in 1994 of $931 million or $3.37 per share increased 46 percent compared to net income of $637 million or $2.33 per share in 1993. The increase is primarily attributable to stronger operating results in the company's chemicals and plastics businesses. A net loss of $496 million or $1.83 per share was recorded in 1992. Effective January 1, 1992, Dow 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). The transition impact of the adoption of these two required accounting standards was a net cumulative charge against 1992 income of $765 million. Income before cumulative effect of accounting change was $276 million in 1992 or 99 cents per share. Dow's share of the earnings of 20%-50% owned companies amounted to $63 million in 1994 compared to a net loss of $111 million in 1993 and net earnings of $71 million in 1992. Dow Corning Corporation, in which the company is a 50 percent shareholder, reported net losses of $7 million in 1994, $287 million in 1993 and $72 million in 1992. Dow Corning's 1994 and 1993 losses reflected after tax charges against income related to breast implant litigation of $152 million and $415 million, respectively. The negative impact of the charges on Dow's net income was $70 million or 25 cents per share in 1994 and $192 million or 70 cents per share in 1993. See Note Q to the Financial Statements for further discussion of breast implant litigation. Dow Corning's 1992 net loss was largely due to the net cumulative effect charge of $100 million for implementation of SFAS Nos. 106 and 109 and to pretax special charges of $109 million related to restructuring costs, litigation and other costs for its discontinued breast implant business. In 1993, Dow's share of the earnings of 20%-50% owned companies was further reduced as a result of the sale of the company's 50 percent ownership in the Dowell Schlumberger group of companies in January 1993 (see Note C to the Financial Statements). In 1992, Dow's share of Dowell Schlumberger's net income was $36 million. Net interest expense, which is comprised of interest income, capitalized interest, interest expense and amortization of debt discount, was $406 million in 1994, down 6 percent from $433 million in 1993 and down 31 percent from $586 million in 1992. The decrease in 1994 was primarily due to lower average borrowings and lower interest rates versus 1993 and 1992. Foreign currency transaction gains for Dow and its consolidated subsidiaries amounted to $7 million in 1994 versus losses of $10 million in 1993 and gains of $11 million in 1992. For a discussion of the company's risk management program for both foreign currency and interest rate risk, see Note J to the Financial Statements. Dow recorded a net loss on investments of $60 million in 1994. The net loss was primarily due to a $132 million pretax charge in the fourth quarter of 1994 related to the pending sale of the Personal Care business of DowBrands. Partially offsetting this charge was a pretax gain of $90 million recorded by the company on its common shares of Magma Power Company, primarily as a result of the merger agreement between Magma and California Energy Company, Inc. In 1993, Dow recorded a net gain on investments of $592 million, primarily due to the sale of its interest in Dowell Schlumberger and portions of its interests in Magma and Crestar Energy Inc. (see Note C to the Financial Statements). The provision for taxes on income was $779 million in 1994 versus $606 million in 1993 and $274 million in 1992. Dow's overall effective tax rate for 1994 was 38.0 percent versus 39.7 percent for 1993 and 31.4 percent for 1992. The underlying factors affecting Dow's overall effective tax rates are discussed in Note D to the Financial Statements. U.S. and other tax law and rate changes during the year did not have a material impact on Dow. Minority interests' share of net income in 1994 was $335 million compared to $275 million in 1993 and $322 million in 1992. The current year increase reflected the improved profitability of Agricultural Products and Pharmaceuticals as well as the full-year impact of certain limited partnerships (see Note K to the Financial Statements). Profitability for Pharmaceuticals declined in 1993 as a result of the special charge recorded by Marion Merrell Dow Inc. (see Note B to the Financial Statements).\nNet Income (Continued)\nThe following table summarizes the impact of special items on earnings per common share.\n1994 1993 1992 - --------------------------------------------------------------------------- Special charges against operating income - $(.30) $(1.02) Impact of Dow Corning Corporation breast implant charges (.25) (.70) - Net gain (loss) on investments (.29) 1.31 - Accounting change: Transition to SFAS No. 106 - - (3.66) Transition to SFAS No. 109 - - .84 Other earnings 3.91 2.02 2.01 - --------------------------------------------------------------------------- Net earnings (loss) per common share $3.37 $2.33 $(1.83) - ---------------------------------------------------------------------------\nDividends The Board of Directors has announced a quarterly dividend of 65 cents per share, payable April 28, 1995, to stockholders of record March 31, 1995. This will be the 333rd consecutive quarterly dividend since 1912. Dow has maintained or increased the dividend throughout that time.\nEnvironment Dow's operations around the world are subject to increasingly stringent laws and government regulations related to environmental protection and remediation. Dow's environmental responsibilities and potential liabilities receive direct and ongoing scrutiny by management to ensure compliance with these laws and regulations. It has been Dow's policy to adhere to a waste management hierarchy that minimizes the impact of wastes on the environment. First, Dow works to eliminate or minimize the generation of waste at the source through research, process design, plant operations and maintenance. Second, Dow finds ways to reuse and recycle materials. Finally, unusable or nonrecyclable hazardous waste is treated before disposal to eliminate or reduce the hazardous nature and volume of the waste. Treatment may include destruction by chemical, physical, biological or thermal (incineration) means. Disposal of waste materials in landfills is considered only after all other options have been thoroughly evaluated and determined infeasible. Dow has specific requirements for wastes that are transferred to non-Dow facilities. Wastes that are recycled, treated or recovered for energy off-site represent less than 1 percent of the total amount of wastes reported as part of the Pollution Prevention Act. Dow's policy of treating its wastes on-site has resulted in only 12 percent of its total environmental liability being directed at remediation under federal or state \"Superfund\" statutes. As Dow develops advanced technology to improve its environmental performance, it disseminates that technology to operations around the world to be incorporated into new and existing plants. Environmental audits are used by management to continually measure and report Dow's progress against environmental expectations. The costs of site remediation are accrued as a part of the shutdown of a facility or, in the case of a landfill, over its useful life. The nature of such remediation includes the cleanup of soil contamination and the closure of landfills and waste treatment ponds. These practices have minimized the company's exposure to environmental liabilities. The policies adopted to properly reflect the monetary impacts of environmental matters are discussed in Note A to the Financial Statements. To assess the impact on the financial statements, environmental experts review currently available facts to evaluate the probability and scope of potential liabilities. Inherent uncertainties exist in such evaluations primarily due to unknown conditions, changing governmental regulations and legal standards regarding liability, and evolving technologies for handling site remediation and restoration. These liabilities are adjusted periodically as remediation efforts progress or as additional technical or legal information becomes available. Dow has been identified as a potentially responsible party (PRP) under federal or state \"Superfund\" statutes at approximately 90 sites. Dow readily cooperates in remediation at sites where its liability is clear, thereby minimizing legal and administrative costs. However, at several of these Superfund sites, Dow has had no known involvement and is contesting all liability; at many others, Dow disputes major liability, believing its responsibility to be de minimis. Because current law imposes joint and several liability upon each party at a Superfund site, Dow has evaluated its potential liability in light of the number of other companies which have also been named PRPs at each site, the estimated apportionment of costs among all PRPs and the financial ability and commitment of each to pay its expected share. Management has estimated that the company's probable liability for the remediation of Superfund sites at December 31, 1994 was $29 million, which has been accrued. In addition, receivables of $15 million for probable third-party recoveries have been recorded related to these sites. Other recoveries are possible since Dow has numerous insurance policies secured from many carriers at various times that may provide coverage at different levels for environmental liabilities. The company is currently involved in litigation to determine the scope and extent of such coverage. Dow has not recorded any receivables for these possible recoveries.\nEnvironment (Continued) In addition to the Superfund related liability referenced above, Dow had an accrued liability of $205 million at December 31, 1994 representing the total probable costs that the company could incur related to the remediation of current or former Dow-owned sites. The company had not recorded as a receivable any third-party recovery related to these sites. In total, Dow's accrued liability for probable environmental remediation and restoration costs was $234 million at December 31, 1994, as compared to $226 million at the end of 1993. This is management's best estimate of these liabilities, although possible costs for environmental remediation and restoration could range up to 50 percent higher. The amounts charged to income on a pretax basis related to environmental remediation totaled $64 million in 1994, $69 million in 1993 and $47 million in 1992. Capital expenditures for environmental protection were $106 million in 1994, $157 million in 1993 and $200 million in 1992. Capital expenditures for environmental protection in future years are currently projected at $100 million in 1995 and $100 million in 1996. It is the opinion of the company's management that the possibility is remote that costs in excess of those accrued or disclosed will have a material adverse impact on the company's consolidated financial statements.\nCapital Expenditures Capital spending for the year was $1.2 billion, down 15 percent from $1.4 billion in 1993 and 26 percent from $1.6 billion in 1992. The decrease primarily reflected the completion of a number of major projects during 1994 and management's continued effort to reduce capital resource requirements. Approximately 43 percent of the company's capital expenditures was directed toward additional capacity for new and existing products, while about 12 percent was committed to projects related to environmental protection, safety and loss prevention, and industrial hygiene. The remaining capital was utilized to maintain the company's existing asset base including projects related to cost reduction, energy conservation and facilities support. Major projects underway during 1994 included a light hydrocarbons plant at Freeport, Texas, a linear low density polyethylene plant at Fort Saskatchewan, Alberta and a DowBrands household cleaners plant in Urbana, Ohio. Start-up on each of these plants has been completed and they are now operational. Because the company designs and builds most of its capital projects in-house, it does not have major capital commitments, other than for the purchase of materials from fabricators.\nLiquidity and Capital Resources Operating activities provided $2.6 billion in cash in 1994, as compared to $2.1 billion in 1993 and $2.0 billion in 1992 (see the Consolidated Statements of Cash Flows). The items affecting operating activities are discussed in the sales, operating income and net income analysis. Cash used in investing activities was $1.2 billion in 1994 versus $622 million in 1993 and $1.3 billion in 1992. The 1993 reduction was largely the result of the sale of the company's interest in Dowell Schlumberger which generated cash proceeds of $675 million (see Note C to the Financial Statements) and outside investors' participation in limited partnerships which generated cash proceeds of $380 million (see Note K to the Financial Statements). These proceeds were used for general corporate purposes and redemption of debt. During 1994, Marion Merrell Dow Inc. (MMDI) increased its ownership in Kodama Ltd. to 99.8 percent, requiring net cash outlays of $101 million (see Note C to the Financial Statements). Net cash of $271 million in 1993 and $14 million in 1994 was used by MMDI to acquire The Rugby Group, Inc., the generic drug business of Rugby-Darby Group Companies, Inc. (see Note C to the Financial Statements). In 1992, the company received cash proceeds of $855 million from outside investors' participation in DowBrands L.P. (see Note K to the Financial Statements). Total working capital at year-end was $2.1 billion versus $2.0 billion at the end of 1993. Cash, cash equivalents, marketable securities and interest-bearing deposits increased by $297 million. Inventories and trade receivables together increased $958 million in 1994 as a result of increased sales activity after consecutive declines in 1993 and 1992 of $238 million and $316 million, respectively. Days-sales-in-inventory was 80 days, 82 days and 91 days at the end of 1994, 1993 and 1992, respectively. Days-sales- outstanding-in-receivables was 52 days at the end of 1994, 1993 and 1992. Short-term borrowings at December 31, 1994 were $741 million, a decrease of $136 million from year-end 1993. Long-term debt due within one year increased $369 million to $534 million at the end of 1994 compared to $165 million at the end of 1993. Long-term debt due in 1995 will be funded by operating cash flows. Accounts payable increased by $318 million to $2.6 billion and income taxes payable increased $419 million during the year. Long-term debt was $5.3 billion, a decrease of $599 million from year-end 1993. During the year, $108 million of new long-term debt was incurred while $526 million of long-term debt was retired and $534 million was transferred to long-term debt due within one year. Total debt was $6.6, $6.9 and $7.5 billion at December 31, 1994, 1993 and 1992, respectively. Net debt, which equals total debt less cash, cash equivalents, marketable securities and interest-bearing deposits, was $5.4, $6.1 and $6.9 billion at December 31, 1994, 1993 and 1992, respectively. The debt to total capitalization ratio decreased to 38.0 percent at year-end 1994 from 39.9 percent at the end of 1993.\nLiquidity and Capital Resources (Continued) The company has unused and available credit facilities with various U.S. and foreign banks totaling $2.0 billion in support of its working capital requirements and commercial paper borrowings. Additional unused credit facilities totaling $2.3 billion are available for use by foreign subsidiaries. Refer to Note I to the Financial Statements for further discussion on credit facilities. In February 1993, Dow effected a shelf registration for debt securities of 50.0 billion Japanese yen with Japan's Ministry of Finance. A total of 20.0 billion yen of this has been used. At December 31, 1994, there was a total of $1.4 billion in available SEC registered debt securities between Dow and Dow Capital B.V., a wholly owned subsidiary. Minority interest in subsidiary companies increased during the year from $2.4 to $2.5 billion at the end of 1994, largely as a result of outside investors' increased ownership in MMDI. Eli Lilly and Company (Lilly) is a 40 percent partner with the company in DowElanco, a global agricultural products joint venture. Lilly holds a put option requiring the company to purchase Lilly's interest in DowElanco at fair market value. Lilly notified the company in September 1994 that it did not plan to exercise the put option at that time. No subsequent notification has been received. During the third quarter of 1994, Dow Deutschland Inc., a subsidiary of the company, signed a letter of intent with the Treuhandanstalt in which Dow Deutschland Inc. agreed to study and evaluate the restructuring potential of several state-owned chemical assets in eastern Germany with the intention of acquiring a majority position. Facilities involved in the evaluation include a steam cracker at Saechsische Olefinwerke GmbH in Boehlen, electrochemical units and derivative operations at Buna GmbH in Schkopau, and polyolefin and intermediate chemical operations at Leuna-Werke GmbH in Merseburg and at Buna GmbH. The Treuhandanstalt is the German government agency charged with privatizing state-owned assets in the former East Germany. In August 1994, Dow announced that it had retained an investment banking firm for advice regarding possible strategic transactions involving Marion Merrell Dow Inc. At the same time, Marion Merrell Dow announced that it had also retained an investment banking firm for advice regarding its own strategic alternatives.\nSubsequent Event On February 28, 1995, The Hoechst Group, Marion Merrell Dow and The Dow Chemical Company announced that they are engaged in discussions concerning the possible negotiated acquisition of all of the outstanding shares of Marion Merrell Dow by the Hoechst Group at a price of $25.75 per share in cash. Dow presently owns approximately 197 million shares, or approximately 71 percent, of Marion Merrell Dow's outstanding common stock. Dow and the Hoechst Group are also discussing the possible acquisition of Dow's Latin American pharmaceuticals business for approximately $200 million. The companies stated that while discussions are ongoing, the boards of directors and supervisory boards of the respective companies have not yet met to consider the possible transactions, no agreements have been reached and there can be no assurance that any agreements will be reached or that any transactions will be consummated.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Responsibility for Financial Statements and Independent Auditors' Report - ---------------------------------------------------------------------------\nManagement Statement of Responsibility The management of The Dow Chemical Company and its subsidiaries prepared the accompanying consolidated financial statements, and has responsibility for their integrity, objectivity and freedom from material misstatement or error. These statements were prepared in accordance with generally accepted accounting principles. The financial statements include amounts that are based on management's best estimates and judgments. Management also prepared the other information in this annual report and is responsible for its accuracy and consistency with the financial statements. The Board of Directors, through its Audit Committee, assumes an oversight role with respect to the preparation of the financial statements. 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. Management has established and maintains a system of internal control that provides reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, and the prevention and detection of fraudulent financial reporting. The system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees with significant roles in the financial reporting process and updated as necessary. Management continually monitors the system of internal control for compliance. The Company maintains a strong internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements. Deloitte & Touche LLP, independent auditors, with direct access to the Board of Directors through its Audit Committee, has audited the consolidated financial statements prepared by the Company, and their report follows. Management has considered recommendations from the internal auditors and Deloitte & Touche LLP concerning the system of internal control and has taken actions that are cost-effective in the circumstances to respond appropriately to these recommendations. Management further believes the controls are adequate to accomplish the objectives discussed herein.\n- --------------------------------------------------------------------------- Independent Auditors' Report\nTo the Stockholders and Board of Directors of The Dow Chemical Company:\nWe have audited the accompanying consolidated balance sheets of The Dow Chemical Company and its 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 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 the financial statements and financial statement schedule 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 consolidated financial statements present fairly, in all material respects, the financial position of The Dow Chemical 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, 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. As discussed in Note B to the financial statements, effective January 1, 1992, the Company changed its methods of accounting for other postretirement benefits and income taxes.\nDeloitte & Touche LLP - --------------------- DELOITTE & TOUCHE LLP Midland, Michigan February 8, 1995\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nPage A Summary of Significant Accounting Policies 30 B Special Charge and Accounting Change 32 C Acquisitions and Divestitures 33 D Taxes on Income 33 E Inventories 35 F Related Company Transactions 35 G Plant Properties 35 H Leased Properties 35 I Notes Payable, Long-Term Debt and Available Credit Facilities 36 J Financial Instruments 38 K Limited Partnerships 40 L Stockholders' Equity 41 M Stock Option Plans 41 N Redeemable Preferred Stock 42 O Pension Plans 42 P Other Postretirement Benefits 43 Q Commitments and Contingent Liabilities 45 R Supplementary Information 47 S Industry Segments and Geographic Areas 48\nA Summary of Significant Accounting Policies\nPrinciples of Consolidation The accompanying consolidated financial statements of The Dow Chemical Company and its subsidiaries (the Company) include the assets, liabilities, revenues and expenses of all majority-owned subsidiaries. Intercompany transactions and balances are eliminated in consolidation. Investments in companies 20%-50% owned (related companies) are accounted for on the equity basis.\nReclassifications Certain reclassifications of prior years' amounts have been made to conform to the presentation adopted for 1994.\nForeign Currency Translation The local currency has primarily been used as the functional currency throughout the world. Translation gains and losses of those operations that use local currency as the functional currency, and the effects of exchange rate changes on transactions designated as hedges of net foreign investments, are included as a separate component of stockholders' equity. Where the U.S. dollar is used as the functional currency, foreign currency gains and losses are reflected in income currently.\nCash and Cash Equivalents Cash and cash equivalents include time deposits and readily marketable securities with original maturities of three months or less.\nInventories Inventories are stated at the lower of cost or market. The method of determining cost is used consistently from year to year at each subsidiary and varies among the last-in, first-out (LIFO) method; the first-in, first-out (FIFO) method; and the average cost method.\nPlant Properties, Investments and Other Assets Land, buildings and equipment, including property under capital lease agreements, are carried at cost less accumulated depreciation. Depreciation is based on the estimated service lives of depreciable assets and is generally provided using the\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nA Summary of Significant Accounting Policies (Continued)\nPlant Properties, Investments and Other Assets (Continued) declining balance method. Fully depreciated assets are retained in property and depreciation accounts until they are removed from service. In the case of disposals, assets and related depreciation are removed from the accounts and the net amount, less proceeds from disposal, is charged or credited to income. The excess of the cost of investments in subsidiaries over the carrying value of assets acquired is shown as goodwill, which is amortized on a straight-line basis over its estimated useful life with a maximum of 40 years. The Company evaluates long-lived assets for impairment based on the recoverability of the asset's carrying amount. When it is probable that undiscounted future cash flows will not be sufficient to recover the asset's carrying amount, the asset is written down to its fair value.\nGain Recognition on Sale of Subsidiaries' Stock Company policy is to record gains from the sale or other issuance of previously unissued stock by its subsidiaries.\nFinancial Instruments Interest differentials on swaps and forward rate agreements designated as hedges of exposures to interest rate risk are recorded as adjustments to interest expense over the contract period. Premiums for early termination of derivatives designated as hedges are amortized as adjustments to interest expense over the original contract period. Interest derivatives not designated as hedges are marked-to-market at the end of each accounting period. The Company calculates the fair value of financial instruments using quoted market prices whenever available. When quoted market prices are not available, the Company uses standard pricing models for various types of financial instruments (such as forwards, options, swaps, etc.) which take into account the present value of estimated future cash flows. Investments in debt and equity securities are classified as either Trading, Available-for-Sale or Held-to-Maturity. Investments classified as Trading are reported at fair value with unrealized gains and losses included in income. Investments classified as Available-for-Sale are reported at fair value with unrealized gains and losses recorded in a separate component of stockholders' equity. Investments classified as Held-to-Maturity are recorded at amortized cost. The cost of investments sold is determined by specific identification.\nEnvironment Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies. These accruals are adjusted periodically as assessment and remediation efforts progress or as additional technical or legal information becomes available. Accruals for environmental liabilities are generally included in the balance sheet as \"Other noncurrent obligations\" at undiscounted amounts and exclude claims for recoveries from insurance or other third parties. Accruals for insurance or other third party recoveries for environmental liabilities are recorded when it is probable that a claim will be realized. Accruals for recoveries are included in the balance sheet as \"Noncurrent receivables.\" Environmental costs are capitalized if the costs extend the life of the property, increase its capacity, and\/or mitigate or prevent contamination from future operations. Costs related to environmental contamination treatment and cleanup are charged to expense.\nTaxes on Income The Company accounts for taxes on income using the asset and liability method wherein deferred tax assets and liabilities are recognized for the future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities using enacted rates. Provision is made for taxes on undistributed earnings of foreign subsidiaries and related companies to the extent that such earnings are not deemed to be permanently invested. Certain countries provide tax incentives which are granted to encourage new investment. Generally, such grants are credited to income as earned.\nEarnings per Common Share The calculation of earnings per share is based on the weighted average number of common shares outstanding during the applicable period.\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nB Special Charge and Accounting Change\nThe second quarter of 1993 included a special pretax charge of $180 by Marion Merrell Dow Inc. (MMDI). The special charge reflected the impact of a number of steps intended to reduce costs and position MMDI for the future, including work force reduction and U.S. business reorganization. The special charge has had total cash expenditures of $107 ($65 in 1994, $42 in 1993), all of which have been funded from operations. Asset write-downs have been $4. At December 31, 1994, the special charge liability was $69. Work force reduction efforts are expected to result in estimated payroll and benefit cost savings in 1995 of $127. The actions intended by the restructuring are expected to be substantially complete by December 1995. The Company owns 71 percent of MMDI. During the fourth quarter of 1992, opportunities were identified to streamline the Company and a special pretax charge of $433 was taken. This charge reflected asset write-offs and write-downs, plant shutdowns, divestitures and the consolidation of a variety of business activities globally. Included were costs related to work force reductions associated with these activities. The actions contemplated by the special charge were substantially complete at December 31, 1993, with no significant adjustments required to the estimates. Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 112 (Employers' Accounting for Postemployment Benefits). The impact on net income for the year was not material. Effective January 1, 1992, the Company adopted SFAS No. 106 (Employers' Accounting for Postretirement Benefits Other Than Pensions) and SFAS No. 109 (Accounting for Income Taxes). SFAS No. 106 requires employers to recognize the cost of certain health care and life insurance benefits provided to retirees and their dependents as a liability during the employees' active years of service. In making the transition to adopt this required accounting standard, a charge of $994 or $3.66 per share was made against 1992 net income. SFAS No. 109 requires an asset and liability approach for financial accounting and reporting for income taxes. The favorable cumulative effect of its implementation was $229 or 84 cents per share in 1992. The net impact of adopting SFAS Nos. 106 and 109 was a cumulative charge of $765 against 1992 net income.\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nC Acquisitions and Divestitures\nIn 1994, the Company recognized a pretax gain of $90 on its common shares in Magma Power Company (Magma), primarily as a result of the merger agreement between Magma and California Energy Company, Inc. In the fourth quarter of 1994, the Company recorded a pretax charge of $132 related to the pending sale of the Personal Care business of DowBrands. During the third quarter of 1994, Dow Deutschland Inc., a subsidiary of the Company, signed a letter of intent to study and evaluate the restructuring potential of several state-owned chemical assets in eastern Germany with the intention of acquiring a majority position. During January and February of 1994, Marion Merrell Dow Inc. (MMDI) increased its ownership of Kodama Ltd. (Kodama), a Japanese pharmaceutical corporation, to 91 percent. By December 31, 1994, MMDI had further increased its ownership of Kodama to 99.8 percent. The net cash cost for 1994 was $101. In November 1993, Dow Chemical Canada Inc. (DCCI) sold shares of Crestar Energy Inc. (Crestar). The net proceeds to the Company were $172 and generated a pretax gain of $101. As a result of the sale, DCCI's common share holding in Crestar was reduced from 50 percent to 17.5 percent. In October 1993, MMDI acquired The Rugby Group, Inc., the U.S.'s largest generic drug company, from the privately held Rugby-Darby Group Companies, Inc. for $285. In June 1993, the Company sold 3.6 million shares of common stock in Magma for which it received gross proceeds of $116. The sale generated a pretax gain of $62 in 1993. In October 1993, the Company sold its option to purchase 2 million shares of Magma common stock to Magma and received consideration of 857,143 shares of Magma's common stock. In January 1993, the Company sold its 50 percent ownership in the Dowell Schlumberger group of companies to Schlumberger Limited. The selling price was $675 in cash and a warrant to purchase 7.5 million shares of Schlumberger stock with an exercise price of $59.95 per share. The warrant is fully vested and nontransferable, and expires in the year 2000. The sale generated a pretax gain of $450. The Company acquired an additional 2.1 million shares of MMDI common stock during 1993 and 1.4 million shares during 1992 at costs of $36 and $43, respectively. The increased interests were accounted for as purchases with increases to goodwill of $21 and $29, respectively.\nD Taxes on Income\nOperating loss carryforwards at December 31, 1994 amounted to $870 of which $108 is subject to expiration in 1995, $176 in 1996, $87 in 1997, $39 in 1998 and $5 in 1999. The remaining balances expire in years beyond 1999 or have an indefinite carryforward period. Tax credit carryforwards at December 31, 1994 amounted to $100 of which $3 is subject to expiration in 1995, $3 in 1996, $4 in 1997, $1 in 1998 and $2 in 1999. The remaining balances expire in years beyond 1999 or have an indefinite carryforward period. Undistributed earnings of subsidiaries and related companies which are deemed to be permanently invested amounted to $2,053, $1,782 and $1,989 at December 31, 1994, 1993 and 1992, respectively. It is not practicable to calculate the unrecognized deferred tax liability on those earnings. The movement in the valuation allowance during 1994 was a net reduction of $37 due primarily to business improvement and an extension in the loss carryforward period in Spain.\nDomestic and Foreign Components of Income before Taxes on Income and Minority Interests\n1994 1993 1992 - ------------------------------------------------------- Domestic $1,161 $1,099 $632 Foreign 891 426 240 - ------------------------------------------------------- Total $2,052 $1,525 $872 - -------------------------------------------------------\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nD Taxes on Income (Continued)\nReconciliation to U.S. Statutory Rate - -------------------------------------------------------------------------- 1994 1993 1992 - -------------------------------------------------------------------------- Taxes at U.S. statutory rate $718 $534 $296 Amortization of nondeductible intangibles 83 45 43 Taxes on foreign operations at rates different from U.S. statutory rate (including FSC) (4) 29 37 Other-net (18) (2) (102) - -------------------------------------------------------------------------- Total tax provision $779 $606 $274 - -------------------------------------------------------------------------- Effective tax rate 38.0% 39.7% 31.4% - ---------------------------------------------------------------------------\nProvision (Credit) for Taxes on Income\n1994 1993 1992 ---------------------- ---------------------- ---------------------- Current Deferred Total Current Deferred Total Current Deferred Total - ------------------------------------------------------------------------------- Federal $457 $13 $470 $404 $(8) $396 $381 $(158) $223 State and local 23 2 25 63 - 63 39 - 39 Foreign 265 19 284 115 32 147 149 (137) 12 - ------------------------------------------------------------------------------- Total $745 $34 $779 $582 $24 $606 $569 $(295) $274 - -------------------------------------------------------------------------------\nDeferred Tax Balances at December 31\n1994 1993 -------------------------- -------------------------- Deferred Tax Deferred Tax Deferred Tax Deferred Tax Assets Liabilities Assets Liabilities - -------------------------------------------------------------------------------- Property $83 $(799) $94 $(732) Inventory 104 (102) 103 (95) Accounts receivable 58 (55) 47 (29) Pension and other compensation accruals 107 (49) 127 (47) Tax loss and credit carryforwards 330 - 355 - Long-term debt 131 (19) 66 (16) Alternative minimum tax 80 - 102 - Accrual for postretirement benefit obligations 624 (9) 625 - Investments 30 (93) 76 (96) Amortization of intangibles 28 (1) 15 (37) Other accruals and reserves 379 (9) 305 (10) Other - net 201 (175) 141 (115) - -------------------------------------------------------------------------------- Subtotal $2,155 $(1,311) $2,056 $(1,177) Less: Valuation allowance 23 - 60 - - -------------------------------------------------------------------------------- Total $2,132 $(1,311) $1,996 $(1,177) - --------------------------------------------------------------------------------\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nE Inventories\nA reduction of certain inventories resulted in the liquidation of some quantities of LIFO inventory, which increased pretax income by $16 in 1994 and decreased pretax income by $18 in 1993 and $6 in 1992. The amount of reserve required to reduce inventories from the first- in, first-out basis to the last-in, first-out basis at December 31, 1994 and 1993, was $119 and $106, respectively. The inventories that were valued on a LIFO basis represented 35 and 41 percent of the total inventories at December 31, 1994 and 1993, respectively.\nF Related Company Transactions\nThe Company's investments in related companies accounted for by the equity method at December 31, 1994 and 1993 were $931 and $1,019, respectively, which approximated the Company's equity in the net assets of these companies. Dividends received from related companies were $15 in 1994, $36 in 1993 and $45 in 1992. All other transactions with related companies, and balances due to or from related companies, were not material in amount.\nG Plant Properties\nPlant Properties at December 31 1994 1993 - ----------------------------------------------------------------------- Land $414 $359 Land and waterway improvements 660 607 Buildings 2,337 2,177 Transportation and construction equipment 211 199 Machinery and equipment 15,332 14,191 Utility and supply lines 1,315 1,244 Office furniture and equipment 836 757 Wells and mineral reserves 355 240 Other 184 229 Construction in progress 1,566 1,605 - ----------------------------------------------------------------------- Total $23,210 $21,608 - -----------------------------------------------------------------------\nDepreciation expense was $1,321 in 1994, $1,343 in 1993 and $1,342 in 1992. Maintenance and repair costs were $974 in 1994, $1,004 in 1993 and $1,152 in 1992.\nH Leased Properties\nThe Company routinely leases premises for use as sales and administrative offices, warehouses and tanks for product storage, motor vehicles, railcars, computers, office machines and equipment under operating leases. In addition, the Company leases a vinyl chloride plant and a Canadian subsidiary leases an ethylene plant. The Company has the option to purchase these plants and certain other leased equipment and buildings at the termination of the leases. Rental expenses under operating leases were $459, $482 and $554 for 1994, 1993 and 1992, respectively. The minimum future lease commitments for all operating leases are included below.\nMinimum Operating Lease Commitments - ------------------------------------------------ 1995 $297 1996 272 1997 250 1998 402 1999 360 2000 and thereafter 1,358 - ------------------------------------------------ Total minimum lease commitments $2,939 - ------------------------------------------------\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nI Notes Payable, Long-Term Debt and Available Credit Facilities\nNotes payable at December 31, 1994 and 1993 consisted of obligations due banks with a variety of interest rates and maturities. The notes payable outstanding at December 31, 1994 and 1993 were $741 and $877, respectively, on which the year-end weighted average interest rates were 4.80 percent and 4.20 percent, respectively, excluding the effects of short-term borrowings in highly inflationary countries. Included in notes payable at December 31, 1994 and 1993 was commercial paper of $191 and $225, respectively. The average interest rate on long-term debt was 6.64 percent in 1994 compared to 7.43 percent in 1993. Annual installments on long-term debt for the next five years are as follows: 1995, $534; 1996, $387; 1997, $649; 1998, $330; 1999, $230. During 1994, $526 of long-term debt was retired. Included in this amount was $135 of 5.75% subordinated exchangeable notes due in 2001 that were exchanged for shares of Magma Power Company. The Company had unused and available credit facilities at December 31, 1994, with various U.S. and foreign banks totaling $2,043, which required the payment of commitment fees. Additional unused credit facilities totaling $2,276 at December 31, 1994 were available for use by foreign subsidiaries. These facilities are available in support of commercial paper borrowings and working capital requirements.\nPromissory Notes and Debentures at December 31\n1994 1993 - ----------------------------------------- 4.63%, final maturity 1995 $150 $150 8.25%, final maturity 1996 150 150 5.75%, final maturity 1997 200 200 5.75%, final maturity 2001 15 150 7.38%, final maturity 2002 150 150 9.35%, final maturity 2002 200 200 7.13%, final maturity 2003 150 150 8.63%, final maturity 2006 200 200 8.55%, final maturity 2009 150 150 9.00%, final maturity 2010 150 150 9.20%, final maturity 2010 200 200 6.85%, final maturity 2013 150 150 7.13%, final maturity 2015 24 150 9.00%, final maturity 2021 300 300 8.85%, final maturity 2021 200 200 8.70%, final maturity 2022 138 150 7.38%, final maturity 2023 150 150 - ----------------------------------------- Subtotal $2,677 $2,950 - -----------------------------------------\nGuaranteed ESOP Obligations at December 31 1994 1993 - ------------------------------------------------------------ 9.42%, final maturity 2004, Dow ESOP $111 $119 9.11%, final maturity 2005, MMDI ESOP 90 95 - ------------------------------------------------------------ Subtotal $201 $214 - ------------------------------------------------------------\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nI Notes Payable, Long-Term Debt and Available Credit Facilities (Continued)\nForeign Bonds at December 31 1994 1993 - ------------------------------------------------------------------- 6.75%, final maturity 1995, German mark $194 $173 5.63%, final maturity 1996, German mark 194 173 10.87%, final maturity 1997, British pound sterling 374 354 4.00%, final maturity 1998, Japanese yen 201 179 4.75%, final maturity 1999, Swiss franc 152 135 4.63%, final maturity 2000, Swiss franc 114 101 6.38%, final maturity 2001, Japanese yen 251 224 - ------------------------------------------------------------------- Subtotal $1,480 $1,339 - -------------------------------------------------------------------\nOther Facilities - Various Rates and Maturities at December 31\n1994 1993 - ------------------------------------------------------------ Foreign currency loans $255 $339 U.S. dollar loans 4 50 Medium-term notes, final maturity 2022 585 607 Pollution control\/industrial revenue bonds, final maturity 2024 707 684 Unexpended construction funds (20) (50) Capital lease obligations 32 40 - ------------------------------------------------------------ Subtotal $1,563 $1,670 - ------------------------------------------------------------\nLong-Term Debt at December 31 1994 1993 - ------------------------------------------------------------ Promissory notes and debentures $2,677 $2,950 Guaranteed ESOP obligations 201 214 Foreign bonds 1,480 1,339 Other facilities 1,563 1,670 Less unamortized debt discount (84) (106) Less long-term debt due within one year (534) (165) - ------------------------------------------------------------ Long-term debt $5,303 $5,902 - ------------------------------------------------------------\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nJ Financial Instruments\nInvestments Total investments at December 31, 1994 and 1993 included cash equivalents of $455 and $362, marketable securities and interest- bearing deposits of $565 and $430, and other investments of $1,529 and $1,726, respectively. The proceeds from sales of Available-for-Sale securities were $981 for 1994. These sales resulted in gross realized gains of $55 and losses of $26. Maturities for most debt securities ranged from one to ten years for the Available-for-Sale classification and one to five years for the Held-to-Maturity classification at December 31, 1994.\nForeign Currency Risk Management The Company's global operations require active participation in the foreign exchange markets. The Company enters into foreign exchange forward contracts and options to hedge various currency exposures or create desired exposures. Exposures primarily relate to (a) assets and liabilities denominated in foreign currency in Europe, Asia and Canada; (b) bonds denominated in foreign currency; and (c) economic exposure derived from the risk that currency fluctuations could affect the dollar value of future cash flows at the operating margin level. The primary business objective of the activity is to optimize the U.S. dollar value of the Company's assets, liabilities and future cash flows with respect to exchange rate fluctuations. Hedging is done on a net exposure basis. Namely, assets and liabilities denominated in the same currency are netted and only the balance is hedged. At December 31, 1994 and 1993, the Company had forward contracts outstanding with various expiration dates (primarily in January of the next year) to buy, sell or exchange foreign currencies with a U.S. dollar equivalent of $6,573 and $3,664, respectively. The unrealized gains or losses on these contracts, based on the foreign exchange rates at December 31, 1994 and 1993, were a loss of $18 and a gain of $9, respectively, and were included in income in \"Net gain (loss) on foreign currency transactions.\"\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nJ Financial Instruments (Continued)\nInterest Rate Risk Management The Company enters into various interest rate contracts with the objective of lowering funding costs, diversifying sources of funding or altering interest rate exposure. In these contracts, the Company agrees with other parties to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated on an agreed upon notional principal amount. The notional principal on all types of interest derivative contracts at December 31, 1994 and 1993 totaled $4,264 and $9,302, with a weighted average remaining life of 3.3 and 3.8 years, respectively. The $37 in gains and $45 in losses in 1994 related to interest derivatives were not recognized in income as they represented hedges of debt-related exposures. The $15 in gains and $93 in losses in 1994 related to cross-currency swaps were primarily recognized in income in \"Net gain (loss) on foreign currency transactions\" and offset the gains and losses from the assets and liabilities being hedged. In 1993, there were $176 in gains and $130 in losses related to cross- currency swaps and interest derivatives. Of these amounts, $142 in gains and $103 in losses had not been recognized in income as they represented hedges of debt-related exposures.\nInterest Derivatives at December 31, 1994\nWeighted Average Rate Notional --------------------- Amount Maturities Receive Pay - ---------------------------------------------------------------------- Cross-currency swaps $1,427 1995-1999 - - Receive Fixed Hedge 1,630 1995-2005 6.1% 5.5% Receive Floating Hedge 1,024 1996-2005 5.5% 6.8% Other 183 1995-1998 - - - ----------------------------------------------------------------------\nThe Company's risk management program for both foreign currency and interest rate risk is based on fundamental, mathematical and technical models that take into account the implicit cost of hedging. Risks created by derivative instruments and the mark-to-market valuations of positions are strictly monitored at all times. The Company uses portfolio sensitivities and stress tests to monitor risk. Because the counterparties to these contracts are major international financial institutions, credit risk arising from these contracts is not significant and the Company does not anticipate any such losses. The net cash requirements arising from risk management activities are not expected to be material. The Company's overall financial strategies and impacts from using derivatives in its risk management program are reviewed periodically with the Finance Committee of the Company's Board of Directors and revised as market conditions dictate. The Company's global orientation in diverse businesses with a large number of diverse customers and suppliers minimizes concentrations of credit risk. No concentration of credit risk existed at December 31, 1994.\nThe Dow Chemical Company and Subsidiaries\n- --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nK Limited Partnerships\nIn April 1993, three wholly owned subsidiaries of the Company contributed assets with an aggregate fair value of $977 to Chemtech Royalty Associates L.P. (Chemtech), a newly formed Delaware limited partnership. In August and October 1993, outside investors acquired limited partner interests in Chemtech totaling 20 percent in exchange for $200. In April 1993, two wholly owned subsidiaries of Marion Merrell Dow Inc. (MMDI) contributed assets with an aggregate fair value of approximately $1 billion to Carderm Capital L.P. (Carderm), a newly formed Delaware limited partnership. Outside investors made contributions of $180 in October 1993 in exchange for limited partner interests in Carderm totaling 15 percent. In December 1991, three wholly owned subsidiaries of the Company contributed assets with an aggregate market value of $2 billion to DowBrands L.P., a newly formed Delaware limited partnership. Outside investors made cash contributions of $45 in December 1991 and $855 in June 1992 in exchange for an aggregate 31 percent limited partner interest in DowBrands L.P. The three partnerships (Chemtech, Carderm and DowBrands L.P.) are separate and distinct legal entities from the Company and its affiliates and have separate assets, liabilities, businesses and operations. Each partnership has as a general partner a wholly owned subsidiary of either the Company or MMDI which directs the business activities of the partnership and has fiduciary responsibilities to the partnership and its other partners. The outside investors in each partnership will receive a cumulative annual priority return on their investments in the partnership and participate in residual earnings. The annual priority return is $14, $11 and $67 for Chemtech, Carderm and DowBrands L.P., respectively. The partnerships will not terminate unless a termination or liquidation event occurs. One such event, which is within the control of outside investors, occurs in the year 2000 for Chemtech and Carderm and 1996 for DowBrands L.P. In addition, the partnership agreements provide for various windup provisions wherein subsidiaries of the Company or MMDI may purchase at any time the limited partnership interests of the outside investors. Upon windup, liquidation or termination, the partners' capital accounts will be redeemed at current fair values. For financial reporting purposes, the assets (other than intercompany loans, which are eliminated), liabilities, results of operations and cash flows of the partnerships and subsidiaries are included in the Company's consolidated financial statements and outside investors' limited partnership interests are reflected as minority interests. Supplemental contractual disclosures required by the partnership agreements are contained within Note R of the December 31, 1993 Form 10-K of The Dow Chemical Company.\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nL Stockholders' Equity\nThe authorized capital stock consists of 250 million preferred shares with a par value of $1.00 per share, and 500 million shares of common stock with a par value of $2.50 per share. The only preferred shares issued are the convertible preferred shares discussed in Note N. The number of common shares issued has remained at 327,125,854 for the last three years. There are no significant restrictions limiting the Company's ability to pay dividends. Undistributed earnings of 20%-50% owned companies included in retained earnings were $269 and $290 at December 31, 1994 and 1993, respectively. In computing earnings per common share, no adjustment was made for common shares issuable under award, option and stock purchase plans, or conversion of preferred shares issued, because there would be no material dilutive effect. The Board of Directors has authorized, subject to certain business and market conditions, the purchase of up to 18,000,000 shares of the Company's common stock. At December 31, 1994, the number of shares purchased under this authorization was approximately 3,700,000. The number of treasury shares purchased was 591,000 in 1994, 300,000 in 1993 and 169,000 in 1992. The number of treasury shares issued to employees was 2,836,000 in 1994, 1,946,000 in 1993 and 2,051,000 in 1992. The number of treasury shares contributed to the pension plan for funding future retiree health care benefits through a 401(h) account was 391,000 in 1994 and 251,000 in 1993.\nReserved Treasury Stock at December 31\nIn thousands of shares 1994 1993 1992 - ---------------------------------------------------------------- Stock option plans 16,517 15,807 14,171 Employees' stock purchase plan 894 1,040 1,120 - ---------------------------------------------------------------- Total shares reserved 17,411 16,847 15,291 - ----------------------------------------------------------------\nM Stock Option Plans\nThe Company has various stock option plans. Options under all plans are granted at the market price of the shares on the date of the grants.\nOption Plans\nIn thousands of shares 1994 1993 1992 - ----------------------------------------------------------------------------- Outstanding at January 1 14,059 11,657 9,986 Granted 2,634 3,431 2,688 Exercised (1,862) (567) (801) Expired (96) (462) (216) - ----------------------------------------------------------------------------- Outstanding at December 31 14,735 14,059 11,657 Price Range $23.54-$74.63 $18.46-$60.88 $18.46-$60.88 - ----------------------------------------------------------------------------- Exercisable at December 31 12,189 10,776 8,869 Available for future grant 559 407 1,177 - -----------------------------------------------------------------------------\nStock options were exercised at prices ranging from $18.46 to $65.06 in 1994, $18.46 to $59.75 in 1993 and $18.46 to $60.88 in 1992. The Company made offerings of common stock to its employees, excluding directors, in 1994, 1993 and 1992 at $54.50, $45.00 and $48.00 per share, respectively, payable generally through payroll deductions. Unfilled subscriptions, cancelable at the option of the employee, were 894,000, 1,040,000 and 1,120,000 shares at December 31, 1994, 1993 and 1992, respectively. Partial payments received on these subscriptions aggregating $32, $28 and $33 at December 31, 1994, 1993 and 1992, respectively, were included in current liabilities.\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nN Redeemable Preferred Stock\nThe Company has an employee stock ownership plan (the ESOP), which is an integral part of the Salaried Employees Savings Plan. The ESOP borrowed funds at a 9.42 percent interest rate with a final maturity in 2004, and used the proceeds to purchase convertible preferred stock from the Company. The preferred stock is convertible into approximately 1.5 million shares of the Company's common stock at $86.125 per common share. The dividend yield on the preferred stock is 7.75 percent of the $86.125 redemption value. In the event the Company consummates certain merger or consolidation transactions involving the Company's common stock, the preferred stock must be redeemed by the Company for cash at a redemption price equal to 105 percent of the $86.125 per share redemption value, plus accrued and unpaid dividends. The convertible preferred stock issued to the ESOP is reported as temporary equity in the Company's balance sheet. Since the Company has guaranteed the ESOP's borrowings, the principal amount of the ESOP loan has been reported as long-term debt and a reduction of temporary equity in the Company's balance sheet.\nO Pension Plans\nThe Company has defined benefit pension plans which cover employees in the U.S. and a number of foreign countries. The Company's funding policy is to contribute annually, at a rate that is intended to approximate a level percentage of compensation for the covered employees, to those plans where pension laws and economics either require or encourage funding. The U.S. funded plan is the largest plan. Its benefits are based on length of service and the employee's three-highest consecutive years of compensation. The weighted average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations were 7.75 and 5.5 percent, respectively, for 1994 and 7.25 and 5.5 percent, respectively, for 1993. The assumed long-term rate of return on assets was 9 percent for 1994 and 1993. All other pension plans used assumptions in determining the actuarial present value of the projected benefit obligations that are consistent with (but not identical to) those of the U.S. plan. Defined contribution plans cover employees in some subsidiaries in the U.S. and in other countries, including Australia, France, Spain, and the United Kingdom. In addition, employees in the U.S. are eligible to participate in defined contribution plans (Employee Savings Plans) by contributing a portion of their compensation. The Company matches compensation deferrals, depending on Company profit levels. Contributions charged to income for defined contribution plans were $71 in 1994, $76 in 1993 and $83 in 1992. The net periodic pension cost for all significant defined benefit plans was as follows:\nNet Periodic Pension Cost 1994 1993 1992 - -------------------------------------------------------------------------- Service cost-benefits earned during the period $170 $152 $122 Interest cost on projected benefit obligation 347 333 306 Actual (return) on assets (93) (494) (341) Amortization and deferred amounts (266) 153 47 Employee contributions to the plans (8) (8) (9) - --------------------------------------------------------------------------- Net periodic pension cost $150 $136 $125 - ---------------------------------------------------------------------------\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nO Pension Plans (Continued)\nThe funded status of significant defined benefit plans for the Company was as follows:\nDefined Benefit Plans at December 31 Fully Funded Partially Funded ------------- ---------------- 1994 1993 1994 1993 - -------------------------------------------------------------------------------- Actuarial present value of benefit obligation: Vested $(3,287) $(3,173) $(467) $(361) Nonvested (292) (324) (40) (50) - -------------------------------------------------------------------------------- Accumulated benefit obligation (3,579) (3,497) (507) (411) Effect of projected compensation increases (826) (838) (125) (164) - -------------------------------------------------------------------------------- Projected benefit obligation for services rendered to date (4,405) (4,335) (632) (575) Plan assets at market value, primarily publicly traded stocks and bonds 4,439 4,534 221 208 - -------------------------------------------------------------------------------- Plan assets in excess of (less than) projected benefit obligation 34 199 (411) (367) Unrecognized transition obligation 28 29 45 35 Unrecognized net (gains) losses 57 (84) (1) 51 Unrecognized prior service cost 9 (4) 39 48 Additional minimum liability - - (49) (8) - -------------------------------------------------------------------------------- Accrued pension asset (liability) $128 $140 $(377) $(241) - --------------------------------------------------------------------------------\nP Other Postretirement Benefits\nThe Company provides certain health care and life insurance benefits to retired employees. The Company funds most of the cost of these health care and life insurance benefits as incurred. The U.S. plan covering the parent company is the largest plan. The plan provides health care benefits, including hospital, physicians' services, drug and major medical expense coverage, and life insurance benefits. The plan provides benefits supplemental to Medicare after retirees are eligible for these benefits, except for employees hired after December 31, 1992. The cost of these benefits is shared by the Company and the retiree, with the Company portion increasing as the retiree has increased years of credited service. The Company has the ability to change these benefits at any time. Effective October 1993, the Company amended its health care benefits plan in the U.S. to cap the cost absorbed by the Company at approximately twice the 1993 cost per person for employees who retire after December 31, 1993. Effective April 1994, the Company extended this amendment to cover all other retired employees. The effect of the October 1993 amendment was to reduce the net periodic postretirement cost by $21 for 1993 and the accumulated postretirement benefit obligation by $327 at December 31, 1993. The effect of the April 1994 amendment was to reduce the net periodic postretirement cost by $71 for 1994 and the accumulated postretirement benefit obligation by $101 at December 31, 1994. For 1994, a discount rate of 7.75 percent and weighted average medical cost trend rates starting at 9.47 percent and declining to 5.53 percent in 2004 were assumed. For 1993, the discount rate assumption was 7.25 percent and the medical cost trend rate assumption was 10.65 percent declining to 5.03 percent in 2004. The assumed long-term rate of return on assets was 9 percent for 1994 and 1993. Increasing the assumed medical cost trend rate by 1 percentage point in each year would increase the accumulated postretirement benefit obligation at December 31, 1994 by $33 and the net periodic postretirement benefit cost for the year by $3. All other postretirement health care and other benefit plans used assumptions in determining the actuarial present value of accumulated postretirement benefit obligations that are consistent with (but not identical to) those of the U.S. parent company plan.\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nP Other Postretirement Benefits (Continued)\nThe net periodic benefit cost of all significant plans was as follows:\nNet Periodic Postretirement Cost 1994 1993 1992 - ---------------------------------------------------------------------------- Service cost - benefits earned during the period $26 $35 $38 Interest cost on accumulated postretirement benefit obligation 89 122 127 Amortization and deferred amounts (43) (9) - - ---------------------------------------------------------------------------- Net periodic postretirement cost $72 $148 $165 - ----------------------------------------------------------------------------\nThe postretirement benefit obligations of all significant plans were as follows:\nPartially Funded Postretirement Plans at December 31 1994 1993 - ----------------------------------------------------------------------- Accumulated postretirement benefit obligation: Retirees $(676) $(792) Fully eligible active plan participants (290) (279) Other active plan participants (210) (234) - ----------------------------------------------------------------------- Total accumulated postretirement benefit obligation (1,176) (1,305) Plan assets at market value, primarily publicly traded stocks and bonds 52 20 - ----------------------------------------------------------------------- Unfunded accumulated postretirement benefit obligation (1,124) (1,285) Unrecognized gain from experience favorable to assumptions (166) (81) Negative prior service costs (373) (319) - ----------------------------------------------------------------------- Accrued postretirement benefit liability $(1,663) $(1,685) - -----------------------------------------------------------------------\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nQ Commitments and Contingent Liabilities\nIn January 1994, Dow Corning Corporation (Dow Corning), in which Dow is a 50 percent shareholder, announced a pretax charge of $640 ($415 after tax) for the fourth quarter of 1993. In January 1995, Dow Corning announced a pretax charge of $241 ($152 after tax) for the fourth quarter of 1994. These charges included Dow Corning's best estimate of its potential liability for breast implant litigation based on the settlement approved by Judge Sam C. Pointer, Jr. of the U.S. District Court for the Northern District of Alabama (the Court); litigation and claims outside of this breast implant settlement; and provisions for legal, administrative and research costs related to breast implants. The charges for 1993 and 1994 included pretax amounts of $1,240 and $441, respectively, less expected insurance recoveries of $600 and $200, respectively. The 1993 amounts reported by Dow Corning were determined on a present value basis. On an undiscounted basis, the estimated liability above for 1993 was $2,300 less expected insurance recoveries of $1,200. As a result of the Dow Corning actions, the Company recorded its 50 percent share of the charges, net of tax benefits available to Dow. The impact on the Company's net income was a charge of $192 for 1993 and a charge of $70 for 1994. In March 1994, Dow Corning signed a Breast Implant Litigation Settlement Agreement (the Settlement Agreement) which was preliminarily approved by the Court in April 1994. The Settlement Agreement received final approval by the Court on September 1, 1994. The Company is not a signatory to the Settlement Agreement and is not required to contribute to the settlement. In certain circumstances, if any defendant who is a signatory to the Settlement Agreement considers the number of plaintiffs who have opted out and maintained lawsuits against such defendant to be excessive, such defendant may withdraw from participation in the Settlement Agreement. Various preliminary estimates of the aggregate number of plaintiffs who have indicated an intent to opt out of the settlement (the Opt Out Plaintiffs) have been made public. Dow Corning has reported that, since July 1, 1994, many former Opt Out Plaintiffs have rejoined the settlement. The Court is continuing to collect information relating to the number of Opt Out Plaintiffs. Dow Corning has stated that, as information is received from the Court, Dow Corning will continue to evaluate the nature and scope of 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. The date by which Dow Corning was required to decide whether to remain as a participant in or to exercise the first of itsoptions to withdraw from the Settlement Agreement was extended to September 9, 1994. On September 8, 1994, Dow Corning's Board of Directors approved Dow Corning's continued participation in the Settlement Agreement. Initial claims were required to be filed with the Court by September 16, 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 contributions to the settlement are sufficient to pay validated claims. The date by which this process will be completed is uncertain. If contributions are not sufficient, claimants with validated claims may have the ability to become Opt Out Plaintiffs during another specified period. In that event, if any defendant who is a signatory to the Settlement Agreement considers the number of new Opt Out Plaintiffs to be excessive, such defendant may decide to exercise a second option to withdraw from participation in the Settlement Agreement. There can be no assurance that Dow Corning will not withdraw from participation in the Settlement Agreement. Dow Corning has reported that, as additional facts and circumstances develop, the estimate of its potential liability 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. Any future charge by Dow Corning resulting from a revision or provision, if required, could have a material adverse impact on the Company's net income for the period in which it is recorded by Dow Corning, but would not have a material adverse impact on the Company's consolidated cash flows or financial position. The Company's maximum exposure for breast implant product liability claims against Dow Corning is limited to its investment in Dow Corning which, at December 31, 1994, was $337. The Company is separately named as a defendant in many of the breast implant claims and lawsuits. It is the opinion of the Company's management that the possibility is remote that the litigation of these claims will have a material adverse impact on the Company's consolidated financial statements.\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nQ Commitments and Contingent Liabilities (Continued)\nNumerous lawsuits have been brought against the Company and other chemical companies alleging that the manufacture, distribution or use of pesticides containing dibromochloropropane (DBCP) has caused, among other things, property damage, including contamination of groundwater. To date, there have been no verdicts or judgments against the Company in connection with these allegations. It is the opinion of the Company's management that the possibility is remote that the resolution of such lawsuits will have a material adverse impact on the Company's consolidated financial statements. The Company has accrued $234 at December 31, 1994, for probable environmental remediation and restoration liabilities, including $29 for the remediation of Superfund sites. This is management's best estimate of these liabilities, although possible costs for environmental remediation and restoration could range up to 50 percent higher. It is the opinion of the Company's management that the possibility is remote that costs in excess of those accrued or disclosed will have a material adverse impact on the Company's consolidated financial statements. In addition to the breast implant, DBCP and environmental remediation matters, the Company and its subsidiaries are parties to a number of other claims and lawsuits arising out of the normal course of business with respect to commercial matters, including product liabilities, governmental regulation and other actions. Certain of these actions purport to be class actions and seek damages in very large amounts. All such claims are being contested. Except for the possible effect on the Company's net income for charges which may be taken by Dow Corning for breast implant litigation, it is the opinion of the Company's management that the possibility is remote that the aggregate of all claims and lawsuits will have a material adverse impact on the Company's consolidated financial statements. On behalf of Destec Energy, Inc. (Destec), a 76 percent owned subsidiary, the Company has guaranteed the lease payments of a Destec subsidiary which leases the Lyondell cogeneration facility near Houston, Texas. Minimum lease payments total $145 for the noncancelable portion of the lease which runs through March 31, 1995. The guarantee is cancelable upon proper notice on any anniversary date of the guarantee. Destec entered into an agreement with the U.S. Department of Energy, PSI Energy Inc. (PSI), and a third party owner to design, construct, and operate a 262 megawatt syngas facility which will repower an existing PSI turbine. Destec will provide coal gasification services under a 25-year contract. Associated with the above agreement, Destec assumed a construction performance obligation of $161 with project completion scheduled for third quarter 1995, at which time Destec will lease the plant. The lease commitments are included in Note H. Destec contracted to design, engineer, build and operate a cogeneration facility in central Florida for a partnership in which Destec owns approximately 50 percent. Commercial operations commenced in January 1995 as planned. Destec has guaranteed $33 to fund its equity contribution. Destec contracted to design, engineer and build a 424 megawatt cogeneration facility in Freeport, Texas and is a 50 percent partner in Oyster Creek Limited which owns the facility. The Company has agreed to purchase steam and power from the facility and estimates that its minimum annual obligation to outside parties is $20, increasing 3 percent annually through 2014. Eli Lilly and Company (Lilly) is a 40 percent partner with the Company in DowElanco, a global agricultural products joint venture. Lilly holds a put option requiring the Company to purchase Lilly's interest in DowElanco at fair market value. Lilly notified the Company in September 1994 that it did not plan to exercise the put option at that time. No subsequent notification has been received. A Canadian subsidiary has entered into two 20-year agreements to purchase 89 percent of the output of an ethylene plant (Plant No. 1) and 40 percent of the output of a second ethylene plant (Plant No. 2). The purchase price of the output is determined on a cost-of-service basis which, in addition to covering all operating expenses and debt service costs, provides the owner of the plants with a specified return on capital. Total purchases under the agreements were $252, $237 and $236 in 1994, 1993 and 1992, respectively. The contracts related to Plants No. 1 and No. 2 expire in 1998 and 2004, respectively. DCS Capital Corporation (the Corporation) is 100 percent owned by DCS Capital Partnership. The Corporation was organized to assist DCS Capital Partnership in raising funds to finance construction of an ethylene plant. DCS Capital Partnership is owned by Shell Canada, Union Carbide and Dow through its 100 percent owned subsidiary, Dofinco, Inc. As part of the ownership agreement, Dofinco indirectly guarantees approximately 52 percent of the debt of the Corporation. Dofinco's indirect guarantee amounted to $68 at December 31, 1994. At December 31, 1994, the Company had various outstanding commitments for take or pay and throughput agreements, including the Canadian subsidiary's take or pay ethylene contract, for terms extending from one to 20 years. In general, such commitments were at prices not in excess of current market prices. The table below shows the fixed and determinable portion of the take or pay and throughput obligations:\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nQ Commitments and Contingent Liabilities (Continued)\nFixed and Determinable Portion of Obligations - --------------------------------------------- 1995 $200 1996 168 1997 155 1998 142 1999 73 2000 through expiration of contracts 197 - --------------------------------------------- Total $935 - ---------------------------------------------\nIn addition to the take or pay and throughput obligations, the Company had other outstanding commitments at December 31, 1994, including ship charters, purchase commitments for materials and property, and other purchases used in the normal course of business. Total purchase obligations under the agreements were $244. In general, such commitments were at prices not in excess of current market prices.\nR Supplementary Information\nAccrued and Other Current Liabilities at December 31\n1994 1993 - ------------------------------------------ Accrued vacations $200 $196 Employees' retirement plans 163 135 Interest payable 124 126 Accrued payroll 316 154 Accrued miscellaneous taxes 146 142 Insurance companies' reserves 168 155 Sundry 742 813 - ------------------------------------------ Total $1,859 $1,721 - ------------------------------------------\nSundry Income - Net 1994 1993 1992 - -------------------------------------------------- Royalty income $25 $26 $21 Gain (loss) on securities (34) (55) 24 Gain on sale of assets 73 57 22 Dividend income 36 93 14 Other-net 3 (74) 5 - -------------------------------------------------- Total $103 $47 $86 - --------------------------------------------------\nOther Supplementary Information\n1994 1993 1992 - ---------------------------------------------------------- Cash payments for interest $576 $611 $690 Cash payments for taxes on income 257 454 439 Provision for doubtful receivables 11 18 9 - ----------------------------------------------------------\nThe Dow Chemical Company and Subsidiaries - --------------------------------------------------------------------------- Notes to Financial Statements - ---------------------------------------------------------------------------\nIn millions, except for share amounts - ---------------------------------------------------------------------------\nS Industry Segments and Geographic Areas\nThe Company conducts its worldwide operations through separate geographic area organizations which represent major markets or combinations of related markets. Aggregation of products is generally made on the basis of process technology, end-use markets and channels of distribution. Chemicals and Performance Products contains a wide range of products that are used primarily as raw materials in the manufacture of customer products, or which aid in the processing of customer products and services. Plastic Products consists of a broad range of thermoplastics, thermosets and plastic fabricated products used in a wide variety of applications in markets which include packaging, automotive, electronics, and construction among many others. Hydrocarbons and Energy encompasses procurement of fuels and petroleum- based raw materials as well as the production of olefins, aromatics, styrene and cogenerated power and steam for use in the Company's manufacturing operations. Income from the construction of power plants by Destec Energy, Inc. is also recorded in this segment. Consumer Specialties includes agricultural chemicals, pharmaceuticals, and food care, home care, and personal care products. The Unallocated segment encompasses the Company's businesses that are not reported elsewhere, including the consolidated insurance and finance companies, and Ventures businesses such as Dow Environmental and advanced electronics materials. This segment also includes activities and overhead cost variances not allocated to other segments. Transfers between areas and industry segments are generally valued at cost except for movements between Consumer Specialties and the other industry segments. These movements are generally valued at market-based prices.\nQuarterly Statistics\nIn millions, except for share amounts (Unaudited) - ------------------------------------------------------------------------------- 1994 1st 2nd 3rd 4th Year - ------------------------------------------------------------------------------- Net sales $4,541 $4,934 $5,046 $5,494 $20,015 Operating income 527 602 579 637 2,345 Income before taxes on income and minority interests (Notes C and Q) 414 570 575 493 2,052 Net income available for common stockholders 171 250 288 222 931 Earnings per common share 0.62 0.91 1.04 0.80 3.37 Cash dividends paid per common share 0.65 0.65 0.65 0.65 2.60 Market price range of common stock: High 66.50 70.13 79.25 78.13 79.25 Low 56.50 58.75 64.88 60.75 56.50 - -------------------------------------------------------------------------------\n1993 1st 2nd 3rd 4th Year - ------------------------------------------------------------------------------- Net sales $4,363 $4,822 $4,370 $4,505 $18,060 Special charge (Note B) - 180 - - 180 Operating income 388 388 346 318 1,440 Income before taxes on income and minority interests (Notes C and Q) 751 364 300 110 1,525 Net income (loss) available for common stockholders 400 148 137 (48) 637 Earnings (loss) per common share 1.47 0.54 0.50 (0.18) 2.33 Cash dividends paid per common share 0.65 0.65 0.65 0.65 2.60 Market price range of common stock: High 59.38 58.63 62.00 60.63 62.00 Low 49.63 49.00 55.25 53.50 49.00 - ------------------------------------------------------------------------------- See Notes to Financial Statements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere has been no reported disagreement on any matter of accounting principles or procedures or financial statement disclosure in 1994 with the Independent Auditors.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation relating to Directors and executive officers of the Company is contained in a definitive Proxy Statement for the Annual Meeting of Stockholders of The Dow Chemical Company to be held May 11, 1995, and is incorporated herein by reference. See also the information concerning executive officers of the registrant set forth in Part I under the caption \"Executive Officers of the Registrant\" in reliance on General Instruction G to Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to executive compensation is contained in a definitive Proxy Statement for the Annual Meeting of Stockholders of The Dow Chemical Company to be held May 11, 1995, and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to beneficial ownership of the common stock as of January 31, 1995, by each Director and all Directors and officers of the Company as a group is contained in definitive Proxy Statement for the Annual Meeting of Stockholders of The Dow Chemical Company to be held May 11, 1995, and is incorporated herein by reference. As of December 31, 1994, no person or entity was known to the Company to beneficially own 5 percent or more of the outstanding common stock.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no such reportable relationships or related transactions in 1994.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) The following documents are filed as part of this report:\n1. The Company's 1994 consolidated Financial Statements and Independent Auditors' Report are included in Item 8 of Part II.\n2. Financial Statement Schedules.\nThe following Financial Statement Schedule should be read in conjunction with the Financial Statements included in Item 8 of this Annual Report on Form 10-K .\nPage Schedule II - Valuation and Qualifying Accounts 52\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 called for is included in the Financial Statements or Notes thereto.\n3. Exhibits---See the Exhibit Index on pages 55 and 56 of this Annual Report on Form 10-K for exhibits filed with this Annual Report on Form 10-K (see below) and for exhibits incorporated by reference.\nThe Company will provide a copy of any exhibit upon receipt of a written request for the particular exhibit or exhibits desired and upon receipt of payment of an amount equal to a charge of twenty-five cents for each exhibit page, with a minimum charge of two dollars per request. All requests should be addressed to the Vice President and Controller of the Company at the address of the Company's principal executive offices.\nThe following exhibits listed on the Exhibit Index are filed with this Annual Report on Form 10-K:\n3(ii) A copy of the Bylaws of The Dow Chemical Company as amended effective as of July 14, 1994.\n10(f) A copy of The Dow Chemical Company Voluntary Deferred Compensation Plan for Outside Directors, as amended effective as of July 1, 1994.\n10(o) A copy of The Dow Chemical Company 1994 Non-Employee Directors' Stock Plan.\n11 Computation of Earnings per Common Share.\n21 Subsidiaries of The Dow Chemical Company.\n23 Independent Auditors' Consent.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K.\nA Current Report on Form 8-K dated January 20, 1995 was filed with the Securities and Exchange Commission. Attached to it was the Company's press release describing the impact on the Company's 1994 earnings resulting from a special charge taken by Dow Corning Corporation for breast implant litigation and related matters.\nA Current Report on Form 8-K dated January 25, 1995 was filed with the Securities and Exchange Commission. Attached to it were two (2) press releases (i) describing the impact on the Company of the pending sale of the Personal Care business of DowBrands; and (ii) constituting the Company's earnings release for the fourth quarter and full year of 1994.\nThe following trademarks of The Dow Chemical Company appear in this report: Affinity, Aim, Aspun, Attane, Calibre, Cyclotene, D.E.H., D.E.N., D.E.R., Derakane, Dowanol, Dowex, Dowfax, Dowflake, Dowfrost, Dowlex, Dowtherm, Drytech, Engage, Ethafoam, Ethocel, Insite, Invert, Isonate, Isoplast, Liquidow, Magnum, Methocel, Opticite, Papi, Peladow, Pellethane, Prevail, Primacor, Pulse, Sabre, Saran, Saran Wrap, Saranex, Specflex, Spectrim, Styrofoam, Styron, Tactix, The Enhancer, Trycite, Trymer, Tyril, Tyrin, Versene, Voranate, Voranol and Zetabon.\nThe following trademarks of DowBrands or an international affiliate appear in this report: Apple Pectin, Fantastik, Glass Plus, Handi-Wrap, Nucleic A, PermaSoft, Scrubbing Bubbles, Smart Scrub, Spray 'N Wash, Style, Vivid, Yes and Ziploc.\nThe following trademark of Dow Corning Corporation appears in this report: Syltherm.\nThe following trademarks of DowElanco or its affiliates appear in this report: Beam, Broadstrike, Dursban, Garlon, Lontrel, Lorsban, Naturalyte, N-Serve, Recruit, Rubigan, Sentricon, Sonalan, Starane, Telone, Tordon, Treflan, Trimidal and Vikane.\nThe following trademark of FilmTec Corporation appears in this report: FilmTec.\nThe following trademarks of Marion Merrell Dow Inc. or its affiliates appear in this report: Carafate, Cardizem, Cardizem CD, Cardizem Injectable, Cardizem SR, Cepastat, Citrucel, Debrox, Gaviscon, Gly-Oxide, Nicoderm, Nicorette, Novahistine, OsCal, Sabril, Seldane, Seldane-D and Targocid.\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 on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, on the 13th day of March, 1995.\nTHE DOW CHEMICAL COMPANY\nBy: R. L. Kesseler ----------------------------- R. L. Kesseler Vice President and Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed on the 13th day of March, 1995 by the following persons in the capacities indicated:\nF. P. Popoff J. L. Downey - ------------------------------ ------------------------------ F. P. Popoff, Director, J. L. Downey, Director and Chairman of the Board and Senior Consultant Chief Executive Officer\nE. C. Falla B. H. Franklin - ------------------------------ ------------------------------ E. C. Falla, Director, B. H. Franklin, Director Executive Vice President and Chief Financial Officer\nR. L. Kesseler F. W. Lyons, Jr. - ------------------------------ ------------------------------ R. L. Kesseler, Vice President F. W. Lyons, Jr., Director and Controller\nJ. K. Barton W. J. Neely - ------------------------------ ------------------------------ J. K. Barton, Director W. J. Neely, Director\nA. J. Butler H. T. Shapiro - ------------------------------ ------------------------------ A. J. Butler, Director and H. T. Shapiro, Director Senior Consultant\nD. T. Buzzelli E. J. Sosa - ------------------------------ ------------------------------ D. T. Buzzelli, Director and E. J. Sosa, Director and Vice President Senior Vice President\nF. P. Corson W. S. Stavropoulos - ------------------------------ ------------------------------ F. P. Corson, Director and W. S. Stavropoulos, Director, Vice President President and Chief Operating Officer\nW. D. Davis P. G. Stern - ------------------------------ ------------------------------ W. D. Davis, Director P. G. Stern, Director\nM. L. Dow - ------------------------------ M. L. Dow, Director\nEXHIBIT INDEX\nEXHIBIT NO. DESCRIPTION\n3(i) Restated Certificate of Incorporation of The Dow Chemical Company, incorporated by reference to Exhibit 3(a) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1992.\n3(ii) A copy of the Bylaws of The Dow Chemical Company, as amended effective as of July 14, 1994.\n10(a) The Dow Chemical Company Executive Supplemental Retirement Plan, incorporated by reference to Exhibit 10(a) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1992.\n10(b) The Dow Chemical Company 1969 Award Plan (included as part of and incorporated by reference to the Prospectus contained in The Dow Chemical Company's Registration Statement on Form S-7, File No. 2-32525, filed April 7, 1969), as amended on August 6, 1974 (incorporated by reference to Exhibit 41 to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1974), as amended on August 9, 1979 (incorporated by reference to Exhibit 4 to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1979), as amended on October 30, 1987 (incorporated by reference to Exhibit 10(j) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1987).\n10(c) The Dow Chemical Company 1972 Option Plan, as amended through December 31, 1982 (included as a part of and incorporated by reference to the Prospectus contained in Post-Effective Amendment No. 13 to The Dow Chemical Company's Registration Statement on Form S-8, File No. 2-44789, filed June 23, 1983).\n10(d) The Dow Chemical Company 1976 Option Plan, as amended through December 31, 1982 (included as a part of and incorporated by reference to the Prospectus contained in Post-Effective Amendment No. 8 to The Dow Chemical Company's Registration Statement on Form S-8, File No. 2-55837, filed June 23, 1983).\n10(e) The Dow Chemical Company 1979 Award and Option Plan, as amended through May, 1983 (included as part of and incorporated by reference to the Prospectus contained in Post-Effective Amendment No. 4 to The Dow Chemical Company's Registration Statement on Form S-8, File No. 2-64560, filed June 23, 1983), as amended April 12, 1984 (incorporated by reference to Exhibit 10(ff) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1984), as amended April 18, 1985 (incorporated by reference to Exhibit 10(fff) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1985), as amended October 30, 1987 (incorporated by reference to Exhibit 10(j) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1987).\n10(f) A copy of The Dow Chemical Company Voluntary Deferred Compensation Plan for Outside Directors, as amended effective as of July 1, 1994.\n10(g) The Dow Chemical Company Executive Post Retirement Life Insurance Program, incorporated by reference to Exhibit 10(g) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1992.\n10(h) The Dow Chemical Company Outside Directors' Pension Plan, incorporated by reference to Exhibit 10(h) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1992.\n10(i) A written description of the Management Achievement Recognition System adopted on April 8, 1987 (incorporated by reference to Exhibit 10(k) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1987).\nEXHIBIT INDEX (Continued)\nEXHIBIT NO. DESCRIPTION\n10(j) The Dow Chemical Company Dividend Unit Plan, incorporated by reference to Exhibit 10(j) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1992.\n10(k) The Dow Chemical Company 1988 Award and Option Plan (included as part of and incorporated by reference to the Prospectus contained in The Dow Chemical Company's Registration Statement on Form S-8, File No. 33-21748, filed May 16, 1988), as amended during 1991 (incorporated by reference to Exhibit 10(k) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1991).\n10(l) The Dow Chemical Company Executive Award Plan, incorporated by reference to Exhibit 10(l) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1992.\n10(m) The Dow Chemical Company Executive Split Dollar Life Insurance Plan Agreement, incorporated by reference to Exhibit 10(m) to The Dow Chemical Company Annual Report on Form 10-K for the year ended December 31, 1992.\n10(n) The Dow Chemical Company 1994 Executive Performance Plan, incorporated by reference to the definitive Proxy Statement for the Annual Meeting of Stockholders of The Dow Chemical Company held on May 12, 1994.\n10(o) A copy of The Dow Chemical Company 1994 Non-Employee Directors' Stock Plan.\n10(p) A written description of the one-time grant of shares of the common stock of The Dow Chemical Company to nonemployee Directors, incorporated by reference to the definitive Proxy Statement for the Annual Meeting of Stockholders of The Dow Chemical Company to be held May 11, 1995.\n11 Computation of Earnings Per Common Share.\n21 Subsidiaries of The Dow Chemical Company.\n23 Independent Auditors' Consent.\n27 Financial Data Schedule.","section_15":""}